404 not found p263501coll9_10.pdf a typology of communication strategies for corporate advocacy annette n. shelby school of business administration georgetown university washington, d. c. that american business has a poor public image has been well documented.[l] further, continuing attacks on business in the mass media have no doubt contributed to the negative image. increasingly, organizations are coming to grips with the image problem and are responding, particularly to media attacks. corporate advocacy advertising, for example, has received widespread attention.[2] whatever the medium used and whether by choice or necessity, corporate spokespersons are becoming advocates for their companies' actions and positions. though akin to public relations, advocacy goes beyond image building to make a case for, support, or defend the corporate point of view, policies, and actions. put simply, the focus of advocacy-whether in speeckmaking or op-ed advertising-is argument.[3] communication strategies provide the framework or structure for argument, prescribe the advocate's options, and thus limit the rhetorical choices to be made. whereas arguments are situation-specific, strategies may be imposed on the conflict independent of content. strategies are thus more universal and reflect policy decisions. this paper presents a conceptual analysis of communication strategies available to the corporate spokesperson. it sets out a typology and describes advantages and disadvantages of the alternatives. nine types of response patterns are identified here: ignore the attack, withdraw or avoid, sleight-ofhand, confrontation, redefinition of the issues, present company position, confirmation, coalition-building, and proactive advocacy. ignoring attacks a traditional way of dealing with hostility toward an organization is to ignore publicly attacks that are made. since refusing to take notice of an attack can minimize conflict while responding may escalate a controversy, the strategy is sometimes useful in handling assaults on the organization. it does "take two to fight." a disadvantage of the strategy, however, is that silence is a message, which is likely interpreted as relinquishment or guilt. if -33_ charges go unanswered, they are often assumed to be true. by not answering attacks, the organization may acquiesce to its detractors and their claims. withdrawl or avoidance a second strategy useful to advocacy is withdrawl from or avoidance of attack or argument. though acknowledging that an attack has been made, the advocate chooses not to respond to it. typical withdrawl or avoidance responses include: "no comment"; "we have no official response to that at this time"; "the president (or whomever) is unavailable for comment." advantages of the withdrawal/avoidance strategy are similar to those of ignoring attacks made on the organization. the advocate does not likely escalate the debate or risk putting the organization on the record, particularly in areas that are extremely sensitive for political or legal reasons. disadvantages of the strategy must also be carefully weighed, howev.er. the i'no comment" response may suggest guilt or be interpreted as corporate arrogance, which would have important negative public relations implications. finally-and perhaps most crucially-the withdrawl/avoidance strategy allows the attacker to draw the issues and present evidence unchallenged. sleight-of-hand sleight-of-hand suggests evading or side-stepping the issue. typical propaganda techniques fall within the rubric of sleight-of-hand: ad hominem argument or namecalling (shifting the emphasis to the person rather than the argument); bandwagon (everyone is doing it); shifting ground (moving to another and irrelevant issue); hasty generalization (drawing conclusions based on incomplete or unrepresentative data); and emotionalism. the primary characteristic of sleight-of-hand is that it obscures the major issue or point of contention. corporate advocates often use sleight-of-hand to side-step indefensible positions. the strategy allows the advocate to focus the discussion on a secondary, perhaps minor or irrelevant issue or fact. thus, it may diffuse or minimize conflict. the strategy has a number of negative ramifications, however. for one thing, it is ethically questionable. not only does it avoid the issue, but also it can be personally damaging (as in namecalling or ad hominem argument), incorrect (as in hasty generalization), or misleading (as in shifting ground). beyond the ethical implications, the strategy is potentially dangerous to use since it only shifts emphasis temporarily. after the sleight-of-hand magic tricks are over, the attacker's position remains substantively unchallenged. particularly if the issue has been generated by or publicized in the mass media, it will likely resurface-often with even stronger force because of the superficiality or irrelevance of its initial defense. _34_ confrontation another strategy organizations are beginning to use to counter attacks leveled against them is to challenge facts and arguments of the opposition or present counter arguments to justify their own position. the successfulness of the confrontative strategy depends on two things: whether the facts and arguments do, in fact, support the organization's position; and, whether the organization can gain access to the necessary media in order to get a hearing for its case. corporations have limited access to the mass media, particularly to television and radio. though companies may buy advertising space in the print media, the national networks prohibit corporate advertising that is issue oriented. some organizations are investigating alternative channels through which to send their messages. for example, a number of organizations are providing to schools educational materials that include the company viewpoint. citizens' lobbies are springing up which are protesting such information dissemination. if organizations are able to get access to necessary media and if their arguments and evidence are convincing to their audiences, they may establish credibility for their position. further, they may undermine their adversaries, particularly when they are able to prove opposing arguments to be incorrect and evidence factually inaccurate. the challenge, of course, is to disprove the entire case of the opposition. one argument left standing can undermine the corporate case or position. redefining the issues redefining the issues differs from shifting ground in that redefinition aims at a clear understanding and examination of the issues, not an effort to sidestep them. sometimes issues are drawn in a biased or prejorative manner that renders counteragument unproductive, if not impossible. in such cases, the advocate may choose to redefine the issue or place it into perspective through comparison. redefining the issue may mean exposing hidden assumptions or agendas. it may focus on determining the real question being asked or the underlying objection being raised. often the actual conflict is obscured by secondary or highly emotional issues. redefinition may be a useful way to uncover the basic point of controversy on its content level. at other times, it calls for separating multiple questions. occasionally it requires asking questions for clarification. the major advantage of redefining the issues is that it can lead to a clearer understanding of what the major points of contention are. further, it tends to focus the controversy on content issues rather than emotional ones. the major disadvantage of the strategy is that it may result in even greater polarization. by clearly drawing the parameters of the conflict, the advocate _35may leave the opposition little maneuverability and may force a commitment to a particular position. presenting the company position presenting the company position may supplement or serve as an alternative to the strategies of confrontation or redefining the issues. when presenting the company position, the advocate sets out that position point by point, explains reasons for the corporate perspective, and documents company claims. sometimes the advocate will choose to examine the relative advantages and disadvantages of the company position, a strategy that can be effective in increasing credibility with negative audiences. advantages of the "present the company position'! strategy are that the advocate has the opportunity to draw the issues and lay the framework! if not ground rules, for debate. further, by taking the offensive, the spokesperson is more likely to argue the company position from a positive point of view. the major disadvantage of the strategy is that it tends to lack credibility, particularly with negative audiences. the corporate advocate is expected to subscribe to and present the company "line.'! that "line" is therefore apt to be suspect. confirmation the strategy of confirmation agrees to the accuracy or legitimacy of the critic's attack but then shifts to a positive discussion of the company's position. a typical confirming response is, "yes, pollution was a problem; but we've invested heavily in clean-up activities. this is what we're doing.... " "you're right, we have had problems in that area" confirms the criticism. "but we're doing something about it" allows the advocate to shift the discussion to the positive things the company is doing. advantages of confirmation as a strategy are that it does not place the advocate in the untenable position of defending the indefensible, and it gives the company spokesperson credibility as a trustworthy source. the major disadvantage is that the strategy puts the company on record as agreeing it has done something that is improper. particularly when legal issues are involved, that position may be dangerous. coalition~building another useful strategy for advocacy is to build coalitions either with organizations with like concerns or, on occasion, with adversaries. the critical factor in coalition-building is to identify commonalities between the organization and those with whom it would seek to work. the tobacco industry has had great success building coalitions with other farm interests _36_ in influencing legislation. labor and management have worked from common goals in attempting to rebuild the american automobile industry. the major advantage to coalition-building is that by focusing on agreement, polarization may be minimized. the major disadvantage is that disagreement may be forced below the surface where it can fester and grow. coalition-building will be successful to the extent that common goals are more silent than the individual goals of either party involved. proactive approach historically, american corporations have felt little need to explain themselves or their policies to the public, even in the face of fierce antimonopolistic and trade union pressures. the consumer movement, however, along with the influence of the mass media's reporting on issues of public concern, has brought the corporation's business into the public's living rooms. consequently, american business is being required to justify its policies. corporate representatives are often unprepared for the hostility and conflict they encounter. they do not anticipate the public uproar that accompanies controversial policy decisions and have little experience and less confidence in dealing with the underlying value conflicts that erupt. in their efforts to defend their organizations, they are often frustrated, confused, and misunderstood. an alternative to the traditional defensive, reactive approaches to advocacy is a proactive strategy that suggest the necessity of corporate intervention before opposition has crystallized or become vocal. the proactive approach-both preemptive and preventative-involves a minimum of four steps: 1) anticipate questions likely to be raised about the organization and its policies; 2) research the facts, precedents, and implications of corporate policy; 3) develop a public relations and advocacy campaign before systematic and damaging attacks begin; and 4) monitor the results of the campaign. the advocacy plan should be well conceived and comprehensively developed. it should identify the audience to be targeted, specify commonalities between the organization and its potential critics, adapt its message to the targeted audience, determine media to be used, develop a timetable, and include plans for implementation. the advantages of such a proactive stance are obvious: the image problems minimized; the arguments answered before they are allowed to escalate into major points of controversy; the advocate's favorable position gained from drawing the issues. the major disadvantage of the approach is that the organization may invite criticism and argument that may not have otherwise been a priority for its critics. a final caveat: the strategies an organization chooses for advocacy depend to a great extent on the managerial style and orientation of the organization's chief decision-makers. some executive officers are sensitive to the _37_ need for good corporate public relations and support proactive advocacy campaigns. others view advocacy as a stop-gap, "putting out fires'! role. ultimately, the advocate can do little without support from the top. and that is a managerial policy decision. references 1. the opinion research corporation, cited in david liff, mary o'connor, and clarke bruno, corporate advertising: the business response to changing public attitudes (washington d.c.: investor responsibility research center, october, 1980). 2. ethics and advocacy advertising, business ethics report (bentley college, waltham, ma: center for business ethics, 1978); s. prakash sethi, " advocacy advertising in america," keynote address at advocacy advertising conference, toronto, november 25, 1981; s. prakash sethi, advocacy advertising and large corporations (lexington, ma: d.c. health, 1977). 3. david thomas, "corporate advocacy: development in forensics," speech communication association national convention, anaheim, ca, november, 1981; robert l. heath, "corporate advocacy: an application of speech communication perspectives and skills-and more,!' communication education, 19 (september 1980), pp. 370-1. _38_ a typology of communication strategies for corporate advocacy volume 40(1) p.i from the editor dear readers: as the journal of business strategies enters its 40th year of publication, we are proud to look back at our rich history, and excited to look forward into the future. i would like to share some highlights from the last year: 2022 was our first full year operating on the new open journal systems platform, using the new url http://business-strategies.org, as well as our first year operating as an open access journal. the move towards an open access online publication has started to pay large dividends already. between january 2022 and december 2022, our total monthly readership (i.e. downloads of full text articles) has increased five-fold! we expect that the increase in visibility will continue to attract high quality research to be published in the journal. the increase in readership was accompanied by an increase in manuscript submissions as well. as we continued to improve the quality and efficiency of our doubleblind peer review process, we can summarize our 2022 activity as follows: days to first editorial decision: 13 average days to accept: 102 desk reject rate: 47% after review reject rate: 41% acceptance rate: 12% in order to continue the upward trajectory of the journal, we are implementing several major changes, starting in 2023 with volume 40: first, the journal’s appearance has received a major face-lift. we have updated the layout of published articles, as well as adopted a new logo that now appears in the top right corner of every title page. the new layout design of the published articles is a modern and professional approach that signals the quality of our publication in an online environment. second, –and most significantly– we are moving to a “publish-as-you-go” scheme. this means that we no longer wait to accumulate several articles into an issue before publication. rather, articles are continuously added to current issues as they are accepted and complete the production process. as an online publication, we are free of the constraints imposed by print publishing, and publishing articles on-the-go will reduce publication lag for our authors, and make the newest research available to our readers more quickly. we are looking forward to an exciting future for the journal of business strategies. i encourage you to submit your work to us at http://business-strategies.org, and hope that you will encourage your colleagues to do the same. best wishes, christian raschke, editor http://business-strategies.org http://business-strategies.org problem loan identification and management (plim) system bart p. hartman and vincent c. brenner department of accounting louisiana state university baton rouge, louisiana reed f. bilbray american bank and trust company baton rouge, louisiana gradual deregulation has increased the pressure on financial institutio~s to produce profits once easily obtained in the protected banking industry. the recent economic recession highlighted this pressure as keener competition became necessary for survival. when interest rates on deposited funds soared and loan demand softened, institutions assumed more risk to remain profitable. as a result, financial institutions loaned money to countries, companies, or individuals that were more risky than normal. the effects of such a policy are evident in both the sizable loan losses being reported and in the number of banks facing financial difficulties. institutions are discovering that these higher risk loans are contributing to losses that often negate the profits such loans provide. loan losses are often a result of the institutions' poor procedures for problem loan identification and management. the ability of an institution to recognize when a loan is experiencing difficulty is increasingly important in minimizing loan losses. this paper examines a problem loan identification and -management (plim) system useful for quickly identifying potential problem loans in an institution's portfolio and techniques to manage them efficiently. the information presented was gather in part through interviews and from guidelines of two well-established mid-sized commercial banks in the southwest. a case history of a problem loan was provided by one of the banks and is used to illustrate the methods of identifying and managing a problem loan. 25 identifying problem loans various items can provide an early warning of potential problem loans. exhibit a sets forth ten early warning signals. exhibit a early warning signals for problem loans 1. borrower's deteriorating financial statements 2. loan payments past due 3. borrower experiencing account overdrafts 4. loans are renewed without reduction in principal 5. borrower is experiencing personal financial problems 6. significant decreases in borrower's average account balances 7. borrower is experiencing foreclosures, civil suit judgments, etc. 8. inquiries received from other lending institutions regarding borrower 9. borrower's failure to file requested information, particularly financial data 10. borrower seeks extension of loan term the plim system for identification and detection of potential or actual problem loans consists of several methods which are designed to produce signals, any or all of which could quickly indicate the necessity to begin further investigation. the methods include: (1) portfolio and financial statement analysis, (2) past due reports, (3) overdraft listings, financial institution inquiries, and checking account variability, (4) outside sources of information, (5) renewed loans without principal reductions, and (6) other unusual factors. the loan review department working with the responsible loan officer should use these methods to manage the bank's loan portfolio. portfolio and financial statement analysis each quarter, the bank's loan portfolio is analyzed by the loan review department. the analysis usually takes a top-down approach which begins with an overall portfolio analysis. this analysis is similar to an evaluation of which securities to include in a stock portfolio. for example, some banks have a policy of maintaining one-third of its loan portfolio in each of three specific loan areas real estate, commercial, and consumer. such a policy is aimed at spreading the bank's risk so as to minimize the effect of a drastic downturn in one of the areas. the portfolio analysis is used to review the mix of outstanding loans to determine if bank policy is being followed and to assess current risk exposure. after the portfolio mix by type of loan is reviewed, the mix within each of these portfolios should be reviewed. for example, in the commercial loan area, a review should be made to determine the mix of industries, type of 26 loan collateral etc. there should not be an over emphasis on one industry because if the industry falls upon hard times the bank could experience significant losses. the goal again is to spread the risk. the overall portfolio review is followed by a review of each individual loan officer's portfolio. the officer's entire portfolio is reviewed because frequently the loan follows patterns that reflect management ability and/or economic exposure. a lengthy list of exceptions is a strong indication of documentation problems and immediate corrective actions should be instituted to limit the bank's exposure on the loans. loan officers typically specialize in a particular industry or region resulting in the concentrated portfolio mirroring the respective economic trend. a track record should be maintained for each loan officer in terms of adequacy of documentation, etc. as well as his history of loan profits to losses. such a record can be used in employee evaluations as well as for pinpointing individuals who are very successful or who may need additional training or increased supervision. to complete the top-down approach, the company itself is analyzed. when annual financial statements of the company are received, ratios are calculated and horizontal and vertical analysis are performed. today this analysis is frequently done using a micro computer and spreadsheet software. to assist in the financial statement analysis, robert morris and associates annual studies are used for industry average data for various businesses. the payment history is also reviewed to determine the current status of the account. the result of this compilation of data is reviewed by the loan officer and loan review officer to settle any discrepancies or questions and to correct any problems that may exist. past due report in most banks a past due report is issued at regular intervals and is contrasted with the loan officer's portfolio analysis. since timeliness is essential, the past due reports should be prepared weekly. this report is frequently the first indicator of a specific problem loan. the loan review officer should meet at regular intervals with the loan officers to discuss their past due accounts. again, because of the important of timeliness, this meeting should be on a weekly or biweekly basis. the bank should set a policy concerning when an account is considered past due. the length of time should be sufficiently long to eliminate the detailed review of loans where payment may have been delayed by mail or by other nonsignificant delays. a period of 15 to 20 days after the due date is recommended for considering a loan past due. banks should establish a particular past due date when the loan receives special or detailed treatment or analysis. for example, once a loan reaches 90 days past due it should be immediately placed in the hands of a special loan officer and several actions instituted such as accounting status, collateral valuation and risk classification. 27 overdraft lists, financial institution inquiries, and checking accounts these three indicators alert either the loan officer or loan review officer of potential managment, sales, or cash flow problems in a company. frequent appearance on the daily overdraft list should indicate that the company does not have enough cash to support operations and could result in late or missed payments on the outstanding loans. frequent overdrafts may also indicate that the borrower does not have an adequate accounting staff. if this is the case, the bank may suggest that the client obtain the necessary accounting services so that he can more efficiently operate his business. any inquiry from another bank or financial institution on the company should be studied as well. frequently such inquiries mean that the client may be seeking to borrow additional funds. while a new loan may satisfy a short-term need of cash for the company or expand their production capacity, the overall risk or exposure of the institutions involved may be increased because of the long-term inability of the company to raise cash from its operations to service the increasing debt. sometimes a company's checking account can also signal potential problems. for example, if sudden changes in account balances from historically high levels to low or insignificant amounts occur, this could indicate funds mismanagement, a sales decline, or rapid operating expenses increases, any of which might cause future loan payment problems. outside sources of information the loan officers should be responsible for keeping abreast of current economic and financial developments as well as with news items involving clients or a client's industry. loan officers should read local and national newspapers and periodicals such as the american banker and the wall street journal. at the local level, they should also review publications of the public records division of the city government. such publications list all court proceedings and parties involved in foreclosures, civil suit judgments, divisional proceedings, mortgages and conveyances, assignments, etc. one bank officer indicated that this is probably the single most important publication used by loan review officers to determine legal activity in the credit environment. renewed loans without principal reductions loans are frequently renewed when the borrower cannot meet the current payment schedule, normally a result of cash flow problems. if there are no principal reductions within a reasonable period of time after the renewal, an inadequate cash flow may exist. the bank may wish to establish a policy regarding the allowed number of renewals without principal reduction before the loan is reviewed in detail. 28 on a theoretical level, a renewed loan without principal reduction might not be considered as a problem loan. the impact of inflation on real interest rates may put the loan in a different light. for example, a loan renewed after a year of ten percent inflation has seen a real decrease in the principal amount owed because of the cheaper dollars needed to repay the loan. presumably, the interest rate charged to the borrower will recoup this real principal reduction. aside from this theoretical argument, lenders still expect a principal reduction of the loan on schedule. other signals of potential problems other indicators commonly include miscellaneous and infrequently occurring items. a customer who fails to file current financial reports or other requested information with the bank could signal a problem. significant devaluations of assets by the company from one statement to the next could also indicate problems. banks should establish a monitoring system to track problem loans by industry or type of business. when a problem loan arises, such a system can provide an early warning concerning possible problems with other clients in the same industry or line of business. finally, if the bank should know of personal financial problems of one or more principal parties of the business, the bank should make an effort to assure themselves that the problems do not extend to the bank loan. problem loan identification a case study to illustrate the application of some of the problem loan identification techniques, an actual case history provided by one of the banks interviewed is presented. because of the confidential nature of the information, the name of the company and bank have been changed. gusher, inc., is a corporation formed in 1979. the company drills for oil and gas throughout the southwest region of the u.s. it was formed with a substantial amount of capital and was managed by proven, capable individuals. a loan for $5,620,000 was made by southwest bank for the purpose of purchasing two newly fabricated drilling rigs in january of 1981. payments were made as agreed through september, 1982. at this point, southwest's loan review department began receiving signals of a potential problem loan with gusher. upon reviewing the bank's portfolio concentration in the first quarter of 1982, it was determined that the bank had an excessive number of i'rig" loans, including the loan to gusher, with respect to other types of loans. appropriate notification was made to the other officers of the unhealthy concentration of loans. this was considered necessary because the oil and gas drilling industry continued to remain depressed during the first quarter of 1982 as a result of the high cost of drilling and the weakening price of and demand for petroleum products. an analysis of gusher's 1981 year-end 29 statements indicated that a potential decline in revenues was likely because of the economic conditions. the past due report was used to determine that gusher, inc. was in trouble when it was late with its september, 1982 payment. in december, 1982, when it was reported that payments were over ninety days late, a special loan officer took the account and began a series of actions and negotiations. these are discussed in a later section. southwest's system enabled it to address quickly the gusher loan. when bank management detected a large number of oil and gas rig loans in its portfolio, it was able to limit its potential exposure in this area by declining any more loan requests. managing problem loans the purpose of loan management is to prevent any unnecessary loss to the bank or unnecessary difficulties for the borrower. the management process should aid in a timely settlement and in proper financial treatment of the problem loan. the various aspects of loan management are discussed below. accounting status banks typically account for loans on an accrual basis of accounting which allows an institution to claim interest income when it is earned (accrued) rather than when it is received. once a loan has reached the point where it is placed in the hands of a special loan officer, for example when it is ninety days past due, a common policy of institutions is to place the loan on a nonaccrual basis until, according to bank policy, an established number of stable payments are received and sufficient collateral is obtained. in the gusher loan situation, the loan was placed on a nonaccrual basis during march, 1983 when it was 180 days past due. all previously accrued interest was removed from the bank's income for 1983. collateral evaluation a collateral valuation is of utmost importance in determining how to manage a loan. all loans should be analyzed to determine their extent of collateralization. such information is essential in the classification of loan risk and is also a necessary input to the proper accounting treatment of problem loans. if the institution finds a problem loan to be fully collateralized, generally the loan will continue to be accounted for on a nonaccrual basis without a change in valuation. in a fully collateralized situation, the bank is secured and should receive the full amount of the loan through possible future repayment or sale of the collateral. on the other hand, if it is determined that the loan is undercollateralized, the fdic requires the institution to reduce the outstanding principal to the amount of equity in the collateral and charge-off the rest, i.e. take a loss on the unsecured amount. 30 institutions do not like to foreclose or charge-off portions of loans, but if it is necessary as a last resort, a proper valuation of the collateral must. be made. gusher's two rigs were originally appraised at $7,500,000 by the frabricator. the basis of the appraised value of a rig is a function of its revenue earning capacity. during 1982, day rates for drilling rigs plummeted to the point where the rigs were worth approximately $1,575,000 (21 % of estimated original value) on a ninety day quick sale basis and approximately $3,541,500 (47% of estimated original value) on a reasonable market basis. as a result, southwest bank had to record a loss on the loan to comply with fdic requirements. the amount of the loss will be discussed in the next section. risk classification once an estimation of the value of the loan's collateral is determined, the institution should perform a classification of the risk on all loans. for example, an eight-tier rating system may be used highest quality, very good quality, fair quality, olem (other loans exceptionally mentioned), substandard, doubtful, and loss. loans receiving a risk classification above olem generally do not present a problem to the bank. this risk classification should be conducted periodically since such items as financial strength, valuation of collateral, etc, may change. if a loan receives a downgraded classification, particularly to one of the lower classifications, it should be carefully reviewed by the loan officer to determine if some action is necessary. such a system can cut loan losses by providing an early signal of loans that may be approaching problems. when a loan receives a rating of olem, it usually indicates that there are deficiencies in the borrower's financial situation, such as deteriorating financial ratios, cash shortages, etc. a substandard rating is given if there is little or no liquidity, cash flow for debt service is marginal, and payout through normal operations is doubtful. it is also substandard if debt repayment could depend in part on fixed asset liquidation or if loans are secured by acceptable collateral, where the collateral value is less than the amount owed. a loan classified as doubtful has all the weaknesses inherent in one classified substandard with the added provision that the weaknesses made collection or liquidation in full, on the basis of current existing facts, highly questionable and improbable. the possibility of loss is extremely high, but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the loan, its classification as an estimated loss is deferred until its exact status may be determined. loans classified as a loss are considered uncollectible and of such little value that their continuance as a loan of,the bank is not warranted. classifying a loan frequently involves both the bank and its examiners. each loan classification below olem lends itself to a percentage that must be taken as a loss substandard (10 percent), doubtful (50 percent), loss (100 31 percent). these loss amounts are only estimates and the fdic will usually dictate the amounts which must be written off. in the gusher example, as the market for the drilling rigs and other petroleum products changed, the collateral valuations and risk classifications also fluctuated because the value is a function of its revenue earning capacity. after the last payment on the gusher loan, the principal outstanding amounted to $5,518,000. the collateral had a 90-day quick sale value of $1,575,000, and a reasonable market value of $3,541,000. given these circumstances, the fdic required southwest bank to take action on the gusher loan. essentially, the fdic split the loan into three categories, a substandard amount, a doubtful amount, and a loss amount. the loss amount was determined to be the difference between the principal outstanding and the reasonable market value ($5,518,000 $3,541,500 = $1,976,500). the loss amount was charged against the bank's reserve for loan losses account (similar to allowance for bad debts). the effect of this was to write off that portion of the loan. the substandard amount of the loan was defined by the fdic to be the quick sale value of the collateral and they required southwest to charge 10% of this amount against income and to credit the reserve account. in addition, the doubtful amount was defined as the difference between the reasonable market value and the quick sale value of the collateral ($3,541,500 $1,575,000 = $1,996,500) and the fdic required southwest to charge 50% of this amount ($983,250) against income and to credit the reserve account. thus in total, the fdic required southwest to immediately write off $1,976,500, and to charge another $1,140,750 ($157,500 + $983,250) against the loan as a potential loss. workout of problem loans when the problem loan has been recognized, the bank should immediately try to do whatever is necessary to salvage the company and the loan. the bank should schedule the initial meeting with the client as soon as possible. this initial meeting should include (if possible) the cpa, attorneys and other principles. this meeting should be used to discuss the problems openly, review the financial position, and determine the relationship and status with other creditors. the latter is important, since the collapse of one client may, at times, have a substantial detrimental impact on other clients. at the same time, the bank should perform an internal evaluation of the situation. the credit department should perform an analysis of the business including cash flow, and a ratio analysis. a proposed plan can be devised by the bank and presented to the client for discussion. when the customer and the bank agree on a plan, the bank should have the customer sign an informal agreement stipulating terms of the agreement. administration of the workout plan after the bank and the customer agree on the workout plan, the bank 32 should set up a file on the customer dealing solely with the workout plan. the new file is updated continuously with information regarding the plan. where appropriate, the new terms of the loan are entered into the bank's computer system. the appropriate officer is notified of the status of the loan for monitoring just the same as the other loans of the bank. if the loan workout plan is not followed by the customer as agreed, another meeting should be scheduled to assess any new problems, and possible situations. bankruptcy and other litigation in all dealings, the bank should stress that litigation is considered only as a last resort, and that the bank hopes the customer will consider bankruptcy only as a last resort. if indeed litigation becomes a probable consequence, the bank's attorney should be called in immediately to discuss the case. the attorney's recommendations are usually followed. if bankruptcy is filed by the customer, the bank must arrange to attend the first meeting of creditors at the bankruptcy court. before the meeting, the bank should provide information regarding the loan amounts and all pertinent information related to the loan to the court. after that meeting the court records are normally reviewed to determine the probable settlement for the bank. once the probable amount is determined, the bank should adjust the value of the loan and record additional losses where necessary. conclusion although the bank is concerned with securing its position on the problem loan, it should also be concerned with the future of the borrower. the bank's goal should be to work with the troubled debtor to do whatever is feasible, within the constraint of minimizing loan losses, to help the debtor work out his financial difficulties. a foreclosure usually eliminates the opportunity for that borrower to continue to provide jobs, taxes, and goods for the community. therefore, banks have a responsibility to work with the borrowers for a reasonable period of time in the hope that the borrower can survive. this assistance could be in the form of more favorable terms on the present loan or even additional loans to develop or modernize a product line to generate more revenues. the financial expertise of the loan officer should always be available to assist the borrower in the recovery process. in the gusher case, the bank loan officer is continuing to work with the company to resolve the problem loan. the procedures outlined above for the plim system should assist banks in the early identification of problem loans. this process can greatly assist the bank in minimizing loan losses. an early warning system can allow the bank to work with clients to overcome problems before they become serious. proper management of problem loans will also reduce loan losses as well as provide a mechanism to make available the much needed assistance to the 33 clients with financial difficulties. thus any effective plim system should benefit the bank, the client and the local community. references the materials for this article were obtained from personal interviews with commercial loan officers of four mid-sized banks in baton rouge, louisiana. they have requested that their banks not be named in the article. 34 problem loan identification and management (plim) system implementing strategic change in manufacturing organizations john e. oliver department of management and information systems valdosta state college \taldosta, georgia gary b. roberts school of business kennesaw college kennesaw, georgia and kerr watson stokely managernent center the university of tennessee knoxville, tennessee one of the most colnmon changes of strategy occurring in manufacturing organizations today is a new 'emphasis on product quality. when the mission of improved quality is operationalized, it involves the setting of quality improvement objectives and the design of programs to implement the ne\-\' strategy. one of the most popular programs for implernent.ing improved product quality is statistical process control (spc) (2). spc esta blishes current levels of quality variance in each st.age of the manufacturing process in order to provide a basis for formulating improvement objectives. then, continued measurernents of quality variances are made to motivate and insure quality improvement through reduced variance a.t each stage in the process. thus, spc is used to formulate quality improvement objectives and to implernent the quality improvement strategy, as well as to evaluate and control strategy implementation. the implementation of a strategy of improved product quality using sp(; provides a. uniquely useful opportunity to study the complete strategy implementation process. th:e organizations in this study are all involved in the manufacture of components for the automobile industry and are all pursuing a strategy of improved product quality. they are implementing that strategy using statistical process control. the purpose of the study "vas to see whether managers in different types of organizations use different mechanisms to implement the new quality strategy. strategy implementation mechanisms galbraith and nathanson (3), after an exhaustive literature review, listed nine mechanisms for implementing strategy hierarchy, rules, goal setting, 1 direct contact, interdepartmental liaison roles, temporary task forces, permanent teams, integrating roles, and integrating departments. to avoid duplication of terms and to clarify definitions, the following labels and definitions have been used in this research: 1. chain of command the boss personally observes and directs the implementation of a new procedure through verbal instructions to the subordinates .. when problems arise the boss usually directs behavior. 2. rules and standard operating procedures behaviors are specified in advance in the form of rules. rules generally eliminate the need for further communication between the boss and subordinates unless specific problems arise. new procedures are implemented through the publication and distribution of standard operating procedures. 3. targeting or goal setting behavior is not specified. employees are allowed to select the way that they a.chieve the goals and objectives specified by the organization. new procedures are presented to employees in the form of targets and they are then free to choose the exact means to reach them. 4. direct contact individuals talk to each other when they are jointly affected by a problem. problems are generally not referred up the chain of command but are resolved by the participants involved. 5. liaison roles the liaison role is a typical example of a specialized role designed to facilitate communication between two interdependent departments and to bypass the long lines of communication involved in upward referral. for example, the engineering liaison in a manufacturing plant is part of the engineering organiza.tion but is physically located in the plant to serve the production organization. these roles link functional departments of the organization. 6. temporary task force the task force is a form of horizontal contact designed for problems across multiple departments. the task force is a temporary group made up of representatives from each of the affected departments. some are full-time members; others may be part-time. it exists only as long as the problem: remains. when a solution is reached participants return to their normal tasks. 7. permanent implementation teams typically formed around frequently occurring problems. teams are permanent groups which meet daily or weekly to discuss problems affecting the group. they solve all the problems which require commitments that they are capable of making. larger problems are referred upward. 8. integrating roles the response of the organization to the concern for decision quality is to create new roles in the organization structure. 2 these roles are called integrating roles. the managers who occupy them do not supervise any of the actual work. instead they assist those who do, so that the work is coordinated in the best interest of the organization. some common titles for this role include: "materials manager," "product manager," "project manager," "program manager," and "unit manager" . 9. integrating departments integrating departments consist of more than one person whose purpose is to assist those individuals and departments who do the actual work. examples of such departments include "product management" and "project management" departments. four types of organizations four types of organizations were found empirically b)7 oliver (7) in his initial studies with the organization description questionnaire: hierarchic, professional, entrepreneurial, and group oriented. each of t.hese four types represents a different internal environment. as campbell, dunnette, la\vler, and weich (1) suggested, the internal environments 'vary in terms of tile amount of individual autonomy that is allowed to organization members, the degr~e of structure that is imposed, the reward orientation, the style of leadership exercised, and the way conflicts are managed. in the hierarchic organization, individual a.utonomy is limited. responsibility and authority are delegat.ed in controlled doses b~y managers at higher levels of the hierarchy. independence is controlled by job descriptions, rules~ regulations, and guidelines. initiative is limited by a system of standard operating procedures, specialization, and close super\rision. the degree of structure is high \\1ith a great deal of formaliza.tion of procedures, centralization of decisions, and direct supervision exercised. re\vards are administered by superiors based on specific, well-defined, and objective criteria like time worked, items processed, errors, etc. the re""ards are distributed on the bases of seniority, merit, and position. there is little consideration a.cc.orded subordinates in terms of warmth or support, and participation is generally kept to a minimum. conflicts are seen as being bad for t.he organization and are discouraged. the most acceptable way of dealing with conflict is to appeal to higher levels in the hierarchy for resolution. in the professional organization, a good deal of individual autonomy is granted. responsibility is broad, with independence and initiative encouraged, so that the professional makes important decisions and takes action within the established body of knowledge and theory of the profession or technical specialty. \lery little structure exists with the exception of formalization. direct supervision is not needed since the code of behavior, professionalism, association, and peer review serve as substitutes for it. decision-making is decentralized. rewards are generally based on very general criteria and are often measured subjectively. th~ rewards generally go to those whose professional accomplishments are judged to be most significant. leadership in the 3 professional organization is characterized by a good deal of warmth, participation, and support, especially from colleagues. conflict is encouraged in the professional organization because it leads to penetrating analysis and creative syllthesis. such conflict is seen as useful and good and is managed through a problem solving approach. the entrepreneurial organization exhibits the greatest amount of individual autonomy with each individual given broad responsibility for accomplishment, complete independence and initiative, and the freedom to pursue goals by whatever means are appropriate. structure is simple or non-existent with little or no formalization, centralization, standardization, or direct supervision. rewards are based on the simple criterion of successful completion of the task or failure. therefore, immediate feedback on success or failure is required and rewards follow automatically. since the individual is left alone to cornplete the task, there is little support, warmth, or participation. conflict is inherent in the task since the individual competes against himself, others, tirrle, and other obstacles to achievement. conflicts must be managed by the individual using whatever techniques are available. this usually means that solutions are forced by the individual, using drive or achievement motivation to overcome the obstacles. the word "entrepreneurial" is not used here to describe the simple structure of the typical small business but rather to describe the entrepreneur-like freedom or autonomy and the attendant risk that is \videly distributed among organization members, as when jobs are enriched or commissioned sales people are given the freedom to set and pursue goals in their own \\'ay with only results being monitored. the group organization replaces individual autonomy with group autonom)'. while individuals may only have narrow responsibilities assigned, with independence and initiative limited, the group, functioning without supervision, takes on responsibility and initiative for the whole operation, which would be reserved for upper level management in the hierarchic organization. there is little or no direct supervision or centralization, but some structure is provided through a degree of formalized procedures. rewards are generally based on specific, objectively measured criteria and distributed by some group incentive plan. since leadership is emergent and democratic, a great den.] of consideration is evident in the form of support, warmth, and ultimate participation. when conflicts occur, they may be perceived as either good or bad and are handled through group confrontation, discussion, and problem solving. the four organization types are presented here as pure or ideal models based on miner's (5) limited domain theories and oliver's (7) empirical work. obviously, the world of organizations is not so neat and simple. most organizations cont.ain some elements of all four types. for instance, hierarchy is a pervasive organization form and some elements of hierarchy will be found in almost all organizations. however, evidence indicates that most organizations can be classified into one of the four types (7). 4 the four types are independent of industry. firms within a given industry may possess anyone of the four types of internal environments or even have different types in various units of the organization. an example of how different types may be found in one industry is the automobile industry. in the united states, most automobiles have traditionally been produced on the assembly line. cars are assembled by workers who perform the same routine, highly specialized tasks over and over while under direct supervision. this is a predominately hierarchic organization. in zama, japan, however, nissans move down an automated assembly line where robots perform the routine tasks and workers are highly trained technicians and troubleshooters who work without close supervision. the workers' technical knowledge and professional orientation guide their behavior. this is a predominately professional organization. in kalmar, sweden, volvos are assembled by autonomous groups of workers in specially designed bays without immediate supervision. the self-directed groups plan, organize, and control production and are paid on a group incentive basis. this is a predominately group type internal environment. organization type, then, would seem to be a determinant of the kinds of strategy implementation mechanisms that an organization might use as well as a determinant of the effectiveness of a particular implementation method for a particular organization. the purpose of this study is to test whether managers in different types of organizations use different mechanisms to implement strategy. in figure 1, the x's indicate which mechanisms are expected to be used in each organization type. the study sainple the data used in this study were gathered from a stratified random sample of 400 executives involved in a training program at a major southeastern university. the subjects represent 67 a.merican and canadian manufacturing organizations in the process of implementing a strategy of product quality improvement via a statistical process control program. usable responses were obtained from 181 of the subjects, yielding a 45.25% response rate. measures nine six-point likert scale items similar to the one below were used to measure the usage of the nine strategy implementation mechanisms: 5 direct contact individuals talk to each other when they are jointly affected by a problem. problems are generally not referred up the chain of command but are resolved by participants involved. never used o rarely used 1 sometimes used 2 often used 3 very often used alvays used 5 the oliver organization description questionnaire (oodq) (7) \\?as used to classify the respondents' organizat.ions as hierarchic, professional, entrepreneurial, group~ or some combination of the four. the oodq is a forced-choice questionnaire \\:hich yields a hierarchic score, a professional score, a task score, and a group sc.ore." a t.otal of fifteen items are scored for each domain scale so that possible scores range from 0 to plus 15. the following is an example of an oodq it.em: 1. in my work, duties are determined by (a) management (b) my profession or ocupation (c) my work group (d) me, based on the goal i am trying to accomplish in addition to the two questionnaires, respondents reported their organization level as top level executive, middle manager, first line supervisor, or professional (engineer, consultant, etc.). organization size was coded for each firm based on the number of employees, a.s listed in standard and poors directory. procedure organiza.tions were classified by highest oodq score. multivariate analysis of variance (manova) and univariate anova tests were conducted to determine whether there were significant differences in the reported usage of strategy implementation' mechanisms in the four types of organizations, in different size organizations, a.nd by organization level. tukey's c.v. tests were used to determine which differences were significant. 6 table 1 mean ratinls of usale of strately implementation mechanisms in four types of oraadizations total hierarchy professional entrepreneurial group sample mechanisms (n=117) (n=10) (n=30) (n=14) (n=181) chain of command 2.58 2.83 2.28 2.14 2.38 s.o.p.'s··· 2.58eg 2.83g 1.94 1.43 2.42 goal-setting·· • 2.25 2.87 3.22" 3.21" 2.56 direct contact··· 2.79 3.48" 3.33" 3.64" 3.02 interdep. liaison 2.42 3.00 2.28 2.86 2.49 temp. task force· 2.60 3.17 2.86 3.36 2.76 perm. imp. team·· 2.29 3.09 2.61 3.36" 2.51 integrating role 2.34 2.22 2.44 2.79 2.32 integrating dept. 2.03 2.04 2.08 2.14 2.05 • mean differences significant p <.05 •• mean differences significant p < .01 ••• mean differences significant p <.001 h = significantly greater than hierarchic sample (p <.01) e = significantly greater than entrepreneurial sample (p <.01) g =significantly greater than group sample (p < .01) results table 1 contains the mean scores of usage ratings for the mechanisms in each organization type, as well ,as the e.ntire sample. significant differences are summarized in the discussion section of this pa.per. table 2 lists the mean scores of usage rati~gs for the mechanisms in four different sized organizations. the differences b.re summarized in the discussion. differences in usage of the mechanisms by executives at each level in the organizations are reported in table 3 and summarized in the discussion. above-average usage is shown in figure 1 by circles (0). circles which contain x's indieate that above-average use was hypothesized and confirmed. seventeen or the twenty hypothesized above-average usages were confirmed. three or those hypothesized were not supported by the data, and five unexpected above-average usages were reported. discussion as mintzberg (6) and others have documented, direct contact is the most popular mechanism for implementing strategy-ranking first in all four types of organizations, all sizes of organizations, and all levels. apparently, managers and professionals still prefer face-to-face contact to get things done. oddly enough, it is more often used in larger rather than smaller org.anizations; and first jine supervisors prefer it. the second most popular mechanism is the temporary task force. while this research does not clearly indicate why the task force is so popular, it can be said that it is the least disruptive, costly, and most flexible of the mechanisms. it was the second most-used mechanism in three of the four 7 table 2 mean ratings of usage of strategy implementation mechanisms in four sizes of organizations. mechanisms chain of command s.o.p.'s· goal-setting·· direct contact*· interdep. liaison temp. task force* perm. imp. team·· integrating role integrating dept. very large (0=65) 2.42 2.18 2.83 3.47 2.89 3.34 3.16 2.44 2.39 large (n=64) 2.32 2.14 3.00 3.31 2.74 2.66 2.55 2.52 2.08 medium (0=34) 2.72 2.07 2.93 3.29 2.71 3.05 2.91 2.04 1.99 small (n=18) 2.48 2.18 2.40 3.02 2.10 2.74 2.32 2.41 1.57 • mean differences significant at p <.0/.*mean differences significant at p <.00/ ivery lorge = >50,000 employees lorge =10,000-50,000 employees medium = /,000-/0,000 employees small = </,000 employees table 3 mean ratinas of usaae of strately implementation mechanisms reported by four levels of respondents! mechanisms chain of command s.o.p.'s·· goal-setting·· direct contact·· interdep. liaison temp. task force perm. imp!. teams· integrating roles integrating depts. top-level (n=16) 2.64 1.58 3.08 3.26 2.61 2.93 3.05 2.52 2.19 mid-level (n=68) 2.45 2.32 2.84 3.28 2.85 3.00 2.79 2.41 2.04 professional (n=41) 2.39 2.27 2.91 3.33 2.59 3.17 3.00 2.20 2.21 fint-line (n=56) 2.45 1.93 2.75 3.42 2.56 2.66 2.42 2.46 2.03 • mean difff.rence significant at p <.oj ••mean differences significant at p <.001 i top-level = top level executives mid-level =middle managers professional = profeslional engineers~ consultants, etc. first.. line =first line supervisors 8 theoretically congruent organization type §. e strately implementation mechanisms ,. . ~ " chain of command ~ 0 standard operating procedures ~ ~ targeting or goal setting ~ ~ ~ fj:> i direct contact ~ ~ 8 interdepartmental liaison roles x 0 8 temporary task forces 8 8 8 permanent implementation teams 8 0 ~ integrating roles 8 8 integrating departments x x 0 0 x :: hypothesized above average usage o =actual reported usage above the mean for the total sample figure i hypothesized and actual reported use of strategy implementation mechanisms by organization type types of organiza.tions and third most-used in the entrepreneurial type, while being most often used by professionals and mid-level managers. although goal setting was the third most-used mechanism overall, its use varied a great deal among the fouf types of organizations. it was second only to direct contact in entrepreneurial organizations where it was hypothesized to be most appropriate, but was eighth out of nine in hierarchic organizations and fifth in the professional type. its unpopularity in hierarchies may be due to the difficulty of changing goals or redirecting emphasis away from their rigid and traditional, bureaucratic goals, policies, and procedures. as expected, permanent implementation teams, which were fourth in popularity overall, were most used in the group type organizations where their use was rated equally with temporary task forces. the use of permanent teams was ranked third and fourth in professional and entrepreneurial organizations, respectively, but seventh in hierarchies. this low usage in hierarchies may reflect the reluctance of hierarchic managers to create long-lived committees which might become opposing forces or obstacles, or it may indicate that the established hierarchic structure is a sufficient and existing "permanent implementation team." interdepartmental liaison roles were ranked fifth out of nine in overall usage putting them at the midpoint of popularity among strategy implementation mechanisms in this study. their use did not vary significantly by size or level of organization. while standard operating procedures, which ranked sixth overall, were reportedly used most often in professional organizatio~s, their use ranked third (tied with chain-of-command) in hierarchies. as expected, their use is most theoretically congruent with hierarchies and professional organizations and is supported by the data. the reported use of chain-or-command, which ranked seventh out of nine overall, was also greatest for hierarchies as was hypothesized. though this hypothesis was not supported statistically, the rank of third most popular does indicate some support for the notion that chain-of-command as a strateg.y implementation mechanism is primarily appropriate to the hierarchic organization. perhaps the lack of clarity in this data is due to the pervasiveness of chain-of-command in all or most organizations. the use of integrating roles and departments as strategy implementation mechanisms, at least in this sample, appears to be rare, with no significant differences among types, sizes, or levels of organizations. this study indicated that as firms move through their life cycle, they may utilize different mechanisms. this study indicates that there may be a life cycle effect in the use of both temporary task forces and permanent implementation teams with small and large organizations using them less than the medium and very large. this could indicate that firms growing from small to medium size experience a reduction in the effectiveness of standard operating procedures and begin to "grope in groups." the teams work for awhile, but their effectiveness fades w"lth time and growth. then, as organizations grow 10 from large to very large, they again turn to "group groping." the pattern of usage for sop's is somewhat different, with significantly greater usage in small and very large firms than in medium and large ones. the use of goalsetting is just the opposite. neither small nor very large firms use goal-setting to the degree that a medium or large one does. sop's and goal-setting may be incongruent mechanisms which hinder each other or cannot be used effectively together. conclusions the findings in this study have limited generalizability due to: the small number of professional, entrepreneurial, and group type organizations represented in the sample; the nature of the single strategy being implemented; and the fact that all of the firms are manufacturers in related industries. further study is needed on a broader variety of organizations implementing a variety of different strategies in order to fill in the missing pieces of the puzzle. however, this study provides support for the general hypothesis that different strategy implementation mechanisms are used in different organizational types and sizes, as well as by executives at different levels of the organization. r.eferences 1. campbell, john p., dunnette, marvin d., lawler, edward e. iii, and weick, karl e., man.agerial behavior, performance, and effectiveness (new york: mcgraw-hill, 1970), p. 393. 2. deming, w. e. (1982) quality productivity, and competitive position. cambridge: ma.ssachusetts institute of technology, center for advanced engineering study. 3. galbraith, j. and nathanson, d. 1978 strategy implementation: the role of structure and process, st. paul, mn: west publishing company. 4. lawrence, paul r. and jay w. lorsch. organization and environment: managing differentiation and integration. boston: graduate school of business, harvard university, 1967. 5. miner, j. b. 1979. "limited domain theories of organizational energy." c. c. pinder and l.b. moore (eds). middle range theory and the. study 0/ organizations. leiden, netherlands: martinus nijoff: 273286. 6. mintzberg, h. the nature of managerial work. new york: harper and row, 1973. 7. oliver, j. e., 1982. "an instrument for classifying organizations." academy of management journal. 25 (4): 855-866. 11 implementing strategic change in manufacturing organizations the strategic use of bankruptcy prediction models: an aid to executive decision making sukumar c. debnath college of business administration prairie view a & m university prairie view, texas aubrey r. fowler, jr. college of business administration nicholls state university thibodaux, louisiana stephen c. bushardt college of business administration university of southern mississippi hattiesburg, mississippi the last decade has seen a flood of business failures in the united states. these failures, ranging from the smallest of entrepreneurial firms to corporate giants, have had a significant impact on the general well being of the u.s. economy, have led to the loss of thousands of jobs, and have cost investors and creditors millions of dollars. in addition the news media give reports, almost daily, of other firms that are exhibiting financial difficulty and facing the imminent possibility of insolvency and the need to seek protection under bankruptcy law. firms in such diverse industries as airlines, meat packing, and computers all appear to be on the brink of seeking reorganization under chapter 11 or liquidation under chapter 7 of the federal bankruptcy code. these business failures are frequently offered as a major criticism of a capitalistic system and the supposed "crisis" created by them as justification for changing to a more controlled economy. however, the fact of bankruptcy and the economic losses associated with it are ac'tually a control mechanism th~t properly rempves economic units that are incapable of effectively competing thereby weeding out the inefficient and rewarding those that are able to meet the needs of the market and properly manage their resources. in effect, bankruptcy is one of the expenses to an economy that allows for both the acceptance of risk and the rewards associated with success. therefore, bankruptcy should not be viewed solely from the viewpoint of the firm involved and those associated with it. furthermore, it should be noted that bankruptcy serves a positive functi<>ll when eliminating inefficient journal of bu8ineu strategie8, volume 4, number 2 (fa111987) 87 competitors as a result of their own financial weakness and that under today's bankruptcy law the act of seeking protection under chapter 11 may relate to issues other than immediate threat of insolvency. for instance, firms may use bankruptcy protection to abrogate a collective bargaining contract. however, given the economic hardship created by business failures, it seems obvious that any tool or technique that could help avoid such failures would be a valuable aid to business decision makers. one such useful technique would be an early identification of those firms at risk of encountering financial difficulty. over the years a number of efforts have been made to devise analytical models useful in predicting corporate financial failure. these efforts have led to the creation of several models with a high degree of predictive ability which are able to detect potential failure as early as three to five years in advance. purpose since the future condition of a company with respect to its financial well being can be very important to a variety of parties (le., executives, investors, employees, or regulatory agencies), an ability to accurately predict financial problems can have a significant impact on decisions· regarding their involvement with companies showing a potential for failure. for example, executives of such companies would have more time in which to determine the causes leading to failure and work to correct them. potential investors would also have a better assessment of the risk they undertake. with financial failure a growing problem in the u.s. ([3], [5], [20)) it would seem that the availability of models capable of predicting such failure is increasingly important. their use will assist in the recognition of potential problems, in helping to identify the underlying causes of those problems, and as a starting point for the development of corrective action. with this in mind the purpose of this paper is to: 1. review the bankruptcy prediction models (bpm's); 2. discuss the use of the bpm's for internal analysis and problem solving; 3. discuss the use of bpm's as a tool for evaluating firms as potential acquisition targets; and 4. briefly identify other possible applications of bpm's. the essential thrust of the paper will be to evaluate the strategic value of bpm's as an important tool in executive decision making. why businesses fail there are a variety of reasons why businesses fail. however, it is generally accepted that the fundamental underlying cause of failure is poor management. this position is supported in the literature ([6], [7], [11)) and has been recognized for a (',onsiderable length of time. among the elements of poor management contributing to failure are: 88 1. faulty decision making, 2. poor allocation of resources, 3. failure to correct operating inefficiencies, 4. poor choice of products and marketing strategy, 5. poor financial management, and 6. inadequate planning. there are, of course, other factors, external to the organization, that can lead to failure. in particular, the overall status of the national economy and the competitive situation are important contributors to failure ([3], [6]' [7]). other contributing factors include: 1. governmental regulation, 2. technological innovation, 3. natural disasters, 4. labor problems, and 5. changes in cultural/social values. when failure occurs it is frequently a shock to most who are associated with the firm involved. particularly when large firms declare bankruptcy the event receives national attention and the public at large is led to wonder how such rich and powerful organizations could fail. there is a tendency to look for singular causes of a disastrous nature when the reality is that financial collapse is seldom sudden and rarely from a single cause [20]. the above observation serves as the foundation for the development of models to predict failure. if those factors that are symptomatic of failure and which show those symptoms in advance can be identified, the failure may be predicted and, with proper management in the interim, avoided. therefore, the bpm's are tools that may improve poor management by identifying in a timely manner potential problems and give some indication oftheir underlying causes. a review of bankruptcy prediction models since the early 1900's, researchers have sought ways of identifying companies that are developing a potential for encountering significant financial problems. these research efforts have resulted in the development of a number of empirically derived bankruptcy prediction models that offer sufficient predictive ability to be of assistance to managers involved in strategic planning. 89 most of the earlier models ([8], [9], [12), [15], [19), [22]) relied on comparative ratio analysis as the basis for their predictions. in them, researchers compared a variety of common financial ratios of failed firms to matching nonfailed firms or industry averages as a basis for determining critical values for those ratios. firms that failed to meet those critical values were determined to be in jeopardy of severe financial consequences. as useful models, these early efforts suffered from a major problem in that each offered several ratios as a basis for comparison. unfortunately, these models failed to provide a single, comprehensive basis for determining potential financial problems due to contradictory results. this issue has been addressed in more recent years through the use of discriminant analysis as a means of identifying significant predic.tor variables (still financial ratios) and their relative importance and interrelationship through the development of a discriminant function to predict financial well being. using these functions a firm or other user of the model computes a score based on the values of the significant variables, model coefficients and constants and compares this score with a single critical value for determining risk of severe financial difficulty (see [1]' [4], [10], [18], and [21]). these models offer a high degree ofpredktive ability, ranging in accuracy from a high of 99% for a one year prediction [21] to a high of 78% for a five year prediction [10]. in spite of this predictive ability the use of bpm's has been criticized. a major problem associated with the models is their inconsistency in selecting significant variables from essentially similar sets of financial ratios. this makes it difficult to determine which model to use and suggests that the accuracy of a given model may be dependent on the general economic environment in which it is applied [14]. a second important criticism involves the limited theoretkal basis for much of the empirical work leading to the development of the models and their ignoring of causal relationships between the financial ratios and failure [17]. in essence, the financial ratios serve as symptoms of potential failure but do not indicate the causes of such failure. for instance, a retail firm that shows a deterioration in its average collection period has a problem, but the ratio itself simply indicates the existence of the problem, not the underlying cause. the deterioration may result from overly liberal credit terms, improper billing and record keeping procedures, or a shift in the economic well-being of the customer base. if the change in the ratio is seen as indicating an important problem, a firm's objective might be to improve that ratio and to accomplish that it must identify the underlying reason for the unacceptable ratio and concentrate on correcting it. therefore, the bpm's are diagnostic tools identifying problems rather than prescriptive tools for avoiding bankrupt~y. an additional criticism is that firms encountering financial problems may delay in reporting financial data which may create accuracy problems in predicting pending failure based on recent operations [13]. 90 a bankruptcy prediction model in use given these models and criticisms of them, a brief overview of one in operation might benefit the reader. in a study reported in 1983 [5], the zeta model was compared with the relative financial strength system published as part of the value line investment survey. in the study the two models were found to be comparable in their ability to predict financial disaster for business firms. using the zeta model 68 of 73 major bankruptcies occurring during the years 1977 to 1982 were predicted based on their zeta score. table i, as exerted from altman and spivack ([5], p. 63), shows the total results of the study and table 2 shows examples of selected companies. table 1 time of financial statement in periods before bankruptcy n umber of firms results 0 1 2 3 4 companies correctly classified 68 62 47 37 34 companies incorrectly classified 5 9 19 23 23 total companies 73 71 66 60 57 percent correct 93 87 71 62 60 percent incorrect 7 13 29 38 40 average score -4.72 -2.62 -1.44 -0.79 -0.53 table 2 examples and results of zeta score use, selected companies n umber of months bankruptcy zeta with company date sc~re negative score a m international 4-14-82 -4.6 20 allied artists 4-5-79 -7.07 120 bobbie brooks 1-17-82 -1.98 103 braniff airlines 5-13-82 -3.40 28 lionel 2-82 -15.79 64 mansfield 'rire 10-79 -8.20 22 sambo's 11-81 -3.51 35 seatrain lines 2-11-81 -2.41 115 white motor co. 9-4-80 -1.41 116 wicker cos. 4-25-82 -0.92 15 91 for all of the companies covered in the study the average lead time by which the zeta score predicted bankruptcy was 53 months. furthermore, as shown by average scores and pointed out by the authors, the trend toward greater negativity appears to be as important in predicting bankruptcy as does the negative score itself. bankruptcy prediction models for internal analysis in recent years, the concept and practice of strategic management has taken on greater importance for business organizations. a fundamental aspect of strategic management is the ability to forecast future events as a basis for current decision making. therefore, the ability to predict an event of such importance as bankruptcy has significant value to the strategic decision maker. in a strategic sense, survival is one of the fundamental objectives of most business organizations. bankruptcy prediction thus acquires an even greater importance, since financial insolvency is one of the strongest possible threats to continued existence. the need, then, is to be aware of bpm's and to be able to use the information available from them in a manner conducive to avoiding the developing problem. fundamental to their use is to remember that the bpm's are diagnostic rather than prescriptive. they indicate that something needs to be done but not what to do. it is the responsibility of the strategic manager to utilize the bpm results to first assess the causes of the pending problem and then to determine how best to avoid that problem. the models' use of financial ratios as the basis for their predictions provide a warning signal and some indication of where imbalance in the firm's operations exists. for instance, a firm using the zeta-model [4] and calculating a zeta score indicative of pending bankruptcy can look at the ratios comprising the discriminant function and compare them with industry standards. those that are substandard provide a basis for determining why the problem is developing. using the zeta model the ratio of retained earnings to total assets is the most important predictor of trouble. therefore if the re/ta ratio for a firm is substantially less than for other firms, particularly those in its industry, the firm has an indication that it relies too heavily on external sources of funds and that it suffers from either or both of substandard profitability, thereby reducing the ability to retain earnings, or overly generous dividend policies, thereby satisfying short term stockholder needs for income while jeopardizing their long term interests. other examples using other ratios or other models can be given. however, the important issue is that the information is potentially available, not the specific details of its use. once an appropriate bpm has been selected and applied to a finn's financial data base, the strategic manager has at hand an important basis for decision making. if the results are favorable, giving no indication of pending trouble, the strategist can then concentrate on improving existing operations and taking advantage of opportunities in the market place. furthermore, strategists in such a position can use favorable bpm results to enhance their firms' standing in the eyes of investors or lenders, 92 making for greater accessibility to capital markets. the strategist might also use a favorable bpm result as a basis for evaluating the impact of changes in the firm's operations or financial structure that affect the predictor variables. for instance, the impact of a heavy debt financing for new operations might be assessed by using the bpm to predict the change in, and status of, the predictor score after allowing for the expected results of the debt financing to manifest themselves. in essence, the bpm can be used as a simulation model to determine the advisability of engaging in certain actions on the basis of their impact on organizational survivability. if the results of the bpm, when applied to current operational results, is unfavorable the signal is for management to concern itself more with finding and correcting the underlying causes rather than seeking growth or general improvement. since bpm's have the capacity to predict problems several years in advance, an effective use of such models should provide ample time in which to avoid those problems. in addition, the longitudinal use of the model can help to evaluate the effectiveness of corrective actions by comparing a series of bpm predictor scores. if the scores show a trend toward or into favorability they indicate that the decisions being made are working as desired. if, however, the scores are unchanged or the trend is toward more unfavorable scores the indication is that the problem still exists and that further corrective action is required. the basic importance of the bpm's to the practice of strategic management is that they provide decision makers with an additional tool with which to assess the future. as such, they can be used to signal a need for action to avoid potential problems and can serve as an evaluative tool for helping to assess the impact of major strategic decisions. if the premise that survival is fundamental to the success of business organizations is accepted, then bpm's can serve a vital function in helping to insure survival by providing timely and potentially critical information. bankruptcy prediction models for external analysis in addition to using bpm's to assess one's own firm, the strategic decision maker can use them to assess the financial well being of other firms. such analysis can be of significant value in determining the relative competitive position of firms and in appraising the value and attractiveness of potential acquisitions or merger partners. if the bpm's are used to assess the bankruptcy potential of competitors the results might have an impact on planning for competitive actions. clearly a firm showing a potential for financial problems is less likely to respond effectively to initiatives in the competitive arena. just as dearly, a firm in a more favorable financial position than its competitors can counter the competition's moves and take actions of its own that might place substantial pressure on the competition. therefore, bpm's can serve as a part of the basis for competitive decisions by helping to identify positions of strength to be exploited and positions of weakness to be avoided. in 93 this instance the bpm is a comparative model assessing the relative financial strength of two or more firms competing in the same marketplace. an alternate use of the bpm's in external analysis is to evaluate the present financial well being of a firm targeted for merger or acquisition and to assess the financial impact of such actions. on one hand, the bpm's may be used to seek firms showing sound financial positions as a means of adding that strength to the acquiring firm and reducing the risk of acquisition. on the other hand, bpm's can identify firms in trouble under the assumption that they might be more readily available, might require a smaller investment to acquire, and might benefit most from an infusion of capital and managerial expertise from the acquiring firm. in either c.ase, the bpm's give important information regarding the firm or firms of interest and thereby provide a sounder basis for deciding what course of action to take, what value to place on the target firm(s), and what risk is created by pursuing the merger or acquisition. other uses of bankruptcy prediction models the primary focus of this paper has been to suggest how bpm's might be used to assist strategic managers in making decisions regarding their own firms. there are, however, other potential uses of these models that are worth mentioning. other firms can use the bpm's to evaluate us just as we can evaluate them. given the public nature of much of the information regarding the operating results of most major corporations it is reasonable to assume that others can estimate our financial well being and long term prospects with accuracy approaching our own. this might create an added impetus to use and react to bpm's since failure to do so might give an unacceptable competitive advantage to those firms which might benefit from our troubles. investors can use bpm's to help their evaluation of the risks associated with a particular firm. whether these investors take the form of subscribers to a stock issue, purchasers of stock via the various stock markets, or lenders, the information provided by the bpm's can affect their investment decision. they may use it to make the go/no-go decision, may use it to determine the type of investment, or may use it to determine the appropriate stock price/interest rate for the investment. these decisions by potential investors will have direct or indirect impact on the firm involved and serve as an additional inducement to firms to correct problems causing an unfavorable result when evaluated with a bpm. government regulatory agencies may use the bpm's as a part of their regulatory review of the firms they are concerned with. such review may include an assessment of current operations and the quality of firm management, may be used to evaluate requests for rate or other changes desired by regulated firms, or may be used as a basis for requesting relief from regulatory restrictions by firms suffering from the adverse financial consequences of compliance. as with investors, bpm's can provide information to regulators that will help determine the relationship between the agency and. the firm being reviewed. 94 a final important user of bpm data is the employees, particularly unionized employees, of the firm being evaluated. since employee expenses are a major cost item for almost all firms, the effect of decisions related to pending financial problems requiring cost reductions will have a significant impact on employees. with their own bpm data, employees or their union representatives can more reliably assess the accuracy of company statements regarding financial doom than if they rely solely on those statements. the union is, therefore, in a better position to bargain for the benefit of its members, to assess the risks associated with their contractual demands, and to sell to members unfavorable contracts made necessary by company inability to pay. alternatively, the results of a bpm showing little potential for bankruptcy may counter company predictions of pending problems or show that the granting of certain benefits or concessions to the union will have no impact on subsequent operational results. at the very least, bpm results will advise employees of the potential for insecurity in their jobs and the financial well being of their employer. conclusion researchers have developed a number of bankruptcy prediction models that serve to assess the potential for future financial problems based on today's operational results. an astute use of the information provided by such models can be of significant value to those parties who are interested in the future of a company. in particular, the use of bpm's can provide strategic decision makers with a sufficiently timely warning of potential trouble to allow for an assessment of the causes of the problem and to devise the necessary corrective action. therefore, the routine use of a bpm as part of the firm's internal assessment process offers a substantial benefit to the organization at a negligible annual cost. the key to the effectiveness of the use of a bpm is the selection of the most appropriate model and then insuring that it is used regularly and in a proper manner. the intention here is not to recommend any particular model but to suggest that, conceptually, a bpm is a useful tool in strategic management and the various models available should be reviewed in detail by interested managers for the purpose of selecting the one which best fits their needs. for those firms interested in using a bpm for one or more of the uses described, it is suggested that a brief review of the literature referenced will provide access to the actual procedures and techniques needed to apply the models. in some cases the model is published and available for anyone's use. in others the model is proprietary and references are given to its developers for contact on a consulting basis. references 1. altman, edward 1. "financial ratios, discriminant analysis and the prediction of corporate bankruptcy." the journal of finance, vol. 23, september 1968, pp. 589-609. 95 2. "the success of business failure prediction models-an international survey." journal of banking and finance, vol. 8, june 1984, pp. 171-198. 3. "why businesses fail" journal of business strategy, vol. 3, september 1983, pp. 15-21. 4. altman, edward i., robert g. haldeman, and p. narayanan. "zeta analysis: a new model to identify bankruptcy risk of corporations." journal of banking and finance, vol. 1, june 1977, pp. 29-54. 5. altman, edward i. and spivack, joseph. "predicting bankruptcy: the value line relative financial strength system vs. the zeta bankruptcy classification approach." financial analysis journal, vol. 39, november 1983, pp. 60-67. 6. argenti, j. corporate collapse: the causes and symptoms, london, uk: mcgraw-hill book company (uk) ltd., 1976. 7. barrickman, ray e. business failures: causes, remedies, and cures. washington, dc: united press of america, inc., 1979. 8. beaver, william h. "altenative accounting measures as predictors of failure." the accounting review, vol. 43, january 1968, pp. 113-122. 9. "financial ratios as predictors of failure." empirical research in accounting: selected studies, supplement to journal of accounting research, vol. 4, 1966, pp. 71-111. 10. dambolena, ismael g. and khoury, sarkis j. -"ratio stability and corporate failure." the journal of finance, vol. 35, september 1980, pp. 1017-1026. 11. dun and bradstreet failure record, new york: dun and bradstreet, inc., 1981. 12. fitzpatrick, paul j. "a comparison of ratios of successful industrial enterprises with those of failed firms." certified public accountant, october, november, december 1932, pp. 598+. 13. lawrence, edward c. "reporting delays for failed firms." journal of accounting research, vol. 21, autumn 1983, pp. 606-610. 14. menash, yaw m. "an examination of the stationarity of multivariate bankruptcy prediction models: a methodological study." journal of accounting research, vol. 22, spring 1984, pp. 380-395. 15. merwin, charles l. "financing small corporations in five manufacturing industries 1926-1936." national bureau of economic research, 1942, pp. 93+. 96 16. sadd, victor and williams, robert t. causes of commercial bankruptcies. washington, dc: u.s. government printing office, 1932. 17. scapens, robert w., robert j. ryan, and leslie fletcher. "explaining corporate failure: a catastrophe theory approach." journal of business finance and accounting, vol. 8, no.1, 1981, pp. 1-25. 18. sharma, subhash and mahajan, vijay.. "early warning indicators of business failure." journal of marketing, vol. 44, fall 1980, pp. 80-89. 19. tamari, m. "financial ratios as a measure of foreca.sting bankruptcy." management international review, vol. 4, 1966, pp. 19+. 20. thompson, c. j. "danger signs of corporate insolvency." financial executive, vol. 50, june 1982, pp. 47-51. 21. toffler, richard and tisshaw, howald. "going, going, gone four factors which predict." accountancy, vol. 88, march 1977, pp. 5052+. 22. winaker, a. and smith, r. f. "changes in financial structure of unsuccessful industrial companies." bureau of business research bulletin, university of illinois press, vol. 51, 1935. 97 the strategic use of bankruptcy prediction models: an aid to executive decision making strategic responses to ballot questions by the private sector alan n. hoffman school of business the university of connecticut storrs, connecticut there has been a renewed interest among researchers to understand how regulation restricts the ability of private industry to do business. miles [19] recently wrote about the history of the tobacco industry and how it became the first major test of corporate social responsibility. the tobacco manufacturers lost their access to public broadcast media, warnings were placed on their labels, and their image and pride were wounded. yet, they developed a series of response strategies that concentrated on domain diversification and overseas expansion that changed the look of the big six from single-business firms to global-multibusiness corporations. mitnick defines regulation as: "... the public administrative policing of a private activity with respect to a rule prescribed in the public interest" ([20], p. 7). most regulatory scholars ([4],[7]) propose that there exists a system of regulation or life cycle, that is, a series of steps from the initial legislation to the establishment of a regulatory agency. farris and sampson [9], shepard [26], and wilcox and shepard [31] have each developed models of the distinct stages of regulation. however, there has been little attention paid to the role of regulatory initiatives and referenda in the regulatory literature and their effects on the performance of private industry. the present article, designed with this shortcoming in mind, shifts the focus away from the traditional regulatory process and takes an in-depth look at this non-traditional method of regulation. background in the past ten years there has been a significant increase in the number of ballot questions whose intent has been to regulate the activities of private industry. such initiatives can be extremely costly. since 1978, there have been more than fifty ballot proposals that have directly affected the regulation of several key industries: banking, defense, bottling, farming, cable television, telecommunications, and tobacco. there are two explanations why the threat of circulating initiative petitions is an integral part of the strategy of lawmaking. the first reason revolves around a state legislature's reluctance to adopt special interest legislation. the initiative process has proved to be an extremely valuable mechanism for representing special interests in our society. laws to mandate the return of bottles and cans is an example of a regulation that has been adopted by means 19 of the initiative process. the second reason for the resurgence of initiatives is that special interest groups often wish to have their proposals adopted in the exact form they were written, rather than "having them amended to death." lee [15] argues that those groups who utilize initiatives most are not significantly different form those groups who normally lobby state legislatures. initiative campaigns in the private sector the renewed interest in the initiative process may arise from the large amounts of money spent by both sides in waging these legislative battles in the public arena. for example, california voters have been subjected to several extraordinarily large and expensive regulatory initiative campaigns in the past few years. in 1980, the tobacco manufacturers spent more than $6 million to defeat a proposal to limit smoking in public areas. additionally, in the primary election of 1980, more than $6 million was spent to defeat an oil profits tax proposal. regulatory initiatives are not unique to california. in 1982, there were regulatory proposals in ten other states. one popular initiative question concerns returnable bottles. proponents of the bottle bills generally argue that returnable bottles conserve natural resources and result in a cleaner environment. opponents generally take an economic approach and claim that laws requiring returnable bottles lead to price increases in excess of the bottle deposit to cover the increased costs associated with storage, transportation, and recycling facilities. such states as michigan, massachusetts, maine, and iowa all have returnable bottle laws (michigan and massachusetts by referendum). it should be noted that these proposals are often not enacted on their first ballot attempt. in 1983, the voters of cambridge, massachusetts, voted down a citywide referendum that called for cambridge to become a nuclear free zone which would have outlawed any work, including research, on nuclear weapons or their components within the city limits after october, 1985. if cambridge had approved the proposal, draper laboratories, a privately owned spinoff of mit, would have been forced to leave the city. the banking industry has also become the target of several initiative campaigns. in three states, washington, michigan, and colorado, there have been ballot questions that would place restrictions on banking operations. in colorado, voters defeated a proposal which would have allowed branch banking. in 1982, the voters of the state of washington defeated a proposal which would have limited retail credit interest rates. the citizens of nebraska, who have witnessed large amounts of their fertile farm land being bought up by corporations, voted in 1982 to prohibit corporations (other than family farm corporations) from purchasing farm and ranch land in their state. it is now evident that initiative campaigns can cost several million dollars to wage. some of the most expensive initiative campaigns are outlined in table 1. 20 tobie 1: recent fuitiative campaigns with cost greater than '5 milliona year state issue outcome cost 1984 arizona control health costs failed > $5,000,000 1984 california lottery passed > $10,000,000 1982 california gun control failed $10,000,309 1982 california returnable bottles failed $7,076,574 1982 michigan ban automatic fuel failed $7,409,002 increases/elect psc 1981 ohio competitive worker's failed $6,000,000 compo insurance 1980 california rent control failed $6,835,433 1980 california oil profits tax failed $6,067,356 1980 california restrict smoking failed $6,000,000 asource: national center for initiative review, englewood, co, 1986 the use of fuitiative and referendum in the regulation of business ever since the brandeis court upheld government regulation of business without infringement of "due process," businesses have faced increasing costs of regulation. energy, transportation, pharmaceuticals, banking, and telecommunications are examples of a few industries that are presently regulated. according to a 1976 study by the congressional budget office, regulation of business generally takes one of the following forms: 1. ~t] impacts the operating business environment of broad sectors of private enterprise, including market entry and exit; rate price, and profit structures; and competition; 2. ~t] impacts specific commodities, products, or services through permit, certification, or licensing requirements; and 3. [it] involves the development, administration, and enforcement of national standards, violation of which could result in civil or criminal penalties which result in the types of impact described above ([20], p. 2). in most legislative bodies there is a maze of parliamentary rules and procedures that traditionally have been used by the minority to prevent or delay a vote on an issue that is favored by the majority ([30], p. 14). strong supporters of our democratic system of government find this manipulation of the rules to be one of the most serious breakdowns in the representative system of government [30]. the referendum and the right of initiative were developed to close this legislative loophole. 21 by the mid-nineteenth century, it was commonplace to require that state constitutional amendments be approved by the voters.... by 1900, americans were no strangers to the concept of approving changes in their fundamental laws by use of the referendum. that they should have the power of initiating such changes was, to many, a logical extension of their power; the right of initiative was adopted quickly in twenty-one states. neither the initiative nor the referendum, however, has ever been employed at the national level ([15], p. 46). it is important to distinguish between the initiative and the referendum processes. the initiative is the sole vehicle available to the electorate to propose legislation without the consent of the legislature. the referendum, on the other hand, ''is merely a popular veto on the acts of a legislative body. it's an instrument of negation. it is conservative, while the initiative is radical" ([30], p. 131). in an attempt to determine the percent of initiatives that eventually become law, magelby, klein, and thomas analyzed initiative results over a recent five year period and found that, when bottle bills were placed in the regulation category, "the s'llccess rate for business/labor regulation would be almost 35 percent-by far the best success rate for all categories" ([16], p. 23). in 1982, less than 30 percent of all proposals titled in initiative states actually qualified for ballot placement. there are four potential types of requirements for qualified ballot placement which, to a certain degree, vary from state to state. these requirements include (1) total number of required signatures, (2) statewide distribution of signatures, (3) certification of signatures, and (4) length of petitioning period. every initiative state has a minimum number of signatures required to place an initiative on the statewide ballot. the number of required signatures is usually a function of the number of votes cast for governor during the previous election. statewide distribution of signatures is required in several states to prevent voters from acting on issues that affect only a small segment of the state population. other states, however, have no distribution requirement, making it significantly easier to place an initiative on the statewide ballot (le., signatures may come from only one county in the state). requirements which are used to validate either all or a small "random" sample of signatures to certify authenticity are not standardized across states. finally, in three states (ohio, florida, and montana) signatures gathered in an unsuccessful petition drive can be carried forward and used in future initiative campaigns to meet signature requirements. in maine, signatures can be carried forward for one year and used in renewed initiative campaigns. a model of priv8te sector str8tegic responses to initi8tive petition responses initiative campaigns can be extremely expensive to wage. however, businesses that are unsuccessful in defending themselves from attacks via the 22 ballot box may find the implementation of regulations even costlier. businesses can scarcely afford to react to special interest groups action, instead, an anticipatory strategy is necessary. . , . (t)he first duty of strategic management is to stay abreast of organizational resources (potential as well as realized) and the opportunities and risks presented by organizational environments (potential as well as operational) ([19], p. 14). the policy problems of business, like those of policy in public affairs, have to do with the choice of purposes, the molding of organization identity, the unending definition of what needs to be done, and the mobilization of resources for the attainment of goals in the face of aggressive competition or adverse circumstances ([3], p. iv). a reactive campaign may have adverse effects on the business climate and should, if possible, be avoided by taking proactive measures at the earliest opportunity. since most modern business is conducted in dynamic an uncertain environments, thompson [27] argues that organizations should develop coping strategies to reduce the impact of uncertainty. many authors suggest that organizations can reduce uncertainty in two ways. first, organizations may reduce uncertainty through the adaptation of specified organizational structures. second, uncertainty can be reduced through the formulation of strategies aimed at altering the organization's structural environments to bring about a response-sensitive organizational-environment alignment ([1],[18],[19,[23],[27]). given the complexity of modern political environments, a model of how corporations might respond to an initiative campaign is illustrated in figure 1. this model is based on a 1982 case study of privately owned energy companies in michigan and consists of the following six phases: • prevention • organization building • coalition building • influencing public opinion • legislative action • mounting an opposition campaign 23 figure 1 model of strategic responses to ballot questions phase i phase ii phase i ii phase iv phase v phase vi prevention ~ i organization' ~ building coalition building ~ influence i~i legislative 1-1 1 mount an public opinion action opposition campaign i. prevention ii. organization building 1. open lines of 1. appoint executive. communication. 2. establish interorgan2. joint legislation. izational linkages. 3. negotiation. 3. retain legal counsel. 4. co-optation. 4. establish political steering committee 5. take the public pulse. 5. create a separate identity. v. legislative action 1. compromise legislation that would render the initiative unnecessary. 2. legislative alternative. i ii. coalition building 1. employees. 2. allies and vendors. 3. fundraising. 4. opinion leaders. 5. newspaper endorsements. 6. spokesmen. vi. mount an opposition campaign 1. retain professional campaign advice. iv. influence public opinion 1. citizens commission. 2. public relations campaign ~ n phose i: prevention in the course of normal legislative lobbying by special interest groups, the threat of circulating an initiative petition has often been used as an effective coercive tactic. modern business must be aware of this potential political occurrence and take steps to monitor such actions [10]. the needs and wants of special interest groups must be considered when formulating corporate policy. organizations that have no formal lobbying mechanism should subscribe to a legislative or an initiative monitoring service. there are several monitoring services, such as the national center for initiative review in englewood, colorado, that track circulating initiative petitions and publish a monthly newsletter on their activity. once there is evidence that petitions are circulating that might affect an organization's operations, a public opinion poll should be commissioned. in a large state, like michigan, a geo-attitudinal poll should be taken. this information is useful to assess the relative strengths and weaknesses of an organization's position. since everyone in the state votes on the same question, support for or against the proposal might be restricted to a specific region of the state. a good poll should measure more than just the amount of support or opposition to a question. it should additionally attempt to understand the public's general feeling toward the organization itself. polling should be repeated to measure changes in public opinion in response to publicity or implementation of the response strategy. the timetable for these repeated measurements are a function of the funds available for polling. funds for polling should not be an area of cost cutting since the information garnered is critical in the development and evolution of the organization's responses to adverse initiative campaigns. phose it: organization building if prevention measures are unsuccessful, there are a series of anticipatory steps which can be undertaken to increase the probability of eventual success in an initiative campaign, while minimizing the cost of the effort. the first step is to build an organization capable of responding to any potential political situation. since businesses most often face political battles with legislatures, and not the general public, a new organizational form is necessary. the size and structure of the new organizational form is a fun<;tion of two factors: (1) the results of the geo-attitudinal poll, and (2) the signals received from the legislative monitoring program. the first task for an organization faced with a potential initiative battle is to appoint an executive to coordinate the organization's response strategy. it is important that this executive be practical, have some previous experience in public affairs, and be knowledgeable about the issue and the state's political structure. the executive's first task is to establish ties with firms that would be similarly affected by the initiative. the coordinator should then solicit their support to join in a unified effort to defeat the ballot proposal. interor25 ganizational coordination should reduce duplication of effort and maximize human end financial resources. a political steering committee should be established to give the effort a pu blic identity distinct from the corporate organization( s). the steering committee shquld seek professional campaign and legal advice. strategic planning, communications, research, polling, and compliance with intricate campaign finance and election laws are a few areas the committee may want to discuss with professional consultants. phase iti: coalition building the political steering committee is responsible for formulating and implementing the response strategy and overseeing all fund-raising and budget decisions. the committee should begin by expanding its base to include other concerned individuals and groups that share in their opposition to the ballot initiative. two separate coalitions should be formed: one consisting of employees and shareholders, who have a vested interest in the continuing success of the fum, and another consisting of allies and vendors (i.e., other firms who would be either directly or indirectly affected by the new regulation). a well-built coalition will have far greater resources (i.e., people and money) and stand a better chance for ultimate success than a loosely coupled network of organizations with competing factions. for example, bottlers found that supermarkets and corner grocery stores were natural allies for their cause because these establishments would have to make provisions for storing and sorting returned bottles and cans. the most important resources a corporation has is its employees, shareholders, and allies. the overall cost of a campaign can be sharply reduced by educating these groups on the issues and training them to handle many of the administrative duties associated with a campaign effort. however, the use of employees can be expensive if they utilize company time to campaign. another critical resource to any organized effort is money. a full-fledged campaign can cost millions of dollars, as evidenced most recently in michigan and california. the establishment of a coalition of allies and vendors can be a valuable source of funds and will allow the cost of a campaign to be spread over several firms, instead of one firm absorbing the full financial burden. the use of outside political consultants makes sense when the complexity of the task becomes unmanageable for company executives. the response strategy can be formulated and implemented by these outside consultants. phase iv: influencing public opinion a comprehensive communications plan needs to be created based on the poll results and other research data at the company's disposal. the communications plan should include such items as direct mail, selected advertising, non-corporate endorsements, and third party spokespersons, with no vested interests, speaking out through a coordinated speakers bureau. radio and television commercials need to additionally be developed to communicate the 26 message of the campaign to the different geographic and demographic target groups within the state. phase v: legislative action businesses can utilize their existing lobbying force to propose compromise legislation that would satisfy both sides and render a campaign unnecessary. a costly campaign showdown should be avoided if at all possible since the results can never be absolutely predicted. compromise legislation may not be attainable because of a lack of agreement between the legislature and the governor. an alternative strategy may be to persuade the legislature to place an alternative question on the ballot that would provide another avenue to defeat the original initiative. all initiative states provide the legislature with the power to place an alternative competing question on the 'ballot. phase vi: mounting an opposition campaign a michigan case study in 1982, consumer advocates in the state of michigan successfully placed an initiative on the statewide ballot that, if adopted, would have adversely affected the economic stability of michigan's three major privately-owned energy providers: the detroit edison company, consumers power company, and the michigan consolidated gas company. this initiative-based proposal, labeled proposition d, called for a ban on all automatic rate increases except when approved at "full cost of service" hearings. the initiative also limited the frequency of these hearings. the consumer groups in michigan achieved a measure of success, despite spending only about $100,000, because their strategy and organization were both highly effective. they were successful in two ways: (1) they forced the private energy companies to support legislation that would abolish automatic fuel adjustments, and (2) they obtained free publicity from their legal maneuvers which allowed them to capitalize on a general hostility among voters toward energy providers. this second area of success arose from the practice of exerting legal challenges to the energy companies' ballot alternative. additionally, the consumer groups were organized at the grass-roots level which allowed them wide exposure and valuable free labor. in june, 1982" after an intensive lobbying effort by energy companies, the michigan state legislature voted to place an alternative referendum, labeled proposition h, on the november ballot. the consumer groups challenged the constitutionality of the alternative referendum in the courts and in september, 1982, the michigan supreme court ruled that the alternative proposal should be placed on the ballot to give the voters a choice. the energy companies made four strategic decisions from the outset that were critical to their ultimate success in defeating the initiative question: 27 • they pooled and committed whatever human and financial resources were necessary to wage a unified campaign • they sought outside counsel to plan and execute their strategy • they fully utilized their legislative options • they established a public coalition separate from their corporate identities to broaden their base of support, allowing a diverse constituency to join their effort (i.e., labor, business, and civic groups) the energy companies response strategy was unique in that: • it allied three competitors against a common problem • it developed a coalition of labor and business support • it supplied the voters an alternative ballot question to vent their frustration toward higher energy bills • it was the second most costly initiative campaign to that date, costing $7,409,002 results in november, 1982, 51 percent of the voters of michigan gave proposal d, the citizen initiative, a yes vote while the energy companies' alternative referendum, proposal h, received nearly 57 percent. legal precedent in michigan has held that if two similar ballot questions both receive a majority vote, the question with the greatest number of affirmative votes prevails. proposal h outpolled proposal d by 198,000 votes. it was an expensive victory for the energy companies. discussion private energy companies, like many other industries, operate in full view of the public and are prepared to respond to regulation from normal government channels. most corporations have established public relations departments and have in-house lobbyists that deal with regulatory agencies, state legislatures, and congress. while many other organizations operate in the public domain, they are not used to being regulated by the general public. most organizations have established contacts with local politicians, opinion leaders, and newspapers. these are not the type of citizen groups that usually initiate a regulatory petition drive. for example, the dart-kraft company is used to responding to regulation concerning the price and quality of dairy products by the food and drug administration (fda). however, they did not perceive that they would become part of the solution to another important problem-hunger in the united states-by becoming directly affected by president ronald reagan's cheese 28 giveaway program. dart-kraft's cheese sales decreased nearly six percent when the giveaway began and the lobbyists of dart-kraft were unsuccessful in their attempt to influence the congress and the fda to modify the program. the inability to revise the program may be attributable, in part, to the immense popularity of the program with the general public. there have been several changes in the use of the initiative since its inception, from the initial purpose of ratifying constitutional amendments and local charters. not 811 states have the right of initiative, nor does there exist a national referendum process. however, initiatives are popular in those states that have them. in california, 85 percent of the voters thought that direct legislation was a good idea [16]. finally, many businesses are finding that elected representatives no longer respond to lobbyists the way they once did. today's representatives are listening more to the constituents they represent. business executives need to learn how to get their message to the general public as a way to influence future legislation rather than relying on the lobbying system. hopefully, this article is a step in that direction. references 1. aldrich, howard and pfeffer, jeffrey. "environments of organizations," annual review of sociology, vol. 2, palo alto, ca: annual review inc., 1976. 2. anderson, jack. "tax revolt: the opening of the u.s. wide movement," de8eret new8, june 13, 1978, p. a3. 3. andrews, kenneth r. the concept of corporate strategy, revised edition, homewood, il: richard d. irwin, 1980. 4. backoff, robert w. "operationalizing administrative reform for improved governmental performance," admini8trative science quarterly, vol. 6, no.1, may, 1974, pp. 73-106. 5. bolt, ernest c., jr. ballob before bullet8: the war referendum approach to peace in america, charlottesville, va: the university of virginia press, 1977. 6. butler, david and ranney, austin. referendums: a comparative study of practice and theory, washington, dc: american enterprise institute for public policy and research, 1978. 7. davis, lance e. and north, douglass c. in8titutional change and american economic growth, cambridge, ma: cambridge university press, 1971. 8. everett, david. "utilities use subtle offense to win at the polls," the detroit new8, november 7, 1982. 29 9. farris, martin t. and sampson, roy j. public utilities: regulation, management and ownership, boston, ma: houghton mifflin, 1973. 10. grefe, edward a., fighting to win: busineljs political power, new york, ny: harcourt, brace jovanovich, 1981. 11. hoffman, alan n., cynthia spanhel, and rolf carlson. ''the answer book," unpublished monograph, matt reese and associates, 1982. 12. initiative quarterly, 1.1, englewood, co: national center for initiative review, october 1982, pp. 7-8. 13. kilpatrick, james. "the year of the taxpayer," san f'rancmco chronicle, june 2, 1978, p. 52. 14. kraft, joseph. "populist hedonism," washington poljt, june 11, 1978, p. c7. 15. lee, alton. the referendum device, new york, ny: macmillan book co., 1981. 16. magleby, david b., walt klein, and sue thomas. "the initiative in the 1980s: popular support, issue agendas, and legislative reform of the process," paper presented at the 1982 annual meeting of the american political science association. 17. mathews, jay. "initiative process gains popularity," waljhington poljt, may 29, 1982. 18. miles, raymond e., charles c. snow, and jeffrey pfeffer. "organizationalenvironment: concepts and issues," induljtrial relationlj, vol. 13, no. 3, pp. 244-264. 19. miles, robert h. coffin nails and corporate strategies, englewood cliffs, nj: prentice-hall, 1982. 20. mitnick, barry m. the political economy of regulation, new york, ny: columbia university press, 1980. 21. mitnick, barry m. ''the strategic uses of regulation and deregulation," busineljlj horizonlj, march/april, 1981, pp. 71-83. 22. navarro, peter. "our stake in the electric utility's dilemma," harvard business review, may/june 1982, pp. 87-97. 23. pfeffer, jeffrey, and leblebici, huseyin. ''the effect of competition on some dimensions of organizational structure," social forcelj, vol. 52, no.2, pp. 268-279. 30 24. price, charles m. 'the initiative: a comparative state analysis and assessment of a western phenomena," western" political quarterly, vol. 28, june 1975, pp. 243-263. 25. quinn, robert s. 'the initiative: who needs it? ," maine sunday telegram, march 14, 1982, p. 4d. 26. shepard, william g. the treatment of afarket power: antitrust, regulation, and public enterpri!le, new york, ny: columbia university press, 1975. 27. thompson, james d. organizations in action, new york, ny: mcgrawhill, 1967. 28. vitali, samuel a., and vento, gerald t. "problems with the initiative and referendum process," unpublished working paper, peralta, gilligan and vitali, 1982. 29. walsh, lawrence r. 'the role of public relations in initiative campaigns," unpublished working paper, hill and knowlton, 1982. 30. wilcox, delos. government by all the people, new york, ny: dacapo press, 1972. 31. wilcox, clair, and shepard, william g. public policies toward business, third edition, homewood, il: richard d. irwin, 1966. 32. will, george. "california votes to undo what has been done," los angeles times, june 8, 1978, p. b7. 31 strategic responses to ballot questions by the private sector volume 34, number 2 111 real estate investment decisions i: commercial office property acquisitions jonathan breazeale sam houston state university • huntsville, tx case description the primary subject matter of this case concerns the financial analysis of the acquisition of a commercial office property. secondary issues examined include aspects of office reits – with which most business students are unfamiliar. the case has a difficulty level of four, appropriate for undergraduate seniors. the case is designed to be taught in a single 80 minute class period and is expected to require three to four hours of outside preparation by students (depending on their level of spreadsheet familiarity). case synopsis you are a member of the investment committee and serve as an outside director on the board of city view office, a publicly traded real estate investment trust (reit) with a focus on commercial office properties. it is the fourth quarter of 2005, and management’s acquisition team has just submitted a package for your approval that will solidify the offer that has just been presented on the forum, a beautiful six-story class a property in the energy corridor of houston, texas. your vote will determine whether or not the firm moves forward with the purchase. real estate investment trusts (reits) real estate investment trusts (reits) were created by congress in 1960 to allow small investors access to capital intensive, large-scale real estate. small investors are allowed to pool their equity in reits just as they would in any other corporation, enabling them to participate in an industry that was formerly inaccessible for the purpose of diversifying their personal portfolios. reits own and, in many cases, operate income-producing real estate of a specific type or types. for instance, there are reits that own office buildings, industrial properties, apartments, hotels, shopping centers, timber, or a combination of these and other types of real estate. reits may also own financial assets such as mortgages and other real estate financing. the most important aspect of a reit is that it does not pay corporate income taxes as long as it meets certain requirements the most important of which 112 journal of business strategies is that it distributes 90% of its otherwise taxable income to its shareholders each year in the form of dividends. it is a great advantage for equity investors to receive untaxed distributions, but the reit is faced with the difficulty of having to access capital markets frequently for external funding since it cannot use much of its net income to fund investment in new assets. in other words, reits have very small amounts of retained earnings on their balance sheets. due to the large amount of depreciation arising from investment in long-term fixed assets and the large gains/losses that can result from the sale of large assets, reits utilize measures of financial performance that deviate somewhat from gaap measures reported by other public corporations. the national association of real estate investment trusts® (nareit – www.nareit.com) is an industry organization that provides services to reits and acts on behalf of its member firms in lobbying and other political efforts. nareit defines the measure funds from operations (ffo) as net income (on a gaap basis) excluding gains or losses from sales of most property as well as depreciation of real estate (national association of real estate investment trusts, inc., 2007). this provides a measure of operating performance more consistent with the recurring nature of the reit’s operations rather than net income that is influenced by large one-time transactions such as asset sales or large changes in depreciation brought about by either sales or acquisitions. therefore, ffo provides a measure that is more consistent with the types of assets held by reits and allows for better comparison of the operating performance of multiple reits as well as trend analysis of individual reits year after year. while ffo provides a more consistent measure of operating performance for the real estate industry, it is not well suited to provide a measure of how much cash is available for a reit to pay its all-important dividends. as a result, some reits also disclose funds available for distribution (fad) which might also be reported as cash available for distribution (cad) or adjusted ffo. while ffo is “standardized” across the industry, the calculation of fad is not. however, fad is essentially ffo less capital expenditures (tenant improvement allowances, leasing commissions, non-revenue enhancements, capital improvements to new acquisitions, etc.) that reduce the actual amount of cash that is available to distribute to shareholders. at the start of 2005, there were more than 200 publicly traded reits on u.s. stock exchanges with assets valued at nearly $1 trillion. office properties comprise approximately 19% of the total value of assets owned by reits making them the largest property type in which reits are invested (national association of real estate investment trusts, 2007). volume 34, number 2 113 city view office properties city view office has been taking it on the chin recently. falling occupancy and rental rates nationwide, along with rising insurance and electricity costs, have resulted in an inability to cover the dividend for the past three years. hot money has also entered every major real estate market in the country – making the acquisition of assets more difficult with the high cost of corporate capital. fortunately, city view office has just closed on a joint venture with a large public employee pension fund that will allow them to pursue investment opportunities with acceptable lower yields. additional yield for city view will come from management, leasing, and construction management fees associated with their wholly-owned realty service subsidiary. terms of the joint venture state that city view realty services has a 10-year non-cancelable contract for these services on every acquisition made by the joint venture. table 1 summarizes the joint venture’s current purchasing criteria. table 1 city view office properties’ published joint venture acquisition criteria size: 100,000 to 1,500,000 square feet, multi-story (250,000 for new markets) quality: class a, aor b+ leasing: 70% to 100% leased to quality credit tenants yield: 7.0% capitalization rate based on 92% occupancy, risk and quality of tenants. unleveraged irr of 8.0%. ownership: 100% fee simple parking: parking must adequately accommodate market and building code requirements as well as service the building at 100% occupancy. replacement cost: current replacement cost cannot exceed the purchase price. replacement cost is the total development cost to recreate the property – and its economics – in today’s dollars. markets: new york boston washington d.c. atlanta chicago houston los angeles phoenix tenants: preference for buildings with a major tenant (30% or more of the total rentable square feet) with at least 5 years remaining on lease. debt: purchases are conducted in all cash. disclaimer: at its sole discretion, city view has deviated and may deviate from its published criteria. 114 journal of business strategies houston office market houston has been a bright spot in an otherwise dismal climate of economic expectations. both occupancy and rental rates are on the rebound – as evidenced by the pace of construction in a majority of the submarkets. and, despite the recessionary overtones heard nationwide as a result of the retraction of inflated residential values, the heavy energy presence in houston has somewhat insulated the commercial office market from the current economic downturn. oil prices continue to climb, and that is good news for houston. city would love to own more property in a market where expansion is actually occurring. table 2 summarizes the current state of both the houston energy corridor submarket and the overall houston market. table 2 class “a” office market statistics market metric energy corridor total houston market size 5,917,994 square feet 58,145,642 square feet vacancy 5.7% 15.5% average rental rate $22.68 $20.67 the energy corridor has long been known as the home of many top players in the energy industry. in close proximity to the forum, british petroleum, exxon mobil, conoco phillips, shell oil, citgo, halliburton, schlumberger and aker maritime all lease substantial amounts of office space. since oil and gas are the revenue generators for these firms, rental rates are very closely tied to oil and gas prices. when oil prices are high, these firms expand their operations and need additional office space. historical rental rates for the energy corridor for the last 8 years have been $25.00, $22.90, $20.50, $24.23, $21.81, $21.79, $21.84, and $22.68, respectively. the forum the forum is a 150,000 square foot, six-story, class a office building located within the energy corridor of houston, texas. it is 100% leased to four quality credit tenants, the largest of which (aaa oil) occupies almost 75% of the building. the existing tenant base has a weighted average gross rental rate of $20.29 and a remaining lease term of 44 months. baring an unforeseen catastrophe, the initial yield of the investment appears solid. the property is located on a 5.3 acre site, volume 34, number 2 115 and a 596 space parking garage services the building (approximately 4 spaces per 1000 square feet of rentable office space). the building and garage were completed in 1999, so no substantial capital expenditures are projected in the near future. the current quoted gross rental rate is $23.00 per foot, and the seller is offering the property on a 100% fee simple basis. the typical floor plate is approximately 25,000 square feet, and each floor is serviced by three dover geared passenger elevators. an additional service elevator is located at a loading dock, and two hydraulic elevators service the four-level garage structure. construction consists of a cast-in-place reinforced concrete slab at grade. the superstructure is comprised of reinforced cast-in-place concrete framing which includes columns, shear walls, elevated concrete floor slabs and roof slabs. exterior walls are precast panels with fixed aluminum framed insulated glass windows. the roof is constructed of multi-ply bituminous built-up roofing membrane over the concrete deck and is toped with aggregate. two 269-ton trane rotary liquid chilled water units provide air conditioning to the building, and all systems are controlled by a johnson controls energy management system. the building uses pneumatic thermostats. the property is well lit on the exterior, and a superior life safety system is in place for fire and other contingencies. management has provided you with the timeline submitted by the seller’s broker in the offering memorandum. this information is contained in table 3. table 3 seller’s desired transaction timetable august 25, 2005 announcement mailing delivered to prospective purchasers investor registration commences september 2, 2005 distribution of offering memoranda to registered parties inspection tours conducted by appointment only informational meetings with property management and interested parties additional material will be made available for review: form purchase and sale agreement boundary survey/site plan preliminary title report tenant leases historical operating information property tax information as-built floor plans operating budget 116 journal of business strategies october 5, 2005 offers are due by letter of intent (loi) in the broker’s office by 5 p.m. investors are encouraged to include verifiable financial information, transaction references and financial references together with their lois. october 12, 2005 finalist(s) selected finalist interviews/conference calls reference checks investigation of funding capabilities october 14, 2005 selection process completed notification to all remaining parties letter of intent executed october 21, 2005 purchase & sale agreement executed formal due diligence period commences information delivery to purchaser november 18, 2005 due diligence period ends earnest money deposit non-refundable december 2, 2005 closing financial projections and market assumptions management has included the forum’s rent roll and the broker’s pro forma cash flow statement that was included in the offering memorandum – along with the included assumptions. tables 4, 5 and 6 detail these crucial sets of information. volume 34, number 2 117 t ab le 4 . r en t r ol l ta bl e 4 r en t r ol l 118 journal of business strategies t ab le 5 . t he f or um p ro f or m a c as h f lo w ta bl e 5 t he f or um p ro f or m a c as h f lo w . . . volume 34, number 2 119 table 6 notes to pro forma cash flow statement (1) average annual occupancy is subject to the broker’s projected lease-up schedule and 12 months of downtime between non-recurring leases. (2) market rental rate / rsf is the assumed market base rent expressed as a gross rate with the tenant being responsible for its prorate share of recoverable operating expenses in excess of a base year amount. the market rental rate for 2006, 2007, and 2008 is $23, $24, and $25, respectively. following 2008, the market rental rate increases 3% annually. (3) base rent is projected pursuant to the terms of existing leases and the following assumptions: all expiring leases are subject to 12 months of downtime and seven-year renewal terms. aaa oil is subject to an 80% renewal probability, while the other tenants are subject to a 65% renewal probability. effective 09/01/2005, the green company (suite 200) reduces its square footage from 16,694 sf to 14,909 sf and continues to pay a base rental rate of $26.85. effective 09/01/2005, griffin gas (suite 225) expands by 1,692 sf to 10,175 sf and extends its current term from 02/28/2006 to 02/28/2011. the rate for the expansion space is $23.00, while the rate for the original premises (8,483 sf) remains at $24.15 until 02/28/2006. on 03/01/2006, the rate for the original premises changes to $23.00. effective 09/01/2005, the management office, which provides no income for the duration of the analysis, expands by 93sf to 1,665 sf. (4) expense recoveries reflects charges to tenants for their respective pro rata share of escalatable operating expenses. aaa oil reimburses in proportionate share of operating expenses on a “nnn” basis plus a management fee equal to 3% of its base rental and recoveries (excluding the standard property management fee). all other tenants reimburse their proportionate share of recoverable operating expenses that exceed a stated or base year amount. moonguard’s $9.00 expense stop resets to a 2006 base year effective 11/01/205, while the green company’s $8.00 expense stop remains constant throughout the analysis. griffin gas’ original square footage (8,483) is subject to an $8.93 expense stop through 02/28/2006, while the expansion space (1,692) is subject to a 2006 base year effective 09/01/2005. griffin’s entire space is subject to a 2006 base year effective 03/01/2006. per griffin’s lease, reimbursements ) ) 120 journal of business strategies are limited by the controlled growth of the property’s recoverable operating expenses. operating expenses cannot increase by more than $8,483 annually through 08/31/2006 and by $10,175 annually thereafter. base year stops are assumed for all renewals other than aaa oil, which assumes a nnn recovery upon renewal. (5) parking income is based on management’s 2005 budgeted amount and inflates 3% annually. (6) telecom income reflects the 2005 schedule rental income from sprint ($18,000) and at&t ($3,417) agreements inflated 3.25% per annum. (7) miscellaneous income consists of management’s 2005 budgeted amounts for overtime utility charges ($50,100) and parking sales tax ($4,358) that inflate 3% annually. (8) collection loss reflects a 1% reduction to schedule base rent for non-credit tenants. the loss factor is not applied to aaa oil or griffin gas during their initial terms. (9) cleaning includes charges for contract cleaning, window washing, trash removal, a day porter, cleaning supplies, and other cleaning expenses. management’s 2005 budgeted amount inflates 3% annually. (10) utilities include the cost for electricity, water, and sewer. management’s 2005 budgeted amount of $356,600 is reduced by $50,100 to exclude directly billed overtime electricity, which is reclassified as a non-recoverable expense. the net amount of $306,500 inflates 3% annually. (11) repairs & maintenance represents all maintenance-related costs for the building including engineer salary and benefits, electrical, hvac, plumbing, elevators, roof, painting, exterminating, supplies, life safety, interior landscaping, and other maintenance related items. management’s 2005 total budgeted amount inflates 3% per annum. (12) security consists of contract charges for guards’ salaries and equipment monitoring. management’s 2005 budgeted amount inflates by 3% per annum. (13) landscaping & grounds expense includes budgeted amounts for exterior landscaping and sweeping. the 2005 budgeted amount inflates by 3% per annum. (14) general & administrative includes various business related costs associated with operating the building such as property manager salary and benefits, management office rent, corporate overhead, telephone, garage expenses, accounting fees, tax consulting fees, and other office related expenses. management’s 2005 budgeted amount inflates 3% per annum. volume 34, number 2 121 (15) management fee is calculated as 2% of effective gross revenue in each year of the analysis. (16) insurance reflects the total liability insurance premiums for the building. management’s 2005 budgeted amount grows by 3% per annum. (17) association dues reflect annual assessments by the owner’s association. management’s 2005 budgeted amount inflates 3% annually. (18) real estate taxes for the first year of the analysis reflect the projected 2005 property taxes that will be paid in 2006. the first year taxes are estimated by inflating the actual aggregate 2004 tax rate of $3.09125 by 3% and applying the result to the 2004 assessed value of $18,332,620. property taxes for 2006, which are paid in 2007, assume the property is reassessed to 70% of the sales price and are subject to the inflated 2005 tax rate of $3.18399 inflated by 3%. thereafter, property taxes increase 3% annually. (19) non-recoverable includes directly billed overtime electricity ($50,100), parking sales taxes ($4,358), and delivery expense ($1,000). the aggregate amount inflates 3% per annum. (20) tenant improvements reflects the total cost to build out leased office areas for both new and renewing tenants. new leases on second-generation space receive a $15 allowance, while all renewing leases are granted a $6 allowance. the assumed amounts for the tenant improvement allowances are expressed in 2006 dollars. tenant improvement allowances for second-generation space grow annually by the general inflation rate. (21) leasing commissions are calculated as 6% of the net effective value of the lease on new leases and 5% for all renewals. all leasing commissions are assumed to be funded 100% upon occupancy. (22) capital reserves of $.10 per square foot are funded in 2006 and increase 3% annually thereafter. references national association of real estate investment trusts. (2007). frequently asked questions about reits: answers to fundamental questions about reits. washington, d.c. 122 journal of business strategies instructors’ notes real estate concepts included in the text of the case are details related to real estate investment trusts (reits). this information is not necessarily pertinent to the calculations required to make decisions about whether to purchase the property in question (the forum), but rather to expose students to an industry they might not otherwise be exposed to in a typical course in financial management. reits (both public and private) are a driving force in the market for commercial real estate, and they own many of the properties that other types of businesses lease space from to conduct their operations. in other words, students stand a good chance of a reit being their commercial landlord. the details in the included offering memorandum closely resemble that of an actual property that sold in the energy corridor of the houston office market in 2005. the name of the property and tenants have been altered, but the express permission of the selling broker to use the offering memorandum has been given. it is an actual real estate deal in a large submarket of a major us city. the math involved in the analysis of the purchase is just difficult enough to give students a feel for how complex real estate valuation can be – especially the estimation of expected future cash flows. the property has four tenants – which is a sweet spot. a single tenant property is substantially easier to analyze. a thirty-tenant property is substantially more difficult. suggested questions for students as students analyze the merits of this investment opportunity, here is a list of questions intended to spark discussion of this capital budgeting opportunity. possible solutions are included. 1. should you purchase the building? answer: as with all capital budgeting questions, the answer depends on the npv of the investment opportunity. student answers here will vary. there are many potential inputs and considerations when identifying the marginal cash flows associated with the office property. students should not rely on the analysis conducted by the selling agent. the agent’s motivation is to generate as high of a sales price volume 34, number 2 123 for the property as possible. he or she will make the numbers look as rosy as can be for the existing set of contracts. students should be skeptical of all the inputs. remember, real estate is sold via a firstprice sealed-bid auction, and the principles of the winner’s curse certainly applies. the buyer should conduct the financial analysis assuming the worst case scenario. an example of this is parking revenue. current tenants are paying for parking, but remember that this is a suburban office property in houston, texas. land (and parking) are in abundance. chances are good that as tenants renew, they will be less likely to pay top dollar for parking spaces as the building ages. 2. what is an appropriate offer price? answer: a detailed excel analysis is available from the author via email at btrazeale@shsu.edu. a conservative estimate for an appropriate purchase price is between $18-20 million. note that our solution is extremely conservative. we’ve included none of the rooftop income or parking revenue in the analysis. we’ve not assumed any increase in rental rates (or expenses) over the next ten years. it may be the case that these adjustments may need to be made in order to be competitive, but technology changes (rooftop). also, our solution provides expected future cash flows on an annual basis. more precise estimates should be calculated on a monthly basis since rent is paid twelve times a year. 3. what makes you comfortable about the purchase? answer: the number one thing that real estate purchasers are concerned about is the financial well-being of the tenants on the rent roll. each of the firms are of quality credit, and that is comforting (although a formal credit analysis is anticipated during due diligence). another nice thing about the property is that it is a relatively new property. capital expenditures in the first years of ownership (other than leasing costs) should be minimal. the roof and heating/ cooling system are in good shape – as is the garage, elevators and life safety systems. eco_wbg sticky note jbreazeale@shsu.edu 124 journal of business strategies 4. what makes you uncomfortable about the purchase? answer: the property is 100% leased to four tenants, but each of them do not occupy 25% of the property. aaa oil is the 800-pound gorilla. the financial success of the investment will be determined by whether or not they intend to renew their lease at the property. their renewal option has sweeteners, but will they be enough to keep aaa oil at the building – paying rent? 5. what type of change(s) in your assumptions would cause you to change your answer to question (2)? answer: aaa oil is modeled as having a 75% likelihood of renewal. if they are less likely to renew than that, then the purchase offer should be lower. their option to renew states that they can renew at 95% of the current market rate (currently $23.00). will they really stay at that price? they currently only pay $18.61 per square foot per year. increasing from $18.61 to $21.85 is an extra $362,000 per year in rent. that may be enough for them to leave – unless you are willing to accept a lower rental rate. 6. what aspects of this real estate case differ from other industrial problems or cases that you’ve worked through in the past? answer: student answers to this question will vary with their previous experience. most student experiences have likely involved production questions (quantity and price) to obtain expected future cash flows. here they are asked to evaluation lease contracts (effectively receivables). brief biograpical sketch of author dr. jonathan breazeale is associate professor of finance at sam houston state university – where he teaches business finance, financial markets and institutions, and security analysis and portfolio management. his research interests include real estate, financial education, and working with students interested in publishing research – at both the undergraduate and graduate levels. prior to becoming a professor, dr. breazeale was vice president of parkway properties, inc. (nyse: pky), a public real estate investment trust (reit) invested in office properties. the experience curve's role in strategic planning mark kroll and roxanna hannan department of management sam houston state university huntsville, texas managers attempting to assess their position in the industry in which they compete, and understand where their firm and industry are headed might benefit from a concept which has been around for a while: the experience curve. the experience curve, or learning curve, was first popularized during world war ii, as government contractors searched for ways to predict costs and time requirements for construction of ships and aircraft (15). later, the boston college group (bcg) used it as one of the foundations upon which they built their "beg growth-share matrix." this paper examines the current status of the experience curve, and its value in the strategic management process. first, the concept of the experience curve is reviewed, along with reasons why costs behave as it suggests. then the relationship between the experience curve and market share is developed, and implications are outlined. next, some of the shortcomings of this relationship are discussed. finally, some guidelines for deciding when and how the experience curve should be used are provided, along with an illustration. the experience curve revisited while the applications of the experience curve, and names given it have changed over the years, the basic concept remains the same. experience curves represent attempts to model the often observed fact that costs in many industries go down as accumulated output increases. while the rate of decline varies from industry to industry, the decline of costs is often highly predictable when constant dollars are used as the unit of measure. it is postulated that every time cumulative output doubles, per unit costs go down by a certain percentage (which is often determined using historical data for the industry). for instance, if an industry is found to have an eighty percent experience curve, and the first unit costs $10 to produce, then the predicted cost for unit two would be $8 ($10 x .80). unit four's predicted cost would be $6.40 (or $8.00 x .80). unit eight's predicted cost would obviously be $5.12, eighty percent of unit four's cost, and so on. exhibit 1 34 illustrates the relationship between accumulated volume (horizontal axis) and direct cost per unit (vertical axis) (7, p. 109). exhibit 1: accumulated volume and cost per unit direct cost/ $10 un; t $ 9 $ 8 $ 7 $6 $ 5 $ 4 $ 3 $ 2 $ 1 $ 0 1 2 3 4 5 6 accumulated volume this cost behavior has been found to exist in a variety of industries, although the cost coefficient varies by industry. the experience curve for margarine production has consistently been found to be about 79%. italian refrigerator manufacturers report an 82% experience curve. even service industries such as life insurance have reported significant experience curve effects over the last thirty-five to forty years (1). reasons for declining costs there are three basic reasons why the experience curve effect exists. these include exogenous progress, economies of scale, and basic improvement learned from cumulative output (4). exogenous progress. this first source includes such factors as improving technologies, improved production layouts, more efficient maintenance schema and better distribution of the final product. in addition, the introduction of new technology to improve performance becomes feasible as higher volume levels justify such commitments. for example, introducing computer controlled production and automation allows management to focus less on routine administrative and managerial duties and more on product advancement and further cost reduction. however, these improvements require that the company achieve enough volume to justify· such costly investments (7, p. 112). as a firm moves down the experience curve, exogenous progress follows something of a compounding effect, allowing the firm to become even more efficient and thus 'lowering its costs even further. 35 economies of scale. economies of scale, or the decrease in average unit costs as productive capacity is expanded, explains a large portion of decreases in costs. economies can usually be achieved in nearly every step of the production process. high volume production increases the availability of improved technology. often resources can only be profitably used when incorporated into fairly large operations. backward and forward integration of manufacturing processes and business activities, which often permits significant savings, can be justified only by large firms operating in stable environments. also, increases in scale often result in a decrease in the firm's cost of capital relative to competitors. as the cost of capital decreases, the company gains an obvious strategic advantage over competitors (11). basic improvement. the last source of cost reduction is basic labor and management improvement gained from cumulative experience. the repetitive performance of a task allows an individual and an organization to learn more about that task and develop skills to complete the task in more efficient ways. such learning leads to specialization and standardization, product improvements through design modification, better utilization and substitution of materials, rationalization of the product-mix and improvements' in the manufacturing process. strategic implications of the relationship between experience and market share the experience curve is normally used 'as a guide in forecasting cost behavior and as such has important strategic internal and external implications. internally, it can provide forcasted cost targets useful in controlling performance. externally, the experience curve permits competitive comparisons (2). this process of comparison has led to a linkage between the experience curve and relative market share. experience curve-market share relationship it has been suggested that if firms competing in a given industry face a fairly uniform experience curve, the company with the greatest cumulative output will have the lowest costs in the industry and therefore the highest profitability (2). in most instances, the firm with the greatest market share will be the one with the greatest cumulative output. as a result, the firm with the largest market share is typically furthest out on the experience curve (having the most accumulated experience) and therefore has the lowest cost. this gives the company not only a cost advantage, but positions the firm so that it can lead the industry in technological innovation and exogenous progress, further enhancing its competitive position. this logic seems to have been in part validated by the results of the profit impact of market strategy study (pims) (9) which identified and measured the major determinants of return on investment (roi). the study found that in various industries each 10 percentage point gain in market share was generally 36 accompanied by a 5 percentage improvement in pre-tax return on investment (roi). the linkage between profitability and market share has also been supported by additional studies of various unrelated industries. in the household and personal care products industry for instance, when firms are ranked according to market share (horizontal axis, exhibit 2) and operating margin (vertical axis, exhibit 2) the results show that as market share increases so do profits (2). exhibit 2: market share and operating margin operating 50 margin 10 5 colgatepalmolive lever brothers procter and gamble 1.0 strategic implications 5.0 10.0 50.0 100 percent of market the relationship between market share and profitability has some important implications for pricing strategies and long-term company survival. exhibit 3 represents the relationship between accumulated output and direct cost per unit (7, p. 114-115). as can be seen, firm a has a significant cost advantage over its competitors. firm d is a marginal firm whose survival will largely be determined by the strategic moves of firm a, which is capable of waging sustained price wars. in such a situation each firm will need to make some fundamental strategic decisions. firm a, if aware of its cost advantage, will need to identify and develop options relative to firms b, c and d. firm d must decide whether to stay in the industry as a marginal competitor, liquidate, or incur the costs necessary to achieve a greater market share. if firm d chooses to remain as a marginal player, it will likely survive only as long as firm a wishes to avoid direct price competition. 37 exhibit 3: company survival cost/ unit b a accumulated output company survival. bruce henderson (1979), building upon the logic just presented, proposes that a stable, competitive industry never has more than three significant competitors, the largest of which has no more than four times the market share of the smallest. this proposition has some important implications. first, if there are many firms competing, a shake-out will inevitably occur in the absence of outside constraints on the competitors. the market leaders (firms a and b in exhibit 3) will likely apply pressure on the low marketshare firms (firms c and d) until the two largest competitors are the only non-losers. second, in order to survive, a firm's volume must grow at a rate faster than the market as a whole or their market share will decrease. when market share decreases, at the very least, large amounts of cash must be used to gain it back which will penalize profits. thirdly, the quicker investments in marginal firms, such as firm d in exhibit 3 are cashed out the better, as such firms are likely to become cash-traps requiring perpetual reinvestments of positive cash flows to compensate for loosing years. investments in firms other than the top one or two are quite risky. pricing implications. in terms of new product pricing, a decision must be made whether to charge a price which reflects the eventual experience curve related savings, or price reflecting initial unit costs. a lower price might be used to gain market share, though as shown later, this does not always work. an alternative is to set a high initial price and enjoy high profits as costs decline, before competitors eventually force prices down. either way, when new competitors start to enter, prices normally decline faster than costs are declining for the average firm. this is true because of the relatively high cost position on the experience curve of the average firm. 38 shortcomings of the experience curve market share phenomenon the experience curve-market share phenomenon and its implications seem straight-forward; leaving the impression that only market share leaders will be profitable and the experience curve will ultimately determine profitability. however, there are limitations to the usefulness of the relationship for strategic planning, and market share is not the only route to profitability. some limitations the experience curve is not a concept that can be applied to all firms in all industries, and those firms that can use the concept need to recognize three major limitations. discontinuation. first, the benefits of learning by doing, at least at the manufacturing level, discontinue after a certain level of output is attained. at some point, the accumulated volume necessary to double output becomes so great and the reduction in costs resulting from a doubling of output so small as to render the experience curve irrelevant (6). change of strategy. secondly, when a firm which has focused exclusively on the market share-volume-cost relationship reaches the limits of that relationship, it may find development of new strategies difficult (14). a company sometimes loses its innovativeness and flexibility because all its energies have been directed toward pursuing the experience curve in one field or product. new strategies can also be very costly if they involve a major change in the technology the company is familiar with and has invested heavily in. the classic example of this is henry ford and his model t. his heavy investments of time and money in the production of the model t were for a time very profitable, until consumers demanded something else. at that point, ford motor lost its innovative edge. since so much was invested in the specific production of the model t, product change was very costly. the resulting setback caused ford to lose market share and leadership of the industry (1). sometimes the transition can be so difficult and costly that it even forces companies out of business. such was the case with the shift from manual to electric typewriters, and mechanical adding machines to electronic calculators (1). spillover effect. finally there is a "spill-over effect" associated with the experience curve phenomenon. a company may reduce its costs not only through its own experience to date, but also through industry-wide experience. the spill-over effect accelerates the process of cost reduction for the entire industry and often reduces the incentive for firms to aggressively pursue cost-reducing measures. this is especially true in industries where the learning process is a matter of public record, as has been the case in the nuclear power plant construction industry (12). 39 alternative approaches the experience curve, as shown earlier, has its limitations and should not be used by all companies. it may be possible to compete effectively without single-mindedly pursuing market share. innovation appears to be the key to alternative strategies. a study done of the nation's most successful mid-size companies found that 74 percent have an innovative product, service or marketing approach (3). innovation is a common thread running through porter's (10) strategic alternatives to pursuing high market share. product differentiation and targeting are two of his more interesting alternatives. differentiation. studies have shown that market share is less important for infrequently purchased or specialty (differentiated) products. the reason appears to be that such products involve greater consumer risk, and consumers are willing to pay extra for quality assurance (12). for example, perdue company differentiated their product by producing a better quality name-brand chicken and was able to command a 10 cent per pound premium (3). targeting. porter's second alternative strategy is to target a particular market segment. this allows the firm to develop a particular strength, charge a higher price and stay profitable. river laboratories, a leading producer of research animals, detected an unmet market for high quality, genetically defined labor rats. in the same way, lenox developed a lucrative bridal market for its china (3). using the experience curve although the experience curve has many limitations and market share is not the only way to compete in the market place, there are certain times when the concept is viable and awareness of its implications are crucial to survival. when to use the experience curve the industry structure, relative positions of key competitors and the level of government involvement are critical variables which must be analyzed in deciding whether the experience curve is relevant (5). industry. included in an analysis of the industry are such factors as: industry life stage, technology risk and prices. the experience curve strategies usually gain greatest leverage in the early stages of a product's life cycle. the reason for this is that cumulative output doubles much more frequently in the early stages of a product's life cycle. for instance, optical fibers and vacuum cleaners follow approximately the same experience curve, but it presently takes two years to double optical fiber output and twenty for vacuum cleaners. second, when analyzing the industry, technology is important. if a company faces technological uncertainty and decides to produce before uncertainty is resolved (get an experience curve head start), the benefits can be 40 great, as was the case for corning glass in the optical fibers market. however the risks and possible losses can also be great, as rca learned with video disk players. finally, experience curve strategies are particularly appropriate in industries where demand is especially price sensitive. a price cut which results in significant volume growth will allow the company to move further down the experience curve and reduce prices further. texas instruments (ti) did this in the calculator market. they made the first major cost-cutting advances and were able to cut prices on previously high priced calculators. this allowed ti to capture a large share of the market, allowing further progress down the experience curve. competitor analysis. if a firm faces weak competition (usually undercapitalized with high cost structures) the experience curve could be beneficial. if the competition is strong though, an aggressive pricing strategy might backfire on the challenging company. hewlett-packard attempted an aggressive pricing strategy in the calculator market but would not compete with ti. hewlett-packard then decided to focus on the premium end of the market instead of battling head-to-head with ti. government intervention. the government affects the viability of the experience curve through competitive policies and the cost of capital. government concerns about predatory pricing and attempts to monopolize can sometimes thwart efforts to use experience curve pricing strategies. government subsidies, tax rates, and depreciation policies can alter the competitive positions of firms within an industry. additionally, high domestic interest rates, in part a result of government deficits and tax policies, put american firms at a cost disadvantage to foreign firms. applying the experience curve before presenting an application of the experience curve a couple of key points need to be made about its use, these are the importance of shared resources within product groups and the fact that a firm may face multiple experience curves at various stages in the value added chain (or the various stages in the development, production, and delivery of products or services). shared resources. in many industries the experience base may be derived from more than just one product. often product groups share the same components, production facilities or delivery systems. when such interrelationships exist the combined experience curve position for the product group should be the focus of analysis (4). the british motorcycle industry found out the hard way about the importance of product group management (8). various classes of motorcycles share many parts and manufacturing processes. the british manufacturers did not realize that in order to maintain a competitive cost position for one product they had to retain the market positions of others, because together they represented accumulated output. initially, they benefited from dropping smaller motorcycle product 41 lines through lower r&d spending. but in the long run they suffered from a loss of cost leadership. the value-added chain. in addition to shared costs, the value-added concept is important in the application of the experience curve. the firm's position on the experience curve at each stage of the value-added chain should be determined. such analysis should not only include manufacturing, but also research and development, procurement of raw materials, fabrication, assembly, marketing, sales and distribution (hax and majluf, 1985). there should be a stage-by-stage comparison of the firm with its leading competitors. the firm's relative strengths should be isolated and exploited. when phillip-morris entered the beer industry with the acquisition of miller brewing it gained market share by exploiting its experience in market segmentation and product innovation (i.e., the introduction and promotion of miller life) (13). an illustration in order to place a firm on an industry production experience curve, along with its major competitors, four steps are required. first, assuming the firm in question uses technology comparable to its competitors, production cost data for the firm must be gathered which will be used to estimate the experience curve behavior for the industry, such as is presented in exhibit 4. note that in this illustration, only direct labor costs are being examined. exhibit 4: cost data for firm z cost data unit unit direct cost dlrect number labor hours/unit per hour labor costs 1 100 $ 12 $1,200.00 2 85 12 1,020.00 4 72.25 12 867.00 8 61.41 12 736.80 16 52.20 12 626.40 32 44.37 12 532.45 64 37.71 12 452.58 128 32.06 12 384.70 256 27.25 12 327.00 512 23.16 12 278.0cr 42 with the above data, the second step can be completed, estimating the rate of decline in costs which occurs with each doubling of production. this step involves calculating some simple percentage cost changes: $1,010 $1,200 = 85%; $ 867 $1,020 = 85%; $736.80 $864 = 85% while each of these sample calculations suggest an 85 percent experience curve (or a 15 percent decline in costs with each doubling of output), the percentage may sometimes vary, and an average may have to be taken. having estimated the production cost behavior for the industry, the third step requires the analyst to formulate a model which will permit estimation of unit production costs at various levels of accumulated output. to do this the following model is u~ed. c x = (k) x log njiog 2 where: ex = direct unit costs required to produce the unit x = unit number k = direct unit costs required to produce the first unit n = learning curve coefficient or factor in the case illustrated here, if the firm is about to produce its 513th unit, the first unit's cost was $1,200, and the experience curve coefficient has been estimated to be 85 percent, the predicted cost would be: c s13 = ($1,200) 513 log.85llog 2 cs13 = ($1,200) 513 -.2344 cs13 = 1200 1 513. 2344 cs13 = $277.93 assume the firm whose cost experience was just analyzed (referred to below as firm z) confronts two major competitors who use similar technology. further assume one of the competing firms, firm a is thought to have 20 percent more accumulated output than firm z. the other firm, firm b, is assumed to have 10 percent less accumulated output than firm z. to complete the fourth step the current cost position of each competitor is estimated as .follows: 43 firm 2' s current accumulated output = 512 units firm a's accumulated output 512 x 1.20 = 614.4 units firm a's unit cost: ca = ($1,200) 614.4 -.2344 ca = $266.42 firm b's accumulated output = 512 x .90 = 460.8 firm b's unit cost: cb = (1,200) 460.8-. 2344 cb = $285.00 placing the firms on an experience curve on log-log-scales, the relative positions are as shown in exhibit 5: exhibit 5: industry experience curve direct costs 1200 600 240 120 123 4 (1 og-l og seal e) 5 10 50 100 1000 accumulated volume as mentioned earlier, it is assumed that firm z's cost behavior is representative of the industry. it is also assumed that the management of firm z has a fairly accurate estimate of the other two firm's accumulated volume. 44 however, it is possible that a competitor may have more or less sophisticated technology which might place it on a different experience curve. as illustrated in exhibit 6, firm c, a new entrant to the industry, enters with superior technology, causing its costs to follow a lower experience curve track. exhibit 6: experience curve shift due to new technology direct costs firm z firm c (log-log scale) there is also the possibility that a new entrant or former laggard in the industry, such as firm b in the earlier illustration, may be able to close the gap due to the spillover effect, which was discussed earlier. finally, it may be quite difficult to get an accurate assessment of the accumulated output of the competition. to correct each of these problems management must make a ''best guess'! of the situation given the information available. obviously, the application of the experience curve in strategic analysis is as much art as science. summary quite simply, experience curve logic suggests that as volume is accumulated costs of production decrease in a predictable, exponential manner. the sources of this cost reduction are exogenous progress, economies of scale, and basic improvements learned from cumulative output. the most important implication of the experience curve is that the firm with the greatest 45 market share will have the lowest costs and enjoy a number of strategic advantages. in fact the market share-experience curve-profitability relationship implies that only those firms with large market shares can be expected to survive. in many instances the industry leader will determine the destiny of the other firms in the industry. the experience curve concept also has major implications for pricing strategies. while the experience curve model is not without its shortcomings, both antidotal and statistical evidence exists which supports the validity of the concept. there are a number of shortcomings and caveats associated with the experience curve. the strategic importance of the experience curve effect is probably minimal for mature or declining industries. no competitive advantage may be accrued from accumulated production if there is significant spillover or exchange of experience-based learning among competitors. in fact, if a firm becomes to enamored with the experience curve it may lose its ability to recognize and respond to coming changes in the industry. an industry in which non-price competition is prevalent may not be susceptible to experience curve analysis. finally, government attitudes toward predatory pricing may diminish the usefulness of experience curve analysis. concluding, the single-minded pursuit of market share might not always be the answer, and may in fact be dangerous. a firm may be able to compete profitly through continuous innovation and careful targeting of their markets. for further reading on the experience curve concept and its application see: abernathy william j. and kenneth wayne, "limits of the learning curve." havard business review, september-october 1974, pp. 109-119. albert, kenneth j., handbook of business problem solving, mcgraw-hill, inc., new york, new york, 1984. porter, michael e., competitive strategies: techniques for analyzing individuals and competitors, free press, n.y., 1980. yelle, louis e., "the learning curve," decision sciences, vi0 1979, pp. 302-28. references 1. abernathy, william j. and kenneth wayne, "limits of the learning curve." havard business review, september-october 1974, pp. 109119. 2. albert, kenneth j., handbook of business problem solving, mcgrawhill, inc., new york, new york, 1984. 3. clifford, donald jr. and richard e. cavanagh, "innovation builds winning performance," advertising age, december 1985, pp. 42-44. 4. ghemawat, pankaj, "building strategy on the experience curve," havard business review, march-apri11985, pp. 143-149. 5. ghemaat, pankaj and michael a. spense, "learning curve spillovers and market performance," quarterly journal of economics, vida 1985, pp. 839-852. 46 6. hall, graham and sidney howell, "the experience curve from the economist perspective," strategic management journal, julyseptember 1985, pp. 197-212. 7. hax, arnold c. and nicholas s. majluf. strategic management, prentice-hall inc., englewood cliffs, new jersey, 1984. 8. keschell, walter. "the decline of the experience curve," fortune, 5 october 1981, pp. 139-146. 9. newton, j.k., "market share-key to higher profitability," long range planning, vol 18 no.1, 1985, pp. 64-72. 10. porter, michael e., competitive strategies: techniques for analyzing individuals and competitors, free press, n.y., 1980. 11. sallenave, jean" paul, "the uses and abuses of experience curves," long range planning, vol 18 no.1, 1985, pp. 64-72. 12. schoeffler, sidney, robert d. buzzell and donald f. hearny, "impact of strategic planning on profit performance," havard business review, march-april 1974. 13. thompson, arthur a., "competition in the u.s. brewing industry," cases in strategic management, business publications, plano, texas (written by a. j. strickland iii and arthur a. thompson, jr.) 1985. 14. woo, carolyn y., "market share leadership-not always so good," havard business review, january-february 1984, p. 50 (3). 15. yelle, louis e., "the learning curve," decision sciences, vi0 1979, pp.302-28. 47 the experience curve's role in strategic planning in-substance defeasance of debt: a solution to a management problem w. alfred mukatis and dahli gray department of accounting oregon state university corvallis, oregon defeasance of debt has been recognized for many years. in defeasance a debtor includes in the debt instrument the legal right to transfer the debt with assets adequate to meet the debt obligation to a trust. in this way the debt is extinguished without being retired. the creditor, holding the debt instrument, knows the debtor may set up a trust to extinguish the debt without retiring it. benefits of defeasance to the debtor include: (1) no payment penalties for early debt retirement; (2) recognition of unrealized gain in the income statement, which enhances earnings per share (eps) and other indicators of performance; and (3) removal of debt from the balance sheet, which enhances the debt-to-equity ratio and other indicators of financial strength. given the tight credit market, debtors are motivated to present high eps and low debt-to-equity ratios. beginning in the 1980s debtors have been using in-substance defeasance to obtain similar benefits. in-substance defeasance of debt is used where defeasance of debt is not included as an option in the debt instrument. the creditor is not forewarned that the debtor might transfer the debt with assets adequate to meet the debt obligation to a trust and, thereby, claim the debt is extinguished. also, the creditor need not be informed when the debt is in-substance defeased. the financial community has enthusiastically embraced this technique. some companies have gone so far as to create debt with the intention of immediately employing in-substance defeasance; i.e., "instantaneous defeasance" to obtain the benefits of defeasance. exxon corporation in 1982 eliminated $515 million of debt from its balance sheet and posted a $132 million profit by buying high-yield treasury securities and placing them in a trust to retire low-interest debt (15). following exxon, american hospital supply corporation issued zero-coupon eurobonds at 11.56% which it matched with a purchase of "stripped/ u.s. treasury bonds yielding 12.25%. new debt of $(2 million was buried in the balance sheet of their unconsolidated subsidiai')l american hospital supply finance corporation (21). 4 lazard realty, inc. in 1984 used in-substance defeasance to unlock equity in 11,000 garden apartments purchased in 1979. second mortgage rates were too high to use for refinancing. so lazard bought $74 million (maturity value) in government securities for $62 million (current value), and placed them in an irrevocable trust to repay a preexisting $74 million debt. it thus reported a $12 million gain in the income statement (13). the fasb banned the use of instantaneous defeasance as of september 1984 (8). james c. treadway jr., an sec commissioner, said: "i am strongly opposed to instantaneous defeasance" and called it "a distortion of accounting principles" (1). but even when not instantaneous, in-substance defeasance is controversial. roman l. weil, director or the institute of professional accounting, stated that in-substance defeasance (which he calls "de facto" defeasance) presents "managers with the opportunity to boost reported earnings, lower the debt-equity ratio and (in some cases) increase their own compensation" (20). representative john d. dingell, democrat from michigan, criticized the sec for not taking "a stronger stand" against in-substance defeasance, "which its critics claim allow companies to create instant profits"(3). john evans, a retired sec commissioner said "i'm queasy about it [in-substance defeasance] because the debt is still legally debt, and the creation of earnings appears to be a charade" (2). in-substance defeasance is viewed by some as "an accounting device companies use to wipe long-term debt off their books" (17). companies are accused of having "concocted so many ways to hide or disguise borrowings that deciphering their true liabilities is often impossible. sometimes, debt isn't acknowledged anywhere; at other times, it's there, but finding it would take a financial wizard with hours of free time and a computer/ (4). in-substance defeasance was referred to as the "equivalent of vanishing debt!' by forbes, which criticized the process because "a borrower can retire debt at a discount, and companies are allowed to show the discount as earnings'! (14). in spite of these criticisms the fasb approved the use of in-substance defeasance within the parameters set in sfas 76. this article illustrates how to achieve profits and avoid losses in implementing sfas 76. the parameters surrounding in-substance defeasance per sfas 76 are discussed, and options regarding the types of trusts with tax implications of each type are also presented. in-substance defeasance defined in-substance defeasance of debt is extinguishment of debt, as specifically addressed by the sfas no. 76 extinguishment of debt (10). but legally the debt still exists. sfas 76 subordinates the form of the contractual debtor/ creditor relationship to its substance but mandates specific action to achieve in-substance defeasance as follows: the debtor irrevocably places cash or other assets in a trust to be used solely for satisfying scheduled payments of both interest 5 and principal of a specific obligation and the possibility that the debtor will be required to make future payments with respect to that debt is remote. in this circumstance, debt is extinguished even though the debtor is not legally released from being the primary obligor under the debt obligation (10, para. 3). the fasb has placed the following specific restrictions on trust assets used for in-substance defeasance: the trust shall be restricted to owning only monetary assets that are essentially risk free to the amount, timing, and collection of interest and principal. the monetary assets shall be denominated in the currency in which the debt is payable. for debt denominated in u.s. dollars, essentially risk-free monetary assets shall be limited to any combination of the following: (1) direct obligations of the u.s. government, (2) obligations guaranteed by the u.s. government, and (3) securities that are backed by u.s. government obligations as collateral under an arrangement by which the interest and principal payments on the collateral generally flow immediately through to the holder of the security. however, some securities described in the previous sentence can be paid prior to scheduled maturity and so are not essentially risk free as to the timing of the coll~~tionof interest and principal; thus, they do not qualify for ownership by the trust (10, para. 4). securities which are callable or convertible cannot be used for insubstance defeasance unless the callable/convertible options are cancelled. costs of placing assets in the trust are taken into account as follows: the monetary assets held by the trust shall provide cash flows (from interest and maturity of those assets) that approximately coincide, as to timing and amount, with scheduled interest and principal payments on the debt that is being extinguished.... if, in conjunction with placing assets in trust to effect an extinguishment of debt, it is expected that trust assets will be used to pay related costs, such as trustee fees, as well as to satisfy scheduled interest and principal payments of a specific debt, those costs shall be considered in determining the amount of funds required by the trust. on the other hand, if the debtor incurs an obligation to pay any related costs, the debtor shall accrue a liability for those probable future payments in the period that the debt is recognized as extinguished (10, paras. 4, 5). 6 in-substance defeasance illustrated in-substance defeasance is allowed when applied to previously outstanding debt, but not to debt issued in contemplation of in-substance defeasance (i.e., instantaneous defeasance). the fasb technical bulletin on insubstance defeasance warns against placing assets in an irrevocable trust about the same time as debt is incurred. corporate directors should take care to either state in the minutes that newly authorized debt is not being issued in contemplation of in-substance defeasance or make no statement on the issue. the directors could currently authorize the issuance of debt, which in the future would qualify for in-substance defeasance so long as it was not issued with that intention. violating the generally accepted accounting standard as mandated in sfas 76 and its technical bulletin might result in an adverse audit opinion or public disapproval by the sec. the following examples illustrate the possible benefits of in-substance defeasance when one stays within the restrictions set by sfas 76. assume it is now june 30, 1986, and the company wishes to in-substance defease an outstanding debt of six hundred,~ $1,000 maturity value, 18% bonds issued at par to mature june 3d, 2012. they purchase u.s. government securities paying 12% annual interest, which will provide cashflow adequate to meet the bond interest and principal payments plus costs of establishing and maintaining a trust to manage both the u.s. securities and the company debt. the trustee takes physical possession of the u.s. securities and supporting debt documentation necessary to make and record the interest and final principal payments and keeps a separate set of financial records regarding management of the assets and debt. depending on the type of trust established, the trust may be liable for tax on the asset income. the unrealized loss resulting from the above example amounts to $430,359 and must be reported in the income statement but not the balance sheet. see table 1 for detailed calculation of the loss and recommended journal entry. table 1 calculation of in-substance defeasance loss cost to set up trust $ 4,000 annual interest payment $600,000 (18%) $108,000 annual trust administration fee 18,000 12e3,ooo times annuity present value factor for 7.8957 994,85926 years at 12% principal at maturity 600,000 times present value factor for 26 years at 12% .0525 30°° required trust principal 1,030,359 carrying value of bonds ~~o-,~q unrealized loss on in·substance defeasance $ 430,359 journal entry bonds payable $600,000 loss on in-substance defeasance 430,359 long-term investment $1,030,359 7 to show a gain one needs a lower interest rate on the outstanding debt, a higher interest rate on the trust assets or both. using the assumptions above and in table 1 except for the bonds being originally issued at 6% instead of 18% results in a gain of $232,881. the calculation and its recommended journal entry are shown in table 2. table 2 calculation of in-substance defeasance gain cost to set up trust annual interest payment $600.000 (6%) annual trust administration fee times annuity present value factor for 26 years at 12 r c principal at maturity times present value factor for 26 years at 12% required trust principal carrying vaiue of bonds unrealized gain on in-substance defeasance s 4.000 s 36.000 6.000 42.000 78957 331.619 600.000 .0525 31.500 367.119 600.000 s 232.881 rtp=a+r~]k1 + r t journal entry bonds payable $600.000 long-term investment $ 367,119 gain on in-substance defeasance $ 232.881 the equation to determine when the breakeven point (be) occurs is as follows: + [fn(b) + nc] x[l (1 _1 )}1) r (l+r)n where rtp = a = b c = fn = n = r the initially required trust principal initial setup costs of trust, stated interest rate on debt based on an annual rate, annual trust administration fees, maturity value of debt, life of debt (and trust) in years, and effective annual interest rate on trust assets be occurs when rtp = fn . if rtp > fn a loss is recognized and when rtp < fn a gain is recognized. to find the effective interest rate at the breakeven point, rip is set equal to fn and equation 1 is rearranged to: r = [~:] +r_r1 +rb +nc] x [1 -_112)l(1 +rtj l fn (1 + r)nj in deriving equations (1) and (2) it is assumed that: (a) all money values are in the same units, e.g., dollars; (b) interest payments are made annually, and 8 the principal is paid at maturity; (c) trust assets earn a constant annual return; and (d) the debt was issued at par. if the debt was issued at a discount or premium, be and the gain or loss is determined by comparing rtp to the carrying value of the debt (cvd) rather than fn . equation (1) may be used to calculate whether the desired gain can be attained. an iterative process is used in equation (2) to determine an effective annual interest rate to break even. by way of example consider the case where: rtp = fn = $1,000,000, a = $10,000, b = 0.1, c = $10,000 (1 % of initial assets), and n = 10 years the authors first guess a value of ro of 0.15 (15%) and in three iterations obtained the following results: r (left side) 0.189 0.200 0.202 0.202 r (right side) 0.150 0.189 0.200 0.202 difference 0.039 0.011 0.002 0.000 thus the trust would -have to earn 20.2% per year to break even on a debt with an interest rate of only 10%. equations (1) and (2) may be appropriately modified when the principal is repaid as an annuity rather than as a lump sum at maturity. the eps increase from in-substance defeasance results when the cost of the debt is less than the return on the trust assets. overall interest rates must substantially increase for risk-free assets, like federal treasury instruments, to have a greater yield than typical company debt. in efficient capital markets bond prices should decrease in recognition of the higher interest rates, enabling a possible gain on the in-substance defeasance. this single period eps' increase improves the debt-to-equity ratio and other indicators of performance and strength for the current period, and the improvement will extend into future periods. in addition to careful consideration of the factors summarized in equation (2), a debt manager must establish the in-substance defeasance trust within particular parameters. to assist in this effort the general aspects of trusts are presented followed by specific characteristics of trusts applicable to insubstance defeasance. general aspects of trusts all trusts maybe categorizes as implied, constructive, or express (5, 16). 9 figure i summarizes the three basic trust types. an implied trust arises by operation of law when a party who intends to create a trust fails to completely manifest that intent. the court will usually decree that a trust exists in favor of the intended beneficiary or where the intended beneficiary cannot be ascertained then in favor of the creator. this is known as a resulting trust. if the court did not furnish a recipient for the trust assets, the trustee might be able to retain the benefits against the settlor's (debtor's) wishes since the former holds legal title to the trust property. a constructive trust is created by law to remedy a wrong. for example, if one party fraudulently obtains property from another, the court can order the wrongdoer to hold the property in trust for the former owner. figure 1 basic trust types express impl ied constructi ve intended and intended but either not intended. imposed completely not stated at all or by courts to prevent stated not completely stated injustice applicable to may be applicable to not applicable to in-substance in-substance defeasin-substance defeasance ance where an express defeasance trust fails to name a remainder beneficiary express trusts, that is, those intentionally created for a valid purpose are applicable and are discussed next. a resulting in-substance defeasance trust could arise where the creator of an express trust neglects to name a recipient of assets remaining after satisfaction of the debt. sfas 76 mandates against return of assets to the settlor (debtor), so a remainder beneficiary is required. attention should also be made to naming a trustee and providing for successor trustees since without a trustee, the trust could fail. characteristics of in-substance defeasance trusts express trusts may be classified in different ways including: (a) intervivos vs. testamentary; (b) revocable vs. irrevocable; (c) simple vs. complex; and (d) grantor vs. nongrantor. an intervivos trust becomes effective while the settlor is alive, whereas a testament~ry trust is part of a will and becomes effective on the settlor's death. testamentary trusts cannot be created by corporations since property transfers which occur when a corpomtion terminates are treated differently than when an individual dies. trusts may be -expressly made revocable or irrevocable. a revocable trust allows the settlor to effectively retain control of the assets. however, an in-substance defeasance trust must be irrevocable per sfas 76. a simple trust by its terms distributes current income only, must distribute all its current income, and has no charitable beneficiaries. if the trust accumulates income or distributes part or all of its corpus, it is complex. 10 many trusts are simple in some years and complex in others. any trust not dry when it terminates is complex in the year of termination because it will distribute something other than current income. under sfas 76, the trust can be simple or complex or both in different years depending on how the debt is structured. in years when the scheduled repayment of debt requires payment only of interest (and administrative expenses and/or taxes) until some maturity date, and the current income matches the interest payment, (and administrative expenses and/or taxes) the trustis simple. however, for a company to show a gain on the balance sheet, it is expected that the annual income on the trust would be greater than the interest to be paid on the debt and associated expenses. hence, income would accumulate until maturity when the debt is retired, and the trust would be complex in every year. there should be no unusual consequences to the defeasance aspects whether the trust is simple of complex in any given year. figure ii summarizes the requirements for a trust used to in-substance defease debt. figure ii in-substance defeasance trust requirements no no no no no no no no 11 tax aspects of the trust selected normally a trust constitutes a separate entity. however, under the grantor trust provisions of the internal revenue code (irc) the settlor (or another person) may be treated as owner of some or all of the assets and accordingly taxed on some or all the trust income (12, sections 671-679). sections 671, 673, 678, and 679 of the irc might be applicable to whether grantor status obtains under the sfas 76 parameters. to avoid grantor status under section 671, the debtor should take care not to assign only future income to the trust but might, for instance, assign a series of bonds. section 673 provides that a settlor will be treated as the owner of any portion of a trust in which either the trust principal or income may reasonably be expected to revert to the settlor within ten years after the date of transfer. since sfas 76 will not allow reinvestment of income, a remainder will probably result which could revert to the settlor underthe resulting trust doctrine. the settlor can avoid grantor status by designating a remainderman for any surplus. the remainderman should be given no power to control disposition of any remainder to avoid taxation under section 678. no conflict with sfas 76 should arise in naming a beneficiary of assets remaining at the debt's maturity. if the trustee is named as remainder beneficiary, any surplus might be deductible to the debtor as a reasonable cost of doing business under ire section 162(a). if a charity were to receive the remainder then because of the sfas 76 requirement of structuring the payouts to coincide closely with the required payments, no charitable deduction would be allowed. to obtain a charitable deduction there must be more certainty to the payout as under a charitable remainder annuity trust, a charitable remainder unitrust, or a pooled income fund (12, section 664(d)(1), section 664(d)(2), and section 642(c)(s). grantor status under irc section 679 can be avoided by using a u.s. trust. for foreign trusts, grantor status may still be avoided in certain cases such as where the beneficiary is not a u.s. citizen either actually or constructively. initially, the fasb appeared to view the trust as a separate taxable entity from the debtor. in paragraph 5 of their revised exposure draft the fasb included "taxes on trust income" as an example of "costs expected to be paid by the trust" (9). in response to this view touche ross & co. stated the following: paragraph 5 refers to providing, at the outset, for "taxes on trust income." ordinarily, such trusts are grantor trusts and the federal income tax consequences thereof are included in the grantor corporation's tax return. because the trust itself is rarely a taxable entity for federal purposes, we suggest some elucidation what the board intended ... (18)? 12 dart & kraft commented as follows: in determining the amount of investment assets needed to defease a set amount of company debt, should the matching of fund inflows and outflows be done on a pretax or after-tax basis? does the placement of investment assets in a grantor trust (which does not have a tax existence separate from the sponsoring company) or a trust that stands alone for tax purposes have a bearing on this? we believe that the matching of fund flows should be done on a pretax basis regardless of the type of trust involved (7). these issues raised by touche ross & co. and dart & kraft will be explored next. although touche ross and co. stated that i'[o]rdinarily such trusts are grantor trusts" (18), there is no such requirement in sfas 76 and no reason in principle they must be. in fact, satisfaction of the sfas 76 requirement of making remote the possibility that the debtor would have to make further payments may mandate selection of an independent trustee. an independent trustee might lessen chances of mismanagement (intentional or negligent) by the debtor and lower the chances that the debtor would be required to make further payments. an independent trustee by itself will not guarantee nongrantor status to the debtor but is one step in that direction. since selection of the trustee can affect not only the grantor status of the trust but also the remoteness criteria of sfas 76 it should be given due consideration. the reason for the statement by dart & kraft, that liew ]e believe that the matching of fund flows should be done on a pretax basis" is not clear. first, consider a grantor trust. the income tax consequences inure to the debtor, and the trustee need not be concerned with them. calculation of the trust assets needed is relatively easy because one needs only to know the administration and setup fees and the presumably fixed interest rate on the investment. also there is no change in grantor status or tax consequences if for some remote reason the trust becomes dry before the debt is satisfied, or the trust terminates with assets remaining. in the former case, the settlor can simply add assets and in the latter case any surplus would go to the named recipient. to place the assets in a grantor trust on an after-tax basis might diminish the possibility that an occurrence such as bankruptcy of the debtor leaves the debt unsatisfied. but bankruptcy taken by the debtor, in and of itself should not lessen the remoteness of the debtor having to make further payment since the bankruptcy would very like discharge the debt. at the same time, matching of fund flows on an after-tax basis would require the grantor to predict personal future tax consequences for a number of years, a feat that seems extraordinarily difficult if not impossible. an occurrence such as bankruptcy taken by the debtor would have the same effect as on a pretax basis. calculation of the amount of assets needed in a nongrantor trust on a 13 pretax basis would be the same as for a grantor trust. but in the former situation the debtor would be required to make annual contributions for taxes based on the trust as a taxable entity .and the trust language should provide for these annual contributions. bankruptcy taken by the debtor in and of itself should not adversely affect the remoteness of the debtor having to make additional payments since again the debt would probably be discharged. to maintain nongrantor status where an excess remains after the debt is paid, the trust should name an appropriate remainder beneficiary. however, if the trust becomes dry before the debt is paid the nongrantor status should not be affected but the trust language should deal with additional payments by the debtor. for nongrantor trusts on an after-tax basis it should also be feasible to calculate the amount of initial assets required, assuming tax laws and r~tes remain constant over the life of the trust. on that basis the amount required for tax payments ·by the trustee could be calculated with certainty. if tax law changes occur, the trust language should take into account possible contributions by the·debtor and disposition of any remainder. care would have to be taken not to change the nongrantor status of the trust. again, bankruptcy should not have any effect on the remoteness of future payments for the same reasons stated above. thus for a grantor trust in an after-tax situation the difficulty of calculating tax consequences clearly points to placing assets on a pretax basis. for a nongrantor trust the reason is not so compelling and the debtor could reasonably place the assets in trust on a pre or after-tax basis. additional considerations express trusts may use a·provision to avoid the often time consuming and expensive judicial approval of the trustee's accounting. but sfas 76 param~ eters allow creation of a trust without the creditor-beneficiary's knowledge, while requiring the possibility of the debtor having to make future payments be remote. it might be wise in this or perhaps in all situations, for a court to approve the accounting to satisfy the requirement that the possibility of further payment be remote. without court approval, mismanagement (intentional or negligent) may be more probable, thereby increasing the probability that further payments are required. if court approval is not obtained, then at a, minimum the trustees should be independent of the debtor even though in principle one person could serve as both. the sfas 76 requirement of assets being irrevocably placed in trust solely for satisfaction of the debt is easily accomplished in theory by basic drafting of the trust instrument. however, are the assets really irrevocably placed in trust? no clear answer exists where the trust is created as a fraud on other creditors or the debtor files for bankruptcy after creation? in the former situation the defrauded creditors can file a creditor's suit in equity to obtain the trust assets (6). in the latter situation the trustee in bankruptcy may be able to obtain the trust assets if the debtor created a preference for one 14 creditor over other creditors (19, section 547) or committed fraud under the bankruptcy act (19, section 548). the independent trustee could evaluate the likelihood of fraud or bankruptcy rather than have the debtor make that judgment. the sfas 76 requirement that the possibility of further payment by the debtor be remote leaves open a similar question of who makes that determination (11). since the technique can be very attractive to the debtor while having a potential for misleading unsophisticated investors, it is again suggested that someone independent of the debtor make the decision. the use of an independent person to judge both the remoteness of the debtor having to make future payments and the good faith of the debtor might quash some of the criticism leveled at in-substance defeasance. summary and conclusion defeasance of debt has bee~ a useful and recognized technique for many years. in-substance defeasance, a controversial new technique has been enthusiastically embraced by the financial community but approved by the fasb only within certain limitations. the fasb has banned the technique if it constitutes instantaneous in-substance defeasance defeasance~one primary purpose of using in-substance defeasance is to recognize an unrealized gain on the income statement and remove debt from the balance sheet, thereby enhancing a company's debt to equity ratio. this article has provided guidelines for using in-substance defeasance within the parameters set by the fasb. two equations are presented to show when a gain or loss occurs and the interest rate needed to breakeven for the case where income on the assets in an in-substance defeasance trust is used to service the debt and the corpus remaining at the debt's maturity is used to retire the debt principal. characteristics of trusts appropriate for in-substance defeasance are examined and presented in figure ii. they may be structured as grantor or nongrantor trusts depending whether the debtor wishes to incur the income tax consequences depending primarily on the relative tax brackets of the debtor and the trust. the authors suggest that for grantor trusts the assets be placed in the trust on a pretax basis; for nongrantor trusts a pretax or after-tax basis may be used. it is the debtor who decides whether the in-substance defeasance trust is within the sfas 76 parameters. since the technique offers the debtor significant benefits while at the same time may be misleading to all but the most sophisticated investors, the authors suggest that someone independent of the debtor decide whether sfas 76 requirements are being met in order to quash some of the criticisms of in-substance defeasance. references 1. berton, lee and ann monroe. "fasb mulls ban on defeasance 15 method which firms issue debt to post gains," wall street journal, september 12, 1984, p. 6. 2. berton, lee. "fasb adopts, 4-3, controversial method that critics assert allows 'instant' profit." wall street journal, november 3d, 1983, p.7. 3. __. "house unit probing sec's monitoring of accounting rules," wall street journal, january 31, 1984, p. 56. 4. __. "loose ledgers: many firms hide debt to give them an aura of financial strength," wall street journal, december 13, 1983, p. 1. 5. bogert, g.g. and g.t. bogert, trusts and trustees, 2d ed revised (st. paul, minn.: west publ. co., 1984),_section 1. 6. creditor's rights and remedies, (portland, oregon: oregon state bar, c.l.e., 1978), section 9.1. 7. dart & kraft comment letter to the fasb regarding exposure draft (revised), extinguishment of debt, october 13, 1983. 8. "fasb acts to ban use of defeasance applied to new debt," wall street journal, september 13, 1984, p. 4. 9. financial accounting standards board, exposure draft (revised), extinguishment of debt, stamford, co.: fasb, 1983. 10. financial accounting standards board, statement of financial accounting standards no. 76, extinguishment of debt, stamford, conn.: fasb, 1983. 11. financial accounting standards board, technical bulletin 84-4 oct. 17, 1984 p. 4. 12. internal revenue code. 13. "investor takes cue from corporations," wall street journal, may 22, 1985 p. 37. 14. konrad, walecia. "numbers game: reading between the pictures," forbes, january 30, 1984, p. 126. 15. peterson, pamela, david peterson and james ang. "the extinguishment of debt through in-substance defeasance," financial management, 14, 1 (spring 1985), 59-67. 16. schantz, w.t. commercial law for business and accounting students: a complete business law text and cpa law review (st. paul, minn.: west publ. co., 1980), p. 1130. 17. "sec approves rules on-device to keep debt off balance sheet," wall street journal, december 23, 1983, p. 3. 18. touche ross & co., comment letter to fasb regarding exposure draft (revised), extinguishment of debt, september 12, 1983, p. 10. 19. united states code ann., title 11 bankruptcy (1979 and west supp. 1985). 20. weil, roman l. "deor misfeasance? a look at the new fasb ruling," barron's, december 5, 1983, p. 50. 21. weiss, stuart. "the accounting watchdog~ have been outfoxed again," business week, november 26, 1984, p. 168. 16 in-substance defeasance of debt: a solution to a management problem 138 journal of business strategies the nexus of immigration and economic conditions in australia burcu ozcan firat university • elazig, turkey abstract in this study, we aim to analyze the causal linkages between immigration and economic conditions unemployment and per capita incomein australia over the period of 1966-2013 by using causality tests developed by toda and yamamoto (1995) and hacker-hatemi-j (2006). the results support one-way causal relationships running from both unemployment and per capita income to immigration. however, immigrants do not have a significant impact on the economic conditions of australia. on the contrary, the high level of income and the low unemployment rate are the pulling factors of immigrants into australia. based on these results, some crucial policy implications would be suggested. keywords: immigration, income, unemployment, causality, australia introduction immigration seems to be more than a simple labor supply shock because it may induce efficient specialization in the labor market by differentiating skill levels and causing more competition (peri, 2008). there are many different economic, political and social reasons for immigration such as war and political pressure, causing people to leave their home countries and to migrate into other nations that are wealthier and safer (troshchenkov, 2011). besides, declining transportation and information costs, as well as widening income differences between developing and developed countries along with accelerating population growth rates in developing countries are the main factors of immigration (jean & jimenez, 2011). based on escalating trends in immigration waves worldwide, scholars from different disciplines have started to analyze the reasons and the results of immigration for various countries. in particular, as a population influx, immigration has led many economists to develop models designed to measure its social and economic impacts on receiving countries’ economies (aydemir & borjas, 2006). however, economic theory cannot provide a definite conclusion for predicting the effects of immigration, in particular on the labor market of the host country (fromentin, 2013). in this regard, some scholars (see borjas, 1994; boddvarsson, 2008; damette volume 33, number 2 139 & fromentin, 2013; troshchenkov, 2011) assert that immigration has a little or no adverse impact on native employment opportunities. for instance, jean and jimenez (2011) argue that irrespective of their skill levels, new immigrants generate additional product demand and thereby raise profitability in the short-run and the capital stock in the long-run, with a positive impact on the demand for all types of labor. additionally, many oecd countries see immigration as a potential solution to compensate for their labor shortages against their aging population problems (boubtane et al., 2013). alternatively, there is also a negative view highlighting that immigrants steal native labors’ jobs, increase the unemployment level, depress the wage rates and financially strain the welfare systems in the receiving country as they are mostly unskilled (feridun, 2007; gross, 2004, pope & withers, 1993). based on the contrasting ideas mentioned above, economic theory indicates that two competing effects (supply-side effects versus demand-side effects) could explain the impact of immigration on the labor market of a host country (see feridun, 2004, 2005, 2007; fromentin, 2013; latif, 2015).supply-side effects highlight the presence of substitutability or complementarity between native and foreign labors. in the case of substitution, there is an increasing competition between citizens and immigrants, resulting in declining wage rates. in such a situation, immigration may cause unemployment among natives who are not willing to work at these lower wages (boubtane et al., 2013). however, in the presence of complementarity between indigenous and foreign labors, the new inflows of immigrants would augment the productivity of domestic employees and raise their wage levels and employment opportunities (see borjas, 2001; boubtane et al., 2013; feridun, 2004, 2005; fromentin, 2013). in this respect, the degree of substitutability or complementarity between native and foreign workers determine the final effect of immigration on the domestic labor market. relative to the demand-side effects, through their spending on goods and services in a direct way and through industrial and government expenditures on their behalf in an indirect way, immigrants lower the unemployment rate and increase wage levels for the native labors (islam, 2007). based on the say’s law in the economic theory, immigrants as consumers demand their own labors (bodvarsson et al., 2008). in other words, immigration provides a derived demand for labor by contributing to aggregate demand and may not deepen the unemployment problem (pope & withers, 1993). because the domestic labor market effect of immigration is difficult to be determined a priori (islam, 2007), this study aims to analyze whether immigration is a burden or a contribution to the australian economy over the period of 1966 140 journal of business strategies 2013. it will also contribute to the related literature in the following ways. first, australia deserves particular research attention since it is one of the best countries to inhabit by international comparisons of wealth, education, health, and quality of life. among oecd countries, australia ranked ninth in respect of foreign population inflow in 2013 (see fig. 1). it has metropolitan cities such as melbourne, identified as the world’s most liveable city in 2015 with residents from more than 140 nations.1 additionally, the inflow of foreign population into australia has followed a rising trend, increasing from 69,808 in 1984 to 251,850 in 2013 (see fig. 2).2 the australian department of migration and border protection 3 (2015) reported that australia’s overseas-born population grew by 51.2 percent to 6.4 million people including legal and non-legal immigrants between 19962013. thus, immigration still continues to be the major component of population growth in australia. additionally, approximately 68 percent of australian immigrants are skilled and educated, and their main birthplaces are mostly developed countries such as the united kingdom and new zealand. figure 1 inflows of foreign population in australia (1984-2013) source: oecd, international migration database. 1 see http://themysteriousworld.com/10-most-liveable-cities-in-the-world/ 2 this number only includes legal immigrants; i.e. people obtaining lawful permanent resident status. see https://www.border. gov.au/about/reports-publications/research-statistics/statistics/live-in-australia/migration-programme 3 see https://www.border.gov.au/reportsandpublications/documents/statistics/migration-trends13-14-glance.pdf2 this number only includes legal immigrants; volume 33, number 2 141 figure 2 inflows of foreign population in 2013 among oedc countries source: oecd, international migration database. second, there are only three empirical studies examining the nexus of immigration and economic conditions for australia (see konya, 2000; pope & withers, 1993; withers & pope, 1985). however, this study differs from them by using current data and a novel causality test developed by hacker and hatemi-j (2006). this new causality test does not require prior analysis to define the order of integration or co-integration features of the variables. also, it has more power than other tests in cases of non-normal and autoregressive conditional heteroscedastic error terms and has a bootstrap distribution that is a good approximation for the empirical studies with small samples. literature review there are a number of studies attempting to identify the impacts of immigration on the host country’s labor market. however, they mostly obtain evidence of causality running from unemployment to immigration instead of from immigration to unemployment (see feridun, 2007; islam, 2007; withers & pope, 1985). the early empirical studies, dating back to the 1980s, applied simple methods such as ordinary least squares (ols) and/or instrumental variables. for instance, withers and pope (1985), using a statistical causality method and a conventional structural model for the years of 1948-1982, found that immigration has no significant impact on unemployment. however, there is a high and meaningful effect running from unemployment to migration for australia. pope and withers 142 journal of business strategies (1993), using two-stage least squares, supported a bidirectional negative causality between immigration and unemployment in australia over the period 1861-1991. for canada, marr and siklos (1994), using quarterly data for the period of 19621990 and applying nonparametric multivariate spectral method, indicated that unemployment decreases immigration before 1978, while immigration positively contributed to unemployment after 1978. pischke and velling (1997), using ols for the late 1980s, found no detrimental effect of immigration on native workers’ employment in germany. dustmann et al. (2005), using data from the british labor force survey and employing the approaches of ols and instrumental variable for the years 19832000, found no substantial evidence that immigration has effects on unemployment and wage levels. based on a production function and a seemingly unrelated regression approach, akbari and devoretz (1992) analyzed the impact of immigrant workers on the employment conditions of canadian-born workers in 125 canadian industries for 1980 and suggested no economy-wide displacement of canadian-born workers by immigrants. by using nonlinear ols, dolado et al. (1994) analyzed the effects of migration for 23 oecd countries based on a solow growth model augmented by migration and human capital over the period of 19601985. their results indicated that if immigrants have a high level of human capital, their negative output and growth effects diminishes. there are also recent time series studies applying novel methods. some of them found that immigration has little or no significant impact on the host country’s labor market and economic development level (see feridun, 2005; islam, 2007; shan, 1999). for instance, using quarterly data for the years 1983 to 1995, shan (1999) found no causality between immigration and unemployment in either direction for australia and new zealand in the framework of the causality test of toda and yamamoto (1995). islam (2007) examined the relationship between unemployment and immigration in canada through cointegration and granger causality tests for the period of 1961:q1-2002:q1. the results confirmed that, in the short-run, there is a one-way negative causality running from unemployment to migration, from migration to wage and from the per capita gdp to migration. however, there is no observed increase in aggregate unemployment rate due to migration in the longrun. the studies by feridun (2004, 2005, and 2007) investigated the causality between immigration, gdp per capita and unemployment using co-integration and granger causality tests for finland (1981-2001), norway (1983-2003) and sweden (19802004), respectively. feridun (2004, 2005) obtained evidence that, when the level of immigration goes up, gdp per capita also increases. however, regarding the relationship between unemployment and immigration, feridun (2004) found that volume 33, number 2 143 rising immigration levels result in a higher unemployment level, whereas feridun (2005) obtained that immigration has no any impact on unemployment rate, and vice versa. in another study, feridun (2007) supported a long-run bidirectional causality between immigration and gdp per capita and a one-way causality from unemployment to immigration. for the british columbia region of canada, gross (2004), using the johansen cointegration test and a vector error correction (vec) model over the period of 1980:q1-1995:q4, found that immigration causes unemployment and raises the real wage in the short-run, while it lowers unemployment in the long-run. in another study, gross (2002), employing a general equilibrium model, the johansen cointegration test, and a vec model, obtained result that show immigrants increase unemployment in the short-run, whereas they lower the unemployment rate in the long-run for the french labor market from 1975 to 1994. there are also time series studies highlighting that immigration has a beneficial impact on native employment. for instance, fromentin (2013), using cointegration test and a vec model over the period of 1970-2008, found evidence of a negative causality running from immigration to unemployment in both the short and long-run. konya (2000), through the causality tests proposed by granger (1969) and toda and yamamoto (1995) for 1981:q2 to 1998:q4, found a negative causality running from immigration to long-run unemployment rate for australia. data and methodology data we use gdp per capita, unemployment rate, and net migration rate data for the period of 19662013 for australia. gdp per capita data (constant 2005, us dollar) are collected from the world bank development indicators database. the unemployment rate, measured as the percentage of the total labor force that is unemployed but looking for a job and willing to work, are from the oecd labor force statistics. the net migration rate data, indicating the difference between immigrants and emigrants for a country per 1000 inhabitants, are obtained from oecd international migration statistics. all variables are used in their natural 4 see there are also panel data studies (see angrist & krugler, 2003; basile et al., 2010; boubtane et al., 2013; damette & fromentin, 2013; ghatak & moore, 2007; ghatak et al., 2008; jean & jimenez, 2011; latif, 2015). however, we abstained the detailed explanations for them for the sake of brevity. 5 we couldn’t include wage variable into the analysis due to unavailability of data for the time period of this study.3 see https://www.border.gov.au/reportsandpublications/documents/statistics/migration-trends13-14-glance.pdf2 this number only includes legal immigrants; 6 entries of persons admitted on a temporary basis are not included in this statistic. 144 journal of business strategies logarithmic forms in the analyses, and some statistical features of variables are tabulated in table 1. table 1 descriptive statistics of variables statistics ingdp inun inmig mean 25590.10 5.973 6.531 median 24461.31 6.090 6.141 maximum 37494.17 10.97 14.87 minimum 15217.90 1.445 1.007 std. dev. 6720.868 2.599 2.774 skewness 0.374577 -0.161 0.541 kurtosis 1.840232 2.385 3.416 jarque-bera 3.812584 (0.1486) 0.965 (0.617) 2.691 (0.260) notes: probabilities were provided in parentheses for the jarque-bera test. the null hypothesis for jarque-bera test is that the variable has a normal distribution. lngdp, lnun, and lnmig represent the natural log of per capita gdp, unemployment rate and net migration rate, respectively. as seen in table (1), the measures of skewness and kurtosis, as well as the test statistic of jarque-berra, support the null hypothesis of a normal distribution for all variables. methodology hacker hatemi-j causality test (2006) the relationship between immigration and economic conditions is extensively analyzed through the granger causality test in the literature. however, granger and newbold (1974) asserted that regression analysis based on the asymptotic distribution theory does not work well, and spurious results can be obtained in the case of non-stationary variables. also, sims et al. (1990) indicated that if there are nonstationary variables, the vector autoregressive (var) model cannot be used in level form irrespective of the co-integration features of the variables. in such a case, toda and yamamoto (1995, ty hereafter) suggested a wald test statistic that asymptotically has a chi-square distribution irrespective of the order of integration or co-integration features of the variables in the model. ty (1995) proposed the following augmented var p+d model: volume 33, number 2 145 (1) eq. (1) can be defined in a compact way as follows: (2) where the modified wald (mwald) test statistic defined in eq. (3) is introduced by ty (1995) to test the null hypothesis for non-granger causality: (3) where = kronecker product, y = ap x n(1+n(p+d)), vu is the estimated variance-covariance matrix of residuals in eq. (2), and = vec(f), where vec implied the column stacking operator. the mwald statistic asymptotically has a x2 distribution based on the assumption that error terms are normally distributed, with the number of degrees of freedom equal to the number of restrictions to be tested. ty (1995) asserted that the usage of asymptotical distribution theory is valid in the case of eq. (2). however, hacker and hatemi-j (2006, hh hereafter) proved that mwald test statistic over rejects the null hypothesis, particularly in cases of non-normal and autoregressive conditional heteroscedastic (arch) error terms by utilizing monte carlo simulations. they also underlined that asymptotic distribution could be a poor . . . 146 journal of business strategies approximation for the empirical studies with small samples. hh (2006) indicated that, for the mwald test, the empirical bootstrap size is close to the correct size in different cases when the extra lags are greater than or equal to the integration order of both variables. to carry out the bootstrap simulations, eq. (2) is first estimated with the null hypothesis of granger non-causality. for each bootstrap simulation, the simulated data is generated, , where f represents the estimated value of parameters in eq. (2). the bootstrap residuals depend on t random draws with replacement from the regression’s modified residuals, each with equal probability of 1/t. then, the mean of the resulting set of drawn adjusted residuals is subtracted from each of the modified residuals in that set. the regression’s raw residuals are modified to have constant variance through the usage of leverages. the bootstrap simulation is run 100,000 times to compute the bootstrap critical values and the mwald test statistic is calculated each time. thereby, the empirical distribution for the mwald test statistic can be produced. before implementing the causality test, we need to determine the maximum integration order (dmax ) of the variables of interest. for that aim, augmented dickeyfuller (1979, adf hereafter) and phillips-perron (1988, pp hereafter) unit root tests were utilized, and their results were tabulated in table (2). table 2 augmented dickey-fuller and phillips-perron unit root test results level adf-constanttrend adf-constant pp-constanttrend pp-constant inun -1.4118 (0.8446) -2.0937 (0.2480) -1.4118 (0.8446) -2.0881 (0.2502) inmig -3.3324c (0.0735) -3.0841b (0.0346) -3.2889c (0.0806) -3.0499b (0.0375) ingdp -2.4237 (0.3632) -1.3653 (0.5911) -2.7199 (0.2337) -1.2948 (0.6244) first-difference adf-constanttrend adf-constant pp-constanttrend pp-constant inun -6.0625a (0.0000) -5.6996a (0.0000) -6.0683a (0.0000) -5.8002a (0.0000) inmig -4.4155a (0.0055) -4.2870a (0.0015) -7.5180a (0.0000) -7.5554a (0.0000) ) ) volume 33, number 2 147 ingdp -5.6767a (0.0001) -5.6996a (0.0000) -5.6164a (0.0002) -5.6499a (0.0002) notes: probability values are tabulated in parentheses, a, b and c indicate 1%, 5%, and 10% significance levels, respectively. schwarz information criterion was used in the lag length selection in the adf test; bartlett-kernel as a spectral estimation method and newey-west bandwidth as a bandwidth selection method were utilized in the pp test. lnun, lnmig and lngdp indicate the natural log of unemployment rate, net migration rate and per capita gdp, respectively. as reported in table (2), all variables are stationary in their level or first differences, i.e. they are i (1) or i (0). therefore, dmax in the ty (1995) and hh (2006) causality tests was decided as one. it is also necessary to define the optimal lag length (p) of the var model. based on the results of akaike information criterion, three lags were selected as an optimal lag order of var model.7 finally, we augmented var (3) model with an extra one lag and estimated var (4) model. the results of the causality tests are tabulated in table (3). as seen in table (3), the both ty and hh causality tests support the presence of one-way causal relationships running from unemployment to immigration and from gdp per capita to immigration. however, immigration does not appear to have any significant impact on the economic conditions of australia. as a visual inspection, we also plot immigration with gdp per capita and unemployment and got a negative relationship between unemployment and immigration (see fig. 3). therefore, based on fig. 3 as well as on the causality tests’ results, it could be concluded that increasing level of unemployment leads to decreases in immigration inflows. this result is in line with the studies of feridun (2007), islam (2007) and withers and popp (1985). however, it is in sharp contrast with the studies of konya (2000), who found a negative causality running from immigration to unemployment, and pope and withers (1993), who obtained a bidirectional negative causality between immigration and unemployment. 7 autocorrelation and heteroscedasticity problems were solved by estimating var (3) model. 148 journal of business strategies table 3 results of toda yamamoto and hacker and hatemi-j causality tests causualities mwald (ty) mwald (hh) critical values 1% 5% 10% inmig inun 2.7621 (0.4298) 2.762 15.027 9.724 7.548 inun inmig 18.754 a (0.0003) 18.753a 13.735 9.000 6.977 inmig ingdp 3.5765 (0.3110) 3.576 14.182 9.211 7.202 ingdp inmig 10.326 b (0.0160) 10.326b 13.627 8.767 6.834 notes: probabilities were provided in parentheses; a and b indicate 1% and 5% significance levels, respectively. modified walt test statistics were tabulated for both tests and the critical values for the hh causality test were provided at 1%, 5%, and 10% significance levels, respectively. ty indicates toda and yamamoto (1995) causality test, while hh shows hacker and hatemi-j (2006) causality test. lnun, lnmig and lngdp show unemployment rate, net migration rate and per capita gdp, respectively. critical values were obtained through 100,000 bootstrap replications. figure 3 plots of immigration with per capita income and unemployment (in logarithmic form) source: author’s own calculation however, immigration does not appear to affect the unemployment rate of australia, probably due to the presence of both substitutability and complementarity among native and immigrant laborers. in this respect, the adverse impacts of substitution on the employment level of australia appear to be compensated for through the positive effects of complementarity. additionally, as gross (2004) asserted, a quality effect may offset the adverse quantity effect from the immigration rate through the high levels of skill and human capital that immigrants have. volume 33, number 2 149 furthermore, foreign workers accept jobs that are rejected by native workers and fill labor or skill shortages in the host labor markets, which does not lead to an increase in the unemployment rate. besides, due to the absorptive capacity of the australian labor market and high-speed adaptation capabilities of immigrant workers, immigration may not aggravate the unemployment level in australia (damette & fromentin, 2013). regarding the relationship between gdp per capita and immigration, there is only a one-way causality running from gdp per capita to immigration. economic development and a high standard of living are expected to pull more immigrant inflows to australia. as such, as latif (2015) states, it is probable that rising gdp per capita provides a signal to potential immigrants about job prospects. however, immigration does not appear to have a significant impact on gdp per capita. this insignificant result implies that the immigrants’ human capital levels are high enough to compensate for the adverse effects caused by a reduction in the capital–labor ratio as a result of migration inflow (boubtane et al., 2013). our result is similar with those of islam (2007) and morley (2006), whereas it is in sharp contrast with feridun (2004, 2005). conclusion and policy implications in this study, we aim to analyze the relationship between immigration, gdp per capita and unemployment over the period of 1966 2013 for australia by employing the causality tests proposed by toda and yamamoto (1995) and hacker and hatemi-j (2006). the results provided evidence of one-way causality from both gdp per capita to immigration and from unemployment to immigration. the economic conditions (unemployment level and income level) appear to affect immigration inflows to australia. in this regard, the low level of unemployment is one of the pulling factors for immigrants into australia. however, immigration does not have any significant impact on the australian labor market. this is not an odd result because as boubtane et al. (2013) state, the empirical studies mostly conclude that immigration does not reduce the labor market prospects of natives. concerning the relationship between gdp per capita and immigration, the results indicate only a one-way causal relationship from gdp per capita to immigration. as such, the higher per capita income level australia has, the more people immigrate to australia. however, immigrants do not appear to affect the income per capita level of australia. overall, our results revealed that immigration inflows do not harm the employment prospects of australian residents. as a policy implication, the australian 150 journal of business strategies government does not need to arrange restrictive immigration policies to prevent new immigrant inflows because they are not harmful to the domestic labor market. as stated before, australian immigrants have a high level of human capital, and thus they should not be seen as threats to the australian economy. moreover, through new integration policies, immigrants could quickly adjust to their new life conditions, and their non-significant employment and income effects would be turned into significant and positive ones. references akbari, a. h., & devoretz, d. j. (1992). the substitutability of foreign-born labor in canadian-production: circa 1980. the canadian journal of economics, 25, 604-614. angrist, j. d., & kugler, a. d. (2003). protective or counter-productive? labor market institutions and the effect of immigration on eu natives. the economic journal, 113, 302–331. aydemir, a., & borjas, g. j. (2006). comparative analysis of the labor market impact of international migration: canada, mexico, and the united states. (nber working paper no. 12327). cambridge, ma: national bureau of economic research. australian department of immigration and border protection. (2015) australia’s migration trends 2013–14 at a glance. retrieved from https://www.border. gov.au/reportsandpublications/documents/statistics/migration-trends13-14glance.pdf basile, r., girardi, a. & mantuano, m. (2012). migration and regional unemployment in italy. the open urban studies journal, 5, 1-13. bodvarsson, o. b., berg, h. f. v. & lewer, j. j. (2008). measuring immigration’s effects on labor demand: a reexamination of the mariel boatlift. labor economics, 15, 560–574. borjas, g. j. (2001). does immigration grease the wheels of the labor market? brookings papers on economic activity, 1, 69–119. borjas, g. j. (1994). the economics of immigration. journal of economic literature, xxxii, 1667–1717. boubtane, e., coulibaly, d. & rault, c. (2013). immigration, unemployment and gdp in the host country: bootstrap panel granger causality analysis on oecd countries. economic modelling, 33, 261–269. volume 33, number 2 151 damette, o., & fromentin, v. (2013). migration and labor markets in oecd countries: a panel cointegration approach. applied economics, 45, 2295-2304. dickey, d.a., & fuller, w.a. (1979). distribution of the estimators for autoregressive time series with a unit root. journal of the american statistical association, 74, 427–431. dolado, j., goria, a., & ichino, a. (1994). immigration, human capital and growth in the host country. journal of population economics, 7, 193–215. dustmann, c., fabbri, f., & preston, i. (2005). the impact of immigration on the british labor market. the economic journal, 115, 324-341. feridun, m. (2007). immigration, income and unemployment: an application of the bounds testing approach to cointegration. the journal of developing areas, 41, 37-49. feridun, m. (2005). investigating the economic impact of immigration on the host country: the case of norway. prague economic papers, 4, 350-362. feridun, m. (2004). does immigration have an impact on economic development and unemployment? empirical evidence from finland (1981-2001). international journal of applied econometrics and quantitative studies, 1, 39-60. fromentin, v. (2013). the relationship between immigration and unemployment: the case of france. economic analysis & policy, 43, 51-66. ghatak, s., mulhern, a., & watson, j. (2008). inter-regional migration in transition economies: the case of poland. review of development economics 12, 209– 222. ghatak, s., & moore, t. (2007). migration and the eu labor market: granger causality tests on a panel var. (discussion paper). kingston upon thames, u.k.: faculty of arts and social sciences, kingston university granger, c. w. j. (1969). investigating causal relations by econometric models and cross-spectral methods. econometrica, 37, 424–438. granger, c. w. j. & newbold, p. (1974). spurious regression in econometrics. journal of econometrics, 2, 111–120. gross, d. m. (2004). impact of immigrant workers on a regional labor market. applied economic letters, 11, 405-408. gross, d. m. (2002). three million foreigners three million unemployed? immigration flows and the labor market in france. applied economics, 34, 1969–83. hacker, r. s. & hatemi-j, a. (2006). tests for causality between integrated variables using asymptotic and bootstrap distributions: theory and application. applied economics, 38, 1489–1500. 152 journal of business strategies islam, a. (2007). immigration unemployment relationship the evidence from canada. australian economic papers, 46, 52-66. jean, s., & jiménez, m. (2011). the unemployment impact of immigration in oecd countries. european journal of political economy, 27, 241–256. konya, l. (2000). bivariate causality between immigration and long-term unemployment in australia, 1981-1998. (working paper no. 18). melbourne, australia: victoria university applied economics. latif, e. (2015). the relationship between immigration and unemployment: panel data evidence from canada. economic modelling, 50, 162–167 marr, w. l., & siklos, p. l. (1994). the link between immigration and unemployment in canada. journal of policy modeling, 16, 1-26. morley, b. (2006). causality between economic growth and immigration: an ardl bounds testing approach. economics letters, 90, 72–76. oecd. (2016). international migration database. retrieved from https://stats.oecd.org/index.aspx?datasetcode=mig oecd. (2016). labor force statistics. retrieved from http://www.oecd.org/ employment/labour-stats peri, g. (2008). immigration accounting: u.s. states 1960-2006. (discussion paper series no: 05). london: centre for research and analysis of migration. phillips, p. c. b. & perron, p. (1988). testing for a unit root in time series regression. biometrika, 75(2), 335–346 pischke, j. s., & velling, j. (1997). employment effects of immigration to germany: an analysis based on local labor markets. the review of economics and statistics, 79, 594-604. pope, d., & withers, g. (1993). do migrants rob jobs? lessons of australian history, 1861-1991. the journal of economic history, 53, 719-42. shan, j. (1999). immigration and unemployment: new evidence from australia and new zealand. international review of applied economics, 13, 253-260. sims, c. a., stock, j. h., & watson, m. w. (1990) inference in linear time series models with some unit roots. econometrica, 58, 133–144. toda, h. y., & yamamoto, t. (1995). statistical inference in vector auto regressions with possibly integrated processes. journal of econometrics, 66, 225-250. troshchenkov, s. (2011). influence of immigration on the unemployment rate: the case of denmark. (master’s thesis, umea university, sweden). retrieved from https://www.diva-portal.org/smash/get/diva2:523614/fulltext01.pdf withers, g. & pope, d. (1985). immigration and unemployment. economic record 61, 554-563. volume 33, number 2 153 world bank. (2016). development indicators database. retrieved from http://databank.worldbank.org/data/reports.aspx?source=world-developmentindicators brief biographical sketch of author dr. burcu ozcan got her phd degree in economics from istanbul university in 2011. she is now an associate professor of economics in the faculty of economics and administrative sciences at firat university in turkey. she teaches macroeconomics and monetary economics. her primary research areas are energy economics, information economics and development economics. she was a visiting professor in the business administration college at sam houston state university from april through september, 2016. organizational performance: strategic persistence versus strategic change rolf d. dixon west texas a&m university canyon, texas kimberly b. boal texas tech university lubbock, texas abstract the relationship of strategy to organizational performance has been of great interest to strategic management scholars. however, the relative contribution to organizational performance of the content of strategic decisions as opposed to the implementation of strategic decisions is not agreed upon in the literature. if it is primarily what strategy you select that leads to higher performance, then strategic change is good. on the other hand, if it is primarily how well you implement any given strategy that leads to higher performance, then strategic persistence is good. this study considers the relative contribution of strategic change versus strategic persistence as they relate to organizational performance in the banking industry. introduction two views have been espoused by strategic management scholars relating to the relationship of strategy to performance. one suggests that a firm's performance ultimately will depend on the content of the organization's strategic decisions what an organization decides to do. the miles and snow (1978) and porter (1980) strategy typologies are well known major contributors to the idea of generic strategies that lead to higher organizational performance when appropriately matched with a firm's current operating environment. this view would suggest that if an organization is not performing well with its current strategy the answer will be to change to another strategy. another view, espoused by scholars such as galbraith (1983), parnell (1994), and peters (1984), suggests that an organization's success will be based not on what strategy is selected, but, rather, on how well an organization manages its internal strategy implementation processes internal capabilities developed over time. taken from this perspective the organization that is not meeting its performance goals should seek to improve its internal implementation processes rather than change its strategic direction. 186 journal of business strategies vol. 13, no. 2 this paper seeks to contribute to our understanding of the value of organizations maintaining their strategic direction over time (strategic persistence), as opposed to that of changing strategies, as it relates to the issue of resulting performance levels for those organizations. the banking industry was utilized as the investigation arena for this study. banking over the last 20 years has gone from a period of environmental stability, to a period of environmental instability; this allows an investigation of the impact of strategic persistence on performance within the context of both a stable industry environment and an unstable industry environment. within each period (stable versus unstable) the performance level of firms that had pursued a constant strategy was compared to that of firms that had changed their strategy. strategic groups, defined as collections of firms pursuing a common strategy, were utilized as the mechanism for this comparison. firms that did not change their strategic group membership for the time period of this study are referred to as constant firms-firms persisting with a particular strategy. firms that either entered or left mid-period a strategic group are referred to as shifting firms-firms exhibiting a change in their strategic direction. managers, driven by a need to establish and maintain high performance levels in their organization, have a vested interest in t111s question is organizational performance a primary function of what an organization decides to do, or of how well it does that which it is already doing? strategic groups the concept of strategic groups was first introduced by hunt (1972) in his dissertation study of the white goods industry. strategic groups have been identified as collections of firms grouped by similar strategic actions and responses to a shared operating environment (cool and schendel, 1987). over the 24 years that have followed hunt's initial study, strategic group research has developed as a significant and popular arena for the investigation of organizational behavior and performance (barney and hoskisson, 1990; mcgee and thomas, 1986; thomas and venkatraman, 1988). fiegenbaum and thomas (1995) have indicated that strategic groups act as important reference points for firms' strategic behavior. the use of strategic groups within the banking industry allowed collections of firms that are pursuing similar strategies. within a strategic group over time, there should be found some firms that have been members of that strategic group for a substantial period of time and some firms that are relatively new members of that strategic group. segmenting these two types of firms within each strategic group makes possible the explicit investigation of the impact of strategic persistence, as identified by long-term strategic group membership, on firm performance. fall 1996 dixon & boal: organizational performance 187 industry environment a contextual issue also considered in this study was to what extent, if any, did the conditioris of industry environmental stability and instability impact the relationship between strategic persistence and finn performance. in tcrms of the management of strategy, the dimension of dynamism/instability, which involves a lack of predictable patterns, acts to reduce the ability of firms to individually and collectively understand what strategics produce the best perfonnance results, and to have the time available to understand all the issues involved in the. successful implementation of any given strategy. further, keats and hitt (1988) indicated that the dimension of instability has a greater impact on an organization's perfonnance than do either munificence or complexity, the other dimensions most commonly utilized to characterize the environment (dess and beard, 1984). thus, the dimension of instability provided the ideal context for investigating the role of the environment on the issues of this study. research hypothesis strategic persistence and performance this research investigates the impact of strategic persistence within strategic groups on perfonnance. for the purposes of this study, firms that remain within a particular strategic group for the duration of the stable or unstable period of time are referred to as "constant" member firms exemplifying strategic persistence. finns that entered or left one or more strategic groups within the stable or unstable period of time are referred to as "shifting" member firms exemplifying strategic change. specifically, to investigate the impact of strate~ gic persistence versus strategic change on perfonnance we test for statistically significant differences in the overall mean levels of performance found for "constant" member firms and for "shifting" member finns. further, we test for significant differences in the variances in perfonnance levels (performance homogeneity) found within both categories of strategic group member firms. in addition, we conduct the statistical tests of our hypotheses during a period of industry stability and a period of industry instability to investigate whether or not environmental stability or instability have any systematic impact on the relationship between strategic persistence and change to performance. hypothesis 1: during conditions of industry stability, the constant firm sets and the shifting firm sets will not exhibit different levels of peifonnance. hypothesis 2: during conditions of industry instability, the constant firm sets and the shifting firm sets will not exhibit different levels of peiformance. 188 journal of business strategies vol. 13, no.2 hypothesis 3: during conditions of industry stability, the constant firm sets and the shifting firm sets will not exhibit different levels of performance homogeneity. hypothesis 4: during conditions of industry instability, the constant firm sets and the shifting firm sets will not exhibit different levels of performance homogenei~v. methods industry sample two prior studies specifically considered the issue of strategic groups in the banking industry. amel and rhoades (1987) investigated whether or not strategic groups could be found in the banking industry, based on a selection of banking industry-specific variables. reger (1988) investigated whether or not managers in the banking industry cognitively identified strategic groups and their firm members. results from these studies suggested that strategic groups do exist in the banking industry, and that the concept of strategic groups is cognitively meaningful to practitioners. further, the banking industry lends itself well to the issues being considered in this study as this industry has gone through significant periods of stability and instability over the past 25 years. the banking industry files contained on compustat provided the sample population for this study. the compustat banking file contains banks of all sizes, as well as from all regions throughout the united states. this file provided a sample of 62 banks for the stable time period of study and 109 banks for the unstable time period. time period selection the research issues of this paper were investigated within the contexts of a period of stability and a period of instability for the banking industry as a whole. dess and beard (1984) define industry environmental stability as a condition where there are only small amounts of change in the key strategic dimensions or conditions facing a particular industry. thus, industry stability should lead to a condition of industry understanding and predictability. three dimensions have become standard in the typing of the environment: munificence, dynamism or instability, and complexity (dess and beard, 1984). keats and hitt (1988), in their study of the impact of the environmental dimensions of munificence, instability, and complexity on organizations, found that the dimension of instability had a greater impact on the behavior and subsequent performance of an organization than did either of the other two dimensions. therefore, the dimension of instability was chosen as the most appropriate to the focus of this study. this study established time periods of relative environmental instability and stability in a manner consistent with the approach utilized by tosi, fall 1996 dixon & boal: organizational peiformance 189 aldaq, and storey (1973), snyder and glueck (1982), and keats and hitt (1988). due to the major role of interest rates in both the revenues and expenses of banks in general the measure of instability was a coefficient of variation, calculated on the prime rate as reported by the federal reserve board, since interest rate changes have been noted as a major source of environmental instability in the banking industry. this study considered the entire period of 1968-1987, the time period on the 20 year banking data file available from compustat. from the analysis of this data file two distinct time periods were found, one which best reflected a period of industry stability 1968-1972, and one which best reflected a period of industry instability 1978-1982. byway of comparison, snyder and glueck (1982) reported coefficients of variation for industries ranging from .24 in the electronics industry (the most unstable) to .10 in the confectionery products industry (the most stable). in our study, the coefficients of variation for the two time periods selected for the study were .06 for the time period of 1968-1972, and .24 for the time period of 1978-1982, providing, therefore, measures for instability and stability in the banking industry that equalled or exceeded those of the snyder and glueck study. furthermore, the choice of these two time periods were externally validated by the opinion of industry specialists (compton, 1987; haraf and kushmeider, 1987), and by the charting of bank failure rates and changes in the prime rate over time. for example, bank failure rates more than doubled during the unstable period of time, relative to that of the stable period of time; and prime rates, which remained basically stable during 1968-1972, fluctuating less than 3 percentage points, ranged over 12 percentage points during the 1978-1982 time period. variable selection this study used a list of scope and resource deployment variables selected by academics and practitioners for their ability to reflect the unique strategic decision alternatives available to managers in the banking industry. the sources for this variable list include amel and rhoades (1987), pohlman (1985), reger (1988), rosenblum and pavel (1985), sinkey (1989) and professors scott macdonald and steven sears of the institute for banking and finance studies at texas tech university. the following variables, used in the present study, reflect the strategic scope and resource deployment choices generally available to banks. these variables were derived from the compustat annual bank file for the time periods of 1968-1972 and 1978-1982. scope variables: (1) loans/total assets (2) treasury securities/total assets (3) state and local government securities/total assets (4) federal funds/total assets 190 journal of business strategies vol. 13, no.2 (5) trust revenue/total assets (6) time deposits/total assets (7) demand deposits/total assets (8) foreign deposits/total assets resource deployment variables: (9) premises, furniture, and equipment/total assets (10) officer and employee salaries and wages/total assets performance variable selection pohlman (1985) identified the following measures of performance that are of specific value to the banking industry and which are used in this study: (1) return on equity (2) return on assets (3) profit margin while the limitations of accounting data have been noted by barney and hoskisson (1990), the variables selected for this study reflect standard practice in strategic group studies, as a review of the 52 strategic group studies since 1972 indicates that over forty of the studies utilized accounting data as the basis for cluster analysis (dixon, 1994). further, in an effort to minimize error, all clustering variables and the resulting groups were subjected to validation by industry expert opinion. cluster analysis procedure for this study, firms within the banking services industry were clustered into strategic groups for each year of the two five-year periods via a non-hierarchical and disjointed clustering technique. a question relative to the choice of a cluster analysis procedure is whether one wishes to obtain disjointed clusters where each firm is found within one and only one cluster. as the major focus of this study was to investigate the influence of a firm's constant, versus shifting, membership in a strategic group on performance, a cluster analysis technique was needed that forces closed strategic group boundaries, thereby allowing firms to belong to only one strategic group at any point in time. the sas institute, inc. procedure of proc fastclus provides the non-hierarchical and disjointed cluster analysis best suited for the issue of the present study and was for the above-stated reasons deemed the most appropriate clustering technique to use in this study. the determination of the appropriate number of strategic groups for each year of the study was based on a review of the r2, the cubic clustering criterion value, and the psuedo-f value generated for each iteration of the clustering technique. a ruleof-thumb identified by fiegenbaum (1987) for the r2 values as a cut-off point in cluster analysis is that one should not increase the number of clusters past the point where the r2 values are increasing at a rate of less than 5%. the proc fastclus procedure generates for each number of strategic groups a cubic clustering criterion and a psuedo-f statistic. these two statistics indifall 1996 dixon & boal: organizational performance 191 cate the appropriate number of strategic groups as being that point at which these two statistical measures peak. strategic group membership status sixty-two banks during the stable time period of 1968-1972, and 109 banks during the unstable time period of 1978-1982, were clustered by their strategic profile, as indicated by the cluster analysis loadings on each of the strategic variables, into five strategic groups (consisting of 4,7, 8, 21, and 22 banks each) during the stable time period and into three strategic groups (consisting of 12, 38, and 59 banks each) during the unstable time period. following the establishment of the appropriate number of strategic groups, as determined by the procedure discussed in the section above, these resulting groups were then further validated by industry expert opinion. then for the two time periods of study, sub-group categories of constant strategic group firm members and shifting strategic group firm members were established for each of the years 1968-1972 and 1978-1982. this was accomplished by a mobius procedure which compares the location of all firms included in strategic group 1 in year n to their strategic group location in year n + i (sudharshan, fiegenbaum, and thomas, 1991). the firms located on the diagonal for the entire five years of each period (stable and unstable) are the constant member firms; all others are categorized as shifting member firms. this procedure was done for all strategic groups for each of the five years of the stable period of 1968-1972 and each of the five years of the unstable period of 1978-1982. hypotheses testing procedures performance means differences, as indicated in hypotheses i and 2, are analyzed by an anoya test available in proc glm of sas. performance variances, as indicated in hypotheses 3 and 4, are analyzed by an f test available in proc trest of sas. results identification of strategic groups the determination of the appropriate number of strategic groups for each year of the study was based on a review of the r2, the cubic clustering criterion value, and the psuedo-f value generated by the cluster analysis procedure. for the stable period of 1968-1972 five major strategic groups were consistently found. the groups as established by the clustering technique were verified by a recognized banking industry expert. a review of the strategic profiles established by the relative weight given each of the strategic variables in the clustering technique utilized in this study resulted in the following groups being identified. they were: (l) commercial banks seeking core deposits, such as certificates of deposits, (2) smaller local banks acting as good corporate citizens by investing heavily in local securities offerings, (3) traditional 192 journal of business strategies vol. 13, no. 2 banks following a match-funding strategy with loans equaling deposits, (4) investment banks, and (5) money center banks seeking foreign deposits. using the identical procedure as above described for the unstable period of 19781982, three major strategic groups were consistently found to be operating within the banking industry. they were identified as: (1) banks which followed the conservative policy of loaning their excess liquidity to other banks, (2) aggressive commercial banks offering short term loans in an effort to maximize gains from rapidly changing interest rate changes,and (3) money center banks seeking foreign deposits. differences in performance means to test for differences in performance means between constant and shifting strategic group firm members, a two-factor model was used. factor 1 indicated a firm's status as either a constant or a shifting strategic group firm member. factor 2 indicated the specific strategic group of which each firm was a member. the analysis was done as detailed for each of the 10 years of the study on three performance variables: return on equity, return on assets and before-tax profit margin. seeking to further our understanding of whether there are performance consequences of strategic group membership, this procedure allowed an investigation into the statistical impact of a variety of performance measures. for the stable time period of 1968-1972, hypothesis 1 was rejected one out of five years for the return-on-equity measure, four out o( five years for the return-on-assets measure, and three out of five years for the before-tax profit measure (table 1). during this period of industry stability, statistically significant differences between mean performance levels for the sub-groups of constant member firms and shifting member firms occurred a little over 50% of the time, depending upon the measure of performance chosen. table 1 performance mean differences between constant and shifting strategic group firm members: stable period perfonnance variables roe roa profit * p-value < .10 ** p-value < .05 *** p-value < .01 1968 1.99* 9.18** 6.62*** 1969 1970 2.60** 1.84* 7.54*** 6.91*** 3.86*** 2.13** 1971 .52 1.76* .52 1972 1.43 3.11 *** 1.13 the results for the unstable time period of 1978-1982, however, do not indicate a general rejection of hypothesis 2 (table 2). for each of the three fall 1996 dixon & boal: organizational performance 193 performance variables, the null hypothesis was rejected only four times out of the fifteen cases available. this would indicate that performance differences between constant and shifting strategic group firm members essentially disappear during times of industry environmental instability. table 2 performance mean differences between constant and shifting strategic group firm members: unstable period performance variables roe roa profit * p-value < .10 ** p-value < .05 *** p-value < .01 1978 1.01 1.55 1.95* 1979 1.19 1.26 1.41 1980 1.37 1.67* 1.70* 1981 3.44*** 1.12 1.04 1982 1.06 1.47 1.66* equality of performance variance for each of the five years of the stable time period (1968-1972) and the unstable time period of the study (1978-1982), an "f" statistic was computed, testing the null hypothesis of equality of variance for the three performance measure means between the sub-group of constant member firms and the subgroup of the shifting member firms. table 3 provides the results of this test for the stable period of 1968-1972. for the performance measure of returnon-equity, hypothesis 3 was not rejected in any year investigated, indicating no statistically significant differences in the variance for this measure between the constant and shifting firm sets. the performance measure of return-an-assets rejected the hypothesis in three out of the five years of the stable period. therefore, for the stable time period of 1968-1972, there is little statistical evidence supporting unequal performance variances between the constant member firm sub-groups and the shifting member firm sub-groups. table 3 constant versus shifting strategic group firm sets test of equality of variance: stable period performance variables roe roa profit * p-value < .10 ** p-value < .05 *** p-value < .01 1968 1.13 4.07*** 1.78 1969 1.63 3.63*** 1.38 1970 1.08 2.90*** 1.44 1971 1.14 1.06 1.09 1972 1.04 1.54 ll7 194 journal of business strategies vol. 13, no.2 table 4 provides the re.sults for the testing of equality of variance for the three performance measures between the constant and shifting member firm sets for the unstable industry time period of 1978-1982. for the performance measure of return-on-equity hypothesis 4 failed to be rejected four out of the five years of this period. for the return-on-assets measure hypothesis 4 again failed to be rejected four out of five years. the hypothesis failed to be rejected for the before-tax profit margin measure two out of five years. again, the statistical results generally failed to support unequal performance variances between the sub-groups of constant and shifting member firm sets. table 4 constant versus shifting strategic group firm sets test of equality of variance: unstable period performance variables 1978 1979 1980 \98\ \982 roe i.o! 1.19 1.37 3.44*** 1.06 roa 1.55 1.26 1.67* 1.12 \.47 profit 1.95* 1.41 1.70* 1.04 1.66* * p-value < .10 ** p-value < .05 *** p-va1ue < .0\ discussion this study suggests that, within strategic groups, firms that have remained constant members will have different performance characteristics than will be found for those firms that have not been constant members of a particular strategic group over a given period of time. for the stable time period of 19681972, constant member firms exhibited higher performance levels than did shifting member firms in 73.3% of the cases. further, during the unstable period of time, constant member firms exhibited higher performance levels than did shifting firms in 72.5% of the cases. the empirical results of this study suggest, therefore, that the inconsistent findings in previous studies between strategic group membership and performance could be partly due to researchers not controlling for the confounding influences of strategic group composition. our results suggest that, within each strategic group, firms that have remained members over time will have higher levels of performance than will firms that are newer to the strategic group, and especially so during times of industry environmental stability. therefore, strategic groups with a high ratio of constant to shifting member firms can be expected to have different performance characteristics than would strategic groups with a low ratio of constant to shifting member firms. this finding is consistent with the general idea of strategic persistence, or "practice makes fall 1996 dixon & boal: organizational performance 195 perfect." it is reasonable to expect that firms will do that better which they have experience doing. further, sub-groups of constant member firms were expected to exhibit significantly less variance in their performance measures than found for the sub-groups of shifting member firms. however, little statistical support was found for this proposition for either the stable time period of 1968-1972 or the unstable time period of 1978-1982. conclusion by tracking the strategic group membership of firms over two five-year time periods, this study supported the proposition that strategic groups do appear to exist in terms of collections of firms that exhibit, over significant periods of time, a tendency to make similar strategic decisions. this would suggest that, within an industry, strategic groups do have an impact on the strategic choices and decisions made by the firms that comprise that industry. while firms can change their strategic group membership, and by definition their strategies, this study found that the highest performers were those that stayed the course, i.e., firms that pursued over a longer period of time a single strategy outperformed those firms that switched strategies over the time periods of the study. further, this research raises issues with one of the fundamental tenets of strategy, that a firm attempt to co-align itself with its environment. prior research suggests that firms can exercise strategic choice in choosing their strategic orientation and that they can change their strategies as they attempt to achieve this environmental alignment. however, research also suggests that strategic change to achieve such an alignment will not necessarily result in superior performance, relative to those that do not change. this is consistent with other work on generic strategies that suggests firms without a coherent strategy will have lower levels of performance than will firms which follow a consistent strategy. based on the results of this study, we would suggest that strategic persistence appears to be a more viable approach to achieving superior financial performance than is strategic change. we do not suggest that strategic change in an effort to enhance environmental co-alignment, or fit, is not a useful concept. rather, that strategic change, due either to a lack of necessary organizational capabilities and/or the misreading of the environment, is as likely to cause a misfit as it is to create a fit references amel, d. and s. rhoades. strategic groups in banking. working paper no. 87-1. fi~ nancial structure section, division of research and statistics. board of governors of the federal reserve system, 1987. 196 journal of business strategies vol. 13, no. 2 barney, j. and r. e. hoskisson. "strategic groups: untested assertions and proposals." managerial and decision economics 11 (1990): 187-198. compton, e. the new world of commercial banking. lexington, ma: lexington books, 1987. cool, k. and d. schendel. "strategic group formation and performance: u.s. pharmaceutical industry, 1963-1982." management science 33 (1987): 11 02-1124. dess, g. and w. d. beard. "dimensions of organizational task environments." administrative sciences ouarterly 29 (1984): 52-73. dixon, r. "performance homogeneity among strategic groups constant member firm sets and shifting member firm sets in the banking industry," ph.d dissertation, texas tech university, 1994. fiegenbaum, a. "dynamic aspects of strategic groups and competitive strategy: concepts and empirical examination in the insurance industry." ph.d. dissertation, university of illinois at urbana-champaign, 1987. fiegenbaum, a. and h. thomas. "strategic groups as reference groups: theory, modeling, and empirical examination of industry and competitive strategy," strategic management journal 16(6), (1995): 461-476. galbraith, j. "strategy and organizational planning." human resource planning, (1983): 63-77. haraf, w. and r. kushmeider. restructuring banking and financial services in america. washington, dc: american enterprise institute for public policy research, 1987. hunt, m. "competition in the major home appliance industry 1960-1970," ph.d. dissertation, harvard uni versity, 1972. keats, b. and m. hitt. "a causal model of linkages among environmental dimensions, macro organizational characteristics, and performance." academy of management journal 31(3), (1988): 570-598. mcgee, j. and h. thomas. "strategic groups: a useful linkage between industry structure and strategic management," strategic management journal 6 (1986): 141160. miles, r.e. and c.c. snow. organization strategy, structure, and processes. new york: mcgraw-hill, 1978. mintzberg, h. and j. quinn. the strategy process. new jersey: prentice hall, 1991. fall 1996 dixon & baal: organizational performance 197 parnell, j. "strategic consistency versus flexibility: does strategic change really enhance performance?" american business review 12(2), (1994): 22-29. peters, t. "strategy follows structure: developing distinctive skills." california management review (spring, 1984): 111-125. pohlman, j. "a framework for strategic planning." in handbook for banking stratm, eds. r. aspinwall and r. eisenbeis. new york: john wiley & sons, 1985. porter, m. competitive strategy. new york: the free press, 1980. reger, r. "competitive positioning in the chicago banking market: mapping the mind of the strategist." ph.d. dissertation, university of illinois at urbana-champaign, 1988. rosenblum, h. and c. pavel. "banking services in transition: the effects of nonbank competitors." in handbook for banking strategy. eds. r. aspinall and r. eisenbleis. new york: john wiley & sons, 1985. sinkey, j. commercial bank financial management in the financial services industry. new york: macmillan, 1989. snyder, n. and w. glueck. "can environmental volatility be objectively measured?" academy of management journal 25 (1982): 185-192. thomas, h. and n. venkatraman. "research on strategic groups: progress and prognosis." journal of management studies 26(6), (988): 537-556. tosi, h., r. aldaq, and r. storey. "on the measurement of the environment: an assessment of the lawrence and lorsch environmental uncertainty questionnaire." administrative sciences ouarterly 18 (1973): 27-36. rolf d. dixon, (ph.d., texas tech university), is an assistant professor of management at west texas a&m university where he is teaching strategic management and contemporary management problems. research areas of interest includes strategic groups as predictors of organizational behavior and performance and management issues in a cross-national environment. prior research has appeared in such journals as health care strategic management journal and the journal of transnational management development. kimberly b. boal, (ph.d., university of wisconsin), is an associate professor of management at texas tech university. currently he is visiting at the pennsylvania state university where he is teaching organizational theory and researching problems associated with integrating merged companies. prior research has appeared in such journals as strategic management journal, academy of management journal, journal of management, organizational behavior and human performance, and leadership quarterly. as well as several scholarly book chapters. organizational performance: strategic persistence versus strategic change volume 32, number 1 55 dynamic effects of u.s. budget deficit and labor productivity-real wage gap on us stock market performance matiur rahman mcneese state university • lake charles, louisiana muhammand south carolina state university • orangeburg, south carolina abstract this paper investigates the dynamic effects of annual u.s budget deficit as a ratio of gdp and labor productivity-real wage gap on us stock market performance. the sample period runs from 1950 through 2012. the standard cointegration methodology is appropriately applied. all the aforementioned variables are nonstationary in levels revealing i(1) behavior. the coefficient of the error-correction term of the vector error-correction model (vecm) has expected negative sign with statistical significance confirming long-run unidirectional causality stemming from the independent variables to the stock market return. however, the speed of adjustment towards a long-run equilibrium is slow as reflected in the low numerical coefficient of the error-correction term. the evidences on short-run interactive feedback effects are also very weak. keywords: budget deficit, productivity-real wage gap, unit root, cointegration, vector error-correction model jel classification code: e60, g10 introduction u.s. federal budget deficits have been perennial at sustainable levels throughout the us history excepting several years, occasionally. the net effect of the budget deficits on stock market returns is confounding and uncertain through interest rate and price channels depending on the methods of financing. this issue remains a puzzle inspiring numerous empirical studies. in theory, rising deficit boosts federal demand for loanable funds that, in turn, lifts interest rate and crowds out private investment. this decline in private investment reduces corporate capital stock with which to work. this contracting capital stock decreases future earnings growth and cash inflows. in addition, rising interest rate used as a discount factor depresses stock prices. monetization of increases in budget deficits through quantitative eas56 journal of business strategies ing lowers interest rates and causes higher expected inflation. both exert opposing influences on stock prices. in finance, the valuation of stocks depends on the expectation of the current and future cash flows from equities, the risks inherent in those flows, and rate at which those flows are discounted. stock prices are also influenced by changes in economic activity, interest rate, and inflation, among other macroeconomic fundamentals. their net effect on stock market at some point of time is ambiguous. efficient market hypothesis in weak-form further claims that budget deficits have little effect on future stock prices as the past deficits are already incorporated in the current stock prices. stock price behaviors have important bearings on private sector capital formation, market liquidity, allocative efficiency and economic prosperity meriting further empirical inquiries. the unprecedented rise in u.s. budget deficit and uncharted behavior of u.s. stock market during 2008-2010 renewed interest in studying further the relation between budget deficits and stock prices. economic theories are unsettling to provide a clear explanation to this uneasy and complex relationship. the effects of rising budget deficits due to income tax cuts or federal spending spree or both on stock prices primarily depend on the state of the economy and the methods of financing the deficits. to explain further, (i) increase in income tax reduces disposable income to spend on consumption goods. this reduces aggregate demand. given the aggregate supply constraint, prices of consumer goods decline resulting in depressed corporate earnings and hence lower stock prices, ii) financing by federal borrowing from loanable funds market raises interest rate that, in turn, reduces stock prices, and (iii) partial or full monetization of deficits by accommodative monetary easing lowers interest rate without risk of surging inflation, if the economy is at lessthan-full employment. this will help lift stock prices. furthermore, if the economy is at full employment, monetary easing will raise the fear of future resurgence of inflation with dampening effects on stock market as rational investors will reshuffle their portfolios by reallocating funds from financial assets to real assets for hedging purposes. thus, the net effect of budget deficits on stock prices at best is uncertain. labor productivity and real wage gap is another piece of puzzle in macroeconomics literature. the growth in real hourly compensation in the us nonfarm business sector has slowed to 0.4 percent a year from 2.4 percent a year over 1960-1973 (bosworth and perry, 1994). the relationship between labor productivity and nonfarm real wage is nonlinear (quadratic) with inverted u-curve (tang, 2012). so, the net effect of this gap on stock prices is again confounding and uncertain. in common sense term, a rising gap raises corporate profit that is used partly to pay higher divivolume 32, number 1 57 dends to shareholders. this, in turn, boosts stock prices. although labor productivity is an important determinant of wage, gains are distributed more in favor of capital than labor since workers are being paid discernibly below their marginal revenue products. the absence of a strong relationship between labor productivity and real wage is unlikely to boost consumption growth with a subdued effect on stock prices due to lackluster sales growths. the primary objective of this study is, thus, to explore the influences of us annual budget deficit as ratio of gdp and labor productivity-real wage gap on u.s. stock market. the standard cointegration framework is invoked to investigate this intricate issue of great importance in view of their puzzling nature. in particular, the casual nexus of stock market and labor productivity-real wage gap is heavily underresearched. the rest of the paper is organized as follows. section ii provides a brief review of the related literature. section iii outlines the empirical methodology and describes data. section iv reports empirical results. section v offers conclusions. brief review of related literature tobin (1969), in his general equilibrium approach of the financial sector, highlighted the role of stock returns as the linkage between the real and the financial sectors of the economy and showed how both money growth and budget deficits can have an important impact on stock returns. in this connection, theoretical discussion/ models are also put forth by (blanchard, 1981, and shah, 1984). it is a well-known fact that government actions (or fiscal decisions) are likely to influence future monetary policy actions (thorbecke, 1997; and patelis, 1997). based on theory and empirical evidences, the expected directional impact of the budget deficit on stock returns should be negative. government budget deficits exert upward pressure on the nominal interest rate or the discount rate, as applied to the firm. this, in turn, lowers expected returns as the risk premium increases (geske and roll, 1983). geske and roll also note that increases in risk premia due to federal budget deficits expose investors to an uncertainty surrounding the reaction of the federal reserve and thus further confound the equity market behavior. several studies have focused on the relationship between fiscal policy (budget deficits) and stock market behavior. these studies examined primarily stock market efficiency with respect to fiscal actions (e.g., rogalski and vinso, 1977; darrat, 1988; darrat and brocato, 1994; and lee, 1997). although the theoretical motivation on the effects of fiscal policy on the stock market (or asset prices) have been laid out more than thirty years ago (e.g., tobin, 1969; blanchard, 1981; and shah, 58 journal of business strategies 1984), the empirical front on the issue has been lagging, both for the u.s. and other countries (darrat, 1988; and ali and hasan, 2003). perhaps, this was due to the assumption of barro’s (1974) ricardian equivalence proposition (of debt-neutrality), which asserts that deficits do not matter if individuals correctly expect and discount future tax increases from current tax decreases thus leaving their net worth unaffected. subsequent investigations, however, have produced mixed results. for instance, some studies have shown support for the proposition (e.g., evans, 1987a, b; and boothe and ried, 1989), others have produced results to the contrary (frenkel and razin, 1986; and zahid, 1988). conventional analysis suggests that sustained budget deficits have profound implications on interest rates, national saving and the external account (gale and orszag, 2003, 2004; engen and hubbard, 2005). thus, going beyond the traditional analysis, large future deficits entail additional risks to the economy which includes a loss in domestic and foreign investor confidence and adverse effects on the exchange rate. specifically, a loss in investor and business confidences would cause a shift of portfolios away from home-currency assets into foreign-currency assets, thereby placing a downward pressure on the domestic currency and an upward pressure on the interest rate. this would limit the ability of the country to finance its liabilities and increase the country’s exposure to exchange rate fluctuations. in contrast, higher government deficits may also encourage higher money growth, resulting from an accommodative behavior of the federal reserve or a decline in interest rates. empirical evidences on this behavior have offered mixed results. specifically, allen and smith (1983) and barnhart and darrat (1989) report a negative relationship between federal budget deficits and money growth. furthermore, deleeuw and holloway (1985) and hoelscher (1986) provide evidence of a positive linkage between the above. therefore, this is still an issue of further empirical investigation. additionally, the effects of money growth on stock returns can be approached from two theoretical perspectives, namely, the efficient market approach (cooper, 1974; and rozeff, 1974) and the general equilibrium portfolio approach. the first approach simply argues that all past information incorporated in the money supply data is reflected in current stock returns and so money supply changes should have no impact on stock returns excepting a possible contemporaneous effect. the second perspective suggests that investors attempt to hold an equilibrium position among all assets, including money and equities. an exogenous shock that increases the money supply would temporarily disturb this equilibrium until investors substitute money for other assets. so, equities respond to monetary disturbance with a lag and that lag volume 32, number 1 59 could, theoretically, be linked to an interest-rate effect, a corporate-earnings effect, a risk-premium effect and so on (hamburger and kochin, 1971). the conventional wisdom about the role of stocks is that they provide a hedge against inflation or the fisherian hypothesis of positive relationship of nominal equity returns with inflation. however, evidences provided by fama and schwert (1977), geske and roll (1983), and mccarthy et al., (1990) suggest a negative relationship between stock returns and inflation. a re-examination of the issue by james et al., (1985), wei and wong (1992), and lee (1992) found support for this hypothesis, while park (1997), siklos and kwok (1999) and laopodis (2006) found evidence against it. thus, this issue is still stirring empirical controversies and remains to be empirically resolved. more recently, quayes (2010) studied the association between budget deficit and stock prices by integrating the effects of inflation and demographic structure. results from the cointegration analysis show that both budget deficit and inflation have negative impact on stock prices. saleem, et.al. (2012) examine the long-run causal relationship between budget deficit and stock market for india and pakistan. results show that due to high development expenditures in pakistan, a long-term positive relationship is observed between budget deficit and stock market. in india, a negative relationship is observed between both variables due to increase in current expenditures. in pakistan, a causal relationship runs from budget deficit to stock market while no causal relationship exists between budget deficit and stock market in india. empirical studies investing the labor productivity and wage relationship are abundant. to cite a few recent ones, mora, et al. (2005) investigated the relationship between wages and labor productivity in 11 european countries for 1981-2001 and found that the gap between nominal wages and labor costs decreased. however, they did not observe a similar decrease of the gap between real wages and labor productivity. lopez-villavicencio and silva (2010) analyzed macroeconomic data of oecd countries between 1985 and 2007. they found that wage increase exceeded productivity growth of permanent workers. for temporary workers, it was just the opposite. narayan and smyth (2009), using the co-integration technique, investigated the relationship among inflation, real wages and growth of labor productivity in the g-7 countries for 1960-2004. they found a positive relationship between real wages and productivity growth. verbic and kuzmin (2009) explored the relationship between wages and labor productivity in slovenia over 1998-2007. they confirmed the hypothesis of high dependence of wages on labor productivity. sidhu (2010) 60 journal of business strategies found that labor productivity had a strong influence on determining wages in the indian economy. one percent increase of labor productivity led to about 0.39 percent increase of wage rates in india. tang (2012) empirically investigated the impact of real wages on labor productivity in the malaysian manufacturing sector using annual data for 1980-2009. this study found a quadratic relationship (i.e. inverted u-shaped curve) between labor productivity and real wage instead of a linear relationship. to our knowledge, the empirical literature on this issue is very scant. a widening labor productivity-wage gap contributes to surges in stock prices. rising productivity boosts aggregate supply (as). but real wage gains lag behind labor productivity gain. as a result, profits rise sharply causing an upsurge in the demand for company shares raising their prices (batra, 1999 and 2003). using quarterly us data for the period of 1970-2000, rashed and samanta (2005) demonstrated a strong positive relationship between labor productivity—wage gap and the stock price within a macroeconomic framework, as suggested in batra (1999). empirical methodology and data the estimating base equation is specified as follows: spr t= α + β1 bdgt + β2 prct + et (1) where, spr = us s&p 500 return, bdgt = annual us real budget deficit as ratio of real gdp, and pcr = labor productivity-real wage gap (productivity/real wage). the causal effect of each explanatory variable on s&p 500 is unidirectional, not bidirectional. so, reverse specifications of equation (1) are not necessary. prior to testing for cointegration, the time series properties of the variables involved are examined. to test for unit root (nonstationarity) in the variables, the efficient modified dickey-fuller test (df-gls), the efficient modified phillips-perron test (elliot et al. 1996; ng and perron 2001) and their counterpart kpss (kwiatkowski, phillips, schmidt and shin 1992) test for no unit root (stationarity) are implemented instead of the standard adf and pp tests for their high sensitivity to the selection of lag-lengths. it is important to examine the time series properties of variables since an application of the ordinary least squares (ols) to estimate a model with nonstationary time series data results in the phenomenon of spurious regression (granger and newbold, 1974) invaliditating the inferences through the standard t-test and joint f-test (phillips, 1986). to be cointegrated, variables must possess the same order of integration, i.e., each variable must become stationary on first-order differencing of level data depicting i(1) behavior. volume 32, number 1 61 second, the cointegration procedure, as developed in johansen (1988, 1992, 1995) and johansen and juselius (1990), is implemented that allows interactions in the determination of the relevant macroeconomic variables and being independent of the choice of the endogenous variables. it also allows explicit hypothesis testing of parameter estimates and rank restrictions using likelihood ratio tests. the empirical exposition of the johansen-juselius methodology is as follows: ∆vt= τ + ωvt-1 + ∑ ωjvt-j + mt (2) where, vt denotes a vector of spr, bdg and prc, and ω = αβ’. here, α is the speed of adjustment matrix and β is the cointegration matrix. equation (2) is subject to the condition that ω is less-than-full rank matrix, i.e., r < n. this procedure applies the maximum eigenvalue test (λmax) and trace test (λtrace) for null hypotheses on r. both tests have their trade-offs. λmax test is expected to offer a more reliable inference as compared to λtrace test (johansen and juselius (1990), while λtrace test is preferable to λmax test for higher testing power (lütkepohl, et al., 2001)). however, the johansenjuselius test procedure is also not immune to supersensitivity to the selection of laglengths. the optimum lag-lengths are determined by the aic (akaike information criterion), as developed in akaike (1969). third, on the evidence of cointegrating relationship among the variables, there will exist an error-correction representation (engle and granger, 1987). the vector error-correction model takes the following form: ∆sprt = β1et-1 + ∑  ϕiδsprt-i + ∑  δj δbdgt-j + ∑  ψj δprct-j + ut (3) equation (3) corresponds to original equation (1). here, et-1 is the error-correction term of equation (3). if β1 is negative and statistically significant in terms of the associated t-value, there is evidence of a long-run causal flow to the dependent variable from the relevant explanatory variables. if δj’s, ϕi’s, and ψj’s do not add up to zero, there are short-run interactive feedback relationships in equation (3). annual data from 1950 through 2012 are employed. the time-span over 60 years is quite sufficient for meaningful cointegration analyses (hakkio and rush, 1991). data sources include new york stock exchange for s&p 500(spr), u.s. department of commerce for nominal budget deficits (bdg) and real gdp; and bureau of labor statistics for labor productivity and hourly real wage. nominal budget deficits are deflated by consumer price indices of corresponding years. annual data 62 journal of business strategies are used for all variables due to availability of budget deficits data only on yearly basis, although quarterly data are available for other variables. empirical results first, to describe the nature of data distribution of each variable, the standard statistical descriptors are computed. they are reported as follows: table 1 descriptive statistics sample: (1950 2011) series mean median stdev skewness kurtosis jaraque-bera spr 5.2458 4.7809 1.261 0.19338 1.8302 23.9212 bdg -15.0106 -14.4790 23.8862 -2.3498 9.5430 167.6576 prc 0.8630 0.8374 0.10453 0.34089 1.7000 55.56644 the above standard descriptors confirm near-normality in the data distribution of each time series variable in terms of mean-to-median ratio being close to unity and moderate skewness. the jarque-bera statistics also reaffirm the above inference. second, pairwise simple correlation coefficients of the variables are reported as follows: table 2 correlation matrix series spr bdg prc spr 1.000000 0.138875 0.63384 bdg -0.44603 1.000000 -0.42927 prc 0.633842 -0.429275 1.000000 as evidenced in table 2, each correlation coefficient has expected sign. the coefficients range from -0.44603 to 0.63384, as observed above. third, time series property of nonstationarity/stationarity in each variable is examined by the applications of df-gls, ng-perron and kpss tests. their calculated values are reported as follows: volume 32, number 1 63 table 3: unit root tests* series level first differences df-gls ng-perron kpss df-gls ng-perron kpss spr -1.1263 -1.4132 0.957 -6.5366 -26.677 0.1148 bdg -0.50929 -1.9411 0.5735 6.402502 -28.4310 0.24003 prc -1.70283 -5.444 0.6201 -8.62633 -29.568 0.08928 *the modified dickley-fuller (df_gls) critical values are -2.653 and -1.954 at 1% and 5% levels of significance, respectively. the modified phillips-perron (ng-perron) critical values are -13.00 and -8.10 at 1% and 5% levels of significance, respectively. the kpss critical values are 0.7 and 0.347 at 1% and 5% levels of significance, respectively. as depicted in table 3, df-gls, ng-perron and kpss tests reveal nonstationarity of each variable by rejecting the associated null hypothesis at 1% and 5% levels of significance. each variable also displays i(1) behavior since first-differencing of level data restores stationarity, as shown above. fourth, as all the variables are nonstationary in levels and depict i(1) behavior. as a result, λtrace and λmax tests are applied to explore the possibility of cointegration. their computed values are reported as follows: table 4 johansen multivariate cointegration test results series: spr, bdg, prc hypothesized no. of ce(s) eigenvalue trace (λtrace) statistic 0.05 critical value prob.** none* 0.452968 49.64508 29.79707 0.0001 at most 1* 0.241613 17.67290 15.4947 0.0231 at most 2 0.05530 3.015119 3.841466 0.0825 trace test indicates 1 cointegratedeqn at 0.05 level. *denotes rejection of the null hypothesis at the 0.05 level. **mackinnon-haug-michelis (1999) p-values 64 journal of business strategies hypothesized no. of ce(s) eigenvalue maximum value (λmax) eigen 0.05 critical value prob.** none* 0.452968 31.97218 21.13162 0.0010 at most 1* 0.241613 14.65778 14.26460 0.0433 at most 2 0.055301 3.015119 3.8414 0.0825 max-eigen value test indicates 1 cointegratedeqn(s) at the level 0.05 level *denotes rejection of the null hypothesis at the 0.05 level **mackinnon-haug-michelis (1999) p-values the computed values of λtrace and λmax statistics being higher than their respective critical values at 5% level of significance clearly reject the null hypothesis of no cointegration. in other words, there exists converging relationship among the variables towards a long-run equilibrium. this is due to one cointegrating vector that drives the dynamic system to converge towards a long-run equilibrium. finally, on the evidence of cointegrating relationship among the variables, vector error-correction model (3) is estimated for long-run causal flows with convergence and short-run dynamic interactive feedback relationship among the variables. the estimates are reported in equation (3)', as follows: δsprt = -0.0373 êt-1+ 0.1658δsprt-1 -0.2105δsprt-2 + 0.0018δbdgt-1 (-2.3005) (1.1059) (-1.2726) (1.0018) + 0.0086δbdgt-2 -0.0115δpcpt-1 -0.2634δpcpt-2 (3)' (0.8870) (-0.0357) (-0.8736) 2 = 0.0336, f = 1.2877, aic = -1.1310 as observed in equation (3)', there exists a long-run unidirectional causal flow from the lagged independent variables to the current change in s&p500 (spr). this inference is based on the expected negative sign of the coefficient of the error-correction term (êt-1) and its statistical significance in terms of the associated t-value. but its numerical coefficient (-0.0373) indicates very slow speed of adjustment towards a long-run equilibrium. there are weak evidences of short-run interactive feedback effects within the system in terms of the statistical insignificance as reflected in the associated individual t-values. 2 reveals that merely 3.36% of δsprt is explained by the independent variables. the f-statistic at 1.2877 shows statistical insignificance of the overall equation (3)'. this is also charted graphically in the appendix. these findings are consistent with those of a host of empirical studies, as cited in the literature review section of this paper. volume 32, number 1 65 conclusions to summarize, time series data on stock market return, federal annual real budget deficit as ratio of corresponding annual real gdp and labor productivity-real wage gap are nonstationary in levels and reveal i(1) behavior. all three variables are found cointegrated in terms of both λtrace and λmax tests. the estimates of the vecm confirm long-run unidirectional causal flows from the lagged independent variables to the contemporaneous stock market return with slow speed of adjustment towards a long-run equilibrium. the evidences show very weak short-run interactive feedback effects among the variables. in closing, real budget deficit and labor productivityreal wage gap have long-run implications for us stock market performance with no significant short-run influences. thus, theoretical analyses partly meet empirics in the long run, though not in the short run. references akaike, h., (1969). fitting autoregressive for prediction. journal annals of the institute of statistical mathematics, 21(1), 243-247. allen, s. d., & smith, m.d. (1983), government borrowing and monetary accommodation. journal of monetary economics 12(4), 605-616. ali, s.m., & hasan, m.a., (1993). is the canadian stock market efficient with respect to fiscal policy? some vector autoregression results. journal of economics and business 45(1), 45-59. barnhart, s.w., & darrat, a.f. (1989). federal deficits and money growth in the united states: a vector autoregressive analysis. journal of banking and finance 13(1), 137-149. barro, r.j. (1974). are government bonds net wealth? journal of political economy 82(6), 1095-1117. batra, r. n. (1999). the crash of the millennium: surviving the inflationary depression, new york: harmony books, 1999. batra, r., (2003). common sense macroeconomics, richardson: liberty press, 2003. blanchard, o. j. (1981). output, the stock market and interest rates. american economic review 71(1), 132-143. boothe, p.m., & reid, b.g. (1989). asset returns and government deficits in a small open economy: empirical evidence from canada. journal of monetary economics 23(1), 65-77. 66 journal of business strategies bosworth, b., & perry g. l. (1994). productivity and real wages: is there a puzzle?. brookings papers on economic activity, (1), 317-344. cooper, r. l. (1974). efficient capital markets and the quantity theory of money. journal of finance 29(3), 887-908. darrat, a.f. (1988). on fiscal policy and the stock market. journal of money, credit and banking 20(3), 353-363. darrat, a.f., & brocato, j. (1994). stock market efficiency and the federal budget deficit: another anomaly? financial review 29(1), 49-75. deleeuw, f., & holloway, t.m. (1985). the measurement and significance of the cyclically-adjusted federal budget and debt. journal of money, credit and banking 17(2), 232-242. elliot, g., rothenberg, t.j. & stock, j.h. (1996). efficient test for an autoregressive unit root. econometrica 64(4), 813-836. engle, r.f. & granger, c.j. (1987). co-integration and error correction: representation, estimation and testing. econometrica, 55(2), 251-276. engen, e., & hubbard, r.g. (2004). federal government debt and interest rates. national bureau of economic research macroeconomics annual, 83. evans, p. (1987). interest rates and expected future budget deficits in the united states. journal of political economy, 95(1), 34-58. evans, p. (1987). do budget deficits raise nominal interest rate?. evidence from six countries. journal of monetary economics, 95, 281-300. fama, e.f., & schwert, g.w., (1977). asset returns and inflation. journal of financial economics, 1977, 5(2), 115-146. frenkel, j.a., & razin, a. (1986). the international transmission and effects of fiscal policies. american economic review, 76(2), 330-335. gale, william g., & orszag, p. r. (2003). the economic effects of long-term fiscal discipline. urban-brookings tax policy center discussion paper, no.8, april. gale, william g., & orszag, p. r. (2004). budget deficits, national saving, and interest rates. brookings papers on economic activity, no. 2, 101-187. geske, r., & roll, r. (1983). the fiscal and monetary linkage between stock returns and inflation. journal of finance 38(1), 1-33. granger, c.w.j., & newbold, p. (1974). spurious regressions in econometrics. journal of econometrics 2, 111-120. hakkio, craig s., & rush, m. (1991). co-integration: how short is the long run?. journal of international money and finance 10, 571-581. hamburger, m. j., & kochin, l. a. (1972). money and stock prices: the channels of influence. journal of finance 27(2), 231-249. volume 32, number 1 67 hoelscher, g.p. (1986). new evidence on deficits and interest rates. journal of money, credit & banking 18(1), 1-17. james, c., koreisha, s., & megan, p. (1985). a varma analysis of the causal relations among stock returns, real output, and nominal interest rates. journal of finance 40(5), 1375-1384. johansen, s. (1988). statistical analysis of co-integration vectors. journal of economic dynamics and control 12, 231-254. johansen, s. (1992). testing structural hypothesis in multivariate co-integration analysis of the ppp and the vip for u.k. journal of econometrics, 53, 211-244. johansen s. (1995). likelihood-based inference in co-integrated vector autoregressive models. oxford: oxford university press, 1995. johansen, s., & juselius, k. (1990). maximum likelihood estimation and inference on cointegration with applications to the demand for money. oxford bulletin of economics & statistics 52(2), 169-210. kwiatkowski, d., phillips, p.c.b., schmidt, p. & shin, y. (1992). testing the null hypothesis of stationarity against the alternative of a unit root. journal of econometrics 54, 159-178. laopodis, n. t. (2006). dynamic linkages among the stock market, inflation, monetary policy and real activity. financial review 41(4), 513-545. bong-soo, l. (1992). causal relations among stock returns, interest rates, inflation, and real activity. journal of finance 42(4), 1591-1603. lee, u. (1997). stock market and macroeconomic policies: new evidence from pacific basin countries. multinational finance journal 1(4), 273-289. lopez-villavicencio, a., & silva, j. (2010). employment protection and the non-linear relationship between the wage-productivity gap and unemployment, working paper cepn-cnrs: university of paris nord. lütkepohl, h., saikkonen, p. & trenkler, c. (2001). maximum eigen value versus trace tests for the cointegrating rank of a var process. econometrics journal, 4, 287-310. mccarthy, j., najand, m., & seifert, b., (1990). empirical tests of the proxy hypothesis. financial review, 25, 251-264. mora, t., lopez-tamayo, j., & surinach, j. (2005). are wages and productivity converging simultaneously in euro-area countries?. applied economics, 37(17), 2001-2008. narayan, p., & smyth, r. (2009). the effect of inflation and real wages on productivity: new evidence from a panel of g-7 countries. applied economics, 41(10), 1285-1291. 68 journal of business strategies ng, s., & perron, p. (2001). lag length selection and the construction of unit root tests with good size and power. econometrica (6), 1519. park, s. (1997). rationality of negative stock-price responses to strong economic activity. financial analysts journal 53(5), 52-56. patelis, a.d. (1997). stock return predictability and the role of monetary policy. journal of finance 52(5), 1951-1972. phillips, p.b., (1986). understanding spurious regressions in econometrics. journal of econometrics, 33, 311-340. quayes, s. (2010). does budget deficit lower equity prices in usa?, economic letters, 107(2), 155-157. rashed, j.a., & samanta, s.k. (2005). the productivity-wage gap and the recent stock price increase: an analysis. international review of economics and finance 14, 169-180. rogalski, r., & vinso, j. (1977). stock returns, money supply and the direction of causality. journal of finance 32(4), 1017-1-30. rozeff, m.s. (1974). money and stock prices. journal of financial economics, 1, 243-302. saleem, f., yasir, m., shehzad, f., ahmed, k., & sehrish, s. (2012). budget deficit and stock prices: evidence from pakistan and india. interdisciplinary journal of contemporary research in business, 4(5), 176-185. sidhu, h. (2010). productivity led wage disparity in the indian industry. indian journal of industrial relations, 45(3), 350-366. tang, c. f. (2012). the non-monotonic effect of real wages on labor productivity: new evidence from the manufacturing sector in malaysia. international journal of social economics, 39 (6), 391-399. verbic, m., & kuzmin, f. (2009). coefficient of structural concordance and an example of its application: labor productivity and wages in slovenia. panoeconomicus, 56(2), 227-240. volume 32, number 1 69 brief biographical sketch of authors dr. matiur rahman is the jp morgan chase endowed professor of finance at mcneese state university. he earned his ph.d in economics from southern methodist university. he is a very prolific researcher in macroeconomics, finance and international business. he has published very extensively in wellregarded refereed academic journals in the usa and abroad. dr. muhammad mustafa is a professor of economics at south carolina state university. he is an avid researcher who has published numerous economics and finance articles in refereed us and foreign journals. his specialization is macroeconomics and applied econometrics. appendix figure 1 bdg = budget deficit/real gdp; pcp = compensation/productivity; sp5 = log of sp 500 volume 34, number 57 conventional mortgage interest rate and the effective federal funds rate pass-through natalie hegwood sam houston state university • huntsville, texas m.h. tuttle sam houston state university • huntsville, texas abstract this paper examines the response of the conventional thirty-year mortgage interest rate to changes in the effective federal funds rate. the results indicate complete pass-through; in the long run, the conventional mortgage interest rate responds in a one-to-one manner with the effective federal funds rate. further, results suggest the conventional mortgage interest rate responds symmetrically to changes in the effective federal funds rate in the long run. in the short run, large, frequent increases in the effective federal funds rate create larger increases in the mortgage interest rate relative to periods where the federal funds rate is rising slowly or falling. our results suggest a long-run mortgage interest rate adjustment halflife of approximately twenty months in response to an effective federal funds rate change. jel codes: c22, e43 key words: thirty-year conventional mortgage interest rate, effective federal funds rate, asymmetric adjustment, pass-through introduction given the recent volatility in housing markets, understanding the impact that federal reserve policy has on the mortgage interest rate is vital. changes in monetary policy through effective federal funds rate changes affect market rates of interest. previous research notes the importance of understanding the magnitude and timing of this effect. sellon (2002) notes that the degree of interest rate passthrough and speed of adjustment are critical to understanding the effectiveness of the monetary transmission mechanism and of monetary policy. this study contributes to the literature by examining both the long-run and short-run dynamic relationships between the conventional thirty-year mortgage interest rate and the effective federal funds rate using three threshold auto-regressive models that are common in the current literature. 58 journal of business strategies literature review two critical issues arise when considering the impact of changes in the effective federal funds rate on other credit market rates. first, one must consider the degree to which a given change in the effective federal funds rate passes through to, or changes, the conventional thirty-year mortgage interest rate in the long run. more specifically, long-run pass-through measures the magnitude of the change in the mortgage interest rate in the long run from a change in the effective federal funds rate. in the long run, the mortgage interest rate will change, moving the rate towards its long-run equilibrium value. the long-run adjustment of the mortgage interest rate to equilibrium takes place over several months. therefore, one must consider the short-run, transitory effect of changes in the effective federal funds rate on the mortgage interest rate. these short-run changes include the immediate impact of changes in the federal funds rate on the mortgage interest rate and the mortgage interest rate’s speed of adjustment, or how quickly the mortgage interest rate moves to its long-run equilibrium value. the degree of pass-through between the effective federal funds rate to the conventional thirty-year fixed mortgage interest rate has become a popular way to assess the effectiveness of monetary policy. pass-through is traditionally examined by testing for cointegration between the two interest rates. finding that these two series are cointegrated suggests that they share a long-run equilibrium relationship. traditionally, research supports cointegration between these two interest rates, meaning that these two interest rates move together in the long run. further, the cointegration results provide the degree of long-run pass-through. granger and newbold (1974) note, however, that ordinary least squares regression (ols) may lead to spurious results when using time-series data. in the interest rate pass-through literature, the engle-granger (1987) test is commonly used to overcome the problem of spurious regression. in the engle-granger (eg) test, one performs ols on the variables. the residuals are then subjected to a unit root test in which the null hypothesis is no cointegration and the alternative is cointegration. if one rejects the null hypothesis, then the coefficient on the regressor is an estimate of the degree of pass-through. the cointegration literature notes, however, that the eg method may lead to biased parameter estimates, and in the context of interest rates, biased measures of pass-through. banerjee et al. (1993) show that the eg method omits short-run dynamics, and it is the omission of these dynamics that potentially leads to biased results. the current literature reaches mixed results concerning the degree of passvolume 34, number 59 through in the long run. payne (2006a, 2006b, and 2007) uses the eg method to test for cointegration and measure pass-through. payne (2006a) notes that switching costs and informational market asymmetries may lead to incomplete pass-through from the effective federal funds rate to the conventional thirty-year mortgage interest rate. payne (2006a) finds cointegration and incomplete pass-through for the period april 1971 through october 2005. in a later paper, payne (2006b) finds cointegration with incomplete pass-through using a shorter sample (february 1987 through january 1994), which corresponds to the duration of the specific monetary policy of federal funds rate targeting. in similar work, payne (2007) finds cointegration with incomplete pass-through in the adjustable mortgage interest rate. in contrast, citing the potential bias of the eg method in estimating the cointegrating coefficient, cook (2008) uses an approach by bardsen (1989) and finds complete pass-through from the effective federal funds rate to the conventional thirty-year fixed mortgage rate. hegwood and tuttle (2013) examine the effect of using the engle-granger method when estimating the long-run relationship between short-run interest rates and long-run interest rates on government debt for several countries. their results suggest that the engle-granger method potentially biases the long-run estimates by an average of 38.4 percent. in this research, we employ an alternate, yet common test for cointegration. using this common test, we find evidence of complete pass-through in the long run. this result suggests that mortgage lenders, on average, maintain a constant margin above the effect federal funds rate in the long run. in addition to the degree of pass-through, the short-run pattern of adjustment to the long run equilibrium is also of interest. multivariate tests of symmetric versus asymmetric long run adjustment take the form of threshold autoregressive (tar), where the threshold is set to zero and where the threshold is endogenously determined, or momentum-threshold autoregressive (mtar) models (enders and siklos, 2001). payne (2006a) uses an mtar model and finds long-run symmetric adjustment for the conventional thirty-year fixed mortgage rate. however, for the shorter period, payne (2006b) finds long-run asymmetric adjustment. in similar work, payne (2007) finds long-run asymmetric adjustment when examining the relationship between the effective federal funds rate and the adjustable mortgage rate. this research (payne 2006a, 2006b, and 2007), however, tests for long-run asymmetric adjustment only. the exclusion of short-run asymmetries may bias the long-run asymmetry results. in this research, we test for long-run and short-run asymmetric adjustment in both interest rates using all three threshold models. our findings show that the 60 journal of business strategies mortgage interest rate responds symmetrically to federal funds rate changes in the long run to changes, which supports payne’s findings (2006a and 2007). in the short run, however, the mortgage interest responds asymmetrically to federal funds rate changes when there are “large,” frequent increases in the federal funds rate over a relatively short period. data and unit root tests the monthly thirty-year conventional mortgage interest rate (mr) and the effective federal funds rate (eff) are available from the federal reserve bank of st. louis fred database. the range is april 1971 through february 2016. due to the time-series nature of the data, we test for nonstationarity using traditional unit root tests. as noted by granger and newbold (1974), if the two series are non-stationary and have a single unit root, then ols will lead to spurious results. table 1 reports the results from the augmented dickey-fuller (adf) test (dickey and fuller 1979) and the kwiatkowski, phillips, schmidt, and shin (kpss) test (kwiatkowsi et. al 1992).1 the preponderance of evidence from these unit root tests suggests that both series are non-stationary, i.e. i(1), which supports findings in previous research. the presence of a structural break, however, may lead to the rejection of the null hypothesis of nonstationarity. perron (1989) has shown that a series that is stationary around an occasionally shifting mean or trend will mimic the behavior of a random walk and lead to failure to reject a unit root. we therefore test the two interest rates for a unit root using perron-voglesang (1992) unit root tests that include a single shift of the mean. we employ both an additive outlier (ao) test with an instantaneous single mean shift and an innovational outlier (io) test in which the shift occurs over time. the ao test is a two-stage process, first running the following regression on each time series: the intercept break dummy variable, dut, equals 1 for all t greater than the break date, tb, and zero otherwise. the residuals, ut are saved and regressed against their lagged value and lagged differences in the second stage of the procedure as follows: 1 the null hypothesis under the adf test is non-stationarity of the series, while the null hypothesis under the kpss test is stationarity of the series. volume 34, number 61 the number of lagged differences, k, is determined by the max-to-min method, with kmax set at eight. the dummy variables d(tb)t-i equal 1 if t = tb +1 and zero otherwise. the two regressions are estimated sequentially for each possible break year, tb = k+2, … t-1 where t is the number of observations. the break date is chosen to minimize the t-statistic on ρ. the unit root null hypothesis is rejected if the minimum t-statistic on ρ is less than the appropriate critical value. as shown in table 1, we fail to reject the null hypothesis of a unit root for both the federal funds rate and the thirty-year conventional mortgage rate. critical values are taken from perron-vogelsang (1992). the io test involves running the following regression on each series: where du and d(tb) are the same as in the ao test. the max-to-min procedure is again used to choose the number of lagged differences, k. the break date, tb, is chosen to minimize the t-statistic on α. the results, shown in table 1, fail to reject the null hypothesis of a unit root based on critical values from perron-vogelsang (1992). we therefore conclude that both the effective federal funds rate and the conventional thirty-year mortgage rate are non-stationary processes, and that this result is robust to the addition of a potential structural change in the mean. therefore, cointegration tests are appropriate, because the use of ols leads to spurious results (granger and newbold 1974). 62 journal of business strategies table 1 unit root tests cointegration methods and results cointegration is tested between the two series, given that they both appear to be non-stationary. banerjee et al. (1993) show that omission of short-run dynamic elements in the engle-granger procedure may lead to biased estimates. for example, cook (2008) and hegwood and tuttle (2013) note that the size of the bias in the engle-granger method may be large and result in finding incomplete pass-through. further, the engle-granger procedure has also been shown to possess low power in the presence of asymmetric adjustment to the long run equilibrium (enders and siklos, 2001). this research uses the method of johansen (1991) to test for a long-run relationship between the two series. the pantula principle, as suggested by hjelm and johansson (2005), is used to identify the proper restrictions on deterministic components. these restrictions include the potential addition of a constant and/or time-trend in the long-run relationship. we start with the least restrictive model until cointegration is achieved. the results suggest the inclusion of an unrestricted constant only. therefore, the long-run and short-run relationships include a constant and exclude a time trend. the results of the johansen cointegration test are provided in panel a of table 2. we reject the null of zero cointegrating vectors and fail to reject the null volume 34, number 63 of at least one cointegrating vector. therefore, the result suggests the two series are cointegrated. from the johansen test, the long-run parameter on the effective federal funds rate, q1, suggests positive co-movement between the two interest rates, with a long-run parameter of 0.899; a one percentage point increase in the effective federal funds rate will results in a 0.899 percentage point increase in the conventional mortgage interest rate in the long run. table 2 cointegration test results as mentioned earlier, ambiguity exists concerning pass-through in previous research. payne’s results (2006a and 2006b) suggest incomplete pass-through. cook (2008), however, notes that the engle-granger method suffers from severe bias. when cook corrects for this bias, results yield complete pass-through. panel b of table 2 provides the results from testing the null hypothesis of complete pass-through (q1 = 1). in panel b, we fail to reject the null hypothesis of complete pass-through, which supports the finding of cook. if there is complete pass-through, then our results show that mortgage lenders attempt to maintain, on average, a constant margin of approximately 3.45 percentage points in the long run, given by the estimate of q2 in panel a. tests of asymmetry and results results in the previous section show that the conventional mortgage interest 64 journal of business strategies rate and the effective federal funds rate move together in the long run. further, we find that the mortgage interest rate moves in a one-to-one manner, given the failure to reject complete pass-through. these results, however, do not describe the mortgage interest rate’s speed of adjustment, nor do they provide the short-run, or immediate impact of the changes in the effective federal funds rate or the conventional mortgage interest rate. we utilize an error-correction model (ecm) to examine the dynamic behavior of these two interest rates. specifically, we employ threshold models to test for asymmetric long-run adjustment and asymmetric short-run adjustment in these two interest rates. previous research utilizes threshold models to test for long-run symmetry only (payne 2006a, 2006b, and 2007). to test for asymmetric responses, we employ two models: a threshold autoregressive (tar) model and a momentumthreshold autoregressive (mtar) model. equations (1a) and (1b) provide the general form of the error-correction models. (2) volume 34, number 65 in equations (1a) and (1b), it is the heaviside indicator, and its value is determined via the error-correction variable, εt-1.2 the parameters, d1,d2,b1, and b2 give the long-run, equilibrium adjustment of the conventional mortgage interest rate due to disequilibrium between these two interest rates. in a similar manner, the parameters μ and ω provide the long-run adjustment of the effective federal funds rate. equation (2) provides the derivation of the error-correction variable; it is derived from the long-run relationship estimated via the johansen cointegration test. when the error-correction variable equals zero, the mortgage interest rate is at its long-run equilibrium value determined by the cointegration vector estimated via the johansen test and provided in table 2. for example, from equation (2), a fall in the effective federal funds rate, during periods of expansionary monetary policy, increases the value of the error-correction variable and the size of the disequilibrium between the two interest rates. the heaviside indicator is greater than zero in the tar models when the error-correction term is positive (or greater than τ). during periods of contractionary monetary policy, the error-correction term is negative and the heaviside indicator is equal to zero. one must interpret the mtar results in a slightly different manner. in the mtar model, the change in the error-correction term determines the value of the heaviside indicator. when the mortgage interest rate is below equilibrium due to contractionary monetary policy, the error-correction term is negative and will increase in subsequent periods towards its equilibrium value of zero. therefore, the error-correction term increases in these periods and the heaviside indicator equals one. when the error-correction term and mortgage interest rate decrease during periods of expansionary monetary policy, the heaviside indicator equals zero. the value of the threshold, t, is set to zero to provide the first set of tar results in table 3. in the tar results in table 4 and mtar results in table 5, the value of t is determined endogenously using chan’s (1993) method, as described in enders and siklos (2001). in equations (1a) and (1b), we allow for potential short-run asymmetric adjustments through the interaction of the heaviside indicator with the lagged firstdifferences of the conventional mortgage interest rate and the effective federal funds rate. several investigations include potential short-run asymmetries, while others do not. for example, payne’s (2006a, 2006b, and 2007) study concerning u.s. mortgage 2 we use the long-run parameters estimated in table 2. we do not assume complete pass-through in subsequent results. 66 journal of business strategies interest rates and becker, osborn, and yildirim’s (2012) research on u.k. mortgage interest rates exclude these short-run interactions. valadkhani and anwar (2012), however, estimate potential short-run asymmetries in australia. the inclusion of these short-run interactions is a more general, less restrictive specification, as suggested by enders and siklos (2001). further, other research uses this method. for example, research investigating the co-movement of gasoline and oil prices uses this approach [see, for example, chen, finney, and lai (2005) or bumpass, ginn, and tuttle (2015)]. the primary coefficients of interest in equation (1a) are g and p. the coefficients g1, g2, and g3 measure the short-run response of the mortgage interest rate to changes in the effective federal funds rate when the error-correction variable is greater than t. the p coefficients, alternatively, measure the response of the mortgage interest rate to changes in the effective federal funds rate when the error-correction term is below the threshold. specifically, the test for short-run symmetry in the mortgage interest rate in response to changes in the effective federal funds rate is g=p. the coefficients b and a measure the short-run changes in the mortgage interest rate to lagged changes in the mortgage interest rate when the error-correction term is above the threshold and below the threshold, respectively. similar coefficients in the federal fund rate equation measure the response of the effective federal funds rate in the same manner. in table 3, the threshold parameter, t, is set to zero. therefore, the adjustment parameters, d1 and d2, yield the adjustment of the mortgage interest rate relative to the long-run equilibrium derived in table 2. for example, when εt-1 is greater than zero, the conventional mortgage interest rate is above its long-run value, given by q1efft-1+q2. the long-run adjustment parameters and the short-run response parameters provide the immediate adjustment of the mortgage interest rate and the federal funds rate when the mortgage interest rate is above or below equilibrium. in more general terms, starting at long-run equilibrium, the error-correction term is positive in periods where the effective federal funds rate is falling and it is negative in periods when the effective federal funds rate is increasing. the results in table 3 suggest that the conventional mortgage interest rate responds symmetrically to changes in the federal funds rate in the long run, given by the test of equality of the long-run adjustment parameters, d1 and d2. the estimated half-life of adjustment in the conventional mortgage interest rate in table 3 is between fifteen and twenty-four months.3 3 the half-life is an estimate of the number of months required to eliminate half of the long-run disequilibrium caused by changes in the federal funds rate. the half-life is calculated via t = (ln(0.5))/(ln(1+δi)). volume 34, number 67 given the results from estimating equation (1b), we fail to reject the strict exogeneity of the effective federal funds rate, i.e. we fail to reject the joint hypothesis that the long-run adjustment parameters and the short run mortgage interest rate parameters are statistically zero with an associated p-value of 0.602 (μ = ω = s = 0). therefore, the long-run equilibrium adjustment between these two rates is resolved solely through changes in the conventional mortgage rate in table 3. table 3 tar results, t = 0 as mentioned, previous research concerning u.s. mortgage interest rate asymmetries does not investigate potential short-run asymmetries in either interest rate. in this specification, the short-run response of the mortgage interest rate due to changes in itself and changes in the effective federal funds rate is asymmetric in table 3. specifically, we reject the null hypothesis that the short-run interactions are equal. the results indicate that the response of the mortgage interest rate to changes in the effective federal funds rate is larger when the mortgage interest rate is greater than its long-run equilibrium rate (sp< sg). in other words, the mortgage interest rate exhibits larger short-run changes when the effective federal funds rate is falling relative to periods when the federal funds rate is rising. the difference, however, is not large economically. the results in table 3 also suggest short-run asymmetric changes in the federal funds rate to lagged changes in itself, relative to the threshold. for example, the sum of the coefficients j1, j2, and j3 are statistically and economically larger than l1, l2, and l3. this means the effective federal funds rate exhibits a larger 68 journal of business strategies response to its own lagged changes in periods where the effective federal funds rate is falling. therefore, there are larger adjustments in the effective federal funds rate in periods where this rate is falling during periods of expansionary policy. in table 4, the threshold value is determined endogenously and, is therefore, less restrictive than the specification used to derive results in table 3. results, available upon request, yield a value of t equal to -1.39. combining the results from table 2, the derivation of t yields the following: the value of t indicates that the mortgage interest rate may respond differently during periods of aggressive contractionary policy, i.e. when the spread between the two interest rates given by the long-run relationship is, roughly, two percentage points or less due to large and/or frequent increases in the effective federal funds rate. from january 1990 through the end of the sample, the difference between the mortgage interest rate and the federal funds rate was less than two percent in sixty-nine of the three hundred fourteen months and occurs during periods of contractionary policy by the federal reserve. for example, during the two-year period from january 2006 through january 2008, the spread, or difference between the mortgage interest rate and the federal funds rate averaged 1.4 percentage points, and the spread was below 2.056 percent during the entire period. during these periods, the short-run response of the mortgage interest rate to changes in the federal funds rate may differ relative to other periods. the short-run response of the mortgage interest rate during these periods of aggressive contractionary policy is given by the p coefficients. the long-run adjustment results for the mortgage interest rate, in table 4, are statistically and economically similar to those of table 3. we fail to reject the null hypothesis of the long-run symmetric response of the mortgage interest rate. further, relative to table 3, there is less disparity between the two long-run adjustment parameters (d1 and d2) in the mortgage interest rate equation. the halflife of adjustment of the mortgage interest rate here is between nineteen and twentytwo months. volume 34, number 69 table 4 tar results, t = -1.39 the short-run adjustment in the mortgage interest rate to its own lagged changes in table 4 is also similar to those of table 3. the results show, however, larger short-run changes in the mortgage interest rate due to changes in the effective federal funds rate when t is less than -1.39, or when the spread between these two rates is around 2.056 or less. the short-run adjustment of the mortgage interest rate to lagged changes in the effective federal funds rate, when it is below the threshold, is larger relative to its above-threshold short-run adjustment. therefore, these results indicate an asymmetric short-run response of the mortgage interest rate during periods of aggressive contractionary monetary policy. again, we find strict exogeneity in the effective federal funds rate (p-value of 0.267). in addition, like the results in table 3, the effective federal funds rate responds asymmetrically to lagged changes in itself in the short run with larger shortrun changes when the federal funds rate is falling. this indicates that the federal reserve produced larger, more frequent reductions in the federal funds rate, relative to periods where the federal funds rate was increasing. finally, table 5 provides the results from the mtar model, which is similar to the method employed by payne (2006a). in the mtar model, the threshold is endogenously determined using lagged changes in the error-correction term. in other words, the adjustment process may be different for larger positive or negative changes in the error-correction term relative to smaller positive or negative changes. using the method of chan, our threshold value for t is -0.075. a change in 70 journal of business strategies the error-correction term, i.e. a change in the size of amount of disequilibrium, of less than -0.075 percentage points, holding the mortgage interest rate constant, may cause a different response in the mortgage interest rate relative to a change in the error-correction term that is greater than -0.075 percentage points. in the mtar results, the heaviside indicator equals one when the change in the error-correction term is positive. the change in the error-correction term is positive when the mortgage interest rate is increasing to restore long-run equilibrium. therefore, the g coefficients give the short-run change in the mortgage interest rate due to changes in the effective federal funds rate when the mortgage interest rate is increasing to restore long-run equilibrium. alternatively, the p coefficients provide the short-run change in the mortgage interest rate when this rate is decreasing. table 5 mtar results, t = -0.075 table 5 supports payne’s (2006a) long-run results. we find that the effective federal funds rate is strictly exogenous (p-value of 0.171), and the mortgage interest rate responds symmetrically in the long run. further, the sizes of the adjustment parameters for the mortgage interest rate are similar to those in table 3. we extend the work of payne by examining potential asymmetric short-run changes in the conventional mortgage interest rate. we find, in this specification, that the mortgage interest rate responds asymmetrically to changes in both interest rates in the short run. specifically, the mortgage interest rate exhibits faster shortrun changes in response to lagged changes in both interest rates when the mortgage interest rate is increasing to restore long-run equilibrium (when the lagged change volume 34, number 71 in the error-correction term is greater than -0.075)4. these results support those of table 4 and show that the mortgage interest rate experiences larger changes in the short run in periods where the mortgage interest rate is increasing due to contractionary monetary policy. the results for the effective federal funds rate in table 5 are similar to those in table 3 and table 4. again, we find strict exogeneity in the effective federal funds rate. further, the effective federal funds rate responds asymmetrically to its own lagged changes, as found in tables 3 and 4. summarizing the short-run results for the mortgage interest rate, we find a general asymmetric response. first, the mortgage interest rate responds asymmetrically to its own lagged changes. further, there is an asymmetric shortrun response of the mortgage interest rate to lagged changes in the federal funds rate. there are some similarities in results across these three tables. first, the shortrun response of the mortgage interest rate, during periods of expansionary policy (increases the error-correction term above the threshold value or the change in the error-correction term is negative), is similar in tables 3, 4, and 5. the difference between the results in these three tables occurs when the effective federal funds rate increases. in table 3, the sum of the p coefficients are statistically zero when the threshold equals zero. table 4’s results show, however, that the response of the mortgage interest rate to increases in the federal funds rate is identical to its response when the federal funds rate decreases, but only when the increases in the federal funds rate are “small,” well-dispersed increases. during periods of large and frequent increases in the federal funds rate due to contractionary policy, however, the size of the short-run changes in the mortgage interest rate increases. in table 5, the short-run change in the mortgage interest rate is larger in periods where the mortgage interest rate is increasing to restore long-run equilibrium. these results suggest that the mortgage interest rate closely follows the effective federal funds rate. in fact, the failure to reject complete pass-through suggests a one-to-one movement in the long run with an average spread of 3.45 percentage points, with the mortgage interest rate responding symmetrically in the long run. further, the mortgage interest rate displays short-run asymmetric adjustment to changes in the federal funds rate. less restrictive results in tables 4 and 5 show that the mortgage interest rate exhibits larger increases in the short run during periods of aggressive contractionary policy. 4 the sums of the two sets of short-run coefficients for the effective federal funds rate are statistically zero. the results, however, reject the null hypothesis that all short run coefficients for the effective federal funds rate are statistically zero. 72 journal of business strategies conclusion we reexamine the relationship between the conventional thirty-year mortgage interest rate and the effective federal funds rate. the johansen test suggests that the two interest rates are cointegrated. further, we fail to reject the null hypothesis of complete pass-through, and, therefore, conclude mortgage lenders appear to maintain a constant margin in the long run. like previous research, we fail to reject the null hypothesis of symmetric long-run adjustment in the mortgage interest rate in all specifications. further, we find the effective federal funds rate is strictly exogenous in all specifications. the results in all models indicate a short-run asymmetric response in the mortgage interest rate to changes in both interest rates. in the short run, results show larger changes in the mortgage interest in the short run during periods of contractionary monetary policy. in other words, long-run mortgage market imperfections, such as asymmetric information, may not be as great as that indicated in some of the previous research. this research demonstrates that potential market imperfections cited in previous literature appear temporary in nature. references banerjee, a., j. donaldo, j. galbraith, & d. hendry. (1993). “co-integration, errorcorrection, and the econometric analysis of nonstationary data.” advanced texts in econometrics. oxford university press, oxford, uk. bardsen, g. (1989). “estimation of long run coefficients in error correction models.” oxford bulletin of economics and statistics, 51, 345 – 350. becker, r., osborn, d., & yildirim, d. (2012). “a threshold cointegration analysis of interest rate pass-through to uk mortgage rates.” economics modelling, 29, 2504 – 2513. bumpass, d., ginn, v., & tuttle, m. (2015). “retail and wholesale gasoline price adjustments in response to oil price changes.” energy economics, 52, 49 – 54. chan, k. (1993). “consistency and limiting distribution of the least squares estimator of a threshold autoregressive model.” the annals of statistics, 21, 520 – 533. chen, l. m. finney and lai, k. (2005). “a threshold cointegration analysis of asymmetric price transmission from crude oil to gasoline prices.” economic letters, 89, 233 – 239. volume 34, number 73 cook, s. (2008). “econometric analysis of interest rate pass-through.” applied financial economics letters, 4, 249 – 251. dickey, d. and fuller, w.a. (1979). “distribution of the estimates for autoregressive time series with a unit root.” journal of the american statistical association, 74, 427 – 431. enders, w. and siklos, p. (2001). “cointegration and threshold adjustment.” journal of business and economic statistics, 19, 304 – 311. engle, r. and granger, c. (1987). “cointegration and error correction: representation, estimation, and testing.” econometrica, 55, 251 – 276. grange, c. and newbold, p. (1974). “spurious regressions in econometrics.” journal of econometrics, 2, 111 – 120. hegwood, n. and tuttle, m. (2013). “a comment on tests for asymmetric threshold cointegration with an application to the term structure: cointegration methods matter.” journal of economics, 39, 73 – 77. hjelm, g. and johansson, m. (2005). “a monte carlo study on the pitfalls in determining deterministic components in cointegration models.” journal of macroeconomics, 27, 691 – 703. johansen, s. (1991). “estimation and hypothesis testing of cointegrating vectors in gaussian vector autoregressive models.” econometrica, 59, 1551 – 1580. kwiatkowski, d., phillips, p., schmidt, p. & shin, y. (1992). “testing the null hypothesis of stationarity against the alternative of a unit root: how sure are we that economic time series have a unit root?” journal of econometrics, 54, 159 – 178. payne, j. (2006a). “the response of the conventional mortgage rate to the federal funds rate: symmetric or asymmetric adjustment?” applied financial economics letters, 2, 279 – 284. payne, j. (2006b). “more on the monetary transmission mechanism: mortgage rates and the federal funds rate.” journal of post keynesian economics, 29, 247 – 257. payne, j. (2007). “interest rate pass-through and asymmetries in adjustable rate mortgages.” applied financial economics, 17, 1369 – 1376. perron, pierre. (1989). “the great crash, the oil price shock, and the unit root hypothesis.” econometrica, 57, 1361 – 1401. perron, pierre, & vogelsang, timothy j. (1992). “nonstationarity and level shifts with an application to purchasing power parity.” journal of business and economic statistics, 10, 301 – 320. 74 journal of business strategies sellon, george. (2002). “the changing u.s. financial system: some implications for the monetary transmission mechanism.” federal reserve bank of kansas city economic review, 1st quarter, 5 – 35. valadkhani, a. and anwar, s. (2012). “interest rate pass through and the asymmetric relationship between the cash rate and the mortgage rate.” the economic record, 88, 341 – 350. biographical sketch of authors natalie hegwood is a clinical assistant professor at sam houston state university in the department of economics and international business. she received her ph.d. from the university of houston. her research interests include international monetary economics and applied time series econometrics. she has published articles in international journal of finance and economics, southern economic journal, midwestern business and economic review, the journal of economics, journal of macroeconomics, and economic analysis and policy. m. h. tuttle is an associate professor of economics in the department of economics and international business at sam houston state university. he earned his ph.d. from the university of tennessee. professor tuttle teaches macroeconomics, managerial economics, and statistics. he has published in several peer-reviewed journals including energy economics, defense and peace economics, southern economic journal, economic inquiry, and the journal of economics. the importance of strategy to global competitors: the strategy-performance relationship across cultures jeffrey p. katz department of management kansas state university manhattan, ks marilyn t. zaneski school of accounting university of central florida orlando, fl h.johnhall department of management university of florida gainesville, fl abstract this study examines the role national culture plays in the relationship between the competitive environment, firm strategies, andfirm peiformance by exteruling prior empirical work to the international marketplace. we firul that business strategies remain an important determinant offirm peiformance when considering the effects of national culture, competitive environment, arul irulustry in which firms compete. implications for global managers arulfuture research are discussed. background strategic management has a rich and multi-disciplinary literature regarding the contingency imposed by a firm's competitive environment on strategy choices. studies of the environment's effect on firm strategy and performance draw from organization theory and industrial organization economics (see for example; duncan, 1972; jauch, osborn & glueck, 1980; porter, 1980). contingency theorists believe firms compete in a multidimensional environment that affects the formulation and implementation of organizational strategies intended to achieve sustained competitive advantage (aldrich, 1979; mitroff & mohrman, 1987). according to contingency theory, firms learn to adapt to the opportunities and threats imposed by their external environment or become competitively disadvantaged and are forced to exit the marketplace (caves, gale & porter, 1974; andrews, fall 1997 katz, et al: the importance of strategy 127 1987). previous studies have reported that firms operate in multifaceted domestic environments affecting strategy (rockart, 1979; hambrick. 1983) and perfonnance (scherer, 1970) both separately and interactively. given the increasingly global nature of competition, it is surprising that relatively little research has considered the impact that national culture has on the environment-strategy-performance relationship of the firm. several studies suggest the importance of cultural values in explaining the differences in cross-national performance (hofstede, 1980; shane, 1993; tse, lee, vertinsky & wehrung, 1988). for example, one study examining national culture and performance finds that national culture explains more than half of the cross-national difference in growth patterns (franke, hofstede & bond, 1991). there are some indications that national culture may also impact firm strategies. for example, nakata and sivakumar (1996), in their review of the literature regarding the role of national culture on new product development, call for more empirical research examining the effects of national culture on business strategies. the authors cite the lack of adequate research to properly assess the role of culture on the environment-strategy-performance relationship. the present study, therefore, attempts to address this set of interrelated factors that potentially affect firm performance. specifically, we examine the role that national culture plays on the relationship between the firm's task environment, strategy, and performance by extending the work of mcarthur and nystrom (1991) into the international arena. by assessing the influence of national culture, while controlling for task environment, we find that certain firm strategies remain important detenninants of performance. the next section discusses the concepts of task environment, strategy, and national culture more fully, followed by commentaries on the research hypothesis, methodology, results and discussion. literature the task environment early work describing the relationship between the task environment and firm success (hofer, 1975) primarily focused on industry factors affecting the potential for sustaining sales growth. the task environment considered was industry munificence, i.e., the factors affecting growth rate of industries over time. aldrich (1979) expanded the description of the task environment by adding complexity and dynamism, thereby making the task environment construct tridimensional. environmental complexity describes the level ofuniformitylheterogeneity of firms within an industry while environmental dynamism addresses the variability of industry growth, that is, market instability. thus, the task environment forms the context in which competitive strategies are developed (hambrick & lei, 1985; lee, lee & ulgado, 1993). in the ground-breaking empirical study of task environments, dess and beard (1984) used standard industrial classifications (sic) as a basis for measuring the 128 journal of business strategies vol. 14, no.2 three environmental dimensions. using objective measures, they found systematic differences in the relationship between how firm's allocate resources (strategies) and their task environments. for 52 sample industries, dess and beard provided factor scores and ranks on munificence, complexity, and dynamism, thereby developing objective measures of the components describing the task environment. by applying these objective measures of the competitive environment in the current study, we are able to control for the effects of the task environment on the strategies adopted by the firm. thus, all industries in our study were placed on a level field relative to any special factors that might make certain industries easier to compete in than others. the role of strategy within the confines imposed by the task environments, how a firm uses its resources reflects its approach to the marketplace and ultimately effects its financial performance (hambrick & lei, 1985; andrews, 1987). a strategy framework receiving considerable recent theoretical and empirical attention is the structurestrategy-performance model popularized by porter (1980). this framework proposes that the performance of a company depends on the strategies undertaken within a particular environment. extending the work of porter, mcarthur and nystrom (1991) examined the direct and moderator effects of the task environment on the strategy-performance relationship. they selected their sample of industries from dess and beard's (1984) study and found evidence that the task environment significantly interacts with strategies to affect performance. mcarthur and nystrom argued that the business environment modifies thefonn of the strategy-performance relationship. they recommended the use of all three task environment dimensions in future studies of strategy-performance and suggested that foreign competition may increase the importance of dynamism and complexity on the strategies and performance of the firm. prescott (1986), noting that specific firm performance measures tend to bias empirical results, recommended that future studies use multiple performance measures when examining the firm's strategy-performance relationship. national culture in the global marketplace, the strategy-performance link may be affected by national culture stemming from national factors that include the country's values, norms, and beliefs. hofstede (1980) defines culture as the collective mental programming of the people in a national context. through empirical study, hofstede developed a numeric classification scheme for national cultures. the four cultural dimensions that emerged from his study are individualism-collectivism, masculinity-femininity, power distance, and uncertainty avoidance. individualism refers to the tendency of people to look after themselves while collectivism is the belief in the importance of group decision-making. masculinity is the degree of traditional masculine values, such as assertiveness and matefall 1997 katz, et al: the importance of strategy 129 riality, while femininity emphasizes concern for others and for the quality of life. power distance is the level of acceptance by a society for the unequal distribution of power in organizations. finally, uncertainty avoidance is the extent to which people feel threatened by ambiguity in the workplace. more recent work proposes that national culture influences those areas where technical imperatives are weakest (hofstede, 1983). for example, a weak technical imperative would be the development and implementation of strategies used to accomplish the firm's profit goal. in this context, hofstede's theory of national culture predicts that culture will significantly affect business strategies as vehicles to achieve the profit goal. however, no research is known to have examined whether national culture interacts with business strategies or impacts the outcome of those strategies-firm performance. figure 1 conceptual factors affecting the strategy-performance relationship national cultural industry strategy firm factors • > factors·· > factors·· • > factors > performance economic values industry resource use profitability systems growth legal systems norms firm markets heterogeneity political beliefs market systems instability technology figure i depicts the relationship between national factors, culture, the task environment and strategies potentially affecting firm performance. it is in this context that global competitors attempt to use the resources at their disposal to develop sustainable competitive advantage. therefore, based on the previous, we propose the following hypothesis: hypothesis i: holding differences in national culture, industry, and task environment constant, firm strategies will significantly affect firm performance. methodology to test the research hypothesis, we designed a study measuring the effect of firm strategies on firm performance while holding the effects of culture, the task environment and industry constant. financial data reflecting performance and use of resources (strategies) on 286 international companies was collected from 130 journal of business strategies vol. 14, no.2 compustat's global vantage data base over the 1988-1992 time period. data on the task environment and national culture was derived from dess and beard (1984) and hofstede (1980), respectively. the measures employed are more thoroughly discussed below, and are summarized in figure 2 comparing the concepts discussed in the literature review to the operationalized measures. the control factors used in this study consist of the four measures of national culture and three measures of the task environment. the independent variables of interest are five measures of firm strategies: inventory turnover, capital intensity, financial slack, research intensity and sales growth. the dependent variable employed is an index of firm financial performance. figure 2 operationalized factors affecting the strategy-performance relationship national culture·· • > indi viduali ty masculinity power distance uncertainty avoidance task environment· •• > munificence complexity dynamism firm strategies· ••••• > inventory turnover capital intensity financial slack research intensity sales growth financial performance roa roe roi control factors task environment. to control for the effects of the task environment, data was collected for all firms in each of the five highest and five lowest ranked industries on the munificence, dynamism, and complexity factors developed by dess and beard (1984). to find the relative five highest and five lowest industries, the standardized factor scores in the dess and beard study were rank ordered. the selected sample contains 286 firms representing 30 industries (five industries for each of the three high and low conditions). a validation of the dess and beard (1984) study was conducted by rasheed and prescott (1987), which provides some degree of assurance regarding the accuracy of the rankings used in the present study. national culture. the 286 firms in our sample represent 27 different countries. in order to assess the impact of national culture on business strategies and firm performance, measures capturing national culture were obtained from hofstede (1980). scores for the four cultural dimensions for each country are on a continuous scale ranging from 6 to 112. thus, culture on the national level and task environment on the industry level are assessed using measures independent of firm financial data collected through global vantage. fall 1997 katz, et al: the importance of strategy 131 strategy measures five strategy measures are used as independent variables. since we are interested in assessing the impact of resource use (strategies) on performance, three business strategies used by mcarthur and nystrom (1991) for which international data was available were replicated: inventory turnover, capital intensity, and financial slack. in addition, research intensity and sales growth were also employed to capture technology and market dominance (hambrick, 1983; shane, 1993). while these measures do not generally constitute a complete set of organizational strategies, they tend to provide a good sample ofthe strategies employed by firms in order to compete within industries (porter, 1985). in order to eliminate effects related to firm size, financial ratios were used. specifica1ly, inventory turnover is the ratio of sales to inventory; capital intensity is the ratio of assets to sales; financial slack is stockholders' equity as a percentage of total debt; research intensity is the ratio of sales to research and development expenses; and, sales growth is the annual change in gross sales. all ratios were averaged over the five year period to eliminate any potential effects attributed to cyclical variations due to macroeconomic factors such as exchange rate or regional recessions. dependent variable the measure of finn perfonnance used in this study is an index comprised of the three most commonly used ratios of financial perfonnance: return on equity (roe), return on investment (roi), and return on assets (roa). an index was formed by conducting a principal component factor analysis and then combining the variables into a single index using the respective factor loading score to weight the individual component. the factor weights were .77, .92 and .94 for roe, roi, and roa, respectively (see appendix 1 for the full factor analysis). an index ofperfonnance was used to lessen the impact of country-based financial reporting differences, since there is evidence that financial reporting varies from country to country due to the absence of unified international accounting standards (barrett, 1976; gray, shaw and mcsweeney, 1981; zarzeski, 1996). also, an index of perfonnance has been suggested to capture the multidimensional nature of finn perfonnance within industries (prescott, 1986; tosi & gomez-mejia, 1989). results table 1 reports the means, standard deviations and bivariate correlations for all measures employed. on a bivariate basis, firm performance is directly related to financial slack (r=.30, p<.oi), negatively related to research intensity (r=-.25, p<.ol) and positively related to sales growth (r=.26, p<.ol). inventory turnover and capital intensity are not found to be significantly related to firm financial performance. as expected, the measures of national culture, on a bivariate basis, are not statistically related to firm performance since the model in figure 2 anticipates table 1 means, standard deviation and correlations ...... vj t,j mn st 1 2 3 4 5 6 7 8 1 performance 12.2 26.8 \.00 2 turnover 7.5 5.3 -.01 \.00 3 capital intensity .42 .25 .08 .09* 1.00 4 financial slack .48 .22 .30** -.05 -.18* \.00 5 research .05 .05 -.25** .05 -.13* .26** \.00 6 sales growth 10.6 19.0 .26** -.04 .09* .18** .17** \.00 7 munificence high .37 .48 -.13* .14* -.27** .02 .35** .19** \.00 8 munificence low .25 .43 -.14** -.14* -.09* .13* .15** -.03 -.43** 1.00 9 dynamism high . 10 .30 .13* -.05 .27** -.13* -.25** -.01 -.25** -.19** ..... 0 ]0 dynamism low .10 .30 .09* -.07 -.11 * .06 -.21** -.11 * -.26** -.19** :;:: ::l ii complexity high .12 .30 .11 * .03 .06 -.14* -.16** -.07 -.38** -.21 ** l:l 12 complexity low .07 .25 .08 .07 .24** 0 -.18** -.05 -.20** -.15** -. 13 uncertainty 55.0 21.1 -.01 -.11 * .15** -.16** -.03 .01 -.06 -.02 ~ 14 power distance 43.2 11.7 .03 -.09* .09* -.09* -.04 -.01 .07 -.04 tx:l :;:: 15 masculinity 62.8 18.2 -.04 -.06 .06 -.04 .01 -.04 -.08 .04 .., 16 individuality 74.9 21.1 -.03 .09 -.17** .11 .09 .02 .04 .03 5' <1l..,.., mn st 9 10 11 12 13 14 15 16 v) i performance 12.2 ...... 26.8 ~ 2 turnover 7.5 5.3 ...... <1l 3 capital intensity .42 .25 ()q-. 4 financial slack .48 .22 <1l.., 5 research .05 .05 6 sales growth 10.6 19.0 7 munificence high .37 .48 8 munificence low .25 .43 9 dynamism high .10 .30 1.00 ~10 dynamism low .10 .30 -. ii * 1.00 11 complexity high .12 .30 -.12* -.13* 1.00 ...... 12 complexity low .07 .25 -.09* -.09* -.10* 1.00 ~ 13 uncertainty 55.0 21.1 -.06 -.10* .21 ** .08 1.00 z 14 power distance 43.2 11.7 -.09 -.08 .07 .05 .68** 1.00 ? 15 masculinity 62.8 ]8.2 -.07 -.05 .16** .03 .65** .24** 1.00 tv 16 individuality 74.9 21.1 .05 .11 * -.]8** -.09 -.61 ** -.72** -.60** 1.00 fall 1997 katz, et al: the importance of strategy 133 culture to affect finn strategies, rather than finn perfonnance, directly. table 1 provides some insight into significant bivariate relationships between national culture and finn strategies. specifically, uncertainty avoidance is negatively related to inventory turnover and financial slack while being positively related to capital intensity. this makes sense. in cultures where uncertainty avoidance is common, firms tend to have greater levels of organizational bureaucracy (hofstede, 1980) which would be characterized by higher levels of capital intensity and lower levels of inventory turnover. similarly, cultures that avoid ambiguity would tend to promote firms with relatively higher debt because bank relationships are more stable than are investor relationships resulting in lower levels of financial slack. similar to uncertainty avoidance, power distance is negatively related to inventory turnover and financial slack while being positively related to capital intensity. this appears reasonable because countries that attempt to avoid ambiguity are more likely to have higher levels of power distance between those in authority and the typical worker (hofstede, 1980). thus, high power distance countries will tend to have more secretive relationships with banks, thereby incurring lower financial slack. individualism is negatively related to capital intensity and positively related to financial slack. individualistic countries tend to foster higher growth rates among finns (hofstede, 1980), thereby encouraging high levels of sales relative to use of capital; this would result in lower levels of capital intensity. in cultures valuing individualism, such as the united states, finns having higher levels of financial slack would allow managers the opportunity to take quick action when market conditions provide opportunities (hitt & ireland, 1987). masculinity is not significantly related to any of the finn strat~gies. this is somewhat surprising but not inconsistent with the lack of significant masculinity relationships found in other disciplines' studies of culture (peterson, et ai., 1995; shane, 1993). research intensity and sales growth are not related to any of the cultural variables. this may occur because the income statement financial data comprising the two measures may simply fail to effectively capture strategic asset-related allocation decisions of the finn. table 2 reports the results of the regression analysis of finn strategy, culture and environment on finn financial perfonnance. three of the five strategy variables are significantly related to finn perfonnance. specifically, financial slack, a measure that compares stockholder equity to total debt, has a strong and positive effect on finn perfonnance (b=.42, p=.oool). research intensity, a measure of research expenditures to sales, is negatively related (b=-.24, p=.0003) to finn perfonnance. finally, sales growth, a measure of average sales increase over five years, is positively related (b=.27, p=.oooi) to finn perfonnance. contrary to the results reported by mcarthur and nystrom (1991), no interactions among the variables were found to be significant. 134 journal of business strategies vol. 14, no.2 table 2 regression of strategy, environment, and national culture on performance variables b sebeta beta pvalue inventory turnover -.03 .27 -.006 .90 capital intensity -.07 6.87 -.0006 .99 slack 52.56 6.89 .42 .0001 research -126.51 34.32 -.24 .0003 sales growth .38 .07 .27 .0001 uncertainty -.10 .21 -.05 .63 power distance .35 .35 .09 .32 masculinity -.07 .21 -.03 .72 indivi duali ty -.06 .21 -.03 .79 constant -17.28 37.09 0 .64 adjusted r2 .33 f 5.91 pvalue .00001 discussion we began this study by seeking to examine the relationship between business strategies and performance in the global marketplace while taking into account other factors that have been suggested to affect the strategy-performance relationship. by hypothesizing that business strategies would be strong predictors of performance, we sought to assess the roles that national culture, competitive environment and industry effects play in firm performance. our study provides evidence that strategy is a dominant influence on the financial performance of international competitors. this has significant implications for global managers and academic researchers alike. managerial implications the results provide evidence that national culture does not systematically affect firm performance directly but operates through the effects of the task environment and business strategies. the implications of these finding for practicing managers are three fold. first, the findings confirm that national culture effects the firm's competitive environment as suggested by hofstede (1983). this gives global competitors the incentive to assess the impact of culture on the operating environment prior to competing in a particular foreign market. thus, managers from one country who attempt to manage in another country should be cognizant of the potential for different strategies across cultures. from our model of the factors impacting performance, it is evident that culture affects firm strategies through the competitive environment. for example, it has been reported that countries have different emfall 1997 katz. et ai: the importance of strategy 135 phases on financing sources and on government restrictions on businesses. in their recent study examining this issue, osland and cavusgil (1996) examined u.s.lchina joint venture performance. they found that the role of the government was a significant force on the resulting performance of joint ventures. it is, therefore, important for managers to assess the likely role of governments when evaluating the possible strategies for ventures in host countries. osland and cavusgil (1996) found that governments have both a constraining and enabling effect on the strategies and performance of international ventures. second, our findings provide evidence that cross-national competitors within industries effectively use certain strategies to achieve competitive advantage. specifically, financial slack is used as a very successful strategy in the global marketplace resulting in enhanced firm performance. that is, maintaining a certain level of unassigned assets allows the firm to capitalize on opportunities as they arise. this confirms the assertions by mitroff and mohrman (1987) that u.s. firms have the unfortunate habit of believing there is one best way to solve all problems by focusing on short-term performance without considering longer term implications. the common "fallacy of efficiency" that arises from the short term horizon of u.s. managers helps make this factor the most important determinant of success among the firms in our study. in addition, our findings suggest that the unfocused use of research and development resources results in reduced financial performance. this is consistent with the results reported by shane (1993) where national cultural characteristics were found to significantly effect the rates of innovation. thus, the most effective business strategies that managers should consider involve increased financial slack, focused research and development funding, and enhanced market share (sales growth). this is consistent with business strategies profiles of many successful japanese competitors (kono, 1984; porter, 1990). finally, in the broader contex.t it is important to extend our findings to other models of national culture. recent work studying the differences between the cultures of countries found that countries tend to cluster together based on their similarities of workplace factors (ronen & shenkar, 1985). thus, in countries that are clustered together it is more likely that managers will be able to develop successful strategies without significant assessment of the impact of culture on the competitive environment of the host country. in their recent study on the influence of national culture on the strategy of international acquisitions, calori. lubatkin and very (1994) found that firms are influenced by their national heritage when acquiring firms in other countries. their study gives strong support to our belief that being cognizant of national culture allows firms to more easily compete in culturally similar countries because the view of competitive strategies will be more consistent than in countries where the firms are culturally dissimilar. research issues there are a number of issues for future international strategy research. in this study, we found the mediating role of the competitive environment on the 136 journal of business strategies vol. 14, no.2 strategy-performance relationship reported by mcarthur and nystrom (1991) to not be evident when the effects of the environment and industry were controlled. these findings provide a useful departure for future inquiry into the interaction of culture, environment, strategy and performance. since the present study examined primarily single business firms by controlling at the four digit sic level, there is still information needed about the resource decisions of firms that operate in multiple markets, that is, di versified firms. further investigation into the role that culture has on corporate level strategy and resulting performance of the firm is suggested (also see calori et ai., 1994). specifically, questions that still need to be answered include: what role does national culture play in the firm's decision to diversify or integrate and what are the interactive effects of culture on the strategy-performance relationship of the firm? and, are corporate diversification strategies and business strategies consistent patterns for successful firms cross-nationally or does national culture impact the manner in which corporate diversification strategy is implemented? thus, our study of business strategies at the basic level can be expanded to broader corporate strategies, e.g., diversification and integration. a look at broader strategies appears warranted in the international arena where firms function in multiple markets. in addition, future research should begin to focus on the effects of task environment and firm strategy onfinancial market measures of performance, rather than on traditional accounting-based measures of performance. because the overall goal of a corporation is to improve shareholder wealth, market measures capturing this are a logical next step. limitations in some ways, the present study raises as many questions as it seems to answer. for example, why were the moderator effects of the environment reported by mcarthur and nystrom (1991) not found in the present study? one explanation could be that the dichotomous measures used as control variables for the three components of the competitive environment were not fined-grained enough to detect the moderator effect. yet, perhaps the answer lies in the broad-based approach of the present study that considered factors underlying the environmental measures, thereby allowing business strategies to explain the maximum amount of variance in performance. another unresolved question addresses why inventory turnover and capital intensity were not found to be significant predictors of performance as reported by mcarthur and nystrom (1991). perhaps these two business strategies do not vary significantly for the size of firms examined. the firms contained in the present study tended to be very large manufacturing firms that aggressively compete globally. according to scherer (1970), firm size has the effect of reducing the variance in firm approaches (strategies) employed in the marketplace. thus we would expect, for example, the variation in capital intensity of global machine tool firms to be fairly similar. fall 1997 katz, et al: the importance of strategy 137 there is one major limitation of this study. we examined only thirty industries because our research design required a dichotomization of the three task environments: munificence, complexity, and dynamism. we examined only the high and low conditions for each environment in order to determine whether the task environment as an effect on finn performance across companies internationally. this design was necessary, due to the numerous interactions expected across the variables of interest. we believe the limitation is a reasonable trade-off for the information obtained. conclusion this present study is meant to be an investigation of the importance of business strategy on firm performance when simultaneously considering the effects of national culture and competitive environment. we found that three business strategies made a significant difference in firm performance. this gives managers the added emphasis to pay close attention when setting strategic targets, especially when considering financial slack, allocating research funds, and setting market share targets. it is these strategies that were found to be strong determinants of enhanced performance within the firms' competitive markets. given the results of our study, global managers should: (l) seek to enhance the levels of financial slack in their firms to allow adequate resources for capitalizing on opportunities as they arise, (2) use resources for research and development sparingly and only when directed toward market share enhancement, and (3) assess the underlying national culture for each country in which they wish to compete to ensure a thorough understanding of the potential impact of the government and behavior of potential venture partners. it is our hope that future research will provide additional pieces to the cross-national strategy-performance puzzle. references aldrich, h. (1979). orianjzatjons and environments. englewood cliffs, nj: prentice-hall. andrews, k. (1987). the concept of corporate strategy. homewood, il: irwin publishing. barrett, m. e. (1976). financial reporting practices: disclosure and comprehensiveness in an international setting. journal of accountini research. 14(1), 10-26. caves, r., gale, b., & porter, m. (1974). interfirm probability differences. journal of economic literature, 88, 181-192. calori, r., lubatkin, m. & very, p. (1994). control mechanisms in cross-border acquisitions: an international comparison. orianization studies. 15(3),361-379. 138 journal of business strategies vol. 14, no.2 dess, g. & beard, d. (1984). dimensions of organizational task environments. administrative science quarterly, 29, 52-73. duncan, r. (1972). characteristics of organizational environments and perceived environmental uncertainty. administrative science quarterly, 17,313:327. franke, r., hofstede, g & bond, m. (1991). cultural roots of economic performance: a research note. strategic manajiement journal. 12, 165-173. gray, s., 1. shaw, and l. mcsweeney. (1981). accounting standards and multinational corporations. journal of international business studies. 12, 121-136. hambrick. d. (1983). high profit strategies in mature capital goods industries: a contingency approach. academy of manaeement journal. 26. 687-707. hambrick, d. & lei, d. (1985). toward an empirical prioritization of contingency variables for business strategy. academy of manaliemept journal. 28, 763-788. hitt, m. & ireland, r. (1987). building competitive strength in international markets.~ ranlie planning. 20(1), 115-122. hofer, c. (1975). toward a contingency theory of business strategy. academy of manaliement journal. 18, 784-810. hofstede, g. (1983). the cultural relativity of organizational practices and theories. imlr: nal of international business studies, fall, 75-89. hofstede, g. (1980). culture's consequences: international differences in work-related ~. beverly hills, ca: sage publications. jauch, l., qsborn, r. & glueck, w. (1980). short term financial success in large business organizations: the environment-strategy connection. strategic manaeement journal. 1,49-63. kono, t. (1984). strateliy and structure of japanese enterprise. new york: sharpe, inc. lee, m., lee, 1., ulgado, f. (1993). marketing strategies for mature products in a rapidly developing country: a contingency approach. international marketinli review. 10(5), 56-72. mcarthur, a. & nystrom, p. (1991). environmental dynamism, complexity and munificence as moderators of strategy-performance relationships. journal of business research. 23, 349-361. mitroff, i., & mohrman, s. (1987). the slack is gone: how the united states lost its competitive edge in the world economy. academy of management executive. 1(1), 6570. fall 1997 katz, et at: the importance of strategy 139 nakata, c. & sivakumar, k. (1996). national culture and new product development: an integrative review. journal of marketini. 60. 61-72. osland, g, & cavusgil, s. (1996). performance issues in u.s. china joint ventures. california manuement review. 38, 106-130. peterson, m. et at (1995). role conflict, ambiguity, and overload: a 21 nation study. academy of manaeement journal. 38(2), 429-452. porter, m. (1990). the competitive advantage of nations. harvard business review. 73, 73-95. porter, m, (1985). competitjve advantaie. new york: free press, porter, m. (1980). competitjve strateey. new york: free press. prescott, j. (1986). environments as moderators of the relationship between strategy and performance. academy of manaument journal. 29, 329-346. rasheed, a. & prescott, j. (1987). dimensions of organizational task environments: revisited. paper presented at the annual meeting of the academy of management, new orleans, la. rockart, j. (1979). chief executives define their own data needs. harvard business review. 57, 81-98. ronen, s. & shenkar, o. (1985). clustering countries on attitudinal dimensions: a review and synthesis. academy of manaiement journal. 10(3),435-454. scherer, f. (1970). industrial market structure and economic performance. chicago: rand mcnally college publishing. shane, s. (1993). cultural influences on national rates ofinnovation. journal of business venturini. 8(1), 59-73. tosi, h. & gomez-mejia, l. (1989). the decoupling of ceo pay and performance: an agency theory perspective. administrative science quarterly. 34, 169-189. tse, d., lee, k., vertinsky, 1. & wehrung, d. (1988). does culture matter? a cross-cultural study of executives' choice, decisiveness, and risk adjustment in international marketing. journal of marketine. 52, 81-95. zarzeski, m. (1996). spontaneous harmonization effects of culture and market forces on accounting disclosure practices, accountin~ horizons. 10(1), 18-37. 140 journal of business strategies appendix factor analysis of performance variables vol. 14, no.2 variable significance variance factor loading return on equity 2.34 return on investment .54 return on assets .12 finn performance = .77 (roe) + .92 (ron + .78 .18 .04 .94 (roa) .77721 .91989 .94391 dr. jeffrey p. katz is an assistant prl .ie department of management at kansas state university. he received his doctol ". philosophy in strategic management from the university of florida. his current research focuses on the strategic role of firm ownership and cross-national business strategies. his work appears in journals such as the academy of management journal, academy of management executi~, business horizons, human resource planning journal, and the journal of applied business re~ dr. marilyn t. zarzeski, ph.d., cpa, cfp is an assistant professor at the university of central florida. she was formerly associate professor at barry university in miami shores, florida. dr. zarzeski received her doctorate from the university of florida and has received two international accounting research paper awards. dr. h. john hall is director, undergraduate programs in the university of florida's college of business administration. he received his doctor of philosophy from the university of georgia. dr. hall's research focuses on the role decision making plays in the strategic behavior of firms. the importance of strategy to global competitors: the strategy-performance relationship across cultures consequence seriousness, gender, and intentions to blow the whistle on an unethical act tim wise southern arkansas university magnolia, ar tim barnett gene brown louisiana tech university ruston, la abstract in organizations, individuals are sometimes confronted with unethical behavior by subordinates, co-workers, or superiors. some might decide to "blow the whistle" and report the wrongdoing to appropriate authorities. numerous situational and individual-level factors are thoug ht to influence this decision. we examined a situational factor, consequence seriousness, and an individual-level factor, gender. we hypothesized that individuals would be more likely to form whistleblowing intentions when consequence seriousness was high. we also expected women to be more likely to fomz whistleblowing intentions than men. our results supported both hypotheses. individuals were more likely to form whistleblowing intentions when the consequences of the focal act were serious and women were more likely to state that they would blow the whistle than men. introduction sometimes individuals are confronted with wrongdoing in the organizations for which they work. in some cases, they may decide to report (blow the whistle on) the unethical act(s) to appropriate parties. whistleblowing has been formally defined as the disclosure by organization members of an employer's illegal, immoral, or illegitimate practices that are under the control of their employers to persons or organizations who may be able to affect action (near and miceli, 1985,4). numerous personal and situational factors are thought to influence an employee's decision whether to blow the whistle on unethical acts. for example, personality variables such as internal locus of control, religiosity, and high levels of moral development have been linked to whist1eblowing (barnett, bass, and brown, 1996; brabeck, 1984; trevino and youngblood, 1990). characteristics of spring 1997 wise, et at.: consequence seriousness 33 the situation, such as a supportive work group (trevino and victor, 1992; victor, trevino, and shapiro, 1991) and organizational norms encouraging whistleblowing (barnett, cochran, and taylor, 1993; keenan, 1990) also appear to influence employees' decisions whether to report wrongdoing. two other factors thought to influence whistle blowing decisions are (1) the seriousness of the consequences of the focal act and (2) the gender of the potential whistleblower. we suggest that individuals form stronger behavioral intentions to report wrongdoing when the consequences of the wrongdoing are serious. we also argue that women are more likely to form intentions to disclose wrongdoing than men. in this paper, we report the results of an empirical study to test the hypothesized relationships. first, however, we review relevant literature concerning consequence seriousness, gender, and whistleblowing. based on this review, we formalize our hypotheses regarding the study variables. literature review and hypotheses whistleblowing literature draws heavily from theories of bystander intervention, prosodal behavior, and ethical decision making (miceli and near, 1992). research has centered on the antecedents of whistleblowing by employees, as well as organizational responses (i.e., retaliation) to the whistleblower. our literature review focuses primarily on the two research variables of interest, consequence seriousness and gender, and their proposed relationship to whistleblowing decisions. seriousness of the focal act's consequences and whistleblowing prosocial behavior theory suggests that people are more likely to engage in helping behaviors when an observed incident has serious consequences (dozier and miceli, 1985; staub, 1978). for example, bystanders would be more likely to intervene to help seriously injured victims of a head-on collision than drivers involved in a fender-bender. of course, factors unique to individuals will also influence their decision whether or not to intervene. the tendency for individuals to react more strongly to events with serious consequences also applies to actions that pose moral or ethical dilemmas. according to jones (1991), seriousness of consequences is one component of what he terms the "moral intensity" of an ethical issue, which is defined as "the extent of issue-related moral imperative in a: situation" (p. 372). other components of moral intensity include social consensus, proximity, temporal immediacy, probability of effect, and concentration of effect. jones (1991) suggests that actions must reach a threshold level of moral intensity before individuals will recognize the moral content of the situation and engage in ethical decision making processes. all other characteristics of the situation being the same, actions with more serious consequences will have greater moral intensity. moral intensity 34 journal of business strategies vol. 14, no. 1 should affect individuals' ethical judgments about actions, as well as their behavioral intentions regarding the actions (jones, 1991). in an organizational context, consequence seriousness should impact employees' reactions to an unethical act (miceli and near, 1992). an employee might be more likely to conclude that an observed act with serious consequences requires a personal response of some kind (dozier and miceli, 1985). graham (1986) suggests that employees will be more likely to believe that blowing the whistle is justified when they perceive that the unethical act will have serious consequences for them, the organization, or society. empirical studies reveal that managers perceive whistleblowing as more acceptable when the wrongdoing in question is serious or has highly negative consequences (clinard, 1983). this may make retaliation against whistleblowers less likely in these situations (miceli and near, 1989; near and miceli, 1986). there is limited empirical evidence supporting the relationship between consequence seriousness and whistle blowing. miceli and near (1985) found that the seriousness of wrongdoing (defined as the level of financial loss) was associated with whistleblowing, particularly whistleblowing to parties outside the organization. another study found that whistleblowers were more willing to openly blow the whistle on unethical acts when the acts had serious financial consequences (miceli, roach, and near, 1988). however, fritzsche (1988) discovered no significant link between the seriousness of consequences and whistleblowing, and miceli, near, and schwenk (1991) found that illegal wrongdoing was no more likely to result in whistleblowing than less serious types of wrongdoing. as shown above, empirical studies regarding the relationship between consequence seriousness and whistleblowing have yielded somewhat inconsistent results. in addition, seriousness has generally been defined in terms of financial loss. seriousness of consequences in terms of environmental issues or health and safety issues has been largely unexamined (miceli and near, 1992). we suggest that, consistent with theories of prosocial behavior (dozier and miceli, 1985) and ethical decision making (jones, 1991) individuals are more likely to form behavioral intentions to blow the whistle on an organizational action when the action is perceived to have serious consequences. in the present study, we define consequence seriousness in terms of an environmental issue that has ramifications for the health of employees and the surrounding community. hypothesis 1: individuals will be more likely to form intentions to blow the whistle on a questionable organizational action when consequence seriousness is high. gender and whistleblowing near and miceli (1985) argue that whistleblowers are more likely to be men than women. they base this supposition on factors affecting the absolute number spring 1997 wise, et al.: consequence seriousness 35 of whistleblowers as well as factors affecting the likelihood of whistleblowing. first, although about 45 percent of all managerial employees are women, less than 5 percent of top executives are women (cascio, 1995). so, men often hold positions within companies where serious wrongdoing is likely to be observed (miceli and near, 1992). women may also have less information about how to report wrongdoing in their organizations (keenan, 1990). therefore, in terms of absolute numbers, it is logical to expect more men to blow the whistle on wrongdoing than women. miceli and near (1992) identify individual-level factors affecting the likelihood of men blowing the whistle. men may have higher levels of self-esteem and greater internal locus of control, which may make them more likely to report perceived wrongdoing (miceli and near, 1992; trevino and youngblood, 1990). in addition, women might be more sensitive to social influence opposing whistleblowing (miceli and near, 1992). a few empirical studies seem to support this position (miceli, dozier, and near, 1991; miceli and near, 19"88). miceli et al. (j 991) conducted an experimental study that held constant the observation of wrongdoing, the nature of the wrongdoing, and controlled for moral development and locus of control. they found that men were more likely to blow the whistle on wrongdoing. miceli and near (1992) suggest that the men and women in this study may have differed in their beliefs regarding the costs and benefits of whistleblowing. despite the above evidence, there are also good reasons to believe that if women have an equal opportunity to observe and evaluate wrongdoing, they will be more likely than men to blow the whistle. gender socialization theory suggests that women are socialized differently than men and that this leads to greater sensitivity about ethical issues (mason and mudrack, 1996). research concerning cognitive development suggests that women may reason differently about ethical issues than men and that women may have a greater ethic of caring (gilligan, 1982). although some empirical studies do not support gender differences on ethics issues «dubinsky & levy, 1985; hegarty and sims, 1978; mcnichols and zimmerer, 1985; sikula and costa, 1994; tsalikis & ortiz-buonafini, 1990), empirical research increasingly uncovers significant differences. harris and sutton (1995) found that female mba students were less tolerant of wrongdoing than their male counterparts. ameen, guffey, and mcmillan (1996) found that women were less accepting of academic dishonesty: two studies concluded that women responded "more ethically" when faced with marketing dilemmas (lane, 1995; malinowski and berger, 1996). in a study with direct implications for whistleblowing, jones and gautschi (1988) found that women were less likely to be loyal to their company when they perceived that it was acting unethically. several other studies have also found that women are less tolerant of perceived unethical behavior (beltramini, peterson, and kozmetsky, 1984; chonko and hunt, 1985; ferrell and skinner, 1988; ruegger and king, 1992; whipple and swords, 36 journal of business strategies vol. 14, no. 1 1992). we believe that differences in the way women and men evaluate ethical issues may cause women to form intentions to report wrongdoing. for example, several models of ethical decision making explicitly acknowledge that individuals must first recognize an ethical dilemma as such before they will engage in ethical decision making processes (jones, 1991; rest, 1986). specifically, only individuals who recognize ethical problems will evaluate them in an ethical context, and decide (1) if they have a responsibility to act in regard to the ethical dilemma, and (2) what action they should take. the above research suggests that women may have greater sensitivity to ethical issues than men. if this is the case, women should be more likely to judge issues in a moral context and more likely to conclude that they should take action in regard to the ethical issue. the relevance to potential whistleblowing situations seems clear. we believe that when women have an equal chance to become aware of and evaluate an action of questionable morality that they will be more sensitive to the ethical problem and form intentions to report the unethical act. therefore, we suggest the following research hypothesis: hypothesis 2: women will be more likely than men to form intentions to blow the whistle on a questionable organizational action. method subjects study subjects were drawn from university students at two southern universities. students enrolled in business classes were asked to participate in the study. a total of 128 students participated. seventy-three were female (57 percent). the average age of the students was about 25 years. almost 80 percent were white, with 15 percent black, and 5 percent members of other minority groups. approximately 90 percent of the subjects were juniors, seniors, or mba students. nearly three quarters of subjects (73.6 percent) were employed, with over a third (36.9 percent) categorizing themselves as full-time employees. vignette each participant in the study was presented with an ethical vignette. alexander and becker (1978) suggest that vignettes provide a concrete stimulus that allows study of attitudinal issues. vignettes make it possible for the researcher to vary the characteristics of a hypothetical situation, and observe the effects on individuals' attitudes and judgments. vignettes are widely used in ethics research (weber, 1990, 1992). the vignette concerned a production process for wheat flour in a milling company. the emission control equipment of the company was not handling the emissions of dust adequately. the management of the company decided to introspring 1997 wise, et at.: consequence seriousness 37 duce the new process on the third shift (10:00 p.m. to 6:00 a.m.). this made it less likely that the unhealthy emissions would be detected. each participant was placed in the role of franklin, a foreman on the third shift, who was aware of the excessive emissions from the process. this vignette was adapted from an earlier study by fritzsche and becker (1984). the full text of the vignette is shown in the appendix. independent variables consequence seriousness. the seriousness of the consequences of the milling process was varied within the text of the vignette. in the "low seriousness" version, the second paragraph of the vignette indicated that the dust emission posed no long-term health risk but was a minor irritant to individuals' throats and lungs. in the "high seriousness" version of the vignette, the second paragraph stated that the dust emission could cause serious lung disease and that it was a long-term health hazard. all other aspects of the scenario were identical for each of the two study groups. a pretest revealed significant differences in the perceived seriousness of consequences for the two versions of the vignette (p < .01). in the actual study, onehalf of the subjects were randomly assigned to each of the two versions of the scenario. as a manipulation check, each participant was asked to rate the seriousn~ss of consequences on a 9-point scale. subjects who read the "high seriousness" version of the scenario judged consequence seriousness to be significantly higher than those who read the "low seriousness" version (p < .0 i), indicating a successful manipulation of this variable. gender. the sex of subjects was assessed by self-report. males were categorized as "i;" females as "2." dependent variable the dependent variable in the study was "stated intentions to blow the whistle on the questionable organizational action." in this case, the action was using a milling process that produced emissions in excess of what company emission control equipment could handle. subjects were asked to indicate the probability that they would report the problem to appropriate agencies on a 4-item, 9-point semantic differential scale anchored by the following word pairs: (i) likelyunlikely, (2) probable-improbable, (3) possible-impossible, and (4) definitely would-definitely would not. coefficient alpha for the scale was .97. covariate as indicated earlier, numerous individual-level variables are thought to influence decisions to blow the whistle on unethical acts. one of the more commonly cited is locus of control, a measure of the amount of personal control a person feels over the things that affect their lives (rotter, 1966). internal locus of control has been linked theoretically and empirically to ethical decisions and 38 journal of business strategies vol. 14, no. 1 whistleblowing (trevino, 1986; trevino and youngblood, 1990). a measure of internal locus of control taken from a scale developed by levenson (1974) was included in the study as a covariate. the measure consisted of an 8-item, likerttype scale with responses ranging from "1 =completely disagree," to "9 = completely agree." sample items include "i can pretty much determine what will happen in my life," "my life is determined by my own actions," and "i am usually able to protect my interests." coefficient alpha for the internal locus of control scale was .63. analysis an analysis of covariance procedure with stated likelihood of blowing the whistle as the dependent variable, consequence seriousness and gender as grouping variables, and internal locus of control as a covariate was performed. this procedure allowed an examination of the joint and independent effects of consequence seriousness and gender, after the effects of the covariate had been considered. results table 1 shows the results of the analysis of covariance. the main effects were significant in predicting whistleblowing intentions (p < .0001). the interaction between consequence seriousness and gender was not a significant influence on intentions to blow the whistle. the covariate, internal locus of control, fell just short of significance at the .05 level. table 1 analysis of covariance results source of variation covariate locus of control main effects consequence seriousness gender interaction eta2 = .16 f statistic 3 .57 9.82 5.02 15.41 .06 significance level .06 .000 .027 .000 .81 table 2 shows the mean values for whistleblowing intentions by two categories of consequence seriousness (low and high) and for men and women. the spring 1997 wise, et at.: consequence seriousness 39 values of whistleblowing intentions ranged from 1 to 9, with numbers closer to 9 indicating a greater probability of reporting the emissions. the overall mean was 6.23, indicating that as a whole, the subjects were somewhat likely to state that they would report the emission problem to appropriate authorities. table 2 whistleblowing intentions by consequence seriousness and gender mean whistleblowing intentions consequence seriousness high (n=64) low (n=64) gender female (n=55) male (n=73) interactions low seriousness-male (n=26) high seriousness-male (,,=29) low seriousness-female (n=38) high seriousness-female (=35) * p < .005 ** p< .001 6.63* 5.84 6.89** 5.36 4.84 5.82 6.52 7.29 hypothesis i stated that individuals will be more likely to form intentions to blow the whistle when consequence seriousness is high. as table ii shows, the mean value for whistleblowing intentions was 6.63 when consequence seriousness was high, and 5.84 when consequence seriousness was low. this difference was statistically significant (p < .05), which supports hi. hypothesis 2 stated that women would be more likely to form whistleblowing intentions than men. women's mean for whistleblowing intentions was 6.89. the mean for men was 5.36. this difference was also statistically significant (p < .001). this provides support for h2. although the hypotheses for both consequence seriousness and gender were supported, a closer examination of the means in table 2 shows that gender appeared to be the more important factor in predicting whistleblowing intentions. the group most likely to form strong whistleblowing intentions was women assigned to the high seriousness condition (x =7.29). the group least likely to form whistleblowing intentions was men exposed to the low seriousness vignette (x = 4.84). women exposed to the low seriousness condition reported stronger 40 journal of business strategies vol. 14, no. 1 whistleblowing intentions (x = 6.52) than men who were assigned to the high seriousness treatment (x = 5.82). the results of the analysis of covariance provides support for both hypotheses. the gender effect was particularly strong. although internal locus of control was associated with stronger whistleblowing intentions, it was not a statistically significant predictor. discussion whistleblowing research has generally followed the person-situation interactionist perspective (trevino, 1986) that forms the basis for most empirical research in the field of business ethics (miceli and near, 1992). numerous individual-level and situational variables are thought to influence whistleblowing decisions. this study provides support for the effect of a situational factor, consequence seriousness, and an individual-level factor, gender. our finding concerning consequence seriousness is generally consistent with previous research (graham, 1986; miceli and near, 1985). consequence seriousness may affect whistleblowing through its impact on the moral intensity of the focal act (jones, 1991). when the consequences of a questionable organizational action are more serious, an individual might be more likely to engage in ethical decision making processes. serious consequences may cause the individual to (1) consider the action unethical, and (2) believe that it requires an appropriate response, which might include whistleblowing. jones (1991) suggests several other factors that affect the moral intensity of an action, including the probability of the consequences occurring, the proximity of victims, and the time lag between the action and the onset of consequences. each of these factors, and others, may affect individuals' reasoning regarding ethical issues. future research should continue to examine such variables' influence on ethical decision making in general and whistleblowing decisions in particular. perhaps the most interesting finding of our study was the effect of a respondent's gender on their intentions to report wrongdoing. previous research suggests that men are more often whistleblowers than women (miceli and near, 1992). our study finds that, given the same information about the action and about response alternatives, women were significantly more likely to form whistleblowing intentions. one possible reason we observed this effect could involve differences between men and women's approach to ethical issues. women may reason differently about ethical issues, and they may be more sensitive to perceived wrongdoing. women may be socialized differently (mason and mudrack, 1996) be more idealistic (forsyth, 1980), and have greater cognitive moral development or ethic of caring (gilligan, 1982). because of this, they may be more likely to report organizational wrongdoing with serious consequences. spring 1997 wise, et at.: consequence seriousness 41 earlier studies of whistleblowing have generally used financial loss as a barometer of the seriousness of the wrongdoing. our study used an environmental issue with health ramifications at the personal and community level. women may be more sensitive to environmental issues (miceli and near, 1992). the greater likelihood of whistleblowing observed in our study could be issue specific. future research should address this issue. in addition, our study had only one response alternative, either to report the wrongdoing to the appropriate parties or do nothing. male subjects might have considered alternatives other than whistleblowing. therefore, one should not conclude from our results that females were "more ethical," only that they were more likely to choose whistleblowing. our findings should be interpreted in light of the methodology employed. our subjects had an equal opportunity to evaluate the action. subjects were not vulnerable to retaliation for making the decision to blow the whistle as they might be in an actual organization. in addition, there was no possibility for confusion about how or to whom reports of wrongdoing should be made. whistleblowing research has generally utilized surveys of actual employees of the federal government. men in these surveys might have been in positions where they were more likely to observe wrongdoing. in addition, in actual workplace settings, female respondents might be less aware of available whistleblowing channels (keenan, 1990) and more fearful of organizational retaliation (miceli and near, 1992). our study was limited by its reliance on an ethical vignette and its use of students as subjects. ethical scenarios allow researchers to reflect real-world decision making situations, to emphasize issues of special interest to the researchers, and to control multiple variables in an experimental setting (cavanagh and fritzsche, 1985). however, responding to a question posed in a hypothetical scenario is certainly not equivalent to actual decision making, but reflects behavioral intentions, which are often, but not always, predictive of ethical/unethical behavior. since it is often not practical to study business ethics situations in the field, scenarios offer a means to test research hypotheses in a carefully controlled environment. in addition, some question the relevance of the business context to a student sample, because of the lack of familiarity that many students have with business settings (weber, 1992). to the degree that students cannot understand organizational realities used in scenarios, their responses may be quite different from subjects who are more familiar with business operations (weber, 1992). this limits the generalizability of research findings based on student samples. although we do not claim that our results are generalizable to the workplace, most of the students in our study were employed (73.6 percent), and almost all were business majors. they should therefore have some awareness of workplace realities. in addition, the scenario used was non-technical and the ethical dilemma was relatively straightforward. the manipulation check indicated that students were able to differentiate between the "high" and "low" seriousness treatments. 42 journal of business strategies vol. 14, no. 1 although we used a student sample and cannot necessarily generalize our findings to workplace settings, they are suggestive that employees will evaluate the seriousness ofthe consequences of an unethical act when deciding if and how to respond to the act. in addition, women might be more sensitive to an unethical action with serious consequences, and more likely to decide that they should report the wrongdoing. this is particularly relevant to u. s. companies in the 1990s, since almost half of the labor force is comprised of women. ethical behavior is of concern to both business practitioners and researchers. one of the more difficult issues faced by many employees is how to respond to the perceived unethical actions of their employer. our research suggests that both situational and individual-level factors are important in determining the individual's response to this dilemma. future research should continue to examine this and similar issues regarding whist1eblowing. references alexander, c.. and h.1. becker. "the use of vignettes in survey research." public opinion quarterly 42 (1978): 93-104. ameen, e.c., d.m. guffey, and j.j. mcmillan. "gender differences in determining the ethical sensitivity of future accounting professionals." journal of business ethics 15 (1996): 591-597. barnett, t., k. bass, and g. brown. "religiosity, ethical ideology, and intentions to report a peer's wrongdoing." journal of business ethics 15 (1996): 1161-1174. barnett, t., d.s. cochran, and g.s. taylor. "the internal disclosure policies of private sector employers: an initial look at their relationship to employee whistleblowing." journal of business ethics 12 (1993): 127-136. beltramini, r.f., r.a. peterson, and g. kozmetsky. "concerns of college students regarding business ethics." journal of business ethics 3 (1984): 195-200. brabeck, m.m. "ethical characteristics of whistleblowers." journal of research in personality 18 (1984): 41-53. cascio, w.f. managing human resources. 4th ed. new york: mcgraw-hili, 1995. cavanagh, s.1., and d.1. fritzsche. "using vignettes in business ethics research." in research in corporate social performance and policy. ed. l. preston. greenwich, ct: jai press, 7 (1985): 279-293. chonko, l.b., and s.d. hunt. "ethics and marketing management: an empirical examination." journal of business research 13 (1985): 339-359. spring 1997 wise, et at.: consequence seriousness 43 clinard, m.b. corporate ethics and crime: the role of middle management. beverly hills, ca: sage, 1983. dozier, j.b., and m.p. miceli. "potential predictors of whistle-blowing: a pro-social behavior perspective." academy of management review 10 (1985): 823-836. dubinsky, a.j., and m. levy. "ethics in retailing: perceptions of retail salespeople." journal of the academy of marketing science 13 (1985): 1-16. ferrell, o.c., and s.j. skinner. "ethical behavior and bureaucratic structure in marketing research organizations." journal of marketing research 25 (1988): 103-109. forsyth, d.r. "a taxonomy of ethical ideologies." journal of personality and social psychology 39 (1980): 175-184. fritzsche, dj. "an examination of marketing ethics: role of the decision maker, consequences of the decision, management position, and sex of the respondent." journal of macromarketing 8 (1988): 29-39. fritzsche, dj., and h. becker. "linking management behavior to ethical philosophy: an empirical investigation." academy of management journal 27 (1984): 166-175. gilligan, c. in a different voice. cambridge, ma: harvard university press, 1982. graham, j.w. "principled organization dissent: a theoretical essay." in research in organizational behavior, eds. l.l. cummings and b.m. staw. greenwich, ct: jai press, 8 (1986): 1-52. harris, j.r., and e.d. sutton. "unraveling the ethical decision-making process: clues from an empirical study comparing fortune 1000 executives and mba students." journal of business ethics 14 (1995): 805-817. hegarty, w.h., and h.p. sims, jr. "some determinants of unethical decision behavior: an experiment." journal of applied psychology 63 (1978): 451-457. jones, t. "ethical decision-making by individuals in organizations: an issue-contingent model." academy of management review 16 (1991): 366-395. jones, t.m., and f.h. gautschi iii. "will the ethics of business change? a survey of future executives." journal of business ethics 7 (1988): 231-248. keenan, j.p. "upper-level managers and whistle-blowing: determinants of perceptions of company encouragement and information about where to blow the whistle." journal of business and psychology 5 (1990): 223-235. lane, j.e. "ethics of business students: some marketing perspectives." journal of business ethics 14 (1995): 571-580. 44 journal of business strategies vol. 14, no. 1 levenson, h. "activism and powerful others: distinctions within the concept of an internal-external control." journal of personality assessment 38 (1974): 377-383. malinowski, c., and k.a. berger. "undergraduate student attitudes about hypothetical marketing dilemmas." journal of business ethics 15 (1996): 525-535. mason, s.e., and p.e. mudrack. "gender and ethical orientation: a test of gender and occupational socialization theories." journal of business ethics 15 (1996): 599-604. mcnichols, c.w., and t.w. zimmerer. "situational ethics: an empirical study of differentiators of student attitudes." journal of business ethics 4 (1985): 175-180. miceli, m.p., j.b. dozier, and j.p. near. "blowing the whistle on data-fudging: a controlled field experiment." journal of applied social psychology 21 (1991): 301-325. miceli, m.p., and j.p. near. "the incidence of wrongdoing, whistle-blowing, and retaliation: results of a natural occurring field experiment." employee responsibilities and rights journal 2 (1989): 91-108. -----. "individual and situational correlates of whistle-blowing." personnel psychology 41 (1988): 267-282. -----. "characteristics of organizational climate and perceived wrongdoing associated with whistle-blowing decisions." personnel psychology 48 (1985): 525543. -----. blowing the whistle: the organizational and legal implications for companies and employees. new york: lexington books, 1992. miceli, m.p., j.p. near, and c.r. schwenk. "who blows the whistle and why?" industrial and labor relations review 45 (1991): 113-130. miceli, m.p., b. roach, and j.p. near. "the motivations of anonymous whistleblowers: the case of federal employees." public personnel management 17 (1988): 281-296. near, j.p., and m.p. miceli. "organizational dissidence: the case of whistleblowing." journal of business ethics 4 (1985): 1-16. -----. "retaliation against whistle-blowers: predictors and effects." journal of applied psychology 17 (1986): 137-145. rest, l.r. moral development: advances in research and theory. new york: praeger, 1986. rotter. j.b. "generalized expectancies for internal vs. external control of reinforcement." psychological monographs. 80 (1966): 1-28. spring 1997 wise, et al.: consequence seriousness 45 ruegger, d., and e.w. king. "a study of the effect of age and gender upon student business ethics." journal of business ethics ii (1992): 179-186. sikula, a., and a.d. costa. "are women more ethical than men?" journal of business ethics 13 (1994): 859-871. staub, e. positive social behavior and morality: social and personal influences. new york: academic press, 1978. trevino, l.k. "ethical decision-making in organizations: a person-situation interactionist model" academy of management review 11 (1986): 601-617. trevino, l.k., and b. victor. "peer reporting and unethical behavior: a social context perspective." academy of management journal 35 (1992): 38-64. trevino, l.k., and s.a. youngblood. "bad apples in bad barrels: a causal analysis of ethical decision-making behavior." journal of applied psychology 75 (1990): 378-385. tsalikis, j., and m. ortiz-buonafini. "ethical belief differences of males and females." journal of business ethics 9 (1990): 509-517. victor, b., l.k. trevino, and d.l. shapiro. "peer reporting of unethical behavior: the influence of justice evaluation and social context factors." journal of business ethics 12 (1991): 253-263. weber, j. "scenarios in business ethics research: review, critical assessment, and recommendations." business ethics ouarterly 2 (1992): 137-160. -----,. "managers' moral reasoning: assessing their responses in three moral dilemmas." human relations 43 (1990): 687-702. whipple, t.w., and d.f. swords. "business ethics judgments: a cross-cultural comparison." journal of business ethics 11 (1992): 671-678. appendix ethical vignette* franklin works as a foreman for master millers. the company has developed a special milling process which yields a wheat flour that provides a higher uniform texture for bread than conventionally milled flour. unfortunately, the process gives off more dust that the emission control equipment of the company can handle effectively. the company is unable to install new emission control equipment for at least two years, due to the unavailability of a better system. if master millers waits that long to introduce the new milling process, competitors might beat it to the market. 46 journal of business strategies vol. 14, no. 1 (low seriousness version) the type of dust emitted by the milling process has been linked to minor irritations of the throat and lungs, but poses little long-term risk to the employees or surrounding community. (high seriousness version) the type of dust emitted by the milling process has been linked to serious lung disease, and poses a long-term threat to the health of the employees and the surrounding community. the general manager has introduced the new milling process during the third shift, which runs from 10 p.m. to 6 a.m. this is the shift on which franklin works. by using the process at this time, the new flour can be introduced and the excess emissions not detected. by the time demand becomes great enough to utilize a second shift, new emission control equipment should be available. question: if you were franklin, what is the likelihood that you would notify appropriate authorities about the excess emission of the dust? *vignette adapted from fritzsche & becker (1984) tim wise (d.b.a., louisiana tech university) is an assistant professor of management at southern arkansas university. he received his d.b.a. in management in 1995. his primary research interest is employee whistleblowing. tim barnett (d.b.a., mississippi state university, 1990) is associate professor of management at louisiana tech university. he has authored or co-authored more than twentyfive articles appearing in journals such as personnel psychology, the journal of business research, human relations, and the journal of business ethics, plus numerous proceedings papers. his current research interests include ethical decision making and ethical issues in human resource management. gene brown (ph.d., university of alabama) is professor of marketing and head, department of management and marketing at louisiana tech university. he received his ph.d. in 1988. he has published more than twenty-five articles in a variety of journals including the journal of marketing research, the journal of business research, the journal of business ethics, and the journal of the academy of marketing science, plus numerous proceedings papers. his research interests include personal selling, retailing, ethics, and methodology. consequence seriousness, gender, and intentions to blow the whistle on an unethical act tax considerations in investment strategies: evidence of functional fixation on asset depreciation richard l. ai/tizer emporia state university emporia, ks d. elaine sanders the university of texas san antonio san antonio, tx abstract tax planning strategies may encourage functional fixation on tax considerations in investment decisions. a desire to reduce income taxes payable may result in the irrational purchase of assets in order to keep depreciation on the income statement. in this case, fixation on tax, which is suggested by past literature involvingfunctionalfixation (haka, friedman, and jones, 1986), could lead to sub-optimal decision-making in settings where after-tax income maximization would be the appropriate response. a controlled experiment was peiformed using m.b.a. students from a southwestern university. the presence or absence of information encouraging the development ofa tax "frame" was the manipulated variable. the results support fixation on tax effects given a framing difference. in addition, a declining incidence of tax fixation was observed to correspond with years of business experience. introduction the usefulness of accounting and other types of data to decision-makers depends not only upon the quality ofthe information but also upon the care with which it is used (hopwood, 1974). among important types of data that decision-makers consider in investment decisions are those relating to tax considerations. while tax planning is an important component of decision making in a business environment, over-emphasizing tax considerations in an investment decision may be a danger, that is, to the degree that other relevant data are not considered or weighted normatively. considering the degree of importance of tax planning's influence on business and management, the effects of tax exposure on decision-making may be considered a prominent force in shaping the course of modem business. awareness ofthe influence of tax considerations on business decisions, though, raises questions regarding the factors that influence the decision-maker's strategies in weighing those factors. decision-makers developing fixed responses based on tax considerations could affect their decision-making judgments, resulting in increasingly costly mistakes as decisions of greater materiality are made (darrell, 1950). 2 journal of business strategies vol. 14, no. the lure of a quick tax dollar is often the only justification for a transaction that might have been accomplished with much sounder economic results and equivalent tax savings if more careful and deliberate consideration had been given to the problem (988-989). an example of a fixed response based on tax considerations might include a businessman who purchases new equipment to replace fully depreciated, serviceable equipment. l the fact that depreciation expense is tax deductible may overshadow the fact that it is also a charge against income. consider the following numerical example: a businessperson currently owns a fully depreciated piece of equipment. the equipment is still serviceable and will remain so for the foreseeable future but has no salvage value. to avoid an increase in income taxes payable, this person is considering the purchase of a new asset to replace the old asset. the normative model for this decision would involve computing the net present value of the relevant differential costs in the decision. the investor will derive no benefit other than reduced income taxes from this asset. if the new asset costs $100,000, is a fiveyear macrs property, will have no salvage value, and the investor has a 40% tax rate and 16% cost of capital, then the net present value of the proposed investment would be <$72,989>. the computations are contained in exhibit 1. the cost of the investment far outweighs the benefit in tax savings that will be obtained, and the normative decision would be to retain the old equipment. jones (1997) states that "tax deductions are a by-product of economic costs" which may be lost if the taxpayer eliminates (or reduces) the cost. jones stresses that taxpayers should focus on controlling costs and not on the potential loss of tax benefits. considering the possibility of sub-optimal decision processes, the potential cost to society of fixation on tax considerations becomes high. a pattern of inferior decisions in busi!1ess could result in the misallocation and, ultimately, the waste of relatively scarce resources (darrell, 1950). the purpose of this research is to discern whether tax fixedness inhibits individual optimal decision-making processes. this issue will be addressed in the following sections. the next section contains the theoretical back-ground including the functional fixation and prospect theory literatures and the hypothesis. the third and fourth sections present the methodology employed in the experiment and the analyses and results. conclusions and plans for future research are presented in the final section. en exhibit 1 "0 :j. ::l 0cl net present value analysis ...... \0 time 0 1 2 3 4 5 6 \0 -......l cash flows ini tial cost of new asset ($100,000) ~---. depreciation n~ tax shield .... r<> (40% tax rate) ~ .20 $8,000* ;::s .32 $12,800 i::l... 'il .192 $7,680 ~'. .1152 $4,608 ~ .1152 $4,608 ~ ('j .0576 $2,304 ~;::s '" total cash flows ($100,000) $8,000 $12,800 $7,680 $4,608 $ 4,608 $2,304 c.: ~ ~...... pvif x 1.000 x.862 x.743 x.641 x.552 x.476 x.410 -.~ ;::s '"present value of cash flows ($100,000) $6,896 $9,510 $ 4,923 $2,544 $2,193 $945 net present value ($ 72,989) *.40($100,000 x .20) = $8,000 w 4 journal of business strategies theoretical background vol. 14, no. 1 functional fixation strictly defined, functional fixation refers to the possible effects of repeated uses of data for a given purpose, followed by inhibition of the ability to adapt the data to other uses (ashton, 1976). kagan and havemann (1976) also suggest that functional fixation is the tendency to make a given response to a given stimulus, as adapted to the function of an object. further, weisberg and alba (1981) argue that the function an object serves is a limitation that we impose upon ourselves. a simple example of functional fixation can be found when duncker (1945) challenged subjects with a well-defined problem: attach three small candles to the walj.2 to accomplish this task, the subjects were given three small boxes, some tacks, a few matches, and three candles. in the fixation condition, the three small boxes held the candles, tacks, and matches. in the non-fixation condition, the items were simply scattered on a table top. when the items were held within the boxes, the boxes were designated as "containers" and the subjects were hesitant to use them as part of the experimental tools. when the items were scattered around, subjects much more quickly incorporated the boxes into their decision scheme by attaching the boxes (upside down) onto the wall with the thumbtacks and setting the candles on top. by the same token, an individual who repeatedly uses earnings data for current valuation purposes might have trouble adapting the data to alternative uses, such as predicting future earnings, or a person who must continually strive to reduce income taxes may have trouble seeing an investment as an income increasing activity. evidence of functional fixation has also been documented in accounting contexts. ashton (1976) and swieringa, dyckman, and hoskin (1979) find that individuals who are fixated on accounting numbers are unable to change their use of that data when accounting changes occurred. abdel-khalik and keller (1979) test and find evidence of functional fixation in investment decisions using fifo and lifo changes. haka, et al. (1986) hypothesize that repeated exposure to cost measures might inhibit optimal decision responses by encouraging over-emphasis on cost data when market value data would be more relevant to the decision. the researchers note: fixation on cost and income data may leave individuals without the ability to discriminate, unaware of the appropriate contexts for the use of those data. that is, correct usage of market value data may become difficult for persons continually exposed to a variety of institutions demanding cost data (457). chang and birnberg (1977) note that the issue of functional fixation is "whether the user exhibits a tendency to make a habitual response and, if so, whether he persists when he is informed of a change in the data inputs" (301). spring 1997 allitzer & sanders: tax considerations 5 further, chang and birnberg suggest two important issues involving accounting research and functional fixation: how past experience affects behavior and how to extinguish older, unnecessary patterns of behavior. the present study concerns itself with the former issue. to strengthen construct validity, this study examines the concept of tax fixedness at the expense of utility maximization in light of another area of relevant thought, prospect theory. prospect theory prospect theory focuses on why individuals might violate widely accepted standards of rational choice. tversky and kahneman (1981) suggest that rational decision-making behavior involves consistency and requires that "preferences or utilities for particular outcomes should be predictive of the experiences of satisfaction or displeasure associated with their occurrence" (458). if this predictive nature of rationality is violated, sub-optimal consequences may result from lack of rationality in choices. the importance of prospect theory to this study lies in three areas. first is the notion of "decision frames," a term that tversky and kahneman use to describe an individual's perception of acts, outcomes, and contingencies associated with a particular choice. decision frames are "controlled partly by the norms, habits, and personal characteristics of the decision-maker" (453). in framing a decision, decision makers establish the perspective that they will take for that decision. the process offraming includes defining the problem and deciding what is important to solve it. as the boundaries of the frame are set, some information will be included while some will be omitted; therefore, once a decision has been framed, the decision maker is left with only a partial view of the problem (russo and schoemaker, 1989). consider again the candle-mounting experiment presented earlier. when the boxes are framed as containers, subjects have difficulty considering them as shelves. when the boxes are just items on the table, however, they do not enter the problem with a specific frame and are summarily incorporated into the solution. second is the magnitude of change observed in the outcome relative to the decision maker's reference point. the reference point is set by the decision maker's perception of the problem context, or decision frame. an important precept of prospect theory is that the value function is steeper for losses than for gains. that is, gains and losses of identical magnitude have different significance for people; the losses are considered more important. this makes intuitive sense from a functional perspective. a primary motive of virtually every organism is survival. hypersensitivity to threats, for example, losses, would serve that motive well (yates, 1990). finally, the result of the decision must be measured. an inappropriate decision that fulfills the needs of the decision maker's frame will not be viewed as a 6 journal of business strategies vol 14, no.1 decision failure by the decision maker. still, the long-term effects of the decision could be devastating. in the tax problem presented earlier, the decision maker can frame this problem in one of two ways: as a tax-reducing problem or as an income-increasing problem. if the decision is framed as a tax-reducing problem, the reference point will be set in reference to reducing tax dollars lost (the steep portion of the prospect curve). if the investment is made and income taxes payable decrease, the decision maker feels that the appropriate decision has been made. in accordance with prospect theory, however, the decision maker has actually made his or her decision based on partial information. the overall effect of the transaction on the well-being of the company has not been fully considered. the volume of tax strategy literature in contemporary business publications suggests that tax considerations will continue to play an important role in investment decisions for the foreseeable future. thus, it is in society's interest to maximize the effectiveness of the decision-making skills of individuals whose decisions are influenced by tax considerations. the emphasis in our society on cost and/or income could affect people's decision processes, resulting in a conditioning phenomenon ..... yet, social conventions, such as income taxes, which specify cost and income as crucial inputs, may cause people to react to this choice in unexpected ways. for example, if pervasiveness of cost data has changed simple decision-making behavior, one might observe a person choosing an item with a higher original cost even if it has a lower current value. if such behavior is widespread, there may be a high societal cost due to suboptimal decision-making behavior (haka, et ai., 1986, 456). the current research question is: does tax fixedness inhibit optimal decision-making processes in individuals? prospect theory is easily transferable into tax research. if decision-makers frame a potential investment as a tax-savings strategy rather than as an income-maximizing strategy, the result could lead to an irrational decision. conversely, if decision-makers are able to work with a potential investment choice without casting the problem into a taxation framework, they will make a more appropriate decision. given the literature regarding the effects of functional fixation and prospect theory, this study hypothesizes that (stated in the alternative): individual decision-makers will show a higher incidence of tax fixedness when an investment problem is framed as a tax problem than when it is not. spring 1997 allitzer & sanders: tax considerations methodology 7 experimental design to test the above hypothesis, the researchers designed and tested a role-playing case study. 3 subjects were cast into a scenario in which they assumed the role of a chemist with the opportunity of entering into a ten-year government contract. the only long-term asset the chemist would have to purchase would be an expensive delivery truck. 4 in the "no-frame" condition, subjects were shown the estimated income statements for the first five years of the project (the depreciable life of the delivery truck). subjects were then told that the budgeted income statements were an accurate reflection of actual business for the first five years. further, although they had experienced no major difficulties with the delivery truck, the manufacturer had now (at the end of the fifth year) developed a new and improved delivery truck. a measure of probability was then taken of the subject's willingness to consider the purchase of a new delivery truck at this time. the "tax-frame" condition simply extended the "no-frame" condition. after the subjects were told of the development of a new delivery truck by the manufacturer, they were presented with budgeted income statements for the remaining life of the contract. these income statements were prepared under the assumption that a new delivery truck would not be purchased, therefore depreciation expense ceased in the seventh year causing both income and income tax expense to increase. as in the "no frame" condition, a measure of probability was then taken of the subject's willingness to consider the purchase of a new delivery truck at this time.s the experimental design, then, is a between-subjects randomized control group/manipulation group design (exhibit 2). exhibit 2 experimental design experimental group control group information ----i..... additional -----i..... measure set information fixation information ------------1...... measure set fixation the actual frame used by the subjects for their final decision is an internal state and cannot be accurately measured. to reject the null hypothesis, however, subjects in the "tax frame" condition should fixate on the role of depreciation expense as a method to reduce the income tax liability and should state a higher 8 journal of business strategies vol 14, no.1 willingness to consider the purchase of a new delivery truck in order to keep depreciation on the income statement. in the "no frame" condition, the expiration of depreciation expense is not obvious, and the subjects should focus on the condition of the existing delivery truck and the increase in net income if a new delivery truck is not purchased. as a result, in the "no-frame" condition, the willingness to consider the purchase of a new delivery truck should be lower. sample m.b.a. students at a southwestern university volunteered to serve as subjects for the study. they had completed at least one semester of graduate-level financial accounting and were currently enrolled in a graduate-level management accounting course. graduate students were considered to be an appropriate and useful subject group for this particular study. the students had all been exposed to and tested over the quantitative and qualitative aspects of net present value analysis, the depreciation tax shield, and cash flows needed to complete the task as presented. procedure the experiment began with subjects completing a statement of informed consent. after these statements were completed and collected, the instruments were randomly distributed to the subjects. the instrument consisted of the basic story contained in the case, a cash flow task, the functional fixation task, and the exit questionnaire. subjects were given unlimited time to complete the instrument; however, the average time to complete was approximately 20 minutes. data analyses and results a total of 152 subjects participated in the study. information gathered on the exit questionnaire provided some demographic information about the subjects; 57% were male and 30% were international students.6 on average, the subjects had 1-5 years of actual business experience and 24% stated that they had occasionally or very often used income statement data in making business decisions. two subjects were dropped due to incomplete instruments. as a control measure for the contents of the scenario, subjects were asked to indicate whether the story suggested the need for a new delivery truck at the end of five years. in the scenario, subjects were told that no major problems had been encountered with the existing truck over the past five years. the purpose of this statement was to induce indifference between the two options. eight subjects answered "yes" when asked if the company needed a new truck. a "yes" answer was interpreted as indicating that the subjects read more into the scenario than was actually presented, thus biasing their responses. those eight subjects were subsequently dropped from the data set. spring 1997 allitzer & sanders: tax considerations 9 the remaining 142 data points were analyzed using a 1 x 2 anova with the stated probability of considering the purchase of a new delivery truck as the dependent measure and whether or not the subjects were encouraged to view the investment within a tax frame as the independent measure. the results of the analysis are presented in table 1. the results indicate a statistically significant effect (at a = .10) for tax frame on the probability of considering the purchase of a new delivery truck (f =3.31, p =0.0708). table 1 anova results for tax fixedness n mean sd no frame 71 42.66 34.01 tax frame 71 53.08 34.22 source df ss fvalue pr>f frame 1 3856.34 3.31 0.0708 (n = 142) subjects who were presented information more conducive to establishing a tax-frame for their decision stated a higher probability of considering the purchase of a new delivery truck than subjects who were presented with more openended information. a problem with using an income statement format in an experimental instrument is the fact that depreciation, income tax, and net income all vary directly in relation to one another. if the subjects equated net income with cash flow, their probabilities of considering a new delivery truck could be tied to the perception of increased cash rather than fixation on decreasing the tax liability. thus, all subjects were asked a cash flow assessment question in the experimental instrument: to state their probabilities that a cash withdrawal of $20,000 would be possible in each of the first five years. because net income was less than $20,000 for each of these years, subjects who equated cash flows with net income would state low probabilities for the desired withdrawal. on the other hand, actual cash flows were greater than $20,000 in each of the first five years. all subjects who stated a probability ofless than 50% on the question of cash withdrawals were dropped from the data set on the assumption that they did not consider the actual cash flows in their final decision. as a result, 62 subjects were dropped from the sample, and the 1 x 2 anova with the stated probability of considering the purchase of a new delivery truck as the dependent measure and 10 journal of business strategies vol. 14, no. 1 whether the subjects were encouraged to view the investment within a tax frame as the independent measure was again computed. the results of the analysis (table 2) indicate a statistically significant effect for tax frame (at a =.05) on the probability of considering the purchase of a new delivery truck (f = 4.31, p = 0.0413). table 2 anova results for tax fixedness n mean sd no frame 45 47.49 34.89 tax frame 35 63.46 33.14 source df s8 fvalue pr>f frame 1 5020.02 4.31 0.0413 (n =80) after controlling for knowledge of cash flows, subjects who were presented information more conducive to establishing a tax-frame for their decision still stated a higher probability of considering the purchase of a new delivery truck than subjects who were presented with more open-ended information. the implications of these results suggest that individual decision makers who frame investment questions with regard to the tax implications may favor investments that they see as tax reducers rather than as income maximizers. additional anovas were used to observe the effect of information gathered from the exit questionnaire on the dependent variable. the independent variables were gender, international status, years of business experience, and frequency of income statement use for decision-making. the only variable that produced a statistically significant result was years of business experience (f = 2.73, p = 0.0354). generally, the more years of experience the subject reported, the lower the probability of considering the purchase of a new truck. table 3 presents the means for the five levels of experience and the comparison of those means using tukey's studentized range test. spring 1997 allitzer & sanders: tax considerations table 3 means for years of business experience 11 n none 16 less than 1 year 5 1-5 years 25 5-10 years 19 more than 10 years 15 mean 63.13 72.80 59.96 54.00 30.60 group a a b a b a b b multiple comparisons using tukey's studentized range test. different letters signify statistically significant differences at p < .05. the data was tested again for interaction effects between years of experience and experimental condition. no interaction effects were found. main effects were then tested to ascertain whether the framing condition would still exhibit statistically significant differences after controlling for the effect of years of experience. the results are contained in table 4. after controlling for years of experience, the effect of the frame manipulation on the dependent variable remains statistically significant (f = 5.76, p = 0.0189). table 4 anova results for tax fixedness after controlling for years of business experience source experience frame df 4 i ss 13215.60 6052.78 fvalue 3.15 5.76 pr>f 0.0191 0.0189 while no hypothesis existed a priori to suggest a decline in functional fixation given years of business experience, it is interesting to note that this finding may be interpreted as paralleling haka, et. ai's (1986) results. in their study, they found age to be inversely related to fixation on selling prices. older subjects were less likely to fixate on selling prices than younger subjects. in the current study, subjects with more years of business experience were less likely to fixate on tax-reducing investments than were subjects with no business experience. conclusions the results obtained in this study suggest that individuals who fixate on the tax consequences of an investment decision are prone to make sub-optimal deci12 journal of business strategies vol. 14, no. i sions. when information was provided to allow subjects to construct a tax-frame for considering an investment opportunity, those subjects found the opportunity much more appealing than did subjects who were presented open-ended information (no frame). additionally, years of business experience were found to relate inversely to the tendency to fixate on tax consequences. if years of business experience can be considered as a proxy for age, then this result supports the findings of haka, et al. (1986). while every effort was made to control internal and external variables that might have affected the results in this study, limitations do exist. in considering the purchase of the new truck, subjects were told that no major difficulties had been encountered with the existing truck to induce indifference between the two options. further, subjects were asked in the exit questionnaire to disclose whether they believed a new truck was needed at this time. the subjects answering "yes" were dropped from the statistical analyses. specific information about differences in the two trucks (potential cost reductions from lower fuel costs, lower repair costs, or lower maintenance costs) were not introduced into the scenario. a limitation of the study is the assumption that the two alternatives were equaliy weighted and that subjects were not considering other possible cost-related scenanos. a second potential limitation of the study is the use of m.b.a. students as subjects. ashton and kramer (1980) suggest that students are an appropriate surrogate for professional decision makers in decisions requiring judgment and decision-making skills with no particular disciplinary expertise. a priori, the current study fit this requirement. given the differences found among years of experience and probability of purchase, however, not using professional decision-makers may limit the ability to generalize the results. finaliy, the age of the references used in the study may be perceived as a limitation in this study, however, functional fixation in decisions of the nature presented here has not been a heavily researched topic in recent years. haka, et al. (1986) is the latest paper to actualiy approach the issue of functional fixation from the viewpoint of interest to the current study. as accountants, we should be keenly aware of the hazards of functional fixation on tax considerations. we should endeavor not to fall prey to this decision error as information providers [as would be dictated by interference theory (haka, et a1., 1986)], and we should be aware of the possibility of these fixating tendencies in our clients. by using normative decision-making procedures (e.g. emphasizing income increasing rather than income tax reducing strategies), we can present information in a manner conducive to optimal decision-making or help clients frame a decision to overcome decision problems like functional fixation. but to truly understand this problem, additional research must be conducted. while the inverse relationship between years of experience and functional fixation supports the results of past research, additional research will assist in spring 1997 allitzer & sanders: tax considerations 13 confirming those results. instruments could more carefully measure business experience and extract specific details of that experience. researchers could then verify the correlation between age and years of experience. in addition, further study should be conducted specifically in the tax arena on the issue of functional fixation and its relationship to both investment strategies and tax avoidance strategies. while the current study casts subjects into the role of an individual making a self-profiting decision, additional research might cast them into an advisory role (tax or financial advisor). differences may exist between the wayan individual frames a decision given their external orientation. also, the effects of interference theory could be tested. while haka, et al. (1986) found no evidence to support interference effects in their study, future research on tax issues could expand the search into the professional environment. one possible study would observe the fixation of students versus professionals. additionally, different levels of students and professionals could be tested (intermediate i students, tax ii students, tax accountants, and financial advisors). in summary, support for functional fixation on tax consequences has been found in the controlled laboratory experiment conducted for this study. the potential of casting a decision into a tax frame has been shown to relate to that fixation, although years of experience seem to mediate fixative effects. further research should be conducted to ascertain when and how fixation occurs. the results can help indiviual decision makers in overcoming this decision problem. notes 1. economically, if he spends a dollar to receive a dollar's worth of reduction (replacing the equipment so as to receive a depreciation deduction), he is better off only when the marginal tax rate exceeds 100 percent. 2. a thorough review of functional fixation can be found in baron (1988), pages 47 -51. 3. a synopsis of the experimental instrument follows in the appendix. 4. by entering into a government contract, we were able to suggest that all other costs and revenues would be constant over the life of the contract, thus eliminating conflicting issues that might have affected net income. 5. this task is analogous to a situation where a tax client's estimated tax liability suddenly increases due to the full-depreciation of assets. in this scenario, however, the client (subject) does not have an accountant telling him or her that the increase in taxes is directly correlated to the cessation of depreciation expense (which could enhance the fixation on the income tax effects of depreciation on the income statement). the omission of a detailed explanation of these effects, that is letting subjects frame the problem for themsel ves, biases against rejection of the null hypothesis and strengthens any statistically significant results that might be obtained. 6. although no theory could be found to support differences in levels of fixation between u.s. and non-u.s. decision makers, a suggestion was made to the authors that the individual and corporate income tax structures in place in other countries might be reflected in the completion of the task by international students. given this very 14 journal of business strategies vol. 14, no. 1 relevant comment, a measure was taken of the international status of the subjects as a possible control variable. references abdel-khalik, a.r., and t.f. keller. "earnings or cash flows: an experiment on functional fixation and the valuation of the firm." studies in accounting research #16. sarasota: american accounting association, 1979. ashton, r.h. "cognitive changes induced by accounting changes: experimental evidence on the functional fixation hypothesis." journal of accounting research (supplement 1976): 1-17. ashton, r., and s. kramer. "students as surrogates in behavioral research: some evidence." journal of accounting research 18 (1980): 1-13. baron, j. thinking and deciding. cambridge: cambridge university press, 1988. chang, d.l., and j.g. birnberg. "functional fixity in accounting research: perspective and new data." journal of accounting research (autumn 1977): 300-312. darrell, n. "some responsibilities of the tax adviser in regard to tax minimization devices." in proceedings of the new york university eighth annual institute on federal taxation. albany, ny: matthew, bender & co., 1950: 988-989. duncker, k. "on problem solving." psychological monographs 58 (whole no. 270), (1945). haka, s., l. friedman, and v. jones. "functional fixation and interference theory: a theoretical and empirical investigation." the accounting review (july 1986): 455-474. hopwood, a.g. "leadership climate and the use of accounting data in performance evaluation." the accounting review 49 (1974): 485-495. kagan, j. and e. havemann. £sychology: an introduction. new york: harcourt brace jovanovich, 1976. jones, s. federal taxes and management decisions. chicago: irwin, 1997. russo, j.e. and p.j.h. schoemaker. decision traps: the ten barriers to brilliant decision making and how to overcome them. new york: doubleday, 1989. swieringa, r.j., t.r. dyckman, and r.e. hoskin. "empirical evidence about the effects of an accounting change on information processing." in behavioral experiments in accounting ii, ed. t.h. bums. ohio state university, 1979: 225-59. spring 1997 allitzer & sanders: tax considerations 15 tversky, a., and d. kahneman. "the framing of decisions and the psychology of choice." science 211 (1981): 453-458. weisberg, r.w., and j.w. alba. "an examination of the alleged role of 'fixation' in the solution of several 'insight' problems." journal of experimental psychology: general 110 (1981): 169-192. yates, j.e judgment and decision making. englewood cliffs, nj: prentice hall, 1990. appendix a synopsis of the experimental instrument the case as an aspiring young chemist, you have discovered a derivative of trinitrotoluene (tnt) that is a clearly superior form of the explosive. in the scientific community, your discovery has been nicknamed tnt2• you have estimated that you can safely produce 200 units of tnt2 in a year. the army corps of engineers (ace) recently approached you with the offer of an exclusive contract for all 200 units of your product for each of the next ten years. ace will pay you $1,000 per unit for tnt2• in addition, ace has offered to intervene on your behalf with potential chemical suppliers, allowing you to contract for a fixed per unit rate over the term of your ace contract. if you accept the ace contract, you will only need to purchase one major piece of equipment: a specially-fitted delivery van for transporting the tnt z• after checking with several potential manufacturers, you are confident that you can purchase the delivery van for approximately $100,000. you have enough cash on hand to begin manufacturing tnt 2, but you are still unsure whether the return on your investment is enough to justify the expenditure of your hardearned savings. so, you has taken the matter to your sister, frieda, who is an accountant. after reviewing the financial estimates and computing something called the "net present value" of the project, frieda informed you that the project promises to offer you a return that is above your minimum expectations. in addition, frieda has prepared estimated income statements for the next five years. the projected income statements that frieda prepared for the first five years are presented below. 16 journal of business strategies vol. 14, no. 1 tnt2 estimated income statement for the years 19x1 through 19x5 19x1 19x2 19x3 19x4 19x5 sales (200 units @ $1,000) $200,000 $200,000 $200,000 $200,000 $200,000 cost of goods sold (200 units @ $500) 100,000 100,000 100,000 100,000 100,000 gross margin 100,000 100,000 100,000 100,000 100,000 operating expenses 60,000 60,000 60,000 60,000 60,000 depreciation expense* 20,000 32,000 19,200 11,520 11,520 operating income before income taxes 20,000 8,000 20,800 28,480 28,480 income taxes (40%) 8,000 3,200 8,320 11,392 11,392 net income $12,000 $ 4,800 $12,480 $17,088 $17,088 *computed using macrs please consider the following questions independently. question i. you wish to withdraw $20,000 each year for personal use. given the information furnished above, what is the probability that you will have the required amount of cash available in each of the first five years? 0% no-frame condition mark your response with a slash (/). 100% question 2. frieda's estimates were a close approximation of the actual business for tnt2, and you have experienced no major difficulties in either the production or delivery of tne during the first four years. in 19x5, the manufacturing company from which you bought the delivery truck informed you that they had developed new systems which they believed would improve the performance of a new van, should you decide to purchase one. given the information provided above, what is the probability that you would consider the purchase of a new van? 0% mark your response with a slash (/). 100% spring 1997 frame condition allitzer & sanders: tax considerations 17 question 3. frieda's estimates were a close approximation of the actual business for tnt2, and you have experienced no major difficulties in either the production or delivery of tnt2 during the first four years. in preparation for the next five years of production, you have asked frieda to once again prepare budgets. the projected income statements for years 19x6-19yo are presented below. tnt2 estimated income statement for the years 19x6 through 19yo 19x6 19x7 19x8 19x9 19yo sales (200 units @ $1,000) $200,000 $200,000 $200,000 $200,000 $200,000 cost of goods sold (200 units @ $500) 100,000 100,000 100,000 100,000 100,000 gross margin 100,000 100,000 100,000 100,000 100,000 operating expenses 60,000 60,000 60,000 60,000 60,000 depreciation expense* 5,760 0 0 0 0 operating income before income taxes 34,240 40,000 40,000 40,000 40,000 income taxes (40%) 13,696 16,000 16,000 16,000 16,000 net income $ 20,544 $ 24,000 $ 24,000 $ 24,000 $ 24,000 *computed using macrs in 19x5, the manufacturing company from which you bought the delivery truck informed you that they had developed new systems which they believed would improve the performance of a new van, should you decide to purchase one. given the information provided above, what is the probability that you would consider the purchase of a new van? 0% mark your response with a slash (i). 100% dr. richard alltizer, (ph.d., university of oklahoma) spent 14 years in public accounting before earning his ph.d. he is currently an assistant professor at emporia state university in emporia, kansas. dr. alltizer teaches a variety of tax issues and has developed numerous continuing education courses in tax. he has published tax-related re18 journal of business strategies vol. 14, no. 1 search in taxation for accountants, taxation for lawyers, and the journal of applied business research. dr. elaine sanders, (ph.d., university of oklahoma) recei ved her phd. after working in the private sector. she is currently an assistant professor at the university of texas at san antonio in san antonio, texas. dr. sanders teaches financial and managerial topics in accounting. her research interests focus on the use of accounting information for decision-making which enables her to conduct research across a broad range of accounting topics. dr. sanders has published in the journal of accounting case research. tax considerations in investment strategies: evidence of functional fixation on asset depreciation volume 40(1) p.1-20 received: june 6, 2022 revision received: september 7, 2022 accepted: september 16, 2022 https://doi.org/10.554155/jbs.40.1.1-20 ceo trustworthiness: its antecedents and effects on corporate governance k. matthew gilleya, roger c. mayerb, bruce a. waltersc, gregory g. dessd, bradley j.olsone a greehey school of business, st. mary’s university, san antonio, tx b poole college of management, north carolina state university, raleigh nc c corresponding author. department of management, louisiana tech university. bwalters@latech.edu d naveen jindal school of management, university of texas at dallas, richardson tx e faculty of management, university of lethbridge, lethbridge ab canada abstract we develop an integrated set of propositions describing the relationships among ceo characteristics, the perceived trustworthiness of the ceo, and the board of directors’ decisions concerning the governance structure of the firm. in particular, we propose that ceo education, tenure, experience, board memberships and founder status affect the board’s perception of the ceo’s ability, benevolence, and integrity (the three key trustworthiness dimensions), and that these trustworthiness perceptions then affect the board’s choice of governance mechanisms with regard to ceo compensation mix, ceo/board chair duality, board size, and outsider representation on the board. our theoretical development suggests that agency theory’s difficulties in explaining corporate governance may be the result of researchers’ failure to incorporate ceo trustworthiness into their models. keywords ceo characteristics, trustworthiness, corporate governance 1. introduction corporate scandals highlight the effects of executive power and trustworthiness on the success or failure of organizations. recent events at theranos, luckin coffee, volkswagen, wells fargo and other organizations demonstrate the dramatic lengths to which unscrupulous executives will go to enrich themselves at the expense of the organization’s stakeholders. such events over the years have led numerous critics in academia and the media to suggest that corporate governance in america’s largest firms has failed to align the interests of top managers with those of the shareholders and other key stakeholders. at the heart of many such criticisms is that complacent, and even complicit, boards are oftentimes unwilling or unable to reign in powerful executives. the board of directors is the governing body that has received the most attention in relation to minimizing inappropriate executive behavior (daily & schwenk, 1996), and the board is deemed the nexus of corporate this work is licensed under a creative commons attribution-noncommercial 4.0 international license. © 2023 the authors. https://doi.org/10.554155/jbs.40.1.1-20 mailto:bwalters@latech.edu gilley et al. / journal of business strategies (2023) 40:1-20 2 governance (finkelstein & hambrick, 1996; hoppmann et al., 2019). since boards of directors are to ensure the alignment of shareholder and executive interests, it is incumbent upon them to assess and adjust the firm’s governance structure and to do so in a way that minimizes the potential risks of moral hazard to the firm brought about by decisions the ceo makes. nevertheless, it is clear that powerful and unscrupulous executives are sometimes allowed to run roughshod over the governance process and, by extension, the best interests of those by whom they are employed. agency theory assumes that the ceo is inherently untrustworthy because he or she is a “rational actor”; that is, the ceo may have something substantial to gain by considering his or her own interests of primary importance (graffin et al., 2020; jensen & meckling, 1976). from an agency theory perspective, unless the interests of the ceo and the firm are directly aligned such that each stands to gain from a given ceo decision, the appropriate action of the board would be to place controls on the ceo so that s/he does not exploit the firm for his or her own gain. that is, the board should choose governance structures that minimize any potential agency costs (joseph et al., 2014; zahra & pearce, 1989). alternatively, stewardship theory suggests that a ceo might make decisions that benefit the firm even at his or her own expense (davis et al., 1997; donaldson & davis, 1991; hernandez, 2012). this is because such a ceo may well attach great utility to outcomes that benefit the organization irrespective of personal gain (chrisman, 2019). when a ceo is motivated to act as a steward, the recommendation would follow that the board should choose governance structures that allow the ceo discretion and latitude to make the decisions that, rather than motivated by the potential for self gain, are motivated by benefiting the organization. thus, we have two different perspectives from which both the board of directors and the ceo might act: an agency perspective and a stewardship perspective. while agency and stewardship theories offer the chance at greater understanding of both the board and the ceo in the context of governance structure, what is left largely unaddressed is the context under which the board will choose an agency versus a stewardship perspective in either imposing or reducing constraints on the ceo in the governance structure it chooses. the governance options most easily influenced by directors are generally believed to be the ceo’s compensation mix and the conduct and structure of the board of directors (including the decision to grant the ceo additional titles, such as board chairperson, and, by extension, more discretion). both executive compensation and board structure have been extensively researched, but most of this work has focused on the performance-related outcomes of corporate governance rather than the factors that affect governance structures themselves. among the largely unanswered questions are: why do some boards grant the ceo the additional role of board chairperson and/or president, while some do not? why are there varying levels of board independence from management? and, why do ceo compensation plans vary across firms with similar characteristics? we argue that the perceived trustworthiness of the ceo is central to answering these questions. we develop an integrated set of propositions highlighting the relationships among ceo characteristics, perceived ceo trustworthiness, and governance structure. we propose that ceo characteristics affect the board’s perceptions of his or her trustworthiness. in addition, we propose that the board’s perception of ceo trustworthiness affects the degree to which the board is willing to put itself and the firm at risk through the firm’s governance structure. in pursuing this line of inquiry, we make several contributions to management theory. first, our paper represents a merging of two previously distinct domains, namely, strategic management’s governance work and organizational behavior’s work on trustworthiness and trust. second, we advance work on governance by further explicating the role of ceos’ personal differences in the governance process. third, we address the extent to which perceived ceo trustworthiness affects corporate governance structure. fourth, we address the antecedents of governance structure, which, as noted above, have received relatively little atgilley et al. / journal of business strategies (2023) 40:1-20 3 tention. finally, we extend theory development on trustworthiness by delineating some of its potential antecedents, which have also received very little attention from either the theoretical or empirical literature. 2. theory development agency theory has long offered a view of the firm in which the board, representing the principals, is pitted against ceos as agents (eisenhardt, 1989), yet we still do not have a clear understanding of the full range of dysfunctional behaviors and their costs to organizational stakeholders and society (bosse & phillips, 2016). agency theory suggests that the interests of owners and their agents can come into conflict, and when this happens, ceos will choose to protect their own interests above those of the principals, or, more specifically, the firm. when the interests of the firm and the ceo are aligned, this presents no problem. that is because the ceo, in making decisions that benefit himor herself, will also be protecting the interests of the firm. this occurs as a side benefit to the firm, but the benefits are nonetheless very real. when they are not aligned and the ceo chooses self-gain over the good of the firm, the firm incurs what are referred to as agency costs. the potential for these agency costs represents risk to the firm, and this risk can be minimized by the choices the board makes with regard to governance structure (krause et al., 2017). for example, the board can align the interests of the ceo with the firm by tying part of the ceo’s compensation to firm performance. or, the board can limit the ceo’s power by appointing someone other than the ceo to be the board’s chair. stewardship theory offers an alternative viewpoint of the relationship between the ceo and the firm (chrisman, 2019; davis et al., 1997; donaldson & davis, 1991; hernandez, 2012). stewardship theory suggests that some ceos make decisions that benefit the firm irrespective of, and perhaps even at the expense of, their own potential for self-gain (hernandez, 2012). that is because such ceos see utility not in their own accumulation of tangible benefits so much as in identifying with the success of the firm. such ceos will forego decisions that benefit themselves if, in doing so, they would bring harm to or miss the chance to benefit the firm. in this instance, the board should be much less concerned about minimizing agency costsandmoreconcernedwithcreatingsituations in which the ceo can do what comes naturally to him or her and benefits the firm. for a ceo who is inclined to act as a steward, the board may do well to choose governance structures that minimize constraints on the ceo and give him/her more latitude. here, the board might not feel compelled to tie a portion of the ceo’s compensation to firm performance and might allow the ceo more discretion by, for example, appointing the ceo to also serve as the board’s chair. davis et al. (1997) gave an extensive treatment of stewardship theory and its comparison to agency theory. they also discussed at length the benefit of having the ceo and the board aligned in their motivations and world views. they suggested that an appropriate match is when a ceo with an agency mindset (meaning he or she is selfinterested) is matched with board that places appropriate constraints on the ceo. another appropriate match occurs when a stewardship-minded ceo is matched with a board that is likeminded and, inturn, minimizesconstraintsontheceo.undesirable situations occur when a ceo with a stewardship focus is paired with a board that assumes the ceo is highly self-interested, or when a highly self-interested ceo is matched with a board that assumes the ceo has a stewardship focus. davis et al. (1997) go on to discuss conditions that might contribute to a ceo adopting a stewardship perspective, citing influences such as the ceo’s value commitment to the organization and the management philosophy of the ceo (control vs. commitment). they also argue that, whereas the appropriate agency scenario minimizes potential costs, the mutual stewardship relationship has the potential to maximize performance. however, only hinted at, and not formally developed in previous work of which we are aware, are the conditions that would influence the board’s perceptions of the ceo’s mindset and whether or not s/he would be considered to be more agencyoriented or stewardship-oriented. while a match gilley et al. / journal of business strategies (2023) 40:1-20 4 is important, to arrive at this point, the board must (hopefully) correctly assess the ceo’s leanings. very simply, a ceo might have a stewardship perspective, but under what conditions will the board provide the ceo with the governance structure to act as a steward? davis et al. (1997) suggested that trustworthiness would be important to this process, but they did not go beyond this suggestion. we draw on this suggestion, first outlining the characteristics of the ceo that will make the board more likely to view him or her as trustworthy and then delineating the effects of these perceptions of trustworthiness on the board’s decisions regarding governance structure. hence, our view places the perceived trustworthiness of the ceo as the intervening variable between the ceo’s characteristics and governance structure. ceo characteristics as antecedents of trustworthiness trust in management has long been thought to be important for organizational performance (argyris, 1994; davis et al., 2000; dirks, 2000), and it has received a considerable amount of attention in the literature. however, one of the problems associated with this work has been the variety of ways trust has been defined and operationalized (bigley & pearce, 1998; sitkin & roth, 1993). to deal with these problems, mayer et al. (1995) developed a conceptual model that separated trustworthiness from trust. trust is defined in their model as a willingness to be vulnerable to the actions of another person or party when that party cannot be monitored or controlled. while trust can be assessed as a willingness to engage in certainactionsthatputoneselfatrisk, it ismanifested as risk taking in a relationship (rtr) with a party in one’s actions or decisions in a specific setting. thus, according to mayer et al. (1995) model, a trustor’s perceptions of a trustee’s characteristics (i.e., trustworthiness) will influence the degree to which the trustor is willing to make himor herself vulnerable to the trustee (i.e., trust). this, in turn, is the primary antecedent to the trustor’s actions and decisions that directly put him or her at risk (i.e., rtr). while other theoretical frameworks are available to invoke trust (lewicki & bunker, 1996; mcallister, 1995; rousseau et al., 1998), we chose to draw upon mayer et al. (1995) because it specifically distinguishes among the trustee’s characteristics, the trustor’s willingness to put himor herself at risk, and the actual behaviors that do so. in the context of the present paper, this allows us to distinguish clearly between the board’s perceptions of the ceo’s trustworthiness and the board’s risk taking (trust manifested) through the decisions they make in the governance structures affecting the ceo. more specifically, the board’s trust intheceois, inpart, manifestedintheextent to which governance structures either impose or lift constraints on the ceo’s autonomy. trustworthiness is a perceived property of the trustee, and it is comprised of the board’s perceptions of the ceo’s ability, benevolence, and integrity. ability refers to “that group of skills, competencies, and characteristics that enable a party to have influence within some specific domain” (mayer et al., 1995, p. 717). it is generally believed to be domain/task specific such that an individual can be seen as capable in some domains but not in others. in a chief executive context, we suggest that ability deals with the extent to which the ceo is perceived by the board to be capable of leading the firm to acceptable levels of performance. as an agent for all the firm’s stakeholders (both those who own shares and those who do not), the ceo’s actions are influenced by the presence of both stakeholder and shareholder representatives on the board of directors (harrison, 1987; luoma & goodstein, 1999). a stakeholder-agency view (hill & jones, 1992) would suggest, then, that directors consider ceos to have ability when they have the skills, competencies, and characteristics necessary to guide the firm toward added value for a wide variety of stakeholders, including both shareholders and non-shareholding stakeholders alike (barney, 2018). benevolence deals with the extent to which the individual in question is thought to be predisposed to act in ways that are advantageous for the trustors (mayer et al., 1995). in this case the trustors are the directors. in the case of the chief executive, benevolence is the extent to which the ceo is believed by the board to care about the board gilley et al. / journal of business strategies (2023) 40:1-20 5 members and their needs, which is likely to put the organization’s needs ahead of his or her own. mayer and colleagues note that, “benevolence is the extent to which a trustee is believed to want to do good to the trustor, aside from an egocentric profit motive” (mayer et al., 1995, p. 718). importantly, regarding the trustee’s belief that the ceo wants to do good, relationships the ceo develops with individual board members can be expected to affect the board’s perception of the ceo’s benevolence. finally, integrity concerns the extent to which “the trustee adheres to a set of principles that the trustor finds acceptable” (mayer et al., 1995, p. 719). in the context of the ceo-board relationship, the board should perceive the ceo to have integrity when s/he is thought to believe that his or her purpose is to maximize the value of the firm to its various stakeholders (including shareholders), and acts consistently to reflect this belief. thus, integrity deals with the ceo’s beliefs, as perceived by the board, about his or her role as a steward of the organization’s resources and constituents, while benevolence deals with the board’s perceptions of the ceo’s intentions to protect the board’s interests. in other words, in applying mayer et al. (1995) conceptualization of integrity to a ceo-board context, what is important to perceptions of integrity is what the ceo is thought to believe about his or her purpose in the organization and putting the organization’s needs first in strategic decisions, not whether he or she intends to take care of the board members’ interests (which would be regarded as benevolence). mayer et al. (1995) address the issue of profit-centricity as it relates to integrity when they note that, “the issue of acceptability precludes the argument that a party who is committed solely to the principle of profit seeking at all costs would be judged high in integrity (unless this principle is acceptable to the trustor)” (mayer et al., 1995, p. 719). given that financial performance maximization is an important principle to shareholders, it may be that ceos will be seen as having more integrity in the eyes of shareholder representatives on the board, in the mayer et al. (1995) conceptualization of “integrity as acceptability,” when they are profitcentric. of course, profit maximization may not be the only basis on which the ceo’s integrity is assessed. profit maximization represents an end state, and directors may care about the means for achieving end states as well. for example, in addition to the emphasis on profit maximization, a board might assess a ceo’s integrity on the basis of how he or she will accomplish profit maximization (i.e., honesty, fairness, etc.); moreover, it may place particular value in balancing the desire to make a profit for the shareholders with the needs of the employees, environment, and other stakeholders. given that non-shareholding stakeholders oftentimes have relatively little representation on boards (crucke & knockaert, 2016), and those types of directors appear to have only a minor effect on organization strategy (hillman et al., 2001), it may be that the most salient factors determining the board’s perception of the ceo’s integrity are those that affect his or her profitability philosophy. we acknowledge, however, that each board member will assess the integrity of the ceo relative to his and her own set of criteria, and these criteria may well differ based on such things as each member’s values and/or the type of role they play on the board (e.g., shareholder vs. non-shareholder). at the core of mayer et al. (1995) model is the idea that perceptions of an individual’s trustworthiness (ability, benevolence, and integrity) are the antecedents of the willingness to trust that person, as well as antecedents of actions that manifest that willingness (rtr). both on the basis of mayer et al. (1995) model and others, much organizational research is focused on what trust is, the effects of trustworthiness on trust and risk taking in relationship, and the consequences of trust and risk taking in a relationship. as for the latter, evidence has emerged that trust can have impacts on such things as individual attitudes and behavioral outcomes (dirks & ferrin, 2002) and on the performance of higher-level units, such as teams and organizations (davis et al., 2000; dirks, 2000). as such, it remains to be determined what specific factors affect a corporate board’s perceptions of the ceo’s trustworthiness, as well as how those perceptions affect corporate governance. what gilley et al. / journal of business strategies (2023) 40:1-20 6 figure 1: relationships among ceo characteristics, perceived ceo trustworthiness, and governancestructure is clear from prior research, however, is that an individual’s characteristics likely affect others’ beliefs in that person’s trustworthiness. with regard to the ceo-board relationship in particular, several ceo characteristics may be uniquely relevant. specifically, we suggest that ceo education, tenure, breadth of functional experience, external boardmemberships, and founderstatus affect the board’s perceptions of the ceo’s trustworthiness. below, we develop propositions specifically dealing with how these factors affect perceived ceo ability, benevolence, and integrity. the proposed relationships are shown in 1. 3. propositions ceo characteristics ceo education. we propose that educationrelated ceo characteristics play an important role in the board’s assessment of the ceo’s abilities and integrity. prior research has used several measures as indicators of top management ability, which we define here as the ceo’s expertise at effectively managing the firm and the decisions that affect it (finkelstein, 1992). prior research has shown a strong correlation between education and an individual’s abilities. becker (1993) argued that education contributes to increased abilities, and that these abilities provide value to organizations. moreover, prior work has shown education level to be related to corporate innovation and strategic change (westphal & zajac, 1995). thus, education level is a possible indicator of ceo ability in the view of the board. in addition, the prestige of the ceo’s alma mater may affect perceptions of his or her ability. chatterjee and pollock (2017) and miller and wiseman (2001) suggested that the university (or universities) attended by a ceo could be an important indicator of perceived ceo attributes. interestingly, the relationship between ceo education and middle manager perceptions of a ceo’s abilities found by miller and wiseman (2001) became stronger gilley et al. / journal of business strategies (2023) 40:1-20 7 when the analysis included tenure of middle management. the more seasoned these managers became, the more emphasis they placed on the importance of elite education. thus, it appears as though individuals with more experience highly value education in others, suggesting that a ceo’s education will be particularly salient to corporate directors, who generally have many years of experience. proposition 1. ceo education level and the prestige of the ceo’s alma mater(s) have a positive effect on board perceptions of ceo ability. it seems reasonable to assume that shareholders, who prefer the ceo to espouse financial performance maximization values as discussed earlier, will believe the ceo is higher in integrity when his or her educational background fits a particular profile. recall that integrity in the ceo context refers to the board’s perceptions of the ceo’s beliefs as to the importance of profit maximization. scholars have argued that individuals with business degrees, and especially those with advanced business degrees, tend to be viewed as possessing greater capacities for strategic decision making (westphal & zajac, 1995). these business school graduates may, in turn, tend to view organizational financial performance as more important than do non-business graduates. we suggest that corporate boards, which are generally dominated by shareholder representatives (hillman et al., 2001), will view ceos as having higher levels of integrity when they possess a degree in a business discipline, especially when the degree is at the graduate level. individuals with business degrees are more likely to be viewed by the board as understanding the “rules of the game” and we believe the board will believe the ceo is likely to lead the organization accordingly. in particular, the mba is seen by many as a hallmark of managerial knowledge. pfeffer and fong (2003) indicate that business-educated executives are valued and thus deemed important in the corporate world. therefore, ceos possessing business degrees should also be viewed by the board as being of greater ability because of the congruence between their educational background and the demands of their position. proposition 2. ceos with business degrees will be perceived by directors to be of greater integrity and ability. ceo tenure. a ceo’s tenure with the organization likely affects the board’s perception of the ceo’s abilities and benevolence. tenure has been widely used in ceo studies as a predictor or control variable, and it has been associated with executive succession (cannella & shen, 2001; chahine & zhang, 2020), compensation (hou et al., 2017), and firm performance (sigler & porterfield, 2001). we are aware of no examinations of the effects of ceo tenure on the board’s perceptions of his or her abilities and benevolence, but it is reasonable to assume that it plays a role. indeed, tenure has been used previously as a proxy for an executive’s human capital (carpenter et al., 2001; finkelstein & hambrick, 1996; geletkanycz et al., 2001; pennings et al., 1998). in addition, hurley et al. (1997) found that career advancement was positively affected by organizational tenure, suggesting that longer-tenured executives are viewed as increasingly competent. in part, this may be because asymmetries between agents and principals regarding their human capital will dissipate over time (quigley et al., 2019). clearly, executives with longer organizational tenures will have become increasingly familiar with the organization’s strategy, culture, competitors, and environment. with increasing organizational tenure, ceos build critical human and social capital that serve to increase their effectiveness, to the benefit of their organizations (pennings et al., 1998). one aspect of social capital that ceos may build with increasing tenure is related to their relationship with the board. specifically, more tenured ceos have had the opportunity to build deeper relationships with the directors, engendering trust and enhanced perceptions of ability, and allowing for heightened reciprocity and decision-making interdependence (cropanzano & mitchell, 2005). in addition, due to the expertise gained from tenure, seasoned ceos are “more reasonably” held accountable for their firms’ performance than are their younger tenured ceo counterparts (buchholtz et al., 1998). gilley et al. / journal of business strategies (2023) 40:1-20 8 moreover, as time passes, the increasing tenure of a ceo within a specific firm may lead to shifts in perceptions of the ceo’s ability, which in turn will affect the firm’s governance structure. thus, directors should view longer-tenured ceos having greater ability. proposition 3. ceo tenure has a positive effect on board perceptions of ceo ability. as noted earlier, in a ceo context, the benevolence component of trustworthiness deals with the extent to which the ceo has the board’s interests in mind when making strategic decisions. mayer et al. (1995) argue that of the three trustworthiness factors, benevolence takes longer to develop. it takes time for ceos to build social capital with their boards of directors (barkema & pennings, 1998), potentially leading the board to believe the ceo has the board’s interests in mind when making decisions. proposition 4. ceo tenure has a positive effect on board perceptions of ceo benevolence. ceo breadth of functional experience. both finkelstein (1992) and daily and johnson (1997) proposed that an important antecedent of expert power for ceos was functional area experience. as a ceo’s breadth of functional experiences increases, his or her understanding of the complex interrelationships among the organization’s diverse range of tasks is enhanced. this is suggested by hurley et al. (1997), who found that diversity of experience positively affected career advancement, implying that those making promotion decisions believe that breadth of experience within the firm may play a role in overall competence. as a result, ceos should be viewed as more able by the board when they have had a broader variety of functional experiences. proposition 5. breadth of functional experience hasapositiveeffectonboardperceptionsofceoability. ceo board memberhsip. another important factor in the board’s perceptions of a ceo’s trustworthiness is the ceo’s involvement on external forprofit company boards. by serving on boards of other organizations, ceos are likely to increase their human and social capital in ways that enhance their apparent abilities and their firm’s performance (geletkanycz et al., 2001; zhu et al., 2020). although a detailed discussion of the organizational benefits of a ceo’s external directorships is beyond the scope of the current paper, such ties help reduce uncertainty surrounding external resource dependencies (pfeffer & salancik, 1978), help increase the breadth of environmental scanning activities, and signal managerial andorganizationalqualitytoexternalconstituents (geletkanycz et al., 2001). as a result, we propose that a ceo’s external directorships will be perceived by the board to enhance the ceo’s ability to run the organization effectively. proposition 6. a ceo’s service on outside for-profit company boards has a positive effect on board perceptions of ceo ability. we also suggest that a ceo’s service on outside boards of for-profit firms will affect the board’s perceptions of the ceo’s integrity. recall that integrity includes perceptions of the ceo’s belief in his or her role as profit-seeker for the firm. ceos serving on outside for-profit boards are more likely to be perceived by their employing company’s directors to understand and identify with their concerns as directors about the firm’s financial performance. in addition, service on outside for-profit boards suggests a degree of social similarity between the ceo and those sitting on his or her company’s board, likely leading those directors to impute a congruence of values on issues of firm performance. as such, we believe that ceos sitting on outside for-profit boards will be viewed by their directors as having more integrity, to the extent that integrity in this context concerns profit-centricity on the part of the ceo. service on non-profit boards may signal ability, but may or may not suggest a commitment to profit centricity, and thus may not contribute to a perception of integrity. proposition 7. a ceo’s service on outside for-profit company boards has a positive effect on board perceptions of ceo integrity. gilley et al. / journal of business strategies (2023) 40:1-20 9 ceo founder status. the ceo’s status as founder of the organization is also likely to affect perceived ceo trustworthiness. we suggest that ceos who are founders of the firms they lead will likely be perceived as being of greater ability and benevolence (lee et al., 2020). regarding ability, founderceos play a key role in setting the firm’s initial direction, outlining objectives, and shepherding the organization in its earliest and most vulnerable days (gimeno et al., 1997; vesper, 1996). in addition, hendricks et al. (2019) argued that founderceos possess deep tacit knowledge of the firm and its operations, have strong relationships with both internal and external stakeholders, and are more strongly identified with and committed to the firm, thus mitigating agency concerns. jayaraman et al. (2000) found inconsistent results when exploring the firm performance effects of a founder-ceo’s continued leadership. nonetheless, the ceo’s abilities were clearly important to the firm’s success, especially given the variety of obstacles through which a founder-ceo must successfully lead his or her organization in the firm’s early years. nelson (2003) found that the stock market reacted more positively to founder ceoled firms than non-founder-led firms. more specifically, the fact that investors will pay a higher premium for founder ceo-led firms’ ipos is likely due to the perceived value of the competencies of the founder-led ceo. thus, we suggest that founderceos are more likely to be perceived by the board as having greater ability than non-founder ceos. proposition 8. founder-ceos will be perceived by the board as having greater ability than ceos who were not founders. the governance effects of ceo trustworthiness the board’s perception of the ceo’s trustworthiness is likely to have far reaching consequences for corporate governance. in general terms, a perceived lack of ceo trustworthiness should increase the board’s concern about agency costs. on the contrary, boards overseeing a ceo who is perceived to have ability, benevolence, and integrity will be less concerned about agency costs. as mayer et al. (1995) note, individuals are willing to put themselves at risk when the other party is perceived to be more trustworthy. in a governance context, high levels of perceived ceo trustworthiness would lead the board to incorporate relatively low levels of rigor in the firm’s governance structure. indeed, strickland (1958) suggests that low levels of trust in employees will increase managerial monitoring of their activities. in addition, del brio et al. (2013) found boards that perceive the ceo to be low in ability and integrity engage in higher levels of monitoring. as a result, we suggest that perceived ceo trustworthiness affects a board’s approach to governing, including setting ceo compensation mix, ceo/board chair duality, board size, and the number of outside directors on the board, all of which are indicators of the rigor of the firm’s governance. given that each of the three dimensions of trustworthiness are separable and can vary independently of one another (mayer et al., 1995), we theorize that ability, benevolence, and integrity may each have unique effects on governance structure. ceo compensation mix. with regard to compensation mix, agency theory (jensen & meckling, 1976) suggests that monitoring costs can be reduced by using compensation structure to align the interests of the ceo with those of the shareholders. in doing so, agency theory indicates that boards should adjust the mix of fixed and performance-contingent compensation such that executives are induced to engage in performancemaximizing behaviors (graffin et al., 2020; stroh et al., 1996). when the ceo’s compensation is heavily reliant on the firm’s meeting its performance targets, executives are discouraged from making ill-advised investments in self-serving strategic initiatives (baumol, 1967; kroll et al., 1990). consistent with agency theory, in cases where directors perceive the ceo to be particularly trustworthy, we suggest that the ceo’s compensation will be comprised of a significantly higher proportion of fixed compensation. we believe the opposite is also true; boards will increase the importance of contingent compensation (such as stock options and bonuses) in a ceo’s pay mix when he or she is perceived to be less trustworthy. we propose that the salient trustworthiness facgilley et al. / journal of business strategies (2023) 40:1-20 10 tors that affect compensation structure are perceived benevolence and integrity. given that abilities or competencies are developed over a lifetime of experiences, boards will recognize that pay structure does little to compensate for relatively lower levels of ceo ability; thus, boards will tend to use other governance mechanisms under conditions of lower perceived ceo ability. further, when boards have more representatives of non-shareholding stakeholders, they will be more likely to increase the importance of non-financial performance (such as environmental impact, employee job security and benefits, supplier relations, and so on) as a contingency for ceo compensation in the face of low levels of perceived benevolence and integrity. nevertheless, financial performance will be the primary contingency upon which less trustworthy ceos’ compensation will be based, given the relatively low representation on boards of stakeholder directors (hillman et al., 2001). proposition 9. ceos who are perceived to be higher on the dimensions of benevolence and integrity will have a lower percentage of contingent compensation. ceo/board chair duality. ceo/board chair duality is clearly suggestive of enhanced executive power and increased risk of self-serving behavior by the ceo. mallette and fowler (1992) found that firms with ceo duality were more likely to adopt a “poison pill” than firms with a separation between the ceo and board chairperson. zantout and o’reilly-allen (1996) found an association between ceo duality and corporate diversification. magnan et al. (1999) found that ceo duality was significantly and positively related to ceo compensation. harrison et al. (1988) found that ceo power leads to entrenchment. finally, hayward and hambrick (1997) found that firms with ceo duality paid greater takeover premiums during acquisitions than firms with separate ceo/chair positions. therefore, duality is generally believed to conveysignificantpowertotheceo.giventhatduality increases the ceo’s ability to force his or her will on the organization, we suggest that each of the three trustworthiness factors affect the likelihood of a board granting the ceo the dual title of board chair. when the chair position is separate from the ceo, board members choose either an outside director or a former executive as the chairperson. we argue that an externally selected chairperson would signal a concern regarding integrity or benevolence. the board wants to ensure that the executive chosen for this important strategic position comes from the outside to safeguard the interests of various stakeholders. on the other hand, a former executive appointment may signal a concern regarding the ceo’s ability, and with the invaluable experience of the former executive, such a team would bode well for effective strategic decision making. in addition to the titles of ceo and board chair, there are other titles frequently combined with ceo that may be indicative of structural power, such as president, chief operating officer, and so on (combs & skill, 2003). top executive with these additional titles of higher authority would have greater influence, since he or she would have much more discretion over critical knowledge and resources than a ceo without these added titles. the consolidation of various positions, which includes board chair, can provide a clear signal to investors that the strategic decision process will be less bureaucratic as well as provide the ceo with a “wide latitude on objectives” (krause et al., 2019, p. 1570). the board will effectively eliminate potential disagreements with key strategic decision makers such as the president. although the president could be viewed as someone who is being groomed for the top executive position, thus engendering teamwork among the executives, another perspective suggests that these positions could just as easily turn combative with the ceo (zhang, 2006). thus, ceos who are perceived by their boards to have ability, benevolence, and integrity will be more likely to hold the dual titles of ceo and board chair, because the board will view this centrality of decision making authority as beneficial to the pursuit of corporate initiatives. as well, boards may grant additional titles such as president to further structure efficient decision making. gilley et al. / journal of business strategies (2023) 40:1-20 11 proposition 10. ceos who are perceived by the board to be higher in ability, benevolence, and integrity are more likely to hold the position of board chairperson and/or president. board size and outsider representation. two factors related to the structure of the board itself may be affected by perceived ceo trustworthiness. these are the size of the board and the proportion of directors who are outsiders. directors are considered here to be outsiders when they have never been employed by the organization (jones & goldberg, 1982; judge & zeithaml, 1992). when directors perceive lower levels of ability, we suggest that they will increase the size of the board. directors clearly bring a variety of skills, social networks, and resource dependence benefits to the task of corporate governance (gnyawali & madhavan, 2001; pfeffer & salancik, 1978), and such skills and networks should prove more valuable in conditions of perceived low ceo ability. by increasing the number of directors, boards may add significant value to organizations with less capable ceos. perceptions of low benevolence and integrity should also lead to increases in board size, but for different reasons. board size is an important indicator of a firm’s passive or vigilant monitoring of the ceo and the other executives (wright et al., 2002). the larger the board, the more difficult it may be for the non-benevolent and/or lowintegrity ceo to pursue a dysfunctional agenda. prior research has suggested that such boards are regarded as most appropriate when there are concerns about agency costs (pearce & zahra, 1992). given that lower levels of perceived ceo benevolence and integrity will likely be viewed by the board of directors as leading to potentially greater agency costs, we would expect board size to be inversely related to perceived ceo benevolence and integrity. proposition 11. perceptions of low levels of ceo ability, benevolence, and integrity will positively affect board size. regarding outsider representation, outsiderdominated boards are more apt to challenge strategic choices that are not conducive to superior firm performance. hill and snell (1988) found that the ratio of outside board members to total board members was positively associated with board involvement in restructuring. evidence suggests that a greater proportion of outsiders on the board is associated with an increased likelihood that the board will replace the ceo after a period of poor corporate performance (coughlan & schmidt, 1985; newman & mozes, 1999; weisbach, 1988). both types of board members (outsiders and insiders) have a duty to ensure that strategies pursued are in the best interest of the shareholders (j. l. johnson et al., 1996). yet, an inside director may feel indebted to the ceo because of his or her employment history with the ceo, and may perceive more benevolence from the ceo based on this existing relationship. therefore, while inside directors will have more knowledge of the daily operations, they will also be less likely to challenge the ceo or other executives on important strategic issues (r. a. johnson et al., 1993). outside board members, however, are not as beholden to the ceo. moreover, these board members are not involved in the daily operations of the company and will not have to deal with the uneasiness of working closely with a ceo with whom they may disagree. also, outside directors may have the added incentive of maintaining their own reputations as directors and avoiding the risks of negative publicity for duties poorly performed (fama & jensen, 1983). firms with outside, more independent boards will be more vigilant in monitoring the ceo, which is particularly important when the ceo is perceived to be low on some combination of integrity, ability, and benevolence. however, where the ceo is perceived to be higher on those dimensions, fewer outsiders will be needed to monitor the ceo, because the board will perceive the ceo to be less of a risk with regard to agency costs. hillman et al. (2000) argue that outside board members serve in three important capacities: business experts, support specialists, and community influentials. business experts impart skills in problem solving and decision making. support specialists provide legitimacy and access to vital gilley et al. / journal of business strategies (2023) 40:1-20 12 resources. community influentials represent nonbusiness perspectives such as outside interests. ceo trustworthiness in these capacities would help determine the type of outside representation boards would seek. for example, boards may want business experts and support specialists if the ceo’s abilities are in question. proposition 12. perceptions of low levels of ceo ability, benevolence, and integrity will positively affect outsider representation on the board. 4. board perceptions of ceo trustworthiness: individual assessments and group decisions. our model, as developed above, suggests that board members will make judgments about the perceived trustworthiness of ceos based on a variety of ceo characteristics. we go on to suggest that it is the board’s perceptions of the ceo’s trustworthiness that will, in turn, directly influence the degree to which the board imposes or lifts constraints on the ceo through the choices the board makes with regard to governance structure. while we acknowledged that different board members may have different perceptions of the ceo’s trustworthiness, what becomes apparent is that, in working toward governance structure decisions, the individuals comprising the board and its decision-making committees must act in unity. given that perceptions of trustworthiness originate within individual board members, the question that arises is how the board arrives at a shared perception on which to act. the effects of trustworthiness perceptions on governance structure decisions represent what currall and inkpen (2002) referred to as a group → person trust situation in their taxonomy of trust in international joint ventures. this group → person label is appropriate for our theorizing in that our context depicts the degree to which a group (the board of directors or a committee thereof) perceivesanindividual (theceo)tobetrustworthy or not. how the board uses the perceptions of its individual members to arrive at governance structure decisions will largely be a function of each board and its established procedures and norms. at one extreme would be the situation in which the board as a whole, or various subcommittees, makes decisions by consensus. here, each board member would need to perceive the ceo to be relatively trustworthy before there would be a decision to remove constraints on the ceo. said another way, the board members would need to share perceptions of ceo trustworthiness. at the other extreme would be a situation in which one of the board members plays a dominant role on the board (or a committee thereof) and other members defer to him or her. this could occur for a variety of reasons, including the rest of the board viewing the dominant member as trustworthy himor herself, and allowing themselves to be vulnerable to him or her. in any event, under such a scenario, the trust relationship boils down to a dyadic phenomenon, or what currall and inkpen (2002) labeled a person → person situation. here, the amount of latitude the ceo is given in the governance structure will largely be a function of not how the board (or a committee) as a collective perceives his or her trustworthiness, but how the dominant individual views it. of course, between these two extremes lie various scenarios in which subsets of the board drive the decision (e.g., majority rules voting patterns and the like). in such cases, the key issue would be the extent to which the majority views the ceo as trustworthy and essentially shares in those judgments. however, this goes beyond the focus of the current paper. we raise these issues here to acknowledge that perceptions of trustworthiness about the ceo are made by individual board members but they oftentimes will be acted upon by the group of board members collectively (either the entire board or a board committee). 5. discussion and conclusions this paper has attempted to link individual ceo characteristics with governance structure by discussing the intervening variable of trustworthiness. in particular, we have suggested that ceos’ education, tenure, functional experience, board membership, and founder status affect the board’s perceptions of the ceo’s trustworthiness. these trustworthiness perceptions will lead the gilley et al. / journal of business strategies (2023) 40:1-20 13 board to exhibit varying levels of trust in their ceos as evidenced in their decisions regarding governance structure. this has important implications for both research and practice. implications for research agency theory and stewardship theory provide alternate theoretical lenses through which the antecedents and outcomes of ceo trustworthiness may be viewed. agency theory suggests that ceos are rational actors concerned with maximizing their own rewards (jensen & meckling, 1976). stewardship theory, by contrast, suggests that ceos will behave in ways that benefit the firm, oftentimes to their own personal detriment (davis et al., 1997; donaldson & davis, 1991). our model suggests that both of these two competing theories may explain governance conditions within the firm quite well, but that the extent to which each apparently explains governance within a firm depends on the underlying trustworthiness of the firm’s top executive. in other words, whether researchers find support for agency theory or stewardship theory in their empirical studies of compensation and governance structure may hinge on trustworthiness, which until now has not been explored as an antecedent of governance. under conditions of high ceo trustworthiness, one would expect the predictions of stewardship theory to hold. those ceos who are characterized by high levels of trustworthiness are given greater authority within their firms to affect organizational outcomes. thus, we would expect greater incidence of duality, higher levels of fixed compensation, fewer outsiders on the board, and a smaller board overall. by contrast, under conditions of low ceo trustworthiness, agency theory should have the most predictive ability in empirical studies dealing with governance and compensation. there are several avenues for future research that may yield theoretical, empirical, and practitioneroriented benefits. first, empirical research on the factors that drive ceo trustworthiness perceptions (and the resulting governance effects) by boards of directors would add richness to the growing body of literature on trust and trustworthiness. such research would extend both theory and empirics. with regard to empirical contributions, scholars would have to determine the appropriate methods for modeling the way(s) in which boards as a group come to make decisions based on individual trustworthiness perceptions. once this was demonstrated empirically, say, by assessing within-board agreement (using, for example, the rwg index of james et al., 1984, 1993) on perceptions of ceo trustworthiness or by assessing the interrater reliability (using, for example, the icc(1) or icc(2) – see bliese, 2000) of perceptions of ceo trustworthiness, the board’s shared perception could be represented by an aggregate of the individual board members’ perceptions of ceo trustworthiness. this is similar to what davis et al. (2000) did when they aggregated employee perceptions of trust in the store manager and related these scores to store performance (though they were not representing the aggregation as a group-level phenomenon). however, doing this empirically in a governance context (i.e., with boards and ceos) would perhaps prove to be particularly challenging. second, future empirical research on the topic may indeed shed light, as we suggest above, on the relative explanatory power of agency theory versus stewardship theory. given the difficulties that prior researchers have had in, for instance, explaining variance in executive compensation, empirical tests employing a trustworthiness approach may be particularly useful in extending the significant body of research on compensation. third, empirical research on ceo trustworthiness perceptions and governance structure/conditions may extend research on trustworthiness by potentially demonstrating the generalizability of the mayer et al. (1995) framework. although this framework has been widely employed, little, if any, of this work has been done with samples of top executives and boards of directors. fourth, research on ceo trustworthiness may include not only observable, objective characteristics but also attitudinal and psychological states. our paper focuses on objective measures; however, the impression created by the ceo’s actions and mannerisms surely provide predictive ability in determining the perceived abilities, benevogilley et al. / journal of business strategies (2023) 40:1-20 14 lence and/or integrity of the ceo. fifth, research could explore more complex relationships among the constructs of interest. consider, for example, nonlinear relationships. the human capital literature generally supports the positive relationship between ceos’ experience and tenure and more favorable perceptions of their ability. in contrast, hildebrand et al. (2020) found that ceos with less prior experience were more likely to have a long-term orientation as well as a more balanced focus between profitability and revenue growth, resulting in higher firm performance. also, studies could explore the interaction effects of, say, ceo board memberships and founder status on ability. ceos who are founders and who sit on multiple for-profit boards may benefit from significantly higher board perceptions of ability because of the associated enhanced credibility and human capital that they would enjoy. finally, governance structure is dynamic across time within organizations, and it clearly varies across organizations. future researchers may wish to consider the frequency and severity of changes in governance (such as changes to the size of the board, the percentage/number of independent directors, duality, and more), and how those changes are driven by perceptions of ceo trustworthiness. in addition, future research may wish to explore the extent to which boards of directors seek out new ceos who fit their governance framework using perceptions of ceo trustworthiness as their indicators of fit. we must be careful to point out that the antecedents of a board’s perception of the ceo’s trustworthiness are surely multifaceted, complex, and difficult to assess/measure. as a result, an important limitation of our paper is that there are likely to be numerous confounding effects that should be controlled for in empirical studies on this topic, such as the financial and operating performance of the firm, among others. given the complex, dynamic, and multifaceted nature of the research questions associated with the relationship between ceo trustworthiness and corporate governance, we propose that much insight can be gained via research methods that employ small sample, intensive studies. as suggested by harrigan (1983, pp. 398–399), "fine grained treatments of strategy benefit from their attention to important details that help researchers characterize the complexities of strategy formulation...(and) can include meticulous attentions to detail, relevance to business practice, and access to multiple viewpoints." such efforts can yield new insights as well as lead to inductive theory building which is invaluable given that research is, of course, a continual process of rediscovery. implications for governance practice our theoretical model implies that corporate governance structure varies across firms, and that this variance hinges on the trustworthiness of the ceo. firms employing ceos who are high on ability, benevolence, and integrity may find that their boards create less value, and that compensation structure is unrelated to subsequent organizational performance (because the ceo would “do the right thing” regardless of pay-related effects). as noted by zahra and pearce (1989), boards perform three primary functions, namely, control, strategy, and service. the control role would be most valuable in situations where the ceo is low in integrity or benevolence. in such cases, the board will engage in both monitoring and incentive alignment such that ceos who have low integrity and/or benevolence are forced to engage in behaviors that are beneficial to the firm, thus minimizing agency costs. however, incurring costs associated with monitoring and incentive alignment is less necessary under conditions of high ceo benevolence and integrity. in addition, the strategy role played by boards is less necessary under conditions of high ceo ability, because highly competent ceos should have the knowledge, skills and abilities to lead the company strategically. finally, the service role of boards of directors may be unaffected by ceo trustworthiness, because much of the service role of boards of directors has little to do with the characteristics of the ceo since those are responsibilities of the board rather than of the ceo. the above discussion is not meant to suggest that boards are irrelevant under conditions of high ceo trustworthiness. clearly, their social and hugilley et al. / journal of business strategies (2023) 40:1-20 15 man capital may still be of value. however, we suggest that corporate governance, and specifically the board of directors, may be viewed as a means for helping low-ability ceos with leadership and strategy issues, and ensuring that ceos with relatively low integrity (in the sense of profit-centricity motives) or benevolence pursue goals preferred by key stakeholders, particularly the board and, by extension, the shareholders. in summary, our model suggests that characteristics of ceos affect the board’s perception of their trustworthiness. these perceptions manifest themselves in risk-taking by the board, specifically in terms of how the board is structured (insiders versus outsiders, number of directors, and ceo/board chair duality), which affects the board’s monitoring function, and how the ceo is compensated (the mix of fixed and performancecontingent pay), which affects incentive alignment. while a great deal of prior research has explored governance, ceo compensation, and trust/trustworthiness, we believe our model provides the first integration of these important topics. accordingly, we contend that research in this vein holds promise for the development of both descriptive and normative theory. references argyris, c. (1994). in s. b. sitkin & r. j. bies (eds.), the legalistic organization. sage. barkema, h. g., & pennings, j. m. (1998). top management pay: impact of overt and covert power. organization studies, 19(6), 975–1003. https://doi.org/10.1177/017084069801900604 barney, j. b. (2018). why resource-based theory’s model of profit appropriation must incorporate a stakeholder perspective. strategic management journal, 39(13), 3305–3325. https://doi.org/10. 1002/smj.2949 baumol, w. j. (1967). business behavior, value and growth [oclc: 228091451]. harcourt brace. becker, g. s. (1993). human capital: a theoretical and empirical analysis, with special reference to education (3rd ed). the university of chicago press. bigley, g. a., & pearce, j. l. (1998). straining for shared meaning in organization science: problems of trust and distrust. the academy of management review, 23(3), 405. https://doi.org/10.2307/ 259286 bliese, p. (2000). in k. j. klein & s. w. kozlowski (eds.), multilevel theory, research, and methods in organizations: foundations, extensions, and new directions. (pp. 349–381). josseybass, inc. bosse, d. a., & phillips, r. a. (2016). agency theory and bounded self-interest. academy of management review, 41(2), 276–297. https://doi.org/10.5465/amr.2013.0420 buchholtz, a. k., young, m. n., & powell, g. n. (1998). are board members pawns or watchdogs?: the link between ceo pay and firm performance. group & organization management, 23(1), 6–26. https://doi.org/10.1177/1059601198231002 cannella, a. a., & shen, w. (2001). so close and yet so far: promotion versus exit for ceo heirs apparent. academy of management journal, 44(2), 252–270. https://doi.org/10.2307/3069454 carpenter, m. a., sanders, w. g., & gregersen, h. b. (2001). bundling human capital with organizational context: the impact of international assignment experience on multinational firm performance and ceo pay. academy of management journal, 44(3), 493–511. https://doi.org/10.5465/3069366 chahine, s., & zhang, y. ( (2020). change gears before speeding up: the roles of chief executive officer human capital and venture capitalist monitoring in chief executive officer change before initial public offering. strategic management journal, 41(9), 1653–1681. https://doi.org/10.1002/smj. 3197 chatterjee, a., & pollock, t. g. (2017). master of puppets: how narcissistic ceos construct their professional worlds. academy of management review, 42(4), 703–725. https://doi.org/10.5465/amr. 2015.0224 https://doi.org/10.1177/017084069801900604 https://doi.org/10.1002/smj.2949 https://doi.org/10.1002/smj.2949 https://doi.org/10.2307/259286 https://doi.org/10.2307/259286 https://doi.org/10.5465/amr.2013.0420 https://doi.org/10.1177/1059601198231002 https://doi.org/10.2307/3069454 https://doi.org/10.5465/3069366 https://doi.org/10.1002/smj.3197 https://doi.org/10.1002/smj.3197 https://doi.org/10.5465/amr.2015.0224 https://doi.org/10.5465/amr.2015.0224 gilley et al. / journal of business strategies (2023) 40:1-20 16 chrisman,j. j. (2019).stewardshiptheory:realism,relevance,andfamilyfirmgovernance.entrepreneurship theory and practice, 43(6), 1051–1066. https://doi.org/10.1177/1042258719838472 combs, j. g., & skill, m. s. (2003). managerialist and human capital explanations for key executive pay premiums: a contingency perspective. academy of management journal, 46(1), 63–73. https:// doi.org/10.2307/30040676 coughlan, a. t., & schmidt, r. m. (1985). executive compensation, management turnover, and firm performance. journal of accounting and economics, 7(1-3), 43–66. https://doi.org/10.1016/01654101(85)90027-8 cropanzano, r., & mitchell, m. s. (2005). social exchange theory: an interdisciplinary review. journal of management, 31(6), 874–900. https://doi.org/10.1177/0149206305279602 crucke, s., & knockaert, m. (2016). when stakeholder representation leads to faultlines. a study of board service performance in social enterprises: faultlines and board service performance. journal of management studies, 53(5), 768–793. https://doi.org/10.1111/joms.12197 currall, s. c., & inkpen, a. c. (2002). a multilevel approach to trust in joint ventures. journal of international business studies, 33(3), 479–495. https://doi.org/10.1057/palgrave.jibs.8491027 daily, c. m., & johnson, j. l. (1997). sources of ceo power and firm financial performance: a longitudinal assessment. journalofmanagement,23(2),97–117.https://doi.org/10.1177/014920639702300201 daily, c. m., & schwenk, c. (1996). chief executive officers, top management teams, and boards of directors: congruent or countervailing forces. journal of management, 22(2), 185–208. https: //doi.org/10.1177/014920639602200201 davis, j. h., schoorman, f. d., & donaldson, l. (1997). toward a stewardship theory of management. the academy of management review, 22(1), 20. https://doi.org/10.2307/259223 davis, j. h., schoorman, f. d., mayer, r. c., & tan, h. h. (2000). the trusted general manager and business unit performance: empirical evidence of a competitive advantage. strategic management journal, 21(5), 563–576. https://doi.org/10.1002/(sici)1097-0266(200005)21:5<563::aidsmj99>3.0.co;2-0 del brio, e. b., yoshikawa, t., connelly, c. e., & tan, w. l. (2013). the effects of ceo trustworthiness on directors’ monitoring and resource provision. journal of business ethics, 118(1), 155–169. https: //doi.org/10.1007/s10551-012-1575-0 dirks, k. t. (2000). trust in leadership and team performance: evidence from ncaa basketball. journal of applied psychology, 85(6), 1004–1012. https://doi.org/10.1037/0021-9010.85.6.1004 dirks, k. t., & ferrin, d. l. (2002). trust in leadership: meta-analytic findings and implications for research and practice. journal of applied psychology, 87(4), 611–628. https://doi.org/10.1037/00219010.87.4.611 donaldson, l., & davis, j. h. (1991). stewardship theory or agency theory: ceo governance and shareholder returns. australian journal of management, 16(1), 49–64. https : / / doi . org / 10 . 1177 / 031289629101600103 eisenhardt, k. m. (1989). agency theory: an assessment and review. the academy of management review, 14(1), 57. https://doi.org/10.2307/258191 fama, e. f., & jensen, m. c. (1983). separation of ownership and control. the journal of law and economics, 26(2), 301–325. https://doi.org/10.1086/467037 finkelstein, s. (1992). power in top management teams: dimensions, measurement, and validation. academy of management journal, 35(3), 505–538. https://doi.org/10.5465/256485 finkelstein, s., & hambrick, d. c. (1996). strategic leadership: top executives and their effects on organizations. west pub. co. https://doi.org/10.1177/1042258719838472 https://doi.org/10.2307/30040676 https://doi.org/10.2307/30040676 https://doi.org/10.1016/0165-4101(85)90027-8 https://doi.org/10.1016/0165-4101(85)90027-8 https://doi.org/10.1177/0149206305279602 https://doi.org/10.1111/joms.12197 https://doi.org/10.1057/palgrave.jibs.8491027 https://doi.org/10.1177/014920639702300201 https://doi.org/10.1177/014920639602200201 https://doi.org/10.1177/014920639602200201 https://doi.org/10.2307/259223 https://doi.org/10.1002/(sici)1097-0266(200005)21:5<563::aid-smj99>3.0.co;2-0 https://doi.org/10.1002/(sici)1097-0266(200005)21:5<563::aid-smj99>3.0.co;2-0 https://doi.org/10.1007/s10551-012-1575-0 https://doi.org/10.1007/s10551-012-1575-0 https://doi.org/10.1037/0021-9010.85.6.1004 https://doi.org/10.1037/0021-9010.87.4.611 https://doi.org/10.1037/0021-9010.87.4.611 https://doi.org/10.1177/031289629101600103 https://doi.org/10.1177/031289629101600103 https://doi.org/10.2307/258191 https://doi.org/10.1086/467037 https://doi.org/10.5465/256485 gilley et al. / journal of business strategies (2023) 40:1-20 17 geletkanycz, m. a., boyd, b. k., & finkelstein, s. (2001). the strategic value of ceo external directorate networks: implications for ceo compensation. strategic management journal, 22(9), 889–898. https://doi.org/10.1002/smj.172 gimeno, j., folta, t. b., cooper, a. c., & woo, c. y. (1997). survival of the fittest? entrepreneurial human capital and the persistence of underperforming firms. administrative science quarterly, 42(4), 750. https://doi.org/10.2307/2393656 gnyawali, d. r., & madhavan, r. (2001). cooperative networks and competitive dynamics: a structural embeddedness perspective. the academy of management review, 26(3), 431. https://doi.org/10. 2307/259186 graffin, s. d., hubbard, t. d., christensen, d. m., & lee, e. y. (2020). the influence of ceo risk tolerance on initial pay packages. strategic management journal, 41(4), 788–811. https://doi.org/10.1002/ smj.3112 harrigan, k. r. (1983). research methodologies for contingency approaches to business strategy. the academy of management review, 8(3), 398. https://doi.org/10.2307/257828 harrison, j. r. (1987). the strategic use of corporate board committees. california management review, 30(1), 109–125. https://doi.org/10.2307/41165269 harrison, j. r., torres, d. l., & kukalis, s. (1988). the changing of the guard: turnover and structural change in the top-management positions. administrative science quarterly, 33(2), 211. https: //doi.org/10.2307/2393056 hayward, m. l. a., & hambrick, d. c. (1997). explaining the premiums paid for large acquisitions: evidence of ceo hubris. administrative science quarterly, 42(1), 103. https://doi.org/10.2307/ 2393810 hendricks,b.,howell,t.,&bingham,c.(2019).howmuchdotopmanagementteamsmatterinfounderled firms? strategic management journal, 40(6), 959–986. https://doi.org/10.1002/smj.3006 hernandez, m. (2012). toward an understanding of the psychology of stewardship. academy of management review, 37(2), 172–193. https://doi.org/10.5465/amr.2010.0363 hildebrand, c., anterasian, c., & brugg, j. (2020). predicting ceo success: when potential outperforms experience. hill, c. w. l., & jones, t. m. (1992). stakeholder-agency theory. journal of management studies, 29(2), 131–154. https://doi.org/10.1111/j.1467-6486.1992.tb00657.x hill, c. w. l., & snell, s. a. (1988). external control, corporate strategy, and firm performance in researchintensive industries. strategic management journal, 9(6), 577–590. https://doi.org/10.1002/smj. 4250090605 hillman, a. j., cannella, a. a., & paetzold, r. l. (2000). the resource dependence role of corporate directors: strategic adaptation of board composition in response to environmental change. journal of management studies, 37(2), 235–256. https://doi.org/10.1111/1467-6486.00179 hillman, a. j., keim, g. d., & luce, r. a. (2001). board composition and stakeholder performance: do stakeholder directors make a difference? business & society, 40(3), 295–314. https://doi.org/10. 1177/000765030104000304 hoppmann, j., naegele, f., & girod, b. (2019). boards as a source of inertia: examining the internal challenges and dynamics of boards of directors in times of environmental discontinuities. academy of management journal, 62(2), 437–468. https://doi.org/10.5465/amj.2016.1091 hou, w., priem, r. l., & goranova, m. (2017). does one size fit all? investigating pay–future performance relationships over the “seasons” of ceo tenure. journal of management, 43(3), 864–891. https: //doi.org/10.1177/0149206314544744 https://doi.org/10.1002/smj.172 https://doi.org/10.2307/2393656 https://doi.org/10.2307/259186 https://doi.org/10.2307/259186 https://doi.org/10.1002/smj.3112 https://doi.org/10.1002/smj.3112 https://doi.org/10.2307/257828 https://doi.org/10.2307/41165269 https://doi.org/10.2307/2393056 https://doi.org/10.2307/2393056 https://doi.org/10.2307/2393810 https://doi.org/10.2307/2393810 https://doi.org/10.1002/smj.3006 https://doi.org/10.5465/amr.2010.0363 https://doi.org/10.1111/j.1467-6486.1992.tb00657.x https://doi.org/10.1002/smj.4250090605 https://doi.org/10.1002/smj.4250090605 https://doi.org/10.1111/1467-6486.00179 https://doi.org/10.1177/000765030104000304 https://doi.org/10.1177/000765030104000304 https://doi.org/10.5465/amj.2016.1091 https://doi.org/10.1177/0149206314544744 https://doi.org/10.1177/0149206314544744 gilley et al. / journal of business strategies (2023) 40:1-20 18 hurley, a. e., fagenson-eland, e. a., & sonnenfeld, j. a. (1997). does cream always rise to the top? an investigation of career attainment determinants. organizational dynamics, 26(2), 65–71. https: //doi.org/10.1016/s0090-2616(97)90006-1 james, l. r., demaree, r. g., & wolf, g. (1984). estimating within-group interrater reliability with and without response bias. journal of applied psychology, 69(1), 85–98. https://doi.org/10.1037/00219010.69.1.85 james, l. r., demaree, r. g., & wolf, g. (1993). rwg: an assessment of within-group interrater agreement. journal of applied psychology, 78(2), 306–309. https://doi.org/10.1037/0021-9010.78.2. 306 jayaraman, n., khorana, a., nelling, e., & covin, j. (2000). ceo founder status and firm financial performance. strategic management journal, 21(12), 1215–1224. https://doi.org/10.1002/10970266(200012)21:12<1215::aid-smj146>3.0.co;2-0 jensen, m. c., & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3(4), 305–360. https://doi.org/10.1016/ 0304-405x(76)90026-x johnson, j. l., daily, c. m., & ellstrand, a. e. (1996). boards of directors: a review and research agenda. journal of management, 22(3), 409–438. https://doi.org/10.1177/014920639602200303 johnson, r. a., hoskisson, r. e., & hitt, m. a. (1993). board of director involvement in restructuring: the effects of board versus managerial controls and characteristics. strategic management journal, 14(s1), 33–50. https://doi.org/10.1002/smj.4250140905 jones, t. m., & goldberg, l. d. (1982). governing the large corporation: more arguments for public directors. the academy of management review, 7(4), 603. https://doi.org/10.2307/257227 joseph, j., ocasio, w., & mcdonnell, m.-h. (2014). the structural elaboration of board independence: executive power, institutional logics, and the adoption of ceo-only board structures in u.s. corporate governance. academy of management journal, 57(6), 1834–1858. https://doi.org/10. 5465/amj.2012.0253 judge, w. q., & zeithaml, c. p. (1992). institutional and strategic choice perspectives on board involvement in the strategic decision process. academy of management journal, 35(4), 766–794. https: //doi.org/10.5465/256315 krause, r., li, w., ma, x., & bruton, g. d. (2019). the board chair effect across countries: an institutional view. strategic management journal, 40(10), 1570–1592. https://doi.org/10.1002/smj.3057 krause, r., withers, m. c., & semadeni, m. (2017). compromise on the board: investigating the antecedents and consequences of lead independent director appointment. academy of management journal, 60(6), 2239–2265. https://doi.org/10.5465/amj.2015.0852 kroll, m., simmons, s. a., & wright, p. (1990). determinants of chief executive officer compensation following major acquisitions. journal of business research, 20(4), 349–366. https://doi.org/10. 1016/0148-2963(90)90011-2 lee, j. m., yoon, d., & boivie, s. (2020). founder ceo succession: the role of ceo organizational identification. academy of management journal, 63(1), 224–245. https://doi.org/10.5465/amj.2017.0091 lewicki, r. j., & bunker, b. b. (1996). developing and maintaining trust in work relationships. in trust in organizations: frontiers of theory and research (pp. 114–139). sage publications, inc. https: //doi.org/10.4135/9781452243610 luoma, p., & goodstein, j. (1999). research notes. stakeholders and corporate boards: institutional influences on board composition and structure. academy of management journal, 42(5), 553– 563. https://doi.org/10.2307/256976 https://doi.org/10.1016/s0090-2616(97)90006-1 https://doi.org/10.1016/s0090-2616(97)90006-1 https://doi.org/10.1037/0021-9010.69.1.85 https://doi.org/10.1037/0021-9010.69.1.85 https://doi.org/10.1037/0021-9010.78.2.306 https://doi.org/10.1037/0021-9010.78.2.306 https://doi.org/10.1002/1097-0266(200012)21:12<1215::aid-smj146>3.0.co;2-0 https://doi.org/10.1002/1097-0266(200012)21:12<1215::aid-smj146>3.0.co;2-0 https://doi.org/10.1016/0304-405x(76)90026-x https://doi.org/10.1016/0304-405x(76)90026-x https://doi.org/10.1177/014920639602200303 https://doi.org/10.1002/smj.4250140905 https://doi.org/10.2307/257227 https://doi.org/10.5465/amj.2012.0253 https://doi.org/10.5465/amj.2012.0253 https://doi.org/10.5465/256315 https://doi.org/10.5465/256315 https://doi.org/10.1002/smj.3057 https://doi.org/10.5465/amj.2015.0852 https://doi.org/10.1016/0148-2963(90)90011-2 https://doi.org/10.1016/0148-2963(90)90011-2 https://doi.org/10.5465/amj.2017.0091 https://doi.org/10.4135/9781452243610 https://doi.org/10.4135/9781452243610 https://doi.org/10.2307/256976 gilley et al. / journal of business strategies (2023) 40:1-20 19 magnan, m., st-onge, s., & calloc’h, y. (1999). feature editorial-governance-power games: when it comes to s ceo’s compensation and performance, who holds the balance of the board? nothing less than good corporate governance is at stake. ivey business journal, 63(3), 38–43. mallette, p., & fowler, k. l. (1992). effects of board composition and stock ownership on the adoption of “poison pills”. academy of management journal, 35(5), 1010–1035. https://doi.org/10.5465/ 256538 mayer, r. c., davis, j. h., & schoorman, f. d. (1995). an integrative model of organizational trust. the academy of management review, 20(3), 709. https://doi.org/10.2307/258792 mcallister, d. j. (1995). affectand cognition-based trust as foundations for interpersonal cooperation in organizations. academy of management journal, 38(1), 24–59. https://doi.org/10.2307/256727 miller, j. s., & wiseman, r. m. (2001). perceptions of executive pay: does pay enhance a leader’s aura?: perceptions of executive pay. journal of organizational behavior, 22(6), 703–711. https://doi.org/ 10.1002/job.110 nelson, t. (2003). the persistence of founder influence: management, ownership, and performance effects at initial public offering. strategic management journal, 24(8), 707–724. https://doi.org/ 10.1002/smj.328 newman, h. a., & mozes, h. a. (1999). does the composition of the compensation committee influence ceo compensation practices? financial management, 28(3), 41. https://doi.org/10.2307/ 3666182 pearce, j. a., & zahra, s. a. (1992). board composition from a strategic contingency perspective. journal of management studies, 29(4), 411–438. https://doi.org/10.1111/j.1467-6486.1992.tb00672.x pennings, j. m., lee, k., & witteloostuijn, a. v. (1998). human capital, social capital, and firm dissolution. academy of management journal, 41(4), 425–440. https://doi.org/10.5465/257082 pfeffer, j., & fong, c. t. (2003). assessing business schools: reply to connolly. academy of management learning & education, 2(4), 368–370. https://doi.org/10.5465/amle.2003.11901962 pfeffer, j., & salancik, g. r. (1978). the external control of organizations: a resource dependence perspective. harper & row. quigley, t. j., hambrick, d. c., misangyi, v. f., & rizzi, g. a. (2019). ceo selection as risk-taking: a new vantage on the debate about the consequences of insiders versus outsiders. strategic management journal, 40(9), 1453–1470. https://doi.org/10.1002/smj.3033 rousseau, d. m., sitkin, s. b., burt, r. s., & camerer, c. (1998). not so different after all: a cross-discipline viewoftrust. academyofmanagementreview, 23(3),393–404. https://doi.org/10.5465/amr.1998. 926617 sigler, k. j., & porterfield, r. (2001). ceo compensation: its link to bank performance. american business review, 19(2), 110. sitkin,s.b.,&roth,n.l. (1993).explainingthelimitedeffectivenessoflegalistic“remedies”fortrust/distrust. organization science, 4(3), 367–392. https://doi.org/10.1287/orsc.4.3.367 strickland, l. h. (1958). surveillance and trust1. journal of personality, 26(2), 200–215. https://doi.org/ 10.1111/j.1467-6494.1958.tb01580.x stroh, l. k., brett, j. m., baumann, j. p., & reilly, a. h. (1996). agency theory and variable pay compensation strategies. academy of management journal, 39(3), 751–767. https://doi.org/10.5465/ 256663 vesper, k. h. (1996). new venture experience: entrepreneurship, text, exercises, cases (rev. ed., 2. print). vector books. weisbach, m. s. (1988). outside directors and ceo turnover. journal of financial economics, 20, 431–460. https://doi.org/10.1016/0304-405x(88)90053-0 https://doi.org/10.5465/256538 https://doi.org/10.5465/256538 https://doi.org/10.2307/258792 https://doi.org/10.2307/256727 https://doi.org/10.1002/job.110 https://doi.org/10.1002/job.110 https://doi.org/10.1002/smj.328 https://doi.org/10.1002/smj.328 https://doi.org/10.2307/3666182 https://doi.org/10.2307/3666182 https://doi.org/10.1111/j.1467-6486.1992.tb00672.x https://doi.org/10.5465/257082 https://doi.org/10.5465/amle.2003.11901962 https://doi.org/10.1002/smj.3033 https://doi.org/10.5465/amr.1998.926617 https://doi.org/10.5465/amr.1998.926617 https://doi.org/10.1287/orsc.4.3.367 https://doi.org/10.1111/j.1467-6494.1958.tb01580.x https://doi.org/10.1111/j.1467-6494.1958.tb01580.x https://doi.org/10.5465/256663 https://doi.org/10.5465/256663 https://doi.org/10.1016/0304-405x(88)90053-0 gilley et al. / journal of business strategies (2023) 40:1-20 20 westphal, j. d., & zajac, e. j. (1995). who shall govern? ceo/board power, demographic similarity, and new director selection. administrative science quarterly, 40(1), 60. https://doi.org/10.2307/ 2393700 wright, p., kroll, m., & elenkov, d. (2002). acquisition returns, increase in firm size, and chief executive officer compensation: the moderating role of monitoring. academy of management journal, 45(3), 599–608. https://doi.org/10.5465/3069384 zahra, s. a., & pearce, j. a. (1989). boards of directors and corporate financial performance: a review and integrative model. journal of management, 15(2), 291–334. https://doi.org/10.1177/ 014920638901500208 zantout, z. z., & o’reilly-allen, m. (1996). determinants of corporate strategy and gains of acquiring firms. journal of accounting, auditing & finance, 11(1), 119–129. https : / / doi . org / 10 . 1177 / 0148558x9601100105 zhang, y. (2006). the presence of a separate coo/president and its impact on strategic change and ceo dismissal. strategic management journal, 27(3), 283–300. https://doi.org/10.1002/smj.517 zhu, q., hu, s., & shen, w. (2020). why do some insider ceos make more strategic changes than others? the impact of prior board experience on new ceo insiderness. strategic management journal, 41(10), 1933–1951. https://doi.org/10.1002/smj.3183 https://doi.org/10.2307/2393700 https://doi.org/10.2307/2393700 https://doi.org/10.5465/3069384 https://doi.org/10.1177/014920638901500208 https://doi.org/10.1177/014920638901500208 https://doi.org/10.1177/0148558x9601100105 https://doi.org/10.1177/0148558x9601100105 https://doi.org/10.1002/smj.517 https://doi.org/10.1002/smj.3183 introduction theory development ceo characteristics as antecedents of trustworthiness propositions ceo characteristics the governance effects of ceo trustworthiness board perceptions of ceo trustworthiness: individual assessments and group decisions. discussion and conclusions implications for research implications for governance practice 48 journal of business strategies oklahoma oil and natural gas severance taxes: a comparative analysis mary n. gade oklahoma state university • stillwater, ok karen maguire oklahoma state university • stillwater, ok francis makamu oklahoma state university • stillwater, ok abstract oklahoma assesses a production tax of seven percent on the extraction of oil, natural gas, and other minerals. however, since july 2002, it has taxed production from horizontal wells at one percent for the first 48 months of production. this is a significant tax incentive relative to the neighboring state of texas, particularly considering the limited evidence of the effectiveness of severance tax incentives for increasing in-state development of immobile resources. this paper examines whether the tax incentive encouraged horizontal development in oklahoma relative to texas. our findings indicate that the incentive is not associated with an increase in development. keywords: severance tax, oil and natural gas, hydraulic fracturing jel codes: h71, h73, q32, q35, q48 introduction the development of horizontal drilling and hydraulic fracturing technologies has triggered a resurgence in oil and natural gas production in the united states. state governments levy different types of production taxes on these unconventional wells, at different rates, with a diverse mix of exemptions, deductions, and incentives. these tax policies are designed to encourage industry activity, development, job creation, and to enhance economic benefits to the state. the state of oklahoma has carried one of the lowest effective tax rates on horizontal wells when compared to peer states.1 the low rate is partly triggered by a 1 throughout the paper, references to horizontal drilling and horizontal wells, refer to those wells that use a combination of horizontal drilling and hydraulically fracturing to access unconventional oil and natural gas resources. these are commonly referred to as fracked or hydraulically fractured wells. see fitzgerald (2012) for a detailed discussion of the economics of fracking. volume 35, number 1 49 four-year production tax holiday that reduces the tax on newly completed horizontal wells from seven to one percent in the first 48 months of production. this tax break has a significant impact on state revenues, but its effect on drilling activity is an open question. this paper empirically examines whether the horizontal wells severance tax incentive has encouraged horizontal drilling activity in oklahoma relative to texas. for the second straight year, oklahomans are faced with nearly a $1-billiondollar budget shortfall (kfor 2017; newson6 2015). according to the oklahoma policy institute, the proposed budget is 15.6 percent below the fiscal year 2009 budget and 39 out of 73 agencies that are allocated state budget funds have been cut by 20 percent or more since then (ok policy 2017). the state’s budget issues have been blamed on a number of factors, including drops in the corporate income tax, an increase in the cost of various tax incentives, and falling oil prices (ok policy 2017; wertz 2016). specifically, the oklahoma policy institute argues that “tax incentives have more than doubled between 2010 and 2014” and that the largest of these incentives are from “lower tax rates on oil and gas production” (ok policy 2017). previous theoretical literature on oil and gas taxes by haughton and tuerck (2006), modeled a proposed indirect processing tax in louisiana on oil and gas produced in the outer continental shelf (ocs) and determined that there would be short term gains in state tax revenue, but they were not sustained over the long term. previous empirical literature has examined the effects of the state’s political environment on oil and gas development and found that price rather than politics determined oil and gas development (maguire 2012). although, on federal lands, the regulatory environment was a key factor in the amount of oil and gas leasing (maguire 2016).2 other work has examined the effects of oil and gas development on regional economic outcomes such as unemployment with mixed results (lee 2015; munasib & rickman 2015; weinstein 2014; weber, 2014; weber 2012; michaels, 2010). to our knowledge, our study is the first to examine the effects of oklahoma’s horizontal well tax incentives. the subject is of interest as oklahoma offers a generous exemption on horizontal production while other neighboring states, such as texas, do not. providing tax incentives would be considered an effective policy for the state if it stimulates development. however, the alternative would suggest that additional production is profitable to firms regardless of the incentives and 2 oklahoma and texas do not have significant federal lands. (blm, public land statistics) 50 journal of business strategies extending tax breaks only harms oklahoma’s economy by reducing its tax revenue. the contemporary tiebout (1956) tax competition literature devotes much attention to the question of whether or not state tax differentials have an empirical impact on the location of economic activity. theoretically, when a jurisdiction lowers its tax rate on a mobile capital base, the net of tax return rises above that available elsewhere, and capital flows in until net of tax returns are equalized across all jurisdictions. the resulting incentive is that a lower tax rate on capital relative to surrounding jurisdictions has the potential to encourage economic activity as part of state development policy. thus, states utilize exemptions, deductions, and other tax incentives in an effort to stimulate economic development. most of the empirical work on state tax incentives centers on the effects of state taxation on geographically mobile capital with mixed results. evidence ranges from a positive influence of incentives on location (bartik 1985; helms 1985; bartik 1989; papke 1991; papke 1994; holmes, 1998; strauss-kahn & vives, 2009) to a small effect or none at all (schmenner 1982; plaut & pluta 1983; carlton 1983; schmenner, huber & cook 1987; blair & premus 1987; dabney 1991; tannenwald 1996; lee 2008). literature reviews also suggest that the results are somewhat ambiguous (wasylenko 1999; buss 2001; and arauzo-carod, liviano-solis, & manjón-antolín, 2010). examination of the effects of state severance tax incentives on oil and gas drilling and production activity requires an alternative perspective. nonrenewable natural resources are geographically immobile. firms engaged in oil and gas production cannot change location to the extent that their main capital consists of the immobile reserve base. therefore, state severance tax preferences cannot encourage relocation across jurisdictions. firms can respond, however, by altering the level and timing of extraction as state tax policy changes. the introduction of horizontal drilling along with hydraulic fracturing technology has expanded the ability of firms to profitably recover natural gas and oil from unconventional sources (eia 2011). however, horizontal drilling comes with higher costs relative to conventional drilling. a horizontal well can cost between 25 to 300 percent more to drill and complete. due to the difference in cost structure, horizontal drilling is restricted to geological plays with low permeability where conventional wells would not be considered economically viable (helms, 2008). there have been few empirical studies that look at how firms in nonrenewable resource industries respond to state tax incentives. they have included simulation and/or econometric studies of the relationship between a specific tax policy and natural resource exploration and production. for example, kunce, gerking, and volume 35, number 1 51 maddux, (2003) simulate the effects of state tax policy changes in wyoming on both the level and timing of exploration and output in the state. the simulation is based on the standard model of natural resource supply from pindyck (1978) and estimates exploration costs, production of reserve additions, and extraction costs for wyoming while incorporating the specific tax parameters that are of interest to the industry. in contrast, leighty and lin (2012) estimate field-specific cost functions based on cost and production data from alaska’s north slope and use those estimated equations to model production decisions and simulate the impact of tax policy on the production rate. lastly, black, mccoy, and weber (2016), find that taxes on the impacts of drilling in pennsylvania, which could act as a deterrent to oil and gas development, have instead not led to significant declines. the conclusions drawn from these studies and others suggest that the volume of oil and natural gas production and drilling activity is insensitive to severance tax rate changes (see also helmski-oskou, narayanan, glover, lyon, & sinha 1992; kunce, 2003; chakravorty, gerking, & leach, 2010; kaiser 2012). in this paper, we build on this existing literature by examining whether oklahoma’s severance tax reduction has led to disparate effects for horizontal versus conventional drilling as compared with texas. our findings suggest that the oklahoma tax exemption has not significantly increased horizontal drilling activity. background oil and natural gas resources oklahoma and texas are not only among the states to apply the lowest oil and gas production taxes in the nation, but are also among the major contributors of oil and gas in the country. the states are selected in this study for their regional proximity as well as their long history of oil and gas production. for the period 1982 to 2013, texas had the highest production (onshore) of natural gas and oklahoma comes in third position (eia 2015). the hugoton gas field which contains one of the largest producing natural gas fields in the u.s. is located in southwestern kansas, but includes parts of the texas and oklahoma panhandles. in 2013, texas accounted for 29 percent of the country’s marketed gas production, well above any other state. oklahoma accounted for 7.1 percent of the u.s. natural gas production and 8.4 percent of the u.s. marketed production in 2013. oklahoma is one of the leading states in terms of the number of gas wells drilled, only behind ohio, pennsylvania, west virginia and texas. texas is also the leading oil producing state with production 52 journal of business strategies levels sometimes exceeding the federal offshore areas. oklahoma ranked fifth in crude oil production in the nation in 2014 (eia 2016). horizontal drilling and hydraulic fracturing horizontal drilling combined with hydraulic fracturing technology allows producers to develop deposits of oil and natural gas that are trapped in deep shale and tight sands formations often one mile below the surface (api 2009). the concept of hydraulic fracturing was developed in 1891, and implemented for the first time in texas around 1929, but it only become commercially viable in the 1980s. the cost of horizontal drilling is generally higher than the conventional vertical drilling, up to 300 percent. however, when financially viable a horizontal drill can produce 2.5 to 7 times the rate and reserves of conventional wells and allow producers to access once economically infeasible resources (king, 1993). for approximately 10 years beginning in the early 2000s, the price of oil and natural gas was rising making more expensive and complicated methods like hydraulic fracturing more attractive.3 it should be noted that gas prices have declined since 2008 and oil prices have fallen significantly recently, leading to a reduction in oil and gas development activity, but this decline occurred largely after our sample period, which ends in 2013 (arezki & blanchard, 2014; asche, oglend & osmundsen, 2012; baffes, kose, & stocker, 2015). state severance tax structures: oklahoma, texas tax structures are not easy to compare as they vary across states and at different levels of government authority, i.e. federal, state, and local jurisdictions. to address this problem, the literature often makes use of the effective tax rates, taxes divided by production value, in order to account for various form of tax incentives granted by states. for example, including severance, property, income and sale taxes, oklahoma and texas have in fy 2010-2011 effective tax rates between 7.4 and 8.4 percent (carey 2014). although their effective tax rates are similar, there are major differences in their tax structures. for example, texas does not levy a corporate income tax while oklahoma does. in addition, counties can impose property taxes on drilling companies, which are independent of the well’s economic value, but the revenue from taxation on structures and equipment are generally not as large as the revenue obtained from the severance tax (kunce & morgan, 2005). also, state and 3 u.s. energy information administration. 2015. u.s natural gas prices. wellhead price from 1922 to 2012. volume 35, number 1 53 federal corporate income taxes are levied on the firm profit and have very little effect on the firm’s decision to explore and produce. they are more likely to affect future drilling investments and output, rather than the actual number of drilling permits issued (deacon, 1993). states grant numerous exemptions and credits to oil and gas producers (kunce, 2003). for example, oklahoma and texas offer exemptions for inactive wells for at least a certain period after the date of certification of two or three years of inactivity. their tax structures also differ on other features. the oklahoma gross severance tax rate on gas is 7 percent when the price of gas exceeds $2.10 per thousand cubic feet (mcf). the state offers exemptions on severance tax for recovery projects, inactive wells (reestablished production), horizontally drilled wells, new discovery wells, and seismic exploration. since 2002, oklahoma has exempted gas production from horizontal drilling to claim only 1 percent for the first four years of production.4 it is the most generous exemption provided by the state which can be claimed by drilling companies for unlimited production for the first forty-eight months regardless of the current market price. like oklahoma, texas has taxed oil and gas production at a rate of 7.5 percent of the market value of gas produced and 4.6 percent of the market value of oil produced.5 (see appendix: table a2 for detailed information on state tax incentives for oklahoma and texas.) the state has provided natural gas tax incentives since 1989 in the form of an exemption for production of gas with higher drilling costs (“high cost gas”) and inactive wells, both for a period of ten years. the tax benefits have been extended several times and made permanent in 2003. more important to our identification, the tax code does not include production tax exemptions for horizontally drilled wells in oil and gas production.6 overall, and essential to our identification strategy, unlike oklahoma, texas does not provide tax incentives that specifically target horizontal drilling. also, texas has not enacted a major change in their tax code for other types of production. texas has not revised chapter 201, its administrative code on tax exemption for natural gas, since 1997, except for minor modifications in 2005 and 2009 (house bill 2161 and senate bill 997). there was also a myriad of minor regulatory changes, but no major statewide regulatory changes over the period (occ 2016, rrc 2016). the empirical specification will control for static differences in the regulatory and tax structure 4 oklahoma statutes. chapter 68 §1001 (e). 5 texas tax code. chapter 201 section 52 (a). 6 other exemptions comprise gas production from low producing wells on and after 2005 and gas production in association with geothermal energy production after 2009. 54 journal of business strategies between texas and oklahoma, but does not control for dynamic regulatory or tax changes occurring over the sample period in either texas or oklahoma. however, our research, indicates that there have not been major relevant regulatory or tax policy changes over the sample. while it is clear that increases in oil and gas production lead to increases in tax revenue, it is not clear that the reduction in oklahoma’s severance tax rate for horizontal wells will lead to additional oil and gas development. this paper focuses on the empirical question of whether the tax credit on horizontal drilling in oklahoma is associated with an increase in drilling permits relative to texas. data for our analysis, the number of oil and natural gas permits issued serves as our measure of oil and gas development. the steps in the development process include permitting, drilling, completion, and production. in each step after the initial drilling permit is issued, firms face additional costs and resource constraints in order to complete the well development process. for this reason, the number of permits issued provides the best measure of the influence of a tax policy on a firm’s initial oil and gas development decision without the confounding effects of subsequent changes in development costs and other constraints facing these firms. the permit provides the firm with authorization to drill in the designated location abiding by any state restrictions regarding drilling methods.7 therefore, the measure provides a complete set of oil and gas development activity; for each oil or natural gas well drilled in a state, the state’s oil and gas commission requires a permit. the drilling permit data for the analysis were collected from the relevant state oil and gas and or geologic agency; the oil and gas division of the oklahoma corporation commission and the railroad commission of texas.8 each drilling permit is categorized by the relevant agency as conventional or horizontal. in addition, permits are designated as oil, natural gas, or simply oil and gas.9 data are collected for the sample period 1995-2013 and aggregated to the month-county level for each county during the sample period. in addition to permit data, we 7 the permits typically require that drilling begin within 6 months to a year from the issue date and expire if not used. the number of permits issued and the number applied for are essentially the same. for example, in oklahoma over the sample period only 20 permits were rejected. in order to eliminate those few cases where permits were denied, we used only approved permits in the measure. 8 permits for oil and gas drilling and recompletion were considered. permits for other wells such as injection wells are excluded from the analysis. for texas, only onshore permits are analyzed. 9 for permits for oil and gas drilling that were not categorized separately as oil or natural gas, we defaulted to a joint oil and gas category. volume 35, number 1 55 also collected data on monthly oil and natural gas prices by state from the energy information association (eia).10 data on population and personal income at the county-year level were collected from the bureau of economic analysis (bea). lastly, information on whether a county is a metro or non-metro and whether the counties were consistent oil and gas producing counties were collected from the economic research service of the united states department of agriculture (ersusda). empirical specification the paper empirically examines whether the severance tax reduction in oklahoma in 2002 is associated with an increase in the amount of horizontal drilling relative to texas. the empirical analysis measures the influence of the horizontal drilling severance tax policy in oklahoma on the number of drilling permits issued. by using a difference in difference approach we can examine whether oklahoma’s state policy is associated with differences in the number of horizontal and conventional drilling permits issued in oklahoma as compared with texas. the main specification of the fixed effects model is: where i = county, j = state, t = month, and y = year (y) represents the county-month number of permits issued. (r) is an indicator of the oklahoma tax policy of interest. (t) is the time period when the oklahoma tax policy is in effect. (price) is a state-month real oil or natural gas price.11 (inc) is county-year real personal income. lastly, (pop) is the county-year population. the difference-in-difference (did) technique that is used relies on the assumption that changes in drilling permits over time would have been the same in both the treatment, oklahoma, and control state, texas, in the absence of the intervention. figure 1, shows that from 1995 through the early 2000s, the share of conventional and horizontal drilling permits approved was constant for both 10 for oil prices, we used the eia first purchase price, while for natural gas prices we used the eia citygate price; first purchase or wellhead prices for natural gas were discontinued in 2013. 11 the policy change in oklahoma was implemented in large part to promote the implementation of hydraulic fracturing technology and increase oil and gas development in oklahoma. while oil and natural gas prices vary by state, they are highly correlated across states and texas did not adopt the same tax policy. technology, which is clearly correlated with price, was the main factor in oklahoma’s decision, though some correlation between the policy and price cannot be ruled out. 56 journal of business strategies states. this is due largely to the absence of hydraulic fracturing technology prior to the mid-2000s and its rapid adoption throughout the united states thereafter. the extent to which the rise in horizontal drilling in oklahoma demonstrated in figure 1 is due to this technological advancement and the degree to which it was influenced by the tax policy in oklahoma is therefore an empirical question. by differencing out the availability of hydraulic fracturing technology, which was also available in texas we are focused on identifying the oklahoma tax policy impacts. specifically, the county and month fixed effects specification controls for all time invariant county characteristics, and the effects of seasonal and annual national economic and policy changes that influenced both oklahoma and texas. still, the possibility of endogeneity exists due to unmeasured county-level heterogeneity in resource potential, which may lead to changes in the number of permits issued and the implementation of the tax policy. in order to control for resource availability, we have used an alternative sample to focus on geologically similar regions across states as designated by the united states geologic survey (usgs).12 in addition, to address concerns over unmeasured local economic factors, we have controlled for dynamic changes in personal income and population. results for the full sample are provided below. results the findings in table 1 indicate that there is not a robust statistically significant relationship between the implementation of the oklahoma tax policy in 2002 and the number of horizontal permits issued. despite the dramatic increase in horizontal drilling demonstrated in figure 2, the results suggest that the tax break was not a determining factor, rather it was oil prices that had a significant influence.13 the rise in horizontal drilling was not limited to oklahoma. figure 2 also shows marked growth in the number of horizontal drilling permits in texas, which did not have the policy. clearly, the technological expansion of horizontal drilling crossed state lines and led to growth in permitting in both texas and oklahoma. oil prices have the expected finding, an increase in oil price is associated with an increase in both horizontal and conventional drilling permits. the coefficient of 12 the data used in the empirical specification do not allow us to entirely control for differences in the amount of increase in oil and natural gas resource by county. while the regions are designated as geologically similar by the usgs, the usgs does not indicate the entire region has the same level of oil and natural gas resources. using an alternative data set or empirical technique that controls for resource heterogeneity at the well level is left for future work. 13 in addition, natural gas prices were also considered and the statistical and economic significance of the policy intervention were consistent when the analyses were conducted using natural gas rather than oil prices. results available upon request. volume 35, number 1 57 0.0038 on oil price in table 1a column 1 combined with the standard deviation for oil price of 28.16 suggests that a one standard deviation increase in oil prices increases county month horizontal permits issued by 0.11. this is an economically significant relationship given that the mean number of horizontal permits issued over the sample period is 1.06. the finding for conventional permits is also statistically significant. the results in table 1b, column 1 indicate that a one standard deviation increase in oil prices is associated with a 0.65 increase in the county-month conventional permits issued. this is also an economically significant finding given that the mean number of conventional drilling permits issued is 3.73. the findings for both horizontal and conventional permits indicate that there is not a consistently significant relationship between either horizontal or conventional drilling and the implementation of oklahoma’s tax policy. robustness checks for the main sample are examined below. oil and gas resource availability there are several distinct geologic areas throughout the sample area. the usgs central region energy team assessed the oil and gas resources of the united states and developed geologic boundaries for the oil and gas resource assessment project from 2005 through 2012. each region, called a province, is defined by major geologic changes.14 (see figure 3) the amount of oil and natural gas resource available is a key factor in determining the amount of drilling that will take place. figure 4 shows that texas has more oil and gas resources than oklahoma and a larger increase in resources over the sample period.15 the heterogeneity in resource availability may confound the effects of the tax policy, i.e. differences in the state’s resource availability may lead to differential development behavior by firms independent of the tax policy. in order to control for resource availability, we analyzed a sample of counties which are in geologic regions that overlap the boundaries of the states.16 the assumption underlying this analysis is that counties in the same geologic region would be expected to have the same development potential before and after 2002, but for the change in oklahoma’s tax policy. the findings for horizontal permitting remain consistent with the full sample 14 see http://energy.usgs.gov/oilgas/assessmentsdata/nationaloilgasassessment.aspx#.vw3pcc-6dpj, http://certmapper. cr.usgs.gov/data/noga00/natl/spatial/geodatabase/usprov12gdb.zip 15 proved reserves can increase due to an increase in resource price, technological growth, or through an expansion in oil and gas drilling activity (eia 2017). 16 the provinces that are included in the overlapping regions sample are the anadarko basin and the bend arch-fort worth basin. 58 journal of business strategies if the analysis is completed for the overlapping geologic regions sample. table 1, column 2 indicates that the policy is not statistically significantly associated with a change in horizontal permitting. still, there may be differences in the amount of increase in oil or gas resources between texas and oklahoma counties in the overlapping regions sample due to differential changes in proved reserves. our analysis does not control for these differences, but does provide a robustness check for the previous results using a more homogeneous resource area. the finding for conventional permitting becomes insignificant and changes sign, indicating that the negative coefficient found in the main sample may have been due to the heterogeneity in resource availability in the full sample. in this sample, there is not a statistically significant effect from the policy. share of permits figure 2 shows that texas has issued considerably more permits than oklahoma. in order to determine if the findings are driven by variation in the magnitude of the number of permits issued, we have also analyzed the share of conventional and horizontal permits. table 1, columns 3 show that for the alternative dependent variable, share of permits, the results for horizontal permitting become significant while conventional drilling remains insignificant. specifically, the findings in table 1a indicate that after the implementation of the tax policy, horizontal permitting increased. importantly, however, the positive significant findings regarding horizontal permitting are limited to the construction of this alternative dependent variable and are not robust across specifications. permits – oil and gas the findings thus far have distinguished permits by type, horizontal or conventional permit, but not by fuel, oil or natural gas. in order to determine if the tax policy was differentially affecting oil and gas permits, we examined the number of permits issued for wells other than oil wells. oil and gas permits are often issued for oil and gas wells jointly, rather than specifically designating either oil or gas individually. in addition, many wells produce oil and natural gas with the ratio of oil and natural gas produced used to determine whether the well is designated oil or natural gas in a particular year. in order to analyze the permits separately, we constructed a variable that is a measure of the total number of county-month permits minus those that were designated as oil permits. the findings in table 1a, column 4 indicate that the results for horizontal permits are insignificant. the policy did have a volume 35, number 1 59 negative and statistically significant relationship with conventional permitting in this sample, but once again the magnitude and direction of influence are not consistent across specifications for the conventional permits. resource rich counties previously, we restricted the sample to overlapping geologic regions in order to analyze a more homogeneous sample in terms of the oil and gas resource availability. for this analysis, we focus on resource rich counties defined as those with continuous oil and/or gas production as reported by ers-usda.18 this specification highlights the potential differences in the relationship between the policy and counties that had marginal resource development versus counties that had continuous resource development. the analysis focuses on a more homogeneous sample in terms of resource development. the findings in table 1a, column 5 indicate that horizontal permitting declined in this sample full sample, the coefficient on the policy variable was -1.18, but for resource rich counties the decline was less -0.218. the results are not consistent with the previous results, and do not support the hypothesis that oklahoma’s tax policy increased horizontal drilling. the policy influence on conventional permitting is also negative, but there is no differential relationship between the policy in marginal and resource rich counties. the lack of a consistent magnitude and direction for the tax policy on horizontal or conventional drilling indicate that there was not a robust statistically significant finding. conclusion and discussion oklahoma’s severance tax reduction was designed to promote the adoption of what was at the time a technological advancement in drilling. resource rich states, such as oklahoma rely on tax revenue from energy production in order to meet their fiscal obligations. this reliance has proven particularly salient recently as oklahoma faces a budget shortfall. according to the oklahoma policy institute, this shortfall is due not only to declining oil and gas production due to falling prices, but to tax incentives, both income and the severance tax reduction (ok policy 2016, 2017). prior to the current environment of declining energy prices, the boom in oil and gas drilling that followed the adoption of hydraulic fracturing technology was credited with providing jobs and revenue for state and local governments. the state tax implications of increased oil and gas production seem clear, but the benefits of 18 see http://www.ers.usda.gov/data-products/county-level-oil-and-gas-production-in-the-us.aspx. the data on oil and gas production cover the period 2000-2011. 60 journal of business strategies the tax break can only be realized if the industry responds by ramping up production when the policy is implemented. industry leaders, including the three largest oil companies in oklahoma indicated that they would reduce drilling if the horizontal tax reduction was allowed to lapse, resulting in a production tax increase back to the full seven percent from the reduced one percent (veith, 2014). the results in this paper suggest, however, that the rise in hydraulic fracturing was due to resource prices, rather than a response from oil and gas producers to the tax policy. in the case of oklahoma’s policy, our findings indicate that the policy is not associated with an increase in horizontal drilling. although no significant effect was found, it is not possible to entirely control for differences in the regulatory and resource environment in texas and oklahoma over the sample period using the current specifications. in terms of the potential for omitted variable bias due to differences in the regulatory environment, we have addressed this by examining the relevant policy environment, presented in appendix a2, and have not found another significant relevant state-level regulatory change during the sample period. in order to address concerns over differences in the growth in resource endowments between oklahoma and texas we have examined the more homogeneous overlapping regions sample and have used the share of permits rather than the absolute number of permits as the dependent variable. across the specifications, the results indicate that there is not a consistent statistically significant association between the oklahoma tax policy and oil and gas development. previous empirical work examining the effect of state tax incentives on geographically mobile capital has found mixed results and this work contributes to that literature; indicating that state tax credits may not provide incentives to increase production for an immobile resource such as oil and natural gas. however, the results also indicate that additional work on the benefits of state tax credits for immobile oil and gas resources is needed in order to determine whether these tax credits are having the desired outcome of increasing oil and gas development. references api (2009). hydraulic fracturing operations, well construction and integrity guidelines. american petroleum institute. api guidance document hf1. http:// www.shalegas.energy.gov/resources/hf1.pdf, accessed september, 09 2015. arauzo-carod, j. m., liviano-solis, d., & manjón-antolín, m. (2010). empirical studies in industrial location: an assessment of their methods and results. journal of regional science, 50(3), 685-711. volume 35, number 1 61 arezki, r., & blanchard, o. (2014). seven questions about the recent oil price slump. imfdirect the imf blog, december 22, 2015. asche, f., oglend, a., & osmundsen, p. (2012). gas versus oil prices the impact of shale gas. energy policy (47), 117-124. baffes, j., kose, a. o., & stocker, m. (april 2015). the great plunge in oil prices: causes, consequences, and policy responses. working paper series. koc universtiy-tusiad economic research forum, 1-60. bartik, t. j. (1985). business location decisions in the united states: estimates of the effects of unionization, taxes, and other characteristics of states. journal of business & economic statistics, 3(1), 14-22. bartik, t. j. (1989). small business start-ups in the united states: estimates of the effects of characteristics of states. southern economic journal, 1004-1018. black, k. j., mccoy, s., & weber, j. g. (2016). when externalities are taxed: the effects and incidence of pennsylvania’s impact fee on shale gas wells. usaee working paper, no. 16-272. blair, j. p., & premus, r. (1987). major factors in industrial location: a review. economic development quarterly, 1(1), 72-85. buss, t. f. (2001). the effect of state tax incentives on economic growth and firm location decisions: an overview of the literature. economic development quarterly, 15(1), 90-105. carey, m. (2014). effective severance tax rates [memorandum], may 11, 2014. colorado legislative council. denver, co. carlton, d. w. (1983). the location and employment choices of new firms: an econometric model with discrete and continuous endogenous variables. the review of economics and statistics, 440-449. chakravorty, u., gerking, s., & leach, a. (2010). state tax policy and oil production. u.s. energy tax policy, 759-774. dabney, d. y. (1991). do enterprise zone incentives affect business location decisions? economic development quarterly, 5(4), 325-334. deacon, r., (1993). taxation, depletion, and welfare: a simulation study of the u.s. petroleum resource. journal of environmental economics and management, volume 24, pp. 159-187. eia (2011). review of emerging resources: u.s. shale gas and shale oil plays, energy information administration, doe. http://www.eia.gov/analysis/studies/ usshalegas/pdf/usshaleplays.pdf. accessed august, 05 2015. 62 journal of business strategies eia (2015). u.s. energy information administration. natural gas gross withdrawals and production. authors’ calculations. http://www.eia.gov/dnav/ng/ng_prod_ sum_a_epg0_fpd_mmcf_a.htm eia (2016). energy information administration. u.s. states: state profiles and energy estimates. https://www.eia.gov/state/ accessed (10/10/16) eia (2017). energy information administration. natural gas: definitions, sources, and explanatory notes. (https://www.eia.gov/dnav/ng/tbldefs/ng_enr_ngl_ tbldef2.asp) accessed (11/1/17) fitzgerald, t. (2012). frackonomics: some economics of hydraulic fracturing. case w. res. l. rev., 63, 1337. haughton, j., & tuerck, d. (2006). the incidence of state taxes on oil and gas. public finance review, 34(5), 527-550. headwaters economics. (2013). unconventional oil and natural gas production tax rates: how does oklahoma compare to peers? bozeman, mt. helms, l.d. (2008). horizontal drilling. north dakota department of mineral resources newsletter, 35(1), pp. 1-3. helms, l. j. (1985). the effect of state and local taxes on economic growth: a time series--cross section approach. the review of economics and statistics, 574-582. helmi-oskoui, b., narayanan, r., glover, t., lyon, k. s., & sinha, m. (1992). optimal extraction of petroleum resources: an empirical approach. resources and energy, 14(3), 267-285. holmes, t. j. (1998). the effect of state policies on the location of manufacturing: evidence from state borders. journal of political economy, 106 (4), 667-705. kaiser, m. j. (2012). modeling the horizontal well severance tax exemption in louisiana. energy, 40(1), 410-427. kfor. (2017). oklahoma faces $878 million shortfall for upcoming year, revenue failure declared. kfor news channel 4. http://kfor.com/2017/02/21/oklahomafaces-878-million-shortfall-for-upcoming-year-revenue-failure-declared/, accessed march 10, 2017. king, r. f. (1993). drilling sideways: a review of horizontal well technology and its domestic application. doe/eia/tr-0565. washington, d.c.: energy information administration. kunce, m. (2003). effectiveness of severance tax incentives in the us oil industry. international tax and public finance, 10(5), 565-587. volume 35, number 1 63 kunce, m., gerking, s., morgan, w., & maddux, r. (2003). state taxation, exploration, and production in the u.s. oil industry. journal of regional science, 43 (4), 749-770. kunce, m., & morgan, w. e. (2005). taxation of oil and gas in the united states 1970-1997. nat. resources j., 45, 77. lee, j. (2015). the regional economic impact of oil and gas extraction in texas. energy policy, 87, 60-71 lee, y. (2008). geographic redistribution of u.s. manufacturing and the role of state development policy. journal of urban economics, 64(2), 436-450. leighty, w., & lin, c. y. c. (2012). tax policy can change the production path: a model of optimal oil extraction in alaska. energy policy, 41, 759-774. maguire, karen. (2012). prices or politics? the influence of markets and political party changes on oil and gas development in the united states, energy economics 34:2013-2020. maguire, karen. (2016). drill baby drill? political influence on federal onshore oil and gas leasing in the western united states. economics of governance, 17 (2), 131-164. michaels, guy (2010). the long term consequences of resource-based specialisation. the economic journal. 121, 31-57. munasib, a., & rickman, d. (2015). regional economic impacts of the shale gas and tight oil boom: a synthetic control analysis. regional science and urban economics, 50, 1-17. newon6 (2015). oklahoma budget shortfall could be $900m in 2016. news on 6. http://www.newson6.com/story/30759089/oklahoma-budget-shortfall-couldbe-900m-in-2016, , accessed march 10, 2017. occ (2016). oklahoma corporation commission: chapter 10 oil and gas conservation (oac 165:10-3-10) in http://www.occeweb.com/rules/rulestxt. htm, accessed january 22, 2016. ok policy (2016). budget trends and outlook – 2016. oklahoma policy institute. http://okpolicy.org/budget-trends-and-outlook-january-2016, accessed january 22, 2016. ok policy (2017). budget trends and outlook — march 2017. oklahoma policy institute. http://okpolicy.org/budget-trends-outlook-march-2017/, accessed march 10, 2017. papke, l. e. (1991). interstate business tax differentials and new firm location: evidence from panel data. journal of public economics, 45(1), 47-68. 64 journal of business strategies papke, l. e. (1994). tax policy and urban development: evidence from the indiana enterprise zone program. journal of public economics, 54(1), 37-49. pindyck, r. s. (1978). the optimal exploration and production of nonrenewable resources. journal of political economy, 86(5), 841-861. plaut, t. r., & pluta, j. e. (1983). business climate, taxes and expenditures, and state industrial growth in the united states. southern economic journal, 99-119. rrc (2016). railroad commission of texas: chapter 3 – oil and gas division (tac 16:1.3) in http://www.rrc.state.tx.us/legal/rules/current-rules/, accessed january 22, 2016. schmenner, r. w. (1982). making business location decisions. prentice hall. schmenner, r. w., huber, j. c., & cook, r. l. (1987). geographic differences and the location of new manufacturing facilities. journal of urban economics, 21(1), 83-104. strauss-kahn, v., & vives, x. (2009). why and where do headquarters move? regional science and urban economics, 39(2), 168-186. tannenwald, r. (1996, january). state business tax climate: how should it be measured and how important is it? in proceedings of the annual conference on taxation held under the auspices of the national tax association-tax institute of america (pp. 225-228). national tax association-tax institute of america. tiebout, c. m. (1956). a pure theory of local expenditures. the journal of political economy, 416-424. veith, warren (2014). drilling tax debate divides industry leaders on the impact of increase. tulsa world. (may 21, 2014) wasylenko, m. (1999). taxation and economic development: the state of the economic literature. public administration and public policy, 72, 309-328. weber, jeremy (2014). a decade of natural gas development: the makings of a resource curse? resource and energy economics. 37, 168-183. weber, jeremy g. 2012. the effects of a natural gas boom on employment and income in colorado, texas, and wyoming. energy economics, 34(5), 15801588. weinstein, amanda l. 2014. unconventional oil and gas development’s impact on state and local economies. choices, 29(4), 1-7. wertz, joe (2016). in oklahoma, low energy prices drive state budget crisis. npr. http://www.npr.org/2016/01/19/463622817/in-oklahoma-low-energyprices-drive-state-budget-crisis, accessed march 20, 2017 wilson, j. d. (1986). a theory of interregional tax competition. journal of urban economics, 19(3), 296-315. volume 35, number 1 65 wilson, j. d. (1999). theories of tax competition. national tax journal, 269-304. biographical sketch of authors mary n. gade is an associate professor and graduate program advisor in the department of economics and legal studies at oklahoma state university. she received her doctorate in economics from michigan state university. her recent work is focused on state and local tax policy, including property tax incidence, tax increment financing, and oil and gas severance taxes in oklahoma. karen maguire is an assistant professor in the department of economics and legal studies at oklahoma state university. she is an active researcher and teacher in the fields of energy economics, environment and resource economics, and regional economics. her primary research and teaching focus is on analyzing energy markets, specifically how politics and policies affect energy development. francis makamu is a visiting instructor in the department of economics and legal studies at oklahoma state university. his research focus is in development economics. 66 journal of business strategies ta bl e 1 m ai n sp ec ifi ca ti on volume 35, number 1 67 figure 1 share of permits (horizontal/conventional) by state figure 2 horizontal and conventional permits by state 68 journal of business strategies figure 3 usgs oil and gas provinces for kansas, oklahoma, and texas figure 4 proved reserves volume 35, number 1 69 appendix 1 summary statistics 70 journal of business strategies appendix 2 summary of key policy changes for gas severance tax exemptions p263501coll9_10.pdf volume 32, number 1 1 does hedging reduce risk? analysis of large domestic airlines garland simmons stephen f. austin state university • nacogdoches, texas abstract in this paper two approaches are applied to understand the hedging behavior of companies which compete in the american airline industry (2007-2014) as they seek to cope with the uncertain, future costs of jet fuel. the first measures the risk that jet fuel prices will fall, a matter of concern to airlines that hedge against rising jet fuel prices, for when jet fuel prices fall, those airlines that have hedged lose money on their hedges. the second describes the risk of hedging or not by using some of the tools of game theory. two different cases are investigated. in the first case airlines compete against one another in a market structure where it is assumed that whether one airline hedges is of no immediate concern to its rivals. in this first case hedging decisions of one airline produce no effects upon other airlines. in the second case airlines compete against one another in the context of an oligopoly. hedging decisions of one airline are connected to the hedging decisions of other airlines. if some airlines hedge jet fuel costs while at the same time others do not, winners and losers are created among the competing airlines. the problem here is that while hedging can fix the price of jet fuel, it cannot guarantee that this fixed price will be lower than the price paid by a rival that did not hedge. the last part of this paper is an empirical data analysis of the differences in jet fuel costs, net of hedging results, is conducted. the null hypothesis that all airlines have equal jet fuel costs after hedge results are accounted for could not be rejected at any reasonable level of confidence. introduction the only purpose of a hedge is to reduce risk. there are different hedge strategies available. some fix the price of an input. other strategies locate the input price below an upper bound or within a range defined by upper and lower bounds. consider the case of an airline wishing to mitigate the effects of an increase in jet fuel prices. this airline may agree to purchase some portion of its future jet fuel usage at a fixed price known today by way of either a forward pricing contract or a swap contract, thus shifting the risk that jet fuel prices might increase to the speculator who 2 journal of business strategies takes the other side of the forward contract or the swap contract. (futures contracts are often used as substitutes for forward contracts.) or an airline may construct a collar around current jet fuel prices. a collar could be constructed by purchasing call options on jet fuel with the exercise price of these calls somewhat above the current level jet fuel prices and by selling put options on jet fuel with the exercise price of these puts somewhat below current jet fuel prices. the effect of this collar would be to fix jet fuel costs within a known range of jet fuel prices. there are other hedging strategies. perhaps the simplest is to buy calls with exercise prices well above the current level of jet fuel prices to insure against a large price increase in jet fuel. readers interested in the nuts and bolts of creating hedges using call options, put options, forward contracts, futures contracts, and swap contracts may consult hull (2009). there are real-world problems with every hedge. there are often problems of basis risk: in some markets jet fuel derivatives are not available, not available in sufficient quantity, or too expensive relative to contracts that are highly correlated with jet fuel price movements. a solution to these difficulties might be to use derivative contracts on heating oil instead of contracts on jet fuel. but heating oil is not the same thing as jet fuel, so the price movements of heating oil and those of jet fuel may be highly correlated, but these changes are not identical. a perfect hedge is impossible in these instances. there are also financial problems that must be addressed. creating hedges requires collateral (margin) to secure performance and/ or cash to make hedge investments. some airlines may be unable to hedge because they had insufficient collateral or not enough cash. of the six airlines studied in this paper four have sought bankruptcy protection in the last 15 years. and financial health remains a problem among large, domestic airlines. in this regard, table 1 contains bond ratings for these companies. of the largest domestic airlines, only southwest airlines is rated as an investment grade risk. the others are rated as below investment grade risks. table 1 bond ratings as of february 2014 united continental american delta southwest jetblue moody’s b1 b1 ba3 baa2 b2 standard & poor’s b b+ bb bbb b fitch b b+ bb bbb b+ source: bloomberg volume 32, number 1 3 rampini, sufi, and viswanathan (2014) find that airlines which are financially vulnerable hedge less than those airlines with stronger balance sheets. in addition to problems of raising money to buy hedge investments or finding assets that can serve as collateral for hedge investments, there is the issue of counterparty risk for those airlines who choose and who are able to afford hedging. every hedge investment is defined by a contract or a collection of contracts. if the other side of the hedge contract (or contracts) does not keep their end of the bargain, then the hedge fails. finally, and of special interest in this paper, there is a problem with hedging that result from competing against rivals within the context of an oligopoly. to see this problem, consider competing airlines within an oligopoly suppose, contrary to the present set of facts which describe the large carriers of the domestic airline industry, all but one of these rival airlines hedge away 100 percent of the jet fuel price risk associated their future jet fuel usage for the next ten years. in doing so each airline that has hedged has done so perfectly without encountering any of the hedging difficulties discussed above, fixing the price of jet fuel for the next ten years. one airline does not hedge any of the jet fuel price risk. and suppose also that after all hedge commitments have been made that will be made by those choosing to hedge, jet fuel prices drop by one-half over the space of six months. should those airlines that have hedged against an increase in jet fuel prices be concerned that jet fuel prices have declined? the answer to this question is yes. why? airlines have some control over the prices that they charge their passengers. if jet fuel prices decline, the airline that chose not to hedge can better afford to reduce the prices that it charges to its passengers because its cost structure is now less than that of its rivals. the main point is this: although hedge contracts can fix input prices so that they are constant, these same hedge contracts cannot guarantee low input prices, low relative to the rival that chose not to hedge. it makes a difference whether all firms in a given oligopoly choose to hedge. if in this oligopoly, competitors all hedge alike, then no airline that fixes the price of its jet fuel will be at a disadvantage if in the future jet fuel prices fall, even though all have locked in fuel costs at an older, higher price. the effort to gain an understanding of the risk that all rivals will not hedge alike motivates this paper. this paper is organized in the following manner. first, brief comments are made about the net present value (npv) concept of capital budgeting and whether or not this tool has been or can be found to be useful in the problem of deciding whether to hedge. as a calculation, npv seems to be of little help in the problem of hedging. this could be because npv works on expected future cash flows or 4 journal of business strategies the certainty equivalent of future cash flows, while hedging works to eliminate the risks of realizing future cash flows that had not been expected. second, a method for measuring the risk that jet fuel prices will decline is studied. hedges are most often designed to deal with the problem of higher jet fuel prices. what is the risk that jet fuel prices will fall instead? that is the problem of this section. to address this problem, a first passage time model operating under an assumption that changes in jet fuel prices follow geometric brownian motion is proposed. the assumption of geometric brownian motion is controversial. pros and cons concerning this assumption are discussed. third, a game theory approach to the problem of hedging is attempted. using ordinal preferences which rank possible outcomes in different future states of the world for each of two competitors, the consequences of the actions of rival airlines are compared. fourth, the last part of this paper is an empirical data analysis of the differences in jet fuel costs, net of hedging results, is conducted. results are inconclusive. net present value as a tool to evaluate hedging decisions the decision of whether or not to hedge can be thought of as a choice to alter the future cash flows of a capital investment. why not calculate the net present value of a hedge in order to determine whether a hedge should be undertaken? npv tools are often used to evaluate capital investment decisions. irving fisher (1930) developed the concept net present value, the quantity of shareholder wealth created by a management’s investment decision. robichek and myers (1965) extended fisher’s work so that the risk of expected future cash flows could be taken into account in the calculation of npv. some have studied the connection of npv to hedging decisions. in perfect markets it may well be the case that decisions to hedge are all zero npv decisions. aretz and bartram (2010) note that shareholders and bondholders themselves can choose to hedge risk without any assistance from corporate management. to apply this reasoning to the case of the airline industry: if southwest airlines should choose to stop hedging the risk that jet fuel prices might increase, there remains nothing to stop their shareholders and bondholders from choosing to hedge this risk in their own accounts. so, it is argued, hedging decisions on the part of managers cannot create or destroy value for owners. and if this is true, then hedging is a zero npv decision in perfect markets. however, capital markets may not be perfect. some argue that corporate managers can generate positive npv from hedging decisions in the presence of volume 32, number 1 5 capital market imperfections produced by tax law and bankruptcy costs, but empirical evidence in this regard is slight. those interested in these issues may see two articles: one written by mackay and moeller (2007), and the other by campello, lin, ma, and zou (2010), for more information about the connection of market imperfections and the ability of corporate managers to create wealth by way of hedge decision making. the works cited above consider whether or not hedging decisions can create a positive npv and if so under what conditions. there are problems in applying npv to a specific hedging problem. npv analysis is understood in terms of expected cash flows or in terms of certainty equivalents of expected cash flows, but hedging is understood in terms of realized cash flows. nevertheless, it may, in some cases, be practical to translate ex ante data about all possible cash flows that may be realized into expected cash flows so that a npv analysis of hedge decision making could be undertaken. one could then consider all possible realized cash flows with and without hedging. and too, it ought to be the case that if one takes an investment proposal and hedges away all of the risk associated with forecasting future cash flows that one has, though this hedging, defined what the certainty equivalent cash flows must be. but no one has pursued this line of reasoning, and this present paper does not study the connection of npv to hedging decisions. when jet fuel hedges lose money through hedging, an airline can choose to eliminate the risk of large increases in jet fuel prices, but the problem remains that jet fuel prices may decline after the airline puts into place these hedge contracts. if this occurs, hedge contracts lose money. plus, in periods of falling jet fuel prices, the airlines that do not hedge pay less for their jet fuel than their rivals that do hedge. this is the risk that remains after management decides to put hedges in place. recently – during the fourth quarter of 2014, jet fuel prices declined. table 2 jet fuel cost per gallon after the results of hedging: fourth quarter results 2014 vs fourth quarter 2013 2014 2013 2014 2013 2014 2013 2014 2013 2014 2013 united continental american delta southwest jetblue per gallon fuel cost (economic) $2.83 $3.08 $2.52 $3.06 $2.62 $2.83 $3.08 $2.52 $3.06 $2.62 source: various company press releases 6 journal of business strategies the cost reduction in american airlines is largest because american airlines has chosen not to hedge jet fuel prices. martin (2015) and levine-weinberg (2014) comment on american airlines’ decision not to hedge jet fuel prices, noting that it is a risky decision, but one that is responsible for increased profits in 2014. what is the probability that jet fuel prices will fall? to answer this question, an assumption must be made as to the stochastic nature of the changes in jet fuel price changes through time. carter, rogers, and simkins (2004) assume that changes in jet fuel prices can be described as geometric brownian motion. not everyone agrees. tan (2002) asserts that there is instead mean reversion in jet fuel prices. perhaps tan is right in identifying ex-post data sets of jet fuel prices in time-series as better described with mean reversion than with other stochastic assumptions of price behavior. if tan (2002) is correct in an ex ante sense, then the first passage time model application of this paper is misguided. in an ex ante sense, a mean reversion model would necessarily produce expectations on future jet fuel prices such that when jet fuel prices move above some price, then they are more likely to decline, and when jet fuel prices move below that same price then they are more likely to increase. any economic story explaining this price behavior would unfold in two parts. first, it would divide the quantity demanded and the quantity supplied of jet fuel into two categories: normal and abnormal. second, it would also fix both supply and demand curves. put these assumptions together and one can then justify mean reversion. when market conditions are normal, jet fuel prices are likely observed in the neighborhood of some mean value. when market conditions are abnormal, jet fuel prices are more likely to be observed farther away from their mean value price. for short-run problems where the opec cartel dominates the market for petroleum products, where supply and demand are fixed, the choice of a mean reversion model seems reasonable. an economic story justifying geometric brownian motion is simpler than that of mean reversion. there is no need to locate reflecting barriers above and below a mean value price and no need to measure the speed at which jet fuel prices return to their mean. and economic thinking consistent with geometric brownian motion permits both the quantity demanded and the quantity supplied to change over time along with both the supply and demand curves of jet fuel. given recent large increases in oil production in texas and north dakota oil fields, it may be argued that the opec cartel has lost the ability to control the price of oil. if this is so, then one could argue that price changes of petroleum products will no longer be mean reverting. volume 32, number 1 7 if a geometric brownian motion assumption is employed to describe the stochastic nature of jet fuel prices, parameter estimates are required to produce forecasts: a drift term µ which describes the constant, instantaneous rate of change of jet fuel prices, absent any random shocks; and a volatility term σ which describes the sensitivity of jet fuel prices to these random economic shocks. this expected drift rate may or may not be realized, for it is a random variable, which in every future time period is normally distributed with expectation equal to a constant µ and standard deviation about this expectation equal to a constant σ. if one can estimate both drift and volatility, then a first passage time model, working in the context of geometric brownian motion, can answer the question: what is probability that jet fuel prices will drop far enough to penetrate some fixed lower boundary price at least once over the next t years? σ 2 2 μ c—s( ( c—s( ( √t σ c—s( ( √t σ where: c is the lower boundary jet fuel price, s is the current jet fuel price, μ is the expected continuous rate of drift in jet fuel prices, σ is the volatility of jet fuel prices, and t is the number of years of the planning horizon. if future changes in jet fuel prices are normally distributed in cross-section, and if changes in jet fuel prices are described as a geometric brownian motion, then the probability solution given in this model above is exact. an example below is provided only to illustrate an application of this first passage model. suppose that management wanted to know the probability that jet fuel prices would fall by fifty percent at least once over the next four years. given parameter estimates for drift and volatility this question can be addressed. 8 journal of business strategies table 3 an illustration of solutions in a first passage time problem planning horizon decline in jet fuel prices as a percentage expected drift rate volatility probability of a specified decline in jet fuel prices occurs at least once 4 years 50 % 0 % 25 % 16.6 % 4 years 50 % 0 % 40 % 38.6 % 4 years 50 % 0 % 55 % 52.9 % holding drift and planning horizon constant, the probability of jet fuel prices penetrating a lower boundary price for jet fuel increases as volatility increases and vice versa. the hedging decision viewed as a game in this section the problem airlines have of choosing whether to hedge jet fuel prices is studied from the viewpoint of a game-theoretic framework. the airline industry is an example of an oligopoly. as such it may be the case that an airlines’ choice to hedge jet fuel prices is not only connected to the future price that an airline will pay for jet fuel but also connected to their rival’s profitability. two cases are considered. in the first case considered below, illustrated in table 4, two rival airlines both make hedging decisions, but these decisions cannot affect the other’s profitability. in the second case, illustrated in table 5, two rivals both make hedging decisions as before, but these decisions can affect the other’s profitability. in table 4 the decision of whether to hedge jet fuel prices is illustrated. two rival airlines make their hedge choices simultaneously and without collusion. after these hedge decisions are made, jet fuel prices change. the change in jet fuel prices is a random variable, beyond the control of either airline. a hedge will be beneficial to an airline if jet fuel prices rise. otherwise, hedging will reduce the airline’s profits. both the potential benefits and the potential losses depend upon the size of the hedge relative to the airline’s jet fuel usage, and how large the movement is in jet fuel prices. in table 4 the outcomes shown are ordinal preferences. these ordinal preferences rank outcomes over all possible future states of the world. game theorists show that knowledge of ordinal preferences, rather than knowledge of the cardinal outcomes associated with these preferences, is sufficient to reach a rational decision. for an explanation see mccain (2004) pages 68-69. volume 32, number 1 9 how are these ordinal preferences assigned? four ranks are employed. rank 4 is the most preferred. in this state jet fuel prices have declined and the airline has not hedged, so there is no cost of hedging to be subtracted from the benefits associated with the decline in jet fuel. rank 3 is assigned to a state where jet fuel prices have declined, but the airline has hedged against the possibility of an increase in jet fuel prices. the cost of this insurance will increase jet fuel costs. rank 2 is assigned to a state where jet fuel prices have increased, but the airline has hedged against higher jet fuel prices. airlines seldom or never hedge all of their jet fuel needs, and at the time that this paper was being written (february 2015), the airlines under study (american, delta, jetblue, southwest, and united continental) each hedged significantly less than half of their jet fuel requirements. so, even though in this state, where jet fuel prices have increased and the airline has hedged against these price increases, the airline would have preferred states where jet fuel prices drop. rank 1, the worst possible outcome, is a state where jet fuel prices increase, but the airline did not hedge against any price increase. table 4 hypothetical preferences (you, rival) over future states of the world for two airlines where rank 1 is least preferred: a case where no one is penalized for being outguessed by a rival or rewarded for outguessing a rival rival hedges rival does not hedge you hedge 2,2 costs rise 3,3 costs fall 2,1 costs rise 3,4 costs fall you do not hedge 1,2 costs rise 4,3 costs fall 1,1 costs rise 4,4 costs fall if airlines can make hedging decisions independently of one another, without any concern that their rival’s hedging choices will affect their profitability or that their hedging choices will affect their rival’s profitability, then preferences over all possible future states for one airline must not depend on the hedging decisions of 10 journal of business strategies any other airline, and vice versa. such independence is plausible if and only if one airline does not gain any economic advantage by outguessing its rival in regard to future jet fuel price movements and it is not subject to any penalty when it is outguessed by its rival. the preferences of table 4 above describe these circumstances. there is no dominant strategy for either airline, no nash equilibrium. but there is a minimax strategy available to both, if they are financially able. von neumann and morgenstern (1947 ), using methods of theorem and proof, justify minimax strategies for decision makers as a reasonable choice for rational decision makers on the grounds of risk aversion. adopting this strategy, both should consider hedging. doing so avoids the worst possible outcome, a state where jet fuel prices drop and this drop is unmitigated by any hedge. unlike the preceding analysis, the ordinal preferences of table 5 below assume an oligopolistic market structure where the hedging decisions of rivals are relevant to the hedging decisions that an airline must make. consistent with these ordinal preferences found below is the notion that outguessing a rival in regard to the direction of future jet fuel price movements generates economic benefits for the airline, and, to the contrary, being outguessed by rivals results in economic penalties. in periods of falling jet fuel prices, airlines that do not hedge (or that do not hedge as much as their competitors) are able to translate reduced jet fuel prices into reduced ticket prices if they want. competitors who choose to hedge jet fuel prices bear this risk unless all hedge alike. if jet fuel prices go up, then those who hedge will benefit from gains associated with their hedge investments which offset to some degree the increases in jet fuel prices. but their unhedged (less hedged) competitors suffer (or suffer more) from higher jet fuel prices. airlines who have hedged before an increase in jet fuel prices takes place are able to translate gains from hedging into lower ticket prices. airlines choosing not to hedge jet fuel prices bear this risk unless all choose not to hedge. an analysis of ordinal preferences in the case where one airline’s hedging choices can affect both its own profitability and the profitability of its rivals requires eight ranks rather than the four of the previous case. why? there is an added dimension to this new problem. as before jet fuel prices may go up or down, and as before an airline may either hedge or not hedge, but now it matters whether an airline pays the same price for jet fuel as its rival. a possible state of the world where both pay the same high price for jet fuel because jet fuel prices went up and neither airline hedged is ranked differently than a possible state of the world where your airline pays a high price for jet fuel because jet fuel prices went up and your airline did not hedge, but your unhedged rival pays less. volume 32, number 1 11 rank 8 is preferred above all others. in this state jet fuel prices have declined and your airline has not hedged (so for your airline there is no cost of hedging to be subtracted from the benefits associated with the decline in jet fuel), but your rival has hedged and thus pays more for jet fuel than your airline does. rank 7, in this state jet fuel prices have declined, your airline has not hedged, and your rival also has not hedged, so both benefit fully from lower jet fuel prices – both your airline and your rival pay the same price for jet fuel. rank 6, in this state jet fuel prices have fallen, your airline and your rival have both hedged, so both do not benefit fully in the decline of jet fuel prices, but neither your airline or your rival are put at a competitive disadvantage by hedging, because both your airline and your rival pay the same price for jet fuel. rank 5, in this state jet fuel prices have fallen, but your airline has hedged against jet fuel price increases while your rival has not hedged, so you must pay more for jet fuel than your rival. rank 4, in this state jet fuel prices have risen, but your airline has hedged against jet fuel price increases while your rival has not, so you pay less than your rival for jet fuel. rank 3, in this state jet fuel prices have increased, but both your airline and your rival have hedged against jet fuel price increases, thus both your airline and your rival pay the same price for jet fuel. rank 2, in this state jet fuel prices have increased, but neither your airline nor your rival has hedged, so your airline and your rival pay the same price for jet fuel. rank 1, in this state jet fuel prices have risen and your airline has not hedged, but your rival has hedged, so your airline pays more for jet fuel than your rival does. table 5 hypothetical preferences (you, rival) over future states of the world for two airlines where rank 1 is least preferred: a case where one is penalized for being outguessed by a rival and rewarded for outguessing a rival rival hedges rival does not hedge you hedge 3,3 costs rise 6,6 costs fall 4,1 costs rise 5,8 costs fall you do not hedge 1,4 costs rise 8,5 costs fall 2,2 costs rise 7,7 costs fall 12 journal of business strategies as in the first case above that is illustrated in table 4, a minimax solution is again available, suggesting that if both you and your rival are rational and risk averse, then both should consider hedging to avoid the worst possible outcome. if all hedge alike, then two good things happen: the risk of paying a high price for jet fuel is mitigated, and, ceteris paribus, all competitors pay the same price for jet fuel. but, what if there is a risk that your rival cannot or will not hedge? if you persist in hedging, then your hedging strategy is made more risky. in this scenario, when jet fuel prices fall your rival will pay less for jet fuel than your airline. if there is a risk that your rival will not hedge, then your airline may consider not hedging as well. if no one hedges against possible changes in jet fuel prices, then, ceteris paribus, all airlines pay the same price for jet fuel in every possible future state. depending on an airline’s ability to pass higher jet fuel costs on in the form of higher ticket prices, decision makers may look with favor upon a strategy that attempts to attain the same price for jet fuel at the expense of hedging against the possibility that jet fuel prices rise. in fact not all airlines do hedge. in table 6 below, one can see that american is unhedged. the other airlines studied: united continental, delta, southwest, and jetblue are hedged in varying degrees against a possible increase in the price of jet fuel. american airline’s decision to not hedge jet fuel prices is consistent with that of us air, which completed a merger with american airlines on december 9, 2013. levine-weinberg (2014) writes that management of this airline decided in 2008 to no longer hedge their jet fuel costs. by the third quarter of 2009 all of their hedging contracts were gone. american shows no hedge losses in the fourth quarter of 2014 because they are not hedged. their rivals all show losses in the fourth quarter of 2014 because they have hedged against the possibility of higher prices for jet fuel, but jet fuel prices fell instead. but, in times past hedging has paid well. gwynne (2012) reports that southwest is the only domestic airline that has avoided bankruptcy. american, united, delta, northwest, and us airways have sought bankruptcy protection since september 11, 2011, or, like continental, have lost their separate existence. when the price of oil began to increase dramatically in 2000, southwest was protected in large degree by jet fuel hedges, which saved the company four billion american dollars from 2000-2011. volume 32, number 1 13 table 6 a comparison of fuel expense per income statement and economic cost of jet fuel as it is reported in schedules associated with financial statements: fourth quarter results 2014 vs fourth quarter 2013 2014 2013 2014 2013 2014 united continental united continental american american delta fuel purchase cost $2,445 $2,987 $2,659 $3,214 $2,394 add: realized hedge losses (gains) 85 (22) 2,146 add: refinery segment impact loss (gain) (105) add: hedge loss (gain) or mark to market effects 151 (4) (1,966) equals: total economic (or adjusted) fuel cost $2,681 $2,961 $2,659 $3,214 $2,469 total fuel expense (gaap) $2,530 $2,965 $2,659 $3,214 $4,435 2013 2014 2013 2014 2013 delta southwest southwest jetblue jetblue fuel purchase cost $2,823 $1,150 $1,364 $410 $463 add: realized hedge losses (gains) (150) 17 3 26 3 add: refinery segment impact loss (gain) 46 add: hedge loss (gain) or mark to market effects 92 (1) (13) equals: total economic (or adjusted) fuel cost $2,811 $1,166 $1,354 total fuel expense (gaap) $2,719 $1,167 $1,367 $436 $466 source: various company press releases and, where information was not available from company sources, calculations by the author. calculations above are consistent with accounting standards: statement of financial accounting standards no. 133 defines jet fuel hedges to be cash flow hedges such that the market value of all derivative contracts are found on the balance 14 journal of business strategies sheet and, for hedges that are effective, the changes in the market value of derivative contracts are booked to other comprehensive income until the jet fuel purchase that is being hedged is used. when the jet fuel is used, the hedging results become a part of the jet fuel expense. on the other hand, ineffective hedging results in immediate income statement recognition. statement of financial accounting standards no. 161, an amendment to fasb statement no. 133, requires that firms disclose how and why they hedge, and how the gains and losses associated with derivatives affect both balance sheet and income statement accounts, and cash flows. one major airline has taken the extraordinary step of making its own jet fuel. delta air lines in 2012 purchased an oil refinery with the intention that this investment will alleviate a shortage of jet fuel supply. hargreaves (2012) reports that delta purchased the shut-down phillips 66 trainer refinery for $150 million, and that delta planned to invest another $100 million to modify the refinery so that it can produce more jet fuel. delta management (2012 form 10-k) explains that the trainer refinery, located near philadelphia, pennsylvania, was acquired in response to delta’s inability to control jet fuel costs through hedging, and that this investment is in response to both higher refining margins for jet fuel and the declining supply of jet fuel in the north-eastern united states. the trainer refinery has a capacity of 185,000 barrels per day. this refinery restarted in september 2012. figure 1 below describes the work of this refinery. delta consumes the jet fuel produced by trainer refinery and sells or swaps the by-products of refinery products to oil companies. figure 1 volume 32, number 1 15 delta, in their 2013 10-k filing, reports that their refinery operations lost money in 2013 because of u. s. environmental agency requirements. the epa requires refiners like delta that do not blend renewable fuels (ethanol) to obtain a waiver from this requirement, or to purchase renewable energy credits in a secondary market from refiners that produce more renewable fuels at their refineries than regulations require. delta chooses to purchase these credits and their cost in 2013 is high enough to cause delta’s refinery business to show a loss. delta is studying the matter and hoping for better results in the future. nevertheless, delta contends that their refinery has succeeded in increasing jet fuel supplies. analysis of variance of jet fuel costs per gallon consider the following data set contained in table 7 below. every year in annual reports airlines report their average jet fuel cost per gallon after hedge results are taken into consideration. similar data, in some instances differing by a penny or so on the gallon, is provided by the bureau of transportation statistics. it could be the case that for the airlines under study, different hedging practices result in different jet fuel costs per gallon after hedging effects are accounted for. proving this by way of hypothesis testing fails. table 7 per gallon jet fuel cost after hedging results are considered united continental american delta southwest us air jetblue 2014 $2.97 $2.91 $2.87 $2.92 n.a $2.99 2013 $3.13 $3.08 $3.07 $3.12 n.a. $3.14 2012 $3.27 $3.20 $3.26 $3.30 $3.17 $3.21 2011 $3.06 $3.00 $3.05 $3.19 $3.11 $3.17 2010 $2.39 $3.20 $2.33 $2.51 $2.24 $2.29 2009 $1.80 $2.00 $2.15 $2.12 $1.74 $2.08 2008 $3.52 $3.03 $3.13 $2.44 $3.17 $3.08 2007 $2.18 $2.13 $2.24 $1.80 $2.20 $2.18 source: company 10-k filings and bureau of transportation statistics 16 journal of business strategies consider the null hypothesis – mean per gallon fuel costs after hedging are equal for all airlines appearing in the sample for the time period indicated. take the data set contained in table 7 which is the jet fuel costs after hedging effects, airline by airline for the years 2008 through 2012. let the treatment variable be identified as the choice of airline, with six levels of that treatment variable, one for each of the six airlines studied. and let the blocking variable be the time periods in which annual per gallon jet fuel costs were measured, with six levels of that blocking variable, one for each of the six years annual per gallon jet fuel costs were recorded. table 8 below is an anova table that results: table 8 analysis of variance of per gallon jet fuel cost after hedging effects for the years 2007-2012 source of variation sum of squares degrees of freedom mean squares f ratio airline 0.155600 5 0.031120 0.55 year 8.761233 5 1.752247 30.85 error 1.419870 25 0.056795 total 10.33670 35 the f ratio calculation of 0.55 is much too low to show at any reasonable level of confidence that fuel costs, net of hedging results, are different from airline to airline. one cannot reject the null hypothesis that mean differences in jet fuel costs after hedging is accounted for are equal for all airlines studied. as expected, the inclusion of blocking variable – time period – is highly effective in making the analysis of variance more powerful than it otherwise could be. the blocking variable is statistically significant at the 99 percent level of confidence. this test is arguably powerful in a statistical sense, and yet the null hypothesis cannot be rejected. the work summarized in table 9 is similar to that of table 8. again an analysis of variance of jet fuel costs, net of results is undertaken. but, in the data set associated with table 9, an airline that has lost its separate identity in 2013 is omitted from the study. however, dropping us air, which now no longer exists as a separate entity, and including the years 2007-2014 do not change the results. again, the null hypothesis that all airlines have equal jet fuel costs after hedge results are accounted for, cannot be rejected at any reasonable level of confidence. volume 32, number 1 17 table 9 analysis of variance of per gallon jet fuel cost after hedging effects for the years 2007-2014 source of variation sum of squares degrees of freedom mean squares f ratio airline 0.092810 4 0.0232025 0.49 year 7.929997 7 1.13285679 23.99 error 1.321990 28 0.04721393 total 9.344797 39 conclusion in the airline industry, hedging may be used by management to fix the price of jet fuel, or to locate it within some predetermined range, but hedging cannot guarantee that an airline will pay a price for jet fuel as low as the price that its competitors pay, unless all competitors hedge alike or all refuse to hedge. hedging cannot guarantee an airline which hedges that its unhedged rivals will not benefit from a decline in jet fuel prices. all in airline industry may wish to hedge alike. there are benefits to the risk averse for doing so. if all do hedge alike, then all are protected against a sudden surge in jet fuel prices and, when ceteris paribus conditions are met, all will pay the same price for jet fuel. but it may be the case that not every airline can afford to hedge jet fuel costs, or hedge as much as they would like. hedge commitments may require collateral and cash beyond the means of some airlines. if this is so, then those airlines which do not hedge are put at further risk should jet fuel prices increase. however, these airlines by not hedging, put their rivals who do hedge at risk should jet fuel prices decline. those who hedge in these instances find themselves paying more for jet fuel than their unhedged rivals. therefore, knowledge that your rival may not or cannot hedge may change your own hedging strategy. you may choose not to hedge as well. if no one hedges against possible changes in jet fuel prices, then, ceteris paribus, all airlines pay the same price for jet fuel in every possible future state. depending on an airline’s ability to pass higher jet fuel costs on in the form of higher ticket prices, decision makers may look with favor upon a strategy that attempts to attain the same price for jet fuel at the expense of hedging against the possibility that jet fuel prices rise. 18 journal of business strategies references american air lines group, inc. (2015). news release: american airlines group reports fourth quarter and full year 2014 profit. january 27, 2015. fort worth, texas: american air lines group, inc. american air lines group, inc. (2015). american air lines group, inc. 10-k annual report pursuant to section 13 and 15(d) of the securities and exchange act of 1934 filed on 02/25/2015 filed period 12/31/2014. fort worth, texas: american air lines group, inc. aretz, k., & bartram, s. m. (2010). corporate hedging and shareholder value. journal of financial research 33(4), winter, 317-371. bailey, jeff. (2007). southwest airlines gains advantage by hedging on long-term oil contracts. the new york times. 2007, november, 28. 2007. retrieved from http://www.nytimes.com/2007/11/28/business/worldbusiness/ bureau of transportation statistics. (2015). airline fuel cost and consumption. retrieved from: http://www.transtats.bts.gov/fuel.asp campello, m., lin, c., ma, y., & zou, h. (2011). the real and financial implications of corporate hedging. journal of finance 66(5), 1615-1647. carter, d., dan, r., & simkins, b. (2004). fuel hedging in the airline industry: the case of southwest airlines. social science research network. abstract 578663, july. delta air lines. (2015). press release: delta airline announces december quarter results, january 20, 2015. atlanta, georgia: delta air lines. delta air lines. (2015). delta air lines, inc. 10-k annual report pursuant to section 13 and 15(d) of the securities and exchange act of 1934 filed on 02/11/2015 filed period 12/31/2014. atlanta, georgia: delta air lines. delta air lines. (2014). delta air lines, inc. 10-k annual report pursuant to section 13 and 15(d) of the securities and exchange act of 1934 filed on 02/24/2014 filed period 12/31/2013. atlanta, georgia: delta air lines. delta air lines. (2013). delta air lines, inc. 10-k annual report pursuant to section 13 and 15(d) of the securities and exchange act of 1934 filed on 02/13/2013 filed period 12/31/2012. atlanta, georgia: delta air lines. financial accounting standards board. (1998). statement of financial accounting standards no. 133 accounting for derivative instruments and hedging activities. norwalk, connecticut: financial accounting standards board of the financial accounting foundation. volume 32, number 1 19 financial accounting standards board. (2008). statement of financial accounting standards no. 161 disclosures about derivative instruments and hedging activities an amendment of fasb statement no. 133. norwalk, connecticut: financial accounting standards board of the financial accounting foundation. fisher, i. (1930). the theory of interest. new york: the macmillan co. fitzpatrick, d., & zuckerman, g. (2012). ‘whale’ tab hits $5.8 billion. wall street journaleastern edition. pp. b1-b2. gwynne, s.c. (2012). luv and war at 30,000 feet. (cover story) texas monthly, 40(3), 124-196. retrieved from http://www.texasmonthly.com/story/luv-andwar-30000-feet hargreaves, s. (2012). delta’s risky oil refinery bet. cnnmoney. may 2, 2012. retrieved from http://news/companies/delta-refinery/index hull, j. c. (2009). options, futures, and other derivatives, upper saddle river, nj: prentice hall, c2009. jetblue. (2015). press release: jetblue announces fourth quarter and full year results. january 29, 2015. new york, new york: jetblue. jetblue. (2015). jetblue air lines, inc. 10-k annual report pursuant to section 13 and 15(d) of the securities and exchange act of 1934 filed on 02/12/2015 filed period 12/31/2014. new york, new york: jetblue. jetblue. (2014). press release: jetblue announces 2013 annual profit. january 29, 2014. new york, new york: jetblue. levine-weinberg, a. (2014). should american airlines group, inc. return to fuel hedging? the motley fool, october 22, 2014, retrieved from http://www.fool. com/investing/general/2014/10/22/should-american-airlines-group-inc-returnto-fuel.aspx mackay, p., & moeller, s.b. (2007). the value of corporate risk management. journal of finance 52(3), 1379-1419. martin, h. (2015). american airlines’ fuel-buying bet pays off in record profit. los angeles times, january 28, 2015. retrieved from http://www.latimes.com/business/la-fi-airlines-fuel-hedging-20150128-story.html mccain, r. a. (2004). game theory: a nontechnical introduction to the analysis of strategy. oh: south-western. nash, j. (1951). non-cooperative games. the annals of mathematics 54(2), 286-295. rampini, a. a., sufi, a., & viswanathan, s. (2014). dynamic risk management, journal of financial economics 111(2), 271-296. robichek, a. a., & stewart, c. m. (1966). conceptual problems in the use of riskadjusted discount rates, journal of finance 21(4), 727-730. 20 journal of business strategies southwest airlines co. (2015). press release: southwest airlines reports fourth quarter and record annual profit; 42nd consecutive year of profitability. january 22, 2015. dallas, texas: southwest airline co. southwest airline co. (2015). southwest airlines, inc. 10-k annual report pursuant to section 13 and 15(d) of the securities and exchange act of 1934 filed on 02/06/2015 filed period 12/31/2014. dallas, texas: southwest airline co. tan, m. (2002). managing aviation fuel risk: emerging market’s airline companies perspective on the international arena. research papers in international business, paper 25-02 united continental holdings, inc. (2015). news release: united announces fullyear and fourth quarter profit. january 22, 2015. chicago illinois: united continental airlines. united continental holdings, inc. (2015). united continental holdings, inc. 10-k annual report pursuant to section 13 and 15(d) of the securities and exchange act of 1934 filed on 02/20/2015 filed period 12/31/2014. chicago illinois: united continental airlines. von neumann, j., & morgenstern, o. (1947). theory of games and economic behavior. princeton, n.j. ; woodstock: princeton university press, 1947. brief biographical sketch of author garland simmons is an associate professor of finance in the nelson rusche college of business at stephen f. austin state university. he teaches business statistics, financial statement analysis, and speculative markets. his recent research interests are in the methodology of financial research and in the use of options and option theory by corporate managers. fostering innovation through humble leadership and humble organizational culture maldonado et al. / journal of business strategies (2021) 38: 73-94 73 journal of business strategies doi:10.54155/jbs.38.2.73-94 fostering innovation through humble leadership and humble organizational culture tiffany maldonadoa, lila cardenb, carol bracec, marie myersd a department of management, marketing, and information systems, sam houston state university, huntsville tx 77341. tmaldonado@shsu.edu (corresponding author). b construction management department, university of houston, 312 technology building, houston tx 77204. lcarden@uh.edu. c marilyn davies college of business, uhd northwest campus at lsc university park, 20515 state hwy 249, houston tx 77077. bracec@uhd.edu. d cfo of hewlett packard, 1501 page mill road, palo alto, ca 94303. marie.myers@hp.com. key words humble leadership; organizational culture; robotic process automation abstract companies understand they need to innovate to stay competitive, but innovation is not as simple as thinking of a great idea and then implementing it. successful innovation requires supportive actions from leaders and the firm especially when the innovation is complex. in order to foster complex technological innovations, such as robotic process automation (“rpa”), we propose that firms benefit from having (1) humble leadership actions and (2) a humble organizational culture. we share what we learned about our propositions after reviewing the finance controllership division within a major multinational technology organization that develops hardware and other computer-related support items. this work is licensed under a creative commons attribution-noncommercial 4.0 international license. copyright (c) 2021 tiffany maldonado, lila carden, carol brace, marie myers. mailto:tmaldonado@shsu.edu mailto:lcarden@uh.edu mailto:bracec@uhd.edu mailto:marie.myers@hp.com https://creativecommons.org/licenses/by-nc/4.0/ https://creativecommons.org/licenses/by-nc/4.0/ 74 maldonado et al. / journal of business strategies (2021) 38: 73-94 1. introduction companies are well aware that they need to innovate to stay competitive in the ever-changing business environment, but innovation is not as simple as thinking of a great idea and then implementing it. successful innovation requires supportive actions from leaders and the firm especially when the innovation is as complex as implementing new technology (aronson et al., 2014). one type of complex technology that more firms are implementing is the use of robots to perform repetitive manual processes via robotic process automation (seasongood, 2016). in robotic process automation (“rpa”), the tools and techniques drive process automations using existing work packages, freeing up human intervention to focus more on complex analytical skills that are unable to be handled by robotics (lacity & willcocks, 2016; seasongood, 2016). in light of a radical change such as rpa, it is expected that firms would face numerous challenges as more complex innovation initiatives are conducted however, such initiatives usually yield greater value than noncomplex technological projects (torugsa & arundel, 2016). to foster such complex innovations, we propose that firms benefit from humble leadership behaviors and a humble organizational culture based on what we learned in a case study of the finance controllership division within a major multinational technology organization (called “tech inc” in this paper) that develops hardware including computers, printers, keyboards, headphones, and other computer-related support items. we define humble leaders as those leaders who are willing to learn, aware of their strengths and weaknesses, appreciative of the contributions of others, and invest in self transcendent pursuits (aziz, 2019; owens & hekman, 2012; vera & rodriguez-lopez, 2004). a humble organizational culture is a culture that nurtures the virtue of humility through six dimensions: employee development, mistake-tolerance, transparency, accurate awareness, recognition, and openness (maldonado et al., 2018). our paper details our propositions that (1) innovation is supported through leadership behaviors, in particular humble leadership behaviors, and (2) innovation is supported through a culture primed for innovation, in particular humble corporate culture. to illustrate our proposal and provide recommendations and implications to managers, we examined a large company, referred to as “tech inc”, that has won several awards due to its innovation. through this case study, we show that organizations cannot maldonado et al. / journal of business strategies (2021) 38: 73-94 75 successfully foster innovation with just humble leadership behaviors or just a humble organizational culture alone, but organizations need the combination of both humble leadership behaviors and humble organizational culture to ensure dynamic innovation. 2. review of literature of innovation, humble leadership and humble organizational culture our paper examines the impact of humble leadership and humble organizational culture on innovation. before we can begin, we must first make note that even though there is an abundance of studies that examine not only the antecedents of innovation but also the benefits, results are unclear as researchers have not agreed on a consistent definition of “innovation” nor a consistent tool or measurement of innovation (calik et al., 2020; collins et al., 1988; hage, 1999). this is not uncommon, and we expect that innovation will continue to have different interpretations. one common definition is that innovation depends mostly on competence and leadership (chapman, 2006). researchers have noted that workplace innovation flourishes in environments in which key leadership activities are conducted (chapman, 2007; moussa et al., 2018) and leaders are a critical factor in the promotion of innovation and creativity (aronson et al., 2014; montes et al., 2005; mumford et al., 2002). more specifically, innovation is supported in humble leadership environments (ye et al., 2020) that embrace personal faults and mistakes as well as recognizes contributions and positive performances as employees sometimes transition into new roles and responsibilities. through the examination of our case study on tech inc, the company has focused on robotic process automation (rpa) which is a process automation that uses software robots or artificial intelligence as a business tool (madakan et al., 2019). the vision for the use of rpa is to reduce the time of repetitive work by automation, which allows organizations such as tech inc to reimagine their strategic implementations including their financial allocations (fluss, 2018). this technology innovation is used to automate business functions that were mostly conducted by humans including integrating data from various sources such as email and enterprise systems. because rpa has this type of capability, the future of work will require innovative thoughts from the leadership teams to implement these solutions with the assistance of new hardware, software, and smart devices. these innovative thoughts will include 76 maldonado et al. / journal of business strategies (2021) 38: 73-94 opportunities to increase productivity and innovation which is fueled by the need for retooled and reskilled workers (fluss, 2018). the work environments that are conducive to automation initiatives such as rpa include environments in which company leadership is attuned to the re-imagining of work including priorities that are focused on quickly embracing the new technologies. this reimagining of work will include an assessment of the business functions that are appropriate for automation such as business functions that follow a frequent, structured process. this re-imagining also includes readying the organization for the change (uzkurt et al., 2013) and needs to include considerations related to humble leadership, humble organizational culture, and innovation. while research exists that suggests the various mechanisms in which leadership supports innovation (back & bausch, 2019; ye et al., 2020), there is still a research gap in identifying which leadership behaviors can influence the innovation of individuals and subunits (khalili et al., 2015). moussa and colleagues (2018) have identified an exhaustive list of key leadership behaviors. they also identified that one challenge of the firm is to develop systems, processes, and climates that promote and demonstrate innovation and creativity. meanwhile, chen and colleagues (2020) propose that leader humility impacts the creativity of the team through leader-leader exchange. we propose that the unique style of humble leadership combined with humble corporate culture can promote and foster technological innovation in firms. according to upper echelon theory, the characteristics of the upper echelons in the organization influence the decisions made and the performance of the firm. one such characteristic that upper echelons can have is humility. humble leaders are open to new information and ideas, willing to correct their mistakes, appreciative of the contributions of others, and eager to learn from others (aziz, 2019; owens & hekman, 2012; vera & rodriguez-lopez, 2004). humility is not a dichotomous virtue where individuals are either humble or they are not humble. instead, humility can be thought of as a continuum, where individuals possess different levels of humility ranging from low to high levels of humility. leaders who are open to new ideas tend to have a learning orientation and leaders with learning orientations often use experiences to develop new routines to change the way the organization operates, which helps the organization to function better than it did in the past. the learning orientation maldonado et al. / journal of business strategies (2021) 38: 73-94 77 innate in humble leaders also influences them to make decisions that enhance the innovation of the firm such as making small and continuous changes rather than large, infrequent changes (owens & hekman, 2012; vroom & jago, 2007). leaders of innovation are those who possess certain characteristics that influence and stimulate others to work collaboratively to achieve new and significant results (prasad & junni, 2017; vroom & jago, 2007). humble leaders have this ability by steadfastly recognizing the contribution of others and modeling how to be willing to correct mistakes (owens & hekman, 2012). research has also shown that there is a positive relationship between creativity and innovation and transformational leadership behaviors (cheung & wong, 2011; eisenbeiss & boerner, 2013; engelen et al., 2014) much like those behaviors of humble leaders (cheung, et al., 2020; ye et al., 2020). in addition to directly influencing innovation in the firm, humble leaders also influence the culture of the organization. organizational cultures are systems of shared beliefs, cognitions and values that produce norms of behavior (cheung & wong, 2011; eisenbeiß & boerner, 2013; engelen et al., 2014). if there is a strong coherence between the strategy and culture, the culture of the organization can facilitate the adoption and implementation of strategy, on the other side, the organizational culture can also serve as a barrier that hinders change (fernandez et al., 2003) and stifles innovation if it is not aligned with strategy. organizations are struggling to innovate for various reasons; thus, practitioners have the challenge to develop cultures that promote innovation and creativity (moussa et al., 2018; uzhurt et al., 2013). one culture that supports innovation is a corporate culture of humility. a culture of humility influences how individuals think and act, and how the firm performs and is built and maintained by policies, processes, routines, and practices that are nurtured by strategic leaders (cameron, 2010). a culture of humility has six dimensions (see table 1): employee development, mistaketolerance, transparency, accurate awareness, recognition, and openness (maldonado et al., 2018). the combination of these dimensions of the humble organizational culture further the company’s ability to continuously innovate in the changing environment. based on our research we propose that it is not only through humble leadership behaviors that companies are able to foster innovation, but also through humble organizational culture. we also propose that it is the humble 78 maldonado et al. / journal of business strategies (2021) 38: 73-94 table 1. impact of dimensions of humble organizational culture humble organizational culture dimension impact employee development cultivates the strengths and abilities of organizational members and the increased knowledge of the members is shared and eventually encoded in organizational routines (maldonado et al., 2018). mistake-tolerance ensures that members can make decisions without fear of negative retaliation, embarrassment or humiliation which encourages members to take more risks and creative decisions which enable the firm to continuously innovate as new discoveries are made (rego et al., 2020). transparency encourages individuals to be honest about their limitations and accept responsibility for mistakes (maldonado et al., 2018). this non-biased selfawareness of employees encourages collaboration which increases innovation. accurate awareness supports the organization in making non-biased, accurate assessments of its strengths and weaknesses and the threats and opportunities in the environment which allows the firm to make wise strategic decisions and to learn from its limitations (maldonado et al., 2018). recognition celebrates the successes of employees which encourages them to become more uninhibited in pursuing larger challenges (maldonado et al., 2018). employees remain motivated knowing that their efforts are recognized and not abused or fraudulently promoted as belonging to upper management. openness considers ideas that are new or external which gives way to new learning within the organization as the absorptive capacity of the firm is increases as the external and new knowledge is integrated and used within the company to innovate (maldonado et al., 2018). maldonado et al. / journal of business strategies (2021) 38: 73-94 79 leadership behaviors that can help facilitate and build this dynamic humble organizational culture (see figure 1). 3. the story of tech inc fostering innovation through humble leadership behaviors and humble organizational culture tech inc is a multinational technology organization with over 50,000 employees. tech inc has received many awards that recognize the firms many successful innovations, such as (award details altered to protect identity of the firm) the star award, which is one of the highest honors in the technology and services industry to recognize a firm’s commitment to outstanding innovation, leadership, and excellence and the design award for the most innovative and cutting-edge industrial, product, and graphic designs. the finance controllership division of tech inc, and the focus of this article, won the prestigious digital award which spotlights companies that are on the cutting edge of digital transformation, including smart automation, robotic process automation, cognitive computing, and advanced analytics. the division was tasked with digitalizing the experience by enabling tools and processes that accelerate their employees’ ability to imagine the future and inspire the team. the finance controllership division, led by jane doe, implemented robotic process automation (rpa), artificial intelligence, advanced analytics, and other emerging technologies to radically streamline financial tasks to improve accuracy and efficiency by 85% due to the ability of rpa to process 24/7 and reduce invoice cycle time by 87%. as a result, the team of 2000+ employees were able to use their time to work on generating new ideas and other higher value-added tasks. the innovations produced such radical change within the division that they were also adopted by other business units in tech inc. the rpa was used throughout the company to figure 1. fostering innovation through humble leadership and humble corporate culture innovation humble corporate culture humble leadership 80 maldonado et al. / journal of business strategies (2021) 38: 73-94 focus on repetitive processes and tasks to automate invoicing processes, security checks, demand expansion, and auditing details for compliance reporting to name a few tasks. through the story of tech inc, managers can learn how to foster innovation through humble leadership behaviors and humble organizational culture. 4. innovation is supported through leadership behaviors, in particular humble leadership behaviors in tech inc, the finance controllership division has been committed to building an innovative culture and developing skills of the future so much that that one award giver mentioned its “best-in-class culture creation”. the innovative culture promotes employees that are data savvy, strategic, creative, and innovative. the culture also includes developing skills for the future related to business acumen, relationship management, and agility for change orientation. the finance controllership division of tech inc has been automating processes leveraging robotic process automation (rpa), advanced analytics, and artificial intelligence in addition to other emerging technologies. tech inc’s ability to support a culture of innovation is based on its “best-inclass culture creation” and leadership. the finance controllership division of tech inc is currently focusing on digitalization as an innovative effort and the impacts to overall communication by initiating these types of efforts. this innovation approach includes starting with a strategy; connecting the dots; making the execution relevant, accessible, and mobile; and telling the story. more specifically, the message from the leaders includes “we nurture digitalization by delivering content and messaging that help employees connect the dots, stay on course and celebrate”. evident in this message are the humble leadership behaviors of recognizing the contribution of others (“celebrate”) and prioritizing employee development (“help employees connect the dots”). tech inc benefits from the humble leadership behaviors of its managers (see table 2). these behaviors demonstrate that the leaders are open to new information and ideas and eager to learn from others, willing to correct their mistakes, appreciative of the contributions of others, and have an accurate awareness of self and others (owens & hekman, 2012; vera & rodriguezlopez, 2004). the leaders of tech inc enact several activities and humble behaviors that help to support and foster technological innovation. jane doe was aware of the strengths and weaknesses of the organization and supports maldonado et al. / journal of business strategies (2021) 38: 73-94 81 innovation through annual scoping and programming of projects in addition to providing clear strategic messaging. jane doe understood that they must be open to new ideas, hence tech inc has an internship program to help generate new innovative thoughts and an innovation advocate core team. finally, these leaders understand that they are successful based on the contributions of others, so they ensure that they recognize and share employee success stories frequently. jane doe saw that new ideas needed to be generated at a greater pace, so they launched a crowd sourcing platform for the entire team of 2500 employees, where every employee was able to go in and post an idea on something that could be improved. the group then used a crowd sourcing approach where employees would vote on the idea and the ideas were reviewed by process experts with the result being that the ideas that had the most votes were included on the implementation schedule for rpa. jane doe helped change the way in which the firm sought out transformation and instead turned it into a "people's transformation" by letting the people drive where things needed to be fixed and improved. this was a dramatic change in approach as normally this was a top-down driven process without a lot of stakeholder engagement. additionally, the leaders at tech inc recognize that it is not just through humble leadership behaviors or a humble organizational culture that they are able to foster innovation, but it is through the combination of both. at tech inc, there are various coordination and integration mechanisms in place to ensure that the humble leader behaviors support the humble organizational culture and vice versa. this can be found in their dedication to building a culture of innovation program, formally supporting employees and being champions of innovation. 5. innovation is supported through a culture primed for innovation, in particular humble corporate culture the organizational culture of tech inc has the six dimensions of humble organizational culture (employee development, mistake-tolerance, transparency, accurate awareness, recognition, and openness) (maldonado et al., 2018). tech inc uses this culture to support innovations related to the collaboration of the digital and physical work environments that support their digital finance structure. this culture of humility is built and maintained by norms that are nurtured by strategic leaders (cameron, 2010) which aligns with 82 maldonado et al. / journal of business strategies (2021) 38: 73-94 table 2. key humble leadership behaviors for innovation leadership support activities leadership support applications within tech inc openness to new information and ideas from employees of all levels created a crowd sourcing platform for the entire team of 2500 employees, where every employee was able to go in and post an idea on something that could be improved eager to learn from others held monthly brown bags concerning innovation willingness to correct self-mistakes and humbly correct mistakes of others department realized that the current rewards programs was not sufficient to drive a culture of innovation, so changed the nature of rewards program department was focused on drone technology for inventory scanning, after little progress, department moved to artificial intelligence is appreciative of the contributions of employees on all levels monthly awards to teams that created new bots or ai scripts has an accurate awareness of self and others understood the lack of skills and abilities of workforce skewed toward millennials annually scopes and programs projects current thought that innovative cultures need to focus on their structure, systems, and culture (bennett & parke, 2015; mackey & deng, 2016). tech inc’s culture focuses on employee development to foster innovation in the firm. this dimension of employee development is so valued that upon winning the digital award for work done in the finance controllership division, tech inc made note that its employees had skills of the future and digital fluency and that the firm was committed to growing their people and cultivating their strengths. to increase the knowledge and strengths of employees jane doe helped to implement “lessons in leadership” training, roundtables focused on innovation and companywide brown bags that include sessions on diversity and inclusion, as well as learning paths. these activities helped to share the increased knowledge of the organizational members to the rest of the employees such that the firm’s training focused on building out maldonado et al. / journal of business strategies (2021) 38: 73-94 83 digitally native skills that was aimed at the entire organization and not just the leadership team. through accurate awareness of others, jane doe realized that with a workforce of 50% millennials, they needed to quickly increase the skills and awareness of the team. they prioritized the development of employees by quickly reskilling the entire workforce of the group through launching a training program focused on analytics and building rpa and digital skills; hosting competitions between key sites to encourage participation and awarded teams that competed and won. this training program and employee competition encoded the increased knowledge and skills of employees into organizational routines. tolerance of competent mistakes allows tech inc to support innovation. at tech inc, they have the motto of “keep reinventing with employee feedback” while continuing to “engage and communicate with experiences that amaze” to ensure that employees can make decisions without fear of embarrassment or negative retaliation. to facilitate this, employees are allowed to take bold risks as tech inc’s employees are taught to fail and fail fast. they are allowed to make many mistakes; but these mistakes never stopped the team, in fact they were constantly scanning the market looking for new technology and trying new ideas. when employees take more risks or creative decisions, such as during the employee technological competitions, the firm can continuously innovate. to encourage this, tech inc took the approach of many pharmaceutical firms, in which they planted a lot of seeds (ideas) and watched to see which might come to the top and which might grow. the firm invested people in these projects and when an investment did not pay off, they quickly cut off the program and then moved onto another. for example, tech inc was working on drones for inventory scanning for about one year, when they saw that little progress was made, they pivoted to ai instead. tech inc prides itself on its transparent communications. the finance controllership division has a dedicated team of employees whose sole focus is on supporting communications. the team has won several awards for their high-quality communications and jane doe continually monitors communications for effectiveness. accurate awareness is a vital part of the culture of tech inc that allows it to successfully support innovation. a notable example is when jane doe realized that the current rewards programs, through welcomed by employees, were not sufficient to drive innovation, so they pivoted to a new program. during strategy planning at tech inc, they evaluate 84 maldonado et al. / journal of business strategies (2021) 38: 73-94 the firm’s swot and because of the analysis, use rpa to capitalize on the opportunity to automate operations to reduce costs and reengineer roles and responsibilities. jane doe made a non-biased, accurate assessment of its weaknesses by recognizing that with a workforce of 50% millennials, the group needed to reskill rapidly based on the changing environment. this allowed the group to make wise strategic decisions and to learn from its limitations. the group is so committed to rewarding transparency and honesty that they created a 3-year strategic plan centered around this dimension. the culture of tech inc includes recognition which celebrates the successes of employees and encourages them to become more uninhibited in pursuing larger challenges. upon receiving the digital award, tech inc made a point to recognize the efforts of employees by saying that “employees [were] an integral part of [their] journey” towards the award and innovation and tech inc makes it a point to regularly share employee success stories. the company makes an effort to ensure recognition programs are effective. for example, at one point, jane doe realized that the current rewards programs were not sufficient to drive innovation and pivoted such that each month the company scanned the division to highlight new technology, such as ai or bots. this new technology was implemented by the team and used a creative approach to inspire inventors. finally, tech inc demonstrates openness in its culture through maintaining open lines of communication. part of the reason tech inc won the digital award; they were able to be so innovative was due to social media crowdsourcing and their commitment to innovating with employee feedback. openness to new ideas was so valued that the finance controllership group implemented a program in which employees could post ideas about areas of improvement before having the ideas vetted by an expert panel and implemented. this program allowed for new concepts to help guide learning and skill acclimation. 6. a culture primed for innovation, in particular humble corporate culture, must be maintained and refined this culture of humility at tech inc (see table 3) supported an environment focused on strategic planning initiatives including the environment, operations, communications, and management. the goal of the strategic planning process was to maldonado et al. / journal of business strategies (2021) 38: 73-94 85 table 3. tech inc’s humble organizational culture behavioral norms actions at tech inc accurate awareness is promoted tech inc promotes an accurate awareness of the firm’s swot through in their strategy planning. the firm uses rpa to automate operations to reduce costs and reengineer roles and responsibilities competent mistakes are tolerated tech inc encourages healthy risk taking and creativity by following a motto of “keep reinventing with employee feedback” and a mission of “engage and communicate with experiences that amaze” transparency and honesty are rewarded tech inc accepts blame, admits weakness, and actively seeks new ideas and feedback from multiple sources through their culture of innovation program and by having an innovation advocate core team openness to the ideas of others is valued and modeled employee development is prioritized tech inc focuses on employee training and encourages difficult goals through its “lessons in leadership” training; brown bag sessions which include learning paths and diversity and inclusion sessions; and its “innovation, design and automation” roundtable employee recognition is practiced regularly tech inc has effective recognition programs, is generous with kudos and spotlight the achievements of others through sharing its employee success stories execute projects that support implementations related to first adopters and design thinkers. the execution of the first adopters and design thinkers included a feedback loop stressing “keep inventing with employees” which indicated the humble leadership behaviors of remaining teachable and willing to learn from others. the environment focused on building a community of small teams that connect the dots and build a reward structure including learning and benefits for motivation which is indicative of the humble leader behaviors and humble organizational cultures that support innovation by encouraging collaboration. to measure the success of the collaborative efforts of digital and physical work environments, there needs to be a system in place to measure the success of the projects (bennett & parke, 2015). this measurement of performance 86 maldonado et al. / journal of business strategies (2021) 38: 73-94 supports the humble organizational culture of the firm in that it allows the firm to have an accurate awareness of its strengths and limitations. tech inc measured its success based on improvements in communications technology. this included automation of services to reduce human intervention and reduce costs. other measurement systems included goal and target setting with innovation metrics such as workload, cost, and return analyses. tech inc strives to achieve operational excellence both internally and externally. internally, tech inc has used an employee survey to assess operational excellence. to further engage the employees and prepare for the cultural changes associated with the innovation, tech inc conducted a survey to determine the overall perceptions of their employees about the innovative path forward for the organization. the survey was distributed to approximately 2000 employees and 179 responded to the survey which represented approximately 8%. the survey results included 89% of the employees approving the innovative path forward and 11% responded that no other path would be better for the organization. the survey respondents also noted that social media communications were not welcomed as much and that methods of communication needed to include videos, websites, email, and in-person communications. the culture of the case organization included an internal work environment predicated on relatable communications and engagement for all employees. this includes modeling the future ahead by clarifying values and setting the example that includes imaging the future by providing relatable values. the culture is also embedded in an atmosphere to inspire the team by being inclusive and defining a vision and mission for everyone. after inspiring the team, there needs to be a structure to support making it happen (ma, 2002) with a growth mindset which includes building relationships, capacity, and expertise across teams to find an avenue for promoting company values through lifestyles. this company support also includes training topics including finance and accounting tools and methods, innovation and automation tools and techniques, and technical software and hardware tools. 7. discussion our paper has several implications for theory and practice. our paper extends the field of knowledge on the implications of humility behaviors and humble organizational culture of the firm by examining how they impact innovation, maldonado et al. / journal of business strategies (2021) 38: 73-94 87 in particular a radical, complex innovation such as rpa. further theoretical implications of our study include considerations for creating environments that will encourage, cultivate, and grow innovation. specifically, the humble leadership will need to ready the organization for the innovative environment built around change. building on the work of kurt lewin (1947) and kotter (1996), a change management theoretical approach for innovation can include the 4-rs below. 1. reimage the organization’s strategy including a new way of doing business that is more efficient and effective as well cost effective. this new way of strategy and forward-thinking includes relationship management that focusses on business demand using data analytics, restructured processes and procedures, and new tools and methodologies. 2. reinforce humble leadership to communicate innovative business acumen and the applicable business factors. this innovative leadership provides resources to support strong interpersonal skills; social and emotional intelligence; and agility. 3. reignite innovative leaders to support open collaborative environments that welcome change and embrace ambiguity with shifting priorities. 4. resource a humble organizational culture with diverse humble leadership including creative ideas that are developed from curiosity and constructive criticism. our paper also provides several implications for practice by developing recommendations for managers to develop complex innovations through humble leadership behaviors and by building a humble organizational culture (see table 3). these humble leadership behaviors are noted in table 3 and applications of the leadership support activities for the finance controllership division are also included herein. these leadership support applications can be implemented in organizations that use innovative technology as an operational strategic tool. managers also need to know that successful technological innovations require employee engagement, valuation of employees, and employee development. the management activities that promote employee engagement are focused on creating environments in which employees are committed at all levels of the organization. some of the ways that managers can create a technological 88 maldonado et al. / journal of business strategies (2021) 38: 73-94 innovation environment include providing challenging work, allowing opportunities for decision-making, creating career advancement opportunities, and supporting collaborative work environments where people work well in teams and have resources to get their job done (bankar & gankar, 2013). managers need to also implement policies and practices that include valuing employees and is based on supporting personal and job resource goals as well as trust and transparency. for example, future job positions and career paths for technological innovations need to include roles that select and train employees on team building, networking, and tolerance of ambiguity due to uncertainty (bankar & gankar, 2013; neves et al., 2017). additionally, managers also need to know that technological innovation implementations include elevating the educational training levels of employees so they can engage in more analytical-type jobs (kesting & ulhoi, 2010; seasongood, 2016). this elevation would include providing employee development programs so that employees can transition into more high-end job functions. based on the mini case of tech inc and previous research, we propose that organizations need more than just a humble organizational culture that supports innovation, or leadership behaviors which support innovation. we propose that organizations need both a humble organizational culture and humble leadership behaviors in order to successfully foster innovation. studies have shown that organizations vary in their degree of humble organizational culture and degree of humble leadership behaviors, thus we offer a matrix (see figure 2) in which organizations can observe how the combination of culture and leadership impacts innovation. our matrix simplifies the degree of organizational humble organizational culture and humble leadership behaviors into high and low for feasibility in applying the model to organizations. organizations can move within the matrix, but for complex innovations to thrive, an organization needs a high level of humble corporate culture and humble leadership behaviors. at this level, organizations will enjoy the success that comes along with being the first mover and innovation leader in their industry. when organizations have high levels of humble corporate culture and low levels of humble leadership behaviors, innovations are often birthed, but rarely survive due to the lack of leadership support to the employees behind the innovation. one way that firms can increase humble leadership behaviors is by ensuring that leaders give employees a voice and increasing the trust employees have in the leader when leaders act as moral role models. maldonado et al. / journal of business strategies (2021) 38: 73-94 89 figure 2. impact of humble leadership actions and humble corporate culture on innovation when organizations have low levels of humble corporate culture and high levels of humble leadership behaviors, innovations are often birthed, but rarely survive due to the lack of processes and structure to support the innovation. firms can increase the process and structure to support innovation by increasing the quantity and quality of humble organizational culture actions (maldonado et al., 2018). finally, when organizations have low levels of humble corporate culture and low levels of humble leadership behaviors, innovations that are birthed die very quickly and eventually, innovations stop being birthed. as a result, these firms risk becoming technologically locked-out of their industry and unable to meet the latest technology standards required to compete. in the future, managers should not depend on their old batch of tricks as innovations take their organizations to new heights. to be on the forefront of the digital revolution, managers need to understand that in order to accommodate the implementation of ai and machine learning systems, such as rpa, they must employ high quality humble leadership behaviors, and a humble corporate culture through many of the actions and behaviors described in this paper. humble corporate culture high low q u a n ti ty a n d q u a li ty o f h u m b le l e a d e rs h ip a c ti o n s h ig h complex innovations thrive innovations birthed, but rarely survive and thrive due to a lack of process/structure to support the innovation(s) l o w innovations birthed, but rarely survive and thrive due to a lack of leadership support innovations rarely birthed, innovations that are birthed quickly die due to lack of support from leadership and organizational systems 90 maldonado et al. / journal of business strategies (2021) 38: 73-94 references aronson, z. h., shenhar, a. j., & wenzhou, w. (2014). the effect of vision, artifacts, and leader values on contextual performance behavior and success in technology challenging projects: qualitative evidence. international journal of innovation and technology management, 11(06). https://doi.org/10.1142/s0219877014500400 aziz, k. (2019). why is humility so relevant for leaders and can it be developed through coaching? strategic hr review, 18(1), 30-33. https://doi.org/10.1108/shr-10-2018-0088 back, p., & bausch, a. (2019). not if, but how ceos affect product innovation: a systematic review and research agenda. international journal of innovation and technology management, 16(03). https://doi.org/10.1142/s0219877019300015 bankar, s., & gankar, s. (2013). employee engagement and change management. journal of commerce and management thought, 4(2), 313-321. bennett, n., & parke, j.m. (2015). struggling to innovate? examine your structure, systems, and culture. business horizons, 58(5), 563-569. https://doi.org/10.1016/j.bushor.2015.05.009 calik, e., cetinguc, b., & calisir, f. (2020). a comprehensive validated model of innovation and performance: an empirical study of turkish companies. international journal of innovation and technology management, 17(03). https://doi.org/10.1142/s0219877020500194 cameron, k. (2010). five keys to flourishing in trying times. leader to leader, 55, 45–51. https://doi.org/10.1002/ltl.401 chapman, m. (2006). building an innovative organization: consistent business and technology integration. strategy & leadership, 34(4), 32-38. https://doi.org/10.1108/10878570610700992 chapman, w. r. (2007). how strategic innovation really gets started. strategy & leadership, 35(1), 21-29. chen, c., feng, j., liu, x., & yao, j. (2020). leader humility, team job crafting and team creativity: the moderating role of leader–leader exchange. human resource management journal. https://doi.org/10.1111/1748-8583.12306 cheung, m., & wong, c. (2011). transformational leadership, leader support, and employee creativity. leadership & organization development journal, 32(7), 656-672. https://doi.org/10.1108/01437731111169988 cheung, s. y., huang, e. g., chang, s., & wei, l. (2020). does being mindful make people more creative at work? the role of creative process engagement and perceived leader humility. organizational behavior and https://doi.org/10.1142/s0219877014500400 https://doi.org/10.1108/shr-10-2018-0088 https://doi.org/10.1142/s0219877019300015 https://doi.org/10.1016/j.bushor.2015.05.009 https://doi.org/10.1142/s0219877020500194 https://doi.org/10.1002/ltl.401 https://doi.org/10.1108/10878570610700992 https://doi.org/10.1111/1748-8583.12306 https://doi.org/10.1108/01437731111169988 maldonado et al. / journal of business strategies (2021) 38: 73-94 91 human decision processes, 159, 39-48. https://doi.org/10.1016/j.obhdp.2019.12.003 collins, p.d., hage, j., & hull, f.m. (1988). organizational and technological predictors of change in automaticity. academy of management journal, 31(3), 512-543. https://www.jstor.org/stable/256458 eisenbeiß, s., & boerner, s. (2013). a double‐edged sword: transformational leadership and individual creativity. british journal of management, 24(1), 5468. https://doi.org/10.1111/j.1467-8551.2011.00786.x engelen, a., schmidt, s., strenger, l., & brettel, m. (2014). top management’s transformational leader behaviors and innovation orientation: a cross-cultural perspective in eight countries. journal of international management, 20(2), 124-136. https://doi.org/10.1016/j.intman.2013.04.003 fernández, e., junquera, b., & ordiz, m. (2003). organizational culture and human resources in the environmental issue: a review of the literature. international journal of human resource management, 14(4), 634-656. https://doi.org/10.1080/0958519032000057628 fluss, d. (2018). smarter bots mean greater innovation, productivity, and value. scouting report. customer relationship management (malibu, calif.), 22(10), 38-39. hage, j.t. (1999). organizational innovation and organizational change. annual review of sociology, 25(1), 597-622. https://doi.org/10.1146/annurev.soc.25.1.597 kesting, p., & ulhoi, j. p. (2010). employee-driven innovation: extending the license to foster innovation. management decision, 48(1), 65-84. https://doi.org/10.1108/00251741011014463 khalili, a., muenjohn, n., & mcmurray, a. (2015), leadership behaviour, creativity and innovative behaviour: instrument development inquiry. iabc conference, hawaii, usa, 2015, p. 322-326. kotter, j. p. (1996). leading change. boston: harvard business school press. lacity, m., & willcocks, l. p. (2016) robotic process automation at telefonica 02. mis q. executive, 15(1), 21-35. lewin, k. (1947). frontiers in group dynamics. in cartwright, d. (ed.), field theory in social science. london: social science paperbacks. https://doi.org/10.1177/001872674700100103 ma, h. (2002). competitive advantage: what's luck got to do with it? management decision, 40(6), 525-536. https://doi.org/10.1108/00251740210433927 https://doi.org/10.1016/j.obhdp.2019.12.003 https://www.jstor.org/stable/256458 https://doi.org/10.1111/j.1467-8551.2011.00786.x https://doi.org/10.1016/j.intman.2013.04.003 https://doi.org/10.1080/0958519032000057628 https://doi.org/10.1146/annurev.soc.25.1.597 https://doi.org/10.1108/00251741011014463 https://doi.org/10.1177/001872674700100103 https://doi.org/10.1108/00251740210433927 92 maldonado et al. / journal of business strategies (2021) 38: 73-94 mackey, j. t., & deng, f. j. (2016). examining the role of management control systems in the creation of an innovative culture. international journal of innovation and technology management, 13(03). https://doi.org/10.1142/s0219877016400022 maldonado, t., vera, d., & ramos, n. (2018). how humble is your company culture? and, why does it matter? business horizons, 61(5), 745-753. https://doi.org/10.1016/j.bushor.2018.05.005 madakam, s., holmukhe, r.m., & jaiswal, d.k. (2019). the future digital work force: robotic process automation (rpa). journal of information systems and technology management, 16. https://doi.org/10.4301/s18071775201916001 montes, f.j.l., moreno, a.r., & morales, v.g. (2005), influence of support leadership and teamwork cohesion on organizational learning, innovation and performance: an empirical examination. technovation, 25(10), 11591172. https://doi.org/10.1016/j.technovation.2004.05.002 moussa, m., mcmurray, a., & muenjohn, n. (2018). a conceptual framework of the factors influencing innovation in public sector organizations. the journal of developing areas, 52(3), 231-240. http://doi.org/10.1353/jda.2018.0048 mumford, m.d., scott, g.m., gaddis, b., & strange, j.m. (2002). leading creative people: orchestrating expertise and relationships. the leadership quarterly, 13(6), 705-750. https://doi.org/10.1016/s1048-9843(02)001583 neves, p., almeida, p., & velez, m.j. (2018). reducing intentions to resist future change: combined effects of commitment-based h|r practices and ethical leadership. human resource management, 57, 249-261. https://doi.org/10.1002/hrm.21830 owens, b., & hekman, d. (2012). modeling how to grow: an inductive examination of humble leader behaviors, contingencies, and outcomes. academy of management journal, 55(4), 787-818. https://doi.org/10.5465/amj.2010.0441 prasad, b., & junni, p. (2017). a contingency model of ceo characteristics and firm innovativeness: the moderating role of organizational size. management decision, 55(1), 156-177. https://doi.org/10.1108/md-022016-0071 rego, a., melo, a. i., bluhm, d. j., e cunha, m. p., & júnior, d. r. (2020). leader-expressed humility predicting team psychological safety: a personality dynamics lens. journal of business ethics, 1-18. https://doi.org/10.1007/s10551-020-04622-1 https://doi.org/10.1142/s0219877016400022 https://doi.org/10.1016/j.bushor.2018.05.005 https://doi.org/10.4301/s1807-1775201916001 https://doi.org/10.4301/s1807-1775201916001 https://doi.org/10.1016/j.technovation.2004.05.002 http://doi.org/10.1353/jda.2018.0048 https://doi.org/10.1016/s1048-9843(02)00158-3 https://doi.org/10.1016/s1048-9843(02)00158-3 https://doi.org/10.1002/hrm.21830 https://doi.org/10.5465/amj.2010.0441 https://doi.org/10.1108/md-02-2016-0071 https://doi.org/10.1108/md-02-2016-0071 https://doi.org/10.1007/s10551-020-04622-1 maldonado et al. / journal of business strategies (2021) 38: 73-94 93 seasongood, s. (2016). not just for the assembly line: a case for robotics in accounting and finance. financial executive, 32(1), 31-32. torugsa, n., & arundel, a. (2016). complexity of innovation in the public sector: a workgroup-level analysis of related factors and outcomes. public management review, 18(3), 392-416. https://doi.org/10.1080/14719037.2014.984626 uzkurt, c., kumar, r., & ensari, n. (2013). assessing organizational readiness for innovation: an exploratory study on organizational characteristics of innovativeness. international journal of innovation and technology management, 10(04). https://doi.org/10.1142/s0219877013500181 vera, d., & rodriguez-lopez, a. (2004). strategic virtues: humility as a source of competitive advantage. organizational dynamics, 33(4), 393-408. https://doi.org/10.1016/j.orgdyn.2004.09.006 vroom, v.h., & jago, a.g. (2007). the role of the situation in leadership. american psychologist, 62(1), 17-24. https://doi.org/10.1037/0003066x.62.1.17 ye, b. h., tung, v. w. s., li, j. j., & zhu, h. (2020). leader humility, team humility and employee creative performance: the moderating roles of task dependence and competitive climate. tourism management, 81. https://doi.org/10.1016/j.tourman.2020.104170 https://doi.org/10.1080/14719037.2014.984626 https://doi.org/10.1142/s0219877013500181 https://doi.org/10.1016/j.orgdyn.2004.09.006 https://doi.org/10.1037/0003-066x.62.1.17 https://doi.org/10.1037/0003-066x.62.1.17 https://doi.org/10.1016/j.tourman.2020.104170 94 maldonado et al. / journal of business strategies (2021) 38: 73-94 the impact of managerial discretion on firm performance anisya susan thomas florida international university miami, florida joseph peyrefitte florida atlantic university ft. lauderdale, florida abstract theoretical arguments from two distinct literatures are integrated to develop a model which attempts to shed further light on the determinants of performance in multinational corporations. it is suggested that the ambiguity of results in prior investigations could be attributed to variations in managerial discretion. building on the concept of managerial discretion, it is hypothesized that in high discretion settings, organizational and leadership factors will be associated with performance. in contrast, in low discretion settings, where environmental factors predominate, managers have limited latitude; therefore, the impact of these factors on performance will be limited. these hypotheses are tested in two different industry settings. the results largely confirm the theoretical contentions. introduction the theoretical roots of international business (ib) are reflected in a rapidly evolving discipline where alternative perspectives and paradigms are continuously introduced and evaluated. while the multiplicity of different approaches contributes to the richness of the field, the failure to synthesize theories has also led to barriers between scholars and the duplication of research across distinct functional areas. in commenting on this trend, dunning (1989) suggests that the advancement of academic excellence in ib will be best achieved by integrating relevant parts of multiple disciplines. in other words, interdisciplinary research which transcends functional borders to develop explanations for the success and failure of organizations in the global arena will contribute substantially to an enhanced understanding of the complexities of a multidimensional field. in this paper we build upon studies in international business and strategic management to explore the determinants of success in multinational corporations (mncs). by using the concept of managerial discretion, we integrate these theo22 journal of business strategies vol. 13, no. 1 retical platforms and develop an argument for the differential impact of environmental, organizational, and leadership factors on financial outcomes. our model is then empirically tested and directions for future research are delineated. hypotheses the determinants of performance in large mncs are an area of persistent and enduring interest to researchers in the field of international business. during the last two decades, several studies have explored the impact of various factors on the success and growth of these organizations (e.g., daniels & bracker, 1989; geringer, beamish, & dacosta, 1989; grant, 1987; haar, 1989; rugman, 1983; sullivan, 1994b). the variables hypothesized to affect mnc performance include organizational factors such as the level of international involvement (multinationality), firm nationality, product diversification, direction of international involvement, advertising expenditures, and research and development spending in addition to environmental factors such as industry differences. although there have been a wealth of studies, empirical findings from these efforts provide little consensus regarding the impact of various internal and external forces on performance outcomes. for example, daniels and bracker (1989), dunning (1981), haar (1989), and kumar (1984) failed to find a link between multinationality and mnc profitability or growth. in contrast, grant (1987), kim, hwang, and burgers (1989), and mitchell, shaver, and yeung (1993) found positive associations, while siddharthan and lan (1982) found negative relationships between the same variables. complicating the matter even further, geringer, et al. (1989) and sullivan (1994b) found curvilinear relationships between the degree of internationalization and performance. similar contradictions characterize the study of the impact of other organizational factors such as r&d spending and capital intensity on the performance of multinational enterprises (e.g. severn & laurence, 1974; siddharthan & lall, 1982; vernon, 1971). in addition, industry differences have been shown to have both significant (daniels & bracker, 1989; haar, 1989) and insignificant (grant, 1987) effects on profitability. table 1 provides a review of the empirical findings in selected studies of mnc performance (for extensive methodological reviews, see ramaswamy (1992) and sullivan (1994a». in spite of two-and-a-half decades of research of the phenomenon, there does not seem to be any consistent pattern in the relationships between various internal and external factors and the performance of mnc's. however, there is a movement away from the examination of individual, unidimensional indicators to more multidimensional conceptualizations that incorporate the combined impact of the organization and environment, through the consideration of constructs such as the role of strategy (geringer et ai., 1989). despite the dominance of the rational-economic and market power models in the literature (see table 1), and the lack of empirical evidence, there is also consid erable agreement that the leaders of multinational organizations do in fact play spring 1996 thomas & peyrefitte: managerial discretion 23 table 1 review of empirical findings in studies of mnc performance8 study sample findings vernon (1971) severn & laurence (1974) buckley, dunning, pearce (1978) 187 fortune 500 firms 48 mncs, 70 non-mncs (u.s.) 1,000 u.s. mncs from various industries mncs earned higher returns than nonmncs. advertising intensity and r&d intensity were also associated with higher returns; mncs typically reflect higher levels of advertising and r&d intensity. no association between foreign direct investment and profitability. overseas profitability was associated with level of r&d. level of overseas activity had a positive relationship with organizational growth for one period of the study. dunning (1981) 188 large u.k mncs in 1979 siddharthan & 74 largest u.s.mncs lall (1982) in 1976-79 rugman (1983) 50 largest u.s.mncs, 50 largest european mncs overseas production was insignificantly related to return on assets. overseas ratio had a negative influence on firm growth once firm size, advertising, r&d intensity, scale economies, and profitability were taken into account. european mncs were less profitable than u.s. mncs. size and risk were not significant. kumar (1984) michel & shaked (1986) grant (1987) grant, jammine, & thomas (1988) 672 u.k. quoted cos., 1972-76 58 mncs, 43 nonmncs (u.s.) 304 british mncs 304 british mncs mncs earned higher return on assets and on sales than domestic firms. overseas ratio was not significantly related to profitability and growth. risk-adjusted performance is superior for non-mncs. muftinationality was positively associated with superior profitability. destination of overseas expansion and industry effects were not significant. product diversity led to declining profitability once firms encountered limits to complexity. however, multinational diversity was strongly related to profitability. 24 journal of business strategies vol. 13, no. 1 table 1 review of empirical findings in studies of mnc performancea cont'd study sample findings daniels & 116 large u.s. firms bracker (1989) geringer, 100 largest u.s. mncs. beamish, & 100 largest european dacosta (1989) mncs the relationship between profit performance and dependence on foreign operations varied widely according to industry u.s. mncs were more profitable than european mncs. related diversification strategies yielded superior performance. the degree of internationalization exhibited a positive relationship with performance until a threshold level was reached. haar (1989) kim, hwang, burgers (1989) mitchell, shaver, & yeung (1993) blaine (1994) 50 largest u.s. mncs, 50 largest european mncs, 50 largest japanese mncs 62 u.s. mncs 17 u.s. firms in a "domestic" industry, 18 u.s. firms in a "transition" industry 100 large industrial companies each in germany, japan, and the u.s. past performance, industry, and nationality significantly impacted performance. size, state ownership, and multi nationality were not significant. profitability varied with the extent of internationalization. related diversifiers outperformed unrelated diversifiers. however, unrelated diversifiers that were well diversified internationally outperformed those that were not. international expansion returns superior performance in both domestic and transition industries. only minor differences were found in the financial performance of large multinational firms (each derives a substantial portion of its revenues from foreign operations) from three nations. accounting differences across countries were controlled for; thus these factors did not play a significant role in the minor differences across firms. spring 1996 thomas & peyrefitte: managerial discretion 25 table 1 review of empirical findings in studies of mnc performance8 cont'd study sample findings carpano, chrisman, & roth (1994) sullivan (1994b) 319 u.s. mncs from 33 industries 100 largest u.s. mncs, 100 largest european mncs; 75 most international u.s. manufacturing mncs geographic scope and segment differentiation were used to distinguish four international strategies in global and multidomestic industries (segmented, mass-market, segmented-focus, and focus). performance across the strategies varied with the measure of performance (roi or sales growth). however, conclusive results were found in global industries. in global industries segmented and focus strategies were more effective than segmented-focus strategies. using the foreign sales/total sales ratio, the threshold of internalization (geringer, beamish & dacosta[1989]) was confirmed; however, when internationalization was measured with an "international scale," the threshold was not confirmed; mncs of slight and high degrees of internationalization experienced both low and high degrees of profitability. • for extensive methodological reviews see ramaswamy (1992) and sullivan (1994a). an important role in designing responses to environmental challenges and marshalling organizational resources to meet them. thus, the extant knowledge about the predictors of performance in multinational organizations can be restated in an integrated form as: h1: the performance of mncs is a function of environmental, organizational, and leadership factors~ however, investigations of mnc performance continue to emphasize methodological solutions to explain the ambiguity and contradictions that characterize the literature (see sullivan, 1994a). while new methodological approaches are critical to the advancement of knowledge, we contend that in order to move towards a better understanding of mnc performance, there is a need for a broader, more holistic conceptualization which looks beyond the findings of any individual study. instead, the focus should shift to the 26 journal of business strategies vol. 13, no. i search for theoretical explanations of why factors such as the extent of involvement in foreign activities contributes to performance in some situations but not in others. we suggest that a potential reason for the differential impact of environmental and organizational factors on the performance of mncs is managerial discretion, an emerging concept in the field of strategic management. managerial discretion: the missing link? the relative importance of managers and the environment to the success and failure of organizations is a source of considerable debate in the strategic management and organization theory literatures. advocates of the strategic choice paradigm (child, 1972) suggest that managers are the main arbiters of organization direction and performance. they suggest that since managers choose the domain for the firm's activities, decide on its resource allocation priorities, and design competitive maneuvers, they are directly responsible for its success or failure. in contrast, the proponents of the population ecology perspective contend that the success or failure of organizations is determined by inertial and environmental forces. in their view, organizational survival is largely dependent on environmental selection (hannan & freeman, 1977; aldrich, 1979). thus, in the framework of this theory, the role of managers and strategy becomes less important to organization performance. these opposing theoretical perspectives have each received considerable empirical support (e.g. lieberson & o'connor, 1972; gupta & govindarajan, 1984). however, their incompatibility has often resulted in mutually exclusive, yet parallel research. in other words, researchers subscribing to these alternative theoretical perspectives often investigate the same phenomena using different lenses. the mixed results of these efforts have highlighted the necessity of bringing these world views closer together. theorists in both camps (hannan & freeman, 1977; miles & snow, 1978; tushman & romanelli, 1985) seem to agree that each perspective may be more useful in some circumstances than in others. in addressing this issue hambrick and finkelstein (1987) developed the concept of managerial discretion. managerial discretion refers to the latitude of managerial action. more specifically, it pertains to the ability of a chief executive officer (ceo) to exert his or her influence in a variety of substantive and symbolic domains such as resource allocation, product-market selection, or the launching of competitive initiatives. hambrick and finkelstein (1987) argue that different ceos have different ranges of decision making options available to them, determined by a combination of environmental, organizational and personal factors. in other words, although environmental, organizational and leadership factors all have the potential to influence outcomes, the relative importance of each can vary by situational constraints. hambrick and finkelstein (1987) illustrate the impact of environmental factors on the level of managerial discretion in their argument which compares spring 1996 thomas & peyrefitte: managerial discretion 27 the latitude available to the ceo of a public utility and his or her counterpart at a medium-sized microcomputer firm. "the computer executive has legitimate options in the areas of pricing, promotion, production technology and locations, distribution, joint ventures and sales force incentives (to name but a few); and, realistically speaking, the utility executive's options in these areas are limited or even nil. viewed another way, the two executives may be said to have the same possible domains of action, but greatly different ranges of discretion in many of those domains" (1987:372). in the former instance, the top manager could make and execute decisions that change the direction and focus of the organization. for example, the decision of steve jobs to maintain the closed architecture in the machines produced by apple computer corp. set the company on an entirely different course from its competitors in the industry. however, in the latter case of the utility executive, the restrictive web of regulatory constraints imposed by environmental and governmental forces largely reduces the leadership role to that of a figurehead. in other words, identical decisions made by the ceos of the computer and utility firms will affect each organization in a different way. theoretically, because of the greater latitude available to the computer executive, the decision will have a much more immediate and significant impact on organizational performance. in contrast, the impact of the utility executive will be substantially diluted by the dominance of external environmental factors such as government regulation and environmental legislation. thus in some environments, managerial actions can alter the course of organizations. in others, environmentally determined factors predominate, limiting executive influence. this theory can be extended to the domain of mnc performance. it is reasonable to theorize that in high discretion settings where managers have the flexibility to make and execute strategic choices about whether to invest in new technologies or enter new markets, a relationship between leadership factors, such as the profile of top managers and strategic factors such as the level of r&d spending and performance outcomes can be expected. since managerial discretion encompasses choices that may be beneficial or detrimental, the relationship may be positive or negative. conversely, in low discretion settings characterized by powerful competitors, suppliers or buyers, low or negative growth rates and long-term contractual obligations, firms may be subject to strong inertial or market forces which overshadow or negate these linkages. thus we hypothesize that: h2: the relationship between organizational and leadership factors and mnc peiformance will vary with the constraints on managerial discretion. organizational and leadership factors have a greater impact on peiformance in high discretion settings in comparison to low discretion settings. 28 journal of business strategies vol. 13, no. i operationalizing managerial discretion although hambrick and finkelstein (1987) defined managerial discretion to be comprised of three sets of forces, the environment, the organization and the chief executive, most studies have operationali zed this concept in terms of the environmental component, using industry as a surrogate for the environment. to quote finkelstein and hambrick (1990): "organizations function within domains defined by their products or services and by the markets they serve (levine and white, 1961). the characteristics of these domains, particularly the industry the firm competes in, greatly affect the level of managerial discretion. for example. lieberson and o'connor (1972) found that more variance in profitability could be attributed to ceos in industries with high advertising intensity and high growth rates-both of which signal discretion (hambrick and finkelstein, 1987)-than in more commodity like or low growth industries .... industries may differ along several important dimensions that affect the level of managerial discretion. one such dimension is product differentiability. industries characterized by product differentiability offer managers discretionary domains that are not available in commodity goods industries. ... other sources of environmental discretion are demand instability, low capital intensity, competitive market structures, market growth and freedom from government regulation. industries that are characterized by these factors offer greater discretion to top managers than do other industries (489)." the logic that the extent of discretion available to top managers varies by industry setting has been implicitly acknowledged in several studies of mnc performance. for example, daniels and bracker (1989) noted that the positive association between multinationality and profit varied widely by the industry environment. they revealed that in industries subject to heavy government regulation (such as aerospace), the multinationality-performance link was very weak. on the other hand, in the differentiated drugs and pharmaceutical industry, this association was much stronger. significant industry differences were also substantiated by haar. (1989) and carpano, chrisman, and roth (1994). therefore in this study, managerial discretion is assessed by industry membership. operationalizing strategic leadership the study of top managers, a field now referred to as strategic leadership, has become a central area of inquiry in strategic management. the origins of this research stream are usually attributed to hambrick and mason (1984) who built on the work of the behavioral theorists (cyert and march, 1963; march and simon, 1958) to explain the link between executive characteristics and organispring 1996 thomas & peyrefitte: managerial discretion 29 zational outcomes. in their view (a) managers have a limited field of visionthey can only scan some aspects of the organization and its environment, (b) managers selectively perceive only bits of information in their fields of vision (c) the information is then interpreted through a filter fonned by the manager's cognitive base and values (d) this individualistic interpretation is the basis of strategic choices. thus, choices made by managers on behalf of the organization reflect the characteristics of these managers, underlining the important role that managers play in determining organizational performance. the literature in strategic leadership suggests that since the cognitive bases which influence information gathering and evaluation are a product of backgrounds, experiences and training, demographic characteristics, such as age and education, can be used to assess this construct (wiersema & bantel, 1992). the efficacy of the demographic approach has been demonstrated in numerous investigations of the relationship between managerial characteristics and organizational outcomes (e.g. chaganti & sambharya, 1987; gupta & govindarajan, 1984; thomas, litschert & ramaswamy, 1991; wiersema & bantel, 1992). for example, wiersema and bantel (1992) found that attributes such as top management team youth, organizational tenure, educational level, and functional backgrounds were useful indicators of an organization's propensity for strategic change. thus, in keeping with the tradition of research in strategic leadership, the impact of managers on performance is examined by considering the relationship between the demographic profiles of the ceos and financial performance. method sample and setting our sample was restricted to u.s. based multinationals in order to control for variations in national context which inevitably influence the competitive posture and behavior of firms (porter, 1990). the initial sample consisted of all the firms in the electronics and computer industries (sic 367 and 368) and the chemical and petroleum industries (sic 281 and 291) listed in fortune magazine's 500 largest industrial organizations that (a) had international sales and (b) for which top manager data were available. these industries were specifically chosen as prior research (see for example, finkelstein and hambrick, 1990; hambrick and finkelstein, 1987) found that they represented distinct levels of managerial discretion. since comparative analysis indicated a large overlap in products and a lack of significant differences in terms of growth rates, size and profitability, the firms in the electronics and computer industries were combined to represent the high discretion setting and the firms in the chemical and petroleum industries were combined to represent the low discretion setting. the high discretion sample consisted of 28 firms that exhibited a high degree of product differentiability, low capital intensity and rapid growth (84% over five years), 30 journal of business strategies vol. 13, no. 1 characteristics specified by hambrick and finkelstein (1987) as being typical of settings where managers had greater latitude. the low discretion sample consisted of 32 firms that together typified an industry that was mature, had lower growth rates (5% over five years), established patterns of investment and subject to considerable government regulation, all characteristics of contexts where managerial latitude is constrained. table 2 presents the descriptive statistics for all the variables in the study. measures and data environmental factors. as discussed above, industry was used to operationalize the degree of discretion in firms' task environments. dummy variables were used to code firms in either high or low discretion environments. the electronics and computer industry represented the high discretion setting and the chemicals and petroleum refining industry represented the low discretion setting. organizational factors. organizational factors were defined in terms of variables that have been found to affect the performance of mncs in previous studies. data on organizational factors were collected for five years (19831987) from the 1989 directory of multinationals, the fortune 500 annual issues and compustat ii tapes. three distinct measures were used to operationalize this construct. these are detailed below: multinationality, an indicator of the level of a firm's involvement in overseas activity, was measured as the proportion of overseas sales to total sales, in keeping with the measurement scheme utilized by prior research (e.g. daniels and bracker, 1989; grant, 1987; haar, 1989). r&d intensity, an indicator of a firm's propensity to differentiate itself, was measured as the ratio of r&d expenses/total sales (e.g. kumar, 1984; siddharthan & lall, 1982). capital intensity, a common indicator of a firm's strategic focus on efficiency and low cost, was measured as the ratio of capital expenses per dollar of total sales. leadership factors. a large body of literature suggests that the chief executive officer (ceo) in a corporation provides the primary direction ofstrategic decision making by leading the firm's emergent social systems or dominant coalitions (e.g. lorange, 1980; pearce & robinson, 1987). further hambrick and finkelstein's (1987) theory of managerial discretion was explicitly related to the latitude of the ceo. hence the ceo was the unit used to measure the leadership construct. data on the chief executive officers were obtained from businessweek and dun and bradstreet's reference book of corporate managements. table 2 en means, standard deviations, and correlations for all variables·,b "0::1. ::s variables high discretion lowdiscretion 1 2 3 4 5 6 7 8 9 10 11 (jq --l.ros .06 .04 1.01.0 (.06) (.05) 0'\ 2.roi .06 .08 .82*** (.05) (.33) ~ 3. roe .13 .09 .71*** .78*** ~ ~ (.11) (.13) l:l.., 4. industry 0 1 -.17* -.18* -.18** ~ (.00) (.00) "l:l 5. multinationality .21 .28 -.06 -.06 -.06 .14# ~ (.14) (.17) ol~ 6. capital intensity .08 .08 .33*** .01 .01 -.02 .07 ~ (.09) (.03) '. ~7. r&d intensity .18 .02 .45*** .07 .04 -.48*** .05 .45*** ;::s (ll ) (.02) ~ 8. age 56.18 60.97 -.06 -.06 .01 .29*** .08 -.10 -.23** ~::l (6.04) (7.02) t:!'-9. company tenure 23.25 31.63 -.03 .02 -.02 .38*** .06 .04 -.35*** .51 *** '=' (10.82) (9.50) ~. n 10. position tenure 9.32 9.88 -.21 ** -.22** -.19** .05 .12# -.10 .02 .67*** .35*** ol.... (8.88) (9.22) s·;::s 11. education 17.68 16.94 -.05 -.04 -.01 -.06 -.12# -.15* -.05 .18* -.01 .15* (2.13) (1.33) 12. functional .46 .28 .06 .15* -.00 -.18** .04 .05 .17* -.25*** -.12# -.10 .11 orientation (.50) (.45) • standard deviations appear in parentheses #p <.10 *p< .05 **p < .01 ***p < .001 w b means and standard deviations are based on 5 year averages 32 journal of business strategies vol. 13, no.1 five demographic dimensions, previously found to be related to organizational outcomes, were used to operationalize this construct. these were: age. the age of the ceo has been linked to the manner in which a decision is reached and decision quality (kirchner, 1958). studies have consistently found that younger managers are associated with growth, innovation and risk taking, while older managers are more risk averse and tend to make more conservative decisions (carlsson & karlsson, 1970; stevens, beyer & trice, 1978). in this study, age was measured as the chronological age of the ceo. tenure in the company and position tenure (both in the company and in the position) has been used as a proxy for experience in the organization (kotter, 1982). previous research indicates that organizations pursuing efficiency strategies tend to be led by longer tenured executives who have been promoted from within the organizations, while market seeking organizations have a greater propensity to recruit from the outside (miles & snow, 1978; thomas et al., 1991). two separate indicators were used to assess managerial tenure, the number of years spent in the company and the number of years in the position of ceo. education the amount of formal education possessed by the leader has been found to be associated with organizational innovation (kimberly and evanisko, 1981). better educated executives are more receptive to new ideas. thus, the level of education possessed by the ceo was used as another indicator of the managerial characteristics construct. to operationalize this measure, a coding scheme was devised whereby each year of college education was added to a base score of 12 (for example, bachelor's degree;: 12 + 4 ;: 16, master's degree = 12 + 6 ;: 18, etc.). functional orientation has been related to the way in which executives approach and solve problems. for example, dearborn and simon (1958) found that when a group of executives from different functional backgrounds were presented with the same problem, they tended to define it primarily in terms of the activities of their own function. hambrick and mason (1984) built on this logic to classify various functional specializations as either "output" functions or "throughput" functions. output functions emphasize externally oriented activities such as developing products to meet market trends and searching for new domain opportunities, while throughput functions focus on the efficient transformation of inputs to outputs. following this logic, functional orientation was dummy coded as either output oriented (e.g. r&d, marketing) or throughput oriented (e.g. finance, production and manufacturing). spring 1996 thomas & peyrefitte: managerial discretion 33 performance. performance was measured using three separate financial ratios, return on sales (ros), return on investment (rol), and return on equity (roe). performance data were collected from compustat ii tapes and cross-validated with the annual survey. data analysis the data analysis was conducted using pooled ordinary least squares (ols) regressions. the cross-sectional organizational data were pooled in order to detect the average effect of the independent variables over the five year period (1983-1987). although pooling the data could violate some of the assumptions underlying ols regression, the approach is defensible because tests of autocorrelation (durbin watson's d) suggested that the errors were uncorrelated. to test hypothesis 1, each performance measure was regressed on environmental, organizational, and leadership factors. the results of this analysis are presented in table 3. to test hypotheses 2, six separate regression models were developed to assess the impact of organization and leadership factors on each performance measure under high and low discretion environments. the number of observations in the regressions varied between 140 and 160. the results of these analyses are presented in table 4. during our initial analysis we also separately regressed the performance variables on the organizational factors alone and also the leadership factors alone, yielding twelve separate regressions. however, these analyses provided only five significant f statistics, suggesting that performance cannot be explained by either organizational or leadership factors alone. results and discussion hypothesis 1 essentially reflected the findings of prior research and formed the baseline for the test of managerial discretion in multinational organizations. according to this hypothesis: the performance of mncs is a function of environmental, organizational, and leadership factors. this hypothesis was clearly supported. as indicated in table 3, the combination of environmental, organizational and leadership factors consistently explained a significant proportion of variance in each performance indicator. although the proportion of variance explained ranges from 35.3% (ros) to 15.4% (roi) and 13.7% (roe), in each case the equations are statistically significant. 34 journal of business strategies vol. 13, no. 1 table 3 pooled ols regression analyses8 variables ros roi roe intercept -.125* -.034 -.175 (.05) (.056) (.133) industry -.004 -.028** -.076** (.008) (.01) (.023) multinationality -.026 -.006 -.007 (.022) (.024) (.057) capital intensity .056 -.061 -.06 (.062) (.07) (.244) r&d intensity .614*** .098 .107 (.092) (.103) (.166) age .003*** .002** .006** (.001) (.001) (.002) company tenure .001* .001* .001 (.000) (.001) (.001) position tenure -.003*** -.003*** -.006*** (.001) (.001) (.001) education .000 -.002 -.001 (.002) (.002) (.006) functional orientation .002 .018* -.001 (.008) (.009) (.02) r2 .353 .154 .137 f 11.757*** 3.94*** 3.43*** • standard errors appear in parentheses *p < .05; **p < .01; ***p < .001; n = 300 hypothesis 2 stated: the relationship between organizational and leadership factors and mnc peiformance will vary with the constraints on managerial discretion. organizational and leadership factors have a greater impact on peiformance in high discretion settings in comparison to low discretion settings. to test, the firms were separated by industry and the tests were repeated. dramatic differences in the proportion of variance explained were observed. there was a significant increase in the variance explained in the high discretion environment [63.8% (ros), 27.1 % (roi) and 31.5% (roe)] and a decrease in the variance explained in the low discretion environment [11.7% ros; 11.7%. (rgi) and 11.7% (roe)]. thus the hypothesis was supported by the observation of the differential impact of organization and leadership factors across different levels of managerial discretion. spring 1996 thomas & peyrefitte: managerial discretion 35 table 4 results of pooled ols regression analyses by industry environment' ros roi roe high low high low high low variables discretion discretion discretion discretion discretion discretion intercept -.152 -.065 -.002 -.082 -.224 -.226 (.095) (.074) (.107) (.085) (.209) (.209) multinationality -.091# -.032 -.031 -.023 -.193# -.009 (.054) (.027) (.061) (.031) (.119) (.076) capital intensity .096 -.046 .079 -.166 .056 -.266 (.101) (.148) (.114) (.169) (.222) (.417) r&d intensity .604*** .697* -.109 .541 -.047 2.105* (.129) (.333) (.145) (.380) (.284) (.936) age .003# .003# .002 .003# .007* .013** (.002) (.001) (.002) (.002) (.003) (.004) company tenure .001 .000 .000 .000 .000 .000 (.001) (.000) (.000) (.000) (.002) (.002) position tenure -.004*** -.002* -.003* -.003* -.006*** -.009** (.00l) (.000) (.000) (.001) (.002) (.003) education .002 -.004 -.002 -.004 .002 -.023# (.003) (.004) (.003) (.005) (.006) (.012) functional -.006 .006 -.004 .018 .002 .062 orientation (.015) (.014) (.017) (.016) (.033) (.040) r2 .638 .117 .271 .117 .315 .117 f 11.585*** 1.832# 2.446* 1.857# 3.013** 1.849# ·standard errors appear in parentheses high discretion environment: n = 140 low discretion environment: n = 160 #p < .10; *p < . 05; **p<.oi; ***p < . 001 a consideration of the directional relationships between the individual organizational and managerial variables and firm performance in the overall sample as compared to the sample separated by level of discretion reveals an interesting picture as well. in the overall sample, there was no relationship between multi nationality and performance. when industry is taken into account, multinationality was significantly and negatively related to two of the three performance indicators in the high discretion environment but no relationship was statistically discernible in the low discretion environment. this is perhaps a result of the high start up costs that firms in the u.s. electronics and computer industries face as they attempt to diversify geographically. 36 journal of business strategies vol. 13, no. 1 capital intensity did not seem to have any impact either in the overall sample or when the firms were separated by industry. on the other hand r&d intensity was important to ros in the overall sample as well as in both discretionary environments. this finding may imply that investment in developing new products and technologies is one of the few variables that consistently enhances performance even in low discretion settings. among the managerial variables, the consistency across the discretionary environments was interesting and surprising. ceo age seemed to have a positive impact on performance, in the overall sample and in the high and low discretion environments as well. this suggests that older ceos were able to improve performance to a greater extent than their younger counterparts, regardless of the industry in which they operated in. position tenure, on the other hand, was negatively related to every performance indicator in both settings. this seems to imply that the ceo might be getting 'stale in the saddle,' reinforcing miller's (1991) contention that long tenured ceos may rely on their past accomplishments and resist reorienting their organizations to changes in the environment, thus negatively impacting performance. overall, the results of this study tell an interesting story that sheds new light on research investigating the determinants of mnc performance. they suggest that the ambiguity and contradictions that characterize prior findings must be interpreted with caution. instead of dismissing and accepting the results of individual studies based on theoretical or methodological merits alone, researchers must attempt to search for underlying explanations which may explain why a factor such as multinationality may be positively related to performance in some settings, and negatively related or not related at all to performance in others. we suggest that managerial discretion, conceptualized in this study as industry membership, offers one avenue worthy of pursuit. under the theoretical umbrella that is discretion, it is possible to argue that the relative strength of the impact of environmental. organizational and leadership factors on firm performance will vary. while it is entirely possible, as this study has indicated, that r&d intensity or ceo age may have a universal impact while others such as multinationality may have a contingency impact, the extent of the impact could depend on the latitude of action available to top managers or the deterministic nature of the environment. limitations the results of this study are exploratory and must be interpreted with caution. the small sample size and the restriction to two settings limit the generalizability of findings. future efforts must replicate the test in larger and more diverse sample. further investigations can also refine the methodology by using generalized least squares procedures that specifically control for autocorrelation. spring 1996 thomas & peyrefitte: managerial discretion conclusion 37 this study has atttempted to integrate the fragmented findings that characterize research about the determinants of performance in multinational organizations. by considering the research stream through the lens of strategic management, it was suggested that mnc performance is essentially a result of environmental. organizational and leadership factors. in so doing, it responds to dunning's (1989) call for more interdisciplinary research and heeds the advice of bartlett and ghoshal (1991) and buckley (1993) who advocate that international business researchers draw on the strategic management literature to explore the role of managers in international, strategic and organizational contexts. further, it was suggested that the contradictions of prior findings can be reconciled under the theory of managerial discretion which suggests that the relative importance of the environment and strategic managers (and therefore organizational factors) can vary across situations. thus it is possible that some factors may have a significant positive or negative impact on performance in some situations and a minimal or no impact on performance in others. this study has some very important implications for researchers studying mncs. it suggests that an investigation of the determinants of mnc performance should be preceded by an evaluation of the factors that enhance and constrain managerial discretion. such an evaluation will provide insight to the relative importance of environmental, organization and leadership factors. it also suggests that single industry studies or studies of firms facing relatively similar constraints are necessary to accurately identify the factors that actually influence mnc performance. since discretion can vary widely by the setting, results of studies which include samples of firms from multiple industries may be contaminated by variations in managerial latitude. practitioners who study mncs should also be cognizant of the latitude of action available to top executives before arriving at prescriptions about avenues to survival and success. although managers are important, their ability to impact performance can vary by the constraints on their discretion. thus in low discretion settings such as petroleum refining, efforts to improve performance through executive succession and recruitment may not always evoke the desired results. similarly, the impact of changed strategies and new resource allocation decisions may be slower in some industries than others. thus the criteria for measuring the success of managers and strategies should reflect the relative freedom available to top managers. 38 journal of business strategies references vol. 13, no. 1 aldrich, h.e. or~anizations and environments. englewood cliffs, nj: prentice-hall, 1979. bart~ett, c.a. and s. ghoshal. "global strategic management: impact on the new frontiers of strategy research." strate~ic mana~ement journal 12 (1991): 5-16. blaine, m. "comparing the profitability of firms in germany, japan, and the united states." manai<'ment international review 34(2) (1994): 125-148. buckley. pj. "the role of management in internalisation theory." mana~ement international review 33(3) (1993): 197-207. buckley, pj., j.h. dunning, and r.d. pearce. "the influence of firm size, industry, nationality and degree of multinationality on the growth and profitability of the world's largest firms 1962-1972." weltwirtschaftlisches archiv 2 (1978): 243-257. carlsson, g., and k. karlsson. "succession and performance among school superintendents." american sociolo~cal review 35 (1970): 710-718. carpano, c., 1.1. chrisman, and k. roth. "international strategy and environment: an assessment of the performance relationship." journal of international business studi§ 25 (1994): 639-656. chaganti, r and r. sambharya. "strategic orientation and characteristics of upper management." strate~ic mana~ement journal 8 (1987): 393-401. child, 1.. "organization structure, environment and performance: the role of strategic choice." sociolo~y 6 (1972): 2-21. cyert, r.m. and j.g. march. a behavioral theory of the firm. englewood cliffs, nj: prentice-hall, 1963. daniels, j.d. and j. bracker. "profit performance: do foreign operations make a difference?" mana~ement international review 29 (1989): 46-56. dearborn, d.c. and h.a. simon. "selective perceptions: a note on the departmental identifications of executives." socjometry 21 (1958): 140-144. dunning, j.h. international production and the multinational enterprise. london: george allen & unwin, 1981. dunning, j.h. "the study of international business: a plea for a more interdisciplinary approach." journal of international busjness studjes 20 (1989): 411-436. spring 1996 thomas & peyrefitte: managerial discretion 39 finkelstein, s., and d.c. hambrick. "top management team tenure and organizational outcomes: the moderating role of managerial discretion." administrative science ouarterly 35 (1990): 484-503. geringer, j.m., p.w beamish, and rc. dacosta. "diversification strategy and internationalization: implications for mne performance." stratekic manakement journal 10 (1989): 109-119. grant, rm. "multinationality and performance among british manufacturing companies." journal of international business studies 18 (1987): 79-89. grant, rm., a.p. jammine, and h. thomas. "diversity, diversification, and profitability among british manufacturing companies, 1972-84." academy of manakement i!rn.m.lll 31 (1988): 771-801. gupta, a.k. and v. govindarajan. "business unit strategy, managerial characteristics and business unit effectiveness at strategy implementation." academy of mana~ement journal 27 (1984): 25-41. haar, j. "a comparative analysis of the profitability performance of the largest u.s., european, and japanese multinational enterprises." management international review 29(3) (1989): 5-18. hambrick, d.c. and s. finkelstein. "managerial discretion: a bridge between polar views of organizational outcomes." in l.l. cummings and barry m. staw (eds.), research in or~anizational behavior 9 (1987): 369-406. greenwich, ct: jai press. hambrick, d.c., and p.a. mason. "upper echelons: the organization as a reflection of its top managers." academy of manae:ement review 9 (1984): 193-206. hannan, m.t. and j.h. freeman "the population ecology of organizations." a!lliti: can journal of socioloe;y 82 (1977): 929-964. kim, wc., p. hwang, and wp. burgers. "global diversification strategy and corporate profit performance." strate~ic management journal 10 (1989): 45-57. kimberly, j.r, and mj. evanisko. "organizational innovation: the influence of individual, organizational and contextual factors on hospital adoptions of technological and administrative innovations." academy of manab,ement journal 24 (1981): 689-713. kirchner, wk. "age differences in short term retention of rapidly changing information." journal of experimental psychology 55 (1958): 352-358. kotter, j.p. the general managers. new york, ny; the free press, 1982. kumar, m.s. growth. acquisition and investment. cambridge, u.k.: cambridge university press, 1984. 40 journal of business strategies vol. 13, no. 1 levine, s., and p.e. white. "exchange as a conceptual framework for the study of interorganizational relationships." administrative science ouarterly 5 (1961): 583-601. lieberson, s., and j.p. o'connor. "leadership and organizational performance: a study of large corporations." american sociolo~ical review 37 (1972): 117-130. lorange, p. corporate planning, prentice hall, englewood cliffs: nj, 1980. march, j.g., and h.a simon. organizations. new york: john wiley, 1958. michel, a, and i. shaked. "multinational corporations vs. domestic corporations: financial performance and characteristics." journal of international business studies 16 (1986): 89-100. miles, r.e., and c.c. snow. organizational strategy. structure. and process. new york: mcgraw-hill, 1978. miller, d. "stale in the saddle: ceo tenure and the match between organization and the environment." management science 37 (1991): 34-52. mitchell, w., j.m. shaver, and b. yeung. "performance following changes of international presence in domestic and transition industries." journal of international business studies 24 (1993): 647-669. pearce, j.a, and r.b. robinson. "a measure of social power in strategic decision making." strategic management journal 8 (1987): 297-304. porter, m.e. competitive advantage of nations. new york, ny: free press, 1990. ramaswamy, k. "multinationality and performance: a synthesis and redirection." advances in international comparative management 7 (1992): 241-267. rugman, a.m. "the comparative performance of u.s. and european multinational enterprises, 1970-79." management international review 23(2) (1983): 4-14. severn, a.k., and m.m. laurence. "direct investment, research intensity, and profitability." journal of financial and quantitative economics 29 (1974): 181-190. siddharthan, n.s. and s. lall. ''the recent growth of the largest u.s. multinationals." oxford bulletin of economics and statistics 44 (1982): 1-12. stevens, j.m., j.m. beyer, and h.m. trice. "assessing personal role and organizational predictors of managerial commitment." academy of management journal 18 (1978): 74-81. sullivan, d.. "measuring the degree of internationalization of a firm." journal of international business studies 25 (1994a): 325-342. spring 1996 thomas & peyrefitte: managerial discretion 41 sullivan, d. ''the "threshold of internationalization:" replication, extension. and reinterpretation." manalit'went international review 34(2) (l994b): 165-186. thomas, a.s., r.j. litschert, and k. ramaswamy. "the perfonnance impact of strategy manager coalignment: an empirical examination." strate~ic mana~ement jourill!! 12 (1991): 509-522. tushman, m.l., and e. romanelli. "organizational evolution: a metamorphosis of convergence and reorientation." in l.l. cummings and barry m. staw (eds.), e&. search in qre-anizational behavior 7 (1985): 171-222. greenwich, ct: jai press. vernon, r. sovereignty at bay: the multinational spread of u.s. enterprises. new york: basic books, 1971. wiersema, m.p. and k.a. bantel. ''top management team demography and corporate strategic change... academy of manae-ement journal 35 (1992): 91-121. the impact of managerial discretion on firm performance volume 34, number 2 125 strategic reorientation in failing firms: the ceo perspective sonia taneja texas a&m university – commerce • commerce, tx guclu atinc texas a&m university – commerce • commerce, tx mildred golden pryor texas a&m university – commerce • commerce, tx abstract this paper addresses new ceos in failing firms and their potential positive or negative impact in terms of strategic reorientation and organizational survival. specifically, the authors recognize the need for new ceos of failing firms to be able and willing to rapidly make strategic and tactical transformative changes through their decisions and actions. specific suggestions are made in terms of capabilities and experience needed by new ceos of failing firms in order for them to positively impact the future of their respective organizations. keywords: strategic reorientation; failing firms; ceo power; managerial discretion; introduction organizations are routinely confronted with significant changes that trigger the need for strategic reorientation. virany, tushman, and romanelli (1992) assert that change in any of the key components of a firm’s strategy – structure, controls, and power distribution – constitute strategic reorientation. lant, miliken, and batra (1992) contend that strategic reorientation is a function of past performance, ceo turnover, top management team turnover, and/or environmental changes. priem, butler & li (2013) caution that our traditional view of strategic management needs to be expanded because strategic reorientation may also be driven by the demand side as consumers seek out greater value. organizational leaders must plan for strategic reorientation in advance of it being urgently needed. since there are precursors to the need for strategic change, it would be beneficial for academicians and practitioners alike to study those precursors and their probable impacts on organizations. stacey (1995) proposed an adaptive system in response to strategic processes most commonly referred to as strategic choice and system dynamics. 126 journal of business strategies successful organizational systems (i.e., successful individual organizations) adapt to the environment based on their upper echelons’ strategic choices (hambrick & mason, 1984), a transformational process in which organizational processes are restructured to adapt to the changes in the environment (zajac & kraatz, 1993). also, organizations adapt to environmental changes based on their ecologies, which is an evolutionary process of competitive selection while it is a challenge for the whole organization to transform and adapt to the environmental change (hannan & freeman, 1977). these well-established perspectives from which the strategic process of an organization is viewed comprise the system dynamics through which organizations are driven by “negative feedback processes toward predictable states of adaptation to the environment” (stacey, 1995: 477). the three perspectives relating to the causes of changes in organizational strategies include the following issues: (1) the issue of systemic properties, characterized by how organizations transform or renew themselves based on the human systems, e.g., how organizations change with the change in the ceo (stacey, 1995; daily & dalton, 1995; dowell, shackell & stuart, 2011); (2) the intention vs. emergence issue which questions the extent to which new organizational states (caused by changing organizational strategies) are the outcome of prior shared intentions of the agents within them or the top management (ceo) changes which impact the competitiveness and potential for survivability of the organization (stacey, 1995; mintzberg & waters, 1985); and (3) the free choice vs. determinism and constraint issue which questions whether the change of organizational strategies is based on the environment in which it operates and its capability to choose strategies and their outcomes (stacey, 1995, bourgeois, 1984; mackay & chia, 2013). we propose that, by utilizing their strategic choices, which is an antecedent for managerial discretion, organizational leaders can expedite and better manage strategic change. this line of research contributes to the extant literature by explaining how organizations can use complex adaptive systems to influence the strategic change process, thereby restructuring the organizations in ways that result in strategic reorientation. gordon, stewart, sweo, & luker (2000) propose that “industry turbulence and ceo turbulence (are) necessary precursors to strategic reorientation and suggest that industry turbulence conditions managers’ external attributions for negative financial performance in influencing strategic reorientation” (911). according to dess and beard (1984), the three dimensions of organizational environment are munificence (generosity), dynamism (turbulence), and complexity (intricacy). over the years, researchers have investigated the environment’s impact on structure (burns & stalker, 1961; karaevli, 2007), strategy (gilley, mcgee & volume 34, number 2 127 rasheed, 2000; miller, 1988), and decision-making processes (baum & wally, 2003; garg, walters, & priem, 2003, priem, rasheed, & kotulic, 1995). in this paper, our focus is on ceo changes in failing firms. over the years, researchers studied the impact of governance changes and firm survival, such as executive and director turnover prior to bankruptcy (daily & dalton, 1995) and board structure on the probability of failure (dowell, shackell, & stuart, 2011). other researchers investigated the effect of power struggle between the boards and the executives on strategic change (golden & zajac, 2001) and the need for ceos to use their discretion as a way to adapt to dynamic occurrences within and outside the organizational boundaries (peteraf & reed, 2007). firms that are failing typically are unable to keep up with the external environment with their routines. once the status quo is not working, there is a definite need for change. hence, the first thing many firms do is to change their ceos. however, research shows that changing ceos does not always help (daily & dalton, 1995). adopting a configurations perspective and partially echoing what prior researchers observed (e.g., ketchen, thomas & snow, 1993), our contention is that incoming ceos should be equipped to deal with the existing instability and dynamism. we also suggest that the only way for incoming ceos to implement radical change is through the use of managerial discretion (hambrick & finkelstein, 1987) which actually provides the source of power to initiate strategic reorientation. in addition, adopting an agency perspective regarding the board, we also propose a possible strengthening effect of board power. we aim to contribute to the ongoing debate about the need for powerful ceos with experience in dynamic environments for firm survival while the board is also powerful to support strategic reorientation. literature review strategic choice/strategic change early theorists proposed that strategic change is a key element for successful organizational entrenchment (barker & duhaime, 1997; stacey, 1995; schendel, patton, & riggs, 1976; hofer & schendel, 1980). if a firm is failing, apparently the current strategy is not working. then, change is needed to get the firm back on track. since the turn of the century, we have witnessed an ever increasing interest in strategic change (mackay & chia, 2013; haynes & hillman, 2010; franken, edwards, & lambert, 2009; lohrke, bedeian & palmer, 2004; crossan & berdrow, 2003). given the important role that strategic reorientations play in turnaround in 128 journal of business strategies declining firms (lohrke, bedeian & palmer, 2004), further assessment becomes imperative. it is necessary to examine the factors that cause organizational leaders to initiate change by utilizing organization’s abilities to achieve strategic reorientation. various studies have supported the assertion that strategic change enhances performance (hambrick & schecter, 1983; zajac & kraatz, 1993) while other studies concluded that strategic change reduces performance (jauch, osborn, & glueck, 1980; singh, house, & tucker, 1986). still others, such as zhang and rajagopalan (2010), found that the relationship between strategic change and performance is not linear. in fact, the authors postulated that, “the level of strategic change in the pattern of resource allocation will have an inverted u-shaped relationship with firm performance” (zhang & rajagopalan, 2010, p.336). in other words, while low levels of change become an adaptive mechanism to align organizational goals with the environment, high levels of change strengthen the disruptive effect which in returns negatively impacts performance. when and to what extent change is needed for a failing firm is the general theme of this study. in the next section, we discuss the importance of strategic precursors that lead to change. strategic precursors our characterization of strategic reorientation follows that of lant, miliken, and batra (1992) who indicate that strategic reorientation is a result of ceo turnover, top management team turnover, and impact of the external environment. there are also other precursors of change. for instance, priem, butler and li (2003) consider consumer demand to be an impetus for strategic reorientation. while, enhancement of customer value perception is an important strategic move, in this paper our focus is on the top executive officer who initiates change as a retrenchment strategy in failing organizations. the level of strategic change reflects the organization’s capabilities to experiment and the risk–taking aspects of the firm’s strategic choices (carpenter, 2000; finkelstein & hambrick, 1990; zhang, 2006). an important organizational condition that is salient to understand the nature and magnitude of strategic change is executive leadership (virany, tushman, & romanelli, 1992). upper echelons theory states that organizational outcomes, including both strategic choices and performance levels, can be predicted by the top management characteristics (hambrick & mason, 1984). in fact, according to hambrick and mason (1984), organizations are reflections of their upper echelons. ceo career experiences, for example, have a high impact volume 34, number 2 129 potential on organizational happenings (greiner, cummings, & bhambri (2002); zhang, & rajagopalan, 2010). one concept to remember is “managerial discretion.” hambrick and finkelstein (1987) define discretion as “latitude of action” (p.369). the potential impact of an executive is determined by the amount of discretion he or she has in an organization. finkelstein, hambrick and canella (2009) propose that environmental, organizational and personal factors determine the amount of executive discretion. one personal characteristic is commitment to status quo. in the case of a failing firm, once a new ceo is brought in, he or she would be reluctant to stick to the status quo. actually, this ceo is brought in to challenge the status quo that is not working in the first place. crossland & hambrick (2011) postulate that “the concept of managerial discretion provides a theoretical fulcrum for resolving the debate about whether chief executive officers (ceos) have much influence over company outcomes (p. 797). the overall impact of the level of strategic change on an organization’s performance can be observed when a ceo moves from one industry to another. for instance, the recently retired ceo of ford motor corp. was previously the ceo of boeing inc. before he joined ford. during his reign, ford went through an entire restructuring process. commensurately, it is beneficial to note that ceo origin has a moderating effect on the impact of strategic change on firm performance (zhang & rajagopalan, 2010). as a side note, barker and mone (1998) purported that change in ceos during a turnaround may lead to mechanistic shifts as new ceos attempt to make decisions and take actions affecting their organizations. they found that “mechanistic structure shifts did restrict firms’ abilities to change their strategic orientations in response to decline” (barker & mone, 1998, p. 1227). another finding of barker and mone (1998) was that “replacing the firm’s ceo during turnaround attempts had conflicting and paradoxical effects on firms’ abilities to enact strategic reorientation” (p. 1227). new ceos are likely to attempt to directly reorient the organizational strategies. for example, ron johnson joined j.c penney’s as chief executive officer. in 2013 (17 months later), he was fired after his controversial attempts to change the retail chain led to a 25 percent plunge in sales (townsend, 2014). to further explain our contentions, we next offer our propositions. to be specific, we assess the possible impact of ceo power, ceo experience, particularly in the case of dynamic industries, and a possible moderating effect of board power on these relationships. 130 journal of business strategies propositions the effect of new ceo power on strategic change according to carpenter (2000), strategic change is comprised of two components. the first one is strategic variation, which refers to change from the existing resource allocation structure of the firm, and the second component is strategic deviation, described as the shift away from the firm’s resource commitments determined by the industry norms. these variations and deviations are managed and handled by the ‘board capital’. as a strategic management concept, hillman and dalziel (2003) described board capital as the sum of the human and social capital of the board of directors and the board’s ability to provide resources to the organization to capture strategic change. one concept is that ceo power acts as an intermediary and moderates the relationship between board capital and strategic variation and deviation (haynes & hillman, 2010). ceo power’s role in strategic decision making (finkelstein, 1992, haynes & hillman, 2010; pearce & zahra, 1991), strategic choice (mackay & chia 2013; quigley & hambrick, 2012; child, 1972), and strategic change (krause & semadeni 2013; hopkins, mallette, & hopkins 2013; haynes & hillman, 2010; hambrick & mason, 1984) to cope with internal and external sources of uncertainty are well documented in the literature. according to finkelstein (1992), for organizations, internal sources of uncertainty are top managers and boards of directors, and major external sources of uncertainty include performance and institutional environments. finkelstein’s (1992) study supports the upper-echelons theory and contends that managerial power affects the relationship between top managers and organizational outcomes. golden and zajac (2001) discussed the effect of boards on strategic change when ceos have power vis-à-vis the board. pearce and zahara’s (1991) typology relating to ceo-board power relationships is worthy of noting. in that study, the authors discuss four different types of ceo power/board power configurations. these board types differ based on composition, characteristics, processes in the organization, and decision making styles of the members of the board. proactive boards exercise more power and they are considered as true instruments of corporate governance. the board power exceeds the ceos power especially when the board consists of outside directors, and in the case of proactive boards, the board’s impact on firm performance is positive. with the participative board, in decision making, the emphasis is on reaching consensus among directors and members of the top management team. therefore, volume 34, number 2 131 negotiation and compromise are essential for effective control (haynes & hillman, 2010). according to haynes and hillman (2010), “a ceo’s preferences with respect to strategic change prevail when the ceo is powerful vis-à-vis the board” (p.1151). ceos may remain committed to the status quo because of industry’s strategic norms (carpenter, 2000) and because industrywide norms reduce competitive uncertainty (spender, 1989). thus, ceos often remain committed to past strategies (datta, guthrie, & rajagopalan, 2002) and strategic conformity to industry central tendencies (zhang & rajagopalan, 2004) because they seek stability in the competitive environment. as a result, “industry effects outweigh the importance of adopting ‘novel strategies’ often associated with the appointment of a new ceo” (haynes & hillman, 2010, p. 1151). “newly appointed ceo’s are known for their proclivity for change, (however) if the ceo is from the firm’s own focal industry, the mandate for change is overridden by the mandate to conform to industry norms” (haynes & hillman, 2010: 1151). another factor which can impact the level of strategic change is career variety of new ceos. crossland, zyung, hiller & hambrick (2014) suggest that ceos with high career variety tend to sponsor rapid change and increased strategic uniqueness so that strategic reorientation is more immediate and transformative. while ceos may tend to follow the status quo and the industry norms in the case of a powerful ceo, it depends on the strategic choices required by the organization. in such a case, the ceo’s preference for industry norms will impact the strategic change/reorientation and may decide the position of the organization in the industry. this is aligned with hambrick and finkelstein’s (1987) managerial discretion concept. the ceo is considered the personification of strategic leadership and is pivotal to the success or failure of an organization (finkelstein & hambrick, 1996). ceos from the outside are sometimes preferred over the inside ceos succession during the time of performance turnarounds because they can bring in fresh perspectives and new skills and they may be more willing to question existing practices and initiate major changes (kesner & sebora, 1994). however, various studies have found that outside ceos are generally less able to have positive effects on firm performance (greiner, cummings, & bhambri, 2002; shen & cannella, 2002; wiersema, 2002). this relates to the disruption and organizational chaos that is often created by the hiring and onboarding of an outsider as the ceo. such disruption often impedes any rapid turnaround efforts of a new outsider ceo. another problem is that “outsiders are less familiar with an organization’s particular routines and competencies and thus are more likely to either ignore or even challenge these 132 journal of business strategies competencies” (zhang & rajagopalan, 2004: 6). strategic change may be required when there is shift in the dynamics of competitive advantage for an industry as a result of technological breakthroughs that favor new rivals, global changes in labor arbitrage, change in cost structure, or new competitors entering markets from other industries. some of the changes are instigated by regulatory upheaval, such as the structural changes to the u.s. healthcare market set in motion by the affordable care act. virtually every ceo of a hospital system in the u.s. is confronting a major disruption to its business model as a result (irwin, topdjian, & ashish, 2013). quigley and hambrick (2012) posit that the retention of the former ceo as board chair restricts a successor’s discretion, thereby diminishing the new person’s ability to make changes and thereby decreasing the new ceo’s potential to greatly alter the firm’s performance. hambrick and finkelstein (1987) first used the term ‘managerial discretion’ and defined it as top management having latitude (flexibility) in their strategic choice and decisions in organizations. rajagopalan and finkelstein (1992) and finkelstein and boyd (1998) further concluded that the greater the level of discretion, the greater the amount of compensation paid to ceos. strategic orientation, environmental change, and reward systems in managerial discretion ultimately affect firm performance. the task environment, the organization, and the managerial capabilities of the ceo are the main determinants for ceo compensation and the discretion emanating from them (hambrick & finkelstein, 1987; finkelstein & boyd, 1998). the ceos who stay on as board chair are often committed to their prior decisions (hambrick, geletkanyez, & fredrickson, 1993; quigley & hambrick, 2012). researchers have studied factors that affect managerial discretion (crossland & hambrick, 2011; finkelstein & boyd, 1998). hambrick and finkelstein (1987) introduced the concept (theoretical construct) of managerial discretion to bridge the gap between two views about how top executive influence their organization so that they are either “inertial or highly adaptive” (p. 369). variation in managerial discretion could potentially be used to assess the suitability of the inertial and strategic-choice views. the polar extremes of executives are described by hambrick and finkelstein (1987) as “the titular figurehead and the unconstrained manager” (p. 369). we propose that, for new ceos in failing firms, power is a critical ingredient for ceo and firm survival. turnarounds in failing firms cannot be expected as a result of simply changing ceos. while the bases of ceo power may vary, the results of ceo power are more predictable. in a recent study, berns and klarner (2017) reported that, contender ceos, those who arrive after the current ones are forced to leave, are more likely to initiate change and likely to succeed. in addition volume 34, number 2 133 that, dowell and shackell (2011) reported increased probability of survival with greater ceo power. we consider managerial discretion as being the foundation for ceo power, and in return propose that, ceo changes in failing firms can only be successful if the new ceo is powerful as stated in the following proposition: proposition 1. ceo changes in failing firms can only increase the chances of firm survival if the new ceo is powerful. various scholars and researchers such as finkelstein (1992); nelson (2003); fischer and pollock (2004); and mackey (2008) further added to the extant literature that the strong position of the ceo in the firm improves the survival prospects of the organization. finkelstein (1992) and fisher and pollock (2004), for instance, observed that the independent position of the ceo in an organization positively affecting the survival prospects for firms facing significant financial distress. powerful ceos will have more impact in an environment that is characterized by low munificence and high uncertainty. such environments offer less with too many unknowns that requires a power source to hold the company together by initializing radical moves to cope up with such windy conditions. position of the ceo gives him/her an ability to take extreme decisions (adams, almeida, & ferreira, 2009). these extreme decisions change the firm’s strategy and in return have an impact on firm’s survival (dowell, shackell, & stuart, 2011). wielding power may not have much impact during periods of organization stability and success. however, as the organization is failing, the ceo capability to utilize power becomes more significant. when an organization faces financial problems, internal or external environmental turbulence and other issues of distress, it is advantageous to have a powerful ceo who can use that power to avoid the stigma of failure and increase the probability of success by making radical decisions. dowell, shackell, and stuart (2011) concluded that the greater the level of financial distress, the more the ceo power decreases the probability of failure. research has documented that firms experience many radical changes in systems, governance mechanisms, and business cycles due to change in ceo power (boone, field, karpoff, & raheja, 2007). firms which are not in equilibrium due to internal or external changes need new governance mechanisms; and failing firms need changes in governance mechanisms to significantly increase their prospect of survival (dowell, shackell, & stuart, 2011). for firms facing a crisis, the powerful ceos are beneficial. they respond faster to the environmental factors and enact necessary changes as required for the firm’s survival and sustenance (dowell, 134 journal of business strategies shackell, & stuart, 2011; boyd, 1995; finkelstein & d’aveni, 1994). powerful ceos have a greater incentive to maintain their reputation as a successful ceo rather than bearing the stigma as having had more responsibility for the firm’s failure (sutton & callahan, 1987). their association with the failure stigmatizes ceos of failed firms (semadeni, cannella, fraser, & lee, 2008). the actions of top management and boards have a direct and profound impact on corporate strategy (haveman, 1993). in short, the failing firm needs powerful ceos and they tend to initiate radical change to turn the company around. the above discussion leads to the below proposition: proposition 2. new powerful ceos of failing firms are more inclined to execute radical change. impact of new ceos from dynamic industries dynamism is about the stability of the environment in which the firm operates. if changes are taking place rapidly in the environment, due to uncertainty, strategic decision makers’ jobs become even more complicated (dess & beard, 1984). in such a turbulent atmosphere, the ceo is challenged to deal with constant change (galbraith, 1979; wholey & brittain, 1989). such an environment turns planning into a more complicated task (aldrich, 1979). for instance, it has been documented that managers operating in such environments are expected to implement broader ranges of strategic options (carpenter & westphal, 2001; karaevli, 2007). if a ceo is experienced to deal with turbulence, a major characteristic of environmental dynamism, he or she can carry that experience forward to manage firms in similar situations. by nature, firms that are failing deal with tremendous amount of turbulence. thinking about the internal routines in failing firms and their apparent failure to deal with the external environment, a ceo who is well equipped with how to deal with turbulence and is willing to use managerial discretion, might be a source of competitive advantage from a resource based view (barney, 1991). in other words, the ceo’s social and human capital becomes an important resource for a failing firm so the chances of survival increase. hence, we offer the following proposition: proposition 3. new ceos with experience in dynamic industries will increase the chances of survival for failing firms. volume 34, number 2 135 moderating role of board power upper-echelons theory highlights that organizational outcomes are affected by the performance of their top managers (hambrick &mason, 1984) and also posits that top management people have to have managerial discretion in strategic decision making. some top managers will have more discretion compared to others depending on the type of organization; hence, managerial characteristics may not always be predictive of organizational outcomes (finkelstein & hambrick, 1990). finkelstein and hambrick (1990) concluded that “(1) organization with long-tenure teams exhibit organizational performance that closely adheres to industry averages, while short-tenure teams are associated with deviations in performance levels; (2) top management-team tenure is more strongly related to strategies and performance in high discretion organizations (within an industry) than in low-discretion organizations” (p.489). moving on to pearce and zahra (1991) typology of board versus executive power, participative type boards, which signifies both parties to be powerful, is the best configuration for organizational outcomes. thinking about failing firms and the argument we made previously regarding the need for powerful ceos and the use of managerial discretion, the other major player of the dominant coalition, board of directors, should enhance the impact of ceos power on organizational outcomes, which in the case of failing firms refers to chances of survival. looking at prior research, several studies assessed the possible moderating effect of ceo power on the relationship between board and organizational outcomes. for instance, combs, ketchen, perryman and donahue (2007) proposed that ceo power interacts with board composition and firm performance. in a more recent study, chen (2014) proposed that board capital and r&d intensity relationship is positively moderated by ceo power. haynes, campbell and hitt (2014) on the other hand, demonstrated the need for powerful boards to minimize the effect of ceo greed while forcing the powerful ceo to work better which then translates into better organizational outcomes. to our knowledge, previous studies did not look at the possible moderating effect of board power on ceo power and firm survival relationship in the case of failing firms. if the ceo is expected to be powerful, particularly in the case of failing firms, paring him or her with a powerful board would not only result in more efficient strategic decision making process but also enhance the current corporate governance structure. we offer the following proposition to be further tested by empirical data: 136 journal of business strategies proposition 4. the relationship between powerful ceos and increased chances of survival will be moderated by board power such that the more powerful the board, the greater the chances of firm survival. conclusions and recommendations when organizations are failing, the prevailing judgment seems to be “change the ceo and do it now.” while we agree that change is needed, we propose that certain features of the ceo should be in place for successful entrenchment. first of all, contrary to the well-known contentions of popular governance theories, such as agency theory, a very powerful ceo is needed for turning around the company. this power is the source for challenging the status quo. if a firm is failing, radical change is needed and this change can only happen through dramatic moves impacting the current company structure. only a powerful ceo can do that. in other words, a ceo who is willing to exercise discretion, can make an impact as urgently needed for a failing firm. in addition, we consider ceo’s experience with dynamic industries to be a determinant factor. in dynamic environments, there is too much turbulence that requires the upper echelons to be on edge all the time. the situation of a failing firm is not very different regardless of the environment in which it operates. hence, a ceo with knowledge of how to deal with turbulence is more likely to change the picture for a failing firm. finally, we proposed a possible moderating effect of board power on the relationship between powerful ceo and chances of survival. we believe that a powerful board will complement the overall entrenchment strategy developed by a powerful ceo. besides, governance mechanisms would work better with such a pairing. all of these propositions are testable with empirical data. future researchers may consider utilizing secondary data sources to verify our propositions. also, we believe that our propositions have both practical and theoretical implications. from a theoretical perspective, we contend that ceo being highly powerful is not such a bad thing in the case of failing firms. this is a challenge to some of the fundamental theories of corporate governance. in addition the need for experience with dynamic industries is consistent with the configurations view. positive impact of the use of managerial discretion and the presence of a powerful board are also consistent with some of the seminal work in corporate governance literature. from a practical perspective, our recommendation to failing firms is to bring in a powerful ceo with experience in dynamic industries, then pair the new executive with a powerful board, and wait for him/her to implement change to save the failing firm. volume 34, number 2 137 in this paper, we offer four propositions to be considered and tested by future researchers. it is natural for firms to go down. however, in many instances some of these firms can be saved by having the right people in place. determining who might be the right person has always been an area of interest for organizational researchers. with this study, we aimed to contribute to this long-time ongoing discussion. references adams, r., almeida, h., & ferreira, d. 2009. understanding the relationship between founder–ceos and firm performance. journal of empirical finance, 16(1): 136-150. aldrich, h.e. 1979. organizations and environments. englewood cliffs, nj: prentice hall. arogyaswamy, k., barker iii, v. l., & yasai-ardekani, m. 1995. firm turnarounds: an integrative two-stage model. journal of management studies, 32: 493-525. barker iii, v. l., & duhaime, i. m. 1997. strategic change in the turnaround process: theory and empirical evidence. strategic management journal, 18(1):13-38. barker iii, v. l., & mone, m. a. 1998. the mechanistic structure shift and strategic reorientation in declining firms attempting turnarounds. human relations, 51(10):1227-1258. barney, j. 1991. firms resources and sustained competitive advantage. journal of management, 7: 99-120. berns, k., & klarner, p. 2017. a review of the ceo succession literature and a future research program. academy of management perspectives, 31: 83-108. baum, j.r., & wally, s. 2003. strategic decision speed and firm performance. strategic management journal, 24: 1107-1129. boone, a.l., field, l.c., karpoff, j.m., & raheja, c.g. 2007. the determinants of corporate board size and composition: an empirical analysis, journal of financial economics, 85(1): 66-101. bourgeois, l.j. 1984. strategic management and determinism, academy of management review, 9(4): 586-596. boyd, b. k. 1995. ceo duality and firm performance: a contingency model. strategic management journal, 16: 301–312. burns, t., & stalker, g. m. 1961. the management of innovation. london: tavistock. carpenter, m.a. 2000. the price of change: the role of ceo compensation in strategic variation and deviation from industry strategy norms. journal of management, 26: 1179–1198. 138 journal of business strategies carpenter, m.a., & westphal, j.d. 2001. the strategic context of external network ties: examining the impact of director appointments on board involvement in strategic decision making. academy of management journal. 4(4): 639-660. chen, h. l. 2014. board capital, ceo power and r&d investment in electronic firms. corporate governance: an international review. 22(5): 422-436. child, j. 1972. organizational structure, environments and performance: the role of strategic choice. sociology, 6: 1-22. combs, j. g., ketchen, d. j., perryman, a. a., & donahue, m. s. 2007. the moderating effect of ceo power on the board composition–firm performance relationship. journal of management studies, 44(8): 1299-1323. crossan, m. m., & bedrow, i. 2003. organizational learning and strategic renewal. strategic management journal, 24(11):1087-1105. crossland, c., & hambrick, d.c. 2011. differences in managerial discretion across countries: how nation-level institutions affect the degree to which ceos matter, strategic management journal, 32: 797-819. crossland, c., zyung, j., hiller, n., & hambrick, d.c. 2014. ceo career variety: effects on firm-level strategic and social novelty, academy of management journal, 57(3): 652-674. daily, c.m., & dalton, d.r. 1995. ceo and director turnover in failing firms: an illusion of change? strategic management journal, 16: 393-400. dalton, d. r., daily, c. m., ellstrand, a. e., & johnson, j. l. 1998. meta-analytic reviews of board composition, leadership structure, and financial performance. strategic management journal, 19: 269–290. dalton, d. r., hitt, m. a., certo, s. t., & dalton, c. m. 2007. the fundamental agency problem and its mitigation: independence, equity, and the market for corporate control. in j. p. walsh & a. p. brief (eds.), academy of management annals, 1: 1–64. essex, uk: routledge. datta, d.k., guthrie, j.p., & rajagopalan, n. 2002. different industries, different ceos? a study of ceo career specialization, human resource planning, 25(2): 14-25. dess, g.g. & beard, d.w. 1984. dimensions of organizational task environments, administrative science quarterly, 29(1): 52-73. dimaggio, p.j., & powell, w.w. 1983. the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48(2): 147–160. volume 34, number 2 139 dowell, g.w.s., shackell, m.b., & stuart, n.v. 2011. boards, ceos, and surviving a financial crisis: evidence from the internet shakeout, strategic management journal, 32: 1025-1045. favaro, k. karlson, per-ola, & neilson, g. l. 2014. the lives and times of the ceo. strategy + business magazine, issue 75: 1-18. retrieved online from http://www.strategy-business.com/article/00254?pg=all#ceo_turnover. finkelstein, s. 1992. power in top management teams: dimensions, measurement, and validation. academy of management journal, 35(3): 505-538. finkelstein, s., & boyd, b.k. 1998. how much does the ceo matter? the role of managerial discretion in the setting of ceo compensation. academy of management journal, 41(2): 179–199. finkelstein, s., & d’aveni, r.a. 1994. ceo duality as a double-edged-sword: how boards of directors balance entrenchment avoidance and unity of command. academy of management journal, 37(5): 1079–1108. finkelstein, s., & hambrick, d. c. 1990. top-management team tenure and organizational outcomes: the moderating role of managerial discretion. administrative science quarterly, 35: 484–503. fischer, h.m., & pollock, t.g. 2004. effects of social capital and power on surviving transformational change: the case of initial public offerings. 47(4): 463-481. franken, a., edwards, c., & lambert, r. 2009. understanding the critical management elements that lead to success. california management review, 51(3): 49-73. fredrickson, j.w., & mitchell, t.r. 1984. strategic decision processes: comprehensiveness and performance in an industry with an unstable environment. academy of management journal. 27(2): 399-423. galbraith, j.r., & nathanson, d.a. 1979. the role of organizational structure and process in strategy implementation. little brown: boston, ma. garg, v.k., walters, b.a., & priem, r.l. 2003. chief executive scanning emphases, environmental dynamism, and manufacturing firm performance, strategic management journal, 24: 725-744. gilley, k.m., mcgee, j.e., & rasheed, a. 2004. perceived environmental dynamism and managerial risk aversion as antecedents of manufacturing outsourcing: the moderating effects of firm maturity, journal of small business management, 42(2): 227-133. gilley, k.m., & rasheed, a. 2000. making more by doing less: an analysis of outsourcing and its effects on firm performance, journal of management, 26(4): 763-790. 140 journal of business strategies golden, b.r., & zajac, e.j. 2001. when will boards influence strategy? inclination x power = strategic change, strategic management journal, 22: 1087–1111. gordon, s. s., stewart, j. h., sweo, r., & luker, w. a. 2000. convergence versus strategic reorientation: the antecedents of fast-paced organizational change. journal of management, 26(5): 911-945. greiner, l., cummings, t., & bhambri, a. 2002. when new ceos succeed and fail: 4-d theory of strategic transformation. organizational dynamics, 32(3): 1–17. hambrick, d.c., & finkelstein, s. 1987. managerial discretion: a bridge between polar views of organizational studies. in l. l. cummings & b.m. staw (eds.) research in organizational behavior, 9: 369–406, greenwich, ct: jai press. reprinted in b.m. staw, & l.l. cummings (eds.), the evolution and adaptation of organizations: 101-138, greenwich, ct: jai press, 1990. hambrick, d.c., geletkanycz, m.a., & fredrickson, j.w. 1993. top executive commitment to the status quo some tests of its determinants. strategic management journal, 14(6): 401–418. hambrick, d.c., & mason, p.a. 1984. upper echelons: the organization as a reflection of its top managers. academy of management review, 9(2): 193– 206. hambrick, d.c., & schecter, s. m. 1983. turnaround strategies for mature industrialproduct business units. academy of management journal, 26: 231–248. hannan, m., & freeman, j. 1977. the population ecology of organizations, american journal of sociology, 82: 929-964. harris, d., & helfat, c.e. 1998. ceo duality, succession, capabilities and agency theory: commentary and research agenda, strategic management journal, 19(9): 901-904. haveman, h.a. (1993). follow the leader: mimetic isomorphism and entry into new markets. administrative science quarterly, 38(4): 593-627. haynes, k.t., & hillman, a. 2010. the effect of board capital and ceo power on strategic change, strategic management journal, 31: 1145–1163. haynes, campbell, & hitt. 2014. when more is not enough: executive greed and its influence on shareholder wealth. journal of management 0149206314535444. herman, e.s. 1981. corporate control, corporate power. new york: cambridge university press. hillman, a.j., & dalziel, t. 2003. boards of directors and firm performance: integrating agency and resource dependence perspectives, academy of management review, 28(3): 383-396. hofer, c. w. (1980). turnaround strategies. journal of business strategy, 2(1): 19. volume 34, number 2 141 hofer, c., & schendel, d. 1978. strategy formulation: analytical concepts. st. paul, minnesota: west publishing. irwin, g. topdjian, j., & kaur, a. 2013. putting an i in the healthcare. business + strategy, 71: 12. retrieved online from http://www.strategy-business.com/ media/file/00167_putting-an-i-in-healthcare.pdf. jauch, l.r., osborn, r.n., & glueck, wf. 1980. short term financial success in large business organizations: the environment-strategy connection. strategic management journal, 1(1): 49–63. karaevli, a. 2007. performance consequences of new ceo ‘outsiderness’: moderating effects of preand post-succession contexts. strategic management journal, 28(7): 681-706. kesner, i.f., & sebora, t.c. 1994. executive succession: past, present & future, journal of management, 20(2): 327-372. ketchen, d., thomas, j.b., & snow, j.b. 1993. organizational configurations and performance: a comparison of theoretical approaches, academy of management journal, 36(6): 1278-1313. krause, r., & semadeni, m. (2013). apprentice, departure, and demotion: an examination of the three types of ceo-board chair separation. academy of management journal, 56(3): 805-826. lant, t. k., milliken, f. j., & batra, b. 1992. the role of managerial learning and interpretation in strategic persistence and reorientation: an empirical exploration. strategic management journal, 13: 585-608. lohrke, f.t., bedeian, a.g., & palmer, t.b. 2004. the role of top management teams in formulating and implementing turnaround strategies: a review and research agenda. international journal of management reviews. 5/6(2): 63-90. mackey, a. 2008. the effect of ceos on firm performance. strategic management journal. 29: 1357-1367. mackay, r. b., & chia, r. 2013. choice, chance, and unintended consequences in strategic change: a process understanding of the rise and fall of northco automotive. academy of management journal, 56(1): 208-230. doi:10.5465/ amj.2010.0734. miller, r. w. 1988. workers, managers, and technological change: emerging patterns of labor relations. employee responsibilities & rights journal, 1(4): 331-333. mintzberg, h. 1978. patterns in strategy formation. management science, 24: 934– 948. 142 journal of business strategies mintzberg, h., & waters, j.a. 1985. of strategies, deliberate and emergent, strategic management journal, 6: 257-272. molz, r. 1985. the role of the board of directors: typologies of interaction, journal of business strategy, 5(4): 86-93. nelson, t. 2003. the persistence of founder influence: management, ownership, and performance effects at initial public offering. strategic management journal, 24(8): 707-724. norburn, d., & birley, s. 1988. the top management team and corporate performance, strategic management journal, 9: 225-237. pearce ii, j. a., & zahra, s. a. 1991. the relative power of ceos. and boards of directors: associations with corporate performance. strategic management journal, 12(2): 135-153. peteraf, m., & reed, r. 2007. managerial discretion and internal alignment under regulatory constraints and change, strategic management journal, 28: 1089– 1112. priem, r.l., butler, j.e. & li, s. 2013. toward reimagining strategy research: retrospection and prospection on the 2011 amr decade award article, academy of management review, 38(4): 471-489. priem, r.l., rasheed, a.m.a., & kotulic, a.g. 1995. rationality in strategic decision processes, environmental dynamism and firm performance, journal of management, 21(5): 913-929. quigley, t.j., & hambrick, d.c. 2012. when the former ceo stays on as board chair: effects on successor discretion, strategic change, and performance. strategic management journal, 33: 834-859. schendel, d., patton, g., & riggs, j. 1976. corporate turnaround strategies: a study of profit decline and recovery. journal of general management, 3: 3-11. semadeni, m., cannella, a.a., fraser, d.r., & lee, d.s. 2008. fight or flight: managing stigma in executive careers, strategic management journal, 29: 557567. shen, w., & cannella, a. a. 2002. revisiting the performance consequences of ceo succession: the impact of successor type, post succession senior executive turnover, and departing ceo tenure. academy of management journal, 45: 717–733. singh, j.v., house r.j., & tucker, d. 1986. organizational change and organizational mortality. administrative science quarterly, 31: 587–611. spender, j.c. 1989. industry recipes. new york: blackwell. volume 34, number 2 143 stacey, r. d. 1995. the science of complexity: an alternative perspective for strategic change processes. strategic management journal, 16(6): 477-495. sutton, r. i., & callahan, a.l. 1987. the stigma of bankruptcy: spoiled organizational image and its management, academy of management journal, 30(3): 405-436. townsend, m. 2014. j. c. penney ex-ceo ron johnson didn’t get severance when he left. business week, p.1. retrieved online from http://www.bloomberg.com/ news/2014-03-07/j-c-penney-ex-ceo-ron-johnson-didn-t-get-severance-whenhe-left.html. virany, b., tushman, m. l., & romanelli, e. 1992. executive succession and organization outcome in turbulent environments: an organization learning approach. organization science, 3: 72-91. wholey. d. h., & brittain, j. 1989. characterizing environmental variation. academy of management journal, 32: 867-882. wiersema, m. f. 2002. holes at the top: why ceo firings backfire? harvard business review, 80(12): 70–77. zajac, e. j., & kraatz, m. s. 1993. a diametric forces model of strategic change: assessing the antecedents and consequences of restructuring in the higher education industry. strategic management journal, 14: 83-103. zhang y. 2006. the presence of a separate coo/president and its impact on strategic change and ceo dismissal. strategic management journal, 27(3): 283–300. zhang, y., & rajagopalan, n. 2010. once an outsider, always an outsider? ceo origin, strategic change, and firm performance. strategic management journal, 31(3): 334-346. zhang, y., & rajagopalan, n. 2004. when the known devil is better than an unknown god: an empirical study of the antecedents and consequences of relay ceo successions. academy of management journal, 47: 483–500. brief biograpical sketch of authors dr. sonia taneja (phd) is an associate professor of management, in the college of business at texas a&m university-commerce. dr. taneja’s primary research focus and publications are in the areas of strategic management and various other management topics from the strategic perspective such as empowerment from the gender perspective, crisis management, and management history. she has published in a number of scholarly peer-review journals including journal of management history, journal of business strategy, international journal of 144 journal of business strategies sustainable strategic management, journal of applied business and economics, and delhi business review. dr. guclu atinc is an associate professor of management at texas a&m university-commerce. his research interests include corporate governance and research methods in social sciences. he currently serves on editorial boards of several national and international journals. his work appeared in numerous outlets such as organizational research methods, journal of organizational behavior, journal of business research and management decision, among others. dr. mildred golden pryor is professor of management at texas a&m university-commerce where she has received many excellence awards for her teaching and research. she has received a number of excellence awards for her research from professional organizations. she also won top excellence awards during her 17 years in industry. dr. pryor has published many articles in a variety of scholarly journals, and she is on the editorial board for several journals. her research interests include: strategic management, quality management, leadership, and related topics. dimensions of culture in cross-border business linkages sara l. keck pace university new york, ny abstract several macroeconomic measures of linkages across numerous national borders are used to explore the impact of cultural distance on international business linkages. greater distances between hofstede's (1980) cultural dimensions are associated with lower total monetary value of several linkages, especially for power distance and individuality. the work here suggests there is cultural bias or constraint in choosing destinations of cross-border linkages. implications of that bias include costs associated with firms that venture outside established paths. introduction porter (1990) acknowledged the effect of culture on economic performance, and others have shown empirically that such a relationship exists. for example, franke, hofstede, and bond (1991) found that culture drives economic growth within the country. they found individualism and confucian dynamism to be positively associated with growth and concluded that cultural characteristics were more strongly related to economic growth than level of gnp per capita, refuting the economic convergence model (baumol, 1986). shane (1993) found that tolerance for uncertainty, individualism, and lack of distance between hierarchical ranks are all positively associated with higher national rates of innovation. the conclusion from previous work must be that factors other than simply economic ones drive economic decisions. firms and nations are not seeking solely other firms in the lowest-cost nations with which to build linkages. important historical cultural variables such as protestantism and achievement motivation (franke, et ai, 1991) and confucian values (hofstede and bond, 1988) are impacting those economic decisions as well. with the exceptions noted above (e.g., shane, 1993; tucker, jain, and failer, 1992), researchers are only beginning to examine the mechanisms through which culture affects measures of macroeconomic performance. the approach in this paper begins with the argument that the aggregate of firms' strategic decisions regarding cross-border linkages is one of the mechanisms through which culture impacts economic performance. cross-border linkages 108 journal of business strategies vol. 13, no. 2 are important because they translate cultural dimensions into firm activity across borders which, when aggregated, become linkages at the macroeconomic level for the nation involved. this is one of the first studies to demonstrate explicitly the aggregate mechanisms through which culture impacts economic performance. those mechanisms are important because the accretion of individual firm strategies impacts cross-border economic relationships among nations. there are several types of linkages among the economies of nations that reflect interorganizational linkages and entry choices. examples are the overall foreign direct investment from one country to another, the total monetary value of all royalties paid by finns in one country to firms in another country, and the total r&d investment of one country's firms in another country. these total amounts indicate the overall value of the relationships that firms are entering. it is important to understand the factors involved in the choice of the most effective international business relationships across national (often meaning economic and cullural) boundaries. there are at least three reasons for this. first, international relationships may act as coordination and control mechanisms for firms and, as such, may be mechanisms for the integration of the global economy. second, ventures abroad, such as foreign manufacturing, entail large investments even more so than in the past (egelhoff, 1988). new entrants have no previous experience from which to draw so initial experiences may be influential in organizational learning regarding linkages. third, the choice of linkages affect the form, structure, and size of the firm (garland, farmer, taylor, 1990). as a result, experiences may become institutionalized for the fiml and even for the industry and economic sector of which the firm is a part. for these reasons, international business linkages as reflected in the macroeconomic linkages has theoretical and practical relevance for transnational finns, industries and economics. other researchers (benito and gripsrud, 1992; keck, 1992; kogut and singh, 1988; tallman and shenbr, 1994) argued that the factors related to choice of interorganizational relationship include: 1) the socio-cullural factors in the country of origin and target country; 2) the organizational characteristics of the firms involved; 3) industry characteristics; and 4) the linkage itself. for example, kogut and singh (1988) empirically demonstrated that firms in countries considered to have cullures more closely aligned with american culture chose entry methods that were less dependent on partnering. further, when socio-cultural distance is great, economic factors will be overridden by cultural ones in the decision making process (benito and gripsrud, 1992; keck, 1992). cultural dimensions and macro linkages socio-cultural differences in managerial style have received systematic attention recently (e.g., adler, 1986a, 1986b; barsoux and lawrence, 1990; fall 1996 keck: cross-border business linkages 109 benito and gripsrud, 1992; calori and lawrence, 1991; hofstede, 1993; kogut and singh, 1988; lachman, nedd, and hinings, 1994; randall, 1993; shenkar and von glinow, 1994). during the decade of the 1980s, systematic evidence of management's cultural blinders has emerged (e.g., kim and naubornge, 1987; von glinow and teagarden, 1988). previous studies have typically addressed distance in a general sense rather than in specific dimensions (anderson and gatignon, 1986; kogut and singh, 1988). for example, kogut and singh (1988) investigated cultural distance as a factor in choice of entry mode and found that cultural distance does play a role in entry mode to the us market but did not specify which dimensions of culture were most important in entry choices. in other general statements of the importance of culture, some studies are beginning to include the impact of specific cultures on international operations (kobrin, 1987; tung, 1987). for example, in the study of expatriate performance, kobrin (1987) found anecdotal evidence that expatriate failures abroad are more often due, not to business conditions, but to the inability of managers to adapt to their assigned locations. more specifically, american expatriates fail more often than european or japanese expatriates because americans lack the international perspective of europeans and the cross-cultural training of the japanese. recognition of general cultural differences and international sophistication is important. but, it may be the cultural distance on specific dimensions rather than cross-cultural sensitivity, generally, that is more important in influencing location choices. this distance concept embodies not only the frequently recognized differences such as asian versus western and planned versus market economy but also more subtle features such as organizational structure and control as well. though other models of culture exist, the hofstede (1980) model provides the conceptual and empirical basis for judging cultural distances based on four dimensions: power distance, uncertainty avoidance, emphasis on individualism, and value placed on styles defined as masculine. hofstede's dimensions are widely used to explicitly recognize one-to-one differences between cultures. therefore, the model proposed here is based upon hofstede's (1980) measures of culture. for example, american firms may be more willing to invest in great britain than in india, chile, or taiwan because the difference between the cultural measures is lower between the u.s. and great britain than between the u.s. and india, chile, or taiwan. of course, the fact that most foreign direct investment into the us is from great britain and the netherlands supports this idea (e.g., us department of commerce, bureau of economic analysis, 1995). international business linkages of all kinds combine different organizational goals, strategy, structure, and personnel. some conceptual work (e.g., keck, 1992; tallman and shenkar, 1994) has recognized that some combinations are likely to be more effective, hence, repeated more often than others, but very little empirical work has documented this to-date. specific differences 110 journal of business strategies vol. 13, no.2 between originating and target cultures may play a major role in influencing which combinations end in successful long-term results that are imitated by firms from one country to another. investigation of differences is important because cultural considerations (embodying language, type of economic system, historical background of the country, and socio-cultural characteristics) may swamp the effects of economic and industrial characteristics when cultural differences are great. national culture is not a monolith. that is, not every member or firm in a culture can be characterized by the attributes of that culture in that there are subcultures and individual differences. there are many similarities or central tendencies, however, that may be observed in individuals and firms. hofstede's (1980) cultural dimensions as defined by national culture are a literature-based means for assessing culture. though there may be some weaknesses in hofstede's (1980) measures, they provide many advantages. because hofstede's (1980) work-related dimensions of culture are the basis of this theory, the relevance of each dimension is briefly described here along with its hypothesized relationship to international business linkages. the four cultural dimensions included are: power distance, uncertainty avoidance, emphasis on individualism, and value of masculinity. power distance refers to the issue of inequality of individuals in the society. in organizations power distance refers to the degree of centralization of authority or the degree of autocratic control (hofstede, 1980). this dimension raises such questions in international linkages as: who maintains control of the linkage; how is control established and maintained; at what level of the organization are decisions made; how is performance evaluated by output or by behavioral measures; and many others. as the distance between these issues increase, the less likely it is that the decision maker will choose the more distant location. therefore, fewer individual firms choose linkages in the more distant culture, and cumulatively the overall value of linkages is lower for the two countries involved. the hypothesis is: hypothesis la: greater differences in power distance between the target and originating nations are associated with lower total monetary value of each type of linkage between those nations. uncertainty avoidance refers to the degree to which a society's members are socialized to live with uncertainty brought about by the fact that the future is unknown. some societies socialize their members to accept uncertainty and not be upset by it. other societies socialize their members to attempt to "beat the future" which creates a higher level of anxiety, emotionality, and aggressiveness (hofstede, 1980). these characteristics suggest that individuals and firms that enter into linkages across national boundaries or cultures have issues to resolve, for example: what types of routine and nonroutine activities fall 1996 keck: cross-border business linkages 111 are they likely to be engaged in; how much fonnal planning must be perfonned; how progress from one step to the next is evaluated; and how decisions to proceed are made. again, as uncertainty-avoidance distance between the two cultures tends to dissuade individual decision makers from choosing the more distant culture, the overall monetary value of each type of linkage goes down for the two nations. the hypothesis is: hypothesis lb: greater differences in uncertainty avoidance between the target and originating nations are associated with lower total monetary value of each type of linkage between those nations. individualism versus collectivism is the third dimension. this is the degree to which the individual is responsible for just looking out for one's self and immediate family. individualism provides a great deal of freedom in the society. in other societies, individuals are taught to look after the interests of one's own ingroup and have limited personal interests (hofstede, 1980). when organizations link across such backgrounds there may be concerns such as: the basis upon which to measure value of the endeavor the individual's personal gain versus the finn's or the nation's; the importance of tradeoffs made between individual gain and society's gain; the degree of integration required of the individuals involved in the linkage; and others. as managers and decision makers differ more widely on these approaches, individual linkages are less likely to occur and the overall monetary value of such linkages will be lower for the two countries. the hypothesis is: hypothesis lc: greater differences in the value of individualism between the target and originating nations are associated with lower total monetary value of each type of linkage between those nations. masculinity versus femininity, the fourth and final dimension, refers to value placed on certain styles and to the division of social roles between genders in society. because social role divisions are more or less arbitrary, hofstede refers to those soci-eties with a high degree of division as masculine and societies with a low degree of division as feminine. related to this division is the value placed on the characteristics of each. that is, showing off, performing, making money, achieving something visible, etc are all valued highly in masculine societies while putting people before money, not showing off, etc are all valued in feminine societies. for organizations, this means that rewards for individuals go to those who match the dominant values. further, decision making systems will exhibit dominant values. in international linkages similar concerns arise: what will the strategic positioning be firstmover versus follower, etc; what will be the primary concerns individual 112 journal of business strategies vol. 13, no. 2 development versus profitability; and others. again, the distance between preferred styles will affect individual decisions and cumulatively result in lower overall monetary value of all linkages. the hypothesis is: hypothesis 1d: greater differences in the value of masculinity versus femininity between the target and originating nations are associated with lower total monetary value of each type of linkage between those nations. specialized strengths to enter linkages some cultures are less likely to succeed in linkages across cultural boundaries in general. for example, kobrin (1987) argued that americans fail in expatriate assignments more to difficulty in cross-cultural adjustment than to business conditions. if this is the case, american managers may be expected to have fewer and lower value cross-border linkages than managers from other countries. hofstede (1980) suggests that firms from cultures that have lower uncertainty avoidance will acquire more cross-cultural sensitivity, ceteris paribus. therefore, firms from cultures that have lower uncertainty avoidance will enter into linkages of all kinds and even vague, unstructured tasks such as research and development more frequently than firms from cultures that seek to avoid uncertainty. because the us has a relatively low uncertainty avoidance score compared to other nations, one would expect the american managers to have higher cross-cultural sensitivity, and higher-valued linkages, not lower. this extension from hofstede places hofstede's and kobrin's assessments in conflict. hofstede's suggestion is explicitly hypothesized here in the context of cross-border linkages. the hypothesis is: hypothesis 2: lower uncertainty avoidance of individual nations will be associated with greater values of all linkages, especially less-structured ones. methods sample data available in foreign direct investment in the united states and u.s. direct investment abroad used in the study are reported only at the level of national economies and only for those with linkages to the us. this may create a bias in the results in that only linkages to and from the us are included. however, there are also advantages in that the data used are consistent and comparable because they come from one data source. the economic data were combined with the work-related cultural values developed by hofstede (1980). data for which economic linkages and hofstede's measures were both available resulted in a maximum sample of 22 countries. countries included in the final sample include i3 west european fall 1996 keck: cross-border business linkages 113 countries, and australia, new zealand, japan, taiwan, canada, brazil, venezuela, israel, and the us. linkages between countries in either direction are included. measures-dependent variables though several types of linkages could be included, the following were available from the data sources: foreign direct investment, income, and return from the investment; capital inflows; royalty payments and receipts from licensing and from services other than those included in licensing; and r&d expenditures. descriptions of the dependent variables are summarized from the two sources from which the data were taken: i) foreign direct investment in the united states, 1990; and 2) u.s. direct investment abroad, 1985. these sources report values for 1987 and 1982, respectively. all values for these variables are reported in millions of dollars per capita to standardize the results by size of the economy. in keeping with commonly used methods, natural logs were taken of the standardized values and were used as the final form of the dependent variables. us foreign direct investment abroad was collected from the u.s. direct investment abroad (1990). investment abroad is us parents' equity in, and net outstanding loans to, their foreign affiliates. this is viewed as the us parents' contribution to total assets of the foreign affiliate. us foreign direct investment income is that which can be directly attributable to the us parent's contribution. us return on foreign direct investment is a return on investment (rgi) income divided by investment. foreign investment in the us, foreign direct investment income, and foreign return on investment in us are analogous to us foreign direct values. for these variables, investment abroad is investment by foreign affiliates in the us. expenditures for r&d in the us by foreign affiliates were taken from foreign direct investment in the united states (1885). the value used here is for r&d expenditures in all industries from each country included in the sample. r&d by us firms abroad and foreign r&d in us are a measure of research activity, whether it was done for themselves or for others. both measures of r&d expenditures represent the extent to which vague or indefinite tasks have been entered into by firms from each country represented. royalty payments and royalty receipts are direct investment royalties and licensing fees. payments are to us firms and receipts are from foreign affiliates (u. s. direct investment abroad, 1990). service payments and service receipts are for miscellaneous arrangements other than direct investment royalties and licensing fees. royalty and service payments are to us firms and royalty and service receipts are from foreign affiliates (u. s. direct investment abroad, 1985). these measures represent more specific, definite, and contract-oriented arrangements, and as such, contrast to the vague, more indefinite arrangements of the r&d expenditure measures. 114 journal of business strategies vol. 13, no.2 foreign capital inflow (to the us) consists of equity capital inflows, reinvested earnings, and intercompany debt inflows. equity capital inflows are net increases in foreign parents' equity in their us affiliates, whether incorporated or unincorporated. reinvested earnings of us affiliates are earnings less distributed earnings after capital gains and after us income taxes. intercompany debt inflows consist of the increase in us affiliates' net intercompany debt pay abies to their foreign parent during the year. this measure reflects change from one year to the next. us capital inflow (to other countries) is defined comparably to foreign capital inflow except that each component flows in the opposite direction from foreign capital inflow. measures-independent variables whereas kogut and singh (1988) used a composite measure of cultural distance, the measures here are individual dimensions. this allows for comparison of the effects of the distance between each cultural dimension. while, uncertainty avoidance is often pointed to as the most important dimension (e.g., anderson and gatignon, 1986; kogut and singh, 1988), this study tests whether this is the case. measures of the four work-related cultural dimensions were taken directly from hofstede (1980). these four dimensions (power distance, uncertainty avoidance, individualism, and masculinity) were discussed in the theory section and will not be individually described here. rather, a summary description of the values used will be described. the values for all the dimensions range from zero to 100 with higher values representing stronger, more apparent occurrences of the cultural trait. that is, higher scores represent more power distance among people, more uncertainty avoidance, more emphasis on the individual rather than the group, and more value on showing off or performing, etc. (or masculinity, to use hofstede's term). one set of analyses uses these actual-value scores (table 1). the distance measure on each dimension is simply the absolute value of the difference between the score for the us and the nation of the affiliate whether that nation entered the us or the us entered that nation. one set of analyses uses these distances. analyses analyses of the data included simple correlations and ordinary least squares for each of the dependent variables. both actual values of hofstede's measures and the distance values described in the measures section were used as independent variables in separate regressions. variance inflation factors were used to verify that there was no significant multicollinearity among the cultural values in any of the models. fall 1996 keck: cross-border business linkages 115 table 1 countries and culture values that are in study uncertainty masculinity vs. qlli.n!n'. power distance avoidance individualism femininty index rank index rank index rank index rank australia 36 13 51 17 90 49 61 35 austria 11 i 70 26~27 55 33 79 49 belgium 65 33 94 45-46 75 43 54 29 brazil 69 39 76 28-30 38 25 49 25 canada 39 15 48 12-13 80 46-47 52 28 denmark 18 10-12 23 3 74 42 16 4 finland 33 8 59 20-21 63 34 26 7 france 68 37-38 86 36-41 71 40-41 43 17-18 germany 35 10-12 65 23 67 36 66 41-42 great britain 35 10-12 35 6-7 89 48 66 41-42 ireland 28 5 35 6-7 70 39 68 43-44 israel 13 2 81 32 54 32 47 23 italy 50 20 75 28 76 44 70 46-47 japan 54 21 92 44 46 28-29 95 50 netherlands 38 14 53 18 80 46-47 14 3 norway 31 6-7 50 16 69 38 8 2 new zealand 22 4 49 14-15 79 45 58 34 philippines 94 47 44 10 32 21 64 39-40 spain 57 23 86 36-41 51 31 42 15-16 sweden 31 6-7 29 4-5 71 40-41 5 i switzerland 34 9 58 19 68 37 70 46~47 taiwan 58 24-25 69 25 17 10 45 20-21 united states 40 16 46 ii 91 50 62 36 venezuela 81 45-56 76 28-30 12 4 73 48 source: hofstede, g. "national cultures in four dimensions." international studies of management and organization 13(1-2) (1983):52 results table 2 presents the descriptive statistics and correlations for the independent and dependent variables. table 2 shows that the measures of both actual and distance measures of cultures are frequently correlated with the dependent measures of linkages; distance is significantly correlated slightly more often. although not all the correlations between distance and the linkage variables are significant, many of them are, and all in the predicted direction except for return on investment. return on investment may not be negatively correlated with distance values because returns can be negative. partially supporting the hypotheses, differences in power distance and individualism are negatively correlated overall with the value of the linkages. table 2 correlations with descriptive statistics 0\ 2 3 4 5 6 7 8 9 10 ii 12 13 14 15 16 17 18 19 20 21 us income abroad' (i) us investment abroad' (2) +.97''' foreign income in us' (3) +.78'" +.80'" foreign investment in us' (4) +.73'" +.76'" +.97''' us r&d expenditure abroad' (5) +.66'" +.72'" +.92'" +.90'" foreign expenditure in us' (6) +.84'" +.85'" +.79'" +.76'" +.76'" royalty payments to affiliates' (7) +.76"'+.71"'+.80"'+.76"'+.75'''+.78''' royalty receipts from affiliates' (8) +.63' +.60' +.56 +.53' +.53' +.42 +.47 service payments to affiliates' (9) +.86'"+.90''' +.84'" +.77'" +.77''' +.82'" +.72'" +.83'" service receipts from affiliates' (10) +.52' +.61" +.77"'+.72'''+.75'''+.74'''+.52' +.84'''+.56' us capital inflow' (lj) +.81''' +.79'" +.68" +.52' +.42 +.53' +.46' +.44 +.69" +.40 foreign capital inflow' (12) +.65" +.67'''+.93''' +.94'" +.82'" +.65" +.66" +.51 +.68" +.62" +.45 annual us returns abroad' (l3) -.02 -.25 -.23 -.24 -.32 -.18 +.11 -.19 -.29 -,45' -.15 annual foreign returns in us· (14) -.08 -.11 -.13 -.38 -.31 -.15 -.36 +.00 -.22 -.18 +.26 power distance" (is) -.72'" -.68'" -.71" -.71''' -.66'" -.66'" -.71'" -.33 -.61" -.38 -.44 uncertainty avoidance" (l6) -.35' -.34 -.27 -.20 -.25 -.10 -.22 -.49 -,45' +.17 -.28 individualism" (17) -.70'" -.69'" -.77'" -.62" -.67'" -.76'"-.81''' -.19 -.72'" -.44 -,49' masculinity" (l8) -.02 -.10 +.22 +.20 +.14 -.03 +.17 -.19 -.02 -.13 -.30 power distance" (l9) -,45' -.38 -.66" -.44' -.50' -.44' -.59" -.44 -,47' -.17 -.31 uncertainty avoidance" (20) -.29 -.27 -.35 -.25 -.26 -.13 -.30 -.45 -,45 +.14 -.21 individualism (21) -.50'" .49'" .31''' -.40" -.19 -.22 +.55'" -.56" .32 -.52" -.24 masculinity (22) -.11 -.03 -.10 -.09 -.09 -.07 -.17 -.06 -.18 +.13 +.18 n= 23 .. ' p :0; .001 .. p :0; .01 , p :0; .05 -.17 -.35 +.14 -.68'" -04 -.17 -.00 -,48' +.06 +.22 +.36 -,47 -.23 -.14 -.05 -.27 -.15 -.01 -.33 +.46 -.02 +.12 -.20 +.18 -.09 +.28 -.15 +.32 +.67'''+.32 -.23 +.00 -07 +.56" +.29 +.56" -.26 +.27 +.79'" +.39 -.23 +.41 +.65'" -,4t' +.72'" .08 -.67'" -.31 +.21 +.22 +.22 -.76"'+.22 +.38 2:;::: ~ ~..... ~ o:l ::: ""5' '"'"""""v1 ~.... '"'"i)q ~. "" ·.22 ~ -vj z ? tv fall 1996 keck: cross-border business linkages table 2 correlations with descriptive statistics (continued) 117 us income abroad" (i) us investment abroad" (2) foreign income in us" (3) foreign investment in us" (4) us r&d expenditure abroad" (5) foreign expenditure in us' (6) royalty payments to affiliates" (7) royalty receipts from affiliates' (8) service payments to affiliates" (9) service receipts from affiliates' (l0) us capital inflow' (11) foreign capital inflow' (12) annual us returns abroad" (13) annual foreign returns in us' (14) power distanceb (15) uncertainty avoidance" (16) individualism" (17) masculinity" (18) power. distance (19) uncertainty avoidance (20) individualism (21) masculinity (22) a: log of per capita values b: absolute value of distance mean +3.95 +5.76 +2.40 +5.14 +0.36 +0.93 +1.01 -2.86 +0.85 -0.16 +3.21 +3.58 -1.81 -2.92 +17.04 +20.61 +28.96 +19.17 +43.48 +61.04 +62.04 +50.91 standard deviation 1.20 1.24 2.14 1.98 2.65 1.48 1.80 1.36 1.64 202 1.46 2.13 0.29 0.59 13.34 14.56 21.09 17.52 21.66 20.48 21.09 23.72 number 23 23 16 23 23 23 23 15 21 20 19 21 23 16 23 23 23 23 23 23 23 23 actual-value models eight of the sixteen regression models using the actual values of cultural dimensions were significant (table 3). the coefficient for hofstede's uncertainty dimension was not significant in any of the actual-value models. hypothesis 2 is not supported when looking at international linkages at the level of the national economy. this conflicts with previous conclusions of significance such as in kogut and singh (1988). in the actual-value models, only individualism is typically significant with positive standardized coefficients. these results suggest that higher levels of individualism are associated with more investment abroad, more r&d expenditure abroad, and more royalty and service payments. the individualism dimension is the only consistently significant actual-value measure. this suggests that cultures more oriented toward personal gain are involved in greater values of all kinds of linkages. distance models though not all distance models are significant, the results of the regression analyses provide partial support for the hypotheses (table 3). first, the ...... table 3 ...... 00 regression results+ (standardized coefficients) us foreign royalty service annual annual us investforeign lnvestforeign us royalty receipts service receipts foreign us us foreign income ment income ment r&d r&d payments from payments from capital capital return return abroad abroad in us in us in us abroad to affil affil to affil affil inflow inflow abroad in us distance models power distance -0.48** -0.46** -0030 -0.52** -0.36* -0038* -0.23 0.13 -0.16 -0.29 -0.62** -0030 -0.02 0.80** ~ uncertainty :;;:: ~avoidance -0.08 -0.07 -0.03 0.05 0.29** 0.01 -0.10 -060 -0.21 0.39 0.03 -0.06 -0.03 -0.09 i:l individualism -0.36* -0.37* -0.28 0.42*** -0.75*** om "--0.54* -0.62*** -0.52*** -0.36 -0.07 -0.28 0.11 -0.44 ~masculinity -0.15 -0.22 0.04 0.06 -0.18 0.03 0.06 -0.18 -0.08 -0.21 0.10 -0031 0.36 0.02 n 22 22 15 22 22 22 22 14 20 19 20 18 22 15 tl::i :;;:: f 7.594*** 7.267** 5.415***10.684*** 5.198***18.579*** 0.977 5.344*** 2.107 3.631 ** 2.164 0.708 1.266 "'"5.044** -.;:s actualvalue models (\l ""power distance -0.09 -0.00 -0.19 -0.16 ""-029 -0.15 -0.08 -0.04 -0.06 0.07 -0.35 -0.09 -0.36 0.22 v:l uncertainty .... ~ avoidance -0.02 -0.05 -0.07 0.01 0.19 0.02 0.08 -0.56 -0.21 0.31 0.13 -0.07 0.13 -013 ....(\l [ndividualism 0.65*** 0.70*** 0.59* 0.55** 0.80*** 0.59** 0.81 *** -0.06 0.62*** 0.64** 0.32 0.44 -0.29 0.07 00 ~. masculinity 0.06 0.14 0.16 0.06 0.05 0.07 0.01 0.22 0.05 0.17 0.07 0.24 -0.37 -0.20 "" n 22 22 15 22 22 22 22 14 20 19 20 18 22 15 f 4.419** 4 .337** 5.275** 2.954** 7.249*** 4.155** 15.961 *** 0.809 5.128*** 1.852 1.726 1.522 1.2[3 0.272 + the author uses the term foreign because us government documents use this term to refer to all non-us sources. r2 is not reported because it is not appropriate for the panel data used here. *** p s .01 ** p s .05 * p s .10 ~ ...... w z o tv fall 1996 keck: cross-border business linkages 119 models for investment and income abroad, us r&d expenditures abroad, r&d expenditures in the us, and royalty and service payments to affiliates are all significant. between 34 and 58 percent of the variance in these models is explained by cultural distance. using the distance measures, two types of linkages do not have statistically significant models. first, return on foreign investments is not significant though the amounts of the foreign investment and income from foreign investments are significant. this may be because the measure used, roi, is a shortterm measure of return and may not be representative of relationships that take many years to become profitable. a long-term measure of return may be needed to assess the value of these linkages between countries. a second type of model that was not significant were the royalty and service payments from affiliates (while royalty and service payments to affiliates were significant). this may reflect a bias in the data in using only us data. that is, some other selection bias may be operating in those countries that seek to license and purchase services in the us. wider data collection may help resolve this possible bias in the data. with two exceptions, the significant distance coefficients are all in the predicted direction. standardized coefficients are reported for each model so that the relative importance of each cultural dimension may be assessed. each distance variable will be discussed separately. virtually the same linkage models are significant in the distance set as the ones in the actual-values set. however, the significant coefficients in the two sets of analyses are different. whereas only individualism is significant in the actual-values models, both power distance and individualism are significant in the distance models. the difference in power distance is significant in seven of the fourteen linkages. overall, the greater the differences in power distance between the two cultures, the lower is the dollar value of the linkage. indicating one of the two strongest effects of all the cultural dimensions, the differences in power distance are often the largest standardized coefficients in each model. the difference in individualism is consistently significant (in the models that are significant overall). the coefficient for distance in individualism is significant for us investment and income abroad, foreign income in the us, r&d in the us and abroad, and for royalty and service payments. the hypothesis for this cultural dimension is supported overall it was hypothesized that the greater the distance in individualism between host and home country, the less the value of the linkages. the results for distance between individualism suggest that this cultural dimension may be very important in future investigation. uncertainty avoidance was significant in only one distance model and not in the predicted direction. the lack of significance of this variable is intriguing given that uncertainty avoidance receives so much attention from cultural literature (anderson and gatignon, 1986; kedia and bhagat, 1989; kogut and singh, 1988) as well as from the decision-making literature. 120 journal of business strategies vol. 13, no.2 the hypothesis for the distance between orientation toward masculine versus feminine characteristics was not supported in any of the models. the lack of results here may result from the potential confounds of gender role and value of traits labeled as masculine. discussion the purpose of the study was to investigate the role of culture in choices of international business linkages. it was predicted that greater distances between cultures would lead to lower overall linkages across those cultures. that the distance between cultural measures are significant more often than the actual-value measures of culture partially supports the overall arguments made here. that is, cultural distance influences linkages more than either cultural sensitivity in general or the specific attributes of the culture from which the firm is operating. the results here also provide an opportunity to assess which dimensions may be more influential than others in linkage choices. the study here shows that differences in the power and the individualism dimensions are most significant and deserve the most attention in future studies. previously, authors have emphasized uncertainty avoidance but have only studied the absolute values rather than distance between cultures or have converged all the dimensions without evidence that they operate in similar patterns (e.g., kogut and singh, 1988). a possible future extension of the results is to investigate which type of linkage is chosen by specific firms from each of these national cultures. one possible question might be the extent to which cultural distance affects the type of linkage chosen or which is chosen more frequently than another. the difference in power distance had a strong, consistently negative relationship with the value of the studied linkages. given that the difference in power distance was so consistently strong and significant in this study, there may be many valuable routes to pursue in studying the types of control mechanisms firms from each national culture employs. at least for linkage decisions among nations, the way managers perceive the hierarchy, power, and control mechanisms may be a significant aspect of choosing partners and markets, or the mechanisms through which managers deal with those partners. the results for distance in power distance suggest that there are many ramifications for firms seeking to establish linkages across borders. firms that follow preexisting routes may have a history that will greet them. first, the ways in which linkages are structured may need careful analysis in that the needs of both partners must be designed and balanced with those of the other. choice of which party will maintain control of the relationship could lead to expectations of partner requests such that firms may be seen as originating from nations requiring controlling interest, equal partnership interest, and/or minority interest. if firms from more distant cultures perceive too much or too fall 1996 keck: cross-border business linkages 121 little hierarchy and/or control, negative experience may result bad publicity, avoidance of future linkages, institutionalization of suspicion toward firms from the outside country could result for the outside firm and/or nation. such cultural barriers could lead to legal or practical limitations on relationships available to other firms searching for advantageous locations. firms can develop a reputation for linkages with other firms, and may be sought out or avoided. for example, unilever and corning are known for their successful linkages (bartlett and ghoshal, 1989). when this happens across borders, not only is the firm's reputation developed, but that of the nation as well. an example of a cross-border effect on reputation might be the indonesian automobile industry's hesitance in entering collaborative arrangements with american auto makers while preferring european auto makers. the second ramification of the results relates to decisions about the level at which decision making and control reside. as those expectations vary across borders, practical limitations on relationships may again emerge. the results for the distance between individualism in the us and other nations was also very significant. the differences in orientation toward personal versus group gains in linkages could have many ramifications for managing linkages with and entries into other countries. the results suggest that potential differences in the assessment of which parties will gain in the linkage and how the gain will be distributed seem to have pervasive effects on the total monetary value of linkages across nations. given that differences in individualism has such a strong effect, it may be that the structure of decisions (how uncertainty is avoided) is less important than the differences in how gains are expected to be distributed. that is, expectations may be as important as actual economic arrangements. because, cultural characteristics may sometimes overwhelm economic ones, conditions under which the result here is obtained must be examined. the lack of significance of the difference in uncertainty avoidance was surprising. it was expected that this dimension would be particularly important in linkages because uncertainty avoidance impacts the type and amount of planning, the types of activities that individuals perform well, etc. this cultural dimension was only significant for foreign r&d in the us, and it is associated with larger values of payments. given that uncertainty reduction has played such a significant role in previous work (e.g., kogut and singh, 1988), future research could address the reasons why uncertainty is not significant at the aggregate level. the results here suggest that, holding all other cultural dimensions constant, uncertainty reduction is relatively unimportant in the economic decisions studied. this is surprising given that uncertainty is closely aligned with economic variables such as rational expectation, etc. the results for masculinity are most difficult to interpret. first, there seem to be two separate factors being measured by this dimension: 1) the distance between gender roles in the culture; and 2) the value placed on masculinelabeled characteristics. the lack of results may occur because the us seems 122 journal of business strategies vol. 13, no. 2 to be in the middle of the range of scores for this dimension (masculinity = 62), and, as a result, positive and negative distance scores wash out any results. on the other hand, the lack of any significant results may indicate that linkages built in cultures with "feminine" styles are successfully executed because the "feminine" partners are using cooperative behaviors that neutralize the distances that would otherwise be a problem. the lack of results requires further examination to suggest possible theoretical explanations. conclusion this paper addressed aggregate cross-border linkages of firms between the us and several other countries and investigates the impact of cultural distance between country of origin and target country. the paper differs from previous studies for three reasons. first, the national aggregate of strategic organizational activity across borders was the unit of analysis rather than the firm-to-firm relationships used in studies such as benito and gripsrud (1992) and kogut and singh (1988). second, cross-border linkages are considered the mechanisms that drive the impact of culture on economic activity performance. third, the study assessed specific dimensions of culture rather than an index. this study has several implications for managers and decision makers. first, cultural bias or constraint in establishing and investing in linkages was demonstrated firms from all studied countries tended to choose linkages to countries with the closest cultural dimensions. this aggregate result implies that finns may be likely to choose linkages along established paths because other firms have done so. future analysis could assess whether firms that choose to go outside the established paths experience benefits or disadvantages. for example, firms may incur higher costs and higher strategic penalties. on the other hand, they may discover culturally-based factors of strategic advantage overlooked by economic analyses. further, researchers may address whether firms who do not use established paths seize the benefits for themselves or whether followers of their strategies benefit more. although this study has begun to combine cultural bases of economic behavior with linkages across national boundaries, there are several limitations that provide further opportunity for future extensions of this research. first, no economic nor organizational factors were entered as theoretical or control variables. second, none of the variables have been measured at the level of the firm. third, more nations and other types of linkages must be included. fourth, only one model of culture has been used. while some consider hofstede's (1980) model controversial, it is also the most widely accepted. therefore, while the chosen model of culture may have weaknesses, it also has many advantages of measurability, acceptability, and availability. the limitations provide opportunities for future study. one avenue for addressing the impact of culture on organizational level linkage decisions would include both organizational culture as well as national culture in determinants fall 1996 keck: cross-border business linkages 123 of linkages. although not directly related to this study, a second organizational stream is suggested. a valuable research agenda would also include the development of dimensions of organizational culture that could be applied to nations in the same way individual responses were used to construct hofstede's cultural characteristics. this would address concerns of some researchers who believe there is a mismatch between hofstede's cultural dimensions and aggregate firm behavior. finally, effective strategic management requires more than economic analysis. recognition of culture is needed in what has traditionally been considered economic decisions. cultural knowledge can become a tool of strategic choice when cultural factors are explicitly recognized for their impact on choices among cross-border linkages. the study here has shown that, similar to economic analyses, cultural analyses can be "serious business" even when they are implicit. references adler, n. j. "a typology of management studies involving culture." journal of international business studies 14(2), (l986a): 29-48. adler, n. 1. "the cultural relativity of organizational practices and theories." journal of international business studies 14(2), (i 986b): 75-90. anderson, e. and h. gatignon. "mode of foreign entry: a transaction cost analysis and propositions." journal of international business studies 17(3), (1986): 1-26. bartlett, c. a. and s. ghoshal. managing across borders: the transnational solution. cambridge, ma: harvard business school press, 1989. barsoux, j. and p. lawrence. management in france. london: cassell educational, ltd., 1990. baumol, w. j. "productivity growth, convergence, and welfare: what the long-run data show." american economic review 76 (1986): 1072-1085. benito, g. r. g. and g. gripsrud. "the expansion of foreign direct investments: discrete rational location choices or a cultural learning process?" journal of international business studies 23(3), (1992): 461-476. calori, p. w. and p. lawrence. the business of europe: managing change. london: sage publications, 1991. egelhoff, w. g. "strategy and structure in multinational corporations: a revision of the stopford and wells model." strategic management journal, 9 (1988): 1-14. 124 journal of business strategies vol. 13, no.2 franke, r. h., hofstede, g., and m. h. bond. "cultural roots of economic performance: a research note." strategic management journal 12 (1991): 165-173. garland, j., farmer, r. n., and m. taylor. international dimensions of business policy and strategy. 2nd edition. kent international business series. boston: pws-kent publishing co, 1990. hofstede, g. "cultural constraints in management theories." academy of management executive 7 (1993): 81-94. hofstede, g. culture's consequences: international differences in work-related values. beverly hills, ca: sage publications, 1980. hofstede, g. and m. h. bond. "the confucius connection: from cultural roots to economic growth." organizational dynamics 16(4), (1988): 4-21. kedia, b. l. and r. s. bhagat. "cultural constraints on transfer of technology across nations: implications for research in international and comparative management." academy of management review 13(4), (1989): 559-571. keck, s. l. "determinants of interorganizational linkage choice: the case of entry mode choice into the ec." in proceedings of the southwest academy of international business 1992, ed. k.s. cooper, (1992): 161-170. kim, c. w. and r. a. naubornge. "cross-cultural strategies." the journal of business strategies 4 (1987): 28-36. kobrin, s. j. "expatriate reduction and strategic control in american multinational corporations." human resource management 27(1), (1987): 63-75. kogut, b. and h. singh. "the effect of national culture on the choice of entry mode." journal of international business studies 19(3), (1988): 411-432. lachman, r., nedd, a., and b. hinings. "analyzing cross-national management and organizations: a theoretical framework." management science 40(1), (1994): 40-55. porter, m. e. competitive advantage of nations. new york: free press, 1990. randall, d. m. "cross-cultural research on organizational commitment: a review and application of hofstede's value survey module." journal of business research 26 (1993): 91-110. shane. s. "cultural influences on national rates of innovation." journal of business venturing 8 (1993): 59-73. shenkar, o. and m. a. von glinow. "paradoxes of organizational theory and research: using the case of china to illustrate national contingency." management science 40(1), (1994): 56-71. fall 1996 keek: cross-border business linkages 125 tallman, s. b. and o. shenkar. "a managerial decision model of international cooperative venture formation." journal of international business studies 25(1), (1994): 91113. tucker, l. r., jain, s. c., and b. failer. "factors affecting the decision to invest in eastern europe." scandinavian international business review 1(2), (1992): 3-20. tung, r. l. "expatriate assignments: enhancing success and minimizing failure" academy of management executive (1987): 117-126. us department of commerce. bureau of economic analysis. u. s. direct investment abroad: 1982 benchmark survey data. washington: bureau, 1985. us department of commerce. bureau of economic analysis. foreign direct investment in the united states: 1987 benchmark survey, final results. washington, dc: bureau. 1990. von glinow. m. a. and m. b. teagarden. 'the transfer of human resources management technology in sino-us cooperative ventures: problems and solutions." human resource management 27(2), (1988): 201-229. sara l. keck is associate professor of management at pace university. she received her ph.d. from columbia university. her research focuses on top management teams and international mangement and appears in various scholarly journals. she is currently working on projects relating to transnational top teams and top team innovativeness. she has taught in indonesia, germany, great britain, and the czech republic. she teaches competitive business strategy and innovation management. dimensions of culture in cross-border business linkages volume 40(1) p.37-52 received: march 16, 2022 revision received: december 19, 2022 accepted: january 6, 2023 https://doi.org/10.54155/jbs.40.1.37-51 business model innovation through open innovation: empirical evidence from the automotive industry benedict seiferlein a, dominik k. kanbach b a hhl leipzig graduate school of management, leipzig, germany. benedict.seiferlein@hhl.de (corresponding author). b hhl leipzig graduate school of management, leipzig, germany. dominik.kanbach@hhl.de. abstract although open innovation (oi) has been characterized as one key driver for business model innovation (bmi), the literature lacks an in-depth understanding of how oi influences the business models (bm) of new ventures. however, such an understanding is crucial for improving the value creation and value capture for technological innovations in inbound oi settings. based upon a unique data set of 19 new ventures from 7 countries, which participated in europe’s largest oi platform, this study finds that oi leads to an expansion in the customer segment, a greater focus in the value proposition, a shorter (but deeper) value chain, and challenges to the revenue model. the paper highlights important theoretical contributions for the bmi and oi literature, and derives tangible managerial guidance for entering oi partnerships. keywords business model innovation, open innovation, automotive industry, new ventures 1. introduction business model innovation (bmi), defined by casadesus-masanell and zhu (2013, p. 464) as “the search for new logics of the firm and new ways to create and capture value,” has become increasingly decisive for commercializing technologies, gaining sustainable competitive advantages, shaping industries, and increasing firm performance (seiferlein et al., 2023). the elaboration of these new value creation and value capture logics into a consistent business model (bm), in which the customer segment, value proposition, value chain, and revenue model are coherently defined, is thereby of key strategic importance to entrepreneurs and a source for innovation in and of itself (zott & amit, 2010). however, despite two decades of research, the academic understanding of how bmi is achieved, and how this affects the elements of a bm, remains limited—particularly for new ventures (foss & saebi, 2017). one of the foremost suggestions for purposefully enabling bmi can be found in the open innovation (oi) literature, which argues that bmi is facilitated by deliberately integrating external partners into the development of new bms (foss & saebi, 2017). following this reasoning, companies this work is licensed under a creative commons attribution-noncommercial 4.0 international license. © 2023 the authors. https://doi.org/10.54155/jbs.40.1.37-51 benedict.seiferlein@hhl.de dominik.kanbach@hhl.de seiferlein & kanbach / journal of business strategies (2023) 40:37-52 38 should use oi to validate assumptions about the customer segment, value proposition, value chain, and revenue model and innovate these bm elements based on feedback from external partners (ibarra et al., 2020). however, thus far, this recommendation has been primarily derived from anecdotal evidence or purely conceptual works (e.g., chesbrough & rosenbloom, 2002; saebi & foss, 2015). accordingly, foss and saebi (2018) concluded that the impact of oi on bmi requires further academic scrutiny. we argue that the need to understand the consequences of oi on bmi is especially critical for new ventures due to the increased flexibility of their bms, smaller companies’ greater reliance on oi to overcome their liabilities of size, the fact that new ventures’ perspectives on oi are underresearched, and the collaboration between incumbents as stimuli for new ventures’ bmi needs further scholarly attention (albats et al., 2021; spithoven et al., 2013; urbaniec & żur, 2021). given thisstartingpoint, newventuresmightparticularly benefit from previously identified benefits of oi, such as increased creativity, more successful technology exploitation, and improved market access, to advance their bmi (chesbrough & appleyard, 2007; chesbrough&schwartz, 2007; marulloetal., 2018). therefore, we ask the research question: how does oi influence bmi in new ventures? we answer this by applying a qualitative research approach, based on a sample of new ventures that participated in europe’s largest oi platform between 2016—2022. building upon a rich and unique data set, including interviews with founders, ceos, and key personnel of 19 new ventures from 7 countries, we provide empirical evidence of how oi impacts bmi alongside the bm components customer segment, value proposition, value chain, and revenue model. in so doing, we provide three main contributions: first, we heighten the understanding of how bmi is fostered—which is among the most frequentlycited gaps in the bmi literature (seiferlein et al., 2023). second, by studying how oi influences bmi as a context-specificfactor, weanswertherequestsfor further research on an issue expressed in recent bmi and oi literature reviews (e.g., foss & saebi, 2017; spender et al., 2017). third, we provide valuable managerial lessons for entrepreneurs and corporate managers engaging in oi, especially since bmi and strategic management are inherently linked (casadesus-masanell & ricart, 2010). the remainder of the paper is structured as follows. section 2 provides the theoretical background on bm and bmi, oi and open bm, and the connections between them. once done, we introduce our methodological approach, before presenting our findings and integrating them into the ongoing academic and managerial discussion. 2. theoretical background business models and business model innovation bms have been defined as “management’s hypothesis about what customers want, how they want it, and how the enterprise can organize to best meet those needs, get paid for doing so, and make a profit” (teece, 2010, p. 172). hence, they serve to define the economic boundaries for converting technological inventions into viable innovations, and link the company-internal technological sphere with the market (chesbrough & rosenbloom, 2002). with this architecture of operations, bms influence the diffusion of novel technologies and speed of market penetration, for which an innovative bm itself could well be a decisive factor (urbinati et al., 2019). moreover, bmi represents an additional opportunity to differentiate from the competition (chesbrough, 2007a). however, conducting bmi is often characterized as a challenging, multifaceted, and interwoven strategic activity, for which new ventures routinely lack the requisite knowledge (garcía-gutiérrez & martínez-borreguero, 2016; kraus et al., 2022). moreover, the existing literature offers new ventures only limited empirical guidance (snihur & zott, 2020). indeed, it tends to only offer instruction on conducting experiments with bm configurations and integrating company-external feedback to reduce a bm’s technological and market seiferlein & kanbach / journal of business strategies (2023) 40:37-52 39 uncertainties (micheli et al., 2020). similarly, trimi and berbegal-mirabent (2012) and ibarra et al. (2020) have advocated for integrating customers for pursuing bmi to validate hypotheses and achieve consistency between a new venture’s offerings and customer expectations. however, hossain (2017) concluded in his bmi literature review that there is still a significant scarcity of knowledge on customer integration for bmi. among those gaps is how customers influence the outcome of bmi in detail (micheli et al., 2020). from a theoretical lens, these recommendations resonate with oi, which is frequently-mentioned in the bmi context, but rarely explicitly discussed (saebi & foss, 2015). thus, recent bmi literature reviews call for more empirical studies on the intersection of bmi and oi (e.g., foss & saebi, 2017). open innovation chesbrough and bogers (2014, p. 3) defined oi as a “distributed innovation process based on purposively managed knowledge flows across organizational boundaries, using pecuniary and non-pecuniary mechanisms in line with the organization’s bm.” the literature differentiates between inbound oi, which is concerned with creating value through integrating external inputs (e.g., ideas, know-how), and outbound oi, which uses external paths to a market for commercializing excess assets (e.g., patents). oi is thus a potential strategy with which to increase firms’ creativity, gain access to new markets, reduce costs and risks, and ultimately improve profitability (chesbrough & appleyard, 2007; chesbrough & schwartz, 2007). in a recent study of 251 european companies, teplov et al. (2019, p. 26) found that inbound oi is more prevalent than outbound oi, while highlighting that only “free revealing, scanning for external technologies, subcontracting r&d, customer co-creation in r&d projects, and idea and start-up competitions” were commonly acknowledged as oi practices by the participants. their results accorded with spieth and meissner’s (2018) observation that the academic discussion of oi is primarily concerned with advancing technological innovations from an r&d perspective. however, in environments with increasing r&d costs and shrinking product life cycles, chesbrough (2007b) proposed applying oi not only in r&d, but also following an open business models logic. open business models according to weiblen (2014, p. 57), “an open business model describes the design or architecture of the value creation and value capturing of a focal firm, in which collaborative relationships with the ecosystem are central to explaining the overall logic”. hence, the interactions between customers and suppliers in an open bm transcend straightforward selling and sourcing transactions in that they also involve a deeper integration of value creation and capture (weiblen, 2014). for instance, this is typically the case for car manufacturers, where suppliers account for approximately 75% of the created value and profoundly influence their partners (seiferlein et al., 2023). frankenberger et al. (2014) argued that inconsistencies in a bm, the pressure to find a new bm for value creation and value capture, collaboration experience, imitation of open bm patterns, and the blurring of industry boundaries are conducive for open bms. however, empirical evidence still lacks details on how this openness influences bms (holm et al., 2013). saebi and foss (2015) argued that the economic benefits of oi for bmi are determined by bm configuration, as well as the breadth and depth of the applied oi strategy. their purely conceptual work suggested that new ventures with radical innovations should design their bm through intensive collaboration with key partners, which is also in line with pynnönen et al.’s (2012, p. 11) recommendation to integrate customers into the bmi “from the very beginning”. in the same vein, marullo et al.’s (2018) crosssectional study of start-ups identified a positive correlation between the integration of external knowledge and successful technology exploitation. however, neither of these studies have provided empirical insights into exactly how firms do this, nor how this affects the bm in detail. this disparity is in line with the knowledge gap on seiferlein & kanbach / journal of business strategies (2023) 40:37-52 40 how bmi arises in new ventures, as well as which role the integration of customers or other firmexternal actors play in bmi (andreini et al., 2021; hossain, 2017; snihur & zott, 2020). consequently, spender et al.’s (2017) literature review on startups and oi concluded with a call to investigate new ventures’ bmi using qualitative research methods based upon original data. accordingly, we seek to narrow this research gap with the present study. 3. methodology research design case-based research is particularly well-suited to studying the dynamics of complex processes with limited pre-existing theoretical foundations, exploring relationships between interrelated concepts, and advancing theory building based on the examined cases (gehman et al., 2018). since all of these aspects apply to our research question, we opted to apply a qualitative research approach (andreini et al., 2021). next, we chose a research context likely to allow for replication between the studied new ventures (eisenhardt, 1989). thus, we focusedourattention on the automotive industry, which is especially appropriate for studying the effects of oi on bmi for four reasons: first, the industry is traditionally highly collaborative with long-standing experience in codeveloping innovations in a tier structure of manufacturers (jacobides et al., 2016). these structures include: tier 1, system suppliers; tier 2, parts suppliers; and tier 3, raw material suppliers. second, the industry is confronted with increasing cost pressure and shrinking product life cycles, as well as market pressure to develop more autonomous, connected, and sustainable mobility options, thereby further emphasizing the need for bmi and oi (ili et al., 2010; leemann et al., 2021; seiferlein et al., 2022). third, the industry is increasingly following chesbrough’s (2007b) recommendations to use oi to create and capture value with bmi (spieth & meissner, 2018). fourth, the automotive industry commonly utilizes startup autobahn—europe’s largest oi platform as measured by the number of partners and implemented projects (daimler ag, 2021; startup autobahn, 2020). since its inception in july 2016, the platform has grown to include 29 corporate partners, and 289 new ventures from 43 countries have developed 380 prototypes, of which every fourth has achieved commercialization following the experimentation phase (schwarze, 2021). drawing our sample from this well-established program allowed us to control for potential influencing factors, such as differences in program design, cross-check inferences between multiple participants of the same program, and benefit from a large variety of interview partners. moreover, startup autobahn is a stage-agnostic program for new ventures, thereby enabling us to gain in-depth insights into oi’s influence on bmi irrespective of the maturation of new ventures. accordingly, this served to increase the generalizability of our findings. finally, the program connects new ventures with incumbents from the automotive industry, including such car manufacturers as mercedes-benz, hyundai, and porsche, and automotive suppliers like basf, bosch, schaeffler, and zf—who can become potential customers for a commercial pilot r&d project with the new venture. as such, these collaborations between new ventures and firmlyestablished corporates fit the oi archetype from a practitioners’ perspective, thus increasing our study’s practical relevance (teplov et al., 2019). data collection following gioia et al. (2012), we collected extensive primary and secondary data through various means. first, we conducted 19 semi-structured interviews with founders and c-level representatives of emerging firms headquartered in austria, bulgaria, finland, israel, germany, slovakia, and the united states, all of whom had participated in startup autobahn since its inception. the participants were randomly selected and approached either in-person, via social media, or through the snowballing technique (biernacki & waldorf, 1981). we conducted the interviews in either gerseiferlein & kanbach / journal of business strategies (2023) 40:37-52 41 man or english, and transcribed them within 48 hours of the interview. our interviews included questions about the bm before their participation in startup autobahn, the introduction of changes during and due to the program, and the lessons they had drawn from their participation. moreover, we also asked individual follow-up questions. second, we conducted in-person field visits to startup autobahn’s oi events in stuttgart, germany, and attended virtual community meet ups to engage in an informal exchange with representatives of new ventures, such as ceos, cfos, and members of the founding team. third, we also attended iaa mobility 2021 (the world’s largest mobility fair) in munich, germany, in order to meet startup autobahn alumni in an industry-specific setting and learn more about the venture’s development. collectively, the field notes and meeting memos gathered for the primary data greatly enhanced our understanding. moreover, we extensively collected secondary data from such sources as podcasts, public interviews with the founders and collaboration partners of the new ventures, and startup autobahn’s own publications (e.g., video recordings of pitches and community events). additionally, we searched for academic and lay publications about the program with search engines, such as ebsco host, google search, and google scholar, to triangulate our findings. having completed the above steps, we collected and analyzed the data iteratively until we reached theoretical saturation, as suggested and defined by thornberg and charmaz (2014). data analysis we followed gioia et al.’s (2012) guidelines for the data analysis, which included coding the transcribed primary and secondary data in maxqda, and built a data structure to categorize our findings. hence, we formed informant-centric firstorder concepts, data-driven conceptual secondorder themes, and connected them with established aggregated dimensions in the bmi literature. consequently, we related each of our twelve second-order themes to one of the four bm components customer segment, value proposition, value chain, and revenue model as found in frankenberger et al. (2013). this final abductive aggregation enabled cross-fertilization within the bmi research domain, contributed to consolidation within the bmi literature, and allowed us to follow an approach applied in other bmi papers (e.g., daood et al., 2021). the result of the data analysis is illustrated in figure 1a and 1b, while additional supporting quotes can be found in table 2 in the appendix. 4. findings our findings indicate that oi influences every component of the bm in three distinctive aspects. we explain these results in the following section. customer segment a bm’s customer segment defines the target group for a company’s offering (frankenberger et al., 2013). our data reveals that oi is conducive for extending the customer base, regardless of whether a new venture has previously been exposed to the specific industry. as such, oi can pave the way for getting in contact with key decision-makers in potential clients and securing their commitments more rapidly than in more closed business settings, thus easing entry into a new industry. one interviewed partner put this rather succinctly: from our point of view, they [startup autobahn] opened us a network in the automotive industry that otherwise would have taken me, as a business developer, a very long time to reach the right contact. the opportunity to talk to a porsche innovation manager at startup autobahn that knows the exact relevant contact and can open that door or make that reference is really, really helpful. interestingly, many of our interview partners—who strategically used oi to enter the automotive industry—strongly discouraged other new ventures from engaging in oi as early as possible, regardless of whether they may have been accepted to an oi program. instead, they shared their experiences that being close to havingaproductready, andreachingthetippingpoint between an explorative and exploitative mode, is seiferlein & kanbach / journal of business strategies (2023) 40:37-52 42 fig ure 1a: da tas tru ctu re seiferlein & kanbach / journal of business strategies (2023) 40:37-52 43 fig ure 1b: da tas tru ctu re seiferlein & kanbach / journal of business strategies (2023) 40:37-52 44 table 1: interview list # position country of ventures’ headquarters 1 ceo & co-founder austria2 ceo & co-founder bulgaria3 sales director finland4 ceo & co-founder finland5 ceo finland6 ceo & co-founder germany7 head of business development germany8 head of marketing germany9 ceo & co-founder germany10 ceo & co-founder germany11 ceo & co-founder germany12 ceo & co-founder germany13 ceo germany14 general manager israel15 general manager israel16 vice president israel17 head of business development slovakia18 sales director united states19 head of business development united states the optimal moment to use oi. indeed, the ceo of a new venture explained: it is crazy and not recommended to participate [in oi] at the beginning of the company, but at that point when you have a product, once you have market maturity, once you want to communicate directly and everything is scalable for the oem, once you know what the customers want, and you know “we just have to make some little adjustments and then let’s go.” that’s the moment when such a program makes sense. an executive of another new venture similarly argued that detailed preparation is pivotal before oi makes sense, due to the thorough checks that even stage-agnostic programs entail for the bms of new ventures: my advice to startups coming to startup autobahn is don’t come before you don’t have all your answers ready. you really need to invest time, effort, and money in building that information brief that has all the answers that the industry is going to require. [...] you need to understand that you will be asked a lot of hard questions, and the answer cannot be, “we don’t know,” or, “we need to check.” you really need to be ready. for companies with a prior initial track record in the industry, oi influences the customer segment by significantly easing expansion within the industry. this is initiated by intentionally making the collaboration visible to the public and the collaboration partner’s organization. one interviewee explained: we produced one video for mercedes and one for porsche, wrote an article, and, of course, did several posts on linkedin. [...] this helped us get a good level of positive internal communication within the respective firms [...]. what we achieved, thanks to this, is that our product is currently rolled out to further mercedes-benz plants, and we’re in talks with porsche on further expanding there, too. this openness also smooths expansion into additional application areas. the new ventures can thus utilize their innovative achievements in one industry alongside their public exposure to venture into areas. one interviewee summarized this thusly: one could see that we were able to expand the types of customers we are able to target [with our solution] since we moved from a pure sales and seiferlein & kanbach / journal of business strategies (2023) 40:37-52 45 automotive retail solution to one that’s also suitable for automotive engineering applications. interestingly, the positive benefits of oi for advancing the customer segment are not limited to industry boundaries. instead, they inspire new ventures to seek additional potential markets, and cross-fertilize business development in adjacent and distant industries, such as aerospace, architecture, pharmaceuticals, and system and machine construction. additionally, according to our primary data, they provide a signaling effect to stakeholders beyond the initial industry. one interviewee exemplified this point: startup autobahn has been a boost for the entire company, even for customers who have nothing to do with automotives. also, the communication of our project has been a boost for investors and sales in the architecture area. it helped us unquestionably to elevate the entire company to a higher level. these extensions in the customer segment ultimately also lead to significant changes in the value proposition. value proposition the value proposition of a bm specifies which value-adding products and services are offered to the customer segment (frankenberger et al., 2013). we found empirical evidence that—thanks to oi—new ventures meticulously reflect on their value proposition, gain an increased level of focus, and ultimately calibrate their offerings to established industry requirements. an interviewee explained: from the technological solution point of view, it also gives more understanding of what kind of physical interfaces we really need to create, meaning the hardware interfaces and software interfaces, and what kind of standards and certifications we need to take care of and study in the long run. a co-ceo and co-founder added: what helped us was to get a sort of a benchmark of what other business models are out there for engineering tools [like ours and] learn from the customer first-hand: what gets billed? what are the specific collaboration modes? what are the service levels, etc.? this led to an itemization of requirements. furthermore, this mix of in-depth and informal exchanges with a variety of industry experts enables new ventures to validate the demand for their solutions, as well as to identify in which areas they have a competitive advantage that should become the focus for their future value proposition. an interview partner exemplified this by stating: eventually, we decided to focus only on providing the foil for our automotive segment by ourselves, and not the electric controller [...] we just had to realize: we cannot offer an entire system, but we have to specialize ourselves onto the core technology. finally, oi supports new ventures in transforming their value proposition into modular offerings, from which customers have higher sourcing flexibility. furthermore, oi motivates them to proactively decrease evaluation barriers from a customer perspective so as to attract additional customers in the future. one interviewee illustrated: we were confirmed through [our participation in] startup autobahn that it’s important to offer components which you can bundle easily [...] if you have industry partners, which have different business models, products, etc., they ask, “what can this startup contribute?” and therefore, i have to make it easy for them and offer a box, where i can say: “this is a working system, just try it out, you can adapt it easily to your needs.” [...] this offering approach is something which has been encouraged by startup autobahn, and which we now offer. all of these value proposition changes also impact the value chain. value chain the value chain details how organizations create and deliver the value proposition through orchestrating activities and processes (frankenberger et al., 2013). according to porter (2004, p. 46), it consists of the primary activities “inbound and outbound logistics,” “operations,” “marketing and sales,” and “service,” as well as the support activities “procurement,” “technology development,” “human resources management,” and such “firm seiferlein & kanbach / journal of business strategies (2023) 40:37-52 46 infrastructures” as finance and general management. our data reveals that new ventures capitalize upon oi to integrate their activities in the industry’s value network, which leads to a shorter and deeper value chain within the new ventures. one co-founder summarized this through stating: on the value creation side, a change occurred in the way we develop, which led us to open our ecosystem and purposefully decide to locate parts of the value chain in a partner. the increased concentration of the value chain along the specialization in key activities facilitates a standardization for all of its remaining parts. accordingly, new ventures heavily engage in the implementation of industry-specific certifications, such as iso and din-compliances, and manage the professionalization of internal workflows in suchawayastoimprovecollaborationwithclients and the manufacturability of their solution. an interviewee explained: the tricky thing is to rig up the collaboration management from a startup perspective in such a way that innovation management, product management, etc., is professionalized very quickly. however, this is challenging for firms, because within the startup autobahn [program] it’s hectic, much is done in an “on request” fashion, and all this has to be transferred into a standard operation mode. finally, new ventures take oi as a vehicle for making significant adjustments to their value chain in terms of strengthening their marketing presence. in particular, they generate brand awareness and build up reference cases so as to fuel further growth: we’re in an industry where you don’t have to ask, “is there a non-disclosure agreement?” but “how many non-disclosure agreements are there?” [...] therefore, it’s always difficult for startups to get visible, and what helps is that such open innovation projects are, by definition, made accessible to a closing panel, a community, or, in the best case, even the press. and that is always very good because then you do have a reference case. all of these changes in customer segment, value proposition, and value chain also impact the revenue model. revenue model the revenue model outlines a bm’s financial aspects, and details the cost and revenue mechanisms through which a company intends to generate profits (frankenberger et al., 2013). our data suggest that new ventures strategically employ oi to evaluate how much value their innovative solutions generate for customers—which is essential information for improving their profitability and own value capturing mechanisms. for example, one interviewee characterized this as follows: what we have learned through dxc was that we were able to quantify how much savings in terms of money we can bring the customer. [...] so we learned a bit about how we need to price one of our solutions. concerning the pricing of oi projects, multiple ventures also made the thought-provoking discovery that increasing the price for oi collaboration serves to heighten the chances of a successful collaboration, since a higher price increases the visibility of the project within the corporate and guarantees management attention. one ceo elaborated upon this in detail: we have a higher probability that the customer supports and actively works with us whenever we charge a substantial amount for such [oi] projects. indeed, the projects that performed worse were those we did for free. these projects go on and on, lack the management attention because the senior management doesn’t know what the frontline employees do, and therefore, the vice president doesn’t know what the team leader does with us, etc. it all boils down to the question of how high-level the project is anchored. and this correlates directly with the project price. that’s a question of commitment and a question of “who’s authorized to approve budgets?” and the more we charge, the higher the project goes in the hierarchy, and the more closely the project gets monitored, and the better the work that gets done at the bottom of the organization. however, according to our data, after establishing an initial oi collaboration between the new venture and a corporate partner, the latter may increase the pressure on the cost and margins of seiferlein & kanbach / journal of business strategies (2023) 40:37-52 47 the former. this is done through applying their market power and in-depth industry know-how in estimating prices through the entire value chain. therefore, corporate partners may impose their billing terms on new ventures, for instance, for extending due dates, and undertake thorough due diligence to uncover any potential for decreasing the cost of the new venture’s solution from a customer’s perspective. one interviewee described it thusly: we had to decrease our overall costs considerably and display the pricing structure for the product very, very transparently to the oem, but also to the tier-1, and as a result, our revenue per square meter shrunk substantially. based upon the shared understanding that the industry prefers lower unit prices over lasting exclusivity rights for commercializing the new venture’s solution in their end product, oi leads to increased sales volumes, which is mutually beneficial for both parties. an interviewee explained: the automotive industry is not so eager to have a kind of exclusivity because even porsche said to us, “you can talk to daimler, you can talk to other car makers,” because they understood that if [our solution] comes exclusively, then the price point will jump. and i think they have learned these kinds of lessons that it’s better to be able to scale it to the huge volumes because, at the end of the day, it comes cheaper to them as well. but obviously, they want to have a certain advantage, perhaps, let’s say, one or two years in advance so that they can be the first company to launch it to the marketplace. in conclusion, our findings underline that oi also influences the revenue model. in the following section, we summarize and discuss our findings in the light of the ongoing academic debate. 5. discussion this study examines how oi influences bmi in new ventures (figure 2). to explore this issue, we applied a qualitative research approach based upon 19 new ventures which participated in europe’s largest oi platform. through clustering our findings into customer segment, value proposition, value chain, and revenue model—as per frankenberger et al.’s (2013) bm framework—we were able to empirically underline how new ventures achieve consistency within their bms through pursuing oi with incumbents as their customers. we provide empirical evidence of how oi leads to an expansion in the customer segment and enables new ventures to enter new industries, accelerate growth in entered industries, and leverage their experience in one sector to prepare for an expansion into others. thus, we confirm previous findings that oi can enable new ventures to identify industries where their solutions can create value (e.g., chesbrough & schwartz, 2007). however, our results contradict the preeminent notion in the bmi and oi literature that a very early engagement in oi is advantageous (e.g., pynnönen et al., 2012). indeed, the experts in our sample consistently stressed the importance of thoroughly preparing the engagement in an oi platform in order to be ready to capitalize on the momentum for scaling the bm. thus, based on our data, we argue that, if new ventures wait to commence oi until they are abundantly prepared, it will increase the odds that oi becomes the tipping point for a new venture to shift from an explorative to an exploitative mode. hence, our data suggest that the managerial recommendation for bmi should not be to integrate customers “from the very beginning” (pynnönen et al., 2012, p. 11), but instead at a point where the new venture is prepared to engage in a meaningful exchange with potential partners. forthevalueproposition, weconfirmmoschneret al.’s (2019) finding that oi is conducive for developing a value proposition from a new venture’s perspective, andextendtheliteraturebydetailingoi’s impact on the value proposition. moreover, we found evidence to suggest that oi might increase the creative potential of what is offered to the customer (cf. chesbrough & appleyard, 2007). however, we have also demonstrated that the market pressure to comply with, and adjust to, established industry practices works against the creative push often associated with oi when viewed from a new ventures’ perspective. therefore, we argue that, in order to maintain the initial creative momentum, new ventures must balance their deseiferlein & kanbach / journal of business strategies (2023) 40:37-52 48 figure 2: oi influence on bm components sire to receive early market feedback with the benefits of developing a solution detached from the direct influence of conformity with the dominant design. in line with chesbrough and appleyard (2007), we have demonstrated that new venture’s value chains become complementary to those already present in the industry. given the predominance of open bms in the automotive sector, this leads to a comprehensive integration of the new ventures into a global value network. consequently, their value chain becomes both shorter and deeper due tospecializationandstandardization, thuslimiting the creative potential for applying unusual practices for value creation in a so highly-regulated and standardized domain as the automotive industry. thus, our data again underline that a prematureengagementinoimighthamperthedevelopment of unusual approaches to create value. finally, we have stressed oi’s influence on the revenue model and confirmed previous research emphasizing the cost reductions which can be realized through oi (cf. chesbrough & schwartz, 2007). however, our data also accentuates that—contrary to previous understandings in the literature—this does not improve profitability per se (e.g., ili et al., 2010). instead, new ventures’ margins are challenged in an oi partnership between new ventures and corporates, thereby reflecting the unevenly distributed market power of the partners. this flipside of oi has been underemphasized in the literature, which could possibly be correlated with the lack of research on new ventures’ perspectives. thus, in light of these findings and the persistent need to improve the academic and managerial understanding of oi’s influences on bmi, this study encourages a careful reflection on the two following aspects. first, the findings underline the importance of identifying the optimal point in time to engage in oi. as demonstrated, this is vital to offset certain disadvantages of oi, such as pressure on margins or loss of creative potential due to premature oi engagement. second, we stress that the gains for one oi partner can come at a price for the other. consequently, we argue that taking the firm’s individual perspective into consideration—for instance, concerning experience with industry requirements—is a critical managerial task before pursuing bmi through oi. 6. limitations and future research we conducted our study with high theoretical and methodological rigor. nevertheless, we acknowlseiferlein & kanbach / journal of business strategies (2023) 40:37-52 49 edge that our research is not free from limitations, which themselves may inspire future research. we studied the effects of oi on bmi in an inbound oi setting in one industry. accordingly, we here acknowledge that the effects may well differ between inbound and outbound oi, as well between industries (spender et al., 2017). however, we mitigated the potential disadvantages of this research setting by examining the most relevant form of oi from a practitioner’s perspective (teplov et al., 2019). moreover, we focused on an industry for which research calls for oi have been expressed, the need for bmi is preeminent, and which hosts europe’s largest innovation platform (ili et al., 2010; seiferlein et al., 2022; startup autobahn, 2020). moreover, our application of a qualitative research method may have limited the generalizability of our findings compared to other methods. however, we would argue that our adoption of this research method is well-justified given the sparse existing theoretical underpinnings. furthermore, by studying 19 new ventures from 7 countries which participated in startup autobahn at different points in time during the last 6 years—and by following gioia et al.’s (2012) guidelines to yield empirical results based on rigor—we believe that our findings are valuable and transferable for entrepreneurs and executives in similar settings. nonetheless, we would value additional quantitative studies to further deepen the understanding of how oi influences bmi. these studies could build upon the identified relationships, quantify the individual impact of the firstorder and second-order themes, and test our hypothesis with a larger sample size. moreover, furtherstudiescouldmeasuretheimpactofpotential mediators on the oi-bmi relationship, such as the absorptive capacity, dynamic capabilities, strategic agility or the previous oi and bmi experience of the studied new ventures, to name but a few (cf. foss & saebi, 2017; zhang et al., 2021). finally, our explicit consideration of the perspective of new ventures for examining oi’s effects on bmi was due to persistent calls in the literature. notwithstanding, we acknowledge that future studies with an inverse corporate perspective could complement our research and draw useful comparisons with our findings, as suggested recently by milei (2022). references albats, e., podmetina, d., & vanhaverbeke, w. (2021). open innovation in smes: a process view towards business model innovation. journal of small business management, 1–42. https://doi.org/10. 1080/00472778.2021.1913595 andreini, d., bettinelli, c., foss, n. j., & mismetti, m. (2021). business model innovation: a review of the process-based literature. journal of management and governance, 26(4), 1089–1121. https: //doi.org/10.1007/s10997-021-09590-w biernacki, p., & waldorf, d. (1981). snowball sampling: problems and techniques of chain referral sampling.sociologicalmethods&research,10(2),141–163.https://doi.org/10.1177/004912418101000205 casadesus-masanell, r., & ricart, j. e. (2010). from strategy to business models and onto tactics. long range planning, 43(2-3), 195–215. https://doi.org/10.1016/j.lrp.2010.01.004 casadesus-masanell, r., & zhu, f. (2013). business model innovation and competitive imitation: the case of sponsor-based business models. strategic management journal, 34(4), 464–482. https: //doi.org/10.1002/smj.2022 chesbrough, h. (2007a). business model innovation: it’s not just about technology anymore. strategy & leadership, 35(6), 12–17. https://doi.org/10.1108/10878570710833714 chesbrough, h. (2007b). why companies should have open business models. mit sloan management review, 48(2), 22–28. chesbrough, h., & appleyard, m. m. (2007). open innovation and strategy. california management review, 50(1), 57–76. https://doi.org/10.2307/41166416 https://doi.org/10.1080/00472778.2021.1913595 https://doi.org/10.1080/00472778.2021.1913595 https://doi.org/10.1007/s10997-021-09590-w https://doi.org/10.1007/s10997-021-09590-w https://doi.org/10.1177/004912418101000205 https://doi.org/10.1016/j.lrp.2010.01.004 https://doi.org/10.1002/smj.2022 https://doi.org/10.1002/smj.2022 https://doi.org/10.1108/10878570710833714 https://doi.org/10.2307/41166416 seiferlein & kanbach / journal of business strategies (2023) 40:37-52 50 chesbrough, h., & bogers, m. (2014). explicating open innovation: clarifying an emerging paradigm for understanding innovation. new frontiers in open innovation. oxford: oxford university press, forthcoming, 3–28. chesbrough, h., & rosenbloom, r. (2002). the role of the business model in capturing value from innovation: evidence from xerox corporation’s technology spin-off companies. industrial and corporate change, 11(3), 529–555. https://doi.org/10.1093/icc/11.3.529 chesbrough, h., & schwartz, k. (2007). innovating business models with co-development partnerships. research-technology management, 50(1), 55–59. https://doi .org/10.1080/08956308.2007. 11657419 daimler ag. (2021). 5th anniversary of startup autobahn: the most successful innovation platform in europe continues to grow internationally [publisher: mercedes-benz group media]. https: //group-media.mercedes-benz.com/marsmediasite/en/instance/ko/5th-anniversary-ofstartup-autobahn-the-most-successful-innovation-platform-in-europe-continues-togrow-internationally.xhtml?oid=50810034 daood, a., giustiniano, l., & gatti, m. (2021). exploring the evolution of business model innovation alliances: the case of velasca. international journal of innovation management, 25(07), 2150079. https://doi.org/10.1142/s1363919621500791 eisenhardt, k. m. (1989). building theories from case study research. the academy of management review, 14(4), 532–550. https://doi.org/10.2307/258557 foss, n. j., & saebi, t. (2017). fifteen years of research on business model innovation: how far have we come, and where should we go? journal of management, 43(1), 200–227. https://doi.org/10. 1177/0149206316675927 foss, n. j., & saebi, t. (2018). business models and business model innovation: between wicked and paradigmatic problems. long range planning, 51(1), 9–21. https://doi.org/10.1016/j.lrp.2017.07. 006 frankenberger, k., weiblen, t., csik, m., & gassmann, o. (2013). the 4i-framework of business model innovation: a structured view on process phases andchallenges. international journal of product development, 18(3/4), 249–273. https://doi.org/10.1504/ijpd.2013.055012 frankenberger, k., weiblen, t., & gassmann, o. (2014). the antecedents of open business models: an exploratory study of incumbent firms. r&d management, 44(2), 173–188. https://doi.org/10. 1111/radm.12040 garcía-gutiérrez, i., & martínez-borreguero, f. j. (2016). the innovation pivot framework: fostering business model innovation in startups: a new tool helps entrepreneurs design business models by identifying the sources of competitive advantage embedded in an innovation. researchtechnology management, 59(5), 48–56. https://doi.org/10.1080/08956308.2016.1208043 gehman, j., glaser, v. l., eisenhardt, k. m., gioia, d., langley, a., & corley, k. g. (2018). finding theory–method fit: a comparison of three qualitative approaches to theory building. journal of management inquiry, 27(3), 284–300. https://doi.org/10.1177/1056492617706029 gioia, d. a., corley, k. g., & hamilton, a. l. (2012). seeking qualitative rigor in inductive research: notes on the gioia methodology. organizational research methods, 16(1), 15–31. https://doi.org/10. 1177/1094428112452151 holm, a. b., günzel, f., & ulhøi, j. p. (2013). openness in innovation and business models: lessons from the newspaper industry. international journal of technology management, 61(3/4), 324–348. https://doi.org/10.1504/ijtm.2013.052674 hossain, m. (2017). business model innovation: past research, current debates, and future directions. journal of strategy and management, 10(3), 342–359. https://doi.org/10.1108/jsma-01-20160002 https://doi.org/10.1093/icc/11.3.529 https://doi.org/10.1080/08956308.2007.11657419 https://doi.org/10.1080/08956308.2007.11657419 https://group-media.mercedes-benz.com/marsmediasite/en/instance/ko/5th-anniversary-of-startup-autobahn-the-most-successful-innovation-platform-in-europe-continues-to-grow-internationally.xhtml?oid=50810034 https://group-media.mercedes-benz.com/marsmediasite/en/instance/ko/5th-anniversary-of-startup-autobahn-the-most-successful-innovation-platform-in-europe-continues-to-grow-internationally.xhtml?oid=50810034 https://group-media.mercedes-benz.com/marsmediasite/en/instance/ko/5th-anniversary-of-startup-autobahn-the-most-successful-innovation-platform-in-europe-continues-to-grow-internationally.xhtml?oid=50810034 https://group-media.mercedes-benz.com/marsmediasite/en/instance/ko/5th-anniversary-of-startup-autobahn-the-most-successful-innovation-platform-in-europe-continues-to-grow-internationally.xhtml?oid=50810034 https://doi.org/10.1142/s1363919621500791 https://doi.org/10.2307/258557 https://doi.org/10.1177/0149206316675927 https://doi.org/10.1177/0149206316675927 https://doi.org/10.1016/j.lrp.2017.07.006 https://doi.org/10.1016/j.lrp.2017.07.006 https://doi.org/10.1504/ijpd.2013.055012 https://doi.org/10.1111/radm.12040 https://doi.org/10.1111/radm.12040 https://doi.org/10.1080/08956308.2016.1208043 https://doi.org/10.1177/1056492617706029 https://doi.org/10.1177/1094428112452151 https://doi.org/10.1177/1094428112452151 https://doi.org/10.1504/ijtm.2013.052674 https://doi.org/10.1108/jsma-01-2016-0002 https://doi.org/10.1108/jsma-01-2016-0002 seiferlein & kanbach / journal of business strategies (2023) 40:37-52 51 ibarra, d., bigdeli, a. z., igartua, j. i., & ganzarain, j. (2020). business model innovation in established smes: a configurational approach. journal of open innovation: technology, market, and complexity, 6(3), 76. https://doi.org/10.3390/joitmc6030076 ili, s., albers, a., & miller, s. (2010). open innovation in the automotive industry. r&d management, 40(3), 246–255. https://doi.org/10.1111/j.1467-9310.2010.00595.x jacobides, m. g., macduffie, j. p., & tae, c. j. (2016). agency, structure, and the dominance of oems: change and stability in the automotive sector. strategic management journal, 37(9), 1942–1967. https://doi.org/10.1002/smj.2426 kraus, s., kanbach, d. k., krysta, p. m., steinhoff, m. m., & tomini, n. (2022). facebook and the creation of the metaverse: radical business model innovation or incremental transformation? international journal of entrepreneurial behavior & research, 28(9), 52–77. https://doi.org/10.1108/ijebr12-2021-0984 leemann, n., kanbach, d., & stubner, s. (2021). breaking the paradigm of sensing, seizing, and transforming evidence from axel springer. journal of business strategies, 38(2), 95–124. https://doi. org/10.54155/jbs.38.2.95-124 marullo, c., casprini, e., di minin, a., & piccaluga, a. (2018). ‘ready for take-off’: how open innovation influences startup success. creativity and innovation management, 27(4), 476–488. https://doi. org/10.1111/caim.12272 micheli, m. r., berchicci, l., & jansen, j. p. (2020). leveraging diverse knowledge sources through proactive behaviour: how companies can use inter-organizational networks for business model innovation. creativity and innovation management, 29(2), 198–208. https://doi.org/10.1111/caim. 12359 milei, p. (2022). the nature of business model innovation in start-up companies. international journal of entrepreneurial venturing, 14(1), 1–15. https://doi.org/10.1504/ijev.2022.122014 moschner, s.-l., fink, a. a., kurpjuweit, s., wagner, s. m., & herstatt, c. (2019). toward a better understanding of corporate accelerator models. business horizons, 62(5), 637–647. https://doi.org/ 10.1016/j.bushor.2019.05.006 porter, m. e. (2004). competitive strategy: techniques for analyzing industries and competitors (first free press export ed). free press. pynnönen, m., hallikas, j., & ritala, p. (2012). managing customer-driven business model innovation. international journal of innovation management, 16(4), 1250022. https : / / doi . org / 10 . 1142 / s1363919612003836 saebi, t., & foss, n. j. (2015). business models for open innovation: matching heterogeneous open innovation strategies with business model dimensions. european management journal, 33(3), 201–213. https://doi.org/10.1016/j.emj.2014.11.002 schwarze, v. (2021). 5 years, 10 programs, countless memories [publisher: startup autobahn]. https: //startupautobahn-poweredbypnp.medium.com/5-years-10-programs-countless-memoriese8a603b3155e seiferlein, b., gernsheimer, o., & kanbach, d. k. (2022). fostering entrepreneurial competencies for business model innovation. international journal of automotive technology and management, 22(4), 401–423. https://doi.org/10.1504/ijatm.2022.10045209 seiferlein, b., kanbach, d. k., & lehmann, c. (2023). internal antecedents for systematic business model innovation: insights from the german automotive manufacturers. international journal of entrepreneurship and innovation management, 27(1/2), 19–50. snihur, y., & zott, c. (2020). the genesis and metamorphosis of novelty imprints: how business model innovation emerges in young ventures. academy of management journal, 63(2), 554–583. https: //doi.org/10.5465/amj.2017.0706 https://doi.org/10.3390/joitmc6030076 https://doi.org/10.1111/j.1467-9310.2010.00595.x https://doi.org/10.1002/smj.2426 https://doi.org/10.1108/ijebr-12-2021-0984 https://doi.org/10.1108/ijebr-12-2021-0984 https://doi.org/10.54155/jbs.38.2.95-124 https://doi.org/10.54155/jbs.38.2.95-124 https://doi.org/10.1111/caim.12272 https://doi.org/10.1111/caim.12272 https://doi.org/10.1111/caim.12359 https://doi.org/10.1111/caim.12359 https://doi.org/10.1504/ijev.2022.122014 https://doi.org/10.1016/j.bushor.2019.05.006 https://doi.org/10.1016/j.bushor.2019.05.006 https://doi.org/10.1142/s1363919612003836 https://doi.org/10.1142/s1363919612003836 https://doi.org/10.1016/j.emj.2014.11.002 https://startupautobahn-poweredbypnp.medium.com/5-years-10-programs-countless-memories-e8a603b3155e https://startupautobahn-poweredbypnp.medium.com/5-years-10-programs-countless-memories-e8a603b3155e https://startupautobahn-poweredbypnp.medium.com/5-years-10-programs-countless-memories-e8a603b3155e https://doi.org/10.1504/ijatm.2022.10045209 https://doi.org/10.5465/amj.2017.0706 https://doi.org/10.5465/amj.2017.0706 seiferlein & kanbach / journal of business strategies (2023) 40:37-52 52 spender, j.-c., corvello, v., grimaldi, m., & rippa, p. (2017). startups and open innovation: a review of the literature. european journal of innovation management, 20(1), 4–30. https://doi.org/10.1108/ ejim-12-2015-0131 spieth, p., & meissner, s. (2018). business model innovation alliances: how to open business models for cooperation. international journal of innovation management, 22(4), 1850042. https://doi. org/10.1142/s1363919618500421 spithoven, a., vanhaverbeke, w., & roijakkers, n. (2013). open innovation practices in smes and large enterprises. small business economics, 41(3), 537–562. https://doi.org/10.1007/s11187-0129453-9 startup autobahn. (2020). europe’s largest open innovation platform startup autobahn presents 40 new pilot projects at expo day. https://startup-autobahn.com/news/press-release/europeslargest-open-innovation-platform-startup-autobahn-presents-40-new-pilot-projects-at-expoday/ teece, d. j. (2010). business models, business strategy and innovation. long range planning, 43(2-3), 172–194. https://doi.org/10.1016/j.lrp.2009.07.003 teplov, r., albats, e., & podmetina, d. (2019). what does open innovation mean? business versus academic perceptions. international journal of innovation management, 23(1), 1950002. https://doi. org/10.1142/s1363919619500026 thornberg, r., & charmaz, k. (2014). grounded theory and theoretical coding. in the sage handbook of qualitative data analysis. sage publications, inc. https://doi.org/10.4135/9781446282243 trimi, s., & berbegal-mirabent, j. (2012). business model innovation in entrepreneurship. international entrepreneurship and management journal, 8(4), 449–465. https://doi.org/10.1007/s11365-0120234-3 urbaniec, m., & żur, a. (2021). business model innovation in corporate entrepreneurship: exploratory insights from corporate accelerators. international entrepreneurship and management journal, 17(2), 865–888. https://doi.org/10.1007/s11365-020-00646-1 urbinati, a., chiaroni, d., chiesa, v., & frattini, f. (2019). the role of business model design in the diffusion of innovations: an analysis of a sample of unicorn-tech companies. international journal of innovationandtechnologymanagement,16(1),1950011.https://doi.org/10.1142/s0219877019500111 weiblen, t. (2014). the open business model: understanding an emerging concept. journal of multi business model innovation and technology, 2(1), 35–66. https://doi.org/10.13052/jmbmit2245456x.212 zhang, h., xiao, h., wang, y., shareef, m. a., akram, m. s., & goraya, m. a. s. (2021). an integration of antecedents and outcomes of business model innovation: a meta-analytic review. journal of business research, 131, 803–814. https://doi.org/10.1016/j.jbusres.2020.10.045 zott, c., & amit, r. (2010). business model design: an activity system perspective. long range planning, 43(2-3), 216–226. https://doi.org/10.1016/j.lrp.2009.07.004 https://doi.org/10.1108/ejim-12-2015-0131 https://doi.org/10.1108/ejim-12-2015-0131 https://doi.org/10.1142/s1363919618500421 https://doi.org/10.1142/s1363919618500421 https://doi.org/10.1007/s11187-012-9453-9 https://doi.org/10.1007/s11187-012-9453-9 https://startup-autobahn.com/news/press-release/europes-largest-open-innovation-platform-startup-autobahn-presents-40-new-pilot-projects-at-expo-day/ https://startup-autobahn.com/news/press-release/europes-largest-open-innovation-platform-startup-autobahn-presents-40-new-pilot-projects-at-expo-day/ https://startup-autobahn.com/news/press-release/europes-largest-open-innovation-platform-startup-autobahn-presents-40-new-pilot-projects-at-expo-day/ https://doi.org/10.1016/j.lrp.2009.07.003 https://doi.org/10.1142/s1363919619500026 https://doi.org/10.1142/s1363919619500026 https://doi.org/10.4135/9781446282243 https://doi.org/10.1007/s11365-012-0234-3 https://doi.org/10.1007/s11365-012-0234-3 https://doi.org/10.1007/s11365-020-00646-1 https://doi.org/10.1142/s0219877019500111 https://doi.org/10.13052/jmbmit2245-456x.212 https://doi.org/10.13052/jmbmit2245-456x.212 https://doi.org/10.1016/j.jbusres.2020.10.045 https://doi.org/10.1016/j.lrp.2009.07.004 introduction theoretical background business models and business model innovation open innovation open business models methodology research design data collection data analysis findings customer segment value proposition value chain revenue model discussion limitations and future research volume 35, number 2 1 outperforming peers through a comprehensive climate change strategy: the case of electric utilities alexandra schmidt panasonic industry europe gmbh • ottobrunn, germany anne bergmann technische universitaet dresden • germany julia hillmann technische universitaet dresden • germany edeltraud guenther technische universitaet dresden • germany abstract firms increasingly aim to combat climate change. for corporate managers, the question whether a related strategy affects financial performance arises. since empirical research on this topic is rather sparse, this study investigates whether pursuing a corporate climate change strategy leads to better corporate financial performance. by applying paired samples t-tests, a sample of 62 companies from the electric utilities sector matched in pairs is investigated over a five-year time span. results indicate that firms with a comprehensive climate change strategy predominantly perform significantly better than their competitors without such a strategy. these findings might contribute to promoting climate change strategies in a corporate context. keywords: climate change; corporate climate change strategy; corporate financial performance; pairwise comparison; matched-pair design; paired samples t-test; electric utilities. introduction climate change is considered one of the greatest long-term challenges facing society (intergovernmental panel on climate change, 2014; steffen et al., 2015). it is a prominent and much debated ecological issue that challenges many business models, requires urgent action and, thus, is strategically relevant to organizations (busch, 2011; kolk & pinkse, 2004; whiteman, walker, & perego, 2013). impacts of climate change occur at different spatial and time levels (hoffmann, sprengel, ziegler, kolb, & abegg, 2009) and therefore resulting risks are difficult to assess 2 journal of business strategies and, in addition, may lie outside of the organization’s coping range (linnenluecke & griffiths, 2012). climate change induces complexity, uncertainty, and rapid change, which, in turn, requires organizations to respond proactively (howard-grenville, buckle, hoskins, & george, 2014). to deal with climate change, a comprehensive climate change strategy, which combines the two response strategies mitigation and adaptation, is required (intergovernmental panel on climate change, 2014) and represents the focus of this paper. until now, mitigation and adaptation has been mainly investigated as two separate response strategies (dlugolecki, 2008). mitigation takes an inside-out perspective and represents the companies’ efforts to reduce their impacts on the natural environment (winn & kirchgeorg, 2005). here, organizations mainly seek to reduce their greenhouse gas emissions (weinhofer & hoffmann, 2010) or to offset them. however, scientists have suggested that even with planned mitigation, the increase in global temperatures and other harmful impacts are irreversible (intergovernmental panel on climate change, 2014). therefore, adaptation – which takes the outside-in perspective (winn & kirchgeorg, 2005) – represents the second response strategy in dealing with the impacts of climate change (winn, kirchgeorg, griffiths, linnenluecke, & guenther, 2011). while mitigation is highly regulated by legislation (kolk & pinkse, 2004), climate change adaptation is only partially in the hands of single states and is not as regulated worldwide (gasbarro, rizzi, & frey, 2016). hence, mitigation strategies are rather clear for organizations, which is not the case for adaptation. climate change adaptation represents a relatively new field which lacks clear signals from scientific communities, leading to confusion within organizations about the urgency and high barriers for investments in adaptation strategies (gasbarro et al., 2016). the agricultural industry represents one example where rising temperatures might not only negatively impact firms, but might also lead to beneficial cases (tate, hughes, temple, boothby, & wilkinson, 2010). however, organizations need to realize that they are facing a ‘new normal’ (howard-greenville et al., 2014) and, thus, a climate change strategy that only consists of mitigation is not sufficient. risks of climate change can only be substantially reduced when mitigation and adaptation efforts are combined (intergovernmental panel on climate change, 2014). thus, organizations should strive for comprehensive response strategies that combine actions of mitigation as well as adaptation, as this will, following beermann (2011) and fankhauser, smith, and tol (1999), be crucial for organizations that aim to develop competitive advantages and reap financial benefits in spite of climate change. actions to build pro-active response strategies further strengthen the strategic ability volume 35, number 2 3 to develop necessary organizational skills to deal with a changing environment, which is fundamental for desirable organizational resilience (limnios, mazzarol, ghadouani, & schilizzi, 2014). after highlighting the importance of a climate change strategy that combines both mitigation and adaptation, it is rather astonishing that, until now, financial benefits of such a comprehensive climate change strategy have not yet been empirically investigated. in order to analyze whether companies with a comprehensive climate change strategy financially outperform companies without such a comprehensive strategy, we apply a matched pair design that follows michalisin and stinchfield (2010). the contribution of such an empirical analysis is twofold. this study is the first to investigate accountingas well as market-based financial benefits of a comprehensive climate change strategy that combines mitigation and adaptation. second, we go beyond their analysis and offer a long-term perspective with a time lag analysis of four years. hence, an analysis that shows managers that companies with a comprehensive climate change strategy outperform their peers without one might be of interest and could lead those managers to opt for a more comprehensive climate change strategy. this paper is organized as follows: we review related literature in section two and build up hypotheses in section three. section four presents results which are then discussed in section five. we provide concluding remarks and avenues for future research in the last section of the paper. literature review the link between climate change strategy and financial performance to date, only two prior studies have investigated the link between a corporate climate change strategy and corporate financial performance, each with different foci: the mitigation perspective (michalisin & stinchfield, 2010) or the adaptation perspective (stechemesser, endrikat, grasshoff, & guenther, 2015). moreover, both studies focus on accounting-based measures for corporate financial performance and do not include measures for market-based financial performance or measures for market risk. the study by michalisin and stinchfield, published in 2010, investigates the financial benefits of mitigation. findings of this study show that firms with a climate change strategy have higher financial returns for return on assets (roa), return on 4 journal of business strategies sales (ros), and total asset turnover than their competitors without a mitigation strategy (michalisin & stinchfield, 2010). they suggest that addressing climate change involves three strategic capability-based climate change strategies that achieve sustainable competitive advantage in a way that sustains natural resources and ecosystems: pollution prevention, product stewardship, and sustainable development (michalisin & stinchfield, 2010). a meaningful aspect that should be underlined is the fact that the authors implicitly equate a so-called ‘proactive climate change strategy’ with mitigation. at the time, adaptation was not as discussed as it is today, which explains its specific focus on the mitigation perspective of a corporate climate change strategy. the second, more recent study by stechemesser et al. (2015) addresses the adaptation perspective on climate change and its relationship to financial performance. they investigate three capabilities that are related to and a result of engaging in climate change adaptation and investigate their link to roa. strategic climate change integration options include new insurance products and services, financing customer improvements, and (re-)investments in climate change solutions. the authors find no significant support for this relationship. however, they find that other climate change related capabilities are positively related to roa, namely climate knowledge absorption and climate-related operational flexibility. one of the reasons for this might be the long-term characteristics of these capabilities as some time may be needed before the integration of climate change pays off. the authors further assume that a relationship is likely to be observed in the future due to the growing importance of climate change adaptation (stechemesser et al., 2015). since literature on that specific link is sparse, we broadened the search to studies that deal with the more general topic of environmental strategies and their relation to financial performance since climate change strategies can be seen as a sub-category of environmental strategies. findings from this literature show that a significant number of studies predominantly state a positive link (e.g. aragóncorrea, hurtado-torres, sharma, & garcía-morales, 2008; chan, 2010; chan, 2005; fergusson & langford, 2006; sánchez-ollero, garcía-pozo, & marchantelara, 2012). some publications find a negative (cainelli, mazzanti, & zoboli, 2011; cordeiro & sarkis, 1997) or simply no significant relationship at all (carmonamoreno, céspedes-lorente, & de burgos-jiménez, 2004; zaman mir & shiraz rahaman, 2011; zhang, wang, yin, & su, 2012). overall, findings on the influence of an environmental strategy on financial performance are inconclusive. a more recent review of mellahi, frynas, sun, and siegel (2016) has proposed that all of these strategies can be subsumed under a more general strand called volume 35, number 2 5 nonmarket strategies. they emphasize that all different variations of nonmarket strategies share similar mechanisms that explain the influence on organizational performance (mellahi et al., 2016). however, even at this more collective level, the paper does not provide a clear conclusion on the link of nonmarket strategies to financial performance, which confirms the findings are inconclusive at best. as an explanation, it could be argued that the implementation of an environmental strategy and its outcomes are generally difficult to measure and the strategy may reveal its effects rather in the long run than in the short run (stechemesser et al., 2015). friedman (1962) argued that social activities require financial and other, e.g. human, resources that are drained from value creating investments. while this argument might be valid in the short run, “in the long term, social and environmental issues become financial issues.” (sørenson, 2015, n.p.). as winner of the 2015 harvard business review competition for ‘the best-performing ceos in the world’, sørenson (2015, n.p.) argued “corporate social responsibility is nothing but maximizing the value of your company over a long period.” thus, trade-offs between short-term negative financial performance and long-term positive financial performance might occur. moreover, financial performance of a company is also subject to many other influences related to the whole value chain and the availability of slack resources (bergmann, rotzek, wetzel, & guenther, 2017). this means that firms with a high corporate financial performance in the preceding years are more likely to invest in improved environmental performance in the following years as they have enough resources to do so (modi & mishra, 2011). due to the inconclusiveness of the results, more future research is needed, especially on the topic of climate change strategies, where a significant research gap still exists (boiral, henri, & talbot, 2012; michalisin & stinchfield, 2010). a comprehensive climate change strategy combines mitigation with adaptation while the value and necessity of climate change mitigation for companies has been studied extensively (see, for example, the review on climate change mitigation research of glienke & guenther, 2016), there is only a small body of literature that addresses the adaptation perspective (stechemesser et al., 2015). the adaptation debate started much later and gained momentum only after the publication of rockström et al. (2009) on the planetary boundaries that suggested that mitigation efforts might be ineffective in addressing climate change risks (e.g., buob & stephan, 2011; nordhaus, 2006). although climate change adaptation has become a central 6 journal of business strategies part of scientific debate (e.g., berkhout, hertin, & gann, 2006; busch & hoffmann, 2009; dlugolecki, 2008; linnenluecke, griffiths, & winn, 2012; stechemesser et al., 2015), both strategies have been mostly discussed separately. only recently have researchers started to examine the necessity to combine both strategies as this can create synergies (e.g., bosello, carraro, & de cian, 2013; buob & stephan, 2011; shalizi & lecocq, 2009). although most of those studies explain these benefits on the policy level, their findings can provide fruitful insights and explanations for why combining mitigation with adaptation at the company level is needed as well. since mitigation concerns the reduction of emissions with the aim of minimizing the impact of climate change, the success of mitigation will determine the need for adaptation actions (shalizi & lecocq, 2009). studies repeatedly emphasized that individual countries have only limited control over total world emissions (shalizi & lecocq, 2009) and, thus, the success of mitigation. consequently, a single company has even less control, increasing the relevance of adaptation even more so. having said this, however, does not render mitigation fruitless, as it depends on the ability to adapt (shalizi & lecocq, 2009). clement and rivera (2017) show that companies, especially those from sectors that heavily rely on ecosystem services for adaptation, face adaptation limits if ecosystems shift and collapse. therefore, mitigation is still suggested as the key to avoiding potentially catastrophic shifts. besides this, there are further reasons for companies to extend their climate change strategy to include adaptation. while mitigation is highly regulated by legislation (kolk & pinkse, 2004), climate change adaptation is only partially in the hands of the state and is not as regulated worldwide as mitigation (gasbarro et al., 2016), thus it is within the organizations’ realm of control. although there might be local policies and regulations that concern climate change adaptation, which is especially the case for firms acting in highly regulated sectors, it is the responsibility of the company to identify their exposure and vulnerability to climate change and to adapt accordingly. therefore, a company’s long-term success and sustained competitive advantage are as dependent on adaptation as they are on mitigation (beermann, 2011; fankhauser et al., 1999). as expected, resources that are invested in mitigation cannot be invested in adaptation, but investing resources in mitigation on a global scale implies fewer resources for adaptation as it reduces the damage to which adaptation is needed (barrett, 2008; bosello et al., 2013; tol, 2005). a successful response to climate change can only be materialized if mitigation efforts are combined with adaptation (beerman, 2011; linnenluecke & griffiths, 2012; winn et al., 2011), volume 35, number 2 7 which strengthens the strategic ability to develop necessary organizational skills to deal with a changing environment, a fundamental element for achieving desirable organizational resilience (limnios et al., 2014). resilience is a “measure of the persistence of systems and their ability to absorb change and disturbance and still maintain the same relationships between populations or state variables” (holling, 1973, p. 14). in the context of organizations, it has been translated into the ability of an organization to persist and absorb disturbances resulting from climate change (impact resistance) and the ability and time to recover from those disturbances (recovery) (linnenluecke & griffiths, 2010; linnenluecke et al., 2012). organizations can apply different strategies to build impact resistance and recovery, i.e. resilience (clement & rivera, 2017; linnenluecke & griffiths, 2010). in the long term, companies that integrate climate change in their strategy can create resilience in terms of an increase in competitiveness through cost reduction, e.g. costs induced by new regulatory requirements, and thus gain independence from governmental agenda setting. moreover, a differentiation strategy, e.g. offering green energy options to customers, can reduce the dependence on existing technologies. risks can thereby be reduced and resilience of the companies enhanced. both strategies – mitigation and adaptation – create organizational resilience, albeit through different mechanisms. hypotheses development since research on the linkage of corporate climate change strategy and corporate financial performance is sparse, we draw from existing research on the relationship between corporate environmental and corporate financial performance. within this research stream, there have been various theoretical explanations for this relationship (guenther & hoppe, 2014). for the relationship where corporate environmental performance predicts corporate financial performance, there are two theoretical explanations: value creation and trade-off theory (guenther & hoppe, 2014). considering the latter, friedman (1962) was one of the first who argued that social activities require financial or human resources that, contemporaneously, cannot be used for other value creating businesses. within the trade-off theory, scholars further claim that investments, such as in pollution control, negatively affect cash positions and, therefore, also lower profits. following mahapatra (1984), this further leads to an increased risk for the original investment. a contrasting viewpoint for this line of reasoning is provided by several studies and meta studies in the field. one of the most recent meta studies includes more 8 journal of business strategies than 2,200 single analyses and its findings indicate an overall positive link between environmental, social, and governance criteria and corporate financial performance (friede, busch, & bassen, 2015). hence, from an empirical point of view, the second perspective, also known as the value creation perspective, seems to better explain the link to financial performance. in addition to its empirical support, there are some other theoretical explanations for the value creation perspective. following the argumentation of guenther and hoppe (2014), the ‘it pays’-link is possible because a reduction in the usage of resources, emissions, or waste can be directly translated to a reduction of related costs (e.g. judge & douglas, 1998; nishitani, kaneko, fujii, & komatsu, 2011). besides costs advantages, benefits might also stem from increased competitiveness through differentiation advantages on the product as well as on the firm level (mcwilliams & siegel, 2000). hence, customers might be willing to pay more as the offered product is environmentally friendly or the company can offer an enhanced environmental management system. when it comes to climate change, the dichotomy of friedman’s argument and the anti-friedman crowd might wane. at first glance, social responsibility can indeed be seen as a contradiction to a mere economic focus. when taking a broader view, however, it is quite rational for entrepreneurs to be socially responsible towards all stakeholders that might affect their financial performance, e.g. employees, the state, or suppliers. thus, the ecological environment as a stakeholder in terms of decent climatic conditions might threaten or foster their financial performance and can be actively integrated into the business model. considering the study’s focus on corporate climate change strategy, michalisin and stinchfield (2010) also favor the value creation perspective and draw on the natural resource based view by hart (1995) to explain the positive mechanisms behind a climate change strategy. these mechanisms can be seen in the development of three strategic capabilities (pollution prevention, product stewardship, and sustainable development). for the strategic capability of pollution prevention, they argue that reduced greenhouse gas emissions and a continuous improvement lead to lower costs which represent the basis for a sustainable competitive advantage. second, competitors can be preempted by product stewardship through renewable energy sources and stakeholder participation. the third strategic capability of sustainable development requires a shared vision and leads the company to face global climate change problems (michalisin & stinchfield, 2010). the reason why corporate decision makers might not see those resulting benefits from proactive environmental business in general and comprehensive climate change strategies in particular might be due to insufficient information volume 35, number 2 9 regarding possible profit opportunities (king & lenox, 2002). to sum up, the value creation perspective provides fruitful grounds for developing related hypotheses. we follow the above-presented considerations and argue that firms can generate value through a comprehensive climate change strategy combining mitigation and adaptation strategies. value generation occurs in terms of financial benefits that are internal (e.g. improved accounting-based financial performance) as well as external (e.g. improved market-based financial performance and reduced market risk). accounting-based measures represent backward looking measures of a firm’s ability to use their assets efficiently and to generate value (peloza, 2009). for instance, climate change mitigation strives to reduce fossil fuel utilization and carbon dioxide emissions, which redirects the energy sector towards low-carbon energy technologies (international energy agency, 2015a). electric utilities, for example, can influence the supply side and increase water efficiency, reduce water use, or utilize municipal effluent for cooling (ebinger & vergara, 2011; international energy agency, 2015b). a major aspect of this redirection is the idea that pollution prevention is related to value maximization (lanoie, laplante, & roy, 1998; porter & van der linde, 1995). as several scholars, such as michalisin and stinchfield (2010), have already highlighted, pollution prevention leads to a reduced usage of additional resources. this potential is at the same time an indicator for the inefficient usage of resources (hart & ahuja, 1996) because reduced consumption of resources includes resources that can be invested elsewhere and, ideally, create value. furthermore, reduced resource usage and lower emissions help to avoid fines or liability costs. product stewardship allows cost advantages to appear on the product level; thus, firms can sell green products for which customers are willing to pay a higher price, ultimately influencing sales outcomes such as ros. on the firm level, environmental leadership, for instance, leads to learning curve advantages (michalisin & stinchfield, 2010), which again leads to using assets more efficiently. adaptation measures can include investments in assets such as transmission and distribution systems (e.g., hardening and reinforcement) or specific asset design to improve impact resistance, ensuring functionality or fast recovery in the face of natural disasters (ebinger & vergara, 2011; international energy agency, 2015b). although costly, those measures can significantly reduce costs of restoration or outage-induced income losses. it can be expected that companies that are aware of this have planned accordingly and have applied related measures and, therefore, experience some stability in their accounting-based measures, even if the value 10 journal of business strategies creation hypothesis might not be the proper theory to explain benefits of adaptation measures. another possibility to adapt to climate change can be achieved at the supply side by building redundancy and flexibility in the supply chain (e.g., jüttner & maklan, 2011; sheffi & rice, 2005). this further supports impact resistance and recovery and, in turn, can ensure stability in terms of sales and income. for example, companies that can ensure functionality or at least faster recovery avoid or reduce the need to purchase energy from competitors as they can ensure their own production. thus, those companies still outperform their peers, although through a different mechanism. moreover, self-reinforcing effects when combining adaptation and mitigation might occur (hallegatte, 2009; international energy agency, 2015b). this selfreinforcing effect in the case of companies can be seen in the stability created for the accounting-based measures in combination with potential changes in accountingbased measures through the positive effects of pollution prevention, product stewardship, and sustainable development. this allows companies to build more slack resources, which again can be reinvested and create a small advantage that over time accumulates and becomes an even stronger competitive advantage. we therefore expect that companies with a comprehensive climate change strategy experience positive effects for accounting-based financial performance. hypothesis 1: companies pursuing a comprehensive climate change strategy financially outperform their competitors without such a strategy in terms of improved accounting-based financial performance. market-based financial performance measures reflect assumptions of investors about a firm’s future developments (balabanis, phillips, & lyall, 1998; endrikat, guenther, & hoppe, 2014; peloza, 2009) and also include intangible assets and reputational effects (surroca, tribó, & waddock, 2010). we hypothesize that the market and investors already perceive and value a comprehensive climate change strategy today for the following reasons: firms with a comprehensive climate change strategy take into account climate risks, prepare accordingly, and reduce their vulnerability. they reduce vulnerability in so far as they continuously anticipate and develop plans to detect further changes and act accordingly by building resilience. as companies cannot avoid all vulnerabilities, they develop strategies to deal with remaining vulnerabilities (e.g., burnard & bhamra, 2011; mcmanus, seville, brunsdon, & vargo, 2007). they are also able to deal with unexpected events and to adjust to external changes volume 35, number 2 11 without experiencing trauma (burnard & bhamra, 2011; hamel & välikangas, 2003; linnenluecke et al., 2012). these activities contribute to stability in terms of less scrutiny and less unsystematic market risk (ortiz-de-mandojana & bansal, 2016). this represents a clear signal to market participants as they assess firms with a comprehensive climate change strategy as being less risky and better managed. thus, we expect further benefits in terms of an improved market-based financial performance and a reduced market risk. hypothesis 2: companies pursuing a comprehensive climate change strategy financially outperform their competitors without such a strategy in terms of improved market-based financial performance. hypothesis 3: companies pursuing a comprehensive climate change strategy financially outperform their competitors without such a strategy in terms of reduced market risk. method and material our chosen sample focuses on the electric utilities industry as it represents a sector with high climate vulnerability since facilities are often located in climate sensitive areas (busch, 2011; gasbarro et al., 2016). moreover, utilities need to rely on long-term assets and infrastructure resulting in high and long-term investments (ebinger & vergara, 2011). hence, as utilities cannot react in the short term regarding their assets, they have to carefully consider building climate change strategies and related resilience. this makes them a meaningful sample for this study. we rely on one distinct industry sector, as this is preferred when studying causality or change (bono & mcnamara, 2011). in addition, we thereby enhance the comparability of the gained results and do not have to control for industry effects (klassen & whybark, 1999). an appropriate test design to compare companies pursuing a comprehensive climate change strategy with their competitors without such a strategy is represented by the method of pairwise comparison (matched-pair design). michalisin and stinchfield (2010) also decided to apply this method as it is preferable when attempting to determine if financial returns of so-called ‘proactive’ firms are significantly greater than those not considered ‘proactive’. first, electric utilities that report to the cdp were added to the sample. cdp provides the largest globally recognized database for information on climate 12 journal of business strategies change and companies (cdp, 2016; kolk & pinkse, 2004). furthermore, it offers important data for climate change related strategy analysis (lewis, walls, & dowell, 2014), which is, for instance, not the case for the kinder, lyndenberg, domini & co. (kld) index. we, thus, select all electric utilities that reported to the cdp in 2012 (reported data refers to the year 2011) in order to expand the investigated time frame as suggested by michalisin and stinchfield (2010). analyzing several years of data (2011-2015) reduces the impact exceptional events may have on a firm’s financial performance, such as buying or selling power plants. it also allows for the consideration of the time lag between an action taken and its measured effect. in 2012, 52 electric utilities were listed in cdp and, out of those, 49 provided reports in english. checking those 49 companies on whether they confirmed the integration of climate change into their business strategy reduced the sample size to 44 companies. second, we manually searched the thomson reuters datastream database for electric utilities from the same country without an externally identifiable climate change strategy in order to match them with the cdp companies. we searched for company information on if and how they address climate change by applying a keyword search in the company’s annual report, the corporate social responsibility report (if existent), and on the company’s website. besides the comparison of the country to minimize country-specific influences, for example legislation, the company size presents a decisive matching criterion. following bansal and hunter (2003) and michalisin and stinchfield (2010), assets were chosen as a company size indicator. since the ownership of power plants is a decisive feature of electric utility businesses, assets are a reasonable indicator for that industry sector. a comparable company, as defined by country and size, could not be identified for each of the 44 companies, which ultimately reduced the sample size to 31 pairs. these 31 pairs, i.e. 62 companies, stem from europe (n=16), north america (n=26), south america (n=12), and asia (n=8). following michalisin and stinchfield (2010), we then conducted a pairedsamples t-test to investigate the differences between the two pairs in terms of corporate financial performance. in contrast to the t-test for a single sample, the paired sample t-test uses difference scores and assumes that the population mean of the difference scores is 0. a difference score entails the difference between the paired values from the two datasets. all difference scores are then treated as a single sample of scores during the hypothesis testing by calculating the mean and standard deviation of the difference scores in order to calculate the t-statistic (aron, coups, & aron, 2011; boslaugh, 2012). therefore, the paired sample t-test can be seen as volume 35, number 2 13 a single sample t-test on the difference scores (weinberg & abramowitz, 2008) that basically tests for a statistical significant difference between matched pairs. measures of corporate financial performance stem from the thomson reuters datastream. we rely on accounting-based as well as on market-based corporate financial performance measures. for accounting-based measures, we investigate the two profitability measures roa and ros as well as asset turnover as a measure for efficiency. for market-based financial performance measures, we rely on market value. market risk is covered by the measures volatility and beta. results the final dataset derived from the matching process described in the previous section is verified by calculating the pearson correlation coefficient in order to check for the correlation of the matched pairs regarding firm size (total assets values from 2011) (michalisin & stinchfield, 2010). the results of this pre-test indicate that the matching process was effective since r = 0.989 (p < 0.001), which inevitably suggests a significant and very strong positive relationship. table 1 and table 2 present statistics for the paired samples, including the means of each dataset, the number of companies in the dataset (n), the standard deviation, and the standard error means. 14 journal of business strategies table 1 paired samples statistics for accounting-based measures volume 35, number 2 15 table 2 paired samples statistics for market-based measures table 3 provides the detailed paired sample t-test results. they are interpreted as follows: for example, the mean of the difference scores that is calculated from the 2011 roa values of the cdp companies minus the 2011 roa values of the matching pair (mp) companies is 0.036. this difference is presumed to be not attributable to chance since p < 0.01 indicates that the roa of cdp companies is significantly better (higher) than the roa of mp companies, thus rejecting h0. the same applies for the roa values of 2012 (p < 0.05), 2013 (p < 0.1), and 2015 (p < 0.05). 16 journal of business strategies table 3 results of paired samples t-tests as the paired samples statistics in table 1 show, the means of the cdp companies are better for roa and ros over the entire investigated five-year timeframe. however, as shown in table 3, the results are only statistically significant for four years of roa and two years of ros. therefore the findings of michalisin and stinchfield (2010) can be confirmed for roa and ros. however, no evidence for higher asset turnover is found since the results do not suggest significant differences between the two investigated groups at all (see table 3). the means themselves are better (higher) for two years each (see table 1). volume 35, number 2 17 considering the analyzed measures for market-based financial performance and market risk, namely market value, volatility, and beta, the conducted paired samples t-tests indicate significant results for all investigated years (see table 3). these results further suggest that a comprehensive climate change strategy leads to better corporate financial performance, particularly in terms of market value and market risk. to sum up, the results of the paired samples t-test show that electric utilities pursuing a comprehensive climate change strategy usually perform significantly better than their peers. discussion since no empirical study that assesses the influence of comprehensive climate change strategies on the corporate market-based performance is known, this study presents unique findings. in comparison to michalisin and stinchfield (2010), who published a static analysis (two-year average, 2005 2006), the results of this study are more comprehensive and meaningful due to the larger dataset investigated. in summary, the results of the hypotheses testing indicate that electric utility companies pursuing a comprehensive climate change strategy predominantly outperform their comparable competitors without such a strategy in terms of corporate financial performance. thus, the presented results not only confirm our underlying theoretical explanation, the value creation perspective, in several ways, but they also refine it: the results regarding accounting performance measures confirm michalisin and stinchfield’s (2010) findings of significantly higher mean values for roa and ros. however, results are not as clear for asset turnover. asset turnover is a measure for the company’s efficiency in terms of how well it uses its assets. companies with a climate change strategy build resilience which is associated with building redundancies, thus being contradictory to efficiency. therefore, a comprehensive climate change strategy might affect this particular financial ratio differently. however, as mentioned in the hypothesis section, companies that build resilience are able to provide some kind of stability by, for example, avoiding long lasting outages in the case of a disturbance due to faster recovery. thus, there are mixed arguments for the influence of a climate change strategy on asset turnover. on the contrary, the results for market-based measures are clearer. our results indicate a stronger relationship between climate change strategy and marketbased measures. one of the reasons could be the long-term characteristic of climate strategies that find expression in the more long-term oriented market-based measures. 18 journal of business strategies in contrast, accounting-based measures represent a short-term orientation. this is in line with other publications that rely on the long-term positive influence of climate strategies (e.g., cainelli et al., 2011; cordeiro & sarkis, 1997; stechemesser et al., 2015; zhang et al., 2012). another explanation for the strong positive relationship of climate change strategy and market-based measures is the reputational benefit proactive managers can trigger with deliberations on how to position the company with regard to future challenges (surroca et al., 2010). as climate change is perceived to be an important risk factor (kreft, eckstein, & melchior, 2017), companies that integrate the expected risks in their company policy are perceived to be more resilient when facing future challenges like climate change. investors seeking possibilities to assess a company’s comprehensive climate change activity might be particularly interested in this possible positive relationship to market value and market risk and might be encouraged to consider cdp as an indicator for a better performance of companies (guenther, guenther, schiemann, & weber, 2016). in addition, two other explanations for the differing results for marketand accounting-based measures are possible: the electric utility sector is highly regulated in many countries and the companies might have the possibility to transfer the costs for adaptation measures to customers or the state, which is, for example, the case in germany with the german renewable energy law. for instance, costs for more resilient grids can directly be incorporated in the pricing policy; thus, the firms’ profitability is not affected. as electricity demand is usually considered to be rather inelastic, net sales of electric utility companies may not vary much in general and may therefore not be influenced by a climate change strategy. finally, if we delve deeper into the observed relationships, we could seek out for drivers behind the applied measures. a comprehensive climate change strategy can be an indicator for good corporate governance in general, increased accountingbased performance can be achieved due to increased efficiency, and increased market-based performance can be attributed to an increased awareness of the general public concerning climate change (kock, santaló, & diestre, 2012). however, it is important to keep in mind that we cannot judge what executives really think based on the analysis of cdp data. thus, our results and their interpretation are based on the assumption that cdp data reflects the real intention of the companies and that they actually ‘walk the talk’. it could be argued that cdp disclosure might also be used for greenwashing (delmas & burbano, 2011). in this case, the result that firms with a comprehensive climate change strategy outperform their competitors without such a strategy would mean that companies with a higher level of greenwashing perform better. for market-based measures this result could volume 35, number 2 19 be explained by investors who have been misled, but for accounting-based measures this conclusion does not hold. thus, we interpret the accounting-based measures as robustness indicators for honest response behavior. conclusion results of this empirical research provide evidence that electric utilities with a comprehensive climate change strategy outperform their matched peers, particularly in terms of market value and market risk. having analyzed financial impacts of climate change strategies within a climate sensitive industry, this conclusion will, first of all, elaborate possible questions for future research. results of this paper provide evidence that, indeed, strategy matters and, thus, empirical analyses on the link of climate change and financial performance should include variables for strategic performance. in other words, future research should not only rely on mere operational data such as co2 emissions. moreover, since time matters for empirical analyses, we therefore encourage future research to avoid using concurrent measures. considering the measures for financial performance, both accounting and market-based measures should be considered within future studies. a final conclusion for future research can be drawn on a meta-level concerning the type of analysis: in contrast to medical research, where matched-pair tests represent a state-of-the-art method, they remain rare in economic analyses. as the comparison of two similar firms allows for a specific focus on the differentiating item to be analyzed (in our case, climate change strategy), more studies based on this design could contribute to a better understanding of success factors. for scholars, the mere process of matching the pairs provides deep insights into corporate practices and can even be superior to only considering confounding variables by accounting for moderators. besides the presented ideas for future research, this conclusion also provides possible implications for investors, top managers, and politicians. investors gain the knowledge that cdp is a good indicator and easy to grasp. moreover, investors learn that, considering the long-term perspective, climate change strategy is not a tradeoff for performance. top managers can use the results to learn that a comprehensive climate change strategy is a means for improving performance and reducing risk – as is also the case for the highly regulated electric utilities sector. hence, the value creation perspective should receive more attention from top management. instead of asking the question of whether a comprehensive climate change strategy pays off, they should try to influence climate change drivers for financial success. finally, this 20 journal of business strategies research can inspire and encourage politicians to cope with climate change, either by mitigation or by adaptation, as opposed to being afraid that such measures could endanger economic growth. references aragón-correa, j. a., hurtado-torres, n., sharma, s., & garcía-morales, v. j. (2008). environmental strategy and performance in small firms: a resourcebased perspective. journal of environmental management, 86(1), 88–103. doi:10.1016/j.jenvman.2006.11.022 aron, a., coups, e. j., & aron, e. 2011. statistics for the behavioral and social sciences: a brief course (5. ed). boston: prentice hall. balabanis, g., phillips, h. c., & lyall, j. (1998). corporate social responsibility and economic performance in the top british companies: are they linked? european business review, 98(1), 25–44. bansal, p., & hunter, t. (2003). strategic explanations for the early adoption of iso 14001. journal of business ethics, 46(3), 289–299. barrett, s. (2008). dikes vs. windmills: climate treatise and adaptation. discussion paper, johns hopkins university, baltimore, md. beermann, m. (2011). linking corporate climate adaptation strategies with resilience thinking. journal of cleaner production, 19(8), 836–842. doi:10.1016/j. jclepro.2010.10.017 bergmann, a., rotzek, j. n., wetzel, m., & guenther, e. (2017). hang the lowhanging fruit even lower evidence that energy efficiency matters for corporate financial performance. journal of cleaner production, 147, 66–74. doi:10.1016/j.jclepro.2017.01.074 berkhout, f., hertin, j., & gann, d. (2006). learning to adapt: organisational adaptation to climate change impacts. climatic change, 78(1), 135–156. boiral, o., henri, j.-f., & talbot, d. (2012). modeling the impacts of corporate commitment on climate change. business strategy and the environment, 21(8), 495–516. doi:10.1002/bse.723 bono, j. e., & mcnamara, g. (2011). publishing in amj part 2: research design. academy of management journal, 54(4), 657–660. doi:10.5465/ amj.2011.64869103 bosello, f., carraro, c., & de cian, e. (2013). adaptation can help mitigation: an integrated approach to post-2012 climate policy. environment and development economics, 18(3), 270-290. doi:10.1017/s1355770x13000132 volume 35, number 2 21 boslaugh, s. 2012. statistics in a nutshell (2nd ed). farnham, surrey, england: o’reilly. buob, s., & stephan, g. (2011). to mitigate or to adapt: how to confront global climate change. european journal of political economy, 27(1), 1–16. doi:10.1016/j.ejpoleco.2010.05.001 burnard, k., & bhamra, r. (2011). organisational resilience: development of a conceptual framework for organisational responses. international journal of production research, 49(18), 5581–5599. doi:10.1080/00207543.2011.563827 busch, t. (2011). organizational adaptation to disruptions in the natural environment: the case of climate change. scandinavian journal of management, 27(4), 389– 404. busch, t., & hoffmann, v. h. (2009). ecology-driven real options: an investment framework for incorporating uncertainties in the context of the natural environment. journal of business ethics, 90(2), 295–310. doi:10.1007/s10551009-0043-y cainelli, g., mazzanti, m., & zoboli, r. (2011). environmentally oriented innovative strategies and firm performance in services. micro-evidence from italy. international review of applied economics, 25(1), 61–85. doi:10.1080/02692170903426146 carmona-moreno, e., céspedes-lorente, j., & burgos-jiménez, j. de. (2004). environmental strategies in spanish hotels: contextual factors and performance. the service industries journal, 24(3), 101–130. doi:10.1080/0264206042000247786 cdp. (2016). catalyzing business and government action. retrieved from https:// www.cdp.net/en-us/pages/about-us.aspx chan, r. y. k. (2005). does the natural-resource-based view of the firm apply in an emerging economy? a survey of foreign invested enterprises in china. journal of management studies, 42(3), 625–672. chan, r. y. (2010). corporate environmentalism pursuit by foreign firms competing in china. journal of world business, 45(1), 80–92. doi:10.1016/j.jwb.2009.04.010 clement, v. & rivera, j. (2017). from adaptation to transformation: an extended research agenda for organizational resilience to adversity in the natural environment. organization & environment, 30(4), 346–365. doi:10.1177/1086026616658333 22 journal of business strategies cordeiro, j. j., & sarkis, j. (1997). environmental proactivism and firm performance: evidence from security analyst earnings forecasts. business strategy and the environment, 6(2), 104–114. doi:10.1002/(sici)10990836(199705)6:2<104::aid-bse102>3.0.co;2-t delmas, m.a. & cuerel burbano, c. (2011). the drivers of greenwashing. california management review, 54(1), 64–87. doi: 10.1525/cmr.2011.54.1.64 dlugolecki, a. (2008). climate change and the insurance sector. the geneva papers on risk and insurance issues and practice. 33(1), 71–90. doi: 10.1057/ palgrave.gpp.2510152 ebinger, j. o., & vergara, w. (2011). climate impacts on energy systems: key issues for energy sector adaptation. a world bank study. washington, d.c: world bank. endrikat, j., guenther, e., & hoppe, h. (2014). making sense of conflicting empirical findings: a meta-analytic review of the relationship between corporate environmental and financial performance. european management journal, 32(5), 735–751. doi:10.1016/j.emj.2013.12.004 fankhauser, s., smith, j. b., & tol, r. s. (1999). weathering climate change: some simple rules to guide adaptation decisions. ecological economics, 30(1), 67–78. doi:10.1016/s0921-8009(98)00117-7 fergusson, h., & langford, d. (2006). strategies for managing environmental issues in construction organizations. engineering, construction and architectural management, 13(2), 171–185. doi:10.1108/09699980610659625 friede, g., busch, t., & bassen, a. (2015). esg and financial performance: aggregated evidence from more than 2000 empirical studies. journal of sustainable finance & investment, 5(4), 210–233. doi:10.1080/20430795.201 5.1118917 friedman, m. (1962). capitalism and freedom. chicago: university of chicago press. gasbarro, f., rizzi, f., & frey, m. (2016). adaptation measures of energy and utility companies to cope with water scarcity induced by climate change. business strategy & the environment, 25(1), 54–72. doi:10.1002/bse.1857 glienke, n., & guenther, e. (2016). corporate climate change mitigation: a systematic review of the existing empirical evidence. management research review, 39(1), 2-34. doi:10.1108/mrr-10-2013-0243 guenther, e., guenther, t., schiemann, f., & weber, g. (2016). stakeholder relevance for reporting: explanatory factors of carbon disclosure. business & society, 55(3), 361–397. doi:10.1177/0007650315575119 volume 35, number 2 23 guenther, e. m., & hoppe, h. (2014). merging limited perspectives. journal of industrial ecology, 18(5), 689–707. doi:10.1111/jiec.12125 hallegatte, s. (2009). strategies to adapt to an uncertain climate change. global environmental change, 19(2), 240–247. doi:10.1016/j.gloenvcha.2008.12.003 hamel, g., & välikangas, l. (2003). the quest for resilience. harvard business review, 81(9), 52–63. hart, s. l. (1995). a natural-resource-based view of the firm. academy of management review, 20(4), 986–1014. doi:10.5465/amr.1995.9512280033 hart, s. l., & ahuja, g. (1996). does it pay to be green? an empirical examination of the relationship between emission reduction and firm performance. business strategy and the environment, 5(1), 30–37. hoffmann, v. h., sprengel, d. c., ziegler, a., kolb, m., & abegg, b. (2009). determinants of corporate adaptation to climate change in winter tourism: an econometric analysis. global environmental change, 19(2), 256–264. doi:10.1016/j.gloenvcha.2008.12.002 holling, c. s. (1973). resilience and stability of ecological systems. annual review of ecology and systematics, 4, 1–23. howard-grenville, j., buckle, s., hoskins, b., & george, g. (2014). from the editors: climate change and management. academy of management journal, 57(3), 615–623. doi:10.5464/amj.2014.4003 intergovernmental panel on climate change. (2014). climate change 2014: synthesis report. contribution of working groups i, ii and iii to the fifth assessment report of the intergovernmental panel on climate change. geneva. international energy agency. (2015a). energy and climate change. world energy outlook special report. retrieved from https://www.iea.org/publications/free publications/publication/weo2015specialreportonenergyandclimatechange.pdf international energy agency. (2015b). making the energy sector more resilient to climate change. retrieved from https://www.iea.org/publications/ freepublications/publication/cop21_resilience_brochure.pdf judge, w., & douglas, t. (2009). organizational change capacity: the systematic development of a scale. journal of organizational change management, 22(6), 635–649. doi:10.1108/09534810910997041 jüttner, u., & maklan, s. (2011). supply chain resilience in the global financial crisis: an empirical study. supply chain management: an international journal, 16(4), 246–259. doi:10.1108/13598541111139062 24 journal of business strategies king, a. a., & lenox, m. j. (2000). industry self-regulation without sanctions: the chemical industry’s responsible care program. academy of management journal, 43(4), 698–716. doi:10.2307/1556362 klassen, r. d., & whybark, d. c. (1999). the impact of environmental technologies on manufacturing performance. academy of management journal, 42(6), 599– 615. doi:10.2307/256982 kock, c. j., santaló, j., & diestre, l. (2012). corporate governance and the environment: what type of governance creates greener companies? journal of management studies, 49(3), 492–514. doi:10.1111/j.1467-6486.2010.00993.x kolk, a., & pinkse, j. (2004). market strategies for climate change. european management journal, 22(3), 304–314. doi:10.1016/j.emj.2004.04.011 kreft, s., eckstein, d., & melchior, i. global climate risk index 2017: who suffers most from extreme weather events? weather-related loss events in 2015 and 1996 to 2015. lanoie, p., laplante, b., & roy, m. (1998). can capital markets create incentives for pollution control? ecological economics, 26(1), 31–41. doi:10.1016/s09218009(97)00057-8 lewis, b. w., walls, j. l., & dowell, g. w. s. (2014). difference in degrees: ceo characteristics and firm environmental disclosure. strategic management journal, 35(5), 712–722. doi:10.1002/smj.2127 limnios, e. a. m., mazzarol, t., ghadouani, a., & schilizzi, s. g. m. (2014). the resilience architecture framework: four organizational archetypes. european management journal, 32(1), 104–116. doi:10.1016/j.emj.2012.11.007 linnenluecke, m. k., & griffiths, a. (2012). assessing organizational resilience to climate and weather extremes: complexities and methodological pathways. climatic change, 113(3-4), 933–947. doi:10.1007/s10584-011-0380-6 linnenluecke, m., & griffiths, a. (2010). beyond adaptation: resilience for business in light of climate change and weather extremes. business & society, 49(3), 477–511. doi:10.1177/0007650310368814 linnenluecke, m. k., griffiths, a., & winn, m. (2012). extreme weather events and the critical importance of anticipatory adaptation and organizational resilience in responding to impacts. business strategy & the environment, 21(1), 17–32. doi:10.1002/bse.708 mahapatra, s. (1984). investor reaction to a corporate social accounting. journal of business finance & accounting, 11(1), 29–40. doi:10.1111/j.1468-5957.1984. tb00054.x volume 35, number 2 25 mcmanus, s., seville, e., brunsdon, d., & vargo, j. (2007). resilience management: a framework for assessing and improving the resilience of organisations. retrieved from http://www.resorgs.org.nz mcwilliams, a., & siegel, d. (2000). corporate social responsibility and financial performance: correlation or misspecification? strategic management journal, 21(5), 603–609. doi:10.1002/(sici)1097-0266(200005)21:5<603::aidsmj101>3.0.co;2-3 mellahi, k., frynas, j.g., sun, p & siegel, d. (2016). a review of the nonmarket strategy literature: toward a multi-theoretical integration. journal of management 42(1), 143–173. doi:10.1177/0149206315617241 michalisin, m. d., & stinchfield, b. t. (2010). climate change strategies and firm performance: an empirical investigation of the natural resourcebased view of the firm. journal of business strategies, 27(2), 123–149. modi, s.b., mishra, s., 2011. what drives financial performance resource efficiency or resource slack? journal of operations management, 29(3), 254– 273. doi:10.1016/j.jom.2011.01.002 nishitani, k., kaneko, s., fujii, h., & komatsu, s. (2011). effects of the reduction of pollution emissions on the economic performance of firms: an empirical analysis focusing on demand and productivity. journal of cleaner production, 19(17-18), 1956–1964. doi:10.1016/j.jclepro.2011.06.021 nordhaus, w. d. (2006). after kyoto: alternative mechanisms to control global warming. american economic review, 96(2), 31–34. doi:10.1257/000282806777211964 ortiz-de-mandojana, n., & bansal, p. (2016). the long-term benefits of organizational resilience through sustainable business practices. strategic management journal, 37(8), 1615–1631. doi:10.1002/smj.2410 peloza, j. (2009). the challenge of measuring financial impacts from investments in corporate social performance. journal of management, 35(6), 1518–1541. doi:10.1177/0149206309335188 porter, m. e., & van der linde, c. (1995). toward a new conception of the environment-competitiveness relationship. journal of economic perspectives, 9(4), 97–118. doi:10.1257/jep.9.4.97 rockström, j., steffen, w., noone, k., persson, a., chapin iii, f. s., lambin, e. f., & et al. (2009). a safe operating space for humanity. nature, 461(7263), 472–475. doi:10.1038/461472a 26 journal of business strategies sánchez-ollero, j. l., garcía-pozo, a., & marchante-lara, m. (2012). environment and strategic behaviour: the case of hotels in andalusia (spain). international journal of environmental research, 6(4), 1067–1076. doi:10.22059/ ijer.2012.577 shalizi, z., & lecocq, f. (2010). to mitigate or to adapt: is that the question? observations on an appropriate response to the climate change challenge to development strategies. the world bank research observer, 25(2), 295–321. doi:10.1093/wbro/lkp012 sheffi, y., & rice, j. b. (2005). a supply chain view of the resilient enterprise. mit sloan management review, 47(1), 41–48 sørenson, l. r. (2015). the best-performing ceos in the world. retrieved from https://hbr.org/2015/11/the-best-performing-ceos-in-the-world%20lars%20 s%c3%b8rensen%20(novo%20nordisk)%e2%80%9d stechemesser, k., endrikat, j., grasshoff, n., & guenther, e. (2015). insurance companies’ responses to climate change: adaptation, dynamic capabilities and competitive advantage. the geneva papers on risk and insurance issues and practice, 40(4), 557–584. doi:10.1057/gpp.2015.1 steffen, w., richardson, k., rockstrom, j., cornell, s. e., fetzer, i., bennett, e. m. et al. (2015). planetary boundaries: guiding human development on a changing planet. science, 347(6223). 1259855-1–1259855-10. doi:10.1126/ science.1259855 surroca, j., tribó, j. a., & waddock, s. (2010). corporate responsibility and financial performance: the role of intangible resources. strategic management journal, 31(5), 463–490. doi:10.1002/smj.820 tate, g., hughes, g., temple, m., boothby, d., & wilkinson, m. (2010). changes to farm business management under extreme weather events: likelihood of effects and opportunities in the uk. journal of farm management, 14(1), 67–86. tol, r.s.j. (2005). adaptation and mitigation: trade-offs in substance and methods. environmental science and policy, 8(6), 572–578. weinberg, s. l., & abramowitz, s. k. (2008). statistics using spss: an integrative approach (2nd ed). cambridge, new york: cambridge university press. weinhofer, g., & hoffmann, v. h. (2010). mitigating climate change – how do corporate strategies differ?. business strategy and the environment. 19(2), 77– 89. doi:10.1002/bse.618 whiteman, g., walker, b., & perego, p. (2013). planetary boundaries: ecological foundations for corporate sustainability. journal of management studies, 50(2), 307–336. doi:10.1111/j.1467-6486.2012.01073.x volume 35, number 2 27 winn, m. i., & kirchgeorg, m. (2005). the siesta is over: a rude awakening from sustainability myopia. in s. sharma & j. aragón-correa (eds.), corporate environmental strategy and competitive advantage. edward elgar publishing. winn, m., kirchgeorg, m., griffiths, a., linnenluecke, m. k., & günther, e. (2011). impacts from climate change on organizations: a conceptual foundation. business strategy & the environment, 20(3), 157–173. zaman mir, m., & shiraz rahaman, a. (2011). in pursuit of environmental excellence. accounting, auditing & accountability journal, 24(7), 848–878. doi:10.1108/09513571111161620 zhang, b., wang, z., yin, j., & su, l. (2012). co2 emission reduction within chinese iron & steel industry: practices, determinants and performance. journal of cleaner production, 33, 167–178. doi:10.1016/j.jclepro.2012.04.012 biographical sketch of authors alexandra schmidt studied at technische universitaet dresden and esc rennes school of business. she received a b.sc. in business and economics and a m.sc. in business management. her main focus was on environmental management, sustainability and energy economics. currently she is working in the electronic industry at panasonic industry europe gmbh as environment & csr officer specializing on recycling, environmental product compliance and corporate social responsibility. dr. anne bergmann studied industrial engineering and management at the technische universitaet dresden and esc rennes school of business. from 2012 to 2016, she worked as a research associate at the chair of environmental management and accounting, technische universitaet dresden and the university of new south wales in sydney. in 2017, she defended her dissertation focusing on the impacts of the natural environment, particularly climate change and resource scarcity, on corporate financial performance and on corporate responses to those impacts. julia hillmann is a doctoral candidate at the chair of environmental management and accounting. she studied business administration at the technische universitaet dresden. she is researching organizational resilience and was part of and held a scholarship of an interdisciplinary graduate school from the leibniz institute of ecological urban and regional development that consisted of doctoral candidates dealing with the concept of resilience from different perspectives. she was also part of the research project on regional climate change adaptation (regklam). 28 journal of business strategies prof. dr. edeltraud guenther received her doctorate in environmental management control from the universitaet augsburg and holds the chair in environmental management and accounting at the technische universitaet dresden since 1996. she has been visiting professor at the university of virginia’s mcintire school of commerce. most recently, prof. guenther has initiated prisma, the centre for sustainability assessment and policy www.tu-dresden.de/prisma. a cross-cultural comparison of expatriates’ shopping behaviour geri j. wijnen development manager • wereldhave, the netherlands astrid d. a. m. kemperman eindhoven university of technology • eindhoven, the netherlands ingrid i. janssen tias nimbas business school • tilburg, the netherlands abstract explored is how shopping centre attributes can be adapted to culture-related shopping behaviour of expatriates. while awareness of consumer ethnicity and effectiveness of culture-based market segmentation are on-going and relevant topics in retailing, there is only limited information available on consumer behaviour of expats, as well as on the translation of market segmentation strategies to shopping environment. an online survey among british, japanese, and american expatriates in the amstelveen/amsterdam region (the netherlands) points out the importance of both lifestyle and ethnicity for the shopping behaviour. managerial implications for retailers, shopping centre developers, and operators are also discussed. introduction globalisation causes consumers to develop more homogeneous needs, tastes, and lifestyles. however, at the same time, it might also lead to greater heterogeneity, as it opens doors for consumers to belong to and identify themselves with several groups simultaneously (de mooij & hofstede, 2002). expatriates are a typical example of such a heterogeneous group. expatriates are in fact all persons who have moved outside their country-of-origin for the purpose of work or study (amsterdam municipality, 2007). however the term is commonly used for professionals employed outside of their host-country (farquhar, 2009). in this study, the term expatriate is used to refer to both the working expat as well as the partner of the working expat. expatriates are usually highly educated and receive an above average income-including various (tax) benefits and remunerations (farquhar, 2009; amstelveen municipality, 2008). because of their affluence they form an interesting target group. expatriates are often regarded as cosmopolitan consumers (hannerz, 1990; caldwell, et al., 2006), but they also stay attached to their cultural or ‘ethnic’ background (thompson & tambyah, 1999), and acculturate to a certain extent to the 126 journal of business strategies host-country’s culture (koubaa, 2011). their adjustment to a host-country has been widely studied (black et al., 1991; van vianen et al., 2004; grinstein & wathieu, 2009). it is clear that non-work or general lifestyle adjustment practices in the host country takes a central position in the life of expats and their well-being (black, 1988; black & stephens, 1989; andreason, 2008). gilly (1995) and koubaa (2011) explored some aspects of expatriate consumer behaviour. however, only limited market information is available about their shopping behaviour. in this study we are interested in the culture-related aspect of expatriates’ shopping behaviour. the cultural aspect of shopping behaviour has been studied extensively world-wide, varying from direct cross-cultural comparisons of shoppers in different countries (sood & nasu, 1995; brunsø & grünert, 1998; nicholls et al., 2000; seock, 2011) or within countries (shim & eastlick, 1998; ackerman & tellis, 2001; michon & chebat, 2004; chebat & morrin; 2007) to relating shopping behaviour to cultural values and dimensions (homer & kahle, 1988; kahle, 2000; hofstede, 2001; kacen & lee, 2002; de mooij, 2004; rubio-sanchez, 2007; zhang & mittal, 2008). however, these ideas have never been applied to a multi-faceted segment like expatriates. the translation from culture to shopping environment has received limited attention in research literature while the retailing industry is continuously being confronted with the importance of local sensitivity in their marketing strategies. in recent years for example, both wal-mart and ikea realised that adaptation of their standardized products and strategy to local consumer preferences is necessary to be successful (holstein 2007; halepete et al., 2009; strategic direction, 2009). international real estate operators and developers also know that there are cultural aspects to location, accessibility, retail mix, leisure, architecture, climate, and routing. in the us, one is familiar with so-called ‘ethnic malls’ that fully target a specific ethnic market such as hispanics, afro-americans or asians (lavin, 1996; hazel, 2005; shearin, 2006; the economist, 2009). cross-border shopping tourism is another field in which such cultural aspects are discernible (timothy, 2005; yüksel, 2007). awareness of the effect of culture on consumer behaviour and the effectiveness of culture-based market segmentation are therefore on-going relevant topics. thus, although the translation from cultural marketing segmentation strategies to the shopping environment is made in practice, research in this area has been sporadic. the relation between items such as shopping behaviour, shopping value, quality perception, and emotions on one hand and the shopping environment (babin & attaway, 2000; stoel et al., 2002; allard et al., 2009; jackson et al., 2011; masicotte et al., 2011) as well as retail atmospherics (turley & milliman, 2000; michon volume 29, number 2 127 et al., 2005; chebat & morrin, 2007) on the other, only recently received more attention. the relation between culture and the shopping environment has thus remained largely under-analysed. chebat and morrin (2007) found in a field-study that french-canadians have a higher perception of product quality while shopping in a warm coloured mall décor, while anglo-canadians experience this perception with a cool colour décor. in contrast, shim and eastlick (1998) found that ethnic identification has a greater influence on personal values and attitudes towards shopping centre attributes and shopping behaviour than ethnicity itself. michon and chebat (2004) suggested that both the shopping environment and ethnic diversity should receive more attention from researchers and mall managers. likewise, the international council of shopping centers (2009) stresses the necessity of understanding the cultural context of developments to retain a local sense of place in shopping centres. therefore, the aim of this study is to examine how shopping centre attributes can be adapted to culture-related shopping behaviour of expatriates. in this study, a ‘shopping centre’ is considered to be a planned retail development comprising at least three shops, under the freehold, managed and marketed as a unit with a minimum gross retail area of 5000 m2 (dennis, 2005). specifically, the cultural values and shopping behaviour of expatriates living in the amstelveen/amsterdam area in the netherlands are investigated through a literature review and data collection, with in-depth interviews and an online survey. the survey results are also compared to existing data on dutch consumers from market research specialist strabo. the outcomes provide shopping centre developers, managers, and retailers with information about how to adapt shopping centre attributes to optimize the shopping experience of expatriates. culture and values the relation of culture and shopping behaviour is the focal point of this study. however, the concept of culture is rather complex and cannot be quantified directly. over the years, numerous attempts have been undertaken to describe the concept (e.g., tylor, 1881; geertz, 1973; mcracken, 1988; hofstede, 1980; rice, 1993). according to rice, culture is “the values, attitudes, beliefs, artefacts and other meaningful symbols that help people interpret, evaluate and communicate as members of society.” values can be regarded as the most important manifestations of culture, next to rituals, heroes, and symbols (hofstede, 2001). the term ‘value’ was defined by rokeach in 1973 as “an enduring belief that one mode of conduct or end-state of existence is preferred over an opposing mode of conduct or end-state of existence.” 128 journal of business strategies values are more or less stable over time and can be determined through research techniques such as interviewing and observation, making them crucial for cross-cultural research (de mooij, 2004; hofstede, 2001). values therefore make the concept of culture measurable and comparable. note, that there is a fundamental and paradoxical problem in trying to compare cultures, since the distinctive “idiosyncratic cognitive categories and dimensions” (brunsø and grünert, 1998, p. 149) that define a culture are exactly those elements that are discarded when trying to catch the concept in a cross-culturally valid value system. moreover, the main value theories have all been developed in a western context, creating another cultural bias. the value-attitude-behaviour hierarchy values owe their importance to their central role in consumer behaviour and decision-making. several theories have been applied to explain consumer behaviour. the theory of planned behaviour (tpb) asserts that specific salient beliefs influence behavioural perceptions and subsequent actual behaviour (ajzen, 1985; 1991). there are three types of beliefs in the tpb that affect three perceptual constructs: behavioural beliefs influence attitudes, normative beliefs affect subjective norms, and control beliefs shape perceived behavioural control. in turn, these three perceptual constructs determine behavioural intentions and actual behaviour. tpb has been recently applied in studies that have examined multi-channel consumer behaviour (keen et al., 2004; kim & park, 2005). one study specifically takes in consideration cross-cultural effects while studying e-commerce activities (pavlou & chai, 2002). this study applied hofstede’s cultural dimensions (hofstede, 2001) to the tpb conceptual framework. theories on individual choice behaviour may also be valuable to explain consumer behaviour (louviere & hensher, 1981; sands, oppewal, & beverland, 2009; timmermans, 1982). these theories assume that consumers perceive shopping centres as bundles of features, called attributes. while selecting the most preferred shopping centre consumers evaluate these attributes. it is assumed that the consumer will choose the shopping centre with the highest perceived value of all attributes. both theories (tpb and theories on individual decision making) count for value systems as being an important determinant for behaviour. however, for this study we have chosen to apply the value-attitude-behaviour hierarchy that was first distinguished by homer and kahle (1988). this theoretical framework has also been applied in shopping research (shim & eastlick, 1998; swinyard, 1998) and is closely related to the personal value system of vinson et al. (1977) (see figure 1). the influence of values on behaviour is regarded as indirect, flowing from abstract volume 29, number 2 129 values (global values) via mid-range attitudes (domain-specific values and evaluations of product attributes) to specific behaviours. figure 1 value-attitude-behaviour hierarchy based on the personal value system of vinson et al. (1977) global values global values reflect more general values or desired end-states such as those defined by rokeach (1973). several methods for measuring such values have been applied in cross-cultural consumer research over the years such as hofstede’s cultural dimensions (2001) and the list of values (lov) (kahle, 2000). relations between cross-cultural shopping behaviour and hofstede’s individualism-collectivism, uncertainty avoidance, and power distance have been identified (kacen & lee, 2002; de mooij, 2004; zhang & mittal, 2008). the lov was used by shim and eastlick (1998) to explain shopping behaviour and attitude towards mall attributes among hispanics and anglo-americans, and recently by kuruvilla and joshi (2010) to develop a shopper typology for indian consumers. as for the rest, the role of personal values in a cross-cultural shopping context has been largely neglected so far. domain-specific values domain-specific values are kinds of attitudes towards certain social or economic activities. in a shopping context, this can be recognized as the attitude towards a shopping experience, or perceived shopping value (babin et al., 1994). shopping value can be assessed along two dimensions, namely, a utilitarian dimension related to task orientation and a hedonic dimension reflecting personal gratification and selfexpression found in the shopping experience itself. utilitarian and hedonic shopping value have turned out to be valuable constructs in shopper research (griffin et al., 2000; michon & chebat, 2004; seo & lee, 2008; allard et al., 2009) and in relation to the shopping environment (babin & attaway, 2000; stoel et al., 2003; eroglu et al., 2005; jackson et al., 2011). however, the idea of hedonic and utilitarian shopping value has only been applied in a few cross-cultural studies. for example, shim and gehrt (1996) found differences in shopping value orientation between hispanic evaluations of product attributes domain-specific values global values behaviour 130 journal of business strategies and native americans, while nicholls et al. (2000) compared chileans and americans, and griffin et al. (2000) compared us and russian shoppers. michon and chebat (2004) found that french-canadian mall shoppers exhibit more hedonistic shopping value than anglo-canadians. rubio-sanchez (2007) studied the relation between cultural dimensions and shopping value. product attribute evaluation the evaluation of product attributes is equivalent to the evaluation of (a set of) shopping centre attributes oppewal (1995) described as part of the shopping decision-making process. that the perception and evaluation of shopping centre attributes by consumers differs cross-culturally seems evident, however it has not been researched extensively. in 1966, hall argued that human perceptions of space such as privacy, personal distance, involvement, and boundaries differ across cultures. kliment (2004) pointed out differences in ethnic preferences with regard to colour brightness, lighting levels and product presentation in stores. in a field study, chebat and morrin (2007) found differences in product quality perception, in relation to mall colour décor, between frenchand anglo-canadians. brunsø and grünert (1998) compared the importance of aspects of ways of shopping for food among danish, british, french, and german consumers, discovering differences in the importance of product information, attitudes to advertising, enjoyment from shopping, specialty stores, price criteria, and shopping lists. with regard to price criteria, ackerman and tellis (2001) suggested that cultural value differences are an explanation for remarkable price differences between chinese and american supermarkets in the usa, indicating towards how deeply rooted cultural influences might be. expatriates as mentioned, expatriates form the focus of this study since they are an under-analysed but interesting consumer segment. when applying the value-attitudebehaviour model, in relation to expat’s shopping behaviour, we can formulate the following research questions: 1. what are the (cultural) values and shopping values of expatriates? 2. how do expatriates perceive and evaluate shopping centre attributes? 3. what is the shopping behaviour of expatriates? 4. how can shopping centre attributes be adapted to culture-related shopping behaviour of expatriates? volume 29, number 2 131 in this section we discuss the value-attitude-behaviour model in relation to expats’ shopping behaviour based on a literature review. values information on the lifestyles of expatriates is available through the international surveys commissioned by hsbc (farquhar, 2008; hsbc, 2008) and some academic research on cosmopolitanism (thompson & thambyah, 1999; cannon & yaprak, 2002; caldwell et al., 2006) as this is often linked to “being an expatriate” (hannerz, 1990). the hsbc study shows that the biggest benefits of being an expat are financial benefits, cultural opportunities, and the increased quality of lifemainly in terms of lifestyle, freedom, and adventure. cosmopolitanism is not without reason commonly associated with an elite and worldly attitude, sophistication, and selfenhancement through travelling (thompson & thampyah, 1999). on the downside of the expat life are social aspects such as missing relatives, language and communication barriers, difficulty making new friends, adapting to the local culture, and facing identity issues (black & stephens, 1989; caldwell et al., 2006; hsbc, 2008; andreason, 2008). consequently, there is an ambiguous tension between being a world-citizen, adapting to local culture and staying close to one’s cultural background. hence, the value orientation and consumer behaviour of expatriates seems under influence of ethnicity as well as lifestyle, displaying both local and global components. shopping behaviour and evaluation of the shopping environment from literature on expatriate consumer behaviour follows that food, ideas about health care, hygiene, and beauty play a role in the expatriate consumer experience and behaviour (gilly, 1995; usunier, 1999; koubaa, 2011). gilly (1995) specifically explored expatriates consumer learning and the meaning of possessions. she found that unfamiliarity with consumer customs frustrates them and that they were keen on obtaining certain products (especially food) from their country-of-origin that symbolize home. they used their networks to obtain those products. usunier (1999) confirmed the importance of food. koubaa (2011) studied the influence of country-of-origin values versus host country values on the consumer attitude regarding buying skin care products. further detailed information on shopping behaviour of expats is basically unavailable. regarding shopping and leisure, expats generally assess the netherlands relatively low in terms of quality of food, entertainment, and clothing (hsbc, 2008). in the regional dutch context of amstelveen, expats indi132 journal of business strategies cated they missed restaurants, cafes, clubs, cultural facilities, and stores with longer opening hours at night and on weekends (amstelveen municipality, 2008). to learn more about shopping behaviour and perception of shopping centre attributes from a cultural perspective, we will discuss some examples of cultural market segmentation from the retailing practice and the cultural reference frame of consumers in the next section. retailing industry in practice there are several examples (mainly in the us) of how shopping centres are successfully marketed to attract a cultural target group. examples are the legaspi group centres (his panic community), the mitsuwa marketplace chain (japanese community), the south dekalb mall in atlanta, ga (afro-american community) and the diamond jambo ree mall in irvine, ca (asian community), and the japan centre in london. extreme examples like this are non-existent in the netherlands, but there is ethnic retailing on a smaller scale by individual retailers in district shopping streets in ethnic neighbourhoods or in shopping venues such as the bazar in the hague, the shoperade on osdorpplein in amsterdam, and the shopperhal in amsterdamse poort, also in amsterdam. from these examples, we can learn about the shopping centre attributes that are significant from a cultural perspective (lavin, 1996; hazel, 2005; shearin, 2006; icsc, 2009; “segregation and shopping,” 2009). most importantly are retail mix, brand mix, and the product assortment. the formulas are often international or contain large amounts of imported products or brands. typical product categories are foods, books, cd’s, dvd’s, clothing, home ware, cosmetics, health products, and gift items. the food assortment can differ in proportions of fresh, instantly prepared, semi-prepared, canned, and dried foods ac cording to the customary food culture. also, aspects like ripeness of fruits and vegetables can vary. regarding fashion, the colours, fabrics, and sizes can be different. in terms of leisure and gastronomy there can be an enhanced focus on entertainment for children, the size and type of food court or on specific concepts such as a tea bar, karaoke bar, or photo sticker store. services on offer often require intensive communication or are subject to cultural customs and societal norms. bilingual staff as well as bilingual signage and information is very important in such mall and stores. the atmosphere, design, sizes of isles (to cater to large families), layout, and lighting level of the centre may be adjusted as well to match certain cultural preferences. volume 29, number 2 133 consumers’ reference frame culture influences behaviour through its manifestations, namely values, heroes, rituals, and symbols (hofstede, 2001). those are intangible, as well as material expressions of culture linked by communication systems (craig & douglas, 2006) that are commonly accepted in a society and form a consumer’s reference frame for approaching the world. with regard to shopping behaviour, those can be norms or standards concerning cuisine, beauty ideal, fashion style, health care, hygiene, gift-giving, and dining-out. for example kacen and lee (2002) stressed the importance of societal norms such as the accepted level of showing emotions and achievement of instant gratification for impulse buying behaviour. apart from being directly related to consumption behaviour, values also indirectly influence shopping behaviour through family or group relations, (male-female) role patterns, school, work, politics, and religion (hofstede, 2001). besides material manifestations such as food culture, also standards regarding housing and transportation can be perceived as a cultural phenomenon influencing shopping behaviour. an example is the small size of houses in japan, and consequently the limited storage space that people have available. another example is the common use of the car as a transportation mode in many countries, resulting in a habit of buying a lot in one time, as opposed to the netherlands where many people also utilize their bicycle for shopping (gilly, 1995; kooijman, 1999; krafft & mantrala, 2006). differences in opening hours and shopping centre locations (e.g., in-town versus out-oftown) can also lead to differences in shopping behaviour and assessment of attributes. data collection to gain further insight into the value orientation and shopping behaviour of expatriates, data was collected using in-depth interviews, online surveys, and then the outcomes were compared to existing data of dutch consumers. in-depth interviews prior to the main data collection, through an online survey, a total of 12 in-depth interviews were held with japanese, british and american expatriates. the outcomes provided insights into the shopping behaviour of expats. due to difficulties in reaching the expat community and obtaining information on their addresses the snowball technique was used to find respondents. the snowball technique is a sampling method where respondents are asked to recruit new respondents within their social network. it is typically used among ‘hidden populations’ such as expatriates. starting point were expat associations, social media, and the researchers’ own network. 134 journal of business strategies first, respondents were asked about their shopping behaviour in the netherlands as compared to their home-country. the main finding from the interviews was that all respondents noticed alterations in their shopping pattern and shopping motivations after they moved to the netherlands. this corresponds with gilly’s findings (1995). the most important reasons for this were opening hours and decreased car mobility. the british and american respondents mentioned that they shopped more often for daily products in the netherlands, but less often (as a leisure activity) for non-daily products. the japanese respondents also no ticed shopping less during leisure time. one japanese respondent noted that: “i have become more cautious about quality and less about price, since i have less opportunity to shop here,” illustrating that a changed shopping pattern can even influence shopping attitude. second, respondents were asked about their attitude towards shopping and the shopping environment in the netherlands in comparison to their home-country. the biggest issues mentioned are the restricted opening hours of stores and restaurants at nights and on weekends, and the service level of personnel. the wide-spread knowledge of english among store personnel is perceived as positive. another main issue are products from home that are missed such as food, personal care products, and clothing due to differences in size and style. expats therefore shop in expat stores, their home-country, elsewhere abroad or online. other items that were mentioned as being different were retail mix, store size and lay out, personal space, level of lighting, pricing, product range, offer of gastronomy, and modes of transportation. three additional interviews with experts on expats’ consumer behaviour confirmed these findings. online survey to enhance insight into the values, shopping behaviour and perception of the shopping environment of expatriates, data was collected with a structured and self-administered online survey in both english and japanese. to cope with issues of linguistic and conceptual equivalence (de mooij, 2004), the english version was checked by three native speakers, after which it was translated into japanese and reviewed by four other native speakers. some minor adaptations were incorporated into the survey based on the outcome of the in-depth interviews. in the japanese version some translations of concepts were adjusted. the scope of the study is limited to american, british, and japanese expats that live in amstelveen and amsterdam. because no sample frame is available, people were notified about the survey via international schools, expat associations, expat networks, expat websites, and a volume 29, number 2 135 number of expat stores. the survey was online from april to june 2010. note that it was not the objective of this study to test specific scales. therefore, we have made a pragmatic decision to use scales that have been used in a variety of studies, and have proven to be reliable, in measuring the various aspects of interest. measurements to measure values, the list of values (homer & kahle, 1988) was utilized since it offers the best prospects in terms of high reliability versus ease of use (grünert & scherhorn, 1990; shim & eastlick, 1998; de mooij, 2004). the nine items of the lov are displayed in table 3. respondents were asked to indicate which three values are most important to them in their personal life. shopping values are operationalised by using a recently developed extended classification of shopping values by seo and lee (2008) with which they investigated differences in perceived shopping value across social class. apart from the utilitarian shopping dimension (efficiency), they distinguished multiple hedonic shopping motives, namely experiential, diversional, reliable, and self-expressive shopping value. efficiency shopping value is related to time-awareness and time-efficiency, experiential shopping value to enjoyment of the shopping experience itself, diversional shopping value to feelings of escapism and problem diversion, reliable shopping value to the perception of product and brand reliability, and self-expressive shopping to self-conscious ness and identification with the shopping environment. the ten statements as defined by seo and lee (2008) are slightly adapted so they reflect a general shopping attitude. see table 4 for an overview of these statements. respondents were asked to indicate to what extent they agree with those statements using a 5-point likert-type scale. shopping behaviour is explored by measuring choices of respondents, i.e. the shopping patronage, favourite brands, main points of purchase for different product categories, and products that are unavailable in regular dutch stores. the perception of the shopping environment was measured by asking respondents to indicate the importance of and satisfaction with 14 shopping centres attributes using a 5-point likert-type scale. the list of attributes is displayed in table 6. it is based on existing lists by oppewal (1995), shim and eastlick (1998), and dennis (2005), and the outcomes of the literature review and in-depth interviews. the overall satisfaction regarding the centre is measured using a 10-point scale. the questions on shopping value and perception of shopping centre attributes each consist of a set of statements; therefore factor analysis was conducted to 136 journal of business strategies determine any underlying dimensions (factors). for each factor analysis, the kaisermeyer-olkin (kmo) measure has to be higher than .5 and bartlett’s test of sphericity should be significantly small, indicating that the sample size is adequate and the correlations between the variables are large enough to perform this type of analysis. the factors with an eigenvalue of >1 are extracted, and they are rotated orthogonally by varimax. to test for significant differences in mean factor scores between the cultural groups, anova and a standard f-test was used. in addition, expats were requested to provide some general information regarding their gender, age, nationality, household structure, occupation, level of education, income, zip code, time of residence in the region, and level of cultural identification (shim & eastlick, 1998). the latter was examined by asking respondents how strongly they relate to their cultural background using a 5-point likert-type scale. comparison in order to gain insight into the dutch context a comparison was made between the collected data and existing data on dutch consumers with a similar age profile in the same area, which was obtained from market research specialist strabo (2008a; 2008b; 2009; 2010).1 results using the research questions that were posed in the introduction, the cultural values of expatriates will be discussed in this paragraph, followed by the findings regarding their shopping behaviour and perception, and evaluation of shopping centre attributes. first however, a description of the sample is given. sample a total of 133 expats completed the questionnaire, of which 24 were american, 27 british, 32 japanese and 50 were distributed among 21 other nationalities (see table 1). the sample consisted of 87% females and 13% males. 71% of the sample was between the age of 35 and 54. as expected, almost all respondents (96%) were high-educated and the majority (59%) has an above average income. note that a quarter did not want to indicate their level of income. around 71% indicated to have been living less than 5 years in the area, which corresponds with the hsbc survey (2008) in which 68% indicated to have been staying 5 years or less in the host-country. due to the distribution of questionnaires via schools the number of women and households with children is overrepresented in the sample. approximately 57% of the respondents were employed and 34% indicated volume 29, number 2 137 they were housewives. table 2 and figure 2 display the level of cultural identification among expatriates. on average expats maintain a moderate to strong connection with their cultural background. interestingly, there is no correlation between the level of cultural identification and the time of residence in the area. based on an f-test though, british expats held a significantly weaker connection to their cultural background than the americans and japanese (f = 7.282, p = 0.001). table 1 sample descriptive total (n = 133) american british japanese variable # % # # # ethnicity american 24 18% british 27 20% japanese 32 24% other nationalities 50 38% gender male 17 13% 1 7 2 female 116 87% 23 20 30 age < 35 years 36 27% 5 2 10 35-54 years 94 71% 18 25 22 > 55 years 3 2% 1 0 0 household one person 18 14% 4 5 5 type two person 32 24% 4 7 9 family with kids 74 56% 16 15 13 other 6 5% 0 0 2 education secondary education 4 3% 0 3 0 professional education 16 12% 1 4 2 university education or higher 111 83% 23 20 30 do not want to say 2 2% 0 0 0 occupation full time job 41 31% 6 12 3 part time job 23 17% 5 6 3 autonomous / freelance 12 9% 1 3 3 house wife / man 45 34% 9 3 20 other 12 9% 3 3 3 income < €2.600 a month 20 15% 5 3 7 > €2.600 a month 79 59% 13 16 17 do not want to say 34 26% 6 8 8 138 journal of business strategies table 2 level of cultural identification mean total american british japanese f p cultural identification level 3.56 3.83 3.07 3.84 7.282 < .001 figure 2 cultural identification across cultures personal values expats were asked to indicate which three values out of the nine-item list of values were most important to them in their personal lives (see table 3). the findings indicate that expats clearly regard fun and enjoyment in life (23%) and warm relationships with others (23%) most frequently as one of their top-3 values in life. other frequently named values are sense of accomplishment (12%) and security (12%). being well-respected, excitement, and a sense of belonging have a rather low total score. although the scores of americans, british and japanese expats are rather comparable, as is shown in figure 3, some significant differences were still identified with chi-square tests (see table 3). fun and enjoyment in life appears to be a much less important value for the americans compared to the british and the japanese. security was more important for the japanese than it was for the british. if compared to the outcomes of rose and shoham (2000) who explored the personal volume 29, number 2 139 values of us and japanese mothers, the relatively high score for the americans on self-respect and the japanese on security and fun and enjoyment is not surprising. table 3 personal values frequency with which value was mentioned in top-3 american british japanese list of values # % # # # c2 p sense of belonging 20 5% 7% 11% 0% excitement 14 4% 3% 1% 9% fun and enjoyment in life 90 23% 18% 28% 28% 7.3961/5.8883 p < .01/p < .05 warm relationship with others 91 23% 24% 26% 27% self-fulfilment 33 8% 11% 6% 6% being well-respected 12 3% 1% 0% 0% sense of accomplishment 49 12% 14% 12% 10% security 48 12% 14% 7% 18% 5.2952 p < .05 self-respect 32 8% 8% 7% 1% total 389 97% 100% 100% 100% 1 significant differences exist between american and japanese expats 2 significant differences exist between british and japanese expats 3 significant differences exist between american and british expats 140 journal of business strategies sense of belonging self-respect security sense of accomplishment being wellrespected self-fulfillment warm relationships with others fun and enjoyment in life excitement 30% 25% 20% 15% 10% 5% 0% american british japanese figure 3 personal values across cultures shopping value to learn about the domain-specific values of expats regarding shopping, they were asked about their general attitude towards shopping, i.e. shopping value (see table 4). explanatory factor analysis was conducted on the variables describing shopping value. the kmo measure was 0.771 and the bartlett’s test of sphericity was significant, indicating adequacy of the sample and data for factor analysis. specifically, two factors were extracted as shown in table 4. subsequently, standard f-tests were carried out to determine differences between groups. the first factor seems to be associated with (1) hedonic shopping motives and leisure, since it comprehends experiential and diversional shopping values on the positive scale and a negative factor loading for “a store visit is good when it is over very quickly.” factor 2 covers values related to efficiency, self-expression and brand-reliability, pointing towards a (2) utilitarian dimension. product-reliability takes a distinct position, since it is not associated with any other components but receives a high score in general from the entire group of expats. these results correspond with general findings on shopping value dimensions, but contrast with the findings by seo and lee (2008). according to them the utilitarian dimension comprehends solely efficiency shopping values. in our findings, this volume 29, number 2 141 dimension includes values regarding efficiency, self-expression, and brand-reliability. the relation of efficiency and reliability might be a manifestation of functionality and saving time. the link with self-expressive shopping values could be explained by a kind of (uncomfortable) self-awareness that is associated with shopping for a purpose and not with shopping as a leisure activity. table 4 shopping attitude mean total total group 1. 2. of expatriates hedonic utilitarian the time required for shopping has a big influence on my shopping experience 3.86 .542 a store visit is good when it is over very quickly 3.04 -.620 .503 shopping trips are truly a joy 3.04 .841 i enjoy shopping trips for its own sake, not just for the items i may purchase 3.10 .864 shopping trips truly feel like an escape 2.56 .762 while shopping, i am able to forget my problems 2.39 .683 .402 i prefer to visit stores that have high reliability for product 4.11 a store is good because it has many well-known brands 2.98 .682 while shopping i feel self-conscious 2.29 .710 i identify myself with the store that i am shopping in 2.45 .656 eigenvalues 3.22 2.45 % of variance 32.22 56.70 american -.233 .331 mean british -.357 -.147 japanese .641 -.554 f 13.391 6.600 p .000 .002 the standard f-test used to test for differences in mean factor scores, between cultural groups, lead to some interesting results. they indicate that on the hedonic dimension the japanese score highly positive whereas the american and british score negative, resulting in a significant difference between the japanese on the one hand 142 journal of business strategies and the american and british on the other. the hedonic value of shopping is very important for the japanese compared to both the british and american respondents. almost the opposite applies to the utilitarian dimension. here, the americans score positive, the japanese score highly negative, and the british score slightly negative. for the american group, the utilitarian shopping value is very important, while this is not the case for the other cultural groups — specifically for the japanese. it was also tested whether the shopping attitudes differ significantly per age, gender, and occupation. whether people work or not and gender showed no differences for shopping attitude. however, for various age groups a significant effect was found (f = 4.266, p = 0.017); the younger the respondents the more important the hedonic shopping value. shopping behaviour shopping patronage the main indicator that was used to define shopping behaviour was the frequency of visits. on average, expatriates make more shopping trips than dutch consumers (see table 5), namely 3.3 per week for daily goods (such as food and personal care products) and 1.5 per week for non-daily goods (e.g. apparel), compared to a total of only 3.0 per week for dutch consumers. regarding other aspects of shopping behaviour such as the patronage of other shopping venues in the area, moment of visit, and customer motivations, there were no clear differences between expats and dutch consumers. the visit frequency of expats does not vary significantly across cultures either. whether shopping frequency differ for various age groups, gender, and occupation was tested and no significant differences were found. table 5 visit frequency per week mean total american british japanese dutch* f(p) number of shopping trips for daily goods per week 3.30 3.27 3.70 2.99 1.553 (.218) number of shopping trips for non-daily goods per week 1.52 1.74 1.44 1.44 .198 (.821) total 4.82 5.01 5.14 4.43 3.06 * based on strabo purchase flow survey 2008 volume 29, number 2 143 missed products and brand preferences expats were asked about products from their home-country that were unavailable in regular dutch stores (see figure 4). the majority indicated that there are indeed specific products that they miss: mainly foods, clothing, books and media, and personal care products. likewise, gilly (1995) and usunier (1999) already stressed the importance of foods from home for expats. in the case of food (29%), personal care (47%) and clothing (45%) those are from specific brands. in general, expats have a greater preference for well-known international brands, while dutch consumers are more oriented on national chains. expats also miss stores with petite or larger clothing sizes, underwear, and designer clothes. those items are related to cultural norms regarding body proportions, beauty ideal, style, and quality perception. some of these products could also symbolize home, just as gilly (1995) found. the results do not indicate that there are differences between cultures regarding this topic or that people with a stronger cultural identification miss more products. figure 4 missed products from home-country figure 5 shows where expats eventually bought the products that they missed. buying online (32%), in expat/ethnic specialty stores (26%) or bringing products from ‘home’ themselves or via family or friends (29%) are popular ways of attaining these products. some expats bought products elsewhere abroad (6%). food was mainly bought in expat stores or brought from their home-country. books and media were generally bought online. clothing and personal care products were brought from their home-country but were also ordered online. japanese expats visited expat stores in order to obtain specific ingredients needed in japanese cuisine. shopping centres with such japanese stores exert a real pull factor on japanese expats since 144 journal of business strategies those are visited more often by them than one would expect based on their place of residence. figure 5 points of attainment for missed products evaluation of shopping centre attributes the evaluation of shopping centre attributes was investigated as part of the value-attitude-behaviour hierarchy. expats were asked to indicate the importance of shopping centre attributes in their decision on where to shop (see table 6), as well as their satisfaction with those attributes in the main shopping venue of amstelveen, stadshart amstelveen (see table 7). in comparison to dutch consumers, expatriates found location and accessibility, opening hours, a fashionable and trend sensitive (international) brand mix, choice in clothing sizes, and the possibility of covered shopping relatively important. expatriates with kids attach importance to stores, facilities and services for children. the service level is evaluated as low in general. factor analysis was conducted on the variables describing the importance of the shopping centre attributes and resulted in four factors (see table 6). the kmo measure was 0.725 and bartlett’s test of sphericity was significant. the four factors are labelled shopping centre functionality, shopping centre identity, essentials, and parking. subsequently, mean scores were generated per respondent for each of the factors and tested whether they significantly differ per cultural group. the results show a significant difference for the factor ‘parking’ for the japanese group, who have a higher mean score on this dimension in contrast to both the americans and the british (p < .001), and find the parking aspect of a shopping centre more important than the other cultural groups. volume 29, number 2 145 table 6 evaluation of importance of shopping centre attributes mean total total 1. 2. 3. 4. group shopping shopping of centre centre expatriates functionality identity essentials parking location/accessibility of the centre 4.59 .575 parking facilities 3.28 .895 retail mix 4.14 .658 opening hours of store 3.98 .562 .482 catering facilities 2.36 .584 facilities and services 2.67 .601 .440 attributes service by personnel 3.29 .428 .483 fashion and trend sensitivity 3.14 .638 promotions and events 2.64 .770 atmosphere of the centre 3.62 .747 design of the centre and public space 3.15 .728 covered shopping 3.33 .663 personal space and privacy 2.80 .782 orientation and way-finding 3.02 .653 eigenvalues 4.03 1.61 1.22 1.12 % of variance 28.77 11.51 8.68 7.96 american -.153 .029 .056 -.311 mean british -.052 .199 .109 -.342 japanese -.194 -.293 -.127 .593 f .182 1.788 .406 10.240 p .834 .174 .668 .000 it was also tested whether other socio-demographic variables show significant differences for the importance of shopping centre attributes. women (f = 8.705, p = 0.004), and respondents without a job (f = 5.417, p = 0.022) find parking more important than men and respondents with a job. because the group of japanese is significantly overrepresented by females and housewives these results should be interpreted with care. 146 journal of business strategies table 7 evaluation of satisfaction with shopping centre attributes mean total total 1. 2. 3. 4. group shopping shopping of centre space centre expatriates identity perception functionality essentials location/accessibility of the centre 4.18 .775 parking facilities 3.50 .668 retail mix 3.36 .466 .405 .506 opening hours of store 3.13 .738 catering facilities 3.00 .766 facilities and services 2.86 .420 .676 attributes service by personnel 2.87 .425 .412 442 fashion and trend sensitivity 3.15 .770 promotions and events 3.17 .635 atmosphere of the centre 3.58 .803 design of the centre and public space 3.50 .612 .444 covered shopping 3.87 .804 personal space and privacy 3.26 .438 .612 orientation and way-finding 3.42 .655 eigenvalues 5.81 1.38 1.12 1.01 % of variance 41.50 9.88 7.98 7.21 american .081 -.509 -.160 -.122 mean british -.398 .097 .473 .308 japanese -.203 .171 -.240 -.228 f 1.360 2.676 3.108 1.754 p .264 .077 .052 .182 exploratory factor analysis was also conducted on variables describing the satisfaction with shopping centre attributes in the main shopping venue in amstelveen (see table 7). the kmo measure was 0.868 and bartlett’s test of sphericity was significant. four factors were found: shopping centre identity, space perception, shopping centre functionality, and essentials. a clear difference was found with the factor analysis of importance. the attributes related to space percep tion form a separate factor with regard to satisfaction, while they are associated with functional attributes when it concerns importance. volume 29, number 2 147 the mean factor sores of the cultural groups were compared by a one-way anova. significant differences were found for the factors space perception and shopping centre functionality. the means show that japanese are most satisfied with space perception, including orientation, way finding, and covered shopping. the british group was slightly positive while the americans were quite negative with regard to this factor. shopping centre functionality, including availability of facilities, services, and opening hours, was positively evaluated by the british. the other two groups were slightly negative with respect to this factor. also tested was whether different age groups, gender, and occupation show significant different means for the factors. the only significant finding was that people with a job (f = 4.308, p = 0.042) are in general more satisfied with the shopping centre functionality factor. conclusion and discussion this study aimed at examining how shopping centre attributes can be adapted to culture-related shopping behaviour of expatriates. the guiding research questions handled cultural and shopping values, shopping behaviour, and perception and evaluation of shopping centre attributes by expats. the answers were established through a literature review, in-depth interviews, an online survey among expats living in the amstelveen/amsterdam area in the netherlands, and a comparison of the results with existing data on dutch shoppers. the results of this study lead towards a somewhat mixed image on the shopping behaviour of expats. although expatriates seem to hold a rather comparable value framework as a group, there are still clear significant differences between cultures regarding personal values and shopping value. japanese expats for example perceive shopping more often as a joyful activity, while americans expats perceive it as more related to time and efficiency. british expats’ shopping values cannot be characterized as typically hedonic, neither as typically utilitarian. this corresponds with earlier findings of rubio-sanchez (2007), who also found that cultural dimensions influence shopping values. shopping values could not be explained by sociodemographic variables like gender and occupations. however, shopping values differ for various age groups. for younger respondents the hedonic shopping values are more important. the actual shopping behaviour, such as visit frequency, does not differ so much between cultures. however, compared to dutch consumers, expatriates make more shopping trips per week. 148 journal of business strategies the evaluation of importance of shopping centre attributes by expatriates turned out to be rather similar across cultures. based on factor analysis four factors could be identified, labelled shopping centre functionality, shopping centre identity, essentials, and parking. only one significant cross-cultural difference exists regarding the ‘parking’ factor for the japanese group. since japanese expats showed strong hedonic shopping values, and parking can be regarded as a factor representing utilitarian attributes, this finding is rather unexpected. an explanation could be the fact that females that do not have a job are over-represented in the japanese sample. a larger and more balanced sample size would have allowed us to be more specific about this issue. variables describing the satisfaction with shopping centre attributes in the shopping venue in amstelveen could be grouped in two (out of four) significant factors: space perception and shopping centre functionality. american expats were quite negative with regard to the factor “space perception” including the attributes “facilities and services” and “services by personnel.” this finding could be related to differences in societal norms regarding service levels between the american and dutch culture. british expatriates were the only group that was positive with regard to “shopping centre functionality” including attributes like “opening hours,” “facilities” and “retail mix.” this could be explained by similarities between the dutch and british culture; they share the same european shopping values. overall, facilities and services (by personnel) received the lowest evaluation by the total group of expats while the location, accessibility and the fact that a shopping centre is covered received the highest evaluation scores. on one hand the results consequently reflect a universal lifestyle among expats, while at the same time they also emphasize cultural differences. cultural sensitivity is therefore definitely important in the marketing of a shopping centre towards a heterogenic group like expats, but should not be exaggerated either since expatriates have some clear common grounds in their value orientation, shopping behaviour and perception of the shopping environment. a certain cognitive proximity among expatriates could be an explanation for these common grounds. from a broader perspective one could say that the adjustment of a shopping centre to a cultural consumer segment can take place on the level of the shopping centre, store and product assortment, and demands a marketing strategy incorporating both lifestyle and ethnicity. insight in the cultural component and potential of such consumers in a catchment area is therefore important, but adjustments should take place without jeopardising the other (dutch) consumers. apart from extended opening hours, which are a continuous subject of debate in the netherlands, the most effective soluvolume 29, number 2 149 tions for shopping centre developers, management, and retailers are therefore in the retail and brand mix, product assortment, (bilingual) service, signing and promotion. as was concluded in the literature review, only a very limited number of studies has explored the consumption and shopping behaviour of expatriates. therefore, further research is needed, preferably based on actual buying behaviour of expats and including data on exact expenditure and share of turnover. the limited sample sizes of the cultural groups in this study also make the results hard to generalise. future studies should therefore be conducted among expatriates from and on different continents in order to improve general applicability and to offer insight into the influence of lifestyle, ethnicity, ethnic identification, and other characteristics. native consumers should also be included in the study too to increase validity. in addition, it might be of interest to apply more advanced modelling techniques, such as structural equation models, to examine more complex relations between the variables and constructs included in the study. we hope to report on these results in the near future. the relation between shopping value and culture and the corresponding measurement scales might be interesting to examine more thoroughly as well. finally, due to the nature of cross-cultural research it would be preferable to have command over a culturally diverse research team and sufficient resources to allow translation/backtranslation of a survey. nevertheless, this study provides further important insights into the relation between consumers’ values, shopping behaviour and the physical shopping environment while emphasizing the complexity of this theme in relation to culture and ethnicity. acknowledgements the authors gratefully acknowledge the support of the market research specialist strabo. end notes 1. (a) visitors’ survey 2008 was held among 871 visitors of stadshart amstelveen; (b) pur chase flow survey 2008 was a phone based survey held among 400 households from amstelveen and 700 in amsterdam zuid, aalsmeer, uithoorn, hoofddorp, badhoevedorp and ouder-amstel; untapped market analysis 2009 was a written survey among 1.800 consumers in diemen, amsterdam-zuid, amsterdam-sloten and badhoevedorp; market analysis 2010 was a phone-based survey among 1.200 households, 400 in each 10-minute catchment area of stadshart amstelveen. 150 journal of business strategies references ackermann, d., & tellis, g. (2001). can culture affect prices? a cross-cultural study of shopping and retail prices. journal of retailing, 77, 57-82. ajzen, i. (1985). from intentions to actions: a theory of planned behavior. in j. kuhl & j. beckmann (eds.). action control: from conition to behavior, 11-39. new york: springer verlag. ajzen, i. (1991). the theory of planned behaviour. organisational behaviours and human decision processes, 50, 179-211. allard, t., babin, b. j., & chebat, j. c. (2009). when income matters: customers evaluation of shopping mall’s hedonic and utilitarian orientations. journal of retailing and consumer services, 16, 40-49. andreason, a. w., (2008). expatriate adjustment of spouses and expatriate managers: an integrative research review. international journal of management, 25(2), 382-395. amstelveen municipality (2008). the international dimension of amstelveen [de internationale dimensie van amstelveen]. retrieved january 21, 2010 from www.amstelveen.nl/web/show?id=199074&langid=43 amsterdam municipality (2007). the expatriates: inventarisation document development physical expat office window [the expatriates: inventarisatiedocument ontwikkeling fysiek expat loket]. retrieved january 21, 2010 from biodata.asp4all.nl/andreas/2008/09012f97803ff698/09012f97803ff698.pdf babin, b. j., darden, w. r., & griffin, m. (1994). work and/or fun: measuring hedonic and utilitarian shopping value. journal of consumer marketing, 20(4), 644-656. babin, b. j., & attaway, j. s. (2000). atmospheric affect as a tool for creating value and gaining share of customer. journal of business research, 49(2), 91-100. black, j. s. (1988). workrole transitions: a study of american expatriate managers in japan. journal of international business studies, 19, 277-294. black, j. s., & stephens, g. k. (1989). the influence of the spouse on american expatriate adjustment and intent to stay in pacific rim overseas assignments. journal of management, 15(4), 277-294. black, j., mendenhall, m., & ouddou, g. (1991). toward a comprehensive model of international adjustment: an integration of multiple theoretical perspectives. academy of management review, 16(2), 291-317. brunsø, k., & grünert, k. g. (1998). cross-cultural similarities and differences in shopping for food. journal of business research, 42, 145-150. volume 29, number 2 151 caldwell, m., blackwell, k., & tulloch, k. (2006). cosmopolitanism as a consumer orientation: replicating and extending research. qualitative marketing research: an international journal, 9(2), 126-139. cannon, h. m., & yaprak, a. (2002). will the real-world citizen please stand up! the many faces of cosmopolitan consumer behaviour. journal of international marketing, 10(4), 30-52. chebat, j. c., & morrin, m. (2007). colors and cultures: exploring the effects of mall décor on consumer perceptions. journal of business research, 60, 189-196. craig, c. s., & douglas, s. p. (2006). beyond national culture: implications of cultural dynamics for consumer research. international marketing review, 23(3), 332-342. dennis, c. (2005). objects of desire: consumer behaviour in shopping centre choices. london: palgrave macmillan. eroglu, s. a., machleit, k., & barr, t. f. (2005). perceived retail crowding: the role of shopping values. journal of business research, 58, 1146-1153. farquhar, j. d. (2009). international explorer expat survey, international journal of bank marketing, 27(3), 242-246. geertz, c. (1973). the interpretation of cultures. new york: basic books. retrieved january 21, 2010 from books.google.com. gilly, m. c. (1995). the consumer acculturation of expatriate americans. in f. r. kardes & m. sujan (eds.). advances in consumer research, 22, 506-510. provo, ut: association for consumer research. griffin, m., babin, b. j., & modianos, d. (2000). shopping values of russian consumers: the impact of habituation in a developing economy. journal of retailing, 76(1), 33-52. grinstein, a., & wathieu, l. (2008). cosmopolitanism, assignment duration, and expatriate adjustment: the trade-off between well-being and performance. esmt working paper, 08-011. retrieved february 20, 2012 from papers.ssrn.com/ sol3/papers.cfm?abstract_id=1353128 grünert, s. c., & scherhorn, g. (1994). consumer values in west-germany: underlying dimensions and cross-cultural comparison with north america. journal of business research, 20, 97-107. halepete, j., seshadri iyer, k. v., & park, s. c. (2008). wal-mart in india: a success or failure? international journal of retail & distribution manage ment, 36(9), 701-713. hall, e. t. (1996). the hidden dimension. new york: anchor books. hannerz, u. (1990). cosmopolitans and locals in a world culture. theory, culture & society, 7, 237-251. 152 journal of business strategies hazel, d. (2005, may), local flavors: forest city’s hispanic retail group targets strong latino markets. shopping centers today. retrieved january 21, 2010 from www.icsc.org/srch/sct/sct0505/manage_market_4.php. hofstede, g. (1980). culture’s consequences: international differences in work-related values. london: sage. hofstede, g. (2001). culture’s consequences: comparing values, behaviors, institutions, and organisations across nations. london: sage. holstein, w. j. (2007, july 27). why wal-mart can’t find happiness in japan. fortune magazine. retrieved january 21, 2010 from money.cnn.com/magazines/ fortune/fortune_archive/2007/08/06/100141311/index.htm homer, p. m., & kahle, l. r. (1988). a structural equation test of the value-attitudebehavior hierarchy. journal of personality and social psychology, 54, 638-646. hsbc bank international (2009). expat explorer survey 2009: expat experience. retrieved january 21, 2010 from www.offshore.hsbc.com/1/2/international/expat/expat-survey/results-2009. icsc (2009). 21st century retail centers: context, culture and community, author. jackson, v., stoel, l., & brantley, a. (2011). mall attributes and shopping value: differences by gender and generational cohort. journal of retailing and consumer services, 18, 1-9. kacen, j. j., & lee, j. a. (2002). the influence of culture on consumer impulsive buying behaviour. journal of consumer psychology, 12, 163-176. kahle, l. r. (2000). cross-cultural consumer psychographics. new york: haworth press. keen, c., wetzels, m., ruyter, k., feinberg, r. (2004). e-tailers versus retailers. which factors determine consumers preferences. journal of business research, 57(7), 685-695. kim, j., park, j. (2005). a consumer shopping channel extension model: attitude shift toward the online store. journal of fashion marketing and management, 9(1), 106-121. kliment, s. a. (2004). building type basics for retail and mixed-used facilities. new jersey: john wiley & sons. kooijman, d. (1999). machine and theatre: design concepts of shopping venues [machine en theater: ontwerpconcepten van winkelgebouwen]. rotterdam: 010 publishers. koubaa, y. (2011), the dual impact of traditional and national cultural values on expatriate ethnic groups’ attitude and willingness to buy. asia pacific journal of marketing and logistics, 23(5), 626-640. volume 29, number 2 153 krafft, m., & mantrala, m. k. (2006). retailing in the 21st century. berlin: springer. kuruvilla, s. j., & joshi, n. (2010). influence of demographics, psychographics, shopping orientation, mall shopping attitude and purchase patterns on mall patronage in india. journal of retailing and consumer services, 17, 259-269. lavin, m. (1996). ethnic/racial segmentation: insights from theory and practice. journal of retailing and consumer services, 3(2), 99-105. louviere, j. j., levin, i. p., meyer, r. j., henley, d. h., stoner, j. w., curry, d. j., anderson, d. a., & woodworth, g. (1981). the development and test of mathematical models of travelers’ perceptions and decisions, final report 27, institute of urban and regional research, university of iowa, iowa city. masicotte, m., michon, r., chebat, j. c., sirgy, m. j., & borges, a. (2011). effects of mall atmosphere on mall evaluation: teenage versus adult shoppers. journal of retailing and consumer services, 18, 74-80. mccracken, g. (1988). culture and consumption: new approaches to the symbolic character of consumer goods and activities. bloomington: indiana university press. retrieved january 21, 2010 from books.google.com michon, r., & chebat, j.c. (2004). cross-cultural mall shopping values and habits: a comparison between englishand french-speaking cana dians. journal of business research, 57, 883-892. michon, r., chebat, j. c., & turley, l. w. (2005). mall atmospherics: the interaction effects of the mall environment on shopping behaviour. journal of business research, 58(5), 576–583. mooij de, m., & hofstede, g. (2002). convergence and divergence in consumer behavior: implications for international retailing. journal of retail ing, 78, 61-69. mooij, de m. (2004). consumer behaviour and culture: consequences for global marketing and advertising. thousand oaks, ca: sage. nicholls, j. a. f., li, f., mandokovic, t., roslow, s., & kranendonk, c. j. (2000). us-chilean mirrors: shoppers in two countries. journal of consumer marketing, 17(2), 106-119. oppewal, h. (1995). conjoint experiments and retail planning: modelling consumer choice of shopping centre and retailer reactive behaviour. eindhoven, the netherlands: eindhoven university of technology. retrieved january 21, 2010 from alexandria.tue.nl/extra3/proefschrift/prf10b/9404520.pdf pavlou, p. a., & chai, l. (2002). what drives electronic commerce across cultures? a cross-cultural empirical investigation of the theory of planned behaviour, journal of electronic commerce research, 3(4), 240-253. rice, c. (1993). consumer behaviour: behavioural aspects of marketing. oxford: butterworth-heinemann. 154 journal of business strategies rose, g. m., & shoham, a. (2000). the values of american and japanese mothers: an application of lov in the us and japan. in l. r. kahle (ed.). cross-cultural consumer psychographics, 45-62. new york: haworth press. rokeach, m. (1973). the nature of human values, new york: free press. rubio-sanchez, a. (2007). cultural dimensions and their influence on shopping value. ann arbor, mi: proquest. sands, s., oppewal, h., & beverland, m. (2009). the effects of in-store themed events on consumer store choice decisions. journal of retailing and consumer services, 16, 386-395. seo, s., & lee, y. (2008). shopping values of clothing retailers perceived by consumers of different social classes. journal of retailing and consumer services, 15, 491-499. seock, y-k. (2011). cultural influence on loyalty tendency and evaluation of retail store attributes: an analysis of taiwanese and american consumers. international journal of retail & distribution management, 39(2), 94-113. shearin, r. (2006, january). seeking cultural dna, shopping centre business. retrieved january 21, 2010 from www.shoppingcenter business.com/articles/ jan06/story3.shtml shim, s., & gehrt, k. (1996). hispanic and native american adolescents: an exploratory study of their approach to shopping. journal of retailing, 72(3), 307-324. shim, s., & eastlick, m. a. (1998). the hierarchical influence of personal values on shopping attitude and behaviour. journal of retailing, 74(1), 139-160. sood, j., & nasu, y. (1995). religiosity and nationality: an exploratory study of their effect on behaviour in japan and the united states. journal of business research, 34, 1-9. stoel, l., wickliffe, v., & lee, k. h. (2003). attribute beliefs and spending as antecedents to shopping value. journal of business research, 57, 1067-1073. strabo (2008a). purchase flow study stadshart amstelveen. amsterdam: author. strabo (2008b). visitors survey stadshart amstelveen. amsterdam: author. strabo (2009). ‘untapped market’ stadshart amstelveen. amsterdam: author. strabo (2010). market analysis stadshart amstelveen. amsterdam: author. strategic direction (2009). china teaches ikea limits of homogeneity: not yet part of the eastern furniture. strategic direction, 25(11), 43-45. swinyard, w. r. (1998). shopping mall customer values: the national mall shopper and the list of values. journal of retailing and consumer services, 5(3), 167172. volume 29, number 2 155 the economist (2009, january 22). segregation and shopping: the call of the mall. retrieved january 21, 2010 from www.economist.com/world/unitedstates/ displaystory.cfm?story_id=e1_tnjrsvvg&source=login_ paybarrier thompson c. j., & tambyah s. k. (1999). trying to be cosmopolitan. journal of consumer research, 26(3), 214-41. timmermans, h. (1982), consumer choice of shopping centre: an information integration approach. regional studies, 3, 171-182. timothy, d. j. (2005). shopping tourism, retailing and leisure. clevedon, uk: channel view publications. retrieved january 21, 201 from books.google.com turley, l. w., & milliman, r. e. (2000). atmosphere effects on shopping behavior: a review of the experimental evidence. journal of business research, 49, 193211. tylor, e. b. (1920) [1871]. primitive culture: researches into the development of mythology, philosophy, religion, language, art and custom, volume 1. (6th ed.). new york: john murray. forgotton books. retrieved january 21, 2020 from books.google.com usunier, j. c. (1999). food consumption and the expatriation experience: a study of american expatriates in france. in b. dubois, t. m. lowrey, l. j. shrum, & m. vanhuele (eds.). european advances in consumer research, 4, 352-360. provo, ut: association for consumer research. van vianen, a. e. m., de pater, i. e., kristof-brown, a. l., & johnson, e. c. (2004). fitting in: surfaceand deep-level cultural differences and expatriates’ adjustment. the academy of management journal, 47(5), 697-709. vinson, d. e, scott, j. e., & lamont, l. m. (1977). the role of personal values in marketing and consumer behaviour. journal of marketing, 41(2), 44-50. yüksel, a. (2007). tourist shopping habit: effects on emotions, shopping value and behaviour. tourism management, 28, 58-69. zhang, y., winterich, k. p, & mittal, v. (2010). power distance belief and impulsive buying. journal of marketing research, 47(5), 945-954 biographical sketch of authors geri wijnen is a development manager at wereldhave, a listed internationally operating investment company with a focus on retail. here she is responsible for redevelopment of two shopping centers in the netherlands. she holds an academic master in real estate management and development and an academic bachelor in architecture building and planning from the eindhoven university of technology. her master thesis focused on the shopping behavior of expatriates. 156 journal of business strategies astrid kemperman is an assistant professor of urban planning at the eindhoven university of technology. her research focuses on the impacts of urban environments on human behavior. she has specific interest in the areas of physical activity and health, leisure activities of different groups in society (e.g., the elderly), and shopping behavior. she also has investigated dynamics of tourist choice behavior, including modeling variety seeking, seasonality and diversification to support planning decision making. ingrid janssen is associate professor at tias nimbas business school and lecturer at the real estate management group at eindhoven university of technology. her research focuses on retail real estate, real estate asset and property management and decision making in real estate. her ph.d. involved decision-making politics in retail property development. a cross-cultural comparison of expatriates’ shopping behaviour a simple export country-market screening technique for small us businesses: a packaged good illustration jose f. medina joel saegert john merrifield university of texas at san antonio san antonio, tx abstract us small businesses are in need of processes and techniques that help them alleviate the difficult experience of choosing foreign markets. using a generic screening process, this paper explains the stages, the screening criteria, and the ranking techniques for selecting country-markets. the paper illustrates the application of shift-share analysis (ssa) as a simple technique to rank country-market potentials. results from an analysis of a packaged good show that ssa is an adequate ranking technique to identify preliminary country prospects. implications for small businesses and future research are given. introduction efforts to export to other countries usually encounter barriers less frequently faced in the domestic marketplace, such as differences in cultural, legal, political, and economic environments. at the same time, many of the sales barriers encountered in export marketing are similar to those of domestic marketing, e.g., ineffectiveness of dealers and distributors, changing customer preferences, lack of customer knowledge of the product, etc. despite the level of similarity (or dissimilarity) of the barriers between domestic and export marketing, small us businesses in growing numbers are eager to step into the international business arena. reports from the government (prosak, 1993) and the general business media (businessweek, 1995) indicate that small us firms, with reasonably priced consumer products and with a proven record of acceptability in the domestic market, have strong export potential. although assessing a product's export potential is a critical step in export marketing, determining where that potential is the greatest is just as important. which countries to export to first and how many is always a vexing question that has challenged many small and medium-sized exporters (mcniven, fall 1996 medina, saegert & merrifield: screening technique 127 1991; ramaswami & yang, 1990). research has found that perceived trade barriers are traced back to managers' difficulties in locating foreign markets (alexandrides, 1971; tesar & tarleton, 1982). unfortunately, there is not a simple, appropriate, and reliable technique to help identify attractive world markets. this is a troublesome circumstance for the many small businesses with simple decision structures (miller & friesen, 1980). the export marketing literature is sparse at best in evaluating processes and techniques on how to select country markets. existing treatments vary from the sophisticated, such as comparative cluster analysis (sheti, 1971), to the much simpler, such as multiple factor analysis (samli, 1977) and shift-share analysis (green & allaway, 1985). one problem with the more sophisticated techniques is that they require large amounts of data manipulation to screen candidate countries. another limitation is that these approaches require good knowledge and understanding of complex statistical techniques. on the other hand, a simpler and more parsimonious technique such as shift-share analysis (ssa) appears to possess characteristics for wider application. shift-share analysis has been around in the economic literature for a long time (fuchs, 1959). it has been traditionally used in studies of regional economics to assess the differences between regional and national trends of economic phenomena (merrifield, 1983). it has been successfully applied in measuring market growth by eliminating many of the limitations inherent in the use of absolute and relative measures (huff & sherr, 1967). some studies have extended its use to international trade, for example, to determine the composition of trade flows for the us and its trading partners (green, 1985; green & allaway, 1985; green & larsen, 1991a; green & larsen, 1991b). to be sure, ssa has three important limitations regarding its use in international trade. first, it involves only two points in time; choosing different points in time might render different ranking results. second, it only ranks one product category at a time. and, finally, the technique's predictive validity has not been tested for ranking exports markets. one result of applying ssa to an export screening process would be that it produces a smaller set of export country-markets that would warrant a more in-depth and focused investigation. in addition, the greater accessibility to export statistics through the internet and similar media renders ssa a more valuable and useful research technique to be applied by small businesses. the purpose of this paper is to examine the effectiveness of applying the ssa ranking technique to readily available us export statistics to measure country-market market potentials. the literature is briefly reviewed regarding the importance to small businesses of exporting as a competitive country-market entry strategy; generic methods for the export country-market screening process; and the convenience and availability of trade data and the shift-share analysis technique. a methodology for a simple export country-market screening method is described using the ssa ranking technique, following which results are described and tested against independent sources for convergent 128 journal of business strategies vol. 13, no. 2 validity. this version of ssa is intended to be one that can be easily understood and used by small us export businesses. thus, the last two sections discuss implications for such companies and make recommendations for research. exporting as a competitive country-market entry strategy exporting should be seen as only one of several possible country-market competitive entry strategies e.g., licensing, joint ventures, collaborative alliances, and direct investment (agarwal & ramaswami, 1992; cavusgil & zou, 1994). an entry strategy is a comprehensive plan that sets forth the objectives, goals, resources, and policies that will guide a company's international business operation. specifically, country-market entry strategies require decisions about the choice of a target country and the choice of an entry mode to penetrate that target (root, 1987). additionally, a competitive strategy requires decisions concerning the level of expansion concentration versus diversification and competitive posture defensive versus offensive (ayal & zif, 1978). a strategy of country-market concentration would focus available resources among a small number of country-markets. conversely, diversification allocates limited resources over a larger number of country-markets. small firms stepping into the international arena would benefit from a concentration approach, where high market growth rate and sales stability allow firms to gradually capture a few "neutral markets." experience has demonstrated that many small us companies become committed to international markets only when they no longer believe that they can attain their strategic objectives by remaining at home (root, 1987). because of their limited international experience and resources, and a "typically" defensive stance relative to their larger competitors, small firms tend to opt for foreign markets that have similar demand structures as those in the us (davidson, 1983). consequently, ayal & zif (1978) would argue that small firms should launch concentrated efforts to capture a few "neutral" countrymarkets to expand their domestic base, and thus defend themselves from a larger competitor's attack at home. many small companies in the united states seem to have now reached the point at which they need to actively seek export opportunities (businessweek, 1995). conventional wisdom and recent empirical research suggest that most small us businesses do not have the capabilities to undertake any entry strategy planning beyond exports (baird, lyles & orris, 1993; baird, lyles & orris, 1994), partly because of their unpreparedness to deal with foreign business practices and foreign government regulations (czinkota, 1994). at the same time, many potential foreign markets do not seem to offer a large enough opportunity to justify more elaborate entry strategies beyond exports. thus, exporting may be seen as the preferred choice of entry mode for most smallsized companies in the us. the continuing expansion of the global economy fall 1996 medina, saegert & merrifield: screening technique 129 will almost certainly bring many more companies to that point in the future, and identifying suitable markets is generally a first step. the export country-market screening process the sometimes complex realties of many foreign environments and the allure of high profit potentials require that export country-markets be sought objectively, systematically, and continuously (cavusgil, 1985). understanding the characteristics of available screening processes is of the utmost importance for small businesses, as they do not have the financial wherewithal to test potentially ineffective procedures (bilkey, 1978; ogram, 1982). export market screening processes were originally conceived to help companies understand information requirements as they studied the possibility of exporting to a potential pool of country-markets (cavusgil, 1985; kale & sudharshan, 1987; root, 1982; walvoord, 1980). the main goal of any screening process is, therefore, to reduce the number of prospective country-markets to a manageable set that can be further explored by the firm. the typical structure of a screening processes would include screening stages, screening criteria, and ranking techniques. most small firms would prefer to produce standardized offerings rather than to make major adjustments (or modifications) to their existing product line. this is in part due to the many potential up-front costs for such modifications, including gathering new information, laboratory testing, and patent protection, just to name a few (terpstra, 1983; walters, 1986). therefore, for small firms, identifying barriers-to-exports may be more important than identifying opportunities. a screening process designed for small firms should be able to eliminate systematically those country-markets with the least likelihood of having customers who would purchase the firm's offerings as they were originally conceived for the domestic market. product offering selection would depend on gathering country-market information guided by company operating strategies and marketplace realities. before undertaking any preliminary screening, managers of small businesses should have a well-rounded understanding of the firm's production expertise and capabilities (fennell & saegert, 1990; kerr & kirkconnell, 1989). additionally, a firm's ability to develop cost-effective product/market research methods such as data-gathering techniques, relevant information requirements and data sources, rests on maintaining a constant vigil on what is happening in the global marketplace (davidson, 1983). after choosing the candidate offering, managers should review the target market profile for the product category of interest the characteristics of the individuals (and/or organizations) that are actual or prospective customers based on their domestic marketplace experience (davidson, 1983; root, 1987; terpstra, 1988). this exercise should help the company identify screening criteria based on demand-generating conditions (or circumstances) for the candi130 journal of business strategies vol. 13, no. 2 date product. the next two sections discuss in more detail the screening stages and criteria, and the ranking technique characteristics. screening stages and screening criteria figure 1 shows an adapted model of the screening process in export country-market selection, and screening criteria and ranking techniques in export country-market selection. the adapted model includes four screening stages: (1) country-market identification, (2) country-market market potential, (3) country-market sales potential, and (4) segment identification in the targeted country market. the screening process is very specific about the research objectives pursued at every stage. for example, the research objective of the first stage is to reduce the pool to prospective country-markets; the second stage is to reduce the pool to country-markets with higher market potential; the third stage is to select a country-market with the highest sales potential; and the fourth is to select an optimal mix of segments in the targeted country-market. in this sequential-screening approach, countries are rejected (or screened) on each new stage, (with the exception of stage 4 where segments are rejected), thus reducing the pool of countries analyzed, and consequently, the total amount of information required. however, the model assumes that, as each new stage is reached, the availability of secondary data screening criteria decreases and the need for primary data screening criteria increases, thereby increasing the quality and cost of the information required. in the first stage, general information about countries and generic product barriers is applied to all countries. the general recommendation in this identification stage is that firms should first eliminate all country-markets that have legal, political, economic, financial, cultural and product-related barriers to exports. general country barriers include trade sanctions imposed by either the domestic or foreign governments, regulations under general or bilateral trade agreements, political risks, erratic economic behavior, cultural dissimilarities, etc. for example, until recently, the us had a total trade embargo placed on vietnam. therefore, vietnam was an unlikely candidate for export activities. no us firm or subsidiary could trade with vietnam without facing economic and/or legal sanctions (rogers, 1994). generic product barriers include country regulations or physical environment characteristics that might interfere with physical attributes of the product such as size, color, dimensions, and packaging. for example, ansell edmont, us producer of work gloves, found that japanese workers have smaller hands and shorter fingers than their us counterparts and therefore require different gloves (jeannet & hennessey, 1995, p. 337). the advantage of this type of data is that they are readily available or observable and can be used to quickly eliminate countries. the problem with some of these indicators, however, is that they systematically vary across product categories (green & kohli, 1991; linder, 1961). in other words, the screening effectiveness of these indicators depends on the attributes possessed by the ...... vj figure 1 'tl2 the screening process, screening criteria, and ranking techniques in export country-market selection --\0 \0 all countries i secondary screening criteria ranking techniques 0'1 data stage i. country-market identification i i economic size and social development: ~ a. general country barriers (cavusgil 1982; douglas et al. 1982; none l1:> ~ b. generic product barriers goodnow and james 1972; green and s· kobli 1991; pezeshkpur 1979; f:l root 1987; sethi 1977). ~ l1:> oq l1:> stage 2. country-market market potential international trade statistics: multiple factor analysis: ~ a. national industry barriers (ayal 1982; green and allaway samli (1977). r'> b. product category barriers 1985; rao 1979; root 1987). shift-share analysis: ~ industry related production green and allaway (1985). l1:>..... country-markets with i i facton: (samli 1977). ..... '5i highest market potential l1:> ~ stage 3. country-market sales potential v:l ~ a. competitors barriers root (1987) none ;;; b. consumer barriers l1:>:::! s· oq country-market with i i ;:;3highest sales potential ~ ~ :::! stage 4. segment identification in the ! kale and sudharshan (1987); none ..e' :::: targeted count-market saeger! and medina (1995). l1:> optimal segment mix in primary targeted country-market data source: screening process adapted from cavusgil ([ 985); kale and sudharsan (1987); and walvoord (1980). 132 journal of business strategies vol. 13, no. 2 country and not on the type of product category being considered. realistically, at this stage, countries are selected for their socioeconomic and cultural similarity to the home markets (linder, 1961; terpstra, 1983). second, to reduce the obtained pool of prospective country-markets to a set of high market potential country-markets, the national industry and product category barriers need to be analyzed. key factors include commodity-specific trade barriers, industry entry barriers such as extent of local production, availability of local procurement, imports from third countries, negative perceptions by local consumers of the product category, and availability of product substitutes. some of the screening criteria required at this stage are difficult to obtain for many candidate countries and products. thus, the literature has focused on trade statistics such as flows of exports, imports and the composition of trade between countries as convenient surrogates for market potential. these indicators are becoming more important in their use because their increasing availability and reliability of measurement; and, unlike the first stage's screening criteria, they have the added advantage that they are largely a function of the product category under consideration (green & kohli, 1991). another advantage of this type of criterion over socioeconomic and political indicators such as those in stage 1 is that they account for the dynamics and the changing nature of the trade environment between economies. one possible disadvantage for small firms is that these trade statistics are usually highly aggregated. thus they are of little help to small firms with very specific narrow product categories. in the third stage, competitor and consumer barriers must be assessed. the strengths of direct competitors (i.e., those who sell similar brands) and their likely reaction to the small firm's entry into the industry must be assessed at this point; as well as potentially unrealistic expectations of local distributors in regards to gross margins, promotional allowances, pricing, etc. customers' familiarity with company brand(s) and their willingness to buy them are also considered here. potential consumers (or their representatives) of the firm's brand(s) must compare these brands with similar local brands to assess their relative advantage, their ease to use, and their compatibility with the user, just to name a few. smaller firms are usually unaware of potential competitor's and consumer's barriers. consequently, they are generally less confident about their knowledge regarding competitor's strengths, channels of distribution, payment conditions, etc. (alexandrides, 1971; ogram, 1982; tesar & tarleton, 1982). however, government-sponsored export-promotion programs help small firms "test the waters" regarding brand recognition and acceptance, and comparability with local as well as international brands, by representing them in international trade fairs and shows (czinkota & ricks, 1981; barrett & wilkinson, 1990). the fourth and final stage identifies segments within the country-market with the highest sales potential. only recently has the literature addressed the importance of adding within-country-market segmentation to the screening fall 1996 medina, saeger! & merrifield: screening technique 133 process; by either following a conventional segmentation approach such as demographics, lifestyles, benefits, etc. (kale & sudharshan, 1987) or by emphasizing the discovery, perhaps through focus groups, of demand-generatingcircumstance segments (fennell & saegert, 1990; saegert & medina, 1995). in both of these approaches, both qualitative and quantitative demand research in the candidate country-market may be required. this information, usually, can only be obtained directly from consumers in the candidate country-market and at great expense to the company. small businesses can get some help at this stage from the us department of commerce's (usdoc) country-desk officers and the us foreign commercial service's (usfcs) offices located in each country. these offices can direct the small company to local inexpensive private sector consultants, or they can prepare specific country market plans and comparison shopping surveys for moderate charges (miller, 1993). ranking technique studies the ranking technique is the third characteristic of the screening process. it is important not to confuse techniques used to classify country-groups on a screening criteria (goodnow & hansz, 1972; sethi, 1971) or used to define screeriing criteria (green & kohli, 1991) with techniques used to rank country-markets on these criteria. for example, sethi (1971) used comparative cluster analysis to agglomerate 91 countries into seven clusters along four criteria, production and transportation, personal consumption, trade, health and education. cluster membership ranged from two to twenty eight members. similarly, green & kohli (1991) applied a multiple regression model to a data set of 102 different manufactured products to estimate the best criteria (le., gop, socioeconomic development, debt burden and fuel imports) to predict imports by countries at different levels of development. these approaches only show that countries are dissimilar (or similar) on the analyzed criteria; they are not based on some specific scale or ranking method. as far as we can tell, there are only two techniques in the literature exclusively used to rank country-markets, those of samli (1977) and green & allaway (1985). samli's (1977) process of preliminary market selection is a multiple factor analysis technique based on the relative size and quality of potential markets. the size component is indicated by the size of the population and the quality component is indicated by the degree of economic development (as indicated by surrogate measures such as steel consumption, kilowatt hours produced, etc.) and the quality of life (as indicated by the surrogate measures such as motor vehicle registration, telephones in use, etc.) all of these variables are expressed as a percentage of the us market, which is assumed to be 100 per cent market potential. in other words, market potential for a given country is expressed in terms of the us's population, economic development, and quality of life. country-markets are ranked based on an averaged percentage figure that present the country's potential (or market size) 134 journal of business strategies vol. 13, no.2 relative to other countries and compared to market size in the us. alternatively, green & allaway's (1985) study demonstrated the way in which ssa can aid in the generation of product/market sets having high export potential. after identifying products with high export potential using ssa, they again applied ssa to identify country-markets for the selected products. next, they identified growth and a normalizing procedure to bring shifts of net share of import values to a common base. this in turn allowed them to rank countrymarkets in a scale of ±100. trade data and shift share analysis trade data as screening criteria for market potential as indicated above, trade statistics are suggested by several authors and government reports as being good indicators of country-market market potentials (ayal, 1982; green & allaway, 1985; plant, 1992; rao, 1979; root, 1987). imports, along with market access (i.e., trade barriers, industry standards), local production, local distribution, and product category acceptability, determine market potential by prospective country-markets. because managers are not likely to have access to all of these statistics for every prospective country, imports could be used as a representative surrogate for them all. the validity of import statistics as a surrogate lies in the fact that information from the other complementary factors is embedded in them. in other words, once trade has been consummated over a period of time, other market potential assessment criteria (i.e., industry specification standards, industry trade barriers, availability of adequate media and channels of distribution, consumers familiarity with the product category, etc.) are sufficiently reflected in import statistics. for example, if there are indications of important import activity by a country, in all probability trade barriers are manageable, there are distribution channels developed for that product category, and consumers are familiar with the product category. the use of import statistics is even more compelling when the product category studied is in the novelty, introductory stage of its life cycle in foreign countries. in such cases, the foreign country's apparent consumption in the short run (local production plus imports minus exports) is reduced to knowing imports alone. l import data are, in most cases, collected and made available by the respective importing and exporting countries. obtaining import statistics from every prospective country could be a daunting task. therefore, us export sale statistics to the rest of the world have become a convenient and adequate substitute. information from the us importjexport of merchandise reports includes data on domestic commodities (i.e., product categories) grown, produced or manufactured in the us, and commodities of foreign origin that have been changed in the us from the form in which they were imported, or that have been enhanced in value by further manufacture in the us (tradex 1994). fall 1996 medina, saegert & merrifield: screening technique 135 these data are readily available on a monthly basis from the us department of commerce's national trade data bank (ntdb). shift share analysis as a ranking technique for market potential the main idea of shift-share analysis is to identify growth differentials (i.e., net shifts in relative share) among members of a group (e.g., countries) on a growth variable (e.g., export sales) over a period of time beginning and end years (huff & sherr, 1967). the net shift, which is calculated in several steps (refer to table 1 and appendix for illustration), will be positive for products gaining market share and negative for products losing market share. thus, group members are ranked from highest to lowest according to whether their shares have increased or decreased (green & allaway, 1985; huff & sherr, 1967). for example, a country that increasingly gains us-export-sales share of a product category over the years (versus other importing countries) represents a potential market for entry. this is so because the product category is clearly in the introductory or growth stage of its life cycle, and the product may be catching on and riding the crest of this cycle at a fast pace. in general, the advantages of ssa are that it requires little and simple information; it is better than either absolute or percentage growth measures; and it measures the size of share gains and losses relative to an estimated growth nonn (huff & sherr, 1967; green & allaway, 1985). from a country-market screening perspective, this approach, as used in the past, is subject to three important limitations. since the traditional shift-share calculations involve only two points in time, a base year and an end year, choosing different base and end years may result in different rankings (barff & knight, 1988). as most export markets do not show stability over the years, one would find it difficult to choose two "representative" points in time (green & allaway, 1985). this drawback has been somewhat attenuated by the dynamic fonn of shift-share suggested by barff & knight, (1988). in their study, these researchers calculated shift-share annually and then summed up the results over the studied period. this modification of ssa eliminates the problem of having to choose the "correct" base-year for analysis. the second limitation of ssa to detennine market potential is that it usually involves only one product category (green & allaway, 1985). it does not account for the possible interactive influence of shifts in net shares of related (or complementary) product categories. for instance, there is a functional complementarity operating between the demand for printers and computers, and between the demand for golf clubs and golf balls (solomon & englis, 1994). finally, the validity of ssa as an adequate ranking technique to select countries with high market potential has not been detennined. understandably, the problem is to find alternative measures of export potential, and these are not easy to come by. an "improved" ssa technique used for export country-market potential screening would overcome these limitations. moreover, if the results using the 136 journal of business strategies vol. 13, no. 2 improved technique can be supported by independent evidence, then, the identification stage (first stage in the screening model, refer to figure 1) can be eliminated from the process, thereby adding parsimony to the overall export country-market screening process. the following section discusses the methodology used for testing an improved ssa technique. methodology mexican sauce is the novel product category selected for this study. many new competitors are entering the mexican sauce market in the us attracted by its incredible growth rate. of all the producers of mexican sauce in the us, the great majority are small or medium-sized firms with statewide or regional distribution. only a handful of competitors are major multinational players with national and even international distribution (packaged facts, 1992). although mexican sauce and its uses are still unknown by most world consumers, there is a growing trade activity of this product between the us and other countries. ssa can help rank and identify country-markets with higher export market potential for the mexican sauce product category. because mexico and canada are considered by many industry producers as natural extensions of the us market, these two countries are omitted from the present analysis. the tested methodology for the screening of country-markets into high market potential country-markets consisted of four steps: (l) selection of complementary products as indicators of market potential, (2) selection of time period to analyze, (3) selection of independent screening measures, and (4) shift-share analysis procedure. selection of complementary products as indicators of market potential. the domestic profile for mexican sauce consumers guided the selection of complementary product categories that might be useful indicators of market potentiaj.2 after carefully analyzing the information available for the domestic and foreign markets, it was discerned that the common factor on which both of these markets agreed was in the usage/circumstance. potential foreign consumers associated mexican sauce with snacks and dipping just as americans do (e.g., susta, 1992a & susta, 1992b). consequently, potato and corn chips were selected as complementary products as they are related with a particular usage (i.e., dipping) and circumstance (i.e., socials) within the american context (lawrence, 1993). the selection of these two complementary products was also based on their availability in the export trade statistics of the us. selection of time period to analyze. a five-year (1989-1993) period of us export sales statistics on mexican sauce, potato chips and corn chips was examined. 1989 was chosen as the beginning year because that is the last time a commodity reclassification occurred table 1 "tj ~ d1ustration of traditional ssa technique applied to us exports of mexican sauces top 10, middle 5, and bottom 10 countries --\0 export data (in 000 of ibs.) calculation of shift-share analysis \0 0'. countries 1989 1993 actual change market growth rate expected value expected change net shift shift-share (%) (i) (2) (3)=(2)-(1) (4 )=(2a)/( 1a) (5)=(i)x(4) (6)=(5)-(1 ) (7)=(3)-(6) (8)=(7)/(7a) ~ ~ i. netherjand 83 1,857 1774 1.72 142.76 59.76 1714.24 17~86% l::l..s· 2. venezuela 81 628 547 1.72 139.32 58.32 488.68 5.09% ~ 3. south korea 46 466 420 1.72 79.12 33.12 386.88 4.03% ~ 4. new zealand 94 531 437 1.72 161.68 67.68 369.32 3.85% ~ 5. united kingdom 295 833 538 1.72 507.40 212.40 325.60 3.39% ~ ~ 6. france 15 201 186 1.72 25.80 10.80 175.20 1.82% ;:,. 7. germany 63 248 185 1.72 108.36 45.36 139.64 1.45% l«> 8. neth antilles 85 284 199 1.72 146.20 61.20 137.80 1.44% ~ 9. belgium 4 112 108 1.72 6.88 2.88 105.12 1.09% ""! ""! 10. australia 200 435 235 1.72 344.do 144.00 91.00 0.95% si 42. slovenia 0 0 0 1.72 0.00 0.00 0.00 o.do% ~ 5: 43. haiti 0 0 0 1.72 o.do o.do 0.00 0.00% '. 44. paraguay 0 0 0 1.72 0.00 0.00 0.00 0.00% v:i n 45. dominica 0 0 0 1.72 0.00 0.00 0.00 o.do% ~ ~ 46. gabon 0 0 0 1.72 o.do 0.00 0.00 0.00% ;::s-. 79. united arab e. 135 38 232.20 97.20 -194.20 -2.02% ;::s -97 1.72 ~ 80. japan 269 253 -16 1.72 462.68 193.68 -209.68 -2.18% ~ 81. singapore 464 579 115 1.72 798.08 334.08 -219.08 -2.28% n ~ 82. honduras 267 225 -42 1.72 459.24 192.24 -234.24 -2.44% ;::s-. 83. spain 165 27 -138 1.72 283.80 118.80 -256.80 -2.67% ..t:;, :::: 84. bahamas 203 0 1.72 349.16 146.16 -349.16 -3.64% ~ -203 85. costa rica 256 57 -199 1.72 440.32 184.32 -383.32 -3.99% 86. taiwan 962 1,247 285 1.72 1654.64 692.64 -407.64 -4.25% 87. ei salvador 316 100 -216 1.72 543.52 227.52 -443.52 -4.62% 88. bermuda 295 3 -292 1.72 507.40 212.40 -504.40 -5.25% yj all total 7,293 (1 a) 12,522 (2a) 5,229 1.72 12,522.00 5,229.00 9600.47 (7a) -..l 138 journal of business strategies vol. 13, no.2 for mexican sauce. it has been through two previous reclassifications, going from broader to narrower commodity descriptions (i.e., from "tomato sauces other than ketchup," through "other sauces and preparations," to "sauces and preparations, mixed condiments and mixed seasonings.") the ending year 1993 was the latest available year for which data were available for all three products. time series data were obtained from the united states department of commerce (usdoq export trade statistics. analyzing export statistics in unit quantity rather than dollar values is important because it eliminates possible distortions regarding changes in product prices (gillespie & alden, t 989) and differences in price-quoting practices between the us and other countries. 3 independent validating measures. independent measures of country-market market potential would validate the predicted ranking of countries as estimated by ssa approaches (see table 2). the top ten ranked country-markets having positive shift shares were matched to a composite index constituted by the combination of two ad hoc independent measures of market potential (l) unsolicited product inquires to a southwest producer of mexican sauce from potential foreign clients and (2) international expansion strategies of large competitors in the us mexican sauce industry. first, unsolicited inquires collected over a period of four years (1990-1994) by a southwest producer of mexican sauce were tabulated by date and by country. then, countries were ranked by their number of inquires, and the top 10 were selected. the second measure was developed based on the assumption that large domestic competitors would be actively looking for foreign expansion opportunities. an analysis of their international expansion and investment patterns would indicate where they believed to be the greatest market potential opportunities. country-markets were ranked based on the number and type of entry strategies. 4 these two validating measures of market potential were subsumed into a composite index. countries in this index were ranked based on their number of appearances and position in the two independently obtained validating rankings. shift·share analysis procedure. first, traditional ssa for the years 1989 and 1993 was applied to a data set of only mexkan sauce export statistics. then, dynamic ssa for the years \989-1990, 1990-199\, 1991-1992, and 1992-1993 was applied to the same data set. here ssa is calculated based on data from each year within the stated period, rather than on just "two points in time" beginning and end years. this will help overcome the original limitation of selecting an appropriate time period and it will also increase the sensitivity of country-rankings to trade fluctuations. ssa estimates obtained for each year arc arithmetically averaged giving a mean estimate. finally, a "modified" ssa was applied to a data set of a composite statistic of mexican sauce, potato chips and corn chips. these three sets of top 10 ranked countries were individually compared to each of the intable 2 top-ten countries from shift share analysis (ssa) ranking approaches and validating measures, and similarity coeffecients between ssa ranking approaches and validating index ssa ranking approaches validating measures traditional ssa dynamic ssa modified ssa unsolicited competitive composite inquiries analysis index* i. netherlands i. netherlands i. taiwan i. japan 1. australia i. japan 2. venezuela 2. south korea 2. venezuela 2. united kingdom 2. netherlands 2. united kingdom 3. south korea 3. new zealand 3. united kingdom 3. venezuela 3. japan 3. australia 4. new zealand 4. venezuela 4. australia 4. south korea 4. united kingdom 4. venezuela 5. united kingdom 5. united kingdom 5. argentina 5. australia 5. venezuela 5. netherlands 6. france 6. neth antilles 6. japan 6. netherlands 6. sweden 6. south korea 7. germany 7. germany 7. south korea 7. czechoslovakia 7. new zealand 7. sweden 8. neth antilles 8. france 8. peru 8. egypt 8. saudi arabia 8. new zealand 9. belgium 9. belgium 9. germany 9. ghana 9. kuwait 9. czechoslovakia 10. australia 10. egypt 10. thailand 10. argentina 10. south korea 10. saudi arabia similarity coeffecients:** 0.20 0.13 0.81 *composite of unsolicited inquires and competitive analysis. **spearman pairwise rank order correlation coefficient between the respective ssa ranking approaches and the validating composite index. 'tl 2-'-0 '-0 0\ ~ ~ s· .f:l ~ ~ ~ ;:;. r<> ~ "'"': "'"': s; ~ f; v:l r") ~ ~ ;:: ~. ~ r") ;::.. ;:: .ts. ;;::: (':l vj '-0 140 journal of business strategies vol. 13, no. 2 dependently obtained validating measures using spearman's pairwise rank-order correlation coefficient. (this coefficient helps us measure the level of similarity betwccn thesc sets of data.) findings thc findings are presented in two sections. first, we discuss results concerning the county-market selection model in figure i. then, we discuss results of applying the methodology and the ssa technique explained above. country-market selection model looking over figure i, it appears that the selection criteria need to have at least two characteristics. first, they must include a variable that is relevant in assessing the potential barriers of one country-market relative to others. second, data on the relevant screening criterion must be available for most country-markets. otherwise, a comprehensive and realistic comparison across countries cannot be made. the literature has emphasized studying screening criteria to identify countries in stagcs i and 2 of the model, but there is little research on screening criteria for stages 3 and 4 (see figure 1). also, from our review of ranking techniques, both multiple factor analysis and ssa are potentially useful techniques for small firms as these reflect analyses from a "reference base" with a home-market framework they can understand. this reference base has commonly been the us's population, economic development, and quality of life (samli, 1977), and the us's total exports to the rest of the world on a given product category (green s& allaway, 1985). moreover, these two techniques may actually be combined to strengthen their prediction power. finally, information from the adapted model in figure i and from studies in the literature raise the question about the wisdom of using country-market identification techniques. the information reviewed suggests that the countrymarket identification stage can, in effect, be completely eliminated from the process for products for which information requirements at latter stages are readily available from public sources (e.g., export statistics for the market potential stage, thereby adding parsimony to the overall export country-market screening process.) ssa technique table 2 outlines the top ten ranked export country-markets from a pool of 88 countries (see table 1) for the three tested ssa ranking techniques traditional ssa (tssa), dynamic ssa (dssa), and modified ssa (mssa) for the two validating rankings unsolicited inquires and competitor's analysis and for their composite index. the table also shows the spearman's pairwise rank order correlation coefficients for the three different types of ranking approaches and the composite index. we first discuss the fall 1996 medina, saeger! & merrifield: screening technique 141 ranking approaches and then their degree of similarity with the composite index. the traditional and the dynamic ssa ranking approaches show "similar" country-ranking compositions as opposed to the modified ssa. this is expected as these two rankings are based on only one product category (i.e., mexican sauce), whereas the modified ssa is based on three combined product categories (i.e., mexican sauce, potato chips and corn chips). also, only four countries venezuela, south korea, united kingdom, and germany out of ten appear in all three ranking lists. moreover, the netherlands, venezuela, united kingdom, germany, and belgium share the same ranking in at least two of the three lists. although the above information alone is important, as it confounds some underlying factors that influence country rankings, it does not accurately tell us anything about how good these rankings are relative to each other. by comparing visually the three ranking approaches against the validating composite index, we observe that at least half of the countries in the composite index appear on each of the three ssa estimated rankings. the traditional ssa seems to capture the most countries with a total of six, and the modified ssa seems to best capture countries with higher rankings in the composite index (i.e., japan and australia). spearman's similarity coefficients between the composite index and the three ssa ranking approaches are shown at the bottom of table 2. these show that the modified ssa has the strongest correlation with the composite index, 0.81. the second strongest correlation is with the traditional ssa, 0.20, showing a slightly better association with the composite index than the dynamic ssa (0.13). this result does not support the alleged theoretical benefits obtained when in-between years are analyzed using the dynamic ssa (barff & knight, 1988). these results show that the modified ssa technique is an adequate ranking method for export country-market selection when analyzing a novel consumer packaged good. they also show that using complementary product categories does increase the power of prediction and ranking accuracy of the ssa technique. discussion and implications small us companies selling products that are perceived as novelties in most other countries, may rely on their own domestic marketplace experience and on us-government produced export statistics to identify countries with market potential because the choice of foreign markets is an investment decision many small businesses are now facing, we tested the validity of a simple and inexpensive ranking method known as shift share analysis (ssa) for selecting country-markets. ssa proved to be an efficient technique to rank country markets as 50% of the top-ten ranked countries were found to correspond to a composite index of two alternate validating measures. moreover, adding 142 journal of business strategies vol. 13, no. 2 information from complementary products to the growth variable (i.e., export sales) improves ssa predictive power significantly, suggesting that studying the small firm's own domestic market to determine possible complementary products is a worthwhile endeavor. general assessment of market potential in a country involves an analysis of local production, local consumption, and imports and exports of the product country in question. but, information on local production, consumption and imports, and exports are usually not available when a novel product is used. in such cases, we have suggested that export sales data can be used as adequate proxy for estimating market potential. this paper demonstrates that applying us export statistics on a simple ranking technique help select countries with the highest market potential for novel packaged goods. although we have demonstrated empirically that us export statistics can be an adequate criterion for the screening of country-markets for a novel packaged-good product category, there are three additional theoretical reasons why us export statistics are adequate as a preliminary screen for packaged goods. first, the us is the largest exporter in the world of packaged goods (us dc, 1995). it exports most known packaged-good product categories to most countries in the world. second, us government reports show that a significant and increasing proportion of the us's packaged goods are sought after and accepted all over the world (e.g., susta, 1992a). the third reason is more practical in nature, that is, that export statistics in general are more easily available from the us government than from foreign governments. as more trade statistics from different countries become available, small firms can benefit by applying the methodology demonstrated in this study in two ways. first, firms could lump us and foreign countries export statistics together and apply ssa. countries with higher shares of imports, regardless of country of origin, would become prime targets for entry. second, firms could investigate the share of us exports to importing countries relative to other exporting countries. for example, if a country has a higher share of imports from the us than it does from another country, the market potential for us products in that country will be greater. in addition, a weighting system reflecting the importance of the relative market share of exporting countries on each import market can be developed before the final country ranking exercise is done. a combination of these two approaches would perhaps be more representative of the actual level of export activity in the prospective country-markets. a final implication from this study is that stage 1, market identification, can be omitted from our adapted country-market selection model (figure 1), when a novel product category is analyzed. specifically, the methodology discussed in this paper can help small firms expedite the "identification of targeted areas" an important component of any export marketing plan (kerr & kirkconnell, 1989) for further in-depth analysis. fall 1996 medina, saegert & merrifield: screening technique 143 future research and study limitations it is important to remember that this study's results are primarily applicable to novel us packaged goods whose characteristics are similar to those of the mexican sauce; namely the product must be perceived as new in most foreign markets and that there is a recent but consistent export trade history from major industry competitors in the us. however, as the product category becomes more widely distributed and produced worldwide, us export trade statistics become less attractive as a single proxy measure of market potential assessment. also, our analysis is pertinent only to the selection of country-markets with the highest market potential (stage 2 of the model in figure 1). however, in considering a country-market's sales potential, a small firm will need to invest in the acquisition of knowledge about the specific aspects of marketing the product in each selected country. this involves obtaining data on the information requirements described in stages 3 and 4 of the model. one limitation of using usdoc export statistics is that novel products are initially assigned to highly aggregated "catch-all' product categories, or may even be missclassified as a result of their novel nature. this in turn can affect the ranking efficacy of the ssa. one alternative to circumvent this problem, is the use of more disaggregated, and perhaps accurate, trade data from independent sources such as piers port import export reporting servicea service by the journal of commerce. because piers reporting is based on product description and not codes, it avoids potential misc1assification pitfalls that are common with newly traded products. future studies should consider using data from this piers's database to test the ranking techniques developed for this study and their efficacy in selecting countries with highest market potential. as information requirements for higher screening stages (e.g., media availability, middlemen accessibility, typical pricing policies, product packaging, etc.) become increasingly available from public sources, small businesses would benefit from empirical work that emphasizes less the determination of socioeconomic and political country criteria and more the examination of industry and product category criteria. most export country-market selection studies found in the literature tend to group countries on socioeconomic and political barriers. there is now a growing need to go beyond this pattern of inquiry into one where we relate trade and industry barriers to specific product categories. finally, in regards to the ranking techniques, there is not enough breadth of options available to the small business in the literature. the only two available techniques, as described in this study, multiple factor analysis and shiftshare analysis, only apply to stage 2 in the model. future studies should emphasize the creation of new ranking techniques applicable to this and latter stages, and the testing of their predictive validity in measuring the stage's objective (e.g., countries' market potential). 144 journal of business strategies notes vol. 13, no.2 1 there is always the exceptional possibility that imports are re-exported to other countries, as is the case for many product categories in hong kong. 2 kotler's (1988, p. 174-175) eight o's is a simple practical guide that profiles target markets based on eight key factors. this tool can help exporters in determining what aspects of the domestic target market resemble its foreign counterparts. 3 for example, it is common for us exporters to quote cif (cost, insurance and freight at port of destination) or c&f (cost and freight at port of destination) to provide additional service to customers of certain countries. however, u.s. customs requires merchandise export sales to be estimated on a ea.s. (free alongside ship at u.s. port of export) basis. because individual exporters or their representatives are required to estimate this adjusted value, there is always a potential for inaccuracies in reporting that may bias export sales values for or against some countries. 4 this information was obtained from articles in various food and business periodicals, general media, company annual statements, and from an interview with a marketing manager of a major manufacturer of mexican sauce products. references agarwal, sanjjeev and sridhar n. ramaswami. "choice of country market entry mode: impact of ownership, location, and internationalization factors." journal of international business studies (first quarter, 1992): 1-27. alexandrides, e.g. "how the major obstacles to expansion can be overcome." atlanta economic review 21 (1971): 12-15. ayal, igal and jehie1 zif. "competitive market choice strategies in multinational marketing." columbia journal of world business (fall, 1978): 72-81. ayal, igal. "industry export performance: assessment and prediction." journal of marketing (fall, 1982): 72-81. baird, inga s., marjorie a. lyles, and j. b. orris. "alliances and networks: cooperative strategies for small businesses." mid-american journal of business 8 (1993): 1724. ------. "the choice of international strategies by small businesses." journal of small business management 32 (1994): 48-59. barff, richard a. and prentice l. knight iii. "dynamic shift-share analysis." growth & change 19 (1988): 1-10. barrett, niegel and ian f. wilkinson, "australian policies for trade promotion and assistance: review and evaluation." in international perspectives on trade promotion and assistance, eds. s. tamer cavusgil and michael r. czinkota. new york: quorum books, 1990. fall 1996 medina, saegert & merrifield: screening technique 145 bilkey, warren j. "an attempted integration of the literature on the export behavior of firms." journal of international business studies (spring/summer, 1978): 39-55. businessweek. "it's a small (business) world." businessweek (april 17, 1995), 96101. cavusgil, s. tamer. "guidelines for export market research." business horizons (november/december, 1985): 27-33. cavusgil, s. tamer and shaoming zou. "marketing strategy-performance relationship: an investigation of the empirical link in export market ventures." journal of marketing 58 (1994): 1-21. czinkota, michael r. "a national export development policy for new and growing businesses." journal of international marketing 2 (1994): 91-101. czinkota, michael r. and david ricks. "export assistance: are we supporting the best programs?" columbia journal of international business (summer, 1981): 73-78. davidson, william h. "market similarity and market selection: implications for international marketing strategy." journal of business research 11 (1983): 439-456. fennell, geraldine and joel saegert. "activity v. apriori groups in defining a market." in proceedings of the society for consumer psychology, american psychological association annual conference. boston, 1990. fuchs, victor r. "changes in the location of us. manufacturing since 1929." journal of regional science i (1959): 1-17. gillespie, kate and dana alden. "consumer product export opportunities to liberalizing ldcs: a life-cycle approach." journal of international business studies 20 (1989): 93-112. goodnow, james d. and james e. hansz. "environmental determinants of overseas market entry strategies." journal of international business studies 3 (1972): 33-50. green, robert t. "internationalization and diversification of us trade: 1970 to 1981." international marketing review (summer, 1985): 53-62. -----and arthur w. allaway. "identification of export opportunities: a shift-share approach." journal of marketing 49 (1985): 83-88. -----and ajay k. kohli. "export market identification: the role of economic size and socioeconomic development." management international review 31 (1991): 37-50. -----and trina l. larsen. "changing patterns of u.s. trade: 1985-1989." business horizons 34 (1991): 7-13. 146 journal of business strategies vol. 13, no.2 -----and trina l. larsen. "japanese trade in international perspective." international marketing review 8 (1991b): 13-27. huff, david l. and lawrence a. sherr. "measure for determining differential growth rates of markets." journal of marketing research 4 (1967): 391-395. jeannet, jean-pierre and h. david hennessey. global marketing strategies. boston: houghton mifflin company, 1995. kale, sudhir h. and d. sudharshan. "a strategic approach to international segmentation." international market review (summer, 1987): 60-70. kerr, jean and paul kirkconnell. "export strategies." small business reports 14 (1989): 20-27. kotler, philip. marketing management: analysis. planning. and control. englewood cliffs, nj: prentice-hall, 1988. lawrence, jennifer. 'taco bell calls on supermarkets." advertising age (february 8, 1993): 3, 47. linder, staffan b. an essay on trade and transformation. new york: wiley, 1961. mcniven, james d. "challenge and response: the rise of state export development policies in the u.s.a." in export development and promotion: the role of public organizations, eds. f. h. rolf seringhaus and philip 1. rosson. new york: klumer academic publishers, 1991. merrifield, john. 'the role of shift-share in regional analysis." regional science perspectives 12 (1983): 48-53. miller, d. and peter h. friesen. "monumentum and revolution in organizational adaptation." academy of management journal 23 (1980): 591-614. miller, myron m. "executive insights: the 10-step road map to success in foreign markets." journal of international marketing 1 (1993): 89-106. ogram, ernest w. "exporters and non-exporters: a profile of small manufacturing firms in georgia." in export management: an international context, eds. m. r. czinkota and george tesa. new york: praeger, 1982. packaged facts. 'the mexican sauce market." unpublished consultant's report on the mexican sauce industry (june, 1992): 31. plant, mark w. "the national trade data bank: the exporter's valuable resource." business america 13 (april, 1992): 16-17. fall 1996 medina, saegert & merrifield: screening technique 147 prosak, sylvia lino, "small businesses are exporting," business america 114 (november, 1993): 2-8, ramaswami, sridhar n. and yoo yang, "perceived barriers to exporting and export assistance requirements," in international perspectives on trade promotion and assistance, eds. s, tamer cavusgil and michael r czinkota. new york: quorum books, 1990. rao, c. p. "a multilevel approach to researching international markets." in international marketing: managerial perspectives , eds, subash c. jain and levis r. trucker, jr. boston: cbi publishing, 1979. rogers, john. "firms in place have advantage; newcomers face uphill climb." the journal of commerce (february 7, 1994): 6a, root, franklin r. entry strategies for international markets. lexington, ma: d.c. heath and company, 1987. ------. foreign market entry strategies. new york: amacom, 1982. saegert, joel and jose f. medina. "conceptualizing market segmentation for the option of going global." in proceedings of the society for consumer psychology. eds. scott b. mackenzie and douglas m. stay man. la jolla, ca: american psychological association, 1995. samli, a. coskun. "an approach for estimating market potential in east europe." journal of international business studies 8 (1977): 49-53. sethi, s. prakash. "comparative cluster analysis for world markets." journal of marketilll: research 8 (1971): 348-354. solomon, michael r and basil g. englis. "observations: the big picture: product complementarity and integrated communications." journal of advertising research (januarylfebruary, 1994): 57-63. susta southern united states trade association. "country profile hong kong & south korea: two of asia's tigers." insight global news. perspectives and updates for the international agribusiness trade (spring, 1992a): 3. ------. "product profile snack food: tempting global taste buds." insight global news. perspectives and updates for the international agribusiness trade (spring, i 992b): 7. terpstra, vern. "critical mass and international marketing strategy." journal of the academy of marketing science 11 (1983): 269-282. 148 journal of business strategies vol. 13, no. 2 ------. international dimensions of marketing. second edition. boston, ma: plus-kent publishing company, 1988. tesar, george and jesse s. tarleton. "comparison of wisconsin and virginia smalland medium-sized exporters: aggressive and passive exporters." in export management: an international context, eds. m. r. czinkota and george tesar. new york: praeger, 1982. tradex. us merchandise export trade by commodity. united states department of commerce bureau of the census, 1994. usdc united states department of commerce. "statistical abstract of the united states." the national trade data book. bureau of the census, 1995. walters, peters g. p. "international marketing policy: a discussion of the standardization construct and its relevance for corporate policy." journal of international business studies 17 (1986): 55-69. walvoord, wayne r. "export market research." global trade magazine (may, 1980): 83. appendix the shift share analysis (ssa) method has been devised to measure the relative size of the gains and losses (i.e., shift-share percentage) of market areas compared with a general market growth rate (or norm). in the present study, the market areas are individual country-markets and the norm derives from the aggregated total of these individual country-markets. the following paragraphs explain the meaning of each column and the steps to calculating shift-share percentages in table 1. the numbers of the formulas below, indicated in parenthesis, correspond to the same numbers in table i. countries these are the names of the countries that constitute the individual country-markets. they are ranked from the highest to the lowest market potential. export data this is the export sales data for the beginning and end years. let vi.1 represent the value of the export sales for country i at the end of time period t. thus, (i) vu-1 and (2) \ii., the total value of export sales for all the export markets from the us is equal to the sum of the values for each of the individual country markets. thus, (i a) m a vi.,.] i=l where ill is the number of all country-markets analyzed fall 1996 medina, saegert & merrifield: screening technique 149 similarly, the total value of export sales for all country-markets at the end of the terminal time period is, (2a) m a. vi,t i=j actual change (avj this is the actual change of export sales in a given country, which is simply the difference in values from one time period to another. thus, (3) avj = vi,l vi,i-j market growth rate (k) this is the growth rate for all country-markets. which is equal to the ratio of the total value in the terminal time period to the corresponding value in the initial time period. thus, m a. vi,l i=j (4) k=-----m a vi,t-j i=1 expected value [ewull this is the expected export sales value at the end of the terminal time period, had the country-market grown at the rate achieved for all the country-markets combined. thus, (5) e(vu) = kvj,i_j expected change [h(a vjl this is the difference between the expected value and the actual value for a given country-market at the initial time period. thus, (6) e(avi) = e(vi,t) vi.t -j net shift (nil. this is the difference between the actual change and the expected change for a given country-market. thus, (7) ni = avj e(avi) absolute net shift (s) the sum of the positive (or negative) net shifts. that is, (7a) p s = a nj i=1 where p is the total absolute number of the positive net shifts. 150 journal of business strategies vol. 13, no.2 shift-share percental!e (pi} this is the relative gain or loss in the value of the export sales for a particular country-market during a given time period. thus, nj (8) pi =--(100%) s jose f. medina is assistant professor of international marketing at the university of texas at san antonio. he has published papers in the journal of international consumer marketing, the journal of consumer affairs and the journal of marketing theory and practice, among others. his research interests include cross-cultural, export marketing and ethnic minorities research. joel saegert is professor of marketing at the university of texas at san antonio. he has published papers in psychology and marketing. the journal of consumer research, the journal of consumer affairs, the journal of marketing. the american journal of psychology. the journal of experimental psychology. among others. he is past-president of the society for consumer psychology, division 23 of the american psychological association. john merrifield is an associate professor of economics at the university of texas at san antonio, a position he has held since 1987. his primary teaching and research fields include international trade, the environment, natural resource management, urban and regional economics, and public choice, especially k-12 school reform. he received a b.s. in natural resource management from cal poly san luis obispo in 1977, a m.a. in economic geography from the university of i11inois in 1979, and a ph.d. in economics form the university of wyoming in 1984. a simple export country-market screening technique for small us businesses: a packaged good illustration journal of business strategies (2022) 39:1-32 https://doi.org/10.54155/jbs.39.1.1-32 received: november 2021 / revision received: february 2022 / accepted: february 2022 should corporations care about negative brand publicity? understanding the impact of negative brand publicity on employees’ corporate brand pride fabian abeda, marion büttgenb a corresponding author. department for corporate management, university of hohenheim, schloss osthof/ost, 70593 stuttgart, germany. f abed@uni-hohenheim.de b department for corporate management, university of hohenheim, schloss osthof/ost, 70593 stuttgart, germany. m.buettgen@uni-hohenheim.de keywords abstract negative brand publicity; corporate brand pride; affective-eventstheory; internal branding; brand experience; brand supporting behavior this article examines the effects of perceived negative brand publicity on employee emotions, attitudes and brand supporting behaviors. drawing on affectiveevents-theory (aet) it attempts to identify underlying affective and cognitive processes leading to behavioral change. using data gathered from a largescale survey of employees in germany, our results show that perceived negative brand publicity affects emotional and attitudinal corporate brand pride of employees. in addition, higher levels of perceived negative brand publicity were negatively associated with brand-supporting behavior, such as employee referrals and word-of-mouth (wom). we show that corporate brand experience through internal communications can be an effective tool in mitigating harmful effects of perceived negative brand publicity. this work is licensed under a creative commons attribution-noncommercial 4.0 international license. copyright (c) 2022 fabian abed, marion büttgen. https://doi.org/10.54155/jbs.39.1.1-32 f_abed@uni-hohenheim.de m.buettgen@uni-hohenheim.de 2 abed and büttgen / journal of business strategies (2022) 39:1-32 1. introduction publicity relating to corporate (brand) behavior is on the rise in recent years (hock & raithel, 2019). corporate brand publicity can be defined as any information about a corporate brand, its products, services or behavior “communicated through editorial media that is not paid for” by the corporation (collins & stevens, 2002, p.1123). it typically involves non-personal mass communication such as tv news items, radio broadcasts or newspaper articles (lee et al., 2013; van hoye & lievens, 2005). corporate brands that have recently been the subject of negative brand publicity in germany include, for example, deutsche bank and volkswagen. the latter is receiving bad press around the world due to its manipulation of emissions. deutsche bank is in the media as a result of planning mass lay-offs and because of continuous misbehavior. in general, poor work conditions, poor management decision making, or quality issues are often matters of media coverage (monga & john, 2008; woo et al., 2020). negative (brand) publicity can have detrimental effects on multiple corporate or brand aspects. the literature provides evidence that sales (e.g. berger et al., 2010), image (e.g. zhu & chang, 2013), consumer purchase intention (e.g. osei-frimpong et al., 2019), consumer trust and consumer affective identification (e.g. lin et al., 2011), brand equity (e.g. woo et al., 2020), share price as well as firm net value (e.g. hock & raithel, 2019) can be adversely affected. moreover, negative press can lead to a lower perceived organizational attractiveness and reduced job pursuit intentions of job applicants (jaidi et al., 2011). previous research on (brand) publicity focused mainly on attitudes and behaviors of consumers and job applicants. to the best of our knowledge, no research has focused on how publicity regarding corporate brands affects employees. more precisely, a deeper understanding of how corporate brand publicity might influence work-related attitudes and behavior of employees is missing from the literature. this is surprising as employees represent a crucial part of brands’ success and competitive advantage (e.g. boukis et al., 2014; löhndorf & diamantopoulos, 2014). this paper answers the following research questions. first, does negative corporate brand publicity affect employees’ corporate brand pride and subsequent brand supporting behavior? second, can corporations mitigate the potentially devastating effect of perceived negative corporate brand publicity abed and büttgen / journal of business strategies (2022) 39:1-32 3 on employees through corporate brand experience, i.e. internal or external communications? 2. theoretical background affective-events-theory (aet) described by weiss and cropanzano (1996) provides us with a macrostructure to understand how brand publicity affects emotional corporate brand pride (emotion), attitudinal corporate brand pride (attitude), and brand supporting behavior such as word-of-mouth (wom) and employee referrals (judgement-driven behavior). corporate brand pride has been chosen because research shows that pride affects employee behavior (e.g. turnover intention) much stronger than other workrelated attitudes (e.g. commitment), making it necessary to further investigate this construct in a brand-employee context (gouthier & rhein, 2011). moreover, several brands already include (brand) pride as central drivers for success, for example “i’m proud to be ritz-carlton” (appleberg, 2005, p.3). in general, aet helps to explain the interplay of work events, work environment features, emotions, attitudes and behaviors. specifically, the theory “explains the structure, causes, and consequences of employees’ affective experiences at work” (matta et al., 2014, p.922). according to aet, certain work-events (e. g. negative corporate brand publicity) are proximal causes of employees’ emotional reactions (e.g. emotional corporate brand pride) which in turn influence work-related attitudes (e.g. attitudinal corporate brand pride) and behavior (e.g. brand supporting behavior) (herrbach et al., 2004; weiss & cropanzano, 1996). following weiss and cropanzano (1996) we define a work-event as something that occurs in a work-related setting during a particular period, like corporate brand publicity. linking perceived negative corporate brand publicity and emotional corporate brand pride following aet, we propose that perceived negative corporate brand publicity is linked to a number of actual and perceived events that cause intense emotional responses (rosen et al., 2009). negative brand publicity is likely to evoke affective responses regarding employees due to various reasons. first, negative corporate brand publicity has usually a surprising character (cleeren et al., 2013). brands have, in contrast to other forms of communication, no direct control over publicity (collins & stevens, 2002). so, publicity exhibits a sort of an unexpected event with regard to the corporate brand 4 abed and büttgen / journal of business strategies (2022) 39:1-32 and its members. for example, employees working for volkswagen have been shocked when they read the embarrassing headlines about the emission scandal without any advance warning. in line with findings of weiss and cropanzano (1996), who state that workevents are sudden changes in circumstances eliciting emotions, we argue that the surprising occurrence of negative brand publicity should influence employees’ affective reactions (e.g. emotional corporate brand pride). second, negative publicity adversely affects the status of a corporate brand, highlighting for instance quality issues or misbehavior. previous research showed that feelings of pride are directly linked to the organization’s reflected glory or achievements (salerno et al., 2015). boons et al. (2015) stated that media, communicating organization level status information elicit feelings of pride. similarly, appleberg (2005) concluded that various aspects of organizational image can instill pride. hence, we argue that employees working for a corporate brand with a poor reputation (reflected in negative stories in the media) should exhibit diminished feelings of emotional corporate brand pride (helm, 2013). these reflections result in the following hypothesis: hypothesis 1. perceived negative corporate brand publicity is negatively associated with emotional corporate brand pride experienced by employees. linking perceived negative corporate brand publicity, wom and employee referrals previous research on negative (brand) publicity revealed detrimental effects on various attitudes (e.g. braxton et al., 2019; zhou & whitla, 2013), behavioral intentions (e.g. müller & gaus, 2015; osei-frimpong et al., 2019) and actual behavior (jaidi et al., 2011, e.g.). specifically, perceived negative publicity adversely affects consumer trust and affective identification (lin et al., 2011; müller & gaus, 2015). as trust and identification are antecedents of wom and (employee) referrals, we suppose that negative corporate brand publicity influences employee wom and referrals, too (bloemer, 2010; de matos & rossi, 2008). hence, we propose: hypothesis 2a. perceived negative corporate brand publicity has a negative influence on employee wom. hypothesis 2b. perceived negative corporate brand publicity has a negative influence on employee referrals. abed and büttgen / journal of business strategies (2022) 39:1-32 5 even though the proposed direct effects are not explicitly specified in weiss and cropanzano (1996), we found support for this approach. zhao et al. (2007) showed, drawing on aet, that work events can have a direct impact on employee behavior. similarly, müller and gaus (2015) revealed that negative media information directly affected behavioral intentions of consumers. linking emotional corporate brand pride and attitudinal corporate brand pride corporate brand pride emotions are, as all emotions, short-lived mental experiences (fisher & ashkanasy, 2000). therefore, pride emotions have downstream consequences with regard to attitudes and behaviors (elfenbein, 2007). this assumption is in line with aet’s suggestion of causality between emotions and work-related attitudes. moreover, we argue that employees who remain in the same corporation for a certain period can experience corporate brand pride emotions repeatedly, which should lead to a more durable state, namely attitudinal corporate brand pride (gouthier & rhein, 2011). therefore, we hypothesize the following: hypothesis 3. corporate brand pride emotions have a positive influence on attitudinal corporate brand pride linking attitudinal corporate brand pride and wom/employee referrals previous research on brand supporting behavior such as wom and (employee) referrals identified multiple antecedents, such as brand passion (albert et al., 2013), positive emotions (lovett et al., 2013), satisfaction (hagenbuch et al., 2008; wangenheim & baón, 2007), brand commitment (albert et al., 2013), product (wangenheim & baón, 2007; wolny & mueller, 2013) or brand involvement (wolny & mueller, 2013). wom can be defined as “informal, person-to-person communication between a perceived non-commercial communicator and a receiver regarding a brand, a product, an organization, or a service” (harrison, 2001, p.63). in contrast to these more general forms, employee referrals represent an internal recruitment method whereby an actual employee of the corporate brand proactively identifies and provides specific information about vacancies to persons he or she knows (breaugh & starke, 2000). based on earlier findings of kraemer et al. (2020) and lythreatis et al. (2019), we assume that corporate brand pride is a strong intrinsic motivator leading to wom and employee referrals due to various reasons. first, 6 abed and büttgen / journal of business strategies (2022) 39:1-32 proud employees have a strong bond with the corporate brand leading to extraordinary intrinsic motivation (kraemer et al., 2020; lythreatis et al., 2019). this is in line with findings of verbeke et al. (2004) who stated that pride (emotion) leads to greater effort of salespeople. similarly, baer et al. (2015) revealed that high levels of pride are positively related to reputation maintenance concerns of employees (e.g. wom). second, (organizational) pride is found to be negatively related to turnover intention of employees (kraemer & gouthier, 2014). as turnover intention is in general known as a form of loyalty, similar to wom and employee referrals, we expect employees with higher levels of corporate brand pride to show stronger brand supporting behavior: hypothesis 4a. attitudinal corporate brand pride has a positive influence on wom hypothesis 4b. attitudinal corporate brand pride has a positive influence on employee referrals. linking corporate brand experience through internal/external communications and perceived negative corporate brand publicity marketing literature often emphasize synergy effects of advertising and publicity, although both aspects need to exhibit the same valence (e. g. stammerjohan et al., 2005; wang, 2006). research analyzing a situation where the two sources of information differ in their valence is scarce, especially with regard to an employee context. to date only few studies show how negative publicity can be mitigated. for example, van hoye and lievens (2005) showed that performance-based negative publicity can be compensated through recruitment advertising, and stammerjohan et al. (2005) found that effects of negative news stories can be mitigated through radio and print advertising in a consumer context. as nowadays many corporate brands extensively use new technologies in order to create an appealing internet and intranet appearance, we assume that employees’ corporate brand experience through internal and external communications can reduce perceptions of negative brand publicity. an indepth analysis of the existing literature provide support for this assumption. first, communication of brand values guides employee behavior (harris & de chernatony, 2001). this, in turn, may lead to reduced misbehavior of employees, which is one potential cause of negative brand publicity. second, abed and büttgen / journal of business strategies (2022) 39:1-32 7 drawing on findings of eisingerich et al. (2011) we state that the extent to which employees experience the corporate brand through internal and external communications as a great place to work (e.g. corporate brand values) can induce resistance to negative information. this case relates to the goodwill of employees. thereby, individuals are less likely to blame the corporate brand for misbehavior, wrongdoings or product failures, because the corporate brand signals its good intentions through both communication channels, which in turn helps the brand to insulate itself from scrutiny when negative publicity occurs (peloza, 2006; yoon et al., 2006). theoretical support for this assumption provides the information integration theory, which states that inconsistent information will receive a decreased weight compared to consistent information. these reflections result in the following hypotheses: hypothesis 5a. corporate brand experience through external communications has a negative influence on perceived negative corporate brand publicity hypothesis 5b. corporate brand experience through internal communications has a negative influence on perceived negative corporate brand publicity linking corporate brand experience through internal/external communications and emotional corporate brand pride employees can experience corporate brand in various ways. obviously, in their daily work environment dealing with colleagues or management (morhart et al., 2009). it is also possible to experience the corporate brand through internal and external communications (aurand et al., 2005; burmann et al., 2009; harris & de chernatony, 2001; king & grace, 2010). as (emotional) corporate brand pride refers to a positive evaluation of status, reputation, or achievements of the corporate brand, we suggest that a corporations who make stories about the corporate brand accessible to their employees (e.g. testimonials, brand values, etc.) instill corporate brand pride in their workforce. this assumption is in line with aet, which posits that work environment features (e.g. internal communication) can directly affect employee emotions (e.g. corporate brand pride). research from boons et al. (2015) supports this assumption, stating that the communication of status-related information positively affects pride in a consumer context. therefore, we propose: 8 abed and büttgen / journal of business strategies (2022) 39:1-32 hypothesis 6a. corporate brand experience through external communications has a positive influence on emotional corporate brand pride hypothesis 6b. corporate brand experience through internal communications has a positive influence on emotional corporate brand pride the theoretical framework and associated hypotheses developed in this section are depicted in figure 1. 3. method sample and procedure data reported in this article were drawn from a large-scale online survey distributed in the largest business network of germany (xing). the survey investigated employees’ responses to various brand and human resources practices in germany. participants were informed about the purpose of the study and its confidentiality, and were encouraged to participate in the survey. in total, 2,870 employees opened the link and 763 completed the online survey (response rate = 26.59%). deletion of missing values and careless responses (i.e. eliminating cases with a response time less than twenty-five percent of the average response time) resulted in a usable sample of 608 employees. fifty-one percent of the respondents were female (n = 310) and forty-nine percent were male (n = 298). the majority of the participants hold a university degree (n = 472, 77.6%) and worked in a company with more than five-hundred employees (n = 375, 61.7%), without managerial responsibility (n = 435, 71.55%). they were employed in a variety of occupational fields, including: human resources (n = 97, 16.0%), sales (n = 82, 13.5%), marketing (n = 66, 10.9%), consulting (n = 64, 10.5%), other (n = 58, 9.5%), research and development (n = 49, 8.1%), information technology (n = 40, 6.6%), finance and accounting (n = 36, 5.9%), manufacturing (n = 23, 3.8%), services (n = 20, 3.3%), administration (n = 20, 3.3%), purchasing (n = 17, 2.8%), management (n = 12, 2.0%), logistics (n = 10, 1.6%), legal (n = 10, 1.6%) and design (n = 4, 0.7%). in terms of corporate tenure, 12.5 percent of employees (n = 76) joined the corporate brand less than a year ago, 21.7 percent of employees (n = 132) joined the brand one to two years ago, 31.9 percent of employees (n = 194) joined the corporate brand three to five years ago, 17.9 percent of employees (n = 109) belonged to the corporate brand between six and ten years, and abed and büttgen / journal of business strategies (2022) 39:1-32 9 f ig u re 1 : t h eo re ti ca l f ra m ew o rk 10 abed and büttgen / journal of business strategies (2022) 39:1-32 16.0 percent of employees (n = 97) joined the corporate brand more than ten years ago. measures the response scale for each survey item ranged from 1 (‘strongly disagree’) to 5 (‘strongly agree’), unless otherwise noted. because the study was conducted in a german-speaking environment, all measures previously developed in english have been translated into german, using the commonly translation-back translation procedure (brislin, 1980). moreover, we intensively pre-tested all used measures regarding reliability, validity and mutual understanding. we measured perceived negative brand publicity with three items on a bipolar response scale ranging from 1 (very negative) to 5 (very positive). the item development was inspired by jaidi et al. (2011) as well as (collins & stevens, 2002). items are: ‘news coverage in the media regarding [corporate brand name] is mostly. . . ’, ‘when [corporate brand name] is mentioned in press, it is mostly. . . ’ and ‘the presentation of [corporate brand name] in television, radio, printor online media is. . . ’. cronbach’s alpha for this scale is 0.93. to assess the level of emotional corporate brand pride, the four-item scale by gouthier and rhein (2011) was used. a sample item is: ‘in these moments i am proud of what the [corporate brand name] has achieved’. cronbach’s alpha for this scale was 0.93. we measured attitudinal corporate brand pride using gouthier and rhein (2011)’s three-item measure. a sample item is: ‘i feel proud to work for my [corporate brand name]. due to its central role in our theoretical framework, we added one item to the existing scale to ensure reliability (‘i’m proud to be part of [corporate brand name]’). the reliability of this scale was 0.94. to measure word-of-mouth, the three-item scale by morhart et al. (2009) was used. a sample item is: ‘i talk up [corporate brand name] to people i know’. cronbach’s alpha for this scale was 0.93. we measured employee referrals with five items. we used two already validated and reliable items developed by bloemer (2010) and inspired by zeithaml et al. (1996). in addition, three items were included to ensure the specific nature of referrals and to distinguish this measure from related constructs such as word-of-mouth. the added items are: ‘i approach friends, when i have the feeling that my employer offers an interesting job, which abed and büttgen / journal of business strategies (2022) 39:1-32 11 suits them.’, ‘i forward job postings to friends, which seek employment.’ and ‘i approach friends, when i have the feeling that my employer offers an interesting job in a similar domain, in which they are currently working.’ the cronbach’s alpha coefficient was 0.94. to assess the level of employees’ brand experience through internal communications, we used a three-item scale developed by egeler et al. (2022) and inspired by aurand et al. (2005). items are: ‘through information in our internal communications, i experience what our corporate brand stands for.’, ‘i experience the corporate brand through editorial content in our internal communications.’, ‘i come in contact with the corporate brand through available media in our internal communications.’ the reliability of this scale was 0.94. brand experience through external communications. to assess the level of employees’ brand experience through external communications we used a three-item scale developed by egeler et al. (2022) and also inspired by aurand et al. (2005). items are: ‘i experience the corporate brand through editorial content in external communications (e. g. television, radio, etc.),’ ‘i experience our corporate brand in a private setting through external communication activities,’ ‘i come in contact with the corporate brand in a private context, through actions of the external communication.’ the cronbach’s alpha for this scale was 0.93. consistent with past research, we controlled for several socio-demographic variables, including gender (1 = female 2 = male), corporate tenure (0-1 years, 1-2 years, 3-5 years, 6-10 years and more than 10 years), corporate size (0-19 employees, 20-99 employees, 100-499 employees and more than 500 employees), employee status (1 = management board 2 = executive employee 3 = employee 4 = freelancer 5 = trainee 6 = intern/working student/temporary staff), functional area (1 = consulting 2 = design 3 = purchasing 4 = finance and accounting 5 = research and development 6 = it 7= services 8 = logistics 9 = marketing 10 = administration 11 = hr 12 = manufacturing 13 = legal 14 = management 15 = sales 16 = other) and education (1 = doctoral and postdoctoral 2 = academic studies 3 = foreman/technician 4 = apprenticeship 5 = university-entrance diploma 6 = general certificate of secondary education 7 = certificate of secondary education 8 = none). 12 abed and büttgen / journal of business strategies (2022) 39:1-32 4. analysis we analysed data following anderson and gerbing (1991) two step approach. in a first step we evaluate the psychometric properties of the scales. moreover, we test for common method bias using established statistical techniques. in a second step, we test the hypothesized relationships using amos 25 (arbuckle, 2003). to assess the quality of the measurement model, we ran a confirmatory factor analysis (cfa). we followed common recommendations from gracia et al. (2013) and stumpp et al. (2009) and used the following fit indices: goodness of fit index (gfi), adjusted goodness of fit index (agfi), comparative fit index (cfi), normed fit index (nfi), tucker lewis index (tli), root mean square error of approximation (rmsea), and standardized root mean square error of approximation (srmr). for gfi, agfi, cfi, nfi and tli values higher than .90 indicate good fit (arbuckle, 2003; bryne, 2001; b. hair et al., 2006; homburg & giering, 1996; hu & bentler, 1998). srmr values lower than .05 indicate good fit respectively (j. hair et al., 1998; hu & bentler, 1998). cfa showed a good model fit: cmin/df = 1.753, srmr = .02, rmsea = .035, gfi = .94, agfi = .92, nfi = .97, tli = .98, cfi = .98. in addition, we compared the hypothesized model with three nested models (table 1). the original model shows a significant better fit than the alternative nested models, providing support for the distinctiveness of the constructs. besides a satisfactory model fit, scales included in this study should exhibit convergent validity, reliability, and discriminant validity (bagozzi & yi, 1988; fornell & larcker, 1981). since the lowest factor loading in our model was 0.75, there is support for convergent validity. for the reliabilities, see table 2. composite reliability (cr) and average variance extracted (ave) were calculated based on the procedure of fornell and larcker (1981). cr and ave for all constructs were above 0.92 and 0.72 respectively. these values fulfill the recommended cut-off values of cr > 0.70 and av e > 0.50 (bagozzi & yi, 1988; fornell & larcker, 1981). similarly, all ave values are greater than the squared correlation between that factor and another factor, suggesting discriminant validity is given. data were collected at a single point of time from a single source, which can represent a potential risk regarding to the problem of common method variance (podsakoff & organ, 1986). to minimize this bias, we referred to survey design guidelines proposed by podsakoff et al. (2003) guaranteeing abed and büttgen / journal of business strategies (2022) 39:1-32 13 t a b le 1 : r es u lt s o f th e c o n fi rm a to ry f a ct o r a n a ly si s m o d el χ 2 d f c f i n f i r m s e a g f i s ev en -f a ct o r m o d el 4 3 6 .4 5 5 2 4 9 0 .9 8 9 0 .9 7 4 0 .0 3 5 0 .9 4 6 s ix -f a ct o r m o d el 1 : 9 3 9 .8 3 0 2 5 5 0 .9 5 8 0 .9 4 3 0 .0 6 7 0 .8 9 8 w o m a n d em p lo y ee re fe rr a ls co m b in ed s ix -f a ct o r m o d el 2 : 1 0 6 7 .4 2 3 2 5 5 0 .9 5 0 0 .9 3 0 0 .0 7 2 0 .8 6 3 e m o ti o n a l co rp o ra te b ra n d p ri d e a n d a tt it u d in a l co rp o ra te b ra n d p ri d e co m b in ed o n efa ct o r m o d el 6 9 3 3 .1 5 9 2 7 0 0 .5 9 1 0 .5 8 3 0 .2 0 2 0 .5 2 7 n o te : c f i co m p a ra ti v e fi t in d ex ; n f i n o rm ed fi t in d ex ; r m s e a ro o t m ea n sq u a re ro o t er ro r o f a p p ro x im a ti o n ; g f i g o o d n es s o f fi t in d ex 14 abed and büttgen / journal of business strategies (2022) 39:1-32 confidentiality, using clear response guidelines, designing focused and specific items, and using different scale endpoints at one of the variables. moreover, we counterbalanced the question order to disrupt the logical flow. to test statistically for potential common method bias, we conducted a harman onefactor test (podsakoff & organ, 1986). results suggested the presence of 5 factors, indicating that common method effects are no serious problem in the data. in addition, we controlled for common method variance using a marker variable test (lindell & whitney, 2001). we selected felfe’s ‘transactional leadership’ as a marker variable, as it was theoretically uncorrelated to most of the constructs. analysis showed that none of the significant correlations of the model became nonsignificant or changed their sign. thus, we assume that cmv is not likely to affect the validity of this study (doty & glick, 1998). 5. results means, standard deviations, correlations and reliabilities are shown in table 2. the results are illustrated in figure 2 and reveal that only one out of ten hypotheses need to be rejected. perceived negative corporate brand publicity adversely affect emotional corporate brand pride, supporting h1 (β = .19, p < .001). similarly, perceived negative brand publicity directly affect brand supporting behavior of employees, namely wom (h2a, β = −.15, p < .001) and employee referrals (h2b, β = −.08, p < .002). moreover, we can confirm h3 stating that emotional corporate brand pride leads to attitudinal corporate brand pride (β = .79, p < .001). in accordance with h4a and h4b, we show that attitudinal corporate brand pride significantly influences wom (h4a, β = .74, p < .001) and employee referrals (h4b, β = .67, p < .001). in contrast to our expectations corporate brand experience through internal communications and corporate brand experience through external communications did not act in the same way in compensating perceived negative corporate brand publicity. corporate brand experience through internal communications mitigates the perception of negative brand publicity (h5b, β = -.22, p < .001), supporting h5b. however, the path between corporate brand experience through external communications and perceived negative brand publicity wasn’t significant, leading to a rejection of h5a (β = −.03, n.s.). to test whether emotional corporate brand pride can be triggered by the corporation through specific corporate brand experience, we test h6a abed and büttgen / journal of business strategies (2022) 39:1-32 15 t a b le 2 : d es cr ip ti v e s ta ti st ic s a n d c o rr el a ti o n s v a ri a b le m ea n s d 1 2 3 4 5 6 7 1 . p er ce iv ed n eg a ti v e b ra n d p u b li ci ty 2 .3 1 0 .8 8 (0 .9 3 ) 2 . e m o ti o n a l co rp o ra te b ra n d p ri d e 3 .8 6 1 .0 1 -0 .2 7 (0 .9 3 ) 3 . a tt it u d in a l co rp o ra te b ra n d p ri d e 3 .7 4 1 .1 1 -0 .2 9 0 .8 4 (0 .9 4 ) 4 . w o m 3 .6 2 1 .1 2 -0 .3 6 0 .6 8 0 .7 8 (0 .9 3 ) 5 . e m p lo y ee r ef er ra ls 3 .3 7 1 .2 3 -0 .2 6 0 .5 8 0 .6 8 0 .6 8 (0 .9 4 ) 6 . b ra n d ex p er ie n ce th ro u g h in te rn a l co m m u n ic a ti o n s 3 .4 4 1 .1 5 -0 .2 4 0 .4 1 0 .4 4 0 .3 9 0 .4 2 (0 .9 4 ) 7 . b ra n d ex p er ie n ce th ro u g h ex te rn a l co m m u n ic a ti o n s 2 .5 7 1 .3 0 -0 .1 3 0 .3 0 0 .3 5 0 .3 4 0 .3 4 0 .4 5 (0 .9 3 ) n o te : a ll c o rr e la ti o n s a re si g n ifi c a n t a t p < .0 1 . c o e ffi c ie n t a lp h a s a p p e a r o n d ia g o n a l 16 abed and büttgen / journal of business strategies (2022) 39:1-32 f ig u re 2 : s tru ctu ra l m o d el abed and büttgen / journal of business strategies (2022) 39:1-32 17 and h6b. in line with expectations corporate brand experience through external communications positively affect emotional corporate brand pride (h6a, β = .14, p < .002). similarly, corporate brand experience through internal communications influences emotional corporate brand pride (h6b, β = .31, p < .001). in addition, we tested for moderators that were not hypothesized. we conducted multi-group analysis as our possible moderators are discrete variables (eberl, 2010). we applied the procedure that bryne (2010) proposes to test the difference in our groups. since gouthier and rhein (2011) suggest that women show more (organizational) pride than men, we tested for gender effects. we also tested whether tenure influence the proposed paths as helm (2013) state that employees with a longer tenure might show higher levels of pride. analysis showed that, in terms of the relationship between perceived negative corporate brand publicity and employee referrals, gender has a significant effect. results suggest that men are less likely to recommend job offers. furthermore, the relationship between corporate brand experience through external communications and emotional corporate brand pride, gender has a significant effect. however, group difference is marginal. regarding tenure analysis showed that almost all paths did not differ, except for the relationship attitudinal corporate brand pride and employee referrals. here, employees with a short tenure tend to show higher employee referrals behavior. finally, multi-group analysis revealed that management and nonmanagement employees slightly differ in referral behavior (β = .04, p < .04). results of the multi-group analysis are presented in tables 3-5. 6. discussion although there are several studies providing empirical evidence that negative (brand) publicity has adverse effects on a number of consumer and applicant attitudes and behavioral intentions, it is unclear to what extent perceived negative corporate brand publicity affects employees. the present study reveals that perceived negative corporate brand publicity directly affects employee emotion, namely emotional corporate brand pride. moreover, perceived negative corporate brand publicity has a direct effect on employees’ brand supporting behavior like wom and employee referrals. as the latter finding is in contrast to prior studies müller and gaus (e.g. 2015) who did not find significant effects of negative media on actual consumer behavior, we argue that a person’s employer (i.e. brand) represent an important 18 abed and büttgen / journal of business strategies (2022) 39:1-32 t a b le 3 : m u lti-g ro u p a n a ly sis, b y g en d er s ta n d a rd co effi cen t g ro u p p a th m a le f em a le d iff eren ce b e in tern a l co m m u n ica tio n → p erceiv ed n eg a tiv e b ra n d p u b licity − 0 .2 3 − 0 .2 2 0 .0 1 b e ex tern a l co m m u n ica tio n → p erceiv ed n eg a tiv e b ra n d p u b licity − 0 .0 2 − 0 .0 2 0 .0 0 p erceiv ed n eg a tiv e b ra n d p u b licity → e m o tio n a l co rp o ra te b ra n d p rid e − 0 .1 8 − 0 .1 9 0 .0 2 e m o tio n a l co rp o ra te b ra n d p rid e → a ttitu d in a l co rp o ra te b ra n d p rid e 0 .8 1 0 .7 7 0 .0 4 a ttitu d in a l co rp o ra te b ra n d p rid e → e m p lo y ee referra ls 0 .6 7 0 .6 7 0 .0 0 a ttitu d in a l co rp o ra te b ra n d p irid e → w o m 0 .7 6 0 .7 2 0 .0 4 p erceiv ed n eg a tiv e b ra n d p u b licity → e m p lo y ee referra ls − 0 .0 9 − 0 .0 7 0 .0 2 ∗ p erceiv ed n eg a tiv e b ra n d p u b licity → w o m − 0 .1 7 − 0 .1 5 0 .0 2 b e in tern a l co m m u n ica tio n → e m o tio n a l co rp o ra te b ra n d p rid e 0 .2 8 0 .3 0 0 .0 2 b e ex tern a l co m m u n ica tio n → e m o tio n a l co rp o ra te b ra n d p rid e 0 .1 3 0 .1 4 0 .0 1 ∗∗∗ n o te : s ig n ifi c a n t a t * * * p < .0 1 ; * * p < 0 .5 ; * p < .1 0 abed and büttgen / journal of business strategies (2022) 39:1-32 19 t a b le 4 : m u lt ig ro u p a n a ly si s, b y t en u re s ta n d a rd co effi ce n t l o n g s h o rt g ro u p p a th t en u re t en u re d iff er en ce b e in te rn a l co m m u n ic a ti o n → p er ce iv ed n eg a ti v e b ra n d p u b li ci ty − 0 .2 4 − 0 .2 7 0 .0 3 b e ex te rn a l co m m u n ic a ti o n → p er ce iv ed n eg a ti v e b ra n d p u b li ci ty − 0 .0 4 − 0 .0 4 0 .0 0 p er ce iv ed n eg a ti v e b ra n d p u b li ci ty → e m o ti o n a l co rp o ra te b ra n d p ri d e − 0 .1 5 − 0 .1 5 0 .0 0 e m o ti o n a l co rp o ra te b ra n d p ri d e → a tt it u d in a l co rp o ra te b ra n d p ri d e 0 .8 1 0 .8 0 0 .0 1 a tt it u d in a l co rp o ra te b ra n d p ri d e → e m p lo y ee re fe rr a ls 0 .6 3 0 .6 7 0 .0 4 ∗ a tt it u d in a l co rp o ra te b ra n d p ir id e → w o m 0 .7 2 0 .7 1 0 .0 1 p er ce iv ed n eg a ti v e b ra n d p u b li ci ty → e m p lo y ee re fe rr a ls − 0 .1 1 − 0 .0 9 0 .0 2 p er ce iv ed n eg a ti v e b ra n d p u b li ci ty → w o m − 0 .1 6 − 0 .1 4 0 .0 2 b e in te rn a l co m m u n ic a ti o n → e m o ti o n a l co rp o ra te b ra n d p ri d e 0 .3 1 0 .3 1 0 .0 1 b e ex te rn a l co m m u n ic a ti o n → e m o ti o n a l co rp o ra te b ra n d p ri d e 0 .1 2 0 .1 3 0 .0 1 ∗∗ ∗ n o te : s ig n ifi c a n t a t * * * p < .0 1 ; * * p < 0 .5 ; * p < .1 0 20 abed and büttgen / journal of business strategies (2022) 39:1-32 t a b le 5 : m u lti-g ro u p a n a ly sis, b y m a n a g em en t r o le s ta n d a rd co effi cen t n o n g ro u p p a th m a n a g em en t m a n a g em en t d iff eren ce b e in tern a l co m m u n ica tio n → p erceiv ed n eg a tiv e b ra n d p u b licity − 0 .2 3 − 0 .2 3 0 .0 0 b e ex tern a l co m m u n ica tio n → p erceiv ed n eg a tiv e b ra n d p u b licity − 0 .0 3 − 0 .0 3 0 .0 0 p erceiv ed n eg a tiv e b ra n d p u b licity → e m o tio n a l co rp o ra te b ra n d p rid e − 0 .2 0 − 0 .1 8 0 .0 2 e m o tio n a l co rp o ra te b ra n d p rid e → a ttitu d in a l co rp o ra te b ra n d p rid e 0 .7 7 0 .7 9 0 .0 2 a ttitu d in a l co rp o ra te b ra n d p rid e → e m p lo y ee referra ls 0 .6 5 0 .6 9 0 .0 4 ∗∗ a ttitu d in a l co rp o ra te b ra n d p irid e → w o m 0 .7 4 0 .7 4 0 .0 0 p erceiv ed n eg a tiv e b ra n d p u b licity → e m p lo y ee referra ls − 0 .0 9 − 0 .0 7 0 .0 2 p erceiv ed n eg a tiv e b ra n d p u b licity → w o m − 0 .1 5 − 0 .1 5 0 .0 0 b e in tern a l co m m u n ica tio n → e m o tio n a l co rp o ra te b ra n d p rid e 0 .2 9 0 .3 0 0 .0 2 ∗ b e ex tern a l co m m u n ica tio n → e m o tio n a l co rp o ra te b ra n d p rid e 0 .1 7 0 .1 5 0 .0 2 n o te : s ig n ifi c a n t a t * * * p < .0 1 ; * * p < 0 .5 ; * p < .1 0 abed and büttgen / journal of business strategies (2022) 39:1-32 21 part of the individual’s self-concept leading to a change in employee behavior (cable & turban, 2003). in line with aet weiss and cropanzano (1996) and earlier findings of gouthier and rhein (2011), our results reveal that emotional corporate brand pride has downstream consequences regarding attitudinal corporate brand pride. similarly, the results demonstrate that attitudinal corporate brand pride strongly influences wom and employee referrals (brand supporting behavior). here, the study helps to broaden the current view on internal branding, which mainly focuses on brand commitment as a central construct, highlighting the importance of (attitudinal) corporate brand pride in an (internal) branding context. contrary to what we expected, corporate brand experience through external communications did not mitigate the perception of negative brand publicity in the same way brand experience through internal communication does. this finding is noteworthy, because it illustrates that employees of a corporate brand seem to be more prone to brand experience through internal communications. in doing so, the results establish an understanding that in an employee context both communication channels are not equally effective in compensating negative corporate brand publicity. from a theoretical point of view, this circumstance might relate to the accessibility of information amongst others, suggesting that the likelihood that information is used as the basis of an evaluation is determined by the accessibility of that information (feldman & lynch, 1988; herr et al., 1991). in the context of our study, employees might use the internal communications more often as accessibility via the intranet is easier and often more detailed compared to external communications. hence, the information is more present and therefore more effective. in addition, de roeck et al. (2014) and gond et al. (2010) showed that employees exhibited stronger feelings from internal csr actions than from csr actions towards other stakeholders, which could support our assumption that employees are more amenable to internal forms of communications. finally, this paper adds value to the existing research by showing how (emotional) corporate brand pride can be stimulated, responding to calls for further research (kraemer et al., 2020). likewise, corporate brand experience through internal communications trigger (emotional) corporate brand pride more strongly. 22 abed and büttgen / journal of business strategies (2022) 39:1-32 the analysis of control variables (multi-group analysis) revealed only minor differences regarding gender, tenure and employee status. here, we did not find strong gender effects. in contrast to expectations employees with a short tenure are more likely to recommend specific jobs of the corporation. it is also interesting that non-management employees are more likely to refer specific jobs to persons he or she knows. as management employees usually have a broad social capital and are usually well informed about vacancies, this result is surprising. limitations and implications for further research despite the new findings noted here, several limitations should be addressed. first, the sample comprise of german employees, implying that the results cannot be generalized. second, this research used a cross-sectional design. however, it may be interesting how the influence of perceived brand publicity varies over time, calling for further research using a longitudinal design. in addition, further studies might use semi-structured interviews to gain insights answering the question what employees of a corporate brand expect in a situation of negative publicity from top management, their supervisors or in general regarding the brand they work for. third, to provide a holistic view on effects of brand publicity the study used a more general measure, capturing various forms of negative brand publicity. in doing so, we disregard previous research showing that various forms of publicity exist, for example performance-related (lee et al., 2013; lin et al., 2011) and value-related publicity (kanar et al., 2010; thwaites et al., 2012). to provide further insights, future studies should include differentiated measures to capture specific forms of (brand) publicity. fourth, this research neglected effects of dispositions. affective-events-theory postulates the importance of dispositions on the relationship of work-events and emotions. for these reasons, future research should include dispositions. fifth, nowadays various communication channels exist (e.g. social media) and future studies should try to answer the question if negative brand publicity is similarly harmful in all channels. 7. practical implications the findings of this research have several implications for management and marketing practitioners. as employees represent a crucial part of brands’ success and competitive advantage, it is important to understand how the abed and büttgen / journal of business strategies (2022) 39:1-32 23 detrimental effects of perceived negative brand publicity on employees’ corporate brand pride and brand supporting behavior can be mitigated. the results show that corporation can effectively mitigate effects of perceived negative corporate brand publicity by creating a corporate brand experience. here, marketing managers may be well advised to highlight corporate brand values through internal communications, which in turn negatively affect the employees’ perception of negative brand publicity. moreover, this study indicates the importance of corporate brand pride as a central driver of brand supporting behavior, namely employee referrals and employee wom. as many branding initiatives base upon brand commitment, practitioners might think of including brand pride in their marketing concepts. this research shows how corporate brand pride can be fostered through specific marketing or branding activities, for example highlighting corporate brand values via internal communications. at the same time, we show that employees with a long tenure are less likely to recommend jobs to friends, compared to employees with a short tenure. as referrals are nowadays an important recruiting source (e.g. pieper, 2015; van hoye, 2013), management and hr practitioners might stimulate employee referrals through incentives targeted at this particular group (e.g. differentiated referral bonuses). similarly, managers are less likely to recommend jobs of their corporate brand to friends, compared to non-management employees. so, managers who usually have a large (business) network and know about various job opportunities within the corporation need to be encouraged to act as facilitators. references albert, n., merunka, d., & valette-florence, p. (2013). brand passion: antecedents and consequences. journal of business research, 66(7), 904–909. https://doi.org/10.1016/j.jbusres.2011.12.009 anderson, j. c., & gerbing, d. w. (1991). predicting the performance of measures in a confirmatory factor analysis with a pretest assessment of their substantive validities. journal of applied psychology, 76(5), 732–740. https://doi.org/10.1037/0021-9010.76.5.732 appleberg, k. a. (2005). the construction of a nomological network for organizational pride. benedictine university. arbuckle, j. (2003). amos 5.0 update to the amos user’s guide. marketing department, spss incorporated. https://doi.org/10.1016/j.jbusres.2011.12.009 https://doi.org/10.1037/0021-9010.76.5.732 24 abed and büttgen / journal of business strategies (2022) 39:1-32 aurand, t. w., gorchels, l., & bishop, t. r. (2005). human resource management’s role in internal branding: an opportunity for crossfunctional brand message synergy. journal of product & brand management. https://doi.org/10.1108/10610420510601030 baer, m. d., dhensa-kahlon, r. k., colquitt, j. a., rodell, j. b., outlaw, r., & long, d. m. (2015). uneasy lies the head that bears the trust: the effects of feeling trusted on emotional exhaustion. academy of management journal, 58(6), 1637–1657. https://doi.org/10.5465 /amj.2014.0246 bagozzi, r. p., & yi, y. (1988). on the evaluation of structural equation models. journal of the academy of marketing science, 16(1), 74–94. berger, j., sorensen, a. t., & rasmussen, s. j. (2010). positive effects of negative publicity: when negative reviews increase sales. marketing science, 29(5). https://doi.org/10.1287/mksc.1090.0557 bloemer, j. (2010). the psychological antecedents of employee referrals. the international journal of human resource management, 21(10), 1769–1791. https://doi.org/10.1080/09585192.2010.500494 boons, m., stam, d., & barkema, h. g. (2015). feelings of pride and respect as drivers of ongoing member activity on crowdsourcing platforms. journal of management studies, 52(6), 717–741. https://doi.org/10 .1111/joms.12140 boukis, a., kostopoulos, g., & katsaridou, i. (2014). imo and different fit types as key enablers of employee brand-supporting behaviour. journal of strategic marketing, 22(2), 117–134. https://doi.org/10 .1080/0965254x.2013.876066 braxton, d. f., muehling, d. d., & joireman, j. (2019). the effects of processing mode and brand scandals on copycat product evaluations. journal of marketing communications, 25(3), 247–267. https://doi. org/10.1080/13527266.2016.1236284 breaugh, j. a., & starke, m. (2000). research on employee recruitment: so many studies, so many remaining questions. journal of management, 26(3), 405–434. https://doi.org/10.1177/014920630002600303 brislin, r. w. (1980). translation and content analysis of oral and written materials. methodology, 389–444. bryne, b. (2001). structural equation modeling with amos: basic concepts, applications, and programming (1st ed.) erlbaum. https://doi.org/10.1108/10610420510601030 https://doi.org/10.5465/amj.2014.0246 https://doi.org/10.5465/amj.2014.0246 https://doi.org/10.1287/mksc.1090.0557 https://doi.org/10.1080/09585192.2010.500494 https://doi.org/10.1111/joms.12140 https://doi.org/10.1111/joms.12140 https://doi.org/10.1080/0965254x.2013.876066 https://doi.org/10.1080/0965254x.2013.876066 https://doi.org/10.1080/13527266.2016.1236284 https://doi.org/10.1080/13527266.2016.1236284 https://doi.org/10.1177/014920630002600303 abed and büttgen / journal of business strategies (2022) 39:1-32 25 bryne, b. (2010). structural equation modeling with amos: basic concepts, applications, and programming (2nd ed.) routledge. burmann, c., zeplin, s., & riley, n. (2009). key determinants of internal brand management success: an exploratory empirical analysis. journal of brand management, 16(4), 264–284. https://doi.org/10.1057 /bm.2008.6 cable, d. m., & turban, d. b. (2003). the value of organizational reputation in the recruitment context: a brand-equity perspective. journal of applied social psychology, 33(11), 2244–2266. https://doi.org/10.1 111/j.1559-1816.2003.tb01883.x cleeren, k., van heerde, h. j., & dekimpe, m. g. (2013). rising from the ashes: how brands and categories can overcome product-harm crises. journal of marketing, 77(2), 58–77. https://doi.org/10.1509/jm.10 .0414 collins, c. j., & stevens, c. k. (2002). the relationship between early recruitment-related activities and the application decisions of new labor-market entrants: a brand equity approach to recruitment. journal of applied psychology, 87(6), 1121–1133. https://doi.org/10.103 7/0021-9010.87.6.1121 de matos, c. a., & rossi, c. a. v. (2008). word-of-mouth communications in marketing: a meta-analytic review of the antecedents and moderators. journal of the academy of marketing science, 36(4), 578–596. https://doi.org/10.1007/s11747-008-0121-1 de roeck, k., marique, g., stinglhamber, f., & swaen, v. (2014). understanding employees’ responses to corporate social responsibility: mediating roles of overall justice and organisational identification. the international journal of human resource management, 25(1), 91–112. https://doi.org/10.1080/09585192.2013.781528 doty, d. h., & glick, w. h. (1998). common methods bias: does common methods variance really bias results? organizational research method, 1(4), 374–406. https://doi.org/10.1177/109442819814002 eberl, m. (2010). an application of pls in multi-group analysis: the need for differentiated corporate-level marketing in the mobile communications industry. in handbook of partial least squares (pp. 487–514). springer. https://doi.org/10.1007/978-3-540-32827-8 22 https://doi.org/10.1057/bm.2008.6 https://doi.org/10.1057/bm.2008.6 https://doi.org/10.1111/j.1559-1816.2003.tb01883.x https://doi.org/10.1111/j.1559-1816.2003.tb01883.x https://doi.org/10.1509/jm.10.0414 https://doi.org/10.1509/jm.10.0414 https://doi.org/10.1037/0021-9010.87.6.1121 https://doi.org/10.1037/0021-9010.87.6.1121 https://doi.org/10.1007/s11747-008-0121-1 https://doi.org/10.1080/09585192.2013.781528 https://doi.org/10.1177/109442819814002 https://doi.org/10.1007/978-3-540-32827-8_22 26 abed and büttgen / journal of business strategies (2022) 39:1-32 egeler, p., abed, f., & büttgen, m. (2022). corporate brand experience as a new construct and its effects on employees’ corporate brand pride and brand-supporting behaviours. international journal of business and management, 17(3). https://doi.org/10.5539/ijbm.v17n3p39 eisingerich, a. b., rubera, g., seifert, m., & bhardwaj, g. (2011). doing good and doing better despite negative information?: the role of corporate social responsibility in consumer resistance to negative information. journal of service research, 14(1), 60–75. https://doi.org/1 0.1177/1094670510389164 elfenbein, h. a. (2007). 7 emotion in organizations: a review and theoretical integration. academy of management annals, 1(1), 315–386. https: //doi.org/10.1080/078559812 feldman, j. m., & lynch, j. g. (1988). self-generated validity and other effects of measurement on belief, attitude, intention, and behavior. journal of applied psychology, 73(3), 421. https://doi.org/10.1037 /0021-9010.73.3.421 fisher, c. d., & ashkanasy, n. m. (2000). the emerging role of emotions in work life: an introduction. https://doi.org/10.1002/(sici)1099-137 9(200003)21:2⟨3c123::aid-job33⟩3e3.0.co;2-8 fornell, c., & larcker, d. f. (1981). evaluating structural equation models with unobservable variables and measurement error. journal of marketing research, 18(1), 39–50. https://doi.org/10.1177/0022243 78101800104 gond, j.-p., el-akremi, a., igalens, j., & swaen, v. (2010). corporate social responsibility influence on employees. international center for corporate social responsibility, 54. gouthier, m. h., & rhein, m. (2011). organizational pride and its positive effects on employee behavior. journal of service management. https: //doi.org/10.1108/09564231111174988 gracia, e., salanova, m., grau, r., & cifre, e. (2013). how to enhance service quality through organizational facilitators, collective work engagement, and relational service competence. european journal of work and organizational psychology, 22(1), 42–55. https://doi.org/ 10.1080/1359432x.2011.628793 hagenbuch, d. j., wiese, m. d., dose, j. j., & bruce, m. l. (2008). understanding satisfied and affectively committed clients’ lack of referral https://doi.org/10.5539/ijbm.v17n3p39 https://doi.org/10.1177/1094670510389164 https://doi.org/10.1177/1094670510389164 https://doi.org/10.1080/078559812 https://doi.org/10.1080/078559812 https://doi.org/10.1037/0021-9010.73.3.421 https://doi.org/10.1037/0021-9010.73.3.421 https://doi.org/10.1002/(sici)1099-1379(200003)21:2<3c123::aid-job33>3e3.0.co;2-8 https://doi.org/10.1002/(sici)1099-1379(200003)21:2<3c123::aid-job33>3e3.0.co;2-8 https://doi.org/10.1177/002224378101800104 https://doi.org/10.1177/002224378101800104 https://doi.org/10.1108/09564231111174988 https://doi.org/10.1108/09564231111174988 https://doi.org/10.1080/1359432x.2011.628793 https://doi.org/10.1080/1359432x.2011.628793 abed and büttgen / journal of business strategies (2022) 39:1-32 27 intent. services marketing quarterly, 29(3), 24–74. https://doi.org/1 0.1080/15332960802125932 hair, b., j.f.and babin, black, w., anderson, r., & tatham, r. (2006). multivariate data analysis (6th edition). pearson. hair, j., anderson, r., tatham, r., & black, w. (1998). multivariate data analysis (5th edition). pearson. harris, f., & de chernatony, l. (2001). corporate branding and corporate brand performance. european journal of marketing. https://doi.org/ 10.1108/03090560110382101 harrison, w. l. (2001). the measurement of word-of-mouth communication and an investigation of service quality and customer commitment as potential antecedents. journal of service research, 4(1), 60–75. https://doi.org/10.1177/109467050141006 helm, s. (2013). a matter of reputation and pride: associations between perceived external reputation, pride in membership, job satisfaction and turnover intentions. british journal of management, 24(4), 542– 556. https://doi.org/10..1111/j.1467-8551.2012.00827.x herr, p. m., kardes, f. r., & kim, j. (1991). effects of word-of-mouth and product-attribute information on persuasion: an accessibilitydiagnosticity perspective. journal of consumer research, 17(4), 454– 462. https://doi.org/10.1086/208570 herrbach, o., mignonac, k., & gatignon, a.-l. (2004). exploring the role of perceived external prestige in managers’ turnover intentions. the international journal of human resource management, 15(8), 1390– 1407. https://doi.org/10.1080/0958519042000257995 hock, s. j., & raithel, s. (2019). managing negative celebrity endorser publicity: how announcements of firm (non) responses affect stock returns. management science, 66(3), 1473–1495. https://doi.org/10.1 287/mnsc.2018.3243 homburg, c., & giering, a. (1996). konzeptualisierung und operationalisierung komplexer konstrukte: ein leitfaden für die marketingforschung. marketing: zeitschrift für forschung und praxis, 18(1), 5–24. https://doi.org/10.15358/3044-1369-1996-1-5 hu, l.-t., & bentler, p. m. (1998). fit indices in covariance structure modeling: sensitivity to underparameterized model misspecification. psyhttps://doi.org/10.1080/15332960802125932 https://doi.org/10.1080/15332960802125932 https://doi.org/10.1108/03090560110382101 https://doi.org/10.1108/03090560110382101 https://doi.org/10.1177/109467050141006 https://doi.org/10..1111/j.1467-8551.2012.00827.x https://doi.org/10.1086/208570 https://doi.org/10.1080/0958519042000257995 https://doi.org/10.1287/mnsc.2018.3243 https://doi.org/10.1287/mnsc.2018.3243 https://doi.org/10.15358/3044-1369-1996-1-5 28 abed and büttgen / journal of business strategies (2022) 39:1-32 chological methods, 3(4), 424–453. https://doi.org/10.1037/1082-98 9x.3.4.424 jaidi, y., van hooft, e. a., & arends, l. r. (2011). recruiting highly educated graduates: a study on the relationship between recruitment information sources, the theory of planned behavior, and actual job pursuit. human performance, 24(2), 135–157. https://doi.org/10.1 080/08959285.2011.554468 kanar, a. m., collins, c. j., & bell, b. s. (2010). a comparison of the effects of positive and negative information on job seekers’ organizational attraction and attribute recall. human performance, 23(3), 193–212. https://doi.org/10.1080/08959285.2010.487842 king, c., & grace, d. (2010). building and measuring employee-based brand equity. european journal of marketing. https://doi.org/10.1108/03 090561011047472 kraemer, t., & gouthier, m. h. (2014). how organizational pride and emotional exhaustion explain turnover intentions in call centers: a multigroup analysis with gender and organizational tenure. journal of service management. https://doi.org/10.1108/josm-07-2013-0173 kraemer, t., weiger, w. h., gouthier, m. h., & hammerschmidt, m. (2020). toward a theory of spirals: the dynamic relationship between organizational pride and customer-oriented behavior. journal of the academy of marketing science, 48(6), 1095–1115. https://doi.org/1 0.1007/s11747-019-00715-0 lee, c.-h., hwang, f.-m., & yeh, y.-c. (2013). the impact of publicity and subsequent intervention in recruitment advertising on job searching freshmen’s attraction to an organization and job pursuit intention. journal of applied social psychology, 43(1), 1–13. https://doi.org/1 0.1111/j.1559-1816.2012.00975.x lin, c.-p., chen, s.-c., chiu, c.-k., & lee, w.-y. (2011). understanding purchase intention during product-harm crises: moderating effects of perceived corporate ability and corporate social responsibility. journal of business ethics, 102(3), 455–471. https://doi.org/10.1007/s1 0551-011-0824-y lindell, m., & whitney, d. (2001). accounting for common method variance in cross-selectional research designs. journal of applied psychology, 86(1), 114–121. https://doi.org/10.1037/0021-9010.86.1.114 https://doi.org/10.1037/1082-989x.3.4.424 https://doi.org/10.1037/1082-989x.3.4.424 https://doi.org/10.1080/08959285.2011.554468 https://doi.org/10.1080/08959285.2011.554468 https://doi.org/10.1080/08959285.2010.487842 https://doi.org/10.1108/03090561011047472 https://doi.org/10.1108/03090561011047472 https://doi.org/10.1108/josm-07-2013-0173 https://doi.org/10.1007/s11747-019-00715-0 https://doi.org/10.1007/s11747-019-00715-0 https://doi.org/10.1111/j.1559-1816.2012.00975.x https://doi.org/10.1111/j.1559-1816.2012.00975.x https://doi.org/10.1007/s10551-011-0824-y https://doi.org/10.1007/s10551-011-0824-y https://doi.org/10.1037/0021-9010.86.1.114 abed and büttgen / journal of business strategies (2022) 39:1-32 29 löhndorf, b., & diamantopoulos, a. (2014). internal branding: social identity and social exchange perspectives on turning employees into brand champions. journal of service research, 17(3), 310–325. https://doi. org/10.1177/1094670514522098 lovett, m. j., peres, r., & shachar, r. (2013). on brands and word of mouth. journal of marketing research, 50(4), 427–444. https://doi.org/10 .1509/jmr.11.0458 lythreatis, s., mostafa, a. m. s., & wang, x. (2019). participative leadership and organizational identification in smes in the mena region: testing the roles of csr perceptions and pride in membership. journal of business ethics, 156(3), 635–650. https://doi.org/10.1007/s1055 1-017-3557-8 matta, f. k., erol-korkmaz, h. t., johnson, r. e., & biçaksiz, p. (2014). significant work events and counterproductive work behavior: the role of fairness, emotions, and emotion regulation. journal of organizational behavior, 35(7), 920–944. https://doi.org/10.1002/job.19 34 monga, a. b., & john, d. r. (2008). when does negative brand publicity hurt? the moderating influence of analytic versus holistic thinking. journal of consumer psychology, 18(4), 320–332. https://doi.org/1 0.1016/j.jcps.2008.09.009 morhart, f. m., herzog, w., & tomczak, t. (2009). brand-specific leadership: turning employees into brand champions. journal of marketing, 73(5), 122–142. https://doi.org/10.1509/jmkg.73.5.112 müller, c. e., & gaus, h. (2015). consumer response to negative media information about certified organic food products. journal of consumer policy, 38(4), 387–409. https://doi.org/10.1007/s10603-0159299-z osei-frimpong, k., donkor, g., & owusu-frimpong, n. (2019). the impact of celebrity endorsement on consumer purchase intention: an emerging market perspective. journal of marketing theory and practice, 27(1), 103–121. https://doi.org/10.1080/10696679.2018.1534070 peloza, j. (2006). using corporate social responsibility as insurance for financial performance. california management review, 48(2), 52–72. https://doi.org/10.2307/41166338 https://doi.org/10.1177/1094670514522098 https://doi.org/10.1177/1094670514522098 https://doi.org/10.1509/jmr.11.0458 https://doi.org/10.1509/jmr.11.0458 https://doi.org/10.1007/s10551-017-3557-8 https://doi.org/10.1007/s10551-017-3557-8 https://doi.org/10.1002/job.1934 https://doi.org/10.1002/job.1934 https://doi.org/10.1016/j.jcps.2008.09.009 https://doi.org/10.1016/j.jcps.2008.09.009 https://doi.org/10.1509/jmkg.73.5.112 https://doi.org/10.1007/s10603-015-9299-z https://doi.org/10.1007/s10603-015-9299-z https://doi.org/10.1080/10696679.2018.1534070 https://doi.org/10.2307/41166338 30 abed and büttgen / journal of business strategies (2022) 39:1-32 pieper, j. r. (2015). uncovering the nuances of referral hiring: how referrer characteristics affect referral hires’ performance and likelihood of voluntary turnover. personnel psychology, 68(4), 811–858. https: //doi.org/10.1111/peps.12097 podsakoff, p. m., mackenzie, s. b., lee, j.-y., & podsakoff, n. p. (2003). common method biases in behavioral research: a critical review of the literature and recommended remedies. journal of applied psychology, 88(5), 879. https://doi.org/10.1037/0021-9010.88.5.879 podsakoff, p. m., & organ, d. w. (1986). self-reports in organizational research: problems and prospects. journal of management, 12(4), 531–544. https://doi.org/10.1177/014920638601200408 rosen, c. c., harris, k. j., & kacmar, k. m. (2009). the emotional implications of organizational politics: a process model. human relations, 62(1), 27–57. https://doi.org/10.1177/0018726708099836 salerno, a., laran, j., & janiszewski, c. (2015). pride and regulatory behavior: the influence of appraisal information and self-regulatory goals. journal of consumer research, 42(3), 499–514. https://doi.org/10 .1093/jcr/ucv037 stammerjohan, c., wood, c. m., chang, y., & thorson, e. (2005). an empirical investigation of the interaction between publicity, advertising, and previous brand attitudes and knowledge. journal of advertising, 34(4), 55–67. https://doi.org/10.1080/00913367.2005.10639209 stumpp, t., hülsheger, u. r., muck, p. m., & maier, g. w. (2009). expanding the link between core self-evaluations and affective job attitudes. european journal of work and organizational psychology, 18(2), 148–166. https://doi.org/10.1080/13594320802281110 thwaites, d., lowe, b., monkhouse, l. l., & barnes, b. r. (2012). the impact of negative publicity on celebrity ad endorsements. psychology & marketing, 29(9), 663–673. https://doi.org/10.1002/mar.20552 van hoye, g., & lievens, f. (2005). recruitment-related information sources and organizational attractiveness: can something be done about negative publicity? international journal of selection and assessment, 13(3), 179–187. https://doi.org/10.1111/j.1468-2389.2005.00313.x van hoye, g. (2013). recruiting through employee referrals: an examination of employees’ motives. human performance, 26(5), 451–464. https: //doi.org/10.1080/08959285.2013.836199 https://doi.org/10.1111/peps.12097 https://doi.org/10.1111/peps.12097 https://doi.org/10.1037/0021-9010.88.5.879 https://doi.org/10.1177/014920638601200408 https://doi.org/10.1177/0018726708099836 https://doi.org/10.1093/jcr/ucv037 https://doi.org/10.1093/jcr/ucv037 https://doi.org/10.1080/00913367.2005.10639209 https://doi.org/10.1080/13594320802281110 https://doi.org/10.1002/mar.20552 https://doi.org/10.1111/j.1468-2389.2005.00313.x https://doi.org/10.1080/08959285.2013.836199 https://doi.org/10.1080/08959285.2013.836199 abed and büttgen / journal of business strategies (2022) 39:1-32 31 verbeke, w., belschak, f., & bagozzi, r. p. (2004). the adaptive consequences of pride in personal selling. journal of the academy of marketing science, 32(4), 386–402. https://doi.org/10.1177/0092010304 267105 wang, a. (2006). when synergy in marketing communication online enhances audience response: the effects of varying advertising and product publicity messages. journal of advertising research, 46(2), 160–170. https://doi.org/10.2501/s0021849906060181 wangenheim, f. v., & baón, t. (2007). the chain from customer satisfaction via word-of-mouth referrals to new customer acquisition. journal of the academy of marketing science, 35(2), 233–249. https://doi.org/1 0.1007/s11747-007-0037-1 weiss, h. m., & cropanzano, r. (1996). affective events theory. research in organizational behavior, 18(1), 1–74. wolny, j., & mueller, c. (2013). analysis of fashion consumers’ motives to engage in electronic word-of-mouth communication through social media platforms. journal of marketing management, 29(5-6), 562– 583. https://doi.org/10.1080/0267257x.2013.778324 woo, h., jung, s., & jin, b. e. (2020). how far can brands go to defend themselves? the extent of negative publicity impact on proactive consumer behaviors and brand equity. business ethics: a european review, 29(1), 193–211. https://doi.org/10.1111/beer.12246 yoon, y., gürhan-canli, z., & schwarz, n. (2006). the effect of corporate social responsibility (csr) activities on companies with bad reputations. journal of consumer psychology, 16(4), 377–390. https://doi.org/1 0.1207/s15327663jcp1604 9 zeithaml, v. a., berry, l. l., & parasuraman, a. (1996). the behavioral consequences of service quality. journal of marketing, 60(2), 31–46. https://doi.org/1251929 zhao, h., wayne, s., glibkowski, b., & bravo, j. (2007). the impact of psychological contract breach on work-related outcomes: a metaanalysis. personnel psychology, 60(3), 647–680. https://doi.org/10 .1111/j.1744-6570.2007.00087.x zhou, l., & whitla, p. (2013). how negative celebrity publicity influences consumer attitudes: the mediating role of moral reputation. journal https://doi.org/10.1177/0092010304267105 https://doi.org/10.1177/0092010304267105 https://doi.org/10.2501/s0021849906060181 https://doi.org/10.1007/s11747-007-0037-1 https://doi.org/10.1007/s11747-007-0037-1 https://doi.org/10.1080/0267257x.2013.778324 https://doi.org/10.1111/beer.12246 https://doi.org/10.1207/s15327663jcp1604_9 https://doi.org/10.1207/s15327663jcp1604_9 https://doi.org/1251929 https://doi.org/10.1111/j.1744-6570.2007.00087.x https://doi.org/10.1111/j.1744-6570.2007.00087.x 32 abed and büttgen / journal of business strategies (2022) 39:1-32 of business research, 66(8), 1013–1020. https://doi.org/10.10146 /j.jbusres.2011.12.025 zhu, d.-h., & chang, y.-p. (2013). negative publicity effect of the business founder’s unethical behavior on corporate image: evidence from china. journal of business ethics, 117(1), 111–121. https://doi.org/ 10.1007/s10551-012-1512-2 https://doi.org/10.10146/j.jbusres.2011.12.025 https://doi.org/10.10146/j.jbusres.2011.12.025 https://doi.org/10.1007/s10551-012-1512-2 https://doi.org/10.1007/s10551-012-1512-2 introduction theoretical background linking perceived negative corporate brand publicity and emotional corporate brand pride linking perceived negative corporate brand publicity, wom and employee referrals linking emotional corporate brand pride and attitudinal corporate brand pride linking attitudinal corporate brand pride and wom/employee referrals linking corporate brand experience through internal/external communications and perceived negative corporate brand publicity linking corporate brand experience through internal/external communications and emotional corporate brand pride method sample and procedure measures analysis results discussion limitations and implications for further research practical implications 110 journal of business strategies response of the cost of equity to leverage: an alternative perspective glenn n. pettengill grand valley state university • allendale, mi diane m. lander saint michael’s college • colchester, vt abstract in this paper we examine the change in a corporation’s cost of equity as the corporation increases leverage. standard textbook treatments present the wellknown modigliani-miller hypothesis that the cost of leverage increases linearly with increases in the debt-to-equity ratio in keeping with a constant cost of capital for the firm. less frequently, textbooks present the modigliani-miller argument that, if the cost of debt rises with high levels of leverage, the cost of equity will increase at a decreasing rate or even decline in order to keep the overall cost of capital constant. standard textbook presentations continue with additional discussions concerning tax effects and bankruptcy costs but without mention of the cost of equity. these presentations leave the impression that the cost of equity remains as presented in the modigliani-miller framework. in this paper we present theoretical and empirical arguments in support of our claim that the cost of equity increases slowly with moderate increases in debt but increases dramatically as leverage increases sufficiently to cause equity investors to fear bankruptcy. introduction what should students know about the cost of equity? two fundamental relationships form the core knowledge base that students should possess about the cost of equity, both from a corporate finance perspective and an investment perspective. first, because debt has a senior payment claim both in the case of normal business operations and in the case of bankruptcy, equity has more risk and the cost of equity is greater than the cost of debt. this holds regardless if the firm uses very little leverage or a great deal of leverage. second, because debt is cheaper than equity, increasing leverage may increase per unit payments to equity, but at the cost of increasing variability in these payments. this increase in financial risk causes equity owners to demand a higher percentage return. it is the path of volume 32, number 2 111 this increased required return to equity that we argue is inadequately addressed by textbooks and provides the focus of this paper. because textbook discussions of the relationship between the cost of equity and leverage typically depend on the theory developed by modigliani and miller, we continue with a discussion of their arguments. modigliani-miller model modigliani and miller’s (1958) nobel prize winning paper on capital structure still underpins textbook discussions of capital structure. at the core of their argument is the proposal that a firm’s value is determined solely by the cash flow and the risk of the cash flow created by the firm’s assets. thus, under perfect market conditions, the value of the firm, and hence its overall cost of capital, is not influenced by the decision to finance the firm by debt or by equity. this result is referred to as the irrelevance proposal, or as modigliani-miller proposition i (mm i), and is supported by the argument that investors can achieve whatever level of leverage they desire in their investment in a firm by borrowing on their own to supplement their personal equity investment (the “homemade leverage” argument). because using debt financing replaces the higher cost of equity with lower costing debt, in order for the cost of capital to remain constant, the cost of equity must increase with leverage and must do so at a prescribed rate as shown in equation (1) below. this relationship is referred to as modigliani-miller proposition ii (mm ii). rrequity = unlevered required return of equity + d/e * (roa – cost of debt) (1) where: rrequity is the required return on equity for a given level of leverage, d/e is the debt-to-equity ratio (measures leverage), and roa is the expected return on assets. the cost of debt is assumed to be constant across levels of leverage. thus, the required return to equity is a constantly increasing linear function of leverage as measured by the d/e ratio. a constantly increasing cost of equity is consistent with constantly increasing financial risk borne by equity holders as the total amount of fixed payments to debt holders increases with leverage. the rationale that this increase in cost can be measured by equation (1) above results because 112 journal of business strategies only this increase will maintain a constant overall cost of capital. to support the validity of mm ii, it is argued that, if the markets incorrectly price equity at any level inconsistent with the cost of equity as determined by equation (1), arbitrage profits will be available and market transactions will move the stock price to the correct level. modigliani and miller consider the relaxation of several key perfect market assumptions, including a constant cost of debt with increasing leverage and the absence of corporate taxes. they find their results robust to the relaxation of these assumptions.1 these results, although widely accepted in the academic community, conflict with the observed behavior of financial managers who clearly believe that the financing decision and the level of leverage used matters. furthermore, keeping the overall cost of capital constant in the face of a rising cost of debt required modigliani and miller to argue that the rate of increase in the cost of equity slowed, or even reversed, as leverage grew high, a seemingly illogical behavior on the part of equity investors. modigliani and miller (1963) revisit the tax issue and their revised results lead to the equally untenable position that the optimum capital structure is 100% debt. textbook treatment textbook discussions of the cost of equity, as included in descriptions of capital structure, provide a fairly standard representation of the effect of leverage on the cost of equity. we find this standard representation lacking in two important aspects. we next discuss the standard presentations and then identify the two aspects of these presentations that we suggest are inconsistent with rational investor behavior, short changing the student. textbook presentations generally begin with the modiglianimiller assumptions that capital markets are efficient and there is no tax on corporate earnings. they emphasize that the value of the firm is determined by the income produced by the firm’s assets and that this asset value does not change with the method of financing. thus, the total value of debt and equity remains constant across levels of leverage. these presentations generally identify this relationship as the modigliani-miller irrelevance proposition, or mm i. discussion of the cost of equity follows from this proposition. textbook presentations may or may not emphasize that the cost of equity is higher than the cost of debt due to lower risk for debt, but do indicate a higher cost of equity relative to the cost of debt. these presentations continue with a discussion of the impact of leverage on the cost of equity. the discussion shows that leverage creates a higher volume 32, number 2 113 eps for the stockholder, but at the cost of higher financial risk. the precise increase in the cost of equity is shown as a mathematical identity whereby the value of the firm is held constant in accordance with the basic proposition that the value of the firm is solely determined by the value of the firm’s assets. in this case, the cost of equity is determined by mm ii (equation (1)) and the overall cost of capital is determined by the cost of debt and cost of equity weighted by their respective book values.2 a graphic presentation of the cost of equity, cost of debt and cost of capital as leverage increases is normally provided. generally, the graphic presentation is made in debt-to-equity space revealing a linear relationship between leverage and the cost of equity.3 most textbooks explicitly recognize that the cost of debt does increase with increasing levels of leverage due to the fear of default. however, an explicit connection between the increasing cost of debt and the optimum capital structure is often absent. indeed, in some cases, the argument made is that an increase in the cost of debt is consistent with a constant overall cost of capital. for example in their undergraduate textbook, fundamentals of corporate finance, brealey, myers and marcus (2013)4 state that the overall cost of capital remains constant despite an increasing cost of debt: “essentially because holders of risky debt begin to bear part of the firm’s operating risk. as the firm borrows more, more of the risk is transferred from stockholders to bondholders” (p. 454). implicit in the statement is the assumption that stockholders remain essentially unscathed by bankruptcy. as did modigliani and miller, textbook discussions then relax the no corporate tax assumption resulting in the conclusion that an optimum capital structure consists of 100% debt. this result relies on the implicit assumption that the cost of equity remains the same as given by mm ii. thus, the increasing cost of equity that was just sufficient to offset the use of cheaper debt when debt offered no tax advantage is now insufficient to keep the overall cost of capital constant, resulting instead in an ever decreasing cost of capital with each incremental addition of a unit of debt to that capital structure. this unrealistic result begs for resolution, which is then presented by bankruptcy costs. textbooks generally present a resolution to the 100% debt dilemma by identifying a tradeoff between the upside of the tax reduction and the downside of increased bankruptcy cost. when interest expense is taxable5, as leverage increases, the higher total interest payments result in more tax deductions and lower taxes. the amount by which the higher interest payments lower taxes is commonly referred to as the interest expense tax shield. as leverage increases, however, the possibility of default also increases. bankruptcy results in a firm having to pay a number of, 114 journal of business strategies what can be significant, direct costs (e.g., legal, accounting, and administration fees) as well as indirect costs (e.g., loss of reputation and ability to purchase supplies/inventory on credit). the tradeoff theory suggests that an optimum capital structure exists when the present value of the tax shield equals the present value of bankruptcy costs. significantly, textbook discussions of bankruptcy costs do not include a discussion of the cost of equity. rather, bankruptcy costs appear to affect the debt holder. for example, brealey, myers and marcus (2013) state that, in the case of bankruptcy involving highly marketable assets such as hotel properties, “the direct bankruptcy costs are restricted to items such as legal and court fees, real estate commissions, and the time the lender spends sorting things out” (p. 461). notice, the cost is borne by the “lender.” of course, in this situation, the stockholder bears no additional cost because this investor has lost everything. but no mention is made of the stockholder’s loss. the student is left to assume the cost of equity must remain as provided by the mm ii equation, unaffected by fears of bankruptcy. textbooks frequently discuss indirect costs of bankruptcy as well. one indirect cost often discussed is the games shareholders are assumed to play at the expense of the bondholder (an example of agency). it may seem to the student that the stockholder actually relishes the prospect of bankruptcy. in many textbooks, the presentation of the tradeoff theory is supplemented with a further discussion of the financing decision. for example, textbooks frequently present the pecking order theory, in part to explain the lack of the utilization of the tax shield by highly profitable companies. yet these additional discussions remain silent about the cost of equity. again, the student is left to assume the cost of equity must remain as determined by the mm ii equation. in this paper, we argue that standard textbook explanations of capital structure are remiss for two reasons. first, we maintain that increases in the probability of bankruptcy do affect the cost of equity and find textbook presentations remiss because no consideration is given to this relationship. we argue this point in greater detail in section ii. second, we maintain that the issue for the corporation is its market value weighted cost of equity and again find textbook presentations remiss because book values are used to determine the cost of equity. modigliani and miller assume the value of the corporation is derived only from income produced by its assets and all earnings are paid out as dividends. textbook presentations emphasize the former and implicitly assume the latter, thus ignoring the possibility that market forces may price income streams differently depending on the division of the income stream. brealey, myers and marcus (2013, p. 446) provide an example relying on the wisdom of yogi berra to make the point to students that value is unchanged by volume 32, number 2 115 selecting different financing options. the story proceeds as follows: yogi is brought an after-game pizza. when asked by the delivery person whether he should slice the pizza, as usual, into four slices, yogi asks for the pizza to be sliced into eight pieces because he is especially hungry on this night.6 the moral is clear. slicing the pizza does not increase the total size of the pizza, thus implying that slicing the value of the corporation between debt and equity does not increase total asset value. we argue that the illustration misses the point that the market value of the corporation depends on the market value of the debt and equity issued by the corporation. we suggest that, just as a pizza vendor may be able to sell eight slices of a given pizza for more than four slices of the same pizza, even if the total size of the pizza remains the same, how the firm slices claims to its cash flow may make a difference as to the total value of the slices. we also argue this point in greater detail in section ii. in section iii we provide empirical evidence for our arguments. a conclusion is found in section iv. theoretical considerations implications of the modigliani-miller model we argue that rational investor response to moderate increases in leverage is inconsistent with key implications of modigliani-miller proposition ii. careful analysis of mm ii reveals several important implications of which we find no direct mention in extant literature. it is these key implications that we suggest are inconsistent with rational investor behavior. 116 journal of business strategies table 1: implications of modigliani-miller proposition ii for the prototype firm % debt 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% 90.00% d/e 0.00 0.11 0.25 0.43 0.67 1.00 1.50 2.33 4.00 9.00 shares out 2.00 1.80 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 earnings $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 eas $10.00 $9.50 $9.00 $8.50 $8.00 $7.50 $7.00 $6.50 $6.00 $5.50 eps $5.00 $5.28 $5.63 $6.07 $6.67 $7.50 $8.75 $10.83 $15.00 $27.50 book equity $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 robe 10.00% 10.56% 11.25% 12.14% 13.33% 15.00% 17.50% 21.67% 30.00% 55.00% mm ii rr 10.00% 10.56% 11.25% 12.14% 13.33% 15.00% 17.50% 21.67% 30.00% 55.00% share price $50 $50 $50 $50 $50 $50 $50 $50 $50 $50 st. dev. robe 5.00% 5.56% 6.25% 7.14% 8.33% 10.00% 12.50% 16.67% 25.00% 50.00% p/e 10.00 9.47 8.89 8.24 7.50 6.67 5.71 4.62 3.33 1.82 “earnings” and “eas” are in $millions. “eas” is earnings available to shareholders. “robe” is return to book equity. “st. dev. robe” is the standard deviation of return on book equity. the calculation of “st. dev. robe” value is described in end note 10. we report these key results in table 1 above for a “prototype firm” under various levels of leverage. based on assumed structural characteristics for the firm, we allow leverage to vary and identify required market results given that mm ii holds. we assume that the firm has assets of $100,000,000 with shares outstanding of 2,000,000, resulting in a market price of $50 per share for the unlevered firm. assuming market efficiency, the average annual return on investment, roi, is 10%. thus, on average, the firm has operating income of $10,000,000 (0.10 * $100,000,000). consistent with modigliani’s and miller’s analysis, we assume that all earnings are paid out as dividends. given the number of shares outstanding and market price per share, the firm has unlevered earnings per share (eps) of $5 ($10,000,000/2,000,000) and a price to earnings (p/e) ratio of 10 ($50/$5). finally, we assume the level of business risk for the “prototype firm” corresponds to a volume 32, number 2 117 required annual return of 10% for an unlevered equity investment and a standard deviation in annual returns of 5%. the first column in table 1 represents results, as described above, for the unlevered firm given assumptions about the firm’s operating characteristics and assuming mm ii holds. in each successive column, we increase the debt financing by 10%. in keeping with mm ii, we assume the cost of debt remains constant, which we set on an ex cathedra basis at 5%. we assume the additional debt is used to retire shares of equity. thus, in column 2 of table 1, 10% of the firm’s assets are financed by debt and 90% are financed by equity. as shown in the second row, the debt-toequity ratio (d/e) is 0.11 (0.10/0.90). the third row, labeled “shares out,” reports the number of shares outstanding in millions of shares. the unlevered firm, as described above, has 2,000,000 shares outstanding. as reported in table 1, when the firm is financed with 10% leverage, there now are 1,800,000 shares outstanding. financing 10% of the firm with debt requires issuing $10,000,000 in debt, which is used to buy back outstanding shares. at $50 a share, a total of 200,000 ($10,000,000/$50) shares are repurchased, leaving 1,800,000 (2,000,000 – 200,000) remaining shares outstanding. each subsequent 10% increase in debt financing results in the same number of shares being repurchased. thus, at 20% there are 1,600,000 shares outstanding, and so on. the fourth, fifth and sixth rows report earnings. row four, labeled “earnings,” reports the total earnings for the firm. we report average annual earnings in $millions which, according to assumptions made above, is 10% of the assets invested, or $10,000,000. the next row, labeled “eas,” reports the earnings available to shareholders in $millions, which is the $10,000,000 earned by the firm minus the debt payment given the debt outstanding and the 5% interest paid on debt. as shown in table 1, when the firm’s assets are financed 10% by debt, eas is $9,500,000 ($10,000,000 – (0.05 * $10,000,000)). increasing debt financing from 0% to 10% results in a $500,000 decrease in eas, and the eas continues to decrease by $500,000 for each additional 10% increase in debt financing given the fixed 5% interest charge. the sixth row reports earnings per share (eps). this value is calculated by dividing eas by the number of shares outstanding. as reported in table 1, eps is $5.28 ($9,500,000/1,800,000) when the firm’s assets are financed 10% by debt and $6.07 (48,500,000/1,400,000) when the firm’s assets are financed 30% by debt. eps increases monotonically with an increase in debt as the average roi of 10% is greater than the constant cost of debt of 5%. the next row reports “book equity” in $millions. given that the value of the firm’s assets does not change and, consistent with modigliani-miller proposition ii, 118 journal of business strategies the value of the firm does not change with leverage, book equity plus the amount of debt issued must always equal $100,000,000. therefore, book equity for the unlevered firm is $100,000,000 and with each debt issue of 10% of firm value, book equity declines by $10,000,000. because we have calculated both earnings available to shareholders and book equity, it is an easy matter to calculate return on book equity, robe.7 for the unlevered firm robe = roi = 10%. as with eps, robe increases monotonically with increases in leverage as the average roi of 10% is greater than the constant cost of debt of 5%; meaning the equity holders pocket the excess of roi over the constant cost of debt. when 10% of the firm is financed by debt, the average robe is 10.56% ($9.5/$90) and, when 30% of the firm is financed by debt, the average robe is 12.14% ($8.5/$70). in the next row we report the required return to equity as determined by mm ii using the well-known modigliani-miller equation (equation (1)). for example, this relationship provides a required return for equity of 10.56% when the firm’s assets are financed by 10% debt and 12.14% when the firm’s assets are financed by 30% debt as shown by equations (2) and (3) below. rrequity10% leverage = 10% + .111 * (10%– 5%) = 10.56% (2) rrequity30% leverage = 10% + .429 * (10%– 5%) = 12.14% (3) thus, the required return to equity, according to mm ii, is equal to the average robe. indeed, if this were not the case, mm i would not hold either. the equality, however, emphasizes the mechanical nature of mm ii and the lack of market behavior content in the hypothesis. mm ii is intended to indicate the required return for investors and, as such, the goal of mm ii should be to calculate rome, return on market equity. there is no analysis to indicate why investors would demand exactly the return that is being observed for book equity under various levels of leverage. the equality between robe and rome, as required by mm ii, results in a constant market price for equity shares regardless of the level of leverage. as shown in row 10 of table 1, the market share price, p, is a constant $50 across all levels of leverage. we know of no documentation of this unusual result, but it is easily illustrated from the data in table 1. recall that all earnings are paid out as dividends, so the rome is simply eps divided by the share price, p. thus rome= eps/p; and volume 32, number 2 119 p = eps/rome. as shown below in equation (4) for each level of leverage the share price is $50. eps/rome = $50 (4) = $5/0.10 = $5.28/0.1056 = $5.63/0.1125 = $6.07/0.1214 = $6.67/0.1333 = $7.50/0.15 = $8.75/0.1750 = $10.83/0.2167 = $15/0.30 = $27.50/0.55 the constant share price accompanied by the ever increasing eps across leverage levels leads to a monotonically decreasing price-to-earnings (p/e). and this ratio decreases dramatically. we find both the constant share price and the dramatic decrease in the p/e ratio to be suspect. in the next section we develop our arguments relative to this position. why mm ii should not hold across moderate levels of leverage as argued below, we find the supposition that the share price for a firm, with a given level of business risk, is constant across all levels of leverage to be untenable. because a constant share price across levels of leverage is required by mm ii, our position argues that mm ii does not hold. results presented in table 1 are based on assumptions about the firm size, number of shares outstanding for the unlevered firm and the level of business risk that associates with the given roi (10%) and cost of debt (5%) for our “prototype firm.” these assumptions imply a share price of $50, but mm ii requires a constant share price across all levels of leverage regardless of the exact price indicated by basic assumptions.8 thus, the mm ii result requires that investors are indifferent between the risk-return tradeoff existing at each level of leverage.9 to present the risk-return tradeoffs, we may compare expected return and standard deviation of return at every level of leverage. as reported in table 1, for each level of leverage, we calculated a return to book equity that is identical to the market return required by mm ii. we assumed a standard deviation of return of 5% for the unlevered firm, which we use to calculate standard deviation for every level of leverage.10 financial risk11 is clearly evident from our calculations. each increase in leverage results in an increase in variability of return and a dramatic increase in return for higher levels of leverage. note that the constant share price of mm ii still allows investors to be risk averse. at the various levels of leverage, investors are paying the same for one share. this share does have higher risk, as measured by the standard deviation of returns, 120 journal of business strategies for every level of risk, but the investor is being awarded higher payments. so investors are adhering to the risk-return tradeoff maxim. our argument with mm ii is not that the risk-return tradeoff is ignored, but that the risk-return tradeoff is forced to adhere to a particular indifference curve that does not have theoretical support and one which we find unreasonable. in the rest of this section, we present arguments suggesting that the cost of equity increases more moderately with leverage than dictated by mm i and mm ii. the data presented in table 1 is annual data. we present the expected annual returns and the standard deviation in annual returns consistent with mm ii. these calculations show that mm ii requires that investors are indifferent between accepting an expected annual return of 10% with a standard deviation of 5% for the unlevered firm or accepting an expected annual return of 15% with a standard deviation of 10% for the levered firm with 50% debt or accepting an expected annual return of 55% with a standard deviation of 50% for the levered firm with 90% debt. without a theoretical basis for this relationship we are suspect that it would actually hold. certainly the reward to risk ratio varies greatly across the options ranging from 2.00 for the unlevered position to 1.10 for the 90% debt position. one may argue that the constant share price implication is supported in that it requires book equity and market equity values to be the same. however, casual empiricism shows that book equity and market equity values are seldom the same. so, indeed, the required equality between book and market values argues against the validity of mm ii. thus, the modigliani-miller arbitrage process must be relied upon to support investors’ indifference across the observed risk-return tradeoffs, but, as noted above, this process is suspect. we next address the question of investor indifference and submit that investor reaction to changes in the risk-return tradeoff caused by the use of leverage is open to question. so, how should we describe the graphic presentation of the firm’s cost of equity to our students? we postulate that the cost of equity increases more slowly with moderate levels of leverage than envisioned by mm ii. we do not, of course, argue against the proposition that stockholders are risk averse. nor do we argue against the proposition that the use of leverage increases financial risk. instead, what we argue is that stockholder reaction to an increase in financial risk is exaggerated by mm ii for at least two reasons. first, casual observations of market behavior suggest a focus on earnings rather than variability in earnings. second, conventional means of measuring return and risk tend to exaggerate the impact of leverage. according to mm ii and as stated above, investors in our “prototype firm” are indifferent between the firm being unlevered, receiving an average annual return volume 32, number 2 121 of 10% with a standard deviation of 5%, or the firm being financed with 50% debt that would provide an average annual return of 15% with a standard deviation of 10%. it is our experience that, when we show students these choices, the students are not indifferent; they choose the higher return. of course, what is important is how actual market investors act. observation of market behavior and investment analyst pronouncements suggests to us that the students are in tune with market behavior. we posit that investors, although typically risk averse, are usually much more attuned to the return portion of the risk-return tradeoff than the risk portion. we posit that investors are more concerned about eps than the variability of eps. we argue that observable market behavior supports our position. a widely used tool by investment analysts is the p/e ratio. application of this tool encourages investors to increase the price that they pay for a stock when eps increases. indeed, there are numerous studies that indicate that following such a strategy “beats the market.” (see, for example, basu (1983)) there is no strategy that encourages investors to buy a stock when the return variability falls. further, the p/e strategy is not modified by a metric measuring variability in earnings. investors eagerly await earnings announcements. market pundits look for the “earnings season” to indicate market direction. these announcements are awaited to see if earnings are changing, not if the associated earnings variability is changing. such announcements move the market, and often the announcements are made after market close to dampen their impact. we do not rely here on casual observance alone, although the uniformity of market reaction may make such observations sufficient. numerous empirical studies show the long-term impact of positive and negative earnings announcements. studies of standardized unexpected earnings (sue) announcements show that unexpectedly high (low) earnings announcements lead to positive (negative) price drifts following the announcements. (see, for example, rendleman, et. al. (1982)) the variable sue is standardized by variability in earnings, not because investors are focused on variability in earnings, but rather to determine if the change in earnings is truly unusual. there is no measure that seeks to explain price changes by a change in the variability of earnings. under sue, if a firm announces a remarkably high quarterly eps, a signal would be given to buy. if variability were the focus, this unusual eps would be a sell signal as variability in earnings would be increased. empirical evidence shows that it is the buy signal that is followed! this general focus on earnings is further illustrated by what is reported in the financial press and on financial internet sites. investors know these outlets report firms’ epss and highlight their p/e ratios. yet these outlets do not typically report 122 journal of business strategies variability in earnings, which is the measure of financial risk. investors may find reports of debt ratios, which indicate leverage and financial risk, but these ratios are not routinely responsible for investment decisions. changes in earnings are. because investors focus on earnings, especially eps, the result of a moderate increase in leverage will tend to be positive, thus increasing the value of the firm. the required payment to equity is not enough to keep the value of the firm constant as suggested by mm ii and the cost of equity rises more slowly than suggested by mm ii. our second rationale supporting the hypothesis that stockholder reaction to an increase in financial risk is exaggerated by mm ii is that conventional means of measuring return and risk tend to exaggerate the impact of leverage. textbook examples showing the creation of financial risk using leverage invariably illustrate the risk with a one-year time horizon. this is common and generally accepted practice, but, in this case as in others, the choice of this time horizon may distort reality. we illustrate our concern first with an example that instructors frequently use to advise students as young investors. the instructor could present students with a risk-return tradeoff, comparing u. s. government debt, say, for example, treasury bills, with large-firm stocks. to illustrate, according to ibbotson (2014), from 1926 through 2013, the arithmetic average annual return to treasury bills is 3.5% and the standard deviation in annual returns is 3.1%. in contrast, for large-firm equities, the 1926 through 2013 arithmetic average annual return is 12.1% and the standard deviation in annual returns is 20.2%. the instructor could use this data to illustrate the tradeoff between risk and return and may find students who prefer the treasury bill over large-firm stocks when using a one-year investment horizon. and such a choice may be reasonable for an investment with a one-year horizon. but surely an instructor would council students against such a choice for retirement investment. a typical student would have 40 plus years until retirement. regardless of the extent of the student’s risk aversion, the student should not select treasury bills. there is no historic 40-year period where large-firm equities have a lower return than treasury bills. over this time horizon, large-firm equities are no longer riskier than treasury bills.12 using a one-year comparison provides a bias against the correct long-term investment choice. a similar, if less extreme, bias exists when comparing equity investment between firms with similar business risk but different levels of leverage. to illustrate the impact of time horizon in this case, we compare returns and risk for our hypothetical firm between the unlevered position and the same firm with moderate leverage levels of 10%, 30% and 50%. data in table 1 indicates the following riskvolume 32, number 2 123 return tradeoffs: the unlevered firm has an average return of 10.00% and a standard deviation of 5.00%; the firm financed with 10% debt has an average return of 10.56% and a standard deviation of 5.56%; the firm financed with 30% debt has an average return of 12.14% and a standard deviation of 7.14%; the firm financed with 50% debt has an average return of 15.00% and a standard deviation of 10.00%. mm ii requires that investors as a whole are indifferent between these four choices. certainly individual investors might prefer any one of the four choices for a one-year investment. but what would the impact of a longer term time horizon have on an investor’s choice between these four levels of leverage? to gain insight into this choice, we simulate 1,000 annual revenue flows13 to the firm with an average annual return of 10% and a 5% standard deviation. then we calculate the annual returns to the unlevered firm and the percentage return for the four levels of leverage listed above. we then use this data to calculate overlapping three-year returns and overlapping ten-year returns for each of the four leverage levels. we calculate the average one-year, three-year and ten-year return and the standard deviations for these return series. we report these results in table 2. table 2: average returns and return standard deviations--various time horizons and various levels of leverage time horizon/ leverage unlevered 10% debt 30% debt 50% debt one-year 10.03%(5.10%) 10.59% (5.65%) 12.19% (7.27%) 15.06% (10.19%) three-year 33.25%(10.70%) 35.30% (12.04%) 41.26% (15.86%) 52.44% (23.28%) ten-year 160.58%(38.02%) 173.91% (44.53%) 216.28% (65.12%) 307.68% (114.90%) each cell reports the average return and the standard deviation (shown in parentheses) for a given level of leverage and a given time horizon. the values result from the same simulation of 1,000 annual returns. the returns for the levered positions are based on a constant 5% cost of debt, consistent with our earlier examples. we report these key results in table 1 above for a “prototype firm” under various levels of leverage. based on assumed structural characteristics for the firm, we allow leverage to vary and identify required market results given that mm ii holds. we assume that the firm has assets of $100,000,000 with shares outstanding of 2,000,000 resulting in a market price of $50 per share, assuming market efficiency, for the unlevered firm. finally, we assume the level of business 124 journal of business strategies risk for the “prototype firm” corresponds to a required annual return of 10% for an unlevered equity investment of $10,000,000 (0.10 * $100,000,000). consistent with modigliani’s and miller’s analysis, we assume that all earnings are paid out as dividends. given the number of shares outstanding and market price per share, the firm has unlevered earnings per share (eps) of $5 ($10,000,000/2,000,000) and a price to earnings (p/e) ratio of 10 ($50/$5). to provide this different perspective, we use the same simulated 1,000 annual returns to assets and the corresponding one-year, three-year and ten-year returns for the unlevered position and each of the three levered positions, the average of which we reported in table 2, but this time compare the levered and unlevered positions across each observation of overlapping 3-year and 10-year returns. on a period by period basis, we compare the returns and identify the percent of the periods when the unlevered position outperformed each of the three levered positions. the results are presented in table 3. table 3: percent of periods when the unlevered positions outperformed the unlevered position time horizon/ leverage 10% debt 30% debt 50% debt one-year 14.90% 14.90% 14.90% three-year 3.91% 4.01% 4.31% ten-year 1.01% 1.01% 1.01% in our example, consistent with modigliani’s and miller’s analysis, the firm pays a constant 5% for debt. thus, any year in which roi is less than 5% all levered positions will underperform the unlevered position. in our simulation, this occurs for 14.90% of the years. an investor with a one-year time horizon faces a reasonable probability that the unlevered position would outperform a levered position. but, as the time horizon for holding the investment increases, the likelihood that the investor would ever be better off with the unlevered position diminishes. for investors with a three-year holding period, the number of periods in which the unlevered position provides a better return is around 4% with the probability increasing as leverage increases. finally, if the investor holds the position for 10 years, there is only a 1%14 chance that the unlevered position outperforms any of the levered positions. for volume 32, number 2 125 an investor with a ten-year investment horizon, financial risk virtually disappears. if we assume two firms with the exact same return on assets and the exact same business risk, and further assume that one firm has no debt while the other has a moderate level of debt, an investor with a ten-year time horizon should pay more for the levered firm. the additional financial risk from leverage will impact an investor with a one-year time horizon, but not this investor. in summary, we maintain that moderate levels of leverage increase the value of the firm because equity investors are less concerned with financial risk than assumed by mm ii. we argued this on the basis that investors in general focus more on returns than risk. we also argued that financial risk resulting from leverage causes little increases in risk for the long-term investor and that this investor will pay more for shares of a levered firm than for shares of an unlevered firm identical in all other characteristics. but will this investor influence market price? some market participants do not care at all about financial risk. for example, high-frequency traders, who account for a significant percent of market volume, are not concerned about financial risk caused by leverage. instead, high frequency traders care about the immediate direction of the market. likewise, momentum traders are completely unconcerned about financial risk; they buy and sell stocks assuming that recent price trends will continue. indeed, all market timers including technicians are blithely unaware of any impact from financial risk. mm ii only holds if investors are fundamentalists who weigh risk against return. and, for these investors, as we have argued, their time horizons must be short enough so that financial risk provides a sufficiently large probability that leverage will reduce return so that the investors are unwilling to pay for an increase in eps. we submit that these conditions are so restrictive as to make mm ii improbable and that the increase in eps created by leverage will increase firm value. why mm ii should not hold at extreme levels of leverage how do equity holders react to extreme levels of leverage? we suggest above that equity holders should react by demanding payment for bankruptcy risk in addition to payment for financial risk. it is accepted that, at high levels of leverage, debtors react by demanding higher payments because of bankruptcy risk. in other words, lenders demand higher interest payments because they fear they will not receive full payment. modigliani and miller (1958) recognize this possibility yet suggest that, at high levels of leverage, equity investors might react by decreasing their required return below that suggested by mm ii. this reduction in the expected 126 journal of business strategies cost of equity is required in order to offset the increasing cost of debt so that the overall cost of capital remains constant. but why should equity holders be willing to accept a less than “fair” payment for financial risk in the face of increasing default risk? do equity holders somehow benefit from increasing risk of bankruptcy? or why is it that equity holders do not fear a high increased bankruptcy risk associated with high levels of debt? the finance discipline has not responded in a constructive manner to this dilemma! textbook presentations recognize a tradeoff between the present value of the tax benefits of debt and the present value of bankruptcy costs that occur with increasing levels of debt. these bankruptcy costs are direct costs, such as legal fees, and indirect costs, such as the ability to purchase supplies/inventory on credit, both of which are very different from “fear of bankruptcy” additional payments demanded by bond holders and lenders. what a paradox that bond holders receive payment for bankruptcy risk but not stock holders! moreover, bond holders receive payment before equity holders, and, when bankruptcy occurs, equity holders may lose their entire investment before bond holders suffer any loss. indeed, this difference in priority alone justifies the higher payment to equity relative to debt at any level of leverage. is it not logical then, that when the probability of bankruptcy is high, because of a combination of business risk and leverage, that equity holders will demand a very high return? this should be observed in the market by investors lowering equity prices when bankruptcy looms in order to receive a very high return if, somehow, the firm overcomes the business risk from operations and the financial risk from leverage. empirical evidence moderate increases in leverage we have argued that, with moderate increases in leverage, the cost of equity grows more slowly than required by mm ii and that, for very highly levered firms, the cost of equity rises precipitously. our arguments, of course, run counter to widely held dogma and will likely be received with some reservation. we point out, however, that there are implications of mm ii, such as the constant share price across leverage, which seem quite suspect. still it behooves us to look for empirical evidence in support of mm ii. possible sources of empirical evidence to support mm ii could consist of: 1) evidence of arbitrage activity to establish mm ii equilibrium; 2) evidence of increases volume 32, number 2 127 in the cost of equity as leverage increases among similar firms; 3) evidence of equal share price, scaled for asset size and shares outstanding, as leverage increases among similar firms; 4) evidence of constantly decreasing p/e ratios as leverage increases among similar firms. the last three possibilities are consistent with relationships reported in table 1. with regard to possibility 1, we simply note that we know of no report of arbitrage activity to support mm ii equilibrium. possibility 2 presents timing difficulties and measurement issues as it is not obvious how the reported changes in debt ratios match reported returns to equity associated with changing debt ratios. possibility 3 reduces the timing issues but presents the difficulty of scaling as price will depend on decisions concerning the number of shares outstanding relative to a given value of book equity. possibility 4 also reduces the timing issue and has the advantage of removing the difficult scaling problem. so, we conduct an empirical test of possibility 4. our sample first consists of the firms comprising the dow jones industrial average (djia) as of january 1, 2009. we then eliminate the four financial firms (american express company; bank of america; jpmorgan chase & co.; the travelers companies, inc.) because the nature of their financial structure has the potential to bias our results. finally, we further adjust our sample by adding nike, inc., which was added to the djia on september 20, 2013. thus our final sample includes twenty-seven firms from the djia. we gather data for these firms for a five-year period: 2009 through 2013. this sample should provide a general similarity in firm business risk allowing an opportunity to measure the impact of changes in the debt ratio. we then calculate the debt ratio at the end of each fiscal year. (a description of the procedure used to determine the debt ratios is found in appendix 1.) there is a considerable range of debt ratios across our twenty-seven sample firms, but in all cases the ratios may be considered to represent moderate to low levels of leverage. table 4 reports the firms with the two highest and the two lowest debt ratios among the twenty-seven firms for each of the five sample years and reports the value of the debt ratios. debt ratios for all twenty-seven firms for each year are available from the authors. 128 journal of business strategies table 4: extreme sample observations of debt ratios by years 2009 highest next highest next lowest lowest ratio 35.00% 28.90% 4.18% 4.12% firm mcdonald’s dupont intel exxon 2010 highest next highest next lowest lowest ratio 35.98% 32.11% 4.11% 3.35% firm mcdonald’s coca-cola nike intel 2011 highest next highest next lowest lowest ratio 37.89% 35.72% 4.85% 4.42% firm mcdonald’s coca-cola chevron nike 2012 highest next highest next lowest lowest ratio 38.52% 37.80% 3.47% 2.49% firm mcdonald’s coca-cola exxon nike 2013 highest next highest next lowest lowest ratio 41.17% 38.58% 6.55% 5.78% firm coca-cola mcdonald’s exxon general electric we also gather the p/e ratio for each firm in our sample for each of the five years in our sample period. (a description of the procedure used to determine the p/e ratios is also found in appendix 1.) we conduct ordinary least square regressions of the debt ratio against the p/e ratio. we conduct separate regressions for each of the five sample years. as described above, according to mm ii, increases in financial risk should increase the required cost of equity in a prescribed manner, leaving share price unchanged but constantly decreasing the p/e ratio. support for mm ii would be found if the changes in the debt ratio explain a significant part of the variation in the p/e ratios and if the slope coefficient for the debt ratio is significantly negative showing a decrease in the p/e ratio across firms as leverage increases. our results, shown in table 5, provide no evidence to support the mm ii position. as shown in table 2, according to mm ii, the p/e ratio should show a constant decrease with increases in the debt ratio. our results indicate that there is no relationship between the debt ratio and the p/e ratio for our sample firms. in four of the five years, the adjusted r-squared is less than zero. in three of the five volume 32, number 2 129 years the slope coefficient, inconsistent with mm ii, is positive. in no case is the relationship with the debt ratio and the p/e ratio significant at the 0.10 level. the relationship is strongest for 2011, but in this year the relationship is contrary to the mm ii hypothesis. thus, comparing the debt and p/e ratios of our sample djia firms provides no evidence in support of mm ii. rather, the evidence is consistent with the view that with moderate levels of leverage the cost of equity rises slowly.15 table 5: annual regressions of p/e ratios against debt ratios for sample dija firms year 2009 2010 2011 2012 2013 adjusted r-squared -4.13% -3.36% 5.31% -2.20% -4.15% y-intercept 14.79 15.24 9.71 13.42 16.56 slope coefficient -0.013 0.198 0.285 0.361 -0.064 t-statistic -0.09 0.39 1.57 0.68 -0.05 we conduct ordinary least square regressions for each of the five sample years, regressing debt ratios against p/e ratios. we omit any observation with a negative p/e ratio resulting in a sample size of 26 for years 2009, 2012, and 2013. there are no omissions for 2010 and 2011 resulting in a sample size of 27. extreme leverage we have argued that, when extreme levels of leverage cause bondholders to demand higher returns because of bankruptcy fears, equity holders must also be increasing the required return in excess of what otherwise would be demanded as payment for financial risk. as equity holders will lose before bondholders, they must logically demand payment for bankruptcy risk if bondholders are demanding payment for bankruptcy risk. providing empirical evidence of this relationship is fraught with difficulties in separating the price impact of bankruptcy fears from other factors. and, we would not expect to find evidence of new equity issues when bankruptcy risk is high because of the expected high cost of such an issue. we, therefore, seek to find anecdotal evidence of the behavior of equity holders when bankruptcy fear has been high. one may argue that, in recent market experience, the 2008 financial crisis would provide a time when bankruptcy fear was high for selected firms in financial distress. we use a year-end financial article, kiviat (2008), to identify firms with 130 journal of business strategies big loses during 2008. these were firms where stockholders feared bankruptcy. according to modigliani and miller (1958) and brealey, myers and marcus (2013), when lenders begin to worry about bankruptcy because of high leverage, they demand a higher return, but stockholders reduce the rate at which their required return would normally increase to compensate for financial risk. we have argued that stockholders should fear bankruptcy more than bondholders. when bankruptcy looms, therefore, stockholders should demand a higher return than otherwise required to compensate for financial risk. although this higher required return will not be observable from new stock issues, the higher return will be observed when new stockholders purchase outstanding shares at prices sufficiently low so as to guarantee high returns if the firm survives. to see if our expectations are met, we determine the return to the firms identified in kiviat (2008) from their low point in 2008 through the end of our sample period december 2013. (we add ford motor company to our sample because of the publicity surrounding ford’s possible bankruptcy during the fall of 2008.) if our argument is correct, the shares of firms that suffered large loses in 2008 would be sold at distress prices reflecting the new investors’ high required returns. if the firms survived, the new investors should enjoy high actual returns reflecting their high required return engendered by the fear of bankruptcy. on the other hand, for some of the firms the investors’ fears should be realized. these firms should experience bankruptcy and a return of -100%. to determine actual returns, from the 2008 nadir to the end of 2013, we search yahoo finance for the lowest adjusted close in 2008 and compare that return to the adjusted close reported on yahoo finance for december 31, 2013. results reported in table 6 indicate that this was exactly what happened. surviving firms experienced very high returns indeed and some firms experienced a return of -100%. we submit this result as anecdotal evidence that when high levels of leverage engender fear of bankruptcy, the cost of equity climbs steeply in opposition to the supposition of modigliani and miller. volume 32, number 2 131 table 6: returns to extreme losers of 2008 company 2008 lowest adjusted close dec 31 2013 adjusted close 2008 to 2013 gain aig $22.10 $50.58 129% ambac $0.76 $24.56 3,132% borders $0.37 $0.00 -100% crocs $0.94 $15.92 1,594% fannie mae $0.30 $3.01 3,078% ford $1.17 $14.95 1,178% freddie mac $0.23 $7.31 3,078% mf global $1.73 $0.00 -100% pier 1 imports $0.31 $22.73 7,232% ruby tuesday $1.08 $6.93 542% conclusions we have argued that textbook presentations of the response of stockholder required return to equity is deficit in two important aspects. in both cases, we argue, these deficits associate with an uncritical acceptance of the modigliani and miller (1958) propositions. specifically, we argue that: 1) at moderate levels of leverage, the required return to equity rises less than postulated by modigliani and miller because equity investors’ reaction to leverage emphasizes the higher expected eps rather than the additional financial risk; and 2) at high levels of leverage, when debt holders demand compensation for bankruptcy risk, stockholders will also demand compensation for bankruptcy risk. the latter argument is in contrast to the modigliani-miller argument that, when bankruptcy risk is high, stockholders will reduce the payment required for financial risk. if one accepts our arguments, then the modigliani-miller irrelevance proposition does not hold. we support our theoretical arguments by two empirical studies. examination of the relationship between debt and p/e ratios among sample djia securities over a five-year period fails to find an inverse relationship between these ratios as required by the modigliani-miller propositions. further, we show that during the 2008 market crisis for firms that appeared to be in danger of bankruptcy, new stockholders demanded a very high 132 journal of business strategies expected return as evidenced by the low prices they paid for the stocks and the subsequent high actual returns if the firms avoided bankruptcy. given these results, instructors could discuss optimum capital structure using the sketch below (figure 1). the instructor can explain that the cost of equity, ke, is more than the after-tax cost of debt, kd, at every level of leverage for two reasons. first, payment to debt holders is more certain. the instructor can emphasize the certain payment to the bondholder required by the bond indenture relative to the uncertain payment to the shareholder. second, the payment to debt is tax deductible. to illustrate this point, the instructor may wish to provide a simple income statement example. the instructor can show how both of these benefits result in a higher expected eps for the stock holder. the instructor could then use a simple wacc example to show how the overall cost of capital would fall using debt. the instructor would need to take care, however, to emphasize the downside of using more debt to the stockholders. a careful example showing multi-year returns or multiple scenarios for a single year could introduce the topic of financial risk. this provides the instructor with another chance to emphasize the risk-reward tradeoff showing an increase in ke. as we have argued, however, we feel that the instructor should show a declining overall cost of capital, because of both the tax effect and the relatively slow increase in ke at moderate levels of leverage. finally, the instructor can emphasize, the increase in both ke and kd as both the bond holders and stockholders begin to fear bankruptcy. we feel that this discussion should emphasize the loss of invested wealth rather than the emphasis on legal costs of bankruptcy that textbooks tend to emphasize. volume 32, number 2 133 figure 1: sketch of cost of capital versus leverage f in a n ci n g c o st percentage of debt financing0% 100% kd ke wacc of course, these are not the only topics that an instructor may wish to cover when discussing a corporation’s decision between issuing debt or equity. among other possible topics an instructor could include are indirect costs of bankruptcy, effect of a debt issue on financial control, need to preserve financial slack, pecking order considerations in issuing debt versus equity. on a purely theoretical level, the instructor may wish to discuss the topics of homemade leverage and the modiglianimiller arbitrage action in support of mm ii. appendix 1 procedure for determining debt ratios a. fiscal year end (fye) financial statements are obtained from annual reports, 10ks, or both. all dollars are in millions. for companies whose fye is in january or february, data is from 2010 to 2014. for all other companies, data is from 2009 to 2013. 134 journal of business strategies b. total assets included cash equivalents, marketable securities, etc.; assets for sale; investments; and financing related assets (e.g., notes receivables). if the company has a separate financing subsidiary (caterpillar, general electric), the subsidiaries “total assets” were excluded. c. total liabilities included short-term notes payable, current portion of long-term debt due, long-term debt, and short-term and long-term capital leases if itemized on the balance sheet. capital leases are assumed not material if not itemized on the balance sheet. if the company has a separate financing subsidiary (caterpillar, general electric), the subsidiaries financing line items were excluded, similar to how “total assets” were adjusted. procedure for determining price/earnings ratios a. stock prices at fiscal year end (fye) 2009 through 2013 were downloaded from http://finance.yahoo.com/. because home depot and walmart have january fyes, the prices for those companies are from 2010 through 2014. the specific values are the adjusted close prices closest to but not past the fye date or month as given the fye financials. for example, if a company has a december 31st fye, the december 31st 2013, december 31st 2012, december 30th 2011, december 31st 2010, and december 31st 2009 adjusted close prices are used. b. annual earnings per share (eps) companies report “basic” eps and “diluted” eps in their fye financials. the “basic” eps value is used for determining the p/e ratios. further, “basic” eps can consist of both eps from continuing operations and eps from other activities (e.g., discontinued operations). some companies break out the “basic” eps into these two components, some do not. for those companies that did not, the eps from continuing operations was not readily apparent and the eps used is the net (total) “basic” eps. end notes 1. lander and pettengill (2012) show that the modigliani-miller arbitrage process, and thus both mm i and mm ii, are inconsistent with an increase in the cost of debt with increasing leverage. 2. book values do not change when all earnings are paid out as dividends. also textbooks do not mention market values implicitly making the assumption that market values equal book values. volume 32, number 2 135 3. an exception to this presentation is provided by brigham and daves (2013) where the graphic presentation of the cost of equity is shown in debt ratio space. lander and pettengill (2010) argue that presentation of the cost of equity in the standard debt-to-equity space provides students with an inappropriate impression that the increase in the cost of equity is moderate at high levels of leverage. 4. we choose to exemplify textbook examples using the brealey, myers and marcus undergraduate textbook because of the high regard with which this textbook is held and the special rigor of their undergraduate text. we examine other textbooks listed in the reference to ensure consistency with our comments. 5. the interest expense deduction is not available in all countries. estonia, for example, has no corporate tax. 6. miller is quoted using this example to summarize their theory quickly in tanous (1997). 7. the normal calculation of return on equity, roe, is calculated as earnings available to shareholders divided by book equity value. we take the liberty of labeling this value robe because of the importance of the difference in return to book value and return to market value for our analysis. 8. the precise assumption made concerning the level of business risk as measured by the standard deviation of returns and the required return for that business risk do not affect the resulting conclusions. if, for example, we had assumed an average annual return of 8% with a standard deviation in annual returns of 4%, we still would have reached the conclusion that share prices would be constant across all levels of leverage if mm ii were to hold absolutely. the exact price would depend on the ratio of total assets to shares outstanding for the unlevered firm. a firm with $200,000,000 in assets and 8,000,000 shares outstanding would dictate a constant price of $25. 9. investors are indifferent because they equally value, in present value terms, each risk-return tradeoff. consider two assets. the first has a one year effective life, is expected to generate $105 at the end of year 1, and has a 5% expected rate of return. in present value terms, this asset is worth $100. the second also has a one year effective life, but is expected to generate $110 at the end of year 1, and has a 10% expected rate of return. in present value terms, this asset also is worth $100. we would say investors are indifferent, in present value terms to the two assets. 136 journal of business strategies 10. the expected return to the firm with any given level of leverage may be determined as follows: robe = ((ebi – i)/(k * ta)), where robe is return to book equity, ebi is expected earnings before interest, i is the constant interest payment for the level of leverage, k is 1 – the percent of debt (in decimal format) and ta is total assets. expected return to the unlevered firm is assumed to be normally distributed with a mean of 10% and a standard deviation of 5%. the variance of expected returns is determined as (1/k)2 * var(ebi/ta). for the unlevered firm, the variance of expected returns is (1/1)2 * (25%) = 25%. when the firm is 10% debt financed, the variance of expected returns is (1/0.9)2 * (25%) = 30.86%. the standard deviation reported in table 1 is the square root of this value. 11. instructors may find the calculation of standard deviation a more effective way of illustrating financial risk than the traditional one year’s return with three states of nature: good, ordinary and bad. 12. for an alternative view see pastor and stambaugh (2012). 13. we ran the simulation 10 times with each simulation including 1,000 revenue observations. from these 10 simulations we selected for presentation the simulation that provided results closest to the assumed firm structure. this selection does not bias our comparison between leverage levels, but merely allows our comparisons to be made with the assurance that our comparisons are made with data that are consistent with the annual returns calculated in table 1. 14. the 1% is as high as it is because of an extreme outlier in an annual return. in one year, the simulation showed an annual return of less than -37%. this annual return was included in ten of the ten-year overlapping return periods. in each one of these ten-year periods, but in no other ten-year period, the unlevered firm outperforms. this extreme value was more than 8 standard deviations below the mean; the highest annual return was just three standard deviations above the mean. we suspect that if the simulation was run again there would be zero periods in which the unlevered position outperforms over a ten-year period. in the interest of academic integrity, we report results from the original simulation. 15. we also test for a relation between leverage and the cost of equity. we find the debt ratios for our sample firms as described in appendix 1. the five-year returns to equity from the 12/13/08 to 12/31/13 adjusted close prices (yahoo finance). there should be a positive relationship between the debt ratio and the cost of equity if mm ii holds. we run two regressions. first we regress the 2009 debt ratio against the five-year return for each firm in our sample with the following results: r2= 0.61%, adjusted r2= -3.36%; the sample regression line volume 32, number 2 137 of the 2009 debt ratio against the five-year return to equity is y= 30.03% + 0.16 * x with t=0.39 for the slope coefficient. we also regressed the change in the debt ratio over the five-year period against the five-year return for each firm with the following results: r2= 0.90%, adjusted r2= -3.06%; the sample regression line of the 2009 to 2013 change in debt ratio against the five-year return to equity is y= 34.10% 0.30 * x with t=0.47 for the slope coefficient. contrary to the very basis of mm ii, we find no evidence of increased required return with regard to moderate increases in leverage. references basu, s. (1983). the relationship between earnings yield, market value and return for nyse common stocks: further evidence. journal of financial economics, 12, 129-156. brealey, r., myers, s. & marcus, a. (2013). fundamentals of corporate finance (7th ed.). boston, ma: mcgraw-hill irwin. ibbotson sbbi classic yearbook: market results for stocks, bonds, bills, and inflation 1926-2012. (2014). chicago il: morningstar, inc. kiviat, b. (2008, december 16). stock winners (yes, there were a few) and losers of ’08. time. retrieved from http://content.time.com/time/business/ article/0,8599,1866799,00.html lander, d. m., & pettengill, g. n. (2010). enhancing understanding of the 1958 modigliani-miller propositions. journal of instructional techniques in finance, 2(1), 35-40. lander, d. m., & pettengill, g. n. (2012). are increasing interest rates from leverage consistent with modigliani-miller arbitrage? journal of instructional technology in finance, 4(1), 1-8. modigliani, f., & miller, m. (1958). the cost of capital, corporation finance and the theory of investment. american economic review, 48(3), 261-297. modigliani, f., & miller, m. (1963). taxes and the cost of capital: a correction. american economic review, 53(3), 433-443. pastor, l., & stambaugh, r. (2012). are stocks really less volatile in the long run? journal of finance, 67(2), 431-478. rendleman, r. j. jr., jones, c. p., & latane, h. a. (1982). empirical anomalies based on unexpected earnings and the importance of risk adjustments. journal of financial economics 10, 269-287. tanus, j. (1997). investment gurus. englewood cliffs, nj: new york institute of finance. 138 journal of business strategies other textbooks examined berk, j., & demarzo, p. (2013). corporate finance (3rd ed.). boston, ma: pearson. booth, l., cleary, w. s., & drake, p. (2013). corporate finance. hoboken, nj: john wiley & sons. brigham, e., & daves, p. (2013). intermediate financial management (11th, ed.). mason, oh: south-western, cengage learning. parrino, d., kidwell, d., & bates, d. (2014). fundamentals of corporate finance (3rd ed.). hoboken, nj: john wiley & sons. short biographical sketch of authors glenn pettengill is a professor of finance at grand valley state university. he earned his phd in economics from the university of arkansas. his research focuses on market efficiency, asset pricing, and finance education. pettengill has served as president, program chair, and executive director for the midwest finance association. diane m. lander is an associate professor in the business administration and accounting department at saint michael’s college. she earned her phd in finance from the university of kansas. her research focuses on real asset valuation techniques, both traditional discounted cash flow models and the real options approach to capital budgeting, and finance education. volume 32, number 2 17 the role of psychic distance in internationalization strategy evaluations and strategic choices stephen horner pittsburg state university • pittsburg, ks daniel baack university of denver • denver, co donald baack pittsburg state university • pittsburg, ks abstract this analysis examines views of the term “psychic distance” and its application to the strategic choice process and managerial arrangements in international operations. it offers a background and conceptual framework of psychic distance, which stresses individual experience as part of the process. individual experience is explored in terms of its components and through the use of information processing models that appear in the marketing literature. next, applications to strategic management are made with regard to the choice to enter specific international markets, modes of entry selected, and the managerial structures that will be established. introduction one major decision facing executives in many companies is in regard to conducting business with or in another country. such a choice affects activities throughout the organization, while the actual judgements regarding whether to internationalize and how to do so boil down to the conclusions drawn by individual managers. the concept of psychic distance, which appears frequently in the international business literature, applies to a variety of theoretical models that relate to this strategic management concern, especially with regard to internationalization strategies and strategic choice processes. the international business literature suggests that psychic distance influences strategic decision makers as they consider expansion into international markets. it may play a role in strategic decisions about whether or not to pursue international expansion, the choice of entry mode (exporting, licensing, franchising, joint ventures, strategic alliances, wholly owned subsidiaries, acquisitions (minority, majority, total), and greenfield ventures), as well as subsequent levels of international affiliate performance. although the concept has been in use for many years (beckermann, 18 journal of business strategies 1956) some complain that applications of the concept are unclear (see shenkar 2001) and the construct has been criticized (stottinger & schlegelmilch, 1998). this analysis examines views of the term “psychic distance” and its application to the strategic choice process and managerial arrangements in international operations. the first section provides a background explaining how the psychic distance concept emerged, primarily within the field of the international business, and to a lesser degree, international marketing. a conceptual framework of psychic distance is then offered. the framework stresses individual perceptual processing of psychic distance, both at the national and business levels, through individual experience. individual experience is explored in terms of its components and through the use of information processing models that appear in the marketing literature. next, applications to strategic management are made. the final section offers some basic conclusions. background and conceptualization of psychic distance welch and luostarinen (1988) defined psychic distance “as the sum of factors preventing the flow of information from and to the market” (in johanson & vahlne, 1977, p. 23; revised 2009). another definition of psychic distance suggests it represents “the mind’s processing, in terms of perception and understanding, of cultural and business differences” (evans, treadgold, & mavondo, 2000, p.375). conceptually, psychic distance may be divided into three components: cultural affinity, trust, and individual experience. cultural affinity includes national level differences, including cultural differences, language, and the legal environment. trust is a business level (rather than national level) consideration that represents the level of confidence between members of companies in an international business relationship. personal experience is strongly linked to the initial discussions of psychic distance and becomes an individual, rather than national or business-level consideration. these components led baack and baack (2006) to describe the construct in the following manner: psychic distance may be viewed as the aggregate of national distance and business distance being processed through individual experience. figure 1 provides a model of this conceptualization as it would apply to strategic management. volume 32, number 2 19 figure 1 a psychic distance conceptual framework this conceptualization essentially divides psychic distance into two components: psychic and distance. distance, refers to differences between domestic and foreign markets, which differences occur at both the national and business levels. these factors create the knowledge deficiencies that individuals must overcome. psychically, knowledge deficiencies are then processed through personal mental processes. therefore, this definition and conceptual model suggest that the impact of distance will be interpreted through individual experience. a review of the literature suggests that individual experience directly affects perceptions of psychic distance. evans and mavondo (2002) write that differences between countries result from an individual’s perceptions of another country’s general values and attitudes. the johanson and vahlne (1977; 2009) definition of psychic distance views it in terms of information flow from source to source, or from individual to individual. these individuals along with their experiences affect perceptions of psychic distance. mitra and golder (2002), using a model that includes both knowledge and distance, found that the distance between markets, when isolated, has no effect on the entry decision. instead, it is only in the context of individual knowledge that distance plays a role. consequently, the framework displayed as figure 1 represents a modification of the way in which psychic distance may be viewed. the construct moves beyond cultural distance to include additional national differences and business level differences. as noted, psychic distance only impacts managerial activities as it is interpreted through individual perceptions and experiences. a further elaboration of these components follows. components: cultural affinity, trust, and individual experience. cultural affinity includes national level differences, including cultural differences, language, and the legal environment. trust is a business level (rather than national level) consideration that represents the level of confidence between members of companies in an international business relationship. personal experience is strongly linked to the initial discussions of psychic distance and becomes an individual, rather than national or business-level consideration. these components led baack and baack (2006) to describe the construct in the following manner: psychic distance may be viewed as the aggregate of national distance and business distance being processed through individual experience. figure 1 provides a model of this conceptualization as it would apply to strategic management. figure 1 a psychic distance conceptual framework psychic distance outcomes nation distance: cultural distance administrative distance geographic distance economic distance individual experience business distance industry distance firm distance entry decision entry mode choice managerial structure 20 journal of business strategies nation distance the first component of psychic distance, nation distance, includes dimensions of cultural, administrative, geographic, and economic distance, which comprise the cage distance framework (ghemawat, 2001). these four dimensions emphasize the importance of relative distance rather than absolute metrics (e.g., cost structures, market access, market size, and markets’ purchasing power). each dimension plays a role in creating perceptions of psychic distance as interpreted through the individual experiences of organizational members. cultural distance has served as a surrogate for psychic distance. national culture consists of the systems of values and norms shared by nationals that in aggregate provide a design for living that are then reflected in the workplace (hill, 2011). differences in national cultures are expressed in language, ethnicity, religion, and social norms (ghemawat, 2001). shenkar (2001) noted that few constructs have gained as much acceptance in the international business literature as cultural distance. it appears in studies in the fields of management, marketing, finance, and accounting. the concept has also been used to investigate innovation patterns (gomez-mejia & palich, 1997) and expatriate adjustment (black & mendenhall, 1991). the cultural distance concept has been criticized (shenkar, 2001). problems may have taken place because it was used in isolation, a situation in which it fails to completely represent every component of psychic distance. further, the measures used to operationalize cultural distance have been critiqued. one measure, the kogut and singh’s (1988) assessment, has its basis in the research of hofstede (1980), which itself has been called into question as being static, insensitive, and flawed (see shenkar, 2001). in spite of these conceptual problems, it seems apparent that differences between national cultures exist. the kogut and singh (1988) questionnaire provides one measure of these differences. future studies may offer additional value if multiple measures of culture are included, possibly incorporating other research on culture utilizing such variables as dominant religions and language differences (schwartz, 1990; hall, 1959). administrative and political distance encompasses nations’ historical and political association, shared monetary systems, and legal and financial institutions (ghemawat, 2001; hill, 2011; rothaermel, kotha, & steemsa, 2006). links between former colonies and their colonial power can increase trade considerably as in relations between the united kingdom and its commonwealth nations and in spain’s relationship with the nations of latin america. shared monetary systems volume 32, number 2 21 also impact administrative distance, of which the euro area is perhaps the most prominent example (ghemawat, 2001). key issues regarding similarity in legal systems include distinctions between common law and civil law, the nature of contract law, treatment of intellectual property, and product safety and liability. differences in legal systems and institutions include conditions emanating from the host country such as tariffs, quotas, and restrictions on foreign direct investment (fdi) as well as protection of certain favored industries in the form of subsidies and regulations such as those extended by nations of the european union to airbus (hill, 2011). differences may also be manifest in practices by the home country. domestic restrictions on bribery along with policies regarding health, safety, and the environment in the u.s. sometimes constrain development of trade relations in countries not sharing similar values (ghemawat, 2001). firms incorporating administrative differences and similarities into decision processes increase the likelihood of success in international trade. geographic distance, the third dimension of the cage framework, encompasses linear distance along with a range of geographic considerations that impact the attractiveness and, ultimately, the perceived psychic distance between one global market and another (ghemawat, 2001). differences in physical size, host country waterways and access to oceans, distances to other nations’ borders, topography, and number of time zones (e.g., russia has 16) are aspects of geographic distance beyond simple linear distances that can significantly influence perceptions of differences between nations. infrastructure (e.g., roads, power, and telecommunications) clearly affects transportation but also impact flows of intangibles such as equity, knowledge, and information. further, the types of products a potential trading partner offers can be heavily affected by geographic considerations (ghemawat, 2001; rothaermel et al., 2006). low value to weight products (e.g., cement) and fragile or perishable products are sensitive to transportation issues. overall, evidence suggests that geographic distance tends to constrain flow of investment and trade (ghemawat, 2001). economic distance often plays a primary role. the conditions of a potential host country’s consumer market as indicated by wealth and consumer per capita income are key characteristics affecting distance between countries. further impacting distance is similarity across countries in the use of economies of experience, scale, and scope, and of standardization. differences in supply chains and distribution channels can also affect trade. firms in industries with key cost drivers whose prices vary widely across borders (e.g., garment and footwear) are often able to create value by exploiting these cross-border differences through economic arbitrage 22 journal of business strategies (ghemawat, 2001). each of these economic features may separate and distance countries from one another. distance is a crucial consideration for managers attempting to expand beyond domestic markets. the cage framework offers a granular approach to identifying relative differences between global markets. it is a multi-dimensional concept intended to help managers assess the challenges of distance and the opportunities of similarity in determining the attractiveness of a foreign market. business distance it seems likely that perceptions of psychic distance will be affected by differences in business practices between firms operating in two separate international markets. therefore, including business distance in any conceptual representation of the psychic distance seems prudent. business distance contains two levels: industry level differences and firm level differences. research by evans and movonda (2002) provides one measure of business distance. the authors note impact of industry structure, which is shaped by forms of competition (monopoly, oligopoly), growth rates, and concentration ratios, such as the number of competitors found in a nation or geographic region (hennart & larimo 1998; trimeche 2002). industry level differences are also manifest in the way industry value chains are organized, especially with respect to distribution channels such as what procter & gamble encountered in japan. there the firm discovered a highly fragmented system involving an intricate series of intermediaries including general wholesalers, product wholesalers, product-specialty wholesalers, regional wholesalers, local wholesalers, and finally retailers adding costs and complexity (kotler, 2003). the evans and movonda approach notes that in some industries, distance levels differ across international boundaries. some industries remain highly standardized across national boundaries (low distance), while in others international differences become much more pronounced (higher distance). in international finance, one nation may not allow interest to be charged. this in turn affects a wide variety of investment evaluations and decision. another perspective regarding industry difference focuses on variances in consumer traits and behaviors (davidson, 1980; mitra & golder, 2002). this industry level difference creates implications for a variety of strategic business activities ranging from product exporting choices to marketing strategies for those products. beyond industry differences, evans and mavondo (2002) describe firm level business distance in terms of business language, business practices, and marketing volume 32, number 2 23 infrastructures. other researchers use similar measures (klein & roth, 1990; vahlne & wiedersheim-paul, 1973). also, corporate culture tends to be separate from national level cultural differences and often permeates every business activity (erammilli & rao, 1990; weber, shenkar, & rayeh, 1996). when interpreted through the individual experiences of managers, these forces may exert greater or lesser influence on perceptions of psychic distance. individual experience individual experience constitutes the final component of psychic distance as conceptualized in figure 1. the inclusion of individual experience constitutes an important component of the psychic distance construct. it may impact the process of strategy evaluation, strategic choice, and the type of managerial structure chosen to be established in a new foreign operation or entity. several attempts have been made to explain individual experience. among them, within-country diversity, accumulated international experience, the similarityattraction paradigm, attribution theory, social identity theory and inor out-group status, self-categorization theory, cultural intelligence, and confirmation bias serve as indicators of individual experience (a more complete description of these factors appears in baack and colleagues (2014). a brief review of these perspectives follows. individual experience models within-country diversity implies that a variance exists within each nation in terms of language, religion, and ethnicity. for example, while substantial linguistic differences may be found between mexico and the united states, a number of mexican citizens are fluent in english and a number of americans are fluent in spanish. the same would hold true in the case of religion, most notably catholicism. for these individuals, national-level indicators of psychic distance may be misleading, because in that situation psychic distance becomes lower due to the familiarity with the language spoken or religion practiced in the other country. where crossunderstanding or commonality does not exist, the individual experiences increase psychic distance as he or she considers expansion or entry into a more “foreign” country. international experience constitutes a distance-bridging factor (child, ng, & wong, 2002; zhao, luo & suh, 2004). as an individual travels internationally, he or she may become more comfortable with other nations. this in turn may reduce perceptions of the degree of distance in those countries and also reduce the person’s 24 journal of business strategies perceptions of distance with all foreign countries. individuals with international experience contribute to a firm’s stock of knowledge (dierickx & cool, 1989) particularly as it relates to international diversification. in this vein, international expansion to a particular market may be more a means than an end. expansion to a particular foreign market, while certainly providing some opportunities and benefits for the firm’s value creation, may also be a step in building the firm’s store of knowledge in order to create greater opportunities in subsequent international market expansion thereby providing a context for additional learning (verbeke, 2003). a firm’s store of knowledge may benefit from an individual’s international experience in at least two ways. first, with long organizational tenure at the focal firm, the individual’s international experience may combine with a deep understanding of the firm’s codified systems and tacit routines (capron, dussauge & mitchell, 1998; dyer & singh, 1998; nelson & winter, 1982; vermeulen & barkema, 2001) enhancing the firm’s capabilities to create additional value through international diversification. second, an individual may have gained international experience through work experience with a variety of firms. recent upper echelons scholarship suggests that although many strategic leaders still rise through the organizational ranks in a single firm or single industry (kotter, 1982), career variety is increasing among ceos and executives (crossland, zyung, hiller, & hambrick, 2014). the increasing cognitive breadth resulting from this career variety tends to increase a manager’s tendency toward experimentation and change. consequently, individual international experience can bring with it considerable knowledge depth and breadth that decreases the perception of psychic distance and increases the likelihood of expansion into a foreign market thereby affecting the decision to enter a foreign market. this knowledge breadth and depth of individual international experience tends to result in reduction of uncertainty concerning the firm’s future international prospects making it more likely that the firm will pursue international investments entailing greater risk such as the high resource commitments associated with foreign direct investment (fdi) (hill, hwang, & kim, 1990). the similarity-attraction paradigm identifies the ways in which people become attracted to things they view as similar while they also find things viewed as different to be unattractive. in terms of individual experience, such differences may lead to reduced interactions with people in other countries or situations. this in turn lessens the frequency of communication (lincoln & miller, 1979) and eventually results in diminished trust and weaker intentions to associate (thomas & ravlin, volume 32, number 2 25 1995). as managers consider international expansion, differences such as these may cause serious concerns. high psychic distance based on differences and lack of attraction between managers in foreign subsidiaries may make it harder for these individuals to understand one another and reduce their willingness to interact and cooperate with each other. attribution theory (heider, 1958) conceptualizes the methods by which a person assigns or attributes responsibility for an action resulting from various contextual factors, one of which is perceptions of similarities between actors. in a case of high psychic distance resulting from individual experience, a manager would be more likely to place responsibility for an adverse outcome in an international operation on the foreign partner. when low psychic distance is present, the responsibility would more likely be attributed to situational influences that are external to the trading partner. the attribution of the manager, then, filters other factors including nation distance, but more importantly, business distance. social identity theory examines how people view themselves, how others view them, how they operate in groups, and how they view out-groups. these perceptions affect many fundamental aspects of life including self-concept, selfesteem, and group identification (ashforth & mael, 1989). when constructing a perception of the differences between oneself and others; the “other” may become categorized as being part of an out-group. most people express a preference for an in-group (billig and tajfel, 1973). viewing others as an out-group may result in discrimination along with the tendency to consider members of that out-group in more extreme ways (ahmed, 2007; linville & jones, 1980). once again, in-group and out-group status will be reflected as individual experience as it alters views of nation and business distance. consider, for example, the impact of religious affiliation. current american attitudes often reflect the assignment of out-group status to islamic citizens, both foreign and domestic. these attitudes would in turn influence the perceived degree of psychic distance when conducting business or considering expansion into some middle eastern and african countries. self-categorization processes is another key area of study. “selfcategorization theory” and the related concept of cognitive complexity suggest that individuals assign schemas or associative networks in long-term memory (zarate & smith, 1990; turner et al., 1987). each category consists of nodes or bundles of semantic meaning that form the basis of the overall meaning of the category. the categories vary across individuals based on different life experiences and cognitive abilities. 26 journal of business strategies as cognitive complexity increases, individuals become less likely to rely on simple heuristics, such as stereotypes, and more likely to employ in-depth decision-making thought processes (park & lessig, 1981). self-category theory and the concept of cognitive complexity cannot make unidirectional predictions about perceptions of psychic distance. instead, greater cognitive complexity may cause one to view a country as closer or more distant, depending on the nature of the heuristic it replaces. this perspective offers implications for the number of underlying dimensions that constitute individual experience. in perceptions of religion, for example, some individuals hold simple schemas that make no distinction between sunni and shia, which means they view all forms of islam as being the same. others, in contrast, possess more complex schemas and regard the two branches of islam as being different. in essence, the individual’s experience of islam varies, thereby leading to a subsequent difference in perceptions of psychic distance. cultural intelligence concepts originated within the international business domain. it notes that some individuals may more readily adapt to and learn about difference aspects of foreign cultures. such increased intelligence leads to more effective functioning when interacting with people in those cultures and a swifter acclimation to unique cultural situations (thomas et al., 2008). logically, higher levels of cultural intelligence would result in lower perceptions of psychic distance and serve as an individual experience influence on perceptions of other factors. finally, confirmation bias explains how an individual’s existing attitudes or beliefs influence the process by which he or she seeks out and processes new information. the overarching premise, that when an individual has a hypothesis or belief about a particular issue, that hypothesis or belief then influences the inferences or conclusions he or she draws about any new information (jussim, 1991). when considering entry into new markets, managers tend to rely on low involvement sources (reid, 1984). consequently, the potential for a manager to discount or disregard information that contradicts his or her existing perceptions occurs. thus, if a manager does exhibit a tendency to focus heavily on information that confirms his or her existing perceptions of psychic distance while avoiding or doubting information contrary to that perception, then the individual considers that information using a strong bias for or against expansion into a new country. through the use of an experimental design, baack et al. (2014) demonstrated that, even with a relatively modest intervention, the impact of confirmation bias on perceptions of distance and risk as well as managerial choices was detected. in summary, the factors associated with nation distance including cultural, administrative, geographic, and economic factors and the factors associated with volume 32, number 2 27 business distance such as industry and firm distance are all going to be examined in the light of individual experience. a manager’s perception of psychic distance, as it is affected by personal experiences, may constitute an important influence on decisions to enter a country, the mode of entry selected, and the managerial structure to be implemented. the manner in which a manager considers these issues may further impact such decisions and actions. information processing models consumer buying decision-making processes have been studied for many years. the result has been a set of models which may be applied to the ways in which individuals consider product purchases. these same models appear to have implications for strategy evaluations and choice processes as they are influenced by individual experiences and subsequent perceptions of psychic distance. four such models include cognitive mapping, the multi-attribute approach, the evoked set method, and affect referral. cognitive maps are used to represent the knowledge structures and memories embodied in an individual’s brain (kearny & kaplan, 1997). these internal mental structures contain a person’s assumptions feelings, beliefs, interpretation of reality, and attitudes regarding the world. within this framework, when a manager encounters information about a country, it can be processed in several ways. if the new information appears to be consistent with current information the individual holds, then an internal linkage becomes stronger. in other words, the concept that australia has a great deal in common with the united states may be strengthened by any new information that suggests similarities between the two countries, much in the manner suggested by confirmation bias. if, on the other hand, new information does not have a linkage to any knowledge in the individual’s brain, a new linkage will be established. thus, a person who does not know that cars are driven on the left side of the road, rather than the right as is the case in the u.s. will need to establish a new linkage. the same person may be aware that drivers in england also use the left hand side of the road. the corresponding linkage may be that the united kingdom and australia have something in common and that, in spite of driving patterns, other similarities remain with the u.s., such as language. psychic distance would be lessened as a consequence. cognitive mapping also explains how short term processing of information moves into longer term memory (kaplan & kaplan, 1982). repetition represents the process by which a message is processed more than once using the person’s 28 journal of business strategies mental linkages, and over time the information becomes stored into the person’s knowledge structure. this structure, normally conceptualized as an associative network, serves as the foundation of memory. consequently, repeated information suggesting that a country “is not all that different from us” would lead to lessened perceptions of psychic distance. such an approach features messages designed to accentuate similarity-attraction, positive attributions, and suggest an in-group status to recipients. as cognitive complexity increases, the number of linkages present in a mental “web” rises. an individual with higher levels of cognitive complexity would likely find more similarities but also differences among nations. subsequent conclusions regarding the perceived degree of psychic distance would then be affected. cognitive mapping explains such processes much in the same way that cognitive complexity appears to operate. that is, the individual may draw differing conclusions about the degree of psychic difference present by the manner in which he or she considers the perceived or experienced similarities and differences between countries. the multi-attribute approach applies to high-involvement purchases, and by inference, high-involvement strategic decisions (wilkie & pessemier, 1983). a consumer considers products in terms of performance over a series of attributes along with the importance of each attribute. for example, when buying a car, the consumer thinks about gas mileage, comfort, reliability, and the looks of the vehicle. a purchaser ranks the attributes from most important to least important and then rates each individual attribute. someone who values comfort over every other feature gives that factor the greatest weight, with the most comfortable car gaining the highest ranking on that factor (bettman, 1979). the sum of the evaluations of the total set of factors, each weighted in terms of importance, then influences the final purchasing choice. in terms of psychic distance, a manager considers the components displayed in figure 1, or nation distance in terms of cultural, administrative, geographic, and economic factors along with business distance in terms of industry and firm factors. each nation under consideration receives a mental rating for all of the factors which are have been ranked in terms of importance to the manager. these assessments will be influenced by the manager’s individual experience. a person who values similarity or in-group status may rank a common language or religion as the most important factor and economic distance as the least, for example. the net result would be a cumulative evaluation of the nation in terms of psychic distance as interpreted volume 32, number 2 29 across various attributes with varying levels of importance to the manager making the assessment. the evoked set conceptualization suggests that individuals make purchases by considering a set of products or companies that first come to mind when the person experiences a need (zeithaml, 1981). for example, if asked, “where do you go for a good steak at a restaurant?” the respondent will recall a set of dining establishments that immediately enters his or her thoughts. that group is the evoked set. in strategic terms, the question, “which country do you think would be best for entry?” would lead to a response naming the nations that come to mind, or the respondent’s evoked set. two additional factors are present. an inept set contains the products, brands, or companies that individuals will not consider because they elicit negative feelings. someone with a negative attitude toward a specific restaurant would not consider going to that establishment to dine. in psychic distance/individual experience terms, those in the out-group stay in the out-group and those that are dissimilar remain dissimilar, which further reflects the presence of a confirmation bias. in terms of strategic decision-making, individual experience would dictate that a nation will not be considered as a target for expansion as a result. any nation which has been engaged in a war with the home company’s country may be quickly placed into an inept set due to individual experience perceptions and its corresponding confirmation bias tendency. the inert set contains brands the consumer knows about but has neither positive nor negative feelings regarding them. in cognitive mapping terms, no linkage is present. the consequence will be that the brand may be eliminated simply due to lack of knowledge. often, marketers seek to change that outcome through advertising and other marketing messages. many nations may be found in the inert sets of managers considering international expansion. the goal for leaders in those countries would be to help their nations move into a decision-maker’s evoked set by creating positive emotions and increasing memories of those countries and emotions. affect referral posits that consumers select the brands they like or the ones with which they hold emotional connections (sneider, 2004). this eliminates thoughts about other brands or products. most of the time, affect referral applies to low involvement purchases. in terms of strategic choice, affect referral would imply that managers will only consider expansion into countries with which they hold positive emotions and those that they perceive would be relatively easy to enter. once again, similarity, in-group status, and confirmation bias might become part of a response modeled by 30 journal of business strategies affect referral. for example, a canadian manager asked to choose the next country to expand into might quickly respond “the united states,” due to positive feelings and the perceived ease of entry. affect referral requires the least amount of mental energy. it also explains how a previous choice (sending one product into a new country), which has been made using a more complex information processing model such as the multi-attribute approach, will simply be confirmed in a subsequent choice. nations belonging to the european union may contain managers who only consider other member nations when making strategic internationalization choices. these information processing models imply that the individual experience components can be combined with models of how individuals make purchasing decisions to further explain the ways in which managers considering internationalization think about their choices. subsequent decisions to enter or not enter a specific country, to utilize a certain mode of entry, and to establish a form of managerial structure may be more clearly understood through such an analysis. previous international experiences, perceptions of similarity, confirmation bias, ingroup status, and various attributions may influence such choices. operationalization of individual experience very few marketing studies include measures of individual experience in any model or methodology regarding psychic distance. the studies that include experience serve as the foundation for operationalizing this component of psychic distance. dicthl, keoglmayr, and mueller (1990) studied individual manager variables including education level, proficiency in foreign languages, degree of foreign travel, and foreign market orientations. other measures of individual experience might include a manager’s knowledge of the foreign market and actual experience and comfort level with this market. additional research could incorporate the personal variables noted here, including perceptions of similarity and difference, the degree or amount of international experience, reflections on inor out-group status with a particular country in mind, the presence of confirmation bias (as explored in the baack et al. 2014 study), and measures of cultural intelligence. individual experience is open to investigation using qualitative methods, such as in-depth interviews combined with observations of the decision-maker’s activities. post hoc analyses of decisions to enter foreign markets, choices of entry modes, and the types of managerial structures volume 32, number 2 31 implemented might also provide valuable insights into strategic decision-making processes in international settings. psychic distance and strategic management the psychic distance concept has been applied to strategic marketing management studies. the foreign direct investment (fdi) process serves as an example. the three main fdi outcomes connected to psychic distance in the marketing literature include: foreign market investment location decisions and the sequence of the investments, the choice of entry mode into a foreign market, and the performance levels of multinational firm affiliates (shenkar, 2001). two of these outcomes apply to strategic management. that is, psychic distance may affect decisions to engage in international operations, choices of country to enter, and modes of entry selected. psychic distance may further explain the managerial structure that will be put into place. choices of countries to enter psychic distance has been strongly linked to the decision to begin international activity in the first place (johanson and vahlne, 1977; 2009). then, deciding where to compete constitutes an integral part of a firm’s corporate level strategy. the role psychic distance plays in such decisions may be an important factor in a strategic manager’s (or management team’s) decision to enter a specific foreign market, because the impact of psychic distance may be context specific and vary in importance by industry and by certain firm characteristics. such evaluations can be modeled using the multi-attribute approach or through assessments of a manager’s evoked set. as a general rule, perceptions of low degrees of psychic distance would seemingly be associated with greater propensities to enter specific countries. if another nation is viewed as “not all that much different,” the decision to select that country as a place to enter becomes easier. in contrast, high perceived psychic distance between a home country and a potential host country would logically result in increased concern regarding the difficulty of entering that specific nation. as an example, industries producing highly consumable products such as food and entertainment may be greatly impacted by cultural factors, thereby influencing perceptions of psychic distance. industries enmeshed tightly with a country’s reputation or national security, such as aerospace, would also affect the degree of psychic distance experienced by a top level manager. further, low value32 journal of business strategies to-weight ratios in the cement industry constrain potential international market options, and the demand for automobiles is income dependent, thereby constraining the potential for development of international markets. consequently, the industry in which a firm operates affects perceptions of psychic distance as part of the decision to enter a specific foreign market (ghemawat, 2001), and these factors may be assessed in the manner suggested by the various decision-making modes, such as the multi-attribute approach or confirmation bias. with regard to the actual choices of countries, some research suggests that firms are more likely to enter geographically-close countries (davidson 1980, johanson and wiedersheim-paul, 1975; denis and depelteau, 1985; welch and luostarinen, 1988). logically, a nearby country may influence individual strategic decision-makers because their perceptions include the view that those nations are culturally similar and may have a greater number of economic, industry-level and business-level similarities, thereby reducing perceived psychic distance. at the same time, the primary impact of psychic distance in the decision to expand into another country has not always been clearly supported by past research. it is possible that a more complex conceptualization, such as the one provided in figure 1, may lead to more in-depth analyses of these relationships in the future. as an example, consider the differences between perceptions of canada and mexico by managers in the united states. factors such as similarity-attraction based on language and/or religion may come into play. modes of entry psychic distance may be a factor that affects the choice of entry mode. standard entry modes include exporting, licensing, franchising, joint ventures, strategic alliances, acquisitions (minority, majority, or total), and greenfield (startup) ventures (agarwal, 1994; hill et al., 1990). costs, levels of risk, and the degree of control constitute three factors influencing such choices (anderson & gatignon, 1986). in general terms, the more involved the modes of entry, in terms of a company’s investment of time and other resources, the greater degree of control that company will seek to hold. at the same time, greater involvement creates increased costs and higher levels of risk. psychic distance, then, may play a key role in the selection of entry mode. the lower the degree of perceived psychic distance, the more likely it becomes that entry will include a more complex and involved entry strategy. volume 32, number 2 33 conversely, greater psychic distance would be associated with increased reticence with regard to making an involved, higher cost, more complex entry choice. in some cases, exports may be the only mode available due to a lack of knowledge and/or risk aversion. when considering exporting, structural arrangements for such an approach typically depend on either arm’s length relationships with intermediaries specializing in foreign trade including traveling sales representatives and foreign-based distributors or agents or on internally coordinated organizational subunits such as domestic-based export departments or overseas sales branches. the choice of exporting as a mode of entry may be impacted by psychic distance in a number of ways. the uncertainty of local market acceptance of the entering firm’s product offering increases that firm’s risk in entering the market. a firm may lack understanding of local business practices and may only with difficulty be able to reach local potential customers without the assistance of local partners. the entering firm may also lack sufficient knowledge to recruit, hire, and manage local personnel. these attributes reflect both nation distance, as demonstrated by the cage framework, and business distance in terms of a lack of knowledge by the firm of local practices. exporting avoids the investment costs of establishing operations in the host country and may allow an exporting firm pursuing a cost leadership strategy to benefit from potential cost advantages from production in its home market (hill et al., 1990; hitt, ireland, & hoskisson, 2009), which in turn may lower perceptions of psychic distance. on the other hand, exporting entails transportation costs and regulatory constraints including potential tariffs and other import duties. reliance on third party intermediaries for marketing, distribution, and sales means higher transaction costs will be associated with contract specification, monitoring, and enforcement (hill et al., 1990; williamson, 1996), thereby producing heightened feelings regarding the degree of distance present. the size of the potential market can require the firm to seek more effective ways of reaching local customers while still recognizing the impact of constraints of distance driving a firm to pursue licensing as a mode of entry. in a licensing arrangement, the licensee assumes the business risks and fixed and variable costs associated with manufacturing and marketing the product (hill et al., 1990), because the home firm sells the rights to a host country firm to manufacture and market the home firm’s products in the host country in exchange for royalties. licensing may allow the firm to make use of host country expertise, for example, in product development or distribution systems and also allow a local 34 journal of business strategies firm access to the foreign firm’s knowledge base allowing both firms to share in the revenue. consequently, perceptions of the degree of psychic distance may decrease, due to the conclusion that lower levels of risk and cost are present. factors that might heighten the perceived degree of psychic distance would include the other costs associated with contracting (searching for an agent, negotiating, monitoring, and enforcement) and the risks that the licensee may learn how to develop the product on its own (dissemination risk) (hill et al., 1990). the multi-attribute model may be used to assess the relative importance of each of these factors (in the mind of the decision-maker/s) affecting the choice of entry mode. with franchising, the franchisee bears the bulk of the investment risk as the franchisor bears the costs of enforcing quality control in addition to the larger issues of contract specification, monitoring, and enforcement which are exacerbated by distance (hill et al., 1990) and, in some cases, differences in the institutional environments of the two countries. business level factors constitute the primary force affecting psychic distance in such deliberations, and these in turn would be influenced by factors such as similarity-attraction or out-group status. multi-firm equity strategic alliances include european aeronautic defense and space (eads), an alliance of aerospace firms from the u.k., spain, germany, and france, a collaborative arrangement between microsoft and toshiba to develop embedded processors for running on-board entertainment functions in automobiles, and nestlé’s 16% stake in l’oreal. in these arrangements, the credible commitment implied by the equity investment may offer partial security against opportunism by the foreign partner (williamson, 1990) which would reduce perceptions of psychic distance. conversely, the same arrangements entail clear long-term agreements with the foreign partners, which create high exit costs. strategic decision-makers would likely be influenced by such factors, which would be associated with the perceived degree of distance present. high-profile examples of international joint ventures exist. general motors is involved in a three party joint venture in china with shanghai automotive industrial corporation (saic) and wuling, a chinese manufacturer, to produce the wuling sunshine, a mini-commercial vehicle for use within china (muller, 2010). in the petroleum industry, chevron and phillips have combined subunits to create chevron phillips chemical company to develop petrochemicals (stynes, 2014). managers assessing economic and business level factors would filter such considerations through the lens of individual experience, when considering potential mergers. strategic alliances including both equity strategic alliances and joint ventures are volume 32, number 2 35 dependent on a certain level of trust that is likely only with a relatively low degree of distance (dyer and singh, 1998). in the case of wholly owned subsidiaries either as acquisitions or as greenfield ventures, the firm shoulders 100% of the risk but also maintains 100% of control. the expanding firm must be capable of understanding and controlling local operations suggesting that only in situations of low distance should firms engage in wholly owned subsidiaries as a mode of entry. cross-border acquisitions, such as kraft’s 2009 purchase of cadbury, are on the increase (jarrone, 2011). these provide a rapid means for large scale initial international expansion and afford the acquirer full control over operations. cross-border acquisitions entail several difficulties. they often involve large amounts of debt financing, are typically more complex than domestic deals (weitzel & berns, 2006), and may involve legal and regulatory considerations of both the acquirer’s home country and the host country of the target firm (hitt, ireland, & hoskisson, 2009). evaluations of such complexity would likely increase perceptions of psychic distance as interpreted through individual experience. factors such as within-country diversity in the company to be acquired along with the accumulated international experience and level of cultural intelligence of the decision-maker may influence such deliberations. acquisitions should typically occur only when there is low distance because the existence in the host market of businesses ripe for acquisition implies an established market for the firm’s product and existing know-how in terms of production, marketing, and distribution. when such attributes are not present but market conditions have demonstrated strong existing and growing demand, greenfield ventures become more likely. greenfield ventures are the establishment of a wholly owned subsidiary built from the ground up. greenfield ventures may allow protection of intangible capabilities (barney, 1991; conner, 1991; dierickx and cool, 1989; kor and mahoney, 2000). in its u.s. market, toyota shifted from exporting to wholly owned subsidiaries bypassing collaborative strategies to protect its knowledge base from appropriation from potential u.s. partners. firms generally use acquisition and greenfield ventures in later stages of development of international strategies. at the same time, when wholly owned subsidiaries are warranted from a business standpoint and under conditions of low psychic distance, local regulations may require a certain level of local ownership suggesting the need for joint ventures instead. in such cases, most of the components of psychic distance are low, but administrative distance in the form of local regulations becomes a rather stubborn driver of distance. mcdonald’s faced similar conditions during its early expansion into europe, forcing the firm to 36 journal of business strategies create a number of joint ventures when it might otherwise have chosen to operate wholly owned subsidiaries. advantages of greenfield ventures include maintaining control over technology, production, marketing, and distribution. disadvantages include high fixed costs and employment of host nationals. psychic distance may play differing roles in the determination of whether to pursue a greenfield venture. a foreign firm pursuing a wholly owned subsidiary entry mode may construct its own facility rather than acquire existing operations. toyota was quite familiar with the u.s. automobile market by the time the company was ready to manufacture cars in the u.s., and the japanese firm was generating considerable revenues from u.s. operations. the firm’s leaders did choose to build company-designed plants (moving from exporting to greenfield ventures) conforming to its rather unique business practices that would likely not have fit well with u.s. automotive plant layouts. in that case, the impact of psychic distance was reduced through the individual, group, and enterprise levels of experience with the u.s. market, but the firm chose greenfield ventures in order to maintain and protect many of its unique capabilities. kikkoman’s construction of a soy sauce production facility may also have been driven by factors other than psychic distance. the firm was also familiar with the u.s. market, having sold its products for nearly two decades through exporting, licensing, and joint ventures. company managers concluded, however, that the complexities of soy sauce production, the need for deep expertise in those processes, and the lack of existing soy sauce plants in the u.s. created the need for a greenfield venture (tanaka, taylor, and claterbos, 2001). in both the kikkoman and toyota cases, nation distance may have been reduced through long periods of individual experience, while business distance may have continued to play a role. ultimately, it was the demands of the product and processes that were largely the determinants of the choice of greenfield ventures. the final choice of mode of entry is somewhat dependent on internal firm processes, and the dynamics of the various modes of entry mean that the choice of mode is highly situation-dependent (hitt et al., 2009). firms whose creation of value is knowledge intensive are more likely to gravitate toward modes of entry associated with greater levels of control. although such a choice increases the level of investment risk, it tends to reduce the level of dissemination risk, the risk that the firm’s knowledge base may be appropriated by an opportunistic foreign partner and used by the foreign firm to develop its own market for the focal firm’s products (hill et al., 1990). therefore, it seems plausible that when individual experience factors volume 32, number 2 37 reduce perceptions of psychic distance, the likelihood of entering a foreign market would increase, assuming all things remain equal. some studies have investigated the impact of psychic distance on entry mode choice, with mixed results (brouthers & brouthers, 2001). eclectic theory suggests that location familiarity (an individual experience component of psychic distance) affects several managerial decisions including the choice of entry mode (hill et al., 1990; brouthers & brouthers, 2000). although a relationship between psychic distance and the choice of entry mode may be present, the form that relationship takes has not been consistent. for instance, high levels of cultural distance are associated with modes in which greater control is present, such as wholly-owned subsidiaries in anand and delios (1997). in other research, high levels of psychic distance were associated with shared or low control modes (kogut & singh, 1988; erramilli & rao, 1990; kim & hwang, 1992). in other research, no relationship was found (erramilli, 1996; gatignon & anderson, 1988; larimo, 1993). again, future research utilizing a more complex conceptualization of psychic distance might yield more precise and informative results. managerial structure the choice of managerial structure accompanies the selection of an entry mode. the assignment of general managers of foreign markets (managerial structure) typically centers around three choices: whether to assign a home country national, a host country national, or a third country national. as with the decision to enter a foreign market and which mode of entry to use, all things being equal, individual experience may also influence these managerial decisions. numerous factors might affect the choice of managerial structure (agarwal & ramaswami, 1992; barkema, shenkar, & vermeulen, 1997). culture, religion, and language affect perceptions of nation distance. industry and firm distance represent business level factors that also influence the degree of psychic distance. a mechanism by which such decisions are made or influenced would be to incorporate components in individual experience into the degree of psychic distance perceived and subsequent choices. in other words, considering managerial structure choices in terms of similarity-attraction, in-group/out-group status, attribution considerations, the degree of foreign experience, and confirmation bias might provide quality insights into such selections. as a component of individual experience, within-country diversity may impact international choices facing organizational decision makers with regard 38 journal of business strategies to managerial structure. also, exposure to a variety of differences within one’s own country (e.g., language, religion, and ethnicity) may make one more readily adaptable and accepting of cultural differences, thereby reducing psychic distance. the example provided earlier of diversity in the u.s. of anglo and hispanic cultural diversity may also extend to other countries. switzerland has three official national languages, belgium two, and spain has several unofficial languages although spanish is the official language in most areas of the country. people raised in such diverse cultures in their own countries may view other cultures as less psychically distant. furthermore, this tendency may be magnified by certain geographical factors such as size and population. a densely populated, diverse country may result in more pronounced experiences of diversity among its populace. in addition, a relatively small country geographically will have less distance to its borders and may border many more countries than would a geographically larger country. further, a small population may drive local firms to seek overseas markets sooner than would firms in countries with larger domestic markets (ghemawat, 2001). thus, withincountry diversity might result in individual experiences that reduce perceptions of psychic distance. cognitive maps, the multi-attribute model, evoked sets, and the affect referral model could be also used to explain the processes by which managers consider and analyze the type of individual who would be suited to an international expansion operation. for example, the combination of international knowledge and reduction of uncertainty may lead the firm to consider other managerial structures by examining the range of managerial talent. this suggests that third country expatriates would become candidates as country subsidiary managers. low psychic distance, or similarity, would likely lead a firm entering a foreign market to assign general management responsibilities to a host country national. low psychic distance implies a high degree of mutual understanding by firm managers and host country nationals regarding host country culture, administrative infrastructure, geography, and economic system. as psychic distance increases, it becomes more likely for the firm to prefer a home country national as general manager in order to maintain control over the foreign division and maintain consistency in communications within the division and between the division and corporate offices. cases of highest psychic distance may lead the firm to assign general management responsibilities to a third country national. this individual may be one with firm experience in another foreign division or an outsider with a certain level of international experience who understands the firm and its home country as well as understanding the host country. volume 32, number 2 39 in general, the greater the degree of perceived psychic distance, the less likely a host country national is to assume general management responsibilities of the foreign division. further, as psychic distance increases it becomes more likely for the firm to rely heavily first on intrafirm experience in the host country, then on intrafirm experience abroad, and then on experience outside the firm but with strong international experience. the experience of kikkoman, the soy sauce producer, expanding into the u. s. market illustrates some of these processes (tanaka et al., 2001). the firm first entered the market as an exporter relying on such specializing intermediaries as domestic-based export agents and u.s. distributors knowledgeable about the u.s. and perhaps with some knowledge of kikkoman’s products and their consumer applications. as the market grew, the firm grew to rely on more involved modes of entry until it built its own production facility in walworth, wisconsin. although kikkoman had had a u.s. presence for nearly twenty-five years, this was the first japanese owned manufacturing plant to be built in the u.s. the plant manager, the finance manager, and the laboratory manager were considered the three key senior management positions and were held by japanese employees of kikkoman. this was due to the rather complex production processes, the associated technologies, and the century long involvement of kikkoman in soy sauce production and distribution. this management structure allowed the u.s. division of kikkoman to operate as an american firm in the japanese style. as the firm’s u.s. market developed further, the management became more american in character, and the plant manager position eventually went to an american. hence, upon entering the u.s. market, kikkoman relied on home country nationals as general managers but became sufficiently assimilated to u.s. styles that a host country national eventually took the position. the knowledge breadth and depth of individual international experience (as may be modeled with cognitive maps) will likely result in less cognitive simplification typical of management when confronted with cognitive complexity leading to less reliance on simplifying heuristics such as stereotypes and leading to greater cultural intelligence. the result is that attributes and characteristics encountered in the realms of international expansion will be seen as more similar than to individuals with more narrow and more shallow knowledge bases, and those attributes and characteristics may seem more attractive resulting in greater attraction thereby reducing psychic distance. in addition, there might be fewer tendencies to categorize differences based on in-group/out-group distinctions. 40 journal of business strategies conclusions and implications this investigation seeks to explore relationships between psychic distance and strategic international considerations as reflected in strategy evaluations, strategic choices, and the choice of managerial structure to be deployed in an international expansion. figure 2 summarizes these proposed relationships. the assertion being made is that individual experience plays an important role in such deliberations. individual experience can be viewed as the various components involved or through the use of consumer purchasing decision models. figure 2 proposed relationships of psychic distance and involvement in international expansion 1. greater nation distance as interpreted through individual experience results in greater perceived psychic distance. 2. greater business distance as interpreted through individual experience results in greater perceived psychic distance. 3. greater perceived psychic distance as interpreted through individual experience reduces managerial intentions to expand across national borders. 4. greater perceived psychic distance as interpreted through individual experience results in less complex modes of entry involving lower levels of investment risk and lower levels of control by the focal firm. 5. greater perceived psychic distance as interpreted through individual experience results in a higher likelihood of employing a foreign national either from the host country or from a third country. in general, greater psychic distance would be viewed as likely to reduce the inclination to enter any new country or pursue an internationalization strategy. greater psychic distance would logically influence leaders (through processes interpreted by individual experience) to avoid or be less inclined to enter certain countries, while low psychic distance would make a nation appear to be more inviting. psychic distance influences the degree of complexity and control associated with various modes of entry. and finally, psychic distance has an impact on the choice of home country, host country, or third party nationals as managers in international subsidiaries. volume 32, number 2 41 two arguments have been made for including individual experience in the psychic distance construct. one is that that individual experiences were part of the initial development of the construct (johanson & vahlne, 1977; hallen and wiedersheim-paul, 1984). second, removing individual experience would take away the psychic aspect, leaving only “distance.” it may be that the actual relationships are more complex and multidimensional. interactions between the three components within the domain of the construct (nation distance, business distance, and individual experience) are likely to be complex and interact with one another. these relationships may become more complicated in strategic decision-making processes, especially those in which groups of individuals voice views reflecting each person’s perception of the degree of psychic distance present with regard to any given potential target nation. some international business experts believe that, for the concept of psychic distance to remain useful, greater clarity regarding terms will be necessary (shenkar, 2001; dow, 2000; evans et al., 2000; brouthers & brouthers, 2001; barkema, bell, & pennings, 1996). brouthers and brouthers (2001) argue that business practice differences and perceptual components of psychic distance are key facets of the construct that have not been included in various studies. instead, the majority of empirical studies substitute cultural distance for psychic distance (shenkar, 2001). this approach limits psychic distance to one facet. such an approach may explain some of the conflicting findings present in studies of psychic distance and subsequent outcomes. therefore, the complete conceptualization of the psychic distance construct as presented here may be of some use. in the end, the goal of this paper is to change the way the psychic distance construct is viewed and used. in addition, the suggestion being offered is that the psychic distance construct provides an insightful lens into studies of the ways in which top managers make strategic internationalization decisions as well as influence the forms of entry strategies and managerial arrangements that result. references agarwal, s. (1994) socio-cultural distance and the choice of joint ventures: a contingency perspective, journal of international marketing, 2(2), 63-80. agarwal, s., & ramaswami, s. n. (1992). choice of foreign market entry mode: impact of ownership, location and internalization factors. journal of international business studies, first quarter, 1-27. 42 journal of business strategies ahmed, a. m. (2007). group identity, social distance and intergroup bias. journal of economic psychology, 28(3), 324-337. anand, j., & delios, a. (1997). location specificity and the transferability of downstream assets to foreign subsidiaries. journal of international business studies, 28 (3), 579-603. anderson, e., & gatignon, h. (1986). modes of foreign entry: a transaction cost analysis and propositions. journal of international business studies, fall, 1-26. ashforth, b. e., & mael, f. (1989). social identity theory and the organization. academy of management review, 14 (1), 20-39. baack, d. w., & baack, d. (2006). psychic distance: a conceptual framework. proceedings, association of collegiate marketing educators meeting, oklahoma city, ok, cd rom. baack, d. w., dow, d., parente, r., & bacon, d. (2014). confirmation bias in individual-level perceptions of psychic distance: an experimental investigation. manuscript submitted for publication. barkema, h. g., bell, j. h. j., & pennings, j. m. (1996). foreign entry, cultural barriers, and learning. strategic management journal, 17 (2), 151-166. barkema, h. g., shenkar, o., vermeulen, f., & bell, j. h. j. (1997). working abroad, working with others: how firms learn to operate international joint ventures. academy of management journal, 40(2), 426-442. barney, j. (1991). firm resources and sustained competitive advantage. journal of management, 17(1), 99-120. beckerman, w. (1956). distance and the pattern of inter-european trade. the review of economics and statistics, 38(1), 31-40. bettman, j. b. (1979) an information processing theory of consumer choice, reading, ma: addison-wesley. billig, m., & tajfel, h. (1973). social categorization and similarity in intergroup behaviour. european journal of social psychology, 3(1), 27-52. black, j. s., & mendenhall, m. e. (1991). the u-curve adjustment hypothesis revisited: a review and theoretical framework. journal of international business studies, 22(2), 225-247. boyacigiller, n. (1990). the role of expatriates in the management of interdependence. journal of international business studies, 21(3), 357-381. brouthers, k. d., & brouthers, l. e. (2000). acquisition or greenfield start-ups? institutional, cultural, and transaction cost influences. strategic management journal, 21(1), 89-97. volume 32, number 2 43 brouthers, k. d., & brouthers, l. e. (2001). explaining the national cultural distance paradox. journal of international business studies, 32(1), 177-189. buckley, p. j., & casson, m. c. (1979). analyzing foreign market entry strategies: extending the internalization approach. journal of international business studies, 29(3), 539-562. capron, l., dussauge, p., & mitchell, w. (1998). resource deployment following horizontal acquisitions in europe and the united states, 1988-1992. strategic management journal, 19(7), 631-661. child, j., ng, s. h., & wong, c. (2002). psychic distance and internationalization. international studies of management and organizations, 32(1), 36-56. conner, k. r. (1991). a historical comparison of resource-based theory and five schools of thought within industrial organizational economics: do we have a new theory of the firm? journal of management, 17(1), 121-154. crossland, c., zyung, j., hiller, n. j., & hambrick, d. c. (2014). ceo career variety: effects on firm-level strategic and social novelty. academy of management journal, 57(3), 652-674. davidson, w. h. (1980). the location of foreign direct investment activity: country characteristics and experience effects, journal of international business studies, 11(2), 9-22. denis, j-e., & depelteau, d. (1985). market knowledge, diversification and export expansion. journal of international business studies, 16(3), 77-89. dicthl, e., keoglmayr, h. g., & mueller, s. (1990). international orientation as a precondition for export success. journal of international business studies, first quarter, 23-40. dierickx, i. & cool, k. (1989). asset accumulation and sustainability of competitive advantage. management science, 35(12), 1504-1513. dow, d. (2000). a note on psychological distance and export market selection journal of international marketing, 8(1), 51-64. dyer, j. h., & singh, h. (1998). the relational view: cooperative strategy and sources of interorganizational competitive advantage. academy of management review, 23(4), 660-679. erramilli, m. k. (1996). nationality and subsidiary ownership patterns in multinational corporations. journal of international business studies, 27(2), 225-248. erramilli, m. k., & rao, c. p. (1990). choice of foreign market entry modes by service firms: role of market knowledge. management international review, 30(2), 135-150. 44 journal of business strategies evans, j., treadgold, a., & mavondo, f. t. (2000). psychic distance and the performance of international retailers – a suggested theoretical framework, international marketing review, 17(4/5) 373-391. evans, j., & mavondo, f. t. (2002). psychic distance and organizational performance: an empirical examination of international retailing operations. journal of international business studies, 33(3), 515-532. gatignon, h., & anderson, e. (1988). the multinational corporation’s degree of control over foreign subsidiaries: an empirical test of a transaction cost explanation. journal of law, economics, and organization, 4(2), 305-335. ghemawat, p. (2001). distance still matters: the hard reality of global expansion, harvard business review, 79(8), 137-147. gomez-mejia, luis r. & leslie e. palich (1997). cultural diversity and the performance of multinational firms, journal of international business studies, second quarter, 309-335. hall, e. t. (1959). the silent language. greenwich, ct: fawcett publishers. hallen, l., & wiedersheim-paul, f. (1984). the evolution of psychic distance in international business relationships. in i. hägg and f. wiedersheim-paul (eds.), between market and hierarchy (15-27). uppsala, sweden: university of uppsala press. heider, f. (1958). the psychology of interpersonal relations. new york: wiley. hennart, j-f., & larimo, j. (1998). the impact of culture on the strategy of multinational enterprises: does national origin affect ownership decisions? journal of international business studies, 29(3), 515-538. hill, c. w. l. (2011). global business today. 7th edition. new york: mcgraw-hill irwin. hill, w., hwang, p., & kim, w. c. (1990). an eclectic theory of the choice of international entry mode. strategic management journal, 11(2), 117-128. hitt, m.a., ireland, r.d., & hoskisson, r.e. (2009). strategic management: competitiveness and globalization (8th edition), cincinnati: south-western/ cengage learning. hofstede, g. (1980). culture’s consequences. beverly hills, ca: sage. jarrone, j. (2011, august 5). kraft breakup alone won’t nourish investors. the wall street journal. retrieved from http://www.wsj.com/articles/sb1000142405311 1903454504576488521705501438. johanson, j., & vahlne, j-e. (1977). the internationalization process of the firm – a model of knowledge development and increasing foreign market commitments, journal of international business studies, 8(1), 23-32. volume 32, number 2 45 johanson, j., & vahlne. j-e. (1990). the mechanism of internationalization, international marketing review, 7 (4) 11-24. johanson, j. & vahlne, j.-e. (2009). the uppsala internationalization process model revisited: from liability of foreignness to liability of outsidership. journal of international business studies 40, 1411-1431. johanson, j., & finn, w-p. (1975). the internationalization of the firm – four swedish cases, the journal of management studies, october, 305-322. jussim, l. (1991). social perception and social reality: a reflection-construction model, psychological review, 98(1) 54-73. kaplan, s., & kaplan, r. (1989). cognition and environment: functioning in an uncertain world, ann arbor, mi: ulrich. kearny, a. r., & kaplan. s. (1997). toward a methodology for the measurement of knowledge structures of ordinary people: the conceptual content cognitive map, (3cm), environment and behavior, 28(5) september, 579-617. kim, w. c., & hwang, p. (1992). global strategy and multinationals entry mode choice. journal of international business studies, first quarter, 29-53. klein, s., & roth, v. j. (1990). determinants of export channel structure: the effects of experience and psychic distance reconsidered. international marketing review, 7(5), 27-38. kogut, b., & singh, h. (1988). the effect of national culture on the choice of entry mode, journal of international business studies, fall, 411-432. kor, y. y., & mahoney, j. t. (2000). penrose’s resource-based approach: the process and product of research creativity. journal of management studies, 37, 109139. kostova, t. (1999). transnational transfer of strategic organizational practices: a contextual perspective. academy of management review, 24 (2) 308-324. kostova, t., roth, k., & dacin, m. t. (2008). institutional theory in the study of multinational corporations: a critique and new directions. academy of management review, 33(4), 994-1006. kotler, p. 2003. marketing management, 11th edition. upper saddle river, nj: pearson education. kotter, j. p. (1982). the general managers. new york: the free press a division of macmillan, inc. larimo, j. (1993). foreign direct investment behaviour and performance: an analysis of finnish direct manufacturing investments in oecd countries (no. 13). universitas wasaensis. 46 journal of business strategies lincoln, j. r., & miller, j. (1979). work and friendship ties in organizations: a comparative analysis of relation networks. administrative science quarterly, 181-199. linville, p. w., & jones, e. e. (1980). polarized appraisals of out-group members. journal of personality and social psychology, 38(5), 689. mitra, d., & golder, p. n. (2002). whose culture matters? near-market knowledge and its impact on foreign market entry timing. journal of marketing research, 39, 350-365. muller, j. (2010). can china save gm? forbes, 185(8), 72-78. nelson, r. n., & winter, s. g. (1982). an evolutionary theory of economic change. cambridge, ma: harvard university press. park, c. w., & lessig, v. p. (1981). familiarity and its impact on consumer decision biases and heuristics. journal of consumer research, 223-231. reid, s. (1984). information acquisition and export entry decisions in small firms. journal of business research, 12(2), 141-157. rothaermel, f. t., kotha, s., & steensma, h. k. (2006). international market entry by us internet firms: an empirical analysis of country risk, national culture, and market size. journal of management, 32(1), 56-82. schwartz, s. h. (1992). universals in the content and structure of values: theoretical advances and empirical tests in 20 countries. in m. zanna (ed). advances in experimental social psychology, 25(1), 1-65. new york: academic press. sethi, s. p. (1971). comparative cluster analysis for world markets. journal of marketing research, 8, 348-354. shenkar, o. (2001). cultural distance revisited: towards a more rigorous conceptualization and measurement of cultural differences. journal of international business studies, 32(3), 519-535. sneider, m. (2004). creating emotional ties with brands for sales. marketing news, 38(may 15), 44-45. stottinger, b., & schlegelmilch, b.b. (1998). explaining export development through psychic distance: enlightening or elusive? international marketing review, 15(5), 357-372. stottinger, b., & schlegelmilch, b.b. (2000). psychic distance: a concept past its due date? international marketing review, 17(2), 169-173. stynes, t. (2014, jan. 29). phillips 66 profit rises as margins fall. the wall street journal. retrieved from http://www.wsj.com/articles/phillips-66-profit-soarson-refining-margins-chemical-growth-1414586714. volume 32, number 2 47 tanaka, n., taylor, m. l., & claterbos, j. a. (2001). kikkoman corporation in the mid 1990s: market maturity, diversification, and globalization. case research journal, 21(3), 1-28. thomas, d. c., & ravlin, e. c. (1995). responses of employees to cultural adaptation by a foreign manager. journal of applied psychology, 80(1), 133. thomas, d. c., elron, e., stahl, g., ekelund, b. z., ravlin, e. c., cerdin, j-l., & poelmans, s. (2008). cultural intelligence domain and assessment. international journal of cross cultural management, 8(2), 123-143. trimeche, m. (2002). toward an actualization of the factors determining the firm’s export expansion: insights from the literature, http://aib.jibs.net/ literature review archive, 1-21. turner, j. c., hogg, m. a., oakes, p. j, reicher, s. d., & wetherell, m. s. (1987). rediscovering the social group: a self-categorization theory. basil blackwell. vahlne, j.-e., & wiedersheim-paul, f. (1973). economic distance: model and empirical investigation. in e. hornell, j.-e. vahlne, & finn wiedersheimpaul, (eds). export and foreign establishments, (81-159). uppsala, sweden: university of uppsala press. verbeke, a. (2003). the evolutionary view of the mne and the future of internalization theory. journal of international business studies, 34(6), 498-504. vermeulen, f. & barkema, h. (2001). learning through acquisitions. academy of management journal, 44(3), 457-476. weber, y., shenkar, o., & rayeh, a. (1996). national and corporate cultural fit in mergers/acquisitions: an exploratory study. management science, 42(8), 12141227. weitzel, u., & berns, s. (2006). cross-border takeover, corruption, and related aspects of governance. journal of international business studies, 37(6), 786806. welch, l. s., & luostarinen, r. (1988). internationalization: evolution of a concept. journal of general management, 14(2), 34-55. wilkie, w. l., & pessemier, e. a. (1983). issues in marketing’s use of multi-attribute models, journal of marketing research, 10, november, 428-441. williamson, o.e. (1996). the mechanisms of governance. oxford university press: new york. xu, d., & shenkar, o. (2002). note: institutional distance and the multinational enterprise, academy of management review, 27(4), 608-618. zarate, m. a., & smith, e. r. (1990). person categorization and stereotyping. social cognition, 8(2), 161-185. 48 journal of business strategies zeithaml, v. a. (1981). how consumer evaluation processes differ between goods and services. marketing of services, 9(1), 25-32. zhao, h., luo, y., & suh, t. (2004). transaction cost determinants and ownershipbased entry mode choice: a meta-analytical review, journal of international business studies, 35(6), 524-544. biographical sketch of authors stephen v. horner is an assistant professor of management in the kelce college of business at pittsburg state university. he previously held positions at bethany college and arkansas state university and taught courses at kansas state university-salina college of technology and aviation and mcpherson college. he is consulting editor for the journal of managerial issues and a member and former president of the southwest academy of management. his research appears in several academic publications. daniel baack is the assistant dean and mba director for the daniels college of business program at the university of denver, after previous time at ball state university. he received his phd in international business and marketing from saint louis university. he has published in a variety of academic journals. he serves on the editorial board of the journal of promotion management and is a regular participant in the academy of international business conferences. donald baack is a professor of management in the kelce college of business at pittsburg state university. he previously held positions at dana college, southwest missouri state university, and missouri southern state college. he is a consulting editor for the journal of managerial issues and is an active participant in the southwest academy of management, receiving its outstanding educator award in 2014. he has authored or co-authored numerous textbooks along with academic journal publications. futures options vs. conventional futures: when to use which russ ray department of finance university of louisville louisville, kentucky in october of 1982, the chicago board of trade introduced a remarkably innovative futures contract options on treasury bond futures which offers some very impressive risk-management features not afforded by conventional futures. unlike prior futures contracts, this particular contract was immediately successful. indeed, the volume in this first-ever "futures option" has already exploded to over ten million contracts per year, and continues to grow. the twofold purpose of this article is to articulate these new risk-management opportunities for money managers, and to compare the hedging effectiveness of this new instrument with that afforded by conventional futures. options are options futures options are essentially the same as any other options: calls or puts can be either bought or written (sold). as with other options, buyers of futures options post no margins; writers do. hedging with futures options is transacted by buying _. not writing calls and puts. call options a call option on futures gives the buyer the right to assume a long position in the underlying futures contract anytime before the expiration of the option. upon exercise of the option, the exercise (or striking) price of the option becomes the futures contract price. the risk of being adversely affected by falling interest rates can be hedged by buying call options on futures. consider, for example, a pension-fund manager who has just been notified that three months from now he'll receive a significant sum of money to invest for long-term purposes. the manager intends to invest the funds in u.s. treasury bonds and he can hedge this future investment against the risk of falling interest rates in the interim by buying call options on treasury bond futures. (see box 1.) assume that it's now late may, that the september 17 may august futures price of a treasury bond is 75-00 (yielding 12%), and that a september/75 call option can be bought at a premium of $1,000. buying a september/ 75 call gives the manager the right but not the obligation to exercise the option and thereafter take delivery of a treasury bond next september at a price of $75,000 (assuming he does not close out his futures position before then). suppose that, by august, yields on long-term u.s. treasury bonds do in fact drop to 10%, causing the september futures price to rise from 75-00 to 85-00. because exercise of the call option would result in an immediate $10,000 gain per bond (by virtue of being able to sell a september bond at $85,000 after having bought it at $75,000), the premium on each call option will reflect at least this intrinsic value. assuming no time value, each of the manager's september/75 calls will rise in value to $10,000. boxl hedging costs/bond using call futures hedge: protect a planned, future investment against the risk of falling interest rates in the interim by buying call options on futures. interest current price/bond of hedging rate september investment strategy 12% $75,000 buy sep/75 calls @ $ 1,000 10% $85,000 sell sep/75 calls @ $10,000 loss = $10,ooolbond gain = $9,000/bond net loss = $l,ooolbond = cost of the option consequently, when the manager lifts his hedge by selling his september/ 75 calls, the net gain of $9,000 per bond ($10,000 premium revenue less $1,000 premium cost) will roughly offset the $10,000 extra cost of each spot treasury bond ($85,000 august price less $75,000 may price) resulting from the decline in interest rates. alternatively, the manager could have exercised his options and thereafter taken delivery of the treasury bonds in september for $85,000 each. selling. the options would, of course, be much easier than taking actual delivery of the treasury bonds. either way, the bottomline cost of the hedge per bond is the $1,000 cost of the option. more importantly, this $1,000 hedging cost per bond is but a small fraction of the $10,000 extra cost the manager would have paid for each of his bonds had he not hedged. the unique advantages of a futures-option hedge over a hedge utilizing conventional futures will be enumerated following a brief discussion of put options. 18 put options put options which give buyers the right to assume a short position in the underlying futures contract enable their holders to hedge against the risk of rising interest rates. suppose a portfolio manager wanted to protect the value .of a treasury bond currently price at 80-00 (yielding 11 %) against the risk of rising interest rates. (see box 2.) suppose also that the premium on a december/80 put option were $500. the manager could protect the value of his spot bond against the risk of rising interest rates by buying a december/so put which gives him the right but not the obligation to exercise the option and thereafter sell a· deliverable treasury bond next december for $80,000. if interest rates subsequently rose from, say, 11 % to 13%,causing the value of his spot bond to drop from 80-00 to 70-00, then his put option would be worth (at least its intrinsic value of) $1,000. the $9,500 increase in the value of his option would roughly offset (and, most likely, more than offset, if time value were considered) the $10,000 decrease in the value of his spot bond. again, the bottom-line cost of the hedge is the $500 cost of the option. box 2 hedging costs/bond using put futures hedge: protect the value of a portfolio against the risk of rising interest rates by buying put options on futures. now later interest portfolio rate value 11% $80,000 13% $70,000 loss = $10,ooo/bond net loss = $500 = cost of the option hedging strategy buy dec/80 puts @ $ 500 sell dec/so puts @ $10,000 gain = $9,500/bond the advantages of futures options the advantages of hedging with futures options instead of with conventional futures are impressive. first, the major advantage is that futures options allow hedgers to avoid potentially adverse interest rates, yet still benefit from more favorable interest rates. such a feature is unique to this new instrument and is not afforded by conventional futures which require a hedger to forfeit more favorable interest rates. thus, in the first example, the manager who hedged against the risk of falling interest rates by buying a call option effectively established an interest rate floor for his future investment but not an interest rate ceiling. if interest rates had subsequently risen instead of fallen, the manager could have 19 simply let his option expire worthless (assuming, again, no time value) and thereafter invested his funds at the more favorable rate. similarly, in the second example, the manager who hedged against the risk of rising interest rates by buying a put option effectively established an interest rate ceiling but not an interest rate floor. in essence, then, futures options are insurance policies against potentially adverse interest rates, with the cost of the insurance being the cost of the option(s). a second advantage of futures options is that margins are not required, so that the cost of hedging is generally less. if the exercise price of the option is equal to (or at least close to) the underlying futures price as was the case in both of the examples above then the cost of the option will generally be significantly less than the cost of margin. finally, a third signific~~t advantage is that the cost of a futures-option hedge is known and fixed in advance it is simply the cost of the option. this is not the case with conventional futures whose margins are marked to the market daily, so that hedging against incorrect expectations can cause unpre.dictable futures losses every day. thus, futures options help stabilize future cash flows. the disadvantage of futures options the disadvantage of hedging with futures options is that option costs are not refundable, whereas margins (on conventional futures) are. if interest rates remain roughly unchanged over the hedging period, then the manager hedging with futures options must incur the cost of the option regardless, whereas the manager hedging with conventional futures will have his margin refunded. obviously, then, the question becomes when <to use which. a volatility criterion futures options become increasingly better hedge instruments than conventional futures as interest rates become more volatile. this is so because the cost of the option is fixed, causing its hedging cost per unit of volatility to become increasingly less as volatility increases. such is not the case with conventional futures whose margins are marked to the market. moreover, as is likely during periods of high volatility, futures options allow the hedger to benefit from more favorable interest rates; conventional futures don't afford this feature. on the other hand, conventional futures are better hedge instruments during periods of low volatility. this is so because, once the (unnecessary) hedge is lifted, margins are refundable, whereas option costs are not. in general, then, the when-to-use-which decision rule is rather straightforward. for hedging periods during which low interest-rate volatility is. expected, conventional futures are a better hedge; for hedging periods during which high interest-rate volatility is expected, futures options are a 20 better hedge. moreover, given that interest-rate uncertainty increases as the length of the hedging period increases, futures options are better hedge instruments for lengthy hedging periods. the key, of course, in implementing this decision rule is to form an expectation regarding interest-rate volatility. if such expectations can be formed, then the hedging decision is rather straightforward. if interest-rate uncertainty is so great that such expectations can't be formed, then the hedging decision is made by default in favor of futures options which insure against such uncertainty. in any case, money managers are able to minimize their cost of hedging. conclusion futures options are a remarkably innovative tool with which to manage the risk of interest-rate uncertainty. by offering several risk-management features not afforded by conventional futures, they enable lenders, borrowers, and managers of money to more efficiently manage the risks associated with seemingly capricious interest rates. for money managers especially those whose fiduciary responsibilities require them to hedge prudently futures options are a welcome element of certainty in a world which is otherwise. references 1. chicago board of trade. introducing options on treasury bond futures, 1982. 2. __. opportunities in options on treasury bond futures, 1982. 3. __. strategies for buying and writing options on treasury bond futures. 4. ray, russ. "financial futures: a powerful risk-management tool." management review. june, 1983. 5. __. "a policymaker's guide to financial futures." business and public affairs. spring, 1983. 6. __. "financial planning with financial futures." financial planning. november, 1985. 21 futures options vs. conventional futures: when to use which catalysis of strategic planning for small business harold w. fox department of marketing, finance and general business pan american university edinburg, texas analysis of the roles and pitfalls of substitute directors who accelerate strategic planning in small firms is the purpose of this paper. it discusses why small companies have use for substitute directors, how they are organized into a quasi-board, and what they do. the first need of a small business, says peter drucker, is strategy (4, p. 469). indeed, research confirms, small companies that engage in strategic planning are significantly more successful than those that do not (8, p. 92). anything that would enhance the small businesses' precarious survival probabilities (9, pp. 28, 31, 148) would seem worth doing. but most small firms eschew strategic planning (11, p. 25). apparently many ownermanagers lack the requisite temperament and tools. daily crises absorb their time and keep them too busy to plan-although many of these crises might have been forestalled with adequate planning. even if owner-managers recognize the need and their own inability to cope with strategic planning, they cannot turn to all the sources of help that are available to larger organizations. they do not have, and do not want, planning personnel or other staff people. strategy formulation is not suitably delegated to consultants since, typically, strategies prepared by others are not used (12, pp. 289-293). the board of directors of a large corporation has overview of strategic planning as one of its duties. no such institution exists for the proprietor or partner. in small, close corporations the board's exercise of its functions is usually nominal (2, passim). enter: quasi-boards to resolve this dilemma, some chief executives have instituted quasiboards of directors (1, p. 103 and 7). these advisory councils act as if they were large-corporation conventional boards of directors. they guide the independent businessperson and the firm's top cadre to formulating and implementing strategies. the operative word is "advisory." logic and persuasion instead of legality and power are their tools. _39_ the accompanying exhibit illustrates the position of each style of board within a corporation. the conventional board has the authority to govern; the chief executive officer is its subordinate. the quasi-board advises; it is subordinate to the chief executive. the conventional board of directors is official. the quasi-board is informal. thus, even in a small corporation where both types of boards may exist, there is no conflict of roles. this informal status is important to the efficacy of quasi-boards. it may make the recruiting process, to be discussed subsequently, easier because members do not assume legal obligations. it frequently makes the adviseand-suggest role more effective because members are no real threat to the owner-manager. the latter appointed them and can dismiss them. owner-managers are psychologically set to hear-and to act upon-the advice they are soliciting. they are more willing to discuss the businesstheir secrets, ideas, errors, and apprehensions-with this nonthreatening group. and they are assured that such disclosures will remain confidential with the well-chosen council. members have no legal mandate and no disclosure requirements. this trust provides a necessary basis for a consultative relationship. in this milieu, examples will demonstrate later, strategic planning is apt to be sound. but such an atmosphere does not develop by happenstance. it derives from judicious organization of the quasi-board. corporate organization chart showing legal relationships istockholderls i board of directors including chairman of the board 1president 1....---------, other officerls i advisory board 1 production manager 1 __ sales manager 1 accounting man~ger other managers _40_ organizing a board an effective quasi-board is small. it comprises three or four outsiders and perhaps two key managers. the owner of the business presides. astute owner-managers seek mentors who are constructive and practical. they invite business acquaintances, owners of noncompeting businesses, speakers or registrants at executive seminars, local professional people, and trusted friends. an important qualification of independent members is that the owner-manager respect their judgment. "you have to be willing to listen to the members," says dick flaute, a wholesaler. "and they have to be strong enough in their personalities to make you listen" (6, p. 42). are people of this caliber willing to join? yes, they may, in fact, be easier to recruit than the members of conventional boards of directors. the latter have come under increasing burdens of legal liabilities. many qualified personages are reluctant to serve (10, p. 23). but members of quasi-boards are exempt from this onus. hence competent candidates usually are receptive to an invitation. motives of quasi-board members vary. perhaps they enjoy the change of pace, welcome the broadening of their experience, or gain fulfillment. but money should not be one of the motives. besides reimbursement of expenses, an honorarium places the relationship on a sound business basis. after all, if the advice were free, it might seem worthless. but the honorarium is modest, perhaps $500 to $1000 per session, which includes betweenmeetings consultations at no extra charge. this contrasts with the average annual compensation of $18,900 for outside directors of over 600 large corporations. additional payments were forthcoming for committee service (3, p. 1). in the case of quasi-boards, the small fee suffices to obligate each member to treat the affiliation seriously. a higher fee could be dysfunctional. it might attract sycophants who value the income above the intrinsic satisfaction. they are liable to say whatever the chief executive wants to hear instead of giving an independent appraisal. the firm's cadre might perceive them as rivals for top-level jobs. (this has happened.) further, a higher fee would be burdensome to many small concerns. council members serve at the owner's pleasure as long as they are effective. if a quasi-board fails to improve the company's strategies and performance, it constitutes a waste. dissolution may be considered by the owner and the board members. more often, some change in staffing is all that is necessary. a few incumbents lose interest. or conditions change. firms encounter situations outside the ken of the panel. the owner monitors these developments. some turnover in membership should be expected and implemented. _41_ the quasi-board and strategic planning one of the main purposes of organizing a quasi-board is to catalyze strategic planning. this can come about through various means, either formal procedures or, more frequently, informal evolution. perhaps the independent business operator has some notions about the arcane art of strategic planning but lacks the sense of urgency and/or the knowledge to get started. that owner may well include "strategic planning" in the statement of purpose or mission of the quasi-board. occasionally, under such circumstances, structured planning becomes a regular task. at the opposite end of the spectrum, the issue arises inevitably even if the owner does not sense the need for formal strategy. at the first orientation session for the carefully selected outside members, their initial request will be: "define your business." this necessary exercise leads to further probes about the firm's objectives and general direction. soon the panel has a fairly good grasp of the extent and usefulness of the firm's planning. at its urging, the formulation and review of strategies becomes a major item on future agendas. most quasi-boards function at some middle range between formal procedures and relaxed comradery. the informal atmosphere and lack of legal compulsions favor some middle course. the change agent can only coach and advise the owner. on the other hand, owners pay for the meeting and respect the participants' expertise. hence they strive to present to the panel the best thought-out, most carefully prepared plans that they can devise. "my quasi-board forced me to think strategically and to formulate a plan that would meet the members' rigorous standards," notes richard r. yoke, chief executive officer of technicote corporation of memphis, tennessee (7). thus this institution not only preserves but actually strengthens the small businessman's independence. the regularly scheduled meetings, quarterly or semi-annual, also provide discipline. to assure productive use of meeting time, owners prepare and distribute briefing papers, financial statements, budgets, and an agenda. in the course of doing so, they review their firm's current position and plans for the future. meetings focus on the substance of the strategy. all aspects are explored. the technical familiarity of the inside board members balances the broad perspectives of the outsiders. jointly, they seek to build on the company's strengths and to shore up or de-emphasize its weaknesses. thanks to the diverse backgrounds of the participants, inputs are practical ideas and suggestions. synergy ensues. to sharpen the analysis, one mem~ ber might even play "devil's advocate." after a strategy has been adopted by consensus, it is recorded in the meeting minutes. at the next session the first order of business will be the owner's report on the implementation of the strategy and on the results to date. _42_ this format exerts strong pressure for strategy formulation and execution. the business chief (perhaps also the concern's top lieutenants) is directly involved in devising the strategy. he or she is psychologically committed to carrying it out and reporting outcomes to the advisory panel. scope of deliberations compared to a large corporation, small firms have simpler strategies. formulation procedures are somewhat haphazard. the owner's intimate familiarity with customers, production processes, and industry characteristics substitutes for multiple planning tiers, sophisticated techniques, even formal research and environmental scanning. these realities favor the use of an auxiliary mechanism such as a quasi-board. with adequate preparation, it can be an effective and efficient catalyst, producing results in a single meeting. a few examples (mostly 7) show some catalysts in action and reveal the breadth of coverage. *two-hour sessions for formulating a growth strategy are customary at dayton plumbing supply, inc., dayton, ohio. the company's president formed a quasi-board several years ago to surmount a plateau in sales. since then, sales have doubled (6, p. 42). *the quasi-board of krizman, inc. of mishawaka, indiana, cleared the air for the owner and the newly appointed general manager by verifying and supporting various strategic policy changes that the latter had instituted. *at another privately held firm, the quasi-board arbitrated between a conservative septuagenarian owner and his daughters who sought to revolutionize strategies. *bank of mid jersey has long maintained three advisory boards corresponding to its segmentation: farming, business, and consumers. each council recommends strategies within its purview. *after orientation, the newly formed advisory board of sterling magnetics pvt. ltd. in goa, india, pondered banking relations, excise tariffs and sales taxes, inventory control, production and subcontracting policies, and personnel. *at chapel electric co. of dayton, ohio, the "four-member advisory board made me do a lot of planning," says fred setzer, jr., president. he credits his board with assisting in this firm's growth (6, p. 42). "'divestment of a hardware store and farm supply operation was one of the recommendations for deli inc. of millston, wisconsin. the sole stockholder was reluctant at first, but says he is now glad he acceded to his advisory council (5, p. c-l). *foothill bank in mountain view, california, uses its advisory panel for two-way communication with the local population. members meet to discuss the bank's new strategies and provide officers with feedback from the community. _43_ although other examples could be adduced, it should be evident that anything of strategic importance is suitable for consideration by a quasiboard. the following comment is typical: "i designed my advisory council so it would fit my company's needs and compensate for my personal weaknesses" (7). these two factors are critical. constructive recommendations for a firm's strategy and compatible chemistry with the owner are the two major criteria of the catalyst's effectiveness. evaluation realistic goals, prudent selection of outside members, and capable administration of quasi-boards can lead to useful contributions. owners report that they divert much more time from hands-on management to strategic planning and board procedures than they expected. moreover, full disclosure to the panel is a prerequisite for constructive performance. boards of companies that withheld financial statements and other particulars failed. astute owner-managers do not expect miracles. outsiders need some time and guidance to learn the intricacies of the business. but suggestions in the realm of generic business strategy should be forthcoming quickly. after two or three meetings, a quasi-board should reach optimum effectiveness. well-functioning councils broaden managerial expertise and present objective inputs for strategic decisions. but they are not universal panaceas. for example, a group is usually unsuitable for coping with a crisis. emergencies of strategic import do not wait for a board to convene and deliberate. in a crisis, one person has to take charge decisively. this person is ordinarily the business owner who retains full responsibility for results. in practice, the owner often calls on one board member who has the particular qualifications needed in that crisis. another intractable challenge for a quasi-board is familial conflict, a common occurrence in closely held companies (2, passim). the board is supposed to be objective, yet the issue is largely emotional. boards tend to recommend what seems best for the business. this may not satisfy the owners. quasi-boards cannot relieve owners of personal problems or major decisions. altogether, as has been shown, the combination of a persuadable proprietor and a proficient panel can help a business thrive. the main benefit of a quasi-board, many entrepreneurs report, is that it requires them to formulate explicit strategies justifiable to critical experts. the catalyst's challenge, on the other hand, is to instill professional discipline in the firm's management without impairing the owner's creative entrepreneurship. references 1. cohn, t. and r.a. lindberg (1974), survival & growth. amacom, new york. _44_ 2. danca, l. (1975), beyond survival. reston publishing co., inc., reston, va. 3. deloitte haskins + sells (april 27, 1984), "survey of board practices," the week in review. 4. drucker, p.f. (1973), management. harper & row, publishers, inc., new york. 5. jouzaities, c. (february 23, 1983), "advisory panels offer good advice at a cheap price," chicago tribune. 6. kunde, d. gune 17, 1984), 'iadvisory panel aids 'little' guy," dayton daily news. 7. personal experience, interviews, or correspondence. 8. robinson, r.b. (march 1982), "the importance of outsiders in small firm strategic planning," academy of management journal. 9. reagan, r. (1983), the state of small business: a report of the president. u.s. government printing office, washington, d.c. 10. rout, l. (march 3, 1981), "job of corporate director becomes more susceptible to legal assault," wall street journal. 11. sexton, d.l. and p.m. van auken guly 1982), "prevalence of strategic planning in small business," journal oismall business management. 12. steiner, g.a. (1979), strategic planning, free press, new york. _45_ catalysis of strategic planning for small business creative financing by multinationals jeff madura college of business university of central florida orlando, florida robert boothe fogelman college of business memphis state university memphis, tennessee multinational corporations (mncs) are well aware of the potential rewards and existing risks when operating in foreign environments. while mncs commonly consider the possibility of lower labor or land costs when producing goods overseas, they often neglect the potential reduction in costs due to financing opportunities available in other countries. relatively low interest rates in some foreign countries will allow for low financing costs for subsidiaries located in these countries. yet, these low foreign interest rates can also support other subsidiaries os well os the parent in other countries where interest rates are relatively high. the following discussion focuses on how mncs can finance much of their global operations with funds from countries where interest rates are low. if conducted correctly, foreign financing can easily save a mnc millions of dollars each year without exposure to exchange rate risk. the financing decision consider a hypothetical u.s. based mnc called global inc., that has foreign production and revenue source subsidiaries in a country that notoriously has high interest rates (called "hint") and in a second country with notoriously low interest rates (called "lint"). global inc. would likely obtain some financing in lint for its subsidiaries based there. revenues generated by these subsidiaries can be used to pay back the low interest rate loans. yet, global inc. may finance the remainder of its operations with funds from the u.s. (its parent's home country), and from hint, even though interest rates are higher in these countries. the obvious reason for not more fully capitalizing on the low-interest rates in lint is that such loans would have to be paid back in lint's home currency (from here on referred to as the lint franc). if the lint franc substantially appreciated against the revenue source currencies over the loan life, the effective (exchange rate adjusted) financing rate could be quite high. 32 mncs are well aware of techniques such as a forward hedge to cover against exchange rate fluctuations. they could, for example, borrow lint francs at the low interest rate, convert them to the currency needed, and simultaneously negotiate a forward purchase of the lint franc for the time at which the loan is to be repaid. yet, under conditions of interest rate parity, the forward rate on the franc would contain a premium large enough to offset the interest rate differential. if so, global inc. would not be reducing its financing costs. because of this offsetting effect from forward hedging, mncs that wish to avoid the exchange rate risk may give in and simply decide to finance in whatever currency can be matched by future inflows (balance sheet hedging). global inc., for example, may simply finance hint's operations from local banks in hint. even though the interest rate is higher in hint, future inflows to subsidiaries located there will most likely be denominated in hint's currency and can therefore be used to repay the loans without exposure to exchange rate risk. while this strategy. may appear sensible on the surface, it reflects neglect of several possible alternative approaches that could substantially reduce the mnc's overall financing cost. these alternative approaches are discussed below. techniques to use foreign financing without increasing exchange rate exposure there are a variety of techniques available to the mnc for obtaining funds from the low interest country (lint in our example) and covering the exchange rate risk. the appropriate technique or techniques that a mnc should use depend on the characteristics of the mnc. all techniques reflect an effort to obtain future cash inflows in lint francs so that low interest rate loans previously obtained from lint could be repaid without worry about exchange rate fluctuations. the techniques can generally be classified into one of four multinational corporate policies: • invoicing policy • transfer pricing policy • dividend remittance policy • strategic planning policy a discussion of how each policy can be implemented to achieve a reduction in financing costs follows. invoicing policy perhaps the most common invoicing policy for the problem at hand is for the u.s. parent and subsidiaries in hint to invoice some of their products in lint francs. this would generate cash flows in lint francs, which could be used to repay loans from lint. if, for example, some foreign customers 33 commonly have net receivables in lint francs, they may desire to pay for their imports from global inc. in francs. for the same reason, the u.s. parent of global should determine whether any u.s. companies it sells products to would prefer to make payment in lint francs. similarly, subsidiaries located in hint should replicate this effort for their sales. mncs that consider the possibilities above exhibit the imagination necessary to obtain low cost financing without becoming exposed to exchange rate risk. yet, the invoicing strategy identified above may only allow for a portion of the overall mnc's financing to be obtained at low interest rates. if global inc. could create more sources of lint franc revenues, it could afford to obtain more financing in lint francs and cover the future interest payments on this financing with these additional sources. for example, consider a subsidiary of global based in lint that periodically purchases dollar-denominated supplies from a u.s. supplier. these subsidiaries in lint could ask their u.s. parent to make payment to the u.s. suppliers for them. in exchange for this favor, the subsidiaries in lint could use their francs that they normally would have converted to dollars to pay for exports from the u.s. supplies to instead repay franc-denominated loans initially drawn by the u.s. parent. in this way, additional financing could be obtained at low interest rates and an additional source of lint franc revenues world be created to cover future interest payments on previous loans. the invoicing possibilities are endless. subsidiaries in lint may even find some local businesses that prefer payment in a currency other than the franc (perhaps to cover their own net payables positions). if so, the subsidiaries in lint, when purchasing local goods, could arrange for the u.s. parent or subsidiaries in hint to use their respective currencies to pay for these goods. in return, the subsidiaries in lint could use their cash inflows to repay francdenominated loans drawn by hint subsidiaries or the u.s. parent. transfer pricing policy beyond invoicing strategies, global inc. could also adjust its transfer pricing policies to allow for additional financing in lint francs. for example, assume that subsidiaries in lint and hint trade with each other. if lint subsidiaries were charged low prices for imported supplies, this would allow them to retain more of their funds to repay franc-denominated loans drawn by any part of global inc. any supplies or managerial services provided by the u.s. parent to lint subsidiaries could also be handled in the same manner. all transfer pricing decisions should be made with consideration of any constraints that may be imposed by the host government. dividend remittance policy the dividend remittance policy by global inc. can also be tailored to insulate against exchange rate risk when financing in lint francs. for example, the u.s. parent could have borrowed francs at the low interest rate and converted these francs into dollars for use in the u.s. it could then in34 struct the subsidiaries in lint to use a portion of their earnings in francs to make interest payments on franc loans drawn by the parent rather than send dividends to the parent. this not only locks in the low financing cost for global inc. but also avoids transaction costs of converting francs into dollars, and can even avoid a withholding tax that may have been imposed by the lint government on dividends remitted back to the parent. strategic planning policy even a firm's strategic planning on where to establish future subsidiaries can reduce financing costs. consider a situation where global inc. plans to establish a research and development subsidiary. because the function of such a subsidiary is not to generate revenues but to create products that may someday be marketed by other subsidiaries, it will operate at a loss. the strategic planning division should consider this information as it decides where to establish such a subsidiary. it the subsidiary was built in lint, it would absorb lint francs from global inc. in order to cover operating costs. this would use up a portion of the franc revenues that could be used to cover interest payments on existing loans, and therefore reduce global's ability to match future cash inflows with future liabilities in lint francs, but should be located elsewhere so that it absorbs some other currency to cover operating expenses. now consider a second strategic plan of global inc. to establish a subsidiary that will act as a distribution center, receiving finished goods from other subsidiaries and sending them to importers from various countries. such a subsidiary could be global's cash cow, since the cost of producing the products could be largely incurred by the subsidiaries that produced the goods. lint would be the ideal location for such a cash cow subsidiary, since the products received by the distribution subsidiary and exported to various markets could be invoiced in francs, thereby serving as a source of lint franc revenues. it is possible that the location of lint relative to the markets where the products are to be sold is not appropriate for a distribution subsidiary (as export transportation costs may be excessive). in this case, the subsidiary could be set up in another country, but still invoice much of the exports in lint francs. the discussion illustrates how proper strategic planning would be able to generate periodic cash inflows over the long run of whatever currency the mnc has used to finance its assets. operationalizing the approach some mncs are using the creative financing techniques described here. for example, honeywell inc. has been known to borrow foreign currencies in which it has future receivables, so that it can cover repayment on such loans. other mncs have from time to time used subsidiary-generated earnings to pay coupon payments on bonds denominated in that currency. yet, it is unusual for mncs to conduct a complete analysis on its sources of financing, with the intention of reducing the firm's cost of capital. mncs typically devote 35 more resources to enhancing revenues or reducing production costs, but rarely evaluate their financial liability position. a dollar saved due to lower financing costs is just as valuable as a dollar save due to reduced production cost. furthermore, it is more valuable than an extra dollar earned from increasing revenue, since additional revenues contribute to earnings by only a fraction (the profit margin) of their increase. to operationalize the approach prescribed here, an mnc needs to first identify sources of low cost funds. even as interest rates do change over time, some countries typically maintain lower interest rates than others. for example, interest rates in japan, switzerland, and west germany are commonly lower than in other countries. in some cases, it is not necessary to borrow specifically from banks in these countries since the currencies involved here are available in the eurocurrency market. our hypothetical example specified only the lint franc as a low cost source of funds. in reality, an mnc with subsidiaries in any countries where interest rates are low may have several alternative sources. this allows for more flexibility in operationalizing the policies recommended to obtain low cost financing. ideally, the mnc would attempt to generate much of its aggregate revenues in the currencies that exhibit low interest rates. its invoicing, transfer pricing, dividend remittance and strategic planning policies would be designed to insulate against the exchange rate risk that results· from financing in one or more low-interest rate currencies. this recommendation is not limited to short-term or even medium-term loans. from. ·a.l~ng-term financing perspective, the mnc could even denominate its bonds in a cur~ency that exhibits a low interest rate and enact policies that force enough periodic net cash inflows in that currency to cover future coupon payments. the amount of financing that can be done in low cost sources of funds without incurring exchange rate risk is dependent on the volume of net cash inflows of these low interest rate currencies that can be generated by the mnc. the major limitation of mncs in generating sufficient cash inflows in these currencies is lack of imagination in modifying their invoicing, transfer pricing, dividend remittance, and strategic planning policies. some critics may mistakenly take the term imagination to infer risky speculative strategies. to the contrary, imagination in the context of multinational financing can achieve a lower cost of financing and simultaneously hedge against exchange rate risk. many large mncs have the equivalent of $1 billion or more in long-term debt alone. it they .could reduce their average cost of financing by just one percentage point, annual interest payments on $1 billion would be reduced by $10 million, and annual pretax profits would rise by $10 million. in reality, a mnc may not be able to transform all of its liabilities into a low interest rate currency unless it was willing to accept some unhedged exposure in that currency. yet, it may easily be able to transform 10 percent or more of its local liabilities to a low interest rate currency, and adequately cover that liability exposure by creating future revenue sources (cash inflows) in that currency. 36 if a mnc with $1 billion in debt transforms just 10 percent or its debt into a low interest rate currency, and saves 3 percentage points on the interest rate, it will reduce its financing costs by $3 million per year. limit8tions to consider the multinational policies recommended to reduce the financing costs of global inc. can distort the profit distribution of the individual units that make up the corporation. any arrangement by which funds within the corporation are being reallocated to capitalize on the low cost of financing can cause a distortion in profits to the individual subsidiaries. this can limit the degree to which a firm may be able to implement the strategies proposed here. to avoid adverse consequences from such a distortion, a centralized management group should be assigned the power to make decisions on the policies involved. this will avoid any potential infighting between subsidiaries on policies that may help one subsidiary at the expense of another. policies should be determined with consideration of not any individual subsidiaries, but of the mnc as a whole. to ensure that management at the subsidiary level maintains a congruent objective of contributing to the overall value of the mnc, they should be rewarded according to their contribution to this objective rather than their individual profit level. some mncs currently follow this managerial style in order to maximize the welfare of the overall mnc. a second possible limitation to the strategies proposed here is the existence of related host government laws. for example, a transfer pricing policy desired by the mnc may not be allowed by a particular host government. while this would prevent use of transfer pricing to build net revenues in the low interest rate currency, the alternative strategies proposed here could be implemented instead. some host governments may prevent the home currency from being converted into another currency. this would disrupt the plan of borrowing the low interest rate currency and converting it to the currency needed. such a barrier typically exists only in non-industrialized countries. thus, the creative financing could still take place within most industrialized countries. given that the mnc needs to generate future revenues in whatever low interest rate currency it borrows, it would likely consider only the currencies of industrialized countries anyway. while the potential obstacles identified here are worth considering, they should not prevent a mnc from restructuring its liability composition in order to reduce its cost of capital. none of the obstacles is too large to forego the opportunity to save the company millions of dollars. concluding comments mncs have generally been very willing to consider potential revenuegenerating ideas in foreign markets. they have also been willing to consider a variety of cost-cutting ideas. these ideas have served as the motivation 37 for firms to become multinational in the first place. however, there has been a tendency to take financing costs as given, as if the mnc has no control over them. granted, the mnc does not dictate interest rate levels in various countries. yet, it does have control over the source from which it obtains its necessary financing. interest rates in some countries are sometimes seven percentage points (annually) less than where the mnc is currently obtaining its funds. how large must this interest rate differential become for mncs to realize the potential savings that can be achieved by the creative financing discussed here? it is hoped that this article will help managers recognize that the differential olready merits their attention in strategic planning. 38 creative financing by multinationals comparable worth: a legal and professional update c. ray gullett college of business administration the university of texas at tyler tyler, texas it is well known that women as a class of workers earn less than men. women's wages average approximately two-thirds of what male workers earn. during the last twenty years this proportion has changed very little [13] although some narrowing of the gap has occurred since 1979. it is also common knowledge that women are clustered in a relatively small number of occupational categories. in 1981 about seventy-five percent of women workers were employed in six broad categories ([21]' p. 54): clerical workers; service workers; educators, librarians, and social workers; sales clerks; nurses and health technicians; clothing and textile workers. in summary, women in general earn less than men and are crowded into a relatively small number of occupations. of course these macro statistics do not tell the entire story. variations by such categories as age, job grouping, location, education, and seniority provide differing results. for an employee the most important wage relationships are in his or her own firm. this is mainly where the individual worker experiences pay equity or inequity. and, as the great volume of publicity in the last few years suggests ([2], [6], [20)), many women in the workforce do believe that they are underpaid for the work they do. much of this underpayment is blamed on sex discrimination. equal pay act of 1963 it is generally agreed [22] that "equal pay for substantially equal work" has been largely achieved through the enforcement of the equal pay act of 1963 [24]. this law prevents employers from paying men more than women who do essentially the same work. thus an employer cannot arbitrarily decide to pay female bank tellers less than male bank tellers simply because of their sex. the law does not require that jobs be identical to be covered. only substantial equality is necessary. neither slight differences in duties nor different job titles create an exception. equality among jobs is measured by their similarity of skill, effort, responsibility, and working conditions. exemptions to the laws include pay differences based on bona-fide merit systems, incentive plans, seniority systems, or any other factor other than sex. 1 limitations of epa coverage while the equal pay act has reduced pay discrimination in the workplace, it is limited in its application. as stated above, the act deals only with discrimination in pay among jobs which are substantially the same in content. it cannot be used to make pay comparisons among jobs which are very different. thus a women clerical worker cannot successfully claim pay discrimination under this law because her salary is less than that of a male maintenance worker. the two jobs do not meet the "substantial equality" test under epa and cannot be compared for purposes of this law. critics of pay practices in government and industry ([2], [4], [19]), have, however, contended that many jobs which are traditionally held by women are undervalued in the marketplace when compared with jobs traditionally held by men. nurses, for example, are commonly paid less than truck drivers; public schoolteachers earn less than skilled craft workers. some critics ([2], [19]) also contend that job evaluation systems used in many firms are designed that "men's jobs" receive a higher rating than jobs which are typically held by women. comparable worth defined these criticisms of pay practices fall under the heading of an approach to pay called comparable worth. jobs are said to be comparable when: (a) they have substantially different duties, but (b) are rated as having approximately equal value by an "objective" job evaluation plan. because they are comparable, it is argued that they should be paid the same even when the average market rates for the jobs differ. title vii of the civil rights act of 1964 and comparable worth because the equal pay act does not cover cases of comparable worth, advocates of reform in pay structures have sought relief under title vii of the civil rights act of 1964 (as amended) [25]. this law is "broad brush" legislation which prohibits discrimination in the workplace based on race, religion, sex, or national origin. it applies to such employment functions as selection, promotion, and termination of employees. but does it apply to compensation practices which may be discriminatory but are not covered by the epa? due to the wording of title vii, there was uncertainty for many years regarding coverage ([15], [18]). in 1981 the supreme court answered this question in its often-cited gunther decision [7]. essentially, the court said that title vii allows persons to file charges of sex-based pay discrimination where there is no epa violation. but the court was careful to state that its ruling in the gunther case did not explicitly deal with comparable worth. gunther opened the door for such charges to be filed, but the court did not reveal how it might rule. 2 both before and after the gunther decision federal courts have heard pay equity cases charging title vii discrimination. not all of these decisions are in agreement with each other. this is in part because of the differences in the facts of each case. additionally, judges vary in their views toward pay comparability. however, the courts have agreed that a crucial factor in finding a title vii violation is intent to discriminate against women with regard to pay. for example [17], the deliberate segregation of women into lower paying jobs and men into higher paying ones is a title vii violation although not a comparable worth situation. similarly, the gunther case involved a decision to pay women less than the market-surveyed rate. this decision was based on an employer belief that at least some women would work for less than the average "going rate." again, the employer lost the case. comparable worth cases the more difficult cases are those involving conflicts between the internally evaluated worth of jobs and their average of "going rate" in the marketplace. these are true comparable worth cases. in these situations the employer has measured a group of jobs with the same internal job evaluation plan. although different in content, some of the predominantly female jobs are ranked equal in value to some predominantly male jobs. however, the male jobs have higher market rates than their female counterparts. when the employer has chosen to pay the market differential rates for these jobs, comparable worth discrimination has been charged. not all federal courts have sided with employers on this type of case. no federal appeals court, however, has ruled against an employer in such a case. in general, discriminatory intent has not been found ([1], [3]' [5]' [9]) where the employer has chosen to follow market rates for jobs internally rated as comparable although dissimilar in content. pay inequities caused by different market rates were not ruled to be intentional discrimination. in short, at the federal level the comparable worth concept shows little legal vitality. while the supreme court has not yet ruled on the issue, it may have already signaled its position when it refused to hear a ninth circuit decision [16] denying a comparable worth claim. the current status of pay equity claims is outlined in figure 1. a number of states have passed some form of comparable worth legislation. frequently these laws apply only to public sector employees. many are worded so vaguely that court tests are needed to define their impact on the private sector. comparable worth and collective bargaining another method for obtaining comparable worth may be through the collective bargaining process. however, union support for this concept has not been uniform. 3 legislative/judicial paths to pay equi ty figure 1 -.:t' plaintiffs likely to lose plaintiffs likely to win ........ ,~ " ... ... equal pay act title vii of civil rights act i'" ......", ",/' ~ ~ , has the employer rated dissimilar jobs as approximately equal in terms of an internal job evaluation plan? has he chosen to pay male-dominated jobs more than comparable female-dominated jobs because of differences in market rates shown in market surveys? are women kept in segregated departments and thus prevented from movement tnto higher paying male-dominated jobs? has the employer made market surveys of "going rates" for jobs? has the employer chosen to pay average market rates for male ~ dominated jobs and less than average "market ) rates for female-dominated jobs? ," are men and women performing substantially equal work in the same enterprise and being paid different rates? are men and women being hired for the same or substantially equal work but being hired at different rates because the employer believes women will work for less? by far, the primary activity in comparable worth bargaining has been in the public sector. examples of agreements that involve pay equity settlements include the city of san jose and the american federation of state, county, and municipal employees (afscme), new york state and its employee unions, the city of los angeles and afscme, and washington state and afscme. by contrast, private sector bargaining over comparable worth has been sparse. yale university has bargained with the hotel and restaurant employees international union, afl-cio on this issue. the result [23] was a substantially improved wage scale for workers in female-dominated jobs, but it is not clear whether a true comparable worth settlement was reached. american telephone and telegraph [20] reports the development of a form of comparable worth for twenty job categories. the company worked with its three unions to develop the plan. at&t claims that little undervaluing of its jobs was discovered. changes were initially delayed because of divestiture concerns. in 1986 negotiations with the cwa and ibew no mention was made of the issue. a look at other recent private settlements on the national level [14] reveals nothing regarding comparable worth. settlements in rubber, autos, steel, transportation, and the garment industry provide examples. in these and other industries, stiff foreign competit~on, high labor costs, and restrictive work rules have forced many unions to concentrate on cost-cutting measures and "give-backs" to preserve jobs and provide retraining for current members. in many industries male domination of unions appears to discourage support for comparable worth bargaining. some non-union firms [6] have also begun to experiment with forms of comparable worth. bankamerica, chase manhattan bank, ibm, tektronix, and motorola have all been involved. tektronix and motorola, both high-tech firms, report little increase in wage costs as a result of their efforts. few of their jobs are dominated by one sex. these two companies have relied on revised job evaluation plans which cover all workers. ibm has taken an even more direct approach by raising the wages for female-dominated jobs which are two or more standard deviations from an average wage level. some firms, such as bankamerica corporation, have revised their job evaluation to put more weight of job characteristics common in jobs traditionally held by women. for example, eyestrain and muscle fatigue are among factors given additional weight. barriers to implementation as noted earlier, there is no federal court support for comparable worth at the appellate level. without new legislation by congress, the supreme court is unlikely to rule against employers in a true comparable worth dispute~ and in the present political climate congress seems unlikely to pass such legislation. 5 politics aside, the implementation of any such legislation would be extremely difficult. an administrative agency would be necessary to monitor and make rulings on pay disputes. ultimately, the federal courts would decide many of these cases. such dispute settlement would be much more complex than enforcement of the equal pay act. it is not, therefore, surprising that congress may avoid passing such legislation. outside the public sector, unions appear unlikely to demand comparable worth settlements. more pressing issues, such as job security and worker retraining, will continue to be their primary interests. perhaps because men make up the large majority of many unions, there is often lit tle internal political support for the issue. also, the leadership of some unions may perceive how difficult a comparable worth settlement would be to establish and administer. from the employer's viewpoint there can be no substitute for market realities. without a law which requires comparable worth or a union powerful enough to insist upon it, most profit-seeking firms with large numbers of lowerpaid ''female'' jobs will simply be unwilling (and perhaps unable) to pay the extra wages. and even if the employer is willing to bear this expense, the resultant web of internal relationships created among dissimilar jobs could result in great administrative problems. a change in the wage rate of any job or elass of jobs could result in changes throughout the firm. if the company is dispersed geographically, the changes could become more involved and complex. if comparability is based on industry standards or other multi-firm relationships, even more complexity could be expected. job evaluation and comparable worth perhaps the biggest problem with comparable worth lies in the assumption that there is a single, truly objective method for determining the worth of all of an organization's jobs. although advocates of comparable worth are sometimes ambivalent about job evaluation, most see it as the solution to valuing dissimilar jobs. unfortunately, job evaluation is not the objective measuring tool that we might wish it to be. instead, it is a collection of methods that systematize judgments regarding the relative value of jobs in a job hierarchy. in truth, job evaluation can be manipulated through statistical or judgmental methods to provide varying measures of job "worth." most companies also use different job evaluation systems for different job families-. clerical jobs, factory jobs, and executive jobs all have separate plans. currently, there is no widely-accepted evaluation system that covers them all. these observations are not meant to discredit job evaluation. they simply point out its somewhat subjective nature. job evaluation may measure what its authors set out to measure. however, it does not provide results which are independent of human design. indeed, job evaluation may be constructed to support or oppose adjustments to pay levels. the choice of compensable factors used, weights placed 6 on each of the factors, and the number of degrees present for each factor would influence outcomes. suppose an employer wishes to make pay adjustments favorable to femaledominated jobs. suppose further that a point-factor plan is being used. the employer could introduce factors found in these jobs and then weight them heavily. examples could include eyestrain and finger dexterity for secretarial and clerical position. the total points for these jobs would increase, and their 'worth" would be greater. pricing the jobs would be done by matching them to more highly paid male-dominated jobs which are comparable in total points. both the male and female jobs would then be paid at the higher male rates . .as our example demonstrates, job evaluation is not an objective answer to pay equity. thus employers are likely to use it only in a way that supports their objectives in pay setting and administration. they are unlikely to agree to any evaluation system which conflicts with market realities. the current status of comparable worth comparable worth has little legal vitality under our federal antidiscrimination laws. unless congress chooses to amend title vii of the civil rights act, comparable worth will not be an equal employment issue. at the state level, public employees have been the only beneficiaries of legislation, and this has actually occurred in only a few states so far. although a number of national unions and the afl-cio have officially endorsed comparable worth, bargaining over the issue has been sparse. political and economic realities have no doubt dampened enthusiasm among union leaders. where settlements in this area have occurred, they have been largely in the public sector. a few well-known private employers have begun to implement comparable worth. in some firms the changes appear to be cosmetic since few jobs are dominated by either sex. in other instances companies with a reputation for leadership in social responsibility are apparently willing to incur extra pay costs in order to maintain this reputation. other motives may be avoidance of public criticism or the belief that many women in their firms are really underpaid. for the great majority of private-sector firms comparable worth has not been implemented and is not likely to be in our current legal and economic environment. summary and conclusions comparable worth is a concept which primarily involves social judgments, not objectively measurable "truths." it can be implemented if society wants it badly enough. its complexity, cost, and subjectivity make it unlikely to be attractive to most employers. it will not be adopted unless external forces (such as legislation or union activity) require its implementation. thus, for 7 the foreseeable future comparable worth is a policy that will not be put into effect in most organizations. references 1. afscme v. state of washington, 578 f. supp. 846 (w.d. wash. 1984), ajj'd, 770 f.2d 1401 (9th cir. 1985). 2. blumrosen, ruth g., "wage discrimination, job segregation, and title vii of the civil rights act of 1964," university of michigan law review, winter, 1980, pp. 233-301. 3. briggs v. city of madison, 536 f. supp. 435 (w.d. wis. 1982). 4. campbell, john g., "equal pay for work of equal value in the federal public service of canada," compensation review, third quarter, 1983, pp. 42-51. 5. christensen v. state of iowa, 417 f. supp. 423 (n.d. iowa 1976), ajj'd, 563 f.2d 353 (8th cir. 1977). 6. "comparable worth: it's already happening," business week, april 28, 1986, pp. 52-56. 7. gunther v. county of washington, 602 f.2d 882 (9th cil. 1979), rehearing denied, 623 f.2d 1303 (9th cir. 1980), ajj'd, 452 u.s. 161 (1981). 8. gullett, c. ray, "comparable worth and pay equity: a challenge for employers," journal of business strategies, vol. 1, no.2, fall 1984, pp. 4-14. 9. lemons v. city and county of denver, 17 fair emp. prac. cas. (bna) 906 (d. colo. 1978), ajj'd, 620 f.2d 228 (10th cir. 1980), cert. denied, 449 u.s. 888 (1980). 10. lorber, lawrence z., et al., se:r, and salary, alexandria, va.: the asoa foundation, 1985. 11. nelson, bruce, "wage discrimination and the comparable worth theory in perspective," journal of law reform, winter, 1980, pp. 231-301. 12. nelson, bruce, "wage discrimination and title vii in the 1980's: the case against comparable worth," employee relations law journal, vol. vi, no.3, pp. 380-405. 13. norwood, janet 1., "perspectives on comparable worth," monthly labor review, december, 1985, pp. 3-4. 14. pay equity and comparable worth, washington, d.c.: bureau of national affairs, 1984. 8 15. rosen, benson, et al., 'ccompensation, jobs, and gender," harvard business review, july-august, 1983, pp. 170-190. 16. spaulding v. university of washington, 740 f.2d 686 (9th cir. 1984), cert. denied, 469 u.s. 1036 (1984). 17. taylor v. charley bros. co., 25 fair emp. prac. cas. (bna) 602 (w.d. pa. 1981). 18. thomas, clarence, "pay equity and comparable worth," labor law journal, january, 1983, pp. 3-12. 19. treiman, donald j. and hartman, h.i. (eds.), women, work, and wages: equal pay for jobs of equal value, washington, d.c.: national academy press, 1981. 20. trist, c., "pay equity, born in public sector, emerges as an issue in private firms," wall street journal, july 8, 1985, p. 26. 21. u.s. department of labor, time of change: 1983 handbook on women workers, washington, d.c.: superintendant of documents, 1983. 22. weiler, paul, "the wages of sex: the uses and limits of comparable worth," harvard law review, vol. 99, no. 1728, pp. 1732-1743. 23. ''white-collar unit posts victory in yale dispute," afl-cio news, january 26, 1985. 24. 29 u.s.c. §206(d) 25. 42 u.s.c. §§2000e et seq. 9 comparable worth: a legal and professional update combining delphi and multiple scenario analysis for planning purposes john f. preble and pradeep a. rau department of business administration university of delaware newark, delaware a rapidly changing business environment has caused most firms to adopt some form of environmental assessment as part of their strategic planning process (10, p. 17; 12, p. 12). by monit.oring the external environment on a regular basis, it is hoped that changing conditions will be detected sufficiently early so that plans and strategies can be developed to exploit opportunities and fight off threats. the delphi technique and scenarios have been widely used to assess future conditions since such an assessment will help cope with rapid environmental change. delphi has been described as, "... a consensus technique that provides for the systematic solicitation and collation of judgments on a particular topic. this is done through a set of carefully designed sequential questionnaires interspersed with summarized information and feedback of opinions derived from earlier responses" (13, p. 157). the delphi technique has been used frequently by various industry experts to generate a set of important future events in the external environment and their associated likelihoods. a scenario is "an internally consistent view of what the future might turn out to be" (11, p. 446). scenarios are written descriptions that help the planner to organize possible future events and issues and their interactions into a meaningful display. since it is frequently desirable to consider several possible snapshots of the future simultaneously, often multiple scenarios or alternative futures are developed. the most common scenario is usually called the 'surprise free' or 'most likely' scenario. this can be sompared to some extreme case, such as the 'worst case' or the 'best case' s~enario. multiple scenario analysis (msa) as a process involves both the construction of several scenarios and their evaluation and comparison by individual firms. to illustrate this approach, three alternative scenarios are developed for which likelihood and impact evaluations are then made. contingency plans can then be formulated for each alternative future. this study will provide a detailed illustration of how this approach might be applied by individual firms in the steel industry. however, this method may be applicable in other industries as well. 12 the steel industry is in considerable trouble. the large integrated producers have recently accumulated substantial losses due to drastic decreases in demand and significant increases in steel imports. meanwhile, the minimills, essentially scrap melting operations, are doing extremely well and increasing their share (2, pp. 24-25). immediate action is necessary to forestall largescale retrenchment and pressures for protection abound. mergers would allow for rationalization to take place, but antitrust provisions would first need to be relaxed (3, pp. 281-287). with this level of change taking place in the industry, it seemed like an excellent situation in which to employ our suggested approach. scenario fordlulation process this paper suggests an approach which combines the delphi technique with multiple scenario analysis (msa) in order to plan better for the future. the various steps in the process identification of eyents, likelihood estimation, scenario construction, impact assessment and favorability evaluation are discussed in detail. the results of this process are then incorpora.ted into a contingency planning framework. delphi the initial step in the scenario formulation process uses the delphi technique to forecast important future events in the steel industry along with an assignment of their individual likelihoods of occurrence. selection of a delphi panel is the first exercise that needs to be undertaken. the type of information and the judgments that need to be made would require the inputs of industry experts. the american iron and steel institute, being the primary trade group in the industry, might be a logical choice to both administer the delphi process and to provide the names of steel executives and steel industry analysts who could serve on the panel. in order to assure the reliablility of the delphi estimates, a minimum panel size of 9 to 11 is suggested (6, p. 28). the steel executives or steel industry analysts, who might be quite dispersed geographically, need not actually meet to perform the exercise as questionnaires are used to develop the events and, in later rounds, to make the probability assignments. preserving the anonymity of the individual participants'responses allows for a free flow of ideas and prevents domination by anyone individual. the actual delphi process would be conducted in a sequence consisting of several steps. initially, a set of key individuals from the american iron and steel institute scans the economic and sociopolitical environment of the steel industry and comes up with a small number of events that are likely to have a significant impact on the industry in the near to intermediate future. a questionnaire depicting these events is then developed and sent out to study participants as round one. participants are asked to add any additional significant events that would be likely to have an impact on the future of the steel industry. they are then asked to evaluate all of these events as to their likelihood of occurrence for the near to intermediate future on a scale ranging 13 from zero (no likelihood) to one (strong likelihood). participants then mail back the completed questionnaires to the administrator (american iron and steel institute) who aggregates the data by averaging the likelihood estimates and determining the variance (extent of agreement of consensus with respect to the estimates). what is sought is a reasonable degree of consensus among panel members regarding important future events that may impact the steel industry and their likelihoods. to help achieve this objective, a second round questionnaire is sent out containing the same events and statistical feedback for the group in the form of some measure of central tendency '(mean, median) and a measure of the degree of consensus achieved (variance, range). the participants are then asked to make new likelihood estimates, keeping in mind the round one group results. individuals wishing to make new estimates that differ substantially from the round one group estimates are asked to either reconsider their estimate or detail, in the 'comment' section of the questionnaire, their rationale for making the estimate. round two responses are then processed by the administrator, and a determination is made as to whether a reasonable degree of consensus (agreement) has been achieved. if not, a round three questionnaire is sent out with the statistical feedback derived from round two and with any comments also indicated next to the trends to which they apply. participants then evaluate this quantitative and qualitative information and make new likelihood estimates. generally, three rounds are adequate to achieve the desired level of consensus, but additional rounds could be conducted as required. the results of such an exercise might look like what is shown in table 1. fifteen events have been suggested, the first ten coming from the economic environment of the steel industry and the last five from the sociopolitical environment. likelihood assignments for the near to intermediate time horizon have been provided. with the events and likelihoods available, it is now possible to draft the actual scenarios at the firm level. fir:m level scenario analysis an approach by which individual firms in the steel industry would go about constructing the scenarios will now be described. it is noteworthy that while multiple scenario analysis has become increasingly popular as a planning tool in recent years, there exists no generally accepted way of drawing up scenarios and that informal approaches are the preferred methodology (7, p. 96; 8, p.45). the first step in scenario development is for the firm to determine the type and number of scenarios that would be needed. two examples of types of scenarios would be 'best case' 'surprise free' 'worst case,' and 'optimistic' 'intermediate' 'pessimistic.' it is generally accepted that three scenarios, properly characterized, are about the right number (15, p. 30). the task of writing these scenarios would be coordinated by a key executive; for example, c.e.o. or v.p. planning. this manager, with the assistance of other knowledgeable executives ,would begin by taking the industry inputs; i.e., events and likelihoods generated by the delphi process described earlier, which the 14 table 1 delphi results for the near/intermediate term economic environment event strong economic recovery modest economic recovery recession real interest rates drop real interest rates remain high value of $ will go down value of $ will stay at current levels value of $ will go higher voluntary trade restrictions will be continued voluntary trade restrictions will be removed likelihood estimate .4 .5 .1 .7 .3 .3 .4 .3 .2 .8 sociopolitical environment event labor concessions without demands some labor concessions with demands no labor concessions antitrust laws relaxed antitrust laws not relaxed likelihood scale likelihood estimate .1 .6 .3 .3 .7 .0 .1 .2 .3 .4 .5 .6 .7 .8 .9 1.0 no likelihood moderate 11 kelihood 15 strong likelihood american iron and steel institute has sent to the firm. these delphi results provide the skeleton for the actual writing of the scenarios. the second step would be to assemble the individual events in such a way as to get a continuum of future conditions in the environment. figure 1 shows a sample of three scenarios which represent such a continuum. it should be noted that in these three alternative futures, the executives writing them have taken the events from table 1 and have fleshed out their consequences and implied interactions into a meaningful display. this ensures the internal consistency of each scenario which was a requirement we had noted earlier (11, pp. 458, (61). the terms 'optimistic,' 'intermediate' and 'pessimistic' refer to the particular set of events contained in the respective scenarios and do not necessarily imply the nature of the impact on the individual firm. the intermediate scenario, for example, contains a mixed bag of events; while the optimistic and pessimistic scenarios contain the same events with positive and negative directions, respectively. the reason for including an integrated producer and a minimill in the illustration that follows is that they represent two extremes of a continuum of firms that make up the steel industry. table 2 illustrates how a large, integrated producer and a minimill can go about evaluating the favorability of the three scenarios. taking the 15 events and their associated likelihoods provided earlier in table 1, the individual firm's executives then use the scale provided by aaker (1, p. 105) to assess the impact each of these events would have on its organization. the scale ranges from -4 to +4 indicating a high negative impact (threat) or a high positive impact (opportunity), respectively. these impact assignments for a fully integrated producer and a minimill are provided in table 2. the overall favorability of each type of scenario for a particular firm can then be computed by multiplying the events' likelihoods by the corresponding impact assessments and summing across events. for example, the integrated producer arrived at an overall favorability rating of 6.7 for the optimistic scenario by multiplying 0.4 x 4, 0.7 x 3, 0.3 x 3, 0.2 x 3, 0.1 x 3, 0.3 x 4, and then summing these products. similarly, the minimill computes a favorability rating for the optimistic scenario by multiplying 0.4 x 0, 0.5 x-i, 0.3 x -3, 0.2 x 1, 0.1 x -2, 0.3 x -1, which totals -1.9. calculations are then made in a similar fashion for the intermediate and pessimistic scenarios. the integrated producer and the minimill are then in a position to rank the three scenarios based on their degree of favorableness (a com bination of likelihood and im pact) to their firm. these rankings are illustrated in the 'totals' section of table 2. the integrated producer finds the optimistic scenario the most favorable at 6.7, while the minimill would rank the intermediate scenario as most favorable at 2.0. this highlights the differing situations in which these two types of firms find themselves. all this suggests that the integrated producer should use the most favorable scenario (in this case the optimistic scenario) as its core strategic basis while keeping the other two scenarios for its alternative plans. similarly, the minimill would 16 table 2 scenarios likelihood and impact comparisons antitrust laws not relaxed antitrust laws not relaxed .7 .7 optimistic strong recovery likelihood .4 impact fully integrated 4 minimill 0 interest rates drop likelihood .7 impact fully integrated 3 minimill -1 value of dollar down likelihood .3 impact fully integrated 3 minimill -3 voluntary trade restrictions continued likelihood .2 impact fully integrated 3 minimill 1 labor concessions without demands likelihood .1 impact fully integrated 3 minimill -2 antitrust laws relaxed like11hood .3 impact fully integrated 4 minim1ll -1 intermediate modest recovery .5 1 2 interest rates drop .7 o 1 value of dollar stays at current level .4 o -1 voluntary trade restrictions continued .2 1 o labor concessions with demands .6 o o 1 1 pessimistic recession .1 -2 -1 interest rates remain high .3 -3 -1 value of dollar will go higher .3 -3 o voluntary trade restrictions removed .8 -2 -1 no labor concessions .3 -3 -2 -2 2 totals (ranking) fully integrated 6.7(1) minim;ll -1.9(3) 1.4(2) 2.0(1) -5.9(3) -0.4(2) impact scale (it p. 105) -4 -3 -2 -1 0 1 2 3 4 high negativ~ no high positive impact (threats) impact impact (opportunities) 17 exhibit 1 steel industry scenarios optimistic the world economy will improve and the recovery will extend to all countries. real interest rates and the value of the dollar will go down with a corresponding improvement in export possibilities. meanwhile imports will decline and will continue to be capped by voluntary restrictions. antitrust provisions will be relaxed al lowing for rationalization of production facilities and swapping of operations. on the labor front, the unions will continue to decline in strength and will remain conciliatory and keep wages and benefits down. intermediate the world economy will recover, though only, at a modest rate. real interest rates will go down though the dollar will continue to be strong. the voluntary trade restrictions by steel producing countries will be maintained. labor may make some concessions on wage rates and future increases but they will also demand a greater degree of job security in their contracts. opportunities for steel manufacturers to swap facilities and rationalize their manufacturing plants will be difficult because of antitrust restrictions. pessimistic the world economy will slip back into a prolonged 'recession. interest rates in real terms will stay high and the dollar will grow even stronger. under these conditions foreign steel producing countries will be opposed to any voluntary restrictions on steel exports. labor will be increasingly reluctant to offer any concessions on wages and benefits. meanwhile. government antitrust laws will be strictly enforced thus preventing steel manufacturers from rationalizing their facilities. 18 type of steel company exhibit 2 contingency planning framework planning priorities fully integrated producer minimill producer basic plan alternative plans optimistic intermediate pessimistic scenario scenario scenario intermediate pessimistic optimistic scenario scenario scenario ., rnake the int.ermediate scenario as its primary focus while using the pessimistic and optimistic scenarios, respectivel}', in their back up plans. this is depicted as a eontingency planning framework in figure 2. \\'hile the point is not specifically addressed in this paper, each steel producer would then develop strategies and plans around these scenarios. it may be worth noting also that the entire exercise has both an industry-specific and a firm .. specific component and mainl}' serves as a useful vehicle for get.ting the individual firm's planners and executives t.o put do\\'n t}leir views of the future ",·hich can then be employed in a contingency framework for developing strategic plans. suidjnary two popular techniques for environmental assessment are delphi and multiple scenario analysis. these techniques were first reviewed and then it was shown ho\\t they could be combined in a planning sit.uation. the steel industry was chosen for illustrative purposes-, recognizing that this industry is fa.ced with an uncertain future. other industries facing similar levels of change might also employ such an exercise. one of the advantages of using the approach suggest.ed here is that it is relatively easy to adopt, and one does not have to generate more than three scenarios incorporating only the most important. environmental changes. the idea is to help the firm's planners form contingency plans for a small number of alternative futures while simultaneously making it easier for them to switch from one plan to another as events unfold (14, pp. 15-16). recent work in strategic planning has suggested the concept of 'dia.lectical inquiry,' which refers to tile irrli)ortance of focusing on the way pr()blems are formulated or 19 framed in organizations, rather than the actual solving of problems (4, p. 662; 9, pp. 129-131). presumably, the very act of structuring the problem as suggested in the paper will improve the firm's ability to plan for an uncertain future. porter suggests that scenarios are powerful devices for taking uncertainty into account in strategic decision making. he further states that scena.rios ". . . allow a firm to move away from dangerous, single-point forecasts of the future in instances when the future cannot be predicted. scenarios can help encourage managers to make their implicit assumptions about the future explicit, and to think beyond the confines of existing conventional wisdom" (11, p. 447). a limitation of the approach suggested in this paper is that it may be timeconsuming and require relatively widespread participation. also, it is difficult to gauge pricisely ex'actly what the future might be. however, planning for the future of an organization is bound to be difficult; and widespread involvement by top executives is desirable. glueck and jauch provide perspective here when they summarize the use of scenarios at general electric and royal dutch shell (london): "it is not important whether the scenarios become the future. they are a training vehicle which stretches executives' minds so that they can deal more effectively with the future environment whatever it is" (5, p. 120). references 1. aaker, david a., strategic market management, new york: john wiley and sons, (1984), p. 105. 2. american iron and steel institute, "steel and america: managing dramatic change~" (may 1985), annual report, pp-. 1-32. 3. barnett, donald f. and louis schorsch. steel upheaval in a basic industry, cambridge, ma: ballinger publishing co., (1983), pp. 257290. 4. eden, c., "operational research and organizationa.l development," human relations, vol. 31, (1978), pp. 657-674. 5. glueck, w. f. and l. r. jauch. business policy and strategic management, new york: mcgraw-hill, inc., 4th ed., (1984), p. 120. 6. jain, subhash c., "predicting impact of change using delphi technique," managerial planning, vol. 23, (sept./oct.1974) pp. 20-28. 7. linneman, robert e. and harold e. klein, "the use of multiple scenarios by u.s. industria.l companies: a comparison study, 1977-1981," long range planning, vol. 16, no.6, (1983), pp. 94-101. 20 8. malaska, p., m. malmivirta., t. meristo, and s. o. hansen, "scenarios in europe who uses them and why?," long range planning, vol. 17, no.5, (1984), pp. 45-49. 9. mason, r. 0., and i. i. mitroff. challenging strategic planning assumptions, new york: wiley, (1981). 10. mesch, allen h., "developing an effective environmental assessment function," managerial planning, vol. 32, no.5, (september 1978). pp. 12-17. 11. porter, m. e., competitive advantage: creating and sustaining superior performance, new york: the free press, (1985), pp. 445-481. 12. preble, john f., "corporate use of environmental scanning," michigan business review, vol. 30, no.5, (september 1978), pp. 12-17. 13. preble, john f., "the selection of delphi panels for strategic planning purposes," strategic management journal, vol. 5, no.2, (1984), pp. 157-170. 14. raubitschek, r. s., "multiple scenario analysis and business planning," colloquium on scenario planning and competitive strategy, harvard business school, boston, ma, (1983), pp. 1-47. 15. zentner, rene d., "scenarios in forecasting," chemical and engineering lvew8, vol. 40, (october 6, 1975), pp. 22-24 and 29-34. 21 combining delphi and multiple scenario analysis for planning purposes volume 36, number 1 59 expanding the competitive profile matrix: introducing the production/operations management, marketing, human resource management, finance/accounting, research and development, and information systems competitive profile matrices charles j. capps iii sam houston state university • huntsville, tx christopher m. cassidy sam houston state university • huntsville, tx renee gravois sam houston state university • huntsville, tx janis a. warner sam houston state university • huntsville, tx abstract capps and glissmeyer (2012) proposed an extension to the internal factor evaluation and external factor evaluation matrices that included an internal competitive profile matrix and an external competitive profile matrix, which use a forced ranking that provides greater understanding of the internal and external categories to which an organization must attend. cassidy, glissmeyer, and capps (2013) mapped an internal-external (i-e) matrix using traditional and extended techniques to enable a greater comparative understanding of the relative strengths, weaknesses, opportunities, and threats of respective companies in an analogous company comparison internal-external matrix using horizontal analysis. this matrix approach to strategic analysis and decision-making is presented in fred david’s strategic management, 16th edition (2016). a traditional competitive profile matrix (cpm) is a corporate-level analytic tool that uses critical success factors. this paper offers a conceptual expansion of the cpm to include a production/operations management cpm, marketing cpm, human resource management cpm, finance/ accounting cpm, research and development cpm, and an information systems cpm to provide additional strategic decision-making analytical tools. if analytical thoroughness is a major goal, then expanding the cpm into the six functional business areas should provide further depth of analysis and more in-depth insight. 60 journal of business strategies keywords: strategic decision-making, performance measurement, competitive profile matrix, internal factor evaluation matrix, external factor evaluation matrix, internal-external matrix, strategic decision-making tools introduction many strategic management professors teaching the capstone course of the bachelor of business administration degree use the matrix approach, presented in fred david’s strategic management, 16th edition (2016). david uses a basic horizontal approach to strategic analysis and presents three stages of analytical matrices for strategic decision-making. the input stage, which includes the internal factor evaluation matrix, the external factor evaluation matrix, and the competitive profile matrix (cpm). the matching stage, which includes the strengths, weaknesses, opportunities, and threats matrix, the space matrix, the boston consulting group matrix, the internal-external (i-e) matrix, and the grand strategy matrix;. finally the decision stage, which only includes the quantitative strategic planning (qspm) matrix. the analytical flow of the matrices is horizontal, and takes the output from the input stage, and uses the matching stage matrices to produce recommendations for consideration in the decision stage. the analytical flow is horizontal except for one, the cpm. could the cpm be expanded to extend its analytical use? could the cpm be made more useful by expanding it vertically? additionally, many strategic management professors believe the process of strategic analysis is as important as the final recommendations. assuming the process itself is valuable, then expansion of the cpm vertically in the strategic management analytical decision-making process to include the six functional business areas is beneficial because it is vital to not overlook something important. our recent work extended the traditional cpm horizontally by creating an internal competitive profile matrix and an external competitive profile matrix, which were subsequently plotted on a nine cell company comparison internalexternal matrix (capps & cassidy, 2016). during the exercise, we considered this question: are there benefits to using vertical analysis when considering a cpm? we believe the answer is “yes” when the corporate cpm is supported by functional area matrices with the top ten concepts in the six functional business areas (capps volume 36, number 1 61 & cassidy, 2016). moreover, because strategists believe the depth and thoroughness of the strategic management decision-making analytical process is a fundamental reason for conducting strategic audits, the authors introduce the following six new matrices production/operations management cpm (pom-cpm), marketing cpm (m-cpm), finance/accounting cpm (f-cpm), human resource management cpm (hrm-cpm), research and development (r&d-cpm), and information systems cpm (is-cpm) to provide more in-depth strategic analytical insight when analyzing competing companies. the new funtional level cpm matrices since there is always a need to advance analytical tools used in the strategic management decision-making process (fleisher & bensoussan, 2003, 2007; chang & huang, 2006; bygrave & zacharkis, 2010; capps & glissmeyer, 2012; cassidy, glissmeyer, & capps, 2013), capps and glissmeyer (2012) advanced the strategic management decision-making process by creating the internal competitive profile matrix and an external competitive profile matrix tools for added insight. cassidy, glissmeyer, and capps (2013) visually mapped an i-e matrix using both traditional and extended concepts. this produced different plotting points, and sometimes the result was also a different i-e cell assignment. based on this foundation we now shift our focus and address the issue of how a cpm can be expanded using vertical analysis by creating six new functional area matrices: the pom-cpm, m-cpm, hrm-cpm, f-cpm, r&d-cpm, and an is-cpm. using vertical analysis, we introduce six cpm extensions expanding the matrix into the six functional business areas for more depth of analysis of companies’ major differences. below are the six proposed cpm matrices for your consideration. introduced first is the pom-cpm, which focuses on the top ten areas of production/operations management (pom) needing analysis and comparison in pom. 62 journal of business strategies table 1 introducing a production/operations management competitive profile matrix (pom-cpm) for four hypothetical firms company 1 company 2 company 3 company 4 weight rating score rating score rating score rating score process 0.10 2 0.20 3 0.30 1 0.10 4 0.40 capacity 0.10 2 0.20 3 0.30 1 0.10 4 0.40 % capacity used 0.10 1 0.10 2 0.20 3 0.30 4 0.40 workforce 0.10 3 0.30 1 0.10 4 0.40 2 0.20 automation level 0.10 1 0.10 3 0.30 2 0.20 4 0.40 just-in-time inventory 0.10 1 0.10 4 0.40 2 0.20 3 0.30 total quality management quality control 0.10 4 0.40 3 0.30 2 0.20 1 0.10 customer tech support 0.10 1 0.10 3 0.30 4 0.40 2 0.20 innovation 0.10 3 0.30 2 0.20 1 0.10 4 0.40 infrastructure 0.10 2 0.20 3 0.30 1 0.10 4 0.40 totals 1.00 — 2.00 — 2.70 — 2.10 — 3.20 volume 36, number 1 63 second, the marketing competitive profile matrix (m-cpm) is introduced with the ten major marketing concepts that need monitoring for comparison analysis in marketing. table 2 introducing a marketing competitive profile matrix (m-cpm) for four hypothetical firms company 1 company 2 company 3 company 4 weight rating score rating score rating score rating score market share 0.10 1 0.10 3 0.30 2 0.20 4 0.40 advertising 0.10 1 0.10 2 0.20 3 0.30 4 0.40 inventory turnover 0.10 3 0.30 2 0.20 1 0.10 4 0.40 customer analysis 0.10 1 0.10 4 0.40 2 0.20 3 0.30 opportunity analysis 0.10 2 0.20 3 0.30 4 0.40 1 0.10 marketing research 0.10 1 0.10 2 0.20 3 0.30 4 0.40 selling products and services 0.10 1 0.10 3 0.30 4 0.40 2 0.20 product and service planning 0.10 2 0.20 3 0.30 1 0.10 4 0.40 distribution 0.10 3 0.30 1 0.10 4 0.40 2 0.20 pricing 0.10 2 0.20 3 0.30 1 0.10 4 0.40 totals 1.00 — 1.70 — 2.60 — 2.50 — 3.20 64 journal of business strategies third, we introduce the human resource management competitive profile matrix (hrmcpm) with the ten primary human resources management concepts that need monitoring for hrm comparative analysis. table 3 introducing a human resource management competitive profile matrix (hrm-cpm) for four hypothetical firms company 1 company 2 company 3 company 4 weight rating score rating score rating score rating score revenue per employee 0.10 1 0.10 2 0.20 3 0.30 4 0.40 compensation per employee 0.10 2 0.20 3 0.30 1 0.10 4 0.40 training cost per employee 0.10 3 0.30 1 0.10 4 0.40 2 0.20 employee absenteeism rate 0.10 1 0.10 4 0.40 2 0.20 3 0.30 employee turnover rate 0.10 4 0.40 3 0.30 2 0.20 1 0.10 osha complaints rate 0.10 1 0.10 3 0.30 2 0.20 4 0.40 eeoc complaint rate 0.10 1 0.10 3 0.30 4 0.40 2 0.20 grievance and lawsuits rate 0.10 3 0.30 2 0.20 1 0.10 4 0.40 core employee’s experience 0.10 2 0.20 3 0.30 1 0.10 4 0.40 % contingent employees 0.10 2 0.20 3 0.30 1 0.10 4 0.40 totals 1.00 — 2.00 — 2.70 — 2.10 — 3.20 note: osha = u.s. occupational safety and health administration; eeoc = u.s. equal employment opportunity commission volume 36, number 1 65 fourth, the finance/accounting competitive profile matrix (f-cpm) is introduced with its ten primary financial concepts that need monitoring for comparison analysis in finance and accounting. table 4 introducing a financial competitive profile matrix (f-cpm) for four hypothetical firms company 1 company 2 company 3 company 4 weight rating score rating score rating score rating score revenue 0.10 1 0.10 2 0.20 3 0.30 4 0.40 profit margin 0.10 2 0.20 3 0.30 1 0.10 4 0.40 quick ratio 0.10 4 0.40 3 0.30 2 0.20 1 0.10 current ratio 0.10 3 0.30 2 0.20 1 0.10 4 0.40 return on investment 0.10 2 0.20 3 0.30 1 0.10 4 0.40 return on equity 0.10 2 0.20 3 0.30 1 0.10 4 0.40 return on assets 0.10 3 0.30 1 0.10 4 0.40 2 0.20 earnings per share 0.10 1 0.10 3 0.30 2 0.20 4 0.40 debt-to-equity ratio 0.10 1 0.10 4 0.40 2 0.20 3 0.30 market capitalization 0.10 1 0.10 3 0.30 4 0.40 2 0.20 totals 1.00 — 2.00 — 2.70 — 2.10 — 3.20 66 journal of business strategies fifth, we introduce the research and development competitive profile matrix (r&d-cpm) with the top ten research and development concepts that need monitoring for r&d comparative analysis. table 5 introducing a research and development management competitive profile matrix (r&dmcpm) for four hypothetical firms company 1 company 2 company 3 company 4 weight rating score rating score rating score rating score r&d investment 0.10 2 0.20 3 0.30 1 0.10 4 0.40 product or process r&d focus 0.10 1 0.10 3 0.30 4 0.40 2 0.20 internal r&d focus 0.10 2 0.20 3 0.30 1 0.10 4 0.40 external r&d focus 0.10 2 0.20 3 0.30 1 0.10 4 0.40 both internal and external r&d focus 0.10 1 0.10 3 0.30 4 0.40 2 0.20 first mover advantage 0.10 1 0.10 2 0.20 3 0.30 4 0.40 innovative imitator 0.10 3 0.30 1 0.10 4 0.40 2 0.20 low cost producer 0.10 1 0.10 3 0.30 2 0.20 4 0.40 product and process total quality management 0.10 4 0.40 3 0.30 2 0.20 1 0.10 basic and applied innovation 0.10 3 0.30 2 0.20 1 0.10 4 0.40 totals 1.00 — 2.00 — 2.60 — 2.30 — 3.10 volume 36, number 1 67 finally, the information systems competitive profile matrix (is-cpm) is introduced with its ten major information systems concepts that need monitoring for comparative analysis in is. table 6 introducing an information systems competitive profile matrix (is-cpm) for four hypothetical firms company 1 company 2 company 3 company 4 weight rating score rating score rating score rating score good change strategy 0.10 2 0.20 3 0.30 1 0.10 4 0.40 access to appropriate it 0.10 1 0.10 3 0.30 4 0.40 2 0.20 technology and it personnel 0.10 3 0.30 1 0.10 4 0.40 2 0.20 adequate management support / owner 0.10 3 0.30 1 0.10 4 0.40 2 0.20 effective it and business communication 0.10 2 0.20 3 0.30 1 0.10 4 0.40 identify and select project champion 0.10 2 0.20 3 0.30 1 0.10 4 0.40 alignment of vision and plans between it and business 0.10 1 0.10 3 0.30 4 0.40 2 0.20 good project management methodology 0.10 1 0.10 2 0.20 3 0.30 4 0.40 sufficient/ acceptable operational performance 0.10 1 0.10 3 0.30 2 0.20 4 0.40 appropriate organizational culture 0.10 4 0.40 3 0.30 2 0.20 1 0.10 totals 1.00 — 2.00 — 2.50 — 2.60 — 2.90 summary and conclusion applying vertical analysis to fred david’s matrix approach to strategic management decision-making, the authors created six new useful cpm matrices, the pom-cpm, m-cpm, f-cpm, hrm-cpm, r&d-cpm, and is-cpm. these matrices are a natural extension to the traditional cpm, whether one agrees or 68 journal of business strategies disagrees with the top ten major functional area concepts. the authors are comfortable with them, but they may be changed or adjusted. the major advantage of expanding the cpm is straightforward because the new matrices allow for greater depth of analysis in strategic management decision-making. because of the greater contrast among companies, organizations are encouraged to apply forced rankings in these matrices, which were used by the authors when extending the original cpm concept horizontally. so what does this extra data for analysis do for analysts? our simple conclusion is that it provides the top critical success factors for each functional business area for a more focused depth of comparison and insight to help improve the analytical effectiveness of decision-making in strategic management. moreover, the new functional strategic matrix tools allow for more thoroughness and in-depth cpm analysis so that important data are not overlooked. references allen, m. 1979. diagramming ge’s planning for what’s watt. in pennington, m. w., & allio, r. j. (eds.) corporate planning: techniques and applications. new york: amacon. alreemy, a., chang, v., walters, r., and wills, g. 2016. critical success factors (csfs) for information technology governance. international journal of information management, 36: 907–16. bygrave, w. d., & zacharakis, a. 2010. entrepreneurship. new jersey: john wiley and sons. capps, c., & glissmeyer, m. 2012. extending the competitive profile matrix using internal factor evaluation and external factor evaluation matrix concepts. journal of applied business research, 28 (5): 1059–62. cassidy, c., glissmeyer, m., & capps, c. 2013. mapping an internal-external (ie) matrix using traditional and extended matrix concepts. journal of applied business research, 29 (5): 1–5. capps, c., & cassidy, c. 2016. expanding the competitive profile matrix (cpm): introducing the financial competitive profile matrix (fcpm). academy of strategic management journal, 15 (2): 9–15. chang, h., & huang, w. 2006. application of a quantification swot analytical method. mathematical and computer modeling, 43: 158–69. david, f. r. 2016. strategic management concepts and cases. (16th ed.). new jersey: pearson prentice hall. volume 36, number 1 69 denolf, j., trienekens, j., wognum, p., van der vorst, j., & omta, s. 2015. towards a framework of critical success factors for implementing supply chain information systems. computers in industry, 68: 16–26. fleisher, c., & bensoussan, b. 2003. strategic and competitive analysis: methods and techniques for analyzing business competition. new jersey: prentice hall. fleisher, c., & bensoussan, b. 2007. business and competitive analysis: effective application of new and classic methods. new jersey: ft press. garrison, g., kim, s., & wakefield, r. 2012. success factors for deploying cloud computing. communications of the acm, 55 (9). huang, m-j., chen, m-y., & yieh, k. 2007. comparing with your main competitor: the single most important task of knowledge management performance measurement. journal of information sciences, 33 (4): 416–34. huang, s-j., wu, m-s., & chen, l-w. 2013. critical success factors in aligning it and business objectives: a delphi study. total quality management, 24 (10): 1219–40. krathu, w., pichler, c., xiao, g., werthner, h., neidhardt, j., zapeletal, m., & huemer, c. 2015. inter-organizational success factors: a cause and effect model. information systems e-business management, 13: 553–93. poon, p., & wagner, c. 2001. critical success factors revisited: success and failure cases of information systems for senior executives. decision support systems, 30: 393–41 brief biographical sketch of authors charles j. capps iii, sphr, is a professor of management at sam houston state university. he earned his d.b.a. at louisiana tech university, and his research interests include strategic management and human resource management. christopher m. cassidy is an associate professor of management at sam houston state university. he earned his ph.d. at texas a&m university, and his research interests include strategy implementation, organizational control systems, ethics, and pedagogical research. renee gravois is associate professor of marketing at sam houston state university. she earned her ph.d. at virginia tech, and her research interest areas include: social marketing and public policy, marketing education, and student writing. janis a. warner, pmp, is associate professor of management information systems at sam houston state university. she earned her ph.d. at florida atlantic university, and her research areas include human-computer interaction technology use, it security from the socio-organizational perspective, project management, and pedagogical research on experiential/service learning. the impact of the underground economy on american business john o. king department of marketing and joseph h. miller college of business southeastern louisiana university hammond, louisiana introduction the underground economy refers to activities giving rise to unreported, unmeasured and untaxed income, whether earned from legal or illegal sources (5). the underground economy has many different names in britain it is called the black economy, in germany the shadow economy, and in italy it is referred to as the submerged economy. bookmaking, prostitution, smuggling, and illegal drugs are some of the activities of the underground economy. business activities which are legal and desirable fall into the underground economy when the business people involved choose to cover up part or all of the income from the~e activities. a business owner who doesn't ring up all cash sales, the plumber who works for cash only, and the teacher who gives the beautician a music lesson in exchange for a haircut, are all examples of the underground economy. the income earned in the underground economy is usually referred to as 'off-the-books' income. if this income were reported it would add to the gnp. the purposes (>f this paper are to describe the size of the underground economy, identify those factors that have caused the underground economy to flourish and to examine the effect that the underground economy has had on the business practices. both the ethical and economic impact of the underground economy are examined. dr. edgar feige of the university of wisconsin estimates that the unreported income from the underground economy is as high as 27 percent of our gnp (3). in terms of the 1986 economy, this would mean an underground economy in the vicinity of $1 trillion. research at the federal reserve bank of atlanta concluded that the underground economy grew from 9 percent of reported gnp in 1970 to at least 15 percent of gnp in 1978 (5). in 1977, professor peter gutmann of baruch college estimated the underground economy at 10 percent of. the recorded gnp (4). while estimates by gutmann assume that all hidden transactions are done with cash, feige's estimate of 27 percent uses additional methods of payment, such as checks. however, 34 none of the estimates take into consideration unreported barter-the practice of exchanging one service or product for another (1). the first in-depth effort by the irs to measure unreported individual income uses 1976 tax-year data (2). this study reported that individuals failed to declare $75-$100 billion in legal income that year, resulting in a loss of $13-$17 billion in tax revenue. the greater part of business activity covered in the irs study was legal, but the participating individuals illegally failed to report the generated income. the same study estimated that unreported income from illicit trade costs the government some $6-$9 billion in lost tax revenues annually. however, as increasingly larger caches of illegal drugs are discovered, this amount may be understated. one bank in florida reports receiving $1.2 million in $20, $50, and $100 bills in one afternoon and more than $10 million in currency in one week, all from illegal cash transactions of its depositors (9). another bank in california reported its em ployees a.s 'almost suffering hernias' from having to carry in so many boxes of currency from a dope-dealing depositor (10). such efforts on the part of the underworld to 'launder' money have become commonplace. while no one can be sure of the exact size of the underground economy, it is certain that it is growing at a faster rate than the above ground economy. using an econometric model, professor feige estimated that during the 1970's the underground economy increased at 2 1/2 times the rate of the above ground economy (15). probably the most serious threat posed by the underground economy directly on legitim ate american businesses is in the area of illegally counterfeited products. the true extent of this aspect of the underground economy cannot be measured, but the counterfeit intelligence bureau in london estimates that up to $60 billion in annual world trade involved counterfeit products in 198-&. the united states house of representatives' energy and commerce committee recently estimated direct losses for american firms to counterfeit products at approximately -$20 billion annually. not only does product counterfeiting involve such consumer goods as cartier watches and cabbage patch dolls, but also chemicals, drugs, pesticides, military hardware, food, and thousands of replacement and component parts. the impact of counterfeit goods on one american based multinational corporation is shown by general motors' estimate that nearly 40 percent of all gm parts in the middle east are counterfeit (10). there are many factors that have caused the underground economy to flourish at an ever increasing rate. one such factor is the overall increase in criminal activity in recent decades, especially drug and narcotic trafficking. in addition to this, high income tax rates, overall inflation, and a distrust of government at all levels have caused many average citizens to explore the possibility of operating in the underground economy. because of actual and potential economic benefits, operating in the underground economy tends to be habit forming for the individuals directly involved, and it tends to spread like a communicable disease as others in society observe the apparent 35 economic rewards accruing to those operating in the underground economy_ in fact, because of the perceived low probability of legal punishment, the major deterrent for most individuals is their particular moral and ethical convictions. one measure of the level of these convictions is seen in the results of two recent surveys concerning cheating on income taxes. a 1984 poll commissioned anonymously by the internal revenue service found 19 percent of the respondents admitted being less than completely honest on their tax returns. a similar poll completed for u.s. news and world report in 1985 found 24 percent of the respondents admitted to dishonesty when filing federal income taxes (7). business iitlplications from the business point of view, it is useful to separate the underground economy into two large segments based on the legal dimensions of the activities. first, we have those economic activities that are illegal for all persons engaged in the production or marketing of the good or service. in this group we find businesses actively engaged in the drug market, trafficking in stolen goods, producing counterfeit goods and smuggling. for reference purposes, we have chosen to designate these as class i activities. again, readers are reminded that class i activities are all in violation of various local, state or federal laws. the second major segment of the underground economy is composed of legal economic activities, but which become illegal because of the way some dimension of the activity is handled. for example, hiring a carpenter to inst~ll storm windows on a house is a perfectly legal activity and paying him in cash is equally legal. however, if he fails to report this cash as income he is in violation of federal income tax laws. in this paper, all such activities are classified as class ii a.ctivities. class i activities businesses should never be involved in class i activities because they are illegal. however, such illegal economic activities are of major concern to business managers because of the following reasons: 1. smuggled, stolen and counterfeit goods are .sold in the market in competition with ordinary goods which tends to give their marketers an unfair cost profit / advantage. 2. huge potential tax revenues are lost in the class i segment of the economy. these are tax revenues that will have to be ultimately paid by the above ground segment of the economy. 3. efforts to police and punish offenders in the class i segment of the economy represents a major drain on governmental budgets at all levels of government. this is money that could and should be spent on more socially desirable projects. 36 4. the class i underground economy tends to have a corrupting influence on governmental officials through attempted bribery and political contributions; thus, lowering the overall efficiency of government. 5. consumer expenditures for illegal goods and services represent lost sales for the legitimate businesses of government. these class i aspects of the underground economy represent a major component of what has been called an 'unwholesome demand' (6). in such situations, the primary goal of the ethical business organization is to unsell the target market on the goods and services involved. unselling a market tends to be very slow, expensive and difficult because it often represents an attempt at intervening in the ways people think and behave. the time, difficulty, and expense associated with unselling a target market or the elimination of the 'unwholesome demand' helps explain why it tends to be most often a.tternpted by large corporations, trade associations, nonprofit organizations and governments. it is obviously desirable for businesses to be informed on the nature and extent of the class i segment of the underground economy. this is especially true when the illegal activity represents direct or indirect competition for their lines of business. also, because of the pro'bable inferior quality and performance of most counterfeit goods, business firms must be on the alert to take legal action against all types of offenders, as well as being ready to defend against product liability suits growing out of consumer injury from the use of counterfeit products and replacement parts. class ii activities business interest in the class ii segment of the underground economy stems from many of the same reasons as does their interest in the class i activities. namely, the unfair competitive element, lost tax revenues for governments, and social costs associated with legal enforcement. in addition, there is an ethical dimension when a marketer has reason to believe that one or more of his business contacts is operating in the class ii underground economy. for example, if a supplier of goods or services requests payment in cash, should the buyer report such a transaction to tax authorities on the presumption that the recipient does not plan to report the cash received as income? obviously, the answer to such ethical questions will depend upon the ethical standards of the persons involved. businesses that contend that they know very little about the underground economy surrounding their lines of business may be telling the truth, but if so, they are probably equally uninformed about the above ground economy in which they operate. for example, a good sales analysis will tell a business who is buying, what they are buying, how they are paying, who is making the sales, and how the goods are being shipped, such that an alert business will have a pretty good idea of the extent of his intentional and a.ccidental involvement in the underground economy. what is really being said is that the 37 extent of a firm's involvement in the underground economy is very dependent on the ethica.l values of the management personnel in the firm. impact on business planning use of incorrect data businesses who engage in strategic planning rely heavily on data from both public and private sources. it is a certainty that omission of data on the underground economy causes many economic indicators to understate the health of the u.s. economy and its various segments. it is widely believed that unemployment figures are too high and personal savings too low. peter gutmann of baruch college maintains that the underground economy causes the true unemployment rate to be overstated by two percentage points, or about 2 million people (15). in recent years,' economic statistics have indicated that personal savings have been decreasing. because of the increased activity in the underground economy, many economists and business planners believe that the commerce department's personal savings estimates are incorrect. further proof of the magnitude of this problem is seen by observing that at a given time the flow offund~ data from the federal reserve showed the savings rate could actually be as high as 9.4 percent at the time the department of commerce was estimating it to be 5.3 percent of disposable income. this translates into a difference of approxim ately $75 billion in savings. the use of incorrect economic data will certainly impact business planning. high unemployment and low personal savings data will cause businesses to be too conservative in their forecasting. in general, businesses may have held off on expansion-both in the purchase of capital equipment and in the addition of new product lines as a result of erroneous data which did not consider the operations of the underground economy. human resource planning the underground economy is even thought to be having a major impact in the area of human resource planning. consider that in 1980 the level of total employment rose by only 0.3 percent, but the number of self-employed rose by 3 percent to a new high of 6.9 million. in the decade of the 1970's, the number of self-employed increased 30 percent faster than did total employment (15). large business corporations appear to be suffering most from this move to become self-employed as increasing numbers of highly skilled personnel have left after the corporation had invested heavily in developing their various abilities. while no data appears to be available on the true extent of talented people moving into the underground economy, the mere fact that the underground economy exists and is growing rapidly among self-employed people leads the authors to believe that many of these talented people are contributing to the growth of the underground economy. sumdlary and conclusions existing environmental factors indicate that the underground economy will continue to grow at a faster rate than the above ground economy_ in38 creases in the level of criminal activity, high taxes, inflation, changing moral values, and a general distrust of government all point toward this trend. the total business implications of the underground economy are numerous, complicated and varied. when analyzing the und,erground economy it is useful to divide it into two broad segments. the first segment, which we have designated as the class i segment, is composed of business activities that are illegal in all respects and should never be practiced. the second major segment of the underground economy has been designated the class ii segment and refers to those business activities that are not inherently illegal, but certain aspects of these business activities become illegal when practiced in an illegal way. the underground economy has caused many businesses to offer a dual pricing structure rewarding customers with special discounts if they pay cash instead of using checks or credit cards. it has also fostered increases in bartering among both households and businesses, and may be contributing toward the growing level of self-employment; particularly in markets where it is relatively easy for the business person to conceal profits. changing moral and ethical values of our society coupled with the inabilit~y of legal authorities to· enforce laws governing activities involved in the underground economy also point toward the continued rapid growth of this segrnent of the american economy. in fact, unless the non-participants in the underground economy become concerned to the point of drastic political or legal action, the underground economy will eventually become so large as to seriously cripple the health and efficiency of the above ground economy. references 1. batt, "'illiam. "the underground economy: what is it? how big is it? and how is it f\1easured?" manhattan college journal of busines~ fall, 1985, pp. 5-10. 2. "estimates of income unreported on individual income tax returns," department of the treasury, internal revenue service, publication 1104, pp. 9-79. 3. feige, edgar. "the irregular economy: its size and macroeconomic implications," working paper 7916, social system research institute. 4. gutmann, peter. "the subterranean economy," financial analysts journal, november-december, 1977, pp. 23-26. 5. haulk, charles, j. "thoughts on the underground economy," economic review of the federal reserve bank of atlanta march-april, 1980, pp. 23-24. 6. kotler, philip. "the major tasks of marketing management," journal of marketing, october, 1973, pp. 41-49. 39 7. mcbee, susanna. "morality," u.s. news & world report, december 9, 1985, pp. 52-58. 8. molefsky, barry. "the underground economy in the united states and abroad," conference board, federal reserve system. 9. montgomery, jim. "feds crack down on 'laundering' of narcotics money," the wall street journal, march 12, 1981, p.l. 10. o'donnell, thomas c., et ai, "the counterfeit trade," business week, december 16, 1985, pp. 64-72. 11. penn, stanley, "narcotics agents track big cash transactions to trap dope dealers," the wall street journal, november 2226, 1980, p.l. 12. poweii~ eileen a. "irs chief lists achievements as he departs," the wall street journal, november 5, 1980, p. 27. 13. simon, carl p. and ann d. witte, beating the system, chicago: auburn press~ 1982. 14. "the income farmers hide,'~ business h"eek, april 17, 1978, pp. 91-92. 15. "the underground economy's hidden force," business week, i\pril 5, 1982, pp. 64-70. 16. "the ltnderground econoffi)t's hidden force," the wall street journal, january 21, 1981, p.l. 17. "underground economy: $100 billion jn lost taxes," u.s. news & world report, april 19, 1982, pp. 48-49. 40 the impact of the underground economy on american business volume 32, number 2 139 net present value simulation: a case study robert stretcher sam houston state university • huntsville, texas introduction this paper presents a strategy for teaching monte carlo simulation using the case of a capital expansion decision for arkmed corporation, a small biomedical device manufacturer located in houston, texas. the company is considering investing in a facility that can provide custom products using 3d printing. the facility would serve the custom orthotics and solid implant needs of the medical community of the greater houston metropolitan area. a simulation of the financial feasibility of the new facility is appropriate since the manufacturing method is unfamiliar to the firm’s management, and because the facility would serve a custom ordered product that would be expeditiously provided, within a few hours to a few days, unlike the company’s current business. the case provides an opportunity to augment coverage of capital budgeting scenario analysis, and to give students an exercise that requires multi-page referencing in excel. it also can provide output data that can be summarized into a histogram and frequency distribution chart. this process allows for a visual of the risk that a project could return a negative npv result. the distribution of npvs thus provides better information on which to base a capital asset expansion decision than would a discrete npv value based on averages of sales growth, expense ratios, and tax rate. case assignment given to students mark findley finished off the last of the coffee and started a new pot brewing. he was waiting for a message from the vice president of arkmed corporation. a new expansion project had been proposed, and it would be mark’s responsibility to analyze the project. the firm had never invested in a project of this type before, a production facility that would custom “print” biomedical devices with a 3d printer. the firm had other types of custom manufacture, so mark figured he could use knowledge from those facilities for cost estimates, but the potential sales could range from disappointing, making little use of the capacity of the plant to full capacity, where the plant would be used around the clock. randle gere, the vice president, finally called. “mark! i’ve asked roberts in operations to coordinate with atwood in cost 140 journal of business strategies accounting to get you operating cost estimates for the new plant. they should be emailing you a spreadsheet soon.” “what is our timing, mr. gere?” asked mark. “do i need to stay late today?” “no, no not necessary. in fact they are both staying late to provide you with the information. you can just do it tomorrow. can you get me your output and a report by the end of the day tomorrow? “not a problem,” mark responded. “i will get it to you around mid-afternoon.” because of the unfamiliarity of 3d printing technology and the range of possible sales, mark planned to carry out a simulation for the net present value of the project. the simulation was similar to other npv analyses he had carried out in the past. he had been with arkmed for four years and had taken over the “chief” position for the forecasting and analytics office after his boss had retired last year. mark had already heard from the firm’s marketing manager, who had done a breakdown of expected revenues by sales region, based on custom manufacturing sales for other products the firm offered. the facility under consideration was sort of a wild card, though, because business would be based mainly on quick turnaround. measurements and specifications would be provided by technicians dealing with patients, an order submitted electronically, and then arkmed would “print” the custom device, coat it with sterile coatings, package it in sterile packing, and expedite delivery to the hospital or medical office where the procedure was being done. while these devices could be delivered in as little as half a day, it was also possible that quick delivery would not be so critical, and that the firm could schedule production within a three to four day window. there was thus potential for the facility to produce at capacity, but it was also possible that there would be times where the three to four day backlog would be completed with no new orders in the queue. that brought about the possibility of idle capacity, but a full staff would have to be retained in order to handle new orders as they came in. the resulting variation in sales could be significant. mark had waited until 7:00 pm, working on other forecasting tasks, and the email from roberts and atwood finally came in. mark began summarizing the analytical inputs for his simulation immediately (exhibit 1). he then structured the inputs into the typical inputs page template in excel (exhibit 2) so that he could spend the next day carrying out the simulation and writing up a brief for mr. gere. volume 32, number 2 141 exhibit 1. mark’s summary. 2015 sales estimate (as if the project were already up and running): $2,748,000 expected sales growth per year: 2016: 8%, 2.8% std deviation 2017: 6.2%, 5.2% std deviation 2018: 6%, 2.5% std deviation 2019: 4%, 2.7% std deviation 2020: 3.5%, 3.1% std deviation 2021: 2%, 3.5% std deviation 2022: 2%, 3.7% std deviation 2023: 2%, 3.8% std deviation 2024: 2%, 4% std deviation 2025: 2%, 4.1% std deviation cash expenses: 2016: 34% of sales, 1.3% std deviation 2017: 34% of sales, 1.5% std deviation 2018: 34% of sales, 1.6% std deviation 2019: 34% of sales, 1.8% std deviation 2020: 34% of sales, 2.0% std deviation 2021: 34% of sales, 2.2% std deviation 2022: 34% of sales, 2.4% std deviation 2023: 34% of sales, 2.6% std deviation 2024: 34% of sales, 2.7% std deviation 2025: 34% of sales, 2.8% std deviation $7,997,000 asset expansion, depreciated on a 7-year macrs schedule, with a 10-year life 142 journal of business strategies macrs 7-year depreciation percentages per year: year 1 14.29% year 2 24.49% year 3 17.49% year 4 12.49% year 5 8.93% year 6 8.92% year 7 8.93% year 8 4.46% tax rates expected: 33.4% of ebit on average, 1.6% standard deviation, based on higher income levels after the expansion and expected political action concerning tax policy) appropriate discount rate for the project: 18.9% volume 32, number 2 143 exhibit 2. mark’s input parameters page. 144 journal of business strategies teaching strategy for the case this simulation will involve many rows of calculated data. spreadsheets, by default, recalculate the entire workbook when any equation is entered. wait time may become problematic when 10,000 iterations times seven pages is recalculating. to speed things up a bit, students may want to turn off autocalculation. this is done in excel 2003 by selecting tools… options… calculate from the toolbar and select “manual” or in excel 2007 by selecting formulas... calculation options... “manual.” the user can then recalculate the workbook at any time by pressing f9. students might also benefit from some guidance on how to specify random numbers or normally distributed random numbers: the “math and trig” function rand() generates uniformly-distributed random numbers. random normallydistributed numbers with, for example, a mean 100 and standard deviation 20, can be generated using the “statistical” function norm.inv, specifying uniform random number inputs rand() within the norm.inv formula: norm. inv(rand(),100,20)). this can also be specified by selecting formulas... more... statistical... norm.inv and entering rand(), 100, and 20, as the specifications. for a bit more orderly analysis, students should set up a standard workbook with five worksheets: mark’s inputs page, sales, cash expenses, nocf, and pvnocf. the “inputs” worksheet (mark’s exhibit) lists the parameters of the model. in the rest of the worksheets, it is most convenient to put the data in “row form” – see exhibit 3 for an example sales worksheet. the sales worksheet generates data as a simple random growth rate model. specifically, salest+1=salest*(1+gt). for each cell of data, the growth rate is normally distributed, with mean and standard deviation specified in the “parameters” worksheet. since each year’s sales may be serially correlated, the sales figure for each year should be based on the prior year’s sales times (1+gt). an initial (year zero) sales figure is shown in cell a17 in exhibit 2. this is used as a base to calculate the expected sales in year 1 (2016). panel a of exhibit 3 shows the syntax for the fx input field for the 2016 sales calculation. each subsequent year’s calculation is based on the prior year’s calculation. once the calculation is established for 2017, the cell can be dragged (copied) to all other years by dragging the cell to year 2025. the student’s own result will differ since every student will have different randomly selected inputs. although only a few rows of data are shown as an example here, the students’ spreadsheets will have 10,000 rows of data per sheet, dragging the row b3:k3 down to 10,000 lines. the remaining worksheets are constructed in a volume 32, number 2 145 similar fashion, with 10,000 rows each by 10 years of projections (2016-2025) in the columns. exhibit 3. sales worksheet visual. panel a panel b the cash expenses worksheet contains values calculated simply as percentages of estimated sales. for convenience, base the cash expenses in a specified cell on the same column and row specified cell from the sales sheet, and the same for the other sheets. exhibit 4 shows a sample, again with the calculations for cells b3 and b4 shown in the fx field. 146 journal of business strategies exhibit 4. cash expense worksheet visual. panel a panel b in this simple model, nocf is calculated as: (salest cash expensest depreciationt)*(1-tax rate)+depreciationt exhibit 5 shows a sample, again with the calculations for cells b3 and b4 shown in the fx field. exhibit 5. nocf worksheet visual. panel a volume 32, number 2 147 panel b the last worksheet is the present value of nocft. recall that: pv(nocft) = nocft/[1+δ] (t-2015) where δ is the discount rate for cashflows. exhibit 6 shows a sample, again with the calculations for cells b3 and b4 shown in the fx field. exhibit 6. pvnocf worksheet visual. panel a panel b 148 journal of business strategies on the pvnocf sheet, construct a single column of data for pv(ncf) within the pvncf worksheet by summing the ten years of pvnocfs. then create another column subtracting the initial cash outlay from the pvnocf total, to get a column of 10,000 npvs. exhibit 7. sum of pvnocf column and npv column visual. excluding the “inputs” worksheet, each worksheet should have a header row representing years 2016-2025 and a single row of data. this single row represents one possible future for our company (based on the chosen parameters). the purpose of the simulation is to generate many realizations of the future and use the distribution of valuations to make meaningful insights into the economic value of the project under consideration. to do so, we must fill each of the data worksheets with 10,000 rows of data. if the formulas were carefully constructed (with proper relative and/ or absolute cell addressing) then this is a trivial matter. for example, suppose you have data in cells b3:k3 and you want to fill in the next 1,000 rows. to do so, click the “name box” in the upper left hand corner and type b3:k1002. this will highlight a block of cells. from the edit menu, select fill->down and all contents are copied. do this for the sales, cash expenses, nocf, and pvnocf worksheets. after all the data is filled, students should be sure to manually recalculate the cells if autocalculation is off (note: the fill can also be accomplished by ‘dragging’ the cell or cells through to the 10,000th line using excel’s “+” function). to create the column of 10,000 npv’s on the pvnocf sheet, or each row (iteration), sum the pvnocf for all ten years and subtract the initial cash outlay, $7,997,000. add descriptive statistics of the distribution of npv to the parameters worksheet. specifically, calculate the minimum, median, mean, maximum, and volume 32, number 2 149 standard deviation of npv using excel’s automated statistical functions (or use the data analysis toolpack to calculate all these measures and more in a single step). an analysis with this level of sophistication has the potential of making or breaking a capital budgeting decision, or the decision by a capital provider to either fund the project or not. absence of an analysis such as this may cause the same to question the firm’s ability to provide valid estimations of the impact of the project on the welfare of the firm’s shareholders. a chart of the distribution of npv’s is a good visual to see the likelihood, given the input distributions, that a positive (or negative) npv would occur. the negative probability can be calculated easily by counting all of the negative npv’s out of 10,000 (this is the probability of a negative npv). the same can be repeated for the positive values. exhibit 8 shows an example of the resulting frequency distribution, created by charting the histogram output using the histogram function in the data analysis toolpack, with an indicator line showing the critical npv value of zero drawn in. while each student’s result will differ a bit from this visual, it is clear to see that the npv has a greater likelihood of being positive, but there is also substantial risk that the npv could be negative as well. exhibit 8. frequency distribution of npv’s. an optional requirement could be to request that students prepare a professional report and correspondence, taking the role of mark, and selling the analysis to upper management. 150 journal of business strategies a solution excel workbook may be downloaded by jbs readers from the author’s website: www.shsu.edu/~fin_rhs/jbssolution.xlsx brief biographical sketch of author dr. robert stretcher is a professor of finance at sam houston state university. he earned his phd in finance and monetary economics from the university of tennessee. his research focuses on empirical market studies, applied finance, and finance education. dr. stretcher has held prominent positions in the academy of economics and finance and the institute of finance case research, and has served on editorial boards and as editor of various finance journals. an empirical examination of the relationship between the background characteristics of the ceo and overall corporate reputation peter a. stanwick sarah d. stanwick auburn university auburn,al abstract this paper examines the relationship between the overall corporate reputation ofan organization and the background characteristics ofthe chiefexecutive officers (ceos) across twenty one major industry classifications. four background characteristics are examined: (1) age, (2) tenure with the company, (3) tenure as ceo, and (4) functional background (career path). these characteristics are explored by examining the overall corporate reputation ofthe organization through a proxy, the fortune corporate reputation index. drawing on past research in the area of background characteristics (hambrick and mason, 1984) and corporate reputation (fombrun and shanley, 1990), hypotheses were tested which examined the background characteristics ofceos and the company soverall corporate reputation. the results of this paper show that, in general, the ceo's background characteristics impact the level of overall corporate reputation of the firm. the type offunctional background of the ceo has a significant positive impact on the level of overall corporate reputation. over afour year time period (1990 to 1994), age, tenure with the company, and tenure as ceo were negatively related to the overall corporate reputation oforganizations that retained their ceo, forfirms that had replaced the ceo, a positive relationship between overall corporate reputation and tenure with the company and age was discovered. introduction fombrun and shanley (1990) state that a firm's corporate reputation can send a strong signal of how well a company is performing compared with other firms in the industry. a strong favorable corporate reputation demonstrates the firm's ability to properly position the firm's products and the effective implementation of the firm's strategies. both caves and porter (1977) and wilson (1985) argue that a favorable corporate reputation can yield excess financial returns for firms by generating a competitive advantage by differentiating themselves from their competitors. a critical component in the development of a competitive advantage is the decision making by the top level management within the organization in142 journal ofbusiness strategies vol. 14, no.2 eluding the ceo. the ceo is considered a dominant force in the decision making process of an organization (beatty and zajac, 1987). dalton and kesner (1985) state that the ceo is the central focal point within the organization. therefore, the purpose of this study is to the examine the relationship between the overall corporate reputation of a firm and the background characteristics of the ceo. this study examines the relationship between background characteristics which include: (1) age, (2) functional background (career path), (3) tenure with the company, and (4) tenure as ceo with the company_ these characteristics are compared with the organization's fortune corporate reputation index. theoretical framework and hypothesis development the underlying theoretical framework is based on a seminal work by hambrick and mason (1984). hambrick and mason (1984) proposed that specific characteristics of top level managers influenced the type of strategic choices made by the firm. as a result, it is proposed in this study that the background characteristics of the ceo can impact the "strategy" of developing a favorable overall corporate reputation. hambrick and mason (1984) present a number of observable upper echelon characteristics which include: functional track, age, and tenure. functional background hambrick and mason (1984) separate functional tracks into three different segments: (1) output functions, (2) throughput functions, and (3) peripheral functions. executives with output functions (marketing, sales, and product research and development) are expected to emphasize growth, product innovation, and the development of new market opportunities. chaganti and sambharya (1987) discovered that firms that were proactive in their approach to new product and new market development had a higher level of executives who had a marketing andlor research and development background. thomas, litschert, and ramaswamy (1991) also discovered that high performing proactive finns had ceos with an output functional background. ceos with an output functional background are committed to the belief that an aggressive proactive strategic philosophy will yield high performance results. output based ceos will be more likely to be not only committed, but are also more likely to convert product innovation efforts into actual product innovations (barbosa, 1985). barbosa (1985) discovered that ceos with marketing experience were more likely to transfer research and development innovations into new products. barbosa (1985) asserts that firms with a ceo who has a marketing background are more likely to: be creative, be market driven, and believe in growth opportunities for the firm. ceos with an output functional background focus on the aggressive expansion of the firm based on examining new product and/or market related opportunities. the ceos believe that the long term success of the firm is based on incorfall 1997 stanwick & stanwick: an empirical examination 143 porating a "pioneering" perspective by embracing new opportunities and new technologies. they believe that a favorable overall corporate reputation could lead to a competitive advantage in the marketplace (caves and porter, 1977; wilson, 1985). these ceos will encourage creative and market driven solutions which would result in favorable overall corporate reputations. it is also posited that ceos with a throughput functional background (production, process engineering, or accounting) are concerned with improving the efficiency of the overall organization by such actions as automation and the improvement of plant and equipment. thomas, litschert, and ramaswamy (1991) found that firms that focused on stability and efficiency had ceos who had a throughput functional background. therefore, the ceos are not as proactive in their strategic focus. strategic issues are classified based on a focus of efficiency. as a result, it is expected that firms with a throughput ceo will have less favorable corporate reputations than ceos with an output functional background. peripheral functional background (law and finance) are functions that are not directly involved with the organization's core activities. song (1982) found that ceos with a peripheral functional background focused on growth opportunities by acquiring firms that were unrelated to the firm's core business. hambrick and mason (1984) assert that peripheral functional ceos do not focus on strategies that relate to the core operations of the firms (i.e., new productlmarket development or efficiency issues) since they do not have the necessary "hands on" experience in their core business. as a result, ceos with a peripheral functional background are more likely to have a reactive instead of a proactive stance concerning strategic issues. therefore, the development of new products which would incorporate new market opportunities would not be developed in a firm with a peripheral ceo nor would the integration of efficiency issues take place as they would with a firm that has a throughput ceo. as a result, it is expected that firms with a ceo with a peripheral functional background will have the least favorable overall corporate reputations. therefore, the following hypothesis is empirically tested in this study: hypothesis 1: firms with ceos with a peripheral functional background will have the least favorable overall corporate reputations. ceo tenure previous research on the relationship between the ceo's age, tenure, and decision making have yielded conflicting results. some studies have shown that ceos that are younger and have less tenure are more flexible and proactive in their decision making (hambrick and fukutomi, 1991; miller, 1991). hambrick and fukutomi (1991) state that there are certain seasons of tenure for a ceo. for the first two years of tenure, the ceo will make organizational adjustments to 144 journal of business strategies vol. 14, no.2 match the ceo's vision. up to the first four years of tenure, the ceo will experiment with new ideas as a re-configuration of the organization occurs. after this relatively short period of time, the ceo becomes further committed to the existing paradigm. as a result, a status quo belief becomes firmly entrenched with a high level of rigidity and commitment to the established policies and procedures of the organization. therefore, as the tenure of the ceo increases, so does the resistance to change by the ceo of the current operations of the organization (finkelstein and hambrick 1990). finkelstein and hambrick (1990) also discovered that there is a positive relationship between the tenure of the ceo and general strategic philosophy of other firms in the industry. chaganti and sambharya (1987) examined the relationship between tenure and strategic focus and discovered that ceos with a long length of tenure focused on stability and efficiency issues, while ceos with less tenure concentrated on more proactive strategies including new product and new market development. the age of the ceo or the 'tenure of life' (finkelstein and hambrick, 1996) has also been empirically examined and has shown the same inverse relationship with pro-activeness and flexibility that was shown with tenure with the organization. vroom and pahl (1971) found a negati ve association between age and risk taking in the decision making process. this finding was supported in subsequent work which demonstrated an inverse relationship between age and product/market innovation strategies (thomas et ai., 1991) and strategic change (grimm and smith, 1991; wiersema and bantel, 1992). therefore, it is expected that tenure would also have an inverse relationship with overall corporate reputation of the organization. based on the ceo seasons of tenure presented by hambrick and fukutomi (1991), a four year time period was selected. hambrick and fukutomi (1991) categorize the tenure of the ceo into 5 major seasons which are: response to mandate (i to 2 years), experimentation (1 to 2 years), selection of an enduring theme (1 to 2 years), convergence (3 to 5 years), and dysfunction (all remaining years). the four year time frame allows the ceo to potentially go into the fourth season (selection of an enduring theme). therefore, this would reduce the probability that the sample would just demonstrate the strategic actions of new ceos. based on the work of miller (1991) and hambrick and fukutomi (1991), it is proposed that over a specific time period (1990 to 1994), there will be an inverse relationship between age and the overall corporate reputation of the organization. it is expected that younger ceos will implement strategic activities that will enhance the overall corporate reputation of the firm. in addition, it is proposed that within a specific time period (1990 to 1994) firms with ceos with less tenure in the organization and less tenure as ceo will have more favorable overall corporate reputations since the ceos are less entrenched in the organization's overall beliefs (hambrick and fukutomi, 1991). since a change in ceo could occur within this four year time frame, the sample will be analyzed based on whether there has been a succession of the ceo or not. it is expected that the relationship between the characteristics will be the fall 1997 stanwick & stanwick: an empirical examination 145 same regardless of whether or not a ceo succession has occurred. as a result, the following hypotheses are empirically tested in this study: hypothesis 2: within a certain time period (1990 to 1994),firms with younger ceos will have more favorable overall corporate reputations. hypothesis 3: within a certain time period (1990 to 1994), firms with ceos with less tenure with the organization will have more favorable overall corporate reputations. hypothesis 4: within a certain time period (1990 to 1994),firms with ceos with less tenure as the ceo with the organization will have more favorable overall corporate reputations. in addition to examining the relationship between the background characteristics of the ceo and the overall corporate reputation of the organization, this paper examines these relationships across different industries. cross industry comparisons have been largely ignored in previous research on overall corporate reputations. methodology sample selection i. for hypothesis 1: the sample of firms for years 1990 and 1994 included in this study meet the following criteria: 1. the firm must be ranked in the fortune corporate reputation index. 2. the firm must be listed in business weeks corporate elite so that the background characteristics of the ceos can be examined. 3. the firm must be listed in fortune's top 1000 companies in order to obtain the firm's industry classification. this criteria resulted in the selection of 235 firms in 1990 and 267 firms in 1994. ii. for hypotheses 2-4: 1. the same criteria as stated in 1. in addition, 2. the firms must be in both the 1990 and the 1994 sample. 3. the firms are separated into two categories: a) firms that retain the same ceo and, b) firms that had a new ceo. this resulted in the selection of 169 firms in which 114 firms had the same ceo and 55 firms had a ceo succession. 146 journal of business strategies vol. 14, no.2 overall corporate reputation overall corporate reputation is based on the fortune corporate reputation index. this index employs over 8,000 executives and outside industry experts who evaluate organizations within their own industry on eight different variables on a scale from zero (poor) to ten (excellent). the eight attributes are: (1) quality of management, (2) quality of products or services, (3) innovativeness, (4) longterm investment value, (5) financial soundness, (6) ability to attract, develop, and keep talented people, (7) wise use of corporate assets, and (8) responsibility to the community and the environment. based on the ranking of these eight variables, an overall reputation number is derived. previous research has used the fortune corporate reputation index to measure the relationship between overall corporate reputation and various accounting, institutional, and strategic signals presented by the firm (fombrun and shanley, 1990). in addition, previous research has also examined the relationship between corporate reputation and prior firm performance using the fortune corporate reputation index (hammond and slocum, 1996). previous studies have also supported the validity of this instrument by using all or part of the fortune corporate reputation index as a measurement of corporate social performance (hoft, hunger and shrader, 1991; mcguire, sundgren and schneeweiss, 1988; thomas and simerly, 1994; wokutch and spencer, 1987). functional background functional background was coded based on the description given in business week s corporate elite. after examining the description of the functional background, it was evident that numerous ceos had multiple functional backgrounds which could not be coded into only one categorization (output, throughput, or peripheral). in addition, the 1990 and 1994 sample did not yield enough observations of ceos with solely peripheral functional background (90 in 1990 and 116 in 1994) to identify significant differences. as a result, the functional backgrounds were grouped into two major categories which are: ceos whose functional background included peripheral training and ceos that did not. as was stated previously, peripheral functional background did not supply the ceo with the necessary "hands-on" experience to become actively involved in the strategic decisions about the core businesses of the firm. even though the ceos may have additional experience in other functional areas, this lack of grounded experience limits their ability to envision the potential benefits of new productj market development and efficiency gains that would enhance overall corporate reputations. as a result, if the ceo had a functional background in output or throughput or a combination of the two, they were classified into the non-peripheral group. if the ceos had functional backgrounds in peripheral or a combination of peripheral and throughput or output, they were classified as having a peripheral functional background. in the 1990 sample, 118 ceos were classified as having a non-peripheral functional background and 117 were classified as having fall 1997 stanwick & stanwick: an empirical examination 147 a peripheral functional background. in the 1994 sample, 127 ceos were classified as having a non-peripheral functional background and 140 ceos were classified as having a peripheral functional background. industry classifications the industries were classified based on the categorizations used in the forbes 500 listing. results a total of 235 firms in 1990 and 267 firms in 1994 were examined. the results showed that firms with favorable overall corporate reputations have a higher incidence of peripheral functional background ceos which is the opposite direction of the relationship that was proposed in hypothesis 1. in addition, when the ceos remain the same over the four year time period, firms with favorable overall corporate reputations had a higher incidence of younger ceos, with less tenure within the organization and less tenure as ceo which supports hypotheses 2 through 4. however, the relationship showed an opposite pattern when a new ceo took over during the four year time period. table 1 provides descriptive statistics for both samples of firms. table 1 descriptive statistics mean std dev minimum maximum 1990 sample rep90 6.36 0.92 3.10 8.86 age 57.58 6.26 41.00 92.00 ten 25.67 11.52 1.00 54.00 tenceo 7.41 7.60 0.50 45.00 1994 sample rep94 6.48 0.81 3.65 8.65 age 57.29 5.80 38.00 79.00 ten 24.67 11.49 1.00 55.00 tenceo 8.44 7.69 1.00 55.00 index: rep90 =fortune corporate reputation index for 1990 rep94 =fortune corporate reputation index for 1994 age =age of the ceo ten =number of years of tenure in the company by the ceo tenceo =number of years of tenure as ceo 148 journal of business strategies vol. 14, no.2 the mean ofthe fol1une corporate reputation index was 6.36 in 1990 and 6.48 in 1994. in addition, this table shows that in 1990, the ceos average age was 57.58 years, tenure with the company was 25.67 years, and tenure as ceo was 7.41 years. the same information for 1994 indicated that the average age was 57.29 years, tenure with the company was 24.67 years, and tenure as ceo was 8.44 years. regression analysis was used to examine the relationship between the firm's overall corporate reputation and the background characteristics of the ceo of the firm. using regression analysis, the results showed that there were indeed strong relationships between the background characteristics of the ceo and the level of overall corporate reputation. in the 1990 sample, the results showed a significant positive relationship between age and overall corporate reputation (t=2.09, p<.0379) and tenure as ceo and overall corporate reputation (t=2.73, p<.oo69) as indicated in table 2. table 2 regression results for overall corporate reputation all finns in the 1990 sample dependent variable = rep90 source model error total df 7 227 234 sum of square 13.1701 188.5911 201.7612 mean square 1.8814 0.8307 fvalue 2.26 prob>f 0.0302* r-square :: 0.0652 variable parameter standard t for ho: prob>t estimate error parameter=o intercept 2.3723 1.6818 1.41 0.1597 tenceo 0.4683 0.1717 2.73 0.0069* age 0.0609 0.0291 2.09 0.0379* ten 0.0898 0.0680 1.32 0.1877 age"'ten -0.0012 0.0011 -1.10 0.2739 tenceo*age -0.0069 0.0027 -2.55 0.0113* tenceo* ten -0.0109 0.0052 -2.10 0.0370* tenceo* age*ten 0.0001 0.0000 1.97 0.0495* *significant at p :: 0.05 index: rep90 :: fortune corporate reputation index for 1990 age:: age of the ceo ten :: number of years of tenure in the company by the ceo tenceo :: number of years of tenure as ceo fall 1997 stanwick & stanwick: an empirical examination 149 in addition, there were significant interactions between tenure as ceo and age and tenure, and a significant three way interaction among all three of the variables, also as indicated in table 2. table 3 presents the results from ex.amining overall corporate reputations of firms with a ceo who was classified as having a peripheral functional background. table 3 regression results for overall corporate reputation for firms with a ceo with a peripheral functional background 1990 sample dependent variable =rep90 source df sum of square mean square fvalue prob>f model 7 16.0056 2.2865 2.52 0.0192* error 109 98.7721 0.9061 total 116 114.7778 r-square ;;;: 0.1394 variable parameter standard t for ho: prob>t estimate error parameter=o intercept -1.0487 2.5825 -0.41 0.6855 tenceo 0.5040 0.2878 1.75 0.0827# age 0.1210 0.0464 2.61 0.0104* ten 0.2038 0.1061 1.92 0.0575# age*ten -0.0032 0.0018 -1.78 0.0780# tenceo*age -0.0070 0.0049 -1.43 0.1546 tenceo*ten -0.0139 0.0072 -1.93 0.0558# tenceo* age*ten 0.0001 0.0001 1.72 0.0891# #significant at p =0.10 *significant at p = 0.05 index: rep90 =fortune corporate reputation index for 1990 age =age of the ceo ten = number of years of tenure in the company by the ceo tenceo = number of years of tenure as ceo results for firms with a ceo classified as having a peripheral career path had a significant positive relationship with age and overall corporate reputation (t=2.61, p<.ol04), tenure and overall corporate reputation (t=1.92, p<.0575), and tenure as ceo and overall corporate reputation (t=1.75, p<.0827). in addition, the results yielded significant interactions between age and tenure, and tenure as ceo and tenure with 150 journal of business strategies vol. 14, no.2 the firm. a significant three way interaction between the three variables was also present. therefore, the results show a significant relationship in the opposite direction than was proposed in hypothesis 1. finns with a favorable overall corporate reputation had a higher incidence of peripheral functional background ceos. the regression analysis for the 1994 sample did not yield significant results. correlation analysis (tables 4 and 5) was used to examine the strength of the relationship between each of the variables examined in this study (reputation, age, tenure, tenure as ceo) from the time period 1990 to 1994 across all 21 industries. the firms were categorized based on whether the firm had replaced the ceo or not within the same period. for the 114 firms that had the same ceo from 1990 to 1994, there were a number of significant correlations. table 4 correlation analysis results change from 1990 to 1994 same ceos industry =computers/communications age ten tenceo crep94 -0.5703 -0.7532 -0.0808 0.1399 0.0310* 0.8491 industry =: consumer durab1es age ten tenceo crep94 0.1639 0.7445 0.4296 0.6509 0.0135* 0.2153 industry = consumer nondurables age ten tenceo crep94 -0.5825 -0.0531 0.1770 0.0998# 0.0819 0.6485 industry =: transportation age ten tenceo crep94 0.6594 -0.6725 -0.9980 0.5416 0.5304 0.0396* industry =: travel age ten tenceo crep94 -0.1316 -0.9998 -0.4488 0.9160 0.0108* 0.7037 #significant at p =0.10 *significant at p =0.05 index: crep94 =: change in fortune corporate reputation index from 1990 to 1994 age =age of the ceo ten =number of years of tenure in the company by the ceo tenceo = number of years of tenure as ceo fall 1997 stanwick & stanwick: an empirical examination 151 from the time period 1990 to 1994, there was an inverse relationship between tenure with the firm and the change in overall corporate reputation in the computer/communications and travel industry and a positive relationship in the consumer durables industry. there was an inverse relationship between age and the change in overall corporate reputation in the consumer nondurables and the health industry. there was an inverse relationship between tenure as ceo and the change in overall corporate reputation in the transportation industry. therefore, hypotheses 2 through 4 are supported. firms with a favorable overall corporate reputation who have the same ceos for the four year time period are younger and have less tenure as ceo and less tenure within the organization. there were also significant correlations for the 55 firms that did change their ceo within the time period 1990 to 1994. table 5 correlation analysis results change from 1990 to 1994 different ceos crep94 crep94 industry = capital goods age ·0.2184 0.7816 industry =computers/communications age crep94 -0.1088 0.8374 industry = consumer durables age 0.9997 0.0148* industry = foodldrinkffobacco age crep94 0.9501 0.0498* #significant at p=o.lo *significant at p=0.05 ten 0.9478 0.0521 * ten 0.8205 0.0454* ten 0.9856 0.1079 ten -0.0933 0.9067 tenceo tenceo 0.2644 0.6126 tenceo 0.9063 0.2778 tenceo 0.3994 0.6005 index: crep94 = change in fortune corporate reputation index from 1990 to 1994 age = age of the ceo ten = number of years of tenure in the company by the ceo tenceo = number of years of tenure as ceo 152 journal of business strategies vol. 14, no.2 there was a positive relationship between tenure with the compapy and the change in overall corporate reputation in the capital goods and computers/communications industry. there was a positive relationship between age and the change in the overall corporate reputation of the firms in the consumer durables and the food/drink/tobacco industries. in contrast to the relationships presented in hypotheses 2 through 4, for firms that had a change in ceo, firms with a favorable overall corporate reputation had older ceos who had more tenure within the organization. conclusions and suggestions for future research the results of this study highlight the complex relationship between the background characteristics of the ceo and the overall corporate reputation of the firm. the results show that, in general, the background characteristics of the ceo do impact the overall corporate reputation. the surprising positive relationship between peripheral functional background and overall corporate reputation can be explained, in part, by recognizing the vast business experience of ceos. this study has demonstrated that ceos have exposure to multiple functional areas as they move up the corporate ladder. as a result, the broad functional training which ceos are exposed to may reduce the resistance to implementing strategies which would enhance the overall corporate reputation of the firm. the results of this study have shown the ceos with a peripheral functional background have been able to compensate for their lack of "hands on" experience as it relates to the firm's core business. through their exposure to different functions of the organization, peripheral ceos have been able to incorporate proactive strategies in their decision making processes. of equal importance is the significant difference between the various industries over the time periods of the study. for firms that retained their ceo, there were significant inverse relationships in five of the six industries. this demonstrates that tenure, tenure as ceo, and age do playa role in the level of overall corporate reputations of organizations. firms with ceos who are younger and have less time vested in the organization are more likely to have a favorable overall corporate reputation. these results support the view of hambrick and fukutomi (1991) and miller (1991) who state that as the ceo establishes himlherself in the ceo position, the ceo will firmly establish a rigid paradigm that will not be altered. the results of firms that have had a change in their ceo during the sample time period also provide some very interesting observations. contrary to what was proposed in hypotheses 2 through 4, the results showed a positive relationship between overall corporate reputation and tenure and age. this could be explained, in part, through the type of ceo succession that took place. of the four industries that had significant correlations, only two of the seventeen firms (11.7%) fall 1997 stanwick & stanwick: an empirical examination 153 had new ceos from outside the firm. therefore, ceo succession from within the company was the dominant form of succession. even though insider succession is considered to support maintenance of the current strategic focus (finkelstein and hambrick, 1996), the ceo succession event will create the opportunity to consider alternative viewpoints (hambrick and futukomni, 1991). since the new ceo is in the early "season" of hislher tenure, the ceo will accept adjustments in the existing paradigm. therefore, the positive relationship between overall corporate reputation and tenure and age is the result of new ceos with the willingness to accept alternative viewpoints. in addition, because the ceos have a long length of tenure with the organization, they previously have acquired a high level of experience about the operations of the organization (thomas and simerly, 1994). there are some limitations of this study that could be addressed in future research. the first limitation is the use of the fortune corporate reputation index. although the authors believe that the fortune corporate reputation index is a valid proxy for overall corporate reputation, the authors realize that this index is only one measure of a very complex construct. another limitation is that the sample contains data from only two years. an extension of this paper would include the tracking of overall corporate reputation over a number of consecutive years in order to examine whether there are trends in the data, possibly between industries. which could be identified. references barbosa, r. (1985). innovation in a mature industry. unpublished ph.d dissertation, columbia university: new york. beatty, r., & zajac, e. (1987). ceo change and firm performance in large corporations: succession effects and manager shifts. strate&ic management journal. 8, 305-317. caves, r., & porter, m. (1977). from entry barriers to mobility barriers. quarterly journal of economics. 91, 421-434. chaganti, r., & sambharya, r. (1987). strategic orientation and characteristics of upper management. strategic management journal. 8, 393-401. dalton, d., & kesner, i. (1985). organizational performance as an antecedent of inside! outside chief executive succession: an empirical assessment. academy of mana&ement journal. 28, 749-762. finkelstein, s., & hambrick, d. (1990). top management team tenure and organizational outcomes: the moderating role of managerial discretion. administrative science quarterly. 35,484-503. 154 journal of business strategies vol. 14, no.2 finkelstein, s., & hambrick, d. (1996). strategic leadership: top executive and their effects on organizations. new york: west publishing. fombrun, c., & shanley, m. (1990). what's in a name? reputation building and corporate strategy. academy of management journal. 33,233-258. grimm, c. & smith, k. (1991). management and organizational change: a note on the railroad industry. strategic management journal. 12,557-562. hambrick d., & mason, p. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review. 9, 193-206. hambrick d., & fukutomi, d. (1991). the seasons of a ceo's tenure. academy of management review. 16, 719-742. hammond, s., & slocum, j. (1996). the impact of prior firm financial performance on subsequent corporate reputation. journal of business ethics. 15, 159-165. hoft, 1., j. hunger, & shrader, c. (1991). characteristics of boards of directors and perceptions of corporate social responsibility: an examination of the fortune survey.lm!m.aj. of business strategies. 8, 77-85. mcguire, j., j. sundgren, & schneeweiss, t. (1988). corporate social responsibility and firm financial performance. academy of management journal. 31 i 854-872. miller, d. (1991). stale in the saddle: ceo tenure and the match between organization and environment. management science. 37, 34-52. thomas, a" r. litschert, & ramaswamy, k. (1991). the performance impact of strategymanager coalignment: an empirical examination. strategic management journal. 12, 509522. thomas, a. & simerly, r. (1994). the chief executive officer and corporate social performance: an interdisciplinary examination. journal of business ethics. 13, 959-968. song, j. (1982). diversification strategies and the experience of top executives of large firms. strategic management journal. 3, 377-380. vroom, v., & pabl, b. (1971). relationship between age and risk-taking among managers. journal of applied psychology. 55, 399-405. wiersema, m., & bantel, k. (1992). top management team demography and corporate strategic change. academy of management journal. 35, 91-121. wilson, r. (1985). reputations in games and markets. in a.e. roth (ed.), game-theoretic models of bargaining. new york: cambridge university press. 65-84. fall 1997 stanwick & stanwick: an empirical examination 155 wokutch, r. & spencer, b. (1987). corporate saints and sinners: the effects of philanthropic and illegal activity on organizational performance. california management review. 29,62-77. appendix major industry classifications aerospaceldefense business services/supplies capital goods chemicals computers/communications construction consumer durables consumer nondurables electric utilities energy entertainmentlinformation financial services food distributors foodldrinkftobacco forest productslpackaging health insurance metals retailing transportation travel dr. peter a. stanwick received his ph.d. in strategic management from florida state university. he is an assistant professor in the department of management at auburn university. dr. sarah d. stanwick received her ph.d. in accounting from florida state university. she is an assistant professor in the school of accountancy at auburn university. an empirical examination of the relationship between the background characteristics of the ceo and overall corporate reputation volume 34, number 1 thunder up the taxes! kyle dean oklahoma city university • oklahoma city, oklahoma russell evans oklahoma city university • oklahoma city, oklahoma jonathan willner oklahoma city university • oklahoma city, oklahoma abstract oklahoma city taxpayers approved a 1% sales tax to raise an estimated $120 million for improvements to lure the seattle supersonics, now the oklahoma city thunder. city civic leaders engaged a “big league city” campaign, touting economic growth, increased business activity and jobs, and better quality of life as reasons to support the initiative. we evaluate the “big league city” economic claims using local sales tax revenues to estimate the level and growth impacts resulting from the relocation of the now oklahoma city thunder. we find no significant relationship between the operation of the franchise and contemporaneous sales tax collections. however, we find a modest positive significant relationship between the presence of the franchise and the year-over-year growth rate of aggregate sales tax collections, providing some support for the amenity “big league city” argument. keywords: sports, tax revenue introduction in 2008 the former seattle supersonics of the national basketball association (nba) began the 2008 – 2009 season as the oklahoma city thunder. in a wellpublicized move, new owners based in oklahoma city relocated the franchise to oklahoma’s capital city. as a relocation incentive, oklahoma city residents agreed to continue a 1% temporary sales tax to fund improvements to the then “ford center” arena and to fund the construction of a new team practice facility. passed in march of 2008, the tax lasted 15 months and raised just over $105 million in revenues to fund the thunder projects. according to forbes’ christopher helman (2012), the oklahoma city-based owners purchased the franchise with the promise to remain in seattle “so long as we are able to negotiate an attractive successor venue and lease arrangement”. following a protracted discussion, the seattle legislature failed to approve the 2 journal of business strategies necessary incentives for new construction and the franchise owner group set the move to oklahoma city in motion. oklahoma city gained experience hosting an nba franchise, the new orleans hornets, after hurricane katrina. the city served as the hornets’ temporary host for two seasons (2005-06 and 2006-07). hosting the hornets created enthusiasm for the nba within okc. the experience provided positive evidence of the city’s ability to support an nba franchise; the announced paid attendance averaged 18,737 per game according to an economic impact study by bryant and evans (2007). while citizens hoped to retain the hornets, their relocation to okc was temporary and they returned to new orleans after only two seasons. however, the hornets experience changed the expectations of okc residents and signaled to the nba that okc was in the market and could support an nba franchise. without support from seattle taxpayers, the new ownership group decided to move the team after okc voters approved the extension of an existing $0.01 (1%) sales tax to fund arena and practice facility improvements. the sales tax extension was widely supported by local leaders as a means to increase economic activity and create long run growth, in turn making okc a desirable place to live and work. okc voters had previously approved two sales tax initiatives beginning in 1993 aimed at increasing local amenities, the metropolitan area projects (maps) and maps for kids. in a supportive “vote yes” television advertisement, mayor mick cornett along with two previous mayors, kirk humphries and ron norick stated “…just like maps, improving the ford center will grow our economy, help attract even more companies, creating better paying jobs and improving quality of life”. using the tagline “big league city,” the message was clear that local leaders expected a long-run amenity effect from the relocated franchise. the potential impacts from professional sports franchises may include both contemporaneous impacts on local sales tax collections and long run impacts on local labor markets and business development from the improved local amenity package and quality of life enhancement. we investigate both impact avenues in the body of this paper. the empirical investigation is intentionally limited to oklahoma city in an effort to identify case-specific fiscal and amenity effects. the relevant literature is reviewed in the next section followed by a discussion of the data and methodology, results, and a conclusion. volume 34, number 3 literature the economic benefits of sports franchises are difficult to estimate. indeed, even obtaining agreement on the term “benefit” is a challenge as evidenced by the multiple approaches for estimation used in the literature. the first best method for determining the net value of public expenditure is to compare total benefits to total costs and estimate the net present value of net benefits for the years of implementation and operation. while the cost of local investment is relatively easy to calculate, benefit calculation requires the estimation of both use and non-use values as well as local growth benefits that may or may not occur due to amenity induced migration. these non-use and growth benefits are at best, difficult to determine and at worst, unknowable. non-use valuation can be estimated, as seen by johnson et al (2001), but the problem of determining the appropriate stakeholders still exists. haughwout and inman (2002) and rappaport (2005) find that the benefits of local amenities are shared between central city and suburban dwellers, as the urban and suburban areas grow (or decline) together. in the case of a top-level sports franchise, the suggestion that cooperative efforts between the urban and suburban areas are likely to yield the best outcome for the region should result in cost sharing agreements, yet in practice, it is difficult to convince suburbs to bear, at least partially, any of the development costs. in oklahoma city, voters within the city agreed to the continued 1% sales tax premium without explicit participation from nearby suburbs. suburban residents contributed to the funding efforts only to the extent that local market conditions allowed for the tax to be successfully exported. studies examining the economic impact of hosting athletic events and franchises admit that the impact is generally negative to neutral, with a few exceptions worth noting. coates and humphreys (1999) find an overall negative effect on per capita income from supporting professional sports franchises in 37 msas from 1969 through 1994. hudson (1999) examines 17 us cities for employment effects from professional franchises in those cities, but finds none. matheson (2005) examines personal income growth in cities with super bowl champion teams and finds no evidence of a positive effect. lertwachara and cochran (2007) use an event study approach to examine the effect of relocation and expansion of professional sports teams on msa per capita income and growth rates of per capita income. they find that professional sport franchises reduce msa per capita income. propheter (2012) examines 24 nba host cities and finds only scant evidence of a positive effect on personal income from building nba arenas. conversely, davis and end (2010) find that winning nfl teams increase local 4 journal of business strategies per capita gdp. coates and humphreys (2003) find both positive and negative wage effects for cities hosting professional franchises estimating the net effect to be neutral and interpret the finding as evidence of household’s substituting in consumption. carlino and coulson (2004) show that wages are lower in franchise cities, though not statistically significant, while rents are significantly higher. coates, humphreys, and zimbalist (2006), in a rejoinder, find that the carlino and coulson results are not robust to model specifications. coates and humphreys (2011) admit that there are some positive effects on wages for nfl hosting cities, but the results are confined to announcers, athletes and others employed in recreation. a subset of papers focus more narrowly on the fiscal impacts of sporting events and franchises. coates (2006) examine the effect of the super bowl and the mlb all-star game on houston sales tax revenues and find positive and significant effects. coates and depken (2009) examine 4 mid-sized texas cities and the effect that college football games had on sales tax revenues in those cities, finding mixed effects, but generally negative and dependent on the opponent in each game. extending their 2009 paper, coates and depken (2011) examine texas sales tax revenue responses to hosting college and professional sports. they find, in many cases, negative effects on sales tax revenues, with positive effects limited to college football towns and the super bowl. finally, somerville & wetzel (2010) find that there was no effect on the residential property tax base from hosting the olympics in vancouver. for the purposes of this paper, the most directly comparable work is baade, baumann, & matheson, (2008). within the work, they examine the impacts to taxable sales in florida counties from hosting a variety of one-time major sporting events and building/improving the venues necessary to accommodate them. in virtually all cases neutral to negative effects were found. in a subsequent paper baade and matheson (2011) discuss the quality of life justification directly, stating that while there is evidence in support of the quality of life argument, the significance of the quality of life benefit may be appropriate for public/private development partnerships but inappropriate for 100% public subsidization. where previous research investigated the impacts of hosting one-time events across a series of cities, this paper modifies the strategy by investigating a series of one-time events hosted in a single city. the quality of life literature provides some guidance in considering the growth effects of local franchises. local quality of life measures were pioneered by roback (1982) who looks specifically at local amenity and productivity effects using hedonic estimates of willingness to pay for local amenities. initial research included naturally occurring amenities leading to questions of whether localities’ long run volume 34, number 5 equilibrium condition rested only with the uncontrollable forces of mother nature. gyourko and tracy (1991) add local fiscal conditions to the mix and find that manmade factors could influence long-run outcomes for municipalities. later research by glaeser et al (2001) finds that not only is urban density good for productivity growth, it is also vital for the creation of consumer amenities which are directly correlated with population growth, as discovered by ciccone and hall (1996). rappaport (2009) studied the migration-induced effects of local amenities and concludes that amenities are the sole determinant of population density asymptotically and that the population densities of cities with identical amenities but different productivity levels eventually converged. noll & willner (2003) provide evidence of a positive role for professional franchises in the quality of city life. in this paper we examine changes in the oklahoma city sales tax revenue growth rates from hosting a series of “one-time” thunder events and finding no evidence of a contemporaneous effect on year-over-year growth rates but modest evidence in support of a longer run, amenity growth effect. data monthly gross sales tax receipts were provided by the city of oklahoma city. the data in levels exhibits a unit root indicating a nonstationary time series. accordingly, the monthly data is converted into year-over-year growth rates for the january 2002 – june 2014 period. a little more than half of the observations occur in the pre-thunder period. the potential amenity effect is represented by a thunder binary variable that takes the value of 1 from november 2008, the thunder’s inaugural season in oklahoma city. the thunder has experienced both deep playoff runs and disappointing season finishes outside the eighth and final playoff position. this reality provides richness in the dataset as many months are characterized by significantly more (or less) home games than the same month of the previous year. the difference between the number of home games played in a month relative to the same month of the previous year serves effectively as a series of “one-time” hosted events. if a contemporaneous effect on monthly sales tax receipts (as measured in year-over-year growth rates) exists, we expect to see it in the differential number of home games variable. yearover-year differentials in the number of away games is also captured and reported. a vector of regional economic control variables is included in the model to capture fluctuations in city economic conditions. the preferred model specification includes economic control variables on the annualized change in oklahoma city 6 journal of business strategies msa nonfarm employment, a u.s. recession dummy variable, and the annualized change in statewide active rig counts (a proxy for expansion or contraction in the state’s primary oil and gas industry). this parsimonious control vector minimizes concerns of correlated explanatory control variables. alternative specifications are reported for other economic controls, including measures of year-over-year growth in oklahoma personal income and year-over-year growth in crude oil and natural gas spot prices for the months under study. all time-series data are stationary in their transformations. the tax rate is unchanged over the entire set of observations. the model results are robust to alternative specifications of the macroeconomic control vector. finally, a time trend is included in all models. a summary of all model variables is provided in table 1. volume 34, number 7 analysis year-over-year growth rates of aggregate tax collections are modeled as a function of regional economic activity, a time trend, a thunder amenity effect, and fluctuations in the number of home and away games played. tax rates, generally a component of revenue models, were unchanged over the entire observation period and are therefore omitted from our analysis. using a general linear model we estimate the following model: a positive fiscal impact attributable to the presence and operations of the thunder franchise would be expected to manifest in either or both of the coefficients on the thunder presence and change in home games played being reported as positive and statistically significant. the primary purpose of the investigation is the influence of a change in the number of home games – the one-time events for that month but, also of interest, is a secondary investigation of the potential amenity effect captured by the thunder presence binary indicator. results and discussion the results are reported in table 2 with nine alternative specifications of the macroeconomic control vector. across all models, the thunder presence variable is positive and statistically significant, but may be overstated as a result of lingering serial correlation. this finding is consistent with the anecdotal evidence that the arrival of the thunder as a permanent oklahoma city franchise is correlated with a rapid development of the city’s core as both businesses and residents return to the city center. we acknowledge that it is difficult to interpret the magnitude of the estimated amenity effect, but our findings suggest we cannot dismiss the notion that a professional sports franchise can be an important component of the urban amenity complex and a catalyst for encouraging density. of course, our findings are not necessarily portable to other locales. it may be that the amenity effects are concentrated in the city’s first franchise, where the franchise is most likely to be a significant component of the urban amenity portfolio, while diminishing returns exist to expansions into subsequent franchises. similarly, 8 journal of business strategies the amenity returns to oklahoma city may be exaggerated by its economic geography. oklahoma city is one of the largest major metropolitan areas in the nation as measured by area (square miles). in terms of area, oklahoma city is roughly the size of houston (about 600 miles2) and considerably larger than dallas, chicago, or san diego. as such, oklahoma city is historically one of the least dense metropolitan areas and conceivably was poised to benefit disproportionately from the productivity and agglomeration benefits associated with increased density. it is possible that the amenity effect is manifest through increased population growth rates generally or expedited urbanization of the city’s core. finally, it should be noted explicitly that our findings do not necessarily imply the optimality of public support for a professional sports franchise as there are potentially other public investment and infrastructure projects that could have impacted the urban amenity portfolio similarly. in contrast to the positive and statistically significant amenity effect, we find no evidence of a contemporaneous impact on city sales tax collections. across all models, playing more home games in a given month relative to the same month in the previous year does not appear to have a positive effect on year-over-year collections growth. this result is consistent with the literature on consumption substitution that concludes one-time events merely shift expenditures from one activity to another with no net increase in aggregate taxable activity. in our dataset, the months with the greatest change in home games played are the result of making a deep playoff run. for example, in the thunder’s second year the team secured the eighth and final playoff spot and faced the would-be champions that year, the los angeles lakers. the thunder lost the series in six games, but in the process secured three additional home games in oklahoma city that were not part of the economic landscape the previous may. if a contemporaneous effect existed, we would expect to find it in this one-time event of hosting three nba playoff games. however, purchase of playoff tickets is not a taxable sale. therefore purchases of playoff tickets may actually be a substitution in discretionary spending away from taxable activities and towards a nontaxable activity. in addition to variations caused by playoff performance, our dataset also captures the effects of the 2011 nba lockout. the combination of playoff performance and the lockout provides ample opportunity to find a contemporaneous effect if it existed in the dataset. volume 34, number 9 10 journal of business strategies conclusion it often seems that economic development agents support the economic benefits of professional sport franchises with an enthusiasm that is only matched by the passion with which economists dismiss them. perhaps the truth lies somewhere in the middle and benefits from case-specific rather than generalized analysis. we investigate the case of oklahoma city, examining specifically the municipal fiscal impacts of the city’s first and only major professional franchise. we find no evidence that the variation in the number of home games played has a statistically significant effect on sales tax growth. however, we do find some evidence of an amenity level effect, suggesting the franchise is an important component of oklahoma city’s developing urban amenity portfolio. references baade, robert a., & matheson, victor a. (2011). “financing professional sports facilities.” college of holy cross, department of economics faculty research series, paper no. 11-02 n.d. baade, robert a., baumann, robert & matheson, victor a. (2008). “selling the game: estimating the economic impact of professional sports through taxable sales.” southern economic journal 74, no. 3: 794-810. bryant, brent and evans, monty. (2007, may). “new orleans/oklahoma city hornets economic impact, city of oklahoma city-revised analysis.” oklahoma capital investments board. carlino, gerald, and coulson, n. edward. (2004). “compensating differentials and the social benefits of the nfl.” journal of urban economics 56, no. 1: 25-50. ciccone, antonio, and hall, robert e. (1996). “productivity and the density of economic activity.” american economic review 86, no. 1: 54-70. coates, dennis. (2007, october). “stadiums and arenas: economic development or economic redistribution.” contemporary economic policy 25, no. 4: 565-577. coates, dennis. (2006). “the tax benefits of hosting the super bowl and the mlb all-star game: the houston experience.” international journal of sport finance 1, no. 4: 239-252. coates, dennis, and humphreys, bard r. (2008). “do economists reach a conclusion on subsidies for sports franchiese, stadiums and mega-events?” econ journal watch 5, no. 3: 294-315. volume 34, number 11 coates, dennis, & brad r humphreys. (2011). “the effect of professional sports on the earnings of individuals: evidence from microeconomic data.” applied economics 43, no. 29: 28-30. coates, dennis, and humphreys, brad r. (2008). “do economists reach a conclusion on subsidies for sports franchiese, stadiums and mega-events?” econ journal watch 5, no. 3: 294-315. coates, dennis, and humphreys, brad r. (2003). “the effect of professional sports on earnings and employment in the services and retail sectors in us cities.” terional science and urban economics 33: 175-198. coates, dennis, and humphreys, brad r. (2011). “the effect of professional sports on the earnings of individuals: evidence from microeconomic data.” applied economics 43: 28-30. coates, dennis, and humphreys, brad r. (1999). “the growth effects of sport franchises, stadia and arenas.” journal of policy analysis and management 18, no. 4: 601-624. coates, dennis, and depken, craig a. (2011). “mega-events: is baylor football to waco what the super bowl is to houston?” journal of sports economics 12, no. 6: 599-620. coates, dennis, and depkin, craig a. (2009). “the impact of college football games on local sales tax revenue: evidence from four cities in texas.” eastern economic journal 35, no. 4: 531-547. coates, dennis, humphreys, brad r., & zimbalist, andrew. (2006). “compensating differentials and the social benefits of the nfl: a comment.” journal of urban economics 60, no. 1: 124-31. davis, michael c., and end, christian m. (2010). “a winning proposition: the economic impact of successful national fottball league franchises.” economic inquiry 48, no. 1: 39-50. glaeser, e. l., kolko, j., & saiz, a. (2001). “consumer city.” journal of economic geography 1, no. 1 (2001): 27-50. gyourko, j., and tracy, j. (1991). “the structure of local public finance and the quality of life.” journal of political economy 99, no. 4: 774-806. haughwout, a. f. and inman, r. p. (2002). should suburbs help their central city:. brookings-wharton papers on urban affairs. helman, christopher. (2012, june). “the sordid deal that created the oklahoma city thunder.” forbes.com. hudson, ian. (1999). “bright lights, big city: do professional sports teams increase employment?” journal of urban affairs 21, no. 4: 397-407. 12 journal of business strategies johnson, bruce k., groothuis, peter a., & whitehead, john c. (2001, february). “the value of public goods generated by a major league sports team: the cvm approach.” journal of sports economics 2, no. 1: 6-21. lavoie, marc, and rodriguez, gabriel. (2005). “the economic impact of proressional teams on monthly hotel occupacny rates of canadian cities: a box-jenkins approach.” journal of sports economics 6, no. 3: 314-324. lertwachara, kaveephong, and cochran, james j. (2007). “an event study of the economic impact of professional sport franchises on local u.s. economies.” jounral of sports economics 8, no. 3: 244-54. matheson, victor a. (2005). “contrary evidence on the economic effect of the super bowl on the victorious city.” journal of sports economics 6, no. 4: 420428. mcgregor, p. g., swales, j. k., & yin, y. p. (1996). “a long-run interpretaion of regional input-output analysis.” journal of regional scinece 36, no. 3: 479500. nelson, arthur c. (2001). “prosperity of blight? a question of major lague stadia locations.” economic development quarterly 15, no. 3: 255-265. noll, dennis, and willner, jonathan. (2003). “professional sports and the quality of city life.” southwestern journal of economics 5, no. 2: 133-153. noll, roger g. and zimbalist, andrew. (1997). sports, jobs and taxes: the economic impact of sports teams and stadiums. brookings institute press. porter, philip k. (2001). mega-sports events as municipal investments: a critique of impact analysis. vol. 2, in the economics of sport, by andrew zimbalist, 370-283. edward elgar. propheter, geoffrey. (2012). “are basketball arenas catalysts of economic development?” journal of urban affairs 34, no. 4: 441-459. rappaport, j. (2009).”the increasing importance of quality of life.” journal of economic geography 9, no. 6: 779-804. rappaport, j. (2005).”the shared fortunes of cities and suburbs.” economic review 90, no. 3: 33-60. rappaport, jordan and wilkerson, chad. (2001). “what are the benefits of hosting a major league sports franchise?” economic review (federal reserve bank of kansas city), first quarter: 55-91. roback, j. “wages, rents and the quality of life.” journal of political economy 90, no. 6 (1982): 1257-1278. volume 34, number 13 siegfried, john, and zimbalist, andrew. (2006). “the economic impact of sports facilities, teams and mega-events.” austalian economic review 39, no. 4: 420-7. siegfried, john, and zimbalist, andrew. (2000). “the economics of sports facilities and their communities.” journal of economic perspectives 14, no. 3: 95-114. somerville, tsur, and wetzel, jake. (2010). “hunting for the olympics bounce: any evidence in real estate?” centre for urban economics and real estate, discussion paper 2010-01, university of british columbia. zaretsky, adam m. (2001, april). “should cities pay for sports facilities.” the regional economist (federal reserve bank of st. louis): 5-9. biographical sketch of authors kyle dean is the associate director, steven c. agee economic research & policy institute and an assistant prof. of economics in the meinders school of business, oklahoma city university. he holds a ph.d. in economics from oklahoma state university. dr. dean began consulting in 2005 and his client list includes some of oklahoma’s most influential businesses and trade associations, including the oklahoma independent producers association (oipa), the oklahoma bankers’ association (oba), the oklahoma telephone association (ota) and many others. he is best known for his comprehensive work with oklahoma tribes, having completed the first ever estimate of the combined economic impacts from oklahoma tribal activities. russell evans is the executive director of the steven c. agee economic research and policy institute (erpi), director of the center for regional economic forecasting and policy analysis, and assistant professor of economics. and assistant professor of economics in the meinders school of business, oklahoma city university. he holds a ph.d. in economics from oklahoma state university. he is a co-founder principal of the economic impact group, llc. as the executive director of erpi he is involved in developing relationships with the business community and directing funded research projects. dr. evans’ research involves issues important to local civic leaders including the economic and fiscal outlook for the okc economy, the oklahoma consumer sentiment index, the oklahoma energy index, and the economic impact of the state’s primary industries including oil and gas and native american operations. jonathan willner is the b.c. clark jr. chair in economics and professor of economics in the meinders school of business, oklahoma city university. dr. 14 journal of business strategies willner specializes in three main areas: sports economics, international trade, and industrial organization. additional areas of expertise are those related to intellectual property rights and natural disasters. his research in sports economics deals with the economic impacts of the olympics and u.s. major league franchises. his industrial organization research deals with conglomerate effects in korea as well as domestic issues associated with legal structures. he teaches courses in a variety of fields including international economics and game theory. a framework for developing an effective mission statement daniel s. cochran and fred r. david department of management mississippi state university mississippi state, mississippi c. kendrick gibson school of business henderson state university arkadelphia, arkansas introduction an increasing number of profit and nonprofit organizations across america are incorporating strategic management activities into their overall operations. strategic management can be defined as the formulation, implementation, and evaluation of actions that will enable a firm to achieve its objectives. the strategic management process is based on the belief that a firm should continually monitor key internal and external events and trends; firms should seek to pursue strategies that capitalize on internal strengths, take advantage of external opportunities, improve internal weaknesses, and minimize the effect of external threats. it is widely acknowledged today that the rate, magnitude, and complexity of changes that impact organizations are accelerating. these changes are creating a different type of consumer, different types of products and services, and consequently a need for different strategies. increased competitiveness worldwide, coupled with rapid social, technological, and economic changes, are major reasons why the strategic management process is being adopted by more and more firms. in a recent review of strategic management models, the mission statement was noted as being an essential first step in the strategic management process (david, 1984, staples and black, 1984). a mission statement can be defined as an enduring document of purpose that distinguishes one business from other firms of its type (pearce, 1982). a mission statement is a declaration of an organization's business or "reason for being." a clear statement of a company's mission is essential to effectively establishing objectives, formulating strategies, setting goals, devising policies, allocatin, 4 resources, and motivating employees. a mission statement is thus an integral component of the strategic management process. as evidenced in the following quotation from peter drucker's classic book entitled management: tasks, responsibilities, and practices, a good mission statement makes strategy formulation, strategy implementation, and strategy evaluation much easier. unless the basic concepts on which a business has been built are visible, clearly understood, and explicitly expressed, an organization is at the mercy of events. not understanding what it is, what it represents, and what its basic concepts, values, policies, and beliefs are, a business cannot rationally change itself. only a clear definition of the mission and purpose of the business makes possible clear and realistic business objectives. the business mission is the foundation for priorities, strategies, plans, and work assignments. it is the starting point for the design of managerial jobs and, above all, for the design of managerial structures. structure follows strategy. strategy determines what the key activities are in a given business. and strategy requires knowing "what our business is and what it should be ." (druckeri p.75). the importance of a mission statement to effective strategic management is well supported in the management literature (staples and black, 1984). a mission statement may be the most visible and public part of a strategic plan. as such, steps should be taken to insure that the statement includes all of the essential components and attributes. in addition, a company mission should be evaluated to insure that it communicates clearly the desired feelings that will guide and motivate employees to action. the purpose of this article is to present a practical framework for developing an effective mission statement. a developmental model is presented and exemplified through application to actual organizations. the proposed mission statement developmental framework is presented in figure i, and includes the following four stages: orientation, component analysis, communication analysis, and applicability analysis. figure 1 steps in the development of an effective mission statement (ms) orientation • create a strategic planning task force • review the strategic planning process • review mission statement significance in strategic planning • review ms development process 5 component analysis • identify desired components • draft ms including derived components communication analysis denotative analysis (readability) • write clear and concise • compute fog index • rewrite if necessary connotative analysis • identify connotative feelings desired from reading ms • administer questionnaire to users (readers) • rewrite if necessary applicability analysis • identify likely situations where ms might be applied develop case • have users evaluate case based on mission statement • determine if mission statement can be applied a strategic planning task force is an appropriate group to do the initial development of an organization's mission statement. however, if this group is too large, a sub-committee could be developed called a "mission statement committee" and charged with going through the suggested stages presented in this paper. orientation process the purpose of orientation is to insure that individuals in the strategic planning task force understand the strategic management process. this orientation training should raise the level of awareness about particular individual's significance and role in planning. a training session would include the following: an overview of the strategic management process, a review of the significance of the mission statement to strategic management, and an introduction into the development process used to design an effective mission statement for their organization. the process of developing a mission statement involves rendering differences of opinion. this is a vital part of achieving an appropriate mission statement for a firm. the task force must become aware that the process the organization goes through in coming to concensus in the development of the mission statement is as important as the output of the process the mission statement itself. 6 component analysis given the understanding of what a mission statement is, the components of such a statement are important. the strategic planning task force must identify the major components to be included in their mission statement. pearce (1982) recently identified eight key components of mission statements: customers, products or setvices, markets, technology, concern for survival, growth, and profitability, philosophy, self-concept, and concern for public image. these components could be used as a guideline by the committee. according to pearce, a well conceived mission statement answers the following questions about an organization: 1. customers who are the enterprise's present and future customers? 2. products or services what are the finn's major products or services? 3. markets where does the firm compete? 4. technology what is the firm's basic technology? 5. concern for survival, growth, and profitability what is the firm's attitude towards economic goals? 6. philosophy what are the basic beliefs, values, aspirations, and philosophical priorities of the firm? 7. self-concepts what are the finns major strengths and competitive advantages? 8. concern for public image what is the finn's public image? an actual example for each component is included in table 1. the mission statement committee would write a draft mission statement from their derived components. actual company examples of each component is included in table 1. the mission statement committee would use these components as a guide in developing their initial mission statement draft. various idea generation techniques* such as nominal grouping or brainstorming could be used to identify other important components for inclusion in this initial draft. table 1 identifying mission statement components: a compilation of excerpts from actual mission statements i. excerpts from corporate mission statements 1. customers we believe our first responsibility is to the doctors, nurses, and patients, to mothers and all others who use our products and services. (johnson & johnson) to anticipate and meet market needs of farmers, ranchers, and rural communities within north america. (cenex) 7 2. product or service 3. markets 4. technology 5. concern for survival 6. philosophy 7. self-concept 8. concern for public image amax's principal products are molybdenum, coal, iron ore, copper, lead, zinc, petroleum and natural gas, potash, phosphates, nickel, tungsten, silver, gold, and magnesium. (amax) we are dedicated to the total success of corning glass works as a worldwide competitor. (corning glass) control data is in the business of applying micro-electronics and computer technology in two general areas: computer-related hardware; and computing-enhancing services, which include computation, information, education and finance. (control data) the common technology in these areas relates to discrete particle coatings. (nashua) in this respect, the company will conduct its operations prudently, and will provide the profits and growth which will assure hoover's ultimate success. (hoover universal) we are committed to improve health care throughout the world. (baxter travenol) we believe human development to be the worthiest of the goals of civilization and independence to be the superior condition for nuturing growth in the capabilities of people. (sun company) hoover universal is a diversified, multiindustry corporation with strong manufacturing capabilities, entrepreneurial policies, and individual business unit autonomy. (hoover universal) we are responsible to the communities in which we live and work and to the world community as well. oohnson & johnson) also, we must be responsive to the broader concerns of the public including especially the general desire for improvement in the quality of life, equal opportunity for all, and the constructive use of natural resources. (sun company) 8 3. markets 4. technology 6. philosophy 7. self-concept 2. product or service 5. concern for survival ii. excerpts from university mission statements 1. customers thus, winthrop fully accepts its role as a forum for public examination of issues as part of its responsibilities, not only to its students, but to all the citizens of south carolina. (winthrop college) the school of business administration has the role of providing at both the undergraduate and graduate levels a sound education and high quality professional training in the broad field of administration for prospective managers and staff specialists ... rendering professional public service in the form of educational programs, research, consultation and assistance to montana organizations.... (university of montana) to develop a partnership with business, community and government leaders and alumni in the detroit metropolitan area, serving one of the most influential industrial metropolitan areas in the world. (university of detroit) . . . to expand the involvement of faculty in research endeavors in the various fields of business and economics by providing ... ample computer facilities . . . . (arkansas state university) use human and financial resources in creative ways to pursue academic excellence within acceptable levels of human cost. (georgetown university) the school's approach is based on the belief that three cornerstones are essential to the development of a quality educational program: 1) the motivated student ...; 2) a faculty dedicated to the highest standards in teaching and research ...; and 3) a curriculum of sufficient depth, breadth, and flexibility to meet diverse student needs and expectations. (atlanta university) along with emphasis on academic quality goes an active effort to use the university's extraordinary locational advantage to build a strong interface with the business, banking, and professional groups in the city, as well as 9 8. concern for public image to develop an equally strong set of ties to leading foreign universities. (new york university) the overall goal of the university of miami school of business administration is to achieve and maintain a position of nationally acknowledged quality within the top fifteen private university schools of business administration in the united states .... (university of miami) more important, the strategy fits well into the demographic trends of the 80' s, for it positions us among the 10 best undergraduate business schools in the nation, with only the wharton school at pennsylvania as a competitor in the northeast. (new york university) communication analysis eventhough the mission statement includes the necessary componets, its communication effectiveness may be poor. recent writings involving "corporate culture" and successful companies have emphasized the significance of effective communications between the organizations many constituents. (peters and waterman, 1982; kennedy, 1984) kennedy reports: the companies and organizations that do the best job thinking through what they are all about, deciding how and to whom these central messages should be communicated and executing the communication plan in a quality way invariably build a strong sense of esprit within their own organization and among the many constituents they serve. (kennedy, 1983, p. 26) since written communication involves denotative as well as connotative meanings both are suggested as part of the community analysis for mission statement development. (bradley and baird, 1983) denotative analysis this aspect or stage is defined as determining the readability of the mission statement e.g., is it written in a clear and concise manner? a classic readability index called the fog index is an appropriate technique to mea sure readability (blundell, 1980). table 2 illustrates how the fog index 10 computed. the mission statement committee would evaluate their drafted mission statement to determine its readability index. if the index was considered too high for their average readership they would rewrite the ms draft by reducing sentence length and usage of multiple syllabled words. table 2 steps in determining a mission statement's readability level 1. compute the number of words 2. compute the number of sentences 3. compute the average number of words per sentence (item 1 divided by item 2) 4. compute the number of hard words (treat as hard words all words of three or more syllables, abbreviations and symbols. do not count capitalized words, unless symbolized or abbreviated.) 5. compute the number of hard words per 100 words (item 4 divided by item 1 times 100) 6. compute the sum of the word average and the hard word percent (item 3 plus item 5) 7. compute the fog index which indicates the readability level (item 6 multiplied by 0.4) source: adapted from how to take the fog out of writing by robert gunning and dougles mueller, chicago, illinois: the dartnel corporation, revised edition, 1981. connotative analysis in their book entitled communication for business and professions, bradley and baird reveal that the connotative meanings and emotional aspects of a written document are important. relating this to development of a good mission statement, a mission statement should arouse one's feelings and emotions for an organization. that is, an effective mission statement results in feelings that a particular organization is successful, knows where it is going, and is worthy of the reader's time, support, and investment. a good mission statement does more than simply include the needed components; it is also inspiring and motivating. quinn (1980) states that such a stateqtent should create elan or create an identity larger than the limits placed upon the firm by the individuals themselves. zaleznik (1970) has found that effective organizational "missions" help satisfy people's needs to produce something worthwhile, to gain recognition, help others, to beat opponents or earn respect. furthermore, according to quinn, the firms must distinguish themselves from all others in the competitive environment. so far, at least, the mission statement must transcend the criteria usually attributed to objectives such as measurable, achievable, etc. in that it should lift the firm above 11 its present state. keller (1983) reminds managers that what is important is the quality, daring and sagacity of the strategy. this connotative step for the mission statement committee involves asking managers to evaluate the mission statement using words that describe the feelings management wanted to be communicated. the feelings/ impressions that should be present are only briefly discussed in the literature. glueck (1980) mentions such things as coherence, agreed upon, top down, etc., while quinn (1980) includes elan in the description. other concepts/words may be more representative for a particular organization and rna; be developed by the management team; however, the following terms are offered as suggested words to use when measuring the "felling/! that others perceive to be inherent in the mission statement, the connotative meanings. optimism the impression that while the goals are large they can be achieved certainty impressions of resoluteness, completeness, commitment aggressiveness impressions of assertiveness or competitiveness inspiration impression of vision, far reaching nature concreteness references to recognition of environmental influences, explicitness, and clarity activity impressions of implementation of ideas, motion forward to measure whether these feelings are present, managers should be asked to indicate their level of agreement or disagreement with several statements or questions related to these terms as reflected in their mission statement. table 3 suggests a format for measurement. table 3 suggested method of measuring connotative feelings generated by mission statement scale used 1 = strongly disagree 2 = disagree 3 = neither agree nor disagree 4 = agree 5 = strongly agree concept scale optimism (not shown on rating sheet) 1. this mission statement gives me the 1 2 3 4 5 feeling that the university is on the verge of achieving great things. 2. i am hopeful for the future of our 1 2 3 4 5 organization. 3. the mission of the organization 1 2 3 4 5 is uninspiring. 12 4. the goals included in the plans 1 2 3 4 5 for the future are too optimistic. .tl\ggressiveness/assertiveness (not shown on rating sheet) 1. we will find it difficult to be 1 2 3 4 5 competitive in our area in the future. 2. the future of our university will be 1 2 3 4 5 insured by following the ideas presented in our mission statement. 3. the goals we have talked about will 1 2 3 4 5 help us achieve little more than we presently are doing. 4. the direction we will be taking in 1 2 3 4 5 the future is much clearer to me. inspiration (not shown on rating sheet) 1. i cannot agree with much of what 1 2 3 4 5 we have decided to do. 2. in my opinion, we will exceed our 1 2 3 4 5 expectations of success by following the plans included in our mission statement. 3. it is better to be on the safe side 1 2 3 4 5 than to try some of these ideas. 4. the foresight exhibited in this 1 2 3 4 5 planning process will help us be prepared for the future better than other colleges i am aware of. applicability analysis the fourth step of the process is to measure the extent to which the statement can be applied in a given situation. use of mini-cases to give the committee an opportunity to apply the direction of the mission statement is suggested to aid in the measurement of practicality. several mini-case situations should be prepared which would require managers to make a decision or recommendation concerning a situation with implications for the various component parts of the statement. the responses or decisions would indicate how well these managers understood the direction provided through the statement as well as their ability to apply the mission statement to the situation. (cochran and gibson, 1979) table 4 gives one example of such a situation for wallace women's college. table 4 wallace women's college* wallace's women's college is a small, exclusive women's college located 13 in north carolina. its major purpose is to foster an understanding and appreciation of the intellectual and cultural heritage of man, cultivate the student's love of the beautiful and the good, and prepare graduates to live in society with happiness for themselves and helpfulness to others. this will be accomplished with classes to improve communication, such as math, languages, and music, classes to improve understanding of the human condition, such as literature, history, and philosophy, and classes on which to build professional and civic careers, such as nursing and education. the college will strive to provide quality education with a highly qualified and stable faculty and a high student/teacher ratio. the college will strive to be sensitive to the educational demands of the area, provide an atmosphere conducive to women's liberal education, and provide cultural activities for students and surrounding residents through student activity, concerts, and recitals. *rudolph e. koletic and lawrence r. jauch, "wallace women's college," in business policy and strategies management, 4th ed., by w.f. glueck, l. table 5 mini-case situation for wallace women's college wallce women's college has recently received an offer of a significant donation from the estate of a retired area businessman who had built a national reputation in his hardware wholesale distributorship. the donation is contingent upon the establishment of a school of business at the college. the college has been experiencing a decline in enrollment for some time, dropping from a total enrollment of over 900 to 600 over the last nine years. as a result, wal!ace women's college had been operating at a deficit and had been using it's endowment funds and borrowed funds for operating expenses. the proposed education program and endowment could keep the college's finances from deteriorating further and help support the schools of music and nursing. what should be the decision of wallace women's college? write your recommendation here and justify based on your understanding of your schools mission statement. from this example the college should not accept the donation under the given restraints since it violates the organization's mission statement. the college would need to either convince the doner to change the constraints to be in line with the mission statement or change the mission statement. the point in this example is to see if the organization's mission statement can be applied to a typical situation regarding the strategic plan. 14 summary the mission statement may be the most visible and public part of a firm's strategic plan. as such, steps should be taken to insure that the statement includes all those correspondents critical to the continued success of the organization. in addition, the statement should be critically evaluated to insure that it communicates both an understanding and the desired feeling that will guide or motivate managers to action. finally, it should be practical. this article proposes a four step process or model for strategic mission statements. this process may be utilized by "mission statement committees" in all types of organizations; it can be accomplished "in house" with only a minimum amount of time and resources. a process of self-evaluation of the mission statement should help managers view their planning concepts more accurately and help the organization to relate the desired planning direction in a positive and forceful way. carefully prepared missions have been the source of success for many companies. poorly formulated missions have brought disaster to some companies. revised missions have turned some companies around. a well developed mission statement can be a unifying and motivating light for all the stakeholders of an organization. an increasing number of organizations today are implementing strategic management concepts. as part of this process, more and more firms are striving to develop a clear and meaningful company mission statement. the framework presented in this article for developing and evaluating mission statements could enhance the strategic management process in organizations. this framework could also provide some direction for much needed empirical research on mission statements. references bennis, warren g. "where have all the leaders gone?" technology review, vol. 79, no.5, (march/april 1977), pp. 37-46~ blundell, w.e. "confused, overstuffed corporate writing often costs versus much time-and money," the wall street journal. thursday, august 28, 1980. bradley, patricia h. and baird, john e. jr., communication for business and the professors, 2nd edition, wm. c. brown, co., dubuque, iowa, 1983. budd, r.w., thorp, r.k., and donohew, l., content analysis of communications, macmillan co., new york, 1967. cochran, daniel s. and gibson, c.k., "putting a square peg into a round hole: communication models and their application." journal of business communication, vol. 17, no.1, (fall, 1979), pp. 27-36. cohen, kalman j., and cyert, richard m., "strategy: formulation; implementation, and monitoring," the journal of business, vol. 46, no.3, ouly, 1973), pp. 349-367. 15 david, fred r. "towards an integration of strategic management models." southern management association, proceedings, 1984, p. 195-197. drucker, peter f., management, tasks, responsibilities, practices. harper and row, new york, 1974. ferguson, charles r., and dickinson, roger. "critical success factors for directors in the eighties," business horizons, (mayljune, 1982), pp. 14-18. gardner, john w., excellence, can we be equal and excellent too, perennial library, harper and row, new york, 1961. gardner, john w., self renewal, the individual and the innovative society, harper and colophon books, harper and row, new york, 1964. glueck, william f., business policy and strategic management, 3rd edition, mcgraw-hill book co., new york, 1980. goldhaber, gerald m., organizational communication, 3rd edition, wm. c. brown co., dubuque, iowa, 1983, p. 411. gunning robert, techniques of clear writing, mcgraw-hill publishing, new york, 1952. hanakawa, 5.1., "how words change our lives," appearing in communication for management and business, 2nd edition, by norman sigband, scott foresman and co., flenview, ill., 1976, pp. 489-496. hollowood, james r., "college and university strategic planning: a methodological approach," planning for higher education, vol. 9 no. 4 (summer, 1981), pp. 8-18. jakobson, r. "closing statement: linguistics and poetics," appearing in style in language, edited by t. sebeok, the m.i.t. press, cambridge, mass., 1960. katz, robert l. management of the total enterprise, prentice-hall, englewood cliffs, n.j., 1970, p. 19. katz, robert l. "skills of an effective administrator," harvard business review, vol. 33, no.1, ijanuary/february, 1955). kennedy, allan. (1984, november). back-fence conversations: new tools for quality conversations. communication world, 1984, november, pp. 2630. koprowski, eugene }., "exploring the meaning of good managment," academy of management review, vol. 6, no.3, (1981), pp. 459-467. kotler, phillip, marketing for nonprofit organizations, 2nd edition, prentice-hall, inc., englewood cliffs, n.j., 1982. lazer, william, and cullev, james d., marketing management, foundations and practices, houghton mifflin co., boston, 1983. mcpherson, michaels., "value conflicts in american higher education, a survey," journal of higher education, vol. 54, no.3, (mayljune, 1983), pp. 243-278. myers, james h., and warner, gregory w., "semantic properties of selected evaluation adjectives," journal of marketing research, vol. v (november, 1968), pp. 408-412. 16 ohmae, kenichi, "the secret of strategic vision," management review, april, 1982, pp. 9-13. pearce, john a. ii., "the company mission as a strategic tool," sloan management review, spring, 1982, pp. 15-24. pearce, john a. ii., and robinson, richard b., jr., strategic management, strategy formulation and implementation, richard d. irwin, inc., homewood, ill., 1982. peters, thomas j., & robert h. waterman. (1982). in search of excellence: lessons from america's best-run companies. new york: harper & row. quinn, james b., strategies for change: logical incrementalism, richard d. irwin, inc., homewood, ill., 1980. staples, w.a. and black, k.v. "defining our business mission: a strategic perspective." journal of business strategies. vol. 1, no. i, spring, 1984, p.33-39. vancil, richard f., '/strategy formulation in complex organizations," appearing in strategic planning systems, by peter lorange and richard f. vancil, prentice-hall, englewood cliffs, n.j., 1977, pp. 4-22. zaleznik, a., "power and politics in organizational life," harvard business review, mayljune, 1970, pp. 47-60. 17 a framework for developing an effective mission statement 154 journal of business strategies the pci – a global risk index for the simultaneous assessment of macro and company individual investment risks christina pakusch bonn-rhein-sieg university • sankt augustin, germany franz w. peren bonn-rhein-sieg university • sankt augustin, germany markus arian shakoor price waterhouse coopers • duesseldorf, germany abstract companies often have difficulties determining which criteria to base their investment decisions in different countries on. when considering direct foreign investment several risk indices are available. the pci (peren-clement-index) in its original form was developed in 1998. its further refinement improves the pci in three major ways: first, it offers a dynamic adjustment of criteria and consideration of recent changes in the international environment. second, it provides business specificities of a company or its industrial sector to be considered in addition to macroeconomic aspects by a two-dimensional presentation, which ensures a customized assessment. third, the pci allows for consolidating investment decisions by combining a resource-orientated with a market-oriented view. the pci allows, unlike other indices, a customized and company-specific strategic planning process. ultimately companies must take up both perspectives in the context of an international investment decision. the use of risk indices in corporate planning for assessing global investments decision creates a fundamentally new of risk assessment. keywords: risk analysis, scenarios, strategic planning, country risks, internationalization introduction companies often have difficulty determining which criteria to choose for their investment decisions in different countries and specific locations. due to the fact that location decisions cannot be easily revised (cheng and kwan 2000; morschett, schramm-klein and swoboda 2010), it is expected that companies use in a wide range of criteria for their considerations and review of possible sites (moran 2001; volume 33, number 2 155 berlemann and tilgner 2006). foreign direct investment (fdi) is the financial participation by an investor in a company located in another country that aims to have a lasting impact on the management of that company. according to international standards a lasting influence is to be expected, if the investment represents at least 10% of the company’s capital stock in the target country (unctad 2006: 294; imf (ed.) 1993: 86). to consider a fdi decision several risk indices are available. the pci (perenclement-index) was published in its original form in 1998 (peren/clement 1998). the index is firmly established in the literature as an instructional tool (wankel 2009: 137; roebuck 2011: 472; hiram 2012). the pci has been further revised into version 2.0 with the following three objectives: 1. creating a process for dynamic adjustment of criteria and consideration of recent changes in the international environment. these include: • intensification of globalized economic relations, which have led to technology and knowledge transfers in emerging and developing countries. • the emergence of outsourcing and offshoring in many industrial sectors. • increasing openness and transparency of corporate decisions due to globally available information and communications technologies. • progress in reduction of tariff and other trade barriers 2. critics claim that risk indices do not consider the specificities of a company or its industrial sector (daum, greife and przywara 2009: 186). this problem has now been addressed by a two-dimensional presentation, which ensures a customized assessment. 3. unlike other indices, the pci uses a theoretical basis to consolidate investment decisions. fundamentally, it combines two main streams of thought within the strategic planning: combining a resourceand a market-oriented view (barney,wright and ketchen 2001; newbert 2007). • the resource based view looks at the uniqueness of the resources of a site as the basis for competitive advantage. these resources have limited mobility and tradability. they interact with the internal resources of an enterprise (inside-out perspective). • the market-based view takes an outside-in perspective. thus the industry structure (production and sales) affects how a company can be positioned in a market. these two perspectives are not mutually exclusive, but complement each other. ultimately companies must address both perspectives in the context of an 156 journal of business strategies international investment decision and consider them as complementary elements in their strategic planning. the quality of location of a region can neither be observed nor easily measured. attempting to measure quality with an empirical study requires that appropriate indicators (variables) need to be identified. as part of an econometric analysis, the market entry motive and the identification of the local production conditions can be identified as significant motives for fdi. additionally, the political and legal frameworks of a site are important (tallmann 1988; chung and alcácer 2002; yeaple 2003; berlemann and göthel 2008). framework for decision making investment decisions of companies should correspond to a systematic and structured order. a differentiation must be drawn between the macro-environment and company-individual micro-environment. on the site-specific micro-level, core competencies can be identified that have a positive impact on the individual competitiveness of a company. in addition, concrete production and sales-oriented motives that reflect the supply and demand conditions of an observed market can be found as well. this framework is illustrated in figure 1. figure 1 framework for decision making of international location decisions resource based view market based view macroenvironment localization (micro-environment) production sales market the framework for decision making of these factors is broken down into 20 criteria. these 20 criteria is assigned a point value of 50 points. each criteria is then weighted from 0 to 2 points, so that the 20 criteria has a maximum total score possible of 100 points.1 1 the weighting is based on an extensive literature review. volume 33, number 2 157 macro-environment this category is largely predefined for companies and the elements are exogenous (table 1). the company observes or anticipates these factors and reacts with strategic adaptation. to assess the macroeconomic environment, a number of current international statistics and aggregate assessments in the form of indices are available that facilitate classification. however, the different norms of these indices and their different characteristics for the measurement and quantification of risk and opportunities for direct investment need to be considered. a few examples: • to assess characteristics such as economic policy, legal security and solvency the detailed analysis of the world economic forum can be used (world economic forum (ed.) 2014a). a high score in the global competitiveness report (e.g. switzerland in 2014, rank 1 with 5.67 points) implies a low risk for direct investment, a low score (e.g. algeria in 2014, rank 100 with 3.79 points), a corresponds to a higher risk (world economic forum (ed.) 2014b). • the indicator of political and social stability describes the capabilities of a government to implement its program, the unity of government, its legislative power and its public support. a high index value expresses a high degree of stability and is thus associated with a lower risk of direct investment. relevant data are, for example, provided by international country risk guides (icrg) (the prs group (ed.) 2014). • to evaluate the bureaucratic obstacles, data from the “index of economic freedom” developed by the heritage foundation can be used (the heritage foundation (ed.) 2014). this index measures the degree of economic freedom on the basis of property rights and the extent of government regulations of the market. other parameters are government corruption, restrictions on foreign trade, income and corporate taxes, and the rule of law. the highest score is set at 100. a high score (e.g. hong kong in 2014 with 90.1 points, rank 1) is associated with greater freedom and tends to be associated with a relatively lower risk of direct investment. a low score (e.g. indonesia in 2014, rank 100 with 58.5 points) would point to a significantly higher risk due to bureaucratic obstacles to foreign direct investment. 158 journal of business strategies table 1 macro-environment factors macro-environment points weighting sum political and social stability 4 bureaucratic obstacles 2 economic policy 3 legal security 3 solvency 3 sum 15 localization (micro-environment) in the globalized world, usually regions, not countries, are competing to attract productive enterprises. here, other factors, as identified in table 2, are important and may not be offered, or may be of lower quantity or quality, at other sites. this dimension can be theoretically linked to the resource-based view (peteraf 1993). specifically, a site`s endowment of human capital, their transport connections, the existing management skills, their access to markets and the quality of life offered are all important. additionally, all the above-mentioned factors are impacted by a variety of other items. for example, the quality of life of a site as a “soft factor” is usually higher the lower the crime rate, the better the health care system and the lower the regional price level is, i.e., the higher is the purchasing power of a monetary unit. other positive effects on the quality of life are cultural activities, education and training opportunities, quality of environment and local recreation and leisure opportunities (cheng and kwan 2000; berlemann and tilgner 2006). these factors are generally not transferable and can be duplicated by competing sites only within limits. the importance of these relationships is emphasized by the factor conditions in porter’s diamond model (porter 1990). in this context the interaction effects between corporate and site-specific resources are especially important. first, local resources affect the attractiveness of a site for companies. second, the investments of companies add to and generate the development and the know-how of a site (windsperger 2006). resources that are available at a site then generate a competitive advantage if company-specific resources and skills are complemented by site-specific resources. therefore, a change volume 33, number 2 159 of location or an alternative location would result in a competitive disadvantage for companies (peteraf and barney 2003). table 2 localization (micro-environment) factors localization points weighting sum human capital 4 transport connections 2 management skills 2 access to markets 2 quality of life 3 sum 13 even if a country can offer an investment-friendly environment, fdi will not take place unless additional company-specific reasons are present. theoretical literature and empirical studies differentiate particularly production-oriented and market-oriented elements. both market aspectssupply and demandcan thus be recorded. in theory, both dimensions can be linked with the market based view, which was strongly shaped by porter (porter 1980), making the analysis of the market an elementary task. competitive advantages of a company emerge mainly due to the proper selection of a market or segment of a target market and (over time) superior positioning within this market (outside-in view) (sakarya, eckman and hyllegard 2007; weber 2008: 277). production of fundamental importance for location decisions is the prevailing economic and property rights, which defines the way in which rights or actions are distributed to economic goods or to the economic actors. these include (see table 3) for example, the right to use assets (decision and right of use), the right to change the ownership of a property or vary it (right to require a change) or the right to transfer the asset completely or partly (transfer rights). moreover, freedom of contract and the principle of liability should be clarified before a location decision is made (berlemann and tilgner 2006: 18). 160 journal of business strategies taken as a whole, it can be assumed that a set of economic and property rights, not based on market principles, significantly inhibits the activity of a company and has a negative effect on prospect settlement decisions. in this context, empirical analyzes also demonstrates the importance of property rights on intellectual property (e.g. patent protection). establishing a company is often based on cost-oriented motives. this can be, for example, lower labor costs, tax benefits, or purchasing and procurement advantages (bevan and estrin 2004). in terms of labor cost advantages the relationship between wages and embodied human capital (unit labor cost) is crucial. low costs in rich countries, neither define the competitive advantage of companies, nor the economic growth of countries. on a macroeconomic level, low costs and high per capita income in the long run may even be contradictory. the stock of human capital thus acts as a kind of procurement advantage in addition to cost orientation. for the implementation of investments companies often need additional capital. if an investment cannot be financed with retained earnings and its current shareholders won’t add additional funds, other appropriate resources can be procured from external equity with either a loan or the issuance of new equity capital. accordingly, positive effects can be a well-functioning capital market and the presence of sufficient investment capital. likewise, important for a stable production are complementary production sectors that are capable of supplying key raw and auxiliary materials. the motive for purchasing and procurement security is particularly relevant for foreign direct investment in countries that are rich in raw material. thus, for example, uncertainties in the pricing of preliminary products can be reduced, if company subsidiaries provide the raw materials. in terms of production-oriented motives, investment incentives are also relevant. they can be provided by the host country, the home country of the investing company, or from multinational agencies. according to the oecd investment reform index, incentives may appear in the following three forms (oecd (ed.) 2010: 43): • regulatory incentives, such as relaxation of working, environmental and social standards. • financial incentives, such as grants for training specialized personnel by the government, subsidized loans and guarantees for loans. • fiscal and tax incentives, e.g., tax reductions for foreign investors such as reductions in the corporate income tax or a temporary tax allowance and the establishment of special tax-privileged areas. volume 33, number 2 161 table 3 production factors production points weighting sum economic and property constitution 2 manufacturing costs 2 capital procurement 3 complementary production sectors 2 investment incentives 2 sum 11 sales location decisions are often based potential market development with the aim at serving a nonor poorly served market (dunning 1998; berlemann and tilgner 2006: 19). table 4 identifies the factors that are likely to impact sales. of initial importance is the size and dynamics of the market. high per capita income can be used as an indicator of a well-funded demand and turns an otherwise uninteresting location into a potentially interesting market for local market development investments (berlemann and göthel 2008: 41). if trade barriers exist between the current location of a company and the potential sales market, this can require a separate location in the target country. trade barriers including both tariff and non-tariff barriers. for the successful development of new markets, adequately functioning distribution structures as well as a high level of confidence in the local distributor are of significant importance. 162 journal of business strategies table 4 sales factors sales points weighting sum size and dynamic of the market 3 per capita income 2 avoidance of tariff barriers 2 reliability of local contractors 2 distribution structures 2 sum 11 risk assessment the design of the pci is based on the cost-benefit analysis which is also called an index scoring model. the index is thus one of the quantitative, non-monetary, analytical methods of the decision theory. the objective is the analysis of alternative courses of action for the purpose of organizing preferences for the decision maker in a multi-dimensional scoring system. results are ordered by specifying the utility values (total) values of the alternatives. the allocation of points is just like other comparable indices e.g. business environment risk intelligence index (beri) (beri s.a. (ed.) 2014) – carried out with a subjective point of view. an option can be the delphi method where points are allocated by various experts. based on the degree of fulfillment of the criteria the following points can be awarded: 0 = not acceptable 0.5 = questionable 1 = acceptable 1.5 = good 2 = very good the 20 criteria, which are identified in tables 1--4 have a total weighting of 50. when each factor is multiplied by the points identified above, a site can receive a maximum of 100 points. based on this point value each site receives a classification of foreign risks can be constructed as shown in table 5. volume 33, number 2 163 table 5 gradation of country risks gradation of country risks (maximum 100 points) points hardly recognizable risk > 80 low risk 70 79 moderate risk, barriers in daily operations, risk covering recommended 60 69 relatively high risk, strongly defected investment environment, risk covering inevitable 50 59 location is not recommended for direct investments < 50 of great benefit is the use of critical variables (knock-out variables). if certain key factors are defined as knock-out variables and a location receives a score of 2 or less among these key factors, a direct investment is rejected. this would also apply even if all other factors had received positive valuations and the overall score showed a good result which made the location appear to be a positive choice. examples: • a company particularly wants to use foreign human capital. however, the de facto use seems questionable. in this case the resulting value is: 0.5 (questionable) • 4 (weighting of the criterion human capital)2 = 2 points • a company intends to benefit from cost advantages in production. in this case, the total evaluation for the criterion must be at least acceptable so that the value is above 2: 1.0 (acceptable) • 3 (weighting of the criterion manufacturing costs)3 = 3 points. the pci allows, unlike other indices, a customized and company-specific presentation. the assessment of the investment risk is based on a two-dimensional presentation. therein both the economical-macroeconomic and the companyindividual point of view are combined in a useful way. this approach will now be explained in an exemplary case study. case study company a and company b wish to internationalize through direct foreign investment, and are considering the two countries/regions x and y. for the measurement and comparative-quantitative assessment of country risks, both companies use the pci index. the pci shows a total score of 71 for country x (table 2 see table 2. 3 see table 3. 164 journal of business strategies 6). this value implies a relatively low investment risk. the calculation for the alternative country/region y also reaches a total score of 71 points (table 7). company a and company b now know that both direct investments would be associated with a relatively low risk. however, the site that would be the most appropriate location for the company cannot be derived from the economical-macroeconomic risk assessment. table 6 risk assessment for country/region x investment alternative 1: country x pci = 71 macro-environment points weighting sum political and social stability 1.5 4 6 bureaucratic obstacles 2 2 4 economic policy 2 3 6 legal security 1.5 3 4.5 solvency 1.5 3 2.5 sum 15 4.5 localization points weighting sum human capital 0.5 4 2 transport connections 2 2 4 management skills 0 2 0 access to markets 1.5 2 3 quality of life 2 3 6 sum 13 15 production points weighting sum economic and property constitution 2 2 4 manufacturing costs 2 2 4 capital procurement 2 3 6 complementary production sectors 2 2 4 investment incentives 2 2 4 sum 11 22 volume 33, number 2 165 sales points weighting sum size and dynamic of the market 0 3 0 per capita income 0.5 2 1 avoidance of tariff barriers 2 2 4 reliability of local contractors 0.5 2 1 distribution structures 1.5 2 3 sum 11 9 total score pci 71 this evaluation deficiency using only the risk indices, shall now be supplemented with another company-individual dimension. table 7 risk assessment for country/region y investment alternative 2: country y pci = 71 macro-environment points weighting sum political and social stability 2 4 8 bureaucratic obstacles 1 2 2 economic policy 1 3 3 legal security 2 3 6 solvency 1.5 3 4.5 sum 15 23.5 localization points weighting sum human capital 1.5 4 6 transport connections 2 2 4 management skills 1.5 2 3 access to markets 2 2 4 quality of life 1.5 3 4.5 sum 13 21.5 166 journal of business strategies production points weighting sum economic and property constitution 2 2 4 manufacturing costs 0.5 2 1 capital procurement 0 3 0 complementary production sectors 0 2 0 investment incentives 0.5 2 1 sum 11 6 sales points weighting sum size and dynamic of the market 2 3 6 per capita income 2 2 4 avoidance of tariff barriers 1.5 2 3 reliability of local contractors 1.5 2 3 distribution structures 2 2 4 sum 11 20 total score pci 71 the two companies are pursuing their internationalization with different company-specific goals. the weighting of these goals is shown in table 8. while it is most important for company a to develop the overseas market and expand the resources available through acquiring additional resources from foreign locations, company b focuses on the cost/benefits that can be generated in producing at the foreign location. table 8 company-specific internationalization goals internationalization goals / company a weighting (=100%) sales in overseas market 50% expanding resources trough localization 30% safeguard foreign location / strategic importance (macro-environment) 15% generating cost benefits (production) 5% volume 33, number 2 167 internationalization goals / company b weighting (=100%) generating cost benefits (production) 70% safeguard foreign location / strategic importance (macro-environment) 15% expanding resources trough localization 10% sales in overseas market 5% the companies now combine this second dimension, shown in table 8, with the weightings of their individual goals to the individual factors of the pci. the factors “macro-environment”, “localization”, “production” and “sales,” shown in tables 1 – 4, with the company-specific goals shown in table 8. the result is a company-specific, two-dimensional total score, which now allows for a particular goal-oriented decision (fig. 2). the two-dimensional cumulative scores now clearly shows in contrast to all prevailing risk indices which site is best suited for which investor for direct investment. company a should opt for direct investment in country/region x, since it will best be able to achieve its individual company goals at its best there. country / region x reaches with company a a company-specific total score of 20.275 points, while the country/region y is company individually evaluated only with a total of 13.85 points. the reason for the now visible distinction is that the two factors “sales” and “localization”, which are the most important for company a, (”sales in the foreign market: 50% “and” expanding resources by localization: 30%”) provide a better starting position in country/region a. company b wants to internationalize in order to achieve cost advantages in production (“generating cost savings in production: 70%”). therefore, company b should choose location y. the country / region y with a total company-specific score of 21.1 points is much better suited for a direct investment for company b as the country / region x (total score of 10.875 points). 168 journal of business strategies figure 2 individual assessment of country risks company specific country results: country x company a: factor pci target weights sum macro-environment 23.5 0.15 3.525 localization 21.5 0.30 6.450 production 6 0.05 0.300 sales 20 0.50 10.000 total score pci 71 1.00 20.275 company b: factor pci target weights sum macro-environment 23.5 0.15 3.525 localization 21.5 0.10 2.150 production 6 0.70 4.200 sales 20 0.05 1.000 total score pci 71 1.00 10.875 company specific country results: country y company a: factor pci target weights sum macro-environment 25 0.15 3.750 localization 15 0.30 4.500 production 22 0.05 1.100 sales 9 0.50 4.50 total score pci 71 1.00 13.850 company b: factor pci target weights sum macro-environment 25 0.15 3.750 localization 15 0.10 1.500 production 22 0.70 15.400 sales 9 0.05 0.450 total score pci 71 1.00 21.100 volume 33, number 2 169 this two-dimensional, graphical presentation clearly shows the advantages of such a combinatorial assessment on an economic macro level on the one hand and company-individual objectives on the other hand, using the example of country/ region x versus country/region y (fig. 3). figure 3 pci simultaneous assessment on an economic macro-level and companyspecific goals in direct investments conclusion the pci (peren-clement-index) has been revised and reorganized to reflect and account for changed global conditions. various levels of assessment are now combined, which should be considered in a direct foreign investment decision. an international location decision is often performed in stages, the first looks at the macroand the micro-environment which offers core competencies and will have a positive impact on a company’s competitiveness. in addition, concrete production and sales-oriented motives that reflect the supply and demand sides must also be incorporated into the investment decision. 170 journal of business strategies the index presented in this paper links two main currents of thoughts in strategic planning in the context of an international investment decision -the resource view and the market-oriented view: • the resource based view uses the uniqueness of the resources of a site as the basis for competitive advantages. these resources have a limited mobility and tradability. they interact with the internal resources of an enterprise (inside-out perspective). • the market-based view takes up an outside-in perspective. thus the industry structure (production and sales) affects how a company can be positioned in a market. these two perspectives are not mutually exclusive, but complementary. ultimately companies must consider both perspectives in the context of an international investment decision and use them as complementary elements in their strategic planning. by a two-dimensional linkage of the economically relevant macro level with the company-individual goals of a prospective direct investment a practical decisionmaking is facilitated. the use of risk indices in the corporate planning for assessing global investments reaches a fundamentally new quality. references barney, j., wright, m., & ketchen, d. j. (2001). the resource-based view of the firm: ten years after 1991. in: journal of management, 27(6), 625-641. beri s.a. (ed.) (2014). the leading country risk rating agency since 1966. url: http://www.beri.com/. berlemann, m., göthel, m. (2008). determinanten der internationalen standortwahl von unternehmen – ergebnisse einer empirischen analyse (determinants of the choice of the international location). in: ifo dresden berichtet, issue 4, 33-43. berlemann, m., tilgner, j. t. (2006). determinanten der standortwahl von unternehmen (determinants of the choice of the international location). ein literaturüberblick. in: ifo dresden berichtet, issue 6, 14-24. bevan, a. a., estrin, s. (2004). the determinants of foreign direct investment into european transition economies. in: journal of comparative economics, 32(4), 775-787. cheng, l. k., kwan, y. k. (2000). what are the determinants of the location of foreign direct investment? the chinese experience. in: journal of international economics, 51(2), 379-400. volume 33, number 2 171 chung, w., alcácer, j. (2002). knowledge seeking and location choice of foreign direct investment in the united states. in: management science, 48(12), 15341554. daum, a., greife, w., przywara, r. (2009). bwl für ingenieurinnen und ingenieure (business for engineers). wiesbaden. dunning, j. h. (1998). location and the multinational enterprise: a neglected factor? in: journal of international business studies, 45-66. hiram, e. c. (ed.) (2012). peren-clement index. plac publishing, london. imf (ed.) (1993). balance of payments manual, 5th edition, washington dc. moran, t. h. (2001). foreign direct investment. blackwell publishing ltd., hoboken, new jersey. morschett, d., schramm-klein, h., & swoboda, b. (2010). decades of research on market entry modes: what do we really know about external antecedents of entry mode choice? in: journal of international management, 16(1), 60-77. newbert, s. l. (2007). empirical research on the resource‐based view of the firm: an assessment and suggestions for future research. in: strategic management journal, 28(2), 121-146. oecd (ed.) (2010). investment reform index 2010. monitoring policies and institutions for direct investment in south-east europe. url: http://www. rciproject.com/rcibhreports_files/iri.pdf [as of: 30.10.2014]. peren, f.w., clement, r. (1998). globale standortanalyse (global location study). in: harvard businessmanager, 20(6), 70-77. peteraf, m. a. (1993). the cornerstones of competitive advantage: a resource-based view. in: strategic management journal, 14(3), 179-191. peteraf, m. a./ barney, j.b. (2003). unravelling the resource-based tangle, managerial and decision economics, 24, 309-323. porter, m. e. (1980). competitive strategy. techniques for analyzing industries and competitors, new york . porter, m. e. (1990). the competitive advantage of nations, new york. reineke, r. d., bock, f. (ed.). gabler lexikon unternehmensberatung, wiesbaden. roebuck, k. (2011). risk management standards: high-impact strategies – what you need to know: definitions, adoptions, impact, benefits, maturity, vendors. emereo pty limited, brisbane. sakarya, s., eckman, m., & hyllegard, k. h. (2007). market selection for international expansion: assessing opportunities in emerging markets. international marketing review, 24(2), 208-238. 172 journal of business strategies springer gabler verlag (ed.) (2014). gabler wirtschaftslexikon, stichwort: perenclement-index, 18th edition, volume 4 wiesbaden. tallman, s. b. (1988). home country political risk and foreign direct investment in the united states. in: journal of international business studies, 219-234. the heritage foundation (ed.) (2014). 2014 index of economic freedom. url: http://www.heritage.org/index/. [as of: 30.10.2014]. the prs group (ed.) (2014). international country risk guide. url: https://www. prsgroup.com/about-us/our-two-methodologies/icrg. [as of: 29.10.2014]. unctad (2006). world investment report 2006. fdi from developing and transition economies: implications for development, united nations, new york, geneva. wankel, c. (2009). encyclopedia of business in today’s world, volume 1, california. weber, j. (2008). das advanced-controlling-handbuch, richtungsweisende konzepte, steuerungssysteme und instrumente, 2nd edition, weinheim. windsperger, j. (2006). a resource-based view of the competitive advantages of cities: empirical results on advantages for headquarters in vienna for central europe. in: south east european journal of economics and business, 2. world economic forum (ed.) (2014a). reports. url: http://www.weforum.org/ reports/ [as of: 22.10.2014]. world economic forum (ed.) (2014b). global competitiveness report 20142015. url: http://www.weforum.org/issues/global-competitiveness [as of: 28.10.2014]. yeaple, s. r. (2003). the complex integration strategies of multinationals and cross country dependencies in the structure of foreign direct investment. in. journal of international economics, 60(2), 293-314. brief biographical sketch of authors christina pakusch is a research assistant at the bonn-rhein-sieg university and is a doctoral candidate at the university of siegen. she received her m.sc. from the heinrich heine university duesseldorf. her field of research comprises sharing and service economies and sustainable development with the focus on future mobility. franz w. peren, ph.d., is a professor of business administration specializing in quantitative methods at the bonn-rhein-sieg university, germany, where he has taught since 1993, and at the columbia university in new york,. his practical experience includes working as a consultant for the german automotive industry at volume 33, number 2 173 the federal ministry of economics and as a strategy consultant for global companies markus arian shakoor is a consultant in finance at pricewaterhousecoopers. he studied business administration at bonn-rhein-sieg university. he completed his postgrad studies in international business (m.com.) at swinburne university of technology in melbourne and in leadership (m.sc.) at northeastern university in boston. volume 33, number 2 95 building a community garden: a collaborative cross-disciplinary academic community engagement project jeffrey r. wozniak sam houston state university • huntsville, tx jeremy bellah west texas a&m university • canyon, tx jason m. riley sam houston state university • huntsville, tx abstract most research concerning service learning discusses the benefits students experience when working on a project; however, for faculty, the challenges involved in facilitating the project are also great. we designed a collaborative crossdisciplinary project to address two goals: 1) to increase student engagement through service learning, while also 2) redistributing the work involved in managing the project from the instructor to a second group of upper-level operations management students. specifically, we used the academic community engagement (ace) pedagogy, which combines community engagement with academic instruction, in a collaborative project between a freshman-level environmental science class and an upper-level operations management class. the project goal for the students was to research and establish a formal plan for the creation of a community garden in the local town. the community garden project goal was achieved over the course of the semester and survey results suggest that we accomplished both of the crossdisciplinary project goals. specifically, many of the students developed a deeper sense of connection to the local community and a more tangible idea of how they can serve their communities in the future. keywords: academic community engagement (ace), community garden, environmental science, experiential learning, operations management, service learning introduction service learning projects can provide a more holistic educational experience at the undergraduate level. while the benefits of small scale, single semester service learning projects are considerable, larger scale (e.g., multiple classes and more than 96 journal of business strategies one community partners), and long-term (e.g., extending multi-semester) projects may offer students a more dynamic service learning experience. these large scale projects may also be beneficial to the community partners engaged in the project. however, while positive outcomes increase with project scope and scale, so do the project management and logistics challenges for instructors overseeing such projects. in response, we propose a collaborative, cross-disciplinary service-learning project that includes students from a target discipline (environmental science) and a support discipline (operations management) to assist in managing the project. for students, the learning objectives are enhanced by the cross-disciplinary design of the project. specifically, students are exposed to several theoretical streams of research, including experiential learning, problem-based learning, and service learning. the target discipline students operated as content specialists and focused on the individual goals of the environmental science course. these students were responsible for the scientific research and design of the community garden project from an environmental science perspective. conversely, the support discipline students functioned as project managers and applied operations management principles from their class to the project and target students. the support discipline students supervised all logistical, project, and operational processes associated with the community garden project. the objective of this paper is to communicate the results of the implementation of a collaborative cross-disciplinary project to address two goals: 1) to increase student engagement through service learning, while also 2) redistributing the work involved in managing the project from the instructor to a second group of upper-level operations management students. in the following sections, we review the related literature, draw connections between different pedagogical foundations and this service learning project, describe the pedagogy in detail, and report both quantitative and qualitative data collected from project participants. literature review service learning projects can take many forms, and at times borrow from different pedagogical foundations. our cross-disciplinary project involves aspects of experiential learning, problem-based learning, and service learning. here we highlight the use and application of these different subject areas in different academic settings and draw connections to their respective roles in this collaborative crossdisciplinary community garden project. volume 33, number 2 97 cross-disciplinary projects cross-disciplinary projects have been used in classes with great success at many universities, but often include disciplines that are closely related. bhavnani and aldridge (2000) for instance, described how product design projects were used to integrate different engineering disciplines at auburn university. similar projects were used at the university of michigan and stanford university, with the main difference being the inclusion of mba students (lovejoy and srinivasan, 2001). another project at stanford university had architecture, engineering, and construction students’ design, plan, and schedule construction projects on the university campus (fruchter, 2001). other university based cross-disciplinary projects include the use of semiconductor processing to integrate physics, chemistry, and engineering activities at san jose state university (muscat et al., 1998); the use of robotics to integrate engineering and computer science students at southern illinois university, edwardsville (weinberg, engel, gu, and karacal, 2001); the use of a proteomics stock market project to integrate marketing, management, and biochemistry classes at murray state university (keller and cox, 2004); and the use of a collaborative clinical teaching project used with nursing and clinical pharmacy across the college of pharmacy and health sciences at butler university, and the indiana university school of nursing (robertson and mcdaniel, 1995). furthermore, some crossdisciplinary projects extend beyond on the academic institution itself. for example, long and carlo (2013) described a multi-institutional initiative involving students from supply chain management, production planning, scheduling, facility layout, and design courses. the goal was the design of a decentralized manufacturing organization for a company that planned to manufacture industrial proton-exchange membrane fuel cells. while all of these projects were successful at integrating multiple, closely related disciplines, they stopped short of actually implementing the deliverables and expanding the collaborative scope to far reaching disciplines. experiential learning existing research suggests that experiential learning is used by educators to help students understand concepts taught in class (ferrari and chapman, 2014). based on kolb’s (1984) learning cycle, this pedagogy involves learning activities such as concrete experience (direct observation), reflective observation (evaluation, comparison), abstract conceptualization (modeling and analysis), and active experimentation (synthesis, design), which leads to a new concrete experience. examples of service learning include the development and publication of quality 98 journal of business strategies management content (foster, jr., 2004), the use of simulation to demonstrate the complexity of project management execution (hartman, et al., 2013), turning business cases into consulting exercises (erzurumlu and rollag, 2013), and hands-on research to stimulate learning in an introductory management information systems course (wu and sankar, 2013). in our community garden project, students from the target and support disciplines gained different forms of experiential learning exposure. the environmental science students for example, engaged in active experimentation when designing the community garden plan, while the support students partook in concrete experiences by directly interacting with target students. further, all of students were required to write a reflective observation at the end of the project. this allowed the participants to reflect on their overall experience. problem-based learning problem-based learning (pbl) uses the problem-solving context to facilitate experiential learning. when using this pedagogy, students are presented with a problem, and then use the appropriate theory and tools to solve the problem. many researchers support the need for pbl in higher education (lenschow, 1998; rouvrais et al, 2006; lehmann, et al., 2008). according to lenschow (1998), the choice of projects is extremely important to the pedagogy because the degree to which the project actually reflects reality determines its effectiveness. when students work on projects that accurately reflect reality, they learn from their experiences. thus, pbl offers significant benefits when compared with traditional lecturing (hicks, 1996). a benefit of working on projects that reflect reality is that the likely cross disciplinary lines. this is important because university students need to understand how organizations from varying backgrounds function (athavale et al., 2008). pbl has been implemented at many universities. heineke, et al. (2010), for instance, described an interactive exercise used to teach the concepts of uncertainty and variability. an innovative teaching method introduced by nargundkar, et al. (2014) presented problems first, with blank spaces for students to work them out. after the problems were presented, key concepts and the corresponding theory were provided. these tools enabled students to understand and ultimately solve the problem. the authors presented evidence suggesting that the proposed method improved critical thinking skills. with our community garden project, we employed pbl by presenting the “problem” of food security in the city of huntsville, texas. huntsville is a mostly rural community with a population of 40,435 and a median household income from volume 33, number 2 99 2012-2014 of $29,257 (us census bureau, 2016). with 37.3% of the population living below the poverty level (us census bureau, 2016), we assert that food security is a concern for public officials and the community at large. students were presented with this issue as a real world problem and were tasked with the need for a real-time, community-based solution. addressing food security was fundamental to the project and served as a driving force for both target and support students throughout the duration of the project. service learning “service learning refers to a teaching strategy that engages students in organized service activities” (what, 2015). instructors regularly leverage this learning technique when teaching students how to work with community organizations and clients. these types of undertakings are called service-learning projects because they provide real value to the receiving organizations. while generally effective, class based projects are often difficult to implement since they are time-consuming and require much coordination when they involve interacting with individuals or organizations outside of the university. the current research is additionally complex since our project crossed disciplines (environmental science and operations management) and was planned to elapse over multiple semesters. service learning projects have been used extensively within the university setting. for instance, students in a strategic management capstone course, at indiana state university, acted as consultants and offered advice to local businesses with respect to organizational objectives (robinson, et al., 2010). similarly, xavier university students worked with local non-profit organizations while completing a project management course (kloppenborg and baucus, 2004). larson and drexler (2010) designed a service-learning assignment for a project management course where students planned and executed events for local charitable organizations. business and communication students at california state university, fullerton, participated in a community project to advise target (department store) about how to communicate with college students to find future leaders (brzovic and matz, 2009). students at grand valley state university worked to solve problems at the university in a course focused on teaching students how to function effectively as members of a work team (mckendall, 2000). students at the university of nebraska, kearney learned six sigma concepts in the context of collaborating with local businesses on quality improvement projects (zuckweiler, 2011). students at kansas state university participated in total quality management (tqm) projects for local businesses, 100 journal of business strategies integrating the disciplines of engineering, business, statistics, and human ecology (mccahon and lavelle, 1998). faculty members at western carolina university used service learning projects to collaborate across multiple classes and multiple semesters for a management information system course (richmond, et al., 2008). sroufe and ramos (2011) compiled information from experiences with 39 service learning projects over a 3-year period and suggested a pedagogy for delivering live projects in mba curriculum focusing on sustainability concepts. these projects provided tremendous value to the participating organization and enabled the students involved a unique learning opportunity. for typical service learning projects, the instructor initiates the project, assigns students to an appropriate team, and provides supervision throughout (heriot, et al., 2008). this requires a number of critical resources including the instructor’s time (cook and belliveau, 2005). heriot and campbell (2002) also found that it can be difficult to recruit and supervise project participants. further, some of these resource requirements may be reduced by modifying the project structure or by shifting the workload to students (heriot et al., 2008). however, we caution that this could result in poorer results for the client and a less than ideal educational experience for the student. to potentially lessen the instructor’s time, our project sought to place the operations management students in a leadership role where they directed the project and managed interactions with community partners. giving both support to the instructor and real work exposure to the operations management students. methodology pedagogy our suggested pedagogy builds upon the model proposed by bellah (2014). in this model, students in an applied project management course are used to manage a project in a target discipline. the management students act as “student facilitators” working to increase student communication and productivity throughout the project. there are multiple benefits to this pedagogy. first, the instructor of the target discipline course in which the project is conducted changes roles. instead of acting as the project manager, he/she becomes a project stakeholder. this reduced role allows the instructor to focus on course objectives rather than spending significant time managing the project. in addition to reducing the instructor’s workload, the pedagogy should result in improved project outcomes, a more diversified educational volume 33, number 2 101 experience for students in the management course, as well as improved collaborative skills for students in the target course (bellah, 2014). leveraging bellah’s (2014) model, we propose using students in a decision science course (project management, operations management, etc.) to initiate, plan, execute, monitor, control, and close all of the processes involved in service learning projects. we believe that this would provide multiple direct and indirect benefits. in addition to providing service learning opportunities for the decision science students, it exposes them to diverse ideas and concepts in a different discipline. additionally, it benefits the instructor and students in the target discipline course, as it should result in a smaller workload for the instructor, better coordination, communication and control of projects, and improved learning outcomes for all students involved. application of the pedagogy: cross-disciplinary collaborative project we designed a collaborative project to address two goals: 1) to increase student engagement through service learning, and 2) to redistribute some of the work involved in managing the project from the instructor to students. the project was implemented using an operations management class with 40 students (support discipline), and an environmental science class with 90 students (target discipline). the operations management students managed the project that was executed by the environmental science students. the project’s goal was to research, design, and establish a formal procedure for the creation and operation of a local community garden. the project was planned as part of an academic community engagement (ace) courses. the ace pedagogy enables student learning by developing collaborative partnerships between the university and local community members. when using the ace methodology, a faculty member works in collaboration with a community partner to design an engagement experience that is directly linked to course objectives and meets a community need. the ace project is structured to occur in addition to the specific lecture components of the course, but works to directly leverage the over-arching themes found within the course. a structured written reflection on the community engagement experience is required and is assessed as a part of the final course grade. unlike service learning experiences, ace projects are structured to go beyond community service and attempt to link a student’s academic learning to community needs. students in the target environmental science class were given the opportunity 102 journal of business strategies to choose from one of twenty different groups which they remained in for the entire semester long project (table 1). we found that letting students choose their group, rather than placing student in pre-determined groups, worked to more effectively match student interests with individual group goals and in the end lead to improved quality of student products. operations management students were divided into 10 groups corresponding to the 10 knowledge areas defined by the pmbok guide (project management institute, 2013). each group was responsible for managing the environmental science groups’ work with respect to one knowledge area. the project integration group was responsible for integrating information from different groups to compile a single consistent deliverable. the project scope management group was responsible for helping environmental science groups to define the scope of their work and verifying that they actually accomplished their goals. the project time management group was responsible for helping the environmental science groups to define activities required to complete the project work, estimate the time involved in those activities, and keep track of the actual time worked. the project cost management group was responsible for estimating and keeping track of all cost related items involved in the project. the project quality management group was responsible for helping the environmental science students to define success criteria for each group and evaluating them with respect to the criteria. the project human resource management group was responsible for keeping track of the group members for all groups in both classes. the project communications management group was responsible for defining how communication would happen throughout the project. the project risk management group was responsible for documenting all possible risks and planned responses. the project procurement management group was responsible for finding procurement sources for all necessary materials for the project. finally, the project stakeholder management group was responsible for identifying and communicating with stakeholders. to facilitate communication between the target and support discipline classes, students were required to attend three joint class sessions. during these joint meetings, the faculty members provided status updates and groups were able to both trouble shoot project issues, as well as request critical information from other groups. management students were able to utilize these sessions to provide face-toface guidance and directives to target discipline students. in addition, to facilitate information sharing between groups, a wikispaces page (www.wikispaces.com) was created, with each group having their own space on the website. this allowed students to post documents, comments and questions to other group’s pages and served as the main document sharing portal for the entire project. at the end of the volume 33, number 2 103 semester, all students again convened for a group session where each environmental science target group (table 1) gave an oral presentation on their group’s findings and linked their efforts to the goal of establishing a formal plan for the creation of a community garden in the local town. community partners and stakeholders in the garden project were invited to attend this semester ending presentation. results and discussion at the end of the semester, we performed both quantitative and qualitative analysis to determine the effectiveness of the pedagogy. for the operations management students, the instructor’s goal was to provide students a better understanding of basic project management concepts and to expose them to diverse ideas and perspectives related to environmental science. for the environmental science students, the goal was to link the core concepts from class (e.g., agriculture, food security, and sustainability) to the community engagement experience and to increase their likelihood the students would actively participate in similar projects in the future. quantitative analysis the survey instrument was designed to compare differences between project-based and lecture-based classes and determine what students learned about operations management, project management, and environmental sciences (see appendix 1). we adapted survey questions from existing business case research measures (erzuruml and rollag, 2013). to evaluate the responses, we used a 7-point likert scale: strongly disagree = 1, disagree = 2, somewhat disagree = 3, neither disagree nor agree = 4, somewhat agree = 5, agree = 6, strongly agree = 7. we also asked respondents to comment on the project with an open-ended question. for the operations management students, we collected survey data from the 38 of the 40 students who participated in the service-learning project at the end of spring semester 2014 (table 2). upon detailed inspection, we note that 35 of 37 respondents were in their 4th year of college (1 respondent did not answer the class year question), confirming that participants were senior level management students. since the management students were in a leadership position during the project, their senior level, as compared to the freshman-level environmental science students, was preferred. to determine the effectiveness of the project-leaning approach, we analyzed the survey results to understand the students’ preferences (table 3). in the results 104 journal of business strategies profile, we categorized responses into two groups: disagree 1-3 (strongly disagree, disagree, or somewhat disagree) and agree 5-7 (somewhat agree, agree, or strongly agree). we then reported the percentage of responses for each group. unlike erzurumlu and rollag (2013), the management students in this class did not prefer the project approach to the traditional in-class lecture format. in fact, only 39% of management students indicated they enjoyed the overall experience. the survey results further indicated the majority of students did not feel the project helped them identify (53% disagreed), think through (58% disagreed), or motivate them (53% disagreed) better than an in-class discussion would. particularly concerning was the fact that only 24% of respondents agreed the project approach enabled them to think through different issues. while the evidence suggests the project approach, as compared to traditional in-class discussions, was less appealing for management students, our analysis also indicated that these management students believed they were able to better identify and understand operational issues. since this was an operations management class, we appreciated the fact that students believed the project-management approach allowed them to identify operational issues 79% of the time and understand potential and actual operations issues 71% of the time. further, since the management students actively participated in the initial stages of this project, we surmise they were able to identify and understand operations issues associated with the project planning and execution stages. our analysis further indicated that the management students felt the project approach helped them understand real-world business issues 71% of the time. because the majority of respondents were 4th year students, we assume they will be graduating and entering the business world shortly. thus, by exposing them to real world issues like project planning, deliverable execution, and teamwork, the project approach seems to prepare these students for the job market. it does so by providing details about experiences. we expect that students can leverage the experiential details when discussing real world situations with potential employers. lastly, the analysis indicated 82% of management respondents felt they were involved with the community garden project. we believe this was a good indicator for class participation. hence, the project approach may provide a method to keep students engaged. this is particularly important as instructors work to engage and motivate students who are nearing graduation. besides the survey questions, we also asked the management students several open-ended question about their overall experience. volume 33, number 2 105 1) (the project) made me aware of subject matters outside of my academic major, better than in-class discussions. 2) (the project) made me aware how businesses and environmental groups could work together, better than in-class discussions. 3) the project got me excited by showing me how businesses and community groups work together. over 60% of the students agreed with each of these statements. contrast that with the fact that only 24% of students agreed with the statement, “i would like to learn more about environmental science.” the responses to the latter statement suggest that the students were not interested in the different discipline; therefore, the results of the former questions are much more powerful. despite not having an overwhelming appreciation for environmental science, the management students recognized that the diverse topics were beneficial. qualitative analysis environmental science students who participated in the project were required to write a reflective essay about their experiences with the project. these essays showed that students’ experiences with the project varied. numerous students noted that they did not enjoy working on the project. many specifically noted the challenges associated with group work as the reason for this displeasure. the written reflections further illustrated that some of the environmental science students did not form a close connection with their management student counterparts. however, we did find that the community garden project was seen as a positive experience for the environmental science students. many of the respondents wrote about a connection between the environmental science lecture material and its direct application to the community garden project. specifically, many students reported they developed a deeper sense of connection to the local community and a more tangible idea of how they can serve the community. conclusion the management students were vital in managing the project as they aided the target discipline students in creation of group timelines, task execution, and project 106 journal of business strategies documentation. throughout the process, many environmental science students had difficulty understanding the role of the management students and often were uncertain with level of authority the management students’ held. we acknowledge that the different roles were not defined in a clear manner at the onset of the project and attribute this confusion to this fact. future iterations of this pedagogy would benefit from a more detailed presentation of the roles of the management students and the target discipline students, and the interaction between the groups, at the start of the project. in the future, the goal will be to illustrate to all students that they are all working in collaboration on the project and the increased communication between management and target discipline students will only result in a more developed final product. we were unable to follow bellah’s (2014) model completely because the management students had not previously completed a project management course. instead, the management students had been exposed to project management principles for two weeks during an operations management class. in retrospect, this limitation in resources likely affected the accomplishment of project goals. this study provided key insight in to the how experiential learning, problembased learning, and service learning can be used to enhance teaching and student experiences. because this was the first time attempting such an endeavor, we encountered multiple unforeseen challenges. some students displayed negative comments related to the experience, but we believe much of the reason behind these comments were due to the exploratory nature of the project and were necessary “growing pains”, which occurred throughout the semester. moving forward, we plan to refine our processes and experiment in many different courses related to decision sciences. in addition, we plan to operationalize many of our processes so they can be replicated for other instructors who want to connect their students with diverse disciplines and the community outside the university. it is important to expose students to diverse ideas and perspectives in education. this can be accomplished successfully by using service learning projects. while the benefits of these projects are great, they come at a cost. the management of the projects always requires significant time and resources, and this can be overwhelming as class size or the number of classes grow. our proposed pedagogy attempts to achieve the benefits of service learning while managing the logistical challenges. our results also show that tangible benefits occurred from the project to students and faculty in both disciplines. volume 33, number 2 107 acknowledgments the authors would like to acknowledge the center for community engagement (cce) at sam houston state university and extend appreciation to dr. joyce mccauley and dr. lee miller. in addition, we thank the cce advisory board and the academic community engagement college coordinators – without their support of academic community engagement this work would not have been possible. funding this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. references athavale, m., davis, r. and myring, m. (2008). the integrated business curriculum: an examination of perceptions and practices. journal of education for business, 291-301. bellah, j. (2014). a systems perspective of project management to support service learning projects. the proceedings of swdsi. bhavnani, h.s. and aldridge, m.m. (2000). teamwork across disciplinary borders: a bridge between college and the work place. journal of engineering education, 13-16. brzovic, k. (2009). students advise fortune 500 company: designing a problembased learning community. business communication quarterly, 72(1): 21-34. cook, r.g. and belliveau, p. (2005). the experiential student team consulting process. dog ear publishing. erzurumlu, s.s. and rollag, k. (2013). increasing student interest and engagement with business cases by turning them into consulting exercises. decision sciences journal of innovative education, 11(4): 359-381. ferrari, j.r. and chapman, j.g. (2014). educating students to make a difference: community-based service learning. routledge. foster, s.t. (2004). freequality: using service learning to motivate student learning. decision sciences journal of innovative education, 2(1): 57-63. fruchter, r. (2001). dimensions of teamwork education. journal of engineering education, 17(4-5): 426-430. 108 journal of business strategies fruchter, r. and emery, k. (1999). teamwork: assessing cross-disciplinary learning. proceedings of the 1999 conference on computer support for collaborative learning. international society of the learning sciences. govekar, m.a. and rishi, m. (2007). service learning: bring real-world education into the b-school classroom. journal of education for business, 3-10. hartman, n.s., watts, c.a. and treleven, m.d. (2013). appreciating the complexity of project management execution: using simulation in the classroom. decision sciences journal of innovative education, 11(4): 323-334. heineke, j., meile. l., liu, l.b., et al. (2010). project flip: a project management case/exercise experience. decision sciences journal of innovative education, 8(1): 113-127. heriot, k.c. and campbell, n.d. (2002). starting new small business institute programs: a survey of new programs begun since 1996. journal of small business strategy, 13(2): 90-96. heriot, k.c., cook, r., jones, r.c., et al. (2008). the use of student consulting projects as an active learning pedagogy: a case study in a production/operations management course. decision sciences journal of innovative education, 6(2): 463-481. hicks, e.r. (1996). experiential learning in a postgraduate project management programme. education + training, 38(3): 28-38. keller, h. and cox, j.r. (2004). the proteomics stock market project – a crossdisciplinary collaboration in biochemistry and business education. journal of chemical education, 81(4): 519-522. kloppenborg, t.j. and baucus, m.s. (2004). project management in local nonprofit organizations: engaging students in problem-based learning. journal of management education, 28(5): 610-629. kolb, d.a. (1984). experimental learning. englewood cliffs, nj: prentice-hall. larson, e. and drexler (jr), j.a. (2010). project management in real time: a servicelearning project. journal of management education, 34(4): 551-573. lehmann, m., christensen, p., du, x., et al. (2008). problem-oriented and projectbased learning (popbl) as an innovative learning strategy for sustainable development in engineering education. european journal of engineering education, 33(3): 283-295. lenschow, j.r. (1998). from teaching to learning: a paradigm shift in engineering education and lifelong learning. european journal of engineering education, 23(2): 155-161. volume 33, number 2 109 long, s.k. and carlo, h.j. (2013). collaborative teaching and learning through multi-institutional integrated group projects. decision sciences journal of innovative education, 11(3): 233-241. lovejoy, s.w. and srinivasan, v. (2001). perspective: ten years of experience teaching a multi-disciplinary product development course. the journal of product innovation management, 19: 32-45. mccahon, c.s. and lavelle, j.p. (1998). implementation of cross-disciplinary teams of business and engineering students for quality improvement projects. journal of education for business, 73(3): 150. mckendall, m. (2000). teaching groups to become teams. journal of education for business, 277282. muscat, j.a., allen, l.e., green, d.h.e., et al. (1997). interdisciplinary teaching and learning in a semiconductor processing course. journal of engineering education, 653-658. nargundkar, s., samaddar, s. and mukhopadhyay, s. (2014). a guided problembased learning (pbl) approach: impact on critical thinking. decision sciences journal of innovative education, 12(2): 91-108. project management institute (2013). a guide to the project management body of knowledge (pmbok guide), 5th edition, newtown square, pennsylvania: project management institute, inc. richmond, w., banerjee, d. and white, b.j. (2008). integrating curriculum across courses in the same semester and across semesters using a service learning project. decision sciences journal of innovative education. 6(2): 509-513. robertson, k.e. and mcdaniel, a.m. (1995). interdisciplinary professional education: a collaborative clinical teaching project. american journal of pharmaceutical education, 59: 131-136. robinson, d.f., sherwood, a.l. and depaolo, c.a. (2010). service-learning by doing – how a student-run consulting company finds relevance and purpose in a business strategy capstone course. journal of management education, 34(1): 88-112. rouvrais, s., ormrod, j., landrac, g., et al. (2006). a mixed project-based learning framework: preparing and developing student competencies in a french grande ecole. european journal of engineering education, 31(1): 83-93. sroufe, r. and ramos, d. (2011). mba program trends and best practices in teaching sustainability: live project courses. decision sciences journal of innovative education, 9(3): 349-369. 110 journal of business strategies united states census bureau (2016). huntsville, texas. available at: http:// quickfacts.census.gov/qfd/states/48/4835528.html (accessed 25 march 2016). what is service learning? (2015, october). retrieved from the virginia commonwealth university, division of community engagement web site: http://www.servicelearning.vcu.edu/what-is-service-learning/. weinberg, b.j., engel, l.g., gu, k., et al. (2001). a multidisciplinary model for using robotics in engineering education. american society for engineering education. wu, y. and sankar, c.s. (2013). impact of hands-on research experience on students’ learning in an introductory management information system course. decision sciences journal of innovative education, 11(4): 335-358. zuckweiler, k.m. (2011). teaching six sigma to undergrads: a simplified real project approach. decision sciences journal of innovative education, 9(1): 137-142. volume 33, number 2 111 biographical sketch of authors jeffrey r. wozniak is an assistant professor of biological sciences at sam houston state university. he received his phd from florida international university and his bs from allegheny college. dr. wozniak is an ecosystem ecologist and his research interests include coastal, estuarine and wetlands ecology. he teaches a wide range of environmental science, ecology and sustainability courses and often includes academic community engagement in these offerings. jeremy bellah is an assistant professor of computer information systems and decision management at west texas a&m university. he received his ph.d. from texas tech university. dr. bellah teaches classes in software development and project management. he conducts research in the areas of offshore information systems development, rfid technology utilization, software use in small and medium sized enterprises, and pedagogical research related to project management. he has published in journals including journal of computer information systems, international journal of productivity and quality management, and journal of information technology case and application research. jason m. riley earned his ph.d. from clemson university. he is an assistant professor of supply chain management in the department of management and marketing at sam houston state university. dr. riley’s research interests include supply chain risk, retail product management, and course modality. he has published in several peer-reviewed journals including the international journal of information systems and social change, journal of business management, and international journal of physical distribution and logistics management. 112 journal of business strategies table 1 list of the main organizational themes and twenty student subgroups for the community garden project in the target environmental science course. project introduction, purpose and implementation plan 1. implementation plan: overview and organization 2. mission statement and needs assessment 3. local community asset assessment overview of other community gardens 4. successful community garden summary 5. garden reconnaissance and site visits garden site selection, preparation and planning 6. local site selection: options and feasibility 7. site preparation 8. soil chemistry garden components and operation 9. organic farming 10. composting 101 11. garden security and safety 12. garden signage outreach and education 13. k-12 educational opportunities 14. university educational opportunities 15. garden communication network 16. publicity and community outreach long-term garden sustainability 17. garden rules and procedures 18. garden budget 19. garden financial sustainability plan 20. garden master plan and organization volume 33, number 2 113 table 2 descriptive statistics compared to in-class discussions, the project count mean std dev min max helped me to identify different issues better than in-class discussions. 38 3.55 1.62 1 7 helped me to think through different issues... 38 3.37 1.62 1 7 helped me to apply critical reasoning... 38 3.68 1.58 1 7 stimulated my interest in the course subject... 38 3.50 1.69 1 6 motivated me to do my best work... 38 3.55 1.52 1 6 allowed me to learn more about the subject matter... 38 3.47 1.62 1 7 made me aware of subject matters outside of my academic major... 38 4.53 1.66 1 7 made me aware how businesses and environmental groups could work together... 38 4.64 1.69 1 7 general response to the project the project allowed me to identify operational issues. 38 5.16 1.39 1 7 the project allowed me to understand operational issues. 38 4.92 1.51 1 7 the project helped me apply concepts i learned in class. 38 4.55 1.43 1 7 i gained valuable experience from this project. 38 3.97 1.67 1 7 i was involved with this project. 38 5.42 1.46 1 7 overall, the project was helpful to my learning. 38 4.18 1.72 1 7 overall, i enjoyed the experience. 38 4.00 1.76 1 7 i would like to learn more about project management. 38 5.50 1.16 2 7 i would like to learn more about environmental science. 38 2.95 1.68 1 6 the project got me excited by showing me how buinesses and community groups work together. 38 4.68 1.44 2 7 allowed me to understand real world business issues. 38 5.11 1.45 1 7 the project challenged my thinking about environmental science. 38 3.47 1.66 1 7 the project helped me realize there is more to the world than just business. 38 4.42 1.37 2 7 control questions gender 36 1.47 0.56 1 2 first generation student 36 1.47 0.51 1 2 age 35 22.54 2.02 19 30 class year 37 3.95 0.23 3 4 114 journal of business strategies table 3 result profile compared to in-class discussions, the project count mean disagree 1-3 disagree % agree 1-3 agree % helped me to identify different issues better than inclass discussions. 38 3.55 20 53% 15 39% helped me to think through different issues... 38 3.37 22 58% 9 24% helped me to apply critical reasoning... 38 3.68 17 45% 12 32% stimulated my interest in the course subject... 38 3.50 19 50% 12 32% motivated me to do my best work... 38 3.55 20 53% 13 34% allowed me to learn more about the subject matter... 38 3.47 18 47% 10 26% made me aware of subject matters outside of my academic major... 38 4.53 11 29% 24 63% made me aware how businesses and environmental groups could work together... 38 4.64 7 18% 26 68% general response to the project the project allowed me to identify operational issues. 38 5.16 4 11% 30 79% the project allowed me to understand operational issues. 38 4.92 6 16% 27 71% the project helped me apply concepts i learned in class. 38 4.55 7 18% 23 61% i gained valuable experience from this project. 38 3.97 15 39% 17 45% i was involved with this project. 38 5.42 3 8% 31 82% overall, the project was helpful to my learning. 38 4.18 11 29% 17 45% overall, i enjoyed the experience. 38 4.00 15 39% 15 39% i would like to learn more about project management. 38 5.50 2 5% 33 87% i would like to learn more about environmental science. 38 2.95 24 63% 9 24% the project got me excited by showing me how buinesses and community groups work together. 38 4.68 9 24% 23 61% allowed me to understand real world business issues. 38 5.11 5 13% 27 71% the project challenged my thinking about environmental science. 38 3.47 20 53% 12 32% the project helped me realize there is more to the world than just business. 38 4.42 8 21% 17 45% volume 33, number 2 115 appendix 1 management student questionaire compared to in-class discussions, the project. 1. helped me to identify different issues better than in-class discussions. 2. helped me to think through different issues better than in-class discussions. 3. helped me to apply critical reasoning better than in-class discussions. 4. stimulated my interest in the course subject better than in-class discussions. 5. motivated me to do my best work better than in-class discussions. 6. allowed me to learn more about the subject matter, than i would have during in-class discussions 7. made me aware of subject matters outside of my academic major, better than in-class discussions 8. made me aware how businesses and environmental groups could work together, better than in-class discussions general response to the project 9. the project allowed me to identify operational issues 10. the project allowed me to understand operational issues 11. the project helped me apply concepts i learned in class. 12. i gained valuable experience from this project. 13. i was involved with this project 14. overall, the project was helpful to my learning. 15. overall, i enjoyed the experience. 16. i would like to learn more about project management 17. i would like to learn more about environmental science 18. the project got me excited by showing me how businesses and community groups work together. 19. allowed me to understand real world business issues. 20. the project challenged my thinking about environmental science. 21. the project helped me realize there is more to the world than just business. 22. what did you like most about the project? control questions 23. male/female 24. age: 25. are you a first generation student (neither parent graduated from a four year college or university): yes, i am a first generation student, no, i am not a first generation student. open-ended question 26. what did you like about the project? volume 34, number 2 75 the stock price effect of emerging from bankruptcy and the associated effect of switching auditors post-bankruptcy…an industry analysis ronald stunda valdosta state university • valdosta, ga abstract this study analyzes firms that emerge from chapter 11 bankruptcy with specific attention given to two groups; those that switch auditors post-bankruptcy, and those who retain previous auditors in a post-bankruptcy environment. in addition, further analysis is made to assess whether or not industry membership, along with pre or post sox environment play a role in results. results indicate that when the pre versus post sox environment is assessed, a significant difference is noted in the sample firms. post sox firms emerging from chapter 11 that switch auditors carry positive information content, therefore, investors tend to bid up the price of stock of these firms. firms emerging from chapter 11 in a post sox environment that do not change auditors tend to convey negative information content as their stock price is bid down by investors. with respect to a pre sox environment, results indicate that investors do not behave significantly different whether the firms change auditors or not after emerging from chapter 11. in both cases, there is a positive correlation between earnings response and stock price. when attention turns to assessing individual industries in a post sox environment, a positive correlation between earnings response and stock price is seen across all industries evaluated when the firm emerging from chapter 11 switches auditors. growth industry firms show the greatest stock price reaction to earnings. with respect to firms that do not switch auditors post-bankruptcy, results are mixed across industries. most industries show a negative stock price reaction but certain growth industries reflect a positive reaction. in a pre sox environment, no significant industry difference is noted, either by firms that switch auditors or those that do not switch. all pre sox industry firms, on average, have a positive correlation between earnings response and stock price. 76 journal of business strategies introduction bankruptcy has the potential to be a tremendously traumatic experience for a firm. the primary purpose of the u.s. bankruptcy code, through chapter 11 filing, is to provide temporary respite from financial obligations to companies with sufficiently high probability of reorganizing obligations successfully. a successful reorganization would allow the company to ultimately emerge from bankruptcy as a much more financially healthy organization. the news of a successful emergence from chapter 11 is then viewed as good market news relative to other firms in the industry. ferris et al (1997) separate firms in comparable industries by those that file for bankruptcy and those that do not. an analysis is then made three years prior to the bankruptcy and three years after emerging from bankruptcy. they find that when the bankruptcy announcement is made, the firms declaring chapter 11 filings see a decline in stock prices, but so do rivals firms in the same industry. when the firms emerge from chapter 11, they see an even greater increase in stock price than stock prices of rival firms. client firms switch auditors for many different reasons. one reason is that a firm may change to a better quality auditor to supply more credible information to creditors, investors, and regulators (schwartz and menon 1985). another reason is that a client firm may be engaged in opinion shopping. a firm may seek a new auditor to conceal or downplay “bad news” or to avoid a qualified or going concern opinion (fried and schiff 1981; chow and rice 1982). a third reason for an auditor change is a disagreement between the auditor and client (davidson et al. 2006). with the advent of sarbanes oxley (sox), the public company accounting oversight board (pcaob) was created and empowered to promulgate new auditing standards for public company audits. one change the pcaob has made is a modification to the second paragraph of statement on auditing standards (sas) no. 59. this change directs auditors to use their knowledge of subsequent events following the financial statement date but before the audit opinion date when considering whether to issue a going concern opinion [pcaob, 2 010, p. 538]. before this change, sas no. 59 instructed auditors to consider subsequent events at the completion of fieldwork [aicpa, 1988]. geiger et al, (2005) find that this change may also result in a selffulfilling prophecy regarding issuance of going concern opinions and resultant bankruptcy declarations. this paper attempts to merge much of the past literature regarding bankruptcy and auditor switches to assess the stock price impact of firms emerging from bankruptcy, and the extent to which those firms switch auditors. another aspect of volume 34, number 2 77 this study, which is beginning to receive greater interest, is the impact of these two issues from an industry-specific basis. the goal of this study is to help provide a clearer picture of the relationship between post-bankruptcy performance and auditor retention by specific industry. the rationale for inclusion of this metric in the study is because any industry-specific findings could have relevance and significance to managers, investors and creditors of those industries. literature review truman and weinstein (1983) posit that most corporate bankruptcies are fully anticipated to the point that no new information is released when bankruptcies are filed. the authors find that greater information follows the emergence from bankruptcy. they find that primary events ocurring around post-bankruptcy include; new management, new corporate form, and new auditors. none of these events are explored by the authors. aharony, jones and swary (2010) find that corporate failure is an indication of resource misallocation and can be industry-specific, although there is no attempt to measure industry differences. lang and stulz (1992) explore a premise that when more than one firm in the same industry announces a chapter 11 filing there exists a tendency for other firms in the same industry to follow. they refer to this as an intra-industry contagion effect. smith and nichols (1992) document a significantly positive share price reaction within 60 days after emerging from bankruptcy. whereas eberhart et al. (1999) find an abnormal positive price change in days following bankruptcy emergence, klock (2004) documents that firms in heavy industry have a significant drop in stock price upon emergence from chapter 11. eberhart et al. (1999) study the stock market performance of firms emerging from chapter 11 bankruptcy. they find that in the first 200 days after shedding the chapter 11 cover, abnormal stock returns average from +24.6% to +138.8%. this result is similar to the findings of bradley and rosenzweig (1992). lang and stulz (1992) extend the analysis and find that this market reaction can exert a positive competitive effect, particularly since the chapter 11 bankruptcy can be an indication of a general negative contagion in the industry in which the chapter 11 emerging company competes. in several of these studies, post-bankruptcy firms have either changed auditors or retained previous ones. there has been no control for assessing either. regarding auditor switches, prior research shows that a reduction in audit fees motivates auditor changes (johnson and lys 1990). lower audit fees may improve company financial performance through lower costs but may also diminish 78 journal of business strategies audit quality (ettredge et al. 2007). auditor changes may be related to higher auditor litigation risk (krishnan and krishnan 2007), auditor industry specialization, carcello and neal 2003), management desire to manage or manipulate earnings (davidson et al. 2006), and better service provided by auditors (johnson and lys 1990; chang et al 2010). asthana, balsam, and krishnan (2010) posit that corporate governance is a factor in switching auditors and that this is especially true after the enron debacle and creation of sarbanes oxley (sox) in 2002. they also find that governance varies from industry to industry, and a multivariate analysis assessing multiple industry firms in a five year study period indicates differing market reaction to the auditor switch within 120 days of the switch. stunda (2012) provides evidence of stock prices changes triggered by new regulation may vary among industries. evidence is found within 90 days of the new regulation taking effect. mackay and phillips (2015) find that industry dictates financial structure. in some cases, financial leverage can be higher or lower depending upon the industry. the study assesses various equilibrium models and discovers that industry firms with higher leverage and risk are more apt to ultimately switch auditors. fries, miller and perraudin (2015) have similar findings of mackay and phillips (2015). in assessing debt in industry equilibrium, the study shows that over-leverage in certain industries can lead to a host of reactions including bankruptcy, and certainly in a post sox environment, a change in auditors. this study attempts to provide a nexus between the extant bankruptcy and auditor switch literature. it also attempts to assess this linkage in a pre and post sox environment, and from an industry perspective. this issue has become more relevant today in light of recent studies highlighting industry differences, particularly as industries continue to evolve in their governance and capital structure. in addition, it is important to place this linkage in perspective to points in time. therefore, the study compares and contrasts findings in order to analyze results in a pre versus post sox environment, and by industry. data and methodology the sample consists of quarterly earnings and security prices during the two sample period years 1992-2001 (pre sox) and 2007-2016 (post sox), for the first quarter after a firm emerges from chapter 11. the rationale for using the first quarter after emergence is to stay as close to the methodology of smith and nichols (1992), who utilize 60 days after the event, asthana, balsam, and krishnan (2010) who volume 34, number 2 79 utilize 120 days after the event, and stunda (2012) who utilizes 90 days after the event. since quarterly data is used in the study, the first quarter after the event is considered to be the most significant. earnings data are obtained from compustat and security price information is derived from the center for research on security prices (crsp). the analysts’ forecast of earnings is obtained from the investment brokers estimate service (ibes), and consists of quarterly point forecasts for the periods mirroring firms’ earnings releases. also, the electronic data gathering and retrieval system (edgar), and the wall street journal (wsj) are used to analyze financial notes and other associated firm information in order to control for such things as change of corporate form, change in ownership, or change in management. if any of these could be documented during the test period, the firm is subsequently eliminated from the study. in addition, edgar is also utilized to identify prechapter 11 versus post-chapter 11auditor changes in the test period firms. in their analysis of earnings forecast accuracy, sinha, brown, and das (2015) conduct a detailed study of industries incorporating such things as corporate governance, average industry revenues, average industry assets, capital structure, regulatory constraints, and long term investment. the study finds that certain industries have experienced above average growth in the last ten years, while other industries have experienced below average growth during this same period. this study incorporates industry analysis from that study to highlight similar above average growth industries, namely; technology, healthcare, oil/gas, and banking/ finance. in addition, the same below average growth industries are also analyzed, they are; utilities, real estate, transportation, and industrials. tables 1 and 2 below provide the full sample of firms in the test period samples. 80 journal of business strategies table 1 firms emerging from chapter 11 2007-2016 (post sox) firms emerging from chapter 11 industry firms switching auditors firms retaining auditors above average growth industries technology 6 8 healthcare 9 7 oil/gas 11 9 banking/finance 15 11 total 41 35 below average growth industries utilities 17 13 real estate 16 8 transportation 14 9 industrials 27 18 total 74 48 grand total 115 83 table 2 firms emerging from chapter 11 1992-2001 (pre sox) firms emerging from chapter 11 industry firms switching auditors firms retaining auditors above average growth industries technology 2 4 healthcare 3 5 oil/gas 5 6 banking/finance 7 5 total 17 20 below average growth industries utilities 5 7 volume 34, number 2 81 real estate 4 6 transportation 9 7 industrials 15 14 total 33 34 grand total 50 54 hypothesis development difference between firms that switch auditors versus firms that do not switch auditors post sox geiger et al. (2005), notes that firms going through chapter 11 may switch auditors to shed association with a past bad experience, while smith and nichols (1992) finds that auditor switches when emerging from bankruptcy provides a signal that in turn generates a significant share price response. the first question to ask is, does a significant difference exist in price between firms switching auditors versus those retaining the same auditor, after emerging from chapter 11? this leads to the first hypothesis, stated in the null form: h1: in a post sox environment, there is no significant difference in the security price of firms, within the first quarter of emerging from chapter 11, regardless of whether or not the same auditor is retained or changed to a new auditor. the association between accounting earnings and security returns was first propounded by ball and brown (1968). the premise of the ball and brown study was to see whether the magnitude of unexpected earnings (as opposed to merely the sign of unexpected earnings) was related to the magnitude of the stock price response. beaver, clarke and wright (1979) addressed the issue and discovered, in fact, that the magnitude of unexpected earnings was related to the magnitude of the stock price response. again, they focused on market-adjusted stock returns to facilitate across-firm comparisons and to control for market-wide movements in stock prices. ball and brown (1968) and beaver, clarke and wright (1979) show that despite the deficiencies of historical cost accounting, accounting earnings are potentially useful to investors. they also ushered in the so-called information perspective on the decision usefulness of accounting. the information perspective 82 journal of business strategies implies that investors’ response to accounting information can provide a guide as to what type of information is or is not valued by investors. the next logical question to ask was whether the market responded more strongly to unexpected earnings in some firms, and less strongly in other firms. this question is quite pertinent to accountants because accountants potentially would be better able to design financial statements if we knew the factors that predict when and why investors respond more strongly (less strongly) to financial statement information. consistent with the literature, the term “earnings response coefficient,” or “erc” is used to describe the strength of the market response to unexpected earnings. to understand this line of research, one needs to have an intuitive understanding of how investors might respond to accounting information in light of single person decision theory, portfolio theory, and efficient market theory. here is the basic idea: let’s say that last period’s earnings were $1 and, accordingly, that is the level of earnings an investor expects this year. when this year earnings are announced, the level of earnings are, say, $1.25, implying a $0.25 earnings surprise. if the investor believes this $0.25 level of unexpected earnings is a one-time shot that will not recur into the future, the investor will increase his assessment of stock value by $0.25. however, if the investor believes this $0.25 unexpected increase in earnings is a permanent boost to earnings that will recur in future years, then the investor’s increase in stock price is $0.25 + the present value of receiving $0.25 into perpetuity. given this framework for thinking about how investors should respond to unexpected earnings, it can be predicted that investors will respond more strongly to unexpected earnings when those earnings are expected to persist into the future. it can also be predicted that investors’ response to unexpected earnings will be smaller the higher the discount rate they use in discounting those unexpected earnings that are expected to be received into perpetuity. subsequent numerous studies have tested these predictions, and find: (1) erc are increasing in the persistence of earnings. this has implications for accountants because it suggests the importance of clearly identifying on the income statement those transactions that are nonrecurring transactions (baginski and hassell, 1990). (2) erc are decreasing in the riskiness of the firm and the leverage of the firm because both imply that investors demand higher expected returns and thus will use a higher discount rate in discounting the unexpected earnings expected to persist into the future. thus, accountants should minimize the opportunities for off-balance sheet financing (or make sure the off-balance sheet financing is transparent) (ajinkya, atiase, and gift, 1991). volume 34, number 2 83 (3) erc are increasing in the growth opportunities of the firm because unexpected earnings reported by growth firms are expected to persist into the future. thus, the forward-looking management discussion and analysis (md&a) disclosures are particularly important because they provide information about growth opportunities (collins and kothari, 1994). (4) erc are increasing in the quality of accounting accruals. thus, detailed information about the components of accounting accruals might be useful to investors (lev, 1989). using the previously explained ball and brown (1968) model to determine the erc, the following model is established for determining information content: �𝐶𝐴𝑅𝑖𝑡=𝑎+𝑏1𝑈𝐸𝑆𝑖𝑡+𝑏2𝑈𝐸𝑅𝑖𝑡+𝑏3𝑀𝐵𝑖𝑡+𝑏4𝐵𝑖𝑡+𝑏5𝑀𝑉𝑖𝑡+𝑏6𝐸𝑖𝑡+𝑏7𝐷𝑖𝑡+𝑒𝑖𝑡 (1) where: carit = cumulative abnormal return firm i, time t a = intercept term uesit = erc for all firms switching auditors uerit = erc for all firms retaining auditors mbit = market to book value of equity as proxy for growth and persistence bit = market model slope coefficient as proxy for systematic risk mvit = market value of equity as proxy for firm size eit = number of audit committee member as proxy for expertise dit = number of years with current auditor as proxy for tenure eit = error term for firm i, time t the above regression is run for all firms in each of the test samples (i.e., firms switching auditors and firms retaining the same auditors). the coefficient “a” measures the intercept. the coefficient b1 is the erc associated with firms switching auditors. the coefficient b2 is the erc associated with firms retaining the same auditors. the erc is measured by determining unexpected earnings. unexpected earnings (uei) is measured as the difference between the management earnings forecast (mfi) and security market participants’ expectations for earnings proxied by consensus analyst following as per investment brokers estimate service (ibes) (exi). the unexpected earnings are scaled by the firm’s stock price (pi) 180 days prior to the forecast: 84 journal of business strategies 𝑈𝐸𝑖=[𝑀𝐹𝑖−(𝐸𝑋𝑖)]/𝑃𝑖 (2) unexpected earnings are measured for each of the sample firms in the first quarter after emerging from chapter 11. the coefficients b3 through b7, are contributions to the erc for all firms in the sample. to investigate the effects of the information content of earnings on security returns, there must be some control for variables shown by prior studies to be determinants of erc. for this reason, the variables represented by coefficients b3 through b7 are included in the study. for each firm sample, an abnormal return (arit) is generated around the event dates of -1, 0, +1 (day 0 representing the day that the firm’s financials were available per djnrs). the market model is utilized along with the crsp equally-weighted market index and regression parameters are established between -290 and -91 days. abnormal returns are then summed to calculate a cross-sectional cumulative abnormal return (carit). difference between firms that switch auditors versus firms that do not switch auditors pre sox utilizing the same approach as in h1, an analysis is made of firms during the pre sox study period. this leads to the following hypothesis: h2: in a pre sox environment, there is no significant difference in the security price of firms, within the first quarter of emerging from chapter 11, regardless of whether or not the same auditor is retained or changed to a new auditor. difference between pre sox and post sox results in order to compare differences between pre and post sox results, an analysis of variance test (anova) is used. baron and kenny (1986) find that an anova test is effective in that it precludes the concept of multicollinearity that sometimes arises in regression results, along with measurement error. this methodology is also used in asthana, balsam, and krishnan (2010) to assess the effect of auditor switches associated with governance issues. this leads to the following hypothesis, stated in the null form: volume 34, number 2 85 h3: there is no significant difference in security prices of firms emerging from chapter 11 between a pre versus post sox environment regardless of whether or not an auditor switch exists. difference across industries post sox aharony, jones and swary (2010) find that corporate failure is an indication of resource misallocation and can be industry-specific, while klock (2004) documents that firms in heavy industry have a significant drop in stock price upon emergence from chapter 11. an important question unanswered by previous bankruptcy studies is, are post-bankruptcy effect significantly different across industries in a post sox environment. this leads to the second hypothesis, stated in the null form: h4: there is no significant post sox industry difference in the security price of firms, within the first quarter of emerging from chapter 11, regardless of whether or not the same auditor is retained or changed to a new auditor. utilizing a similar approach to that of hypothesis one the following model is presented: car=𝑎+𝑏1𝑈𝐸𝑆𝑖𝑡+𝑏2𝑈𝐸𝑅𝑖𝑡+𝑏3𝑀𝐵𝑖𝑡+𝑏4𝐵𝑖𝑡+𝑏5𝑀𝑉𝑖𝑡+𝑏6𝐸𝑖𝑡+𝑏7𝐷𝑖𝑡+𝑒𝑖𝑡 (3) where: carit = cumulative abnormal return firm i, time t a = intercept term uesit = erc for firms switching auditors by specific industry uerit = erc for firms retaining auditors by specific industry mbit = market to book value of equity as proxy for growth and persistence bit = market model slope coefficient as proxy for systematic risk mvit = market value of equity as proxy for firm size eit = number of audit committee member as proxy for expertise dit = number of years with current auditor as proxy for tenure eit = error term for firm i, time t the above regression is run multiple times for each industry in the sample. the coefficient “a” measures the intercept. the coefficient b1 is the erc associated with firms switching auditors. the coefficient b2 is the erc associated with firms retaining the same auditors. the erc is measured by determining unexpected 86 journal of business strategies earnings. unexpected earnings (uei) is measured as the difference between the management earnings forecast (mfi) and security market participants’ expectations for earnings proxied by consensus analyst following as per investment brokers estimate service (ibes) (exi). the unexpected earnings are scaled by the firm’s stock price (pi) 180 days prior to the forecast, similar to the approach used in hypothesis one. for each firm sample, an abnormal return (arit) is generated around the event dates of -1, 0, +1 (day 0 representing the day that the firm’s financials were available per djnrs). the market model is utilized along with the crsp equally-weighted market index and regression parameters are established between -290 and -91 days. abnormal returns are then summed to calculate a cross-sectional cumulative abnormal return (carit). differences across industries pre sox utilizing the same approach as in h4, an analysis is made of firms during the pre sox study period. this leads to the following hypothesis: h5: there is no significant pre sox industry difference in the security price of firms, within the first quarter of emerging from chapter 11, regardless of whether or not the same auditor is retained or changed to a new auditor. results table 3 provides results of assessing all post sox firms in the sample that switch auditors subsequent to emerging from chapter 11 versus those which retain the same auditor prior to chapter 11 filing. the erc associated with the firms switching auditors, represented by variable b1, is positive .13 and is significant at the .01 level. the erc associated with firms retaining the same auditor, represented by variable b2, is negative .03 and is significant at the .05 level. all other variables in the model are not significant at conventional levels. results indicate that for both variables, b1, and b2, significant information content is present when correlating to stock prices. however, investors perceive the two scenarios differently. for those firms emerging from chapter 11 with different auditors, a positive relationship exists between the earnings response coefficient and security prices, potentially signaling a positive change in direction of the firm, thus supporting the findings of smith and nichols (1992). for firms emerging from volume 34, number 2 87 chapter 11 with the same auditor, a negative relationship exists between earnings response coefficient and security prices. an interpretation may be that the firm has been perceived as not moving past status quo. regardless of the reason, the first hypothesis which states that there is no significant difference in the security price of firms, within the first quarter of emerging from chapter 11, regardless of whether or not the same auditor is retained or changed to a new auditor, must be rejected. in addition, whenever regression variables are employed, there is a probability of the presence of multicollinearity within the set of independent variables which may be problematic from an interpretive perspective. to assess the presence of multicollinearity, the variance inflation factor (vif) is utilized. values of vif exceeding 10 are often regarded as indicating multicollinearity. in the test of hypothesis 2, a vif of 2.5 is observed, thus indicating a non-presence of significant multicollinearity. table 3 test of hypothesis one-post sox analysis of emerging from chapter 11 model:�𝐶𝐴𝑅𝑖𝑡=𝑎+𝑏1𝑈𝐸𝑆𝑖𝑡+𝑏2𝑈𝐸𝑅𝑖𝑡+𝑏3𝑀𝐵𝑖𝑡+𝑏4𝐵𝑖𝑡+𝑏5𝑀𝑉𝑖𝑡+𝑏6𝐸𝑖𝑡+ 𝑏7𝐷𝑖𝑡𝑒𝑖𝑡 + eit a b1 b2 b3 b4 b5 b6 b7 adjusted r2 .06 .13 -.03 .29 .11 .09 .11 .23 .238 (.58) (2.27)*** (1.68)** (.48) (.33) (.29) (.31) (.45) b1 = all post sox firms in sample switching auditors after emerging from chapter 11 (n=115) b2 = all post sox firms in sample retaining auditors after emerging from chapter 11 (n=83) ***significant at the .01 level **significant at the .05 level table 4 provides results of assessing all pre sox firms in the sample that switch auditors subsequent to emerging from chapter 11 versus those which retain the same auditor prior to chapter 11 filing. the erc associated with the firms switching auditors, represented by variable b1, is positive .08 and is significant at the .01 level. the erc associated with firms retaining the same auditor, represented by variable b2, is positive .04 and also is significant at the .01 level. all other variables in the model are not significant at conventional levels. results indicate that for both variables, b1, and b2, significant information content is present when correlating to stock prices. in addition, investors perceive the two scenarios as not being significantly different. unlike the results in the post 88 journal of business strategies sox environment, investors seem to place little significance associated with auditor changes after emerging from chapter 11 in a pre sox environment. hypothesis two, that states that there is no significant difference between these two periods, cannot, therefore be rejected. to assess the presence of multicollinearity, the variance inflation factor (vif) is utilized. values of vif exceeding 10 are often regarded as indicating multicollinearity. in the test of hypothesis 2, a vif of 2.7 is observed, thus indicating a non-presence of significant multicollinearity table 4 test of hypothesis two-pre sox analysis of emerging from chapter 11 model:�𝐶𝐴𝑅𝑖𝑡=𝑎+𝑏1𝑈𝐸𝑆𝑖𝑡+𝑏2𝑈𝐸𝑅𝑖𝑡+𝑏3𝑀𝐵𝑖𝑡+𝑏4𝐵𝑖𝑡+𝑏5𝑀𝑉𝑖𝑡+𝑏6𝐸𝑖𝑡+𝑏7𝐷𝑖𝑡𝑒𝑖𝑡 + eit a b1 b2 b3 b4 b5 b6 b7 adjusted r2 .09 .08 .04 17 .19 .05 .07 .18 .214 (.32) (2.19)*** (2.29)*** (.27) (.41) (.22) (.24) (.40) b1 = all pre sox firms in sample switching auditors after emerging from chapter 11 (n=50) b2 = all pre sox firms in sample retaining auditors after emerging from chapter 11 (n=54) *** significant at the .01 level table 5 indicates the one-way anova results for the two groups analyzed (i.e. pre and post sox samples). the one-way anova test indicates an f-ratio of 23.614 with an associated p-value of .0000. when the levene test is performed to assess for homogeneity of variance, a levene statistic of 6.7719 is obtained with a significance level of .001. this test indicates significant differences in the variances of the groups. because the variances of the groups are not equal, there exists violation of the assumption of homogeneity across the samples. in order to account for this, the welch’s test is performed. this test assesses significance between groups when variances do not equal. based on the welch’s test, and as indicated in table 5, a t-statistic of 1.750 is computed with a p-value of less than .025. this indicates that the means of the sample groups are significantly different, and thus the null hypothesis of similarity between the groups is rejected. in addition, close analysis of table 5 indicates that the average composite change in stock price for the pre sox sample is +10.669, the respective change for volume 34, number 2 89 the post sox sample is +5.115. this indicates that stock price swings are nearly double in a pre sox environment. in addition, the variance in the stock movements for pre sox firms is approximately half of that for the post sox firms studied, indicating the potential for less risk in the pre sox environment. table 5 test of hypothesis threeone way anova test pre versus post sox samples groups count sum average variance pre sox firms 104 1109.5 10.669 6.228719 post sox firms 198 1012.9 5.115 13.289172 source of variation ss df ms f-ratio p-value between groups 2517.158 1 426.691 23.614 .0000 within groups 988.621 301 3.327 total 3507.881 302 levene statistic df1 df2 two-tail significance 6.7719 1 301 .001 t-stat df p-value welch’s t-test 1.750 1<.025 tables 6 and 7 provide results of assessing post sox firms in the sample by industry membership. table 6 presents results, by industry, of variable b1-firms switching auditors subsequent to emergence from chapter 11. results indicate that the ercs associated with each industry sample are positively related to security prices and are significant at conventional levels. the association between earnings response and security price seems to be stronger for growth industry firms (i.e. technology, healthcare, oil/gas and banking/finance). with respect to firms retaining the same auditor after emergence from chapter 11 (b2 variable), table 7 indicates that the ercs are predominantly negative. the exceptions are the growth industry firms in technology, healthcare, and oil/ gas. these results further detail the findings of hypothesis one and pinpoint those industries which are more likely to be perceived from a negative security price perspective after recovering from chapter 11. table 7 indicates that there is no real consistency among industry firms when the auditor is retained after chapter 11 emergence, except that high growth industry firms may possess a greater advantage 90 journal of business strategies over low growth industry firms, most likely as a result of their inherent growth component. as a result, hypothesis four which states that there is no significant post sox industry difference in the security price of firms, within the first quarter of emerging from chapter 11, regardless of whether or not the same auditor is retained or changed to a new auditor, must be rejected. in addition, the variance inflation factor (vif) is assessed in each of the regressions run for this hypothesis test. in each case, the vif is found to be below 3, indicating a non-presence of significant multicollinearity. table 6 test of hypothesis four auditor switching firms by industry, b1 variable-post sox model: car=𝑎+𝑏1𝑈𝐸𝑆𝑖𝑡+𝑏2𝑈𝐸𝑅𝑖𝑡+𝑏3𝑀𝐵𝑖𝑡+𝑏4𝐵𝑖𝑡+𝑏5𝑀𝑉𝑖𝑡+𝑏6𝐸𝑖𝑡+𝑏7𝐷𝑖𝑡+eit industry n erc p-value technology 6 .25 1.62*** healthcare 9 .19 1.59*** oil/gas 11 .38 1.67*** banking/finance 15 .17 1.89** utilities 17 .08 1.78** real estate 16 .05 2.19* transportation 14 .12 2.25* industrials 27 .03 2.38* *** significant at the .01 level ** significant at the .05 level * significant at the .10 level volume 34, number 2 91 table 7 test of hypothesis four auditor retaining firms by industry, b2 variable-post sox model: car=𝑎+𝑏1𝑈𝐸𝑆𝑖𝑡+𝑏2𝑈𝐸𝑅𝑖𝑡+𝑏3𝑀𝐵𝑖𝑡+𝑏4𝐵𝑖𝑡+𝑏5𝑀𝑉𝑖𝑡+𝑏6𝐸𝑖𝑡+𝑏7𝐷𝑖𝑡 + eit industry n erc p-value technology 8 .06 1.67*** healthcare 7 .03 1.85** oil/gas 9 .02 1.91** banking/finance 11 -.01 2.32* utilities 13 -.02 1.82** real estate 8 -.04 2.02* transportation 9 -.01 1.76** industrials 18 -.10 1.66*** *** significant at the .01 level ** significant at the .05 level * significant at the .10 level tables 8 and 9 provide results of assessing pre sox firms in the sample by industry membership. table 8 presents results, by industry, of variable b1-firms switching auditors subsequent to emergence from chapter 11. results indicate that the ercs associated with each industry sample are positively related to security prices and are significant at conventional levels. results appear consistent, regardless of industry membership. with respect to firms retaining the same auditor after emergence from chapter 11 (b2 variable), table 9 indicates that the ercs are again positively related to security prices. there also appears to be little variation in significance in this sample, regardless of industry membership. findings indicate that in a pre sox environment, industry memebership appears to be discounted when a firm emerges from chapter 11 regardless of whether or not the firm switches auditor. as a result, hypothesis five which states that there is no significant pre sox industry difference in the security price of firms, within the first quarter of emerging from chapter 11, regardless of whether or not the same auditor is retained or changed to a new auditor, cannot be rejected. 92 journal of business strategies in addition, the variance inflation factor (vif) is assessed in each of the regressions run for this hypothesis test. in each case, the vif is found to be below 3, indicating a non-presence of significant multicollinearity. table 8 test of hypothesis five auditor switching firms by industry, b1 variable-pre sox model: car=𝑎+𝑏1𝑈𝐸𝑆𝑖𝑡+𝑏2𝑈𝐸𝑅𝑖𝑡+𝑏3𝑀𝐵𝑖𝑡+𝑏4𝐵𝑖𝑡+𝑏5𝑀𝑉𝑖𝑡+𝑏6𝐸𝑖𝑡+𝑏7𝐷𝑖𝑡 + eit industry n erc p-value technology 2 .10 1.58*** healthcare 3 .07 1.64*** oil/gas 5 .09 1.66*** banking/finance 7 .05 1.57*** utilities 5 .09 1.60*** real estate 4 .07 1.69*** transportation 9 .04 1.55*** industrials 15 .06 1.61*** *** significant at the .01 level ** significant at the .05 level * significant at the .10 level volume 34, number 2 93 table 9 test of hypothesis five auditor retaining firms by industry, b2 variable-post sox model: car=𝑎+𝑏1𝑈𝐸𝑆𝑖𝑡+𝑏2𝑈𝐸𝑅𝑖𝑡+𝑏3𝑀𝐵𝑖𝑡+𝑏4𝐵𝑖𝑡+𝑏5𝑀𝑉𝑖𝑡+𝑏6𝐸𝑖𝑡+𝑏7𝐷𝑖𝑡 + eit industry n erc p-value technology 4 .05 1.77** healthcare 5 .06 1.82** oil/gas 6 .04 1.66*** banking/finance 5 .03 1.72** utilities 7 .05 1.66*** real estate 6 .02 1.69*** transportation 7 .05 1.71** industrials 14 .02 1.78** a significant at the .01 level b significant at the .05 level c significant at the .10 level conclusions this study analyzes firms that emerge from chapter 11 bankruptcy with specific attention given to two groups; those that switch auditors post-bankruptcy, and those who retain previous auditors in a post-bankruptcy environment. in addition, further analysis is made to assess whether or not industry membership, along with pre or post sox environment play a role in results. results indicate that when the pre versus post sox environment is assessed, a significant difference is noted in the sample firms. post sox firms emerging from chapter 11 that switch auditors carry positive information content, therefore, investors tend to bid up the price of stock of these firms. firms emerging from chapter 11 in a post sox environment that do not change auditors tend to convey negative information content as their stock price is bid down by investors. with respect to a pre sox environment, results indicate that investors do not behave significantly different whether the firms changes auditors or not after emerging from chapter 11. in both cases, positive information content is inferred by the bidding up of stock price. 94 journal of business strategies when attention turns to assessing individual industries, in a post sox environment, a positive correlation between earnings response and stock price is seen across all industries evaluated when the firm emerging from chapter 11 switches auditors. growth industry firms, namely; technology, healthcare, oil/ gas, and banking and finance seem to show the greatest stock price reaction to earnings. with respect to firms that do not switch auditors post-bankruptcy, results are mixed across industries. most industries show a negative stock price reaction but certain growth industries (i.e. technology, healthcare, and oil/gas) reflect a positive reaction. in a pre sox environment, no significant industry difference is noted, either by firms that switch auditors or those that do not. all pre sox industry firms, on average, have a positive correlation between earnings response and stock price. this study brings together previous bankruptcy and auditor switching research and interjects the differing environment between the pre and post sox era. operating in a post sox period, greater emphasis is placed on industry distinction when it comes to emerging from chapter 11. above average growth industry firms, generate greater positive investor reaction when an auditor switch is made while below average growth industry firms generate a greater negative investor reaction when an auditor switch is not made. these results are beneficial to managers, investors, and creditors associated with the affected industries. references aharony, j., c. jones, & j. swary (2010). an analysis of corporate bankruptcy using capital market data. the journal of finance, 55(4), 1001-1016. ajinkya, b., r. atiase, & m. gift (1991). volume of trading and the dispersion in financial analysts’ earnings forecasts, the accounting review 66, 389-401. american institute of certified public accountant (aicpa) (1988). institution of the public company accounting oversight board, new york, 1-23. asthana, s., s. balsam, & j. krishnan (2010). corporate governance, audit firm reputation, auditor switches, and client stock price reaction, international journal of auditing, vol 14 (3), 274-293. baginski, s., & j. hassell (1990). the market interpretation of management earnings forecasts as a predictor of subsequent financial analyst forecast revision, the accounting review 65, 175-190. ball, r., & p. brown (1968). an empirical evaluation of accounting income numbers, journal of accounting research, (autumn) 159-178. volume 34, number 2 95 baron, r., & d. kenny (1986). the moderator-mediator variable distinction in social psychological research: conceptual, strategic, and statistical considerations, journal of personality and social psychology, vol. 51, no. 6, 1173-1182. beaver, w, r. clarke, & w. wright (1979). the association between unsystematic security returns and earnings forecast errors, journal of accounting research (autumn), 316-340. bradley, m., & m. rosenzweig (1992). the untenable case for chapter 11, yale law journal, 101, 1043-1089. carcello, j., & t. neal (2003). audit committee characteristics and auditor dismissals following new going concern reports. the accounting review, 78(1), 95-117. chang, h., a. cheng, and k. reichelt (2010). market reaction to auditor switching. journal of practice and theory, 29(2), 83-114. chow, c., & s. rice (1982). qualified audit opinions and auditor switching. the accounting review, 57 (april), 326-335. collins, d., & s. kothari (1994). lack of timeliness and noise as explanations for the low returnearnings associations, journal of accounting and economics 18, 289-324. davidson, w., p. jiraporn, & p. dedatt (2006). causes and consequences of auditor shopping. quarterly journal of finance and accounting, 45 (winter), 69-87. eberhart, a., e. altman, & r. aggarwal (1999). the equity performance of firms emerging from bankruptcy. journal of finance, 54, 1885-1868. ettredge, m., c. li, & s. scholz (2007). audit fees and auditor realignments. accounting horizons, 21(4), 371-386. ferris, s., n. jayaraman, & a. makhija (1997). the response of competitors to announcements of bankruptcy: an empirical examination of competitive effects. journal of corporate finance, 3, 367-395. fried, d., & a. schiff (1981). cpa switches and associated market reactions. the accounting review, 56 (april), 326-342. fries, s., m. miller, & w. perraudin (2015). debt in industry equilibrium, the review of financial studies, 10 (1), 39-67. geiger m, k. raghunandan, & d. rama (2005). recent changes in the association between bankruptcies and prior audit opinions. audit practice and theory, 24(1), 21–35. johnson, w., & t. lys (1990). the market for audit services: evidence from voluntary auditor changes. journal of accounting and economics, 12 (january), 281-308. klock, m. (2004). the stock market reaction to a change in certifying accountant. auditing and finance, 9(2), 339-347. 96 journal of business strategies krishnan, j., & j. krishnan (2007). litigation risks and auditor resignations. the accounting review, 72 (october), 539-560. lang, l., & r. stulz (1992). contagion and competitive intra-industry effects of bankruptcy announcements. journal of financial economics 32, 45-60. lev, b. (1989). on the usefulness of earnings and earnings research, journal of accounting research 27, 153-192. mackay, p., & g. phillips (2015). how does industry affect firm financial structure? the review of financial studies, 18 (4), 1433-1466. schwartz, k., & k menon (1985). auditor switches by failing firms. the accounting review, 60 (april), 248-261. sinha, p, l. brown, & s. das (2015). “a re-examination of financial analysts’ differential earnings forecast accuracy,” contemporary accounting research, 30-44. smith, d., & d. nichols (1992). a market test of investor reaction to auditor disagreements. journal; of accounting and economics, 4(2), 109-120. stunda, r. (2012). auditor switches in a post-sox environment, does the change in auditor mean a change in stock price? journal of business and behavioral sciences, 24(3), 58-69. truman, c., & m. weinstein (1983). the behavior of the bankrupt firm. the journal of finance, 38(3), 489-504. biographical sketch of author dr. ron stunda is professor of accounting and department chair at valdosta state university in valdosta, georgia. his primary area of interest is market-based financial accounting. he has published in numerous accounting and finance journals and is a reviewer and editorial board member of several academic journals. volume 40(1) p.21-36 received: july 30, 2022 revision received: october 28, 2022 accepted: october 31, 2022 https://doi.org/10.54155/jbs.40.1.21-36 personal and social determinants of fear of missing out (fomo) in younger consumers timothy h. reisenwitza, jie g. fowlerb a corresponding author. department of management and marketing, valdosta state university, valdosta, georgiatreisenw@valdosta.edu b department of management and marketing, valdosta state university, valdosta, georgia jgfowler@valdosta.edu abstract this study expands the exploration of a consumer behavior concept that has received considerable attention recently: the fear of missing out (fomo). several variables were analyzed in terms of their potential influence on fomo: social media usage, self-concept, social identity, smartphone usage, innovativeness, and gender. the study builds upon the premise that the construct has two distinct components: a personal dimension and a social dimension. the importance of these results is discussed in terms of advancing fomo theory as well as assisting practitioners in directing their promotional efforts. keywords fear of missing out (fomo), younger consumers, personal dimension of fomo, social dimension of fomo 1. introduction an emerging concept in consumer behavior is the fear of missing out (fomo). it was introduced in academia by herman (2000) who offered it as an explanation for the success of limited-edition brands. fomo was later introduced by the news media (columnist, 2010; fake, 2011). however, the concept has been present throughout history in any communication form that increases a consumer’s knowledge about his or her friends, family, or even strangers. these communication forms include newspapers, letters, annual holiday newsletters, and emails (wortham, 2011). however, more recently its influence has greatly expanded via the context of social media marketing. fomo is the feeling of being “left behind” when someone sees that peers own or experience something that seems rewarding that he or she is not owning or experiencing. researchers have provided many definitions of fomo (see table 1). according to zhang et al. (2020), the construct has two components, particularly when following a self-concept approach: the private self and/or the public self or a personal and/or a social dimension. fomo is characterized as an uneasy feeling, a feeling of anxiety. so, consumers can fear missfunding for this research was provided by a steele foundation summer grant. this work is licensed under a creative commonsattribution-noncommercial 4.0 international license. © 2023 the authors. https://doi.org/10.54155/jbs.40.1.21-36 treisenw@valdosta.edu jgfowler@valdosta.edu reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 22 ing out on experiences that other people enjoy (social fomo) and can also fear missing out on experiences they had wished for themselves (personal fomo). the purpose of the study is to assess the influence of variables on the fear of missing out (fomo). much of the previous research on fomo has examined variables individually and how each influences fomo. this study addresses multiple variables and how they influence fomo. the study also assesses the efficacy of the two-component depiction of the fomo construct based upon the self-concept approach introduced by zhang et al. (2020). 2. literature review and theoretical framework of fomo past studies show that fear illustrates how social power is constituted, legitimated, and communicated through media logic with mediated formats guiding the use of technology (altheide, 2013). fear is an emotion resulting from perceived threats to one’s well-being (gill & burrow, 2018). threats involve adverse outcomes that the individuals want to terminate, escape from, or avoid (gray, 1971). the concept of fomo was first introduced by herman (2000) as a potential explanation for the success of limited edition brands. he argues that when consumers feel incapable of exhausting all the options of products in the marketplace, they become fearful about the risk of possibly missing desirable opportunities. thus, fomo increases consumers’ urgency to exhaust all available offerings, especially those that are scarce. as a result, fomo could be a powerful motivation to encourage buying (herman, 2000). in consumer psychology, the fomo phenomenon has been defined as a pervasive apprehension that others might be having rewarding experiences from which one is absent and is characterized by the desire to stay continually connected with what others are doing (przybylski et al., 2013). in other words, fomo refers to the anxiety social media users feel when they perceive their peers are doing, experiencing, or possessing something rewarding while they are not (przybylski et al., 2013). research has explored the prevalence of fomo and its relation to social media (abel et al., 2016). a recent study by alt (2015) finds a positive link between social media engagement and fomo. in fact, social media users have grown exponentially in the past decade. in 2021, over 4.26 billion people were using social media worldwide, a number projected to increase to almost six billion in 2027 (statista, 2022). college students are the heaviest social media users (alt, 2015). smartphone penetration is believed to be one of the dominating forcesdrivingsocialmediausage(swar&hameed, 2017). research has shown that the excessive use of smartphones links to adverse outcomes, such as smartphone addiction (aljomaa et al., 2016; lee et al., 2014). in addition, the research examines the conceptual background of fomo with offline consumer behavior. zhang et al. (2020) propose a theoretical foundation for fomo by following a self-concept approach. they posit that consumers experience fomo when they perceive that missing experience poses a psychological threat to the private and/or public self. the private self refers to the evaluation of oneself (e.g., self-identify or membership), and the public self is the projection of others’ view of oneself (e.g., self-concept/feeling of the self). finally, zhang et al. (2020) indicate novelty seeking or innovativeness may be a variable associated with fomo. recent research also shows that fomo may be multidimensional (zhang et al., 2020) and that fomo involves two dimensions: a personal fomo and a social fomo. accordingly, a new scale was developed, offering researchers to further test the concept of fomo and related variables. to conclude, many variables may activate fomo. fomo may be activated by threats to the selfconcept (zhang et al., 2020). consumers tend to purchase goods and services that are consistent with or enhance, their self-concept. consumers may perceive that missing out on experiences may be inconsistent with their self-concept. furthermore, higher social media engagement may activate fomo (alt, 2015), although the construct has been found in non-online contexts as well, includreisenwitz & fowler/ journal of business strategies (2023) 40:21-36 23 table 1: previous definitions of fear of missing out (fomo) author (year) definition jwt intelligence inprzybylski et al.(2013) the uneasy and sometimes all-consuming feeling that you are missing out,that your peers are doing something, are in the know about, or in posses-sion of more of something better than you. przybylski et al.(2013) a phenomenon characterized by the desire to stay continually connectedwith what others are doing and a pervasive apprehension that others mightbe having rewarding experiences from which one is absent. gil et al. (2015) fear of missing out is a concept that aims to describe the feeling that some-thing is happening on social networks and you are not part of it. riordan et al. (2015) the uneasy and often all-consuming sense that “friends or others are hav-ing rewarding experiences from which one is absent.” salem (2016) a kind of anxiety, a sense that you will be inadequate or left behind if youdon’t react. abel et al. (2016) fomo is comprised of irritability, anxiety, and feelings of inadequacy, withthese feelings tending to worsen when an individual logs on to social mediawebsites. (zhang et al., 2020) ing smartphone overuse (elhai et al., 2016). those consumers who are considered innovators (early users) in the product adoption process may also significantly impact fomo (manning et al., 1995). finally, higher degrees of social identity in consumers may also influence fomo (reed, 2002). social media usage it is well-documented that those with a high dependence on social media also have a high level of fomo (argan & tokay argan, 2020; asif, 2020; classen et al., 2020; kang et al., 2020; przybylski et al., 2013). so, social media services such as instagram, youtube, facebook, twitter, and tiktok may be especially attractive for those who fear missing out. furthermore, there are positive and negative consequences of this attraction. on a positive note, social media are excellent for those who are seeking social connection and may provide greater social involvement. knowing what friends and family are doing and buying is beneficial for connection and interaction. however, time is a scarce commodity and so the negative result is missing out on some of the activities found via social media. so, unfortunately, social media and a fear of missing out may result in overall unhappiness. feelings of irritability, anxiety (gray, 1971), and inadequacy can impact the fear of missing out and these may intensify when individuals view social media (abel et al., 2016). providing the ability to see others’ updates inreal-time, socialmediaallowsconsumerstoconstantlyseewhattheymaybemissingouton, possibly resulting in dissatisfaction, anxiety, and unworthiness (abel et al., 2016). elhai et al. (2016) state that fomo can drive the overuse of social media. in sum, social media is “kerosene on fomo’s fire” (miller, 2012, p.2). based on this discussion, the following hypothesis is proposed: hypothesis 1a. individuals exhibiting greater social media usage will have a greater personal fear of missing out. hypothesis 1b. individuals exhibiting greater social media usage will have a greater social fear of missing out. self-concept sirgy (1982) first suggested that some purchase decisions can be affected by a consumer’s selfconcept. he stated that self-concept is the sum reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 24 of an individual’s thoughts and feelings about himself or herself relative to other objects. consumers generally have favorable attitudes towards products and brands that are consistent with their self-concept and less favorable attitudes towards products and brands perceived to be inconsistent with their self-concept (graeff, 1996). furthermore, zhang et al. (2020) proposed that fomo, “is the fear an individual feels from missing out on an experience that can enhance or maintain her/his self-concept” (p. 1630). although they can overlap, zhang et al. (2020) posit that there are two major types of selfconcept: a private self and a public self. the private self refers to thoughts that the individual does not share with others or perhaps a small group of people. these thoughts include reflections, daydreams, or fantasies that can be satisfied through a consumption experience, which would maintain or enhance their private selfconcept. most research dealing with fomo has focused on the public self, which is based upon what other people are doing or saying, fueled largely by social media. what people say on social media, whether discussing others or discussing events, can intensify fomo (zhang et al., 2020). based on this discussion, the following hypothesis is proposed: hypothesis 2a. individuals with a greater selfconcept will have a lower personal fear of missing out. hypothesis 2b. individuals with a greater selfconcept will have a lower social fear of missing out. social identity social identity theory divides self-concept into two categories: personal identity, or how people view themselves, and social identity, or collective identity, which refers to how they view their social groups (dutot, 2020). additionally, social identity theory shows the importance of social group memberships to individuals’ self-concept (dutot, 2020). similarly, duman and ozkara (2021) state that social identity is a part of self-concept that comes from the knowledge that an individual belongs to a social group(s) coupled with the value and emotional significance of that membership. based on this discussion, the following hypothesis is proposed: hypothesis 3a. individuals exhibiting greater social identity will have a greater personal fear of missing out. hypothesis 3b. individuals exhibiting greater social identity will have a greater social fear of missing out. smartphone usage the mental disorders associated with excessive smartphone use have been well-documented, including depression, anxiety, sleeping issues (demirci et al., 2015), stress, depression, and suicidal ideation (kim et al., 2019). people high in fomo overuse their smartphones in order to stay connected. elhai et al. (2016) found that excessive smartphone use was associated with anxiety, the need for touch, and fomo. additionally, fomo was the variable that was most related to excessive smartphone use on a bivariate and multivariate basis. fomo and the need for touch were significant predictors of dysfunctional smartphone use. furthermore, both elhai et al. (2016) and przybylski et al. (2013) found that fomo is a discriminating variable between problematic and non-problematic smartphone use. based on this discussion, the following hypothesis is proposed: hypothesis 4a. individuals exhibiting greater smartphone usage will have a greater personal fear of missing out. hypothesis 4b. individuals exhibiting greater smartphone usage will have a greater social fear of missing out. innovativeness innovativeness is the degree to which an individual adopts a new idea faster than others (vandecasteele & geuens, 2010). rogers (1995) introduced the diffusion of innovations model, which grouped adopters of innovations based on the time of adoption. the two earliest groups in the reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 25 model are innovators and early adopters (girardi & chiagouris, 2018). early adopters connect the innovators with the mass groups of adopters, the early majority and the late majority. innovators and early adopters are both depicted as having a high degree of innovativeness. clark and goldsmith (2006) report that academicians contend that innovators prefer to use nonpersonal sources of information versus interpersonal sources of information when making new product purchase decisions. in other words, innovativeness has been shown to be more closely associated with opinion leadership than opinion seeking: “innovativeness is the degree to which an individual makes innovation decisions independently of the communicated experience of others” (midgley & dowling, 1978, p. 235). they use nonpersonal sources, such as mass media versus interpersonal sources, such as social media. this discussion of innovativeness and the behavior of innovators runs counter to the concept of fomo, in which consumers place great importance on knowing what others are doing. although communicating with innovators is a critical requirement for the acceptance of an innovation and its diffusion, it can be concluded based on the literature that those with a high fomo are not part of the innovator group. therefore, the following hypothesis is proposed: hypothesis 5a. individuals exhibiting greater innovativeness will have less personal fear of missing out. hypothesis 5b. individuals exhibiting greater innovativeness will have less social fear of missing out. gender knowledge involving gender differences may be useful for fomo research in order to control potential gender effects. however, previous research provides mixed results regarding the relationship between gender and fomo. przybylski et al. (2013) and qutishat (2020) found that young males tended to have higher levels of fomo than females. in contrast, beyens et al. (2016) and stead and bibby (2017) found that females reported higher levels of fomo than males. moreover, rozgonjuk et al. (2021) found no significant gender differences in experiencing fomo. therefore, the following hypothesis is proposed: hypothesis 6a. there are no gender differences regarding the personal fear of missing out. hypothesis 6b. there are no gender differences regarding the social fear of missing out. 3. method the sample consisted of undergraduate students, alumni, and non-students belonging to either generation y or generation z. the questionnaire was sent via a university “student announcements” email. any completed questionnaires that were outside of the age range of the latter two generational cohorts (generation y, 1981-1996, and generation z, 1997-2012) were omitted from the sample. although a convenience sample, these respondents are appropriate for the study since fomo is more evident in young people (zhang et al., 2020). similarly, przybylski et al. (2013) found that younger consumers had higher levels of fomo, concurring with early industry reports that fomo was more prevalent in younger people (jwt, 2011, 2012). respondents were introduced to the study in the body of the email and then asked to click on the link that would take them to the qualtrics questionnaire. the questions capture the respondents’ demographics (age, race, education, occupation, religion, etc.) and psychographic information, which focused on the variables in the hypotheses. a pretest was conducted before the questionnaire was distributed to the main sample. the questionnaire was completed by six undergraduate students who were currently enrolled in at least one class. an additional questionnaire was sent to a recent alumnus who was named “student of the year” for the university’s college of business. no problems were reported by anyone taking the pretest questionnaire. as a result, no changes were made to the questionnaire before its administration to the main sample. reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 26 the total number of questionnaires received over a two-week period, with a one-week reminder email after the first week, was 280. since the focus of the study is younger consumers, only those respondents in generation y (millennials) or generation z were retained, leaving a total of 229 respondents. next, questionnaires with a significant amount of missing data were eliminated, leaving a total of 225 for the final sample size. the final sample’s demographics were analyzed. the profile emerged that the typical respondent is described as the following: female (73%), a member of generation z (63%), has an income of $010,000 (55%), has never married (79%), is white (caucasian) (58%), has completed an undergraduate degree (45%), and is a student (59%). the complete demographic data is presented in table 2. scales existing multiple-item scales will be used for each of the psychographic variables or constructs that may have an impact on fomo. they will be included as independent variables in a multiple regression analysis with fomo as the dependent variable. social media usage rapp et al. (2013) created this scale, consisting of ten, seven-point items from “strongly disagree” to “strongly agree” to measure how much someone uses social media to stay current with brands, retailers, and consumers. three statements were removed due to their context-specificity. the last question was changed from “retail stores” to “retailers” to accommodate online sellers. self-concept the six-item, seven-point semantic differential scale was created by de angelis et al. (2012) (bruner, 2016). it is intended to measure how one feels about himself or herself. social identity the social identity scale was created by narioredmond et al. (2004). there are eight items on a seven-point scale from “not at all important to who i am” to “extremely important to who i am.” it was reduced from a nine-point to a seven-point scale forconsistency withthe other psychographic measures in this study. social identity was defined for the respondent as how an individual is identified by his or her group memberships. smartphone usage the smartphone usage scale was used in several studies (cheever et al., 2014; hoffner & lee, 2015; smith, 2015). the scale was expanded from six to seven points for consistency across scales in this study. it consists of 11 items on a “never” to “very often” scale. respondents who did not own a smartphone were instructed to skip these questions. innovativeness the scale used for innovativeness was based upon the notion that a consumer’s level of innovativeness is domain-specific, i.e., it is based upon a product category (klink & athaide, 2010). the other forms of consumer innovativeness are consumer innate innovativeness (cii) and vicarious innovativeness (vi) (chao et al., 2012). prior research shows that the relationship between consumer innate innovativeness and new product adoption is weak and inconsistent. and although it has been shown that mass media and wordof-mouth influence new product adoption, few researchers have used vicarious innovativeness (chao et al., 2012). the innovativeness scale in this study was used by shalev and morwitz (2012). bruner (2016) reported that the scale was actually developed by shalev. it was domain-specific and used the product category of high-technology products. shalev and morwitz (2012) justified using the category based on the fact that younger consumers tend to be innovators of high-technology products. the scale was a ten-item, seven-point likert “strongly disagree” to “strongly agree” measure. fomo the scale used for fomo was developed by zhang et al. (2020). they proposed that fomo has two components: personal fomo, related to the private self, and social fomo, related to the public self. their analysis treated fomo as a feeling that individuals can experience not only online, especially via social media, but also offline. the scale was a seven-point likert scale from “strongly disagree” to “strongly agree.” it consisted of five items to measure the personal fomo dimension reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 27 table 2: descriptive information of the sample items percent (n) gender male 24 (54)female 73 (164)non-binary/ third gender 3 (6) birth year 1981 1996 37 (83)1997 2012 63 (142) income 0-10k 55 (124)10,001 30k 20 (46)30,001 50k 12 (27)50,0001 70k 7 (15)above 70k 5 (12) marital status married 18 (40)widowed 1 (3)divorced 1 (2)separated 1 (2)never married 79 (178) race white(caucasian) 58 (131)black 27 (60)hispanic 6 (14)asian american 3 (7)pacific islander 1 (2)other 6 (13) educ completed ged & high school 36 (81)undergraduate 45 (101)graduate 13 (29)other 6 (13) occupation student 59 (133)homemaker/not employed 2 (5)self-employed 1 (3)educator 5 (11)professional 8 (18)work for company/business 22 (49)other 3 (6) percentages may not total 100 due to missing data or may exceed 100 due to rounding reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 28 and four items to measure the social fomo dimension. 4. results reliability coefficients were computed for each of the scales (table 3a and 3b). all coefficient alphas were above the 0.70 value recommended by nunnally (1978). in this analysis, the independent variables consisted of social media usage, selfconcept, social identity, smartphone usage, and innovativeness; the dependent variable was fear of missing out (fomo). since the study focuses on both personal and social aspects of fomo, fomo was treated as two dependent variables, i.e., fomopersonal and fomosocial. according to the analysis, the independent variables have a relationship to personal fomo, i.e., fomopersonal (f = 9.746, p < 0.001) (see table 4, table 5). as hypothesized, social media usage has a positive influence on fomopersonal (β = 0.208, t = 2.713, p < 0.05) (h1a). moreover, individuals with greater self-concept are negatively associated with fomopersonal (β = -0.39, t = -5.852, p < 0.05) (h2a). in addition, the analysis shows smartphone usage has a positive impact on fomopersonal (β = 0.174, t = 2.493, p < 0.05) (h4a). yet, neither social identity (h3a) nor innovativeness (h5a) are associated with fomopersonal (β = -0.115, t = -1.562, p > 0.05) (β = -0.118, t = -1.679, p > 0.05). furthermore, the results show that self-concept is significant with a negative impact on fomosocial (β = -0.482, t = -7.503, p < 0.05) (h2b) (see table 6, table 7). also, there were no gender differences in relation to fomo (tpersonal = -0.72, p > 0.05; tsocial = 0.475, p > 0.05) (h6a), (h6b). 5. discussion fomo is an emerging topic in consumer psychology, which is a feeling of being “left behind” (salem, 2016). it generally relates to technological advancements, such as social media and smartphone usage. according to zhang et al. (2020), fomo not only refers to the fear of missing out on experiences other people may enjoy but also the feeling of missing out on experiences they had wished for themselves. therefore, fomo tends to be activated by psychological threats to the selfconcept. it is often a result of threats to the public and/or private self. this study contributes to fomo theory by examining the personal and social aspects of fomo. specifically, it explores possible connections between social media, smartphone usage, innovativeness, social identity and self-concept, and fomo. it also supports the lack of gender difference in relation to fomo. as przybylski et al. (2013) posit, social media can be “thought of as reducing the ‘cost of admission’ for being socially engaged” (p. 1841). yet, it was found that the use of technology, such as social media engagement and smartphone usage, has an impact on the personal dimension of fomo but does not have an impact on the social dimension of fomo, indicating that technology may have a more significant effect on personal fomo than social fomo. the non-significant results for social fomo may indicate that ultimately consumers will engage in activities or purchase products that are right for them versus right for their social group(s). to concur with earlier research, the analysis shows that individuals with greater self-concept tend to exhibit less personal fomo or social fomo. individuals with a confident “self” are less likely to be fearful. the results also reveal that innovativeness and social identity are not related to either personal fomo or social fomo. finally, there was a non-significant difference between gender and fomo. this finding may reflect the gender roles among generation z. generally speaking, generation z favors gender role flexibility and is less in favor of the patriarchy (lampert, 2021). theoretical and practical implications this study aimed to examine the relationship between the two dimensions of fomo and the“self” andtoevaluatetherelevantliterature. specifically, the study contributes to theory by supporting the self-concept view of fomo proposed by zhang et al. (2020), which differentiates the personal and reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 29 table 3a: reliability coefficients items coefficient alpha social media usage 0.90i use social media to follow sales and promotions.i use social media to monitor events.people use social media to reach me.i use social media to improve my relationship with different brands.i use social media to communicate with retailers.i use social media to improve my relationship with retailers.my relationship with my retail stores is enhanced by social media. self-concept 0.95unsatisfied with yourself satisfied with yourselfnot proud of yourself proud of yourselffeel bad about yourself feel good about yourselffeel unsuccessful feel successfulnot confident about yourself confident about yourselffeel worthless feel like a person of worth social identity 0.83the similarity i share with others in my group(s)my family nationality or nationalitiesthe memberships i have in various groupsthe places where i have livedmy sense of belonging to my own racial groupmy gender groupthe color of my skinmy being a citizen of my country smartphone usage 0.81video and voice calls (making and receiving)text/instant messaging (sending and receiving)email (sending and receiving)social networking sitesinternet/websitesgamesmusic/podcasts/radiotaking pictures or videoswatching videos/tv/moviesreading books/magazinesmaps/navigation reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 30 table 3b: reliability coefficients items coefficient alpha innovativeness 0.95in general, i am among the first in my circle of friendsto buy a new high-tech product when it appears.if i heard that a new high-tech product was available,i would be interested enough to buy it.i am usually one of the first people to know about new high-tech products.i will buy a new high-tech product even if i haven’t tried it yet.i actively try to learn about new high-tech products.i generally keep up on high-tech products news and events.i consider myself very up-to-date when it comes to high-tech products.in general, i have a strong interest in high-tech products.high-tech products are a very important product category to me.high-tech products matter to me a lot. personal fomo 0.90i feel anxious when i do not experience events/opportunities.i believe i am falling behind compared with others when imiss events/opportunities.i feel anxious because i know something important or fun must happenwhen i miss events/opportunities.i feel sad if i am not capable of participating in events due to constraintsof other things.i feel regretful of missing events/opportunities. social fomo 0.93i think my social groups view me as unimportant when i missevents/opportunities.i think i do not fit in social groups when i miss events/opportunities.i think i am excluded by my social groups when i miss events/opportunities.i feel ignored/forgotten by my social groups when i miss events/opportunities. table 4: hypothesis testing for fomopersonal hypotheses results hypothesis 1a individuals exhibiting greater social media usage willhave a greater personal fear of missing out. accepthypothesis 2a individuals with greater self-concept will have less per-sonal fear of missing out. accepthypothesis 3a individuals exhibiting greater social identity will have agreater personal fear of missing out. rejecthypothesis 4a individuals exhibiting greater smartphone usage willhave a greater personal fear of missing out. accepthypothesis 5a individuals exhibiting greater innovativeness will haveless personal fear of missing out. rejecthypothesis 6a therearenogenderdifferencesregardingpersonalfearof missing out. accept reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 31 table 5: regression analysis for fomopersonal β standardized β t sig. (constant) 3.395 5.557 0.000social media usage 0.217 0.208 2.713 0.007self-concept/image -0.378 -0.390 -5.852 0.000social identity 0.133 0.118 1.679 0.095smartphone usage 0.276 0.174 2.493 0.013innovativeness -0.122 -0.115 -1.562 0.120 table 6: hypothesis testing for fomosocial hypotheses results hypothesis 1b individuals exhibiting greater social media usage willhave a greater social fear of missing out. rejecthypothesis 2b individuals with greater self-concept will have less socialfear of missing out. accepthypothesis 3b individuals exhibiting greater social identity will have agreater social fear of missing out. rejecthypothesis 4b individuals exhibiting greater smartphone usage willhave a greater social fear of missing out. rejecthypothesis 5b individuals exhibiting greater innovativeness will haveless social fear of missing out. rejecthypothesis 6b there are no gender differences regarding social fear ofmissing out. accept table 7: regression analysis for fomosocial β standardized β t sig. (constant) 3.746 5.645 0.000social media usage 0.169 0.144 1.945 0.053self-concept/image -0.526 -0.483 -7.503 0.000social identity 0.133 0.118 1.679 0.095smartphone usage 0.276 0.174 2.493 0.013innovativeness -0.122 -0.115 -1.562 0.120 reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 32 social aspects of fomo. table 5 and table 7 report the differences in regression analysis results between the personal dimension of fomo and the social dimension of fomo in regard to variables. the findings show that social media engagement and smartphone usage have a positive influence on the personal dimension of fomo, whereas selfconcept has a negative influence. the findings regarding social media and smartphone usage are consistent with previous research that fomo is related to the overuse of technology (e.g. elhai et al., 2016). in other words, for those who are afraid of missing out, social media and smartphones provide means to connect with others. fomo is an anxiety disorder that is defined as not being aware of exciting things when not being looked at, or missing out on the experiences of others. although the fomo effect has a negative meaning, businesses manage to use this concern to their advantage. for example, the results show that social fomo is associated with selfconcept. these findings may help social media marketers to identify fomo consumers based on the “self-concepts.” that being said, social media marketers may use selfies as an indicator of selfconcept on social media, thus finding insights into fomo consumers. additionally, limited production, shortage of products in stock, short-term discounts, showing the number of people interested in the same product, and promotions offered as opportunities not to be missed are among the efforts of businesses to persuade consumers through fomo. furthermore, the call to action (e.g., do not miss out, a one-day sales event) may likely be contingent on social media usage and smartphone use. digital marketers may use these “calls to action” to leverage more effective social media marketing campaigns. in particular, digital marketers may be able to incorporate consumers’ desires or fear as a motivational tool to purchase a product or seek out information. moreover, digital marketers may need to be aware that individuals exhibiting greater smartphone usage and more significant socialmediausehaveagreaterfearofmissingout. this finding indicates that marketers can use software to track the usage of screen time and identity a particular consumer group that is afraid of missing out. finally, the results show that gender and innovativeness have no impact on fomo, which offers marketers insights that gender and innovativeness are not the variables needed to be considered or focused on for market segmentation in the context of fomo in social media advertising campaigns. in sum, the fear of missing out on something can be a powerful emotion, and it is one that many individuals struggle with, especially members of gen z. this idea has been studied by various researchers who have found evidence supporting its validity as an explanation for why consumers select special editions over others (altheide, 2013). as a result, fomo may drive consumers to make impulsive buying decisions. thus, consumers should be aware of fomo in the context of social media promotion and be conscious of the consequences of fomo. a similar construct to fomo, cognitive dissonance, which has been described as post-purchase anxiety in non-routine purchases, is an undesirable consumer behavior condition that both marketers and consumers wish to minimize or eliminate. although fomo is similar to cognitive dissonance in that it is a form of consumer anxiety, it is actually a condition that can be advantageous to the marketer. for the marketer who wishes to leverage fomo as a promotional tool, a “don’t be left out” or “limited edition” approach may be prudent, specifically via social media and/or smartphone technology. limitationsanddirectionsforfutureresearch this study has some limitations. first, the sample, although representative of the target of younger consumers, was a convenience sample since an email list of students, alumni, and non-students of one university was used. second, the results regarding gender may have been compromised due to the groups being rather unbalanced, with the majority of the sample consisting of female respondents (73%). this shortcoming is often addressed in studies using panels and/or offering incentives for participation. additionally, this study has concluded that there are no gender differreisenwitz & fowler/ journal of business strategies (2023) 40:21-36 33 ences regarding fomo, concurring with some previous research. yet, due to inconsistencies in the results found in other studies, this finding may need to be validated in future research. fomo has often been seen as a novel phenomenon that emerged with the increasing popularity of social media. this is perhaps the first study to simultaneously investigate multiple variables, specifically, innovativeness, self-concept, and social identity with both dimensions of fomo. future research may investigate why technology has not had an impact on the social aspect of fomo. it is also worthwhile to examine why social identity is not related to fomo and why most of the results for fomosocial were non-significant. the fomo construct is based upon social relationships, so intuitively, those results were unexpected. researchers may further collect a nonstudent sample to compare generations y and z with the other generational cohorts, i.e., matures, baby boomers, and generation x. nevertheless, generation y and generation z may be important cohorts to target since younger consumers still use technology to a greater degree than older consumers (thanasrivanitchai et al., 2017). references abel, j. p., buff, c. l., & burr, s. a. (2016). social media and the fear of missing out: scale development and assessment. journal of business & economics research (jber), 14(1), 33–44. https://doi.org/ 10.19030/jber.v14i1.9554 aljomaa, s. s., al.qudah, m. f., albursan, i. s., bakhiet, s. f., & abduljabbar, a. s. (2016). smartphone addiction among university students in the light of some variables. computers in human behavior, 61, 155–164. https://doi.org/10.1016/j.chb.2016.03.041 alt, d. (2015). college students’ academic motivation, media engagement and fear of missing out. computers in human behavior, 49, 111–119. https://doi.org/10.1016/j.chb.2015.02.057 altheide, d. l. (2013). media logic, social control, and fear: media logic, social control, and fear. communication theory, 23(3), 223–238. https://doi.org/10.1111/comt.12017 argan, m., & tokay argan, m. (2020). share or worry! relationship among fomo, social visibility and conspicuous sharing. journal of internet applications and management, 11(2), 63–80. asif, s. (2020). herd consumption behaviour of indian youth towards luxury fashion brands: the mediating role of fomo. xi’an dianzi keji daxue xuebao/journal of xidian university, 14, 707–728. https: //doi.org/10.37896/jxu14.10/075 beyens, i., frison, e., & eggermont, s. (2016). “i don’t want to miss a thing”: adolescents’ fear of missing outanditsrelationshiptoadolescents’socialneeds,facebookuse,andfacebookrelatedstress. computers in human behavior, 64, 1–8. https://doi.org/10.1016/j.chb.2016.05.083 bruner, g. c. (2016). marketing scales handbook. 8: multi-item measures for consumer insight research / gordon c. bruner (2. edition). gcbii productions. chao, c.-w., reid, m., & mavondo, f. t. (2012). consumer innovativeness influence on really new product adoption. australasian marketing journal, 20(3), 211–217. https://doi.org/10.1016/j.ausmj. 2012.02.001 cheever, n. a., rosen, l. d., carrier, l. m., & chavez, a. (2014). out of sight is not out of mind: the impact of restricting wireless mobile device use on anxiety levels among low, moderate and high users. computers in human behavior, 37, 290–297. https://doi.org/10.1016/j.chb.2014.05.002 clark, r. a., & goldsmith, r. e. (2006). interpersonal influence and consumer innovativeness. international journal of consumer studies, 30(1), 34–43. https://doi.org/10.1111/j.1470-6431.2005. 00435.x classen, b., wood, j. k., & davies, p. (2020). social network sites, fear of missing out, and psychosocial correlates. cyberpsychology: journal of psychosocial research on cyberspace, 14(3). https://doi. org/10.5817/cp2020-3-4 https://doi.org/10.19030/jber.v14i1.9554 https://doi.org/10.19030/jber.v14i1.9554 https://doi.org/10.1016/j.chb.2016.03.041 https://doi.org/10.1016/j.chb.2015.02.057 https://doi.org/10.1111/comt.12017 https://doi.org/10.37896/jxu14.10/075 https://doi.org/10.37896/jxu14.10/075 https://doi.org/10.1016/j.chb.2016.05.083 https://doi.org/10.1016/j.ausmj.2012.02.001 https://doi.org/10.1016/j.ausmj.2012.02.001 https://doi.org/10.1016/j.chb.2014.05.002 https://doi.org/10.1111/j.1470-6431.2005.00435.x https://doi.org/10.1111/j.1470-6431.2005.00435.x https://doi.org/10.5817/cp2020-3-4 https://doi.org/10.5817/cp2020-3-4 reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 34 columnist, m. m., sf gate. (2010). oh my god you are so missing out. retrieved october 28, 2022, from https://www.sfgate.com/entertainment/morford/article/oh-my-god-you-are-so-missing-out2536241.php de angelis, m., bonezzi, a., peluso, a. m., rucker, d. d., & costabile, m. (2012). on braggarts and gossips: a self-enhancement account of word-of-mouth generation and transmission. journal of marketing research, 49(4), 551–563. https://doi.org/10.1509/jmr.11.0136 demirci, k., akgönül, m., & akpinar, a. (2015). relationship of smartphone use severity with sleep quality, depression, and anxiety in university students. journal of behavioral addictions, 4(2), 85–92. https://doi.org/10.1556/2006.4.2015.010 duman, h., & ozkara, b. y. (2021). the impact of social identity on online game addiction: the mediating role of the fear of missing out (fomo) and the moderating role of the need to belong. current psychology, 40(9), 4571–4580. https://doi.org/10.1007/s12144-019-00392-w dutot,v. (2020).asocial identityperspectiveofsocialmedia’s impactonsatisfactionwithlife.psychology & marketing, 37(6), 759–772. https://doi.org/10.1002/mar.21333 elhai, j. d., levine, j. c., dvorak, r. d., & hall, b. j. (2016). fear of missing out, need for touch, anxiety and depression are related to problematic smartphone use. computers in human behavior, 63, 509–516. https://doi.org/10.1016/j.chb.2016.05.079 fake, a. c. (2011). fomo and social media. retrieved october 28, 2022, from https://caterina.net/2011/ 03/15/fomo-and-social-media/ gil, f., chamarro, a., & oberst, u. (2015). po-14: addiction to online social networks: a question of" fear of missing out"? journal of behavioral addictions, 4(s1), 51–52. gill, m. j., & burrow, r. (2018). the function of fear in institutional maintenance: feeling frightened as an essential ingredient in haute cuisine. organization studies, 39(4), 445–465. https://doi.org/ 10.1177/0170840617709306 girardi, p., & chiagouris, l. (2018). the digital marketplace: early adopters have changed. journal of marketing development and competitiveness, 12(1). https://doi.org/10.33423/jmdc.v12i1.1412 graeff, t. r. (1996). using promotional messages to manage the effects of brand and self-image on brand evaluations. journal of consumer marketing, 13(3), 4–18. https : / / doi . org / 10 . 1108 / 07363769610118921 gray, j. a. (1971). the psychology of fear and stress. weidenfeld; nicolson. herman, d. (2000). introducing short-term brands: a new branding tool for a new consumer reality. journal of brand management, 7(5), 330–340. https://doi.org/10.1057/bm.2000.23 hoffner, c. a., & lee, s. (2015). mobile phone use, emotion regulation, and well-being. cyberpsychology, behavior, and social networking, 18(7), 411–416. https://doi.org/10.1089/cyber.2014.0487 jwt. (2011). jwt explores fear of missing out phenomenon: report outlines how fomo is manifesting in the zeitgeist. https://www.prweb.com/releases/2011/5/prweb8378292.htm jwt. (2012). jwt explores fear of missing out report, sxsw presentation spotlight how brands can leverage fomo. https://www.prweb.com/releases/2012/3/prweb9265660.htm kang, i., he, x., & shin, m. m. (2020). chinese consumers’ herd consumption behavior related to korean luxury cosmetics: the mediating role of fear of missing out. frontiers in psychology, 11, 121. https://doi.org/10.3389/fpsyg.2020.00121 kim, h.-j., min, j.-y., kim, h.-j., & min, k.-b. (2019). association between psychological and self-assessed healthstatusandsmartphoneoveruseamongkoreancollegestudents. journalofmentalhealth, 28(1), 11–16. https://doi.org/10.1080/09638237.2017.1370641 klink, r. r., & athaide, g. a. (2010). consumer innovativeness and the use of new versus extended brand names for new products: consumer innovativeness and brand names. journal of product innovation management, 27(1), 23–32. https://doi.org/10.1111/j.1540-5885.2009.00697.x https://www.sfgate.com/entertainment/morford/article/oh-my-god-you-are-so-missing-out-2536241.php https://www.sfgate.com/entertainment/morford/article/oh-my-god-you-are-so-missing-out-2536241.php https://doi.org/10.1509/jmr.11.0136 https://doi.org/10.1556/2006.4.2015.010 https://doi.org/10.1007/s12144-019-00392-w https://doi.org/10.1002/mar.21333 https://doi.org/10.1016/j.chb.2016.05.079 https://caterina.net/2011/03/15/fomo-and-social-media/ https://caterina.net/2011/03/15/fomo-and-social-media/ https://doi.org/10.1177/0170840617709306 https://doi.org/10.1177/0170840617709306 https://doi.org/10.33423/jmdc.v12i1.1412 https://doi.org/10.1108/07363769610118921 https://doi.org/10.1108/07363769610118921 https://doi.org/10.1057/bm.2000.23 https://doi.org/10.1089/cyber.2014.0487 https://www.prweb.com/releases/2011/5/prweb8378292.htm https://www.prweb.com/releases/2012/3/prweb9265660.htm https://doi.org/10.3389/fpsyg.2020.00121 https://doi.org/10.1080/09638237.2017.1370641 https://doi.org/10.1111/j.1540-5885.2009.00697.x reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 35 lampert, m. (2021). meet gen z: redefining gender roles and challenging patriarchy. retrieved october 28, 2022, from https://glocalities.com/reports/meet-gen-z lee, y.-k., chang, c.-t., lin, y., & cheng, z.-h. (2014). the dark side of smartphone usage: psychological traits, compulsive behavior and technostress. computers in human behavior, 31, 373–383. https: //doi.org/10.1016/j.chb.2013.10.047 manning, k. c., bearden, w. o., & madden, t. j. (1995). consumer innovativeness and the adoption process. journalofconsumerpsychology,4(4),329–345.https://doi.org/10.1207/s15327663jcp0404_ 02 midgley, d. f., & dowling, g. r. (1978). innovativeness: the concept and its measurement. journal of consumer research, 4(4), 229. https://doi.org/10.1086/208701 miller, s. (2012). fear of missing out: are you a slave to fomo? https://abcnews.go.com/health/ wellness/fear-missing-slave-fomo/story?id=16629972 nario-redmond, m. r., biernat, m., eidelman, s., & palenske, d. j. (2004). the social and personal identities scale: a measure of the differential importance ascribed to social and personal selfcategorizations. self and identity, 3(2), 143–175. https://doi.org/10.1080/13576500342000103 nunnally, j. c. (1978). psychometric theory (2d ed). mcgraw-hill. przybylski, a. k., murayama, k., dehaan, c. r., & gladwell, v. (2013). motivational, emotional, and behavioral correlates of fear of missing out. computers in human behavior, 29(4), 1841–1848. https: //doi.org/10.1016/j.chb.2013.02.014 qutishat, m. g. m. (2020). academic adjustment, emotional intelligence, and fear of missing out among undergraduate students: a descriptive correlational study. oman medical journal, 35(5), e174– e174. https://doi.org/10.5001/omj.2020.116 rapp, a., beitelspacher, l. s., grewal, d., & hughes, d. e. (2013). understanding social media effects across seller, retailer, and consumer interactions. journal of the academy of marketing science, 41(5), 547–566. https://doi.org/10.1007/s11747-013-0326-9 reed, a. (2002). social identity as a useful perspective for self-concept-based consumer research. psychology and marketing, 19(3), 235–266. https://doi.org/10.1002/mar.10011 riordan, b. c., flett, j. a., hunter, j. a., scarf, d., & conner, t. s. (2015). fear of missing out (fomo): the relationship between fomo, alcohol use, and alcohol-related consequences in college students. annals of neuroscience and psychology, 2(7), 1–7. https://doi.org/http://dx.doi.org/10.7243/20553447-2-9 rogers, e. m. (1995). diffusion of innovations (4th ed) [oclc: 700853045]. free press. rozgonjuk, d., sindermann, c., elhai, j. d., & montag, c. (2021). individual differences in fear of missing out (fomo): age, gender, and the big five personality trait domains, facets, and items. personality and individual differences, 171, 110546. https://doi.org/10.1016/j.paid.2020.110546 salem, p. j. (2016). human communication technology [oclc: 956331419]. sentia publishing. shalev, e., & morwitz, v. g. (2012). influence via comparison-driven self-evaluation and restoration: the case of the low-status influencer. journal of consumer research, 38(5), 964–980. https://doi.org/ 10.1086/661551 sirgy, m. j. (1982). self-concept in consumer behavior: a critical review. journal of consumer research, 9(3), 287. https://doi.org/10.1086/208924 smith,a. (2015).u.s.smartphoneusein2015.retrievedoctober28,2022,fromhttps://www.pewresearch. org/internet/2015/04/01/us-smartphone-use-in-2015/ statista. (2022). number of worldwide social network users from 2017 to 2027. https://www.statista.com/ statistics/278414/number-of-worldwide-social-network-users/ https://glocalities.com/reports/meet-gen-z https://doi.org/10.1016/j.chb.2013.10.047 https://doi.org/10.1016/j.chb.2013.10.047 https://doi.org/10.1207/s15327663jcp0404_02 https://doi.org/10.1207/s15327663jcp0404_02 https://doi.org/10.1086/208701 https://abcnews.go.com/health/wellness/fear-missing-slave-fomo/story?id=16629972 https://abcnews.go.com/health/wellness/fear-missing-slave-fomo/story?id=16629972 https://doi.org/10.1080/13576500342000103 https://doi.org/10.1016/j.chb.2013.02.014 https://doi.org/10.1016/j.chb.2013.02.014 https://doi.org/10.5001/omj.2020.116 https://doi.org/10.1007/s11747-013-0326-9 https://doi.org/10.1002/mar.10011 https://doi.org/http://dx.doi.org/10.7243/2055-3447-2-9 https://doi.org/http://dx.doi.org/10.7243/2055-3447-2-9 https://doi.org/10.1016/j.paid.2020.110546 https://doi.org/10.1086/661551 https://doi.org/10.1086/661551 https://doi.org/10.1086/208924 https://www.pewresearch.org/internet/2015/04/01/us-smartphone-use-in-2015/ https://www.pewresearch.org/internet/2015/04/01/us-smartphone-use-in-2015/ https://www.statista.com/statistics/278414/number-of-worldwide-social-network-users/ https://www.statista.com/statistics/278414/number-of-worldwide-social-network-users/ reisenwitz & fowler/ journal of business strategies (2023) 40:21-36 36 stead, h., & bibby, p. a. (2017). personality, fear of missing out and problematic internet use and their relationship to subjective well-being. computers in human behavior, 76, 534–540. https://doi. org/10.1016/j.chb.2017.08.016 swar, b., & hameed, t. (2017). fear of missing out, social media engagement, smartphone addiction and distraction: moderating role of self-help mobile apps-based interventions in the youth: proceedings of the 10th international joint conference on biomedical engineering systems and technologies, 139–146. https://doi.org/10.5220/0006166501390146 thanasrivanitchai, j., moschis, g. p., & shannon, r. (2017). explaining older consumers’ low use of the internet. international journal of internet marketing and advertising, 11(4), 355. https://doi.org/ 10.1504/ijima.2017.087271 vandecasteele, b., & geuens, m. (2010). motivated consumer innovativeness: concept, measurement, and validation. international journal of research in marketing, 27(4), 308–318. https://doi.org/10. 1016/j.ijresmar.2010.08.004 wortham, j. (2011). feel like a wallflower? maybe it’s your facebook wall. the new york times. retrieved october 28, 2022, from https://www.nytimes.com/2011/04/10/business/10ping.html zhang, z., jiménez, f. r., & cicala, j. e. (2020). fear of missing out scale: a self-concept perspective. psychology & marketing, 37(11), 1619–1634. https://doi.org/10.1002/mar.21406 https://doi.org/10.1016/j.chb.2017.08.016 https://doi.org/10.1016/j.chb.2017.08.016 https://doi.org/10.5220/0006166501390146 https://doi.org/10.1504/ijima.2017.087271 https://doi.org/10.1504/ijima.2017.087271 https://doi.org/10.1016/j.ijresmar.2010.08.004 https://doi.org/10.1016/j.ijresmar.2010.08.004 https://www.nytimes.com/2011/04/10/business/10ping.html https://doi.org/10.1002/mar.21406 introduction literature review and theoretical framework of fomo social media usage self-concept social identity smartphone usage innovativeness gender method scales results discussion theoretical and practical implications limitations and directions for future research a review of interfirm networks: a deeper understanding of the relationships paradigm jie g. fowler valdosta state university • valdosta, georgia timothy h. reisenwitz valdosta state university • valdosta, georgia abstract interfirm relationships or networks take a variety of forms and can potentially provide significant synergy for the participants. yet, most of research studies, to date, have primarily analyzed interfirm networks based upon one paradigm/ perspective. this review aims to examine a complete theoretical basis of network research and looks for research gaps and practical implications for both researchers and practitioners. specifically, it summarizes six conceptual perspectives regarding interfirm networks: motivational, relational, structural, evolutionary, interactional, and governance, in order to address similarities and differences among different perspectives. with this purpose in mind, the relevant literature is reviewed and, at the conclusion of each conceptual perspective, areas of research that require more development and investigation are identified. finally, suggestions for managers contemplating or engaged in interfirm networks are presented. introduction the network paradigm originally built upon the notion that economic actions are embedded in a social network of relationships. in essence, organizations can be interconnected with other organizations through a wide array of social networks in order to improve effectiveness and efficiency. for instance, through examining a variety of forms of collaboration, ranging from consortia to joint venture, to franchising, to dealership, fabrizio (2011) found collaboration among firms of different sizes helps to overcome weaknesses without increasing transitional costs. other scholars found that firms organized in networks have higher survival chances and that prestigious partners help firms to go to ipo faster (gulati, dialdin & wang, 2002). in addition, networks may also enable firms to gain access to capital in order to sustain operations and investment, while lower the transitional costs (khanna & rivkin, 2001). for instance, research findings show that network members in china reported higher financial performance and productivity (keister, 1998). further, networks may reduce consumer uncertainty attitudes towards the brand. for instance, volume 30, number 1 53 ingram and baum’s (1997) study of chain affiliation of manhattan hotels suggests that a hotel that joins a high status hotel chain signals its high status. recent literature on networks attempted to examine the knowledge transfer among connected firms. for instance, the vertical networks between toyota and its suppliers and among suppliers themselves facilitate knowledge learning and provide members learning and productivity advantages over non-members (dyer & nobeoka, 2000). traditional economic literature identified that a firm has at least three alternatives in order to maintain its strategies, such as searching for suppliers and new markets (mariti & smiley, 1983): the firms have options to develop a cooperative agreement with other firms, firms may make resources available to individual market transactions, and firms may organize themselves internationally. the last two alternatives can illustrated by the technological approach based upon economies and diseconomies of scale and adam smith’s principle of division of labor---refined and elaborated by stigler (1951), coase (1937), and williamson (1975). however, recent empirical evidence shows that the maxim of “networks matter” may contradict the traditional economics of scope/scale and successful exploitation of personal or organizational relationships is essential for firms to gain and maintain competitive advantages (khoja, 2010). as such, practitioners should be vigilant to develop relationships in networks. by definition, a network describes a collection of actors (e.g., persons, divisions, firms, countries) and their connections (iacobucci, 1996; thorelli, 1986). brass, galaskeiwica, greve, and tsai (2004) define a network as “a set of nodes and the set of ties representing some relationships, or lack of relationships, between the nodes” (p. 481). the ties that connect actors take many different forms. they can be directed (i.e., potentially unidirectional as in giving advice to someone) or undirected (e.g., being physically proximate), and they can be dichotomous (e.g., present or absent) or valued (e.g., the strength of a friendship) (borgatti & foster, 2003). an organizational network is defined as a collection of more than two firms that pursue repeated exchange relationships with one another but lack a legitimate organizational authority to manage the exchange process (podolny & page, 1998). this definition encompasses a wide range of interfirm relations, including alliances, joint ventures, business groups, franchises, and research consortia, while excluding such market arrangements as short term contracts or spot-market transactions. sydow and windeler (1998) investigate the properties of interfirm networks, which they consider “as an institutional arrangement among distinct but related for-profit organizations which are characterized by a special kind of network relationship, a certain degree of flexibility, and a logic of exchange that operates differently from 54 journal of business strategies that of markets and hierarchies” (p. 266). in essence, interfirm networks differ from any interorganizational arrangement of firms at least with respect to the three properties above. traditionally, networks have been investigated in connection with other topics, such as sociology. for instance, various sociologists have investigated such topics as embeddedness (uzzi, 1997), social capital (portes, 1998), social exchange (cook, 1977), and structuration theory (giddens, 1984) in an organizational network context. increasingly, they have become interesting topics unto themselves in organizational research. organizational scholars found that economic actions are embedded in social relations and interfirm relations generate and are generated by embedded relations that differ from traditional arm’s-length market ties. in marketing and management, over the last three decades, this recognition is reflected in the increase in, and the character of, research on distribution channels, supply chain management, buyer-seller relationships, buying centers, diffusion of innovations, and new product alliances. as a result, recent expansion of research interest in management and marketing calls for a review and classification of work in interfirm networks. as such, the primary objective of this paper is to review, synthesize, and integrate empirical and conceptual articles on interfirm networks in management and marketing literature and to offer suggestions and direction for researchers and practitioners in this area. we examine the articles in six groupings, based upon what we interpret as one of six primary conceptual perspectives that they reflect: motivation, relational, structural, evolutionalist, interactionalist, and governance. the following discussion begins with examinations of interfirm network research that reflects each of the previously noted six conceptual perspectives. for each perspective, the literature is reviewed and the research gap in each perspective is identified at the end of each section.1 the motivation perspective and research gaps the motivation perspective is concerned with why firms behave in certain ways with respect to the networks. it focuses on two basic questions: why do firms enter into network entities such as alliances, joint ventures and other business groups such as buying groups and trade associations; and why do they make certain strategic choices about relations and interactions with other network members? in general, this body of work is based upon cost factors (transaction costs), internal factors (firm’s capabilities, resources-based view), and external influences (social volume 30, number 1 55 capital, institutional-based view) (e.g., eisenhardt & schoonhoven, 1996; williamson, 1985). traditionally, the approach that has been used to understand how strategic alliances form is transaction cost economics (williamson, 1985). transaction cost economics emphasizes transaction cost efficiency as a motivation for the corporation to enter into a network (eisenhardt & schoonhoven, 1996). it has been effective in predicting vertical integration among suppliers and buyers in mature industries, such as automobile manufacturing (e.g., osborn & baughn, 1990). however, the logic of transaction costs does not capture many strategic aspects of networks, such as learning, creation of legitimacy, and fast market entry (eisenhardt & schoonhoven, 1996). in order to address the firm’s capabilities in forming strategic alliances, eisenhardt and schoonhoven began to examine strategic needs as motivation for firms forming alliances and positioning themselves in a network. such work begins to move beyond transaction costs and looks at logical resource needs and social resource opportunities. in comparison, the resource-based view of motivation in interfirm networks emphasizes strategic factors and characteristics of the firm rather than transaction costs. furthermore, this view focuses on the logic of needs rather than efficiency. many studies on firms’ motivations for entering into alliances take a resource-based view. das and teng (2000) attempt to relate different resource characteristics (i.e., property-based and knowledge-based resources) to alliance formation and structure. lee, lee, and pennings (2001) further examine the influence of internal capabilities and external networks. lavie (2006) borrows the notion of network resources (gulati, 1999) to extend the resource-based view by incorporating network resources of interconnected firms. lavie (2006) proposes a model that distinguishes shared resources from non-shared resources and reveals how interconnected firms can extract value from resources that are not fully-owned or controlled by the organization. another stream of research on firms’ motivations employs social capital theory. scholars who have contributed to social capital theory include bourdieu (1983, 1986), burt (1997), coleman (1988), lin (1999), portes (1998), and putnam (2000). specifically, social capital theory explains how organizations access and use resources embedded in a social network to gain returns (e.g., seeking economic help). based upon this theory, organizations are motivated to engage in interaction and networking in order to enhance outcomes (lin, 1999). organizational scholars have utilized social capital theory for decades. for instance, koka and prescott (2002) suggest that social capital could yield informational benefits for the firm. lee et al. (2001) argue that the firms’ capabilities and social capital interactively influ56 journal of business strategies ence start-up firms’ performance in terms of sales growth but that social capital alone has weak main effects on firm performance. in recent years, due to the rising global marketplace, scholars have begun to apply social capital theory to cross-cultural research. for instance, gu, huang, and tse (2008) draw upon social capital theory to examine how firms make strategic choices through guanxi networks in china. additionally, a series of studies grounded in the institutional-based view can be used to explain the firm’s motivation to make strategic choices as well. institutional theories (dimaggio & powell, 1983; scott, 1987) believe that organizational actions are driven by social justification. from this perspective, strategic decisions are social and normatively defined because their motives derive from an actor’s propensity to legitimate cooperating activities. participants in the network believe that their effectiveness is judged by other constituents (e.g., shareholders, customers, suppliers). according to the theory, organizations are motivated to seek legitimacy or approval from those potential constituents. so far, there are only a few scholars who have applied this theory in network research. for instance, dacin, oliver, and roy (2007) examine the legitimating aspect of strategic alliances. drawing upon an institutional-based view, they argue that the social symbolic and signaling characteristics of alliances serve as a source of legitimacy for partnering, and legitimacy serves as a means to achieve competitive advantage. as previously mentioned, motivational studies in network research tend to explain why firms enter into networks and why they make certain strategic choices within those networks. the research reviewed thus far highlights many of the theories (transaction cost economics, resource-based view, social capital theory, and the institutional-based view), and each of them emphasizes different aspects of what motivates firms to enter into networks. however, each also tends to ignore or tradeoff other important factors that may lead firms to enter into networks. for instance, transaction cost economics theorists highlight the cost and efficiency but lack explanations of social legitimacy. the resource-based view theorists focus upon firms’ capabilities but ignore the cost factor. additionally, social capital theorists concentrate on social gain and membership but lose sight of stakeholders’ capabilities. furthermore, while researchers have shown that different theories can explain different kinds of motives, there are no clear boundaries among these theories. for instance, the institutional-based view, which concerns social norms, may potentially overlap with social capital theory in terms of social sanctions and expected reciprocity. the resource-based view may overlap with social capital theory in terms of instrumental return. in general, while a few scholars (e.g., lee et al., 2001) often acknowledge that there is a need for combining theories when conducting research, volume 30, number 1 57 we believe that examining the commonality and difference between theories can create an outlet for future research. finally, though much research has been done in terms of organizational motives to enter into a network, there is a lack of research concerning the retreat or exit from a network. there is a need to investigate the causes/motivations for exiting a strategic network. factors such as relational conflicts, asymmetric exchange, new partnership formation, relationship maintenance costs, industrial environmental change, and network structure transition need to be examined as well. such studies will not only inform us as to what motivates firms to exit networks but potentially what motivates firms to enter them. the relational perspective and research gaps relational studies represent one of the earliest streams of research related to networks and continue to be of interest to network researchers. in general, the relational perspective is concerned with how aspects of the relationships among networks members—including strength, distance, and other qualities of ties—affect and are affected by other factors, such as member firms’ strategic choices, performance, and knowledge creation. specifically, relational network studies are based upon the relational tie literature, which is primarily concerned with the nature of the relational bond between two or more actors. scholars in this domain typically classify the relationship between social actors as being linked by weak or strong, instrumental or expressive, and direct or indirect ties. for instance, larson (1992) shows that strong ties promote or enhance trust, mutual gain, and reciprocity among firms from a long-term perspective. consequently, partners are likely to form joint problem solving arrangements as well (powell, 1990; uzzi, 1996). several important studies have clarified, and in some cases modified, the theory of relational ties by extending the research in new directions. gulati and westpal (1999) examine how interlocking ties have different effects on the formation of joint ventures between firms. based upon this finding, the content of ties (direct vs. indirect) can have a strong influence over corporate strategy decisions; some ties may promote the creation of a new alliance, while others could actually reduce the likelihood. in addition, gulati, nohria, and zaheer (2000) argue that network ties are important sources of referrals that enable prospective partners to identify and learn about each other’s capabilities and reduce the informational asymmetries that increase contracting costs. in order to test the hypothesis, the authors define tie strength by the frequency of interaction between partners and their level of resource 58 journal of business strategies commitment to the relationship. further, rowley, behrens, and krackhardt (2000) explore the conditions under which strong and weak ties are positively related to firm performance. specifically, the authors argue that whether or not firms form their strategic alliances through strong or weak ties depends on how it is structurally embedded in the network. in essence, ties can act as a social control agent in terms of governing how alliance partners behave or cooperate in the marketplace. a few recent studies provide useful challenges and an extension to the traditional relational-based view of interfirm networks. rindfleisch and moorman (2001) examine the acquisition and utilization of information in new product alliances from a strength-of-ties perspective. drawing upon network theory (granovetter, 1973, 1983), the authors suggest that horizontal alliances have a lower level of relational embeddedness and a higher level of knowledge redundancy than do vertical alliances. the results also question the key underlying assumptions of the strength-of-ties literature. for instance, strong ties are typically assumed to share both high levels of embeddedness and high levels of redundancy; however, the findings of rindfleisch and moorman (2001) indicate that this assumption does not hold for organizational contexts. in an organizational context, strong ties are more likely to act as “bridges” than weak ties. additionally, khanna and rivkin (2006) extend interfirm ties beyond the strength-of-ties literature and define ties by their content. based upon a survey in chile, the findings suggest that the content of ties (e.g., family connections, common owners) play a role in determining the boundary of a business group. mariotti (2011) investigated how firms gather and combine knowledge through strengthened bridging ties and high quality relationships. most recently, lee, kroll and walters (2011) developed a model of corporate governance stages and suggested that, in transitional economics, corporate governance is likely to shift from a bureaucratic control-based structure to a more relational governance structure. although few studies have provided challenges and extensions to the relational-based view, a large amount of research is grounded in network theory (granovetter, 1973, 1983). however, we should also realize that network theory originally examined individuals within those networks and not organizations. we should further investigate the theoretical boundaries of organizational network research. in other words, we are not clear as to whether or not individual ties can be fully applied to organizational research. additionally, we have to acknowledge that organizations do not build ties, people build ties. if this is true, how managers transfer their personal ties to the organization becomes an interesting research question which has yet to be studied in detail. lastly, there is no clear definition of the qualities of interorganizational ties, and other qualities of ties besides tie strength (i.e., volume 30, number 1 59 distance, symmetry, etc.) have not been fully examined as well. the structural perspective and research gaps despite the value and quality of work conducted under the relational perspective, many recent studies have moved from the relational perspective to a network structure perspective. for instance, liao (2010) studies the firm’s ability to process and create knowledge in interfirm networks from a structural perspective. westbrock (2010) found that an efficient network typically has a dominant group in the structure of oligopolistic markets. the structural perspective is concerned with how the overall structure of networks and structural factors within networks affect and are affected by other factors such as member firms’ strategic choices, performance, knowledge creation, and knowledge transfer. overall, the structure of networks refers to vertical networks (e.g., vertical alliances or marketing channel networks that typically include suppliers, manufacturers, distributors, and/or retailers), horizontal networks (e.g., horizontal alliances and buying groups that are typically composed of competitors in the same industry and that share the same market), mixed networks that include both horizontal and vertical networks (e.g., multichannel networks), and intermarket or concentric networks (e.g., japanese keiretsu). structural factors within networks refer to factors such as size, density, actors’ positions (centrality), network composition, interlocking board memberships, and structural holes (e.g., achrol & kotler, 1999; fombrun, 1982; gulati, nohria, & zaheer, 2000; provan & kenis, 2007; sydow & windeler, 1998). early research in the structural perspective has attempted to understand and define interorganizational relations within marketing channels (reve & stern, 1979), leaving little question as to why marketing has a long tradition of examining vertical relationships between firms. in the past, many authors conceive of networks in this sense (snow et al., 1992). by definition, the vertical network is the organizational set of firms comprising vertical exchange relations (achrol, 1997). scholars have brought together a variety of research arenas relating to vertical networks such as interdependency, contracting, and relational behavior in marketing channels (e.g., kumar, heide, & wathne, 2011; lusch & brown, 1996) and power (walker, 1972). achrol and kotler (1999) argue that marketing can be a network integrator in vertical channels because the network members are highly specialized and the burden rests on marketing managers to organize information and resource flow. in marketing, ganesan et al. (2009) further brought vertical network research into a retailing context, finding that retailers are looking beyond their or60 journal of business strategies ganizational boundaries to develop and leverage the resources and capabilities of their supply chain partners to create superior value and competitive advantage in the marketplace. the authors also discuss how global sourcing, multichannel routes, and relationship-based innovation lead to performance improvements with regard to brand image, reputation, sales, profits, innovation, and relationships. additionally, a recent study conducted by zaheer and bell (2005) concludes that firms with superior network structure may be better able to exploit their internal capabilities and thus enhance performance. horizontal networks have also been examined in recent literature (e.g., frels, shervani, & sriastava, 2003; provan & sebastian, 1998; rindfleisch & moorman, 2009; rowley, behrens, & krackhardt, 2000; swaminathan & moorman, 2009; zaheer & bell, 2005). for instance, nygaard and dahlstrom (2002) state that horizontal arrangements are increasingly deployed in organizational networks. in order to address the lack of horizontal alliances in the marketing literature, the authors examine the distribution system of two oil companies that operate through a horizontal alliance at the retail level in order to address the role of stress in horizontal alliances, the influence of role stress on organizational outcomes, and the organizational and communicative processes that influence the level of stress in alliances. additionally, rindfliesch and moorman (2001) suggest that horizontal alliances have lower levels of relational embeddedness and higher levels of knowledge redundancy than vertical alliances. aside from vertical and horizontal networks, the concentric network is also a network form that marketers are becoming more and more aware of. the concentric network, also known as an intermarket network, is defined as an enterprise group consisting of affiliations that operate in several related and unrelated industries and center around a major corporation (achrol & kotler, 1999) the concentric network, at this point, is largely a phenomenon of the japanese and korean business environment (achrol, 1997). normally, the enterprise group is organized around one or more major financial institutions in the financial market. however, we believe that concentric networks not only exist in the japanese and korean environments but also in the western marketplace. a possible example is in uzzi’s (1997) study of structural embeddedness. uzzi did not identify his research context as a concentric network. however, his study involves a major manufacturer surrounded by an interfirm network (e.g., design studio, warehouse, showroom, and retailer), which can be considered a concentric network. mixed networks, a fourth network structure, have rarely been examined, much less defined, in past literature. mcguire and dow (2009) reviewed the major volume 30, number 1 61 theoretical and empirical work of japanese keiretsu, dividing the keiretsu structure into vertical and horizontal networks and claiming that the distinction between the two is often blurred. often, there is an overlap between the two. for instance, the overlap between the mitsubishi horizontal and production centered grouping and the overlap between toyota (vertical) and mitsui (horizontal) groups are classic examples. it seems that researchers have made considerable efforts to study vertical or horizontal networks. however, we take note that any discussion of vertical or horizontal network structures is likely to be oversimplified. networks are characterized by permeable and evolving ties. for instance, each of the ties could move from horizontal to vertical structures and vice versa. practically, simply examining horizontal networks may neglect the other vertical relationships the firms may have established that have an impact on the horizontal networks at play. possibly, the combination of ties leads to superior performance instead of any one single vertical or horizontal tie. in other words, simply looking at vertical or horizontal networks separately may lead to inaccurate research results. as such, we believe that investigating the mixed network could possibly provide a new research arena. the evolutionary perspective and research gaps an already large and still growing body of literature concerning organizational networks draws attention to the importance of network evolution. the evolutionist perspective focuses on how and why changes in networks affect and/or are affected by firms’ strategic choices, industry events, and institutional factors (i.e., changing social norms, laws, or regulations) within a network. for example, how do the changing size, density, and positions of new or existing firms in a network, joint venture, and alliance formation impact the relationships within those networks? additionally, research has focused on the stages of relationship development among existing and potential network members. specifically, the majority of the body of work concerning the evolutionist perspective focuses on network formation and network dissolution. in the view of network formation, organizations build ties based upon theories of social and socioeconomic exchange (larson & starr, 1993), social capital (walker, kogut, & shan, 1997), and structure roles. for instance, larson and starr (1993) detail the three stages of network building, focusing on dyads and converting dyadic ties to socioeconomic exchanges while layering the exchanges with multiple exchange processes. during the three stages, organizations selectively use the network dyads 62 journal of business strategies to match their business decision making. further, gulati (1993) investigates how social structure affects interfirm alliance formation patterns through a longitudinal study in which he proposes that the social context emerging from prior alliances and consideration of strategic interdependence influences partnership decisions between firms. the social network then facilitates new alliances by providing information to firms about the capabilities and reliability of the potential partners. as such, organizations create ties to manage uncertain environments and to satisfy their resource needs (gulati & gargiulo, 1999). in addition, organizational scholars investigate network evolution from other social theories other than social exchange which, to some extent, overlap with the motivational perspective. however, evolutionists focus upon the stage and process of building networks. for instance, changes in political and economic power can affect channel structure and firms’ decisions in terms of social network formation (dahab, gentry, & sohi, 1996). resource dependence theorists have argued that the formation of interorganizational ties, such as strategic alliances, is a result of underlying resource dependence (pfeffer & nowak, 1976). in addition, madhavan, koka, and prescott (1998) draw upon the structural perspective to theorize about how and why interfirm networks change over time. they argue that interfirm networks evolve in response to key industry events. scholars of corporate strategy have suggested that firms form or change alliances to improve their strategic position in the network and in the marketplace (contractor & lorange, 1988; kogut, 1988; porter & fuller, 1986). interestingly, gulati and garguilo (1999) argue that the new alliance modifies the existing network, prompting a dynamic between organizational action and network structure. through testing the ideas over a nine-year period, the study shows a new alliance may increase with their interdependence and also with their prior mutual alliances, common third parties, and joint centrality in the alliance networks. in recent years, scholars have begun to investigate network dissolution. due to the complexity of collecting data, the research is mostly theoretical. baker, faulkner, and fisher (1998) analyzed the dissolution of interorganizational ties between advertising agencies and their clients as a function of competition, power, and institutional forces. specifically, they find that most exchange relationships between advertising agencies and their clients are exclusive, and most last for several years; but competition, power, and institutional forces support or undermine these relationships. powerful advertising agencies use resources to increase stability, but their clients mobilize resources to increase or decrease stability. competition has an effect on tie dissolution, and institutional forces, such as changing norms, destabilize volume 30, number 1 63 relationships. although researchers have made significant strides in understanding how networks evolve through joining new networks, modifying existing networks, and natural evolution within current networks, they have left a few questions relatively unexplored. some scholars, for example, assume that exchange relationships between two firms exist as a given and seek to explain how those relations are formalized (c.f. pisano, 1989). this assumption that exchange relations may guide tie formation between firms may actually lead to false conclusions. some scholars, despite an understanding that other reasons may guide tie formation, may not account for network formation and change. for instance, little research has been conducted that explains if marketing capabilities are a resource that firms do not rely upon when entering a new network. interestingly enough, though resource factors have been specified in the past, the question remains whether or not these resources are tangible (e.g., financial or human resources) or intangible (e.g., accessibility to other networks, capabilities in managing partnerships). further, a large body of studies in this domain focuses upon the formation of alliances instead of the formation and change of networks. although the formation of alliances can provide insights into network formation, it is hard to know how other business networks (e.g., buying groups or business associations) form through this conceptual perspective. as such, research on informal business groups could be a possible future research arena. lastly, arguably, institutional forces, such as cultural norms, play an important role in network formation. although a few scholars (c.f. peng, 2003; peng & zhou, 2005) investigate how firms use network-centered strategies and how networks evolve in a transitional economy, little work has been done to compare network evolution in different cultures or to analyze network evolution that involves firms from more than one culture. the interactionist perspective and research gaps much network research draws attention to the importance of interaction among firms (e.g., belle, katsikeas, & robson, 2010). the interactionist perspective focuses on the types, conditions, and consequences of interaction among firms in networks. as such, informational exchange, knowledge transfer, organizational learning, contractual and informal exchange, and reciprocity are important transactions that concern the interactionists. this perspective can be traced back to the 1970s. in general, early research simply focused on exchange interactions between entities in a network, and scholars agreed that conditions such as power, exchange 64 journal of business strategies behavior, and environmental forces served as important factors influencing and facilitating interactions among firms. for instance, bensen (1975) proposes that resource concentration, power network dependence, resource abundance, and environmental control mechanisms are dimensions for firms to build networks and make interactive strategic decisions. cook (1977) borrowed an exchange model for analysis of interorganizational relations and defines interorganizational linkages as networks of exchange interaction. organizational activities are viewed as networks of exchange network relations. in order to develop his exchange model, cook proposes that building interorganizational relationships such as alliance formation are correlated with power and position in the network. in addition to these early conceptual articles, larson (1992) further conducted a field study through a sample of dyadic relationships established by high growth entrepreneurial firms and finds that a process model of network formation, which emphasizes reciprocity and mutual interdependence. jones, hesterly, and borgatti (1997) further combine network theory and transaction cost economics to assert that the interaction among firms are based upon asset specificity, demand uncertainty, task complexity, and frequency. these conditions drive firms to use their social mechanisms for exchange interaction. although early research focuses on the exchange interaction aspect of networks, little has been done to investigate alliance constellations in recent years. das and teng (2002) were the first scholars to propose that social interaction should be applied to alliance constellations. alliance constellations are strategic alliances formed by multiple partner firms. popular constellation types include r&d consortia, joint bidding, and code-sharing among airlines and other industries. in the process of exchange among firms, reciprocity plays an important function for subsequent transactions. while the early work with an interactional perspective is dominated by exchange theorists, researchers have focused on learning aspects of interaction in the past two decades. scholars generally agree that economic exchanges among firms may involve both more obvious and less obvious tangible and intangible resources (such as market information). for instance, uzzi (1997) finds that information exchange is very proprietary in arm’s length ties and that learning synergies can arise from sharing insights within a network (morgan, 2004). in addition, bell and zaheer (2007) examine the geographic impact on knowledge flow among networked firms. they acknowledge that knowledge—which is closely linked to a firm’s innovativeness—is accessed across interorganizational boundaries and geographic space via networks. using a combination of primary and secondary data on mutual fund firms, volume 30, number 1 65 they find that institutional level ties (ties formed by the industry trade association structure arising incidentally to the firms involved rather than purposefully by the firms or their executives) are valuable in knowledge transmission only when such ties are geographically proximate. organizational ties fail to act as transmitters of knowledge transference regardless of the location while, on the other hand, individual ties are superior for knowledge flow. in general, past research has focused on common themes, such as exchange behavior among firms and organizational learning. however, there is much left to be done in terms of the interactivity among firms. peters, gassenheimer, and johnston (2009) call for a more explicit connection to the interactivity and network literature. the nature of interactions, as a dynamic phenomenon, has presented researchers with challenges that are both conceptual and empirical. for instance, although scholars focus upon interfirm interaction, we still lack an understanding of how individual ties serve as transmitters of knowledge flow among or within firms. we do not yet know much about how specific knowledge links to a specific tie or resource. we also do not know how different ties influence the levels or amount of knowledge or information flow. in addition, we may need to seek a better understanding of how the types of interaction (e.g., frequency, the length of the relationship, etc.) impact organizational learning. the governance perspective and research gaps in recent years, scholars have recognized that the forms of governance may serve as key factors affecting research results. the governance perspective focuses on the locus of control within networks. major examples of governance include network administrative organizations (nao) networks that govern by an overarching entity that is separate from the firms within the network (i.e., a trade association), lead organizational governed networks (log) that are governed by a lead or dominant organization within the network, and participant governed networks (pgn) that are jointly governed by the many firms in the network. provan and kenis (2007) propose that the simplest and most common form of network governance is the pgn, which is governed by the network members themselves with no separation of the governance entity. in health and human services, shared governance networks are common, in part because networks are often considered to be an important way of building community (chaskin et al., 2001). in such a context, network members will only be likely to be committed to the goals of the network if they all participate on an equal basis. in business, shared governance 66 journal of business strategies may be used in small, multi-firm strategic alliances and partnerships to develop new products or attract new businesses, which could not be easily done through the independent efforts of network members (venkatraman & lee, 2004). shared governance may also be used in multilateral relations among banking firms to assemble financial investment (eccles & crane, 1988). at another extreme, log governance can occur in horizontal networks, most often when one organization has sufficient resources to play a lead role (provan & kenis, 2007). it can also occur in vertical, buyer-supplier relationships, especially when there is a single, powerful buyer/supplier/funder and several weak and small suppliers or buyers. the most classic example can be found in the japanese keiretsu model (gerlach, 1992) and other similar models of cooperative buyer-supplier models in the u.s. (uzzi, 1999) and europe (inzerilli, 1990; lazerson, 1995). additionally, lead organizations play important roles across different industries. for instance, in the entertainment industry, the log may be a major firm’s studio (jones & defillippi, 1996). the log can also occur in health and human services; in community health, it may be a hospital or health clinic (weiner & alexander, 1998). teisman and klijn (2002) also argue that a government agency can act as a lead organization in networks. graddy and chen (2006) focus on the role of the lead organization in governing child welfare in los angeles. a third form of network governance is the nao in which the basic governance model is a separate administrative entity set up to govern the network. although the network members still interact with one another, the nao model is highly centralized (provan & kennis, 2007). for example, human and provan (2000) describe two networks in the wood processing industry that are both guided by an nao. all the firms were for-profit, but the naos were non-profit. however, the nao can be for a for-profit organization as in the case of nexial international, the global accounting network discussed by koza and lewin (1999). other scholars (e.g., mcevily & zaheer, 2004; provan, isett, & milward, 2004) argue that the nao can also be used as a mechanism to enhance network legitimacy, to deal with unique and complex network level problems and issues, and to reduce the complexity of shared governance. in recent years, scholars (e.g., provan et al., 2004) find that a more formalized nao typically have board structures that include all or a subset of network members. the board addresses strategic concerns, leaving operational decisions to the nao. organizations join or form networks for a variety of reasons, including the need to gain legitimacy, serve clients efficiently, gain resources, and solve operational problems; and due to the different needs of the network, governance may vary. volume 30, number 1 67 in the past, although marketing scholars have made significant efforts to address the impact of networks, few of them clearly distinguish the type of network governance examined. of the existing literature, only that within the health and human service sector has even attempted to distinguish the type of governance examined. even so, a clear identification of governance within those studies in health and human services was far from universal. most articles lack a specific explanation of the governance structure. as such, there is also a need to classify the network governance structure and discuss the basic characteristics of each form of governance. in marketing, we suspect that each form of governance may have a different impact on marketing variables (e.g., new product development, increasing market share). on the other hand, positive marketing outcomes may require different forms of network governance. last, firms may interact or be embedded within several different types of network governance. from a micro-level, how firms manage their position in a specific or multiple network governance is unknown, providing fuel for additional research in the area. discussion research scholars have conducted interfirm network research for a few decades. however, much research was built upon one paradigm/perspective and lacked a complete theoretical view. for instance, research built upon the relational perspective was only concerned about the strength or quality of ties and ignored the potential network effects of network structure or network density. research on network governance, however, put little emphasis on personal relationships. in other words, there is a need to combine different perspectives in order to have a complete understanding of how networks play roles in terms of gaining and maintaining competitive advantages in different areas such as, facilitating knowledge transfer and innovation, seeking financial support, and reducing consumer uncertainty towards a brand. in addition, research on each of the paradigms was incomplete and may need to be developed further. for instance, the network evolutionists may conduct more longitudinal studies to examine the change of the relationships over time. relational researchers may investigate the quality or characteristics of personal relationships besides the tie strength. for instance, the ties may be built upon reciprocity, and others may be built upon shared objectives. relational ties may also involve emotions. according to past research, emotions play important roles in strategic decision making (flint & fleet, 2011; holmes et al., 2011). as such, studying the emotion elements in tie building can be meaningful. 68 journal of business strategies further, this review provides researchers opportunities to engage in empirical network research. as khoka (2010) suggested, for example, many antecedents have been left out of network research. for instance, resource and financial requirements and organizational structure should be studied as antecedents for organizational network research. in addition, a more balanced view of network performance and network costs needs to be researched. also, a study of comparing formal and informal networks can be valuable. for instance, chinese guanxi, which is considered as an informal relationship, can be a valuable resource to form formal relationships, perhaps because in high context cultures like china, networks are essential in business strategies (liu, atinc, & kroll, 2011). much network research has been done on a theoretical level, which perhaps is due to the difficulties of data collection. though network structuralists, for example, may believe it is feasible to design simulations to calculate network intensity/density or distance between the nodes, it can be out of reach for managers to envision the structure of the network they embedded within. that is to say, there is a deep gap between theoretical network research and its practical value. this may explain why conceptual work tends to focus upon the network level of analysis, but empirical research on networks tends to examine alliances at the firm or relational level (see table 1 and table 2). the conceptual perspectives have implications for managers representing organizations that are contemplating interfirm relationships, managing interfirm relationships, and/or considering expanding or exiting interfirm relationships. thus, for managers, it is also important to understand different network perspectives, such as relational and structure perspectives. this is because network structure/density and other network characteristics in which the relationship is embedded may have effects on the quality of personal ties and such an impact may, as a result, influence the outcome of the relationships, such as sharing information or knowledge. firms also need to evaluate and balance resources, e.g, financial costs, knowledge, social capital/social ties before entering into a network. additionally, the capability of managing interpersonal ties may determine the firm’s potential capability of entering and maintaining its interfirm networks. managers should also give attention to the structure of the network that the firm adopts because the structure may have potential impact on the amount of benefit the firm may obtain from its networks. moreover, as networks change, the benefits that the firm may gain from such a network may decline/increase. as other firms enter or withdraw from the network, managers need to design flexible strategies to react such a change. as a volume 30, number 1 69 result, managers should be aware of both positive (e.g., share resources) and negative consequences (e.g., being dominated by another organization) of a network. last, managers may need to be aware that network structure is culturally-based. for instance, the participant governed networks (png) may not apply to cultures which are rather hierarchical, e.g., india. thus, managers can be cognizant that there are multiple motivations for engaging in interfirm networks and be informed about the possible relational and structural composition of networks. furthermore, there are consequences of the interactions between and/or among network firms and that there will be effects of network change over time (evolutionary). finally, managers can note that there are several ways in which networks are controlled or governed. this paper reviewed the research regarding interfirm networks, and as such, the purpose of this paper has been to provide an overview of the existing research into the phenomenon as well as directions for future research. as with any such review, there are limitations due to the conceptual nature of the paper. unlike a metaanalysis, this paper does not provide a systematic statistical analysis of the interfirm network research findings. also, we approached this review from a managerial marketing perspective as opposed to an economic perspective. in this review, we have outlined the conceptual perspectives and methodological foundations of organizational networks. organizations engaged in and/or considering developing an organizational network need to be aware of the various conceptual perspectives of interfirm networks so that the relationship potential is maximized. a better understanding of organizational network perspectives may not only potentially enhance existing relationships, paving the way for their further development and expansion, but also foster new relationships. in today’s increasingly complex marketplace, successful organizations may no longer be huge, vertically-integrated firms. in many cases, they may be lean, specialized organizations that are part of a network of firms. arguably, these developments signal the need for added and conceptually richer investigations of interfirm networks. intuitively, there are varying levels of synergy as a result of interfirm collaboration. a clear understanding of the way in which these relationships are facilitated may maximize this synergy. note 1 the research gap for each perspective is identified at the end of each section. the overall discussion of research gaps is summarized in the end of the paper. 70 journal of business strategies a ut ho r( s) / y ea r l ar so n (1 99 2) g ul at i ( 19 95 ) e is en ha rd t & sc ho on ho ve n (1 99 6) w al ke r, k og ut & s ha n (1 99 7) c on ce pt ua l pe rs pe ct iv e e vo lu tio na l m ot iv at io na l e vo lu tio na l m ot iv at io na l e vo lu tio na l m ot iv at io na l e vo lu tio na l m ot iv at io na l t he or y ba se (s ) so ci al c on tr ol so ci al e xc ha ng e so ci al n et w or k r b v st ru ct ur at io n (i m pl ic it) r b v so ci al c ap ita l so ci al n et w or k ty pe s of ne tw or ks a lli an ce pg n a lli an ce pg n a lli an ce pg n u nc le ar l ev el o f an al ys is r el at io na l r el at io na l r el at io na l n et w or k k ey fi nd in gs / t he or et ic al c on tr ib ut io ns t hr ee p ha se s of e nt re pr en eu ri al d ya d fo rm at io n (p re co nd iti on s, c on di tio ns to b ui ld e xc ha ng e st ru ct ur e, a nd in te gr at io n an d co nt ro l) ; fi rm s ar e go ve rn ed b y so ci al n or m s of tr us t a nd re ci pr oc ity . in si gh ts o n: p ro ce ss es a nd s tr uc tu re o f s us ta in ed d ya di c in te rfi rm ex ch an ge , n et w or k as a lte rn at iv e to v er tic al in te gr at io n fo r e nt re pr en eu ri al fir m s, a nd n et w or ks a s ba se s fo r fi rm g ro w th . c on si st en t w ith s tr at eg ic in te rd ep en de nc e an d so ci al s tr uc tu ra l t he or ie s, so ci al n et w or k af fe ct s ne w a lli an ce s by g iv in g in fo rm at io n to fi rm s on ca pa bi lit ie s an d re lia bi lit y of p ot en tia l p ar tn er s. sh ow s im po rt an ce o f s oc ia l n et w or k in a lli an ce fo rm at io n, w hi ch p ro vi de s br id ge b et w ee n ne tw or k an d re so ur ce in te rd ep en de nc e th eo ri es . d if fic ul t m ar ke t c on di tio ns a nd ri sk y fir m s tr at eg ie s in cr ea se ra te o f al lia nc e fo rm at io n. t op m an ag em en t’s c ha ra ct er is tic s af fe ct a lli an ce fo rm at io n. e xt en ds re so ur ce -b as ed v ie w to is su e of a lli an ce fo rm at io n. n et w or k fo rm at io n an d in du st ry g ro w th a re im pa ct ed b y de ve lo pm en t a nd nu rt ur -i ng s oc ia l c ap ita l. c on tr ib ut es to c om pa ri so n of s oc ia l c ap ita l a nd s oc ia l n et w or k th eo ri es in e xp la in -i ng n et w or k fo rm at io n. s tr uc tu re h ol es s ho ul d be g iv en m or e at te nt io n in m ar ke t t ra ns ac tio ns ra th er th an fi rm s’ c oo pe ra tiv e re la tio ns hi ps . a ls o in di ca te s in te rfi rm c ol la bo ra tio n re qu ir es a na ly si s of ne tw or k as a w ho le . ta bl e 1: s um m ar y of s el ec te d e m pi ri ca l i nt er fir m n et w or k st ud ie s volume 30, number 1 71 a ut ho r( s) / y ea r u zz i ( 19 97 ) m ad ha va n, k ok a, & pr es co tt (1 99 8) pr ov an & se ba st ia n (1 99 8) w al ke r, k og ut & s ha n (1 99 7) c on ce pt ua l pe rs pe ct iv e st ru ct ur al e vo lu tio na l st ru ct ur al e vo lu tio na l m ot iv at io na l t he or y ba se (s ) e m be dd ed ne ss u nc le ar n et w or k so ci al c ap ita l so ci al n et w or k ty pe s of ne tw or ks l o g a lli an ce pg n pg n (i m pl ic it) h or iz on ta l u nc le ar l ev el o f an al ys is n et w or k r el at io na l n et w or k n et w or k k ey fi nd in gs / t he or et ic al c on tr ib ut io ns e m be dd ed ne ss is lo gi c of e xc ha ng e th at a id s ec on om ie s of ti m e, in te gr at iv e ag re em en t, pa re to im pr ov em en t i n al lo ca tiv e ef fic ie nc y, a nd co m pl ex a da pt at io n, b ut a ls o ha s ne ga tiv e ef fe ct s. o ff er s ex pl an at io n of li nk s be tw ee n so ci al s tr uc tu re , d ec is io n m ak in g, a nd ec on om ic o ut co m es in a o rg an iz at io na l n et w or k. p ro po se s fr am ew or k to ex pl ai n ho w p ro pe rt ie s of e m be dd ed ne ss v ar y w ith q ua lit y of s oc ia l t ie s, st ru ct ur e of o rg an iz at io na l n et w or k, a nd fi rm ’s p os iti on in n et w or k. sh ow s in du st ry e ve nt s m ay b e cl as si fie d as re in fo rc in g or lo os en in g th e st ru ct ur e of th e ne tw or k. d ev el op s a m od el to e xp la in h ow in du st ry n et w or ks e vo lv e ov er ti m e in re sp on se to s pe ci fic e ve nt s. n et w or k ef fe ct iv en es s is n eg at iv el y re la te d to in te gr at io n of fu ll ne tw or ks . it is p os iti ve ly re la te d to in te gr at io n am on g sm al l c liq ue s of a ge nc ie s w he n cl iq ue s ha d ov er la pp in g lin ks th ro ug h re ci pr oc at ed re fe rr al s an d ca se co or di na tio n. sh ow s va lu e of s tu dy in g ne tw or k cl iq ue s tr uc tu re , e xp la in s ou tc om es (s uc h as n et w or k ef fe ct iv en es s) , a nd p oi nt s to n ee d to c on si de r n et w or ks an d ne tw or k st ru ct ur e in m ic ro an al yt ic w ay . n et w or k fo rm at io n an d in du st ry g ro w th a re im pa ct ed b y de ve lo pm en t a nd nu rt ur -i ng s oc ia l c ap ita l. c on tr ib ut es to c om pa ri so n of s oc ia l c ap ita l a nd s oc ia l n et w or k th eo ri es in e xp la in in g ne tw or k fo rm at io n. s tr uc tu re h ol es s ho ul d be g iv en m or e at te nt io n in m ar ke t t ra ns ac tio ns ra th er th an fi rm s’ c oo pe ra tiv e re la tio ns hi ps . a ls o in di ca te s in te rfi rm c ol la bo ra tio n re qu ir es a na ly si s of ne tw or k as a w ho le . ta bl e 1: s um m ar y of s el ec te d e m pi ri ca l i nt er fir m n et w or k st ud ie s 72 journal of business strategies a ut ho r( s) / y ea r g ul at i & w es tp ha l (1 99 9) g ul at i & g ar gi ul o (1 99 9) b au m , c al ab re se , & s ilv er m an (2 00 0) r ow le y, b eh re ns , & k ra ck ha rd t (2 00 0) c on ce pt ua l pe rs pe ct iv e e vo lu tio na l st ru ct ru al e vo lu tio na l r el at io na l st ru ct ur al r el at io na l t he or y ba se (s ) u nc le ar e m be dd ed ne ss st ru ct ur at io n (i m pl ic it) u nc le ar e m be dd ed ne ss so ci al c ap ita l ty pe s of ne tw or ks b oa rd in te rl oc k jo in t ve nt ur es a lli an ce s pg n s a lli an ce a lli an ce h or iz on ta l v er tic al a lli an ce l ev el o f an al ys is r el at io na l r el at io na l n et w or k n et w or k r el at io na l k ey fi nd in gs / t he or et ic al c on tr ib ut io ns c e o -b oa rd re la tio ns hi ps w ith in de pe nd en t b oa rd c on tr ol re du ce li ke lih oo d of a lli -a nc e fo rm at io n by p ro m ot in g di st ru st b et w ee n fir m le ad er s, w hi le c e o -b oa rd c oo pe ra tio n pr om ot es a lli an ce fo rm at io n by e nh an ci ng tr us t. a ls o, d ir ec t i nt er lo ck ti e ef fe ct s ar e am pl ifi ed b y ne tw or k tie s an d in di re ct tie s im pa ct fi rm a ct io n. g oe s be yo nd fo cu s on c on te nt a nd e ff ec ts o f d ya di c tie s. s ug ge st s in di re ct tie s, in w hi ch p ar tn er s to a n in te rl oc k tie a re e m be dd ed , m ay p os iti ve ly a nd ne ga tiv el y im pa ct in te ro rg an iz at io na l a ct io n. pr ob ab ili ty o f n ew a lli an ce b et w ee n or ga ni za tio ns in cr ea se s w ith th ei r in te rd ep en de nc e, p ri or m ut ua l a lli an ce s, a nd c om m on th ir d pa rt ie s, a nd th e jo in t c en tr al ity in th e al lia nc e ne tw or k. d iff er en tia tio n of e m er gi ng ne tw or k st ru ct ur e lim its e ff ec ts o f i nt er de pe nd en ce a nd e nh an ce s ef fe ct o f jo in t c en tr al ity o n ne w a lli an ce fo rm at io n. so ci al s tr uc tu re s ha pe s or ga ni za tio na l a ct io n, w hi ch s ub se qu en tly a ff ec ts so ci al s tr uc tu re . a lli an ce c om po si tio n im pa ct s fir m p er fo rm an ce . e nr ic he s lit er at ur e, b y ex am in in g ve rt ic al , h or iz on ta l, up st re am a nd do w ns tr ea m a lli an ce a nd e ff ec ts o f n et w or k co m po si tio n (e .g ., si ze , ef fic ie nc y, a lli an ce w ith ri va ls , a nd fi rm a ge s) . in g en er al , w ea k tie s an d st ro ng ti es p os iti ve ly a ff ec t fi rm s’ p er fo rm an ce an d ef fe ct s of re la tio na l e m be dd ed ne ss d ep en d on s tr uc tu ra l e m be dd ed ne ss an d en vi ro nm en ta l c on te xt . st ro ng a nd w ea k tie s ar e im po rt an t t o fir m s fo r d iff er en t p ur po se s, in di ff er en t c on di tio ns , i nd us tr ia l c on te xt s, a nd ti m es . a ls o, re la tio na l a nd st ru ct ur al e m be dde dn es s ca n on ly b e un de rs to od w ith re fe re nc e to e ac h ot he r. ta bl e 1: s um m ar y of s el ec te d e m pi ri ca l i nt er fir m n et w or k st ud ie s volume 30, number 1 73 a ut ho r( s) / y ea r st ev en so n & g re en be rg (2 00 0) k ha nn a & r iv ki n (2 00 1) l ee , l ee , & pe nn in gs (2 00 1) c on ce pt ua l pe rs pe ct iv e e vo lu tio na l in te ra ct io na l m ot iv at io na l m ot iv at io na l t he or y ba se (s ) so ci al m ov em en t tr an sa ct io n co st ec on om ic s (t c e ) r b v so ci al c ap ita l ty pe s of ne tw or ks u nc le ar b us in es s gr ou p u nc le ar l ev el o f an al ys is fi rm n et w or k fi rm k ey fi nd in gs / t he or et ic al c on tr ib ut io ns st ra te gi es fi rm s us e to im pa ct g ov er nm en t p ol ic y, u se a b ro ke r t o re ac h ag re em en t, or fo rm a c oa lit io n w ith o th er o rg an iz at io ns to s ha pe go ve rn m en t d ec is io ns d ep en d on s oc ia l c on te xt . e ve n pe ri ph er al a ct or s ca n af fe ct p ol ic y if th ey u se a d ir ec tc on ta ct s tr at eg y an d th e po lit ic al op po rt un ity s tr uc tu re is fa vo ra bl e. a pp lie s so ci al m ov em en t t he or y, w hi ch , u nl ik e so ci al n et w or k th eo ry , m ak es a llo w an ce fo r a ct or m ov em en ts . a ls o, s yn th es iz es m or e m ac ro so ci al le ve ls o f o rg an iz at io na l a na ly si s w ith m or e m ic ro le ve l a ct io ns o f in di vi du al s. fo cu se s on th e ec on om ie s of th ir te en c ou nt ri es : a rg en tin a, b ra zi l, c hi le , in di a, in do ne si a, is ra el , m ex ic o, p er u, th e ph ili pp in es , s ou th k or ea , ta iw an , t ha ila nd , a nd t ur ke y. b us in es s gr ou ps a ff ec t t he e co no m ic pe rf or m an ce in 1 2 of th e m ar ke ts . i n ot he r w or ds , t he g ro up a ffi lia tio n im pa ct p er fo rm an ce . i n ad di -t io n, th e an al ys is p ro vi de s no s up po rt fo r t he vi ew th at g ro up s ar e pr im ar ily re sp on se s to c ap ita l m ar ke t i m pe rf ec tio ns , no r f or th e vi ew fo r r en tse ek in g be ha vi or . in di ca te s th at g ro up s ex is t f or d if fe re nt re as on s an d pe rf or m d if fe re nt fu nc tio ns in e ac h in di vi du al in st itu tio na l s et tin g. in te rn al c ap ab ili tie s ar e im po rt an t p re di ct or s of fi rm p er fo rm an ce . n ot a ll in di ct or s of e xt er na l n et w or k pr ed ic t s ta rt -u p fir m s’ p er fo rm an ce . s ev er al in te ra ct io ns b etw ee n in te rn al c ap ab ili tie s an d ex te rn al n et w or ks a ls o em er ge . su gg es ts in te gr at in g vi ew s of r b v (o n fir m c ap ab ili tie s) a nd s oc ia l c ap ita l (o n ex te rn al n et w or ks ) t o pr ed ic t fi rm s’ p er fo rm an ce . ta bl e 1: s um m ar y of s el ec te d e m pi ri ca l i nt er fir m n et w or k st ud ie s 74 journal of business strategies r in dfl ei sc h & m oo rm an (2 00 1) st ru ct ur al in te ra ct io na l so ci al n et w or k n ew pr od uc t al lia nc e h or iz on ta l v er tic al r el at io na l h or iz on ta l a lli an ce s te nd to h av e lo w er le ve ls o f r el at io na l e m be dd ed ne ss an d hi gh er le ve l o f k no w le dg e re du nd an cy th an v er tic al a lli an ce s. e m be dd ed ne ss e le va te s ac qu is iti on a nd u til iz at io n of in fo rm at io n. r ed un da nc y re du ce s ac qu is iti on b ut e nh an ce s ut ili za tio n of in fo rm at io n. c ha lle ng es v ie w o n so ci al n et w or ks b as ed o n g ra no ve tte r’ s w or k. f or ex am pl e, in di vi du al s w ith c lo se ti es a re a ss um ed to s ha re b ot h hi gh le ve ls of re la tio na l e m be dd ed ne ss a nd in fo rm at io n re du nd an cy . f in di ng s su gg es t as su m pt io n do es n ot h ol d fo r i nt er or ga ni za tio na l r el at io ns hi ps . a ut ho r( s) / y ea r c on ce pt ua l pe rs pe ct iv e t he or y ba se (s ) ty pe s of ne tw or ks l ev el o f an al ys is k ey fi nd in gs / t he or et ic al c on tr ib ut io ns k ok a & pr es co tt (2 00 2) fr el s, s he rv an i, & s ri as ta va (2 00 3) b ra df or d, st ri ng fe llo w , & w ei tz (2 00 4) m ot iv at io na l st ru ct ur al in te ra ct io na l so ci al c ap ita l u nc le ar u nc le ar a lli an ce h or iz on ta l u nc le ar fi rm n et w or ks r el at io na l su pp or ts h yp ot he se s th at s oc ia l c ap ita l i s a th re e di m en si on al c on st ru ct . c on si de rs th e co ns tr uc t v al id ity a nd c on tin ge nt n at ur e of s oc ia l c ap ita l. su gg es ts th at s oc ia l c ap ita l s ho ul d be v ie w ed te rm s of th e di ff er en t in fo rm at io n vo lu m e, in fo rm at io n di ve rs ity , a nd in fo rm at io n ri ch ne ss av ai la bl e to fi rm s. v al ue a dd ed b y th e th re e ne tw or ks is p os iti ve ly re la te d w ith re so ur ce s al lo ca te d to c om pe tin g pr od uc t b y bu si ne ss c us to m er s. t he th re e ne tw or ks m ed ia te th e re la tio ns hi p be tw ee n pr od uc t p er fo rm an ce a nd re so ur ce al lo ca tio n. r efi ne th e no tio n of m ar ke t b as ed a ss et s. p ro po se in te gr at ed n et w or k m od el of d iff er en t t yp es o f n et w or ks , e xt en d co nc ep tu al iz at io ns o f i nn ov at io n di ff us io n, c od iff us io n, a do pt io n, a nd in tr ao rg an iz at io n ad op tio n. n eg at iv e ef fe ct s of in te rp er so na l a nd ta sk c on fli ct o n ne tw or k ou tc om es ca n be re du ce d by c on fli ct m an ag em en t. h ow ev er , e ff ec tiv en es s of u si ng di ff er en t c on fli ct m an ag em en t a pp ro ac h di ff er s. e xt en ds id ea s on c on fli ct in c ha nn el re la tio ns hi ps b y co ns id er in g ef fe ct iv en es s of c on fli ct m an ag em en t. a ls o ex pl ai n ho w ty pe s of c on fli ct an d co nfl ic t m an ag em en t a ff ec t n et w or k ou tc om es . ta bl e 1: s um m ar y of s el ec te d e m pi ri ca l i nt er fir m n et w or k st ud ie s volume 30, number 1 75 po w el l e t a l. (2 00 5) e vo lu tio na l u nc le ar h or iz on ta l n et w or k a s or ga ni za tio ns in cr ea se th ei r c ol la bo ra tio n an d di ve rs if y th ei r n ew tie s to o th er s, s ub -n et w or ks (c ha ra ct er iz ed b y m ul tip le , i nd ep en de nt pa th w ay s) fo rm . s uc h st ru ctu ra l c ha ng es , i n tu rn , m ay c ha ng e ch oi ce s an d op po rt un iti es a va ila bl e fo r t he fi rm a nd , t hu s, re in fo rc e an a tta ch m en t. su gg es ts th at n ei th er m on ey n or m ar ke t c an d om in at e a fie ld ’s n et w or k ev ol ut io n. in st ea d, o rg an iz at io ns w ith d iv er se p or tf ol io s of w el lco nn ec te d co lla bo ra to rs a re in th e m os t c oh es iv e an d ce nt ra l p os iti on s an d ha ve th e po w er to s ha pe th e fie ld ’s e vo lu tio n. a ut ho r( s) / y ea r c on ce pt ua l pe rs pe ct iv e t he or y ba se (s ) ty pe s of ne tw or ks l ev el o f an al ys is k ey fi nd in gs / t he or et ic al c on tr ib ut io ns z ah ee r & b el l (2 00 5) k ha nn a & r iv ki n (2 00 6) st ru ct ur al r el at io na l st ru ct ur al r b v so ci al c ap ita l so ci al n et w or k pg n in dir ec t a nd dir ec t e qu ity ho ldi ng s d ire cto r int erl oc ks f am ily co nn ec tio ns fi rm n et w or ks fi rm s’ in no va tiv e ca pa bi lit ie s an d ne tw or k st ru ct ur es e nh an ce p er fo rm an ce , bu t e ff ec t o f s tr uc tu ra l h ol es o n pe rf or m an ce is g re at er fo r i nn ov at iv e fir m s. fi rm s w ith s up er io r n et w or ks c an e xp lo it th ei r c ap ab ili tie s to im pr ov e pe rf or m an ce . c ha lle ng es n et w or k st ud y vi ew th at fi rm s au to m at ic al ly b en efi t f ro m po si tio ns th ey o cc up y. s ho w s fir m s w el len do w ed w ith in te rn al c ap ab ili tie s ar e be tte r a bl e to e xp lo it fa vo ra bl e ne tw or k st ru ct ur e an d ne tw or k cl os ur e do es n ot a lw ay s im pa ct fi rm p er fo rm an ce (a s c ol em an a rg ue d) . o ve rl ap in o w ne rs , i nd ir ec t e qu ity h ol di ng s an d di re ct or in te rl oc ks a re st ro ng g ro up b ou nd ar y de lin ea to rs , w hi ch is n ot th e ca se fo r f am ily co nn ec tio ns a nd d ir ec t e qu ity h ol di ng s. d is tin gu is h di ff er en t t ie s an d th ei r u se in te rm s of d efi ni ng g ro up bo un da ri es . ta bl e 1: s um m ar y of s el ec te d e m pi ri ca l i nt er fir m n et w or k st ud ie s 76 journal of business strategies b el l & z ah ee r (2 00 7) l uo & h as sa n (2 00 9) sw am in at ha n & m or rm an (2 00 9) in te ra ct io na l in te ra ct io na l st ru ct ur al o rg an iz at io na l le ar ni ng k no w le dg e m an ag em en t n et w or k (i m pl ic it) so ci al n et w or k so ci al n et w or k na o go ve rn an ce ne tw or k (im pli cit ) pg n (e. g., eq uit y ho ldi ng al lia nc e; im pli cit ) u nc le ar a lli an ce pg n r el at io na l fi rm r el at io na l n et w or k in st itu tio na l l ev el ti es a re v al ua bl e in k no w le dg e tr an sf er , i f t he y ar e ge og ra ph ic al ly p ro xi m at e. o rg an iz at io na l l ev el ti es fa il to tr an sf er kn ow le dg e, re ga rd le ss o f g eo gr ap hi c lo ca tio n. in di vi du al le ve l f ri en ds hi p tie s ar e su pe ri or c on du its fo r k no w le dg e flo w a nd s pa n ge og ra ph ic h ol es . sh ow s di ff er en t t yp es o f t ie s ac ro ss o rg an iz at io ns d if fe r i n pr op en si ty to tr an sm it kn ow le dg e w he n th ey a re g eo gr ap hi ca lly p ro xi m at e or d is ta nt . n et w or ki ng p ro m ot es k no w le dg e cr ea tio n bu t t oo m uc h ne tw or ki ng em be dd ed ne ss le ad s to d im in is he d re tu rn s. n et w or ki ng d is pa ri ty a ls o ha s ne ga tiv e im pa ct . c om pe tit iv e en vi ro nm en t a nd te ch no lo gi ca l t ur bu le nc e im pa ct n et w or ki ng d is pa ri ty a nd m ar ke tin g kn ow le dg e le ar ni ng . t hi s is be ca us e in m or e co m pe tit iv e an d tu rbu le nt m ar ke ts , b ro ke ra ge o pp or tu ni tie s of fe re d by c om pl em en ta ry k no w le dg e ba se s w ou ld b e ev en g re at er . o ff er s in si gh ts o n in flu en ce o f i nt er na l s oc ia l a ct or s (t op m an ag em en t) a nd de ba te o n re la tiv e be ne fit s of w ea k so ci al n et w or ks . a rg ue th at n et w or ki ng st re ng th m ay h av e m or e co m pl ic at ed e ff ec ts th an u su al ly e xp ec te d. r el at io ns hi p is in ve rt ed u -s ha pe (n ei th er to o st ro ng n or to o w ea k tie s ar e op tim al ). a ls o, n ot e ne tw or k ef -f ec ts m ay d ep en d on m ar ke t c on di tio ns . m ar ke tin g al lia nc es c re at e va lu e fo r fi rm in a nn ou nc em en t p er io d ev en t w in do w . n et w or k ef fic ie nc y an d ne tw or k de ns ity h av e st ro ng es t p os iti ve im pa ct w he n th ey a re m od er at e. n et w or k re pu ta tio n an d ne tw or k ce nt ra lit y ha ve n o ef fe ct . i n ad di tio n, re la tio na l n et w or k ch ar ac te ri st ic s ha ve g re at er ro le th an s iz e or s ta tu s be ne fit s. m ar ke tin g al lia nc e ca pa bi lit y, w hi ch re fle ct s a fir m ’s a bi lit y to m an ag e a ne tw or k of p re vi ou s m ar ke tin g al lia nc es , h as a po si tiv e im pa ct o n va lu e cr ea tio n. in di ca te s th e ro le o f r el at io na l n et w or k ch ar ac te ri st ic s. a ut ho r( s) / y ea r c on ce pt ua l pe rs pe ct iv e t he or y ba se (s ) ty pe s of ne tw or ks l ev el o f an al ys is k ey fi nd in gs / t he or et ic al c on tr ib ut io ns ta bl e 1: s um m ar y of s el ec te d e m pi ri ca l i nt er fir m n et w or k st ud ie s volume 30, number 1 77 b el lo , k at si ke as , & r ob so n (2 01 0) k um ar , h ei de , & w at hn e (2 01 1) in te ra ct io na l st ru ct ur al a cc om m od at iv e re sp on se b eh av io rs u nc le ar a lli an ce v er tic al ne tw or ks fi rm r el at io na l fi rm r el at io na l e xa m in es a fi rm ’s p er fo rm an ce in a n in te rn at io na l m ar ke tin g al lia nc e w he n it re sp on ds to a s el fse rv in g pa rt ne r’ s ex pl oi tiv e be ha vi or . t he au th or s fo un d th at a fi rm ’s p ay of f f ro m a cc om m od at io n de pe nd s on it s ap pr oa ch to m on ito ri ng , e ith er e m pl oy in g ov er t s ur ve ill an ce o r r el yi ng o n its p ar tn er ’s s el fco nt ro l. fo r i ns ta nc e, o ve rt s ur ve ill an ce c an u nd er m in e ac co m m od at io ns ’ a bi lit y to c on vi nc e a se lfi sh p ar tn er th at c oo pe ra tio n is be ne fic ia l a nd n ot in co ns is te nt w ith it s se lf -i nt er es t. e xa m in es h ow m an uf ac tu re ’s g ov er na nc e of a n ex te rn al s up pl ie r r el at io ns hi p af fe ct s its p er fo rm an ce to w ar ds a d ow ns tr ea m re ta il cu st om er . f or in st an ce , th e au th or s fo un d th at a m an uf ac tu re ’s re lia nc e on s up pl ie r n or m s an d in ce nt iv es p ro m ot es p er fo rm an ce . h ow ev er , i nt er na l i nc en tiv es w ea ke n th e ef fe ct o f e xt er na l n or m s, a nd in te rn al n or m s w ea ke n th e ef fe ct o f e xt er na l in ce nt iv es . a ut ho r( s) / y ea r c on ce pt ua l pe rs pe ct iv e t he or y ba se (s ) ty pe s of ne tw or ks l ev el o f an al ys is k ey fi nd in gs / t he or et ic al c on tr ib ut io ns ta bl e 1: s um m ar y of s el ec te d e m pi ri ca l i nt er fir m n et w or k st ud ie s 78 journal of business strategies b en so n (1 97 5) c oo k (1 97 7) fo m br un (1 98 2) in te ra ct io na l in te ra ct io na l st ru ct ur al is t in st itu tio na l e xc ha ng e th eo ry u nc le ar r el at io na l r el at io na l m ul tile ve l fo cu se s on e nv ir on m en ta l f or ce s an d co nd iti on s th at im pa ct n et w or k re la tio ns . e nv ir on m en ta l d im en si on s in cl ud e re so ur ce c on ce nt ra tio n, p ow er c on ce nt ra tio n, n et w or k au to no m y, e nv ir on m en ta l d om in an ce , r es ou rc e ab un da nc e, a nd e nv ir on m en t n et w or k co nt ro l m ec ha ni sm s. p ro po se s fo ur g en er al s tr at eg ie s fo r c ha ng in g ne tw or k re la tio ns : co op er at iv e, d is ru pt iv e, m an ip ul at iv e, a nd a ut ho ri ta tiv e st ra te gi es . a ls o id en tifi es fo ur di m en si on s of in te ro rg an iz at io na l e qu ili br iu m : d om ai n co ns en su s, id eo lo gi ca l c on se ns us , po si tiv e ev al ua tio n, a nd w or k co or di na tio n. a rg ue s no o ne th eo re tic al p er sp ec tiv e w ill e na bl e sc ho la rs to c om pl et el y ex pl ai n or ga ni za tio n in te ra ct io n (n et w or ks ). e ve ry th eo ry h as s co pe re st ri ct io ns . m aj or c on tr ib ut io n is to p re se nt a n ex te ns io n of e xc ha ng e th eo ry fo r a na ly si s of in te ro rg an iz at io na l r el at io ns . i n do in g so , t he or et ic al fr am ew or k fo cu se s on e ff ec ts o f p ow er o n ex ch an ge re la tio ns a m on g or ga ni za tio ns . a ls o of fe rs d efi ni tio ns a nd p ro po si tio ns a nd d is cu ss es li nk ag e be tw ee n di ff er en t t yp es o f e xc ha ng e ne tw or ks a nd m ar ke t s tr uc tu re . fi na lly , r ev ie w s cr iti ci sm s of e xc ha ng e an al ys is o f i nt er or ga ni za tio na l r el at io ns a nd d is cu ss es fu tu re d ir ec tio ns fo r re se ar ch . a rg ue s re se ar ch er s sh ou ld id en tif y ty pe s of n et w or ks (e .g ., at tr ib ut e ne tw or ks a nd tr an sa ct io na l n et w or ks ). id en tifi es th re e ki nd s of s tr at eg ie s fo r n et w or k re se ar ch (n od al , dy ad ic , a nd tr ia di c) . n od al a pp ro ac he s ar e gr ou nd ed in c ro ss -s ec tio na l c om pa ri so n of a s et of in di vi du al a ct or s. d ya di c ap pr oa ch es fo cu s on re la tio ns hi p am on g pa ir s an d ar e gr ou nd ed in in fo rm at io n ab ou t t he w ho le n et w or k in te rm s of p ai r d is ta nc e. t ri ad ic a pp ro ac he s ex pl or e al l p os si bl e tr ia ds in th e ne tw or k an d re ly o n th e de gr ee o f b al an ce in th e ne tw or k. a ls o di sc us se s st re ng th a nd w ea kn es s of n et w or k re se ar ch a nd a pp lic at io n of th re e re se ar ch ap pr oa ch es . m aj or c on tr ib ut io n is to la y ou t k ey m et ho do lo gi ca l i ss ue s av ai la bl e fo r re se ar ch er s w ho w is h to u se a n et w or k ap pr oa ch to o rg an iz at io na l a na ly si s. a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks volume 30, number 1 79 t ho re lli (1 98 6) po w el l (1 99 0) ia co bu cc i & h op ki ns (1 99 2) a nd er so n, h ak an ss on & j oh an so n (1 99 4) u nc le ar u nc le ar u nc le ar in te ra ct io na l n et w or k th eo ry e m be dd ed ne ss (i m pl ic it) u nc le ar e m be dd ed ne ss & so ci al e xc ha ng e n et w or k n et w or k r el at io na l & n et w or k r el at io na l & o rg an iza tio na l su m m ar iz es s tr at eg ic is su es in vo lv in g ne tw or ks : ( 1) tu rn ke y co nt ra ct s an d “s ys te m se lli ng ”, (2 ) b ar te r a nd re ci pr oc al tr ad in g, (3 ) m ak ele as e or b uy d ec is io n, (4 ) s pl it or un if y so ur ci ng , ( 5) tr an sa ct io ns b et w ee n fir m ’s d iv is io ns , ( 6) c ar te ls , ( 7) i nt er lo ck in g di re ct or at es , ( 8) jo in t v en tu re s, m er ge rs , a nd a cq ui si tio ns , ( 9) d iv er si fic at io n, (1 0) in te rn at io na liz at io n, a nd (1 1) v er tic al in te gr at io n. n ot es s tr at eg ic im pl ic at io ns o f n et w or k pa ra di gm in m ar ke tin g (d is tr ib ut io n ch an ne ls ) a nd o th er fi el ds . a rg ue s th at re la tio na l o r n et w or k fo rm s of o rg an iz at io n ar e an id en tifi ab le fo rm o f e co no m ic ch an ge u nd er c er ta in c ir cu m st an ce s. t he s al ie nt fe at ur es o f t hr ee m od es o f o rg an iz at io n (m ar ke t, hi er ar ch y, a nd n et w or ks ) a re id en tifi ed a nd c om pa re d. t he lo gi c of n et w or k fo rm s is e xp lo re d sy st em at ic al ly . e m ph as iz es th e im po rt an ce o f s oc ia l r el at io ns a nd e xp la in s th e tr an sf or m at io n of an e xc ha ng e dy ad ic re la tio ns hi p to a s et o f s ta bl e, m ul tid im en si on al , m ul til ay er ed in te ro rg an iz at io na l n et w or ks . t he a ut ho r p ro po se s th re e st ag es o f e nt re pr en eu ri al n et w or ki ng ac tiv ity w hi ch a re u se d to s ec ur e th e cr iti ca l e co no m ic a nd n on -e co no m ic re so ur ce s ne ed ed to s ta rt a b us in es s. 1 . f oc us o n es se nt ia l d ya ds , 2 . t ra ns fe r d ya di c tie s to s oc io ec on om ic ex ch an ge ti es a nd 3 . l ay er th e in iti al e xc ha ng e re la tio ns hi p w ith a dd iti on al b us in es s fu nc tio ns , a ct iv iti es , a nd le ve ls o f e xc ha ng e (f ro m p er so na l e xc ha ng e to o rg an iz at io na l ex ch an ge ). pr ov id es c on ce pt ua l d ev el op m en t o f d ya di c bu si ne ss re la tio ns hi ps th at c ap tu re s th e em be dd ed c on te xt a nd fo rm ul at es b us in es s ne tw or k co ns tr uc ts fr om fo ca l fi rm ’s p er sp ec tiv e an d its p ar tn er s’ p er sp ec tiv e. in th e ar tic le , t he a ut ho rs ’ c on ce pt ua liz e th e bu si ne ss n et w or k as s et s of c on ne ct ed re la tio ns hi ps . a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks 80 journal of business strategies jo ne s, h es te rl y & b or ga tti (1 99 7) a ch ro l (1 99 7) d ah ab , g en tr y & s oh i (1 99 7) po do ln y & pa ge (1 99 8) sy do w & w in de le r (1 99 8) in te ra ct io na l & m ot iv at io na l st ru ct ur al st ru ct ur al e vo lu tio na l st ru ct ur al tr an sa ct io n co st ec on om ic s & so ci al n et w or k th eo ri es u nc le ar in st itu tio na l u nc le ar st ru ct ur at io n th eo ry n et w or k o rg an iz atio na l n et w or k n et w or k n et w or k & or ga ni za tio na l in te gr at es tr an sa ct io n co st th eo ry a nd s oc ia l n et w or k th eo ri es . c la im s ne tw or k fo rm o f go ve rn an ce is a re sp on se to e xc ha ng e co nd iti on s of a ss et s pe ci fic ity , d em an d un ce rt ai nt y, ta sk c om pl ex ity , a nd fr eq ue nc y. t he se e xc ha ng e co nd iti on s dr iv e fir m s to w ar d em be dd in g th ei r t ra ns ac tio ns a nd le t t he m u se s oc ia l m ec ha ni sm s to c oo rd in at e an d sa fe gu ar d ex ch an ge s. w he n al l o f t he se c on di tio ns a re in p la ce , n et w or k go ve rn an ce fo rm h as ad va nt ag es o ve r b ot h hi er ar ch y an d m ar ke t s ol ut io ns . s ho w s ho w e m be dd ed ne ss p ro vi de s fo un da tio n fo r fi rm s to c oo rd in at e an d sa fe gu ar d ex ch an ge in n et w or k go ve rn an ce . a na ly ze s th e ev ol ut io n of th e ne tw or k or ga ni za tio n an d ex pl or es th e ch ar ac te ri st ic s of fo ur ty pe s of n et w or k or ga ni za tio ns , i nc lu di ng th e in te rn al m ar ke t n et w or k, th e ve rt ic al m ar ke t ne tw or k, th e in te rm ar ke t n et w or k, a nd th e op po rt un ity n et w or k. su gg es ts c ha nn el s in tr an si tio na l e co no m ie s m ay b e co nt ro lle d by g ro up s or n et w or ks of p eo pl e w ith m ut ua l i nt er es t ( in te re st d om in at io n) . e xa m in es in te re st d om in at io n by m an ag er s, c om m un is t c ad re s, a nd o th er p ar ty e lit e in tw o tr an sf or m in g ec on om ie s an d de sc ri be s ho w c om m an d ec on om ie s m ig ht b e co nd uc tiv e to in te re st d om in at io n fo r m ar ke tin g ch an ne ls . p re se nt s pr op os iti on s of h ow p ol iti ca l, so ci al , a nd e co no m ic fa ct or s th at s us ta in in te re st d om in at io n. e xa m pl es fr om h un gr y an d ta jik is ta n ar e us ed to p ro vi de co nt ex t f or th e di sc us si on . r ev ie w s lit er at ur e of n et w or k or ga ni za tio ns a nd fo cu se s on v ar ia tio n cr os sin du st ry a nd cr os spo pu la tio n. e xp la in s w hy o rg an iz at io ns d o no t a do pt n et w or k ap pr oa ch es . f in al ly , ca lls fo r a tte nt io n to s uc ce ss a nd fa ilu re o f n et w or k fo rm o f o rg an iz at io n. a pp lie s g id de n’ s st ru ct ur at io n th eo ry to a na ly ze n et w or k pr oc es se s. d efi ne s in te rfir m ne tw or k an d th en m ov es to o rg an iz at io na l n et w or k pr ac tic es . s tr es se s ho w s tr uc tu re o f si gn ifi ca tio n, d om in at io n, a nd le gi tim at io n sh ap e ne tw or k pr oc es se s an d ho w s tr uc tu re is cr ea te d un de r a us pi ce s of n et w or k ef fe ct iv en es s. a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks volume 30, number 1 81 a ch ro l & k ot le r ( 19 99 ) l in (1 99 9) d ac in , v en tr es ca & b ea l (1 99 9) g ul at i, n oh ri a & z ah ee r (2 00 0) st ru ct ur al m ot iv at io na l u nc le ar st ru ct ur al e m be dd ed ne ss & th eo ry o f n et w or ks (i m -p lic it) so ci al c ap ita l e m be dd ed ne ss so ci al c ap ita l (i m pl ic it) n et w or k r el at io na l & n et w or k u nc le ar / or ga ni za tio na l, re la tio na l, & n et w or k o rg an iz atio na l, re la tio na l, & n et w or k d efi ne s an d di st in gu is he s fo ur ty pe s of n et w or k or ga ni za tio ns , i nc lu di ng in te rn al ne tw or ks , v er tic al n et w or ks , i nt er -m ar ke t n et w or ks , a nd o pp or tu ni ty n et w or ks . m os t im po rt an tly , e xp la in s ro le o f m ar ke tin g in d iff er en t t yp es o f n et w or k or ga ni za tio ns a nd th e lim ita tio ns o f n et w or k or ga ni za tio ns . a na ly ze s th e ev ol ut io n of th e ne tw or k or ga ni za tio n an d ex pl or es th e ch ar ac te ri st ic s of fo ur ty pe s of n et w or k or ga ni za tio ns , i nc lu di ng th e in te rn al m ar ke t n et w or k, th e ve rt ic al m ar ke t ne tw or k, th e in te rm ar ke t n et w or k, a nd th e op po rt un ity n et w or k. r ev ie w s re se ar ch o n em be dd ed ne ss a nd c on tr ib ut e to u nd er st an di ng e m be dd ed ne ss o f or ga ni za tio ns . c ov er s re se ar ch o n ec on om ic s oc io lo gy , n et w or k th eo ri es o f a lli an ce , or ga ni za tio ns a nd s tr at eg y, s oc ia l c ap ita l, an d ne tw or k th eo ry a nd o rg an iz at io ns , a nd n et w or k th eo ry a nd c ul tu ra l s oc io lo gy . m ai nl y fo cu se s on c on ce pt ua liz at io n of e m be dd ed ne ss . pr es en ts in te gr at ed fr am ew or k th at c on si de rs s ou rc es , m ec ha ni sm s, o ut co m es , a nd s tr at eg ic im pl ic at io ns o f e m be dd ed ne ss . a ls o, c om m en ts o n fu tu re re se ar ch a nd is su es re la te d to ne tw or ks a nd m et ho do lo gy . n ot es th at s tr at eg ic n et w or ks e nc om pa ss in te ro rg an iz at io na l t ie s (e .g ., st ra te gi c al lia nc es , jo in t v en tu re s, lo ng -t er m , b uy er -s up pl ie r p ar tn er sh ip s, a nd m an y ot he r t ie s. a rg ue s th at re la tio ns hi ps in w hi ch fi rm s ar e em be dd ed s ha pe th ei r c on du ct a nd p er fo rm an ce . id en tifi es fiv e ar ea s of s tr at eg y re se ar ch th at m ay in vo lv e st ra te gi c ne tw or ks : ( 1) in du st ry s tr uc tu re , (2 ) p os iti on in g in a n in du st ry , ( 3) in im ita bl e fir m re so ur ce s an d ca pa bi lit ie s, (4 ) c on tr ac tin g an d co or di na tio n co st , a nd (5 ) d yn am ic n et w or k co ns tr ai nt s an d be ne fit s. d is cu ss es s tr at eg ic ne tw or ks ’ p ot en tia l p os iti ve (e .g ., in fo rm at io n ac ce ss , r es ou rc es , m ar ke ts , t ec hn ol og ie s, a nd sc op e ec on om ic s po si tiv e, r is k sh ar in g, a nd o ut so ur ci ng ) a nd n eg at iv e ef fe ct s. a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks 82 journal of business strategies d as & t en g (2 00 0) d as & t en g (2 00 2) b or ga tii & fo st er (2 00 3) pe ng (2 00 3) m ot iv at io na l & ev ol ut io na l in te ra ct io na l u nc le ar e vo lu tio na l r es ou rc eba se d th eo ry so ci al e xc ha ng e so ci al c ap ita l, ne tw or k, & di ff us io n th eo ri es in st itu tio na l, re so ur ce -b as ed , & ne tw or k th eo ri es o rg an iz atio na l r el at io na l a ll, b ut pr im ar -i ly or ga ni za tio na l & re la tio na l fi rm r ev ie w re so ur ce -b as ed th eo ry o f s tr at eg ic a lli an ce li te ra tu re , a nd s yn th es iz es th e fin di ng s. pr op os es fo ur m aj or a sp ec ts o f s tr at eg ic a lli an ce s: ra tio na le , f or m at io n, s tr uc tu ra l pr ef er en ce s, a nd p er fo rm an ce . n ot es re so ur ce -b as ed v ie w s ug ge st s th at th e ra tio na le fo r al lia nc es is th e va lu e cr ea tio n an d re so ur ce s ch ar ac te ri st ic s, s uc h as im pe rf ec t m ob ili ty , fa ci lit at e al lia nc e fo rm at io n. id en tifi es re so ur ce c ha ra ct er is tic s, d is cu ss es a ty po lo gy o f al lia nc e an d st ru ct ur e pr ef er en ce s fo r a lli an ce s tr uc tu re s, a nd u se s a se t o f p ro po si tio ns to in di ca te fu tu re re se ar ch d ir ec tio ns . d ev el op s a so ci al e xc ha ng e pe rs pe ct iv e of a lli an ce c on st el la tio ns (m ul tifir m a lli an ce s) , w hi ch e m ph as iz es ro le o f e xc ha ng e. a ls o, d is cu ss es th re e so ci al c on tr ol m ec ha ni sm s, (e .g ., re ci pr oc ity , s oc ia l s an ct io ns , m ac ro cu ltu re ) fo r m iti ga tin g di ffi cu lti es o f m an ag in g co ns te lla tio ns . p ro po se s ty po lo gy o f c on st el la tio ns b as ed o n di m en si on s of e xc ha ng e. c on tr ib ut es to a lli an ce li te ra tu re th at is la rg el y ba se d on a n ex ch an ge p ro ce ss , b ut w hi ch h as be en c en te re d on in te rp er so na l r el at io ns . r ev ie w s an d de ve lo ps ty po lo gy a nd d im en si on s of n et w or k st ud ie s in o rg an iz at io na l re se ar ch . e xt en ds li te ra tu re o n ho w o rg an iz at io ns m ak e st ra te gi c ch oi ce s du ri ng in st itu tio na l tr an si tio ns . i ts th re e pr im ar y co nt ri bu tio ns a re to (1 ) h ig hl ig ht in st itu tio na l c ha ng e, (2 ) de ve lo p tw oph as e m od el , f oc us in g on l on gi tu di na l p ro ce ss to m ov e fr om re la tio ns hi pba se d, p er so na liz ed tr an sa ct io n st ru ct ur e re qu ir in g ne tw or k ce nt er ed s tr at eg ie s to a ru le ba se d, im pe rs on al e xc ha ng e m od el th at e m ph as iz es m ar ke tce nt er ed s tr at eg y, a nd (3 ) e xt en d w or k of in st itu tio na l b as ed v ie w o f s tr at eg y ch oi ce . c au tio ns th at n ot a ll ne tw or ks a re th e sa m e an d fir m s ca n pr ac tic e bo th n et w or k a nd m ar ke tba se d st ra te gi es , w hi ch a re n ot m ut ua lly e xc lu si ve . c ul tu ra l d iff er en ce m ay a ls o in te ra ct w ith in st itu tio na l c ha ng e. a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks volume 30, number 1 83 b ra ss e t a l. (2 00 4) b et ts & s to ud er (2 00 4) c ur ra h & w ri gl ey (2 00 4) u nc le ar u nc le ar in te ra ct io na l u nc le ar u nc le ar o rg an iz at io na l le ar ni ng / kn ow le dg e m an ag em en t fi rm & re la tio na l o rg an iza tio na l, re la tio na l, & n et w or k r el at io na l & o rg an iza tio na l r ev ie w s an te ce de nt s an d co ns eq ue nc es o f n et w or ks b y le ve ls o f a na ly si s (i nt er pe rs on al le ve l, gr ou p le ve l, in te ro rg an iz at io na l l ev el ) a nd , o n ea ch le ve l, su gg es ts a re as th at h av e be en o ve rl oo ke d by re se ar ch er s. r ev ie w s m aj or n et w or k or ga ni za tio n re se ar ch a nd n ot es th at a lth ou gh m uc h is w ri tte n on n ot io n of “ ne tw or k or ga ni za tio ns ,” m os t a rt ic le s ar e th eo re tic al a nd ra re ly u se w el les ta bl is he d ne tw or k an al yt ic al te ch ni qu es . s ug ge st s th at n ot io n of n et w or k or ga ni za tio n is st ill d ev el op in g an d do es n ot h av e a cl ea r m ea ni ng . c ri tiq ue s us e of n et w or k an al ys is a nd co nc ep t o f n et w or k or ga ni za tio n, w hi ch h av e lit tle o ve rl ap in th e lit er at ur e. a pp lie s “c om pe te nc e ba se d” v ie w o f t he fi rm to e m er gi ng tr an sn at io na l c or po ra te (t n c ) re ta ili ng in du st ry . a na ly ze s ge og ra ph ic im pa ct o f o rg an iz at io na l l ea rn in g an d in ve st ig at es ad ap ta tio n am on g re ta il t n c s, to ra is e aw ar en es s of th ei r c on ce pt ua l i m po rt an ce . u se s co nc ep t o f i nt er -fi rm , i nt ra -fi rm , a nd e xt ra -fi rm re la tio na l n et w or k to s he d lig ht o n na tu re of e m be dd ed ne ss . o ff er s m or e de ta il by fo cu si ng o n in te rp la y be tw ee n ex tr afir m n et w or ks of s to re -b as ed le ar ni ng a nd in tr afir m n et w or ks o f k no w le dg e ex ch an ge a nd o rg an iz at io na l ad ap ta tio n. a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks 84 journal of business strategies pe ng & z ho u (2 00 5) e vo lu tio na l n et w or k th eo ry r el at io na l e xa m in es h ow n et w or k st ra te gi es e vo lv e w ith in st itu tio na l t ra ns iti on s. a rg ue s th at w hi le ce rt ai n ne tw or k st ra te gi es a re b ec om in g le ss im po rt an t, ot he r n et w or k st ra te gi es m ay b ec om e m or e cr uc ia l. sp ec ifi ca lly , w ea k tie s tr at eg ie s m ay d om in at e ne tw or k st ra te gy c ho ic es a s tr an si tio n ev ol ve s. in st ea d of b ei ng p ha se d ou t, st ro ng ti es m ay b e tr an sf or m ed in to w ea k tie s. a rg ue th at p ol iti ca l a nd le ga l f or ce s m ay s ha pe th e co nt en t o f d iff er en t n et w or ks th at fo cu s on b us in es sto -g ov er nm en t a nd b us in es sto -b us in es s tie s. s up po rt s id ea th at b us in es s ne tw or ks in a si a dr iv en b y im pa ct o f i ns tit ut io na l c ha ng e. n ot es th at th e di ff er en ce s be tw ee n fir m s in d ev el op ed a nd e m er gi ng e co no m ie s is n ot th at fo rm al , d o no t u se n et w or k st ra te gi es an d th e la tte r o nl y us e ne tw or k st ra te gi es . a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns l av ie (2 00 6) pr ov an & k en is (2 00 7) e vo lu tio na l st ru ct ur al e m be dd ed ne ss n et w or k th eo ry o rg an iz atio na l, re la tio na l, & n et w or k n et w or k st re ss es th eo ry d ev el op m en t r at he r t ha n lo gi ca l p os iti vi sm . c on tr ib ut es to a d eb at e fr om di ff er en t t he or et ic al v ie w s. f in al ly , i t o ff er s a dy na m ic s ta bi lit y ap pr oa ch to a na ly ze n et w or k re se ar ch . a ut ho rs s ee o rg an iz at io na l n et w or ks a s co m pl ex a da pt iv e sy st em th at e xh ib its b ot h pe rs is te nc e an d ch an ge . pr ov id es ra tio na le fo r s tu dy in g ne tw or k go ve rn an ce , i ts ro le , a nd it s im pa ct o n ne tw or k ef fe ct iv en es s. p ro po se s th re e ba si c fo rm s of n et w or k go ve rn an ce (n a o m od el , l ea d or ga ni za tio na l g ov er ne d ne tw or ks , a nd p ar tic ip an t g ov er ne d ne tw or ks ). a ls o di sc us se s te ns io ns in e ac h go ve rn an ce fo rm a nd h ow to m an ag e th em . l av ie (2 00 6) m ot iv at io na l r es ou rc eba se d vi ew fi rm & re la tio na l o ff er s sy st em at ic th eo re tic al a na ly si s of c om pe tit iv e ad va nt ag e of fi rm a lli an ce s an d in te gr at es a nd e xt en ds re la tio na l v ie w /s oc ia l n et w or k th eo ri es w ith tr ad iti on al re so ur ce ba se d vi ew (r b v ) w ith a re fo rm ul at ed v er si on th at s ho ul d be ta ke n in to a cc ou nt in n et w or k lit er at ur e. c on tr ib ut es to e xt en si on o f r b v a nd fi rm s’ c om pe tit iv e ad va nt ag e in n et w or ke d en vi ro nm en ts . a ut ho r r ev ea ls h ow a fi rm c an e xt ra ct v al ue fr om re so ur ce s th at a re n ot fu lly ow ne d or c on tr ol le d by it s in te rn al o rg an iz at io n. t o do s o, h e de ve lo ps m od el th at a llo w s fo r es tim at in g di ff er en t t yp es o f e co no m ic re nt th at fi rm c an g en er at e by re ly in g on re so ur ce s ac ro ss it s ne tw or k of a lli an ce s. it id en tifi es fi rm -s pe ci fic , r el at io nsp ec ifi c an d pa rt ne rsp ec ifi c fa ct or s. f in al ly , i t c al ls fo r i nt eg ra tio n of r b v a nd n et w or k th eo ri es . ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks volume 30, number 1 85 pr ov an , f is h, & s yd ow (2 00 7) d ac in , o liv er , & r oy (2 00 7) pe te rs , g as se nh ei m er & j oh ns to n (2 00 9) st ru ct ur al m ot iv at io na l in te ra ct io na l n et w or k th eo ri es in st itu tio na l o rg an iz at io na l le ar ni ng & st ru ct ur at io n th eo ry n et w or k fi rm o rg an iz atio na l & re la tio na l m ai nl y fo cu se s on in te ro rg an iz at io na l n et w or ks a t t he n et w or k le ve l r at he r t ha n at or ga ni za tio na l o r r el at io na l l ev el o f a na ly si s. a rg ue s th at w e ne ed to e xa m in e w ho le ne tw or k, to fu rt he r u nd er st an d is su es s uc h as h ow n et w or ks e vo lv e, a re g ov er ne d, a nd h ow ne tw or k ou tc om es m ig ht b e ge ne ra te d. f or in st an ce , s tu dy in g th e w ho le n et w or k w ou ld h el p sh ed li gh t o n ho w m ul til at er al c ol la bo ra tio n im pa ct s ov er al l b us in es s cl im at e in a n in du st ry or re gi on . s ug ge st s re se ar ch er s an d pr ac tit io ne rs s ho ul d ha ve p er sp ec tiv es th at g o be yo nd pe rf or m an ce o f i nd iv id ua l o rg an iz at io ns . a ls o no te s th at s tu dy in g w ho le n et w or k m ay re ve al im pl ic at io ns fo r i ts m em be rs , e .g ., st ag e of n et w or k ev ol ut io n m ay e xp la in h ow in di vi du al s re ac h th ei r g oa ls . a gu es le gi tim ac y ga in ed v ia p ar tic ip at io n in s tr at eg ic a lli an ce c an h av e a m aj or im pa ct o n fir m p er fo rm an ce . s ug ge st s al lia nc es s er ve im po rt an t f un ct io ns fo r fi rm s. p ro po se s fiv e ty pe s of le gi tim ac y as so ci at ed w ith a lli an ce s (m ar ke t, re la tio na l, so ci al , i nv es tm en t, an d le gi tim ac y) . o ff er s pr op os iti on s to e xp la in w he n fir m s ar e m os t l ik el y to e nt er in to a lli an ce s fo r l eg iti m ac y pu rp os es a nd h ow le gi tim at in g ro le o f a lli an ce s co nt ri bu te s to fi rm a nd al lia nc e pe rf or m an ce . m os t i m po rt an tly , s up po rt s id ea th at le gi tim at io n m ay b e an im po rt an t ro le fo r a lli an ce s an d ex te nd s al lia nc e lit er at ur e fr om in st itu tio na l p er sp ec tiv e. a rg ue s th at th e ne w m ar ke tin g lo gi c re qu ir es m or e re fin em en t a nd e xp lic itn es s in ne tw or ki ng li te ra tu re . a dd re ss es th is n ee d by e xp lo ri ng h ow v al ue c re at io n in m ar ke tin g re lie s on o rg an iz at io na l l ea rn in g. u se s st ru ct ur at io n th eo ry to e xp la in re la tio ns hi p be tw ee n or ga ni za tio na l a nd in di vi du al le ar ni ng . e xp lo re s th re e fa ce ts o f s tr uc tu ra tio na l p ro ce ss o f or ga ni za tio na l l ea rn in g: (1 ) s tr uc tu ra l p ro pe rt ie s th at e na bl e an d co ns tr ai n le ar ni ng p ro ce ss es , (2 ) w ay s th at in di vi du al s ca rr y ou t l ea rn in g pr ac tic e, (3 ) s oc ia l p ro ce ss in w hi ch le ar ni ng pr ac tic es a re e m be dd ed . i llu st ra te s pr oc es s w ith e xa m pl es o f t yp ic al n et w or k re la tio ns hi p in co ns tr uc tio n in du st ry a nd h ig hl ig ht s ro le o f m ar ke tin g in e nh an ci ng k no w le dg e m an ag em en t, or ga ni za tio na l l ea rn in g, a nd v al ue c re at io n. a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks 86 journal of business strategies g an es an , g eo rg e, j ap , pa lm at ie r, & w ei tz (2 00 9) m cg ui re & d ow (2 00 9) st ru ct ur al st ru ct ur al k no w le dg e m an ag em en t & ne tw or k th eo ri es (i m pl ic it) u nc le ar fi rm & re la tio na l n et w or k d is cu ss es h ow re ce nt tr en ds a nd c ha ng es in re ta ile r s up pl y ch ai n m an ag em en t i m pa ct fir m p er fo rm an ce . p ro po se th re e di re ct io ns in w hi ch re ta ile rs le ve ra ge u ps tr ea m a nd do w ns tr ea m re la tio ns hi ps in s up pl y ch ai n to c re at e pe rf or m an ce o ut co m es fo r b ra nd s, re pu ta tio n, re ve nu es , i nn ov at io n, a nd lo ng te rm p ro sp ec ts (s ou rc in g pr ac tic es o n w or ld w id e, m ul tic ha nn el , a nd n at ur e of in te rfi rm ti es b as es ). r ev ie w s m aj or th eo re tic al a nd e m pi ri ca l w or k on v er tic al a nd h or iz on ta l j ap an es e k ei re ts u. d is cu ss es h is to ry , c ha ra ct er s, a nd c ha ng es fo r e ac h ty pe o f k ei re ts u in p os t19 92 p er io d. su gg es ts fu tu re re se ar ch a nd im pl ic at io ns . a ut ho r( s) / y ea r r es ea rc h pe rs pe ct iv e t he or et ic al b as e l ev el o f an al ys is k ey c on tr ib ut io ns ta bl e 2: s um m ar y of s el ec te d e xa m pl es o f c on ce pt ua l r es ea rc h on i nt er fir m n et w or ks volume 30, number 1 87 references achrol, r. s. (1997). changes in the theory of interorganizational relations in marketing: toward a network paradigm. journal of the academy of marketing science, 25 (1), 56-71. achrol, r. s., & kotler, p. (1999). marketing in the network economy. the journal of marketing, 63, 146-163. baker, w. e., faulkner, r. r., & fisher, g. a. (1998). hazard of the market: the continuity and dissolution of interorganizational marketing relationships. american sociological review, 63(2), 147-177. bell, g. g., & zaheer, a. (2007). geography, networks and knowledge flow. organization science, 18(6), 955-972. bell, d. c., katsikeas, c. s., & robson, m. j. (2010). does accommodating a selfserving partner in an international marketing alliance pay off? journal of marketing, 74(nov), 77-93. bensen, k. j. (1975). the interorganizational network as a political economy. administrative science quarterly, 20(2), 229-249. borgatti, s. p., & foster, p. c. (2003). the network paradigm in organizational research: a review and typology. journal of management, 29(6), 991-1013. bourdieu, p. (1983). the forms of capital, in soziale ungleichheiten (soziale welt, sonderheft 2), ed. reinhard kreckel, 183-98, goettingen: otto schartz & co. bourdieu, p. (1986), the forms of capital. in: richardson, j. g. ed. handbook of theory and research for the sociology of education. new york: greenwood press. brass, d., galaskeiwicz, j. greve, h. r., & tsai, w. (2004). taking stock of networks and organizations: a multilevel perspective. academy of management journal, 47(6), 795-817. burt, r.s. (1997). the contingent value of social capital. administrative science quarterly, 42, 339-365. chaskin, r. j., brown, p., venkatesh, s., & vidal, a. (2001). building community capacity. new york: aldine de gruyter. coase, r. (1937). the nature of the firm. economica, 4(16), 386-405. 88 journal of business strategies contractor, f. j., & lorange, p. (1988). cooperative strategies in international business. oxford, uk: elsevier science, ltd. cook, k. s. (1977). exchange and power in networks of interorganizational relations. the sociological quarterly, 18(1), special issue, 62-82. coleman, j. s. (1988). social capital in the creation of human capital. american journal of sociology, 94, s95-s120. dacin, m. t., oliver, c., & roy, j-p. (2007). the legitimacy of strategic alliances: an institutional perspective. strategic management journal, 28, 169-187. dahab, d .j., gentry, j. w., & sohi, r. s. (1996). interest domination as a framework for exploring channel changes in transforming economies. journal of macromarketing, 16(2), 8-23. das, t. k., & teng, b-s. (2000). a resource-based theory of strategic alliance. journal of management, 26(1), 31-61. das, t. k., & teng, b-s. (2002). alliance constellations: a social exchange perspective. the academy of management review, 27(3), 445-456. dimaggio, p. j,. & powell, w. w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48, 147-160. dyer, j. h. & nobeoka, k. (2000). creating and managing a high performance knowledge sharing network: the toyota case. strategic management journal, 21, 345-67. eccles, r. g., & crane, d. b. (1988). doing deals: investment banks at work. boston: harvard business school press. eisenhardt, k. m., & schoonhoven, c. b. (1996). resource based view of strategic alliance formation: strategic and social effects in entrepreneurial firms. organization science, 7(2), 136-150. fabrizio, c. (2011). contractual networks, interfirm cooperation and economics growt., cheltenham, uk: edward elgar publishing, inc. flint, g. d., & fleet, d. d. (2011). the competitive cohort: an extension of strategic understanding. journal of business strategies, 28(2), 97-122. fombrun, c. j. (1982). strategies for network research in organizations. the academy of management review, 7(2), 280-291. volume 30, number 1 89 frels, j. k., shervani, t. & srivastava, r. k. (2003). the intergrated networks model: explaining resource allocation in network markets. journal of marketing, 67(1), 29-45. ganesan, s., george, m., jap, s., palmatier, r.w., & weitz, b. (2009). supply chain management and retailer performance: emerging trends, issues, and implications for research and practice. journal of retailing, 85(1), 84-94. gerlach, m. l. (1992). alliance capitalism: the social organization of japanese business. berkeley, ca: university of california press. giddens, a. (1984). the constitution of society. outline of the theory of structuration. cambridge: polity. graddy, e. a., & chen, b. (2006). influences on the size and scope of networks for social service delivery. journal of public administration research and theory, 16, 533–552. granovetter, m. (1973). the strength of weak ties. american journal of sociology, 78(6), 1360-1390. granovetter, m. (1983). the strength of weak ties: a network theory revisited, in social structure and network analysis, p.v. mardsen and nan lin (eds), 201-233, beverly hills, ca: sage publications. gu, f. f., hung, k., & tse, d. k. (2008). when does guanxi matter? issues of capitalization and its dark sides. journal of marketing, 72(4), 12-28. gulati, r. (1993). the dynamics of alliance formation. unpublished doctoral dissertation, harvard university. gulati, r. (1999). network location and learning: the influence of network resources and firm capabilities on alliance formation. strategic management journal, 20(5), 397-420. gulati, r., & garguilo, m. (1999). where do interorganizational networks come from? american journal of sociology, 104(5), 1439-93. gulati, r., & westphal, j. d. (1999). cooperate or controlling? the effects of ceoboard relations and the content of interlocks on the formation of joint ventures. administrative science quarterly, 44, 473-506. gulati, r., nohria, n., & zaheer, a. (2000). strategic networks. strategic management journal, 21, 203-205. http://en.wikipedia.org/wiki/polity_%28publisher%29 90 journal of business strategies gulati, r., dialdin, d. a., & wang, l. (2002). organizational networks. in j. a. c. baum (ed.), the blackwell companion to organizations: 281-303. malden, ma: blackwell. holmes, r. m., bromiley, p., devers, c. e., holcomb, t. r., & mcguire, j. b. (2011). management theory applications of prospect theory: accomplishments, challenges, and opportunities. journal of management, 37(4), 1069-1107. human, s. e., & provan, k. g. (2000). legitimacy building in the evolution of small-firm networks: a comparative study of success and demise. administrative science quarterly, 45, 327–65. iacobucci, d. (1996). networks in marketing. thousand oaks, ca: sage publications. ingram, p., & baum, j. a. c. (1997). chain affiliation and the failure of manhattan hotels, 1998-1980. administrative science quarterly, 42, 68-102. inzerilli, g. (1990). the italian perspective: flexible organization and social management. international studies of management and organization, 20, 6–21. jones, c., & defillippi, r. j. (1996). back to the future in film: combining industry and self-knowledge to meet career challenges of the 21st century. academy of management executive, 10(4), 89–104. jones, c., hesterly, w. s., & borgatti, s. p. (1997). a general theory of network governance: exchange conditions and social mechanism. the academy of management review, 22(4), 911-945. keister, l. a. (1998). engineering growth: business group structure and firm performance in china’s transitional economy. american journal of sociology, 104, 404-40. khanna, t., & rivkin, j. w. (2006). interorganizational ties and business group boundaries evidence from an emerging economy. organization science, 17(3), 333-352. kogut, b. (1988). joint ventures: theoretical and empirical perspectives. strategic management journal, 9(4), 319-332. khoja, f. (2010). the triad: organizational cultural values, practices and strong social intra-firm networks. journal of business strategies, 27(2), 205-228. volume 30, number 1 91 koka, b. r., & prescott, j. e. (2002). strategic alliance as social capital: a multidimensional view. strategic management journal, 23, 795-816. koza, m. p., & lewin, a.y. (1999). the coevolution of network alliances: a longitudinal analysis of an international professional service network. organization science 10, 638–53. kumar, a, heide, j. b., & wathne, k. h. (2011). performance implications of mismatched governance regimes across external and internal relationships. journal of marketing, 75(march), 1-17. larson, a. (1992). network dyads in entrepreneurial settings: a study of the governance of exchange processes. administrative science quarterly, 397, 76-104. larson, a., & starr, j. a. (1993). a network model of organization formation. enterpreneurship theory and practice, winter, 1042-2578. lavie, d. (2006). the competitive advantage of interconnected firms: an extension of the resource based view. academy of management review, 31(3), 638-658. lazerson, m. (1995). a new phoenix? modern putting-out in the modena knitwear industry. administrative science quarterly, 40, 34–59. lee, c., lee, k., & pennings, h. m. (2001). internal capabilities, external networks, and performance: a study on technology-based ventures. strategic management review, 22, 615-640. lee, s., kroll, m. j., & walters, b. a. (2011). stages of corporate governance in transition economies. journal of business strategies, 28(2), 151-176. liao, y. c. (2010). internal capabilities, external network position, and knowledge creation. doctoral dissertation, rensselaer polytechnic institute, 2010. lin, n. (1999). building a network theory of social capital. connections, 22(1), 28-51. liu, y., atinc, g., & kroll, m. (2011). the unique nature of chinese corporate governance practices. journal of business strategies, 28(1), 29-58. lusch, r. f., & brown, j. r. (1996). interdependency, contracting, and relational behavior in marketing channels. journal of marketing, 60(october), 19-38. madhavan, r., koka, b. r., & prescott, j. e. (1998). networks in transitions: how industry events (re)shape interfirm relationships. strategic management journal, 19(5), 439-459. 92 journal of business strategies mariotti, f. (2011). knowledge mediation and overlapping in interfirm networks. journal of knowledge management, 15(6), 875-899. mariti, p. & similey, r. h. (1983). co-operative agreements and the organization of industry. the journal of industrial economics, 16(4), 437-451. mcevily, b., & zaheer, a. (2004). architects of trust: the role of network facilitators in geographical clusters. in trust and distrust in organizations, ed. r. kramer and k. cook, 189-213. new york: russell sage foundation. mcguire, j., & dow, s. (2009). japanese keiretsu: past, present, future. asia pacific journal of management, 26, 333-351. morgan, r. e. (2004). market-based organizational learning – theoretical reflections and conceptual insights. journal of marketing management, 20, 67-103. nygaard a. & dahlstrom, r. (2002). role stress and effectiveness in horizontal alliances. the journal of marketing, 66(2), 61-82. osborn, r. n., & baughn, c. c. (1990). forms of interorganizational governance for multinational alliances. academy of management journal, 3, 503-519. peng, m. w. (2003). institutional transitions and strategic choice. the academy of management review, 28(2), 275-296. peng, m.w., & zhou, j. q. (2005). how network strategies and institutional transitions evolve in asia. asia pacific journal of management, 22, 321-336. peters, l. d., gassenheimer, j. b., & johnston, w. j. (2009). marketing and the structuration of organizational learning. marketing theory, 9, 341-368. pfeffer, j., & nowak, p. (1976). joint ventures and interorganizational interdependence. administrative science quarterly, 21(3), 398-418. pisano, g. p. (1989). using equity participation to support exchange: evidence from the biotechnology industry. journal of law, economics and organization, 5(1), 109–126. podolny, j. m, & page, k. l. (1998). network forms organization. annual review sociology, 24, 57-76. porter, m., & fuller, m. b. (1986). coalitions and global strategy. in michael porter, ed. competition in global industries, 315-344, boston: hbs press. volume 30, number 1 93 portes, a. (1998). social capital: its origins and applications in modern sociology. annual review of sociology, 24, 1-24. powell, w. w. (1990). neither market or hierarchy: network forms of organization. research in organizational behavior, 12, 295. provan, k. g., isett, k. r., & milward, h. b. (2004). cooperation and compromise: a network response to conflicting institutional pressures in community mental health. nonprofit and voluntary sector quarterly, 33, 489-514. provan, k.g., & kennis, p. (2007). modes of network governance: structure, management, and effectiveness. journal of public administration research and theory, august, 1-24. provan, k.g., & sebastian, j.g. (1998). network within networks: service link overlap, organizational cliques and network effectiveness. the academy of management review, 41(4), 453-463. putnam, r. d. (2000). bowling lane: the collapse and revival of american community. new york: simon & schuster. reve, t., & stern, l. w. (1979). interorganizational relations in marketing channels. the academy of management review, 4(3), 405-16. rindfleisch, a., & moorman, c. (2001). the acquisition and utilization of information in new product alliances: a strength of ties perspective. journal of marketing, 65, 1-18. rowley, t., behrens, d., & krackhardt, d. (2000). redundant governance structures: an analysis of structural and relational embeddedness in the steel and semiconductor industries. strategic management journal, 21, 369-386. scott r.w. (1987). the adolescence of institutional theory. administrative science quarterly, 32, 493-511. snow, c. c., miles, r.e., & coleman, h.j., jr. (1992). managing 21st century network organizations. organizational dynamics, 21(winter), 5-20. stigler, g. j. (1951). the division of labor is limited by the extent of the market. journal of political economy, 59(3), 185-93. swaminathan, v., & moorman, c. (2009), “marketing alliances, firm networks, and firm value creation. journal of marketing, 73, 52-69. 94 journal of business strategies sydow, j., & windeler, a. (1998). organizing and evaluating interfirm networks: a structurationist perspective on network processes and effectiveness. organization science, 9(3), 265-283. teisman, g. r., & klijn, e. h. (2002). partnership arrangements: governmental rhetoric or governance scheme? public administration review, 62, 197-205. thorelli, h. b. (1986). networks: between markets and hierarchies. strategic management journal, 7, 37-51. uzzi, b. (1996). the sources and consequences of embeddedness for the economic performance of organizations: the network effects. american sociological review, 61, 674-698. uzzi, b. (1997). social structure and competition in interfirm networks: the paradox of embeddedness. administrative science quarterly, 42, 35-76. uzzi, b. (1999). embeddedness in the making financial capital: how social relations and networks benefit firms seeking financing. american sociological review, 64(4), 481-505. venkatraman, n., & lee, c. (2004). preferential linkage and network evolution: a conceptual model and empirical test in the u.s. video game sector. academy of management journal, 47, 876-892. walker, o. c., jr. (1972). the effects of learning on bargaining behavior. in 1971 combined proceedings, f. c. allvine, ed. chicago: american marketing association, 1, 94-99. walker g., kogut, b., & shan, w. (1997). social capital, structure holes and the formation of an industry network. organization science, 8(2), 109-125. weiner, b. j., & alexander, j. a. (1998). the challenges of governing public-private community health partnerships. health care management review, 23(2), 39-55. westbrock, b. (2010). natural concentration in industrial research collaboration. the rand journal of economics, 41(2), 351-371. williamson, o. e. (1975). market and hierarchies: analysis of antitrust implications. london, uk: the free press. williamson, o. e. (1985). the economic institutions of capitalism: firms, markets, relational contracting. new york: free press. volume 30, number 1 95 zaheer, a., & bell, g.g. (2005). benefiting from network position: firm capabilities, structural holes, and performance. strategic management journal, 26, 809-82. biographical sketch of authors dr. jie g. fowler is assistant professor of marketing at valdosta state university. she received her ph.d in marketing from the university of nebraska-lincoln. her recent work focuses on social networks, beauty appeals in advertising, and family dynamics/relationships in the marketplace. her research appears in journal of macromarketing and advances in consumer research. dr. timothy h. reisenwitz is professor of marketing at valdosta state university. he received his dba in marketing from cleveland state university. his work examines social media, generational cohorts, and academic dishonesty. his research appears in the international journal of internet marketing and advertising, journal of consumer marketing, marketing management journal, journal of college teaching & learning, and academy of educational leadership journal. volume 32, number 1 21 active waiting as business strategy: learning from the serengeti plains c. w. von bergen southeastern oklahoma state university • durant, oklahoma martin s. bressler southeastern oklahoma state university • durant, oklahoma abstract fast decision making, a propensity for action, and getting things done appear to be highly valued by both practitioners and academics in the united states. under such monikers as exhibiting initiative, being proactive, walking the talk, and taking charge, getting things done is widely lauded and promoted. as a result, most managers are content to deal with day-to-day operational activities that require immediate attention, daily routines, and superficial behaviors rather than addressing important issues requiring reflection, systematic planning, creative thinking—and above all— time. to address this often unproductive busyness the authors propose active waiting which involves the recognition that not all problems are open to a quick fix and that sometimes waiting can be a valuable option. however, waiting does not have to be passive. the authors recommend that managers act like the skilled, veteran lions of the serengeti plains and adopt active waiting in order to be able to seize the opportune moment in pursuit of effective business strategy. this paper offers a sixstep process to help leaders integrate active waiting into their supervision style and concludes with recommendations for managers. keywords: business strategy, active waiting, second-mover advantage introduction “every morning in africa, a gazelle wakes up. it knows it must run faster than the fastest lion or it will be killed. every morning a lion wakes up. it knows it must outrun the slowest gazelle or it will starve to death. it doesn’t matter whether you are a lion or a gazelle. when the sun comes up, you better start running” (friedman, 2005, p. 114). the above quote by thomas friedman reminds us that organizations are competing for their very survival and that the quickest, swiftest, and fastest continue to live another day while those left behind become food for the lion. fast action enables both people and organizations to survive and flourish. however, while running is im22 journal of business strategies portant for lions, lions also need to be cautious in doing so. younger lions lacking in experience, will instinctively chase targets often resulting in failure. successful hunters surprise their victims after carefully scanning the horizon and patiently waiting with focused attention for just the right circumstances before taking action (stander & albon, 1993). the key to the lion’s survival is not only size and strength, but also cleverness in knowing when and how to attack their prey. even when hungry, lions will forego a meal rather than hazard a hasty and uncontrolled attack (haas, 2013). the serengeti plains of africa provide us with an important lesson regarding business strategy. that lesson features an overemphasis on quick decision making and speed of action that in many instances at the expense of reflective thinking, thoughtfulness, and resourcefulness demonstrated by the lions’ successful hunting strategy. both the academic and practitioner literature in the united states emphasize the importance of quick decision making and fast action. taking action—the practitioner’s perspective the emphasis on swift action has become so entrenched in management thinking that fastcompany, and their magazine is now a popular read for many business managers. the bias for action has also been underscored by many practitioneroriented books. for example, eccles and nohria (1992), in their book beyond the hype wrote that “management was, is, and always will be the same thing: the art of getting things done…. and to get things done, managers must act themselves and mobilise collective action on the part of others” (p. 32). further, kelley (1998) emphasized initiative along with other proactive behaviors as the explanation that distinguishes top performing employees from average employees in his book how to be a star at work. in addition, bruch and ghoshal (2004) stated in their book a bias for action, that management is essentially the art of doing and getting things done. renowned management guru and former chairman of general electric jack welch, said that “an organization’s ability to learn, and translate that leaping into action rapidly, is the greatest competitive advantage” (welch, n. d.). we are reminded that relentless execution is central to achieving superior business performance (bruch & ghoshal, 2010), and we generally respect individuals who make decisions quickly and even refer to them as “decisive”—a highly valued quality (greenberg, 2011). in their book in search of excellence (1982) peters and waterman pointed to “a bias for action” (p. 119) as an important attribute of excellent companies that supports and strengthens all other qualities. additionally, peters and waterman prescribed “ready, fire, aim” (p. 119) as the means to build an action orientation. volume 32, number 1 23 these books and others provide motivating accounts of organizational heroes who achieve significant success by emphasizing action and speed while at the same time implying that those slow to act are modern-day dinosaurs destined for extinction. the importance of action is even celebrated in motivational posters such as “the essence of survival” from friedman’s 2005 bestseller the world is flat and his accompanying words in the introduction of this paper. from another perspective, the term “analysis paralysis” or “paralysis of analysis” refers negatively to a situation where a person or an organization continues to rework or refine analyses, calculations, or computations, thus extending the decision making process and taking more time than reasonable and necessary, and in some instances with the result being no action taken (langley, 1995). because over the past decade the organizations’ ability to gather, store, access, and analyze data has grown exponentially, too much analysis is becoming an increasing problem (shah, horne, & capellá, 2012). taking action—the academic perspective additionally, the academic literature reports and promotes the importance of fast decision making and taking action. a great deal of research addresses proactive issues (parker & collins, 2010), actively adjusting to new job conditions (ashford & black, 1996), using initiative (den hartog & belschak, 2007), communication to positively change the organization (lepine & van dyne, 1998), promoting critical issues to leaders (dutton & ashford, 1993), taking charge to effect change (morrison & phelps, 1999), self-initiated role expansions (parker, wall, & jackson, 1997), the need for employees to be self-starting (campbell, 2000; ibarra, 2003), and the importance of network building (morrison, 2002). from another perspective keinan and bereby-meyer (2012) observed the danger in avoiding taking action rather than taking action in areas such as dodging cancer screenings (howard & huang, 2012) or not saving for retirement (kogut & dahan, 2012), as well as other researchers have investigated the dangers of inaction including the status quo bias, which is the tendency for people to prefer the current situation rather than consider similar or possibly better options (kahneman, knetsch, & thaler, 1991). despite different terminology and theoretical foundations, these concepts involve an action mindset or in other words, “making things happen.” procrastinators are typically labeled lazy, indolent, and unambitious—pejorative words in achievement-oriented societies (knaus, 1973). desimone (1993), however, reported that many pre-industrialized societies did not have words compa24 journal of business strategies rable to today’s notion of procrastination. similar words or constructs have existed throughout history, although with different, and usually less negative, connotations. the term procrastination comes directly from the latin verb procrastinare, meaning quite literally, to put off or postpone until another day (desimone, 1993). this actually is a compilation of two words—pro, a common adverb implying forward motion, and crastinus, meaning “belonging to tomorrow.” the combined word was used numerous times in latin texts and seemed to reflect the notion that deferred judgment may be necessary and prudent, such as when it is best to wait the enemy out and demonstrate patience in military conflict (ferrari et al., 1995). furthermore, the oxford english dictionary (oed, 1989) lists the earliest known english usage of the word procrastination as occurring in 1548 in edward hall’s chronicle: the union of two noble and illustrious families of lancestre and yorke. according to the oed, the word procrastination was in common usage by the early 1600s and notes that the term was used several times in this work and apparently without disparaging connotations, reflecting more of the concept of “informed delay” or “wisely chosen restraint” popular in roman accounts (ferrari, 2001, p. 30). the negative moral connotations of the term did not seem to emerge until the mid-18th century, at approximately the time of the industrial revolution. perhaps to the ancients, procrastination involved a sophisticated, astute decision regarding when not to act. this paper examines such an interpretation as well as questioning the implicit expectation that managers must do everything quickly, must be permanently active, and must not hesitate to take immediate action. active waiting as described in the successful lion hunts noted earlier in this paper is offered as an alternative approach. active waiting the nature of a manager’s job typically leaves little room for reflection, resulting in supervisors who might ignore or postpone dealing with the organization’s most crucial issues since such matters usually require a “big picture” perspective— which means reflection, systematic planning, or creative thinking, and—above all— time. managers often spend much of their time addressing trivial operational issues that require their energy, time, and focus but are insignificant in the grand scheme of things. daily routines, superficial behaviors, or poorly prioritized tasks act like leeches on managers’ capacities—making unproductive busyness perhaps the most critical behavioral problem in companies (bruch & ghoshal, 2010). american fast-action culture calls for easy answers and quick solutions devolume 32, number 1 25 mand managers determine what is wrong and act quickly to resolve the situation. the abundance of technology and the “instant gratification” technological advancements typically bring (samuelson, 1995) increases the need for quick solutions. managers will often jump to a conclusion and then try to implement the solution they reached. this course of action causes managers to limit their search, not consider all alternatives, and pay enough attention to people who would be affected by the decision, not realizing that decisions often fail because of these reasons (nutt, 1999). fast action is most often favored, even in situations where there is no real time pressure. there seems to be a strong inclination to move forward and a fear of being seen as an indecisive manager. even when managers know that making decisions this way is foolhardy, the pressure for hasty solutions often wins out (nutt, 1999). the virtue of patience organizations tend to be dominated by cultures of frenzy and unreflected activity (gosling & mintzberg, 2003). energized action is necessary, but that does not mean being hyperactive or continuously implementing change. taking time for reflection, seriously reviewing and questioning projects are neither the usual practice nor well received in many organizations. rarely do firms question such values. that is what makes the international federation of red cross and red crescent societies, headquartered in geneva, switzerland so unique. executives there worried that it was drifting too far toward a fast-action culture. it realized that it must act quickly in responding to disasters everywhere—earthquakes, wars, floods and famines—but it also saw the need to engage in the slower, more delicate task of building a capacity for action that was careful, thoughtful, and tailored to local conditions and needs. what was needed was an approach where reflective thinking meets practical doing (gosling & mintzberg, 2003). active waiting, or what the center for advanced health refers to as “watchful waiting”, is a common practice in the health care profession. doctors believe that for certain medical conditions the preferred strategy is to delay treatment while monitoring progress of the illness. in fact, in many instances, such as aching muscles or a child’s ear infection, the illness may be minor and go away on its’ own. using the “watchful waiting” approach, doctors can often better determine the best approach to treating the illness (http:www.cfah.org). active waiting is recommended to encourage the necessary management reflection,. it is a process in which individuals intentionally hold back from impetuously diving into making irreversible commitments of resources (minniti, 2006). 26 journal of business strategies this, however, takes patience. it is often hard for individuals to believe that they will get more done by starting out slowly, patiently, planfully (i.e., by waiting around), but the patience of active waiting is essential for slowing and preparing the mind, which otherwise races on to the next crisis. therefore, “active waiting is less a matter of time management than of emotional management” (boice, 2000, p. 108). leveraging the second-mover advantage many business strategists advocate the value of “first-mover advantage”, being first to market with an innovative new product or technology. other strategy analysts support another school of thought that proposes “second-mover advantage” in which organizations and companies that are followers benefit by learning from first-movers mistakes. these “second movers” in many cases are then able to surpass those companies that rushed to be first in the market. henricks (2009) cites several companies that benefitted from second-mover advantage. for example, voodoo tiki tequila, a high-end tequila liquor challenged the category market leader, patron spirits company. patron’s strategy was based on educating and convincing consumers to switch from drinking vodka to instead drinking tequila. second-mover tiki voodoo tequila did not have to spend the time, effort, and money educating consumers as patron had already taken on that task. instead, tiki instead chose to make significant improvements to packaging. while patron uses a traditional style mexican packaging, tiki uses bottles made from hand-blown glass with a tiki inside the bottle. in addition, each bottle is numbered, giving the impression of a limited series collection. consumers now willingly pay more for a perceived premium, high-end tequila liquor product. henricks (2009) points to other examples of successful second-movers including southwest airlines, which learned from earlier entrants in the economy segment of the airline industry. in addition, google gained considerable knowledge from the experience of previous search engine companies (e.g., webcrawler and lycos). although nokia and ericsson were the early entrants in the cell phone industry, today, companies like samsung and apple tower over the market. active waiting allows the second-mover to take advantage of the market leader’s mistakes or lack of follow-through. in some instances, the market leader might lack intellectual property protection or channels of distribution. in other examples, high costs associated with research and development or market introduction could leave the company in a financially weakened position. in addition, the first-mover might have introduced their product before all the product errors were identified and corrected. volume 32, number 1 27 other examples can also be found where second-mover companies benefitted by active waiting: target stores learned from walmart and amd computer acquired important information from observing intel. the real test however is profitability. rasmusen and yoon (2012) found that when second-movers possess better business or product knowledge, the company can employ second-mover advantage resulting in greater profits. what about the strategic importance of speed? gamble, thompson, and peteraf (2013) reported that mobile phone usage around the world did not immediately take off. in fact, it took ten years for the industry to grow from 10 million users to 100 million users worldwide! similarly, it took nearly ten years for broadband home usage to reach 100 million users around the globe. gamble et al. (2013) also remind us that the market penetration curve for many business opportunities is much longer than many businesses estimate. many additional companies could likely benefit from an active waiting strategy and take better advantage of business opportunities within the market penetration curve. putting active waiting into practice the authors propose a six-step process to implement an active waiting strategy. this approach calls for managers to be doubtful, generate alternatives, assess the alternatives, be flexible, implement slowly, and then take action. this six-step procedure is illustrated in figure 1 and is discussed below. figure 1 the six-step process of active waiting 28 journal of business strategies be doubtful people and organizations both appear to be culturally eager to praise the power of conviction. self-confident persons demonstrate sureness in their ability to make decisions, organize and execute action plans, perform new tasks, and offer opinions (mayo, kakarika, pastor, & brutus, 2012). self-confident leaders are also more likely to be assertive and decisive, which gains others’ confidence in decisions which is crucial for their effective implementation. moreover, kirkpatrick and locke (1991) identified self-confidence as one of six key leadership traits. if leaders are not sure of what decision to make, or express a high degree of doubt, then followers are less likely to trust those leaders and be committed to their vision. such confidence, in fact overconfidence, seems to be central to human nature (kahneman, 2011). individuals are often confident even when they are wrong, and an objective observer is more likely to detect their errors than the person who is wrong. people often have excessive confidence in what they believe they know, and an apparent inability to acknowledge the full extent of their ignorance and the uncertainty of the world they live in. they are prone to overestimate how much they understand about the world and their high subjective confidence is not to be trusted as an indicator of accuracy. individuals also tend to exaggerate their ability to forecast the future, which fosters optimistic overconfidence (kahneman, 2011). nevertheless, some degree of uncertainty may be useful. bandura and locke (2003) reported “in preparing for challenging endeavors, some self-doubt about one’s performance efficacy provides incentives to acquire the knowledge and skills needed to master the challenges’’ (p. 96) and chamorro-premuzic (2012) indicated that being somewhat unsure may be helpful and serve as a catalyst for beneficial change. woodman, akehurst, hardy, and beattie (2010) also found that a decrease in self-confidence resulted in significant improvement in performance from practice to competition in a sports-related activity. gladwell (2013) indicated that “[d]oubt was creative because it allowed for alternative ways to see the world, and seeing alternatives could steer people out of intractable circles and self-feeding despondency. doubt, in fact, could motivate: freedom from ideological constraints opened up political strategies, and accepting the limits of what one could know liberated agents from their dependence on the belief that one had to know everything before acting, that conviction was a precondition for action.” doubt may help prevent what barker (1993) describes as “paradigm paralysis” when it is assumed there is only one way to do something. this condition actually can prevent managers from exploring and considering other options. volume 32, number 1 29 generate alternatives the second step in the process involves developing alternate courses of action in response to an opportunity or threat. management experts often cite the failure to consider alternatives as a key reason why managers sometimes make poor decisions (bazerman & moore, 2008). almost every discussion of effective decision making calls for developing multiple options. the rejected possibilities are not wasted, however, as they assist in confirming the value of a preferred course of action and frequently offers the means to improve it. different choices allow managers in decision-making roles to combine the best features of various options to make a superior one, and to make a comparison with a preferred action to demonstrate its merits. nutt (1999), however, reported that managers produced several courses of action in less than 20 percent of their decisions. when multiple options were developed, success rates jumped from 56 percent to 70 percent. multiple ideas provide another way to increase one’s chance of success but developing several possibilities is time consuming and to save time, the practice is often ignored. moreover, some managers are used to seeing the world from a single perspective due to their “managerial mind-set” and find it difficult to view problems from a fresh perspective. according to best-selling management author peter senge (2006), humans are trapped within our personal mental models of the world—that is, our ideas about what is important and how the world works. generating creative alternatives to solve problems and take advantage of opportunities may require that we abandon our existing mind-sets and develop new ones—something that usually is difficult to do. managers today are encouraged to set aside their traditional paradigms of management decision making and generate creative alternatives. this new approach is reflected in the interest and growth in the work of authors such as senge (2006) and de bono (1968), who have popularized management techniques for stimulating problem solving and creative thinking. more recently gladwell (2013) noted that creativity develops from embracing chaos and releasing control. gladwell (2013) also noted that famed economist albert hirschman even criticized organizations like the world bank for trying to remove obstacles and secure economic and infrastructural stability in developing countries. for hirschman, obstacles cause frustration and anxiety, which in turn spur motivation. this chaotic unpredictability serves as the motor of creative energy—getting the rug pulled out from under us knocks us into a free fall that builds more momentum than standing securely on our feet. 30 journal of business strategies assess alternatives once managers have developed a set of alternatives, they must evaluate the advantages and disadvantages of each alternative (russo & schoemaker, 1992). the key to a good assessment of the alternatives is to define the opportunity or threat exactly and then specify the criteria that should influence the selection of alternatives for responding to the problem or opportunity. one reason for bad decisions is that managers often fail to specify the criteria that are important in reaching a decision (bazerman & moore, 2008). in general, successful managers use four criteria to evaluate the pros and cons of alternative courses of action (jones & george, 2011). often times a manager must consider these four criteria simultaneously: 1. legality: managers must ensure that a possible course of action will not violate any domestic or international laws or government regulations. 2. ethicalness: managers must ensure that a possible course of action is ethical and will not unnecessarily harm any stakeholder group. many decisions managers make may help some organizational stakeholders and harm others. when examining alternative courses of action, managers need to be clear about the potential effects of their decisions. 3. economic feasibility: managers must decide whether the alternatives are economically feasible-that is, whether they can be accomplished given the organization’s performance goals. typically managers perform a cost-benefit analysis of the various alternatives to determine which one will have the best net financial payoff. 4. practicality: managers must decide whether they have the capabilities and resources required to implement the alternative, and they must be sure the alternative will not threaten the attainment of other organizational goals. at first glance an alternative might seem economically superior to other alternatives; but if managers realize it is likely to threaten other important projects, they might decide it is not practical after all. some of the worst managerial decisions can be traced to poor assessment of the alternatives, such as the decision to launch the challenger space shuttle. in that particular case, the desire of nasa and morton thiokol managers to demonstrate to the public the success of the u.s. space program in order to ensure future funding (economic feasibility) conflicted with the need to ensure the safety of the astronauts (ethicalness). managers deemed the economic criterion more important and decided to launch the space shuttle even though there were unanswered questions about volume 32, number 1 31 safety. tragically, some of the same decision-making problems that resulted in the challenger tragedy led to the demise of the columbia space shuttle 17 years later, killing all seven astronauts on board (berger, 2004). in both the challenger and the columbia disasters, safety questions were raised before the shuttles were launched; safety concerns took second place to budgets, economic feasibility, and schedules; top decision makers seemed to ignore or downplay the inputs of those with relevant technical expertise; and speaking up was discouraged (glanz & schwartz, 2003). rather than making safety a top priority, decision makers seemed overly concerned with keeping on schedule and within budget (wald & schwartz, 2003). be flexible centuries ago playwright and keen observer of human behavior william shakespeare noted in the merchant of venice (1596) that “thus hath the candle singed the moth” (act 2 scene 9) meaning that just as a moth is attracted to a flame that leads it to make a fatal mistake, so too are people irresistibly and dangerously tempted by situations that often lead to disaster. similarly, in business a firm’s steadfast commitment to a long-term view of what it should be doing and where it should be going, often touted as a powerful tool for improving corporate performance, can be problematic when such attraction leads to tunnel vision, a narrow concentration, and missing the big picture. for example, sull (2004) details how microsoft’s fixation on mission statements related to pcs blinded them to opportunities and threats presented by the explosive growth of the internet. organizations must be careful to avoid such a “moth-to-candle syndrome” that can lead to its demise. rather than getting too focused on clear, long-term visions that can distract firms from emerging situations in the present, companies may want to consider softening such single-mindedness. indeed, sull (2005) tells leaders to “avoid marching headlong toward a well-defined future and instead articulate a fuzzy vision. ... a fuzzy vision works because it provides a general direction and sets aspirations without prematurely locking the company into a specific course of action” (p. 124). such a vision contributes to a company’s situational awareness—the ability to identify, process, and comprehend the critical elements of information about what is happening around it (united states coast guard, n. d.)—and can act as a corrective measure when organizations fixate on and become preoccupied with one aspiration often losing the ability to detect other important environmental information. fuzzy visions can motivate employers to explicitly consider alternatives and options because the flexible perspective inherent in such mission statements can promote 32 journal of business strategies greater functional dissent and other forms of constructive conflict. such flexibility is particularly important in rapidly changing environments, including emerging markets, technology intensive industries where change is often revolutionary rather than evolutionary, and fields where different industries are converging (e.g., information technology and entertainment). implement slowly the fifth step calls for measured, deliberate action. there is a saying in martial arts: you have to go slow to go fast. the idea is that individuals have to be relaxed and calm to move as quickly as they are capable of doing. famous movie character, ferris bueller, voiced a similar theme when he said, “life moves pretty fast. if you don’t stop and look around once in a while, you could miss it” (hughes, 1987). more formally, nobel laureate daniel kahneman (2011) summarized the research literature on decision-making and problem solving and described mental life by the metaphor of two agents, called system 1 and system 2, which respectively produce fast and slow thinking. system 1 is generally automatic, affective, and heuristic-based, and relies on mental “shortcuts.” it quickly proposes intuitive answers to problems as they arise. system 2, which corresponds closely with controlled processes, is slow, effortful, conscious, rule-based, and also can be employed to monitor the quality of the answer provided by system 1. if system 2 is convinced that our intuition is wrong, then it is capable of correcting or overriding the automatic judgments. system 2 takes over when things get difficult. each system impacts the other because individuals have only so much attentional focus. if system 2 is engaged then system 1 may be negatively impacted. intense focusing on a task can make people miss stimuli that normally attract attention. system 1 thinking can also negatively impact system 2 thinking. in a business context bruch and ghoshal (2002) noted that frequently there is an astonishing amount of fast-moving activity in organizations that allows almost no time for reflection. such unproductive busyness characteristic of system 1 thinking, and what bruch and ghoshal (2002) call “active nonaction,” can be a hazard for managers and organizations since fully 90% of managers squander their time in all sorts of ineffective activities. what is needed is more system 2 thinking or what bruch and ghoshal (2002) refer to as concentrated attention—the ability to zero in on a goal and see the task through to completion which seem to define what they call purposeful managers. volume 32, number 1 33 such attention requires that purposeful managers choose not to respond immediately to every issue that comes their way or get sidetracked from their goals by distractions like email, meeting, setbacks, and unforeseen demands. such system 2 thinking involves carefully weighing options before selecting a course of action. moreover, because purposeful managers commit only one or two key projects, they can devote their full attention to the projects they believe in. purposeful managers manage time carefully and some refuse to respond to phone calls or visitors outside certain periods of the day. other such managers build “think time” into their schedules. one executive, bruch and ghoshal (2002) observed, frequently arrived at the office at 6:00 a.m. to think about issues before his colleagues showed up. this executive said, “in the busiest times, i slow (italics ours) down and take time off to reflect on what i actually want to achieve and sort what’s important from irrelevant noise. then i focus on doing what is most important” (bruch & ghoshal, 2002, p. 68). sometimes it is important to slow down and let an individual’s system 2 take control, which is often associated with the subjective experience of agency, choice, and concentration. this involves active waiting. while the one minute manager (blanchard & johnson, 1981) focused on quick action was a best seller some years ago, more and more discussion is today being focused on reflection and moving forward slowly (honoré, 2004). take action the final step in the six-step strategy is to take action. this final step calls for applying the selected alternative and carrying out the decision. in taking action it may be fitting to consider various mental shortcuts that frequently sabotage managerial judgment and action. hammond, keeney, and raiffa (1998, 1999) and kahneman, slovic, and tversky (1982) have identified several key psychological traps that managers should be alert to and compensate for them when taking action. an example of this would be the status quo bias—the tendency to stick to the current state. by being aware of the role that this bias plays in their own lives, individuals can take actions to reduce the influence of this bias in their decision making. to avoid this error managers should 1) ask if the status quo really serves their objectives, 2) ask if they would choose the status quo if it were not the status quo, and 3) downplay the effort or cost of switching from the status quo. like college students who mistakenly think that in a multiple-choice test, they should always stick with their first answer, rather than changing it (benjamin, cavell, & shallenberger, 1984), managers likewise often misguidedly stay with 34 journal of business strategies those options that first come to mind. they often fail even to think through the possible implications of information that would be harder to get. to minimize the distortion caused by variations in “recallability,” managers must take a very disciplined approach to making forecasts and judging probabilities and should 1) carefully examine all assumptions to ensure they are not unduly influenced by their memory and improperly give more weight to recent events, 2) get actual statistics whenever possible, and avoid being guided by impressions and dramatic events, and 3) try and recall instances of events that are not so memorable. summary and conclusion this paper focuses on the potential benefits of waiting strategically. to some degree this is in response to what the authors consider as an overemphasis on swift action, execution, and doing. while the “ready, fire, aim” concept is about velocity and the profound benefits of moving from ideas into action—from thinking into doing—at the fastest possible speed, it is essential to realize that such an approach may do more harm than good since such a strategy may cause individuals to completely miss the target if activities are undertaken with reckless abandon and bolting into action before due diligence is exercised. managers are encouraged to heed the words of noted financier, warren buffet (n. d.), who said “i insist on a lot of time being spent, almost every day, to just sit and think. that is very uncommon in american business. i read and think. so i do more reading and thinking, and make less impulse decisions than most people in business.” we offer active waiting as an alternative to the cultural and business demands for quick action. today’s fast-paced modern life, in many ways, has encouraged people to demand things immediately and to be impatient. people eat fast food, use high speed internet, and command that their emails be answered within an hour. active waiting, on the other hand, allows managers time for additional study, research and testing, consulting advisors, and thoughtful deliberation—in a word patience. although some situations require a rapid response, emergencies for example, most day-to-day decisions managers make in the course of their duties allow more time to pause and consider possible courses of action. patience is not only a virtue, but can also be considered essential to sound management. the authors find numerous examples of the importance of patience (active waiting) in business, perhaps none more significant than a study by baumann (2010) that found a firm can improve performance through moderate patience, allowing for some additional exploration of other possibilities. volume 32, number 1 35 rasmusen and yoon (2012), henricks (2009), and birger (2006) support the advantages of active waiting. companies ranging from southwest airlines to lowe’s home improvement stores benefited from being second-movers in their respective industries, resulting in better market positions and stronger financial performance. a famous quote by sun tzu in the art of war (goodreads.com) states “if you wait patiently by the river, the body of your enemy will float by”. like the lion waiting for the perfect time to strike its prey, smart managers and organizations need to take the time to thoroughly evaluate their environment, resisting the urge to act too quickly. as the authors present in this paper, many types of organizations find active waiting the best approach in their industry. the question then, is when will your company management adopt an active waiting strategy? references amsel, a. (1992). frustration theory: many years later. psychological bulletin, 112, 396-399. ashford, s. j., & black, j. s. (1996). proactivity during organizational entry: the role of desire for control. journal of applied psychology, 81, 199-214. bandura, a., & locke, e. a. (2003). negative self-efficacy and goal effects revisited. journal of applied psychology, 88(1), 87-99. barker, j. (1993). paradigms: the business of discovering the future. new york: harper business. baumann, o. (2010). search, failure, and the value of moderate patience. retrieved at http://www.sbr-online.de/pdfarchive/einzelne_pdf/sbr_2010_july_234-259.pdf barratt, e. s., & patton, j. h. (1983). impulsivity: cognitive, behavioral, and psychophysiological correlates. in m. zuckerman (ed.), biological bases of sensation seeking, impulsivity, and anxiety (pp. 77-116). hillside, nj: lawrence erlbaum associates. bazerman, m. h., & moore, d. a. (2008). judgment in managerial decision making (7th ed.).new york: wiley. benjamin, l. t., cavell, t. a., & shallenberger, w. r. (1984). teaching of psychology, 11(3), 133-141. berger, b. (2004, january 26). nasa: one year after columbia—bush’s new vision changes agency’s course midstream, space news business report, retrieved at http://www. space.com/spacenews/businessmonday_040126.html birger, j. (2006). second-mover advantage. fortune, 153(5), 20-21. 36 journal of business strategies blanchard, k., & johnson, s. (1981). the one minute manager. new york: the william morrow company, inc. boice, r. (2000). advice for new faculty members. needham heights, ma: allyn and bacon. briñoll, p., petty, r. e., & tormala, z. l. (2006). the malleable meaning of subjective ease. psychological science, 17(3), 200-206. bruch, h., & ghoshal, s. (2002). beware the busy manager. harvard business review, 80(2), 63-69. bruch, h., & ghoshal, s. (2004). a bias for action: how effective managers harness their willpower, achieve results, and stop wasting time. boston: harvard business school press. bruch, h., & ghoshal, s. (2010). think again: management is the art of doing and getting done. business strategy review, 21(2), 70-75. buffet, w. (n. d.). warren buffet quotes. retrieved at http://www.goodreads.com/ author/quotes/756.warren_buffett campbell, d. j. (2000). the proactive employee: managing workplace initiative. academy of management executive, 14, 52-66. center for advanced health “what is watchful waiting?” retrived at http://www. cfah.org/prepared-patient/make-good-treatment-decisions/ chabris, c. f., & simons, d. j. (2009). the invisible gorilla: how our intuitions deceive us. new york: crown publishing. chamorro-premuzic, t. (2012). less-confident people are more successful. retrieved from http://blogs.hbr.org/2012/07/less-confident-people-are-more-su/ den hartog, d. n., & belschak, f. d. (2007). commitment, affect and initiative at work. journal of occupational and organizational psychology, 80, 601-622. de bono, e. (1968). lateral thinking. london: penguin. desimone, p. (1993). linguistic assumptions in scientific language. contemporary psychodynamics: theory, research & application, 1, 8-17. dutton, j. e., & ashford, s. j. (1993). selling issues to top management. academy of management review, 18, 397-428. eccles, r. g., & nohria, n. (1992). beyond the hype. boston: harvard business school press. ferrari, j. r. (2001). getting things done on time: conquering procrastination. in c. r. snyder, coping with stress: effective people and processes (pp. 30-46). new york: oxford university press. ferrari, j. r., johnson, j. l., & mccown, w. g. (1995). procrastination and task avoidance: theory, research, and treatment. new york: plenum press. volume 32, number 1 37 freud, s. (1959). collected papers, vol. 4. new york: basic books. friedman, t. l. (2005). the world is flat. new york: farrar, straus and giroux. gamble, j., thompson, a., & peteraf, m. (2013). essentials of strategic management, the quest for competitive advantage (3rd ed.). new york: irwin/mcgraw-hill. gladwell, m. (2013). the gift of doubt: albert o. hirschman and the power of failure. the new yorker. retrieved at http://www.newyorker.com/arts/critics/ books/2013/ 06/24/130 624crbo_books_gladwell?currentpage=all glanz, j., & schwartz, j. (2003, september 26). dogged engineer’s effort to assess shuttle damage. the new york times, p. a1. gollwitzer, p. m. (1996). the volitional benefits of planning. in p. m. gollwitzer & j. a. bargh (eds.), the psychology of action: linking cognition and motivation to behavior (pp. 287-312). new york: guilford. gosling, j., & mintzberg, h. (2003, november). the five minds of a manager. harvard business review, 1-9. greenberg, j. (2011). behavior in organizations (10th ed.). upper saddle river, nj: prenticehall. haas, r. b. (2013). masters of their universe: business (and life) secrets taught by four-legged professors. minneapolis, mn: langdon street press. hammond, j. s., keeney, r. l., & raiffa, h. (1998). the hidden traps in decision making. harvard business review, 76(5), 47-48, 50. hammond, j. s., keeney, r. l., & raiffa, h. (1999). smart choices: a practical guide to making better decisions. boston: harvard business press. henricks, m. (2009, june). when second really is the best. entrepreneur, 71-77. honoré, c. (2004). in praise of slow: how a worldwide movement is challenging the cult of speed. new york: harpercollins publishers. howard, d. h., & huang, y. (2012). serious health events and discontinuation of routine cancer screening. medical decision making, 32, 627-635. hughes, j. (director) (1987). ferris bueller’s day off (movie). paramount pictures. ibarra, h. (2003). working identity: unconventional strategies for reinventing your career. cambridge, ma: harvard business school press. jones, g. r., & george, j. m. (2011). contemporary management (seventh ed.). new york: mcgraw-hill/irwin. kahneman, d. p. (2011). thinking, fast and slow. new york: farrar, straus, and giroux. kahneman, d. p., knetsch, j. l., & thaler, r. h. (1991). anomalies: the endowment effect, loss aversion, and status quo bias. the journal of economic perspectives kahneman, d. p. slovic, p., & tversky, a. (eds.). (1982). judgment under uncertainty: heuristics and biases. new york: cambridge university press. 38 journal of business strategies keinan, r., & bereby-meyer, y. (2012). “leaving it to chance”—passive risk taking in everyday life. judgment and decision making, 7(6), 705-715. kelley, r. e. (1998). how to be a star at work: 9 breakthrough strategies you need to succeed. new york: times books. kirkpatrick, s. a., & locke, e. a. (1991). leadership: do traits matter? academy of management executive, 5(2), 48-60. klein, g. (2007). performing a project premortem. harvard business review, 85(9), 18-19. knaus, w. (1973). overcoming procrastination. rational living, 8, 2-7. kogut, t., & dahan, m. (2012). do you look forward to retirement? motivational biases in pension decisions. judgment and decision making, 7, 282-291. langer, e. j. (1989). mindfulness. new york: perscus books. langley, a. (1995). between “paralysis by analysis” and “extinction by instinct.” sloan management review, 36(3), 63-76. lawson, r. (1965). frustration: the development of a scientific concept. new york: macmillan. lepine, j. a., & van dyne, l. (1998). predicting voice behavior in work groups. journal of applied psychology, 83, 853-868. loewenstein, g., & elster, j. (1992). choice over time. new york: sage. marrow, a. j., bowers, d. f., & seashore, s. e. (1967). management by participation. new york: harper and row. mayo, m., kakarika, a. m., pastor, j. c., & brutus, s. (2012). aligning or inflating your leadership self-image? a longitudinal study of responses to peer feedback in mba teams. academy of management learning & education, 11(4), 631-652). minniti, m. (2006). entrepreneurship. westport, cn: greenwood publishing group. mischel, w. (1974). processes in delay gratification. in l. berkowitz (ed.), advances in experimental social psychology, vol. 7 (pp. 249-292). new york: academic press. morrison, e. w. (2002). newcomers’ relationships: the role of social networks during socialization. academy of management journal, 45, 1149-1160. morrison, e. w., & phelps, c. c. (1999). taking charge at work: extrarole efforts to initiate workplace change. academy of management journal, 42, 403-419. nutt, p. c. (1999). surprising but true: half the decisions in organizations fail. academy of management executive, 13 (4), 75-90. oxford english dictionary (2nd ed.). (1989). j. simpson & e. weiner (eds.). oxford: oxford university press. volume 32, number 1 39 parker, s. k., & collins, c. g. (2010). taking stock: integrating and differentiating multiple proactive behaviors. journal of management, 36(3), 633-662. parker, s. k., wall, t. d., & jackson, p. r. (1997). “that’s not my job”: developing flexible employee work orientations. academy of management journal, 40, 899-929. peters, t. j., & waterman, r. h. j. (1982). in search of excellence: lessons from america’s best-run companies. new york: harpertrade. rasmusen, e., & yoon, y. (2012). first versus second mover advantage with information asymmetry about the profitability of new markets. journal of industrial economics, 60(3), 374-405. read, j. d. (1995). the availability heuristic in person identification: the sometimes misleading consequences of enhanced contextual information. applied cognitive psychology, 9(2), 91-121. rogers, w. (n. d.). will rogers legacy: remembering that old cowboy. retrieved at http://www.parks.ca.gov/?page_id=23998 russo, j. e., & schoemaker, p. j. h. (1992). decision traps: ten barriers to brilliant decision-making and how to overcome them. samuelson, r. j. (1995). the good life and its discontents: the american dream in the age of entitlement, 1945-1995. new york: times books. senge, p. m. (2006). the fifth discipline: the art & practice of the learning organization. new york: currency. shah, s., horne, a., & capellá, j. (2012). good data won’t guarantee good decisions. harvard business review, 90(4), 23-25. shakespeare, w. (1596). the merchant of venice. retrieved from http://www.opensource shakespeare.org/views/plays/playmenu.php?workid=merchantvenice stander, p. e., & albon, s. d. (1993). hunting success of lions in a semi-arid environment. symposia of the zoological society of london, 65, 127-143. sull, d. n. (2004). look out for the tunnel vision trap. retrieved from http://www.ft.com/cms/s/2/e0bcb1ac-e576-11d8-bfd2-00000e2511c8. html#axzz2hthbw1xb sull, d. n. (2005). strategy as active waiting. harvard business review, 83(9), 120-129. sun tzu. (n. d.). sun tzu quotes. retrieved at https://www.goodreads.com/ quotes/803224-if-you-wait-patiently-by-the-river-the-body-of united states coast guard. (n. d.). situational awareness. retrieved from http://www.uscg.mil/auxiliary/training/tct/chap5.pdf vanderbilt, t. (n. d.). tom vanderbilt reviews the invisible gorilla. retrieved at http://www.amazon.com/the-invisible-gorilla-intuitions-deceive/dp/0307459667 40 journal of business strategies wald, m. l., & schwartz, j. (2003, august 28). nasa chief promises a shift in attitude. the new york times, p. a23. welch, j. (n. d.). retrieved from http://www.brainyquote.com/quotes/quotes/j/jackwelch 173305.html woodman, t., akehurst, s., hardy, l., & beattie, s. (2010). self-confidence and performance: a little self-doubt helps. psychology of sport and exercise, 11(6), 467-470. brief biographical sketch of authors c.w. von bergen is professor of management and the john massey endowed chair in management at southeastern oklahoma state university. dr. von bergen has authored more than 100 articles for a wide variety of academic journals, focusing on the fields of human resources, employee relations, and organizational behavior issues. martin s. bressler is professor of management & marketing and the john massey endowed chair in entrepreneurship at southeastern oklahoma state university. dr. bressler is a fulbright scholar and served as resource panel expert to the 1995 white house conference on small business. dr. bressler has authored many articles, focusing primarily on small business and entrepreneurship. the urge to merge: the role of governance structures in mergers and acquisitions catherine m. daily purdue university west lafayette, in dan r. dalton indiana university bloomington, in abstract the 1990s have witnessed merger and acquisition activity which rivals that of the 1980s "merger mania." as firms continue to consolidate either within industries or across industries it is appropriate to investigate those a!,pects of a target firm which might attract a bidder. the board of directors, a central decision-making body in the corporation, may provide insights into this process. this study investigates the relationship between board composition and size and the incidence of a firm being targeted for a merger or acquisition. results of a logistic regression analysis of a matched set of target firms and firms not targeted for merger or acquisition reveal that target firms have higher proportions of independent outside directors and more total numbers of directors. moreover, we find that target firms have greater exposure to institutional investors. introduction mergers and acquisitions continue to dominate the corporate landscape. recent mega-mergers and acquisitions within industries such as upjohn co. with pharmacia ab and chase manhattan with chemical bank, as well as those across industries such as walt disney co. with capital cities/abc, are some evidence that the "merger mania" of the 1980s has not subsided (business week, 1995; u.s. news & world report, 1995). a growing body of research focuses on the motives which drive merger and acquisition activity (e.g., amihud & lev, 1978; eckbo, 1983; lubatkin, 1983; roll, 1986). thus far, however, this research has not yet provided consensus regarding the motives of bidder firms (e.g., haunschild, 1993). an enhanced appreciation for those elements of a target firm which are attractive to a bidder firm will enable both researchers and practitioners to gain a more comprehensive understanding of the likelihood of any given firm being targeted as a merger or acquisition candidate. 152 journal of business strategies vol. 13, no. 2 the structure of firms' board of directors may provide insight into the attractiveness of a target firm. the board of directors is central to a decision to engage in merger or acquisition activity. ultimate approval of major strategic moves lies with firms' board of directors (d' aventi & kesner, 1993; paul, 1995). some observers have noted that board activity may be greatest during strategic shifts such as a merger or acquisition (lorsch & maciver, 1989; zald, 1969). while the board of directors is clearly central to merger and acquisition activity, we still know very little about its role (see e.g., d' aveni & kesner, 1993; gibbs, 1993; haunschild, 1993; walsh & kosnik, 1993 for notable exceptions). the vast majority of mergers and acquisitions research has focused on firms' management, not their boards of directors. this study expands cufrent research by focusing on target firms' board composition and size. one reason bidder firms may target another firm is because they expect little resistance from the target firm's board of directors (d' aveni & kesner, 1993). firms dominated by outside directors, for example, may prove quite open to negotiations should the proposed deal be valuable from a shareholder perspective. boards dominated by target firm management may be expected to strongly resist a merger or acquisition due to fears of job loss. we examine the extent to which board composition discriminates between those firms engaging in merger and acquisition activity as compared to those firms not targeted by bidder firms. we also consider the impact of board size. it may be that target firms are characterized by smaller boards, leaving fewer numbers of individuals with which bidder firms must negotiate. alternatively, larger boards may be attractive to bidder firms due to the scope of linkages to a target firms' task environment. target firms and the board of directors there is considerable consensus in the conceptual literature that boards of directors can be most appropriately configured with a preponderance of outside directors (e.g., zahra & pearce, 1989). the rationale for this preference is the expectation that outsiders, non-management directors, bring an objectivity to their role as directors not provided by insiders. this objectivity is expected to directly benefit the shareholders whom directors serve (nussbaum & dobrzynski, 1987). we recognize that there are several potential benefits to inside directors, such as their superior level of firm specific knowledge (baysinger & hoskisson, 1990; fama, 1980; fama & jensen, 1983). additionally, inside directors have been found to be effective in ceo compensation decisions (boyd, 1994). as will be developed, however, inside directors may be subject to conflicts of interest which complicate their ability to objectively evaluate a merger or acquisition opportunity (johnson & siegel, 1987). while outsider dominated boards may effectively mitigate potential conflicts of interest that insiders face fall 1996 daily & dalton: the urge to merge 153 in this situation (e.g., fama, 1980; mizruchi, 1983), jauch, martin and osborn (1981) provide compelling evidence that insiders may experience some difficulty in separating the threat of job loss as a result of a merger or acquisition from their fiduciary responsibility to shareholders. recently researchers have begun investigating distinctions among outside directors. it may be that differing levels of objectivity can be expected across different categories of outside directors (e.g., daily & dalton, 1994; kosnik, 1987). independent outside directors (hereafter referred to as outside directors) are recognized as those directors whose association to the firm is strictly a function of their role as directors. these directors are believed to be best positioned to provide objective service to the firm. affiliated directors maintain personal or professional relationships with either the firm or firm management. these affiliations may impede the ability of the directors to be objective in their service to the firm and the firm's shareholders (e.g., daily & dalton, 1994). board composition may yield insights into directors' predispositions regarding resisting a merger or acquisition (gibbs, 1993; johnson & siegel, 1987; zalecki, 1993), as it has been identified as one of several dimensions of the balance of power in an organization (finkelstein, 1992). target firm inside directors, for example, may resist merger and acquisition opportunities due to the increased likelihood of job loss or a dramatic redefinition of job responsibilities (e.g., gutknecht & keys, 1993; jensen & ruback, 1983; morek, shleifer & vishny, 1988; walsh, 1988, 1989; walsh & ellwood, 1991). inside directors' fears are apparently well-founded. both corporate raiders and academics have commented that a primary motive in acquiring a firm is to increase firm value by replacing ineffective managers (fama & jensen, 1983; herman & lowenstein, 1988; leahn, 1988; jensen & meckling, 1976; pickens, 1986). outside directors, due to their independence from firm management; may be able to effectively control behaviors which conflict with shareholder interests (fama & jensen, 1983). moreover, we might expect outside directors to be responsive to organizational moves which benefit firm shareholders. as a consequence of their perceived ability to control managerial opportunism and an expectation that they will have a strong shareholder orientation, target firms with outsider dominated boards may be more attractive to bidder firms than boards with alternative board configurations (e.g., d' aveni & kesner, 1993). research by brickley and james (1987) suggests that board composition may be a significant factor in the merger and acquisition process. they found that the proportion of outside directors was significantly lower on boards of banks in states that restrict banking acquisitions as compared to those states without such restrictions. based on their findings, brickley and james concluded that outside directors play a major role in evaluating takeover proposals. accordingly, we hypothesize: hypothesis 1: target firms will be characterized by greater proportions of outside directors than non-target firms. 154 journal of business strategies vol. 13, no. 2 due to the sophisticated financing requirements and legal maneuverings inherent in the merger and acquisition process, it may be that target firms with higher proportions of outside directors who are lawyers and investment bankers may facilitate a merger or acquisition (e.g., d' aveni & kesner, 1993; kesner, shapiro & sharma, 1994; lofthouse, 1984). bidder firms may perceive that targets with strong legal and financial representation are best able to appreciate the intricacies involved in a merger or acquisition, especially from the shareholder perspective. accordingly, we hypothesize: hypothesis 2: target firms will be characterized by greater proportions of directors who are lawyers and investment bankers than non-target firms. finally, the size of the board may impact the attractiveness of a target firm. consistent with the resource function of boards (e.g., pfeffer & salancik, 1978), large board size may be some indication of the variety of external constituents with which the firm must work (e.g., chaganti, mahajan & sharma, 1985; pfeffer, 1972). in this view, directors provide critical linkages to the external environment which may enable the firm to more effectively manage its interdependencies, as well as provide access to important firm resources (e.g., pfeffer & salancik, 1978; provan, 1980; stearns & mizruchi, 1993). directors with these linkages and interdependencies may be perceived as a critical component of a successful merger or acquisition. while a larger board may enable the firm to more effectively address a broader range of constituents, it may also be less manageable from a control perspective (chaganti et ai., 1985). moreover, a larger board is likely to be more heterogeneous than a smaller board, perhaps increasing the difficulty of reaching consensus when faced with a decision to engage in a merger or acquisition. rather than serving as a means to enhance the assimilation of a target firm with the bidder, a larger board may be perceived as an obstacle due to the potential for many differing interests which must be effectively addressed in the negotiation process. smaller boards, then, may prove more attractive to bidder firms than larger boards. based on the lack of consistency regarding the anticipated impact of board size we hypothesize: hypothesis 3a: target firms ~vill have greater total numbers of directors than non-target firms. hypothesis 3b: target firms will have fewer total numbers of directors than noll-target firms. fall 1996 daily & dalton: the urge to merge methods 155 this sample consists of 55 finns engaging in a merger or acquisition during the years 1987-1992 and a matched pair of 55 control firms. target firms were selected from the list of top 100 announced deals reported annually by mergers and acquisitions. in order to ensure data availability only those firms which were publicly-traded at the time of the acquisition or merger and involved in a "traditional" merger or acquisition (i.e., one finn acquires another finn) were included (haunschild, 1993: 573; see also datta, 1991). also, firms operating in regulated environments (e.g., utilities, railroads, airlines) and banks and financial institutions were excluded (flagg, giroux & wiggins, 1991; healy, palepu & ruback, 1992; hennalin & weisbach, 1988). we relied on ward's business directory of us. private and public companies to generate a set of publicly-traded control finns by matching targets on the basis of four-digit sic codes and finn size (e.g., daily & dalton, 1994; hambrick & 0' aveni, 1992; kesner & johnson, 1990). target finns with no comparable match listed in wards business directory of us. private and public companies were excluded. logistic regression analysis confirmed that matched finns did not significantly differ from target finns on the basis of finn size, as measured by the natural logarithm of sales, assets, and number of fulltime employees. variables the dependent variable is dichotomous; either the finn was the target of a merger or acquisition (coded as i) or not targeted (coded as 0) during the focal year. the three independent variables include: total number of directors, proportion of outside directors (directors with no discernible tie to the firm or its management other than in their service as directors) and the proportion of outside directors who are lawyers or investment bankers. these data were collected from corporate proxy statements. several control variables are appropriate for inclusion in these analyses. researchers have long speculated about the liabilities of newness and size (stinchcombe, 1965). younger finns may be more likely to fail as a result of environmental pressures or organizational factors and may possess fewer resources than more established finns (e.g., van de ven, hudson & schroeder, 1984), limiting their ability to protect themselves from a merger or acquisition. larger finns typically have greater resources available which might discourage bidders from pursuing a target due to the prohibitively high costs of financing a large transaction (morek et al, 1988) and the ability to effectively resist a bidder (holl & pickering, 1988). finn age is computed from the time the finn was founded. finn size is the natural logarithm of sales revenues. these data were collected from wards business directory of us. private and public companies. we also control for finn perfonnance in these analyses. there is some evidence that firms with abnormally low performance are more likely to become 156 journal of business strategies vol. 13, no.2 targets (e.g., asquith, 1983; bartley & boardman, 1986; bradley, desai & kim, 1983; hasbrouck, 1985). perfonnance may indicate the availability of resources which may be needed to resist a bidder (d' aveni & kesner, 1993). relying on guidance from flagg et al. (1991) three categories of performance indicators are included in these analyses: profitability (return on assets), liquidity (current ratio), and leverage (debt-to-equity ratio). all financial data were collected from corporate annual reports, moody's industrial manual, and moody's over-the-counter manual. equity holdings may also impact the incidence of being targeted for a merger or acquisition. institutional holdings and large block holdings have been the subject of previous investigation in corporate restructuring (e.g., bethel & liebeskind, 1993; johnson, hoskisson & hitt, 1993). their anticipated impact, however, is unclear. bidding firms may be attracted to target firms with significant institutional holdings expecting institutions to sell their holdings to the highest bidder (e.g., buchholtz & ribbens, 1994; palmieri, 1986). alternatively, institutions may support incumbent firm management (0' aveni & kesner, 1993; ikenberry & lakonishok, 1993). similar rationale would apply for large block holders (individuals holding five percent or more of firm's stock). institutional holdings are measured as the percentage of firms' stock held by institutional investors. large block holders are captured as the percentage of firms' stock held by five percent or greater equity holders. these data were collectcd from standard & poor's corporation security owner's stock guide and corporate proxy statements. analyses given the dichotomous nature of the dependent variable we rely on logistic regression analysis (likelihood ratio method). this method combines aspects of hierarchical multiple regression and discriminant function analysis. results table i provides thc descriptive statistics and inter-item correlations for the study variables. results of the logistic regression analysis are reported in table 2. the baseline hit-rate for these analyses is 50 percent; half of the firms were targeted, half were not. in the first step the financial, firm size, and firm age control variables were included in the analyses. as demonstrated in table 2, these variables do not result in a significantly improved model (58.18 percent hit-rate) as compared to the baseline model. while three of these five variables are independently significant, this information must be interpreted cautiously given a non-significant model. at the next step the stock holding control variables were added. inclusion of these variables results in an improved model, as demonstrated by the improvement chi-square (65.45 percent hit-rate). based on the logistic coefficients we can determine that this improvement is a function of significantly greater "i1 table 1 ~ ...... descriptive statistics and inter-item correlations '-0'-0 01 variable mean s.d. (i) (2) (3) (4) (5) (6) (7) (8) (9) (i) finn size 6.55 1.39 (2) finn age 58.97 40.32 .37*** t;:, l.:l ~ (3) profitability .04 .11 .24* .23* r<> (4) liquidity 2.31 1.50 -.39*** -.11 -.18 ~........... c:. (5) leverage 37.67 158.12 -.19 .05 .15 .24* ;::.. ~ (6) institutional holdings 46.70 19.90 .24* .16 .24* -.07 -.10 '"c::: (7) large block holdings 27.62 24.87 -.30*** -.18 -.05 -.10 .00 -.49*** ~'"..... c:. (8) outside director proportion .26 .is .21* .22* -.01 -.05 -.05 .28** -.31 *** ~ (9) lawyer/banker proportion .14 .13 -.19 -.22* -.08 .00 -.07 .15 .08 -.25** ~ '" (10) total directors 10.37 3.45 .59*** .33*** .07 -.24* -.18 .16 -.20* .25** -.17 *p < .05 **p < .01 ***p < .001 -vi -.l 158 journal of business strategies vol. 13, no.2 table 2 logistic regression analysis of target and nontarget firms coefficients se logmodel improvement sig. hit-rate likelihood chi-square chi.square baseline 152.49 50.00% ~ 147.35 5.14 5.14 .399 58.18% firm size , -.50* .24 firm age profitability , -4.80* 2.22 liquidity• -.29* .17 leverage ~ 136.72 10.63 10.63 .005 64.45% institutional holdings , 5.16*** 1.58 large block holdings lrl!...ilij;! 128.13 8.59 8.59 .035 70.00% outside director proportion• -2.21* 1.34 lawyerlban ker proportion total directors . .17* .08 • indicates variable was a significant indicator in the step in which it was entered. *p < .05 **p < .01 ***p < .001 fall 1996 daily & dalton: the urge to merge 159 exposure to institutional holdings for target firms, as compared to those firms not targeted. the final step includes the board composition and size variables. this model results in a significant improvement chi-square and a 70 percent hitrate. it is possible to directly address the research hypotheses based on the logistic coefficients. as demonstrated in table 2, hypotheses 1 and 3a are supported. target firms have significantly higher proportions of outside directors than do those firms not targeted. also, target finn boards are larger than those of non-target firms, lending support to the resource view. hypothesis two was not supported. there is no statistically significant difference in the proportion of lawyers and investment bankers serving target firms as compared to those firms not targeted. in sum, these analyses demonstrate that target firms have higher proportions of outside directors, larger numbers of directors, and greater exposure to institutional investors. discussion these findings demonstrate the importance of the outside director in mergers and acquisitions. those firms with higher proportions of outside directors are apparently more attractive to bidder firms than are firms with lower proportions of outside directors. these results may suggest that outside directors are perceived by bidder firms as being more amenable to a potential merger or acquisition; le., they are more willing to "make a deal." perhaps those directors with no personal or professional ties to the firm are able to evaluate merger and acquisition opportunities based on a return-to-shareholder analysis which is not complicated with the concerns of inside directors for job security or the concerns of affiliated directors for the potential loss of business relationships. an alternative view, however, is that outside directors are willing to "make a deal," but that the deal does not serve target firm shareholders as well as more director resistance to the merger/acquisition proposition. attractiveness to the acquiring firm may be largely dependent on consummating a deal which best serves the interests of the bidding firm's shareholders. perhaps the anticipated resistance by inside and affiliated directors makes a target firm less at· tractive to a bidding firm, but that this resistance serves to increase the purchase price an outcome which is clearly attractive to target finn shareholders, but not to the bidding firm shareholders (jarrell et ai., 1988). we would note, however, that target firms' board of directors have apparently been responsible to their shareholders in merger and acquisition situations. prior research has demonstrated that excess returns, premiums averaging approximately 30 percent, are realized primarily by target firm shareholders; this same benefit is not shared by bidding firm shareholders (jarrell, brickley & netter, 1988; jarrell & poulsen, 1989; jensen & ruback, 1983; zalecki, 1993). the finding that larger boards are more attractive to bidder firms may indicate the importance of the director's resource role. these analyses may sug160 journal of business strategies vol. 13, no. 2 gest that bidder firms appreciate the linkages that directors provide to firms' external environment. given the increasing complexity of the business environment, greater numbers of directors may indicate a convenient means for gaining access to those resources most crucial for the effective functioning of the business. access to these resources may prove critical to the long-term success of the merger or acquisition. this resource role is particularly important in light of past research which has demonstrated that financial benefits to the acquiring firm may not be immediately apparent at the time of the bid (jarrell et al., 1988). it may be that bidder firms see the long-term potential of directors and that this dominates any short-term loss. an interesting finding of this study is that the presence of lawyers and investment bankers does not differentiate between target and non-target firms. past research has suggested that lawyers, in particular, would be particularly useful in negotiating a merger or acquisition agreement (e.g., d' aveni & kesner, 1993). lawyers and investment bankers arguably possess the specialized knowledge often needed in both structuring and completing a merger or acquisition agreement. it may be, however, that no statistically significant differences were found because the complexity of the environments in which most firms operate require the presence of these specialized directors. perhaps lawyers and investment bankers are a necessity on today's corporate boards. alternatively, it may be that bidder firms view target firm lawyers and investment bankers as one more impediment in successfully negotiating a deal. bidder firms may view their own legal and financial counsel as the only beneficial counsel in this domain. these results also have interesting implications regarding the role of institutional investors. institutional investors have been the target of some criticism for reportedly supporting management, not shareholders, in the case of a conflict between management and shareholder interests (e.g., graves, 1988; lipton, 1987; mieher, 1993). these results would seem to indicate the opposite; larger percentages of institutional holdings are positively associated with being targeted. as with outside directors, institutions may be perceived by bidder firms as being open to objectively reviewing the benefits to shareholders of a potential merger or acquisition. institutions are apparently not as loyal to firm management as some critics have charged (e.g., thompson, 1994). as with outside directors, however, there is the concern over whose shareholders most directly benefit from a merger/acquisition. implications for practice and research the competitive environment in which firms operate today requires organizational leaders to constantly monitor means for gaining competitive advantage. the mergers and acquisitions environment makes this task challenging. mergers and acquisitions are extending beyond consolidations across industries and are increasingly within industry consolidations (e.g., business week, 1995; fall 1996 daily & dalton: the urge to merge 161 us. news & world report, 1995). with much of recent merger and acquisition activity being driven by a desire to control distribution networks, firms missing the opportunity to benefit from industry consolidation are likely to be confronted by issues of organizational survival (us. news & world report, 1995; wysocki, 1995). "big is better" is back with a vengeance (us. news & world report, 1995: 46). with the acceleration of merger and acquisition activity, managers may benefit from guidance on those elements of a firm's governance structure which are discussed in this study. knowledge of the types of board configurations which attract a bidder firm may assist firm management in appropriately structuring their own board of directors and in assessing the viability of potential targets. this would be especially important for those firms seeking a "strategic" merger or acquisition, for example, in order to remain competitive in a rapidly changing environment. moreover, understanding the role of boards of directors in this arena is potentially time and resource saving given the recent trend toward using the proxy system to unseat unfriendly directors (lipin, 1995). proxy contests can consume a considerable amount of time and financial resources. perhaps careful attention to the composition and size of potential target firm boards will provide bidding firms with valuable information regarding anticipated resistance to a proposed deal, as well as the type of resources available once the deal is consummated. careful attention to ways in which the composition and size of a target firm's board may either save resources or provide future resources to the bidder firm may be a step toward improving the returns to bidder firm shareholders. the results of this study, coupled with the consistency of merger and acquisition activity, would suggest the need for further attention to these important governance issues. references amihud. y., and b. lev. "risk reduction as a managerial motive for conglomerate mergers." bell journal of economics 12 (1978): 605-617. asquith, p. "merger bids, uncertainty, and stockholder returns." journal of financial economics 11 (1983): 51-83. bartley, 1. and c. boardman. "the replacement-cost adjusted valuation ratio as a discriminator among takeover target firms." journal of economics and business 38(1), (1986): 41-55. baysinger, b. and r. e. hoskisson. "the composition of boards of directors and strategic control: effects on corporate strategy." academy of management review 15 (1990): 72-87. 162 journal of business strategies vol. 13, no. 2 bethel, j. e. and j. liebeskind. 'the effects of ownership structure on corporate restructuring." strategic management journal 14 (1983): 15-31. "big!" u.s. news & world report (september ii, 1995): 46-48. boyd, b. k. "board control and ceo compensation." strategic management journal 15 (1994): 335-344. bradley, m., a. desai and e. h. kim. "the rationale behind interfirm tender offers: information or synergy?" journal of financial economics ii (1983): 183-206. brickley, j. a. and c. m. james. "the takeover market, corporate board composition, and ownership structure: the case of banking." journal of law and economics 30 (1987): 161-180. buchholtz, a. k. and b. a. ribbens. "role of chief executive officers in takeover resistance: effects of ceo incentives and individual characteristics." academy of management journal 37 (1994): 554-579. chaganti, r. s., v. mahajan and s. sharma. "corporate board size, composition, and corporate failures in retailing industry." journal of management studies 22 (1985): 400-417. daily, c. m. and d. r. dalton. "bankruptcy and corporate governance: the impact of board composition and structure." academy of management journal 37 (1994): 1603-1617. datta, d. k. "organizational fit and acquisition performance: effects of post-acquisition integration." strategic management journal 12 (1991): 281-297. d' aveni, r. a. and i. f. kesner. "top managerial prestige, power and tender offer response: a study of elite social networks and target firm cooperation during takeovers." organization science 4 (1993): 123-151. eckbo, e. h. "horizontal mergers, collusion, and stockholder wealth." journal of financial economics 11 (1983): 241-274. fama, e. f. "agency problems and the theory of the firm." journal of political economy 88 (1980): 288-307. fama, e. f. and m. c. jensen. "separation of ownership and control." journal of law and economics 26 (1983): 301-325. finkelstein, s. "power in top management teams: dimensions, measurement, and validation." academy of management journal 35 (1992): 439-450. flagg, j. c., g. a. giroux and c. e. wiggins. "predicting corporate bankruptcy using failing firms." review of financial economics 1 (1991): 67-78. fall 1996 daily & dalton: the urge to merge 163 gibbs, p. a. "determinants of corporate restructuring: the relative importance of corporate governance, takeover threat, and free cash flow." strategic management journal 14 (1993): 51-68. graves, s. b. "institutional ownership and corporate r&d in the computer industry." academy of management journal 31 (1988): 417-428. gutknecht, j. e. and j. b. keys. "mergers, acquisitions and takeovers: maintaining morale of survivors and protecting employees." acagemy of management exes;utive 7(3), (1993): 26-36. hambrick, d. c. and r. a. d' aveni. "top team deterioration as part of the downward spiral of large corporate bankruptcies." manas-ement science 38 (1992): 14451466. hasbrouck, j. 'the characteristics of takeover targets and other measures." journal of banking and finance 9 (1985): 351-362. haunschild, p. r. "interorganizational imitation: the impact of interlocks on corporate acquisition activity." administrative science ouarterly 38 (1993): 564-592. healy, p. m., k. g. palepu and r. s. ruback. "does corporate performance improve after mergers?" journal of financial economics 31 (1992): 135-175. hermalin, b. e. and m. s. weisbach. "the determinants of board composition." rand journal of economics 9 (1988): 589-606. herman, e. s. and l. lowenstein. "the efficiency effects of hostile takeovers." in knights. raiders. and targets. eds. j. c. coffee, l. lowenstein and r. roseackerman. new york: oxford university press, ]983. holl, p. and 1. f. pickering. "the determinants and effects of actual, abandoned and contested mergers." managerial and decision economics 9 (1988): 1-19. leahn, c. "kahn on icahn." fortune (february 29, 1988): 54-58. ikenberry, d. and j. lakonishok. "corporate governance through the proxy contest: evidence and implications." journal of business 66 (t 993): 405-435. jarrell, g. a., j. a. brickley and j. netter. "the market for corporate control: the empirical evidence since 1980." journal of economic perspectives (winter, 1988): 4968. jarrell. g. a. and a. b. poulsen. "the returns to acquiring firms in tender offers: evidence from three decades." financial management (autumn, ] 983): 12-19. jauch, l. r., t. n. martin and r. n. osborn. "top management under fire." journal of business strategy 1(4), (1981): 33-41. 164 journal of business strategies vol. 13, no.2 jensen, m. c. and w. h. meckling. "theory of the firm: managerial behavior, agency costs and ownership structure." journal of financial economics 3 (1976): 305-360. jensen, m. c. and r. s. ruback. "the market for corporate control: the scientific evidence." journal of financial economics 11 (1983): 5-50. johnson, r. a., r. e. hoskisson and m. a. hitt. "board of director involvement in restructuring: the effects of board versus managerial controls and characteristics." strategic management journal 14 (1993): 33-50. johnson, 1. 1. and m. siegel. "corporate mergers: redefining the role of target directors." university of pennsylvania law review 136 (1987): 315-416. kesner, 1. f. and r. b. johnson. "an investigation of the relationship between board composition and stockholder suits." strategic management journal 11 (1990): 327336. kesner, 1. f., d. l. shapiro and a. sharma. "brokering mergers: an agency theory perspective on the role of representatives." academy of management journal 37 (1994): 703-721. kosnik, r. d...greenmail: a study of board performance in corporate governance." administrative science quarterly 32 (1987): 163-185. "land of the giants." business week (september 11, 1995): 34-35. lipin, s. "more potent weapons dwell in takeover arsenal." the wall street journal (september 9, 1995): cl, c12. lipton, m. "corporate governance in the age of finance corporatism." university of pennsylvania law review 136 (1987): 1-72. lofthouse, s. "strategy and tactics for resisting take-over." long range planning 17(4), (1984): 38·50. lorsch, j. w. and e. maciver. pawns or potentates: the reality of america's corporate boards. boston: harvard business school press. 1989. lubatkin. m. "mergers and the performance of the acquiring firm." academy of management journal 8 (1983): 218-225. mieher, s. "weak force, shareholder activism, despite hoopla, leaves most ceos unscathed; only big, famous companies draw consistent scrutiny of institutional owners a case study in mississippi." the wall street journal (may 24, 1993): ai. mizruchi, m. s. "who controls whom? an examination of the relation between management and boards of directors in large american corporations." academy of management review 8 (1983): 426·435. fall 1996 daily & dalton: the urge to merge 165 morck, r, a. shleifer and r w. vishny. "characteristics of hostile and friendly takeovers." in corporate takeovers: causes and consequences. ed. a. j. auerbach. chicago: university of chicago press, 1988. nussbaum, b. and j. h. dobrzynski. "the battle for corporate control." business week (may 18, 1987): 102-109. palmieri, f. w. "fiduciary responsibilities under erisa in corporate takeovers." journal of comorate taxation 13(2), (1986): 127-142. paul, c. e. "scouting the m&a landscape for quality targets." merger & acquisitions (marchiapril, 1995): 20-26. pfeffer, j. "size and composition of corporate boards of directors: the organization and its environment." administrative science ouarterly 17 (1972): 218-228. pfeffer, j. "size, composition, and function of hospital boards of directors: a study of organization-environment linkage." administrative science ouarterly 18 (1973): 349-364. pfeffer, j. and g. r salancik. the external control of organizations: a resource depend'ence perspective. new york: harper & row, 1978. pickens, t. b. "professions of a short-termer." harvard business review 64(3), (1986): 75-79. provan, k. g. "board power and organizational effectiveness among human service agencies." academy of management journal 23 (1980): 221-236. roll, r. "the hubris hypothesis of corporate takeovers." journal of business 59 (1986): 197-216. stearns, l. b. and m. s. mizruchi. "board composition and corporate financing: the impact of financial institution representation on borrowing." academy of management journal 36 (1993): 603-618. stinchcombe, a. "social structure and organizations." in handbook of organizations. ed. j. g. march. chicago: rand mcnally, 1965. thompson, l. m. "a corporate governance committee of the board." directors & boards (summer, 1994): 37-39. van de ven, a. h., r. hudson and d. m. schroeder. "designing new business startups: entrepreneurial, organizational, and ecological considerations." journal of management 10 (1984): 87-107. walsh, j. p. ''top management turnover following mergers and acquisitions." strategic management journal 9 (1988): 173-183. 166 journal of business strategies vol. 13, no. 2 walsh, j. p. "doing a deal: merger and acquisition negotiations and their impact upon target company top management turnover." strategic management journal 10 (1989): 307-322. walsh, j. p. and j. w. ellwood. "mergers, acquisitions, and the pruning of managerial deadwood." strategic management journal 12 (1991): 201-217. walsh, j. p. and r. d. kosnik. "corporate raiders and their disciplinary role in the market for corporate control." academy of management journal 36 (1993): 671-700. wysocki, b. "improved distribution, not better production is key goal in mergers." the wall street journal, (august 29, 1995): al-a2. zahra, s. a. and j. a. pearce. "boards of directors and corporate financial performance: a review and integrative model." journal of management 15 (1989): 291-334. zald, m. n. "the power and functions of boards of directors: a theoretical synthesis." american journal of sociology 75 (1969): 97-111. zalecki, p. h. "the corporate governance roles of the inside and the outside directors." university of toledo law review 24 (1993): 831-858. catherine m. daily is an assistant professor of management in the krannert graduate school of management, purdue university. she received her ph.d. degree in strategic management from the graduate school of business, indiana university. her research interests include corporate governance, strategic leadership, the dynamics of business failure, ownership structures, and research methods. dan r. dalton is the samuel and pauline glaubinger chair and associate dean of the graduate school of business, indiana university. he received his ph.d. degree from university of california. his research interests include corporate governance, managerial ethics, corporate social resonsibility, and research methods. the urge to merge: the role of governance structures in mergers and acquisitions millennials’ strategic decision making through the lens of corporate social responsibility and financial management reavis et al. / journal of business strategies (2021) 38: 125-146 1 journal of business strategies doi:10.54155/jbs.38.2.125-146 millennials’ strategic decision making through the lens of corporate social responsibility and financial management mark reavisa, kuldeep singhb, jack tuccic a finance department, university of central oklahoma, edmond, ok 73034. mreavis1@uco.edu (corresponding author). b department of management and marketing, arkansas tech university, russellville, ar 72801. ksingh1@atu.edu. c william m. lemley endowed chair, department of management and marketing, arkansas tech university, russellville, ar 72801. jtucci@atu.edu. key words corporate social responsibility; millennials; strategic decision making, aacsb; stakeholder theory abstract corporate social responsibility (csr) is the touchstone for millennials when looking at the means for making their world a better place. higher education’s focus on csr has allowed millennials to focus their decision-making using a csr/stakeholder approach to financial management decisions. millennials’ support for a csr/stakeholder approach has grown as they have been completing college. the csr/stakeholder approach has increased partly due to social awareness created by curricula that highlights areas of social and environmental inequality. this csr/stakeholder approach has recently emerged as a bona fide strategic management option globally. this paper extends csr research by evaluating millennial financial decisions and the resulting competitive company performance in a widely used business simulation. proactive university equality initiatives, resulting in curriculum changes, reinforce millennials’ ethos of social and environmental sustainability. as millennials will soon take the reins of industry, the results of their ethos will significantly influence society. this work is licensed under a creative commons attribution-noncommercial 4.0 international license. copyright (c) 2021 mark reavis, kuldeep singh, jack tucci. mailto:mreavis1@uco.edu mailto:ksingh1@atu.edu mailto:jtucci@atu.edu https://creativecommons.org/licenses/by-nc/4.0/ https://creativecommons.org/licenses/by-nc/4.0/ 126 reavis et al. / journal of business strategies (2021) 38: 125-146 1. introduction the advancement of both individuals and society is strategically accomplished through education. advancement is further reinforced by institutions of higher learning and by their governing accrediting bodies through accreditation requirements or initiatives. the association to advance collegiate schools of business (aacsb) (the world’s leading business accrediting body) nearly three decades ago, put as one of its required standards the subject of business ethics. many business schools implemented a required ethics course(s), or infused ethics in several required courses. by 2020, the aacsb “standard 9” required that each institution shall have “engagement and social impact” and must have measures in place which specifically address corporate social responsibility (csr). csr is an active component in the education of the students through “hands-on” community projects as service-learning initiatives (stonkute et al., 2018; larran et al., 2018). “service learning” is a common means to meet the standard 9 through a minimum number of hours of service, or award diploma citations/notations to the student who maintain a specified level of participation (miftachal et al., 2018). the question remains: “does the curriculum engaged by a college of business have an influence on business students?” a secondary question closely related is: “do the students engaged by this curriculum have changed social norms?” millennials perceive an ethical duty to reengineer society and become change agents (howe & strauss, 2000). nevertheless, a research question begs to be answered: “will millennials make strategic decisions with a csr focus or a profit focus?” the term 'millennial' as used in this research refers not only to a generation of young people by age, but also to their worldview and society's perception of them (ohio university, 2020). by age, this generation was born approximately 1982-2000. this is the sample boundary used in this study. millennial’s worldview is much more social-oriented than their parents or grandparents. they are activists and seek to make the world a better place. society regards this generation as special and as having a capacity for greatness (howe & strauss, 2000). this generation is inherently different than their predecessors. "the millennial future is what america is destined to become" (howe & strauss, 2000, p. 367). reavis et al. / journal of business strategies (2021) 38: 125-146 127 2. the model the aacsb is global accrediting body and as such many international schools of business incorporate csr (ferrell et al., 2016; prutina, 2016; serban, 2015). curriculum changes are being made to benefit society through the efforts of students, business schools, and in the long-term, business (horng et al., 2019). the ability to manage companies while improving societal imbalances is paramount and it has shifted the focus from a stockholder approach to a stakeholder approach in response to these societal changes (reavis et al., 2017; elalfy, 2020). global business school accreditation standards (aacsb) have aided business schools in transitioning to a csr curriculum from an ethics focused curriculum. aacsb standards recognize the shift of business practices from a stockholder to stakeholder approach (reavis & orr, 2021). the aacsb standards provide encouragement/guidance to business schools/students to teach/learn how businesses can be successful and effect positive social change. this paradigm shift is ultimately focused on movement toward a sustainability ethos of decision making, based on ethical behavior and social responsibility. the model in figure 1 is depicted with these drivers of the change, ethical behavior and csr, providing upward force. this force more than supports changes in thought, it is a driving force for societal evolution of thought about people, profit, and planet. this model contends that this evolution of thought is times based; however, this change will accelerate when the current millennials emerge in the “c” level suite. the efforts of aacsb to require csr in the early 2000’s as reflected by service-learning initiatives, the natural outcome is the emerging sustainability model and certified type b corporations. universities have spent countless person-hours modifying business education which warrants a review of the results of these changes in the curriculum. if the curriculum is truly impactful, then the predictions by the brookings institute bear closer watch (winograd & heis, 2018). earlier studies analyzed and discovered that millennials have a stakeholder preference over a stockholder approach and indicate that csr decisions stem from a values proposition (ferrell et al., 2016; serban, 2015). a further study also found that a student’s chosen major had an influence on their decision making; those with a qualitative, organizational behavioral approach preferring a stakeholder approach (reavis & tucci, 2020). in comparison, students who majored in 128 reavis et al. / journal of business strategies (2021) 38: 125-146 quantitative studies in business, finance, economics, and accounting, still leaned towards a stakeholder approach but less so than their organizational behavior focused counterparts. 3. literature review stockholder and stakeholder theory: contrasting perspectives smith and ronnegard in 2016 posited that stockholders must be held in the highest regard in all business decisions because they risked personal capital for the profits of invested business. they drew their philosophy from adam smith’s writing in wealth of nations, that laid the foundational concepts of stockholder’s risk. following that thought, stockholder theory contends that it is the “individual risk taker” who has the right to engage in socially responsible actions of their own choosing. this approach was strongly supported by milton friedman (1970). smith and friedman acknowledge that a business cannot pursue profits at any cost, but must deal with “externalities” or rules, and quantifiable analysis supports their position (lopez et al., 2007). in impactors sustainability corporate social responsibility (csr) ethics figure 1. evolution towards sustainability: the efficacy of change in accreditation standards reavis et al. / journal of business strategies (2021) 38: 125-146 129 contrast, those who argue in favor of csr argue that there are benefits to the stakeholder approach (aquilera et al., 2007). the stanford research institute defines “stakeholder” as "groups without whose support the organization would cease to exist" (freeman, 1983). stakeholder theory as championed by freeman, 1983, came to be defined simply as interconnectedness. symbiotic relationships in society between individuals and corporations explain why companies engaged in csr to increase employee affective commitment (prutina, 2016). stakeholders include employees, suppliers, vendors, customers, creditors, government entities, resource communities, etc. (post et al., 2002). stakeholders are affected by the business’ operations and the business is obligated to provide value to these various stakeholders to some degree at the expense of stockholders (rausch, 2011). measures and methods of the stakeholder approach and sustainability the balanced scorecard approach is a method of quantifying the results of business decisions in various identified areas in a semi-holistic approach. the scorecard is used by a wide range of entities, from business to government to military to nonprofits and is a planning and management tool that aligns activities with organizational goals and missions (cokins, 2013). the balanced scorecard institute (bsi) helps organizations develop a scorecard for their organization through the development of a framework of nine steps organized around four core components: customers/ stakeholders, financial/ stewardship, internal processes, and organizational capacity (“nine steps to success”, 2017). the triple bottom line (tbl), another approach to measuring csr, was mainstreamed by john elkington’s book (1997) cannibals with forks: the triple bottom line of 21st century business. the key aspect is the sustainability of the business through performance in financial, social, and environmental areas (slaper & hall, 2011). the concept is simple; along with the profit-making operational decisions of a company, there are two other operational areas to address: people and planet. these three combined provide the basis for the 3p model. while there is still not a universal tbl that fully addresses sustainability, companies are finding that it is useful in showcasing their corporate social responsibility initiatives (slaper & hall, 2011). wilburn & wilburn (2015) advise that a 2010 study showed companies that have proof of positive csr programs enjoyed higher sales among global customers that were willing to pay more for their products. 130 reavis et al. / journal of business strategies (2021) 38: 125-146 a certified b corp is a company that has been certified by the independent, non-profit organization b lab founded in 2006 by three entrepreneurs (honeyman, 2015). their mission was to create a corporate entity that was both about maximizing wealth and positively impacting society and the environment through sustainability initiatives. a certified b corp must establish the public benefit they are pursuing. (b lab, 2017). it could be a specific public benefit that addresses such social issues as unemployment, nutrition, or education. a certified b corp must assess their overall social and environmental impact using an accepted third-party standard for their industry. b lab specifically directs that the company’s benefit director has a duty to consider the impact of business decisions on a variety of stakeholders. a study in 2015 of the forty-five original certified b corp companies found that all made progress toward their stated goals, were profitable, and had published annual reports for greater transparency (wilburn & wilburn, 2015). these founding certified b corp companies were all from canada and the united states (wilburn & wilburn, 2015). as of march 2019, there were over 2,500 certified b-corps in 50 countries (b lab, 2019). more importantly to drive home the point; there has been a not insignificant increase of nearly 50% in both b corp companies and countries utilizing this form of incorporating in the last year alone. the csr movement is growing internationally (ferrell et al., 2016). in 2020 there were 3,585 companies in 74 countries that are utilizing the b corp form of incorporation. this upturn in csr – sustainability focus reflects the growing awareness and acceptability that there is a growing stakeholder perspective. as of 2019, thirty-four states and the district of columbia have enacted benefit corporation legislation (benefit corporation, 2019). this legally allows the designated company to operate in a manner that does not require the company to pursue maximization of stockholder wealth at the expense of public benefit (el khatib, 2015). unlike traditional for-profit corporations, benefit corporations (which are still in the business to make a profit) cannot be held accountable for business practices by stockholders unless there is a question of the company pursuing its stated benefit goals (hacker, 2016). the very existence of the various measures and methods employed to demonstrate any stakeholder approach to corporate governance begins to create an illusion for consumers that a company is more socially responsible than other, more traditional, for-profit corporations. this perspective bias reavis et al. / journal of business strategies (2021) 38: 125-146 131 theoretically creates an unfair advantage much to the detriment of a traditional company. ‘greenwashing’ is defined as “use of a public-relations-enhancing social purpose to fritter away money without oversight” (solomon, 2015). hacker (2016) and el khatib (2015) both refer to greenwashing as using the labels that convey to the consumer the company is engaged in a public benefit when in actuality it is just a complex marketing ploy and there is no substantive effort by the company or results from efforts to actually pursue the stated public benefit. csr and sustainability internationally in addition to the expansion of b lab to certify companies globally, other countries have taken legal steps to require corporations to engage in csr. in 2013, india passed the indian companies act 2013, an amendment to india’s laws governing corporations. this act included a specific requirement for indian companies to spend at least 2% of their average earnings on csr activities. to be required to comply with this new law, a company in india must meet certain revenue and/or asset thresholds. to comply, a company may spend its earnings on such issues as hunger, poverty, education, child mortality, or maternal health (hiralal, 2015). in 2015, italy became the first foreign nation to make benefit corporations legal entities; similar legislation is also being advocated in australia, argentina, chile, colombia and canada (benefit corporation, 2019). future leadership and the millennial perspective this literature review has so far described relevant theory and practice with regard to csr. the results of this study add to the existing body of knowledge by providing evidence of millennials’ philosophy and attitudes on csr reflected in their financial decisions while participating in a strategic business simulation. the 18-year period between 1982 and the year 2000 is the most commonly accepted period where the millennial generation fits in most published estimates (mcglone et al., 2011). this generation is critical to our future economy as they play an important role in csr because they will significantly influence society toward a more stakeholder-centered approach. millennials are optimistic, cooperative, and more importantly civic minded. they “will demand that employers make good on fair play on pay and benefits will be at issue” (howe & strauss, 2000). millennials will not only demand changes in the workplace that focus on their needs but also tend to seek out 132 reavis et al. / journal of business strategies (2021) 38: 125-146 and buy “products that combine their focus on family….and community approval” (howe & strauss, 2000). millennials are activists. they will seek to influence community, political, economic, and environmental issues (howe & strauss, 2000). this leads us to the assumption that sustainability through corporate csr efforts will be the “natural” outcome of this generations’ influence and future leadership. millennials are largely misunderstood in the workplace today. they are often viewed as lazy, entitled, and never satisfied (roker, 2017). millennials have a different self-perception. they view themselves as ambitious, innovative, connected, and expressive. millennials are “looking for things to support because we want to feel like we’re making a change in the world” (roker, 2017). for millennials, actions are important. they seek to reward or punish corporations based on csr involvement (mcglone et al., 2011). millennials also perceive that doing good is not enough, that authentic leadership is critical (kim et al., 2018). it is not doing good for external measures; it is doing good because it is what the organization is at its core. this is an effort to prevent the greenwashing evidenced by firms who in times past “were not fully committed to the ethos of sustainability and lacked authenticity” (tucci et al., 2015). millennials have become the largest generation in the u.s. labor force making up 35% of the total u.s. labor force (arkansas business, 2018). over half of the workforce will be composed of millennials by 2025. they already seek change in society and soon they will have achieved critical mass and its associated power to effect change. this current age grouping seeks to advance societal welfare over individual success (winograd & hais, 2014). however, these demanded changes are not balanced. prutina (2016) identified that as individuals rise in position and authority and are engaged in csr, organizational commitment increases. what remains to be seen, is why is this phenomenon increasing? this study contends curricula and culture have coincided. this paper reinforces that this rise of millennials and the make-up of the future corporate leadership class illuminates the force behind the change. with the move towards csr, the gender leadership ratio is changing simultaneously. women see both a higher level of organizational commitment and commitment to their personal values than men as they rise within the organization (aggarwal et al., 2018). as the baby-boomers age, turnover reavis et al. / journal of business strategies (2021) 38: 125-146 133 increases, and women ascend the corporate ladder into executive leadership, the expected change will be increased csr efforts and commitments to that as a bona-fide strategy. the corresponding lower likelihood of being replaced as a corporate leader in uncertain times will entrench these new leaders into the social fabric of these corporations (cooper, 2017). evolutionary factors such as increases in board diversity and changes in strategy are becoming the norm (rao & tilt, 2016) (marques-mendes & santos, 2016). the research question a review of the literature firmly establishes that a stakeholder approach is the “preferred” approach of millennials. nevertheless, the question addressed by this study is, “given the opportunity, would millennials in a capstone competitive simulation use a stakeholder approach (csr focus) strategy when financial performance is the measure of success?” the syllabus provided to these students clearly stated that a basket of financial measures would be used to determine their grade as this part of the course. csr does help the students overall scores to a point, however, just like investments in r&d, and marketing/advertising, there are diminishing rates of return once optimal levels of investment have been reached. students were aware that excessive investment in csr is detrimental to their overall score. 4. methodology millennial students were selected for this study as appropriate to test the prediction that they would have a greater propensity to seek the common good, be more socially conscious, and take a more active role in society and politics that clearly follows the concepts of sustainability empowered by csr than previous generations. in previous studies it has been shown that millennials’ do have a heightened sense of csr as reflected in a philosophy of “better for the common good” by business students attending a senior level business class (reavis, et al., 2017; reavis & orr, 2021). what has not been analyzed are the decision behaviors of millennials in operational decision making and if those decisions reflect their stated values. the assignment used to test the research question is a commonly used business simulation called glo-bus (glo-bus.com). in the simulation, students are assigned to teams of two to four individuals. these teams compete not only against their classmates, but also against teams from other business schools around the world. typically, about 3,800 teams compete in this 134 reavis et al. / journal of business strategies (2021) 38: 125-146 simulation that lasts approximately 10 to 12 weeks. the simulation allows each team to manage a company that produces two products, an action camera and a flying drone. the products are hypothetically made in east-asia and are marketed around the world. there is a combination of decisions to manage both products’ design, finance, manufacturing, quality control, operations/production, human resources, as well as the marketing and distribution. ancillary to direct operational decisions; each team must also decide whether they want to engage in csrc (corporate social responsibility and citizenship) by investments in charitable contributions, environmental sustainability through the use of a “renewable energy program,” an on-site child-care facility and an on-site employee cafeteria, improved working conditions through increased lighting and ventilation, and the implementation of a supplier code of conduct requiring all suppliers to follow an ethical code of conduct. the ancillary decisions are the focus of the research to determine if millennials will in fact engage in csr decisions given the pressure to maximize profits in a financially competitive simulation. students in the capstone business policy class are randomly assigned to glo-bus teams prior to the beginning of the semester. when the semester begins, the students must first read the participants guide that is a 32-page pdf document explaining each of the key areas in which decisions must be made, how they are made, and the potential costs and benefits of each of those decisions. three weeks into the course, each team takes control of the company in the simulation. it is assumed in the simulation that the companies are already in production and previously had five years of profitability. all teams start with exactly the same financial standing and market share. the students get two practice decision cycles to manipulate the simulation decision matrix and compare notes from simulation generated competitive intelligence reports. after the two practice years are completed, the following week, the simulation is reset back to year five and students operate the company making decisions for years 6 through 14 (there is a year 15, but due to time constraints, it is not required). students are coached in the first week of school to pick a strategy and stick with that strategy for the long term since it has been proven in earlier classes that randomly making decisions leads to early failure. if students choose a lowcost strategy, all decisions should be made to minimize un-needed / excessive reavis et al. / journal of business strategies (2021) 38: 125-146 135 expenditures. if they choose a differentiation strategy, they must make decisions that enhance the features and benefits of the product, making their products stand out from competitors’ offerings. the third strategy is a bestcost strategy where they try to apply both a low cost and a differentiation strategy to satisfy customers’ needs at an affordable price. there are two optional areas for students to invest profits. the first is research and development (r&d). research and development does not have an immediate payback but does have high return over time in direct portion to how much they invested up to a point and then the return is diminishing. research and development and the delayed return on investment is not the subject of this paper. investment in csrc initiatives has immediate payback but has escalating diminishing returns once an investment plateau has been reached. often students do not fully understand foreign labor and 12-hour work days nor lack of access to food during work hours nor readily available child-care for manufacturing facilities. lack of employee benefits in these forms for foreign workers is discussed in lecture as the course progresses and is covered in the text. to test our research question, we looked at the 2018 academic year and selected the students who met our definition of millennial in a senior business policy (strategic management) class. students in business policy are required to be graduating seniors in their last semester and past performance for these students has been satisfactory. the business college that hosts the simulation typically places very high in the global competition (at least three to four teams out of 12 teams score in top 100), and just the year before data was collected (2017) two students won recognition as best performance in competition with 3800 other teams worldwide. students falling outside of the 1982 to 2000 birth years were not used in the analysis. the students selected for this study have been exposed to csr topics and theory in several other classes before participating in the glo-bus simulation. we used an academic year format (five course sections) since a great majority contained students who we knew to fit the millennial definition. in previous csr studies, using different data, millennial students have shown to favor a stakeholder approach over a stockholder approach to corporate governance (see figure 2). 42.81% of millennial students in the previous study “strongly support” a stakeholder approach to corporate governance. when added to the ‘leans towards stakeholder approach’ amount of 21.57%, 64.38% 136 reavis et al. / journal of business strategies (2021) 38: 125-146 of millennials identify as stakeholder oriented. in comparison, only 18.63% (the total of both ‘strongly support’ and ‘lean towards’) of millennials’ share milton friedman’s stockholder approach to corporate governance. those that were neutral, not preferring either the stakeholder or stockholder approach, represented 16.99% of the sample. as a research team we also considered other variables from the course data obtained from the simulation: leadership skills, collaboration & teamwork, analytical skills, operation management, marketing management, human resources management, and strategic analysis & planning. however, only financial management and csr were found to have any significant statistical relationships. the financial performance variable data was based on the company's eps, roe, credit rating, and stock price performances, whereas the csr variable data was based on the percentage of company revenues spent on the six corporate social responsibility initiatives. 5. analysis and results the students from five different sections in the 2018 academic year enrolled in a business policy class participating in the glo-bus simulation in 2018 were selected for this study. the original sample had 138 respondents. eight students were eliminated from the data because they did not fall within the age range definition of millennial and another 10 were eliminated due to missing or incomplete values. a final sample of 120 students was used for our study. table 1 shows the descriptive statistics of all the variables in this study. the 0 5 10 15 20 25 30 35 40 45 -2 -1 0 1 2 p e rc e n ta g e rating purel stakeholder perspective neutral perspective stockholder perspective figure 2. student philosophy by rating (reavis & tucci, 2020) reavis et al. / journal of business strategies (2021) 38: 125-146 137 mean score on financial management was 50.76, with a standard deviation of 18.56. on the other hand, the mean score on csr was 53.58, with a standard deviation of 25.99. a correlation analysis was performed to examine the relationship between financial management and csr and the result is tabulated in table 2. the correlation result shows that financial management and csr are significantly negatively associated with each other. table 1. descriptive statistics of variables within study table 2. correlation table of financial management and csr score in the study variable csr financial management -0.213* significance (2-tailed) 0.019 note: correlation is significant at the 0.05 level (2-tailed) to further analyze the relationship between financial management and csr, we performed a cluster analysis on financial management in relationship to csr scores. the goal of cluster analysis is to divide the data into meaningful subgroups when there is no knowledge about the composition and/or number of the subgroups (fraley & raftery, 1998). there is no exact formula on the number of clusters, but the decision can be made based on a rule of thumb. for example, lehmann (1979) suggested that the number of clusters based on sample size (n) should be between n/30 and n/60. in this study, the sample size was 120, so the range of the number of clusters based on the above guidelines is between 2 and 4. we decided to use a four-cluster solution shown in table 3 in this study as four-cluster solution provided more insight as compared to a two or three cluster solution without increasing the complexity. the cluster analysis suggests that cluster 2 has the highest mean of 73, whereas cluster 4 has the lowest cluster mean of 23. in order to examine the differences across four groups, one-way analysis of variance (anova) was used to test for the differences in mean score on csr among four clusters. the results of anova are shown in table 4, and variable response mean standard deviation financial management 120 50.76 18.56 csr 120 53.58 25.99 138 reavis et al. / journal of business strategies (2021) 38: 125-146 table 3. cluster solution on financial management in relation to csr investment 1 (medium) 2 (high) 3 (low) 4 (lowest) cluster mean 55.37 73.28 39.04 22.73 sample size 41 32 25 22 table 4. one-way anova results (dependent variable = csr) note: significant at the 0.05 level (2-tailed) the results indicate that the proposed model is significant (f=3.011, and pvalue=0.033) and we can infer that there is a significant difference among four clusters on the mean csr score. also, the mean score on csr for all four clusters is shown in figure 3. the mean plot indicates cluster 3 has the highest score among all clusters on csr, whereas the cluster 1 has lowest score on csr. the mean score of csr plot also suggests that cluster 3 and 4 score high on csr in comparison to cluster 1 and 2. the data indicates that there tends to be a bi-polar split in the distribution of students use of stakeholder theory as measured by our study. there is a strong association between the lower financial performance score and a higher csr score as associated with preferences towards stakeholder theory. conversely, there is a less strong relationship between higher financial performance and a stakeholder approach to decision making by millennials in this study, especially in cluster 3. further analysis of cluster 4 revealed that some students in this cluster were deficient in their financial decision-making and only moderately investing in csr. students in cluster 4 typically made strategic errors early in the competition that minimized the financial health of their company. the students are aware of the costs for every decision they make. decisions are not made in a vacuum, but with a financial overview of their competitors’ investments (competitive intelligence report), including their csr activities. sum of squares df mean square f sig. between groups 5807.760 3 1935.920 3.011 0.033* within groups 74577.407 116 642.909 total 80385.167 119 reavis et al. / journal of business strategies (2021) 38: 125-146 139 finally, we conducted the fisher’s lsd post-hoc test to identify the differences among clusters on csr. the result of fisher’s lsd is shown in table 5. the post-hoc test reveals that there is significant difference on mean csr score between cluster 1 and 3. similarly, the results also indicate that there is significant difference on mean csr score between cluster 2 and 3. the results of the statistical analysis supports that students do engage in a stakeholder model of decision-making and that decision-making had a direct financial impact on their teams’ performance. the analysis further indicates that the higher the score in the csr values, the lower the financial performance by that team. this indicates that the business students in this study are willing to forgo profits to maximize stakeholder values in making strategic/financial decisions. interestingly, what several students wrote in the required final paper for the course “what i learned in this class,” was the repeated expression “at the outset, our strategy was designed to make a difference in the world.” the decision to engage in csr was a conscious decision from the outset for them. csr and investment in csr is clearly covered in the simulation instructions and the pros and cons of said investments. the simulation awards teams who lead the industry in csr, even though their financial performance lags those with a more “balanced management portfolio.” the balance being that you have the appropriate dollars invested in csr activities, just as you would at setting employee salaries (which the students are also required to do). this simulation is done over a nine-week period with approximately 50 decisions 40 45 50 55 60 65 70 1 2 3 4 m e an o f c s r cluster number of case figure 3. mean plot of csr 140 reavis et al. / journal of business strategies (2021) 38: 125-146 table 5. multiple comparison (fisher’s lsd post-hoc test) (i) cluster number (j) cluster number mean difference (i-j) std. error sig. 95% confidence interval lower bound upper bound 1 2 2.36 5.981 0.694 -9.49 14.21 3 -16.150* 6.434 0.013 -28.89 -3.41 4 -6.754 6.701 0.316 -20.03 6.52 2 1 -2.36 5.981 0.694 -14.21 9.49 3 -18.510* 6.768 0.007 -31.92 -5.1 4 -9.114 7.022 0.197 -23.02 4.8 note: significant at the 0.05 level (2-tailed) required weekly with a “competitive intelligence report” to determine optimal/competitive positions. limitations the use of the terms csr, stakeholder theory, and stockholder theory as used in this study have become commonplace, at times probably misused or misunderstood, and issues of construct validity may give rise to error in differences in either interpretation or definition by either researchers or respondents. a second limitation is the geographic region from which a majority of the respondents have historically been limited in their desire for mobility and exposure to other belief models limited. to overcome this second limitation, further studies of millennials in other geographic regions could be tested to minimize this potential limitation. further study of millennials as they age, marry, work, and support themselves financially could result in changes to the conclusions of their generational philosophy as a whole. a third limitation was that for cluster groups one and two in this study, it might be observed by them that they did not perceive the exercise as an opportunity for engaging in csr, or did not understand that this opportunity for csr engagement was a risk worth taking during this exercise. 6. conclusions millennials mostly prefer a stakeholder approach as postulated by howe and strauss (2000). this study extends earlier research findings, which illustrate that millennial students prefer a stakeholder approach, by illustrating a negative reavis et al. / journal of business strategies (2021) 38: 125-146 141 financial consequence exists as behavior follows stakeholder preference. nevertheless, millennials do prefer csr as a tool in their decision-making process across the population even by those who do not use it as a primary referent when making decisions. all groups did engage in csr activities, but groups three and four at a much higher rate. we believe that even groups one and two will increase over time due to accreditation requirements, curriculum changes, and the very nature of the teaching materials and cases available to professors in aacsb accredited business schools. the results of this study give colleges of business institutional support that integrating csr activities and goals into the curriculum does have an impact that supports corporate social responsibility as per the aacsb “standard 9.” business students use csr as a tool in strategic decision-making. this is evidence of the associated increase in commitment to organizational change as millennials advance to the c level suite within organizations as postulated by aggarwal, dhaliwal, & nobi (2018) and prutina (2016). the analysis presented herein indicates that as more millennials ascend to leadership positions in authority, there should be a corresponding change from a stockholder to stakeholder approach in corporate governance. if financial performance is the same for real world corporations as it is in glo-bus, millennials’ stakeholder approach to corporate governance will result in decreased financial performance for firms. the millennial generation supports social accountability as evidenced by their decision-making. the millennial generation supports the common good over financial profit. this study lends support to the predictions by howe & strauss (2000) that as millennials continue to enter the c-level suite, they will lead significant cultural and strategic changes. they will impact the fabric of commercial, political, educational, and religious institutions. as their actions follow their philosophy, significant changes in society will occur. 142 reavis et al. / journal of business strategies (2021) 38: 125-146 references aacsb. (2020). standard 9 and societal and engagement impact arkansas state legislature. (2013). arkansas benefit corporation act, ark. stat. ann.§§ 4-36-101-401. retrieved from http://www.arkleg.state.ar.us/assembly/2013/2013r/pages/billinformat ion.aspx?measureno=hb1510 aggarwal, a., dhaliwal, r., & nobi, k. (2018). impact of structural empowerment on organizational commitment: the mediating role of women’s psychological empowerment. vision, 22(3), 284-294. https://doi.org/10.1177/0972262918786049 aguilera-caracuel, j., guerrero-villegas, j., garcía-sánchez, e. (2017). european journal of management and business economics, 26(3), 329-346. https://doi.org/10.1108/ejmbe-10-2017-019 arkansas business (2018). millennials constitute 35% of u.s. labor force. retrieved from http://www.arkansasbusiness.com/article/122227/millennials...t=dailyreport&utm_campaign=newsletter&enews_zone=3818 b lab (2017). b corporation. retrieved from www.bcorporation.net b lab (2019). b corporation. retrieved from www.bcorporation.net b lab (2021). b corporation. retrieved from www.bcorporation.net benefit corporation (2019). state by state status of legislation. retrieved from http://benefitcorp.net/policymakers/state-by-statestatus. benefit corporation (2019). international legislation. retrieved from http://benefitcorp.net/international-legislation. benioff, m. (2016). from cbs this morning june 1, 2016. chalmers, a., & van den broek, o. (2019). financial volatility and public scrutiny as institutional determinants of financial industry firms' csr. business and politics, 21(2), 240-266. https://doi.org/10.1017/bap.2018.28 cokins, g. (2013). kite with a broken string – the balanced scorecard. balanced scorecard institute. retrieved from http://www.balancedscorecard.org/resources/articles-white-papers cooper, e., (2017). corporate social responsibility, gender, and ceo turnover, managerial finance, 43(5) 528-544. https://doi.org/10.1108/mf02-2016-0049 elalfy, a., palaschuk, n., el-bassiouny, d., wilson, j., & weber, o. (2020). scoping the evolution of corporate social responsibility (csr) research in the sustainable development goals (sdgs) era. sustainability, 12(14). https://doi.org/10.3390/su12145544 http://www.arkleg.state.ar.us/assembly/2013/2013r/pages/billinformation.aspx?measureno=hb1510 http://www.arkleg.state.ar.us/assembly/2013/2013r/pages/billinformation.aspx?measureno=hb1510 https://doi.org/10.1177/0972262918786049 https://doi.org/10.1177/0972262918786049 https://doi.org/10.1108/ejmbe-10-2017-019 http://www.arkansasbusiness.com/article/122227/millennials...t=daily-report&utm_campaign=newsletter&enews_zone=3818 http://www.arkansasbusiness.com/article/122227/millennials...t=daily-report&utm_campaign=newsletter&enews_zone=3818 file://///winfscommon/common/cbed/jbs/manuscripts/copyediting/38-2/5473%20-%20reavis/www.bcorporation.net file://///winfscommon/common/cbed/jbs/manuscripts/copyediting/38-2/5473%20-%20reavis/www.bcorporation.net file://///winfscommon/common/cbed/jbs/manuscripts/copyediting/38-2/5473%20-%20reavis/www.bcorporation.net https://doi.org/10.1017/bap.2018.28 http://www.balancedscorecard.org/resources/articles-white-papers https://doi.org/10.1108/mf-02-2016-0049 https://doi.org/10.1108/mf-02-2016-0049 https://doi.org/10.3390/su12145544 reavis et al. / journal of business strategies (2021) 38: 125-146 143 el khatib, k. (2015). the harms of the benefit corporation. american university law review, 65(1), 151-189. https://digitalcommons.wcl.american.edu/aulr/vol65/iss1/3 elkington, j. (1997). cannibals with forks: the triple bottom line of the 21st century business. gabriola island, bc: new society publishers. ferrell, o., thorne, d., & ferrell, l. (2016). business and society: a strategic approach to social responsibility & ethics. chicago business press, 5th ed. fraley, c., & raftery, a. (1998). how many clusters? which clustering method? answers via model-based cluster analysis. the computer journal, 41(8), 578-588. https://doi.org/10.1093/comjnl/41.8.578 freeman, r. e. (1983). stockholders and stakeholders: a new perspective on corporate governance. california management review, 25(3), 88. https://doi.org/10.2307/41165018 friedman, m (1970). the social responsibility of business is to increase its profits. the new york times. gilbert, j. (2010). tedxphilly jay coen gilbert on better businesses. retrieved from https://www.youtube.com/watch?v=mgnz-w9p5fu glo-bus.com, (2021). an online business strategy simulation. retrieved from glo-bus.com hacker, m. a. (2016). “profit, people, planet" perverted: holding benefit corporations accountable to intended beneficiaries. boston college law review, 57(5), 1747-1780. harrison, virginia. (2019). “it’s a delicate dance”: understanding csr relationships from the nonprofit perspective. journal of communication management, 23(2), 142-158. https://doi.org/10.1108/jcom-10-20180100 honeyman, r. (2015). a look at the history of the b corp movement. retrieved from http://www.triplepundit.com/2014/08/fascinating-lookhistory-b-corp-movement/. hiralal, m. (2015). india: corporate social responsibility – indian companies act 2013. retrieved from http://www.mondaq.com/india/x/366528/corporate+governance/cor porate+social+responsibility+indian+companies+act+2013 horng, j., hsu, h., chang-yen, t. (2019). learning corporate ethics and social responsibility: developing an influential curriculum for undergraduate tourism and hospitality students, journal of hospitality, leisure, sports and tourism education, 24, 100-109. https://doi.org/10.1016/j.jhlste.2019.01.003 https://digitalcommons.wcl.american.edu/aulr/vol65/iss1/3 https://doi.org/10.1093/comjnl/41.8.578 https://doi.org/10.2307/41165018 https://www.youtube.com/watch?v=mgnz-w9p5fu https://doi.org/10.1108/jcom-10-2018-0100 https://doi.org/10.1108/jcom-10-2018-0100 http://www.mondaq.com/india/x/366528/corporate+governance/corporate+social+responsibility+indian+companies+act+2013 http://www.mondaq.com/india/x/366528/corporate+governance/corporate+social+responsibility+indian+companies+act+2013 https://doi.org/10.1016/j.jhlste.2019.01.003 144 reavis et al. / journal of business strategies (2021) 38: 125-146 howe, n. & strauss, w. (2000). millennials rising: the next great generation. new york: vintage books. kim, b., nurunnabi, m., kim, t., & kim, t., (2018) doing good is not enough, you should have been authentic: organizational identification, authentic leadership, and csr. sustainability, 10(6), 20-26 larrán, m., andrades, j., herrera, j, (2018). an examination of attitudes and perceptions of spanish business and accounting students toward corporate social responsibility and sustainability themes. revista de contabilidad, 21(2), 196-205. https://doi.org/10.1016/j.rcsar.2018.02.001 lehmann, d. r. (1979). market research and analysis. homewood, il: r. d. irwin. lopez, m., garcia, a., rodriguez, l. (2007). sustainable development and corporate performance: a study based on the dow jones sustainability index. journal of business ethics, 75, 285-300. https://doi.org/10.1007/s10551-006-9253-8 marques-mendes a. & santos, m. (2016) strategic csr: an integrative model for analysis. social responsibility journal, 12(2), 363-381. mcglone, t., spain, j., & mcglone, v (2011). corporate social responsibility and the millennials. journal of education for business, 86(4), 195-200. https://doi.org/10.1080/08832323.2010.502912 miftachul, h., mulyadi, d., hananto, a., nasrul, h., kamarul, s. (2018). empowering corporate social responsibility (csr): insights from service learning. social responsibility journal, 14(4), 875-894. http://dx.doi.org/10.1108/srj-04-2017-0078 nine steps to success. (2017). balanced scorecard institute retrieved from http://www.balancedscorecard.org/resources/the-nine-steps-tosuccess ohio university (2020). why corporate social responsibility is important. onlinemasters.ohio.edu/blog/why-corporate-social-responsibility-mattersin-todays-society/ february 6th porter, m., & kramer, m. (2011). creating shared value. harvard business review. post, j., preston, l., & sachs, s. (2002). redefining the corporation: stakeholder management and organizational wealth. stanford, ca: stanford university. prutina, zana (2016). the effect of corporate social responsibility on organizational commitment. journal of contemporary management issues, 21, 227-248. rao, k. & tilt c. (2016). board composition and corporate social responsibility: the role of diversity, gender, strategy and decision making. https://doi.org/10.1016/j.rcsar.2018.02.001 https://doi.org/10.1007/s10551-006-9253-8 https://doi.org/10.1080/08832323.2010.502912 http://dx.doi.org/10.1108/srj-04-2017-0078 http://www.balancedscorecard.org/resources/the-nine-steps-to-success http://www.balancedscorecard.org/resources/the-nine-steps-to-success reavis et al. / journal of business strategies (2021) 38: 125-146 145 journal of business ethics, 138(2), 327-347. https://www.jstor.org/stable/24755872 reavis, m. & orr, d. (2021). the journey of american capitalism: from stockholders to stakeholders. american journal of management, 21(4), 1-15. https://doi.org/10.33423/ajm.v21i4.4553 reavis, m., tucci, j., & st. pierre, g. (2017). corporate social responsibility and millennials’ stakeholder approach. journal of leadership, accountability and ethics, 14(4), 74-83. https://doi.org/10.33423/jlae.v14i4.1488 reavis, m. r., tucci, j.e., (2020). sustainability effort acceleration as measured by increased propensity of corporate social responsibility. journal of management and sustainability, 10(2) 121-134. doi: 10.5539/jms.v10n2p121 roker, a. (2017). millennial misconceptions-how they are changing the workplace. today. new york city, ny: national broadcast corporation. rausch, a. (2011). reconstruction of decision-making behavior in stockholder and stakeholder theory: implications for management accounting systems. review of managerial science, 5(2-3), 137-169. https://doi.org/10.1007/s11846-010-0053-2 serban, a. (2105). how personal values influence romanian csr manager’s involvement in csr campaigns. management dynamics in the knowledge economy, 3(4), 729-748. slaper, t. & hall t. (2011). the triple bottom line: what is it and how does it work? indiana business review, 86(1). smith, n., & rönnegard, d. (2016). stockholder primacy, corporate social responsibility, and the role of business schools. journal of business ethics, 134(3), 463-478. https://www.jstor.org/stable/24703783 solomon, s. (2015). idealism that may leave stockholders wishing for pragmatism. the new york times. retrieved from https://www.nytimes.com/2015/10/14/business/dealbook/laureateeducation-for-profit-school-public-benefit.html?_r=0 starbucks 2012 annual meeting (2013). starbucks annual meeting, retrieved from https://www.youtube.com/watch?v=hoibhe0i22e&t=9s stonkutė, e., vveinhardt, j., sroka, w. (2018). training the csr sensitive mind-set: the integration of csr into the training of business administration professionals, sustainability, 10(3), 754. https://doi.org/10.3390/su10030754 triple bottom line (2009). the economist. retrieved from http://www.economist.com/node/14301663. https://www.jstor.org/stable/24755872 https://doi.org/10.33423/ajm.v21i4.4553 https://doi.org/10.33423/jlae.v14i4.1488 file://///winfscommon/common/cbed/jbs/manuscripts/copyediting/38-2/5473%20-%20reavis/10.5539/jms.v10n2p121 https://doi.org/10.1007/s11846-010-0053-2 https://www.jstor.org/stable/24703783 https://www.nytimes.com/2015/10/14/business/dealbook/laureate-education-for-profit-school-public-benefit.html?_r=0 https://www.nytimes.com/2015/10/14/business/dealbook/laureate-education-for-profit-school-public-benefit.html?_r=0 https://www.youtube.com/watch?v=hoibhe0i22e&t=9s https://doi.org/10.3390/su10030754 146 reavis et al. / journal of business strategies (2021) 38: 125-146 tucci, j., shin, s., & benefield, m. (2015). logistics sustainability? long term technology investments and integration. journal of management and sustainability, 5. doi:10.5539/jms.v5n2p48 wilburn, k. & wilburn, r. (2015). evaluating csr accomplishments of founding certified b corps. journal of global responsibility, 6(2), 262-280. https://doi.org/10.1108/jgr-07-2015-0010 winograd, m. & hais, m. (2014). how millennials could upend wall street and corporate america. the brookings institution. washington, dc. file://///winfscommon/common/cbed/jbs/manuscripts/copyediting/38-2/5473%20-%20reavis/10.5539/jms.v5n2p48 https://doi.org/10.1108/jgr-07-2015-0010 volume 35, number 2 29 religiosity and corporate illegal activity joseph e. coombs virginia commonwealth university • richmond, va k. matthew gilley st. mary’s university • san antonio, tx joseph p. o’connor recently retired from the university of texas at el paso • el paso, tx timothy e. thorley dixie high school • st. george, ut curtis l. wesley ii university of houston • houston, tx abstract this paper explores the effects of regional religiosity on the illegal financial actions of business executives. in particular, we examine the extent to which agency and institutional theories may be used to explain fraudulent financial reporting and stock options backdating. our findings indicate that religiosity has a negative influence on illegal corporate activity but that this relationship is primarily limited to stock options backdating. board size and independence are also shown to moderate the relationship between religiosity and illegal corporate activity. these results provide support for an institutional theory perspective on mitigating executive opportunism. keywords: corporate fraud; executive compensation; financial reporting; institutional norms; religiosity; stock options backdating introduction agency theory is the primary theoretic lens through which executive compensation and corporate governance issues are examined (dalton, hitt, certo, & dalton, 2007; devers, cannella, reilly, & yoder, 2007; eisenhardt, 1989). this continues despite growing evidence that agency theory prescriptions may inadvertently contribute to the agency problems they were designed to solve (dalton et al., 2007; devers et al., 2007) such as financial fraud (e.g., ndofor, wesley, & priem, 2015; o’connor, priem, coombs, & gilley, 2006) and stock option backdating (heron and lie, 2007; lie, 2005). one possible way to address these issues is to follow eisenhardt’s recommendation that researchers, “use agency theory with complementary theories” (eisenhardt, 1989, p. 71) because agency theory ignores organizational complexity. we 30 journal of business strategies follow this recommendation and offer institutional theory as an important compliment to agency theory when studying certain agency problems. institutions provide society with rules and standards that influence individuals and organizations, and hence, economic activity (hitt, ahlstrom, dacin, levitas, & svobodina, 2004; north, 1990; scott, 2001). institutions affect individuals’ and firms’ strategic choices (hitt et al., 2004; peng, 2003) partly because they define acceptable behaviors within a society (dimaggio & powell, 1983; north, 1990; scott, 2001). one institutional dimension of particular importance to executives and organizations is the normative dimension. normative institutions introduce values and norms into social life that “define legitimate means to pursue valued ends” (scott, 2001, p. 64). in particular, normative institutions not only define socially acceptable goals such as making a profit, but they also specify acceptable rules for meeting those goals (blake & davis, 1964). in our context, we examine how one particular normative institution, religion, influences the likelihood of socially unacceptable actions such as corporate illegal activity. the purpose of our research, then, is to integrate agency and institutional theories and demonstrate how they may act together to explain corporate illegal activity. in doing so, we make several contributions to the literature. first, we respond to eisenhardt (1989) by integrating agency and institutional theories to explain corporate illegal activity. consistent with warnings that agents may look for new ways to increase their personal gain when old ways are monitored and controlled (dow, 1987; ghoshal & moran, 1996), executives at many organizations have engaged in illegal actions. agency theory prescriptions have not only failed to mitigate these actions, but may have actually contributed to them (dalton et al., 2007; devers et al., 2007). we posit that pressure from normative institutions may help to mitigate these actions. second, we develop theory to help understand how normative institutions influence social actors to not engage in corporate illegal activity. more specifically, we explain how religiosity in the geographic region in which an organization is headquartered creates social norms of honesty and risk aversion in which executives live and make decisions (cialdini & goldstein, 2004; halek & eisenhauer, 2001; kohlberg, 1984; sunstein, 1996). lastly, we extend recent work relating religiosity with legal accounting tactics such as earnings management (callen, morel, & richardson, 2011; mcguire, omer, & sharp, 2012) and financial restatements (dyreng, mayew, & williams, 2012), as well as investment and growth rates (hilary and hui, 2009) by examining the relationship between religiosity and corporate illegal activity. volume 35, number 2 31 literature review religiosity as a normative institution religion has been defined as shared beliefs, ideologies, and behaviors based on faith in a higher power, or supernatural forces (iannaccone 1998). religiosity is often used in the social sciences to represent the measurable behaviors, affect, and cognitions of respondents that are related to religion (mcguire et al., 2012). consistent with the view that normative institutions define socially acceptable goals and specify acceptable rules for meeting those goals (blake & davis, 1964), religious norms provide individuals guidelines for what constitutes ethical action (mcguire et al., 2012; weaver & agle, 2002). within organizations, religiosity may influence honesty and risk aversion, two individual characteristics likely associated with the likelihood to commit illegal (dishonest and risky) acts. recent research suggests religiosity, while not consistently associated with honesty (weaver & agle, 2002), remains the best predictor of attitudes about honesty (katz, santman, & lonero, 1994). this relationship may stem from both a direct and an indirect relationship between religiosity and honesty. for example, perrin (2000) reported that students were more likely to be honest if they were more religious, as evidenced by church attendance, involvement in religious activities, and belief in life after death, suggesting a direct relationship between religiosity and honesty. this relationship may be indirect as well, however. according to dyreng and colleagues (2012), religious reminders such as “what would jesus do?” bracelets and religious bumper stickers in more highly religious geographic areas provide a consistent reminder of the region’s moral code. additionally, mazar, amir, & ariely (2008) demonstrated that religious reminders such as reciting the ten commandments tend to curb dishonest reporting that would have led to personal financial gain even for individuals not explicitly associated with any religious group. further evidence at the organization level suggests religiosity is associated with employees’ honesty in terms of their willingness to voluntarily disclose bad news rather than hide it (dyreng et al., 2012). religious individuals are also typically associated with risk aversion more so than are those who are non-religious (diaz, 2000; dohmen, falk, huffman, sunde, schupp, & wagner, 2011; hilary & hui, 2009; liu, 2010; miller, 2000; miller & hoffman, 1995). much like the relationship between religiosity and honesty, the relationship between religiosity and risk aversion does not necessarily suggest religious individuals are more risk averse but that the relationship is driven by the social aspect 32 journal of business strategies of religion (noussair, trautmann, van de kuilen, & vellekoop, 2013). evidence for this relationship also exists at the organization level. hilary and hui (2009) found that organizations are more conservative in choosing investments when located in a more religious geographic area. additionally, dyreng and colleagues (2012) report that religious adherence is associated with a lower risk of voluntary, rather than forced, financial restatement. the authors of each of these papers suggest their findings provide evidence of social norms influencing corporate decision-making. religious norms and the organization while religiosity is measured at the individual level, there is reason to conclude that individual religiosity can influence decisions at the organization level. religious norms of the population located around an organization’s headquarters are one aspect of the social environment in which organization decisions are made (cialdini & goldstein 2004; dyreng et al., 2012; kohlberg, 1984; sunstein, 1996). even when managers themselves are not religious, the likelihood of interacting with religious individuals exposes managers to religious social norms and increases the likelihood that managers are influenced by these norms (kennedy & lawton, 1998). as evidence of this relationship, welch, tittle, and petee (1991) found that religious social norms in a community can cause individual adherence to these social norms. more specifically, welch and colleagues (1991) demonstrated both individual and community religiosity influenced whether an individual would evade taxes or use employer equipment for personal gain. religiosity and financial reporting in some cases, managers manipulate earnings to bolster their own financial rewards, or to create a false sense of security for key stakeholders regarding the company’s finances. in a study looking at both religiosity and other cultural variables, callen and colleagues (2011) found that earnings management is unrelated to both religious affiliation and religiosity, as measured by attendance and self-ratings of religious conviction and importance. however, other cultural variables, individualism and uncertainty avoidance, had a relationship with earnings management. these variables were examined at the national level, so it is possible that differences in religiosity within a particular country may relate to earnings management. in a working paper, grullon, kanatas, and weston (2014) found that organizations in areas with a higher level of per capita adherents to an organized religion were less likely to be the targets of class action lawsuits, engage in forms of options backdating volume 35, number 2 33 that are not illegal per se, and manipulate their earnings. however, as they note, their rather coarse-grained measure of religiosity presents limitations. mcguire and colleagues (2012) found that social norms created or influenced by religion help to reduce financial reporting irregularities, especially when other control mechanisms are less effective. as with other studies, these results may suggest that the manager making a decision does not have to be particularly religious in order to be influenced by the religious practices, attachment, and affiliation in the region in which he or she works. dyreng and colleagues (2012) examined different aspects of financial reporting and found similar results. more specifically, they determined that non-forced restatements, made necessary by inappropriate reporting or omissions, are less likely in more religious areas. they also found that firms located in more religious areas do not delay or avoid reporting bad news as much as firms located in less religious areas. whether these reporting practices reflect the values adopted by executives because of the area in which they work, or represent a response to social norms and pressures from stakeholders, is unclear. corporate illegal behavior there is an extensive body of work on corporate illegal activity, which we define as deliberate actions taken by executives to misrepresent their firm’s operations and financial activities for monetary gain. this definition covers issues such as fraudulent financial reporting (arthaud-day, certo, dalton, & dalton, 2006; harris & bromiley, 2007; ndofor et al., 2015; o’connor et al., 2006; zhang, bartol, smith, pfarrer, & khanin, 2008) and stock option backdating (aboody & kasznik, 2000; heron & lie, 2007; lie, 2005). harris and bromiley (2007) reported that fraudulent financial reporting increased when stock options made up a higher percentage of total compensation. ndofor and colleagues (2015) describe how industry and firm level complexity are associated with fraud, while ceo stock options increase the likelihood of fraud in association with high industry complexity. o’connor and colleagues (2006) found that fraudulent financial reporting and stock option grants were related when boards of directors also held options. according to zhang and colleagues (2008), fraudulent financial reporting is more likely to occur when ceos hold greater amounts of “out of the money” options. a common thread amongst these studies is that ceo stock options are associated with fraudulent financial reporting. for agency theorists, this is problematic, as stock options are the primary mechanism used to reduce opportunistic behavior by aligning the interests of agents and principals (eisenhardt, 1989; fama & jensen, 1983; jensen & meckling, 1976). 34 journal of business strategies stock option backdating occurs when stock option grant dates are changed (1) with the benefit of hindsight to a past date when the stock price was appreciably lower and (2) without notifying or obtaining approval from principals (lie, 2005). because most stock option plans limit the number of shares awarded annually, and because options are typically granted “at the money” (the price of the firm’s common stock on the day the options are granted), backdating provides an illegal and “covert method of maximizing the option component value of executives’ compensation” (heron & lie, 2007, p. 274). researchers have provided substantial evidence that backdating is widespread (aboody & kasznik, 2000; heron & lie, 2007, 2009; heron, lie, & perry, 2007; lie, 2005; narayanan, schipani, & seyhun, 2007; narayanan & seyhun, 2008) and, despite regulatory changes, continues to be a significant issue. specifically, researchers estimate that the enhanced regulations instituted through the sarbanesoxley act of 2002 (sox) have reduced backdating events by only half (heron and lie, 2009), and that 20 percent of stock grants do not conform to sox’s reporting requirements (narayanan & seyhun, 2008). consistent with their expectation, aboody and kasznik (2000) reported changes in stock prices and analyst earnings forecasts around option awards consistent with stock option backdating. heron and lie (2007) reported that stock returns are abnormally negative before option grants and abnormally positive afterward options grants in a large sample of public firms, suggesting backdating is widespread. in a subsequent study, heron and lie (2009) provided evidence that from 1996-2005, 13.6% of all option grants to top executives were backdated or manipulated. narayanan and colleagues (2007) calculated an average loss to shareholders of about 8% in firms where executive stock options were backdated. lastly, narayanan and seyhun (2008) report evidence of both stock option backdating and forward dating. perhaps even more problematic for agency theorists, stock option backdating results suggest executives are manipulating the very mechanism designed to reduce their opportunistic behavior (eisenhardt, 1989; fama & jensen, 1983; jensen & meckling, 1976). hypothesis development we theorize that religious social norms affect corporate illegal activity through their influence on executive decision-making. the primary focus of previous corporate illegal activity research has been on how firm financial reports and stock options have been manipulated to the benefit of executives. a primary focus of a second research stream examined how religiosity influenced several accounting volume 35, number 2 35 tactics legally used to benefit organizations. religiosity can also be examined in terms of its relationship with corporate illegal activity, which is the purpose of the current study. religious individuals within a particular geographic area interact with employees and executives from local firms, and in doing so, expose these organization members to religious social norms prevalent in the area (kennedy and lawton, 1998). we posit that religious social norms such as honesty (dyreng et al., 2012; mazar et al., 2008) and risk aversion (diaz, 2000; dyreng et al., 2012; hilary & hui, 2009; miller, 2000; miller & hoffman, 1995) influence accounting tactics such that the likelihood of using these tactics is lower in areas with higher religiosity. to the extent that religious social norms are prevalent in the community, we expect executives to be influenced by these norms when considering whether to take illegal actions. more specifically, when located in a community with higher religiosity, we expect executives to adhere to the accompanying religious social norms and be more honest and risk averse. executives in more religious communities are less likely to commit illegal acts because other executives or employees, similarly influenced by religious social norms, are likely to view such actions as unethical (mcguire et al., 2012). taken together, these arguments suggest executives in organizations headquartered in more religious communities will be less likely to commit illegal acts. more specifically, we propose: hypothesis 1: regional religiosity negatively affects corporate illegal activity. board of director size as a moderator agency theory suggests that boards of directors can be important monitors of the agent-principle relationship (fama, 1980; fama & jensen, 1983; jensen & meckling, 1976). there remains uncertainty, however, amongst research as to whether larger or smaller boards are more effective monitors of management actions (williams, fadil, & armstrong, 2005). from an agency perspective, there are several reasons larger boards may be better monitors than smaller boards. first, larger boards have more specialized human capital than smaller boards and may, therefore, be better able to process larger quantities of information more quickly, thus decreasing information asymmetries between management and shareholders (amason & sapienza, 1997; williams et al., 2005). larger boards may also be able to form and use more committees with which to monitor management (pearce & zahra, 1992; zahra & pearce, 1989). additionally, larger boards likely have more independent board members with which to monitor the executives. in addition, larger boards 36 journal of business strategies are better able to constrain executives’ internal political coalitions (ocasio, 1994; williams et al., 2005). multiple political coalitions are more easily formed in larger boards, and these coalitions may be more effective in confronting political coalitions within the executive ranks (ocasio, 1994). lastly, larger boards may be more likely to be represented by members of the community who are of a religious orientation, thus affecting executive decision-making. these arguments suggest that executives who are not sufficiently influenced to avoid illegal acts by religious social norms may be further influenced to avoid such actions by larger boards. in other words, we expect that board size and regional religiosity interact such that the negative effects of religiosity on illegal activity are enhanced when a company’s board is larger. therefore, we propose: hypothesis 2: board size moderates the effects of religiosity on corporate illegal activity, such that the negative relationship between religiosity and corporate illegal activity will be stronger in organizations with a larger board of directors. percentage of outsiders on the board as a moderator in addition to board size, agency theory suggests boards with a higher percentage of outsiders can better monitor executive actions (mizruchi, 1983; zahra & pearce, 1989). the belief is that outside directors, as a result of their independence from management, will produce superior firm performance (dalton, daily, ellstrand, & johnson, 1998). ezzamel and watson (1993) provide support for this perspective with their finding that board outsiders were associated with greater firm profitability. other researchers, such as baysinger and butler (1985) and pearce and zahra (1992), have also reported results consistent with outside board members’ ability to monitor management and deliver greater firm performance. this research suggests that when executives are not sufficiently influenced to avoid illegal acts by religious social norms, more independent boards may further influence executives to avoid such actions. thus: hypothesis 3: board independence moderates the relationship between religiosity and corporate illegal activity, such that the negative effects of religiosity on corporate illegal activity will be stronger in organizations with more independent boards. volume 35, number 2 37 methodology sample selection our sample contains firms that have been involved in illegal corporate activity, including reporting fraudulent financial results and backdating stock options. these illegal acts are relatively rare, making random sampling inappropriate, necessitating use a matched pair design (o’connor et al., 2006). consistent with o’connor and colleagues (2006), to identify firms that had fraudulently inflated financial results, we reviewed 12,222 articles using the proquest® newspapers database of over 550 newspapers and searched for variations of the word “restate” in the text of fulltext articles. to identify firms with specific instances of backdating, we used the wall street journal online options scorecard. janney and gove (2011) used the full database to study relationships between corporate social responsibility and stock option backdating. to ensure firms in our sample were unambiguously involved with backdating, firms had to meet one of three criteria: (1) the firm admitted that certain historical stock option grants were found to differ from the recorded grant dates, or (2) the firm restated financial results for costs related to backdating, or (3) the firm settled backdating charges with the federal government. the backdating firms included in this sample had at least one instance of backdating. next, to provide a comparison group (non-restating and backdating firms), we developed a matched-sample design (denis, hanouna, & sarin, 2006; harris & bromiley, 2007; o’connor et al., 2006) by closely matching each firm that had committed an illegal act with a similar firm based on five criteria. all matched firms (1) are publicly traded, (2) are based in the u.s. as of the year corresponding to the backdating, (3) share four-digit standard industry classification codes (sic), (4) have similar net sales, and (5) have similar net incomes. our review of proquest® articles identified 103 firms that met our criteria, and we were able to identify close matches for 65 firms. our review of the the wall street journal online options scorecard included fourteen backdating firms that we dropped because the necessary financial data were unavailable or they were headquartered outside of the u.s., leaving 82 firms for our analyses. thus, the final sample included 65 firms that had been forced to restate their financial reports and 82 backdating firms. including the matched firms, our sample totals 294 firms, of which 130 make up the forced restatement group and 164 are in the backdating group. 38 journal of business strategies because the exact date of each instance of illegal activity is typically not identifiable, we incorporate a one-year lag in our models. thus, if a firm was investigated for backdating or restated earnings in year t, data for all independent and control variables were collected for year t-1 (except for value of exercisable options, discussed below, which were collected for year t). this lag structure is appropriate since ceo compensation (including stock options) is determined annually and is influenced by firm performance in the prior year (coombs & gilley, 2005). the data sources for all variables are the wall street journal online options scorecard, the proquest® newspapers database, compustat, execucomp, and the sec’s edgar database. dependent variables the dependent variable is corporate illegal activity, which is a binary variable coded as 1 if the firm committed an illegal activity (either backdating or forced restatements) and 0 if the firm did not. a binary variable is used because whether a firm committed an illegal act is a dichotomous phenomenon and because assigning a specific dollar amount for the financial consequences of these illegal acts requires consideration of numerous arbitrary factors. control variables twelve control variables are used in the analyses. executives in larger firms may be more likely to commit illegal acts because they may face more pressure to suppress their values if they hinder organizational priorities (gabbioneta, greenwood, mazzola, & minoja, 2013). thus, we control for firm size using the natural logarithm of total sales. we control for the number of audit committee meetings held annually (o’connor et al., 2006), as the number of audit committee meetings may decrease the likelihood of illegal acts (ndofor et al., 2015; o’connor et al., 2006). ceo age is used as a control variable because of its relationship with both managerial risk propensity and moral judgment (zahra, priem, & rasheed, 2005) as well as its negative relationship with financial misconduct (o’connor et al., 2006). ceo age is measured in years. ceo cash compensation is measured as the sum of salary and bonus cash compensation. volume 35, number 2 39 higher ceo cash compensation might be expected to decrease ceo motivation to commit illegal acts (finkelstein and boyd, 1998; henderson and fredrickson, 1996). stock option grants are the very mechanism through which executives have enriched themselves, whether it is from fraudulent financial reporting or stock option backdating. we expect more option grants to increase the likelihood that executives will commit illegal acts. stock option grants are measured as the number of stock options the ceo received in the year of the organization’s illegal act. ceo tenure is associated with experience and power (shen, 2003) and is measured as the number of years the ceo has held that title at the focal firm. ceo duality is measured as 1 if the ceo is also the chair of the board of directors and 0 if the ceo is not, and it is considered a measure of ceo power (harris & bromiley, 2007). ceo ownership is measured as the percentage of stock owned by the ceo (zhang et al., 2008). we expect that when ceos have higher ownership they have less motivation to commit illegal acts. as harris and bromiley (2007) note, poor performance against historic company standards motivates executives to respond. as a result, self reference equals 1 where the firm’s return on assetst-1 minus its return on assetst-2 is positive and 0 if not (harris & bromiley, 2007). board of directors (bod) options is a binary variable reflecting the presence (1) or absence (0) of bod stock options. hambrick and jackson (2000) provided evidence that companies with directors who own company stock outperform other firms, suggesting these options may align board member interests with shareholder interests. moderators williams and colleagues (2005) recently argued that larger boards are better able to monitor executive actions because larger boards may process larger quantities of information more quickly, thus decreasing information asymmetries between management and shareholders. larger boards may also form and use more committees with which to monitor management, and they are better able to constrain executives’ political coalitions. board members are measured as the total number of board members for each firm. percentage of outsiders on the board (abrahamson & park, 1994) was measured as the number of outsiders divided by the total number of directors. 40 journal of business strategies independent variable religiosity is the independent variable in our analyses. to create our measure, we followed the process used by mcguire and colleagues (2012). we used a gallup organization database of over 610,000 interviews conducted nationwide on a range of religious characteristics and focused on three of religiosity’s distinct elements: cognitive, affective, and behavioral (parboteeah, hoegl, & cullen, 2008). consistent with mcguire and colleagues (2012), we used three poll questions that correspond with the three elements of religiosity: (1) are you affiliated with a particular religion (cognitive); (2) is religion important in your daily life (affective); and (3) do you attend religious services weekly (behavioral). data for these questions is available at the county level. we grouped counties into metropolitan statistical areas (msas) and aggregated scores for each question into an msa-level score. we then changed the scores for each question into z-scores and summed these results to create msalevel scores for religiosity. data analysis and results to test our hypotheses, we use logistic regression, which is appropriate for analyzing models with dichotomous dependent variables (hoetker, 2007). conditional logistic regression is typically used with dichotomous dependent variables when the sample follows a matched-pair design (agresti, 2002); however, it does not provide an intercept necessary for graphing interaction results. so to confirm our logistic regression results, we also tested our hypotheses with conditional logistic regression and found consistent results. we also follow hoetker’s (2007) and wiersema and bowen’s (2009) suggestions to report marginal effects when interpreting direct effects between independent variables and the dependent variable. consistent with sanders and hambrick (2007), we report one-tailed tests for our hypothesized interactions and two-tailed results for our control variables. lastly, all variables (except for binary variables) were mean centered before hypothesis testing. table i reports uncentered descriptive statistics and correlations for the variables. volume 35, number 2 41 table 1 correlation matrix table 1 (cont.) correlation matrix 42 journal of business strategies table 2 logistic regression results for religiosity and illegal financial activity (includes backdating and forced restatements) results for hypothesis 1 are shown in model 2 of table ii. hypothesis 1 argued that religiosity is negatively associated with corporate illegal activity. results from model 2 support the statistical significance of this relationship, although the relationship is weak. this result suggests that religiosity does have a weak but significant negative influence on illegal corporate activity. results for hypotheses 2 and 3 are shown in model 4 of table ii. hypothesis 2 argues that board size moderates the relationship between religiosity and corporate illegal activity, such that the negative relationship between religiosity and corporate illegal activity will be stronger in organizations with a larger board of directors. hypothesis 2 is not supported. the interaction between religiosity and board size is positive and our plot of these results confirms that larger boards actually increase the likelihood of backdating as the level of religiosity rises. hypothesis 3 stated that board independence moderates of the relationship between religiosity and corporate illegal activity, such that the negative relationship between volume 35, number 2 43 religiosity and corporate illegal activity will be stronger in organizations with more independent boards. our results provide support for hypothesis 3 and our plot of this relationship lends further support. figure 1 interaction between religiosity and board size figure 2 interaction between religiosity and outsider percentage to determine whether our results were consistent across different types of illegal acts, we also conducted the above analyses separately for only firms that restated financial results and for only firms where stock options were backdated. interestingly, for firms that restated their financials, there was no significant 44 journal of business strategies relationship between religiosity and restatements. further, the interaction of religiosity and board size was not significant. the interaction of religiosity and board outsider percentage, however, was negative and significant suggesting that religiosity can still influence restatements, and that the influence is enhanced by board independence. regarding firms where stock option backdating occurred, religiosity had a highly significant, negative influence, suggesting that religiosity by itself may serve to limit stock option backdating. further, the interaction between religiosity and board size is significant and positive as in our original set of analyses, suggesting that larger boards inhibit the influence of religiosity on stock option backdating. the interaction between religiosity and percentage of outsiders on the board is not significant, indicating that board independence does not enhance the effect of religiosity on stock option backdating. table 3 logistic regression results for religiosity and forced restatements volume 35, number 2 45 table 4 logistic regression results for religiosity and stock option backdating discussion our study was motivated by the desire to extend theory by integrating institutional theory (north, 1990; scott, 2001) with agency theory (fama & jensen, 1983; jensen & meckling, 1976) as suggested by eisenhardt (1989). in doing so, we introduced religiosity as a normative institutional construct that may reduce the likelihood of agent-based opportunism in the form of illegal corporate activity. we view illegal corporate activity as a form of opportunistic behavior that has been largely overlooked because research has focused on more easily observable forms of opportunism (dow, 1987; ghoshal & moran, 1996). we focus on forced financial restatements and stock option backdating as forms of illegal corporate activity because the sec has formally recognized these activities as fraudulent and because stock options have been viewed as aligning interests of agents and principals (eisenhardt, 1989). moreover, these forms of opportunism are less researched than 46 journal of business strategies other forms, such as excessive compensation. our research makes three specific contributions of interest to institutional and agency theory researchers. first, we take up eisenhardt’s (1989) call to integrate agency theory with other complementary theories by introducing institutional theory to explain how corporate illegal activity may be reduced. corporate illegal activity is particularly important to understand, as it may reflect executives’ attempts to increase their personal gain to offset compensation reductions resulting from increased monitoring in other areas (dow, 1987; ghoshal & moran, 1996). eisenhardt’s (1989) suggestion to draw from other theories is particularly timely because agency theory prescriptions to mitigate opportunism appear to have increased other forms of opportunism (dalton et al., 2007; devers et al., 2007). we posit that pressure from normative institutions may help to mitigate these new forms of opportunism. second, we develop theory to clarify how normative institutions may influence social actors such as executives to not engage in corporate illegal activity. more specifically, we introduce religiosity as a normative institutional concept and explain how the level of religiosity in the geographic region around an organization’s headquarters forms social norms of honesty and risk aversion in which executives live and make decisions (cialdini & goldstein, 2004; halek & eisenhauer, 2001; kohlberg, 1984; sunstein, 1996). additionally, we explain how institutional norms are transferred from the social to the organizational level and discuss how these institutional norms interact with board of director variables to influence corporate illegal activity. finally, we extend recent work relating religiosity with legal accounting tactics such as earnings management (callen et al., 2011; mcguire et al., 2012), voluntary financial restatements (dyreng et al., 2012), and investment and growth rates (hilary & hui, 2009) to the realm of illegal corporate activity. we also extend recent work on corporate illegal activity by examining two forms of illegal activity (i.e., fraudulent restatements and stock option backdating). specifically, we investigate the direct effect of religiosity on corporate illegal activity as well as the interaction effects of board size and board independence. we formally hypothesized that religiosity would negatively affect illegal corporate activity. our results support this direct hypothesized relationship, particularly with regard to backdating. this result indicates that executives in firms located in more religious geographic areas are indeed influenced by the social norms of their environment. although both backdating and reporting fraudulent financials are illegal, there are clearly important differences in the underlying reasons they occur. volume 35, number 2 47 moreover, we hypothesized that board size moderates the relationship between religiosity and illegal corporate activity. our results did not support this hypothesis. in fact, larger boards actually increased the likelihood of illegal activity occurring. this result suggests that smaller boards may monitor executives more effectively with respect to these actions, perhaps because smaller boards encourage greater focus, engender member participation and cohesiveness, endure less social loafing, and encourage genuine debate among board members (firstenberg & malkiel, 1994; lipton & lorsch, 1992; williams et al., 2005). they may also be more homogenous and easier to coordinate with regard to executive control mechanisms. subsequent analyses show that this relationship is entirely associated with stock option backdating and not fraudulent financial reporting, further demonstrating underlying differences between these illegal activities. we also hypothesized that board independence would moderate the relationship between religiosity and illegal corporate behavior. our results support this hypothesis, as the relationship between religiosity and illegal activity becomes stronger as board independence increases. once more, subsequent analyses clarify this relationship. it is actually only for firms restating fraudulent financials that this relationship holds. once more, a difference between the two forms of illegal activity is evident. implications our results indicate that eisenhardt (1989) was correct when she suggested that agency theory might fruitfully be combined with other theories to explain organizational phenomena. we integrate institutional theory with agency theory and demonstrate that social norms associated with religiosity can influence executive decisions to act illegally. this is a key finding, as some scholars (e.g., ghoshal & moran, 1996) suggest that when some forms of opportunism are closely monitored, agents react by searching for other opportunities, even if they involve illegal actions. our findings are consistent with institutional theory in that social norms can influence executive decision-making (north, 1990; scott, 2001). for practitioners, our results have important implications. considerable effort has gone into finding ways to keep executives from acting opportunistically. these efforts have primarily been aimed at aligning the interests of executives and shareholders through stock options and similar tools. our findings suggest that those efforts may yield unintended consequences by inducing executives to game compensation systems. 48 journal of business strategies limitations and future research as with any study, ours has limitations that provide future research opportunities. first, our study focused on illegal corporate activity in the form of fraudulent financial reporting and stock option backdating. scholars may consider whether other forms of opportunism are being used by executives and whether agency theory alone can explain these activities or if additional theories may be required. scholars may also consider whether opportunism is even more multifaceted. it may be that there are different forms of opportunism that require different actions be taken to limit their damage. a second limitation of our study was its focus on a single institutional measure (religiosity) and a limited number of board characteristics (board size and board independence). institutions are not limited to those that are social in nature. scholars may consider whether regulative and cultural-cognitive institutions may have as much of an effect on illegal corporate activity as do normative institutions. additionally, other board and ceo characteristics such as power are ripe areas to be integrated with other theories. in particular, an examination of ceo religiosity and its influence on behaviors may yield interesting results. finally, our study focuses only on the ceo. evidence suggests, however, that in many cases of illegal activity, other executives such as the cfo and coo are involved. there is also evidence in testimony to the securities and exchange commission that managers below the executive rank have benefitted from and been involved in illegal activities. research to help scholars better understand these actions would be beneficial. conclusion to date, scholars still understand too little regarding illegal corporate activity, despite its continued occurrence. our study demonstrates that religiosity directly influences illegal corporate activity, but that this influence holds for stock option backdating and not fraudulent financial reporting. we further argued and found support for the moderating effect of board characteristics, though these relationships depend on the type of illegal activity examined. our study confirms that corporate illegality is highly complex and that additional measures are necessary to prevent its occurrence. we hope that our research stimulates development in agency theory regarding how different forms of opportunism can be curtailed. we also hope that our research stimulates the integration of other theories with agency theory to provide a more complete understanding of how opportunism can be mitigated. volume 35, number 2 49 references aboody, d., & kasznik, r. (2000). ceo stock option awards and the timing of corporate voluntary disclosures. journal of accounting and economics, 29, 73100. abrahamson, e., & park, c. (1994). concealment of organisational outcomes: an agency theory perspective. academy of management journal, 5: 1302-1334. agresti, a. 2002. categorical data analysis (2nd ed.). hoboken, nj: wiley. amason, a. c., & sapienza, h. j. (1997). the effects of top management team size and interaction norms on cognitive and affective conflict. journal of management, 23, 495-516. arthaud-day, m., certo, s. t., dalton, c. m., & dalton, d. r. (2006). a changing of the guard: executive and director turnover following corporate financial restatements. academy of management journal, 49, 1119-1136. baysinger, b. d., & butler, h. h. (1985). corporate governance and the board of directors: performance effects of changes in board composition. journal of law, economics, and organization, 1, 101-124. blake, j., & davis, k. (1964). norms, values, and sanctions. in handbook of modern sociology, farris, r. e. l. jr., (ed.). chicago: rand mcnally, 456-484. callen, j. l., morel, m., & richardson g. (2011). do culture and religion mitigate earnings management? evidence from a cross-country analysis. international journal of disclosure and governance, 8, 103-121. cialdini, r. b., & goldstein, n. j. (2004). social influence: compliance and conformity. annual review of psychology, 55, 591-621. coombs, j. e., & gilley, k. m. (2005). stakeholder management as a predictor of ceo compensation: main effects and interactions with financial performance. strategic management journal, 26, 827-840. dalton, d. r., daily, c. m., ellstrand, a. e., & johnson, j. l. (1998). meta-analytic reviews of board composition, leadership structure, and financial performance. strategic management journal, 19, 269-290. dalton, d. r., hitt, m. a., certo, t. s., & dalton, c. m. (2007). the fundamental agency problem and its mitigation: independence, equity, and the market for corporate control. academy of management annals, 1, 1-64. denis, d. j., hanouna, p., & sarin, a. (2006). is there a dark side to incentive compensation? journal of corporate finance, 12, 467-488. 50 journal of business strategies devers, c. e., cannella, a. a., reilly, g. p., & yoder, m. e. (2007). executive compensation: a multidisciplinary review of recent developments. journal of management, 33, 1016-1072. diaz, j. (2000). religion and gambling in sin-city: a statistical analysis of the relationship between religion and gambling patterns in las vegas residents. the social science journal, 37, 453-458. dimaggio, p. j., & powell, w. w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48, 147-160. dohmen, t., falk, a., huffman, d., sunde, u., schupp, j., & wagner, g. g. (2011). individual risk attitudes: measurement, determinants and behavioral consequences. journal of the european economic association, 9, 522-550. dow, g. k. (1987). the function of authority in transaction cost economics. journal of economic behavior and organization 8, 13-38. dyreng, s. d., mayew, w. j., & williams, c. d. (2012). religious social norms and corporate financial reporting. journal of business finance and accounting, 39, 845-875. eisenhardt, k. m. (1989). agency theory: an assessment and review. academy of management review, 14, 57-74. ezzamel, m. a., & watson, r. (1993). organizational form, ownership structure, and corporate performance: a contextual empirical analysis of uk companies. british journal of management, 4(3), 161-176. fama, e. f. (1980). agency problems and the theory of the firm. journal of political economy, 88, 288-307. fama, e. f., & jensen, m. c. (1983). separation of ownership and control. journal of law and economics, 26, 301-325. finkelstein, s., & boyd, b. k. (1998). how much does the ceo matter: the role of managerial discretion in the setting of ceo compensation. academy of management journal, 41, 179-199. firstenberg, p. b., & malkiel, b. g. (1994). the twenty-first century board-room: who will be in charge? sloan management review, 36, 27-35. gabbioneta, c., greenwood, r., mazzola, p., & minoja, m. (2013). the influence of the institutional context on corporate illegality. accounting, organizations and society, 38, 484-504. ghoshal, s., & moran, p. (1996). bad for practice: a critique of the transaction cost theory. academy of management review, 21, 13-47. volume 35, number 2 51 grullon, g., kanatas, g., & weston, j. religion and corporate (mis)behavior. unpublished working paper. rice university. halek, m., & eisenhauer, j. (2011). demography of risk aversion. journal of risk and insurance, 68, 1-24. hambrick, d. c., & jackson, e. m. (2000). outside directors with a stake: the linchpin in improving governance. california management review, 42, 108127. harris, j., & bromiley, p. (2007). incentives to cheat: the influence of executive compensation and firm performance on financial misrepresentation. organization science, 18, 350-367. henderson, a. d., & fredrickson, j. w. (1996). information-processing demands as a determinant of ceo compensation. academy of management journal, 39, 575-606. heron, r. a., & lie, e. (2007). does backdating explain the stock price pattern around executive stock option grants? journal of financial economics, 83, 271295. heron, r. a., & lie, e. (2009). what fraction of stock option grants to top executives have been backdated or manipulated? management science, 55, 513-525. heron, r. a., lie, e., & perry, t. (2007). on the use (and abuse) of stock option grants. financial analyst journal, 63, 17-27. hilary, g., & hui, k. w. (2009). does religion matter in corporate decision making in america? journal of financial economics, 93, 455-473. hitt, m. a., ahlstrom, d., dacin, m. t., levitas, e., & svobodina, l. (2004). the institutional effects on strategic alliance partner selection in transition economies: china vs. russia. organization science, 15, 173-185. hoetker, g. (2007). the use of logit and probit models in strategic management research: critical issues. strategic management journal, 28, 331-343. iannaccone, l. r. (1998). introduction to the economics of religion. journal of economic literature, 36, 1465-1495. janney, j. j., & gove, s. (2011). reputation and corporate social responsibility aberrations, trends, and hypocrisy: reactions to firm choices in the stock option backdating scandal. journal of management studies, 48, 1562-1585. jensen, m. c., & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs, and ownership structure. journal of financial economics, 3, 305360. katz, r. c., santman, j., & lonero, p. (1994). findings on the revised morally debatable behaviors scale. journal of psychology, 128(1), 15-21. 52 journal of business strategies kennedy, e. j., & lawton, l. (1998). religiousness and business ethics. journal of business ethics, 17, 163-175 kohlberg, l. (1984). essays on moral development vol. 2, the psychology of moral development. san francisco, ca: harper and row. lie, e. (2005). on the timing of ceo stock option awards. management science, 51, 802-812. lipton, m., & lorsch, j. w. (1992). a modest proposal for improved corporate governance. business lawyer, 48, 59-77 liu, e. y. (2010). are risk-taking persons less religious? risk preference, religious affiliation, and religious participation in taiwan. journal for the scientific study of religion, 49, 172-178. mazar, n., amir, o., & ariely, d. (2008). the dishonesty of honest people: a theory of self-concept maintenance. journal of marketing research, 45, 633-644. mcguire, s. t., omer, t. c., & sharp, n. y. (2012). the impact of religion on financial reporting irregularities. the accounting review, 87, 645-673. miller, a. (2000). going to hell in asia: the relationship between risk and religion in a cross-cultural setting. review of religious research, 40, 5-18. miller, a. s., & hoffman, j. p. (1995). risk and religion: an explanation of gender differences in religiosity. journal for the scientific study of religion, 34, 63-75. mizruchi, m. s. (1983). who controls whom? an examination of the relation between management and board of directors in large american corporations. academy of management journal, 8, 426-435. narayanan, m. p., schipani, c. a., & seyhun, h. n. (2007). the economic impact of backdating of executive stock options. michigan law review, 105, 1597-1641. narayanan, m. p., & seyhun, h. n. (2008). the dating game: do managers designate option grant dates to increase their compensation? the review of financial studies, 21, 1907-1945. ndofor, h. a., wesley, c., & priem, r. l. (2015). providing ceos with opportunities to cheat. journal of management, 41, 1774-1797. north, d. (1990). institutions, institutional change and economic performance. cambridge, uk: cambridge university press. noussair, c. n., trautmann, s. t., van de kuilen, g., & vellekoop, n. (2013). risk aversion and religion. journal of risk and uncertainty, 47, 165-183. ocasio, w. (1994). political dynamics and the circulation of power: ceo succession in u.s. industrial corporations, 1960-1990. administrative science quarterly, 39, 285-312. volume 35, number 2 53 o’connor, j. p., priem, r. l., coombs, j. e., & gilley, k. m. (2006). do ceo stock options prevent or promote corporate accounting irregularities? academy of management journal, 49, 483-500. parboteeah, k. p., hoegl, m., & cullen, j. b. (2008). ethics and religion: an empirical test of a multidimensional model. journal of business ethics, 80, 387-398. pearce, j. a., & zahra, s. a. (1992). board composition from a strategic contingency perspective. journal of management studies, 29, 411-438. peng, m. w. (2003). institutional transitions and strategic choices. academy of management review, 28, 275-296. perrin, r. d. (2000). religiosity and honesty: continuing the search for the consequential dimension. review of religious research, 41, 534-544. sanders, w. g., & hambrick, d. c. (2007). swinging for the fences: the effects of ceo stock options on company risk taking and performance. academy of management journal, 50, 1055-1078. scott, w. r. (2001). institutions and organizations. thousand oaks, ca: sage. shen, w. (2003). the dynamics of the ceo-board relationship: an evolutionary perspective. academy of management review, 28, 466-476. sunstein, c. r. (1996). social norms and social rules. columbia law review, 96, 903-968. weaver, g. r., & agle, b. r. (2002). religiosity and ethical behavior in organizations: a symbolic interactionist perspective. academy of management review, 27, 7797. welch, m. r., tittle, c. r., & petee, t. (1991). religion and deviance among adult catholics: a test of the “moral communities” hypothesis. journal for the scientific study of religion, 30, 159-172. wiersema, m. f., & bowen, h. p. (2009). the use of limited dependent variable techniques in strategy research: issues and methods. strategic management journal, 30, 679-692. williams, r. j., fadil, p. a, & armstrong, r. w. (2005). top management team tenure and corporate illegal activity: the moderating influence of board size. journal of managerial issues, 17, 479-493. zahra, s. a., & pearce, j. a. (1989). boards of directors and corporate financial performance: a review and integrative model. journal of management, 15, 291334. zahra, s. a., priem, r. l., & rasheed, a. a. (2005). the antecedents and consequences of top management fraud. journal of management, 31, 803-828. 54 journal of business strategies zhang, x., bartol, k. m., smith, k. g., pfarrer, m. d., & khanin, d. m. (2008). ceos on the edge: earnings manipulation and stock-based incentive misalignment. academy of management journal, 51, 241-258. brief biographical sketch of authors joseph e. coombs is an associate professor of management and academic director for entrepreneurship programs in the school of business at virginia commonwealth university where he teaches courses in entrepreneurship and strategic management. he received his doctorate from temple university. he has held faculty positions at rutgers university, james madison university, the university of richmond, and texas a&m university. k. matthew gilley holds the bill greehey chair in ethics and corporate social responsibility in the greehey school of business at st. mary’s university. he holds a doctorate in strategic management from the university of texas at arlington. his primary teaching and research interests are in the areas of ethical leadership, corporate responsibility, and bridging academic research and practice. joe o’connor recently retired from the marketing and management department after 11 years at the university of texas at el paso. dr. o’connor earned his ph.d. in management science in 2005 from the university of wisconsin – milwaukee. prior to joining academia, he spent 25 years as a senior leader in human resources for major corporations, as well as serving eight years on active duty with the united states army. tim thorley has a master’s degree in management from virginia commonwealth university and teaches financial literacy at dixie high school in st. george, utah. when he is not teaching, tim is busy with his kids, reading, and working in his garden. dr. curtis wesley is an assistant professor of strategy and entrepreneurship at the university of houston c.t. bauer college of business. his primary areas of interest are the positive organizational scholarship in corporate governance and entrepreneurship. he serves on the editorial board of the journal of management and has published in a variety of management outlets including the journal of management, strategic entrepreneurship journal, and business ethics quarterly. 66 journal of business strategies status incongruence in supervisor-subordinate dyads—the effects on subordinate job satisfaction and creative performance carliss d. miller sam houston state university • huntsville, tx orlando c. richard university of massachusetts – amherst • amherst, ma abstract extant research on status incongruence has begun to explore the resulting tensions it may engender between supervisor and subordinate, yet it excludes the role of other demographic factors beyond age which influence status perceptions. we draw on role congruity theory to examine how organizational culture influences whether supervisor-subordinate dyadic status incongruence has a negative or positive impact on subordinate job satisfaction and creative performance. we find that status incongruence reduces job satisfaction when supervisor-subordinate dyads work in a hierarchical organizational culture (i.e. low clan organizational culture), and job satisfaction increases for supervisor-subordinate dyads that work in a clan organizational culture (i.e. high clan organizational culture). furthermore, these effects on job satisfaction ultimately impacted subordinate creative job performance, supporting a moderated-mediation model. implications for future research on status incongruence are discussed. keywords: status incongruence, organizational culture, job satisfaction, creative job performance, role congruity theory, supervisor-subordinate dyads introduction status incongruence depicts a circumstance in which traditional status characteristics (e.g., age, work experience, organizational tenure) associated with leader roles and subordinate roles are reversed (hirschfeld & thomas, 2011; jarmon, 1976; perry, kulik, & zhou, 1999). traditional hierarchical norms depict supervisors as being the older, wiser, and more educated leader (collins, hair, & rocco, 2009), whereas in instances of status incongruence, the subordinate may be older and have more work experience or organizational tenure (triana, richard, & yücel, 2017). with the generational shifts in the labor market, organizations have a greater likelihood of status incongruence between supervisors and subordinates (collins et al., 2009), and it is important to investigate how status incongruence volume 37, number 2 67 impacts employee subjective states which are suggested to affect employee creativity (brief & weiss, 2002). for example, in a large company, it would not be an uncommon notion for an employee to manage someone 10-15 years older (knight, 2015). the supervisor-subordinate age difference dynamic (considering age as a status characteristic) has been well established in the literature (collins et al., 2009; kunze & menges, 2017; perry et al., 1999), but less is known about the additive effects of multiple instances of status incongruence where the supervisor is younger, less experienced, less tenured, and less educated (see lucas, 2017 for an example). in this scenario, employees may feel more qualified than their supervisor, and this feeling may greatly affect the employees’ level of job satisfaction (smith, 2013) and other subsequent effects. research suggests that status incongruence can result in tensions between subordinates and supervisors (collins et al., 2009; hirsch, 1990; shellenbarger & hymowitz, 1994). collins and colleagues (2009) reported that elder subordinates had low expectations of a younger supervisor, and they argue that low expectancy results in low support from the subordinate. other studies have shown that younger supervisors are reluctant to give directives to subordinates who are of the same age as their parents or grandparents (hirsch, 1990), and that elder employees also do not like to take orders from supervisors who are their children’s and grandchildren’s ages (hirsch, 1990; shellenbarger & hymowitz, 1994). perry et al. (1999) explain that younger supervisors managing older subordinates may contradict age norms because older employees typically manage younger employees. their research has documented well the tensions that status incongruence may engender between supervisor and subordinate. however, they only analyzed the impact of age difference, thereby negating the role of other factors influencing status. in this manuscript, we aim to build on the current literature on status incongruence by investigating the effects of incongruence on multiple characteristics (i.e. age, work experience, education, and organizational tenure), versus focusing on a single status characteristic. specifically, adopting triana, richard, and yucel’s (2017) characterization, status incongruence includes situations where the subordinate is not only potentially older than the supervisor, but also has possibly more education than the supervisor, has more work experience and/or has more organizational tenure than the supervisor. when there is no status incongruence, we would have status congruence, which refers to a situation where the supervisor is older, has more organizational tenure, work experience, and education than the subordinate. in this circumstance, the two members of the dyad are involved in a relationship which is congruent with traditional social status characteristics, and 68 journal of business strategies where role congruity theory (eagly & johannesen-schmidt, 2001; eagly & karau, 2002; eagly, karau, & johnson, 1992) would predict no reduction in subordinate affect (i.e., job satisfaction). as the workplace becomes more generationally diverse, it is necessary for researchers and managers alike to know what to expect from this diversity so they can better manage it. as the status incongruence phenomenon may or may not, in isolation, impact subordinate attitudes about their job situation or their ability to perform creatively, we consider the role that organizational context plays. specifically, we set out to explore how status incongruence affects subordinate overall job satisfaction, particularly when the organizational culture (de)emphasizes power differentials and hierarchy. organizational culture is defined as the pattern of shared values, beliefs, and assumptions that provide behavioral norms and social cues for organizational members, serving as an organizational control mechanism (deshpande and webster, 1989; perrone, zaheer, & mcevily, 2003). williams and o’reilly (1998) put forth that organizational culture acts as a powerful mechanism to manage differences, and it can encourage either solidarity or divisiveness. research supports the notion that organizational culture makes organizational identity salient for employees and encourages diverse members to base their social categorizations on common interests with the organization rather than on status characteristics (chatman, polzer, barsade, & neale, 1998). therefore, we examine whether status incongruence will have more negative (or positive) effects on subordinate job satisfaction when hierarchical status is (de)emphasized. we argue that job satisfaction is critical when managing across generations, as is the influence of organizational culture—the more employees feel valued in their working environment, they stand a greater likelihood of being satisfied with their jobs (delcampo, 2011; westerman & yamamura, 2007) despite the existence of status incongruence. because increased job satisfaction facilitates job performance (bowling, khazon, meyer, & burrus, 2015; wright, cropanzano, & bonett, 2007), we also examine under what organizational culture conditions that status incongruence effects on job satisfaction ultimately increase or decrease the creative aspect of subordinate job performance. our focus on creativity is justified due to the concern that status incongruence episodes may impede creative performance when influenced by the dissatisfaction that one may have with their job situation. furthermore, the possibility that a subordinate may express higher job satisfaction and thereby realize a creative performance advantage from being in a status incongruent situation, has not yet been acknowledged in the relational demography literature. for example, the literature on volume 37, number 2 69 teams would suggest that dyadic dissimilarity and even status incongruence–within the appropriate context–may also yield enhanced information sharing, creativity, and improved problem-solving capabilities (gilson, lim, luciano, & choi, 2013; homan, van knippenberg, van kleef, & de dreu, 2007; van knippenberg, de dreu, & homan, 2004; van knippenberg & schippers, 2007). therefore, we examine whether a high clan organizational culture—an environment that encourages employees to view coworkers and supervisors as an extended family of cohesiveness (ouchi, 1980; perrone, zaheer, & mcevily, 2003)—may create a positive context where subordinates working in status incongruent dyads actually express more job satisfaction, and therefore improve their subsequent creative performance. in summary, we explore relational demography within supervisor-subordinate dyads to understand subordinates’ states of affect, as well as behavioral reactions to status incongruence. figure 1 the conceptual model of the hypothesized of effects of supervisorsubordinate status incongruence on creative performance via job satisfaction when moderated by organizational culture our conceptualization offers a key organizational contextual factor, organizational culture, as a relevant contingency condition, through which job satisfaction mediates the relationship between status incongruence and subordinate creative job performance. we test the predictions of our theoretical model by conducting a field study using a sample of 178 supervisor-subordinate dyads, and we offer implications for future research and practice. 70 journal of business strategies theory and hypotheses status incongruence in supervisor-subordinate dyads according to eagly and karau’s (2002) role congruity theory, an impending situation for prejudice arises when social perceivers hold beliefs and expectations about individuals based on the status cues of certain demographic characteristics that may contrast with hierarchical norms related to age, education, or experience. these status characteristics (e.g. age, education, and/or experience) are often considered legitimizing status signals congruent with certain leadership positions and visible roles in organizations. in situations where employees see themselves as the leader prototype more so than the individuals leading them, perceptual inconsistency has been formed based on the employees’ beliefs and role expectations. the perceptual inconsistency of role expectations versus reality can lower employees’ selfevaluation (diekman & hirnisey, 2007; koenig, eagly, mitchell, & ristikari, 2011). perceived incongruity between employees’ status affiliations and the expected role for themselves and their leaders can lead to attitudes that are less positive toward the individuals who occupy a high-stakes role, such as in a supervisory role or leadership position. the perceived incongruity can lead to a form of prejudice where an older, more educated and more tenured subordinate may perceive a supervisor less qualified for the leadership role than themselves (monzani, hernandez bark, van dick, & peiró, 2015). in sum, role incongruity increases the likelihood that a supervisor with lower status characteristics (e.g. on the basis of age, education, and/ or experience) comparative to a subordinate may be perceived as less competent by the subordinate, which leads to the plausibility of negative subordinate responses to the job situation. a pertinent example of such a phenomenon is the prejudice toward leaders perceived as younger than their subordinates, which is derived from the incongruity that many people perceive between the characteristics of age and the requirements of leader roles, for example, older age should equate to leadership. based on role congruity theory, prejudice toward such leaders consists of two types of disadvantage—biased perceptions of leadership ability and fitting the leadership prototype (eagly & karau, 2002). first, drawing from the descriptive aspect of the age role, is the perception of younger leaders as possessing less leadership ability than their elder counterparts. second, deriving from the injunctive aspect of the age role is the less advantageous evaluation of behavior that fulfills the prescriptions of a leader role when this behavior is enacted by a younger leader compared to an elder employee. volume 37, number 2 71 the first type of disadvantage stems from social perceivers’ combining of the descriptive aspects of the leader roles. this blending produces the perception that younger and less tenured employees possess less agency and more communion, and therefore are less qualified for leadership, especially for executive roles (diekman & hirnisey, 2007). these two forms of disadvantages would lead to consequences such as less favorable attitudes toward younger and less tenured leaders, greater difficulty in younger and less tenured individuals attaining leadership roles, and greater difficulty in being recognized as effective in these roles (diekman & hirnisey, 2007). the above-mentioned discrepancy in status may have important effects on individual behaviors and outcomes. status incongruence refers to a situation where traditional status characteristics associated with the leader and subordinate roles appear to be reversed (triana et al., 2017). it is a relationship where lower-ranked individuals (e.g. a subordinate) possess more prestige-based status characteristics than do their high-ranked counterpart (e.g. a supervisor). nevertheless, following the trends of demographic changes and generational shifts in the workplace, it is not uncommon for older workers to report to younger supervisors (cappeli & novelli, 2010; kunze & menges, 2017). the pre-established patterns of behavior were well settled and accounted for over the past two decades, with studies elucidating how elder employees are reluctant to take instructions from supervisors who are younger than they are (hirsch, 1990; shellenbarger & hymowitz, 1994). in the same vein, sometimes younger supervisors are uncomfortable giving orders to subordinates who are older than they are (hirsch, 1990). conversely, status incongruence research which looked at status as embedded in age found that older workers expect less from younger supervisors than do younger workers (collins et al., 2009) still, findings about the impact of status incongruence on individual outcomes and behavior has been divided; evidence on age status incongruence in work dyads shows that tension is a probable outcome of status incongruence, whereas other studies have found more positive outcomes. for instance, perry et al (1999) found some evidence that age status incongruence may have serious implications in dyadic relationships. elder subordinates working under younger supervisors are more likely to engage in work change behavior, or adaptive behavior as a result of negative work affect (perry et al., 1999). they are also likely to exhibit positive conduct, such as citizenship behaviors, both towards other individuals and towards their organizations. one possible explanation may reside in the fact that elder employees engross in more citizenship when the organizational culture promotes inclusiveness. in sum, the perceived congruence between an individual’s status and role expectations results in attitudes that may be less positive toward their job situation 72 journal of business strategies when they are supervised by someone with lower status characteristics. if the individual’s self-concept is embedded in role congruence, then status incongruence withing the supervisor-subordinate dyad may be personally threatening and an impediment to the indivduals’s creative job performance (tierney & farmer, 2002). we argue that the saliency of status incongruence effects is dependent upon the organizational context, specifically the organizational culture in which the incongruence resides, as well as the performane nature of the job. the moderating role of clan organizational culture given that organizational culture is a control mechanism guiding behavior for organizational members, it creates a context which either elevates or buffers the likely tensions between dissimilar or status incongruent supervisor-subordinate dyads (deshpande & webster, 1989; perrone, zaheer, & mcevily, 2003; williams & o’reilly, 1998), depending on the type of culture (richard & miller, 2013). a clan-based organizational culture encourages employees to minimize the salience of individual differences between organizational members, and align more with the shared values, beliefs, and behavioral norms of the organization (chatman, polzer, barsade, & neale, 1998). organizational culture typologies vary along the cooperation and interdependence dimensions of human interaction (chatman & barsade, 1995; mcmillan-capehart, 2005; richard, kochan, & mcmillan-capehart, 2002). within the competing values framework (deshpande & webster, 1989; deshpande, farley, & webster, 2000), the dominant attributes that distinguish organizational culture types are considered and are operationalized across two dimensions: formal-informal organizational processes, and internal-external focus. for the purposes of our study, we will focus on the dimension of formal-informal organizational processes, operationalized as clan organizational culture (i.e. high clan culture) and hierarchical organizational culture (i.e. low clan culture), given that both organizational cultures are internally focused. clan organizational culture and hierarchical organizational cultures are antipodes. the clan organizational culture is considered a friendly place to work due to its informal governance. it emphasizes the development of human resources, employee participation in decision-making, teamwork, and cohesiveness, whereas the hierarchical organizational culture emphasizes formalization and mechanistic governance that reduce flexibility and variety, and thus may hamper the advantages of diversity/dissimilarity (richard & miller, 2013). employees working in clan volume 37, number 2 73 organizational cultures are largely influenced by internalized values and goals rather than by formal rules to determine appropriate action and behaviors due to a heavy emphasis on socialization (ouchi, 1980; perrone, zaheer, & mcevily, 2003). according to kerr and slocum (1987), a clan organizational culture is essentially characterized by long socialization processes, high commitment from organizational members, peer pressure to conform to expected behavioral norms, and the importance of supervisors functioning as mentors for social cues. for status incongruence in supervisor-subordinate dyads to yield positive outcomes, there necessitates a context that emphasizes cohesiveness, participation, and teamwork (dwyer, richard, & chadwick, 2003; pless & maak, 2004; richard, kochan, & mcmillan-capehart, 2002). for instance, a group atmosphere that encourages freedom of expression should facilitate openness among status incongruent supervisor-subordinate dyads (swann, polzer, seyle, & ko, 2004). this openness should lead to reduced conflict and tension, and instead create more positive outcomes, such as job satisfaction. per mcmillan and colleagues (2012), an “organizational culture based on hierarchies relies on the use of legitimate authority to achieve performance goals” (p. 312), to which job satisfaction has an important relationship (bowling, khazon, meyer, & burrus, 2015; wright et al. 2007). the consideration of legitimate authority is problematic in status incongruent supervisor-subordinate dyads because although the younger, less tenured, or less educated supervisor has positional power, the subordinate may be less willing to show deference, particularly in a hierarchical organizational culture (i.e. low clan organizational culture). hierarchical organizational cultures emphasize stability, structure, greater formalization, and are less concerned with creating and maintaining supportive relationships among organizational members (mcmillan et al., 2012). with more focus on employee control, monitoring, implementing rules and standard operating procedures (mcmillan et al., 2012; ouchi & price, 1993), this heightened attention from a lower status supervisor may create greater tension and lower job satisfaction for higher status subordinates because the expectations associated with the status characteristics conflict with the positional expectations (collins et al., 2009; hirsch, 1990; perry et al., 1999; shellenbarger & hymowitz, 1994). thus, we argue that subordinates in status incongruent dyads will likely experience greater job satisfaction in a clan organizational culture (i.e. high clan organizational culture) than in a hierarchical organizational culture (i.e. low clan organizational culture). hypothesis 1: dyadic status incongruence is negatively related to subordinate job satisfaction when clan organizational culture is low (i.e., 74 journal of business strategies hierarchical culture is high), and positively related to subordinate job satisfaction when clan organizational culture is high. the mediating role of job satisfaction previous research has consistently shown that job satisfaction increases employee job performance (franke & park, 2006; judge, thorese, bono, & patton, 2001; morrisson, 1997; petty, mcgee, & cavender, 1984). job satisfaction may increase individual performance because “people who evaluate an attitude-object favorable, tend to engage in behaviors that foster or support it, and people who evaluate an attitude object unfavorable tend to engage in behaviors that hinder or oppose it” (eagly & chaiken, 1993: 12). for example, keaveney and nelson (1993) found that job satisfaction increases job performance, arguing that such individuals intrinsically satisfied with their job may have a higher motivation orientation to perform better. furthermore, when studying the effects of job satisfaction and organizational commitment, shore and martin (1989) found that job satisfaction explained more incremental variance in the supervisor-rated measures of job performance. in addition, job satisfaction has been shown to be a mediator between a host of organizational factors and employee job performance (crede, chernyshenko, stark, dalal, & bashshur, 2007; yousef, 2000, 2002). one salient aspect of job performance, the creative component, has recently gained much attention in the literature (shalley, gilson & blum, 2009, tierney & farmer, 2002, zhang & bartol, 2010). we define creative job performance as the deliberate creation, promotion and actualization of novel ideas within one’s job function, work group, and organization, for the sake of the same job function, work group, and organization (janssen & van yperen, 2004; kanter, 1988; scott & bruce, 1994; west & farr, 1989). to encourage more creative performance, organizations have moved away from seniority-based compensation and promotion plans to meritbased plans to encourage competition and creative performance, giving younger and less tenured employees an opportunity to pursue leadership roles and stretch assignments that may have previously been out of reach. young, “fresh blood” may be less experienced, but they can also come with fresh ideas and more innovation. their lack of experience is viewed as an advantage, as they are considered not to be tainted with the notion of doing things the way they have always been done. this perspective is likely beneficial for supervisor creative performance; however the creative outcomes for the subordinates may be overlooked, as well as the implications of additive status incongruence between subordinates and their supervisors. volume 37, number 2 75 as we have argued above, low job satisfaction is a possible outcome for subordinates in status incongruent dyads, depending on the organizational culture. a potential symptom of job satisfaction is the status threat employees may experience due to the status differences with their supervisor. status threats may cause some individuals to behave in assertive, competitive ways towards their supervisors in order to defend their status (tiedens & fragale, 2003; lee, choi & kim, 2018) which can undermine the subordinate’s ability to perform creatively (lee et al., 2018). individuals processing the implications for experiencing multiple status differences with their supervisor takes extra mental energy which impedes one’s ability to think and perform creatively and innovatively. in a recent study by lee, choi, and kim (2018), the authors argue that status conflict—”disputes over the relative status positions of people in the social hierarchy of their group”—can hinder team creativity (p. 187). although status conflict is a different construct from status incongruence, our operationalization of status incongruence implies there is a felt conflict for the individual who is likely to feel more threatened by the lack of status congruence (i.e. the subordinate), thus impacting job satisfaction. because job satisfaction has been shown to be a key mediator in the organizational behavior domain, we examine whether it behaves as a mediator of the status incongruence to subordinate’s creative job performance relationship across high and low clan organizational culture. hypothesis 2: the negative (positive) effect of status incongruence on subordinate job satisfaction when clan organizational culture is low (high) will reduce (increase) supervisor-rated creative job performance. methods sample our data collection effort targeted both working professionals enrolled in a graduate program at a major university in the united states as well as their supervisors. the working professionals received a survey and subsequently invited their respective supervisors to respond to another survey; each supervisor responded to one survey as participants were from multiple organizations. this central aspect of our study design allowed us to collect data from the participants’ direct supervisor to increase the external validity of our research (rosnow & rosenthal, 2008), as well as to reduce the likelihood of common source bias. all survey respondents answered of their own will and the responses were 76 journal of business strategies kept confidential. the surveys were collected online using survey monkey to ensure the highest possible response rate. to guarantee the authenticity of the data collected, the supervisors could opt to provide their contact information for the researchers to conduct random checks for true submissions. responding students were granted extra credit for completing the employee survey, and additional extra credit if the supervisor completed the supervisor survey, which included an introductory note explaining the nature, purpose and procedure of the study. this was followed by a questionnaire which instructed the respondents how to answer the questions in the survey. in the employee survey, demographic data, as well as key measures including dyadic tenure (experience in years with the current supervisor) and job satisfaction were collected. the supervisor survey–collected one month after all subordinate surveys were turned in–inquired about the demographics of the supervisor as well as a request to rate the subordinate’s creative job performance. at the end of this process, both surveys were matched by means of an identification number provided by the subordinate participant to ensure proper matching of the subordinate and supervisor surveys, and to maintain confidentiality of the data (tepper & taylor, 2003). the initial response rate was 100%; however more than half (55%) did not yield a fully completed survey from their supervisor. in all, 178 dyadic pairs (matched employee and supervisor surveys) were collected, resulting in a final sample from various industries. such industries include service (42.7%), wholesale (3.5%), manufacturing (17.8%), government and education (12.9%), retail (7.7%), healthcare (6.9%), and other (8.4%). women represent 38.2% of the respondents, and the age range was between 18 and 59 years old. table 1 offers summary statistics and correlations between the variables of interest. dependent variable creative job performance (cjp) (supervisor-reported). the subordinate’s creative job performance was collected from the immediate supervisor. the measure was adopted from janssen and van yperen (2004) and consisted of nine items measured on a five-point likert scale with a coefficient alpha of .93. a sample item is, “creating new ideas for improvements.” volume 37, number 2 77 independent variables status incongruence (between subordinate and supervisor). consistent with previous status incongruence measures in the literature (jarmon, 1976; lundberg, kristenson, and starrin, 2009; perry et al., 1999; triana et al., 2017), we first determined whether there was a status incongruence between the supervisor and subordinate on the basis of age, education, work experience, and organizational tenure. employee education was measured on the employee survey in a question that asked them to rate their highest education degree received. the same question was asked in the supervisor survey to determined supervisor education. education was coded (1 = high school, 2 = associate degree, 3 = bachelor’s degree, 4 = graduate degree). both work experience and organizational tenure were measured in number of years and collected directly from the designated employee and the employee’s supervisor. consistent with triana, richard, and yucel (2017), we calculated the supervisor credentials (age, education, work experience, or organizational tenure) and then subtracted the subordinate credentials for each variable. this resulted in four calculations: one for age, one for education, one for work experience, and one for organizational tenure. if the result is negative, that means the subordinate has higher credentials than the supervisor on that variable (e.g. older age, higher educational attainment, more work experience, greater organizational tenure). then, following jarmon (1976), we dummy coded each of the four resulting calculations (i.e. 1 = high status incongruence or 0 = low status incongruence) to create four indicators of status incongruence. finally, we added these four incongruence indicators together to create an overall measure of status incongruence between the supervisor and subordinate, with values ranging from 0 to 4. mediator job satisfaction. we utilized three items from cammann, fichman. jenkins, and klesh (1983). a sample item is “in general, you are satisfied with your job.” measured on a sevenpoint likert type scale, the coefficient alpha is .84. 78 journal of business strategies moderator clan organizational culture (subordinate-reported). to measure clan organizational culture employees responded to a four-item scale adapted from the competing values framework scale developed by quinn and colleagues (cameron & quinn, 1999; quinn, 1988; quinn & rohrbaugh, 1983; quinn & spreitzer, 1991) and further validated by other researchers (howard, 1998; quinn & sprietzer, 1991). items were measured on a five-point likert scale where 1 = strongly disagree and 5 = strongly agree. items were: 1) my company is a very personal place. it is like an extended family, 2) the head of my company is generally considered to be a mentor, sage, or a father or mother figure, 3) the glue that holds my company together is loyalty and tradition, 4) my company emphasizes human resources. high cohesion is important. cronbach’s alpha for this measure was .80. control variable subordinate respondents provided information on our control variable, dyad tenure, which was number of years working under the direction of the supervisor (also collected from supervisor as validity check). descriptive statistics (means, standard deviations, and correlations) for all variables are shown in table 1. table 1 means, standard deviations, and correlations 25 table 1 means, standard deviations, and correlations variables m sd 1 2 3 4 5 1. dyad tenure 1.89 1.57 2. status incongruence .66 .73 .25** 3. clan culture 3.34 .90 .13 -.07 4. job satisfaction 3.88 .84 .02 -.10 .50** 5. creative job performance 3.50 .80 .29** .13 .10 .14 note: n = 178; ** p < .05; two-tailed volume 37, number 2 79 results before testing the hypotheses, we first evaluated the distinctiveness of the key constructs. because there were several scales assessed from the subordinate respondents, we conducted a confirmatory factor analysis (cfa) with amos 24.0 of the two subordinate-rated variables: clan organizational culture (4 items) and job satisfaction (3 items). the results showed that the hypothesized two-factor model provided an adequate fit to the data (χ2 = 27.81, p = .01, df = 13, cfi = .971). this model was significantly better than a one factor model (χ2 = 145.52, p = .000, df = 14, cfi = .744) that did not have acceptable fit. we then estimated our models using ordinary least squares regression and used the process macro in spss 24 (models 1 and 7) by hayes (2012) to test our moderation and moderated-mediation hypotheses table 2 regression tables for effects on job satisfaction and creative job performance (cjp) hypothesis 1 suggests that the relationship between status incongruence and job satisfaction is negative when clan culture is low and positive when clan culture is high. in model 4 of table 2, a significant interaction effect emerges (∆r2 = 5.04%) for job satisfaction (ß = .287, p = .0004), lending support for h1. we suggested status incongruence would be negatively (positively) related to job satisfaction when clan culture was low (high). figure 2 depicts a significant and negative slope when clan culture is low (-3.68; p = .0003) and a significant and positive slope when clan culture is high (2.65; p = .009). 26 table 2 regression tables for effects on job satisfaction and creative job performance (cjp) variable tested job satisfaction cjp model 1 model 2 model 3 model 4 model 5 constant 3.86*** 3.91** 2.39*** 3.92*** 2.71*** (.10) (.11) (.23) (.86) (.28) 1. dyad tenure .01 .03 -.02 .02 .14*** (.04) (.04) (.04) (.04) (.04) 2. status incongruence -.12 -.06 -.10 .08 (.09) (.08) (.08) (.08) 3. clan culture .47*** .44 (.06) (.06) 4. status incongruence x clan culture h1 .29*** (.08) 5. job satisfaction h2 .14* (.07) r-square .00 .01 .25 .30 .11 the coefficients and standard error (in parenthesis) are reported; n = 178 *** p < .001, ** p < .01, * p < .05 80 journal of business strategies figure 2 three-way interaction between status incongruence and clan culture on job satisfaction we used the bootstrapping approach to confirm mediation effects for our moderated-mediation hypotheses (h2) (preacher, rucker, & hayes, 2007). we ran our analysis using 5,000 bootstraps. hypothesis 2 predicts the conditional indirect effect of status incongruence on creative job performance via job satisfaction will be negative (positive) in low (high) clan cultures. as predicted, table 3 reports 95% bootstrapping confidence intervals showing the indirect effects. status incongruence effects on our creative job performance (via a decrease in job satisfaction) are negative under low clan culture conditions (table 3) (effect = -.0486, boot llci = -.1302 and boot ulci = -.0071) and positive under high clan culture conditions (effect = .0217, boot llci = .0018 and boot ulci = .0629) supporting h2. 29 figure 2 three-way interaction between status incongruence and clan culture on job satisfaction 3 3.2 3.4 3.6 3.8 4 4.2 4.4 4.6 4.8 5 low status incongruence high status incongruence jo b sa tis fa ct io n low clan organizational culture high clan organizational culture volume 37, number 2 81 table 3 moderated-mediation results. bootstrapped condtional indirect effects of job satisfaction on supervisor-rated creative job performance discussion our study’s aim was to investigate how multiple characteristics of status incongruence affect subordinate affect (i.e. job satisfaction), and ultimately, subordinate creative job performance across clan versus hierarchical organizational culture types. we found that in hierarchical organizations, typified by a low clan organizational culture, status incongruence leads to lower (overall) job satisfaction, but it increases job satisfaction in organizations with high clan cultures. additionally, such status incongruence impacts subordinates’ creative job performance as a result of the interplay between status incongruence and organizational culture. limitations and future research although the study and its design rely on multi-sourced data which signals great confidence in our findings, we offer a few limitations that may inform future research. first, our study may produce restricted findings because of its use of a cross-sectional design (i.e., we collected data related to organizational culture and job satisfaction at the same time), thereby limiting the extent of our inference for causality. our design did, however, put variables under scrutiny which are trait-based (i.e, status incongruence) and not state-based, suggesting characters, behaviors and feelings that are consistent and long-lasting. these differ from psychological states, which are temporary behaviors or feelings that depend on a person’s situation and motives (mehroof & griffiths, 2010). furthermore, we were able to collect creative performance from the supervisor at a 1-month period later than the subordinate, offering some longitudinal tenets. to curb potential doubts about cross-sectional design, future studies may consider a longitudinal design to show the robustness of our trait-based cross-sectional design. 27 table 3 moderated-mediation results. bootstrapped conditional indirect effects of job satisfaction on supervisor rated creative job performance dependent variable: creative job performance mediator-job satisfaction moderator-clan culture effect boot se bootllci bootulci low -.05 .03 -.13 -.01 high .02 .02 .00 .06 note: n = 178. bootstrap sample size = 5,000 82 journal of business strategies an additional potential limitation of our study is a monocultural source of data as we only sampled participants from the united states. despite the deliberate nature of this choice to show that there is variance among individuals’ perception of the importance of status in role congruity, such a sample may spark skepticism about the generalizability of the perception of status by the participants in our study. future research may want to test the influence of organizational culture types on the outcomes of status incongruence in other countries beyond the u.s. to test the generalizability of our findings. contributions the extant literature concerning role congruity and status incongruence has been helpful in predicting the interpersonal dynamics that affect supervisor and subordinate relationships; however, the literature has not directly addressed the influence of organizations and organizational context in shaping supervisorsubordinate relations. we understand anecdotally and empirically that status incongruence between a supervisor and subordinate may result in some interpersonal tension that could stifle the subordinate’s job satisfaction and ability to perform creatively; however, our results provide evidence that the culture of the organization can exacerbate or lessen the negative implications of those tensions. our study complements the literature by specifying the type of organizational culture that would most likely foster greater job satisfaction and creative performance relative to the effects of supervisor-subordinate status incongruence. we show that clan organizational culture can indeed foster positive effects of status incongruence on subordinates’ job satisfaction and creativity. furthermore, while previous studies have shown that age is one factor that creates incongruence in supervisor-subordinate relationships, we follow the work of recent studies to show how multiple characteristics of status together affect the perceptions of roles and positions within dyads. our findings show that status incongruence should simultaneously consider additional characteristics including age (i.e. education, work experience, and organizational tenure), and thereby reconcile the literature to show that the effects of status incongruence have more theoretical and empirical precision when it is considered multidimensionally. conclusion this paper draws on a multidimensional conceptualization of status incongruence to explore when and how it affects subordinate’s job satisfaction and volume 37, number 2 83 creative performance. we provide evidence of the importance of organizational culture in shaping how both supervisor and subordinate may respond to situations when lower status individuals are conferred positional power. our results show that status incongruence decreases job satisfaction in a hierarchical organizational while it increases job satisfaction for dyads that work in a clan organizational culture, and that these ultimately impact subordinate creative job performance. these findings invite us to rethink the way we currently see status incongruent dyads by pointing to a more key part played by organizations in shaping how such incongruence affects individuals, dyads, and organizations. references brief, a. p., & weiss, h. m. (2002). organizational behavior: affect in the workplace. annual review of psychology, 53(1), 279-307. bowling, n., khazon, s., meyer, r., & burrus, c. (2015). situational strength as a moderator of the relationship between job satisfaction and job performance: a meta-analytic examination. journal of business & psychology, 30(1), 89-104. doi:10.1007/s10869-013-9340-7 cameron, k.s. & quinn, r.e. (1999). diagnosing and changing organizational culture. reading, mass.: addison-wesley. cammann, c., fichman, m., jenkins, d. g., jr., & klesh, j. r. (1983). assessing the attitudes and perceptions of organizational members. in s. e. seashore, e. e. lawler, p. h. mirvis, & c. cammann (eds.), assessing organizational change (pp. 711-738). new york: wiley. cappeli, p., & novelli, b. (2010). managing the older worker: how to prepare for the new organizational order. cambridge: harvard business press. chatman, j. a., & barsade, s. g. (1995). personality, organizational culture, and cooperation: evidence from a business simulation. administrative science quarterly, 423-443. chatman, j. a., polzer, j. t., barsade, s. g., & neale, m. a. (1998). being different yet feeling similar: the influence of demographic composition and organizational culture on work processes and outcomes. administrative science quarterly, 749-780. collins, m. h., hair jr, j. f., & rocco, t. s. (2009). the older‐worker‐younger‐ supervisor dyad: a test of the reverse pygmalion effect. human resource development quarterly, 20(1), 21-41. 84 journal of business strategies crede, m., chernyshenko, o. s., stark, s., dalal, r. s., & bashshur, m. (2007). job satisfaction as mediator: an assessment of job satisfaction’s position within the nomological network. journal of occupational and organizational psychology, 80(3), 515-538. delcampo, r. g. (2011). managing the multi-generational workforce: from the gi generation to the millennials. farnham, surrey: routledge. deshpande, r., & webster jr, f. e. (1989). organizational culture and marketing: defining the research agenda. the journal of marketing, 3-15. deshpande, r., farley, j. u., & webster, f. e. (2000). triad lessons: generalizing results on high performance firms in five business-to-business markets. international journal of research in marketing, 17(4), 353-362. diekman, a. b., & hirnisey, l. (2007). the effect of context on the silver ceiling: a role congruity perspective on prejudiced responses. personality and social psychology bulletin, 33(10), 1353-1366. dwyer, s., richard, o. c., & chadwick, k. (2003). gender diversity in management and firm performance: the influence of growth orientation and organizational culture. journal of business research, 56(12), 1009-1019. eagly, a. h., & chaiken, s. (1993). the psychology of attitudes. harcourt brace jovanovich college publishers. eagly, a. h., & johannesen‐schmidt, m. c. (2001). the leadership styles of women and men. journal of social issues, 57(4), 781-797. eagly, a. h., & karau, s. j. (2002). role congruity theory of prejudice toward female leaders. psychological review, 109(3), 573. eagly, a. h., karau, s. j., & johnson, b. t. (1992). gender and leadership style among school principals: a meta-analysis. educational administration quarterly, 28(1), 76-102. franke, g. r., & park, j. e. (2006). salesperson adaptive selling behavior and customer orientation: a meta-analysis. journal of marketing research, 43(4), 693-702. gilson, l. l., lim, h. s., luciano, m. m., & choi, j. n. (2013). unpacking the cross‐ level effects of tenure diversity, explicit knowledge, and knowledge sharing on individual creativity. journal of occupational and organizational psychology, 86(2), 203-222. hayes, a. f. (2012). process: a versatile computational tool for observed variable mediation, moderation, and conditional process modeling [white paper]. retrieved from http://www.afhayes.com/public/ process2012.pdf volume 37, number 2 85 hirsch j. s. (1990, february 26). older workers chafe under young managers. wall street journal, p. b1. hirschfeld, r. r., & thomas, c. h. (2011). age‐and gender‐based role incongruence: implications for knowledge mastery and observed leadership potential among personnel in a leadership development program. personnel psychology, 64(3), 661-692. homan, a. c., van knippenberg, d., van kleef, g. a., & de dreu, c. k. (2007). bridging faultlines by valuing diversity: diversity beliefs, information elaboration, and performance in diverse work groups. journal of applied psychology, 92(5), 1189-99. howard. l.w. (1998). validating the competing values model as a representation of organization cultures. the international journal of organizational analysis, 6(3), 231-80. janssen, o., & van yperen, n. w. (2004). employees’ goal orientations, the quality of leader-member exchange, and the outcomes of job performance and job satisfaction. academy of management journal, 47(3), 368-384. jarmon, c. (1976). education as a dimension of status incongruence between parents and the self-perceptions of college students. sociology of education, 49, 218222. judge, t. a., thoresen, c. j., bono, j. e., & patton, g. k. (2001). the job satisfaction– job performance relationship: a qualitative and quantitative review. kanter, r. (1988). when a thousand flowers bloom: structural, collective, and social conditions for innovation in organizations. in b. m. staw & l. l. cummings (eds.), research in organizational behavior, (vol. 10, pp. 169–211). greenwich, ct: jai press. keaveney, s. m., & nelson, j. e. (1993). coping with organizational role stress: intrinsic motivational orientation, perceived role benefits, and psychological withdrawal. journal of the academy of marketing science, 21(2), 113-124. kerr, j., & slocum, j. w. (1987). managing corporate culture through reward systems. the academy of management executive, 1(2), 99-107. knight, r. (2015). when your boss is younger than you. harvard business review digital articles, 2-6. koenig, a. m., eagly, a. h., mitchell, a. a., & ristikari, t. (2011). are leader stereotypes masculine? a meta-analysis of three research paradigms. psychological bulletin, 137(4), 616-642. doi:10.1037/a0023557 86 journal of business strategies kunze, f., & menges, j. i. (2017). younger supervisors, older subordinates: an organizational‐level study of age differences, emotions, and performance. journal of organizational behavior, 38(4), 461–486. https://doi.org/10.1002/job.2129 lawrence, b. s. (1996). organizational age norms: why is it so hard to know one when you see one? the gerontologist, 36(2), 209-220. lee, h. w., choi, j. n., & kim, s. (2018). does gender diversity help teams constructively manage status conflict? an evolutionary perspective of status conflict, team psychological safety, and team creativity. organizational behavior and human decision processes, 144, 187–199. https://doi.org/10.1016/j. obhdp.2017.09.005 lucas, s. (2017, september). new employee promoted over longer term employees: is this fair, legal, and good for employee morale to promote a new employee? retrieved from https://www.thebalance.com/new-employeepromoted-over-longer-term-employees-1919142 lundberg, j., kristenson, m., & starrin, b. (2009). status incongruence revisited: associations with shame and mental wellbeing. sociology of health & illness, 31(4), 478-493. mcmillan-capehart, a. (2005). a configurational framework for diversity: socialization and culture. personnel review, 34(4), 488-503. mcmillan, a., chen, h., richard, o. c., & bhuian, s. n. (2012). a mediation model of task conflict in vertical dyads: linking organizational culture, subordinate values, and subordinate outcomes. international journal of conflict management, 23(3), 307-332. mehroof, m., & griffiths, m. d. (2010). online gaming addiction: the role of sensation seeking, self-control, neuroticism, aggression, state anxiety, and trait anxiety. cyberpsychology, behavior and social networking, 13(3), 313–316. https://doi.org/10.1089/cyber.2009.0229 monzani, l., bark, a. s. h., van dick, r., & peiró, j. m. (2015). the synergistic effect of prototypicality and authenticity in the relation between leaders’ biological gender and their organizational identification. journal of business ethics, 132(4), 737-752. morrison, k. a. (1997). how franchise job satisfaction and personality affects performance, organizational commitment, franchisor relations, and intention to remain. journal of small business management, 35(3), 39-67. ouchi, w. g., & price, r. l. (1993). hierarchies, clans, and theory z: a new perspective on organization development. organizational dynamics, 21(4), 62-70. volume 37, number 2 87 ouchi, william g. (1980). markets, bureaucracies, and clans. administrative science quarterly, 25, 12941. perrone, v., zaheer, a., & mcevily, b. (2003). free to be trusted? organizational constraints on trust in boundary spanners. organization science, 14(4): 422439. perry, e. l., kulik, c. t., & zhou, j. (1999). a closer look at the effects of subordinate– supervisor age differences. journal of organizational behavior, 20(3), 341-357. petty, m. m., mcgee, g. w., & cavender, j. w. (1984). a meta-analysis of the relationships between individual job satisfaction and individual performance. academy of management review, 9(4), 712-721. pless, n., & maak, t. (2004). building an inclusive diversity culture: principles, processes and practice. journal of business ethics, 54(2), 129-147. preacher, k. j., rucker, d. d., & hayes, a. f. (2007). addressing moderated mediation hypotheses: theory, methods, and prescriptions. multivariate behavioral research, 42(1), 185-227. quinn, r. e. (1988). beyond rational management: mastering the paradoxes and competing demands of high performance. jossey-bass. quinn, r. e., & rohrbaugh, j. (1983). a spatial model of effectiveness criteria: towards a competing values approach to organizational analysis. management science, 29(3), 363-377. quinn, r. e., & spreitzer, g. m. (1991). the psychometrics of the competing values culture instrument and an analysis of the impact of organizational culture on quality of life. emerald. richard, o. c., & miller, c. d. (2013). considering diversity as a source of competitive advantage in organizations. the oxford handbook of diversity and work, 239-250. richard, o. c., kochan, t. a., & mcmillan-capehart, a. (2002). the impact of visible diversity on organizational effectiveness: disclosing the contents in pandora’s black box. journal of business and management, 8(3), 265. rosnow, r. l., & rosenthal, r. (2008). assessing the effect size of outcome research. in a. m. nezu & c. m. nezu (eds.), evidence-based outcome research: a practical guide to conducting randomized controlled trials for psychosocial interventions (pp. 379–401). new york, ny: oxford university press. scott, s. g., & bruce, r. a. (1994). determinants of innovative behavior: a path model of individual innovation in the workplace. academy of management journal, 37(3), 580-607. 88 journal of business strategies shalley, c. e., gilson, l. l., & blum, t. c. (2009). interactive effects of growth need strength, work context, and job complexity on self-reported creative performance. academy of management journal, 52(3), 489-505. shellenbarger, s., & hymowitz, c. (1994, june 13). over the hill? as population ages, older workers clash with younger bosses. wall street journal, p. a1. shore, l. m., & martin, h. j. (1989). job satisfaction and organizational commitment in relation to work performance and turnover intentions. human relations, 42(7), 625-638. smith, j. (2013). when you’re more qualified than the boss. forbes.com 22. business source complete, ebscohost (accessed january 5, 2018). swann, w. b., polzer, j. t., seyle, d. c., & ko, s. j. (2004). finding value in diversity: verification of personal and social self-views in diverse groups. academy of management review, 29(1), 9-27. tepper, b. j., & taylor, e. c. (2003). relationships among supervisors’ and subordinates’ procedural justice perceptions and organizational citizenship behaviors. academy of management journal, 46(1), 97-105. tiedens, l. z., & fragale, a. r. (2003). power moves: complementarity in dominant and submissive nonverbal behavior. journal of personality and social psychology, 84(3), 558–568. https://doi.org/10.1037/0022-3514.84.3.558 tierney, p., & farmer, s. m. (2002). creative self-efficacy: its potential antecedents and relationship to creative performance. academy of management journal, 45(6), 1137-1148. triana, m. d. c., richard, o. c., & yücel, i̇. (2017). status incongruence and supervisor gender as moderators of the transformational leadership to subordinate affective organizational commitment relationship. personnel psychology, 70(2), 429-467. van knippenberg, d., & schippers, m. c. (2007). work group diversity. annual review of psychology., 58, 515-541. doi: 10.1146/annurev.psych.58.110405.085546 van knippenberg, d., de dreu, c. w., & homan, a. c. (2004). work group diversity and group performance: an integrative model and research agenda. journal of applied psychology, 89(6), 1008-1022. doi:10.1037/0021-9010.89.6.1008 west, m. a., & farr, j. l. (1989). innovation at work: psychological perspectives. social behaviour, 4(1), 15–30. westerman, j. w., & yamamura, j. h. (2007). generational preferences for work environment fit: effects on employee outcomes. career development international, 12(2), 150-161. volume 37, number 2 89 williams, k., & o’reilly iii, c. (1998). forty years of diversity research: a review. in b. m. staw & l. l. cummings (eds.), research in organizational behavior, 20: 77-140. greenwich: jai press. wright, t. a., cropanzano, r., & bonett, d. g. (2007). the moderating role of employee positive well-being on the relation between job satisfaction and job performance. journal of occupational health psychology, 12(2), 93–104. yousef, d. a. (2000). organizational commitment: a mediator of the relationships of leadership behavior with job satisfaction and performance in a non-western country. journal of managerial psychology, 15(1), 6-24. yousef, d. a. (2002). job satisfaction as a mediator of the relationship between role stressors and organizational commitment: a study from an arabic cultural perspective. journal of managerial psychology, 17(4), 250-266. zhang, x., & bartol, k. m. (2010). the influence of creative process engagement on employee creative performance and overall job performance: a curvilinear assessment. journal of applied psychology, 95(5), 862. zhou, j., & hoever, i. j. (2014). research on workplace creativity: a review and redirection. annual review of organizational psychology and organizational behavior, 1, 333-359. brief biographical sketch of authors carliss d. miller is an assistant professor of management in the college of business administration at sam houston state university where she currently teaches organizational behavior, human resource management, and the mba seminar in team leadership. her primary research interests include workplace diversity, leader-follower relationships, and workplace deviance. dr. miller holds a ph.d. in international management studies from the university of texas at dallas, specializing in organizational behavior and human resource management. orlando c. richard (ph.d. from university of kentucky) is the dean’s research professor at the university of massachusetts amherst. the majority of his research studies fall under the domain of demographic diversity (both visible and nonvisible attributes) and seeks to move the field forward in understanding the complexities in how it relates to organizational processes and outcomes. strategic planning emphasis and planning satisfaction in small firms: an emprircal investigation javad kargar john a. parnell north carolina central university durham, nc abstract most empirical studies examining strategic planning effectiveness have focused on its impact on financial performance. however, solid empirically-based conclusions concerning the usefulness of strategic planning have not yet emerged. the present study takes an alternative perspective, examining two dimensions of executive satisfaction with strategic planning. results support a link between seven strategic planning characteristics and planning satisfaction among small firms. introduction according to a recent business week (1992:60) special edition, "change can [no longer] be an occasional episode in the life of a corporation. companies with rigid structures will be swept away. corporate cultures that can adapt will survive and thrive... " flexibility-as well as the related constructs of speed, adaptability, and change-has been touted as a key tenet of the "paradigm for the postmodern manager" (byrne, 1992:62). to yield positive results, change and flexibility necessitate prior effective strategic planning. however, researchers have not yet conclusively determined why some planning efforts are more successful than others in meeting this challenge. the present study examines the relationship between various facets of strategic planning and performance in small community banks. drawing on the planning literature, this article suggests that planning-performance research on small firms can produce meaningful results. strategic planning and performance over the past decade, researchers have investigated the effects of formal strategic planning on financial performance in small firms. many have concluded that there is no consistent association between the strategic planning process and performance (cappel, 1990; greenley, 1986; leontiades & tezel, 1980; orpen, 1985; robinson & pearce, 1983). in response to studies highlighting the impact of strategic planning on firm performance (karger & malik, 1975; rhyne, 1986; sapp & seiler, 1981; welch, 1984), recent research has 2 journal of business strategies vol. 13, no. 1 seen a greater emphasis on the strategic process rather than only on the strategy content that hofer (1975) proposed in his early study. steiner (1979) provided a thorough conceptualization of strategic planning. according to steiner, planning is an attitude and a process concerned with the future consequences of current decisions. formal strategic planning links short, intermediate, and long-range plans. strategic planning does not attempt to make future decisions or even forecast future events. it need not replace managerial intuition and judgment with massive, detailed sets of plans. steiner argued for the importance of strategic planning, providing keen insight into overcoming the barriers and biases associated with planning failures. however, research by steiner and others is founded in the critical assumption that planning is important. but the debate rages on in the literature. the key question remains: is there really a link between planning and performance? the literature is inundated with the apparent advantages of planning, most notably its ability to improve the fit between the organization and its external environment (godiwalla, meinhart, & warde, 1981). others have argued that planning aids in the identification of future marketing threats and opportunities, elicits an objective view of managerial problems, creates a {ramework for internal communication, promotes forward thinking, and encourages a favorable attitude to change (hausler, 1968; loasby, 1967; stern, 1966; wilson, 1979). further, there are intrinsic benefits that accrue as a result of the planning process, including the positive effects of planning on local employment and the economy (greenley, 1986). langley (1988) also provided support for the benefits of planning, identifying four roles of formal strategic planning. in the public relations role, formal strategic planning is intended to impress or influence outsiders. the information role provides input for management decisions. the group therapy role is intended to increase organizational commitment through the involvement of people at all levels of the organization in strategic planning. finally, the direction and control role is fulfilled when plans serve to guide future decisions and activities toward some consistent ends. according to roach and allen (1983), the strategic planning process is the product of the best minds inside and outside the corporation. the process considers future implications of current decisions, adjusts plans to the emerging business environment, manages the business analytically, and links, directs, and controls complex enterprises through a practical, working management system. this process plays a vital role in firm performance (roach & allen, 1983). cartwright (1987) suggested that effective planning is not as rational and analytical as it has been portrayed in the literature. he argues for the lost art (rather than science) of planning. he contends that planning is both (1) a generic activity whose success determinants are partially independent of the area in which it is applied, and (2) an area where judgment, intuition, and creativity are still important. spring 1996 kargar & parnell: strategic planning in small firms 3 robinson and pearce (1984) argued that fonnal strategic planning is a conceptual activity suited solely to larger finns and therefore has no effect on the financial perfonnance of small finns. wortman (1986) reviewed a set of small business planning-perfonnance studies in the context of a broad survey of the methodologies employed in the small business literature. wortman developed typologies but did not focus on the particular issue of the effect of fonnal strategic planning on small finn perfonnance. however, he clearly addressed the need for continued refinement in planning-perfonnance relationships and recommended the use of sophisticated statistical techniques for addressing such substantive research questions. greenley (1986) agreed with robinson and pearce and others to follow (cartwright, 1987; langley, 1988; ramanujam & venkatraman, 1987), but provided an alternative perspective, suggesting that there may not even be a positive relationship between planning and perfonnance. specifically, greenley noted the face validity of the planning-perfonnance linkage, but reports that existing empirical data has not yet substantiated the relationship. ramanujam and venkatraman (1987) provided limited support for greenley's contention. however, their empirical analysis of high and low perfonning finns elicited significant differences between the groups that relate to the planning process. specifically, their research examined the quality of the planning. for example, high perfonning finns tend to commit resources to planning and promote line-staff cooperation substantially more than low perfonning finns. low perfonners may plan; they just may not plan effectively. pearce, freeman, and robinson (1987) examined the perceived substantive contributions of each of eighteen existing studies, concluding that empirical support for the nonnative suggestions that all small finns should engage in fonnal strategic planning has been inconsistent and often contradictory. in a similar vein, schwenk and shrader (1993) recently meta-analyzed fourteen studies on fonnal strategic planning and perfonnance in small finns. while they did not find that planning necessarily improves perfonnance, they argued against the assertion that strategic planning is only appropriate for large finns. as such, they concluded that strategic planning promotes long-range thinking, reduces the focus on operational details, and provides a structured means for identifying and evaluating strategic alternatives. since this was the first review that clearly demonstrated the planning-perfonnance link across studies, it strengthened the case for recommending the use of strategic planning in all finns, regardless of size. sinha (1990) appears to have empirically established some kind of a planning-perfonnance linkage. sinha examined 1087 decisions made by 129 fortune 500 finns between 1982 and 1986. he concluded that characteristics of the decisions accounted for 15 percent of the variance in data and therefore should be regarded as important detenninants of the contribution planning makes to decision making. however, sinha concedes that the quality of planning is critical to the relationship. 4 journal of business strategies planning and strategic change vol. 13, no.1 there are three frequently cited reasons why top managers pursue changes in strategy (parnell, 1994). first, a change in strategy may appear attractive because desired performance levels are not being attained by the organization. in many cases, top managers may believe that a change in strategy will improve the ability of the business to generate revenues or profits, increase market share, and/or improve return on assets or investment. many studies have concluded that declining profitability is the most common catalyst for strategic change (boeker, 1989; webb & dawson, 1991). second, an environmental shift may necessitate strategic change to maintain alignment. such shifts may result from changes in either the macroenvironment (e.g., new regulations, social forces, demographic changes, etc.) or the industry environment (e.g., new competitors, changes in competitor strategies, etc.). changes in competition and technology necessitate a change in the knowledge base within the organization if it is to survive (whipp, rosenfeld, & pettigrew, 1989). according to the population ecology perspective (hannan & freeman, 1977~ ulrich, 1987), the environment determines which organizations will survive and which ones will not. new firms better suited to the changing environment constantly replace existing ones. competitors constantly struggle for existence by seeking to procure additional resources. as such, strategic change can be seen as a means to access additional resources and survive in a turbulent environment (aldrich, mckelvey, & ulrich, 1984). third, strategic change can enhance effective resource utilization (barney, 1991; lado, boyd, & wright, 1992). proponents of the resource-based perspective have noted that competitive advantage often occurs from such organizational attributes as informational asymmetries (barney, 1986b), culture (barney, 1986a; fiol, 1991), resource accumulation (dierickx & cool, 1989), and the minimization of transaction costs (camerer & vepsalainen, 1988). hence, as organizational human and capital resources evolve, changes in strategy become necessary to fully utilize the resources available to the organization. resource shifts necessitating strategic change are more prevalent in some organizations than in others. researchers have found that organizational performance, age, and length of tenure of the founding entrepreneur influence the degree to which a founding strategy endures and thus, the prospects for strategic change (boeker, 1989). in fact, new ceos are often recruited to attempt strategic changes upon entering the organization (greiner & bhambri, 1989). benefits and costs of strategic change there are three potential benefits of strategic change that are commonly cited in the literature. first, strategic change can enhance the strategy-environment fit. for example, calingo (1989) found that the low cost leadership strategy was most successful in price sensitive markets, whereas the differentiaspring 1996 kargar & parnell: strategic planning in small finns 5 tion strategy was most successful when consumers perceived great differences among product offerings. second, strategic change can open new dimensions of competitive advantage previously untapped by competitors. these first mover advantages result from the willingness of an organization to enter a new market or develop a new product or service prior to the competition (gannon, smith & grimm, 1992; lieberman & montgomery, 1988; mascarenhas, 1992; wemerfelt & kamani, 1989). finally, strategic change can improve an organization's ability to adapt by forcing healthy changes within the business. the initial pain associated with change may be offset by the emergence of a lean, rejuvenated organization with a fresh focus on its goals and objectives. on the contrary, organizations that maintain strategic consistency over time may become stagnant, limiting the creativity and potential contributions of its members (grimm & smith, 1991; wiersema & bantel, 1992). regardless of the potential benefits, four potential costs that may be incurred as a result of strategic change have received considerable attention in the literature. first, strategic change increases perceived risks; a change in any key strategic, environmental, or organizational factor requires that the business develop a new "formula" for success suited to the change (gaertner, 1989; yoshihara, 1990). second, change can disrupt the strategy-culture alignment (green, 1988; scholz, 1987; schwartz & davis, 1981). although the organizational culture may be changed (saffold, 1988; schein, 1990) to reflect and support the change in strategy, the period of time required to do so is likely to take several years (lorenz, 1988; saffold, 1988; schein, 1985; scholes, 1991). third, measures required to implement a change in strategy may necessitate the outlays of capital (miles & snow, 1978). finally, strategic change may result in consumer confusion as they begin to alter their perceptions of the organization's products and services. even when strategic change results in a successful new product or service, there is no assurance that this success can be maintained. indeed, competitors may distort consumer perceptions and reap the benefits of the initial strategic change. for example, many consumer goods companies implement an "imitation strategy" (foxman, muehling & berger, 1990). as a result, many consumers purchase the imitation product thinking it is the original. if the consumer dislikes the product, this dissatisfaction can be transferred to the origina1. if the consumer likes the product, the consumer may realize that the product is an imitator and transfer the positive associations with the original product to that of the imitator. either scenario can prove costly to the originator (loken, ross & hinkle, 1986). constructs and propositions empirical studies in small firms have generally employed a single dimension measure such as the presence or absence of planning or its degree of 6 journal of business strategies vol. 13, no. i formality to explain variations in organizational performance. such conceptualizations are inconsistent with the multidimensional view of planning systems that are being viewed as more important in the recent literature (e.g. dyson & foster, 1982; king, 1983; kukalis, 1991; lorange, 1979, 1980; rhyne, 1987; veliyath & shortell, 1993). although many strategic planning system characteristics have been suggested in the literature, no consensus has yet emerged. for example, ramanujam and venkatraman (1987) proposed six dimensions of planning systems: use of techniques, attention to internal facets, attention to external facets, functional coverage, resources provided for planning, and resistance to planning. in another attempt to categorize strategic planning, veliyath and shortell (1993) identified five dimensions for strategic planning systems: planning implementation, market research competence, key personnel involvement, staff planning assistance, and innovativeness of strategies. further, these studies focused on large firms. thus, an expanded conceptualization of the notion of small-firm strategic planning is germane. following recent work (ramanujam & venkatraman, 1987~ veliyath & shortell, 1993), the strategic planning system characteristics in the present study includes: (l) the degree of internal orientation of the system, (2) the degree of external orientation of the system, (3) the level of integration achieved within functional departments, (4) the extent of key personnel involvement in the planning process, and (5) the extent of use of analytical techniques in addressing strategic issues. these planning system attributes, in addition to being well-grounded in the existing literature (see table 1), also appear to be problem areas in strategic planning within the banking industry. 1\vo dimensions of planning satisfaction most researchers who have investigated small-firm strategic planning have used financial and marketing measures as indicators of performance. these performance measures are based on how a business has performed in the past, implicitly assuming that such success can be extrapolated into the future. however, financial superiority is only one element of organization performance. perhaps more attention should be attached to an organization's ability to adapt to changes that are occurring and will occur in its environment. a realistic model of organization performance must reflect a highly complex paradigm and requires more than a single criterion (brown & laverick, 1994). as such, the present study adopts a broader perspective, examining satisfaction with planning. specifically, two dimensions are examined: satisfaction with the concrete and financial outcomes believed to be associated with the planning process, and satisfaction with the contribution of strategic planning efforts to overall organizational effectiveness. the first dimension follows the tradition of earlier studies that sought to examine the impact of planning on financial performance. although perfonnance objectives were included in the goal attainment spring 1996 kargar & parnell: strategic planning in small finns 7 dimension, there is a clear distinction between achieving perfonnance goals and being a high-perfonnance organization. the second dimension reflects a goal-centered approach to assessing organizational effectiveness (cameron & whetten, 1983; ramanujam, venkatraman & camillus, 1986). the goal attainment measure is primarily concerned with the specific end results nonnally anticipated from a planning system. this view reflects king's (1983) suggested approach to the evaluation of planning and steiner's (1979) notion of measurement against purpose. table 1 characteristics of strategic planning systems characteristic description supporting literature hitt, ireland, & paba (1982); hitt, ireland. & stadler (1982); lorange (1980); snow & hrebiniak (1980); ramanjam et at. (1986); ramanjam & venkatraman (1987) andrews (1971); mcdaniel & kolari (1987); ramanjam et a1. (1986); snow & hrebiniak (l980); veliyath & shortell (1993) cartwright (1987); greenley (1986); ramanjam et al. (1986); roach & allen (1983); shank, niblock & sandal (1973) andrews (1971); camillius (1975); king & cleland (1978); langley (1988) govindrajan (1986); mowday et at. (1982); ramanjam & venkatraman (1987); steers (1977); veliyath & shortell (1993) fredrickson (1984); grant & king (1982); hax & majluf (1984); ramanjam & venkatraman (1987) the degree of emphasis placed on planning as a means of organizational control the extent of attention camillus & venkatraman (l984); devoted to an organization's grant & king (1982); king & recent history and current cleland (1978); lorange & situation, past performance, vancil (1977); steiner (1979); and analysis of strengths stevenson (1976) and weaknesses ability to obtain reliable and timely research information in order to learn about external environmental opportunities and threats. the extent of coverage given to different functional areas with a view to integrating different functional requirements into a general management perspective. the degree of involvement of top management, board members, line and staff managers in planning process. the extent of reliance on appropriate planning techniques in order to solve ill-structured strategic problems. the degree to which planning efforts emphasize new modes of thinking. focus on control key personnel involvement creativity in planning functional integration internal orientation external orientation use of analytical techniques 8 journal of business strategies vol. 13, no. 1 propositions almost all previous small-firm research has examined relationships between strategic planning and organization performance with unidimensional treatments. however, the issue becomes more complicated when both sets of variables are conceptualized in multidimensional terms, as some authors have recently argued (e.g. ramanujam et al., 1986; ramanujam & venkatraman, 1987). hence, a positive relationship between strategic planning and performance dimensions among small firms is expected. specifically, the present study posits two propositions: 1. increased emphasis placed on each of the seven planning characteristics will be positively associated with each of the two dimensions of planning satisfaction. 2. top executives of firms that place the greatest emphasis on all seven planning characteristics will report the greatest satisfaction with planning along the two dimensions. likewise, top executives of firms that place the least emphasis on all seven planning characteristics will report the lowest satisfaction with planning along the two dimensions. methodology, analysis, and findings sample sixty-nine u.s. commercial banks in the state of north carolina were examined, representing the entire population with fewer than $500 million in total deposits. all 69 banks are considered small banks by banking industry standards (robinson and pearce, 1983). surveys were sent to the senior executives (presidents and/or ceos) of all the 69 banks. to improve the response rate, the north carolina commissioner of banks asked that each bank president and/or ceo cooperate by completing a questionnaire that would be sent to them. forty-seven of the 69 banks completed and returned the research questionnaire for a response rate of 68 percent. forty-one of these banks were chosen for further analysis to eliminate banks less than five years old as well as those that did not provide complete information. these criteria ensured that sample would not be biased toward banks with inadequately developed strategic planning systems, reducing the effective response rate to 59 percent. north carolina's small community banks provide an excellent opportunity to apply evaluation processes that are normally employed to study strategic planning in small businesses because they historically have had broad powers to engage in various businesses traditionally not associated with commercial lending (north carolina banking commission, 1991). challenges requiring strategic management by small community banks go beyond establishing new branches and typically include introducing new products/services, offering competitive personalized services, meeting the needs of small businesses, and altering racial lending patterns. the relative stability of the north carolina comspring 1996 kargar & parnell: strategic planning in small firms 9 mercial banks in an industry under turmoil also provided for a strong population from which to draw the sample. further, there was only one bank failure each in 1991 and in 1993 in north carolina. strategic planning characteristics the specific strategic planning system characteristics are summarized in table 2 and based on five-point likert scales ranging from no emphasis (1) to great emphasis (5). internal orientation was measured through the perceived degree of attention devoted to customer services, efficiency of operations process, attracting and retaining high-quality employees, and analysis of financial strengths and weaknesses. external orientation was measured by four items relating to the analysis of investment and deposit opportunities, competition and market analysis. functional coverage was measured by ramanujam and venkatraman's (1987) four-item scale relating to the perceived degree of emphasis accorded to functional involvement, coordination, and integration in planning activity. key personnel involvement was measured by the degree of ceo, board member, and line manager involvement in the strategic planning process. creativity in planning is assessed by ramanujam and others nine-item scale addressing the firm's ability to anticipate surprises and crises, to adapt to unanticipated changes, and so forth. the control aspect was measured by ramanujam and others (1986) ten-item scale which addressed the degree of emphasis given to managerial motivation, upward and downward communication in the hierarchy, integration of operational areas, and the like. finally, the use of planning techniques was measured by the degree of emphasis devoted to the application of financial models, portfolio analysis, and forecasting analysis techniques. strategic planning satisfaction planning satisfaction was measured via the two aforementioned dimensions, hereafter abbreviated as financial performance (finance) and organizational effectiveness (orgeff). these dimensions were measured by an eight-item, two-factor scale (see table 3) based on prior'work by ramanujam and venkatraman (1987), including items addressing areas such as the prediction of future trends, improving short-term performance, improving long-term performance, evaluating alternatives, and enhancing management development. respondents were asked to indicate their yiews via a 5-point scale, ranging from much deterioration (1) to much improvement (5), on eight criteria as a primary goal. factor loadings (see tables 2 and 3) indicate that all the factors tapped characteristics measuring states of planning system and organization performance. factor loadings in each scale were above 0.50 and eigenvalues for each factor were well above 1.0. internal consistency of each scale was also assessed and judged strong using cronbach's alpha (cronbach, 1951; van de yen & ferry, 1980). these assessments provide adequate support for the reliability 10 journal of business strategies vol. 13, no. 1 of the measures employed. factor scores were computed for each planning system characteristic and planning satisfaction dimension to serve as composite measures for hypothesis testing. table 2 planning system characteristics and their factor loadings* factor loadine internal orientation (intnlx 1: alpha =0.79) customer services 0.57 efficiency of operating process 0.91 attracting and retaining high-quality employees 0.86 analysis of financial strengths and weakness 0.80 external orientation (extnlx1; alpha = 0.66) analysis of investment opportunities 0.75 analysis of deposits opportunities 0.87 analysis of competition 0.73 performing market research 0.71 functional coverage (funtnx1; alpha =0.75) marketing function 0.77 finance function 0.86 personnel function 0.77 operations function 0.72 involvement of key personnel (resrsx1; alpha = 0.51) time spent by the ceo in strategic planning 0.93 involvement of line managers in strategic planning 0.54 involvement of board members in strategic planning 0.77 use of planning techniques (techkx1; alpha =0.63) financial models 0.90 forecasting and trend analysis 0.86 portfolio analysis techniques 0.71 creativity in planning (creatx1; alpha = 0.85) ability to anticipate surprises, threats and crises 0.74 flexibility to adapt to unanticipated changes 0.70 value of a mechanism for identifying new business opportunities 0.53 role of identifying key problems 0.78 value as a basis for enhancing innovation 0.69 capacity to generate new ideas 0.68 formulating goals to be achieved in the bank's competitive environment 0.50 capacity to generate and evaluate a number of strategic alternatives 0.72 anticipating, avoiding, and removing barriers to strategy implementation 0.73 focus on control (contrx1; alpha =0.94) value as a tool for management control 0.66 ability to communicate top management's expectations down the line 0.81 value as a tool for managerial motivation 0.79 capacity to foster organizational learning 0.78 ability to communicate line management's concern to top management 0.84 value as a mechanism for integrating diverse functions and operations 0.60 spring 1996 kargar & parnell: strategic planning in small firms 11 table 2 planning system characteristics and their factor loadings cont'd* factor loadina: monitoring & controlling the implementation of the bank's strategy 0.90 using multiple financial & non-financial control measures 0.83 using control techniques for monitoring performance 0.89 having control systems to revise current plans 0.83 *all scales were (1-5) likert scales: no emphasis (1) to great emphasis (5) table 3 satisfaction with planning and their factor loadings dependent variables factor loadina:s finance orgeff .73 .59 .82 .84 .83 financial performance items: predictions of future trends enhancing management development improving short-term performance improving long-term performance direct impact on financial performance organizational effectiveness items: improving ability to evaluate alternatives .15 improving ability to avoid mistakes .27 improvement of budget process .38 *all scales were (1-5) likert scales: no emphasis, to great emphasis. .41 .37 .18 .15 .36 .85 .79 .68 table 4 presents correlations among the dimensions. each planning system characteristic positively and significantly correlates with only finance and orgeff (at the .05 percent level). these results are consistent with the conceptual literature from which dimensions were distilled. the presence of the expected bivariate relationships between the planning system characteristics and these two satisfaction dimensions is encouraging, but the main focus of this study is on the multivariate relationship between the planning characteristics and planning satisfaction. having established the existence of appropriate measurement scales, proposition testing can be pursued. the first proposition was strongly supported. emphasis on each of the seven planning characteristics was positively associated with both satisfaction dimensions. further, firm size (employes) was not significantly associated with any of the seven characteristics. the second proposition was partially supported. to examine which factors contributed to the greatest satisfaction in planning along both dimensions, the forty-one businesses were clustered on the seven planning emphases into three distinct groups (see table 5). the purpose of the cluster analysis was to identify several groups of organizations, each of which would contain businesses with similar emphases on the seven planning characteristics. although table 4: descriptive statistics and correlations ....... n extnlxl funtnxi resrsxi techkxi creatxl contrxi finance orgeffcorrelations: employes intnlx i employes ooסס.1 p--. intnlxi .0041 1.0000 p=a90 p--. extnlxi -.1873 .6147 p=.120 p=.ouo funtnxi -.1630 a739 p=.154 p=.ool resrsxl .0914 a594 p=.285 p=.ool techkxi .1252 .3292 p=.218 p=.018 creatxi -.2428 .5637 p=.063 p=.ooo contrxi -.1430 .6026 p=.186 p=.ooo finance -.2057 .3478 p=.099 p=.0l3 orgeff -.0716 .3056 p=.328 p=.026 1.000 p--. .7994 1.0000 p=.ooo p--. .3731 .4411 1.0000 p=.008 p=.002 p--. .2641 .3041 .2812 1.0000 p=.048 p=.027 p=.037 p--. .5416 a861 a654 .5391 1.0000 p= .000 p=.ool p=.ooi p=.ooo p-. .5054 a061 .6053 .5296 .8590 1.0000 p= .000 p=.004 p=.ooo p=.ooo p=.ooo p=. a393 .4872 .3529 .3952 .5863 .5768 1.0000 p=.002 p=.ool p=.0l2 p= .005 p=.ooo p=.ooo p--. .3125 .2700 .3360 .2702 .5901 .6272 .0000 p=.023 p=.044 p=.016 p=.044 p=.ooo p=.ooo p=.5oo 1.0000 p=. ~ $;;: :.i l::l~ ~ $;;: ""s· !li """" ~ ~ ~ ~' "" ~ ...... w z 9 ...... spring 1996 kargar & parnell: strategic planning in small firms 13 a variety of clustering methods could be applied, ward's algorithm was selected because of its tendency to cluster cases into groups of similar sizes, an aspect critical for small populations (barney & hoskisson, 1990; hair, anderson & tatham, 1987). the optimum solution contained three clusters of eight, eleven, and twenty-two businesses. table 5 planning system satisfaction means for each cluster cluster analysis variable employees intnlxl extnlxi funtnxi resrsxl techkxl creatxl contrxi finance orgeff cluster i cluster 2 (n=8, 19%) (n=ll, 27%) 235.38 592.64 0.37 ·0.32 0.72 1.28 0.87 -0.53 0.43 -0.20 0.38 -0.12 0.88 ·0.47 0.75 -0.46 0.73 -1.23 1.09 0.39 cluster 3 (n=22, 54%) 118.68 0.02 0.80 -0.05 -0.06 -0.08 -0.09 -0.04 0.35 -0.59 sig. level .178 .335 .035 .006 .375 .500 .009 .028 .000 .000 firms in the first cluster placed the greatest emphasis on six of the seven planning characteristics and also reported the greatest satisfaction with planning along both dimensions. firms in the second cluster placed the least emphasis on six of the seven characteristics, also reporting the least satisfaction with planning dimensions. significant differences among the clusters were found in four of the seven emphases and both planning satisfaction dimensions. external emphasis did not associate with the other six planning characteristics, suggesting that heavy external emphasis may be more associated with planning that does not lead to satisfaction with the process. conclusions and future directions taken together, it seems evident 'that the relationship between planning and performance in small firms bears significantly on strategic management research and practice, and that strategy scholars should not abandon this line of inquiry altogether. the planning literature appears to suggest two key themes: first, planning should be an integral part of the strategic management process. the benefits of planning can outweigh the costs. and most critically, one's competitors will likely enjoy the benefits of planning. therefore, to ignore planning is to relegate a source of competitive advantage to disadvantage. the second theme is perhaps most critical. effective planning-not just the process of planning-appears to be positively associated with performance. 14 journal of business strategies vol. 13, no. 1 in other words, organizations that plan effectively are more likely to achieve higher performance than those that do not. but the key here is effective planning; ineffective planning appears to have no predictable or consistent association with performance. going through the motions of planning provides no great insights or benefits; it may actually result in a depletion of resources and lower quality decisions. thus, a strong emphasis placed on planning is only justified when it is also focused on effective planning. future research may address five areas appropriate to this study. first, a longitudinal research design may improve the reliability of strategy measures and examine the long-term (le., beyond five years) effects of strategic planning. golden (1992) found that 58 percent of organizations he surveyed did not agree with the previously validated accounts of their organization's past strategies! hence, retrospective accounts of strategy and planning emphases may not always be valid. a longitudinal design would eliminate the reliance on ceos' perceptions of past strategy-a limitation of this exploratory study. second, future inquiries should expand the planning assessment process beyond the chief executive officer. although a high response may be more difficult when complete anonymity is not assured, a more accurate depiction of planning activity may be gleaned from surveying several managers within each organization in addition to the ceo. further, the validation of self-reported financial results with archival data would improve the validity of the study. third, additional industries may be examined. this study addressed only the banking industry. additional investigations should include those industries experiencing major macroenvironmental changes. in such industries, one may actually find a greater value in strategic planning activities. fourth, the identification of important planning characteristics should provide an impetus to further efforts at reconceptualizing planning in more realistic terms than the unidimensional treatments common in the previous smallfirm empirical research. similarly, the results support such a multidimensional treatment, which argues against the use of narrow conceptualizations of planning effectiveness in future studies. in general, these findings suggest the need for future research to explore not only the degree of emphasis and perceived effectiveness of various strategic planning dimensions but also the reasons for these choices. such research will help to provide a better understanding of why managers of small firms choose various strategic planning system approaches as well as how these approaches give rise to possible changes in organization strategy. finally, the present study involved a relatively small number of banks in the study. future investigations into process and content dimensions unique to small firm strategic planning process could focus on larger industries. spring 1996 kargar & parnell: strategic planning in small firms 15 references aldrich, h., b. mckelvey, and d. ulrich. "design strategy from the population perspective." journal of management 10 (1984): 67-86. andrews, k.r. the concept of cqrporate strategy. homewood, il: dow jones-irwin, 1971. barney, 1.b. "firm resources and sustained competitive advantage." jqurnal of management 17 (1991): 99-120. barney, lb. "organizational culture: can it be a source of sustained competitive advantage?" academy of management review 11 (1986a): 656-665. barney, j.b. "strategic factor markets: expectations, luck, and business strategy." m<.magement science 32 (1986b): 1231-1241. barney, j.b., and r.e. hoskisson. "strategic groups: untested assertions and research proposals." m<.magerial <.md decision economic§ 11 (1990): 167-198. boeker, w. "strategic change: the effects of founding and history." academy of mana~ment jqurnal 32 (1989): 489-515. brown, d.m., and s. laverick. "measuring corporate performance." long range planning 27 (1994): 89-98. business week. "managing change." business week 1992 spe.£ial boiju§ issue: r$}inventing america (1992): 60-74. byren, j.a. "paradigms for postmodern managers." busine§§ w$}ek 1992 special bonus issue: reinventing america (1992): 62-63. calingo, l.m.r. "environmental determinants of generic competitive strategies: preliminary evidence from structured content analysis of fortune and business week articles (1983-1984)." human relation§ 42 (1989): 353-369. camerer, c., and a. vepsalainen. "the economic efficiency of corporate culture." strategic management journal 9 (1988): 115-126. cameron, k. and d.a. whetten. org<.mizational effectivene§s: a compari'son qf multiple mod&b. new york: academic press, 1983. camillus, j.c. "evaluating the benefits of formal planning." l.qng, range planning 8 (1975): 3340. camillus, j.c., and n. venkatraman. "dimensions of strategic choice." planning review 12 (1984): 26-31. 16 journal of business strategies vol. 13, no. 1 cappel, s.d. strategic profiles and performance in service qrganizatioqs: examinin2 retail department. variety and general merchandise stores. unpublished doctoral dissertation, memphis state university, memphis, tennessee, 1990. cartwright, tj. "the lost art of planning." long range planning 20 (1987): 92-99. cronbach, lj. "coefficient alpha and the internal structure of tests." psychometrica 16 (1951): 297-334. dierickx, 1., and k. cool. "asset stock accumulation and sustainability of competitive advantage." management science 35 (1989): 1504-1511. dyson, rg., and mj. foster. "the relationship of participation and effectiveness in strategic planning." strategic mam!l~ement journal 3 (1982): 77-88. fiol, c.m. "managing culture as a competitive resource: an identity-based view of sustainable competitive advantage." journal of management 17 (1991): 191-211. foxman, e.r, d.d. muehling, and p.w berger. "an investigation of factors contributing to consumer brand confusion." journal of consumer affairs 24 (1990): 170189. fredrickson, j. w "the comprehensiveness of strategic decision process, extensions, observations, future directions." academy of management journal 27 (1984): 45-466. gaertner, k.n. "winning and losing: understanding managers' reactions to strategic change." human relations 42 (1989): 527-545. gannon, mj., k.g. smith, and c. grimm. "an organizational information-processing profile of first movers." journal of business research 25 (1992): 231-241. godiwalla, y.m., wa. meinhart, and w.a. warde. "general management and corporate strategy." managtfrial planning 30 (1981): 17-29. golden, b.r "the past is the past-or is it? the use of retrospective accounts as indicators of past strategy." academy of management journal 35 (1992): 848-860. govindrajan, v. "impact of participation in the budgetary process on managerial attitudes and performance: universalistic and contingency perspectives." decision sciences 7 (1986): 96-516. grant, j.h., and wr king. the logic of strategic planning. boston: little, brown & company, 1982. green, s. "strategy, organizational culture, and symbolism." long range planning 21 (1988): 121-129. greenley, g. "does strategic planning improve company performance?" long ram~e planning 19 (1986): 101-109. spring 1996 kargar & parnell: strategic planning in small firms 17 greiner, l.e., and a bhambri. "new ceo intervention and dynamics of deliberate strategic change." strategic mana~ment journal 10 (1989, summer): 67-86. grimm, em., and k.g. smith. "management and organizational change: a note on the railroad industry." strategic management journal 12 (1991): 557-562. hair, j.p., re. anderson, and rl. tatham. multivariate data analysis. new york: macmillan, 1967. hannan, m. and j. freeman. "the population ecology of organizations." americ;an journal of sodolqgy 82 (977): 929-964. hausler, j. "planning: a way of shaping the future." management international review 2 (1968): 12-21. hax, a.c., and n.s. majiuf. strategic management: an integrative approach. englewood cliffs, nj: prentice-hall, 1984. hitt, m.a, ra. ireland, and g.a. stadter. "functional importance and company performance: moderating effects of grand strategy and industry type." strategic management journal 3 (1982): 315-330. hofer, c.w. "toward a contingency theory of business strategy." acaql;idy of manal;!eident journal 18 (1975): 784-809. karger, d.w, and z.a. malik. "long range planning and organizational performance." long range planning 8 (1975): 60-64. king, wr "evaluating strategic planning systems." strategic management journal 4 (1983): 263-277. king, wr., and dj. cleland. strategic planning and policy. new york: van nostrand reinhold, 1978. kukalis, s. "determinants of strategic planning systems in large organizations: a contingency approach." journal of management studil;s 28 (1991): 143-60. lado, a, n. boyd, and p. wright. "a competency based model of sustained competitive advantage: toward a conceptual integration." journal of management 18 (1992): 77-91. langley, a. "the roles of formal strategic planning." long range planning 21 (1988): 40-50. leontiades, m., and a. tezel. "planning perceptions and planning results." strategic management journal i (1980): 65-75. lieberman, m.r, and d.b. montgomery. "first-mover advantages." strategic management journal 9 (1988): 41-58. 18 journal of business strategies vol. 13, no. 1 loasby, bj. "long-range formal planning in perspective." journal of management studies 4 (1967): 12-21. loken, 8., i. ross, and rl. hinkle. "consumer confusion of origin and brand similarity perceptions." journal of public policy and marketing 5 (1986): 195-211. lorange, p. "formal planning systems: their role in strategy implementation." in strategic management: a new view of business policy and planning. eds. d.e. schendel and c.w. hofer. boston: little brown & company, 1979. lorange, p. corporate planning: an executive view point. englewood cliffs, nj: prentice-hall, 1980. lorange, p., and r.f. vancil. strategic planning systems. englewood cliffs, nj: prentice-hall, 1977. lorenz, c. "why strategy has been put in the hands of line managers." financial ~ (may 18, 1988): 20. mascarenhas, b. "first mover effects in multiple dynamic markets." strategic management journal 13 (1992): 237-243. mcdaniel, s.w., and j.w. kolari. "marketing strategy implications of the miles and snow strategic typology." journal of marketing 51 (1987): 19-30. miles, re., and c.c. snow. organizational strategy, structure. and process. new york: west, 1978. mowday, rt., l.w. porter, and rm. steers. employee-organization linkages the psychology of commitment. absenteeism and turnover. new york: academic press, 1982. north carolina banking commission. state qf north carolina commissioner of banks 1991 annual report. raleigh, nc: 1991. orpen, c. "the effects of long-range planning on small business performance: a further examination." journal of small bu&iness management 1 (1985): 16-23. parnell, j.a. "strategic consistency versus flexibility: does strategic change really enhance performance?" american business review 12 (1994): 22-30. pearce, la., ii, e.b. freeman, and rb. robinson. 'the tenuous link between formal strategic planning and financial performance." academy of management review 12 (1987): 658-675. ramanujam, v., and n. venkatraman. "planning and performance: a new look at an old question." busi nes& horizons 30 (1987): 19-25. spring 1996 kargar & parnell: strategic planning in small finns 19 ramanujam, v., n. venkatraman, and j.e. camillus. "multi-objective assessment of effectiveness of strategic planning: a discriminant analysis approach." academy of mana2emept journal 29 (1986): 347-372. rhyne, l.c. "contrasting planning systems in high, medium and low performance companies." journal of mana2ement studies 24 (1987): 363-85. rhyne, l.c. 'the relationship of strategic planning to financial performance." strateiic mana2ement journal 7 (1986): 423-436. roach, j.d.c., and m.g. allen. "strengthening the strategic management process." in the strategic mana2ement handbook, 1983. robinson, r.b., and j.a. pearce. 'the impact of formalized strategic planning on financial performance in small organizations." strate2ic mana2ement journal 4 (1983): 197-207. saffold, g.s. iii. "culture, traits, strength, and organizational performance: moving beyond strong culture." academy of manaiement review 13 (1988): 546-558. sapp, r.w., and r.e. seiler. "the relationship between long-range planning and financial performance of u.s. commercial banks." management planning 29 (1981): 3236. schein, e.h. "organizational culture." american psychologist (feb. 1990): 109-119. schein, e.h. organizational culture. san francisco: jossey-bass, 1985. scholes, k. "the way to manage strategic change." accountancy 107 (1991): 98-99. scholz, e. "corporate culture and strategy-the problem of strategic fit." ~ range planning 20 (1987): 78-87. schwartz, h., and s. davis. "matching corporate culture and business strategy." organizational dynamics (summer, 1981): 475-493. schwenk, e.r., and c.b. shrader. "effects of formal strategic planning on financial performance in small firms: a meta-analysis." entrepreneurship theory and practice 17 (1993): 53-64. shank, j.k., e.j. niblock, and wt. sandall. "balance 'creativity' and 'practicality' in formal planning." harvard business review 51 (1973): 87-95. sinha, d.k. "the contribution of formal planning to decisions." strategic management journal 11 (1990): 479-492. snow, c.c., and l. hrebiniak. "strategy, distinctive competence, and organizational performance." administrative science quarterly 25 (1980): 317-35. 20 journal of business strategies vol. 13, no. 1 steers, rm. "antecedents and outcomes of organizational commitment." administrative science quart~rly 22 (1977): 46-56. steiner, g.a. strategic planning: what every manager must know. new york: free press, 1979. stem, m.e. marketing planning: a systems approach. new york: mcgraw-hill, 1966. stevenson, h.h. "defining corporate strengths and weaknesses." sloan management review 17 (1976): 51-68. ulrich, d. "the population perspective: review, critique, and relevance." human relations 40 (1987): 137-152. van de yen, a., and d. ferry. measuring and assessing organizations. new york: wiley, 1980. veliyath, r., and s.m. shortell. "strategic orientation, strategic planning system characteristics and performance." journal of management studies 30 (1993): 359-381. webb, j., and p. dawson. "measure for measure: strategic change in an electronic instruments corporation." journal of management studies 28 (1991): 191-206. welch, j.b. "strategic planning could improve your share price." long range planning 17 (1984): 144-147. wernerfelt, b., and a. karnani. "competitive strategy under uncertainty." strategic management journal 8 (1987): 187-194. whipp, r., r rosenfeld, and a. pettigrew. "managing strategic change in a mature business." lom: range planning 22 (1989): 92-99. wiersema, m.e, and k.a. bantel. "top management team demography and corporate strategic change." academy of management jqurnal 35 (1992): 91-121. wilson, rm.s. mana&\<ment controls and marketing planning. london: heinemann, 1979. wortman, m.s. "a unified framework, research typologies, and research prospectuses for the interface between entrepreneurship and small business." in the art and science of entrepreneurship. eds. d.l. sexton and re. smilor. cambridge: ballinger, 1986. yoshihara, h. "originality in management." journal for quality & participation (dec. 1990): 14-21. strategic planning emphasis and planning satisfaction in small firms: an emprircal investigation effective followership: leadership turned upside down robert p. vecchio department of management university of notre dame notre dame, indiana the twelve members of a professional association recently met to select a new president. each member had a hand in pressuring the former president to resign. ai; a result of a number of minor actions and omissions of actions the members had made the president's task so difficult that he had found it nearly impossible to function as the head of the association. now, each member was prepared to fight for a preferred candidate for the presidential position. when the group's discussion came to the selection of a new president, one member observed, "who can we find that will be able to lead us?" unexpectedly, one clever member replied, "more importantly, who can we find that we will be able to follow?" this wry reply provides an insight to a much neglected feature of the process of leadership: followership. traditionally, studies of leadership have focused on leader behaviors and leader attributes. omitted in these writings is a serious consideration of the impact of followership as a determinant of effective leadership. yet, the activities of leadership and followership are inextricably related. the concepts are intertwined in ying-yang fashion: one concept implies (and, in fact, requires) the other. for example, consider the following propositions developed by trudy heller and jon vantil [3]: • the leader must lead, and do it well to retain leadership; the follower must follow, and do it well to retain followership • where all seek to lead, or all seek to follow, there can be no leadership or followership. • good leadership enhances followers, just as good followership enhances leaders. • leadership, and followership, may be an art in which people can become more highly skilled. a good argument can be made that when we commonly speak of effective leadership, we are really speaking of effective followership. as evidence of this, consider that we typically measure a manager's effectiveness by examining the performance of his or her unit. the performance of a unit, however, is often more a function of the talents and desires of the followers than the leader. a 39 given level of subordinate talent and motivation can have far more to do with the unit's performance than the leader's efforts. ai; an essential element in the development and management of an effective business strategy, the human resources configuration of those units comprising an organization is critical. in this article, the importance and dynamics of effective followership will be explored. in addition, techniques for fostering and maintaining effective followership will be considered. the limits of leadership in many situations, it can be extremely difficult for a leader to influence, easily or directly, the performance of a unit. social scientists have recently come to recognize that many factors can serve as "substitutes" for and ''neutralizers" of a leader's efforts [5]. substitutes for leadership include explicit rules and procedures, rigid reward structures which a leader cannot affect, and physical distance between a leader and his subordinates. for example, subordinates who are given explicit goals and rules for performing their jobs, will not need to be given direction by a leader. characteristics of individuals can serve to neutralize a leader's influence. for example, subordinates who are highly experienced, possess sufficient training and knowledge, and have a high need for independence or a sense of professionalism will not need, or may even resent, a leader who tries to be directive. task characteristics, such as routineness, frequent feedback, and a high degree of structure can also undercut a leader's potential influence. what we typically think of as being failures in leadership, may also be rightly characterized as failures in followership. a degree of responsibility for unit performance rests squarely on subordinates. superiors, where their influence can make a difference, cannot be effective if subordinates do not subscribe to unit goals, or exert sufficient effort. subordinates have a responsibility to be conscientious, and to expend energies for unit goals. in an enlightened view, both leaders and followers share in the responsibility of being productive and effective. leadership and followership: some popular fictions the traditional view of leadership assumes that leaders are responsible for motivating subordinates and eliciting their commitment that subordinates are initially lacking in responsibility and a willingness to commit. of course, a leader's success at eliciting commitment depends on many factors. it is partly a function of individual differences in subordinates' willingness of predisposition to be committed, loyal, etc. an individual's upbringing can play an important role in determining the degree of his or her willingness to follow [8]. whether or not, and to what degree, specific values are emphasized in a child's home can influence that individual's attitude toward superiors, as an adult. the emerging findings from the social sciences also suggest that managers are seldom fully in command (as frequently portrayed), and subordinates are rarely as submissive or faceless as is generally assumed. 40 much has been made of the need to avoid being deceived by yes-men. a variation of this notion is popularly referred to as group-think, wherein a leader is surrounded by yea-sayers and devotees who contribute to the group's self-deception about its invulnerability [4]. in a unit that is victimized by the group-think phenomenon, the leader may make a disastrous decision because his or her followers have total conviction of the ultimate success of the group's efforts. such a group will not seriously entertain the possibility of failure. the bay of pigs fiasco of the kennedy administration and the early escalation of u.s. military involvement in vietnam by the johnson administration have often been attributed to group-think. in both the bay of pigs and vietnam escalation decisions, the respective leaders and their supportive followers unconsciously conspired to create a mindset that inhibited their ability or foresee obstacles to the success to their plans. the group-think phenomenon is most likely to occur in a highly cohesive work unit where the members are already strongly committed to their leader and the group's objectives. the message portrayed by the group-think examples is largely overstated since, in reality, the preconditions for group-think (i.e., extreme cohesion and total followers hip ) are rare. more typically, managers must wrestle with a situation wherein their subordinates are far less loyal, and far less attracted to other members of the work unit than groupthink requires. there is a good deal of potential followership held in reserve by subordinates. various anecdotal accounts of the group-think phenomenon have made it possible, and popular, to criticize the notion of followership. similarly, wellpublicized accounts of the predisposition of some individuals to blindly submit to authority in experimental settings have contributed to a criticism of followership. one famous study by stanley milgram [9] found that a majority of normal adults would administer seemingly painful electric shocks to another participant in a research study, even if the recipient of the shock protested and demanded to be set free. a related study by phil zimbardo [12] reported that college students who participated in role playing the job of prison guard would all too readily engage in the more cruel and sadistic activities stereotypically thought to characterize the treatment of prisoners by prison guards. in addition, the predisposition of some individuals to follow authority has been denigrated by the reports of social scientists in early research on the "obedient personality." specifically, researchers during world war ii sought to better understand the so-called "nazi personality" and thus attempted to study fascist tendencies via a personality scale [10]. this research on the obedient (or fascist) personality, of course, represents an attempt to understand an aberrant style of behavior. omitted in these classic studies were attempts to understand followership within normal settings (that is, hospitals, profitoriented organizations, etc.). while these studies provide fascinating insights into the more bizarre aspects of human behavior, their results do not have firm implications for life in organizations. although laboratory experiments can offer insights to employee 41 behavior, these popular studies often involved the creation of brief, transitory episodes, wherein people were placed in highly ambiguous and tension-charged settings of very short duration. normal, adult behavior in the ongoing role of employee/subordinate does not readily lend itself to cruelty and blind obedience. the social norms and codes of personal conduct that exist in the real world (and are largely suspended in the temporary setting created in a research laboratory), inhibit tendencies toward excessive cruelty and blind obedience. in addition, most managers do not deliberately seek to be surrounded by blindly obedient and subservient individuals. the traits of good followership (that is, a sense of responsibility, adult-orientation, commitment, openness, and loyalty) are what most managers desire. styles of followership all managers are familiar with the notion of "styles of leadership." when this expression is used, we typically think of such terms as autocratic, participative, laissez-faire, etc. we can also extend this perspective to include styles of followership. although a neglected topic, it is useful to consider the major dimensions along which subordinates differ, and to consider how follower styles may be developed and maintained.! figure 1 displays a framework for conceptualizing styles of followership. the framework incorporates two dimensions: compliance-defiance, and loyaltyhostility. the dimension of compliance-defiance is a behavioral dimension, and reflects the extent to which a follower conforms to the directives of a superior, versus undermines or counters the supervisor's desires. loyalty-hostility is an attitudinal dimension which represents the degree to which a subordinate is supportive of, versus antagonistic toward, a supervisor and his or her goals. by crossing the two dimensions, we create a set of quadrants, each of which has a unique meaning. in quadrant i (loyal, compliant), we are dealing with a supportive and conforming individual. quadrant ii refers to a compliant, but hostile individual. this would be the case of a subordinate who is maliciously obedient. quadrant iii is a person who is both hostile and defiant, while quadrant iv is a person who is defiant, but loyal (such as a conscientious objector would be). in the extremes of each quadrant (i.e., outside the circle), we are dealing with a form of mental illness. in their most exaggerated forms, the blindly obedient follower and the extremely hostile subordinate (quadrants i and iii) represent forms of illness. an extremely hostile but obedient individual is being logically inconsistent, and is perhaps only compliant because of external constraints (for example, fear of being terminated or having difficulty finding another position). an individual in quadrant iii is also, in the extreme, experiencing distress. such a person (who is simultaneously defiant, but committed to a supervisor's goals) may eventually be called to explain his or her lone useful framework, which was developed by zaleznik [11], served as the starting point for developing the present scheme. 42 actions, perhaps before a disciplinary board or a court. eventual separation from the unit is the most likely outcome for an individual who is caught in the dilemma of supporting a supervisor, but defying his diiectives. at the extreme, this may be thought of as a situation which induces a form of mental illness. finally, it should be noted that although the two dimensions are, in the "real world," likely to be highly correlated (such that loyal employees are likely to be compliant, and so on), there are certainly many occasions wherein attitudes and behaviors are not highly correlated. figure i. dimensions of followership compliance loyalty defiance 43 hostility developing and mointoining effective followership managers, of course, have a responsibility for developing and maintaining the followership of their subordinates (note: being a follower and being a subordinate are not equivalent notions, as being a leader and being a supervisor also are not equivalent terms). the framework displayed in figure 1 provides a guide for understanding how to approach the task of developing followership. the compliant-defiant (that is, behavioral) aspect of followership can be best attended to by rewarding subordinates for engaging in appropriate action and withholding rewards for inappropriate action. volumes have been written on the importance and utility of tying rewards more closely to performance [6). generally, making rewards contingent on performance tends to enhance productivity. simple compliance can also be more reliably predicted from contingent rewards. enhancing the attitudinal aspect of followership (i.e." the dimension of loyalty-hostility) is far more complicated, in terms of the social processes that are involved. nonetheless, several recommendations can be deduced from the available literature in the social sciences. the cost of admission making the expense of attaining group membership more costly to the individual is a powerful means of inducing employee commitment. that is to say, individuals will have a more positive attitude toward group membership if they are compelled to expend more time, money, or effort to attain and maintain membership. a dramatic illustration of this phenomenon comes from a classic social science study by eliott aronson and judson mills [1]. as part of their research, these investigators had research subjects engage in an unpleasant activity as a prerequisite for admission to a group. specifically, individual female college students, who were interested in joining a group that discussed topics related to human sexuality, were asked to read a written passage into a tape recorder (ostensibly to test their voice for maturity of reaction). several groups of subjects were run in the study. one group was given a fairly innocuous passage to read (i.e., a mild initiation experience), while other groups read relatively more explicit and relatively sexually detailed passages in order to gain admission to the group (i.e., more severe initiation experience). all students were then asked to listen to a tape-recording of the group discussion (the group had allegedly already met several times). the discussion was deliberately staged so as to be extremely boring and unattractive (e.g., the members dryly and haltingly discussed the sexual habits of grasshoppers and other insects). the investigators were primarily interested in how each applicant for group membership would evaluate the group. intriguingly, the females who were put through the more difficult initiation experience rated the group more highly (le., gave higher ratings of the members's attractiveness, and intelligence, based on the tape). in a replication of this study by gerard and mathewson, subjects were required to demonstrate their ability to control their emotions 44 by being given varying degrees of electric shock. the results were identical: the more electric shock a subject received, the more favorably she rated the group [2]. thus, it appears that the more costly it is to individuals to gain admittance to a group, the more they will value their membership. this form of rationalization can be found in other varieties of group membership. for example, fraternities and sororities require "pledges" for membership to undergo a hazing period, where distasteful initiation experiences are forced on the would-be members. the resulting loyalty of the members of these organizations is well known. participation in decision making a second method for inducing loyalty is to involve subordinates in the decision-making process. participation in decision making increases an individual's sense of involvement and, thereby dedication to the ultimate course of action. if the participation is genuine, participation can lead to a sense of "ownership" for a goal. a manager must be careful not to merely create an illusion of participation by asking for advise and input from subordinates, which he or she does not intend to incorporate into the final decision. many popular motivational schemes (e.g., mbo and quality circles) incorporate the notion of involving subordinates in planning, goal setting, and suggesting improvements in work methods. creating a sense of identification a third device for soliciting loyalty is to create a sense of identity with a group or its leader. many organizations try to illicit a sense of identity by having group members wear uniforms, or by emblazoning a company logo on paychecks, stationery, and ld. cards. beyond these simple techniques, a sense of identity can be fostered by first understanding the value system of employees. if employees value certain notions (such as the importance of being a part of a family, or the importance of self-reliance), a manager can appeal to these notions by frequently relating to and highlighting these values as part of the theme of his or her administration. for example, as part of his election campaigns, president reagan skillfully managed to identify his administration with the values of a strong defense and self-reliance (themes which were attractive to the american populace, especially at the end of president carter's term in office). in short, a sense of identity can be achieved by frequent use of symbols (both tangible and verbal). accenting the importance of followership finally, a manager can enhance loyalty by demonstrating to his unit that loyalty and commitment are highly valued. for example, he or she can highlight the history of the organization and what makes for success and failure in the organization; a manager can stress the importance of loyalty and commitment in attaining both personal and corporate success. by their own conduct, managers communicate the extent to which loyalty is likely to be valued in 45 their own units. if a manager is cynical and critical of superiors, he is more likely to create within his own unit a belief that sarcasm and second-guessing of superiors is an acceptable norm. that is not to say, of course, that a manager should be blindly devoted and praiseworthy of superiors. rather, a manager should be respectful toward and considerate of the reputation of superiors (and all others) and predisposed to offer support and aid to help the organization achieve its goals. to be sure, organizations would come to a grinding halt without a minimal degree of followership. yet, the level of followership in the united states over the past two decades appears to be at an historically low level. 2 our capacity for greater levels of effective followership is not completely utilized. perhaps our readiness to follow is at a low ebb because of the level of leadership (as distinct from headship) has not also been maximal. our country has come through a difficult era for top-level leaders, a period characterized by assassinations and assassination attempts, near-impeachments, and questioning of traditional values. also, employees are better educated, more outspoken, and more conscious of rights and entitlements than in the past. however, it is still popular to call for more effective leadership. yet, organizational performance will not be maximal without the necessary condition of responsible followership. the principle of followership is perhaps best understood at the u.s. military academy at west point, where leadership is a central focus of the curriculum-the interrelated nature of leadership and followership is acknowledged. as they say at west point, "(i)f you wish to develop people into leaders, you must begin by teaching them to be followers" [7]. references 1. aronson, e. and mills, j. 'the effect of severity of initiation on liking for a group." journal of abnormal and social psychology, vol. 59, pp. 177-181 (1959). 2. gerard, h. b. and mathewson, g. c. 'the effects of severity of initiation on liking for a group: a replication." journal of experimental social psychology, vol. 2, pp. 278-287 (1966). 3. heller, t. and vantil, j. v. "leadership and followership: some summary propositions." journal of applied behavioral science, vol. 18, pp. 405-414 (1982). 4. janis, i. l. groupthink, second edition. boston, ma: houghton mifflin (1982). 2followership in the united states is also noticeably suboptimal when one considers the apparent level of followership in other industrialized nations, such as japan and west germany. 46 5. kerr, s. and jermier, j. "substitutes for leadership: their meaning and measurement." organizational behavior and human performance, pp. 375-403 (1978). 6. lawler, e. e., iii. "whatever happened to incentive pay?" new management, vol. 1, pp. 37-41 (1984). 7. litzinger, w. and schaeffer, t. "leadership through followership." b1uineu horizon~, (1982). 8. mcclelland, d. the achieving society. princeton, nj: vannostrand (1961). 9. milgram, s. obedience to authority. london: thvistock publications (1974). 10. sanford, f. h. authoritariani~m and leadership. philadelphia, pa: stephenson (1950). 11. zaleznik, a. ''the dynamics of subordinancy." harvard busine~s review, may-june 1965, pp. 119-131. 12. zimbardo, p. g. ''the power and pathology of imprisonment." congres~ional re~earch, serial no. 15, washington, dc: u.s. government printing office (1971). 47 effective followership: leadership turned upside down 76 journal of business strategies an exploratory study of information use by nonsurgical cosmetic procedures consumers timothy h. reisenwitz valdosta state university • valdosta, ga jie g. fowler valdosta state university • valdosta, ga abstract this exploratory study investigated the amount of information used by consumers when engaging in non-surgical cosmetic procedures. moreover, the primary purpose of the research is to investigate the linkage between non-surgical cosmetic procedures and the constructs associated with the “self,” such as attitude toward social media advertising, attitude toward traditional (mass media) advertising, cognitive age, risk aversion, satisfaction, and self-image or self-concept. t-tests of the data yielded significant results for most of the variables. this research will hopefully aid marketers to better focus on important areas of information use by non-surgical cosmetic procedures consumers. these results are discussed, along with managerial implications, limitations and directions for future research. introduction lupton and seymour (2003) describe that the body is an object that must be groomed and maintained in an optimal state to maximize benefit. from this perspective, the body is regarded as an always unfinished object and is viewed as mediating the negotiation of health and illness. thus, cosmetic procedure is utilized to rectify perceived deficiencies in the human body (davis, 2002). through cosmetic procedure, individuals are able to exercise their intent to join a culture of beauty. though the studies of the culture of beauty have typically prescribed to women, other research has noted that the culture of beauty is not limited to women and that both genders are increasingly utilizing technologies to change their physical appearance and alter the aging process (beier, 2004). in general, there are two types of cosmetic procedures: non-invasive and surgical procedures. non-surgical/non-invasive techniques consist of injections of chemicals/fillers into muscles or penetration of laser light to inhibit or intervene with certain body parts. cosmetic surgery is a discipline of medicine focused on enhancing appearance through surgical and medical techniques (mohan, 2018). volume 35, number 2 77 according to the american society of plastic surgery (2008), american consumers spend more than twelve billion dollars annually on cosmetic procedures. throughout the last decade, the consumption of cosmetic procedures has consistently been growing. in 2011, more than 12.6 million procedures were performed, which included breast augmentation, rhinoplasty, liposuction, eyelid surgery and tummy tucks. in addition, the top five non-invasive cosmetic procedures were botox, soft tissue fillers, chemical peel, laser hair removal, and microdermabrasion. in 2016, 17.1 million cosmetic procedures were performed (american society of plastic surgery, 2016), among which 15.4 million were minimally invasive procedures. non-surgical procedures are considered the fastest growing medical treatment in the u.s. (grumbein & goodman, 2015). cosmetic procedures have been seen as a self-enhancement technology undermined by negative media news (e.g., deadly frozen face, addiction and deadly poison) (giesler, 2012). however, it has begun to gain acceptance among consumers in recent years. this neutralized process may due to the social process of legitimation (humphreys, 2010). for instance, botox received approval from the fda in 2002. since 2007, it has become the most commonly used non-surgical cosmetic enhancement procedure in north america to soften a person’s frozen lines for up to four months (american society for aesthetic plastic surgery, 2009). the market success was led by the baby boomer female consumer segment. institutional theory: cultural aesthetics and body project vargo (2011) notes marketing’s foundation is derived from economic science which, in turn, is built on smith’s (1776) normative views about what nations need to do to accumulate wealth in the context of the industrial revolution. institutional economists emphasize the role of the human agency in devising institutions. north (1990), for example, describes institutions as humanly-devised constraints that structure political, economic, and social interaction. they are consistent with both informal constraints (e.g., sanctions, taboos, customs, and traditions) and formal rules (e.g., constitutions and laws). essentially, the development of institutions is critical, in part, because humans have limited cognitive abilities, which is contrary to the assumptions of neoclassical economics (vargo & lusch, 2016). economic sociologists further argue that economic action is embedded in ongoing social ties that at times facilitate and at times derail exchange (granovetter, 1985). the concept of embeddedness states that economic action is embedded in the social structure 78 journal of business strategies (uzzi, 1997), which is contrary to the agency theory that focuses on self-interested human nature and dyadic ties. similarly, sociologists define the institution as rules, norms, meanings, symbols which have a profound effect on the thoughts, feelings, and behavior of individuals and collective actors (lawrence & suddaby, 2006). the institution can be viewed as holding enduring social patterns and includes three dimensions that are cultured cognitive, normative, and regulative elements (scott, 2001). this view shares with the notion of habitus, which is defined as a set of established rules and routines (emirbayer & mische, 1998). although institution theory has been applied in various aspects of marketing research, the concept of institutional work has received little attention. the neoinstitutional theory emphasizes the institutional change and stability that emerge. the concept of “work” refers to a future-oriented intentionality which emphasizes consciously and strategically reshaping social situations (lawrence, suddaby, & leca, 2011). actors or individuals can work to create, maintain and disrupt institutions (e.g., dimaggio, 1988). individuals who are constrained by institutions are nevertheless able to work to affect the institutions. this new stream of institution research focuses on boundary work, which represents the attempts of actors to create, shape, and disrupt established norms (gieryn, 1999). this theory may be applied to the institutionalization of cosmetic surgery. the body is colonized (via medical modification) that deems the person’s way of life and determines if the person can be assimilated into the dominant group (okopny, 2005). individuals, for example, judge the person’s cultural identity based upon the “ethnic nose” (okopny, 2005). as a result, cosmetic procedures involve cultural assimilation and reinforce the empowerment of women (olopny, 2005). as sullivan (2001) argues, the benefits of being attractive transfer to economic gain and so the beauty ideal is highly institutionalized. beauty is a social construction because it varies between culture and shifts throughout time (okopny, 2005). for instance, asian women desire pale skin and many westerners desire tanner looks. li, min, belk, kimura, and bahl (2008) found that “whiteness” is considered an important element to construct female beauty in asian cultures. the meanings of whiteness are influenced by western ideologies as well as institutionalized asian values, norms, and beliefs (li et al., 2008). as such, xu and feiner (2008) use the term, “beauty economy” to describe beauty pageants, modeling, cosmetic, and cosmetic surgeries, etc. (p. 307). further, women’s breast sizes are also influenced by institutionalized social, cultural, and political meanings (millsted & frith, 2003). the size of the breast is volume 35, number 2 79 seen as a measurement of her value and worth in the western world (millsted & frith, 2003). furthermore, large breasts can be considered being feminine, attractive, and sexy. to conclude, there are cultural enclaves (e.g., male gaze, attraction, empowerment) that impact the pursuit of beauty ideals (little, 1998). additionally, the institutionalization of cosmetic surgery has resulted with each generation of cosmetic augmentation, increasing the likelihood of future generations selecting the procedure, therefore increasing the overall medicalization of beauty (voelker & pentina, 2011). according to gumin’s (2012) study of women who had cosmetic surgery, the majority of the participants did not expect cosmetic surgery to make them beautiful. instead, many hoped the procedure to make them have a “normal” appearance. a paradigm for understanding the transformative body practice is the body project, where the body becomes the object to be focused upon, worked on, and improved (shilling, 2012). as such, the “marketed self” has become an important asset in social relationships. purpose of the study and hypotheses it is clear that individuals see their own bodies as living records of consumption habits. they consistently negotiate disparities between their current status and the often-idealized conceptions of the body. essentially, the body becomes central to the individual’s reflexive identity project and self-actualization. as such, the primary purpose of the research is to investigate the linkage between non-surgical cosmetic procedures and the constructs associated with the “self,” such as attitude toward social media advertising, attitude toward traditional (mass media) advertising, cognitive age, risk aversion, satisfaction, and self-image or self-concept. this research will hopefully aid marketers so that they may better focus on important areas of information use by non-surgical cosmetic procedures consumers. media impact traditionally, advertising in the health professions was a contentious issue (moser, 2008). however, most healthcare associations and societies have accepted advertising as one means of communicating to healthcare clients. more recently, for example, moser (2008) found that consumers are generally receptive to the use of dental advertising to communicate information about dental services. kash, boyer, and beathard (2008) note that nursing homes adopted advertising after hospitals and other health-delivery systems, supposedly to remain competitive and to address 80 journal of business strategies negative publicity from poorly-run facilities. the development and communication of a unique image showcasing quality-of-life values and strong service may help differentiate a nursing home from the competition. masoni, guelfi, and gensini (2011) note that online advertising is attractive to healthcare organizations, yet it needs to be regulated due to inappropriate or misleading uses of search terms. the increase of the demand for cosmetic procedures is believed to result in part from the ease of access to relevant information through media (nabi, 2009). social media has become an important online channel where people look for information that is related to cosmetic procedures (vance, howe, & dellavalle, 2009). in view of this, many cosmetic surgeons have actively adopted social media in their practices. in a recent survey, more than 50 percent of cosmetic surgeons have used social media sites to promote their services (vardanian, kusnezov, im, lee, & jarrahy, r., 2013). the homepage, as a website entry point, serves to orient consumers and acts as a complex visual sign, presenting consumers with important aesthetic cues (grumbeim & goodman, 2015). however, there are limited studies examining cosmetic advertising per se. h1: patients who use more cosmetic procedures information (word-of-mouth, mass media, and social media) have a greater attitude toward social media advertising of cosmetic procedures. h2: patients who use more cosmetic procedures information (word-of-mouth, mass media, and social media) have a greater attitude toward mass media advertising of cosmetic procedures. ageism and cognitive age interest in cosmetic surgery is greater in older cohorts, i.e., interest may be more likely to translate into use with age (slevec & tiggemann, 2010). butler (1969) created the term, ageism, to refer to the “systematic stereotyping of, and discrimination against people because they are old, just as racism and sexism accomplish this with skin colour and gender” (p. 243). ageism is based upon a societal obsession with youthfulness. the loss of a youthful appearance is particularly damaging to women, who are socialized to be more concerned with their appearances than their male counterparts (bartky, 1990). schewe (1989) states that aging is an individual event as no two persons age the same way at the same time. the biology of aging is dependent on genetic inheritance and on the environment. consumers not only inherit their physical volume 35, number 2 81 features, but also their susceptibility to disease and the predisposition to other facets of aging, such as wrinkling, weight change, and hair alterations. the environment also affects longevity (schewe, 1989). moreover, personal intervention of the aging process can be achieved by weight control, diet, smoking cessation, and a reduction of psychological stress (schewe, 1988). therefore, some individuals really do age more gracefully than others and it is improper to group people by chronological age and assume the same physiological and psychological changes have taken place. cognitive age, in contrast to chronological age, is the age that an individual identifies with. it is linked to an individual’s self-perception and how old he or she feels, regardless of his or her chronological age (le serre, weber, legoherel, & errajaa, 2017). the pressure to look youthful motivates consumers to mask, if not alter, the physical signs of aging with the use of interventions such as hair dye, make-up, and non-surgical and surgical cosmetic procedures (clarke & griffin, 2008). based upon this discussion, consumers who use more cosmetic procedures information may be more engaged or involved in thinking about having a cosmetic procedure to look youthful and thus may have lower cognitive ages: h3: patients who use more cosmetic procedures information (word-of-mouth, mass media, and social media) have lower cognitive ages. h3a: patients who use more cosmetic procedures word-of-mouth information have lower cognitive ages. h3b: patients who use more cosmetic procedures mass media information have lower cognitive ages. h3c: patients who use more cosmetic procedures social media information have lower cognitive ages. risk aversion perceived risk is “a function of the unexpected results of adoption and an outcome that deviates from expectation” (hirunyawipada & paswan, 2006, p. 187). risk aversion exists when consumers, who are faced with uncertainty, attempt to lower that uncertainty (adhikari & agrawal, 2016). satisfied patients of cosmetic procedures tend to generate positive word-of-mouth about the service (wirtz & chew, 2002). these former patients will likely be a source of information about favorable outcomes of cosmetic procedures. therefore, interpersonal experiences 82 journal of business strategies may aid in reducing the perceived physical and psychological risks of cosmetic procedures (park & cho, 2010). similarly, those consumers who use advertising, including social media, may be doing so to reduce their level of risk, and therefore, may be more risk-averse than other consumers: h4: patients who use more cosmetic procedures information (word-of-mouth, mass media, and social media) are more risk-averse. h4a: patients who use more cosmetic procedures word-of-mouth information are more risk-averse. h4b: patients who use more cosmetic procedures mass media information are more risk-averse. h4c: patients who use more cosmetic procedures social media information are more risk-averse. satisfaction satisfaction has been traditionally associated with the disconfirmation of expectations theory, which is based on the assumption that consumers compare the result with their expectations. a result greater than expectations, or a positive disconfirmation, yields satisfaction, whereas a result less than expectations, or a negative disconfirmation, yields dissatisfaction (castañeda, muñoz-leiva, & luque, 2007). zare-farashbandi, lalazaryan, and rahimi (2017) found that having healthrelated information increases patients’ satisfaction regarding the treatment process. additionally, young and im (2012) found that web site design quality showed positive effects on perceived information quality and indirect effects on satisfaction and word-of-mouth (wom) intention. h5: patients who use more cosmetic procedures information (word-of-mouth, mass media, and social media) are more satisfied with the cosmetic procedure results. h5a: patients who use more cosmetic procedures word-of-mouth information are more satisfied with the cosmetic procedure results. h5b: patients who use more cosmetic procedures mass media information are more satisfied with the cosmetic procedure results. volume 35, number 2 83 h5c: patients who use more cosmetic procedures social media information are more satisfied with the cosmetic procedure results. self-image or self-concept theoretically, body image can be defined as “mental construction, embedded in a self-schema” (myers & biocca, 1992, p. 116). as such, a person’s body is meaningfully perceived in relation to a cognitive structure (thompson & hirschman, 1995). belk (1988) conceptualizes possessions as extensions of self and categorizes the body and body parts as the most valued possessions that are central to our conception of the self. it has been suggested that some purchase decisions may be affected by the consumer’s self-image or self-concept (sirgy, 1982). self-concept, the sum total of an individual’s ideas, thoughts and feelings about himself or herself relative to other objects, is a multidimensional concept, which includes actual self-concept, how individuals perceive themselves to be, and ideal self-concept, how an individual would like to be perceived (sirgy, 1982). consumers generally have favorable attitudes towards products and brands that are consistent with their self-image and less favorable attitudes towards products and brands perceived to be inconsistent with their self-image (graeff, 1996). subsequently, consumers may be influenced to direct their purchase behavior toward products and services that will protect or enhance their self-concept (litvin & kar, 2003). consumers internalize ideal body images as their own standards of physical attractiveness. as a result, because it raises both awareness and internalization, media exposure will enhance an ideal self-image (park & cho, 2010). furthermore, pentina, taylor, and voelker (2009) concluded that advertising’s unrealistic ideals of appearance (ideal self-image) may lead to an increase of an actual-ideal selfimage discrepancy and may cause consumers, particularly young women, to choose unnecessary invasive cosmetic procedures that may lead to health complications. h6: patients who use more cosmetic procedures information (word-of-mouth, mass media, and social media) have greater increases in self-image after the cosmetic procedure. h6a: patients who use more cosmetic procedures word-of-mouth information have greater increases in self-image after the cosmetic procedure. h6b: patients who use more cosmetic procedures mass media information have greater increases in self-image after the cosmetic procedure. 84 journal of business strategies h6c: patients who use more cosmetic procedures social media information have greater increases in self-image after the cosmetic procedure. methodology the study sample was a regional convenience sample. the respondents consisted of undergraduate marketing research students and consumers who were approached by the undergraduate marketing research students. if the undergraduate marketing research students had experienced non-surgical cosmetic procedures within the past two years, they completed the questionnaire. additionally, those participants that the students sought who also had experienced non-surgical cosmetic procedures within the past two years were asked to complete the questionnaire. the undergraduate marketing students were trained by the instructor regarding data collection procedures. the approach of marketing students finding representative respondents to complete the questionnaire has been successfully used in previous research (e.g., arnold & reynolds, 2003; bitner, booms, & tetreault, 1990; jones & reynolds, 2006). qualtrics was used to administer the instrument online. after the screening question asking the type of non-surgical cosmetic procedure and the month/year it was performed, an introduction to the questionnaire briefly described the study and the anonymity of the responses. the first section of the questionnaire included demographics questions (see table 1). the next two sets of questions focused on multiple-item measures, cognitive age, and risk aversion. all multi-item scales were established scales, some of which were revised for use in the study. cognitive age was measured by a four-item scale with eight choices, ranging from “teens” to “80’s” (barak & schiffman, 1981). the risk aversion scale was a four-item, seven-point, strongly disagree to strongly agree, likert scale (donthu & gilliland, 1996). the next section of the instrument asked respondents to report their internet usage in a series of dichotomous questions and frequency-level questions. this section was followed by a question asking respondents to indicate the information source(s) that were used to help with the non-surgical cosmetic procedure decision. in addition to choices of self, friends/relatives, and family, the major forms of the mass media and social media were included. each information source was measured using a seven-point, strongly disagree to strongly agree, likert scale. volume 35, number 2 85 the questionnaire continued with two identical sets of semantic differential scales, one measuring overall attitude toward the social media advertising of the non-surgical cosmetic procedure, the other measuring overall attitude toward the traditional (mass media) advertising of the non-surgical cosmetic procedure. these measures for attitude toward the advertising were identical four-item, seven-point, semantic differential scales. these items were drawn from the inventory of 64 bipolar adjective scale items from bruner and hensel (1998), who noted that past generated scales, “have relied heavily on researcher judgment with respect to which specific adjective pairs are appropriate for a given situation” (p. 818). a similar five-item, seven-point, semantic differential scale was generated for measuring overall attitude toward the non-surgical cosmetic procedure. the next multiple-item measure explored the satisfaction of the non-surgical cosmetic procedure results using a five-item, seven-point likert scale (oliver, 1980). the measures for attitude toward the online advertising and the attitude toward the traditional (mass media) advertising of the non-surgical cosmetic procedure were identical four-item, seven-point, semantic differential scales. a five-item, sevenpoint, strongly disagree to strongly agree, satisfaction scale (oliver, 1980) was adapted to assess satisfaction of the non-surgical cosmetic procedure results. next, a six-item, seven-point, strongly disagree to strongly agree, self-congruency, selfimage, or self-concept scale was also slightly modified for use in the study regarding the non-surgical cosmetic procedure results (sirgy, grewal, mangleburg, park, chon, claiborne, johar, & berkman, 1997). the final sample size was 103. there was no response rate, since all questionnaires submitted were from students and others who agreed to participate in the study. the sample size and subsequent group sizes were sufficient for analysis, since it is noted that a sample size of “at least 20 can be expected to provide very good results even if the populations are not normal” (anderson, sweeney, & williams, 2009, p. 390). reliabilities were run for the multiple-item scales (overall cronbach’s alpha = 0.87). all values were above the minimum acceptable value of 0.70 (nunnally & bernstein, 1994), except for the risk aversion scale value of 0.65. the last item of the risk aversion scale was deleted for an increase in reliability to 0.74 (see table 2). analysis and results several groups were formed based upon information sources: all information sources, word-of-mouth information sources (own experience, friends/relatives, and 86 journal of business strategies family), traditional or mass media information sources (magazines, newspapers, television, radio, and billboard), and social media information sources (facebook, youtube, instagram, and google+). next, the averages of all the variables in each of the four groups were computed. these averages became the midpoint for the dummy variables of high information use and low information use. these high and low information groups were then compared with the means of the multiple-item psychographic variables. the results are summarized in table 3. there were many significant results. h1 and h2 were supported, i.e., patients who use more cosmetic procedures information have a greater attitude toward social media advertising and mass media advertising of cosmetic procedures, respectively (p < 0.00 and p < 0.05). h3, h3b, and h3c were supported, i.e., patients who use more cosmetic procedures information overall, mass media information, and social media information, have lower cognitive ages (p < 0.00). h4, regarding risk aversion, was not supported, i.e., patients who use more cosmetic procedures information are not more risk-averse. h5, h5a, and h5b, were supported, i.e., patients who use more cosmetic procedures information overall, word-of-mouth information, and mass media information, are more satisfied with the cosmetic procedure results (p < 0.05, p < 0.05, and p < 0.10). finally, h6, h6a, and h6b were supported, i.e., patients who use more cosmetic procedures information overall, word-of-mouth information, and mass media information have greater self-image after the procedure (p < 0.00). discussion this exploratory study investigated the amount of information used by consumers when engaging in non-surgical cosmetic procedures. the results indicated that those using more information also had a greater attitude toward the mass media and social media advertising. the group using more mass media and social media information had lower cognitive ages. this indicates that those who feel younger, and who may want to look younger than their chronological age, used information to a greater degree to better address this desire. those patients who used more information in the word-of-mouth and mass media sources were more satisfied with the cosmetic procedure. and finally, patients who used more information in the word-of-mouth and mass media sources experienced greater self-image after the procedure. volume 35, number 2 87 conclusions in this study, the common thread for those variables with significant results was mass media. marketing managers in the non-surgical cosmetics industry should primarily focus on those particular areas of the mass media that best communicate with the target market. for example, it is interesting to note that millennials, who are becoming one of the major target market groups for cosmetic procedures (saade, de castro maymone, & vashi, 2018), have been using a broad variety of media, which includes all four major forms of the mass media (geraci & nagy, 2004). in particular, the communication should consist of messages that address the non-surgical cosmetic procedure as enhancing a youthful self-image, based upon the results of the cognitive age and self-image variables in this study. promotion can also emphasize the satisfaction that patients experience from these procedures. the present study has limitations, which suggest fruitful areas for future research. first, only an online survey was used to collect data, which can be supplemented by the qualitative method for more robust results. moreover, it is critical to use in-depth interviews and observation to investigate these issues. second, it may be beneficial to have a larger sampling frame, which may explain the perceptual differences towards cosmetic procedures, based upon the demographic and psychographic variables. third, the administration of the questionnaire was to marketing research students as well as others who had experienced non-surgical cosmetic procedures within the past two years. this variation in questionnaire administration may have biased the results. fourth, researchers may compare various media types and investigate the differences in regard to individuals’ decision-making processes on cosmetic procedures. finally, studies may examine the differences between non-invasive and invasive, or surgical, cosmetic procedures decision making processes. therefore, it may be essential to investigate the individuals who have gone through invasive procedures. references adhikari, b. k., & agrawal, a. (2016). does local religiosity matter for bank risktaking? journal of corporate finance, 38, 272-293. american society for aesthetic plastic surgery. (2008). retrieved from https://www. plasticsurgery.org/news/plastic-surgery statistics?sub=2008+plastic+surgery +statistics. american society for aesthetic plastic surgery. (2009). retrieved from https://www. surgery.org/media/statistics. 88 journal of business strategies american society for aesthetic plastic surgery. (2016). retrieved from https:// d2wirczt3b6wjm.cloudfront.net/news/statistics/2016/plastic-surgery-statisticsfull-report-2016.pdf. anderson, d. r., sweeney, d. j., & williams, t. a. (2009). essentials of statistics for business and economics (5th ed.). mason, oh: thomson higher education. arnold, m. j. & reynolds, k. e. (2003). hedonic shopping motivations. journal of retailing, 108(2), 1-20. barak, b. & schiffman, l. g. (1981). cognitive age: a nonchronological age variable. advances in consumer research, 8, 602-606. bartky, s. l. (1990). femininity and domination: studies in the phenomenology of oppression. new york, ny: routledge. beier, l. m. (2004). expertise and control: childbearing in three twentieth-century working-class lancashire communities. bulletin of the history of medicine, 78(2), 379-409. belk, r. w. (1988). possessions and the extended self. journal of consumer research, 15(2), 139-168. bitner, m. j., booms, b. h., & tetreault, m. s. (1990). the service encounter: diagnosing favorable and unfavorable incidents. journal of marketing, 54(1), 71-84. bruner, g. c., & hensel, p. j. (1998). marketing scales handbook: a compilation of multi-item measures: volume ii. chicago, il: american marketing association. butler, r. (1969). ageism: another form of bigotry. the gerontologist, 9(3), 243246. castañeda, j. a., muñoz-leiva, f. & luque, t. (2007). web acceptance model (wam): moderating effects of user experience. information & management, 44(4), 384-396. clarke, l. h. & griffin, m. (2008). visible and invisible ageing: beauty work as a response to ageism. ageing & society, 28, 653-674. davis, k. (2002). a dubious equality: men, women and cosmetic surgery. body & society, 8(1), 49-65. dimaggio, p. (1988). interest and agency in institutional theory. institutional patterns and organizations culture and environment, 3-21. donthu, n., & gilliland, d. (1996). observations: the infomercial shopper. journal of advertising research, 36(2), 69-77. emirbayer, m., & mische, a. (1998). what is agency? american journal of sociology, 103(4), 962-1023. volume 35, number 2 89 geraci, j. c. and nagy, j. (2004). millennials – the new media generation. young consumers, 5(2), 17-24. gieryn, t. f. (1999). cultural boundaries of science: credibility on the line. chicago: university of chicago press. giesler, m. (2012). how doppelgänger brand images influence the market creation process: longitudinal insights from the rise of botox cosmetic. journal of marketing, 76(6), 55-68. grabe, s., ward, l. m. & hyde, j. s. (2008). the role of the media in body image concerns among women: a meta-analysis of experimental and correlational studies. psychological bulletin, 134(3), 460. graeff, t. r. (1996). using promotional messages to manage the effects of brand and self-image on brand evaluations. journal of consumer marketing, 13(3), 4-18. granovetter, m. (1985). economic action and social structure: the problem of embeddedness. american journal of sociology, 91(3), 481-510. grumbein, a., & goodman, j. r. (2015). pretty as a website: examining aesthetics on nonsurgical cosmetic procedure websites. visual communication, 14(4), 485-523. gumin, m. (2012). ugly on the inside: an argument for a narrow interpretation of employer defenses to appearance discrimination. minnesota law review, 96, 1769. hirunyawipada, t. & paswan, a. k. (2006). consumer innovativeness and perceived risk: implications for high technology product adoption. journal of consumer marketing, 23(4), 182-198. humphreys, a. (2010). megamarketing: the creation of markets as a social process. journal of marketing, 74(2), 1-19. jones, m. a. & reynolds, k. e. (2006). the role of retailer interest on shopping behavior. journal of retailing, 82(2), 115-126. kash, b. a., boyer, g. j., & beathard, p. k. (2008). advertising expenditures in the nursing home section: evaluating the need for and purpose of advertising. journal of healthcare management, 53(4), 242–256. lawrence, t., suddaby, r., & leca, b. (2011). institutional work: refocusing institutional studies of organization. journal of management inquiry, 20(1), 52-58. lawrence, t., & suddaby, r. (2006). institutions and institutional work. in stuart, r., clegg, c. hardy, t., lawrence, b. & nord, w. r. (eds.), the sage handbook of organization studies (2nd ed.), pp. 215-254). london: sage. 90 journal of business strategies le serre, d., weber, k., legoherel, p., & errajaa, k. (2017). culture as a moderator of cognitive age and travel motivation/perceived risk relations among seniors. the journal of consumer marketing, 34(5), 455-466. li, e. p. h., min, h. j., belk, r. w., kimura, j., & bahl, s. (2008). skin lightening and beauty in four asian cultures. association of consumer research, north american advances. 35, 444-449. little, m. o. (1998) cosmetic surgery, suspect norms, and the ethics of complicity. enhancing human traits: ethical and social implications, 162-176. litvin, s. w., & kar, g. h. (2003). individualism/collectivism as a moderating factor to the self-image congruity concept. journal of vacation marketing, 10(1), 23-32. lupton, d., & seymour, w. (2003). ‘i am normal on the’net’: disability, computerised communication technologies and the embodied self. in discourse, the body, and identity (pp. 246-265). basingstoke, uk: palgrave macmillan. masoni, m., guelfi, m. r., & gensini, g. f. (2011). online healthcare advertising needs regulation. british medical journal, 342, 1–2. millsted, r., & frith, h. (2003). being large-breasted: women negotiating embodiment. women’s studies international forum, 26(5), 455-465. mohan, t. (2018). injection lipolysis to address small fat deposits and long-term outcomes. the american journal of cosmetic surgery, 35(1), 8-46. moser, h. r. (2008). how consumers view dental advertising: an empirical analysis. journal of medical marketing, 8(3), 229-240. myers, p. n., & biocca, f. a. (1992). the elastic body image: the effect of television advertising and programming on body image distortions in young women. journal of communication, 42(3), 108-133. nabi, r. l. (2009). cosmetic surgery makeover programs and intentions to undergo cosmetic enhancements: a consideration of three models of media effects. human communication research, 35(1), 1-27. north, d. c. (1990). institutions and a transaction-cost theory of exchange. perspectives on positive political economy, 182, 191. nunnally, j. c., & bernstein, i. h. (1994). psychometric theory (3rd ed.). new york, ny: mcgraw hill. okopny, c. l. (2005). reconstructing women’s identities: the phenomenon of cosmetic surgery in the united states. graduate theses and dissertations. oliver, r. l. (1980). a cognitive model of the antecedents and consequences of satisfaction. journal of marketing research, 17(4), 460-469. volume 35, number 2 91 park, j. s. & cho, c-h. (2010). factors explaining college students’ intention to receive cosmetic surgery in the future: a structural equation modeling approach. journal of medical marketing, 11(2), 127-143. pentina, i., taylor, d. g. & voelker, t. a. (2009). the roles of self-discrepancy and social support in young females’ decisions to undergo cosmetic procedures. journal of consumer behavior, 8, 149-165. saade, d. s., de castro maymone, m. b., & vashi, n. a. (2018). the ethics of the cosmetic consult: performing procedures on the body dysmorphic patient. international journal of women’s dermatology, 4, 185-187. schewe, c. d. (1988). marketing to our aging population: responding to physiological changes. the journal of consumer marketing, 5(3), 61-73. schewe, c. d. (1989). effective communication with our aging population. business horizons, 32(1), 19-25. scott, w. r. (2001). institutions and organizations (2nd ed.). thousand oaks, ca: sage. shilling, c. (2012). the body and social theory. thousand oaks, ca: sage. sirgy, m. j. (1982). self-concept in consumer behavior: a critical review. journal of consumer research, 9(3), 287-300. sirgy, m. j., grewal, d., mangleburg, t. f., park, j-o., chon, k-s., claiborne, c. b., johar, j. s., & berkman, h. (1997). assessing the predictive validity of two methods of measuring self-image congruence. academy of marketing science journal, 25(3), 229-241. slevec, j., & tiggemann, m. (2010). attitudes toward cosmetic surgery in middleaged women: body image, aging anxiety, and the media. psychology of women quarterly, 34, 65-74. smith, a. (1776). the wealth of nations. london: methuen & co. sullivan, d. a. (2001). cosmetic surgery: the cutting edge of commercial medicine in america. new brunswick, nj: rutgers university press. thompson, c. j., & hirschman, e. c. (1995). understanding the socialized body: a poststructuralist analysis of consumers’ self-conceptions, body images, and selfcare practices. journal of consumer research, 22(2), 139-153. uzzi, b. (1997). social structure and competition in inter-firm networks: the paradox of embeddedness. administrative science quarterly, 42(1), 35-67. vance, k., howe, w. & dellavalle, r. p. (2009). social internet sites as a source of public health information. dermatologic clinics, 27(2), 133-136. 92 journal of business strategies vardanian, a. j., kusnezov, n., im, d. d., lee, j. c., & jarrahy, r. (2013). social media use and impact on plastic surgery practice. plastic and reconstructive surgery 131(5), 1184-1193. vargo, s. l. (2011). market systems, stakeholders and value propositions: toward a service-dominant logic-based theory of the market. european journal of marketing, 45(1/2), 217-222. vargo, s. l., & lusch, r. f. (2016). institutions and axioms: an extension and update of service-dominant logic. journal of the academy of marketing science, 44(1), 5-23. voelker, t. a., & pentina, i. (2011). cosmetic surgery intent among generation y consumers: a social network perspective. health marketing quarterly 28(1), 38-56. wirtz, j., & chew, p. (2002). the effects of incentives, deal proneness, satisfaction and tie strength on word-of-mouth behavior. international journal of service industry management, 13(2), 141-162. xu, g., & feiner, s. (2007). meinü jingji/china’s beauty economy: buying looks, shifting value, and changing place. feminist economics, 13(3-4), 307-323. young, h., & im, h. (2012). role of web site design quality in satisfaction and word of mouth generation. journal of service management, 23(1), 79-96. zare-farashbandi, f., lalazaryan, a., & rahimi, a. (2017). the effect of patientphysician relationship on health information seeking behavior of diabetic patients. bmj open, 7, a-73-a-74. brief biographical sketch of authors timothy h. reisenwitz has a dba in marketing from cleveland state university, cleveland, ohio, usa, and is professor of marketing in the department of marketing & international business at valdosta state university, valdosta, georgia, usa, where he teaches at the undergraduate and mba program levels. his work is published in several journals, including journal of consumer marketing, marketing management journal, journal of medical marketing, journal of marketing education, marketing education review, journal of business strategies, and academy of educational leadership journal. timothy h. reisenwitz is the corresponding author and can be contacted at treisenw@valdosta.edu. jie g. fowler has a phd in marketing from university of nebraskalincoln, lincoln, nebraska, usa, and is associate professor of marketing in the department of marketing & international business at valdosta state university, valdosta, georgia, usa, where she mainly teaches marketing research, promotion, volume 35, number 2 93 and marketing channels. her work is published in journal of advertising research, journal of macromarketing, qualitative market research, journal of business strategies, journal of current issues, and research in advertising. 94 journal of business strategies volume 35, number 2 95 96 journal of business strategies a note on the legal theory of constructive deceit dale buckmaster and m el£nda k wart department of business administration university of delaware this article is about one aspect of stockholder rights when there is a corporate merger or takeover. corporate mergers and takeovers have become common events in recent years. few corporations are safe from a takeover bid. the financial benefits to stockholders of target companies are likely to vary considerably among these stockholders, particularly when the target company is a relatively small, closely held organization. as a result, the facts related to the merger or takeover transactions are frequently misrepresented or in adequately disclosed. there are state and federal laws to protect the rights of stockholders who might be financially injured from being misled about a merger or takeover transaction. generally federal jurisdiction is considered more advantageous to the injured stockholders than pursuing a suit in the state courts. thus, it is worth while for directors and stockholders to be a\\'are of the possible determinants of which the court has jurisdiction. in this article we discuss both the availability of a federal forum under current legal theory, as well as the advantages of electing this option. section 10 and rule lob-5 of the securities exchange act of 1934 (8) may provide injured minority stockholders a course of action in a merger or takeover when there is no remedy in the state courts. the theory of constructive deceit has been used as one interpretation of rule iob-5 that greatly expands the availability of a federal suit. the objective of this article is to provide a general description of this theory and its utility in determining the jurisdictional location of a suit. rule iob-5 and the theory of constructive deceit rule 10b-5 of the securities act of 1934 reads: it shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails or of any facility of any national securities exchange (a) to employ any device, scheme, or artifice to defraud, (b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, 41 or (c) to engage in any act, practice, or course of business which operates or would operate as 8. fraud or deceit upon any person, in connection with the purchase or sale of any security. the question of when a rule lob-5 suit may be properly brought before the federal courts is of some importance and the determinants of when this might occur have changed over the years. at present, the legal theory of constructive deceit allows an injured stockholder a chance to bring a suit under rule lob-5 in cases in which the share holder formerly may have been thwarted from instituting such a federal claim. the theory of constructive deceit suggests that when a a corporation has purchased or sold securities under the control of a group of its directors who are engaging in an undisclosed course of self-dealing, then the corporation has been deceived in its function as representative of the minority interests. deceit, a necessary element to a rule lob-5 action, is difficult to establish wi~h a corporate victim since a corporation is normally imputed with the knowledge of its agents. however, under the theory of constructive deceit, which is supported by agency principles, there is a different result if a. sufficient number of interested directors are involved since knowledge acquired in selfdealing is not imputed to the corporation. however, in order to prevail in a rule lob-5 case, it is necessary to prove that the omission or misrepresentation is sufficiently material to have kept the stockholder from redressing what would have been a recognized wrong in state court. in goldberg v. meridor (2), for instance, a successful rule lob5 action was brought on behalf of the corporation challenging the issuance of shares for inadequate consideration under the theory that the corporation was prompted to make this issuance by its controlling shareholder who personally denefited from the. arrangement. the unfairness of the exchange was covered up with the use of misleading press releases. had the shareholders known of the inadequacy, they could have pursued an injunction remedy under state law. on this basis, the court concluded that the materiality factor was met, and therefore a rule lob-5 suit was made out. some federal circuits have not fully accepted the availability of a federal securities suit when a director or officer has concealed or failed to disclose some act of negligence, even when it is actionable under state law. the case of biesenbach v. guenther (1), for example, involved a claim that the corporation's directors failed to disclose the true purpose behind a transaction that they misleadingly reported was in the shareholders' best interests. in response, the third circuit came to the somewhat anomalous conclusion that "[t]he unclean heart of a director is not actionable, whether or not it is 'disclosed', unless the impurities are translated into actionable deeds or omissions both objective and external." [p.402] many federal circuits have acknowledged that such a federal claim exists but limit its accessibility to those occasions where a shareholder can first prove that he or she would have succeeded or would have a reasonable probability of succeeding in obtaining 42 a remedy in a state forum. [see, for example, (3),(4), and (8).] constructive deceit and santa fe industries, inc. v. green judge friendly of the second circuit formalized the theory of constructive deception in which a corporation can be deceived through its stockholders. the rule states "there is deception of the corporation (in effect, of its minority shareholders) when the corporation is influenced by its controlling shareholders to engage in a transaction adverse to the corporation's interests (in effect, the minority shareholders' interests) and there is nondisclosure or misleading disclosure as to the material facts of the transaction." (2) the theory initially failed to develop because it was inconsistent with the theory of "new fraud" , an alternate and more pqpular interpretation of rule 10b-5. under the "new fraud" theory, no showing of deceit is necessary to predicate a rule lob-5 claim despite the apparent lob-5 requirement for such. this theory merely requires a showing of unfairness or a general breach of fiduciary duty rather than deception. but the supreme court effectively dismissed the theory of "new fraud" in the santa fe industries (5) case. this opened the way for the acceptance and refinement of the theory of constructive deceit. in footnote 14 of the santa fe industries case, the supreme court recognized that a federal rule lob-5 cause of action can be premised on any breach of fiduciary duty that might have led to a state remedy had it been disclosed. (1, p.474) this failure to disclose then constitutes a material omission which deceives the stockholder. unfortunately, this suit was unavailable to many stockholders because the proposed corporate action which the shareholder sought to contest was commonly effectuated through the corporation's purchase or sale of securities. in this way, the stockholder could not establish a necessary prerequisite to the in~titution of a rule iob-5 suit, his personal purchase or sale of securities. at this stage, the theory of constructive deceit became most useful, allowing the worsted shareholder to institute a derivative rule lob-5 action on behalf of the corporation, which constitutes the investor in the disputed transaction. implications for directors and stockholders the theory of constructive deceit is the common law rule that is currently used to determine whether cases involving minority stockholders opposing a merger will be under the jurisdiction of state courts or federal courts. where the cases are heard may be of considerable consequence. plaintiffs generally prefer federal to state forums because of the availability of nationwide service of process, liberal class action rules, jury trials and relief from state security-for-expenses requirements. furthermore, remedies for the minority stockholders in state courts are normally limited to the appraisal remedy. that is, the minority stockholders may be reimbursed for the appraised fair market value of their stock. in smith v. van gorkom, for example, the complaining class of shareholders was accorded the fair value of their holdings and denied the requested rescission of a cash-out merger, despite the 43 court's determination that the board had acted in a grossly negligent manner by failing to disclose all material facts before soliciting shareholder approval. (6,p.890) on the other hand, it is possible that the injured minority stockholders might obtain some kind of equitable relief in the federal courts, such as an injunction blocking the merger or the recovery of the shares by the issuer. alternatively, the investor may obtain an award of monetary damages not limited to the worth of the shares alone but determined by the losses sustained by the investor. references 1. biesenbach v. guenther, 588 f.2d 400 (3d cir. 1978). 2. goldberg v. meridor, 567 f.2d 209 (2d eire 1977) cert. denied, 434 u.s. 1069 (1978). 3. healy v. catalyst recovery, inc., 616 f.2d 641 (3d eire 1980). 4. kidwell ex rei penfold v. meikle, 597 f.2d 1273 (9th cir. 1979). 5. santa fe industries, inc. v. green, 430 u.s. 462 (1977). 6. smith v. 'tangorkom, 488 a.2d 858 (del. 1985). 7. wright v. heizer corp., 560 f.2d 236 (7th cir. 1977), cert. denied, 434 u.s. 1066 (1978). 8. 17 cfr section 240. lob-5 (1976). 44 a note on the legal theory of constructive deceit a framework for conducting an external strategic management audit fred r. david department of management mississippi state university mississippi state, mississippi the strategic management process can be viewed to consist of three basic stages: strategy formulation, strategy implementation, and strategy evaluation (3). the strategy formulation stage includes activities such as performing an internal audit, conducting an external audit, developing a clear business mission, establishing' objectives, and devising strategies. an external audit identifies and evaluates economic, social, political, technological, and competitive trends and events that impact an organization's strategic position (16). firms should strive to pursue strategies that capitalize upon external opportunities and avoid the impact of external threats (5). the existence and magnitude of environmental changes today underlie the need for an effective external audit (7). two new analytical tools called the competitive profile matrix (cpm) and the external factor evaluation matrix (efem) are presented and exemplified in this article (4). a five-step approach for conducting an external audit is recommended as follows: i. isolate key environmental variables ii. isolate key sources of environmental information iii. develop appropriate forecasts n. construct a competitive profile matrix v. construct an external factor evaluation matrix (3). isolate key environmental variables the first step in performing an external audit is to isolate key variables in a firm's environment. key variables to be monitored typically vary widely depending on a company's situation and industry. environmental variables can be categorized into five major groups: (1) economic, (2) social, cultural, demographic, and geographic, (3) political, governmental, and legal, (4) technological, and (5) competitive. relationships among key environmental variables and an organization are depicted in exhibit 1. 22 exhibit 1: relationships among key environmental variables and a firm f~onamic -------, political, legal, -------~ and c:dvernrreptal socinl, cultural, oerrog-raphic, and geographic -------~ technological competitive -------..1, -------~ canpetitors suppliers distributors creditors custaners employees canmmities managers stockholders labor unions governrrents trade associations special interest gro11os products services markets i\ c o -----~ oooortunities m p -----~ threats ..7)., n y changes in environmental variables translate into changes in consumer demand for industrial and· consumer products and services. environmental forces affect the types of products developed, the nature of positioning and market segmentation strategies, the types of services offered, and the choice of businesses to acquire or sell. identifying and evaluating environmental opportunities and threats enables a company to formulate or reformulate its basic mission, to design strategies to achieve its objectives, and to develop policies to achieve its goals (1). economic variables can have a direct impact on the potential attractiveness of various company strategies. for example, as interest rates rise, individuals' discretionary income declines, which lowers the demand for discretionary goods. other economic variables such as the availability of credit, the level of disposable income, inflation rates, federal government budget deficits, consumption patterns, unemployment trends, the value of the dollar in world markets, import/export factors, price fluctuations, monetary policies, fiscal policies, and tax rates often represent key opportunities and threats for organizations. social, cultural, demographic, and geographic changes can also have a dramatic affect upon a firm's products, services, markets, and customers (2, 9). in virtually every aspect of life, the united states is much different in the 1980's than it was in the 1970's, and the 1990's promise even greater changes. social changes are creating a different type of consumer and consequently a need for different products, different services, and different company strategies. a maturing american society is resulting in new products, services, markets, and personnel policies as "well as a new look in advertising, a decreased emphasis on schools" an increased emphasis on health care, a growing market for luxury items, and a drop in crime rates. the aging and geographically shifting u.s. population affects the strategic orientation of nearly every organization. 23 political, governmental, and legal variables can represent key opportunities and threats for both small and large organizations. federal, state, and local governments are a major regulator, deregulator, subsidizer, employer, and customer of organizations in the united states. for industries and firms that depend heavily on government contracts or subsidies, political forecasts can be the most important part of an external audit. changes in patent laws, antitrust legislation, and lobbying activities can significantly impact firms. the increasing global interdependence among economies, markets, governments, and organizations makes it imperative that firms of all sizes consider the possible impact of political variables on the formulation and implementation of competitive strategies. frederick gluck (8) concludes that a world market is emerging from what previously was a multitude of distinct national markets. in an industry that is or is rapidly becoming global, the riskiest possible posture for a domestic firm may be to remain a domestic competitor. technological variables can dramatically affect an organization's products, services, markets, suppliers, distributors, competitors, customers, manufacturing processes, marketing practices, and competitive position (15, 10, 13). technological advancements can create new markets, result in a proliferation of new and improved products, change the relative competitive cost positions in an industry, render existing products and services obsolete, collapse or merge previously separate businesses by reducing or eliminating cost barriers, create shorter production runs, create shortages in technical skills, and result in changing values and expectations of employees, managers, and customers. technological advancements can create new competitive advantages that are more powerful than existing advantages. no company or industry today is insulated against emerging technological developments. in high-tech industries, identification and evaluation of key technological opportunities and threats can be the most important part of an external strategic management audit. as an example, electronic greeting cards were introduced in 1984 and performed relatively simple feats like beeping jingle bells and humming joy to the world. for christmas 1985, a new generation of cards will play complex melodies, blink lights, and even wish recipients christmas greetings in a real voice. the new technology for these cards is coming from the far east. the big three in this industry, hallmark cards, american greetings, and gibson greeting cards, are making substantial investments in new technologies, including laser printing and holography. hallmark is presently constructing a $20 million dollar technology and innovation center to take advantage of technologicalopportunities. finally, competitive variables are critically important in performing an external audit. they focus on rival firms' strengths, weaknesses, capabilities, opportunities, threats, objectives, goals, and strategies. collecting and evaluating competitive information is essential to performing an external audit effectively. ,the more information and knowledge a firm can obtain 24 about each of its major competitors, the more likely it can formulate and implement effective strategies. major competitors' weaknesses can represent external opportunities; maj9r competitors' strengths could represent key threats. top managers could isolate key variables by conducting a comprehensive study to determine what environmental factors have affected their industry most in the past. this information would provide a basis for isolating key variables to monitor in the future. the number and complexity of key variables to be monitored would depend on a particular firm's industry, size, location, and competitive position. however, a set of five to twenty· environmental variables should be isolated as being most important for monitoring in the future. an effective technique for isolating the most important variables form a list of many factors is nominal grouping. nominal grouping is a process whereby individuals rank order key factors and then collectively decide which variables are most important. isolate key sources of environmental information the second step in performing an external audit is to isolate key sources of environmental information. a wealth of strategic information is available to organizations from both published and nonpublished sources (6, 16). environmental information can be obtained through nonpublished sources such as customer surveys, market research, speeches at professional meetings, conversations with stockholders, interviews, and aerial photographs. published sources of strategic information include periodicals, journals, reports, government documents, abstracts, books, directories, and manuals. to access published sources of information effectively, a number of indexes can be used to locate strategic information by subject, topic, source, author, company, and industry. indexes such as the f&s index, the wall street journal/barrons index, and the business periodicals index can save a considerable amount of time and effort identifying and evaluating environmental opportunities and threats. some important published sources of environmental information are provided in exhibit 2. exhibit 2: sources of environmental information statistical abstract of the u.s. standard and poor's corporation. survey of business fortune business conditions digest dun's business month survey of buying power industry week federal register business week scientific and technical information source barrons u.s. industrial outlook forbes value line ~nvestment survey the wall street journal moody's industrial manual facts on file moody's bank and finance manual the wall street transcript note: this is not an exhaustive list of useful sources. 25 develop appropriate forecasts once key environmental variables have been selected and specific sources of information have been located, the third step in performing an external strategic management audit is to forecast key environmental variables. forecasts are educated assumptions about future trends and events. forecasting is a complex activity due to many interrelated factors such as changes in political situations, technological innovations, changes in cultures, new products, improved services, stronger competitors, shifts in government priorities, changing social values, unstable economic conditions, and unforeseen events. forecasting is so complex that many strategists rely upon published environmental forecasts to effectively identify key environmental opportunities and threats (12). many publications regularly forecast environmental variables, including industry week's trends and forecasts, business week's investment outlook, standard & poor's earnings forecaster, and the u. s. industrial outlook. the reputation and viability of these publications depends to some extent upon accurate forecasts, so published sources of information can offer the best projections available for some variables. when published forecasts of key internal or external variables are not available, organizations must develop their own projections. most organizations forecast their own revenues and profits, and sometimes must generate other forecasts such as market share or customer loyalty information in local areas. forecasting tools can be broadly categorized into two groups: quantitative techniques and qualitative techniques (14). there are three basic types of quantitative forecasting techniques: econometric models, regression, and trend extrapolation. econometric models are based on simultaneous systems of regression equations. with the advent of sophisticated computers, econometric models have become the most widely used approa'h for forecasting economic variables. single and multiple regression is a statistical technique that explains variations in a dependent variable by changes in one or m.ore independent variables. trend extrapolation is simply projecting past trends into the future. it is important to note that all quantitative forecasts, regardless of statistical sophistication and complexity, are based on historical relationships among key variables. linear regression, for example, is based on the assumption that the future will be just like the past which it never is. forecasting tools must be used carefully or the results can be more misleading than helpful. as historical relationships become less stable, quantitative forecasts become less accurate. qualitative forecasts are most appropriate when historical data is not available and when the relationships among key variables are not expected to continue in the future. there are six basic qualitative approaches to forecasting future environmental conditions: (1) salesforce estimate, (2) juries of executive opinion, (3) anticipatory surveys or market research, (4) scenario forecasts, (5) delphi forecasts, and (6) brainstorming. too often in qualitative forecasting, managers are guilty of "predicting" what they would like to occur. no forecast is perfect and some forecasts are even wildly inaccurate. this fact accents the need for strategists to devote sufficient time and effort to study the 26 underlying bases for published forecasts and to develop internal forecasts of their own. key external opportunities and threats can be effectively identified through good forecasts. accurate forecasts can provide major competitive advantages for organizations. forecasts are vital to the strategic management process and to the success of organizations. construct a competitive profile matrix of all the environmental trends and events that can affect a firm's strategic position, competitive forces are often considered to have the greatest impact (17). for this reason, step four in performing an external audit is to construct a competitive profile matrix (4). this analytical tool identifies a firm's major competitors and tells where the rival firms are particularly strong and weak. the procedures required to develop a competitive profile matrix are given below: 1. identify key success factors in the industry. 2. assign a weight to each key success factor to indicate the relative importance of that factor to success in the industry. weights range from 0.0 (not important) to 1.0 (very important). they apply to all competitors and must sum to 1.0. 3. assign a rating to each competitor to indicate that firm's strength or weakness on each key success factor, where 1 = major weakness, 2 = minor weakness, 3 = minor strength, and 4 = major strength. 4. multiply the weight assigned to each key success factor by the corresponding rating for each competitor to determine a weighted score for each firm. the weighted score indicates the relative strength or weakness of each competitor on each key success factor. 5. sum the weighted score column for each competitor. total weighted scores in a competitive profile matrix reveal the relative overall strength of the major competitors in an industry. the highest total weighted score indicates the strongest competitor while the lowest total weighted score corresponds to the weakest firm. the total weighted score could range from 1.0 (lowest) to 4.0 (highest), with 2.5 being the average. an example competitive profile matrix is given in exhibit 3. the example illustrates that customer service, price, product quality, technological superiority, dealer relations, financial strength, and advertising effectiveness are key success factors in the personal computer industry. the rating scores of 4 suggest that company 1 is strongest in customer service, dealer relations, and advertising effectiveness; company 2 is strongest in price competitiveness, and company 3 is strongest in technological superiority and financial strength. company 3 is weak in price competitiveness (rating = 2), while company 2 is weak in two areas, financial strength and advertising effectiveness. based on this example, company 1 is the strongest competitor in 27 the personal computer industry, with a total weighted score of 3.41, followed by company 3 and company 2 with scores of 3.01 and 2.91 respectively. a competitive profile matrix for winnebago industries, inc. is provided in exhibit 4. note that two competing firms, fleetwood and coachman, have surpassed winnebago as leaders in the motor home industry. exhibit 3: a sample competitive profile matrix key success factor company 1 canpany 2 ccrnpany 3 weight bating weighted p..atinq \~eiqhted hating ~':eighted score score score customer service .22 4 .88 3 .66 3 .66 price .20 3 .60 4 .80 2 .40 proouct ouality .18 3 .54 3 .54 3 .54 technological .11 3 .33 3 .33 4 .44 superiority dealer felations .10 4 .40 3 .30 2 .20 f~nancial strength .10 3 .30 2 .20 .40 advertising .09 .36 2 .18 3 .27 effectiveness 1.00 'idtal weigi-ited scores 3.41 3.01 2.91 exhibit 4: a competitive profile matrix for winnebago industries key success factor winr~~~ fleetwood coachman--vjeight rating ~~leighted p..atinq weighted rating v:eiqhted score score score sales vol1..dtle .15 2 .jo 4 .60 .45 ~vel of r&d .14 4 .56 3 .42 .42 expenditures net profit margin .14 4 .56 3 .42 3 .42 prarotion .11 2 .22 4 .44 3 .33 effectiveness p.:arket share .14 3 .42 .56 3 .42 technology .10 4 .40 3 .30 3 .30 advertising .10 2 .20 3 .30 4 .40 i..cx::ation .07 2 .14 3 .21 4 .28 product quality .05 3 .15 4 .20 3 .15 1.00 tctal heightill scores 2.95 3.55 3.07 in developing a competitive profile matrix, strategists should utilize objective information as much as possible in choosing key factors, deciding on appropriate weights, and assigning ratings. however, subjective judgments are always necessary, so this analytical tool should not be used 28 indiscriminately in making decisions. a competitive profile matrix answers the following key questions about a firm: 1. who are our major competitors? 2. what key factors are most important to being successful in the industry? 3. what is the relative importance of each key factor to success in the industry? 4. to what extent is each competitor strong or weak on each key success factor (where 1 = major weakness, 2 = minor weakness, 3 = minor strength, and 4 = major strength)? 5. overall, how strong or weak is each major competitor. construct an external factor evaluation matrix the final step in conducting an external strategic management alldit is to construct an external factor evaluation matrix (4). presented for the first time in this article, this analytical tool is offered as an effective way to summarize and evaluate environmental opportunities and threats. the procedures required to construct an external factor evaluation matrix (efem) are given below: 1. list the firm's key opportunities and threats. 2. assign a weight that ranges from 0.0 (not important) to 1.0 (very important) to each factor. the weight assigned to a given factor indicates the relative importance of that factor to success in a given industry. the summation of all weights assigned to the factors must total 1.0. 3. assign a one to four rating to each factor to indicate whether that variable represents a major threat (rating = 1), a minor threat (rating = 2), a minor opportunity (rating = 3), or a major opportunity (rating = 4) to the organization. 4. multiply each factor's weight by its rating to determine a weighted score for each variable. 5. sum the weighted scores for each variable to determine the total weighted score for an organization. regardless of the number of key opportunities and threats that are included in an efem, the highest possible total weighted score for an organization is 4.0 and the lowest possible total weighted score is 1.0. the average total weighted score is therefore 2.5. a total weighted score of 4.0 would indicate that an organization competes in an attractive industry and has abundant external opportunities, while a total score of 1.0 would characterize an organization that competes in an unattractive industry and faces severe external threats. the recommended number of key opportunities and 29 threats to include in an efem is from five to twenty. an external factor evaluation matrix answers four basic questions: 1. what are the firm's environmental opportunities and threats? 2. what is the relative importance of each key opportunity and threat to success in the industry? 3. does each key factor represent a major threat (rating = 1), a minor threat (rating = 2), a minor opportunity (rating = 3), or a major opportunity (rating = 4). 4. what is the firm's total weighted score resulting from the external factor evaluation? is the score above or below the average of 2.5? an example of efem is provided in exhibit 5. note that government deregulation is the most important environmental factor affecting this industry. the sample firm has two major opportunities, "population shift to the american west" and "computerized information systems". the sample organization has one major threat, "rising interest rates." the total weighted score of 2.7 indicates that the sample firm competes in an industry that is just above average in overall attractiveness. exhibit 5: a sample external factor evaluation matrix weighted key external factor weight rating score rising interest rates .20 1 .20 population shift to the american west .10 4 .40 government deregulation .30 3 .90 a major competitor's expansion strategy .20 2 .40 computerized information system .20 4 .80--total 1.00 2.70 an efem is provided in exhibit 6 for dresser industries. dresser is a three billion dollar energy company with over 40,000 employees. such a large firm obviously faces many external opportunities andthreats, but a finite set (five to twenty) of the most important external factors should be included in the evaluation matrix. note in the dresser example that four key external threats and one key opportunity face the company in early 1984. among the key factors included in the matrix, u.s. trade sanctions are most important to success in the industry, as indicated by a weighting of .35. this factor also represents dresser's major threat as evidenced by a rating of 1. a minor opportunity (rating = 3) that dresser could take advantage of in the future is 30 large u.s. coal reserves. note that dresser's key external factors are (and should be) stated in specific terms. the total weighted score of 1.90 indicates that this company has a weak external strategic position. dresser's weak external position could be a major reason why sales and profits have been declining yearly in the 1980's. exhibit 6: a sample external factor evaluation matrix dresser industries, inc. key external factor 1. u.s. trade sanctions barring dresser fran supplying the soviet union and other foreign countries: 79% of dresser's net profit in 1983 came fram operations in europe. 2 . in the petroleum industry, drilling expenditures declined nearly 50% percent between 1981 and 1983; 45% of dresser's revenues cctn2 fran petroleum operations. 3. oil prices are declining. they fell fran $34 per barrel to $29 per barrel in 1983. 4 • turrroil in the middle-east. iran and iraq are threatening to disrupt oil shiprents fran the persian gulf. 5. the u.s. coal market, which accounted for 50% of dresser's mining sales in 1983, is booming. weighted weighting pating score .35 1 .35 .15 2 .30 .10 2 .20 .25 2 .50 .15 3 .45 'iural weighted score 1.00 1.90 source: based on dresser's 1984 annual report and an article entitled "dresser industries: a leaner idok as it waits out a lingering slump." business week, september 26, 1983, p. 78-79. conclusion due to increasing turbulence in business environments around the world, the external audit has become an explicit and complex part of the strategic management process (8). this article presents a new five-step approach for collecting and evaluating economic, social, political, technological, and competitive information. firms that do not identify, monitor, forecast, and evaluate key environmental variables may fail to anticipate emerging opportunities and threats. this can lead to the pursuit of ineffective strategies. a 31 major responsibility of strategists is to develop an effective external audit system. the external audit approach described in this article can be effectively used by any size or type of organization. matching environmental opportunities and threats with internal strengths and weaknesses provides the basis for successful strategy formulation (3). the competitive profile matrix and external factor evaluation matrix that are presented and exemplified in this article can help top managers identify and evaluate key environmental factors. without the aid of analytical techniques, the external strategic management audit often becomes too subjective and general .. however, the competitive profile matrix and external factor evaluation matrix should never be used indiscriminately, because intuitive judgments are always required in assigning weights and ratings. good judgment and common sense is essential throughout the process of conducting an external strategic management audit. references 1. aaker, d.a. "organizing a strategic information scanning system." california management review, vol. xxv, no.2, january 1983, p. 76-83. 2. brown, g.h. "the impact of demographic and societal changes on u.s. business." planning revievj. vol. ii, no.3, may 1983, p. 32-39. 3. david f.r. fundamentals of strategic management: concepts and cases. columbus, ohio: charles e. merrill publishing company, 1986, (in press). 4. david, f.r. formulating strategies objectively: an analytical approach. handbook of business strategy -1985-1986 yearbook. new york, n.y.: warren, gorham, & lamont, november, 1985, (in press). 5. diffenbach, j. "corporate environmental analysis in large u. s. corporations." long range planning. vol. 16, no.3, june 1983, p. 107-116. 6. fella, j.w. "capitalizing on information in the public domain." planning review. march 1984, p. 34-38 & 42. 7. filho, p.v. "environmental analysis for strategic planning." managerial planning. january/february, 1985, p. 23-30. 8. gluck, f. "global competition in the 1980's." journal of business strategy. spring 1983, p. 22-27. 9. kresch, s.d. "the impact of consumer trends on corporate strategy." journal of business strategy. winter 1983, p. 58-63. 10. mcfarlan, f.w. "information technology changes the way you compete." harvard business review. may-june, 1984, p. 98-103. 11. mesch, a.h. "developing an effective environmental assessment function." managerial planning. vol. 32, no.5, march/april 1984, p. 17-22. 32 12. moyer, r. "the futility of forecasting." long range planning. vol. 17, no. i, february 1984, p. 65-72. 13. parsons, g.l. "information technology: a new competitive weapon." sloan management revietv. fall, 1983, p. 3-14. 14. pearce, i.a. ii and robinson, r.b. jr. "environmental forecasting: key to strategic management." business. july-september 1983, p. 3-12. 15. porter, m. "technology and competitive advantage." journal of business strategy. winter, 1985, p. 60-79. 16. rhyne, l.c. "strategic information: the key to effective planning." managerial planning. vol. 32, no.4, januarylfebruary 1984, p. 4-10. 17. wiseman, c. and macmillan, i.c. '/creating competitive weapons from in.formation systems." journal of business strategy. fall, ls'84, p. 42-50. 33 a framework for conducting an external strategic management audit volume 32, number 2 51 entrepreneurial strategies for emerging markets jamie d. collins sam houston state university • huntsville, tx christopher r. reutzel sam houston state university • huntsville, tx abstract this study involves an investigation into the strategies utilized by entrepreneurial firms in india. given the number of people living in emerging markets (e.g., china, india, others), understanding which conditions are related to the opportunity-seeking behavior of productive entrepreneurship is an important first step in deriving better policies aimed at improving living standards in countries that have been historically plagued by extreme poverty. equipped with insights regarding factors that increase opportunity-seeking behavior, scholars, regulators, and practitioners alike can be better positioned to positively shape competitive environments in emerging markets. introduction this study involves an investigation into the strategies utilized by entrepreneurial firms in india. given the number of people living in emerging markets (e.g., china, india, others), understanding which conditions are related to the opportunity-seeking behavior of productive entrepreneurship is an important first step in deriving better policies aimed at improving living standards in countries that have been historically plagued by extreme poverty. equipped with insights regarding factors that increase opportunity-seeking behavior, scholars, regulators, and practitioners alike can be better positioned to positively shape competitive environments in emerging markets. emerging markets represent a unique and complex context in which to examine entrepreneurial activity (bruton, ahlstrom & obloj, 2008). from a theoretical perspective this is due to the fact that emerging markets are characterized by relatively weak economic institutions (ahlstrom & bruton, 2002). such ‘institutional voids’ represent potential barriers to the success of entrepreneurial firms in emerging markets. entrepreneurial firms competing in emerging markets must pursue strategies that allow them to overcome these challenges. as a result, gaining access to critical and often limited resources represents a fundamental challenge of 52 journal of business strategies implementing such strategies. from a practical perspective emerging economies are experiencing rapid growth (hoskisson, eden, lau & wright, 2000) and increased integration with developed financial markets (bell, moore, & al-shammari, 2008), thus also providing significant entrepreneurial opportunities. with their rapid growth and increasing integration with developed financial markets (bell, moore, & al-shammari, 2008), developing economies provide significant entrepreneurial opportunities (north, 2005). exploitation of these opportunities, however, requires entrepreneurs within these countries to confront institutional challenges frequently not faced by their western counterparts (ahlstrom & bruton, 2002). for example, the failure to create and protect property rights in developing countries often frustrates entrepreneurs’ attempts to appropriate the value they have created, strongly discouraging investment in innovation (baumol, 2002; khanna & rivken, 2006). similarly, high transaction costs can delay the introduction and diffusion of innovations by preventing the internalization of technological externalities (rodrik, 2007) or the incorporation of feedback from the price system (hayek, 2002; mcmullen, bagby, & palich, 2008). thus, entrepreneurial firms competing in emerging markets must pursue strategies that allow them to overcome these institutional obstacles while simultaneously striving to allocate critical and limited resources as effectively and efficiently as possible. firms must respond to idiosyncratic institutional environments to succeed in international markets and develop a competitive advantage. these idiosyncratic constraints directly influence how effectively entrepreneurs choose strategic alternatives and manage key resources under conflicting demands from multiple stakeholders (delios & beamish, 2001; hitt & collins, 2007; kostova & zaheer, 1999). understanding variation in firms’ strategic choices is a key component of the growing literature that speaks to the effects of managerial decisions on the process of entrepreneurial success. baumol (1993; 1996) argues that entrepreneurs seek profit, not necessarily value-maximizing (from a societal perspective) innovation. as a primarily profit-seeking undertaking, entrepreneurship becomes an activity that can manifest in productive, unproductive, or destructive forms. productive entrepreneurship “…refers, simply, to any activity that contributes directly or indirectly to net output of the economy or to the capacity to produce additional output” (baumol, 1993:30). such opportunity-seeking behavior can be seen in firm actions, such as entering new geographic markets, offering new products or services, re-designing internal processes and/or adopting leading edge technologies. investing in research and development, market research, or the development of new volume 32, number 2 53 internal capabilities are also activities that indicate that the firm is actively pursuing opportunities for growth and profitability (baumol, 2002). unproductive entrepreneurship consists of rent seeking behaviors (baumol, 1993, 1996; dallago, 2000). rent seeking refers to “any activity whose objective is the acquisition of some of the monopoly profit or the other economic rents currently generated or potentially available in the economy” (baumol, 2002:61). as such, it represents the “expenditure of resources in (deliberate) pursuit of economic rents by means that do not (automatically) contravene the accepted rules of society” (baumol, 1993:51). examples include lobbying, litigation, and takeovers. thus, attempts to manage relationships with politicians, civil servants, and political consultants, in the effort to change the rules of competition versus comply with the existing rules within one’s industry are indicative of rent-seeking (baumol, 2002). in spite of the practical and theoretical importance of examining entrepreneurship in emerging markets, few studies have done so. in a recent review of research on entrepreneurship in emerging markets, bruton and colleagues (2008) found that less than one half of one percent of entrepreneurship articles focused on emerging markets. while a recent special issue in entrepreneurship theory and practice has focused on entrepreneurship in emerging markets there exists a need for much further research in this area. for example, bruton and colleagues (2008:8) note that the paucity of studies that have examined entrepreneurial activity in india “is not justifiable”. in order to address this gap in extant research we draw upon resource-based logic to argue that the most successful entrepreneurial ventures in india will tend to be those who have an ability to effectively acquire and leverage resources despite the challenges presented by the institutional voids characteristic of the indian markets. specifically, we argue that indian entrepreneurial firms will pursue various options for acquiring resources that can contribute to their performance. these include, but are not limited to, accessing the knowledge and expertise of foreign investors or parent firms as well as leveraging social capital in its various forms. developing a resource portfolio opens up new strategic options, although the efficient use of resources remains a critical concern to entrepreneurs. 54 journal of business strategies theory development institutional voids prior research has established the fact that the institutional environments differ significantly across countries (kostova & zaheer, 1999, xu & shenkar, 2002). research also indicates that such differences between countries affect firm-level outcomes, such as the survival of new international subsidiaries (barkema, bell & pennings, 1996), the inter-unit transfer of processes (kostova & roth, 2002), firms’ ability to establish legitimacy in a particular country (delios & beamish, 2001; kostova & zaheer; 1999), and ownership structures in foreign markets. as a result, a firm’s performance is shaped by its ability to manage the institutional context of its operations (hitt et al., 2000, 2004). institutional theory suggests that the institutional context is a source of complex sets of information and knowledge with which firms must deal and from which they must learn. organizations must absorb and utilize the knowledge associated with the multiple institutional constituents (e.g., consumers, regulatory agencies, employees, capital providers, etc.) (dimaggio & powell, 1983; meyer & rowan, 1977). the extent to which firms comprehend the nuances of a particular institutional environment affects their ability to comply with institutional pressures, access resources in the environment and operate successfully in the environment. each country has its own unique set of institutions (kostova, 1999; kostova & zaheer, 1999) that exhibit differing levels of development. the level of institutional development affects the complexity of the knowledge required to operate effectively in a given country and also affects the amount of uncertainty faced by firms competing in these markets (delios & henisz, 2003; hitt et al., 2004, 2000). for example, greater uncertainty reduces a firm’s ability to extract and absorb knowledge from an environment (cohen & levinthal, 1990). thus, uncertainty reduces the volume of information firms are likely to acquire from any particular market (podolny, 1994; tsai, 2001, 2000). the extent to which firms understand a country’s institutional environment and develop the necessary resources directly influences the potential for firms to choose effective strategies for operating successfully in that country. frequently, emerging markets are economically under-developed due in large part to relatively weak economic institutions (harriss et al. 1995; khanna & palepu 2000). an important complicating condition facing firms in emerging markets is the existence of “institutional voids” (khanna & palepu 2006, 1997). such “institutional voids” are barriers to conducting business successfully. accordingly, companies in volume 32, number 2 55 emerging markets need to utilize their resources to effectively work around existing institutional voids (khanna et al. 2005; khanna & rivken 2006). entrepreneurial firms’ strategic responses one important factor that may be valuable in overcoming the challenges presented by the institutional voids typical of emerging markets is the presence or absence of a foreign parent to entrepreneurial ventures in emerging markets. entrepreneurial firms can find themselves at a competitive disadvantage to foreign competitors. this liability of localness (perez-batres, 2012; perez-batres & eden, 2008) is expected to be particularly profound for entrepreneurial firms. foreign investors in emerging market entrepreneurial firms typically come from home countries with stronger economic institutions. the experience and knowledge of doing business in a more stable institutional environment may provide them with advanced expertise in legal agreements and deal structuring to protect their property rights within investment deals in emerging markets. it also suggests that they may possess skills in identifying attractive economic opportunities in emerging markets. as a result, it is reasonable to expect to find a positive relationship between foreign ownership and the performance of entrepreneurial firms in emerging markets. hypothesis 1: entrepreneurial firms perform better in emerging markets if the firm has a foreign parent. the upper echelons literature emphasizes the importance of key leaders and their social capital to the performance of their respective firms. social capital facilitates access to a range of resources and knowledge needed in order to thrive in competitive markets (kostova & roth, 2002). yet, while the nature of social capital ties is that they facilitate exchange and discourage opportunism among partners, developing and maintaining social ties can also be quite costly. entrepreneurs maintaining numerous social ties are likely constrained in executing their responsibilities to their firms because these ties require ongoing resources and attention to maintain. additionally, the more ties an entrepreneur maintains, the less time, energy and attention can be devoted to innovation and creativity within her/ his firm. thus, entrepreneurs holding multiple external ties may be less effective in making resource-allocation decisions than entrepreneurs with a limited number of ties. this suggests that the added value of additional social capital decreases while the costs to develop this capital remains high thus, we expect to find a curvilinear 56 journal of business strategies relationship between the number of social capital ties held by entrepreneurial firms’ key executives and the performance of their firms. hypothesis 2: the performance of entrepreneurial firms in emerging markets is curvilinearly related (inverted u-shape) to the number of social capital ties held by the firm’s leaders. according to baumol, entrepreneurs will pursue whichever form of behavior promises the most expected payout (baumol, 1993, 1996). which form of entrepreneurial behavior manifests within a nation’s economy (and to what extent) is then explained in terms of the politico-economic institutional conditions in which this behavior occurs (baumol, 2002; north, 1990). the existence of productive entrepreneurship depends on the incentives provided by institutions (baumol, 2002). north (2005:2) suggests that people construct elaborate beliefs about the reality of the politico-economic system which serve as “both a positive model of the way the system works and a normative model of how it should work” and adds that, over time, these beliefs result in “the accretion of an elaborate structure of institutions that determine economic and political performance.” firms have a range of competitive options available to them including the adoption of an entrepreneurial posture (kuratko, hornsby, & goldsby, 2007). managers are constantly seeking new ways of improving their capabilities, processes, and product offerings to enrich the value proposition offered to customers (kuratko, ireland, covin, & hornsby, 2005). entrepreneurship involves innovations that are expected to develop to be consequential innovations that and adopted in support of/aid in the firm’s pursuit for competitive advantage (morris, kuratko, & covin, 2008). these innovations can focus on the firm’s strategy, product offerings, internal organization, market focus, or business model (ireland & webb, 2007). furthermore, having this type of intentional reliance on entrepreneurial behavior can rejuvenate the organization through recognition and exploitation of entrepreneurial opportunities (ireland et al., 2009). thus, innovation is an essential component of successful corporate entrepreneurship (ireland, kuratko, & morris, 2006a, b). commonly, innovation is considered to be product or process improvements that result in increased value for the firm’s customers thereby helping the firm to achieve or maintain a competitive advantage (kuratko et al., 2005). however, firms can innovate in a variety of ways ranging from relatively minor (yet valuable to the customer) changes to existing products, processes, or services to radically new products, services or processes. volume 32, number 2 57 minor changes can include improvements in: reliability, size, performance or specific product features. radical breakthroughs in products, processes or services can introduce unique and attractive features, substantial cost improvements and/or exceptional performance. thus, innovation can involve a relatively small number of discrete changes as well as numerous continuous improvements by the firm. regardless of the frequency and size of innovative actions, corporations can benefit from having their internal processes organized to support incremental adaptation and major changes (kuratko, hornsby, & corso, 1996). to enact innovation requires firms to develop and use new ideas in ways that create value (linder, jarenpaa, & davenport, 2003). innovation can become a primary vehicle to improved productivity and greater profitability in highly dynamic environments. by having an intentional focus on how to best deliver value to consumers, firms that embrace innovation can often create sustainable growth (mcevily, eisenhardt, & prescott, 2004). firms can foster innovation by promoting the development and adoption of new products, services or processes that increase profitability and overall competitiveness (zahra, nielsen, & bogner, 1999). companies can leverage their innovative capabilities by engaging in strategic entrepreneurship, which involves simultaneous opportunity-seeking and advantage-seeking behaviors and may result in superior performance (ireland, hitt, & sirmon, 2003). firms rely on well-developed internal capabilities and knowledge in order to achieve desired levels of performance. acquisitions are expected to be associated with better performance because, a) they provide access to resources that are particularly hard to find in factor markets, and b) only firms that have well-developed internal capabilities are likely to be able to execute acquisitions in emerging economies. the expertise required to complete acquisitions is also expected to be beneficial in terms of making decisions regarding offering new products or services, entering new geographic markets, and improving processes or technologies. entrepreneurial firms’ performance in emerging markets should therefore be positively associated with recent acquisition activity. hypothesis 3: the performance of entrepreneurial firms in emerging markets is positively related to the number of recent acquisitions that firm has completed. the scope of products/services offered represents an additional aspect of firm strategy that may influence the performance of entrepreneurial firms in emerging 58 journal of business strategies markets. others have argued that institutional voids in emerging markets often make a highly diversified competitive position desirable for achieving greater firm performance (khanna & palepu, 1997, 2006; khanna et al., 2005). given the resource constraints typical of entrepreneurial ventures, combined with the necessary allocation of resources required to cope with the institutional voids in emerging markets, an alternative perspective is that entrepreneurial firms will lack sufficient resources to successfully manage a broad product/service lines. conversely, entrepreneurial firms in emerging markets that pursue a more focused approach will more likely possess sufficient resources to implement effective strategies to market their product/service lines. formally stated, we hypothesize the following: hypothesis 4: entrepreneurial firms’ performance in emerging markets is negatively related to the number of products/services offered. methods this study involves survey responses from 170 founders and senior executives of entrepreneurial firms in india. due to the importance placed on inter-personal relationships for entrepreneurs and in emerging markets, we used in-person, semistructured interviews in this study. this approach helped improve response rates and data quality. the survey instrument was written in english and was pre-tested in india and the u.s. english is one of the official languages of india, is typically the language of choice for business and is also the language in which almost all business contracts are written. the pretests involved a total of 12 senior executives from indian firms. face validity and content validity of the instrument and its items were assessed by multiple researchers with experience in conducting survey research via the pretests of the survey. input regarding the instrument was also solicited from 3 business professors and 4 graduate students in india. in the u.s., feedback was gathered from a total of 5 business professors (including 2 from india), 2 indian doctoral students in business and 2 business people of indian heritage. we measured firm performance by using a multi-item perceptual measure appropriate to assess firm performance in an emerging economy (tan & litschert, 1994). see table 4 for a listing of individual items and their factor loadings. the ‘performance’ measure assesses the firm’s relative position vis-à-vis its competitors in the areas of: assets, return on sales, sales growth, profitability and overall competitive position. the reliability of this measure was α = .944. volume 32, number 2 59 control variables several variables were controlled for to eliminate alternative explanations to the hypotheses. these include: industry, firm age (in years since founding), and size (represented by the natural log of the number of the firm’s full-time employees) (collins et al., 2009; uhlenbruck et al., 2006). older and/or larger firms might have greater access to economic or political opportunities and less motivation to engage in innovative behavior as a result of having acquired many of the resources needed to be competitive or having established influential relationships with relevant constituents in the past. in addition, older firms are thought to have less concern for survivability than younger firms (stinchcombe, 1965). firm age (in years since founding) and size (represented by the logarithm of the number of the firm’s fulltime employees), diversification, primary industry membership, industry structure, and market volatility were included as control variables. we also controlled for the percentage of each firm’s revenues attributable to the government as customer. further, a measure was included in the survey specifically to measure whether interviewees were likely providing socially-desirable responses. this approach is consistent with prior research (collins, et al., 2009). the items were obtained from the balanced inventory of desirable responding (paulhus, 1991). given that pressures to adapt the environmental constraints vary by industry, we controlled for industry differences (e.g., brown, davidsson & wiklund, 2001; collins et al., 2009) by categorizing all industries represented in the survey as either: basic sector, manufacturing, wholesale and retail, professional industries, or other. the ‘professional industries’ category is comprised of firms engaged in financial, legal, business consulting, accounting, and health services. firms providing these services rely on highly trained employees and top managers who demonstrate very strong loyalty to their profession (løwendahl, 2000). the ‘basic sector’ category consists of firms whose primary business activities are related to agriculture (livestock production, fishing, and forestry), construction, mining, and quarrying. the ‘manufacturing’ category represents all firms engaged in production of consumer and/or industrial products. the ‘wholesale and retail’ category encompasses such activities as retail shops and stores, tourism, hotels, restaurants, storage, transportation, and all non-professional service activities. all firms which fell outside of these four categories are grouped into ‘other’. foreign ownership is a dichotomous variable indicating whether or not the firm has at least one foreign parent. entrepreneur’s social capital is a multi-item measure which assesses the number of connections the participating executives 60 journal of business strategies have to various other family businesses, bank ownership interests, and connections to civil servants and politicians. the recent acquisitions variable is a count of the number of acquisitions the firm has completed within the past three years. finally, we also included a count measure related to the number of products or services currently being produced by the firm. due to the importance placed on inter-personal relationships for entrepreneurs (coviello & jones, 2004) in emerging markets (hitt, et al., 2002), we used in-person, structured interviews conducted by interviewers who each have some social or business network connection with the respondents. this approach helps improve response rates and data quality, as well as mitigate the risk of socially-desirable responses (kirkman & law, 2005). study respondents were specifically assured that all responses would be kept confidential. responses to sensitive questions were worded such that they did not implicate the respondent of potentially embarrassing behavior. sensitive questions were asked toward the end of the interview, after the interviewer had time to establish credibility and trust; these questions were asked in different sections of the instrument. results table 1 presents the results of our statistical analyses. table 2 summaries these results. each of our four hypotheses received support in our analytical models. hypothesis 1 was supported at the .05 level of significance. entrepreneurial firms in india saw performance benefits from having at least one parent being a foreign firm. hypothesis 2 was supported at the .01 level; i.e., a curvilinear relationship was found between entrepreneurial firms’ use of key executives’ social capital and their firms’ performance. hypothesis 3was supported at the .05 level of significance. thus, a positive relationship was found between the number of recent acquisitions made by entrepreneurial firms and their performance. conversely, a negative relationship was found for the level of diversification (number of products / services) and entrepreneurial firms’ performance in india. this provided support for hypothesis 4, at the .05 level of significance. the adjusted r2 and f values in table 1 also demonstrate support for each of our models. the adjusted r2 value increases from .125 in model 1 to .261 in model 2. moreover, model 1 is statistically significant at the .01 level, whereas model 2 is significant at the .001 level. these results collectively demonstrate that the inclusion of each set of independent variables in model 2 contributes significant additional explanatory power to the model. volume 32, number 2 61 these models therefore provide evidence that the performance of entrepreneurial firms in india is influenced by the strategic choices made by those firms. significance of study findings provide empirical support for baumol’s (2002) contention that entrepreneurs will respond predictably to the incentives provided by such institutions and that these institutions are largely responsible for channeling entrepreneurial talent towards or away from productive entrepreneurship (baumol, litan, and schramm, 2007a, 2007b). we chose to sample from indian entrepreneurs because india offered a political economy whose institutions possessed the rules-based institutions of capitalism, such as rule of law, property rights, and markets (zacharakis et al., 2007). but it also possessed many of the marks of a relationship-based economy, which are often susceptible to corruption when transitioning from personal exchange to arm’s length market transactions (zacharakis et al., 2007). such institutional conditions help to ensure that all three forms of entrepreneurial behavior are plausible options for even the most legitimate of entrepreneurial ventures. however, developing economies often tend to have a large informal economy as well, which we did not study. thus, the unique configuration of rules-based and relationship-based institutional characteristics combined with our sample of legally registered ventures suggests that our findings may be specific to entrepreneurs operating in the formal sector of emerging economies. with india boasting over one-fifth of the world’s population and one of the planet’s largest and fastest growing economies, however, such generalizability concerns are greatly assuaged. this study examines performance of entrepreneurial ventures in a unique context, the emerging market of india. in doing so, this study contributes to a growing body of research on entrepreneurship in international settings. additionally, this study provides insight into the role of resource management in entrepreneurial firms in overcoming institutional voids. in particular this study finds support for the idea that entrepreneurs use a variety of methods for maximizing their profit potential. although institutional voids in emerging markets pose challenges for innovation, entrepreneurial firms with a foreign parent rely on resource access provided by such a parent to overcome resource challenges. they also rely on social capital connections to enable them to capture entrepreneurial opportunities. results also show that entrepreneurial firms in india utilize acquisitions as a profitable 62 journal of business strategies avenue for firm growth. however entrepreneurial firms in india relied on product/ service diversification for firm growth, evidence suggests the performance of these firms suffer. references alstrom, d. and bruton, g. d, (2002), “an institutional perspective on the role of culture in shaping strategic actions by technology focused entrepreneurial firms in china”, entrepreneurship theory and practice, 26(4), 53-70. baumol, w.j. (1993), entrepreneurship, management, and the structure of payoffs. cambridge, ma: the mit press. baumol, w.j. (1996), “entrepreneurship: productive, unproductive, and destructive”, journal of business venturing, 11(1), 3-22. baumol, w.j. (2002), the free-market innovation machine: analyzing the growth miracle of capitalism. princeton, nj: princeton university press. baumol, w.j., litan, r.e., & schramm, c.j. (2007a), good capitalism, bad capitalism, and the economics of growth and prosperity. new haven, ct: yale university press. baumol, w.j., litan, r.e., & schramm, c.j. (2007b), sustaining entrepreneurial capitalism. capitalism and society, 2(2), 1-36. bell, r. g., moore, c. b. & al-shammari, h. a. (2008), “country of origin and foreign ipo legitimacy: understanding the role of geographic scope and insider ownership”, entrepreneurship theory and practice. 32(1), 185-202. brown, t.e., davidsson, p. & wiklund, j. (2001), “an operationalization of stevenson’s conceptualization of entrepreneurship as opportunity-based firm behavior”, strategic management journal, 22(10), 953-968. bruton, g. d., ahlstrom, d., and obloj, k. (2008), “entrepreneurship in emerging economies: where are we today and where should the research go in the future”, entrepreneurship theory and practice. 32(1), 1-14 cohen, w. m. and levinthal, d. a. (1990), “absorptive capacity: a new perspective on learning and innovation”, administrative science quarterly, 35, 128-52. collins, j. d., uhlenbruck, k. & rodriguez, p. (2009), “why firms engage in corruption: a top management perspective”, journal of business ethics, 87(1), 89-108. coviello, n. e. & jones, m. v. (2004), “methodological issues in international entrepreneurship research”, journal of business venturing, 19(4), 485-508. volume 32, number 2 63 dallago, b. (2000), “the organizational and productive impact on the economic system: the case of smes”, small business economics, 15,303-319. delios, a. & beamish, p. (2001), “survival and profitability: the roles of experience and intangible assets in foreign subsidiary performance”, academy of management journal, 44, 1028-1038. delios, a. and henisz, w. j. (2003), “political hazards, experience and sequential entry strategies: the international expansion of japanese firms, 1980-1998”, strategic management journal, 24, 1153-1164. dimaggio, p.j. and powell, w.w. (1983), “the iron cage revisited: institutional isomorphism and collective rationality in organizational fields”, american sociological review, 48, 147-160. harriss, j., hunter, j., & lewis, c. j. (1995), the new institutional economics and third world development, routledge, london, uk. hayek, f.a. (2002), “competition as a discovery procedure”, quarterly journal of austrian economics, 5(3), 9-23. hitt, m.a., & collins, j.d. (2007), “business ethics, strategic decision making and firm performance”, business horizons, 50(5), 353-357. hitt, m. a., dacin, m. t., levitas, e., arregle, j.-l. and borza, a. (2000), “partner selection in emerging and developed market contexts: resource-based and organizational learning perspectives”, academy of management journal, 43, 449-467. hitt, m.a., ahlstrom, d., dacin, m.t., levitas, e. and svobodina, l. (2004), “the institutional effects on strategic alliance partner selection in transition economies: china versus russia”, organization science, 15, 173-185. hoskisson, r. e., eden, l., lau, c. m., and wright, m. (2000), “strategy in emerging economies”, academy of management journal, 43, 249-267. ireland, r. d., covin, j. g., & kuratko, d. f. (2009), “conceptualizing corporate entrepreneurship strategy”, entrepreneurship theory and practice, 33(1), 1946. ireland, r. d., hitt, m. a., & sirmon, d. g. (2003), “a model of strategic entrepreneurship: the construct and its dimensions”, journal of management, 29(6), 963-989. ireland, r. d., kuratko, d. f., & morris, m. h. (2006a), “a health audit for corporate entrepreneurship: innovation at all levels: part i”, the journal of business strategy, 27(1), 10. 64 journal of business strategies ireland, r. d., kuratko, d. f., & morris, m. h. (2006b), “a health audit for corporate entrepreneurship: innovation at all levels: part ii”, the journal of business strategy, 27(2), 21. ireland, r. d., & webb, j. w. (2007), “a cross-disciplinary exploration of entrepreneurship research”, journal of management, 33(6), 891-927. khanna, t., & palepu, k. (1997), “why focused strategies may be wrong for emerging markets:, harvard business review, 75(4), 41-51. khanna, t. & palepu, k. (2000), “is group affiliation profitable in emerging markets? an analysis of diversified indian business groups”, journal of finance, 55(2), 867-891. khanna, t. & palepu, k. (2006), “emerging giants”. harvard business review, 84(10), 60-69. khanna, t. & rivkin, j.w. (2006), “interorganizational ties and business group boundaries: evidence from an emerging economy”, organization science, 17(3), 333-352. khanna, t., palepu, k., & sinha, j. (2005), “strategies that fit emerging markets”, harvard business review, 83(60), 63-76. kirkman, b. & law, k. (2005), “international management research in amj: our past, present, and future”, academy of management journal, 48(3), 377-386. kostova, t. (1999), “transnational transfer of strategic organizational practices: a contextual perspective, academy of management review, 24, 308-324. kostova, t. & roth, k. (2002), “adoption of an organizational practice by subsidiaries of multinational corporations: institutional and relational effects”, academy of management journal, 45, 215-233. kostova, t. & zaheer, s. (1999), “organizational legitimacy under conditions of complexity: the case of the multi-national enterprise”, academy of management review, 24, 64-81. kuratko, d. f., hornsby, j. s., & goldsby, m. g. (2007), “the relationship of stakeholder salience, organizational posture, and entrepreneurial intensity to corporate entrepreneurship”, journal of leadership & organizational studies, 13(4), 56. kuratko, d. f., ireland, r. d., covin, j. g., & hornsby, j. s. (2005), “a model of middle-level managers’ entrepreneurial behavior”, entrepreneurship theory and practice, 29(6), 699. løwendahl, b. (2000), strategic management of professional service firms (2nd ed.), copenhagen, denmark: copenhagen business school press. volume 32, number 2 65 mcmullen, j.s., bagby, r., & palich, l. (2008), “economic freedom and the motivation to engage in entrepreneurial action”, entrepreneurship: theory & practice, 32(5), 875-895. meyer, j. & rowan, b. (1977), “institutionalized organizations: formal structure as myth and ceremony”, american journal of sociology, 83, 340-363. north, d. (2005), understanding the process of economic change. princeton: princeton university press. paulhus, d. l. (1991), measurement and control of response bias. in j. robinson, p. shaver & l. wrightsman (eds.), measures of personality and social psychological attitudes. san diego, ca: academic press. perez-batres, l. a. (2012), “efficient labor reallocation and the liability of localness: unintended consequences of nafta and other commercial agreements”, american journal of business. 27(1), 79-90. perez-batres, l. a. & eden, l. (2008), “is there a liability of localness? how emerging market firms respond to regulatory punctuations”, journal of international management. 14(3), 232-251. podolny, j. m. (1994), “market uncertainty and the social character of economic exchange”, administrative science quarterly, 39, 458-483. rodrik, d. (2007), one economics many recipes: globalization, institutions, and economic growth. princeton, nj: princeton university press. stinchcombe, a. (1965), “social structures and organizations”, in j.g. march (ed.), handbook of organizations: 153-193. chicago: rand mcnally. tan, j.j. & litschert, r.j. (1994), “environment-strategy relationship and its performance implications: an empirical analysis of the chinese electronics industry”, strategic management journal, 15(1), 1-20. tsai, w. (2000), “social capital, strategic relatedness and the formation of intraorganizational linkages”, strategic management journal, 21, 925-939. tsai, w. (2001), “knowledge transfer in intraorganizational networks: effects of network position and absorptive capacity on business unit innovation and performance”, academy of management journal, 44, 996-1004. uhlenbruck, k., rodriguez, p., doh, j., & eden, l. (2006), “the impact of corruption on entry strategy: evidence from telecommunication projects in emerging economies”, organization science, 17, 402-414. zacharakis, a.l., mcmullen, j.s., & shepherd, d.a. (2007), “venture capitalists’ decision policies across three countries: an institutional theory perspective”, journal of international business studies, 38, 691-708. 66 journal of business strategies biographical sketch of authors jamie d. collins received his ph.d. from texas a&m university, specializing in strategic management and entrepreneurship; he is currently an associate professor at sam houston state university. he teaches courses in strategic management, entrepreneurship / family business and corporate social responsibility. he has previously served as a founding member of a private equity group, where he led investment screening and due diligence for the firm. other prior industry experience includes: aerospace/defense, energy, financial services, software, real estate, and agri-business. christopher r. reutzel, phd is an assistant professor at sam houston state university. he has a doctorate in strategic management from texas a&m university. his research interests include strategic leadership, entrepreneurship, and emerging markets. volume 32, number 2 67 table 1 regression models dependent variable = firm performance model 1 model 2 control variables firm age 0.004 -0.001 firm size 1.223** 1.236** diversification -0.136 -0.066 socially desirable response index 0.036 0.071 † basic sector industry -0.074 0.082 wholesale & retail industry 0.087 0.071 professional services industry 0.490 † 0.333 other industries 0.200 0.259 sales % to govt. 0.004 0.001 industry structure 0.115* 0.087 † market volatility 0.019 0.024 independent variables foreign parent 1.018* entrepreneur’s social capital -0.294** entrepreneur’s social capital 2 0.015** number of recent acquisitions 0.204* number of products/services -0.001 adjusted r2 .125 .261 f value 2.629** 3.758*** notes: n=170; † p< .10; * p< .05; ** p< .01; *** p< .001 68 journal of business strategies table 2 summary of results hypothesis 1: positive relationship between firm performance and having a foreign parent • supported (.05) hypothesis 2: curvilinear relationship between executive social capital and firm performance • supported (.01) hypothesis 3: positive relationship between firm performance and number of recent acquisitions • supported (.05) hypothesis 4: negative relationship between firm performance and number of products/ services offered • supported (.05) volume 32, number 2 69 ta bl e 3 c or re la ti on t ab le m ea n 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 1. p er fo rm an ce 2. 96 6 1. 00 0 2. f ir m a ge 18 .3 70 0. 09 5 1. 00 0 3. % o f e m pl oy ee s 1. 62 0 0. 17 7 0. 07 0 1. 00 0 4. s d r in de x 9. 95 1 0. 11 3 0. 12 3 0. 12 9 1. 00 0 5. b as ic s ec to r 0. 04 7 -0 .0 09 0. 05 0 -0 .0 29 0. 07 8 1. 00 0 6. w ho le sa le & r et ai l 0. 23 5 0. 08 2 -0 .0 54 0. 05 7 0. 08 4 -0 .1 23 1. 00 0 7. p ro fe ss io na l s er vi ce s 0. 15 9 0. 16 0 0. 29 8 -0 .0 01 0. 06 7 -0 .0 97 -0 .2 41 1. 00 0 8. o th er in du st ri es 0. 35 9 -0 .1 90 -0 .1 15 -0 .0 13 -0 .1 14 -0 .1 66 -0 .4 15 -0 .3 25 1. 00 0 9. # o f p ro du ct s 31 .8 34 -0 .0 95 -0 .0 21 0. 18 8 0. 03 6 -0 .0 25 0. 14 2 -0 .0 35 -0 .0 39 1. 00 0 10 . f or ei gn p ar en t 0. 04 7 0. 30 2 0. 14 2 0. 09 8 -0 .0 59 -0 .0 49 -0 .0 58 0. 13 1 -0 .0 50 -0 .0 07 1. 00 0 11 . s al es % to g ov t 11 .6 47 0. 07 5 -0 .0 58 0. 09 4 -0 .0 38 0. 25 9 -0 .1 56 -0 .0 15 0. 13 6 -0 .0 22 0. 05 0 1. 00 0 12 . i nd us tr y s tr uc tu re 3. 93 6 0. 29 9 -0 .0 01 0. 18 0 0. 09 9 -0 .0 75 0. 05 1 0. 12 3 -0 .0 63 0. 10 6 0. 15 4 0. 00 6 1. 00 0 13 . m ar ke t v ol at ili ty 5. 25 4 0. 10 3 0. 03 3 -0 .0 61 0. 16 5 0. 01 9 0. 04 3 0. 08 3 -0 .0 17 0. 06 1 0. 10 4 -0 .0 18 0. 06 4 10 .0 0 14 . s oc ia l c ap ita l 0. 74 7 0. 00 1 -0 .0 13 0. 06 1 -0 .1 25 0. 01 4 -0 .0 54 -0 .1 12 0. 13 2 -0 .0 37 -0 .0 41 0. 14 8 0. 11 3 0. 06 9 1. 00 0 15 . d iv er si fic at io n 2. 58 5 -0 .1 21 -0 .1 40 -0 .0 53 -0 .0 64 -0 .0 03 0. 02 8 -0 .2 03 0. 07 0 -0 .1 27 -0 .0 07 -0 .0 11 -0 .1 39 -0 .1 62 -0 .0 99 1. 00 0 16 . # o f a cq ui si tio ns 0. 42 4 0. 25 5 0. 06 1 0. 13 6 -0 .1 44 0. 00 1 0. 06 3 0. 13 0 -0 .0 43 -0 .0 45 0. 00 1 0. 22 9 0. 16 5 0. 01 5 0. 14 1 -0 .2 13 1. 00 0 70 journal of business strategies table 4 performance factor loadings 1. size of total asset base as compared to your competitors 0.826 2. after-tax return on total sales as compared to your competitors 0.821 3. firm total sales growth compared to your competitors 0.839 4. overall firm performance and success compared to your competitors 0.870 5. firm competitive position compared to your competitors 0.845 the lights used to be brighter there: market-driven strategies for rehabilitating the retail trading areas of mid-sized cities mohammed y.a. rawwas university of northern iowa cedar falls, ia david strutton university of southwestern louisiana lafayette, la abstract the wellbeing of downtowns is an important issue. yet key decision makers throughout the u.s. may have reached the point where they are ready to bidfarewell to these historical focal points of commerce, entertainment, and political activity. such an outcome would be quite unfortunate: in fact, some suggest the decline of city cores is one of the most pressing issues facing america today. in this study, a theoretical framework is developed incorporating supplyand demand-relatedfactors that are likely to influence consumers' decision to shop or not shop downtown. the framework is then tested, using a consumer sample taken from three midsized american cities. actionable recommendations regarding how downtown retail trading areas of midsized u.s. cities may be renewed are then developed and discussed. introduction petulia clark's 1960's-era musical tribute to "downtown" rings increasingly hollow in the 1990s. these days, many smaller and midsized downtowns (hereafter, the term "downtown" is used without a size modifier) are just that: down. actually, most have been for some time. for several decades running, most americans apparently have accepted the steady decline of urban retailing centers as a necessary consequence of commercial, societal, and individual progress (swan, 1995). many key decision makers may have reached the point where they are ready to bid farewell to these historical focal points of commerce, entertainment, and political activity (frieden and sagalyn, 1989). the days of small-town independent proprietors operating successful main street shops have generally yielded to sprawling suburban malls and massive retailers like wal-mart, k-mart, and target. are such changes just another price that must be paid in return for social or commercial progress? possibly, but the costs associated with deteriorating downtown retailing bases are greater than many realize. in fact, the types of commer48 journal of business strategies vol. 14, no. 1 cial and social problems widely assumed to be uniquely associated with the inner cores of cities may soon twist around and afflict people living in surrounding suburban areas (porter, 1995; schiller, 1994). the decline of inner city cores is perhaps the most pressing social issue facing america (stone, 1995), although, admittedly, the decline of downtown retailing centers is but one of many social concerns in urban landscapes. for a number of reasons, the welfare of downtown retail trading centers remains an important issue. but three factors dominate the rest. they are: downtowns (l) offer the most prominent reflection of healthy or unhealthy cities, (2) exist as the historical nucleus and cultural repositories of most communities, and (3) are (still) key employment centers (leinenkugel, 1995). at this point in the decline of america's urban infrastructure, donne's classic assertion that "no man is an island ... every man is a part of the main" should strikes business strategists as uncommonly prescient. donne's metaphor neatly captures the current relationship between traditional retailing centers in many midsized cities and the outlying business sectors that jointly form modern commercial systems. no commercial islands exist in today's global economy where one sector's wellbeing remains unaffected by the performance of other areas. when even the quality of the air we breathe is affected by decisions made hundreds of miles away, there is no room for isolationism in american business. research objectives strategies for revitalizing the central retailing destinations that once encompassed the hearts of communities are receiving growing attention. so much so, in fact, that at this point discussions concerned with urban renewal are hardly news. twenty years ago, planners who attempted to restore downtown retail sectors to their former glories were pioneers. by and large, such trailblazers slogged their way through the process the best they could. but now, given the hindsight developed from a two-decade history of revitalization efforts, it is obvious that field of dreams-type tactics "if you built it, they will come" (palma, 1992) usually will not work. these failings apparently result in part from the fact that business strategies aimed at urban revitalization have rarely approached the issue from consumers' perspectives. market-based analyses therefore appears to represent a necessary first step to developing successful downtown revitalization strategies. knowledge gained from such analyses could subsequently be used to improve private retail sectors' business decisions and public sectors' governance decisions. if it is driven by strategic concerns, this knowledge should reflect information concerned with how best to market downtowns, which business hours to keep, what types of stores to emphasize in downtown retailing mixes, or which types of streetscape improvements to make. market-driven approaches to developing downtown revitalization strategies should also inform business and municipal developers regarding who curspring 1997 rawwas & strutton: market-driven strategies 49 rent downtown shoppers are, who potential shopping candidates are, and what each group wants. mindful of these imperatives, our first objective was to: develop a conceptually-based strategic model incorporating factors that influence consumer's decision to shop (not shop) downtown. then, following from the model, our second objective was to: profile differences in consumers who shop (do not shop) in the downtowns of small to midsized cities and investigate whether differences existed between what shoppers and nonshoppers sought with respect to their downtown shopping experiences. literature review and hypothesis development the downtowns of most u.s. cities face a dilemma. they are widely viewed as being representative of their overall city identity, so cities of all sizes and in all regions are committed to successful downtown redevelopment. but beginning during the 1960s, and generally continuing since, the inner cores of midsized cities have generally lost population and income. during the same period, increasing traffic congestion (consisting largely of commuting workers) and the growing absence of other evening and weekend shoppers contributed to the relative unattractiveness of downtowns as shopping destinations. retailers themselves grew increasingly averse to downtown locations because higher security was necessary, shoplifting was more common, and room for expansion was generally lacking. to stay abreast of their customers' changing preferences, retailers shifted their business focus from downtown areas to suburban locations. downtown areas today usually feature proportionately less retail activity than their populations would otherwise suggest (ettorre, 1995; newman, 1995). still, in some urban settings, downtowns continued to provide viable retailing sites. perhaps the important element sustaining the relative health of some downtowns lies in the fact that people still must enter them to work. here and there, cities have also provided substantial financial incentives to retailers who choose to locate or remain downtown. over the last two decades many urban areas have also experimented with a process known as gentrification. gentrification occurs when older buildings are restored as new offices, homes, or retail sites. but efforts at downtown gentrification have not always been successful. underground atlanta, refurbished in the city's historical center in the 1980s, 50 journal of business strategies vol. 14, no. 1 is widely viewed as a failure. persuading consumers to drive downtown to acquire merchandise that is available elsewhere is clearly a challenging task. in the development of retail strategy as is true of most aspects of business strategy one of the few real constants is change. time marches on and, as any child who has ever set up a lemonade stand on a dead end street already knows, the marketplace is heartless. in recent years retailing powercenters clusters of big stores like wal-mart, home depot, or target have incessantly hammered away at the high suburban market shares that malls had enjoyed for years (khennouch, 1995). malls, of course, grabbed most of their original shares from downtown shopping areas. the reason for both market shifts is simple: retailing outlets, as well as the locales housing those outlets, must change to satisfy shopper needs. most shoppers today do not have time to browse around the farflung assortment of retail outlets found in malls. more women work outside the home than ever before. men, of course, continue to work, and spend record amounts of time on the job. shoppers are thus likely to assign an increasingly high value to the convenience made possible by any site offering large selection (one-stop shopping), nearby parking, and late hours all in one place. nevertheless, if market forces really were the only influences that counted, downtown retailing centers would have virtually disappeared some years back. for instance, among many americans the current nostalgia for old or familiar places is so strong that some downtowns have been able to successfully foster the illusion of activity where little would have occurred on its own (tarricone, 1994). other consumers simply are not willing to easily let go of their past, and downtowns are unquestionably a big part of america's past. other downtowns have successfully renovated old theaters, enticed entrepreneurs to move in or current downtown workers to shop there by offering financial incentives, and, at times, coerced secondary financial support from federal or state level governmental sources. of course, few downtowns will survive, much less prosper, merely on basis of the warm sentiments certain consumers may hold toward the romance of downtowns' better days-gone-bye or the occasional worker who scurries off during lunch to buy a sweater. that is where the need arises for a market-driven examination of the strategic forces that affect downtowns' futures. these market-driven ebbs and flows in the identity of "desirable" retailing locations imply that the ability of downtown retail trading areas to entice a respectable proportion of shoppers back to their locales depends on their attractiveness relative to other trading area options. the notion of any retail trading center's relative attractiveness ought logically to be based on a combination of retailing, nonretailing, and aesthetic factors that are associated with it. logically, specific differences in the attractiveness of an area to downtown shoppers and downtown nonshoppers then may be assessed as a means of gaining actionable insights regarding how to increase the attractiveness of downtown trading areas. from a conceptual perspective, few restrictions exist on the number of factors that might be considered in a model evaluating the attractiveness of downspring 1997 rawwas & strutton: market-driven strategies 51 towns as shopping locations (nevin and houston, 1980). but, based on the existing literature, these factors should probably reflect issues broadly relating to retailing factors, environmental factors, and aesthetic characteristics associated with downtown locations (chain store edge executive, 1992; robertson, 1995; wilson, 1994). retail factors should include issues such as the number and type of stores available downtown (brown, 1994). environmental (or nonretail) factors would need to address downtown issues that existed external to stores themselves (taubman, 1987). aesthetic characteristics could entail issues pertaining to considerations of convenience or culture (rybczynksi, 1995). all these factors or considerations represent supply-side issues. moreover, each such factor may be associated to a greater or lesser degree with any downtown locale. finally, strategically-driven action plans could be developed with respect to each if the proper information and insights were developed. the influence of demographic or demand-side factors should also be considered in a model predicting how to renew downtowns as a retailing center. demographic considerations should address issues like consumers' place of residence and work, gender, age, marital status, education and income, given that each factor clearly may influence their propensity to shop in downtown retail trading centers (lorch and smith, 1993). as a result, these demand-side factors are also evaluated in the model of the factors that may influence consumers to visit downtown. this set of supplyand demand-side factors that coalesce to contribute to the relati ve attractiveness or unattracti veness of a downtown trading area are summarized in figure 1. creating a desirable image for a downtown shopping area will surely prove crucial to its strategic renewal efforts. once this image is properly communicated consumers residing or working in outlying areas presumably can be moved through a hierarchy of effects; passing through stages that reflect "liking," "intention to visit," and, eventually, action downtown "shopping behaviors". the creation of a favorable retailing supply image thus appears to be a prerequisite to getting consumers to change their existing downtown shopping intentions and behaviors. it follows that a broad variety of attributes should contribute to a downtown trading area's image. issues like the breadth and depth of product/service assortment available, aesthetic considerations, convenience, and broad aspects of environmental ambience should each affect consumer's trading area choices (bearden, 1977; brown, 1989; weisbrod, parcells and kern, 1984). other issues such as crime or panhandling unquestionably also affect the attractiveness of downtown shopping areas, but were excluded from consideration in this study because they lie beyond the control of retail or urban planners. by contrast, the factors described in the above framework are each actionable. this characteristic should thus allow retailers, merchant associations, or municipal governments to develop strategies aimed at targeting consumers in ways that will renew the welfare of their downtown trading areas. 52 journal of business strategies figure 1 vol. 14, no. 1 theoretical model of factors that influence consumers to visit downtown supply-side factors i iretail factors consumer major needs i retail format i i women's ware i i discount store i i specialty stores i i exotic stores i demand-side factors i gift stores i customer heirarchy of effects non-retail factors shopper nonshopper exquisite willingness ambience rprimary town to visit resident downtown outdoor secondary town activities resident fringe town resident aesthetic purchase characteristics intent assortment and presentation i i contentment y purchase i i convenience i i looks i spring 1997 rawwas & strutton: market-driven strategies consistent with this model and theory, the following hypotheses were tested: hypothesis i: downtown shoppers and nonshoppers will be characterized by significantly differing demographic properties. hypothesis 2: downtown shoppers and nonshoppers will differ significantly regarding their perceptions of the importance of retailing and environmental factors typically associated with downtown trading areas. hypothesis 3: downtown shoppers and nonshoppers will differ significantly regarding their perceptions of the quality of aesthetic factors typically associated with downtown trading areas. method 53 sample development data were obtained by mailing surveys to three randomly selected groups of 333 consumers. members of each consumer group resided in one of three midwestern locales. the decision to investigate midsized downtown markets in this study was based on three strategic issues. these factors are discussed below: first, larger central business districts that have successfully revitalized themselves in recent years typically have grounded their progress in gentrification processes. these gentrification efforts generally have been made possible through the combined efforts of regional corporate communities and the local municipal government. for instance, the recent rejuvenation of downtown cleveland is almost entirely due to the combined efforts of its local government and private business sectors. unfortunately, midsized cities usually lack the absolute corporate scale necessary to underwrite the huge makeovers required for successful gentrification (heikkila and kantiotu, 1992). almost without fail, midsized cities must rely more on traditional marketing-oriented approaches to power their urban renewal efforts (barrett and greene, 1993). second, a large proportion of every dollar spent in a walmart or target store represents monies not spent in privatelyowned local stores. many such stores traditionally have been located downtown. that several of sam walton's heirs are 54 journal of business strategies vol. 14, no. i among the richest americans provides glowing testament to their father's ingenuity and insight. but their wealth also illustrates that some $30 billion fewer dollars are now circulating annually through america's smaller business communities (rogers, 1995). insights need to be developed regarding how downtown retailers operating in midsized cities might better overcome their scale limitations and these external threats to their continued existence. third, midsized downtowns typically do not face the overwhelming levels of crime against persons and property that are endemic to many downtown retailing environments in large cities. strip shopping centers located downtown in larger cities spend up to $2 more per square foot than comparable suburban shopping centers (porter, 1995). these extra costs largely result from a need for more security, increased lighting, and continuous cleaning. more significantly, the prospect of crime against employees and customers creates an unwillingness to work in and patronize such retail centers, and restricts operating hours. because these factors are beyond the purview of a study such as this, a decision to study smaller markets is reinforced. the first sampling domain was a midwestern city having approximately 40,000 inhabitants (designated as the "primary" domain). the second domain was a nearby city having approximately 11 0,000 residents (designated as the "secondary" domain). the third population sampled consisted of consumers residing outside the corporate boundaries of either municipality (designated as the "fringe" domain). respondents taken from within each sampling domain were grouped together during all subsequent analysis, a process which should increase the generalizability of the results. each municipal location featured a distinct downtown shopping district. of the 999 instruments mailed, 225 were returned for a response rate of22.5%. of this total, 218 instruments were deemed usable for analysis. this response rate compares favorably with returns realized by other retail studies sampling the general populace (dabholkar, thrope and rentz, 1996; rooks and weinroth, 1993; welch and massey, 1987). the demographic data revealed that most respondents were over 35 years of age and married. respondents also generally had at least some college education and higher than average annual incomes for this u.s. region (statistical abstracts 1995). other information relating to the demographic distributions observed is provided in table 1. measurement retail shopping area image represents a composite of issues that consumers perceive as characteristic of the trading locale. a number of questions should be table 1 r:.n'0 :!. ;:3 demographics {jq -'-0 '-0 1. age 5. highest level of education 10. the time subjects -.l under 18 1.9 % high school or less 23.5 % usually go downtown ::0 18 24 31.2 some university 39.0 weekdays: >::l 25 34 13.0 university degree 29.6 during morning 5.9 % ~ ~ 35 49 25.1 graduate degree 8.0 at lunch 5.9 >::l '" 50 64 18.1 6. town of residence during afternoon 29.2 r<> 65 and over 10.7 primary 45.4 % during evening 8.6 v:>.... "l 2. gender secondary 23.1 saturdays 47.0 =:.... male 38.0% fringe 31.5 sundays 3.2 ~? female 62.0 7. town of work 11. mark-downs as a motivating ~3. marital status primary 37.6% factor to shop downtown married 58.2 % secondary 34.9 yes 64.4% ~ ~ not married 41.8 fringe 27.5 no 35.6 .... i tl 4. total household 8. primary downtown as a 12. the appealing word in "l yearly income (i,ooos) shopping destination visualizing downtown ~. ~ ;:: under $10 13.9 % yes 58.4 % parkade 58.0 % v:> $10 $19 10.7 no 41.6 mainstreet 42.0 .... i:l $20 $29 19.5 9. advertising media that .... ~ 1>0 $30 $39 19.6 attracts attention the ~. $40 $49 9.9 most to primary downtown '" $50 $59 13.2 direct mail 9.0% $60 $69 7.3 t.y. 23.4 $70 or over 4.9 radio 19.7 newspaper 42.0 billboards 5.9 vi vi 56 journal of business strategies vol 14, no. 1 used to capture each shopping area image dimension, especially in exploratory studies where no guiding framework is present. for this reason, the instrument was divided into four sections. the first section featured questions addressing the importance to consumers of the availability of various retail store types (e.g., drugstores, office supply stores, factory outlets) that may attract shoppers downtown. the second section addressed the importance to respondents of environmental issues like cultural activities, historical ambiance, or parking, which may stimulate downtown traffic when consumers are considering where or whether to shop. in each of these two sections, consumer beliefs were assessed using five-point likert-type scales, with (i) indicating "extremely unimportant" and (5) indicating "extremely important." the third section dealt with consumer perceptions of the quality of various aesthetic factors that may be associated with a downtown's retailing environment. again, consumer responses were measured along a fivepoint scale, but now (l) indicated "miserable" and (5) indicated "excellent." the instrument's final section measured demand-side related demographic characteristics of respondents and featured "yes-no" questions that permitted respondents to be classified into downtown shopper-nonshopper categories. to summarize the patterns of correlations existing among the questions, an exploratory factor analyses with varimax rotation was performed on 35 items measuring the importance of retail store-types. this analysis identified storctype subgroups viewed by this sample as similarly important in their ability to attract customers downtown. the roots criterion and scree test criteria were used in combination to determine the suitable number of factors to extract. that juncture on the scree plot with a large break in the plot of the eigen roots was assumed to be the point where factor extraction should stop with the additional provision that all eigenvalues be near or greater than one. this procedure revealed that 27 items loaded on seven retail store-type factors. eight items were dropped because of low loadings. based on the identity of the items loading on them, these factors were labeled as focused consumer needs stores, traditional retail format stores, women s wares stores, discount stores, specialty stores, discount stores, exotic stores, and gift stores, respectively. an identical scale building procedure was used with respect to the items measuring downtown environmental issues. two factors, labeled old fashioned values and activities and circumstances external to stores, were extracted. the first construct reflected circumstances relating to historical buildings, period images, artistic factors, and/or cultural activities that may be present downtowns. the lattcr factor encompassed considerations relating to the availability downtown of frec parking, special events, parks and picnic areas, and recreational activities. four factors were extracted from the final factor analysis, which was performed on fifteen items measuring perceptions of downtown trading area's aesthetic characteristics. the emergent factors were labeled as assortment and atmospheric presentation, appearance, quality transactions, and convenience, respectively. characteristics such as a downtown trading area's merchandise varispring 1997 rawwas & strutton: market-driven strategies 57 ety, window displays, layout, building facades, and quality of goods/services loaded on the assortment and atmospheric presentation factor. appearance reflected the cleanliness and attractiveness of a downtown trading area. a downtown's traffic flow patterns (e.g., straight vs. serpentine), parking accessibility, accessibility to disabled persons, and shopping hour convenience correlated highly, thus fashioning the convenience construct. finally, salesperson friendliness, safety, and general costs of a downtown's goods and services loaded together to form a quality transactions factor. table 2 summarizes the items, loadings, and coefficient alphas corresponding to each factor. analysis the hypotheses were tested using manova. the manova procedure used to test the second and third hypotheses also employed a covariate analysis, controlling for respondents' town of residence and of work. covariate analysis increases the power of a manova significance test to detect true differences in downtown shopper/nonshopper perceptions. removing the possible effects of residence and employment on respondents' perceptions of their downtown trading areas was desirable because those conditions might have biased the results. on the other hand, no strategic need existed to address these effects since neither retailers nor municipal planners can meaningfully influence any targeted consumer group's places of residence or employment. discriminant analysis was also used. using discriminant analysis in conjunction with manova facilitates insights into the direction and intensity of any significant relationships. while manova tests for significant differences from the null hypothesis of no differences in the demographic characteristics (or perceptions of what is important in a downtown shopping experience) of downtown shoppers/nonshoppers, discriminant analysis determines the weights of the combination of criterion variables that optimize departure from the null. examining each demographic or perceptual variable's contribution to the discriminant function facilitates a more precise interpretation of any differences in demographics or image perceptions across downtown shoppers and nonshoppers. results objective 1 manova was used to test the hypothesis concerned with whether consumers who shop or did not shop "downtown" would display significantly different demographic characteristics. demand characteristics included in the model were income, marital status, place of work, place of residence, age, gender, and education. manova revealed a significant overall difference in the demographic characteristics associated with downtown shoppers and nonshoppers. using discriminant analysis to determine the direction and intensity of the hypothesized relationships across the shopper categories was thus appropriate. 58 journal of business strategies table 2 vol. 14, no. 1 retail businesses that may attract customers to primary downtown (factor analysis) item factor loadings coefficient alpha 1. retail factors consumer needs stores financial services (e.g., stock brokers, banks) personal services (e.g., barbers, hair dressers, ins., medical, travel ins.) office supplies photo studios computers, electronics hardware furniture shoes men's, women's and children's traditional retail format stores box (limited-line) store (e.g., aldi) supermarket (e.g., hy vee) drugstores department store fast-food restaurants (e.g., mcdonald's) video sales and rentals women's wares stores women's wear women's accessories discount stores off-price store (e.g., tj maxx) factory outlet (e.g., galt sand, liz claiborne) large specialty store (e.g., the limited) specialty stores specialty food (e.g., coffees, fr~nch pastries, candies) specialty gifts (e.g., boutiques. lingerie) exotic stores hobby stores sports apparel luggage, executive gi fts jewelers gift stores cards and gifts children's clothes and gifts .711 .688 .676 .602 .578 .511 .503 .486 .738 .707 .675 .550 .534 .454 .776 .708 .853 .848 .727 .786 .709 .720 .577 .505 .479 .726 .634 .81 .77 .84 .84 .80 .66 .64 spring 1997 rawwas & strutton: market-driven strategies table 2 59 retail businesses that may attract customers to primary downtown (continued) item factor loadings coefficient alpha 2. non-retail factors old-fashioned values preservation of historic buildings a downtown that projects image (e.g., ethnic or time period) artistic environment (e.g., art studios, art galleries) cultural activities (e.g., live theater, musical performances) activities and circumstances external to stores free parking special events and festivals availability of parks and picnicking areas recreational activities (e.g., biking, water activities, movies) 3. aesthetic characteristics assortment and atmospheric presentation variety of stores window and in-store displays variety of goods/service store layout building facade quality of goods/service quality transactions friendliness of salespeople safety cost of goods/service convenience traffic flow (straight vs. serpentine main street) parking convenience store accessibility to handicapped patrons shopping hours appearance cleanliness attracti veness .82 .828 .815 .744 .722 .69 .734 .688 .744 .636 .88 .812 .763 .754 .751 .710 .603 .794 .743 .633 .66 .749 .687 .634 .355 .83 .886 .872 60 journal of business strategies vol. 14, no. 1 this analysis revealed that only one demographic variable, income, significantly discriminated between downtown shoppers and nonshoppers. consumers reporting higher incomes were significantly more likely to shop downtown. surprisingly, no other demand-related factor (e.g., marital status, place of work or residence, age, gender, and education) was significantly related to this sample's downtown shopping behaviors. one must conclude that the first hypothesis was not supported. mean values, canonical loadings, and multivariate and univariate significance tests associated with this analysis are reported in table 3. table 3 analysis of demographic differences means variable income status (dummy) workl (dummy) live2 (dummy) age work2 (dummy) sex (dummy) education livel (dummy) canonical loading .6451 .2605 .2360 .1782 .1273 .0997 .0512 .0362 .0052 f·test .022 .437 .398 .986 .393 .721 .583 .897 .750 shoppers 4.214 0.643 0.393 0.140 3.607 0.446 0.321 2.232 0.482 nonshoppers 3.235 0.568 0.314 0.216 3.372 0.412 0.373 2.255 0.451 multivariate chi-square chi-square significance percent of variance explained percent correctly classified analysis sample hold out sample 11.975 .0175 100% 66.36 % 54.81 % objective 2 the broad content of the propositions associated with the second research objective was illustrated in figure 1. mancova was used to test the second hypothesis that downtown shoppers and nonshoppers would exhibit significantly differing perceptions regarding what they view as important in a downtown shopping experience. after adjusting for the possible influence of work and residence, significant overall differences were revealed in the perceptions held by shoppers and nonshoppers. discriminant analysis again was used to determine spring 1997 rawwas & strutton: market-driven strategies 61 the direction and intensity of the univariate relationships across the downtown shopping/nonshopping groups. downtown shoppers were significantly more likely than nonshoppers to view the downtown presence of specialty stores as important. but nonshoppers were more likely to report that they felt the downtown presence of discount and traditional retail format stores was important. this implies the availability of these store types should increase the likelihood that downtown nonshoppers would alter their shopping behaviors. while downtown shoppers apparently seek more depth in product lines (availability), nonshoppers appear more interested in value and the width of product mix available. these latter properties are presumably more widely available in suburban retail settings. when evaluated against some rehabilitative efforts that have recently unfolded in a few midsized downtowns the strategic implications of these results are particularly evident. some cities have begun to revive their long-dormant downtown trading areas by offering deeper product lines. burlington, iowa, and stillwater, minnesota are each success stories in progress. each city has largely built its renewal around decisions to feature deep product lines of a single specialty product, antiques (business directory, 1995). one will recall from the demographic analysis that downtown shoppers generally enjoy higher incomes than nonshoppers. because shoppers are apparently more interested in the sorts of unique items that theoretically could be more widely available downtown as opposed to malls or shopping centers, these results imply that downtown nonshoppers can be expected to seek more value and assortment in downtown offerings. when compared with nonshoppers, downtown shoppers also felt that "oldfashioned values" were more important. since these downtown shoppers tended to have higher incomes it may be inferred that they are a bit more sophisticated or cultured than their nonshopping counterparts. consumers who shopped downtown may have elected to patronize the locale because they were more appreciative of the historic buildings, art, cultural activities, and generally erudite image that they perceived to be available there. downtown shoppers also assigned more favorable evaluations to various aspects of the downtown's aesthetic characteristics, (i.e., hypothesis 3). differences existed between the groups with respect to two factors: "quality transactions" and "assortment and atmospheric presentation." each factor captures a broad range of characteristics that may attract shoppers downtown. for instance, while each shopping group assigned above average ratings to the aesthetic factors, nonshoppers evaluated the friendliness of downtown sales staffs, safety, and considerations of cost less favorably than shoppers. downtown nonshoppers were also less favorably impressed with the variety of stores, window and point-of-purchase (pop) displays, variety of goods/services, store layouts, and quality of goods/services available downtown. to attract more nonshoppers downtown, retailers apparently should take action aimed at addressing these particular shortfalls. 62 journal of business strategies vol. 14, no. 1 because discriminant analysis generates a linear function based on the criterion variables best distinguishing shoppers from nonshoppers, the importance of each criterion in discriminating the groups is given by the relative size of the canonical loadings. in descending order, the downtown characteristics exerting the greatest influence on overall group differences were: "quality transactions," "old-fashioned values," "assortment & amospheric presentation," "discount stores," "specialty stores," and "traditional retail format stores." two of the first three factors are associated with a downtown's aesthetic characteristics. the overall size of the mean values associated with the retail and nonretail factors indicated that, regardless of their shopping behaviors, this sample believed most of the shopping area characteristics investigated were at least somewhat important. regardless of their shopping behaviors, those persons sampled also generally felt that the aesthetic characteristics of their downtown was at least fair. convenience was the sole exception to this trend. nonshoppers felt the level of "convenience" associated with a downtown shopping experience was relatively poor. again, the strategic implication is that downtown retailers should increase the convenience or perception of the convenience associated with a downtown shopping experience. such an action should entice more nonshoppers to venture downtown. given the absence of significant differences across the shopper groups with respect to the following dimensions, one may likewise conclude that non-retail factors such as "activities and circumstances external to stores" and aesthetic characteristics such as "convenience" and "appearance" are equally important to both groups. "appearance" was seen as particularly important by both shoppers and nonshoppers. the means, canonical loadings, and multivariate and univariate significance tests associated with this analysis are shown in table 4. strategic implications for years, retail strategists and public planners have too frequently shared an attitude of "why try to develop in an area that is more difficult to develop." but now, the easy, early pickings for retailers and urban planners are mostly gone. downtowns are usually situated in what should be economically viable locations, e.g., near a port, river, or transportation nexus. population density is another telling characteristic of downtowns. strategically speaking, downtowns simply have or are near too many people to be ignored. consequently, downtown retail centers clearly offer an attractive option retailers who could benefit from close proximity to population, tourism or entertainment centers, central business districts, or locale near the center of the logistical infrastructure. in the near term private and public developers are increasingly likely to realize that they have an implied responsibility to their city, society and selves to attempt to renew their downtown's well being. but the fact remains that retail trading areas situated in downtown locations generally cannot compete on an equivalent footing with malls. nor can they reasonably aspire to cultivate distribution structures that will allow spring 1997 rawwas & strutton: market-driven strategies table 4 63 analysis of factors that may attract customers to primary downtown controlling for place of residence and work 1. retail factors means* variable canonical loading f~test shoppers nonshoppers discount stores .333 .019 3.46 3.75 specialty stores -.305 .031 3.37 3.70 traditional retail format stores -.297 .036 3.80 3.59 women's wares stores -.110 .432 3.73 3.82 gift stores .097 .489 4.00 3.92 consumer needs stores .090 .520 3.66 3.61 exotic stores .067 .634 3.49 3.45 2. non-retail factors means* variable canonical loading f·test shoppers nonshoppers old-fashioned values .475 .001 3.57 3.16 activities & circumstances external to stores .201 .153 4.11 3.97 * "i" corresponds to "extremely unimportant," and "5" corresponds to "extremely important." 3. aesthetic characteristics means* variable canonical loading f·test shoppers nonshoppers quality transactions .536 assortment and atmospheric presentation .447 convenience .146 appearance -.089 overall manova f-test value * "i" corresponds to "miserable," and "5" corresponds to "excellent." .000 3.70 .002 3.44 .298 3.03 .525 3.67 .000 3.661 3.37 3.18 2.95 3.72 64 journal of business strategies vol. 14, no. 1 them to offer pricing levels more competitive than those already available in nationally prominent discount stores. this set of market characteristics provide a useful backdrop against which to interpret these results. apparently, these results suggest that for waning downtown retailing districts to approach their former vigor, they must develop a series of strategically compelling competitive advantages that provide reasons why more people would want to begin shopping there again. the findings imply that vibrant retailing activity in downtown retail trading areas will be reborn only when such locations boast sustainable competitive advantages (le., old fashioned values such as the preservation of older buildings) and occupy defensible niches (i.e., specialty stores such as antique or handicraft shops) that cannot be easily replicated elsewhere. these results also suggest that downtown business communities should capitalize on their heritage those aspects which make them unique. such an approach would give downtowns a distinct positioning advantage over faceless malls and look-alike suburban stores. the flow of this study's results (see figure 1) implies that two sets of decision criteria are likely used in most of consumers' patronage decisions: (l) those attributes that affect a downtown districts overall shopping image, and (2) those that affect a consumer's preference for particular retail outlets. thus, when individual retailers compete vigorously and do those things necessary to derive a desirable store image, they simultaneously bolster the image of their entire shopping area. thus, a spirit of "one for all and all for one" truly should prevail relative to downtown revitalization efforts. but this findings also imply that individual retailers cannot reasonably hope to revive the flagging fortunes of downtowns on their own. on their own, individual retailers cannot reasonably hope to effect "old-fashioned values" throughout an entire downtown. nor can they ensure that an ideal retailing mix is available throughout a downtown trading area. this is why an overarching strategic plan that incorporates the concurrent efforts of governmental and community activists should also be engaged. such efforts would complement the classic competitive tactics of retailers aimed at delivering for themselves a more auspicious retailing mix or set of atmospherics. the inner retailing cores of most midsized american cities have declined for many reasons. this urban decline thus represents a complicated problem. it is widely recognized that simple solutions to complex problems are rare. moreover, it is understood that successful urban revitalization will require enormous resources. the nature of this problem and scope of these resources suggests the burden of renewal efforts should be borne proportionately across the broad range of publics who affect or are affected by a given downtown's relative welfare. these publics include retailers, nonretailing businesspeople, entrepreneurs, community activists, and public servants. the cooperation and coordination of private and public sectors is undoubtedly crucial to the success of virtually all downtown renewal strategies. this implies that in the development of such strategies some overarching organizaspring 1997 rawwas & strutton: market-driven strategies 65 tional body should be established and assigned the responsibility of bridging the value gaps held by these disparate groups. this organization should also ensure that the efforts of the private and public sector are cohesively directed toward mutually acceptable outcomes. this could be achieved by forming private-public partnerships whose basic mission is to reinvent and reinvest in the downtown in question. based on these data, it is apparent that a planning commission representing private sector retailers and public sector government offices would do well to devise a plan that operationalizes two broad tasks: the establishment of specialty stores and the rejuvenation of what were termed old-fashioned values. this study further indicates that a coherent downtown redevelopment strategy must begin with a fundamental understanding of what the market in question seeks (or feels is absent) from their downtown shopping experiences. working together, relevant constituencies operating within the trading area could then strive to deliver to the market the features it has singled out as desirable. only downtown retailing attributes that are unique, or devised in such a way as to appear unique, within a relevant geographical market, will promote and support viable levels of business. in this study, the significance of the "old-fashioned values" construct implies that downtowns may be able to carve out a position of relative strength by doing business the old-fashioned way. by positioning downtown shopping experiences as being more like they once were, retail and public policy strategies apparently may be to cultivate a more viable future for downtowns. this would, by turns, require strategic goals based on exploiting downtowns' historic appearances, and on generally promoting downtowns as traditional social, cultural, and entertainment centers. in this regard, businesspeople would also do well to stress the community and cultural pride that derives naturally from a healthy downtown. a sense-of-place and an appreciation for history are likely to prove important to the future "self-concepts" of cities, given that virtually all american cities started as port or rail towns featuring vital downtowns. naturally, the "product offering" that is a downtown would have to be reformulated in ways consistent with these claims of old-fashioned values. retailers are clearly incapable of doing this alone. the results of this study also underscore the multidimensional nature of the opportunities currently enjoyed by downtown retailers. business strategists acting on behalf of downtown interests apparently can increase the vitality of their districts as shopping destinations by purposefully operating on selected aspects of the retail factors, nonretail factors, and aesthetic characteristics evaluated in this study. for example, government officials could endeavor to provide the sorts of incentives necessary to stimulate the private sector's retail development or the maintenance of the right mix of stores. the city would be responsible for providing technical information, assistance, incentives, and loans to encourage the necessary sorts of private property investments and improvements. innovative, nontraditional contributions to the development of the desired retailing mix could corne in the form of helping to solve regulatory or zoning problems, the forma66 journal of business strategies vol. 14, no. 1 tion of development organizations to support the project and in some cases functioning as owners or developers themselves. the public sector would also have to take actions that enhance public property, leading to improvements in the downtown's atmospheric presentation. these could include traditional activities such as streetscape or lighting improvements, and landscaping. community activists, on the other hand, certainly would have a critical role to play in the preservation of older buildings, the advancement or conservation of a compatible artistic environment, and the promotion of appropriate cultural activities. in this regard, community activists will always enjoy an advantage based in their intimate knowledge and understanding of what is unique in tenus of the artistic dimensions of their downtowns. these insights can help them promote the right types of historical development. retail strategists, of course, are largely responsible for insuring that quality transactions between stores and consumers transpire, that a suitable assortment of goods and services is available, and that a suitable atmosphere is developed. retailer associations might be used to initiate measures aimed at establishing specialty stores with a common theme. such stores could feature unique products or services that complement one another. retailers should also plan to improve product offerings, window displays, merchandising and marketing techniques. finally, the results associated with the model suggest that the success of downtown revitalization efforts may in large part depend on how effectively two economic standbys supply and demand are addressed. in this instance, however, the conventional relationship between these two elements ought to be reversed. specifically, the results imply that to revitalize downtown trading areas demand for retailer services should be established before~ is furnished. demand could be grown, for instance, by having chambers of commerce engage in strategic development aimed at attracting more and more high paying jobs downtown. this could be achieved by influencing state officials to offer incentives such as tax abatements to new businesses (including manufacturers). once consumer demand for retail services and products has been established in this manner, the supply of "appropriate" retailing services would likely expand as a natural consequence. at that point, the opportunity would emerge to fine tune the mix and number of specialty stores downtown, as would the opportunity to purposefully improve selected aspects of the public infrastructure of the downtown in question. infrastructure encompasses parking, lighting, street sidewalks, public restrooms, trees, parks, and so forth. with respect to these supply and demand issues, working agreements could be enjoined between all involved publics that penuit each party to concentrate on what it does best, thus allowing other publics to exercise their own distinctive strengths. these "strategic partnerships" should include the mayor, top government officials, public agencies, downtown resident associations, retail associations, and non-retailing businesses. various aspects of the downtown community spring 1997 rawwas & strutton: market-driven strategies 67 life, heritage and ideals, as well as land use and retail design issues ought to be deliberated (bramhall, 1992). working together in this fashion should allow natural synergies to develop. all the publics having a stake in a given downtown's welfare would do well to remember that they should hang together in these renewal efforts. otherwise, borrowing from the words of benjamin franklin, they will surely hang separately ("hang" as in watching the slow, inevitable strangulation of something that should be dear to them). these publics would then be left with little more than a doughnut hole in place of what used to be the lively center of their cities. limitations and future research these findings must be evaluated in light of certain limitations. any discussion derived from a single, cross-sectional study reporting consumer responses is less than completely generalizable. this shortfall can be addressed in part by investigating these same issues using different samples taken from other regions of the country, or by developing longitudinal studies of these same effects. this study is also limited in that issues such as land-use, technology, entertainment, employment patterns, or crime that also may influence consumers' downtown shopping behaviors are not considered. the possible influence of such factors on downtown revitalization efforts should be investigated in future research. references barrett, k. and r. greene. "return from the crypt." financial world 162,5 (1993): 5253. bearden, w.o. "determinant attributes of store patronage: downtown versus outlying shopping centers." journal of retailin~ 53,2 (1997): 15-22. bramhall, b. "building people power in three cities." plannin~ 58 (november 1992): 23-26. brown, s. "retail location theory: the legacy of harold hotehing." journal of retailing 65,4 (1989): 450-470. -----. "retail location at the micro-scale: inventory and prospect." service industries journal 14,4 (1994): 542-576. dabholkar, p.a., oj. thrope and j.o. rentz. "a measure of service quality for retail stores: scale and validation." journal of the academy of marketing science 24, 1 (1996): 3-16. 68 journal of business strategies vol. 14, no. 1 ettorre, b. "should businesses remain in the inner cities?" management review 84,5 (1995): 13-18. frieden, bj. and l.b. safalyn. downtown inc.: how america rebuilds cities. cambridge: mit press, 1989. heikkila, ej. and c. kantiotu. "calculating fiscal inputs where spatial efforts are present." regional science and urban economics 22, 3 (1992): 475-490. khermouch, g. "target hits bullseye." brandweek 36, 23 (1995): 22-26. leinenkugel, j. "urban revitalization: it's not just for large cities." executive speeches 9 (february/march, 1995): 12-16. lorch, bj. and m.j. smith. "pedestrian movement and the downtown enclosed shopping center." journal of the american planning association 59, 1 (1993): 75-86. newman, o. "defensible space a new physical planning tool for urban revitalization." journal of the american planning association 61, 2 (1995): 149-155. nevin, j.r. and mj. houston. "image as a component of attraction to intraurban shopping areas." journal of retailing 56, 1 (1980): 77-93. palma, d. "the top ten ways to revitalize your downtown." american city & country 23 (november, 1992): 48-55. porter, m.e. "the competitive advantage of the inner city." harvard business review (may/june, 1995): 55-71. robertson, k.a. "downtown redevelopment strategies in the united states: an end-ofthe-century assessment." journal of the american planning association 6 i, 4 (1995): 429-437. rooks, w.a. and j. weinroth. "an empirical confirmation of dual strategies used in marketing high-technology goods and services: the decision-supporting software example part one: theoretical, philosophical, and pragmatic foundations for the research." journal of professional services marketing 9, 1 (1993): 173-181. rogers, d. "surviving the supercenter's shadow." supermarket business 50, 1 (1995): 35-40. rybczynksi, w. "culture's urban fortunes." civilization (november/december, 1995): 33-35. schiller, r. "vitality and visibility: challenge to the town center." international journal of retail & distribution 22,6 (1994): 46-50. spring 1997 rawwas & strutton: market-driven strategies 69 smallwood, c. "a matter of pride." american city & country 12 (february, 1994): 4751. stanwood, pg. john donne and the theolo&y of lan&uage. columbia, mo: university of missouri press, 1991. statistical abstracts of the united states: the national data book. u.s. department of commerce. washington, dc: 1995. stone, n. "old problems, new solutions." harvard business review (may/june, 1995): 18. swan, c. "demography and the demand for housing a reinterpretation of the mankivweil demand variable." regional science & urban economics 25, i (1995): 41-58. tarricone, p. "a league of their own." civil engineering 5 (1994): 58-61. taubman, a.a. "challenging myths that plaque retail development." retail estate finance journal 25 (summer, 1987): 61-64. "the downtowns strike back: coexistence now the goal for city retail." chain store age executive 68, 11 (1992): 64-66. ''the ultimate sales & credit tool (1994-1995)." american business directories. omaha, ne: university of nebraska press, 1996. weisbrod, g.e., rj. parcells and c. kern. "a disaggregate model for predicting shopping area market attraction." journal of retailing 60, i (1984): 65-83. welch, j.l. and t.k. massey. "a data collection alternative for services professionals: the 'answer check.'" journal of professional services marketing 3,2 (1987): 35-45. wilson, m. "retail goes downtown: building stores in urban markets." chain store age executive 70, 9 (1994): 28-30. mohammed y.a. rawwas (ph.d., university of mississippi) is an assistant professor of marketing at the university of northern iowa. his primary research interests lie in the areas of international marketing and ethics. dr. rawwas's research has appeared in the journal of business ethics, journal of promotion management, marketing education review, journal of international consumer marketin& and the journal of business research, among others. david strutton (ph.d., university of mississippi) is the acadiana bottling professor of marketing and j. w. steen professor of business administration at the university of northern iowa. his research has appeared in the journal of advertisin& research, journal 70 journal of business strategies vol. 14, no. 1 of the academy of marketing science, journal of macromarketing, journal of personal selling & sales management, and the journal of business research, among others. strutton is co-author of marketing channels: a relationship management approach (richard d. irwin & co., 1996). the lights used to be brighter there: market-driven strategies for rehabilitating the retail trading areas of mid-sized cities toward a synthesis of the resource-based view and organizational economics in the context of grand strategies james g. combs university of mississippi university, ms david j. ketchen, jr. louisiana state university baton rouge, la abstract the resource-based view (rbv) and organizational economics (oe) are influential perspectives in the field ofstrategic management. in essence, the rbv is concerned with the creation and deployment of resources with certain qualities whereas oe is focused on efficiently monitoring operations. an important area of research where these approaches have both been employed is the choice of grand strategy. grand strategies are the alternative ways that firms can implement an expansion offirm scope, includingjor example, joint ventures and internal development. the rbv and oe can, because oftheir different emphases, lead managers toward different grand strategies. guided by prior research, this paper develops a model suggesting that firms will generally place their resource needs before monitoring considerations and that this choice brings about the best possible peiformance. propositions designed to guide subsequent empirical research are developed and implications for both theory and practice are discussed. introduction researchers have enlisted several theoretical perspectives to explain organizational actions and subsequent finn perfonnance (e.g., child, 1972; hannan & freeman, 1977; williamson, 1975; wemerfelt, 1984). in recent years, two of these perspectives, the resource-based view (rbv wemerfelt, 1984) and organizational economics (oehesterly, liebeskind & zenger, 1990) have been used to explain a wide variety of organizational actions including diversification (markides & williamson, 1996; teece, 1980), the evolution of competitive advantage (barnett, greve & park, 1995; mehra, 1996), international entry mode (anderson & coughlan, 1987; anderson & gatignon, 1986; oviatt & mcdougall, 1994), vertical integration (carney & gedajlovic, 1991; mahoney, 1992; mcwilliams & gray, 1995), and organizational structure (masten, 1984; russo, 1991). as several important attempts to integrate these perspectives attest, they do not consistently direct researchers and prac84 journal of business strategies vol. 14, no.2 titioners toward similar conclusions (carney & gedajlovic, 1991; mahoney & pandian, 1992; mcwilliams & gray, 1995). in this paper, we examine one context grand strategies wherein prescriptions emanating from the rbv can contradict those from oe. defined as strategies that increase the scope of a firm (i.e., internal development, acquisition, joint venture, long-term contracting pearce, 1982), grand strategies can have a profound impact on organizational performance (koh & venkatraman, 1991; lamont & anderson, 1985; williamson, 1994). thus, in order to develop a better understanding of the relationship between grand strategies and performance, we work toward an integration of rbv and oe predictions in this context. according to the rbv, managers choose among alternative strategies based on the need to build strategically valuable resource stocks (dierickx & cool, 1989). grand strategies should be chosen to enable the firm to acquire and/or protect the unique and valuable resources needed to compete effectively (e.g., barney, 1991; wernerfelt, 1984). by contrast, oe states that managers respond to governance costs (mahoney, 1992). specifically, firms are thought to seek strategies that minimize the costs of negotiating and enforcing (i.e., governing) transactions across markets vis-a-vis internal hierarchies (williamson, 1975; 1985). also, the costs of monitoring and bonding agents (e.g., managers or cooperative partners) gives rise to agency costs, which are another form of governance costs the firm will wish to minimize (jensen & meckling, 1976). thus, grand strategies are chosen such that transaction and agency costs are minimized. the potentia] conflict between these two approaches emanates from the dual nature of the grand strategies. on one hand, grand strategies can be viewed as a tool to help the firm gain access to important resources that is, to overcome resource constraints (martin & justis, 1993; shane, 1996). alternatively, grand strategies can serve as a way to minimize the cost of negotiating with organizational participants and monitoring their behavior as the firm grows (lafontaine, 1992; williamson, 1991). in partial reconciliation of these dual purposes, mcwilliams and gray (1995) have argued that resource-scarce firms place their resource-based needs before governance cost considerations when choosing among alternative grand strategies. using their study as a point of departure, we build a model wherein we predict the preferred grand strategy for several resource stock-governance cost contingencies. in so doing, we explain how the variables offered by de play an important secondary role. an additional step is taken by combining the rbv and oe logic to predict performance. finally, we offer advice to managers for achieving competitive advantage as their resource and governance conditions change. literature review the rbv and oe differ considerably in terms of the factors believed to influence managerial action and the performance consequences of such actions. specifically, the rbv is concerned with how extant resource endowments can influence the firm's ability to grow. furthermore, the rbv draws a fall 1997 combs & ketchen: toward a synthesis 85 direct link between the deployment of resources and performance. in contrast, oe is centered on how managers minimize the costs of monitoring and controlling the firm's activities. the consequence of efficient governance is improved performance (hill & snell, 1988; williamson, 1994). resource-based view in a seminal work that laid the foundation for business-level strategic analysis, andrews (1965) painted a fairly balanced picture of how internal and external factors contribute to successful strategies. in the ensuing years, most research in strategic management centered on external forces; it is only in the last decade that scholars have begun to carefully examine how firm-level resource differences shape strategy and performance (barney, 1995). at the heart of the rbv of strategy is the notion that firms act to acquire "strategically valuable" resources that can be a source of a sustainable competitive advantage (i.e., superior long-term performance) forthe firm (barney, 1991; conner, 1991; peteraf, 1993). indeed, it is this link between the nature of certain resources and performance that sets the rbv apart from related theories such as resource dependency (pfeffer & salancik, 1982), which is primarily concerned with the firm's efforts to protect the flow of resources between the firm and its environment. much of the research using the rbv attempts to describe the characteristics of strategically valuable resources that will, over time, build a sustainable advantage. such resources must be: (1) valuable, meaning buyers are willing to purchase the resources' outputs at prices significantly above their costs, (2) rare, so that buyers cannot turn to competitors with the same (or substitute) resources, and (3) imperfectly imitable, meaning it would be difficult for competitors to either imitate or purchase the resources (barney, 1986a; 1991; lippman & rumelt, 1982; peteraf, 1993; reed & defillippi, 1990). some of the spegific resources that may meet these conditions are management teamwork (castanias & helfat, 1991; hambrick, 1987), culture (barney, 1986b), brand name capital (aaker, 1991), implementation of total quality management (powell, 1995), and trust (barney & hansen, 1994). firms in possession of strategically valuable resources are expected to achieve superior performance. that is, resource-based differences among firms can help explain performance differences because the set of products and services that can efficiently emerge from any unique configuration of resources is itself unique. performance differences emerge from buyer preferences, which generally favor the outputs (i.e., products and services) of some resource configurations more than others (barney, 1991; wernerfelt, 1984). in addition to the strategically valuable resources that underlie competitive advantage, firms must also have access to any "complementary" resources that are necessary to bring products or services to market (barney, 1995; teece, 1987). for example, a superior design is of little use without access to the manufacturing and distribution facilities necessary to reach buyers. when complemen86 journal of business strategies vol. 14, no.2 tary resources are lacking, products cannot be provided to markets and returns to strategic resources cannot be realized (mahoney & pandian, 1992). thus, both strategic and complementary resources are important components of the firm's endowments (barney, 1995). because resources are closely linked to performance, managerial action is, according to the rbv, directed primarily toward building strategically valuable resources. however, these resources can take considerable time to develop (dierickx & cool, 1989). as penrose (1959) explained, the time it takes to hire and develop experienced and committed managers can slow organizational expansion; growth must be put on hold until a cadre of capable managers can emerge. other resource-building efforts such as the development of organizational routines (nelson & winter, 1982; shane, 1996), the building of a reputation (dierickx & cool, 1989) and access to a pool of capital (martin & justis, 1993) have also been shown to affect organizational growth rates. thus, resources can influence managerial action by compelling managers to find ways to delimit their resource-based constraints (mahoney & pandian, 1992). one common solution is to invoke a grand strategy that involves cooperation with an external organization so that the firm can grow with the aid of the other's resources (erramilli & rao, 1990; harrigan, 1985; ingham & thompson, 1994; teece, 1987). indeed, because firms can often perform activities in cooperation that neither could perform independently (erramilli & rao, 1990; hamel, 1991), resource sharing has become a primary explanation for many forms of cooperation (borys & jemison, 1989). organizational economics transaction cost economics and agency theory constitute the two major theories supporting oe (barney & ouchi, 1986; hesterly et ai., 1990). transaction cost asserts that firms choose strategy so that organizational activities are performed in the least cost environment hierarchy or market (i.e., whether to internalize a function or contract for it with an external actor williamson, 1975). transaction cost economics can trace its roots to the work of coase (1937). by recognizing the costs inherent in using markets to perform transactions, coase hypothesized that firms will grow until the marginal costs of organizing equals the marginal costs of contracting in markets. williamson (1975) extended this logic by articulating market and transaction specific variables that may influence a firm's choice between hierarchy and market. in general, as a firm becomes interdependent with another, it increases its exposure to potential opportunistic behavior on the part of the other firm. risk of opportunism is thus a cost that encourages firms to internalize activities otherwise performed by external organizations (williamson, 1975). for transaction cost economics, the pivotal variable affecting governance costs is the specificity of assets deployed in the performance of organizational activities (e.g., dyer, 1996; teece, 1980; 1987). asset specificity refers to the fa111997 combs & ketchen: toward a synthesis 87 difficulty of redeploying assets to alternative uses without sacrificing their productive value (williamson, 1991). essentially, because highly specific assets cannot be easily used for other purposes, they render those who have invested in them dependent on the participants charged with employing them. if participants take advahtage of the firm, expected profits from investments in specific assets would be lost. thus, if the firm must invest in specific assets, it will seek to control those resources as tightly as possible usually through direct ownership (anderson & gatignon, 1986; williamson, 1985; 1991). agency theory is the second dominant perspective comprising oe. it is focused on the relationship between principals and their agents to whom some decision making authority is delegated (eisenhardt, 1989; jensen & meckling, 1976). agency theory was developed in the 1960s and i970s by economists studying how groups could be efficiently monitored given group members' incentive to shirk (e.g., alchian & demsetz, 1972). because principals and agents are assumed to have divergent self-interests, the central premise of agency theory states that they will jointly minimize: (i) the principal's costs of monitoring the agent's actions, (2) any costs paid by the agent to ensure the principal's interests (i.e., bonding costs), and (3) any residual loss due to remaining divergence between their respective goals (jensen & meckling, 1976). a key agency variable is the task programmability of organizational participants' responsibilities (gomez-mejia & balkin, 1992; mahoney, 1992; stroh, brett, baumann & reilly, 1996). the cost of monitoring participants' behavior directly is lower when job tasks can be easily specified in advance. thus, hierarchical relationships between participants are likely when task programmability is high. in contrast, task ambiguity and other impediments to the gathering of meaningful information about participants' job performance such as geographic distance (e.g., brickley & dark, 1987) or cultural differences (e.g., roth & o'donnell, 1996) can raise the costs of monitoring within the hierarchy. in these conditions, it is often less costly to contract for products and services from agents outside the firm (e.g., lafontaine, 1992; mahoney, 1992). although they do not share the same academic legacy, the two theories that compose the oe perspective have some notable similarities. both possess an efficiency orientation that offers guidance for selecting among alternative grand strategies. moreover, as depicted in table i, they share many of the same assumptions and emphasize many of the same independent variables (hesterly et ai., 1990). indeed, mahoney (1992) showed that by including both ex ante information search and negotiation costs, as well as ex post monitoring, bonding, and adaptation costs, transaction cost simply encompasses a broader array of governance cost variables into its framework. hence, agency costs can be viewed as a sub-set of transaction costs. the theories' central differences are found in their units of analysis and dependent variables. transaction cost economics is generally used to analyze governance relationships between organizational units whereas agency 88 journal of business strategies vol. 14, no.2 table 1 similarities and differences between the primary theories of organizational economicsl dimension focus unit of analysis dependent variable independent variables assumptions central governance costs transaction costs organizational boundary transaction organizational governance (i.e., market v. hierarchy) asset specificity uncertainty/complexity transaction frequency number of buyers/sellers self interest goal conflict bounded rationality information asymmetry efficiency motive ex ante: information search negotiation ex post: monitoring bonding maladaptation loss adaptation costs agency theory principalagent relationship contract agent governance (le., behavior-based v. outcome-based contracts) risk propensities uncertainty task programmability information asymmetry self interest goal conflict bounded rationality information asymmetry efficiency motive risk aversion ex post: monitoring bonding adaptation loss maladaptation loss i this table draws heavily from eisenhardt (1989), mahoney (1992), and williamson (1975; 1985). theory emphasizes the relation between the firm (as principal) and individual actors (as agents). as a result, transaction cost analysis economics is generally used to investigate grand strategies where key individual actors are sometimes difficult to isolate (e.g., acquisition, joint ventures) while agency theory is used to investigate strategies where principal-agent dyads are clear (e.g., long term contracts). because the grand strategies represent alternative ways to organize the firm's activities, both theories are needed to explain the choice of grand strategy along the entire range of alternatives. thus, following others who have drawn from the oe perspective (e.g., barney & ouchi, 1986; hesterly et al., 1990), we fall 1997 combs & ketchen: toward a synthesis 89 emphasize transaction cost economics' and agency theory's common concern for efficiency and treat them as complementary. toward an integration of perspectives in recent years, several articles have incorporated ideas from both the rbv and oe (e.g., bergh, 1995; carney & gedajlovic, 1991; conner, 1991; mahoney & pandian, 1992; mcwilliams & gray, 1995). broadly speaking, three identifiable patterns can be seen in the literature that help define how the rbv and oe approaches might be related. first, they can be viewed as independent explanations in which only one perspective is considered to explain a particular phenomenon with little consideration of the other. for example, much of the vertical integration literature (e.g., masten, 1984; monteverde & teece, 1992; walker & weber, 1984; see argyres, 1996 for a recent exception) and the international entry mode literature is grounded in oe (e.g., anderson & coughlan, 1987; anderson & gatignon, 19,86; see oviatt & mcdougall, 1994 for a recent exception), whereas the evolution of competitive advantage is usually grounded in the rbv (e.g., barnett, greve & park, 1995; levinthal & myatt, 1995). a second approach is to envision these perspectives as complementary, each offering insights that generally point managers and researchers in similar directions. the complementary view is, in part, found in the recognition that specific assets share an important quality with strategically valuable resources (e.g., amit & schoemaker, 1993; dyer, 1996). that is, specific assets are difficult to trade (chi, 1994), which is one of the conditions needed for a set of resources to meet the definition of strategically valuable (peteraf, 1993). this commonality explains why greater performance among firms with certain diversification postures can either be explained as the product of an efficient (i.e., governance cost minimizing) way to organize activities (e.g., hill, hitt & hoskisson, 1992; teece, 1980) or a strategy for exploiting strategically valuable resources in new markets (e.g. chatterjee & wernerfelt, 1991; markides & williamson, 1996; prahalad & hamel, 1990; robins & wiersema, 1995). in their examination of vertical integration, mcwilliams and gray (1995) have addressed a third view the relationship can be conflictive. this can occur when managerial action is directed toward delimiting resource constraints while governance conditions point elsewhere. grand strategies offer a context in which to study this managerial dilemma. grand strategies grand strategies refer to the alternative ways that firms can expand their scope (pearce, 1982). although each contains numerous variations, grand strategies can generally be categorized into four basic groups internal development, acquisition, joint venture, and long-term contracting (anderson & gatignon, 1986; erramilli & rao, 1990). firms engaged in internal development supply all 90 journal of business strategies vol 14, no.2 necessary resources and control operations by extending their hierarchy (barney, 1988; chatterjee, 1990). acquisitions involve the transfer of control from a previous set of owners to a new one (borys & jemison, 1989). a joint venture is a new organization is that is supported and controlled by two "parent" organizations (harrigan, 1985; koh & venkatraman, 1991). under long-term contracting, cooperating firms do not create a third entity. such arrangements are generally held together by the legal system (williamson, 1991), often with the aid of credible commitments by participants (teece, 1987). grand strategies are fundamental to business growth and have been studied in the context of diversification entry mode (e.g., chatterjee, 1990; yip, 1982), vertical integration (e.g., carney & gedajlovic, 1991; mcwilliams & gray, 1995), and geographic (primarily international) expansion (e.g., anderson & gatignon, 1986; hill, hwang & kim, 1990). as shown in table 2, the choice of grand strategy can reflect a response to either resource demands or governance conditions. thus, the grand strategies open a window into the potential conflict between the rbv and oe because they contain both a resource and a governance element. from the rbv, alternative expansion modes make different resource demands on the firm. internal development and acquisition demand that the firm supply all of the strategic and complementary resources needed to successfully implement an expansion effort (cf. barney, 1988; chatterjee, 1990). joint ventures and long-term contracts, in contrast, permit the firm to share its resource burden with external partners (borys & jemison, 1989; oviatt & mcdougall, 1994). thus, the latter offer means to overcome resource-based constraints to growth (erramilli & rao, 1990; ingham & thompson, 1?94; teece, 1987). grand strategies also serve as alternative arrangements for governance. that is, they are different methods for governing the behavior of organizational actors, each imbued with different governance cost incentives and penalties (e.g., anderson & gatignon, 1986; lafontaine, 1992; williamson, 1991; 1994). specifically, internal development and acquisition offer greater control over organizational participants because behavior can be monitored directly. the employment contract gives firms significant latitude to replace organizational participants who are not acting in the firm's best interests (williamson, 1991). when there are considerable incentives for an external partner to act opportunistically (e.g., because of the programmability of the work and/or specificity of assets involved), these grand strategies offer the tools to offset such risks. conditions that might foster opportunism among external partners are labeled here as high cost ofexternal governance. the behavioral controls offered by internal development and acquisitions, however, must be balanced against inefficiencies and inflexibility that can result from the larger bureaucracy created by these strategies (i.e., bureaucratic costsjones & hill, 1988; merton, 1945). long-term contracting and joint ventures, in contrast, can offer increased flexibility and efficiency because firms only pay for needed products or services. thus, when the risks of opportunistic behavior on fall 1997 combs & ketchen: toward a synthesis 91 table 2 grand strategies juxtaposed against resource-based and organizational economics criteria internal development acquisition joint venture long-term contracting pure market exchangel organizational economics criteria control flexibility [ mcwilliams & gray, 1995 • • ] high risk of opportunism low risk of opportunism [ . williamson, 1991 ] high low interorganizational interorganizational dependence dependence [ contractor & lorange, 1988 ] high control low control [ • anderson & gatignon, 1986 ] resource-based criteria high resource availability low resource availability [ ingham & thompson, 1994 ] high resource involvement low resource involvement [ erramilli & rao, 1990 ] internal external resource resource access access [ chatterjee, 1990 ] ·pure market exchange is not considered a grand strategy because the firm has not increased the scope of its operations. the part of an external partner is low, the firm will prefer to cooperate. these conditions are labeled here as low cost of external governance. propositions figure 1 presents a model that integrates the rbv and de in the context of grand strategy. in the model, strategy is influenced jointly by resource and governance conditions. the grand strategies, in turn, affect performance directly. 92 journal of business strategies vol. 14, no.2 figure 1 an integrative model of grand strategy and performance resource stocks governance cost conditions } grandstrategy performance effects of resource stocks and governance cost conditions on strategy the potential conflict between the rbv and de occurs when the firm's resourceversus governance-based contingencies push the firm toward different grand strategies (cf. carney & gedajlovic, 1991; mcwilliams & gray, 1995). specifically, what is a firm to do when it does not have access to the resource stocks necessary to use the governance cost minimizing strategy? such firms either have to cooperate with an external firm that can help delimit resource constraints or forego expansion opportunities. because cooperative strategies such as joint ventures and long-term contracts best delimit resource constraints by permitting independent firms to cooperate, these will be preferred when resource stocks are insufficient to permit the firm to achieve its growth objective independently (ingham & thompson, 1994). resource constrained firms simply have no alternative but to grow through long-term contracting or joint ventures, even when these are not the most efficient governance arrangements (mcwilliams & gray, 1995). if the resource stocks that are missing can be furnished by an external partner with little risk of opportunism, then the firm will take advantage of this low cost of external governance situation by contracting. thus, it is predicted that: proposition 1: when firms possess insufficient resource stocks under low cost ofexternal governance, long-term contracts will be preferred. conversely, when needed resources cannot be easily contracted for without considerable exposure to potential opportunism, joint ventures become the only viable option. the governance costs of contracting can be high because the firm must expose its strategically valuable resources to the external firm in order to create a configuration of resources sufficient for existing opportunities. under a long-term contract, the firm risks creating a competitor if its partner can, over time, imitate the firm's strategically valuable resources. similarly, there is considerable risk that after highly specific investments have been made by the firm, the partner could demand to renegotiate their contract as a condition for continfall 1997 combs & ketchen: toward a synthesis 93 ued cooperation. the advantage of ajoint venture is that both firms must make a credible commitment to the venture (hennart, 1988; teece, 1987). because each partner must expose its resources to potential loss, gains from opportunistic behavior are reduced. accordingly, we expect: proposition 2: when firms possess insufficient resource stocks under high cost of external governance, joint ventures will be preferred. when firms possess adequate resource stocks, the need to use strategy for resource accumulation is eliminated. hence, strategic choices will reflect minimization of governance costs. as mc williams and gray (1995) pointed out, firms that possess a complete set of strategically valuable resources have an incentive to control these resources tightly through company ownership because they are the source of above average returns. thus, resource-abundant firms can be expected to grow primarily through the grand strategies of internal development and acquisition. however, if the strategically valuable resources must be combined with complementary resources that can be contracted for at competitive prices and with little risk of opportunism then there is room for cooperation (mahoney & pandian, 1992; teece, 1987). under these low costs of external governance conditions, there is no reason for the firm to endure the bureaucratic costs and loss of flexibility that may accompany the internal development or acquisition of complementary assets. for example, a clothing designer may earn higher returns and increase flexibility by contracting for manufacturing and distribution activities. thus, when strategically valuable resources are sufficient, but the cost of external governance remains low, we expect firms to contract for any activities that are not central to their competitive advantage. stated formally: proposition 3: when firms possess sufficient stocks ofstrategically valuable resources under low cost ofexternal governance, they will prefer internal development or acquisition for those activities that depend on strategically valuable resources and long-term contracts for activities that depend on complementary resources. occasions also exist in which complementary activities must be so tightly linked to strategically valuable activities that it would be difficult for them to be conducted in different firms because of the risk of opportunism (e.g., sales and manufacturing of industrial products anderson & coughlan, 1987). when the firm is relatively resource rich, it has no incentive to expose its anticipated income stream to opportunistic behavior from external firms (mcwilliams & gray, 1995) and will thus engage new opportunities through internal development or acquisition. stated formally: 94 journal of business strategies vol. 14, no.2 proposition 4: when firms possess sufficient stocks ofstrategically valuable resources under high cost ofexternal governance, they will prefer internal development and/or acquisition. the four propositions above are visually depicted in figure 2. figure 2 proposed integration of resource stock and governance cost effects on grand strategy resource stocks sufficient insufficient high cost of external governance low internal development joint venture and/or acquisition internal development and/or acquisition long-term and contracting long-term contracting the distinction between internal development and acquisition depends on the firm's current configuration of resources (chatterjee, 1990; yip, 1982). if existing resource stocks can be employed in the new market, internal development is preferred. this might occur, for example, for brand extensions or geographic growth. however, if the configuration of resources needed to engage the target market differ considerably from existing resource stocks, acquisition is likely to be used to access needed resources. such would likely be the case for some types of diversification. thus, we offer the following corollaries to propositions 3 and 4: corollary 1: firms with sufficient stocks of strategically valuable resources will prefer internal development when the new activity is an extension of current resources. corollary 2: firms with sufficient stocks of strategically valuable resources will prefer acquisition when the new activity requires a new configuration of resources. fall 1997 combs & ketchen: toward a synthesis 95 grand strategy and performance because a distinguishing characteristic of strategic management research is its emphasis on performance (summer et ai., 1990; venkatraman & ramanujam, 1986), it is not enough to specify the influence ofresource stocks and governance costs on grand strategy. unless there are implications for performance, the value of matching strategy to resource and governance conditions is limited. above it was suggested that long-term competitive success rests first on the firm's capacity to access and exploit strategically valuable resources. it was predicted that when firms possess few of these resources, they will be prompted to engage in joint ventures and long-term contracting to gain the use of resources, even if governance cost conditions might predict otherwise. however, firms will still consider their governance cost conditions when selecting between joint ventures and long-term contracts. specifically, when high external governance costs conditions make cooperation potentially costly, firms will favor joint ventures. the expectation that governance cost will impact performance through strategy is based, in part. on the efficiency logic that underlies oe (barney & ouchi, 1986; hesterly et ai., 1990). that is, by responding appropriately to governance cost pressures, firms are selecting low cost alternatives. presumably, choosing the "correct" (i.e., low cost) strategy translates into better performance (hill & snell, 1988; williamson, 1994). taken together, we expect the following propositions to hold true: proposition 5: firms that engage in long-term contracting when their resource stocks are insufficient and their cost of external governance is low will perform better than firms that use other grand strategies under these conditions. proposition 6: firms that engage in joint ventures when their resource stocks are insufficient and their cost of external governance is high will perform better than firms that use other grand strategies under these conditions. when stocks of strategically valuable resources are sufficient, firms are expected to defer to oe concerns when selecting grand strategy. nevertheless, firms can increase their strategic flexibility and minimize bureaucratic costs by contracting for complementary activities when the cost of external governance is low. this additional efficiency should translate into improved performance. accordingly: proposition 7: firms that engage in the internal development or acquisition ofstrategically valuable resources and long-term contracting for complementary resources when resource stocks 96 journal of business strategies vol. 14, no.2 are sufficient and the cost of external governance is low will perform better than firms that use other grand strategies under these conditions. the luxury of contracting complementary activities is not efficient when the costs of external governance are high. the risk of opportunistic behavior is simply too severe considering the firm can access au needed resources internally. thus, we expect that: proposition 8: firms that engage in internal development or acquisition when stocks ofstrategically valuable resources are sufficient and the cost of external governance is high will perform better than firms that use other grand strategies under these conditions. discussion several implications can be drawn for research and practice from our synthesis of rbv and oe insights into grand strategies. for researchers, it appears that both perspectives are needed to fully explain choices among grand strategies. if so, empirical investigations that recognize both perspectives should enjoy greater predictive power than existing models. for practitioners, this integration offers guidance for selecting among grand strategies. specifically. the trade-offs in responding to resource versus governance contingencies may have an impact on performance. below we suggest that the nature of this trade-off changes as the firm grows and matures. implications for research the logic developed above indicates that the relationship between resource stocks and grand strategy depends on governance costs and the relationship between governance costs and grand strategy depends on resource stocks. the implication is that prior research examining any of the grand strategies from one perspective without consideration ofthe other should be viewed cautiously. likewise, future scholars focused on either resource stocks or governance costs should include measures of the other, at least as control variables, or they will face the risk of having an underspecified empirical model. indeed. models that include both rbv and de variables should have enhanced predictive power because more fully specified models have greater potential to explain variance. increased predictive power is important to managers who need to better predict competitors' behavior and to researchers who wish to use these models to better understand the link between strategy and performance. although our solution to the conflict between the rbv and de in the context of grand strategies is consistent with each perspective's prior empirical fall 1997 combs & ketchen: toward a synthesis 97 results, little has been done empirically to compare the joint effects of resources and governance conditions on grand strategy. examining these relationships in more detail will be an important next step for future inquiry. in this paper, we have examined rbv and de prescriptions regarding grand strategies without challenging any of the fundamental assumptions that underlie either perspective. thus, another potentially fruitful avenue of research may be to relax key theoretical assumptions (barney, 1990). indeed, an important body of literature has emerged contradicting de assumptions concerning the rational self-interested behavior of organizational participants (e.g., donaldson, 1990; moran, 1996). this research argues that organizational participants are, as often as not, trustworthy. that is, participants will act according to generally accepted ethical principles even when it is not in their rational self-interest to do so (hosmer, 1995). extant research suggests that the need for formal governance arrangements are diminished when a climate of trust prevails (chiles & mcmackin, 1996; granovetter, 1985; duchi, 1980). moreover, because trust may diminish the need for expensive formal governance arrangements, it can be viewed as a strategically valuable resource (barney & hansen, 1994). although it may be difficult to tease out behaviors based in trust versus self-interest, such an effort might give researchers insight into the extent to which trust affects the choice of grand strategy. future research could also benefit from increased understanding of the social and psychological antecedents of trust (granovetter, 1985; mayer, davis & schoorman, 1995). managerial implications the ideas developed in this paper have important implications for managers as well. modern organizations are forced to confront a staggering array of challenges, including rapid advances in information technology (fulk & desanctis, 1995), the emergence of new organizational forms (miles & snow, 1994), and the globalization of many markets (chang, 1995). under such conditions, understanding the relationship between strategy and performance is of great practical interest. indeed, a well-constructed strategy is one of the few weapons managers have available to help ensure the viability of the organization. building on prior research, this paper suggests that managers give resource issues primacy over governance concerns in grand strategy decisions. this was based on evidence from the rbv suggesting that deployment of strategically valuable resources is central to performance. nevertheless, as the de perspective points out, there is an efficiency loss when firms must cooperate with others through, for example, a joint venture to gain access to valuable resources when governance conditions dictate otherwise. although accessing a partner's strategically valuable resources may enhance performance, the apparent loss of efficiency might be expected to reduce profits vis-a-vis a competitor owning all needed resources. in time, however, the firm possesses two avenues for recovering this efficiency loss. first, trust between the firm and its joint venture partner can be built, 98 journal of business strategies vol. 14, no.2 which may negate the need for formal hierarchical governance (barney & hansen, 1994). second, the firm could use the joint venture to, over time, develop its own endowments and either acquire or shutdown its joint venture operations (hamel, 1991). under either scenario, the firm suffers a small short-term inefficiency in order to capitalize on strategically valuable resources over the long-term. overall, managers are encouraged to view increased deployment of strategically valuable resources as sources of increased revenue. their second concern should be to manage these resources as efficiently as possible with an eye toward building future resources. managers must be aware that this prioritization may require short-term inefficiencies as a price for enhanced long-term performance. conclusion the rbv and oe are increasingly popular views of organizational action. in the context of grand strategies, these views do not always point managers in the same direction. we have taken a step toward reconciliation of these views and drawn a link between resourceversus governance-based antecedent conditions, strategy and performance. future inquiry into grand strategies may enjoy greater predictive power by recognizing the contributions of each perspective. more importantly, managers can use insights from both views to better understand potential trade-offs and their impact on firm performance. references aaker, d. (1991). mauaiini brand eqyity: cm:litalizini on the value of brand naml;<. new york: free press. alchian, a. a., & demsetz. h. (1972). production, information costs. and economic organization. aml;<rican economic review. 62, 777-794. amit, r, & schoemaker. p. (1993). strategic assets and organizational rent. strate~ic manail;<ment journal. 14,33-46. anderson, e.• & coughlan. a. t. (1987, january). international market entry and expansion via independent or integrated channels of distribution. journal of marketing. li.71-82. anderson, e .• & gatignon, h. (1986). modes of foreign entry: a transaction cost analysis and propositions. journal ofinternational business studies. 17. 1-26. andrews. k. r. (1965). the concept of corporate strategy. homewood, il: irwin. argyres. n. (1996). evidence on the role of firm capabilities in vertical integration decisions. stratl;<iic management journal. 17. 129-150. fall 1997 combs & ketchen: toward a synthesis 99 barnett, w. p., greve, h. r., & park, d. y. (1995). an evolutionary model of organizational performance. strategic management journal. 15, 11-28. barney, j. b. (1986a). strategic factor markets: expectations, luck, and business strategy. management science. 32, 1231-1241. barney, j. b. (l986b). organization culture: can it be a source of sustained competitive advantage? academy of mana~mentreview. ii, 656-665. barney, j. b. (1988). returns to bidding firms in mergers and acquisitions: reconsidering the relatedness hypothesis. strategic management journal 9, 71-78. barney, j. b. (990). the debate between traditional management theory and organizational economics: substantive differences or intergroup conflict? academy of management review. 15,382-393. barney, j.b. (1991). firm resources and sustained competitive advantage. journal of management, 11, 99-120. barney, 1. b. (1995). looking inside for competitive advantage. academy of management executive. 9, 49-61. barney, j. b., & hansen, m. h. (1994). trustworthiness as a source of competitive advantage. strategic management journal. 15, 175-190. barney, j. 8., & ouchi, w. g. (l986).. qrzanizational economics: toward a new paradh~m for understanding and studyjng organizations. san francisco: jassey-bass. bergh, d. d. (995). size and relatedness of units sold: an agency theory and resourcebased perspective. strategic management journal. 16, 221-240. borys, b., & jemison, d. b. (1989). hybrid arrangements as strategic alliances: theoretical issues in organizational combinations. academy of management review. 14.234249. brickley, j. a., & dark, f. h. (1987). the choice of organizational form: the case of franchising. journal of financial economics. 18,401-420. carney, m., & gedajlovic, e. (1991). vertical integration in franchise systems: agency theory and resource explanations. strateg:ic manag:ement journal. 12,607-629. castanias, r. p., & helfat, c. e. (1991). managerial resources and rents. jqumal of management. 17, 155-172. chang, s. 1. (1995). international expansion strategy of japanese firms: capability building through sequential entry. academy of manag:ement jqurnal. 38, 383-407. 100 journal of business strategies vol. 14, no.2 chatterjee, s. (1990). excess resources, utilization costs, and mode of entry. academy of management journal. 33, 780-800. chatterjee, s., & wernerfelt, b. (1991). the link between resources and type of diversification: theory and evidence. strategic management journal. 12, 33-48. chi, t. (1994). trading in strategic resources: necessary conditions, transaction cost problems, and choice of exchange structure. strategic management journal. 15,271-290. child, j. (1972). organizational structure, environment and performance: the role of strategic choice. sociology, 6, 1-22. chiles, t. h., & mcmackin, j. f. (1996). integrating variable risk preferences, trust, and transaction costs economics. academy of management journal. 21, 73-99. coase, r. h. (1937). the nature of the firm. econometrica. 4,386-405. conner, k. r. (1991). a historical comparison of resource based theory and five schools of thought within industrial organization economics: do we have a new theory of the firm? journal of management. 17. 121-154. contractor, f. j., & lorange, p. (1988). why should firms cooperate? the strategy and economics basis for cooperative ventures. in f. j. contractor & p. lorange (eds.), cooperative strategies in international business (pp 3-30). lexington, ma: lexington. dierickx, i., & cool, k. (1989). asset stock accumulation and sustainability of competitive advantage. management science. 35,1504-1514. donaldson, l. (1990). the ethereal hand: organizational economics and management theory. academy of management review. 15, 369-381. dyer, j. h. (1996). specialized supplier networks as a source of competitive advantage: evidence from the auto industry. strategic management journal. 17,271-292. eisenhardt, k.m. (1989). agency theory: an assessment and review. academy of management review. 14, 57-74. erramilli, m. k., & rao, c. p. (1990). choice of foreign market entry modes by service firms: role of market knowledge. management international review. 30,135-150. fulk, j., & desanctis, g. (1995). electronic communication and changing organizational forms. organization science. 6, 337-349. ghoshal, s. & moran, p. (1996). bad for practice: a critique of the transaction cost theory. academy of management review. 21, 13-47. fall 1997 combs & ketchen: toward a synthesis 101 gomez-mejia, l. a., & balkin, d. b. (1992). determinants of faculty pay: an agency theory perspective. academy of management journal. 35,921-955. granovetter, m. (1985). economic action and social structure: the problem of embeddedness. american journal of sociology. 91, 481-510. hambrick, d. c. (1987). the top management team: a key to strategic success. california management review. 30, 88-108. hamel, g. (1991). competition for competence and inter-partner learning within international strategic alliances. strate~ic mana~ement journal. 12,83-103. hannan, m. t. & freeman, j. h. (1977). the population ecology of organizations. american journal of sociolo~y, 82, 929-964. harrigan, k. (1985). joint ventures and competitive strategy. strate~ic mana~ement jourlli!!.....2,141-158. hennart, j. f. (1988). a transaction costs theory of equity joint ventures. strategic mana~ement journal. 9,361-374. hesterly, w. s.• liebeskind, j., & zenger. t. r. (1990). organizational economics: an impending revolution in organization theory? academy of mana~ementreview. 15. 402-420. hill. c. w. l., hitt. m. a., & hoskisson, r. e. (1992). cooperative versus competitive structures in related and unrelated diversified firms. organization science. 3. 501521. hill, c. w. l., hwang, p., & kim, c. w. (1990). an eclectic theory of the choice of international entry mode. strate~ic mana~ement journal. 11. 117-128. hill. c. w. l., & snell, s. (1988). external control, corporate strategy, and firm performance in research-intensive industries. strate~ic management journal. 9, 577-590. hosmer, l. t. (1995). trust: the connecting link between organizational theory and philosophical ethics. academy of management review. 20, 379-403. ingham, h., s., & thompson, s. (1994). wholly-owned versus collaborative ventures for diversifying financial services. strateltic management journal. 15,325-334. jensen, m. c., & meckling, w. (1976). theory of the firm: managerial behavior, agency costs, and ownership structure. the journal of financial economics. 3, 305-360. jones, g. r., & hill, c. w. l. (1988). transaction cost analysis of strategy-structure choice. strategic management journal. 2, 159-172. 102 journal of business strategies vol. 14, no.2 koh, j., & venkatraman, n. (1991). joint venture formations and stock market reactions: an assessment in the information technology sector. academy of mana~ementjourm!.....3a, 869-892. lafontaine, f. (1992). agency theory and franchising: some empirical results. rand journal of economics. 23, 263-283. lamont, b. t., & anderson, c. r. (1985). mode of corporate diversification and economic performance. academy of mana~ementjournal. 28, 926-934. levinthal, d., & myatt, j. (1995). co-evolution of capabilities and industry: the evolution of mutual fund processing. strategic management journal. 15,45-62. lippman, s. a., & rumelt, r. p. (1982). uncertain imitability: an analysis of interfirm differences in efficiency under competition. bell journal of economics. 13,418-453. mahoney, j. t. (1992). the choice of organizational form: vertical financial ownership versus other methods of vertical integration. strate~ic mana~ementjournal. 13, 559584. mahoney, j. t., & pandian, j. r. (1992). the resource-based view within the conversation of strategic management. strategic management journal. 13, 363-380. markides, c. c., & williamson, p. j. (1996). corporate diversification and organization structure: a resource-based view. academy of management journal. 39, 340-367. martin, r. e., & justis, r. t. (1993). franchising, liquidity constraints and entry. applied economics.25,1269-1277. masten, s. e. (1984). the organization of production: evidence from the aerospace industry. journal of law and economics. 27.403-417. mayer, r. c., davis, j. h., & schoorman, f. d. (1995). an integrative model of organizational trust. academy of management review. 20, 709-734. mcwilliams, a., & gray, s. r. (1995). understanding quasi-integration. journal of busjness strategies. 12,69-85. mehra, a. (1996). resource and market based determinants of performance in the u.s. banking industry. strategic management journal. 17.307-322. merton, r. k. (1945). bureaucratic structure and person ali ty. sod al forces. 23, 405-415. miles, r. e., & snow, c. c. (1994). fit. failure & the hall of fame: how companies succeed or fail. new york: free press. fall 1997 combs & ketchen: toward a synthesis 103 monteverde, k., & teece, d. j. (1982). supplier switching costs and vertical integration in the automobile industry. bell journal of economics. 13,206-213. nelson, r., & winter, s. (1982). an evolutionary theory of economic chan~. cambridge, mat belknap. ouchi, w. g. (1980). markets, bureaucracies and clans. administrative science quarterly. 2.2., 129-141. oviatt, b., & mcdougall, p. (1994). toward a theory ofinternational new ventures.1.lllir:: nal of internutiqnal business studies. 25, 45-64. pearce, j. a. (1982). selecting among alternative grand strategies. california mana~ment reyiew. 24. 23-31. penrose, e. t. (1959). the theory of the firowth of the firm. new york: john wiley. peteraf, m. a. (1993). the cornerstones of competitive advantage: a resource-based view. stmteiic munaiement journal. 14, 179-191. pfeffer, j., & salancik, g. r. (1982). the external control of orianizations: a resource dependence perspective. new york: harper and row. powell, t. c. (1995). total quality management as competitive advantage: a review and empirical study. strateiic manuiem~ntjournal. 16, 15-37. prahalad, c. k., & hamel, g. (1990). the core competence of the corporation. hurvurd business reyiew (may-june), 79-91. reed, r., & defillippi, r. j. (1990). causal ambiguity, barriers to imitation, and sustainable competitive advantage. acllqemy of management review. 15, 88-102. robins, j., & wiersema, m. f. (1995). a resource-based approach to the multibusiness firm: empirical analysis of portfolio interrelationships and corporate financial performance. struteiic mana~mentjqyrnal. 16,277-300. roth, k., & q donnell, s. (1996). foreign subsidiary compensation strategy: an agency theory perspective. aca<lemy of munaiement journal. 39, 678-703. russo, m. v. (1991). the multidivisional structure as an enabling device: a longitudinal study of discretionary cash as a strategic resource. academy of management jomnal...m,718-733. shane, s. a. (1996). hybrid organizational arrangements and their implications for firm growth and survival: a study of new franchisors. academy of manaiement journal. .3.2., 216-234. 104 journal of business strategies vol. 14, no.2 stroh, l. k., brett, 1. m., baumann, j. p., & reilly, a. h. (1996). agency theory and variable pay compensation strategies. academy of management journal. 39, 751-767. summer, c. e., bettis, r. a., duhaime, 1. h., grant, j. h., hambrick, d. c., snow, c. c., & zeitham1, c. p. (1990). doctoral education in the field of business policy and strategy. journal of management. 16, 361 ~398. teece, d. j. (1980). economies of scope and the scope of the enterprise. journal of economic behavior and organization. 1, 223-247. teece, d. j. (1987). profiting from technological innovation: implications for integration, collaboration, licensing, and public policy. in d. j. teece (ed.), the competitive chal~. pp. 185-219. new york: ballinger. venkatraman, n., & ramanujam, v. (1986). measurement of business performance in strategy research: a comparison of approaches. academy of management review, 11, 801-814. walker, g., & weber, d. (1984). a transaction cost approach to make-or-buy decisions. administrative science quarterly. 29, 373-391. wernerfelt, b. (1984). a resource-based view of the firm. strategic management journal. 5" 171-180. williamson, o. e. (1975). markets and hierarchies: analysis and antitrust implications. new york: free press. williamson, o. e. (1985). the economic institutions of capitalism: firms. markets. and relational contracting. new york. macmillan free press. williamson, o. e. (1991). comparative economic organization: the analysis of discrete structural alternatives. administrative science ouarterly. 36, 269-296. williamson, o. e. (1994). strategising, economizing, and economic organization. in r. p. rumelt, d. e. schendel, & d. j. teece (eds.), fundamental issues in strategy pp. 361-402. boston: harvard business school. yip, g. (1982). diversification entry: internal development versus acquisition. strategic management journal. 3, 331-345. fall 1997 combs & ketchen: toward a synthesis 105 dr. james g. combs (ph.d., louisiana state university) is an assistant professor of management at the university of mississippi. his research interests include the resource-based view as a competing theory of the firm and the antecedents to inter-organizational cooperation, especially in the context of franchising. previous research has been published in the academy of manallement journal and the journal of small business mana~ement. dr. david j. ketchen, jr. (ph.d., penn state university) is an assistant professor of management at louisiana state university. his research interests include identifying the determinants of organizational performance, the nature and impact of organizational configurations, and sensemaking processes in organizations. prior research has appeared in such journals as academy of management journal, strategic management journal, and journal of management. toward a synthesis of the resource-based view and organizational economics in the context of grand strategies the d&o liability insurance policy in the small corporation kenneth w. hollman martin chair of insurance middle tennessee state university murfreesboro, tennessee h. ronald moser director, small business institute middle tennessee state university murfreesboro, tennessee joe h. murrey director, insurance excellence program university of mississippi oxford, mississippi at one time, service on the board of directors of a corporation was the ultimate status symbol-an accolade that businesses paid successful and leading citizens. duties were light and the rewards, both emotional and financial, were substantial. risk was almost nonexistent. directors did not often direct, and few were held accountable for not doing so ([4],[5]). however, the situation has changed in recent years. officers and directors are increasingly held accountable as fiduciaries. if a cause of action exists-perhaps due to a thoughtless slip or blunder-the director or officer may be exposed to personal liability in large amounts. ultimately, a personal liability claim could place all of a director's or officer's assets at risk. the risk of liability faced by the executives of even small corporations can be great. directors and officers of small corporations face suits by employees, stockholders, regulators, customers, and clients, just like their counterparts in larger ones. the risk is probably greater for directors and officers in large companies. however, there may be a greater likelihood in small corporations of claims arising from disputes between and among directors and officers, particularly in closely held family firms. also, small corporations are more likely than larger ones to be new, and they have higher failure rates. directors and officers are sometimes held accountable for such failures. in addition, small corporations are probably at least as susceptible as larger ones to merger, acquisition, or takeover attempts, which often precipitate lawsuits against directors and officers by disgruntled stockholders. several articles and books have been written on the underlying substantive liabilities of directors and officers ([1),[2],[7],[8]), but there is less information 10 concerning protection for them against the financial consequences of their wrongful acts.! most of the writings available are shaped in light of information on large corporations, with little consideration for small ones. the purpose of this paper is to close this informational gap by acquainting directors and officers of small corporations with techniques to handle loss exposures arising from alleged breaches of duty in their official capacities as directors and officers. the paper is divided into four sections. the first section discusses the two main alternatives available to the director or officer to deal with lawsuits brought against them: reimbursement by the corporation and the transfer of risk by insurance. the second section contains a discussion of recent trends in directors' and officers' liability insurance, including a tightening of the market that has forced premium rates upward and reduced available limits. the third section provides helpful hints for corporate managers who are thinking of purchasing such policies, and the fourth section contains the summary and conclusions of the paper. legal protection for directors and officers while directors and officers face potentially severe consequences for wrongful acts, they do have certain financial defenses available. first, they may look to the corporation, which may reimburse (indemnify) them for economic loss resulting from lawsuits. second, they' may look to specialized insurance contracts which provide a substantial measure of protection against gaps in coverage via corporate reimbursement. these alternative means of protection are discussed in turn below. mdemnification by company corporate reimbursement to directors and officers for their economic loss due to a successful legal challenge is authorized by statute in every state. some states permit flexibility as to whether such payments will be made, while others make them mandatory. when a defense against an alleged wrongful act is successful, there is certainly nothing improper in the reimbursement of an officer or director by the corporation. even when a defense is unsuccessful, repayment of expenses will often be sustained, and reimbursement for judgments and amounts paid in settlement are sometimes permitted, depending on the circumstances of the particular case ([6],[9],[10]). ithe leading wrongful 8ct allegation in director's and officer's (d&o) litigation is misleading representation. this may take the form of false or misleading statements in prospectuses, communications to stockholders, or registration statements. this class of wrongful 8ct comprised 25 percent of all allegations of wrongful conduct in 1984. the second most common 811egation in d&o claims in 1984 was collusion or conspiracy to defraud, 8ccounting for 12 percent of 811 claims. an example of an alleged offense under this cll.tegory would be conspiracy by directors and officers with the corporation in violation of the federal criminal conspiracy statutes. in descending order of frequency, the following types of allegations occounted for seven percent or more of 811 d&o suits in 1982: improper expenditures, breach of duty to minority stockholders, antitrust violations, interference with contractual rights, civil rights denial, and conflict of interest [18]. 11 it is important to note that corporate reimbursement is not always available to directors and officers for protection against defense costs and damage awards or settlements. for example, there are areas of lia~ility for corporate managers that are not indemnifiable. these include judgments or settlements in actions brought by stockholders where the court finds gross negligence, and liabilities for violations of federal securities laws. to this should be added those cases in which the corporation cannot indemnify because it is bankrupt or goes out of existence. to protect against gaps in coverage afforded by reimbursement statutes, or failure by the corporation to provide reimbursement, executives are advised to consider the purchase of directors' and officers' liability insurance (d&o insurance) ([6]'[7]'[16]). directors' and officers' lia bility insurance d&o insurance is a specialized type of professional liability coverage designed to protect a director or officer of a firm for liability due to breaches of duty resulting from negligence. 2 it remains one of the least understood types of insurance coverage because of the intricacy of the d&o contract and the complex situations in which it is asked to respond. insuring clause. the insuring clause or insuring agreement is the heart of any insurance contract. in the insuring clause of the d&o policy, the insurer agrees to pay on behalf of the insured for a loss or claim from actual or asserted wrongful acts that occur during the policy period. no reference is made to judgment in most d&o insuring clauses. contracts are framed to cover lack of good business acumen ([6],[7],[13]). the d&o contract covers losses due to judgments and settlements as well as costs of defense and appeals. subject to policy conditions and exclusions, the insured (defendant) may recover from the insurer even if the plaintiff wins the case ([7]'[12]). coverages. there is no standardization of the insurance written for d&o coverage, but carriers consider the exposure from two points of view. that is, the d&o policy provides hybrid coverage and is typically issued with two coverage sections. the first is called "corporate reimbursement coverage" and the other is called "directors' and officers' coverage" or " personal coverage." these coverages are discussed briefly below. corporate reimbursement roverage responds to indemnify the insured corporation for business-related legal fees or judgments that it incurs as a result of the indemnification it pays its directors and officers for their wrongful acts. in effect, corporate reimbursement coverage insures the corporation's obligations to repay its directors and officers where it is permitted or required to do so. d&o policies usually do not protect the corporate entity itself for direct actions which a plaintiff may bring against it. 2negligence involves the failure to act 8s 6 reasonable and prudent person would have acted in similar circumstances, or doing what a prudent person would not have done. 12 corporate reimbursement coverage is obtained and paid for by the corporation. all of the directors and officers in positions that are named in the contract are included in the coverage on a blanket basis. the contract also covers new positions that are created during the term of the policy, as well as new appointees to either new or old positions ([2]'[6]'[7]). personal coverage is the second part of the dual-form d&o policy. it is much more important to the individual director of officer, since they are most interested in protecting themselves in those cases where corporate reimbursement coverage is inapplicable, i.e., where the corporation cannot or will not indemnify them. for example, an unsuccessful director or officer defendant in a suit brought by the corporation for fraud is hardly in a position to ask the corporation (which has just won the suit) to reimburse him/her for defense costs and the award he/she is ordered to pay. for a single loss, personal coverage would not apply if corporate coverage applied. personal coverage protects directors and officers in the same named positions as would corporate reimbursement coverage, and the scope of coverage is similar for both. however, under the personal coverage provision, the indemnification is made directly to the director or officer for those sums for which he or she may become liable while acting in an official capacity. the premium cost for personal coverage is sometimes paid by the individual executive, in which case it is a tax-deductible item on the executive's personal income tax return, but it is usually paid by the corporation if the law permits ([2]'[7],[8]). claims-made coverage. the d&o policy provides coverage for wrongful acts of directors and officers that occur during the policy period if suit is brought during the policy period and proper notice is given. that is, the d&o policy is a "claims-made" policy. however, upon cancellation or nonrenewal the insured should report to the carrier any incident or situation that might give rise to a claim. then, any claim made after expiration/cancellation that arises out of the information reported will be treated as a claim made during the policy period. as noted above, there is no coverage for a claim brought after cancellation or non-renewal, unless circumstances surrounding the claim were previously reported to the carrier. however, there is a way in which directors and officers may protect themselves in these situations. through the use of an endorsement, coverage may be extended for up to 12 months beyond the cancellation or expiration date for wrongful acts alleged to have been committed during the policy period. inclusion of this extended-coverage endorsement in the policy has traditionally involved a cost of about 25 percent of the three-year premium, but this cost has risen in the past two years ([6]'[10]'[16]). exclusions. a lot of fine print and a number of exclusion clauses complicate the d&o contract. the most common exclusion is for any claim that can be covered under other insurance. d&o insurance is a form of business malpractice insurance and coverage is very broad, but the d&o policy is not a single global corporation legal liability policy. claims based on damage to 13 tangible property or on any type of bodily injury, disease, sickness, or death are excluded from all d&o policies. many of these types of claims can be covered by other policies such as worker's compensation insurance, property insurance, or general liability insurance policies. many d&o policies deny coverage for directors acting as fiduciaries (managers) of a pension or retirement plan. others insert a rider or special endorsement (with an additional premium) to the basic policy to cover some or all of any additional liability which directors face because of service on pension or retirement plans. a company not adding an endorsement or rider has the option of purchasing a separate insurance policy covering executives who act as plan fiduciaries. other exclusions that are common in newer d&o contracts are those relating to seepage or to pollution, contamination, or nuclear hazards. d&o carriers do not want to provide coverage for environmental impairment or nuclear disaster, which can be obtained in other policies. also, there is an exclusion in most d&o contracts when the suit is brought by a person covered by the policy. the purpose of this exclusion is to deny coverage when one stockholder group is fighting another for control of the corporation. another exclusion relates to any claim arising from a dishonest or criminal act of a director. the denial is based on the premise that acts harmful to the public interest should not be insured or reimbursed. finally, there is an exclusion for any claim based on the failure of directors to maintain an adequate program of insurance for the corporation. this mandate is included to promote the sale of other forms of insurance and to prevent the d&o contract from becoming a general, all-risk liability insurance policy ([6]'[14]'[15]). dedudibles and coinsurance. typically, the deductibles in the d&o policy are split between the two major coverages. the deductible on the personal coverage is usually lower than the deductible for the corporation itself on the corporate reimbursement coverage. the deductible must be borne by the insured and not be reinsured. coinsurance provisions in many d&o policies state that the carrier will pay a certain percent of each loss in excess of the retention, and that the insured will pay the remainder. the retention by the insured is typically five percent. however, it is sometimes possible to negotiate the elimination of the five percent coinsurance provision for coverages beyond certain limits, though underwriters have become increasingly reluctant to do so, particularly for smaller corporations. as with the deductible, coinsurance participation may not be insured with another carrier ([7),[10],[13]). recent trends in d&o coverage the d&o market is currently in a state of turmoil that has impacted the cost and availability of coverage. in some cases this has affected the ability of corporations to stay in business. several trends which have resulted from this crisis are noted below. 14 retention there is an increasing tendency for insurance companies to assume a smaller portion of the risk for directors' and officers' liability. underwriters look favorably on the corporate client that is willing to share some of the risk with the carrier. the risk can be shared through an increase in the deductible or through reduction of coverage limits. carriers began to increase the deductible when market conditions tightened in the early 1980's. the increase was most often imposed on the corporate reimbursement provision of the coverage. this has proven particularly damaging to small corporations, since 95 percent of all d&o claims fall under the corporate reimbursement provision of the policy ([3]'[17]'[18]). simultaneous with the increase in deductible, carriers began to lower coverage limits in a further effort to restrict loss exposure. one large carrier that specializes in d&o coverage for small corporations now has a $10,000,000 coverage limit along with a $1,000 deductible per individual director and officer. these retention levels are probably near the norm for the industry ([3],[6],[20]). coverage and company size d&o insurance protection remains more predominant among larger corporations than smaller ones, and the prevalence of coverage rises with the size of the organization. a partial explanation is that there is a high correlation between company size and the frequency of liability claims against directors and officers-medium and large companies are sued more often than small ones. only 62 percent of the corporations with less than $25 billion in 8ssets purchase d&o protection, and less than half the small businesses in certain industry categories purchase this coverage ([17], [20]). rates d&o premiums were at one time very low. some corporations purchased d&o insurance in the 1960's at prices not much greater than for a personal line automobile policy. the situation changed in the 1980's as lawsuits proliferated and the amount of court awards and settlements increased. some insurers withdrew from the hardening market, forcing long-time clients to fend for themselves in an increasingly hostile environment. for those carriers that remained, renewal prices were often a multiple of expiring prices. along with higher rates came underwriter-mandated restrictions and exclusions that greatly limited coverage. significant differences exist in d&o premium rates between large and small corporations. premium rates are proportionately higher for larger ones. however, rates tend to vary greatly even between companies of the same size. the amount a company pays depends, 8s in other lines of insurance, on the degree of exposure. the policy limits being afforded, vulnerability to legal action, the deductible and retention arrangements, past adverse publicity, and corporate profitability help determine the rates for a particular company. small closely-held (family owned) companies usually pay more than small 15 publicly-held ones because they are subject to domestic feuds ([2]'[11]'[19]). many directors' and officers' liability cases are settled out of court since corporations and their directors seek to avoid adverse publicity and to settle contested issues as quickly as possible. given the usually slow court process, a protracted case can damage a company's expansion plans, its stock market rating, and its relations with creditors. if a company loses a suit, this may force its d&o rates up, if it can get such coverage at all. also, a lawsuit can be harmful both professionally and financially to the directors and officers involved. therefore, corporate executives may prefer to avoid a public fight and settle out of court, if at all possible, even if they feel they are innocent. buyer's checklist economic realities indicate the the officer in charge of the small corporation's insurance program should exercise great care in the purchase of d&o liability insurance. the following suggestions and strategies may help that person in designing a professional liability risk management program for the protection of directors and officers. first, the application for d&o insurance should be filled out very carefully. policies typically contain restrictive language that limits the response for any wrongful act that took place prior to policy inception if any insured director or officer knew of that act. questions about knowledge of such prior acts should not be answered with a simple yes or no, but should be explained in detail. the corporation should utilize internal and external counsel in all phases of policy negotiation, particularly with respect to policy wording. second, the buyer of d&o coverage should request a quote from several different carriers. the pricing is uncontrolled and premium quotations vary significantly from company to company. senior management should keep itself informed of specific conditions in the market (price, availability, new exclusions) as well as the stability (likelihood of renewal) of the company's own placement. third, the renewal time frame should be reasonable for the broker or insurance carrier. renewal information should be in the broker's or carrier's hands no less than 120 days prior to policy expiration, to provide the broker or carrier with adequate time to prepare a renewal quotation. then, the corporation should insist upon the receipt of the renewal quotation no less than 45 days prior to expiration. timing is very important to insure that coverage is continuous. fourth, senior executives of small corporations in particular should ask the insurer to quote premium rates for coverage on directors and officers who, in the general interest and as a service to the subject corporation, sit on the boards of other profit or nonprofit corporations. at one time, this extension of coverage was quite common. however, in today's tight market, underwriters are becoming increasingly reluctant to offer it ([3],[15j,[21]). 16 summary and conclusion d&o liability insurance is the vehicle most frequently used to safeguard corporate officers and directors against the potential legal liability resulting from their managerial errors and omissions. despite the obvious need for d&o protection, a significant percentage of small businesses operate without it. many small businesses feel that they are operating fairly and honestly and see no need to purchase coverage to protect their officers and directors. however, executives of small as well as large corporations face potentially severe liability exposures, and the exposures may be as great for the directors and officers of small corporations as for those of larger ones. the market for d&o insurance has been very unstable in the past two years. renewal premiums have skyrocketed, policy limits have dropped dramatically, and nonnegotiable limitations and exclusions have become commonplace. while the full impact of the turbulence in the d&o marketplace is difficult to determine, one effect is that directors of many corporations, small as well as large, are choosing to leave their positions. those who stay are exercising greater care in the execution of their duties and insisting on adequate protection for themselves against charges of breach of duty or other wrongful acts. candidates for boards are concerned about becoming embroiled in legal entanglements that might place their personal assets at risk. reluctance by individuals with management experience to serve on boards of directors could be devastating to many small businesses. small corporations are often unable to attract highly qualified board members as quickly and easily as larger ones because their board positions offer less prestige. however, small businesses must be able to get top-notch directors to serve on their boards if they are to survive in today's highly competitive economy. as a corollary, those serving on boards should be free to make decisions regarding the business without fear of legal consequences. simply put, d&o insurance should be available to directors and officers at reasonable prices and without overly restrictive coverage. otherwise, it will become increasingly difficult for small corporations to induce competent businesspeople to serve on their boards of directors. references 1. bisler, roland m. ''the board of directors: major functions and responsibilities." american business review, january, 1985, pp. 29-34. 2. brockmeier, warren g. "directors' and officers' liability." professional liability: impact in the eighties. malvern, pa: the society of property and casualty underwriters, fall, 1983. 3. clarke, richard c. 'negotiating d&o without losing coverage." risk management, august, 1985, pp. 20-24. 4. dentzer, susan and wang, penelope. "empty seats on the board." newsweek, august 5, 1985, p. 46. 17 5. fitch, thomas p. 'the heat is on." united states banker, june, 1985, pp. 32-34. 6. gawel, michael s., jain, jagat p., and agnello, vincertt. "directors' and officers' indemnification insurance: what is being offered?" journal of the american society of clu, november, 1985, pp. 92-101. 7. johnston, joseph f., jr. protecting the corperate officer and director from liability. new york: practicing law institute, 1979. 8. knepper, william e. liability of corporate officers and directors. indianapolis, in: the allen smith co., 1978. 9. leisner, richard m. "boardroom jitters: a landmark court· decision upsets corporate directors." barron's, april 22, 1985, pp. 34-38. 10. mchugh, thomas m. ''do directors and officers need liability coverage?" financial ezecutive, april, 1980, pp. 42-48. 11. mcintire, kathryn j. '~acquisition, liquidation force new d&o plans." business insurance, april 25, 1980, p. 46. 12. nicolson, miklos. duties and liabilities of corporate officers and directors. englewood cliffs, n.j.: prentice hall, inc., 1972. 13. read, william e. corporate officers' and directors' handbook. englewood cliffs, n.j.: prentice-hall, inc., 1980. 14. rubin, harvey w. "an analysis of directors' and officers' liability exposures and appropriate insurance coverages." louisiana business review, may, 1977, pp. 1-4. 15. salvatico, albert l. "negotiating d&o coverage that fits the risk." risk management, january, 1986, pp. 16-19. 16. siver, edward w. the ezecutive guide to commercial property and casualty insurance. chicago, il: crain books, 1981. 17. taravello, steve. "directors' and officers' insurance." small business report, april, 1985, p. 29. 18. taravello, steve. "firms hiked d&o limits during 1984, study says." business insurance, january 21, 1985, pp. 1; 24. 19. taravello, steve. "large banks exploring coverage alternatives." business insurance, july 22, 1985, pp. 1; 83. 20. taravello, steve. ''many small businesses ignore d&o risk." businesl insurance, december 10, 1984, pp. 30-31. 21. taravello, steve and shapiro, stacy. "pssst... do you know a d&o insurer?" business insurance, july 29, 1985, pp. 1; 29. 18 the d&o liability insurance policy in the small corporation the ethical dilemma in the managerial accounting profession l. murphy smith department of accounting texas a&m university college station, texas james h. thompson department of accounting and finance auburn university auburn, alabama an ethical conflict may arise in the managerial accounting area because a management accountant is an employee, on the one hand, and a member of the profession, on the other hand. this issue can be viewed in light of two applicable theories of ethics: 1. utilitarianism this theory states that a certain behavior is acceptable if it results in the greatest good for the greatest number of people (3, pp. 4-5). while much of the social legislation adheres to this principle, this simple axiom contains some disadvantages. whether the greatest good is always served through social legislation remains debatable. in addition, inequity will result when the majority is not morally right. these disadvantages lead to a wider acceptance of a second major theory, deontology. 2. deontology this alternative theory states that the relationships among people have an importance which is separate from the results of these relationships. a person's position derives certain duties and responsibilities regardless of their effect on society. central to the theory of deontology is kant's "categorical imperative" which states that one should never act in a manner that he would not be willing to have his action serve as a universal law (3, pp. 5-6). in other words each time a given circumstance was encountered, one would respond in the same manner. the above theories suggest that business and in particular the managerial accountant have social and professional responsibilities as well as obligations to the employer. that is, there is more than just adam smith's "invisi18 ble hand" or milton friedman's "the business of business is business" at work in our economic system. history of ethical standards for management accountants in addition to the responsibility to his employer, the management accountant also has a responsibility toward his profession. while the managerial accountant has a responsibility to the development of his profession, the profession did not reciprocate in providing a written code of ethics to guide in the development of the management accountant until recently. the conditions established by the board of regents of the national association of accountants for awarding the certificate in management accounting (cma) require candidates to: 1. present evidence of good moral character and educational attainment, 2. pass, within a three-year period, a rigorous five-part examination, and 3. present evidence of at least two years of professional experience in managerial accounting. obviously, the management accountant must adhere to certain standards to become a cma. nevertheless, once the corporate accountant has attained this status, he looks to the profession which must offer some further written standards of conduct by which he is to abide. recognizing the obligation of management accountants to the organizations they serve, their profession, the public, and themselves to maintain the highest standards of ethical conduct, the national association of accountants (naa) issued statement on management accounting no. ic (sma no. ic), standards of ethical conduct for management accountants, in june 1982. sma no. ie describes the ethical standards to which a management accountantis to subscribe in order to achieve the objectives of management accounting. these standards are composed of four articles: competence, confidentiality, integrity, and objectivity. management accountants are instructed not to commit acts contrary to these standards nor to condone the commission of such arts by others within their organizations. the ethical dilemma this dilemma applies to any situation where the management accountant is required by corporate management to perform certain acts which ~ are counter to the ethical and moral standards of the accountant. as nash and hermanson stated: the managerial accountant is an employee of the company and owes a direct loyalty to those who pay his or her salary. in contrast to the independent auditor, who is expected to remain detached even aloof the managerial accountant is not an impartial observer of the company's fortunes, but must be com19 mitted to attainment of orgaftizational goals. the managerial accountant cannot afford to remain aloof but must be directly involved in the company's survival and development. (5, p. 13) because of the force that corporate management can exert upon the accountants, the management accountant might have found himself performing many acts that he would otherwise not do. understanding that the management accountant may encounter problems in identifying unethical behavior or in resolving an ethical conflict by applying the standards of ethical conflict, sma no. ic provides a resolution to ethical conflict that management accountants are to follow. first, the management accountant should follow the established policy of the organization bearing on the resolution of such conflict. if these policies do not resolve the ethical conflict, management accountants should consider the following courses of action: · discuss such problems with the immediate superior except when it appears that the superior is involved, in which case the problem should be presented initially to the next higher managerial level. if satisfactory resolution cannot be achieved when the problem is initially presented, submit the issues to the next higher managerial level. if the immediate superior is the chief executive officer, or equivalent, the acceptable reviewing authority may be a group such as the audit committee, executive committee, board of directors, board of trustees, or owners. contact with levels above the immediate superior should be initiated only with the superior's knowledge, assuming the superior is not involved. · clarify relevant concepts by confidential discussion with an objective advisor to obtain an understanding of possible courses of action. · if the ethical conflict still exists after exhausting all levels of internal review, the management accountant may have no other recourse on significant matters than to resign from the organization and to submit an informative memorandum'to an appropriate representative. except where legally prescribed, communication of such problems to authorities or individuals not employed or engaged by the organization is not considered appropriate (6, p. 3). relationship of ethical dilemma to utilitarianism and deontology in light of the two theories of ethics previously discussed, 'what should be the theoretical ethical base within which the management accountant resolves the ethical dilemma? utilitarianism is unacceptable on the grounds that accounting "decision-making" information cannot be prepared on the basis of providing the "greatest good for the greatest number of people. '1 management accounting information, by its very nature, must provide relevant facts for a particular business decision to be made by the decision maker. for the management accountant, there can be no utilitarian trade-off 20 to derive the greatest good; that is, the information is either relevant or not relevant to a decision and should if relevant be considered by the decision maker. the focus of deontology is on the role that the position, in this case one in management accounting, performs for society. the theory of deontology asserts that the actions of the management accountant must be based upon the "ideals" of the position. ideals (or standards) would include integrity, objectivity, technical competence, and confidentiality. these ideals will be examined in more detail in a subsequent section of this paper. deontology is the appropriate theoretical basis for the management accounting profession's "code of ethics." actions of management accountants should logically be governed by a code of ethics based on the management accountant's function in society. relationship of ethical standards to the ethical dilemma now that the written standards have been issued, a question then arises: will the standards help to resolve the ethical dilemma? to solve the ethical dilemma, three events must occur: first, there must be an improvement in the values of the individual. second, there needs to be a change in the moral tone of the corporate structure. and third, there needs to be a standard or code of ethics set for the managerial accounting profession (2, p. 6). from an individual's point of view, ethical judgments involve beliefs and values as well as morality. values grow out of our beliefs and are affected by our earlier experiences as well as our contact with society. any breakdown in the moral fiber resulting from the stress placed upon the accountant by management should cause a reassessment of his environment and society in general (4, p. 31). in considering the change in any ethical position of any individual, whether an accountant or not, the emphasis should come from within the individual. while an existentialist would indicate that a person shquld be solely responsible for his own behavior, one should not discount the fact that there are less than ideal individuals, and there are forces external to the individual that have an impact upon him. from the point of view of the corporate structure, corporate action flows from objectives and policies set at the top levels of management. to set proper realistic goals for all employees is one of the first steps that management can take to ensure an ethical organization. as a result, it is a primary responsibility of business management to instruct, motivate, and inspire their employees to conduct themselves with honesty, propriety, and fairness (2, p. 9). one of the primary actions management should take in setting the moral tone in a corporation is a corporate code. a recent survey developed by the )pinion research corporation revealed that 73% of the companies had titten codes of ethics (7, p. 47). this result shows that companies are more 21 and more conscious of the significance of corporate structure in solving the dilemma. from the point of view of the profession, it should be noted that a profession is formed on the basis of (1) a generally accepted body of knowledge (2) a widely-recognized standard of attainment, and (3) an enforceable code of ethics (8, p. 14). therefore, a code of ethics is an indispensable element in forming a profession. admittedly, the newly adopted code of ethics has, to some extent, cleared up the uncertainty involving the duties and responsibilities of the management accountant. while a code of ethics may not insure ethical behavior on the part of management accountants, it "will further buttress their inclination and their tendency to 'tell like it is'" (8, p. 15). as theodore purcell stated, "ethical codes are no panacea .... but they can help to clarify ethical thinking and to encourage ethical behavior" (2, p. 9). comparison to the ethical aspects of the public profession a review of the code of professional ethics of the american institute of certified public accountants (aicpa) reveals a striking similarity to the naa code. the aicpa code of professional ethics identifies five broad concepts: independence, integrity and objectivity; general and technical standards; responsibilities to client; responsibilities to colleagues; and other responsibilities and practices (1, pp. 4281-2). the following discussion briefly describes and evaluates the aicpa code in relation to the naa code. article i of the aicpa code primarily deals with the integrity and objectivity of an accountant, and his independence from those he serves. the public accountant is encouraged to be professionally prudent, maintain client confidentiality, and base his fees upon factors other than those contingent upon his findings. this article closely parallels the integrity and objectivity articles of the management accountant's ethical standards. in fact, integrity and unbiased objectivity are a self-regulating aspect of any profession, and the ethics of the individuals is its cornerstone. the key to the success of a system is based upon the individual's integrity, and consequently the key to the success of a profession is based upon its members' willingness to regulate themselves so as to assure the profession's longevity and to satisfy the public demand. the independence aspect of the aicpa code is notably different from any article in the naa code. the management accountant is entirely responsible to management rather than being independent from it. this different orientation is due to the inherent difference in the professions. article ii of the aicpa code deals with general and technical standards. a certified public accountant (cpa) should not render professional services without being aware of, and complying with, the applicable general and technical standards. article i of the naa code parallels this article of the aicpa code. management accountants have a responsibility to maintain an 22 appropriate level of professional competence by ongoing development of their knowledge and skills; performing their professional duties in accordance with relevant laws, regulations, and technical standards; and preparing complete and clear reports and recommendations after appropriate analyses of relevant and reliable information. article iii of the aicpa code deals with responsibilities to clients. this article requires the public accountant to hold in strict confidence all information concerning a clients' affairs which he acquires in the course of his engagement. this article closely corresponds to article iii of the naa code charging management accountants with the responsibility of confidentiality. for public accountants, this responsibility does not mean they should acquiesce if a client is unwilling to make disclosures in financial reports which are necessary for fair presentation. confidential information should not be disclosed by management accountants unless authorized or legally obligated to do so. article iv of the aicpa code deals with responsibility to colleagues. the public confidence and respect a cpa enjoys is largely the result of the cumulative accomplishments of all cpas, past and present. thus, support of colleagues is in the cpa's own interest as well as in the interest of the general public so as to not detract from their reputation and well-being. article ii of the naa code somewhat parallels this article of the aicpa code by the way in which a management accountant is expected to deal with subordinates. the management accountant is charged to inform subordinates as appropriate regarding the c,onfidentiality of information and to monitor their activities to assure the maintenance of that confidentiality. article v of the aicpa code deals with other responsibilities and practices. this article requires a cpa to conduct himself in a manner which will enhance the stature of the profession and its ability to serve the public. this article of the aicpa code is embodied somewhat within all four articles of the naa code. however, the management accountant is primarily concerned with loyalty to his company. as the resolution of ethical conduct of the naa states, communication of ethical conflicts to authorities or individuals not employed or engaged by the organization is not considered appropriate. the· similarity of the aicpa code to that of the naa code is substantial. while the aicpa code lists five articles and the naa code lists four articles, they in substance, deal with mainly the same issues. there are some important differences, but those differences are produced by differences in the professions themselves. conclusions as long as men are motivated by the desire to make a profit, there will always be some who will turn to unethical and dishonest methods. all that is required is a moral atmosphere that will promote ethical behavior. by 23 composing strong corporate and professional codes of conduct, a positive influence is imposed upon managerial accountants, as well as upon all of business. now that the naa has adopted a code of ethics, the managerial accounting profession, like the public accounting profession, will have a stronger influence on its members, as well as on the rest of the corporate structure. references 1. american institute of certified public accountants, a/cpa professional standards, volume b (new york: aicpa, june 1, 1984), pp. 4271-4342. 2. carroll, archie b., "linking business ethics to behavior in organizations," sam advanced management/oumal (summer 1978), pp. 4-11. 3. mery, c. mike and david f. groebner, toward a code of ethics for management accountants (new york: national association of accountants. 1981). 4. mobley, louis r., "should finance officers be concerned with ethics," government finance (february, 1977), pp. 31-36. 5. nash, john f. and roger h. hermanson, "wanted: a code of ethics for internal accountants," business (november-december, 1980), pp. 1217. . 6. national association of accountants, standards of ethical conduct for management accountants, statement on management accounting no. lc, oune i, 1983). 7. opinion research corporation, "code of ethics in corporations," directors and boards (summer 1980), pp. 45-60. 8. shultis, robert l., "ethics for the management accountant," georgia journal of accounting (spring 1982), pp. 10-16. 24 the ethical dilemma in the managerial accounting profession the relationship between minority business enterprises and corporate purchasing personnel: perceptions from both sides of the table james c. wimbush marc j. dollinger dan r. dalton indiana university bloomington, in cathy a. enz cornell university ithaca, ny catherine m. daily purdue university west lafayette, in abstract this paper addresses the nature of the difficulties mbes face when conducting business with large companies through mbe purchasing programs. data collected from mbes and purchasing personnel were analyzed with logistic regression to demonstrate that mbes and their corporate purchasing counterparts have different perceptions across human, environmental, and organizational dimensions of transaction cost economics. these differences help to explain the problems: (1) that mbes have in selling to large companies and the problems that mbes and purchasing personnel have in implementing mbe purchasing programs; (2) of reaching agreement in the marketplace; and, (3) of collectively pursuing the economic development of the minority business community. we offer recommendations for improving the relationship between these parties. introduction the development of a strong and independent minority business sector has been recognized as a major societal priority by all levels of government, the business community, and communities of racial minorities (bates & furino, 1985).1 the federal government, for example, requires large corporations with i this study was funded by the center for advanced purchasing studies, arizona state university, tempe, az. spring 1996 wimbush, et. al.: minority business enterprises 43 government contracts to contract and procure from minority business enterprises (mbes). according to public law 95-507 of 1978, contractors must report the percentage of their business that is allocated to small minority firms. the more directive public law 99-661 of 1986 requires department of defense contractors to purchase at least five percent of their business from small minority enterprises that are owned and operated by black, native, hispanic, and asian/pacific americans. however, each of these legislative mandates has been severely narrowed due to two recent supreme court rulings. in richmond v croson 1989 (gray and peery, 1990; rice, 1991) the court ruled that states must demonstrate specific patterns of discriminatory purchasing in order to justify set-asides. in adarand v pena 1995 (mydans, 1995) the court applied the strict test of croson to the federal government. but, in addition to federal legislation, programs have been established to provide minority business enterprises with opportunities for greater access to the mainstream of american business. to this end, hundreds of corporations not under federal mandate voluntarily pursue minority suppliers and vendors to increase opportunities for mbes, to generate minority employment, and to be socially responsible (spratlen, 1978; dollinger and daily, 1989). whether the action is voluntary or due to legislative mandate, the goal is for large companies to promote full participation of minorities in the american economic system. although the establishment of relationships between large companies and mbes is an indication of progress compared to the nature of the relationship several years ago, for many businesses, the mbe/large company relationship is wrought with problems. thus, attempts to meet legal requirements and voluntary efforts to aid in the economic development of minority businesses often end in failure and frustration for all parties (dollinger, enz and daily, 1991; bates, 1985; dowst, 1981; giunipero, 1980). this paper focuses on one aspect of the effort towards improving opportunities for mbes in corporate america: the nature of the difficulties small minority businesses have when conducting business with large companies through mbe purchasing programs. to this end we try to identify the reasons why the programs have not been as successful as they were expected to be by examining the perceptions of mbes and their corporate counterparts, corporate purchasing personnel (cpps), on key variables which affect the relationship. an understanding of the problems which exist between mbes and cpps in a purchasing relationship will enable mechanisms to be devised to improve their working relationships and, concomitantly, improve the role of the purchasing programs. the theoretical framework and perspective for the study is based on transaction costs economics (tce) theory. according to tee, high transaction costs impose a burden on the parties to a transaction, above and beyond issues such as price, quality, and delivery. this burden can prove to be an impediment to bringing the buyer and vendor together; a burden which may cause the negotiation process to break down (williamson, 1975; 1981; coase, 44 journal of business strategies vol. 13, no.1 1952; simon, 1957; thompson, 1967). thus, the major research question we address is: do mbes and cpps differ in their perceptions of the various costs of doing business; and, if so, does it impact the likelihood of successful transactions? we will proceed to address the research question by: (1) briefly describing tce and how it provides the basis for understanding the nature of the mbe/cpp relationship; (2) discussing how the major factors which influence transaction costs affect the mbe/cpp relationship; (3) suggesting avenues which may be taken to"improve the mbe/cpp relationship; and, (4) providing implications for research and practice. transaction costs economics and the mbe/cpp relationship tce and its basis for mbe purchasing programs transaction cost economics combines elements of organizational theory and microeconomics to explain market failure (walker & weber, 1984). transactions are the transfer of goods and services between technologically separate units, and 'transaction costs' are the costs associated with exchanges that vary independent of the prices of the goods and services sold (robbins, 1987). according to ouchi (1980, p. 130), transaction costs foster cooperation between parties who enter into an economic exchange arrangement. these costs are usually the result of difficulty in determining the value of the goods or services being exchanged, or from a lack of trust between the parties-a lack of trust which may stem from the uncertainty associated with engaging in new relationships. because parties to a transaction rarely have identical goals, an interdependency must be established to develop trust between the parties and to assure each party to the transaction a cooperative arrangement. a lack of trust may very well exist between mbes and cpps who have not entered into previous working relationships. large companies are concerned about whether mbes will be able to deliver the agreed upon services at or within the agreed upon time period, the quality of the services or goods rendered, and the overall stability of the mbe. especially if the mbe folds during the contract period or even after the goods or services have been delivered, the cpp may have substantial problems with future procurements, resolving any problems which develop with the already delivered goods or services, procuring replacement parts, or with obtaining follow-up service. in an attempt to alleviate these problems, according to tce theory, if mistrust exists then the mistrusting party will want, even demand, additional contractual protections (ouchi, 1980). however, placing costly, extra contractual obligations upon the mbes may foster in the mbe a mistrust of the large companies. the mbes mistrust in the large company may also stem from a feeling of vulnerability because the large company could decline to renew a contract after the mbe has undertaken the major expense to meet the company's needs. thus, due to a lack of trust, there would be a certain anxiety, if not reluctance, on the part spring 1996 wimbush, et. al.: minority business enterprises 45 of both parties about entering into a relationship. while the lack of trust is costly to both parties, however, we would argue that the cost is likely to be greater for mbes than large companies. corporate purchasing programs were developed to facilitate an exchange arrangement between the mbes and large companies. the arrangement is consistent with tce theory for these programs were established to eliminate barriers which may hinder the development of a relationship between the parties. the purpose of the program is to reduce the uncertainty which fosters the mistrust at most, and concern at the very least, about the perfonnance and sustenance of mbes. major factors which influence transaction costs tce theory specifies that the costs of contracting across a market can vary by three factors: human decision makers, properties of the markets (environmental factors), and the internal structures (organizational factors) of the firms (pearson, fawcett and cooper, 1993). if the costs of overcoming these factors are too high or the gap between the parties too large, no contract will be forthcoming. this type of situation defines market failure. human factors. the major human factors which may lead to market failure are complexity and opportunism. complexity refers to the limits people experience in formulating and solving problems and in processing infonnation. people intend to be rational, but when there is a great deal of complexity, rationality may be difficult. perceptions and values may differ, adding to the complexity (bnz, dollinger and daily, 1990). the presence of complexity leads to high contracting costs (e.g., time consuming negotiations, legal expenses, etc.). however, the costs imposed by complexity may be borne more heavily by the mbe than the cpp of a large company because the owner of a relatively small mbe probably participates in the work flow of the business, performs and supervises several tasks, and represents the firm in major negotiations with cpps. the purchasing agent, on the other hand, has significantly fewer duties-all of which are related to procuring a narrow set of specialized items. to reduce complexity, the purchasing agent can often refer to a purchasing manual of procedures or call upon staff specialists to sort out the details of complex specifications or contracts. the mbe does not have these resources at her or his disposal and, therefore, must readily engage in complex information processing in which multiple concepts related to both procurement and other tasks associated with the business must be juggled simultaneously. opportunism, too, may affect mbes and cpps differentially. opportunism represents shrewd, egoistic behavior whereby, people act according to their own exclusive self-interest without regard for the impact their actions have on their employer, peers, customers, employer's competitors, or society-at-iarge. people who intentionally make inaccurate statements and empty promises, for example, are behaving opportunistically. the consequences of opportunistic be46 journal of business strategies vol. 13, no. 1 havior may affect the mbe more severely than the cpp. most companies with mbe purchasing programs, for example, espouse the importance of the program's contribution to corporate objectives. however, all agents, including cpps, are susceptible to the moral hazard of acting in their own personal best interests which may diverge from corporate objectives. the presence of opportunism, then, can lead to increased costs of monitoring transactions, auditing contracts andlor structuring incentives so that agents' motives coincide with corporate objectives. in addition, corporate purchasing personnel can mislead mbes. the false promise of a large contract can result in the overextension of an mbe's financial and operating resources. the sudden cancellation of an on-going relationship without explanation by the cpp can devastate the mbe. so, while mbe opportunism is little threat to the survival and success of a large company, many forms of corporate opportunism can have major detrimental consequences for the mbe. therefore, we hypothesize that: hi: due to resource differences, complexity of contracting is perceived to be higher by the mbe than by cpps. h2: the threats to survival due to opportunistic behaviors are perceived to be higher by mbes than by cpps. environmental factors. the major environmental factors which influence transaction costs are the presence of small numbers of mbes and uncertainty about their performance. small numbers can increase searching costs for purchasing personnel since mbes in certain industries and geographical areas are hard to find or do not even exist. pearson et al (1993) reported that increasing minority business visibility was a major objective of minority firms. the small numbers problem makes renegotiation of mbe contracts more challenging and awkward because a buyer will not want to lose a high performing mbe knowing how difficult it will be to replace that firm in the buyer's portfolio. moreover, many cpps have no experience at all in dealing with minority firms. this unfamiliarity increases the time' and energy that cpps must devote to understanding the mbe firm. lastly, the sparsity of mbe firms in certain geographic/industry areas places a strategic constraint on the buyer. having multiple mbes from which to choose will help to foster a favorable degree of competition among the mbe firms, enabling the large companies to receive the best service or goods. thus, corporate purchasing programs may work best where there are a number of firms available to large companies. performance uncertainty refers to the managerial and technical ability of the parties to fulfill the specifications of the contract. for many minority owned firms, the opportunity to do business within an mbe purchasing program may be the big "break" that turns a struggling business into a profitable one. this makes it necessary for the mbe to minimize the perception of perspring 1996 wimbush, et. ai,: minority business enterprises 47 formance uncertainty when pursuing corporate contracts. however, larger vol~ urnes, strict performance tolerances, and short deadlines can prove to be chal~ lenges that tax the resources of the mbe. these uncertainties can impose costs on cpp which can jeopardize the contract. uncertainty may lead to increased monitoring of mbe firms, increased inspection, and the provision of training and managerial assistance for mbes. therefore, we hypothesize that: h3: due to the small number of mbes, the costs offinding and un~ derstanding mbes is perceived to be higher by cpps than by mbes. h4: due to managerial and technical ability, peiformance uncertainty is perceived to be higher by the cpps than by the mbes. organizational factors. the major organizational factors which can potentially increase transaction costs are information asymmetry and negotiation atm mosphere. when asymmetry is present, the party to the transaction without the needed information has to incur a cost to procure this information (or negotiate a suboptimal contract). information asymmetry may affect either the corporation or the mbe, but is likely to be a larger problem for the mbes. buyers have information costs related to finding, certifying the qualifications, and monitoring the performance of mbes. but, mbes face an even higher cost. they typically are not a part of the network which provides advance notice and information concerning forthcoming contracts. thus, they become aware of potential contracts very late in the process or even after bids are due. more~ over, the mbe owner often must negotiate alone in the bureaucratic maze that often characterizes procurement programs. atmosphere refers primarily to the nature of the climate in which negotiations evolve and take place. when the atmosphere of a negotiation is hostile and discriminatory the parties may never reach agreement. the costs of this fiasco are' borne by both sides, but perhaps more heavily by the mbe. there may be several plausible explanations for a hostile atmosphere. first, many cpps have had limited experience dealing with racial and cultural minorities and may have unfavorable preconceived notions about engaging in a working relationship with an mbe (enz et ai, 1990). these preconceived notions may be linked to a certain degree of stigmatization associated with being in an mbe program. secondly, cpps report a "backlash" against the actual and perceived special treatment for, and affirmative action given to, mbes. therefore, the use of "old-boy networks" composed of "comfortable" vendors instead of the employment of competitive bidding may seem to be prudent from the cpps' viewpoint, but is a violation of purchasing ethics and often serves to discriminate against racial and cultural minorities. therefore, we hypothesize that: 48 journal of business strategies vol. 13, no. 1 h5: due to information asymmetry, mbes are perceived to incur a higher cost to procure information than cpps. h6: due to the atmosphere of negotiations, mbes are perceived to incur a higher cost of doing business than cpps. avenues for improving the mbe/cpp relationship activities which may serve to prevent the potential market failure facing mbes and corporations fall into five general categories: (1) monitoring activities, (2) searching activities, (3) activities designed to improve perfonnance quality, (4) activities designed to mitigate the atmosphere problem, and, (5) activities which internalize the mbe/cpp relationship (pearson et al, 1993). monitoring activities are designed to provide contracting parties control and audit capabilities over the contracting process. induded in this process are the mbe purchasing program itself as well as the fonnal contract negotiation. examples of monitoring activities include perfonning credit checks on mbes, auditing the corporate mbe purchasing program and monitoring subcontractors' compliance with federal regulations. these activities may help to reduce uncertainty and infomlation asymmetry by providing the parties with timely data. monitoring may also mitigate problems of opportunism by reducing the chances of non-detection of opportunistic behavior. if each party stands to gain from its own opportunism, then it must be deterred in order to provide a climate conducive to good faith negotiations and for sustenance of a mutually beneficial reciprocity nonn. monitoring will enable cpps to receive assurances, through certification of the mbe, that the mbe will help them meet the company's goals and target level of mbe involvement. by the same token, mbes benefit from certification because the process eliminates "front" organizations that are not truly minority owned and operated, thereby, providing maximum opportunity for authentic mbes. furthermore, a series of successful certifications for an mbe may enhance its legitimacy and reputation with buyers. searching activities are designed to assist large companies with identifying potential mbe parties with whom to contract. these search activities may include attending mbe trade fairs, placing advertisements in the mbe press to publicize opportunities, or automating procurement lists for mbe bidding. search activities represent an effort to overcome the problems of small numbers, bureaucratic complexity, and infonnation asymmetry. these activities are hypothesized to benefit mbes because they supplement the mbe's marketing system by bringing the corporate customer directly to the mbe's door. quality assurance activities are designed to increase the probability that mbes will successfully perform the contract. these activities are achieved by the large company providing mbes with management, financial, and technical spring 1996 wimbush. et. at.: minority business enterprises 49 assistance to minimize expense to the mbes. however, mbes invest time, energy, and human resources for these activities. thus, quality assurance activities not only cost large companies but mbes, too. cultural interaction activities promote racial and cultural understanding between the parties. examples include affirmative action for the hiring of minority buyers, special training for buyers in the problems of mbes and multicultural diversity, and social events at which mbes and buyers have the opportunity to interact. these activities may partially ameliorate the atmosphere problem previously discussed. to the extent that the parties to the contract are able to relate to each other well interpersonally, they will be able to conduct their negotiations without rancor and racial prejudice. internalization activities bring the mbe within the usual arms length contracting relationship. efforts toward internalization include engaging in joint ventures with mbes, investing in venture capital pools for mbes, and giving mbes access to corporate training programs. by bringing the mbe partially inside the large company, many of the human, environmental, and organizational barriers may be offset. to the extent that business uncertainty is a cost factor, for example, corporate equity participation in the mbe venture may help insure the success of the mbe as an on-going firm. mbes, therefore, have potentially much to gain by the lowering of the transaction costs which may inhibit the success of mbe purchasing programs. thus, mbes may tend to look more favorably than cpps upon the policies, procedures and activities that remove, shift, delay, or mitigate the incurring of transaction costs of mbes. typically, these policies and activities have the effect of transferring costs to the corporation. cpps may also favor these policies and activities but only to the extent that they shift costs away from the individual buyer and onto another administrative unit, either somewhere else in the organization or outside the organization, (e.g., a governmental agency that certifies minority status). therefore, it is hypothesized that: h7: mbes will favor more strongly than cpps, activities designed to improve the performance of mbe purchasing programs in the following areas: monitoring, searching, quality assurance, cultural interaction. and internalization. methodology sample a field study was conducted in two phases in order to test the seven hypotheses (dollinger and daily, 1989). in the first phase, interviews were held around the country with the owners of ten mbe firms as well as cpps from thirteen large companies. corporate participants were selected at random from the membership lists of the national association of purchasing management. among the corporate participants in this stage were northern telecom, us 50 journal of business strategies vol. 13, no. 1 west, arca, nabisco brands, and eli lilly. minority participants were selected from the try us '88 directory of minority business. the interviews were conducted at the subjects' places of business and provided preliminary support for the applicability of the tce framework. the problems of complexity and bounded rationality emerged from our interviews. subjects repeatedly referred to the problems of the corporate bureaucracy and details of bidding procedures. both mbes and corporate purchasing agents were able to give many examples of opportunistic behavior. false promises were often mentioned by mbes as examples. purchasing personnel were sensitive to the minority "front" organization. from the interviews we discerned the issues of small numbers and performance uncertainty. these were emphasized by the purchasing people, but also acknowledged as problems by the mbes. without a critical mass of high quality suppliers, the mbes felt they were always going to be viewed suspiciously and would incur extra monitoring costs. lastly, the "atmosphere" problem was discussed in the interviews. neither side was reluctant to talk about racism, although most admitted it was usually hidden within the protocols of the bidding procedure. the corporate people mentioned what they called a "give-me" attitude that polluted their negotiations. the mbes noted the distasteful remarks and condescending attitudes by purchasing agents. the initial phase provided the basis for the development of the questionnaire used in phase two. the second phase of this study was then administered in three parts. mbes were surveyed at random from the try us '88 directory of minority business (minneapolis, minn.). four hundred and seventy five questionnaires were sent, 166 usable responses were received (two mailings) for a response rate of 35 percent. the mbes surveyed represented 83 different 4-digit sic codes and 112 different 3-digit zip codes. the second group sampled consisted of cpps. twenty three of 83 firms approached from the membership of the national minority supplier development association agreed to participate (27.7%). from these 23 firms, 547 usable questionnaires were returned from cpps-purchasing agents (buyers), their managers, corporate staff involved in mbe purchasing programs, and corporate executives with mbe responsibility. the corporate respondents represented 103 corporate divisions, 102 separate 3-digit zip codes and 21 4-digit sic codes. measures scales were developed from a .list of items to capture the transaction cost dimensions and activities (see appendix a). a factor analysis of scale items revealed that uncertainty was two dimensional, therefore two scales, one for business uncertainty and one for production uncertainty were created. similarly, monitoring and searching were separated into two dimensions, one for mbes and one for large companies. quality assurance had three dimensions: financial, managerial, and technical. table 1 presents an overview of the measures, spring 1996 wimbush, et. al.: minority business enterprises 51 summary statistics and reliabilities for the scales. in every case, the reliability of the measures were well within acceptable standards (nunnally, 1978). table 1 overview of dimensions of transaction cost and activities variables dimensions of transaction cost variables complexity costs imposed by complex rules and procedures. 17 items, alpha = .70 opportunism costs of opportunistic, unethical, or illegal behavior. 4 items, alpha = .62 small numbers costs associated with a small number of sellers. 8 items, alpha = .70 business uncertainty costs of firm's uncertain future. 4 items, alpha = .79 production uncertainty costs of uncertain production quality. 5 items, alpha =.71 information asymmetry costs of both parties not having information. 7 items, alpha = .77 atmosphere costs of hostile environment. s items, alpha = .75 monitoring mbes . control and audit capabilities. 6 items, alpha =.71 monitoring companies control and audit capabilities. 11 items, alpha = .87 searching for mbes identification of mbes for contracts. 6 items, alpha = .64 searching for companies identification of companies for contracts. 6 items, alpha = .81 financial assurance activities to reduce financial uncertainty. 3 items, alpha = .78 managerial assurance activities to reduce managerial uncertainty. 4 items, alpha = .56 technical assurance activities to reduce technical uncertainty. 3 items, alpha = .74 cultural interaction promoting racial and cultural understanding. 3 items, alpha = .64 internalization activities to bring mbes within reach of company. 4 items, alpha = .78 52 journal of business strategies results vol 13, no.1 demographics the mbe sample was mostly nonwhite (84.3%) and male. the respondents in the mbe sample who identified themselves as white were either women or may have represented a cultural minority such as hispanic. on the other hand, the cpp sample was mostly white. blacks represented 7.7% of the cpp sample. there was no statistical difference in responses based on race. table 2 presents an overview of the characteristics and demographics of the sample. table 2 characteristics of the mbe and cpp samples mbe cpp (n=166) (n=547) # % # % race: caucasian 26 (5.7) 474 (86.7) black 65 (39.2) 42 (7.7) hispanic 41 (24.7) 10 (1.8) asian-american 26 (15.7) 8 (1.5) native american 8 (4.8) 13 (2.4) sex: male 109 (65.7) 370 (67.6) female 56 (33.7) 174 (31.8) not stated 1 (.6) 3 (.6) education: less than high school 3 (1.8) 0 (0.0) high school graduate 16 (9.6) 38 (6.9) some college 43 (25.9) 128 (23.4) college graduate 39 (23.5) 203 (37.1) some graduate school 25 (15.1) 100 (18.3) graduate degree 40 (24.1) 74 (13.5) age in years: (mean) 45.5 41.4 tenure on job in years: (mean) 11.2 5.6 title (mbe) !t. % owner 138 (83.1) senior manager 28 (16.9) title (cpp): !t. ~ buyer 374 (68.4) manager 173 (31.6) spring 1996 wimbush, et. al.: minority business enterprises 53 with regard to education, the cpp group was comprised of more college graduates. interestingly, however, the high percentage of minority respondents with graduate degrees (24.1 %) suggest that minorities who might otherwise be productively employed in large companies, have found an alternative in entrepreneurship. there was a statistically significant (f::::19.70, p<.ool) difference between the mbe (11.2 years) and cpps (5.6 years) for the length of tenure on the job. this may be indicative of the turnover which occurs in corporate purchasing. the ownership of a small, established business is apparently a more stable endeavor. the mbe sample was composed of owners (83%) and senior level managers (28%), the people in the best position to know their firm's experience with corporate purchasing programs. over half of the corporate respondents identified themselves as buyers (68.4%), while 31.6 percent identified themselves as managers of buyers. the respondents in the cpp sample occupied positions which had direct line responsibility for executing mbe purchasing programs. hypotheses testing hypotheses 1-7 explored whether there were differences between the mbes and cpps on the following transaction costs: complexity, opportunism, small numbers, performance uncertainty, production uncertainty, information asymmetry, atmosphere, monitoring of mbes, monitoring of large companies, searching for mbes, searching for large companies, financial assurance, technical assurance, managerial assurance, cultural interaction, and internalization. to test these hypotheses two sets of analyses were conducted. t-tests were conducted to identify differences between the two groups on each variable. the results, as shown in table 3, revealed that significant differences existed on au variables except for two-cost of monitoring mbes and the small number of mbes. while these results are instructive, a more conservative approach would dictate a multi-variate procedure whereby all independent variables can be simultaneously assessed. accordingly, the next set of analyses relied upon logistic regression for hypotheses testing. because the wald statistic rapidly loses power as the absolute value of the regression coefficient increases (e.g., hosmer & lemeshow, 1989; norusis, 1990), we will use the likelihood-ratio (l-r) approach. the lr approach also has the advantage of ease of interpretability inasmuch as it can be used as the functional equivalent of hierarchical multiple regression. moreover, the l-r approach also has elements of a discriminant function analysis in that it provides familiar "hit-rate" information as well. table 4 shows the results of logistic regression analysis. the initial (i.e., baseline) log-likelihood statistic was 464.09 (based only on the constant of the regression equation in an l-r approach, not any of the 16 transaction cost variables) and the hit-rate was 78.43 percent. this result 54 journal of business strategies table 3 t-test for differences between mbes and cpps on transaction cost variables vol. 13, no. 1 variables complexity opportunism small numbers business uncertainty production uncertainty information asymmetry atmosphere monitoring of mbes monitoring of corps. searching for mbes searching for corps. financial assistance managerial assistance technical assistance cultural interaction internalization mbe mean 42.28 21.43 34.80 13.63 18.11 35.54 31.49 36.01 62.44 34.22 35.56 14.48 22.07 15.03 16.71 20.99 cpp mean 47.92 16.18 34.18 15.83 19.47 25.93 23.36 36.48 54.63 30.66 31.08 9.46 21.14 12.28 15.17 16.40 ·5.80*** 14.72*** .89 ·4.38*** -2.91 *** 15.17*** 13.21 *** ·.88 7.94*** 7.39*** 9.90*** 12.23*** 2.64** 7.77*** 5.04*** 10.34*** *p < .05; **p < .01; ***p < .001 table 4 results of logistic regression model variables logmodel chimodel sig. likelihood square improve hit rate baseline 464.09 .000 78.43 final model 248.134 mbes searching financial assurance managerial assurance atmosphere internalization small numbers production uncertainty opportunism information asymmetry 215.96 215.96 .000 88.54 is intuitive. based on the sample itself, we know that 78.43 percent of the subjects are corporate. clearly, then, any observer would simply choose the corporate designation if asked to guess which category that any given data spring 1996 wimbush, et. at.: minority business enterprises 55 point might appear. this person would be correct, of course, some 78.43 percent of the time. the next step considers the importance of the inclusion of independent variables into the model. initially, 16 variables were entered. based on an iterative procedure, the l-r approach evaluates each variable in turn and determines which subset of independent variables results in the most robust model. table 4 in the "final model" section illustrates the results of this procedure. notice that only variables (1) mbes searching for large companies, (2) financial assurance, (3) managerial assurance, (4) atmosphere, (5) internalization, (6) small numbers, (7) production uncertainty, (8) opportunism, and, (9) information asymmetry are so included. the final model log likelihood is 248.13, for a model chi-square and improvement chi-square of 215.96 (p<.ooo). notice, too, that the hit rate has been improved to 88.54 percent. from this we see that the inclusion of: mbes searching for large companies, financial assurance, managerial assurance, atmosphere, internalization, small numbers, production uncertainty, opportunism, and information asymmetry result in a far more robust model. table 5 provides a more precise indication of the contribution of independent variables to the model. as expected, all variables in the final model are statistically significant. in addition, the odds ratio (noted as exp[b] in table 5) provides some indication of the magnitude of contribution as well. an odds ratio of "1," for example, would indicate no relationship with the dependent variable. such a variable, of course, would not be included in the final model. as odds ratios deviate from 1, greater absolute deviations are properly interpreted as stronger individual relationships with the dependent variable. accordingly, it would seem that, while all the included variables are statistically significant, managerial assurance, atmosphere, and opportunism provide the greatest explanatory power. table 5 logistic coefficients in final model variable b s.e. wald df sig r exp(b) -.1594 .0416 14.7048 1 .0001 -.1655 .1864 .0565 10.8798 1 .0010 -.1383 .3104 .0624 24.7393 1 .0000 .2214 .1962 .0732· 7.1801 1 .0074 .1056 -.1417 .0587 5.8356 1 .0157 -.0909 .1014 .0312 10.5582 1 .0012 .1358 .0986 .0365 7.3056 1 .0069 .1069 search for company financial managerial atmosphere internalization small numbers production uncertainty uncertainty opportunism information asymmetry constant -.2583 -.0838 3.8522 .0534 .0304 1.2616 23.3733 7.5804 9.3236 .0000 .2146 .0059 -.1097 .0023 .8526 .8299 1.3639 1.2168 .8678 1.1067 1.1036 .7723 .9196 56 journal of business strategies discussion vol. 13, no. i the results of this study demonstrate that mbes and their corporate purchasing counterparts have different perceptions across all three dimensions of transaction costs: human, environmental, and organizational (hypotheses 1-6). mbes and purchasing personnel differed on all the variables except the effects of small numbers. these differences empirically demonstrate, the problems that mbes have in selling to large companies and the problems that mbes and purchasing personnel have in implementing mbe purchasing programs, in reaching agreement in the marketplace, and in couectively pursuing the economic development of the minority business community. for the mbe, the stakes of successfully participating in an mbe purchasing program are quite high; therefore, they view the transaction costs as hurdles to be overcome regardless of cost (to the large company). corporate purchasing people have a lower stake in the problem. while they too identify transaction costs as hurdles, they are rather less willing to engage in costly activities to overcome barriers to contracting. on all of the activities variables (i.e., activities to prevent mbes from market failure with large companies), except monitoring of mbes, there was a significant difference between the mbes and cpps (hypothesis 7). thus, when considered in tandem with the results of the analysis of the transaction costs variables, the implication here is that mbe purchasing programs do not prevent "market failure." the transaction costs which impede contracting between minority firms and large companies are borne more heavily by mbe firms, and activities designed to shift or remove these costs are less favored by corporate personnel. although the mission of mbe purchasing programs, to increase mbe procurement, is simple, the implementation of these programs is complex and challenging. within an efficiency context, the logic of mbe procurement would dictate the internalization, or takeover, of these minority firms. this, of course, is a common reaction by large companies experiencing supply problems. however, this strategy fails to meet federal guidelines or social objectives. based on this study, it can be concluded that currently mbe purchasing programs are ineffective as a means of equalizing or mitigating mbe transaction costs. structures designed to reduce or shift transaction costs for both mbes and corporate personnel would seem to be in the interests of both. implications for mbes the results of the study suggest that selling to large companies is not a panacea for mbes, especially those that utilize the mbe purchasing programs. for au of the benefits derived from having large corporate customers, mbes still incur costs. these costs are inherent in the transaction, and may not be recognized directly as accounting type costs, but they nonetheless reduce the effectiveness of the mbe firm. mbes would be advised to broaden their customer base beyond corporate purchasing programs and sell to other small firms spring 1996 wimbush, et. al.: minority business enterprises 57 and midto large-size firms that do not have special mbe purchasing responsibilities. a second recommendation for the mbe owners is for them to recognize that there are structural impediments that occur when selling to a large company; that is, not all conflict is racially motivated. when transaction costs are present, the mbe can do at least three things to make it easier for the corporation to do business. first, mbes should freely provide information to reduce uncertainty about their business operations and their capabilities to deliver quality goods and services. secondly, mbes should request infonnation from corporations concerning their procurement needs, policies and timetables before becoming involved in costly and prolonged negotiations and conflicts. this information seeking would help to reduce the information asymmetry which currently exists. the prepared mbe helps reduce the costs of complexity by being prepared for the transaction. a final recommendation for mbes is for them to make use of organizations which exist to reduce the transaction costs between large companies and mbes (e.g., regional supplier development councils). effective liaisons are designed to be matchmakers and bring mbes together with corporate managers who have procurement responsibilities. they also help to monitor mbe and corporate behavior within these transactions, and can serve as ombudsman for either side when the transaction costs increase such that they threaten the relationship. implications for corporate management the present study suggests new directions for mbe purchasing programs. the first recommendation for cpps and mbes is to work harder at implementing the programs as they are now configured. ,this means addressing the impediments directly and focusing on those activities which reduce transaction costs between mbes and cpps. reducing complexity, increasing the pool of qualified mbes, improving the atmosphere for negotiations, encouraging trust while implementing disincentives for opportunistic behavior, minimizing business uncertainty, and keeping information lines open in both directions may have this effect. however, it serves to the advantage of the cpp, not mbe. a second recommendation is to employ mechanisms to shift transactions costs away from the decision makers, namely, the cpps and the mbe owners. this may uncouple the decision to contract from the high costs of executing and monitoring the contract. administrative units or personnel are needed to absorb these shifted costs. this could take the form of staff specialists who are outside of purchasing, specialists within purchasing but not responsible for contract negotiating, or units outside of the firm altogether such as minority purchasing councils. effective minority purchasing councils are capable of absorbing these transaction costs (and covering the expense with its dues and membership fees) and facilitating agreements. they can also provide economies of scale (size) and scope (range of activities) that a single purchasing 58 journal of business strategies vol. 13, no. 1 organization can not achieve. however, it is recognized that the minority purchasing councils may also have problems similar to those faced by the mbe: barriers and insufficient power. a third recommendation addresses the criteria for evaluating the results of mbe purchasing programs. it is recommended that corporations adopt multiple criteria for evaluating their programs and the performance of their purchasing personnel. quantitative goals like total sales dollars and the federal quota are useful, but limited. indeed, sometimes these targets can be used against promoting minority business because a filled quota is often frowned upon and an unattainable dollar figure (in the absence of sanctions) tends to make people cynical. qualitative goals and criteria with the flexibility to allow many different modes of success are recommended to augment current methods. the final recommendation is to experiment with some innovative programs suggested by the results of the study. these innovations fall under the heading of "internalization." they require the mixing of corporate and mbe resources, assets, money and people in a manner that is less than arms-length contracting. internalization is a way to bring the mbe and corporation together either physically or contractually for a self-defined limited time period, so that, once the firms are separated and once again legally distinct, the transaction costs will be permanently reduced. an mbe incubator facility, for example, would reduce the business and production uncertainty transaction costs factors by providing resources and by securing monitoring capability. an incubator facility is an overhead sharing device that allows a number of small businesses to share space costs, administrative overhead, and specialist employees. with corporate financial assistance and monitoring, an incubator would enable cpps to directly observe the progress of the mbes, and enable the mbes immediate access to corporate personnel and information. the mbes would no longer be "outsiders" with all the barriers of selling to a large company to overcome. another example of internalization would be a program similar to an affirmative action program for recruiting college students. except with this program, minority students would be recruited for special training with the goal of eventually pursuing an entrepreneurial opportunity. during the minority person's training, he or she would be exposed to the large company's operations which might be best suited to mbe procurement. then, when the trainee leaves the company, that individual is uniquely suited to act as a supplier to his or her prior employer. while it is recognized that this may be a relatively expensive program for the large company, it serves the purpose of lowering the transaction costs of later procurement. there is also potential for product innovation and development. implications for human resources management there are implications from the findings for human resources management for the large company as well as the mbe. these implications are grounded spring 1996 wimbush, et. al.: minority business enterprises 59 in the basic premise of tce. according-to ouchi (1980), organizations can rely upon socialization as an efficient, and the principle mechanism, for mediation or control. socialization is necessary because new or prospective employees will not share the same devotion to the values and mission of the organization. such socialization would allow the basis for reciprocity to be established and maintained among employees of both parties. however, it is important for both parties to recognize that the socialization is more than mere discussions about what is valued at the company (be it an mbe or large company), but an inclusive approach to shaping employees' behavior. we believe companies should be more socially responsible to minority finns therefore, socialization would consist of formal and informal programs for teaching new employees about the values and philosophy of the firm as well as the procurement programs and their purpose, a mechanism for evaluating performance, and a reward system designed to further reinforce the company's value of working with minority firms. for it is through common values and beliefs that the occurrence of opportunistic behavior is mitigated, if not eliminated. it is also through this process of socialization that the nature of the mbelcpp relationship is more fully understood, hopefully, to the extent that any stigmatization for mbe participation is erased. references axelrod. r. the evolution of cooperation. new york: basic books, 1984. bates, t. and a. furino. "a new nationwide data base for minority business." journal of small business manaji!ement 23 (1985): 41-52. coase, r. ''the nature of the firm," in readjnji!s in price theory. eds. stigler and bouldingood, homewood, il: irwin, 1952. dollinger, m., c. enz, and c. daily. "impediments to purchasing from minority small businesses: a tansaction cost approach." journal of purchasing and materials manaument 27 (1991): 9-14. dollinger, m. and c. daily. "impediments to minority purchasing programs: a transaction costs perspective." center for advanced purchasini studies, arizona state university, phoenix az, 1989. dowst, s. "sure route to better minority sourcing." purchasinji! 8 (1981): 77-81. enz, c., m. dollinger, and c. daily. "value orientations of minority and non-minority small business owners: a focus on customer relations." entrepreneurship: theory and practice 15 (1990): 23·35. giunipero, l. "differences between minority and non-minority suppliers." journal of purchasini and materials manaiement 16 (1980): 2-8. 60 journal of business strategies vol. 13, no. 1 gray, b. and b. peery. 'the u.s. supreme court's croson decision: effects on small businesses contracting with non-federal public entities." journal of small business mana~ement 28 (1990): 56-59. hosmer, d.w. and s. lemeshow. applied logistic regression. new york: john wiley & sons, 1989. mydans, s. "challenging the concept of 'disadvantaged'; white contractor gets court review." new york times june 18, 1995. norusis, m.j. spss advanced statistics. chicago: spss, inc., 1990. ouchi, w.g. "markets, bureaucracies, and clans." administrative science ouarterly 25 (1980): 129-141. pearson, j., s. fawcett, and a. cooper. "challenges and approaches to purchasing from minority-owned firms: a longitudinal examination." entrepreneurship; theory and practice 18 (1993): 71-88. rice, m. "government set-asides, minority business enterprise and the supreme court." public administration review 51 (1991): 114-122 robbins, j. "organizational economics: notes on the use of transaction cost theory in the study of organizations." administrative science ouarter1y 32 (1987): 68-86. simon, h. models of man. new york: wiley, 1957. spratlen, t. ''the impact of affirmative action purchasing." journal of purchasing and materials management 14 (1978): 8-11. thompson, j. organizations in action. new york: mcgraw hill, 1967. walker, g. and d. wever. ''transaction cost approach to make or buy decisions." administration science ouarterly 29 (1984); 373-391. williamson, o. markets and hierarchies. new york: free press, 1975. williamson, o. "the economics of organization: the transaction cost approach." american journal of sociology 87 (1981): 548-577. spring 1996 wimbush, et. at.: minority business enterprises appendix a minority business enterprise purchasing program survey 61 the purpose of this survey is to investigate some of the issues of minority business enterprise (mbe) purchasing programs and the potential solutions to these problems. your cooperation is vital. please answer all of the questions as best you can. your answers are completely confidential; only the researchers at the center for advanced purchasing studies and indiana university will see this survey. thank you for your help. instructions: on the following pages are statements used to describe problems of minority business enterprise (mbe) purchasing programs. read each statement carefully and think about your own company. then indicate whether you (1) strongly disagree, (2) moderately disagree, (3) slightly disagree, (4) neither agree nor disagree, (5) slightly agree, (6) moderately agree, or (7) strongly agree with the statement by circling the appropriate number next to the statement. 1 2 3 4 strongly moderately slightly neither disagree disagree disagree agree nor 5 6 7 slightly moderately strongly agree agree agree 1. doing business with large corporations is not very profitable for mbes. 2. finding contracts to bid is time-consuming for mbes. 3. mbes have difficulty advertising their products/services. 4. corporations apply their purchasing regulations inconsistently. 5. it is difficult for mbes to get information from corporations. 6. corporations don't get the word out about their mbe programs. 7. it is hard to match the mbe firm with the corporation's need. 8. the designation of "minority business" hurts mbes. 9. subcontractors don't help mbes. 10. mbes can't compete with bigger firms. 11. buyers don't know much about minority-owned firms. 12. mbes need technical assistance. 13. buyers are inconsistent in implementing the mbe program. 14. buyers use mbes just to satisfy statistics. 15. buyers don't work closely with mbes. 16. corporatons don't give much feedback to mbes. 17. corporations take too long to pay. 18. it's hard for mbes to get their foot in the door. 19. mbes become disillusioned with corporate bureaucracy. 20. mbes are often undercapitalized. 21. there is a lack of corporate commitment to mbe purchasing programs. 1 234 5 6 7 1 234 567 1 2 3 4 5 6 7 1 234 5 6 7 i 2 3 4 5 6 7 1 234 5 6 7 i 234 567 1 2 3 4 5 6 7 1 2 345 6 7 1 234 5 6 7 1234567 1 234 5 6 7 1 234 5 6 7 1 2 3 4 5 6 7 i 234 5 6 7 1 234 567 1 2 3 4 5 6 7 1 2 345 6 7 1 234 5 6 7 1 2 345 6 7 1 2 345 6 7 62 journal of business strategies vol. 13, no. 1 appendix a minority business enterprise purchasing program survey cont'd 1234567 strongly moderately slightly neither slightly moderately strongly disagree disagree disagree agree nor agree agree agree 22. mbes are powerless to negotiate favorable terms. 23. cultural misunderstandings hurt mbe purchasing programs. 24. mbes need long lead times to correct quality problems. 25. buyers rely on their "old-boy networks" for supplies. 26. only small-volume orders are placed with mbes. 27. the government doesn't enforce the regulations on mbe purchasing. 28. lead times for mbe quotes are too short. 29. lead times for mbe deliveries are too short. 30. mbes are not available in specialized areas. 31. buyers are not aware of available mbes. 32. mbes don't expand their businesses to meet corporate needs. 33. mbes are naive/inexperienced with the corporate world. 34. mbes are not price-competitive. 35. buyers lack information on mbe capability. 36. mbes can't handle the paperwork. 37. mbes can't meet bid/quote deadlines. 38. mbes hide problems that they are having. 39. racial biases hurt mbe purchasing programs. 40. buyers have no incenteive to make mbe purchasing program work. 41. mbes have a "give-me" attitude. 42. the mbe pruchasing program is all politics. 43. mbes are clustered in a few industry areas. 44. mbes are clustered in a few geographic areas. 45. performance by mbes is too uncertain. 46. mbes have poor bidding practices. 47. buyers feel stress and conflict reaching mbe purchasing goals~ 48. mbes have inefficient production capacities. 49. subcontractors are impossible to monitor. 50. mbe distributor and wholesale business blocked by national agreements. 51. unions prevent subcontracting to mbes. 52. corporate resources to develop mbes is a costly process. 53. corporations don't have the imagination to make mbe programs work. 54. identifying and qualifying mbes is a costly process. 55. individual buyers are out on their own when it comes to mbe programs. 56. high buyer turnover hurts long-term relationships with mbes. 1 2 345 6 7 1 2 345 6 7 1 2 3 4 5 6 7 1 2 345 6 7 1 2 3 4 5 6 7 1 234 567 1 2 345 6 7 1 2 3 4 5 6 7 1 2 3 4 5 6 7 1 234 5 6 7 1 2 345 6 7 1 2 3 4 567 1 2 345 6 7 1 234 5 6 7 1 2 3 4 5 6 7 i 2 345 6 7 i 2 3 4 5 6 7 1 2 3 4 5 6 7 1 2 3 4 5 6 7 1 234 5 6 7 1 2 3 4 5 6 7 1 2 345 6 7 1 2 345 6 7 1 2 345 6 7 1 2 3 4 5 6 7 1 2 345 6 7 1 2 3 4 5 6 7 1 2 345 6 7 1 2 3 4 5 6 7 1 2 345 6 7 1 2 3 4 5 6 7 1 2 345 6 7 1 2 3 4 5 6 7 1 2 3 4 5 6 7 1 2 3 4 5 6 7 spring 1996 wimbush, et. al.: minority business enterprises appendix a minority business enterprise purchasing program survey cont'd 63 1 2 strongly moderately disagree disagree 3 slightly disagree 4 neither agree nor disagree 5 slightly agree 6 7 moderately strongly agree agree 57. mbe purchasing programs are at odds with efficient purchasing practice. 58. mbe programs lead buyers to compromise their professional standards. 59. mbes have high failure rates. 60. mbes sometimes act as a "front" for non-minority business. 61. mbes lack qualified engineering personnel. 62. mbes lack qualified managerial personnel. 63 mbes lack qualified sales personnel. 1 2 345 6 7 i 2 345 6 7 i 2 345 6 7 i 2 3 4 5 6 7 i 2 345 6 7 i 2 3 4 5 6 7 i 2 3 4 5 6 7 instructions: below are activities that are sometimes used to implement aspects of minority business enterprise (mbe) purchasing programs. read each statement carefully and think about your own company. then indicate whether you (1) strongly disagree, (2) moderately disagree, (3) slightly disagree, (4) neither agree nor disagree, (5) slightly agree, (6) moderately agree, or (7) strongly agree that the activity should be part of a large corporation's mbe program by circling the appropriate number next to the statement. 1 2 3 strongly moderately slightly disagree disagree disagree 4 neither agree nor disagree 5 slightly agree 6 7 moderately strongly agree agree this item should be part of a large company's mbe purchasing program i. provide or use a certification process. 2. offer management assistance. 3. engage in joint ventures. 4. employ company expediters to offer aid to mbes. 5. give mbes access to company technical resources. 6. make company internal training available to mbes. 7. sponsor mbe attendance at business education programs. 8. offer materials management and supply help. 9. hold quality assurance meetings. 10. offer loans or loan guarantees to mbes. ii. offer subsidies to mbes. 12. develop national agreements with black/hispanic groups. 13. attend mbe trade fairs. 14. place ads in the minority press. 15. establish prepayment agreements. i 2 3 4 5 6 7 i 2 3 4 5 6 7 i 2 3 4 5 6 7 i 2 3 4 5 6 7 i 2 3 4 5 6 7 i 2 345 6 7 i 2 3 4 5 6 7 1 2 3 4 5 6 7 i 2 345 6 7 1 2 345 6 7 i 2 345 6 7 1 2 3 4 5 6 7 1234567 1 2 345 6 7 i 2 345 6 7 64 journal of business strategies vol. 13, no. 1 appendix a minority business enterprise purchasing program survey cont'd 1 2 strongly moderately disagree disagree 3 slightly disagree 4 neither agree nor disagree 5 slightly agree 6 7 moderately strongly agree agree 17. invest in venture capital pools for mbes. 18. waive restrictive requirements. 19. employ automated monitoring/tracking of mbe agreements. 20. monitor mbe participation in subcontracts. 21. implement program audits. 22. help with bid preparation. 23. train purchasing agents in problems of mbes. 24. require performance bonds. 25. perform credit checks. 26. check references. 27. check letters of credit. 28. set specific purchasing target goals for mbes. 29. establish an mbe advocate program within the company. 30. develop capability to monitor mbe purchases. 31. visibility and commendations for buyer participation in mbe program. 32. get top management involved in mbe purchasing program. 33. organize a permanent in-house task force. 34. offer monetary incentives for buyers who meet or exceed mbe goals. 35. take a leadership role in mbe economic development in the community. 36. challenge non-minority suppliers to become involved. 37. simplify bidding process. 38. have an mbe vendor listing available to all departments. 39. establish an mbe program in every department. 40. employ automated data bases for mbe procurement. 41. disseminate long-term purchasing. 42. provide feedback to unsuccessful bidders. 43. publish general information on supply procudures. 44. publish list of buyer names. 45. publish list of commodities sought. 46. list large volume opportunities. i 234 5 6 7 1 2 345 6 7 1 2 345 6 7 1 2 3 4 5 6 7 i 2 345 6 7 1 234 5 6 7 i 2 345 6 7 1 2 345 6 7 1 2 345 6 7 1 2 345 6 7 1 2 345 6 7 1234567 1 2 3 4 5 6 7 1 2 3 4 5 6 7 1234567 i 234 567 1 234 5 6 7 1 234 5 6 7 2 3 4 5 6 7 i 2 3 4 5 6 7 i 2 345 6 7 i 2 345 6 7 1 2 345 6 7 1 2 345 6 7 i 2 345 6 7 i 2 345 6 7 i 2 345 6 7 i 2 345 6 7 i 2 345 6 7 i 2 3 4 5 6 7 the relationship between minority business enterprises and corporate purchasing personnel: perceptions from both sides of the table volume 31, number 2 283 marketization and its impact on the functional focus, relational focus, and character of guanxi ties jie g. fowler valdosta state university • valdosta, georgia timothy h. reisenwitz valdosta state university • valdosta, georgia abstract prior research generally neglects how guanxi is used for marketing purposes by managers, and ignores possible differences in guanxi during marketization. in contrast, this paper argues why and how marketization may affect the marketing uses of guanxi, types of persons involved, and nature of their guanxi ties. as background, it provides an overview of salient features of marketization policy and marketplace conditions in three stages of marketization. it explains the functional focus, relational focus, and character of guanxi ties, and how managers are likely to use guanxi for strategic purposes at various marketization stages. introduction in 1982, xu min sat in his office working on a five-year production plan with a group of his colleagues. the doors to the west and, in particular, western investment had only recently been opened by deng xiao ping in 1979. just a few years before, the government still regulated the production and the market system, what little of it was effective. now, with the open door policy and other reforms, xu min expected to transition into a new way of doing business that set aside guanxi, the art of building personal relationships, in favor of more practical and effective methods. it wasn’t until after 1984 that any of the expected changes actually began to happen. the state-owned enterprise (soe) that xu min was in charge of began to face greater competition as a direct result of the open door policy. sales and demand both began to increase as well. but even though change had come, xu min and his colleagues still had to rely on guanxi to access the necessary market information, to look for expertise in various industry silos, and to negotiate with the state agencies and suppliers. guanxi had not disappeared as expected, but it had expanded. instead of simply focusing upon relationships with state agencies and suppliers, xu min had to actively build relationships with new clients. xu min knew that it was now 284 journal of business strategies absolutely critical to have good guanxi with new buyers because if he was accepted as part of the “family,” then he and his company could have more contracts. so he and his colleagues worked hard to build guanxi with these potential customers, sending them gifts and taking them out to dinner and even doing them favors when they could. by 1992, xu min had completely cast aside the notion that the market system would replace the necessity of building guanxi as the practice of doing so expanded yet again. as more policies were implemented to help reform the industrial system in china, his organization began to face increased opportunities as well as even more competition from both domestic and, now, foreign firms. new guanxi relationships—not just with potential and current clients, suppliers, and state agencies—needed to be built to help pave the way for his business. xu min now began to build guanxi with various industrial and other business groups. though the nature of guanxi may have changed, he expected that the art of guanxi would never end. in recent years, global firms have also begun to strategically use guanxi in china. for example, the ceo of leveno has developed guanxi with low-cost suppliers to reduce the production cost (biediger et al. 2004). volkswagen shanghai has established guanxi with local chinese suppliers, which allows them to have overnight shipments (yang 2011). hong kong billionaire, ka-shing li, has used guanxi to win licenses and permission to develop real estate in mainland china. he acknowledged that guanxi has been an “admission ticket” (balfour 2007). in addition, kfc has used guanxi to obtain licenses quickly and prevent regulatory hurdles (luo 2000). in 1987, guanxi played a central role when kfc opened its largest chain in tiananmen, beijing (luo 2000). coke intentionally placed its headquarters in beijing, as it is convenient to access resources in the central government there (tangen 2013). coke also gave its first three bottling plants directly to the chinese government as “gifts,” which later has allowed coke to expand its sales and distribution in many areas in china. guanxi has also been used in other contexts, such as employment. for example, jerry lui, who joined p&g in shanghai along with his 80 “friends” in 1997, called this action, guanxi, a bonding experience (balfour 2007). guanxi, as a governance mechanism, generally refers to a personal connection in china, which helps firms to gain favorable/unfavorable social capital (carlisle and flynn 2005; lin and si 2010), facilitate knowledge transferring (guo and miller, 2010; ramsamy, goh and yeung 2006), build competitive advantage (fock and woo, 2003), influence channel power (zhuang, xi and tsang 2010), and impact organizational performance (luo, huang, and wang 2012). however, previous research stresses economic aspects of marketization and gives little attention to how volume 31, number 2 285 guanxi is used for marketing purposes. in contrast, we argue that marketization affects guanxi’s qualities and that the purposes of guanxi, types of persons involved, and nature of their ties as marketization unfolds. as such, this research offers theoretical insights on differences in the functional focus, relational focus, and character of guanxi ties in different marketization stages. though china is in the third marketization stage, marketization has not been equally implemented in, or equally affected, all regions and parts of the economy. for example, the last stage of marketization is less of a factor in non-coastal than in coastal areas (bao et al. 2002; demurger et al. 2002; goodman 2008; fan, kanbur, and zhang 2009; liou 1998). moreover, the state has considerable control or ownership in some industries, e.g., petroleum, construction, banking and insurance, transportation, and telecommunications (chen 2009; chen, wu, and xie 2000; wang 2003). yet, insights on how guanxi may differ in different marketization stages may be useful in terms of designing marketing strategies in less-developed areas and more controlled industries in china. they may shed light on how cultural tendencies may be adapted and integrated into marketing practices in societies in transition. the paper begins with an overview of marketization and salient features of policy and marketplace conditions in three marketization stages. next, it describes guanxi’s general nature and marketization’s impact on guanxi’s voluntary, pluralistic, and adaptive qualities. then, it offers propositions on how managers use guanxi and how guanxi ties differ in various stages. finally, it reviews theoretical, managerial, and research implications of these considerations. marketization the marketization process takes place over time and involves aspects of public policy, the character of marketplaces, and firms’ marketing practices. marketization of public policy introduces institutional changes that create opportunities to shift the relative importance of public and private sectors in economic life. these conditions are conducive to the weakening and eventually replacement of a centrally-planned system and authority mechanisms with market-oriented mechanisms in an economy (carman and dominguez 2001; chen, wu, zhe, and xie 2000). some key elements of marketization policy are the introduction of competition, removal of state subsidies, deregulation, organizational restructuring, decentralization, and privatization (cf. chen et al. 2000; liou 1998; yu 2005; see table 1). the policies feature three stages of marketization, which are similar to le, kroll and walter’s (2010, 2011) propositions. according to le et al. (2010, 2011), the early 286 journal of business strategies or first stage is characterized by a state control-supporting institutional framework and the economic system is largely influenced by a planned system. it was clear that a market-based economic system was not established by 1982 (naughton 2007; yu 2005). in the intermediate or second stage, policies moved toward a two-track system in the agriculture and, gradually, in the industrial sectors (chen, wu, and xie 2000; naughton 2007; shen 2000). the two-track system involved coexistence of central planning and market mechanisms, planned and market prices, planned distribution and market allocation of resources, and state enterprises and private firms. evidence showed that firms are likely to rely on networks/relationships strategies in the second stage (le et al. 2010, 2011; peng and heath 1996). the late or third stage is characterized by the prevalence of a free market supporting system. china officially ended the dual-track system, officially accepted a market-oriented system, and decontrolled state authorities in the marketplace (chen, wu, and xie 2000; naughton 2007; shen 2000). for over three decades, china has been moved away from a quasi-socialist economy to gradually adapt to a new market system (atinc et al. 2012). as marketization unfolds in china, managers may face new opportunities and threats due to the changing character of the marketplace. they may deal with issues about products and services offerings, brand marketing, business relationships, and other marketing matters. like managers in other transition nations, they may face challenges in using value-added adaptive innovations in their marketing practices. the experience in china and other nations seems to indicate that marketization does not generate consistent results in different societies (cf. carman and dominguez 2001). instead, historical, cultural, and social factors may shape the character and outcomes of marketization. guanxi is such a factor. the nature of guanxi scholars generally agree that guanxi involves a special relationship between two persons and describe it in terms of reciprocal and mutually-dependent interpersonal ties (gold 1985; osland 1990; pye 1982; yang 1989). individuals with a guanxi tie are committed to each other and their relationship involves hidden norms of reciprocity and relational congruence that are mostly characterized by exchange (cf. ambler, styles, and wang 1999; ang and leong 2000; davies et al. 1995; dekeijzer 1992; kipnis 2002; leung, lai, richy, and wong 2005; lovett, simmons, and rajo 1999). volume 31, number 2 287 however, such ideas do not equate guanxi and business friendship. unlike business friendship (price and arnould 1999), guanxi may be sought for instrumental versus intrinsic relational reasons and it may not involve openness and sharing of personal experiences. as noted later, there are bases for guanxi besides friendship, and friendship does not insure that guanxi will exist (alston 1989). guanxi is also broader in scope than business friendships. unlike business friendships (alston 1989; grayson 2007), guanxi may not be built by interactions in a business context, though it may promote business friendships. additionally, guanxi ties are dyadic or interpersonal, do not have a group connotation, and do not automatically translate to intergroup or inter-organizational links (fock and woo 1998). yet, they may foster indirect benefits and benefits that relate to social capital (warren et al. 2004). scholars in other areas argue that marketization fosters new needs and uses for guanxi (cf. lo and otis 2003; millington, eberhardt, and wilkinson 2006; yang 2002), e.g., to find employment (bian 1997), recruit and organize labor (smart 1998), and attract overseas investment for enterprises in local areas (wu 1997). more generally, they suggest that marketization transforms guanxi from an institutionalized ideology of confucianism and maoist rules into a widely-used cultural metaphor for building new ties with others, including strangers. thus, guanxi is being modularized, which allows it to be voluntary, pluralistic, and adaptive in many ways. as a result, guanxi’s functional focus (its purposes), guanxi’s relational focus (the types of persons involved), and the character of guanxi ties may change during marketization. yet, research on use of guanxi in marketization glosses over marketing-related issues, and ignores differences in guanxi as marketization unfolds. arguably, a partial exception is work on managers’ use of interpersonal relationships and guanxi to deal with marketization’s challenges, get marketplace advantages, and enhance their firms’ market performance (child and tse 2001; gu, hung and tse 2008). functional focus of guanxi as xu min, a soe manager, stated, guanxi is essential to firms’ success. the functional focus of guanxi concerns its use in trying to facilitate marketing outcomes. the interest here is in efficiency, effectiveness, information sources, expertise, and personnel. marketing efficiency refers to better ways of conducting existing marketing activities by reducing and reallocating efforts to achieve cost savings and better productivity (cf. carman and dominguez 2001). using guanxi to try to aid marketing efficiency is consistent with marketplace conditions in the first stage. in 288 journal of business strategies stage 1, state ownership and control of raw materials and other inputs is more dominant, competition for buyers and sales is more limited, and the pace of changes in the marketplace is slower than in later stages. thus, firms are likely to be more focused on operational efficiencies than in later stages. their operational emphases are more compatible with the less competitive situation and degree of state economic control in stage 1 than with conditions in later stages. they are also consistent with their probable lack of marketing experience, relative insensitivities to nuances of the marketplace, and limited grasp of how to adapt marketing to fit market circumstances in the first stage. in ensuing stages, managers are apt to become increasingly experienced and competent in these matters. thus, they may focus on using guanxi for matters other than marketing efficiencies. using guanxi to aid marketing efficiency is also feasible in early stages. in many cases, such efforts may involve ties with persons in state agencies who dealt with managers in the maoist era. as noted, guanxi is not created instantaneously; it takes time to establish. thus, use of guanxi to aid marketing efficiency is more apt to involve ties with state authorities in stage 1 than later stages. in addition, marketing effectiveness refers to conducting marketing in new ways, e.g., via marketing innovations, such as new products and services, new modes of distribution, and new marketing communication methods (cf., carman and dominguez 2001). the idea that guanxi may affect marketing effectiveness is indirectly supported by evidence that it enhances a firm’s brand performance, channel capability, and ability to adapt to market changes and sustain advantages during industry changes (gu, hung and tse 2008). in successive marketization stages, it is increasingly likely that managers will try to use guanxi to obtain the previously-noted, and other, competitive advantages. in each stage, managers typically face increasing competitive pressures and have increasing freedom to take marketing initiatives. these conditions create added incentives and opportunities for managers to seek competitive advantages, as marketization continues. in addition, they are consistent with the increasing likelihood of managers trying to use guanxi to improve marketing effectiveness in successive marketization stages. of course, such efforts may not succeed. innovative actions do not ensure success, which, arguably, explains why competitive intensity and technological turbulence may dampen guanxi’s positive impact on market performance (gu, hung and tse 2008). this reasoning leads to the following propositions (see excerpt of table 2 below). p1: in successive marketization stages, there is a decrease in managers’ tenvolume 31, number 2 289 dencies to use guanxi to try to facilitate marketing efficiency. p2: in successive marketization stages, there is an increase in managers’ tendencies to use guanxi to try to improve marketing effectiveness. managers may obtain marketing information from internal and external sources (sinkula 1994). internal sources offer information that is congenital (from the firm’s founders), experiential (from trial and error), or experimental (e.g., from trying to develop innovations or improve processes), or from critical reflection. information from external sources may come from searching (e.g., from the state or market research), borrowing (e.g., from consultants), grafting (e.g., acquiring other firms that have market information), and collaborating (e.g., joint ventures; dixon 1992; huber 1991). in stage 1, managers are apt to have less need for marketing information than in later stages in which there is less state control and central planning. compared to later stages, in stage 1 there is less policy reform, decentralization, decontrol of marketplaces and prices, reliance on market mechanisms, and competition. managers also have less authority and responsibility for marketing performance and wholesale markets, trade centers, and professional and consulting services are less developed in stage 1 than in later stages. managers also may have less chance to gain experience in using guanxi for competitive marketing purposes, with fewer and less varied firms in stage 1 than in later stages. stages 1 and 3 differ more in each of these respects than stages 1 and 2. in stage 1, market information is scarce since marketization is at an early point. in areas in which state control is relaxed, managers have some opportunities to gain experiential and experimental knowledge (sinkula 1994) that gives their firms potentially valuable internal sources of market information. when possible, they may also gain market knowledge from external sources via ties with persons in state agencies, who may be the only ones privy to it. managers also face problems in getting market information from other sources in stage 1. they have little experience in the marketplace or in coping with new conditions. there are few or no external private information sources and, even if they exist, managers are unlikely to know them or gain access to them via guanxi since there is apt to be insufficient time to cultivate new guanxi ties. due to state policies and marketplace conditions, managers are apt to have more chances to develop ties with persons in government or other firms who they may not know in stage 2 than stage 1. the same factors also are likely to allow them 290 journal of business strategies to have more ways to combine public and private sources of information and use internal and external information. thus, they are apt to have better chances to gain marketplace experience and understanding in stage 2 than stage 1. in stage 3, managers have more opportunities to use internal and external information sources and to expand their marketplace experience and understanding than in prior stages. xu min stated that there are more accessible public and private sources of marketplace information in today’s environment. compared to earlier stages, in stage 3 managers also have more chances to build ties with persons that they do not know and more freedom to act independently. there are also more firms in the marketplace in stage 3 than in prior stages. still, in the last stage, the growing set of firms selling professional services and marketing information and expertise is apt to partially reduce managers’ needs to use guanxi to access public and private information sources. thus, managers’ tendencies to use guanxi ties to try to access public and private information sources differ in different marketization stages. this logic leads to the following three-part proposition. p3a: the likelihood of managers using guanxi to try to access public and private information sources is lowest in the first of the three marketization stages. p3b: the likelihood of managers using guanxi to try to access public and private information sources is greatest in the second of the three marketization stages. p3c: the likelihood of managers using guanxi to try to access public and private information sources is greater in the third marketization stage than in the first stage, but is lower in the third marketization stage than in the second stage. as marketization proceeds, it generally leads to market growth and heightened competition. these changes are likely to increase managers’ needs to employ marketing experts and marketing personnel. there may be increasing numbers of consultants and persons seeking marketing employment in successive stages of marketization. yet, managers in an economy in transition are likely to lack sufficient experience and knowledge to readily find and judge the suitability of marketing consultants and marketing personnel for their firms. managers may find potentially direct and indirect help in both regards in their guanxi networks. persons in those volume 31, number 2 291 networks may have, or know others with, experience and abilities to deal with such matters. hiring good professional expertise (e.g., marketing communication and strategy consultants) and personnel can be beneficial. these factors are compatible with the following proposition. p4: in successive marketization stages, there is an increase in managers’ tendencies to use guanxi to try to access potential marketing expertise and personnel. table 2 (excerpt): functional focus of guanxi and propositions type of expected difference early stage/ stage 1 intermediate stage/stage 2 late stage/ stage 3 p1: marketing efficiency p1: most p1: less p1: least p2: marketing effectiveness p2: least p2: less p2: most p3: access public and private information sources p3a: lowest p3b: greatest p3c: lower p4: access marketing expertise and personnel p4: least p4: less p4: most relational focus of guanxi the relational focus refers to using guanxi to try to facilitate relationships with persons in state agencies, suppliers, b2b buyers, and persons in other strategic relationships. for example, managers are likely to be concerned with relationships with persons in state agencies during marketization. all marketization reforms are not instituted or implemented at once. the state still controls some essential resources and information and intervenes in some business matters. managers may also be uncertain about regulatory policies and the comprehensiveness of legal frameworks. in stage 1, managers are more apt to use guanxi with persons in state agencies than in later stages. state policies and marketplace conditions limit managers’ abilities to make independent marketing decisions and lead them to stress ties with 292 journal of business strategies persons in government versus persons in other firms. in stage 1, reform policies deal with decentralization of control of agricultural commodities and dismantlement of the commune system. yet, many factors constrain private sector development. for example, state ownership is dominant, financial institutions and most major raw materials are under state control, technology development is slow, market information is controlled, and competition is weak. other sources of market information typically are not available or are not known by managers. moreover, problems such as mismatch between demand and supply in different geographic areas emerge in stage 1. demand dramatically increases, but managers lack the information and abilities to adjust their marketing accordingly. in stage 1, access to other resources, such as financing, raw materials, and information are, in effect, controlled by state officials. managers have little experience with the marketplace or with coping with these conditions. moreover, they are apt to lack the time needed to cultivate new guanxi ties with persons in other firms to substitute for their links with persons in government. these factors are apt to be conducive to managers focusing on ties with persons in state agencies. in stage 2, marketization policies expand and the two-track system allows central planning and market mechanisms to coexist. as a result, the number of private firms and level of competition are greater in stage 1 than stage 2. compared to stage 1, these changes give managers more opportunities to gain marketplace experience, have more varied sources of information, and develop a wider set of relationships with persons in other firms. as a result, managers’ emphasis on ties with persons in state agencies is apt to be somewhat lower in stage 2 than stage 1. presumably, ties to persons in other firms might offer managers critical advantages, such as access to the benefits of embeddedness in local and regional markets. yet, ties with persons in state agencies are apt to be important for a number of reasons. marketization of marketplaces is increasing, but it is limited due to state control. government is one of a few large providers of market information and raw materials. available information is inaccurate or incomplete in many cases, which makes continuing links with the state essential. guanxi with persons in state agencies also enables managers to get help to understand changing marketplace regulations and evolving conditions. it also puts them in positions to benefit, for example, in obtaining desirable land, licenses, and distribution channels (child and tse 2001). thus, managers are likely to still have guanxi ties with persons in state agencies in stage 2 and rely on them less in stage 1. compared to prior stages, conditions in stage 3 are likely to create a faster pace of change, a more varied set of firms, a more competitive climate, and a more volume 31, number 2 293 diverse set of potential ties for marketing purposes. reform policies, marketplace development, and firms’ strategies begin to reflect increased marketization in 1992. for instance, new state policies allow firms to get crucial resources from formal markets with less difficulty than in the past. in stage 3, the creation of market infrastructures, such as wholesale markets, introduces new distribution channel efficiencies. more retail prices are decontrolled. in addition, newly-established private consulting, accounting, and marketing research firms and other agencies begin to offer more complete and reliable marketing information than was formerly available from private sources. due to marketization, firms’ ties to government are still important, but are less salient than their strategies in influencing business performance (law, tse and zhou 2003). thus, managers are less apt to use guanxi ties with persons in state agencies for marketing purposes in stage 3 than prior stages. in addition, guanxi is apt to be an important element in supplier relationships, particularly in stage 1. yet, the likelihood of managers using guanxi to try to facilitate relationships with suppliers is apt to decrease in successive marketization stages. managers are likely to be concerned with securing supply whereas, as noted earlier, other aspects of marketing are apt to increasingly occupy their attention in later stages. moreover, due to marketplace conditions and the time needed to build guanxi, relationships with suppliers are more likely to be subject to influence through guanxi in stage 1 than in later stages. in stage 1, state ownership and control of raw materials and other inputs is more dominant and competition for buyers is more limited than in later stages. thus, supplies and dependable relationships with suppliers are apt to be scarcer tangible and intangible resources for firms in stage 1 than later periods. in addition, managers emphases on supply and suppliers in stage 1 probably reflect their relative inexperience with other marketing matters and with the marketplace. moreover, using guanxi to try to facilitate relationships with suppliers is feasible in stage 1, since it is likely to involve existing ties. in stage 1, many supplies are controlled by persons in stage agencies. it would not be unusual for managers to have dealt with these persons in the maoist era. use of guanxi to aid supply is more likely to involve ties with state authorities in stage 1 than in later stages in which state authorities play decreasing roles in controlling supplies. thus, it is likely that managers’ use of guanxi to facilitate supplier relationships also decreases. managers are more apt to need to build new guanxi ties with persons in other firms to facilitate supply in later stages than in stage 1. there is also less state control in the marketplace in stage 3 than in earlier stages. as a result, managers are less likely to rely on persons in state agencies and more likely to build new guanxi ties 294 journal of business strategies with persons in other firms to secure supply in stage 3 than earlier stages. moreover, it is more likely for market mechanisms and supply contracts to at least partially supplant managers’ needs for guanxi relationships to secure supplies in successive stages of marketization. further, success in cultivating b2b relationships is apt to have an increasing bearing on firms’ marketing performance, as marketization proceeds. among other things, such relationships may help firms build customer equity, increase sales, expand market share, cut long-term promotion costs, and obtain market information. the likelihood of managers using guanxi to try to facilitate ties with buyers is apt to increase in successive stages. in stage 1, the command system, rather than a market mechanism, plays a major role in determining sales and distribution. ownership and control of raw materials and other inputs are dominated by state-owned enterprises. in many, if not most, cases, firms rely on the state as a buyer. firms sell their output to state-owned enterprises and government agencies, which decide where and to whom to resell it. competition among firms is weak. sales and market share in the private sector are not major concerns of firms. as a result, managers may sell products without building strong relationships with b2b buyers. managers also may not have time to build guanxi in the relatively brief first stage of marketization and they may lack the marketing experience and sensitivities to efficiently and effectively establish ties with potential non-governmental buyers. in stage 2, decontrol of the economy expands and the dual-track system allows firms to build vertical sales and distribution links with other firms. firms are required to sell a large part, or most, of their output to the private sector. many startup firms also begin to operate and there is more competition than in stage 1. firms need new b2b ties and new customers to respond to these challenges. as a result, in stage 2, managers have more responsibility for their firms’ marketing performances and are more apt to focus on using guanxi to facilitate b2b relationships than in stage 1. yet, they are less likely to focus on guanxi ties with buyers in stage 2 than stage 3, since marketization is a gradual process and state decontrols are less extensive in stage 2. marketization is more extensive in stage 3 than earlier stages. as marketization unfolds, competition intensifies and new buyers appear. firms face more competition from private firms, reformed state enterprises, and foreign firms in stage 3 than in prior stages. they also need to build new relationships to sell their products to an increasing number of potential buyers, including new local and regional firms, new state-owned enterprises, and foreign firms. more competition and new potential buyers are apt to be incentives for managers to use guanxi to try to build b2b relavolume 31, number 2 295 tionships. the favored treatment and obligations that are associated with guanxi may be barriers to competitors and help managers retain future sales. there are apt to be more rewards for building and maintaining guanxi in b2b relationships and more severe consequences for not doing so in stage 3 than in prior stages. this reasoning leads to the following propositions (see excerpt of table 2). p5: in successive marketization stages, there is a decrease in managers’ tendencies to use guanxi to try to facilitate relationships with persons in state agencies for marketing purposes. p6: in successive marketization stages, there is a decrease in managers’ tendencies to use guanxi to try to facilitate relationships with suppliers. p7: in successive marketization stages, there is an increase in managers’ tendencies to use guanxi to try to facilitate relationships with b2b buyers. firms in other strategic relationships may be in similar or complementary lines of business, e.g., networks of suppliers, manufacturers, dealers, retailers, industry groups, and buying groups. they may be in trade associations, lobbying entities, and local and regional development groups. they may share expertise, research and development costs, and facilities. they may form vertically/horizontally-integrated supply and distribution systems. developing, sustaining, and insuring the efficacy of these and other strategic relationships may involve substantial effort and risk. during the process of marketization, firms’ needs for strategic relationships are apt to increase, as new and more diverse types of firms appear in ensuing stages. as this occurs, managers are increasingly likely to use guanxi to try to develop, sustain, insure the efficacy, and reap the potential benefits of coordinated strategic ties and activities with other firms. guanxi may help them foster trust and feelings of obligation and avoid opportunism among those involved. arguably, signs of these effects are due, in part, to the adaptability of guanxi in marketplace relationships. for example, as redding and witt note (2007), the chinese economy operates as a form of network capitalism. networks are needed, since many goods cannot be efficiently produced by one firm. thus, firms specialize and then link, often with the flexibility to adjust to changes in demand, technology, or price. as they create opportunities to expand, resources become embedded in these networks. the networks are informal and flexible, with long-standing personal ties providing bases for complex transactions (nee 1996). the impact of these ties and guanxi may not be 296 journal of business strategies limited to long-standing relationships in some cases. marketization may foster new needs and uses for guanxi, transform it into a metaphor for building new ties with others including strangers, and allow guanxi links to take new voluntary, pluralistic, and adaptive forms and expressions (cf. lo and otis 2003; millington, eberhardt, and wilkinson 2006; yang 2002). managers may get benefits from guanxi, even without such flexibility (bian 1997, dunfee and warren 2001, park and luo 2001, tsui and farh 1997, xin and pearce 1996). yet, they are increasingly likely to take advantage of guanxi’s flexibility in successive stages to gain access to a wider array of resources and opportunities. these resources and opportunities may be directly and indirectly available via the extended zones of effective ties (lo and otis 2003), set of relationships (aufrecht and bun 1995) and social capital (warren et al. 2004) that are embedded in strategic relationships with other firms. these factors suggest the following proposition. p8: in successive marketization stages, there is an increase in managers’ tendencies to use guanxi to try to facilitate other strategic relationships. table 2 (excerpt): relational focus of guanxi and propositions type of expected difference early stage/ stage 1 intermediate stage/stage 2 late stage/ stage 3 p5: persons in state agencies p5: greatest p5: less p5: least p6: suppliers p6: most p6: less p6: least p7: b2b buyers p7: least p7: less p7: most p8: persons in other strategic relationships p8: least p8: less p8: most character of guanxi ties chinese tend to see guanxi with different qualities, as xu min noted. the character of guanxi ties deals with the relative symmetry/asymmetry, number of guanxi bases, strength, and instrumental nature of guanxi ties. the relative asymmetry of guanxi ties refers to the activeness or passiveness of the persons involved. in a more asymmetric relationship, the person who needs favors is more active in volume 31, number 2 297 pursuing the connection than the other person (who does not have a pressing need). the relative number of bases for guanxi ties concerns the extent to which guanxi is grounded on different foundations (e.g., common educational background or business interests; fan 2002; kiong and kee 1998). the strength of ties generally concerns the closeness of the relationships. in stage 1, managers’ guanxi ties with state officials for marketing purposes are apt to be relatively asymmetric. due to their past dealings and state controls, these ties are apt to be more readily available to managers than other ties. relatively asymmetric ties with persons in state agencies may help managers’ firms reduce uncertainties and gain supplies, information, protection, and access to markets in which formal regulations and institutions are not developed or clearly understood. state control and limited marketization are apt to restrict the number of guanxi bases in stage 1.the number of bases for managers’ guanxi ties is apt to be larger in stage 2 than stage 1, due to state policy and marketplace conditions in which central control and market systems coexist. in stage 2, managers are apt to have similar needs for state assistance. yet, they may be less dependent on the state than in stage 1, due to expanded marketization policies, changing marketplace conditions, their increasing marketplace experience, and their guanxi links with persons in other firms. thus, it is likely that their guanxi ties are less asymmetric in stage 2 than stage 1. the asymmetry of ties for marketing purposes is apt to be less pronounced in stage 3 than in prior stages, due to the faster pace of change, more varied set of firms, and a more competitive climate. the idea that there is less asymmetry in managers’ guanxi ties in ensuing stages is consistent with recent reports that, due to marketization, chinese firms’ ties to the state have less impact on business performance than their strategies (law, tse, and zhou 2003). it is also indirectly supported by indications that asian managers are less apt to need favored treatment from state authorities or actively seek links with persons in state agencies due to institutional transitions (e.g., in state resource control, state intervention in business, clarity of regulatory policy, and comprehensiveness and effectiveness of legal frameworks; peng and zhou 2005). p9: in successive marketization stages, the guanxi ties that managers use for marketing purposes are likely to be more symmetric. as marketization unfolds, it is more likely that, in stage 2, managers have ties with varied persons in state agencies and other firms that are founded on a wider 298 journal of business strategies set of guanxi bases than in stage 1. in stage 3, there is a faster pace of change, more varied set of firms, a more competitive climate, and a more diverse set of potential ties for marketing purposes than in earlier stages. moreover, marketization is a modernizing force that loosens old links and forges new ones, which are often less permanent (gu, hung and tse 2008). as a result, compared to prior stages, in stage 3 managers’ contacts with persons in state agencies and other firms are more apt to include previously unfamiliar persons with varied social and economic positions, backgrounds, status levels, social identities, experiences, etc. thus, the number of bases for managers’ guanxi ties is apt to be greater in stage 3 than prior stages. this expectation is consistent with views on how aspects of social capital operate in other settings. for instance, scholars argue that, for firms to develop (hite and hesterly 2001) and economic development to continue (woolcock 1998), more diverse ties may have to replace or supplement less diverse ties. they also note that bounded solidarity (one motive that underlies social capital) results from actual or perceived shared membership due to, among other things, individuals’ common situation or fate, sense of external opposition, and distinctive traits (portes 1998; portes and sensenbrenner 1993). in ensuing marketization stages, managers are apt to have more varied reasons to identify with their counterparts in other firms, due to common trade association memberships, competitive threats, characteristics of their firms, and many other factors. these considerations are consistent with the following expectation (see excerpt of table 2 below). p10: in successive marketization stages, there is an increase in the number of bases for managers’ guanxi ties for marketing purposes. the relative strength of guanxi ties may also differ. generally, persons with stronger ties are more socially involved with one another than individuals with weaker ties (granovetter 1983). evidence suggests that persons with stronger ties have more overlap in their personal communication networks than those with weaker ties. strong ties have advantages, but weak ties may be needed for an individual to access information and benefits that are not readily available in his/her primary social network (granovetter 1983). generally speaking, weak ties are more instrumental than strong ties. managers are more likely to have stronger ties with these persons than with unfamiliar individuals in stage 1. moreover, it is apt to be easier for managers to get marketing help by tapping guanxi ties with these persons, rather than turning to other people with whom they have weaker ties. research in other contexts indirectly volume 31, number 2 299 supports this expectation. for example, it suggests that individuals in insecure positions are likely to resort to use of stronger versus weaker ties for protection and uncertainty reduction. it also suggests that stronger ties are typically more readily available than weaker ties (granovetter 1973). thus, it is likely that managers tend to try to use stronger versus weaker guanxi ties to help them do business in markets with insufficient or non-existent formal guiding regulations and institutions. in stage 2, the circumstances give managers more chances to build a wider set of guanxi ties with persons in state agencies and other firms than stage 1. conditions in stage 3 and reports from other settings are consistent with the idea that managers tend to rely on weaker guanxi ties for marketing purposes in stage 3 than in prior stages. the development of new ties for marketing purposes is apt to be more necessary and possible in stage 3 than prior stages. in ensuing stages, there is also an increasingly diverse set of firms and managers that have increasing opportunities to gain experience in using a wider set of ties for marketing purposes. as noted, these ties may give managers competitive advantages. weaker relationships are more prevalent and their roles are more influential in modern society than in its predecessors (simmel 1950). in addition, such contacts are often of limited duration and are instrumentally focused. weaker ties are compatible with achieving instrumental goals (boormann 1975; blau 1974; ibarra 1993; putnam 1993). compared to stronger ties, weaker ties also tend to involve less frequent interaction, require less time to maintain, and are likely to involve less reciprocity than stronger ties (granovetter 1973). moreover, individuals are more able to reallocate their time and energy if ties are weaker versus stronger. strong ties require more time to maintain than weaker ties (boormann 1975). thus, partners may shift from stronger guanxi ties to weaker guanxi ties to avoid obligations. a clear-cut exit from guanxi ties may be infrequent. yet, people may minimize their participation in some relationships as time goes on (lo and otis 2003). as a result, managers are apt to find it easier to uncouple themselves from weaker as opposed to stronger guanxi ties. these are among the reasons that weaker guanxi ties are apt to have important roles in the increasingly market-oriented chinese economy and why guanxi ties are apt to be weaker in stage 3 than in earlier stages. the idea that the strength of managers’ guanxi ties decreases in ensuing stages is also consistent with views on how facets of social capital function in other contexts. for instance, scholars indirectly indicate that strong ties may not be needed for guanxi relationships because social capital may operate for reasons besides bounded solidarity, e.g., value introjection or instrumental motives (portes 1998; portes and sensenbrenner 1993). they also 300 journal of business strategies suggest that, in asia, the strength of ties in business-to-government and business-tobusiness networks decrease due to the institutional transitions noted earlier (peng and zhou 2005). moreover, researchers indicate that, as firms develop, their networks evolve from identity-based ties to more calculative connections to allow firms to gain resources and adapt to environmental uncertainties. identity-based ties stem from prior relationships with social, family, and long-held sources and are strongly embedded, whereas calculative ties are weaker and more intentionally managed to meet firms’ changing needs for economic benefits (hite and hesterly 2001). they also suggest that the calculus of costs and benefits of embeddedness in networks may change as economic development continues. strong ties provide the cohesion that is often initially essential for development, but they can constrain continued development. as development continues, businesses may need external linkages, which involve weaker ties than those that initially aided development, to help them access larger and more complex networks and markets (woolcock 1998). the prior considerations are consistent with the following propositions (see excerpt of table 2 below). p11: in successive marketization stages, there is a decrease in the strength of managers’ guanxi ties for marketing purposes. p12: in successive marketization stages, there is an increase of the instrumental nature of managers’ guanxi ties for marketing purposes. table 2 (excerpt): character of guanxi ties and propositions type of expected difference early stage/ stage 1 intermediate stage/stage 2 late stage/ stage 3 p9: relative symmetry p9: relative symmetry p9: relative symmetry p9: relative symmetry p10: relative number of bases p10: relative number of bases p10: relative number of bases p10: relative number of bases p11: relative strength p11: relative strength p11: relative strength p11: relative strength p12: relative expressive/ instrumental nature p12: relative expressive/ instrumental nature p12: relative expressive/ instrumental nature p12: relative expressive/ instrumental nature volume 31, number 2 301 conclusions china has become a major player in the global economy and this emerging market has become increasingly crucial for both local and foreign firms’ success (johnson and tellis 2008). although firms may face opportunities (sheng, zhou and li 2011), competition is increasing (tsang 1998). in order to overcome the challenges and gain sustained competitive advantages (tsang 1998), cultivating networks/ relationships becomes essential to a firm’s success in china (sheng et al. 2011). this paper seeks to contribute to the managerial marketing knowledge about guanxi’s role in the marketization process in china and to examine marketingrelated issues that are neglected in prior research. it presents an overview of some salient aspects of public policy and marketplaces in three stages of marketization and reviews the general nature of guanxi. in combination, the propositions suggest that managers are less likely to focus on using guanxi to try to aid marketing efficiency and facilitate relationships with persons in state agencies and suppliers in successive marketization stages. in contrast, they indicate that managers are increasingly likely to focus on using guanxi to try to aid marketing effectiveness, access marketing expertise, and facilitate relationships with b2b buyers and persons in other strategic relationships in successive stages. they also suggest that managers are most apt to stress using guanxi to try to access public and private information sources in stage 2 and least likely to do so in stage 1. moreover, they indicate that the relative symmetry, number of bases, strength, and instrumental nature of managers’ guanxi ties are likely to increase in successive marketization stages (see table 2). in managerial terms, an implication of the ideas presented here is that the significance of guanxi is not declining in the transition process (yang 2002). managers should recognize the functional focus, relational focus, and character of guanxi ties as significant elements in the marketization process and as factors in marketplace competition. inevitably, there are limitations in trying to deal with a subject as broad as marketization and guanxi. of necessity, the propositions are generalizations that do not take into account the idiosyncrasies of different industries or firms. the marketization process is likely to be more complex and nuanced than suggested by any single conceptual framework, including the one used here. moreover, for example, there may be sizable time lags in the effects of shifts from stronger to weaker guanxi ties in emerging economies (carney 2004). arguably, the overall differences suggested by the propositions apply to different industries but the magnitudes of these differences may differ depending on the nature of the business and factors such as technology, turbulence, and internationalization. in addition, the details of 302 journal of business strategies functional focus and relational focus may differ by firm. different firms in the same industry may have different competencies, needs, and problems that cause them to navigate the marketization process in different ways. as a result, they may focus on different facets of effectiveness, efficiency, strategic relationships, seek different specific combinations of ties in the marketplace, etc. (koka and prescott 2002; steensma et al. 2005). in theoretical terms, the propositions and reasoning that underlies them underscores the frequently overlooked notion that marketing is an important element in the marketization process. in addition, they reflect the notion that marketization is not a purely economic matter. they also provide examples of how cultural tendencies may be adapted and shape managers’ marketing activities in a society in transition. moreover, they imply that there is interplay between marketing and marketization. that is, marketing is affected by and it affects marketization. from a macromarketing perspective, it is also possible that there is an interplay between marketing and guanxi. it is possible that the ways in which guanxi is adapted to marketing circumstances and needs may extend to other parts of life in china. research is needed to test these propositions in cross-sectional or longitudinal studies that use quantitative and qualitative methods. particularly, a case study using in-depth interviews with managers who have been through the marketization process can be insightful. additionally, examining soe and its privatization process might provide some argument to support the propositions. future work should also include areas of china and industries that differ in the extent of marketization. additionally, the significance of guanxi can be further elevated in terms of a governance mechanism. future research agenda may also access how guanxi can be effective in reducing agency costs in the marketization process. it should be useful to study possible antecedents of guanxi, e.g., dependence, adaptation, trust, and favor (buttery and wong 1999), uncertainty and opportunism (williamson 1975), perceived similarity (lee, pae, and wong 2001). it should also be valuable to explore how institutions and networks co-evolve due to guanxi (peng and zhou 2005) and the antecedents and consequences of terminating guanxi. moreover, other potential consequences of the use of guanxi should be examined. positive effects should be investigated, e.g., perceived relationship quality and interdependence (lee, pae, and wong 2001), commitment (anderson and weitz 1992; heide 1994), and marketing performance (kao 1993). negative consequences should also be studied, e.g., ethical violations and distorting effects of material facets of guanxi exchanges (lovett, simmons and kali 1999) and the possible added costs, deception, burden of obligations, exclusion, opportunism, excessive demands, and personal indebtedness due to volume 31, number 2 303 guanxi. it is perceived that guanxi is associated with bribery and corruption (yang 2011). for example, diagnostic product corporation, which is a manufacturer of medical equipment, has been noted to pay chinese doctors and hospital administrators to gain market share (norton 2006). thus, examining the association of guanxi and corruption is crucial for future research. building guanxi is a complicated strategic process (vanhonacker 2004). vanhonacker (2004) posited that establishing guanxi involves four steps: targeting, scouting, signaling, and packaging. first of all, it is crucial to identify the key person who may be involved in the guanxi relationship (targeting). scouting requires identifying the common basis of the potential guanxi (e.g., family friends, alumni). once the commonality is found, the individual may signal the target. if the link is established, guanxi will exist. however, empirical studies on guanxi building/maintaining are rare and future research may be needed in this area. furthermore, future research may examine how to structure guanxi (e.g., guanxi building/maintaining, strong/weak ties) without ethical violations. today, xu min is a successful leader in one of the largest international corporations in china. his guanxi relationship with many government officials and others allows him in developing new markets, obtaining new licenses, finding new partners, and attracting additional capital. recently, xu min joined one of the most prestigious executive mba programs in shanghai and he firmly believed that building new guanxi is essential to future success. as his classmate, jack ma (the founder of the online exchange alibaba.com) wrote, “guanxi means access; once you have it you could open doors. it is a relationship that can inform you and educate you.” references alston, j. p. (1989). wa, guanxi, and inhwa: managerial principles in japan, china and korea. business horizons, 32(2), 26-31. ambler, t., styles, c., & wang, x. (1999). the effect of channel relationships and guanxi on the performance of inter-province export ventures in the people’s republic of china. international journal of research in marketing, 16(1), 75-87. swee hoon, a., & siew meng, l. (2000). out of the mouths of babes: business ethics and youth in asia. journal of business ethics, 28(2), 129-44. anderson, e., & weitz, b. (1992). the use of pledges to build and sustain commitment in distribution channels. journal of marketing research, 29(2), 18-34. 304 journal of business strategies atinc, g., liu, y., kroll, m., & walters, b. a. (2012). an inquiry into chinese initial public offerings from a corporate governance perspective. journal of business strategies, 29: 99-123. aufrecht, s. e. & li siu, b. (1995). reform with chinese characteristics: the context of chinese civil service reform. public administration review, 55(2), 175182. balfour, f. (2007). you say guanxi, i say schomoozing. retrieved from http://www. businessweek.com/stories/2007-11-18/you-say-guanxi-i-say-schmoozing. bian, y. (1997). bringing strong ties back in: indirect ties, network bridges, and job search in china. american sociological review, (3). 366-385. beidiger, j., decicco, t., green, t., hoffman, g., lei, d., mahadevan, k., ojeda., s., & ward, k. (2004). strategic action at lenovo. paper presented at the 21st pan-pacific conference, anchorage, ak. bao, s. p., chang, g. p., sachs, j. p., & woo, w. p. (2002). geographic factors and china’s regional development under market reforms, 1978-1998. china economic review: an international journal, 13(1), 89-111. blau, p. m. (1974). presidential address: parameters of social structure. american sociological review, 39(5), 615-635. boormann, s. a. (1975). a combinatorial optimization model for transmission of job information through contact networks. bell journal of economics, 6(1), 216249. buttery, e. a., & wong, y. h. (1999). the development of a guanxi framework. marketing intelligence and planning, 17(3), 147-154. doi: 10.1108/02634509910271605 carlisle, e., & flynn, d. (2005). small business survival in china: guanxi, legitimacy, and social structure. journal of development entrepreneurship, 10(1), 79-96. carman, j. m., & dominguez, l.v. (2001). organizational transformations in transition economies: hypotheses. journal of macromarketing, 21(2), 164-180. carney, m. (2004). the institutions of industrial restructuring in southeast asia. asia pacific journal of management, 21(1/2), 171–188. chen, z., wu, c., zhe, w., & xie, s. (2000). the extent of marketization of economic systems in china. ny: nova science publishers. chen, s. (2009). marketization and china’s energy security. policy and society, 27(3), 249-260. doi: 10.1016/j.polsoc.2008.10.007 child, j., & tse, d. k. (2001). china’s transition and its implications for international business. journal of international business studies, 32(1), 5-21. volume 31, number 2 305 davies, h., leung, t. p., luk, s. k., & yiu-hing wong, s.k. (1995). the benefits of “guanxi” the value of relationship in developing the chinese market. industrial marketing management, 24(3), 207-214. de keikzer, a. j., & liu, a.h. (1992). china: business strategies for the ‘90s / arne j. de keijzer, with the collaboration of allan h. liu ; foreward by eugene theroux ; case study contributed by the u.s.-china business council…[et al.].. berkeley, calif. : pacific view press, 1992. demurger, s., sachs, j. d., woo, w. t., bao, s., & chang, g. (2002). the relative contributions of location and preferential policies in china’s regional development: being in the right place and having the right incentives. china economic review (1043951x), 13(4), 444-465. dunfee, t. w., & warren, d. e. (2001). is guanxi ethical? a normative analysis of doing business in china. journal of business ethics, 32(3), 191-204. dixon, n. m. (1992). organizational learning: a review of the literature with implications for hrd professionals. human resource development quarterly, 3(1), 29-49. fan, y. (2002). questioning guanxi: definition, classification and implications. international business review, 11(5), 543-561. fan, s., kanbur, r., & zhang, x. (2009). regional inequality in china. london: routledge. fock, h. k., & woo, k. (1998). the china market: strategic implications of guanxi. business strategy review, 9(3), 33-43. gold, t. b. (1985). after comradeship: personal relations in china since the cultural revolution. china quarterly, 104, 657-675. goodman, d. s. g. (2008). china’s regional development. kentucky: taylor & francis, inc. granovetter, m. s. (1973). the strength of weak ties. american journal of sociology, 78(6), 1360-1980. granovetter, m. s. (1983). the strength of weak ties: a network theory revisited. sociological theory, 201-233. grayson, k. (2007). friendship versus business in marketing relationships. journal of marketing, 71(4), 121-139. gu, f. f., hung, k., & tse, d. k. (2008). when does guanxi matter? issues of capitalization and its dark side. journal of marketing, 72(4), 12-28. doi: 10.1509/ jmkg.72.4.12 guo, c., & miller, j. (n.d.). guanxi dynamics and entrepreneurial firm creation and development in china. management and organizational review, 6(2), 267-291. 306 journal of business strategies heide, j. b. (1994). interorganizational governance in marketing channels. journal of marketing, 58(1), 71-85. hite, j. m., & hesterly, w. s. (2001). the evolution of firm networks: from emergence to early growth of the firm. strategic management journal, 22(3), 275286. huber, g. p. (1991). organizational learning: the contributing processes and the literatures. organization science, 2(1), 88-115. ibarra, h. (1993). network centrality, power, and innovation involvement: determinants of technical and administrative roles. academy of management journal, 36(3), 471-501. doi: 10.2307/256589 johnson, j., & tellis, g. j. (2008). drivers of success for market entry into china and india. journal of marketing, 72(3), 1-13. doi:10.1509/jmkg.72.3.1 kao, j. (1993). the worldwide web of chinese business. harvard business review, 71(2), 24-36. kipnis, a. (2002). practices of guanxi production and practices of gaining avoidance. in t. gold, d. guthrie., & d. wank (eds.), social connection in china: the institution, culture and changing nature of guanxi. uk: cambridge university press, 21-37. kiong, t. c., & kee, y. p. (1998). guanxi bases, xinyong and chinese business network. british journal of sociology, (1), 75-96. koka, b. r., & prescott, j. e. (2002). strategic alliances as social capital: a multidimensional view. strategic management journal, 23(9), 795-816. doi:10.1002/ smj.252 law, k. s., tse, d. k., & zhou, n. (2003). does human resource management matter in a transitional economy? china as an example. journal of international business studies, (3), 255-295. le, s., kroll, m., & walters, b. (2010). the impact of institutional changes on corporate governance mechanisms in transition economies. journal of management & governance, 14(2), 91-114. doi:10.1007/s10997-008-9075-4 le, s. a., kroll, m. j., & walters, b. a.( 2011). stages of corporate governance in transition economies. journal of business strategies, 28(2), 151-176. lee, d. j., pae, j. h., & wong, y. (2001). a model of close business relationship in china (guanxi). european journal of marketing, 35(1-2), 51-69. doi:10.1108/030905601363346 leung, t. p., kee-hung, l., chan, r.k., & wong, y.h. (2005). the roles of xinyong and guanxi in chinese relationship marketing. european journal of marketing, 39(5/6), 528-559. doi:10.1108/03090560510590700 volume 31, number 2 307 liou, k. t. (1998). managing economic reform in post-mao china. london: praeger publisher. jun, l.,. & si, s. x. (2010). can guanxi be a problem? context, ties, and some unfavorable consequences of social capital in china. asia pacific journal of management, 27(3), 561-581. lo, m., & otis, e. (n.d.). guanxi civility: process, potentials, and contingencies. politics and society, 31(1), 131-162. luo, y. (2000). guanxi and business. singapore: world scientific publishing company, 2000. lovett, s., simmons, l. c. & kali, r. (1999). guanxi versus the market: ethics and efficiency. journal of international business studies, 30(2), 231-247. luo, y., huang, y., & wang, s. l. (2012). guanxi and organizational performance: a meta-analysis. management and organization review, 8(2), 139-172. millington, a., eberhardt, m., & wilkinson, b. (2006). guanxi and supplier search mechanisms in china. human relations, 59(4), 505-531. naughton, b. (2007). the chinese economy: transition and growth. london: the mit press. nee, v. (1996). the emergence of a market society: changing mechanisms of stratification in china. the american journal of sociology, (4), 908-949. norton, p. m. (2006). the foreign corrupt practices act dilemma. china business review, 33(6), 22-27. osland, g. e. (1990). doing business in china: a framework for cross-cultural understanding. marketing intelligence and planning, 8(4), 4-14. park, s. h., & luo, y. (2001). guanxi and organizational dynamics: organizational networking in chinese firms. strategic management journal, (5), 455-477. peng, m.w., & heath, p.s. (1996). the growth of the firm in planned economies in transitions: institutions, organizations, and strategic choice. academy of management review, 21(2), 492-528. doi:10.5465/amr.1996.9605060220 peng, m. w., & jessie qi, z. (2005). how network strategies and institutional transitions evolve in asia. asia pacific journal of management, 22(4), 321–336. portes, a. (1998). social capital: its origins and applications in modern sociology. annual review of sociology, 24(1). 1-24. portes, a., & sensenbrenner, j. (1993). embeddedness and immigration: notes on the social determinants of economic action. american journal of sociology, (6), 1320-1350. price, l. l., & arnould, e. j. (1999). commercial friendships: service providerclient relationships in context. journal of marketing, 63(4), 38-56. 308 journal of business strategies putnam, r. d., leonardi, r., & nanetti, r. (1993). making democracy work: civic traditions in modern italy / robert d. putnam with robert leonardi and raffaella y. nanetti. princeton, n.j. : princeton university press, c1993. pye, l. (1982). chinese commercial negotiation style. cambridge, ma: gunn and hain. ramsamy, b., goh, k., & yeung, m. c. (2006). is guanxi (relationship) a bridge to knowledge transfer? journal of business research, 59(1), 130-139. doi:10.1016/j.jbusres.2005.04.001 redding, s. g., & witt, m. a. (2007). the future of chinese capitalism: choices and chances / gordon redding and michael a. witt. oxford ; new york : oxford university press, 2007. shen, r. (2000). china’s economic reform: an experiment in pragmatic socialism. westport, conn: praeger. sheng, s., zhou, k. z., & li, j. j. (2011). the effects of business and political ties on firm performance: evidence from china. journal of marketing, 75(1), 1-15. doi:10.1509/jmkg.75.1.1 sinkula, j. m. (1994). market information processing and organizational learning. journal of marketing, 58(1), 35-45. simmel, g. (1950). the sociology of georg simmel. new york: the free press. smart, a. (1998). guanxi, gifts, and learning from china: a review essay. anthropos, 94/6). 559-565. steensma, h. k., tihanyi, l., lyles, m. a., & dhanaraj, c. (2005). the evolving value of foreign partnerships in transitioning economies. academy of management journal, 48(2), 213–235. doi:10.5465/amj.2005.16928394 tanger, e. (2013, november 25). coke and the myth of guanxi. retrieved from http://www.biztimes.com/article/20131125/magazine03/311219987/0/bubbler. tsang, e.w.k. (1998). can guanxi be a source of sustained competitive advantage for doing business in china? academy of management executive, 12(2), 64-73. doi:10.5465/ame.1998.650517 tsui, a., & farh, j. (n.d.). where guanxi mattersrelational demography and guanxi in the chinese context. work & occupations, 24(1), 56-79. vanhonacker, w. r. (2004). guanxi networks in china. the china business review, 31(3), 48-53. wang, x. (2003). contribution of the non-state sector to china’s economic growth. in r. garnaut & l. song (eds.), china’s third economic transformation: the rise of private economy. london: routledge. volume 31, number 2 309 warren, d. e., dunfee, t. w., & naihe, l. (2004). social exchange in china: the double-edged sword of guanxi. journal of business ethics, 55(4), 355-372. williamson, o. e. (1975). market and hierarchies, analysis and antitrust implications: a study in the economics of internal organization / oliver e. williamson. new york: the free press, [1975]. woolcock, m. (1998). social capital and economic development: toward a theoretical synthesis and political framework. theory and society, 27(15), 151-208. wu, j. (1997). strange bedfellows: dynamics of government-business relations between chinese local authorities. journal of contemporary china, 6(15), 319346. xin, k. k., & pearce, j. l. (1996). guanxi: connections as substitutes for formal institutional support. academy of management journal, 39(6), 1641–1658. doi:10.2307/257072 yang, f. (2011). the importance of guanxi to multinational companies in china. asian social science, 7(7), 163-168. yang, m. m. (1989). the gift economy and state power in china. comparative studies in society and history, (1). 25. yang, m. m. (2002). rebuttal: the resilience of guanxi and its new deployments: a critique of some new guanxi scholarship. the china quarterly, (170). 459-476. yu, g. (2005). accomplishments and problems: a review of china’s reform in the past twenty-three years. in t. y. cao (ed.), the chinese model of modern development. london: routledge. zhuang, g., xi, y., & tsang, a. s. (2010). power, conflict, and cooperation: the impact of guanxi in chinese marketing channels. industrial marketing management, 39(1), 137-149. doi:10.1016/j.indmarman.2008.07.002 310 journal of business strategies biographical sketch of authors jie g. fowler has a phd in marketing from university of nebraska-lincoln, lincoln, nebraska, usa, and is assistant professor of marketing in the department of marketing & international business at valdosta state university, valdosta, georgia, usa, where she mainly teaches marketing research, promotion, and marketing channels. her work is published in journal of macromarketing, qualitative market research, journal of business strategies, and journal of current issues and research in advertising. timothy h. reisenwitz has a dba in marketing from cleveland state university, cleveland, ohio, usa, and is professor of marketing in the department of marketing & international business at valdosta state university, valdosta, georgia, usa, where he teaches at the undergraduate and mba program levels. his work is published in several journals, including journal of consumer marketing, marketing management journal, journal of real estate literature, journal of medical marketing, marketing education review, journal of business strategies, and academy of educational leadership journal. timothy h. reisenwitz is the corresponding author and can be contacted at, treisenw@valdosta.edu. volume 31, number 2 311 table 1 salient features of policy in the three marketization stages early/stage 1 (1978-1983) intermediate/stage 2 (19841991) late/stage 3 (1992) • decentralization of commune system and agricultural decision making • stimulation of production and private sector activities in agriculture and rural areas • state negotiated contracts with famers to lease land and sell given amounts of output to government; farmers could sell excess output to the market • increased agricultural procurement prices paid by the state • small local businesses allowed to sell output beyond production quotas to the market • non-farm (industrial) state enterprises given expanded decision –making autonomy and allowed to keep profits that exceeded planned earnings • state ownership and control still dominant in most raw materials, financial services, and other sectors • both central planning and market mechanisms (dual track system) for prices, distribution, and allocation of resources in agriculture and (gradually in) industrial sectors • expanded authority and responsibility of state owned enterprise managers • introduction of contracts between employers and employees • state permitted restructuring of state owned enterprises via sales of shares to employees, provincial and local governments, and private firms • many state owned enterprises allowed to sell output in excess of production quotas at market prices • state encouragement of establishment of private firms • sales between state owned enterprises and private firms at market prices permitted • gradual price reforms • development zones in coastal cities • decontrol of prices of most consumer goods • wide range of reforms initially focused on southern china • end of dual track system, officially acceptance of market-oriented system, decontrol of state authorities in marketplace, and promotion of market price mechanisms • widespread decontrol of retail prices and coal • restructuring and downsizing of state owned corporate sector; reorganizing state owned enterprises into limited liability corporations • changes in legal infrastructure, stock markets, and tax, banking, patent protection, and social security systems • local government officials given increased authority over bankruptcy, mergers and acquisitions, sales, and auctions of state owned enterprises • new wholesale markets, e.g., for garments, clothing, meat, and sugar • new trading centers, e.g., in grain, steel, and petroleum • development of professional services, e.g., accountants, consultants, and other types of agencies • china becomes wto member cf. chen 1995; chen, et al. 2000; liou 1998; rawski 1995; steinfeld 2004; storey 1983; watson 1994; yu 2005. a capability-driven turnaround strategy for the current economic environment booma yandava babson–f. w. olin graduate school of management • wellesley hills, ma abstract many businesses were prompted to reevaluate their products and services as a result of the recent economic downturn. changes were made to their business models to realign capabilities and performance in some cases. businesses need to provide better products and faster services while faced with more discerning customers, emerging markets, and dynamic regulatory environments. in a turnaround situation, businesses need to reinvent strategies and position themselves to meet short-term goals, while functioning in a competitive landscape for the long-term. the capability-driven model leverages core business and operating capabilities to optimize the entire value chain; innovation and corporate social responsibilities are integrated carefully for long-term sustainability. the proposed framework is based on careful studies of companies that returned to profitability from a failing situation. introduction businesses evolve all the time. however, the recent economic downturn (survey of current business, 2009, 2010; imf sees major slowdown for global economy, calls for strong and coordinated policies to support a turnaround. october, 2008) accelerated this market dynamic and many businesses found themselves floundering for survival. changes in customer behavior (annual retail trade report, 2008, 2009, 2010) and competitive pressures, along with blind spots that companies develop over time (dwindling profitability) stagnates revenue growth and loss of market capitalization (consumer trend data, 2009-1010; annual retail trade report, 2008, 2009, 2010; and all times bankruptcy, p1995-2010). companies once regarded highly in terms of shareholder value and market share fail to recognize changing market conditions; these firms need a strategy for turnaround. several studies suggest numerous factors influencing turnaround including managerial changes, improvement in financial instruments, and tactical changes such as operational efficiency and competitive improvement (barker & duhaime, 1997; moulton, thomas & pruett, 1996). these studies examine declining firms in the context of decline sources and organizations’ responses to the decline (barker & duhaime, 1997; 158 journal of business strategies moulton, thomas & pruett, 1996; castrogiovanni & burton, 2000). it is argued that turnaround strategies are not applicable to all firms because most retrenchment activities are a consequence of decline and not a necessity to achieve turnaround (barker & mone, 1994). typical retrenchment activities are cost reduction and fixed asset reduction. the influence of typical retrenchment strategies in turnaround is understood poorly. cost cutting measures are important, but an important question still remains unanswered, how to influence a declining firm toward turnaround other than adoption of a mere balance sheet approach?” this study examines the turnaround approaches of companies that did not file bankruptcy and took measures to address declining profitability. several companies, from various industries, fallen victim to market blindness were studied. these companies emerged stronger and with long-term viability, by implementing a holistic turnaround strategy. this study contributes to the emerging trend that suggests against the simplistic and standard approach to turnaround situations for companies in need of changing from non-profitability to profitability. this study reveals pertinent and repeating adaptable capabilities that every business in most industries can execute for long-term growth and profitability-at the heart of which is returning to core. to formulate an adaptable strategic framework for successful turnaround in the wake of recent changes in economics and customer behaviors and preferences, a study to test the following research questions was conducted: (1) does sustainable turnaround require a holistic approach with a strong focus on core business capabilities? (2) is an effective operational strategy, with a coordinated approach, spanning the entire value chain of a business, more critical for a successful turnaround, rather than a finance focused approach? examining these research questions, a better understanding of factors that contribute to successful turnaround other than financial ones emerge. this study reveals capabilities that many businesses can develop and adopt to emerge from declining profitability, for a long-term, sustained growth trajectory. the next section reviews some of the literature on corporate restructuring and turnaround. the precipitating factors leading to a turnaround situation are discussed. the following section discusses in detail the conceptual framework for a capabilitybased turnaround strategy. the approach for the study leading to the capability-based framework is delineated. although several companies were studied and analyzed over two years, seven representative case study companies are discussed to illustrate specific propositions derived from the analysis: kraft foods inc., chiquita brands volume 29, number 2 159 international, inc., the talbots inc., apple inc., tyco intl. ltd., blockbuster llc, and starbucks corporation. current literature turnaround studies are not new; there are several studies quoted in the management literature on various strategies with the purpose of enhancing a firm’s chances of attaining sustainable recovery (barker & duhaime, 1997; barker & mone, 1994; gilson, 1989). however, these studies are highly fragmented with primary emphases on a strong balance sheet and minimal attention given to business models that address competitive advantages (hofer 1980; hoffman, 1989; vincent, barker iii, & duhaime, 1997; lohrke & bedeian, 1998; schendel, patton, & riggs, 1976). schendel et al. proposed that turnaround strategies can be classified under two categories: efficiency oriented and entrepreneurially oriented. in 1980, hofer (1980) extended studies that addressed variability in achieving successful turnaround to include the original causes of a decline. he proposes that severity of decline dictates whether drastic cost cutting or operational improvements should be undertaken. operational efficiencies such as cost cutting and asset trimming are part of turning a company around, more so in economic downturns. it is interesting how firms take bold steps with entrepreneurial measures to position themselves, not just for short-term profitability but for long-term growth.. many companies have recently cut costs by reallocating capital structures, shutting down manufacturing plants, reducing their workforce, or relocating to low-cost countries. are businesses that cut costs effectively positioned for a turnaround? only about one-third of companies intending to turn around their worsening condition do so; of these, only 40% to 50% position themselves for long-term growth (all times bankruptcy., 1995-2010; barker & duhaime, 1997; schendel, patton, & riggs, 1976). miller (1994) suggests that companies with great success either become prone to inertia (at inception or over time), immoderation, and inattention to changing market conditions. several studies show that internal factors far outweigh external situations — directly or indirectly — as causes of failure. the predominant internal factor is failure to recognize deterioration. as pointed out by miller and supported by this study, corporate cultures converge in few strategic ideals: do what works best and continue doing the same. it is easy to miss early warnings, which tend to be weak signals with elusive evidence. upper management tends to not act or ignore early warning signs unless challenged by a crisis (hoffman, 1989). there is a strong tendency to ignore preliminary data that signal 160 journal of business strategies business stagnation. contributing to this is over-confidence and a reluctance to consult subordinates. warning signs of a decline have historically been financial indicators such as decreased working capital and the inability to service short-term and long-term obligations. factors such as changing customer behavior and increased competitive pressures are less measurable, though they are strong indicators. however, the most important indicators of how a company performs are observation and communication within the organization; t few studies address these factors. management must make a conscientious attempt to cultivate relationships across all levels of the organization. strategic choices made by managers in a declining corporate turnaround situation are a function of organizational ineptitude and management’s perception of external factors (tan & see, 2004). more studies are warranted to further understand these factors. turnaround approaches often face severe time limits, limited resources, and lack of stakeholders support (vincent, barker iii, & duhaime 1997; hitt & ireland 1985) that warrants a systematic approach; though levels of deterioration and resource constraints on strategic turnaround choices are not addressed. in 1998, mone, mckinley, and barker predicted that a firm responds either conservatively or innovatively as two ends of a spectrum, based on an organization’s capacity constraints (mone, mckinley, & barker 1998). a literature review indicates that few studies address the sequence of actions that lead to successful recovery. when addressed, research focuses primarily on top management changes and firm-wide cost reduction through retrenchment. (lohrke & bedeian, 1998; schendel, patton, & riggs, 1976). the current study offers a clear sequence of actions that can readily be adopted under most turnaround situations. given the complex nature of turnarounds, this study is grounded by a few representative companies, from diverse industries, that positioned themselves for growth, because of turnaround strategies. the goal is to examine companies that had an appropriate amount of time to strategize turnaround approaches while facing declining performance. for the purposes of this study, turnaround is defined as the recovery of a firm’s performance following a consistent decline, with potential threat to its existence. the proposed framework is based on what worked. the criteria center on successful repositioning as assessed by z-score analysis (altman, 1968), by applying a broad array of factors considering the entire turnaround process. situations not leading to successful turnarounds are analyzed briefly. the proposed capability-driven framework is based on research and analysis. this framework includes seven pillars that enabled these companies to emerge from either, non-profitability or negative volume 29, number 2 161 growth, to achieve real growth. they did so by recognizing the problem quickly and realigning capabilities, to address new demands in emerging markets. they integrated short-term profitability goals with operational execution. in the process, they redefined themselves as opportunity seekers, with the goal of optimizing operational performance. along with efficiency measures, these organizations adopted entrepreneurial approaches to revising the business model, recognizing blind spots, paying attention to early warnings of deterioration, and enacting measures to create situational leaders among employees. they laid a solid foundation for long-term sustained growth, by integrating innovation and social responsibility, within the corporate culture. precipitating factors for turnaround various factors contribute to declining profitability. turnaround requires a drastic change that produces significant achievement in growth and profitability in a short period, followed by long periods of sustained improvements. although business failures more than quadrupled in recent years (2005 to 2009), many businesses are growing. strategic planning for a stronger organization has become a key component of growth and traditional methods of turnaround strategies have often not yielded desired results. analyzing the roots of failure, most result from refusing to adapt to changing markets, poor execution of core business strategies, lack of longterm visions and poor governance structures, and the core removed too far from the current state. although the balance sheet is an indicator of business failure, many companies face challenges beyond it. identifying in advance key factors that underlie poorly performing balance sheets is a challenge. firms also choose to implement a variety of ineffective turnaround methods, borne from improper diagnoses of causative agents that led to poor performance. the literature suggests various turnaround actions including organizational, financial, and operational. however, there is lack of comprehensive analyses of the various precipitating and industry competitive factor characteristics of the type of business. situation analysis of selected sample cases organizations generally have a set of capabilities that differentiates them and makes them successful in the market. after several years of successful growth, organizations are blind-sided by sudden changes in the environment such as increased competition; they become complacent after several years of growth. going back to the core business model forces one to ask the question, “to whom do we offer value?” 162 journal of business strategies with unprecedented growth from 150 stores in 1992, to over 16,000 stores worldwide today, starbucks is credited with converting a commodity into a premium. after more than a decade of steady growth, starbucks did not expect to report losses. some store sales declined in 2007 — the first time in the company’s history. its products were excessive in a time of recession and competitors offered coffee at much lower prices. in addition, starbucks saw a steep increase in its capital expenditures due to declining real estate prices. starbucks’ core competency in gaining customer loyalty was in decline; the company needed to attract customers lured away by cost-effective coffee shops and rebuild customer loyalty. companies that grow too quickly, or grow with acquisitions over time, tend to be far removed from their core in comparison to companies that have organic growth strategies. it is challenging for organizations to take an objective look at existing competencies and determine how to differentiate themselves for longterm growth. for the companies we examined, there was no choice however long it took to get back to their core. part of returning to core activities is also reigniting the entrepreneurial spirit among decision-makers and employees. although toyota is not one of the sample companies in this study, recent safety issues almost brought the company to its knees in rethinking its core business and threatened its seat at the top of the automobile industry (kingston, february 2010). focusing on unsustainable market share goals, toyota took a risky approach and sacrificed its core competency, quality. chasing market share as a primary goal, toyota absorbed too much risk in the development of its products, which allowed quality issues to surface. changes in markets sophisticated customers force executives to refocus their vision and internal capabilities to maintain differentiation. along with customer demands, organizations need to adapt to changes in the global environment and meet increasing regulatory and environmental requirements. in 2001, chiquita brands filed for bankruptcy due to changes in market conditions, driven by trade tariffs in the european union. anticipating that the eu would open its borders to free trade, chiquita invested heavily in infrastructure, incurring billions in debt. however, the eu imposed a quota system that favored imports from africa and other countries over those from latin america. this change in market conditions forced chiquita’s bankruptcy. new ceo, cyrus freidheim, implemented a commit and deliver strategy to focus on the core business of fresh fruit. volume 29, number 2 163 kraft was forced to rediscover its business and refocus its product portfolio to meet social demands as diet changes caused consumers switched from fat-based to organic and healthier food choices. social changes caused declining revenues in 9% to 11% of companies (annual retail trade report., 2008, 2009, 2010). technological changes force the retail industry to rediscover both online and brick-and-mortar presences to suit discerning customer needs. operational inefficiencies operational edge is not considered a force in gaining a competitive edge for businesses. the strategic focus for profitability has largely been gaining market share or pricing advantage. however, changing technology, global outreach, discerning customers, and economic downturns forced businesses to recognize operational strategy as indispensable — a kind of trigger for greater competitive advantage in a global arena. operational inefficiencies were a factor in all companies studied. however, these companies recognized these inefficiencies and corrected them. business process misalignments with the value chain and redundant manual processes led to inadequate use of resources. these, in turn, lead to operational inefficiencies that increased the risk of missing delivery targets and running operations at excessive costs. operational efficiency gained by investments in technology or reengineered business processes allowed businesses to reinvent their models and deliver value to customers; we investigate this area further in subsequent sections. failure to adapt to customer needs kraft foods, which grew to a global company through acquisition, had a strong centralized management structure, combined with bureaucracy and misplaced decision-making. the company had difficulty keeping up with consumers’ rapidly changing tastes, just as other big food companies did when commodity prices rose. meanwhile, other private label brands and price pressure, from retailers such as wal-mart, led to declining market share in various divisions of kraft around 2004. it missed earnings for several years. kraft’s lower margins, global scale, high diversification, and underleveraged balance sheet made it a good candidate for restructuring (kraft – annual reports, 2003-2010). the restructuring efforts came with identification of troubles and cost-cutting measures along with organizational change from a highly centralized to a decentralized model when irene rosenfeld took over in 2006. talbots inc. failed to see changing taste in customer demographics. after years of 164 journal of business strategies growth and steady revenue, talbots posted its yearly loss of $189 million in 2007 (talbots inc. annual reports, 2006-2010). customer research conducted by a new management team revealed that many customers, including middle-aged women, saw talbot’s merchandise as targeted to much older women; talbots failed to engage with changing customer’s lifestyle. lack of corporate accountability a recent study suggested that violation of corporate governance — financial or non-financial — is as high as 9% (nini, sufi, & smith, 2010). such violations are followed by decreased investment spending, reduction in net debt issuance, and lower leverage and shareholder payouts. this forces managers to engage in riskier activities. it is interesting to note, that incidence of covenant violation as a repeat act, is far greater than first-time violations (figure 1). figure 1 this figure represents the portion of firms that violated a financial covenant form 1996 to 2007. a new covenant violation is a financial violation by a firm that has not violated a covenant in the previous four quarters. this study included a sample of 8,666 firms. (reproduced with permission) between the years 1990 to 2000, tyco made 1000 acquisitions at a minimum with no back-office support, business integration strategy, or operational support. although tyco’s book value in 2001 exceeded $110 billion, its long-term debt was over $30 billion. in the middle of 2001, tyco was embroiled in massive scandals and class action lawsuits from state governments for defrauding shareholders. at figure 1 figure 2 long-term shareholder value –return to ‘core’ with integrated business model –value delivery to the best customers, partners strategic capabilities innovation capabilities new products/services process innovation sustainability social responsibility ‘serve the society’ culture –centralized core processes –efficient off shoring activities –tight business integration; quality of products/services operational capabilities total organizational efficiency with differentiated capabilities improved cost structures (near term liquidity) expanded revenue targets efficient working capital management financial capabilities –leadership with strong delegation (path changer) –instill culture of trust with greater emphasis on autonomy –strategic vision and flexibility convey sense of urgency leadership capabilities – knowledge and skill based workforce; act as change harbingers – performance and accountability based organizational dna – commitment to organization organizational capabilities clear corporate governance capability-driven turnaround strategy volume 29, number 2 165 the peak of its growth, with close to 260,000 employees and strong revenues, it became a symbol of runaway excess. with alleged debt-covenant violations and fraud charges against key executives, tyco began massive restructurings. corporate accountability and business ethics have been the sole cause of dwindling profitability in only a few cases. as companies take a more active role in corporate social responsibility (csr), corporate accountability has come to the center of public policies. c-level managers are monitored even more closely for conduct and violations. proposed capability-driven turnaround model demographic, social, and economic trends reshape consumer behaviors continually, which will become more substantial, dramatic, and global in the future. the companies examined, except blockbuster inc. went through the decline phase and recovered or are on a path to recovery. they showed a remarkable ability to respond to changing socioeconomic conditions. in light of current economic conditions, the traditional definition of a turnaround based on profitability alone is unrealistic. there is a time lag between improvement in competitiveness and subsequent profit improvement (stopford & baden-fuller, jul 1990). we examined several factors that contribute to decreasing profitability and the actions necessary for successful turnaround. based on our analyses, we suggest a capability-driven business model that many companies in need of a turnaround can adopt. the capability-driven model is based on seven capabilities that allow organizations to emerge with stronger performance and market-driven capabilities figure 2 includes a coherent set of interplays between strategy, operations, and tactics where a business can outperform, not only its existing status quo, but also its competition. at the heart of the model is aligning with the core of its business strongly, value for sustained growth. each set of capabilities is organized further under its own section, with a summary of the capabilities listed in figures 5 through 10 respectively, under the analysis and discussion section. the summarized capabilities are the results of interviews with the companies under study. 166 journal of business strategies figure 2 capability-driven turnaround strategy long-term shareholder value innovation capabilities sustainability new products/services social responsibility process innovation ‘serve the society’ culture strategic return to ‘core’ with integrated business model capabilities value delivery to the best customers, partners operational centralized core processes capabilities efficient off shoring activities tight business integration; quality of products/services total organizational efficiency with differentiated capabilities financial improved cost structures (near term liquidity) capabilities expanded revenue targets efficient working capital management leadership leadership with strong delegation (path changer) capabilities instill culture of trust with greater emphasis on autonomy strategic vision and flexibility convey sense of urgency organizational knowledge and skill based workforce; act as change harbingers capabilities performance and accountability based organizational dna commitment to organization clear corporate governance capability-driven framework data collection and analysis in the corporate turnaround literature, multiple approaches including declining profitability (robbins & pearce, 1992) and proximity of bankruptcy (barker & duhaime, 1997) identify failing companies (lohrke & bedeian, 1998). initial analyses centered on identifying companies experiencing decreased profitability for at least two consecutive years, after consistent profitability and growth for several years in comparison to industry average. this sampling criterion is called the + + – (plus, plus, minus) rule. the sample covers the period from 2001 to 2010, although data points were drawn from 2006 and 2010 due to relevancy. from an initial list of 245 companies, from 2000 companies from standard & poor’s (s&p) database, we volume 29, number 2 167 refined the target to those companies that did not file for bankruptcy, but experienced declining profitability and growth. initial data on the firms’ restructuring activities and explanations were collected from hoovers international, capitaliq (and other databases), annual and quarterly reports, wall street journal – news and summaries, extel annual news, standard and poor’s compustat (spc) industrial annual research file of companies, and other sources. from an initial identification of a random sample of 25 to 30 companies, we narrowed the list further to seven companies for in-depth analyses through interviews and follow up communication. the sample was stratified by considering only firms that indicated confidence in their performance, due to implementation of strategies for improvements discussed in this paper. the interview data was analyzed for text correlation using an excel-based, text-mining approach. apple, inc. served as a positive indicator for turning around its performance since 2001, where its net margin was close to -0.7%. we depended on stakeholder opinion through interviews about the organization’s strategies and implementation of improvement measures for hypothesis testing. this gave us a perspective of both financial and non-financial information about the business. questions were open-ended, unstructured, and non-grouping to avert implicit bias in data collection. analysis of the data yielded a set of repeated themes and patterns of analysis that were linked directly to an action on the ground scenario. we developed into a framework, a set of themes and patterns that can be applied, over several months, to turnaround situations. results analysis of existing literature indicates that fitzpatrick (1931) was the first researcher to use ratio analysis as a comparative measure between failed and successful companies, although a significant relationship was not demonstrated. in 1966, beaver (1966) used univariate analysis to predict business failure with no clear relationship. altman (1968) expands on beaver’s work with multiple discriminate analyses in his seminal paper to predict business failures. altman subsequently revised his model to incorporate a four-variable a-score prediction model. currently, the z-score bankruptcy predictor is a widely accepted variable based on an algorithm proposed by altman. the accepted cut-off criteria of z-score recommended and used in this study are as follows: 168 journal of business strategies • z-score 3.0 or above – based on financial data, the firm is likely to emerge from a bankruptcy situation. there are other factors, such as management capabilities, that influence the company negatively. • z-score 2.7 to 3.0 – predicts company survival • z-score 1.8 to 2.7 – predicts bankruptcy likely within two years • z-score below 1.8 – predicts bankruptcy for the purposes of our analyses, z-score was used only as a means to compare the health of companies before and after turnaround, along with other factors. in addition, a turnaround situation is considered when a firm encountered multiple years of declining financial performance metrics following a period of profitability within its industry, as observed from public databases (bibeault, 1892; hambrick & schecter, 1983) firms positioned for turnaround improved their operating performance substantially over post-recovery years, contributing to improvements in their z-score. the firms showed improvements in terms of profit margin, (pbit/sales), return on asset (roa), and cash flow. the ash-flow measure also suggests positioning for long-term growth. figure 3 z-score analyses of target companies z-score analyses of target companies during the analysis period. kft: kraft foods inc. cbq: chiquita banana international; tlb: talbots, inc.; aapl: apple, inc., bbi: blockbuster, inc., sbux: starbucks, inc. figure 3 figure 4 1.30 0.30 3.26 3.50 1.68 5.39 5.28 1.54 2.59 1.03 8.91 1.80 1.60 8.71 kft cqb tlb aapl tyc bbi sbux z-score analysis of target companies 2006 2010 0.8 1.1 1.4 2 1.6 1.4 2.2 2 1.6 1.7 1.1 1.2 0.79 1.97 06 10 06 '10 06 '10 06 '10 06 '10 06 '10 06 '10 kft cqb tlb aapl tyc bbi sbux current ratio current ratio 0.4 0.6 0.9 1.3 0.6 0.6 1.8 1.7 0.8 1.1 0.3 0.4 0.3 0.4 06 10 06 '10 06 '10 06 '10 06 '10 06 '10 06 '10 kft cqb tlb aapl tyc bbi sbux acid test ratio acid test ratio 10.70 11.70 0.00 7.80 0.15 0.00 22.80 35.00 10.50 8.00 0.08 0.00 26.00 28.50 06 10 06 '10 06 '10 06 '10 06 '10 06 '10 06 '10 kft cqb tlb aapl tyc bbi sbux roe% roe% 17 36 20 16.3 11.9 0 11.5 53 89 36.3 5.00 -1.72 26.4 28.5 06 10 06 '10 06 '10 06 '10 06 '10 06 '10 06 '10 kft cqb tlb aapl tyc bbi sbux book value per share ($) book value per share ($) volume 29, number 2 169 figure 3 shows the z-score analyses of our case study companies in the base and analysis years. talbots and blockbuster showed a decline in a-score while chiquita international, apple, tyco international, and kraft exhibited increases in z-score, indicative of returning to profitability. we also compared return on equity, acid test, and current ratios of the firms analyzed before and after turnaround (figure 4). acid test and current ratios show improvements in the firms’ ability to cover immediate liabilities without selling inventory. although we included blockbuster in our study for its revenue improvement, it remained unprofitable due to liquidity issues and intense competition. as predicted by our financial metrics and a-score analyses, blockbuster filed for bankruptcy recently — examined further in the discussion section. talbots showed improved revenue last quarter. we discuss talbots in subsequent sections for its interesting turnaround approaches; although bankruptcy is predicted according to z-score analysis. figure 4 comparative analysis of roe, acid test, and current ratios of the target companies current and acid test ratios assess short-term profitability. roe = return on total equity: net income/average stockholders’ equity. acid test ratio also referred to as quick ratio: (cash + marketable securities+ net receivables)/current liabilities; current ratio = current assets/current liabilities. book value per share is included here only as a reference; not a significant contributor to this study due to rapid changes in book value because of the economic downturn. figure 3 figure 4 1.30 0.30 3.26 3.50 1.68 5.39 5.28 1.54 2.59 1.03 8.91 1.80 1.60 8.71 kft cqb tlb aapl tyc bbi sbux z-score analysis of target companies 2006 2010 0.8 1.1 1.4 2 1.6 1.4 2.2 2 1.6 1.7 1.1 1.2 0.79 1.97 06 10 06 '10 06 '10 06 '10 06 '10 06 '10 06 '10 kft cqb tlb aapl tyc bbi sbux current ratio current ratio 0.4 0.6 0.9 1.3 0.6 0.6 1.8 1.7 0.8 1.1 0.3 0.4 0.3 0.4 06 10 06 '10 06 '10 06 '10 06 '10 06 '10 06 '10 kft cqb tlb aapl tyc bbi sbux acid test ratio acid test ratio 10.70 11.70 0.00 7.80 0.15 0.00 22.80 35.00 10.50 8.00 0.08 0.00 26.00 28.50 06 10 06 '10 06 '10 06 '10 06 '10 06 '10 06 '10 kft cqb tlb aapl tyc bbi sbux roe% roe% 17 36 20 16.3 11.9 0 11.5 53 89 36.3 5.00 -1.72 26.4 28.5 06 10 06 '10 06 '10 06 '10 06 '10 06 '10 06 '10 kft cqb tlb aapl tyc bbi sbux book value per share ($) book value per share ($) 170 journal of business strategies we further analyze interview data in terms of weighted average scores across various factors along the framework described in following sections. these factors support the initial hypothesis, that focusing on core business, is of paramount importance to returning to profitability in a turnaround situation. these firms had long-term operational strategies with investment in technology, research and development, and sustainability practices across the entire business for successful turnaround. in the following sections, we discuss our analysis in terms of capabilities that emerged as a theme, a summary of which can be found in tables 1, 2a, and 2b. we find that these firms assumed minimal alternatives in impacting change in various areas; although the time pattern and intensity varies slightly. table 1 bankruptcy asset declaration reduction sample (as of yearend + cost sample firm sic code characteristics 2010) reduction manufacturing; kft kraft foods inc.) 20220000 food retail no yes cqb (chiquita brands int’l. inc.) 01790000 manufacturing no yes tlb (the talbots inc.) 56210000 retail no yes manufacturing aapl (apple inc.) 36630000 and services no n/a tyc (tyco intl. ltd.) 92240000 security products no yes bbi (blockbuster llc) n/a entertainment retail yes yes sbux (starbucks corporation) 58120000 specialty eateries no yes table 1: the industrial characteristic of the sample companies along with their bankruptcy status is defined. the companies studied underwent asset and cost reductions as a proactive measure influenced by economic downturn. data are derived from public databases. volume 29, number 2 171 table 2a sample firm recovery observations methodology data source kft return to core, operational restructuring, interviews with firm wide reorganization with centralized qualitative; experienced core processes; sr. managers’ performance financial stat. managers, and accountability analysis secondary sources cqb return to core(service excellence; fresh fruits focus); capital expenditure (brand strengthening, innovation); business interviews with diversification from commodity to qualitative; experienced non-commodity; leadership change with financial stat. managers, accountability and emphasis on sustainability analysis secondary sources tlb return to core; operational restructuring interviews with (investment in technology), capital qualitative; experienced restructuring, reimage initiatives with financial stat. managers, emphasis on its core customers analysis secondary sources aapl capital expenditure (brand strengthening, innovation), return to core(innovation and interviews with product development) with open culture; qualitative; experienced product development is tightly with all levels financial stat. managers, of workforce analysis secondary sources tyc return to core capabilities; focus on lasting changes in value creation; governance interviews with processes; standards of integrity, qualitative; experienced accountability and innovation; managed financial stat. managers, communication to over communication analysis secondary sources bbi operational efficiencies; diversified capital qualitative; interviews with intensive investments in partnerships and real financial stat. experienced estate; blind sighted by increased competition analysis managers, secondary sources; company archives sbux return to core (customer service; brand qualitative; interviews with positioning);tight integrated business model financial stat. experienced with voice of the customer; quality of products analysis managers, and services secondary sources summary of the sample firms and their recovery strategies 172 journal of business strategies table 2b definitions of terms used in table 2a observed variable definition core capabilities core capabilities are defined as key business strengths the organization has acquired that differentiate it from others. (further discussion on core under section – strategic capabilities) operational restructuring applying set of capabilities with a focus on improving business efficiencies (refer to section for the operational capabilities identified in this study: ) capital restructuring changes to the capital structure of a firm to achieve financial efficiencies value creation delivering what the end customers value. if customers value quality of delivery, then the business processes, systems and resources that produces the customer desired quality is highly valuable to the organization accountability an organizational governance process requiring clear disclosure of financial results and financial ownership voice of the customer insights into customer preferences standards of integrity an organization’s moral code analysis and discussion academics and industries have long sought to identify the factors that allow companies to move from under-performance to over-performance. the case study approach with selected companies shows that these companies improved not only their balance sheets but also positioned themselves for long-term growth, even in the face of economic adversity. the companies we studied realized the fundamental need for transformation in several areas; they returned to their core, engaged employees, re-assessed global markets, and adapted to market conditions. to provide clarity, we describe the proposed model first. the concept of reinventing the core is not new; hamel and prahalad (1990) proposed core capabilities as key to achieving competitive advantage. rediscovering core values is easier said than done in a turnaround situation where the marketplace, company resources, company culture, management, products, and services change. clever industry analysis builds customer focus and high product and service quality as differentiating factors. volume 29, number 2 173 when howard schultz took over starbucks again in 2008, he focused on improving its cost structure by taking operational measures such as labor cost reductions and eliminating unprofitable stores. he renewed customer focus as the core business model. with less reliance on revenues based on premium pricing and more focus on added customer value, starbucks repositioned to offer service excellence along with brand strengthening and innovative service offerings. chiquita brands repositioned to offer service excellence along with brand strengthening and innovative service offerings. since its commodity distribution business was misaligned with its core, the company looked to divest this business unit. similarly, other companies sought to integrate customer service with extended marketing strategies, technology, and real-time services as part of their core business. although starbucks closed unprofitable stores, it launched free wi-fi services in others. by creating an online starbucks community network at www.mystarbucksidea.com, it invites customers to share their ideas and passion for coffee. its loyalty card programs in the u.s. are popular. talbots’ strong synergy between its online store catalog and stores, with centralized inventory control mechanism and distribution system, offers great efficiency to managing sales. talbots tried to move away from its core business — classic styles for women — into trendier styles. apart from financial restructuring, it restructured operations to understand and cater to online customers more effectively. realizing its home resides with loyal core customers, talbots re-launched its website with new and more customer-focused product mix offerings, store segmentation, and loyalty programs. talbots’ major advantage has been strong consumer data, collected via proprietary credit card and loyalty programs and its ability to meld this information with sales, marketing, and customer service. by reducing its outstanding debt and stock repurchase program with the acquisition of bpw, talbots achieved operating income close to $60 million for 2010, following two consecutive years of loss. with some liquidity in stock, talbots is able to focus on long-term strategies such as enhanced marketing programs and improving store productivity. apple extended its core technology business into building its capabilities around a new industry — online music. it needed to reinvent its business from manufacturing and selling computers to integrating its online store music producers, vendors, and customers. apple extended its core capability in technology to the web, building an online retail store for music; its innovation is pervasive, from products to process to impacting customer behavior. in a recent study, heracleous and wirtz (2010) described how singapore airlines has both quality service and operational effectiveness through technology. its 174 journal of business strategies core business is flying, yet it leverages not only software technology, but manufacturing process efficiency. for example, it ensures that fewer vehicle parts are used to reduce the risk of malfunction and high repair costs. meeting customer needs means reaching out and understanding the customer mindset. retailers have already begun to understand finer segmentation as a basis for a multi-banner model. kraft realized that the local deli is a competitor and rebranded some of its own in line with local competition. chiquita brands introduced its fresh express salads and fruit bites in keeping with its core and customers focus. internationally, it introduced fresh fruit smoothies in the middle east. apple’s repositioning of its consumer products business and its popular retail stores made it one of the most admired companies for innovation and design. apple does not just meet customer needs; it transcends customer needs by creating markets for its products. for some companies, it is too soon to say whether they meet customer needs in terms of product portfolio, functionality and services. however, these companies have the right elements for a turnaround. blockbuster rolled out several measures to prevent bankruptcy; at the time of this study, it could not return to profitability. blockbuster’s failure to discern changes in market dynamics and customers attitude was influential. it had difficulty improving margins in the face of competition, a shift in consumer behavior, and rapidly changing digital technology. its rival companies, apple and netflix, embraced technology to deliver services and digital media cost-effectively. blockbuster experienced several challenges integrating on-line delivery with its business model when it started adopting technology, in contrast to apple which was able to integrate its business model with technology and customers seamlessly. our findings revealed several factors that contributed to decreasing profitability and the actions necessary to turnaround business performance positively. many companies in need of turnaround can adopt the capability-driven business framework (figure 2). the model is based on seven capabilities that allow organizations to emerge with stronger performance and market-driven capabilities. strategic capabilities strategic theorists predict that factors that sustain competitive advantage often generate long-term growth and performance. a firm’s strategic capabilities offer companies competitive advantage, a distinguishing set of values that attract customers, employees, and investors. as stated by zook (33), the right to win accrues to companies that stick to core business and find novel ways to use and exploit them. companies with declining profits wandered from core capabilities by acquiring comvolume 29, number 2 175 panies with minimal compatibilities contesting in unfamiliar markets or those simply having their lost core competencies. the companies studied here refocused their turnaround strategy on core capabilities and built other capabilities around them. figure 5 summary of strategic capabilities return to core capabilities emphasize strategy to grow and not slash investment in r & d flexible and agile value-chain to meet customer demands notes: definition of core capabilities; for the purposes of this article, core capabilities are defined as key strengths an organization acquired that differentiate it from others, giving it an uncontested competitive advantage for long-term success. core capabilities relate to products and services. core capabilities are different from core values such as excellent customer service or emphasis on quality. core values reflect what is important to an organization to compete on core capabilities. core values underpin an organization’s culture that excite, attract, and retain the work force, suppliers, and associated stakeholders. after two years of reporting losses, talbots refocused its core business on women in their 50s and above. in 2006, talbots acquired j. jill with the aim of catering to children and it started selling men’s clothing. it soon realized that these products were unrelated to its existing core business. its turnaround strategy, returning to its core capabilities, earned talbots its right to win. the latest 10k statement (2011, 2nd quarter) from talbots shows an operating income of $60 million, as opposed to an operating loss of $11 million in 2009. starbucks strategy to cut out breakfast and restore connections that customers have with the company’s coffee was a successful return to core when howard schultz returned as ceo in early 2008. successful turnaround was attributed to a series of investments in coffee-related products and offerings which were responsible for reigniting a coffee attachment with customers. starbucks’s latest financial statements indicate a successful turnaround, with reported profits for two subsequent years, and same-store increases of about 7% to 8% (talbots financial statements – 2009, 2010). defining core business capabilities is critical for both short and longterm profitability because it further defines and influences other capabilities required for execution. 176 journal of business strategies operational capabilities turnaround companies realize they cannot recover competitive edge by adding market share alone or reducing product prices. there needs to be a concerted approach across the value chain, from customers, products, supplies, technology, and compliance from partners in bringing efficiency and operational strategic advantages. an efficient organizational capability leads to efficient integration across the entire value chain that, in turn, leads to operational excellence. operational efficiency requires considerable investment in technology, but it offers not only automated business processes but far greater value from integrating businesses and processes. the result is a competitive advantage and an ability to differentiate by process innovation. with its full range of systems across retail, finance, merchandising inventory distribution, and control, talbots manages its inventory and customers in its online and brick and mortar stores. it succeeded in boosting sales from 28% to 46% in eight years with its loyalty card and credit card programs companies must try to cause minimal organizational disruptions when improving operation efficiencies; they should be part of a long-term turnaround strategy since it requires considerable thought, investment, and adaptation (figure 8). teams should align prioritized processes with strategic goals and quality improvements such as reducing non-conformance in a pharmaceutical manufacturing scenario. figure 6 summary of operational capabilities automated business processes across key value chain for improved efficiency strategic investment in key technologies achieve transformational process efficiency rather than continuous improvement minimal organizational disruption while improving operational efficiency strong focus on quality of products and services top manufacturers go further; they integrate and align core processes to increase transparency between manufacturing facilities and the customer. this leads to better management of processes and operations, and more process efficiencies with reduced cycle times and manufacturing costs. volume 29, number 2 177 financial capabilities firms with successful turnarounds reduced debt to manage cost of capital. the key is to identify non-performing or underperforming business units or products and quickly find buyers. sellers can use cash from liquidation to reduce debt or increase their cash balance. well-managed companies always focus on cash and capital management. they cut down capital investments to the core. however, not all capital investments may be a non-priority. for example, one can take advantage of making an investment in real estate during an economic downturn. companies in this study examined the factors listed in figure 7 for successful restructuring, thereby improving debt-to-equity ratio. in addition, complete financial visibility and transparency led to improved decision-making and resource allocation. figure 7 summary of financial capabilities disposing non-performing assets longer payment terms to suppliers restructure debt and equity structure swapping equity for debt (however painful it may be) assess opportunity to improve cash flow both in the short term and long term some companies have been especially innovative in their approach to capital restructuring. despite a 40% employee and 31% inventory reduction and cost restructuring measures, talbots experienced continued imbalance with enormous debt to its majority shareholder, aeon. this japanese retailer — talbots’ largest creditor — had an enormous liquidity problem even before the 2008 economic downturn. in a recent creative move, talbots offered to merge with bpw acquisitions, a special purpose acquisition company (spac) — a deal which offered enough funds to allow talbots to retire existing debt. this bold and creative move also gave the retailer additional ability to secure capital from ge capital. transforming leadership capabilities studies repeatedly shown that turning a company from a non-growth, low profitability, and possibly bankruptcy situation, to one of high growth and profitability, needs not only sound strategy, but clear and swift execution. strong leaders who 178 journal of business strategies assemble a winning team with superb ability to delegate, communicate, coordinate, empower, and motivate staff are of paramount importance. in essence, the transformational leader should be a pathfinder with an ability to exploit the market-oriented uniqueness in key areas that directly supports the strategic direction. when tyco international was mired in scandal and ed breen was brought in to rescue the $38 billion company with $30 billion in debt, his first action was to communicate honestly and openly not only to shareholders, but to other external parties, such as the media, to rebuild trust and reputation. today, tyco is positioned for acquisition, using the same business model by which the company grew internationally (bolt-on acquisition strategy). although breen took other measures such as downsizing staff and adopting six sigma methodologies for operational efficiency and eliminating non-core businesses, he could rebuild trust only through strong communications. tyco provided strong governance with accountability and sufficient autonomy in decision-making. in a recent transaction, tyco acquired brink’s home security holdings after almost nine years of strengthening its strategic focus on security platforms (figure 8). figure 8 summary of transformational leadership capabilities strategy led by strongly committed senior executives focus on long term value creation integrated vision – with an ability to address all elements of organizational performance instill strong corporate entrepreneurial spirit create positive, dynamic environment for employees over communicate than under communicate manage change – as organizational dna path finder create change implementer rather than change manager organizational capabilities studies on organizational culture emphasize the importance of committed and motivated employees willing to support the corporate restructuring process. the entrepreneurial spirit of the team responsible for decision-making makes a signifivolume 29, number 2 179 cant difference. division heads and top management do make strategic decisions, though employees should make autonomous and creative decision in executing a turnaround strategy. line managers should have profit and loss responsibilities with incentivized decision-making abilities. hodak (2000) states that profit centers provide accountability. combined with autonomy and operational decision-making, line managers and business unit heads are able to focus on process, efficiency, and profitability. although this was apparent in most of the companies studied, kraft, with its organizing for growth initiative, rewired the entire organization from being highly centralized to being highly decentralize in a span of three years. in addition to autonomy, organizations should position themselves to operate in a cross-functional, cross-departmental culture. far greater value is realized when team members are assembled across functions. a cross-functional team organization leads to cross-pollination of ideas and the ability to solve problems. however, cross-functional team should be assembled and dissolved in keeping with business demands. cross-functional teams are supported by a flatter organizational structure because it fosters entrepreneurial abilities of knowledge workers. knowledge and skills-based workforces act as change harbingers. building a cross-functional organization is difficult, demanding a highly interactive organizational culture, quick decision-making, and trust among employees. it is the responsibility of the management teams to create a positive, dynamic environment for employees, and functional skills are vital. teamwork, character values, creative conflict resolution, and interactive openness are key skills that must be fostered through strong training and collaborative talent development models (figure 9). figure 9 summary of organizational capabilities integrated vision – with an ability to address all elements of organizational performance – skills, accountability, and employee commitment instill strong corporate entrepreneurial spirit create positive, dynamic environment for employees over communicate rather than under communicate manage change – as organizational dna create change implementers rather than change managers 180 journal of business strategies an effective organizational capability to manage people should be aligned with competitive advantage; organizational capability is the engine under the turnaround vehicle. managers and employees need to be aligned with business needs and focused employee roles and responsibilities. sustainability and corporate social responsibility (csr) sustainability is an imperative for any organization, but corporations define and adopt it differently. they look beyond shareholder value to add social value and environmental sustainability. several studies have found a high correlation between financial performance and level of corporate social responsibility (csr). in a turnaround situation, csr takes a backseat. companies need to detach themselves from the now attitude and look at csr initiatives as a value-adding and sustained long-term goal. sustainability initiatives lead to high investor confidence if done correctly. common mistakes occur when companies assume too many sustainability initiatives or initiatives that do not align with strategic core competencies. sustainability practices should extend to suppliers, contractors, and partners to have triple bottom-line impacts. transparency and performance accountability should drive sustainability initiatives with improvements to the initial plan. as companies become more involved in csr activities, they are monitored closely for public policy violations. a commitment to csr itself is insufficient; appropriate corporate governance and business ethics should be in place. along with making csr an integral part of core business operations, strict standards of business conduct including provisions to avoid conflict of interest are necessary (figure 10). figure 10 summary of csr capabilities sustainability and csr initiatives should be in alignment with the core competencies should be part of the organizational dna an extended sustainability initialize that is applicable to suppliers, contractors, and partners in imperative be innovative be mindful that sustainability initiatives are not one-time but an on-going effort collaborate and continuously improve volume 29, number 2 181 conclusion extant literature and turnaround management professionals propose several avenues to identify factors that allow companies to return to profitability after a decline. in this paper, we focussed on proposing an adaptable framework by studying companies that showed marked improvement in performance after a decline in profitability. although industry characteristics are important, the author observed that a holistic approach with firm-specific transformation capabilities is important (figure 11). rather than a focused attempt to continuous improvement, companies need a fundamental shift in the way they think about performance. this study suggests that clear understanding and focusing on well-defined their core capabilities lead to sustained profitable growth. organizations studied in this paper refocused core business capabilities after experimenting with adjacent businesses, expanded core capabilities, or both (e.g., starbucks). in the case of blockbuster, the core business is renting videos, and renting videos online require a different set of operational capabilities than renting videos in retail stores. key decisions were made such as hiring a retail chain ceo and making investments in video drop boxes without much attention to core business. in a turnaround situation, returning to core ranges from investing in a management team that understands the core business, to defining core markets, suppliers, and core business models. cost optimization measures should span entire corporate functions such as finance, technology services, procurement, accounting, and human resources. cost centers should be transformed to be value centers by returning to core business models and values. this includes eliminating underperforming business units, strategic reallocation of capital, or even strategic long-term investment aligned with core business. similarly, operational efficiency measures should span the entire key value-chain with a strong focus on quality. operational excellence with strong emphasis on efficiency leads to financial results. for example, a customer management model must be based on partnership, rather than just another account. 182 journal of business strategies figure 11 transformation capabilities a fearless visionary leadership must provide a strong cultural framework for employees and motivate employees to achieve greater accountability and performance goals. long-term strategic goals such as innovation and sustainability become the backbone of organizational transformation that leads and sustains the organization until market forces change again. traditional approaches examine one or two aspects such as financial or operational improvements. these approaches are incremental and lacking in organizational perspective. adapting a holistic approach transforms a cost center to a value center with strategically aligned, efficient business processes and strong customer value. companies are challenged by external factors constantly. as shown by our case study firms, turnaround should be examined as organizational adaption to external changes; it is an opportunity to redefine standards of a competitive landscape. although this study describes a capabilitydriven framework, a large industry-specific sample of companies would allow researchers to test the conceptual framework in a predictable context. acknowledgement the author greatly acknowledges constant encouragement, help with research and critical readings of the manuscript by prof. peter cohan – professor of business strategy, babson-olin school of management. the author also appreciates critical reading of the manuscript by dr. chandri yandava – broad institute, mit. figure 10 figure 11 •sustainability and csr initiatives should be in alignment with the core competencies •should be part of the organizational dna •an extended sustainability initialize that is applicable to suppliers, contractors and partners in imperative •be innovative •be mindful that sustainability initiatives are not one-time but an on-going effort. •collaborate and continuously improve cost center value center return to core business reduce operating cost secure cash or financing operational efficiency through integrated business processes integrated business model , new market penetration product expansion lt capital allocation focus on strong quality of products and services short term long term volume 29, number 2 183 references altman, e. (1968). financial ratios, discriminant analysis and the prediction of corporate bankruptcy. journal of finance, 23(4), 589-609. baden-fuller, c., & stopford, j. m. (1992). rejuvenating the mature business: the competitive challenge. london: routledge. barker, v, & duhaime, i. (1997). strategic change in the turnaround companies: theory. strategic management journal, 18, 18-35. barker, v., & mone, m. (1994). retrenchment: cause of turnaround or consequence of decline? strategic management journal, 15(5), 395-405. beaver, w. h. (1966). financial ratios and predictors of failure. empirical research in accounting, 4, 71-111. bibeault, d. b. (1892). corporate turnaround. new york: mcgraw hill. bowman, e. d., & singh, h. (1993). corporate restructuring: reconfiguring the firm. strategic management journal, 14, 5-14. castrogiovanni, g., & bruton, g. (2000). business turnaround processes: reconsidering. journal of business research, 48, 25-34. fitzpatrick, p. j. (1931). symptoms of industrial failures. catholic university of. gilson, s. c. (1989). management turnover and financial distress. journal of financial economics, 25, 241-262. hambrick, d. c., & schecter, s. m. (1983). turnaround strategies for mature industrial-product business units. academy of management journal, 26(2), 231-248. heracleous, l., & wirtz, j. (2010). singapore airlines’ balancing act – asia’s premier carrier successfully executes a dual strategy: it offers world-class service and is a cost leader. harvard business review, 88(2010), 145-149. hitt, m. a., & ireland, r. d. (1985). corporate distinctive competence, strategy. strategic management journal, 6, 273-93. hodak, m. (2000). the viable eva center (or how to slice a company so it doesn’t bleed). journal of applied corporate finance, 13(3), 71-79. hofer, c. w. (1980). turnaround strategies. journal of business strategy, 1, 19-31. hoffman, r. c. (1989). strategies for corporate turnaround: what do we know about them? journal of general management, 46, 46-66. kingston, j. (february, 2010). a crisis made in japan. retrieved march 2011, from online.wsj.com/article/sb10001424052748704533204575047370633234414. html lohrke, f. t., & bedeian, a. g. (date???). managerial responses to declining performance. advances in applied, 5, 3-20. 184 journal of business strategies miller, d. (1994). what happens after success: the perils of excellence. journal of management studies, 31(3), 326-358. mone, m., mckinley, w., & barker, v. (1998). organizational decline and innovation: a contingency framework. academy of management review, 23(1), 115-322. moulton, w., thomas, h., & pruett, m. (1996). business failure pathways. journal of management, 22, 571-595. nini, g., sufi, a., & smith, d. c. (november 2010). creditor control rights, corporate governance, and firm value. social science research network. prahalad, c. k., & hamel, g. (1990). the core competence of the corporation. harvard business review, 68(3). robbins, d. k., & pearce, j. a. (1992). turnaround: retrenchment and recovery. strategic management journal, 13(4), 287-309. schendel, d., patton, g. r., & riggs, j. (1976). corporate turnaround strategies: a study of profit decline and recovery. journal of general management, spring, 3-11. stopford, j. m., & baden-fuller, c. (july 1990). corporate rejuvenation. journal of management studies, 27, 399-415. tan, h., & see, h. (2004). strategic reorientation and responses to the asian financial crisis: the case of the manufacturing industry in singapore. asia pacific journal of management, 21, 189-211. vincent, l., barker iii, a., & duhaime, i. m. (1997). strategic change in turnaround firms: theory and empirical evidence. strategic management journal, 1, 13-38. zook, c., & allen, j. (2001, 2010). profit from the core: a return to growth in turbulent times. harvard business press. consumer trend data. (2009-1010). retrieved jan 2011, from www.nrf.com/modules.php?name=pages&sp_id=1419 imf sees major slowdown for global economy, calls for strong and coordinated policies to support a turnaround. (october, 2008). retrieved january 2010, from www.imf.org/external/np/sec/pr/2008/pr08236.htm all times bankruptcy. (1995-2010). retrieved january 2011, from www.bankruptcydata.com/researchcenter2.htm latest annual retail trade report. (2008, 2009, 2010). retrieved jan 2011, from www.census.gov/retail/#arts survey of current business. (september 2010). retrieved january 2011, from www. bea.gov/scb/index.htm volume 29, number 2 185 biographical sketch of author booma yandava received her mba from babson – olin graduate school of business. she is a certified global business professional, consulting and researching on a range of global business strategic and operational issues, including turnaround, operational improvement, and execution. this research work, started at babson, is the result of an iterative process between collecting primary data, concept development and testing ideas. at present she is with kpmg. a capability-driven turnaround strategy for the current economic environment a profile of high level corporate managers in the united states robin t. peterson college of business administration and economics new mexico state university las cruces, new mexico introduction what are the backgrounds of the leaders of large and medium sized businesses in the united states? these individuals wield considerable power and influence. their personality characteristics have been widely discussed by the popular press. many television series depict top managers as highly educated men, who jump from one company to another, in pursuit of more desirable jobs. are these and other beliefs about top managers mythical or do they approximate reality? this paper presents the results of an inquiry into the characteristics, background, and behavior ofthe senior managers in large and medium sized united states business firms. objective data on these variables should be of value in identifying and characterizing the top leaders and in suggesting vehicles which may have been responsible for their ascension to their current posts. rationale it is apparent that there is need to analyze top managers' characteristics and background. information on the characteristics of top managers is very useful in a macro sense, since the leadership that they provide is vitally significant to the well-being of the country at large. top managers make decisions which affect the prosperity of the country, consumer satisfaction, and the state of the natural and cultural environment. another reason for studying the characteristics of top managers is to determine the extent to which they are a homogeneous group. are they part of an internally similar cluster, or do they come from diverse elements of society? have affirmative action and related laws exerted an impact upon the makeup of this group? such questions are difficult to answer, but data which provides clues to their resolution can be of substantial value. this study was designed to provide some insights into the questions raised above and to other related issues. journal of bu6ineu strategie6, volume 4, number 2 (fall 1987) 74 the study the sample the sample consisted of 1,200 individuals who were c.e.o.'s or second or third level executives for firms with annual operating revenues of $50,000,000 or more in 1985, and whose names appeared in the 1984-85 edition of who's who in a merica. corporate directors were excluded, since many of them have been appointed to boards for outstanding achievement in fields other than business, such as the military, and might not fit the definition of business leaders. the sample was random and sequential. the data were drawn from numerous industries, rather than being restricted to particular ones, such as some previous studies have. further, the sample covered firms with sales above $50 million, not just those listed in the fortune 500. this was logical as the intention was to assume a relatively composite view, one that was not oriented to only the very largest firms. top managers of concerns that are in the $50 million or more range certainly exert an influence upon the economic and political fortunes of the united states, even if they are not encompassed in the fortune 500. the rationale for this study, as outlined above, dictates that these "smaller" large companies be included in the sample. collection of data the data. resulted from an examination of biographical entries in the 198485 edition of who's who in america. this source sets forth considerable information on the characteristics of over 75,000 biographees. the researcher randomly selected names of managers from this volume who were c.e.o.'s or second or third tier managers. the position of the individual in the organization and total annual operating revenues of the company in 1985 was then determined through reference to moody's publications and annual reports. the managerial characteristics which were studied were those which who's who in a merica reports upon in a consistent and unambiguous fashion. results on personal characteristics this section sets forth information on selected personal characteristics of the respondents. the information contained in who's who in america is self-reported by the biographees, which means that it cannot be readily verified. however, the who's who staff ma.kes it rigorous attempt to elicit accurate information and since the information is printed and widely disseminated, there is motivation for accurate self reporting. gender the membership of the sample was overwhelmingly male. of those enumerated, 1160 were men, 28 women, and 12 were not evident. obviously, 75 women have a long way to go if they are to gain anywhere near equal representation in the top executive positions. however, the results of this study do show a bit more female representation than do those of an inquiry into fortune 500 top executives, taken by sturdivant and adler in 1975 [6]. in the 1975 study, none of the 444 executives analyzed were women ([6], p. 127). in another study of chief executive officers of large corporations, made in 1980, only one of 800 chief executives was a woman ([2], p. 50). hence, the data in the present study might be taken as an indication of slightly more female participation. the small numbers of women in top positions should not be viewed as evidence of the failure of equal opportunity efforts by industry or of women to achieve in business. women only entered schools of business, engineering, and other professional fields in large numbers during the past decade and a half, are in the process of gaining experience and seniority, and more time must necessarily pass before they have advanced to the top positions in large concerns. after the passage of this time corporations will have available to them a new and expanding resevoir of executive talent. age table 1 outlines the frequencies of individuals occupying the top positions by age group. it also presents the age distribution of chief executive officers of large corporations, according to another study. the bulk of the sample is in the 50-59 and 60-69 age groupings. the median figure is 55.8. this compares to a median of 57 in a 1976 study of fortune 500 executives ([6], p. 176). the 1980 study referenced above listed a median of 55.2 ([2], p. 51). it appears that top managers are well into their years and that many are not far from retirement (although retirement at age 65 is often resisted by upper-echelon executives). in general, those who seek high-level positions may have to wait until they have accumulated considerable tenure, before they can acquire their target positions. the age of the sample may help in explaining rationale for the charges of conservatism and lack of venturesomeness which are sometimes hurled at the united states business establishment [1]. perhaps a younger cadre of senior executives might be more inclined to take risks and might extend its vision more into the long run impact of decision making. firms such as apple computer, that are headed by younger managers often tend to be more inclined to absorb risk. birthplace table 2 sets forth the birthplaces reported by the sample. it is apparent that the mid-atlantic, east-north-central, and west-north-central regions account for the highest proportions of the total numbers. the last column sets forth total u.s. population in the various regions. in comparison to these, the mid-atlantic, east-north-central, and west-north-central areas produced more than their commensurate share of top executives, while the 76 south-atlantic, east-south-central, west-south-central, mountain, and pacific areas did not fare as well. it is apparent that the top executive group is clustered geographically (with almost sixty-five percent of the top executives in three regions). table 1 age distribution of the sample age distribution age according to 1980 studya grouping frequency percentage percentage 20 29.9 12 1.0 0.6 30 39.9 24 2.0 0.6 40 49.9 172 14.3 11.6 50 59.9 484 40.3 49.6 60 69.9 404 33.7 35.0 70 79.9 84 7.0 2.5 80 & over 8 0.7 0.1 not stated 12 1.0 0.0 totals 1200 100.0 100.0 clsource: louise boone & james c. johnson, "profiles of the 1980 men and women at the top." bui/ineu horizonl/, february 1980, p. 51. table 2 place of birth of sample members sample u.s. population birthplace frequency percentage percentagea northeast 81 6.8 5.4 mid-atlantic 362 30.2 16.1 south-atlantic 68 5.7 16.3 east-south-central 44 3.7 6.4 west-south-central 76 6.3 10.8 eastnorth-central 269 22.4 18.0 westnorth-central 148 12.3 7.5 mountain 21 1.7 5.2 pacific 57 4.8 14.3 not stated 19 1.6 n.a. foreign and other 15 1.3 n.a. totals 1200 100.0 100.0 clsource: statil/tical abl/tract oj the united statel/. washington, dc: u.s. government printing office, 1983, p. 12. 77 number of children who's who in america does not report on the marital status of its biographees. however, it contains a proxy variable on family status by indicating the number of children of each respondent. table 3 contains the frequencies uncovered in the study. it indicates that most had two, three, or four children. these frequencies are typical for the united states at large ([5], p. 24), indicating that, at least with regard to number of children, the major executives do not differ significantly from the pattern of the average family. table 3 n umber of children reported by the sample members number of children frequency percentage 0 55 4.6 1 64 5.3 2 357 29.8 3 313 26.1 4 220 18.3 5 37 3.1 6 28 2.3 7 5 0.4 8 3 0.3 more than 8 2 0.2 not stated 116 9.7 totals 1200 100.0 education another set of variables relates to the levels and kinds of education which the top executives have attained. this section provides an examination of these. degree level table 4 sets forth the classification of the respondents by degree level. the bulk of the group holds a bachelor's degree, although the portion who have completed a master's is approximately twenty percent of the total. in turn, those with doctorates account for close to sixteen percent ofthe total number. compared to the population at large ([5], p. 134), this is very much a well educated group. only about 3 percent of the sample had no degree. this compares with 4 percent in a 1976 study ([6], p. 130). 78 table 4 college degree level of the sample designation no college degree ba.chelors degree masters degree doctorate degree percentage 3.2 61.5 19.6 15.7 public and private designation another varia.ble of interest is the extent to which the executive received their degrees from public or private colleges and universities. of the 1,153 exec.utives with degrees, 653 received them from private colleges and universities, 459 from public institutions, and 51 from institutions whose status could not be determined. this can be partially explained by the fact that many executives received their degrees prior to the mid 1950's, when private schools produced more graduates than their public counterparts. year of graduation another variable of interest is the year in which the executives graduated from college. this indicates what cohort groups are now in power at the top. table 5 furnishes the relevant statistics. table 5 year in which respondents received college degrees year of graduation frequency percentage 1920-1929 12 1.0 1930-1939 128 11.1 1940-1949 331 28.7 1950-1959 432 37.5 1960-1969 175 15.2 1970-1979 39 3.4 1980-1983 5 0.4 not stated 31 2.7 totals 1153 100.0 most of the sample graduated during the 1950's. the second largest group received their degrees during the 1940's. they are followed by the 1960's and 1930's. managers who graduated in the 1940's and 1950's tend to be relatively conservative in nature and are endowed with the work ethic [4]. as these individuals move out of power positions others with different values may replace them and transplant new cultures into the organizations which they 79 lead. it should be expected that many of the values of the 1960's and 1970's will supplant those of the 1940's and 1950's over time. degree field another variable of interest is the area in which the top executives received their degrees while in college. table 6 presents the data from the study. by far the largest segment is made up of business administration, followed by law i engineering, and liberal arts. most of the top managers, then, are from professional schools that provide a somewhat pragmatic educational background. the high concentration in business administration suggests that aspiring top executives should seriously consider a college in that field. table 6 field in which the respondents received college degrees field frequency percent business admin. 517 44.8 law 196 16.9 engineering 176 15.4 liberal arts 110 9.5 accounting 60 5.2 economics 22 1.9 other 51 4.4 not stated 21 1.9 totals 1153 100.0 work experience the past work experience of the sample members provides some guidelines as to potential means of going to the top of an organization. entry position one key variable in this field is the entry level position which sample members occupied. table 7 sets forth the results of the study on entry level. unfortunately, many of the biographies did not report the nature of their entry level position. of those which were enumerated, however, the largest is attorney, followed by manager, accountant, salesman, engineer, and trainee. these data may be somewhat misleading, as some individuals probably are well-established in their fields (such as an attorney) prior to joining their current employer. other studies have indicated that the main background fields of high-level managers are finance, banking, administration and marketing ([3], p. 45). another characteristic is the number of employers t.he sample members have worked for in their careers (including the current employer). table 8 indicates that the largest number of top executives had two employers. it would 80 appear that loyalty to the organization has paid off for many who have made a minimum number of interemployer job moves. another study [7]' which indicates that well over one half of the top managers of large organizations have worked for only one employer during their careers, reinforces this finding. table 7 entry level position of sample members position frequency percent attorney 91 7.6 manager 80 6.6 accountant 73 6.1 salesman 69 5.8 engineer 68 5.7 trainee 27 2.2 other 156 13.0 not stated 636 53.0 number of employers 1200 100.0 table 8 number of employers of the sample members number of employers frequency percent 1 202 16.8 2 306 25.5 3 193 16.1 4 191 15.9 5 112 9.3 6 96 8.0 7 31 2.6 8 20 1.7 9 9 0.8 10 4 0.3 over 10 7 0.6 not stated 29 2.4 totals 1200 100.0 number of jobs with present company the research involved tabulating the number of jobs that the sample members had held with their present company. table 9 presents the results. the highest frequencies are associated with two, one, and four positions. the typical top executive, then, has held several jobs with the firm. on the 81 other hand, a smaller number of executives have held many positions with the same enterprise as they progress upward in the hierarchy. table 9 number of positions held with current employer number of positiona frequency percent 1 313 26.1 2 355 29.6 3 197 16.4 4 133 11.1 5 51 4.3 6 69 5.7 7 25 2.1 8 z7 2.2 9 4 0.3 10 8 0.7 more than 10 5 0.4 not stated 13 1.1 totals 1200 100.0 number of jobs with other companies another variable enumerated was the number of executive level jobs the sample members had held with other firms. table.10 specifies the frequencies. the bulk of the respondents have not held executive level jobs with other firms. of those who have, the highest frequencies are associated with one, two, and three positions. it would not appear, based upon these frequencies, and those in table 8 the sample members made their way to their present jobs through frequent job-hopping from one organization to another. rather, tenure with a single company seems to be an excellent means of progressing to the top. military service the bulk of the sample-702 respondents-had served in the military at some time in the past. on the other hand, 303 respondents had not served. the remainder-195 respondents-did not state if they had served or not. of those who were in the service, 229-about a total of one third-were oflk.ers. the others were enlisted personnel or did not state their rank. in the population at large approximately 40% of those over age 21 are veterans ([5], pp. 24j 346). thus the percentage of top business leaders who are veterans is larger than that for the population in general. 82 affiliations there are a number of affiliations of sample members which give clues to their past history. political party ofthe total sample, 479 (39.9%) indicated that they were republicans and 124 (10.3%) that they were democrats. the remainder, 597 (49.8%), did not state a political party affiliation. it would appear that many of the executives are either independent or do not have a strong enough political preference to set it forth in who's who. of those who cite a preference the ratio is almost four to one in favor of the republicans. according to survey data the number of adults in the general population who were registered democrats substantially exceeded the number of registered republicans ill 1985 ([5], p. 149). table 10 nuulber of executive level jobs held with other companies nuulber of jobs frequency percent 0 585 48.7 1 174 14.5 2 136 11.2 3 80 6.7 4 47 3.9 5 57 4.8 6 36 3.0 7 33 2.8 8 11 0.9 9 9 0.8 10 24 2.0 over 10 7 0.6 not stated 1 0.1 totals 1200 100.0 religious preference table 11 reports on the religious preferences of the sample members. most did not cite their religious preference. of those who did, the leading denominations are presbyterian, episcopalian, and roman catholic. the number of top managers who embrace the jewish religion stated as a percentage of the total population who embrace the religion is slightly higher than the similar percentage for the protestant religion. the percentage for protestants is three times larger than that for those who are roman catholic [8]. 83 table 11 religious preferences of sample members religion frequency percent presbyterian 120 10.0 methodist 61 5.1 roman catholic 72 6.0 baptist 23 1.9 episcopalian 84 7.0 jewish 37 3.1 church of christ 8 0.7 mormon 23 1.9 other 108 9.0 not stated 664 55.3 totals 1200 100.0 national associations the number of national organizations of which the respondents were members was tabulated. table 12 furnishes the results. memberships for most executives are in the range of one to four organizations, although some report many more. the data suggest that on average, top executives do not seek membership in numerous national associations. multiple memberships may not be a requisite for the upward-bound. table 12 number of memberships reported in national associations number of associations frequency percent 1 263 21.9 2 225 18.8 3 140 11.7 4 127 10.6 5 77 6,4 6 19 1.6 7 9 0.8 8 24 2.0 9 5 0.4 10 15 1.2 over 10 21 1.8 not stated 275 22.8 totals 1200 100.0 84 number of members in regional or local organizations finally, the study tabulated the number of memberships in regional or local organizations. table 13 presents the data. table 13 memberships in regional or local organizations number of memberships frequency percent 1 267 22.3 2 165 13.8 3 64 5.3 4 25 2.1 5 3 0.2 6 32 2.7 7 0 0.0 8 4 3.3 9 0 0.0 10 0 0.0 over 10 0 0.0 not stated 640 50.3 totals 1200 100.0 the largest frequency is not stated, indicating that the biographies probably did not perceive local memberships to be of extreme importance, so that they would be listed in the publication. beyond "not stated" the highest frequencies are with one, two and three organizations, in that order. as in the c.ase of national organizations, multiple memberships appear not to be highly sought-after. summary and conclusion a summary view of the accumulated information from the study permits the formulation of a composite picture of typical top executives. they are mainly men, age 50-70 who were born in the mid-atlantic and east-northcentral regions. the bulk of these individuals have 2-4 children. they have a bachelors degree from a private institution, which they received in the 1940's or 1950's, probably in business administration. they entered their professional careers as an attorney or manager trainee and have had less than three employers and only one or two positions with their current employer. they have military experience and are either not affiliated with a political party or are republicans. of those who state their religious affiliation the largest numbers are presbyterian, episcopalian or roman catholic, many biographees report belonging to a small number of national or regional and local organizations. 85 finally, the findings indicate that top executives manifest substantial similarities in some respects, such as sex, age, number of children, and education, but certainly do not make up a homogeneous group. there are major differences within the group with respect to birthplace, public versus private college education, entry position, number of past positions held, and religious affiliation. top executives are similar in many ways but also exhibit numerous differen~es. references 1. bachholz, rogene a. "an empirical study of contemporary beliefs about work in american society." journal of applied psychology, vol. 63, 1978, pp. 219-228. 2. boone, louis e., and johnson, james c. "profiles of the 801 men and 1 woman at the top." business horizons, february 1980, p. 50. 3. fleenor, g. patrick, david likurtz, and louis e. boone. "the changing role of business leadership." business horizons, july/august 1983, p. 45. 4. sharp, laure m. education and employment, baltimore: the johns hopkins press, 1970, pp. 77-82. 5. statistical abstract of the united states, washington, d.c. u.s. government printing office, 1986, p. 24. 6. sturdivant, frederick d., and adler, roy. "executive origins: still a gray flannel world?" harvard business review, november/december 1976, p. 127. 7. tuckel, peter, and siegel, karolynn. "the myth of the migrant manager." business horizons, january/february 1983, pp. 65-67. 8. "voter registrations." opinion roundup, january/february 1987, pp. 23 & 24. 86 a profile of high level corporate managers in the united states managerial decision making and changing prices: the effects of inflation on internal information and operating policies tho.mas e. king and m. robert carver department of accounting southern illinois university edwardsville, illinois the accounting assumption of a stable measuring unit gellerally has allowed accountants to ignore the changing value or purchasing power of the dollar in preparing external accounting reports. nevertheless, the issue of whether or not financial statements should be adjusted to reflect changing prices of either the specific or general variety has been of concern for many decades. with tche higher inflation rates of the late seventies and early eighties, the validity of the stable-measuring-unit assumption has been a topic of frequent debate; and the entire issue of accounting for the effects of changing prices has gained in relevance. in 1979, the financial accounting standards board issued fasb statement no. 33 (4) requiring that large public enterprises disclose the effects of changing prices as supplementary information to pu blished financial statements prepared on an unadjusted basis. the pronouncement originally required that supplementary income summaries be computed and disclosed on both a "constant dollar" and a "current cost" ba.sis. constant dollar reporting states the financial statement elements in dollars of the same general purchasing power. current cost reporting states financial statement elements at what their costs would be at the balance sheet date to the time of their use. in 1984, the fasb issued statement n~o. 82 (5) eliminating the requirement for constant dollar reporting under certain conditions. sfas no. 33 applies to all public companies which prepare their financial statements in u.s. dollars in accordance with u.s. generally -accepted accounting principles and which have either total assets of more than $1 billion or inventories and gross plant, property, and equipment of more than $125 million at the beginning of the current fiscal year. the amounts for these criteria are the amounts shown in the company's consolidated financial statements. while sfas no. 33 placed certain requirements on particular companies with regard to their external reporting, internal reporting is not so constrained. managements continue to be free to choose what they consider to 22 be the most appropriate information sets for internal decision making without the interference of external bodies such as the fasb or sec. therefore, if, as the literature suggests, the effects of changing prices are important in managerial decision making, managers should incorporate adjustments for changing prices in the information that they use for internal purposes, regardless of any requirements established to regulate external reporting. especially when considering long-tern projects, managers could be expected to consider the cumulative effects of inflation over the lives of projects and the possible impact 'of changing rates of inflation. purpose of the study the purpose of this study is to examine the extent to which the effects of changing prices are incorporated into managerial decision making and the extent to which the inclusion of such effects is associated with increasing rates of inflation and the issuance of sfas no. 33. the studies to date generally have been concerned either with (1) describing why the effects of changing prices should be incorporated into managerial decisions and how this might be done or (2) reporting and compliance problems associated with implementing sfas no. 33 for external reporting and the anticipated reactions of external users to financial data adjusted for changing prices (see, for example, 1, 2,6,8,9). hawkins (7), however, suggests that there will also be a significant impact of sfas no. 33 on the internal actions of managers in their attempts to influence the financial statement information required under sfas no. 33. his expectation is that internal managers take different actions when required to present external reports adjusted for changing prices. there could also be another effect related to the issuance of sfas no. 33. if certain firms are required to present information adjusted for changing prices for external purposes, that information is available for internal decision making at no additronal cost. thus, the sfas no. 33 requirements may have provided the impetus to begin using the same information internally. while most studies relating to sfas no. 33 and adjustments for changing prices deal with external reporting, there are three that are concerned specifically with internal reporting and decision making. casey arid sandretto (3) look at the internal reporting practices of fortune 500 companies with respect to inflation-adjusted accounting information. rosenzweig (11) focuses specifically on sfas no. 33 data and how they are used internally for decisions. the results of these two studies seem to conflict somewhat in that casey and sandretto find that nearly half of the companies responding to their survey report inflation-adjusted data internally, while rosenzweig finds little internal reporting and little internal use of sfas no. 33 information. it should be noted that casey and sandretto's study deals with all types of inflation adjusted data, not just that prepared in accordance with sfas no. 33; and it concerns only whether the data is reported internally, not whether the data 23 actually is used. further, they found greater reporting of inflation-adjusting data to top management than to operating management. in a study of canadian companies, waterhouse (13) reported that less than six percent of the respondents indicated that inflation-adjusted financial reports were prepared for use by management and that the vast majority of canadian managers saw little advantage to the use of such data for internal decisionmaking purposes. this result might be expected if, in fact, an external reporting requirement such as sfas no. 33 does promote the internal use of the data. currently, there is no requirement in canada similar to sfas no. 33 requiring external accounting reports to include information that is adjusted for changing prices. this study is concerned with the degree to which inflation-adjusted data are incorporated into managerial decisions in the united states, the extent to which that phenomenon has been associated either with high rates of inflation or the issuance of sfas no. 33, and the specific types of decisions for which inflation-adjusted data have been used. in addition, the study examines the relationship between several attributes of the firms surveyed and the use of inflation-adjusted data for internal decision making. for the manufacturing firms surveyed, these attributes include the size of the firm and the type of industry. for financial institutions, size, type of institution, a,nd geographical location were identified as potentially important variables. methodology the study involved three related stages. first, an examination was made of the relevant accounting and economics literature to identify those decision areas that should be most affected by changing prices. second, selected audit mana,gers with major public accounting firms, and financial managers with several industrial firms and financial institutions were interviewed to further help identify decision areas that would be most affected by changing prices. in addition, these managers helped identify company attributes that were expected to be related to the use of inflation-adjusted information. third, based upon the results of the first two stages of the study, a questionnaire was developed and sent to financial and operating officers of major corporations and" financial institutions. the questionnaire focused upon the decision areas previously identified as most likely to be affected by changing prices. some of the areas explored in the questionnaire include: capital budgeting and investments in fixed assets, investments in inventory, evaluation of managers, credit decisions and policies, and financing decisions. the questionnaire asked managers to describe the way in which the effects of changing prices were incorporated into their decisions in each of the various decision areas and how long these approaches had been used be the company. also, the managers were asked to specify whether their companies reported external accounting information in accordance with fasb statement no. 33 and, regardless of the external reporting requirement, whether the pronouncement had any effect on their internal re24 porting. the survey was conducted immediately prior to the issuance offasb statement no. 82 so that any impact of fasb statement no. 33 would be reflected in the data, but not any effects of fasb statement no 82. the questionnaire was mailed to 1,000 chief financial and operating officers of companies that were divided equally between industrial firms and financial institutions. the industrial firms, selected at random, were from a broad range of industries (e.g., manufacturing, retailing, real estate) and included small, medium, and large firms. small firms were defined as having sales of less than $10 million; medium-sized firms, sales of between $10 million and $100 million; and large-sized firms, sales over $100 million. financial institutions surveyed included commercial banks, mutual savings banks, and savings and loan associations. the size classifications for financial institutions were defined as follows: small, deposits of less than $1 million; medium, deposits of between $1 million and $500 million; and large, deposits of over $500 million. the overall response rate to the questionnaire was 22 percent. a second mailing of the questionnaire was made for both types of firms, and no significant differences were found between the results of the first and second mailings. of the companies responding to the survey, 33 percent of the manufacturing and tra,ding firms prepare external accounting reports in conformity with sfas no. 33, while 44 percent of the financial institutions prepare such reports. results of the study this study is somewhat broader than the three previous studies dealing with internal reporting of inflation-adjusted data in that it looks at the impact of.sfas no. 33 data as well as the use of other types of data, adjusted for changing prices. in addition, the study looks at the impact of inflation itself on the decisions of firms in the study. further, this study found that the use of inflation-adjusted data for internal decision making is related in a few cases to certain company attributes; and these attributes are noted where the relationship is statistically significant (at the .05 level unless otherwise indicated). use of inflation-adjusted inforlllation of the manufacturing firms responding to the survey, well over half of the firms use inflation-adjusted data in some way for internal decision making. the type of data, the extent of the usage, and the way in which the data are used differs considerably with individual firms. table 1 summarizes the responses of manufacturing firms in the sample by the type of use of inflationadjusted data. current cost data a.re used by 87 percent of the manufacturing and trading firms in computing costs of production and operation, excluding depreciation. almost two-thirds of the manufacturing and trading firms use some type of inflation-adjusted information in capital budgeting decisions, and ha.lf of the firms use such information in pricing their goods. inflation-adjusted is 25 table 1 internal uses of inflation-adjusted data manufacturing firms type of use percent responding yes no evaluatin2 expected revenues from capital projects evaluating expected costs associated with capital projects evaluating desired rate of return on capital projects stating most dollar performance goals and objectives ~f managers making comparisons between budgeted amounts and actual results pricing goods computing materials and other input costs of productions computinr depreciation for calculating production costs 26 63 66 58 36 25 50 87 29 37 34 42 64 75 50 13 71 used by this group of forms to a lesser extent in performance evaluation of managers, although 36 percent did report using such data in stating most dollar performance goals and objectives of managers and 25 percent in making comparisons between budgeted and actual amounts. interestingly, the use of inflation-adjusted data by the manufacturing and trading firms responding affirmatively was not a recent phenomenon. in each case, more than half of the firms using inflation-adjusted data for the purpose indicated had been doing so since prior to the issuance of sfas no. 33. even though the percentage of financial institutions preparing external accounting reports in conformity with sfas no. 33 was higher than that for the manufacturing firms responding, the financial institutions seem to use inflation-adjusted data to a lesser extent internally. table 2 shows the percentage of the' financial institutions in the survey indicating that they use inflation-adjusted data in the ways listed. with two notable exceptions, the percentage of financial institutions employing inflation-a,djusted data for the various individual uses listed ranges between 16 and 21 percent. almost none of the financial institutions used inflation-adjusted data for performance evaluation, either in terms of stating managers' goals and objectives or making comparisons between budgeted and actual amounts. this result. is in contrast to the findings for the manufacturing firms, which indicate that at least onethird of those firms use inflation-adjusted data in some way for performance evaluation, even though that is the least frequent use of such data of those listed. as compared with the length of time that the manufacturing and trading firms had been using inflation-adjusted data, the financial institution respondents that were using such information adopted the practice fairly recently. well over half of the financial institutions had adopted their particular use of inflation-adjusted data within the previous five years, or since sfas no. 33 was issued. characteristics of the respondents overall, no general pattern of relationship between the internal use of inflation-adjusted data and the chosen company's attributes of the respondents was found. however, a significant relationship was found with respect to several of the specific uses of inflation-adjusted data.. for example, different types of companies refle~ted different usage of inflation-adjusted data for budget comparisons, with ieal estate, manufacturing, construction, a.nd wholesale companies reporting: significantly higher usage of such data than did other types of companies. size of the firm was found to be a significant variable with respect to the use of current costs in computing depreciation for internal reporting. surprisingly, smaller firms were found to use current cost depreciation internally significantly more often than larger firms; and this was true for both manufacturing companies and financial institutions. for financial institutions, the type of institution and geographical location were found to be significant in some cases. with regard to evaluating expected 27 table 2 internal uses of inflation-adjusted data financial firms type of use evaluating expected revenues from: percent responding ~ no consumer and mortgage loans commercial loans acquisition of bank or assoc. property investments in securities other evaluating expected expenses related to consumer and mortgage loans commercial loans acquisition of bank or assoc. property investments in securities other evaluating desired rate of return from: consumer and mortgage loans commercial loans acquisition of bank or assoc. property investments in securities other setting loan rates stating performance goals and objectives of managers or officers making comparisons between budgeted amounts and actual results computing depreciation for calculating 0llerating costs 28 18 18 19 18 21 17 19 21 17 25 20 18 16 20 19 19 5 3 12 82 82 81 82 79 83 81 79 83 75 80 82 84 80 81 81 95 97 88 expenses relating to consumer and mortgage loans, most of the savings and loan associations (83%) indicated that the data they used were not adjusted for inflation. on the other hand, a majority of commercial banks (55%) indicated that they did use inflation-adjusted data. similarly, in setting loan rates, use of inflation-adjusted data was highest among commercial banks (26%) and lowest among savings banks (3%). geographical location was found to be related to the use of inflationadjusted data by financial institutions in evaluating both expected revenues and expected expenses. the results of the study indicate that financial institutions outside of the south are more likely to use inflation-adjusted data for this purpose than firms in the south. more specifically, inflation-adjusted data were used by 8~% of the firms in the midwest, 67% of those in the west, and 53% of those in the northeast; only 22% of the firms in the southeast and 17% of those in the southwest used inflation-adjusted data for evaluating expected revenues and expected expenses. impact of sfas no. 33 tables 3 and 4 summarize the responses for the manufacturing/trading firms and financial institutions, respectively, indicating the impact of sfas no. 33 on each of several internal reporting and decision areas. the questions in this part of the survey have a somewhat narrower focus than those in the previous section; these questions deal only with the effects of sfas no. 33 rather than with all types of inflation-adjusted data. on a percentage basis, considerably more manufacturing and trading firms were impacted internally by sfas no. 33 than financial institutions. in fact, sfas no. 33 seems to have impacted very few financial institutions internally. the areas most affected for both types of firms are (1) evaluation of c.apital projects and (2) budgeting and goal-setting. the impact of sfas no. 33 on budgeting and goal-setting is somewhat surprising given that this area is one where both types of firms were least likely to use inflation-adjusted data. one explanation for the apparent discrepancy might be that inflation-adjusted data are not used for stating most performance goals, which is how the question was worded, but are used at higher management levels for goal-setting. this explanation would be consistent with casey and sandretto's findings that top management received inflation-adjusted data more frequently than operating management. another explanation might be that, while managem.ent does not use inflation-adjusted data to a large extent in goal-setting, sfas no. 33 does impact the budgeting and goal-setting, as hawkins (7) suggested, because managers take different actions when required to present external reports adjusted for changing prices. operating policies in response to inflation this section of the survey is somewhat different form the other sections in that it deals with operating policies rather than different types of information. tables 5 and 6 show the extent to which the manufacturing/trading firms and the financial institutions in the sample, respectively, have adopted the listed operating policies in response to inflation. nearly all of the firms in the survey 29 table 3 internal reporting and decision areas affected by fasb statement no. 33 manufacturing firms area financial ratios profits or costs by responsibility center, product, or type of operation evaluation of capital projects budgeting and goal setting performance evaluation other table 4 percent .responding yes -l!213 87 13 87 22 78 20 80 15 85 0 100 internal reporting and decision areas affected by fasb statement no. 33 financial firms area financial ratios profits or costs by responsibility center or type of operation evaluation of capital projects or long-tenn invesunents budgeting and goal setting performance evaluation other 30 percent responding yes -l!26 94 4 96 15 85 10 90 3 97 1 99 have made at least some changes in operating policies because of inflation. "most firms in the sample have taken multiple actions. almost all of the firms responding, both manufacturing/trading and financial, have reduced idle cash balances; and a considerable majority have tightened credit and/or collection policies. for manufacturing/trading firms, the reduction of idle cash balances was related to the size of the firm. overall, more of the larger firms had reduced idle cash balances; and they had been doing it for a longer time than the smaller firms. with respect to financial institutions, the tightening of credit and/ or collection policies was found to be related to the type of institution. this action had been taken most often by savings and loan associations and least often by commercial banks. for those commercial banks that did take this action, however, 76% did so in 1982 or before, while 40% of the savings and loans indicated that the action had been taken since 1982. perhaps this result partially explains the serious plight of many savings and loans currently. most manufacturing firms were found to have been buying inventories earlier to avoid price increases, increasing the amount of time before paying suppliers, and increasing the use of fixed dollar contracts and/or debt financing arrangements. nearly half of the manufa.cturing firms have decreased the required payback period for new capital projects. nearly all of the financial institutions responding have decreased their long-term fixed-rate lending, and most have shortened the required maturity for new loans. the type of financial institution most frequently indicating a reduction in required maturity for loans was s'avings and loan associations. this result might be expected given the impact of inflation on the type of longterm lending normally done by savings and loans. however, almost half of the savings and loans indicate that they have decreased maturities only since 1982, indicating a rather late response to a serious problem. interestingly, only about a quarter of the financial institutions responding have increased their long-term fixed-rate borrowing. summary and conclusions the results of this study indicate that quite a number of companies use inflation-adjusted information to at least some extent in internal reporting and decision making. this tends to be true nflore for the manufacturing/trading firms in the sample than for the financial, institutions. many firms that currently are using inflation-adjusted data started doing so prior to the issuance of sfas no. 33, although most financial institutions that use such data internally started doing so after the effective date of the pronouncement. overall, the issuance of sfas no. 33 appears to have had only a small impact on the use of inflation-adjusted data internally, probably less of an impact than the high inflation rates of the late seventies. 31 table 5 operating policies undertaken in response to inflation manufacturing firms operating policy percent responding yes no buy inventories earlier to avoid higher prices later increase use of fixed dollar contracts andlor debt financing arrangements tighten credit andlor collection policies increase amount of time before payment is made to suppliers reduce idle cash balances shorten the required payback period for capital projects table 6 60 53 84 64 95 48 40 47 16 36 5 52 operating policies undertaken in response to inflation financial firms operating policy percent responding yes no increase the portion of borrowing done through long-tenn fixed-rate arrangements tighten credit andlor collection policies reduce idle cash balances shorten required maturity for new customer loans decrease the portion of long-tenn fixed-rate lending 32 27 79 95 72 94 73 21 5 28 6 references 1. arthur andersen & co. inflation accounting-a simplified approach: reporting the impact of inflation from a new perspective, arthur andersen & co., 1980. 2. berlinger, robert w. and gerboth, dale l. "fasb statement no. 33, 'the great experiment,"' journal of accountancy, may 1980,48-54. 3. casey, c. j. and sandretto, m. j. "internal uses of accounting for inflation," harvard business review, november-december 1981, 149-156. 4. financial accounting standards board. statement of financial accounting standards no. 93, "financial reporting and changing prices," september 1979. 5. financial accounting standards board. statement of financial accounting standards no. 82, "financial reporting and changing prices: elimination of certain disclosures," november 1984. 6. hawkins, david f. inflation) market effi·ciency and accounting data: key to identifying the corporate and investor winner, boston: drexel burnham lambert inc., may 1974. 7. hawkins, david f. "thinking real: living with fasb 33," harvard busines8 review, september-october 1980, 119-127. 8. hayes, robert h. and abernathy, william j. " managing ouf way to economic decline," harvard business review, july-august 1980. 9. lembke, valdean c. "replacement costs: an analysis of financial statement and tax policy effects," journal of accounting) auditing and finance, winter 1980, 147-162. 10. raiborn, debra d. and ratcliffe, thomas a. "are you accounting for inflation in your capital budgeting process?" management accounting, september 1979, 19-22. 11. rosenzweig, kenneth. "companies are not using fas 33 data.," managemer. accounting, april 1985, 51-57. 12. scott, george m.research study on currentvalue accounting measurements and utility, touche ross foundation, 1978. 13. waterhouse, j.reporting non-historical accounting data to canadian managers. study paper no.5, edmonton, canada: canadian certified general accountants' research foundation, may 1984. 33 managerial decision making and changing prices: the effects of inflation on internal information and operating policies volume 35, number 1 1 strategic political emphasis (spe), environmental uncertainty, and firm performance in ghana john a. parnell university of north carolina at pembroke • pembroke, nc edwin c. mensah university of north carolina at pembroke • pembroke, nc derek oppong data link institute • tema, ghana abstract this paper reports on a survey of 125 managers concerning strategic political emphasis (spe), environmental uncertainty, and firm performance in ghana. results with a 95% confidence interval identified technology uncertainty as a significant driver of spe, strategic emphasis on competitors, and strategic emphasis on customers. spe was also a positive and significant driver of performance. when a 90% confidence interval was applied, market uncertainty prompted strategic emphases on both competitors and customers, and strategic emphasis on competitors was positively linked to performance. these findings underscore the influence of spe on firm performance in ghana, and suggest that similar relationships could be found in other nations, particularly those with developing and emerging economies. keywords: ghana, strategic political emphasis (spe), corporate political analysis, nonmarket strategy, strategic political management, uncertainty. introduction the influence of a nonmarket orientation in firms has been recognized for some time, primarily within the strategic analysis stage (aplin & hegarty, 1980), but more recently within the formulation and execution domains (parnell, 2015). with heightened regulations, increasing political influence, greater emphasis on government-business partnerships in many nations, and the rapid development of emerging markets, the notion of nonmarket strategy (nms) is now widely viewed as a key component of a firm’s overall strategic orientation and has been investigated within several research traditions. strategic political management (spm) refers to the strategic actions that firms plan and execute to extract profits directly or indirectly from the political environment. strategic political emphasis (spe) refers to the amount of emphasis placed on spm. corporate political activity (cpa) 2 journal of business strategies encompasses spm as well, but also includes other activities (hillman & hitt, 1999; hillman, keim, & schuler, 2004; oliver & holzinger, 2008). each of these variations on nms underscores the relevance of political considerations in modern firms. in many instances, the means by which organizations address such factors can ultimately drive performance (doh, lawton, & rajwani, 2012; henisz & zelner, 2012; kingsley, bergh, & bonardi, 2012; sawant, 2012). an effective nms rooted in an elevated strategic political emphasis (spe) is also vital to many firms from the perspectives of both profit maximization for shareholders and the satisfaction of broader, social objectives (singer, 2013). it has evolved as business has become more global, and many governments in developing and emerging nations have adopted mixed economic models that blend extensive regulatory regimes, government influence in specific sectors, public-private partnerships, and large, private firms well connected to government entities (bach & allen, 2010, p. 41). advances in nms scholarship notwithstanding, the shortage of work in africa and other parts of the developing world is an ongoing challenge (coffie & owusu-frimpong, 2014; obeng, robson, & haugh, 2014; saffu, walker, & hinson, 2007). this paper addresses this gap by investigating spe in ghanaian firms. as a relatively stable, developing country compared to its sub-saharan neighbors, ghana has made tremendous strides in the last decade in promoting private sector growth. nonetheless, cultural differences between ghanaian and western firms cannot be overemphasized. an investigation of the strategic tools adopted by ghanaian firms would inform our understanding of ghanaian organizations within the global context. the remainder of the paper begins with an overview of extant nms literature, followed by hypotheses, findings, discussion of results, conclusions and directions for additional research. nonmarket strategy and strategic political emphasis nms emphasizes lobbying, campaign contributions, direct collaboration with government actors, and other factors not directly linked to market activity (delmas & montes-sancho, 2010; lawton, mcguire, & rajwani, 2013; okhmatovskiy, 2010). while nms exists in all nations, its prominence has long since been recognized in developing and socialist regimes fraught with corruption. as emerging economies develop and their governments emphasize partnerships with private firms, the use of nms becomes more prominent. it is now seen by many as a complement to market strategy (brito-bigott, faría, rodríguez, & sánchez, 2008; doh et al., 2012; volume 35, number 1 3 henisz & zelner, 2012; kingsley et al., 2012; meyer & peng, 2016; sawant, 2012), insomuch that firms invoke a nonmarket orientation to enhance competitiveness (iriyama, kishore, & talukdar, 2016). however, why firms develop nms and how doing so impacts performance is not completely understood (parnell, 2015). distinct, overlapping streams have emerged from nms research, including cpa, spe, and spm (hillman & hitt, 1999; hillman et al., 2004; hillman & zardkoohi, 1999; oliver & holzinger, 2008). an integrated assessment of these streams highlight two pervasive concerns. the first is the extent to which nonmarket and market strategies represent distinct, alternative paths to firm performance. some scholars posit nms and ms as complementary and often built on multiple stakeholder interests rather than those of shareholders and customers (bosse, phillips, & harrison, 2009; choi & wang, 2009; harrison, bosse, & phillips, 2010; harrison & wicks, 2013). from this perspective, nms promotes firm performance by helping the organization achieve broader, social objectives (singer, 2013). in contrast, others emphasize market and nonmarket trade-offs, suggesting that firms unable to compete effectively through market means emphasize nms instead (adly, 2009; parnell, 2015). they see conflicts across stakeholders and between market and nonmarket approaches as unavoidable, thereby requiring strategic managers to make choices (baron, 1995; cavazos & rutherford, 2012; hadani, dahan, & doh, 2015). the second unresolved issue across research streams is whether nms should be viewed primarily as a means of protecting the organization against government or as a response to inappropriate oversight. indeed, government oversight typically responds to firm activity over time rather than anticipating it; hence firms do not only attempt to influence government intervention, but also engage in market activity to influence or modify the effects of government regulation (funk & hirschman, 2017). one school of thought argues for a nonmarket orientation as a defense mechanism for firms facing government overreach. the cpa perspective suggests that emphasizing a nonmarket approach can advance firm interests, minimize the effects of adverse government regulations, and/or maintain a favorable status quo (baines & viney, 2010; keillor, wilkinson, & owens, 2005; lawton et al., 2013). even proponents of a strong nonmarket orientation acknowledge the need for responses to increases in government regulation (krozer, franco-garcía, & micallef, 2013; parnell, 2015; woiceshyn, 2011). a second school of thought views nms—particularly political involvement within the context of spe—as a proactive approach to enhance society rather than as a reactive approach to protect the organization. hence, firms should be involved in the nonmarket realm to address social and environmental concerns through 4 journal of business strategies responsible business practice, a view referred to as political corporate social responsibility (pcsr) (scherer & palazzo, 2011; scherer, palazzo, & baumann, 2006; wickert, 2016). following this perspective, csr is a building block of nms because both seek to align public policy with social values and to enhance trust between organizations and society (liedong, ghobadian, rajwani, & o’regan, 2015; kamel mellahi, jedrzej george frynas, pei sun, & donald siegel, 2016b; scherer, 2017; scherer & palazzo, 2011; schneider & scherer, 2016). the validity of this view is difficult to confirm in practice because executives tend to couch nms in csr terms. nms is rooted in the behavioral theory of the firm, which incentivizes managers to engage in extraordinary or risky behavior when firm performance goals are not met (cyert & march, 1963; ji-yub, jerayr, & finkelstein, 2011; liu, maslach, desai, & madsen, 2015). it can also be understood through an institutional lens as well (peng, wang, & yi, 2008; wright, liu, buck, & filatotchev, 2008). political legitimacy, gained through the firm’s adaptation of nonmarket initiatives as required by local institutional norms (kamel mellahi, jędrzej george frynas, pei sun, & donald siegel, 2016a), is critical to organizational performance in emerging countries (guo, xu, & jacobs, 2014), where restrictive institutional conditions pressure firms to ensure that their actions are deemed suitable within norms and values recognized by institutional actors (liedong, ghobadian, rajwani, & o’regan, 2015; zheng, luo, & maksimov, 2015). legitimacy can result in positive outcomes such as regulatory leniency for the organization (hong & liskovich, 2015) and also help minimize risk (stevens, xie, & peng, 2016). the prominence of corporate political behavior is well documented in the business press (bachner & ginsberg, 2016; drutman, 2015; healy, 2014). scholarly interest on nms and spe has increased in recent years as well. parnell (2015) surveyed 275 managers in the united states to investigate factors associated with spe. managers in firms placing greater spe also reported greater uncertainty about competition and markets, and lower capabilities with regard to management and technology. managers in organizations with weaker market orientations—including greater uncertainty about competition and markets, and lower capabilities in management and technology—emphasized greater nonmarket orientations. firms reporting lower capability levels were more likely to emphasize spe and to have increased it in recent years. select uncertainties and capabilities—not competitive strategy per se—appear to have prompted an increase in spe. the nms perspective also acknowledges the inherent reality that individuals cannot be trusted, but its ethical concerns focus on links between executives and volume 35, number 1 5 nonmarket actors, namely representatives of government entities. while some activities such as bribery are overt and illegal in most countries, others such as collusion with competitors, lobbying legislators, and seeking favor from regulators, are more subtle and contextual, and hence lack a clear legal standing (cavazos & rutherford, 2012; kingsley et al., 2012; mantere, pajunen, & lamberg, 2009; parnell & dent, 2009; parnell, scott, & angelopoulos, 2013; rival, 2012; vázquezmaguirre & hartmann, 2013). this problem is more common in emerging economies like ghana because they tend to lack efficient legal frameworks that protect property rights and an appropriate infrastructure (barron, 2010; holburn & vanden bergh, 2008; lailani laynesa & mitsuhashi, 2013; mantere et al., 2009; vázquez-maguirre & hartmann, 2013). from a global perspective, uncertainty highlights and drives both market and nonmarket strategies (j.-p. bonardi, g. l. f. holburn, & r. g. vanden bergh, 2006; delios & henisz, 2003; ghemawat, 2008). anecdotally, however, many scholars and practitioners have noted additional emphasis on nms in developed nations as well (decker, 2011; galang, 2012; obeng et al., 2014; obi berko, 2013; papaioannou, watkins, mugwagwa, & kale, 2016; “planet plutocrat,” 2014; p. sun, mellahi, & wright, 2012). hypotheses this paper assesses spe in the west african nation of ghana. formerly known as gold coast, ghana is a politically stable nation bordering the gulf of guinea near the equator, with togo on the east, cote d’ivoire on the west, and burkina faso on the north. the development of a stable, multiparty democratic system in ghana, combined with a commitment to market reforms, is promoting solid economic growth (parnell, spillan, & mensah, 2014). indeed, ghana is endowed with natural resources with a per-capita gdp about twice of that of neighboring nations. ghana offers access to large seaports and a thriving industrial sector supporting its import and export markets. the country’s economy includes a growing formal economy as well as a traditional, informal economy of street venders. the nation’s most prevalent trading center is the accra-tema metropolitan area—ghana’s most populous region with about 3.5 million people. financial capital is widely available in ghana, but access is generally limited to large, established firms. these firms tend to be more successful than their smaller counterparts in the capital markets because they have stronger bargaining power. unfortunately, the private sector is dominated by small enterprises, especially in the informal sector, and these businesses tend to give little attention to competitive strategy. the popularity of strategic planning 6 journal of business strategies among large firms and its relationship to superior performance has been documented (agyapong & boamah, 2013; agyapong & muntaka, 2012). this paper tests two sets of hypotheses aimed at understanding strategic political emphasis within the ghanaian context, and more broadly within developing nations. the first set of hypotheses assess the notion that uncertainty influences the spe among ghanaian firms. strategies are developed to shape the competitive environment and in part, to address strategic uncertainty (jauch & kraft, 1986; parnell, lester, zhang, & köseoglu, 2012; s.-y. sun, hsu, & hwang, 2009). executives craft competitive strategies partly as means of addressing uncertainty (parnell et al., 2012). higher levels of strategic uncertainty can prompt strategic managers to emphasize certain factors as they formulate strategies (parnell, lester, & menefee, 2000; parnell et al., 2012). ceteris paribus, it is expected that perceived environmental uncertainty about markets, technology, and competitors will be positively associated with spe as reflected in both the degree of emphasis on political-legal factors and recent changes in spe. the importance of spe may be most acute in developing economies (bach & allen, 2010). in specific terms, nonmarket relationships in the political arena can be critical because government entities in less developed nations tend to wield greater control in terms of access to business opportunities, regulations, subsidies, and licensing (dieleman & boddewyn, 2012). per the public choice perspective, spe can be viewed as a means of promoting mutually beneficial exchange between firms and government actors (bonardi, hillman, & keim, 2005; j.-p. bonardi, g. holburn, & r. g. vanden bergh, 2006; frynas, mellahi, & geoffrey allen, 2006). for example, a politically-oriented firm may be able to secure government support for a project in exchange for job creation, which generates goodwill for politicians (elg et al., 2012). a link between uncertainty and competitive strategy has been documented in previous work (parnell, 2015; parnell et al., 2012; swamidass & newell, 1987; teece, peteraf, & leih, 2016). following institutional theory, strategic uncertainty tends to be higher in developed and emerging economies (peng et al., 2008; wright et al., 2008). in a similar vein, uncertainty in three categories—markets, technology and competition—are expected to drive strategic emphasis on competitors and customers. h1a: uncertainty about markets will be a positive driver of spe. h1b: uncertainty about markets will be a positive driver of strategic volume 35, number 1 7 emphasis on competitors. h1c: uncertainty about markets will be a positive driver of strategic emphasis on customers. h2a: uncertainty about technology will be a positive driver of spe. h2b: uncertainty about technology will be a positive driver of strategic emphasis on competitors. h2c: uncertainty about technology will be a positive driver of strategic emphasis on customers. h3c: uncertainty about competitors will be a positive driver of spe. h3b: uncertainty about competitors will be a positive driver of strategic emphasis on competitors. h3c: uncertainty about competitors will be a positive driver of strategic emphasis on customers. links between market strategies and performance have been investigated in the literature (blackmore & nesbitt, 2013; dess & davis, 1984; parnell, 1997; yu, liu, zhu, & li, 2015). the diversity of market strategies tends to be greater in developed nations, while cost leadership is more common in less developed countries like ghana (agyapong, osei, & akomea, 2015). there is growing evidence that nonmarket orientation—including spe—is also associated with performance (doh et al., 2012). mellahi et al. (2016b) evaluated 163 studies and found that 102 of them identified a positive link between nonmarket strategy and performance. several notable studies support an spe-performance link in developing economies in africa. ackah, aryeetey, ayee, and clottey (2010) assembled a panel representing 256 ghanaian companies that operated between 1991 and 2002 to investigate if and how the state-business relationship proved beneficial to economic performance. they found a negative association between political environments perceived to be hostile, unstable or even unpredictable and productivity. a qualitative assessment between 1992 and 2008 demonstrated that a shift from an informal and ad hoc working relationship between business and government was strongly 8 journal of business strategies correlated with an improvement in firm productivity. hence, firms that stay “closer to government” can navigate regulatory obstacles more easily. qureshi and velde (2007) found that membership in a business association in zambia greatly enhanced firm performance by as much as 37-41%, as business associations are quite influential in lobbying governments and addressing challenges related to information management and coordination of business activities within the industry. foreign-owned companies, however, tend to outperform their domestic counterparts in economic performance and lobbying effectiveness. these studies highlight the role played by government in the performance of business firms. extending these findings, we expect a link between spe and performance in ghana yielding the following hypotheses: h4a: spe will be a positive driver of firm performance. h4b: strategic emphasis on competitors will be a positive driver of firm performance. h4c: strategic emphasis on customers will be a positive driver of firm performance. methods data was collected in early 2016 via self-administered surveys using the drop-off/pick-up approach. a total of 150 survey questionnaires were administered to managers of businesses in accra, the capital city of ghana, and the port city of tema. the accra-tema metropolis is the most populated and culturally diverse region in the country. it is also the hub for most of the economic activities and the primary location for major industries in the nation. the proximity to ports and major government centers has given the metropolis a reputation for attracting both foreign and local businesses into the region, making it well suited for the collection of a representative, convenience sample for the study. of the 150 participants sampled, 125 responded and completed the survey, resulting in a response rate of 83.3%. each prospective respondent (business executive/administrator) was asked to complete the survey at his or her convenience, and arrangements were made to retrieve the completed surveys at a specified time a few days later. participants from these cities are familiar with surveys and therefore more apt to complete the one utilized for this volume 35, number 1 9 study. existing scales were utilized in this study. scales developed and validated by desarbo, benedetto, song, and sinha (2005) were used to assess market environment uncertainty, competitive environment uncertainty, and technological environment uncertainty. performance was self-reported with five indicators: roa, growth in revenues, growth in profits, market share, and overall success. a five-point likert scale was utilized in all instances. several additional items were developed specifically for this study. respondents were asked to rate the strategic emphasis (i.e., low or high) their firms place on the following three factors when formulating strategy: (1) “political-legal factors, such as elections, legislation, judicial court decisions and government agency activity,” (2) customers, and (3) competitors. respondents were also asked to assess the change in strategic emphasis on these areas (i.e., less or more) during the past decade. as such, strategic emphases on political factors (i.e., spe), competitors, and customers were measured by two-item scales. the first item for each measure addressed the extent to which each domain is currently emphasized, while the second item addressed the extent to which emphasis on each domain appears to have changed during the previous five years. the survey instrument containing the strategy, uncertainty, capability, and strategic emphasis items was completed by managers in ghana. surveys completed by individuals not employed as managers at the time were discarded and not included in the sample. multiple levels, backgrounds, industries and firm sizes were represented (see table 1). this sample provides a cross-sectional gauge of perceptions from managers who have been exposed to a wide variety of strategies. moreover, extending the focus beyond top managers informs the inquiry, as they play a greater role in both strategy formulation and implementation than they have in past decades (balogun & johnson, 2004; raes, heijltjes, glunk, & roe, 2011). the decision to include non-executives in the analysis was assessed in the findings section. 10 journal of business strategies table 1 sample characteristics the hypotheses were tested via smartpls (version 3) software. advances in partial least squares modeling is well documented in the strategic management literature and is especially appropriate for exploratory research and complex modeling with latent constructs (hair, sarstedt, pieper, & ringle, 2012). findings strategy, uncertainty and capability scales were assessed for reliability, validity, and collinearity. the original uncertainty scales were reduced to three items to produce an optimal solution. coefficient alphas did not exceed .700 in volume 35, number 1 11 three of the seven scales, a common conundrum in cross-cultural research and for scales with three or fewer items. however, composite alphas exceeded .700 and average variance explained (ave) exceeded .500 for all constructs, suggesting adequate reliability (see table 2). fornell-larcker results are presented in table 3. in addition, meterotrait-monotrait (htmt) scores ranged from .203 to .778, suggesting discriminant validity in all instances. vif scores for all constructs and indicators ranged from 1.022 to 1.921, suggested that collinearity was not a critical concern. table 2 construct reliability 12 journal of business strategies table 3 discriminant validityfornell-larcker matrix neither the level of emphasis on the political-legal environment nor the change in that emphasis was significantly associated with performance. hence, there is no evidence that placing a greater emphasis on the political-legal environment benefits organizations in terms of overall performance, and doing so could be detrimental, ceteris paribus. with this preliminary analysis as background, attention now turns to the hypotheses. hypotheses were tested by bootstrapping (5000 subsamples) a structural model containing all of the proposed links. table 4 and figure 1 summarize the results. the first set of hypotheses was not supported at the .05 level. the link between market uncertainty and the strategic emphasis on competitors was significant at the .10 level, however. volume 35, number 1 13 table 4 tests of hypotheses table 4 tests of hypotheses (2) 14 journal of business strategies the second set of hypotheses was supported, but the third set was not. technology uncertainty was a positive and significant driver of spe, strategic emphasis on competitors, and strategic emphasis on customers. competitive uncertainty was not a significant driver of spe, strategic emphasis on competitors, or strategic emphasis on customers. the fourth set of hypotheses was partially supported. spe was a significant and positive driver of performance at the .05 level. a final, composite model was developed, starting with the tested model. bootstrapping was applied and insignificant links were removed in a stepwise fashion until only ones significant at the .10 level remained in the model. all path coefficients in the final model are positive. r2 coefficients were .100, .185, .267 and .108 for spe, strategic emphasis on competitors, strategic emphasis on customers, and performance, respectively. the srmr of .107 suggests that this model is worthy of consideration from an exploratory perspective (west, taylor, & wu, 2012). results from the final bootstrap are presented in table 4 and figure 2. table 5 final model volume 35, number 1 15 figure 2 final model the inclusion of lower and middle managers in the study was re-evaluated to determine if non-executives appeared to respond in ways that differed from their top-level counterparts. group sizes were inappropriate for rigorous statistical comparisons. however, path coefficients and p-values for each group—the composite (n=125), middle and top managers only (n=108), and top managers only (n=47)— suggest similar relationships across groups, but with fewer instances of significance at the .05 level in the smaller groups. hence, the decision to include all three groups of managers in the analysis was reinforced. discussion the influence of technology uncertainty on all three realms of emphasis— nonmarket, competitors, and competition—is intriguing. in ghana, technology appears to be the strongest uncertainty driver of strategy in a broad respect. put another way, uncertainty about technology prompts a shift in strategic political emphasis, but the subsequent link to performance is less clear. several explanations are possible. despite the significant growth and political stability ghana continues 16 journal of business strategies to enjoy, the performance of businesses is often weakened by the conduct of private corporations and some government officials. the link between technology uncertainty and strategic emphasis can be attributed to a number of factors including obsolete technology and infrastructural deficiencies (dwomoh, 2011; dzisi, john-englebert, & ofosu, 2013). a recent world bank enterprise survey in ghana reported by the african development bank (2016) identified infrastructural weakness as one of the dominant factors mitigating growth and development in the country. the same study reports that in the mid-2000s, ghana’s infrastructure gap was estimated at about 7% of gdp and about half of this was associated with shortfalls in the power sector alone. given the robust economic growth in ghana, the inadequate investment in infrastructural services could increase the infrastructure gap and hamper business growth and performance. the recent erratic power supply (“dumsor”) in the country, affects equipment durability, creates managerial uncertainty, and introduces other operational inefficiencies that hamper firm productivity. in addition, the lack of access to financial capital, government interventionism, complex bureaucratic processes and the lack of reliable market data exacerbate uncertainty in the ghanaian market making it difficult for companies in ghana to plan strategically and forecast effectively using ms. the positive link between spe and performance, and the absence of a link between competitor or customer emphasis and performance at the .05 level, highlights the relative importance of political considerations in the ghanaian business environment. this finding is supported anecdotally. an examination of the 2011-2014 ghana club 100 rankings shows that many top companies such as communications giant rlg, with solid government connections, failed to maintain their lead in the market during the tenure of unfavorable regimes or when the political temperature changed unfavorably against them. interestingly, most of the firms that rank at the top of the ghana club 100 list (e.g. produce buying company and anglogold ashanti), tend to be whollyor partly-owned government interests and enjoy virtual monopolies in their respective fields of operation during the tenure of a given regime. these organizations thrive on political contracts that vary with regime change; hence, growth emanating primarily from their spe may not be sustainable in the long run. on the contrary, some of the ghana club 100 firms emphasize a market orientation to maintain a competitive edge regardless of the regime in power; these companies tend to be more consistent in the ranking of firms. a typical example is new crystal health services, which placed ninth overall in 2014 and was deemed the best national health care provider. new crystal maintains an active electronic database to track its customers, remind them of appointments, and send personalized volume 35, number 1 17 messages. the company also has diversified its scope of operations from orthodox medicine to herbal medicine. the measures taken to differentiate the delivery of health services have sustained the firm’s competitiveness in the ghanaian health care industry. overall, the nation cannot be exonerated from the plague of “crony capitalism.” a number of factors including the corrupt political and legal environment in ghana contribute to spe by businesses in ghana. like many sub-saharan african countries, there seems to be a correlation between political connections and entrepreneurial success in ghana. in fact, “whom you know,” in the socio-political arena continues to be the primary factor guaranteeing the startup, survival of firms and the subsequent sustainability of businesses profits. decades ago, kennedy (1977) discussed this conduct in the context of the “bureaucratic capitalist” whose ability to profit depends on the monopolistic privileges granted by bureaucracy. he identified a crucial aspect of this phenomenon where the government deliberately carves out a niche to protest local business leaders from competition through legislation. indeed, recent revelations about corrupt ghanaian judges and government officials by undercover investigative journalists, including anonymous anas ameyaw (a.k.a. anas), attest to the fact that quid pro quo and other pay-to-play practices are very pervasive in the ghanaian economy (adadevoh, 2014; anas, 2015; asante, 2012; ayagre & aidoobuameh, 2014). this has contributed to, and promoted the use of nms by many top executives of firms in ghana. one can argue that forging political alliances to ensure the survival of businesses is quite common in the developing world and is not unique to ghana. in kenya, political connections and aid from government in the form of loans, state guarantees of commercial credit, and other means have been used to protect local businesses in trade, manufacturing, contracting and road transport from foreign competition (kennedy, 1977). on a broader scale, politicians in west africa have used their power to hand out contracts in return for “commission” or exploit their status to establish their own businesses. while kennedy’s work is dated, cronyism remains prevalent in many business environments throughout the region. it might be reasonable to expect that globalization encourages firms to pursue a market orientation as they seek to maximize profit. unfortunately, corporate political connections are so widespread and entrenched in the ghanaian business environment that many firms depend on the use of nms for their very survival. in his study on nms in asia, faccio (2006) attributes this to the lack of stringent regulations and political conflicts of interests, a phenomenon that is quite prevalent in asian markets. hence, employing spe in lieu of ms will likely remain an attractive 18 journal of business strategies option in the foreseeable future with the entry of more chinese and nigerian firms into the ghanaian market. the africa report of april 30, 2015 argued that although ghana has passed solid anti-graft legislation, set-asides are common and companies are frequently accused of using bribes to win contracts. it is worth noting that the ghanaian government is not only the largest employer but also the largest contractor in the nation. a simple “gift” given to a few public officials would not only cut through a lot of red tape, but also guarantee lucrative contracts without the competitive struggles associated with ms. enu-kwasi (2014) simplifies this by noting, “corruption can increase or decrease the production costs faced by the firm or the product costs faced by the individual. bribes paid to expedite government regulatory activities, to obtain import licenses or to win government contracts, will all raise costs. in contrast, bribes paid to circumvent government regulations like health and safety, environmental requirements, and taxes may reduce the net cost to the company, and impose social costs” (p.88). enu-kwasi (2014) also notes that as a way of fighting corruption, the procurement act (663) was passed in 2003 but it has not stopped officials from exerting favoritism. sociocultural underpinnings could also contribute to the heightened influence of spe on performance. as opposed to the developed world, ghanaian cultural norms and values generally eschew vigorous competition that puts the survival of rival firms at stake. the traditional orientation in ghana favors a harmonious coexistence of all firms with a “healthy,” less competitive environment that assures survival for all. subsequently, the extinction of firms through “competition” is abhorrent to many. cognitive agreements among individuals and businesses or with governments tend to be socially preferred to hyper-competitive environments, which are often considered to be unhealthy and socially unacceptable. while there seems to be some implicit understanding that exploiting a firm’s party affiliation could be politically expedient, any deliberate act by politically connected firms to undermine the existence of competing firms is intolerable. conclusions and future directions this paper assessed factors associated with uncertainty, spe and performance. technology uncertainty was found to be a driver of spe, as well as strategic emphases on competitors and customers. market uncertainty prompted emphases on both competitors and customers, but only at the .10 level. strategic emphasis on competitors was a driver of performance at the .10 level, while the spe-performance volume 35, number 1 19 link was positive and significant at the .05 level. additional work is required to replicate the prominent technology uncertainty-spe-performance link presented herein in other emerging economies. the increased prominence of spe creates both opportunities and challenges for the organization, particularly in nations like ghana. nonmarket and market concerns are not always consistent, challenging executives to integrate and balance them into a broader firm strategy that includes a market orientation (cavazos & rutherford, 2012). nonmarket approaches have also been associated with the lack of adequate infrastructure in emerging economies. whereas executives in developing nations may be accustomed to strong political intervention and a precarious regulatory environment, most of their counterparts in developed economies have been trained to excel in the market arena and may not have the skill set and temperament necessary for success under such circumstances (bach & allen, 2010; vázquez-maguirre & hartmann, 2013). several limitations should be noted. first, while the sample was diverse and included managers from different levels and multiple industries, the cross-industry design does not allow for the assessment of industry-level influences and is not necessarily representative of all firms operating in ghana. second, this study assessed relative competitive and objective performance via self-typing scale (ramanujam & venkatraman, 1987; venkatraman & ramanujam, 1986). this approach offers key advantages for cross-industry samples, but utilizing objective, financial measures of performance may provide additional insight. monomethod bias is always a concern with this type of study as well. third, the instrument employed in the present study inquired about changes in strategic emphasis over time rather than attempting to measure such emphasis across specific time points. while such an approach is more efficient because it does not depend on a longitudinal design, it also relies more on the perceptions and recollection of the individual respondents. three key questions remain. first, while the analysis presented herein suggests a general shift in favor of spe among firms in ghana, success with spe requires satisfying politicians, regulatory agencies, interest groups, and other nonmarket actors (bach & allen, 2010; henisz & zelner, 2012; lux, crook, & woehr, 2011; rui, 2010). the long-term alignment between spe and performance remains to be seen, in ghana and in other developing economies (bach & allen, 2010; parnell & dent, 2009; singer, 2013). in a similar vein, while some firms appear to benefit through an increased non-market emphasis, the ostensible existence of a collective benefit to heightened 20 journal of business strategies spe remains unresolved. managers of each firm have an incentive—and perhaps a fiduciary responsibility—to craft and implement strategies that reflect increased political influence. however, such emphasis detracts time, energy, and resources away from market-related factors such as customers, competitors, and technology. it could be argued that even firms with a successful nms might perform better if they emphasized market factors instead. moreover, if some firms are better resourceequipped than others to address non-market factors, then those best resource-equipped to address market factors may not be the best performers in a given industry. this question remains unresolved in the literature, with some scholars promoting the public and social benefits of nms (den hond, rehbein, de bakker, & kooijmansvan lankveld, 2014; matten & crane, 2005; scherer, palazzo, & matten, 2014; scherer, rasche, palazzo, & spicer, 2016) while others do not (liedong, ghobadian, rajwani, & o’regan, 2015; mellahi et al., 2016b; scherer, 2017; scherer & palazzo, 2011; schneider & scherer, 2016). finally, the findings presented here allude to deeper questions about increases in strategic political emphasis. specifically, additional research is needed to address the extent to which such emphasis is a net positive or negative for the broad economy. such a concern should be investigated from strategic, social, and philosophical perspectives (baron & diermeier, 2007; leroux & goerdel, 2009; oliver & holzinger, 2008; ozer, 2010; p. sun et al., 2012; vaara & durand, 2012). references ackah, c., aryeetey, e., ayee, j., & clottey, e. (2010). state-business relations and economic performance in ghana. ippg disussion papaer series, 35(january). adadevoh, e. a. (2014). new wine in new wine skins: the anti-corruption framework of ghana. journal of world energy law & business. doi: 10.1093/jwelb/jwu011 adly, a. i. (2009). politically-embedded cronyism: the case of post-liberalization egypt. business and politics, 11(4), 6-7. doi:http://dx.doi.org/10.2202/14693569.1268 agyapong, a., & boamah, r. b. (2013). business strategies and competitive advantage of family hotel businesses in ghana: the role of strategic leadership. journal of applied business research, 29(2), 531-543. agyapong, a., & muntaka, a. s. (2012). strategic planning and performance of businesses in ghana: a comparative study of micro, small, and large firms. the international business & economics research journal (online), 11(11), 1261-n/a. volume 35, number 1 21 agyapong, a., osei, h. v., & akomea, s. y. (2015). marketing capability, competitive strategies and performance of micro and small family businesses in ghana. journal of developmental entrepreneurship, 20(4), 1. anas, a. a. (2015). ghana in the eyes of god: epic on injustice video released by anas aremeyaw anas. aplin, j. c., & hegarty, w. h. (1980). political influence: strategies employed by organizations to impact legislation in business and economic matters. academy of management journal, 23(3), 438-450. asante, s. (2012). estimating the underground economy and tax evasion in ghana. ssrn electronic journal. doi:http://dx.doi.org/10.2139/ssrn.2013176 ayagre, p., & aidoo-buameh, j. (2014). whistleblower reward system implementation effects on whistleblowing in organisations. european journal of accouting, auditing, and finance research, 2(1), 80-90. bach, d., & allen, d. (2010). what every ceo needs to know about nonmarket strategy. mit sloan management review, 51(3), 41-48. bachner, j., & ginsberg, b. (2016). what washington gets wrong : the unelected officials who actually run the government and their misconceptions about the american people. amherst, ny: prometheus books. baines, p. r., & viney, h. (2010). the unloved relationship? dynamic capabilities and political-market strategy: a research agenda. journal of public affairs, 10(4), 258. balogun, j., & johnson, g. (2004). organizational restructuring and middle manager sensemaking. academy of management journal, 47(4), 523-549. doi:10.2307/20159600 bank, a. d. (2016). republic of ghana strategy paper (2012-2016). retrieved from accra: http://www.afdb.org/fileadmin/uploads/afdb/documents/project-andoperations/ghana csp draft for comments.pdf baron, d. p. (1995). integrated strategy: market and nonmarket components. california management review, 37(2), 47-65. baron, d. p., & diermeier, d. (2007). strategic activism and nonmarket strategy. journal of economics & management strategy, 16(3), 599-634. doi:10.1111/ j.1530-9134.2007.00152.x barron, a. (2010). unlocking the mindsets of government affairs managers. cross cultural management, 17(2), 101-117. doi:http://dx.doi. org/10.1108/13527601011038697 22 journal of business strategies blackmore, k., & nesbitt, k. (2013). verifying the miles and snow strategy types in australian smalland medium-size enterprises. australian journal of management (sage publications ltd.), 38(1), 171-190. doi:10.1177/0312896212444692 bonardi, j.-p., hillman, a. j., & keim, g. d. (2005). the attractiveness of political markets: implications for firm strategy. academy of management. the academy of management review, 30(2), 397-413. bonardi, j.-p., holburn, g., & vanden bergh, r. g. (2006). nonmarket strategy performance: evidence from u.s. electric utilities. academy of management journal, 49(6), 1209-1228. bonardi, j.-p., holburn, g. l. f., & vanden bergh, r. g. (2006). nonmarket strategy performance: evidence from u.s. electric utilities. academy of management journal, 49(6), 1209-1228. doi:10.5465/amj.2006.23478676 bosse, d. a., phillips, r. a., & harrison, j. s. (2009). stakeholders, reciprocity, and firm performance. strategic management journal, 30(4), 447-456. brito-bigott, o., faría, h. j., rodríguez, j. m., & sánchez, a. (2008). corruption and complex business rules. journal of private enterprise, 24(1), 1-21. cavazos, d. e., & rutherford, m. a. (2012). bringing regulatory agencies into organizational studies: broadening the lens used to examine the state. journal of management inquiry, 21(1), 4-12. choi, j., & wang, h. (2009). stakeholder relations and the persistence of corporate financial performance. strategic management journal, 30(8), 895-907. coffie, s., & owusu-frimpong, n. (2014). alternative positioning strategies for services in ghana. thunderbird international business review, 56(6), 531. cyert, r., & march, j. g. (1963). behavioral theory of the firm. englewood cliffs, nj: prentice-hall. decker, s. (2011). corporate political activity in less developed countries: the volta river project in ghana, 1958-66. business history, 53(7), 993. delios, a., & henisz, w. j. (2003). political hazards, experience, and sequential entry strategies: the international expansion of japanese firms, 1980-1998. strategic management journal, 24(11), 1153-1164. delmas, m. a., & montes-sancho, m. j. (2010). voluntary agreements to improve environmental quality: symbolic and substantive cooperation. strategic management journal, 31(6), 575-601. den hond, f., rehbein, k. a., de bakker, f. g. a., & kooijmans-van lankveld, h. (2014). playing on two chessboards: reputation effects between corporate social responsibility (csr) and corporate political activity (cpa). the journal of management studies, 51(5), 790. volume 35, number 1 23 desarbo, w. s., benedetto, c. a. d., song, m., & sinha, i. (2005). revisiting the miles and snow strategic framework: uncovering interrelationships between strategic types, capabilities, environmental uncertainty, and firm performance. strategic management journal, 26(1), 47-74. doi:10. 1002/smj.431 dess, g. g., & davis, p. s. (1984). porter’s (1980) generic strategies as determinants of strategic group membership and organizational performance. academy of management journal, 27(3), 467-488. doi:10.2307/256040 dieleman, m., & boddewyn, j. j. (2012). using organization structure to buffer political ties in emerging markets: a case study. organization studies, 33(1), 71. doh, j. p., lawton, t. c., & rajwani, t. (2012). advancing nonmarket strategy research: institutional perspectives in a changing world. the academy of management perspectives, 26(3), 22-39. drutman, l. (2015). the business of american is lobbying: how corporations became politicized and politics became more corporate. new york: oxford university press. dwomoh, l. y. (2011). internationalisation of small and medium scale enterprieses (smes in ghana: challenges and opportunities). unpublished executive masters thesis. kwame nkrumah university of science and technology. dzisi, s., john-englebert, s., & ofosu, d. (2013). globalisation and smes in ghana: effects, challenges and the way forward. journal of business and enterprise development, 4(1), 40-64. enu-kwasi, f. (2014). combating corruption in ghana and africa: the role of stakeholders. oguaa journal of social sciences, 7, 77-99. faccio, m. (2006). politicall connected firms. american economic review, 96(1), 369-386. frynas, j. g., mellahi, k., & geoffrey allen, p. (2006). first mover advantages in international business and firm-specific political resources. strategic management journal, 27(4), 321-345. funk, r. j., & hirschman, d. (2017). beyond nonmarket strategy: market actions as corporate political activity. academy of management review, 42(1), 32-52. doi:10.5465/amr.2013.0178 galang, r. m. n. (2012). victim or victimizer: firm responses to government corruption. the journal of management studies, 49(2), 429-462. ghemawat, p. (2008). reconceptualizing international strategy and organization. strategic organization, 6, 195-206. doi:10.1177/1476127008090010 24 journal of business strategies guo, h., xu, e., & jacobs, m. (2014). managerial political ties and firm performance during institutional transitions: an analysis of mediating mechanisms. journal of business research, 67(2), 116-127. doi:10.1016/j.jbusres.2012.11.009 hadani, m., dahan, n. m., & doh, j. p. (2015). the ceo as chief political officer: managerial discretion and corporate political activity. journal of business research, 68(11), 2330. hair, j. f., sarstedt, m., pieper, t. m., & ringle, c. m. (2012). the use of partial least squares structural equation modeling in strategic management research: a review of past practices and recommendations for future applications. long range planning, 45(5-6), 320. harrison, j. s., bosse, d. a., & phillips, r. a. (2010). managing for stakeholders, stakeholder utility functions, and competitive advantage. strategic management journal, 31(1), 58-74. harrison, j. s., & wicks, a. c. (2013). stakeholder theory, value, and firm performance. business ethics quarterly, 23(1), 97-124. doi:10.5840/ beq20132314 healy, r. (2014). corporate political behavior: why corporations do what they do in politics. new york: routledge. henisz, w. j., & zelner, b. a. (2012). strategy and competition in the market and nonmarket arenas. the academy of management perspectives, 26(3), 40-51. hillman, a. j., & hitt, m. a. (1999). corporate political strategy formulation: a model of approach, participation, and strategy decisions. academy of management review, 24(4), 825-842. doi:10.5465/amr.1999.2553256 hillman, a. j., keim, g. d., & schuler, d. (2004). corporate political activity: a review and research agenda. journal of management, 30(6), 837-857. doi:10.1016/j.jm.2004.06.003 hillman, a. j., & zardkoohi, a. (1999). corporate political strategies and firm performance: indications of firm-specific benefits from. strategic management journal, 20(1), 67-81. holburn, g. l. f., & vanden bergh, r. g. (2008). making friends in hostile environments: political strategy in regulated industries. academy of management. the academy of management review, 33(2), 521-540. hong, h. g., & liskovich, i. (2015). crime, punishment and the halo effect of corporate social responsibility. nber working paper no. w21215. volume 35, number 1 25 iriyama, a., kishore, r., & talukdar, d. (2016). playing dirty or building capability? corruption and hr training as competitive actions to threats from informal and foreign firm rivals. strategic management journal, 37(10), 2152-2173. doi:10.1002/smj.2447 jauch, l. k., & kraft, k. l. (1986). strategic management of uncertainty. academy of management review, 11(4), 777-790. doi:10.5465/amr.1986.4283934 ji-yub, k., jerayr, h., & finkelstein, s. (2011). when firms are desperate to grow via acquisition: the effect of growth patterns and acquisition experience on acquisition premiums. administrative science quarterly, 56(1), 26-60. keillor, b. d., wilkinson, t. j., & owens, d. (2005). threats to international operations: dealing with political risk at the firm level. journal of business research, 58(5), 629-635. kennedy, p. (1977). indigenous capitalism in ghana. review of african political economy, 4(8), 21-38. kingsley, a. f., bergh, r. g. v., & bonardi, j.-p. (2012). political markets and regulatory uncertainty: insights and implications for integrated strategy. the academy of management perspectives, 26(3), 52-67. krozer, y., franco-garcía, m.-l., & micallef, d. (2013). interactions management in environmental policy. management research review, 36(12), 1210-1219. doi:10.1108/mrr-06-2013-0141 lailani laynesa, a., & mitsuhashi, h. (2013). dynamics of entering politically risky foreign markets. management research review, 36(6), 580-595. doi:http:// dx.doi.org/10.1108/01409171311325741 lawton, t., mcguire, s., & rajwani, t. (2013). corporate political activity: a literature review and research agenda. international journal of management reviews, 15(1), 86-105. doi:http://dx.doi.org/10.1111/j.1468-2370.2012.00337.x leroux, k., & goerdel, h. t. (2009). political advocacy by nonprofit organizations a strategic management explanation. public performance & management review, 32(4), 514-536. liedong, t. a., ghobadian, a., rajwani, t., & o’regan, n. (2015). toward a view of complementarity: trust and policy influence effects of corporate social responsibility and corporate political activity. group & organization management, 40(3), 405. liedong, t. a., ghobadian, a., rajwani, t., & o’regan, n. (2015). toward a view of complementarity: trust and policy influence effects of corporate social responsibility and corporate political activity. group & organization management, 40(3), 405-427. doi:10.1177/1059601114560064 26 journal of business strategies liu, c., maslach, d., desai, v., & madsen, p. (2015). the first 50 years and the next 50 years of a behavioral theory of the firm: an interview with james g. march (vol. 24, pp. 149-155). lux, s., crook, t. r., & woehr, d. j. (2011). mixing business with politics: a meta-analysis of the antecedents and outcomes of corporate political activity. journal of management, 37(1), 223-247. mantere, s., pajunen, k., & lamberg, j.-a. (2009). vices and virtues of corporate political activity: the challenge of international business. business and society, 48(1), 105-132. matten, d., & crane, a. (2005). corporate citizenship: toward an extended theoretical explanation. academy of management review, 30(1), 166-179. doi:10.5465/amr.2005.15281448 mellahi, k., frynas, j. g., sun, p., & siegel, d. (2016a). a review of the nonmarket strategy literature. journal of management, 42(1), 143-173. doi:10.1177/0149206315617241 mellahi, k., frynas, j. g., sun, p., & siegel, d. (2016b). a review of the nonmarket strategy literature: toward a multi-theoretical integration. journal of management, 42(1), 143. meyer, k. e., & peng, m. w. (2016). theoretical foundations of emerging economy business research. journal of international business studies, 47(1), 3-22. doi:http://dx.doi.org/10.1057/jibs.2015.34 obeng, b. a., robson, p., & haugh, h. (2014). strategic entrepreneurship and small firm growth in ghana. international small business journal, 32(5), 501. obi berko, o. d. (2013). strategic factors and firm performance in an emerging economy. african journal of economic and management studies, 4(2), 267287. okhmatovskiy, i. (2010). performance implications of ties to the government and soes: a political embeddedness perspective. the journal of management studies, 47(6), 1020. oliver, c., & holzinger, i. (2008). the effectiveness of strategic political management: a dynamic capabilities framework. academy of management review, 33(2), 496-520. doi:10.5465/amr.2008.31193538 ozer, m. (2010). top management teams and corporate political activity: do top management teams have influence on corporate political activity? journal of business research, 63(11), 1196-1201. volume 35, number 1 27 papaioannou, t., watkins, a., mugwagwa, j., & kale, d. (2016). to lobby or to partner? investigating the shifting political strategies of biopharmaceutical industry associations in innovation systems of south africa and india. world development, 78, 66. parnell, j. a. (1997). new evidence in the generic strategy and business performance debate: a research note. british journal of management, 8(2), 175-181. parnell, j. a. (2015). strategic political emphasis, strategic capabilities and uncertainty. journal of strategy and management, 8(1), 41. parnell, j. a., & dent, e. b. (2009). philosophy, ethics, and capitalism: an interview with bb&t chairman john allison. academy of management learning & education, 8(4), 587-596. parnell, j. a., lester, d. l., & menefee, m. l. (2000). strategy as a response to organizational uncertainty: an alternative perspective on the strategyperformance relationship. management decision, 38(8), 520-530. parnell, j. a., lester, d. l., zhang, l., & köseoglu, m. a. (2012). how environmental uncertainty affects the link between business strategy and performance in smes. management decision, 50(4), 546-568. doi:http://dx.doi. org/10.1108/00251741211220129 parnell, j. a., scott, g. j., & angelopoulos, g. (2013). benchmarking tendencies in managerial mindsets: prioritizing stockholders and stakeholders in peru, south africa, and the united states. journal of business ethics, 118(3), 589605. doi:http://dx.doi.org/10.1007/s10551-012-1555-4 parnell, j. a., spillan, j. e., & mensah, e. c. (2014). competitive strategy and performance in southern ghana. international journal of management & enterprise development, 13(2), 109-129. doi:10.1504/ijmed.2014.062546 peng, m. w., wang, d. y. l., & yi, j. (2008). an institution-based view of international business strategy: a focus on emerging economies. journal of international business studies, 39(5), 920-936. planet plutocrat. (2014). the economist, 410(8878), 57-58. qureshi, m., & velde, d. w. (2007). state-business relations and firm performance in zambia. retrieved from www.ippg.org.uk raes, a. m. l., heijltjes, m. g., glunk, u., & roe, r. a. (2011). the interface of the top management team and middle managers: a process model. academy of management review, 36(1), 102-126. ramanujam, v., & venkatraman, n. (1987). planning system characteristics and planning effectiveness. strategic management journal, 8(5), 453-468. 28 journal of business strategies rival, m. (2012). are firms’ lobbying strategies universal? comparison of lobbying by french and uk firms. journal of strategy and management, 5(2), 211-230. doi:http://dx.doi.org/10.1108/17554251211222901 rui, j. p. d. f. (2010). institutions, politics, and non-market strategy. california management review, 52(2), 123-131. saffu, k., walker, j. h., & hinson, r. (2007). an empirical study of perceived strategic value and adoption constructs: the ghanaian case. management decision, 45(7), 1083. doi:http://dx.doi.org/10.1108/00251740710773925 sawant, r. j. (2012). asset specificity and corporate political activity in regulated industries. academy of management. the academy of management review, 37(2), 194-210. scherer, a. g. (2017). theory assessment and agenda setting in political csr: a critical theory perspective. international journal of management reviews, 19, 1-24. scherer, a. g., & palazzo, g. (2011). the new political role of business in a globalized world: a review of a new perspective on csr and its implications for the firm, governance, and democracy. journal of management studies, 48(4), 899-931. doi:10.1111/j.1467-6486.2010.00950.x scherer, a. g., palazzo, g., & baumann, d. (2006). global rules and private actors: toward a new role of the transnational corporation in global governance. business ethics quarterly, 16(4), 505-532. scherer, a. g., palazzo, g., & matten, d. (2014). the business firm as a political actor: a new theory of the firm for a globalized world. business & society, 53(2), 143-156. doi:10.1177/0007650313511778 scherer, a. g., rasche, a., palazzo, g., & spicer, a. (2016). managing for political corporate social responsibility: new challenges and directions for pcsr 2.0. journal of management studies, 53(3), 273-298. doi:10.1111/joms.12203 schneider, a., & scherer, a. g. (2016). government beyond the shadow of hierarchy the case of the csr policies of the european union. academy of management annual meeting proceedings, 1-1. doi:10.5465/ambpp.2016.11887abstract singer, a. e. (2013). corporate political activity, social responsibility, and competitive strategy: an integrative model. business ethics, 22(3), 308-324. doi:http://dx.doi.org/10.1111/beer.12023 stevens, c. e., xie, e., & peng, m. w. (2016). toward a legitimacy-based view of political risk: the case of google and yahoo in china. strategic management journal, 37(5), 945-963. doi:10.1002/smj.2369 volume 35, number 1 29 sun, p., mellahi, k., & wright, m. (2012). the contingent value of corporate political ties. the academy of management perspectives, 26(3), 68-82. sun, s.-y., hsu, m.-h., & hwang, w.-j. (2009). the impact of alignment between supply chain strategy and environmental uncertainty on scm performance. supply chain management, 14(3), 201-212. doi:10.1108/13598540910954548 swamidass, p. m., & newell, w. t. (1987). manufacturing strategy, environmental uncertainty and performance: a path analytic model. management science, 33(4), 509. teece, d., peteraf, m., & leih, s. (2016). dynamic capabilities and organizational agility: risk, uncertainty, and strategy in the innovation economy. california management review, 58(4), 13-35. doi:10.1525/cmr.2016.58.4.13 vaara, e., & durand, r. (2012). how to connect strategy research with broader issues that matter? strategic organization, 10(3), 248-255. doi:10.1177/1476127012452827 vázquez-maguirre, m., & hartmann, a. m. (2013). nonmarket strategies of media enterprises in the mexican television industry. journal of business research, 66(10), 1743-1749. venkatraman, n., & ramanujam, v. (1986). measurement of business performance in strategy research: a comparison of approaches. academy of management review, 11(4), 801-814. doi:10.5465/amr.1986.4283976 west, s. g., taylor, a. b., & wu, w. (2012). model fit anf model selection in structural equation modeling. in r. h. hoyle (ed.), handbook of structural equation modeling (pp. 209-231). new york: guilford press. wickert, c. (2016). “political” corporate social responsibility in small and medium-sized enterprises. business & society, 55(6), 792-824. doi:10.1177/0007650314537021 woiceshyn, j. (2011). a model for ethical decision making in business: reasoning, intuition, and rational moral principles. journal of business ethics, 104(3), 311-323. doi:10.1007/s10551-011-0910-1 wright, m., liu, x., buck, t., & filatotchev, i. (2008). returnee entrepreneurs, science park location choice and performance: an analysis of hightechnology smes in china. entrepreneurship: theory & practice, 32(1), 131155. doi:10.1111/j.1540-6520.2007.00219.x yu, l., liu, h., zhu, a., & li, x. (2015). empirical analysis on the choice of non market strategy in different life cycle. journal of shenyang university of technology (social science edition), 8(5), 420-424. 30 journal of business strategies zheng, q., luo, y., & maksimov, v. (2015). achieving legitimacy through corporate social responsibility: the case of emerging economy firms. journal of world business, 50(3), 389-403. doi:10.1016/j.jwb.2014.05.001 biographical sketch of authors john parnell is the belk chair in management at the university of north carolina at pembroke. he is the author and co-author of two current textbooks, strategic management: theory and practice, and crisis management: leading in the new strategy landscape. he has also published over 200 articles and has lectured in many countries, including china, mexico, peru and egypt. his current research focuses on business strategy, nonmarket orientation, crisis management and ethics. edwin “cliff” mensah is a professor of economics at the university of north carolina at pembroke, and a visiting professor at valley view university and data link institute in the biographical sketches of both mensah and oppong. his research interests include mobile platforms for monetary transactions (emoney), as well as the economic impact of currency modification and money management among ghana’s ultra-poor. derek oppong is a lecturer in the school of business at data link institute. he worked previously with mediators beyond borders in managing former child soldiers and war-affected youth from the liberian civil war. his research interests include development of a psychosocial and economic model for managing refugees and deprived populations, as well as developing culturally competent systems for managing psychological distress. volume 35, number 1 31 alliance portfolio diversity and dominant logic theory dr. christopher penney university of north texas • denton, tx abstract alliance portfolio diversity has emerged as a topic of considerable research interest. two central questions remain: why are some firms are better at managing alliance portfolio diversity than others, and does the form of alliance portfolio diversity matter? i develop a framework using dominant logic theory to explore these questions. i distinguish related alliance portfolio diversity from unrelated alliance portfolio diversity, and argue that when a firm engages in related alliance portfolio diversity strategy that matches its dominant logic(s), it will experience greater performance. i expect that firms lacking a prominent dominant logic will engage in unrelated alliance portfolio diversity. i also argue that if firms engage in related alliance portfolio diversity in an area(s) that does not match its dominant logic(s), there will be a mismatch, triggering a reduction in firm performance and the development of a new dominant logic. finally, i offer directions for future research. introduction today’s firms cannot “go it alone (lee, kirkpatrick-husk, & madhavan, 2017).” on the contrary, managers must competently manage a greater number of alliances than ever before (kale & singh, 2009). thus, a focus on alliance portfolios, defined as a firm’s ongoing set of alliances (ozcan & eisenhardt, 2009; das & teng, 2000; hoffmann, 2005; 2007; wassmer, 2010), is important. indeed, a firm’s alliance portfolio is likely to be more crucial to firm performance than any individual alliance (ozcan & eisenhardt, 2009). in the past decade, research attention in alliance portfolios has increased, resulting in two literature reviews (i.e., kale & singh, 2009; wassmer, 2010) and a meta-analysis (i.e., lee et al., 2017). recent work has begun to explore how alliance portfolio managers configure their portfolios in ways that lead to greater performance (e.g., lee et al., 2017; wassmer, 2010). a key descriptor of alliance portfolio configuration is alliance portfolio diversity (lee et al., 2014; wuyts & dutta, 2014), which refers to the degree of variance in alliance partners in terms of resources, capabilities, knowledge, and technology (goerzen & beamish, 2005; jiang, tao, & santoro, 2010; lee et al., 2014). alliance portfolio diversity offers managers several key benefits, including 32 journal of business strategies access to greater resources, capabilities, and information (baum, calabrese & silverman, 2000; dussauge, garrette, & mitchell, 2000; lee et al., 2017). most importantly, alliance portfolio diversity offers the potential to generate knowledge (dussauge et al., 2000; wuyts & dutta, 2014), which may be used to stimulate firm innovativeness (baum et al., 2000; cui & o’connor, 2012). thus, in theory, it is more beneficial to form a smaller set of alliances with diverse partners than it is to form a larger set of alliances with less diverse partners (lee et al., 2014). in practice, however, the many costs involved with alliance portfolio diversity may outweigh their benefits (goerzen, 2007; lee et al., 2014). indeed, as alliance portfolio diversity increases, it becomes more difficult to manage and coordinate across each partner (bamford & ernst, 2002; goerzen & beamish, 2005; lee et al., 2014). alliance portfolio diversity makes management costlier, in turn, because managers must juggle different firms’ “vocabularies, paradigms, and even objectives” (goerzen & beamish, 2005). as the focal firm’s ability to coordinate and manage its portfolio is compromised, partners may reduce trust levels (lee et al., 2014), requiring greater monitoring costs (goerzen & beamish, 2005). specific types of diversity may be even costlier. for example, geographic diversity may involve countries that are unable to resolve conflicts (lee et al., 2014), whereas industry diversity may involve resource misfits or a lack of synergies between partners (jiang et al., 2010). ultimately, these problems may adversely affect firm performance (e.g., goerzen & beamish, 2015; lee et al., 2017). presently, the relationship between alliance portfolio diversity and performance remains elusive (lee, kirkpatrick-husk, and madhaven, 2017; wuyts & dutta, 2014). the literature has begun to realize that not all firms benefit from alliance portfolio diversity (wuyts & dutta, 2014), and it appears that some managers are better able to reduce the costs of, and in turn benefit more from, alliance portfolio diversity (e.g., jiang et al., 2010; lee et al., 2017). therefore, there is a need to consider why some firms can better manage alliance portfolio diversity than others, and if the particular form of alliance portfolio diversity matters (lee et al., 2017). to help explore these important research questions, it is warranted to consider what we know about firm diversification, and use that knowledge to inform an investigation of alliance portfolio diversity1. once we can better understand how managers approach alliance portfolio diversity, we can begin to untangle the relationship between alliance portfolio diversity and firm performance. 1 throughout this paper, the terms “diversity” and “diversification” are used interchangeably. following the literature’s prevailing nomenclature and to avoid confusion, the sooner is used for the alliance portfolio level and the latter is reserved for the firm level. volume 35, number 1 33 there are many parallels between alliance portfolio diversity and firm diversification. in the 1980s, the relationship between firm-level diversification and performance was also described as elusive (grant, 1996; prahalad & bettis, 1986). the firm diversification literature was able to resolve some of the tension after prahalad and bettis (1986) developed the concept of a dominant logic. dominant logic is a theory of corporate level management that deals with the influence of key executives and their abilities to manage diversified firms, and ultimately improve performance. prahalad and bettis (1986:490) define a dominant logic as “the way in which managers conceptualize the business and make critical resource allocation decisions.” consequently, a dominant logic “can allow a diversified firm to develop a framework that guides its different business units without becoming involved in each of their specific strategic decisions (lampeel & shamsie, 2000:593).” thus, dominant logic theory became central to the understanding of the relationship between firm diversification and performance (grant, 1988). in more recent years, dominant logic theory has been expanded to apply to virtually any decision made throughout the firm, owing to a shared mind-set and world view (lampel & shamsie, 2000). prior to the development of dominant logic theory to explain why managers can more effectively manage certain types of firmlevel diversification, the literature lacked theory to connect firm diversification to performance. thus, in this paper i extend dominant logic theory into the alliance portfolio diversity context. in doing so, i explain why some firms are more (less) likely to benefit from certain forms of alliance portfolio diversity. this paper is organized as follows: first, the alliance portfolio diversity literature is reviewed. i then propose a framework to resolve the current debate in alliance portfolio research – whether the relationship between alliance portfolio diversity and performance is positive or negative. following the firm diversification literature, i will (1) distinguish related alliance portfolio diversity from unrelated alliance portfolio diversity, and (2) apply dominant logic theory to argue that the direction and value of a firm’s alliance portfolio diversity depends in part on that firm’s dominant logic(s). i submit that when the firm matches its alliance portfolio diversity strategy to its dominant logic(s), it will experience greater performance. next, i will argue that if firms engage in alliance portfolio diversity in an sector(s) that does not match its dominant logic(s), there will be a mismatch, triggering a reduction in firm performance and the development of a new dominant logic. finally, i offer directions for future research. literature review 34 journal of business strategies alliance portfolio diversity has been the focus of many modern studies in the strategic management literature (lee et al., 2017). although the impact of alliance portfolio diversity on performance has received much attention (e.g., goerzen & beamish, 2005, jiang et al., 2010; lee et al., 2014; ozcan & eisenhardt, 2009; wuyts & dutta, 2014), the results are mixed (lee et al., 2017; wuyts & dutta, 2014). a recent meta-analysis found that the direction of the results depend on the specific theory used and the specific type of alliance portfolio diversity measured (e.g., industry, geographic, etc.; lee et al., 2014). indeed, papers that employ transaction cost economics and focus on the costs of diversity are likely to report a negative relationship between alliance portfolio diversity and performance, whereas papers that employ the resource based view and focus on the resource or learning benefits of diversity are more likely to report a positive relationship (lee et al., 2014). although alliance portfolio diversity is an important construct, it is theoretically complicated (lee et al., 2014). thus, it is warranted to decompose alliance portfolio diversity into separate dimensions to help make sense of the alliance portfolio diversity and firm performance relationship. to decompose alliance portfolio diversity, it may be useful to first consider the process used by management scholars to decompose firm diversification. the firm diversification literature separates firm diversification into related diversification and unrelated diversification dimensions, which together equal total firm diversification (e.g., bettis, 1981; palepu, 1985; rumelt, 1974). prahalad and bettis (1986:499) define related diversification as the “strategic similarities of [a firm’s] businesses and the cognitive composition of the top management team.” thus, related diversification considers similarities in markets, industries, and technologies (grant, 1988). the distinction between related and unrelated firm diversification is important; related firm diversification leads to greater profitability than unrelated firm diversification (rumelt, 1974). similarly, bettis (1981) found that firms employing related diversification outperform firms that employ unrelated diversification. related diversification allows companies to exploit their core factors, enjoying economies of scale, more efficient resource allocation, and the ability to exploit technical and managerial skills (palepu, 1985). related diversification also allows managers to draw from schemas to inform decisions. unrelated diversification, on the other hand, offers fewer operating synergies, and is unlikely to positively affect performance unless the unrelated diversifier can achieve significant market power (palepu, 1985). following prior research on schemas and mental maps, prahalad and bettis (1986) theorized that managers face limits on the diversification levels that can be volume 35, number 1 35 managed by schemas, developed from managers’ interpretations of past experiences. the schemas serve as a mental road map, which become part of the organization’s culture (ginsberg, 1989). schemas are shared among the top management team as a dominant logic (prahalad & bettis, 1986). put differently, a dominant logic is a common way for managers to view their business and allocate resources, manifested in the expectations and assumptions managers hold about a particular business context (kor & mesko, 2013). a dominant logic allows diversified firms to create a framework that guides their business units without requiring the top management team to make specific strategic decisions in each unit (lampel & shamsie, 2000). in using a dominant logic, organizations sustain their current strategy and typically perform well at their current tasks (prahalad, 2004). therefore, a dominant logic translates the firm’s top management team’s capabilities into competencies within a given business (kor & mesko, 2013). strategically similar forms of diversification (i.e., related) may then be grouped into sectors and managed by a single dominant logic (prahalad & bettis, 1986). as firms enter new businesses, they must add additional dominant logics; “diversified firms, with strategic variety, impose the need for multiple dominant logics (prahalad & bettis, 1986:490).” additional dominant logics must then be carefully developed and supported by the top management team (lampel & shamsie, 2000), which then requires the ability to simultaneously process multiple dominant logics (prahalad & bettis, 1986). ultimately, an established dominant logic influences the direction and extent to which a firm will innovate and grow (kor & mesko, 2013). for example, the international experiences of individual members of the top management team may lead to a framework that directs a business unit’s international diversification (sambharya, 1996; tihanyi, ellstrand, daily, & dalton, 2000). indeed, research supports the notion that firms are more likely to benefit from diversification that matches the firm’s dominant logic. continuing our example, if the international experience of the top management team is concentrated in a particular geographic region, the firm is likely to diversify into that region (tihanyi et al., 2000). similarly, as a firm gains foreign partnering experience, adding additional foreign partners leads to increases in firm performance (lavie & miller, 2008). in short, a firm should only add an international alliance partner to its portfolio when doing so is consistent with the firm’s dominant logic. in other words, the firm can enjoy an economy of scale from its dominant logic as it engages related diversification that matches the logic. when the firm’s dominant logic indicates that diversifying would be optimal, the firm should realize an increase in performance from doing so (prahalad & bettis, 36 journal of business strategies 1986). in sum, dominant logic theory explains why related firm diversification, on average, leads to better results than unrelated firm diversification. a firm can develop a specialization in a certain sector, and therefore a dominant logic. the organization may then spread resources, skills, and other core factors across the sector of related businesses. in the next section, i will consider how the same process used to help untangle the impact of firm diversity on performance can be used in the alliance portfolio context. theoretical development above, i restated the value in distinguishing between related firm diversification and unrelated firm diversification, and reviewed the reasons why, on average, related firm diversification leads to higher profitability than unrelated firm diversification. dominant logic theory explains, in part, how firms can capitalize on related diversification. i will now shift the discussion to the alliance portfolio context. alliance portfolios sometimes include overlapping partners that conduct related transactions (wassmer, 2010). on the other hand, alliance portfolios sometimes include partners that share very few similarities (goerzen & beamish, 2005). because the firm diversity literature suggests that the two different types of diversity have important managerial and performance consequences, i submit that it is important to decompose alliance portfolio diversity; the distinction may help explain variation in outcomes such as performance. when managers form multiple alliances with partners from the same industry (i.e., related alliances), they are more likely to build high performing portfolios (e.g., ozcan & eisenhardt, 2009). henceforth, i use the term ‘related alliance portfolio diversity’ to refer the degree that a firm’s alliance portfolio contains alliances that share similarities along one or more dimensions of diversity (e.g., there are multiple alliances located in a particular geographic region). i conceptualize related alliances distinct from horizontal alliances, which is any alliance the focal firm forms that belongs to the same industry as the focal firm (c.f., chan, kensinger, keown, & martin, 1997). related alliance portfolio diversity serves several purposes – it allows faster learning (c.f. baum et al., 2000; draulans, deman, & volberda, 2003), reduces any one alliance partner’s bargaining power (c.f. ozcan & eisenhardt, 2009), supports network resource exchange (c.f. lavie & miller, 2008), and allows a complete transaction to split among alliance partners who may each complete segments of the overall transaction (wassmer, 2010). this may be beneficial, in that volume 35, number 1 37 similarities across alliances may offer managers opportunities to create synergies (ozcan & eisenhardt, 2009) and a higher potential for learning (jiang et al., 2010). i conceptualize ‘unrelated alliance portfolio diversity’ to refer to the degree that a firm’s alliance portfolio contains alliances that do not share similarities. theory suggests that there may be certain environments where unrelated alliance portfolio diversity would be advantageous. indeed, unrelated alliance portfolio may allow managers to reduce uncertainty, develop skills and resources, and exploit market power (goerzen & beamish, 2005). as noted earlier, maintaining a small alliance portfolio with diverse (i.e., unrelated) partners may offer managers better access to a wider range of resources, information, and capabilities than a larger alliance portfolio with related partners. in practice, however, it is often difficult to realize such benefits from unrelated alliance portfolio diversity (goerzen & beamish, 2005; inkpen & beamish, 1997). despite the possible benefits (and costs) of alliance portfolio diversity, the alliance portfolio diversity literature finds that differences exist between firms that employ the same – or very similar levels of alliance portfolio diversity (e.g., lee et al., 2017). thus, theoretically, it is unknown whether related alliance portfolio diversity necessarily results in better performance as it does in the firm diversity context. consequently, dominant logic theory may be useful to help explain which type of alliance portfolio diversity may be most beneficial. accordingly, the correct type of alliance portfolio diversity depends on the firm’s dominant logic(s). extensiveness of apd. as discussed earlier, a dominant logic is the manifestation of the beliefs, assumptions, and intentions of the ceo and top management (kor & mesko, 2013; lampel & shamsie, 2000). accordingly, a firm’s dominant logic extends beyond the managerial level and influences firmlevel properties such as knowledge, capabilities, and resource commitments (kor & mesko, 2013). strategically similar forms of diversification may be grouped into sectors (prahalad & bettis, 1986). thus, in shifting the focus to the alliance portfolio level, managers may benefit from a dominant logic by holding the ability to leverage an extensive knowledge base across an entire sector of related alliances. indeed, a dominant logic(s) that matches a related alliance sector is beneficial because managers can draw from their extensive knowledge bases, capabilities, and resources (prahalad & bettis, 1986). learning presents one of the greatest advantages for engaging related alliance portfolio diversity when it matches the firm’s dominant logic(s). there is evidence that increased similarity between the focal firm and its alliance portfolio increases organizational learning (e.g., lane & lubatkin, 1998). i propose that (1) 38 journal of business strategies a firm is more likely to learn – and thus improve the firm’s dominant logic(s) – when it maintains a related alliance sector that matches the firm’s dominant logic(s), and (2) the firm’s dominant logic(s) allows managers to more effectively manage alliance portfolio diversity that matches the dominant logic(s). consider the case of absorptive capacity, which is defined as a firm’s ability to recognize, assimilate, and apply external information (cohen & levinthal, 1990). by engaging in related alliance portfolio diversity that matches the firm’s dominant logic(s), managers can maximize absorptive capacity, or the likelihood that it will recognize, assimilate, and apply the new knowledge. thus, a firm may be able to enjoy learning-based economies of scale across the related alliance sector. the schemas and assumptions that together comprise the firm’s dominant logic are encoded in the organization’s routines (kor & mesko, 2013); a prominent dominant logic encourages management to make decisions consistent with the logic (kor & mesko, 2013). forming additional (related) alliances in the sector(s) that match the firm’s dominant logic(s) would be one such action that is consistent with the firm’s dominant logic. while a dominant logic(s) creates learning-based economies of scale that reduces the costs and complexity of adding additional (related) alliances, the firm’s dominant logic(s) also directs managers’ attention away from forming alliances with partners in sectors that do not match the firm’s dominant logic(s). indeed, a dominant logic functions as an information filter that rejects unneeded and unwanted information (bettis & prahalad, 1995; kor & mesko, 2013), allowing managers to focus their attention on relevant information that does match the firm’s dominant logic(s) (kor & mesko, 2013). prahalad (2004) suggests that dominant logics limit a firm’s peripheral vision. therefore, it is little surprise that reuer, park, and zollo (2002) found that when managers have very homogeneous alliance experience, it was difficult to benefit from that experience when they added dissimilar alliances to the portfolio. when the firm forms alliances in many different sectors (i.e., unrelated alliances), it must maintain different vocabularies, paradigms, and objectives (goerzen & beamish, 2005). therefore, a prominent dominant logic(s) reduces the ability of the firm to pursue unrelated alliance portfolio diversity because the very information that managers are likely to reject is, by definition, necessary for unrelated alliance portfolio diversity. therefore, i expect that as the prominence of the firm’s dominant logic increases, firms will engage more extensively in related alliance portfolio diversity in sectors that match the firm’s dominant logic(s), and will engage less extensively in unrelated alliance portfolio diversity. stated formally: volume 35, number 1 39 proposition 1a: as the prominence of a firm’s dominant logic(s) increases, it will engage more extensively in related alliance portfolio diversity in sectors that match its dominant logic(s). proposition 1b: as the prominence of a firm’s dominant logic(s) increases, it will engage less extensively in unrelated alliance portfolio diversity although firms can benefit from maintaining a prominent dominant logic(s), it is possible that certain firms may lack prominent logics(s). using a case of a small company operating in a remote village, prahalad (2004) acknowledges this possibility. prahalad (2004:178) offers that the “lack of an old and deeply entrenched dominant logic gives them a tremendous advantage in seeing the opportunities of these peripheral markets.” indeed, maintaining more dissimilar alliance partners could be advantageous in that they offer managers a chance to develop more capabilities at a lower cost than instead maintaining alliances with similar partners (baum et al., 2000). thus, i submit that forming alliances in peripheral markets will give managers more general alliance management skills, in turn an alliance management capability (c.f., reuer et al., 2002; wassmer, 2010). given that managers are more motivated to diversify internationally when their shared mindset has a worldwide outlook (sambharya, 1996), i similarly expect that the existence of an alliance management capability will motivate managers to continue seeking partners in peripheral markets when there is a benefit to do so. lacking a prominent dominant logic, managers may forge alliances with companies in these peripheral markets for reasons other than learning, such as real options (e.g., vassolo, anand, & folta, 2004). according to real options theory, firms may elect to form alliances in peripheral markets to discover new opportunities, thereby creating an option in the future to acquire the alliance partner if uncertainty around those opportunities is reduced (vassolo et al., 2004). in sum, i expect that firms lacking a prominent dominant logic(s) will engage in higher levels of unrelated alliance portfolio diversity, and lower levels of related alliance portfolio diversity. stated formally: proposition 2a: as the prominence of a firm’s dominant logic(s) decreases, it will engage more extensively in unrelated alliance portfolio diversity proposition 2b: as the prominence of a firm’s dominant logic(s) decreases, it will engage less extensively in related alliance portfolio diversity in sectors 40 journal of business strategies that match its dominant logic(s). performance of apd. the price to create a possible real option, however, is high. indeed, unrelated alliance portfolio diversity is difficult to manage, and it is often a challenge for firms to realize any benefits from such activities (goerzen & beamish, 2005; inkpen & beamish, 1997). indeed, as firms become more diverse and introduce new businesses, there is a loss in corporate focus that leads to higher costs and higher chances of resource misallocation (goerzen & beamish, 2005). indeed, due to cognitive limits on how much new information they can handle, in dissimilar industries, managers face difficulty identifying and selecting the best partners, and monitoring partners’ actions (vasudeva & anand, 2011). in sum, managers are unlikely to make the correct changes when the firm’s dominant logic does not match a given situation (prahalad & bettis, 1986). engaging in related alliance portfolio diversity that matches the firm’s dominant logic(s), on the other hand, allows managers to apply their schemas and experiences, resulting in greater efficiency and the ability to respond quickly to environmental changes (prahalad & bettis, 1986). in the case for firms with multiple dominant logics that maintain firm diversification in multiple sectors, managers only need to update the logic that matches the industry undergoing change (c.f., prahalad & bettis, 1986). generally speaking, when firms increase the efficiency of their alliance portfolios, they realize greater performance (e.g., jiang et al., 2010; lee et al., 2017; wassmer, 2010). thus, because i expect a dominant logic(s) to reduce the complexity and difficulty of managing related alliance portfolio diversity, managers should experience greater performance when they engage in related alliance portfolio diversity that matches a prominent dominant logic. thus, i expect that related alliance portfolio diversity is more likely to be successful when it matches the firm’s dominant logic(s). stated formally: proposition 3: firms will experience greater performance as they increase related alliance portfolio diversity in a sector(s) that matches its dominant logic(s) a mismatch could occur if a dominant logic(s) is present in the top management team, and (1) the firm pursues unrelated alliance portfolio diversity, or (2) the firm pursues related alliance portfolio diversity in a sector that does not match the firm’s dominant logic(s). i propose that either scenario would be problematic because it ignores the dominant logic(s), and may lead to a lack of focus. it would volume 35, number 1 41 therefore lead to a higher likelihood that managers will make suboptimal decisions. indeed, managers often apply dominant logics to new businesses, even when the new businesses do not match the firm’s dominant logic(s) (prahalad & bettis, 1986). thus, prahalad (2004) acknowledges that a dominant logic will hinder diversity outside the sector of the logic. ultimately, goerzen and beamish (2005) suggest that such alliance portfolio diversity could harm firm performance, because the (unrelated) alliance portfolio diversity’s administrative burden, inefficient resource allocations, and possibility for errors lead to increased costs. to eventually benefit from diversity in sectors it lacks a dominant logic, the firm will need to change its dominant logic, or develop a dominant logic in the new sector (prahalad & bettis, 1986). however, it may be very difficult and costly to change a dominant logic for several reasons (prahalad, 2004). first, changing a dominant logic usually first requires some type of crisis whereby the firm’s survival is dependent on finding a new logic (prahalad & bettis, 1986). then, before strategic learning of any kind can occur, firms need to “unlearn” the old dominant logic (bettis & prahalad, 1995). through unlearning, managers purge old logics and behaviors to allow room for the new logic (bettis & prahalad, 1986). bettis and prahalad (1986) describe the process of changing a dominant logic, which involves (1) adding individuals with significantly different experiences to the top management team, (2) encouraging managers to take sabbaticals and educational experiences to enrich their experiences, (3) rehearsing for scenarios the firm may encounter in the future, (4) changing managerial evaluations so that managers are not punished for failed experiments, and (5) allowing dissent. alternatively, an organization may retain the old dominant logic and add a new one. the process of adding a new logic, however, requires a firm to develop the ability to simultaneously handle multiple logics (prahalad & bettis, 1986). thus, when managers engage related alliance portfolio diversity in sectors in which it lacks a dominant logic, they are likely to suffer in efficiency and environmental awareness as the existing logic is based on knowledge that is inappropriate for the new sector. in turn, i expect these firms will experience a decrease in firm performance. to overcome the decrease in firm performance, the firm must then change its existing logic or add a new one. stated formally: proposition 4: firms that engage in related alliance portfolio diversity in sectors it lacks a dominant logic (i.e., a mismatch) will experience decreased performance 42 journal of business strategies proposition 5: firms that engage in related alliance portfolio diversity in sectors it lacks a dominant logic (i.e., a mismatch) will develop a dominant logic in that sector. discussion this framework offers a perspective that describes why certain firms are better able to handle – and thus experience greater performance from -alliance portfolio diversity (e.g., jiang et al., 2010; lee et al., 2017). my paper is the first to distinguish related alliance portfolio diversity from unrelated alliance portfolio diversity. i propose that when managers match alliance portfolio diversity to the firm’s dominant logic(s), they will experience greater operational synergies, learning opportunities, and performance. when managers do not engage the appropriate form of alliance portfolio diversity given the firm’s dominant logic(s), performance suffers, and the firm will need to either add a new dominant logic or change the existing logic. this study has several key implications for alliance portfolio research. one, i argue that the remedy to the elusive link between alliance portfolio diversity and firm performance may be found by considering dominant logic theory. the present paper explores the idea that (1) it is important to distinguish related alliance portfolio diversity from unrelated alliance portfolio diversity, and (2) that firms with a single (multiple) dominant logic(s) are suited to engage and benefit from greater alliance portfolio diversity in the sector(s) matching the firm’s dominant logic(s). future empirical research would be useful to test the propositions put forth in this paper. in particular, qualitative research would be beneficial in that such research could more fully consider the many compromises managers face in adding alliances that do not match the firm’s dominant logic(s). alternatively, an archival based approach could be executed. an archival based approach could measure the firm’s dominant logics by coding the experiences and backgrounds of the top management team. data needed to compute related alliance portfolio diversity and unrelated alliance portfolio diversity could be created by first coding alliance announcements, then utilizing the calculation of related and unrelated firm diversification developed by palepu (1985). as lee et al. (2017) find, the specific measure of performance may influence findings. thus, future researchers should include a broad perspective of performance measures, spanning economic, innovative, and market-based performance measures. future research may also volume 35, number 1 43 consider moderators on the relationship between related alliance portfolio diversity that matches the dominant logic and performance. as lee et al. (2017) find, the type of theory used may influence the relationship. in addition, there may be other industrial and environmental moderators that may influence performance. i submit that researchers and practitioners should be able to predict the type of alliance portfolio diversity firms will engage by exploring the structure (i.e., the firm’s dominant logic[s]). practitioners are advised to consider the increased learning and synergistic opportunities created by matching alliance portfolio diversity to an existing dominant logic, and the possible signaling effect that adding a new dominant logic will create. for managers, the present paper points to the possibility that early decisions made by the firm, such as whom to include in the top management team, may impact future strategic decisions such as the optimal choice of alliance partners. the firm’s dominant logic likely affects other alliance level processes, such as alliance management capabilities, coordination across multiple alliances, and the potential to realize innovation (e.g., cui & o’connor, 2012). thus, future alliance portfolio research should control for the effect of top management team level characteristics. managers should also be advised that diversifying into new businesses where it lacks a dominant logic may lead to negative performance and the need to revise or develop an appropriate logic. consider the case of euro disney, itself formed as an alliance between disney and the kingdom holding company. in expanding to a new region, disney initially applied its dominant logic, gained from many years of experience operating disneyland in california, where alcohol was forbidden inside the theme park. disney’s dominant logic led the company to ignore the french culture, where sipping wine in boulevard spanning patios is commonplace. disney acknowledged prohibiting alcohol was a mistake, taking corrective action that allowed wine to be served in its french theme park. it spent effort learning the french culture, thereby adding a new logic. future research should consider alternative explanations for the varied relationships found between alliance portfolio diversity and performance, such as the role of the environment and transaction costs (e.g., goerzen & beamish, 2005). more attention should be given to the role of capabilities, which was previously thought of exclusively as a generalized alliance management skill that would apply to each alliance present on the portfolio (e.g., baum et al., 2000). however, dominant logic theory holds that the appropriate capability depends on the specific sector of diversity. therefore, the firm’s skill in managing alliances located in a specific industry may not necessarily transfer to other industries. future work would be useful to delineate the need for specialized versus general alliance portfolio knowledge. 44 journal of business strategies conclusion the present paper reinforces the notion that managers are more careful and purposeful about the level of alliance portfolio diversity employed. i posit that when there is a prominent dominant logic, managers will select related alliance portfolio diversity that matches the firm’s dominant logic(s), and it will perform well for doing so. when a firm lacks a prominent dominant logic, they will engage in unrelated alliance portfolio diversity. if a firm pursues related alliance portfolio diversity in a sector that does not match its dominant logic, it will experience a decrease in performance and must develop a dominant logic in the new sector. it is my hope that this paper establishes a framework to settle the on-going debate in the alliance portfolio diversity literature. future research on alliance portfolio diversity could benefit by drawing more from the firm diversification literature, where dominant logic theory was used to reconcile a similar debate. instead of searching for a blanket statement that definitively states whether alliance portfolio diversity increases or decreases firm performance, i strongly suggest that alliance portfolio researchers accept that the answer is “it depends”, and begin to identify other boundary conditions that determine when alliance portfolio diversity will improve firm performance. references bamford, j., & ernst, d. (2002). managing an alliance portfolio. the mckinsey quarterly, 3: 29-39. baum, j., calabrese, t., & silverman, b. (2000). don’t go it alone: alliance network composition and startups’ performance in canadian biotechnology. strategic management journal, 21: 267-294. bettis, r. (1981). performance differences in related and unrelated diversified firms. strategic management journal, 2:379-393. bettis, r., & prahalad, c. (1995). the dominant logic: retrospective and extension. strategic management journal, 16: 5-14. chan, s., kensinger, j., keown, a., & martin, j. (1997). do strategic alliances create value? journal of financial economics, 46: 199-221. cohen, w., & levinthal, d. (1990). absorptive capacity: a new perspective on learning and innovation. administrative science quarterly, 35:182-152. cui, a., & o’connor, g. (2012). alliance portfolio resource diversity and firm innovation. journal of marketing, 76(4), 24-43. volume 35, number 1 45 das, t., & teng, b. (2000). a resource-based theory of strategic alliances. journal of management, 26: 31. draulans, j., deman, a, & volberda, h. (2003). building alliance capability: management techniques for superior alliance performance. long range planning, 36: 151-166. dussauge, p., garrette, b., & mitchell, w. (2000). learning from competing partners: outcomes and durations of scale and link alliances in europe, north america and asia. strategic management journal, 21, 99-126. ginsberg, a. (1989). construing the business portfolio: a cognitive model of diversification. journal of management studies, 26: 417-38 goerzen, a., & beamish, p. (2005). the effect of alliance network diversity on multinational enterprise performance. strategic management journal, 26: 333-354. grant, r. (1988). on ‘dominant logic’, relatedness, and the link between diversity and performance. strategic management journal, 9: 639-642. hoffmann, w. (2005). how to manage a portfolio of alliances. long range planning, 38(2): 121-143. hoffmann, w. (2007). strategies for managing a portfolio of alliances. strategic management journal, 28: 827. inkpen a, beamish p. (1997). knowledge, bargaining power, and international joint venture stability. academy of management review 22: 177–202. jiang, r., tao, q., & santoro, m. (2010). alliance portfolio diversity and firm performance. strategic management journal, 31(10), 1136-1144. kale, p., & singh, h. (2009). managing strategic alliances: what do we know now, and where do we go from here? the academy of management perspectives, 23: 45-62. kor, y., & mesko, a. (2013). dynamic managerial capabilities: configuration and orchestration of top executives’ capabilities and the firm’s dominant logic. strategic management journal, 34(2), 233-244. lampel, j., & shamsie, j. (2000). probing the unobtrusive link: dominant logic and the design of joint ventures at general electric. strategic management journal, j., 21: 593-602 lane, p.j., & lubatkin, m. (1998). relative absorptive capacity and interorganizational learning. strategic management journal, 19:461-477. lavie, d., & miller, s. (2008). alliance portfolio internationalization and firm performance. organization science, 19: 623-646. lee, d., kirkpatrick-husk, k., & madhavan, r. (2017). diversity in alliance portfolios and performance outcomes: a meta analysis. journal of management. 46 journal of business strategies ozcan, p., & eisenhardt, k. m. (2009). origin of alliance portfolios: entrepreneurs, network strategies, and firm performance. academy of management journal, 52: 246-279. palepu, k. (1985). diversification strategy, profit performance and the entropy measure. strategic management journal, 6(3), 239-255. prahalad, c. (2004). the blinders of dominant logic. long range planning, 37:171-179. prahalad, c., & bettis, r. (1986). the dominant logic: a new linkage between diversity and performance. strategic management journal, 7: 485-506. reuer, j., park, k., & zollo, m. (2002). experiential learning in international joint ventures: the roles of experience heterogeneity and venture novelty, in f.j. contractor and p. lorange (eds.) cooperative strategies and alliances, 321344. oxford, uk: pergamon elsevier science. rumelt, r. (1974). strategy, structure and economic performance, harvard university press, cambridge, ma. tihanyi, l., ellstrand, a., daily, c., & dalton, d. (2000). composition of the top management team and firm international diversification. journal of management, 26: 1157-1177. sambharya, r. (1996). foreign experience of top management teams and international diversification strategies of us multinational corporations. strategic management journal, 17: 739-746. vassolo, r., anand, j., & folta, t. (2004). non-additivity in portfolios of exploration activities: a real optionsbased analysis of equity alliances in biotechnology. strategic management journal, 25: 1045-1061. vasudeva, g., & anand, j. (2011). unpacking absorptive capacity: a study of knowledge utilization from alliance portfolios. academy of management journal, 54, 611-623 wassmer, u. (2010). alliance portfolios: a review and research agenda. journal of management, 36: 141-171. wuyts, s., & dutta, s. (2014). benefiting from alliance portfolio diversity: the role of past internal knowledge creation strategy. journal of management, 40(6), 1653-1674. volume 35, number 1 47 biographical sketch of author dr. christopher penney is an assistant professor of management at the university of north texas in denton, tx. dr. penney earned his phd from florida state university. his research focuses on alliance portfolios, cooperative strategy, family businesses, transaction cost economics, and firm diversification. volume 32, number 2 73 generating press, bold ideas, and stubbornness: the impact of celebrity ceos shelby j. solomon louisiana state university • baton rouge, la joshua bendickson university of louisiana at lafayette • lafayette, la abstract our purpose is to investigate and discuss the impact of celebrity ceos. numerous ceos have attained celebrity status through infusion into media coverage. consequently, ceos routinely enter into american popular culture. we offer general propositions that successful ceos gain positive media coverage, and thus gain celebrity ceo status. subsequently, celebrity ceos are vulnerable to becoming rigid in their business strategy and also fixate on increasing firms’ corporate social responsibility operatives, both of which are enhanced by narcissism. under negative conditions (i.e., poor performance, bad press), celebrity ceos tend to escalate their commitment as opposed to admitting a change is necessary. keywords: celebrity ceos; media coverage; narcissism; escalating commitment introduction chief executive officer (ceo) research and theory has primarily focused on how the characteristics, values, schemas, and ownership of ceos relate to organizational outcomes (e.g., angriawan & abebe, 2011; daily & dalton, 1992; hambrick & mason, 1984; hayward & hambrick, 1997). this stream of research formally known as upper echelons theory has been successful in demonstrating how ceo attributes (e.g., personality or tenure) affect organizational strategies (e.g., chatterjee & hambrick, 2007; miller, 1991). the study of ceo attributes in relation to organizational outcomes represents a promising avenue to conceptualizing how modern media attention and the process of a ceo becoming a celebrity may affect a firm’s business strategy. furthermore, news stories about ceos have been on a steady rise in popularity within american news media (park & berger, 2004). yet throughout the course of ceo studies, researchers have neglected to offer neither a composite description of how celebrity and non-celebrity ceos may differ in business strategy nor a definitive conclusion as to what extent the firm and ceo share the benefits (or detriments) of celebrity status. moreover, relatively few studies 74 journal of business strategies of upper echelons theory investigate the effects of celebrity status on firm level outcomes (treadway, adams, ranft, & ferris, 2009). to address these gaps in the research we conducted an extensive review of the literature regarding celebrity ceos with the goal of identifying underlying themes of celebrity ceo behavior and firm strategies. as a result of our effort we are able to offer a model that better conceptualizes how the celebrity status of a ceo affects the specific strategies that are pursued by the ceo. additionally, we are able to make the general conclusion that celebrity status disparately affects both the ceo and firm level outcomes. specifically, we determine the general trend that ceos are most often positively rewarded for their celebrity status while the firms employing the celebrity ceos receive a mix of positive and negative outcomes. to understand the implications of ceo celebrity status, we first explain a ceo’s impact on the firm. this is accomplished through a brief examination of the literature regarding upper echelons theory. second, we delve into the process and antecedents of how a ceo becomes a celebrity. third, we look into the possible effects that celebrity status has on a given ceo’s strategic decision-making ability. additionally, we offer testable propositions regarding the possible outcomes of a celebrity ceo’s decisions and how they might differ from a non-celebrity ceo. finally, we identify the implications for future research, the limitations, and the conclusion. upper echelons theory a ceo, in some ways, is comparable to the captain of a ship. a ship’s captain may not actually own the ship and may not be the one in charge of selecting the ultimate destination that the ship is traveling toward. however, in the short run, a ship’s captain is in charge of how the ship makes the trip to a specified destination. this allows a captain some autonomy in exercising their judgment in choosing the best course of travel. therefore, how the ship operates on its trip to a specified destination is a direct manifestation of the captain’s decisions. although, a ceo may not be the owner of the firm and is assigned the goal of creating wealth for the shareholders, the ceo still has the ability to control the direction of the firm in the short run and is allowed to use their best judgment in determining the most suitable course. the notion that a firm will be a reflection of the firm’s dominant coalition or top management has been in existence for a long time. for example, agency theory can be viewed as largely economics based relative to upper echelons theory. a link volume 32, number 2 75 between agency theory and upper echelons theory exists because agency theory states that the manager in charge of a firm may act in a self-interested fashion, which is often detrimental to the owner of a firm (jensen & meckling, 1976; nyberg, fulmer, gerhart, & carpenter, 2010). therefore, if a manager has the ability to behave in a self-interested fashion and influence the strategy of the firm, it would appear that the strategy of the firm is directly related to the ceo’s motivations. however, agency theory only states that a ceo will act in such a way that benefits their personal motives, and typically assumes that monetary wealth creation is the driver behind all actions. it was not until nearly a decade after agency theory rose to prominence that the concepts from organizational behavior, psychology, sociology, and strategic management would be combined to form upper echelons theory (hambrick & mason, 1984). upper echelons theorists seek to go beyond the assumption of selfinterest to identify the origins of managerial motives, which makes the perspective distinct from the economics based view associated with agency theory. according to the seminal work in upper echelons theory, a firm’s strategic maneuvers are a function of managerial perceptions (hambrick & mason, 1984). using perceptions as the determinate of behavior requires that scholars must take into account the personal characteristics of the beholder, because perceptions by definition include a level of subjectivity. therefore, according to upper echelons theory, one may predict that personal characteristics, relationships, properties, and demographics such as experience, race, age, values, and education, along with bounded rationality combine to form a perception of reality which is used to make a strategic choice (hambrick, 2007; hambrick & mason, 1984). one example of how a ceo’s personal characteristics affect their behavior can be observed in a ceo’s tenure. past research has shown that across firms with long tenured ceos, there is less change in strategy than in firms with short tenured ceos (miller, 1991). furthermore, ceo impact has been supported through research, demonstrating that firms in which a ceo has recently been replaced, experience a higher degree of change in firm strategy than those firms that have not recently replaced a ceo (boeker, 1997). in the current paper we take into account the implications of upper echelons theory and propose that celebrity status can affect a ceo’s behavior. ultimately, the effects of celebrity status on a ceo will be manifested in a unique set of firm level outcomes. the effects of celebrity status on ceo and firm level performance are further discussed in the following sections and an overview of the model is provided in figure 1. 76 journal of business strategies figure 1. summary of propositions* the process of becoming a celebrity ceo the term celebrity is a commonly used but not always entirely understood by the general public, and can easily be confused with reputation by the layperson. the notion of “celebrity” is a construct that was developed outside of the management literature and originates in the field of mass communication (treadway et al., 2009). a classical definition of celebrity is: a social actor who is able to favorably capture the attention of the masses in such a grand fashion that their notoriety has the ability to be a profit generating resource (gamson, 1994; rein, kotler, & stoller, 1987). more recently celebrity has been conceptualized as, “a property of the actor’s relationship with an audience, rather than a characteristic of the actor him/her/itself” (rindova, pollock, & hayward, 2006: 52). taking this view of celebrity into account, celebrity can be seen as an intangible asset very similar to goodwill, which is often (yet not always) a positive attribute. the process from which a celebrity arises requires a certain set of antecedents (hayward, rindova, & pollock, 2004; treadway et al., 2009). for a ceo to draw the attention of popular culture and reach celebrity status, the ceo must first be successful enough to differentiate themselves from the common crowd of business professionals, and demonstrate a degree of consistent and distinct action and behavior (hayward et al., 2004; treadway et al., 2009). the combination of success and distinct personal attributes makes it possible for the ceo to be represented to the public as a unique “character” or “celebrity.” for example, steve jobs first built a successful computer company, however, he was distinct from other business professionals because he embraced his persona as a free spirit who would wear figure 1 summary of propositions* ceo narcissism commitment to csr ceo success positive press celebrity ceo ridged business strategies negative press performance decline *all relationships included within the model are theorized to be positive volume 32, number 2 77 sandals, travel to india for spiritual retreat, and even admit to experimenting with drugs. additionally, jobs demonstrated a high degree of consistent behavior through his commitment to innovation, intuitive design, and quality. furthermore, he fostered his relationship with the media through engaging in highly publicized product releases. consequently, one may observe how he became a successful businessman and how he also behaved in a fashion that showcased his unique persona, thus meeting the previously mentioned antecedents. this makes jobs a prime example of a celebrity ceo. media coverage is typically viewed as a strong correlate of one’s level of celebrity (park, kim, & sung, 2014), and this aspect is important because journalists are under social and financial pressure to publish stories that meet the public’s demands (darnton, 1975; mcquail, 1985; nimmo & sanders, 1981). however, media coverage has a unique bias which serves to further propagate a celebrity’s unique persona. media coverage is often guilty of dramatizing reality to build a story that is complete and in turn, interesting to viewers (andreassen, 1987; mccartney, 1987; rindova et al., 2006). hence, the news and media may cater to the public’s need for entertainment at the expense of their desire for information. this bias is manifested in the news coverage of ceos. the news is known to portray ceos as protagonists (or antagonists) who are similar to characters in a story that possess defining characteristics. these tendencies over emphasize the uniqueness of a given ceo, and give little attention to the more common attributes of the ceo. this bias also takes form in a second type of attribution error whereby the media credits the ceo’s unique capabilities as the cause for the organization’s success, rather than the significance of the other more ambiguous sources (hayward et al., 2004). thus, in an attempt to explain a firm’s success, the media can take a ceo, who is somewhat distinct, and portray him/her as being an extremely idiosyncratic individual who is entirely responsible for the organization’s success. this process then generates public interest in the ceo and a cycle of celebrity may be put into action. in addition to success, distinctive action, and the tendencies of the media, becoming a celebrity ceo also involves how ceos respond to the media attention. in the past, firms such as wendy’s, apple inc., martha stewart living, and chrysler have used their ceo as a spokesperson in an attempt to draw in the public’s attention. other business personalities have entered on to television shows such as shark tank, the apprentice, and undercover boss for perhaps similar reasons. the rationale for a ceo to desire celebrity status can be in part explained by the conceptualization of celebrity as a profit-generating attribute of a social actor (rindova et al., 2006). a second rationale for corporate conformity is institutional pressure (dimaggio 78 journal of business strategies & powell, 1983). due to the conceptualization of success and differentiation as the antecedents of celebrity, business professionals of modest success may want to be perceived as being successful, and therefore seek the public’s attention. the result of this isomorphic pressure pushes ceos to seek media attention and further incentivizes ceos to aim to achieve celebrity status. proposition 1a: successful ceos will attract positive attention from the media. proposition 1b: positive attention from the media will enhance ceo celebrity status. celebrity ceo status as a cage if we accept the premise that human actors are supposed to exercise rationality, then a ceo who remains ridged in her strategy and conforms to her celebrity image in the face of failure, presents an anomaly. though rindova et al. (2006) discuss celebrity as a profit generating intangible asset; there are times when a ceo will face the decision of whether or not to break character in order to seize an opportunity or to avoid a threat. at such times, the costs of character rigidity can offset the returns of celebrity. taking into account the assumption of bounded rationality, the ceo will hold character only if she believes it to be the best course of action. the aim of this section is to take a look at why a ceo might place such high trust in him/herself and value character rigidity and celebrity; even when it may not appear to be the most efficient decision. to facilitate the advancement of the celebrity ceo literature, we have also provided a thorough overview of the celebrity ceo literature as positioned relative to our research. please see table 1 for a systematic review of relevant research based on a keyword search of the discovery database. in order to conduct a thorough exploration of the literature we searched for articles that contained (in the abstract) any combination of the word ceo along with celebrity, media coverage, media attention, press coverage, press attention, or narcissism. the search yielded a list of 109 scholarly peer reviewed articles. we then combed through the results of the search for any articles that were directly related to the present manuscript. that is, we selected articles for inclusion in our literature review if the articles concerned the topic of celebrity ceos or ceo media coverage and how the celebrity status/ media coverage affected the ceo or firm. volume 32, number 2 79 ta bl e 1 r ev ie w o f f oc al l it er at ur e a ut ho r( s) , y ea r t he or et ic al l en s / r es ea rc h st re am sa m pl e c el eb ri ty v ar ia bl es / a nt ec ed en ts in te rv en in g v ar ia bl es o ut co m e( s) r es ul ts / p ro po si ti on s e ff ec ts fo r c e o e ff ec ts fo r th e f ir m pe tre nk o, ai m e, r id ge , & h ill, 2 01 5 u pp er ec he lo ns ; ag en cy th eo ry c eo s of s &p 50 0 fir m s ov er th e ye ar s 19 97 -2 01 2 c eo n ar ci ss is m c sr ; fi rm pe rfo rm an ce c eo s hi gh in n ar ci ss is m ar e lik el y to e ng ag e in hi gh p ro file c sr in o rd er to g ai n pr ai se a nd m ed ia at te nt io n. c sr w he n pe rfo rm ed b y na rc is si st c eo s is le ss li ke ly to le ad to p os iti ve fi na nc ia l ou tc om es . po si tiv e n eg at iv e pa rk , k im , & su ng , 20 14 sc ap eg oa tin g th eo ry k or ea n pu bl ic fir m e xe cu tiv es m ed ia b as ed m ea su re fi rm pe rfo rm an ce c eo a nd ex ec ut iv e di sm is sa l d ur in g tim es o f p oo r pe rfo rm an ce c el eb rit y c eo s ar e le ss li ke ly to be d is m is se d, a nd in tu rn ot he r fi rm e xe cu tiv es ar e m or e lik el y to b e di sm is se d in th ei r p la ce . po si tiv e li ke ly n eg at iv e c he n, y i, & li n, 2 01 3 c or po ra te go ve rn an ce 11 89 n on fin an ci al fi rm s lis te d on th e ta iw an s to ck ex ch an ge fi rm m ed ia co ve ra ge b y th e ta iw an ec on om ic jo ur na l c o. , lt d c eo co m pe ns at io n c eo s w ho w or k at fir m s th at re ce iv e hi gh le ve ls o f m ed ia c ov er ag e an d po si tiv e ne w s re ce iv e hi gh le ve ls o f co m pe ns at io n. po si tiv e 80 journal of business strategies b ed na r, 20 12 c or po ra te go ve rn an ce , ag en cy th eo ry 25 0 ra nd om ly se le ct ed s &p 50 0 fir m s m ed ia c ov er ag e ba se d on ar tic le s in th e fa ct iv a da ta ba se c eo d is m is sa l, c eo co m pe ns at io n, po si tiv e m ed ia a tte nt io n is li ke ly to le ad to hi gh er le ve ls o f c eo co m pe ns at io n an d jo b se cu rit y. po si tiv e si nh a, in ks on , b ar ke r, 20 12 es ca la tio n of co m m itm en t n ew z ea la nd ai rli ne c eo q ua lit at iv e st ud y w hi ch us ed d at a ob ta in ed fro m m ed ia ac co un ts o f an a cq ui si tio n in th e ai rli ne in du st ry m ed ia at te nt io n ac qu is iti on pe rfo rm an ce th e ce le br ity c eo fe ll vi ct im to h is d es ire fo r s el f j us tifi ca tio n an d es ca la te d hi s co m m itm en t t o a fa ilin g st ra te gy w hi le p re se nt in g an il lu si on o f c on tro l. n eg at iv e k oh , 2 01 1 ag en cy th eo ry an d m an ag er ia l op po rtu ni sm th eo ry 18 9 c eo s ov er th e ye ar s of 19 87 -2 00 3 h ig h pr ofi le aw ar ds g ra nt ed to th e c eo s fi rm pe rfo rm an ce ; ac co un tin g pr ac tic es c el eb rit y c eo s ar e as so ci at ed w ith co ns er va tiv e ac co un tin g pr ac tic es a nd le ss o fte n en ga ge in o pp or tu ni st ic ea rn in g m an ag em en t sc he m es to m ee t sh or tte rm g oa ls . f irm s op er at ed b y ce le br ity c eo s of fe r h ig h le ve ls o f lo ng -t er m p er fo rm an ce af te r t he c eo w in s th ei r in iti al h ig h pr ofi le a w ar d. po si tiv e volume 32, number 2 81 tr ea dw ay , ad am s, r an ft, fe rri s, 2 00 9 le ad er sh ip th eo ry de ve lo pm en t pi ec e m ed ia a tte nt io n po lit ic al s ki ll pe rc ep tio ns o f au th en tic ity ; f irm pe rfo rm an ce ; c eo re pu ta tio n; c eo co m pe ns at io n c el eb rit y c eo s w ho ar e po lit ic al ly s ki lle d sh ou ld re ce iv e po si tiv e at tri bu tio ns o f a ut he nt ic ity fro m s ta ke ho ld er s, w hi ch sh ou ld th en le ad to gr ea te r fi rm p er fo rm an ce , c eo re pu ta tio n, a nd co m pe ns at io n. c or e, g ua y, & la rc ke r, 20 08 ag en cy th eo ry 31 26 c eo s lis te d on ex ec uc om p ov er th e ye ar s 19 93 to 2 00 1 m ed ia c ov er ag e n eg at iv e m ed ia co ve ra ge a s a re sp on se to e xc es s co m pe ns at io n; ch an ge in c eo co m pe ns at io n; c eo tu rn ov er ; op tio n ex er ci se s de cl in e c eo s w ho re ce iv e ex ce ss p ay o r h av e la rg e op tio n ex er ci se s at tra ct n eg at iv e m ed ia at te nt io n. h ow ev er , ne ga tiv e m ed ia a tte nt io n do es n ot a pp ea r t o af fe ct c eo c om pe ns at io n or tu rn ov er . n eu tra l g at es , r ec ke rs , & r ob in so n, 20 09 so ur ce cr ed ib ilit y th eo ry ; at tri bu tio n th eo ry ex pe rim en ta l st ud y th at in vo lv ed 2 45 pr ac tic in g au di to rs a s pa rti ci pa nt s m an ip ul at ed m ed ia a tte nt io n au di to r pe rc ep tio ns of c or po ra te et hi cs ; a ud ito r pe rc ep tio ns of fi na nc ia l st at em en t f ra ud ris k au di to rs ju dg ed fi rm s ru n by c eo s th at re ce iv e po si tiv e m ed ia a tte nt io n as h av in g a lo w er le ve l o f fin an ci al s ta te m en t f ra ud ris k an d hi gh le ve ls o f co rp or at e et hi cs . po si tiv e 82 journal of business strategies w ad e, po ra c, po llo ck , & g af fin , 20 08 ex pl or at or y st ud y c eo s of 2 82 s& p 50 0 fir m s w in ne rs o f th e fi na nc ia l w or ld ’s c eo of th e ye ar co nt es t fi rm pe rfo rm an ce st oc k m ar ke t ev al ua tio ns ; ac co un tin g pr ac tic es ; c eo co m pe ns at io n u po n w in ni ng th e c eo of th e ye ar c on te st a nd ac hi ev in g ce le br ity s ta tu s th e st oc k m ar ke t w ou ld po si tiv el y ev al ua te th e fir m . h ow ev er , a fte r 24 0 da ys s to ck m ar ke t ev al ua tio ns d ec re as e by 8 .2 3% o n av er ag e. c el eb rit y c eo s do n ot di ffe r f ro m n on -c el eb rit y c eo s in re ga rd to ac co un tin g pr ac tic es . c el eb rit y c eo s en jo y an in iti al p ay in cr ea se u po n ac hi ev in g ce le br ity s ta tu s, bu t w er e m or e ha rs hl y pe na liz ed w he n fir m pe rfo rm an ce w as p oo r. po si tiv e (s ho rt te rm ) po si tiv e (s ho rt te rm ) volume 32, number 2 83 r an ft, zi nk o, fe rri s, & b uc kl ey , 20 06 r ep ut at io n an d im pr es si on m an ag em en t li te ra tu re re vi ew /th eo ry pi ec e m ed ia at te nt io n; 2 ce le br ity pa ra di gm s (1 ) pe op le a ch ie ve ce le br ity s ta tu s be ca us e th ey ar e gi fte d an d th ey re ce iv e ju st ifia bl e cr ed it (2 ) t he m ed ia gi ve s at te nt io n to p eo pl e of a ll ty pe s eq ua lly an d so m et im es cr ed it is g iv en to th os e w ho do n ot de se rv e it. co m pe ns at io n; c eo p ow er / au to no m y; sc ru tin y b en efi ts o f c el eb rit y c eo s: c el eb rit y c eo s ca n be a ss oc ia te d w ith in cr ea se d le ve ls of c om pe ns at io n, a nd gr ea te r p ow er /a ut on om y. o rg an iz at io ns th at em pl oy c el eb rit y c eo s ar e of te n as so ci at ed w ith p os iti ve m ar ke t ev al ua tio ns a nd c an u se th e c eo ’s c el eb rit y st at us to in fo rm th e pu bl ic th at th e fir m is m ov in g in a n ew d ire ct io n. c os ts o f c el eb rit y c eo s: c el eb rit y c eo s du rin g po or p er fo rm an ce m ak e fo r h ig hl y vi si bl e sc ap eg oa ts . c el eb rit y c eo s m ay b e re st ric te d in th ei r a ct io ns , a s pr ef or m in g ou t o f r ol e co ul d di m in is h th ei r st at us . c el eb rit y c eo s an d th ei r e m pl oy in g fir m s ar e as so ci at ed w ith gr ea te r l ev el s of s cr ut in y. 84 journal of business strategies h ay w ar d, r in do va , & po llo ck , 20 04 at tri bu tio n th eo ry th eo ry de ve lo pm en t pi ec e c on si st en t or d is tin ct iv e ac tio ns a cr os s m ul tip le or ga ni za tio ns is lik el y to a ttr ac t c eo m ed ia at te nt io n. w he n th e m ed ia b eg in s to a ttr ib ut e fir m ac tio ns a nd pe rfo rm an ce to th e c eo s vo lit io n th e c eo w ill be co m e a ce le br ity c eo a nd st ak eh ol de r pe rc ep tio ns o f th e ce le br ity c eo ’s c on tro l ov er th e fir m h ub ris ; e sc al at io n of c om m itm en t w he n c eo s ga in a ce le br ity s ta tu s th ey a re lik el y to p er ce iv e th at th ey a re in c on tro l o f t he fir m a nd th e m or e lik el y st ak eh ol de rs a re to g ra nt th em c on tro l. c eo s th en fe el p re ss ur ed to b eh av e co ns is te nt ly in o rd er to co nt in ue to re ce iv e th e po si tiv e ev al ua tio ns . pa rk & b er ge r, 20 04 ex pl or at or y st ud y n ew s co ve ra ge of c eo s in fo ur le ad in g ne w s pa pe rs ov er th e ye ar s 19 90 -2 00 0. m ed ia c ov er ag e in th e h us to n c hr on ic le , n ew yo rk t im es , u sa t od ay , w al l s tre et jo ur na l. n um be r o f n ew s st or ie s re po rte d; th e to ne o f t he ne w s st or ie s (p os iti ve v s. ne ga tiv e) th e nu m be r o f s to rie s ab ou t c eo s in th e ne w s ha s ris en o ve r t im e an d c eo s ar e m os t o fte n pr es en te d in a p os iti ve lig ht . t he m os t c ov er ed ne w s to pi c re ga rd in g c eo s is s to rie s of c eo s ch an gi ng fi rm s. f in al ly, st or ie s ab ou t c eo s in th e ne w s ha ve b ec om e in cr ea si ng ly le ss c rit ic al ov er ti m e. n a n a volume 32, number 2 85 the hot hand fallacy ceos may be separated from the general public by a wide economic and business status margin. however, ceos are still humans and like other humans, they are vulnerable to the same fallacies and pitfalls of their needs and cognitive abilities. first, consider the antecedents of celebrity status which are success and the level of consistent uniqueness that differentiates the celebrity ceo from the general population of ceos (hayward et al., 2004; treadway et al., 2009). consequently, ceos reaching celebrity status are often known for particular characteristics or strategies that can be partially attributed to their success. it has long been an assumption of human nature that people have a desire to find the causes of different outcomes (heider, 1958). in the case of celebrity ceos, the media reinforces the relationship between the ceo’s idiosyncratic personal traits and their success, by dramatizing the reality of the situation to increase public interest in the topic (andreassen, 1987; mccartney, 1987; rindova et al., 2006). additionally, previous laboratory studies have been conducted to investigate the bias of success being most frequently attributed to leaders. a classic laboratory study of attributional bias involved a sample of undergraduates who were asked to read an unbiased vignette which described an organization and its performance (meindl, ehrlich, & dukerich, 1985). the findings of the study supported the hypothesis that people have a bias toward attributing the performance of an organization to that organization’s leader. meindl et al. (1985) theorize that this phenomenon is a cultural preference. therefore, we as a culture tend to favor the dramatic story of a heroic leader, rather than a complex interaction of people and inputs when determining the causes of success. the increased level of success experienced by a ceo, compounded by the positive press, can have negative effects on a ceo’s future performance. the negative effects can come in the form of hubris traps and pitfalls as a result of one’s inflated ego. gilovich and colleagues’ past research has demonstrated one example of a hubris trap called the “hot hand effect” (gilovich, vallone, & tversky, 1895; tversky & gilovich, 1989). the hot hand effect is a term popularly used by athletes and sports fans to describe a performance streak. according to the premise of the hot hand effect, one is more likely to achieve a successful outcome, such as making a basket while playing basketball, if they had previously made several baskets in a row. to examine this phenomenon, gilovich et al. (1985) studied both the performance of a professional basketball team and the attitude of the players and fans toward the hot hand effect. they found that both the players and fans believed that the hot hand effect was true and that players who made several baskets in a row were more h ay w ar d, r in do va , & po llo ck , 20 04 at tri bu tio n th eo ry th eo ry de ve lo pm en t pi ec e c on si st en t or d is tin ct iv e ac tio ns a cr os s m ul tip le or ga ni za tio ns is lik el y to a ttr ac t c eo m ed ia at te nt io n. w he n th e m ed ia b eg in s to a ttr ib ut e fir m ac tio ns a nd pe rfo rm an ce to th e c eo s vo lit io n th e c eo w ill be co m e a ce le br ity c eo a nd st ak eh ol de r pe rc ep tio ns o f th e ce le br ity c eo ’s c on tro l ov er th e fir m h ub ris ; e sc al at io n of c om m itm en t w he n c eo s ga in a ce le br ity s ta tu s th ey a re lik el y to p er ce iv e th at th ey a re in c on tro l o f t he fir m a nd th e m or e lik el y st ak eh ol de rs a re to g ra nt th em c on tro l. c eo s th en fe el p re ss ur ed to b eh av e co ns is te nt ly in o rd er to co nt in ue to re ce iv e th e po si tiv e ev al ua tio ns . pa rk & b er ge r, 20 04 ex pl or at or y st ud y n ew s co ve ra ge of c eo s in fo ur le ad in g ne w s pa pe rs ov er th e ye ar s 19 90 -2 00 0. m ed ia c ov er ag e in th e h us to n c hr on ic le , n ew yo rk t im es , u sa t od ay , w al l s tre et jo ur na l. n um be r o f n ew s st or ie s re po rte d; th e to ne o f t he ne w s st or ie s (p os iti ve v s. ne ga tiv e) th e nu m be r o f s to rie s ab ou t c eo s in th e ne w s ha s ris en o ve r t im e an d c eo s ar e m os t o fte n pr es en te d in a p os iti ve lig ht . t he m os t c ov er ed ne w s to pi c re ga rd in g c eo s is s to rie s of c eo s ch an gi ng fi rm s. f in al ly, st or ie s ab ou t c eo s in th e ne w s ha ve b ec om e in cr ea si ng ly le ss c rit ic al ov er ti m e. n a n a 86 journal of business strategies likely to make subsequent shots. however, the performance results did not provide any supporting evidence for the hot hand effect. hence, a streak of success does not necessarily breed future success, but can lead one to have an inflated view of their self-efficacy or ability to successfully engage in a particular task. the competency trap, known as the “hot hand effect,” represents a pattern of behavior where initial success inhibits an individual from making adaptive strategic decisions. this idea is replicated in both the organizational learning literature and in the upper echelons literature regarding ceo tenure (levitt & march, 1988; march, 1991: miller, 1991). in organizational learning researchers have commonly asserted that a string of successes can lead individuals (within a firm) to stop engaging in experimentation and become rigid to a set of processes. the result of the rigidity associated with success is ultimately expected to lead to organizational decline, as the firm will not have gained the necessary knowledge by undergoing the experimentation needed to adapt to environmental change. within the literature regarding upper echelons, miller (1991) found that ceos typically start out employing a broad range of strategies, but over time restrict themselves to those strategies that have been successful in the past. the “hot hand effect” could be interpreted and generalized, regarding ceos and basketball players alike, in the business environment as: leading people to believe that their success is unlikely to fluctuate in the short term (gilovich et al., 1985). similar to tossing a coin or spinning a roulette wheel, there is a chance that one will experience a duration in which he/she correctly selects the outcome on numerous consecutive occurrences. however, each of these outcomes is an independent event and it is only by chance they have fallen in a row. in the context of a celebrity ceo, they have likely achieved celebrity status by riding a string of successes to the top and have captured the public’s attention. the ceo’s streak of success is then likely to be further exaggerated by the press’ attribution of firm success to the ceo (andreassen, 1987; mccartney, 1987; meindl et al., 1985; rindova et al., 2006). this scenario can set a ceo up to believe they possess the “hot hand.” therefore, the ceo may become involved in an increased number of subsequent endeavors, because their ego has become inflated by a combination of the previous success streak and the public’s attention crediting the success of the organization to the celebrity ceo. conversely, the subsequent endeavors are likely to be even more failure prone than the previous endeavors, because the general public and press may falsely attribute the success to the actions taken by the ceo and therefore fostering hubris. unlike in the hot hand effect study, where the players who made the basket received the credit, the cause of success and attribution of credit may be decoupled in a firm volume 32, number 2 87 setting (gilovich et al., 1985). the likelihood of decoupling the events leading up to the success and the attribution of credit for the success will be magnified if the ceo is a celebrity. the decoupling will occur because the celebrity ceo will attract the attention of the media, which has a bias to dramatize events in a simplistic fashion that typically romanticizes the ceo as the hero so that the public’s demands are met. therefore, once a ceo becomes a celebrity they may falsely receive positive feedback. that is, a firm’s success clearly cannot all be attributed to the ceo, yet the ceo is the one who is most likely to receive the credit. a situation where the cause and credit for success are decoupled may lead a ceo whose actual success rate is in a slow decline, to believe that he/she is on a hot streak and should engage in more endeavors. the subsequent undertakings will now be a function of the ceo’s declining success rate and will be less likely to succeed, than activities initiated by the more successful departments of the firm. moreover, the celebrity ceo similar to the basketball player will continue to use the same technique which resulted in their initial success, but they will now be emboldened to employ it more liberally and with greater confidence. for the celebrity ceo, this may result in a myopic strategy that misses possible opportunities and is vulnerable to environmental shifts. an additional laboratory study related to the hot hand effect was that of hilary and menzly (2006), which found that analysts who had a streak of successful investments were more likely to become overconfident in their abilities. the overconfidence was found to be a temporary phenomenon and its duration was a factor of the level of success and the length of the streak. when the findings of hilary and menzly’s (2006) study are applied to the ceo position of a firm, the risk of overconfidence becomes multiplied. this overconfidence or hubris will result because the celebrity ceo is given credit for great success even when their inputs may have been modest, so long as the firm is successful as a whole (andreassen, 1987; mccartney, 1987; meindl et al., 1985; rindova et al., 2006). moreover, combining the implications from the previous hot hand studies with studies which indicate that hubris and overconfidence lead to paying higher acquisition premiums (hayward & hambrick, 1997), we conclude that ceos who engaged in the overpriced acquisitions likely did so because they were successful in previous acquisitions and now have subscribed to a static strategy based on a previous success streak. a stream of literature that is related to the hot hand effect is that of escalation of commitment. the research on escalation of commitment offers a convergent set of predictions in describing how a celebrity ceo can become locked into a rigid course of action (staw, 1981). escalation of commitment refers to situations where individuals face adversity and instead of yielding to the adversity at a certain point 88 journal of business strategies to cut their losses, they expend more resources in an attempt to conquer the obstacle. furthermore, prior research indicates that people are likely to filter out some of the criticism when making wrong decisions (salancik & kiesler, 1971). therefore, individuals may construe feedback in such a way that they do not see the full costs of their actions. zajac and bazerman (1991) theorize that overconfidence can leave one vulnerable to the competency trap of escalation of commitment. if one is feeling overconfident or arrogant, then one will be biased toward seeing fair possibilities of success, even in situations that are most likely to produce a treacherous outcome. this mental state makes the hubristic decision maker particularly vulnerable to competency traps such as escalation of commitment or the hot hand effect. in the business world, a ceo may display vulnerability to competency traps by insisting a firm remains loyal to a failing strategy. therefore we propose the following: proposition 2: as ceos gain more celebrity status, the more ridged they will become with their business strategy. social pressures the previous section of this paper discussed why a celebrity ceo might employ a static business strategy. the rationale for this inefficient behavior was based on the ceo’s perceived level of competency. the following section of the paper examines social pressures that are likely to persuade a ceo to become strategically static. ceos are in a position of high visibility, because they are at the helm of the firm and in charge many aspects of a firm’s decision making. being in a position of high visibility is likely to lead ceos to monitor and manage their impression. previous research states that, “publicity affects impression motivation because public behaviors are more likely to be relevant to the accomplishment of one’s goals than are private behaviors” (leary & kowalski, 2009: 38). therefore, as a ceo begins to attract more attention from the media, he/she will become increasingly motivated to manage impressions in order to achieve one’s goals (e.g., avoiding public scrutiny). relatedly, prior research demonstrated that when people noticed they were being watched by a security camera, they were more likely to engage in helping behaviors (van rompay, vonk, & fransen, 2009). the findings from the van rompay et al. (2009) study demonstrates that when a person is in a position of visibility, they are more likely to engage in socially acceptable behaviors for reasons of impression management. the impression management construct can be translated to the corporate level. accordingly, if ceos ascend to the ranks of celebrity status, then they will be volume 32, number 2 89 aware that the media is watching. once ceos are aware of their level of publicity, they are more likely to engage in socially acceptable behaviors in an attempt to manage their impression. at this point, the celebrity ceo will have a difficult time engaging in acts which may be efficient but socially undesirable. therefore, the result of the publicity will put the ceo in a position where some courses of action will no longer be an option. additionally, the publicity will require a firm to take a relatively static stance on other socially approved actions. mcguire (1963) discusses how the actions of a firm and an individual are similar to one another; that as part of a ceo’s duty to a firm, he/she must behave in a way that is respectful to society. hence, one measurable outlet of socially approved actions that a ceo may take is to engage in acts of corporate social responsibility. for example, a firm run by a relatively unknown ceo would be less likely to engage in corporate social responsibility behaviors because she would not experience the same degree of exposure and perceived social pressure as a result of press coverage (as would a firm run by a celebrity ceo). accordingly, we develop the following proposition. proposition 3: as ceos gain more celebrity status, the more committed they will become with regard to corporate social responsibility. narcissism another issue that can lead ceos to overconfidence and strict adherence to their strategy involves dimensions of a ceo’s personality. narcissism is a trait characterized by an inflated image of one’s self, self-love, and a desire for recognition (kernberg, 1989). narcissists are understood to be undesirable to work with and arrogant (buffardi & campbell, 2008; o’boyle, forsyth, banks, & mcdaniel, 2012). additionally, narcissists are known to have a belief that they are the only one whom they can rely on and believe that their ideas and needs are superior to all others. therefore, narcissists have a self-centered outlook in which they do not behave in the best interest of the group, but rather are most interested in acting in accordance with their goals and desires (kets de vries & miller, 1985). a ceo who is high in narcissism will then be characterized by a disregard for the input of others and an adherence toward their strategies exclusively. this will serve to bind the ceo to a limited number of strategies based on their ingenuity and will not allow the ceo to use the advice of others to create a truly dynamic strategy. though the verdict is unclear as to whether or not narcissism is a more commonly displayed trait in ceos rather than in the general population (chatterjee & hambrick, 2007), narcissism is applicable to the topic of celebrity ceos. 90 journal of business strategies past research found that a defining attribute of the narcissistic ceo is that they prefer dramatic strategic decisions that offer the possibility of high returns as opposed to a more intermediate route (chatterjee & hambrick, 2007). these strategies are designed to capture the attention of the business community and public, so that the narcissist may obtain desired time in the spotlight. these risky strategies are likely to be successful on occasion, at which point the narcissistic ceo will succeed in receiving attention from the business community and perhaps even the media. in addition to preferring bold strategies, the narcissistic ceo has also been found to engage in high profile corporate social responsibility (csr) activities at a higher rate than other ceos (petrenk, amie, ridge, & hill, 2015). the narcissistic ceo is likely to engage in csr in order to capture the attention of the media and public as opposed to more genuine motives associated with creating social welfare. hence, a strong commitment to csr and other highly visible displays of ethics may also be a tactic used by the narcissistic ceo to gain the positive attention that they desire. once in the public spotlight a narcissistic ceo is likely to be better able to maintain a prominent position in media coverage because of the strong self-promotion characteristic of a narcissistic personality (buffardi & campbell, 2008). as discussed previously, the antecedents of celebrity status are both success and uniqueness. therefore a self-promoting, narcissistic ceo who has recently experienced success through the use of a risky and audacious strategy and/or is known for highly visible displays of csr, will be in a position to achieve greater celebrity status. additionally, one can expect the process of operant conditioning or the notion that organisms will repeat behaviors which previously produced a desired outcome, will have an effect on the future behavior of the narcissistic ceo. if the ceo is able to achieve celebrity status through a combination of recognition, for the use of a daring business strategy and self-promotion, then it becomes possible for a static pattern of behavior to occur. in accordance to the theory of operant conditioning, once a narcissistic ceo has been able to successfully gain and maintain the attention of the press, it is expected that the ceo will continue to use such bold strategies. this will result in the newly created celebrity/narcissistic ceo learning that the use of bold strategies is a viable action for achieving access to fame and praise (ferster & skinner, 1957). in addition to providing the ceo with desired levels of media attention, ceos are financially incentivized to continually generate positive media attention as positive media attention is often linked to desirable ceo outcomes, such as increased job security and greater compensation (bendar, 2012; chen, yi, lin, 2013; park et al., 2014). hence, one may rationalize that positive media attention can help the ceo to gain notoriety in the external job market and allow the ceo volume 32, number 2 91 to have a powerful bargaining position during talks of compensation. the ceo can also take advantage of favorable attribution errors and hold the other executives accountable for mistakes. therefore, a narcissistic/celebrity ceo will most likely employ strategies that play to the media, as such strategies are more likely to satisfy the ceo’s need for attention and monetary rewards more effectively than dynamic strategies that focus strictly on helping the firm and producing reliable market gains. hence, the following propositions are offered. proposition 4a: narcissism will positively moderate the relationship between ceo celebrity status and ridged business strategies proposition 4b: narcissism will positively moderate the relationship between ceo celebrity status and the commitment to corporate social responsibly. celebrity ceo reactions to negative performance and negative press in addition to our theoretical model, we also weigh in on ceo reactions to negative outcomes. as noted previously, ceos are in a position of both leadership and visibility in regards to the firm they serve. moreover, ceo’s actions are subject to their attitudes and characteristics as described in upper echelons theory (hambrick, 1984). therefore, a reasonable conclusion is that ceos will follow the same set of norms that are subscribed to by other leaders. additionally, celebrity ceos will be even more visible than the average ceo, and will be subject to perform a higher degree of impression management than non-celebrity ceos who are in a position of less visibility (van rompay et al., 2009). in addition to avoiding public scrutiny for behaving in a socially undesirable fashion, there is also a degree to which leaders are expected to make correct decisions. the social pressure to succeed, though very different from the over confidence syndrome mentioned earlier, can lead to a similar process of an escalation of commitment with a focus on external justification (fox & staw, 1979; staw, 1981; staw & ross, 1980). moreover, this cycle has been supported in a laboratory setting demonstrating that when one is under pressure to succeed and/or dispute critics, they are most likely to increase their commitment to a particular course of action (fox & staw, 1979). a second laboratory study by staw and ross (1980) found that followers have a desire for their leader to behave in a consistent manner when confronted with adversity. this desire for leader consistency was demonstrated by asking study participants to evaluate the leadership skills of hypothetical administrators. the study included conditions that varied the administrator’s behaviors based on 92 journal of business strategies the use of either experimental or consistent strategies that led the administrator to either success or failure. the results of this study demonstrated that administrators receiving the highest ratings are those that employ a consistent strategy and are also successful (staw & ross, 1980). a prominent rationale explaining why followers prefer leaders who behave consistently to achieve success is that the consistency demonstrates a leader’s fortitude, granting them a heroic persona (staw, 1981; staw & ross, 1980). at the ceo level, the externally focused escalation of commitment framework is likely to have effects similar to the overconfidence based escalation of commitment (staw, 1976; staw, 1980). however, the externally focused escalation of commitment scenario is expected to be brought on by a different circumstance. while previous success and praise is often the driver of escalation of commitment in the overconfidence scenario, poor performance and negative press favor association with the externally focused escalation of commitment scenario (fox & staw, 1979; hayward & hambrick, 1997; staw, 1981). therefore, we expect that when celebrity ceos are facing either public scrutiny or a decline in demand, they will become more inflexible and resistant to change with the hope that the situation will turn around so they can be vindicated in demonstrating their leadership skills. therefore, the final propositions suggest: proposition 5a: when a celebrity ceo’s firm experiences a decline in performance, the ceo will become more rigid with their business strategy. proposition 5b: when a celebrity ceo faces negative press regarding their current strategy, the ceo will become more rigid with their business strategy. discussion by drawing on upper echelons theory, personality, and organizational literatures we begin to unpack antecedents and outcomes of celebrity ceo status. it is important for researchers and practitioners alike to better understand the constructs and phenomenon that impact ceo behavior and what results stem from this behavior, at the executive and organizational levels. by conducting an in depth review of the literature regarding how the celebrity status of the ceo affects both the business executive and the organization, we were able to identify a trend in the pattern of benefits associated with celebrity status. specifically, we found that ceos are most often the primary beneficiary of their celebrity status, while organizations do not receive the same level of rewards and sometimes face negative consequences as a result of ceos’ celebrity status. the positive organizational level outcomes volume 32, number 2 93 associated with ceo celebrity were also most often based on positive evaluations of the firm’s accounting integrity rather than any direct link to financial performance (e.g., gates, reckers, & robinson, 2008; koh, 2011). alternatively, the positive outcomes attributed to ceos often led to desirable financial rewards for ceos (e.g., bender, 2012; park et al., 2013). hence, even when the effects of ceo celebrity status benefit both the organization and ceo, one may rationalize that the executive receives a greater reward than the organization. in addition to offering a review of the literature, we also further build theory around the effects and processes of ceo celebrity status by offering a theoretical model of how the ceo celebrity can lead to inertial organizational outcomes. we address how media press and public praise for successful ceos is likely to lead the ceo toward celebrity status. the results of this media coverage impacts ceos and organizations such that ceos will likely be interested in gaining more celebrity status and prestige; and organizations will be pressured to support the ideas of celebrity ceos. additionally, we contribute to the upper echelons theory literature by integrating both micro and macro levels of management as advocated by hambrick (2007). in doing so we address how celebrity ceo status is affected by the presence of individual level traits (e.g., narcissism) yet we also examine differences between celebrity and non-celebrity ceos at the firm level in regards to the firm’s strategy (i.e., competency traps). moreover, our theoretical model is reflective of the general trend of asymmetric executive and organizational rewards in celebrity ceo research, as we describe how a ceo may reach celebrity status and then fall victim to competency traps that are harmful to firm performance. thus, a ceo should most often be drawn toward increasing their celebrity status as by definition it relates to an array of positive personal outcomes. these positive executive level outcomes however may not always transfer over to the organization and at times can be harmful, as we have outlined in our manuscript. limitations and future research while the scope of our paper is restricted to the effects of the ceo on firm inertia, we believe that studying ceo behavior is important to understanding relevant organizational outcomes (hambrick, 2007). moreover, we are limited by a lack of empirical testing, each of the propositions previously mentioned are theoretically derived and can be empirically tested. while some variables such as corporate social responsibility can easily be found in the databases such as the one provided by kld research and analytics, other variables will require a degree of 94 journal of business strategies ingenuity to measure. a future study might look into the number of times a particular ceo is mentioned in the media as a proxy for ceo celebrity. another possible measure of ceo celebrity would be to calculate a ceo’s amount of airtime received on television, radio, and the average length of text dedicated to them in any form of print media. of course, for either of these proxy measurements of celebrity status, it would be necessary for one to take into account how well the media is disseminated across the public. this would be necessary because the construct of celebrity requires a two-way relationship where a social actor is able to capture the interest of the public. therefore, if a ceo was on a small time television program that had less than ten viewers but aired for 3 hours every night, the ceo would not rank highly as a celebrity due to their limited appeal to the public (gamson, 1994; rein et al., 1987). next, narcissism can be assessed in a number of different ways. direct measures of narcissism include surveys such as the npi-16 (ames & anderson, 2006). narcissism can be assessed through more unobtrusive measures as performed by chatterjee & hambrick (2007). the noninvasive measure of narcissism used by chatterjee & hambrick (2007) involved examining how prominent the ceo made themselves in the firm. for example, one may measure prominence in company media, relative pay discrepancies, and even the use of singular pronouns used during interviews. a critical benefit of the unobtrusive measure is that it can be applied to past ceos, provided the researcher(s) has access to archival firm media. finally, in regards to financial data, many proxies exist (e.g., stock price, market capitalization, and return on assets). in manipulating the variable of decreasing demand one may identify demand shocks in the economy such as the great financial crisis of 2008. one may then longitudinally investigate if the experimental celebrity or celebrity/narcissist group performs poorly as a function of their rigid strategies when compared to a control group of non-celebrity ceos. additionally, the use of financial performance before and after recessions as a dependent variable could be used to investigate whether or not firms run by celebrity ceos would be more likely to continue to invest in csr activities in the face of economic down turn as compared to non-celebrity ceos. the method of using recession years as a dependent variable would allow researchers to measure firm dynamism and investigate the moderating effect of celebrity ceos. volume 32, number 2 95 conclusion while celebrity status in and of itself is considered a profit-generating attribute of a given social actor; this paper proposes several scenarios where this property can lead to firm level inertia (gamson, 1994; rein et al., 1987; rindova et al., 2006). in the modern business era, firms are pushed to embrace the absorption of skills and to remain strategically dynamic as to maintain a competitive advantage (barreto, 2010; cohen & leventhal, 1990; zahra & george, 2002). therefore, we conclude that although celebrity status often generates profit, the cost of firm inertia is likely to offset the celebrity associated profits particularly during times when a change in strategy is needed, such as a recession. this paper was developed as a form of guidance to aide future researchers in testing the previously mentioned propositions. if a link is established between celebrity status and ceo inertia, it would challenge the validity of the age old phase stating that “all press is good press.” references angriawan, a., & abebe, m. (2011). chief executive background characteristics and environmental scanning emphasis: an empirical investigation. journal of business strategies 28(1), 75-96. ames, d. r., rose, p., & anderson, c. p. (2006). the npi-16 as a short measure of narcissism. journal of research in personality, 40, 440-450. andreassen, p. b. (1987). on the social psychology of the stock market: aggregate attributional effects and the regressiveness of prediction. journal of personality and social psychology, 53, 490-496. bednar, m. k. (2012). watchdog or lapdog? a behavioral view of the media as a corporate governance mechanism. academy of management journal, 55, 131150. buffardi, l. e., & campbell, w. k. (2008). narcissism and social net-working web sites. personality and social psychology bulletin, 34, 1303–1314. boeker, w. (1997). strategic change: the influence of managerial characteristics and organizational growth. academy of management journal, 40, 152-170. chatterjee, a., & hambrick, d. c. (2007). it’s all about me: narcissistic chief executive officers and their effects on company strategy and performance. administrative science quarterly, 52, 351-386. chen, c. w., yi, b., & lin, j. b. (2013). media coverage, board structure and ceo compensation: evidence from taiwan. journal of multinational financial management, 23, 434-445. 96 journal of business strategies cohen, w. m., & levinthal, d. a. (1990). absorptive capacity: a new perspective on learning and innovation. administrative science quarterly, 128-152. core, j. e., guay, w., & larcker, d. f. (2008). the power of the pen and executive compensation. journal of financial economics, 88(1), 1-25. daily, c. m., & dalton, d.r. (1992). officer and director stock ownership and firm performance in the publicly trade small corporation. journal of business strategies, 9(2), 101-113. darnton, r. (1975). writing news and telling stories. daedalus, 104, 175-194. dimaggio, p. & powell, w. (1983). “the iron cage revisited: institutional isophomorphism and collective rationality in organizational fields.” american sociological review, 48, 147-160. gamson, j. (1994). claims to fame: celebrity in contemporary america. berkeley and los angeles: university of california press. ferster, c. b., and skinner, b. f. (1957). schedules of reinforcement. new york: appleton-century-crofts. fox, f. v., & staw, b. m. (1979). the trapped administrator: effects of job insecurity and policy resistance upon commitment to a course of action. administrative science quarterly, 449-471. gates, s., reckers, p., & robinson, d. (2009). media image of the ceo and the impact on auditors’ perception of financial reporting reliability and client risk assessments. advances in accounting, 25(2), 156-164. gilovich, t., vallone, r., & tversky, a. (1985). the hot hand in basketball: on the misperception of random sequences. cognitive psychology, 17, 295-314. hambrick, d. c. (2007). upper echelons theory: an update. academy of management review, 32, 334-343. hambrick, d. c., & mason, p. a. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review, 9, 193-206. hayward, m. l., rindova, v. p., & pollock, t. g. (2004). believing one’s own press: the causes and consequences of ceo celebrity. strategic management journal, 25, 637-653. hayward, m. l., & hambrick, d. c. (1997). explaining the premiums paid for large acquisitions: evidence of ceo hubris. administrative science quarterly, 103127. heider, f. (1958). the psychology of interpersonal relations. new york: wiley. hilary, g., & menzly, l. (2006). does past success lead analysts to become overconfident?. management science, 52, 489-500. volume 32, number 2 97 koh, k. (2011). value or glamour? an empirical investigation of the effect of celebrity ceos on financial reporting practices and firm performance. accounting & finance, 51, 517-547. kernberg, o. f. (1989). the narcissistic personality disorder and the differential diagnosis of antisocial behavior. psychiatric clinics of north america, 12, 553– 570. jensen, m. c., & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3, 305360. leary, m. r., & kowalski, r. m. (1990). impression management: a literature review and two-component model. psychological bulletin, 107, 34-47. levitt, b., & march, j. g. (1988). organizational learning. annual review of sociology, 319-340. march, j. g. (1991), “exploration and exploitation in organizational learning,” organizational science, 2, 71-87. mccartney, h. p. (1987). applying fiction conflict situations to analysis of news stories. journalism & mass communication quarterly, 64, 163-170. mcguire, j. w. (1963). business and society. new york: mcgraw-hill. mcquail, d. (1985). sociology of mass communication. annual review of sociology, 93-111. meindl, j. r., ehrlich, s. b., & dukerich, j. m. (1985). the romance of leadership. administrative science quarterly, 78-102. miller, d. (1991). stale in the saddle: ceo tenure and the match between organization and environment. management science, 37, 34-52. nyberg, a. j., fulmer, i. s., gerhart, b., & carpenter, m. a. (2010). agency theory revisited: ceo return and shareholder interest alignment. academy of management journal, 53, 1029-1049. o’boyle, jr., e. h., forsyth, d. r, banks, g. c., & mcdaniel, m. a. (2012). a metaanalysis of the dark triad and work outcomes: a social exchange perspective. journal of applied psychology, 97, 557-579. park, d. j., & berger, b. k. (2004). the presentation of ceos in the press, 19902000: increasing salience, positive valence, and a focus on competency and personal dimensions of image. journal of public relations research, 16, 93125. park, j. h., kim, c., & sung, y. d. (2014). whom to dismiss? ceo celebrity and management dismissal. journal of business research, 67, 2346-2355. 98 journal of business strategies petrenko, o. v., aime, f., ridge, j., & hill, a. (2015). corporate social responsibility or ceo narcissism? csr motivations and organizational performance. strategic management journal. doi:10.1002/smj.2348 ranft, a. l., zinko, r., ferris, g. r., & buckley, m. r. (2006). marketing the image of management: the costs and benefits of ceo reputation. organizational dynamics, 35, 279-290. rein, i. j., kotler, p., & stoller, m. r. (1987). high visibility. new york: dodd, mead & company. rindova, v. p., pollock, t. g., & hayward, m. l. (2006). celebrity firms: the social construction of market popularity. academy of management review, 31, 50-71. salancik, g. r., & kiesler, c. a. (1971). behavioral commitment and retention of consistent and inconsistent attitude word-pairs. the psychology of commitment. sinha, p. n., inkson, k., & barker, j. r. (2012). committed to a failing strategy: celebrity ceo, intermediaries, media and stakeholders in a co-created drama. organization studies, 33, 223-245. staw, b. m. (1976). knee-deep in the big muddy: a study of escalating commitment to a chosen course of action. organizational behavior and human performance, 16, 27-44. staw, b. m. (1981). the escalation of commitment to a course of action. academy of management review, 6, 577-587. nimmo, d. d., & sanders, k. r. handbook of political communication. beverly hills: sage publications. treadway, d. c., adams, g. l., ranft, a. l., & ferris, g. r. (2009). a meso level conceptualization of ceo celebrity effectiveness. leadership quarterly, 20, 554–570. tversky, a., & gilovich, t. (1989). the “hot hand”: statistical reality or cognitive illusion?. chance, 2, 31-34. wade, j. b., porac, j. f., pollock, t. g., & graffin, s. d. (2008). star ceos: benefit or burden?. organizational dynamics, 37(2), 203-210. van rompay, t. j., vonk, d. j., & fransen, m. l. (2009). the eye of the camera effects of security cameras on prosocial behavior. environment and behavior, 41, 60-74. zahra, s. a., & george, g. (2002). absorptive capacity: a review, reconceptualization, and extension. academy of management review, 27, 185-203. zajac, e. i., & bazerman, m. h. (1991). blind spots in industry and competitor analysis: implications of interfirm (mis) perceptions for strategic decisions. academy of management review, 16, 37-56. volume 32, number 2 99 biographical sketch of authors shelby j. solomon is a ph.d. candidate at louisiana state university, studying strategic management and entrepreneurship. before attending louisiana state university, shelby earned a b.a. in economics and an mba, both from the university of new mexico. his research interests focus on topics centered on entrepreneurship and critical theory. in addition, he is also interested in strategic decision-making research. shelby is also active in aom, sma, and usasbe. josh bendickson earned his ph.d. in strategic management from louisiana state university. josh’s research interests include strategic human capital, small business/entrepreneurship, and international strategy and he is a member of multiple professional organizations including the academy of management, southern management association, and the united states association for small business and entrepreneurship, among others. josh is an assistant professor of management at the university of louisiana at lafayette. volume 32, number 2 1 brand loyalty and store loyalty for consumers purchasing a product warranty in a health care setting: an investigation of the differences across gender, age, and income groups timothy h. reisenwitz valdosta state university • valdosta, ga sanjay gupta valdosta state university • valdosta, ga abstract the product warranty plays an increasingly important role in today’s highly competitive marketplace. the use of warranties is widespread, but their use has only relatively recently been applied in the health care sector. this study will look at the different levels of brand loyalty and store loyalty for respondents who were grouped by demographic characteristics. the demographics were divided into two groups: male/female, high income/low income, and younger/older. the respondents consisted of 120 patients at a privately-owned and operated, single-outlet, retail optical center. the two groups were compared based on brand loyalty and store loyalty using independent-samples t-tests. the analysis revealed that younger patients who purchase the warranty are more brand loyal than older patients who purchase the warranty. additionally, patients with higher incomes were significantly more store loyal than patients with lower incomes. keywords: product warranty, healthcare, brand loyalty, store loyalty introduction although retailers have offered warranties to customers for more than a century, it is only relatively recently that other sectors, including health care, have started offering warranties as a marketing tool (ostrom & iacobucci, 1998). product warranties provide value to purchasers of durable products by insuring against product failure. this can increase customers’ perception of product reliability and the health care provider’s reputation, which increases their confidence in the purchase decision. competition has intensified in the health care and other professional service industries (hart, schlesinger, & maher, 1992). professional service organizations are constantly attempting to achieve a competitive advantage and are searching 2 journal of business strategies for ways to differentiate themselves from the competition (falkenreck & wagner, 2011; oumlil, 2008). warranties enable a firm to gather useful data about customer concerns, satisfaction, and dissatisfaction about services in ways that traditional consumer surveys may not be able to do (levy, 1999). usually the organization does not receive negative feedback until a consumer is completely dissatisfied and exercises the warranty. furthermore, service warranties are an effective way to recruit and retain customers. finally, the service warranty helps the organization build consumer loyalty, trust, and satisfaction (kennett-hensel, min, & totten, 2012; levy, 1999), with a potential increase in profitability. several health care providers have offered warranties for their products, ranging from home blood pressure monitors (pr newswire, 1998) and hearing aids (shumaker, 2002), to services, including bypass surgery (bush, 2007) and lasik laser eye surgery (pr newswire, 2007). delta dental plan, a dental insurance provider, experienced an increase in its retention rate from 97 percent to 99 percent, an increase worth $19 million annually as a direct result of a service warranty on several aspects of its service (hart, schlesinger & maher, 1992). opticians have also offered warranties for their products, including contact lenses (the optician, 2007; business wire, 1999), prescription sunglasses (the optician, 2007), traditional frames (the optician, 2005), and rimless lenses (the optician, 2006). this study will assess the effectiveness of an eyeglass warranty based upon brand loyalty and store loyalty. literature review and hypotheses warranty definition and theory by definition, a warranty is a contractual agreement between a manufacturer (seller) and a consumer (buyer), requiring the manufacturer to address any failure(s) that occur during the warranty period (oumlil, 2008; jack & van der schouten, 2000). similarly, “a warranty is assurance that the supplier of an item will back the quality of the item in terms of correcting any legitimate problems with the item at no cost for a particular period of time or use” (cope, folse, & cope iii, 1999, p. 31). furthermore, it is a pledge by the manufacturer to the customer that the product will perform its intended function under normal condition of use for at least the period of the warranty (karim & suzuki, 2005). there are three theories on warranty: exploitation theory, market signal theory, and investment theory (oumlil, 2008). the exploitation theory states volume 32, number 2 3 that the warranty is determined by the market power of the manufacturer and the buyer. if the manufacturer has more market power (i.e., an environment of less competition) over the buyer, then a less attractive warranty would be offered, and vice versa. however, two studies have refuted this theory (kelley, 1988; priest, 1981). one study looked at the major appliance market and found that warranties of those products with high concentration (more competition) did not differ from those products with low concentration (less competition), which is not consistent with the exploitation theory (priest, 1981). the second study found that dishwasher brands with higher market shares offered better warranties than brands with less market share, the opposite of what exploitation theory advocates (kelley, 1988). the market signal theory states that warranties are a signal of product reliability. this theory is the most practical theory and suggests that marketers could differentiate their product as a reliable product by offering a warranty that is superior to the competition’s warranty (oumlil, 2008). investment theory holds that the warranty is an insurance policy and a repair contract (priest, 1981). the premise of this warranty is customer demand and the comparable cost of providing the repair. investment theory has been explained in terms of the investment by the customer in the search process (gerner & bryant, 1981). the more customers search, the less the warranty terms among manufacturers will vary. conversely, a lower level of customer search will result in an increase in the variation of warranty terms. brand loyalty and store loyalty the retail health care industry is characterized by mainly undifferentiated commodity products with an expected level of quality and prices. the brand needs to differentiate an organization’s products and services to develop loyalty (miller, 2001). brand loyalty is the attachment of a consumer toward a brand even if the brand changes in terms of price or product features (chahal & bala, 2010). a wellestablished brand name, whether a product or an organization, helps to preserve brand loyalty. increasing brand loyalty enhances brand equity, which develops the consumer’s behavior in the health care sector (chahal & bala, 2010). a health care organization that develops brand loyalty can compete more effectively, improve its financial strength, and effectively communicate its benefits to the community (miller, 2001). the importance of loyalty is related to its positive influence upon customer retention, repurchase, long-term profitability and long-term customer relationships 4 journal of business strategies (astuti & nagase, 2014). repeat business represents the core of any organization, since it improves market share by providing positive word-of-mouth that can attract even more customers (caruana & fenech, 2005; reichheld & sasser, jr., 1990). the loyalty construct has evolved in both width and depth over time and includes brand, product, vendor, retail store, and service loyalty, among others (caruana & fenech, 2005; reichheld & sasser, jr., 1990). in the health care sector, loyalty management programs are growing in importance, given the increasing number of patients who may be able to choose their health care providers. a successful loyalty program yields increased market share, growing practices, and improved financial outcomes (chaska, 2006). albaum and wiley (2010) note that extended warranties may increase customer loyalty and generate additional sales. there are mixed findings in terms of differences in brand loyalty across gender. in service settings, patterson (2007, p. 114) observes that “the psychological disposition of females indicates that they may be more brand loyal.” jensen (2011) found that men were less loyal consumers compared to women in the grocery product market. rocereto and mosca (2012) found that achieving brand loyalty is different between genders depending upon product type, whether utilitarian or hedonic. however, they found that in both cases, women are more strongly influenced toward loyalty behaviors. patterson (2007) also found that mature age groups (35-54 and over 55 years of age) showed significantly more loyalty than younger age groups (18-24 and 25-34 years of age). this may be because older consumers evaluate their experience with the product at the time of the purchase decision (beneke, 2013). there has also been mixed findings with respect to loyalty across income groups. patterson (2007) found that shoppers who are more price sensitive are less loyal, with higher income groups exhibiting more loyalty than low income groups. however, beneke (2013) found that consumers with higher incomes have fewer restrictions, making them less loyal to a brand than customers with lower incomes. based on the previous discussion, the following hypotheses are proposed: h1a there is greater brand loyalty among females who purchase a warranty compared to males who purchase a warranty. h1b there is greater brand loyalty among more mature consumers who purchase a warranty compared to younger consumers who purchase a warranty. h1c there is greater brand loyalty among lower income groups who purchase a warranty compared to higher income groups who purchase a warranty. volume 32, number 2 5 loyalty includes a commitment to the brand or store, which often results in a commitment over time and recommending the brand or store to others (swimberghe, sharma, & flurry, 2009). in the retail service sector, a satisfied customer tends to become a loyal customer who exhibits repeat purchase behavior (chen & quester, 2006). recently, store loyalty has weakened due to increased store choices, competitive awareness, consumer mobility, and consumers’ shortage of time (bove & mitzifiris, 2007). these factors may negatively influence a store’s profitability, since loyalty toward a company or store results in customer retention, which may in turn reduce costs. these challenges have provided greater motivation for companies to develop customer loyalty programs in order to retain customers (lu & seock, 2008). warranties influence consumers by increasing satisfaction via dissonance reduction (shimp & bearden, 1982) and increasing loyalty (oumlil, 2008). thus, the importance of patient retention or repeat purchase rests in the ability to positively affect customer satisfaction before and after the health care encounter. however, the organization can incur serious problems due to product failure within the warranty period, causing consumer dissatisfaction and organization expense to fulfill the warranty (gutierrez-pulido, aguirree-torres, & christen, 2006). regarding gender, the literature is mixed in terms of store loyalty. harmon and hill (2003) found that men were heavy users of grocery store loyalty cards. in contrast, stan (2015) found that women are more loyal to the store than men. also, kurtulus and ertekin (2015) found that female shoppers are more store loyal than male shoppers. evanschitzky and wunderlich (2006) studied the relationship of store loyalty to age and income, among other demographics, using customers of a large do-ityourself retailer. they state that, regarding age, information processing suggests that older consumers are less likely to seek new information, relying on heuristic or schema-based forms of processing. in contrast, younger consumers seek alternative information, which may also change their loyalty. finally, there has been considerable work suggesting that income is related to consumer loyalty (crask & reynolds, 1978; korgaonkar, lund, & price, 1985; zeithaml, 1985). based upon this research, evanschitzky and wunderlich (2006) concluded that store loyalty will be stronger for low-income consumer than for highincome consumers. based on the previous discussion, the following hypotheses are proposed: 6 journal of business strategies h2a there is greater store loyalty among females who purchase a warranty compared to males who purchase a warranty. h2b there is greater store loyalty among more mature consumers who purchase a warranty compared to younger consumers who purchase a warranty. h2c there is greater store loyalty among lower income groups who purchase a warranty compared to higher income groups who purchase a warranty. methodology the study sample was a regional sample from a metropolitan statistical area (msa) in the southeastern united states. an msa is a metropolitan area surrounded by nonmetropolitan counties and is neither socially nor economically dependent on another metropolitan area. a metropolitan area has a city or urban area with at least 50,000 consumers and a total metropolitan population of at least 100,000 (pride & ferrell, 2010). the respondents consisted of current patients at a privately-owned and operated, single-outlet, retail optical center. the quota sampling method was used, since it was desired to collect data from only patients of the optical center. the questionnaires were distributed at the receptionist’s counter in the patient waiting area to those patients who were willing to complete them. the anonymity of the respondent was assured by the receptionist to foster accurate responses. the eyeglass warranty covered any damage for one year with free replacement of the frame and lens if necessary. the cost was $29 and was included at no charge with a purchase at full retail price. as generous as this warranty may seem at first, it falls short of the unconditional warranty, which, in its pure form, promises at a minimum, a full refund (hart, schlesinger, & maher, 1992). the sample size of those who had previously purchased a warranty (n = 120) was accompanied by relevant demographic information. only subjects who had purchased a warranty were relevant for this study. in terms of gender, there was a two-to-one difference between females (n = 72, 60%) and males (n = 36, 30%). age groups were fairly evenly distributed among three of the generational cohorts, generation y (n = 34, 28.3%), generation x (n = 37, 30.8%), and baby boomers (n = 36, 30%). matures were not well-represented (n = 5, 4.1%). income was concentrated in the first three income categories, $0-10,000 (n = 24, 20%), $10,001-30,000 (n = 34, 28.3%), and $30,001-50,000 (n = 27, 22.5%). complete information on the sample description is in table 1. volume 32, number 2 7 table 1 descriptive information of sample (n = 120)* items percent (n) gender male female 36 (30.0) 72 (60.0) age under 18 18-28 29-42 43-61 62-65 over 65 8 (6.7) 34 (28.3) 37 (30.8) 36 (30.0) 4 (3.3) 1 (0.8) income 0-10k 10,001-30k 30,001-50k 50,001-70k 70,001-100k above 100k 24 (20.0) 34 (28.3) 27 (22.5) 14 (11.7) 14 (11.7) 3 (2.5) marital status married single living with another widowed separated divorced 56 (46.7) 38 (31.7) 6 (5.0) 2 (1.7) 7 (5.8) 10 (8.3) race white (caucasian) african american hispanic american pacific islander asian american native american other 79 (65.8) 29 (24.2) 3 (2.5) 2 (1.7) 2 (1.7) -04 (3.3) education completed ged high school undergraduate graduate professional degree technical other 8 (6.7) 33 (27.5) 34 (28.3) 24 (20.0) 11 (9.2) 4 (3.3) 3 (2.5) occupation homemaker/not employed self-employed educator professional work for company/business other 16 (13.3) 9 (7.5) 13 (10.8) 18 (15.0) 49 (40.8) 11 (9.2) patient status new patient returning patient 28 (23.3) 92 (76.7) * percentages may not total 100 percent due to missing data (nonresponse) 8 journal of business strategies measures loyalty to the product/brand and loyalty to the store (lichtenstein, netemeyer, & burton, 1990; raju, 1980) are both well-established scales that have been used in previous research. all items were measured on a seven-point likert scale from “1 = strongly disagree” to “7 = strongly agree,” in which the rating, 4, was for respondents who felt neutral. dichotomous or dummy variables were defined for each of the three demographics, with male = 1 and female = 2 for gender, younger (to age 42) = 1 and older (43 years of age and older) = 2, low income ($0-50,000) = 1 and high income (greater than $50,000) = 2. analysis and results reliability coefficients were computed for each of the loyalty scales. both alpha values were well above the 0.70 value as recommended (nunnally, 1978). table 2 presents the alpha values for the items used. table 2 reliability coefficients scale/ statements coeffcient alpha brand loyalty 0.93 i generally buy the same brands of eyewear that i have always bought. once i get used to a brand of eyewear, i hate to switch. if i like a brand of eyewear, i rarely switch from it just to try something different. even though certain products/services are available in a different number of brands, i always tend to buy the same brand of eyewear. store loyalty 0.88 i generally visit the same eye care professional that i have always used. once i get used to an eye care professional, i hate to switch. if i like an eye care professional, i rarely switch just to try something different. even though certain products/services are available with different optical centers, i always tend to visit the same eye care professional. volume 32, number 2 9 independent-samples t-tests were used to test the hypotheses; the results are summarized in table 3. the results are significant for hypothesis 1b, brand loyalty and age (p < 0.05), albeit in the opposite direction hypothesized, and similarly for hypothesis 2c, store loyalty and income (p = 0.10). thus, although significant, both hypotheses are rejected. younger patients who purchased a warranty had greater brand loyalty than older patients who purchased a warranty. higher income patients who purchased a warranty had greater store loyalty than lower income patients who purchased a warranty. table 3 brand and store loyalty and differences among gender, income, and age variable brand loyalty mean (sd) t-value sig. store loyalty mean (sd) t-value sig. male female 4.01 (1.87) 3.85 (1.93) 0.39 0.68 5.87 (1.36) 6.07 (1.19) -0.73 0.82 younger older 3.95 (1.97) 3.88 (1.73) 0.18 0.03* 5.89 (1.33) 6.16 (1.07) -1.08 -1.16 0.15 higher income lower income 3.98 (1.19) 3.85 (1.73) 0.30 0.29 6.05 (1.20) 5.90 (1.37) 0.56 0.10** * p < 0.05 **p = 0.10 conclusions this study attempted to look at the different levels of brand loyalty and store loyalty for respondents who were grouped by demographic characteristics at a privately-owned and operated, single-outlet, retail optical center. the variables examined were brand loyalty and store loyalty. based on the analyses, younger patients who purchase the warranty were more brand loyal than older patients who purchase the warranty. this significant result, although in the opposite direction of the hypothesis, concurs with more recent surveys where the relationship between brand loyalty and age has been overstated and where brand loyalty varies more by category than by age (setlow, 2002). additionally, patients with higher incomes were significantly more store loyal than patients with lower incomes. brand and store loyalty are two of several possible factors aiding customer retention, with the caveat that it costs between five and eight times more to attract 10 journal of business strategies a new patient than keeping an existing one. moreover, raising patient retention by just five percent can increase the lifetime value of the average patient by 25-100 percent (reid, 2009). these concepts comprise the basis of customer relationship management (crm) or relationship marketing. customer retention and loyalty are central to relationship marketing. moreover, establishing a long-term relationship with a service provider holds a unique appeal to consumers. customers prefer personalized, closer relationships with service providers (bendall-lyon & powers, 2002). the results of this study suggest that optical marketers target younger consumers and higher income consumers in terms of their warranty offerings. discussion based on the results of this study, relationship marketing is just one strategic option that the product warranty may support. the results suggest that an eyeglass warranty at a retail optical center is important for younger patients in terms of brand loyalty and higher income patients in terms of store loyalty. after incorporating the warranty as part of the product, increases in warranty purchases may be facilitated via the optical center’s professional staff and its utililization of personal selling techniques. the other elements of the promotional mix, advertising, sales promotion, and public relations may be leveraged with this same message as part of an integrated marketing communications (imc) campaign toward younger consumers and higher income consumers. limitations and suggestions for future research there are some limitations to this study that future research can address. for example, the results in this study were based on a privately-owned, single outlet, retail optical center in an msa in the southeastern united states. the results may not be generalizable to other optical organizations, including those with multiple outlets, other health care organizations, other service organizations, or other regions of the united states. future research needs to determine if the results would be different with any of these variations, a larger sample, and a different sampling method. this study examined warranty effectiveness in terms of brand loyalty and store loyalty. further analysis may investigate warranty effectiveness using other types of loyalty and/or other variables. finally, a warranty adds to the cost of the product. given the added organizational expense of offering warranties, this topic is important for marketers to continue to study and hopefully this paper encourages future research and discussion. volume 32, number 2 11 references anonymous (2005). tres jolie at a very pretty price. the optician, august 19, 230(6015), 10. anonymous (2005). get hooked with minima zero. the optician, june 3, 229(6004), 11. anonymous (2006). riviera rimless offers guarantee of glazing confidence. the optician, november 24, 232(6079), 9. anonymous (2007). maui jim expands rx range, the optician, june 29, 233(6108), 9. anonymous (2007). ultravision keeps customers informed, the optician, february 9, 233(6088), 10. albaum, g., & wiley, j. (2010). consumer perceptions of extended warranties and service providers. journal of consumer marketing, 27(6), 516-523. astuti, j. h., & nagase, k (2014). patient loyalty to healthcare organizations: relationship marketing and satisfaction. international journal of management and marketing research, 7(2), 39-56. bendall-lyon, d., & powers, t. l. (2002). the impact of gender differences on change in satisfaction over time. the journal of consumer marketing, 19(1), 12-22. beneke, j. (2013). a closer inspection of the impact of perceived risk on purchase intention of premium private label brands: the effect of age, gender, income and racial group. journal of business and retail management research, 7(2), 44-56. bove, l., & mitzifiris, b. (2007). personality traits and the process of store loyalty in a transactional prone context. journal of services marketing, 21(7), 507-19. bush, h. (2007). surgery with a guaranteed price. hospitals & health networks, 81(7), 30. business wire (1999). cooper ceo says new marketing initiatives will mean rapid growth and market leadership. april 29, 1. caruana, a., & fenech, n. (2005). the effect of perceived value and overall satisfaction on loyalty: a study among dental patients. journal of medical marketing, 5(3), 245-255. chahal, h., & bala, m. (2010). confirmatory study on brand equity and brand loyalty: a special look at the impact of attitudinal and behavioural loyalty. vision –the journal of business perspective, 14(1,2), 1-12. chaska, b. w. (2006). growing loyal patients. physician executive, 32(3), 42-47. 12 journal of business strategies chen, s-c., & quester, p. g. (2006). modeling store loyalty: perceived value in market orientation practice. journal of services marketing, 20(3), 188-198. cope, r. f., folse, r. o., & cope, r. f. iii (1999). quality control for software warranties: a conceptual and economic perspective. management research news, 22(7), 30-40. crask, m. & reynolds, f. (1978). an indepth profile of the department store shopper. journal of retailing, 54(summer), 23-32. evanschitzky, h., & wunderlich, m. (2006). an examination of moderator effects in the fourstage loyalty model. journal of service research, 8(4), 330-345. falkenreck, c., & wagner, r. (2011). the impact of perceived innovativeness on maintaining a buyer-seller relationship in health care markets: a cross cultural study. journal of marketing management, 27(3-4), 225-242. gerner, j. l., & bryant, k. (1981). appliance warranties as a market signal? journal of consumer affairs, 15(1), 75-86. gutierrez-pulido, h., aguirre-torres, v., & christen, j. a. (2006). a bayesian approach for the determination of warranty length. journal of quality technology, 38(2), 180-189. harmon, s. k. & hill, c. j. (2003). gender and coupon use. journal of product & brand management, 12(3), 166-179. hart, c. w. l., schlesinger, l. a., & maher, d. (1992). guarantees come to professional service firms. sloan management review, 33(3), 19-29. jack, n., & van der schouten, f. (2000). optimal repair-replace strategies for a warranted product. international journal of production economics, 67, 95-100. jenson, j. m. (2011). consumer loyalty on the grocery product market: an empirical application of dick and basu’s framework,” journal of consumer marketing, 28(5), 333-343. karim, m. r., & suzuki, k. (2005). analysis of warranty claim data: a literature review. the international journal of quality & reliability management, 22(7), 667-686. kelley, c. a. (1988). an investigation of consumer product warranties as market signals of product reliability. the academy of marketing science, 16(2), 72-78. kennett-hensel, p. a., min, k. s., & totten, j. w. (2012). the impact of healthcare service guarantees on consumer decision-making: an experimental investigation. health marketing quarterly, 29, 146-162. korgaonkar, p. k., lund, d., & price, b. (1985). a structural equations approach toward examination of store attitude and store patronage behavior. journal of retailing, 61(2), 39-60. volume 32, number 2 13 kurtulus, k. & ertekin, z. ö. (2015). consumers’ attitude to and choice of store brands in fashion apparel: role of gender and shopping style. metu studies in development, 42(1), 1-28. levy, j. s. (1999). marketing service guarantees for health care. nursing economics, 17(4), 214-219. lichtenstein, d. r., netemeyer, r. d. & burton, s. (1990). distinguishing coupon proneness from value consciousness: an acquisition-transaction utility theory perspective. journal of marketing, 54 (july), 54-67. lu, y., & seock, y-k. (2008). the influence of grey consumers’ service quality perception on satisfaction and store loyalty behavior. international journal of retail & distribution management, 36(11), 901-918. miller, d. w. (2001). a core strategy – developing a brand. health forum journal, 44(1), 36-38. nunnally, j.c. (1978). psychometric theory. new york: mcgraw hill. ostrom, a. l., & iacobucci, d. (1998). the effect of guarantees on consumers’ evaluation of services. the journal of services marketing, 12(5), 362. oumlil, a. b. (2008). warranty planning and development framework: a case study of a high-tech multinational firm. journal of business & industrial marketing, 23(7), 507-517. patterson, p. g. (2007). demographic correlates of loyalty in a service context. journal of services marketing, 21(2), 112-121. pr newswire (1998). americans still need help tackling blood pressure – many doctors recommend home monitors as management tool. september 30, 1. pr newswire (2007). lasikplus ‘lifetime warranty’ raises patient advocacy and wall street concerns. may 9, 1. pride, w. m., & ferrell, o. c. (2010). marketing. mason, ohio: south-western cengage learning. priest, g. l. (1981). a theory of the consumer product warranty. the yale law journal, 90(6), 1297-352. raju, p. s. (1980). optimum stimulation level: its relationship to personality, demographics,and exploratory behavior. journal of consumer research, 7 (december), 272-282. reichheld, f. f., & sasser, jr., w. e. (1990). zero defections: quality comes to services. harvard business review, 68(5), 105-111. reid, d. (2009). love the ones you’re with. the optician, 238(6226), 18. 14 journal of business strategies rocereto, j. f., & mosca, j. b. (2012). self-concept, gender, and product type: an investigation of brand loyalty. journal of business & economic research, 10(1), 25-36. setlow, c. (2002). the myth and reality of brand loyalty. dsn retailing today, 41(18), 16. shimp, t. a., & bearden, w. o. (1982). warranty and other extrinsic cue effects on consumers’ risk perceptions. journal of consumer research, 9(june), 38-46. shumaker, c. (2002). west virginia asks hearing-aid dealer to refund customers. knight ridder tribune business news, august 15, 1. stan, v. (2015). does consumer gender influence the relationship between consumer loyalty and its antecedents? the journal of applied business research, 31(4), 1593-1604. swimberghe, k, sharma, d., & flurry, l. (2009). an exploratory investigation of the consumer religious commitment and its influence on store loyalty and consumer complaint intentions. journal of consumer marketing, 26(5), 340-347. zeithaml, v. a. (1985). the new demographics and market fragmentation. journal of marketing, 49(summer), 64-75. brief biographical sketch of authors timothy h. reisenwitz, has a dba in marketing from cleveland state university and is professor of marketing in the department of marketing and international business at langdale college of business, valdosta state university, where he teaches at the undergraduate and mba program levels. his work is published in several journals, including journal of consumer marketing, marketing management journal, journal of real estate literature, journal of medical marketing, marketing education review, journal of business strategies, and academy of educational leadership journal. sanjay gupta is the associate dean and a professor of accounting at the langdale college of business, valdosta state university. his primary research interests are in executive compensation, business ethics, quality modeling, and pedagogy. tax savings for exporters under the new foreign sales corporation option c.d. baron and m.p. dillal¥ay department of accounting new mexico state university introduction many factors must be considered in deciding whether it would be profitable for a u.s. business to export its products to customers in foreign countries. one factor sometimes overlooked is the potential for higher profit margins when export sales are channeled through a special corporation permitted by the income tax laws. this article summarizes the main features of this tax device as provided for in the tax reform act of 1984 (1). disc's replacement: the foreign sales corporation until 1984, the tax law provided for a system of tax deferral for u.s. businesses selling their products in foreign markets. under this system, special corporations known as domestic international sales corporations, or discs, were created (usually as a wholly owned subsidiary of a parent corporation) and interposed between the manufacturer or distributor and its foreign customer. using this device, the tax on a portion of the income from export receipts, generally 42.5 percent, could be deferred indefinitely until distribution to the disc's shareholders. discs came into the tax law in 1971 and have been widely used by exporting companies since that time. in 1979, for example, more than 7,208 disc tax returns were filed, accounting for almost $99 billion of gross export receipts and $6.4 billion in disc net income, of which more than $2 billion was tax deferred. since its enactment, the disc had been the subject of an ongoing dispute between the united states and certain other signatories of the general agreement on tariffs and trade (gait), who have contended that the disc amounts to an illegal export subsidy. after a decade of debate, the u.s. (1) this article summarizes selected portions of a complex part of the tax code and is not intended as a complete discussion of the subject. its purpose is to acquaint the reader ~ a general way with the tax savings potential of a disc or fsc. readers interested in specific applications to their own business should consult the tax literature or their tax adviser. _46_ agreed to enact tax legislation that would address the concerns of the other gait members. relevant provisions of the tax reform act of 1984 (the act) are the outcome. in the act, signed into law in]uly, this system of discs is to be replaced (but not entirely abolished) by the foreign sales corporation, or fsc. the underlying concept of the rules change is that only foreign-source income income attributable to economic activities occurring outside the united states is to be exempt from u.s. taxation. accordingly, exporters are required to establish "foreign sales corporations'! to administer their export sales activities occurring outside u.s. territorial limits in order to qualify for the partial tax exemption. a broad outline of the changes are summarized as follows: 1. the act provides that a portion of the export income of an eligible fsc, generally 32 percent, will be exempt from federal income tax. 2. it allows a domestic parent corporation a 100 percent dividendsreceived deduction for dividends distributed from the fsc out of exempt foreign trade income. thus, the export profits of the fsc can be repatriated to the parent as soon as possible without any adverse u. s. tax consequences. 3. the accumulated tax-deferred income of a december 31, 1984 disc will be deemed previously taxed income, exempting it forever from taxation. 4. small business exporters may find it difficult to comply with certain of the foreign presence requirements of the fsc rules. the act provides, therefore, two options to eligible small businesses: the interestcharge disc and the small fsc. these main provisions will now be explained in greater detail. formation and operation of a fsc to qualify as an fsc, a corporation must have adequate "foreign presence'!; that is, it must be created, managed and operated to a substantial degree outside the united states. this is a major departure from the previous disc concept where the tax vehicle could be a mere shell corporation on the domestic parent's books. when creating an fsc for tax purposes! three foreign presence requirements must be met. first, the fsc must be incorporated under the laws of a qualifying country (generally tax-treaty countries, but the treasury department is to issue a list of countries that qualify). second, the fsc must maintain an office outside of the u.s. where a complete set of tax and accounting records is kept. third, the fsc's board of directors must include one individual who is not a resident of the u.s., although that individual may be a u.s. citizen. _47_ after formation of the fsc, additional foreign presence tests must be met during each taxable year in order to maintain its tax status. for example, as evidence that the fsc is managed outside of the u.s., all meetings of its board of directors must be in a foreign country; and its principal bank account must be maintained in a foreign bank. in order for export transactions to produce foreign-source income subject to tax exemption, a substantial amount of the export sales effort must take place outside of the u.s. this requirement is satisfied when both parts of a two-part test are met. in the first of these, employees of the fsc or their agents must have performed either the solicitation, negotiation, or finalization of the export sales contract activity outside of the u.s. generally, this test is applied on a per customer, per contract basis. in the second part of this foreign presence test, at least 50 percent of the direct costs of initiating, processing and settling the export sale transaction must be traceable to activities performed outside of the u.s. the fsc may contract with its u.s. parent or with any other party, related or unrelated, to act as its agent in carrying out these activities, provided they are substantially performed outside of the u.s. tax treatment of fsc income income of the fsc subject to exemption is restricted to foreign trading income derived from export sales. investment income or income from intercompany transactions is not included. complications aside, the foreign trading income of the fsc is the difference between the selling prices paid by foreign customers for export property sold by the fsc and the cost prices for those goods paid by the fsc to its suppliers-its related parent manufacturer in the typical case. export revenue eligible for tax exemption is deliberately similar to the previous disc concept of qualified gross receipts, being derived from the sale or lease of qualified "export property." export property represents property that is manufacturer, produced, grown or extracted in the u. s. for sale to an fsc in the ordinary course of business for direct use of consumption outside of the u.s. such property must not have more than 50 percent of its fair market value attributable to articles imported into the u.s. four types of property are specifically excluded from being classed as export property, the most notable being (1) oil, gas or any primary product therefrom and (2) intangible assets, such as patents, copyrights, designs and like property. the unit cost prices to be matched against the export gross receipts in computing fsc foreign trading income are derived from one of two approaches available to the taxpayer. in one approach, the general corporate tax rules for arms-length pricing of intercompany transfers is to be used. in the other approach, special administrative pricing rules contained in the act can be used. the mechanics of intercompany pricing are too detailed to _48_ review in this summary, although many of the marginal costing, no-loss, and transaction grouping rules familiar to disc users are carried over into the new legislation. foreign trading income of the fsc derived as outlined above is composed by definition of two parts: (1) so-called foreign-source income, which is exempt from taxation; and (2) u.s.-source income, which is taxed currently at the fsc level. the exact portion of the fsc income that is category (1) and exempt depends on the intercompany pricing approach chosen by the taxpayer. generally, approximately 32 percent of fsc trading income is exempt from taxation. small business use of the fsc small businesses are likely to find the foreign presence requirements for creating and operating an fsc extremely burdensome. for this reason, the act provides relief in two forms: (1) the interest-charge disc, and (2) the designated small fsc. for those small business exporters having less than $10 million in gross export receipts who are presently using a disc, special provisions apply that should be analyzed carefully in formulating a sound tax planning strategy. under the act, companies may elect to continue their existing discs and are not required to convert to an fsc. this avoids the need to meet the foreign presence requirements of the latter. furthermore, certain provisions of the previous disc rules have been eliminated, which makes the disc vehicle even more attractive for the small exporter. for example, the 57.5 percent deemed distribution and the incremental income rules are no longer applicable to existing discs. as a result, substantially all of the disc income attributable to $10 million of gross export receipts (for a year after 1984) is deferred. if export receipts for a particular post-1984 year exceed this amount, the disc will not be disqualified; there would merely be no deferral of tax on the excess. however, unlike the previous-law disc, an interest charge will be imposed on shareholders of the disc in lieu of tax. the interest charge is computed on the accumulated post-1984 deferred tax liability of disc shareholders using a base period treasury bill interest rate. generally, all other previous-law rules applicable to discs remain applicable under the new act. as an alternative to the interest-charge disc, or for those small business exporters without an existing disc, the act provides for electing to be treated as a i'small fsc." under these circumstances, a small fsc need not meet the foreign presence requirements outlined previously. however, in determining the amount of exempt foreign-source income, any export gross receipts in excess of $5 million will not be taken into account. the small fsc is allowed to select the export transactions to be applied to the $5 million cap, _49enabling the taxpayer to assign high profit margin export transactions to the tax-exempt portion of fsc income. transition rules for existing discs the last taxable year of each disc beginning during 1984 is deemed to have closed on december 31, 1984. the corporation's disc election is deemed revoked on december 31, 1984. if a disc did not elect to be an i'interest-charge disc" by january i, 1985, it is referred to as a former disc. any amounts distributed by a former disc, including an i'interest-charge disc," after july i, 1985, shall be treated as first out of current profits, and then out of previously taxes income. (any distributions before july i, 1985, shall be considered as previously taxed income.) establishing and electing status as an fsc, or small fsc the election to be an fsc or small fsc requires the filing of form 8279. this election must be made within 90 days after the beginning of the taxable year. for those corporations which were in existence before june 30, 1985, the election to be qualified as an fsc must be made during a 90-day period prior to the first day of the taxable year. once created, the new fsc continues in effect until it is explicitly revoked by the taxpayer or fails to meet the qualifying requirements for five consecutive years. if qualified status is revoked, it can be reinstated at a later time. summary and conclusions exporting products to foreign markets is a complex but potentially profitable business undertaking. one important factor to consider in deciding whether to enter or to expand foreign operations is the potential tax savings of using a special tax-status corporation to channel the export sales. under previous tax laws, exporters could use the disc corporation. the tax reform act of 1984 retains limited use of the disc for small businesses and introduces the fsc corporation. formation and operation of an fsc requires that a substantial portion of export sales activity must take place outside of the u.s. if this occurs, approximately 32 percent of fsc income derived from foreign trade can be exempt from u.s. taxation. a small business exemption from the burdensome need to locate sales activity offshore is provided for in the act. for other businesses contemplating export operations, details of the fsc provisions should be carefully considered. the tax benefits resulting could well be sufficient to affect the business decision. _50 tax savings for exporters under the new foreign sales corporation option evaluation and use of financial ratios in assessing management excellence beverly l. little department of business administration northwestern louisiana university natchitoches, louisiana introduction in their 1982 best-seller, in search of excellence, thomas j. peters and robert h. waterman, jr. identify a number of american companies which exemplify excellence in management. their research was extensive, encompassing months of personal interviews and on-sight exploration. from this research, eight attributes emerged as characterizing the most innovative, excellently-managed companies: a bias for action; closeness to the customer; autonomy and entrepreneurship; productivity through people; hands-on, value-driven philosophy (the now-famous management by wandering around); sticking to the knitting; simple form, lean staff; and simultaneous loose-tight properties. innovation is not an end itself, but a means to success. therefore, in order to be included in the final list a company had to meet certain financial criteria. an excellent company had to have been in the top half of its industry in four of six standards: tnree measures of growth (compound asset growth, compound equity growth, and ratio of market price to book price) and three measures of return on capital (average return on capital, average return on equity, average return on sales) over the twenty-year period 1961-1980 (5). purpose of the study the value of analysis of accounting information in judging the performance of a company is generally accepted in the financial community. the purpose of this study was to examine the companies deemed as excellent in light of recent accounting data to determine if the claim of excellence was c,?nfirmed. the hypothesis was that the results of the analyses performed would support the contention of excellence, and thereby, substantiate the value of accounting analysis as a tool for the evaluation of the management of a business enterprise. 35 methodology from peters and waterman's final list of fourteen, data was available though compustat for thirteen: boeing, caterpillar, dana, delta airlines, digital, emerson electric, fluor, hewlett-packard, ibm, johnson and johnson, mcdonald's, proctor & gamble, and 3m. (bechtel was not available). regular financial statements, common-size financial statements, and financial ratios for these thirteen firms and their corresponding industries were generated by compustat for the five most recent years available, 19781982. the companies themselves were excluded from the industry composite; in cases when more than one of the firms were in the same industry (hewlett-packard, ibm, and digital; and johnson and johnson, and 3m) each was compared to a composite from which all were excluded. a list of the companies used in compiling the industry composite figures is provided in appendix a. the measures selected for analysis in this study were five of the most widely-reported and standard ratios: acid-test ratio, debt to asset ratio, inventory turnover, accounts receivable turnover, and return on investment. these represent the basic areas of liquidity, leverage, activity, and profitability. each of the ratios will be treated separately. the focus of this analysis was to assess the performance of each company over the five-year period and to compare each company with composite ratios for its industry. analysis of ratios acid-test ratio the acid-test ratio is a measure of a firm's liquidity based on those assets most quickly convertible into cash. it shows the relationship of a firm's cash, cash equivalents, and accounts receivable to its current liabilities. it is a sterner test of liquidity than is the current ratio (current assets/current liabilities) because it does not include inventory. the exclusion of inventory relieves the ratio of any distortion due to variations in inventory accounting methods but also discounts the liquidity of fast-turning inventory (i, p. 72). as can be seen from table i, no distinct pattern emerges that allows the analyst to conclude excellence on the basis of liquidity. the only similarity is the presence of wider swings in the company's ratio than in that of its industry. boeing company and caterpillar maintained higher average acidtest ratios than did their industries, but experienced wider swings. mcdonaid's and johnson and johnson experienced wider swings than did the industry, but maintained ~ower averages. proctor and gamble, dana, fluor, delta and 3m maintained lower acid-test ratios than did their industries. ibm, hewlett-packard, digital, and emerson, maintained higher acid-test ratios than did their industries. 36 table 1 acid-test ratio 1978-1982 high low average ibm 1.41 .93 1.15 h-p 1.69 1.23 1.38 digital 2.95 2.25 2.49 industry .91 .82 .86 dana .95 .80 .87 industry 1.11 .89 1.04 delta .82 .53 .63 industry .97 .59 .75 emerson 1.10 1.00 1.04 industry .91 .82 .86 fluor 1.03 .65 .87 industry 1.31 1.12 1.19 j&j 1.86 1.25 1.43 3m 1.46 1.03 1.20 industry 1.83 1.40 1.51 mcdonald's .82 .33 .55 industry .77 .70 .74 boeing 1.23 .24 .73 industry .67 .51 .58 caterpillar 1.15 .45 .72 industry .79 .50 .67 p&g 1.14 .75 .89 industry 1.35 1.14 1.24 debt to assset ratio the ratio of total debt to total assets is a measure of the percentage of total funds provided by creditors (financial leverage). this ratio is of interest to owners, who may wish to limit their investment by augmenting it with debt, 37 but who do not want their control of the company to be overly diluted. potential creditors are concerned with, the level of owner investment and a firm's ability to meet its liabilities. incurring debt requires a fixed payment of interest charges. accompanying sales growth in excess of that required to meet such fixed charges can magnify earnings. therefore, the debt/asset ratio should be evaluated in conjunction with a profitability measure (6, p. 140). table 2 total debtlrotal assets 1978-1982 high low average ibm .12 .03 .09 h-p .09 .06 .07 digital .03 .19 .13 industry .27 .22 .24 dana .26 .19 .23 industry .24 .21 .22 delta .24 .10 .13 industry .53 .41 .46 emerson .15 .08 .11 industry .13 .11 .12 fluor .26 .18 .13 industry .36 .26 .31 j&j .08 .04 .07 3m .12 .09 .11 industry .22 .19 .21 mcdonald's .44 .35 .40 industry .34 .30 .32 boeing .06 .02 .04 industry .13 .06 .10 caterpillar .36 .23 .27 industry .26 .20 .22 p&g .17 .14 .15 industry .27 .17 .23 38 as can be seen in table 2, ten of the companies, ibm, hewlett-packard, digital, delta, emerson, fluor, johnson and johnson, 3m, boeing, and proctor and gamble maintained debt/asset ratios lower in every case than those of their respective industries. dana experienced wider swings then did their industry, and averaged about the same. caterpillar and mcdonaid's maintained debt/asset ratios higher in every case than those of their composite industries. while the average debt ratios ranged from .04 for boeing to .40 for mcdonald's, it can be seen that most of the excellent companies' use of debt is less than that of their competitors. inventory turnover inventory turnover (cost of goods sold/average inventory) is a measure of the speed with which inventories move through the business. this ratio is of significance because inventory represents an investment for the purpose of making a profit. it would appear that the faster a business turns its inventory the better, but this is true only to a point. a high turnover should not be achieved at the expense of a low gross margin or an inventory level that is too low. on the other hand, while a firm must maintain inventory adequate to generate sales, excessive inventories require costs of storage and insurance and tie up funds that could be used otherwise (4, p. 52). table 3 inventory turnover 1978-1982 high low average ibm 4.4 3.3 3.8 h-p 3.0 2.4 2.7 digital 2.1 1.8 1.9 industry 2.9 2.8 2.8 dana 4.2 3.3 3.7 industry 5.8 5.4 5.8 delta 114.1 55.0 83.3 industry 23.9 21.4 22.0 emerson 2.8 2.5 2.7 industry 5.7 4.9 5.4 fluor 57.7 21.0 37.6 industry 10.5 5.4 7.7 39 j&j 3.0 2.5 2.9 3m 2.3 2.8 2.3 industry 4.9 4.5 4.7 mcdonald's 78.1 71.1 73.9 industry 28.3 18.3 24.2 boeing 10.4 1.9 6.2 industry 4.1 3.7 3.8 caterpillar 3.9 2.8 3.5 industry 3.0 2.8 2.9 p&g 5.5 5.2 5.3 industry 4.6 3.8 4.3 as can be seen in table 3, no definite pattern emerges as to the speed with which inventory is turned over. eight of the companies (ibm, hewlettpackard, delta, fluor, mcdonald's, boeing, caterpillar, and proctor and gamble) turned their inventory over more rapidly than did their respective industries. boeing's average was almost double that of its industry; delta's was four times their industry average. mcdonald's low of 71.1 compares to 18.3 for the industry. both johnson and johnson and 3m turned their inventory more slowly then did their industry; digital, emerson, and dana also underperformed their industries in turnover of inventory. accounts receivable turnover for any firm which sells largely on credit, accounts receivable are a significant source of working capital. accounts receivable turnover is a measure of the speed with which accounts receivable are turned into cash. it is related directly to the firm's credit policies, which should be loose enough to encourage sales but tight enough to avoid losses through uncollectibles. assuming an appropriate credit policy, the more times per year receivables are turned, the better the cash flow (1). table 4 accounts receivable turnover 1978-1982 ibm h-p digital industry high 6.7 5.8 5.0 4.8 40 low 5.2 5.4 4.1 4.4 average 5.8 5.6 4.4 4.6 dana 9.4 6.6 7.7 industry 7.6 7.0 7.5 delta 12.6 10.6 11.7 industry 9.7 8.5 8.8 emerson 7.5 6.7 6.8 industry 5.8 5.5 5.6 fluor 10.1 8.4 9.2 industry 7.2 4.7 5.8 j&j 8.2 7.9 8.0 3m 6.1 5.8 5.9 industry 7.2 6.8 6.9 mcdonald's 36.2 33.1 35.9 industry 18.0 16.2 16.7 boeing 18.9 13.6 16.8 industry 8.9 8.2 8.6 caterpillar 10.7 5.6 9.3 industry 11.4 7.4 9.4 p&g 14.7 13.7 14.1 industry 8.7 7.7 8.4 a definite pattern emerges from table 4. ten of the thirteen companies, (ibm, hewlett-packard, dana, delta, emerson, fluor, johnson and johnson, boeing, proctor and gamble, and mcdonald's) exceeded their industries' accounts receivable turnovers, and caterpillar averaged only slightly below its industry. only digital and 3m were consistently below their industries. it could be said with some degree of certainty that excellently managed companies collect their accounts receivable more rapidly than do their industries. return on investment the measures of liquidity, leverage, and activity used above reveal specific things about a firm, but measures of profitability show the end result of management's decisions. in a 1982 survey funded by deloitte, haskins and sells, profitability ratios were rated as the most important by financial 41 executives (2). the measure of profitability examined herein was return on investment (net income/total assets). table 5 return on investment 1978-1982 high low average ibm .15 .11 .13 h-p .12 .11 .11 digital .11 .09 .10 industry .06 .04 .05 dana .10 .03 .07 industry .07 .03 .05 delta .08 .01 .05 industry .05 -.02 .007 emerson .13 .12 .13 industry .08 .06 .07 fluor .08 .03 .06 industry .09 .07 .08 j&j .13 .12 .12 3m .14 .11 .13 industry .09 .08 .08 mcdonald's .09 .08 .08 industry .06 .05 .06 boeing .10 .04 .08 industry .07 .03 .05 caterpillar .08 -.03 .05 industry .08 -.12 .02 p&g .10 .10 .10 industry .08 .08 .08 as can be seen from table 5, twelve of the companies' return on investment exceeded that of its industry, with only fluor underperforming its industry. caterpillar's return on investment of -.03 in 1982 compares favorably to the .12 composite figure for the industry. the largest margins 42 of outperformance were by ibm, hewlett-packard, digital, and emerson. the return on investment ratios for these excellently managed companies roughly parallel their industry, but are consistently above. referring to table 2, it is noteworthy that ibm, digital, hewlett-packard, delta, emerson, johnson and johnson, 3m, boeing, and proctor and gamble maintained higher returns on investment with lower levels of financial leverage than did their industries. summary and conclusions it appears from this study that the analysis of financial ratios generally backs up the contention of excellent management for the five companies examined. this is not to say that in every case the company outperformed its industry, but in terms of accounts receivable turnover, debt/asset ratios, and return on investment (and in general, inventory turnover) the comparisons were favorable. ratio analysis is a useful tool of financial analysis, but the user should be aware of its limitations. a particular ratio should not be taken out of context, that is, viewed independently of its relation to other information about the company, the industry, or even the economy as a whole. but in such a comparison there arises another major weakness of ratios, the inconsistency of their computations (3, p. 78). one choosing to compare companies based on ratios should be sure those ratios were computed using similar bases. one means of countering this is to obtain all the ratios under consideration from one source. despite these weaknesses, ratios are valuable. they provide an inexpensive, easily obtained means of analysis for the average investor or analyst. studies such as peters and waterman's provide excellent in-depth information, but they are impractical or impossible for most people. when viewed from a cost/benefit perspective, financial ratios provide starting points from which more detailed study can be done. appendix a companies included in industry composites ibm, et al. burroughs control data ncr pitney-bowes speed-o-print xerox emerson aeroflex labs conrac general electric dana arrow automotive arvin industries borg-warner donaldson dynalectron echlin fruehauf facet enterprises hastings mfg. kysar raymark 43 delta amr corp-del alaska airlines aloha, inc. eastern air lines frontier holdings hawaiian airlines klm royal muse air northwest airlines ozark airlines psa litton n.a. philips tractor westinghouse caterpillar allis-chambers am. hoist and derrick bucyrus-erie cmi clark equipment pengo prodor &t gamble clorox colgate-palmolive economic laboratory nch oaklite stephan chemical j at j, 3m am. controlled ind. bemis co. dennison ipea papercraft rexham tambrands technical tape tranzonic standard products superior products transway wynn's boeing bangor punta cessna glatfelter general dynamics grumman mcdonnel douglas fluor amca int. alpha portland banister cont. elgin foster wheeler great lakes halliburton mcdowell ent. morrison-knudson l.e. myers group perini references pan am piedmont aviation republic airlines texas air tiger twa val usair western airlines world airways mcdonald's ara services carrol's devl. church's collins denny's frisch's helm resources kapok tree inns marriott pizza inn ponderosa restaurant assoc. saga corp. 1. bernstein, leopold a., the analysis of financial statements homewood, illinois: dow jones-irwin, 1978. 2. gibson, charles h., "how industry perceives financial ratios," management accounting, (april, 1982): 13. 3. gibson, charles h., "the need for disclosure of uniform financial ratios," the journal of accountancy, (may, 1980): 78. 4. helfert, erich a., techniques offinancial analysis homewood, illinois: dow jones-irwin, 1972. 5. investors management sciences, inc., compustat englewood, co: mcgraw-hill company. 6. peters, thomas j., and robert h. waterman, jr. in search of excellence new york: harper and row, 1982. 7. weston, j. fred, and eugene f. brigham, managerial finance hinsdale, illinois: the dryden press, 1981. 44 evaluation and use of financial ratios in assessing management excellence shareholder wealth maximization unde non-constant marginal cost of capital: lifeway science, inc.1 robert stretcher sam houston state university • huntsville, texas steve johnson sam houston state university • huntsville, texas mary funck sam houston state university • huntsville, texas introduction traditional capital budgeting methods used in capital expenditure decisions are routinely applied to managerial decisions. each method has its own strengths and weaknesses, and is often positioned in relation to another in assessments of the validity of the method. the capital expenditure decision is also traditionally thought of as separate from the funding of capital projects; that is, the cost of capital is considered a given in expositions of capital budgeting decision criteria. most finance textbooks, and indeed, most managers, accept simplifying assumptions in order to avoid the complications associated with a true business environment. for example, while a manager might wish to consider the funding of capital expenditures a separate and distinct decision, funds providers, particularly creditors, certainly consider the two decisions intertwined. in fact, creditors funding capital assets often require specific assets to be pledged as security in order to have a secondary repayment conduit if the primary means of repayment fails. while the pledging of collateral may not materially affect a capital budgeting decision in some cases, other elements of capital budgeting complexities might. the presence of mutually exclusive projects, projects with unequal lives, and presence of multiple divisions are all possible complicating factors in the decision process. one complexity present in virtually all capital budgeting analyses, yet assumed away or ignored by both finance educators and practicing managers is the presence of nonconstant marginal cost of capital. assuming some benchmark discount rate for use with capital budgeting techniques may simplify the analysis of projects, but can lead to overor under-investment, inclusion and exclusion errors, and substantive errors in estimating the shareholder wealth consequences of accepting or rejecting a capital project. it is difficult to determine a correct business strategy if a key element of the business reality is ignored or assumed away. there are, however, few resources 36 journal of business strategies available to educators or practicing managers that highlight the decision errors that can result from not recognizing the effects of the non-constant marginal cost of capital. it is in this spirit that anecdotal scenarios, or cases, can be of help to both educators and practicing managers in understanding the proper application of capital budgeting methods. the case featured in this paper concerns a small company considering five investment projects. the question posed in the case appears simple at first glance: assess the independent projects under consideration and come up with an optimal investment decision. the non-constant marginal cost of capital faced by the company, however, requires a solution that is more complex than decision methods presented in textbooks, usually the case when real business situations are addressed. the reader is tasked with figuring out and performing the appropriate solution, given the typical analytical tools (excel, and perhaps other software) and time pressures of a professional management environment. the case is appropriate for senior level finance majors, or perhaps administrative problems courses at the mba level. in a group setting, students should expect to spend 10-20 hours on the solution, depending on the degree of automation they can achieve with analytical software. case assignment for distribution to students lifeway science, inc.: a capital budgeting challenge nathan young, a recently hired financial manager for lifeway science, inc. (lsi), had been with the company for only three months. he had been given responsibility for the firm’s capital budget for the current year. the chief financial officer (cfo), natalie miller (nathan’s direct supervisor), had given nathan a brief history on her past capital budgeting methods and project selections. natalie had been the sole financial manager for the firm for the past four years, and had brought in some personal biases four years ago, and had developed several more since. she had emphasized a strong (exclusive?) preference for the modified internal rate of return (mirr) method for making the firm’s investment decisions. nathan had listened carefully to her summary and had some records from the past capital budgeting processes. nathan had graduated three years prior from a regional state university with a degree in finance, and had gone to work for a community bank in memphis, tennessee, first as a credit analyst, and then as a loan officer and vice president of the volume 30, number 1 37 credit department. he had lost interest in making loans, though, in those three years, and was seeking to find a more challenging (and better paying) career when the position at lsi became available. a friend had referred him to natalie, and he changed positions last october. nathan fully understood the mirr method and its assumptions. the method assumed that the cashflows from the project would be reinvested at the firm’s cost of capital. this differed from the traditional internal rate of return (irr), which assumed that cashflows from the project were reinvested at the same irr as the project. this was not a problem when the irr was sufficiently close to the firm’s cost of capital, but problematic for projects with an exceptionally high return, since the likelihood of finding other exceptionally high return projects in which to reinvest was questionable. a ‘rate of return’ had qualities of both meaning to laypeople (most people understand a percent return) and use as a ranking measure. and the irr decision rule also considered the required returns of funds providers, unlike the payback period. the opportunity to apply his academic finance background was appealing, after his three years of performing credit analyses for a lender. nathan really had no problem with the mirr method — it was perhaps the best one to use, along with the net present value (npv) method; he recalled that from his managerial finance courses in college. lsi projects lsi has several projects under consideration. the sales and cost estimates are already done for these projects, using information from the marketing manager and the firm’s internal accountants. the expected net operating cashflows (nocf’s) were estimated based on this information. the first project involves building a $2.8 million facility to produce massage tables and chairs, and physical therapy machines. the project has a fifteen year scope. the second project, a ten-year $1.9 million project, is an equipment update in one of lifeway’s lease facilities. the rental income and costs were provided to nathan. the third project, a $1.4 million project, has a ten-year life. it is also an equipment upgrade. the fourth project is a $2 million tenyear project involving the creation of a new lease facility, including a stand-alone building with physical therapy equipment. the lease has already been arranged with a chiropractic group in memphis. the last project, at $1.86 million, is a production facility where electronic monitoring systems would be produced. the exact estimates for net cash inflows and project costs are presented in exhibits 2 through 6. 38 journal of business strategies these projects fall into the traditional product/service lines that lsi had been managing for several years, and none of them represents a major expansion for the company. they are all independent, with no contingency or mutual exclusivity. capital costs nathan had been provided with a generic “benchmark” cost of capital figure, 12.3%, which was apparently the extent of the information that had been used in previous capital budgeting analyses. upon further exploration with the firm’s cost accountants, he discovered that this was the same capital cost that had arbitrarily been used for years, with disregard for the equity required returns, bond yields, or lender-specified rates that were prevailing at a given point in time. nathan began to wonder about the decisions that had been made in the past based on this unchanging capital cost, and being a new analyst, was determined not to fall victim to an unrealistic assumption in this dynamic fundraising environment. nathan began to explore the firm’s actual current capital cost. he contacted the four commercial banks that the firm appeared to work with on a regular basis. each lender worked with nathan to construct a loan appropriate to the risks associated with the overall projects (which were about the same as the firm’s existing business). the rates were different for each lender, since each lender faced different subordination of claims to earnings and collateral pledged as security on the loans. nathan collected commitments from each one for the rates, terms, and limits for their long-term financing alternatives for the firm. he then looked at the going yield for the firm’s bonds, and summarized dividend, growth, and pricing information for the firm’s stock to estimate internal and external costs of equity financing. nathan also looked at the firm’s present debt use in comparison to some of the firm’s peers. he found that lsi was using about 49% debt in its capital structure. the peer firms were using substantially more debt, and seemed to be flourishing at the higher level. he also noted that lsi’s coverage ratios were more than adequate to sustain payments to creditors, even if the firm adopted greater debt use. he recommended to natalie that the firm use about 82% debt for any of the expansion projects currently under consideration, and she was agreeable. each wacc level in the mcc schedule given in the case is a weighted average of debt (82%) and equity (18%) cost. the breakpoints represent the jump in cost as a firm exhausts either a cheaper source of debt or equity (retained earnings). the heavier weight on debt financing was reflected in more pronounced increases in the firms wacc as the cheaper sources were exhausted. the new policy would increase lsi’s debt ratio, but would volume 30, number 1 39 still leave it lower than the average for the peer firms, but closer to the average. the implied marginal cost of capital schedule (given the series of breakpoints based on the available retained earnings and four debt limits from the banks) is presented in exhibit 1. in his earlier discussion with natalie, he was told that management had no intention of placing an artificial budget constraint on the investment decisions; any projects that were acceptable would be adopted for investment. it was up to nathan to demonstrate the attractiveness of the projects, justify his decisions, and manage all of the arrangements for the accepted investments to be undertaken. dependence of mirr and npv on mcc nathan’s belief that using the arbitrary 12.3% cost of capital was erroneous had the effect of complicating matters. while assuming a constant cost of capital had allowed a fairly simple capital budgeting decision in the past, it had not taken the actual capital costs into account. however, nathan now realized that his accurate mcc schedule, which increased in a stepwise manner, made a simple decision using the mirr impossible. the mirr level depended on the magnitude of the mcc used as the reinvestment rate input. at the same time, he had already agreed with natalie during his series of interviews that the mirr was the ideal method to use. going against that agreement now might cause significant friction between them, friction that nathan would be causing in reversing his earlier position. his thoughts were focused on this as he drove home. it was now the evening of december 28th, a wednesday, and the capital budget was expected at the beginning of january. nathan decided to analyze the projects as best he could over the coming long weekend; the firm would be closed from december 30th through january 2nd. he poured himself a cup of coffee and walked into his “study” (a corner of his living room). he had kept his advanced financial management book from his undergraduate program. after perusing it for an hour, he came to the conclusion that this particular element of capital budgeting simply had not been covered. the mirr benefits and drawbacks had been discussed but not in terms of the current business reality facing him: a non-constant marginal cost of capital. nathan determined, however, that he would figure out the correct methodology. he reluctantly decided to start with “natalie’s technique” and evaluate each project using the constant cost of capital. then he could address how critical the error was by using a proper decision method. 40 journal of business strategies exhibit 1 marginal cost of capital schedule 8 10 6 12 14 16 18 20 1.1135 2.9556 4.5131 4.9121 7.7903 10 m ill io ns 7.552.50 6.28% 8.34% 10.95% 14.71% 16.19% 19.5% mcc % exhibit 2 project a cashflow estimates year est. cashflow 0 -$2,794,561.00 1 $398,198.00 2 $429,472.00 3 $419,830.00 4 $406,287.00 5 $400,190.00 6 $397,287.00 7 $390,844.00 8 $385,924.00 9 $381,955.00 10 $376,921.00 11 $371,438.00 12 $361,847.00 13 $348,730.00 14 $309,177.00 15 $278,276.00 volume 30, number 1 41 exhibit 3 project b cashflow estimates year est. cashflow 0 -$1,900,250.00 1 $398,291.00 2 $402,389.00 3 $393,839.00 4 $391,112.00 5 $387,340.00 6 $379,004.00 7 $374,854.00 8 $369,789.00 exhibit 4 project c cashflow estimates year est. cashflow 0 -$1,394,527.00 1 $0.00 2 $0.00 3 $399,789.00 4 $379.837.oo 5 $368,471.00 6 $352,909.00 7 $332,746.00 8 $321,736.00 9 $313,808.00 10 $301,548.00 exhibit 5 project d cashflow estimates year est. cashflow 0 -$1,933,980.00 1 $365,990.00 2 $360,980.00 3 $358,276.00 4 $349,999.00 5 $345,090.00 6 $239,856.00 7 $334,856.00 8 $329,377.00 9 $320,002.00 10 $319,897.00 exhibit 6 project e cashflow estimates year est. cashflow 0 -$1,856,945.00 1 $0.00 2 $0.00 3 $0.00 4 $0.00 5 $362,994.00 6 $389,089.00 7 4385,412.00 8 $380,189.00 9 $375,189.00 10 $371,254.00 11 $368,534.00 12 $366,259.00 13 $360,158.00 14 $358,613.00 15 $335,123.00 16 $352,197.00 17 $350,088.00 18 $345,987.00 19 $340,127.00 20 $334,157.00 21 $328,657.00 22 $320,121.00 23 $312,599.00 24 $304,572.00 25 $299,099.00 26 $294,948.00 42 journal of business strategies teaching note under natalie’s unrealistic simplifying assumption of a constant marginal cost of capital across the range of investment at a point in time, it is easy to initiate a simple mechanical process for calculating net present values and modified internal rates of return, since both are dependent on the cost of capital as an input. unfortunately, the assumption is very likely to result in suboptimal capital budgeting decisions, as in this case. in exhibit tn1 the irr, mirr, npv, and acceptance decisions associated with using natalie’s “benchmark” cost of capital are presented. exhibit tn1 constant cost of capital 12.30% total npv using constant cost of capital $15,921 project irr npv mirr accept total npv a 11.11% ($166,108) 11.84% no $0 b 12.54% $15,921 12.42% yes $15,921 c 12.14% ($11,249) 12.21% no $0 d 11.08% ($94,200) 11.76% no $0 e 11.76% ($99,651) 12.09% no $0 a constant marginal cost of capital, however, would seldom describe the actual fundraising costs faced by a firm at any given point in time; instead, firms generally line up financing for their capital budget where convenient, usually from multiple sources. this is the case for lsi. each wacc level in the mcc schedule given in the case is a weighted average of debt (82%) and equity (18%) cost. the breakpoints represent the jump in cost as a firm exhausts either a cheaper source of debt or equity (retained earnings). in order to emphasize the error associated with using natalie’s benchmark, the breakpoints have been exaggerated in comparison to the actual breakpoints encountered by the disguised subject firm. the irr method is fairly straightforward, as its calculation is independent of the firm’s cost of capital. the irr solution, though, would result in a sub-optimal solution (shown in exhibit tn2), since the npv of the order of projects implied by the irr is only $659,710.52, accepting projects b and c according to the investment opportunity schedule (ios) in figure 1. volume 30, number 1 43 exhibit tn2 figure 1 marginal cost of capital and investment opportunity schedule superimposed 8 10 6 12 14 16 18 20 1.1135 2.9556 4.5131 4.9121 7.7903 10 m ill io ns 7.552.50 6.28% 8.34% 10.95% 14.71% 16.19% 19.5% mcc ios % b 12.544437% c 12.140555% e 11.76184896% a 11.108696% d 11.077726% 1.9003 3.2948 5.1517 7.9163 9.9303 the projects are presented in order of attractiveness according to the irr. projects b and c are accepted, since their irr’s exceed the mcc throughout the scope of investment (up to $3,294,777) and projects a and d are rejected since the mcc exceeds their respective irrs. the decision on project e, however, is less clear since its spans one mcc level below and two levels above its irr. the marginal project is evaluated using the appropriate weighted mcc: $4,513,100 3,294,777 wmcc = ( ) (10.95) + $1,856,945 $4,912,100 4,513,100 $5,151,722 4,912,100 ( ) (1471) + ( ) (16.19) $1,856,945 $1,856,945 wmcc = 12.434% 44 journal of business strategies since the weighted mcc for project e exceeds the irr of 11.762%, the project is rejected. in some cases, the irr decision might represent shareholder wealth maximization. the maximum npv selection, though, is the optimal decision. in this case, the total npv associated with the irr decision is $659,710.95 for accepting projects b and c (using appropriate mcc inputs of .071329 and .089748 for projects b and c, respectively). the net present value for the remaining possible permutations must be determined for the accepted projects for each permutation to determine if it is the true optimal capital budget. a rather cumbersome technicality, however, for using either net present value (npv), or modified internal rate of return (mirr), is that these require the project’s marginal cost of capital (mcc) as an input. the order of presentation, as well as the combination of projects, is necessary to consider, since projects ordered first are assessed using lower mcc averages than those ordered subsequently. reinvestment of cash flows at the appropriate mcc often creates profound differences in project npv based on the rank ordering. to illustrate, suppose we select a different order of projects than the order shown in exhibit 1, (e a b c d). the net present value (or the mirr) can be calculated using the weighted mcc for each project, and then the npv’s for the accepted projects totaled. for this permutation, the ios changes: figure 2 marginal cost of capital and investment opportunity schedule superimposed 8 10 6 12 14 16 18 20 1.1135 2.9556 4.5131 4.9121 7.7903 10 m ill io ns 7.552.50 6.28% 8.34% 10.95% 14.71% 16.19% 19.5% mcc ios % e 11.761848% a 11.108696% b 12.544437% c 12.140555% d 11.077726% 1.8569 7.9463 9.9303 4.6515 6.5518 volume 30, number 1 45 in figure 2, the ios is superimposed on the mcc with the eabcd rank ordering. it is interesting to note that the irr (the height of each project) is always irrelevant when determining the npv. the inputs that matter are the cashflows of each project (including the initial cash outflow as the width of each project) and the appropriate wmcc applied to each project. in this case, the total npv associated with this permutation is $1,441,440.44 for accepting projects e and a (using appropriate wmcc inputs of .0710474 and .101101246 for projects e and a, respectively). note that the npv associated with accepting projects e and a exceeds both that of the irr decision and the decision implied by using natalie’s “benchmark” method. neither of the two permutations exhibited above, however, represents the maximum npv solution. to be certain of a maximum npv solution, the calculation must be repeated for all possible permutations. there are several possible approaches to solution of the dilemma. first, a manual approach could be used — rather cumbersome, given that there are 120 (5!) possible permutations, but certainly an alternative, especially since students may not be familiar enough with programming to automate the process. second, there are various alternatives for producing a programmed solution. students with good programming backgrounds in excel can create solutions for each permutation and select the maximum npv result. more sophisticated processes can be created using visual basic or other programming languages. a combination could also be used, such as using the visual basic add-in in conjunction with excel spreadsheets. the analytical output, regardless of the process to handle calculations, is a net present value associated with each possible permutation. the npv solution for each appears in tables 1a, 1b, and 1c. the maximum npv solution is $1,555,930.02, highlighted in table 1c for the two permutations tied for highest npv (ecbad and ecbda). in either case, projects e, c, and b are accepted and projects a and d are rejected. to check students’ work, tables 1a, 1b, and 1c can be referenced. the detail for the optimal solution appears in exhibit tn3. 46 journal of business strategies exhibit tn3 (rank order 1,2,3,4,and 5 corresponds to projects a,b,c,d and e respectively) permutations: 5, 3, 2, 1, 4 project investment mwacc npv 5 $1,856,945 7.10% $1,288,636.62 3 $1,394,527 8.89% $257,928.56 2 $1,900,250 12.40% $9,364.84 1 $2,794,561 16.37% $0.00 4 $1,983,980 19.50% $0.00 total npv: $1,555,930.02 optimal investment: $5,1561,722.00 permutations: 5,3,2,4,1 project investment mwacc npv 5 $1,856,945 7.10% $1,288,636.62 3 $1,394,527 8.89% $257,928.56 2 $1,900,250 12.40% $9,364.84 4 $1,983,980 16.19% $0.00 1 $2,794,561 18.72% $0.00 total npv: $1,555,930.02 optimal investment: $5,1561,722.00 volume 30, number 1 47 table 1a npv’s for permutations 1-40 (rank order 1,2,3,4,and 5 corresponds to projects a,b,c,d and e respectively) rank accepted permutation order total npv projects 1 1 2 3 4 5 $716,266,53 a, b 2 1 2 3 5 4 $716,266,53 a, b 3 1 2 4 3 5 $716,266,53 a, b 4 1 2 4 5 3 $716,266,53 a, b 5 1 2 5 3 4 $716,266,53 a, b 6 1 2 5 4 3 $716,266,53 a, b 7 1 3 2 4 5 $729,569.15 a, c 8 1 3 2 5 4 $729,569.15 a, c 9 1 3 4 2 5 $729,569.15 a, c 10 1 3 4 5 2 $729,569.15 a, c 11 1 3 5 2 4 $729,569.15 a, c 12 1 3 5 4 2 $729,569.15 a, c 13 1 4 2 3 5 $618,196.45 a 14 1 4 2 5 3 $618,196.45 a 15 1 4 3 2 5 $618,196.45 a 16 1 4 3 5 2 $618,196.45 a 17 1 4 5 2 3 $618,196.45 a 18 1 4 5 3 2 $618,196.45 a 19 1 5 2 3 4 $771,921.60 a, e 20 1 5 2 4 3 $771,921.60 a, e 21 1 5 3 2 4 $771,921.60 a, e 22 1 5 3 4 2 $771,921.60 a, e 23 1 5 4 2 3 $771,921.60 a, e 24 1 5 4 3 2 $771,921.60 a, e 25 2 1 3 4 5 $546,060.29 b, a 26 2 1 3 5 4 $546,060.29 b, a 27 2 1 4 3 5 $546,060.29 b, a 28 2 1 4 5 3 $546,060.29 b, a 29 2 1 5 3 4 $546,060.29 b, a 30 2 1 5 4 3 $546,060.29 b, a 31 2 3 1 4 5 $659,710.52 b, c 32 2 3 1 5 4 $659,710.52 b, c 33 2 3 4 1 5 $659,710.52 b, c 34 2 3 4 5 1 $659,710.52 b, c 35 2 3 5 1 4 $659,710.52 b, c 36 2 3 5 4 1 $659,710.52 b, c 37 2 4 1 3 5 $536,727.67 b, d 38 2 4 1 5 3 $536,727.67 b, d 39 2 4 3 1 5 $536,727.67 b, d 40 2 4 3 5 1 $536,727.67 b, d 48 journal of business strategies table 1b npv’s for permutations 41-80 rank accepted permutation order total npv projects 41 2 4 5 1 3 $536,727.67 b, d 42 2 4 5 3 1 $536,727.67 b, d 43 2 5 1 3 4 $931,421.00 b, e 44 2 5 1 4 3 $931,421.00 b, e 45 2 5 3 1 4 $931,421.00 b, e 46 2 5 3 4 1 $931,421.00 b, e 47 2 5 4 1 3 $931,421.00 b, e 48 2 5 4 3 1 $931,421.00 b, e 49 3 1 2 4 5 $723,519.16 c, a 50 3 1 2 5 4 $723,519.16 c, a 51 3 1 4 2 5 $723,519.16 c, a 52 3 1 4 5 2 $723,519.16 c, a 53 3 1 5 2 4 $723,519.16 c, a 54 3 1 5 4 2 $723,519.16 c, a 55 3 2 1 4 5 $738,071.12 c, b 56 3 2 1 5 4 $738,071.12 c, b 57 3 2 4 1 5 $738,071.12 c, b 58 3 2 4 5 1 $738,071.12 c, b 59 3 2 5 1 4 $738,071.12 c, b 60 3 2 5 4 1 $738,071.12 c, b 61 3 4 1 2 5 $657,310.59 c, d 62 3 4 1 5 2 $657,310.59 c, d 63 3 4 2 1 5 $657,310.59 c, d 64 3 4 2 5 1 $657,310.59 c, d 65 3 4 5 1 2 $657,310.59 c, d 66 3 4 5 2 1 $657,310.59 c, d 67 3 5 1 2 4 $1,193,210.45 c, e 68 3 5 1 4 2 $1,193,210.45 c, e 69 3 5 2 1 4 $1,202,575.52 c, e, b 70 3 5 2 4 1 $1,202,575.52 c, e, b 71 3 5 4 1 2 $1,193,210.45 c, e 72 3 5 4 2 1 $1,193,210.45 c, e 73 4 1 2 3 5 $463,466.52 d, a 74 4 1 2 5 3 $463,466.52 d, a 75 4 1 3 2 5 $463,466.52 d, a 76 4 1 3 5 2 $463,466.52 d, a 77 4 1 5 2 3 $463,466.52 d, a 78 4 1 5 3 2 $463,466.52 d, a 79 4 2 1 3 5 $562,033.60 d, b 80 4 2 1 5 3 $562,033.60 d, b volume 30, number 1 49 table 1c npv’s for permutations 81-120. rank accepted permutation order total npv projects 81 2 4 5 1 3 $562,033.60 d, b 82 2 4 5 3 1 $562,033.60 d, b 83 2 5 1 3 4 $562,033.60 d, b 84 2 5 1 4 3 $562,033.60 d, b 85 2 5 3 1 4 $593,337.54 d, c 86 2 5 3 4 1 $593,337.54 d, c 87 2 5 4 1 3 $593,337.54 d, c 88 2 5 4 3 1 $593,337.54 d, c 89 3 1 2 4 5 $593,337.54 d, c 90 3 1 2 5 4 $593,337.54 d, c 91 3 1 4 2 5 $847,501.24 d, e 92 3 1 4 5 2 $847,501.24 d, e 93 3 1 5 2 4 $847,501.24 d, e 94 3 1 5 4 2 $847,501.24 d, e 95 3 2 1 4 5 $847,501.24 d, e 96 3 2 1 5 4 $847,501.24 d, e 97 3 2 4 1 5 $1,441,440.43 e, a 98 3 2 4 5 1 $1,441,440.43 e, a 99 3 2 5 1 4 $1,441,440.43 e, a 100 3 2 5 4 1 $1,441,440.43 e, a 101 3 4 1 2 5 $1,441,440.43 e, a 102 3 4 1 5 2 $1,441,440.43 e, a 103 3 4 2 1 5 $1,507,687.79 e, b 104 3 4 2 5 1 $1,507,687.79 e, b 105 3 4 5 1 2 $1,507,687.79 e, b 106 3 4 5 2 1 $1,507,687.79 e, b 107 3 5 1 2 4 $1,507,687.79 e, b 108 3 5 1 4 2 $1,507,687.79 e, b 109 3 5 2 1 4 $1,546,565.18 e, c 100 3 5 2 4 1 $1,546,565.18 e, c 111 3 5 4 1 2 $1,555,930.02 e, c, b 112 3 5 4 2 1 $1,555,930.02 e, c, b 113 4 1 2 3 5 $1,546,565.18 e, c 114 4 1 2 5 3 $1,546,565.18 e, c 115 4 1 3 2 5 $1,421,464.95 e, d 116 4 1 3 5 2 $1,421,464.95 e, d 117 4 1 5 2 3 $1,421,464.95 e, d 118 4 1 5 3 2 $1,421,464.95 e, d 119 4 2 1 3 5 $1,421,464.95 e, d 120 4 2 1 5 3 $1,421,464.95 e, d 50 journal of business strategies communication and protocol issue in the case one element of the case that professors may want to stress is that, after the analysis of the possible permutations is complete and the maximum npv choice clear, it is still nathan’s responsibility to report his findings in a, let’s say, “politically sensitive” way, to natalie miller (nathan’s direct supervisor). it is clear from the case that the mirr method was her strong preference, and also clear that decisions in the past were based on faulty analysis, since her assumed “benchmark” cost of capital had been used as long as the accountants could remember. however, nathan would be well advised to avoid informing natalie of her errors (nobody likes to be told they’re wrong, especially if they are). while a variety of student responses to this dilemma may be forthcoming, we suggest a way that potentially maintains the integrity of the analysis and calms the potential storm from the change in decision process. we suggest that nathan should calculate mirr’s for each of the accepted projects based on the proper rank ordering, and present this to natalie as the optimal decision. in the report to natalie, nathan should explain the optimizing methodology, dismissing the irr method’s decision as suboptimal, and position the rank ordering as the basis for determining proper mcc’s for each of the projects in the maximizing permutation. he should base the mirr calculations on these mcc’s. the mirr’s are what natalie expects in the report, after all. nathan should not mention the prior practice of assuming a benchmark rate, since it is an incorrect method, unless someone challenges him about it. instead, he should highlight the credit terms offered by the actual creditors supporting the capital budget. while this does not guarantee that no negative reactions occur, it might help to minimize the possibility. finally, nathan might want to be prepared for the uninformed nay-sayer who uses natalie’s “benchmark” rate of 12.3% cost of capital to come up with the “decision” since it is possible someone might bring it up publicly (in front of natalie). he might want to refer to the npv implied by that method (presented earlier in the teaching note), and be prepared to show that it is not the maximum npv decision. the true npv (using the actual wmcc of .0713289) if only project b is accepted is $408,955, obviously suboptimal. while we certainly do not support presenting incorrect processes or answers to students, professors may want to stress the possible errors that managers may make, and how nathan should deal with that awkward situation in a sensitive (job-preserving) way. volume 30, number 1 51 possible use of “leading questions” for student groups that may need more guidance to reach the proper conclusions in the case, professors may wish to structure some “leading” questions: 1) what decision is implied by the irr method using the arbitrary benchmark cost of capital? 2) is the associated npv optimal? 3) why does the order in which projects are listed in the investment opportunity schedule important to assure maximizing the npv? 4) what ordering of projects maximizes the npv for the capital budget under consideration? 5) what are some of the politics involved with asserting a valid analysis, given the improper analyses performed in the past by nathan’s cfo? it is at the professor’s discretion to use these questions or their own series of questions to guide students through the thought process. for more advanced students, the professor may prefer to simply make the task to “solve the case.” note 1 the authors would like to thank the following participants at the 2012 financial education association meeting for insightful comments: irv degraw, jocelyn evans, robert heller, sivarama krishnan, thomas musser, and stephanie smith. biographical sketches of authors dr. robert stretcher is a professor of finance at sam houston state university. he earned his phd in finance and monetary economics from the university of tennessee. his research focuses on empirical market studies, applied finance, and finance education. dr. stretcher has held prominent positions in the academy of economics and finance and the institute of finance case research, and has served on editorial boards and as editor of various finance journals. dr. steve johnson is an assistant professor of finance at sam houston state university. he earned his phd from the university of utah. his research focuses on real options, applied finance and finance education. dr. johnson serves in various capacities in the academy of economics and finance and is managing editor of the journal of instructional techniques in finance. dr. mary funck is an assistant professor of finance at sam houston state university. she earned her phd from the university of mississippi. her research focuses on market microstructure, applied finance and finance education. volume 34, number 2 97 empirics of the traditional u.s. phillips curve: evidence from 1930-2016 muhammad mustafa south carolina state university • orangeburg, sc matiur rahman mcneese state university • lake charles, la abstract this study revisits the trade-off relationship between inflation and unemployment rates for the usa, as observed by the traditional philips curve. annual data are used from 1930 to 2016. the ardl bounds testing approach is applied accompanying efficient unit roots testing [(df-gls) and (ng-perron) tests] and the determination of the order of integration of the variables in levels. the ardl bounds testing estimates confirm co-integration between the above variables. the estimates of error-correction model (ecm) clearly support the existence of the traditional philips curve for the long run, but subdued for the short run. however, there is evidence of short-run interactive feedback effect between the variables. key words: phillips curve, efficient unit root testing, ardl, bounds testing, vecm jel classifications: e24, e31, e32 introduction the traditional phillips curve is an empirical observation from statistical plots of uk’s wage inflation and unemployment rates over 1861-1957 revealing a tradeoff (inverse) relationship between the above (phillips, 1958). this relationship is useful to formulation and implementation of monetary and fiscal policies striving for a comfortable combination of both to ensure macroeconomic stability. to keep inflation at a tolerable level and to reduce unemployment rate toward a full employment level is a serious challenge to macroeconomic policymakers. at the same time, the phillips curve underscores the limitation of macroeconomic policies to deal with both problems simultaneously over various phases of near-inevitable business cycle. for example, expansionary policies are invoked during recession period to reduce unemployment rate risking future surge in inflation rate. conversely, contractionary policies are pursued to tame rising inflation rate risking future higher underemployment rate during a period of strong economic recovery. 98 journal of business strategies during the 1970s oil crisis, the us economy experienced stagflation questioning the existence of the phillips curve. again, the reversal of stagflation to soft-landing during the 1990s posed the same question. the most recent us great recession (december 2007-june, 2009) called for unprecedented expansionary monetary and fiscal policies. amid fluctuations, the unemployment rate from a peak of 10% in 2009 tepidly came down to 4.2% in september, 2017 with persistent average inflation rate at 1.5% annually in recent years. this is below the fed’s hypothesized 4.6% natural unemployment rate. but inflation rate is not rising. seemingly, this is inconsistent with the assertion of the traditional phillips curve. prevailing low inflation during the period is largely attributed to several global factors (e.g., plunging crude oil price, strong us dollar, falling metal prices, slowing of china’s economy). questions are also being raised regarding the short-run and long-run validity of the phillips curve including its stability. in light of the foregoing brief discussions, this topic merits a further empirical revisit in the us context analyzing data for 1930-2016. thus, the sole focus of this econometric inquiry is to obtain additional insights. the autoregressive distributive lag (ardl) bounds testing and vector error-correction (vecm) models are implemented. the remainder of the paper proceeds as follows: brief review of the related empirical literature; empirical methodology; results and conclusions with policy implications. brief review of related empirical literature phillips (1958) inspired numerous subsequent theoretical and empirical studies for validation, refutation and questioning the existence of the traditional phillips curve (e.g., lipsey, 1960; solow, 1970; onder, 2004). lipsey (1960) finds an inverse relation for uk prior to the world war-i (1914 1918), but not after the world war-ii. turner (1997) argues that structural break since the 1970s in uk’s economy may have caused the instability of the traditional phillips curve. he emphasizes more on the stability than its existence. atkeson and ohanian (2001) also support turner (1997). hansen and pancs (2001) find inverse relation between the series for lativa. bhanthumnavin (2002) finds evidence of the phillips curve for thailand, but only in the post -1997 asian flu. graham and snower (2002) demonstrate a stable phillips curve for chile. they argue that the trade-off in the long run is due to inter-relation between money growth and rise in nominal wages. using stock-watson procedure, furuoka (2007) finds relation between inflation and unemployment for malaysia, which was later confirmed by tang and volume 34, number 2 99 lean (2007). schreiber and wolters (2007) apply var co-integration approach and find a long-run relation for germany. friedman (1968) argues that this relationship is only short-run phenomenon. in the long run, workers and employers take inflation into account in employment contracts that increase pay at rates near anticipated inflation. this implies that over the long run, there is no tradeoff between inflation and unemployment. niskannen (2002) points out that the phillips curve in its original form suffers misspecification and that the positive slope of the long-run phillips relation may be due to lack of indexed tax code. gali et al., (2005) and rudd and whelan (2005) use gmm approaches but fail to find strong phillips curve relation. reichel (2004) applies co-integration method to the industrialized economies but find trade-off only for the usa and japan. karanassou, et al.(2008) also analyze the relation between us inflation and unemployment from the perspective of ‘frictional growth’. in particular, they focus on the interaction between money growth and nominal frictions and conclude that monetary policy has not only persistent, but permanent real effects, giving rise to a long-run inflationunemployment trade-off. karanassou, et al. (2010) employ the chain reaction theory approach for the new phillips curve to provide a synthesis of the traditional structural macroeconometric models and the (structural) vector autoregressions. they again show that frictional growth, i.e. the interplay between lags and growth, generates an inflationunemployment trade-off in the long run. they, therefore, suggest that a holistic framework, such as, the chain reaction theory, should be used to jointly explain the evolution of inflation and unemployment. malinov and sommers (1997), and turner and seghezzea (1999) both employ seemingly unrelated estimation method and confirm phillips curve relation. eliasson (2001) specifies linear phillips curve for sweden, australia, and the united states and check for parametric stability. they do not find the phillips curve for australia and sweden, but find one for the usa. unlike islam et al. (2003) revisit the us phillips relation using 1950-1999 data, but did not find a strong relation. del boca et al. (2008) find phillips curve for italy for 1861-1998. the paper captures the effects of structural changes and asymmetries on the estimates of the trade-off relation and finds that a trade-off exists only during low inflation and stable aggregate supply. russell and banerjee (2008) investigate vertical phillips curve assuming non-stationarity in the time series data. they find positive relation between inflation and unemployment rates in the short run for the united states. paul (2009) argues that droughts, oil shocks and liberalization policy of the early 1990s may be the reason for the absence of a phillips curve in india. after adjusting for the shocks, 100 journal of business strategies this study finds the evidence for the phillips curve suggesting a short-run trade-off between inflation and industrial output for india. focusing on regimes of inflation and unemployment and using the statistical technique of fuzzy clustering, ormerod et al. (2003) explore for the united states, the united kingdom and germany between 1971 and 2009. they report that the factors which govern the inflation/unemployment trade-off are so multi-dimensional that it is hard to identify periods of short-run phillips curves which can be assigned to particular historical periods with any degree of accuracy or predictability. they, therefore, identify for each country three distinct regimes in inflation/unemployment space and find that similarities exist across countries in both the regimes and the timings of the transitions between regimes. according to them, the inflation/ unemployment relationship or the phillips curve experiences from time to time major shifts. the relationship inherently is unstable even in the short run. they, however, conclude that the typical rates of inflation and unemployment experienced in the regimes are substantially different. fitzgerald and nicolini (2013) could not find stable us phillips curve over the last forty years using national annual data. in contrast, they found stable regional phillips curves for the usa over the same period with consistent negative relationship between regional inflation and unemployment. financial friction and shocks could imply slow recoveries and persistently low inflation. several recent papers [e.g., blanchard (2016); and gilchrist and zakrajsek (2013)] have shown that financial frictions play an important role in shaping the dynamics of prices after the recent global financial crisis. globalization has increased the role of international factors and decreased the role of domestic factors in the inflation process in industrial economies. these hypotheses originated from the concerns of some monetary policymakers of an increasing disconnect between monetary policy on one side and domestic inflation and long-term interest rates on the other. the evidence of the importance of global factors is however mixed (ihrig et al. 2010; bianchi and civelli 2015). the inability of stabilization policy duet to the effective lower bound on policy rates to lower real interest rates enough to bring the economy back to long-run sustainable levels and to achieve longrun inflation goals. policymakers have emphasized how persistently low inflation poses substantial risks if monetary policy is constrained by the zero bound, and could derail the economic recovery (e.g., constanciao, 2014). the studies on the evolution of the relation between inflation and unemployment [e.g., blanchard, et al (2015); ball and mazumder (2011); kiley (2015)] conclude that i) low unemployment still pushes inflation up; high unemployment pushes it down. put another way, the us phillips curve is alive. ii) inflation expectations, volume 34, number 2 101 however, have become steadily more anchored, leading to a relation between the unemployment rate and the level of inflation rather than the change in inflation. in this sense, the relation resembles more the phillips curve of the 1960s than the accelerationist phillips curve of the later period. iii) the slope of the phillips curve, i.e., the effect of the unemployment rate on inflation at given inflation expectation, has substantially declined. but the decline dates back to 1980s rather than to the recent financial crisis. there is no evidence of further decline during the crisis. iv) the standard error of the residual in the relation is large, especially in comparison to the low level of inflation. empirical methodology the basic estimating model is specified as follows: inft�=�∝+�βurt�+�et………………………(1) where, inf = inflation rate, ur= unemployment rate, e = error term that is independently and identically disturbed, and t= time subscript. this study employs the unrestricted ardl bounds testing approach to cointegration following the methodology proposed in [pesaran and pesaran (1997), peasran and shin (1999), pesaran, et al. (2001)]. this methodology is preferred to classical co-integration procedures (johansen, 1988, 1991; johansen and juselius, 1990) as it has certain advantages over them. for example, it can be applied regardless of the time series properties of variables in the sample. secondly, it allows for separate unbiased inferences on long-run and short-run estimates with valid t-values which are not possible under the classical co-integration procedures. furthermore, ardl model can accommodate a greater number of variables in comparison to vector autoregressive (var) models. also, this approach is applicable to relatively small sample size. to begin with, data have to be tested for unit root. this testing is necessary to avoid the possibility of spurious regression as bounds test is based on the assumption that the variables are i(0) or i(1). if data are found i (0) or i (1), the unrestricted ardl approach to cointegration is applied. however, for any i (2) variable, the system may crash. thus, unit root tests are desirable to avoid this possibility. the existence of a long-run relationship between or among the variables is established by testing for the significance of one-period lagged level variables in an error-correction mechanism regression. then, the first lags of all variables in level are added to the equation to create the error-correction mechanism equation for performing additional test by computing the f-test on the significance of all the lagged variables. the 102 journal of business strategies ardl form of equation is estimated where the optimal lag-length is selected by akaike (1969) information criterion (aic). low aic-value indicates good fit of the model with minimum loss of information. the ardl representation for co-integration is specified as follows: for null hypothesis (ho) of no co-integration, ψ = γ = 0 ……. for alternative hypothesis (ha) of co-integration, ψ ≠γ ≠0 ……. this method provides lower and upper bound critical values where the lower bound critical values assume all variables are i(0) and the upper bound critical values assume all variables are i(1). if the calculated f statistic exceeds the upper bound critical f-value, the null hypothesis of no co-integration is rejected. if it falls below the lower bound critical f-value, the null hypothesis of no long-term relationship cannot be rejected. however, if it falls within the bond of the above critical f-values, inference would be inconclusive. on the evidence of co-integration, an errorcorrection model using the first-differences of the variables is estimated for long-run solution, and to determine the speed of adjustment toward long-run equilibrium. a general error-correction model following engle and granger (1987) is specified below: the estimated coefficient (𝜋̂ ) of the error-correction term (ect−1) is expected to be negative and significant in terms of the associated pseudo t-value for longrun convergence and causal flows. if 𝑖’s and 𝑖’s are non-zeros, lagged changes in unemployment and inflation rates lead the current change in inflation rate in the short-run. their relative numerical magnitudes indicate relative influence of the relevant explanatory variable on the dependent variable. the sum of the coefficients of each lagged independent variable shows its net interactive feedback effect with other variables. to restate, annual time-series data for the usa are utilized spanning over 1930 to 2016. the relevant data are obtained from the bureau of economic analysis. results prior to testing for cointegration, the time series properties of the variables involved are examined. to test for unit root (nonstationarity) in the variables, the modified dickey-fuller (df-gls) test and the modified phillips-perron (ng-perron) test (elliot et al., 1996; ng and perron, 2001) are applied. the fairly standard kpss (kwiatkowski, phillips, schmidt and shin, volume 34, number 2 103 1992) test for no unit root (stationarity) and the adf and pp tests are not employed for concerns of their high sensitivity to the selection of lag-lengths. it is important to examine the time series properties of variables since an application of the ordinary least squares (ols) to estimate a model with nonstationary time series data results in the phenomenon of spurious regression (granger and newbold, 1974) invalidating the inferences through the standard t-test and joint ftest (phillips, 1986). efficient df-gls and ng-perron unit root tests results are reported as follows: table 1 unit root tests variable levels first difference df-gls without trend with trend without trend with trend ur -1.5846 -2.1676 -1.1302 -3.59787** inf -0.8390 -1.4064 -1.7470 -3.0144* ng-perron ur -1.51889 -2.0605 -2.1184 -4.4269** inf -4.4099** -13.1577** 4.14099** -13.1577*** note: *, ** and *** denote stationary at 10%, 5% and 1% significance levels, respectively. as observed in table 1, unemployment rate is stationary in level depicting i(0) behavior, while inflation rate is nonstationary in level with i(1) behavior at 5 percent level of significance. the ardl estimates for co-integration corresponding to eqution (2) are reported as follows: 104 journal of business strategies table 2 ardl bounds test null hypothesis: no long-run relationships exist test statistic value k f-statistic 4.27 1916 1 critical value bounds significance i0 bound i1 bound 10% 3.02 3.51 5% 3.62 4.16 2.5% 4.18 4.79 1% 4.94 5.58 the coefficient of urt−1 and inft−1 in equation (2) are statistically significant and non-zeroes. the computed f-statistic for ardl bounds testing is 4.27916 and above the upper bound critical f-values at 5% and 10% levels of significance. thus, the null hypothesis of no co-integration is rejected signify co-integrating relationship between inflation and unemployment rates over the sample period. to add further, low aic-value at 3.6807 indicates good fit of the model with minimum loss of information. dwvalue at 2.1732 indicates presence of very mild negative serial correlation in the time series data for the sample period. consequent upon the above, the vector error-correction model estimates relating to equation (3) are reported as follows: (2) eco_wbg sticky note there shouldn't be a break in the sentence here. eco_wbg sticky note omit the (2) volume 34, number 2 105 as expected, the error-correction term (ect-1) has negative coefficient with statistical significance in terms of the associated pseudo t-value. this suggests convergence toward longrun equilibrium at a very slow pace of adjustment in terms of a tiny magnitude of the coefficient of the error-correction term. moreover, the short-run feedback effects of lagged changes in unemployment rates on the current change in inflation rate are negative and statistically significant in terms of the associated t-values. however, past changes in unemployment rates can explain barely 29.16 percent of change in current inflation rate. the traditional philips curve thus appears to be valid for the long run amid some short-run instability as shown by cusum-square test (pesaran and pesaran, 1997) beyond 5% confidence band (appendix). however, for the overall sample period, it is relatively stable in terms of the cusum test. again, low aic-value at 2.6916 confirms good fit of the model with minimum loss of information. conclusions and policy implications the empirics of the traditional phillips curve clearly support the validity of the trade-off relationship between inflation and unemployment rates for the long run. however, the evidence for the short run is relatively weak and subdued in terms of the interactive feedback effects and associated t-values. additionally, there is evidence of some short-run instability, as displayed by the cusum-square test. for policy implications, the fed should focus on the long run to be able to exploit the traditional phillips curve relationship to navigate the economy on a desired trajectory through appropriate monetary and federal funds rate adjustments. 106 journal of business strategies references akaike, h. (1969). fitting autoregression for prediction. annals of the institute of statistical mathematics, 21: 243-247. atkeson a., & ohanian, l. e. (2001). are phillips curves useful for forecasting inflation? frb minneapolis quarterly review, 2-11. ball, l., & s. mazumder. (2011). inflation dynamics and the great recession. imf working paper 11/121, washington: international monetary fund. biancdhi, f., & civelli, a. (2015). globalization and inflation: evidence from a time-varying var. review of economic dynamics, elsevier for the society for economic dynamics, vol.18(2), 406-433, april. blachard, o. (2016). the phillips curve: back to the 60s? american economic review, 106(5):31-34. blachard, o., cerutti, e., & summers, l. (2015). inflation and activity-two explorations and their monetary policy implication. nber working paper 21726. constancio, v. (2014). recent challenges to monetary policy in the euro area. speech by vitor constancio, vice-president of the ecb, at the athens symposium on banking union, monetary policy and economic growth, athens, june. del boca, a. m., fratianni, f.s., & trecroci, c. (2008). the phillips curve and the italian lira, 1861-1998. working paper, department of economics, university of brescia. eliasson, a. (2001). is the short-run phillips curve nonlinear? empirical evidence for australia, sweden and the united states.sveriges riksbank working paper 124, stockholm school of economics, department of economic statistics. elliot, g., rothenberg, t. j., & stock, j. h. (1996). “efficient test for an autoregressive unit root”. econometrica, 64:813-836. engle, r. f., & granger, c.w.j. (1987). co-integration and error-correction representation, estimation and testing. econometrica, 55: 251-276. fitzgerald, t., & j. p. nicolini. (2013). is there a stable relationship between unemployment and future inflation? evidence from u.s. cities, working paper. federal reserve bank of minneapolis. friedman, m. (1968). the role of monetary policy.american economic review, 68:1-17. furuoka, f. (2007). does the phillips curve really exist? new empirical evidence from malaysia. economics bulletin, 5: 1-14. volume 34, number 2 107 gali, j., gertler, m., & lopez-salido, j.d. (2005). robustness of the estimates of the hybrid new keynesian phillips curve. journal of monetary economics, 52: 1107-1118. gilchrist, s., schoenle, r., & zakrajsek, e. (2013). inflation dynamics during the financial crisis.society for economic dynamics, 2013 meeting papers 826. graham, l., & snower, d. (2002). the return of the long-run phillips curve. working paper, department of economics, birkbeck college, university of london. granger, c.w.j. and newbold, p. (1974). “spurious regressions in econometrics.” journal of econometrics, 2: 111-120. hansen, m., & pancs, r. (2001). the latvian labour market transition: the beveridge and phillips curve as indicators of normalization.riga: euro faculty. ihrig. j., s. kamin, d. linder, & marquez, j. (2010). some simple tests of the globalization and inflation hypothesis. international finance, vol 13, no 3, 343375. islam, f. k., hassan, m., & rahman, m. (2003). the empirics of us phillips curve: a revisit. american business review, 20(1): 107-112. johansen, s. (1988). statistical analysis of co-integration vectors.journal of economic dynamics and control, 12: 231-254. johansen, s. (1991). estimation and hypothesis testing of co-integration vectors in gaussian vector autoregressive models. econometrica, 59 (6): 1551-1580. johansen, s., & juselius, k. (1990). maximum likelihood estimation and inference on cointegration with application to the demand for money. oxford bulletin of economics and statistics, 52: 169-210. karanassou, m., sala, h., & snower, d.j. (2008). the evolution of inflation and unemployment: explaining the roaring nineties. australian economic papers, 47(4): 334-354. karanassou, m., sala, h., & snower, d.j. (2010). phillips curves and unemployment dynamics: a critique and a holistic perspective. journal of economic surveys, 24(1): 1-51. kiley, m. (2015). low inflation in the united states: a summary of recent research. feeds notes, november 23. board of governors of the federal reserve system. kwiatkowski, d., phillips, p.c.b., schmidt, p., and shin, y. (1992). “testing the null hypothesis of stationarity against the alternative of a unit root”. journal of econometrics, 54:159-178. lipsey, r. g. (1960). the relation between unemployment and the rate of change of money wage rate in united kingdom 1962-1951. econometrica, 24: 1-12. 108 journal of business strategies malinov, m. j., & sommers, p. m. (1997). a new line on the phillips curve. social science quarterly, 78(3): 740-746. ng, s. and perron, p. (2001). “lag length selection and the construction of unit root tests with good size and power.” econmetrica, 64:813-836. niskanen, w.a. (2002). on the death of phillips curve.cato journal, 22: 193-198. ormerod, p., rosewell, b., & phelps, p. (2013). inflation/unemployment regimes and the instability of the phillips curve.applied economics, 45(2): 1519-1531. paul, b.p. (2009). in search of the phillips curve for india. journal of asian economics, 20: 479-488. pesaran, h., m., shin, y., & smith, r. j. (2001). bounds testing approaches to the analysis of level relationships. journal of applied econometrics, 16 (3): 289326. pesaran, m.h., & pesaran, b. (1997). ‘working with microfit 4.0: interactive econometric analysis.’ oxford university press, u.k. pesaran, m.h., & shin, y. (1999). ‘an autoregressive distributed lag-modeling approach to cointegration analysis, in econometrics and economic theory in the 20th century: the ragnar frisch centennial symposium, s. strom ed. cambridge university press, u.k., pp. 371-413. phillips, a.w. (1958). the relationship between unemployment and the rate of change of money wage rates in the united kingdom. econometrica, 25: 258299. phillips, p.c.b. (1986). “understanding spurious regressions in econometrics.” journal of econometrics, 33:311-340. reichel, r. (2004). on the death of the phillips curve: further evidence. cato journal, 24: 341-348. rudd, j., & whelan, k. (2005). new tests of the new keynesian phillips curve. journal of monetary economics, 52: 1167-1181. russell, b., & banerjee, a. (2008). the long-run phillips curve and non-stationary inflation. journal of macroeconomics, 30: 1792-1815. tang, c.f., & lean, h.h. (2007). the stability of phillips curve in malaysia. discussion paper39, monash university. turner, d., & segnezza, e. (1999). testing for a common oecd phillips curve. economics department working paper no. 219, oecd. turner, p. (1997). the phillips curve, parameter instability and the lucas critique. applied economics, 29(1): 7-10. volume 34, number 2 109 brief biographical sketch of authors muhammad mustafa is a professor of economics at the south carolina state university, carolina, usa. he is an avid researcher and published very extensively in refereed us and foreign academic journals. he has a diverse teaching portfolio and long teaching experience. he is a distinguished educator. matiur rahman is a jp morgan chase endowed professor at the mcneese state university, louisiana, usa. he earned his phd in economics from the south methodist university, texas usa. he is a very prolific researcher. he has published numerous impactful papers on diverse topics in economics and finance of current interests. appendix cusum test cusum test -30 -20 -10 0 10 20 30 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 15 cusum 5% significance cusum-squares test -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 15 cusum of squares 5% significance 110 journal of business strategies cusum-squares test cusum test -30 -20 -10 0 10 20 30 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 15 cusum 5% significance cusum-squares test -0.2 0.0 0.2 0.4 0.6 0.8 1.0 1.2 40 45 50 55 60 65 70 75 80 85 90 95 00 05 10 15 cusum of squares 5% significance 116 journal of business strategies optimizing manufacturer profit in downstream retail markets under conditions of uncertainty evan c. moore auburn university at montgomery • montgomery, al james d. francisco auburn university at montgomery • montgomery, al abstract abstract: this paper presents the results of three differing sales incentives, from the manufacturer, in models involving a manufacturer selling a product to cournot-type retailers competing in the retail market. we investigate the effectiveness of these incentives under two scenarios: profit maximizing retailers and retailers with an incentive function that is a mix between sales and profits. the optimal sales incentive is discussed. introduction and literature review as the saying goes, “the only thing worse than a monopolist is two monopolists.” thus is the problem of double marginalization, first explored by spengler (1950). the problem arises when a “downstream” monopolist is dependent on inputs from an “upstream” monopolist. the result is a sub-optimal solution: both of the monopolists suffer losses, and the resulting inefficiencies cause a “welfare loss,” or loss of value to society as a whole. the double marginalization problem, which involves monopolists in both the upstream and downstream markets, has been viewed from a variety of perspectives. bresnahan and reiss (1985) extended the standard double marginalization model into a “successive monopoly” model, showing largely stackelberg behavior, which is a situation in which one firm functions as a “leader,” and the other as a “follower.” the authors found that the most important factor influencing the manufacturerretailer relationship was the curvature of the demand curve. other studies have extended bresnahan and reiss’ approach to evaluate its impact on certain other economic phenomena, such as price discrimination (cowans, 2012), tax incidence (weyl and fabinger, 2013), and “cost pass through”, or the extent to which price changes in response to a change in marginal cost (adachi and ebina, 2014), all finding similar results. hegji and moore (2006) evaluated a similar scenario under both stackelberg conditions, described above, and cournot conditions, which refers to a situation volume 33, number 2 117 in which firms make decisions on output based on anticipated output decisions of the other firm. they found that under certain circumstances, franchise fees were an effective tool for manufacturers to maximize profits, and also control retail prices. the manufacturer’s use of a franchise fee amounts to a two-part tariff; the manufacturer sells units to retailers and charges each retailer a franchise fee. the franchise fee is used by the manufacturer to capture the retailers’ profits, thereby increasing the manufacturer’s own profits. hegji and moore also found that such franchise fees could offset the potential welfare losses suffered under double marginalization. some firms (and similar entities) address the problems of competing manufacturer/retailer incentives (including, inter alia, double marginalization) by engaging in resale price maintenance (rpm). rpm is an agreement between a manufacturer and dealer through which the dealer agrees to a retail price floor for the sale of a manufacturer’s products. a substantial literature on rpm exists, including hamilton (1990) and others, examining rpm as a solution to double marginalization and other problems. all of the studies cited above assume profit maximization at every stage by each firm in the analysis; fershtman and judd (1987), drawing upon baumol (1958) and others, examine the possibility of alternative objective functions (such as sales maximization) in an imperfectly competitive environment. specifically, fershtman and judd contemplated mixed objective functions in the context of a principal-agent problem faced by owners seeking to incentivize optimal behavior by managers. fershtman and judd found that in an oligopoly situation, owners may wish to provide incentives in order to shift their managers’ incentives away from strict profit maximization. we extend the approaches cited above by considering cases involving a manufacturer interacting with downstream retailers in an imperfectly competitive retail market. specifically, we examine how such a manufacturer can use sales incentives to encourage retailers to increase sales, with the manufacturer’s ultimate aim being to increase its profit. this paper presents the results of 4 different scenarios, in models involving a manufacturer selling a product to cournot-type retailers competing in the retail market. these include no sales incentive, a constant per-unit incentive, a sales incentive as a function of a retailer’s own-sales, and an incentive as a function of the total retail sales of the manufacturer’s product. we build upon the fershtman and judd (1987) approach by investigating 2 different types of objective functions: retailers focused solely on profits, and retailers with mixed objective functions involving a mix between sales and profits. we seek to determine what the optimal sales incentive is from the manufacturer’s perspective 118 journal of business strategies under the different objective functions, under conditions of uncertainty relating to the retailers’ objective function, and conditions of uncertainty with regard to retail demand. further, in keeping with the spengler (1950) approach, we determine which solution most ameliorates the welfare problems presented by double marginalization. model and results a manufacturer is dependent on sales in the downstream, imperfectly competitive, market by retailers engaged in cournot-type competition. we attempt to model two potential forms of an objective function for the retailer: pure profit maximization, as well as a mixed objective function for profit maximization combined with revenue maximization. we present the derivation of the pure profit maximization case below. we start with the inverse retail demand function – or, the demand for a good expressed in terms of the price of the good rather than the quantity of the good in a market with n retailers: where pr represents the price the retailer receives. for a pure profit maximization approach, the retailer’s objective function would be represented as follows: where pm represents the price paid to the manufacturer by the retailers. the profit maximizing manufacturer faces the following profit maximizing objective function: we first consider the situation in which the retailer operates as a pure profit maximizer according to (2), and the manufacturer offers no sales incentives. to do so we begin by determining a retailer’s reaction function. the reaction function for retailer i indicates the best response, i.e. profit maximizing level of retail sales for firm i, given the sales produced by the other retailers. the derivation of the reaction function is in section a.1. of the appendix. in this case, maximization of (2) results in the ith retailer’s reaction function: volume 33, number 2 119 solving (4) results in the ith retailer’s output of and use of (5) in the demand function results in the equilibrium retail price of use of (5) in equation (3) and maximization of the manufacturer’s profit with respect to pm results in: using (7) in the various equations results in equilibrium results of when retailers are operating with mixed objective functions, a retailer’s objective function would be represented as follows: lambda (λ) represents the weight that a retailer places on profit maximization and (1λ) the weight on sales maximization; it follows that 0 ≤ λ ≤ 1. the derivations for the results of the retailers with mixed objective functions is in section a.2. of the appendix. table 1 presents the results from retailers operating with pure profit maximizing and mixed objective functions. 120 journal of business strategies table 1 equilibrium results with no sales incentives variable pure profit max mixed objective function retailer’s price retailer’s sale manufacturer’s price retailer’s profit manufacturer’s profit lambda na as expected, a retailer’s sales are greater under the mixed objective function. similarly, the manufacturer’s profit is greater when retailers compete using mixed objective functions due to the increased sales. we provide equations (13) – (15) below to allow for useful comparisons with the above results and the various sales incentive results to follow. these equations are the results if the manufacturer is able to retail directly, i.e. there are no downstream retailers, with no additional costs. volume 33, number 2 121 a comparison of equation (15) with the manufacturer’s profits in table 1 reveals that the manufacturer would enjoy increased profits from retailing directly with no additional costs. the manufacturer would provide a higher level of units for sale while maintaining its price (pm ). as increased sales lead to greater manufacturer profits, up to the level indicated in equation (14), the manufacturer has an interest in increasing retailers’ sales through sales incentives. we investigate 3 potential options of various per-unit sales incentives from the manufacturer to the retailer. these are a: 1. constant per unit incentive (d); this incentive is a fixed amount (d) provided to a retailer for each unit (xi ) sold. for example, the manufacturer may offer a sales incentive of $1 per unit sold. the profit maximizing retailer’s profit function in this case is the mixed objective retailer’s function in this case is 2. per unit incentive that is a function of an individual retailer’s own sales (dxi ); this incentive increases as a retailer increases its own sales. for example, if d = $1, then a retailer selling 2 units will receive a $2 sales incentive for each unit sold, whereas a retailer selling 3 units will receive a $3 sales incentive for each unit sold. the profit maximizing retailer’s profit function in this case is the mixed objective retailer’s function in this case is 3. per unit incentive that is a function of all retailer sales ; this incentive increases as the total sales, i.e. the sales of all retailers in the market, increases. for example, suppose d = $1 and there are 2 retailers in the market selling 2 and 3 units respectively. the each retailer will receive a $5 sales incentive for each unit sold. 122 journal of business strategies the profit maximizing retailer’s profit function in this case is the mixed objective retailer’s function in this case is a general model of a manufacturer using per-unit sales incentives involves the manufacturer attempting to maximize its profits, πm (pm , d),subject to the following constraints: these contraints indicate that each retailer must have nonnegative profits (πi ) and sales (xi ) in equilibrium. note that retailer profits of zero are normal economic profits; this indicates that the retailer has covered all costs of production, including both explicit and implicit costs. additionally, the prices charged by the retailer (pr ) and manufacturer (pm ) must be nonnegative. the component (d) of any sales incentive offered must be nonnegative as well. finally, if the manufacturer is to offer sales incentives it must be the case that its profit from offering the incentives is at least as large as it would be from not offering any sales incentives. the derivations for these models, with results presented in tables 2 through 4 below, are presented in the appendix; those for the profit maximizing retailers are in section a.3. and for the mixed objective retailers in section a.4. table 2 presents the results from the manufacturer offering a constant per-unit incentive (d) to retailers operating with pure profit maximizing or mixed objective functions. volume 33, number 2 123 table 2 equilibrium results with constant per unit sales incentives variable pure profit max mixed objective function retailer’s price retailer’s sale manufacturer’s price retailer’s profit manufacturer’s profit lambda na the use of a constant per unit incentive, d, does not result in any change in the manufacturer’s profits. this is evident by a comparison of the manufacturer’s profits from tables 1 and 2 in each of the profit maximizing and mixed objective function retailers scenarios. similarly, the retailers in each case earn similar profits as those they would earn if no incentive was used. this is due to the manufacturer increasing its price (pm ) by the amount of the per unit incentive, d, in equilibrium. table 3 presents the results from the manufacturer offering a per unit incentive that is a function of an individual retailer’s own sales, (dxi), to retailers operating with pure profit maximizing or mixed objective functions. 124 journal of business strategies table 3 equilibrium results with per unit incentives that are a function of an individual retailer’s own sales variable pure profit max mixed objective function retailer’s price retailer’s sale manufacturer’s price retailer’s profit manufacturer’s profit lambda na the per unit incentive, which is a function of an individual retailer’s own sales, (dxi ) may indeed be profit maximizing but the manufacturer must be certain of the retailer’s behavior. if the retailers are profit maximizing then the manufacturer will want to set d=b, i.e when the sales incentive piece, d, is set equal to the slope of the inverse demand function, b. this will result in the manufacturer’s profit being equal to that of retailing directly without additional costs, equation (15). however, in the mixed objective case the manufacturer must set the sale incentive piece, d, less than b. this is evident from manufacturer’s profit with retailers using mixed objective functions. a retailer’s profit in this scenario binds if d=1/4(2b+bn-b√(4+4n+n2)), which is a decreasing function of the number of retailers, n. as the retailers are already selling more than they would be if they were profit maximizing, a value of d in excess of the binding value would encourage them to sell too many volume 33, number 2 125 units, potentially decreasing the manufacturer’s profit or leading to retailers suffering negative profits. if the manufacturer is uncertain of the retailers’ behavior then this introduces uncertainty regarding the choice of d. table 4 presents the results from the manufacturer offering a per unit incentive that is a function of all retailer sales, , to retailers operating with pure profit maximizing or mixed objective functions. table 4 equilibrium results with per unit incentives that are a function of all retailer’s sales variable pure profit max mixed objective function retailer’s price retailer’s sale manufacturer’s price retailer’s profit manufacturer’s profit lambda na the use of a per unit incentive that is a function of all retailer sales can lead to manufacturer profits equal to those of the manufacturer selling directly to the final consumers with no additional retailing costs. note that the manufacturer’s profits in table 4 are equal to equation (15) when the sales incentive piece, d, is set 126 journal of business strategies equal to the slope of the inverse demand function, b. in both the profit maximizing and mixed objective cases the retailers would end up with normal economic profits. note that it is not important, from the manufacturer’s point of view, whether the retailers are profit maximizing or using mixed objective functions. numerical example table 5 provides numerical solutions to the equations in tables 1-4. note that the headings from the previous tables are changed; “pure profit max” is reduced to “π” and “mixed objection function” to “mof” to allow for comparisons in one table. the values of the variables are as follows: a = 10 b = 1 cm = 1 n = 4 d varies among the tables. this coincides with a retail inverse demand function of pr = 10 – x; costs to the manufacturer of 1 per unit; and 4 retail firms in the market. table 5 numerical solutions for equilibrium results listed in tables 1 4. table 1 (d=0) table 2 (d=0.5) table 3 (d=1) (d=0.177) table 4 (d=1) variable π mof π mof π mof π mof π mof retailer’s price 6.4 5.76 6.4 5.76 5.5 2.8 6.27 5.5 5.5 5.5 retailer’s sales 0.9 1.06 0.9 1.06 1.13 0.8 0.93 1.13 1.13 1.13 manufacturer’s price 5.5 5.5 6 6 6.75 7.3 5.68 5.7 10 10 retailer’s profit 0.81 0.28 0.81 0.28 0 -1.22 0.72 0 0 0 manufacturer’s profit 16.2 19.06 16.2 19.06 20.25 32.4 16.79 20.25 20.25 20.25 lambda n/a 0.855 n/a 0.841 n/a 0.630 n/a 0.838 n/a 1 a comparison of the numerical results for the table 1 and 2 columns reveals that a constant per unit incentive is ineffective at increasing the profitability of the manufacturer. the manufacturer’s profit remains 16.2 when facing profit maximizing retailers and 19.06 when facing retailers with mixed objective functions. volume 33, number 2 127 the maximum profit for the manufacturer, when selling the product directly without retailing costs, in this example is 20.25. as noted in the discussion surrounding table 3, the choice of d depends on the objectives of the retailers. if the retailers are profit maximizing then the manufacturer will set d=b, in this example equal to 1, to maximize profits. however, this results in negative profits for retailers with mixed objective functions and therefore cannot be an equilibrium in this case. when facing mixed objective retailers, the manufacturer will have to restrict d to 0.177 to result in maximum profits of 20.25. but with this lower value of d, if the manufacturer is in fact facing profit maximizing retailers then the manufacturer’s profit increases only by 0.59, from 16.2 to 16.79. as discussed earlier, if the manufacturer is uncertain of the retailers’ behavior then this introduces uncertainty regarding the choice of d. finally a comparison of the columns regarding table 4, involving per unit incentives that are a function of all retailer sales, reveals that this sales incentive approach maximizes the manufacturer’s profits and leads to the retailers providing identical levels of sales regardless of whether they compete under profit maximizing or mixed objective functions. conclusion we examined how two alternative objective functions affect downstream retailer behavior, and how such alternate specifications are impacted by various incentive structures offered by an upstream manufacturer. we find that a constant per unit incentive is ineffective in increasing sales or the manufacturer’s profits, regardless of whether the retailers are engaged in profit maximization or using a mixed objective function. our results show that a per unit incentive, which is a function of an individual retailer’s own sales, (dxi) may indeed be profit maximizing but the manufacturer must be certain of the retailers’ behavior. if the manufacturer is unsure of the retailers’ objective functions, then setting the value of d incorrectly will lead to profits below those of the manufacturer retailing directly without retailing costs. we find that in both retailer scenarios the optimal solution from the manufacturer’s perspective is to create a per-unit incentive that is a function of total retailer sales. by setting the sales incentive piece, d, equal to the slope of the inverse demand function, b, the manufacturer is able to increase sales and earn profits equal to those of retailing directly. additionally, the market is more efficient as this sales incentive results in greater total surplus, or value to society, due to increased consumer surplus and greater joint profits. 128 journal of business strategies appendix a.1. reaction function derivation – the equation numbers in this section of the appendix match those found in the body of the text the profits of the ith retailer are: the reaction function is found by differentiating (2) with respect to xi , which results in: set this derivative equal to zero and solve for xi . this results in the ith retailer’s reaction function: where . due to symmetry in retailer output, substituting for in equation (4) results in the ith retailer’s output of a. 2. derivations for retailers operating with mixed objective functions now consider the situation in which n cournot retailers compete under incentive contracts. the objective function for the manager is using the demand function and simplifying results in the objective function: maximization of (a.2.1) results in the ith retailer’s reaction function: where . summing over all retailers yields: solving (a.2.3) results in the market output: volume 33, number 2 129 use of the definition and substitution of (a.2.4) into (a.2.3) yields the individual retailer’s output while the retail price is obtained from the inverse demand curve and (a.2.3). these are, respectively: the retailer price-cost margin (prpm ) with equations (a.2.5) and (a.2.6) can be used to derive the ith retailer’s realized profits in terms of the parameters λi: differentiating (a.2.7) with respect to λi, and noting that because of symmetry of response λi = λj , yields the profit maximizing value of λi: substituting (a.2.8) into (a.2.5) and (a.2.6) results in the retailer output, market output, and retail price: equation (a.2.10) can be used to derive the manufacturer’s profit expressed in terms of its price-cost margin. this yields the optimal manufacturer price use of this manufacturer price in the various equations results in the equilibrium conditions listed in table 1. a. 3. derivations for pure profit maximizing retailers operating with various manufacturer incentives 130 journal of business strategies the derivations in this section follow a similar set of steps for each of the 3 sales incentive schemes. constant per unit sales incentive, d: the retailer’s profit function is maximization of (a.3.1) results in the ith retailer’s reaction function: where due to symmetry in retailer output, solving (a.3.2) results in the ith retailer’s output of and use of (a.3.3) in the demand function results in the equilibrium retail price of the manufacturer’s profit is given by: use of (a.3.3) in equation (a.3.5) and maximization of the manufacturer’s profit with respect to pm results in: using (a.3.6) in the various equations results in equilibrium results presented in table 2. per unit sales incentive a function of a retailer’s own sales, dxi: the retailer’s profit function is maximization of (a.3.7) results in the ith retailer’s reaction function: (a.3.8) where . due to symmetry in retailer output, volume 33, number 2 131 solving (a.3.8) results in the ith retailer’s output of and use of (a.3.9) in the demand function results in the equilibrium retail price of the manufacturer’s profit is given by: use of (a.3.9) in equation (a.3.11) and maximization of the manufacturer’s profit with respect to pm results in: using (a.3.12) in the various equations results in equilibrium results presented in table 3. per unit sales incentive a function of all retailer sales, : the retailer’s profit function is maximization of (a.3.13) results in the ith retailear’s reaction function: (a.3.14) where . due to symmetry in retailer output, solving (a.3.14) results in the ith retailer’s output of and use of (a.3.15) in the demand function results in the equilibrium retail price of 132 journal of business strategies the manufacturer’s profit is given by: use of (a.3.15) in equation (a.3.17) and maximization of the manufacturer’s profit with respect to pm results in: using (a.3.18) in the various equations results in equilibrium results presented in table 4. a. 4. derivations for mixed objective function retailers operating with various manufacturer incentives the derivations in this section follow a similar set of steps for each of the 3 sales incentive schemes. constant per unit sales incentive, d: the objective function for the managaer is using the demand function and simplifying results in the objective function: maximization of (a.4.1) results in the ith retailer’s reaction function: where . summing over all retailers yields: solving (a.4.3) results in the market output: substitution of (a.4.4) into (a.4.2) and use of the definition yields the retailer’s output while the retail price is obtained from the inverse demand volume 33, number 2 133 curve and (a.4.3). these are, respectively: the retailer price-cost margin (prpm+d ) with equations (a.4.5) and (a.4.6) can be used to derive the ith retailer’s realized profits in terms of the parameters λi : differentiating (a.4.7) with respect to λi , and noting that because of symmetry of response λi = λj, yields the profit maximizing value of λi : substituting (a.4.8) into (a.4.5) results in the retailer output and market output: equation (a.4.10) can be used to derive the manufacturer’s profit expressed in terms of its price-cost margin. this yields the optimal manufacturer price . use of this manufacturer price in the various equations results in the equilibrium conditions listed in table 2. per unit sales incentive a function of a retailer’s own sales, dxi: the objective function for the manager is using the demand function and simplifying results in the objective function: 134 journal of business strategies maximization of (a.4.11) results in the ith retailer’s reaction function: where . summing over all retailers yields: solving (a.4.13) results in the market output: use of the definition and substitution of (a.4.14) into (a.4.13) yields the individual retailer’s output while the retail price is obtained from the inverse demand curve and (a.4.13). these are, respectively: the retailer price-cost margin (prpm+d xi ) with equations (a.4.15) and (a.4.16) can be used to derive the ith retailer’s realized profits in terms of the parameters λi : differentiating (a.4.17) with respect to λi , and noting that because of symmetry of response λi = λj, yields the profit maximizing value of λi : volume 33, number 2 135 substituting (a.4.18) into (a.4.15) results in the retailer output and market output: equation (a.4.20) can be used in the manufacturer’s profit equation to derive the manufacturer’s profit expressed in terms of its price-cost margin. this yields the optimal manufacturer price use of this manufacturer price in the various equations results in the equilibrium conditions listed in table 3. per unit sales incentive a function of all retailer sales, : the objective function for the manager is using the demand function and simplifying results in the objective function: maximization of (a.4.21) results in the ith retailer’s reaction function: where . summing over all retailers yields: solving (a.4.23) results in the market output: use of the definition and substitution of (a.4.24) into (a.4.23) yields the individual retailer’s output while the retail price is obtained from the inverse demand curve and (a.4.23). these are, respectively: 136 journal of business strategies the retailer price-cost margin (prpm+d x) with equations (a.4.25) and (a.4.26) can be used to derive the ith retailer’s realized profits in terms of the parameters λi : differentiating (a.4.27) with respect to λi , and noting that because of symmetry of response λi = λj, yields the profit maximizing value of λi : a substituting (a.4.28) into (a.4.25) results in the retailer output and market output: equation (a.4.30) can be used in the manufacturer’s profit equation to derive the manufacturer’s profit expressed in terms of its price-cost margin. this yields the optimal manufacturer price use of this manufacturer price in the various equations results in the equilibrium conditions listed in table 4. references adachi, t. and ebina, t. (2014). cost pass-through and inverse demand curvature in vertical relationships with upstream and downstream competition. economics letters, 124(3), 465-68 volume 33, number 2 137 baumol. w. j. (1958).on the theory of oligopoly. economica, 25(99), 187-198. bresnahan, t. f. and reiss, p. c. (1985). dealer and manufacturer margins. rand journal of economics, 16(2), 253-68. cowan, s. (2012). third-degree price discrimination and consumer surplus. journal of industrial economics, 60(2), 333-45. fershtman, c. and judd, k. (1987). equilibrium incentives in oligopoly. american economic review, 77(5), 927-40. hamilton, j. h. (1990). resale price maintenance in a model of consumer search. managerial and decision economics, 11(2), 87-98. hegji, c. e. and moore, e. c. (2006).on the economics of manufacturers and dealers: a reexamination. southwestern economic review, 33(1), 107-20. spengler, j. (1950) vertical integration and antitrust policy. journal of political economy, 58(4), 347-352. weyl, e.g. and fabinger, m. (2013). pass-through as an economic tool: principles of incidence under imperfect competition. journal of political economy, 121(3), 528-83. brief biographical sketch of authors dr. evan moore joined the department of economics at auburn university montgomery in 2002. he is a professor and his primary teaching interests are industrial organization, game theory, and microeconomic theory. his current areas of research include industrial organization and sports financial markets. he has published in a variety of journals including the american economic review. dr. james francisco joined the auburn university montgomery faculty in 2013. he is an assistant professor whose research and teaching interests include law and economics, industrial organization and competition economics, and sports economics. volume 32, number 1 41 institutional differences of information content on voluntary earnings releases in the u.s. and canada ronald stunda valdosta state university ● valdosta, georga abstract historically, canadian laws have created a less litigious environment than those of the u.s. this changed in 1998 with the passage of the securities litigation uniform standards act (slusa), and in 2000 with the passage of regulation full disclosure (regulation fd). the intent of these acts were to not only encourage more u.s. firms to release voluntary earnings forecasts, but to offer protection for such disclosures against lawsuits, similar to laws in canada. in addition, with the advent of international financial accounting standards (ifrs), voluntary earnings releases play a bigger role, in increased frequency and revision of forecasts. since canada requires the use of ifrs in financial reporting, it serves as a good base of comparison of what may be to come in the u.s. these types of differences comprise what can be characterized as institutional differences. this study finds that canadian managers tend to issue voluntary earnings forecasts more frequently across the board than their u.s. counterpart, even after the interdiction of slusa and regulation fd in the u.s. in addition, the canadian forecasts tend to be more precise than those offered by u.s. managers. on the surface, it appears that the slusa and regulation fd have not completely achieved their goal of creating greater and more informative voluntary earnings disclosures in the u.s., but in addition, ifrs adoption in canada may have also led to the increased frequency and accuracy of earnings forecasts. introduction while the canada revenue agency does not specify that financial statements must be prepared following any particular type principles or standards, the accounting standards board of canada (acsb) requires reporting entities to use international financial reports standards (ifrs) in the preparation of all interim and annual financial statements. this is important for two reasons: 1. canada is the closest north american country to the u.s. to adopt ifrs reporting standards, and therefore serves as a good standard for what may be on the horizon for u.s. firms, 42 journal of business strategies 2: ifrs adoption has an impact on the increased frequency of both new and revised voluntary earnings forecasts [balakrihnan, li, and yang (2014)]. as the u.s. inches closer to an ifrs basis (the latest ifrs-based adoption regarding revenue recognition taking place in 2015), it behooves accounting researchers to evaluate the impact of increased voluntary financial disclosures in the u.s. with the potential advent of ifrs looming in the background. in addition, the mechanics of how voluntary forecast issues in canada may form a basis for how we may address voluntary releases in the u.s. for both the near term and long term future. the international accounting literature in general recognizes the existence of different accounting models. frank (1979) and nair and frank (1980) classify countries’ financial reporting practices built around the contrast between commonlaw and code-law systems, and any variations within. recent accounting studies examine institutional factors that shape and characterize the u.s. accounting system, and compare that system with other countries. guenther and young (2000) find u.s. accounting earnings more reflective of underlying economic reality due to their institutional differences. ball, kothari, and robin (2000) argue that the difference between common-law and code-law systems manifests in the dichotomy of shareholder and stakeholder corporate governance models. the shareholder governance model, they find, resolves the information asymmetry through public disclosures, while the stakeholder model does it through private communication. many extant studies compare the differences in accounting models between code-law and common-law countries [joliet and muller (2009), jacobsen and aaker (1993), harris et al (1993), bodnar and weintrop (1997), barth and clinch (1996) and bodnar et al (2003)]. very few studies, however, assess accounting differences of countries within those two groups. one such likely comparison is that of the two largest economic powers in the western hemisphere, the u.s. and canada. in recent years, canada has undergone tremendous economic growth, fueled by oil production. its percentage increase in net exports now outpaces the u.s., its gdp exceeds that of the u.s., it has greater wealth per capita ($51,147 versus the u.s.’s $48,147), and the canadian dollar has just about pulled even in value to the u.s. dollar. both are common-law countries and trading partners, but little research has been done on the difference between the two countries from an accounting perspective. one such area where differences between these two countries may be explored is that of voluntary earnings forecasts. in the area of voluntary earnings disclosures, prior research finds that managers release information that is unbiased relative to subsequently revealed earnings volume 32, number 1 43 and that tends to contain more bad news than good news [baginski et al (1994), and frankel (1995)]. such releases are also found to contain information content [patell (1976), waymire (1984), and pownell and waymire (1989)]. although forecast release is costly, credible disclosure will occur if sufficient incentives exist. these incentives include bringing investor/manager expectations in line [ajinkya and gift (1984)], removing the need for expensive sources of additional information [diamond (1985)], reducing the cost of capital to the firm [diamond and verrechia (1987)], and reducing lawsuits [lees (1981)]. other studies show that managers are more likely to issue voluntary forecasts in a less litigious environment [frost (2001), johnson et al (2002)], while another [baginski (2002)] finds that there are potential legal environment differences between the u.s. and canada when issuing earnings forecasts. clarkson and simunic (2004) note that unlike the u.s., courts in canada generally require unsuccessful plaintiffs to pay the costs of a successful defendant. also, because plaintiffs have no absolute right to a jury trial in canada, judges hear technical cases and are less likely to award large settlements. in addition, canadian provinces do not permit trial lawyers to work on a contingency basis. also, it is much more difficult to bring a class action suit in canada. all of these differences in the two legal systems create a natural environment in which voluntary earnings releases may be perceived differently. this situation creates an opportunity to evaluate two neighboring commonlaw countries from an accounting perspective focusing on the release of voluntary earnings forecasts, and the information content they contain. this comparison becomes even more relevant given the passage of the securities litigation uniform standards act (slusa) in 1998 when the u.s. congress attempted to protect u.s. firms issuing earnings forecasts from litigation, and the continuing effort by the financial accounting standards board (fasb) to get u.s. firms to release more voluntary forecasts for the benefit of the investor. this was further enhanced in 2000 by congressional passage of regulation fair disclosure which also attempts to shield such forecasts. hypothesis development three hypotheses are tested. first, king et al (1990) finds that forward looking information disclosure in the u.s. increases the firm’s exposure to legal liability. balakrishnan et al (2014) find that canadian firms have adopted ifrs and are therefore more likely to issue voluntary forecasts. for these reasons many u.s. firms, by comparison, have not exhibited a desire to issue voluntary forecasts on a consistent 44 journal of business strategies and on-going basis. the first hypothesis, stated in the alternative form is: h1: canadian firms, faced with institutional differences such as a less-litigious legal environment, and the requirements of ifrs engage in more voluntary earnings forecasts relative to u.s. firms. the second hypothesis, also stated in the alternative form, relates to previous studies that indicate u.s. firms are less likely to issue voluntary forecasts during good news periods for fear of litigation: h2: canadian firms, faced with institutional differences, engage in voluntary forecast releases that are less-related to earnings than u.s. firms. the third hypothesis, stated in the alternative form, centers around the notion that as voluntary forecasts are made with greater frequency, they should also tend to exhibit greater accuracy over the long term: h3: canadian firm faced with institutional differences, engage in more precise forecasting of earnings information. research design the sample consists of all quarterly and annual earnings estimates made during the period 1999-2013 (1st quarter). the reason that this time period was chosen is because slusa and regulation fd passage took place during this period (1998 and 2000 respectively). these are the acts that, in essence, provided litigation relief for u.s. firms filing voluntary earnings forecasts. these acts presumably permit u.s. firms similar legal protection as canadian firms, thus facilitating more accurate comparison. in addition, in 2006, canadian firms, as required by the canada revenue agency, began to report financial information under an ifrs basis. as a result, the numbers of voluntary forecasts tended to grow [balakrishnan et al (2014)]. the sample used in the study takes these events and their dates into consideration as inclusive of the overall sample. the sample met the following criteria: 1) the voluntary earnings forecast was recorded by the dow jones news retrieval service (djnrs). the canadian exchanges list the dow jones as a preferred means of disclosure. 2) earnings data was obtained from compustat. the overall sample consists of firms which made at least one management earnings forecast during the period 1999-2013 (1st quarter). all american exchanges (nyse, nasdaq, otc, volume 32, number 1 45 ase) and all canadian exchanges (toronto, vancouver, montreal, regional, nonlisted canadian) were included in the sample. table 1 provides the summary of the sample used in the study. table 1 study sample summary u.s. canadian total firm-years available on compustat firm-quarters available on compustat total firm years/quarters sample 158,297 482,216 640,513 21,223 79,228 100,451 179,520 561,444 740,964 forecasts identified by djnrs loss due to compustat requirement final forecast sample 7,213 (542) 6,671 3,801 (271) 3,530 11,014 (813) 10,201 test of hypotheses table 1 reports that 179,520 firm-years and 561,444 firm-quarters are available on compustat for the sample total of potential voluntary forecast periods from 1999-2013 (1st quarter). a total of 6,671 u.s. forecasts are made by 750 firms (8.90 per firm over 14+ years) while 3,530 forecasts are made by 275 canadian firms (12.84 per firm over 14+ years). forecast frequency and good versus bad news forecasts to test h1 and h2, a logistic regression model is used similar to the one employed in baginski et al (2002). it uses a combined sample of canadian and u.s. firms across all potential forecasting periods (n = 740,964): forecastit = a0 + a1∆esignit + a2canadait + a3canadait x ∆esignit + a4|δearningsit| + a5lsizeit + a6regulateit + a7hightechit + €it (1) where: forecastit = 1 if the firm issued a voluntary earnings forecast during the period 0 otherwise. 46 journal of business strategies ∆esignit = the sign of the earnings change1, 1 if ≥ 0 (good news), and 0 if < 0 (bad news). canadait = 1 if the potential forecasting period relates to a canadian firm, 0 otherwise. |δearningsit| = the absolute value of δearningsit lsizeit = size of the firm using the natural log of the market value of equity at the beginning of the period. regulateit = 1 if the firm is in a regulated industry, and 0 otherwise. hightechit = 1 if the firm is in a high-technology industry, and 0 otherwise. figure 1 maps the coefficients in equation (1) to h1 and h2. column (1) lists the coefficient sums in earnings increase periods (i.e., good news, ∆esignit = 1) for canadian firms in row 1 and for u.s. firms in row 2. column (2) provides analogous coefficients for earnings decrease periods (i.e., bad news, ∆esignit = 0). the last row indicates the difference between countries in the propensity to issue forecasts in periods of good news (a2 + a3), and bad news (a2). hypothesis 1 predicts that canadian firms issue more forecasts, thus, both sets of coefficients are expected to be positive (a2 + a3 > 0, a2 > 0). column (3) in figure 1 provides coefficients associated with differences between good and bad news periods (i.e., “sign-related” forecast behavior) in canada (row 1) and the u.s. (row 2). the last row in the column shows that the coefficient a3 measures the differences between countries in sign-related forecasting behavior. if legal-liability-created asymmetric forecast disclosure incentives in the u.s. lead to more forecasts in bad news periods, then the expectation is that a1 < 0. hypothesis 2 predicts a3 >0, indicating that canadian managers are less likely to skew forecast disclosures toward bad news periods. following baginski, hassel, and kimbrough (2002), control variables are established for; volatility (|δearningsit|), firm size (lsizeit), whther the firm is in a regulated industry and therefore requires fewer forecasts (regulateit), and whether the firm is in a high tech field which is riskier and therefore requires more forecasts (hightechit). volume 32, number 1 47 figure 1 mapping equation (1) into hypothesis tests good news period ∆esignit =1 bad news period ∆esignit = 0 difference across sign canadian (canada = 1) a0 + a1 + a2 + a3 a0 + a2 a1 + a3 u.s. (canada = 1) a0 + a1 a1 difference between countries (row 1 – row 2) (h1 test during good news periods): a2 + a3 > 0 (h1 test during bad news periods): a2 > 0 difference between countries in signrelated behavior (h2): a3 > 0 forecast precision king et al (1990) argue that u.s. managers are concerned about potential litigation if a forecast turns out to be inaccurate. accordingly, researchers have argued that, when faced with perceived higher expected litigation costs, u.s. managers will issue less-precise forecasts (i.e., range, minimum, maximum or general impression forecasts instead of point forecasts). empirical evidence shows that this is consistent among u.s. firms [skinner (1994), baginski and hassell (1997), bamber and cheon (1998)]. the canadian legal system has historically exacted lower legal penalties for inaccuracy than the u.s. legal system. in addition, with the advent of ifrs adoption in 2006, canadian firms have issued more financial forecasts, in addition to issuing more revised forecasts. canadian managers, therefore, should have the ability to issue more precise management forecasts (h3) and to make forecast precision choices that are less likely to depend on whether the firm is performing poorly during the period (h2). to test these hypotheses, the following ordered logistic regression model is used for a pooled sample of all forecasts issued by u.s. and canadian firms (n = 10,201). precisei = b0 + b1∆esigni + b2canadai + b3canadai x ∆esigni + b4lsizei + b5regulatei + b6hightechi + b7horizoni + vi (2) 48 journal of business strategies management forecast precision is measured using an ordinal coding scheme that assigns the highest value to the most precise forecasts. precise equals 3, 2, 1, and 0 for point, closed interval, open interval, and general impression forecasts, respectively. hypothesis 3 predicts that canadian firms will issue more precise forecasts because historically, the legal penalties for inaccuracy are smaller, and the requirements of ifrs. for earnings decreases, this suggests that b2 > 0, and for earnings increases, it suggests that b2 + b3 > 0. if fear of legal liability, and noncompliance with ifrs leads u.s. firms to issue less precise forecasts when the firm is performing poorly, then b1 > 0. hypothesis 2 predicts that canadian forecast precision is less skewed toward poor performance than is u.s. forecast precision (b3 < 0). based on baginski, hassell, and kmbrough (2002), controls are established for; firm size (lsize), representing the natural log of the market value of equity at the beginning of the period, if the firm belongs to a regulated utility (regulate) since regulated bodies are required to produce a large amount of financial information, thus forecasts are deemed unnecessary, if the firms are high-technology (hightech) since they are riskier and may require more forecast data, and the number of days between the forecast date and the end of the period being forecast (horizon) since the shorter the period between these dates, the more precise the forecast. results forecast frequency and good versus bad news forecasts table 2 describes variable distributions for the sample of 740,964 potential forecasting periods and 10,201 voluntary earnings forecasts. this table shows that forecast frequency is only 1.0415% for u.s. firms and 3.5142% for canadian firms. table 2 also indicates that canadian firms release voluntary management earnings forecasts 60% of the time when the earnings information is good news compared with 40% of the time for their u.s. counterparts. with respect to precision of the forecast, table 2 shows that canadian firms are more likely to issue point forecasts (most precise type) 58% of the time versus 24% for u.s. firms. volume 32, number 1 49 table 2 variable distributions for 1999-2013 (1st quarter); sample of 740,964 potential forecasting periods (n = 100,451 canadian and n = 640,513 u.s.); and sample of 10,201 management earnings forecasts (n = 3,530 canadian and n = 6,671 u.s.) good news periods bad news periods total (∆esignit = 1) (∆esignit = 0) potential forecast periods: u.s. firms 269,015 (40%) 371,498 (60%) 640,513 canadian firms 56,252 (56%) 44,199 (44%) 100,451 total 325,267 415,697 740,964 management earnings forecasts: u.s. firms 2,668 (40%) 4,003 (60%) 6,671 canadian firms 2,118 (60%) 1,412 (40%) 3,530 total 4,786 5,415 10,201 forecast frequency rates in potential forecast periods: u.s. firms .9918% 1.0775% 1.0415% canadian firms 3.7652% 3.1946% 3.5142% management forecast type: u.s. firms canadian firms total point 1,601 (24%) 2,047 (58%) 3,648 (36%) range 1,667 (25%) 635 (18%) 2,302 (23%) minimum 1,734 (26%) 706 (20%) 2,440 (24%) maximum 867 (13%) 141 (4%) 1,008 (9%) general impression 802 (12%) 1 (0%) 803 (8%) total 6,671 (100%) 3,530 (100%) 10,201 (100%) table 3 presents the equation (1) logistic regression tests of h1 and h2. coefficient a2 is significantly positive (p = 0.001), so canadian firms are more likely to issue voluntary earnings forecasts during bad news periods relative to u.s. firms. the sum coefficients a2 + a3 is also significant (p = 0.002), indicating that canadian 50 journal of business strategies firms are also more likely to issue voluntary earnings forecasts during good news periods. these results support h1’s prediction that the possibility of institutional differences such as lower legal liability and the adoption of ifrs in canada may lead to more forecast disclosures during both good and bad news periods. these results are also consistent with findings on forecast frequency rates in table 2. with respect to h2, the results are also consistent with expectations. u.s. firm behavior is as expected, coefficient a1 is significantly negative (p = 0.005). this indicates more forecast disclosure in bad news periods relative to good news periods. coefficient a3, which measures the difference between u.s. and canadian sign-related behavior, is significantly positive (p = 0.001) indicating that canadian forecasts occur more often in good news periods. these results are also consistent with findings in table 2. these differences between canadian and u.s. forecasting behavior arise even after controlling for the absolute value of the earnings surprise (a4 is significantly negative with a p-value of 0.006), firm size (a5 is significantly positive with a p-value of 0.001), regulated industry membership (a6 is significantly negative with a p-value of 0.001), and high tech industry membership (a7 is insignificantly different from 0). table 3 management earnings forecast frequency in the u.s. and canada forecastit = a0 + a1∆esignit + a2canadait + a3canadait x ∆esignit + a4|δearningsit| + a5lsizeit + a6regulateit + a7hightechit + €it independent variable (coefficient) expected sign coefficient estimate (p-value) intercept (a0) none predicted -5.913 (0.223) ∆esign (a1) negative -0.221 (0.005) canada (a2) positive (h1 for bad news) 0.522 (0.001) canada x ∆esign (a3) positive (h2) 0.612 (0.001) |δearnings (a4)| negative -0.351 (0.006) lsize (a5) positive 0.480 (0.001) regulate (a6) negative -1.321 (0.001) hightech (a7) none predicted -0.129 (0.162) coefficients a2 + a3 positive (h1 for good news) 0.857 (0.001) volume 32, number 1 51 forecast precision table 4 presents results of equation (2). as h3 predicts, the b2 coefficient is significantly positive (p = 0.001), indicating that canadian firms issue more precise forecasts in bad news periods than do u.s. firms. also, the sum of coefficients b2 + b3 are significantly positive (p = 0.001), indicating that canadian firms issue more precise forecasts in good news periods than do u.s. firms. coefficient b1 is significantly positive (p = 0.003) indicating that u.s. firms issue less precise forecasts when earnings are declining. firm size and regulated industry are insignificant (b4 and b5 respectively), while the degree of technology of the firm (b6), is significant with a p-value of 0.07, along with the horizon of the forecast, (b7), significant with a p-value of 0.001. in summary, results reported in table 4 support h3, indicating that canadian firms issue more precise voluntary earnings forecast than do u.s. firms when institutional differences are taken into consideration. table 4 management earnings forecast frequency in the u.s. and canada precisei = b0 + b1∆esigni + b2canadai + b3canadai x ∆esigni + b4lsizei + b5regulatei +b6hightechi +b7horizoni + vi independent variable (coefficient) expected sign coefficient estimate (p-value) intercept (b0) none predicted -2.115 (0.391) ∆esign (b1) positive 0.272 (0.003) canada (b2) positive (h3 for bad news) 1.310 (0.001) canada x ∆esign (b3) negative (h2) 0.305 (0.311) lsize (b4) negative -0.005 (0.412) regulate (b5) negative -0.298 (0.174) hightech (b6) none predicted -0.153 (0.070) horizon (b7) negative -0.002 (0.001) coefficients b2 + b3 positive (h3 for good news) 0.830 (0.001) 52 journal of business strategies summary this study utilizes one of the largest samples of voluntary earnings forecasts to date, covering a period of over 14 years, to show that institutional differences may characterize why there are differences in the numbers of voluntary forecasts and their associated precision between the u.s, and canadian firms. canadian firms have traditionally operated in a less litigious environment, and also were required to adopt ifrs in 2006. these institutional differences may help explain variations in voluntary earnings disclosures between the two countries. this study finds that canadian managers disclose more earnings forecasts (in both good news and bad news periods) and are more precise in their forecasts than their u.s. counterparts. even though stunda (2012) finds that more u.s. firms issue forecasts after the adoption of regulation fd, and stunda (2013) finds the same after adoption of slusa, results of these two studies may be mitigated by the overall numbers of firms in canada that issue forecasts relative to the u.s., especially since the adoption of ifrs in canada. the general implication of this study provides a key for stockholders. with respect to disclosure issues, u.s. firms tend to not offer voluntary disclosures as precisely as their canadian counterparts for the time period studied. in addition, u.s. firms still tend to issue more bad news forecasts than good news forecasts (as seen in extant studies), perhaps out of habit from pre-slusa and regulation fd days, or perhaps because canadian firms have a stricter requirement from ifrs.. endnotes 1 the change in earnings is defined as (epsit –epsit-k)/priceit-k, where epsit equals earnings per share for firm i in period, epsit-k = earnings per share for firm i in period t-1 for annual and t-4 for quarterly periods; and priceit-k equals security price for firm i at the end of period t-1 for annual and t-4 for quarterly periods…all obtained from compustat. references ajinkya, b. b., & gift, m. j. (1984). corporate managers’ earnings forecasts and adjustments of market expectations. journal of accounting research, (2), 425-444. baginski, s. p., hassell, j. m., & waymire, g. (1994). some evidence on the news content of preliminary earnings estimates. the accounting review, (1), 265-271. baginski, s. p., hassell, j. m., & kimbrough, m. d. (2002). legal environment and voluntary disclosures. journal of accounting research, 77(1), 25-49. volume 32, number 1 53 balakrishnan, k, xi, l., & yang, h. (2014) mandatory financial reporting and voluntary disclosure evidence from mandatory ifrs adoption. wharton school of business, 1-53. ball, r., s. kothari, s., & robin, a. (2000). the effect of international institutional factors on properties of accounting earnings. journal of accounting and economics, 29(1), 1-52. bamber, l. s., & cheon, y. s. (1998). discretionary management earnings forecast disclosures: antecedents and outcomes associated with forecast specify choices. journal of accounting research 36 (2), 167-190. barth, m. e., & clinch. g. (1996). international accounting differences and their relation to share prices: evidence from u.k., australian, and canadian firms. contemporary accounting research 13(1), 135-170. bodnar, g. mm., & weintrop, j. (1997). the valuation of foreign income of us multinational firms: a growth opportunities perspective. journal of accounting and economics 24(1), 69-97. bodnar, g. m., hwang, l., & j. weintrop (2003). the value-relevance of foreign income: an australian, canadian, and british comparison. journal of international financial management & accounting, 14(3), 171-193. clarkson, p. m., dontah, a., & sefcik, s. e. (1992). the voluntary inclusion of earnings forecasts in ipo prospectuses. contemporary accounting research, 8(2), 601-626. diamond, d. w. (1985). optimal release of information by firms. the journal of finance, 40(4), 1071-1094. diamond, d. w., & verrechia, r. (1987). constraints on short-selling and asset price adjustments to private information. journal of financial economics, (18), 277-311. frank, w. g. (1979). an empirical analysis of international accounting principles. journal of accounting research, 32(2), 137-164. frankel, r., mcnichols, m., & wilson, g. p. (1995). discretionary disclosures and external financing. the accounting review, 70(1), 135-150. frost, c. (1994). accounting disclosure practices in the united states and the united kingdom. journal of accounting research, 32(1), 75-102. guenther, d. a., & young, d. (2000). the association between financial accounting measures and real economic activity: a multi-national study. journal of accounting and economics, 29(1), 53-72. 54 journal of business strategies harris, t. s., lang, m., & moller, p. h. (1993). the value-relevance of german accounting measures: an empirical analysis. journal of accounting research 32(2), 187-209. jacobsen, r., & aaker, d. (1993). management behavior with efficient, but imperfect, financial markets. journal of accounting and economics 16, 383-405. joliet, r., & muller, a. (2009). dividends and foreign performance signaling. journal of accounting research (2), 201-232. lees, f. a. (1981). public disclosure of corporate earnings forecasts. new york, n.y.: conference board, c1981. nair, r. d., & frank, w. g. (1980). the impact of disclosure and measurement practices on international accounting classifications. accounting review, 55(3), 426-450. patell, j. m. (1976). corporate forecasts of earnings per share and stock price behavior: empirical tests. journal of accounting research, 14(2), 246-276. saulter, s. b., & doupnik, t. s. (1992). the relationship between legal systems and accounting practices. advances in international accounting, 5, 3-22. stunda, r.a. (2012). regulation fair disclosure and its impact on earnings forecasts. international journal of business and social sciences, 3(17), 2012. stunda, r.a. (2013). the effects of the securities litigation uniform standards acts (slusa) on earnings forecasts. international journal of business, accounting, & finance, volume 7(2), 97-104. waymire, g. (1984). additional evidence on the information content of management earnings forecasts. journal of accounting research, 22(2), 703-718. biographical sketch of author ronald stunda is associate professor of accounting at valdosta state university. he also serves as reviewer for several journals. his research deals mainly with market-based applied accounting research and has appeared in such journals as: journal of accounting and taxation, academy of business journal, journal of business and behavioral sciences, advances in business research, and the journal of accounting and financial studies. he can be reached at valdosta state university, 1500 north patterson street, valdosta, ga, 31698 rastunda@valdosta.edu tax code revision and the value of tax-deductible debt william lewis randolph norfolk state university norfolk, va abstract this paper examines a tax policy change that would eliminate the interest expense as a tax-deductible item for businesses. we analyze this change using a tax revenue neutral setting in a modigliani-miller world. the analysis uses two scenarios to compare the change to the present u.s. tax code. scenario one assumes a non-competitive environment with sticky prices. scenario two assumes that companies or industries with low leverage would cut prices instead of realizing excess profits. the reduction in prices will redistribute the present value of the corporate tax shield from the stockholder to the consumer. using the modigliani-miller methodology for valuation, the maximum value (equivalent to theoretical value in this case) of the tax shield is approximately $712 billion. the actual value is probably less than half the theoretical amount. under either scenario, the weighted average cost of capital increases for levered firms. introduction for business owners an important feature of the u.s. tax code is the policy that allows business interest expense to be tax deductible. modigliani and miller (1963) have shown that tax-deductible interest expense adds value to the firm when debt is used in the capital structure. several changes to the tax code have been proposed that would eliminate this important deduction. these proposals include the flat-tax, value added tax (vat), and a national sales tax. sullivan (1995) examines these tax proposals in detail but does not address the loss in value from the elimination of tax-deductible business debt. this paper examines the effects of a corporate tax policy under which interest expense is not tax deductible. this change could be the result of either the elimination of corporate taxes or a modification in the corporate tax code. a tax code change that eliminates the firm value added by tax deductible debt would be of strategic importance to investors and business managers. considering the theoretical relationship between firm value, leverage, and taxes developed by modigliani and miller (1963), a tax code change of this type will have an impact on relative firm valuation that will directly impact stock prices. this change will also affect capital structure decisions and could impact capital budgeting decisions because of potential cost of capital changes. 20 journal of business strategies vol. 14, no. 1 we examine this issue by analyzing a tax system change that eliminates the tax deductibility of interest expense while keeping total corporate tax revenue constant. the externalities associated with the current tax system would undergo changes if interest expenses were no longer deductible. the most important change would be the loss of the value of the tax shield to the owners of the business. but wealth is neither created nor destroyed by changing the tax code, it is merely redistributed. we show in our findings that in a perfectly competitive economy the value of the tax shield is redistributed back to the consumer through lower pnces. this change in the tax code will also affect the cost of capital for firms that use debt. since the use of tax-deductible interest expenses increases the value of the firm, the cost of capital of the firm can be reduced by using debt. firms using debt would have their cost of capital increase if the change is considered in isolation. an increase in the cost of capital would tend to put u.s. firms at a competitive disadvantage in international markets. other aspects of some of the proposed tax changes such as making dividend payments and capital gains nontaxable for investors would reduce the cost of capital and help offset increases from the loss of the interest expense deduction. another factor we examine is the effect of the tax code change on the risk associated with debt repayment. the risk associated with a claim on the firm's cash flow is inversely related to the priority of the claim on the earnings stream of the firm. under the current tax system, interest payments to lenders have priority over corporate income taxes since interest expense is deducted before taxes are computed. this makes the lenders' claim less risky in comparison to a tax code change that results in interest expenses not being deductible. if business interest expenses become nondeductible, this change will have an differing impact on firms with different capital structures. the firm with low financial leverage could benefit from this change while the highly levered firm would not benefit. we show in the findings how the change would impact the stock prices of firms with different amounts of leverage. this factor is of critical importance to financial analysts and the investing public. corporate valuation the modigliani-miller (1958, 1963) analysis of the effect of capital structure on the cost of capital forms the basis for our analysis. we use the standard modigliani-miller (mm) assumptions that assume, among other things, that all firms are in the same risk class and that firms issue only two types of claims; riskfree debt and risky equity. for a complete list of assumptions and a detailed presentation of the mm analysis, see copeland and weston (1988). the mm proposition i, modified for tax-deductible corporate debt, holds that the value of the levered firm, vi, is equal to the value of an unlevered firm, vu, plus the present value of the tax shield provided by debt, td. we have spring 1997 randolph: tax code revision 21 vi = vu + td, (1 ) where t is the corporate tax rate and d is the amount of debt used. if the corporate tax code were to be changed where interest expenses related to corporate debt were no longer tax-deductible then we would have vi =vu. (2) the present value of the tax shield that belonged to the owners of the firm is lost. the source of the added value is usually not addressed in finance literature, but, as we will demonstrate, this value is redistributed to the consumer in a perfectly competitive economic system. the mm proposition ii states that the expected return on a share of stock is equal to the appropriate capitalization rate, r, for an unlevered stock plus a premium related to financial risk equal to the debt-to-equity ratio (b/s) times the difference between r and the cost of borrowing, kb. adjusted for taxes, the return on equity, ks, can be computed using ks =r + (j-t) (r-kb) (b/s). (3) one of the great contributions of the mm papers was the demonstration that the cost of capital for the firm was invariant to capital structure in the absence of tax effects. but since the interest expense on corporate debt is tax-deductible, the cost of capital can be reduced by using debt in the capital structure. the weighted average cost of capital (wacc) is computed using wacc =(l-t) kb [b/(b+s)] + ks [s/(b+s)]. (4) analysis assumptions and methodology to analyze the effects of tax policy change, we assume that any changes made in the tax code will be revenue neutral. thus, the total taxes collected after the change will equal the total taxes collected before the change. this assumption allows the analysis to focus on the impact of this change alone. if interest expenses are no longer tax-deductible the taxable income would increase. to maintain revenue neutrality, we reduce the tax rate so the government collects the same amount of tax revenue after the change. since firms use different amounts of debt in their capital structure, the reduction in the tax rate will affect firms differently. after the change, firms with below average amounts of debt will pay less tax. firms with higher than average debt will pay more tax. firms with an average amount of debt would find their corporate income tax unchanged. the change would benefit firms that use little debt and hurt firms that use higher than average amounts of debt. the economic behavior of firms who pay lower taxes as a result of the change is a critical factor in the analysis. we use two scenarios to examine the change under competitive and non-competitive economic environments.. in the first scenario, we assume a non-competitive environment. in this environment, prices are sticky and do not change when we reduce the tax rate. since prices do not change, 22 journal of business strategies vol. 14, no. 1 total corporate sales and total earnings for the three finns will be the same as under the current tax policy (the base case). in this scenario, the no-leverage finn receives an earnings increase, the high-leverage finn receives an equal earnings decrease, and the average-leverage finn has constant earnings. in the second scenario, we assume competition. competitive pressure from firms with belowaverage leverage would lead to price cuts rather than windfall profits. under either scenario, the value of finns that are identical except for leverage becomes equal after the tax code change. their tax bills also become equal when the distortion caused by the tax system is removed or changed, finns with identical functions and levels of sales would have the same value and pay the same tax. what happens to the value of the tax shield, td? in the examples below, we show that in the non-competitive scenario high leverage finns lose value to low leverage finns. under perfect competition, the consumer receives the value of the tax shield as price reductions. we analyze the effect that this change in the tax code has on investors. we do this by examining changes in the risk/return characteristics of the securities of the corporation. we examine changes in stock prices and the return on equity (roe) which will affect shareholders. we also show how the change could affect risky debt. an important risk indicator for bondholders is the times-interest earned or coverage ratio. the coverage ratio is the amount of earnings available for debt service di vided by the amount of the interest expense. high coverage ratios mean less risk for the bondholders. the example it is straight forward to show the loss of the tax if interest expenses are not tax-deductible. it is also evident that stockholders of highly levered firms will suffer losses on their investment in these finns. to show what happens to this value is more complicated. if some stockholders will be worse off, who will benefit? we have outlined the answer to this question above. we use an example to demonstrate the logic of these answers. the example details the flow of funds that would occur due to the change in the tax code. in the following example we use three finns that differ only in capital structure to demonstrate the ramifications of making interest expenses non-deductible. one company uses no debt in its capital structure, another company uses a relatively large amount of debt, and the third company uses an average amount of debt. we assume a modigliani-miller world with corporate taxes. the unlevered company, nolevco, has a net income (also cash flow) of $187.50 and the appropriate capitalization rate or discount rate, r, is 12.5%. since the company is unlevered, the cost of capital and roe are also 12.5%. this results in $1500 value for nolevco and, because the company has 150 shares outstanding, the market value of a share is $10.00. the pre-change corporate tax rate is 25%. the first column of table i presents the base case financial data for nolevco. spring 1997 current policy tax deductible interest sales $1,000.00 costs (750.00) op. pro 250.00 int. exp. 0.00 e. b. tax 250.00 tax (@25%) (62.50) n. i. 187.50 randolph: tax code revision table 1 nolevco financial data income statement nondeductible interest expense scenario 1 scenario 2 sales $1,000.00 sales $987.50 costs (750.00) costs (750.00) op. pro 250.00 op. pro 237.50 tax (@20%) (50.00) tax (@21%) (50.00) e. a. tax 200.00 e. a. tax 187.50 int. exp. 0.00 int. exp. 0.00 n. i. 200.00 n. i. 187.50 values and ratios 23 current policy nondeductible interest expense tax deductible interest scenario 1 scenario 2 equity book value $1,500.00 $1,500.00 $1,500.00 tax shield value 0.00 0.00 0.00 sticky price value 0.00 125.00 0.00 amount of debt 0.00 0.00 0.00 total value of firm $1,500.00 $1,625.00 $1,500.00 return on equity 12.50% 12.31 % 12.50 % weighted average cost of capital 12.50 % 12.31 % 12.50 % share price $10.00 $10.83 $10.00 earnings per share $1.25 $1.33 $1.25 debt coverage ratio na na na notes: shares outstanding = 150, op. pro = operating profit, e. b. tax = earnings before tax, n. i. = net income int. exp. =interest expense, e. a. tax =earnings after tax, 24 journal of business strategies vol. 14, no. 1 the capital structure of the company with average leverage, normco, is $1000 equity (s) and $500 debt (b). the cost of borrowing is 10%. the value of the tax shield (the tax rate multiplied by the amount of debt) is $125. this results in an equity market value of $1125. with 100 shares outstanding, the value per share is $11.25.· the roe is computed using (3), and for normco is 13.33%. the cost of capital is computed using (4) and the result is 11.54%. the financial data for normco is presented in the first column of table 2. the company with high leverage, hilevco, has borrowed $1000, has a book equity value of $500, and a tax shield worth $250. the market value of the equity is $750. with 50 shares outstanding, the value per share is $15.00. hilevco has a return on equity of 15.00% and a cost of capital of 10.71%. refer to the first column in table 3 for the financial data of hilevco. findings next we examine these companies after the tax change using the two economic scenarios outlined above: sticky prices and perfect competition. after the tax code change, we compute taxes after deducting operating costs. these operating costs are equal for the three firms since they differ only in capital structure. we reduce the tax rate from 25% to 20% in the first scenario and to approximately 21 % in the second scenario to achieve tax revenue neutrality. in the first scenario, we assume a non-competitive environment. in this environment, prices are sticky and do not change after we reduce the tax rate. since prices do not change, total corporate sales and total earnings will be the same as under the current tax policy (the base case). while the totals remain the same, the no-leverage firm receives an earnings increase, the high-leverage firm and equal earnings decrease, and the average-leverage firm has constant earnings. the middle column of table 1 shows the financial impact of the tax change under scenario one for nolevco. the tax bill ofthe firm decreases from $62.50 to $50.00, increasing earnings by $12.50. treated as a perpetuity and discounted at the risk free rate of 10.00%, this addition to earnings will add $125 to the value of the firm. in the mm analysis, the present value of the tax shield is computed by discounting at the risk free rate. we use the same logic here to compute the present value of a stream of excess profits. the $125 added value, recorded in the sticky-price value row of table 1, also will apply to the other two firms under the first scenario. the effect of these windfall profits is to reduce the discount rate applicable to the firm (and the roe) to 12.31 %. this rate can be found by dividing the earnings by the value of the firm ($200/$1625). perfect competition is the assumption in the second scenario. competitive pressures from firms with below average leverage would lead to price cuts rather than windfall profits. if we assume that costs and unit volume remain constant, tive pressures from firms with below average leverage would lead to price cuts rather than windfall profits. if we assume that costs and unit volume remain constant, then sales revenue decreases by the amount of the price cut. we show spring 1991 randolph: tax code revision table 2 25 normco financial data income statement current policy nondeductible interest expense tax deductible interest scenario 1 scenario 2 sales $1,0000.00 sales $1,000.00 sales $987.50 costs (750.00) costs (750.00) costs (750.00) op. pro 250.00 op. pr. 250.00 op. pro 237.50 int. exp. (50.00) tax (@20%) (50.00) tax (@21%) (50.00) e. b. tax 200.00 e.a. tax 200.00 e.a. tax 187.50 tax (@25%) (50.00) int. exp. (50.00) int. exp. (50.00) n.t 150.00 n.t 150.00 n. i. 137.50 values and ratios current policy tax deductible interest nondeductible interest expense scenario 1 scenario 2 equity book value $1,000.00 $1,000.00 $1,000.00 tax shield value 125.00 0.00 0.00 sticky price value 0.00 125.00 0.00 amount of debt 500.00 500.00 500.00 total value of firm $1,625.00 $1,625.00 $1,500.00 return on equity 13.33 % 13.33 % 13.75 % weighted average cost of capital 11.54 % 12.31 % 12.50 % share price $11.25 $11.25 $10.00 earnings per share $1.50 $1.50 $1.38 debt coverage ratio 5.00 4.00 3.75 notes: shares outstanding = 100, op. pro =operating profit, int. exp. =interest expense, e. b. tax =earnings before tax, e. a. tax =earnings after tax., n. i. =net income 26 journal of business strategies table 3 vol. 14, no. 1 hilevco financial data income statement current policy nondeductible interest expense tax deductible interest scenario 1 scenario 2 sales $1,000.00 sales $1,000.00 sales $987.50 costs (750.00) costs (750.00) costs (750.00) op. pro 250.00 op. pro 250.00 op. pro 237.50 int. exp. (100.00) tax (@20%) (50.00) tax(@21%) (50.00) e. b. tax 150.00 e. a. tax 200.00 e. a. tax 187.50 tax (@25%) (37.50) int. exp. (100.00) int. exp. (100.00) n. i. 112.50 n. i. 100.00 n. i. 87.50 values and ratios current policy tax deductible interest nondeductible interest expense scenario 1 scenario 2 equity book value $500.00 $500.00 $500.00 tax shield value 250.00 0.00 0.00 sticky price value 0.00 125.00 0.00 amount of debt 1000.00 1000.00 1000.00 total value of firm $1,750.00 $1,625.00 $1,500.00 return on equity 15.00 % 16.00 % 17.50 % weighted average cost of capital 10.71 % 12.31 % 12.50 % share price $15.00 $12.50 $10.00 earnings per share $2.25 $2.00 $1.75 debt coverage ratio 2.50 2.00 1.88 op. pro = operating profit, int. exp. = interest expense, e. b. tax = earnings before tax, e. a. tax =earnings after tax., n. i. = net income spring 1997 randolph: tax code revision 27 nolevco's financial results for the second scenario in the third column of table 1. in this scenario, nolevco's earnings remain at the original $187.50 level and the firm's discount rate remains at the base case rate of 12.50%. the share price that increased in the first scenario to $10.83 due to the windfall in~ crease in earnings, returns to the original level of $10 in the second scenario. there are no windfall benefits for the firm, and we assign zero value the stickyprice value row. the tax change would not affect the stockholders of this firm under scenario two. we present the post-tax change financial information for normco in column two and three of table 2. in scenario one, the firm looses the value of the tax shield ($125) but gains an equal benefit from sticky prices. the wacc increases to 12.31 %, the same as the discount rate of the unlevered firm under windfall profits. the values of the levered and unlevered firm have to be equal when there is no tax shield. this result is consistent with the theory of mm. the way this happens under the first scenario is for the sticky-price value to apply to the levered as well as the unlevered firm. in the second scenario, competition from the unlevered firm causes prices to decrease and normco will experience a $12.50 reduction in earnings. since the value of the tax shield has been lost and there is no benefit from sticky prices, the value of the firm is the same as the value of the unlevered firm. the share price falls to $10, the same price as the unlevered firm. column two and three in table 3 shows the financial data for hilevco after the tax change. because hilevco has above average leverage, the tax change will cause a reduction in earnings in both scenarios. the reduction in earnings in the first scenario equals the gain realized by nolevco. in scenario one, value'is transferred from firms with above average leverage to firms with below average leverage. the loss in stockholder value by hilevco is equal to the gain in nolevco stockholder value. in the second scenario, hilevco share price declines to $ i0.00, the same as the other two firms. in tables 1 through 3 the share prices, earnings per share (eps), and roe are consistent with the mm propositions. in scenario two, we have the situation where all firms have the same wacc and share price. the eps and roe increase with leverage to reward the stockholders for exposure to financial risk. to maintain the mm result under the second scenario, the present value of the price reduction must equal the present value of the tax shield. the total value of the tax shields of the three firms is $375; nolevco $0, normco $125, and hilevco $250. the price cut (reduction in revenue) is $12.50 per firm, or $37.50 in perpetuity. using the risk free rate of 10%, the present value of this perpetuity is $375. the loss in value to the stockholders is redistributed to the consumer. the consumer would receive a price reduction of 1.25% under perfect market conditions. goods that previously cost $1,000 would now cost $987.50. we also show debt coverage ratios in tables 1 through 3. the debt coverage ratio decreases when interest payments are no longer tax-deductible. bondhold28 journal of business strategies vol. 14, no. 1 ers would hold securities that are subject to a somewhat higher risk of default because the priority of the bondholders' claim has been reduced as a result of the change. this would adversely effect the market price of the bonds and require the company to make higher coupon payments when debt is issued in the future. since we are assuming risk free debt we will not attempt to model the effect of the decrease in the coverage ratio. size of the redistribution as cutler (1988) and downs and tehranian (1988) point out, it is very difficult to estimate the impact of tax policy changes on the stock market. we use the mm methodology to estimate the maximum impact that changing the deductibility of interest expense would have on stock prices. according to the federal reserve board, the amount of corporate borrowing outstanding in the u.s. at the end of 1995 was $2,849 billion. if we use an effective tax rate of25% and assume td from (1) holds for risky debt, then the maximum value of the tax shield would be $712 billion. a reduction of this size in the market value of corporate stock would approximate the stock market crash of october 1987. several factors diminish the actual value of the tax shield. if stockholders discount the value of the tax shield because of its problematic nature, then this would reduce its value, and the actual impact on stockholder wealth would be considerably diminished. in addition, the growing impact of the alternative minimum tax has reduced the value of all tax preference items and would reduce the value of the tax shield if the firm has tax deductions it can not currently use. the nature of the tax law change could also reduce the impact on shareholders. for example, if the corporate tax is replaced by a vat or national sales tax then the corporate deferred tax liability would be eliminated, and the balance of this account would be transferred to retained earnings and would increase stockholder book value. this would increase shareholder wealth and offset the loss of the tax shield. givoly and hayn (1992) estimate that investors treat the deferred tax liability as if it were worth 40 or 50 percent of the balance sheet value. any policy change that reduces or eliminates the deferred tax liability would thus increase the value of the firm for the shareholder. the flat tax proposal of hall and rabushka (1983) would incorporate other changes that would tend to increase the value of corporate securities. these changes include the elimination of the capital gains tax and taxes on interest and dividend income. summary and conclusions summary this paper considers a tax policy alternative that would eliminate the interest expense as a tax-deductible item for u.s. businesses. we examine this policy change in a tax-revenue neutral setting. this results in a decrease in tax rates since taxable income is increased. we use two assumptions concerning economic spring 1997 randolph: tax code revision 29 markets and compare the results to the present corporate tax code. scenario one assumes that prices are sticky and would not change because of a change in the tax code. scenario two assumes that competition by companies with low leverage would lead to reduced prices instead of excess profits. the new tax policy would have the following results under scenario one: 1. total corporate earnings would remain constant under constant sales. 2. unlevered firms and firms with less than average leverage would enjoy increased eps. firms with greater than average amounts of debt would have lower eps. the average firm would have constant eps. this will result in a transfer of wealth from the shareholders of firms with above average leverage to the shareholders of firms with below average leverage. 3. for all levered firms the value of the debt tax shield is lost. 4. all firms will receive an increase in value based on the size of the extra earnings received by the un levered firm due to the tax rate decrease and sticky prices. in the case affirms with below average leverage, the value of the windfall profits could exceed the loss of the debt tax shield. under the perfect-competition conditions of scenario two, the following would occur: i. if unit demand is constant, total corporate sales and earnings would decrease as a result of price reductions. 2. unlevered firms would have the same eps as under the present tax policy. all1evered firms would experience a decrease in eps and a loss in value. 3. the loss of value for the stockholders of levered firms is greater than under scenario one due to the loss of the tax shield and no benefit from sticky prices. 4. consumers receive a transfer in wealth from shareholders, in the form of lower prices whose present value is equal to the present value of the lost tax shields. under either scenario the following will occur: 1. corporate debt would become more risky due to the reduction in priority of payment. 2. the wacc would increase to the discount rate appropriate to the riskiness of earnings stream. the average cost of capital would therefore increase. leverage is still able to increase the risk and return on equity capital. but will not lower the wacc. which is the more likely scenario? the answer to this question could vary from industry to industry depending on the degree of competition present in the industry. in highly competitive industries with generic products, the result should approximate scenario two. in less competitive industries, the result would approach scenario one. 30 journal of business strategies vol. 14, no. 1 implications for managers and policy makers the results that we show in our analysis have important strategic implications for decision makers. the tax code is a significant factor in the business environment. a change that eliminates the tax deductibility of business interest expense will have several impacts on businesses. according to mm, an immediate impact would be the loss of the value of the tax shield. the loss of the tax shield will have a greater impact on highly levered firms and cause decreases in the value of these firms. in the example we use above, the stock price of the highly levered firm went from $15 to $10. this was under perfect market conditions in an industry where an unlevered firm will set product prices. in the real world we would not expect to see such large changes. all firms use some leverage and perfect market conditions do not hold. however, our results lead us to predict that firms with relatively high amounts of debt in their capital structure would restructure to lower levels of debt if the proposed tax change had a high likelihood of being implemented. this type of restructuring could have enormous implications for the capital markets since large amounts of debt would probably be retired by raising additional equity capital. a simultaneous change that makes dividend income non-taxable for investors would make it easier to raise equity capital and reduce the upward pressure of the cost of capital. references copeland. t. and f. weston. financial theory and corporate policy. 3rd ed. new york: addison-wesley, 1988. cutler, d.m. "tax reform and the stock market: an asset price approach." the american economic review 5 (1988): 1107-1117. downs, t.w. and h. tehranian. "predicting stock price responses to tax policy changes." the american economic review 5 (1988): 1118-1130. jorgenson d.w. and k.y. yun. tax reform and the cost of capital. oxford: clarendon press, 1991. givoly, r. and c. hayn. "the valuation of the deferred tax liability: evidence from the stock market." the accountine review (apr. 1992): 394-410. hall, r. and a. rabushka. low tax. simple tax, flat tax. new york: mcgraw hill, 1983. masulis, r. the debt/equity choice. new york: ballinger publishing company, 1988. modigliani, f. and m. miller. 'the cost of capital, corporation finance, and the theory of investment." american economic review (june 1958): 261-297. spring 1997 randolph: tax code revision 31 -----. "corporate income taxes and the cost of capital: a correction." american economic review (june 1963): 433-443. poterba. j.m. "why didn't the tax reform act of 1986 raise corporate taxes?" tax policy and the economy 6 (1992): 43-58. sinn, h.w. "taxation and the cost of capital: the "old" view, the "new" view, and another view." tax policy and the economy 5 (1991): 25-54. scholes, m. and m. wolfson. taxes and business strategy, a planning approach practice. englewood cliffs, nj: prentice hall, 1992. slemrod, j. and m. blumenthal. the income tax compliance cost of big business. washington, dc: tax foundation, 1993. sullivan, m. flat taxes and consumption taxes: a guide to the debate. new york: american institute of certified public accountants, 1995. william lewis randolph, (ph.d., university of alabama) is an associate professor of finance at norfolk state university where he teaches courses in corporate finance and investments. he is also managing editor of the journal of developmental entrepreneurship. he received his ph.d. in 1986. he is a former navy carrier pilot whose last assignment in the navy was commanding officer of training squadron nineteen. his major research interests include options, after-tax investment returns, and developmental entrepreneurship. professor randolph is a chartered financial analyst. his consulting areas include securities arbitration and litigation and security analysis. tax code revision and the value of tax-deductible debt volume 32, number 2 151 vulnerability to poverty: a survey ratul mahanta gauhati university • assam, india daisy das north eastern hill university • meghalaya, india. abstract there has been no consensus over the concept and measurement of vulnerability to poverty (vp). many scholars bring in different perspectives to discuss various conceptual and measurement issues. this paper summarizes the available economic literature on the definitions and measurements of vp. despite a lack of agreement, the concept of vp essentially captures the dynamic aspects of poverty, which are extremely important for formulating appropriate and effective poverty alleviation policies. this paper discusses the three basic approaches for measuring vp. further, the data-related issues are also discussed. then the paper reviews previous studies on the vulnerability estimation for different countries and highlights the relative importance of various shocks in determining vulnerability. finally, the paper ends by raising a number of policy-related issues. keywords: vulnerability to poverty; risks; poverty alleviation policy introduction the substantial mobility of people into and out of poverty in modern societies makes the dynamics of poverty an intriguing topic of study to many empirical researchers. such movement in and out of poverty is very common, particularly in developing countries (jadotte, 2010). these movements depend on a wide variety of economic and social deprivations that are mostly dynamic in nature. it implies that poverty is not necessarily a stagnant state for an individual or a group of individuals. thus, a complete appraisal of poverty requires incorporation of these dynamic aspects in the concept and measurement of poverty. the recognition of this fact has led to the concept of ‘vulnerability to poverty (henceforth vp)’. the static poverty measures are ex-post in nature and, therefore, imperfect to shed light on poverty dynamics. thorbecke (2004) argues that there are many unresolved issues of poverty analysis which are related to the dynamics of poverty. the dynamic aspect of poverty takes into account the change of welfare attributes over time. according to the static 152 journal of business strategies approach, it is difficult to have a sense of poverty incidence in near future. thus, measures based on the static approach are inadequate guide to imminent poverty status which is important for policy makers. the concept of vp has been put forward as a solution to this problem that policy makers face. a household is considered to be ‘vulnerable to poverty’ if it is likely to be poor in near future. it is now widely recognized that the dynamic aspect of poverty is the important ingredient of any poverty alleviation program. poverty analysts advocate that the forward-looking approach of poverty measurement deals more with people’s well-being than does the static approach. the latter approach is criticized on the ground that it ignores the risk and uncertainty that a human being faces while maintaining its income or consumption at the minimum sustainable level. in contrast, the forward-looking approach recognizes that that the experience of negative shocks can make the endowment level volatile leading to permanent poverty. studies on vp shed lights on the sources and types of risks that households face, which help them prepare strategies to mitigate or reduce risks. poverty alleviation programs can reduce temporary poverty through aid but to address vulnerability to poverty, prevention, mitigation and coping mechanism are more important (jha and dang, 2010). poverty alleviation measures target those who were poor in the previous period based on poverty threshold of income or consumption. this may lead to the failure of poverty alleviation program as it may provide income support to those who may no longer be ‘poor’ in the current year as they are out of poverty. in contrast, the program may leave out those ‘non-poor’ in the previous period who may have slipped into poverty in the current period due to some shocks. therefore, an appropriate poverty alleviation policy should target those who are currently poor as well as those who are not poor but likely to be poor in near future due to their exposure to some shocks. vulnerability to poverty makes a clear distinction between ex-ante poverty prevention and ex-post poverty alleviation measures. there are many scholars who have tried to articulate the concept of vp and its measurement. but there has been no consensus. this paper is an attempt to summarize the definitions and measurements of vp that have been proposed by different scholars. further, findings of some key studies have also been reported. the paper is divided into five sections. section 2 presents the conceptual issues related to poverty and vulnerability as well as the meaning of vp. measurement of vp is discussed in section 3 where approach based and data related measurement issues are explained. section 4 describes the summary of results from empirical study. the last section includes our concluding remarks. volume 32, number 2 153 conceptual framework: poverty and vulnerability the link between poverty and vulnerability has been widely recognized in theory and practice (banerjee and newman, 1994; morduch, 1995; chaudhuri et al., 2002). in order to understand this link, we will first explore the concept of poverty and its relation with uncertainty. poverty is often defined as either chronic or transitory. it is chronic if a household is poor in every period of the sample under consideration. in case of chronic poverty, both household’s income, i, and consumption, c, are less than the defined poverty line, z. this implies that i < z as well as c < z. in contrast, transitory poverty arises when a household fails to control the stochastic elements that lower the consumption of the household in any period over the sample. as stochastic elements are the sources of poverty, it is also called stochastic poverty. in this case, c < z < i. in most low income countries, the transitory or stochastic poverty is synonymous with chronic poverty. there are two reasons. first, as the income earner in a household falls sick, it reduces its earning capacity and, consequently, its permanent income drops. second, it is not even possible for the household to borrow against future earnings as there is no well-developed financial system nor any social insurance institutions available. these structural sources of poverty are often more important than the inherent aspects of the income process in low income countries (walker and ryan, 1990; morduch, 1994). since these stochastic elements are uncertain in nature, it is important to understand the link between poverty and uncertainty that highlights the dynamic aspects of poverty. although the economics of poverty and of uncertainty are well developed, the intersection between these two has been discussed only recently. even the most established poverty measure by foster, greer and thorbecke (fgt, 1984) evaluates the poverty status of households in a static sense and ignores the dynamic aspects. as a result, if we go with this measure it is difficult to know whether the poverty is because of structural causes (e.g. low endowments) or due to large fluctuations in income caused by uninsured risks (gunther and harttgen, 2009). from a policy perspective, it is important to know the distinction between poverty caused by low endowments and poverty caused by volatility in endowments due to some shocks. morduch (1994) views that the unexplored interaction between poverty and uncertainty may be due to practical as well as conceptual reasons. the practical difficulty of exploring the link is a lack of availability of longitudinal data on income, consumption, and risk in most developing countries. conceptually, it is difficult to explore the link as transitory poverty may be due to structural causes and 154 journal of business strategies risk may not play any role. stating the importance of stochastic elements as a source of poverty, tendon and hasan (2005) view that poverty should not only be understood in terms of monetary and social deprivations but also in terms of exposure to shocks faced by households. in the same line, ligon and schechter (2003) argue that household’s well-being is affected not just by income or expenditure but also by the shocks that household faces. in the 1990s, some researchers tried to examine the effect of shocks on consumption that provides an indication of vulnerability (e.g. ravallion, 1988; morduch, 1994; ravallion et al., 1995; grootaert et al., 1997; glewwe and hall, 1998). in poverty due to uninsured or partially insured risk, lies the meaning of vp. the theoretical link between poverty and vulnerability is based on two observations: (i) generally the poor are most exposed to diverse risks and (ii) the poor do not have enough resources to mitigate these risks (holzmann and jørgensen, 2001). exposure to these risks reduce household well-being by permanently lowering human capital formation and income (morduch, 1994; jacoby and skoufias, 1997; dercon, 2001, 2004 & 2006; ligon and schechter, 2003; kasirye, 2008). studies show that households and individuals could sometimes mitigate or partially insure these risks (morduch, 1995; townsend, 1994). however, even the uninsured part of the risks could be a cause of poverty (dercon, 2004). dercon (2001) presents a schematic approach (see table 1) to illustrate the links between risk and well-being. his approach is comprehensive in listing all different types of assets and incomes that are potentially at risk and showing how they affect the household’s ability to acquire capabilities that determine well-being. recognizing the effects of enormous and diverse risks faced by the poor, policy makers, development practitioners, and researchers are of the opinion that risk management should be an integral part of poverty-reducing strategies (holzmann and jørgensen, 2001; christiaensen and subbarao, 2004). volume 32, number 2 155 table 1. link between risk and well-being assets incomes well-being -“capabilities” • human capital, labor • physical/financial capital • commons and public goods • social capital   • returns to activities and assets • returns from asset disposal • savings, credit and investment • transfers and remittances  ability to obtain (inter alia) • consumption • nutrition • health • education  examples of risk (a) • loss of skills due to health and unemployment • land tenure insecurity, uncertain titles to other assets • asset damage due to climate, war or disaster • access to commons and unclear commitments and trust • loss in value of financial assets or pension funds linked to inflation, stock market or exchange rate collapses  examples of risk (b) • output risk due to climate shocks, disease, conflict • output price risk • covariance in incomes and asset prices • risk in asset returns from savings and investment including inflation) • uncertain access to inputs or cash flow support during production • imperfect enforcement of contracts, such as payment for goods and services rendered • uncertainty about enforcement of informal arrangements, including informal protection-for example, transfer and remittances may not materialize • uncertainty regarding rationing in public support, for example, risk of exclusion from safety net • imperfect information and knowledge about opportunities • risks in policy environment-credibility and commitment to continue policies  examples of risk (c) • price risk in food markets • food availability and rationing risk • uncertain quality of public provision in health and education • uncertainty about rationing scheme employed in health or education • imperfect knowledge about health and nutrition ‘production’ (uncertainty about right answer) source: dercon, 2001. p.17 156 journal of business strategies there are diverse scenarios associated with the meaning of vp in the literature. in general, vp is the probability that a household will fall below the poverty line (typically defined by a threshold of income or consumption) in future if the household is currently ‘non-poor’. it is also the probability that a currently ‘poor’ household will remain in poverty or will fall deeper into poverty in future. vp is an ex-ante position i.e. the knowledge about the actual shocks beforehand while poverty is the ex-post situation where outcome is observed after the experience of the shocks. the vulnerable households not only include those that are already poor but also those who are currently above the poverty line and are subject to possible risk with little resources to mitigate such risk (holzmann and jørgensen, 2001). the degree of vulnerability depends on the characteristics of risk, socio-economic factors, and the household’s ability to respond (alwang et al., 2001, dercon, 2001, christiaensen and boisvert, 2000). the household’s ability to cope with shocks is shaped by local conditions as well as human and physical endowments (khandker, 2007). calvo and dercon (2005), calvo (2008) and calvo and dercon (2013) argue that household well-being is jeopardized not only by severe consumption deficits but also by a wide variety of social deprivations. the feeling of insecurity is one of the main sources of deprivation that affects well-being. the 2000-01 world development report also emphasizes the importance of ‘security’ in the framework for poverty alleviation, which further stimulates the study of risk and it’s mitigation at the core of the antipoverty campaign. supporting sen’s (2000) view that freedom from vulnerability to poverty is an important dimension of well-being, dercon (2001) argues that it is both an end and a mean to development. vp measurement theoretical approaches to vp measurement in general, there are three approaches to measure vulnerability in the literature: vulnerability as expected poverty (vep), vulnerability as expected low utility (veu) and vulnerability as uninsured exposure to risk (ver). irrespective of different approaches, vulnerability is a function of expected mean and variance of household’s consumption. the expected mean of household consumption is determined by various individual and community characteristics while the variance is affected by idiosyncratic and covariate shocks as well as individual’s capacity to use different strategies against these shocks (gunther and harttgen, 2009). volume 32, number 2 157 in contrast to veu and ver that mostly use panel or pseudo panel data, vep is the most suitable approach to estimate vulnerability in developing countries as vep can be calculated with cross-section data. researchers like pritchett et al. (2000), chaudhuri et al. (2002), christiansen and subbarao (2004), gunther and harttgen (2009) and jadotte (2010) use the vep approach. according to this approach, vulnerability is measured by comparing future consumption with an exogenously given poverty threshold that is essentially a socially defined poverty line. according to vep proposed by chaudhuri et al. (2002), vulnerability of a household ‘h’ at time ‘t’ is the probability that household’s per capita consumption at ‘t+1’ will fall below the poverty line at ‘t’. (1) where vht is the vulnerability index of household h at time t. ch, t+1 is the household’s per capita consumption level at time t+1 and z is the socially defined poverty line. the higher the value of vulnerability index, the greater is the level of vulnerability of household h and vice versa. based on the fgt measure of poverty, vulnerability is expressed as: (2) where f(ch,t+1) and f(ch,t+1) denote the cumulative distribution and density functions of ch,t+1 respectively. α is an integer that taking the values: 0, 1, 2 etc. household consumption in period t depends on a number of factors: (3) where xh represents the household’s observable characteristics, βt is the vector of parameters describing the state of the economy at time t and αh and eht are unobserved time-invariant household fixed effects and idiosyncratic shocks respectively. substituting (3) in (2) gives the household vulnerability at time t as: (4) two problems may be encountered with this procedure. one is the measurement error that overestimates the variance of consumption and the other is the assumptions of capturing temporal variability through cross-section variability and that the disturbances for all households have the same variance. the measurement error is critical as it contributes ⅓ to ½ to total variance (pritchett et al. 158 journal of business strategies 2000). chaudhuri et al. (2002) control the measurement error through multiplicative adjustment of estimated variance but allow the latter problem to exist. to correct for unobserved heterogeneity, kamanou and morduch (2002) and kuhl (2003) propose a non-parametric approach that uses monte-carlo bootstrapping to estimate the distribution of future consumption. although this approach is quite promising, it is not entirely free from the heteroskedasticity problem. a combination of parametric and non-parametric methods could provide a good solution (chaudhuri, 2003). instead of estimating household vulnerability for only the next period i.e t +1 , pritchett et al. (2000) extends the time horizon and assume that a household may be vulnerable at any time over a relatively long span of time. they argue that vulnerability (or risk represented by r(.)) of household h for n periods is the probability of observing at least one episode of poverty (based on poverty line, pl) for n periods, which is 1 minus the probability of no episodes of poverty. (5) now, based on the poverty line threshold z, they define that a household h is vulnerable if the risk in n periods is greater than z. that is, (6) where i (.) is the indicator function equal to 1 if the condition on the right hand side of (6) is true and zero, otherwise. incorporating the effect of shocks on consumption and household’s coping capacity or ability to smooth consumption in the face of shocks, christiaensen and subbarao (2004) and kasirye (2008) extend the vep method developed by chaudhuri et al. (2002). they use repeated cross-sections with information on shocks and estimate the relative contribution of idiosyncratic and covariant shocks to vulnerability. they formulate the following consumption function with a heteroskedastic specification: (7) where st+1 are observable, locally covariant, idiosyncratic shocks faced by households at time t+1, γ is a vector of time invariant unobservable household and environmental characteristics. the household’s coping ability is represented by the interaction between shocks faced by the household and its observable characteristics. the last term allows consumption variance to differ across households depending on their characteristics and locality of shocks. volume 32, number 2 159 to reduce unexplained heterogeneity, gunther and harttgen (2009) and jadotte (2010) decompose the unexplained variance of consumption into household and community level. thus, consumption of household h in community j can be represented as a function of household-specific idiosyncratic and communityspecific covariate shocks. (8) where the first and second part represent deterministic and stochastic component respectively. µij and εhj represent unexplained community and household variance. the interaction term mjxhj represents cross-section level interactions between variables at the household and community level. the bias due to overestimation of covariate shocks is controlled by introducing multilevel (or hierarchical) data structure. in most methods discussed above, vulnerability is estimated assuming 0.50 as the vulnerability threshold and consumption follows a log-normal distribution. zhang and wan (2008) show that the use of 50 percent as the vulnerability line is a better identification of vulnerability rather than the head count ratio. besides, they find that, with the assumption of log-normal distribution, weighted average of past incomes is preferred to instrumented income as an estimate of permanent income. the utility based approach known as veu proposed by ligon and schechter (2003) is based on the concept of risk aversion. it provides a clear disaggregation of vulnerability due to either poverty or uninsured risk. the risk component can be further divided into idiosyncratic, covariate and unexplained components. when a household faces with comparable returns, it is likely to use the less risky alternative with same utility. using the concave utility function of risk-aversion, vulnerability of household h can be represented by: (9) where z is the consumption level at poverty line or certainty-equivalent consumption equal to or above which people is considered as ‘non-vulnerable’. eu stands for expected utility. equation (9) can be rewritten as: (10) the first term on the right hand side is the utility gap measure (i.e. poverty) and it satisfies all axiomatic requirements placed on fgt poverty measure. the second term represents a shock faced by the household and it can be divided into 160 journal of business strategies two components: idiosyncratic and covariate shocks. (11) again, considering that consumption is likely to be measured with error, the authors further divide the idiosyncratic part into time varying household characteristics and unexplained risk as well as measurement error. (12) where the 2nd, 3rd and 4th term on the right hand side represent idiosyncratic, covariate and unexplained as well as measurement error component respectively. as before, the first term is the utility gap measure. now, to measure vulnerability, the four terms in equation (12) are to be estimated following the steps below: 1. the first part can be derived by assuming a simple form of the utility function: and estimating . ligon and schechter (2003) normalize c assuming that the average of consumption over all households in all periods equals 1 which also represents inequality. 2. of the 2nd, 3rd and 4th term can be estimated by regressing consumption on household and community characteristics. chaudhuri (2003) and calvo and dercon (2005) argue that their proposed vulnerability measure is in fact similar to the measure developed by ligon and schechter (2003) though they use different forms of utility functions. although the veu approach is conceptually sound and attractive, due to non-availability of panel or repeated cross-section data and methodological issues, the estimation of individual risk preferences through veu for developing countries is a formidable task. furthermore, veu can lead to overestimation of risk aversion if the utility function curvature is entirely attributed to observed risk response (just and pope, 2003). christiaensen and subbarao (2004) choose not to use the utility based approach to measure vulnerability. according to them, it is hard to estimate risk attitudes empirically and, even if it could be, it is not obvious to consider risk attitudes to evaluate people’s expected poverty. moreover, as individuals are illinformed about their preferences, it is difficult to assume that human knowledge can volume 32, number 2 161 perfectly feel future hunger or pain. the third approach, ver, is developed by glewwe and hall (1998), amin et al. (1999), dercon and krishnan (2000), and tesliuc and lindert (2002). it differs from vep in that it compares future consumption with an internal threshold set at the person’s current consumption level. using primarily panel data, ver makes an expost assessment of the extent to which welfare losses is caused by negative shocks. this approach measures vulnerability as the inability to smooth consumption in the presence of shocks. there are many methods that measure the change in well-being due to uninsured risk. in general, the following form of consumption function is used to measure vulnerability in this approach: (13) equation (13) represents change in consumption (consumption between t and t-1 period) as a function of household and community characteristics. d is the community dummy variable. incorporating the effect of shocks, this equation can be rewritten as: (13) where id and cv are the idiosyncratic and covariate shocks respectively. like in veu approach, we can estimate relative contributions of idiosyncratic and covariate shocks to welfare loss. moreover, this approach can be used to determine the share of shocks at different community level. one major disadvantage of this approach is that it doesn’t produce a ‘headline’ vulnerability estimate (hoddinott and quisumbing, 2003). chaudhuri (2003) criticizes this approach arguing that the assumption of symmetry of shocks is not acceptable. calvo and dercon (2005) criticize it as there is no role for probability of occurring shocks in ver. it only focuses on reaction to shocks. furthermore, christiaensen and subbarao (2004) criticize ver on the ground that poor who are generally placed in the lower tail of the distribution are not considered as vulnerable as they do not experience a large change in their consumption due to shocks although there may be a large change in consumption due to a small shock. for example, sickness of the family income earner can change household consumption level drastically. in contrast, non-poor are considered as vulnerable if their wealth are subject to high probability of adverse shocks (investment in stock market) though currently they are sufficiently well-off not to become poor. the vep and veu approaches are primarily used for assessing household 162 journal of business strategies vulnerability although it is claimed that aggregate vulnerability could also be estimated by aggregating individual vulnerability. calvo and dercon (2013) oppose this view and are of the opinion that individual vulnerability is not enough to compose the aggregate picture. based on the concept developed by fleurbaey (2010), they argue that individual outcome may not be favorable to society. considering ‘ex-post’ importance in welfare assessment, calvo and dercon (2013) argue that if we add up individual vulnerability to assess the aggregate, then widespread simultaneous poverty that a society face will remain unnoticed. contrary to the existing approaches, they discuss aggregation by invoking axiomatic foundations of measures that take into account the social threat of widespread poverty. calvo and dercon (2005) define vulnerability from a different perspective rather than uncertainty faced by a household that changes its consumption level as stated by vep, veu and ver approaches. they define vulnerability as an exposure to ‘threats’ or ‘downside risks’. data related measurement issues the measurement of vulnerability would be different for developing and developed countries. the reason is the inefficiency of financial markets or/and a lack of social insurance program that prevents people from managing idiosyncratic risks in developing countries (jha and dang, 2010). moreover, non-availability of panel data could be one reason for the differences in vulnerability measurement although repeated cross-section and single cross-section studies are used to measure vulnerability in developing countries (chaudhuri et.al., 2002; chaudhuri, 2003; gunther and harttgen, 2009; jadotte, 2010). as said earlier, vp can be examined with the help of lengthy panel data on consumption or income (holzmann et al., 2003). however, although such data are available for developed countries, they are rarely available for developing countries. in some cases, data are available either in the form of single cross-section or repeated cross-section (pseudo panel) having two or three waves. however, researchers have estimated household vp from single cross-sections (chaudhuri et al., 2002; tesliuc and lindert, 2002; suryahadi and sumarto, 2003; albert et al., 2007; jamal, 2009; gunther and harttgen, 2009; novignon, 2010; jha and dang, 2010; jadotte, 2010). but researchers show that panel data in short waves could be useful to examine the effect of shocks on well-being. townsend (1994) and urdy (1995) did some pioneering work along this line by first using panel data to analyze households ability to insure consumption caused by idiosyncratic shocks (gunther and harttgen, 2009). afterwards, various scholars have analyzed the effects of shocks on consumption volume 32, number 2 163 over time (glewwe and hall, 1998; jalan and ravillion, 1999; dercon and krishnan, 2000 and 2006; pritchett et al., 2000; christiaensen and boisvert, 2000; ligon and schechter, 2003; dercon, 2004; skoufias and quisumbing, 2004; christiaensen and subbarao, 2004; morduch, 2005; kasirye, 2008; calvo, 2008; jha et al., 2010). however, gunther and harttgen (2009) criticize these analyses on three grounds. first, in most of these studies, the scholars focus on the effect of selected shocks on consumption due to limited information on idiosyncratic and covariate shocks. as a consequence, the effects of the limited shocks on consumption are likely to be overestimated. second, the impacts of shocks on consumption across households are often assumed to be the same. third, there may be severe reverse causality problem as household’s well-being could impact the possible effect of shocks on consumption. to tackle these problems, gunther and harttgen (2009) use a two-level hierarchical analysis to investigate the effect of idiosyncratic and covariate shocks on household’s vulnerability based on cross-sectional data. jadotte (2010) further extends this two-level hierarchical method to three-level hierarchical variance-components model to assess vulnerability from a single cross-section summary of the results from empirical studies this section highlights the major findings of the works related to vulnerability estimation and the relative share of idiosyncratic and covariate shocks. appendix table a.1 highlights the characteristics of some key studies. applying the veu approach to panel data for 1997-98, christiaensen and boisvert (2000) estimate that 76% households are vulnerable in the northern part of mali. they find that households with more children are more vulnerable while female headed households are less vulnerable to drought shocks partly due to community solidarity. christiaensen and subbarao (2004) also find that female headed households are less vulnerable in rural kenya. in contrast, chaudhuri et al (2002), kuhl (2003), jadotte (2010) find that female headed households are more vulnerable than their male-headed counterparts. chaudhuri et al. (2002) use 1997 family income and expenditure survey (fies) and 1998 annual poverty indicator survey (apis) of philippines to observe that bulk of male headed households are ‘relatively vulnerable’ while bulk of female headed households are ‘highly vulnerable’. most researchers find that education of the head of the household is negatively related to vulnerability (tesulic and lindert, 2002; chaudhuri et al., 2002; kuhl, 2003; kasirye, 2008; jadotte, 2010). comparing vulnerability between rural and urban households, researchers find that vulnerability to poverty is higher in rural areas than in urban areas (chaudhuri 164 journal of business strategies et al., 2002; jha and dang, 2010; jha et al., 2010; jadotte, 2010). using panel data from 1998 to 2002, calvo (2008) find that rural households are more vulnerable to consumption poverty and less vulnerable to leisure-poverty in comparison to urban in peru1. overall, vulnerability to consumption poverty (0.10) is greater than vulnerability to leisure poverty (0.02) in peru. gunther and harttgen (2009) estimate that rural people are more vulnerable to consumption poverty (86%) than urban (24%) in madagscar. they assert that idiosyncratic shocks with low expected mean consumption are higher in urban areas while covariate shocks with higher fluctuations in consumption are higher in rural areas. in the same line, tesulic and lindert (2002) using 2000 living standards measurement survey (encovi) data for guatemala, also shows that rural households are more vulnerable than urban. they estimates that 20 percent households are vulnerable due to high volatility in consumption while 80 percent are due to low expected consumption. they find that the high consumption volatility leads even highly educated households to be vulnerable. in contrast, jadotte (2010) find that rural vulnerability (93%) is lesser than urban vulnerability (96%) in haiti. the rural vulnerability is mainly due to low consumption while urban vulnerability is due to volatility in consumption. kasirye (2008) point out that vulnerability in uganda is mainly caused by low mean consumption. out of 14% vulnerable households, two thirds are due to low mean consumption. dercon and krishnan (2006) finds that vulnerability to low mean consumption is much higher than poverty estimates in rural ethiopia. in terms of relative share of idiosyncratic and covariate shocks, most researchers state that these shares vary across regions/countries. using 1994 and 1997 welfare monitoring survey data for rural kenya, christiaensen and subbarao (2004) find that covariate shocks like rainfall volatility are more in arid and semi-arid areas while idiosyncratic shocks like malaria are more in non-arid areas. possession of sheep/ goat helps to reduce idiosyncratic shocks especially in arid zones while they are ineffective in reducing covariate shocks. jadotte (2010) makes a distinction between three types of shocks: idiosyncratic, meso-level (community wise) and covariate. applying the three-level hierarchy model to the haiti living conditions survey of 2001 (ecvh-2001), jadotte (2010) finds that idiosyncratic shocks are far more than meso-level shocks which in turn are more prevalent than covariate shocks in haiti. in contrast, calvo (2008) discovers that the importance of idiosyncratic shocks is similar for both rural and urban areas in peru. jha et al. (2010) find that idiosyncratic 1 deducting working time from “total time”, calvo (2008) calculate leisure time as 119 hours per week (17 x 7, allowing 7 hours as daily sleep). assuming work beyond 8 hours per day as severe deprivation of leisure time, he set the leisure-poverty threshold as 71(119-48, 8 hours as working hours for 6 days in a week) weekly hours. volume 32, number 2 165 shocks are dominant in tajikistan while ligon and schechter (2003) observe that covariate shocks are more dominant in determining vulnerability in bulgaria. sarris and karfakis (2006) also note that covariate shocks, particularly weather-induced fluctuations in production and terms of trade shocks, are the foremost determinants vulnerability in tanzania. dercon and krishnan (2006) conclude that households are vulnerable to common climatic and crop shocks as well as idiosyncratic shocks to livestock in rural ethiopia. social vulnerability rather than individual vulnerability is the subject matter of most studies in developed countries like the u. s. in recent times. using social and physical factors in the factor and data envelope analysis, geroge et al. (1998) develop vulnerability maps for revere city, massachusetts, usa, and argue that vulnerability maps can be used as an important tool for mitigating risk due to coastal flood. myers et al. (2008) find that outmigration, following hurricane katrina and rita in the u. s., is linked with social vulnerability. they state that outmigration pattern of a county is related not only to various dimensions of social vulnerability of that county but also to the migration patterns and social vulnerability of the surrounding counties. wang and yarnal (2012) show that social vulnerability due to hurricane hazards among elderly people of sarasota, florida, vary across locations. applying principal component analysis (pca), they find that elderly people living in barrier islands face a considerable physical vulnerability but less social vulnerability because of their wealth. in contrast, inhabitants of inland are far less physically vulnerable but they have limited adaptive capacity. concluding remarks estimation of vp makes more sense than does poverty estimation as vp captures dynamic aspects that are ignored in conventional poverty estimates. besides, by focusing on poverty dynamics over time, vp sheds light on the sources of poverty: whether poverty is because of low consumption or because of consumption volatility due to risks of shocks. there are many ways to define vp but most researchers agree that it is the risk of falling below poverty line in near future. although panel data or pseudo-panel data seem to be better suited for the estimation of vp as captured by fluctuations in well-being over a period of time, researchers have shown that single cross-section data could be used to estimate vp and its source as well. based on the results of vp estimation and its sources, researchers conclude that decentralized planning could be useful to curb poverty in near future. greater community level shocks on household’s income and consumption than covariate shocks highlight 166 journal of business strategies the importance of an effective role that the local government can play in designing policies to fight poverty. to minimize the effects of idiosyncratic shocks, it has been proposed that importance should be given to risk management strategies that enhance coping ability of the poor people. as almost all researchers find that education is highly related to vp, increased access to education is a necessary step and, therefore, it is imperative to invest more in the education sector. to fight with covariate shocks, it is suggested that appropriate safety nets should be used to target specific aggregate shocks. various methods have been suggested for the estimation of individual vulnerability. although aggregate vulnerability could be estimated by adding up individual vulnerability, individual outcome may not be favorable to society. moreover, the adding up solution may ignore the threat of simultaneous widespread poverty while calculating aggregate vulnerability. while most researchers use consumption deficits as a threat to well-being, of late, it has been recognized that the feeling of insecurity may be a cause of reduced well-being. this shows that vulnerability is the result of multidimensional deprivations. calvo (2008) uses a bidimensional criterion of well-being (consumption and leisure) to measure vp though there is scope for extending this concept to multiple dimensions, both conceptually and empirically. as stated by calvo (2008), the substitutability and complementarity among dimensions need to be assessed and it is important to know how individual vulnerability to multidimensional poverty index could be aggregated to have a single aggregate index. this is an open question for future research. references albert, .r.g., elloso, l. v. & ramos, a.p. (2007). toward measuring household vulnerability to income poverty in the philippines. pids discussion paper series no. 2007-16 available at http://www.pids.gov.ph. alwang, j., siegel, p. & jorgensen, s. (2001). vulnerability: a view from different disciplines. social protection unit, human development network, world bank. amin, s., rai, a. & topa, g (1999). does microcredit reach the poor and vulnerable? evidence from northern bangladesh. working paper 28, center for international development at harvard university. banerjee, a., & newman, a. (1994). poverty, incentives and development. american economic review, aea papers and proceedings, 82 (2), 211-215. calvo, c. (2008). vulnerability to multidimensional poverty: peru, 1998-2000. world development, 36(6), 1011-1020. volume 32, number 2 167 calvo, c., & dercon, s. (2005). measuring individual vulnerability. oxford economics discussion paper, 229. calvo, c. & dercon, s. (2013). vulnerability to individual and aggregate poverty. soc choice welf , 41, 721–740, doi 10.1007/s00355-012-0706-y. chaudhuri, s., jalan, j., & suryahadi, a. (2002). assessing household vulnerability to poverty from cross-sectional data: a methodology and estimates from indonesia’. discussion paper series 0102-52. new york: department of economics, columbia university. chaudhuri, s. (2003). assessing vulnerability to poverty: concepts, empirical methods, and illustrative examples. columbia university, mimeo. christiaensen, l., & boisvert, r. (2000). on measuring household food vulnerability: case evidence from northern mali. department of agricultural, resource, and managerial economics, cornell university, ithaca, new york. christiaensen, l., & subbarao, k. (2004). towards an understanding of household vulnerability in rural kenya. world bank policy research working paper 3326. clark, g.e., moser, s.c., ratick, s.j., dow, k., meyer, w.b., amani, s., jin, w., kasperson, j.x., kasperson, r.e. & schwarz, h.e. (1998 ) assessing the vulnerability of coastal communities to extreme storms: the case of revere, ma., usa. mitigation and adaptation strategies for global change 3, 59–82. dercon, s. (2001). assessing vulnerability to poverty, department of economics, oxford university. paper prepared for the dfid. available at http://www. economics.ox.ac.uc/members/stefan.dercon, accessed on 12th january 2015. dercon, s. (2004). growth and shocks: evidence from rural ethiopia. journal of development economics, 74 (2), 309–29. dercon, s. (2006). economic reform, growth and the poor: evidence from rural ethiopia. journal of development economics, 81, 1-14. dercon, s., & krishnan, p. (2000). vulnerability, seasonality, and poverty in ethiopia. journal of development studies, 36 (5), 25-53. fleurbaey, m. (2010). assessing risky social situations. journal of political economy, 118(4), 649–680. foster, j., greer, j. & thorbecke, e. (1984). notes and comments: a class of decomposable poverty measures. econometrica, 52 (3), 761-766. george, e.c., susanne, c.m., samuel, j.r., kirstin, d., william, b.m., srinivas, e., weigen, j., jeanne, x. k., roger, e.k., & harry, e.s. ( 1998), assessing the vulnerability of coastal communities to extreme storms: the case of revere, ma, usa. mitigation and adaptation strategies for global change, 3, 59–82. 168 journal of business strategies glewwe, p. & hall, g. (1998). are some groups more vulnerable to macro economic shocks than others? hypothesis tests based on panel data from peru. journal of development economics, 56, 181-206. grootaert, c., kanbur, r. & oh, g. (1997). the dynamics of welfare gains and losses: an african case study. journal of development studies, 33 (5), 635657. günther, i. & harttgen, k. (2009). estimating vulnerability to idiosyncratic and covariate shocks. world development. 37(7), 1222-1234. hoddinott, j., & quisumbing, a.r. (2003). methods for microeconometric risk and vulnerability assessments. social protection discussion paper, no. 0324. washington: world bank. holzmann, r., & jørgensen, s. (2001). social risk management: a new conceptual framework for social protection, and beyond. international tax and public finance, 8, 529–56. holzmann, r., sherburne-benz, l. & tesliuc, e. (2003). social risk management: the world bank’s approach to social protection in a globalizing world. the world bank, washington, dc. jadotte, e. (2010). vulnerability to poverty: a microeconometric approach and application to the republic of haiti. document de treball, 10.04, department d’economia aplicada, universitat autonoma de barcelona. jacoby, h. & skoufias, e. (1997). risk, financial markets, and human capital in a developing country. review of economic studies, 64(3), 311-336. jalan, j. & ravallion, m. (1999). are the poor less well insured? evidence on vulnerability to income risk in rural china. journal of development economics, 58(1), 61–81. jamal, h. (2009). assessing vulnerability to poverty: evidence from pakistan. mrpa paper no. 40228, available at http://mpra.ub.uni-muenchen.de/40228/. jha, r., dang, t. & tashrifov, y. (2010). economic vulnerability and poverty in tajikistan. econ change restruct, 43:95–112, doi 10.1007/s10644-009-90793. jha, r. & dang, t. (2010). vulnerability to poverty in papua new guinea in 1996. asian economic journal, 24(3), 235–251. just, e. & pope, r.d. (1979). production function estimation and related risk considerations. american journal of agricultural economics, 61, 276-284. kamanou, g. & morduch, j. (2002). measuring vulnerability to poverty. wider discussion paper 2002/058. united nations university, helsinki. volume 32, number 2 169 kasirye, i. (2008). vulnerability and poverty dynamics in uganda, 1992-1999. economic policy research centre, makerere university, mpra paper no. 8557 available at http://mpra.ub.uni-muenchen.de/8557/. khandker, s.r. (2007). coping with flood: role of institutions in bangladesh. agricultural economics, 36, 169–180. kühl, j. (2003). disaggregating household vulnerability: analyzing fluctuations in consumption using a simulation approach. paper presented at northest universities development consortium conference, yale university, october 17-19, 2003, http://www.csae.ox.ac.uk/conferences/2004-gprahdia/ papers/2r-kuhl-csae2004.pdf . ligon, e. & schechter, l. (2003). measuring vulnerability. the economic journal, 113(486), c95–c102. morduch, j. (1994). poverty and vulnerability. american economic review, papers and proceedings, 84(2), 221-5. morduch, j. (1995). income smoothing and consumption smoothing. journal of economic perspectives, 9 (3), 103-114. myers, c.a., slack, t. & singelmann, j. (2008). social vulnerability and migration in the wake of disaster: the case of hurricanes katrina and rita. popul environ, 29, 271–291, doi 10.1007/s11111-008-0072-y. novignon, j. (2010). estimating household vulnerability to poverty from cross section data: an empirical evidence from ghana. mrpa paper no. 39900, available at http://mpra.ub.uni-muenchen.de/39900/. pritchett, l., suryahadi, a. & sumarto, s. (2000). quantifying vulnerability to poverty: a proposed measure, with application to indonesia. wb policy research working paper 2437. washington, dc: world bank. ravallion, m. (1988). expected poverty under risk-induced welfare variability. economic journal, december, 98(393), 1171-82. ravallion, m., vandewalle, d. & gautama. m. (1995). testing a social safety net. journal of public economics 57 (2),175-199. sarris, a. & karfakis, p. (2006). household vulernability in rural tanzania. fao commodity and trade policy research working paper no. 17. sen, a. (1983). poor, relatively speaking. oxford economics papers, 35, 153-169. sen, a. (2000). development as freedom, oxford university press. skoufias, e. & quisumbing, a. r. (2004). consumption insurance and vulnerability to poverty: a synthesis of the evidence from bangladesh, ethiopia, mali, mexico and russia. european journal of development research, 17(1), 24–58. 170 journal of business strategies suryahadi, a. & sumarto, s. (2003). poverty and vulnerability in indonesia before and after the economic crises. asian economic journal, 17(1), 45-64. tendon, a. & hasan, r. (2005). conceptualizing and measuring poverty as vulnerability: does it make a difference? asian development bank economic and research department policy brief series no.41. tesliuc, e. & lindert, k. (2002). vulnerability: a quantitative and qualitative undp assessment. guatemala poverty assessment program. washington, d.c.: world bank. thorbecke, e. (2004). conceptual and measurement issues in poverty analysis. discussion paper no 2004/04, wider. townsend, r.m. (1994). risk and insurance in village india. econometrica, 62 (3), 539-591. udry, c. (1995). risk and saving in northern nigeria. the american economic review, 85(5), 1287–1300. walker, t.s. & ryan, j.g. (1990). village and household economies in india’s semiarid tropics. baltimore, md, john hopkins university. wang, c. & yarnal, b. (2012). the vulnerability of the elderly to hurricane hazards in sarasota, florida, nat hazards, 63, 349–373, doi 10.1007/s11069-012-0151-3. world bank (2001). world development report 2000/ 2001. attacking poverty. new york: the world bank and oxford university press. zhang, y. and wan, g. (2008). can we predict vulnerability to poverty? wider research paper no. 2008/82. helsinki: unu-wider. brief biographical sketch of authors ratul mahanta is a full time faculty in the department of economics of gauhati university, assam, india. his research interests are health and natural resources economics. mahanta has published articles in many peer reviewed national and international journals. he has also presented papers in several conferences and seminars. daisy das is a full time faculty member in the department of economics, north eastern hill university, meghalaya, india. her field of interest includes environmental and energy economics. she has authored a number of articles and presented papers in both national and international conferences. her papers have been published in small scale forestry, social indicators research, international journal of ecological economics and statistics, and several other journals. volume 32, number 2 171 appendix table a.1: characteristics of some key studies researcher method where data used vulnerability to expected poverty (vep) chaudhuri et al., 2002 vep through 3sfgls philippines 1997 family income and expenditure survey and 1998 annual poverty indicator survey tesliuc and lindert, 2002 chaudhuri et al. (2002) vep approach guatemala living standards measurement survey (encovi, 2000) christiaensen and subbarao, 2004 vep through pseudo panel data with repeated cross-section rural kenya 1994 and 1997 welfare monitoring surveys albert et al., 2007 vep through panel data philippines 1997 fies as well as 1998 and 1999 (apis) zhang and wan, 2008 vep based on weighted average of past savings rural china household survey data collected in 1989, 1991, and 1993 kasirye, 2008 vep using christiansen and subbarao (2004) and chaudhuri (2003) uganda uganda integrated household survey (uihs) 1992/93 and uganda national household survey (unhs) 1999/2000 gunther and harttgen, 2009 multilevel analysis madagascar, subsaharan africa household survey data of 2001 covering 5,080 households jamal, 2009 chaudhuri et al. (2002) vep approach pakistan pakistan cross-sectional data of hies, 2000-01 and 200405 jha and dang, 2010 chaudhuri et al. (2002) vep approach through clustering, stratification etc. papua new guinea 1996 papua new guinea household survey jadotte, 2010 multilevel analysis haiti haiti living conditions survey 2001 (ecvh-2001) vulnerability as expected low utility (veu) christiansen and boisvert, 2000 veu through 3sfgls northen mali panel data of 1997-98 172 journal of business strategies kamanou and morduch, 2002 monte carlo bootstrap method côte d’ivoire 1985–88 rounds of the côte d’ivoire living standards survey. ligon and schechter, 2003 veu bulgaria household budget survey (hbs) 1994 dercon and krishnan, 2006 regression model with household and village level fixed effects rural ethiopia panel data of 1994-95 vulnerability as uninsured exposure to risk (ver) glewwe and hall, 1998 one form of ver peru peru living standard surveys 1985–1986 and 1990. amin et al., 1999 one form of ver bangladesh household survey data of 1991-92 tesliuc and lindert, 2002 one form of ver guatemala living standards measurement survey (encovi, 2000) dercon and krishnan, 2000 one form of ver rural ethiopia household survey data during 1994-95 others jha, dang and tashrifov, 2010 using both vep and veu tajikistan two period household panel for 2004 and 2005 calvo, 2008 vulnerability to multidimensional poverty through panel data peru national household surveys 19982002 calvo and dercon, 2013 vp through random effects model ethiopia 1994, 1999 and 2004 of rural household panel data survey source: authors’ compilation volume 34, number 33 foreign aid allocation: a neural network approach sevinc rende isik university • istanbul, turkey abstract during the last twenty years, there have been strong supporters of foreign aid, and equally strong critiques. the debate is based on an effort to establish a causal relationship between foreign aid and economic growth, and it is still ongoing. rather than seeking to uncover the causal relationships, i examine foreign aid and its relation to structural indicators in aid dependent countries using a special type of artificial neural networks, known as kohonen maps. the findings suggest that aid allocation and coordination could be based on institutional and climate-based similarities across recipient countries rather than the geographical proximity or the cultural ties, or preferences, between the donor and recipient countries. jel codes: f35, o1, d63, c45 key words: oda, aid, aid distribution, kohonen maps, machine learning, data mining introduction the role of foreign aid in economic development is important for at least two reasons. first, economic development in poor countries involves importing of some of the institutions, norms and sometimes industrial and technical goods of advanced economies. second, foreign aid changes the relationship between the state, civil society and private sector in the delivery of public goods and services in the aid-recipient economies. during the last twenty years, there have been strong supporters of foreign aid, and equally strong critiques (gulrajani, 2011). the debate is based on an effort to establish and measure a causal relationship between foreign aid to economic growth, and it is still ongoing. the methodological challenge has been identifying the counterfactual, namely what kind of development trajectory the aid-recipient countries would have followed in the absence of foreign aid. the prevalent opinion in the literature seems to be that foreign aid is a tool that may not be efficient in promoting growth in poor countries, but has been shown to be effective in improving outcomes that carry intrinsic value for human life, such as health and education (mishra and newhouse, 2009; doucouliagos and paldam, 2011; d’aiglepierre and 34 journal of business strategies wagner, 2013). the non-linear interactions involved in the delivery of foreign aid in a complex setting, however, make a full accounting of causal relationships extremely difficult. even if we were able to measure causal relationship between foreign aid and economic growth, it would probably surprise no one that no two episodes of foreign aid flow have achieved their effect exactly same way in two different countries. what might be the reasons for this complexity? first, the delivery of aid involves interdependent policies within and between the aid institutions and the state. some of these relationships are transnational, others are local. second, receiving foreign aid shifts the production and distribution structure in the economy in the recipient states. as a result, a clear and directional attribution of development outcomes to aid is challenging. in this study, i propose an alternative perspective. rather than seeking to uncover the causal relationships between foreign aid and development outcomes, i document the potential benefits of allocating foreign aid by relying on structural similarities between the aid-recipient countries, rather than allocating aid by cultural ties or preferences between donor and aid recipient countries. the methodology does not neglect the importance of the causal relationship of aid effectiveness, namely “what works?”, but focuses on “why does it work?”, a pragmatic approach which may be more relevant for the poor living in aid-recipient countries. for this purpose, i examine allocation of foreign aid and its relation to institutional indicators using a special type of artificial neural networks, known in the literature as kohonen selforganizing maps (kohonen maps). the kohonen map is a particularly useful tool for studying the complex factors that may play a role in foreign-aid allocation because focusing on the similarities across institutional structures of aid-recipient countries promotes both mutual cooperation and consultation in policy development in these countries. i begin with a review of relevant literature and introduce the conceptual framework, followed by a description of kohonen maps. i then identify a number of indicators that are highlighted in the literature on foreign aid and discuss the results, supported by selected examples. in conclusion, i evaluate the contribution of kohonen maps to the discussions on the efficiency of foreign aid allocation. volume 34, number 35 literature review a quick exploration of the literature highlights that the sheer scale and complexity of foreign aid delivery presents a major puzzle in itself, even before attempting to measure its effectiveness. as a result, there is a wide and diverse body of literature examining the causal relationship between aid and economic growth, as well as a wealth of studies examining the factors influencing the effective delivery of aid. studies exploring the causal relationship from development aid to economic growth have found mixed results. some studies find that foreign aid helps economic growth, others assert that foreign aid and economic growth have no statistically significant relationship, and a significant number of studies focus on the fragility of the results to changes in coverage in data and the definition of the variables undertaken (burnside and dollars, 2000; hansen and tarp, 2001; easterly, 2003; kourtellos et. al., 2007; doucouliagos and paldam, 2008; kimura et. al.. 2012; lof et. al., 2014). a good review on the aid literature is provided by arndt et. al. (2010), who suggest that identifying theoretically and practically acceptable counterfactuals in searching for aid effectiveness on economic growth has proved to be elusive. furthermore, the objectives for aid may vary between the donor and recipient countries (gomanee et. al., 2005). several other studies concentrate on the variations of aid types to seek for a causal relationship. looking at the contribution of developmental and non-developmental aid to economic growth, minoiu and reddy (2010) find that only the type of “aid expended in a manner to promote development” contributes to economic growth. in a recent study, arndt et. al. (2014) meet these challenges with a combination of growth empirics and reduced form estimates of aggregate and intermediate outcomes. their findings suggest that investments in human and physical capital seem to be the most effective transmission channels that lead from foreign aid to economic growth. de matteis (2013) however, argues that aid is more effective when it focuses on poverty, rather than on growth. even then, the 2008 global recession and its repercussions may reduce the size of aid budgets to a level of insignificance as a contribution to anti-poverty programs in the recipient countries (kjeizer, 2012). a considerable number of studies give particular attention to the variations in the aid allocation. here, the focus has been on understanding the institutional context within which foreign aid operates. a framework for understanding the allocation of aid is offered by mcgillivray (2004), who derives his classification from a close study of descriptive and prescriptive approaches to aid allocation on 36 journal of business strategies the one hand, and actual allocations, on the other. the main competing explanations for the variations in aid allocation are donor-related parameters and the institutional environment in aid recipient countries. some authors have emphasized donor-related factors that may regulate the delivery of aid, such as the relationship between aid commitments and disbursements, multilayered donor objectives, the cultural values of and public and political support for aid in the donor country, and donor policy rules (torsvik, 2005; dalgaard, 2008; ball, 2010; hudson, 2013; djankov et. al., 2013; fuchs, et.al., 2015). others have investigated the relevant indicators for aid allocation in the recipient countries, such as democracy, conflict, the effectiveness of rules and regulations, and absorption capacity of the government (kosack, 2003; busse and gröning, 2009; feeny and de silva, 2012; kersting and kolby, 2014; winters and martinez, 2015). following the inclusion of development aid as the eighth goal of the millennium development goals, a vast literature revealed the complex economic environment within which aid operates, both at the national and international levels. however, the connection between theory and practice in the field has not been able to meet the challenge of causal relationships to adequately test the usefulness of foreign aid. ideally, to address poverty reduction and to support economic growth, one has to find ways to move from theory to applications to address the multilayered factors that influence aid effectiveness. as a result, an analysis of clustering of the recipient countries by aid-relevant indicators has the potential to highlight and develop pragmatic policy proposals. methodology as a special case of artificial neural networks, kohonen maps allow multidimensional data to be projected onto a two dimensional space to facilitate clear visualization and easy identification of clusters with similar characteristics. the methodology is developed by mimicking neural connections to provide pattern recognition by machine learning and to detect relationships in large datasets (jagric et al 2015). the network is a non-linear vector projection of a multi-dimensional input space into lower output dimensions, while preserving the topology of the input space. in other words, the algorithm of kohonen maps seeks to reduce a high dimension input data, n x d onto a two-dimensional grid while preserving the most important topological relationships. in doing so, the algorithm reveals the associations which cannot be easily visualized at high dimensions. volume 34, number 37 figure 1 a typical som representation to be specific, the kohonen map uses an unsupervised learning algorithm and places each vector in the input space on a grid. the component of the lowerdimensional grid is called a node, which is linked to a weight vector. each weight vector is of the same dimension as the input data vector, and is projected onto a node in the grid space. the algorithm works as the following: 1. let the input data map size be ɍ x ɍ, and the weight vector of node i is μi. 2. initialize all weight vectors, μi(0), randomly by assigning small values. 3. randomly choose a vector x=[x_1,…,x_n] from the input data. compute the score, usually the euclidian distance, φi, between x and node i 4. find the best matching node (winning node) k, which is the closest to the input vector, x. 38 journal of business strategies 5. adjust and update the weight vectors of the winning node, k, and its neighborhood with a non-parametric recursive regression where ρ (t) is an adaptive neighborhood function that decreases as the distance between the ith and the kth node increases. the recursive regression ensures that the weights of any node are updated at each iteration. 6. iterate steps 24 until the map converges and changes in the weights stabilize. following the initialization in step 1, step 2 reflects the unsupervised learning phase where the algorithm seeks associations across input values. during this stage the weight vectors span the input data space to cover its probability density. this is the topology preservation feature of the algorithm. the next step, step 3, is the competitive phase during which the nodes compete among themselves to become the winning node, which is the node whose weight vector is the most similar to the input vector. the cooperative phase of the algorithm is during step 4, when the neighboring nodes update with the winning node, and that is how the resulting map as represented on a grid becomes self-organized. at the end of the training, the resulting map is called a unified distance matrix (u-matrix), with additional nodes placed around the output nodes in the grid. these surrounding nodes denote the euclidian distance between the neighboring nodes, and allow visualization of the cluster structure on the map: the lighter the color, the smaller the distance between two nodes on the grid. by placing similar input vectors closer to each other on the grid, the u-matrix displays the clusters, uncovering the multidimensional associations within the input data space. it has to be noted that there is a trade-off in ensuring the quality of the map: well-defined clusters may not be able to preserve the topology of the input data vector, on the other hand, preserving the topology may lead to proliferation of clusters. the idea of clustering of countries by their socio-economic development is first explored by kaski and kohonen (1996), nag and mitra (2002), deichmann et. al. (2003) and collan et. al. (2007). later, hua et al (2009) investigate the clustering patterns for 190 countries. nguyen et al (2009) visualize province level human development in vietnam by relying on the similarities among different human development dimensions. pisati et al (2010) and whelan et al (2010) apply kohonen maps to understand multiple-deprivation profiles in ireland using the eu volume 34, number 39 silc data. recently, vázquez and sumner (2013) use a special case hierarchical clustering algorithm and argue that income-based categorization of countries does not adequately address the multidimensionality of economic development. two recent studies employ special cases of clustering and network analysis to trace the variations in the delivery of foreign aid. coscia et. al. (2013) present an analysis of the organization and relevance of aid in recipient countries by applying a network analysis. their results suggest that there is significant room for improvement in the coordination of aid in order to adequately address the correct combination of issues and countries. sianesi et. al. (2014) evaluate the classification of the commitment to development index of the center for global development by employing a hybrid clustering methodology. in their case, the methodology relies on rating, rather than ranking, to classify the commitment of donor countries to development. both studies argue that research into clustering of the countries may help us understand the mechanisms that can be supported for improving the efficiency of foreign aid delivery. but how do we understand the kinds of similarities in the recipient countries, considering the range of relevant factors from corruption to regime stability in the delivery of foreign aid? description of the data in this section, i provide an outline of the indicators drawn from the literature that constitute the input data for the kohonen analysis. the dataset relies primarily on the world bank open data. the working sample consists of 113 countries, which were net official development aid recipients in 2005 and in 2010, excluding the small island states. the countries included in the dataset represent 76% of the world population. in selecting the indicators i focused to the greatest extent possible on previous studies which focused on the causal relationship between foreign aid and that particular indicator. in my analysis, i will compare two kohonen maps, one for the year 2005 and the other for the year 2010. in doing so, the maps will allow us not only to observe clustering of the selected indicators in that particular year, but also to trace the changes in clustering across the years. in the literature, the discussion of the causal relationship between foreign aid and the institutional structure of the recipient countries has revolved around the size of the recipient country, its level of need and ability to administer aid funds (cogneau and naudet, 2007; wood, 2008). the first indicator included into the input data vector is the net official development aid per capita. the next indicator in the input space is the size of military. by changing budgetary priorities, foreign aid 40 journal of business strategies may be associated with an increase in military expenditures (gomanee et. al., 2005; savun and tirone, 2011). it is reasonable to assume that the complex ways in which aid intersects with different sectors of an economy would not leave the size of the military sector unaffected. the third indicator is the average precipitation during the previous year in the country. in a world where climate change affects mostly poor and aid-dependent countries, the availability of water for human use and agriculture production is undoubtedly as important as access to safe water (alabi, 2014). the next indicator selected for the input space is the prevalence of non-communicable diseases (ncds), such as cardio-vascular diseases, diabetes, or cancer. while the literature on foreign aid has mostly been concerned with communicable diseases, such as hiv/aids and tuberculosis for public health reasons, the evidence suggests that death rates due to ncds are higher than those recorded for communicable diseases (nugent and feihl, 2011; bikbov et. al., 2014). furthermore, for my purposes in seeking the similarities between the institutional structures among aidrecipient countries, the prevalence of ncds is a proxy for continuous strain on the country health system, in addition to representing the access to and affordability of health services in the country. the remaining indicators concern governance and population structure in the recipient countries. as a measure of governance, i selected an indicator for informal payments to public officials. the relationship between aid and corruption has been investigated and the general finding seems to be that aid is less effective in more corrupt countries (okada and samreth, 2012; tezanos et. al., 2013; acht et.al., 2015). the other indicator for governance measures the aid absorption capacity and bureaucratic design of the recipient country (feeny and de silva, 2012; arel-bundock, et.al., 2015). the institutional ability of a recipient government to administer aid funds is expected to be a factor in whether funding will be approved by the donors. the indicator measuring the absorption capacity of an aid-recipient country is drawn from the database of worldwide governance indicators (kaufmann et. al., 2011). the next indicator representing governance institutional structure comes from the polity iv dataset and measures regime stability. this indicator is a proxy for the stability of governing institutions (chauver, 2002; marshall and jaggers, 2011). finally, as an indicator of population structure, i use ethno-lingual fraction as an indicator in the input space. the ways in which sub-populations can communicate and interact with one another is expected to influence how the society coordinates and cooperates in the distribution of public resources. the source of this indicator is the dataset provided by desmet et. al. (2012). and, lastly, the functionality of access to markets is measured by an indicator of the road density per 100 km square, volume 34, number 41 available from the world bank open data. the indicator selection process following the review of the literature and available data sets brings the total number of indicators to 9. these indicators and the summary measures are listed in table 1. table 1 foreign aid and institutional context: summary statistics 42 journal of business strategies discussion the kohonen maps display the associations among the high dimensional data, which would not otherwise be clearly visible. in this case using 9 indicators and 113 countries, i selected a 9 by 12 map with 108 estimated vectors, each of which has 9 estimated components, equivalent to the number of indicators. each of the 113 countries is positioned on the map on the basis of the smallest euclidian distance between its input data vector and each of the 108 estimated vectors. before running the algorithm, all variables must be standardized to prevent scale-based distortions in calculating the euclidian distances. the preliminary analysis begins with constructing the d-matrix to display the clusters of countries following the training of the input vector data. the cluster structure driven by the kohonen map algorithm is displayed by two main maps, the u-matrix and the component planes. after the training, each country is placed on a node in the u-matrix. as mentioned above, the placement of a country is set by the minimum euclidian distance between its input data vector and the estimated weight vectors. therefore, the high dimensional association between the countries is reduced to a two-dimensional grid, represented by the u-matrix. it is possible that a node may contain several countries if the input data vector of each country is similar to the input data vectors of the other countries on the same node. additionally, the number of nodes in the u-matrix exceeds the number of nodes in the d-matrix; these additional nodes denote the distance between the weight vectors of the two neighboring nodes. the distance between the two neighboring nodes is shaded from light to dark, that is, the darker the node, the greater the distance. figures 2a and 2b, and figures 3a and 3b depict the clustering with and without these additional nodes that denote distance between the clusters. for instance, a white node signals that the distance between the two neighboring nodes is small, whereas a black node signals that the neighboring nodes are distant from each other, set by the values of the estimated weight vectors. (deichmann et. al., 2007; hua et. al., 2009). volume 34, number 43 figure 2a 2005 u-matrix: a dark empty node indicates high distance between the two occupied nodes nearby. for comparison, figure 2b depicts the cluster of countries without the distance nodes. figure 2b the placement of countries on the u-matrix without the distance nodes 44 journal of business strategies figure 3a 2010 u-matrix: a dark empty node indicates high distance between the two occupied nodes nearby. for comparison, figure 3b depicts the cluster of countries without the distance nodes. figure 3b the placement of countries on the u-matrix without the distance nodes. identification of the clusters, which is the driving mechanism of kohonen map, should be sufficiently stable only if the variations between the identified clusters exceed the variations within the clusters. davies and boulding (1979) propose an index which aims to minimize the ratio of the within-cluster variation to the between-cluster variation. the panels displayed in figure 4 present the davies – boulding index and the suggested k-means clustering. the index value shows volume 34, number 45 that the number of clusters declined from 11 in the year 2005 to 9 in the year 2010, suggesting that the countries included in the sample have converged to a smaller number of clusters over time by the indicators chosen for this analysis. figure 4 david-boulding index and k-means clustering table 2 presents the means of the indicators by clusters for 2005 and 2010 as delineated by the davies – boulding index. the table provides preliminary evidence that foreign aid can be allocated more efficiently, depending on the program targets. for instance, in 2005, the countries in group 3 received higher foreign aid ($66 per capita) than the countries in group 8 ($54 per capita), although the countries in group 8, on average, suffered from higher deaths from ncds, have relatively less corruption and are characterized by more stable regimes. similarly, the countries in group 5 received less foreign aid ($16 per capita) than the countries in group 11 ($36 per capita), even though the countries in group 11 have lower deaths by ncd and exhibit relatively higher corruption and less stable regimes. in 2010, we observe that 11 countries in group 5 received the lowest level of foreign aid per capita. yet, these countries exhibit high stress on the health sector, as represented by the deaths from ncds, compared with the countries in other clusters. 46 journal of business strategies ta bl e 2 m ea ns b y c lu st er s of c ou nt ri es , 2 00 5 an d 20 10 volume 34, number 47 the component maps, figures 5a and 5b, display a clear visualization of the estimated weight vector for each indicator in the input space placed on the grid. as such, it is possible to identify the direction of each input vector by tracing from light to dark nodes as the component value increases. for example, in 2010, the component map of the input corresponding to regime stability shows that the duration of regime shortens from the upper left corner to the lower right corner. just as the u-matrix map displays the clustering by the associations at the high dimension input data, the interpretation of moving across the u-matrix is provided by the directions in the component maps. for instance, the directions of the components maps in 2005 and in 2010 indicates that net official per capita aid was highest in countries with corruption measured at medium levels. in 2005, net official per capita aid is recorded high in countries with relatively low regime stability. in contrast, in 2010, the pattern of net official per capita aid seems to have shifted, it was higher in countries with high ethno-language fractions. 48 journal of business strategies f ig ur e 5a c om po ne nt p la ne s, 2 00 5 volume 34, number 49 f ig ur e 5a c om po ne nt p la ne s, 2 00 5 50 journal of business strategies case studies it is essential to understand why some countries show progress as recipients of aid while others lag behind. the kohonen maps provide a novel way of considering how foreign aid operates in relation to the institutional factors that were highlighted in the literature. before proceeding, it is essential to emphasize that neither the unit of analysis the countries -, nor the indicators included in this analysis need to be the final selections. my analysis relies on an extensive reading of the literature and publicly available datasets to illuminate the contribution of kohonen maps to ask new questions about efficient and effective methods of delivering foreign aid. the kohonen maps displayed in figures 2a and 2b place nigeria close to ethiopia and nepal for the year 2005. by 2010, in figures 3a and 3b nigeria moves to occupying the same node with benin and gambia. the component planes, displayed in figures 5a and 5b, corresponding to corruption indicate that the level of corruption in nigeria has increased during that time, but the level of official development aid the country has received stayed at the same level in comparison to other countries. similarly, in 2005 and in 2010, we observe that pakistan was placed close to yemen. in none of these countries, the level of per capita official development aid has changed, but the prevalence of deaths due to ncds have increased in pakistan between 2005 and 2010, suggesting a need to reconsider the allocation of health-related foreign aid in the country. iraq, which in 2005 shared the same node with afghanistan, moved to the same node with kyrgyzstan and tajikistan in 2010. iraq remained one of the most highly aid-dependent countries, as the component plane shows, but deaths due to ncds increased by 2010, as we observe in pakistan. egypt in 2005 was placed near tunisia by the similarity in their structural parameters. yet, in 2010, egypt was more similar to paraguay, whereas tunisian indicators were closer to those of turkey. from 2005 to 2010, the component planes associated with government effectiveness shows that in egypt, the effectiveness of government declined, even though the net official per capita development aid remained high. what does this tell us? for one thing, the institutional structure in egypt represented by the indicators may not be as close to that of the countries in the same region. furthermore, plans to direct official development aid to tunisia could consider that the institutional structure in tunisia resembled turkey in 2010. in 2005, the kohonen map algorithm placed china, libya and myanmar on the same node. in 2010, china leaves its previous cluster and is placed on the same node with vietnam. during this period, the per capita net official development aid volume 34, number 51 in china dropped, so did the level of corruption. libya and myanmar are placed on the same node in both years. an interesting example is bangladesh, which shared similar characteristics, as reflected by the indicators included, with sri lanka and jamaica in 2005. in 2010, the institutional structure in bangladesh shows more similarity with dominica and jamaica. one implication of these bilateral comparisons of bangladesh with the other countries is that geographical neighborhood, while highly correlated with the institutions of a country, may not carry the greatest weight in considering aid allocations. conclusion the study of foreign aid has tended to focus almost exclusively on finding the causal relationship between development aid and economic growth. however, aid operates in a complex environment in which drawing causal relationships is extremely difficult. and evaluating the impact of aid which varies in form depending on the country context in which it takes place is a complex task. this paper argues that one way to improve aid effectiveness would be to draw on the structural and climate-based similarities between the aid-recipient countries. once the similarities between the countries are established, it becomes possible to investigate further the kind of aid that these countries have received. looking at bilateral institutional similarities may encourage mutual learning among the aidrecipient countries, in addition to signaling to the donors of the characteristics of the recipients’ institutional structure which may not be immediately observable. the contribution of this study is to suggest that kohonen maps, which enable visualization of associations within a set of multidimensional factors, can be employed to design multi-pronged aid delivery policies. in the particular context that i employed kohonen maps, the findings suggest that aid allocation and coordination could be based on institutional similarities rather than the geographical proximity of recipient countries or the cultural ties (preferences) between the donor and recipient countries. measuring aid effectiveness and deciding on aid allocation has become more challenging and has made multi-dimensional taxonomies increasingly important. the analysis offered here also partially answers the questions that were raised recently regarding the delivery and future of aid, when the majority of the poor live in non-poor, medium income countries (sumner and mallett, 2013). for this reason, drawing on similar institutional structures can be expected to increase the targeting 52 journal of business strategies effectiveness of aid allocation and coordination. to be sure, kohonen maps are neither as simple or widely accepted as other simpler taxonomies, such as hdi, but it is a tool flexible enough for the donors and country partners to employ in deciding on how to distribute aid according to their priority concerns. obviously, this study raises more questions than it answers. further studies expanding the number of indicators or extending the time period covered would be welcome. among the possibilities are questions such as: to what extent does the clustering pattern change with the mdg outcomes? what kind of aid modalities might have worked in tunisia in 2005 but not in 2010? in what ways do the kohonen maps support opportunities for learning in the field, especially considering donor proliferation in the aid-dependent countries? the challenge for future work will be to expand the questions set, a challenge that may be best addressed by a methodology that benefits from the use of kohonen maps. references acht, m., mahmoud, t.o., & thiele, r. (2015). corrupt governments do not receive more state-to-state aid: governance and the delivery of foreign aid through nonstate actors. journal of development economics, 114, 20-33 alabi, r. a. (2014). impact of agricultural foreign aid on agricultural growth in subsaharan africa. agrodep working paper 006. arel-bundock, v., atkinson, j., & potter, r.a. (2015). the limits of foreign aid diplomacy: how bureaucratic design shapes aid distribution. international studies quarterly, 59, 544 – 556 arndt, c., jones, s., & tarp, f. (2015). assessing foreign aid’s long run contribution to growth and development. world development, 69, 6 – 18. http://doi. org/10.1016/j.worlddev.2013.12.016 arndt, c. jones, s. & tarp, f. (2010). aid, growth, and development: have we come full circle? journal of globalization and development, 1(2), 1-30, doi: 10.2202/1948-1837.1121 ball, r. (2010). cultural values and public policy: the case of international development aid. quarterly review of economics and finance, 50, 3–16 bikbov, b., perico, n. & remuzzi, g. (2014). mortality landscape in the global burden of diseases, injuries and risk factors study. european journal of internal medicine, 25, 1–5. burnside, c. and dollar, d. (2000). aid, policies, and growth. american economic review, 90 (4), 847-868. volume 34, number 53 busse, m., and gröning, s. (2009). does foreign aid improve governance? economics letters 104: 76–78 chauvet, l. (2002). socio-political instability and the allocation of international aid by donors. european journal of political economy 19: 33–59 collan, m., eklund, t., & back, b. (2007). using the self-organizing map to visualize and explore socio-economic development. ebs review 22 (1), 6-15. cogneau, d., and naudet. j. d. (2007). who deserves aid? equality of opportunity, international aid, and poverty reduction. world development 35 (1), 104–120. coscia, m., hausmann, r., & hidalgo, c.a. (2013). the structure and dynamics of international development assistance. journal of globalization and development, 3(2), 142. d’aiglepierre, r. and wagner, l. (2013). aid and universal primary education. economics of education review, 37: 95–112 de matteis, a. (2013). relevance of poverty and governance for aid allocation. review of development finance, 3: 51–60. dalgaard, c. j. (2008). donor policy rules and aid effectiveness. journal of economic dynamics & control 32: 1895–1920. davies, d. l. and bouldin, d. w. (1979). a cluster separation measure. ieee transactions on pattern analysis and machine intelligence, pami-1, no.2: 224 227 deichmann, j. i., eshgi, a., haughton, d., sayek, s, teebagy, n., & topi, h. (2003). geography matters: kohonen classification of determinants of foreign direct investment in transition countries. journal of business strategies, 20(1), 23 – 44. deichmann, j. i., eshgi, a., haughton, d., woolford, d. & sayek, s. (2007). measuring the international digital divide: an application of kohonen selforganising maps. international journal knowledge and learning, 3 (6), 552 – 575. desmet, k., ortuño-ortín, i. & wacziarg, r. (2012). the political economy of linguistic cleavages. journal of development economics, 97: 322–338. djankov, s., montalvo, j. g., & reynal-querol, m. (2009). aid with multiple personalities. journal of comparative economics 37: 217–229 doucouliagos, h., and paldam, m. (2008). aid effectiveness on growth: a meta study. european journal of political economy, 24, 1–24. doucouliagos, h., and paldam, m. (2011). the ineffectiveness of development aid on growth: an update. european journal of political economy, 27, 399–404. 54 journal of business strategies easterly, w. (2003). can foreign aid buy growth? journal of economic perspectives, 17 (3), 23-48. feeny, s., and de silva, a. (2012). measuring absorptive capacity constraints to foreign aid. economic modelling, 29: 725–733. fuchs, a., nunnenkamp, p., & öhler, h. (2015). why donors of foreign aid do not coordinate: the role of competition for export markets and political support. the world economy, 255 – 285. gomanee, k., morissey, o., mosley, p. & verschoor. a. (2005). aid, government expenditure, and aggregate welfare. world development, 33 (3), 355–370. gulrajani, n. (2011). transcending the great foreign aid debate: managerialism, radicalism and the search for aid effectiveness. third world quarterly, 32 (2), 199-216, doi:10.1080/01436597.2011.560465 hansen, h., and tarp, f. (2001). aid and growth regressions. journal of development economics, 64: 547–570 hua, g., skaletsky, m. & westermann, k. (2009). exploratory analysis of cia factbook data using kohonen self-organizing maps. case studies in business, industry and government statistics, 3 (1), 48–59. hudson, j. (2013). promises kept, promises broken? the relationship between aid commitments and disbursements. review of development finance, 3, 109–120 jagric, t., bojnec, s. & jagric, v. (2015). optimized spiral spherical self-organizing map approach to sector analysis – the case of banking. expert systems with applications, 42(13), 5531 – 5540. kaski, s., and kohonen, t. (1996). exploratory data analysis by the self-organizing map: structures of welfare and poverty in the world. in neural networks in financial engineering. proceedings of the third international conference on neural networks in the capital markets, london. world scientific pub (pp. 498– 507). kaufmann, d., kraay, a., & mastruzzi, m. (2011). the worldwide governance indicators (wgi) project. retrieved july 24 2014, from http://info.worldbank. org/governance/wgi/index.aspx#home kersting, e., and kilby, c. (2014). aid and democracy redux. european economic review, 67,125–143. kimura, h., mori, y., & sawada, y. (2012). aid proliferation and economic growth: a cross-country analysis. world development 1(40), 1–10. kjeizer, n. (2012). the future of development cooperation: from aid to policy coherence for development? working paper. brussels: ecdpm. volume 34, number 55 kohonen, t. (2013). essentials of the self-organizing map. neural networks, 37, 52 – 65. kosack, s. (2003). effective aid: how democracy allows development aid to improve the quality of life. world development, 31(1), 1–22. kourtellos, a., tan, c.m., & zhang, x. (2007). is the relationship between aid and economic growth nonlinear? journal of macroeconomics 29: 515–540 lof, m., mekasha, t.j., & tarp, f. (2015). aid and income: another time-series perspective. world development, 69, 19 – 30. http://dx.doi.org/10.1016/j. worlddev.2013.12.015 mcgillivray, m. (2004). descriptive and prescriptive analyses of aid allocation: approaches, issues, and consequences. international review of economics and finance, 13: 275–292. marshall, m. g., gurr, t.r., & jaggers, k. (2011). polity iv project: political regime characteristics and transitions. center for globalpolicy, school of public policy, george manson university. retrieved july 24, 2014 from http://www. systemicpeace.org/ minoiu, c. and reddy. s.g. (2010). development aid and economic growth: a positive long-run relation. quarterly review of economics and finance, 50, 27–39 mishra, p. and newhouse, d. (2009). does health aid matter? journal of health economics, 28, 855–872 nguyen, p., haughton, d., & hudson, i. (2009). living standards of vietnamese provinces: a kohonen map. case studies in business, industry and government statistics 2 (2), 109–113 nugent, r. a., and feigl, a.b. (2010). where have all the donors gone? scarce donor funding for non-communicable diseases. center for global development working paper no. 228 okada, k., and samreth, s. (2012). the effect of foreign aid on corruption: a quantile regression approach. economics letters, 115, 240–243. pisati, m., whelan, c., lucchini, m., & maître. b. (2010). mapping patterns of multiple deprivation using self-organising maps: an application to eu-silc data for ireland. social science research, 39 (3), 405–418. doi:10.1016/j. ssresearch.2009.11.004 savun, b., and tirone, d.c. (2011). foreign aid, democratization, and civil conflict: how does democracy aid affect civil conflict? american journal of political science, 55 (2), 233–246 56 journal of business strategies sianes, a., dorado-moreno, m., & herva´s-martinez, c. (2014). rating the rich: an ordinal classification to determine which rich countries are helping poorer ones the most. social indicators research 116: 47–65 doi: 10.1007/s11205-0130270-6 sumner, a., and vázquez, s. t. (2014). how has the developing world changed since the late 1990s? a dynamic and multidimensional taxonomy of developing countries. center for global development working paper no. 375 sumner, a., and mallett. r. (2013). the future of foreign aid: development cooperation and the new geography of global poverty palgrave macmillan: new york. tezanos, s., quiñones, a., & guijarro. m. (2013). inequality, aid and growth: macroeconomic impact of aid grants and loans in latin america and the caribbean. journal of applied economics, 16 (1), 153-177 torsvik, g. (2005). foreign economic aid; should donors cooperate? journal of development economics, 77: 503– 515 vázquez, s. t., and sumner, a. (2013). revisiting the meaning of development: a multidimensional taxonomy of developing countries. journal of development studies, 49 (12), 1728-1745. doi: 10.1080/00220388.2013.822071 whelan, c.t., lucchini, m., pisati, m. & maître, b. (2010). understanding the socioeconomic distribution of multiple deprivation: an application of self-organising maps. research in social stratification and mobility, 28 (3), 325 – 342. winters, m.s., and martinez, g. (2015). the role of governance in determining foreign aid flow composition. world development, 66, 516 – 531. wood, a. (2008). looking ahead optimally in allocating aid. world development, 36(7), 1135–1151. brief biographical sketch of author dr. sevinc rende is an assistant professor of economics at isik university, istanbul turkey. she specializes in analysis of social and economic policy interactions in transition and post-conflict societies, with subfields in aid modality and incomplete welfare systems. psychological type and sales orientation-customer orientation kenneth e. bass frederic]. hebert east carolina university greenville, nc abstract a business firm expects that salespersons' degree of customer orientation will be compatible with the extent to which thefirm itselfhas adopted the marketing concept. customer orientation is an important behavior on the part of salespersons, yet it has received relatively little attention from organizational researchers. differing psychological types show promise as a tool by which a salesperson s performance can be predicted. this exploratory research was designed to evaluate the relationships between individuals' psychological type preferences and their customer orientation. this study found jungian psychological types to be significantly related to salespersons' customer orientation. these findings suggest that personality types can playa supplemental role in salesperson selection and training. managerial implications and suggestions for future research are also presented. introduction the marketing concept suggests that business firms should adopt an external focus, thus concentrating on building long-term cooperative and mutually beneficial relationships with customers by identifying and satisfying their needs. however, the extent to which an individual firm adopts the marketing concept is determined by its overall concern with customer needs and competitive actions. once a firm decides the degree to which it will adopt the marketing concept, it should act to insure that this strategy is reflected in the customer orientation of its salesforce (siguaw, brown, and widing, 1994). customer orientation can be defined as the application of the marketing concept at the salesperson-customer level. in contrast, a sales orientation calls for a business firm to make its offerings available with less regard for customer needs (saxe and weitz, 1982). a customer orientation is important in that individuals who practice a high level of customer orientation behave in ways that increase satisfaction of their customers (dunlap, dotson, and chambers, 1988). though customer-oriented selling is an established practice on the part of salespeople, understanding of this behavior and its antecedents is incomplete. however, some individuals seem to innately behave in a more customer oriented 72 journal of business strategies vol. 14, no. 1 manner than others (dunlap, dotson, and chambers, 1988; williams and weiner, 1990). saxe and weitz (1982) suggested that a number of situational variables and individual differences constructs such as inner-outer directedness and selfmonitoring may be related to customer orientation. are there other measurable differences among individuals that might differentiate those who are customer oriented from those who are sales oriented? a number of researchers have suggested that differences in personality factors may influence job behavior (e.g., bass and hebert, 1993; hoy and hellriegel, 1982; porter and miles, 1974; sager and ferris, 1986). differing jungian psychological types (jung, 1971) have been shown to influence individuals' behavior in a number of organizational situations (e.g., hoy and hellriegel, 1982; nutt, 1990; ruble and cosier, 1990). psychological tests based on jung's theory are widely used by business firms for purposes such as team building and management development (gardner and martinko, 1996). such differing psychological types may also influence the customer orientation of salespersons. little empirical research has examined potential relationships between personal variables and customer orientation. this dearth of research calls for further investigation. the purpose of this exploratory research was to investigate potential effects of differing psychological types upon individuals' customer orientation. the potential association between these divergent psychological types and customer orientation could be of great importance to managers as well as researchers. psychological types might be useful as supplemental decision criteria for salesperson hiring and training decisions if such types prove to be significant antecedent variables of customer orientation. the next section of this paper provides a brief literature review, theoretical rationale, and research questions. we then present the research methodology and discuss the findings of the study. finally, implications for management practice and future research are presented. literature review and theoretical rationale sales orientation and customer orientation the marketing concept has been a cornerstone of marketing thought for many years. this concept calls for an organization to focus on its customers, determine their needs, and then fill those needs more effectively than competitors while meeting its own goals through an integrated organizational effort (houston, 1986; saxe and weitz, 1982). customer-oriented selling is compatible with the marketing concept. saxe and weitz defined customer-oriented selling as " ... the practice of the marketing concept at the level of the individual salesperson and customer" (343). in contrast, the selling concept calls for an organization to increase demand for its products. by embracing a selling orientation, a salesperson attempts to increase sales volume by using techniques such as high-pressure selling with little regard for the needs of the customer. spring 1997 bass & hebert: psychological type 73 the market orientation of a finn is determined by the extent to which the finn adopts the marketing concept as a business philosophy (saxe and weitz, 1982). the marketing concept has been recommended almost universally as an optimal strategy for business firms. however, it may not be an appropriate strategy for all organizations (houston, 1986). some researchers have suggested that a firm consider its external environment and internal capabilities and requirements in making a choice between a market-oriented and a sales-oriented strategy (houston, 1986; kohli and jaworski, 1990; narver and slater, 1990). once one of these strategies is selected and established by a firm, that firm can be expected to likewise influence its salesforce to embrace and practice the adopted philosophy in their selling efforts (siguaw, et al., 1994). a firm may use a number of practices to influence the degree of customer orientation practiced by its salesforce. for example, a high degree of customer orientation may be established and maintained through salesforce training and by rewarding customer oriented behaviors such as helping customers assess their needs and offering products that will satisfy those needs. on the other hand, an organization can establish and reinforce a selling orientation by rewarding behaviors such as high-pressure selling with little regard for building long-term customer relationships. a firm may reasonably expect that salespeople will adopt a customer orientation consistent with the firm's degree of market orientation. as stated earlier, a firm can train and reward its salesforce to develop and maintain a customer orientation consistent with the degree of market orientation of the firm. however, a salesperson's customer orientation may diverge from the market orientation of the firm. some individuals may naturally act in a more customer oriented manner than others and are more easily able to learn to do so (williams and weiner, 1990). saxe and weitz (1982) developed and validated a scale, the sales orientation-customer orientation (soco) scale, in order to measure sales orientation and customer orientation of salespeople. since that time, a number of empirical studies have been conducted which investigated sales-oriented and customer-oriented behaviors. for example, kelley (1992) found that salespersons' perceptions of the organizational climate impact on their customer orientation. in another study, dunlap, dotson, and chambers (1988) surveyed residential real estate brokers and customers and found conflicting perceptions among customers and brokers regarding the extent to which the brokers were customer oriented. brokers rated themselves to be significantly more customer oriented when the broker results were compared with the rating of the customers who were surveyed. o'hara, boles, and johnston (1991) investigated a set of personal variables as antecedents to customer orientation. these researchers found that organizational commitment was related to selling style, but other personal variables such as job tenure and gender were found to be situation dependent. in a more recent study of industrial salespeople, siguaw, et al. (1994) found that salesper74 journal of business strategies vol. 14, no. 1 sons' customer orientation was significantly influenced by the market orientation of the firm. psychological types jung's (1971) theory of psychological type provides a framework for defining and evaluating individual differences in organizational behavior. two psychological dimensions of particular importance in management and marketing research are the ways that individuals acquire information and the ways that they make decisions about the information that has been acquired (ruble and cosier, 1990). jung referred to these dimensions respectively as perception and judgment. he proposed that individuals develop one of two dominant ways to perceive information about their environment: sensing (s) or intuition (n). the s psychological type individuals prefer information that is factual, precise, concrete, and practical, which is derived from their senses. the n type individuals prefer to acquire holistic information by examining an entire situation and focusing on its overall meaning. jung also proposed that individuals develop one of two dominant ways to judge information to make decisions: thinking (t) or feeling (f). the t psychological type individuals reason by using logic to make rational judgments or decisions. the f type individuals stress value judgments, and prefer to reason and make decisions based in terms of personal and subjecti ve values (ginn and sexton, 1990). according to jung, individuals do not operate through both sand n modes simultaneously, but have a preference for one of the two modes for perception. likewise, individuals do not operate through both t and f modes simultaneously, but have a preferred mode of judgement (herden and lyles, 1981). empirical research based on differing psychological types has reported significant effects in many areas of organizational performance. a number of empirical studies have evaluated possible linkages between differing jungian psychological types and individual differences variables of interest to organizational managers and researchers. a comprehensive literature review concerning psychological types and personal characteristics and behaviors of managers is beyond the scope of this paper, although such a review is presented by gardner and martinko (1996). we provide a selective overview of this literature below. kilmann and mitroff (1976) investigated the effects of different psychological types on organizational preferences. these researchers found that subjects' concepts of an ideal organization differed by psychological type. kilmann and thomas (1975) confirmed that differing psychological types are related to preferred methods of conflict resolution. ts were found to be more assertive and less cooperative than fs, and fs were found to be more accommodating. nutt (1990) investigated the effects of managers' various psychological types on decision making under varying degrees of uncertainty. the combination of sand f types were found to be less risk averse and to adopt more projects than other combinaspring 1997 bass & hebert: psychological type 75 tions. gardner and martinko (1990) studied the relationships between psychological type and managerial effectiveness. high school principals who preferred the s type were found to perform at higher levels than individuals preferring the n function. however, other studies contradict these findings (gardner and martinko, 1996). ginn and sexton (1990) compared psychological types of entrepreneurs whose businesses were classified as high-growth with those of entrepreneurs whose businesses were classified as slow-growth. entrepreneurs who were oriented toward growth preferred the n personality type for receiving information and the t type for making decisions. this present research is exploratory in nature and is intended to examine possible effects of psychological types upon customer orientation. since psychological types have been shown to affect several different types of behavior in organizations, it is reasonable to expect that differing psychological types will also affect the attitude toward selling behavior as well as the selling behavior of salespersons. owing to the dearth of literature in this area, we decided to engage in an exploratory research effort to examine the relationships between various jungian personality types and salespersons' customer orientation. therefore, the following research questions are posited: rl: is there a statistically significant difference in soco scores between individuals who prefer a sensing function compared with those who prefer an intuitive function? r2: is there a statistically significant difference in soco scores between individuals who prefer a thinking function compared with those who prefer a feeling function? methodology sample and data collection a student sample was judged to be appropriate for this study since our purpose was to assess relationships between psychological types and innate customer orientation, thereby focusing on subjects prior to sales training by an organization. participants in this study were 123 senior business students enrolled in business policy and strategy courses and graduate students enrolled in a graduate course in management in a large mid-atlantic university. all of the subjects were business majors. participation was voluntary, and students were assured that their responses were anonymous. about 49 percent were seniors while 51 percent were mba students. respondents ranged in age from 21 to 48 years, with a mean age of approximately 25 years. of the 123 respondents, 56 percent were male and 44 percent were female. none of the subjects had previous employment as a salesperson. 76 journal of business strategies vol. 14, no. 1 measures sales orientation-customer orientation. saxe and weitz (1982) developed and validated a scale to measure sales orientation and customer orientation (soco) of salespersons. the soco scale is composed of 24 items that relate to specific behaviors that salespersons might employ when reacting with customers. saxe and weitz reported high levels of internal consistency reliability and presented evidence of convergent and discriminant validity. instructions for the soco scale asked individuals to describe ways in which they might act with a customer. however, we slightly altered the instructions and asked students to assume that they were working as a sales representative and to indicate how they believed they would actually deal with customers. participants recorded their responses on a nine-point scale for each of the 24 items on the scale (saxe and weitz, 1982). a soco score for each respondent was derived by computing the mean across the 24 items of the scale. myers-briggs type indicator. individuals' psychological types were measured by administering the myers-briggs type indicator, form g (mbt!) (myers and myers 1987). the mbt! is a forced-choice, self-reporting personality assessment instrument which is grounded in jungian personality type theory. this instrument was used to measure the basic preferences of individuals regarding their psychological types and preferred decision-making styles. the mbti has been widely used in research and applied settings (gardner and martinko, 1996; ruble and cosier, 1990). carlson (1985) reported reasonable estimates of validity for the instrument. procedure subjects were asked to complete a three-part questionnaire and the myersbriggs type indicator. the questionnaire consisted of the soco scale, a section designed to gather classification data, and a section for participants to record their psychological types as determined by the mbti instrument. differences among group mean responses of participants' psychological types were evaluated using the analysis of variance (anova) technique. the soco variable was metric in nature, while personality types were treated as categorical variables. results means, standard deviations, and correlations of the variables employed in this study are presented in table 1. the results indicate statistically significant correlations (p < .01) between the sin psychological types and soco scores and between tip psychological types and soco scores. the mean soco score was 7.4 on a 9-point scale (9 = high customer orientation), indicating that respondents appeared to be highly customer oriented. individual mean scores across the 24 items on the soco scale ranged from 4.42 to 8.96, with a standard deviation of spring 1997 bass & hebert: psychological type 77 .84. the soco mean scores in this study compare favorably with those reported by saxe and weitz (1982) (means of7.6 and 7.7 for two samples). table 1 descriptive statistics and pearson correlation matrix variables means s.d. 1 1. soco 7.40 .84 1.0000 2. sin .30 .46 .2741 ** 3. t/f .37 .48 .2435** * p < .05 ** p < .01 soco = sales orientation and customer orientation sin = sensingiintuition psychological types t/f = thinkinglfeeling psychological types s.d. =standard deviation s = 0, n = 1 t=o,f= 1 2 1.0000 .2290* 3 1.0000 4 the mbti instrument was used to determine the respondents' sin and tif orientations. the s orientation was preferred by 69.7 percent of the respondents while 30.3 percent preferred the n orientation. the t orientation was preferred by 63.4 percent and the f orientation was preferred by 36.6 percent. this distribution of psychological type preferences is consistent with previous studies of business students (myers and mccaulley, 1985). mean soeo scores by psychological types are presented in table 2. as shown in the table, the n psychological group is more customer oriented than the s group, while the f group is more customer oriented than the t group. table 2 soco scores by psychological types psychological type mean s.d. s 7.2213 .8333 n 7.7185 .6981 t 7.2051 .8598 f 7.6296 .7373 the research questions were evaluated by testing for significant differences between the sand n psychological type groups by soeo as well as between the 78 journal of business strategies vol. 14, no. 1 t and f type groups by soco using an anova model. the dependent variable was the soco scores, and the independent variables were the psychological type groups. the anova results were statistically significant at the 0.05 level as shown in table 3. the two-way interactions were not significant. these results confirm statistically significant differences between the sand n type groups when employing soco as a dependent variable. the n type group was more customer oriented than the s type group. a statistically significant difference was also found between the f type group and the t type group, with the f types being more customer oriented than the t types. table 3 statistically significant differences between sin and tif orientations source df sum of mean f prob. squares square stat. f main effects 2 5213.11 2602.55 7.29 .001 sin 1 2462.71 2462.71 6.88 .010 t/f 1 1516.60 1516.60 4.24 .042 2-way interactions 1 1048.54 1048.54 2.93 .089 sin t/f error 120 42934.29 357.78 total 123 49195.93 399.96 discussion, conclusions, and implications the purpose of this research was to determine whether or not individuals' innate customer orientation was related to their psychological type preferences. the primary psychological types under consideration were individuals' preferred method for gathering information from the external environment (sensing and intuition functions) and their preferred method for drawing conclusions and making decisions from the information (thinking and feeling functions). more specifically, the first research question called for an evaluation of possible relationships between individuals's and n preferences and their customer orientation. results of this research indicate that customer orientation appears to be influenced by differing psychological types. a statistically significant difference in customer orientation was found between groups of individuals who preferred a sensing function compared with those who preferred an intuitive function. those who preferred the intuitive function scored a higher mean soco value than did those who preferred the sensing function. as stated earlier, type theory holds that ns prefer abstract information, whereas ss favor concrete data and tend to think in terms oflogical and objective data. further, ns tend to think in terms of possibilities and associations. they think beyond what is present in a spring 1997 bass & hebert: psychological type 79 situation and propose creative solutions to problems. customer orientation calls for a person to diagnose customers' needs and propose creative solutions to their problems. the n psychological type preference appears to be consistent with highly customer-oriented behavior. the second research question calls for an assessment of potential relationships between individuals' t and f preferences and their sales orientation-customer orientation. a statistically significant difference in customer orientation scores was found between groups of individuals who preferred a thinking function compared with those who preferred a feeling function. individuals who preferred the feeling function scored a higher mean soeo value than did those who preferred the thinking function. the thinking-feeling dichotomy reflects two different ways ofjudging information and making decisions. individuals who prefer the thinking function focus on making decisions through the use of logical and objective data. for those who prefer a feeling function, the focus is on making decisions based on personal and subjective data. a customer-oriented approach calls for a salesperson to get to know customers and their needs and focus selling efforts on a customer's specific situation rather than using a single generic sales approach for all customers. since a more personal approach is consistent with highly customer oriented behavior, the f psychological type preference appears to be consistent with a high level of customer orientation. these findings have important implications for strategy implementation. the marketing concept may not be the best management philosophy for all organizations (houston, 1986). but in many cases, an organization can be expected to consider optimal levels of concern with and responsiveness to customer needs as well as its internal capabilities in determining the extent to which it should adopt a customer orientation versus a sales orientation. once an organization determines its appropriate marketing orientation-sales orientation strategy, an important part of strategy implementation is to motivate its salespeople to employ the chosen orientation in their selling tasks (siguaw, et ai., )994). an important implication ofthe findings ofthis research is th<lt myers-briggs psychological type profiles could be a useful predictor of individuals' innate customer orientation. individuals with nand f psychological type preferences were found to be more customer oriented than those with sand t psychological type preferences. therefore, the myers-briggs type inventory, a paper and pencil test, could be a useful supplemental tool in recruiting and selecting salespeople. an organization could select salespersons whose personality type is compatible with its market orientation. for example, recruitment of entry level salespeople might feature a personality type profile, and this profile could be useful as a supplement to the selection process rather than as the sole device employed. since specific personality types were found to be related to customer orientation in this study, such a profile might also be useful in assessing training needs of presently employed salespeople. additionally, personality type profiles might be useful as a way to assess training effectiveness. 80 journal of business strategies vol. 14, no. i finally, important limitations of the findings of the current study exist. first, the research should be repeated with professional salespersons. though the student sample was appropriate for an exploratory study of linkages between innate personality types and soco scores, the results should be generalized with great care. further, by asking students to assume that they were working as sales representatives, the subjects were role playing. a second limitation is the inability to draw causal inferences since all variables were measured simultaneously. time sequence of the relationships cannot be determined with certainty. references bass, k.e. and el. hebert. "psychological types, decision styles, and ethical decisionmaking." journal of business strategies 10 (fall 93): 79-94. carlson, j.g. "recent assessments of the myers-briggs type indicator." journal of personality assessment 49 (1985):356-365. dunlap, r.j., m.j. dotson, and t.m. chambers. "perceptions of real estate brokers and buyers: a sales-orientation, customer-orientation approach." journal of business research 17 (988): 175-187. gardner, w.l. and mj. martinko. "the relationship between psychological type, managerial behavior, and managerial effectiveness: an empirical investigation." journal of psychological type 19 (1990): 35-43. -----. "using the myers-briggs type indicator to study managers: a literature review and research agenda." journal of management 22 (1996): 45-83. ginn, e.w. and d.l. sexton. "a comparison of the personality type dimensions of the 1987 inc. 500 company founders/ceos with those of slower-growth firms." journal of business venturing 5 (september 1990): 291-299. herden, r.p. and m.a lyles. "individual attributes and the problem conceptualization process." human systems management 2 (1981): 275-284. houston, fs. "the marketing concept: what it is and what it is not." journal of marketing 50 (april 1986): 81-87. hoy, f and d. hellriegel "the kilmann and herden model of organizational effectiveness criteria for small business managers." academy of management journal 25 (1982): 308-322. lung, e.o. the collected works of c. g. jung. trans. h.g. baynes, ed. r.c.f. hull. princeton, nj: princeton university press, 1971. spring 1997 bass & hebert: psychological type 81 kelley, s.w. "developing customer orientation among service employees." journal of the academy of marketing science 20 (1992): 27-36. kilmann, rh. and kw. thomas. "interpersonal conflict-handling behavior as reflections of jungian personality dimensions." psychological reports 37 (1975); 971-980. kilmann, rh. and i.i. mitroff. "qualitative versus quantitative analysis for management science: different forms for different psychological types." interfaces 6 (1976); 16-27. kohli, a.k. and b.j. jaworski. "market orientation: the construct, research propositions, and managerial implications." journal of marketing 54 (april 1990): 1-18. myers, lb. and m.h. mccaulley. manual: a guide to the development and use of the myers-brjggs type indicator. palo alto, ca: consulting psychologists press, 1985. myers, lb. and k.d. myers. myers-briggs type indicator form g. palo alto, ca: consulting psychologists press, inc., 1987. narver, j.e. and s.f. slater. "the effect of a market orientation on business profitability." journal of marketing 54 (october 1990): 20-35. nutt, p.e. "strategic decisions made by top executives and middle managers with data and process dominant styles." journal of management studies 27 (march 1990): 173194. o'hara, b.s., 1.s. boles, and m.w. johnston. "the influence of personal variables on salesperson selling orientation." journal of personal selling and sales management xi (1991): 62-67. porter, l. and r. miles. "motivation and management." in contemporary management: issues and viewpoints. ed. joseph mcguire. englewood cliffs, nj: prentice hall, 1974. ruble, t.l. and r.a. cosier. "effects of cognitive styles and decision setting on performance." organizational behavior and human decision processes 46 (1990): 283-295. sager, j.k. and g.r ferris. "personality and salesforce selection in the pharmaceutical industry." industrial marketing management 15 (1986); 319-324. saxe, r., and b.a. weitz. 'the soco scale: a measure of the customer orientation of salespeople." journal of marketing research 19 (august 1982): 343-351. siguaw, j.a., g. brown, and re. widing ii. "the influence of the market orientation of the firm on sales force behavior and attitudes." journal of marketing research 31 (february 1994): 106-116. 82 journal of business strategies vol. 14, no. 1 williams, m.r. and j. wiener. "does the selling orientation-customer orientation (soco) scale measure behavior or disposition?" in enhancing knowledge development in marketing, eds. w. bearden, et ai., 239-242 chicago: american marketing association, 1990. kenneth e. bass, d.ra. (louisiana tech) is assistant professor of management at east carolina university. he has published articles in several journals, including the journal of busin!iss strategies, journal of business ethics and journal of personal selling and sales management. his research interests include ethical decision making, ethical strategy, and total quality management. frederic j. hebert, d.b.a. (louisiana tech) is associate professor of management at east carolina university. he has published articles in several journals, including the journal of small business management, sam advanced management journal and the journal of business & entrepreneurship. his research interests include the application of psychological type theory to managerial practice, as well as various topics relating to entrepreneurship and small business management. psychological type and sales orientation-customer orientation the measurement of strategic orientation and its efficacy in predicting financial performance laurence g. weinzimmer bradley university • peoria, il jennifer robin bradley university • peoria, il eric j. michel university of illinois at chicago • chicago, il abstract for decades, the strategic management literature has recognized strategic orientation as an important cultural attribute in the investigation of the link between organizational culture and firm performance. using three studies, we develop a survey measure of strategic orientation that is unidimensional, reliable, and predictive of financial performance. our final study uses a sample of 779 respondents from 20 companies and empirically demonstrates a positive relationship between strategic orientation and firm performance. our results support the notion that managers should both encourage and support behaviors and execute actions that are consistent with our measure of strategic orientation to create a coherent strategic approach, resulting in improved financial performance. introduction over the past several decades, organizational researchers have yielded a description of organizational culture that is consistent across both macroand micro-level domains (cf. denison & mishra, 1995; lee & yu, 2004; schein, 1985; siehl & martin, 1988; wallach, 1983). at times, likened to the firm’s very identity, culture is a complex set of shared values, beliefs, philosophies, and symbols that define the way in which a firm conducts its business (barney, 1986; denison, 1984; goll & sambharya, 1995; jones, jimmieson, & griffith, 2005; michalisin, kline, & smith, 2000; sorensen, 2002). ultimately this shared set of values and beliefs is transmitted through behaviors and actions of employees within an organization (wilkins & ouchi, 1983; schein, 1985), thus leading to different organizational outcomes (lee & yu, 2004). despite the potential effects and significance of organizational culture, the link between corporate culture and firmlevel performance is underdeveloped both theoretically and empirically (reichers & schneider, 1990; sackman, 2010). 82 journal of business strategies in the strategy literature, researchers have used multiple variables to study the culture-performance relationship, including strategic orientation. strategic orientation has been defined as the inclination of a firm to focus on strategic direction and proper strategic fit to ensure superior firm performance (barney, 1986; gatignon & xuereb, 1997; pleshko & nickerson 2008). it has also been conceptualized as a continuous and iterative process that must focus on the different effects of rational, economic, political, and subjective aspects of strategic change on competitive performance (porter, 1980; whipp, rosenfeld, & pettigrew, 1989; zhou, gao, & zhou, 2005). a firm’s strategic orientation is important in the examination of its culture’s impact on performance, as this cultural attribute (and cultural phenomena in general) indicates where its employees focus their time, energy, and resources in decision-making (cahlik, howard, & godkin, 1999; jones, jimmieson, & griffiths, 2005; schein, 1983; trevino, 1986). thus, with regard to strategic orientation, employees share values and execute actions toward maintaining a coherent strategic approach given broad environmental factors; this cognitive and behavioral attention influences aspects of organizational performance. strategic orientation research a review of the research attempting to operationalize strategic orientation can be seen in table 1. these studies have identified almost 20 attributes to measure strategic orientation. while the miles and snow (1978) typology is the most common approach, it only makes up a small percentage of studies. as mentioned above, strategic orientation has been defined as the inclination of a firm to focus upon strategic direction and proper strategic fit to ensure superior firm performance (barney, 1986; gatignon & xuereb, 1997; porter, 1985). studies have conceptualized strategic orientation utilizing various approaches including classifying firms into typologies such as the miles and snow (1978) archetype (pleshko & nickerson, 2008) or identifying cultural attributes (venkatraman, 1989). much confusion exists regarding the conceptualization and operationalization of strategic orientation, let alone its impact upon organizational performance due to the wide variety of overlapping definitions and measures used. this is problematic given its prevalence in the strategy literature. one conceptual confound in particular, strategic aggressiveness (cf. venkatraman, 1989), deserves special attention, as the extant literature has evidenced that it is often interchanged with strategic orientation. volume 29, number 2 83 table 1 comparison of empirical definitions of the strategic orientation (so) construct in culture-performance literature author dimensions of so definitional keywords venkatraman (1989) 6 aggressiveness, analysis, defensiveness, futurity, proactiveness, riskiness conant, mokwa, & 4 miles & snow (1978) typology (prospectors, varadarajan (1990) defenders, analyzers, reactors) veliyath & shortell (1993) 4 miles & snow (1978) typology (prospectors, defenders, analyzers, reactors) goll & sambharya (1995) 3 progressive decision making, social responsibility, organicity gatignon & xuereb (1997) 5 customer orientation, competitor orientation, interfunctional coordination, product orientation, technological orientation voss & voss (2000) 3 customer orientation, competitor orientation, product orientation morgan and strong (2003) 6 aggressiveness, analysis, defensiveness, futurity, riskiness aragon-sanchez & 4 miles & snow (1978) typology (prospectors, sanchez-marin (2005) defenders, analyzers, reactors) o’reagan & 2 modified miles & snow (1978) typology (prospectors ghobadian (2005) vs. defenders) zhou, yim, & tse (2005) 5 customer orientation, competitor orientation, interfunctional coordination, technological orientation, entrepreneurial orientation zhou, gao, yang, & 3 intelligence generation, intelligence dissemination, zhou (2005) responsiveness to intelligence laforet (2008) 2 modified miles & snow (1978) typology (prospectors vs. defenders) where strategic orientation is the inclination of a firm to focus upon strategic direction and proper strategic fit, strategic aggressiveness examines a firm’s strategic posture relative to the deployment of resources to functional areas over time (fombrun & ginsberg, 1990; romanelli, 1989). conceptually, both strategic orientation and strategic aggressiveness are a means to the same end: superior firm performance. however, they are fundamentally and operationally different constructs, yet researchers use them interchangeably. strategic orientation refers to shared perceptions that results in parallel behaviors. strategic aggressiveness focuses on the act of resource allocation. stated differently, strategic orientation is pri84 journal of business strategies marily operationalized as a latent construct as seen in table 1. in contrast, researchers operationalize strategic aggressiveness by measuring resource allocations such as expenditures in research and development and advertising intensity (cf. feeser & willard, 1985; weinzimmer, 2000). thus, we argue that they are distinct concepts and should be treated as such in construct and measurement development. strategic aggressiveness may well be a mediator between strategic orientation and financial performance, but strategic orientation is the cultural variable on which we focus in this study. accordingly, laforet (2008) called for a better understanding of the measurement of strategic orientation. we agree, and we submit that sources of ratings and consistency in measurement are also areas in need of research attention. the purpose of this paper is to develop a measure of strategic orientation that is comprehensive, yet conceptually distinct from other cultural constructs of interest, such as aggressiveness. we draw on previous studies to develop items, we ensure our measure of strategic orientation is reliable, and we establish the criterion-related validity of our measure by investigating the relationship between strategic orientation and firm performance. we conclude by delineating practical implications for researchers and practitioners interested in examining relationships between strategic orientation and firm performance. firm level performance a thorough review of the strategy literature on culture reveals over the last decade more than a dozen articles have attempted to link cultural attributes, such as strategic orientation, to firm-level performance. each study utilizes different measures of culture and performance as well as sampling different numbers and levels of respondents in organizations. unsurprisingly, findings have been equivocal. strategic orientation focuses on strategic direction and long-range vision. therefore, we would expect a positive relationship to exist between strategic orientation and long-term financial performance. by continuously seeking out new opportunities and ensuring strategic alignment, firms that exhibit a robust strategic orientation take action in new markets or product areas in order to generate a competitive advantage (miles & snow, 1978; porter, 1980), resulting in improvements in long-term financial performance metrics, such as revenue growth (cf. barney, 1986; porter, 1980). in contrast, other research has shown a negative relationship between strategic orientation and short-term outcomes such as profitability and return on sales (goll & sambharya, 1995; veliyath & shortell, 1993; venkatraman, volume 29, number 2 85 1989). unfortunately, many of the previous findings are confounded by combining measures with different time horizons (morgan & strong, 2003), or findings are non-significant (cf. voss & voss, 2000). due to these inconsistencies, none of the research examined showed an unequivocally positive relationship between strategic orientation and firm performance, though conceptually we would expect one to exist. item development based on a review of the extant research, we developed a list of potential survey items to measure strategic orientation as a unique construct. we drew on existing studies from the strategy literature to identify construct items that had been empirically tested in previous research. we then performed an inter-rater reliability assessment to address the consistency of the potential items (cf. carmines & zeller, 1991). specifically, we asked a panel of seven experts (defined as academics researchers actively involved in studying antecedents of financial performance) to match potential individual survey items with our construct of strategic orientation. values greater than 0.70 are typically acceptable for consistency estimates of inter-rater reliability (crocker & algina, 1986). therefore, when an individual item received an inter-rater reliability score of less than 0.70, it was dropped from the item pool. once we established the content of the scale and an agreement as to its construct validity, we arrived at the 6-item strategic orientation scale appearing in appendix 1. respondents were asked to rate the degree to which each statement accurately described the cultural orientation of their organization (using a five-point likert scale where 1 = strongly disagree, and 5 = strongly agree). method three studies were then conducted to further develop our measure of strategic orientation. studies 1 and 2 were designed solely to ensure that we had created reliable measures of strategic orientation. the third study attempted to show the link between strategic orientation and three different measures of financial performance. in these studies, we also attended to an often overlooked aspect of culture research that can also affect the observed culture-performance link: the sources of ratings and the nature of the sample. many researchers have attempted to collect data from large cross-sectional samples, but as a tradeoff, they only collect data 86 journal of business strategies from one person per company (denison & mishra, 1995). as culture is, by definition, a shared value and belief system, this approach does not align properly with our treatment of strategic orientation as a cultural variable. even when studies have attempted to measure strategic orientation by surveying many individuals in very few companies (calori & sarnin, 1991), basic perceptual agreement is necessary to conclude that a variable is, in fact, a cultural phenomenon (denison, 1996; james, 1982; james, joyce, & slocum, 1988). in many cases, perceptual agreement is not ensured before aggregating data and treating the mean as a measure of a shared strategic orientation. therefore, to overcome conceptual inconsistencies in previous research, we surveyed all employees (as opposed to one employee) in multiple organizations (as opposed to a single organization) in order to assess how strategic orientation impacted firm-level performance in study 3. agreement was also assessed before collapsing individual responses into a mean score that can reasonably be considered cultural in nature. specifically, in study 3, we surveyed 779 respondents from 20 companies. study one: reliability and unidimensionality in study 1, employees in a medium-sized service organization completed our survey instrument to measure unique constructs for strategic orientation. specifically, respondents were asked to agree or disagree with a statement concerning the workplace using the five-point likert scale. we achieved a 67% response rate yielding 447 usable responses. we found encouraging internal reliability and dimensionality results from this initial survey. we measured internal reliability using cronbach’s alpha. specifically we found that our measure of strategic orientation yielded an alpha score of 0.90, which exceeded nunnally’s (1967) stringent threshold of 0.70. moreover, items loaded onto a single factor in a principal components analysis. when items showed high “alpha if deleted” statistics and low factor loadings, they were revised to be clearer and more aligned with strategic orientation. study two: criterion-related validity in order to replicate the content validity of our measures from study 1 and to assess the criterion-related validity of our strategic orientation measure, we conducted a second study. in study 2, we collected data from employees from various profit centers in a technology-based organization using the revised strategic orienvolume 29, number 2 87 tation measure from study 1. we also collected performance data across 43 profit centers. note that financial performance was measured in this organization as a composite of revenue growth and sales growth for the profit center. we collected survey data for strategic orientation using mail surveys. our response rate was 45%, yielding 117 responses. consistent with study 1, we assessed the internal reliability of our strategy-orientation measure using cronbach’s alpha with a reliability measure of 0.90, again exceeding the threshold of 0.70. before aggregating the results by profit center, we ensured within-group perceptual agreement. our variables of interest are group-level variables, therefore, for us to have confidence that individual employees’ perceptions are a characteristic of the group that is predictive of organizational performance, we first need to assess whether employees share these perceptions within each organization. a well-accepted measure of agreement — rwg(j) (james, demaree, & wolf, 1984; james, 1993; lebreton & senter, 2008) — was used to justify the aggregation of individual level data in this study. using a uniform null distribution (which was deemed appropriate for this sample), the average rwg(j) across all profit centers that had more than one respondent was 0.88, and only 4 profit centers returned results lower than the 0.70 threshold established by lebreton and senter (2008) for strong agreement. to assess criterion-related validity, we examined the relationships between strategic orientation and performance. specifically, we used hierarchical ols regression modeling to test this relationship. before any regression results were interpreted, a complete set of diagnostic procedures was completed to ensure that this modeling technique was appropriate for these data. specifically, data were checked for normality, patterns in residuals such as heteroscedasticity, and outliers (cf. weinzimmer, mone, & alwan, 1994). our results from study 2 further confirmed the viability of our measure of strategic orientation. additionally, we found initial evidence for establishing criterion-related validity. specifically, using ols regression modeling, we found that strategic orientation was significant and positively related to firm performance (p < .01) with an adjusted r2 of .13, indicating that 13% of the variance in the performance measure was explained by our strategic orientation measure. study three: strategic orientation and firm level performance in study 3, we used our measure to investigate the extent to which strategic orientation impacts financial performance. we surveyed all employees from multi88 journal of business strategies ple companies to overcome methods problems from previous research (e.g., surveying all employees from one company or one employee from multiple companies). specifically, we surveyed all employees in 20 companies from a range of industries. companies were all: (1) independent businesses that were not owned by a parent company; (2) single-product firms; (3) operating in one geographic location. the size of the organizations in our study consisted of 122 employees on average. ultimately, we gathered data from 779 respondents across the 20 companies. data aggregation before conducting analyses, it was again necessary to aggregate data from individual employee ratings into firm-level variables, namely, the strategic orientation of the firm. we did so using rwg. in this case, we examined both a uniform null distribution, and a slightly skewed null distribution — the latter being the closest to the distribution of the responses in this data set. using the slightly skewed null, responses from 19 of the 20 companies exceed or approach the 0.70 threshold for strong agreement (lebreton, james, & lindell, 2005) and statistics ranged from 0.30-0.86. while the overall pattern of results justifies aggregating data to perform the analyses required (lebreton & senter, 2008), subsequent analyses were run with and without the low-agreement organization. however, results were not impacted by inclusion or removal of the low-agreement organization, so results reported here reflect the total sample. firm-level performance. strategic management researchers suffer from a lack of consistency defining firm-level performance (venkatraman & ramanujam, 1986). however, in terms of the culture-performance literature, much of the research focuses on financial performance (e.g., profit growth), while the remainder examines market performance (cf. christensen & gordon, 1999) or process outcomes, such as successful value innovation (gatignon & xuereb, 1997; ogbonna & harris, 2002; wiklund & shephard, 2003). chandler and hanks (1993) conducted a validation study that empirically demonstrated the use of revenue and profit data as reliable measures when testing the impact of various organizational attributes on firm-level performance. given that the financial performance measures are accepted in the cultureperformance literature, we measure firm performance in terms of profit growth over a five-year period, revenue growth over a five-year period, and return on equity, to recognize financial performance as a multidimensional phenomenon (weinzimmer, 2000). volume 29, number 2 89 there is a substantial amount of research in the strategic management literature that considers the relationship between specific strategies and dynamic measures of financial performance (short, ketchen, bennett, & du toit, 2006). we felt it was necessary to measure performance longitudinally, as cultural dimensions such as strategic orientation evolve over time and therefore would have a dynamic effect on firm performance. five-year periods were chosen, as they are common timeframes found in the strategic management literature. specifically, revenue growth rates, profit growth rates, and roe growth were calculated from 2003 to 2007. furthermore, we used objective measures of performance as multiple scholars (dess & robinson, 1984; harris, 2001; meyer, 1991) have indicated that objective performance measures are more preferable than subjective ones. control variables. because we were testing the impact of strategic orientation across multiple industries, it was necessary to control for industry impacts on firm-level performance (cf. dess, ireland, & hitt, 1990). in the strategy literature, measures for industry-level performance are commonly used as control variables in research investigating firm-level performance across multiple industries (christenson & gordon, 1999). subsequently, we used industry-level control variables based on previous research examining culture and firm-level performance — namely munificence, dynamism, and concentration. munificence, defined by dess and beard (1984) as the ability of an industry to support growth and dynamism, defined by dess and beard (1984) as the degree of change in an industry, were both measured using data from six-digit naics codes. specifically, munificence was measured by using the standardized regression coefficient (β’) of industry sales data over time and dynamism was measured as the standard error of the regression coefficient (σβ1k) for the munificence measure (cf. dess & beard, 1984; weinzimmer, nystrom, & freeman, 1998). competitive concentration was measured using a four-firm concentration ratio. results descriptive statistics: correlations and reliabilities. initial analyses revealed significant positive correlations between our strategic orientation measure and firm performance. strategic orientation was positively related to profit growth, revenue growth, and roe growth (p < .01). note that industry munificence also had significant positive correlations with all three performance measures. competitive concentration was also significantly correlated to roe growth (p < .01). while there was only one significant correlation among the control variables, between 90 journal of business strategies dynamism and munificence (p < .01), only one control variable concentration was significantly correlated with strategic orientation (p < .05). all means, standard deviations, and correlations of variables are presented in table 2. note that similar to study 2, strategic orientation had an internal reliability estimate of 0.90. table 2 means, standard deviations, correlations for study 3 variable mean sd 1 2 3 4 5 6 7 1. profit growth -1.52 17.03 2. revenue growth 3.42 7.84 .61** 3. roe .02 .07 .53** 4. strategic orientation 4.12 4.23 .20** .13** .13** 5. munificence 13.21 11.88 .14* .16* .22** .07 6. dynamism 5.48 7.07 .09 .01 .04 .03 .27** 7. competitive concentration 4.71 .59 .01 .07 .14** .11* .05 .04 notes: n = 20 * p < .05, ** p < .01 ols regression modeling. we used regression analyses to show how strategic orientation behaves when modeled as an antecedent to firm-level performance. table 3 presents regression results. data were checked for normality, patterns in residuals such as heteroscedasticity, and outliers (cf. weinzimmer, et al., 1994). results from model 1, in table 3, show a significant positive relationship between strategic orientation and profit growth (p < .01). this suggests that a strong strategic orientation is positively linked to profit growth. note that among the control variables, industry munificence was also positively related to profit growth (p < .01), however the other two control variables were not significant. the overall model was significant (p < .01) and the adjusted r2 was .51, suggesting that 51% of the variance in profit growth may be explained by the model. volume 29, number 2 91 table 3 ols regression results for firm performance for study 3 model 1 model 2 model 3 profit growth revenue growth roe growth control variable munificence .61*** .47* .53*** dynamism .15 .19 .23 concentration .16 .22 .37* strategic orientation .48*** .50** .27 f 6.22*** 4.41*** 5.80*** adj. r2 .51 .34 .24 notes: n = 20 * p < .10, ** p < .05, *** p < .01 results from model 2, in table 3, shows a significant positive relationship between strategic orientation and revenue growth (p < .05). this suggests that a strong strategic orientation is positively linked to revenue growth. again, among the control variables, industry munificence was also positively related to profit growth (p < .10), however, the other two control variables were not significant. the overall model was significant (p < .01) and the adjusted r2 was .34, suggesting that 34% of the variance in profit growth may be explained by the model. finally, results from model 3, in table 3, show that a significant positive relationship between strategic orientation and roe does not exist. this suggests that strategic orientation is not linked to roe growth. however, note that two of the control variables, industry munificence (p < .01), and competitive concentration (p < .10) have significant positive relationships with roe growth. the overall model was significant (p < .01) and the adjusted r2 was .24, suggesting that 24 percent of the variance in profit growth may be explained by the model. discussion the findings of our study and their implications are two-fold. first, we developed and tested a reliable and valid strategic orientation measure that resolves the historical problems with construct contamination. specifically, the measure created in this study is reliable and unidimensional, and it shows criterion-related validity when predicting firm level performance. our study confirms and extends the work 92 journal of business strategies of gatignon and xuereb (1997) by identifying a direct relationship between the cultural construct of strategic orientation and the quantifiable performance measure of profit growth. gatignon and xuereb established an indirect relationship between strategic orientation and firm performance, using new product development as a moderator. note, that while we expected strategic orientation to be related to all three firm-level financial measures, there was no significant relationship between strategic orientation and roe growth in model 3. this may be explained by industry effects. note that industry munificence and competitive concentration accounted for 24% of the explained variance. while strategic orientation was significantly correlated with roe growth, when controlling for effects of the industry, it was no longer significantly related to roe growth. second, our research underlines prescriptive calls to operations managers to encourage and support a culture that both values and executes upon strategic fit and environmental alignment over the long term. culture is critical when developing organizational strategy and that strategy should be altered to meet strategic changes facing the organization (calori & sarnin, 1991; sayles & wright, 1985). thus, given that strategic orientation predicts organizational performance, it should be considered an important tool in producing the results needed for organizational success and longevity. additionally, operations managers may benefit from a careful examination of the items included in appendix 1. focusing on improving organizational focus within each of these areas will increase the level of strategic orientation. as suggested in this research, strategic orientation may improve financial performance in terms of profit growth and revenue growth. limitations we note some limitations in the present research. first in all three studies, we conducted cross-sectional research using surveys. although our firm performance measures were “hard” measures of performance gleaned from company financial information, all other independent variable data were collected via self-report surveys. thus, we cannot exclude the possibility that some of our results occurred in part from response bias. second, though our results in study three were significant, our sample size was small. while we gathered data from 779 people, they were nested within 20 companies, which decreased the power of our analyses. we found statistically significant results, but we would have been more confident with a larger sample, not to volume 29, number 2 93 mention the ability to look more closely at moderating variables (such as strength of culture) or additional controls (such as company age.) while easier said than done, culture research conducted on larger samples would advance the knowledge in this area. finally, there was a modest correlation between strategic orientation and competitive concentration. even though there was a positive correlation between strategic orientation and all three performance variables, the possibility of multicollinearity may exist. future research directions in this study, we created a measure that was unidimensional, both conceptually and statistically. future research should take care to isolate constructs of interest to further understand how they predict financial performance, and the interrelationships between concepts. we also ensured inter-group and inter-organization agreement among respondents before aggregating the data and treating the mean as a groupor organization-level variable. including this practice more routinely in strategy research is imperative, as the very definition of culture suggests that basic perceptual agreement is necessary. future research should align hypothesis testing using all culture variables, including strategic orientation with current prescriptions in organizational culture research. chan (1998) discussed the various ways we may look at compositional data such as that used in this and any study using surveys to assess culture. direct consensus is often the most appropriate compositional model. lastly, as mentioned in our limitations section, we urge researchers to aspire to use larger samples of organizations with larger samples of employees surveyed within each organization. though the efforts required in gathering such data is extensive, doing so allows us to ensure that the cultural variable of interest is widely shared throughout the organizations while also allowing complex analyses that hone our understanding of culture’s impact upon financial performance. conclusion in the current study, we develop a survey measure of strategic orientation that is unidimensional, reliable, and predictive of financial performance. we urge researchers to use surveys to assess shared values, philosophies, and behaviors, but to assess agreement before elevating the mean perception to an organizational-level variable. our results also support the notion that culture (broadly), and strategic orientation (specifically) impact financial performance. additional research should 94 journal of business strategies build upon these findings and those of others using larger sample sizes and more complex analyses. managerial implications of these results include a recommendation to encourage and support a culture that both values and executes upon strategic fit and environmental alignment over the long term. references aragon-sanchez, a. & sanchez-marin, g. (2005). strategic orientation, management characteristics and performance: a study of spanish smes. journal of small business management, 43(3), 287-308. barney, j. (1986). organizational culture: can it be a source of competitive advantage? academy of management review, 11(3), 656-665. cahlik, d., howard, j., & godkin, l. (1999). compensation strategy and financial performance of community banks: an exploratory study. journal of business strategies, 16(2), 151-169. calori, r., & sarnin, p. (1991). corporate culture and economic performance: a french study. organization studies, 12, 49-74. carmines, e. g., & zeller, r. a. (1991). reliability and validity assessment. newbury park, ca: sage publications. chan, d. (1998). functional relations among constructs in the same content domain at different levels of analysis: a typology of composition models. journal of applied psychology, 83(2), 234-246. chandler, g., & hanks, s. (1993). measuring the performance of emerging businesses: a validation study. journal of business venturing, 8, 391-408. christensen, e. w., & gordon, g. g. (1999). an exploration of industry, culture and revenue growth. organization studies, 20, 397-422. conant, j. s., mokwa, m. p., varadarajan, p. r. (1990). strategic types, distinctive marketing competencies and organizational performance: a multiple measures-based study. strategic management journal, 11, 365-383. crocker, l., & algina, j. (1986). introduction to classical and modern test theory. orlando, fl: harcourt brace jovanovich. denison, d. r. (1984). bringing corporate culture to the bottom line. organization dynamics, 13, 4-22. denison, d. r. (1996). what is the difference between organizational culture and organizational climate? a native’s point of view on a decade of paradigm wars. academy of management review, 21(3), 619-654. denison, d. r., & mishra, a. k. (1995). toward of theory of organization culture and effectiveness. organization science, 6, 204-223. volume 29, number 2 95 dess, g., & beard, d. (1984). dimensions of organizational task environments. administrative science quarterly, 29, 52-73. dess, g. g., & robinson, r. b. jr. (1984). measuring organizational performance in the absence of objective measures: the case of the privately-held firm and conglomerate business unit. strategic management journal, 5(3), 265-73. dess, g., ireland, r., & hitt, m. (1990). industry effects and strategic management research. academy of management journal, 16, 7-27. feeser, h. r., & willard, g. e. (1990). founding strategy and performance: a comparison of high and low growth tech firms. strategic management journal, 11, 87-98. fombrun, c. j., & ginsberg, a. (1990). shifting gears: enabling change in corporate aggressiveness. strategic management journal, 11, 297-308. gatignon, h., & xuereb, j. m. (1997). strategic orientation of the firm and new product performance. journal of marketing research, 34, 77-90. goll, i., & sambharya, r. b. (1995). corporate ideology, diversification and firm performance. organization studies, 16, 823-846. harris, l. (2001). market orientation and performance: objective and subjective empirical evidence from uk companies. journal of management studies, 38(1), 17-43. james, l. r. (1982). aggregation bias in estimates of perceptual agreement. journal of applied psychology, 67(2), 219-229. james, l. r., demaree, r. g., & wolf, g. (1984). estimating within-group interrater reliability with and without response bias. journal of applied psychology, 69(1), 85-98. james, l. r. (1993). rwg: an assessment of within-group interrater agreement. journal of applied psychology, 78(2): 306-309. james, l. r., joyce, w. t., & slocum, j. w. (1988). organizations do not cognize. academy of management review, 13(1), 129-132. jones, r. a., jimmieson, n. l., & griffith, a. (2005). the impact of organizational culture and reshaping capabilities on change implementation success: the mediating role of readiness for change. journal of management studies, 42(2), 361-386. laforet, s. (2008). size, strategic, and market orientations affects on innovation. journal of business research. 61, 753-764. lebreton, j. m., james, l. r., & lindell, m. k. (2005). recent issues regarding rwg, r*wg, rwg(j), and r*wg(j). organizational research methods, 8, 128-138. 96 journal of business strategies lebreton, j. m., & senter, j. l. (2008). answers to 20 questions about interrater reliability and interrater agreement. organizational research methods, 11(4), 815-852 lee, s. k., & yu, k. (2004). corporate culture and organizational performance. journal of managerial psychology, 19(4), 340-359. meyer, a. 1991. what is strategy’s distinctive competence? journal of management, 17, 821-833. michalisin, m., kline, d., smith, r. (2000). intangible strategic assets and firm performance: a multi-industry study of the resource-based view. journal of business strategies, 17(2), 91-117. miles, r. e., & snow, c. c. (1978). organizational strategy, structure, and process. new york: mcgraw hill. morgan, r., & strong, c. (2003). business performance and dimensions of strategic orientation. journal of business research, 56(3), 163-176. nunnally, j. (1967). psychometric theory. new york mcgraw-hill. ogbonna, e., & harris, l. c. (2002). organizational culture: a ten year, two-phase study of change in the uk food retailing sector. journal of management studies, 39, 673-706. o’regan, n., & ghobadian, a. (2005). innovation in smes: the impact of strategic orientation and environmental perceptions. international journal of productivity and performance management, 54(2), 81-97. pleshko, l. & nickerson, i. (2008). strategic orientation, organizational structure, and the associated effects on performance in industrial firms. academy of strategic management journal, 7, 95-110. porter, m. (1980). competitive strategy. new york: free press. porter, m. (1985). the competitive advantage: creating and sustaining superior performance. new york: free press. reichers, a., & schneider, b. (1990). climate and culture: an evolution of constructs. in b. schneider (ed.), organizational climate and culture. san francisco: jossey-bass. pp. 5-39. romanelli, e. (1989). environments and strategies in organization start-ups: effects on early survival. administrative science quarterly, 34, 369-387. sackmann, s. a. (2010). culture and performance. in n. m. ashkanasy, c. p. m. wilderom, & m. f. peterson (eds), the handbook of organizational culture and climate. thousand oaks, ca: sage. sayles, l. r., & wright, r. (1985). the use of culture in strategic management. in issues and observations 5/4 (november): 1-9. center for creative leadership. volume 29, number 2 97 schein, e. h. (1983) organizational culture. organizational dynamics, 12, 13-28. schein, e. (1985). organizational culture and leadership. san francisco: jossey-bass. short, j., ketchen, d., bennett, n., & du toit, m. (2006). an examination of firm, industry and time effects on performance using random coefficients modeling. organizational research methods, 9, 259-284. siehl, c., & martin, j. (1988). measuring organizational culture: mixing qualitative and quantitative methods. in m. o. jones, m. d. moore, & r. c. snyder (eds.), inside organizations: understanding the human dimension. newbury park, ca: sage publications. pp. 79-103. sorensen, j. b. (2002). the strength of corporate culture and the reliability of firm performance. administrative science quarterly, 47, 70-91. trevino, l. k. (1986). ethical decision making in organizations: a person-situation interactionist model. the academy of management review, 11(3), 601-617. veliyath, r., & shortell, s. 1993. strategic orientation, strategic planning system characteristics and performance. journal of management studies, 30(3), 359-381. venkatraman, n. (1989). strategic orientation of business enterprises: the construct, dimensionality, and measurement. management science, 35(8), 942-962. venkatraman, n., & ramanujam, v. (1986). measurement of business performance in strategy research: a comparison of approaches. academy of management review, 11, 801-814. voss, g., & voss, z. (2000). strategic orientation and firm performance in an artistic environment. the journal of marketing, 64(1), 67-83. wallach, e. (1983). individuals and organizations: the cultural match. training and development journal, 29-36. weinzimmer, l. g. (2000). a replication and extension of organizational growth determinants. journal of business research, 48(1), 35-41. weinzimmer, l. g., mone, m. a., & alwan, l. c. (1994). an examination of perceptions and usage of regression diagnostics in organization studies. journal of management, 20, 179-192. weinzimmer, l., nystrom, p., & freeman, s. (1998). measuring organizational growth: issues, consequences and guidelines. journal of management, 24, 235-262. whipp, r., rosenfeld, r., & pettigrew, a. (1989). culture and competitiveness: evidence from two mature uk industries. journal of management studies, 26(6), 561-85. 98 journal of business strategies wiklund, j., & shepherd, d. (2003). aspiring for achieving growth: the moderating role of resources and opportunities. journal of management studies, 40, 1919-1941. wilkins, a., & ouchi w. g. (1983). efficient cultures: exploring the relationship between culture and organizational performance. administrative science quarterly, 28, 468-481. zhou, k. z., gao, g. y., & zhou, n. (2005a). developing strategic orientation in china: antecedents and consequences of market and innovation orientations. journal of business research, 58, 1049-1058. zhou, k. z., kin, c., & tse, d. k. (2005b). the effects of strategic orientations on technologyand market-based breakthrough innovations. journal of marketing, 69, 42-60. biographical sketch of authors laurence g. weinzimmer is the caterpillar inc. professor of strategic management in the foster college of business at bradley university. he has written four books and regularly publishes in the areas of strategic growth, culture and performance, and construct measurement. jennifer robin is an assistant professor in the foster college of business at bradley university. she publishes in the areas of leadership, the impact of organizational culture on performance, and human resources management. she has authored two books, a life in balance and the great workplace. jennifer also blogs at www.jenniferrobin.net eric j. michel is a doctoral student in the department of managerial studies at the university of illinois at chicago. his research interests include the strategic implications of organizational culture, determinants of superior firm performance, antecedents of organizational creativity, and multilevel analysis. appendix 1 strategic orientation scale 1. there is a shared vision of what the company will be in the future 2. our strategic direction is clear 3. the company’s goals and objectives can be linked to our mission, vision, and strategy 4. short-term thinking does not compromise our long-range vision 5. we have an effective strategic plan 6. the company has regular and effective planning processes at all levels the measurement of strategic orientation and its efficacy in predicting financial performance an empirical investigation of the utilization of external and internal board of directors and management advisory assistance on the performance of small business diane j. garsombke university of wisconsin superior thomas liz garsombke university of minnesota crookston abstract this article reports the usage and effectiveness of advisory bodies (i.e. advisory boards, boards of directors, management consultants, accountants, family, friends) that exist in smaller businesses. the authors find that advisory boards have the most significant impact on various company performance criteria. this result implies that strategic marketing and planning is enhanced by the use of advisory boards. additionally, the authors discover that the entrepreneur's attitude is even more important than previously reserched inhibitors of lack of resources to greater use of advisors. introduction the united states has a long tradition of entrepreneurship in small and medium sized businesses. unfortunately, new startup firms are subject to many perils in the business world. with a 60% failure rate cited for new endeavors, it is important that entrepreneurs learn how to overcome the obstacles to success. from the past research on business failures, many firms suffer due to inadequate knowledge by the owner/manager on running the business poor understanding of markets, the customer and competition, inadequate financial controls, lack of strategic planning, and inadequate capitalization. gobeli and seville (1989, 8) state that "lack of management expertise is the primary cause of small business failure." researchers have assessed the reasons for success and failure in small business. dimma (1996) and montagno et al. (1986) emphasize the importance of strategic planning to entrepreneurs who concentrate only on day-to-day operations. the primary reason for business failures is the lack of marketing and managerial expertise (fox, 1983; miskin and rose, 1990). khan and rocha (1982), however, cite four interrelated problems in marketing, accounting, inventory and cash flow which endanger the small firm's ability to survive and 168 journal of business strategies vol. 13, no.2 prosper. ibrahim and goodwin (1986) conclude that entrepreneurial behavior and managerial skills are key success factors for new startups. entrepreneurs often lack the skills and experience necessary to overcome many problems encountered. to compensate for their lack of knowledge, entrepreneurs seek expertise from persons and groups both internal and external to the firm. aid can be formal or informal. for instance, some executives set up a board of directors. boards can be of two types 1) advisory members give their opinions to the owner/manager but are not held legally or structurally to the firm or 2) governing members make decisions on resource allocations as part of the legal structure of the firm. others turn to personal contacts such as friends, family, and marketing, advertising, and management consultants on an ad-hoc basis. the government or trade association may offer valuable assistance to the small business executive as well. the question to be addressed by this research is: to what degree does the use of an advisory or governing board of directors or management advisory assistance impact on the successful performance of the firm? the entrepreneur is ultimately the person to whom the blame is placed when the firm fails. is it in the best interest of the firm for the owner/manager to turn to different advisory persons or groups? do the practices of asking for assistance follow a pattern for more successful firms? this information could help entrepreneurs to learn which types of assistance are most beneficial given the limited time and financial resources available to most entrepreneurs, this research may pinpoint the critical situations and resources where getting assistance "pays ofl" this study will provide information on the use of a board of directors and other advisors and the linkage to performance measures which are key to strategic marketing and planning. a second area of investigation is to determine the major inhibitors which prevent small businesses from establishing and using board of directors/advisory assistance. previous research assistance forms most research which has been done on the topic of boards of directors and managerial advisory assistance in the united states focuses on the structure, composition, recruitment, forms and sources of assistance (baldwin and hughes, 1995; baysinger and hoskisson, 1990; business owner, 1990; kesner, 1989; lorsch, 1995). fox's (1984) research, for example, focuses in on the types and structures of small business boards of directors. he states that a panel of counselors can help small business owners in the areas of marketing, managerial and technological advice. his work has shown that "quasi-boards" (non-governing and advisory only) can offer ideas and recommendations to help strengthen the business by formal planning, deliberation in major decision making and providing outside objectivity. the study by nelson (1989) fall 1996 garsombke & garsombke: empirical investigation 169 confirms that female entrepreneurs value outside assistance in two areas: basic business support and for day-to-day business support in planning, operating and coordi~ating. in their interviews of 148 small businesses in oregon, gobeli and seville (1989) found that 79% of the firms used cpa firms for accounting services. in determining the sources of assistance, baldwin and hughes's (1995) book paralleled the research of franklin and goodwin (1986). both writings found that small businesses overwhelmingly turned to accountants, lawyers and bankers for most of their managerial problems. perceived effectiveness of assistance the primary focus of past research has been on the entrepreneur's perceived effectiveness of the assistance type or form, as measured by an effectiveness scale. professional consultants and advisors, such as accountants, bankers, and lawyers have been rated "high" in their effectiveness in past studies (baldwin and hughes, 1995; gales and blackburn, 1990). gobeli and seville's (1989) results show that most small business owners perceive accountants to be helpful only in tax return preparation rather than in management information system design or forming strategic marketing and management plans. baysinger and hoskisson's (1990), ford's (1989) and shapiro's (1995) research on effectiveness of boards revealed that most ceos believed inside directors were more helpful than outside directors because of their knowledge of the firm, but no direct linkage between the use of these boards and positive performance was determined. in an empirical study on information sources for small firms, specht (1987) and fann and smelter (1989) both found personal sources to be more effective than impersonal ones. in light of these studies, the present research focuses on different types of personal sources. performance in their research, holmes and nicholls (1988) found a tentative assistance-performance linkage to the use of professional accountants; the "lower the level of sales, the greater the proportion of owner/managers restricting accounting information to st (statutory meaning for irs tax returns)." that is, firms with greater sales volumes used accountants for preparation of tax returns as well as budgets and plans. dollinger (1985) also found that the use of outside consultants (marketing and management) was positively correlated with performance, measured as perceived organizational effectiveness in 53 small retailing firms. probably the strongest empirical evidence supporting the relationship between the use of entrepreneurial assistance and firm performance has been conducted by chrisman and leslie (1989). rather than concentrating on the different forms of outside assistance (such as formal and advisory boards, accountants, family, friends), they studied three types of assistance, namely, "strategic, administrative, and operating" and their impact on performance. two financial performance criteria were utilized in their research sales growth and 170 journal of business strategies vol. 13, no.2 incremental return on sales (ros). the major finding of the paper was that only firms which obtained comprehensive assistance (meaning of all three types) were belter performers in terms of ros. none of the assistance types were significantly linked to sales growth. while this study focuses on the impact of the content of assistance on performance of the firm, it is limited in some important ways the sample size is fairly small (watts and ormsby, 1990); performance was measured narrowly by two financial criteria; and assistance was received through one form (i.e. government sponsored assistance through a sbdc small business development center in georgia). another study with the similar limitation of having examined only sbdc consulting and performance did confirm the link of advisors to upward trends in sales, profit, net worth, and number of employees (nahavandi and chesteen, 1988). dollinger (1985) like chrisman et al. (1989) says comprehensive attention to a mix of factors (i.e. suppliers, marketing and management consultants, trade associations, regulators, stockholders and competitors) contributes to higher sales, net income and profitability for small firms. building upon this foundation of research, the present study analyzes a variety of assistance forms in a larger sample size with a more comprehensive look at performance criteria. that is, the goal of this research is to comprehensively evaluate the advisors and their relationship to positive company performance measures found in previous research: sales (chrisman and leslie, 1989; nahavendi et. al, 1988); market share (gales and blackburn, 1990); productivity sales per employee (garsombke and garsombke, 1989); return on sales (cragg and king, 1988; franklin and goodwin, 1986); return on assets (hornaday and wheatley, 1986); return on equity and new geographical sales area (garsombke et. ai, 1989). inhibitors another important area of research on board of directors/management advisory assistance deals with the barriers facing small businesses in the development and use of advisors, if a firm is not using a board of directors or other entrepreneurial assistance, are there reasons why? most of the impediments to assistance researched thus far have concentrated on the cost of establishing or maintaining these boards or advisors and finding appropriate expertise in needed functional areas and the industry. smale et. al (1995) suggest that small companies have difficulty in providing the resources needed to acquire and develop outside expertise and advisory assistance. in fact, shapiro cautions small businesses to "leverage their internal brainpower first before calling consultants" (1995, p. 31). weiss (1995) and mcmenamin (1993) researched the inhibitors which affect the entrepreneur's use of outside advisors and state that the factors are primarily lack of financial and organizational resources. while small businesses will surely benefit from long term planning, marketing techniques which include building relationships as well as enhancing sales, preparation of organizational documents, and computer utilization, most of these fall 1996 garsombke & garsombke: empirical investigation 17l smaller firms encountered significant problems in setting up and fully implementing their consultant's advice. methodology a mail questionnaire was the basic research methodology used in this study with questions developed into four major topical areas. the first section contained a list of various board of directors/management advisory assistance forms previously evaluated by researchers (gales and blackburn, 1990; nahavandi and chesteen, 1988; specht, 1987; verespej, 1994; weidenbaum, 1995). the forms of assistance described above included both advisory and governing, individual and group, and professional and non-professional. the "usage" of assistance measured the amount each assistance form was consulted over the past 3 years through a 5 point likert scale with '1' being "used very little" and '5' being "used extensively." the "effectiveness" of managerial assistance was measured by using a five point likert scale ranging from "not effective" to "extremely effective." the points were averaged for all respondent firms to calculate an effectiveness score. the second section consisted of a list of possible inhibitors derived by the authors and other small business professionals in their research (johnson and kuehn, 1987; miskin and rose, 1990). this list contains factors which have or are presently inhibiting the development and/or implementation of board of directors/management advisory assistance. the third part of the questionnaire identified performance indicators focusing on the seven performance factors from the literature as outlined previously. because of the reluctance on the part of small business owners to divulge financial data, this study employed self report qualitative measures of positive organizational performance. this performance rating system was designed, tested and utilized by dess and robinson (1984). it has been used in a series of studies where current specific financial data have not been available (chrisman and leslie, 1989; garsombke et. ai, 1989; vance, 1983). the fourth major section of the survey contained questions dealing with business characteristics such as approximate annual sales, number of employees, types of products produced, and ownership forms. the sample the target population for this study included sman and medium sized companies in the state of maine listed in the 1992 maine directory of small and medium sized firms. this directory contains the listing of all manufacturing firms by sic code and county. a random number generator was used to select five hundred questionnaire recipients. of the five hundred firms sampled, one hundred twenty-six firms participated in the study for a twenty five percent (25%) response rate. 172 journal of business strategies vol. 13, no. 2 a majority of firms in the study had less than one million dollars in annual sales per year (68%), had fewer than fifty employees (69%), and were incorporated (81 %). the sample fits well within the guidelines for small business given by nappi and vora (1980); a typical small business has less than $1 million in sales, 100 employees and is independently operated. over sixty-seven different sic classifications were represented in the responding firms, with the greatest concentration in the manufacturing and marketing of wooden products (8.5%). products manufactured included wood products, mat tresses and springs, canned foods, packaging material, metal fabrication, electronic parts and equipment, printing, and building materials. of the firms responding, fifty-nine per cent (59%) identified themselves as manufacturers, seven per cent (7%) as wholesaler/distributor, five per cent (5%) as service businesses, and three per cent (3%) as retailers and twenty six per cent (26%) as a mixed type. chi-square analysis of response and nonresponse firms showed no significant differences between the two groups regarding product type, number of employees, amount of yearly sales, and type of ownership. backwards stepwise regression statistics were utilized to enable the researchers to focus on the most elemental factors by taking out those which did not add significantly to the overall effectiveness model. results table i summarizes the commonly used fonns of assistance (frequency and percent of usage) by the responding firms and how effective these [onus are relative to one another. the most frequently cited factors which inhibit table 1 usage (frequency and per cent) and effectiveness of board of directors and management advisory assistance forms usage usage effectiveness frequency percent accountant 102 81 3.12 attorney 90 71 3.16 banker 72 57 3.60 consultant 70 56 3.66 governing board 61 48 3.49 trade association 60 47 150 friend or rdative 58 46 4.14 supplier 58 46 4.64 advisory board 50 40 3.62 government sponsored program 47 37 2.94 (i.e. sbdc. score. s8i. sba) customer 11 9 1.85 fall 1996 garsombke & garsombke: empirical investigation 173 implementation of advisors are shown in table 2. while these statistics show some interesting patterns regarding use and perceived effectiveness of assistance and their inhibitors, they do not address the question of significance. table 3 addresses this issue and reports the significant regression results relevant to each of the assistance forms and performance factors studied. table 2 frequency and percent of inhibiting factors factors frequency percent belief advisors would not help 47 37 lack of time to evaluate 43 34 lack of capital 34 27 lack of staff 32 26 lack of knowledge 31 25 difficulty of obtaining funds 20 16 lack of advisors in area 16 13 table 3 summary table for significant regressions of performance factors on advisory forms beta r square probability change sales: adv 0.208 0.090 0.100 sup 0.140 0.040 0.095 productivity (sales/employee): adv 0.245 0.061 0.136 con 0.107 0.048 0.192 market share: adv 0.245 0.061 0.135 con 0.107 0.048 0.192 tra 0.091 0.042 0.161 return on equity (net incomeffotal stockholder's equity): adv 0.402 0.333 0.000 cus 0.059 0.032 0.241 return on sales (net incomeffotal sales): adv 0.430 0.261 0.003 fri 0.089 0.057 0.147 return on assets (net ineomerrotal assets): ady 0.228 0.063 0.197 fri 0.097 0.040 0.211 new geographical sales area: gsp 0.372 0.176 0.040 sup 0.21 i 0.060 0.093 legend: ace accountant fri friend or relative ady advisory board of directors goy governing board of directors att attorney gsp government sponsored program con consultant sup supplier cus customer tra trade association 174 journal of business strategies vol. 13, no.2 discussion of strategic marketing and planning implications advisors the first area explored in this study was the advisory form entrepreneurs used and their perceived effectiveness of these fonns. entrepreneurs most often used a board of directors, which is a group fonn of professionals. this represents an increase in usage of boards by smaller finns since vance's (1983) study, which reported small business use at approximately 80%. the next most used forms of advisors were individual professionals: accountants (81 %), attorneys (71 %), bankers (57%), and marketing and managerial consultants (56%). these results are consistent with previous research findings (gales and blackburn, 1990; specht, 1987). the "governing" board of directors fonn was used slightly more frequently (48%) than the "advisory" board fonn (40%). government programs and customers, as advisory forms, were the least used (37% and 9% respectively). explanations for this low usage of government programs and customers when compared to other fonns are related to the perception of the government and customers by small business owners. small business, in general, is suspect of government interference and bureaucracy; customers are seen as sources of revenues, not assistance to overcome problems the business faces. many entrepreneurs believe that admitting they have problems and need outside help could hurt customer confidence and loyalty. however, entrepreneurs should be careful not to miss opportunities to gain advice from their customers especially in the areas of new product development and existing product improvements. most small businesses have become competitive because they have offered something special to their customers or appealed to a unique customer group or niche. of the most used forms of advice, small business owners who responded believed that suppliers and friends were the most effective forms of advisory assistance. consultants, bankers, boards, trade associations, attorneys, and accountants were next in order of perceived effectiveness. government programs and customers were judged to be the least effective forms. counterpointing usage and effectiveness brings two strategic implications for entrepreneurs. although usage is relatively low, assistance from suppliers and friends is perceived as extremely effective. perhaps this has to do with the fact that small business people did not pay for this assistance and yet the results surpassed their expectations. in addition, of all assistance forms, suppliers and friends seem likely to be viewed as trustworthy and helpful. such a view builds up with long term relationships of this kind (weiss, 1995). also more frequent and intense communications with suppliers have been tied to more frequent use of advertising and strategic marketing plans (gales and blackburn, 1990; franklin and goodwin, 1986). entrepreneurs who are not establishing these strong relationships may be overlooking the benefits of such contacts. fall 1996 garsombke & garsombke: empirical investigation 175 it is important to note that professional assistance, both group and individual, also fared well. usage and effectiveness were relatively high for these forms. this is contrasted to the forms of government sponsored programs and customers, which had relatively low usage and poor effectiveness ratings. one may wonder, in fact, if low usage of these forms is due to the perceived effectiveness of these sources. word of mouth between entrepreneurs is often the way the business community hears about sources of assistance. consultants have long used testimonials of entrepreneurs and clients to increase their business. inhibitors the most frequently cited inhibitors found in the study were a "belief that management advisory assistance or board of directors would not help operations" (37%) and "lack of time to investigate management advisory assistance" (34%). "lack of capital" was the reason checked for inhibiting use of assistance by 27% of the respondents. other research on advisors have reported lack of resources (i.e. time and money) as the major obstacles (fraser, 1995; gales and blackburn, 1990). examining watts and ormsby's (1990) research on the effects of long-range planning on small firm performance, insights can be drawn regarding inhibitors to advisors. attitude was found to be of paramount importance; 79% of managers in the lower performing group said that the expense and time involved in planning often outweighed the benefits. it could be that some entrepreneurs do not believe the benefits of advisors outweigh the expense and time involved in soliciting advice. this study addresses the issue of benefit of advisors to the firm by relating assistance forms and performance measures. sales a backwards stepwise multiple regression analysis was performed to test the relationships between the studied independent variables (usage of each advisory form) and the dependent variables (seven performance factors). results reveal that the performance factor of sales was positively impacted by two independent variables, "advisory board of directors," and "supplier or resource contributors." these two factors together accounted for 20.6% in the variance in sales (i.e. usage of an advisory board and supplier for business advice). this confirms that advisory boards are beneficial to the firm as castaldi and wortman (1984) predicted in their research the "coilegial" board structure (also called quasi or advisory board) was deemed as the most "efficient" form and "crucial to success". the finding on suppliers being a good source of advice parallels the research of dollinger (1985) on environmental contacts and performance entrepreneurs who repeatedly contacted suppliers for information and advice (primarily to get environmental information for use in strategic marketing and planning) had higher sales and net incomes in their firms. the results did not confirm the finding of a positive relationship be176 journal of business strategies vol. 13, no. 2 tween sales and use of government sponsored programs, particularly sbdc, which nahavandi and chesteen (1988) reported. however, it could be interpreted that the advisory board and suppliers did give the same type of information that sbdc consultants were most often reported giving business planning (17%) and marketing planning (19%). the present study did not collaborate holmes and nicholls's (1988) linkage between use of accountants for planning and sales increases. the finding on the importance of suppliers and advisors confirms somewhat the recent empirical work by gales and blackburn (1990) that showed close wholesale relationships (greater communications) impacted retailer planning and promotional activity although not sales or profitability directly. together with previous research, the current study suggests that suppliers can provide information and advice to significantly benefit their small firm clients. only two independent variables, "advisory boards" and "consultants," accounted for eleven percent (11 %) of the variance on productivity, which was measured as the ratio of sales per employee. again, this result corresponds to the belief (castaldi and wortman, 1984, 2) that the "collegial" board structure was the most "efficient" form, which could easily relate to greater productivity. although no study on advisors which assessed productivity can be found to compare to these results, nahavandi and chesteen's (1988) research looked at sales and number of employees as separate factors relating to sbdc consulting. from an analysis of these separate results, productivity was also positively impacted because sales increased more percentage points (35%) relative to the percentage increase in the number of employees (19%). in the present study, entrepreneurs were asked to evaluate the effectiveness of paid professional consultants to free sbdc student consultants (in the form of "government sponsored programs") and the professional emerged as more effective. so it is not really surprising that the professional consultant would have a more significant relationship to small firm performance. nahavandi and chesteen (1988) themselves questioned the owner/managers why they did not implement the student consultant recommendations and two areas emerged the lack of the consultants' experience and their understanding of the business, particularly in overall business and marketing planning. market share three variables were moderately related to the market share factor "advisory boards," "consultants" and "trade association assistance" with 15% of the changes in market share being explained by these variables. the impact of all three advisors was fairly evenly split, but advisory boards showed a larger beta weight. market share is an illusive goal since it is very hard to define markets. it is noteworthy that this factor should have a variety of assistance forms which are related, but yet only explain a relatively small amount of the flux in market share. as evidenced from previous studies on market share, a complex array of factors such as advertising expenditures, industry fall 1996 garsombke & garsombke: empirical investigation 177 stage, competitive factors, the degree of marketing research and planning and other market-related factors have been found to be significant (baldwin and hughes, 1995; provan and skinner, 1989; specht, 1987). profitability ratios the analysis also revealed that 2 independent variables accounted for 36 percent of the positive variation in return on equity. "advisory boards" usage was highly significant contributing over 33% of the variance in roe and "customer" assistance explained 3% of the changes in this performance factor. in his study, dollinger (1985) used a slightly different measure of profitability (i.e. the owner's draw, fringe benefits, cash dividends and net income divided by the prorated percentage of ownership) and uncovered a negative relationship with the customer. he explains this unexpected outcome between a high number of customer contacts and low profitability by saying the entrepreneur is taking on the role of sales personnel and does not have time for other executive tasks which are more cost efficient and profit generating activities. when the customer contact is factored out of dollinger's correlation, the remaining factors together (including trade associations, suppliers and consultants but no categories for government sponsored programs or boards) accounted for 36% of the variance in profitability. the strongest positive relationship was found between the dependent variable of return on sales and the independent variable of "advisory board" assistance. this assistance form accounted for over 26% of the variance in ros and was weighted the highest of all dependent variables studied (beta of 0.430). in addition, the variable of "government sponsored programs" was moderately related to this variable measuring profit margin. interestingly enough, these two advisor forms are usually without significant cost to the firm in terms of money, but may be high in terms of time. ros is positively effected by strategies and advice that result in lowering costs and/or increasing gross revenues. this result confirms two previous studies: nahavandi and chesteen (1988) reported a 23% average increase in profit margin for firms using sbdc consulting in the state of utah; chrisman and leslie (1989) analyzed that comprehensive advice on strategic. administrative and operating decisions by sbdc consultants resulted in significant ros increments. the regression equation for return on assets showed only marginally significant and weak relationships with "advisory board" and "friends" in the expected positive direction. possible explanations for this could be that assets increased relative to net income for the sampled firms on a whole and thus advisor choice did not serve as a discriminating factor. in fact, for manufacturing firms in maine inefficient asset acquisition could be triggered by the recent economic slowdown and competitive pressures to keep up with technological advancements. 178 journal of business strategies vol. 13, no. 2 new geographical sales area two variables (government sponsored programs and suppliers) were strongly related to an increase in new geographical sales area, explaining twenty-four percent of the variance. manufacturing firms which experienced greater growth in their geographical sales area (i.e. going from a local to regional to national or international area) used suppliers and government sponsored consultants as advisors. these two forms of advisors could offer clients their knowledge about the state, regional, national and/or international sales areas and markets that the small firm may not have or be able to acquire on their own. for example, the federal government through its sba programs offers export seminars and resources to small firms. in the state of maine, particular emphasis on expanding to international sales areas has been given in seminars on canadian markets and the recent free trade agreement. experts agree that suppliers have valuable information on sales regions in which they hope to expand because of a competitive edge or where they have recently lost a distributor, client or competitor. often they entice small firms to enter new territories to fill these gaps by offering them purchasing discounts and exclusive contracts. suppliers also offer information concerning products, markets, competitors, and the general business environment which could easily contribute to expansion into new geographical areas as well (dollinger, 1985; franklin and goodwin, 1986; provan and skinner, 1989). conclusions advisory boards from the data analyzed, most of the performance factors were positively related to the use of an advisory board of directors. although this form of management advisory assistance appeared to have the greatest overall impact on performance, it was utilized by only 40% of the businesses, ranking eighth out of the eleven forms of assistance. advisory boards had the greatest impact on the profitability ratios of return on equity and sales, in rank order. the use of boards by entrepreneurs seems to be increasing in popularity, as evidenced by the 88% of the sample who had one. boards offer the entrepreneur contact with a group of professionals with a variety of backgrounds marketing, accounting, legal, managerial, and financial and therefore the content of advice is probably more comprehensive than most of the individual advisors (park, 1995). this study leads credence to the idea that the comprehensiveness of advice leads to better performance, but did not fully support that advice from many sources at once is better than from one source, as in dollinger's (1985) work. although some evidence for the cumulative effect of different advisory groups was given (eg. government sponsored programs contributed 18% to expansion in geographical areas by itself, but taken together with the impact of suppliers explained 24% of the difference in this fall 1996 garsombke & garsombke: empirical investigation 179 perfonnance variable). clearly, however, for overall impact on perfonnance, seeking assistance from an advisory board was the most beneficial choice. so why did the advisory board seem to overshadow the governing board in these results? this intriguing question may be answered by the purpose of the advisory board which is to advise or counsel as compared to the governing board which is to govern or control the actions of the entrepreneur. the difference is in the setup and charter given them. when the board is given legal responsibility and structural power, the entrepreneur is in fact sharing some of the decision making role. although small privately-owned finns are under no obligation to have a board, beyond the minimally required state specified constitutional board, many entrepreneurs have created fully functioning boards, some advisory and some governing. inherently, there is more resistance to the governing fonn and more voluntarism in the advisory fonn (verespej, 1994). the advisory board can be an easy way for an entrepreneur to get professional consulting advice. for example, when john fox was starting up minute maid in 1945, he said that he used the board as a "substitute, and a really cheap substitute, for all the consultants i couldn't afford. they helped me decide on such vital issues as getting the company launched ... held my hand through all kinds of growing pains" (vance, 1983, 25). in an advisory form, directors offer their general or specialized backgrounds and experiences to be applied to specific marketing, financial and management problems of the company (baldwin and hughes, 1995; fraser, 1995). in fact, successful entrepreneurs select directors on their complementary knowledge and specialties to best fit the needs of the finn and management, but contrary to popular belief that does not always mean that the majority of board members are outsiders. in fact, ford (1988) showed that the predominantly insider (members of family, and present, fonner, or retired managers or officers of the firm) boards are more influential. contingency theory from the research, it is evident that small business decision makers need to select assistance forms with the most impact on the perfonnance criteria which are important to them. for example, if sales or return on sales are extremely important, the advice of an "advisory board" should be sought. if growth into new geographical areas is the target, "government sponsored programs" and "suppliers" together would be the best choice for assistance. but, performance goals are sometimes contradictory. for example, hornaday and wheatley (1986) showed that organizational growth was not correlated with higher profits in small retail firms. the strategic implications of this research are that there are tradeoffs between performance measures which affect the impact of the various fonns of managerial assistance. entrepreneurs should decide on their primary emphasis and choose advisors to fit those strategic goals. in addition, advisors are only one factor among many which can help 180 journal of business strategies vol. 13, no. 2 to attain strategic goals and entrepreneurs need to utilize other key success factors to accomplish their strategies and objectives. this study is an initial attempt to determine the impact that usage of advisors have on positive performance of small businesses. while entrepreneurs overwhelmingly (94%) use some advisory form to help in running their firms, the form of "advisory board of directors" appears to have a greater impact on positive performance than other forms of advisors, even though advisory boards were utilized less frequently than other forms such as accountants, attorneys, and bankers which were utilized the most. after the advisory board, government sponsored programs and suppliers showed the next greatest potential for specific performance improvements in small firms. future research future research could be attempted to determine more specifically the type or content of advice and information (functional knowledge such as marketing or financial or kind of information such as strategic versus operational) for each advisory form. this could clarify why the individual professional advisors such as attorneys, bankers, accountants, and lawyers, although perceived as being effective, did not show any empirically significant relationships to performance. it seems likely that these types of professionals give a narrow array of advice and information that is related to their specialty, but further research is warranted to test this assumption. this study shows that the choice of advisory forms depends both on the needs of the entrepreneur and the performance goals sought, and adds to existing contingency theory. future research could expand the performance model to include factors along with advisors such as innovativeness, owner decision making, and goal setting, which dollinger (1985) found related to performance. in addition, future research could focus on firm and industry differences as well. due to the limitation of a single state sample, it's recommended that future studies expand this research drawing a sample from several other states or nationally to increase the meaningfulness and generalizability of the results. this study has shown that the greatest inhibitor to small business use of boards and advisors was the belief that these forms of advisors would not help operations and provide the company with viable assistance. additionally, the results confirm previous research which cited lack of time and resources as major inhibitors to use of advisors. this and future research analyzing the role of advisors more fully could contribute to eliminating the bias against use of advisors and convince entrepreneurs that the time and resources expended in gaining advice would be beneficial to the success of the firm. fall 1996 garsombke & garsombke: empirical investigation references 181 baldwin, rollin p. and jonathan t. hughes. boards at their best: a new approach toward improved board effectiveness. new york: connolly-cormack, 1995. baysinger, barry and robert e. hoskisson. "the composition of boards of directors and strategic control: effects on corporate strategy." academy of management review 15(1), (1990): 72-87. business owner. "how to use outside advisers to maximize corporate results." business owner 9(6), (1985): 13-14. castaldi, richard, and max s. wortman. "boards of directors in small corporations: an untapped resource." american journal of small business 9(2), (1984): 1-9. chrisman, james j. and john leslie. "strategic, administrative, and operating problems: the impact of outsiders on small firm performance." entrepreneyrship theory and practice 13(3), (1989): 37-5 l cragg, paul b. and malcolm king. "organizational characteristics and small firms' performance revisited." entrepreneyrship theory and practice 13 (winter, 1988): 49-64. dess, g. g. and richard b. robinson. "measuring organizational performance in the absence of objective measures: the case of the privately held firm and conglomerate business unit." strategic management journal 5 (1984): 265-273. dimma, william a. "the changing role of the board of directors." vital speeches of the day 62 (january 15, 1996): 217-220. dollinger, m. j. "environmental contacts and financial performance of the small firm." journal of small business management 23 (january, 1985): 24-30. fann, g. and l. r. smeltzer. "the use of information from and about competitors in small business management" entrepreneurship theory and practice 13 (summer, 1989): 35-46. ford, roger h. "outside directors and the privately-owned firm: are they necessary?" entrepreneurhip theory and practice 13(1), (1988): 49-57. fox, harold w. "quasi-boards: guidance without governance." american journal of small business 9(1), (1984): 12-18. franklin, stephen g. and jack s. goodwin. "problems of small business and sources of assistance: a survey." journal of small business mana~ement 2(2), (1986): 5-12. fraser, jill a. "boardroom benefits." inc 17 (august, 1995): 103-104. 182 journal of business strategies vol. 13, no.2 gales, l. and r. s. blackburn. "an analysis of the impact of supplier strategies and relationships on small retailer actions, perceptions, and performance." entrepreneurship theory and practice 15 (fall, 1990): 7-22. garsombke, diane j. and thomas w. garsombke. "robots, computers, and automation: implications for small manufacturers." journal of small business management 27(4), (1989): 34-44. gobeli, david h. and mary alice seville. "the small business-cpa interface." journal of small business management 27(4), (1989): 8-16. holmes, scott and des nicholls. "an analysis of the use of accounting information by australian small business." journal of small business management 26(2), (1988): 57-68. hornaday, r. w. and w. j. wheatley. "managerial characteristics and the financial performance of small business." journal of small business management (april, 1986): 1-7. ibrahim, a. b. and 1. r. goodwin. "perceived causes of success in small business." american journal of small business 11(2), (1986): 41-50. johnson, l. and l. kuehn. 'the small business owner/manager's search for external information." journal of small business management (july, 1987): 53-60. kesner, idalene f. "directors' characteristics and committee membership: an investigation of type, occupation, tenure, and gender." academy of management journal 31(1), (1989): 66-84. khan, m. r. and j. r. rocha. "recurring managerial problems in small business." american journal of small business 7(1), (1982): 50-58. lorsch, jay w. "empowering the board." harvard business review 73 (jan-feb, 1995): 107-110. mcmenamin, brigid. "non-executive stress: the quality of outside directors in company boardrooms." the economist 329 (november 6, 1993): 15-17. miskin, val and jerman rose. "new venture initiation: factors influencing success." journal of small business strategy 1 (october, 1990): 1-9. montagno, r. v., d. f. kurato, and j. h. scarcella. "perception of entrepreneurial success characteristics." american journal of small business 10(3), (1986): 25-32. nahavandi, afsaneh and susan chesteen. 'the impact of consulting on small business: a further examination." entrepreneurship theory and practice 13 (fall, 1988): 29-40. fall 1996 garsombke & garsombke: empirical investigation 183 nappi, a. r and jay vora. "small business eligibility: a definitional issue." journal of small business management (october, 1980): 23. nelson, george w. "factors of friendship: relevance of significant others to female business owners." entrepreneurship theory and practice 13(4), (1989): 7-18. park, jae c. "reengineering boards of directors." business horizons 38 (march-april, 1995): 63-74. provan, k. g. and skinner, s. j. "interorganizational dependence and control as predictors of opportunism in dealer-supplier relations." academy of management journal 32 (1989): 202-212. shapiro, eileen. "consultant trap." inc 17 (december, 1995): 31-32. smale, john g., alan patricof, denys henderson, bernard marcus, and david w. johnson. "redraw the line : between the board and the ceo." harvard business review 73 (march, 1995): 153-165. specht, p. h. "planning group characteristics as moderators of the relationship between perceived environmental characteristics and information sources used." american journal of small business 4 (1987): 21-34. vance, stanley c. corporate leadership: boards. directors. and strategy. new york: mcgraw-hill, inc., 1983. verespej, michael a. "what's next for directors?" industry week 243 (february 21, 1994): 11-13. watts, larry and j. g. ormsby. "the effect of operational and strategic planning on small firm performance." journal of small business strategy 1(2), (october, 1990): 27-35. weidenbaum, murray l. "the evolving corporate board." society 32 (march-april, 1995): 21-24. weiss, alan. "double your fees: 8 ways to grow a successful consulting business." home office computing 13 (september, 1995): 54-58. diane j. garsombke, (ph.d., university of tennessee), is associate professor of management and chairperson of the department of business administration, university of wisconsin superior. her research concentrates on strategic management of small businesses in america and asia. her publications include the international management review, journal of small business management, planning review and organizational dynamics. she has taught and consulted in russia, indonesia, malaysia, and belize. 184 journal of business strategies vol. 13, no.2 thomas w. garsombke is visiting professor of business administration at the university of minnesota crookston. his research has been published in the journal of small business management, business insights, issues in international business and the journal of marketing. he has taught in executive m.b.a. programs in hong kong, malaysia, and singapore. additionally. he has worked with guatemalan entrepreneurs and consulted under the asian development bank in indonesia. an empirical investigation of the utilization of external and internal board of directors and management advisory assistance on the performance of small business strategic management: is it an academic discipline? marcus z. cox university of north texas • denton, tx josh daspit university of north texas • denton, tx erin mclaughlin nova southeastern university • fort lauderdale-davie, florida raymond j. jones iii university of north texas • denton, tx abstract this paper seeks to address the question of whether strategic management is an academic discipline, as critics have argued it is not. we offer a synthesized definition of strategic management and assess whether strategic management is an academic discipline by utilizing the framework established by biglan (1973). this framework requires disciplines to have a unifying paradigm(s) as well as practical application of its theories. after analysis, we conclude that strategic management meets biglan’s (1973) requirements and should be considered an academic discipline. in closing, we consider the future direction of strategic management research and new research methods. introduction the field of strategic management is relatively young compared to other academic disciplines (e.g. economics, chemistry, law, etc.) and has been criticized by scholars who question its legitimacy and relevance. strategic management is criticized for failing to have a concise, formal definition, lacking its own unique theories, and being a sub-field of other disciplines (mockler, 1995; mcgrath, 2007; rumelt, schendel, & teece, 1991). additionally, the field is criticized for focusing too heavily on theory and lacking practical application for managers, for focusing too heavily on practical application and not on theory, and even for being built upon a loose set of ideas with no adequate structure (barney, 2002; mahoney & mcgahan, 2007; mcgrath, 2007). in all, some scholars do not consider strategic management to be a viable academic discipline. other scholars have a different perspective. additional assessments of strategic management indicate the existence of a demanding, complex, and refined discipline, continued growth, and a strong theoretical base with substantial empirical research (bettis, 1991; coyne & subramaniam, 1996; hoskisson, hitt, wan, & yiu, 26 journal of business strategies 1999). these contradictory statements cast an aura of uncertainty on the state of strategic management as an academic discipline. while the aforementioned criticisms may have some level of validity, claims alone do not disqualify strategic management as a discipline. the claims merely illustrate that the field may be moving in the wrong direction or that weaknesses exist that need to be addressed. our intention is not to negate each criticism of strategic management but instead to identify the current status of the field, utilize a framework to determine if it is a discipline, and highlight areas of concern related to its future direction. the question of whether strategic management is an academic discipline may at first seem as though its answer is an obvious, foregone conclusion; however it is important that we answer this question using the same scientific methods we would for any research topic. additionally, and perhaps more importantly, we should examine whether recent research in the field has taken strategic management too far away from its roots or if this diverse research stream simply represents the natural maturation of an academic field. furthermore, the advantages and implications of strategic management being classified as a discipline are also worthy of consideration. according to hambrick, if strategic management is not an academic discipline, “our purpose as a field, the study of the roles of and responsibilities of general managers, will cease to have a place on the academic landscape” (2004, p. 91). if strategic management is found to not be accurately classified as an academic discipline, then our theoretical and practical contributions to management as a whole may be considered inconsequential, thus encouraging strategic management scholars to focus their efforts toward another, more stable field (barney, 2002). at the heart of this question is the concept of legitimacy. according to institutional theory, organizations often develop symbolic systems, artifacts, and routines not for operational efficiencies, but instead for the sake of being considered legitimate (dimaggio & powell, 1983; scott, 2001). obtaining legitimacy is important for an academic discipline because it impacts promotion and tenure decisions, salaries, and other career opportunities. for these reasons it is important that scholars critically examine the current state of the field to determine whether we can, and should, consider strategic management a discipline. thus, we intend to assess the field, using procedures of scientific inquiry, to determine if strategic management should be considered an academic discipline. in addition, we address why it is important for strategic management to be classified as an academic discipline for both academicians and practitioners. while understanding volume 29, number 1 27 past developments in the field are important, it is perhaps as important to understand the future direction of our field. we conclude our analysis by addressing some of the emerging research streams in strategic management and new methods of analysis. practitioners and academicians alike should be concerned about the state of strategic management and understand the criticisms that have been leveled against it. strategic management defined before we address the central issue of whether strategic management is an academic discipline, we must first define strategic management. there is no consensus on a single, widely accepted definition of strategic management. the ongoing struggle with defining the field is evident in the literature as numerous definitions are used to describe strategic management. nag, hambrick, and chen (2007) suggest that strategic management is difficult to define because it is a relatively new field rooted in other disciplines (e.g. economics, marketing, sociology, finance, etc.). they conclude that, “it comes as little surprise, then, that the published, espoused definitions of strategic management vary. and we can anticipate that asking strategic management scholars to define the field might elicit an array of responses” (p. 935). wright, kroll, and parnell define strategic management as “the continuous process of determining the mission and goals of an organization within the context of its external environment and its internal strengths and weaknesses, formulating appropriate strategies, implementing those strategies, and exerting strategic control to ensure the organization’s strategies are successful in attaining its goals” (1996, p. 18). additionally, porter defines strategy as “the creation of a unique and valuable proposition, involving a different set of activities… [that differentiates the firm] from rivals” (1996, p. 67). he argues that if only one ideal position in an industry existed, then all firms would simply race to achieve the desired position. thus, the need for strategy would not exist because success would hinge on operational effectiveness. next we use these descriptions, and others presented in the literature, to synthesize a definition of strategic management. the major dimensions identified in the review include: analyzing internal and external environments, formulating strategies, developing a competitive advantage, and achieving organizational goals (bowman, singh, & thomas, 2002; bracker, 1980; jemison, 1981; porter, 1996; rumelt, et al., 1994; schendel & hofer, 1979; teece, 1990; wright, et al., 1996). in the context of this manuscript, strategic management is defined as the process by which managers of the firm analyze the internal and external environments for the 28 journal of business strategies purpose of formulating strategies and allocating resources to develop a competitive advantage in an industry that allows for the successful achievement of organizational goals. using the given definition of strategic management, we next assess whether strategic management is an academic discipline. assessment of strategic management a guiding framework is essential to assessing the status of an academic discipline. biglan (1973) performed an early comparison of academic disciplines, which has been used to assess the status of several fields. biglan (1973) postulates two primary dimensions to be used by scholars when assessing an academic discipline: the existence of a paradigm and the practical application of theory. a third dimension (related to life systems) is also proposed but is not relevant to assessments in the social sciences. the primary dimensions of biglan’s (1973) framework are in line with commonly found components in literature, which also reiterate the importance of paradigmatic developments and the practical application of knowledge in disciplines (bird, welsch, astrachan, & pistrui, 2002; whetten, 1989). the primary dimensions of biglan’s (1973) model have been used either directly or indirectly to examine and define various fields of study as academic disciplines including educational technology, computer sciences, event studies and event management, pharmacy education, and journalism (clark, 2006; czerniewicz, 2008; de burgh, 2003; getz, 2002; holmes & desselle, 2004). thus, we seek to extend the application of biglan’s (1973) framework and assess the current state of strategic management. to analyze the field, primary dimensions are defined and subsequently applied to the context of strategic management for further evaluation. paradigms paradigms are important for a scientific community given that the accumulation of knowledge can only occur when members of the community adhere to an existing paradigm. without agreement on a starting point, scientists would not be able to build on the work of others (pfeffer, 1993). according to kuhn (1996), a paradigm is a set of beliefs shared by a scientific community that regulates scientific research. a paradigm describes what is to be observed, what kinds of questions are to be asked, how those questions are to be structured, and how the results of the inquiry are to be interpreted (kuhn, 1996). according to eckberg and hills (1979), four conditions should exist to confirm the existence of paradigms: (1) paradigms should not be discipline wide, (2) paradigms will be found within sub-disciplines volume 29, number 1 29 that have considerable amounts of research, (3) paradigms must have a cohesive community of researchers that have unified bodies of belief, and (4) paradigms must be used to both generate and solve problems, thus developing a visible research tradition. paradigms in strategic management according to peng, sun, pinkham, and chen (2009), two main paradigms exist in strategic management: the industry-based view, which came out of industrial organizational economics, and the resource-based view of the firm. industrial organizational (i/o) theory focuses on industry structure as a key element for competition, and the notion of competitive strategy established consensus among scholars of both economics and business. scholars of i/o theory agree that industry structure is the key determinant of profitability (harrigan, 1980; oster, 1982; porter, 1981). the resource-based view of the firm is a theory of competitive advantage based not on industry structure but on unique resources of individual firms. these firm-specific resources are capable of generating rents given the existence of unique conditions (i.e., resources are valuable, rare, inimitable, and non-substitutable) that allow the firm to achieve long-term, super-normal profits (barney, 1991; eisenhardt & martin, 2000; rumelt, 1984). it is important to note that kuhn believed paradigms cannot exist at a disciplinary level but rather only at the sub-disciplinary level. for example, there is no one paradigm of physics, but there are paradigms for different areas, such as the study of heat or mechanics. as for strategic management, paradigms exist in subfields such as the resource-based view and the i/o view, yet there is no one paradigm of strategic management as a whole (martins, 1972). additionally, paradigms are “unified bodies of belief shared by a cohesive community” (eckberg & hills, 1979, p. 932). the existence of a paradigm assumes a community of integrated practitioners share a uniform set of beliefs such that a consensus develops around the questions asked, the methods used, interpretation of the data, and so forth (eckberg & hills, 1979). given the acceptance of the industrybased and resource-based perspectives in strategic management, we recognize that both perspectives are supported by cohesive communities of scholars. in all, it is evident that the identified primary paradigms are not discipline wide and are found in sub-disciplines supported by a considerable amount of research. the industry and resource-based perspectives are also supported by communities of scholars who utilize the paradigms to guide problem generation and 30 journal of business strategies problem solving. given the conditions specified, strategic management meets the criteria established for the existence of paradigms. the next criterion for assessing a discipline concerns the practical application of its theories. practical application according to the biglan (1973) framework, the second dimension for evaluation of an academic discipline is the extent to which practical application exists within the field. practical application is concerned with the implementation of theory to practice and is found in numerous fields. for example, in biology and energyrelated studies, new methods of producing hydrogen for use in hydrogen-based fuel cells is theorized, but the theory has not yet successfully transitioned to practice (levin, pitt, & love, 2004). similar developments hold true in the social sciences as researchers seek to implement theory to practice. we seek to examine whether the practical application of theory exists in strategic management. practical application in strategic management strategic management is considered by many to be an “applied, professional field, whose purpose is not merely to describe organizational phenomena but to predict and change them” (gopinath & hoffman, 1995, p. 576). evidence for the claim that strategic management has practical application comes from jarzabkowski & giulietti (2007) whose research supports the argument that strategic management is an applied science and strategic management tools are used in business. additionally, benbasat and zmud (2003) present a series of benchmarks for assessing the extent to which practical application exists in an academic discipline: (1) the institutionalization of the discipline as an integral part of today’s organizational and economic contexts, (2) the acknowledgement of the importance of the field by academic accreditation bodies, (3) the presence of the academic departments and degree programs at most public and private universities, and (4) a professional society able to demonstrate influence in the organizational field. strategic management is institutionalized as a vital part of today’s business and economic contexts. porter’s seminal work, competitive strategy (1980), contributed to the foundation for the growth of the strategic management field and has served as one of the most influential contributions (barney, 2002). porter’s generic strategies “remain the most commonly supported and identified in key strategic management textbooks and in the literature” (allen, helms, takeda, & white, 2007, p. 73). strategic management has influenced diverse fields such as global public volume 29, number 1 31 health, the hospitality sector, and human resource management to name a few (crook et al., 2006; foster-pedley & lerer, 1999; reichel, 1983). the aacsb (association to advance collegiate schools of business) recognizes strategic management as viable field of study, as reflected by the number of mba programs in strategic management which are recognized by the accrediting body. additionally, there are numerous post-graduate programs in strategic management offered worldwide by private and public universities. today, the presence of strategic management-oriented courses is commonplace in business programs at various levels. moreover, the field of strategic management contains numerous professional associations. one such professional organization is the strategic management society (sms), which consists of over 2,600 academic and business practitioners from more than sixty countries. the professional society focuses on the advancement of strategic management through the development and dissemination of knowledge pertaining to the discipline. sms publishes three journals including the strategic management journal, strategic entrepreneurship journal, and the global strategy journal. the strategic management journal is regularly ranked as one of the top 20 business journals by bloomberg businessweek and the financial times. businessweek also called strategic management journal “one of the key indicators of business school brainpower” (hitt, boyd & li, 2004, p. 2). more than 50 percent of sms members are from outside north america, which depicts the growth and popularity of the field globally. another important publication is the journal of business strategies that was first published in 1984 and has consistently aimed to publish quality articles that appeal to practitioners and academicians alike (mehta & bumpass, 2008). the journal of business strategies was ranked by researchers in the top quartile (position 12) of 50 academic journals devoted to general management or strategy (yuyuenyongwatana & carraher, 2008). an additional example of the increasing growth trend in strategic management can be seen in the membership of the academy of management where there are approximately 17,800 members in business policy and strategy division with 25 percent of those members residing outside of the united states. of the twentyfour professional divisions and interest groups within the academy of management, the business policy and strategy division is the second largest and growing at approximately 5 percent annually. the strong presence of professional organizations and successful journals indicates that strategic management is successfully working to apply theory to practice. 32 journal of business strategies some researchers claim that academicians have fallen short of applying theory to practice (baldridge, floyd, & markoczy, 2004; duncan, 1974; gopinath & hoffman, 1995; hambrick, 2007). the major criticisms being that the academic community and its theories do not keep pace with practice, the theories are not able to shape practice, and academicians are overly concerned with developing theory while losing sight of practical relevance (jarzabkowski & whittington, 2008). baldridge et al. (2004) went so far as to question whether it is possible that “academic quality and practical relevance are mutually exclusive” (2004, p. 1063). despite these shortcomings, researchers and practitioners have a symbiotic relationship in that one group provides for the growth and development of the other. researchers study business practices to formulate new theory development. once theory is abstracted from research, it is disseminated through journal articles, textbooks, mba courses, and consultants (jarzabkowski & whittington, 2008). the disseminated theory then impacts business managers who implement practices and, thus, the cycle continues. furthermore, strategic management faculty have trained a large number of degree-seeking students and working professionals, thus having a central and substantial influence on strategic thinking and the practice of management (mahoney & mcgahan, 2007). overall, strategic management has practical application in the field based on the assessment of the criteria presented by biglan’s (1973) framework for classification of an academic discipline. although there are criticisms about academia’s “theory fetish”, the theories of strategic management shape business practices in a wide range of organizational areas (hambrick, 2007). therefore, it is determined that the field of strategic management successfully engages in practical application of theory. assessment of strategic management as a discipline results we set forth to assess the current state of strategic management as an academic discipline. an assessment of the state of strategic management was performed through an analysis of the known paradigms and the level to which strategic management knowledge is practically applied. the existence of two overarching paradigms in the field provide strong support that strategic management is guided by a commonly accepted and shared network of beliefs that regulate scientific inquiry as defined by kuhn (1996). furthermore, additional sub-paradigms not only exist in the field but contribute to the richness of knowledge and inquiry. an evaluation of the practical application of strategic management knowledge was also conducted. strategic management consists of professional organizavolume 29, number 1 33 tions aimed at promoting the advancement of strategy-related literature. moreover, jarzabkowski and giulietti (2007) find that the academic-practitioner gap is narrowed by the education of practitioners exposed to the tools of strategic management through training. additionally, with the presence of strategic management degree programs and the recognition of the field by accrediting institutions, it is determined that strategic management engages in practical application. based on the assessment of the paradigms and practical application, it is concluded that the field of strategic management is classified as an academic discipline when evaluated using the dimensions of paradigms and practical application from biglan’s (1973) framework. the assessment of strategic management as an academic discipline is in no way intended to signal to researchers that investigations of strategic management are complete. thus, in the next section the implications of these findings are discussed. future implications as strategic management matures as a field of academic study, it is important to address concerns about the future development of the discipline and how these concerns affect academicians and practitioners. research indicates that the concerns regarding future developments fall into three broad categories: diversity of the research streams, adequacy of the research methods, and the extent of practical application. we review these three areas and suggest their implications for the future development of the discipline. diversity of research streams hambrick asserts that, “our field is rapidly being pulled apart by centrifugal forces” (2004, p. 91), and with our disparate research agendas, we run the risk of being absorbed by adjacent disciplines such as microeconomics, marketing, sociology, and psychology. hambrick (2004) further claims that numerous strategic management scholars are in search of the next big theory, yet what is most needed is the further refinement and enhancement of existing theories. according to kuhn (1996), after the period in revolutionary science when new paradigms are created, we enter a period of normal science where “mopping-up” activities occur (i.e., the paradigm is further clarified under more stringent conditions). thus, hambrick (2004) calls for members of the scientific community to “mop-up” the existing theories of strategic management instead of pursuing an endless stream of new theories. 34 journal of business strategies research methods development in light of hambrick’s (2004) recommendation, the testing of existing strategic management theory is crucial. this includes a need for more empirical articles in which predictions are grounded using existing models, diagrams, and figures to explicitly delineate the causal connections among sets of variables and indicate the critical influences that govern relationships and/or processes previously proposed by existing theory (colquuitt & zapata-phelan, 2007). the more we, as strategic management researchers, are able to underpin theories with empirical observations, the better our ability for disconfirmation (which is a primary criterion for judging theory), thus strengthening our existing theories (van maanen, sorenson, & mitchell, 2007). this is not to say that extension of existing theories and development of new theoretical perspectives is not important for the field. as hoskisson, et al. (1999) noted, strategic management researchers and practitioners are constantly challenged to new, frequent, and discontinuous changes. when examining a more dynamic view of the world, whether from rapid technological changes, volatile economic conditions, or other reasons entirely, strategic problems continues to require varied theoretical perspectives and innovative empirical methodology that shape the trajectory of the field (d’aveni, dagnino, & smith, 2010). nonetheless, hafsi and thomas (2005) caution that unless strategic management develops conceptual frameworks to bring research and practice together, the discipline runs the risk of being broken apart and absorbed by neighboring disciplines. additionally, concern about the future direction and development of the strategic management discipline is not limited to new theory development. ketchen, boyd, and bergh (2008) argue that the theoretical developments in any field are only as good as the research methods used to produce them. as a field matures and advances, the research tools should also advance. in their study of strategic management journals over three time periods (1980-1982; 1990-1992; 2000-2002), ketchen et al. (2008) discovered a dramatic increase in the volume of articles related to strategic management and the research methods employed to study the discipline. venkatraman (2008) adds that researchers must continue to develop new methodologies while enhancing the precision of how constructs are conceptualized and relationships among them are assessed. strategic management theory and conceptualizations also continue to grow and spread to other respected fields and disciplines. new strategic management publications have emerged in fields such as entrepreneurship and marketing. strategic volume 29, number 1 35 management society (sms) began publishing the strategic entrepreneurship journal quarterly in 2007. the emphasis of the journal is to recognize the strategic nature of entrepreneurship when it adds value to society in significant, sustainable, and durable ways. journal of strategic marketing has also emerged, with seven issues a year, as an outlet for publishing articles related to marketing activities that achieve organizational objectives and strategies. ketchen et al. (2008) also note two major weaknesses exist in strategic management’s current research methods that do not properly analyze some of the key issues. first, we are limited by our use of survey instruments to “tap into executives’ motives, preferences, and decisions… [and that these surveys] are quite limited in their ability to capture these nuanced phenomena” (ketchen et al., 2008, p. 652). next, the authors note that the issues in strategic management span multiple levels of analysis (e.g., industry, strategic group, firm, managers, etc.), and current research tools are not capable of measuring and evaluating these complex relationships. recent literature calls for greater use of research tools such as qualitative comparative analysis in strategic management and the application of new technologies or the use of existing methods in new ways (greckhamer, misangyi, elms, & lacey, 2008; venkatraman, 2008). one possible tool is diction, a content analysis program that may aid strategic management research by examining the impact that management narratives have on the financial and organizational performance of the firm (short & palmer, 2008). another potential resource is the greater application of critical discourse analysis in strategic management (phillips, sewell & jaynes, 2008). this methodology is useful for examining how organizations are created and maintained via discourse. possible future areas of research using this methodology would include strategy formulation and execution of strategy. strategic management research would benefit from investigations using multiple levels of analysis (hitt, beamish, jackson, & mathieu, 2007), where there is consistency between the level of theory, level of measurement (level of the entities from which data are derived), and the level of analysis (unit to which the data are assigned for hypothesis testing and statistical analysis) (rousseau, 1985). additional focus on causation and what it means for strategic management research is also necessary (durand & vaara, 2009). causation can be more readily addressed in strategic management through methods such as counterfactuals, which probe the direction and stability of a relationship between an event and its consequence or through the combination of laboratory and field research (durand & vaara, 2009; schwenk, 1982). in short, the lack of sufficient research tools indicates that important questions remain to be unanswered. 36 journal of business strategies practical application development much has been written about the topic of whether strategic management literature is practical to business managers and whether research keeps pace with today’s dynamic marketplace (baldridge et al., 2004; duncan, 1974; gopinath & hoffman, 1995; grundy, 2004; hambrick, 2007; jarzabkowski & wilson, 2006). according to our assessment, strategic management engages in practical application; yet, there are hurdles to achieving successful communication between academics and practitioners. despite these differences, researchers and practitioners have a mutually beneficial relationship where each party assists the other in developing new theories, training management, and implementing new practices. the existence of bi-directional communication between researchers and practitioners is mutually beneficial and leads to new theory development. to further strengthen the relationship between researchers and practitioners, we recommend that researchers first engage the business community to better understand their needs while working to develop mutually beneficial research streams. the theories that we as strategic management researchers are building and advancing should be “problem-driven” to address problems and explain phenomena relevant to practice. second, researchers are encouraged to engage in prescient scholarship to focus on future problem domains. by anticipating coming conceptual and practically relevant domains in strategic management, researchers will become less reactive. additionally, researchers must be cognizant of communicating research-oriented lexicon in a manner appropriate for practitioners (baldridge et al., 2004). following this proactive approach will allow academics to communicate work that is pragmatically useful for practitioners (corely & gioia, 2011). the benefits of bridging this academic-practitioner divide are seen in what van de ven and johnson (2006) label “enacted scholarship,” which is a collaborative form of inquiry and bi-directional communication where academics and practitioners are able to find common ground in the questions being asked and where the design, conducting, and implementation of the research is performed in realworld settings. leveraging perspectives and competencies from both practitioners and academics allows for a “coproduction” of knowledge about relevant problems and phenomenon. this knowledge not only becomes relevant for practitioners but academics as well. these recommendations follow schendel, ansoff, and channon’s recommendation — which appears in the first issue of strategic management journal — that as the strategic management discipline matures, we must never lose sight of pursuing research that “both academics and practitioners would find… of interest” (1980, p. 4). volume 29, number 1 37 conclusion overall, this analysis intends to provide a report on the status of the field of strategic management. specifically, the field’s status as an academic discipline is determined given conflicting criticism from scholars. to evaluate the development of the field, we utilized a framework proposed by biglan (1973) to identify two dimensions used to classify a field of study as an academic discipline. the dimensions include: having identifiable paradigms that regulate the research and having practical application to its proposed end-users. based on our analysis of the field, we conclude that strategic management meets the criteria identified by biglan (1973) and is an academic discipline. the classification of strategic management as an academic discipline does not imply that the duty of strategic management scholars is any less. moreover, it is an encouraging finding that should motivate researchers to continue refining paradigms and developing practical application to assure further enrichment. the discipline is poised to continue producing theoretical and practical advancements that will further the development of strategic management and have far-reaching implications for complementary disciplines. references allen, r. s., helms, m. m., takeda, m. b. & white, c. s. (2007). porter’s generic strategies: an exploratory study of their use in japan. journal of business strategies, 24(1), 69-90. ansoff, h. i. (1965). corporate strategy. new york: mcgraw-hill. baldridge, d., floyd, steven w., & markoczy, l. (2004). are managers from mars and academicians from venus: toward an understanding of the relationship between academic quality and practical relevance. strategic management journal, 25, 1063-1074. barney, j. b. (1991). firm resources and sustained competitive advantage. journal of management, 17(1), 99-120. barney, j. b. (2002). strategic management: from informed conversation to academic discipline. academy of management executive, 16(2), 53-57. benbasat, i., & zmut, r. w. (2003). the identity crisis within the is discipline: defining and communicating the discipline’s core properties. mis quarterly, 27(2), 183-194. bettis, r. (1991). strategic management and the straightjacket: an editorial essay. organization science, 2(3), 315-319. 38 journal of business strategies biglan, a. (1973). the characteristics of subject matter in different academic areas. journal of applied psychology, 57(3), 195-203. bird, b., welsch, h., astrachan, j. h., & pistrui, d. (2002). family business research: the evolution of an academic field. family business review, 15(4), 337-350. bowman, e. h., sing, h., & thomas, h. (2002). the domain of strategic management: distory and evolution. in a. pettigrew, h. thomas, & r. whittington (eds.), handbook of strategy and management. london: sage. bracker, j. (1980). the historical development of the strategic management concept. academy of management review, 5(2), 219-224. clark, m. (2006). a case study in the acceptance of a new discipline. studies in higher education, 31(2), 133-148. colquitt, j. a. & zapata-phelan, c. p. (2007). trends in theory building and theory testing: a five-decade study of the academy of management journal. academy of management journal, 50, 1281-1303. corely, k. g., & gioia, d. a. (2011). building theory about theory building: what constitutes a theoretical contribution? academy of management review, 36(1), 12-32. coyne, k. p., & subramaniam, s. (1996). bringing discipline to strategy. mckinsey quarterly, 4, 14-25. crook, t. r., bratton, v. k., street, v. l., & ketchen, d. (2006). has strategic management shed the normal science straightjacket?: revisiting bettis’ (1991) critiques. journal of managerial issues, 18(3), 409-423. czerniewicz, l. (2008). distinguishing the field of educational technology. the electronic journal of e-learning, 6(3), 171-178. d’aveni, r. a., dagnino, g., smith, k. (2010). the age of temporary advantage. strategic management journal, 31, 1371-1385. de burgh, h. (2003). skills are not enough: the case for journalism as an academic discipline. journalism, 4(1), 95-112. dimaggio, p. j. & powell, w. w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational field. american sociological review, 48, 147-160. duncan, w. j. (1974). transferring management theory to practice. the academy of management journal, 17(4), 724-738. durand, r. & vaara, e. (2009). causation, counterfactuals, and competitive advantage. strategic management journal, 30, 1245-1264. eckberg, d. l. & hill, l. (1979). the paradigm concept and sociology: a critical review. american sociological review, 44(6), 925-937. volume 29, number 1 39 eisenhardt, k. m., & martin, j. a. (2000). dynamic capabilities: what are they? strategic management journal, 21(10/11, special issue: the evolution of firm capabilities, 1105-1121. foster-pedley, j., & lerer, l. (1999). the application of strategic management theory in global public health: towards a model of health determinants, health status and interventions. international journal of healthcare technology and management, 1(1), 148-167. getz, d. (2002). event studies and event management: on becoming an academic discipline. journal of hospitability and tourism management, 9(1), 12-23. gopinath, c., & hoffman, r. c. (1995). the relevance of strategy research: practitioner and academic viewpoints. journal of management studies, 32(5), 575594. greckhamer, t., misangyi, v. f., elms, h., & lacey, r. (2008). using qualitative comparative analysis in strategic management research: an examination of combinations of industry, corporate and business-unit effects. organizational research methods, 11(4), 695-726. grundy, t., (2004). rejuvenating strategic management: the strategic option grid. strategic change, 13, 111-123. hafsi, t. & thomas, h. (2005). the field of strategy: in search of a walking stick. european management journal, 23(5), 507-519. hambrick, d. c. (2004). the disintegration of strategic management: it’s time to consolidate our gains. strategic organization, 2(1), 91-98. hambrick, d. c. (2007). the field of management’s devotion to theory: too much of a good thing? academy of management journal, 50(6), 1346-1352. harrigan, k. r. (1980). clustering competitors by strategic groups. proceedings of the southwest academy of management conference, san antonio. hitt, m. a, beamish, p. w., jackson, s. e., & mathieu, j. e. (2007). building theoretical and empirical bridges across levels: multilevel research in management. academy of management journal, 50, 1285-1399. hitt, m. a., boyd, b. k., & li, d. (2004). the state of strategic management research and a vision of the future. research methodology in strategy and management, 1, 1-31. holmes, e., desselle, s. (2004). is scientific paradigm important for pharmacy education? american journal of pharmaceutical education, 68(5), 1-10. hoskisson, r. e., hitt, m. a., wan, w. p., & yiu, d. (1999). theory and research in strategic management: swings of a pendulum. journal of management, 25(3), 417-456. 40 journal of business strategies jarzabkowski, p., & giulietti, m. (2007). strategic management as an applied science, but not as we (academics) know it. the third organization studies summer workshop, crete, greece. jarzabkowski, p., & whittington, r. (2008). directions for a troubled discipline. journal of management inquiry, 17(4), 266-268. jarzabkowski, p., & wilson, d. c. (2006). actionable strategy knowledge: a practice perspective. european management journal, 24(5), 346-367. jemison, d. b. (1981). the contributions of administrative behavior to strategic management. academy of management review, 6(4), 633-642. ketchen, d., boyd, b., & bergh, d., (2008). research methodology in strategic management: past accomplishments and future challenges. organizational research methods, 11(4), 643-658. kuhn, t. (1996). the structure of scientific revolutions (3rd ed.). chicago: university of chicago press. levin, d., pitt, l., & love, m. (2004). biohydrogen production: prospects and limitations to practical application. international journal of hydrogen energy, 29, 173-185. mahoney, j. t, & mcgahan, a. m. (2007). the field of strategic management within the evolving science of strategic organization. strategic organization, 5(1), 7999. martins, h. (1972). the kuhnian “revolution” and its implications for sociology. in t. j. nossiter, a. n. hanson, & s. rokkan (eds.), imagination and precision in the social sciences. london: faber and faber. mcgrath, r. g. (2007). no longer a stepchild: how the management field can come into its own. academy of management journal, 50(6), 1365-1378. mehta, s. s. & bumpass, d. (2008). the journal of business strategies: the first twenty-five years. journal of business strategies, 25(2), 9-26. mockler, r. j. (1995). strategic management: the beginning of a new era. international review of strategic management, 6, 1-42. nag, r., hambrick, d., & chen, m. (2007). what is strategic management, really? inductive derivation of a consensus definition of the field, strategic management journal, 28, 935-955. oster, s. (1982). intra-industry structure and the ease of strategic change. review of economics and statistics, 64, 376-383. peng, m. w., sun, s. l., pinkham, b., & chen, h. (2009). the institution-based view as a third leg for a strategy tripod. academy of management perspectives, 23(3), 63-81. volume 29, number 1 41 pfeffer, j. (1993). barriers to the advance of organizational science: paradigm development as a dependent variable. academy of management review, 18(4), 599-620. phillips, n., sewell, g., & jaynes, s. (2008). applying critical discourse analysis in strategic management research. organizational research methods, 11(4), 770789. porter, m. e. (1980). competitive strategy. new york: free press. porter, m. e. (1981) the contributions of industrial organization to strategic management. academy of management review, 6, 609-620. porter, m. e., (1996). what is strategy?, harvard business review, 61-78. reichel, a. (1983). strategic management: how to apply it to firms in the hospitality industry. service industries journal, 3(1), 329-343. rousseau, d. m. (1985). issues of level in organizational research: multi-level and cross-level perspectives. in l. l. cummings & b. m. staw (eds.), research in organizational behavior, vol. 7, 1-37. rumelt, r. p. (1984). towards a strategic theory of the firm. in r. lamb (ed.), competitive strategic management, 556-570. englewood cliffs, nj: prentice-hall. rumelt, r. p., schendel, d. e., & teece, d. j. (1991). strategic management and economics. strategic management journal, 12, 5-29. rumelt, r. p., schendel, d. e., & teece, d. j. (1994). fundamental issues in strategy: a research agenda. boston: harvard business school press. schendel, d. e., & hofer, c. w. (1979). strategic management: a new view of business policy and planning. boston: little, brown. schwenk, c. r. (1982). why sacrifice rigour for relevance? a proposal for combining laboratory and field research in strategic management. strategic management journal, 3, 213-225. short, j. c., & palmer, t. b. (2008). the application of diction to content analysis research in strategic management. organizational research methods, 11(4), 727-752. scott, w. r. (2001) institutions and organizations. thousand oaks, ca: sage. teece, d. j. (1990). contributions and impediments of economic analysis to the study of strategic management. in j. w. fredrickson (ed.), perspectives on strategic management, 39-80. new york: harper business. van de ven, a., & johnson, p. (2006). knowledge for theory and practice. academy of management review, 31(4), 802-821. van maane, j., sorenson, j. b., & mitchell, t. r. (2007). the interplay between theory and method. academy of management review, 32, 1145-1154. 42 journal of business strategies venkatraman, n. v. (2008). advancing strategic management insight: why attention to methods and measurement matters. organizational research methods, 11(4), 790-794. whetten, d. a. (1989). what constitutes a theoretical contribution? academy of management review, 14(4), 490-495. wright, p., kroll, m., & parnell, j. (1996). strategic management: concepts and cases. englewood cliffs, nj: prentice hall. yuyuenyongwatana, r. p., & carraher, s. m. (2008). academic journal ranking: important to strategic management and general management researchers? journal of business strategies, 25(2), 1-8. biographical sketch of authors marcus z. cox is a doctoral candidate in strategic management at the university of north texas. he received his m.b.a. from stephen f. austin state university and a c.a.m. from babson college. his current research interests are strategy, environmental sustainability, strategic innovation, and ethics. josh daspit is a doctoral candidate in strategic management at the university of north texas. he received his m.b.a. from the university of st. thomas and his bs from lamar university. his research interests include absorptive capacity, firm capabilities, and strategic human resource management. erin b. mclaughlin is an assistant professor in the h. wayne huizenga school of business and entrepreneurship at nova southeastern university. her research interests are in the areas of strategy, small business management, entrepreneurial cognition and emotional intelligence. raymond jones is currently a ph.d. candidate in the department of management at the university of north texas. he received his m.b.a. from the st. bonaventure university and b.a. from mercyhurst college. his current research interests focus on macro-level entrepreneurial action in the form of innovation and collaborative strategies. acknowledgement the authors wish to thank derrick d’souza for his guidance and support and brooklyn cole, victor mckee, and ashwini joshua for their contributions to an earlier draft. strategic management: is it an academic discipline? small retailer employment of older workers: an assessment robin t. peterson new mexico state university las cruces, new mexico abstract this paperfocuses on a study which examined the employment ofolder workers by small retailers in the united states. it considers the literature on the future role ofsenior employees in the economy, the merits ofhiring these individuals, their needs, and steps which can be undertaken to improve their motivation and make them more productive. further, it sets forth the results ofan empirical investigation into the senior citizen employment practices of small retailers, advantages and disadvantages ofemploying seniors, and expectedfuture employment trends. the manuscript concludes with a discussion ofthe implications ofthese patterns for small retailers. introduction the past several decades have witnessed an aging of the united states population, as those in the baby boom generation and their progeny move on into maturity. this trend continues, as the median age of the country advances rapidly and steadily with the passage of time (moyers & dale, 2004). improvements in nutritional practices, exercise patterns, and medical care have resulted in larger numbers of individuals who reach age 65 and beyond. in tum, many of these experience mental and physical health status that is superior to that of previous generations. further, large numbers of seniors evidence a preference for expanding their working years beyond age sixty-five, either on a full-time or a part-time basis (dychtwald, erickson, & morison, 2004). some small retailers are confronted with difficulty in recruiting, hiring and retaining capable employees and have vacant positions in both the skilled and unskilled ranks (kraut, 2005). this pattern is perhaps most evident in regions of the country experiencing substantial economic growth, such as portions of the southwest and southeast. various means of acquiring additional sought employees are available, but one that appears to possess considerable potential is to hire and retain older workers. for some small retailers, this may be the superior alternative (peterson & spiker, 2005). 124 journal ofbusiness strategies objectives of the study vol. 24, no.2 the study which this manuscript addresses focused on several objectives: 1. to provide insights on the degree to which small retailers in the united states employ older workers. 2. to uncover advantages of employing older workers, in the opinion of small retailers. 3. to uncover problems associated with employing older workers, in the opinion of small retailers. 4. to assess expected future hiring and retention intentions for older workers among small retailers. review of the literature the literature contains various articles which consider recruiting, hiring, and retaining seniors for positions in business and not-for profit organizations (sullivan & duplaga, 1997). however, a substantial proportion of the studies cited in the articles have been generic and have not focused on small business in general or small retailing in particular (greller & stroh, 2004). further, some of the literature contains narratives reflecting the authors' opinions and case studies of individual firms, rather than statistical analysis which considers multiple companies (bell, 2001). while valuable, these inquiries do not provide comprehensive coverage of the status of small retail business employment patterns. studies indicate that the workforce in the united states is aging rapidly and will continue to do so well into the twenty-first century ( purcell, 2005; fusaro, 2001). current labor shortages were caused by unusually low birth rates among baby boomers and recent (sometimes early) retirements by these individuals. in tum, the shortages are particularly acute in various skill-demanding occupations, and in some parts of the country. given the relatively small magnitude of new entrants into the labor force and the potentially large number of boomer retirements on the horizon, labor shortages are likely to become significant during upcoming decades. (mcevoy & blahna, 200 i). the baby boomers are aging, and this is important since 55 and older individuals make up the fastest-growing segment of the workplace (albright & cluff, 2005; barrier, 2002). and some take early retirement. this creates potential job opportunities for those age 65 and older. yet many small retailers are not actively seeking older workers, promoting them, or taking other steps to retain those already employed (adams, 2002). in a positive vein, however, some seniors, made up of early retirees from large businesses, have formed a large number of small retail businesses and are actively involved in engaging older workers (minerd, 1999). the impact of baby boomer retirements on the economy and on specific occupations and industries, including small retailing, could be substantial-a work force short on workers and long on retirees. according to one consultant the aging workforce promises to restructure the economy, reshape the family, redefine fall 2007 peterson: employment of older workers 125 politics and even rearrange the geopolitical order of the next century. unlike many predictions, global aging is no mere hypothesis: its approximate timing and magnitude are already locked in. (van yoder, 2002). research suggests that many workers who are age sixty-five and older are very productive and motivated members of the work force (anonymous, 2003; swanson, kopecky, & tucker, 1997; bell, 2001; welboume & cyr, 1999; kraut, 2005). various employers have come to prefer seniors because oftheir experience, possession ofthe work ethic, and lack ofneed for extensive training (mcshulskis, 1997). research by the independent institute for employment studies suggests that older workers are more committed and reliable, have better customerfacing skills, understand business better, and take less time in short term sickness absence (anonymous, 1999). further, these individuals are willing to work at a variety of schedules and can serve as mentors (challenger, 2004; anonymous, 2003) other research indicates that many seniors have a strong service orientation, a positive attitude toward work, and experience less turnover than do their younger counterparts (tshirhart, 1998; finegold, mohrman, & spreitzer, 2002). still other studies indicate that seniors often work well with others and have well-developed interpersonal skills (anonymous, 2001 ;halachmi, 1998). in a review by crampton, hodge, & mistra (1996), older workers are reported as enjoying themselves more on the job and less concerned with advancement, more loyal to the company than other employees, and possessing high morale. tschirhart (1998) indicates that over 60 workers are receptive to feedback and perceived their work to be more meaningful than do younger employees. studies in psychology have discovered that men and women in the age group 55 to 72 scored as well or better than those in younger groupings in ability to handle complex tasks, capacity for multitasking, and productivity (bushko & raynor, 1999). in sum, the literature contains multiple citations to the effect that older workers possess capabilities which can enable them to be very productive employees of small retail firms. for many companies, their competitive advantage hinges on their ability to recruit and retain experienced older workers with critical skills (albright & cluff, 2005). however, there is evidence that the strengths possessed by senior employees are very appropriate for certain types of work, but perhaps not for other types. there are positions which are often better served by their younger counterparts. over a time period spanning many decades, researchers have well-documented a differentiation between two broad types of intellectual abilities across the adult life span. these are (1 )fluid intellectual abilities termed "gr' and (2) crystallized intellectual abilities termed "gc" (cattell, 1987). the research indicates a gradual decline in fluid intelligence as one ages. in tum, this type of intelligence is associated with working memory, abstract reasoning, attention, and processing of novel information. most research shows that maximum levels of gf are normally reached in the early twenties and steadily declines thereafter (schaie, 1996). high gf is associated with extroversion and openness to new experiences and technology. some positions which especially require this orientation include computer scientists, mathematicians, and scientists. 126 journal ofbusiness strategies vol. 24, no.2 on the other hand, crystallized intellectual abilities (gc) tend to increase with age. these represent broad aspects of educational or experiential knowledge and are associated with general knowledge, extent of vocabulary and verbal comprehension (cattell, 1987). high gc is associated with more conscientiousness, emotional control, higher level goals, and desires to promote the interests of others. some of the positions which require high gc are salespersons, managers, supervisors, human relations specialists, and trainers. most small retailers probably require some combination of gc and gf skills, given the wide range of responsibilities and duties which are assigned to individual employees. in turn, older individuals can compensate for declines in gf by selecting jobs and goals and by using strategies that optimize existing gc knowledge and skills (baltes & baltes, 1990). in general, older workers excel in jobs and companies where high gc is required. however, they may be able to function well in environments associated with high gf if they are willing to exert the effort needed to master the skills which are required. still, employers should face the reality that seniors may perform well in some kinds of jobs but not in others. there are indications to the effect that numerous managers are not heavily motivated nor successful in recruiting and retaining senior employees. one informed source speculates that, " ... in the united states, a better job of managing industrial scrap is done than that of managing careers of older workers at least companies recognize the values to be derived from industrial scrap and there is not a similar acknowledgment of the value gained from the appropriate use and development of the older work force" (greller & stroh, 2004). an inquiry cited in the human resources department management report has indicated that more than half of the organizations surveyed did not target older workers in their recruiting efforts and those that did relied most on employee referrals and networking (anonymous, 2003). another source states that a study has revealed that two-thirds of u.s. employers do not actively recruit older workers, more than half do not actively attempt to retain key ones, and 80% do not offer any special provisions (such as flexible work arrangements) (dyctwald, erickson, & morison, 2004). further, many senior employees tend to receive lower rates of pay than their junior counterparts (gangl, 2005). one study revealed that fewer than ten percent of the organizations surveyed provided training and retaining for older employees, organizations were less likely to be adjusting training methods to accommodate the needs of older employees, and there was little attempt to provide age awareness training to managers of older employees (armstrongstassen & templer, 2005). one source reports that older workers face bias and stereotyping, that most victims of discrimination are not made whole, and that society's lack of concern for this type of discrimination may prove to be more costly in the future as employers pay more to obtain older workers to fill projected workforce gaps (grossman, 2005). the term "ageism" appears repeatedly in the literature, and refers to prejudice and discrimination directed toward older persons (rupp, vodanovich, & crede, 2005). it is sometimes referred to as the third great ism of our society fall 2007 peterson: employment ofolder workers 127 (following racism and sexism). palmore (1999) has explained that ageism involves both prejudice and discrimination, both stereotypes and attitudes, and therefore both cognitive and affective processes. research has indicated that ageism is even more prevalent in today's society than sexism and racism, although it is typically much more difficult to detect (levy & banaji, 2002). a meta-analytic investigation on ageism has discovered that older individuals are generally perceived less favorably than those who are younger (kite & stockdale, 2004). it appears that there is considerable research and opinion on the advantages and disadvantages of utilizing seniors in the work force, for the economy at large, in various sectors, and in individual companies. however, there is no existing literature on the situation that exists for the small retailer grouping. the present study was directed to uncovering insights on this application. the research theory a study was undertaken to provide insights into the extent to which small retailers hire seniors, the advantages which these employers associate with these workers, problems associated with these employees, and anticipated future hiring of seniors. a questionnaire was constructed, based upon an earlier study focusing upon the hiring of seniors (peterson, 1990). this instrument was oriented to the needs of the present study and then pretested among 20 small business retailers in the community where the researcher resides, and subsequently modified in accordance with feedback emanating from the results of the pretest. the researcher mailed packets ofquestionnaires to 100 directors of small business institutes or similar agencies providing small business consulting assistance at 100 united states colleges and universities in 41 states. the survey respondents were selected at random from the membership directory, international council for small business. each survey respondent who was included in the sample received ten questionnaires and a request to distribute these to ten randomlyselected current and past small retailer consulting clients. after completing the questionnaires, the clients returned them to the professors, who in turn mailed them to the researcher in self-addressed stamped envelopes. the total usable sample was 302 (a 30.2 response rate). in the questionnaire, the small retailerrespondents were asked ifthey currently employ or have in the past employed seniors (defined as persons sixty-five years of age or older) and, if they did, for the proportion of their work force that was comprised of members of this group. if they did not employ any seniors, they were instructed not to respond to further questions contained in the questionnaire, except for the last one, which asked if they planned to employ larger or smaller numbers of older persons in the future. those who currently employ seniors or once had done so were queried as to their perceived advantages and disadvantages of employing seniors in their respective companies. further, they were asked to estimate if they would hire more or less or about the same proportion of older workers in the future as they have to date. 128 journal ofbusiness strategies research results vol. 24, no.2 the questionnaire asked the respondents if their firms employed seniors at present or did so sometime in the past. a total of238 (78.8 percent of the total) responded in the affirmative. a t test reveals that this percentage was significantly larger than the percentage who indicated that they do nor or did not hire seniors, at the .05 level. table i sets forth the percentage of the surveyed companies' work forces that, at present, included seniors. a total of 211 respondents indicated that they currently employ older workers .. in this case, the majority are in the one percent to 4.9 percent category. in tum, the second largest classification was in the 5.0% to 9.9 % grouping. in tum, the median percentage was 3.8 percent. in contrast, approximately sixteen percent of the united states population is made up of persons age 65 and older (u.s., 2005). however, it should be recognized that many older persons do not choose to or cannot work, so a direct comparison of employment status and percent of the population can be somewhat misleading. overall, seniors make up 3.2 percent of the labor force (u.s. department of commerce, 2005). these figures suggest that small retail employment of older persons slightly exceeds that of business in general. table 1 percentage of respondents' current workforces comprised of seniors frequency percentage of workforce number percent 14.9% 113 53.6% 5-9.9% 42 19.9 10-14.9% 17 8.1 15-19.9% 19 9.0 20-24.9% 9 4.3 25% and over 11 5.1 total 211 100.0% older persons might be more successful in attaining and retaining positions in small retail establishments if managerial attitudes were altered. there is anecdotal evidence to support the claim that the ideal candidate is a single new college graduate who is very computer savvy and is willing to work numerous hours per week, while older workers are viewed as dinosaurs (weinberg, 1998). some employers are characterized by stereotypes regarding the potential ability of seniors (prewitt, 2002). in the united states there is a cultural orientation among some managers toward worship of youth and a preference for acquiring "new blood" by replacing older with younger employees (snape & redman, fall 2007 peterson: employment of older workers 129 2003). such attitudes may impair the ability of seniors to acquire and maintain employment at the small retailer level. the respondents were asked, through an open-end question, to cite the advantages, based upon experiences in their companies, of employing seniors. in tum, these responses were coded by three ph.d. graduate student analysts into categories. the author provided training and practical instruction in code development to the analysts prior to their involvement in the research. the coding scheme was established by each individual student first scrutinizing the respondents' cited advantages, then developing relevant categories, and finally by meeting with other students to discuss and arrive at a consensus as to the most valid and reliable set of composite categories. all this was done under the guidance of the author. this methodology is widely-used in content analysis and there is considerable evidence as to its validity and reliability (larson, 2002; cameron & trope, 2004). once the classification scheme was established, the students assigned each survey response to a category. differences of opinion were resolved through discussion by the three analysts. once this allocation to categories had been completed, the tabulation process was undertaken. table 2 outlines the frequencies associated with each category of response. table 2 cited advantages of employing seniors advantage number of respondents* percent of total productive 206 18.8% experienced 172 15.6 possess work ethic 153 13.9 trustworthy 111 10.1 responsible 109 9.9 reliable 95 8.6 punctual 69 6.3 mature 53 4.8 respect authority 49 4.6 loyal to company 21 1.9 interpersonal skills 17 1.5 flexible work scheduling 14 1.3 limited family responsibilities 8 0.7 other 22 2.0 total 1099 100.0% *the number of responses exceeds the sample size, since all sample members surveyed cited more than one advantage. 130 journal ofbusiness strategies vol. 24, no.2 several advantages received substantial numbers of frequencies. these were productive, experienced, possess work ethic, trustworthy, and responsible. these were followed by reliable, punctual, mature, and respect authority. smaller frequencies were associated with loyal to company, interpersonal skills, flexible work scheduling, limited family responsibilities, and other. table 3 sets forth the disadvantages of employing seniors which the respondents reported in the survey. in terms ofraw numbers (from tables 2 and 3) the advantages outweigh the disadvantages 1099 to 486 (over two to one), furnishing some evidence that small retailers are impressed with the performance of these individuals. the disadvantages which received the largest number of frequencies are physical restrictions, lack of desire to receive training, opinionated, slow paced, and difficult to train. these are followed by absent minded, do not identify with younger employees, expensive medical benefits, and illness. receiving smaller frequencies are difficulty in multitasking, excessive complaining, limited computer skills, criticize other employees, only available part time, excessive attention to details, and other. table 3 cited disadvantages of employing seniors disadvantage number of respondents* percent of total physical restrictions lack of desire to receive training opinionated slow paced difficult to train absent minded do not identify with younger employees expensive medical benefits lllness difficulty in multitasking excessive complaining limited computer skills criticize other employees only available part time excessive attention to details other total 73 70 66 52 49 34 33 27 27 14 10 8 5 5 4 9 486 15.0% 14.4 13.6 10.7 10.1 7.0 6.8 5.6 5.6 2.8 2.1 1.6 1.0 1.0 .8 1.9 100.0% *the number of responses exceeds the sample size, since all sample members surveyed cited more than one advantage. fall 2007 peterson: employment of older workers 131 the sample members were requested to specify ifthey planned to employ larger percentages of seniors in their work forces in the future than they had in the past. the responses were 197 (65.2%) yes, 71 (23.5%) no, and 34 (11.3%) don't know. the percentage noting "yes" was significantly greater than the percentage noting "no" according to a t test at the .05 level overall, it appears that small retailers intend to rely more on older workers with the passage of time. discussion the research upon which this paper was based was undertaken to assess the degree to which small retailers employed older workers, perceived advantages and disadvantages of employing these individuals, and planned future hiring of seniors. a large number of the respondents employ older workers, although their percentage of the work force is not great. the respondents set forth a number of advantages, indicating that older workers have substantial potential for various types of small retailers. the advantages cited by the respondents emphasized productiveness, experience, possession ofthe work ethic, trustworthiness, responsibility, and reliability. firms that seek these advantages may desire to consider increasing their employment of seniors. there are disadvantages of employing seniors and these should be considered by potential employers. the major disadvantages reported by respondents were physical restrictions, lack of desire to receive training, opinionated, slow paced, difficult to train, and inability to identify with younger employees. finally, a high percentage of the respondents plan to employ more older workers in the future. this suggests that small retailers may be becoming increasingly aware of opportunities available through the hiring of these individuals. this could signal more competition from other companies, in attracting seniors into positions of employment. this study had several limitations. the respondents were asked to set forth their plans and intentions for hiring seniors in the future. it is possible that a number of respondents had no specific plans and!or could not forecast their future actions and therefore had to guess when providing this information. the sample selection process was not entirely random, although an attempt was made to approximate this status. further, some retailers may not be fully aware of the specific advantages and disadvantages of employing seniors, especially if these respondents do not work closely with their employees. finally, when coding of responses is employed, some degree of subjectivity is introduced into the analysis. it should be recognized that this may have introduced bias into the assessment of research results. the results of the study give rise to some implications for small retailers. it is apparent that these companies will experience a number of specific advantages, as well as disadvantages, as a result of employing older workers. they will employ even larger numbers in the future than in past periods. for some this will involve continuing to employ current workers past normal retirement dates. for others, 132 journal of business strategies vol. 24, no.2 it will require hiring new employees from the ranks of the elderly. both of these strategies should be considered by forward-looking managers. the substantial number of advantages set forth by the sample members suggests that small retailers who are not committed to well-conceived programs to recruit and retain older workers may be overlooking a significant potential pool of managerial and operative talent. this is particularly the case for those regions and retail industries which now are or will experience personnel shortages and deficiencies in the capabilities of current employees. recruitment and retainment programs targeted at older job seekers may hold substantial promise for these firms. hence, those who are not already using such programs may be well-advised to do so. small retailers who are contemplating the employment of older workers should consider the particular advantages and disadvantages revealed through the study. if, for instance, productiveness, experience, possession of the work ethic, trustworthiness, responsibility and reliability and other advantages set forth in table 2 are of considerable importance to the firm, seniors may be a very good source of applicants and personnel to retain. on the other hand, if the position in question would not be appropriate for those with physical restrictions, lack of desire to receive training, opinionated personalities, slow paced, difficult to train, or other disadvantages specified in table 3, the employer may approach the senior applicant and retention pool with caution, unless modifications, such as alterations in the nature of the work or training programs for seniors can be readily activated. when seniors are recruited, small retailers may have to rely on different sources of job applicants than is the case for recruiting their younger counterparts. some senior citizen centers are involved in placing members who seek employment. there are firms that have developed their own senior citizen temporary help pools, frequently composed of ex-employees. small retailers who seek senior employees may be well-advised to consider these alternative sources. when older workers are hired or retained, the small retailer may find it to be advantageous to alter some methods of supervising employees and arranging their work. since older workers are experienced, possess the work ethic, are trustworthy, responsible, and reliable, they may require less close supervision. it may be advisable to convert some positions to part-time or job-sharing or to utilize flex-time, if these are not already in place. some job responsibilities may have to be redesigned, so that they are less physically demanding. arrangements, such as furnishing transportation from senior centers to workplaces, may be useful. in some cases, training procedures and content may require deviations from those employed for younger employees. since many older workers are experienced, their training may not need to be extensive. in some cases, adjustments may be needed in the training format, as in presenting materials slower to older workers than for their younger counterparts. a positive development is that the training benefits may accrue to the small retailer in more permanent form for seniors, since their turnover tends to be less and they are less likely to move on to fall 2007 peterson: employment of older workers 133 other firms after they have obtained valuable training from their current employer and have adjusted to the work environment of the small retailer. what do seniors want in their work-related activities, environment, and relationships with others? of course, there is considerable variation from one person to another. however, a number of generic and widely held desires have been uncovered through research efforts. basically, these individuals prefer some degree of control over the tasks they perform on the job (moyers & coleman, 2004). in tum, they are predisposed toward work that promotes their health and safety (moyers & dale, 2004). there is evidence that they place substantial value on career autonomy (karp, 1987). in addition, they prefer quality rather than quantity of production and favor working at their own pace (kelly, 1990). generally, older workers have a desire for variety and the possibility to choose among tasks (rix & chusmir, 1990; kelly, 1990). in addition they prefer supportive and understanding supervisors who recognize their experience and maturity (rupp, vodanovich, & crede, 2005; ramsey, 1993). they like feeling useful to the organization and to society at large (zetlin, 1992). in this regard, they are motivated toward obtaining affective rewards (emotional satisfaction) and activities which support their identities. many of these individuals want to assume new roles, such as mentors, trainers or consultants (sheppard, 1988). most older workers seek enjoyment ofthe same opportunities as younger workers and equal access to training, career advancement, and career development (dychtwald, erickson, & morison, 2004;siegel, 1993). they want to be heard, to be fairly compensated for their contributions to the organization, and to be recognized for their qualifications (rix & chusmir, 1990). in addition, they often prefer adjustments to their work function, such as part time work, job sharing; phased retirement, and working during early hours of the day (challenger, 2004; purcell, 2005; dibden & hibbett, 1993). how can small business retailers improve their efforts directed to to attracting and retaining older workers? one tested approach is "positive psychology," an avenue that has emerged and gained momentum and that redirects focus from what is wrong with people toward one that emphasizes human strengths that allow individuals to thrive and prosper. the goal is to create organized systems that actualize human potential this requires taking steps to accentuate the positive by recognizing the capabilities of older employees as potential exceptionalleamers and performers. then, seniors are encouraged to employ the resources that they have learned through education, training, and experience to grow professionally and to lend their capabilities to the resources of the organization and the efforts of co-workers (peterson & spiker, 2005). there are a number of other actions which small retail managers can take to acquire and retain needed older workers. according to one source, useful practices toward this end are flexible work arrangements, time for individual (not professional) development, insurance and retirement benefits, training, and compensation policies tailored toward the needs of seniors (wellner, 2002). another source suggests training to upgrade the skills of older workers, providing 134 journal ofbusiness strategies vol. 24, no.2 opportunities for them to transfer to more desirable jobs, furnishing attractive benefits such as health care, long term care insurance, elder care and flextime, and institute-phased retirement programs. (fusaro, 2001; kindelan, 1998). yet other authorities favor providing time for individual development as opposed to professional development (wellner, 2002) and maintenance of a balance between work and personal goals (smola & sutton, 2002). other policies for attracting and retaining older workers are available. some relate to recruiting practices. in this regard, companies are urged to alter the appearance and placement ofrecruiting advertisements, expand company recruiting policies, and train employees on how to interview older job applicants (sullivan & duplaga, 1997). other policies focus on retaining older members of the work force. the suggestions include auditing the company culture, rethinking and changing attitudes toward older employees in the workplace, discussing age discrimination and other adult issues with other companies, and developing a friendly environment for older adults. another possibility is to change stereotypical beliefs of younger workers, many of whom have negative impressions regarding the training, promotion, and retention of older workers (chiu, chan, snape, & redman, 2001). for some small business retailers, alterations in the physical workplace can be of value in attracting and retaining seniors. no one wants to live or work in a misdesigned world, where light is too dim, words are unintelligible, switches are too fussy, and objects are too heavy to lift. yet older people face exactly this problem if steps are not taken to design a more hospitable environment. older workers will feel weak, frail, and dependent, creating lower morale, less productivity, and more missed time. the good news is that designing for the older worker is simply good design. the effort spent creating a suitable environment for older people will increase safety and productivity of all workers (green, 2002). in this same vein, one source calls for the redesign of safety programs in the workplace to address the special needs of older workers. prevention of on-thejob injuries can lead to lower costs associated with employing older workers, while still managing the injuries characteristic of younger workers. effective accident prevention programs can be of value in reducing both injury frequency and severity (findley & a bennett, 2002). one authority sums up the suggestions for utilizing older workers as "providing seniors with a satisfying career" (st. edmunds & pullin, 1998). another sums it up by specifying furnishing seniors with want fulfillment (easton, 2002). dychtwald, erickson, and morison (2004) have developed a program for recruiting and training older workers. their recommendations appear in figure 1. moyers & coleman (2004) provide suggestions for the purposes of recruiting and retaining senior workers. these are set forth in figure 2. fall 2007 peterson: employment of older workers figure 1 dychtwald, erickson and morison program for recruiting and training older workers (2004) 135 1. create a culture that honors experience a. in recruiting advertisements emphasize "experience," "knowledge" and "expertise," rather than "energy," "fast pace," and "fresh thinking." b. recruit through city agencies, the national council on aging, and community organizations. c. for interviewing-use a technique such as role-playing to gauge candidates' ability to handle customers, rather than building something with legos or verbal gymnastics. d. make training (including refresher training) available to older workers. e. create a culture that values older persons' experience and capabilities. 2. offer flexible work a. design jobs so that staying on is more attractive than leaving b. make work less time-consuming and pressured c. use f1ex-work-f1exible in both where and when work in performed d. use compressed workweeks, job sharing, and part-time schedules e. allow those with flexible work to be considered for promotions f. allow employees to redesign their jobs 3. introduce flexible retirement a. allow retirement after age 65 b. allow retirees to work periodically for the firm as consultants or independent contractors figure 2 moyers & coleman suggestions for recruiting and retaining older workers (2004) a. adjust the physical demand of the job, e.g., heavy lifting, to the capabilities of semors b. instruct older workers on how to adjust to changes in technology c. strike a balance between job enrichment and repetitiveness d. improve the work environment, as through better lighting, decreasing glare, and larger print on written materials e. provide recognition for superior performance f. change the culture of the company so that it dispels myths regarding older worker ability 136 journal of business strategies conclusion vol. 24, no.2 overall, seniors have the potential for assisting a number of small retailers in fulfilling their personnel needs. while adjustments may have to be made in recruiting, hiring, training, and supervising practices, the net result may be very positive for those retailers who choose to employ this class of personnel. references adams, s. j. (2002). passed over for promotion because of age: an empirical analysis of the consequences. journal of labor research, 23,446-461. albright, w. d. jr., & cluff, g.a. (2005). ahead of the curve: how mitre recruits and retains older workers. journal of organizational excellence, 24,53-63. anonymous. (1999). the wisdom of older workers. management services, 43,6-8. anonymous. (2001). financial executives seek 'soft' skills when evaluatingjob applicants. afp exchange, 21,65-68. anonymous. (2003). older workers will be critical for workplace planning, studies show. human resources department management report, 3, 12-13. armstrong-stassen, m.. , & templer, a. (2005). adapting training for older employees: the canadian response to an aging workplace. journal of management development, 24, 57-67. baltes, m. m., & baltes, p. b. (1990). psychological perspectives on successful aging: the model of selective optimization and compensation. in p. b. baltes & m. m. baltes (eds.) successful aging perspectivesfrom the behavioral sciences. (pp.i-34). new york: cambridge university press. barrier, m. (2002). an age-old problem. hr magazine, 47,34-37. bell, j. (2001). career crossroads. journal of property management, 66,42-46. bushko, d., & raynor, m .. (1999). more on the aging worker: who are they and how can they stay vital? journal of management consulting, 10, 68-69. cameron, j. a., & trope, y. (2004). stereotype-biased search and processing of information about group members. social cognition, 22,650-672. cattell, r. b. (1987). intelligence: its structure, growth, and action. amsterdam: north holland. challenger, j. a. (2004). waking up to the senior worker. futurist, 38, 19-20. fall 2007 peterson: employment of older workers 137 chiu, w., chan, a., snape, e., & redman, t. (2001). age stereotypes and discriminatory attitudes toward older workers: an east-west comparison. human relations, 54, 629-661. crampton, s., hodge, j., & mishra, j. (1996). transition-ready or not: the aging of america's workforce. public personnel management, 25,243-256. dibden, j., & hibbett, a. (1993). older workers: an overview ofrecent research. great britain department ofemployment-employment gazette. 101,237-250. dychtwald, k., erickson, t., & morison, b. (2004). it's time to retire retirement. harvard business review, 82,22-34. easton, l. j. (2002). let's bring down age retention barriers. nursing management. 33, 17-19. findley, m. e., & o'bennett, j. (2002). safety & the silver collar worker. professional safety, 47, 34-38. finegold, d., mohrman, s., & spreitzer, g. m. (2002). age effects on the predictors of technical workers' commitment and willingness to turnover. journal of organizational behavior, 23, 655-674. fusaro, r. (2001). needed: experienced workers. harvard business review, 79,20-21. gangl, m. (2005). income inequality, permanent incomes, and income dynamics: comparing europe to the united states. work & occupations, 32, 140-162. green, m. (2002). environmental design for the older worker. occupational health and safety, 71,47-49. greller, m. m.,. & stroh, l. k. (2004). making the most of late career for employers and workers themselves: becoming elders not relics. organizational dynamics, 33, 202-214. grossman, r. j. (2005). the under-reported impact of age discrimination and its threat to business vitality. business horizons, 48, 71-78. halachmi, a. (1998). dealing with employees over fifty: reflections and an introduction. public productivity & management review, 22, 6-14. karp, d. (1987). professionals beyond midlife: some observations on work satisfaction in the fifty-to-sixty decade. journal ofaging studies, 11,209-223. kelly, j. (1990). employers must recognize that older people want to work. personnel journal, 27,44-47. 138 journal ofbusiness strategies vol. 24, no.2 kindelan, a. (1998). older workers can alleviate labor shortages. hr magazine, 43, 200-207. kite, m. e., & stockdale, g. d. (2004). attitudes toward younger and older adults: an updated meta-analysis review. journal of social issues, 27,42-58. kraut, a. i (2005). retirees: a new resource for american industries. personnel administrator, 22,26-29. larson, m. s. (2002). race and interracial relationships in children's television commercials. the howard journal of communications, 13,223-235. levy, b. r., & banaji, m. r. (2002).implicit ageism. in nelson. t. d. (ed) ageism: stereotypes and prejudice against older persons. (pp.49-75). cambridge, ma: mit press. mcevoy, g. m., & blahna, m. j.( 200l).engagement or disengagement! older workers and the looming labor shortage. business horizons, 44, 31-49. mcshulskis, e. (1997). older workers in demand. hr magazine, 42, t 8-23. minerd, 1. (1999). a 'gray wave' of entrepreneurs. the futurist, 33,10-14. moyers, p. a., & coleman, s.d. (2004). adaptation of the older worker to occupational challenges. work, 22,71-78. moyers, p. a., & dale, l. m. (2004). challenges and opportunities for the older worker. work, 22,3-4. palmore, e. b.(1999). ageism: negative and positive. new york: springer publishing company. peterson, r. (1990). large retail firm involvement in hiring senior citizens. business journal, 16, 5368. peterson, s. j., & spiker, b. k. (2005). establishing the positive contributory value of older workers: a positive psychology perspective. organizational dynamics, 34, 153-167. prewitt, m. (2002). senior moment: chains forget older customers. nation s restaurant news, 36, 1-4. purcell, p. (2005). older workers: employment and retirement trends. journal ofpension planning & compliance, 30, 49-70. ramsey, r. d. (1993). what it takes to supervise older workers. supervision, 54,9-10. fall 2007 peterson: employment of older workers 139 rix, c., & chusmir, l. (1990). a shift in values is squeezing older people. personnel journal, 24, 48-52. rupp, d., vodanovich, s. 1., & crede, m. (2005). the multidimensional nature of ageism: construct validity and group differences. the journal of social psychology, j45, 335-362. schaie, k. w. (1996). intellectual development in adulthood: the seattle longitudinal study. new york: cambridge university press. siegel, s. r. (1993). relationships between current performance & likelihood ofpromotion for old versus young workers. human resource development quarterly, 4, 39-50. sheppard, h. (1988). work continuity versus retirement: reasons for continuing work. in r. morris & s. bass (eds.) retirement reconsidered: economic & social roles for older people. (pp. 103-137). new york: springer publishing company. smola, k. w., & sutton, c. d. (2002). generational differences: revisiting generational work values for the new mlllennium. journal oforganizational behavior, 23,363-382. snape, e., & redman, t. (2003). too old or too young? the impact of perceived age discrimination. human resource management, 13, 78-90. 81. edmonds, b., & pullin, j. (1998). parable of the talents. professional engineering, 11, 33-39. sullivan, s. e., & duplaga, e. a. (1997). recruiting and retailing older workers for the new millennium. business horizons, 40,65-69. swanson, c. e., kopecky, k. j., & tucker, a. (1997). technology adoption over the life cycle and aggregate technological progress. southern economic journal, 63, 872-887. tschirhart, m. (1998). understanding the older stipended volunteer: age-related differences among americorps members. public productivity & management review, 22~ 35-48. u.s. department of commerce, bureau of the census (2005). statistical abstract of the united states 12lst edition, 38.washington, d.c.: u.s. government printing office. van yoder, s. (2002). coping with the graying workforce. financial executive. 18,2629. welbourne, t. m., & cyr, l. a. (1999). the human resource executive effect in initial public offering firms. academy of management journal, 42,616-629. weinberg, n. (1998). career crisis. network world, 15, 1-5. 140 journal ofbusiness strategies vol. 24, no.2 wellner, a. s. (2002). tapping a silver mine. hr magazine, 47, 26-32. zetlin, m. (1992). older & wiser: tips to motivate the 50's crowd. management review, 35, 30-33. robin t. peterson is distinguished professor ofmarketing, college ofbusiness, new mexico state university, las cruces, new mexico. he received the ph.d. in marketing from the university of washington and has written articles and books in the fields of marketing, small business, and business ethics. small retailer employment of older workers: an assessment special issue on migration, remittances, and trade agreements: an introduction hiranya k. nath sam houston state university • huntsville, texas the journal of business strategies published a special issue on migration and remittances in spring 2009 with six articles selected from the papers presented at the conference on regional trade agreements, migration, and remittances with special focus on cafta and latin america held at the college of business administration, sam houston state university, in april 2008. the current special issue is a continuation of that effort and includes five more articles selected from the pool of papers presented at the conference. in addition to topics related to migration and remittances, this issue also includes articles on regional trade agreements (rtas). while migration of people across natural and man-made borders has remained a powerful force that contributes to the progress of human civilization, remittances the transfers of money by migrants to family and friends left behind in their respective home countries have been recognized as "the most tangible and ... the least controversial link between migration and development, having the potential to contribute significantly to poverty reduction and achievement of other un millennium development goals" (irving et ai, 2010). although new migration flows fell during 2008-09 due to the global economic crisis, existing migrants were not returning even though the employment prospects have been bleak in many destination countries. in 2008, officially recorded remittances to developing countries reached a higher-than-expected level of $338 billion and it represented a growth of about 17 percent from $289 billion in 2007. 1 while south and east asia witnessed a stronger-than-expected growth in remittance flows during 2008-09, latin america and the caribbean, middle east, and north africa experienced larger-than-expected declines. 2 in addition to migration and remittances, greater trade liberalization, particularly in developing countries, has become another hallmark of the current wave of globalization. however, the development of a multilateral trading system based on global free trade under the aegis of the general agreements on trade and tariff (gatt)/world trade organization (wto) has been extremely slow mainly due to the complexity of multilateral negotiations. this has given way to an unprecedented proliferation of regional trade agreements (rtas), which have become a prominent feature of the multilateral trading system (mts). 3 almost every country is a part of one or more rtas. some 462 such agreements have been notified to the gatt/wto up to february 2010 and 271 of them were in force. this trend is likely 2 journal of business strategies to continue as many more rtas are currently under negotiations. of these rtas, free trade agreements (ftas) and partial scope agreements account for 90 percent, while customs unions (cus) account for 10 percent. 4 the rise of rtas raises the time-honored question of whether these agreements help or hinder global trade liberalization. the classic analysis of the "trade diversion effect" (diversion of trade from a more efficient exporter towards a less efficient one by the formation of an fta) by jacob viner (viner 1950) was later extended to a full range of theoretically plausible effects of rtas. the expositions on the implications of rtas for global free trade are collectively known as the "stumbling bloc" or "building bloc" debate. 5 in this debate, rtas are "stumbling blocs" if they prevent or slow multilateral trade liberalization, while they are "building blocs" if they accelerate or at least do not hinder multilateral ism. numerous mechanisms have been presented in the literature to suggest that one or the other position is likely. the classic "trade diversion effect" as described above and the "trade creation effect" (more trade with the members of the rta) are two such mechanisms extensively discussed in the literature. migration and remittances the first two articles in this special issue deal with topics related to international migration and remittances. while borraz, pozo, and rossi examine the effect of migration on the subjective well-being of the family left behind by the migrants using data from cuenca in ecuador, mamun and nath analyze various aspects of workers' migration from bangladesh and examine the economic impact of remittances received from these migrant workers. international migration and happiness although the socio-economic effects of migration on the migrant-sending households have been extensively studied in the migration literature, the subjective well-being the level of happiness of the family members left behind by the migrant has not received much attention. one formidable issue is how to measure happiness. recently, a few studies on this topic based on survey data have appeared in the literature. 6 the article by borraz, pozo and rossi belongs to this strand of the literature and aptly complements cardenas et al (2009) . using data on subjective well-being and migration of family members in cuenca, one of the ecuador's largest cities, they examine the impact of migration on the happiness of the family left behind. they find that although the heads of migrant-sending households volume 27, number 1 3 seem to be less happy, after controlling for several socio-economic characteristics, they are no different from their counterparts of non-migrant households in their stated levels of happiness. that is, households that have experienced migration of their family members express the same level of happiness as those households that have no migrant members. the authors suggest that the remittances received by the households from the migrant members offset the decrease in their happiness level. workers' migration and remittances in bangladesh in the article by mamun and nath, the attention is directed to issues related to migration and remittances in bangladesh, one of the poorest and most densely populated countries in the world. bangladesh with a size of 1.5 percent of the u.s. in area and less than 1 percent in gdp has a population of more than 150 million, about half the size of the u.s. population. constrained in many ways, this country has very few options left in its effort to achieve economic growth and development. no wonder that encouraging international migration to more prosperous countries has been a strategic policy tool for the government to contain the pressures in its ever-exploding labor market. over a period of more than three decades since the mid-1970s, bangladesh has sent more than 6.7 million workers to over 140 countries. most of these workers temporarily migrate to work in middle east and southeast asia. note that if the people who migrated legally or illegally to other countries for permanent settlement were counted, the total number of bangladeshi migrants would be much higher. the mass movement of temporary migrant workers has not only eased some pressures on the over-burdened labor market in bangladesh, but also the remittance transfers received from these migrant workers have significant economic impact in this country. these remittance transfers have reached a phenomenal level of over 10 billion us dollars in 2009, approximately 12 percent of gdp in bangladesh. this paper analyzes trends and various other aspects of workers' migration and remittances in bangladesh. it further discusses the micro and macroeconomic impacts of remittances. while most remittance transfers have been used by migrant-sending households for consumption, there is evidence to show that these transfers have helped reduce poverty in bangladesh. the analysis presented in this paper also demonstrates that these remittances have significant impacts at the macroeconomic level. the empirical analysis indicates that these transfers have positive impact on the growth of industrial production and exports. 4 journal of business strategies regional free trade agreements the last three articles focus on issues related to rtas. the first two articles theoretically explore whether rtas are the "building blocs" or the "stumbling blocs" for achieving the goal of global free trade under a multilateral trade arrangement. the last article empirically examines whether rtas lead to more trade or less trade (that is, to a "trade creation effect" or a "trade diversion effect") and how they contribute to economic growth in 17 latin american countries. politics and economics of free trade agreements the article by trupkin uses a political-economy framework to analyze whether regional free trade agreements are building blocs or stumbling blocs for multilateral trade liberalization. the paper builds on a framework originally introduced by grossman and helpman (995). the aim of their model was to explain the viability of ftas between two countries when special interest groups the lobbies make political campaign contributions to influence trade policies. the author extends the model to a three-country setting to analyze whether ftas are "building blocs" or "stumbling blocs." this paper uses a specific example to show that under certain conditions ftas are only partial "building blocs" for global trade liberalization. implications of a south-south customs union following the failure of multilateral trade negotiations at the cancun meeting and the doha round of the wto, developing countries have pursued an alternative in so-called "south-south" trade agreements. since these agreements lead to trade di version from efficient north (developed) countries to less efficient south (developing) partners, there have been widespread concerns regarding their welfare implications. using a three country oligopoly model of trade, the article by nath and yildi z first examines statically the implications of a south-south cu on the pattern of tariffs and welfare. the authors find that south countries always have incentives to fonn a cu that reduces the welfare of the north country. moreover, when south finns are sufficiently inefficient relative to north finns , a south-south cu leads to a large trade · diversion effect and reduces world welfare . they further show that, in a repeated interaction model, free trade is less likely to be sustainable under the south-south cu relative to no agreement. volume 27, number 1 5 implications of trade agreements in latin america using data for a sample of 17 latin american countries for the period 19502004, barboza and trejos examine the effects of preferential trade agreements (ptas) and gatt/wto membership on economic growth. their results indicate that the proliferation of bilateral and multilateral regional and extra regional trade agreements has not led to faster economic growth. however, they find that ptas and wto membership have a weak positive effect on trade openness. furthermore, after controlling for capital, labor force, and trade openness, ptas and wto membership do not have any direct effect on economic growth. these results are robust to both static and dynamic model specifications. notes 1. see irving et al. (2010) 2. see ratha et al (2009). 3. rtas are preferential trade agreements (ptas) that may take one of the following forms: 1. a free trade agreement (ft a) is an agreement between two or more countries that have eliminated tariffs and other trade restrictions on most (if not all) goods and services traded between them. 2. a customs union (cu) is a group of two or more countries that have an fta and that also apply a common external tariff on goods and services from non-members. 3. a regional economic integration agreement is the next step: it can include the free movement of capital as well as goods and services, a common currency, and a common economic policy. 4. see wto (2010). 5. for a detailed discussion on the debate, see panagariya (1999) or bhagwati( 2008). 6 cardenas et al. (2009), published in this journal is an example. 6 journal of business strategies references cardenas, m., di maro, v., & sorkin, r. (2009). "migration and life satisfaction: evidence from latin america." journal of business strategies, vol 26,no. 1, 9-34. grossman, g ., & helpman, e. (1993). "the politics of free-trade agreements." nber working paper, no. w4597. irving, j., mohapatra, s., & ratha, d. (2010). "migrant remittance flows: findings from a global survey of central banks." world bank working paper 194. washington: the world bank. panagariya, a. (1999). "the regionalism debate: an overview." the world economy, vol 22, no.4, 455-476. ratha, d., mohapatra, s. , & silwal, a . (2009). "migration and remittance trends 2009: a better-than-expected outcome so far, but significant risk ahead." migration and development brief 11. washington: the world bank. viner, j. (1950). the customs union issue. new york: carnegie endowment for international peace. world trade organization (wto). 2010. regional trade agreements. http://www. wto.orglenglishltratop _ e/region_ e/region _ e.htm. biographical sketch of author hiranya k. nath is an associate professor of economics at sam houston state university. he has published on inflation and relative price behavior, the growth oftransition economies of central · and eastern europe, the growth of bangladesh, and information economy in refereed journals including applied economics, applied economics letters, applied financial economics letters. california management review, comparative economic studies, economics letters, journal of international trade & economic development, journal of macroeconomics, journal of money, credit and banking, and review of development economics. he earned his ph.d. in economics from southern methodist university, dallas (tx). special issue on migration, remittances, and trade agreements: an introduction volume 37, number 1 1 measuring levels of fundamental attribution error ascribed to leadership of entrepreneurial organizations across national cultures dr. lee w. lee, phd central connecticut state university • new britain, ct dr. robert a. fiore, dba central connecticut state university • new britain, ct abstract this study empirically assesses respondent’s attribution to organizational outcomes across multi-national communities. as applied to entrepreneurship, the fundamental attribution error (fae), nominally defined as the naturally occurring cognitive bias of humans to over-attribute organizational outcomes to leadership dispositions and in the case of celebrity entrepreneurship, a heightened attribution to the news-worthy disposition of celebrity-entrepreneurs. likewise, there would be a biased and corresponding under-attribution of organizational outcomes to circumstantial factors. within this current research, respondents within differing cultures report on their perceptions of importance of founder dispositions to entrepreneurial outcomes. a survey instrument measuring differential disposition and circumstantial attribution was developed and results showed strong fae across cultures. evidence was found that perceivers external to the organization exhibit strong attribution error globally and that business leaders attribute business success to their own talents and reinforce fae. a small difference in levels of fae between individualistic and collective cultures was found. implications of the findings are discussed in relation to organizational behavior, organizational development, organizational outcomes and rates of return on invested capital. keywords: entrepreneurship, management, small business management, organizational behavior, fundamental attribution error, international management, investment analysis, global management acknowledgement the authors gratefully acknowledge the contributions of the multi-national collaborative team who gathered data used in the current research. we acknowledge the data gathering of professor louis jianchang liu of the zhejiang fashion institute of technology business school, china, phd student reka pusztai, and zoltan szabo, assistant professor, business and economics school, university of pecs, hungary. 2 journal of business strategies dr. pard teekasap, chair of the international business department, thai-nichi institute of technology, thailand. the authors also wish to thank deborah alm, director of the doggett international center at springfield college, chris elliott, coordinator of the intensive english program at the international language institute of massachusetts, and toyin ayeni, associate director of the center of international student and scholar center at central connecticut state university for their assistance in locating respondents. we are deeply indebted to these collaborators whose effort and cooperation were essential to the completion of this project. we also thank the anonymous reviewers for their insightful and helpful comments. introduction “one of the most widely researched areas within psychology is attribution theory” (heider, 1958; kelly 1967). lee, hallahan, and herzog (1996) state, “attributions, or making causal explanations for behavior, are basic and common human tendency. understanding what causes things to occur in the world provides perceivers with some capacity to foresee the consequences of events and with knowledge to guide their own behavior.” ross (1977) outlined, “the most common explanation is that the bias is due to perceiver’s causal theories about the determinants of human behavior, implying situational factors have little impact on human behavior. this ubiquitous underestimation of situational influences on human behavior is usually called the fundamental attribution error.” gawronski (2004) continues, “there is a long history of research in social psychology showing that perceivers draw correspondent dispositional inferences from other’s behavior even when the observed behavior was highly constrained by situational factors.” ceding there a few business situations less highly constrained than new entrepreneurial endeavors where success is impacted by a multitude of circumstantial market and economic factors, we acknowledge fae and created a measurement tool to test the strength and variance of fae across various nations. for entrepreneurial endeavors, the number of circumstantial events impinging on organizational success cannot be underestimated. for the nascent mcdonalds organization to have survived as an ongoing entity, hundreds of competing firms had to perish. many innovations had to have been in place (i.e., the multimixer) and hundreds of antecedent events must have occurred (i.e., founder ray kroc meeting the mcdonald brothers). all of these antecedent circumstances were critical to organizational success, yet perceivers heavily discount these circumstantial events. this is largely due to audiences not being aware of these hidden events. many volume 37, number 1 3 people attribute the success and existence of mcdonalds to the only factor they note as news-worthy, the biography of ray kroc as a well-publicized entrepreneur. ray kroc himself attributed the success of mcdonalds to his own dispositional talents as he often spoke about his own self-described set of dispositions. the natural tendency to focus on the founders’ dispositions and simultaneously under-regard the multitude of circumstantial factors highlights the phenomena of fae within entrepreneurship. jellison and green, (1981) reflect this tendency, “in personal psychology… individuals prefer to attribute causality to internal or dispositional properties. several studies document the pervasiveness and tenacity of this tendency of the average person, when perceiving the behavior of others, to emphasize internal causes even in light of salient environmental factors.” even after his death, many people consider the past ceo steve jobs as a prime casual factor in the success of apple, inc.. people consider bill gates as synonymous to microsoft even though he has not been active in the management for many years. the fae may lend business leaders and investors to invest capital in projects supported by the owner and under-capitalize projects supported by the remaining organization, possibly under-funding critical technology. jobs’ decisionmaking performance was important but so was the transistor, and the invention of the flat-screen pixel-display, and charge-coupled display devices. yet these critical circumstantial events and factors are judged to be of lesser importance to organizational success. within, we postulate that for new business ventures, respondents will demonstrate a natural tendency to link leadership dispositionalism to organizational outcomes. the natural origins of tendency to attribute dispositional causation are well outlined in the literature. krull, et al, (1999) outlined four generalized causes of fae when they stated, “first perceivers may display the bias because they lack awareness of the situational forces that influence behavior... second... they underestimate the power of the situation to influence behavior... third… expectations influence their perceptions of the behavior… fourth… perceivers may lack the cognitive resources or motivation necessary to fully consider how the situation may have influenced the actor’s behavior.” in prior research (fiore, lussier, 2014) evidence was found to support the hypothesis that public sample respondents over-attribute the impact of factors dispositional to entrepreneurs while simultaneously under-attributing the impact of circumstantial-situational factors when assessing organizational outcomes. this tendency is strong even when noting the lack of information available regarding circumstantial events. in light of the prior discussion, a test for over4 journal of business strategies attribution of entrepreneurial business outcomes perceived to be under the control of the entrepreneur (i.e. dispositional) vis-à-vis’ situational-circumstantial factors surrounding entrepreneurial endeavors was conducted across national borders. furthermore, we highlight a small sample of entrepreneurs’ personal historical statements indicating ex-ante doubts of business outcomes matched with ex-post statements of certainty of ensuing outcomes. this indicates internal overattribution of the ceo-founders personal (dispositional) impact on subsequent business outcomes. here we examine evidence there may not be ex-ante belief in the actual business outcome. entrepreneurs naturally issue positive communication, signaling the importance of dispositions enhancing these fundamental attribution errors reinforcing fae. this paper explores a series of archive-based recollections of the entrepreneur’s ex-ante thoughts to demonstrate that many legendary-business ceo-entrepreneurs did not expect the organization’s extraordinary ex-post-facto market successes. despite such evidence, ceos habitually link organizational success to their own perceived dispositional factors. hence, the validity of dispositional factors as nominal cause-effect attributions to outcomes arises. biased attribution fundamental attribution error (fae) or attribution bias, describes the tendency to over-value dispositional or personality-based explanations for observed behaviors while under-valuing situational circumstantial explanations for those behaviors. the fundamental attribution error is most visible when people explain the behavior of others. this discrepancy is called the actor–observer bias. li, et al, (2012) summarize the subject well, “attribution theory, one of the cornerstones of the study of social cognition, concerns people’s explanations for behavior.” kunda (1999) describes human tendency to over-identify the impact of a leader’s actions with a group’s success. she states (p. 430), “… studies have also demonstrated that we are often too quick to jump to conclusions about others’ abilities, traits and attitudes based on small samples of their behavior, we fail to appreciate the extent to which situational forces had contributed to that behavior.” she continues, “we simply don’t realize how powerful the situation is… we fail to correct our impressions for situational constraints even if we understand these constraints… our ultimate conclusions about a person may remain contaminated by our initial inferences about this person…” kunda (p. 441) specifically addresses fundamental attribution error, “when we observe or hear about another person’s volume 37, number 1 5 behavior, we often fail to appreciate the extent to which this behavior may have been shaped by circumstances. instead, we assume that the behavior was driven by the person’s enduring underlying disposition.” the present paper builds on kunda, and kahneman’s et al, nobel prize work in behavioral psychology. discussion a generalized tendency by humans to over-attribute perceived dispositional or personality based factors when evaluating a leader’s performance is well specified in the psychological literature. the corresponding tendency to underweight environmental, circumstantial or situational forces is also well noted. this tendency holds even though circumstantial factors most likely have a significantly greater cumulative impact on the outcome than do dispositional factors. it seems natural the immediately observable factors, factors such as; a person’s affect, education, background, posture, voice, mental strength, vocabulary and facial expressions encourages people to attribute organizational success or failure to these visible factors. situational factors of the economy, competition, technological failure and so forth are circumstantial events not normally readily available for noteworthy inspection and analysis and therefore are naturally discounted in a person’s analysis of business outcome causation. it is important to note that circumstantialenvironmental causative factors are usually myriad, cumulative, and aggregate and in all probability have a sum total greater effect on organization outcome than any one person’s mental or physical impact. both kahneman and kunda note humans make quick and unsubstantiated judgments and often tie effect-causation of business outcomes to the founder. it is noted the person identified as the entrepreneurial leader usually plays a role in causing fae. beyond fae, over-attribution of organizational success to the contributions of the ceo-founder may be magnified by a similar prevalent bias outlined by kahneman (2011) where he denotes the prevalent bias of “unwarranted entrepreneurial optimism.” kahneman wrote, “people tend to be overly optimistic about their relative standing on any activity in which they do moderately well.” he explains, “pervasive optimistic bias” can be detrimental. for example, “...only 35 percent of small businesses survive in the u.s. when surveyed, however, 81 percent of entrepreneurs assessed their odds of success at 70 percent, and 33 percent of them went so far as to put their chances at 100 percent.” these reality-distorting views can lower the proper attribution to circumstantial success/failure factors and degrade the relative value of the managerial team as an important contributing factor to new 6 journal of business strategies business success. kahneman and others also note a relevant “planning fallacy” which may be one of the most pervasive bias exhibited by humans, defined as, “our tendency to overestimate benefits and underestimate costs, and foolishly to take on risky projects.” the biases outlined here have real and substantial costs to society yielding lower rates of growth in the economy. any misappropriation of capital results in lower investment returns. buehler, griffin, ross, (1994) wrote, “… dispositionalism drives people to make overly confident predictions about others and even themselves with little allowance for the uncertainty of pertinent situational details… sometimes resulting in “the planning fallacy” or the tendency to underestimate the number of situational constraints and their power to subvert the strongest of intentions.” it is proposed the rise of the media-driven ceo celebrity may lead to stronger attribution errors. most of the world knows of jack ma’s seemingly instantaneous creation of alibaba. hence, executive management should attribute more of resulting economic value to the impact of organizational dynamics, organizations behaviour and organizational development. in summary, it is important for decision-makers to actively identify and compensate for persuasive biases of; fae, planning fallacy, and excess optimism, to conduct effective strategic management and produce optimal investment decisions. application of attribution error to entrepreneurship attribution error bias may lead both the general public, investors and the board of directors to overemphasize the impact of the celebrity enhanced ceo-entrepreneur’s dispositional characteristics when assessing causation of organizational outcome. this effect would simultaneously under-emphasize the value of corresponding organizational factors such as; team-building, hiring talented people, using new technologies, brainstorming, the use of strategic partners, financial analysis, the use of intellectual property, and group dynamics. additionally, the board of directors may be induced by biases highlighted in this current study to under-value the potential impact of circumstantial factors on outcomes such as; a change in interest rates, levels of foreign competition, the labor market, national economics and natural disasters. mis-identification of authentic cause-effect linkages to business outcomes most likely leads to inappropriate managerial conclusions and decisions. critically, in the task of strategic planning, such phenomena may lead to systematic under-consideration for circumstantial eventualities. volume 37, number 1 7 entrepreneur’s ex-ante statements generating fae the authors note evidence to suggest fae is promoted within the organization. these strong-leadership narratives are generated largely because they help attract capital. to highlight dispensational attribution promoted by ceo-entrepreneurial leadership, the authors provide archival quotes from well-known entrepreneurs. we examine statements made by celebrity leaders regarding ex-ante organizational growth and compare those statements to the actual ex-post growth and later statements about the properties of their own organizational effectiveness. although these quotes were found ex-post organizational success, the presented quotes are the entrepreneur’s own ex-ante statements on expected outcomes. additional examples are found in the previously published work (fiore, 2012). we present two examples of celebrity entrepreneurs creating fae within organizations with large market capitalizations. it is interesting to note, in every other sample of ex-post archived statements examined by the authors, the entrepreneur attributed organizational success to a set of dispositions. fred deluca, (co-founder of subway, (doctors associates, inc.)) ex-ante quote: “subway actually started by accident, i was, ah, just out of high school… was working at a hardware store… and my folks took me to see pete buck…i said, pete, do you have any ideas on how i can pay my way through college? he said you should open a submarine sandwich shop… that first day, after we decided to go into business… the next thing we did was… we decided to make a plan… what are going to do after we opened the first store, so, we set a goal, we were going to open 32 stores in 10 years, that was our goal, that was our plan… actually, that was our agreement. he gave me $1,000... i went off to find a little store to rent.” actual attribution: success was a circumstantial accident. ex-post quote: “i was willing to try solutions that other people may not even have thought of.” fae: when deluca explains the overwhelming success of subway, he 8 journal of business strategies attributes organizational success to his innate vision and courage, a set of dispositions. steve ells, (founder of chipotle, inc.) ex-ante quote: “i had the notion of becoming a chef… thought of opening my own (full size) restaurant, i knew i needed some way to fund that restaurant… that’s where the notion of chipotle came in…” actual attribution: success was a circumstantial accident, the creation of chipotle was merely a secondary goal to ells and at the nascent formation stage the venture was literally disposable to ells. there was no ex-ante determined strategic goal. success was a circumstantial accident. ex-post quote: “i had a strong vision.” fae: ells attributes the success of chipotle to his innate vision, a disposition. the quotes presented highlight a strong disparity between ex-post success and ex-ante intentions therein exposing an “internally-generated” source of fae bias as a tendency to attribute organizational success to dispositional factors. as fae is a generalized tendency in the population, we provide evidence for fae reinforcing narratives produced internally by ceo-leadership. we suspect stories of strong leadership excites investors, thereby increasing the availability of capital, reducing the cost of capital, and enhancing growth and success. the interaction of two sources of bias most likely interact to promote a reinforcing, symbiotic and sustained level of fae. attribution across nations the literature many studies in social psychology propose a variation of fae phenomena across and within cultures. shweder and bourne (1984, p. 191) proposed cultural differences in dispositionalism exist as people may be “culturally primed.” lee et. al. (1996, p. 735) suggested, “dispositionalism is related to both the perceiver’s culture and the domain of the attribution task.” kitayama et al (2006) argued that a cultural ethos can develop as a population volume 37, number 1 9 migrates and that migration is motivated by necessity. such migration may satisfy the desire for independence, hence certain cultures may generally evolve to comprise higher levels of “independent” attributes compared to collective societies. those authors explain cultural attitudinal differences of northern japan to southern japan and the american west to the american east via such reasoning. independent individuals associate happiness with personal achievement and people honoring personal achievement are more prone to “commit a dispositional bias in causal attribution.” those authors state, “thus, for people with independent agency, happiness should depend primarily on personal achievement, whereas for those with more interdependent orientations, happiness should depend more on social harmony.” this conjecture was found significant by kitayama and subsequent research also provided support for the concept of acculturalization of cognitive tendencies within cultures. the idea of acculturalization of attributive cognition is supported throughout the literature. choi et al (1999) wrote, “east asians are less likely to show.. a preference for explanations of behavior in terms of traits, dispositions… of the target”. norenzayan and nisbett (2000) stated, “miller (1984) showed that hindu indians preferred to explain ordinary life events in terms of situational context in which they occurred, whereas americans were much more inclined to explain similar events in terms of presumed dispositions.” they attribute these cultural differences to the lasting effects of history, wherein chinese farmers were more inclined to cooperate on terrace farming practices and their society tended to be collectivistic in nature whereas, in greece and italy the land was mountainous and people were required to fish and hunt, thereby activities which promoted tended to be individualistic basic nature. nakamura (1988) maintains the cognitions of east asians are more holistic than westerners. thomas and mueller (2000) stated, “… unlike the idealized american entrepreneur, characterized by rugged individualism, there is growing evidence that asian entrepreneurs rely on familial ties in developing their business.” hence, in the present research, we hypothesize that the existence of variation of fae across cultures, and that levels of fae may be causally and culturally linked to levels of individualism and collectivism of each society. furthermore, we speculate growing use of media and signals radiating from within the company and ceo him/herself are producing stronger levels of fae. 10 journal of business strategies importance to the field the over-attribution of economic outcome to the dispositional factors of the entrepreneur most likely leads simultaneously to the discounting of circumstantial outcome factors in decision-making. this error in cognition may have a harmful effect on entrepreneurial activity and decision-making, and most likely encourages sub-optimal economics and rates of return. capital invested based solely on founderbacked projects as “perceived” to be important while ignoring circumstantial factors most likely result in sub-optimal financial outcomes. for example, a board normally subject to fae bias may decide to increase a ceo’s pay package and decrease r&d, wherein r&d expenditures may, in fact, produce a better yield on investment. likewise, a board of directors heavily influenced by fae may vote to increase a founder’s stock options, wherein such action may marginally decrease shareholder wealth. a board subject to fae may likely expect the founder to have operational abilities he or she may not, in fact, have. likewise, pronounced fae may induce a board to identify the “entrepreneur’s work habits” as a factor more significant than the potential impact of a “fire at a factory” or a “change in national economics” even though there is a strong possibility these circumstantial factors may have a greater sequential and time-wise, cumulative impact on the outcome of the business. importantly, the existence of the fae may induce decision-makers to under-appreciate the impact of critical organizational dynamics in organizational outcomes. hypotheses employing hofstede’s cultural classifications, the following alternative hypotheses are developed from the stated literature and the theory outlined within. h1a: respondents will show significant differences when ranking the importance of circumstantial versus dispositional causes of entrepreneurial organizational outcomes. h2a: respondents will show significant differences when ranking circumstantial verses dispositional causes of organizational outcomes across international cultures. h3a: cultures exhibiting individualist characteristics will exhibit higher levels of preference for dispositional causes of organizational outcomes as compared to collectivist cultures. h4a: cultures exhibiting collective characteristics will exhibit higher levels volume 37, number 1 11 of preference for circumstantial causes of organizational outcomes as compared to individualist cultures. methodology samples worldwide faculty participating in the 2014 babson college’s global entrepreneurship monitor reports were sent emails asking if they would participate in the current study and translate and administer the survey instrument. this sample was assumed to be actively involved in international teaching and research. of the twenty-two countries asked to participate, china, thailand, the u.s.a., and hungary agreed and the survey instrument was sent to them. russian faculty refused to participate. surveys were returned via u.s. mail or by scanned email. the responding sample countries include collective and individualistic societies. for the purpose of the present study, the current authors rely on the hofstede (2001) paradigm of cultural dimensions wherein hofstede classified the usa and hungary to be “individualistic” societies, and china and thailand to be “collectivist.” a total of 275 usable surveys were obtained [china (n=62), thailand (n=68), u.s.a. (n=95), and hungary (n=50)]. table 1 shows the study participants by country and gender. table 1 study participants by country and gender gender total man woman nation china 36 (58%) 26 (42%) 62 (100%) hungary 23 (46%) 27 (54%) 50 (100%) usa 63 (66%) 32 (34%) 95 (100%) thailand unidentified unidentified 68 (100%) total 122 (59%) 85 (41%) 275 (100%) 12 journal of business strategies the instrument in prior research, a survey instrument categorizing dispositional and circumstantial outcome factors testable to significant categorization was developed (fiore, 2012). of the 32 tested items in a proposed survey instrument, 31 factors were found to be significantly distinguishable wherein 15 classified factors were dispositional and 16 were considered circumstantial factors. in that study, a onesample chi-square test was applied to test if there was a significant difference in categorization responses on each of the 32 variables. respondents strongly agreed that 31 of the items with their assessment of categorizing dispositional and circumstantial factors as significant so 31 items were retained. table 2 shows the 31 event factors considered by respondents to be either dispositional or circumstantial. table 2 list of 31 dispositional and circumstantial factors effecting business outcomes dispositional circumstantial the entrepreneur’s knowledge a fire at the business the entrepreneur’s preparation a competitor’s bankruptcy the entrepreneur’s mental strength a labor shortage the entrepreneur’s background change in national economics the entrepreneur’s industry training the weather the entrepreneur’s academic training change in technology the entrepreneur’s business experience sabotage the entrepreneur’s intelligence change in inflation the entrepreneur’s business skills natural disasters the entrepreneur’s personal work habits economy the entrepreneur’s office environment foreign competition the entrepreneur’s leadership interest rates the entrepreneur’s financing market for the product the management team’s effectiveness competitor’s financing costs the quality of entrepreneur’s product global warming effects volume 37, number 1 13 in the current study, respondents were asked to consider a large entrepreneurial company with a founder who had a strong influence in the company’s economic outcome. this instruction purposefully primed perceivers to respond with an entrepreneurial situation in mind. a specific company or entrepreneur was not employed as one particular company or person may not be known or understood by all nationalities. the survey solicited responses indicating respondent’s perceptions of the relative importance of the 15 dispositional and 16 circumstantial factors to the success of a company. the survey instructed the dispositional and circumstantial factors be ranked in importance using a discreet scale of 7 = essential to 1 = not important, to the outcome of the company. in the united states, the survey was administered in english. in the case of non-english speaking countries, the instrument was translated by the participating faculty member. the possible circumstantial and dispositional business outcome factors were randomly placed on the actual survey instrument to prevent obvious classification and respondent predisposition. results all 31 causative factors were analyzed by the multi-dimensional scaling (mds) technique. mds was used in order to explore how the response items that are spatially distributed as dispositional or circumstantial factors by the study participants. mds is a statistical technique which creates a map displaying the relative positions of a number of objects, giving a visual map of the distances between them. the technique calculates either metric or the non-metric solution. within mds, the orientation of the image is arbitrary. the mds map shows the relative proximity of all attribution elements in the identified (two in this case) dimensions and presents clusters and dispersions along these two dimensions. in short, close proximity and clusters suggest potential similarity of the elements or domains; and dispersion of the elements suggests difference their domain. through qualitatively examining these domains and their proximity and direction of the dispersions, we can infer meanings of the axes and clusters. difference in dispositional versus circumstantial attribution figure 1 shows the resulting spread of the 31 items (integrated score by all participants) in the two dimensional space in relation to a origin. other than two items (change in technology and market for the product), most of the circumstantial factors 14 journal of business strategies (denoted “c”) were spread in the top right-side of the plane, and all the dispositional factors (denoted “d”) were spread in the bottom left-side. the factor “change in the technology” and “market for the product” were perceived to be more closely related to the circumstantial factors than dispositions. this result implies those two factors could be perceived by respondents as factors which entrepreneurs had control over. this noticeably distinctive spread on the mds two dimensional space suggests distinction of the two dimensions. further examination of the factor spread shows support for the horizontal dimension of “man-made” (west-bound) versus “naturedriven” (east-bound). the vertical separation dimension of “micro-person” factors (south-bound) and “macro-global” causations (north-bound) were also robust. differences among nations figure 2 shows data from four countries were analyzed separately for mds, and the resulting diagrams were exhibited next to each other for the purpose of comparison. in figure 2, four separate figures are presented in the order of the u.s., china, thailand, and hungary. except for a few items, the spread pattern of the four country responses are very similar, indicating participants perceive the importance of these fae items and their relative positions of attributions are not very different from country to country. in summary, all participants by country in the study presented a similar cognitive structure of these entrepreneurial success factors of circumstances and dispositions. hence, this result causes the authors to reject hypothesis 2a (respondents will show significant differences when ranking circumstantial verses dispositional causes of organizational outcomes across international cultures.) volume 37, number 1 15 figure 1 overall examination of fae items structure (all four country respondents integrated) 16 journal of business strategies figure 2 further examination of fae items structure by country volume 37, number 1 17 18 journal of business strategies anova analysis of variance was conducted to test for differences in mean scores of fae among four countries. table 3 provides results. except for a few items, all the fae items demonstrated statistically significant differences among four countries (p<.01 for most of the items). participants scored higher on dispositional items than circumstantial ones. american participants showed higher scores for dispositional items and thai participants showed higher scores for circumstantial items. in order to visually show the differences of the scores by category and by the country, all 31 items were sorted by the score of american participants and graphed in figure 3. volume 37, number 1 19 ta bl e 3 m ea n sc or es o f f a e a m on g fo ur c ou nt ri es a nd r es ul ts o f a na ly si s of v ar ia nc e te st c at eg or y it em m ea n s co re s um o f s qu ar es m ea n s qu re s fr at io s ig . u sa c h in a th ai h u n g b et w ee n g ro up s (d f= 3 fo r a ll) w ith in g ro up s (d f= 27 1 fo r a ll) c irc um st an ce s m ar ke t 6. 40 5. 48 5. 91 6. 28 20 1. 3 73 2. 7 67 .1 24 .8 1 0. 00 te ch no lo gy 6. 27 5. 89 6. 12 6. 70 87 .9 67 0. 6 29 .3 11 .8 4 0. 00 c om pe tit or p ro d 5. 72 5. 10 5. 71 5. 56 86 .0 69 6. 2 28 .7 11 .1 6 0. 00 n at io na l e co n 5. 61 5. 39 6. 01 4. 58 19 .4 30 8. 7 6. 5 5. 67 0. 00 g lo ba l e co no 5. 59 5. 05 5. 93 5. 42 62 .1 44 6. 5 20 .7 12 .5 6 0. 00 fi na nc in g co st 5. 46 4. 29 5. 46 5. 24 94 .4 67 2. 4 31 .5 12 .6 8 0. 00 fo re ig n co m pe t 5. 45 4. 19 5. 72 5. 04 24 5. 2 68 0. 7 81 .7 32 .3 0. 00 in te re st ra te 4. 91 4. 19 4. 91 3. 64 26 .0 36 0. 7 8. 7 6. 51 0. 00 in fla tio n 4. 66 4. 19 5. 16 3. 50 88 .1 64 8. 8 29 .4 12 .2 7 0. 00 fi re a t b us in es s 4. 61 3. 69 4. 99 3. 16 69 .9 57 4. 8 23 .3 10 .9 8 0. 00 c om pe tit or b an kr 4. 61 3. 94 4. 84 4. 02 35 .5 23 3. 8 11 .8 13 .7 0. 00 la bo r s ho rta ge 4. 52 4. 81 5. 06 3. 34 61 .9 46 4. 4 20 .6 12 .0 4 0. 00 sa bo ta ge 3. 61 3. 08 4. 59 3. 30 20 2. 2 71 6. 5 67 .4 25 .5 0. 00 n at ur al d is as te r 3. 09 2. 53 4. 60 2. 32 17 .0 57 3. 2 5. 7 2. 68 0. 05 20 journal of business strategies g lo ba l w ar m in g 2. 60 2. 48 4. 34 1. 98 12 7. 6 75 3. 5 42 .5 15 .3 0. 00 w ea th er 2. 44 2. 45 4. 34 1. 66 37 .9 84 0. 5 12 .6 4. 07 0. 00 d is po si tio n pr od uc t q ua lit y 6. 59 6. 52 6. 12 6. 24 23 .5 31 6. 4 7. 8 6. 71 0. 00 vi si on 6. 47 5. 84 6. 10 6. 00 15 .3 34 3. 6 5. 1 4. 01 0. 00 le ad er sh ip 6. 46 6. 11 6. 24 6. 06 23 .1 33 7. 1 7. 7 6. 19 0. 00 k no w le dg e 6. 45 5. 69 5. 96 6. 06 17 .1 71 9. 9 5. 7 2. 14 0. 10 m an gt t ea m 6. 33 6. 39 6. 28 5. 72 27 .8 52 4. 6 9. 3 4. 78 0. 00 fi na nc in g 6. 33 5. 31 5. 97 5. 66 11 .7 60 7. 0 3. 9 1. 74 0. 16 pr ep ar at io n 6. 28 5. 92 6. 03 5. 62 9. 6 47 8. 2 3. 2 1. 82 0. 14 sk ills 6. 27 6. 23 6. 26 5. 50 10 .9 22 4. 7 3. 6 4. 4 0. 00 m en ta l s tre ng th 6. 15 6. 40 5. 60 6. 20 0. 9 35 5. 5 0. 3 0. 22 0. 88 m is si on 6. 07 5. 55 5. 21 6. 00 15 .5 24 7. 4 5. 2 5. 68 0. 00 w or k h ab it 6. 05 5. 18 5. 66 4. 80 23 .6 30 3. 5 7. 9 7. 02 0. 00 in te llig en ce 6. 04 6. 19 6. 09 6. 10 42 .3 29 5. 2 14 .1 12 .9 4 0. 00 ex pe rie nc e 5. 52 5. 52 5. 93 5. 44 61 .5 41 9. 0 20 .5 13 .2 6 0. 00 o ffi ce e nv iro nm 5. 52 4. 92 5. 43 4. 82 24 .8 41 4. 3 8. 3 5. 4 0. 00 tr ai ni ng 5. 21 5. 19 4. 57 5. 48 7. 3 21 6. 9 2. 4 3. 04 0. 03 b ac kg ro un d 4. 78 4. 32 4. 88 4. 32 17 .2 29 2. 4 5. 8 5. 33 0. 00 ac ad em ic t ra in 4. 56 4. 98 4. 56 4. 38 35 .6 48 5. 0 11 .9 6. 63 0. 00 volume 37, number 1 21 figure 3 circumstances and dispositions by country figure 3 visually displays circumstantial factors on the left and dispositional factors on the right. thai participants scored highest among the four countries on most of the circumstantial items; and american participants scored the highest among four countries on most of the dispositional items. table 4 correlation among four countries by fae scores usa china thai usa 1.00 china 0.93** 1.00 thailand 0.88** 0.83** 1.00 hungary 0.95** 0.91** 0.81** **. correlation is significant at the 0.01 level (2-tailed). while the four country participants demonstrated statistically significant differences in rating each fae item, it is interesting to note their patterns of ratings on all items in relation to each other were very similar. in order to investigate this 22 journal of business strategies similarity of pattern on a numerical basis, the average scores of all 31 items (column 3 through 6 on table 3) were correlated by the four different countries. table 4 shows the results of this correlational analysis and correlations show statistical significance. these high correlations indicate very similar cognitive structure of fae items as we noted through the multiple multidimensional scaling analyses above. again, the results lead to rejection of h2a. while all four country participants rated very similarly in relation to each other of the fae items (high correlation between countries), americans rated the highest of the dispositional factors overall and thai participants rated the circumstantial factors the highest among four nations. this result supports the proposal americans are likely to explain organizational outcomes by a leader’s dispositions than are other cultures. thai participants give a high level of importance to circumstantial factors. table 5 shows average scores of circumstance factors and all disposition factors compared among four countries. figure 5 illustrates the differences among aggregate scores of the perceived importance of circumstance and disposition factors. it is interesting to note thai participants showed the narrowest gap between dispositional and circumstantial factors. thailand may be considered the strongest buddhist nation among the four, wherein such faith is rooted in the belief of a “supernatural fate” perceived to be beyond human control. generally, americans and hungarians have christian traditions, generally showing belief that humans expected to control nature. the chinese have gone through the cultural revolution, generally reducing traditional buddhist beliefs possibly explaining why chinese respondents rated circumstantial factors significantly lower (average score of 4.17) than dispositional factors (average score of 5.66). in explaining outcomes, american participants highly rated dispositional factors (5.95) the highest among four countries as important and circumstantial factors significantly lower (score of 4.72). volume 37, number 1 23 table 5 average scores of importance of circumstances and dispositions by country country circumstance disposition usa 4.72 5.95 china 4.17 5.66 thailand 5.23 5.70 hungary 4.11 5.55 figure 4 average scores of circumstances and dispositions by country further research it is suggested more detailed research on attribution be performed on a greater number and range of collective and individualist cultures. a study of the extent of fae and tendency of attribution to dispositionalism and company performance correlated with stock market returns could provide additional evidence of the financial effect of dispositional tendencies. recent research (liu, et. al. 2018, koh, 2011) has suggested firms with celebrity ceos produce lower rates of return for investors than lesser-known leaders. we note notable celebrity jack welch, jr. ceochairman of ge for twenty years and ge stock now at $9/share. further research on the impact of the fae to different samples, demography, 24 journal of business strategies stakeholder groups, nations and industries could yield useful results. a more complete analysis of the strength of attributions exhibited by the general public and fae generated by ceo-entrepreneurial leadership would also yield important research results. conclusions the results of the present study support ten important facets of fae applicable to entrepreneurial situations and management. it was found; 1. there exists a global tendency of perceivers to attribute organizational outcome to the perceived dispositional factors of ceo-leadership within entrepreneurial situations. 2. a global tendency of perceivers to have lower regard for the impact of circumstantial factors while assessing the outcomes of entrepreneurial business organizations. 3. a global tendency of perceivers to make decisions based on the perceived importance of influential leader’s skills while considering circumstantial factors less important when assessing business cause-effect outcomes. 4. anecdotal evidence suggesting the celebrity status of the founders may produce and enhance the effect of fae and possibly reduce long-run returns on investment. 5. a tendency for ceo-entrepreneurial leaders to purposefully create ex-post intentionality and invent dispositional skills even though evidence of ex-ante intentionality may not have existed. 6. a tendency for ceo-entrepreneurial leaders to attribute organizational outcomes to his or her personal dispositional factors while ignoring a multiplicity of important circumstantial events in assessing causation of business outcomes. 7. a possibility for decision makers to allocate capital sub-optimally in capital budgeting using biased assumptions of the value of founding leadership dispositions skewing allocations away from circumstantial factors. 8. a tendency for decision makers in collective societies to be less impacted by fae biased managerial decisions than in societies considered to be individualistic. 9. a tendency for americans to be highly affected by fae. 10. the similarity of fae responses from differing cultures may show a global standard in fae in the human mind. volume 37, number 1 25 executive boards within a country exhibiting high levels of fae (notably america) may more likely expect the founder to have operational or organizational abilities which he or she may in fact, not have. although the entrepreneur may recognize and seize the initial opportunity, it is likely the organization’s subsequent development, strength and situational circumstances are large factors in determining subsequent success. attention to, and management of circumstantial factors and events may produce more economic value than relying on a leader’s personal dispositions. references aldrich, h. e. (2011). heroes, villains, and fools: institutional entrepreneurship, not institutional entrepreneurs, entrepreneurship research journal, 1(2), 2157-5665. buehler, r., griffin, d., ross, m. (1994) exploring the “planning fallacy”: why people underestimate their task completion times, journal of personality and social psychology, 67(3) 366-381. byers, t., kist, helen, sutton, r. characteristics of the entrepreneur: social creatures, not solo heroes, paper prepared for the handbook of technology management, richard c. dorf (editor), crc press llc.. boca raton, fl, 33431. bygrave, w.d., fast, n., khoylian, r., vincent, l. (1989). early rates of return on 131 venture capital firms started 1978-1984, journal of business venturing, 4, 93-106. chipotle (2012) video file retrieved from https://www.youtube.com/ watch?v=wmh73diqf5q choi, i., nisbett, r., norenzayan, a. (1999) causal attribution across culture: variation and universality, psychological bulletin, 3(125), 47-63. dimov, d. (2007). beyond the single-person, single-insight attribution in understanding entrepreneurial opportunities, entrepreneurship: theory and practice. fiore, r. (2012). the entrepreneur’s random walk, journal of applied business research, 28(3), 403-410. fiore, r. and lussier, r. (2015) “measuring and testing general fundamental attribution error in entrepreneurship effecting public policy”, journal of entrepreneurship and public policy, 4(2), 171-186. 26 journal of business strategies gawronski, b. (2004) theory-based bias correction in dispositional inference: the fundamental attribution error is dead, long live the correspondence bias, european review of social psychology, 15(1),183-217. gompers, p., kovner, a., lerner, j., scharfstein, d. (2006). skill vs. luck in entrepreneurship and venture capital: evidence from serial entrepreneurs, nber working papers, working paper 12592, national bureau of economic research. hayward, m.l.a., rindova, v.p. and pollock, t.g. (2004). believing one’s own press: the causes and the consequences of ceo celebrity, strategic management journal, 25(7), 637-653. heider, f. (1958). the psychology of interpersonal relations. hoboken, nj, us: john wiley & sons inc. hofstede, g., (2001). cultures consequences: comparing values, behaviors, institutions and organizations across nations, sage. hornaday, r. (1990). dropping the e-words from small business research: an alternative typology, journal of small business management, 28(4), 22-33. jellison, j. m., & green, j. (1981). a self-presentation approach to the fundamental attribution error: the norm of internality. journal of personality and social psychology, 40(4), 643-649. jones, e. e., harris, v.a. (1967). the attribution of attitudes, journal of experimental social psychology, 3(1) 1-24. kahneman, d. (2011). thinking, fast and slow, new york, new york, farrar, straus and giroux. kitayama, s., mesquita, b., & karasawa, m. (2006). cultural affordances and emotional experience: socially engaging and disengaging emotions in japan and the united states. journal of personality and social psychology, 91(5) 890903. kelly, g. (1963). a theory of personality: the psychology of personal constructs. w.w. norton and company. koh, k. (2011). value or glamour? an empirical investigation of the effect of celebrity ceo’s on financial reporting practices and firm performance, accounting and finance, 51(2), 517-547. krull, d., s., loy, m. h.-m., lin, j., wang, c.-f., chen, s., & zhao, x. (1999). the fundamental attribution error: correspondence bias in individualist and collectivist cultures. personality and social psychology bulletin, 25(10), 1208–1219. volume 37, number 1 27 kunda, z. (1999). social cognition: making sense of people, cambridge, ma., massachusetts institute of technology. lee, f., hallahan, m., & herzog, t. (1996). explaining real-life events: how culture and domain shape attributions. personality and social psychology bulletin, 22(7), 732–741. li, y. j., johnson, k. a., cohen, a. b., williams, m. j., knowles, e. d., & chen, z. (2012). fundamental(ist) attribution error: protestants are dispositionally focused. journal of personality and social psychology, 102(2), 281-290. liu, d., fisher, g., chen, g. (2018) ceo attributes and firm performance: a sequential mediation process model, academy of management annals, 12 (2). miller, j. g., bersoff, d. m., & harwood, r. l. (1990). perceptions of social responsibilities in india and in the united states: moral imperatives or personal decisions? journal of personality and social psychology, 58(1), 33-47. nakamura, h., (1964/1991). ways of thinking of eastern peoples, east-west center press, now university of hawaii press. norenzayan, a., & nisbett, r. e. (2000). culture and causal cognition. current directions in psychological science, 9(4), 132–135. palich, l., bagby, d.r. (1999). using cognitive theory to explain entrepreneurial risk-taking: challenging conventional wisdom, journal of business venturing, 10(6), 425-438. rogoff, e.g., m. lee, d. suh, (2004). “who done it?” attributions by entrepreneurs and experts of the factors that cause and impede small business success”, journal of small business management, 42(4), 364-376. ross, l. (1977) the intuitive psychologist and his shortcomings. in l. berkowitz (ed.) advances in experimental social psychology, 10, 173-220, new york, new york, academic shane, s. (2008). the illusions of entrepreneurship, new haven, ct., yale press. shweder, r. a., bourne, e. j., (1984) culture theory: essays on mind, self and emotions, university of cambridge, u.k. subway (2006) retrieved from: trade show video, doctors associates, inc. thomas, a. s., mueller, s. l., (2000) a case of comparative entrepreneurship: assessing the relevance of culture, journal of international business studies, 31(2), 287-301 van dyck, c., frese, m., baer, m., sonnentag, s., (2005). organizational error management culture and its impact on performance: a two-study replication, journal of applied psychology, 90(6), 1228-1249. 28 journal of business strategies biographical sketch ofauthors lee w. lee teaches organizational behavior and management at central connecticut state university. he earned his mba and ph.d. at suny at buffalo and is a two-time fulbright international exchange scholar. his research interest includes technology management, entrepreneurial strategy, leadership, cross-cultural comparative study and publishes his works widely. robert a. fiore holds a d.b.a. from argosy university-school where his dissertation was the entrepreneurial process: the emerging organization’s structure and the wealth generation period which won the coleman foundation best paper award. he holds a m.b.a. and b.a. from the university of massachusetts. dr. fiore is a grantee of the u.s. fulbright specialist program for entrepreneurship, lecturing in china. dr. fiore has published in the journal of entrepreneurship and public policy, the journal of business and economics, the journal of applied business research, and the journal of small business strategy and many others. he has founded and harvested his own corporations. mavericks, visionaries, protectors, and sages: toward a typology of cognitive structure for decision making in organizations dennis duchon donde p. ashmos maria nathan university of texas at san antonio san antonio, tx abstract this paper reports a study of the relationship between cognitive structure and organizational decision making. cognitive structure, aframework that helps the decision maker organize and interpret information, has both context (conventional vs. non-conventional) and process (conclusive vs. nonconclusive) dimensions. based upon context and process combinations, four cognitive structures are identified. results indicate systematic relationships between cognitive structure and both the perception of a problem and the choices made. the four types can be seen as mutually supportive, each contributing special strengths to decision making in organizations. introduction decision making in organizations often involves multiple players, who bring to the task varying frames of reference and interpretation skills. in the case of strategic decisions, for example, the actors engage in choice making about how to align a company's competencies with the opportunities and threats in its environment. yet before any kind of alignment can take place, the nature of competencies, opportunities, and threats must be identified, understood, and articulated by the decision maker or decision making group. each individual decision maker mentally observes and organizes data in a way that gives meaning to these variables. to do this each decision maker conceptualizes these variables in a mental framework that makes sense and which enables the interpretation of organizational issues and strategic choice making (janis, 1982). most decision making in organizations depends on the compilation of objective data, but the interpretation of these data is influenced by decision makers' cognitions (bateman & zeithaml, 1989; anderson & payne, 1975; das, 1986; mitchell, rediker & beach, 1986; weick, 1995; 1979). thus, human cognitive and psychological processes (bateman fall 1997 duchon, et at: toward a typology 107 & zeithaml, 1989; eisenhardt & zbaracki, 1992) are important factors which influence organizational decision making. cognitive psychologists have established that individuals use conceptual frameworks, sometimes called cognitive structures or schemas (hogarth, 1980), to organize beliefs and preferences which influence decisions. in this paper we suggest that the cognitive structures of decision makers differ on two dimensions: preference for context and preference for process. grounded in hogarth's (1980) view of schemas as including an acquisition component (le., how information is acquired) and a processing component (i.e., how information is processed), we combine dimensions of context and process and create four characteristic cognitive structures in order to examine whether or not some combination of these mental structures helps explain decision makers' interpretations and choices. an examination of 123 decision makers indicates that differences in cognitive struc~ tures, in fact, are associated with different interpretations of strategic issues and different choices (cf., gioia & mehra, 1996). based on our results we identify implications of having multiple cognitive structures represented in decision making in organizations. cognitive structure the choices that organizations make and the outcomes of those choices are reflections of the cognitive structures of top level decision makers (hambrick & mason, 1984). these cognitive structures are a powerful influence on decision making in an organization. janis (1989), for example, suggests that individual cognitive structures significantly constrain organizational problem solving. nystrom & starbuck (1984) go even further by arguing that organizational crises are most often created by the manager's thinking processes rather than external events. thus, in order to better understand how decisions are made in organizations, we must know something about the cognitive structures that guide and shape perception and choice. decision makers use mental frameworks to organize information in ways that enable them to understand decision issues and to make choices (hall, 1984; hogarth, 1980; schoemaker, 1993). these frameworks are the "net~ works of ideas that people possess mentally when they confront their world" (cowan, 1987). such frameworks, sometimes referred to as cognitive structures, and sometimes referred to as schemas (hogarth, 1980; ireland, hitt, bettis, & deporras, 1987), characterize a person's experience and beliefs about a task environment (hogarth, 1980). cognitive structures are constructed from past experiences (kiesler & sproull, 1982) and enable individuals to perceive, remember, infer, and evaluate. in choice situations, cognitive structures impart meaning (gioia & poole, 1984) and allow managers to categorize events, assess consequences, and consider appropriate actions in a timely and efficient manner (ireland et. ai., 1987). 108 journal of business strategies vol. 14, no.2 hogarth (1980) argues that cognitive structures or schemas can be decomposed into two operations: acquisition of information and processing of information. these operations lead to choices. thus, a person's schema or cognitive structure, is expressed or reflected by the nature of information that is acquired (e.g., where it comes from, what type it is) and by the way the information is processed (i.e., what mental operations are applied to the information). hogarth's framework provides the basis for the conceptualization we offer in this paper (see figure 1). we argue that decision makers, because of differences in cognitive structures, differ in their preferences for types of information and differ in their preferences regarding information processing. that is, the cognitive structure predisposes or prepares the decision maker to form certain kinds of perceptions (information acquisition) and make certain kinds of choices (information processing). preference for context hogarth (1980) argues that judgment is a function of two operations: acquisition of information and processing of information. in order for decision makers to make choices, they select information they believe salient to the task and they then adopt a processing strategy. russo and schoemaker (1990) argue that individuals develop preferences for both the types of information they select and the processing style they use. these preferences constitute a personal frame or structure which, over time, proves useful and familiar. in this study, we describe cognitive structure in terms of two dimensions. we refer to the preference for acquiring a particular type of information as the "context" dimension because the type of information selected creates a context for processing and choice. we refer to the preference for using information as the "process" dimension of cognitive structure. the context dimension reflects the decision maker's preference for a particular type of information which derives from a consistent source. hogarth suggests that an individual's memory is a major source of information. memory, in turn, is a function of the individual and as individuals differ in what information they select from memory to be relevant to a given task, they construct different contexts which can lead ultimately to different choices. thus, a decision maker's cognitive structure leads him/her to familiar information in order to reduce uncertainty in choice situations. in uncertain choice situations, there will not be an obvious or "rational" source of information. therefore, the decision maker retreats to an information source that is comfortable, familiar and has proven useful in past episodes. this fall back posi· tion is a preference and functions as a reference point. for example, in an uncertain situation a decision maker might characteristically use history or tradition as the preferred context or source of information (march, 1981; mitchell et. ai., 1986). alternatively, the decision maker may characteristically reject tradition and seek out a source of information which contravenes conventional wisdom. in either case, however, the choice of what information to acquire via a preferred fa111997 duchon, et al: toward a typology 109 context is rooted in the decision maker. building on the work of kirton (1976) and myers (1962) we propose that it is useful to think of the context dimension as being characterized by a preference for information which is anchored in either a conventional or non-conventional context. conventional context. the conventional context is a preference for current paradigms, accepted practice, or standard procedures. thus, the primary source of information needed for decision making within this context is tradition or history. in the conventional context, decision makers accept things the way they are and look to historical practices for clues in dealing with current issues. in relying on the conventional context, decision makers might be on the lookout for improvements, but these improvements will take the form of modifications of current practice, or the achievement of greater efficiency by "tinkering." such an incremental approach results from an information source preference for tried and true practices. the conventional context represents a cognitive structure which guides the decision maker within the domain of what is known. non-conventional context. the non-conventional context, in contrast, is a preference for new or alternative paradigms and untried ideas. thus, the primary source of information needed for decision making lies outside current ways of thinking, the existing system and its traditions. in the non-conventional context, decision makers do not look to historical patterns as the major source of information. rather, they seek improvements by challenging accepted practice and ignoring the existing system. such an approach is undertaken because the major source of preferred information lies outside the existing system and outside history and tradition. the non-conventional context expresses a cognitive structure which guides the decision maker's information search outside the domain of what is known. preference for process in addition to the context dimension (which can be thought of as providing an anchor or reference point), there is also a process dimension that reflects the decision maker's preference for seeking closure or continuing to acquire information (hogarth, 1980). current views of information processing are grounded in simon's (1978) descriptions of the limits of human information processing. due to cognitive limitations, decision makers do not use exhaustive search and evaluation processes. rather than trying to cope with enormous information demands, decision makers attempt to constrain the decision problem and then seek a satisfactory (rather than optimal) solution to that problem. taylor (1984) refers to the constraint pressures on cognitive processes as "cognitive strain" (p. 80) and suggests, as others have (d. tversky & kahneman, 1974) that decision makers typically deal with cognitive strain by developing simple heuristics or rules-of-thumb. what is important for the current study, however, is taylor's (1984) claim that decision makers vary in their ability to cope with cognitive strain. the cognitive characteristics of 110 journal of business strategies vol. 14, no.2 decision makers influence information handling and exert a major influence on idiosyncratic decision making behaviors such as whether or not to search for more information (p. 101). others have also noted individual differences in a preference for a satisfactory "amount" of information processing. harrison (1981), for example, notes that information search activity persists as long as acceptable standards are not obtained. the acceptability of standards varies among decision makers because the search for alternatives is mediated by human preferences. huber (1980) argues that in the decision making stage of generating alternatives some people will slight the alternative-generation process in favor of proceeding to evaluation and choice, and that this has the effect of reducing the opportunity for high quality solutions to be identified. thus, individuals have a process preference, in particular, a preference for the amount of information processing they will undertake. maccrimmon and wehrung (1986), in a large-scale study of managerial decision making and risk taking, note individual differences in information processing by observing that some managers have a propensity to gather more information and others have a propensity to decide based on the information already at hand. interestingly, the managers who delayed making choices by gathering more information tended also to be risk-averse. in this paper, we focus on the preference of the decision maker to act on information or to search for more. the information acquired is used either to make ajudgment or as the springboard for further information gathering. thus, we propose that it is useful to think ofthe process dimension as being characterized by a preference for either a conclusive or nonconclusive process. conclusive process. this process expresses a preference for using information to make ajudgment and to reach closure. decision makers who use a conclusive process are trying to settle things, finalize and categorize through procedures that are definite although reasonable and rational. a preference for conclusive processes is accompanied by a preference for planning and following plans. a conclusive process is orderly and fast. nonconclusive process. this process expresses a preference for knowing more and using the information at hand to determine what additional information is needed. it is a process used to find out more acquire or develop more information and thus delay closure. decision makers who use a nonconclusive process are trying to stay open to other (new) possibilities and they resist finalizing or concluding. a preference for a non conclusive process is most likely not orderly and may be slow. four cognitive structure categories by combining the context and process dimensions we can propose four characteristic cognitive structures. we have labeled each combination and describe them below. see figure 1 for a summary description of the four categories. fall 1997 duchon, et al: toward a typology figure 1 cognitive structures preference for process (lnfonnation processing) 111 nonconclusive conclusive conventional preference for context (information acqui si ti on) non-conventional current paradigms current paradigms accepted practice accepted practice standard procedures standard procedures discover more seek closure delay deciding make judgement stay open to possibilities finalize sage protector outside current paradigms outside current paradigms challenge current practice challenge current practice ignore existing system's ignore existing system's current paradigms current paradigms discover more seek closure delay deciding make judgement stay open to possibilities finalize visionary maverick protector. the protector structure prefers a conventional context and a conclusive process. thus, the protector seeks information within the existing domain, prefers order and acts decisively. in organizational decision making, the protector relies on tradition as a source of information for what the organization should do next and seeks to use the information to act, decide or reach closure. protectors might seek small variations in current practice in order to achieve greater efficiencies and then actively pursue those small changes. sage. the sage structure prefers a conventional context and a nonconclusive process. thus, the sage looks to past practice and the existing system for information needed to interpret events, yet feels little necessity to move towards closure. tradition and history provide the major sources of critical information needed for organizational decision making, however the cognitive structure differs from that of the pro112 journal of business strategies vol. 14, no.2 tector because the sage rejects process boundaries, preferring to use existing information to search for new problem solutions. the sage structure may create conflict for a decision maker who gets caught between the rigors of standard procedures and curiosity about alternatives. the sage functions as a caretaker, conventional but distant, seeing to it that history and tradition provide the decision making anchor, yet finding it unnecessary to move towards closure quickly. maverick. the maverick structure prefers a nontraditional context and a conclusive process. thus, the maverick rejects existing paradigms, looks for information beyond the established order, and is intentional and decisive in making choices. the major source of critical information needed for organizational decision makers is in new ideas and alternate frameworks. the maverick prefers nontraditional sources of information but then seeks to act on the newly acquired information. the maverick will assert the need for paradigm shifts, and will relentlessly make the choices to effect that shift. the maverick prefers to lay the new framework on existing problems, then decide and move on. visionary. the visionary structure prefers a nontraditional context and nonconclusive processes. thus, the visionary structure relies on information outside the established order and is also open to alternative ways of using that information. the visionary constantly seeks to know more. the visionary appears hesitant because slhe avoids a final decision. the visionary may be able to articulate a new direction for an organization, but may lack the decisiveness to chart the course and implement that direction. the visionary could be viewed as an eccentric someone who is out of touch. differences in cognitive structure (i.e., preferences for context and process) will lead to systematic differences not only in the ways decision problems are perceived, but also in the decisions that are made. while there are many ways to capture perceptions of decision problems, in the current study, we have operationalized perception in terms of the degree of risk seen in a decision problem. while perception of risk does not capture the entire problem space, it does capture an important element which can be "seen" different ways by different people. we believe that differing perceptions of risk will in turn be associated with different behaviors. thus, based upon the discussion above, we make the following predictions: hypothesis 1. decision makers characterized by a preference for a conventional context (sages and protectors) will perceive more risk in a given decision situation than will decision makers characterized by a preference for non-conventional context (mavericks and visionaries). that is, cognitive structures which prefer conventional practice will perceive risk in something outside conventional practice, while cognitive structures which prefer non-conventional practice will not. fall 1997 duchon, et al: toward a typology 113 hypothesis 2: decision makers characterized by a preference for a conventional context (protectors and sages) will make choices that are more risk averse than will decision makers characterized by a preference for non-conventional context (mavericks and visionaries). that is, cognitive structures which prefer conventional practice will make choices in support of conventional practice, while cognitive structures which prefer nonconventional practice will not. hypothesis 3. decision makers characterized by a preference for nonconclusive process (sages and visionaries) will perceive more risk in a given situation than will decision makers characterized by conclusive processes (protectors and mavericks). we expect this outcome because the nonconclusive cognitive structure does not seek closure and will find it risky to commit to an alternative. the conclusive cognitive structure, on the other hand, seeks closure and will not necessarily perceive commitment to a choice as a risk. hypothesis 4: decision makers characterized by a preference for nonconclusive process (sages and visionaries) will make choices that are more risk averse than will decision makers characterized by a preference for conclusive processes (protectors and mavericks). again, the nonconclusive cognitive structure seems risk averse because it prefers not choosing. method the present study is an experiment in which decision makers assessed the amount of risk involved in a decision (an act of interpretation) and then made a choice. decision makers were classified according to their characteristic or preferred cognitive structure. we then examined how these different cognitive structures might be associated with different interpretations of risk and different decision outcomes. the sample consisted of 123 employees from an international, high-technology engineering firm: 70% males, 30% females, average age 33.9 years. these people have, on average, been with the company 5.5 years, and in their present jobs 3.9 years. approximately 27% of the sample have some college, 9% graduated from a technical school, 30% have bachelor's degrees, 31% have master's degrees and 3% hold a ph.d. (there are six employees for whom educational data are missing.) 114 journal of business strategies vol. 14, no.2 procedure subjects were administered a questionnaire that measured each decision maker's characteristic cognitive structure. subjects also read a scenario describing a strategic decision making situation involving a proposed corporate joint venture with a competitor and responded to questions about their perceptions and choices. in order to make the scenario as realistic as possible, it was designed with the help of representative managers not included in the study. a strategic decision situation was devised that these managers felt was both realistic and possible. in addition, language and procedures idiosyncratic to the firm were incorporated to ensure subject familiarity with, as well as interest in, the situation being described. see appendix a for details of the scenario. note that in terms of expected value (i.e .• given the probabilities and other information in the scenario), the "best" choice is accepting the joint venture. refusing the joint venture is a riskier alternative. thus, the conventional choice is to accept the joint venture. independent variable the independent variable in this study was cognitive structure. cognitive structure can manifest itself in both the interpretational and choice making stages of decision making. we assessed two dimensions of cognitive structure: preference for context and preference for process. context measure. cognitive context was measured with the kirton adaptationinnovation inventory (kai) (kirton, 1976). the kai is an assessment of cognitive structure based upon the assumption that individuals can be located on a continuum ranging from a predisposition to "doing things better" (adaptor) to a predisposition to "doing things differently" (innovator). these anchor points are equivalent to our descriptions of conventional and non-conventional contexts. the conventional context consists of tried and true methods to solve problems, and concerns itself with problem solutions that will be efficient, precise, and reliable. individuals who prefer the conventional context seek stability, order and continuity. people whose style is to do things differently are said to prefer a non-conventional (innovator) context. the non-conventional context does not consist of tried and true approaches to problems. rather it is characterized by tangential thinking and novel approaches to problems, approaches outside the accepted system. the nonconventional context does not rely on customary procedures. the original kai (kirton, 1976) was composed of 32 items. based on psychometric work conducted by keller and holland (1978a, 1978b, 1979), the present study used a l3-item version of the original instrument. the instrument requires subjects to imagine presenting a certain image of themselves to others. they are then asked to rate the difficulty of presenting such an image for each of the traits or attributes stated in the 13 items. responses to the items were indicated on a 5point scale which was anchored by "very easy" and "very difficult." the scale was scored such that scores above the mean were rated non-conventional strucfall 1997 duchon, et al: toward a typology 115 ture and scores below the mean were rated conventional structure. the cronbach's alpha forthe scale in the present study was .78. process measure. cognitive process was measured using the myers-briggs indicator (myers, 1962). this is a well known measure of cognitive styles (cf. henderson & nutt, 1980; cowan, 1987; kummerow & hirsch, 1986), and is based on jung's (1924) theoretical network of personality functions. we utilized the judging/perceiving measure which describes a general overall preference either for making decisions and corning to a conclusion or delaying decisions and avoiding closure (busche & gibbs, 1990). individuals who prefer a conclusive (judging) cognitive process are those who desire to make decisions and achieve closure. they operate as if things should be decided (bushe & gibbs, 1990) and they show concern for planning and organizing activities. they are methodical and orderly. they tend to find meaning from previous experiences, plans and customs. they seek closure and finality. decision makers who prefer the nonconclusive (perceiver) process are more spontaneous, flexible, open to new possibilities, reluctant to finalize and not rigid in their reliance on past experience. they avoid closure so as not to miss an important experience (bushe & gibbs, 1990). the measure captures an individual's preference for making a decision (and not seeking more information) or delaying a decision (in order to seek out more information) as noted by taylor (1984), harrison (1981), huber (1980) and maccrimmon & wehrung (1986). the cronbach's alpha for the measure in this study was .62. the correlation between the measures of the two cognitive dimensions was -.17 (p < .10). dependent variables the dependent variables in the experiment were an interpretation of risk and decision outcome. first, subjects were asked to make an assessment in probability terms of how likely it would be for them to enter the joint venture (see appendix a). a low probability estimate meant that a decision maker was not inclined to enter the joint venture, while a high probability estimate meant that a decision maker was more inclined to enter the joint venture. the mean response to this question (probability) was 47.6, sd=24.03. in other words, on average, subjects reported that they required slightly less than a fifty/fifty chance of success to go it alone. subjects were then asked: "what is the likelihood you would reject yyy's offer?" and indicated their response on a five-point scale anchored by l=reject; 2=lean toward rejecting; 3=uncertain; 4=lean toward accepting and 5=accept. this response provided a second measure of decision outcome. mean response to this question (likelihood reject) was 2.47, sd=1.42. finally, subjects were asked about their interpretation of the risks involved in the situation: "indicate the level of risk yq!! believe is associated with rejecting yyy's offer". subjects indicated their response on a five-point scale with the following anchors: 1=no risk; 2=some risk; 3=normal risk; 4=considerable risk and 5=too risky. mean response to this question (risk level) was 2.70, 116 journal of business strategies vol. 14, no.2 50=.90. thus, consistent with the expected values built into the scenario, subjects on average reported that rejecting the joint venture had some risks. results manipulation checks scenario based research captures reported intentions, not necessarily a decision maker's "real" actions. it is thus important to estimate how seriously the subjects approached the experimental task. so, after reading the decision scenario the subjects answered three questions that were intended to assess how seriously they viewed their roles in the experiment and how much responsibility they felt as decision makers. subjects were asked how important the decision was (l=not important, 5=very important: mean response=4.26, so=.76); how responsible they felt for the decision (1=not at all responsible, 5=very responsible: mean response= 4.19, so=.73), and where they felt the locus of success resided (l=out of my hands, 7=in my hands: mean response=5.23, 50=1.10). the results of these manipulation checks indicated that subjects viewed the problem as important they felt responsible for the decision and they felt that the opportunity for a successful outcome was in their hands. based on the responses to these three questions, we concluded that the subjects had projected themselves into the scenario and took their decision making task seriously. data analysis tables 1,2 and 3 report the cell means and standard deviations for the dependent variables. table 4 reports the results of 2 x 2 analysis of variance procedures used to test the hypotheses. table 1 cell means for probability (standard oeviations in parentheses) process nonconclusive conclusive 40.8 (22.0) 68.2 46.8 (18.7) (23.7) sage protector 44.2 37.5 (24.3) (20.0) visionary maverick non-conventional context 54.6 conventional (24.1) 55.1 (24.8) 42.5 (42.5) 41.6 (24.0) fall 1997 duchon, et al: toward a typology 117 table 2 cell means for risk interpretation (standard deviations in parentheses) process nonconclusive conclusive 2.4 (.84) 3.2 2.9 (.83) (.91 ) sage protector 2.6 2.3 (1.0) (.68) visionary maverick 3.0 conventional (.89) non-conventional context 2.8 (.99) 2.6 (.84) 2.7 (.90) the data in table 2 support hypothesis 1. subjects with conventional cognitive structures reported perceiving more risk than those with non-conventional cognitive structures. the mean response for conventionals was 3.0 (sd .89) while the mean response for non-conventionals was 2.4 (so .84) and these means are significantly different (f= 13 .57. p < .00 1). table 3 cell means for likely to reject offer (standard deviations in parentheses) process nonconclusive conclusive 2.1 (1.4) 3.0 2.7 (1.3) (1.4) sage protector 2.5 1.8 (1.5) (1.3) visionary maverick 2.8 conventional (1.4) non-conventional context 2.7 (1.5) 2.3 ( 1.4) 2.5 (1.4) 118 journal of business strategies vol. 14, no.2 table 4 analyses of cognitive structure preferences dependent variable independent variable f pr r2 probability full model 6.08 .000 .19 context 11.14 .001 process 7.90 .006 cxp 2.15 .14 risk level full model 5.23 .002 .12 context 13.57 .000 process 2.89 .09 cxp .10 .75 likelihood reject full model 4.27 .007 .10 context 7.74 .006 process 3.90 .050 cxp .50 .48 data in tables 1 and 3 support hypothesis 2. subjects with conventional cognitive structures were more risk averse. they required a higher probability of success to go it alone (54.6% vs. 40.8%) and they reported leaning toward accepting the joint venture offer (2.8 vs. 2.1). both of these mean differences were statistically significant (see table 4). data in table 2 do not support hypothesis 3. while the data were in the predicted direction, the differences in the means did not reach conventional levels of statistical significance. data in tables 1 and 3 support hypothesis 4. subjects with nonconclusive cognitive structures were more inclined to accept the joint venture (take the risk averse option) (2.7 vs. 2.3) and also required a higher probability of success to go it alone (55.1 % vs. 42.5%). both these mean differences were statistically significant (see table 4). follow-up cell contrasts indicated that the maverick structure was significantly more risk seeking than the sage for each of the dependent variables. moreover, the data in the tables showed a remarkably similar pattern in terms of perception and behavior. for each of the dependent variables the sage was the most risk averse, the protector second most risk averse, the visionary second most risk seeking, and the maverick the most risk seeking, although as noted the statistically significant difference was between the maverick and sage. discussion in this paper we have helped contribute to a richer understanding of individual decision making in organizations by demonstrating the importance of one fall 1997 duchon, et al: toward a typology 119 kind of individual difference: the individual's cognitive structure. we have suggested that decision makers tend to use one of four distinct types of cognitive structure, and that each type organizes information, interprets problems, and chooses in a distinct way as a result. more specifically, we have suggested that cognitive structures differ on two dimensions: cognitive context and cognitive process. an individual may prefer a conventional context, referring retrospectively to historical practices for clues in dealing with current issues. alternatively, individuals may prefer what is nonconventional; look outside current paradigms and traditions, and generally challenge accepted practices. the cognitive process dimension, on the other hand, refers to the individual's preferences for using information either to make a decision (conclusive), or as a springboard for further information gathering (nonconclusive). the conclusive process is decisive, purposeful and exacting while the nonconclusive process is open, disorderly and possibly slow. while the conclusive process pushes the decision through to closure, the nonconclusive process delays decision making because of the desire to keep searching for more information. the two dimensions combined yield four possible types: protector (conventional, conclusive), sage (conventional, nonconclusive), visionary (nonconventional, nonconclusive) and maverick (non-conventional, conclusive). the resulting types range from decision makers who are decisive and rely on history to guide decisions (protector) to information gatherers who prefer information from traditional sources and engage in exhaustive yet delayed problem solving (sage), to swift, decisive, innovators who move boldly (maverick), to opportunity-seeking decision makers who are capable of charting new directions for an organization, yet who seem to love the search for new and interesting information (visionaries). our study shows that the four cognitive structures lead to different interpretations of problems and ultimately different choices. this study has implications both for decision making in organizations and for decision making in groups. one implication is that the manager may be able to improve hislher own decision making by first understanding hislher own cognitive structure, and second, by becoming aware that individuals differ in their preferences for context and process. though the manager may think that ability and experience can lead to objective and balanced decision making, our findings suggest that the choices an individual makes may be much a function of individual differences. moreover, an organization's strategies may then also be a function of the cognitive structures of the top manager or top management team (hambrick, 1984). for example, a powerful protector coo may take hislher organization down the tried and true path dictated by years of organizational history. on the other hand, a top management team that is "stacked" with visionaries may formulate new directions for the organization, but not have the ability to move as decisively as needed. 120 journal of business strategies vol. 14, no.2 in practical terms, decision making in organizations can be enhanced by the self aware manager who uses information about his/her own and others' preferences to construct decision making groups that, in balance, can make better decisions. although future research would have to demonstrate the value of "balanced groups," it is nonetheless possible to logically infer how each of the four types provides a countervailing proficiency for what is lacking in the others. for example, the protector will remind the group to look back and give proper respect to an organization's history, and will also move for efficient, orderly decisions; the sage will prompt the team to delay in order to gather more information new, useful information about the environment that can assist the group to gain richer insights and better ideas; the visionary can unstick the group from rigid thinking, and even boldly take the group into exciting new territories; the maverick can be the project champion who gets the job done once slhe is convinced of the best direction for the organization to take. the four types all together provide for a fast (but not too fast), decisive (but not at the expense of new, exciting data) balanced team. by being mindful of the countervailing forces in play when individuals with diverse cognitive structures work together, the manager can anticipate strengths and possible weaknesses of team decision efforts. the issue of more cognitively diverse teams likely cannot proceed without conflict. in fact, our results show significant differences in the perception of problems and actual decision outcomes between mavericks and sages. these two categories represent cognitive polarities both in tenns of context and process. in decision making teams, the most conflict is likely to occur between people possessing these two structures because there is agreement neither on what context provides the most appropriate information, nor on how to decide. disagreement over context means there is tension about what is important and disagreement over process means there is tension about how to decide. managers can greatly improve conflict laden processes by anticipating that conflict is increasingly part of organizational life and if managed effectively can lead to growth and innovation. managers can achieve this insight if they understand that not everyone sees things the same way they do. multiple cognitive structures lead to multiple interpretations of the world, the organization, and its problems. the conflict that likely results from this cognitive diversity should not discourage managers. as weick (1995) has suggested, it is only by unveiling the conflict that organizations can make sense of their environments. he warns managers not to see cognitive diversity as a weakness. "people often treat the existence of multiple interpretations as a symptom of a weak organizational culture rather than as an accurate barometer of turbulence outside the organization" (p. 101). the presence of multiple cognitive structures, managers' acknowledgment of this fact, and the ability to capitalize on those differences are likely to distinguish effective organizations from less effective ones. fall 1997 duchon, et al: toward a typology references 121 anderson, c., & paine, f. (1975). managerial perceptions and strategic behavior. academy of mana~ementjournal. 18, 811-823. bateman, t. s. & zeithaml, c.p. (1989). the psychological context of strategic decisions: a model and convergent experimental findings. strategic management journal. 10. 59-74. bushe, gervase r. & gibbs, barrie w. (1990). predicting organization development consulting competence for the myer-briggs type indicator and stage of ego development. the journal of applied behavioral science. 26. 337-357. cowan, d. a. (1987). the effect of decision styles and levels of experience on executive's representation of different problem situations. paper presented at national decision sciences meeting, boston, ma. das, t. k., (1986). the subjective side of strate~y making. new york: praeger. eisenhardt, k. m. & zbaracki, mj. (1992). strategic decision making. strategic management journal. 13, 17-37. gioia, d. & poole, p. (1984). scripts in organizational behavior. academy of management review. 9, 449-459. gioia, d. & mehra, a. (1996). a review of weick's sensemaking in organizations. academy of management review. 21, 1226-1230. hall, r. t. (1984). the natural logic of management policy making: implications for the survival of an organization. mana~ement science. 30.905-927. hambrick, d. & mason, p. (1984). upper echelons: the organization as reflection of its top managers. the academy of management review. 9, 193-206. harrison, e. f. (1981). the mana~erial decision-makin~process. (2nd ed.l. houghton mifflin company: boston. henderson, j. c. & nutt, p. c. (1980). the influence of decision style on decision making behavior. mana~ement science. 26, 371-386. hogarth, r. m. (1980). jud~ment and chojce. john wiley & sons: new york. huber, g. (1980). managerial decision making. scott, foresman and company: glenview, il. 122 journal of business strategies vol. 14, no.2 ireland, r. d., hitt, m. a., bettis, r. a. & de porras, d. a. (1987). strategy formulation processes: differences in perceptions of strength and weakness indicators and environmental uncertainty by managerial level. strategic management journal. 8,469485. janis, i. l. (1982). groupthink: psychological studies of policy decisions and issues (2nd ~. houghton, miflin co., boston. jung, c. (1924). psychological '[ypes. harcourt brace: new york. keller, r. t. & holland, w. e. (1978a). individual characteristics of innovativeness and communication in research and development organizations. journal of applied psychology. 63, 759-762. keller, r. t. & holland, w. e. (1978b). a cross validation study of the kirton adaption innovation inventory in three research and development organizations. applied psychological measurement. 2, 563-570. keller, r. t. & holland, w. e. (1979). toward a selection battery for research and development of professional employees. ieee transactions on en~ineeringmana~ement. 2.q,90-93. kiesler, s. & sproull, l. (1982). management response to changing environments: perspectives on problem sensing from social cognition. administrative science ouarterly. 27, 548-570. kirton, m. (1976). adaptors and innovators: a description and measure. journal of applied psychology. 61,622-629. kummerow, w. j. & hirsch, s. k. (1986). introduction to type in organizational consultin~ settings. consulting psychologists press, inc.: palo alto, ca. maccrimmon, k. r. & wehrung, d. a. (1986). taking risks: the mana~ement of uncer1ai.n.ty. the free press: new york. march, j. g. (1981). decision making perspectives: decisions in organizations and theories of choice. in yan de yen, a. h. & joyce, w. f. (ed's) perspectives on organization desiim & behavior. new york: john wiley & sons. mitchell, t., rediker, k., & beach, l. image theory and organizational decision making. sims, h. & gioia, d. (ed's) the thinking organization. san francisco: jossey-bass. myers, i. (1962). the myers briggs '[ype indicator. consulting psychological press: palo alto, ca. fall 1997 duchon, et al: toward a typology 123 nystrom, p. c. & starbuck, w. h. (1984). to avoid organizational crises, unlearn. qrga.: nizational dynamics. 4, 53-65. russo, j. e. & schoemaker, p. j. h. (1990). decision traps: the ten barriers to brilliant decision-makinl: and how to overcome them. simon & schuster: new york. schoemaker, p. j. h. (1993). strategic decisions in organizations: rational and behavioral views. journal of manal:ement studies. 107-130. simon, h. a. (1978). rationality as process and product of thought. american economic review. 2a, 1-16. taylor, ronald. (1984). behavioral decision makin!:. scott, foresman and company: glenview, il. tversky, a. & kahneman, d. (1974). judgment under uncertainty: heuristics and biases. science. 185, 1124-1131. weick, k. e., (1979). the social psychol0i:y of orl:anizinl:. reading, ma: addison-wesley. weick, k. e., (1995). sensemakinl: in orl:anizations. thousand oaks, ca.; sage publications, inc. appendix a scenario note: when respondents read this scenario they read the real names of companies and products. those names and products have been disguised here (placed in quotes) for reasons of confidentiality. you are the vice-president and g.m. of "xxx/xxx". the manager of product planning has just requested an emergency meeting to discuss a proposal by "yyy" corporation, your most aggressive competitor. it seems that "yyy" has been re-evaluating the "aaa" market and feels that with the advances in "xxx" solids modelling capability, "xxx" could potentially capture a large share of this market. ironically "yyy" has also targeted this market, but believes that together, "xxx" and "yyy" could be more successful via cooperation than through the destructive effects of market entry by two big competitors. "xxx" attorneys have already looked at the anti-trust implications of such a joint venture and there appears to be no legal problems. "yyy" seems determined to enter the market with or without "xxx", so if "xxx" refuses to go with "yyy" into this market, "xxx" can plan on aggressive competition. 124 journal of business strategies vol. 14, no.2 product planning has made some "best guess" estimates as to the bottom-line odds and payoffs of "xxx" going it alone or in combination with "yyy." they feel that if "xxx" goes it alone and captures a large market share, "xxx" could realize an after-tax roi of 22%, while capturing a small market share would yield approximately 10% roj. they estimate the chances of "xxx" attaining a large market share on its own to be i in 3, or 33%. if "xxx" teams up with "yyy" on the terms they propose, it is virtually assured "xxx" would achieve an after-tax roi of 14% with the same total investment. either way, the investment seems attractive. "yyy" has requested a yes or no answer in two weeks. as vp of "xxx" you must decide the course to pursue. if the chances of "xxx" achieving a large market share were 99 out of 100 you would probably recommend going it alone. conversely, if the chances of achieving a desirably large market share were only 1 in 100 you would probably recommend going in jointly with "yyy." as "xxx's" chances of achieving the desired market share were increased, there would be a point at which you would recommend going it alone as opposed to going with the joint venture; that is, what is the ~chance of "xxx" being successful that would prompt you to go it alone versus the joint venture? ---_% for the questions/statements below circle the number that comes closest to describing how you feel. a. what is the likelihood yqy would reject "yyy's" offer? reject lean toward rejecting uncertain lean toward accepting 1 2 3 4 accept 5 b. indicate the level of risk you believe is associated with rejecting "yyy's" offer. no risk some risk normal risk considerable risk too risky 1 2 3 4 5 c. how responsible do you feel for the decision to undertake the project with or without "yyy"? not very responsible 1 2 neutral 3 4 very responsible 5 very important 54 neutral 32 d. how important do you think this decision is? not very important 1 e. responsibility for the success of the project. .. is out of my control equally shared i 2 3 4 5 is in my hands 6 7 fa111997 duchon, et al: toward a typology 125 dr. dennis duchon is an associate professor of management at the university of texas at san antonio. he received his ph.d. from the university of houston. his research interests include decision making in organizations, work motivation, and leadership. he has published in the journal of applied psychology. the journal of management. organizational behavior and decision processes, and decision sciences, among others. dr. donde p. ashmos is an associate professor of management at the university of texas at san antonio. she received her ph.d. in strategic management from the uni versity of texas at austin. dr. ashmos' publications have appeared in the academy of management review, organizational behavior and decision processes, journal of applied behavioral science, interfaces. health services research and human resource management, among others. dr. maria nathan is an assistant professor of management at the uni versity of texas at san antonio. she received her ph.d. in management from the university of southern california in 1992, and has also taught at the university of california, los angeles, and the university of wisconsin-madison. her research is in strategic decision making, crisis learning, and nonprofit governance, and she has published in the academy of management review, the academy of management executive, the journal of applied behavioral science, among others. mavericks, visionaries, protectors, and sages: toward a typology of cognitive structure for decision making in organizations the influence of board characteristics on the frequency of lo-k investigations of firms in the financial services sector mel e. schnake william b. fredenberger robert j. williams valdosta state university valdosta, ga abstract this study examined the possible impact ofboardmember composition (number oloutside directors), board tenure, boardsize, and the number ofother board, on ~vhich directors serve, on the number ofinvestigations and/or legal proceedings brought against the samplejirms by various individuals, groups, andfederal and state agencies. a sample of 180 jirms were selectedfor study from the jinancial services sector ofthe economy for the years 1998-2002. the results suggest that, contrary to theory, neither the proportion (~routside directors or board size had a s·ign~ficant affect on the number of investigations brought against the sample .firms. further, as predicted the results revealed a signtficant and negative link between board tenure and the number of10k investigations, and a significant andpositive relationship between the number ofother board, served on by directors and the number ofinvestigations. although contrary to theory, this last.finding offers some evidence that directors who serve on several other boards may become too distracted to properly monitor their.firms. corporate governance continues to be an area of interest to researchers, stakeholders, and the general public (sonnefeld, 2004). the influence of board characteristics on firm financial performance has been heavily researched over the past few years. such board characteristics as board size, board tenure, number of inside and outside directors, number of female board members, and number of other boards on which members serve have been related to a variety of firm performance measures. dalton, daily, ellstrand and johnson (1998) and dalton, daily, johnson and el1strand (t 999) performed a meta-analysis to summarize the often-conflicting research results in this area and concluded that there is little evidence that board characteristics influence firm financial performance. researchers have also begun to examine the influence of board characteristics on aspects of firm performance beyond financial performance. it is suggested that there may be incompatible interests between managers and stakeholders which may adversely affect the social performance of an organization (simerly, 1995). one view is that the primary responsibility of a business is to maximize 102 journal of business strategies vol. 22, no.2 profit. this may give social performance and responsibility a back seat, or perhaps even divert resources away from social performance. the stakeholder view is that businesses are given legitimacy by society and, therefore, have a responsibility to behave in a socially responsible manner (freeman, 1984). an integrative view is that social responsibility may actually contribute to business success (werner, 1992). wood (1991 a, 1991 b) has described "corporate social performance" as consisting of three components. the first component, corporate social performance, has to do with firm public responsibility and legitimacy within society. the second component is corporate social responsiveness and includes environmental assessment and stakeholder management. the third component consists of the outcomes affirm behavior and includes social impacts, social programs, and social policies. obviously, corporate social performance can be measured in a variety of ways and this has lead to conflicting research results to date (stanwick & stanwick, 1998). one dimension offirm behavior related to corporate social performance is the legality of a firm's actions. kesner and johnson (1990) examined the relationship between board characteristics and shareholder lawsuits in the state of deleware. they found a positive relationship between the proportion of inside directors and the likelihood ofa firm's board of directors being sued by a shareholder for failure to maintain their fiduciary responsibilities. they also tested for the possibility that shareholders tend to file more lawsuits when firm performance is poor, by controlling for both return on assets and return on equity, and found no support for this hypothesis. in contrast, in a study of fortune 500 firms, kesner, victor and lamont (1986) found no relationship between the proportion of outsiders on boards of directors and illegal acts (consent and litigation decrees entered in federal and state courts for cases involving possible violations of antitrust laws and the federal trade commission act). thus, the issue of whether the proportion of outsiders reduces firm illegal acts and/or lawsuits against the firm and/or board of directors is far from settled. outside directors there are three primary reasons for including outsiders on a firm's board of directors (vance, 1983). first, outsiders may increase the breadth of experience and knowledge of the board enabling it to make better decisions. in addition, outsiders may also have contacts which enable them to secure scarce resources for the firms they represent. finally, outsiders may be more independent from the ceo and/or top management team and, therefore, better able to protect shareholder interests. current trends in corporate governance have resulted in an increase in the proportion of outsiders on many firm's boards. while heidrick and struggles (1986) observed an outsider ratio of75% in 1985, this proportion had increased to 81 % by 1999 (wheel en & hunger, 2004). this trend toward more outsiders has resulted from the growing influence of institutional investors such as caipers, fall 2005 schnake et al.: influence ofboard characteristics 103 tlaa-cref, various pension funds, mutual funds, and insurance companies who are putting increased pressure on firms to improve performance (wheelen & hunger, 2004). in november, 2003, the securities and exchange commission approved new listing standards that apply to companies listed on the new york stock exchange and nasdaq. these standards require that a majority ofa listed firm's board be composed of independent (i.e., outside) directors. wang and dewhirst (1992) found that outside directors are very committed to representing various stakeholders, beyond just the stockholders. as a result they tend to be sensitive to environmental issues, women and minorities, and employees. they are also more likely to be knowledgeable about issues facing the firm and comply with legal requirements in order to avoid penalties and negative public relations (johnson & greening, 1999). board tenure there are two competing hypotheses regarding the relationship between board tenure and firm performance (vafeas, 2003). the expertise hypothesis suggests that longer tenure is related to board member experience, commitment, and competence. this may translate into greater financial and social performance of the firm. in contrast, the management friendliness hypothesis suggests that longer tenure is associated with a "management-friendly" board. management friendly boards may lose their objectivity and independence resulting in lower financial and social performance. vafeas (2003) found a positive relationship between outside director board tenure and their occupying a "management friendly" occupation as well as sitting on the firm's compensation committee. board tenure on the compensation committee, in turn, was further associated with ceo compensation levels, thus providing some support for the management friendliness hypothesis. in addition to becoming too management-friendly, other disadvantages may accompany long board tenure. long board tenure may limit cognitive conflict among board members, and may restrict the number of views and opinions that are openly discussed and debated by the board (daboub, rasheed, priem & gray, 1995; lau & murnighan, 1998). symptomatic ofreduced cognitive conflict, long tenure has been associated with commitment to the organizational status quo and with group conformity (finkelstein & hambrick, 1990; hambrick & fukutomi, 1991; hambrick & mason, 1984; weirsema & bantel, 1992). long tenure may reduce information processing among members, as board members limit their information sources over time, and members may be more apt to anticipate the views of fellow board members over time (finkelstein & hambrick, 1990; katz, 1982; michel & hambrick, 1992, staw & ross, 1980). long-tenured board members may lose their ability to recognize and respond to changing environmental conditions (daboub, et ai., 1995). such heightened conservatism and reduced information processing might encourage "sloppy" management oversight, and may support an environment in which firm misbehavior is more likely to occur. as a result, long tenured board members may be 104 journal of business strategies vol. 22, no.2 slow to detect and react to certain legal violations committed within the firm. based on this, we expect a positive relationship between board tenure and the number of 10k investigations. board size the research evidence on the effects of board size on firm performance is equivocal. resource dependence theory suggests that larger boards may enable the firm to more easily form critical environmental linkages and secure scarce resources (pfeffer & salancik, 1978; mintzberg, 1983; goodstein, gautam & boeker, 1994). in contrast, jensen (1993) argues that large boards may function ineffectively and may be easier for a ceo to control. with increasing group size come problems such as social loafing (kidwell & bennett, 1993), and decreased group cohesiveness (lipton & lorsch, 1992). on the other hand, zahra and pearce (1989) argue that larger boards may not be as susceptible to ceo domination as are smaller boards. a meta-analysis by dalton, dailey, johnson and ellstrand (1999) provide some evidence about this issue. they found a small, positive relationship between board size and firm financial performance. this relationship was moderated by firm size, such that the board size and firm financial performance relationship was stronger for small firms. while there is no specific research to guide us, board size may interact with other board characteristics to influence firm performance. with respect to firm oversight, there is no consensus as to whether larger or smaller boards are better able to monitor the firm. larger boards are generally more diverse and less cohesive than smaller boards. such diversity among board members encourages conflict and debate, and results in the formation of a wide variety of decision alternatives (dalton, et ai., 1999; johnson, daily & ellstrand, 1996). a larger board possesses more specialized skills and opinions among its members than a smaller board, and is better equipped to obtain and process a great deal of information about the firm and its environment (amason & sapienza, 1997). having more members, a larger board should be better equipped to monitor the firm through the establishment of specialized oversight committees (pearce & zahra, 1992; zahra & pearce, 1989). a large board serves to constrain the firm's top management team from exerting excessive political influence (ocasio, 1994). rival political coalitions are better able to emerge in larger boards, and serve to challenge the top management team and the political factions it has created (ocasio, 1994; pearce & zahra, 1992). some researchers take the opposing view, and argue that smaller boards may be better able to monitor the firm. they argue that larger, more heterogeneous boards serve a co-optive function by linking the firm with its environment and buffering the firm from environmental disturbances (alexander, fennel & halpern, 1993; chaganti, mahajan & sharma, 1985). such an outward view by the board may provide certain advantages, especially when it comes to firm survival nevertheless, it follows that some boards may be too outwardly fall 2005 schnake et af.: h?fiuence of board characteristics 105 focused, and less concerned about internal policy making and the internal control functions needed to adequately monitor the firm (alexander, et ai., 1993; chaganti, et ai., 1985). smaller boards may encourage greater focus, more member participation and cohesiveness, less social loafing, and genuine debate among board members than larger boards (firstenberg & malkiel, 1994; lipton & lorsch, 1992). when there is disagreement and fragmentation among board members, as is more common in larger boards, the top management team can gain relative advantage in power and influence through a number of political strategies, including coalition-building, selective channeling of information, and "dividing and conquering" (alexander, et ai., 1993). smaller boards, therefore, may be less subject to manipulation by the top management team (alexander, et ai., 1993; lipton & lorsch, 1992). while both views regarding board size have merit, we were swayed by the dual advantages oflarger boards, and the meta analysis by dalton, et a1. (1999). specifically, larger boards possess more human assets needed to properly monitor the firm, and may be more inclined to create specialized subcommittees for this purpose. in addition, larger boards should provide more fertile ground for the emergence of rival political coalitions to challenge the firm's top management team. based on this, we expect a negative relationship between board size and the number of 10k investigations, after controlling for the effects of firm size. number of other boards on which directors serve there is some evidence that board interlocks may be associated with effective capital acquisition (mizruchi & stearns, 1988; stearns & mizruchi, 1993). thus, a board whose directors also serve on several other boards may enable the firm to gain access to critical resources and vital information through these interlocking directorships (zahra & pearce, 1989). such information may enable a board to be more aware of potential legal liabilities and the importance of good social performance. interlocked directors may be able to observe investigations and legal proceedings against other firms on whose boards they serve, and bring that information back to the remaining boards on which they serve, enabling these firms to take action to avoid similar proceedings. therefore, we expect a negative relationship between the number of other boards on which members serve and the number of 10k investigations. firm size while the issue may not be completely decided, a preponderance ofthe extant research literature suggests a positive relationship between organizational size and firm financial performance ( dalton, todor, spendolini, fielding & porter, 1980; judge, 1994). larger firms have greater capacity to meet demand, wider depth and variety of human resources, a wider variety of suppliers and customers, and greater slack resources (kimberly, 1976). in terms of firm social performance, spicer (1978) found firm size to be positively related to pollution control in the 106 journal afbusiness strategies vol 22, no.2 pulp and paper industry. cochran (1985) found firm size was inversely related to the frequency of golden parachutes. preston and sapienza (1990) found firm size was positively related to perceptions of social responsibility. while clearly not a settled issue, larger firms may be more concerned with their public image and, therefore, devote more effort and resources toward social performance. they may also, of course, have greater resources to expend on social performance. dalton and kesner (1983) suggest that larger firms are more complex and that size and complexity may cloud relationships between board composition and firm performance. zahra and pearce (1989) argue that directors of large, complex firms may find it more difficult to exert control over firm performance and/or the top management team. several authors have suggested that boards may be able to exert greater influence in smaller firms (eisenhardt & schoonhoven, 1990; finkelstein & hambrick, 1990; dailey & dalton, 1992; 1993). to isolate the relationships between board characteristics and the incidence of 10k investigations, firm size was employed as a control variable in the current research. 10k investigations researchers generally agree that corporate social performance (csp) is multidimensional (carroll, 1991; griffin & mahon, 1997). previous researchers have operationalized csp variously as the firm's impact on the community in which it operates, impact on the environment, treatment of women and minorities, employee relations, and product quality (johnson & greening, 1999). johnson and greening, (1999) collapse these aspects of csp into two dimensions: a people dimension (community, women and minorities, and employee relations), and a product quality dimension (product quality and environment). a relatively broad measure of possible firm misbehavior, which is one aspect of csp, is the number of investigations reported in each firm's io-k reports. we use the term "investigations" because not all of these actions result in legal proceedings. specifically, 10k investigations involve those investigations and legal proceedings instituted by the u.s. department ofjustice, the securities and exchange commission, the environmental protection agency, the federal trade commission, the equal employment opportunity commission, or similar agencies at the state level. (fbrought to fruition with sanctions against the firm, these proceedings could significantly impact the firm's long term financial position as well as the public's perception of the social responsiveness or legitimacy of the firm. these types of serious violations are the direct responsibility of the board to monitor and prevent, and may include investigations involving accounting fraud, product liability, environmental degradation, workplace discrimination, antitrust activity, and employee safety. thus, 10k investigations relate to both of johnson and greening's (1999) dimensions of corporate social performance. investigations by the eeoc and osha relate to the people dimension, while investigations by the sec, department of justice, and epa relate to the product quality dimension. fall 2005 schnake et al.: influence olboard characteristics 107 based on previous research, the following research hypotheses are offered: hypothesis 1: the proportion o.loutsiders on boards a/directors will be negatively related to the number 0/ 10k investigations, ajter controlling/or the effects a/organizational size. hypothesis 2: higher board tenure will be positively related to the number 0/ 10k investigations, after controlling jhr the effects %rganizational size, hypothesis 3: larger boardsize will be negatively related to the number ol jok investigations, after controlling jor the eifects ojorganizational size. hypothesis 4: the number (~lother boards on which directors (if afirm serve will be negatively relatedto the number oj10k investigations, after controllingjor the eflccts a/organizational size. method sample firms the financial services sector of the u.s. economy was selected for study. beginning with all 1,337 firms in this sector listed with the sec between 1998 and 2002, we eliminated all firms not on the new york stock exchange. next we eliminated all firms that did not have at least three 1o-ks during the five-year study period, this resulted in 192 firms drawn from the following industries within this sector; (1) consumer financial services, (2) accident and health insurance, (3) life insurance, (4) property and casualty insurance, (5) investment services, (6) money center banks, (7) regional banks, (8) savings banks, and (9) miscellaneous financial services. some of these firms are holding companies with only 5 to 10 employees. after eliminating these by selecting only firms with 100 or more employees, 180 firms remained in the data set. this study was limited to firms within a single sector so as to reduce any possible industry effects (e.g., different technologies, product life cycles, etc.). given that financial services firms are highly regulated by various state and federal agencies, the potential impact of board characteristics on these firms should be of particular interest. we preferred that the sample firms have five (5) 10k reports (i.e., one each for the period 1998-2002), but we decided to accept firms that had at least three 10k reports that were available through our data source during the study period, board characteristics board composition data were gathered from the edgar database compiled by the securities and exchange commission. the sample firms' 10-k reports and 108 journal ofbusiness strategies vol. 22, no.2 def 14-a reports for the years 1998-2002 were the sources of the data. we were able to obtain board data for each firm which included (i) average board size (total number of directors) during the study period, (2) the board composition--insiders versus outsiders, (3) the average tenure of each firm's board during the study period, and (4) the average number of other boards that each director served on during the study period. in addition, the average number of each firm's employees during the study period served as the measure offirm size, and was obtained from hoover:" company profiles. all of the following variables represent the average over the five year study period. in determining whether a director was an insider or an outsider, we were keenly aware of the lack of independence and potential inadequacies in firm monitoring posed by, so called, "gray" directors (ryan and wiggins, 2004). gray directors may be retired former directors or employees of the firm, or they may be family directors with family ties to the firm's founder and may hold large blocks of the firm's stock.. in addition, gray directors may work for other affiliated firms that are large suppliers of the firm, or other firms that may handle the insurance, legal, or consulting work for the firm. while it is often difficult to identify gray directors, we did make a diligent effort to do so. in compiling the data, we opted to classify family directors, retired former directors and employees, and affiliated directors as insiders. while these directors were not technically insiders, their influence would, in all likelihood, exert the same level of independence as an insider. investigations a measure of one aspect of corporate social performance, the number of investigations initiated against each firm, was obtained from the sec edgar database. a detailed description of these investigations, if any, are presented in item 3 of each firm's 10k reports. the number of 10k investigations was selected as a measure of firm social performance as these investigations reflect possible corporate misbehavior, and reflect how well firms are being monitored by their boards. only those investigations conducted between 1998-2002 were included. the possible types of misbehavior for which firms are investigated are frequently very serious in nature, and involve legal proceedings beyond the firm's ordinary business activity. in analyzing the 10k reports, two raters were used to categorize the types and timing of the various investigations. in the vast majority of cases, the raters were in agreement as to the nature and time period in which the investigations were undertaken. in the few cases where agreement could not be reached, a third rater was used to settle the issue. results variable characteristics and a correlation matrix appear in table 1. as shown in the table, the average number of i ok investigations was significantly and posifall 2005 schnake et al.: influence of board characteristics 109 tively correlated with only the average number of employees (i.e., firm size), and the average number of boards on which board members serve, but significantly and negatively correlated with the average years of service of board members. table 1 variable characteristics and a correlation matrix std. mean dev. 2 3 4 5 6 i. proportion of outside directors .73 .13 1.00 .30** .14 -.15* .26** .06 2. average total no. of directors 11.89 4.10 1.00 .34** -.02 .08 .01 3. average no. of employees 12,964.49 26651.10 1.00 -10 .44** .37** 4. average years on board of all members 8.57 3.92 1.00 -.34** -.28** 5. average no. of boards on which all members serve 1.82 1.13 1.00 .41 ** 6. average 10k investigations 2.14 3.71 1.00 n = 1go *p < .05 **p < .01 stepwise regressions were performed to test hypothesized relationships among the variables (cohen & cohen, 1983). average number of employees (firm size) was entered on the first step of the regression analysis. followed by the four independent variables (board characteristics). a significant change in the r-squared value indicates that the independent variables contribute to explained variance in the number of 10k investigations beyond the effect of firm size. before performing this analysis we checked for significant interaction effects among the independent variables. all four-way, three-way, and two way interactions did not achieve traditional levels of statistical significance. therefore, it was appropriate to interpret the main effects. both main effects and the control variable (organizational size measured by number of employees) were statistically significant. these results are presented in table 2. 110 journal of business strategies table 2 results of the stepwise regression analysis of board characteristics on 10k investigations change in r2 vol. 22, no.2 signif. size .14 years, prop out, board size. other bds .25 size= firm size (average number of employees) prop out = proportion of outsiders board size = average total number of directors on board other bds = average number of boards on which directors serve years = average total years of service of board members 10k = average number of 10k investigations .14 .11 .00 .00 to determine the relative contribution of independent and control variables to the explained variance in the number of 10k investigations. beta coefficients were examined. these appear in table 3. table 3 standardized beta coefficients of independent and control variables independent and control variables size years boardsize other bds prop out model r2 std. beta .28** -.17* -.09 .24** -.04 .25** n=180 * p < .05 **p < .01 size = firm size (average number of employees) prop out proportion of outsiders board size = average total number of directors on board other bds = average number of boards on which directors serve years = average total years of service of board members 10k = average number of 10k investigations firm size, as predicted, was positively and significantly related to the number of 10k investigations. no support was found for hypotheses hi. the proportion of outsiders on boards of directors was not significantly related to the number fall 2005 schnake et al.: in/fuence ofboard characteristics 111 of 10k investigations, after controlling for the effects of firm size. contrary to h2, board tenure was negatively related to the number of 10k investigations, after controlling for the effects of firm size. hypothesis h3 was not supported. board size (total number of board members) was not significantly related to the number of 10k investigations, after controlling for the effects of firm size, suggesting that larger boards may be better firm monitors than smaller boards. in contrast to hypothesis h4, the number of other boards on which directors serve was significantly and pos itively related to 10k investigations, after controlling for the effects of organizational size. taken together, these variables explained 25% of the variance in the number of 10k investigations. firm size alone explained slightly over one-half of this variance. the number of other boards on which members serve and board tenure explained the other half. discussion in recent years, public confidence in corporations has been diminished in light of scandals such as enron and worldcom. this study has examined four specific board member characteristics and their potential influence on a board's ability to adequately monitor its firm. surprisingly, the results failed to support a significant link between either the proportion of outside directors or board size and the number of 10k investigations instigated against the sample firms. whether the proposed benefits of outside director independence is, in general, overstated, or whether the benefits of outsiders is less evident in financial services firms is unclear. at any rate, the inclusion of more outsiders on the sample firms' boards failed to reduce the number of investigations brought against the firms. the growing influence that institutional investors have over boards to prompt them to appoint more outsiders might not produce the desired results for firms in this sector. these firms tend to be highly regulated by various regulatory agencies. perhaps, the benefits of having more independent and objective outsiders might be more evident for firms in industries that lack such stringent oversight. similar research in other industries is strongly recommended to determine whether the results of the current study are industry specific. the notion that long board tenure tends to encourage board "staleness" and management-friendly behavior was not supported by the results. among the sample firms, each board member served, on average, 8.6 years on his/her firm's board. while a measure of top management team tenure was beyond the scope of this study and was not included, the average level of board tenure may be considerably less than the average top management team tenure for the sample firms. such a discrepancy, ifit exists, might reduce the management-friendly orientation of the board. or, perhaps, boards do not become "management-friendly" until much later in their tenures than the average observed in this study. our findings suggest that longer board tenure is associated with fewer 10k investigations. consistent with the "expertise hypothesis," perhaps the experience 112 journal ofbus iness strategies vol. 22, no.2 of board members results in members increased effectiveness in monitoring firm decisions and actions. our findings are also inconsistent with the "management friendly hypothesis" which suggests that board members lose their objectivity with longer tenure. the findings did not suggest that larger boards may be better monitors of the firm than smaller boards. others have speculated that, consistent with resource dependence theory (pfeffer & salancik, 1978), larger boards have more resources (human assets) available to monitor and guide the firm. from a political perspective, larger boards should provide more fertile ground for rival factions to emerge and challenge the top management team. nevertheless, the benefits associated with larger boards would probably occur only over a range of board sizes as boards become too large, too diverse, and hard to coordinate, these benefits would, in all likelihood, begin to diminish. our results do not support this argument. although contrary to theory, the significant and positive link between the number of other boards served on by directors and 10k investigations strongly supports the notion that directors may become distracted and too involved with the affairs of other firms to properly manage the affairs of the focal firms. this seems logical, given the limited time and energy of directors, as well as the possible different industry settings that directors may encounter as they serve on multiple boards. future research might explore the impact that diversity among board members plays in fostering the emergence of political factions that serve to restrain the power of the top management team, and, thereby, reduce the incidence of firm misbehavior. perhaps the addition ofmore female and/or minority board members might change the allocation of board power. another interesting analysis might focus on how the professional backgrounds of the board members (e.g., legal, accounting, liberal arts) might serve to alter the balance of power between the board and the top management team. several limitations were evident in the present study. by using the total number of investigations as reported in the firms' 10k reports, differences in the magnitude of investigations were not taken into account. obviously, investigations involving less serious violations might be committed more often than more serious violations. while the dependent variable, "investigations," was used to measure firm misbehavior, it may be more reflective of a "sloppy" management decision framework. even so, the responsibility for sloppy management must ultimately rest with the board. the use of a more precise measure offirm misbehavior might be considered for use in future research. another limitation may involve the selection for study the firm from industries within the financial services sector. we suspect that there is an industry effect here, as firms in certain industries have greater exposure to various regulations and government agency oversight. does this increased exposure, as commonly occurs among financial services firms, result in better behavior or greater likelihood for the detection of misbehavior by regulatory agencies? answers to these questions might be obtained by examining similar variables in firms from other industries. fall 2005 schnake et al.: influence ofboard characteristics 113 a final limitation is the use of average data over a five year time period. this obviously ignores any potential fluctuations in the variables over time. future research may consider the effects of time. that is, perhaps there is a delay between the time in which the board takes some action and it has an effect on firm performance, both financial and social references alexander, j.a., fennel. m. l., & halpern, m. t. (1993). leadership instability in hospitals: the influence of board-ceo relations and organizational growth and decline. administrative science quarterly, 38, 74-99. amason, a.c. & sapienza, h. j. (1997). the effects of top management team size and interaction norms on cognitive and affective conflict. journal of management, 23, 495-516. carroll, a.b. (1991). csp measurement: a commentary on methods for evaluating an elusive construct. in j .e. post (ed.) research in corporate social performance and policy. (pp. 385-40 i). greenwich, ct: jai press. chaganti, r.s., mahajan, v., & sharma, s. (1985). corporatc board size, composition and corporate failures in retailing industry. journal of management studies, 22, 400-417. cochran, p., wood, w., & jones, t. (1985). the composition of boards of directors and incidence of golden parachutes. academy oj' management journal. 27, 42-56. cohen, j. & cohcn, p. (1983). applied regression/correlation ana~vsisjor the hehavioral sciences, (2nd ed.). hillsdale, n./: lawrence erlbaum publishers. daboub, aj., rasheed, a. m., priem, r. l., & gray, d. a. (1995). top management team characteristics and corporate illegal activity. academy of management review. 20, 138-170. dailey, c. m. & dalton, d. r. (1992). the relationship between governance structure and corporate performance in entrepreneurial firms. journal of business venturing, 7, 375-386. dailey, c. m. & dalton, d. r. (1993). board of directors leadership and structure: control and performance implications. entrepreneurship theory and practice, 17, 65-81. dalton, d. r. , todor, w., spendolini, m., fielding" g., & porter, l. (1980). organizational structure and performance: a critical review. academy ofmanagement review, 5,49-64. 114 journal olbusiness strategies vol. 22, no.2 dalton, d. r., daily, c. m., ellstrand, a. e., & johnson, j. l. (1998). meta-analytic reviews of board composition, leadership structure, and financial performance. strategic management journal, 19,269-290. dalton, d. r., daily, c. m., johnson, j. l., & ellstrand, a. e. (1999). number of directors and financial performance: a meta-analysis. academy of management journal, 42, 674-686. dalton, d. r. & kesner, i. f. (1983). the effect of board composition on ceo succession and organizational performance. quarterly journal ofbusiness and economics, 42, 3-20. eisenhardt, k. m. & schoonhoven, c. b. (1990). organizational growth: linking founding team, strategy, environment, and growth among u.s. semiconductor ventures, 1978-1988. administrative science quarterly, 35, 504-529. finkelstein, l. m. & hambrick, d. c. (1990). top management team tenure and organizational outcomes: the moderating role of managerial discretion. administrative science quarterly, 35,484-503. firstenberg, p. b. & malkiel, b. g. (1994). the twenty-first century boardroom: who will be in charge. sloan management review, 36, 27-35. freeman, r. e. (1984). strategic management: a stakeholder approach. boston: pitman. goodstein, j., gautam, k., & boeker, w. ( 1994). the effects of board size and diversity on strategic change. strategic management journal, 15,241-250. griffin, j. j. & mahon, j. f. (1997). the corporate social performance and corporate financial performance debate: twenty-five years of incomparable results. business & society, 36, 5-31. hambrick, d. c. & fukutomi, g. d. s. (1991). the seasons of a ceo's tenure. academy of management review, 16,719-742. hambrick, d. c. & mason, p. a. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review, 9, 193-206. heidrick & struggles, inc. (1979-1986). the changing board. chicago: heidrick & struggles. johnson, j. l., daily, c. m., & ellstrand, a. e. (1996). boards of directors: a review and research agenda. journal of management, 22, 409-438. johnson, r. a. & greening, d. w. (1999). the effects of corporate governance and institutional ownership types on corporate social performance. academy ofmanagement journal, 42, 564-576. fall 2005 schnake et al.: l'?fluence ~lboard characteristics 115 judge, w.q, jr. (1994). correlates of organizational effectiveness: a multilevel analysis of a multidimensional outcome. journal (~fbusiness ethics, 13, 1-10. katz, r. (1982). the eftects ofgroup longevity on project communication and performance. administrative science quarterly, 27, 81-104. kesner, i. f. & johnson, r. b. (1990). an investigation of the relationship between board composition and stockholder suits. strategic management journal, 11, 327-336. kesner, i. f., victor, b., & lamont, b. t. (1986). board composition and the commission of illegal acts: an investigation of fortune 500 companies. academy of management journal, 29, 789-799. kidwell, r. e. & bennett, n. (1993). employee propensity to withhold effort: a conceptual model to intersect three avenues of research. academy oj'management revieh', 18,429-456. kimberly, j. s. (1976). organizational size and the structuralist pcrspective: a review, critique, and proposal. administrative science quarterly, 21,571-597. lau, d. c. & murnighan, 1. k. (1998). demographic diversity and faultlincs: the compositional dynamics of organizational groups. academy of managemencreview, 23, 325-340. lipton, m. & lorsch, j. w. (1992). a modest proposal for improved corporate governance. business lawyer, 48, 59-77. michel, 1. g. & hambrick, d. c. (1992). diversification posture and top management team characteristics. academy oj'management journal, 35, 9-37. mintzberg, h. (1983). power in and around organizations. englewood clitfs, nj: prentice-hail. mizruchi, m. s. & stearns, l. b. (1988). a longitudinal study of the formation of interlocking directorates. administrative science quarterly, 33, 194-210. ocasio, w. (1994). political dynamics and the circulation of power: ceo succession in u.s. industrial corporations, 1960-1990. administrative science quarterly, 39, 285-312. pearce, j. a. & zahra, s. a. (1992). board composition from a strategic contingency perspective. journal of management studies, 29, 411-438. pfeffer, j. & salancik, g. r. (1978). the external control of organizations' a resourcedependence perspective. new york: harper & row. preston, l. & sapienza, h. j. (1990). stakeholder management and corporate performance. journal of behavioral economics, 19,361-375. 116 journal o{business strategies vol. 22, no.2 ryan, h. e. & wiggins, r. a. (2004). who is in whose pocket? director compensation, board independence, and barriers to effective monitoring. journal of financial economics, 73,497-524. simerly, r. l. (1995). institutional ownership, corporate social performance, and firms' financial performance. psychological reports, 77, 515-525. sonnefeld, j. (2004). good governance and thc misleading myths of bad metrics. academy of management executive, 18, 108-113. spicer, b. h. (1978). investors, corporate social performance and information disclosure: an empirical study. the accounting review, 53, 94-111. stanwick, p. a. & stanwick, s. d. (1998). the relationship between corporate social performance and organizational size, financial performance, and environmental performance: an empirical examination. journal 4 business ethics, 17, 195204. staw, b. m. & ross, j. (1980). commitment in an experimenting society: a study ofthe attribution of leadership from administrative scenarios. journal ofapplied psychology, 65, 249-260. stearns, l. b. & mizruchi, m. s. (1993). board composition and corporate financing: the impact offinancial institution representation on borrowing. academy ofmanagement journal, 36, 603-618. vafeas, m. (2003). length of board tenure and outside director independence. journal of business finance and accounting, 3d, 1043-1064. vance, s. c. (1983). corporate leadership, boards, directors. and strategy. new york: mcgraw-hili. wang, j. & dewhirst, d. h. (1992). board of directors and stakeholder orientation. journal ofbusiness ethics. 11, 115-124. weirsema, m. f. & bantel, k. (1992). top management team demography and corporate strategic change. academy of management journal, 35, 91-121 . werner, s. b. (1992). the movement for reforming american business ethics: a twentyyear perspective. journal of business ethics, 11,61-70. wheelen, t. l. & hunger, 1. d. (2004). strategic management and business policy. (9th ed.). upper saddle river, nj: prentice-hall. wood, d. (1991 a). corporate social performance revisited. academy of management review, 16,691-718. wood, d. (1991 b). social issues in management: theory and research in corporate social performance. journal of management, 17,383-406. fall 2005 schnake et al.: influence ofboard characteristics 117 zahra, s. a. & pearce,.j. a. ( 1989). boards ofdirectors and corporate financial performance: a review and integrative model. journal (?f management, 15,291-334. dr. mel e. schnake, d.b.a. (mississippi state university) is professor of management in the langdale college of business at valdosta state university. dr. schnake's research has appeared in numerous journals including journal of management, journal of applied psychology, human relations, personnel p5ychology, and journal of occupational and organizational psychology. dr. schnake's research interests include organizational citizenship behavior, organizational misconduct, work motivation and leadership. dr. william b. fredenberger, ph.d. (university of georgia) is professor of management information systems in the langdale college of business at valdosta state university. dr. fredenberger's research has appeared in such journals as journal of management information systems, journal of business forecasting, journal of applied business research, and american business review. dr. fredenberger's research interests include corporate governance, business turnarounds, organizational change, and instructional improvement. dr. robert j. williams, ph.d. (florida state university) is associate professor of management in the langdale college of business at valdosta state university, valdosta, georgia. dr. williams' research has appeared in such journals as academy of management journal, human relations, journal of business research, journal of managerial issues, and journal ofbusiness strategies. dr. williams' research interests include top management teams, corporate governance, and business ethics. the influence of board characteristics on the frequency of 10-k investigations of firms in the financial services sector price-cap regulation and the incentive to cooperate in research mark w. frank sam houston state university • huntsville, texas abstract this paper considers the impact of price-cap regulation on r&d and the incentive of firms to form research joint ventures. using a symmetric two-stage duopoly model of cost-reducing r&d with multiple forms of research cooperation, we find that r&d is greatest when firms fully cooperate in research and share all research knowledge. price-cap regulation, however, appears to have a small but negative effect on r&d, leading to lower total welfare. introduction during the 1990s the telecommunications industry, along with other traditionally regulated industries, replaced rate-of-return forms of regulation with pricecap and other incentive-based types of regulation. 1 before the divestiture of at&t in 1984, for example, all 50 states employed rate-of-return regulation to regulate intrastate telecommunication operations. following the divestiture, however, several states began experimenting with alternative forms of incentive-based regulations (e.g. earnings sharing regulation, rate case moratoria, and price-cap regulation).2 by 1996, price-cap regulation had emerged as the most common form of these new regulations. by the time of the new millennium, only twelve states retained the use of rate-of-return regulation, while thirty-five utilized price-cap regulation (see ai and sappington, 2002). the rise of price-cap regulation can be attributed to its potential of providing stronger incentives for innovation than traditional rate-of-return regulation (see vogelsang, 2002; clemenz, 1991; cabral and riordan, 1989).3 empirical support for this view has gained considerable ground in recent years. studies by ai and sappington (2002), prieger (2002; 2001), and resende (2000) have all found price-caps to be associated with greater innovation and greater productive efficiency, while uri (200la) and lehman and weisman (2000) have found qualified support. the potential of price-cap regulation to encourage greater innovation has special importance in industries such as telecommunications, where innovations playa critical role in the industry's growth. uri (200lb), for example, finds that productivity in telecommunications increased nearly 5% per year in the 1990s, with much of this growth primarily due to the development of new production technolo60 journal of business strategies gies. the practice of developing these innovations, however, has increasingly involved firms cooperating with other firms. duysters and hagedoorn (2000) find that joint research partnerships in telecommunications during the 1989 to 1996 period were up 317% over the 1980 to 1988 period.4 this emerging practice of regulated firms increasing r&d through r&d cooperation with other firms, however, remains largely ignored in the theoretical and empirical literatures. the purpose of this paper is to explore the impact of price-cap regulation in an environment where firms may choose to cooperate in the development of research. our analysis relies on a symmetric two-stage duopoly model to compare r&d and output levels both with and without price-cap regulation. in the initial stage, firms must choose to either compete in the production of r&d, form a research joint venture by cooperating in the production of r&d, or cooperate in the production of r&d and fully share all cost-reducing research information. table i presents a summary description of these three research scenarios. in the second stage of our model, firms compete in the output market. s the results are then compared based on the substitutability of the firm's products, the presence and efficacy of price-cap regulation and the degree to which new knowledge can spillover to rival firms. a spillover occurs, for example, when a firm's privately created knowledge becomes publicly available and the firm lacks any legal mechanism to enforce excludability.6 table 1 research scenarios research scenario r&d production r&d spillovers noncooperative research (n) cooperative research (c) cooperative research and full information sharing (cs) firms are noncooperative in the production of r&d. firms cooperate in the production of r&d. firms cooperate in the production of r&d. firms do not fully share cost reducing research information, although some information may become public (0 ~ a < 1). firms do not fully share cost reducing research information, although some information may become public (0 ~ a < 1). firms fully share all cost reducing research information (a = 1). our findings indicate that the intersection between regulatory policies and research cooperation matters. r&d is greatest when firms cooperate in the producvolume 28, number 1 61 tion of research, fully share all research information, and are unregulated. production output, however, is greatest when firms cooperate in the production of research, fully share all research information, but are subject to price-cap regulation. with respect to the three research scenarios, research production cooperation coupled with full research information sharing (cs) consistently dominates noncooperative research production (n) and cooperative research production (c). when r&d information has a low rate of spillover to other firms, noncooperative research production dominates cooperative research production. when the information spillover rate is high, however, cooperative research production dominates noncooperative research production. the following section presents the initial postulations and the subgame-perfect nash equilibrium outcomes. the final section presents an analysis of the results and suggestions for further research. all proofs are included in the appendix. the model consider an industry of two firms with the linear inverse demand: f3 e (0,1) (i) where p is market price, qj is output from the i'h firm, qj is output from the fh firm, and f3 is a substitutabi i ity parameter. if f3 = i, then qj and qj are perfectly substitutable. if f3 = 0, then qj and qj are perfectly unsubstitutable (i.e. each firm is a monopoly). assume that per unit production cost may be lowered through cost reducing r&d, c. = c x. ox. , i i ) (j e (0,1) (2) where x. is cost reducing r&d from the i'h firm and x is cost reducing r&d from the i ) fh firm. we assume that c > xi + ox j ' since costs cannot be negative. the parameter (j represents exogenous r&d spillovers. if both firms agree to fully share all costreducing research information, then the spillover is internalized, and (j = 1. in the absence of a research information sharing agreement, some research knowledge may still spillover given the public good nature of knowledge, hence o :::: (j < i. knowledge spillovers may also arise by deliberate disclosures or involuntary leaking, for example. the case of (j = 0 would imply that all cost-reducing research information remains private to the firm. 62 journal of business strategies following from d'aspremont and jacquemin (1988), de bondt, siaets, and cassiman (1992), and poyago-theotoky (1995), it is assumed that the total cost of firm i's own r&d reflects the existence of decreasing returns to scale: (3) where y is the price of r&d. price-cap regulation (pc) involves the imposition of a binding price ceiling that is periodically adjusted downwards by a preannounced productivity factor. in the literature on pc regulation, it is common to assume that the regulated price is initially set equal to the firm's per unit production costs, thus enabling the firm to make normal profits (see heyes and liston-heyes, 1998; clemenz, 1991; carbral and riordan, 1989). this price-cap is then periodically adjusted downwards by some factor x (often referred to as the rpj x factor, where rpj is the retail price index). this adjustment lowers the price-cap to account for changes in projected industry-wide technological improvement? firms can make greater than normal profits if they produce cost-reducing innovations in excess of x iffirms produce innovations amounting to less than x, however, they may request a rate hearing. the result of this rate hearing will be that the regulator adjusts the price-cap so that the firm is again making normal profits.s it is assumed that the firm never chooses a price below the pc (hence, the pc is binding). the regulator initially sets the price-cap equal to the firm's per unit production costs. this cap is subsequently adjusted downwards by x: p = c -x. (4) the objective of the regulator is to anticipate future cost-reducing innovations by the firm, meaning p = c x ox . the firm will be able to gain financially if actual i j cost reductions (x + ox) are greater than the adjustment factor (x). if x> x. + ox i } i } , however, the firm requests a rate hearing and forces the regulator to set x = xi + ox . j from 0), the inverse demand is p = a qi f3qj' hence, the per unit regulatory objective is: (5) volume 28, number 1 63 the problem for the pc regulated firm is then to maximize profits subject to the regulatory constraint: x 2 l = (a q fjq c + x + ax) q. r-l a/a q. fjq. c + x. + ax) i j j i 2 i j i l' (6) where 0 :s a :s 1, and a reflects the efficacy of regulation. this is the second stage payoff function for the i'h firm. as a approaches one, regulation converges to the regulator's objective (5). as a falls towards zero, regulation diverges from the regulator's objective (x falls increasingly further below the actual amount of cost-reducing innovation, x. + ax v i .i proposition 1: if (j >~, then xcs > xc > x n, qcs > qn, and wcs > we > wn. if (j < ti 2 ,' however, xcs~ xn; xc, lqcs 1 > qn ~ qc, and wcs ~ i 1 i i i i 1 1 ~n > ~c. (proof provided in the appendix.) proposition i tells us that r&d is greatest under research cooperation coupled with full sharing of all cost reducing r&d information (xics). when spillovers of research information are greater than 0.5 and product substitutability is sufficiently low, noncooperative research production (xt) is inferior to cooperative research production, ceteris paribus. this relationship is plotted in figure 1. the shaded area represents values of (j and f3 that result in x i n being greater than x i c • this relationship between x n and x c occurs because noncooperative research i i suffers from an appropriability problem; when research information becomes public at a high rate, and rival products are relatively unsubstitutable (the non-shaded area of figure 1), the firm finds it profit max imizing to reduce their own production of r&d and free ride off the research efforts of the rival firm. in this case, the firm can overcome this appropriability problem by agreeing to cooperate in the production of r&d (hence, xc> xn). i i production output and total welfare (the "first-best" standard) follow similarly. if (j> 0.5{3, then qics > qic > qin and wics > ~c > ~n. if (j< 0.5{3, however, q cs > qn > qc and wcs > wn > wc. that is, cooperative research production i i i i i i coupled with full information sharing dominates the noncooperative and cooperative research production. the noncooperative research scenario outperforms the cooperative research scenario, so long as information spillovers are less than 0.5 and 64 journal of business strategies product substitutability is sufficiently high. otherwise, the appropriability problem causes noncooperative research production to underperform cooperative research production. figure 1 the appropriability problem 1 0.8 0.6 0.4 0.2 o f3 o 0.2 0.4 0.6 0.8 1 note: in the shaded area, x n > xc; in the non-shaded area x n < xc. i i i i proposition 2: r&d and total welfare from each of the three research scenarios are decreasing functions of the pc regulatory parameter, a. production output, however, is an increasing function of the pc regulatory parameter. (proof provided in the appendix.) as the regulatory parameter approaches unity, r&d falls, ceteris paribus. whenever a < 1, this implies that the regulator is not able to fully enforce its regulatory objective (5). this would occur when the price-cap is not lowered by the full amount of the firm's cost-reducing r&d (x + ox), thus enabling the firm to earn i i greater than normal profits. when the enforcement of pc regulation improves (as a --+ 1), the firm receives less of the benefits from cost-reducing innovation. as a result, r&d decreases. production output under pc regulation, by contrast, is an increasing function of the regulatory parameter in each of the three research scenarios. as a --+ 1, the volume 28, number 1 65 profit maximizing firm is induced to increase production output. this effect has important welfare implications. better enforcement of pc regulation forces the firm to transfer the benefits from cost-reducing innovations to consumers in the form of increased output (recall that if /t = 1, then x = x. + ox). consumer surplus, therei j fore, is increasing in a. what is good for consumers is not, in the case of pc regulation, good for producers. total profit for the firm under each ofthe three research scenarios decreases as /t ----> 1. lax regulation means the firm can gain greater profits because actual cost-reducing innovations (x; + ox;) are greater than the regulatory productivity-adjustment factor (x). the impact of regulation on total profit within each of the three research scenarios, however, is greater that than the impact on consumer surplus. hence, as /t approaches unity, total welfare decreases. conclusion this article has considered the impact of price-cap regulation on the incentive to cooperate in r&d. our findings are based on a symmetric two-stage duopoly framework in which the firms choose to either compete in the production of r&d, cooperate in r&d production, or cooperate in r&d production and share all research information. the findings have relevance to industries such as telecommunications, where price-cap regulation occurs alongside the increasing use of inter-firm research partnerships. figure 2 presents a graphical summary of the r&d and production output rankings.1o the first column of the graphs plots r&d (x) on the vertical axes, while the second column plots production output (q). each row presents variations of a different parameter (0; [3, and /t, respectively), while keeping the remaining two parameters constant at 0.5. notice that x. and q. are always greatest when firms i i cooperate in the production of research and fully share research information (cs). noncooperative research production (n) performs better than cooperative research production (c) in terms of r&d and output only when research spillovers are less than 0.5 and product substitutability is sufficiently high (i.e. when (j< 0.5[3). otherwise, noncooperative research production suffers from an appropriability problem and is inferior to cooperative research production. with respect to price-cap regulation, r&d is greatest when the firm is unregulated (/t = 0), though the impact of regulation appears relatively small. this outcome is replicated in each of the three research scenarios. production output, by contrast, increases as the efficacy of regulation increases (/t ----> 1). this outcome is 66 journal of business strategies again replicated in each of the three research scenarios. consequently, price-cap regulation presents important tradeoffs between r&d and production output. using a first-best total welfare standard, our analysis suggests that the gains from effective enforcement of price-cap regulation do not offset the r&d losses, at least in the comparative static setting. figure 2 r&d and production output comparisons p= 0.5, j. = 0.5 p = 0.5, j. = 0.5 * • •• • • • • ,~ * j '~ i " • • i i , • i • a ••••• 4 • jo at • itj; l ,c' '0< " ,~ ; " ,~~-",-~ -;,.', • •• • i i i i • • • , '(j o 0.2 0.4 0.6 0.8 o 0.2 0.4 0.6 0.8 j. = 0.5, 0' = 0.5 j. = 0.5, 0' = 0.5 o 0.2 0.4 0.6 0.8 o 0.2 0.4 0.6 0.8 i x; p = 0.5, 0' = 0.5 p = 0.5, 0' = 0.5 • '. j * i .' i ii' • • i •• ,'*j • i • , • i i , i • • • o 0.2 0.4 0.6 0.8 1 a o 0.2 0.4 0.6 0.8 -n c -cs volume 28, number 1 67 it remains an open question, however, how robust these findings would be in a more dynamic setting, or what insights empirical testing may provide. given the ongoing coexistence of price-cap regulation in industries with firms engaging in cooperative research agreements, it is hoped that our findings will prove suggestive for future research. acknowledgements thanks to barry 1. seldon and donald g. freeman for helpful comments. sam houston state university's research enhancement fund provided financial support for this research project. all errors remain my responsibility. appendix proof of proposition 1: the nash-coumot symmetric equilibrium for the second stage is: q. = (a c a)(f3 2) + xlf3cj2) + xlf3 20) i f32-4 (ai) if q; were negative, the firm would not produce. it is therefore assumed that qi is positive. this in turn requires that a c a > o. the first stage payoff function for the i th firm is found by substituting (a6), into the second stage profit function (9): n = [[a c a(f3 + 1)](f3 2) + x;cf3cj 2) + x,(f3 20)] _ 2 _ 4 + i (f32 _ 4)2 { a(f3 ) x2 [(a c + a)(f3 2) + 4f3cj2) + x/f3 20)]} r~ . (a2) under noncooperative research production, the symmetric profit maximizing level of r&d (xt') is found by differentiating (ai) with respect to xi: 2(a c a af3)(2 f30) x n = ---'------'--'--'---'----'---i r(2 f3)(2 + f3)2 2(1 + 0)(2 f30) (a3) substituting x i n into (ai) yields the profit maximizing level of production output for the game: 68 journal of business strategies y(4 f32)(a c + a) 2aci + 0)(2 130) qi n = y(2 {j)(2 + {j)2 2(1 + 0)(2 130) . (a4) substituting x i n and qin into second stage profits (6), reveals firm i's total profits for the game: y(-a + c + a + a{j)2[y(4 fj2)2 2(2 130)2] iti n = [y(2 _ {j)(2 + {j)2 2(1 + 0)(2 _ f3o)p' (as) with linear inverse demand (1), consumer surplus is qn(1 + {j). total welfare is the i sum of consumer surplus plus profit: y(-a + c + a + f3a)2[y(f32 4)2 2(f3er 2)2] r= + i [y(f3 2)(2 + {j)2 2(1 + o)(f3er 2)]2 (1 + {j)[y(f32 4)(a c + a) + 2ac2 2er+ f3erf3er2)]2 [y(f3 2)(2 + {j)2 2(1 + o)(f3er 2)]2 (a6) when firms cooperate in the production of r&d, the profit maximizing symmetric level of r&d (xc) is found by adding both profit functions (a2) together and i differentiating with respect to r&d: 2(a c a a{j)(1 + 0) x c = . i y(2 + {j)2 2(1 + 0)2 (a7) substituting x i c into (ai) yields the profit maximizing level of production output for the game: y(2 + {j)(a c + a) 2aci + 0)2 qi c = y(2 + {j)2 2(1 + 0)2 (as) substituting x i c and qic into second stage profits (6), reveal firm i's total profits: y(-a + c + a+ a{j)2 itc = -'--------'-i y(2 + {j)2 2(1 + 0)2 (a9) volume 28, number 1 69 with linear inverse demand (1), consumer surplus is qjc(l + fj). total welfare is the sum of consumer surplus plus profit: ~c = [r(2 + fj)2 2(1 + 0)2]2 {r[r(2 + fj)2 2(1 + 0)2] (-a + c i + ,1,+ afj)2 + (l + fj)[2a(1 + 0)2 r(2 + fj)(a c + a)p} . (a 10) when firms cooperate in the production of r&d and fully share all costreducing research information, (j = 1. consequently, 4(a c ,1,afj) r(2 + fj)(a c + a) 8,1, \cs = r(2 + fj)2 _ 8 ' qi cs = r(2 + fj)2 8 ' r(-a + c + ,1,+ afj)2 rr~=~--------~~ ; r(2 + fj)2 8 and . r[r(2 + fj)2 8] (-a + c + ,1,+ afj)2 + (l + fj)[r(2 + fj)(a c + a) 8ap wcs= . i [r(2 + fj)2 8]2 (all) the second order conditions for each of the three research scenarios (n, c, and cs) are as follows: 2(1 + 0)(2 (30) 2(1 + 0)2 8 r > r > and r > (ai2) (2 fj)(2 + fj)2 ' (2 + fj)2 ' (2 + fj)2 ' respectively. note that each ensures that the dominator is always positive. consequently, x;cs is greater than x i c for all (j and f3 because 4(a c ,1,afj) 2(a c ,1,afj)(1 + 0) > . r(2 + fj)2 8 r(2 + fj)2 2(1 + 0)2 (a 13) likewise, x i c is greater than x i n for all (j and f3 because 70 4(a c /l/lfj) y(2 + fj)2 8 journal of business strategies 2(a c /l/lfj)(2 f3d) >----~------~~~~--y(2 fj)(2 + fj)2 2(1 + d)(2 f3d) , (ai4) and x,c is greater than x i n only if (j> 0.5{1 for small research spillover rates, (j < 0.5/3, x i c is less than xt. production output, total profit, and total welfare follow similarly. q.e.d. proposition 2: in each of the three research scenarios, r&d output under pc regulation is decreasing in jl. this follows because 2(a c /l/lfj)(2 f3d) 2(a c /l/lfj)(i + d) x n = x c = --'--------'--'-'----', y(2 fj)(2 + fj)2 2(1 + d)(2 f3d)' i y(2 + fj)2 2(1 + d)2 ' and 4(a c /l/lfj) x cs = . , y(2 + fj)2 8 (ai5) production output, however, is increasing in /l. recall that the second order conditions (defined in proof of proposition 1) place a minimum level on r in the noncooperative case (q/i), this follows because 2(1 + d)(2 f3d) 2(1 + d)(2 f3d) ---'-----'--''-----'----''> ----'-----'-'-'--"----'4 + f32 (2 fj)(2 + fj)2 for all relevant values of 13 and a: in the case of qic, 2(1 + d)2 2+13 and in the case of qics , 8 8 -->---2+13 (2 + fj)2 (ai6) (ai7) (ai8) volume 28, number 1 71 the profit maximizing firm will produce a positive amount of r&d under pc regulation so long as a c ,1, f3,1, > o. q.e.d. end notes 1. in general, under price-cap regulation the firm will be free to raise its price at the rate of inflation minus an amount set to expected productivity (for an introduction, see viscusi, 2005). 2. see ai and sappington (2002) for a general overview of these changes. 3. in its performance review of at&t, the fcc justified its change to price-cap regulation because rate-of-return regulation offered "little incentive to innovate new and innovative services" (fcc 1992, 5322). 4. duysters and hagedoorn also report joint formations of separate research corporations are up 87% between the two periods, while large company investments in small innovative companies (what they term "minority investments") are up 89%. their findings are from the merit-cat! database on inter-firm partnerships, which is maintained by the university of maastricht (see also, hagedoorn and kranenburg, 2003). 5. the possibility of production cooperation is set aside because anti-trust enforcement of production cooperation is a dissimilar policy instrument from price-cap regulation. moreover, through government policies such as the national cooperative research act (ncra), r&d cooperation is actively encouraged by offering antitrust protection to firms who cooperate in the production of r&d (see scott, 1989). the same is not true for production cooperation. 6. for a general discussion of knowledge spillovers, see chapter 14 in martin, 2001. 7. bernstein and sappington (1999) provide an analysis of how this adjustment factor should be set under varying market conditions. note also that our model drops the rpi aspect of the x factor. this is done merely for simplicity, though it has the benefit of avoiding the occurrence of a rising price-cap, which would occur when rpi becomes greater than x 8. in its regulation of at&t, the fcc set this adjustment factor (x) at 3% per year. the fcc argued that at&t had historically achieved 2.5% productivity growth under rate-of-return regulation, and 0.5% was added as a consumer productivity dividend (cpd) (fcc 1992, 5323). similarly, in its regulation of british telecom, the british government initially set x at 3% (beesley and littlechild 1989). 72 journal of business strategies 9. laffont and tirole (2002) argue that imperfections in the administration of pricecap regulation are common. reasons for this include the practice by regulators of using price averages in the monitoring of price-caps, the unsystematic treatment of new services and phasing out of existing services, the lack of an intertemporal price-cap adjustment, and lack of incentives for service quality (see section 2.3 in chapter 2). 10. figure 2 is based on the numeric assumption that a c = 10, and y= 5. references ai, c., & sappington, d. e. (2002). the impact of state incentive regulation on the u.s. telecommunications industry. journal of regulatory economics, 22, 13360. beesley, m. e., & littlechild, s. c. (1989). the regulation of privatized monopolies in the united kingdom. rand journal of economics, 20, 454-72. bernstein, 1. i., & sappington, d. e. (1999). setting the x factor in price cap regulation plans. journal of regulatory economics, 16,5-25. cabral, l. m., & riordan, m. h. (1989). incentives for cost reduction under price cap regulation. journal of regulatory economics, 1,93-102. clemenz, g. (1991). optimal price cap regulation. the journal of industrial economics 39, 391-408. de bondt, r., slaets, p., & cassiman b. (1992). the degree of spillovers and the number of rivals for maximum effective r&d. international journal of industrial organization, 10, 35-54. duysters, g., & hagedoorn, 1. (2000). a note on organizational modes of strategic technology partnering. journal of scientific & industrial research, 58, 640-49. d'aspremont, c., & jacquemin, a. (1988). cooperative and noncooperative r&d in duopoly with spillovers. american economic review, 78, 1133-37. federal communications commission. (1992). price cap performance review for at&t. notice of inquiry filed in cc docket 92-134,7 fcc rcd 5322. hagedoorn, 1., & kranenburg, h. (2003). growth patterns in r&d partnerships: an exploratory statistical study. international journal of industrial organization, 21,517-31. heyes, a. g., & liston-heyes, c. (1998). price cap regulation and technical change. journal of public economics, 68, 137-51. laffont, 1. 1., & tirole, 1. (2002). competition in telecommunications. cambridge, massachusetts: mit press. volume 28, number 1 73 lehman, d. e., & weisman, d. l. (2000). the political economy of price cap regulation. review of industrial organization, 16,343-56. martin, s. (2001). advanced industrial economics, (2nd ed.). new york: wileyblackwell. poyago-theotoky,1. (1995). equilibrium and optimal size of a research joint venture in an oligopoly with spillovers. the journal of industrial economics, 63, 209-26. prieger, 1. e. (200 i). telecommunications regulation and new services: a case study at the state level. journal of regulatory economics, 20, 285-305. prieger, 1. e. (2002). a model for regulated product innovation and introduction with application to telecommunications. applied economics letters, 9, 625-29. resende, m. (2000). regulatory regimes and efficiency in u.s. local telephony. oxford economic papers, 52,447-70. scott, 1. t. (1989). historical and economic perspectives of the national cooperative research act. in link, a. n. & tassey, g. (eds.) cooperative research and development: the industry-university-government relationship. norwell, massachusetts: kluwer academic publishers. uri, n. d. (200ia). technical efficiency, allocative efficiency, and the implementation of a price cap plan in telecommunications in the united states. journal of applied economics, 4, 163-86. uri, n. d. (200lb). telecommunications in the united states and changing productive efficiency. journal off ndustry, competition and trade, i, 321-335. viscusi, w. k. (2005). economics of regulation and antitrust, (4th ed.). new york: the mit press. vogelsang, i. (2002). incentive regulation and competition in public utility markets: a 20-year perspective. journal of regulatory economics, 22, 5-27. biographical sketch of author mark frank is an associate professor of economics and international business at sam houston state university. he received his ph.d. from the university of texas at dallas. his research interests include telecommunications regulation, the economics of advertising in the liquor industry, and income inequality within the united states. 74 journal of business strategies price-cap regulation and the incentive to cooperate in research the competitive cohort: an extension of strategic understanding gerald david flint texas a&m university • college station, tx david d. van fleet arizona state university • mesa, az abstract the use of referent others to establish the concept of competitive cohorts is presented as a way to extend the understanding of strategic decision making in organizations. the competitive cohort concept does not replace other perspectives of the firm, industry or strategic group definitions, strategy formulation, or decision making, but rather, helps in understanding how organizational goals are established and performance is shaped and measured. the use of the competitive cohort concept may also give a new coherency in and view of the concepts of competitive advantage and sustained competitive advantage. introduction a fundamental concern of research in the strategic management and entrepreneurship literatures is to provide explanations for strategic managerial decision making and firm performance. that concern has prompted examination and instruction of both external and internal factors that have the potential to influence strategy formulation, implementation, and resultant performance. for example, hitt, ireland, and hoskisson’s (2011) widely used textbook for strategic management categorizes inputs into the strategic management decision making process as either belonging to the external or the internal environments of the organization. the textbook uses the industrial-organizational (i/o) perspective to address the external factors decision makers must consider and the resource-based view (rbv) of the firm to address internal factors facing decision makers. though not specifically directed toward antecedents of firm performance, traditional i/o economics as a field includes a focus on effects that industries have upon firm performance (nair & kotha, 2001; thomas & pollock, 1999). that focus has not resulted in a complete understanding of firm performance, though it has provided some useful insights regarding external influences upon performance. in contrast, the rbv and its internal perspective of the firm have been elaborated upon in a variety of ways that attempt to explain performance based on the het98 journal of business strategies erogeneity of the resources and capabilities within organizational boundaries (barney, 2001; barney, wright, & ketchen, 2001; oliver, 1997). the rbv has turned the search for antecedents of performance toward the internal factors that influence firm performance, but it does not answer important questions about the external influences that are exerted upon performance. in this light, then, an important question arises when considering the two separate domains of external and internal factors that influence decision making inside firms: how do decision makers link the two domains within a management process and develop performance goals? the concept of a competitive cohort, introduced below, is proffered as a way to help answer that question because it seeks to address the motivations of decision makers as they process information and formulate organizational strategy within the intersection of external and internal domains. additionally, organizational boundaries are changing in ways that may blur the traditional categorizations of internal and external influences upon performance and complicate decision making about adopting performance goals and measures. some of those changes result in organizations operating in nontraditional ways and with fewer people (conner, 2003; markus, manville, & agres, 2000). not only are the boundaries changing, but so too are the ways in which comparisons across firms are made. sic (standard industrial classification) or naics (north american industry classification system) codes were the traditional way in which organizations were classified as a way to understand groups of organizations and their operations. the north american industry classification system (naics) has replaced the u.s. standard industrial classification (sic) system. developed jointly by the u.s., canada, and mexico, naics provides new comparability in statistics about business activity across north america. nevertheless, these approaches for classifying firms have not yielded consistent explanations of firms’ adoption of specific strategies or of variance in firm performance. indeed, a whole industry, agribusiness, is not even recognized by either of those systems. consequently, other approaches to grouping or classifying organizations, understanding decision making processes, and explaining organizational strategies have emerged in the attempt to explain strategy formulation and performance variance. after reviewing below some of the major efforts to group organizations and explain decision making, this paper offers the competitive cohort concept as a means of linking some of the more critical external and internal factors influencing both strategy formulation and firm performance. volume 28, number 2 99 the role of strategic groups and strategic reference points in decision making the concept of strategic groups was first proposed by hunt (1972) and then advanced as a way to better understand strategic decision making (nath & gruca, 1997; porter, 1979; newman, 1978). a strategic group is defined as a group of firms classified according to their strategic choices such that they follow common strategies that are distinctive from other firms in the same industry (mcgee & thomas, 1986). a commonly used typology of strategic groups is that of miles and snow (defenders, reactors, analyzers, and prospectors) although recent research incorporates type of ownership to further this type of strategic grouping (peng, tan, & tong, 2004). both performance and reputation have been found to vary across such groups (ferguson, deephouse, & ferguson, 2000). while it was hoped that identifying such strategic groups would cast light on strategy formulation and performance (e.g., peteraf & shanley, 1997; reger, 1990), that approach has not been as helpful as researchers had hoped (gonzález-fidalgo & ventura-victoria, 2002; dranove & peteraf, 1998; wiggins & ruefli, 1995; barney & hoskisson, 1990; reger & huff, 1993). it was suggested that the concept of the strategic group needed to be extended to include strategic reference points (fiegenbaum & thomas, 1995). a firm’s strategic reference point has been defined as the target or benchmark that the firm’s managers use to evaluate strategic choices (bamberger & fiegenbaum, 1996). generally, three dimensions were involved: the internal capabilities of the firms, the extant external conditions, and the time frame involved (fiegenbaum, hart, & schendel, 1996). over time, however, it was proposed that the main dimensions involved in the selection of strategic reference points might instead consist of the nature of the industry, the organizations’ strategies, their performance, and, indeed, the entire network of contacts among the participants (moliterno & mahony, 2011; shoham & fiegenbaum, 2002). these and other studies clearly began to recognize that strategic decision makers are humans who have emotions, particularly risk taking propensities, that need to be considered if we are to understand their decision making (e.g. narayanan, zane, & kemmerer, 2011; mathieu & chen, 2011; feigenbaum & thomas, 2004; shoham & fiegenbaum, 2002; lewicka, 1997). in an effort to incorporate the emotional component within human decision making to understand more of the variance in selection of organizational strategies and performance outcomes across firms, one may turn to theories from both economic and psychological literatures. 100 journal of business strategies the role of prospect theory in decision making the concept of recognizing emotions, particularly risk taking, led to the incorporation of prospect theory into the study of strategic decision making. beginning with the work of kahneman and tversky (kahneman & tversky, 1979; tversky & kahneman, 1986), prospect theory has become widely used in analyzing a variety of organizational phenomena (fiegenbaum, 1990; fiegenbaum & thomas, 1986). it quickly became used in finance (schleifer, 2000; edwards, 1996) and developed as an extension of agency theory (wiseman & gomez-mejia, 1998). in a different but related approach, chatterjee, wiseman, fiegenbaum, & devers (2003) have proposed merging behavioral (emotional) and economic concepts of risk to better understand strategic decision making. as with any novel contribution, over time extensions (henkel, 2003) and criticisms to prospect theory have mounted (levy & levy 2002; mcdermott, 2004; sturdy, 2003). for instance, prospect theory has been suggested as more applicable to inexperienced decision makers than to experienced ones (list, 2004). experienced decision makers may learn from past outcomes from specific decisions to avoid common mistakes when making a similar decision in the future. inexperienced decision makers would not have the same knowledge base from which to develop new decisions. nevertheless, prospect theory has extended our understanding of the role emotions play in strategic decision making (holmes, bromiley, devers, holcomb, & mcguire, 2011). as an approach for analyzing strategic decision making that directly incorporates the risk taking behavior of decision makers, it has become widely used (mcnamara & bromiley, 1999), at least in part because it does not attempt to supplant earlier concepts but rather complement them to further our understanding (mcdermott & kugler, 2001). basic to this approach is the notion that decision makers evaluate alternatives relative to some reference point, which may vary from situation to situation (hastie & dawes, 2001). the central point, therefore, is an understanding of the reference point used by strategic decision makers. other approaches to decision making that focus on emotional influences behavioral theory (cyert & march, 1963; march, 1962; march, 1994), which predated prospect theory, drew our attention to limiting factors in decision making but did little to directly aid our understanding of strategic decision making. the behavioral focus on conflicting motivations and self-interests within organivolume 28, number 2 101 zations heightened awareness of the fact that decisions are made within complex interactions among individuals, leading to decision outcomes that may be less than optimal from an organizational standpoint. however, the extensive research streams regarding social cognition (lewicka, 1997; peeters, czapinski, & lewicka, 1992; porac & thomas, 1990; porac & thomas, 1994; porac, thomas, wilson, paton, & kanfer 1995; reger & huff, 1993; reger & palmer, 1996; spencer, peyrefitte, & churchman, 2003) and mental mapping (daniels, johnson, & de chernatony, 2002; hodgkinson, 2003; hodgkinson, maule, & brown, 2004) have assumed important positions in extending our understanding of the role that emotion plays in strategic decision making. huff and her associates have suggested that it may take a combination of approaches to understand more fully strategic decision making (huff, 1997; balogun, huff, & johnson, 2003). thus, emotion is recognized as a possible factor within a complex mix of factors that drive strategic decision making. seo, goldfarb, and barrett (2010) have empirically demonstrated that affective states can override framing effects in stock investment simulations, and the research implies that emotion in strategic decision making can become a dominant factor under some conditions. however, emotion is clearly not the dominant factor for all strategic decision making. we think there is a fundamentally different concept that may need to be considered as a critical influence upon decision makers in a strategic management process. the possible effects of referent others in decision making the central thesis of this article rests in an assumption that further insight can be gleaned by incorporating more research regarding human behavior. specifically, research regarding the role of referent others as they influence behavior and performance at the individual level provides a means to understand how the use of the internal resources and capabilities of an organization (the focus of the rbv) can be influenced by external factors that are not necessarily equivalent to the industry level factors typically studied in io economics. nor is the role of referent others equivalent to the behavioral and emotional factors discussed above. those who develop and implement strategies are people, and like other people, they are products of their social environments (shah, 1998, p. 249). the literature on organizational behavior — particularly group dynamics, social information processing, and social comparison research — clearly demonstrates that social factors influence behavior (carmeli & schaubroeck, 2007; festinger, 1954; levine & moreland, 1990; wheeler & miyake, 1992). recent research in strategic management also finds support 102 journal of business strategies for the influence of social forces on strategic decisions (combs, michael, & castrogiovanni, 2009). the fundamental premise of social comparison theory is that people compare themselves to others who may be similar to them in some way (kulik & ambrose, 1992; ronen, 1986). there is, however, less agreement as to how such referent others are selected (ambrose & kulik, 1999; oldham, nottenburg, kassner, ferris, fedor, & masters, 1982; oldham, kulik, stepina, & ambrose, 1986). such comparisons can be positive, negative or neutral. dakin & arrowood (1981) suggest that comparisons can be any of three types: (1) competitive, wherein the individual wants to look better than the referent; (2) conformist, wherein the individual wants to be equal to the referent; or (3) cooperative, wherein the individual wants both to look good. huseman and others (huseman, hatfield, & miles, 1987) modified this to advance the concept of equity sensitivity. here there is a continuum going from (1) entitleds (who see themselves more favorably than their referents), to (2) equity sensitives (who see themselves on about equal footing with their referents), to (3) benevolents (who see themselves less favorably than their referents). while these may be useful for studying individual behavior, executives are highly likely to be best described as competitive in their comparisons, although recent research suggests that the ethnic group of immigrant entrepreneurs may well influence their strategic decisions (ndofor & priem, 2011) relative deprivation theory (crosby, 1984) contends that when comparisons are made feelings of deprivation may result. those feelings of deprivation then lead to changes in behavior. equity theory (adams, 1963 & 1965; austin, 1977) suggests that when comparisons of inputs and outputs are not equal, individuals are motivated to change. six options exist: the individual can change inputs (work less); attempt to change outcomes (try to get more); distort perceptions of oneself; distort perceptions of the referents; choose a different referent or set of referents; or withdraw from the situation (conner, 2003). sources of influence in the selection of referent others social influence comes from many sources, including cohesive actors (friends) and structurally equivalent actors (those in similar positions) (brass, 1984; burkhardt & brass, 1990). social comparison theorists posit similarity, availability, and relevance as important factors in people’s selecting referents (festinger, 1954; kulik & ambrose, 1992; levine & moreland, 1987). selecting similar others reduces the complexity of the comparisons. referents may be similar in gender, eduvolume 28, number 2 103 cation, or roles. kulik and ambrose (1992) suggest that the main factors in referent selection are availability (access to information) and relevance (attractiveness). both personal factors (gender, race, age, and tenure) and situational factors (job, physical proximity) affect the reference choice. research related to centrality and proximity in networks indicates that people are influenced by others with whom they have close interpersonal ties (ibarra & andrews, 1993). the frequency, intensity, and proximity of interaction determines the relevant referent others (shah, 1998). this research suggests one aspect of how innovations move from organization to organization. “the adoption of the innovation by one actor helps the other develop a better understanding of its merits and thus triggers her or his own adoption” (shah, 1998, p. 250). in contrast, research related to the existence and awareness of social norms (cialdini, reno & kallgren, 1990; gino, ayal & ariely, 2009) has demonstrated that close interpersonal ties are not necessary to establish norms that influence people’s behavior. these norms may be established in very subtle ways, such as via observation of others’ behavior (cialdini et al., 1990) or by manipulating awareness of unethical behavior (gino et al., 2009). considering both centrality/proximity research and social norm research, one can conclude that social influences upon decision making and the selection of referent others may come from close personal relationships or impersonal observations of others. the structural equivalence literature suggests that people are influenced by others in similar positions so that they share a similar pattern of relationships (burt, 1987). while structural equivalents may be an important source of information, the lack of direct ties or a fear of appearing incompetent may mean that individuals would “hesitate to approach their competitors for needed information” (shah, 1998, p. 262). thus, we would expect that those developing and implementing strategies would develop referents or strategic cohorts with which to compare themselves and which would be influential in determining strategic choices and that those referents might well be from outside the industry. an entrepreneur, for instance, might be likely to select as referent others entrepreneurs from other industries. however, the selection of across-industry referent others is not suggested to be confined to entrepreneurs. “more specifically, the higher the manager’s education level, the more likely the manager was to select a referent outside of the company” (conner, 2003, p. 138). 104 journal of business strategies synthesizing a complementary concept in regard to strategic decision makers the wide mix of social influences as evidenced by the research streams briefly outlined above can influence the selection of referent others and adoption of normative standards by decision makers. the suggestion is made that a set of influential referent others is likely to exist for strategic decision makers as they formulate strategies, but the postulated referent other set may be very difficult to determine or define and has not been scrutinized using any of the existing social science research streams. though the set of referent others around a strategic decision maker is currently unexamined in regard to its influence during the formulation and implementation of strategic decisions, that set of referent others may be a significant factor in explaining both strategy formulation and implementation beyond the understandings provided by traditional strategic management and economic perspectives. for the sake of convenience, the term “competitive cohort” is now advanced to quickly identify a set of referent others having influence upon strategic decision makers. therefore, based upon the review of the various research literatures noted above and shown below in table 1, the competitive cohort concept is the fundamental idea advanced by this discussion and intended to help researchers more fully understand the relationships involving internal and external factors that are related to firm performance. the use of the concept seeks to bring awareness to the possibility that decision makers within organizations are influenced by a set of external or internal-to-the-organization referent others to assess their organizations’ internal and external environments, formulate strategy, adopt performance goals, and consequently, experience performance variance. volume 28, number 2 105 table 1 perspectives regarding antecedents of organizational performance industrial/organizational economics perspective 1 industry classification and grouping a sic b naics c strategic groups 2 industry structural characteristics (e.g., concentration, barriers to entry and exit, etc.) 3 competitive dynamics (e.g., degree of competition, game theory models, types of competitive environments such as cournot or bertrand, etc.) resource based view perspective 1 identification of superior resources and capabilities 2 assessment of value, rareness, inimitability, and substitutability cognitive groups perspective 1 risk-return characteristics (e.g., from prospect theory) 2 behavioral theory recognizing limits on human decision making 3 social cognition theory examining mental map characteristics within an industry or geographic area competitive cohort perspective 1 identification of referent others from within or without an industry classification or geographic area 2 acknowledgement of the factors influencing the selection of referent others (e.g., perceptions of equity, availability, relevance, structural equivalence, social and/or egoistic factors, etc.) 3 influence of referent others upon strategy formulation, implementation and assessment of performance. the concept definition in regard to the practice of strategic management, a competitive cohort is the set of salient entities that are viewed by those who formulate and implement an organization’s strategic policies as defining and exemplifying the appropriate standards against which subsequent performance should be measured and compared. assumption as in equity theory (adams, 1963, 1965) and other social comparison theories (buunk & mussweiler, 2001; festinger, 1954), the concept of the competitive cohort rests upon an assumption that people typically do not formulate and imple106 journal of business strategies ment strategy without comparison to a set of salient entities that serve as references for determining relative success or failure of strategic policies; in other terms, strategy and its objectives are not conceived, operationalized, nor assessed in a vacuum. strategies are formulated and implemented by people. people tend to use referent others as they determine their strategic goals, job satisfaction, and perceptions of equity at the individual level. therefore, one can assume that the people formulating organizational level strategies are likely to be influenced in their thought processes by reference to significant others at an organizational level. this assumption is an extrapolation from research at the individual level that notes and confirms the role of referent others in determining the antecedents of behavioral choices and the variety of factors that influence the selection of a referent other at the individual level. a review of the theories regarding why and how individuals choose referent others can be found in kulik and ambrose’s (1992) very thorough discussion. this extrapolative assumption regarding the use of referent others at the top management’s level of strategy formulation seems reasonable, given the thrust of strategic management research that seeks to discover the sources of competitive advantage and that inherently rests upon a foundation of assuming that top managers in organizations are seeking to achieve performance outcomes better than seen in other organizations. this selection of referent others may be particularly important for entrepreneurs, and the competitive cohort concept may provide additional insight for advancing the state of entrepreneurship research literature, which was reviewed in its current state by wright, low, and davidson (2001). lack of equivalency to other strategic classifications the competitive cohort is not equivalent to present strategic classification systems commonly in use (sic, naics, strategic groups, cognitive groups, etc.), though the members of a particular class may overlap to some degree with the members of the competitive cohort. the concepts of existing strategic classifications and the competitive cohort may actually be equivalent in some situations, but there is no necessity for that equivalency and it may, in fact, be rare. there are several reasons why this lack of equivalency is noted. view of classification systems. first, many industry classifications typically focus upon organizations that produce similar goods and/or services. such classification systems can overlook important factors that tend to mitigate or enhance the salience of one organization to another (castrogiovanni, 2002); for example, geographic dispersion and/or market segmentation may obscure the performance of volume 28, number 2 107 one organization from another though they are both engaged in producing similar outputs. a simple lack of information that would be necessary for useful comparisons may be in effect. therefore, some organizations within the classification may not view each other as relevant for the purposes of assessing performance outcomes. dissimilar organizations in the cohort. second, the competitive cohort of an organization may contain dissimilar organizations that do not produce comparable outputs. the adoption of broad performance measures that can be applied across dissimilar organizations removes the necessity of comparing similar organizations. for example, performance measures such as roe or the stock price of a publicly traded firm can enhance the salience of that organization to other organizations with very dissimilar outputs. those who formulate and implement strategies in organizations and have access to information about the broadly measured performance outcomes of dissimilar organizations may incorporate that data into their thought processes, helping them to make judgments about the potentials for performance outcomes within varying conditions. thus, an executive may draw comparisons from organizations with completely dissimilar outputs in an effort to enrich his or her strategic decisions. competition outside the cohort’s industry class. third, an organization is sustained by providing value of some kind to its social environment, and other organizations from outside its industry class may compete for or exert influence upon that value in such a manner as to be perceived as a comparative organization in terms of performance. identifying the organizations that can affect and compete for value produced by an organization and to which that same organization compares its performance can therefore broaden the range of salient organizations beyond an industry class. to explain further, the provision of value by an organization must be at least sufficient to replace the value that the organization requires to function and that it must extract from its social environment. in a for-profit context, organizations must be able to pay for present inputs and retain enough value from sales of outputs to allow for future operations. the value that is placed into the market by a profit-seeking organization is subject to imitation, competition and manipulation, not just from organizations producing similar outputs but also from organizations making dissimilar outputs with comparable value, organizations that can affect how much value is diverted to other uses (e.g., taxes, regulatory requirements, charitable donations), and organizations that can influence demand patterns in society (e.g., societal institutions, media, activists). conceivably, an organization may view whatever entities that have the most potential to affect the value of its outputs and its retention of any residual value between costs and revenues as being the competition against which 108 journal of business strategies it must perform. in such a case, performance may not be viewed in terms of broad measures of returns or stock prices but rather as a win/lose proposition involving a contest against other entities. external factors that isolate from competition. fourth, organizational performance is subject to the influence of external factors that may serve as mechanisms that isolate one firm’s market from competition (peteraf, 1993). an organization’s strategic planners who perceive the organization to be isolated from the competitive effects of other organizations’ activities may be less likely to use those organizations as comparative entities. one external factor that might provide this isolating mechanism is a significant switching cost for the consumers of an organization’s outputs. if consumers of an organization encounter high switching costs when contemplating the adoption of substitute outputs from other organizations, then switching is less likely to occur. if that switching cost is the result of factors completely external to an organization’s internal strategic policy implementation, perhaps a regulatory outcome of a political process, then the organization’s managers may view the organization as being isolated from any direct competitors and select other organizations for relevant performance comparisons. comparative advantage. fifth, the role of a comparative advantage may influence the selection of performance comparators. an organization with a lower opportunity cost of production as compared to the other members of its industry class may be satisfied with performance outcomes significantly lower than those obtained by other members of the industry class. in some instances, the for-profit organization enjoying a very large comparative advantage may only be concerned with earning some level of positive economic rents, and its competitive cohort would consist of the market in general that is the potential source for those positive economic rents. as an example of this type of comparative advantage effect upon the selection of a competitive cohort, consider a firm in a developing nation with an extremely low opportunity cost for labor. that firm’s comparative advantage could be large enough in relationship to firms in other nations that it becomes the producer of labor-intensive outputs that were once manufactured in other nations. the firm’s performance is the direct result of a lower opportunity cost for labor. as a result, the firm may not be interested in comparisons of performance with firms producing similar outputs with higher labor costs. instead, the firm may be focused rather narrowly upon earning enough positive economic rents to maintain a profitable operation while keeping its wages competitive in the local labor market. its most salient competitors may not be the foreign companies attempting to produce similar products but rather the local firms producing very dissimilar outputs but competing for volume 28, number 2 109 labor in the local market. if the firm can earn enough positive economic rents to pay slightly higher wages than the other firms in the local market, then it can continue to exploit its comparative advantage in the global context. social or personal factors. sixth, social or egoistic factors may influence strategy formulation and the selection of referent others. an individual in a leadership position within an organization may be content with a particular level of performance if those with whom he or she comes into social contact share similar or lower levels of performance. sudden shifts in an individual’s economic and/or social standing (e.g., stock market disruption, divorce, catastrophic illness) may lead to a shift in that individual’s goals for the organization or to a shift in the referent set, having little or nothing to do with the organization’s resources, products, or industry, but rather, having much to do with the decision maker’s personal life. comparisons with other board members. finally, the competitive cohort may be derived from comparisons among those serving on multiple boards of directors. westphal and his associates have shown that ceo-board social ties and interlocks can be powerful forces shaping strategic decision making (gulati & westphal, 1999; westphal, 1999). comparisons by ceos with the performance of others serving on the board may well impact decisions as much as, if not more than, actions of competitors, suppliers, regulators, or other groups that are more commonly considered. implications of the concept given these seven reasons that can result in the lack of equivalency between an industry classification system or strategic groups within that industry and a competitive cohort, and admitting that there may be other reasons for this lack of equivalency left unexplored, some implications for the use of the competitive cohort concept follow. focus and measurement. first, what is focused upon and measured for comparative purposes may influence what is actually achieved. people respond to the setting of goals and objectives (locke & latham, 1990). their responses are dependent in some degree upon what will be measured to assess their performance. hence, the determination of the actual composition of the competitive cohort that is being used for comparative purposes by the top managers or entrepreneurial owners of a firm may help researchers understand the antecedents of the performance outcomes that are obtained by that firm. while not necessarily corresponding tightly with for-profit organizations, the different divisions within collegiate athletic programs of the united states can serve 110 journal of business strategies to illustrate this point. division i programs compete at a different level of expectation as compared to lower division programs. the records achieved are put into the context of a division cohort. to take the athletic programs example further, key rivalries between some schools overwhelm other performance measures. specifically, intrastate rivalries can dominate the performance expectations of certain programs: arizona state university vs. the university of arizona, texas a&m university vs. the university of texas, and brigham young university vs. the university of utah all are examples of intense rivalries with outcomes that can, at times, overwhelm the respective teams’ performances against other opponents. the use of peer institutional comparisons by universities is yet another example of such an approach even when the universities do not actually compete for students. again, while not an exact correspondence to other types of organizations, this focus on perceived key competitors can reasonably be expected to occur in other organizational contexts. awareness of the concept’s relationship to competitive advantage. second, the realization of the competitive cohort concept has substantial implication for what has traditionally been asserted as a key focus of strategic management research: the pursuit of competitive advantage/sustained competitive advantage (ca/ sca). competitive advantage is often used ambiguously in textbooks and research. for example, similar to besanko, dranove, shanley, and schaefer (2004, p. 360), hill and jones’ (2004) textbook refers to a competitive advantage defined and measured “when its profitability is greater than the average profitability for all firms in its industry…” (hill & jones, 2004, p. 4). on the other hand, hitt, ireland and hoskisson’s (2003) textbook refers to the concept as “… when a firm implements such a strategy and other companies are unable to duplicate it or find it too costly to imitate, this firm has a sustained (or sustainable) competitive advantage (hereafter called simply competitive advantage)…” (hitt, ireland, & hoskisson, 2003, p. 6). the historical variance in definitions regarding competitive advantage suggests that the concept behind the term may lack clear agreement among researchers and authors. if true, this lack of agreement presents an opportunity to consider whether or not there might be a better definition of competitive advantage in terms of bringing commonality to its understanding and usage. regardless of the ambiguity of the concept of competitive advantage in the literature, if one desires to more fully understand an organization’s performance, then one must understand the motivations and objectives within the organization that led to its performance outcomes. by determining the constituents of the competitive cohort that an organization adopted for comparative purposes, one could more clearly understand what that organization would view as ca/sca. in fact, one volume 28, number 2 111 might offer other definitions of ca/sca based upon the competitive cohort of an organization rather than the definitions that are presently used in strategic management literature: competitive advantage for an organization is an achievement of specific performance measures salient to the organization above its competitive cohort’s average performance level on those same performance measures over a chosen period of time. sustained competitive advantage for an organization is an achievement of the specific and salient performance measures above its competitive cohort’s average level of performance on those same performance measures that has been maintained for a period of time that is significantly longer than the average period of time for a competitive advantage to be exhibited by members of the organization’s competitive cohort. these definitions are suggested as emerging from what an organizational decision maker would hope to gain by implementing strategy based on comparison to a competitive cohort. the decision maker would set strategy and performance goals in relationship to the competitive cohort including the time period for which “averages” would be determined. the decision maker would consider an advantage to have been gained based on relative performance to the competitive cohort. sustainability of the advantage would also be considered in relationship to duration of performance outcomes within the competitive cohort. the salient criteria for determining overor under-performance would tend to link to the referent others with whom the decision maker identifies. again, in the context of universities, comparisons are made based on referent others (public, private, large, small, location, etc.) that the particular institution finds relevant. avoiding apples-oranges comparisons. third, the use of the competitive cohort concept may help researchers avoid the proverbial apples-and-oranges comparison in terms of performance. for example, the base assumption of the rbv is that performance varies based on the heterogeneity of resources and capabilities across firms and that superior resources and capabilities result in superior performance. based on the competitive cohort concept, one could add that a complicating factor underlying performance variance across firms would be the objectives for performance that are set by top managers or entrepreneurial owners of organizations in reference to a competitive cohort. returning to an earlier example of a firm with a substantial comparative advantage due to low opportunity costs in its local labor market, one 112 journal of business strategies could argue that its lack of superior resources and capabilities is actually the source of its performance in the global market. nevertheless, its performance at the global level might be above all other firms with similar outputs in the global market. the rbv would have to be expanded to some extent in order to equate a global performance level because of lower opportunity costs to superior resources and/or capabilities that are contained wholly within the boundaries of the firm. in such a condition, that firm’s relationship to its competitive cohort in the local market is the means by which one would begin to see how superior uses of resources could result in ca/sca in relationship to the local market conditions. what could perhaps be observed as superior performance without considering the competitive cohort might not be considered as superior performance in the context of a competitive cohort, or vice versa. admittedly, there also may be usefulness in comparing apples to oranges for some purposes. scrutinizing the performance of firms that do not consider themselves to be within a competitive cohort as a non-cohort set could serve to educate researchers regarding the potential uses of resources or the varying productivities associated with capabilities across organizations. understanding how organizations have achieved their performance levels can be valuable regardless of the relationship among the observed organizations. advances in understanding the potentials that may exist within organizations can be made through such comparisons. however, the comparison of a firm’s performance to organizations outside its competitive cohort may also serve to obscure the antecedents of that firm’s performance. broadening the research focus. fourth, the competitive cohort concept allows for a broadening of possible targets for research regarding organizational performance. typically, research has focused upon for-profit organizations because of the availability of broad, quantitative measures of performance that must be maintained by for-profit organizations. however, the competitive cohort concept need not be limited to for-profit entities. if other types of organizations can be examined from the standpoint of those organizations having competitive cohorts, then one can begin to ask performance questions that do not necessarily rely upon the standard forprofit measures of performance. for instance, charitable organizations must compete for donations, but the competitive cohort of one charitable organization may differ substantially from that of another. in fact, there may be instances when non-profit organizations view themselves as competing directly with for-profit organizations, and vice versa. assessing relative performance within such a competitive cohort may involve developing qualitative or non-standard quantitative measures in order to discover how those organizations actually view their respective performance levels within the cohort. volume 28, number 2 113 consequences of different definitions of a firm’s cohort. fifth, the competitive cohort construct may help to explain the decisions in the market for corporate control among publicly traded firms (hollingsworth, & lindberg, 1985; pound, 1992). the underperformance of some firms may not result in changes in ownership and management of public corporations because present managers and owners along with potential managers and owners perceive a firm to be within a range of performance acceptable within their respective definitions of the firm’s competitive cohort. in other circumstances, above average performance in comparison to standard industry comparisons may result in a move in the market for corporate control to replace management and/or ownership of the public company because of variance from what is perceived to be the competitive cohort’s acceptable level of performance. strength of the cohort effect over other considerations. sixth, some additional explanatory power might be provided by the competitive cohort concept in regard to why organizations that are provided with similar environmental conditions and access to resources in efforts to foster successful performance show varying levels of performance (siegel, westhead, & wright, 2003). although provided with similar conditions and resources, organizations may adopt different competitive cohort referent others, leading to different strategic goals and outcomes. if the competitive cohort effect has validity, the implication in this particular case would be that governmental efforts to provide incubating environments for businesses might be influenced by how the targeted companies’ managers and/or entrepreneurial owners select a competitive cohort. performance outcomes in such a situation might be significantly affected by the competitive cohort effect regardless of the characteristics of the incubating environment provided to firms. propositions following from the competitive cohort concept given the discussion of the concept above, we put forward two propositions regarding a firm’s performance and its measurement. proposition 1: over time, as decisions are adjusted, a significant positive correlation should be noted between an organization’s performance and the performance of the competitive cohort with which the organization’s leadership identifies and to which the organization’s leadership makes performance comparisons. proposition 2: a significant positive correlation should be noted between the performance measures adopted by an organization and the 114 journal of business strategies performance measures adopted by the competitive cohort with which the organization’s leadership identifies and to which the organization’s leadership makes performance comparisons. these propositions, if confirmed, may shed light on why examination of strategic groups and classification systems that are determined via outside observers’ assessments have remained lacking in regard to explaining performance variance within the groups. these propositions may also help researchers to understand why organizations with very dissimilar external environments and internal resource bases adopt similar strategic stances. the competitive cohort concept and these propositions, if confirmed, emphasize the role of social influences, particularly referent others, on shaping how decision makers view and integrate the external and internal domains of their organizations to achieve performance outcomes. conclusion the competitive cohort concept makes a distinction among measures and assessment of performance within industry classes, measures and assessment of performance across firms selected by criteria established by researchers who are external to the firms, and the measures and assessment of performance used internally by firms as their top managers select salient organizations for comparative purposes. as discussed earlier, the competitive cohort is not intended to replace either the i/o or the resource based view of the firm. rather it is argued that organizational performance is some function of all of the components interacting in ways only dimly understood at present. the use of the competitive cohort concept may give a coherency and alternative view of the concepts of competitive advantage and sustained competitive advantage that are presently lacking in the strategic management literature. the implications of the competitive cohort concept may serve to enrich, clarify and broaden the research agendas of those who seek to understand the antecedents of performance outcomes among firms by the following: 1) illuminating what motivates the adoption of strategic policies, 2) providing insight into how organizations assess their relative success or failure to achieve performance objectives, 3) allowing for new concepts of performance and its measurement across organizations that may or may not have similar outputs and operations, and 4) helping researchers consider the validity of potentially inappropriate comparisons of the performance measures of organizations that have no degree of saliency between them. some possible consequences to ignoring the competitive cohort concept are outlined below in table 2. volume 28, number 2 115 table 2 possible consequences of ignoring the competitive cohort construct • an incomplete understanding of decision makers’ motivation. • a lack of explanatory power when observing strategy formulation, implementation, and resultant firm performance. • a lack of understanding why certain strategic organizational goals are adopted/accepted. • a tendency by observers to view companies as competitors when the decision makers of the companies do not consider themselves to be competitors. • a tendency by observers to view companies as non-competitors when the decision makers of the companies do consider themselves to be competitors. • a misunderstanding about why some decision makers consider their organizations to have or not have a competitive advantage in the market. • a misunderstanding why the market for corporate control may or may not be in evidence across a range of firm performance. • a lack of understanding about why some decision makers are content with performance levels that others would find unacceptable, or discontent with performance that others would find acceptable. • a lack of understanding about why similar incubating environments surrounding organizations exhibit varying performance outcomes for those organizations. while competitive cohorts may be difficult to identify, relations between performance measures among the organizations in a cohort should prove to be stronger than those obtained through other groupings of organizations. further, the identification of competitive cohorts will greatly aid researchers in understanding the complex nature of strategic decision making, particularly the role of social forces and networks in that decision making process. managers should be aware of their competitive cohort. indeed an overt recognition of who and what organizations are coming into play as they develop their strategic thinking should help those managers to consider the implications of those social comparisons. adjusting the cohort could lead to improved performance over time. references adams, j. s. (1963). toward an understanding of inequity. journal of abnormal and social psychology, 67, 422-436. adams, j. s. (1965). inequity in social exchange. in l. berkowitz (ed.), advances in experimental psychology (pp. 267-300). new york: academic press. 116 journal of business strategies ambrose, m. l., & kulik, c. t. (1999). old friends, new faces: motivation research in the 1990s. journal of management, 25(3), 231-239. austin, w. (1977). equity theory and social processes. in j. m. suls & r. m. miller (eds.), social comparison processes (pp. 279-301). washington: hemisphere. balogun, j., huff, a. s., & johnson, p. (2003). three responses to the methodological challenges of studying strategizing. journal of management studies, 40(1), 197-224. bamberger, p., & fiegenbaum, a. (1996). the role of strategic reference points in explaining the nature and consequences of human resource policy. academy of management journal, 21(4), 926-958. barney, j. b. (2001). resource-based theories of competitive advantage: a ten-year retrospective on the resource-based view. journal of management, 27(6), 643-650. barney, j. b., & hoskisson, r. e. (1990). strategic groups: untested assertions and research proposals. managerial and decision economics, 11, 187-198. barney, j., wright, m., & ketchen, d. (2001). the resource-based view of the firm: ten years after 1991. journal of management, 27(6), 625-642. besanko, d., dranove, d., shanley, m., & schaefer, s. (2004). economics of strategy, 3rd ed. new york: john wiley & sons. brass, d. j. (1984). being in the right place: a structural analysis of individual influence in an organization. administrative science quarterly, 29, 518-539. burkhardt, m. e. & brass, d. j. (1990). changing patterns or patterns of change: the effects of a change in technology on social structure and power. administrative science quarterly, 35, 104-127. burt, r. s. (1987). social contagion and innovation: cohesion versus structural equivalence. american journal of sociology, 92, 1287-1335. buunk, b. & mussweiler, t. (eds.). (2001). new directions in social comparison research [special issue]. european journal of social psychology, 31(5), 467-475. carmeli, a. & schaubroeck, j. (2007). the influence of leaders’ and other referents’ normative expectations on individual involvement in creative work. the leadership quarterly, 18(1), 35-48 castrogiovanni, g. j. (2002). organization task environments: have they changed fundamentally over time? journal of management, 28(2), 129-150. chatterjee, s., wiseman, m. r., fiegenbaum, a., & devers, e. c. (2003). integrating behavioral and economic concepts of risk into strategic management: the twain shall meet. long range planning, 36, 61-79. cialdini, r. b., reno, r. r., & kallgren, c. a. (1990). a focus theory of normative conduct: recycling the concept of norms to reduce littering in public places. journal of personality and social psychology, 58(6), 1015-1026. volume 28, number 2 117 combs, j. g., michael, s. c., & castrogiovanni, g. j. (2009). institutional influences on the choice of organizational form: the case of franchising. journal of management, 35(5), 1268-1290. conner, d. s. (2003). social comparisons in everyday life. journal of occupational and organizational psychology, 76, 133-147 crosby, f. (1984). relative deprivation in organizational settings. in c. m. staw & l. l. cummings (eds.), research in organizational behavior (vol. 6, pp. 5193). greenwich, ct: jai press. cyert, r. m., & march, j. g. (1963). a behavioral theory of the firm. englewood cliffs, nj: prentice-hall, inc. dakin, s., & arrowood, a. j. (1981). the social comparison of ability. human relations, 34(2), 89-109. daniels, k., johnson, g., & de chernatony, l. (2002). task and institutional influences on managers’ mental models of competition. organization studies, 23(1), 31-62. dranove, d., & peteraf, m. a. (1998). do strategic groups exist? an economic framework for analysis. strategic management journal, 19(11), 1029-1044. edwards, k. d. (1996). prospect theory: a literature review. international review of financial analysis, 5(1), 19-38. ferguson, t. d., deephouse, d. l., & ferguson, w. l. (2000). do strategic groups differ in reputation? strategic management journal, 21(12), 1195-1214. festinger, l. (1954). a theory of social comparison processes. human relations, 7, 117-40. fiegenbaum, a. (1990). prospect theory and the risk-return association: an empirical examination in 85 industries. journal of economic behavior & organization, 14, 187-204. fiegenbaum, a., & thomas, h. (2004). strategic risk and competitive advantage: an integrative perspective. european management review, 1, 84-95. fiegenbaum, a., & thomas, h. (1995). strategic groups as reference groups: theory, modeling, and empirical examination of industry and competitive strategy. strategic management journal, 16(6), 461-476. fiegenbaum, a., & thomas, h. (1986). dynamic and risk measurement perspectives on bowman’s risk-return paradox for strategic management: an empirical study. strategic management journal, 7(5), 395-407. fiegenbaum, a., hart, s., & schendel, d. (1996). strategic reference point theory. strategic management journal, 17(3), 219-235. gino, f., ayal, s, & ariely, d. (2009). contagion and differentiation in unethical behavior: the effect of one bad apple on the barrel. psychological science, 20(3), 393-398. 118 journal of business strategies gonzález-fidalgo, e., & ventura-victoria, j. (2002). how much do strategic groups matter? review of industrial organization, 21(1), 55-71. gulati, r., & westphal, j. d. (1999). cooperative or controlling? the effects of ceo-board relations and the content of interlocks on the formation of joint ventures. administrative science quarterly, 44(3), 473-506. hastie, r., & dawes, r. m. (2001). rational choice in an uncertain world: the psychology of judgment and decision making. thousand oaks, ca: sage publications. henkel, j. (2003). the risk-return paradox for strategic management: disentangling true and spurious effects. paper presented to the academy of management, seattle. hill, c. w. l., & jones, g. r. (2004). strategic management: an integrated approach, 6th ed. boston: houghton mifflin. hitt, m. a., ireland, r. d., & hoskisson, r. e. (2003). strategic management: competitiveness and globalization, 5th ed. mason, oh: thomson/south-western. hitt, m. a., ireland, r. d., & hoskisson, r. e. (2011). strategic management: competitiveness and globalization, 9th ed. mason, oh: south-western cengage learning. hodgkinson, g. p. (2003). the interface of cognitive and industrial, work and organizational psychology. journal of occupational and organizational psychology, 76, 1-25. hodgkinson, g. p., maule, a. j., & brown, n. j. (2004). causal cognitive mapping in the organizational strategy field: a comparison of alternative elicitation procedures. organizational research methods, 7, 3-26. hollingsworth, j. r., & lindberg, l. n. (1985). the governance of the american economy: the role of markets, clans, hierarchies, and associative behaviour. in w. streeck & p. c. schmitter (eds.), private interest government: beyond market and state. london: sage. holmes, r. m., bromiley, p., devers, c. e., holcomb, t. r., & mcguire, j. b. (2011). management theory applications of prospect theory: accomplishments, challenges, and opportunities. journal of management, 37(4), 1069-1107. huff, a. s. (1997). a current and future agenda for cognitive research in organizations. journal of management studies, 34(6), 947-952. hunt, m. (1972). competition in the major home appliance industry. doctoral dissertation, harvard university, 1972. huseman, r. c., hatfield, j. d., & miles, e. w. (1987). a new perspective on equity theory: the equity sensitivity concept. academy of management review, 12(2), 222–234. volume 28, number 2 119 ibarra, h., & andrews, s. b. (1993). power, social influence, and sense making: effects of network centrality and proximity on employee perceptions. administrative science quarterly, 38, 277-303. kahneman, d. & tversky, a. (1979). prospect theory: an analysis of decisions under risk. econometrica, 47, 313-327. kulik, c. t., & ambrose, m. l. (1992). personal and situational determinants of referent choice. academy of management review, 17(2), 212-237. levine, j. m. & moreland, r. l. (1990). progress in small group research. in m. r. rosenzweig & l. w. porter (eds.), annual review of psychology, 41, 585-634. palo alto, ca: annual reviews. levine, j. m., & moreland, r. l. (1987). social comparison and outcome evaluation in group contexts. in j. c. masters & w. p. smith (eds.), social comparison, justice, and relative deprivation: theoretical, empirical, and policy perspectives (pp. 105-127). hillsdale, nj: erlbaum. levy, h., & levy, m. (2002). experimental test of the prospect theory value function: a stochastic dominance approach. organizational behavior and human decision processes, 89(2), 1058-1081. lewicka, m. (1997). rational or uncommitted? depression and indecisiveness in interpersonal decision making. scandinavian journal of psychology, 38(3), 227-236. list, j. a. (2004). neoclassical theory versus prospect theory: evidence from the marketplace. econometrica, 72(2), 615-625. locke, e. a., & latham, g. p. (1990). a theory of goal setting and task performance. englewood cliffs, nj: prentice hall. march, j. g. (1994). a primer on decision making. new york: free press. march, j. g. (1962). the business firm as a political coalition. journal of politics, 24, 662-678. markus, m. l., manville, b., & agres, c. e. (2000). what makes a virtual organization work? sloan management review, 42(1), 13–26. mathieu, j. e., & chen, g. (2011). the etiology of the multilevel paradigm in management research. journal of management, 37(2), 610-641. mcdermott, r. (2004). prospect theory in political science: gains and loses from the first decade. political psychology, 25(2), 289-312. mcdermott, r., & kugler, j. (2001). comparing rational choice and prospect theory analyses: the us decision to launch operation ‘desert storm,’ january 1991. the journal of strategic studies, 24(3), 49-85. mcgee, j., & thomas, h. (1986). strategic groups: theory, research and taxonomy. strategic management journal, 7(2), 141-160. 120 journal of business strategies mcnamara g., & bromiley, p. (1999). risk and return in organizational decision making. academy of management journal, 42(3), 330-339. moliterno, t. p., & mahony, d. m. (2011). network theory of organization: a multilevel approach. journal of management, 37(2), 443-467. nair, a. & kotha, s. (2001). does group membership matter? evidence from the japanese steel industry. strategic management journal, 22(3), 221-235. narayanan, v. k., zane, l. j., & kemmerer, b. (2011). the cognitive perspective in strategy: an integrative review. journal of management, 37(1), 305-351. nath, d., & gruca, t. s. (1997). convergence across alternative methods for forming strategic groups. strategic management journal, 18(9), 745-760. ndofor, h. a., & priem, r. l. (2011). immigrant entrepreneurs, the ethnic enclave strategy, and venture performance. journal of management, 37(3), 790-818. newman, w. h. (1978). strategic groups and the structure-performance relationship. the review of economics and statistics, 60(3), 417-27. oldham, g. r., kulik, c. t., stepina, l. p., & ambrose, m. l. (1986). relations between situational factors and the comparative referents used by employees. academy of management journal, 29(3), 599-608. oldham, g. r., nottenburg, g., kassner, m. w., ferris, g., fedor, d., & masters, m. (1982). the selection and consequences of job comparisons. organizational behavior & human performance, 29, 84-111. oliver, c. (1997). sustainable competitive advantage: combining institutional and resource-based views. strategic management journal, 18(9), 697-713. peeters, g., czapinski, j., & lewicka, m. (1992). positive-negative asymmetry in affect and evaluations. european journal of social psychology, 22, 5-6. peng, m. w., tan, j. & tong, t. w. (2004). ownership types and strategic groups in an emerging economy. journal of management studies, 41, 1105-1129. peteraf, m. a. (1993). the cornerstones of competitive advantage: a resource-based view. strategic management journal, 14(3), 179-191. peteraf, m., & shanley, m. (1997). getting to know you: a theory of strategic group identity. strategic management journal, 18(summer special issue), 165-186. porter, m. e. (1979). the structure within industries and companies’ performance. the review of economics and statistics, 61(2), 214-27. porac, j. f., & thomas h. (1994). cognitive categorization and subjective rivalry among retailers in a small city. journal of applied psychology, 79, 54-66. porac, j. f. & thomas h. (1990). taxonomic mental models in competitor definition. academy of management review, 15(2), 224-240. volume 28, number 2 121 porac, j. f., thomas h., wilson, f., paton, d., & kanfer, a. (1995). rivalry in the industry model of scottish knitwear producers. administrative science quarterly, 40, 203-227. pound, j. (1992). beyond takeovers: politics comes to corporate control. harvard business review, march-april, 83-93. reger, r. k. (1990). managerial thought structures and competitive positioning. in a. s. huff (ed.), mapping strategic thought (pp. 71-88). chichester, uk: wiley. reger, r. k., & huff, a. (1993). strategic groups: a cognitive perspective. strategic management journal, 14(2), 104-124. reger, r. k., & palmer, t. b. (1996). managerial categorization of competitors: using old maps to navigate new environments. organization science, 7(1), 22-39. ronen, s. (1986). equity perception in multiple comparisons: a field study. human relations, 39(4), 333-345. schleifer, a. (2000). inefficient markets: an introduction to behavioral finance. new york: oxford university press. seo, m., goldfarb, b., & barrett, l. f. (2010). affect and the framing effect within individuals over time: risk taking in a dynamic investment simulation. academy of management journal, 53(2), 411-431. shah, p. p. (1998). who are employees’ social referents? using a network perspective to determine referent others. academy of management journal, 41(3), 249-276. siegel, d. s., westhead, p. & wright, m. (2003). science parks and the performance of new technology-based firms: a review of recent u.k. evidence and an agenda for future research. small business economics, 20, 177-184. shoham, a., & fiegenbaum, a. (2002). competitive determinants of organizational risk-taking attitude: the role of strategic reference points. management decision, 40(2), 127-141. spencer, b., peyrefitte, j., & churchman, r. (2003). consensus and divergence in perceptions of cognitive strategic groups: evidence from the health care industry. strategic organization, 1(2), 203-230. sturdy, a. (2003). knowing the unknowable?: a discussion of methodological and theoretical issues in emotion research and organizational studies. organization, 10(1), 81-105. thomas, h. & pollock, t. (1999). from i-o economics’ s-c-p paradigm through strategic groups to competence-based competition: reflections on the puzzle of competitive strategy. british journal of management, 10(2), 127-140. tversky, a., & kahneman, d. (1986). rational choice and the framing of decisions. journal of business, 59, 251-278. 122 journal of business strategies westphal, j. d. (1999). collaboration in the boardroom: behavioral and performance consequences of ceo-board social ties. academy of management journal, 42(1), 7-24. wheeler, l., & miyake, k. (1992). social comparison in everyday life. interpersonal relations and group processes, 62, 760-773. wiggins, r. r., & ruefli, t. w. (1995). necessary conditions for the predictive validity of strategic groups: analysis without reliance on clustering techniques. academy of management journal, 38(6), 1635-1656. wiseman, r. m., & gomez-mejia, l. r. (1998). a behavioral agency model of managerial risk taking. academy of management review, 22(1), 133-153. wright, m., low, m., & davidson, p. (2001). entrepreneurship research, progress and prospects. entrepreneurship, theory & practice, 25, 5-15. biographical sketch of authors gerald david flint, clinical associate professor of management in the mays business school at texas a&m university, has numerous publications and presentations focusing predominantly on strategy and entrepreneurship. he is a serial entrepreneur involved with five small business endeavors covering software, real estate, insurance, education outside of the united states, and transportation activities. he serves as a board member for multiple non-profit organizations with both domestic and international activities. david d. van fleet is professor of management in the morrison school of agribusiness and resource management. he is a fellow of the academy of management and former deputy dean of the fellows, a fellow of the southern management association and former dean of the sma fellows. david is the author of numerous articles and books on management and former editor of both the journal of management and the journal of behavioral and applied management. author’s note the helpful comments of drs. avi carmeli, michael hitt, robert hoskisson, abagail mcwilliams, luiz mesquita, donald siegel, and ella w. van fleet on earlier drafts of this manuscript are gratefully acknowledged, although their contributions should not be taken as an endorsement of the ideas presented here. the competitive cohort: an extension of strategic understanding volume 35, number 1 71 risk management lessons from the financial crisis: a textual analysis of the financial crisis inquiry commission’s report corey j. fox texas state university • san marcos, tx abstract there have been several retrospective analyses of the financial crisis. an area that continues to receive attention is the failure of risk management in financial firms at the heart of the crisis. after the crisis, the united states government convened the financial crisis inquiry commission to explore causes of the crisis. their conclusions have gone largely unexplored, especially in academic research. in this study, i first examine the commission’s report on the crisis identifying several reappearing themes. an exploratory follow-up analysis looking at financial and nonfinancial firms suggests non-financial firms have areas to improve upon compared to their financial counterparts. keywords: financial crisis; risk management; risk management failure; financial crisis inquiry commission; fcic “those who cannot remember the past are condemned to repeat it.” – george santayana (philosopher) introduction the financial crisis of 2008 and 2009 was the worst financial disaster to hit the united states in over seven decades. organizations of all types were impacted as the events in the financial industry rippled throughout the economy. the crisis left the economy in shambles, dissolved trillions of dollars in wealth, and left millions of people without jobs and homes (financial crisis inquiry commission [fcic], 2011). there have been many opinions about what the root causes of the crisis were (jickling, 2009). while some recent research has suggested that excessive investment in financial products (both ordinary and exotic) were a considerable culprit (e.g., tuckman, 2016; vo, 2015) there has been much less work focused on the impact that risk management failures at the managerial level had on failing financial firms (e.g., hubbard, 2009). in 2009, the u.s. government commissioned a committee to look into the 72 journal of business strategies causes of the financial crisis. this committee, known as the financial crisis inquiry commission (fcic), gathered and analyzed a myriad of data before putting out a complete report based upon their extensive analysis, outlining what it believed to be the main causes of the crisis. while this report was made public, there has been little exploration or discussion of the findings in academic circles (per mention in academic research papers) especially as it relates to risk management within organizations. this is unfortunate since the report is built upon a vast amount of information and has implications for management practices related to the management of risk. as suggested by the quote above from george santayana, it is thought that finding a cause(s) can help businesses learn, and hopefully avoid, making the same (or similar) mistakes in the future. the purpose of this paper is to look, qualitatively, at the commission’s in-depth report, analyze the passages around risk management and discuss the implications of the findings. additionally, this paper explores whether financial and non-financial firms have learned from the failures identified in the commission’s report. the purpose behind expanding the study beyond just the large financial firms associated with the crisis, was to assess the degree of learning (if any) at other large, visible firms. the organizational learning literature (huber, 1991; madsen and desai, 2010) has suggested that firms can make adaptations to its business operations and strategy as a result of reflections on their own experiences (experiential learning) or the experiences of others (vicarious learning). financial institutions that were at the center of the crisis (such as the large financial firms and large regional banks) should be most likely to have made adaptations post crisis. however, we might also expect that other large, visible firms would make adaptations due in part to what they learned from the failings of these financial firms. however, the changes may be less pronounced since those firms were further away from the actual learning event. in doing so, this paper makes three important contributions to the extant literature in risk management and organization studies. first, this paper adds to what is currently known about risk management failure, and more specifically risk management failure during the financial crisis. while much has been made about the failure of complex quantitative risk management systems, less is known about managerial-level failures. second, this paper synthesizes and condenses a broad array of disparate statements in the fcic report on risk management during the crisis into a small set of important risk management issues. these issues are described and discussed in detail so that managers and organizations (in all industries) can learn from the mistakes of these failed institutions. last, there are prescriptive remedies given to help companies avoid risk management failures in the future. volume 35, number 1 73 research background the commission following the financial crisis, the us government convened a commission known as the financial crisis inquiry commission (fcic)1, to examine the causes of the crisis. the fcic was commissioned by the fraud enforcement and recovery act of 2009 and tasked with conducting a thorough investigation into the causes of the financial and crisis.2 the commission worked together for over 18 months gathering data from a multitude of sources and conducting interviews with people involved at various stages and levels of the crisis. over that time frame, the commission scoured over millions of pages of documents, including the work of journalists, academics and other published sources. the commission interviewed more than 700 material ‘witnesses’ and conducted numerous public hearings across the country in an attempt to learn about what happened. despite the widely held belief amongst industry regulators that financial firms were prudent risk managers with sophisticated financial models who had strong ‘market’ incentives to undertake sound risk management practices, the risk management systems at these large firms failed. risk management, like strategic management, is a process directed by the top managers of a firm during strategy formulation (chapman, 2011). risk management is generally described as an iterative, holistic process whereby firms identify, analyze, strategize, treat and communicate risks (chapman, 2011; frame, 2003; shenkir, barton and walker, 2010; shortreed, 2010). during the financial crisis, for many financial firms, there was a breakdown in the process. as a result, the following research questions were explored in this paper: 1) what were the contributing factors that led to financial firms’ risk management failures during the crisis? 2) post crisis, have firms (both financial and non-financial) learned from these failures? methodology to explore the research objectives identified, i conducted two studies. in study 1, i pursued a textual approach research methodology. the textual approach 74 journal of business strategies examines texts to gain insights about events. this research approach has been used before to make sense of events surrounding situations of crisis (e.g. gephart, 1993). the purpose of study 1 was to examine where the breakdown in risk management occurred at the large financial institutions who were at the heart of the crisis. in study 2, i pursued an exploratory analysis where four separate types of firms were identified – large financial institutions, large regional banks, large non-financial companies with a dedicated financial services business segment, and large nonfinancial companies without a dedicated financial services business. for each group identified, three representative firms were chosen and a textual analysis of these firms’ proxy statements from before and after the crisis was undertaken. the purpose of study 2 was to examine whether financial and non-financial firms had learned from the failures identified in study 1. study 1 first, i downloaded the entire fcic report from the fcic website (cited in the reference section). to find passages that were about risk management, i searched the text document for the phrase ‘risk manage’ which would catch any reference to risk management or risk manager. i also searched for two other variants of risk management by searching for ‘managing risk’ and ‘manage risk.’ in total, there were roughly 103 instances in the body of the main report of 410 pages. a graduate assistant and i parsed these instances and pulled out the surrounding sentences to create a list of passages. of the 103 passages initially identified, 34 of the passages (33%) were identified as containing no substantive or relevant information to address the research question. appendix a has several examples of these passages, all of which were excluded from consideration. an additional 30 passages (29%) discussed other influences of risk management failures beyond the scope of this study. for instance, information about regulators or the institutional environment were outside the boundary of the firm and thus subsequently excluded. the remaining 39 passages (38%) were related to risk management inside the financial firms so were used for the analysis. the assistant and i looked for themes in each of the passages. after initial analysis and conversations, five sources of failure emerged. the first category was classified as risk management process failures. this category included any mention of problems related to risk assessment, risk evaluation and analysis, risk treatment, or risk communication. this category also included any mention of problems with the firms existing risk management protocols. the second category volume 35, number 1 75 was classified as support system failures (compensation). this category consisted of passages showing failures in the firm’s compensation system which may have had an impact on risk behavior. the third category was classified as resource allocation failures. this category included any passage that described the human or financial resources allocated to support the risk management function. the fourth category was called top management failures. this category focused on failures created by top management overconfidence and hubris. the fifth and final category was called objective tradeoff failures. this category consisted of passages focusing on the tradeoffs made between risk and financial objectives. to validate the categories and the correct assignment of passages to categories, six undergraduate students, majoring in finance with a concentration in insurance and risk management at a large midwestern university, volunteered to participate in exchange for extra credit. the students were randomly given between 12 and 14 passages where each passage was evaluated by two students. in addition to the passage, students were given the category titles and a description of each category. in addition to the five categories mentioned above, an other category was also included if the student thought the passage did not belong in any of the categories. each student was instructed to place the passage into the category which they felt best described the passage. while it is certainly possible that some of the categories could indeed be related with one another (for instance, compensation systems might impact whether a firm focuses on performance metrics or risk management outcomes), the purpose was to validate the themes surrounding risk management according to the fcic report (i.e., what appeared most often). across the six volunteers, agreement was obtained just over 73% of the time. there were four passages in which both students failed to classify the passage according to one of the pre-specified categories. these passages were omitted from consideration, leaving 35 total passages. any remaining passages where at least one student classified the passage according to the pre-specified categories and another did not, were resolved through discussion. results after the analysis was complete the passages were explored in relation to the five general themes which had emerged. below is a discussion of each general theme, each of which is supported with reference to several representative passages which provided information to identify the theme. several of the themes are similar in nature and could be interpreted as being from relatively similar sources, however 76 journal of business strategies an effort was made to try and segment the themes to be as fine-grained as possible. all of the supporting passages discussed can be found in appendix a under the appropriate heading.3 risk management process failures. the most often mentioned failure found in the report points to a general failure of the risk management process in financial firms. the risk management process, according to literature in finance and strategic management, is generally conceived of as a holistic approach spanning the entire organization (e.g., clarke and varma, 1999; fraser and simkins, 2010; miller, 1998; miller and waller, 2003) and has been referred to by various names like enterprise (erm), integrated (irm) or strategic (srm) risk management. this process generally includes risk identification, assessment, evaluation, treatment, review and communication (chapman, 2011). passages within the report suggest that there were breakdowns in each of these areas in addition to using a holistic approach. during the financial crisis, firms were still subscribing to the antiquated ‘silo’ approach to risk management. the first general problem was that risks were being managed independent of one another without much information sharing across business lines. there is evidence of this shown in passage 1 where citigroup’s risk management function was operating independently along each of its separate business lines. employees just steps away from each other, working with similar risk assets, or risk products which were related, did not know what each other were doing. information that was gained from each business line with respect to the risk assets was being kept away from other sources that could potentially benefit from such information. a second area of concern was with the risk identification, assessment, evaluation and treatment process. for instance, as suggested in passage 2 & 3, risk managers were not able to properly identify soft risks. soft risks are those which require judgment and are not purely financial in nature. in too many instances, instead of using judgment, managers were using mathematical models as predictors for risks. furthermore, the models being used to determine which risks should be managed were based on assumptions that were markedly wrong. there was little evidence of scenario planning in assessing the probabilities and worst case scenarios for home price declines. lastly, as evidenced by additional passages, managers were comfortable using financial hedges as effective treatment strategies since it had the added benefit of reducing the amount of financial slack the firm had to hold. a third problem related to risk management processes was risk communication. risk communication involves communication and consultation volume 35, number 1 77 between management and the individuals/departments responsible for implementing and carrying out the risk management strategy to make it more effective over time (chapman, 2011). prior research has found that having communication links between the governing parties of the organization and those in charge of risk management can increase efficiency and firm performance (grace, leverty, phillips and shimpi, 2015). during the crisis it was evident that in some firms, communication between the management team and the risk management department/team was less than ideal. in passage 4 for instance, the executive committee at lehman brothers failed to include the company’s chief risk officer in decisions that directly impacted the risk of the firm. finally, in some cases, the entire risk management process was inadequate and lacking. in one passage, a consultant hired to examine bear stearn’s risk management process was highly critical suggesting that key elements in the process, such as risk identification and assessment, were infrequent. he continued that the risk management function did not have the resources it needed (as discussed in more detail below) and was of a low priority to the firm. support system failures (compensation). one of the most common systems for supporting goals and strategic decisions in organizations is the compensation system. in the management literature, executive compensation is a tool often used to align management interests with the interests of the firm’s owners. scholars in the risk management arena have similarly concluded that one way to focus management’s attention on risk management is to align their compensation with risk management objectives and outcomes (lam, 2014). firms must reward risk management behavior through incentive structures which align good risk management practices with pay. indeed, grace and colleagues (2015) found evidence that firm performance was enhanced when compensation was aligned with risk management. there are numerous instances in the report which suggest that several of the failed financial firms were not incentivizing good risk management, and instead were incentivizing more risky, short-term oriented behavior. passages 5 through 7 highlight this notion. for instance, the head of the federal deposit insurance corporation (fdic) remarked that incentives favored short-term risk-taking and profits over long-term risk considerations, sustainability and solvency. lam (2014) has suggested that incentivized performance can be problematic for risk management when incentives are one dimensional -they focus on a single, bottom-line figure. at the time of the crisis, financial firms, in particular, tied aggressive pay packages filled with stock options to the price of the firm’s stock. in many situations, the options granted to executives came with accelerated payouts. in 2006, one year 78 journal of business strategies before the onset of the company’s demise, merrill lynch ceo stanley o’neal made $91 million. when he walked away from the company as it began its decline he left with a total consolation package of $161 million (farrell and hansen, 2009). richard fuld, ceo of lehman brothers, was awarded $34 million before he departed. these kinds of pay structures, littered with stock options, created incentives to increase the amount of risk executives took to improve returns. this included greater leverage levels and, in some cases (e.g. frannie and freddie), fraudulent financial filings. indeed, academic research has argued that executives at bear stearns and lehman brothers in particular, had incentives to take on large amounts of risk as they had already pulled out hundreds of millions of dollars in options and bonuses prior to the collapse (bebchuk, cohen and spamann, 2010). resource allocation failures. one of the pre-requisites for successful risk management is the allocation of necessary resources to adequately perform the job. depending upon the size of the organization and the scope of the risk management system (and goals for the system), the two most critical resources are human and financial capital. firms need to have staff ready to engage with the risk management process, and depending upon the risk management strategies developed, the risk management staff needs the appropriate amount of capital to execute the strategy. during the financial crisis, the fcic report alludes to both elements lacking. in terms of inadequate personnel, the auditors of several of the failed firms were critical of the firms’ appointed risk managers. this included managers hired to lead the risk management departments. for instance in passage 8, the auditors of aig raised concerns about the skill sets of the top management team (ceo, cfo and cro) and managers appointed to the erm department concerning their capacity to do the job of managing risk. also, in passage 9, the sec criticized bear stearns because their risk management functions lacked expertise in the risky products they were supposed to manage the risk, and the risk management function was understaffed. in addition to personnel, financial resources were also inadequate. firms withheld, and sometimes cut, the resources for the risk management departments to do their jobs. for example, passage 10 exhibits a willingness by management to tell the board of directors at fannie mae that risk management had all necessary resources to act on risk management initiatives. however, the cro disagreed as his department saw double digit budget cuts which led to a reduction in head count in the year leading up to the crisis. top management failures. many of the failures in risk management during the crisis can be traced back to failures at the top of the firm and with each volume 35, number 1 79 firms’ corporate governance. in the management literature, the upper echelon’s perspective (hambrick and mason, 1984) suggests that firms are a reflection of its top management team as well as those in charge of setting the strategic direction of the firm. in the case of the financial crisis, top management teams were seen as a major reason why some firms had failed. indeed, in testimony to the fcic, j.p. morgan ceo jamie dimon, one of the firms that survived the crisis, suggested that top management teams were to blame for the problems at the failed financial institutions and nobody else. another cause of risk management failure during the financial crisis was managerial hubris concerning risk management competencies. hubris refers to an extreme level of pride or overconfidence in one’s self and abilities. hubris has been associated with a number of corporate maladies including overpaying for acquisitions (hayward and hambrick, 1997) and corporate social irresponsibility (tang, qian, chen and shen, 2014). related to hubris, the overconfidence bias is the tendency for a person to have greater subjective confidence in their judgment or abilities than is objectively warranted. in many of the failed financial firms, the top management teams were very confident about the effectiveness and adequacies of their risk management systems. numerous ceos had made mention of their risk management competencies even though none had necessarily been tested in remotely turbulent market environments. for instance, in passages 4,11 & 12 the ceos of lehman brothers, aig and merrill lynch touted their risk management programs, going so far as to suggest that their risk management programs were strong and a fundamental component of their business model. two potential reasons are apparent from the report which may have resulted in executive hubris. first, the resilience of the big financial institutions to avoid big losses in prior debacles, like the dot com bubble, led managers and firms to believe they had robust and successful risk management systems in place. second, hubris may have resulted from misplaced overconfidence in the complex mathematical models used for assessing risk. financial institutions were lulled into a false sense of security as these models would show that financial firms had little to be concerned about, and which up to that point, had kept the firms safe. in some instances, the complex models had even given the firms’ auditors reason to believe that risk had been reduced or eliminated. as an example, in passage 13, aig’s auditors were convinced that the firm’s economic risks were essentially zero. thus, the models appeared to have been a contributing factor to executive hubris. auditors and ceos were not alone in their false sense of security. regulators and industry experts like fed chairman greenspan at the time, also believed the sophisticated modeling 80 journal of business strategies techniques would protect financial firms from disaster. one might also consider that while cognitive bias appeared present, the other themes addressed herein are also the domain of top managers. thus, while top management failures are highlighted as a function of managerial cognition, the other elements of failure are also reflections of decisions made by members of the top management team at the financial firms. objective tradeoff failures. the final contributing factor from the analysis suggests that some firms were faced with a difficult tradeoff between, what were framed as, mutually exclusive choices. the firms could either do the right thing from a risk management perspective or pursue strategies that advanced the goals and aspirations of the firm -but not both. for instance, in passage 14, there is clear indication that management at some firms, including fannie mae, were pursuing strategies that increased their firm’s level of risk while in pursuit of corporate objectives but which ran counter to good risk management practices. additionally, some objectives and aspirations encompassed by corporate initiatives like growth, played a role in some decisions by risk management departments to loosen the reign on risk appetite. as mentioned in passage 15, citigroup allowed risk management departments to approve higher risk limits if a business line was growing. study 1 conclusions. to sum up, the analysis of the fcic report seems to support five areas of risk management failure during the financial crisis. first, there were failures in the risk management process and the use of holistic risk management models. second, systems (more specifically, compensation systems) that should support the risk management process and promote risk management thinking, were not constructed properly. third, the necessary human and financial resources to properly support effective risk management functions were not provided. fourth, top management hubris created a false sense of confidence in the existing risk management systems. finally, firms were faced with a false choice between managing risk properly and achieving the bottom line objectives of the company. all of these issues, combined, led to an environment where risk management was likely to be less than adequate to deal with the challenges presented by the financial crisis. study 2 in study two, i wanted to explore some of the conclusions of study one in more detail and probe whether firms, both in and outside of the financial industry, had addressed the shortcomings which led to the failure of risk management. as such, study two was an exploratory study – a first step, in assessing pre and post crisis firm volume 35, number 1 81 behavior. firms were segmented into four categories, each more removed from the center of the crisis. i started by identifying a representative set of three firms for each of the following four categories. the categories and representative firms were: large financial firms (j.p. morgan chase (jpm), bank of america (bac), wells fargo (wfc)), large regional banks (suntrust banks (sti), bb&t corp (bbt), fifth third bancorp (fitb)), large non-financial firms which had a dedicated financial services business segment (general electric (ge), ford motor company (f), deere & co (de)), and large non-financial firms which did not have a dedicated financial services business segment (nike (nke), proctor & gamble (pg), the coca-cola company (ko)). for each firm, proxy statements filed before the crisis (2005-2007) and after the crisis (2010-2012) were pulled from the sec website. each of the proxy statements was examined using a basic text analysis. i calculated averages for both sets of data so that i could get a more accurate picture of each firm’s situation before and after the crisis. in study two, i looked at four things related to study one. first, related to the use of a holistic risk management program, i looked at how often the terms ‘risk manage,’ or some variant of ‘manage risk’, were used in the proxy statement. second, i looked for evidence that the appropriate human resources were allocated to risk management by searching for someone with a title who was designated as someone in charge of managing risk (e.g., chief risk officer (cro), risk executive, or risk manager). third, related to the focus of compensation design, i looked for how prevalent risk and risk management were in a company’s discussion of executive compensation. last, i explored the prevalence of ‘growth’ and ‘return’ in the proxy statements compared to the use of the word ‘risk’ as this may relate to the trade-off between risk and the firm’s bottom line. in this last part of the analysis, i made sure to only count the word ‘risk’ when it was not in reference to anything risk management-related. the use of word counts, as proxies for the level of importance of a theme or idea, has been described in prior qualitative methods research (e.g., carley, 1993; duriau, reger, & pfarrer, 2007) and used in strategic management research (e.g., angriawan & abebe, 2011). results in regards to the use of a holistic risk management process, i searched for the phrase “risk management” and other variants (e.g., manage risk) to proxy for the importance of a formal risk management process. the number of instances were counted for each company and the results are displayed in figure 1. the following 82 journal of business strategies observations can be made when looking at the data. first, risk management was rarely discussed in the proxy documents before the crisis across all types of firms, whereas after the crisis, risk management appeared much more frequently. second, financial institutions and regional banks – those closest to the crisis, used the phrase more than non-financial companies (as much as two to four times more). after the crisis, financial institutions used the term more than any other type of firm while non-financial firms without dedicated financial services business segments used the term the least (on average). this result is consistent with the findings of the fcic that described pre-crisis behavior related to risk management. while aftercrisis behavior regarding risk management seems to have improved, the relatively infrequent mention of risk management in non-financial firms is troubling. with regards to human resource allocation, i searched the proxy statement for evidence that the firms had a dedicated executive or manager who was responsible for risk oversight. it was important that risk oversight was governed by someone within the firm as opposed to a committee on the board of directors. search terms such as ‘chief risk,’ ‘risk executive,’ and ‘risk manager’ were used to capture titles which designate a position dedicated to risk oversight. prior work in the risk management literature have used similar search terms as proxies for evidence of risk management programs and risk management implementation. for instance, liebenberg & hoyt (2003) uses the presence/absence of a chief risk officer (cro) as a proxy to identify a firm’s adoption of enterprise risk management. similarly, hoyt & liebenberg (2011) use the cro as a proxy for risk management implementation. along these lines, beasley and colleagues (2005) identifies the cro and other high level risk managers as champions of risk management, thus suggesting that these human resources are necessary resources for successful risk management. the following observation was made from this qualitative search.4 before the crisis, two of the financial institutions and two of the regional banks had a chief risk officer (although one of the regional banks only mentions the cro in 2005 but not 2006 or 2007), while none of the non-financial companies had one before the crisis. after the crisis, all of the financial institutions and regional banks had appointed an individual as the head of risk oversight, while only one non-financial company had done so. however, the non-financial company that appointed a cro had a financeoriented business segment. this result is in-line with the fcic report in that before the crisis, most financial firms had not allocated the appropriate human resources to risk management. here too it seems troubling that non-financial companies have not followed in the footsteps of their financial counterparts and appointed an individual with a risk designation. volume 35, number 1 83 the third aspect of study one examined was the integration of risk management outcomes and processes in compensation design. to explore this, each company’s compensation discussion section in the proxy statement was examined. of particular interest was how each company talked about the integration of risk processes in setting compensation policies – not simply how much of a compensation package was ‘at risk’ but how the compensation package took into account risk assessment, management and outcomes. the following observation was made from this qualitative search.5 before the crisis, most all of the financial institutions and regional banks specifically identified how risk was taken into account when designing compensation while none of the non-financial companies described in much detail how risk management was considered in setting compensation. after the crisis, all of the financial institutions and regional banks discuss in detail how risk was considered in setting compensation. for non-financial firms, half of them discuss some aspect of how risk was considered in setting compensation, however only one does so thoroughly. this result too is in-line with the fcic report in that firms did a poor job pre-crisis in linking risk management outcomes with compensation design. the final issue examined from study one was the focus on strategies aimed to improve the bottom line and which overshadowed sound risk management. to explore this relationship, i searched for the words ‘growth’ and ‘return’ in the firm’s proxy statements. after getting a count of these words, a ratio of how often the word ‘risk’ appeared in relation to these two words was calculated. the ratios are graphed in figure 2. as can be seen in the graphs, risk is talked about more than return after the crisis compared to before. a ratio of less than one means that the firm talked about return more than risk. an interesting take-away appears when looking at the magnitude of the ratios. for financial institutions and regional banks, four of the six firms mention risk over two times more than return after the crisis, with one of those firms mentioning risk over four times as much, and one firm mentioning it almost three times as much. while for non-financial firms, the use of risk compared to return increases post crisis; four of the six firms use risk and return about the same number of times while two talk about risk less than return. these results, particularly for financial firms, appear to be in line with the fcic report. almost all of the firms focus more on return and growth prior to the crisis than risk. general discussion the purpose of this study has been twofold. first, i wanted to identify the contributing factors or risk management failure leading up to, and during, the (2) 84 journal of business strategies financial crisis. drawing upon the fcic report, five ‘themes’ emerged from the passages which mention risk management. second, i wanted to explore, in a very general sense, the extent to which failures identified at the large financial companies at the center of the crisis, had been remedied immediately after the crisis by all types of firms, not just financial firms. the analyses uncover several areas for firms to consider as they look to improve their risk management. these suggestions are aimed largely at nonfinancial institutions. the reason being that following the crisis, regulatory bodies in the u.s. issued a number of regulations and specific guidance for risk-reporting aimed at financial institutions and regional banks. for instance, in response to risk management failures the government passed legislation like the dodd-frank wall street reform and consumer protection act (2010) aimed at reducing future risks to the financial industry. this legislation was largely aimed at the risk management at financial institutions, giving oversight authority to the federal reserve. in addition to dodd-frank regulations, the sec approved the proxy disclosure enhancement (2009) guidelines designed to enhance disclosures about risk in the firm’s proxy filings. in the new guidelines, firms are required to make some reference to compensation design and risk, as well as the role the board of directors plays in risk oversight. while helpful, the sec rules do not require behavioral changes, only the disclosure of additional information. however, given the present analysis, it is apparent that financial firms and regional banks have done a much better job post-crisis in addressing how risk management and risk, in general, figure into the management of the firm. these firms appear to be adhering to the new standards. while it is clear that financial institutions and regional banks have addressed the shortcomings of risk management found during the financial crisis (likely in response to increased reporting and regulatory requirements), nonfinancial companies appear to have several areas which need improvement. while financial firms seemed to have at least made some aesthetic changes based upon their experiences (i would hesitate to call it learning without more detailed internal information about the processes of the firm), it does not appear that non-financial companies have learned vicariously from the experiences of the financial companies. there are multiple opportunities for non-financial firms to improve upon their risk management processes, which are addressed below. volume 35, number 1 85 compensation systems compensation systems are one area that non-financial firms could improve in their pursuit of improved risk management. as suggested by lam (2014), incentivized performance becomes problematic when the incentives are focused on one dimension of firm performance -in many instances, stock price. furthermore, incentives became especially problematic for financial firms when those contracts came with accelerated payout options. these two characteristics, a singular focus on stock price performance and accelerated payout options, made it difficult for managers to focus on the long-term outcomes of risk when making decisions. recent research has suggested (e.g. rochette, 2009) and empirically found (e.g. grace et al., 2015) that one way to improve risk management is to tie incentives to risk management objectives in addition to other outcomes. for firms seeking to improve the alignment of their compensation with risk management, first managers need to identify key performance indicators (kpi) that will either a) be impacted by the risk management process, or b) be reflective of success for key risk management activities. each kpi is developed by first establishing the performance objective, then identifying the appropriate performance measure for the objective, and finally, developing the kpi. once kpis have been established, compensation needs to be explicitly linked to each kpi. as an example, one of the key risk factors identified by john deere in its 2010 financial report, which may materially impact the firm’s financial performance, is stated as “john deere’s business results depend largely on its ability to develop, manufacture and market products that meet customer demand.” as a result, one of deere’s performance objectives might be: to have all customers rate their satisfaction with the quality of deere products as the best in the industry – this would seem to substantially reduce the risk that customers are dissatisfied with deere products. the performance measure could be: the percentage of customers that rate deere products as highest quality in the industry. the kpi could then be: 90% of customers ranking deere as having the highest quality products in the industry each quarter/half-year/ etc. if deere is hitting this kpi, they in theory, would reduce one of the key risks that could materially impact their business. the ceo’s compensation would then be tied to this kpi. (to be clear, this is just an illustrative example using a company that is highly visible. i am not suggesting that deere is not using kpis tied to risk factors when it comes to designing executive compensation.) as lam (2014) has suggested, compensation must not be aligned with simple measures of return, but with long-term risk-adjusted return hurdles with appropriate 86 journal of business strategies vesting periods. additionally, plans should continue to reward management for stability, continuity, and comparative performance to incentivize a long-term view when making decisions involving risk. also, organizations may consider clawback policies for compensation when management knowingly engages in harmful behavior or exceeds the risk appetite of the firm. eliminating golden parachutes and sizeable compensation packages upon termination for poor performance, as a result of exceeding pre-specified risk thresholds, may also encourage executives to act in a responsible way as they consider risk. lastly, management also needs to be mindful that their compensation plans, while incorporating the above, still encourage innovation and capital investment to increase long-term value. this can be done using risk-adjusted hurdle rates to determine which projects or strategies are in-line with the firm’s stated level of risk tolerance. human resource allocation in terms of resource inadequacies, there are several areas for improvement. first, managers need to staff the risk management function with human capital which has the appropriate certifications and qualifications given the business of the firm, and second, provide adequate funding for the risk management function to execute on its risk management strategy. risk managers should be chosen based upon their track record, their experience, their knowledge of the industry and their knowledge of the business. as risk management has become more important as a result of recent crises, universities are offering more risk management degrees and professional organizations are offering special certificates for risk management certifications. for example (at the time of the writing of this paper), new york university offered a masters degree in risk management in their global degree department in the business school; john hopkins university offered a masters degree in erm; and many other universities (e.g., university of connecticut) have financial risk management programs. other universities, such as stanford university, offer an online program for a risk management certificate through their center for professional development. non-university entities like the national alliance for insurance education and research also offered a class-based/seminar-based certified risk management (crm) program. in addition to education-based training, many professional organizations offer certification tests for risk managers in specific functional fields. for example, the project management institute offers a risk management professional (rmp) certification test; the american hospital association offers a certified professional volume 35, number 1 87 healthcare risk manager (hrm) designation; and the risk and insurance management society offers a certified risk management professional (crmp) credential test. thus, in theory, these programs should make finding risk management professionals easier and more cost efficient. just as you would not have a chief financial officer without financial or accounting expertise, firms should not have a chief risk officer without substantive risk management expertise. ideally, firms would select risk managers that are educated in the risk management field, has experience managing risk in the specific functional area, has the appropriate designation (for instance, a risk manager which is certified as a healthcare risk manager is probably not the appropriate manager to work as a risk management professional in a bank), and is credentialed. financial resource allocation in addition to human capital, firms need to be more diligent about allocating financial resources to their risk management functions. by having better risk management systems as mentioned above, identifying the scope of the risk management program should be easier for management. with a better understanding of the scope of the risks which need to be treated, managers can make more accurate budgets. instead of taking shots in the dark, managers can develop reasonable and accurate figures for risk management expenses. in addition to allocating resources to the risk management function, firms should also build up financial slack buffers that insulate the firm from risk events. there is considerable evidence that having cash on hand is not inefficient, but can drive firm value. kim and bettis (2014) show that large cash holdings, beyond what is needed for transactional purposes, have a positive impact on firm value. similarly, deb, david and o’brien (2017) found that cash creates shareholder value when it is used for adapting to uncertainty, such as by firms operating in competitive, research-intensive or growth-oriented industries. thus, the adequate level of financial resources for risk management is dependent on the firm, its existing resource position, and industry conditions. while the state of financial resource allocation was not examined specifically in this study, future work should explore this domain. risk vs. return additionally, managers need to align their risk management performance with their corporate objectives and goals. managers may want to consider using 88 journal of business strategies objectives that are not purely based on financial performance, such as growth and returns. for instance, s&p has begun to rank firms on their risk management activities. depending upon the industry, firms may want to consider pursuing a particular level of risk management ranking as a stated year-end objective. if firms want to continue incorporating financial metrics they could incorporate risk by utilizing risk-adjusted performance outcomes. firms may also want to consider developing performance indicators which address the key risks they disclose in their annual reports (please see the example above in the compensation systems section for an example). a focus on reducing the key risk indicators could be considered in addition to purely performance-based measures. it is important to keep in mind that the suggestions mentioned here are not exhaustive and are but a few of the many things management can do to improve risk management. it is important to remember that risk management should be an integral part of a firm’s strategy. risk management should be incorporated into the strategy-making process so that it is not subjugate to business objectives, but instead helps the firm accomplish its long-term goals and objectives. limitations and future research as with all research there are limitations associated with this study. first, the most obvious is that this study relies on a commission’s report which is based on first-hand accounts of the events leading to the crisis. thus, there is no ability to control for any biases or omissions of the commission. however, the creation of the commission was done in a way which sought to limit this concern from the outset. the commission was constructed as a bi-partisan effort and was given unprecedented access to information sources that any researcher studying the crisis will not be able to collect on their own. furthermore, while the research presented here is based on the report of a single commission, it bears noting that the commission’s work is the amalgamation of over 700 first-hand accounts, millions of pages of text and research, and countless hours of public scrutiny. nevertheless, this limitation should be taken into account when interpreting the findings of this study. second, the methodology incorporated in study 2 of the current research may also be considered a limitation. the author purposefully selected a limited sample of highly visible and recognizable firms to perform the exploratory analysis. given the exploratory nature of the study, it was not the intent to collect a large number of firms and employ econometric analysis. highly visible firms are typically more heavily scrutinized by the public than are low visibility firms. the firms that i have volume 35, number 1 89 chosen, i have reasoned, would be the most susceptible to pressure to improve their risk management activities following a crisis such as the financial crisis. investors, and the public alike, want to know what these large firms are doing to ensure the safety of investments and the economy in response to what was seen in the financial industry. thus, if these firms had not changed their approach to risk management, it is highly likely that other firms facing less scrutiny would have done so. finally, findings of study 1 are based solely upon the experiences of financial companies during the crisis. the conclusions of study 2 are based upon an analysis of non-financial companies. as a result, this may represent a threat to the external validity of the results. the purpose of applying lessons from financial companies to non-financial companies was to highlight the clear shortcomings in risk management at firms’ where risk management is a critical factor in achieving success, and using this as a platform for all firms to build and learn from in the future. this is similar to the ‘strategic benchmarking’ concept (drew, 1997), where firms find examples of other firms who have capabilities or competencies in a particular area (such as risk management), and benchmark their own activities in this area versus the activities of the selected firms that have built those capabilities. in this instance, the financial firms should have capabilities and competencies in risk management. non-financial firms, then, should be able to learn from the strategies and activities (or lack thereof) of these financial firms. ultimately however, in choosing the method and a limited sample, the generalizability of the conclusions reached in this study should be considered when interpreting the results. attempts were made to ensure rigor and validity in both studies, however, stricter protocols for qualitative research could be argued for. with respect to future research, there are several avenues to pursue. from a theoretical perspective, there is still much we do not know about what contributes to risk management success or failure. just by looking at the shortcomings of risk management during the financial crisis there seems to be several management-related research themes. first, it might be instructive to understand what characteristics of executives are associated with better or worse risk management. an upper echelons perspective would be informative in this area, exploring biases, personalities and other demographic characteristics that may be associated with risk management. additionally, research on corporate governance is a natural fit with the risk management literature. exploring the impact of board composition, executive compensation and other governance characteristics on risk management systems might be informative. from a methodological perspective, future research might focus on more 90 journal of business strategies qualitative studies. one of the avenues mentioned briefly in the present paper is the role of risk communication in the risk management process. perhaps exploring how executives and risk managers are interacting and communicating can give us more insight in to why the risk management process can be so difficult for firms. finally, future quantitative research could focus on themes touched upon in this study related to resource allocation, executive compensation and risk management performance. however, before research on these areas can commence, better measures of risk management outcomes are necessary -this too could be an area for theoretical development. finally, i would be remiss to not mention that the items identified in this paper were occurring against a backdrop that included a very weak institutional environment. the institutional environment (e.g., scott and davis, 2007) as described in the management literature, provides a backdrop for firm behavior. the institutional environment embodies both informal and formal pressures exerted on firms by outside influences. the fcic report consistently mentioned the general weakness of the institutional environment before the crisis. this was apparent in two areas -weak regulating bodies not promoting best practices in risk management, and an overreliance on institutionalized practices such as letting firms police themselves. whilst a more detailed discussion is beyond the scope of the current paper, they need to be mentioned. conclusion to conclude, the goal of this paper was to highlight the shortcomings of financial firms’ risk management activities during the financial crisis in the hopes of uncovering areas for improvement for all firms regardless of industry.the assumption is that risk management failures occur because organizations do not have (sophisticated) risk management systems in place. this research suggests that is not entirely true. in the case of many of the financial firms that failed, most had “sophisticated” risk management systems. to make matters worse, many thought their systems were strong. the failures of these institutions help us understand that while a system might be in place, the system needs to be constructed such that the fundamental elements like resources, incentives, corporate objectives and managers, must be aligned. while this may seem like a relatively basic idea, it has escaped many companies. the fcic’s report on the financial crisis provides a wealth of insight and information. yet the implications for risk management as a result of the commission’s volume 35, number 1 91 work has not yet been fully understood. it is easy to look back in hindsight and point out all of the missteps which occurred. the foresight required to steer clear of all possible sources of risk during the crisis was probably outside the grasp of any human being. be that as it may, i have identified a number of failures that were within the grasp of managers and boards of directors. successful risk management was not impossible. perhaps after exploring the reasons for failure in more detail, managers can be more cognizant of these issues in the future. endnotes 1. the commission was an independent group of individuals, consisting of 10 private citizens that had experience across a number of different fields related to different aspects of the crisis (e.g. banking, housing, finance, etc.). the members of the commission were elected by both parties in congress to ensure bi-partisan conclusions (a majority opinion was reached although there were some members who provided a minority opinion). 2. this article is based upon, to a large extent, information which is contained in the fcic’s report. thus, statistics, quotes, and paraphrased comments not cited directly in the document are sourced from the fcic’s report which is cited in the references section above. 3. the list of passages presented in appendix a is not exhaustive, i.e. is not the complete list of passages used for the analysis. a complete list of passages can be obtained from the author. 4. the specific data points are not presented quantitatively in the paper but are available upon request from the author. 5. see note 4. references angriawan, a. & abebe, m. (2011). chief executive background characteristics and environmental scanning emphasis: an empirical investigation. journal of business strategies, 28(1), 1-22. beasley, m., clune, r. & hermanson, d. (2005). enterprise risk management: an empirical analysis of factors associated with the extent of implementation. journal of accounting and public policy, 24, 521-531. bebchuk, l., cohen, a., & spamann, h. (2010). the wages of failure: executive compensation at bear stearns and lehman 2000-2008. yale journal of regulation, 27, 257-265. 92 journal of business strategies carley, k. (1993). coding choices for textual analysis: a comparison of content analysis and map analysis. in p. marsden (editor), sociological methodology (pp. 75-126). oxford: blackwell. chapman, r. (2011). simple tools and techniques for enterprise risk management. new york: west sussex, uk: john wiley and sons, ltd. clarke, c. & varma, s. (1999). strategic risk management: the new competitive edge. long range planning, 32(4), 414-424. deb, p., david, p., & o’brien, j. (2017). when is cash good or bad for firm performance? strategic management journal, 38(2), 436-454. drew, s. (1997). from knowledge to action: the impact of benchmarking on organizational performance. long range planning, 30(3), 427-441. duriau, v., reger, r., & pfarrer, m. (2007). a content analysis of the content analysis literature in organization studies. organizational research methods, 10(1), 5-34. farrell, g., &hansen, b. (2008, april 9). stock may fall but execs’ pay doesn’t. usa today. retrieved from http://usatoday30.usatoday.com/money/companies/ management/2008-04-09-ceo-pay_n.htm financial crisis inquiry commission. (2011). the financial crisis inquiry report: final report of the national commission on the causes of the financial and economic crisis in the united states.washington, d.c.: u.s. government printing office. (available from https://fcic.law.stanford.edu) frame, j. (2003). managing risk in organizations. san francisco: jossey-bass. fraser, j. & simkins, b. (2010). enterprise risk management: an introduction and overview. in j. fraser & b. simkins (eds), enterprise risk management: today’s leading research and best practices for tomorrow’s executives (pp. 3-17). hoboken, nj: john wiley and sons. gephart, r. (1993). the textual approach: risk and blame in disaster sensemaking. academy of management journal, 36(6), 1465-1514. grace, m., leverty, j., phillips, r., & shimpi, p. (2015). the value of investing in enterprise risk management. the journal of risk and insurance, 82(2), 289316. hambrick, d. & mason, p. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review, 9(2),193-206. hayward, m. & hambrick, d. (1997). explaining the premiums paid for large acquisitions: evidence of ceo hubris. administrative science quarterly, 42(1), 103-127. volume 35, number 1 93 hoyt, r. & liebenberg, a. (2011). the value of enterprise risk management. the journal of risk and insurance, 78(4), 795-822. hubbard, d. (2009). the failure of risk management: why it’s broken and how to fix it. hoboken, nj: john wiley and sons. huber, g. (1991). organizational learning: the contributing processes and the literatures. organization science, 2(1), 88-115. jickling, m. (2009). causes of the financial crisis (r40173). washington, dc: congressional research service. retrieved from: http://digitalcommons.ilr. cornell.edu/key_workplace/600 kim, c. & bettis, r. (2014). cash is surprisingly valuable as a strategic asset. strategic management journal, 35(13), 2053-2063. lam, j. (2014). enterprise risk management: from incentives to controls. john wiley and sons. liebenberg, a. & hoyt, r. (2003). the determinants of enterprise risk management: evidence from the appointment of chief risk officers. risk management and insurance review, 6(1), 37-52. madsen, p. & desai, v. (2010). failing to learn? the effects of failure and success on organizational learning in the global orbital launch vehicle industry. academy of management journal, 53(3), 451-476. miller, k. (1998). economic exposure and integrated risk management. strategic management journal, 19, 497-514. miller, k. & waller, h. (2003). scenarios, real options and integrated risk management. long range planning, 36, 93-107. rochette, m. (2009). from risk management to erm. journal of risk management in financial institutions, 2(4), 394-408. scott, r. & davis, g. (2007). organizations and organizing: rational, natural and open system perspectives. upper saddle river, nj: pearson prentice hall. shenkir, w., barton, t., & walker, p. (2010). enterprise risk management. in j. fraser & b. simkins (eds), enterprise risk management: today’s leading research and best practices for tomorrow’s executives (pg. 441-463).hoboken, nj: john wiley and sons. shortreed, j. (2010). erm frameworks. in j. fraser and b. simkins (editors), enterprise risk management: today’s leading research and best practices for tomorrow’s executives (pg. 97-123). hoboken, nj: john wiley and sons. tang, y., qian, c., chen, g. & shen, r. (2014). how ceo hubris affects corporate social (ir)responsibility. strategic management journal, 36(9), 1338-1357. 94 journal of business strategies tuckman, b. (2016). derivatives: understanding their usefulness and their role in the financial crisis. journal of applied corporate finance, 28(1), 62-71. vo, l. (2015). lessons from the 2008 global financial crisis: imprudent risk management and miscalculated regulation. journal of management sciences, 2(1), 205-222. biographical sketch of author corey j. fox is an assistant professor of management in the mccoy college of business at texas state university. he received his phd in business administration from oklahoma state university. his current research focuses on issues related to risk and risk management in organizations, corporate resource allocation decisions, and corporate citizenship. his work has been published in such outlets as the journal of managerial issues and strategic organization. volume 35, number 1 95 appendix a example passages 96 journal of business strategies volume 35, number 1 97 figure 1 risk management counts figure 2 risk/return ratios international acquisitions from a network perspective and market based competencies timothy s. kiessling eastern kentucky university richmond, ky r. glenn richey the university of alabama tuscaloosa, al abstract trillions ofdollars are spent annually on international acquisitions and often these acquisitions are considered a failure in regard to performance. the importance of valuation of an international targetfirm cannot be underestimated, especially in the global market where networks ofstrategic alliances are required to compete. for international acquisitions the value of the firm is often its network ofrelationships. thus, the valuation by the acquiringfirm takes on new more complex dimensions than simply reviewing the balance sheet and income statement results. this manuscript explores the valuation o.finternational target acquisitions when the intangible value is its network ofstrategic alliances. additionally, the manuscript employs theory and grounded examples to develop a theoretical model for future examination. introduction the market for international expansion is certainly a complex one for managers to navigate. the complexity is increasing as domestic markets continue to become more concentrated, economic barriers to trade continue to fall, transportation and technological advances lower physical barriers to trade, and international trade blocks continue to form. yet each of these complexities can also be considered a motivation as, now more than ever, firms are encouraged to enter the global marketplace. one popular choice of international market entry, international acquisition, continues to be a course taken by many firms. in 1984, in the united states alone, nearly $36 billion was spent in acquiring 241 firms. in 1998 it was estimated that over $1 trillion was spent in international acquisition activity (business week, 1998). in 1999, in the united states alone, $1.75 trillion in mergers and acquisitions were announced and $3.4 trillion was spent worldwide (hitt, harrison and ireland, 200 i). recent examples of this strategy are petro-canada's $3.2 billion acquisition of verba oil and gas gmbh (january, 02), china national offshore oil co. 's $598 million purchase of rep2 journal ofbusiness strategies vol. 22, no. 1 sol-yepeo (december, 0 1), tyco international's $650 million purchase of paragon trade brands (december, 0 i), and baxter international's $470 million purchase of asta medica onkologie gmbh & co kg (sec filings, 2001, 2002). in 2002, over 5,400 deals worth more than $346 billion were announced through september 30 (business week, 2002). the managerial importance of the international acquisition phenomena is made apparent by the size of these figures alone. subsequently, expansion through acquisition continues to be a viable international strategy utilized by firms. as these numbers grow so grows the importance of the correct valuations of a target firm. managers will no doubt be forced to access both the traditionally tangible assets and the often more important intangible market based assets to arrive at an appropriate valuation of an international acquisition. increasingly the question becomes how to value potential international acquisitions. numerous answers, that are often conflicting, have been proposed. most of these focus on valuation with disregard to one of the true values of the target firm: its network of relationships. this manuscript suggests the potential value of a target firm's intangible assets (such as the firm's network or relationships) is much greater than the value of the tangible assets (lusch, harvey, and speier, 1998). specifically, this manuscript focuses on the determinants of value of an acquisition when its value is its network. researchers have investigated the logic behind the acquisition/ownership decision for years. the transaction cost theory (williamson, 1975) rationale for acquisition rests with minimizing the sum of production and transaction costs. the resource-based view (wernerfelt, 1984) suggests that through acquisition a firm can maximize value by gaining access to the target firm's valuable resources (madhok, 1997; ramanathan, et. ai., 1997). additionally, the resource-based view suggests that, as a firm acquires another firm for its network of relationships, it must be able to utilize the very same network it is hoping to acquire to earn normal returns (wemerfelt, 1984). it is definitely an unrealistic assumption to expect that the entire network of relationships will transfer to the acquiring firm. issues such as network or partner incompatibility, cultural distance, loss of boundary spanners, insufficient resources of the acquirer, and/or positional embeddedness within the network may all deter ongoing relationships between the acquirer and the established network. if the acquisition is driven by the intangible value of the target firm's network ofrelationships, it must be recognized that any loss of network partners may devalue the target firm. the focus ofthis manuscript is on how to value the acquisition of an international foreign target firm when its value is its network ofrelationships. strategic theories of management and marketing that make up the network paradigm transaction cost theory, the resources based view, and relationship marketing will be used to determine the relative value of the integration of the acquirer into the target firm's network. first, we will review the literature in regard to networks and then apply the literature to international valuation of firm acquisition. next, we will develop propositions that derive a model of the valuation of international spring 2005 kiessling & richey: international acquisitions 3 firms from a network perspective. finally, we will discuss the implications of the model and draw conclusions. the network and firm value the global economy has created a new competitive landscape one in which events change constantly and unpredictably (ireland and hitt, 1997). even before the forces of global competition became more visible, there was a trend toward more flexible organizations. these organizational forms are difficult to capture with a traditional organization chart because they include a network of complex relationships that provide value to the firm as a whole (miles and snow, 1984, 1986; powell, 1990; thorelli, 1986; webster, 1992). this shift in organizational form drives the research focus away from transactions and towards relationships. here, customers become partners and the firm must make long-term commitments to maintaining quality, service, and innovation (anderson and narus, 1991). instead of developing these relationships over time some firms hope that the acquisition of a target firm will automatically transfer the existing network of relationships. thus, the inherent value placed upon a network of relationships is contingent upon its transferability. to compete effectively in the global dynamic economy firms have evolved to focus on large-scale managed networks representing a legitimate alternative to markets or hierarchy. embeddedness (concrete relations and structures "networks" which generate trust and discourage malfeasance) is the fundamental concept differentiating the network paradigm from economic theories of organization (granovetter 1985). a firm's core competency may be the valuable resource and capabilities that attract acquisition attempts. specific to each successful company is a core competency, or a unique amalgam of skills, resources, technologies, people, etc, that make a company a leader in a specific area (valentino, 1992; planning review, 1994). core competencies are described as unique, not imitable by competitors, and sustainable or durable (lasting). these core competencies are frequently composed of intangible assets that allow a company to effectively compete in marketplaces and to differentiate themselves from primary competitors (willens, 1993; prahalad and hamel, 1990). examples of intangible assets are: i) company reputation, 2) product reputation, 3) employee know-how, 4) networks, 5) supplier know-how, 6) databases, and 7) distribution know-how (hall 1992). ifthe core competency of the international target firm is its network of relationships, supplier know-how, or distributor know-how (hall's, 1992; 1993) the question then becomes how to value the target firm. financial analyses frequently fail to recognize that the acquisition includes an important network offirm and human relationships, as well as, financial activity. in focusing only on financial results such as income statement, ratios, and balance sheet issues the role of people, knowledge gained, and/or other immeasurable goals are often overlooked (hunt, 1987; levinson, 1970; kitching, 4 journal ofbusiness strategies vol. 22, no. i 1967). despite this, acquisition decisions and negotiations still typically center on financial results and rarely involve any analysis of relationships (cartwright and cooper, 1992). for example, a recent study illustrates that although all the organizations in the study conducted detailed and thorough legal and financial audits, no audit in regard to human resources occurred. surprisingly, thirty percent considered the implications ofa pension plan which is directly related to retention of employees and thus intangible relationships (hunt, 1987). in an international acquisition, the managers of the acquirer firm must be cautious in evaluating the target's value based solely on accounting measures. this is because managers at the target firm have discretion as to what accounting methods and allocation procedures (ex. overhead, indirect costs, etc.) will be utilized. thus, target managers may intentionally or unintentionally inflate the costs/value of the acquisition. accounting practices can significantly impact such things as the setting-up of accruals, writing off goodwill, eliminating costs from other divisions through allocation, etc. possibly the largest flaw in utilizing accounting measures, especially in the new knowledge economy, is the valuation of intangible assets and liabilities. a firm's intangible resources and capabilities are productive assets that are difficult to observe, describe, and value. nevertheless, these resources can have a significant impact of a firm's performance. researchers have noted that the impact of this limitation is great and the magnitude for misrepresentation is significant (fisher and mcgowen, 1983; ijiri and kelly, 1980). recent research has focused on the external value of the firm or firm's market based asset value. market based assets fall into two categories: 1) relational outcomes of the relationship between a firm and key external stakeholders, including distributors, retailers, end customers, other strategic partners, etc.; and 2) intellectualthe types of knowledge a firm possess about the environment, such as the emerging and potential state of market conditions and the entities in it (srivastava, et. ai., 1998). the most common market based assets include: brand equity (aaker, 1991; keller, 1993; shocker, srivastava, and ruekert, 1994), customer satisfaction (yi, 1990) and the management of strategic relationships (anderson and narus, 1996; bucklin and sengupta, 1993). traditional theories describing marketing channel interactions are founded on the assumption that in the absence of suitable safeguards, economic agents are prone to opportunistic and self-interest-seeking behavior (williamson 1975). thus, firms must determine the most efficient contract to govern the relationship given the characteristics of the parties involved. still, the fact remains that environmental uncertainty and the costs of obtaining information make it impossible for the principle to efficiently and effectively monitor the agent completely (agency theory, arrow 1985). thus, network theories have evolved to explain phenomena that emphasize the normative and social structure in which exchanges are embedded as the primary determinant of behavior (granovetter, 1985). much ofthe research in relationship management and marketing strategy point to the mediating and moderating characteristics of key relational variables. such spring 2005 kiessling & richey: international acquisitions 5 is the case with firm trust and commitment (morgan and hunt 1994); interpersonal relationships (crosby, evans, and cowles 1990); and relational aspects of culture (nakata and sivakumar 2001). a central theme in these works is the importance of relationships to the success of the firm. thus, the value of a firm may often be attributed to its network of relationships. positional embeddedness of firm and acquisition valuation positional embeddedness ofa firm captures the impact ofthe positions organizations occupy in the overall structure of the alliance network. the more central an organization's network position, the more likely it is to have better information about a larger pool of potential partners in the network (gulati and gargiulo, 1999). the embeddedness argument stresses the role of concrete personal relations and structures (or networks) of such relationships in generating trust and discouraging malfeasance (granovetter, 1985). the greater the centrality of the positional embeddedness of a firm, the more valuable the firm should be (gulati and gargiulo, 1999). hence, the control of information throughout the network should create valuable opportunities for the central firm, as well as its more numerous contacts. it is the central firm that often decides whether to allow new firms to enter the fringes or to end relationships with those found untrustworthy or invaluable. communication is a capability used to coordinate outputs. communication serves to embed an organization in its environment and network. guetzkow (1965) identifies several important characteristics of communication in organizations, including formal and informal flows; vertical and lateral flows; and omissions and distortions. ultimately, " ... communication can be described as the glue that holds together a channel of distribution (mohr and nevin, 1990, p. 38)." the positional embeddedness of a firm in an international marketplace is of great value to an acquirer who may know little of the host-country marketplace. the information flow from the network members may assist the acquirer in entering the new marketplace and allow for some early control over other network members. grounded evidence part one on september 23, 2002, datatrak international (ohio) announced a definitive agreement to acquire french technology firm oriam. dr. jeffrey a. green, president & chief executive officer of datatrak international, inc., suggests that the acquisition was very much in regard to oriam's central role in its network (i.e. oriam's customer base and knowledge base). oriam's customer base currently includes 33 clients, predominantly european-based pharmaceutical companies, although expansion into the american markets was recently evident with the adoption of oriam's software suite by a prominent biotechnology firm and a major u.s. academic medical center. several of oriam's key customers 6 journal ofbusiness strategies vol. 22, no. 1 have utilized its technology for many years and have progressively expanded their base to more than 500 users per company. "this strategy is based on management's conviction that the breadth of technological applications used in clinical trials should be integrated and follows a continuous [continuum], compatible, and progressive flow of information... however, in today's environment for clinical trials such integration is presently absent. at this time, there only exist 'point solutions' throughout this industry offered by a variety of different companies with completely disjointed data models none of which inherently or easily communicate with each other" (pr newswire europe, 2002). in essence, oriam's central control of their client's technology and reporting structures is the value focus of this acquisition. therefore, we propose: position i: the international decision-maker svaluation ofa target acquisition will be higher when he/she perceives high centralization of the target firm within a network. dependence and network compatibility to acquisition valuation 1. dependence and acquisition valuation dependence is generally described as: firm a's dependence on b is directly proportional to the motivational investment in goals mediated by b and inversely proportional to the availability of those goals to a outside the a-b relationship (emerson, 1962). pfeffer and salancik (1978) argue that dependence comprises three elements: 1) the importance of the resource and the extent to which the organization requires it, 2) the extent to which the other party has discretion over that resource, and 3) the extent to which there are few alternatives. for example, a firm is considered more dependent on a supplier when that supplier provides a larger fraction of its business. if alternative suppliers are not available (i.e. options are limited), dependence also exists. transaction cost theory also postulates that transaction specific investments (assets of considerable cost with few to no alternative uses) may create a dependency situation (williamson, 1985). identification oflarge asset specific holdings by network partners may result in "hostage" type relationships by the acquiring firm until and only if other relational options can be established. resource dependence theory suggests that a lack of self-sufficiency creates potential dependence on the parties from whom the focal resources are obtained (emerson, 1962). the main implication is its identification of dependence and uncertainty as the key antecedent variables motivating the establishment of interfirm relationships. as the acquisition occurs, firms may re-evaluate their relationship with the acquirer, especially when the acquirer is of a different nationality. management practices and routines vary significantly due to differences in national culture (hofstede, 1983). thus cultural uncertainty may increase for the acquiring firm (in the target firm's network) after acquisition. however, if the spring 2005 kiessling & richey: international acquisitions 7 network offinns is resource dependent upon the target finn, they may not immediately embark on the uncertain territory of establishing new ties. the greater the uncertainty of other finns within the market, the greater the potential that the acquirer may be given the opportunity to establish a relationship within the network. with an inability to obtain focal resources, the network may continue to rely on the acquirer unless negative market signals are delivered. 2. network compatibility and acquisition valuation if an acquisition attempt is to have an opportunity to have access to the network relationships the target finn has, one must realize that in an international/cross cultural context the network may be culturally directed (such as in a kieretsu or chaebol). moreover, the acquiring finn brings its own network of strategic alliances and relationships into the scenario. in this ambiguous and complex configuration of finns that constitute the network, the finn themselves develop network identities (hakansson and johanson, 1993). network identity is meant to capture the perceived attractiveness (or repulsiveness) of a finn to an exchange partner due its unique set of connected relations with other finns, links to their activities, and ties with their resources (anderson, hakansson, and johanson, 1994). each identity communicates a certain orientation toward other actors. the identity of the acquiring finn may be deemed unacceptable/unsuitable to the members of the network due to past perfonnance, the relationships it has established in its network of suppliers or customers, a nationalistic network (ex. chaebol), or even direct competition with the new network members. thus, the network the acquiring finn is embedded in may actually hinder successful entry through acquisition. gulati and gargiulo (1999) show that membership in one cohesive network truly hinders the ability to build cooperative ties with other networks. acquiring the target member of a network due to its value of network relationships does not represent an automatic "get in free card" for the acquiring finn. acquirer network associations and those of the target finn should be reviewed before committing resources to the acquisition. an important element in any business partnership is a common business understanding, mission identity, or network identity. this has also been tenned organizational identity (albert and whetton, 1985) meaning "the theory organizational members have about who they are" (barney and wright, 1998: p. 103). however this identity is not stable and evolves as new members enter and exit (gioia, schutz and corley, 2000). in essence, the target finn also influences the acquiring finn's network and relationships among the members. each finn's network identity communicates a certain orientation toward other actors. it conveys a certain competence, because it is based on each actor's perceived capability to perfonn certain actions and is based on the particular resources each actor possesses (yamagashi, gillmore, and cook, 1988). allowing finns to enter the alliance without attention to composition can lead to conflict among a finn's partners. this is enhanced as duplication of roles, tasks, and positions creates rivalry among the partners (gomes-casseres, 1994). careful attention should 8 journal ofbusiness strategies vol. 22, no.1 be paid to not only the compatibility of the purchaser's network, but to what the effect will be of the inclusion of the target's identity into the purchaser's network. grounded evidence part two pllva's (croatia) june 11, 2002 acquisition of us-based sidmak laboratories for $219 million was done mainly to access sidmak's network. zeljko covic, chief executive officer of pllva, suggested that direct access to the us pharmaceutical market through an established sales network, an experienced management team, and skilled employees were the main reasons for acquisition (business wire, 2002a). if pllva anticipated loss of either the sales network or the internal network, the target acquisition would either not have occurred or would have been valued at a lower price. therefore in regard to dependence and network compatibility we propose: position 2: the international decision-maker 50 valuation of a target acquisition will be higher when he/she perceives a higher level ofdependence ofand compatibility in the network to the target firm. network based relational density and acquisition valuation in essence, what makes the network valuable is the quality ofrelationships. relationship dimensions include: non-hierarchical/long-term commitments, multiple roles and responsibilities, mutuality, and affiliational sentiments. therefore, what differentiates the network organization is its density, multiplexity, reciprocity of ties, and shared value system defining membership roles and responsibilities. in short network relationships add value to the firm (achrol 1997). grounded evidence part three an example of such importance is the recent daisytek international corporation's (texas) aug. 19, 2002 acquisition of isa international pic (uk), one of the largest pan-european distributors of computer supplies with revenues of more than $500 million. daisytek suggests that the synergistic combination of daisytek's distribution expertise, financial resources, and management experience combined with isa's pan-european reach, customer relationships, and local knowledge may provide firm value (business wire, 2002b). the importance of the acquisition is in the network of customer relationships as well as local knowledge of the distribution, suppliers, and marketplace dynamics. the number offunctioning relationships a target holds in a network is a target's relational density. the relational density of a firm represents a significant contribution to the global success of the respective firm. the relationships between the target firm and alliance members may very well contribute extensively to the revenue generation and innovative ability of the firm. transference of these spring 2005 kiessling & richey: international acquisitions 9 relationships to the acquiring firm may, or may not, be accomplished. if the relationships do not transfer, performance may be negatively impacted. additionally, the cultural distance of the firm may also directly affect the process of assimilation into relationship network. therefore, we suggest: position 3: the international decision-maker s valuation of a target acquisition will be higher when he/she perceives higher relational density that will transfer with the acquiring firm. credibility portion of trust and boundary spanner retention to acquisition valuation i. transference of the credibility portion of trust and acquisition valuation: literature that is more recent examines networks from a relationship marketing perspective (day, 1997). relationship marketing is seen as relationships, networks, and interactions in which two or more parties (supplier, customer, competitor, etc.) create value for each other. relationship marketing is part of the developing "network paradigm" which recognizes that global competition occurs increasingly between networks offirms (thorelli, 1986). frequently quoted properties of relationship marketing include trust, reliability, and commitment. relationship marketing is clearly more than a theory; it represents a paradigm shift in marketing thought (gummesson, 1997). trust is dimensionalized as credibility (a partner's perception of require expertise to perform ajob effectively) and benevolence (a partner's perception that the intentions and motives of the other firm, when reacting to new conditions, will match its needs) (ganesan, 1994). several terminologies are borrowed from transaction cost theory including opportunistic behavior and transaction specific assets (williamson, 1981). in relationship marketing, relational governance or relational contracting is seen as providing the best (both lowest cost and productive) governance mechanism and transaction specific investments may be shared due to high levels of trust. a firm that that enters a network through the acquisition of another firm may not transfer the benevolence portion of trust that has been developed over time (i.e. history of actions/interactions). this may occur despite the acquiring firm having substantial credibility identified/signaled through its resources, its history of actions within it current network, and/or market capabilities. the acquiring firm may transfer the credibility portion of trust, but it may take time to successfully develop the benevolence portion if at all. grounded evidence part four yincor international inc., one of north america's largest producers of wine and related products announced on october 9, 2002 that it has entered into a definitive agreement to purchase privately held goundrey wines of australia. "goun10 journal ofbusiness strategies vol. 22, no.1 drey also has an excellent network of distributors and company sales force which provides an outstanding platform for continued sales growth within australia," said donald triggs, vincor's president and ceo. from the goundrey side, "i am pleased that joining vincor and leveraging its economies of scale and growing distribution reach may provide an opportunity for our exceptional people and wines to realize their full potential in domestic and international markets", added jack bendat, goundrey's owner and chairman. "equally important to our decision to join vincor was its ongoing commitment to preserve the unique culture and identity of each member of its growing family of estate wineries." (canada news wire ltd., 2002). 2. boundary spanner retention and acquisition valuation a major source of information relevant for firms and networks is boundary spanners. boundary spanning refers to the effective interaction between an organization and its external environment through people or firms. boundary spanners link an organization to its environment by the nature of their interactions with non-members (thompson, 1967). boundary spanning communication is important to organizations as a source of new information that increases awareness of environmental changes (weedman, 1992). ultimately, boundary spanners facilitate an even flow of information between the two or more parties. this vital transference of information allows the parties to share strategic views on the external market environment, mutually decide a course of action, and then implement a truly synergistic strategy. dyer and singh (1998) described knowledge sharing routines as a regular pattern of interfirm interactions that permits the transfer, recombination, or creation of specialized knowledge. von hippel (1978) argues that a production network with superior knowledge transfer mechanisms among users, suppliers, and manufacturers may be able to "out innovate" production networks with less effective knowledge sharing routines. the cultural differences that an international acquisition may have to overcome to build upon a network of strategic alliances require the establishment and management of informal and formal communication chains. boundary spanners help establish and manage these chains of communication that may assist in overcoming many of the cultural differences that threaten future relations. for example, personal relationships among key individuals have played a crucial role in producing trust between organizations in japanese industrial groups (lincoln, gerlach, and ahmadjian, 1996) and in contractual relationships (bradach and eccles, 1989). beneath the formalities of contractual agreements, multiple formal interpersonal relationships emerge across organizational boundaries, which facilitate the active exchange of information and the production of trust that foster interorganizational cooperation (walker, kogut, and shan, 1997; gulati, 1995). culture diversity can be an obstacle in cross-national business relationship communication. previous research has shown that developed country joint ventures tend to have an instability rate of around 30% with developing countries spring 2005 kiessling & richey: international acquisitions 1i between 45% to 50% (beamish, 1984; 1985; reynolds, 1984). although joint ventures have concerns that differ from acquisitions, the failure rate due to cultural diversity is a point not to be over looked. grounded evidence part five the daimler-benz acquisition of chrysler corporation appeared to be a sure success due to the potentially complementary core businesses of the two firms; that of chrysler's mid-priced autos and minivans and daimler's luxury automobiles. however, due to major difficulties in cultural nuances and complicated communication, integration was difficult and performance of the merged firm suffered. even worse, many members of chrysler quit, and with them their network of relationships was lost. in addition, wal-mart acquired a 21-store hypermarket in 1997 and acquired 74 interspar stores in 1998. they imposed their own style of management and suffered significant human resource loses (turnover) due to cultural problems. wal-mart learned from this experience when it approached target firms in england. it gave the managers the freedom to adjust market style to fit the necessary cultural nuances and be successful (zellner, et. ai., 200 i). given this extended discussion on the transference of the credibility portion of trust and boundary spanner retention, we propose three possible moderating relationships: position 4a: the international decision-maker s valuation of a target acquisition will be higher when he/she perceives high centralization of the target firm within a network given the retention ofthe targetfirm s existing relationships. position 4b: the international decision-maker s valuation of a target acquisition will be higher when he/she perceives a higher level ofdependence ofand compatibility in the network to the targetfirm given the retention ofthe targetfirm:~ existing relationships. position 4c: the international decision-maker s valuation ofa target acquisition will be higher when he/she perceives higher relational density that will transfer with the acquiringfirm given the retention of the target firm s existing relationships. summary and managerial implications the dynamic global marketplace has forced firms to utilize networks of relationships and strategic alliances as a vehicle for international success. as firms expand internationally, the acquisition of firms continues to be a popular mode of market entry. to value these international target firms, acquiring firms use tangible assets and intangible assets as tools. often the true value of a firm is the 12 journal of business strategies vol. 22, no.1 intangible value of its network of strategic alliances. due to the network as the source of value of the acquisition target, the importance of the acquiring finn's ability to maintain these relationships is examined, we have discussed the value of the target finn due to its network of relationships from a theoretical perspective. this was accomplished through the examination of several components of the network paradigm including: transaction cost economics, the resource based view, and relationship marketing. a managerial holistic model of international target finn valuation follows (see figure i), figure 1 a valuation model of international acquisitions ........................ .. ... "'\. . : ~ _---------total value ~," .....,.,, ., . ',~ ~ ... ............................. •r------------~------------,, l ~ .------------------------------------~~ control variable considerations • tangible accounting value • other intangible assets • other intangible liabilities spring 2005 kiessling & richey: international acquisitions 13 the acquisition target's value is due to its network of relationships developed over time. the acquiring firm may value the target corresponding to the number of relationships. the greater the number of relationships, the larger the network and ability to obtain new sources of competencies from other firms, thus making the target firm more valuable. unfortunately, a firm can be overvalued if the relationships cannot be transferred to the acquiring firm. major local suppliers, customers, etc., or groups of these relationships, ifperceived to potentially be lost, may then force decision-makers to lower the projected value of the target and/or cancel the acquisition. firms are either developing or entering networks to compete in the global market. these networks each have an identity of their own and the firms within identify themselves as such. the acquisition of a firm due to its value within a network also suggests that this firm has a network identity that mayor may not be compatible with the acquiring firm's network. if the networks are incompatible, the perceived resulting value may diminish due to the inability to transfer the relationships. as noted, although a greater number of relationships makes more resources available, the inability to transfer a larger number of these, especially key relationships, would diminish the value of a target firm. the target firm may be valued higher when the network has a high dependency on it and if the firm is centralized within the network. dependence of other firms on the target firm may give the acquiring firm time to begin to establish a relationship. if the acquirer's resources and reputation are credible, this portion of trust could transfer and hopefully develop the benevolence portion of trust over time. the centralization of the target firm within the network makes the firm more valuable as it controls most of the information and often decides which firms will enter/exit the network. this control of knowledge also creates increased network dependence on the target firm. in essence, international acquisition managers must evaluate their own firm's resources, reputation and network with regard to the target firm. if the networks are not compatible or their resources and reputation are not transferable, the target firm's valuation may decline. if the target firm has high dependence on other firms (or interdependence within the network) and is central within in its network, then the acquiring firm may value the firm more highly. if the relationships within the network appear to not transfer and the boundary spanners appear not willing to remain and assist with the acquisition transition, then the target firm may be devalued. of course, there are combinations and many of the variables mitigate and moderate one another, but when the international strategy is acquisition due to a target firm's network, these variables must be inspected for proper valuation. 14 journal ofbusiness strategies references vol. 22, no.1 aaker, d. (1991). managing brand equity. new york: the free press. achrol, r. (1991). evolution of the marketing organization: new forms for dynamic environments. journal of marketing, 55(oct.), 77-93. achrol, rs. (1997). changes in the theory of interorganizational relations in marketing: toward a network paradigm. academy of marketing science. 25(1): 56-72. albert, s. & whetton, d. (1985). organizational identity". in l. l. cummings and barry staw (eds.) research in organizational behavior, 7. (pp. 263-295). greenwich, ct: jai, anderson, e. & weitz, b. (1992). the use of pledges to build and sustain commitment in distribution channels. journal of marketing research, 29 (feb), 18-34. anderson, j. & 1. narus (1991). marketing as a focused market strategy, california management review,31, 95-113. anderson, j. & 1. narus (1996). rethinking distribution: adaptive channels. harvard business review. 74,112-122. anderson, 1., hakansson, h. & johanson, 1. (1994). dyadic business relationships within a business network context. journal of marketing. 58(10).1-15. arrow, k. (1985) "the economics of agency", in john w. pratt and richard j. zeckhauser (eds.) principles and agents: the structure of business (pp. 37-5ltharvard business school press, boston, ma. axelrod, r. (1984). the evolution of cooperation. new york: basic books. barney, 1. & wright, p. (1998). on becoming a strategic partner: the role ofhuman resources in gaining competitive advantage. human resource management. 37(1), 31-47. beamish, p. (1984). joint venture performance in developing countries. unpublished dissertation, university of western ontario. beamish, p. (1985). the characteristics of joint ventures in developing countries. colombian journal of world business. 20. 13-19. blankenburg-holm, desiree, eriksson, k., & johanson, 1. (1999). creating value through mutual commitment to business network relationships. strategic management journal, 20, 467-486. bradach, j. & eccles, r. (1989). price, authority, and trust: from ideal types to plural forms. annual review of sociology.15, 97-107. spring 2005 kiessling & richey: international acquisitions 15 bucklin, l. p & sengupta s. (1993). organizing successful company marketing alliances. journal of marketing. 57, 32-46. business week. (1998). that was just a warm-up, (12-28-98), p 15]. business week. (2002). why most big deals don't payoff. (october 14). business wire. (2002a). pliva announces acquisition of us-based sidmak , (june 11). business wire. (2002b). daisytek announces proposed offer to buy isa international pic , (may 7). canada newswire ltd. (2002). vincor international announces agreement to acquire australia's goundrey wines october 9. cartwright, s. & cooper, c. (1992). mergers and acquisitions: the human factor. oxford, butterworth-heinemann. crosby, lawrence a., evans, k. r. & cowles, d (1990). relationship quality in services selling: an interpersonal influence perspective. journal of marketing. 54 (july), 6881. d' aveni, t. (1994). hypercompetition: manning the dynamics of strategic maneuvering. new york: the free press. day, g. (1994). the capabilities of market driven organizations. journal of marketing. 58(oct),37-52. day, g. (1997). maintaining the competitive edge: creating and sustaining competitive advantage in dynamic competitive environments. in g. day and reibstein (eds.) wharton on dynamic competition. (pp. 48-75) new york: john wiley. day, g. (2000). managing market relationships. academy of marketing science. 28, 2430. deschpande, r., farley, j.y. & webster, f.e. (1993). corporate culture, customer orientation, and innovativeness in japanese firms: a quadrad analysis. journal of marketinz,.21,23-37. doney, p., cannon, 1. & mullen, m. (1998). understanding the influence of national culture on the development of trust. academy of management review, 23(3), 601-620. drucker, peter e, (1993). the ecological vision. new brunswick, nj, transaction publishers. dwyer, e, schurr, p, & oh, s. (1987). developing buyer-seller relationships. journal of marketing, 51 (april), 11-27. 16 journal ofbusiness strategies vol. 22, no. 1 dyer, j. & singh, h. (1998). the relationship view: cooperative strategy and sources of interorganizational competitive advantage. academy of management review. 23(4), 660-679. emerson, r. (1962). power-dependence relations. american sociological review. 27( i), 31-41. emerson, r. (1981). social exchange theory. in m. rosenberg and r. turner [eds.]. social psychology: sociological perspective. new york: basic books. fisher, f. & mcgowan, j. (1983). on the misuse of accounting rates of return to infer monopoly profits. the american economic review, 73(1): 82-98. francis, n. p. (1991). when in rome? the effects of cultural adaptation on intercultural business negotiations. journal of international business studies, 22(3), 403-428. ganesan, s. (1994). determinants of long-term orientation in buyer-seller relationships. journal of marketing, 58(2), 1-20. gioia, d.a., schultz, m. & corley, k. g. (2000). organizational identity image and adaptive instability. academy of management review, 25(1): 63-92. gittell, j.h. (2002), coordinating mechanisms in care provider groups: relational coordination as a mediator and input uncertainty as a moderator of performance effects. management science, 48( 11), 1408 1426. gomes-casseres, b. (1994). group versus group: how alliance networks compete. harvard business review, 72(4), 62-71. granovetter, m. (1985). economic action and social structure: the problem embeddedness. american journal of sociology, 91 (november),481-51o. guetzkow, h. (1965). communications in organizations, in handbook of organizations. j. march ed. chicago: rand mcnally and company, 534-73, gulati, r. (1995). social structure and alliance formation pattern: a longitudinal analysis. administrative science quarterly, 40, 619-52. gulati, r. & gargiulo, m. (1999). where do interorganizational network's come from? the american journal of sociology, 104(5), pp 1489-1502. gummesson, e. (1997). relationship marketing as a paradigm shift, some conclusions from the 30r approach. management decision, 35(4), 267-272. hakansson, h. & johanson, j. (1993). industrial functions of business relationships. advances in international marketing, 5, 13-30. spring 2005 kiessling & richey: international acquisitions 17 hall, r. (1992). the strategic analysis of intangible resources. strategic management journal.ll. 135-144. hall, r. (1993) a framework linking intangible resources and capabilities to sustained competitive advantage. strategic management journal 14(8): 607-618. hitt, m.a., harrison, 1. s. & ireland, r. d. (200 i). mergers and acquisitions. new york: oxford university press hofstede, g., (1980). culture's consequences. beverly hills, ca: sage. hofstede, g. (1983). the cultural relativity oforganizational practices and theories. journal of international business studies, 13, 75-89. hunt, j. (1987). hidden extras-how people get overlooked in takeovers. personnel management. july: 24-26. ireland, r. & hitt, m. (1997). performance strategies for high growth entrepreneurial firms. frontiers of entrepreneurship research, 91-104. ijiri, y. & kelly, e. c. (1980). multidimensional accounting and distributed databases: their implications for organizations and society. accounting, organizations and society. ~(1): 115-122. keller, k. (1993). conceptualizing, measuring, and managing customer based broad equity. journal of marketing, 57, 1-22. kitching, j. (1967). why do mergers miscarry? harvard business review, november! december: 35-42. kohli, a. & jaworski, b. (1990). market orientation, the construct, research propositions and managerial implications. journal of marketing, 54, 1-18. levinson, h. (1970). a psychologist diagnoses merger failures, harvard business review, march-april: 84-101. lincoln, j., gerlach, m. & ahmadjian, c. (1996). keiretsu networks and corporate performance in japan. american sociological review, 61 (i), 67-87. luo, y. (2001). antecedents and consequences of personal attachment in cross-cultural cooperative ventures. administrative science quarterly, 46(2), 177 20 i. lusch, r. f., harvey, m., & speier, c. (1998). roil, the building blocks for successful global organizations in the 21 rst century. european management journal, 16(6), 714-728. madhok, a. (1997). cost, value and foreign market entry mode, the transaction and the firm. strategic management journal 18,39-61. 18 journal of business strategies vol. 22, no. 1 marcus, a. (1988). implementing externally induced innovations, a comparison of rule bound and autonomous approaches. academy of management journal, 31, 235-256. mcnamara, c. p. (1972). the present status of the marketing concept. journal of marketing, 36, 50-57. miles, r. & snow, c. (1984). fit, failure and the hall of fame. california management review, 26, 10-28. miles, r. & snow, c. (1986). network organizations, new concepts for new forms. california management review, 28, 62-73. mohr, j. & nevin, j. (1990). communication strategies in marketing channels: a theoretical perspective journal of marketing, 54(4): 36-52. morgan, r. & hunt, s. (1994).the commitment-trust theory of relationship marketing. journal of marketing, 58 (july), 20-38. nakata, c. & sivakumar, k. (200 i). instituting the marketing concept in a multinational setting, the role of national culture. journal of the academy of marketing science, 29(3),255-275. norman, r. & ramirez, r. (1993). from value chain to value constellation, designing interactive strategy, harvard business review. 71(4),65-77. pfeffer 1. (1994). competitive advantage through people boston, ma: harvard business school press. pfeffer, j. & salancik, g. (1978). the external control of organizations. new york: harper & row. planning review, (1994). how to identify and enhance core competencies. 22(6), november-december, 24-26. powell, w. w. (1990). neither market nor hierarchy, network forms of organizations. research in organization behavior, 12,295-336, pr newswire europe. (2002) reuters, september 20. prahalad, c. & hamel, g. (1990). the core competencies of corporations. harvard business review, 30, 25-42. ramanathan, k., seth, a. & thomas, h. (1997). explaining joint ventures, alternative theoretical perspectives. in p. w. beamish and j, p. killing (eds.), cooperative strategies. vol. i. north american perspectives (pp. 51-85). san francisco, california: new lexington press. reicheld, f. (1996). the loyalty effect. cambridge, ma: harvard business school press. spring 2005 kiessling & richey: international acquisitions 19 reynolds, a. (1984). current valuation techniques. accounting review. 52(2), 183-198. ring, p. & van de ven, a. (1992). structuring cooperative relationships between organizations. strategic management journal, 13,483-98. ring, p. & van de ven, a. (1994). developmental processes of cooperative interorganizationa1relationships. academy of management review, 19( i), 90-118. scanzoni (1979). social exchange and behavioral interdependence. in r. burgess and t. houston (eds.) social exchange in developing relationships. new york: academy press. shocker, a.d., srivastava, r.k. & ruekert, r.w. (1994). challenges and opportunities facing brand management, an introduction to the special issue. journal of marketing research, 31, 149-158. slater, s. & narver, j. l. (1995). market orientation and the learning organization. journal of marketing, 59(5), 63-74. slater, s. & narver, j. l. (1999). market oriented is more than being customer-led. strategic management journal, 20, 165-168. srivastava, r.k., tassadua, a.s. & fahey, l. (1998). market-based assets and shareholder value, a framework for analysis. journal of marketing, 62, 2-18. thompson, j. (1967). organizations in action. new york: mcgraw-hill book company. thorelli, h. (1986). networks, between markets and hierarchies. strategic management journal 7(nov), 37-51. valentino, d. (1992). do more of what you do best. across the board, 29(i1), november, 53-54. von hayek, f. a. (1960) the constitution of liberty. london: henley. von hippel, e. (1978). a customer active paradigm with evidence and implications. journal of marketing, 42(jun), 39-49. walker, g., kogut, b. & shan, w. (1997). social capital, structural holes and the formation of an industry network. organization science, 8, 109-125. webster, f. (1992). the changing role of marketing in the corporation. journal of marketing. 56(4),1-17. weedman, j. (1992). informal and formal channels in boundary spanning communication. journal of the american society for information service, 43(3), 257-267. 20 journal ofbusiness strategies vol. 22, no. i wernerfelt, b. (1984). a resource-based view of the finn. strategic management journal. }, 171-180. willens, r. (1993). amortization of intangibles, is a mergers and acquisitions boom imminent? the cpa journal. 63( 11),46-57. williams, j., han, s., & qualls, w. (1998). a conceptual model and study of cross-cultural business relationships. journal of business research. 42, 135-43. williamson, a.e. (1975). markets and hierarchies, analysis and antitrust implications. new york: free press. williamson, a. e. (1985). the economic institutions of capitalism. new york: the free press. yamagishi, t., gillmore, m. r. & cook, k. s. (1988). network connections and the distribution of power in exchange networks. the american journal of sociology, 93(4), 833-852. yi, y. (1990). a critical review of customer satisfaction. in v. zeithaml (ed.) review of marketing. chicago: american marketing association, 68123. zellner, w. schmidt, k., ihlwan, m. & dawley, h. (2001). how well does wal-mart travel? after early missteps, the retailing giant may finally be getting the hang of selling overseas. business week, september 3, 8292. timothy s. kiessling is an assistant professor of management at eastern kentucky university. he has published in academic journals such as thunderbird international review, journal of global marketing, journal of applied management and entrepreneurship, international journal of human resource management, and international journal of intercultural relations. professor kiessling has over 14 years in international business before entering academia. r. glenn richey is an assistant professor of supply chain management at the university ofalabama. he has published in academic journals inc1udingamerican business review, international journal of logistics management, international journal of physical distribution & logistics management, journal of business logistics, journal of international management, and journal of marketing channels. before joining academia, professor richey worked for 10 years in various supply chain management positions. international acquisitions from a network perspective and market based competencies entrepreneurial orientation in a situational context: comparisons between germany and the united states darla domke-damonte coastal carolina university conway, sc jensandreasfauhtich rheinahr campus, remagen fachhochschule koblenz remagen, germany william woodson iii abstract previous research has evaluatedsome elements ofu.s. students'entrepreneurial orientation, while the present research extends and broadens this research to consider different situational settings across students in both germany (n = 95) and the united states (n = 147). the study evaluates both self-perceptions ofentrepreneurial orientation and perceptions ofthe average level ofentrepreneurial orientation ofthe country in which the student resides, based on parental involvement and the different economic and social conditions within which the student resides. results indicate that parental entrepreneurship and country of origin affect self-perception ofentrepreneurial orientation, but that only country oforigin affects perceptions ofone s countrymen s entrepreneurial orientation. entrepreneurial orientation provides an indicator of the requisite behavioral initiatives that are conducive to new venture development (lumpkin & dess, 1996) and insight into the predispositions that an individual may carry with him or her into a business setting (grant & bush, 1995; west, bamford, & marsden, 2008). however, limited attention has been given to the evaluation of an individual's self-perceptions of his or her entrepreneurial orientation and how that evaluation may differ by the social and economic background of the country in which the individual was socialized. the present paper attempts to integrate an explanation of the effects of social and economic issues on self-perception of entrepreneurial orientation. the paper begins by providing a basic literature review and overview of its major hypotheses, the methods used to collect the data are described along with the process used to evaluate the data, and finally results are presented along with a discussion of the outcomes of the process. 16 journal ofbusiness strategies vol. 25, no.1 figure 1 research model: effects of social and economic conditions on perceptions of entrepreneurial orientation economic and social setting (country) situational influence (parental involvement in entrepreneurship) demographic influence (age, gender) / entrepreneurial orientation (self perception) (perception of countrymen) literature review and hypothesis development lumpkin and dess (1996: 136-137) note that entrepreneurial orientation (eo) "involves the intentions and actions of key players functioning in a dynamic generative process aimed at new venture creation .... the key dimensions that characterize an entrepreneurial orientation include a propensity to act autonomously, a willingness to innovate and take risks, and a tendency to be aggressive toward competitors and proactive relative to marketplace opportunities." miller (1983) noted that competitive aggressiveness was a strong component of entrepreneurial orientation, and burgelman (1983) noted that independent action and autonomy were critical elements of internal corporate venturing behavior. the present research attempts to formulate a clearer understanding of some of the precursors to individuals' own perceptions of entrepreneurial orientation. as shown in figure 1, the research model attempts to link the economic and social setting within which an individual grows up to his or her own perceptions of entrepreneurial orientation. in addition, the model recognizes and builds on prior work that indicates that situational factors, such as role models in entrepreneurial activity, and demographic factors also may affect entrepreneurial orientation. the following paragraphs further delineate the constructs under study, provide background on the research supporting the model's proposed relationships, and develop specific hypotheses which are tested in the research. a core challenge with the previous conceptualization of much of the work on entrepreneurial orientation is that it is linked only to the top management team level, or to the organizational level and not to the individual level of analysis. spring 2008 domke-damonte et al.: entrepreneurial orientation 17 to fonnalize the measurement of the construct of entrepreneurial orientation, a variety of scales have been developed. lyon, lumpkin, and dess (2000) note numerous ways to measure the construct, but point out that it may be an artifact of the individual respondent, rather than a finn-level construct. miller (1983) developed a scale to assess the eo construct which covin and slevin (1989) expanded. however, numerous challenges have been posed with these instruments, based on the combination of both present and past behaviors. moreover, these scales were developed to assess finn-level entrepreneurship, while our intention in the present paper was to measure entrepreneurial orientation of future potential business owners. as bird (1988) noted, entrepreneurial intention is the precursor to entrepreneurial activity and it is in this direction that the current research is directed as clearly the initiative and interest must exist before the action ofstarting a business will proceed. grant and bush (1995) noted that "these scales assess an organization's business orientation rather than an employee's psychological orientation or propensity to act in an entrepreneurial manner." as a result, they developed and validated a scale to measure entrepreneurial orientation (eo) among individual salespeople. the approach taken by grant and bush (1995) is unique from other conceptualizations, which focus on the domain of entrepreneurial orientation on the top management team (morris & paul, 1987; lyon, lumpkin, & dess, 2000; lumpkin & dess, 1996; hughes & morgan, 2007; avlonitis & salavou, 2007, among others). grant and bush (1995) allow for the notion that entrepreneurial orientation may be noted at any level of an organization, because it may not be viewed just as a strategic orientation of top managers, but rather as a psychological disposition to acting within any organizational environment. this distinction is critical to the present argument, because it suggests that individuals arrive into an institutional setting with a comfort zone of how they will approach risk taking, innovation, acting autonomously, and proactively initiating action on the part of the firm. as grant and bush (1995) note, it is more likely that these attitudes develop from childhood experiences. generational effects that condition behaviors starting in young and early adulthood (baumeister & muraven, 1996) may condition individuals to perceive the social environment around them in ways that either encourage or discourage innovation and risk taking behavior. belief systems theory (rokeach, 1973) also notes that as long as the individual is relatively happy with his or her own self-concept and self-presentation to others, the value systems and perceptions that have been adopted will remain stable. self-concept may be both oriented toward one's own role within society and also may be used to gauge the perception of the society from an insider's perspective. this perception of the level of entrepreneurial activity of one's own society may be instructive as it should also condition the potential pursuit of future activity, according to belief systems theory (rokeach, 1973). therefore, to fully understand an individual '8 self-perception of entrepreneurial orientation as well as their perception of their countrymen's level of entrepreneurial orientation, it is clearly 18 journal of business strategies vol 25, no, 1 important to consider the ways in which social forces may affect differences in entrepreneurial orientations. gender has long been suggested to be tied to risk taking behavior and career choice. jiankoplos and bernasek (1998) note that women are more risk averse in financial risk taking, while hersch (1996) noted more conservative consumer decision making practices. parks-yancy, ditomaso, and post (2005) demonstrate that women have lower access to social capital resources than do men, and brush (1997) noted that women experience important cultural and situational barriers to entrepreneurship. langowitz, sharpe, and godwin (2006) note that women face significant levels of challenge with respect to establishing new businesses, including their own perception of their ability to be successful, and grant (1996) found that women had lower entrepreneurial intentions. furthermore, the importance of social capital to successful startup of new ventures has been established by davidsson and honig (2003), and that networks (aldrich & martinez, 2001) and role models (wagner & sternberg, 2004) are important for successful startup. langowitz, et al. (2006) note that there is a strong increase in the support available to women entrepreneurs in the u.s, has increased over the last few decades especially since the passage of hr 5050, which was also known as the women's business ownership act of 1988. despite the larger number of role models of female entrepreneurs evident than in the past, with 5.4 million businesses generating $819 billion in revenues owned by women in 1997 in the united states (small business administration, 2003), it is anticipated that women's self-perceptions of entrepreneurial orientation will be lower than men's. in addition, because self-perception may also be linked to inference ofthe level of entrepreneurial orientation of others, it is also likely that perceptions of countrymen's entrepreneurial orientation will differ by gender (rokeach, 1973). thus, the following hypothesis is proposed: hypothesis 1: gender will be correlated with both self-perceptions of entrepreneurial orientation and perceptions of entrepreneurial orientation offellow countrymen, with males scoring higher in both areas than women. in addition, it is not unreasonable to expect that those who have a parent who is involved with his or her own business will have higher entrepreneurial orientation because they will more likely understand the demands that it places on risk taking, innovation, and being proactive within the competitive environment. previous research (krueger 1993; scott & twomey, 1988, grant, 1996) has found that those with parents who have their own businesses are more likely to have an interest or to be planning to be involved in entrepreneurial activity. moreover, van lange, de bruin, otten, and joireman (1997) suggested that basic value orientations are partly linked to the types of social interactions engaged in during early childhood to early adulthood and further influenced by the social interactions and experiences encountered during adulthood, as these students will have perceived their spring 2008 domke-damonte et at.: entrepreneurial orientation 19 parents to have the role of risk taker, innovator, and proactive business leader, it is expected that they will be more likely to generalize this perception to their fellow countrymen. as noted by aldrich and martinez (200 i) and wagner and sternberg (2004), role models and networks are critical to entrepreneurial activity, and the networks that these individuals see as a normal part of their parent's or parents' business environment as entrepreneurs may contribute to their believing that all of their countl)f111en have similar circumstances. thus, the following hypothesis is proposed: hypothesis 2: individuals who have parents who operate their own businesses will have greater perceptions of their own entrepreneurial orientation and higher perceptions of their countrymen s average level of entrepreneurial orientation. finally, social settings may also influence self-perceptions of entrepreneurial orientation and of the level of entrepreneurial orientation of one's countrymen. modernization theory (c.f., inglehart & baker, 2000; gundelach, 1994) suggests that scarcity in social and economic resources provide strong influences on the creation ofinitial value systems for young preadults, by enabling increasingopportunities and reinterpretation of existing social norms during periods of economic and social growth and prosperity, and by requiring a curtailed focus on survival needs during times of economic scarcity and social pressures (inglehart & baker, 2000). changes in the basic social institutions in various countries have made the process of growing up different for youth over the last fifty years (trump, 1991). baumeister and muraven (1996: 406) suggest that there has been "an immense loosening of societal guidelines, restrictions, and pressures, allowing people an almost unprecedented degree of freedom." this freedom has placed additional pressures on individuals to create their own identity, and this pressure is particularly acute during adolescent years (gundelach, 1994). moreover, the increasing range of potential career opportunities available and increases in educational availability to students from more disparate economic backgrounds and genders have made the choice of one's identity broaden from the list available to those in earlier generations. trump (1991:367) notes that inglehart's modernization theory suggests "environmental conditions in existence when one is growing up are seen as crucial in determining the psychological need level at which one fixates, and therefore the type of values one holds most dear." in support of this view, bloodgood, sapienza, and carsrud (1995) note that factors such as community, government agencies, financial resources, and fami ly issues all may affect entrepreneurial activity as well. to consider this effect requires that one evaluate the different social settings in which these students have grown up as lee and peterson (2000: 403) noted "individuals' personalities, and behaviors, firms, political legal systems, economic conditions, and social mores are all intertwined with the national culture from which they originate." it is further appropriate to consider the effects of such social and economic conditions on what individuals 20 journal ofbusiness strategies vol. 25, no.1 within the respective country think about the level of entrepreneurial orientation oftheir countrymen because these perceptions may also frame a different dimension to the readiness to actually engage in entrepreneurial activity. as one seeks to understand whether social and economic conditions contribute to perceptions ofentrepreneurial orientation, it seems appropriate to first test whether such differences existed in two well developed nations that are more similar to one another culturally. in their qualitative study, lee-ross and mitchell (2007) found that prevailing economic conditions make for very different conditions and possibilities for entrepreneurs and noted significant divergence from western models. as such, our assumption was that if such differences existed between individuals within two well developed nations, then there was justification in exploring differences in social settings that were even more diverse. given that germany and the united states score relatively closely to one another on several of hofstede's (200 i} dimensions, with the only large difference that of the u.s. being much higher on individualism than germany and a moderate difference in uncertainty avoidance with germany higher on uncertainty avoidance that the united states, this study sought to explore differences in perceptions of entrepreneurial orientation between the united states and germany. the following section provides a snapshot of the differing economic and social evolutions in the u.s. and germany over the last two decades. figure 2 new business start ups of firms with employees in germany and the united states, 1990-2002 :: f-----..--~wfl ....."-··.. ·i.'i... 800 750if)0 0 0..... 700 ~.. 650til e.... u::: 600 ~ (j) z 550..... 0 .... 500(j) ..0 e :::l 450z 400 1990 1995 2000 2001 2002e source: u.s. small business administration; federal statistical office of germany spring 2008 domke-damonte et al.: entrepreneurial orientation 21 basic overview of the conditions for small business startup in the united states the united states has the highest level ofentrepreneurial activity in the g7 and within first world countries (minniti & bygrave~ 2004). in the united states~ the last decades have provided consistency in gross domestic savings at approximately 17% ofgdp~ inflation in consumer prices has dropped from approximately 5.4% in 1990 to 2.19 % in 1999, real interest rates have remained relatively stable at around 6% with periods of increases and decreases, gdp per capita rose from $23,000 to approximately $32,000, and unemployment dropped over the 1990s until the fallout from the technology sector losses and the aftermath of the september 11,2001 attacks (world bank i international bank for reconstruction and development, 2001). aside from the challenges of the technology slump and the terrorist attacks in 2001, the economic and social settings have been relatively stable. attention to small business development has been a longstanding area of focus with the small business administration getting its start as early as 1932 but officially beginning to offer service in 1953, since which time it has helped more than 20 million people start and grow businesses and offered more than $170 billion in loans, grants, or other programs to these individuals. according to the u.s. small business administration (small business administration office of advocacy, 2003), small businesses represented more than 99.7% of all employers (less than 500 employees) in the united states in 2002 and provided more than 50% of the nonfarm gdp in the united states, employed over fifty percent of all private sector employees, and totaled approximately 22.9 million businesses overall in 2002. new business start up of employer firms (those employing more than one person) in the united states had strong periods of growth in the 1990s~ but growth in this sector slowed in the 2000s, as shown in figure 2. however, it is important to note that sole proprietorships are not reported in this data~ and they represent approximately two times the number of enterprises as do employer firms in the united states (small business administration, 2003). basic overview of the conditions for small business startup in germany in germany, the period beginning in 1990 was fraught with social change, the most important of which was the reunification of the former east germany with west germany. vast sums of money were used to support the reunification effort and to enable economic development and infrastructure support to the new states in the eastern part of the reunited country. large increases were made in taxes paid by west germans to fund infrastructure development, and economic improvements were centered on the eastern states in an effort to raise salaries~ deal with an unemployment rate at least twice that of the western states, and to buffer economic productivity. at the same time, during that decade, the country's overall unemployment rate raised from 6% to 9.7%, real interest rates stayed stable at around 8%, consumer price inflation was reduced, gross domestic savings stayed stable at approximately 23%, and gdp per capita grew from $19,000 to over $23,000 (world bank i international bank for reconstruction and development, 22 journal ofbusiness strategies vol 25, no.1 2001). at the same time, the "mittelstand" sector of the economy, which includes small and medium sized enterprises, consisted on.2 million enterprises in 1999, represented 99.3% of all enterprises subject to vat (value added tax payments), and employed 20 million people (hauser, 2000). as figure 2 demonstrates, the number of new business registrations in germany increased much over the 19905, reflecting an increasing trend toward entrepreneurial activity in both the former east germany and the western states. however, the increasing shift to entrepreneurial development in germany has not yet been mirrored in the way in which early stage venture capital investment funds are being spent in the two countries though. according to eurostat (eurostat 2003), between 2-3 times the percentage of gdp is spent in early stage venture capital investment in the united states than in germany. in his evaluation of the state of small and medium enterprises in germany in 2000, hauser (2000: 14-15) notes, " the entrepreneurial spirit in the overall population has been invigorated and an increasing number of people nowadays is prepared to take on the risks and opportunities ofself-employment. .. during the first years after the reunification, the number of self-employed has increased more rapidly in the new federal states than in the old ones .... but in the following years the number of newly established businesses, starting from a very high level, has been decreasing." as a result of the differing social and economic conditions in place in each country over the last fifteen years, it was anticipated that the students who had grown up in these settings would have different self-perceptions about entrepreneurial orientation as well as different perceptions about the entrepreneurial orientation of their countrymen. hypothesis 3: individuals from countries with less volatile economic and social conditions will have a higher selfperception oftheir entrepreneurial orientation and a higher perception ofthe entrepreneurial orientations oftheir countrymen. methods the survey was designed as a part of a cross-national summer school project involving students from two institutions, a university of applied sciences in germany and a comprehensive liberal arts university in the southeastern united states. students studying business administration topics at both institutions were administered the survey. surveys were administered in english only, after piloting the survey with english-speaking german students majoring in business studies at the university of applied sciences indicated acceptable understanding of all terms and requirements of the surveys. surveys were done as a part of an english class assignment for the business students in germany (n = 100 students), and as a part of several sections of management courses in the united states (n = 177 students), resulting in a total sample of277. the german students involved in the study had already had several years of english language study and were spring 2008 domke-damonte et al.: entrepreneurial orientation 23 completing some of their respective university course work in english as well. three of the students from the german institution and 35 of the students from the u.s. institution were not citizens from the country in which the respective educational institution was located, to enable the comparison of perceptions of entrepreneurial orientation based on country-specific social and economic issues, these students were eliminated from the analysis, and therefore, the remaining sample (n = 242) included 95 german students studying at the university of applied sciences in germany and 147 u.s. students studying at the liberal arts university in the southeastern u.s. the scale used to assess entrepreneurial orientation was taken from grant and bush (1995) and adapted to also enable the capture of students' perceptions of the level of entrepreneurial orientation of their countrymen. as this scale was originally developed with the use of a student sample, this was not deemed problematic, in addition, as the scale was developed to test student perceptions of entrepreneurial orientation, the exploratory extension to using it within the context of identifying student perceptions of countrymen's entrepreneurial orientations was not deemed problematic, though all ofthe standard factor structure and reliability analyses were done and reported for each scale separately in this extension. the scale asked respondents to identify the extent to which they were more or less likely to act in a particular manner with respect to 6 core behaviors: seek creative ways to solve problems, challenge others to explore new ways of thinking, look for new ways of dealing with routine situations, demonstrate persistence in efforts to influence change, seek unusual or novel solutions to problems, and continue efforts to change things even when others claim the "old" way of doing things is better. we used this scale to measure self-perceptions of entrepreneurial orientation by asking respondents, "relative to most people you know, are you more or less likely to ... " with each of the behaviors. we also used this scale to measure perceptions of countrymen's entrepreneurial orientation, by asking respondents, "on average, most people in my home country are more or less likely to ... " with each of the behaviors. in both cases the scales were assessed, as in grant and bush (1995) on a six-point scale. in this way, we were able to assess both the student's own perceptions about hislher own behavior, as well as the student's perceptions of how strong the entrepreneurial orientation is among his/her countrymen. grant and bush (1995) found acceptable reliability of the scale instrument (a = .80) and a single factor which accounted for 46.8% of the variability in the six items. we evaluated reliability for each group (german and us) separately as well as a combined reliability measure. in our evaluation of the reliability of the instrument for measuring self-perceptions ofentrepreneurial orientation, we found reliability acceptable for germany (a = .76), the united states (a = .90) and the combined group (a = .87). in evaluating the reliability of the instrument for measuring perceptions of countrymen's entrepreneurial orientation, we also found acceptable reliability for all three (a = .84 for the germans; a = .93 for the united states; and a = ,90 for the combined group). 24 journal o/business strategies vol. 25, no.1 principal components analysis was done for both scales to identify ifthey were unidimensional, as noted in previous work. factor analysis for the self-perceptions ofentrepreneurial orientation scale indicated one factor, with an eigenvalue of 3.67 and variance explained of 60.94%, with commonalities ranging from .43 .68 for the combined groups on self-perceptions of entrepreneurial orientation. individual factor analyses were completed for each subgroup, and both yielded one factor each, though the commonalities were rather low for one of the items in the german sample. factor analysis was also completed for the perceptions of countrymen's entrepreneurial orientation. one factor resulted with an eigenvalue of 4.101, explaining 68.35% of the variance, with commonalities ranging from .50 .75. factor analysis was also completed for each of the subgroups with similar findings. parents' business status was assessed with five choices including neither parent had his or her own business, father had his own business, mother had her own business, each of the parents had his or her own business, and both parents worked together in their own business. for data analysis purposes, these alternatives were compressed to provide a dichotomous variable with 0 indicating that neither parent was involved in their own business and 1 indicating that at least one was involved in his or her own business. further operationalizations of the data were the coding of gender (0 if a male and 1 if a female) and country (l for germany and 2 for the united states). table 1 descriptives and correlations variable mean s.d. correlations 1.age 23.4 3.18 2. country 1.60 .49 -.09:1: 3. gender .4 .49 -.02 .11* 4. parents have own business? .38 .49 .11* .03 -.05 5. perception of country entrepreneurial orientation 15.91 6.08 .07 .14* .09a .03 6. self-perception of entrepreneurial orientation 18.91 5.65 .11* .10f .06 .17** .26** ~ p :; .10 * p =: .05 ** p:; .01 n:; 242 spring 2008 domke-damonte et al.: entrepreneurial orientation table 2 regression results 25 self·perceptions of perceptions of countrymen's variable entrepreneurial orientation entrepreneurial orientation age .198:1: .233" .252* .130 .136 .163 gender .656 .562 ,43 1,098 1.082 .901 parents' business status 2.084** 2.157** .356 .456 country 1.292:1: 1.765* f 1.895 3.975** 3.788** 1,501 1.062 2.033+ r2/ sign. f change .124 .218/8.023** .244/3.122+ .111 .114/.196 .181 /4.895* :j:p=.10 *p=.05 **p=.01 n=242 data analysis consisted of completing regression with age and gender in the first step, and then adding in subsequent steps parents' business status, and country for regressing each of the dependent variables of self-perceptions of entrepreneurial orientation and perceptions of countrymen's entrepreneurial orientation. descriptive statistics and correlations are provided in table 1. results inspection oftable 1 indicated that self-perception of entrepreneurial orientation was positively and significantly correlated with age (p < .05), indicating a potential maturational effect (inglehart & baker, 2000). moreover, country of citizenship was associated with both perception ofcountrymen's entrepreneurial orientation (p < .05) and self-perception ofentrepreneurial orientation (p < .10). parent's business status was associated with self-perception of entrepreneurial orientation (r = -.17; p < .01). further, gender was only associated with perceptions of countrymen's entrepreneurial orientation (p < .10). in reviewing the results ofthe regression analysis in table 2, the results indicate no support for hypothesis i, which suggested that females would score lower on entrepreneurial orientation than would males. perhaps the lack of specificity in the wording of the scale prompted the finding that was different from previous studies. however, another explanation may be that these males and females had self-selected into the respective business field of study and were already similarly challenged with needs for risk taking and innovation. results indicated partial support for hypothesis 2, which suggested that those students who have parents with their own business will have higher levels of 26 journal ofbusiness strategies vol. 25, no. i entrepreneurial orientation than will those students whose parents are not so engaged (p < .05). however, there was no significant difference on evaluation of countrymen's entrepreneurial orientation (p > .10). further analysis indicated no significant differences on these perceptions based on whether the students' father or mother had his or her own business. or whether the parents each had their own businesses or operated a business together, and there was no significant difference in female students' self-perceptions of eo scores based on which parent had a business. finally, results indicated support for hypothesis 3 that self-perceptions of entrepreneurial orientation (p < .10) and perceptions of countrymen's entrepreneurial orientations (p < .05) will differ by social and economic settings with the students from the u.s. reporting higher scores on both measures than students from germany. discussion this paper has broadened the consideration of entrepreneurial orientation by creating parallel measures of self-perception and perceptions of countrymen's entrepreneurial orientation. in addition, we have attempted to extend the assessment of entrepreneurial orientation by including different economic and social settings within which business students have been socialized. the results provide preliminary insight into the need for further consideration of the effects of different social, economic, and cultural settings on the development of entrepreneurial orientation. future research will need to explore the construct of entrepreneurial orientation as well as to include measures of entrepreneurial intention to further identify potential outcomes of orientations. more work is also needed to identify the specific social and economic indicators that contribute to increased entrepreneurial orientation of young people and future business leaders. moreover, further attention may also be directed to exploring the nature of the relationship between parental involvement in entrepreneurship and effects on their children's interest and involvement in entrepreneurial activity of their own. the limitations of the study include a focus on only one institution from each country, which may not be representative of all institutions in the respective countries (tung, 2008). the study also employs a rather conservative sample size, but this is not unique as many cross-national samples rely on small sample size (e.g., preston, karahanna, and rowe (2006) compared information sharing among clos in the u.s. (n = 163) and france (n = 44); kickul, lester, and belgio (2004) compared the perceptions of the psychological contract between u.s. (n = 60) and hong kong chinese (n = 76); and lee, yang, and graham (2006) studied total of 176 chinese and u.s. executives to compare tension in buyer seller interactions.) furthermore, the questions asking about entrepreneurial orientation were loosely tied to specific entrepreneurial activity, and more directed statements should be formalized to assure common interpretation of the spring 2008 domke-damonte et al.: entrepreneurial orientation 27 construct. all respondents were required to answer the survey questionnaire in english. also, since harzing (2005) notes that when english-language instruments are administered to non-native speakers, there is a tendency for results to more mirror those of native speakers, it would be helpful to evaluate and compare the differences in results for such instruments and outcomes when administered in native languages. finally, it would probably be helpful in future studies to include formal cultural, economic, and social indicators measures to use that as a control rather than country by itself. despite these limitations, this study demonstrates a tentative and exploratory step to uncover the differences in perception about risk taking behavior among business students, and potentially future business leaders, in germany and the united states. if such differences exist among well developed nations that are somewhat similar on cultural values (hofstede, 2001), then this work supports further the call of lee-ross and mitchell (2007) in arguing for further development of the issues that contribute to differences in entrepreneurial orientation as a precursor to entrepreneurial activity. references aldrich ii, b., & martinez, m. a. (2001). many are called, but few are chosen: an evolutionary perspective for the study of entrepreneurship. entrepreneurship theory and practice, 25(4),41-57. avlonitis, g., & salavou, h. (2007, may). entrepreneurial orientation ofsmes, product innovativeness, and performance. journal o/business research, 60(5),566-575. baumeister, r. f., & muraven, m. (1996). identity as adaptation to social, cultural, and historical context. journal ofadolescence, 19. 405416. bird, b. (1988). implementing entrepreneurial ideas: the case for intention. academy 0/ management review, 13, 442-453. bloodgood, h. m., sapienza, h. j., & carsrud, a. l. (1995). the dynamics o/new business startups: person, context, and process. in j, a. katz & r. h. brockhaus (eds.), advances in entrepreneurship, firm emergence, and growth. vol. 2. stamford, ct: jai press, 123-144. brush, c. (1997). women-owned businesses: obstacles and opportunities. journal 0/ developmental entrepreneurship. 2(1), 1-24. burgelman, r a. (1983). a process model of internal corporate venturing in the diversified major firm. administrative science quarterly, 28, 223-244. covin, j. g., & slevin, d. p. (1989). strategic management of small firms in hostile and benign environments. strategic management journal, 10. 75-87. 28 journal ofbusiness strategies vol. 25, no. 1 davidsson. p., & honig, b. (2003). the role of social and human capital among nascent entrepreneurs. journal of business venturing, 18(3), 101-23. eurostat. the european commission. (2003). retrieved september 12, 2003, from http://eufopa.eu.intlcommleurostat/public!datashop/print-product/en?catalogue=eur ostat&product= l-ir061-en&mode=download. federal statistical office of gennany. (2003). retrieved september 5, 2003, from http:// www.destatis.delbasis/e!fistifisttaboll.htm. grant, e. s., & bush, a. 1. (1995). entrepreneurial orientation in the salesforce: development of the eos measure. proceedings of the southern marketing association, november 8-11, 1995. retrieved april 4, 2003, from http://www.sbaer.uca.edu/research/i 995/sma/95swa132.htm. grant, 1. m. (1996). the proactive personality scale as a predictor of entrepreneurial intentions. journal ofsmall business management. 34(3),42-50. gundelach, p. (1994). national value differences: modernization or institutionalization? international journal oj comparative sociology, 35(1-2),37-58. harzing, a. (2005, august). does the use of english-language questionnaires in cross-national research obscure national differences? international journal ojcross cultural management. 5(2),213-224. hauser, h.-e. (2000). smes in germany: facts and figures. institut fur mittelstandsforschung bonn. retrieved september 3, 2003, from http://www.ifm-bonn.de/ergebnis/ sme.htm. hersch, j. (1996). smoking, seat belts and other risky consumer decisions: differences by gender and race. managerial and decision economics, september, 471-81. hofstede, g. 2001. culture 8' consequences: comparing values, behaviors, institutions, and organizations across nations. second edition. thousand oaks, ca: sage. hughes, m., & morgan, r (2007, july). deconstructing the relationship between entrepreneurial orientation and business performance at the embryonic stage of firm growth. industrial marketing management, 36(5),651-661. inglehart, r. (1995). changing values, economic development and political change. international social science journal, 47, 379-403. inglehart, r, & baker, w. e. (2000). modernization, cultural change, and the persistence of traditional values. american sociological review, 65, 19-51. jiankoplos, n. a, & bernasek, a. (1998). are women more risk averse? economic inquiry, 36(4), 620-631. spring 2008 domke·damonte et al.: entrepreneurial orientation 29 kickul, j., lester, s., & belgio, e. (2004, august). attitudinal and behavioral outcomes of psychological contract breach: a cross-cultural comparison of the united states and hong kong chinese. international journal of cross cultural management, 4(2), 229-252. krueger, n. e (1993). the impact of prior entrepreneurial exposure on perceptions of new venture feasibility and desirability. entrepreneurship theory and practice, 18(1), 5-21. langowitz, n., sharpe, n., & godwyn, m. (2006). women's business centers in the united states: effective entrepreneurship training and policy implementation. journal of small business & entrepreneurship, 19(2), 167-181. lee, k., yang, g., & graham, j. (2006, september). tension and trust in international business negotiations: american executives negotiating with chinese executives. journal ofinternational business studies, 3 7(5), 623-641. lee, s. m., & peterson, s. 1. (2000). culture, entrepreneurial orientation, and global competitiveness. journal of world business, 35(4),401-416. lee-ross, d., & mitchell, b. (2007, june). doing business in the torres straits: a study of the relationship between culture and the nature of indigenous entrepreneurs. journal ofdevelopmental entrepreneurship. 12(2), 199-216. lumpkin, g. t., & dess, g. g. (1996). clarifying the entrepreneurial orientation construct and linking it to performance. academy of management review, 21(1), 135-172. lyon, d. w., lumpkin, g. 1., & dess, g. g. (2000). enhancing entrepreneurial orientation research: operationalizing and measuring a key strategic decision making process. journalo/management. 26(5), 1055-1085. miller, d. (1983). the correlates of entrepreneurship in three types of firms. management science, 29, 770-791. minniti. m., & bygrave, w. (2004). gem global entrepreneurship monitor: national entrepreneurship assessment. united states of america. 2003 executive report. babson park, ma: babson college. morris, m. h., & paul, g. w. (1987). the relationship between entrepreneurship and marketing in established firms. journal ofbusiness venturing, 2(3),247-259. parks-yancy, r., ditomaso, n., & post, c. (2005, august). the effects ofsocial capital resources on the careers of gender and class groups. in: gender and diversity in organizations conference paper abstracts. (2005). academy of management proceedings, academy of management, new york. 30 journal ofbusiness strategies vol 25, no.1 preston, d., karahanna, e., & rowe, f. (2006, may). development ofshared understanding between the chief information officer and top management team in u.s. and french organizations: a cross-cultural comparison. ieee transactions on engineering management, 53(2), 191-206. rokeach, m. (1973). the nature of human values. new york: free press. scott, m. g., & twomey, d. f. (1988). the long-term supply of entrepreneurs: students' career aspirations in relation to entrepreneurship. journal ofsmall business management, 26(october), 37-44. small business administration office of advocacy. (2003, may). small business by the numbers. washington: u.s. small business administration. trump, t. m. (1991). value formation and postmaterialism: inglehart's theory of value change reconsidered. comparative political studies, 24(3),365-390. tung, r. (2008, january). the cross-cultural research imperative: the need to balance cross-national and intra-national diversity. journal ofinternational business studies, 39(1 ),41-46. van lange, p.a. m., debruin, e. m. n., otten, w., & joireman, j.a. (1997). development of prasodal, individualistic, and competitive orientations: theory and preliminary evidence. journal ofpersonality and social psychology, 73(4),733-746. wagner. j., & sternberg, r. (2004). start-up activities, individual characteristics, and the regional milieu: lessons for entrepreneurship support policies from german micro data. the annals of regional science 38(2), 219-39. west, g., bamford, c., & j. marsden (2008, january). contrasting entrepreneurial economic development in emerging latin american economies: applications and extensions of resource-based theory. entrepreneurship: theory & practice, 32(1), 15-36. world bankiinternational bank for reconstruction and development. (2001). world development indicators. program. win-stars. v4.2 cd-rom. darla domke-damonte, ph.d., is assistant dean of international programs at the e. craig wall college of business administration at coastal carolina university (usa). jens andreas faulstich, m.a., is deputy director of languages and international affairs at the fachhochschule koblenz rheinahr campus (gennany). william woodson iii was fonnerly the director ofthe wall fellows program at coastal carolina university (usa). he is now in independent law practice. entrepreneurial orientation in a situational context: comparisons between germany and the united states accounting students' likelihood of compliance with tax preparation standards edward monsour, jd, cpa rafik z. elias, dba, cpa cheryl a. cruz, jd, cpa california state university, los angeles los angeles, ca abstract the current study examines the likelihood that accounting students will comply with the aicpa senforceable statements on standards for tax services (ssts). a sample of 224 accounting students completed a questionnaire including ssts scenarios. overall, a significant portion of accounting students was not likely to follow the standards onfive out of six scenarios. a group of students that received specific instruction in ssts was not more likely to comply with them compared to a group that did not learn the standards. in addition, there were differences based on gender, age and class grade in the likelihood ofcompliance. accounting professionals have faced increasing pressures from regulators and the public in the wake of corporate accounting scandals a few years ago. the american institute of certified public accountants (aicpa) has emphasized the need for accountants to focus on their responsibilities to the public. in the areas of tax preparation and tax planning, these responsibilities are framed within the framework of statements on standardsfor tax services (ssts). these standards, effective since 2000, represent enforceable codes ofconduct by cpas in tax return preparation and tax planning. the purpose of this paper is to investigate accounting students' likelihood of following these tax standards. accounting students represent future cpas and their perception of tax standards, after being exposed to them, can give an insight into their perception of the importance of such standards. hume, larkins, and iyer (1999) investigated tax professionals' compliance with statements on responsibilities in tax practice (srtp), which were advisory in nature and were superseded by the enforceable ssts. however, in hume et al. (1999), one possible limitation of the results was that cpas may not have been familiar with srtp since they were only suggested guidelines. in the current study, accounting students are divided into two groups: one group received specific instruction on ssts and another group did not the study examines the likelihood of compliance with ssts and investigates whether demographic factors such as gender, age and class grade have an effect on students' compliance. 156 journal ofbusiness strategies vol. 23, no.2 the paper is organized as follows: after this introduction is a background on the concepts of tax preparation along with a discussion of ethics and an examination of ssts. this is followed by an explanation of the research design and sample selection. the results are presented next followed by discussion and implications for accounting education and the accounting profession. background tax preparation and ethics a significant segment of cpas is involved in tax preparation of individual tax returns and tax planning. approximately 55% of all federal income tax returns and even greater percentages of complex tax returns are prepared by tax professionals. the cost exceeds $11 billion annually (yetmar & rioux, 2004). even with increasing complexities of tax laws and increased demand for tax preparation, cpas face competition from accountants without the cpa designation, enrolled agents, tax-preparation chains and software programs (fisher, 1994). this increasing competition from less-expensive sources presents cpas with a dilemma in determining their level of conservatism. in providing tax preparation and planning services, cpas attempt to satisfy many constituents such as clients, employers, professional organizations and government agencies. given these constituents with different goals and risk preferences, it is not surprising for cpas to face ethical conflicts during their careers (yetmar, 1997). cpas are confronted with ethical dilemmas especially when there is client pressure to adopt overly aggressive tax positions (hume et ai., 1999; cruz, shafer & strawser, 2000). finn, chonk, and hunt (1988) noted this problem in an earlier survey of cpa tax preparers where almost half of them indicated their biggest problem was clients' proposals to alter tax liability and/or tax fraud. almost half of the respondents felt that cpas outside their firms often engaged in unethical activities. in facing these ethical challenges, cpas must sometimes balance competing interests. taxpayers and the irs have different expectations of cpas. the irs maintains that cpas should have loyalty to the u.s. tax system and act as government agents (brody & masselli, 1996). on the other hand, research shows that many taxpayers are ambivalent about whether tax cheating is morally wrong and are often willing to play the audit lottery (i.e., adopting aggressive or even fraudulent positions based on a low audit probability) (kaplan & reekers, 1985; westat, 1980). yetmar and eastman (2000) noted that taxpayers expect cpas to minimize their clients' tax liability and be the clients' advocate. schisler (1995) found that taxpayers were generally more aggressive than preparers on every scenario presented and schisler (1994) concluded that preparers adhered to the aggressive tendencies of their clients. in order for the irs to illustrate the importance of its position, it has increased penalties on tax preparers in recent years. yetmar and rioux (2004) estimated that a quarter of all tax preparers would be assessed for some type of preparer fall 2006 monsour et al.: tax preparation standards 157 penalty during their career. brody and masselli (1996) criticized the irs position and noted that it failed to consider the possibility that two or more tax positions, even though they differ in their level of aggressiveness, may still meet the good faith criterion for recommending a position. erard (1993) found that cpas and lawyers were more likely to condone aggressive reporting activities as well as recommend tax shelters to their clients compared to nonlicensed preparers. research regarding the impact of sanctions on cpas' behavior has reached mixed conclusions. for example, reekers, sanders, and wyndelts (1991) found that preparer penalties were effective in reducing cpas aggressiveness in signing returns. on the other hand, cuccia (1994) found preparer sanctions increased the effort by cpas in the engagement but did not have an effect on aggressiveness. some research has attempted to determine factors influencing tax preparers' ethical decisions. cruz et a1. (2000) found that tax practitioners' behavior was consistent with five ethical philosophies: moral equity, contractualism, utilitarianism, relativism, and egoism. another study found that expert tax preparers seemed to be most influenced by personal integrity and professional ethics when confronted with clients' desires in tax matters (jackson, milliran & toy, 1988). in dealing with potential ethical conflicts in tax preparation, the aicparequires members to act with integrity and maintain the public trust. the ssts illustrate the cpas' commitment to meet their responsibilities to the public. ssts and responsibilities between 1964 and 1977, the aicpa issued srtp. they were guidelines that helped cpas recognize their ethical obligation to the public. they dealt with issues such as knowledge of an error in a filed tax return, use of estimates, and cpas taking aggressive tax positions that will circumvent tax audits. the srtp were voluntary standards. however, they became de facto enforcement standards with courts, the irs, state accountancy boards and other professional organizations relying on them as accepted professional conduct in tax practice (swails, 2000). in 2000, theaicpareplaced srtpwith ssts. the ssts differ from the srtp in one important way. the ssts are explicitly enforceable professional standards. members of the aicpa who do not adhere to ssts are subject to sanctions. although other tax practice standards exist, most notable treasury department circular 230 and penalty provisions of the internal revenue code (irc), they are limited in that (1) they do not provide the depth of guidance contained in the ssts, and (2) they may be considered to take an unrealistic or oversimplified view of the complexities of tax practice (swails, 2000). the ssts were written in as simple and objective a manner as possible. in terms of content, the ssts mirror the old srtp: the name, number, and substance of each statement remain essentially the same. the current study uses the ssts to investigate accounting students' likelihood of compliance. 158 journal ofbusiness strategies vol. 23, no.2 accounting students and ethics prior research has shown that despite widespread efforts by practitioners and educators to encourage greater emphasis on ethics in accounting education, there has been minimal coverage ofethics in the accounting curriculum (e.g. thompson, mccoy & wallestad, 1992). however, a more recent national survey by mastracchio (2005) found that half ofthe colleges of business offered a separate course in business ethics. in addition, 90% ofthe surveyed schools noted that protecting the public interest was covered in the auditing course. although research has investigated accounting students' ethical reasoning in general accounting settings, little research has specifically examined tax settings. since many accounting students will be involved with tax preparation and planning, whether as cpas in public practice or as cmas in industry, it is important to understand their perception of tax preparation standards and the likelihood of compliance with such standards. in a literature review, borkowski and ugras (1998) identified several factors (e.g. gender, age and class grade) that can affect accounting students' ethical reasoning with mixed conclusions. in a tax context, grasso and kaplan (1998) investigated gender and age differences in tax ethics perception among accounting students. the results showed that females tended to believe more strongly than males that evading taxes was immoral. contrary to most previous ethics research regarding age, grasso and kaplan (1998) found that younger students «25 years old) perceived evading taxes as more immoral compared to older nontraditional students. in several scenarios, students believed actions to be ethical, even though they believed these actions conflicted with the aicpa code of conduct. fallan (1999) also investigated gender in a tax context. the results showed that females reconsidered their position on tax ethics issues more often than males. some research has also investigated the extent oftax knowledge and exposure on ethical decision making. eriksen and fallan (1996) examined whether a tax course had an effect on accounting students' perception of their own tax evasion, their attitude towards other people's tax evasion and the students' perception of tax fairness. in a preand post-test design, the authors concluded that increased tax knowledge resulted in accounting students viewing their own and others' tax evasion as more serious. students' perception oftax fairness also increased after the course. similar results were reported in fallan (1999). the current study examines gender, age, class grade and specific exposure to ssts on accounting students' likelihood of compliance with professional standards. the current study does not attempt to form conclusions about tax practitioners' likelihood ofcompliance with standards, or use students as surrogates for tax practitioners. rather, it examines the accounting student population, at this early stage of career development. research method sampling the sample for this study consisted of accounting students in a large aacsbaccredited public university. the students were enrolled in individual and corporate fall 2006 monsour et al.: tax preparation standards 159 tax classes. the survey was administered two weeks before the end of the term to allow students to learn all the necessary tax information. overall, nine sections were surveyed over a six-month period. these sections were taught by four different instructors. the voluntary survey took about 10-15 minutes to complete and students were assured of confidentiality. a total of 237 responses were received. after eliminating responses with missing information, the useable sample was 224 responses. the students were divided into two groups: one group (four sections, 88 students) received detailed classroom instruction on ssts. the other group (five sections, 136 students) did not receive instruction on ssts. the purpose of this split is to investigate if specific instruction on enforceable standards would have an effect on students' likelihood of following them. measures the survey used in this study consisted of a questionnaire and demographic questions. the questionnaire was adapted from hume et a1. (1999). in that study, the authors developed six scenarios that mirrored the content of srtp at that time. they surveyed cpas involved in tax preparation as well as nonlicensed preparers to investigate the likelihood of following the srtp guidelines. the results indicated that the majority of cpas followed the srtp in most of the issues more often than nonlicensed preparers. however, a statistically significant number of cpas do not follow the srtp on half the issues and did not follow them more often than nonlicensed preparers on these issues. since the ssts are identical to the srtp in content, the same scenarios from hume et a1. (1999) were used in this study. the scenarios are presented in the appendix. they deal with issues such as knowledge of an error, inquiries, yielding to client pressure and the appropriateness of using estimates among others. research results the sample's demographic characteristics are presented in table 1. the table shows that most of the sample consisted of females and undergraduate students. in order to investigate whether specific education in ssts has an impact on students' likelihood to follow them, both groups of respondents were compared on each scenario using the chi-square test. the results indicate no statistically significant differences between the two groups on any of the scenarios. the results are reported in table 1. a test ofproportions was used to examine the likelihood of accounting students not following ssts. in general, the great majority of students tended to follow ssts in scenario i. however, significant portions of students did not follow the standards in all other scenarios. a significant portion of students did not follow ssts in scenario 2, regarding the use of estimates. ssts specifically prohibits cpas from reporting an estimated amount as an exact amount. overall, 34% of the students did not follow the standards in scenario 2. in scenario 3, almost 18% of the students did not follow the standards, while the percentages of non160 journal ofbusiness strategies vol. 23, no.2 compliance for scenarios 4,5 and 6 were 16%, 14% and 22% respectively. these results are alarming because they indicate that a significant portion of future tax preparers do not follow ssts. table 1 demographics and accounting students' compliance with ssts panel a: demographic characteristics (n) gender: age: class grade: m~e n female 152 < 25 years old (traditional) 101 25 years or > (nontraditional) 123 undergraduate 150 graduate 74 panel b: scenario % complying % complying % complying with ssts with ssts with ssts (overall) (after education) (without education) (n=224) (n=88) (n=136) 1. 95.5% 96.5% 94.8% 2. 66%*** 62.5% 68.3% 3. 82.5%*** 78.4% 85.2% 4. 84.8%*** 85.2% 84.5% 5. 86.6%*** 88.6% 85.2% 6. 77.7%*** 83% 74.3% ***p<.oi probability that significant respondents do not follow ssts in order to investigate the impact of demographic factors on the likelihood of following ssts, logistic regression (logit) was used with the responses of compliance or noncompliance as the dependent variable and the demographics as the independent variables for each scenario separately. due to the fact that explanatory variables such as age, gender and class grade might be correlated, correlation analysis was conducted between these variables. the results indicated no correlation between gender and age (r = -.28; p = .67) or between gender and class grade (r = .11; p = .08). however, there was a statistically significant correlation between age and class grade (r = .19; p < .01). therefore, the following fall 2006 monsour et al.: tax preparation standards 161 results regarding age and grade should be interpreted in light oftheir correlation, the significant results are reported in table 2. table 2 demographic differences between accounting students scenario gender 1. 2. percentage complying with ssts age class grade undergraduate graduate 98%*** 90.5%*** 3. 4. 5. male female 6. 79.1%** 90.1%** traditional nontraditional traditional nontraditional 90.1%** 76.4%** 71.3%** 83%** undergraduate 86.6%** graduate 74.3%** undergraduate 92%*** graduate 70.2%*** undergraduate 81.4%** graduate 70.3%** traditional = < 25 years old nontraditional = 25 years or > *** p< .01 ** p < .05 the results indicate significant differences based on gender in scenario 5 only (regarding inquiry about information that appears incorrect). in that case, the proportion of females likely to follow sstp (90.1 %) was significantly higher than males (79.1 %). there were no significant differences on any other scenarios based on gender. regarding age differences, there were significant differences in scenarios 3 and 6. in scenario 3 (dealing with notifying the client of an error in a previous return), younger students were more likely to follow sstp (90.1 %) compared to older students (76.4%). however, in scenario 6 (dealing with changing an item under client pressure), older students were more likely to follow sstp (83%) compared to younger students (71 %). class grade differences were also significant. in scenario i (dealing with correcting an error in a current return), undergraduate students were more likely to 162 journal ofbusiness strategies vol. 23, no.2 follow ssts (98%) compared to graduate students (90.5%). in scenarios 3, 4 and 6, similar differences emerged with undergraduate students more likely to comply with sstp compared to graduate students. discussion and implications the current study's results provide several conclusions about the likelihood of accounting students following required tax standards. in general, with the exception of scenario 1 (dealing with correcting an error in a current return), a significant portion of accounting students were not likely to comply with ssts. the results are alarming since many of these students will be cpas in public practice or cmas in industry, both involved with tax preparation and planning. the results of this study, however, can not be directly compared to hume et a1. (1999) regarding cpas and other tax preparers because at the time hume et a1. (1999) was conducted, srtp were advisory guidelines, while current ssts are enforceable standards. more alarming is the conclusion that specific education about ssts did not influence students' likelihood offollowing them in tax preparation. these results conflict with grasso and kaplan (1998) who found that tax students exposed to professional ethics and responsibilities exhibited higher ethical standards. the results also conflict with ward and ward (1996) who found that students receiving specific instructions in the aicpa code of conduct were more likely to follow it compared to students who did not receive such training. it is possible, as grasso and kaplan (1998) indicated, that some students believe that a particular behavior is ethical while professional standards consider it unethical. the extent of this possibility can be the subject of future research regarding the enforceable sstp. regarding demographic factors, there were minor differences based on gender and only on scenario 5 were females more likely to comply with ssts than males. results regarding age were mixed since in scenario 3, younger students were more likely to comply than older students while in scenario 6, the opposite results appeared. the evidence was stronger in favor of class grade differences in likelihood of compliance. in four out of six scenarios, undergraduate students were more likely to comply with standards compared to graduate students. this finding is also alarming since graduate students possess more accounting and tax education. the results of this study indicate that accounting instructors must emphasize ethics in the classroom in a more productive manner. since there was no impact of extra education on standards, perhaps accounting instructors should emphasize the reasons for such standards. instructors should emphasize tax preparers' responsibilities to both clients and the irs and explain the purpose of each standard separately, rather than their enforceability alone. a future study can examine students' likelihood of following ssts before and after the class, after extensive discussion of the reasons and ethics of such standards. the study also has implications for accounting practitioners. ahadiat and mackie (1993) argued that new entrants in the accounting profession were sefall 2006 monsour et al.: tax preparation standards 163 lected from the pool of university graduates. the authors argued that recruiters should consider ethics in making hiring decisions. the current study helps future employers in two ways: it identifies certain groups of accounting students that can potentially have different ethical characteristics compared to others. it also shows the compliance likelihood offuture employers with professional standards, just before they enter the profession. based on the study's findings, employers should make an effort to emphasize tax compliance among their new recruits. references ahadiat, n., & mackie, j. (1993). ethics education in accounting: an investigation of ethics as a factor in the recruiting decisions of public accounting firms. journal of accounting education, 12, 243-257. borkowski, s. c., & ugras, y. j. (1998). business students and ethics: a meta-analysis. journal ofbusiness ethics, 17, 1117-1127. brody, r. g., & masselli, j. j. (1996). tax preparers: whose team are they on? national public accountant. 41, 18. cruz, c. a., shafer, w. e., & strawser, j. r. (2000). a multidimensional analysis oftax practitioners' ethical judgments. journal ofbusiness ethics, 24, 223-244. cuccia, a. d. (1994). the effects of increased sanctions on paid preparers: integrating economic and psychological factors. the journal ofthe american taxation association, 16, 41-66. erard, b. (1993). taxation with representation: an analysis of the role of tax practitioners in tax compliance. journal of public economics, 163-197. eriksen, k., & fallan, l. (1996). tax knowledge and attitudes towards taxation: a report on a quasi-experiment. journal of economic psychology, 17, 387-402. fallan, l. (1999). gender exposure to tax knowledge, and attitudes towards taxation; an experimental approach. journal of business ethics, 18, 173-184. finn, d. w., chonko l. b., & hunt, s. d. (1988). ethical problems in public accounting: the view from the top. journal ofbusiness ethics, 7, 605-615. fisher, a. b. (1994). finding the right tax advisor. fortune. 129. 77-80. grasso, l. p., & kaplan, s. e. (1998). an examination of ethical standards for tax issues. journal ofaccounting education. 16, 85-100. hume, e. c., larkins, e. r., & iyer, g. (1999). on compliance with ethical standards in tax return preparation. journal ofbusiness ethics, 18. 229-238. 164 journal ofbusiness strategies vol. 23, no.2 jackson, b. r., milliron, v. c., & toy, d. r. (1988). tax practitioners and the government. tax notes 41, 333-341. kaplan, s. e., & reekers, p. m.( 1985). a study of tax evasion judgments. national tax journal, 97-102. mastracchio, n. j., jr. (2005). teaching cpas about serving the public interest. the cpa journal, 75, 6. reekers, p., sanders, d., & wyndelts, r. (1991). an empirical investigation of factors influencing tax practitioner compliance. the journal of the american taxation association, 30-46. schisler, d. l. (1995). equity, aggressiveness, consensus: a comparison of taxpayers and tax preparers. accounting horizons, 9, 76-87. schisler, d. l. (1994). an experimental examination of factors affecting tax preparers' aggressiveness a prospect theory approach. the journal of american taxation association, 16, 124-142. swails, j. e. (2000). new standards for tax practice. journal of accountancy, 190, 7986. thompson, j. h., mccoy, t. l., & wallestad, d. a. (1992). the incorporation of ethics into the accounting curriculum. advances in accounting, 10,91-103. ward, s. p., & ward, d. r. (1996). the code of professional conduct: instructional impact on accounting students' ethical perceptions and attitudes. journal of education for business, 71, 147-151. westat, inc, (1980). individual income tax compliance factors study qualitative research. (prepared for the internal revenue service). yetmar, s. a., & rioux, j. (2004). components of the aicpa's statements on standards for tax services. the cpa journal, 74, 64-66. yetmar s. a., & eastman, k. k. (2000). tax practitioners' ethical sensitivity: a model and empirical examination. journal ofbusiness ethics, 26, 271-288. yetmar, s. a., (1997). recognizing srtp violations in return preparation. the tax adviser, 28, 654-658. fa112006 monsour et ai.: tax preparation standards appendix 165 ssts scenarios adapted from hume et al. (1999) i. you assured your client early in the engagement that a particular expenditure would be deductible on his income tax return. after preparing the client's return, but before mailing it, you discover that a revenue ruling clearly disallows a deduction for the expenditure in question. after some further investigation, you believe that the revenue ruling is a correct interpretation of the law and that there is no reasonable basis for taking the deduction. nonetheless, you do not think the item will be detected by the irs. you have basically two choices: (1) you could ignore the revenue ruling and mail the return. (2) you could notify the client of the mistake and correct the return. would you notify the client of the mistake and correct the return? ____ yes no 2. you client incurred an expense which is deductible on her tax return. however, the exact dollar amount is not known and must be estimated. for this type of expense, the tax law allows the use of estimates. you have basically two choices: (i) you can present the estimated estimate (e.g. $1,983) . (2) you can present the estimated item in the return as a rounded amount (e.g. $2,000) . would you present the estimated item as a rounded amount (e.g. $2,000)? yes ____ no 3. in preparing your client's income tax return this year, you discover that the return prepared last year contained a material error. (assume you are not acquainted with the person who prepared that return last year). in particular, a $1,000 deduction was listed as a $3,000 deduction. correcting the error will result in additional tax liability for the client. the mistake does not appear to have been intentional and it is unlikely that the irs will ever detect the error. you have basically two choices: (i) you could ignore the error. (2) you could notify the client of the error. would you notify the client of the error? ____ yes no 4. in preparing your client's income tax return this year, you discover that the return you prepared last year for this client contained a material error. in particular you listed a $1,000 deduction as a $3,000 deduction. correcting the error will result in additional tax liability for the client. the mistake was not intentional and it is unlikely that the irs will ever detect the error. you have basically two choices: (i) you could ignore the error. (2) you could notify the client of the error. would you notify the client of the error? ____ yes no 166 journal of business strategies vol. 23, no.2 5. one of your clients is a well-connected executive in a large firm. you want to maintain a good relationship with this client in the hopes of future business referrals. your new client has presented information to you in a relationship to the preparation of his income tax return. some of the information appears to be incorrect, and you suspect that your client is attempting to reduce his tax liability inappropriately. you have basically two choices: (i) you could go ahead and prepare the tax return according to the client's representation. (2) you could first inquire about the correctness of the information. would you inquire about the correctness of the information? ____ yes no 6. one of your most important clients has strongly suggested that you change the treatment of an item on his income tax return. you believe that the treatment of the item suggested by the client will materially understate the client's correct tax liability. further, there is no reasonable basis for the change. you have basically two choices: (1) you could refuse to change the item. (2) you could agree to change the item as suggested by the client. would you agree to change the item? ____ yes no edward monsour is assistant professor of accounting at california state university, los angeles. he received his j.d. from cleveland-marshall college of law and he is a cpa. his research has been published in business journal of entrepreneurs and many national and regional conference proceedings. his research interests are in the areas of taxation, accounting ethics and education. rafik z. elias is associate professor ofaccounting at california state university, los angeles. he received his dba in accounting from louisiana tech university and he is a cpa. his research has been published in advances in accounting, journal of business ethics, advances in public interest accounting, research on accounting ethics, and many conference proceedings. his research interests are in the areas of auditing, accounting ethics and education. cheryl a. cruz is currently associate dean, undergraduate studies and professor of tax and accounting at california state university, los angeles. she earned her j.d. from university of california, los angeles, and she is a cpa. her research has been published in journal ofbusiness ethics, journal ofbusiness and management and journal ofthe academy ofbusiness administration. her research interests are in the areas of taxation and ethics. accounting students' likelihood of compliance with tax preparation standards customer service management in western and central europe: a concurrent validation strategy in entrepreneurial financial information services organizations shawn m. carraher, ph.d. cameron university lawton, ok sarah c. carraher consolidation enterprises lawton, ok alma mintu-wimsatt, ph.d. texas a & m university commerce commerce, tx abstract the purpose ofthe present study was to test whether or not a biodata inventory could be used to measure service orientation within global entrepreneurial organizations in western and central europe. a concurrent validation strategy was conducted consistent with the methodology previously presented by schoenfeldt (1999). within the samples of403 and 295 non-american employees, the service orientation ratings were highly correlated with four scales: "extroversion," "openness to experience, " "conscientiousness, "and "agreeableness" and not significantly correlated with "emotional stability. " the findings suggest that for organizational employee development and selection, service orientation may be effectively measured by an instrument such as this one and therefore potentially improve customer service management systems. introduction perceived customer service is often the determining factor in the initial purchase and/or repeat purchase of products. positive customer service experiences drive customer satisfaction that subsequently affects the level of customer satisfaction. on the other hand, negative experiences reinforce customer dissatisfaction. a dissatisfied customer may become an economic liability to the organization, and worst, a critic of the products and services provided (carrier, 1999; waldman & gopalakrishnan, 1996). the image of the organization in the mind of an individual consumer is often produced by a series of possible interactions with a finite number of [organi42 journal of business strategies vol. 22, no.1 zation's] employees. as a result, firms often attempt to shape their image with customers by managing the types of behaviors employees display (becherer & maurer, 1999; hipkin, 2000; martin, 2000; o'gorman & doran, 1999). this is because firms that emphasize higher levels of customer service report higher profitability, return on sales, return on investments, return on assets, and profit growth than those reporting less emphasis on customer service by the individual employees (wright, pearce, and busbin, 1997). in fact, mcwilliams, van fleet, & wright (2001) have argued that organizations may gain a global competitive advantage through the strategic use of their human resources. to the extent that an organization's success depends on effective customer relations, the customer service employee plays a vital boundary spanning role for the organization (robertson, 1995). the literature suggests that the nature of these front-line service jobs is uniquely demanding. indeed, the social and emotional skills required of these employees are quite intense (carraher & hart, 1995; hui, lam, & schaubroeck, 200 i; pugh, 2001). while customers may typically have as few as one or two service encounters daily; service employees may have to deal with several hundred customers or potential customers each day. more importantly, many ofthese customers have complaints about the organization's products and/or services. for employees of small to medium size businesses, the situation may be worse since nearly all employees may have normal contact with customers on a daily basis (o'gorman & doran, 1999; zinger, lebrasseur, & zanibbi, 2001). because the social interaction and boundary spanning aspects of service jobs may demand nontechnical and noncognitive skills, these may be difficult to measure for many employees. this is particularly true for entry-level jobs where costly assessment techniques are rarely utilized (mitchell, 1997). consequently, other means of assessing skill sets necessary for customer service employees are often sought. this study offers an alternative means ofevaluating employees' service orientation. in particular, the current authors test whether a biodata inventory could be used to measure the service orientation construct across multiple cultures. biodata information from employees of multinational entrepreneurial financial information services organizations was evaluated. because of the size and nature of the organization's core business, the boundary spanning role of most employees are expected to be critical to the firm's success. the remainder of this paper consists of four major sections. the first section lays the theoretical foundation for study. the second section discusses the methodology used in the study. next, we report the results of the statistical analyses. the final section contains our conclusions including a discussion of the findings, limitations and managerial implications. literature review a stream of research has established the relationships between service orientation and overall job performance (c.f., hogan & hogan, 1992) as well as spring 2005 carraher et at. .customer service management 43 service orientation and customer satisfaction (c.f., carraher et ai., 1998). given the importance of service orientation, several studies have been conducted attempting to identify key antecedents and/or traits of this variable. among the most significant works in the area of identifying service-oriented employees has been that of hogan, hogan, and busch (1984). they defined service orientation as employees "disposition to be helpful, thoughtful, considerate and cooperative" (p. 167). from their definition of service-orientation, hogan et ai. (1984) developed the service orientation index (sol) that was derived from the hogan personality inventory (hpj). the sol consisted of 87 true-false items covering issues of agreeableness, adjustment, conscientiousness, and sociability. validation of the solon a group of healthcare workers revealed a correlation of r = .31, (12 <.05) between sol scores and service orientation ratings (hogan & hogan, 1992; hogan et ai., 1984). since that time, both the hpj and sol have been altered so that the hpi currently is designed to measure the big five personality factors (viswesvaran & ones, 2000) and contains 206 items (a 40-item research version of the questionnaire is also available) and the sol contains 14 items. since hogan et al. (1984) performed their work on the service orientation construct, a number of consulting companies such as personnel decisions international., questar data systems, and core corporation have developed their own instruments to measure service orientation. these instruments are based on measures of attitudes and/or behaviorally-based personality questions. unfortunately, research published in peer referred journals performed by individuals not employed by the consulting companies has yet to be presented on the efficacy ofthese instruments as these organizations are primarily interested in revenue generation rather than academic research and publication. an additional limitation of current measures of service orientation is their focus on cognitive abilities (mitchell, 1997). bowen, siehl, & schneider (1989), on the other hand, have recommended the use of more "behaviorally based selection procedures" (p. 83) ~ such as biographical information blanks (schneider, 1997) or biodata for short. biographical data credit for the first modern use of biographical information in employee selection dates back to 1894 when t. l. peters used biographical information for the selection of insurance agents (ferguson, 1962). research using biographical questionnaires in multiple-choice format blossomed during world war ii, and much research was performed demonstrating that background items could predict success in the military (parish & drucker, 1957). crawford (1947) went as far as to examine the effectiveness of bomber crews and found that 83 % of teams matched using biographical type information were judged to be effective teams which was nearly twice the success rate of teams designed by conventional means. reviews of further work support the empirical validity of biographical data in predicting various criteria includingjob placement success (harvey-cook 44 journal o.lbusiness strategies vol. 22, no. i & taffler, 2000), turnover (brush & owens, 1979), and performance for service employees in large organizations (allworth & hesketh, 2000). while biodata typically differ from measures of values, attitudes, moods, interests, personality, and abilities, it can assess constructs in all of these domains (stokes, 1999). biodata questions are often presented in a standardized self-report questionnaire with a multiple choice format that asks individuals to describe their past experiences, behaviors, feelings, and/or attitudes (gatewood & field, 2001). for example, "in high school, how easy were your math classes?" is a biodata question that may reflect perceived cognitive ability while "in comparison with most people you know, how often do your friends come to you for advice or guidance" is a biodata question used to infer the personality construct of agreeableness (stokes, 1999). researchers who use biodata assume that the best predictor of future behavior is past [and present] behaviors, attitudes, interests, and intentions (owens, 1976; stokes, 1999). schoenfeldt (1999) reported on several studies attempting to use empirically, factorially, and rationally derived biodata scales to predict service orientation in a concurrent validation strategy. using responses from 867 service employees of a large communications organization and a 137-item biodata questionnaire constructed to measure 16 aspects of service delivery, he sought to predict supervisory ratings of service orientation. schoenfelt (1999) found that service orientation could be predicted using biodata items. in particular, he found that service oriented employees honor commitments, are happy in both work situations and life in general, and have parents who were not overly involved in their lives. he also found that the factorially and rationally derived biodata scales did a better job of predicting the criterion of interest than the empirically derived scales. based upon the works of hogan et al. (1984), parasuraman, zeitham1, and berry (1985), saxe and weitz (1982), and schoenfeldt (1999), mcbride, mendoza & carraher (1997) used samples of undergraduate students in order to create a more parsimonious biodata inventory purported to measure constructs related to service orientation. they developed a 39-item biodata inventory hypothesized to contain the following seven topical scales: life satisfaction, sociability, agreeableness, resistance to stress, responsibility, need for achievement, and desire to make good impressions on others. it was found that the sociability and good impressions scales were significantly related to estimates of service orientation. carraher, mendoza, buckley, schoenfeldt, and carraher (1998) used four samples with a combined sample size of 861 in order to examine whether or not a modified version of the 39 item biodata instrument developed by mcbride (1988, 1997; mcbride et ai., 1997) could be used to measure the service orientation construct. as a result, they developed a new version of the need for achievement scale and changed several items so that they all contained 5 response options with the exception of sex and age. using limited information factor analysis, carraher et al. (1998) found that service orientation ratings spring 2005 carraher et al.: customer service management 45 were consistently related with three of the topical scales: good impression, sociability, and helpfulness. chait, carraher, and buckley (2000) used 605 subjects who were applicants for customer service positions with a large financial services organization to reexamine the relationship between the biodata measure and service orientation. using a full profile principal components analysis, they found support for a five factor model with mcbride's biodata instrument and further found that this five factor model was similar to the big five personality factors of extroversion, conscientiousness, emotional stability, agreeableness, and openness to experience. more recently carraher, buckley, scott, parnell, & carraher (2002) used three samples of applicants for entry level customer service positions within a single global entrepreneurial information services organization with operations in the us, canada, and the uk. they found it to be a useful screening device for selection decisions across all three countries. in this study, we seek to extend the work of chait et al. (2000) and examine if mcbride's biodata instrument is useful within global entrepreneurial organizations (combining results from multiple countries within the same sample). however, unlike previous research, the current study does not focus on whether or not the job is perceived as that of a "typical" customer service representative. this is important since the goal here is to assess whether the instrument may also be of use with all current employees rather than just job applicants. research methodology subjects subjects included 403 non-american employees from all organizational levels within a global entrepreneurial financial information services organization in the united kingdom (england, scotland, wales, and northern ireland) and 295 non-american employees from another organization in poland, russia, and ukraine. the gender composition of the first sample was 52% males and 48% females with the average age being 28.44 (sd = 4.58) while it was 55% males and 45% females with the average age being 28.16 (so = 5.84) for the second sample. instrument the primary instrument was the personality and biodata-oriented inventory developed by mcbride (1988, 1997; mcbride et ai., 1997 [mcbride et al. has a list of the items in an appendix]) as modified by carraher et al. (1998). using full-profile principal components analysis (as was used by chait et al., 2000), we found support for the five-factor model. as a result, we are going to use the fivefactor model in this study with scales calculated using regressed factor scores. due to problems with the use of coefficient alpha reliability estimates (sethi & carraher, 1993), and the admonition that commonly used internal consistency 46 journal ofbusiness strategies vol. 22, no.1 estimations of reliabilities are "generally inappropriate for biodata" (mitchell, 1994:492), we did not calculate them but supported the internal consistency of the scales using limited information factor analysis as suggested by schoenfeldt and mendoza (1994) and mitchell (1994). carraher et al. (2002) examined the 6-month test-retest reliability for the scales and found them to range from .7323 (openness to experience) to .8441 (extroversion). in terms of item content, in addition to covering basic demographics (age, sex, etc.), many of the questions contained in the inventory consisted of experiential, attitudinal, and behaviorally-based items (e.g. "when you were a member of a small group, how much do you participate?" and "how comfortable are you in new places and situations?"). the response formats for all questions except for age and gender had five response categories. customer-interaction situation subjects in the samples completed the questionnaire as part of the developmental process within their respective organizations. after completing the questionnaire subjects were scheduled to participate in the experimental task and informed that their performance would not influence their performance appraisals, merit raises, or threaten their jobs in any way. the assessment (described below) was designed by industrial psychologists and management professors involved in a larger project on the validation of selection and developmental procedures. the experiential tasks were based upon detailed job analyses of customer service situations within the organization. questions used in the assessment were gleaned from actual customer-employee interactions that had been videoand audio-taped. the organizations' chief executives/founders were interested in being able to use the questionnaire to identify which employees were in need of additional customer service training. the subjects were asked to role play the part of a telemarketing customer service representative who answered questions from customers about the firm's products (see schoenfeldt, 1989; schoenfeldt, varca, mendoza, & carraher, 1995). following the briefing period, each subject (one per session) was escorted to the experimental laboratory. the subject was seated at a desk with a telephone and given a catalog with descriptions of the services offered by the organization. subjects were given time to familiarize themselves with the information and to situate themselves to the surroundings after which the "customer" (a confederate with a standard set of questions) called the subject. the "customer" then proceeded to ask the subject questions about the product. subjects were debriefed and given personalized feedback about their biodata scores after the assessment. criterion: ratings of service-orientation the telephone conversation between the customer and subject was recorded and later evaluated independently by three raters including the owners of the spring 2005 carraher et at.: customer service management 47 organizations. each rater had previously been trained in order to accurately and consistently identify differing levels of service-orientation. after listening to a conversation, raters would rate each of the subjects. service-orientation was measured using a 17-item rater evaluation form consisting of items such as "the subject courteously and effectively dealt with customers" which were developed from the results of the job analyses performed by schoenfeldt et al. (1995). each rater assessed all ofthe subjects. as suggested by tinsley and weiss (1975), interrater reliabilities were assessed with corrected intraclass correlations from the rater evaluation forms for the three raters. the intrac1ass correlations were [ = .81 for the first sample and [= .83 for the second sample. these reliability estimates are comparable to those found by hogan et al. (1984). the criterion scores were obtained by averaging the service-orientation scores given by the raters. this is similar to what hogan et al. (1984), mcbride (1988), carraher et al. (1998), chait et al. (2000); and carraher et al. (2002) have previously done. results as done in previous studies utilizing this scale, pearson product-moment correlations between the criterion (the average composite measure of service orientation from the three raters) and each of the topical scales were examined as were the multiple r's regressing all five of the scales on the criterion. the results of these analyses are presented in table 1. focusing on the results of the correlations, we found that the extroversion, agreeableness, openness to experience and conscientiousness scales have the highest correlations with ratings on service-orientation for both samples. it is interesting to note that the overall correlations tend to be stronger in the central european samples than the western european sample. this may be because of the more clear relationship between pay and performance in the central european organization (allen & helms, 2002) as the labor laws allow the organization a greater degree of latitude in hiring and firing employees than in western europe. additionally it should be noted that the coefficients found here are similar to those found by hogan et al. (1984), personnel decisions inc., (paajanen, 1995), and core corporation (fogli, 1995) with other measures of service-orientation and the owners of the organizations personally agreed with the ratings. core corporation reports that their measures of service-orientation have validity coefficients in the range of .19 to .36 for the service-oriented performance of tellers in the banking industry (undated) and personnel decisions international report validity coefficients in the range of .19 to .32 across a variety of occupations for their measure of service-orientation (mclellan & paajanen, 1994). carraher et al. (1998; 2002) found multiple r's between.42 to .56 for customer service employees. 48 journal ofbusiness strategies vol. 22, no. i scales table 1 correlations of service-orientation with biodata scales correlation with criterion central europe western europe extroversion agreeableness emotional stability conscientiousness openness to experience .40'" .22'" .29'" .13" .10 .07 .29'" .10' .35'" .16'" multiple r from regression analysis including 5 topical scales r squared '= p < .05; .• = p < .01; .., = p < .001 .50'" .25 conclusions .37''' .14 the findings here suggest that service-orientation can be effectively identified using a biodata inventory such as the one used in this study. more importantly, we found that biodata inventory can also be used within organizations for all levels of employees. these findings are consistent with those found by previous researchers (carraher et al. 1998; 2002) suggesting that this instrument may be useful with job applicants for selection purposes. the instrument can also be utilized for developmental purposes in order to determine which organizational employees may benefit from customer service training. given the size and nature of the organizations sampled in this study, the findings regarding the potential of using biodata to pinpoint customer service orientation is particularly critical. as o'gorman and doran (1999) emphasized, it is through the focus on serving the customer well that small and medium sized businesses may more effectively compete with larger organizations that may have the cost advantage (meters & ketzenberg, 2000). the results ofthe current study clearly show service orientation to be reflective ofextroverted individuals who make a conscious effort to actively help others and seek out new ways to satisfy the needs of customers. as a consequence, it does appear that inventories such as the one utilized in this study may serve as useful screening devices for identifying individuals with the tendency to exhibit strong service oriented behaviors for both developmental and selection purposes and therefore we suggest that practicing managers make use of instruments such as this one in their hiring decisions when seeking to hire customer service oriented employees. spring 2005 carraher et al.: customer service management 49 while the identification of proactive, considerate employees may be important to any organization, it is especially crucial in ones in which customer service may be a major part ofthe job for most of the positions within the organization as is increasingly becoming the case in the united states and around much of the world and as is especially important in entrepreneurial businesses where most employees may be called upon on a consistent basis to interact with both internal and external customers. moreover, the generalizability ofthe instruments used to tap the construct is enhanced by the concept of service orientation itself. that is, it is not occupation specific and as shown here may be used across all levels of an organization making it especially useful in general selection decisions. it should be noted that the current study is limited in its scope as only individuals from the uk, poland, ukraine, and russia within a single industry were sampled and while based upon actual customer service interactions, the behavioral exercise was simulated. in the future we would like to see research done examining actual customer service interactions performed across an even wider number of countries. it might also prove useful to perform validation studies within organizations using both predictive and concurrent validation strategies in order to see how comparable the results may be. this research has served to shed light on those areas of service orientation that may be most important in the identification of individuals likely to behave in a service-oriented manner. knowing which factors are important is a significant asset in developing a program designed to increase the service orientation of both new and existing employees. in fact, in positions where service orientation may be important, individuals should be selected based upon the degree to which they possess these characteristics and are likely to utilize them in the context of the position itself. therefore, we believe that the biodata data inventory instrument utilized here can make an important contribution in the identification of individuals across occupations likely to exhibit high levels of service-oriented behaviors whether for selection or developmental purposes and therefore likely to increase the perceived service quality for the organization (duffy, duffy, & kilbourne, 2001). references allen, r. & helms, m. (2002). employee perceptions of the relationship between strategy, rewards, and organizational performance. journal of business strategies, l2. (2), 115-i40. allworth, j. & hesketh, b. (2000). job requirements biodata as a predictor of performance in customer service roles. international journal of selection and assessment, .8. (3),137-147. becherer, r. & maurer, j. (1999). the proactive personality disposition and entrepreneurial behavior among small company presidents. journal of small bu$iness management, 37 (i), 28-36. 50 journal olbusiness strategies vol. 22, no. i bowen, d.e., siehl, c. & schneider, b. (1989). a framework for analyzing customer service orientations in manufacturing. academy of management review, 14,75-95. brush, d. & owens, w. (1979). implementation and evaluation of an assessment classification model for manpower utilization. personnel psychology, 32, 369-383. carraher, s.m. & hart, d. (1995). theory and measurement of customer service-orientation. symposium presented at the annual meeting of the society for industrial and organizational psychology, orlando. carraher, s.m., mendoza, j., buckley, m.r., schoenfeldt, l., & carraher, c. (1998). validation of an instrument to measure service orientation. journal of quality management, 1 (2), 211-224. carraher, s., buckley, m., scott, c., parnell, j. & carraher, c. (2002). customer service selection with biodata in a global entrepreneurial information services organization. journal of applied management & entrepreneurship, 1 (2) 45-55. carrier. c. (1999). the training and development needs of owner-managers of small businesses with export potential. journal of small business management,37 (4), 30-41. chait, h., carraher, s.m., & buckley, m.r. (2000). measuring service orientation with biodata. journal of managerial1ssues.ll (i), 109-120. core corporation undated. core corporation's customer service testing. pleasant hill, ca: author. crawford, m. (1947). psychological research on operational training in the continental air forces. (research report no. 16). army air forces aviation psychology program. duffy, j., duffy, m., & kilbourne, w. (2001). a comparative study of resident, family, and administrator expectations for service quality in long-term care facilities. health care management review. 26 (3), 75-85. ferguson, l. w. (1962). the heritage of industrial psychology. hartford, ct: author. fogli, l. (1995). construct validity of service first from core corporation. paper presented at the annual meeting of the society for industrial and organizational psychology, orlando. gatewood, r. & field, h. (200 i). human resource selection 5th ed. harcourt college p.: fort worth. harvey-cook, j. & taffler, r. (2000). biodata in professional entry-level selection: statistical scoring ofcommon format applications. journal ofoccupational & organizational psychology, 73 (i), 103-118. spring 2005 carraher et al.: customer service management 51 hipkin, 1. (2000). tqm: the paradox of empowerment and conformance in the service sector. south african journal of business management, 11 (1), 1-8. hogan, r., & hogan, j. (1992). hogan personality inventory manual. tulsa: hogan assessment systems. hogan, r., hogan, j., & busch, c. (1984). how to measure service orientation. journal of applied psychology, 69, 167-173. hui, c., lam, s., & schaubroeck, j. (2001). can good citizens lead the way in providing quality service? a field quasi experiment. academy of management journal,44 (5) 988-995. martin, c. (2000). acid tests of employees' customer service orientation. journal of services marketing, 11 (2),90-91. mcbride, a. (1988). the development of a service orientation employee selection instrument. unpublished masters thesis, texas a & m university. mcbride, a. (1997). when is biodata not biodata? southern management association proceedings, 302-304. mcbride, a, mendoza, j., & carraher, s. (1997). development of a biodata index to measure service-orientation. psychological reports,.ti, 1395-1407. mclellan, r.a & paajanen, g.e. (1994). poi customer service inventory manual. minneapolis: pdi. mcwilliams, a, van fleet, d., & wright, p. (2001). strategic management of human resources for global competitive advantage. journal of business strategies, .l..8. (1), 1-24. metters, r. & ketzenberg, m. (2000). small is beautiful: the re-emergence of the convenience strategy. journal of business strategies, 11 (1), 25-36. mitchell, t. (1994). the utility of biodata. in biodata handbook. eds. g. stokes, m. mumford, & w. owens. palo alto, ca: cpp. mitchell, t. (1997). biodata for customer service performance: do nice guys finish last? paper presented at the 12th meeting of the society for industrial and organizational psychology, st. louis. o'gorman, c. & doran, r. (1999). mission statements in small and medium-sized businesses. journal of small business management, 37 (4), 59-67. owens, w. (1976). background data. in handbook of industrial and organizational psychology ed. marvin dunnette. chicago: rand mcnally. 52 journal o.lbusiness strategies vol. 22, no. 1 paajanen, g. (1995). construct validity of the poi customer service inventory. paper presented at the annual meeting of the society of industrial and organizational psychology, orlando. parasuraman, a., zeithaml, v., & berry, l. (1985). a conceptual model of service quality and its implications for future research. journal of marketing, 49,41 ·50. parish, j. & drucker, a. (1957). personnel research of officer candidate school, usa tago personnel research branch technical research report. no. 117. pugh, s. (2001). service with a smile: emotional contagion in the service encounter. academy of management journal, 44 (5),1018-1027. robertson, p. (1995). involvement in boundry-spanning activity: mitigating the relationship between work setting and behavior. journal of public administration research & theory, 5. (1),73-98. saxe, r. & weitz, b. (1982). the soco scale: a measure of the customer orientation of salespeople. journal of marketing research, l2., 343-351. schneider, b. (1997). customer service-orientation: predictive validity and beyond discussants comments for symposium presented at the 12th meeting of the society for industrial and organizational psychology, st. louis. schoenfeldt, l. (1989). biographical data as the new frontier of employee selection research. presented at the annual meeting of the american psychological association, new orleans, la. schoenfeldt. l. (1999). from dust bowl empiricism to rational constructs in biographical data. human resource management review, 2 (2), 147-167. schoenfeldt., l. & mendoza, j. (1994). developing and using factorially derived biographical scales. in biodata handbook eds. g. stokes, m. mumford, & w. owens. palo alto, ca: cpp. schoenfeldt, l.f., varca, p.e., mendoza, j.l. & carraher, s.m. (1995). selecting serviceoriented employees with biodata. paper presented at the annual meeting ofthe society for industrial & organizational psychology, orlando. sethi, v. & carraher, s.m. (1993). developing measures for assessing the organizational impact of information technology: a comment on mahmood and soon's paper. decision sciences, 24, 867-877. stokes, g. (1999). introduction to special issue: the next one hundred years ofbiodata. human resources management review, 99 (9), 111-116. tinsley, h.e. & weiss, oj. (1975). interrater reliability and agreement of subjective judgements. journal of counseling psychology, 22, 358-376. spring 2005 carraher et al.: customer service management 53 viswesvaran, c. & ones, d. (2000). measurement error in abig five factors@ personality assessment: reliability generalization across studies and measures. educational and psychological measurement, 60 (2), 224-235. waldman, d. a. & gopalakrishnan, m. (1996). operational, organizational, and human resource factors predictive of customer perceptions of service quality. journal of quality management, 1, 91-107. wright, n., pearce, j., & busbin, j. (1997). linking customer service orientation to competitive performance: does the marketing concept really work? journal of marketing theory and practice, ~ (4),23-33. zinger, j., lebrasseur, r., & zanibbi, l. (2001). factors influencing early stage performance in canadian microenterprises. journal of developmental entrepreneurship, q (2),129-150. shawn m. carraher received his ph. d. in business administration from the university of oklahoma. he is the virginia brewczynski endowed chair in entrepreneurial studies, director of the center for emerging technology & entrepreneurial studies, head of entrepreneurial studies, and director of the small business institute at cameron university. his primary research interests combine strategic management, international management, human resources/ organizational behavior, and entrepreneurship in order to examine cross-cultural differences in compensation, selection, and staffing within entrepreneurial organizations. his recent publications have appeared in the journal of applied psychology, decision sciences, educational and psychological measurement, journal of managerial issues, journal of vocational behavior, journal of quality management, journal of applied management and entrepreneurship, journal of business & entrepreneurship, global business and finance review, and the journal of business strategies. sarah c. carraher has degrees in history and music performance and is owner of consolidation enterprises. she has done research on expatriate stress, customer service orientation, work norms among global entrepreneurs, and the application of equity theory to global entrepreneurs. her previous research has been published in the academy of entrepreneurship journal, international journal of family business, and the journal of small business strategy. alma mintu-wimsatt is a professor of marketing at texas a&m universitycommerce. she received her ph.d. from the university in kentucky_ her areas of research interest are cross-cultural negotiations, buyer-seller interaction and teaching pedagogy focusing on technology mediated learning. her research works have been published in management science, journal of the academy of marketing science, thunderbird international business review, journal of 54 journal ofbusiness strategies vol. 22, no. i personal selling and sales management, international journal of research in marketing, european journal of marketing, journal of business and industrial marketing, and marketing education review, to name a few. customer service management in western and central europe: a concurrent validation strategy in entrepreneurial financial information services organizations leadership's activation of team cohesion as a strategic asset: an empirical simulation michael d. michalisin steven j. karau southern illinois university carbondale carbondale, il charnchaitangpong north dakota state university fargo, nd abstract the current study examined the linkage between leadership, team cohesion, and superior performance using group process and performance data collectedfrom a strategic management simulation conducted over afour-month period. results showed that organizational leadership was not directly associated with superior performance (sp) ofsimulatedfirms. however, leadership was significantly associated with team cohesion, which in turn was significantly associated with sf, suggesting that leadership may strengthen performance indirectly by effectuating key group process mechanisms. consistent with the resource based view ofthe firm, thesefindings suggest that leader behavior, through its positive impact on the development ofteam cohesion, can yield superior performance. introduction organizational researchers have long studied the effects of organizational leadership on firm performance, producing a rich array of theories and empirical findings (bass, 1990; house & podsakoff, 1995; yuki, 1998). these theories and studies have revealed that the relationship between leadership behavior and specific performance outcomes is complex, and that the specific behaviors that are effective often depends on a variety of variables, including situational factors and follower characteristics (blake & mouton, 1985; hersey & blanchard, 1988; house, 1971). although the context-dependency of effective leader behavior may make consistent, direct relationships with firm performance unlikely, it is possible that leadership might still serve to activate group process variables and other intangible factors that may have a more stable, direct, and significant relationship with ongoing firm performance. thus, consistent with the resource based view of the firm (dierickx & cool, 1989), leadership could serve to activate resources and core processes crucial to organizational functioning that could, in turn, have a potent effect on firm performance. one such resource could be the cohesion of 2 journal afbusiness strategies vol. 24, no.1 the top management team (tmt). indeed, a large number of studies have shown that cohesion often has a strong relationship with group performance (mullen & copper, 1994). tmt cohesion may also have the potential to operate as an intangible strategic asset by helping the tmt reach consensus on strategic direction and organizational controls, as well as by facilitating communication and commitment to shared organizational goals (smith, smith, olian & sims, 1994). the current research examines the nature ofthe relationship between leadership and superior performance. does leadership directly affect performance? or does leadership indirectly influence performance through group process resources, such as team cohesion? the major purpose of the study was to examine the possibility that leadership has an indirect effect on superior performance that operates via cohesion. specifically, we sought to empirically examine the following relationships: (a) the relationship between leadership and the superior performance of simulated firms, (b) the relationship between team cohesion and superior performance, and (c) the relationship between leadership and team cohesion. leadership and firm performance existing research on the relationship between leadership and firm performance has produced mixed results (bass, 1990; lieberson & o'connor, 1972; salancik & pfeffer, 1977; thomas, 1988). this has divided scholars in their contention (channon, 1979; hambrick & mason, 1984; waldman, ramirez, house & puranam, 2001; weiner & mahoney, 1981) or opposition, that leadership, in and of itself, has a direct impact on firm performance (cyert & march, 1963; hannan & freeman, 1977; khurana, 2002; lieberson & o'connor, 1972; salancik & pfeffer, 1977). some have argued that the inconsistent findings are due to methodological differences, (thomas, 1988; weiner & mahoney, 1981), whereas others propose that further empirical studies should focus on when and how leadership affects firm performance (day & lord, 1988). the lack of consistency in prior empirical findings suggests that consistent, direct relationships between leadership behavior and firm performance may be unlikely to emerge. prior research and theory on both leadership style and contingency approaches to leadership provide additional support for our reasoning that the relationship between leadership and firm performance is more likely to be indirect, rather than direct. with regard to leadership style research, the classic research programs conducted by scholars at ohio state (stodgill & coons, 1957) and michigan (katz & kahn, 1978) converged on the identification of two primary leadership styles consisting of task and interpersonal aspects (initially called initiating structure and consideration), but no single leadership style appeared to be appropriate to all situations. similarly, research on autocratic, democratic, and participative leadership (foels, driskell, mullen & salas, 2000), as well as on transactional, transformational, and charismatic leadership (lung & avolio, 1999; howell & shamir, 2005) has also found than no single leadership style is universally effective. although blake and mouton's (1985) "high-high" notion that effective spring 2007 michalisin et al.: team cohesion as a strategic asset 3 leaders must be attentive to both task and social aspects of the work setting resonated with many scholars, empirical results generally found that no single style of leadership was effective across all contexts (bass, 1990). due to the difficulty in identifying universally effective leadership styles, a host of contingency theories were developed to try to explain what behaviors are effective in what specific contexts. for example, situational leadership theory (hersey & blanchard, 1988), path-goal theory (house, 1971), and the normative decision model (vroom & yetton, 1973) all created different classifications of leader behaviors that could lead to either positive or negative performance, depending on workplace variables, follower characteristics, and individual and team processes. thus, all of these views suggest that the degree offit between leader behavior and work context should enhance performance via specific individual and group-level processes. however, these views disagree on what specific leadership behaviors impact performance under different conditions. for example, the leadership match theory focuses on task structure and managerial position power, path-goal theory implicates subordinate perceptions regarding expectancy and instrumentality of effort, and the normative model focuses on characteristics of decisions that may require more or less input from subordinates. interestingly, despite disagreements about the conditions under which specific leader behaviors are optimally effective, all of these views converge to highlight the importance that task-focused and socially-oriented leadership behaviors play in supporting and enhancing processes key to organizational performance, such as worker motivation and team dynamics. thus, although these theories disagree on when specific leadership styles are most effective, they agree that leadership is likely to have an impact on organizational processes that may be more directly linked with performance. taken as a whole, the prior leadership literature depicts a complex relationship between leaders' task and social behaviors and firm performance and suggests that neither task nor social behavior is likely to have a direct eftect on the firm's ability to produce sustainable competitive advantage across a range of contexts, as would be evidenced by superior performance over time. thus, we predicted that leadership would be unlikely to show a significant, direct relationship with the superior performance of the simulated firms used in the current study. hypothesis 1: leadership will have no direct relationship with the performance ofsimulated firms. hypothesis i a: task leadership will have no direct relationship with the performance ofsimulatedfirms. hypothesis 1b: social leadership will have no direct relationship with the performance ofsimulatedfirms. although both task and social leadership may be unlikely to have direct effects on performance that are not heavily context-dependent, they could well have direct effects on team processes that are, in turn, central to performance. one key team process that is often central to performance is cohesion (mullen & 4 journal ofbusiness strategies vol. 24, no. i copper, 1994). thus, to the extent that task and social leadership contribute to the development and maintenance ofteam cohesion, leadership may well contribute indirectly to performance via cohesion. we will now address the theoretical and empirical support for the linkages between leadership and team cohesion, as well as between team cohesion and performance, in separate sections. leadership and team cohesion cohesion is a complex, possibly multidimensional construct that has been defined and operationalized in a variety ofways. however, the majority oftheoretical and empirical treatments have emphasized members' attraction to the group and desire to remain in the group (cartwright, 1968; hogg, 1992). consistent with these prior treatments, we defined team cohesion as the degree to which members are attracted to their team and desire to remain in it. we propose that both task and social leadership can contribute to team cohesion, such that leaders can engage in behaviors that are likely to increase members' attraction to the group and desire to continue interacting with the group. most of the cohesion literature has focused on performance outcomes rather than on factors that create cohesion (the performance studies are reviewed in the section below entitled cohesion and firm performance). nevertheless, a number of studies examining a variety of group contexts do converge to suggest that leadership can contribute to cohesion. for example, several studies have found positive relationships between transformational leadership and team cohesion among laboratory groups (hoyt & blascovich, 2003), light infantry platoons (bass, lung, avolio & berson, 2003), fire rescue personnel (pillai & williams, 2004), and workgroups in korean firms (lung & sosik, 2002). bass et al. (2003) also showed that team cohesion was positively associated with platoon performance. though these studies did not identify the specific elements of transformational leadership responsible for increased cohesion, lung and sosik (2002) reasoned that empowering followers, emphasizing cooperation, and realigning values may have played a role. rozell and gunderson (2003) found that leaders who used effective impression management techniques heightened feelings of cohesion within laboratory groups. within the team sports context, research has found that coaches who attend actively to skill development, motivational communication, and social support of players tend to have more cohesive teams (gardner, shields, bredemeier & bostrom, 1996; turman, 2003). similarly, literature on team building has emphasized the coaching or facilitation role that leaders can play in building the group's cohesion and commitment to shared goals, in order to make optimal use of group resources (dyer, 1977; pritchard, roth, jones, galgay & watson, 1988). finally, a review of 23 studies examining leadership behaviors and associated outcomes in environments designed as analogs for long-duration space flight concluded that effective leaders maintained group harmony and cohesion by attending both to mission-specific task outcomes and to the expertise and personal qualities of crew members (nicholas & penwell, spring 2007 michalisin et al.: team cohesion as a strategic asset 5 1995). thus, a number of prior studies have documented relationships between leadership and team cohesion, though the specific leader behaviors, team types, tasks, and settings examined have varied widely. although research on the specific issue of leadership and team cohesion is limited, research on the broader issue of how cohesion develops does help to identify factors relevant to leadership that may contribute to cohesion. specifically, it has been found that cohesion is stronger among groups that have a shared social identity (hogg & terry, 2000), common goals (guthrie & hollensbe, 2004; seashore, 1954), a shared commitment to completing team tasks (myers, 1962), a belief that teammates are trustworthy (yalom, 1985), and an awareness of a shared outcome or fate (brewer & kramer, 1986). thus, it is possible that task leadership could enhance cohesion by keeping group members focused on completing important tasks and attaining valued goals and outcomes. research has also shown that cohesion is fostered by demonstrations of liking and respect among teammates (hoegl & gemuenden, 2001; lott & lott, 1961), harmony among group members (stokes, 1983), lessened social anxiety (pepitone & reichling, 1955) and meaningful, shared social experiences (darley, gross & martin, 1951; yalom, 1985). studies have also found that teams can develop cohesion, in part, by establishing clear behavioral norms and enforcing these norms by rejecting deviant behavior (feldman, 1984; williams, 2001). thus, it is possible that social leadership could enhance cohesion by encouraging respect for team members, maintaining group harmony, fostering positive group experiences and social activities over time, encouraging information sharing among members, and preventing deviant team members from exerting a negative influence on the group. in summary, prior research on the specific issue ofleadership and team cohesion has provided initial evidence that leader behaviors can contribute to cohesion. research on the more general issue of sources of cohesion provides evidence suggesting that task leadership can contribute to cohesion by keeping the team focused on the work and enhancing shared commitment to completing the work, and that social leadership can contribute to cohesion by maintaining team harmony and good relationships, facilitating meaningful social interaction, and thwarting deviant members' attempts to exert negative influence on the group. hypothesis 2: leadership will be positively associated with cohesion. hypothesis 2a: task leadership will be positively associated with cohesion. hypothesis 2b: social leadership will be positively associated with cohesion. cohesion and firm performance a large empirical literature consisting of hundreds of studies has shown that cohesion can enhance the performance of a wide variety of groups and teams, 6 journal ofbusiness strategies vol. 24, no. 1 including laboratory groups, sports teams, work teams, therapy groups, and organizational groups (beal, cohen, burke & mclendon, 2003; hogg, 1992; mullen & copper, 1994). however, nearly all ofthese studies have studied either non-organizational teams, or teams at lower levels of the organization, and have examined group performance rather than firm performance. a top management team (tmt) is a group of high-level managers responsible for formulating and implementing the firm's strategies. the power to control the direction and performance of the firm probably makes tmt the most important and influential team in the firm (smith et ai., 1994). thus, among all organizational teams, it is the cohesion of the tmt that is most likely to have an impact on firm performance. untortunately, only three studies (michalisin, karau & tangpong, 2004; michel & hambrick, ] 992; smith et ai, 1994) have examined the association between top management team cohesion (or variables highly relevant to tmt cohesion) and firm performance. specifically, michalisin et al. (2004) documented a positive association between team cohesion and superior performance. similarly, michel and hambrick (] 992) found a positive association between team tenure and firm performance, and smith et al (1994) found a positive association between social integration and firm performance. taken as a whole, the available empirical research provides strong evidence for a relationship between team cohesion and team performance and initial evidence for a relationship between tmt cohesion and firm performance, though the research on the latter topic is clearly in its embryonic stages. in the current research, we examine cohesion within a large sample of teams of students playing the role of the top management team of airline firms in a complex strategic management simulation to draw well-controlled inferences about linkages between leadership, cohesion, and the superior performance of simulated firms. given the dearth of cohesion and performance studies among practicing tmts, the use of a well-controlled simulation methodology allows us to contribute insights about phenomena that are typically very hard to access in actual tmts. though the empirical research on tmt cohesion and firm performance is limited, the resource based view ofthe firm (rbv) provides a strong theoretical basis for predicting that this relationship should be significant and positive. according to the rb v, resources are the main drivers of sustainable competitive advantage. the most valuable resources referred to as strategic assets are simultaneously valuable, rare, difficult and costly to imitate, and nonsubstitutable (amit & schoemaker, ] 993; barney, 199]). since its inception (wernerfelt, ] 984), rbv has received considerable attention in the strategy literature, indicating some consensus as to its viability as an alternative explanation of superior industry returns (mauri & michaels, ] 998). according to the rbv, resources are valuable when they allow the firm to take advantage of opportunities and/or neutralize threats in the external environment (barney, 1991). given the central role that the tmt plays in implementing offensive and defensive firm strategies (smith et ai., 1994), resources that facilitate tmt performance, such as cohesion, should be highly valuable to the firm. the spring 2007 michalis in et al.: team cohesion as a strategic asset 7 large literature on cohesion and performance cited earlier clearly provides both logical and empirical support for the value oftmt cohesion. in addition a number of studies have documented that cohesion is conducive to effective group processes that are also likely to enhance tmt performance. for example, ensley, pearson, and amason (2002) found that tmt cohesion was positively associated with cognitive conflict (i.e., task-focused conflict that is often essential to making quality decisions) and was negatively associated with affective conflict (i.e., personalized conflict that often detracts from effective team performance). additional research has shown that cohesion can facilitate effective communication (lott & lott, 1961), coordination ofmember inputs (hoegl & gemuenden, 2001), and willingness to exert effort on group tasks (karau & williams, 1997). thus, in relation to rbv logic, the available empirical evidence converges to suggest that tmt cohesion should constitute a highly valuable resource to the firm. top management team cohesion (tmtc) also appears to simultaneously possess all of the remaining characteristics of a strategic asset. tmtc is rare, and difficult and costly to imitate for six reasons. first, consensus in the team cohesion literature is that similarity among team members in terms of background, experience, and values promotes cohesion (hogg, 1992). if true, then tmtc will vary across companies based on the unique composition of each tmt, including differences in tmt size (jones, george & hill, 1998). second, tmtc develops over time and is affected by interaction and unique historical conditions, making it rare and difficult to imitate (barney, 1991). third, tmtc is a socially complex phenomenon reflecting the unique attributes of team members and their attraction to one another and the team (barney & mcewing, 1996). fourth, tmtc is an invisible resource, making it hard for competitors to imitate (godfrey & hill. 1995). fifth, even if competitors are cognizant of a firm's tmtc, its impact on firm performance is often causally ambiguous (reed & defillippi, 1990). sixth, attempting to perfectly replicate another firm's tmtc would probably require hiring their entire tmt. even if all tmt members agreed to join the competitor, it may be very costly and the team's cohesion could be impacted by the new corporate climate. tmtc is also imperfectly substitutable. because team cohesion has been shown to be an evolving social dynamic that emerges partially as a function of shared experiences, exposure to shared threats, reciprocal self-disclosure, expression of similar values, and cooperation in the pursuit of common goals (hogg, 1992), it would be practically impossible to provide a perfect substitute for cohesion without creating these same shared experiences over time. in sum, tmtc appears to possess all of the attributes of a strategic asset, and thus, according to the rbv, should be positively related to superior firm performance. therefore, based both on the logic of the rbv and on prior empirical findings on cohesion and team performance, we predicted that cohesion would be positively related with the performance of the simulated firms used in our current study. also, given that cohesion-performance relationships are likely to be stronger and more consistent than leadership-performance relationships (that will vary as a function 8 journal ofbusiness strategies vol. 24, no. 1 of situational factors and other contingencies), we predicted that cohesion would explain more variation in performance than leadership. hypothesis 3: cohesion will be positively associated with the performance ofsimulatedfirms. hypothesis 4: cohesion will explain more variation in the performance ofsimulatedfirms than will leadership. method participants participants were 328 undergraduate management students (202 men, 126 women; 305 native u.s. students, 23 international students) enrolled in nine sections (three fall semester sections and six spring semester sections) of the capstone strategic management and policy course for graduating seniors at a doctoral/research extensive university. we created diverse teams in each section by categorizing individuals in terms of major, gender and nationality and then randomly assigned individuals to teams within each category in a stepwise fashion so that each team included a variety of majors, included no more than one international student, and included both men and women. in short, the process resulted in 81 diverse teams, representing 81 companies. team size ranged from three to five, with a mean of 4.05. one team did not respond to our leadership questionnaire and was therefore dropped from the study, resulting in 80 teams for this empirical investigation. strategic management simulation recent years have seen increased use of complex management simulations as an empirical tool, and the paradigm has produced valuable results on a number of issues central to strategic management, organizational theory, and organizational behavior (chatman & barsade, 1995; chatman et al., 1998; chesney & locke, 1991; isabella & waddock, 1994; lant & mezias, 1990; waddock & isabella, 1989). we chose simulation as our research method because it allowed us to study complex organizational phenomena in a controlled setting in a manner that was involving to participants and that incorporated a host of company and industry factors commonly faced by managers. our use of a simulation methodology adds breadth to the leadership-cohesion-performance literature, which has relied on other methodological tools to examine this important relationship. we used airline, a strategic management simulation (smith & golden, 1994). airline is a complex, computer-assisted strategic management simulation in which teams function as top management teams of individual airlines that compete against one another in the commuter airline industry. the simulation was designed to model many key attributes of top management decisions and resultant firm outcomes and produce rich financial feedback to participants about spring 2007 michalisin et al.: team cohesion as a strategic asset 9 both their own firm and the industry. the simulation is also rather unique in that the simulation algorithms are based on extensive research ofthe commuter airline industry, thereby providing as high a level of realism in the market dynamics of the simulation as possible. each ofthe nine sections represented a single industry comprised of 4-12 firms. although sections varied in the number of competing airlines, all firms within each section had an equal chance to attain profitability because the simulation adjusted the number of available markets to each airline based on the number of firms in the industry. after an initial 75-minute meeting in which individuals were assigned to teams, became acquainted with their teams, and began discussing the simulation, teams then met weekly in separate 75-minute sessions across a twelveweek period to make all strategic and tactical decisions about their business. each simulation period (i.e., week) represented a calendar quarter for the firm. experienced graduate teaching assistants keyed the decision form information into the computer's simulation software each week, which computed a myriad of team and industry information. at the beginning of each simulation period, each team received printouts of their financial statements, operations management statistics, financial statistics, market reports, industry statistics, and so on. each graduate assistant received formal training on how to run the software and manage the simulation classes to promote consistency in administering this research. the authors also periodically attended each section to be sure that all simulation sections were being run the same way. ten percent of each student's grade in the course was based on his or her airline's financial performance relative to competitors. this was determined using a number of financial ratios, including those used to measure the dependent variable used in this study. each week, every simulation team received a report showing their overall financial performance to date, relative to their competitors. this promoted industry competition and created a shared goal among teams to enhance their airline's performance across the course of the simulation. measurement of superior performance (sp) of simulated firms firm profitability, or financial performance, is the dominant measure of firm performance in strategy research (venkatraman & ramanujan, 1986). woo and willard (1983) factor analyzed fourteen quantitative financial and operational measures of performance and found that the profitability factor had the highest factor magnitude and that return on sales (ros) and return on investment (ro!) loaded highly on that factor. we used relative median return on sales (rmros) as one measure of superior performance (sp) of simulated firms. rmros is the differences between the firm's ros and industry median ros, indicating whether the firm's ros was above (superior), at (median), or below (inferior) industry ros (and to what extent). each firm can buy or lease airplanes. as a result, common roj measures, such as return on assets (roa), are problematic because the cost of leasing planes does not appear on the balance sheet making roa difficult to compare across firms. arguably, two of the largest resources in an airline 10 journal of business strategies vol. 24, no.1 company are its airplanes and employees. as such, we used two common airline profitability measures that are associated with these two resources to measure sp relative median net profit per seat mile (rmnpsm) and relative median net profit per employee (rmnpe). a fourth measure of sp, relative median earnings per share (rmeps), was added to determine whether a firm's shareholders were reaping earnings per share better than, worse than, or at the industry median. thus, for this study, we define superior performance (sp) of simulated firms as performance (on rmros, rmnpsm, rmnpe, rmeps) that is above the industry median. triangulating across multiple measures helps to overcome weaknesses inherent in each measure of sp (kerlinger, 1986). at the end of each simulation period, we collected firm and industry financial data and converted them into sp measures: rmros, rmnpsm, rmnpee and rmeps. then, each sp measure was averaged across 11 simulation periods to represent an overall sp measure over the entire period of the study. principal component analysis (pca) showed that these four sp measures were highly correlated and loaded onto a single component (see results). therefore, we used the pca score as a single composite measure of sp. measurement of leadership behaviors at the end of the entire simulation, participants completed a questionnaire which asked them to identify who was the leader of their team or who acted most like the leader of their team (in the rare event of a tie, scores on question 1 below were used to identify the leader). participants were then asked to rate the leader's behaviors using the following questions (each employing a five-point scale with i = strongly disagree, 2 = disagree, 3 = neither agree nor disagree, 4 = agree, and 5 = strongly agree). 1. contributed to the leadership of the firm 2. kept the team focused on completing its work 3. helped maintain team harmony and good relationships 4. proved trustworthy in doing their fair share of the work 5. was a negative influence on the team (reverse scored for principal component analysis) we then averaged the team members' scores for each of the five questions (excluding the leader's scores). principal component analysis (pca) showed that questions 1, 2 and 4 were highly correlated and loaded onto one principal component, which we labeled leader's task behavior, while questions 3 and 5 were highly correlated and loaded onto another principal component, which we labeled leader's relationship behavior. though time constraints in administering the questionnaires did not allow us to use longer, previously validated measures such as the leader behavior description questionnaire (stogdill & coons, 1957), our use oftwo multi-item scales reflecting leader's task behavior and relationship behavior is consistent with the large body of prior work on leadership style that has emphasized task and interpersonal behavior as the two primary dimensions of leadership style (bass, 1990; katz & kahn, 1978). spring 2007 michafisin et al.: team cohesion as a strategic asset 11 measurement of cohesion after each of the twelve simulation periods, participants were asked to complete a one-page questionnaire assessing team cohesion. items were written both to assess cohesion within each simulated firm directly, using our definition of cohesion as member attraction to the team and desire to remain in it, and to assess group processes and member perceptions that have been demonstrated repeatedly in prior research to be strongly associated with cohesion, including good working relationships (darley, gross & martin, 1951; seashore, 1954), high contribution levels (karau & williams, 1997), and a shared commitment to completing the group task (klein & mulvey, 1995). these elements are assessed in many widely-used comprehensive group cohesion questionnaires, such as the group environment questionnaire (carron, widmeyer & brawley, 1985) and the group attitude scale (evans & jarvis, 1986), that were unsuitable for the current research due to their length and the time limitations inherent to our simulation periods. specifically, the following items were used to assess cohesion and its key elements in a clear, efficient, and face-valid manner were as follows: 1. i enjoyed working with my teammates. 2. i wish j was on a different team. (reverse scored for principal component analysis) 3. the team worked well together. 4. everyone contributed to the discussion. 5. the team wasted a lot of time. (reverse scored for principal component analysis) 6. j trust that my teammates will do their fair share of the work. each member responded to these six questions about the cohesion of their simulated firm using the following scale, 1 = strongly disagree, 2 = disagree, 3 = neither agree nor disagree, 4 = agree, and 5 = strongly agree. individual responses for each question were aggregated into a team average, which was then averaged across simulation periods. principal component analysis (pca) showed that these six questions were highly correlated and loaded onto a single component (see results). therefore, they were combined into a single component measure of cohesion. control variables leader's gender. since gender has become a more prominent issue in the leadership literature (bass, avolio & atwater, 1996; eagly, karau & makhijani, 1995), we controlled for its effect in the statistical models using dummy coding (male leaders = 1 and female leaders = 2). firm size and team size. firm size can impact performance through economies of scale, monopoly power and bargaining power (chandler, 1990). in this study, firm size is measured as total airplane seats (in their fleet) to capture both the number and the size of their planes. in addition, because the team size ranged from three to five members depending on enrollment in each section, we included team size (number ofteam members) as a control variable. 12 journal ofbusiness strategies vol 24, no.1 leverage. companies with high debt levels use large portions of their cash flows to service debt obligations, thus reducing free cash flow. a reduction in free cash flow disciplines managers to invest wisely (jensen, 1986) and to closely monitor business strategy (hoskisson, johnson & moesel, 1994). hence, leveraging debt can improve performance unless the firm uses too much debt to fund the firm's assets and is unable to meet its debt obligations. in this study, leverage is measured using the firm's debt to asset ratio. competitors. each section of the course represented one industry. each industry contained between four and twelve airline companies depending on the number of students in the section. porter (1980) tells us that the number of competitors in an industry can affect the attractiveness ofthe industry and thus its profitability, and can impact industry rivalry. moreover, competitive rivalry might also have psychological effects on teams' strategic decisions. as such, we included a control variable that represented the number of competitors in the industry. although we partly controlled for industry effects by using firm performance relative to industry median, having the number of competitors in the industry as a control variable could further control for the industry effects on firm performance, which allowed us to better evaluate the relationship between organizational leadership, cohesion, and firm performance. statistical models we used correlation and multiple regression to test our hypotheses. tests across statistical models involved computing and testing the statistical-significance of incremental r2 to determine the extent to which key variables stated in the hypotheses explained variation in the dependent variable beyond variables in the control model and other models involved the specific comparative analyses. results principal component analysis (pca) was performed to summarize most of the total variance into the minimum number of principal components (hair, anderson, tatham & black, 1995). table 1 shows barlett's test of sphericity (bts), eigenvalues, total variance explained, and the component loadings ofsp (4 measures), cohesion (6 items) and leadership behaviors (5 items). the bts chi square statistics were statistically significant at p < 0.00 i for all three constructs. pca offour sp measures showed that the first component accounted for 95.88% of the total variance and was the only principal component with an eigenvalue significantly greater than one. similarly, pca of the cohesion questionnaire items showed that all 6 items loaded highly onto one principal component, which had an eigenvalue significantly greater than one and accounted for 82.59% of the total variance. we found a high degree of internal consistency among these six cohesion items with a cronbach 's alpha score of 0.96. spring 2007 michalisin et af.: team cohesion as a strategic asset 13 table 1 pca analysis of cohesion, performance, and leadership behaviors superior leadership cohesion performance behaviors (6 items) (4 measures) (5 items) factor 1 all items all measures 3 items loadings (min-max): 0.85-0.98 0.96-0.99 0.80-0.86 eigenvalue 4.95 3.84 2.67 % variance 82.59% 95.88% 53.36% factor 2 n/a n/a 2 items loadings (min-max): n/a n/a 0.83-0.92 eigenvalue 0.39 0.11 1.10 % variance 5.87% 0.75% 21.90% barlett's test 588.31 *** 660.78*** 126.35*** *** indicate that the bts chi square statistic was significant at p < 0.001 pca of five questionnaire items of leadership behaviors showed that three items (item #1, #2 and #4) loaded highly onto one principal component (labeled leader task behavior) and two items (items #3 and #5) loaded highly onto a second principal component (labeled leader relationship behavior). both components had eigenvalues greater than one and collectively accounted for 75.26% ofthe total variance. high cronbach alpha scores of 0.88 and 0.82 for the leader task behavior items and the leader relationship behavior items, respectively, indicate high internal reliability. the pca scores for sp, cohesion, leader task behavior, and leader relationship behavior were later used for correlation and regression analysis. correlations and descriptive statistics are summarized in table 2. leader relationship behavior had a weak correlation with sp (p < 0.10), and leader task behavior had no statistically-significant relationship with sp, providing support for hypothesis i. both leader relationship behavior (p < 0.0 i) and leader task behavior (p < 0.01) had strong positive associations with cohesion, providing strong support for hypothesis 2. cohesion had a highly significant, positive relationship with sp (p < 0.01), providing strong support for hypothesis 3. the control variables firm size (p < 0.01) and leverage (p < 0.05) were negatively correlated with sp, and cohesion had a weak, negative association with leader gender (p < 0.1). some of the control variables had statistically-significant relationships, however the variance inflation factors did not indicate multicollinearity. other statistical and graphical analyses did not show any violations of the assumptions underlying multiple regression analysis. table 2 ~ correlations and descriptive statistics variable mean s.d. i 2 3 4 5 6 7 8 9 10 1 superior performance 0.00 1.00 1.00 2 leader presence 0.80 0.19 0.12 1.00 3 leader task 0.00 1.00 0.08 0.07 1.00 ~s:: "': 4 leader relation 0.00 1.00 0.19t 0.00 0.00 1.00 ;:s t:l-... 5 leader gender 1.31 0.46 0.07 0.06 0.05 -0.15 1.00 ~ b.:l s:: 6 cohesion 0.00 1.00 0.30** 0.08 0.32** 0.34** -0.22t 1.00 ""5' (l) 7 team size 4.04 0.56 0.07 -0.03 -0.06 -0.28* 0.10 -0.13 '"1.00 '"v)..... 8 competitors 10.38 2.90 -0.12 -0.05 0.02 -0.13 -0.05 -0.18 0.54*** 1.00 "': s:::...... 9 firm size 91.32 30.19 -0.42*** 0.17 -0.03 -0.05 -0.15 0.04 -0.03 -0.05 1.00 ~ (t' '" 10 leverage 0.55 0.20 -0.24* -0.03 0.10 -0.17 0.25* -0.01 0.09 0.08 0.11 1.00 t p < 0.10 * p < 0.05 6** p <0.01 ~ *** p < 0.001 n ~ z 0 spring 2007 michafisin et al.: team cohesion as a strategic asset 15 tables 3 and 4 show the multiple regressions most central to testing our hypotheses. table 3 shows those regressions for which performance is the dependent variable, and table 4 shows those regressions for which cohesion is the dependent variable. hypothesis 1 states that leadership will have no direct relationship with sp. model i in table 3 tests the direct effects of leadership behaviors (task behavior and relationship behavior) on sp. after controlling for number of competitors, team size, firm size, leverage, and leader gender (the control variables), leader relationship behavior was only weakly associated with sp (p < 0.10) and leader task behavior had no significant association with sp, supporting hypotheses 1a and i b. the incremental r2 for model i is also non-significant, meaning that the leadership variables do not significantly explain variation in sp beyond that explained by the control variables, which also supports hypothesis 1. hypothesis 2 states that leadership will be positively associated with cohesion. the full model shown in table 4 tests the direct effects of leadership behaviors (task behavior and relationship behavior) on cohesion. after controlling for the effects team size, number of competitors, firm size, leverage, performance (sp), and leader gender (the control variables) both leader relationship behavior and leader task behavior have strong, positive, highly significant relationships with cohesion, with p-values of p < 0.00 i and p < 0.05, respectively, providing strong support for hypotheses 2a and 2b. the 14% change in r2 from adding the leadership variables to the control model is also highly significant at p < 0.001, providing strong support for hypothesis 2. hypothesis 3 states that cohesion will be positively associated with sp. model 2 in table 3 tests the direct effect of cohesion on sp. after controlling for the control variables, cohesion has a highly-significant, positive relationship with sp (p < 0.001), provide strong support for hypothesis 3. the incremental r2 for model 2 is also highly significant (p < 0.001), with cohesion explaining 28% of the total variation in sp for model 2 (i.e., the 10% incremental r2 divided by the total r2 of 36% for model 2), which also lends support to hypothesis 3. hypothesis 4 states that cohesion will explain more variation in sp than will leadership. in model 3 in table 3 (the full model), we tested the direct effect of both leadership behaviors and cohesion on sp. the results indicate that the presence of cohesion in the full model reduced the level of significance of leader relationship behavior from being weakly significant (p < 0.10) in model i to being non-significant, and leader task behavior remained statistically non-significant. as in model 2, cohesion continued to maintain a strong, highly-significant, positive relationship with sp (p < 0.01) in the full model. the mere i% change in incremental r2 (from 10% to 11 %) going from model 2 to model 3 shows that adding the leadership variables does little to explain any additional variation in sp beyond that already explained by cohesion. in other words, cohesion is explaining more variation in sp than both leadership variables combined, supporting hypothesis 4. in sum, our statistical results provide strong support for all the hypotheses set forth in this paper. 16 journal of business strategies vol. 24, no.1 table 3 results of multiple regression analysis (y = superior performance) modell: model 2: model 3: y=sp control controls + controls + full model model leadership cohesion beta" beta" beta" beta" control variables: team size 0.20 0.26* 0.20t 0.23t competitors -0.23t -0.24* -0.17 -0.17 firm size -0.39*** -0.38*** -0.39*** -0.38*** leverage -0.20t -0.19t -0.23* -0.21 * leader gender 0.03 0.05 0.11 0.12 independent var's: leader task behavior 0.11 0.00 leader relationship behavior 0.19t 0.09 cohesion 0.34*** 0.31 ** r2 0.26 0.30 0.36 0.37 adjusted r2 0.21 0.23 0.31 0.30 f value 5.13*** 4.38*** 6.95*** 5.15*** incremental r2h 0.04 0.10 0.11 incremental f valueh 1.50 12.04*** 3.91 ** a standardized regression coefficients h listed model versus the control model t p <0.10 * p < 0.05 ** p < 0.01 *** p < 0.001 spring 2007 michalisin et al.: team cohesion as a strategic asset 17 table 4 results of multiple regression analysis (y = team cohesion) y == team cohesion control variables: team size competitors firm size leverage performance (sp) leader gender independent var's: leader task behavior leader relationship behavior adjusted r2 f value incremental r2b incremental f value b control model beta" -0.10 -0.09 0.15 0.16 0.42*** -0.26* 0.22 0.15 3.39** full model beta" 0.02 -0.13 0.14 0.13 0.31 ** -0.24* 0.30*** 0.26* 0.36 0.29 4.98*** 0.14 16.45*** " standardized regression coefficients b listed model versus the control model t r < 0.10 * p < 0.05 ** p < 0.01 *** p < 0.001 discussion our results support the reasoning that leadership's activation ofteam cohesion can serve as a strategic asset capable of generating a sustainable competitive advantage and superior performance (sp). specifically, we found that leadership had no direct relationship with performance. however, it did have a significant, positive relationship with cohesion. in turn, cohesion had a strong, significant, positive relationship with performance. thus, cohesion was a significant predictor at p < .001 and accounted for a significant percentage of the explained variance in sp. moreover, cohesion added significant explanatory power over and above a model containing both all control variables and leadership, with 18 journal of business strategies vol. 24, no. 1 the incremental r2 significant at p < .01. thus, cohesion appears to be strongly linked to performance, and accounts for more variation in performance than does leadership. further, our full model is potent in that it explains 37% of the total variance in sp. taken as a whole, our results suggest that leadership does play a role in enhancing performance, but that this indirect role is to strengthen team cohesion, which has a more direct relationship with performance. with regard to the rbv (bamey, 1991), our results provide additional evidence that cohesion can serve as an intangible strategic asset capable of creating superior firm performance. the rbv suggests that in order for resources to be a source of sustainable competitive advantage they must be invested in, upgraded, and reconfigured to meet changes in competitive context (collis & montgomery, 1997). our results suggest that leaders can playa key role in creating competitive advantage by fostering the development of cohesion, which is particularly pertinent in today's competitive landscape where changes in top management team membership are not uncommon due to organizational restructuring, reorganization, mergers, and acquisitions. to our knowledge, the present research is the only empirical attempt to examine the leadership-cohesion-performance relationship from an rbv perspective. our results also support the reasoning inherent in many contingency theories that leadership cannot be used to explain team effectiveness without considering the role ofadditional variables such as task attributes (hersey & blanchard, 1988), follower characteristics (graen & uhl-bien, 1995), the instrumentality of worker efforts ('house, 1971), and group processes (barrick, stewart, neubert & mount, 1998; vroom & yetton, 1973). our results suggest that leaders can behave in ways that optimize key intangible resources within individuals and groups, such as cohesion, that can substantially enhance performance (dionne, yammarino, atwater & james, 2002; ensley et al. 2002; jung & sosik, 2002). although our results clearly support the logic that variables other than leadership can be crucial determinants of performance, they also show that leadership can still play an important role by serving as a lever for enhancing team cohesion. thus, although it is possible that cohesion could operate as a stand-alone asset, leadership may stm be crucial in developing and sustaining cohesion. thus, leadership could serve as the feedstock of effective group processes, such that over time, team cohesion could well deteriorate in the absence of effective leadership. with regard to tmts, our results suggest that leadership may be central to the focus and open communication necessary for making etlective strategic decisions conducive to high levels of performance. thus, if our results replicate in future studies on actual firms, it is possible that ceos could enhance the profitability of their firms indirectly through the use ofleadership activities that may activate interpersonal strategic assets such as cohesion. specifically, extending prior research on leadership and cohesion to tmt contexts, ceos may be able to strengthen tmt cohesion via the use of effective task-oriented behaviors such as building commitment to shared goals, coordinating and realigning corporate values, and keeping tmt members focused on tasks with high value and relevance to the spring 2007 michalisin et al.: team cohesion as a strategic asset 19 firm. similarly, ceos might also be able to enhance tmt cohesion by using effective relationship behaviors involving coaching and facilitation, impression management, skill development, motivational communication, social support of tmt members, and the development of meaningful, shared social experiences. although we acknowledge that these conclusions are currently speculative, they do provide fodder for future exploration. our research strategy had unique strengths, as well as some limitations that could be addressed in future research. first, our use of a strategic management simulation allowed us to study key variables in a well-controlled fashion in a manner that is not usually possible in work organizations, contributing to internal validity. yet, external validity is a concern because we studied senior-level business students playing the role of top managers rather than studying tmts in intact organizations. our sample was also restricted to a single university, and the simulation was based on only one industry. nevertheless, our results may still have some implications for practicing organizations despite sample constraints because: (a) the simulation incorporated a host of decision factors that were modeled after actual industry variables and that reflected random change in the competitive environment; (b) each team functioned as a simulated tmt in terms of planning and implementing all strategic, tactical, and operating elements of their firm; (c) teams made their own decisions, and resulting firm and industry outcomes were reliant on the interaction of the decision outcomes of multiple firms and industry variables; (d) the simulation was involving to participants, thereby enhancing the likelihood that key processes relevant to organizational settings were indeed activated. nonetheless, future research that examines these processes in actual organizations would clearly enhance the literature. second, our research has taken a crucial step by documenting that leader behaviors are associated with team cohesion, and that cohesion is associated with enhanced performance, suggesting that leadership can affect performance by strengthening cohesion. however, we examined only two aspects of leadership style, and have not isolated the specific mechanisms through which cohesion enhances performance. future research might seek to identify the exact processes through which leadership style may be linked to enhanced team cohesion and performance, using more extensively-validated and comprehensive measures of leadership behavior and cohesion. future studies could also seek to employ longer, more extensively-validated measures of leadership style and team cohesion. finally, future research could also examine the effects of leadership on other potentially important group processes, such as conflict, coordination, and communication. the influence of other variables, such as team member personality, diversity, or top management team culture could also be examined for its impact on team processes and performance. we hope that the current study is useful in generating additional interest in the impact of leadership on other variables important to team effectiveness and firm performance, as well as in highlighting the usefulness ofcomplex business simulations in studying the rbv and strategic management issues. 20 journal of business strategies references vol. 24, no.1 amit, r., & schoemaker, p. j. h. (1993). strategic assets and organizational rent. strategic management journal, 14. 33-46. barney, j. (1991). firm resources and sustained competitive advantage. journal of management, 17, 99-120. barney, j. b., & me ewing, m. d. (1996). gaining and sustaining competitive advantage. boston: addison-wesley. barrick, m. r., stewart, g. l., neubert, m. j., & mount, m. k. (1998). relating member ability and personality to work-team processes and team effectiveness. journal of applied psychology, 83,377-391. bass, b. m. (1990), bass & stogdill:s' handbook ofleadership (3rd ed.). new york: frce press. bass, b. m., avolio, b, j., & atwater, l. (1996), the transformational and transactional leadership ofmen and women. applied psychology: an international review, 45,5-34. bass, b. m., jung, d. 1., avolio, b. j., & berson, y. (2003). predicting unit performance by assessing transformational and transactional leadership. journal ofapplied psychology, 88,207-218. beal, d. j., cohen, r. r., burke, m. j., & mclendon, c. l. (2003). cohesion and performance in groups: a meta-analytic clarification of construct relations, journal of applied psychology, 88, 989-1004. blake, r. r., & mouton, j. s. (1985). the managerial grid ill: the key to leadership excellence. houston: gulf publishing. brewer, m. b., & kramer, r. m. (1986). choice behavior in social dilemmas: effects of social identity, group size, and decision framing. journal ofpersonality and social psychology. 50. 543-549. carron, a. v, widmeyer, w. n., & brawley, l. r. (1985). the development of an instrument to assess cohesion in sport teams: the group environment questionnaire. journal of sport psychology, 7, 244-266. cartwright, d. (1968). the nature of group cohesiveness. in d. cartwright & a. zander (eds.), group dynamics: research and theory (3rd ed., pp. 91-109). new york: harper & row. chandler, a.d. 1990. scale and scope. cambridge, ma: harvard university press. channon, d. (1979). leadership and corporate performance in the service industry. journal of management studies, 16, 185-20 i. spring 2007 michalisin et at.: team cohesion as a strategic asset 21 chatman, j. a., & barsadc, s. g. (1995). personality, organizational culture, and cooperation: evidence from a business simulation. administrative science quarterly, 40,423-443. chatman j. a., polzer j. t., barsade s. g., & neale m. a. (1998). being different yet feeling similar: the influence of demographic composition and organizational culture on work processes and outcomes. administrative science quarterly. 43, 749-780. chesney a. a., & locke e. a. (1991). relationships among goal difficulty, business strategies, and performance on a complex management simulation task. academy of management journal. 34, 400a24. collis, d. j., & montgomery, c. a. (1997). corporate strategy: resources and the scope of the firm. chicago: irwin. cyert, r. m., & march, j. g. (1963). a behavioral theory ofthefirm. englewood cliffs, nj: prentice-hall. darley, j. g., gross, n., & martin, w. e. (1951). studies of group behavior: stability, change, and interrelations of psychometric and sociometric variables. journal of abnormal and social psychology. 46, 565-576. day, d. v., & lord, r. g. (1988). executive leadership and organizational performance: suggestions for a new theory and methodology. journal of management. j4, 453464. dierickx, 1., & cool, k. (1989). asset stock accumulation and sustainability of competitive advantage. management science, 35, 1504-1511. dionne, s. d., yammarino, f. j., atwater, l. e. & james, l. r. (2002). neutralizing substitutes for leadership theory: leadership effects and common-source bias. journal ofapplied psychology, 87,454-464. dyer, w. g. (1977). team building: issues and alternatives. reading, ma: addisonwesley. eagly, a. h., karau, s. j., & makhijani, m. g. (1995). gender and leader effectiveness: a meta-analysis. psychological bulletin, 117, 125-145. ensley, m. d., pearson, a. w., & amason, a. c. (2002). understanding the dynamics of new venture top management teams: cohesion, conflict, and new venture performance. journal of business venturing, 17, 365-386. evans, n. j., & jarvis, p. a. (1986). the group attitude scale: a measure of attraction to group. small group behavior, 17, 203-216. feldman, d. c. (1984). the development and enforcement of group norms. academy of management review, 9,47-53. 22 journal ofbusiness strategies vol. 24, no.1 foels, r., driskell, j. e., mullen, b., & salas, e. (2000). the effects of democratic leadership on group member satisfaction. small group research. 31,676-701. gardner, d.e., shields, d. l. l., bredemeier, bj.l., & bostrom, a. (1996). the relationship between perceived coaching behaviors and team cohesion among baseball and softball players. sport psychologist. 10. 367-381. godfrey, p. c., & hill, c. w. l. ( 1995). the problem with unobservables in strategic management research. strategic management journal, 16, 519-533. graen, g. b., & uhl-bien, m. (1995). development of leader-member exchange (lmx) theory of leadership over 25 years: applying a multi-level multi-domain perspective. leadership quarterly, 6, 219-247. guthrie, j. p. & hollensbe, e. c. (2004). group incentives and performance: a study of spontaneous goal setting, goal choice and commitment. journal of management. 30, 263-284. hair, j. f., anderson, r. e., tatham, r. j., & black, w. c. (1995). multivariate data analysis. englewood cliffs, nj: prentice hall. hambrick, d. c., & mason, p. a. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review. 9, 193-206. hannan, m. t., & freeman, j. h. (1977). the population ecology of organizations. american journal of sociology. 82, 929-964. hersey, p., & blanchard, k. h. (1988). management of organizational behavior. englewood cliffs, nj: prentice-hall. hoegl, m., & gemuenden, h. g. (2001). teamwork quality and the success of innovation projects: a theoretical concept and empirical evidence. organization science, 12,435-449. hogg, m. a. (1992). the social psychology of group cohesiveness: from attraction to social identity. new york: new york university press. hogg, m. a., & terry, d. j. (2000). social identify and self-categorization processes in organizational contexts. academy of management review, 25, 121-140. hoskisson, r. e., johnson, r. a., & moesel, d. d. (1994). corporate divestment intensity in restructuring firms: effects of governance, strategy and performance. strategic management journal. 37, 1207-1251, house, r. j. (1971 ). a path-goal theory of leadership effectiveness. administrative science quarterly. 16, 321-338. spring 2007 michalisin et at.: team cohesion as a strategic asset 23 house, r. j., & podsakoff, p. m. (1995). leadership effectiveness: past perspectives and future directions for research. in j. greenberg (ed.), organizational behavior: the state of the science (pp. 45-82). hillsdale, nj: erlbaum. howell, j. m., & shamir, b. (2005). the role offollowers in the charismatic leadership process: relationships and their consequences. academy of management review, 30,96-112. hoyt, c., & blascovich, j. (2003). transformational and transactional leadership in virtual and physical environments. small group research, 34, 678-715. isabella, l. a., & waddock, s. a. (1994). top management team certainty: environmental assessments, teamwork and performance implications. journal of management, 20, 835-858. jensen, m. c. (1986). agency costs of free cash flow, corporate finance, and takeovers. american economic review, 76,323-329. jones, g. r., george, j. m., & hill, c. w. l. (1998). contemporary management. new york: mcgraw-hili. jung, d. 1., & avolio, b. j. (1999). effects of leadership style and followers' culture orientation on performance in group and individual task conditions. academy of management journal. 42, 208-218. jung, d. i., & sosik, j. (2002). transformational leadership at work groups: the role of empowerment, cohesiveness, and collective-efficacy on perceived group performance. small group research, 33, 313-336. karau, s. j., & williams, k. d. (1997). the effects of group cohesiveness on social loafing and social compensation. group dynamics: theory, research, and practice. 2, 156-168. katz, d., & kahn, r. l. (1978). the social psychology of organizations (2nd ed.). new york: wiley. kerlinger, f. n. (1986). foundations of behavioral research (3rd ed.). new york: holt, rinehart and winston. khurana, r. (2002). the curse of the superstar ceo. harvard business review, 80, 6067. klein, h. j., & mulvey, p. w. (1995). two investigations of the relationships among group goals, goal commitment, cohesion, and performance. organizational behavior and human decision processes, 61,44-53. 24 journal ofbusiness strategies vol. 24, no.1 lant, t. k., & mezias, s. j. (1990). managing discontinuous change: a simulation study of organizational learning and entrepreneurship. strategic management journal, ll, 147-179. lieberson, s., & o'connor, j. f. (1972). leadership and organizational performance: a study oflarge corporations. american sociological review, 37, 117-130. lott, a. j., & lott, b. e. (1961). group cohesiveness, communication level, and conformity. journal ofabnormal and social psychology. 62,408-412. mauri, a. j., & michaels, m. p. (1998). firm and industry effects within strategic management: an empirical examination. strategic management journal. 19,211-219. michalisin, m.d., karau, s.l., & tangpong, c. (2004). top management team cohesion and superior industry returns: an empirical study of the resource-based view. group and organization management. 29, 125-140. michel, j. g., & hambrick, d. c. (1992). diversification posture and top management team characteristics. academy of management journal, 35,9-37. mullen, b., & copper, c. (1994). the relation between group cohesiveness and performance: an integration. psychological bulletin, 115, 210-227. myers, a. e. (1962). team competition, success, and the adjustment of group members. journal ofabnormal and social psychology. 65, 325-332. nicholas, j. m., & penwell, l. w. (1995). a proposed profile of the effective leader in human spaceflight based on findings from analog environments. aviation. space, and environmental medicine, 66, 63-72. pepitone, a. & reichling, g. (1955). group cohesiveness and the expression of hostility. human relations, 8,327-337. pillai, r., & williams, e. a. (2004). transformational leadership, self-efficacy, group cohesiveness, commitment, and performance. journal of organizational change management. 17, 144-159. porter, m. e. (1980). competitive strategy. new york: free press. pritchard, r. d., roth, p. l., jones, s. d., galgay, p., & watson, m. d. (1988). designing a goal-setting system to enhance performance: a practical guide. organizational dynamics, 17, 69-78. reed, r., & defillippi, r. j. (1990). causal ambiguity, barriers to imitation, and sustainable competitive advantage. academy of management review, 15, 88-102. spring 2007 michalisin et al.: team cohesion as a strategic asset 25 rozell, e. j., & gundersen, d. e. (2003). the effects of leader impression management on group perceptions of cohesion, consensus, and communication. small group research. 34, 197-222. salancik, g. r., & pfeffer, j. (1977). constraints on administration: the limited influence of mayors on city budgets. urban affairs quarter~v, 12, 475-498. seashore, s. e. (1954). group cohesiveness in the industrial work group. ann arbor, mi: institute for social research. smith, j. r., & golden, p. a. (1994). airline: a strategic management simulation. englewood cliffs, nj: prentice-hall. smith, k. g., smith, k. a., olian, j. d., & sims, h. p. (1994). top management team demography and process: the role of social integration and communication. administrative science quarterly, 39,412-438. stogdill, r. m., & coons, a. e. (1957). leader behavior: its description and measurement. columbus, oh: bureau of business research. stokes, j. p. (1983). components ofgroup cohesion: intermember attraction, instrumental value, and risk tasking. small group behavior, 14, 163-173. thomas, a. b. (1988). does leadership make a difference to organizational performance? administrative science quarterly, 33,388-400. turman, p. d. (2003). coaches and cohesion: the impact of coaching techniques on team cohesion in the small group sport setting. journal (~f sport behavior. 26, 86-103. venkatraman, n., & ramanujan, v. (1986). measurement of business performance in strategy research: a comparison of approaches. academy of management review. lj,801-814. vroom, v. h., & yetton, p. w. (1973). leadership and decision-making. pittsburgh, pa: university of pittsburgh press. waddock, s. a., isabella, l. a. (1989). strategy, beliefs about the environment, and performance in a banking simulation. journal of management, 25,617-632. waldman, d. a., ramirez, g. g., house, r. j., & puranam, p. (2001). does leadership matter? ceo leadership attributes and profitability under conditions of perceived environmental uncertainty. academy of management journal, 44, 134-143. weiner, n., & mahoney, t. a. (1981). a model of corporate performance as a function of environmental, organizational, and leadership influences. academy ofmanagement journal, 24,453-470. 26 journal o/business strategies vo1. 24, no. 1 wernerfelt, b. (1984). the resource-based view of the firm. strategic management journal, 5, 171-180. williams, k.d. (2001). ostracism: thepower afsilence. new york: guildford press. woo, c. y., & willard, g. (1983). performance representation in business policy research: discussion and recommendation. paper presented atthe annual meeting the academy of management, dallas, tx. yalom, l d. (t 985). the them}' and practice of group psychotherapy (3rd ed.). new york: basic books. yuki, g. (1998). leadership in organizations (4th ed.). upper saddle river, nj: prentice hall. michael d. michalisin is associate professor of management at southern illinois university at carbondale where he teaches strategic management courses. he received his ph.d. in strategic management and macro-organizational theory from kent state university. his research interests include the resource based view of the firm, the natural-resource-based view of the firm, supply chain management, strategic leadership, top management team dynamics, and the validity of annual reports. steven j. karau is associate professor of management at southern illinois university at carbondale where he teaches organizational behavior, human resource, and methodology courses. he received his ph.d. in social psychology from purdue university. his research focuses on interpersonal influence processes in social and organizational contexts, including individual motivation within groups, effects of temporal and situational factors on group performance, gender differences in leadership, and ethical perceptions of organizational change processes. charnchai tangpong is assistant professor of management at the college of business, north dakota state university where he teaches strategy and organization management courses. he received his ph.d. in business administration from southern illinois university at carbondale. his current research interests include strategic values offirm-supplierrelationships, corporate strategy, dynamic capabilities and innovativeness in stakeholder networks. leadership's activation of team cohesion as a strategic asset: an empirical simulation compensation managers' beliefs about strategies that affect compensation program goals nancy e. day university of missouri-kansas city kansas city, missouri abstract a study was conducted to investigate whether individual compensation program goals of recruitment effectiveness, motivational effectiveness, administrative manageability, cost effectiveness, retaining employees and encouraging poor performers to leave were differentially impacted by eleven compensation strategies. it was found that compensation strategies did have differential effects on perceptions of the effectiveness of the compensation goals. while participation in compensation plan design and internal consistency were the most consistent predictors, there was significant variation in the compensation strategies that were predictive across all effectiveness perception variables. based on these results, compensation managers should carefully consider the organization s strategy and desired employee behaviors before designing compensation programs. introduction more than ever before, compensation programs are being challenged to provide a definite and measurable impact on the bottom line results of the company. many organizations are designing pay programs that de-emphasize individual effort in favor of team, group, or organizational performance. others are radically altering the traditional conception of base pay by creating broad bands rather than the typically narrow grades. some organizations are putting less money into base pay programs and more into pay that requires employees to take significant amounts of risk. however, no matter the extent and type of compensation innovations, the ultimate goals of compensation systems are to attract and retain good employees and motivate their performance. although organizations utilize a variety of different methods to achieve these compensation objectives, there is currently little research that identifies compensation strategy components that are associated with these specific goals of effective compensation programs. previous researchers (balkin & gomez-mejia, 1990; gomez-mejia, 1992) found that compensation program effectiveness and organizational effectiveness were higher when particular pay strategies were appropriately matched with organizational strategies. specifically, they found that compensation strategies that 66 journal of business strategies vol. 13, no. 1 emphasize more flexible, adaptive and incentive-based pay plans were most effective in organizations that focus on a single product or service and are in a growth stage. mature organizations that are more diversified, focusing on a dominant rather than a single product or service, and that use traditional, jobbased, hierarchical and less flexible compensation strategies tend to be most successful. however, the effectiveness of any compensation system hinges on its success in meeting a number of critical objectives. in their 1990 study, balkin and gomez-mejia measured compensation effectiveness through compensation managers' overall ratings of their compensation systems. they did not focus on the specific goals of compensation, that is, to attract, retain and motivate employee performance and behaviors. the study described in this paper investigates the pay strategies that compensation managers perceive as being most associated with achievement of each of the compensation system's primary goals. compensation programs have multiple goals, most commonly expressed as attraction, retention and motivation. the decisions to accept a job offer, to remain with or leave the employer and to perform well are controlled to some degree by the compensation program, and there is little reason to believe that simply because a compensation system attracts and retains employees that it also is able to motivate them (wallace & fay, 1988). different pay strategies would theoretically have differential effects on the achievement of each of these multiple goals. for example, evidence exists that well-designed individual incentives, such as bonuses that are contingent on an employee achieving certain goals, have a positive effect on productivity (gerhart & milkovich, 1992). however, pay programs that require a significant percentage of pay to be "at risk," (employees' wages are contingent upon achieving a certain performance level) may be more problematic in recruiting workers, since the guaranteed wage is often lower than at competitor organizations (bna, 1988; milkovich & newman, 1993). thus, a pay-at-risk strategy may differentially affect two compensation system goals, attraction and motivation. further, pay that is equal to or better than that found at competing organizations may greatly affect attraction and retention, but has little effect on motivation once the workers have been hired (mahoney, 1979). although research in efficiency wage theory has found that higher pay does seem to increase the number of candidates (krueger, 1988; holzer, 1990; rynes & barber, 1990), attract and retain more employees (lawler, 1971) and attract better quality and longer tenured employees (brown & medoff, 1989; holzer, 1990) there is little research to indicate that employees' motivation is affected by pay level during employment. additionally, the decision processes involved in the acceptance of a job offer and maintaining organizational membership may rely on different types of information about payor other factors. comparisons involving internal equity (the internal value the organization places on jobs, usually established through some type of job evaluation program) are less likely to be made in spring 1996 day: compensation program goals 67 the initial job-choice decisions, since the internal hierarchy is not obvious to job candidates. factors that affect the attractiveness of the organization, such as management practices, quality of supervision or organizational climate may be less known to job candidates, but may make a larger contribution to turnover decisions than characteristics of the compensation system. in addition to attraction, retention and motivation, compensation systems must also meet secondary objectives which are related to the constraints in which all organizations operate, such as efficiency and equity (milkovich & newman, 1993). compensation systems must have goals of cost-effectiveness and administrative manageability, and include considerations of the organization's ability to pay, compliance with legislation and labor contracts, and effective responses to internal and external labor markets (hills, bergmann & scarpello, 1994). for example, pay secrecy is an administrative strategy that may increase the manageability of the system, in that less infonnation has to be communicated and fewer challenges to fairness may have to be negotiated. however, pay secrecy would also theoretically make it difficult to use the system as an incentive to perfonnance (wallace & fay, 1988), since employees may be unaware of the magnitude of potential salary increases available through advancement through their current salary grade or promotions. similarly, pay levels that are high relative to the market may improve recruitment but have a negative effect on cost effectiveness. thus, it is clear that different compensation strategies should theoretically affect compensation effectiveness outcomes differentially. knowing if, when and how these differential effects may occur could be of great benefit to compensation managers responsible for the design of these programs. for example, if an organization's strategy necessitates attraction and retention of highly skilled workers, what compensation strategy mix would maximize these goals? on the other hand, if the organization needs to increase productivity, enhancing motivation through a properly designed compensation system is essential knowing the strategies that will maximize the desired compensation effectiveness outcomes would be invaluable. in this study, we propose to begin an investigation into these design issues by asking compensation managers which strategies they believe are most effective for each of the major compensation program goals. the proposition to be addressed in this study is: proposition: compensation managers' perception of the effectiveness of the individual goals of compensation (recruitment, retention, motivation, etc.) will be differentially predicted by the type of compensation strategy utilized. because there is little previous work that would guide and direct specific predictions, this proposition does not delineate precise relationships between compensation strategies and measures of compensation program goal effectiveness. one of our goals is exploratory; we seek to investigate possible relationships 68 journal of business strategies vol. 13, no. 1 that can be built upon in future research. the proposition formally investigated is that no one strategy or strategies will predict effectiveness perception measures, but we are also interested in the pattern of relationships that emerges from our findings. method a questionnaire was sent to 1,121 midwestern organizations, taken from two samples. one sample was from a dun & bradstreet database (866 organizations of 200 or more on-site employees from five states: arkansas; iowa, kansas, missouri, nebraska); the other was a membership directory of a local hr manager's professional organization (the human resource management association of greater kansas city; 255 organizations). the person in charge of the compensation system, who was identified through telephone calls (for the dun & bradstreet sample) or through the membership roster (for the hr professional organization), was sent a copy of the survey. the six page questionnaire asked respondents to answer questions regarding their compensation policies as of january 1, 1994 only for non-union employee groups. from the dun & bradstreet (d&b) sample, 121 organizations responded, resulting in a response rate of 14%; for the hr managers' group, 52 responded, for a response rate of 20%. the total response rate was 15%. to ensure that the respondents were comparable to non-respondents, analyses of variances were conducted between these groups for the d&b database (comparable data were not available for the hrma database). there were no significant differences between the d&b respondents and non-respondents in sales or whether they were private or publicly owned. respondents did tend to be from slightly larger companies (the mean number of employees for respondents was about 225 more than for non-respondents) and to have been in business longer (the mean of number of years in business was about 10 years more for respondents than for non-respondents). these findings are to be expected, since larger, more established companies would not only have more advanced compensation practices but also would have more staff available to complete the survey. for the hrma database, the only comparative data available on nonrespondents was industry sector, and for both samples chi square analysis found no significant differences between respondents and non-respondents in this variable. to ensure that the respondents from the two samples were comparable and could be analyzed together, analyses of variances were conducted that revealed no significant differences in the major variables. measures compensation strategy compensation strategy components were measured using gomez-mejia's (1992) scale (see appendix). in gomez-mejia's original study, the individual spring 1996 day: compensation program goals 69 items used were averaged to fonn 15 scales, which were then analyzed using principal component analysis. the end result was one factor, with negative loadings indicating an "algorithmic" strategy (using more routinized and mechanistic pay practices) and positive loadings indicating an "experiential" strategy (using more flexible and participative pay practices). we initially replicated this analysis, but one single factor did not emerge. further analyses of the 15 scales revealed very low reliabilities for our sample, although gomezmejia's work showed acceptable reliabilities (ranging from .74 to .89). because of these dramatically different results, which indicate that this scale may not be generalizable across populations, we conducted further analyses, using principal component analysis with varimax rotation, to detennine how these variables were meaningful in the current data set. because our replication of the previous analysis was so significantly different, assumptions based on the earlier work about the constructs the scale measures were not relevant. this led us to choose principal component analysis, since our goal was not to define an underlying causal model among the variables, as factor analysis would do. principal component analysis linearly summarizes the data into simpler components (kim & mueller, 1978), and we believed it would more adequately satisfy our mission of showing that differing compensation strategy choices affect compensation program goals. also, we wanted to use factor scores, and this method produces exact scores rather than estimates (hair, anderson & tatham, 1987). further, factor analysis using maximum likelihood extraction was conducted on these data, resulting in substantially the same factor structure. varimax rotation was used because of its ability to produce more stable results over different sets of data and to simplify the columns, thus making interpretation easier (hair, anderson & tatham, 1987). again, other rotation methods (quartimax and equimax) did not substantially change the factor structure. using principal component analysis, 11 meaningful factors emerged (using the criteria of eigenvalues greater than 1.0), accounting for 61 % of the variance. to ascertain the reliability of these factors, or the degree of association between each component and its factor scale (kim & mueller, 1978), we conducted separate principal component analyses on the factors that had heavy loadings (greater than .4) on each component, as recommended by carmines and zeller (1979). all 11 of these analyses showed that a single phenomenon was being measured by the major variables of each component (they loaded on one factor, which accounted for 40% or more of the variance; carmines & zeller, 1979). using factor scores, we then created 11 variables that represented compensation strategy choices (table 1). using factor scores also had the advantage of providing independent variables that were uncorrelated. 70 journal of business strategies vol. 13, no. 1 table 1 factor loadings for principal component analysis of gomez-mejia's compensation strategy variables 1 2 3 4 5 6 7 8 9 10 11 component eigenvalue 5.42 3.43 2.52 1.96 1.74 1.61 1.55 1.42 1.27 1.19 1.16 percentage of variance accounted for 14.3 8.8 6.6 5.2 4.3 4.2 4.1 3.7 3.3 3.1 3.1 use a job-based system -.00 .32 -.00 -.00 -.00 -.00 -.00 -.00 -.59 -.00 -.00 do not use a skill-based system -.33 .36 -.36 emphasis on job evaluation -.65 rewards based on contributions .51 .43 individual over team emphasis .72 emphasis on long term goals .61 seniority not important .79 emphasis not on short term goals -.56 pay based on group performance .69 large part of pay is variable .79 employees should be risk takers .65 corporate performance is a pay criterion .71 internal equity is important goal .74 try hard to achieve comparable pay across org. .83 higher priority to interna than external equity .45 -.31 large pay differentials based on performance .30 .43 .39 provides perks to top management .80 spring 1996 day: compensation program goals 71 table 1 factor loadings for principal component analysis of gomez-mejia's compensation strategy variables cont'd 1 2 3 4 5 6 7 8 9 10 11 base pay is not an important part of pay package .72 base salary low relative to other types of pay .74 benefits are not an important part of compensation .56 -.39 benefit package is not generous .86 special pay packages to top management .39 .55 .30 incentives are important part .82 incentives provide significant amount of pay .68 bonuses provided often .67 psychological needs not considered important .38 .53 focus on monetary v. intrinsic rewards .72 pay not egalitarian; special rewards to elite groups .72 policies are not uniform across units .59 .30 line managers can make pay decisions pay information is not kept secret .30 .65 pay policies do not require secrecy .71 we openly disclose pay development procedures .66 • employee preferences are considered .35 .57 72 journal of business strategies vol. 13, no. i table 1 factor loadings for principal component analysis of gomez-mejia's compensation strategy variables cont'd 1 2 3 4 5 6 7 8 9 10 11 employees have say in pay policies .84 pay decisions are not autocratic .71 preferred salary position is above market .30 .66 preferred benefit position is above market .83 components: 1. pay based on corporate performance 2. internal consistency and equity 3. participation in designing compensation programs 4. benefits 5. disclosure of pay practices a key strategy 6. hierarchical rather than egalitarian pay 7. base salary not a major component of pay 8. pay based on individual performance 9. pay not based on the job 10. monetary rewards versus psychological rewards emphasized 11. long term competitiveness compensation program effectiveness respondents were asked to rate the effectiveness of the current pay system for both exempt and nonexempt employees using a four-point scale, from highly effective to highly ineffective. nine dimensions were measured for both exempt and nonexempt employees, and six factors emerged (see table 2). based on these factors, six averaged variables were created: compensation program effectiveness in recruitment (a = .89), motivating and retaining top employees (a = .89), administrative manageability (a = .89), cost effectiveness (a = .91), retaining average employees (a = .89) and encouraging poor performers to leave (a = .90). appropriateness of effectiveness measures although we believe these compensation effectiveness measures are appropriate, they have some limitations which should be discussed. the first is that they are self-reported responses from compensation managers, who may have a stake in seeing positive relationships between the programs they have spring 1996 day: compensation program goals 73 table 2 factor loadings for principal component analysis of compensation effectivess variables 1 2 3 4 5 6 component eigenvalue 6.17 2.48 2.03 1.55 1.31 1.09 percentage of variance accounted for 34.3 13.8 11.3 8.6 7.3 6.0 attracting large enough pool of exempt applicants .85 attracting large enough pool of nonexempt applicants .86 attracting highly qualified exempt applicants .76 attracting highly qualified nonexempt applicants .82 motivating top performance in exempt employees .82 motivating top performance in nonexempt employees .74 retaining top exempt employees .85 retaining top nonexempt employees .77 retaining average exempt employees .93 retaining average nonexempt employees .93 encouraging below average exempt employees to leave .95 encouraging below average nonexempt employees to leave .95 being a cost effective compensation systemexempt plan .86 being a cost effective compensation systemnonexempt plan .90 being administratively manageab1eexempt plan .82 being administratively manageab1enonexempt plan .78 being easy to communicate to exempt employees .86 being easy to communicate to nonexempt employees .80 factor names: 1. recruitment effectiveness 2. administrative manageability 3. motivation effectiveness 4. encourage poor performers to leave 5. retaining average employees 6. cost effectiveness 74 journal of business strategies vol. 13, no. 1 designed and achievement of compensation objectives. however, the responses from the sample contain ample variance and means that do not reflect an extremely strong positive bias (see table 3 below, variables 5 through 10). if the respondents had greatly inflated their programs' benefits, there may have been more consistently positive results than were seen. second, because many compensation managers ultimately have limited impact on the final compensation programs, they may not feel totally responsible for their outcomes and thus are likely to provide fairly objective responses regarding compensation effectiveness. top management can dramatically affect budgets, philosophies and programs, and the compensation manager does not have omnipotent power over the final package. additionally, because of the confidentiality of the survey (questionnaires were returned directly to the researcher's university), there is little motivation for respondents to deliberately bias their responses. therefore, it is unlikely that the respondents would have greatly overestimated the impact of their programs. third, as in all self-report studies, the possibility of common method variance should be addressed. common method variance refers to the fact that "because both measures come from the same source, any defect in the source contaminates both measures" (podsakoff & organ, 1986, page 533). common method variance is present when correlations between measures are not due to "true" relationships between the constructs but simply because the same respondents provide the measures for both constructs. one method of investigating whether this condition exists is harmon's one factor test (podsakoff & organ, 1986), which consists of a factor analysis of all relevant variables. if a large degree of common method variance is present, one factor will emerge (podsakoff & organ, 1986; miceli, lung, near & greenberger, 1991). such an analysis was conducted on the compensation effectiveness perception and strategy variables in this sample. fourteen factors emerged, with the first factor (which, in cases of common method variance, would account for a majority of the variance) only accounting for 15% of the variance. thus, common method variance is unlikely to be at issue here. fourth, researchers (balkin & gomez-mejia, 1987; gomez-mejia, page & tornow, 1982) have asserted that management opinions about effectiveness may actually be more valid indicators than "objective" data such as profitability, market share and shareholder value, since these measures are subject to a vast number of contaminating variables, including trends in the economy and other environmental factors. indeed, researchers have argued that the "bottom line" of compensation effectiveness is its value as perceived by its users. other researchers concur that self-report measures may, in some cases, represent more accurate descriptions than more objective measures (howard, maxwell, weiner, boynton & rooney, 1980; podsokoff & organ, 1986). in the present study, since we are interested in the technical success of the compensation program, the only people with the breadth and depth of knowledge to adequately evaluate these dimensions are the compensation managers. spring 1996 day: compensation program goals 75 finally, since we were interested in_assessing the separate components of a successful pay system, we were limited in the number of objective measures that were available and within the scope of this study. because of the previously stated arguments. we concluded that the expert opinions of compensation managers would be valid and appropriate for this study. as podsakoff and organ argue, "the practical utility of these types of measures makes them virtually indispensable in many research contexts" (page 540) and may be acceptable if adequate controls, such as harmon's one factor test, are reported for the data. while we believe that further research into these effectiveness constructs, using multiple measures from multiple constituents are essential, for this initial study in our research we believe that they are acceptable. control variables four variables were analyzed as control variables, since past research has found relationships with these variables and compensation strategies and effectiveness. these control variables are sales, size of the organization in number of employees (day, 1995; gerhart & milkovich, 1990; gomez-mejia, 1992), extent and process of diversification and life cycle stage (balkin & gomez-mejia, 1990; gomez-mejia, 1992; gomez-mejia & balkin, 1992). the magnitude of sales was evenly distributed across respondents: 33% reported sales of over $500 million; 32% reported sales of under $50 million. the mean number of employees was 1,253. the measures of diversification and life cycle stage (see appendix) were taken from the work of gomez-mejia and balkin (balkin & gomez-mejia, 1990; gomez-mejia, 1992; gomez-mejia & balkin, 1992) who had used rumelt's (1974) earlier work on diversification. the four diversification extent categories include: single product/service firm (95% or more of revenues are derived from a single product/service line); dominant product/service firm (may be several products/services but a dominant product/service accounts for 70% to 94% of revenues); related product/service firm (70% or less of revenues are derived from any single product/service); unrelated product/service firm. most respondents (46%) judged their organizations to be dominant product; similar numbers judged their organizations to be either single product (26%) or related products (29%). only one respondent judged the organization to be unrelated. process of diversification included two categories: organizations that are vertically integrated with a commitment to an existing product/service and that expand primarily in that product/service area; organizations that prefer to expand by acquiring new businesses, even if unrelated to existing product/service lines. most respondents (77%) believed their organizations were vertically integrated. twenty-three percent believed that their organizations expanded outside current product/service lines. similarly, the life cycle stages of organizations were analyzed. these stages included: start-up (a small company five or fewer years old, run by an 76 journal of business strategies vol. 13, no. 1 entrepreneur); growth (sales are growing at 20% or more annually, with technology and company structure changing); mature (growth is stable and slow and products/services are familiar to most prospective users); decline (growth is declining). most respondents (64%) judged their organizations to be mature. twenty-seven percent believed their organizations were growing. only 2% saw their organizations as start-up and only 7% saw them as declining. data were analyzed using hierarchical regression analysis for equations for each of the six dependent variables. the five control variables were entered in the first step of the equations. in order to determine the unique variance accounted for over and above the control variables, the eleven compensation strategy variables were entered in the second step of the equation. results means, standard deviations and the correlation matrix for the major variables can be found in table 3. in the first step, for all six dependent variables, the control variables entered as a block did not account for significant variance (table 4). in the second step, the proposition was confirmed for five of the six dependent variables (table 4). as predicted, there was variation in the specific strategy variables that affected each compensation effectiveness goal, and the compensation strategy variables accounted for at least 20% of the variance for the five measures of effectiveness perceptions in recruitment, motivation, administration, cost and encouraging poor performers to leave. no compensation strategy variables were significantly related to the perceived effectiveness of the compensation system in retaining average performers. two compensation strategies showed significant relationships with four of the six dependent effectiveness perception measures. participation in plan design was predictive of effectiveness in recruitment, motivation, cost effectiveness and encouraging poor performers to leave the organization. an emphasis on internal consistency was predictive of effectiveness perception in recruitment, motivation, administration and cost effectiveness. an emphasis on paying for individual performance was predictive of three effectiveness perception measures: motivational effectiveness, cost effectiveness and encouraging poor performers to leave. contemporary thinking about compensation practices would predict that participation and incentive pay, since they are innovative and nontraditional approaches, would be associated with effectiveness. however, it is surprising that an emphasis on internal consistency, which has been maligned because it has been seen as unsupportive of organizational goals (lawler, 1990; schuster & zingheim, 1992), would so consistently predict effectiveness perceptions. this finding may indicate that internal consistency is, as many compensation analysts have claimed for decades, a critical component of compensation effectiveness, regardless of organizational strategy. table 3 ci':l means, standard deviations and correlation matrix 't:l.,..... ::s mean i7c/ sd 1 2 3 4 5 6 7 8 9 10 -1,0 control variables 1,0 0'. i. sales 2.80 1.49 1.00 2. number full-time employees 1248.28 2460.71 .46 1.00 3. diversification extent 2.04 .75 .13 .10 1.00 4. life cycle stage 2.76 .60 .12 .01 -.17 1.00 t:l compensation effectiveness variables ~ 5. recruitment effectiveness 3.14 .62 .26 .18 .04 -.01 1.00 ~6. motivational effectiveness 2.84 .60 .16 .12 .08 -.10 048 1.00 7. administrative manageability 3.11 .68 .02 .01 .15 .02 .32 .32 1.00 ~ ('<l 8. cost effectiveness 3.02 .72 .01 -.02 .13 -.06 .26 046 al 1.00 ~ t., 9. effec. in retaining avg. performers 3.27 .65 .03 -.00 -.08 .05 .27 .18 .28 .13 1.00 l::l..... 10. effec. in encouraging poor performers to leave 2.20 .91 .00 -. .04 .06 -.08 .08 .17 .26 .28 -.07 1.00 i::l ~ pay strategy variables "t1 ii. participation in design of plan -.23 -.14 .il -.07 .24 .22 .07 .28 -.06 .20 ~oq 12. pay for corporate performance .27 .31 .29 -.20 .18 .26 -.01 .23 .il -.04 ~ 13. pay disclosure .20 .05 -.10 .08 .23 .08 .12 .01 .00 -.11 ;: 14. competitiveness .07 -.03 .01 .02 .15 .28 .28 .09 .01 -.01 ~ 15. monetary rewards -.03 -.04 -.15 .12 .12 .00 .04 -.01 .08 -.09 i::l l::l ""16. low emphasis on base pay -.08 .01 -.03 -.il -.05 .10 .07 .00 -.02 -.03 t., 17. pay for individual performance .10 -.00 -.02 .10 .08 .20 .16 .29 .07 .29 18. benefits major part of compo .07 -.02 -.03 -.01 .23 .16 .03 -.04 .15 -.03 19. jobs versus skills .13 .00 .10 .05 .09 .12 .08 .07 .07 -.02 20. internal consistency .00 .il .07 -.13 .30 .31 .35 .28 .16 .il 21. hierarchical rewards .26 .07 .02 -.07 -.04 -.04 -.24 -.14 -.03 -.11 significance of correlations: .30 or above, p < .001; .23 to .29, p < .01; 17 to .22, p < .05. compensation effectiveness variables are based on a five-point scale, with 5 indicating the highest level of effectiveness. since the pay strategy variables -....j are factor scores, their means are o. standard deviations are 1.0 and correlations with each other are .00. thus these statistics are not included in this table. -.l table 4 regression analyses of organization and compensation strategies on effectiveness variables recruitment motivation administrative effectiveness effectiveness effectiveness cost effectiveness -...j 00 beta ~z beta ~z beta step 1; control variables .05 .04 sales .121 .033 -.094 -.040 number full-time employees .102 .112 .104 .042 diversification extent -.066 .011 .151 .107 diversification process .117 -.094 -.133 -.200* life cycle stage -.022 -.152 .039 -.068 step 2; compensation strateeies .31*** .32*** participation in design of plan .343*** .201 * .031 .333*** pay for corporate performance .071 .193 * -.060 .336** pay disclosure .189* .117 .123 .024 long term competitiveness .136 .274** .261 ** .123 monetary rewards .090 -.009 .039 -.093 low emphasis on base pay .015 .139 .041 .103 pay for individual performance .064 .275** .140 .321 *** benefits major part of compo .256*** .129 .062 -.075 skills versus jobs .076 .076 .088 .048 internal consistency .299*** .253** .351 *** .338*** hierarchical rewards -.000 -.108 -.222* -.169 *** p < .001 ** p < .01 * p < .05 + p < .10 ~z .05 .32*** beta .1rz .05 .43*** ~ l:: g~ b:l l:: c.., s· ~ c.., c.., ~ s3 ~ ~~ ~--vj z !:ltable 4 regression analyses of organization and compensation strategies on effectiveness variables cont'd effectiveness in retaining effectiveness in encouraging average peformers poor performers to leave r.t:l "'0 >; _. ~ f1q ...... '0 '0 0'1 step ii control variables sales number full-time employees diversification extent diversification process life cycle stage step 2: compensation strate&ies participation in design of plan pay for corporate perfonnance pay disclosure long tenn competitiveness monetary rewards low emphasis on base pay pay for individual performance benefits major part of compo skills versus jobs internal consistency hierarchical rewards *** p < .001 ** p < .01 * p < .05 + p < .10 beta -,035 .080 .004,051 .089 -.059 .205+ .031 -.055 .086 -.100 .080 .195+ .118 .180+ -.077 .1.r2 .01 .14 beta ar2 .03 -.035 .053 tj .172+ ~ -.068 ~ .015 ~ ~ .20* ;::: .275** ~.... -.090 c' ;::: -.095 "tl .107 <3 oq -.123 i:1 .065 ~ .283*** (j <::l .013 l::l '"'"" -.063 ,lis -.113 -j '0 80 journal of business strategies discussion vol. 13, no. 1 our proposition, that compensation strategies will differentially affect the objectives of an effective compensation system, was supported. however, some of the relationships suggested in the introductory section of this paper were not supported. for example, we suggested that internal consistency may be positively related to retention but not related to recruitment, since those outside the organization would not understand the internal pay structure. our findings were opposite this prediction. while we did not find relationships between internal consistency and retention, we found that it was predictive of recruitment effectiveness perceptions. we also suggested that pay secrecy would positively affect administrative effectiveness because it requires less salary communication, but secrecy would negatively affect motivation, since employees would be unaware of potential pay increases. we did not find these relationships. we also believed that pay at risk would be positively associated with motivation effectiveness, which these data supported; basing pay on both corporate and individual performance was positively related to motivation effectiveness. however, we had suggested that paying for performance would be negatively associated with recruitment effectiveness, which was not found in these data. predictors of recruitment effectiveness compensation systems are in part designed to attract acceptable candidates to the organization. most frequently this is conceptualized as offering a package of pay and benefits, along with appropriate working conditions and other psychological accouterments that will be appealing to the appropriate type and quality of candidate. we found that four compensation strategies were significantly related to perceptions of recruitment effectiveness. first, as would be anticipated, was an emphasis on benefits. since the value of benefits as a recruitment device has increased dramatically over the last few years (aca, 1993), this finding is not surprising. of some interest is that an emphasis on benefits did not predict any other effectiveness perception variables. second, participation in pay program design was predictive of recruitment effectiveness, perhaps indicating that active employee input produces pay programs that are more attractive, not only to current incumbents, but also to job candidates. third, the relationship between pay disclosure and recruitment may indicate that the more pay information job candidates are able to gather, the more they are apt to perceive that the organization offers adequate financial incentives and is open with key job information. finally, an emphasis on internal consistency was predictive of perceived recruitment effectiveness. while it is doubtful that external candidates are aware of the level of internal equity present in the organization, it may be that an emphasis on internal equity is positively correlated with pay level. recent authors have claimed that traditional point-factor job evaluation programs, which are found in pay programs emphasizing internal equity, are spring 1996 day: compensation program goals 81 more likely to pay over the market (lawler, 1990; schuster & zingheim, 1992) and thus may be more attractive to recruits. alternatively, if internal consistency is coupled with pay disclosure, this may communicate to candidates that the organization has an organized and equitable pay structure that rewards appropriately for skills and abilities that the organization values. motivational effectiveness four compensation strategies were predictive of perceived motivational effectiveness. participation in design of pay programs, an emphasis on long-term competitiveness and paying for individual performance were associated with pay programs that were seen as motivational. these findings reflect current professional thinking regarding compensation programs and their ability to elicit appropriate employee behaviors (lawler, 1990). individual incentives, when designed properly, have been found to be motivational (gerhart & milkovich, 1992), and participation in plan development encourages acceptance and understanding of the plan (crepanzano & folger, 1989; milkovich & newman, 1993), which may result in increased motivation. it is interesting that an emphasis on internal consistency was also predictive of motivational effectiveness. this may refute the current philosophy that complicated point-factor job evaluation programs, typically used to establish internal equity, support the status and thus detract from the accomplishment of key organizational goals (emerson, 1991; lawler, 1990; schuster & zingheim, 1992). indeed, these results indicate that internal consistency may assist the compensation system in motivating employees toward goal accomplishment. administrative manageability emphases on long term competitiveness, internal consistency and egalitarian rather than hierarchical pay were found to be predictive of administrative manageability. these predictors indicate that emphasizing both competitiveness and internal equity are associated with a more easily managed compensation program, facts with which most compensation managers would probably concur. less emphasis on hierarchical relationships, especially in perquisites and status-related pay and benefit components, was associated with a pay system that is easier to administer, perhaps through fewer grade levels or otherwise simpler programs. effectiveness in retaining average performers no compensation strategy variables were predictive of this measure. however, the lack of associations with the main effects of compensation strategies may be because the variable itself is not seen as a 9ritical goal of compensation programs. while retaining employees who "meet expectations" is theoretically an important compensation goal, it may not be one that is very prominent in the minds of compensation managers or is actively promoted. 82 journal of business strategies vol. 13, no. 1 encouraging poor performers to leave participation in plan design and individually based incentive plans were predictive of encouraging poor performers to leave the organization. the latter finding supports commonly held beliefs that incentive pay will not be attractive to poor performers, since they are unable to reap the same rewards as others while continuing to shirk or perform poorly (gerhart & milkovich, 1992; lawler, 1990), and will thus be more likely to leave. participation in design of the compensation program may create a program that maximizes perceived fairness and equity based on performance inputs, which sends a message to those who do not perform as well as others that their behavior will not be well rewarded. recommendations for compensation managers although further research is needed, some suggestions should be considered regarding the development of compensation programs in specific organizations based on this study. first, different compensation objectives were seen to be supported by different compensation strategies, and a careful analysis of the intent and purpose of compensation in the context of the entire organization's strategic plan should be done to ensure that pay strategies match the objectives for which the program is being designed. for example, does the organizational strategy demand that highly skilled employees be recruited from a competitive labor market? if so, those compensation strategies that affect recruitment should be examined to ensure that they are designed adequately. for example, is the benefits package competitive for the segment of the labor force the organization wishes to attract? would employee participation in pay plan design produce a compensation package that would be attractive to job candidates? alternatively, if the organization is geared toward improving productivity and cost-cutting, compensation strategists may carefully evaluate whether the program includes those strategy choices that seem to positively predict motivation and cost effectiveness. can employees participate in plan design? is the compensation program internally equitable? does the organization pay for performance, both at the corporate and individual level? ensuring that these compensation strategies are utilized may assist in accomplishing the organization's goals of improving productivity and reducing costs. two strategies, participation in plan design and internal consistency, were associated with four key compensation goals, and thus may prove to be critical compensation strategies across a number of programs. while there has been much recent negative opinion about establishing internal equity, the respondents surveyed in this study believe that it is associated with a significant number of desirable outcomes. indeed, since the basic psychological makeup of human beings will probably not change dramatically, we may assume that basic equity judgments will continue to' be made. thus, compensation strategies should take internal equity into consideration. spring 1996 day: compensation program goals 83 our results also indicate that participation in pay program design may be critical to many facets of compensation effectiveness. thus, compensation managers may want to carefully consider to what degree and extent employees can become involved in this process. while probably not contributing to administrative effectiveness (as indeed our results indicate), establishing compensation programs based on employee input may be worth the time and trouble since they may enhance other important goals of the compensation program. compensation managers should consider those compensation strategies that showed limited relationships with effectiveness: an emphasis on benefits and pay disclosure. the extremely high cost of benefits in today's organizations is well known and should be carefully considered in light of these results. if benefits serve primarily a recruiting function, then the benefits package needs to be designed so that it obtains maximum recruitment impact. while a competitive benefits package may have a dramatic effect on other noncompensation issues, such as a sense of security or organizational commitment, it may not produce broad positive compensation effects. similarly, pay disclosure was related only to recruitment effectiveness perceptions. since pay disclosure involves increased communication, potential challenges to fairness and associated complaints and grievances, compensation managers should carefully consider whether a policy emphasizing secrecy or disclosure is appropriate. once information about a compensation program is disclosed, it will always be disclosed. especially if disclosure does not result in added motivation or retention, it may be more prudent to lean towards a policy of non-disclosure. finally, compensation managers should also take note of those compensation strategies that were not useful in predicting compensation effectiveness. for example, an emphasis on monetary over psychological rewards, low emphasis on base pay and an emphasis on skills versus jobs were not associated with any of the effectiveness measures in this study. these compensation managers place greater value on other strategies as the real drivers of compensation effectiveness. recommendations for further research in interpreting these results, it must be kept in mind that our sample was not representative of all us firms. first, our analyses showed that these firms tended to be somewhat larger and older than the nonrespondents. they also reported themselves as being mainly dominant product/service and vertically integrated. additionally, they are midwestern firms, often accused of being more conservative in outlook and practices than the rest of the country. whether these results would generalize to a broader population is not known. the major limitation of this study is its use of compensation manager ratings of compensation effectiveness. further research should attempt to measure the pay effectiveness dimensions from multiple constituencies and, if possible, objective sources. for example, recruiters should be surveyed regarding 84 journal of business strategies vol. 13, no. 1 the effectiveness of the compensation program. the relationship of compensation strategies to cost effectiveness could be examined through analyzing actual payroll and costs of activities associated with compensation. administrative effectiveness could be ascertained through infonnation obtained from line managers who must administer the program on a day-to-day basis. further fonnulation and definition of these constructs are needed and future research should focus on these. there also may be other compensation effectiveness dimensions that would be of interest, such as ability of the system to withstand legal challenges or support labor-management relationships. further, dimensions could be expanded to include sub-dimensions. for example, recruitment effectiveness could focus on ease of recruiting specific job types, such as r&d positions, clerical positions, etc. finally, the compensation strategy measures used in this study were those used previously by other researchers, but we found dramatically different statistical results in our sample. future research should compare and contrast this scale with others to ascertain its validity and reliability, and/or to develop another more useful and generalizable measure of compensation strategies. references american compensation association. certification course 7: fundamentals of employee benefit pr0i:rams. scottsdale, az: american compensation association, 1993. balkin, d.b., and l.r. gomez-mejia. "a contingency theory of compensation strategy." strategic management journal 8 (1987): 169-182. balkin, d.b., and l.r. gomez-mejia. "matching compensation and organizational strategies." strategic management journal ii (1990): 153-169. brown, c. and j. medoff. "the employer size-wage effect." journal of political economy 96 (1989): 1027-1053. bureau of national affairs. changing pay practices: new developments in employee compensation. washington, d.c.: bureau of national affairs, 1988. carmines, e.g. and r.a. zeller. reliability and validity assessment. beverly hills, ca: sage publications, 1979. crepanzano, r. and r. folger. "referent cognitions and task decision autonomy: beyond equity theory." journal of applied psychology 74 (1989): 293-299. day, n.e. "an investigation into pay level policy: relationships with pay structure characteristics and effectiveness." paper presented at the annual meeting of the midwest academy of management, st. louis, mo, march, 1995. spring 1996 day: compensation program goals 85 emerson, s. "job evaluation: a barrier to excellence?" compensation and benefits review 23 (1991): 39-51. gerhart, 8., and g.t. milkovich. "organizational differences in managerial compensation and financial performance." academy of management journal 33 (1990): 663691. gerhart, b., and g.t. milkovich. "employee compensation: research and practice." in m. dunnette & l.m. hugh (eds.), handbook of indystrial/organizational psycholqgy. 2nd edition, 481-569, palo alto, ca: consulting psychologists press, 1992. gomez-mejia, l.r "structure and process of diversification, compensation strategy and firm performance." strategic management journal 13 (1992): 381-397. gomez-mejia, l.r. and d.b. balkin. compensation, qrganizational stratefly and firm performance. cincinnati: south-western publishing co., 1992. gomez-mejia, l.r., r.c. page, and w.w. tornow. "a comparison of the practical utility of traditional, statistical and hybrid job evaluation approaches." academy of management jqurnal 25 (1982): 790-809. hair, j.f., re. anderson, and rl. tatham. multivariate data analysis, 2nd edition. new york: macmillan publishing company, 1987. hills, f.s., t.j. bergmann, and v.g. scarpello. compensation decision making. fort worth: the dryden press, harcourt brace college publishers, 1994. holzer, h.j. "wages, employer costs, and employee performance in the firm." in:. dustrial and labor relations review 43 (1990): 147s-164s. howard, g.s., s.e. maxwell, rl. wiener, k.s. boynton and w.m. rooney. "is a behavioral measure the best estimate of behavioral parameters? perhaps not." applied psychological measurement 4 (1980): 291-311. kim, j.o. and c.w. mueller. factor analysis: statistical methods and practical issues. beverly hills, ca: sage publications, 1978. krueger, a.b. "the determinants of queues for federal jobs." industrial and labor relatiqns review 41 (1988): 567-581. lawler, e.e. m. pay and organizatiqnai effectiveness: a psychoiqgical view. new york: mcgraw-hill, 1971. lawler, e.e. m. strategic pay: aligning organizational strategies and pay systems. san francisco: jossey-bass publishers, 1990. mahoney, t.a. compensation and reward perspectives. homewood, il: richard d. irwin, 1979. 86 journal of business strategies vol. 13, no. 1 miceli, m.p., i. jung, j.p. near, and d.b. greenberger. "predictors and outcomes of reactions to pay-for-performance plans." jgurnal gf applied psychology 76 (1991): 508-521. milkovich, g.t., and j.m. newman. compensation, 4th edition. homewood, il: irwin, 1993. podsakoff. p.m., and d.w. organ. "self reports in organizational research: problems and prospects." journal of management 12 (1986): 531-544. rumelt, r.p. strate~y, structure and economic perfqrmance. boston: division of research, harvard business school, 1974. rynes, sara l., and alison e. barber. "applicant attraction strategies: an organizational perspective." aca<lemy of managemsmt review 15 (1990): 286-310. schuster, l.r.. and p.k. zingheim. the new pay: unkin~ employee and organizatignal performance. new york: lexington books, 1992. wallace, mj., and c.h. fay. compensation theory and practice, 2nd edition, boston: pws-kent publishing company, 1988. appendix a compensation strategy scale (balkin & gomez, 1990,. gomez-mejia & balkin, 1992) "the following questions ask about the general philosophy and policies of your overall pay system's characteristics. please indicate your level of agreement using this scale:" (scale used: i = strongly agree to 5 = strongly disagree) 1. we use a job-based pay system. that is, factors within the job are key determinants of the amount of pay received by incumbents. 2. we have a skill-based pay system. that is, individuals are rewarded in part on their mastery of job skills. 3. the job is a more importaat factor than an incumbent's ability or performance in the determination of pay rates in this organization. heavy emphasis is placed on job evaluation procedures to determine pay levels. 4. we have a strong commitment to distribute rewards based upon contributions to the organization. 5. individual performance is emphasized as a basis for pay rather than group or team performance. 6. our pay system has a futuristic orientation. it focuses employees' attention on long-term (two or more years) goals. 7. the employee's seniority does not enter into pay decisions. spring 1996 day: compensation program goals 87 8. the pay system in this organization rewards employees for short-term accomplishments during a fixed time period (such as annual or semiannual performance reviews). 9. in this organization, a portion of an employee's earnings is contingent on group or organization performance goals being achieved. 10. we designed our compensation system so that a substantial portion of our compensation costs is variable pay in the form of incentives, bonuses or related rewards. 11. we believe that employees should be risk takers with some of their pay. 12. corporate performance is used as a criterion for pay decisions and aggregate incentive programs (e.g. gainsharing, profit sharing) for employees. 13. internal pay equity is an important goal of our pay system. 14. we try hard to achieve comparable pay relationships across different parts of the organization. is. we give a higher priority to internal pay equity than to external market factors. 16. there is a large pay spread between low performers and high performers in a given job. 17. our compensation system reflects a low degree of hierarchy in that we try to give a minimum of perks (reserved parking spots, first-class air travel, etc.) to top executives. 18. the base salary is an important part of the total compensation package. 19. the base salary is high relative to other forms of pay (such as bonuses or other incen-tives) that an employee may receive in this organization. 20. benefits are an important part of the total pay package. 21. the employee benefits package is very generous compared to what organizations similar to us offer. 22. we offer special pay packages and privileges as status symbols to the higher echelons in the organization. 23. pay incentives such as a bonus or profit sharing are an important part of the compensation strategy in this organization. 24. pay incentives are designed to provide a significant amount of an employee's total earnings in this organization. 25. bonuses are provided often; the frequency of bonuses is viewed at least as important as their magnitude. 26. this organization tries hard to meet the psychological needs of employees by offering intrinsic rewards through such means as job enrichment and quality of work programs. monetary rewards are underemphasized. 27. while intrinsic aspects of the job are not ignored, this organization clearly uses monetary rewards as a crucial part of its human resource strategy. 28. we try to make our pay system as egalitariail as possible; in other words, there are very few special rewards available to any "elite" groups of employees. 29. pay policy is applied uniformly across all organizational units. 30. the personnel staff in each business unit has freedom to develop its own compensation programs (if your company has only one business unit, please leave this item blank). (since the majority of respondents left this item blank, it was omitted from the analyses.) 31. there is a minimum of interference from corporate management with respect to pay decisions made by line managers. 88 journal of business strategies vol. 13, no. 1 32. we keep pay information secret from employees. 33. we have formal policies that discourage employees from divulging their pay to coworkers. 34. our organization does not openly disclose the administrative procedures on how pay levels and pay raises are established. 35. employees' feelings and preferences for various pay forms (e.g. bonus v. profit sharing) are taken very seriously by top management. 36. many different kinds of employees (individual contributors, managers, personnel staff, executives) have a say in pay policies. 37. pay decisions in this organization are made on an autocratic basis. we tend to "follow the book" very closely. very few employees have any input to pay decisions. 38. over most of our jobs, the preferred position of our organization's salary levels with respect to competitors is: (responses were: substantially above the market; somewhat above the market; generally equal to the market; somewhat below the market; substantially below the market) 39. the preferred position of our organization's benefits level with respect to competitors is: (responses were same as for number 38.) compensation managers' beliefs about strategies that affect compensation program goals the influence of supervisors’ leadership style on telecommuters paul e. madlock texas a&m international university • laredo, tx abstract the purpose of the current study was to extend prior scholarship by examining how employees who telecommute perceive their supervisor’s leadership style and the subsequent outcomes. specifically, the way in which leadership style influences employees’ perceptions of their supervisors’ communication competence and communication satisfaction with their supervisor. employees’ job satisfaction and organizational commitment was also assessed. participants included 157 full time telecommuters from a variety of organizations across the united states. the findings suggest that supervisors in the virtual workplace engaged in task oriented more than relational oriented leadership style. also, task oriented leadership served as the greatest predictor of the communication satisfaction, job satisfaction, and the organizational commitment of telecommuters. recommendations for practitioners were also provided indicating that more might be done to enhance the task related leadership competencies of supervisors in the virtual work setting. introduction the emergence of technology in the workplace has provided both large and small organizations with the ability to compete on a global scale, while at the same time, changed the way in which organizations interact and coordinate activities with customers, suppliers, and its members. these changes involve the substitution of everyday business activities which took place through face-to-face (ftf) interactions with electronic information exchanged through the use of computer technology (straub & watson, 2001). further, herrmann (2006) argued that with the growth of computer technology in the workplace, mediated communication has become infused into nearly every business communication context. the introduction of computer technologies into the organizational context has also brought about a number of changes to both the organization and its members by altering core elements of the organization, such as its structure, culture, and performance (jackson, poole, & kuhn, 2002). these technological advances have also allowed for a greater level of autonomy in the workplace, such as the ability to work away from the office. this work arrangement is being embraced by more and more companies who intend on capital2 journal of business strategies izing on the benefits of technology while minimizing costly resources such as office space (wilkes, frolick, & urwiler, 1994). this alternative form of work has historically been called telecommuting, telework, or virtual work, which is broadly defined as “working at one’s home or another location where employees use computers and communication technology to communicate with the main office, supervisors, coworkers, and customers (gibson, blackwell, dominicus, & demerath, 2002, p. 76). with over 20 million workers in the u.s. engaged in telecommuting and the number of telecommuters growing by over 20 percent annually, still very little is known about this increasingly popular work arrangement. one effect of this shift toward telecommuting is that leaders must assume more responsibility for working with followers who are at a distance (antonakis & atwater, 2002; bureau of transportation statistics, 2003; itac, 2000). according to bass (1990) effective leadership “depends on physical proximity, social and organizational propinquity, and networks of open channels of communications” (p. 658). to date, much of the published leadership research has been situated in contexts where leader/follower interactions take place in traditional ftf work environments. such research has demonstrated that leadership behaviors influence organizational performance, that strong leaders outperform weak leaders, and that relational oriented leadership style generates higher performance than does task oriented leadership (bass, 1990; madlock, 2010). however, the lack of research in the virtual workplace has also raised questions about the performance implications of telecommuting (neufeld & fang, 2005). although, “leadership is enacted through communication” (barge, 1994, p. 21), we still do not have a very clear understanding of how communication and leadership in the realm of telecommuting are related. therefore, leadership researchers have called for developing an improved understanding of the links between leadership and communication (conger & kanungo, 1988; mumford et al., 2000). effective leaders may tend to communicate using more metaphors, symbols, imagery and persuasive argumentation to sway others to accept their position (bass, 1985). they may also engage in interpersonal communication to help followers understand their visions and strategies for action (pondy, 1978). apart from a broad acknowledgement that leadership and communication seem to be conceptually related, there has been little empirical research explicitly examining leader communication effectiveness (den hartog & verburg, 1997). thus, the objective of this paper is to improve our theoretical and practical understanding by engaging in a study of leadership and communication in the telecommuting setting. specifically, the goal was to determine what form of leadership style (task and relational) and or communication behavior would elicit the most favorable volume 29, number 1 3 outcomes in the realm of telecommuting. therefore, the following section will offer additional support for the relevance of telecommuting research. telecommuting telecommuting has become increasingly popular because it gives employees increased flexibility in scheduling, less commuting time, and reduced work-family conflict and provides businesses with reduced real estate expenses and maintenance costs, increased productivity by employees, and access to global markets (manochehri & pinkerton, 2003; raghuram & wiesenfeld, 2004). as previously noted, improved productivity is probably the most widely touted benefit associated with telecommuting (pinsonneault & boisvert, 2001). the primary explanation for this proposed advantage in performance is that doing tasks remotely also means fewer disruptions while working (bailey & kurland, 2002). in addition to these benefits, the possible disadvantages associated with telecommuting include reduced communication with staff, feelings of isolation, decreased connectedness to the organization, and frustration at feeling ‘out of the loop’ in office politics (gainey, kelley, & hill, 1999; wiesenfeld, raghuram, & garud, 2001). also, increased reliance upon electronic communication, such as email, may constrain the spontaneity and interactivity that typically take place with others in the office (daft & lengel, 1986). in response to these conflicting perspectives researchers have adopted social identity theory and social isolation theory to better explain the detrimental social consequences associated with telecommuting (allen, renn, & griffeth, 2003; feldman & gainey, 1997). similarly, scholars have commonly invoked media richness theory and social presence theory to predict reduced meaningfulness of relationships between telecommuters and their supervisors do to limitations found in computer mediated communication (cmc) (daft & lengel, 1986; short, williams, & christie, 1976; workman, kahnweiler, & bommer, 2003). unlike the theories previously referenced that portray technology as a barrier to effective communication between supervisors and telecommuters, social information processing theory (sipt) appears to offer support for the use of technology as a viable means of communication between supervisors and telecommuters (walther, 1992). since leadership style is comprised of task and relational communication behaviors, sipt served as a theoretical underpinning for the current study in order to better explain the possible use and impact of relational oriented messages from leaders in the virtual work setting. 4 journal of business strategies social information processing theory according to sipt, communicators often form impressions about others moods or state of mind despite the relatively limited nonverbal and physical cues available through mediated communication (walther, 1992). in essence, sipt rejects the view that the lack of physical cues limits individuals from effectively exchanging relational oriented information through computer technology. walther (1992) argued that when denied these physical cues (e.g., nonverbal) that are available in ftf interactions, individuals sending and receiving messages via technology encode and decode relational messages using the cue systems that are available in the technology they are using. in sum, users of technology communicate in such a way that they exchange social information through the content, style, and timing of messages (walther, 1992). in support of sipt, several researchers have found that on-line relationships develop in a similar way as they do in the physical realm (walther & boyd, 2002). we know that in ftf interactions in traditional work settings leaders tended to use a relational oriented leadership style more than they used a task oriented style (madlock, 2008). further, it is also known that the use of relational oriented leadership style has a greater positive influence on the job satisfaction and commitment of workers than does task oriented leadership. however, we do not know which form of leadership style is most frequently used, or has the greatest influence on communication and organizational outcomes in the realm of telecommuting. therefore, in order to better understand how supervisors effectively lead employees in the virtual workplace, leadership style will be considered in greater detail below. leadership style leadership has been defined in a number of ways, such as the ability to guide followers toward shared goals and as a form of influence (bryman, 1992; hersey, 1984). pfeffer and salancik (1975) indicated that effective leaders’ tend to exhibit two distinct forms of communication (i.e., task and relational) when interaction with subordinates. in other words, leadership can be divided into task and relational oriented messages. the ohio state and the michigan studies were strong representatives of the styles approach. the ohio state studies identified two types of behaviors explaining what leaders do: leaders provide structure and nurture subordinates (hemphill & coons, 1957). at nearly the same time, the michigan studies identified the behaviors of effective leaders to contain employee-oriented behaviors and production-oriented behaviors (cartwrite & zander, 1960; likert, 1961, 1967). volume 29, number 1 5 prior research indicates that leadership is enacted through communication and that it can be divided into the content of the message (task) and the presentation (relational dimension) of the messages (barge, 1994; holladay & coombs, 1993). much of the published leadership literature research has been situated in traditional brick and mortar businesses. research related to the styles approach to leadership indicated that relationship oriented leadership was displayed more frequently, preferred more often, and had a greater impact on employees’ communication and job satisfaction than did task oriented leadership (madlock, 2008). additional research involving the effects of leadership style includes its relationship with group satisfaction, effective communication skills, interpersonal communication, and rapport building (anderson, madlock, & hoffman, 2006; campbell, white, & johnson, 2003; fairhurst, 1993; mintzberg, 1994; quick & macik-frey, 2004). however, results may differ for close versus distant leader/follower relationships (shamir, 1995). some prior research that has dealt with leadership in the virtual workplace has examined leadership impression management, leadership and communication effectiveness, and leadership performance appraisal (conger & kanungo, 1988; ferris et al., 1994; neufeld, wan, & fang, 2008). according to conger and kanungo (1998), the physical proximity to the leader to his or her followers may influence the importance of certain behavioral components in attributions of leadership effectiveness. similarly, shamir (1995) showed that rhetorical skills were more frequently attributed as an important characteristic of physically distant leaders, while being considerate of others and exhibiting unconventional behavior were more important attributions for close leaders. research has yet to fully examine the link between leadership style and communication in the realm of telecommuting. based on what we do know, it could be extrapolated that when interacting with telecommuters the leadership style of supervisors and the associated outcomes may differ from those in traditional ftf work environments. from the foregoing one baseline research question was advanced: research question 1: which leadership style will be utilized most often by supervisors of telecommuters? communication is most effective when it leads to shared understanding and interpersonal communication skills are critical in determining whether a leader’s message will be recalled and embraced (conger & kanungo, 1998; qureshi, liu, & vogel, 2006). the most effective leaders interact and communicate with their followers frequently, fostering mutual trust, respect, and commitment between leader 6 journal of business strategies and followers (uhl-bien & graen, 1998). effective leaders tend to craft their messages carefully, are open to followers’ input, communicate candidly, and appeal to followers’ aspirations in order to gain followers’ trust and commitment (bass, 1998). leaders can also exercise their influence to motivate and inspire followers so as to draw them toward a shared understanding (avolio, 1999). however, the connection between leadership style and communication competence has yet to be assessed in the virtual workplace and their association may differ from that of traditional work settings (madlock, 2008). given the task and relational component of communication competence its inclusion in the current study appeared warranted. communication competence communication competence has been conceptualized “as a form of interpersonal influence in which an individual is faced with the task of fulfilling communication goals (effectiveness) while maintaining conversational and interpersonal norms (appropriateness)” (spitzberg & cupach, 1981, p. 1). in following with this notion, communication competence has been conceptualized to encompass task related components, such as: knowledge and skill, as well as relational competencies, including: motivation, negotiation, and listening (cushman & craig, 1976; spitzberg, 1983). in a similar vein, salacuse (2007) indicated that as a result of changing work environments in which employees are more educated and intelligent than past generations, leaders are now required to lead by negotiation. specifically, salacuse (2007) noted that in order for leaders to persuade people to follow their vision, they need to communicate effectively by appealing to the interests of the followers in order to sell their vision. leaders in a virtual work setting may have greater difficulty in achieving high levels of communication effectiveness. these leaders must rely more heavily on explicit task oriented communication, whereas leaders in traditional work settings may have at their disposal additional informal influence behaviors such as “standing on furniture” or “hanging ideas on clotheslines” (jaussi & dionne, 2003, p. 475). leaders and followers communicate and work synchronously and asynchronously through all kinds of information and communication technologies (e.g., e-mail, voice mail, video conferencing, and collaborative software systems), but technology mediated communication may be less effective in conveying social presence (daft & lengel, 1986). this may be related to limited opportunities for interaction, reduced access to popular communication channels, time delays, and lack of shared language among diversified members (powell, piccoli, & ives, 2004). therefore, distant leadvolume 29, number 1 7 ers have to spend extra effort in converting and explicating what otherwise could be shared with ease through social presence in a physically proximate situation (avolio & kahai, 2003). therefore, based on the limited amount of prior research, the following research question was advanced: research question 2: which form of leadership style displayed by supervisors in a virtual work setting will be the greatest predictor of their communication competence? in the telecommuting setting there also appears to be a gap in the research examining supervisor task and relational oriented leadership and employee outcomes such as communication satisfaction. as a result, communication satisfaction was considered here and will be discussed in greater detail below. communication satisfaction communication satisfaction in the workplace has been defined as satisfaction with various aspects of the communication that occurs in the organization, such as the amount and quality of information available (crino & white, 1981). various studies highlighted the importance of communication on organizational success and have shown that communication quality is associated with employees’ job satisfaction and motivation, job performance, productivity and organizational commitment (clampit & downs, 1993; gruneberg, 1979; joshi & sharma, 1997; orpen, 1997; putti, aryee, & phua, 1990). research also indicated that employees who experience low levels of communication satisfaction experience reduced commitment, greater absenteeism and turnover, increased industrial unrest, and reduced productivity (hargie, tourish, & wilson, 2002). more recent research involving communication satisfaction indicated an association between supervisor leadership style and the communication satisfaction of their subordinates, with relational oriented leadership having a greater positive impact on the communication satisfaction of subordinates than did task oriented leadership (madlock, 2008). in the virtual work setting research indicated that as a result of lower social presence telecommuters experienced sharply diminished perceptions of intimacy and immediacy and a reduction in communication quality (kurland & cooper, 2002; short et al., 1976). however, there appears to be a lack of research involving leadership and communication satisfaction in the realm of telecommuting. based on the nature of the telecommuting work environment, it could be extrapolated that the communication interactions between leaders and telecommuters may differ from those found in the traditional brick and mortar work setting. coupled with the lack 8 journal of business strategies of prior research involving communication satisfaction in the virtual workplace, the following research question was advanced: research question 3: which behavior displayed by supervisors; task leadership style, relational leadership style, or communication competence, will serve as the greatest predictor of a telecommuter’s communication satisfaction? in addition to communication satisfaction, other outcomes of interest here include the job satisfaction and organizational commitment of telecommuters related to their supervisors’ leadership style and communication competence. therefore, the following section will highlight the value of job satisfaction and organizational commitment to the current study. job satisfaction and organizational commitment job satisfaction has been defined as “a pleasurable or positive emotional state resulting from the appraisal of one’s job or job experiences” (locke, 1976, p. 1297). the most common factors leading to worker stress and dissatisfaction are those emanating from the nature of the job itself, within which interpersonal relationships between employees and management take place (kenny & cooper, 2003). according to korte and wynne (1996), a deterioration of relationships in organizational settings resulting from reduced interpersonal communication between workers negatively influences job satisfaction, and sometimes leads to employees leaving their jobs. previous research in the traditional work setting has consistently demonstrated that work-related attitudes are important for individual performance as well as overall organizational productivity. two specific groups of work related attitudes; job satisfaction and organizational commitment, have been examined for their relationship to the attitudes employees hold about their work and the organization (miller & mange, 1986). while there has been considerable speculation as to the antecedent factors related to job satisfaction, its major effects on employees are quite clear. low job satisfaction has been shown to be associated with high rates of absenteeism, tardiness, and turnover (porter & steers, 1973). while job satisfaction deals with a person’s attitudes toward the job, organizational commitment addresses the person’s attitudes toward the organization. organizational commitment is characterized by a strong belief in and acceptance of the organization’s goals and values, a willingness to exert considerable effort for the organization, and a desire to retain membership in the organization (sager & johnston, 1989). research has indicated positive relationships between organizational comvolume 29, number 1 9 mitment and job satisfaction, job performance, and leadership (bateman & strasser, 1984; cohen, 1992; morris & sherman, 1981). prior research has also indicated that both job satisfaction and organizational commitment are directly related, in that the more satisfied employees are, the more committed to the organization they appear to be (firth et al., 2004). more recently, madlock (2008) found that both task and relational leadership styles had a positive influence on the job satisfaction and commitment of employees. in the realm of telecommuting, both job satisfaction and commitment have often been cited as advantages of telecommuting (coveyduck, 1997; pratt, 1999). specifically, coveyduck (1997) found that telecommuters derived relatively high level of job satisfaction, work autonomy, commitment, and feelings of organizational support. tucker (1997) reported that telecommuters had high levels of job satisfaction and hill (1995) found that productivity, morale, and organizational commitment were positively influenced by telework. despite the positive association between telecommuting and job satisfaction and commitment, there has been a lack of research examining the influence of leadership on these outcomes. however, gibson et al. (2002) did suggest that situational leadership could be applicable to the virtual workplace and may produce similar positive outcomes as it has in traditional work settings. it was further argued that this type of leadership would make telecommuters feel comfortable and connected which could be linked to their job satisfaction and retention (gibson et al., 2002). therefore, the following hypotheses and research questions were advanced: hypothesis 1: there will be a positive relationship between a supervisor’s task and relational leadership style and their telecommuters’ job satisfaction. hypothesis 2: there will be a positive relationship between a supervisor’s task and relational leadership style and their telecommuters’ organizational commitment. research question 4: which behavior displayed by a supervisor, task leadership, relational leadership, or communication competence, will serve as the greatest predictor of a telecommuter’s job satisfaction? research question 5: which behavior displayed by a supervisor; task leadership, relational leadership, or communication competence, will serve as the greatest predictor of a telecommuter’s organizational commitment? 10 journal of business strategies method participants and procedures the data collection procedure followed that of (hartman, stoner, & arora, 1991). based upon a review of the telecommuting literature 21 organizations believed to have telecommuting programs were contacted by the author for possible participation in this study. of the organizations contacted, seven agreed to participate in the current study. participants included full-time non-management employees working for companies with established telecommuting programs in which employees worked from home using technology (i.e., telecommuters) to conduct business and communicate with their supervisors. the organizations that agreed to participate in the study either distributed copies of the questionnaire, allowed the author to distribute copies of the questionnaire, or made copies of the questionnaire available to employees on a volunteer basis. respondents mailed completed questionnaires to the author. based on distributions of questionnaires and on reports from site managers, approximately 400 telecommuters were invited to participate in the study; 157 telecommuters (approximately 39.2%) provided useable completed surveys. participants were comprised of (48% female, n = 85) and (52% male, n = 92), whose overall tenure at their current job ranged from 3 to 12 years (m = 7.65, sd = 3.27). participants ranged in age from 23 to 49 (m = 30.86, sd = 6.59) and reported working for a variety of organizations including; insurance (30.5%, n = 54), healthcare (26.5%, n = 47), high tech (26.0%, n = 46), and banking/finance (17%, n = 30). of the technology used, all of the participants reported using a combination of technologies when communicating with their supervisors. these technologies included the most frequently reported form being cell phones (blackberry®) (68%), followed by computers (desktop and laptop) (29%), and landline telephones (3%). the most prevalent forms of communication used were text message, instant message (im), voice (primarily via cell phone), email, blogging, and video calls (e.g., skype®). measures all measures used in this study were submitted to principal component factor analysis using varimax rotation. criteria for factor and item retention were: 1) eigenvalues greater than 1.0 for retained factors, 2) primary factor loadings of .60 or greater, 3) no secondary loadings exceeding .40, 4) loading on a factor with a minimum of two items, and 5) theoretical interpretability (comrey & lee, 1992). all the items for the following measures met the aforementioned criteria. volume 29, number 1 11 leadership style was measured by the 20-item leadership style questionnaire developed by northouse (2001). the instrument measures the task and relational leadership styles and, when summed, represents a general leadership profile. a 5-point likert-type scale (1 = strongly disagree to 5 = strongly agree) was used in this study, which was the same as the original measure. prior research reported scale reliabilities ranging from .92 to .95 (anderson et al., 2006; madlock, 2008). cronbach’s alpha for the current study found that task leadership style was .91 (m = 3.88, sd = .58), and relational leadership style was .92 (m = 2.6, sd = .56). communication competence was measured by the 12-item communicator competence questionnaire developed by monge et al. (1982). the items were measured on a 5-point likert-type scale ranging from (1 = strongly disagree to 5 = strongly agree), which was the same as the original measure. prior research reported scale reliability of .93 (madlock, 2006a). cronbach’s alpha for the current study was .91 (m = 4.10, sd = .62). communication satisfaction was measured with the 19-item interpersonal communication satisfaction inventory (icsi) developed by hecht (1978). a 7-point likert scale (1 = strongly disagree to 7 = strongly agree) was used here, which was the same as the original measure. a slight modification was made to the original scale with a lead in sentence (when communicating with my supervisor i feel...) preceding each statement. prior studies reported reliabilities ranging from .72 to .93 and strong validity (rubin, palmgreen, & sypher, 1994). cronbach’s alpha for the current study was .89 (m = 5.65, sd = 1.67). job satisfaction was measured by the eight-item abridged job in general scale (ajig) (russell et al., 2004). a 5-point likert-type response format (1 = strongly disagree to 5 = strongly agree) was used in the current study instead of the original scale formatting (i.e., using 0 for “no,” 1 for “?” and 3 for “yes”) to be consistent with other parts of the questionnaire. the scale is comprised of single word or short statements regarding an employee’s overall perception of their job (e.g., good, better than most, undesirable). prior research used the modified scale formatting and the study indicated that the ajig scale had strong reliability with a cronbach’s coefficient alpha of .90 (madlock, 2010). cronbach’s alpha for the current study was .87 (m = 3.83, sd = .54). organizational commitment was measured with the 15-item organizational commitment questionnaire (ocq) (mowday et al., 1979). the items were measured on a 5-point likert scale ranging from (1 = strongly disagree to 5 = strongly agree), which was the same as the original measure. the scale is intended to measure employee attachment to the organization, for example, “i am proud to tell others that 12 journal of business strategies i am part of the organization”. prior research indicated scale reliability of .93 (madlock, 2006b). cronbach’s alpha for the current study was .90 (m = 3.81, sd = .53). results hypothesis one predicted there would be a positive relationship between the task and relational leadership style of supervisors and the job satisfaction of their telecommuters. results of pearson’s correlational analysis showed that the data were consistent with the hypothesis by indicating a significant positive relationship between the variables. the strength of all the correlational relationships examined in this study were based on the guidelines set forth by cohen (1988, pp. 77-81). specifically, a strong relationship was indicated between telecommuters’ job satisfaction and their supervisor’s task oriented leadership style (r = .65, p < .01) and a weak relationship with their supervisor’s relational oriented leadership style (r = .22, p < .01) (see table 1 for all the correlational results). hypothesis two predicted there would be a positive relationship between the task and relational oriented leadership style of supervisors and the organizational commitment of their telecommuters. results of pearson’s correlational analysis showed that the data were consistent with the hypothesis by indicating a significant positive relationship between the variables. specifically, a strong relationship was indicated between telecommuters’ organizational commitment and their supervisor’s task oriented leadership style (r = .42, p < .01), whereas a weak relationship was indicated between telecommuters’ organizational commitment and their supervisor’s relational oriented leadership style (r = .20, p < .05). table 1 pearson correlations among variables (mean scores) 1 2 3 4 5 6 1 task leadership .— 2 relational leadership .15 .— 3 job satisfaction .65** .22** .— 4 communication satisfaction .58** .18* .49** .— 5 communication competence .31** .29** .42** .22** .— 7 organizational commitment .42** .20* .32** .20* .36** .— note: ** statistically significant at p < .001, * statistically significant at p < .05 volume 29, number 1 13 research question one sought to answer the question of which leadership style would be utilized most often by supervisors of telecommuters. results indicated that supervisors engaged in greater task oriented leadership (m = 3.88, sd = .58) than they engaged in relational oriented leadership behaviors (m = 2.6, sd = .56). research question two sought to answer the question of which form of leadership style displayed by supervisors in a virtual work setting would be the greatest predictor of their communication competence. using multiple regression, supervisor communication competence was regressed on a linear combination of the two predictor variables. results indicated that (r2 = .10) 10% of the variance in communication competence was accounted for by task oriented leadership style, f(1, 155) = 16.24, p < .001, whereas (r2 = .15), 15% of the variance in communication competence was accounted for by the model containing both task and relational leadership style, f(2, 154) = 14.54, p < .001. overall, task oriented leadership style was found to be a greater predictor of communication competence, β = .27, p < .001, than was relational oriented leadership style β = .25, p < .001. research question three sought to answer the question of which behavior displayed by supervisors; task leadership style, relational leadership style, or communication competence, would serve as the greatest predictor of a telecommuter’s communication satisfaction. using multiple regression, communication satisfaction was regressed on a linear combination of the three predictor variables. results indicated that (r2 = .049) 4.9% of the variance in communication satisfaction was accounted for by a supervisor’s communication competence, f(1, 155) = 7.93, p < .01; (r2 = .063), 6.3% of the variance in communication satisfaction was accounted for by the model containing both communication competence and relational leadership style, f(2, 154) = 5.19, p < .01; (r2 = .34), 34% of the variance in communication satisfaction was accounted for by the model containing communication competence, relational leadership style, and task leadership style, f(3, 153) = 26.57, p < .001. overall, task oriented leadership style was found to be the greatest predictor of communication satisfaction, β = .56, p < .001, whereas communication competence β = .02, p > .05 and relational leadership style β = .09, p > .05 were not found to be a significant predictor of communication satisfaction. 14 journal of business strategies table 2 summary of regression analysis for variables predicting communication competence communication competence predictor b se b β relational leadership style .15 .04 .25** task leadership style .29 .08 .27** (constant) 2.60 .32 f(2, 154) = 14.54, p < .001 *p < .05. **p < .001. research question four sought to answer the question of which behavior displayed by supervisors; task leadership style, relational leadership style, or communication competence, would serve as the greatest predictor of a telecommuter’s job satisfaction. using multiple regression, job satisfaction was regressed on a linear combination of the three predictor variables. results indicated that (r2 = .179) 17.9% of the variance in job satisfaction was accounted for by a supervisor’s communication competence, f(1, 155) = 33.74, p < .001; (r2 = .188), 18.8% of the variance in job satisfaction was accounted for by the model containing both communication competence and relational leadership style, f(2, 154) = 17.80, p < .001; (r2 = .479), 47.9% of the variance in job satisfaction was accounted for by the model containing communication competence, relational leadership style, and task leadership style, f(3, 153) = 46.84, p < .001. overall, task oriented leadership style was found to be a greater predictor of job satisfaction, β = .57, p < .001 than was communication competence, β = .23, p < .001. relational oriented leadership style was not found to be a significant predictor of job satisfaction β = .06, p > .05. research question five sought to answer the question of which behavior displayed by supervisors; task leadership style, relational leadership style, or communication competence, would serve as the greatest predictor of a telecommuter’s organizational commitment. using multiple regression, organizational commitment was regressed on a linear combination of the three predictor variables. results indicated that (r2 = .130) 13% of the variance in organizational commitment was accounted for by a supervisor’s communication competence, f(1, 155) = 23.12, p < .001; (r2 = .140), 14% of the variance in organizational commitment was accounted for by the model containing both communication competence and relational leadership volume 29, number 1 15 style, f(2, 154) = 12.55, p < .001; (r2 = .239), 23.9% of the variance in organizational commitment was accounted for by the model containing communication competence, relational leadership style, and task leadership style, f(3, 153) = 16.06, p < .001. overall, task oriented leadership style was found to be a greater predictor of organizational commitment, β = .33, p < .001 than was relational oriented leadership style, β = .23, p < .001. relational oriented leadership style was not found to be a significant predictor of organizational commitment β = .08, p > .05. table 3 summary of regression analysis for variables predicting job satisfaction and organizational commitment job organizational satisfaction commitment predictor b se b β b se b β communication competence .20 .055 .23** .20 .07 .23* relational leadership style .03 .031 .06 .04 .04 .05 task leadership style .53 .03 .34** .30 .07 .33** (constant) .88 .057 1.72 .31 f(3, 153) = 46.84, p < .001 f(3, 153) = 16.06, p < .001 *p < .05. **p < .001. discussion today, with the anyplace and anytime nature of mobile technology, telecommuting has become more common and a more important work arrangement for organizations, and that there will be well over 90 million of these technology mediated jobs in the u.s. by 2030 the study of telecommuters appears to be warranted (wilkes et al., 1994). one effect of this shift toward virtual work arrangements is that leaders must assume more responsibility for working with followers who are at a distance and leaders may find it more difficult in achieving high levels of communication effectiveness (antonakis & atwater, 2002; bass, 1990). thus, the objective of this paper is to improve our theoretical and practical understanding by engaging in a study of leadership and communication in the telecommuting setting. specifically, the goal was to determine what form of leadership style (task and relational) and or 16 journal of business strategies communication behavior would elicit the most favorable outcomes in the realm of telecommuting. the first finding of interest centers on the correlational findings, which indicate that there was a greater emphasis placed on task oriented leadership in the virtual workplace compared to traditional work settings. this may be the result of distant leaders having to rely more heavily on explicit communication, whereas leaders in traditional ftf work settings may have at their disposal additional informal influence (jaussi & dionne, 2003). leaders and followers communicate and work synchronously and asynchronously through all kinds of information and communication technologies (e.g., e-mail, voice mail, video conferencing, and collaborative software systems), but technology mediated communication may be less effective in conveying nuances of meaning that are essential to the development of interpersonal relationships (kiesler et al., 1987). this may lead to a reduction in emotional tone and feeling being both expressed by the communicator and understood by the receiver (kiesler et al., 1987). therefore, distant leaders have to spend extra effort in converting and explicating what otherwise could be shared with ease through social presence in traditional work settings (avolio & kahai, 2003). this finding may also shape the expectations of telecommuters to the extent that they do not expect relationship oriented communication when conversing with leaders because it is thought to be less possible, hence they evaluate their leaders in task terms because that is what is expected. although these findings appear to contradict sipt, another interpretation centers on the nature of the telecommuting work environment (walther, 1992). meaning, that the kinds of work that can effectively done via technology are more heavily task oriented, therefore valued leadership is one that is focused on tasks. therefore, communication in this technologically mediated environment lends itself to the exchange of task related information. it is also possible that employees who are effective and comfortable with this type of work are themselves more task-oriented and as a result, appreciate like-minded leadership. not to discount relational oriented leadership, but it seems that in the realm of telecommuters, effective leadership style may be perceived differently than in traditional work settings. additional findings of interest that buttress with the correlational results were found in the regression models indicating that task oriented leadership style was a greater predictor of the communication satisfaction, job satisfaction, and commitment of telecommuters than was communication competence and relational oriented leadership. this finding again suggests that in order for supervisors to be perceived as effective leaders they must possess the knowledge and skills associated with the volume 29, number 1 17 job in order to be able to communicate task relevant information to telecommuters. lastly, as organizations and employees become increasingly dispersed, communication becomes the principal means by which individuals exercise leadership (penley & hawkins, 1985). since communication effectiveness has also been broadly linked with leadership effectiveness, it is possible that communication competence may be associated more with task oriented leadership in the virtual work setting than in the traditional work environment (klauss & bass, 1982). based on the current findings recommendations for practitioners indicate that more might be done to enhance the task related competencies of supervisors in the realm of telecommuting. these recommendations include, additional training on task related competencies and how to effectively communicate task related knowledge to telecommuters through the use of technology. supervisors also need to be aware that it is possible that telecommuters prefer task oriented leaders because of the limitations found in technology, the expectations of telecommuters, the nature of the telecommuting work environment being heavily task oriented, and that telecommuters themselves may be more task-oriented and appreciate like-minded leadership. limitations and future directions although the current study adds to our understanding of leadership and communication in the realm of telecommuting work it is not without limitations. in order to fully understand the impact of the current findings a qualitative study needs to be considered in which the researcher can ask probing questions to uncover nuances not found in a quantitative study. another limitation found here involves a level of uncertainty about the amount of time telecommuters spent in the office. this information may indicate whether telecommuters who frequented the office felt more connected and satisfied than those telecommuters who rarely visited the office. another limitation connected to this study is that all the forms of technology were chained together as if they had the same characteristics of emotional tone. however, there are some differences in voice based on the form of technology used and with heavy and long term use (walther, 1992). in order to tease out these possible differences in technology, future researchers may want to collect a larger sample and compare the leadership styles and communication of supervisors based on the form of technology used. given the relevance of telecommuting, there are a number of additional research directions that one could pursue. one possible direction centers on a dialogic approach to examine the communication interactions that take place between su18 journal of business strategies pervisors and telecommuters. this may allow researchers to better understand how and why specific communication behaviors shape the perceptions of telecommuters more than others. further, a dialogic approach may also shed light on the reasons why task oriented leadership has such a positive impact on telecommuters and their work related outcomes. another possible direction for future researchers involves cross-cultural studies of leadership and communication in the virtual workplace. given, today’s global economy, these research findings may prove to enhance leadership training programs. references allen, d. g., renn, r. w. & griffeth, r. w. (2003). the impact of telecommuting design on social systems, self-regulation, and role boundaries. in g. ferris & j. martochhio (eds.), research in personnel and human resources management (pp. 125-163). boston: jai press. anderson, c. m., madlock, p. e. & hoffman, p. (2006). leadership, commitment,and attitudes as predictors of satisfaction in small task groups. paper presented at the central states communication association convention, indianapolis, in. antonakis, j. & atwater, l. (2002). leader distance: a review and proposed theory. leadership quarterly, 13, 673-704. doi:10.1016/s1048-9843(02)00155-8 avolio, b. j. (1999). full leadership development: building the vital forces in organizations. thousand oaks, ca: sage. avolio, b. j., & kahai, s. s. (2003). adding the “e” to leadership: how it may impact your leadership. organizational dynamics, 31, 325. doi:10.1016/s00902616(02)00133-x bailey, d. e., & kurland, n. b. (2002). a review of telework research: findings, new directions and lessons for the study of modern work. journal of organizational behavior, 23, 383-400. barge, j. k. (1994). leadership: communication skills for organizations and groups. new york: st. martin’s press. bass, b. m. (1985). leadership and performance beyond expectations. new york: free press. bass, b. m. (1990) bass & stogdill’s handbook of leadership: theory, research, and managerial applications. new york: free press. bass, b. (1998). transformational leadership: industrial, military, and educational impact. mahwah, nj: erlbaum. bateman, t. s., & strasser, a. (1984). a longitudinal analysis of the antecedents of organizational commitment. academy of management journal, 27, 95-112. volume 29, number 1 19 bryman, a. (1992). charisma and leadership in organizations. london: sage. bureau of transportation statistics. (2003). omnibus household survey results (august). washington: u.s. government printing office. campbell, k. s., white, c. d., & johnson, d. e. (2003). leader-member relations as a function of rapport management. journal of business communication, 40, 170-194. cartwrite, d., & zander, a. (1960). group dynamics-research and theory. evanston, il: row peterson. clampit, p. g., & downs, j. d. (1993). employee perceptions of the relationship between communication and productivity: a field study. journal of business communication, 30, 5-28. cohen, j. (1988). statistical power analysis for the behavioral sciences (2nd ed.). hillsdale, nj: erlbaum. cohen, a. (1992). antecedents of organizational commitment across occupational groups: a meta-analysis. journal of organizational behavior, 13, 539-558. comrey, a. l., & lee, h. b. (1992). a first course in factor analysis (2nd ed.). hillsdale, nj: erlbaum. conger, j. a., & kanungo, r. n. (1988). charismatic leadership: the elusive factor in organizational effectiveness. san francisco: jossey bass publishers. conger, j. a., & kanungo, r. n. (1998). charismatic leadership in organizations. thousand oaks, ca: sage. coveyduck, d. h. (1997). investigation of selected factors on job satisfaction among telecommuters. unpublished master’s thesis, carleton university, ottawa, ontario, canada. crino, m. e., & white, m. c. (1981). satisfaction in communication: an examination of the downs-hazen measure. psychological reports, 49, 831-838. cushman, d. p., & craig, r. t. (1976). communication systems: interpersonal implications. in g. r. miller (ed.), exploration in interpersonal communication (pp. 37-58). beverly hills, ca: sage. daft, r. l. & lengel, r. h. (1986). organizational information requirements, media richness and structural design. management science, 32, 554-571. den hartog, d. n. & verburg, r. m. (1997). charisma and rhetoric: communicative techniques of international business leaders. leadership quarterly, 8, 355-391. doi:10.1016/s1048-9843(97)90020-5 fairhurst, g. t. (1993). the leader-member exchange patterns of women leaders in industry: a discourse analysis. communication monographs, 60, 321-351. 20 journal of business strategies feldman, d. c., & gainey, t. w. (1997). patterns of telecommuting and their consequences: framing the research agenda. human resource management review, 7, 369-388. ferris, g. r., judge, t. a., rowland, k. m., & fitzgibbons, d. e. (1994). subordinate influence and the performance evaluation process: test of a model. organizational behavior and human decision processes, 58, 101-135. doi:10.1006/ obhd.1994.1030 firth, l., mellor, d. j., moore, k. a., & loquet, c. (2004). how can managers reduce employee intention to quit? journal of managerial psychology, 19, 170187. gainey, t. w., kelley, d. e., & hill, j. a. (1999). telecommuting’s impact on corporate culture and individual workers: examining the effect of employee isolation. s.a.m. advanced management journal, 64, 4-10. gibson, j., blackwell, c., dominicus, p. & demerath, n. (2002). telecommuting in the 21st century: benefits, issues and a leadership model which will work. the journal of leadership studies, 8, 75-86. gruneberg, m. m. (1979). understanding job satisfaction. new york: john wiley. hargie, o., tourish, d., & wilson, n. (2002). communication audits and the effects of increased information: a follow-up study. the journal of business communication, 39, 414-436. hartman, h. i., stoner, s. r., & arora, r. (1991). a. investigation of selected variables affecting telecommuting productivity and satisfaction. journal of business and psychology, 6, 207-225. hecht, m. l. (1978). the conceptualization and measurement of interpersonal communication satisfaction. human communication research, 4, 253-264. hemphill, j. k., & coons, a. e. (1957). development of the leader behavior description questionnaire. in r. m. stogdill & a. e. coons (eds.), leader behavior: its description and measurement (pp. 6-38). columbus: the ohio state university, bureau of business research. herrmann, a. f. (2006). stockholders in cyberspace: weick’s sensemaking online. journal of business communication, 44, 13-35. hersey, p. (1984). the situational leader. escondido, ca: center for leadership studies. hersey, p., & blanchard, k. h. (1969). management of organizational behavior utilizing human resources. new jersey: prentice hall. hill, e. j. (1995). j. (1995). the perceived influence of mobile telework on aspects of work life and family life: an exploratory study [abstract] (doctoral dissertation, utah state university, 1995). proquest digital dissertation, aat 9603489. volume 29, number 1 21 holladay, s. j., & coombs, w. t. (1993). communication visions: an exploration of the role of delivery in the creation of leader charisma. management communication quarterly, 6, 405-427. international telework association and council (itac). (2000). telework america report 2000. jackson, m. h., poole, m. s., & kuhn, t. (2002). the social construction of technology and studies of the workplace. in l. lievrouw & s. livingstone (eds.), the handbook of new media (pp. 236-253). london: sage. joshi, r. j., & sharma, b. r. (1997). determinant of managerial job satisfaction in a private organization. indian journal of industrial relations, 33, 101-110. jaussi, k. s., dionne, s. d. (2003). leading for creativity: the role of unconventional leader behavior. leadership quarterly, 14, 475. doi:10.1016/s10489843(03)00048-1 kenny, d., & cooper, c. (2003). introduction: occupational stress and its management. international journal of stress management, 10, 275-279. kiesler, s., siegel, j., & mcguire, t. w. (1987). social psychological aspects of computer mediated communication. in k. finnegan, r. salamon, & r. thompson (eds.), information technology: social issues (pp. 290-306). seven oaks, uk: hodder and stoughton. korte, w. b., & wynne, r. (1996). telework: penetration, potential and practice in europe. amsterdam: ohmsha press. kurland, n. b., & cooper, c. d. (2002). manager control and employee isolation in telecommuting environments. journal of high technology management research, 13, 107-126. likert, r. (1961). new patterns of management. new york: mcgraw-hill. likert, r. (1967). the human organization: its management and value. new york: mcgraw-hill. locke, e. a. (1969). what is job satisfaction? organizational behavior and human performance, 4, 309-336. madlock, p. e. (2006a). do differences in displays of nonverbal immediacy and communicator competence between male and female supervisors affect subordinates, job satisfaction. ohio communication journal, 44, 61-78. madlock, p. e. (2006b, november). supervisors’ nonverbal immediacy behaviors and their relationship to subordinates’ communication satisfaction, job satisfaction, and willingness to collaborate. paper presented at the national communication association convention, san antonio, tx. madlock, p. e. (2008). the link between leadership style, communicator competence, and employee satisfaction. journal of business communication, 45, 61-75. 22 journal of business strategies madlock, p. e. (2010). the development of technological management model: a conceptualization of computer technology in the workplace. international association for technology, education, and development, 38, 4564-4576. manochehri, g. & pinkerton, t. (2003). managing telecommuters: opportunities and challenges. american business review, 21, 8-16. miller, k., & mange, p. r. (1986). participation, satisfaction, and productivity: a metaanalytic review. academy of management journal, 29, 727-753. mintzberg, h. (1994). rounding out the manager’s job. mit sloan management review, 36, 11-25. monge, p. r., backman, s. g., dillard, j. p., & eisenburg, e. m. (1982). communicator competence in the workplace: model testing and scale development. communication yearbook, 5, 505-528. morris, j. h., & sherman, j. d. (1981). generalizability of an organizational commitment model. academy of management journal, 24, 512-526. mowday, r. t., steers, r. m., & porter, l. w. (1979). the measurement of organizational commitment. journal of vocational behavior, 14, 234-247. mumford, m. d., zaccaro, s. j., harding, f. d., jacobs, t. o., fleishman, e. a. (2000). leadership skills for a changing world: solving complex social problems. leadership quarterly, 11, 11-35. doi:10.1016/s1048-9843(99)00041-7 neufeld, d. & fang, y. (2005). individual, social and situational determinants of telecommuter productivity. information management, 42, 1037. doi:10.1016/j. im.2004.12.001 nilles, j. m. (1976). the telecommunications-transportation tradeoff. new york: wiley & sons. nilles, j. m. (1998). managing telework: options for managing the virtual workforce. new york: wiley & sons. northouse, p. g. (2001). leadership: theory and practice (2nd ed.). thousand oaks, ca: sage. orpen, c. (1997). the interactive effects of communication quality and job involvement on managerial job satisfaction and work motivation. journal of psychology, 5, 121-125. penley, l. e. & hawkins, b. (1985). studying interpersonal communication in organizations: a leadership application. academy of management journal, 28, 309328. doi:10.2307/256203 pfeffer, j., & salancik, g. r. (1975). determinants of supervisory behavior: a role set analysis. human relations, 38, 138-153. volume 29, number 1 23 pinsonneault, a., & boisvert, m. (2001). the impacts of telecommuting on organizations and individuals: a review of the literature. in n. j. johnson (ed.), telecommuting and virtual offices: issues and opportunities (pp. 163-185). hershey, pa: idea group publishing. pondy, l. (1978). leadership as a language game. in m. c. w. mccall, & m. m. lombardo (eds.), leadership: where else can we go? (pp. 87-99). durham, nc: duke university press. porter, l. w., & steers, r. m. (1973). organizational, work, and personal factors in employee turnover and absenteeism. psychological bulletin, 80, 151-176. powell, a., piccoli, g., & ives, b. (2004). virtual teams: a review of the current literature and directions for future research. database advanced information systems, 35, 6-33. pratt, j. h. (1999). 1999 telework america national telework survey: cost/benefits of teleworking to manage work/life responsibilities: the international telework association & council. putti, j. m., aryee, s., & phua, j. (1990). communication relationship satisfaction and organizational commitment. group & organization studies, 15, 44-52. quick, j. c., & macik-frey, m. (2004). behind the mask: coaching through deep interpersonal communication. consulting psychology journal: practice and research, 56, 67-74. qureshi, s., liu, m., & vogel, d. (2006). the effects of electronic collaboration in distributed project management. group decision and negotiation, 15, 55-75. raghuram, s., & wiesenfeld, b. (2004). work-nonwork conflict and job stress among virtual workers. human resource management, 43, 259-277. rubin, r. b., palmgreen, p., & sypher, h. e. (1994). communication research measures: a sourcebook. new york: guilford. russell, s. s., spitzmüller, c., lin, l. f., stanton, j. m., smith, p. c., & ironson, g. h. (2004). shorter can also be better: the abridged job in general scale. educational and psychological measurement, 64, 878-893. sager, j. k., & johnston, m. w. (1989). antecedents and outcomes of organizational commitment: a study of salespeople. journal of personal selling & sales management, 9, 30-41. salacuse, j. w. (2007). real leaders negotiate. harvard management update, 10, 2-3. shamir, b. (1995). social distance and charisma: theoretical notes and an exploratory study. leadership quarterly, 6, 19-47. doi:10.1016/1048-9843(95)90003-9 short, j. a., williams, e., & christie, b. (1976). the social psychology of telecommunications. new york: wiley. 24 journal of business strategies spitzberg, b. h. (1983). communication competence as knowledge, skill, and impression. communication education, 32, 323-329. spitzberg, b. h., & cupach, w. r. (1981, november). self-monitoring and relational competence. paper presented at the speech communication association convention, anaheim, ca. straub, d. w., & watson, r. t. (2001). research commentary: transformational issues in researching is and net-enabled organizations. information systems research, 12, 337-345. uhl-bien, m., & graen, g. b. (1998). individual self-management: analysis of professionals’ self-managing activities in functional and cross-functional work teams. academy of management journal, 41, 340-350. doi:10.2307/256912 walther, j. b. (1992). interpersonal effects in computer-mediated interaction: a relational perspective. communication research, 19, 52-91. walther, j. b., & boyd, s. (2002). attraction to computer-mediated social support. in c. a. lin & d. atkin (eds.), communication technology and society: audience adoption and uses, (pp. 153-188). cresskill, nj: hampton press. wiesenfeld, b. m., raghuram, s., & garud, r. (1999). communication patterns as determinants of organizational identification in a virtual organization. organization science, 10, 777-790. wilkes, r. r., frolick, m. n., & urwiler, r. (1994). critical issues in developing successful tele-work programs. journal of systems management, 45, 28-34. wood, a. f., & smith, m. j. (2001). online communication: linking technology, identity, and culture. mahwah, nj: erlbaum. workman, m., kahnweiler, w., & bommer, w. (2003). the effects of cognitive style and media richness on commitment to telework and virtual teams. journal of vocational behavior, 63, 199-219. biographical sketch of author paul madlock ph.d. is an assistant professor in the college of business administration at texas a&m international university. he has published numerous articles on technology, communication, leadership, and other management areas. the influence of supervisors' leadership style on telecommuters 312 journal of business strategies the effect of inter-partner relatedness on stock market reactions to joint venture announcements: differences between manufacturing and marketing deals daniel a. cernas ortiz universidad autonoma del estado de mexico • toluca, estado de mexico grant e. miles university of maine • orono, maine abstract the degree of relatedness between a joint venture´s partners that maximizes the stock market returns upon its announcement continues to be a contentious topic in joint venture literature. with some prior findings suggesting that high inter-partner relatedness may be best for companies and other studies suggesting the contrary, the evidence on the matter is inconclusive. in this study, we found that returns are highest when inter-partner relatedness is neither too low nor too high. further, we found evidence that the type of joint venture matters, with returns being significantly higher for highly related companies when they announce a marketing deal than when they announce a manufacturing one. key words: joint ventures, firm relatedness, stock market returns introduction a joint venture involves the pooling of two (or more) firms´ resources within a common legal organization (kogut, 1988). joint ventures are common business agreements, yet they are a challenge to managers because their probability of failure is high (beamish & lupton, 2009). further complicating matters for managers is the fact that the impact of the decision to form a joint venture may be felt immediately. upon the announcement of any particular joint venture deal, the stock market reacts, adjusting the announcing firms’ values according to the impact that investors believe the venture is likely to have on the firms’ cash flows (koh & venkatraman, 1991; mcconnel & nantel, 1985; swaminathan & moorman, 2009). as mcwilliams and siegel (1997) note, a negative reaction by the market can lead to a significant decrease, at least in the short run, to a firm’s overall value. volume 31, number 2 313 past research has shed light on a variety of factors that influence the stock market reaction to a particular joint venture announcement. these studies provided evidence that such diverse factors as ownership configuration (park & kim, 1997), cultural and institutional distance between partners (merchant & schendell, 2000) and joint venture experience (anand & khana, 2000; gulati, lavie & singh, 2009; kale, dyer & singh, 2002), among several others, can influence the market reaction to the announcement. such studies inform us about the factors that might affect the processes that enable a firm to reap benefits from the resources involved in the venture. however, they inform us little about the nature of the resources brought to the joint venture by the partners that in the first place makes them amenable for possible synergy generation, and thus possible value creation. the degree of relatedness between two firms is one such factor that addresses the nature of the resources that may create value in the joint venture context (koh & venkatraman, 1991). relatedness refers to the extent to which the firms’ different lines of business or industries are likely to be able to be linked (luo, 2002). a common argument indicates that because firms from related industries generally possess resources that are similar (teece, 1982), any collaboration between them has the potential to render cost-based (i.e., economies of scope) and/or revenue-based (i.e., market power) synergies that affect a firm´s cash flow positively. suggesting that synergies of this type may be unavailable to deals between unrelated firms, some researchers have found that joint ventures announced by highly related partners produce a more favorable reaction from the stock market than those that are announced by unrelated partners (chan, kensinger, keown & martin, 1997; garciacasarejos, alcalde-fradejas & espitia-escuer, 2009; koh & venkatraman, 1991). notwithstanding, another view suggests that related firms are likely to experience rivalry complexities and other non-cooperative behaviors that may stifle any synergies between them. because such complexities arise mainly from overlapping of the firms´ competitive spheres (park & russo, 1996), they may be less likely to occur in the relationship between unrelated partners. in line with this argument, a variety of studies have found that the stock market reacts significantly and more positively to joint ventures announced by unrelated partners than to those announced by related ones (balakrishnan & koza, 1993; johnson & houston, 2000; kumar, 2010; park & kim, 1997; reuer & koza, 2000; sánchez-lorda, 2006). given the contradictory evidence, we still do not adequately know the level of relatedness that maximizes the stock market response to a joint venture´s announcement. further complicating the picture, several factors might alter the influence of firm relatedness on stock market reactions to joint venture announcements. the type 314 journal of business strategies of deal that firms announce is one such factor. in the main, it is evident that the type of alliance that firms form signals the type of synergies they are attempting to reap from the venture. past studies argue that horizontal, integrative, and scale alliances can generate cost-based synergies out of the sharing of similar resources that generate economies of scope (c.f., dussauge, garrette & mitchell, 2000; johnson & houston, 2000; park & russo, 1996). they also provide evidence that vertical, sequential, and link alliances may generate revenue-based synergies derived from resource complementarities. nevertheless, it is still necessary to examine in more depth if the effect of the inter-firm complexities that interfere with synergy generation varies across the different types of deals that firms announce with differently related partners. because inter-firm rivalry and non-cooperative behavior depend, in part, on the specific resources that firms bring into an alliance (kumar, 2010), we believe that operationalizing joint venture type by functional area (manufacturing versus marketing) helps to address such a gap in the joint venture literature. after all, the resources that firms bring into a joint venture differ according to the functional area in which firms want to collaborate through the alliance (anand & khana, 2000; swaminathan & moorman, 2009). in the context of the previous gaps in the joint venture literature, in this study we draw on resource-based theory (barney, ketchen & wright, 2011) to provide evidence concerning two inter-related questions. first, what is the association between a joint venture´s partners degree of relatedness and the stock market reaction to the venture announcement? second, how does a joint venture´s functional area moderate such an association? analyzing a sample of 214 joint ventures, our findings are in line with prior evidence indicating that inter-partner relatedness has a significant influence on stock market responses to a joint venture´s announcement. however, we contribute to the existing knowledge by suggesting and providing evidence that the market may exhibit sensitivity to the synergies generated by moderately related partners; i.e., synergies that are potentially unavailable to unrelated firms and that might be less affected by the complexities involved in the relationships between highly related partners. also, advancing beyond prior knowledge, we found that the market reaction to manufacturing and marketing joint ventures can differ according to the level of relatedness between the announcing firms. the rest of this paper is as follows. in the next section, we present the theory that promotes two hypotheses. next, we describe the research methods employed to verify them and show the results of the empirical investigation. we finish with a discussion of the findings, the limitations of the research, and some opportunities for further studies in the area. volume 31, number 2 315 theory and hypotheses taking a resource-based perspective, some studies suggest that a high degree of relatedness between a joint venture´s partners might maximize the benefits of the partnership. highly related firms, for example, are likely to control similar resources, which enables them to share plant capacity, facilities, expertise, and a variety of other tangible and intangible resources in order to reap economies of scale and/ or scope (teece, 1982). given their high product-market scope overlap, related firms might also be able to influence industry structure in order to gain market power (pfeffer & nowak, 1976). unrelated firms, in contrast, can exhibit a high degree of resource dissimilarity between themselves, and thus economies of scale and/or scope are limited or absent in their collaborative associations. therefore, joint venture formation between firms from related industries might improve the firms´ future cash flows more, and hence might trigger a more favorable reaction from the stock market analysts, than those between firms from unrelated industries. several studies show evidence in this direction (chan, et al., 1997; garcia-casarejos et al., 2009; koh & venkatraman, 1991). despite the above arguments and findings, a variety of studies report that joint ventures announced by unrelated partners may be the most valuable ones. balakrishnan and koza (1993), for example, argue that while resource sharing and other synergy potential between highly related firms may be possible, it is likely to be difficult to realize by means of a joint venture. they, and other researchers following the same line of thought (e.g., reuer & koza, 2000), argue that high relatedness between joint venture partners is likely to induce complexities associated with the management of a relationship with a competitor that can hinder synergy generation. such issues as inter-firm rivalry (park & russo, 1996), learning races (khana, gulati & nohria, 1998), and non-cooperative behavior in general (kumar, 2010) may make it difficult for highly related firms to synergize. unrelated firms are less likely to overlap in market scope and are thus less prone to such issues. further, though unrelated firms may be less likely to reap synergy gains given their high degree of resource dissimilarity, they can still benefit from learning about a future acquisition target and/or market exploration for future expansion that may offset some synergy or market power losses (kogut, 1991). in line with this view, various studies have found that the stock market generally reacts more positively to joint ventures announced by unrelated partners than to those announced by highly related ones (balakrishnan & koza, 1993; johnson & houston, 2000; park & kim, 1997; reuer & koza, 2000; sánchez-lorda, 2006). 316 journal of business strategies while the evidence to date appears to be contradictory, resource-based theory provides a perspective through which to examine the possibility that stock market returns are higher when firms announce deals with partners that are neither highly related nor completely unrelated to them. as applied to the joint venture context, resource-based theory indicates that a joint venture may allow the participating firms to bring together some of their resources in order to reap various benefits that would be difficult to obtain otherwise. the result of the pooling of two firms´ resources can potentially be more valuable, rare, and more difficult to imitate and substitute than the results that could be obtained should such resources be kept apart without the inter-firm collaboration (capron & hulland, 1999). as discussed previously, firms can achieve competitive advantage when they share some of their similar resources in order to reap economies of scope and scale that can drive costs down (koh & venkatraman, 1991). they can also combine some of their resources that are complementary in order to exploit combinations that could be valuable and novel, and that can increase their revenue base (schmidt & keil, 2013). cost-based and revenuebased benefits, however, might be lower when a joint venture´s partners are either highly related or unrelated than when they are moderately related. when two firms are completely unrelated, they control dissimilar resources that are likely difficult to share in order to realize economies of scale and scope. the combination of complementary resources is also likely to be difficult in these conditions because firms need at least some amount of resource interdependence in order to combine their resources effectively (milgrom & roberts, 1995; tanriverdi & venkatraman, 2005). and even though forming a joint venture with an unrelated partner could produce other benefits, such as having the opportunity to learn about a future acquisition target or the exploration of new markets for future expansion (kogut, 1991), such benefits are likely to materialize only in the long run. because long run benefits are difficult for the stock market analysts to estimate at the moment of an event´s announcement (zollo & meier, 2008), short run benefits are more likely to produce a favorable reaction from them. thus, even though the stock market reaction to joint venture deals announced by unrelated partners might be high, it is likely to be higher when firms form joint ventures with partners that possess resources that are dissimilar, but that are more likely to be interdependent and mutually supportive with theirs (wang & zajac, 2007). that is, the stock market reaction is likely to be higher to a joint venture between medially related partners that, as such, make it possible for a firm to reap synergies out of resource complementarities that can positively influence its cash flows in the short run. volume 31, number 2 317 unlike partners with moderate levels of mutual relatedness, those with higher degrees of relatedness possess resources that are more likely to be similar than complementary (tanriverdi & venkatraman, 2005; wang & zajac, 2007), and are therefore more apt to realize synergies out of resource sharing. however, even when the benefits associated with different types of synergies could be equally valuable, joint ventures announced by highly related partners may be likely to produce a lower impact on a firm´s cash flow given the inter-firm complexities that can be experienced in such ventures. when a firm forms a joint venture with a related partner, it is usually managing a relationship that could be expensive to such a degree that the cost of forming and managing the venture could be higher than its benefits. after all, highly related collaborators are likely to be close competitors and hence could experience a series of competitive rather than cooperative dynamics that interfere with resource sharing (kumar, 2010). rival partners may each implement expensive administrative controls in order to deter the other´s opportunistic inclinations (park & russo, 1996). in line with this thinking, there is evidence to suggest that when a firm wants to share resources with a highly related partner, it usually prefers to acquire it as an attempt to eliminate the complexities of an alliance (wang & zajac, 2007). because two less related firms are less likely to be close competitors (park & russo, 1996), joint ventures announced by moderately related partners are likely to be viewed as having the potential for a better impact on firm cash flows than those announced by highly related ones. on the whole, the preceding arguments suggest two main points. first, unlike joint ventures announced by unrelated firms, those announced by moderately related partners are likely to produce synergies that can increase the partners´ cash flow in the short run. second, unlike joint ventures announced by highly related partners, those that are announced by moderately related ones are less prone to experience the type of inter-firm complexities that might stifle synergy generation. this reasoning suggests the following hypothesis. hypothesis 1: there is an inverted curvilinear association between the degree of relatedness between joint venture partners and the stock market reaction to the joint venture announcement. there are reasons to believe, however, that the market could react differently depending on the functional area of the announced joint venture (anand & khana, 2000). a joint venture´s functional area is of interest because it is a significant determinant of the types of resources that firms bring together in the inter-firm col318 journal of business strategies laboration and may therefore influence the likelihood of gaining synergies and/or facing competitive challenges. while a variety of functional area joint ventures are possible, we focus here on two that typically involve different types of resources – manufacturing joint ventures and marketing joint ventures. for example, firms may bring in such resources as machinery, plant capacity, manufacturing knowledge, processes, and technologies to manufacturing partnerships (walters, peters & dess, 1994), but they may bring in brands, market knowledge, sales forces, and marketing management expertise when they form marketing joint ventures (capron & hulland, 1999; swaminathan & moorman, 2009). existing research does not provide sufficient evidence to make definitive claims regarding the differences in market reaction to manufacturing and marketing deals announced by firms. that said, the basic logic of relatedness provides a basis for the development of likely outcomes at different levels of relatedness between the joint venture firms. for example, the lack of similarity or complementarity among resources, found at low levels of relatedness between the partners suggests that the association between joint venture partner relatedness and the stock market reactions to the announcement of the joint venture is likely to be low for manufacturing as well as for marketing deals. further, when inter-firm relatedness is medium, synergistic benefits could be more easily realized in both types of deals because the firms´ resources are more likely to produce valuable complementarities. however, when inter-firm relatedness is high, there are reasons to speculate that the stock market could react more favorably to marketing joint ventures than to manufacturing ones. when a joint venture´s functional area is manufacturing and the degree of relatedness between the partners is high, inter-firm complexities are likely to hinder the benefits of the venture. when two manufacturing firms are highly related, they are likely to possess resources that can render cost-based synergies in the form of economies of scope (dussauge, et al., 2000). especially in regard to resources such as manufacturing knowledge and processes, however, similarity makes firms able to understand each other´s knowledge and capacities, and thus they can more easily appropriate the other´s resources and exploit them to their advantage (park & russo, 1996). when a joint venture partner attempts to appropriate resources, it is likely to be reciprocated with similar behavior, turning the partnership into a learning race or tit-for-tat situation that may stifle potential cost-based synergies in manufacturing contexts (kumar, 2010). additionally, shared decision making on machinery and plants is common in manufacturing alliances, and as each partner´s representatives try to maintain consistency between the alliance’s operations and their own practices, the partners are virtually guaranteed to clash occasionally (park & russo, 1996). volume 31, number 2 319 all this might even elevate the costs of the joint venture above its benefits for one or both of the partners. in contrast, when firms form marketing joint ventures and the degree of relatedness between them is high, they can still realize benefits that could have a positive impact on their cash flows. marketing resources such as brands and sales forces are based on a firm´s substantial historical investments in marketing communications that result in superior consumer awareness and positive consumer attitudes toward brands and sales forces (capron & hulland, 1999). this might diminish the ability or desire of the partners to imitate one another, and thus reduce the probability of learning races in marketing contexts. in addition, because brands with strong equities have a considerable value when they are extended to new product variants or product categories (capron & hulland, 1999; dacin & smith, 1994), firms can enjoy monopoly gains based on all of the products to which a brand is extended through the joint venture. chatterjee (1986) referred to these synergies as collusive and found them producing gains superior to those generated by cost-based synergies. in line with this evidence, capron and hulland (1999) found that such resources as brands, sales forces, and general marketing expertise produce revenue-based synergies that are more easily transferred between firms when the market similarity between them is high. overall, the preceding arguments suggest the following hypothesis. hypothesis 2: a joint venture´s functional area moderates the association between the degree of relatedness between joint venture partners and the stock market reaction to the joint venture announcement. this, in such a way that when relatedness between the venture partners is high, the stock market reactions are higher for marketing joint ventures than for manufacturing ones. methods sample data to test these hypotheses were gathered as part of a more comprehensive study of firm strategies between the years 2000 to 2003. lack of access to data after 2003 makes this year the forward limit of our time frame. in this study, a joint venture’s announcement as reported by the sdc platinum database is the unit of analysis. the sample was focused on only those joint venture deals involving two partnering firms announced during the years 2000 to 2003, and was further restrict320 journal of business strategies ed by including only those deals in which at least one firm is a u.s. based public manufacturing company (sic codes 2011-3999). sampling u.s. based public firms ensures the availability of data on stock market reactions to a firm’s joint venture announcement. sampling manufacturing firms broadly controls for type of business and focuses on a business segment where firms experience strong incentives to form partnerships in order to respond to intense global competition and realize efficiency gains (dussauge et al., 2000). for the purposes of the present study, our focal firms (those on which we focus the event study and the regression analysis) are the u.s. based firms that announced the joint venture. a search in the sdc platinum database produced 6476 joint venture announcements including two transacting companies during the years 2000 to 2003. according to the center for research in security prices (crsp), in 1383 out of 6476 cases at least one of the firms had a publicly available stock price on the day of the joint venture announcement. after the elimination of cases where neither of the partners was a u.s. based manufacturing company, 334 cases were left in the sample. after checking the accuracy of the joint ventures’ announcements in lexis-nexis, 104 observations were removed because there was no clear agreement regarding the joint venture announcement date and/or because the functional area of the venture was unclear. in line with the focus of hypothesis 2 on the potential moderating role of joint venture functional focus, all of the observations retained were agreements specifically created to manufacture or to market a good. after deletion of extreme outliers, a final sample of 214 joint venture announcements by u.s. based manufacturing firms was available for further analysis. as can be seen in table 1, the sample includes roughly similar numbers of joint ventures with a manufacturing focus and with a marketing focus. interestingly, the joint ventures included in the sample involved a significant number of partnerships with foreign firms (as non-focal firms), though these too were roughly evenly split between a focus on manufacturing and a focus on marketing. table 1 sample composition by joint venture functional area and partner origin*   1       table 1 sample composition by joint venture functional area and partner origin* *note: the focal firms in the sample are all u.s. based firms whose primary industry is manufacturing (sic 2011 – 3999) * note: the focal firms in the sample are all u.s. based firms whose primary industry is manufacturing (sic 2011 – 3999) volume 31, number 2 321 the sample is unevenly distributed in terms of joint venture activity across the years 2000 to 2003. activity was highest in the year 2000 followed by a progressive decline in the following years. this distribution is consistent with a decline in the u.s. economy during the sampled years, and is also very similar to the distribution for the entire pool of 6476 observations initially extracted from sdc. in this regard, the elimination criteria discussed previously appear not to have biased the sample to any significant degree. our sample (214 observations) contains both diversified and non-diversified firms in terms of classification of the overall corporate portfolio. the total number of focal firms in the sample is 155 (some firms have more than one joint venture in the period studied). in this pool of firms, non-diversified firms make up the majority (85 non-diversified firms versus 70 diversified firms). diversified firms, however, account for a majority of the observations included in the sample (128 cases for diversified firms versus 86 for non-diversified firms). variables measurement dependent variable: stock market reactions to joint venture announcements. following common practice in joint venture research within the strategy literature (e.g., koh & venkatraman, 1991), we operationalize this variable as the cumulative abnormal returns that firms experience in the stock market. we use a window of three days (-1, 0, +1) -that is, one day before the day of a joint venture announcement, the day of the announcement, and one day after. this three-day aggregation is undertaken in order to account for stock market reactions that may have been made before or after trading hours. cumulative abnormal returns are calculated by means of an event study following the method described by brown and warner (1985). the rate of return on the share price of firm i on day t is calculated by the equation: rit = α+βirit +ɛit, where rit is the rate of return of firm i’s share on day t, rmt is the rate of return on a given market portfolio of stocks, α is the intercept term, β equals stock i’s systematic (or market related) risk, and ɛit is the error term. based on this equation, a firm’s abnormal return can be calculated by the equation: arit= rit (ai+ bi rmt ) in this equation, ai and bi are the ordinary least squares parameter estimates produced by the regression of rit on rmt over the estimation period (t) preceding an event (e.g., 200 to 40 days prior to the event). arit, hence, represents the abnormal return, or the deviation 322 journal of business strategies of a firm’s stock price from the market price after investors have adjusted the firm’s stock price as a consequence of the announcement of a specific event. cumulative abnormal returns (car) for individual firms are obtained by accumulating arit over the event window. data to carry out the event study were obtained from crsp. it is worth noting that the fama-french four-factor model (fama & french, 1996) is an alternative method to estimate abnormal returns that has gained prominence in the finance literature. in this study, however, we utilize the brown and warner (1985) market model because it is widely used in strategy research (e.g. gulati et al., 2009; kumar, 2010; merchant & schendel, 2000), and thus makes our results more directly comparable to others in this area. in addition, some alliances studies have found very similar results when they employ both estimation methods en parallel (e.g. swaminathan & moorman, 2009). independent variable: joint venture partner relatedness. we measured this variable following a validated approach by merchant and schendel (2000). this approach consists in identifying and counting the number of sic codes that the firms in a joint venture have in common at the four-digit sic level and then dividing this number by the total number of four-digit sic codes that both companies cover. because this operation produces a wide range of values between 0.0 and 0.5, just as merchant and schendel (2000), and porrini (2004) did, we treat this measure as continuous. the extreme scores in this measure correspond to unrelated partners (0.0) and completely related partners (0.5). data to calculate this variable were extracted from the sdc platinum database. moderating variable: joint venture functional area. we operationalized functional area as a categorical variable that takes the value of one if a joint venture´s functional area is manufacturing and zero if it is marketing. initial categorization was based on data from sdc platinum, which provides descriptions of the alliances’ main purposes. these were then cross-checked in lexis-nexis for further accuracy. in addition, we controlled for several variables that prior research indicates may influence the stock market analysts´ reaction to the announcement of a joint venture. volume 31, number 2 323 control variables industry-adjusted firm profitability (focal firm). poorly performing firms are expected to continue that way in the short run. additionally, some industries are just more profitable than others. we deducted industry profitability from firm profitability. the former was calculated as the mean return on assets (roa) of all the firms in an industry during a given year. the latter was measured as roa for each firm in the sample during the years 2000 to 2003. in each case, roa was averaged over two years to reduce bias caused by single-year outliers. data were obtained from the compustat database. firm size. larger firms may have more resources to enhance the probability of alliance success (kale et al., 2002). we measured this variable as the natural logarithm of firms´ total assets. data were extracted from compustat. firm leverage. both favorable and unfavorable leverage positions can influence a firm’s financial outcomes. for instance, highly leveraged firms may be less inclined to undertake unprofitable strategic actions because they are more closely monitored by creditors (haleblian & finkelstein, 1999). we measured a focal firm´s leverage as its total debt divided by its total assets. data were extracted from compustat. diversified firm. based on the diversification discount hypothesis, diversified firms might experience less positive reactions from the stock market analysts to their strategic actions than non-diversified ones (villalonga, 2004). in the analysis, we included a categorical variable that took the value of one if a focal firm was diversified and zero otherwise. joint venture ownership configuration. ownership differentials can create incentives to cheat, as the partner with fewer resources invested in the venture may be tempted to undercut its contribution and free-ride on the contributions of the other partner (park and russo, 1996). we operationalized this variable as the square root of the subtraction of a firm’s percent ownership minus the percent ownership of its venture partner. data were obtained from sdc platinum. joint venture partner cultural distance. this factor may be associated with inter-firm cooperation, conflict resolution, organizational learning, and some other phenomena that affect the potential benefits of joint venture formation between firms from different countries. we employed kogut and singh´s index (1988) with data from hofstede, hofstede, and minkov (2010) to compute this variable. partner-specific joint venture experience. prior research indicates that repeated experience with a specific partner increases the probability that a firm can 324 journal of business strategies obtain benefits from joint venture formation. thus, this factor may positively influence the returns upon a joint venture announcement (gulati et al., 2009). we counted all the prior joint ventures that a focal company had formed with the same partner precedent to a focal joint venture and used this measure as a control. data were obtained from sdc platinum. relatedness with the joint venture. a high level of relatedness on the part of one partner with the joint venture´s operations has a positive influence on the stock market reactions to a joint venture´s announcement (garcia-casarejos et al., 2009). we measured this factor using a variant of haleblian and finkelstein´s (1999) scheme to measure inter-firm relatedness. the level of relatedness between a focal partner and the joint venture took the value of one if a focal firm´s and the joint venture´s primary sic codes matched at the level of two digit, two if the match was at the level of three digit, and three if the match existed at the four digit level. other control variables. several other controls were taken into consideration during preliminary analysis. year dummies were included to control for macroeconomic effects on stock market reactions (the year 2000 was the base). diversification degree was controlled by means of teece, rumelt, dosi and winter’s (1994) index with data from compustat. a categorical variable was included to control for the domestic-international status of the joint venture partner. institutional distance between international joint venture partners was measured using kogut and singh’s (1988) index with data from the world bank governance indicators. these controls were removed from the final statistical output, however, as they produced strongly non-significant coefficients that, given our small sample size, deteriorated the estimation models´ level of significance and statistical power. analysis and results table 2 provides descriptive statistics for this study’s variables. the results in this table indicate that the average cumulative abnormal return for the focal companies in the sample is 0.003 (sd = 0.053), a result statistically different from zero (p < 0.05). putting this in perspective, the average value created for the firms under study was $172 million, with 55 percent of the announcements resulting in gains. these results are in line with those reported in similar studies (e.g., gulati et al., 2009; swaminathan and moorman, 2009), and do not vary significantly when the event window comprises the day of the announcement and the day before (window = -1, 0; car = 0.0031, p < 0.01), or when it includes the day of the announcement and the day after (window = 0, +1; car = 0.004, p < 0.01). volume 31, number 2 325 keeping in mind that the measure of partner relatedness can vary from 0.0 (completely unrelated) to 0.5 (completely related), a perusal of table 2 further indicates that the average degree of inter-firm relatedness is low (0.069). in other words, a considerable number of joint ventures announced during the years of analysis were announced between less related partners. table 2 also provides correlations among this study’s variables. while there is no significant correlation between the stock market reactions to a joint venture´s announcement and the degree of relatedness between the announcing partners, this does not rule out a possible curvilinear relationship between these variables. table 2 also indicates no significant association between stock market reactions to a joint venture´s announcement and the joint venture’s functional area. preliminarily, this is a positive result in terms of the hypothesized moderating role of joint venture functional focus, as moderator variables should preferably not be significantly correlated with the dependent variable in a regression equation (baron & kenny, 1986). we employed panel data analysis techniques to test the hypotheses. the hausman test indicates that generalized least squares (gls) random effects estimation is appropriate for the data at hand (χ2 = 21.93, p > 0.05). because this study´s data are a small and unbalanced panel, a swamy-arora adjustment is implemented as derived in baltagi and chang (1994). 326 journal of business strategies   28   t ab le 2 d es cr ip ti ve s ta ti st ic s an d in te rc or re la ti on s of v ar ia bl es volume 31, number 2 327 ta bl e 3 g l s r an do m e ff ec ts e st im at io n on s to ck m ar ke t r ea ct io ns to j oi nt v en tu re a nn ou nc em en ts c o ef . st d .  e rr . c o ef . st d .  e rr . c o ef . st d .  e rr . c o ef . st d .  e rr . c on st an t 0. 00 4 0. 01 6 0. 01 48 0. 01 7 0. 01 39 0. 01 79 0. 01 48 0. 01 86 in du st ry -a dj us te d fi rm p ro fi ta bi lit y 0. 00 2 0. 00 7 0. 00 4 0. 00 7 0. 00 4 0. 00 7 0. 00 4 0. 00 7 fi rm s iz e -0 .0 02 0. 00 2 -0 .0 02 0. 00 2 -0 .0 02 0. 00 2 -0 .0 02 0. 00 2 fi rm le ve ra ge 0. 01 4 0. 02 2 0. 01 8 0. 02 2 0. 01 7 0. 02 2 0. 01 7 0. 02 2 d iv er si fi ed fi rm 0. 01 2 0. 00 8 0. 01 2 0. 00 8 0. 01 2 0. 00 8 0. 01 3 0. 00 8 jo in t v en tu re o w ne rs hi p co nf ig ur at io n 0. 00 1 0. 00 1 0. 00 1 0. 00 1 0. 00 1 0. 00 1 0. 00 1 0. 00 1 jo in t v en tu re p ar tn er c ul tu ra l d is ta nc e 0. 00 2 0. 00 3 0. 00 1 0. 00 3 0. 00 1 0. 00 3 0. 00 1 0. 00 3 pa rt ne rsp ec if ic jo in t v en tu re e xp er ie nc e -.0 17 ** 0. 00 7 -0 .0 18 ** 0. 00 7 -0 .0 18 ** 0. 00 7 -0 .0 18 * 0. 00 7 r el at ed ne ss w ith th e jo in t v en tu re 0. 00 2 0. 00 3 0. 00 1 0. 00 3 0. 00 2 0. 00 3 0. 00 2 0. 00 3 & jo in t v en tu re p ar tn er re la te dn es s 0. 14 48 * 0. 06 3 0. 21 48 ** 0. 07 16 0. 22 5* 0. 09 7 jo in t v en tu re p ar tn er re la te dn es s2 -0 .8 03 * 0. 33 7 -0 .7 44 * 0. 33 7 -0 .8 19 0. 56 3 jo in t v en tu re fu nc tio na l a re a -0 .0 02 0. 00 73 -0 .0 04 0. 01 06 jo in t v en tu re p ar tn er re la te dn es s x jo in t v en tu re fu nc tio na l a re a -0 .1 39 * 0. 06 89 -0 .1 57 0. 12 87 jo in t v en tu re p ar tn er re la te dn es s2 x j oi nt v en tu re fu nc tio na l a re a 0. 11 37 0. 70 16 r 2 w al d χ2 n = 21 4 t   =   p  <  .1 0. *   =   p  <  .0 5. **  =  p  <  .0 1. ** *   =   p  <  .0 01 m o d el  1 m o d el  2 m o d el  3 m o d el  4 ta bl e 3 g l s r an do m e ff ec ts e st im at io n on s to ck m ar ke t r ea ct io ns to j oi nt v en tu re a nn ou nc em en ts v ar ia bl es 9. 6% 22 .4 5* 5. 7% 12 .0 2 7. 8% 18 .1 3* 9. 6% 22 .5 1* 328 journal of business strategies table 3 shows tests for this study´s hypotheses. it contains mean-centered variables to avoid multicollinearity problems between linear, quadratic, and interaction terms. model 1 includes only control variables; it fits the data poorly (wald χ2 = 12.02, p > .10). hypothesis 1 suggests that there is an inverted curvilinear association between joint venture partner relatedness and stock market reactions to joint venture announcements. in table 3, model 2 contains, in addition to control variables, joint venture partner relatedness linear and quadratic terms. this model indicates that both the linear and the quadratic joint venture partner relatedness terms are significant and different from zero. whereas the linear term is positive, the quadratic term is negative, a pattern that is consistent with a non-symmetric inverted u-shaped relationship as described by aiken and west (1991). model 2 fits the data well (wald χ2 = 18.13, p < .05). however, before claiming support for hypothesis 1, we determined the inflection point associated with the nonlinear effects of joint venture partner relatedness on stock market reactions to a joint venture´s announcement. to do this, we calculated the first partial derivative of the regression equation shown in table 3, model 2. such a point is 0.09. at this point, returns from increasing relatedness are at a maximum, and they begin to diminish. note that 0.09 is higher than the mean joint venture partner relatedness of the sample (0.069). still, given that the joint venture partner relatedness scale ranges from 0.0 to 0.5, the inflection point falls in the low range. all together, the evidence mentioned so far provides partial support for hypothesis 1. hypothesis 2 predicts that joint venture functional area moderates the association indicated in hypothesis 1. in table 3, model 3 includes a linear by linear interaction term (joint venture partner relatedness x joint venture functional area) in addition to the control variables, the linear and quadratic terms of joint venture partner relatedness, and the joint venture functional area linear term. results from model 3 indicate that not only is the interaction term significant, but also the linear joint venture partner relatedness term becomes stronger and more significant when the interaction term is present (i.e., compared to model 2). model 3 fits the data well (wald χ2 = 22.52, p < .05). to determine the point at which returns from increasing relatedness are at a maximum depending on whether the announced joint ventures’ functional areas were marketing or manufacturing, we calculated the first partial derivative of the regression equation presented in model 3. the point is 0.05 when the area is manufacturing, and 0.14 when it is marketing. all together, this evidence provides strong support for hypothesis 2. volume 31, number 2 329 as a final test, model 4, in table 3, includes an interaction term formed by the joint venture partner relatedness squared term and the joint venture functional area linear term. the fact that this term is not significant and its inclusion does not improve the model fit suggests that the association predicted in hypothesis 1 does not change the nature of its concavity (upward / downward) across different functional areas. the results just described are presented pictorially in figure 1. as can be seen, when a joint venture´s functional area is manufacturing, the association between joint venture partner relatedness and stock market reactions to a joint venture´s announcement follows a curvilinear pattern. however, this pattern is flatter than that for marketing joint ventures. consistent with hypothesis 2, figure 1 shows that under conditions of high relatedness between joint venture partners, stock market reactions to marketing joint ventures are higher than those to manufacturing ones. figure 1 stock market returns to marketing and manufacturing joint ventures   30   figure 1 stock market returns to marketing and manufacturing joint ventures before turning to the discussion of the preceding results, it is worth noting some additional pieces of information. although r2s in table 3 are low, they are in accordance with most studies that use stock market reactions as the dependent variable (e.g., haleblian & finkelstein, 1999). moreover, the results of table 3 remain very similar even when stock market reactions are accumulated over a two-day (-1, 330 journal of business strategies 0 or 0, +1) rather than a three-day window. finally, analysis for multicolinearity suggests that this is not likely to be an undue influence on the results. the highest variance inflation factor (vif) is returned for the squared joint venture relatedness variable, but all vifs are within acceptable ranges. discussion in this study, we aimed to contribute to the discussion about the factors that influence the stock market reaction to a joint venture´s announcement. in order to accomplish this objective, we focused on the degree of relatedness between a joint venture´s partners, as this factor speaks about the nature of the resources that firms bring into the collaborative agreement and the type of synergies and complexities that can be generated. in order to better understand this phenomenon, we also investigated the moderating role of joint venture functional area, as synergy generation and the inter-firm complexities that hinder it may depend on the actual resources that firms bring into the venture. results of this investigation both support and extend existing knowledge on the topic. at a broad level, and in accordance with the preponderance of the results in the pertinent literature, we found that the degree of relatedness between a joint venture´s partners has a significant effect on the stock market responses to its announcement. as such, it would appear that the market evaluates the potential value creation coming from joint ventures at least in part based on the level of relatedness between the two firms. the findings presented here, however, go beyond the existing contradictory evidence, as we found support for the argument, built from a resourcebased theory foundation, that returns are at a maximum when the level of relatedness between the partners is neither too high nor too low. interestingly, the results indicate that returns reach a maximum at a relatively low level of inter-partner relatedness, suggesting that while the market sees the potential synergies that may be available to moderately related partners and that are unavailable to unrelated firms, too much relatedness may raise concerns. while by no means conclusive in terms of cause, these results are in line with the view that synergies growing out of resource complementarities are best accomplished with a limited degree of relatedness. that is, the greatest gains may be found where achievement of such synergies is less likely to be hindered by the inter-firm complexities growing out of competitive concerns over resource similarities that can occur between more highly related partners. the findings reported here concerning the differences in stock market reactions to manufacturing and marketing joint ventures are also in line with such a view. volume 31, number 2 331 we found that stock market returns are, in general, significantly higher for related partners when they announce a marketing joint venture that when they announce a manufacturing one. the archival nature of the data do not allow for direct assessment of the thinking that generated such results. a case can be made, however, that greater relatedness between partners in marketing based joint ventures is less likely to generate inter-firm complexities that might constrain the achievement of synergies. that is, because marketing deals do not generally require as much exchange of proprietary knowledge or skills as do manufacturing joint ventures, the benefits argued for relatedness may be more easily achieved for marketing joint ventures even when the partners are more highly related. we recognize, though, that like all studies, there are limitations that suggest caution be used in extending or generalizing the findings presented here. for example, the fact that the sample contains many joint ventures announced by unrelated partners may have influenced the point at which the inverted association between inter-partner relatedness and returns upon joint venture announcements reached its maximum. other studies with more balanced samples might examine if the inflection of the curve really peaks at the relatively low level of relatedness found here. also, while suggestive, the nature of the data and approach utilized here does not allow for direct causal analysis nor allow for any direct observation of the thinking that is driving the stock market reactions to different joint venture announcements. that said, the current findings should serve to encourage further research aimed at clarifying the controversies regarding the role of relatedness in explaining the benefits likely to accrue to joint ventures. clearly, joint ventures remain a popular and appropriate means for firms to access and develop resources and capabilities in a timely and cost effective manner. clarity regarding the most appropriate choice of partners for such ventures, however, has remained elusive. the current findings of an inverted relationship peaking at a relatively low level of relatedness and a moderating role on this relationship for joint venture focus add to our understanding. both suggest that there is likely a balance to be found between having enough relatedness between partners to allow for the development of complementarities and having enough differences so that these complementarities can be pursued without undue competitive concerns between the partners. thus, in the end, we hope that the present study serves as a stepping stone for future research in the choice of joint venture partners. 332 journal of business strategies references aiken l., & west, s. g. (1991). multiple regression: testing and interpreting interactions. thousand oaks, ca: sage. anand, b. & khana, t. (2000). do firms learn to create value? the case of alliances. strategic management journal, 21(3), 295-315. balakrishnan, s., & koza, m. (1993). information asymmetry, adverse selection, and joint ventures. theory and evidence. journal of economic behavior and organization, 20, 99-117. baltagi b., & chang, y. (1994). incomplete panels: a comparative study of alternative estimations for the unbalanced one-way error component regression model. journal of econometrics, 62, 67-89. barney, j. b., ketchen, d. j., & wright, m. (2011). the future of resource basedtheory: revitalization or decline? journal of management, 37(5), 1299-1315. baron, r. m., & kenny, d. a. (1986). the moderator-mediator variable distinction in social psychological research: conceptual, strategic, and statistical considerations. journal of personality and social psychology, 51(6), 1173-1182. beamish, p. w., & lupton, n. c. (2009). managing joint ventures. the academy of management perspectives, 23(2), 75-94. brown, s., & warner, j. (1985). using daily stock returns. the case of event studies. journal of financial economics, 14, 3-31. capron, l., & hulland, j. (1999). redeployment of brands, sales forces, and general marketing management expertise following horizontal acquisitions: a resourcebased view. journal of marketing, 63(2), 41-54. su han, c., kensinger, j. w., keown, a. j., & martin, j. d. (1997). do strategic alliances create value? journal of financial economics, 46(2), 199-221. chatterjee, s. (1986). types of synergy and economic value: the impact of acquisitions on merging and rival firms. strategic management journal, 7(2), 119-139. dacin, p. a., & smith, d. c. (1994). the effect of brand portfolio characteristics on consumer evaluations of brand extensions. journal of marketing research (jmr), 31(2), 229-242. dussauge, p., garrette, b., & mitchell, w. (2000). learning from competing partners: outcomes and durations of scale and link alliances in europe, north america, and asia. strategic management journal, (2), 99-126. fama, e. f., & french, k. r. (1996). multifactor explanations of asset pricing anomalies. journal of finance, 51(1), 55-84. volume 31, number 2 333 garcia-casarejos, n., alcalde-fradejas, n., & espitia-escuer, m. (2009). staying close to the core: lessons from studying the costs of unrelated alliances in spanish banking. long range planning, 42(2), 194-215. gulati, r., lavie, d. & singh, h. (2009). the nature of partnering experience and the gains from alliances. strategic management journal, 30(11), 1213-1233. haleblian, j., & finkelstein, s. (1999). the influence of organizational acquisition experience on acquisition performance: a behavioral learning perspective. administrative science quarterly, 44(1), 29-56. hofstede, g., hofstede, g. & minkow, m. (2010). cultures and organizations: software of the mind. ny: mcgraw-hill. johnson, s. a., & houston, m. b. (2000). a reexamination of the motives and gains in joint ventures. journal of financial and quantitative analysis, 35(1), 67-85. khana, t., gulati, r. & nohria, n. (1998). the dynamics of learning alliances: competition cooperation and relative scope. strategic management journal, 19(3), 193-210. kale, p., dyer, j. h. & singh, h. (2002). alliance capability, stock market response, and long-term success: the role of the alliance function. strategic management journal, 23(8), 747-767. kogut, b. (1988). joint ventures: theoretical and empirical perspectives. strategic management journal, 9(4), 319-335. kogut, b. (1991). joint ventures and the option to expand and acquire. management science, 37(1), 19-33. kogut, & singh, h. (1988). the effect of national culture on the choice of entry mode. journal of international business studies, (3). 411-432. koh, j., & venkatraman, n. (1991). joint venture formations and stock marke treactions: assessment in the information technology sector. academy of management journal, 34(4), 869-892. kumar, m. s. (2010). are joint ventures positive sum games? the relative effects of cooperative and noncooperative behavior. strategic management journal, 32(1), 32-54. luo, y. (2002). product diversification in international joint ventures: performance implications in an emerging market. strategic management journal, (1), 1-20. mcconnell, j. j., & nantell, t. j. (1985). corporate combinations and common stock returns: the case of joint ventures. journal of finance, 40(2), 519-536. mcwilliams, a., & siegel, d. (1997). event studies in management research: theoretical and empirical issues. academy of management journal, 40(3), 626-657. 334 journal of business strategies merchant, h., & schendel, d. (2000). how do international joint ventures create shareholder value? strategic management journal, 21(7), 723-737. milgrom, p., & roberts, j. (1995). complementarities and fit. strategy, structure, and organizational change in manufacturing. journal of accounting and economics, 19(2/3), 179-208. park, s. h., & kim, d. (1997). market valuation of joint ventures: joint venture characteristics and wealth gains. journal of business venturing, 12(2), 83-108. seung ho, p., & russo, m. v. (1996). when competition eclipses cooperation: an event history analysis of joint venture failure. management science, 42(6), 875890. pffefer, j., & nowak, p. (1976). joint ventures and inter-organizational inter-dependence. administrative science quarterly, 21, 398-418. porrini, p. (2004). can a previous alliance between an acquirer and a target affect acquisition performance? journal of management, 30(4), 545-562. reuer, j. j., & koza, m. p. (2000). asymmetric information and joint venture performance: theory and evidence from domestic and international joint ventures. strategic management journal, (1). 81-88. sánchez-lorda, p. (2006). stock market response to acquisitions and alliances in the european telecom industry: an information asymmetry perspective. etri journal, 28, 638-647. schmidt, j., keil, t. (2013). what makes a resource valuable? identifying the drivers of firm-idiosyncratic resource value. academy of management review, 38(2), 206-228. swaminathan, v., & moorman, c. (2009). marketing alliances, firm networks, and firm value creation. journal of marketing, 73(5), 52-69. tanriverdi, h., & venkatraman, n. (2005). knowledge relatedness and the performance of multibusiness firms. strategic management journal, 26(2), 97-119. teece, d. j. (1982). toward an economic theory of the multiproduct firm. journal of economic behavior and organization, 3, 39-63. teece, d., rumelt, r., dosi, g., & winter, s. (1994). understanding corporate coherence. theory and evidence. journal of economic behavior and organization, 23, 1-30. villalonga, b. (2004). diversification discount or premium? new evidence from the business information tracking series. journal of finance, 59(2), 479-506. wang, l., & zajac, e. (2007). alliance or acquisition? a dyadic perspective on interfirm resource combinations. strategic management journal, 28, 1291-1317. volume 31, number 2 335 walters, b. a., peters, s., & dess, g. (1994). strategic alliances and joint ventures: making them work. business horizons, 37(4), 5-10. zollo, m., & meier, d. (2008). what is m&a performance? the academy of management perspectives, 22(3), 55-77. biographical sketch of authors daniel a. cernas ortiz is a faculty member in the accounting and administration school (facultad de contaduría y administración) at the universidad autónoma del estado de méxico. he received his ph.d. from the university of north texas. his research interest focuses on several areas but most often on corporate level strategy topics such as diversification, acquisitions and alliances. grant miles is an associate professor in the maine business school at the university of maine. he received his ph.d. from the pennsylvania state university. his research, which has appeared in many of the top academic and practitioner journals, covers a range of areas but focuses most often on the role of collaboration in the process of sustainable organizational adaptation and the implications of this for new ways of organizing. journal of business strategies (2022) 39: 33-59 https://doi.org/10.54155/jbs.39.1.33-59 received: december 2021 / revision received: march 2022 / accepted: march 2022 integrating informal learning into deployment planning and project scheduling michael jahra, felix mynarekb a corresponding author. department for management, european university of applied sciences, kaiserstraße 6, 50321 brühl, germany. m.w.jahr@gmx.de b department of marketing and management, university of hohenheim, schwerzstr. 42, 70599 stuttgart, germany. felix.mynarek@t-online.de keywords abstract informal learning; hybrid approach; multi-criteria optimization; simulation dynamic organizations constantly search for new ways to improve the quality of their processes. a core element of these efforts is the integration of informal learning into daily workflows. interdisciplinary research is required to accomplish this challenging task and make informal learning manageable. in this study, we propose a novel combination of organizational theory and operational research using a quantitative project scheduling approach to create efficient workflows, including systematized informal learning. the concept of integrating the informal learning activities of knowledge sharing, reflection, and self-organization is presented based on a multi-objective, multi-resource constrained project scheduling problem with limited renewable resources, activity splitting, and preemption. additional simulation studies demonstrate the calculation of informal learning ratios, together with further discussion of strategic management options. this work is licensed under a creative commons attribution-noncommercial 4.0 international license. copyright (c) 2022 michael jahr, felix myranek. https://doi.org/10.54155/jbs.39.1.33-59 m.w.jahr@gmx.de felix.mynarek@t-online.de 34 jahr and mynarek / journal of business strategies (2022) 39:33-59 1. introduction the advancing digitalization of economic processes requires optimized integration of different management tasks. furthermore, a crucial characteristic of the fourth industrial revolution is a dynamic change to flatten hierarchies and agile management (benkenstein et al., 2017). informal learning is a growing research field that requires an interdisciplinary perspective (cerasoli et al., 2018). therefore, organizations that are subject to digital transformation need an understanding of agility and learning that adapts to their organizational type (e.g., functional, matrix, or project-oriented), structure, and culture (bigelow & barney, 2021; claver-cortés et al., 2012; verhoef et al., 2021). learning is a complex and idiosyncratic internal process involving an individual’s cognitive, emotional, and motivational resources (freigang et al., 2018). however, formal learning, which comprises structured learning content, has weaknesses in promoting further learning (blume et al., 2010). in contrast, informal learning focuses on individual learning by providing employees control over their learning processes in the workplace (gulati & puranam, 2009; sambrook, 2005). cerasoli et al. (2018) indicate that up to 90 percent of organizational learning occurs informally rather than through formal training. consequently, organizations must create and foster conditions that support systematic informal learning, which is characterized as being unstructured and unguided (garćıa-peñalvo & conde, 2014).therefore, integrating informal learning into business processes and systematically measuring possible effects is a challenging management task and a significant success factor (blit, 2017). this is also highlighted by march (1991), who indicates that proper use of information technology and organizational learning is likely to improve competitive positions. we consider a systematic integration of informal learning behaviors into operations management, that is, quantitative project scheduling, based on the resource constraint project scheduling problem (rcpsp), presented inter alia by brucker et al. (1999), hartmann and briskorn (2010), kataoka et al. (2019), and speranza and vercellis (1993).the contribution of this study is twofold. first, we extend classical quantitative scheduling to create a multi-objective perspective and include a manageable procedure to incorporate the three informal learning behaviors: (1) knowledge sharing, (2) reflection, and (3) self-organization. second, we provide a concept for jahr and mynarek / journal of business strategies (2022) 39:33-59 35 measuring the impact of informal learning on project performance (edmondson & mcmanus, 2007; sauermann & stephan, 2013). the resulting novel learning-oriented hybrid scheduling approach provides managers with stable structures to learn exploitation strategies (fang et al., 2010; posen & levinthal, 2012) and helps them develop their businesses toward continuous learning organizations (greve, 2020). the remainder of this paper is organized as follows. section 2 describes the role and possible challenges in managing informal learning. the process of integrating informal learning behaviors into project scheduling and the concept for measuring the effects of informal learning are presented in section 3. furthermore, in section 4, we present a mathematical model for informal learning-oriented project scheduling. insights into the model structure and simulation analysis are provided in section 5, based on a use case from the it service industry. finally, a discussion in section 6 and conclusions provided in section 7 conclude the article. 2. the role of informal learning behaviors informal learning promotes employee motivation and participation, and increases job satisfaction as uncertainty is reduced through newly-acquired knowledge and abilities (zhang et al., 2020). it helps expand experience, and activities can be performed more routinely with fewer errors (guadalupi, 2018). thus, informal learning increases performance and allows further learning by fulfilling the three basic psychological needs of competence, relatedness, and autonomy (ryan & deci, 2017). from a management perspective, informal learning contains a deficit in that it mostly takes place unintentionally and is, therefore, hardly tangible. most practical knowledge is inevitably developed in this manner (cefis et al., 2020; noe et al., 2010; shepherd et al., 2014). informal learning is highly situation-specific; that is, the learning effect experienced in general routines depends on its context. thus, it requires abstraction skills at a higher level and the ability to transfer the acquired knowledge to new contexts (cerasoli et al., 2018). consequently, the acquired knowledge is not necessarily reflected in the individual’s behavior, but in the expanded potential for behavioral flexibility (hoyle, 2015). furthermore, the application of new capabilities depends on organizational conditions and individuals’ mindset (jiang et al., 2016). therefore, in addition to the external aspects of learning, subjective internal aspects are important and can only 36 jahr and mynarek / journal of business strategies (2022) 39:33-59 be modified under certain conditions (matsuo, 2019; tews et al., 2017). for businesses, it is important to channel informal learning activities, make knowledge available to the entire organization, and build competencies (zhang et al., 2020). in addition to traditional ways of improving job performance and learning, such as advanced trainings, seminars, and annual reviews with supervisors or formal guidance, organizations should identify new ways to support informal learning. managers and employees need work schedules that provide a certain level of free space or agility embedded in the overall working process without endangering strategic company goals in terms of customer satisfaction and market position. therefore, we intend to create working environments (workflows) that promote informal learning behaviors (bednall et al., 2014; thomas et al., 2001). particularly, the evaluation of learning embedded in social interactions and teams should be made possible (guadalupi, 2018; yakhlef, 2010). in this context, informal learning behaviors refer to three specific factors: knowledge sharing, reflection, and self-organization (bednall et al., 2014). we consider complex business projects that characteristically show high potential for (informal) learning based on their dynamic structure (jahr, 2014). therefore, we aim to systematize traceable time slots for learning activities in a project schedule and make informal learning manageable (1). however, owing to their complex structure, it is, in principle, not possible to simply add dummy activities for learning to project schedules. moreover, projects must be cost and time efficient. consequently, we use operational research to optimize schedules. 3. a concept for integrating and measuring informal learning behaviors in business projects we use a modified operational research algorithm (model mrcpssle, see section 4) to generate optimal project schedules, including optimized time slots that can be used for systematic informal learning activities. figure 1 shows the process of integrating and measuring informal learning behaviors in optimal project schedules. first, the project structure is established. here, we consider a multi-objective approach, including project efficiency, measured by the total project duration, and project quality, which is also time-based, as a proxy for activity efforts. this creates a conflict as both objectives are negatively correlated, that is, increasing project durations indicate increasing efforts and thus qualjahr and mynarek / journal of business strategies (2022) 39:33-59 37 f ig u re 1 : p ro ce ss o f sy st em iz in g in fo rm a l le a rn in g in p ro je ct s 38 jahr and mynarek / journal of business strategies (2022) 39:33-59 ity, but at the same time decreasing efficiency, which is given by reductions in project durations. it is important for businesses to optimize efficiency and quality to meet customer needs. in the mathematical model, strategic orientation is depicted by a target weight 0 ≤ w ≤ 1. in the next step, project activities subject to learning must be identified. the model structure allows for learning to be assigned to any activity. however, it is more likely that learning, in particular, occurs in value-adding tasks, such as code programming and software design (see section 5). therefore, a learning time slot factor α is integrated into the activity-shifting constraint. we propose that this factor is related to the trade-off in the objective function by assuming a linear functional relationship (1). w = 1 2 α (1) based on the weight value range and equation (1), the time slot factor 0 ≤ α ≤ 2 can maximally force an activity to take twice its duration for possible learning activities, which is a realistic upper bound for maximum delays (jahr, 2014). additionally, if quality is not considered in a project run (w = 0), then there are no additional explicit time slots for learning, and the project focus is solely on efficiency (1 − w). the optimal schedule offers different types of time slots for learning activities (section 4). therefore, an adequate type of informal learning behavior depends on the number of available free resources. for example, if all resources are available in a scheduled time slice, knowledge-sharing learning formats can be planned (e.g., barcamp). in the case of a reduced number of free resources, reflectionlearning formats are possible (e.g., lean coffee or working-out-loud). finally, if only individuals are free, they can use self-organized learning formats (digital internal (wikis) or external company platforms). hence, the schedule is complemented by suitable learning time slots that offer identifiable shares of the total project duration. consequently, the repeated execution of projects with similar resources can be monitored by an informal learning ratio (ilr). ilr = tsilk tdk · 100% ∀k ∈ k (2) the ilr considers the share of informal learning on total team days (sum of employees assigned to activities, multiplied with the process times of the jahr and mynarek / journal of business strategies (2022) 39:33-59 39 activities) in each project run k ∈ k. thus, the denominator is the total number of team days in the project. the numerator (3) collects those informal learning time slices in the optimal schedule that extend the considered pure activity durations and, hence, are intended for informal learning activities. tsilk = ilj∑ j=1 m∑ m=1 [(cj − sj) − pjm] (3) the difference between a job completion time and starting time (cj − sj) indicates the actual job execution. if the execution time is equal to the jobprocessing time in modes m , pjm, then there is no extra time in terms of activity-split or preemption (see section 4). positive and increasing informal learning ratios between runs k ∈ k are beneficial in principle. however, next to the ilr, the project duration must be controlled to monitor project efficiency. for example, an increasing numerator at a constant denominator indicates that more time is spent on informal learning activities; that is, more resources (employees) could participate in the format. simultaneously, if the project duration remains constant, then there is also an indication of learning (curve) effects (wright, 1936) with a positive impact on efficiency (e.g., section 5, table 1, scenario variation w = 0.6). by contrast, increasing denominators can decrease the ilr and hence indicate fewer options for employees to participate in informal learning formats. these findings are also in accordance with the learning curve paradigm (wright, 1936). 4. learning-oriented multi-objective resource constrained project scheduling to generate optimal project schedules, we consider relevant types of scheduling models based on the (rcpsp), which is a well-examined and highly complex planning problem (ballest́ın et al., 2008; hartmann & drexl, 1998). we use the basic formulation introduced by buddhakulsomsiri and kim (2006) to provide an easily traceable mathematical formulation. this formulation provides chronological starting and completion times for project activities and includes activity splitting and preemption. however, we extend their model by using four elements. we consider optimizing multiple weighted criteria, taking into account the total project duration and project quality (constraint 4). furthermore, we incorporate direct resource-to-job assignment (constraint 5) and resource-dependent renewable capacities (constraint 12). 40 jahr and mynarek / journal of business strategies (2022) 39:33-59 moreover, we incorporate learning time slot factors (constraint 6). therefore, the relationship (1) is not explicitly modelled within a constraint to maintain a mixed-linear structure and prevent nonlinearity. thus, the factors w and a are calculated separately in the process (see figure 1 and the appendix). in this case, the individual learning time slots can be assigned α = ∑a j=1 αj . a supportive learning environment is defined as a schedule that creates specific time slots for informal learning activities. these time slots are automatically assigned via sequencing. figure 1 shows that the underlying activity-on-node network (aon) must identify relevant activities for informal learning, such as meetings. in this case, the model must ensure that all resources are assigned to this activity in one time period and, therefore, book a joint time slot. in addition, capacity constraint scheduling can result in activity splitting and preemption, thereby creating time slots with free resources (razavi & mozayani, 2007; vanhoucke & coelho, 2019; zare, 2012). thus, both procedures generate additional free time slots. however, in addition to providing a feasible and efficient schedule, the model offers limited possible shifting for manual control. here, we assume two different simple effort levels (high and low) for service projects, that is, software projects (coelho & vanhoucke, 2011). however, the operation modes can also be used to represent any technical element. the resulting multiobjective resource constraint project scheduling for self-organized learning (mrcpssle) considers multiple objectives, multiple operation modes, limited renewable resources, activity-splitting, preemption usable for informal learning activities next to intended meeting activities, and reflection during the process of an activity and self-organization by directly assigning resources to jobs. we use the following notations: indices j ∈ a — jobs index and (i, j) ∈ v precedence relation of jobs i and j m — operation modes index r — renewable resources index t — time index jahr and mynarek / journal of business strategies (2022) 39:33-59 41 parameters ajrm — the capacity utilization coefficient for job j ∈ a performed by resource r ∈ r in mode m ∈ m αjm — learning slot factor in jobs j ∈ a in mode m ∈ m λjrm — binary parameter to designate whether resource r ∈ r is able to perform job j ∈ a (λjrm = 1) or not (λjrm = 0) krt — renewable capacity of resource r ∈ r in time period t ∈ t pjm — processing time for job j ∈ a in operation mode m ∈ m estj — earliest starting time of job j ∈ a letj — latest ending time of job j ∈ a n — large number or maximum project horizon, respectively w — objective function weights variables xjrmt — binary variable indicating the actual time periods t ∈ t in which jobs j ∈ a are performed in mode m ∈ m using resource r ∈ r yjm — binary variable allocation mode m ∈ m for job j ∈ a sj — positive variable indicating starting time of job j ∈ a cj — positive variable indicating completion time of job j ∈ a the model the model can then be formulated as follows. max z = w ∗ q − (1 − w) ∗ cj (4) subject to m∑ m=1 yjm = 1, ∀j ∈ a (5) t∑ t=1 xjrmt = pjm (1 + αjm) yjmλjrm, ∀j ∈ a, r ∈ r, m ∈ m (6) ci ≤ sj − 1, ∀(i, j) ∈ v (7) sj ≤ xjrmt ∗ t + n ∗ (1 − xjrmt), ∀j ∈ a, r ∈ r, m ∈ m, t ∈ t (8) cj ≥ xjrmt ∗ t, ∀j ∈ a, r ∈ r, m ∈ m, t ∈ t (9) sj ≥ estj − 1, ∀(j) ∈ a (10) cj ≤ letj − 1, ∀(j) ∈ a (11) 42 jahr and mynarek / journal of business strategies (2022) 39:33-59 krt ≥ a∑ j=1 m∑ m=1 ajrm ∗ xjrmt, ∀r ∈ r, t ∈ t (12) q = a∑ j=1 r∑ r=1 m∑ m=1 pjm ∗ (1 + αjm) ∗ yjm ∗ λjrm (13) xjrmt ∈ {0, 1}, ∀j ∈ a, r ∈ r, m ∈ m, t ∈ t (14) yjm ∈ {0, 1}, ∀j ∈ a, m ∈ m (15) sj ≥ 0, ∀j ∈ a (16) cj ≥ 0, ∀j ∈ a (17) the objective function (4) considers the completion time of the last job cj and thus, the total project duration or makespan. from the customer (and cost) perspective, shorter completion times are preferred (liu & cheng, 2004). we assume that the quality of the project (or product) will increase with a longer total processing time, q (chen et al., 2020; shepherd et al., 2014). furthermore, employee motivation will probably improve as less time pressure favors an individual’s participation in the job (schaufeli et al., 2009). hence, the objective function is a weighted multi-criteria function with weights w and (1 − w) seeking efficient alternatives for the opposing goal variables. as the objective function represents discrete optimization, one must consider that an optimal solution cannot be guaranteed. in fact, it is more likely that only the relevant efficient alternatives are selected using this approach (see figure 2).thus, available potentially good compromises may be disregarded by optimization, depending on the weight definition (olson, 2001; t’kindt & billaut, 2001). however, the automated calculation of efficient solutions is still a significant benefit compared with the widely used standard manual scheduling (abedinnia et al., 2017). mode allocation condition (5) ensures that a job is performed in only one operation mode, that is, the effort levels for the jobs. applying less effort to perform a job, and hence, reducing processing times, results in a shorter makespan. this may lead to longer processing times for follow-up rework and troubleshooting. therefore, the expected quality of the project will decrease if less time is spent performing the project. therefore, we show a positive correlation between project effort and quality (see figure 2 ). job distribution condition (6) splits the total job processing time (rightjahr and mynarek / journal of business strategies (2022) 39:33-59 43 f ig u re 2 : s o lu ti o n sp a ce in d is cr et e m u lt ic ri te ri a o p ti m iz a ti o n 44 jahr and mynarek / journal of business strategies (2022) 39:33-59 figure 3: job schedule example with job-splitting and preemption hand side) into parts along the time axis (left-hand side). accordingly, the activity splitting and preemption of jobs can be depicted in combination with constraints (7) to (11) (ballest́ın et al., 2009). figure 3 shows the basic functions. the positive variables sj and cj indicate the time span in which a job can be performed (owing to the model and data structure, they take integer values). however, the time periods within the time span in which the jobs are actually performed are given by the binary variables xjrm, and t. consequently, a job can be interrupted and resumed within the time interval and/or preempted earlier than the possible completion time. however, each completion of a job requires corresponding capacity units. furthermore, in constraint (6), α is added to the processing time. the qualification for a job is considered by the binary parameter λjr. assigning only suitable resources is also part of the self-organization aspect. in constraint (7), the sequence relations between jobs are considered (de reyck & herroelen, 1999). hence, the predecessor job i must be completed before successor job j can start. constraints (8)–(11) ensure that jobs start with their first part before the completion of their last part within the possible time span from the earliest starting time to the latest completion time (elmaghraby, 1977; kelley, 1963). in constraint (12), renewable resource capacities are considered so that the processing of a job part does not exceed the available capacities in a specific time period. constraint (13) is the total processing time, which is a proxy for the project quality. finally, constraints (14)–(17) define the decision variables. 5. use case simulation study for the analysis, we consider the real-life use case of a software service provider for customized it applications with a maximum project horizon of n=135 days (jahr, 2014). figure 4 shows the aon project. after team kick-off, the project specifications and time requirements were determined. jahr and mynarek / journal of business strategies (2022) 39:33-59 45 then, team member-specific jobs are performed, such as budget and scope calculations, customer coordination, and creating the technical system structure. following the first-level front-end and back-end programming, the first team meeting must be assigned to collect the lessons learned. in the second project phase, the specific jobs are continued, that is, documentation, test scenarios, and second-level programming. finally, after a second team meeting, software testing and delivery closes the project. a simulation study including a baseline scenario is used to calculate the project performances, that is, the project durations (pd) or makespans, and the informal learning ratios (see table 1 and table 2 and appendix). five varying scenarios were compiled for ten alternative variations of weights w and learning factor α in each case. the considered project includes software code programming (frontend and backend) as value-adding activities in early and later project phases, i.e. activities ‘g’, ‘h’, ‘l’ and ‘m’. it is likely that (informal) learning has the greatest effect and is used by the company in these activities. therefore, simulation scenarios 1 to 5 show different combinations of valueadding activities (see table 1). the baseline scenario (scenario 0) reflects a pure multiple objectives resource constraint project scheduling, focusing on project efficiency, that is, minimal project durations without systematic informal learning and thus w = α = 0. scenario 1 includes all value-adding activities and therefore reflects the other ‘extreme’ ending of the simulation study. the computations of the mrcpssle were carried out using gams version 24.8.5, and the scip and baron solvers for mixed integer and nonlinear problems (kılınç & sahinidis, 2018; vigerske & gleixner, 2018). all calculations were executed on an intel core i5 7200u cpu with 8 gb of ram and 2.71 ghz. both hardware and software reflect the standard technology in this field. most scenarios were solved optimally and within an acceptable timeframe (see appendix). consequently, improving computation times using heuristics, such as serial schedule generation schemes (kolisch & hartmann, 1999), is not required for the considered simulation scope. however, regarding the general complexity of the problem (anderson, 1999; zareei & hassan-pour, 2015), larger data sizes might require heuristic procedures (lova et al., 2006). table 1 shows the simulation results as well as the scenario means, standard deviations (sd), and coefficients of variation (variation). in addition, table 46 jahr and mynarek / journal of business strategies (2022) 39:33-59 f ig u re 4 : it p ro ject a o n jahr and mynarek / journal of business strategies (2022) 39:33-59 47 2 shows the average results for varying weights in scenarios 1 to 5. in all scenarios, a complete focus on quality (w = 1) required the total project horizon (n=135). the baseline scenario shows a certain degree of unsystematic informal learning but at a low level with high volatility, which impedes the structured usage of learning effects. in addition to the ilr, the baseline results, in terms of project duration, are efficient and stable. all other scenarios show project durations at the same higher level because of the systematic informal learning efforts. an interesting effect can be observed between weights w = 0.7 and w = 0.8. there, the project performance increases, that is, the duration decreases, and informal learning ratios remain stable or even increase. this could indicate possible classic learning (curve) effects for higher quality focuses in the considered test setting. however, scenarios 3 and 4, which emphasize informal learning activities in later phases, outperform those with informal learning in earlier stages (scenarios 2 and 5). furthermore, further analysis of the five core scenarios indicates that ‘extreme’ scenario 1 promises the best overall project performance while considering informal learning. thus, one-sided learning activities in the early or later project phases as well as selected in this sense, the use of all value-adding activities for informal learning behaviors reflects continuous informal learning in a project. this is the best way to reduce project performance volatility and offers stable options for informal learning effects and quality improvements. regarding the trade-off between quality and efficiency (minimal makespan), a quality focus range of 0.3 ≤ w ≤ 0.5 appears to be favorable; that is, the performance volatility is rather low and a stable systematic use of informal learning is available. therefore, efficiency (1 − w) remains the recommended focus of projects. the aggregated development of informal learning ratios and project durations compared with the baseline scenario (figure 5) indicates a smoothing effect for informal learning and partly for makespans. this can be explained by the structure of equation (6) and the functional relation in equation (1). a similar effect has been observed in time-series forecasting based on smoothing models (hyndman & athanasopoulos, 2021). there, the forecasting factors shift weights between current and historic data and hence smoothen the forecast in time. in our case, varying α-values shifted the project time to informal learning. simultaneously, the objective function 48 jahr and mynarek / journal of business strategies (2022) 39:33-59 t a b le 1 : s im u la tio n resu lts fo r a ll scen a rio s a n d scen a rio -sp ecifi c a n a ly sis (0 ) (1 ) (2 ) (3 ) (4 ) (5 ) m ix ed m ix ed t o ta l f irst s eco n d l ea rn in g 1 l ea rn in g 2 b a selin e v a lu e-a d d in g l ev el l ev el f ro n ten d – b a ck en d – s cen a rio a ctiv ities p ro g ra m m in g p ro g ra m m in g b a ck en d f ro n ten d w e ig h t il r p d il r p d il r p d il r p d il r p d il r p d 0 .1 0 .0 5 5 4 8 6 0 .1 4 0 1 1 0 1 0 .0 5 6 7 8 9 0 .0 7 3 4 9 8 0 .0 5 9 7 9 7 0 .0 2 0 9 8 7 0 .2 0 .0 4 0 0 8 6 0 .1 5 0 5 1 0 3 0 .0 6 9 6 9 2 0 .0 4 9 0 9 1 0 .0 5 0 8 1 0 0 0 .0 5 7 3 9 1 0 .3 0 .0 6 9 4 9 6 0 .1 4 0 4 1 1 8 0 .0 3 3 3 1 0 5 0 .1 0 8 8 1 0 8 0 .0 7 1 1 1 0 5 0 .0 6 5 7 1 0 8 0 .4 0 .0 9 7 4 1 0 6 0 .1 1 1 6 1 2 2 0 .1 1 4 5 1 2 2 0 .1 0 4 2 1 2 2 0 .0 6 7 1 1 2 2 0 .0 5 3 7 1 2 2 0 .5 0 .0 3 9 5 1 0 6 0 .1 9 0 7 1 2 6 0 .1 0 6 8 1 2 6 0 .1 3 4 9 1 2 6 0 .0 8 8 4 1 2 6 0 .0 9 7 7 1 2 6 0 .6 0 .0 7 8 9 1 0 6 0 .2 0 3 6 1 3 0 0 .1 1 7 3 1 3 0 0 .1 3 3 2 1 3 0 0 .0 8 7 3 1 3 3 0 .0 8 4 1 1 3 0 0 .7 0 .0 9 7 4 1 0 6 0 .2 0 5 8 1 3 4 0 .1 7 2 4 1 3 4 0 .1 6 3 0 1 3 4 0 .1 0 6 7 1 3 5 0 .0 9 0 5 1 3 4 0 .8 0 .0 7 8 9 1 0 6 0 .2 0 5 8 1 2 4 0 .1 0 0 9 1 3 3 0 .1 6 5 9 1 2 8 0 .0 9 3 8 1 2 5 0 .1 0 0 9 1 2 8 0 .9 0 .0 4 2 1 1 0 6 0 .2 0 5 8 1 2 4 0 .1 2 3 6 1 3 4 0 .1 9 6 5 1 3 2 0 .1 0 9 1 1 2 6 0 .1 1 1 1 1 3 4 1 .0 0 .2 0 0 0 1 3 5 0 .2 0 5 8 1 3 5 0 .1 1 7 4 1 3 5 0 .1 9 1 4 1 3 5 0 .1 1 3 7 1 3 5 0 .1 3 0 4 1 3 5 m ea n 0 .0 7 7 9 1 0 4 0 .1 7 6 4 1 2 2 0 .1 0 1 3 1 2 0 0 .1 3 2 0 1 2 0 0 .0 8 4 8 1 2 0 0 .0 8 1 2 1 2 0 s d 0 .0 4 3 5 1 3 .0 3 0 .0 3 4 8 1 1 .0 4 0 .0 3 7 3 1 7 .0 2 0 .0 4 6 3 1 4 .9 5 0 .0 2 0 7 1 3 .6 8 0 .0 3 0 5 1 7 .0 1 v a ria tio n 5 6 .5 3 % 1 2 .5 4 % 1 9 .7 3 % 9 .0 7 % 3 6 .8 1 % 1 4 .1 8 % 3 5 .0 7 % 1 2 .4 2 % 2 4 .4 4 % 1 1 .3 7 % 3 7 .4 9 % 1 4 .2 3 % il r : in fo rm a l l e a rn in g r a tio ; p d : p ro je c t d u ra tio n ; w e ig h t: o b je c tiv e w e ig h t fo r q u a lity w jahr and mynarek / journal of business strategies (2022) 39:33-59 49 table 2: weight specific analysis for simulations of scenarios 1 to 5 ilr pd weight mean sd variation mean sd variation 0.1 0.0702 0.0309 55.64% 94 5.43 5.75% 0.2 0.0490 0.0382 50.66% 95 5.08 5.33% 0.3 0.1088 0.0371 44.19% 109 4.79 4.40% 0.4 0.1042 0.0249 27.64% 122 0.00 0.00% 0.5 0.1349 0.0369 29.86% 126 0.00 0.00% 0.6 0.1332 0.0434 34.66% 131 1.20 0.92% 0.7 0.1630 0.0438 29.51% 134 0.40 0.30% 0.8 0.1659 0.0447 33.47% 128 3.14 2.46% 0.9 0.1965 0.0428 28.68% 130 4.20 3.23% 1.0 0.1914 0.0389 25.65% 135 0.00 0.00% ilr: informal learning ratio; pd: project duration; weight: objective weight for quality w aims to achieve a trade-off between increasing the time for quality (w) and reducing the time for greater efficiency (1 − w). therefore, the optimization intends to smoothen the project time usage, which is most clear for values w ≥ 0.4. by contrast, the ilr in the baseline scenario reacts more strongly to varying weights. furthermore, there is a strong surge in project duration to full quality focus (w = 1) compared to the smoothed aggregated scenarios. in this respect, the model is easier to predict and offers improved planning reliability. in conclusion, the simulation indicates that informal learning can be systematically integrated into project scheduling and simultaneously provide reliable project performance. the strategic implications remain a focus on efficiency (w ≤ 0.5) with continuous usage of informal learning in all relevant value-adding activities, up to 10% of the available resource time. 6. discussion according to ryan and deci (2017), social integration into an organization, is one of the basic psychological needs of employees, such as social support or collectivity. therefore, it is important to generate optimal project schedules to enable employee participation in informal learning activities. our approach systematically incorporates informal learning into project scheduling, making informal learning behaviors identifiable. 50 jahr and mynarek / journal of business strategies (2022) 39:33-59 f ig u re 5 : il r a n d p d d ev elo p m en t o f th e b a selin e scen a rio a n d a v era g e o f scen a rio s 1 to 5 jahr and mynarek / journal of business strategies (2022) 39:33-59 51 however, a crucial point when transferring real-life system elements into an abstracting mathematical model is the accurate mapping of qualitative aspects into quantitative parameters (nasrallah et al., 2003). here, the representation of informal learning behaviors shows a limited theoretical accuracy of psychological processes. nevertheless, we show that the systemization of informal learning allows for the application of mathematical modelling. the considered approach intends to make efficiency-oriented management more flexible and adaptive to the way individuals collaborate and perform their work in the b2b and b2c contexts. in this context, a lively discussion focused on innovative organizational methodology in the early 2000s, that is, traditional versus agile management (heimicke et al., 2020; jahr, 2014; schmidt, 2019). following this discussion in recent years, observers have obtained the impression that they represent opposing sides or philosophies of business management. on the one hand, traditional management is based on fixed structures and scheduling, hierarchical decision-making, and control, which focus on customer demands, particularly by meeting delivery times, quantities, and prices, that is, costs or budgets. in this traditional management environment, relatively broad qualitative and quantitative methods have been available and continuously refined for a long time. on the other hand, there is a relatively-new agile methodology that focuses on employee needs with flat hierarchies and flexible work schemes. this approach is beneficial to employee motivation and, therefore, has a positive effect on process and product quality (carbonell et al., 2009). however, the encounter of customers and upper management expectations about fixed budgets and times, and employee expectations about free space while performing their tasks is a constant source of conflict. it could be argued that both worlds are not completely contrary; for example, the agile scrum project management concept is not agile in the way that it was initially meant to be (manifesto for agile software development, 2001), but an interpretation of traditional project management with enhanced free space for employees. the strongest reference to this view is the fact that the editors of the agile manifesto withdrew their philosophy some years later, following the above lines of argument (manifesto for halfarsed agile software development, 2001). here, we do not intend to expand on the discussion. we recognize that business managers, especially in the 52 jahr and mynarek / journal of business strategies (2022) 39:33-59 service industry, face the challenge of keeping up with innovative agile management approaches in an area of tension between markets, stakeholders, and shareholders. 7. conclusions knowledge creation is a key task at the center of strategic management decisions. therefore, learning has become a competitive factor for organizations to improve their performances and sustain their market position. however, organizational learning is largely informal and thus organizations require efficient methodology to make informal learning calculable. the objective of this study is the systematization and integration of informal learning into daily project workflows. we show that hybrid approaches combining artificial intelligence and agile organizational theory can be used to balance strategic efficiency and quality based goals. thus, providing opportunities to learn within an organization can lead to increased commitment of an individual and team, which in turn helps increase employee retention (neininger et al., 2010). furthermore, the approach implicitly aims at an individual’s self-efficacy, which describes people’s inner conviction to achieve greater professionalism through their own abilities and actions (alt & raichel, 2020). another important aspect is the quantification of the causes and effects of informal learning. here, we propose an informal learning ratio that quantifies the informal learning options for employees within a project. a simulation study shows that up to 10% of the working time can be used for informal learning activities within projects at acceptable project durations compared to a baseline scenario. moreover, stable (or decreasing) project durations and increasing ilr can indicate learning effects, as described by wright (1936). this study also revealed that classic efficiency-oriented management is recommended as the dominant strategic option. nevertheless, new organizational aspects can be considered without significantly increasing project efficiency. consequently, we present an enhanced multiobjective resource constraint project scheduling model to integrate systematic time slots for informal learning and agile elements into efficiency-based operations management. there is considerable need for research on the application of hybrid approaches in agile management and digitalization, notably in the service industry. for example, benkenstein et al. (2017) indicated that operational jahr and mynarek / journal of business strategies (2022) 39:33-59 53 research methodologies are increasingly being used in the service industry. hence, broad-based empirical studies and economic experiments focusing on the specifications of model variables and parameters can refine the accuracy of the presented scheduling in strategic management. moreover, a large amount of traditional operational research and new agile concepts can be combined and extended to solve the current problems in various business areas. references abedinnia, h., glock, c. h., & schneider, m. d. (2017). machine scheduling in production: a content analysis. applied mathematical modelling, 50, 279–299. https://doi.org/10.1016/j.apm.2017.05.016 alt, d., & raichel, n. (2020). enhancing perceived digital literacy skills and creative self-concept through gamified learning environments: insights from a longitudinal study. international journal of educational research, 101, 101561. https://doi.org/https://doi.org/10. 1016/j.ijer.2020.101561 anderson, p. (1999). perspective: complexity theory and organization science. organization science, 10(3), 216–232. https://doi.org/10.1287/ orsc.10.3.216 ballest́ın, f., valls, v., & quintanilla, s. (2008). pre-emption in resourceconstrained project scheduling. european journal of operational research, 189(3), 1136–1152. https://doi.org/https://doi.org/10.1016/ j.ejor.2006.07.052 ballest́ın, f., valls, v., & quintanilla, s. (2009). scheduling projects with limited number of preemptions. computers & operations research, 36(11), 2913–2925. https://doi.org/https://doi.org/10.1016/j.cor. 2009.01.006 bednall, t. c., sanders, k., & runhaar, p. (2014). stimulating informal learning activities through perceptions of performance appraisal quality and human resource management system strength: a two-wave study. academy of management learning & education, 13(1), 45– 61. https://doi.org//amle.2012.0162 benkenstein, m., bruhn, m., büttgen, m., hipp, c., matzner, m., & nerdinger, f. w. (2017). topics for service management research–a european perspective. journal of service management research, 1(1), 4–21. https://doi.org/10.1016/j.apm.2017.05.016 https://doi.org/https://doi.org/10.1016/j.ijer.2020.101561 https://doi.org/https://doi.org/10.1016/j.ijer.2020.101561 https://doi.org/10.1287/orsc.10.3.216 https://doi.org/10.1287/orsc.10.3.216 https://doi.org/https://doi.org/10.1016/j.ejor.2006.07.052 https://doi.org/https://doi.org/10.1016/j.ejor.2006.07.052 https://doi.org/https://doi.org/10.1016/j.cor.2009.01.006 https://doi.org/https://doi.org/10.1016/j.cor.2009.01.006 https://doi.org//amle.2012.0162 54 jahr and mynarek / journal of business strategies (2022) 39:33-59 bigelow, l. s., & barney, j. b. (2021). what can strategy learn from the business model approach? journal of management studies, 58(2), 528–539. https://doi.org/10.1111/joms.12579 blit, j. (2017). learning remotely: r&d satellites, intra-firm linkages, and knowledge sourcing. journal of economics & management strategy, 26(4), 757–781. https://doi.org/10.1111/jems.12213 blume, b. d., ford, j. k., baldwin, t. t., & huang, j. l. (2010). transfer of training: a meta-analytic review. journal of management, 36(4), 1065–1105. https://doi.org/10.1177/0149206309352880 brucker, p., drexl, a., möhring, r., neumann, k., & pesch, e. (1999). resource-constrained project scheduling: notation, classification, models, and methods. european journal of operational research, 112(1), 3–41. https://doi.org/10.1016/s0377-2217(98)00204-5 buddhakulsomsiri, j., & kim, d. s. (2006). properties of multi-mode resourceconstrained project scheduling problems with resource vacations and activity splitting. european journal of operational research, 175(1), 279–295. https://doi.org/10.1016/j.ejor.2005.04.030 carbonell, p., rodŕıguez-escudero, a. i., & pujari, d. (2009). customer involvement in new service development: an examination of antecedents and outcomes. journal of product innovation management, 26(5), 536–550. https://doi.org/10.1111/j.1540-5885.2009.00679.x cefis, e., marsili, o., & rigamonti, d. (2020). in and out of balance: industry relatedness, learning capabilities and post-acquisition innovative performance. journal of management studies, 57(2), 210–245. https: //doi.org/https://doi.org/10.1111/joms.12441 cerasoli, c. p., alliger, g. m., donsbach, j. s., mathieu, j. e., tannenbaum, s. i., & orvis, k. a. (2018). antecedents and outcomes of informal learning behaviors: a meta-analysis. journal of business and psychology, 33(2), 203–230. https://doi.org/10.1007/s10869-017-9492-y chen, r., liang, c., gu, d., & zhao, h. (2020). a competence-time-quality scheduling model of multi-skilled staff for it project portfolio. computers & industrial engineering, 139, 106183. https://doi.org/10. 1016/j.cie.2019.106183 claver-cortés, e., pertusa-ortega, e. m., & molina-azoŕın, j. f. (2012). characteristics of organizational structure relating to hybrid competitive strategy: implications for performance. journal of business https://doi.org/10.1111/joms.12579 https://doi.org/10.1111/jems.12213 https://doi.org/10.1177/0149206309352880 https://doi.org/10.1016/s0377-2217(98)00204-5 https://doi.org/10.1016/j.ejor.2005.04.030 https://doi.org/10.1111/j.1540-5885.2009.00679.x https://doi.org/https://doi.org/10.1111/joms.12441 https://doi.org/https://doi.org/10.1111/joms.12441 https://doi.org/10.1007/s10869-017-9492-y https://doi.org/10.1016/j.cie.2019.106183 https://doi.org/10.1016/j.cie.2019.106183 jahr and mynarek / journal of business strategies (2022) 39:33-59 55 research, 65(7), 993–1002. https://doi.org/10.1016/j.jbusres.2011. 04.012 coelho, j., & vanhoucke, m. (2011). multi-mode resource-constrained project scheduling using rcpsp and sat solvers. european journal of operational research, 213(1), 73–82. https://doi.org/10.1016/j.ejor. 2011.03.019 de reyck, b., & herroelen, w. (1999). the multi-mode resource-constrained project scheduling problem with generalized precedence relations. european journal of operational research, 119(2), 538–556. https: //doi.org/https://doi.org/10.1016/s0377-2217(99)00151-4 edmondson, a. c., & mcmanus, s. e. (2007). methodological fit in management field research. academy of management review, 32(4), 1246– 1264. https://doi.org/10.5465/amr.2007.26586086 elmaghraby, s. e. (1977). activity networks: project planning and control by network models. john wiley & sons. fang, c., lee, j., & schilling, m. a. (2010). balancing exploration and exploitation through structural design: the isolation of subgroups and organizational learning. organization science, 21(3), 625–642. https: //doi.org/10.1287/orsc.1090.0468 freigang, s., schlenker, l., & köhler, t. (2018). a conceptual framework for designing smart learning environments. smart learning environments, 5(1), 27. https://doi.org/10.1186/s40561-018-0076-8 garćıa-peñalvo, f. j., & conde, m. á. (2014). using informal learning for business decision making and knowledge management. journal of business research, 67(5), 686–691. https : / / doi . org / 10 . 1016 / j . jbusres.2013.11.028 greve, h. r. (2020). learning theory: the pandemic research challenge. journal of management studies, 57(8), 1759–1762. https://doi.org/ 10.1111/joms.12631 guadalupi, c. (2018). learning quality through prices and word-of-mouth communication. journal of economics & management strategy, 27(1), 53–70. https://doi.org/10.1111/jems.12230 gulati, r., & puranam, p. (2009). renewal through reorganization: the value of inconsistencies between formal and informal organization. organization science, 20(2), 422–440. https://doi.org/10.1287/orsc. 1090.0421 https://doi.org/10.1016/j.jbusres.2011.04.012 https://doi.org/10.1016/j.jbusres.2011.04.012 https://doi.org/10.1016/j.ejor.2011.03.019 https://doi.org/10.1016/j.ejor.2011.03.019 https://doi.org/https://doi.org/10.1016/s0377-2217(99)00151-4 https://doi.org/https://doi.org/10.1016/s0377-2217(99)00151-4 https://doi.org/10.5465/amr.2007.26586086 https://doi.org/10.1287/orsc.1090.0468 https://doi.org/10.1287/orsc.1090.0468 https://doi.org/10.1186/s40561-018-0076-8 https://doi.org/10.1016/j.jbusres.2013.11.028 https://doi.org/10.1016/j.jbusres.2013.11.028 https://doi.org/10.1111/joms.12631 https://doi.org/10.1111/joms.12631 https://doi.org/10.1111/jems.12230 https://doi.org/10.1287/orsc.1090.0421 https://doi.org/10.1287/orsc.1090.0421 56 jahr and mynarek / journal of business strategies (2022) 39:33-59 hartmann, s., & briskorn, d. (2010). a survey of variants and extensions of the resource-constrained project scheduling problem. european journal of operational research, 207(1), 1–14. https://doi.org/10.1016/ j.ejor.2009.11.005 hartmann, s., & drexl, a. (1998). project scheduling with multiple modes: a comparison of exact algorithms. networks, 32(4), 283–297. https: //doi.org/10.1002/(sici)1097-0037(199812)32:4⟨283::aid-net5⟩3. 0.co;2-i heimicke, j., chen, r., & albers, a. (2020). agile meets plan-driven-hybrid approaches in product development: a systematic literature review. proceedings of the design society: design conference, 1, 577–586. https://doi.org/10.1017/dsd.2020.259 hoyle, r. (2015). informal learning in organizations: how to create a continuous learning culture. kogan page publishers. hyndman, r. j., & athanasopoulos, g. (2021). forecasting: principles and practice (3rd ed.). otexts. jahr, m. (2014). a hybrid approach to quantitative software project scheduling within agile frameworks. project management journal, 45(3), 35– 45. https://doi.org/10.1002/pmj.21411 jiang, y., jackson, s. e., & colakoglu, s. (2016). an empirical examination of personal learning within the context of teams: personal learning in teams. journal of organizational behavior, 37(5), 654–672. https: //doi.org/10.1002/job.2058 kataoka, t., morikawa, k., & takahashi, k. (2019). strategic human resource management simulation considering work elements, skills, learning and forgetting. procedia manufacturing, 39, 1633–1640. https: //doi.org/10.1016/j.promfg.2020.01.278 kelley, j. e. (1963). the critical-path method: resource planning and scheduling. industrial scheduling. kılınç, m. r., & sahinidis, n. v. (2018). exploiting integrality in the global optimization of mixed-integer nonlinear programming problems with baron. optimization methods and software, 33(3), 540–562. kolisch, r., & hartmann, s. (1999). heuristic algorithms for the resourceconstrained project scheduling problem: classification and computational analysis. in project scheduling (pp. 147–178). springer. https://doi.org/10.1016/j.ejor.2009.11.005 https://doi.org/10.1016/j.ejor.2009.11.005 https://doi.org/10.1002/(sici)1097-0037(199812)32:4<283::aid-net5>3.0.co;2-i https://doi.org/10.1002/(sici)1097-0037(199812)32:4<283::aid-net5>3.0.co;2-i https://doi.org/10.1002/(sici)1097-0037(199812)32:4<283::aid-net5>3.0.co;2-i https://doi.org/10.1017/dsd.2020.259 https://doi.org/10.1002/pmj.21411 https://doi.org/10.1002/job.2058 https://doi.org/10.1002/job.2058 https://doi.org/10.1016/j.promfg.2020.01.278 https://doi.org/10.1016/j.promfg.2020.01.278 jahr and mynarek / journal of business strategies (2022) 39:33-59 57 liu, z., & cheng, t. e. (2004). minimizing total completion time subject to job release dates and preemption penalties. journal of scheduling, 7(4), 313–327. https://doi.org/10.1023/b:josh.0000031424.35504. c4 lova, a., tormos, p., & barber, f. (2006). multi-mode resource constrained project scheduling: scheduling schemes, priority rules and mode selection rules. inteligencia artificial, 10(30), 495. https : //doi.org/10.4114/ia.v10i30.947 manifesto for agile software development. (2001). agile alliance. http:// www/agilemanifesto.org manifesto for half-arsed agile software development. (2001). agile alliance. http://www.halfarsedagilemanifesto.org/ march, j. g. (1991). exploration and exploitation in organizational learning. organization science, 2(1), 71–87. https://doi.org/10.1287/orsc.2. 1.71 matsuo, m. (2019). empowerment through self-improvement skills: the role of learning goals and personal growth initiative. journal of vocational behavior, 115, 103311. https://doi.org/10.1016/j.jvb.2019.05.008 nasrallah, w., levitt, r., & glynn, p. (2003). interaction value analysis: when structured communication benefits organizations. organization science, 14(5), 541–557. https://doi.org/10.1287/orsc.14.5.541. 16764 neininger, a., lehmann-willenbrock, n., kauffeld, s., & henschel, a. (2010). effects of team and organizational commitment – a longitudinal study. journal of vocational behavior, 76(3), 567–579. https://doi. org/10.1016/j.jvb.2010.01.009 noe, r. a., tews, m. j., & mcconnell dachner, a. (2010). learner engagement: a new perspective for enhancing our understanding of learner motivation and workplace learning. academy of management annals, 4(1), 279–315. https://doi.org/10.5465/19416520.2010.493286 olson, d. l. (2001). comparison of three multicriteria methods to predict known outcomes. european journal of operational research, 130(3), 576–587. https://doi.org/10.1016/s0377-2217(99)00416-6 posen, h. e., & levinthal, d. a. (2012). chasing a moving target: exploitation and exploration in dynamic environments. management science, 58(3), 587–601. https://doi.org/10.1287/mnsc.1110.1420 https://doi.org/10.1023/b:josh.0000031424.35504.c4 https://doi.org/10.1023/b:josh.0000031424.35504.c4 https://doi.org/10.4114/ia.v10i30.947 https://doi.org/10.4114/ia.v10i30.947 http://www/agilemanifesto.org http://www/agilemanifesto.org http://www.halfarsedagilemanifesto.org/ https://doi.org/10.1287/orsc.2.1.71 https://doi.org/10.1287/orsc.2.1.71 https://doi.org/10.1016/j.jvb.2019.05.008 https://doi.org/10.1287/orsc.14.5.541.16764 https://doi.org/10.1287/orsc.14.5.541.16764 https://doi.org/10.1016/j.jvb.2010.01.009 https://doi.org/10.1016/j.jvb.2010.01.009 https://doi.org/10.5465/19416520.2010.493286 https://doi.org/10.1016/s0377-2217(99)00416-6 https://doi.org/10.1287/mnsc.1110.1420 58 jahr and mynarek / journal of business strategies (2022) 39:33-59 razavi, n., & mozayani, n. (2007). a resource leveling model based on genetic algorithms: activity splitting allowed. imecs, 109–114. ryan, r. m., & deci, e. l. (eds.). (2017). self-determination theory: basic psychological needs in motivation, development, and wellness. guilford press. https://doi.org/10.1521/978.14625/28806 sambrook, s. (2005). factors influencing the context and process of workrelated learning: synthesizing findings from two research projects. human resource development international, 8(1), 101–119. https: //doi.org/10.1080/1367886052000342591 sauermann, h., & stephan, p. (2013). conflicting logics? a multidimensional view of industrial and academic science. organization science, 24(3), 889–909. https://doi.org/10.1287/orsc.1120.0769 schaufeli, w. b., bakker, a. b., & van rhenen, w. (2009). how changes in job demands and resources predict burnout, work engagement, and sickness absenteeism. journal of organizational behavior, 30(7), 893–917. https://doi.org/10.1002/job.595 schmidt, t. s. (2019). agile development of physical products: an empirical study about potentials, transition and applicability. shepherd, d. a., patzelt, h., williams, t. a., & warnecke, d. (2014). how does project termination impact project team members? rapid termination, ‘creeping death’, and learning from failure. journal of management studies, 51(4), 513–546. https://doi.org/10.1111/joms. 12068 speranza, m., & vercellis, c. (1993). hierarchical models for multi-project planning and scheduling. european journal of operational research, 64(2), 312–325. https://doi.org/10.1016/0377-2217(93)90185-p tews, m. j., michel, j. w., & noe, r. a. (2017). does fun promote learning? the relationship between fun in the workplace and informal learning. journal of vocational behavior, 98, 46–55. https://doi.org/10.1016/ j.jvb.2016.09.006 thomas, j. b., sussman, s. w., & henderson, j. c. (2001). understanding “strategic learning”: linking organizational learning, knowledge management, and sensemaking. organization science, 12(3), 331– 345. https://doi.org/10.1287/orsc.12.3.331.10105 https://doi.org/10.1521/978.14625/28806 https://doi.org/10.1080/1367886052000342591 https://doi.org/10.1080/1367886052000342591 https://doi.org/10.1287/orsc.1120.0769 https://doi.org/10.1002/job.595 https://doi.org/10.1111/joms.12068 https://doi.org/10.1111/joms.12068 https://doi.org/10.1016/0377-2217(93)90185-p https://doi.org/10.1016/j.jvb.2016.09.006 https://doi.org/10.1016/j.jvb.2016.09.006 https://doi.org/10.1287/orsc.12.3.331.10105 jahr and mynarek / journal of business strategies (2022) 39:33-59 59 t’kindt, v., & billaut, j.-c. (2001). multicriteria scheduling problems: a survey. rairo operations research, 35(2), 143–163. https://doi. org/10.1051/ro:2001109 vanhoucke, m., & coelho, j. (2019). resource-constrained project scheduling with activity splitting and setup times. computers & operations research, 109, 230–249. https://doi.org/10.1016/j.cor.2019.05.004 verhoef, p. c., broekhuizen, t., bart, y., bhattacharya, a., qi dong, j., fabian, n., & haenlein, m. (2021). digital transformation: a multidisciplinary reflection and research agenda. journal of business research, 122, 889–901. https://doi.org/10.1016/j.jbusres.2019.09.022 vigerske, s., & gleixner, a. (2018). scip: global optimization of mixedinteger nonlinear programs in a branch-and-cut framework. optimization methods and software, 33(3), 563–593. https://doi.org/10. 1080/10556788.2017.1335312 wright, t. p. (1936). factors affecting the cost of airplanes. journal of the aeronautical sciences, 3(4), 122–128. https://doi.org/10.2514/8.155 yakhlef, a. (2010). the corporeality of practice-based learning. organization studies, 31(4), 409–430. https://doi.org/10.1177/0170840609357384 zare, z. (2012). preemption multi-mode resource-constrained project scheduling problem. interdisciplinary journal of contemporary research in business, 3(9), 636–642. zareei, m., & hassan-pour, h. a. (2015). a multi-objective resource-constrained optimization of time-cost trade-off problems in scheduling project. iranian journal of management studies, 8(4). https://doi.org/10. 22059/ijms.2015.55006 zhang, c., nahrgang, j. d., ashford, s. j., & derue, d. s. (2020). the risky side of leadership: conceptualizing risk perceptions in informal leadership and investigating the effects of their over-time changes in teams. organization science, 31(5), 1138–1158. https://doi.org/10. 1287/orsc.2019.1350 https://doi.org/10.1051/ro:2001109 https://doi.org/10.1051/ro:2001109 https://doi.org/10.1016/j.cor.2019.05.004 https://doi.org/10.1016/j.jbusres.2019.09.022 https://doi.org/10.1080/10556788.2017.1335312 https://doi.org/10.1080/10556788.2017.1335312 https://doi.org/10.2514/8.155 https://doi.org/10.1177/0170840609357384 https://doi.org/10.22059/ijms.2015.55006 https://doi.org/10.22059/ijms.2015.55006 https://doi.org/10.1287/orsc.2019.1350 https://doi.org/10.1287/orsc.2019.1350 introduction the role of informal learning behaviors a concept for integrating and measuring informal learning behaviors in business projects learning-oriented multi-objective resource constrained project scheduling use case simulation study discussion conclusions business innovation, ethics, and prosperity: the primacy of microeconomics rock-antoine mehanna notre dame university • zouk mosbeh, lebanon youssef yazbeck central bank of lebanon and saint joseph university • beirut, lebanon abstract this paper examines the role of "business innovation" and "business ethics" two seemingly unrelated principles in underpinning the disparities in economic prosperity across 107 countries over the period from 2003 to 2006. unlike porter, ketels, and delgado's (2007) statistical approach, which relies on partial correlations, this paper uses a multiple regression analysis within a general macro/microeconomic framework to examine business innovation strategies and ethics, while controlling for human capital, geography, and socio-cultural demographics. additionally, this paper borrows from wu (2005) to assess the interaction between business innovation strategies and business ethics. econometric results indicate that business innovation and business ethics are both positively correlated with and needed to sustain economic prosperity. additional results show that microeconomic variables have the primacy over macroeconomic ones. relevant policy implications are discussed. introduction the problem of creation of wealth has always been the in-focus of economic research. while the bulk of the literature emphasized the role of macroeconomic factors, the micro economic foundations of economic prosperity escaped theoretical and empirical scrutiny. building on porter's (1990, 2007) approach to economic prosperity, the purpose of this paper is to empirically test the following: (1) the significant relationship of each of "business innovation" and "business ethics" (or corruption) two seemingly unrelated principles in underpinning the disparities in economic prosperity across a sample of 107 countries over the average period from 2003 to 2006; (2) the interaction between business innovation strategies and business ethics; and (3) the size and significant roles of macroand microeconomic foundations in affecting economic prosperity. the microeconomic approach to economic prosperity gained much importance with the growing pace of globalization. globalization increases the uncertain142 journal of business strategies ties of macroeconomic policies and makes countries more vulnerable to the fluctuation of variables, such as exchange rates and commodity prices among others. in fact, argentina failed to experience a sustainable path of growth because the improvement of the microeconomic environment was not in-line with the macroeconomic reforms that the government has undertaken (ketels, 2006). while the potential to create a competitive advantage at the corporate level lies in the development of innovative products and processes, including conducting innovation-driven business strategies, this paper suggests that corporate ethics, specifically corporate corruption should not be underestimated. borrowing from wu (2005), the tough enforcement of the foreign corrupt practices act may have forced u.s. companies to focus their attention on developing their long-term competitive advantage through implementing business innovation strategies leading them to be recognized as global leaders in their fields. unlike porter's et a1. (2007) statistical approach which relies on partial correlations, this paper employs a general micro/macroeconomic framework and uses a multiple regression to examine the effects of business innovation and business ethics (corruption) on economic prosperity as measured by the level of per capita gross domestic product (gdp). it controls for salient features of economic prosperity, including human capital (education), geography (latitude), and socio-cultural demographics (religious fractionalization). using the standardized estimation of the independent variables, this paper assesses the magnitudes between microeconomic and macroeconomic environments and their impact on economic prosperity. the rest of the paper is organized as follows . the second section reviews succinctly the related literature, while suggesting a synthetic theoretical diagram (figure 1). the third section offers the specification of the model and the fourth section analyzes the econometric results. finally, the fifth section concludes the study and provides some relevant policy implications. literature review business innovation and economic prosperity the relationship between innovation and economic prosperity (or economic development) witnessed a surge in interest over the last decades. contemporary innovation theories (i.e., new growth models and evolutionary theories) revived the seminal contribution of schumpeter (1934, 1939, 1943); innovation within large corporations explain the never ending and ever changing process of economic prosperity (castellacci, 2007). new growth theories highlight the role of innovation while emvolume 26, number 2 143 ploying a neoclassical typological thinking (see among others, romer, 1986; lucas, 1988; grossman & helpman, 1990; bresnahan & trajtenberg, 1995; helpman, 1998). evolutionary theories like, for instance, the neo-schumpeterian theory (see among others, freeman, clark, & soete, 1982; perez, 1985 ; freeman & lou9a, 2002), the technology gap approach (see among others, abramovitz, 1994; chui, levine, murshed, & pearlman, 2002), the nelson and winter-like evolutionary theorizing (nelson & winter, 2002), and the innovation system frameworks (freeman, 1987; porter 1990) consider that agents are heterogeneous and follow routines and habits of thoughts that are embodied in their minds and in the organization's production activities . these routines and habits are transmitted over a population and explain a stable inertial pattern of production over time. innovation is shaped by the interaction between microeconomic actors and macroeconomic structures. it continuously counteracts this inertial pattern via novel learning processes and exploring activities. such phenomena make evolution a never ending process. without innovation, competition and selection between the heterogeneous firms reduce the initial heterogeneity and explain the convergence to a stable steady state. porter's approach to economic prosperity falls within the framework of the national innovation system. following freeman (1987), a national innovation system is a network of public and private institutions, whose activities and interactions initiate, modify, and diffuse new technologies. porter (1990) and porter et al. (2007) argue that differences in economic prosperity within countries depend on two areas that are inextricably intertwined: (1) the quality of the microeconomic business illustrated by the components of the porter's diamond (1990) (i.e., input conditions, context for firm strategy and rivalry, demand conditions, related and supporting industries); and (2) the quality of the sophistication with which domestic companies and foreign subsidiaries operating in a country compete. the holistic view of the process of economic prosperity does not neglect the pivotal role played by the population of heterogeneous firms in sustaining the evolutionary phenomena of competition and selection. firms are agents of value creation. value creation occurs via the introduction of innovative products and processes and the implementation of innovation driven business strategies that identify a firm's competitive advantage. business/corporate ethics and economic prosperity [n this paper the terms business ethics and corporate ethics are used interchangeably. the bulk of economic literature dealing with the syndrome of corporate ethics (corruption) underpinned the detrimental effects of corrupt government 144 journal of business strategies officials (mauro, 1995, 1996; treisman, 2000; henisz, 2000; smarzynka & wei, 2000; meon & sekkat, 2005). corruption reduces domestic and foreign investment. it amplifies the unofficial activity, lowers private sector employment, leads to a misallocation of public spending, exacerbates poverty and inequality, undermines the rule of law, and increases political instability. corporate corruption, a specific dimension of corporate ethics, escaped much scrutiny. it generates organizational and environmental deficiencies that undermine the competitiveness offirms and exhibit detrimental effects on economic prosperity. organizational deficiencies are a mere reflection of the principal-agent problem at the organization's level. such a problem may represent a corporate threat (coulomb, 1997). corruption leads to a misallocation of resources and a deterrence of capacity building. a competent management who strategically allocates a company's limited resources is fundamental to boost a firm's growth potential. however, corruption may lead to the concealment of management's real contribution to the increase of the economic value of firms (wu, 2005). accordingly, corrupt practices (within an organization or between an organization and its environment) may be substitutable for innovation-driven organizational skills. despite several critics that have been addressed to the foreign corrupt practices act for placing american companies in a competitive disadvantage in many emerging markets, it seems that toughness on bribery might have forced the u.s. companies to focus their attention on developing their innovative capacity (wu, 2005). furthermore, corporate corruption mirrors dishonesty and untrustworthiness and destroys business networks. building a long-term competitive advantage requires to maintain long-term relationships with suppliers, distributors, consumers, and other agents involved in a value chain. environmental deficiencies involve the socio-economic impact of corporate corruption. assume that two firms compete for a public contract and the pay-off pattern is represented as follows: (1) if none of the two firms pays a bribe, both gain four monetary units; (2) if both firms make a bribe payment, they gain one monetary unit; and (3) one firm gains an unfair advantage (i.e., three monetary units) over the other firm if the latter does not pay a bribe (no monetary gain). theoretically, such a game has two equilibria: (1) bribe-bribe; or (2) do not bribe-do not bribe. rationality implies that the first equilibrium is the most probable. such equilibrium is not but the worst scenario to the collectivity. additionally, hellmann and schankerman (2000), kaufmann and kraay (2002), and others argue that firms may have vested interest in a socially inefficient statusquo. hellmann and schankerman show that captor firms benefit from their ties with volume 26, number 2 145 government officials to impose high regulatory burdens on their competitors , such a regulatory burden sustains their power and leads to a "monopolistic" social deficiency, figure 1 the macroeconomic-microeconomic framework; underlining the role of business innovation and business ethics economic prosperity ,f\ productivity ... microeconomic foundatklns macroeco nomic foundations l' co mpetitive enviro nment i ... company sophistication & quajity of business environment innovation organ izational influences of j corporate ethics (corruption) others methodology t environmentallnfluences of corporate ethics (corruption) others private in ves tment trade openness public spend ing population education others this paper estimates the following functions on a sample of 107 countries using a multiple regression analysis following the white's procedure (1980) over the average period from 2003 to 2006 : log gdp c ; = f (i;; openness;; edu;,' ibs;,' latitude;; fractionalization) (1) log gdp _ =f/[; openness; edu.; ethics; latitude.; cl {.i i i i i i fractionalization ) (2) log gdp c ; = f ((1/ openness;; edu;; (ibs*ethics) ; latitude;; fractionalization)) (3) 146 journal of business strategies where i is a subscript that represents the country and the level of per capita gdp is used as a proxy for economic prosperity. the rational for relying on the level of per capita gdp is sustained by the following: (1) there exists a common agreement among economists that the current dispersion of per capita gdp levels among countries reflect differences in their long-term growth (kaufmann & kraay, 2002); (2) differences in economic growth rates across countries may be transitory; and (3) differences in economic policies are empirically associated with differences in levels rather than differences in economic growth rates (see among others, hall & jones , 1999). the quality of ethics is represented by the following : (1) "ethical behavior of firms ," a broad indicator which represents the quality of interactions between a firm and its environment (i.e., private organizations or public ones); and (2) " illegal corruption," an indicator that specifically assesses the level of corporate corruption within a country (i.e., private-public corruption). variables employed as proxies for business innovation and business ethics are not included in the same regression to avoid multicollinearity problems. the interaction between business ethics and business innovation is not but the product of the innovation and business sophistication score (ibs) and index reflecting the ethical behavior of firms. table 1 provides a synthetic description of each of all variables employed to estimate the above functions. relying on both the theoretical framework previously described as weil as on porter's et al. (2007) empirical results, this paper hypothesizes the following : (1) the degree of business innovation and business sophistication should have a positive and significant impact on economic prosperity; (2) business ethics, whether measured broadly or specifically, is a precondition to sustainable prosperity and should not be underestimated; (3) business innovation and business ethics interact so that improvement in both indicators is needed to sustain economic prosperity; and (4) the role of micro economic foundations is as instrumental as macroeconomic ones (ifnot more!) in enhancing national economic prosperity. mankiw, romer, and weil (1992) argue that the level of economic development depends upon the accumulation of physical and human capital. hence, it is possible to predict a positive relationship between investment (as a share of output) and the level of economic development, as well as enrollment in secondary education and the level of economic development. trade openness is positively associated with economic prosperity (yannikaya, 2003). international trade would enhance global competition and increase productivity under certain assumptions. as for latitude, it is expected to have a positive impact on economic prosperity; countries that are far from equator are more likely to have a higher level of ecotable 1 description of dependent and independent variables variable gdpc gross domestic product per capita, ppp adjusted (current international dollars) i investment as a share of gdp (%) description gop per capita (ppp adjusted) is the gross domestic product divided by midyear population converted to international dollars using purchasing power parity rates. an international dollar has the same purchasing power over gdp as the u.s. dollar has in the united states. logged values are taken into consideration. investment share of current gross domestic product. openness trade openness as a share of gdp (%) sum of exports and imports as a share of gop. education gross enrolment rate in secondary education (%) number of pupils enrolled in secondary, regardless of age, and expressed as a percentage of population in the theoretical age group for secondary education. year-period 2006 2003-2006 2003-2006 2003-2006 source international monetary fund (imf), world outlook database 2007 penn world tables, un statistics penn world tables, un statistics world bank, education statistics ~ e" ~ "' tv ~ ~ ~ (l-' "' "'t tv -'" ~ table 1 cont'd. description of dependent and independent variables variable ibs innovation and business sophistication score ethics ethical behavior of firms description simple average of the following scores developed by the world economic forum (wef): (1) business sophistication score, a composite index which comprises, among other components, the production process sophistication, the extent of marketing, the willingness to delegate authority, the nature of competitive advantage and the presence of a value chain; and (2) innovation score, which covers, among others components , the degree of company spending on research and development, the quality of government procurement of advanced technology products and the number of utility patents. this composite indicator varies from 1 (low level of business sophistication and business innovation) to 7 (high level of business sophistication and business innovation). measures the quality of the ethical behavior of a countryrs firms in interactions with public officials, politicians, and other enterprises}. it varies from 1=among the world's worst to 7=the best in the world. year-period 2006 2004 source world economic forum, the global competitiveness report, 2007-2008 world economic forum, the global competitiveness report , 2005-2006 ...... .j>. (xl ~ ~ "'\ ;:$ ~ ~ ~ ~ '" ;;. f1> '" '" (';') ~ .... ~ ... f1> '" table 1 cont'd. description of dependent and independent variables variable illegal corruption distance from absolute latitude equator fractionalization relig ious fractionalization description simple average of the following indices: (1) irregular payments inpublic contracts ; and (2) irregular payments in judicial decisions. such an index assesses the level of private-public corruption within a country. it varies from 1 (corrupt practices are common) to 7 (corrupt practices never occur) absolute latitude / 90 measures the distance from equator. probability that two random ly se lected individuals from the country in question will not belong to the same religious group. year·period 2004 2006 2003 source world economic forum the global competitiveness report, 2005-2006 meghanna, oemirguc-kunt and maksimovic (2006) . ales ina et al (2003) ~ ;: ~ no n 9' ~ ~ '3"' no "'t n ~ ~ (0 150 journal of business strategies nomic development. finally, political economy models suggest that countries with high fractionalization (i.e., ethnic, linguistic, or religious fractionalization) have a lower level of economic development (for a theoretical framework, see lindner & strulik, 2004). thus, it is expected to have a negative association between religious fractionalization and economic prosperity. econometric analysis table 2 offers the descriptive statistics of all the dependent and independent variables. the sample comprises 107 observations and covers the period from 2003 to 2006. the descriptive statistics offer the mean, the ranges (minimum and maximum), and the standard deviation of each of the cited variables. table 2 descriptive statistics of all dependent and independent variables std. range minimum maximum mean deviation gross domestic product (ppp adjusted) 4.62 6.69 11.31 9.17 1.08 investment (i) 41.13 3.42 44.55 15.82 7.65 trade openness (openness) 365.84 21.58 387.42 87.43 51.37 gross enrollment in secondary 144.6 7.50 152.1 79.46 29.11 education (edu) innovation & business sophistication (ibs) 3.15 2.62 5.77 3.85 0.81 ethical behavior of firms (ethics) 3.50 2.80 6.30 4.29 0.88 illegal corruption (ethics) 4.25 2.35 6.60 4.31 1.12 innovation & business sophistication 26.62 7.42 34.04 17.15 7.17 (ibs)*ethical behavior (ethics) latitude 0.70 0.01 0.71 0.34 0.19 religious fractionalization 0.86 0.00 0.86 0.42 0.23 (fractional ization) note: valid sample size is 107 countries. the cross-nature of the study raises suspicion of heteroskedasticity in the error term that could lead to econometric problems by overestimating the estimated coefficients. subsequently, the problem of heteroskedasticity is addressed following white's procedure, which gives robust-heteroskedasticity estimates for the variance-covariance matrix of the estimated regression coefficients (1980). the volume 26, number 2 151 multicollinearity test (i.e., the correlation among all pairs of independent variables) shows no serious signs of multicollinearity (table 3). additionally, one could not but argue that business innovation and business ethics are endogenous to economic prosperity. however, the lack of valid instruments deters the use of the two-stage least squares estimation technique, which could have improved the quality of the econometric findings. table 4 shows the regression results of the three models previously stated. the coefficients measuring business innovation (i.e., innovation and business sophistication score) and business ethics (i.e., ethical behavior of firms and illegal corruption) are positive, statistically and economically significant at the 99% level of confidence. they show support for the theoretical frameworks previously elaborated. a one-point improvement (i.e., increase) in each of the 7 points scale stimulates the log value of level of per capita gdp by 0.47, 0.46, and 0.38 units, respectively, at the 99% level of confidence. noteworthy is the equal economic significance of business innovation and business ethics to economic prosperity. the interaction between innovation and business sophistication and the ethical behavior of firms seems to have a statistically significant impact at the 99% level of confidence. one possible interpretation of such results is that the deterrence of unethical practices, specifically corrupt practices, within an organization and between an organization and its environment on one hand, and the focus on introducing innovative products and processes on the other one, are essential to sustaining productivity and economic prosperity. the coefficients of investment and enrollment in secondary education are positive and significant at the 99% level of confidence. trade openness loses its significance in models 2 (a) and 2 (b) when variables measuring business ethics are introduced, despite the absence of any significant correlation between the above variables. such a result shows that trade openness is not a robust predictor of economic prosperity. the signs of the coefficients oflatitude and religious fractionalization are consistent with the expected signs but statistically insignificant. both sets of macroeconomic and microeconomic variables seem symbiotic and instrumental to fostering economic prosperity. interestingly, the standardized estimates of all the independent variables used in the three models show the primacy of microeconomic variables (innovation and business sophistication, ethical behavior of firms, and illegal corruption) over macroeconomic ones (investment and trade openness). table 3 correlation matrix among independent variables gross innovation enrollment and in business trade secondary sophistiinvestment openness education cation (i) (openness) (edu) (ibs) investment (i ) 1 0.16 0.52 0.54 trade openness (openness) 0.16 1 0.21 0.17 gross enrollment in secondary education (eou) 0.52 0.21 0.60 innovation & business sophi stication (ibs) 0.54 0.17 0.60 ethi cal behavior of firms (ethics) 0.53 0.20 0.60 0.89 illegal corruption (ethics) 0.49 0.25 0.66 0.80 ibs* ethics 0.55 0.18 0.61 0.97 latitude 0.42 0.11 0.66 0.43 religi ous fractio nalization (fractionalization) 0.02 -0.01 -0.04 . 0.11 note: valid sample is 107 countries . ethical behavior of firms (ethics) 0.53 0.20 060 0.89 0.90 0.97 0.42 0.14 illegal corruption (ethics) ibs* ethics 0.49 0.25 0.66 0.80 0.90 0.86 0.48 0.11 0.55 0.18 0.61 0.97 0.97 0.86 0.44 0.13 religious fractionalization (fractionlatitude alization) 0.42 0.03 0.11 -0.01 0.66 -0.04 0.43 0.11 0.42 0.14 0.48 0.11 0.44 0.13 1 -0.04 -0.04 --l (ti i\) '0'~ "'t ;:: :!.. ~ t:x:i ~ '" -. ;:: ~ '" '" vl .... "'t ~ .... ~ -. ~ '" volume 26, number 2 153 table 4 regression results; testing for the micro-macro framework of economic development model 1 model 2 (a) model 2 (b) model 3 dependent variable log gdp~2006 log gdp. 2q06 log gdp. 2og6 log gop c 2006 independent variables constant 5.50*** 5.432** * 5.846*** 6.434*** (0.262) (0.258) (0.205) (0.188) investment (i) (%) 0.023** * 0.023*** 0.028 **' 0.022 *** (0.008) (0.008) (0 .01 ) (0.008) 0.163 0.165 0.200 0.158 trade openness (openness) (%) 0.002** 0.002 0.001 0.002 (0.001 ) (0.001 ) (0.001 ) (0.001 ) 0.103 0.090 0.069 0.097 gross enrollment rate in secondary 0.016*** 0.016*** 0.015 *** 0.016*** education (edu) (%) (0.003) (0.420) (0.003) (0.003) 0.441 0.420 0.392 0.433 innovation and business 0.468** * sophistication (l8s) (0.084) 0.352 ethical behavior of firms (ethics) 0.460*** (0.077) 0.377 illegal corruption (ethics) 0.378*** (0.062) 0.392 ibs * ethics (ethical behavior of firms) 0.055*** 0.010 0.367 latitude 0.336 0.368 0.239 0.301 (0.355) (0.348) (0.348) (0.353) 0.060 0.066 0.043 0.054 religious fractionalization -0.235 -0.311 -0.282 -0.292 (0.224) (0.222) (0.220) (0.225) -0.050 -0.066 -0.060 -0.062 adjusted r-squared 0.765 0.773 0.775 0.768 prob . (f-statistic) 0.0*** 0.0* ** 0.0** * 0.0*** durbin-watson statistic 1.95 1.936 2.10 1.919 note : valid sample size is 107 countries; p-values *<0.1; **<0.05 ; ***<0.01; the dependent variable is economic prosperity measured by the level economic development. estimates are white robust-heteroskedasticity estimates for the variance-covariance matrix and are reported in the above table. standard errors are reported between parentheses. standardized coefficients are reported in bold. 154 journal of business strategies conclusion the purpose of this paper is to empirically investigate the effects of business innovation and business/corporate ethics on economic prosperity and their interaction. additionally, it examines the roles of macroand microeconomic foundations in fostering national economic prosperity across a sample of 107 countries over the average period from 2003 to 2006 . it employs a general macro/microeconomic framework to assess environmental contributions towards productivity and hence economic prosperity. the econometric results support our hypothesis and show that business innovation and business ethics are significant determinants of economic prosperity. these variables are equally important and interact to sustain economic prosperity. the standardized estimation approach crystallizes the primacy of the microeconomic foundations of economic prosperity over macroeconomic ones. accordingly, the sustainability of economic prosperity relies on the capacity of companies to enhance their competitive advantage through innovative products and processes. effective management of the value chain, decentralization, empowering employees, enhancing research and development are, among others, possible means to enhance the competitive advantage of companies and foster productivity. effective enforcement of policies and procedures that deter unethical practices (including corrupt practices at the company's level) help reaching a company's objectives and maintain its competitive advantage. from a policy perspective, the sustainability of the competitive advantage of companies also requires a criminalization of all kinds of unethical private-private and private-public practices. ratifying the united nation convention against corruption could be one way to reach this objective. encouraging firms to innovate requires governments, for instance, to enhance the quality of education, enforce the protection of intellectual property rights, simplify and lower the cost of doing business, and promote an entrepreneurial culture via crafting proper tax incentives that can serve such objectives. to conclude, this study of business innovation and ethics within the prosperity · context is a salient issue in a large number of countries that rely heavily on pointsource products, such as several middle eastern and north african (mena) countries, among others. further research is encouraged to test this micro/macroeconomic framework , coupled with pertinent instrumental variables and a richer longitudinal sample (which is currently not available, especially for the governance variables) that would enable the use of a simultaneous econometric approach on different regions. volume 26, number 2 155 references abramovitz, m. (1994). the origins of the postwar catch-up and convergence boom, in j. fagerberg, b. verspagen, & n. von tunzelmann (eds). the dynamics of technology, trade and growth. aldershot, uk: edward elgar. alesina, a., devleeschauwer, a., easterly, w., kurlat, s., & wacziarg, r. (2003). fractionalization. working paper no. 9411. cambridge, ma: national bureau of economic research. bresnahan, t., & trajtenberg, m. (1995). general purpose technologies: engines of growth? journal of econometrics, 65, 83-108. castellaci, f. (2007). evolutionary and new growth theories: are they converging? journal of economic surveys, 21,585-627. chui, m., levine, p., murshed, m., & pearlman, j. (2002). north-south models of growth and trade. journal of economic surveys, 16(2), 123-165. coulomb, r. (1997). corruption as a corporate threat. business ethics, 6, 184-186. freeman, c. (1987). technology policy and economic performance: lessons from japan. london: pinter. freeman, c., clark, j., & soete, l. (1982). unemployment and technical innovation, london: pinter. freeman, c., & louca, f. (2002). as time goes by: from the industrial revolutions to the information revolution. oxford, uk: oxford university press. grossman, g., & helpman, e. (1990). comparative advantages and long run growth. american economic review, 80, 796-815. hall, r., & jones, c. (1999). why do some countries produce so much more output per worker than others. the quarterly journal of economics, 114( 1), 83-116. henisz, w. (2000). the institutional environment for multinational investment. journal of law, economics and organization, 16, 334-64. hellmann, j., & schankerman, m. (2000). intervention, corruption, and capture. economics of transition, 8, 545-576. helpman, e. (1998). general purpose technologies and economic growth. cambridge, ma: mit press. kaufmann, d., & kraay, a. (2002). growth without governance. policy research working paper no. 2928, washington: world bank. ketels, c. (2006). michael porter's competitiveness framework recent learning and new research priorities. journal of industry, competition and trade, 6, 115136. 156 journal of business strategies lindner, i., & strulik, h. (2004). why not africa? growth and welfare effects of secure property rights. public choice, 120, 143-167. lucas, r. (1988). on the mechanics of economic development. journal of monetary economics, 22, 3-42. mankiw, g., romer, d., & weil, d. (1992). a contribution to the empirics of economic growth. quarterly journal of economics, 107, 407-437. mauro, p. (1995). corruption and growth. quarterly journal of economics, 11 0, 681-712. meghana, a., demirguc-kunt, a., & maksimovic, v. (2006). what determines protection of property rights? an analysis of direct and indirect effects. policy research working paper series no. 3940. world bank. meon, p., & sekkat, k. (2005). does corruption grease or sand the wheels of growth? public choice, 122,69-97. nelson, r., & winter, s. (2002). evolutionary theorizing in economics. journal of economic perspectives, 16(2), 23-46 perez, c. (1985). microelectronics, long waves and world structural change: new perspectives for developing countries. world development, 13(3),441-463. porter, m. (1990). the competitive advantage of nations. new york: free press. porter, m., ketels, c., & delgado, m. (2007). the microeconomic foundations of prosperity: findings from the business competitiveness index, in the global competitiveness report: 2007-2008: the world economic forum. romer, p. (1986). increasing returns and long-run growth. journal of political economy, 94(5), 1002-1037. smarzynska, b., & wei, s. (2000). corruption and composition of foreign direct investment: firm-level evidence. working papers 7969. cambridge, ma: national bureau of economic research. schumpeter, j. (1934). the theory of economic development. cambridge, ma: harvard university press. schumpeter, j. (1939). business cycles. philadelphia: porcupine press. schumpeter, j. (1943). capitalism, socialism and democracy. new york: harper. treisman, d. (2000). the causes of corruption: a cross-national study. journal of public economics, 76,399-457. white, h. (1980). a heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. econometrica, 48, 817-838. the global competitiveness report: 2007-2008. world economic forum. volume 26, number 2 157 the global competitiveness report: 2005-2006. world economic forum. wu, x. (2005). corporate governance and corruption: a cross-country analysis. governance: an international journal of policy, administration, and institutions, 18, 151-170. yannakaya, h. (2003). trade openness and economic growth: a cross-country empirical investigation. journal of development economics, 72,57-89. biographical sketch of authors dr. rock-antoine mehanna is the dean of the faculty of business administration and finance at la sagesse university. he is a full professor; chief consultant of the global strategic consulting group; vice president of the southwest academy of international business (usa); and vice president for the mediterranean region ofthe academy for global business advancement (usa). he has previously taught at major universities in the united states, where he has received his graduate studies and professional training. he holds a ph.d. in business policy and an mba in finance. he has published several books and a large number of articles in international refereed journals. he has received a large number of international awards, including the most recent "best economic & business researcher in the middle east. " mr. youssef yazbeck is a financial analyst in the banking control commission at the central bank of lebanon. he holds a m.s. in economic sciences and a b.s. in economics from the saint joseph university. he has researched in the fields of economic development, political economy, economics of competition, among other topics. he has worked as a graduate assistant for dr. mehanna on several major research projects. 158 journal of business strategies business innovation, ethics, and prosperity: the primacy of microeconomics corporate social responsibility as institutional hybrids eva boxenbaum copenhagen business school copenhagen, denmark abstract this paper empirically examines the impact ofsocietal context on constructs of corporate social responsibility (csr). the empirical analysis is informed by neo-institutional theory, which conceptualizes csr constructs as potential or actual institutions. a case study from the danish business setting identifies the steps that a project group ofbusiness actors took to develop a new csr construct. the steps include the transfer and translation ofa foreign institution in response to a field-level problem, major events, and partial deinstitutionalization of an established csr construct. thefindings suggest that the new csr construct is an institutional hybrid, a combination offoreign andfamiliar institutions that make a new csr construct innovative, legitimate, and continuous with existing practice in the business setting. the paper proposes that csr constructs are malleable institutional hybrids that are most easily implemented if tailored to the social context. it concludes with implications for managers who want to select, design and implement csr constructs in their own business settings. the global compact in an address to the world economic forum on 31 january 1999, united nation secretary-general kofiannan challenged business leaders to join an international initiative the global compact that would bring companies together with un agencies, labour and civil society to support nine (now ten) principles in the areas of human rights, labour, the environment, and anti-corruption. the global compact's ten principles in the areas of human rights, labour, the environment and anti-corruption enjoy universal consensus and are derived from 'the universal declaration of human rights,' 'the international labour organization's declaration on fundamental principles and rights at work,' 'the rio declaration on environment and development, and 'the united nations convention against corruption,' the global compact is now entering its next stage of development from a phase of entrepreneurial growth to one of increasing organizational maturity. with a network of nearly 2,000 companies and other 46 journal ofbusiness strategies vol. 23, no.1 stakeholders, operating in more than 70 countries, the global compact is ready to move to a new level of performance. in december 2004, the first draft of a white paper proposing a new business model and governance structure will be shared with governments, businesses, labour and civil society groups, and other stakeholders, for review, comment and input. in september 2005, the global compact office will begin to implement the new business model and governance structure. (extracts, www.unglobalcompact.org, november 18,2004) this paper addresses the process through which a new csr construct comes into existence and, in particular, the role of social context in this construction process. the global compact exemplifies one such construct of corporate social responsibility (csr). a csr construct is a form of csr that is specific enough to be implemented in practice. the global compact is a unique construct in that it draws exclusively on international conventions. it defines csr as universally as possible to make the construct relevant and appealing across the globe. the global compact also exemplifies a csr construct that has been successful in its ambition of spreading rapidly across the world. not all csr constructs make it this far, or this fast. some never diffuse beyond the innovative setting, others vanish like yesterday's fads and fashions. yet others are never intended for global diffusion, targeting instead implementation at a more modest scale. there are many different csr constructs, some of which are local or national in scope, while others are more international in orientation. a close look reveals that they draw on quite different elements and traditions in their csr definitions. these differences can manifest themselves in divergent csr practices across nations. for instance, socially responsible investment and philanthropy are most widespread in united states, while formal reporting on social and environmental performance is only obligatory in france. in united kingdom, pension funds are obliged to make their investment criteria transparent, while denmark has made legal and administrative provisions to optimize socially responsible human resource management. empirical research confirms that there are national variations in csr constructs (maignan & ralston, 2002), and that csr constructs therefore do not travel easily across societal boundaries (rowley & berman, 2000). there is widespread acknowledgement that csr can take various forms in practice. as a result, much effort has been devoted to develop typologies and taxonomies for csr (e.g., carroll, 1979; wood, 1991; clarkson, 1995; commission of the european communities, 2001; roberts, 2003). none of these frameworks apparently enjoy widespread consensus. interestingly, despite the efforts devoted to defining csr, this notion is surrounded by much the same ambiguity today as it was 30 years ago (see sethi, 1975). in recent years, scholars have increasingly abandoned the quest for a normative csr theory and a universal csr definition. instead, they have turned their attention to the contextual features ofcsr, calling for a better understanding of the institutional processes that shape the creation, spring 2006 boxenbaum: corporate social responsibility 47 utilization, and change ofcsr (rowley & berman, 2000:415). the present paper responds to this call in empirically investigating the institutional processes that lead to the generation of new csr constructs. previous csr research offers little insight into the factors that make csr constructs vary across societal context. some suggest that empirical research is excessively difficult to conduct without a solid theoretical platform for csr (ullman, 1985; mitnick, 1993; rowley & berman, 2000). an alternative perspective may be that the very pursuit of a unique csr theory is a mistake in the first place. a more general theory, which applies to csr yet also extends far beyond it, may be very useful for an empirical analysis. neo-institutional theory is a promising theory for such an undertaking. it conceptualizes csr constructs as potential institutions, i.e., beliefs and practices that are closely associated with csr in a given societal context. neo-institutional theory thus offers insight into the convergence of csr within nations and the divergence across nations, without discounting the possibility of global diffusion (see, e.g., kostova & roth, 2002). in recent years, neo-institutionalists have addressed the micro-processes that lead to the emergence of new institutions. this insight is applied in the present paper to investigate the making of a new csr construct in its societal context. the first section of the paper outlines neo-institutional theory in relation to csr, while the second section describes the analytical framework and methodology. in the third section, a case study from the danish business setting shows how a group of business actors developed a new csr construct in response to the societal context. the paper concludes with a discussion that emphasizes the managerial implications of the research findings. csr and neo-institutional theory neo-institutional theory conceptualizes csr constructs as institutions or potential institutions. a csr construct is an institution if it is taken for granted and perceived as a universal definition of csr in a given societal context. it is a potential institution if it is seen as one among other plausible definitions of csr. a csr construct must diffuse widely before it comes to be a potential institution. at the initial steps of diffusion, it is but a proto-institution. proto-institutions are "new practices, rules and technologies that transcend a particular collaborative relationship and may become new institutions if they diffuse sufficiently" (lawrence, hardy & phillips, 2002: 281). proto-institutions are thus new constructs that diffuse beyond the innovative setting. this initial diffusion is most likely to occur if the new construct is designed for diffusion purposes (hargadon & douglas, 2001) and if the innovators are highly engaged in inter-organizational collaboration and highly embedded in the societal context (lawrence, hardy & phillips, 2002). neo-institutional theorists are still struggling to explain the micro-dynamics of the construction process itself. at present, there are multiple proposals as to the making of a new construct before it diffuses and is enacted in other settings. 48 journal of business strategies vol. 23, no.1 the global compact is an example of a construct that first became a proto-institution and then a potential institution. few other csr constructs have diffused as widely as the global compact, yet many csr proto-institutions certainly exist at various national or regional levels of the world. presumably, only few of these proto-institutions will diffuse far beyond their innovative setting and become institutions. most will probably fade away or reside the space to other csr constructs. to become an institution at the global level, the global compact must come to be perceived around the world as the natural form of csr. institutions are the forces that exert pressure on firms to adopt similar csr constructs to other firms in the same societal context. neo-institutional theory operates with three types of institutions. cognitive institutions are the worldview, the collective beliefs about the social world, or, more precisely, the causal relations believed to guide social interaction (dobbin, 1994). normative institutions are the collective norms that determine appropriate behaviour, that designate which goals are valuable to pursue and how to legitimately pursue them (scott, 1987, 1994). regulative institutions are the formal rules and regulations that carry formal sanctions if violated, e.g., laws. the three types of institutions overlap considerably with one another, but are rarely fully separable in practice (scott, 2001). they tend to reinforce one another, although there are many exceptions. for instance, norms may differ from the law, just as a norm may persist after the abandonment of the corresponding belief. institutions form at various levels of society. in theoretical formulations, institutions form inside an organizational field. an organizational field is the primary social environment of a firm: it may be an industry or a nation (dimaggio & powell, 1991) or a collection of firms interested in the same topic (hoffman, 1999). "the notion of field connotes the existence of a community of organizations that partakes of a common meaning system, and whose participants interact more frequently and fatefully with one another than with actors outside the field" (scott, 1994: 207-8). since firms in the same organizational field are subjected to the same institutions, they tend to adopt similar structures and practices (fligstein, 1991). they do so to obtain legitimacy, which is required to survive on the market (dimaggio & powell, 1983). analytical framework the analytical framework draws on a recent process model of institutional change (greenwood, suddaby & hinings, 2002). the model proposes that new institutions emerge through six consecutive steps: 1) precipitating jolts, 2) de institutionalization, 3) preinstitutionalization, 4) theorization, 5) diffusion, and 6) reinstitutionalization (alternatively fading away as fads and fashion). the third step, pre institutionalization, is when a new construct takes initial form, before theorization refines and generalizes it so as to optimize diffusion. preinstitutionalization occurs when organizations make independent innovation as they try to find solutions to perceived problems (ibid: 60). spring 2006 boxenbaum: corporate social responsibility 49 the mechanisms of institutional innovation, ofpreinstitutionalization, consist in path-dependency and diffusion (campbell, 2004, chap. 3). these two mechanisms are embodied in the notion of translation. translation is the process through which an institution is modified as it diffuses from one field to another (czarniawska & joerges, 1996; djelic, 1998; lippi, 2000). the purpose of modification is to fit the foreign institution to the receiving field, making it recognizable in this setting (campbell, 2004; hargadon & douglas, 200 i; kostova & roth, 2002; lippi, 2000), and meeting the interests of adopters (zeitlin, 2000; pieterse, 1994). ifperceived as superior to existing forms in the field, the translated form optimizes chances of adoption, which is a precondition for impacting on the receiving field (djelic, 1998). before being translated, foreign institutions diffuse in the form of novel practices. practices are templates for action, scripts that guide the behavior of actors (barley & tolbert, 1997). these behavioural templates boil down to cognitive frames. cognitive frames have a powerful effect on behaviour exactly because they are taken for granted. they operate as background structures and are rarely subjected to scrutiny, simply because they are not seen as options and choices. frames exercise hegemonic power when they position some actors better than others without being recognized for having this function (lukes, 1974). cognitive frames are a component of cognitive and normative institutions in as much as they capture the dominant worldview and norms offield members. they can take the form of causal relations, that is, as means-end frames that field members implicitly believe to be universally true and appropriate (dobbin, 1994; scott, 200 i). methodology the aim of the empirical analysis is to illuminate the process through which a new csr construct comes into being. according to the analytical framework above, new csr constructs are local modifications of foreign institutions. the objective is to trace and outline this modification process, using a case study from a danish business setting. this case study represents a deliberate example ofcsr construction. not all new csr constructs emerge in such a deliberate, explicit fashion. an explicit case is useful to the extent that it illuminates construction processes that apply to less explicit cases as well. construction processes are best illuminated in a real-time study, one that permits direct observation of microdynamic processes. a real-time study of csr construction processes must, of course, be conducted long before it is known whether a new csr construct will become an institution or fade away as yesterdays' fads and fashion. the general construction processes should be similar in either case. the case study is a partnership between two large firms in the danish service industry. the partnership is a project group composed of about 10 business actors, which are associated directly or indirectly with the departments of human resource management in one of the two participating firms. the project group designed and implemented new managerial practices relating to csr and diversity management in the two participating firms. their initial meetings resulted in 50 journal ofbusiness strategies vol. 23, no. i a formal funding application to the european union (eu). the project received funding for three years, which took the form of 50/50 cost sharing between the eu and the participating firms. i collected real-time data in 2002 during the conceptual phase of the project. data collection spanned about eight months and covered the period when the new csr construct was developed in such detail that implementation was made feasible. data collection consisted in observing project group meetings as a nonparticipant observer, conducting individual interviews with ten key members of the group, and collecting written material used or produced during this phase of the project. i collected supplementary data at the field level to identify the institutions in play during reconstruction. the organizational field is denmark in as much as the two firms and the participating business actors oriented themselves primarily to the national context when discussing csr. field level data consisted in keyword searches in a national newspaper database (lnfomedia), an online governmental database (www.folketinget.dk). and relevant ministerial websites. the keywords were drawn from non-participant observation of project group meetings and individual interviews. the unit of analysis is the mean-ends frame. as discussed previously, meansend frames are implicit causality structures that guide practices and make them socially meaningful. institutionalized means-end frames are standard templates for action in an organizational field; they are core features of cognitive and normative institutions. established means-end frames remain institutionalized as long as field members continue to reproduce them without reflection, that is, without consideration of alternatives (dobbin, 1994; zucker, 1988). for a csr construct to be new, it must draw upon a means-end frame that differs from the established means-end frame in relevant domains of practice. the empirical question is thus how the ten business actors developed a new means-end frame for csr, one that differed from the governmental csr construct that was already institutionalized in the field. the analytical procedures, assisted by the qualitative software program atlas.ti, consisted in identifying means-end frames in the data material, both institutionalized and novel means-end frames. to identify the institutionalized ones, i triangulated data from the project group level (interviews, observations, texts) with data from the field level (texts). this procedure resulted in a set of institutionalized means-end frames that represent the relevant cognitive and normative institutions in the field. these frames were the ones that field members apparently agreed to be true and appropriate for human resource management practice. to identify novel means-end frames, i singled out means-end frames that interviewees implicitly brought up when describing the novel csr construct. means-end frames were registered as novel only if they differed significantly from the means-end frame of the governmental csr construct, significantly referring to the end of such frames. the novel means-end frames were singled out for open-ended analysis to trace their origin and trajectory into the minds cape of actors. spring 2006 boxenbaum: corporate social responsibility results: the making of a new csr construct 51 this section outlines how the ten business actors developed a new csr construct with path-dependency to the governmental csr construct. it presents the process of preinstitutionalization as it applies to one case of csr construction. the new csr construct came about as actors adopted a foreign practice, diversity management, and merged it with the practices flowing from the governmental csr construct. the resulting construct became a csr proto-institution as it diffused into the two participating firms and to danish society more broadly. space does not permit due attention to the subsequent diffusion process. the case study focuses on the construction process, and provides a preamble to contextually situate this process. the preamble introduces the governmental csr construct and two precipitating jolts that led to partial deinstitutionalization of this construct. the central part outlines the innovative construction process that followed in the project group as the new csr construct was developed. preamble: precipitating jolts and deinstitutionalization in 2002, this national context was one of growing reflection on a well-established governmental csr construct. this governmental csr construct had developed in 1994 as part of a csr campaign launched by the social democratic government of denmark. the campaign was a reponse to demographic projections that predicted relatively more elderly people, immigrants, and single-parent families in the danish population. this demographic composition would increase the demand on public finances andjeopardize the economic foundation of the danish welfare state, making the state unable to offer the 1994 level of public services in 2010 (ministry of labour et ai., 2001: 8). to circumvent this turn of events, the social demographic government faced an imperative to intervene. it opted to activate more passive income recipients and launched the csr campaign. the campaign encouraged firms to integrate and retain more people in the active labour force, the principal target groups being immigrants, refugees, the physically challenged, and people with a temporarily reduced working capacity. through csr, firms would contribute to protecting the future of the danish welfare state. the csr campaign, which ran until 2002, underscored firms' moral duty to participate in reaching collective goals. the government assigned the primary responsibility for employee retention to firms (ministry oflabour et ai., 2001: 10) and requested firms to act in the collective interests of the nation, not expecting to derive financial benefits from every act of inclusion and responsibility (ibid: 21). in return, the government subsidized firms that hired or retained employees with low working capacity (flex jobs), rewarded the best firms with prizes, and developed a certification system (the social index) to enable firms to brand themselves on good csr performance (www.detsocialeindeks.dk). it made legal adjustments to improve the interfaces between labour unions, private firms, and municipal authorities so as to remove administrative barriers that could discourage firms from acting responsibly (social partnerships). in short, the government 52 journal of business strategies vol. 23, no.1 developed an elaborate administrative structure and set of new practices relating to corporate social responsibility. the governmental csr campaign promoted the means-end frame in figure 1. it stipulates that optimal workforce integration and retention (the means) lead to socioeconomic development of the danish welfare state (the end). this means-end frame represents the governmental csr construct, later to be known as well as the inclusive labour force. the governmental csr construct and its related means-end frame spread throughout the field in the second half of the 1990s (figure 2). it became increasingly synonymous with csr and was widely perceived to constitute the normative essence of csr in 200 1, perhaps because of few alternative csr constructs in the field. the governmental csr construct was an institution. figure 1 means-end frame of governmental csr construct same treatment of individuals protection of -----.... danish welfare state figure 2 keyword search on 'corporate social responsibility' in the national, daily newspaper of berlingske tidende 40 35 30 25 20 15 10 5 o 1994 1995 1996 1997 1998 1999 2000 ii corporate socialresponsibility source: infomedia spring 2006 boxenbaum: corporate social responsibility 53 in 2001, the governmental csr construct became subject to scrutiny and debate. the occasion was two major events, two precipitating jolts, which unsettled the taken-for-granted status ofthe governmental csr construct. the first event was the green paper on csr that the european commission published in july 2001 (commission ofeuropean communities, 2001). this document defined csr much broader than did the danish government. this alternative definition gave rise to a field-level discussion of what csr 'really' means. the danish parliament held a public hearing on the green paper and concluded that the danish csr construct was superior to that of the european commission, primarily because of its more operational definition and superior tools for implementation and measurement (europaudvalget, 2002). the choice to hold on to the governmental csr construct indicated a high level of institutionalization (zucker, 1991). the second event was a change of danish government in november 2001. the liberal party replaced the social democratic party. this change spurred a revision of social and labour policy. for instance, the primary partners of the government shifted from labour unions to private firms, and the responsibility for csr moved from the ministry of social affairs to the ministry of employment. these changes, fully predictable in relation to a right-wing tum of government, unsettled the governmental csr construct and gave momentum to a process of deinstitutionalization. deinstitutionalization set in as it became apparent that firms were not implementing the governmental csr construct to the extent the government had hoped. many danish firms, including the two firms in the case study, responded positively to the governmental csr campaign and adopted it in their policies and formal structures. they also implemented some dimensions in practice, but were apparently reluctant to sacrifice financial performance for a better csr performance. one visible effect was the failure in integrating immigrants and refugees into the work force. six years into the csr campaign, a governmental task force on the integration of immigrants concluded with dismay that "the unemployment rate of ethnic minorities is almost 17% as opposed to 5.6% in the remaining population, ... a problem that both the government and labor market partners consider very important to address" (partsudvalget om integration, 2000: 4). it was a classic situation of firms not walking the talk. there was discrepancy between discourse and practice: firms endorsed the governmental csr construct, but were hesitant or selective in their implementation of it. this discrepancy, also known as decoupling (meyer & rowan, 1977), resulted in partial deinstitutionalization of the governmental csr construct. this context gave favourable conditions for innovation and construction at the stage of preinstitutionalization. preinstitutionalization the constitution of the project group took place in late 200 1, immediately after the two precipitating jolts and during the deinstitutionalization process. the idea to the project had taken form in the spring and summer of 2001, and the three initiators had subsequently received preliminary funding to establish a project group and elaborate a formal funding application during the winter of 54 journal of business strategies vol. 23, no.1 2001/2002. the initiators recruited participants from the two firms involved in the project and attached some external experts to the project as well. in starting to develop a new csr construct, the project group immediately targeted the problem of decoupling. their proposal was to integrate social responsibility in the core of current business strategies in the two firms (confidential document, january 2002). this, they argued, would increase the likelihood of implementation and make csr more resistant to economic conjectures. their goal was thus one of combining social responsibility with financial performance, a combination absent from the governmental csr construct. another strategy of the project group was to target the integration of immigrants. this problem received much attention in the field at the time (see figure 3), and was widely perceived as a major challenge for danish society, much as in other fields: denmark is a very homogeneous society. we have only had one problem, we think, and that was gender. we have worked a lot with that, come to disagree and agree about it. but what sets a new agenda in denmark now is the arrival of immigrants and refugees who have not been requested to come here, as were foreign workers some decades ago. we get a group of people that live regular lives here and who do not behave as guests. and that is a major challenge for us. what do we do with this? that is when ethnic integration is put on the agenda and when the real challenge begins: immigrants and refugees are from all kinds of different origins and cannot be treated in a uniform way. (consultant) figure 3 keyword search on '''integration and immigrants" in the national, daily newspaper of berlinske tidende 300 250 200 150 100 50 o _.... ";' integration and !ii immigrants 1993 1995 1997 1999 2001 2003 source: infomedia spring 2006 boxenbaum: corporate social responsibility 55 the problem in integration of immigrants, combined with the decoupling problem, assured alignment of project objectives with the objectives of the participating firms and the field of denmark. the new liberal government was keen to collaborate with firms on the integration of immigrants, and the two firms were interested in optimizing their csr performance. this alignment of objectives helped mobilize resources to the project. the two firms engaged in a 50/50 cost sharing agreement with a european union fund, administered through the danish government, for a period of three years. besides aligning objectives and generating resources, the project group worked intensively on turning their idea into a practice format. their idea was to adopt a north american practice that had proved itself superior in integrating immigrants, relative to the danish governmental csr construct. the inspiration came from north american working experience: two years ago, in the summer of2000, i move back to denmark [after five years in united states]. 1 get a shock when r return to denmark because the debate on immigrants and refugees has become quite hateful and nasty. now i have been in a country, united states, where it is common to work with turning these sentiments of aggression and anger into something constructive. it was not very pleasant to return to this narrow-minded, condescending debate in denmark. so you can say, i come home to a country that has not at all worked with these problems, and i come with knowledge that it is feasible to do it differently. i also know that it is possible in canada, which is similar to denmark in many ways. this was the 'luggage' i had when the immigration problem came up, and this luggage turned out to be quite useful. (consultant) the idea came up in response to a problem experienced in denmark, the idea originating in another field. this idea was to implement the north american practice of diversity management in denmark. diversity management is a human resource management practice that fosters personal development of employees while putting the skills ofdifferent individuals to optimal use for the firm (thomas & ely, 1996; kelly & dobbin, 1998). diversity management is thus a win-win strategy that integrates financial and personal development goals. figure 4 shows the means-end frame that underpins this concept and its related practices. the practice is targeted at socially marginalized groups, that is, individuals with skills and potential hidden behind structural barriers of discrimination. immigrants and refugees belong to the target group, as do women with managerial potential, homosexuals, religious minorities, etc. diversity management appealed to the project group for two reasons: it promised to be a superior solution to the integration of immigrants, and it simultaneously minimized the decoupling between discourse and practice because it aligned better with financial performance indicators than did the governmental csr construct. the project group adopted this foreign institution and proceeded to plan the implementation of it in the two danish firms. 56 journal ofbusiness strategies figure 4 means-end frame of diversity management vol. 23, no.1 individualized treatment of employees financial performance of firm personal development of employees as the project group investigated the options of implementation, it became clear that its means-end frame collides with institutions in the field. the end of profit generation is illegitimate in the field in as much as it is incompatible with the normative institution ofdistributing financial resources as equally as possible. though profit generation is acceptable in the sense of helping firms survive, it should be a means to an end, not an end in itself. it certainly is inappropriate as the primary motivation for engaging in a socially oriented practice like csr: i can feel that danish managers prefer social responsibility to the bottom line. in denmark we do not like this concept of the bottom line, of making money. we have this equalizing society that pulls the bottom up, and the top down. it is extremely equalizing. nowhere in the world do you find better or worse. it is not so nice for poor people that others make money; so do not speak too loudly about it, okay. (consultant) the end of profit generation, contained in the means-end frame of diversity management, is thus incompatible with the normative institution of equalization. in fact, the means is equally at odds with this normative institution. individualized treatment ofemployees violates the norm oftreating people as equally as possible: diversity management is interpreted differently in denmark than it is in england, where it is legitimate to make categories that are based on terms that we tend to find discriminating, such as whites and blacks. in england, there is more open recognition of the fact that people are different and people talk more freely about the differences. in a danish context, where we are used to a homogenous society, it is rather appalling to mention the fact that people are different. it can have negative consequences because if you cannot talk about people being different, then you also cannot talk about treating them differently. i think that the danish tendency to equalize and homogenize is, in fact, an obstacle to diversity management and individual differences. in denmark, we see it as a matter of fairness to treat people equally. we are trained to equalize. (project manager) spring 2006 boxenbaum: corporate social responsibility 57 the quote clearly indicates the inappropriateness of treating employees in an individualized manner. hence, the means-end frame of diversity management is significantly at odds with a core value in the receiving field, namely the normative institution of equalization. this collision made chances slim that diversity management could successfully be implemented in the two firms, let alone diffuse within the field. to optimize the implementation and diffusion ofthe imported means-end frame, the project group translated it. they first softened the means and the end to remove their negative connotations. when that procedure turned out to be insufficient for gathering support in the two firms, the project group combined the foreign institution with the governmental csr construct, which carried legitimacy in the field. this combination was a deliberate attempt to facilitate the implementation of diversity management: social responsibility carries great symbolic value in denmark. diversity management is about working with differences, but in denmark that stirs a reaction of "oh no, we don't want that." our conviction is that there is no real conflict in incorporating social responsibility under diversity management. social responsibility adds symbolic value because it is already present. we also use it because the firm had begun to work more seriously with social responsibility. when diversity management is connected to that, it makes sense to people. (consultant) the project group thus utilized the governmental csr construct to help the foreign institution of diversity management bypass a normative institution in the field. the governmental csr construct legitimized the foreign institution, and simultaneously established continuity to current practices and administrative structures in the firms. both features facilitated the implementation of diversity management in the two danish firms. at the level of practice, the two practices were combined through an overlap in their target groups. both targeted socially marginalized groups, not necessarily identical ones, but nevertheless target groups with a sufficient overlap between them. the project proposed to integrate immigrants, physically challenged, and troubled youth, and to develop women's managerial potential. this mixed target group allowed for an overlap in practice. the overlap also occurred conceptually. a new csr construct emerged as the project group combined the means-end frames of the two original institutions from respectively north america and denmark. the combination resulted in a novel means, individualized treatment ofemployees, and the combined ends ofthe original frames. the new csr construct is thus an institutional hybrid, a combined means-end frame with multiple ends (see figure 5). it confines csr practices to the individualized treatment of employees in such a way as to target all three ends simultaneously. an example could be the profit-seeking skill development of unemployed immigrants. this institutional hybrid is the new csr construct, 58 journal of business strategies vol. 23, no.1 generated through diffusion and path dependency in response to precipitating jolts and deinstitutionalization. figure 5 means-end frame of csr reconstruction individualized treatment of employees conclusion protection of danish welfare state financial performance of firm personal development of employees the case study illustrated how a group of danish business actors developed a new csr construct. in short, they selected a foreign institution, the north american institution of diversity management, and transferred it to the field of denmark. they then translated it to bypass the normative institution of equalization in the receiving field, which provided a significant barrier to implementation and diffusion. the translation consisted in a combination with a legitimate institution, namely the governmental csr construct, developed and institutionalized under the social democratic government in the period 1994-2001. the means-end frames of both institutions were combined, resulting in a new csr construct that was novel and continuous with existing practice. this new csr construct eventually appealed to the participating firms and the field more broadly, and became a proto-institution as it diffused beyond the innovative setting. the present paper focused on the construction process, leaving aside the subsequent diffusion process. in theoretical terms, the construction process occurred during the pre-institutionalization stage of institutional change (greenwood, suddaby & hinings, 2002), and evoked the two mechanisms of diffusion and path-dependency (campbell, 2004). at a general level, the case study findings suggest that c sr constructs are eclectic constructs. they are apparently combinations of heterogeneous institutions, built from heterogeneous means-end frames. as such, csr constructs may be institutional hybrids. this conclusion resonates with previous research that suggest foreign institutions to be adopted and adapted selectively to suit local economic and institutional circumstances (zeitlin, 2000), and to be recombined with other institutions to generate new practices (rowe & shelling, 1991; pieterse, 1994). spring 2006 boxenbaum: corporate social responsibility 59 the institutional building blocks appear to be both foreign and familiar institutions, selected for their perceived superiority in solving a problem, alternatively for their strong symbolic value in the field. both components may well be required for new csr constructs to appear at once novel and legitimate in a field. striking a balance between novelty and familiarity may be a general feature of innovative constructs that diffuse successfully. for instance, a technical innovation like edison's electric light only diffused when the familiar institution of gas lighting was partially incorporated into the innovative construct of electric lighting (hargadon & douglas, 2001). the role ofthe familiar institution is that of skeumorphs, which are "elements of a design that serve no objectively functional purpose but are essential to the public's understanding of the relationship between innovations and the objects they replace (basalla, 1988)" (ibid: 491). skeumorphs make an innovation meaningful to field members, and allow it to diffuse in a field. a contemporary example of a skeumorph is the garbage can icon on computer screens, which makes files similar to paper. in the present case study, the governmental csr construct became a skeumorph in the new csr construct in as much as it made diversity management meaningful to field members. diversity management was also novel: it was sufficiently foreign to make the new csr construct significantly different from the familiar institution of the governmental csr construct. the new csr construct apparently stroke this balance between novelty and familiarity, making it possible for it to diffuse as a novel construct in the field. as institutional hybrids, csr constructs are also malleable entities that can be rebuilt to fit new contexts and fields. actors may replace institutional components in an existing construct or add new components to it as they see fit. new csr constructs are perhaps most malleable in their embryonic stage, growing more robust as they are institutionalized through the subsequent steps of theorization and diffusion (greenwood, suddaby & hinings, 2002). during preinstitutionalization, csr is apparently constructed in response to a societal context. in the case study, the societal context was one of preoccupation with the integration of immigrants in the danish work force and partial deinstitutionalization of a governmental csr construct. this societal context resulted in a new csr construct that was tailored to this particular field, at this particular point in time. despite it being tailored, the new csr construct certainly contain elements of relevance to other societal contexts, elements that may inspire actors in other fields to adopt and modify it to fit their own societal context. the research findings may certainly be used for prescriptive purposes. managers may use them to design new csr constructs that have good chances of being implemented in their own firms and of diffusing in their organizational fields. for instance, managers may begin by identifying the organizational field, i.e., the grouping of firms and organizations to which they feel kinship. for a multinational corporation, it may be other multinational firms, while an sme with historical roots in a local community may identify most with other firms in the local region or the nation. the manager may proceed by identifying a shared 60 journal ofbusiness strategies vol. 23, no.1 preoccupation, for instance a tenacious social problem that affect the firm and the field, and that requires resolution. a search is then required to find a successful, institutionalized solution to a similar problem in another field. when found, this practice must be transferred to the receiving field, and perhaps translated. translation is required if the new practice contradicts with norms and values in the field. if so, the transferred practice must be combined with a legitimate institution to facilitate implementation and diffusion. the combination is the novel and legitimate csr construct. managers may wish to implement csr even ifthere is no tenacious problem at hand. in that case, managers may select an existing csr construct that fit the institutions in the field and modify it if required. in either case, it is important to keep in mind that a new csr construct must be both novel and familiar to be implemented in practice. ideally, it is also timely and helpful in resolving an acknowledged problem. these factors, combined, may account for the empirical observation that csr takes different form across national contexts. perhaps they also explain why many csr constructs never quite make it beyond the pr room, the boardroom, or formal policies, despite the best of intentions to make a real impact on practice. references carroll, a. b. (1979). a three-dimensional conceptual model of corporate performance. academy of management review, 4, 497-505. czarniawska, b. & joerges, b. (1996). travels of ideas. in b. czarniawska & g. sevon (eds.), translating organizational change (pp. 13-48). berlin: walter de gruyter. clarkson, m. b, e. (1995). a stakeholder framework for analyzing and evaluating corporate social performance. academy of management review, 20. 92-117. commission of the european communities (200 i). green paper. promoting a european frameworkfor corporate social responsibility. brussels: author. retrieved july 18, 200 i, from europa.eu.int/comm/employment_sociallsoc-dial/csr/csr_index.htm dimaggio, p. j. (1988). interest and agency in institutional theory. in l. zucker (ed.), institutional patterns and organizations (pp. 3-22). cambridge, ma: ballinger. dimaggio, pj. & powell, ww (1991). introduction. in w w powell, & pj. dimaggio (eds.), the new institutionalism in organizational analysis (pp. 1-40). chicago: the university of chicago press. dimaggio, p. j. & powell, w w (1983). the iron cage revisited. institutional isomorphism and collective rationality in organizational fields. american sociological review, 48 (2), 147-160. spring 2006 boxenbaum: corporate social responsibility 61 djelic, m.-l. (1998). exporting the american model: the postwar transformation of european business. oxford: oxford university press. djelic, m.-l. & quack, s. (eds.) (2003). globalization and institutions: redefining the rules of the economic game. cheltenham, uk: edward elgar publishing. dobbin, f. (1994). forging industrial policy. the united states, britain, and france in the railway age. cambridge: cambridge university press. europaudvalget (2002). referat af frellesh0ringen om gnmbogen om virksomhedernes sociale ansvar. [summary of the public hearing on the green paper on csr]. folketingsaret 2001-2002,2. samling, info-note j 67. fligstein, n. (1991). the structural transformation of american industry: an institutional account of the causes of diversification in the largest firms, 1919-1979. in w. w. powell, & p. j. dimaggio (eds.), the new institutionalism in organizational analysis (pp. 311-336). chicago: the university of chicago press. fligstein, n. (1997). social skill and institutional theory. american behavioral scientist, 40 (4), 397-405. greenwood, r., suddaby, r., & hinings, c. r. (2002). theorizing change: the role of professional associations in the transformation of institutionalized fields. academy of management journal, 45 (1), 58-80. hargadon, a. b., & douglas, y. (200 i). when innovations meet institutions: edison and the design of electric light. administrative science quarterly. 46. 476-501. hoffman, a. (1999). institutional evolution and change: environmentalism and the u.s. chemical industry. academy ofmanagement journal, 42 (4), 351-371. huff, a. s., & jenkins, m. (eds.) (2002). mapping strategic knowledge. london: sage publications. kelly, e. & dobbin, f. (1998). how affirmative action became diversity management. employer response to anti-discrimination law, 1961 ~ 1996. american behavioral scientist, 41 (7), 960-984. kostova, t. & roth, k. (2002). adoption of an organizational practice by subsidiaries of multinational corporations: institutional and relational effects. academy ofmanagement journal, 45 (1), 215-233. lawrence, t.e., hardy, c., phillips, n. (2002). institutional effects of interorganizational collaboration: the emergence of proto-institutions. academy of management journal, 45 (1),281-291. 62 journal ofbusiness strategies vol. 23, no.1 lippi, a. (2000). one theory, many practices. institutional allomorphism in the managerialist reorganization of italian governments. scandinavian journal of management, i6,455-477. lukes, s. (1974). power: a radical view. london: macmillan press ltd. maignan, i. & ralston, d. (2002). corporate social responsibility in europe and the u.s.: insights from businesses' self-presentations. journal ofinternational business studies, 33 (3),497-514. meyer, j. & rowan, b. (1977). institutionalized organizations: formal structure as myth and ceremony. american journal ofsociology, 83, 340-363. ministry of labour, ministry of employment, ministry of internal affairs, ministry of social affairs, ministry of education, ministry of economics, ministry of finance. (april 2001 ). brugfor aue danmark 20 i () og et mere rummeligt arbejdsmarked. [a need for everyone denmark 20 10 and a more inclusive labour force]. copenhagen: j. h. schultz grafisk a/s. mitnick, b. (1993). organizing research in corporate social performance: the csp system as core paradigm. [paper presented as a showcase session at the annual meeting of the international association for business in society (labs), san diego, ca, march 19-21, 1993]. partsudvalget om integration (january 2000). rapport fra partudvalget om integration om integration af indvandrere og flygtninge pa arbejdsmarkedet. [report from the subgroup of integration on the integration of immigrants and refugees]. copenhagen, danish ministry of employment. from www.bm.dk pieterse, j. n. (1994). globalization as hybridization. international sociology. 9(2), 161-184. roberts, j. (2003). the manufacture of corporate social responsibility: constructing corporate sensibility. organization, io (2).249-265. rowe, w. & schelling, v. (1991). memory and modernity. popular culture in latin america. london: verso. rowley, t. & berman, s. (2000). a brand new brand of corporate social performance, business and society. 39 (4), 397-418. scott, w. r. (200 i). institutions and organizations (2nd ed.). thousand oaks, ca: sage. scott, w. r. (1994). conceptualizing organizational fields: linking organizations and societal systems. in u. gerhardt, h.-u. der1ien, & f. w. scharpf(eds.), systems rationality and partial interests (pp. 203-221). baden-baden, germany: nomos-verlag. spring 2006 boxenbaum: corporate social responsibility 63 scott, w. r. (1987). the adolescence of institutional theory. administrative science quarterly, 32 (4).493-509. seo, m. g. & creed, w. e. d. (2002). institutional contradictions, praxis, and institutional change: a dialectical perspective. academy of management review, 27, 222-247. sethi, p. s. (1975). dimensions of corporate social performance: an analytical framework. california management journal. 17 (3). 58-64. thomas, d. a. & ely, r. j. (1996). making differences matter: a new paradigm for managing diversity. harvard business review, 74,79-90. ullman, a. h. (1985). data in search of a theory: a critical examination of the relationships among social performance, social disclosure, and economic performance of u.s. firms. academy of management review, 10, 540-557. wood, d. j. (1991). corporate social performance revisited. academy of management review, 16,691-718. zeitlin, j. (2000). introduction: americanization and its limits: reworking us technology and management in post-war europe and japan. in j. zeitlin & g. herrigel (eds.), americanization and its limits: reworking us technology and management in postwar europe and japan (pp.i-52). oxford: oxford university press. zucker, l. (1991). the role of institutionalization in cultural persistence. in w. w. powell, & p. j. dimaggio (eds.), the new institutionalism in organizational analysis (pp. 83-107). chicago: the university of chicago press. zucker, l. (1988). where do institutional patterns come from? organizations as actors in social systems. in l. g. zucker (ed.), institutional patterns and organizations: culture and environment (pp. 23-52). cambridge, ma: ballinger. eva boxenbaum is assistant professor in the department of organization and industrial sociology at copenhagen business school from where she recently obtained a ph.d. in economics and business administration. she conducts research on corporate social responsibility, cross-national transfer of management practices, and micro-dynamics of translation. her work has been published in strategic organization, american behavioral scientist, and best paper proceedings ofacademy of management annual meeting 2005. 64 journal ofbusiness strategies vol. 23, no.1 corporate social responsibility as institutional hybrids welfare enhancing collusion in a service provision model evan moore auburn university at montgomery • montgomery, al james boswell booz allen hamilton • washington, dc abstract this paper provides a model of service provision with homogeneous goods that allows for welfare comparisons between firms engaged in cournot-type competition and joint-profit maximization. an important factor in this analysis is the role of service provision on the demand for the product. we find that collusion can be social welfare enhancing in a static framework and show that under certain conditions both consumers and producers can benefit from collusion; this occurs if the number of firms in the market exceeds roughly 20.4 firms. additionally, we present a collusive result that we have not found elsewhere in the literature. introduction much of the research on collusion finds that social welfare is maximized when firms are engaged in competition rather than collusion. this is particularly true for static models, with exceptions usually arising when the models are dynamic. examples of increased social welfare when firms are colluding are often related to quality, advertising, mergers, or research and development related joint ventures (cellini & lambertini, 2003; deltas & serfes, 2002; fershtman & pakes, 2000; kamien, muller, & zang, 1992; verboven, 1995).1 using a static modeling approach, this paper provides a model of service provision with homogeneous goods that allows for welfare comparisons between firms engaged in cournot-type competition and joint-profit maximization. an important factor in this analysis is the role of service provision on the demand for the product. unlike other works, we find that collusion can indeed be social welfare enhancing in a static framework. we show that under certain conditions both consumers and producers can benefit from collusion; this occurs if the number of firms in the market exceeds roughly 20.4 firms. additionally, we have not found a collusive result in any other work that is similar to the one presented in this paper. much of the remainder of the paper is based on a theoretical model involving mathematical derivations. we would like to briefly mention some aspects of the 44 journal of business strategies model and implications for the reader that is not interested in the technical aspects of the work. we assume that the firms are producing, or selling, a homogeneous good with an associated level of service. our central result, the finding that collusion can be social welfare enhancing, rests on the assumption that firms can engage in service provision which has a cumulative effect on potential buyers. if the effect is sufficiently strong then this induces individuals, who were not previously purchasing the good, to buy the product. these consumers are known as marginal consumers in the economics literature. while the product being sold is identical, with similar amounts of service provided by each firm in equilibrium resulting in similar costs of provision, the nature of the service provided may vary among the firms. some information may be viewed as bundled with the product but only from a certain firm. for example, one firm may provide a handout containing product information, while another may provide a demonstration regarding usage, and yet another convenient location in the store to view or sample the product.2 it is also possible to view our findings with firms required to provide both identical types and amounts service provision in equilibrium. the results show that the returns to collusion are greater, with higher total service provision, with greater numbers of firms. this can be interpreted that the pervasiveness of the product, i.e. availability in prime locations within the retailers, encourages the marginal consumer to buy due to repeated viewings at various outlets.3 however, if the service provision of the various firms is not cumulative, i.e. a firm’s sales are not positively affected by the increased service levels of another firm, then collusion results in each firm receiving and equal share of the monopolist’s profit and does not result in increased welfare for consumers; the total surplus is constant under this setting with producer and consumer surplus remaining constant regardless of the number of firms in the market. the appendix contains an alternative specification of the demand function which reflects each firm’s sales as a function solely of its service provision, rather than the total level of service. a brief discussion comparing these results with the model in this section is provided.4 our results suggest that managers need to consider how service provision affects the demand for the product being sold. we focus our efforts on homogeneous, i.e. identical, products where the total service provision in the market affects demand and also provide an alternative model where the firm’s, or retailer, service provision is not cumulative. while it is not surprising that collusion among firms would lead to higher profits in either setting, if demand is indeed affected by the total level of service provision then coordinated efforts regarding the services provided may envolume 29, number 1 45 hance not only producer surplus but consumer surplus as well. this could serve as a justification for trade or retail organizations and suggests that managers may want to participate in these groups. the remainder of the paper is organized as follows. “the model” presents the results of an n-firm model providing services in a market involving homogeneous goods. “collusion and welfare comparisons” provides welfare comparisons between firms engaged in competition and collusion. ”conclusion” provides a summary of the findings. the model consider an industry of n identical firms facing a market demand function of q(p,s) = s(a p), where q is the industry output, p is the output price, s is the level of service provided in the market, and a is a shift parameter corresponding to the intercept on a linear demand curve with a > 0. this demand function is used by boswell and moore (2009), hegji and moore (2005), and pepall, richards, and norman (2002).5 with this demand function increased service levels result in increased reservation prices and an increase in market size. hegji and moore (2005) note that, “…demand does not shift parallel with an increase in service but, rather, rotates around the price axis” (p. 135). this demand function is useful in cases where service is directly bundled to the product, such as product assembly or repair information. alternatively, service could be viewed in terms of product display or other cases where service costs are incorporated into product price. total costs are a function of both service provision and production costs. production costs are assumed to be at a constant marginal cost of c and service, s, at a constant per unit cost of φ. we assume si > 0 and φ > 0. the total cost for firm i is tci = qi(c + φsi). to ensure positive equilibrium output levels we assume a > (c + φsi). the market inverse demand function is: q p = a . (1) s where q = n σ i=1 qi and s = n σ i=1 si . to simplify our notation in the following derivations, we define qj = n σ k≠i qk and sj = n σ k≠i sk . profit for firm i is thus qi + qjπi(qi,si) = [a ]qi (c + φsi)qi , (2) si + sj 46 journal of business strategies maximizing (2) with respect to qi results in the reaction function (a φsi c)(si + sj) qjqi = (3) 2 2 maximizing (2) with respect to si yields the relationship qi + qjsi = √ sj . (4) φ in equilibrium the firms will have identical levels of quantity and service such that q = nqi and s = nsi . it follows that qj = (n 1)qi and sj = (n 1)si . substituting (3) into (4) and solving for si in terms of qi results in qisi = . (5) √φnqi solving for qi in terms of si gives nsi(a c φsi)qi = . (6) n + 1 use of equations (5) and (6) results in equilibrium output and service of n(a c)2 q*i = (7) φ(n + 2)2 a c s*i = (8) φ(n + 2) hence the equilibrium price is 2a + nc p* = (9) n + 2 and the resulting equilibrium profit for firm i is n(a c)3 π*i = (10) φ(n + 2)3 as expected, in the limit, as the number of firms increases price is driven to marginal cost, c, and profits are driven to zero. additionally, a cursory glance at (7) and (8) reveals that firm i’s output and service fall as the number of firms increases. these decreases occur as intensifying competition reduces the value of service provolume 29, number 1 47 vision, in terms of increased revenue, for a given firm; the costs of service provision cannot be recouped due to the pricing constraints of the competitive market and this leads to reduced service provision. this in turn leads to lower output for a given firm. collusion and welfare comparisons we define collusion as setting output and service levels with the goal of maximizing joint profits. given that the firms face identical costs of production, the profit function facing any firm engaged in collusion is q πi (qi, si) = [a ]qi (c + φsi)qi , with q = nσi=1qi and s = nσi=1si . (11) s each firm will then choose the same level of output and service provision, such that q = nqi and s = nsi. using these values in (11) yields nqiπi (qi, si) = [a ]qi (c + φsi)qi , which simplifies to nsi qiπi (qi, si) = [a ]qi (c + φsi)qi . this is the profit function of a sole firm, or si monopolist. this results in the firm’s collusive level of output, service, profit, and (a c)2 a c 2a + c (a c)3 the market price of q*m = , s * m = , pm * = , and πm * = . 9φ 3φ 3 27φ these values can also be found by using n = 1 in equations (7) through (10). we use the subscript m to indicate that each firm in the collusive arrangement will produce the monopoly level of output and service while earning the monopolist’s level of profit. the implications for producers are straightforward as participating in the collusive arrangement yields greater profits than engaging in competition. producer surplus in the competitive case is found by multiplying equation (10) by n resulting n2(a c)3 n(a c)3 in pscomp = , while producer surplus in collusion is pscollusion = . φ(n + 2)3 27φ producer surplus in the competitive case is maximized with 4 firms in the market; producer surplus in the collusive framework increases linearly as the number of firms increases.6 48 journal of business strategies the figure below presents producer surplus in the two cases using values of a = 10 and c = φ = 1.7 figure 1. comparison of producer surplus it is evident that the firms are jointly more profitable when colluding for any value of n ≠ 1. the effects on consumer welfare are straightforward to discern. consumer surplus equals ½(a p*)q*, where p* is the equilibrium price and q* is the joint equilibrium output. use of (7) and (9) results in the competitive consumer surplus of n3(a c)3 cscomp = . (12) 2φ(n + 2)3 consumer surplus is a monotonic, concave function in the number of firms, n. this follows the usual cournot result with the minimum consumer surplus occurring with a single monopoly producer. consumer surplus asymptotically approaches the perfectly competitive market values from below as n → ∞. the consumer surplus when the firms are colluding is n(a c)3 cscollusion = . (13) 54φ 250 200 150 100 50 0 surplus 0 2 4 6 8 10 number of firms (n) ps competition ps collusion volume 29, number 1 49 a comparison of equations (12) and (13) yields a result of interest. for values of n > 2(5 + 3√3), which is approximately 20.4 firms, the consumer surplus is greater when the firms operate in collusion as opposed to competitively. this is shown in figure 2 below. figure 2 comparison of consumer surplus finally, total surplus in the competitive market is n2(a c)3 tscomp = . (14) 2φ(n + 2)2 similar to consumer surplus, the total surplus asymptotically approaches the perfectly competitive market values from below as n → ∞. the total surplus in the collusive market is n(a c)3 tscollusion = . (13) 18φ a comparison of equations (14) and (15) reveals that for n > 4 the total surplus in the collusive framework exceeds that of firms engaged in cournot competition.8 this is shown in figure 3 below. 400 300 200 100 0 surplus 0 10 20 30 number of firms (n) cs competition cs collusion 50 journal of business strategies figure 3 comparison of total surplus this result is driven by the increases in producer surplus when n is relatively small. for 4 < n < 2(5 + 3√3), the losses in consumer welfare are more than made up for by the gains to producers. however, both consumers and producers prefer collusion if n > 2(5 + 3√3) as the surplus is greater for each group. this arises as collusion results in greater aggregate levels of service provision relative to the competitive case for a given large number of firms. this encourages marginal consumers to purchase the good, and the effect of this greater service provision on marginal consumers is stronger when there are many firms in the market.9 additionally note that in the limit, as n → ∞, the total surplus in the competi (a c)3 tive framework is tscomp = , which is the maximum possible value for 2φ of this maximum with the total surplus in the collusive arrangement, equation (15), reveals that for n > 9 the total surplus from collusion exceeds the maximum possible from competition. note that for n > 4 the total output in the collusive market exceeds that of n firms engaged in competition. also the total service level is greater in collusion for n > 3 versus the competitive case. this relatively large level of service provision induces marginal consumers to enter the market and purchase the product, as the price remains constant in the collusive case. 400 300 200 100 0 surplus 0 2 4 6 8 10 number of firms (n) ts competition ts collusion volume 29, number 1 51 conclusion we have developed a theoretical framework to study the profitability of collusion with firms producing homogeneous goods with accompanying service provision. using a static equilibrium, we show that collusive behavior results in each firm producing the monopoly level of output and service provision; our results indicate that each firm enjoys the monopoly level of profit as well. we have not come across such results in the literature. we show that consumers can benefit from collusion as the number of firms increases beyond 2(5 + 3√3). additionally, total surplus is greater under collusion if the number of firms exceeds 4. we realize that our results may not be particularly robust. the results are likely sensitive to the choice of cost function. our cost function results in the marginal cost of increasing service provision per unit of output rising with a firm’s total production. an alternative specification could separate the cost of service provision from the level of output, such as tci = cqi + φsi. this choice may reflect more accurately the externalities that arise from certain types of service provision, such as promotional messages, and remove the implied scale diseconomy of service provision described above. however, the nature of our results, welfare enhancing collusion that benefits both consumers and producers with total welfare increasing as the number of firms increases, is unique. there are a variety of avenues for extending this modeling approach. these potential research areas could focus on sequential move play, cost asymmetries, the ability and likelihood of mergers, and/or incentives to cheat on any collusive arrangement. additionally, more generalization of the demand and cost functions could prove fruitful. appendix collusive and competitive results with and alternative demand specification and a brief comparison with the primary results this appendix contains the results from firms engaged in cournot-type competition and profit-maximizing collusion with firms facing the market demand function qi qjp = a σ (a1) si sj where qj and sj are the output and service levels for any firm i ≠ j and the total cost for firm i is tci = qi(c + φsi). the results are provided in table a1 below. 52 journal of business strategies table a1 results with alternative demand specification (a1) collusion competition (a c)2 (a c)2 quantity qi n9φ φ(n + 2) 2 a c a c service si 3φ φ(n + 2) 2a + c 2a + nc price p 3 n + 2 (a c)3 (a c)3 profit πi n27φ φ(n + 2) 3 (a c)3 n(a c)3 producer surplus 27φ φ(n + 2)3 (a c)3 n2(a c)3 consumer surplus 54φ 2φ(n + 2)3 (a c)3 n(a c)3 total surplus 18φ 2φ(n + 2)2 the results of this model follow the traditional results, i.e. in the collusive case the firms each produce a 1/n share of the monopolist’s level of output, resulting in constant levels of surplus. it is of some interest to note that the prices and service levels from each case match their counterparts in the primary model. however, the non-cumulative nature of service provision in demand specification (a1) leads to much lower level of output for a given n number of firms. a quick comparison q*i of (equation 7) and q*m with the corresponding results above reveals that output associated with market demand function (1) is n times greater; this is due to the entry of marginal consumers from the associated benefits of cumulative total service provision in this market. volume 29, number 1 53 end notes 1. in another arena, roumanias (2007) finds collusion among corrupt agents increases social welfare as coordination reduces graft. 2. this is not to be confused with a multiproduct oligopoly model, which may arise due to factors such as economies of scope (bailey & friedlander, 1982) in production or product offerings of different quality. the products are assumed to be homogeneous in our model, and the resulting output and service levels are constant across the firms in equilibrium. 3. a potential empirical test for this line of reasoning might involve sales data for each firm selling the product as the number of firms offering the product increases. our competitive model shows per-firm sales falling while the collusive results indicate constant per-firm sales as the number of firms increases. 4. we thank an anonymous referee for this suggestion. 5. none of these works investigates collusion. additionally, boswell and moore (2009) and hegji and moore (2005) focus on duopoly settings while pepall et al. (2002) focus on the monopoly case. 2n(a c)3 3n2(a c)3 6. differentiating pscomp with respect to n results in . σ(n + 2)3 σ(n + 2)4 this equals zero for values of n of 4 and 0. taking the second derivative of pscomp 2(a c)3 12n(a c)3 12n2(a c)3 with respect to n results in + . at n = 4 this σ(n + 2)3 σ(n + 2)4 σ(n + 2)5 (a c)3 simplifies to – . hence, n = 4 satisfies the necessary and sufficient 324 σ conditions of being a maximum of pscomp. 7. we use values of a = 10 and c = φ = 1 for the remaining figures as well. 8. additionally, similar to jin’s (1996) finding that information sharing should be granted if firms’ average squared sales increase, the average squared sales are greater under collusion if n > 4 versus the competitive outcome. 9. we thank an anonymous referee for noting that equation (5) reveals that a 1 percent increase in service ties with a 2 percent increase in quantity demanded for a 54 journal of business strategies given firm (firm i). this relationship aids in indicating the magnitude of increasing marginal consumers as service provision increases. references bailey, e., & friedlander, a. (1982). market structure and multi-product industries. journal of economic literature, 20. boswell, j., & moore, e. (2009). service provision and product differentiation. journal of business strategies, 26(2). cellini, r., & lambertini, l. (2003). advertising with spillover effects in a differential oligopoly game with differentiated goods. central european journal of operations research, 11, 409-423. deltas, g., & serfes, k. (2002). semicollusion vs. full collusion: the role of demand uncertainty and product substitutability. journal of economics, 77(2), 111-139. fershtman, c., & pakes, a. (2000). a dynamic oligopoly with collusion and price wars. rand journal of economics, 31(2), 207-236. hegji, c., & moore, e. (2005). a note on the strategic use of service. journal of business strategies, 22(2), 135-141. jin, j. (1996). a test for information sharing in cournot oligopoly. information economics and policy, 6, 75-86. kamien, m., muller, e., & zang, i. (1992). research joint ventures and r&d cartels. the american economic review, 82(5), 1293-1306. pepall, l., richards, d., & norman, g. (2002). industrial organization: contemporary theory and practice. cincinnati, oh: south-western. roumanias, c. (2007). is collusion of corrupt agents welfare increasing? economics letters, 94, 421-425. verboven, f. (1995). corporate restructuring in a collusive oligopoly. international journal of industrial organization, 13, 335-354. biographical sketch of authors dr. moore joined the department of economics at auburn university montgomery in 2002. he is currently an associate dean for the school of business. his primary teaching interests are industrial organization, game theory, and microeconomic theory. his primary areas of research include industrial organization and experimental economics. he has published in a variety of journals including the american economic review. volume 29, number 1 55 james boswell joined booz allen hamilton as an operations research analyst in 2009. he provides modeling & simulation support to defense and space industry clients. his research interests include computational statistics, industrial organization, and game theory. james has a b.s. in mathematics from auburn university montgomery, and a m.a. in applied economics from johns hopkins university. 56 journal of business strategies welfare enhancing collusion in a service provision model breaking the paradigm of sensing, seizing, and transforming – evidence from axel springer leemann et al. / journal of business strategies (2021) 38: 95-124 95 journal of business strategies doi:10.54155/jbs.38.2.95-124 breaking the paradigm of sensing, seizing, and transforming – evidence from axel springer niklaus leemanna, dominik kanbachb, stephan stubnerc a hhl leipzig graduate school of management, jahnallee 59, 04109 leipzig, germany. niklaus.leemann@hhl.de (corresponding author). b junior professorship in strategic entrepreneurship, hhl leipzig graduate school of management, jahnallee 59, 04109 leipzig, germany. d.kanbach@hhl.de. c professor and chairholder, dr. ing. h.c. f. porsche ag chair of strategic management and digital entrepreneurship, hhl leipzig graduate school of management, jahnallee 59, 04109 leipzig, germany. stephan.stubner@hhl.de. key words dynamic capabilities; incumbent adaptation; resource-based view abstract dynamic capabilities have typically been conceptualized as sensing, seizing, and transforming. this article explores the interplay of these procedural dimensions employing a longitudinal case study of axel springer, a leading media corporation that has exercised dynamic capabilities to convert from a print publisher to an internet company. insightful evidence is produced from interviews with current and former top managers. the case study shows iterations, overlaps, and interconnections between sensing, seizing, and transforming. sensing-by-seizing is introduced as a dynamic capability to seize concrete opportunities while concurrently sensing them. a conceptual model furnishes implications and recommendations for managerial decision-making. this work is licensed under a creative commons attribution-noncommercial 4.0 international license. copyright (c) 2021 niklaus leemann, dominik kanbach, stephan stubner. mailto:niklaus.leemann@hhl.de mailto:d.kanbach@hhl.de mailto:stephan.stubner@hhl.de https://creativecommons.org/licenses/by-nc/4.0/ https://creativecommons.org/licenses/by-nc/4.0/ 96 leemann et al. / journal of business strategies (2021) 38: 95-124 1. introduction the concept of dynamic capabilities aims to explain what processes, abilities, or routines enable the firm to thrive amid changing environments (e.g., teece et al., 1997; eisenhardt & martin, 2000; zollo & winter, 2002; winter, 2003; teece, 2007; helfat et al., 2007; schilke et al., 2018). as such, dynamic capabilities also contribute to economic stability and social cohesion as they enable incumbent firms to adapt to a change in their contextual setting. the conceptual introduction of dynamic capabilities to the literature was followed by a multitude of empirical contributions. typically, such studies follow the procedural dimensions of teece (2007) that specify dynamic capabilities as sensing, seizing, and transforming (schilke et al., 2018). accordingly, many studies tend to construct incumbent adaptation in rather discrete and linear steps from the identification of opportunities and threats to the building up or alteration of resources, and finally to the transformation of the organization (e.g., gebauer, 2011; mousavi & bossink, 2017; vézina et al., 2019). we believe that change in the real world is not that discrete and linear over time. hence, our research question is: how do sensing, seizing, and transforming interplay over a longer time period of incumbent adaptation to changing environments? this proposes an extended perspective on dynamic capabilities and addresses calls in the literature to recombine, revise, and extend the existing procedural dimensions (e.g., protogerou et al., 2012; schilke et al., 2018). we explore our research question by applying the critical case approach (flyvbjerg, 2006; yin, 2018) to a longitudinal study of axel springer, a leading international media corporation that has managed to successfully convert from a print publisher to an internet company in the past two decades. interviews with 18 current and former top managers, including five members of the board as well as peers covering the entire observation period, allowed us to gain rich and insightful data on the case. the axel springer case shows that incumbent adaptation over time is a less discrete and linear organizational phenomenon than the pertinent literature suggests. the firm began transforming before exercising any sensing and seizing activities. it sensed opportunities while already being in the process of seizing them, and when building up new businesses, it constantly iterated between sensing, seizing, and transforming. leemann et al. / journal of business strategies (2021) 38: 95-124 97 with this study, we provide three main contributions. first, we find support that incumbent adaptation is an iterative process with overlaps and interconnections between sensing, seizing, and transforming. second, we introduce the concept of sensing-by-seizing, which describes the dynamic capability of gaining knowledge through action. third, we present a conceptual model for dynamic capabilities in incumbent adaptation that furnishes implications and recommendations for managerial decision-making. 2. theoretical background rooted in the resource-based view (e.g., penrose, 1959; wernerfelt, 1984; barney, 1991), dynamic capabilities are the firm’s processes, abilities, or routines to purposefully create, extend, modify, or release its resources to address changing environments (e.g., teece et al., 1997; eisenhardt & martin, 2000; helfat et al., 2007; schilke et al., 2018). teece (2007) has further advanced the concept by specifying dynamic capabilities as sensing, seizing, and transforming. in particular, the micro-foundations of sensing capabilities are “analytical systems […] to learn and to sense, filter, shape, and calibrate opportunities […] and threats” (teece, 2007, p. 1322, 1326); those of seizing capabilities are “enterprise structures, procedures, designs and incentives for seizing opportunities” (p. 1334); and those of transforming capabilities are “continuous alignment and realignment of specific tangible and intangible assets” (p. 1340). subsequent empirical research has typically constructed its findings within these procedural dimensions of dynamic capabilities (schilke et al., 2018), often suggesting a linear sequence and clear distinction among them (e.g., gebauer, 2011; mousavi & bossink, 2017; vézina et al., 2019). moreover, zollo and winter (2002) conceptualize dynamic capabilities as “learned and stable pattern[s]” that are “systematically” (p. 340) applied in the strategic adaption of the firm. their routinized, repetitious, and patterned nature also distinguishes dynamic capabilities from “ad hoc problem solving” that addresses the same purpose but is performed by employees or teams who are otherwise employed in ordinary capability roles, thus, carrying a lower cost burden on the firm (winter, 2003). the literature on dynamic capabilities serves as a theoretical framework that we aim to extend with our grounded theory research approach. we confront the theoretical background with our findings in the discussion section. 98 leemann et al. / journal of business strategies (2021) 38: 95-124 3. methodology given the exploratory nature of our research, we employed a grounded theory research approach (e.g., corbin & strauss, 1990; gioia et al., 2012) using the case study method that is particularly indicated for “how” research questions (yin, 2018). in our quest to identify a theoretical sample that is “likely to replicate or extend the emergent theory” (eisenhardt, 1989, p. 537), we selected the publishing industry as context and a longitudinal view (2000–2020) of axel springer, a leading media corporation, as its critical case. with the emergence of the internet, the media industry has suffered a tremendous decline in its traditional print-based business models. similarly, the media industry has been considered suitable for dynamic capabilities research in other studies (e.g., ellonen et al., 2011; makkonen et al., 2014; prescott, 2014). within that context, axel springer stands out as a firm that is managing this transition outstandingly, with 73% of its current revenue being digital, realizing an ebitda margin of 20% (cf. table 2a-c). the firm, therefore, has demonstrated dynamic capabilities by definition (i.e., to thrive in a changing environment). axel springer thus uniquely qualifies as a “critical case” (flyvbjerg, 2006; yin, 2018) or “unique exemplar,” respectively (eisenhardt in gehman et al., 2018). as the aim of the study is to explore how dynamic capabilities interplay over a longer time period, the longitudinal single case is the pertinent method, which has also been used by other studies of dynamic capabilities (e.g., danneels, 2010; dixon et al., 2014; pandit et al., 2018). we collected primary data from 18 semi-structured interviews with current and former managers, as well as peers (cf. table 1). the collective tenure of these informants covers the entire observation period, which allowed us to conduct a longitudinal case study examining “the same single-case at two or more different points in time” (yin, 2018, p. 51) with an ex-post perspective. the interviews were conducted in the years 2020 and 2021, recorded and transcribed verbatim except for one (due to confidentiality preferences), for which we took a memo. the interviews were subsequently coded according to the procedures outlined by gioia et al. (2012) using the atlas.ti software. initial coding resulted in 502 open codes. by seeking similarities and differences among the open codes, we reduced the categories to a manageable number of 1st-order concepts while retaining informant terms, from which we eventually leemann et al. / journal of business strategies (2021) 38: 95-124 99 table 1. overview of interviews # relevant positions, inter alia unit full tenure at axel springer 1 managing director newspapers 2004–2011 2 board member peer 3 board member corporate 2004–present 4 publishing director newspapers 2007–2012 5 executive vice president subsidiary 2004–present 6 managing director newspapers 2001–2008 2015–present 7 founder / director digital asset 2004–2011 8 chairman, board member corporate 1999–2017 2020–present 9 board member corporate 2000–2020 10 editor-in-chief newspapers 2001–2005 2008–present 11 managing director digital ventures 2001–present 12 chief of staff to the ceo corporate 2007–2017 13 board member corporate 2006–present 14 senior vice president peer 15 senior vice president finance 2001–2011 16 founder / publisher peer 17 board member corporate 2013–present 18 senior vice president m&a 2001–present constructed our data structure with 2nd-order themes and aggregate dimensions, as shown in figures 1a-c. secondary data was retrieved from openly accessible sources such as annual reports, trade press articles, or social media. this data was mainly used to triangulate interview data and give more context. data collection and analysis were performed iteratively until theoretical saturation (corbin & strauss, 1990). 100 leemann et al. / journal of business strategies (2021) 38: 95-124 figure 1a. data structure 1s t o rd e r c o n c e p ts a g g re g a te d im e n s io n s • n o m in at in g m an ag e rs w it h r ig h t m in d se t fr o m o u ts id e i n k e y p o si ti o n s (“ b o y g ro u p ” ) • c re at in g a t e am o f “ u n it e d a rt is ts ” • f ir in g m an ag e rs w it h w ro n g m in d se t o r sk il l se t r e c o n fi g u ri n g t h e m an ag e m e n t te am t ra n sf o rm in g st e p -b y -s te p a n d la y e rb y -l ay e r • e st ab li sh in g l e ad e rs h ip v al u e s: c re at iv it y , e n tr e p re n e u rs h ip , an d i n te g ri ty • s p e ak in g o p e n ly a b o u t d e c li n e o f le g ac y b u si n e ss • c u lt iv at e a n o p e n d e b at e c u lt u re ; n o t re w ar d in g “ y e sm e n ” e st ab li sh in g a li b e ra l m in d se t • s e n d in g t h re e t o p e x e c u ti v e s o n a s il ic o n v al le y s tu d y e x c u rs io n f o r m an y m o n th s • d iv e st in g m aj o r p ar ts o f th e l e g ac y b u si n e ss • c le ar ly c o m m u n ic at in g t h at d ig it al m in d se t is e x p e c te d • e m p o w e r th e w o rk fo rc e ( e .g ., r e -t ra in in g o p ti o n s) a n d a ls o e x c h an g e l ar g e p ar ts s ig n al in g r ad ic al n e e d f o r c h an g e • b u il d in g a m ar k e ti n g m ac h in e o u t o f “ b il d ” • l au n c h in g a n d e x p e ri m e n ti n g w it h n e w b u si n e ss a n d re v e n u e m o d e ls • in tr o d u c in g p ay w al ls f o r o n li n e p u b li sh in g s it e s • in n o v at in g , b u t n o t d is ru p ti n g ; b e in g a g n o st ic d e v e lo p in g n e w re v e n u e s tr e am s • m e rg in g d if fe re n t p u b li sh in g b ra n d s an d o rg an iz at io n al u n it s to r e al iz e s y n e rg ie s • d o w n si z in g o v e rh e ad s tr u c tu re s d o w n si z in g c o st st ru c tu re s • d iv e st in g t h e b o o k p u b li sh in g b u si n e ss , m in o ri ty i n te re st s, u n c o n n e c te d d ig it al a ss e ts , an d r e g io n al n e w sp a p e rs a n d m ag az in e s e x it in g l ar g e p ar ts o f th e le g ac y p o rt fo li o p ro fi ti z in g a n d st re am li n in g t h e le g ac y b u si n e ss 2 n d o rd e r t h e m e s leemann et al. / journal of business strategies (2021) 38: 95-124 101 1s t o rd e r c o n c e p ts a g g re g a te d im e n s io n s s e n si n g -b y se iz in g • h av in g n o s tr in g e n t in v e st m e n t ap p ro ac h ( "k a n g ar o o in v e st in g ") • s ta ti n g t h re e r o u g h g u id e li n e s fo r g ro w th ( "j u st h e ad li n e s" ) • l o o k in g i n to v ar io u s le g ac y a c q u is it io n t ar g e ts • s e ri o u sl y a ss e ss in g a n d o p e n ly d is c u ss in g m a n y p ro p o sa ls • l o o k in g i n to m a n y s h i* * y p ro p o sa ls a ss e ss in g v ar io u s sc at te re d i n v e st m e n t p ro p o sa ls • a b o rt a c q u is it io n o f p 7 s 1 d u e t o a n ti tr u st r e st ri c ti o n s • r e p o rt in g b ig l o ss a ft e r p in g ro u p a c q u is it io n • e x p e ri e n c e c o rp o ra te n e ar -d e at h • p iv o ti n g c o u rs e o f ac ti o n s w if tl y t o d ig it al i n v e st m e n ts af te r fa il u re s f ai li n g w it h t w o m aj o r ac q u is it io n s • n o t h av in g a s y st e m at ic a n d r e g u la r m ar k e t sc re e n in g p ro c e ss • s n e ak in g u p t o n e w b u si n e ss m o d e ls • g ai n in g s u p e ri o r k n o w le d g e i n d u e d il ig e n c e p ro c e ss e s l e ar n in g b y a ss e ss in g ac q u is it io n t ar g e ts • r e tr o sp e c ti v e ly f o rm u la ti n g a s tr at e g y • s h ap in g s tr at e g y t h ro u g h m & a f o rm u la ti n g s tr at e g y ar o u n d a ss e ss e d in v e st m e n t o p ti o n s 2 n d o rd e r t h e m e s figure 1b. data structure (continued) 102 leemann et al. / journal of business strategies (2021) 38: 95-124 1s t o rd e r c o n c e p ts a g g re g a te d im e n s io n s • h av in g a s in g le p o in t o f c o n ta c t to h e ad q u ar te rs ( sm al l p o rt fo li o m a n ag e m e n t te am ) • is su in g v is it in g b an s fo r h e ad q u ar te rs a n d l e g ac y b u si n e ss • w ai v in g a n y s y n e rg y e ff e c ts f ro m d ig it al a ss e ts • a ll o w in g d ig it al a ss e ts t o c o m p e te w it h l e g ac y b u si n e ss ( se lf c an n ib al iz at io n ) p ro te c ti n g d ig it al a ss e ts fr o m h q a n d l e g ac y b u si n e ss m an ag in g d ig it al as se ts a t d is ta n c e • in st al li n g s u b je c t m at te r e x p e rt g ro u p s fo r ap p ro x im at e ly 2 0 to p ic s • n o m in at in g e x p e rt s o n w o rk in g l e v e l (v s. m an ag e m e n t le v e l) • in st al li n g c o -d ir e c to rs t h a t w e re t ra in e d i n t h e l e g ac y b u si n e ss • l o o k in g a t ac q u ir e d d ig it al a ss et s as e x p e rt s in t h e ir f ie ld s e c u ri n g k n o w le d g e sh ar in g t h ro u g h e x p e rt g ro u p s • k e e p in g e n tr e p re n e u rs i n c h ar g e a s m an ag e rs • s te ad il y i n c re a se p ar ti c ip at io n r at e a n d k e e p e n tr e p re n e u rs a s sh ar e h o ld e rs k e e p in g e n tr e p re n e u rs ab o ar d a s sh ar e h o ld e rs an d m an ag e rs • h av in g a n a n c h o r sh ar e h o ld e r al o n g t h e e n ti re o b se rv at io n p e ri o d • b e n e fi ti n g f ro m t h e s to c k m ar k e t li st in g a s c o rr e c ti v e • r e c ru it in g k k r a s lo n g -t e rm g ro w th i n v e st o r s e c u ri n g a s u p p o rt in g sh ar e h o ld e r st ru c tu re • r e in te rp re ti n g t h e f o u n d e r' s le g ac y i n t o d ay 's t im e • h o ld o n t o f iv e c o rp o ra te p ri n c ip le s d e fi n e d b y t h e f o u n d e r • b e in g l o y al t o e ac h o th e r an d t o t h e c o m p an y u si n g c o rp o ra te p ri n c ip le s a n d f o u n d e r fi g u re a s fo c al p o in t • a ss ig n in g k e y p e o p le t o v ar io u s d if fe re n t m an ag e m e n t ro le s • s e c u ri n g c o m m o n k n o w le d g e a n d u n d e rs ta n d in g o f m ar k e ts s af e g u ar d in g c o n ti n u it y in t h e m an a g e m e n t te am s af e g u ar d in g st ab il it y a n d c o n ti n u it y 2 n d o rd e r t h e m e s figure 1c. data structure (concluded) leemann et al. / journal of business strategies (2021) 38: 95-124 103 4. axel springer vignette axel springer was founded in 1946 as a print media publisher by axel cäsar springer (1912-1985). today, the firm is active in digital classifieds and news media with annual revenue of 3,112m€. by 2000, axel springer was mainly active in germany with newspapers, magazines, and books. international and digital business played a minor role with 16% and 3% of total revenue, respectively. after decades of high margins, the company reported its first loss in 2001, which coincided with the beginning of the market’s decline. subsequently, the company began consolidating its print-based legacy business and looking for external growth options. from 2003, axel springer aimed to take over prosiebensat.1 media (“p7s1”), one of the two major tv corporations in germany, a move that was eventually prohibited by anti-trust authorities. afterward, the company stepwise acquired pin group, a postal service provider. following the introduction of a minimum wage, pin group became loss-making, and axel springer sold the group in 2007 with a significant loss of 545m€. the firm then focused its growth strategy on digital assets, acquiring a series of digital firms (e.g., idealo, stepstone, zanox, aufeminin, seloger). in 2014, it sold a significant part of its legacy print business to funke mediengruppe. following this sale, the firm acquired digital journalism products (e.g., politico europe, business insider). throughout the observation period, the share of digital revenues increased to 73%, and ebitda increased from 217m€ to 631m€, which was in part debt-financed, though, debt ratios remained moderate. this overview is based on the official company timeline (axel springer se, 2020), annual reports, and context given by informants. tables 2a-c summarize key figures for the market and the case. 104 leemann et al. / journal of business strategies (2021) 38: 95-124 2 0 0 5 4 ,7 2 9 4 ,2 1 5 9 ,0 3 6 2 7 ,4 0 3 0 .7 2 ,3 9 2 4 1 4 2 3 1 n / a 3 2 7 0 .8 3 5 1 0 ,1 6 6 s o u rc e s: * b u n d e sv e rb an d d ig it al p u b li sh e r u n d z e it u n g sv e rl e g e r (2 0 0 1 -2 0 2 0 ), a n n u al y e ar b o o k s 2 0 0 0 -2 0 1 9 , b u n d e sv e rb an d d ig it al p u b li sh e r u n d z e it u n g sv e rl e g e r, b e rl in . * * s ta ti st is c h e s b u n d e sa m t (2 0 2 0 ), b ru tt o in la n d sp ro d u k t fü r d eu ts c h la n d 2 0 1 9 , s ta ti st is c h e s b u n d e sa m t, w ie sb ad e n . * * * a x e l s p ri n g e r (2 0 0 0 -2 0 2 0 ), a n n u al r e p o rt s 1 9 9 9 -2 0 1 9 , a x e l s p ri n g e r, b e rl in . * * * * b ö rs e .d e (2 0 2 0 ), " a x e l s p ri n g e r a k ti e ", a v ai la b le a t: h tt p s: / / w w w .b o e rs e .d e/ h is to ri sc h e -k u rs e / a x e ls p ri n g e ra k ti e / d e 0 0 0 5 5 0 1 3 5 7 ( ac c e ss e d d ec 2 9 , 2 0 2 0 ) 2 0 0 4 4 ,7 4 2 4 ,1 6 3 8 ,9 9 5 2 8 ,1 9 2 1 .2 2 ,4 0 2 4 3 3 1 4 8 n / a 1 7 3 0 .4 2 9 1 0 ,7 0 0 2 0 0 3 4 ,6 8 0 4 ,1 4 1 8 ,9 0 6 2 8 ,7 6 3 -0 .7 2 ,3 2 1 2 9 0 1 1 2 n / a 1 0 2 3 1 0 ,9 4 9 2 0 0 2 5 ,2 7 3 4 ,1 4 7 9 ,4 2 0 2 9 ,5 6 0 -0 .2 2 ,7 7 7 1 1 0 6 1 n / a n / a n / a 1 6 1 3 ,2 0 3 2 0 0 1 5 ,9 9 6 4 ,0 0 2 9 ,9 9 8 3 0 ,2 3 4 1 .7 2 ,8 6 4 3 3 -1 9 8 n / a n / a n / a 1 8 1 4 ,0 6 9 2 0 0 0 6 ,9 0 0 3 ,8 9 0 1 0 ,7 9 0 3 0 ,4 5 3 2 .9 2 ,9 0 2 2 1 7 9 8 n / a n / a n / a 3 3 1 3 ,5 9 0 1 9 9 9 6 ,4 0 0 3 ,7 1 0 1 0 ,1 1 0 3 0 ,7 9 1 1 .9 2 ,6 6 4 2 6 2 1 5 1 n / a n / a n / a n / a 1 2 ,5 0 4 u n it b € b € b € k c o p ie s % m € m € m € % m € ra ti o € h e ad s m ar k et d at a a d v er ti si n g r e v en u e * c ir c u la ti o n r e v en u e * t o ta l re v e n u e * t o ta l ci rc u la ti o n * g d p g ro w th * * a x el s p ri n g er d at a r e v en u e * * * e b it d a * * * n e t in c o m e / l o ss ( -) * * * s h ar e o f d ig it al r e v en u e * * * n e t d e b t* * * n e t d e b t / e b it d a s h ar e p ri ce ( e n d o f y e ar )* * * * e m p lo y ee s (a v e ra g e )* * * t ab le 2 a. k ey m ar k e t an d c as e d at a (1 9 9 9 -2 0 0 5 ) leemann et al. / journal of business strategies (2021) 38: 95-124 105 2 0 1 2 3 ,4 3 2 4 ,7 1 7 8 ,2 3 0 2 3 ,2 2 9 0 .4 2 ,7 3 7 4 9 9 2 5 9 4 5 -4 5 0 -0 .9 3 2 1 2 ,0 8 0 s o u rc e s: * b u n d e sv e rb an d d ig it al p u b li sh e r u n d z e it u n g sv e rl e g e r (2 0 0 1 -2 0 2 0 ), a n n u al y e ar b o o k s 2 0 0 0 -2 0 1 9 , b u n d e sv e rb an d d ig it al p u b li sh e r u n d z e it u n g sv e rl e g e r, b e rl in . * * s ta ti st is c h e s b u n d e sa m t (2 0 2 0 ), b ru tt o in la n d sp ro d u k t fü r d eu ts c h la n d 2 0 1 9 , s ta ti st is c h e s b u n d e sa m t, w ie sb ad e n . * * * a x e l s p ri n g e r (2 0 0 0 -2 0 2 0 ), a n n u al r e p o rt s 1 9 9 9 -2 0 1 9 , a x e l s p ri n g e r, b e rl in . * * * * b ö rs e .d e (2 0 2 0 ), " a x e l s p ri n g e r a k ti e ", a v ai la b le a t: h tt p s: / / w w w .b o e rs e .d e/ h is to ri sc h e -k u rs e / a x e ls p ri n g e ra k ti e / d e 0 0 0 5 5 0 1 3 5 7 ( ac c e ss e d d ec 2 9 , 2 0 2 0 ) 2 0 1 1 3 ,7 7 1 4 ,6 5 4 8 ,5 1 0 2 3 ,8 5 0 3 .9 3 ,1 8 5 5 9 3 2 8 9 3 1 -4 7 3 -0 .8 3 3 1 2 ,8 8 5 2 0 1 0 3 ,8 5 6 4 ,5 7 7 8 ,5 1 8 2 4 ,7 8 1 4 .2 2 ,8 9 4 5 1 1 2 7 4 2 7 8 0 0 .2 4 0 1 1 ,5 6 3 2 0 0 9 3 ,9 0 3 4 ,4 7 3 8 ,4 5 8 2 5 ,3 0 9 -5 .7 2 ,6 1 2 3 3 4 3 1 4 2 1 -1 9 3 -0 .6 2 5 1 0 ,7 4 0 2 0 0 8 4 ,6 3 9 4 ,3 7 3 9 ,0 9 8 2 5 ,9 5 2 1 .0 2 ,7 2 9 4 8 6 5 7 1 1 9 -3 7 0 -0 .8 1 6 1 0 ,6 6 6 2 0 0 7 4 ,8 3 7 4 ,2 6 1 9 ,1 8 7 2 6 ,4 5 2 3 .0 2 ,5 7 8 4 7 0 -2 8 8 9 -7 4 3 1 .6 3 2 1 0 ,3 4 8 2 0 0 6 4 ,7 9 3 4 ,2 6 1 9 ,1 4 4 2 6 ,9 6 0 3 .8 2 ,3 7 6 4 3 4 2 9 1 7 4 7 7 1 .1 4 5 9 ,7 3 3 u n it b € b € b € k c o p ie s % m € m € m € % m € ra ti o € h e ad s m ar k et d at a a d v er ti si n g r e v en u e * c ir c u la ti o n r e v en u e * t o ta l re v e n u e * t o ta l ci rc u la ti o n * g d p g ro w th * * a x el s p ri n g er d at a r e v en u e * * * e b it d a * * * n e t in c o m e / l o ss ( -) * * * s h ar e o f d ig it al r e v en u e * * * n e t d e b t* * * n e t d e b t / e b it d a s h ar e p ri ce ( e n d o f y e ar )* * * * e m p lo y ee s (a v e ra g e) * * * t ab le 2 b. k ey m ar k e t an d c as e d at a (2 0 0 6 -2 0 1 2 ) 106 leemann et al. / journal of business strategies (2021) 38: 95-124 2 0 1 9 2 ,1 9 4 4 ,9 6 3 7 ,1 5 6 1 6 ,8 7 8 0 .6 3 ,1 1 2 6 3 1 2 6 4 7 3 -1 ,9 5 3 -3 .1 6 3 1 6 ,1 2 0 s o u rc e s: * b u n d e sv e rb an d d ig it al p u b li sh e r u n d z e it u n g sv e rl e g e r (2 0 0 1 -2 0 2 0 ), a n n u al y e ar b o o k s 2 0 0 0 -2 0 1 9 , b u n d e sv e rb an d d ig it al p u b li sh e r u n d z e it u n g sv e rl e g e r, b e rl in . * * s ta ti st is c h e s b u n d e sa m t (2 0 2 0 ), b ru tt o in la n d sp ro d u k t fü r d eu ts c h la n d 2 0 1 9 , s ta ti st is c h e s b u n d e sa m t, w ie sb ad e n . * * * a x e l s p ri n g e r (2 0 0 0 -2 0 2 0 ), a n n u al r e p o rt s 1 9 9 9 -2 0 1 9 , a x e l s p ri n g e r, b e rl in . * * * * b ö rs e .d e (2 0 2 0 ), " a x e l s p ri n g e r a k ti e ", a v ai la b le a t: h tt p s: / / w w w .b o e rs e .d e/ h is to ri sc h e -k u rs e / a x e ls p ri n g e ra k ti e / d e 0 0 0 5 5 0 1 3 5 7 ( ac c e ss e d d ec 2 9 , 2 0 2 0 ) 2 0 1 8 2 ,3 6 4 4 ,8 1 1 7 ,1 7 4 1 7 ,6 3 1 1 .5 3 ,1 8 1 7 3 8 3 3 6 7 1 -1 ,2 4 9 -1 .7 4 9 1 6 ,3 5 0 2 0 1 7 2 ,5 2 4 4 ,8 9 0 7 ,4 1 4 1 8 ,3 2 6 2 .5 3 ,5 6 3 6 4 6 3 2 8 7 2 -1 ,0 2 0 -1 .6 6 6 1 5 ,8 3 6 2 0 1 6 2 ,6 7 4 4 ,8 8 9 7 ,5 6 3 1 9 ,0 8 8 2 .2 3 ,2 9 0 5 9 6 3 0 0 6 7 -1 ,0 3 5 -1 .7 4 6 1 5 ,3 2 3 2 0 1 5 2 ,8 0 6 4 ,8 4 0 7 ,6 4 6 2 0 ,5 0 7 1 .7 3 ,2 9 5 5 5 9 2 7 9 6 2 -1 ,0 6 7 -1 .9 5 1 1 5 ,0 2 3 2 0 1 4 2 ,9 9 4 4 ,7 6 4 7 ,7 5 9 2 1 ,4 5 7 2 .2 3 ,0 3 8 5 0 7 2 5 1 5 5 -6 6 8 -1 .3 5 0 1 3 ,9 1 7 2 0 1 3 3 ,1 0 0 4 ,7 0 5 7 ,8 8 4 2 2 ,3 6 0 0 .4 2 ,8 0 1 4 5 4 2 3 0 4 8 -4 7 1 -1 .0 4 7 1 2 ,8 4 3 u n it b € b € b € k c o p ie s % m € m € m € % m € ra ti o € h e ad s m ar k et d at a a d v er ti si n g r e v en u e * c ir c u la ti o n r e v en u e * t o ta l re v e n u e * t o ta l ci rc u la ti o n * g d p g ro w th * * a x el s p ri n g er d at a r e v en u e * * * e b it d a * * * n e t in c o m e / l o ss ( -) * * * s h ar e o f d ig it al r e v en u e * * * n e t d e b t* * * n e t d e b t / e b it d a s h ar e p ri ce ( e n d o f y e ar )* * * * e m p lo y ee s (a v e ra g e) * * * t ab le 2 c. k e y m ar k e t an d c as e d at a (2 0 1 3 -2 0 1 9 ) leemann et al. / journal of business strategies (2021) 38: 95-124 107 5. findings in our quest to study the interplay of sensing, seizing, and transforming in the context of incumbent adaptation, we identified the following dynamic capabilities (cf. figures 1a-c; table 3). 5.1 transforming step-by-step and layer-by-layer axel springer exercised transforming activities in two distinguishable steps: the first encompassed only some layers of the firm while the second radically transformed it as a whole. in 2000, when markets began to decline, axel springer was the market leader with a profitable business. its culture, however, was driven by infighting and intriguing, which made it inert and unable to innovate and adapt to looming market change. the first reported loss in 2001 was a pivotal warning shot and led to the election of a new ceo who came to realize that the management, as well as the corporate mindset, was not ready to confront the challenges ahead. before initiating any sensing or seizing activities, the ceo began transforming the organization by hiring key personnel from outside. “from the beginning, he got several managers from gruner + jahr and bertelsmann. […] this included also three new board members. all of them had another upbringing and leadership philosophy […]. this was set up from the beginning […] and contributed heavily to the success.” (current manager) furthermore, the new ceo initiated an open dialogue and self-critical reflection about the firm, which previously would have been taboo. this introduced a liberal mindset that led to frank discussions about the declining core business. these first transforming steps can be considered the essential condition for the following adaptation, as they preceded any significant sensing or seizing activity. more than a decade later, the second and more radical transforming step was initiated. “previously, the transformation was point-by-point. […] but then, digitalization was broadened and everybody was taken aboard. […] from this point, we were a digital company.” (current manager) in 2012, axel springer sent three key executives to silicon valley on a ninemonth trip to study digitalization. back home, they initiated radical change. 108 leemann et al. / journal of business strategies (2021) 38: 95-124 afterward, a management conference was held in the silicon valley with one clear message: from now on, the transformation would be radical, and everybody would have to think digital – no excuses. “the trip to the silicon valley was a highly symbolic act. […] now nobody can remain in springer’s leadership team without endeavoring in digitalization.” (former manager) in consequence, the composition of the workforce changed significantly: “from the 14,000 employees we had at the beginning of the year 2000, […] no more than 1,000 are still here.” (former manager) additionally, the divestment of legacy assets in 2014 underscored the communicated radicality with concrete actions. 5.2 profitizing and streamlining the legacy business the strategic role axel springer attributed to the legacy business was to generate cash flow to partly finance investments into new businesses. thus, it was put under a strict profitizing mandate which meant to find new revenue streams and cut costs. additionally, the portfolio was divested where necessary. profitizing involved particularly the newspaper bild which was the main breadwinner of the company in the first half of the observation period. rather than limiting consolidation mainly to cost cuts, axel springer put equal efforts into boosting revenues by innovating the print product offerings. most notably, the bild brand was repositioned, which opened it up for new advertisers. axel springer created many new advertising formats that allowed it to tap into further advertising budgets, and it also launched new print products, which stabilized circulation and advertising revenues. moreover, axel springer has been at the forefront when it comes to digitalizing the legacy business. for example, it was the first publisher to launch a news app when the ipad was introduced, and it introduced paywalls on its online publishing sites. a move that has been copied by many of its peers afterwards. these innovations were coupled with cost-cutting programs. in the labor-intensive media business, cost is predominantly reduced by making job cuts. axel springer reduced its legacy workforce steadily with various programs across the entire organization. these measures allowed to keep legacy profits high for several years after the markets started to decline. leemann et al. / journal of business strategies (2021) 38: 95-124 109 “the consolidation of the core business […] was very important to finance the expansion. […] the print market peaked in 2000, but the earnings of bild peaked as late as 2009 or 2010. […] the strategy was to keep the print business up in the air like a paraglider and move the touchdown point as far as possible into the future.” (current manager) however, for some legacy assets, these measures were exhausted at one point. axel springer constantly screened its portfolio from a valuation point of view and divested assets that were evaluated to be at the end of their lifecycle. “axel springer has always managed to recognize when an asset has been milked out. […] [the firm] has identified intelligent cutoff points […].” (former manager) these cutoff points included the book publishing business in 2003 (175m€ annual revenues), stakes in regional newspapers in 2009 (not consolidated), and a significant share of its magazines and newspapers in 2014 (514m€ annual revenues). these divestments represented over one-fourth of the original business portfolio. 5.3 sensing-by-seizing in 2001, three strategic priorities were defined: consolidation, internationalization, and digitalization. these remained, however, simple headlines of a strategy that had yet to be written. furthermore, the firm did not practice any systematic and regular sensing activities. “i would make a big question mark to whether this [i.e., sensing] was made systematically and regularly. […] we always looked at single pieces of the puzzle without analyzing everything until the end.” (former manager) consequently, axel springer assessed a plethora of investment opportunities as broad as the articulated strategic priorities. this even included acquisitions in the declining print media business that never materialized. eventually, the firm did engage from 2005 to 2007 in the p7s1 and pin group transactions, which turned out unsuccessful due to antitrust and regulatory reasons, respectively, despite a comprehensive strategic calculus. by seizing these opportunities, however, axel springer learned about the political reluctance to let a powerful media corporation or a competitor to the state-owned deutsche post emerge. we see from the interviews that these strategic roadblocks would most likely not have been detected if the firm had just engaged in traditional sensing activities during the due diligence for these 110 leemann et al. / journal of business strategies (2021) 38: 95-124 transactions (e.g., desk research, management workshops). hence, the firm gained knowledge through action rather than planning action based on knowledge. therefore, we introduce sensing-by-seizing as a dynamic capability. this novel understanding proposes that the firm senses its environment more concretely and reliably when seizing particular opportunities. “they […] very systematically gained knowledge from this trial-and-error approach. […] for example, in the follow-ups to the prosiebensat.1 disaster, [they asked] why did it fail? what other possibilities are there? and so on. they are very good at analyzing.” (peer) as the following findings show, sensing-by-seizing has developed as a learned and stable pattern at axel springer. after the two unsuccessful transactions with p7s1 and pin group, the firm managed to pivot expeditiously to digitalization; a strategic priority it had previously begun to sense by seizing idealo in 2006. idealo was its first major digital acquisition, which allowed axel springer to explore digital business models at low risk because idealo was acquired at a relatively low price and because its founders were kept aboard as managers. the path to digitalization was further emphasized by the acquisitions of zanox in 2007, stepstone in 2009, and seloger in 2011, among other companies. this series of acquisitions represent the beginning of axel springer’s development into an internet company. today, stepstone is the main breadwinner. the way stepstone found its way into the firm shows an exemplary sensing-by-seizing capability. to enter the german market, the norwegian start-up founded a joint venture with axel springer in 2004. therefore, axel springer was able to sense the new market empirically for quite a while and then conclude to invest further. in 2009, it acquired the entire company. “in the case of new and unknown business models, we decided to gradually sneak up on [them]. meaning, we felt more comfortable in a minority situation initially, to get to know the business and the management. later, we increased our share to a majority.” (current manager) the concept of sensing-by-seizing appears to work particularly well in nascent markets with only a few experts in the field such as the digital classifieds market at that time. axel springer was unable to acquire the necessary expertise to assess its digital classifieds acquisition targets outside of the firm (e.g., consultants, lawyers). thus, it had to build up the expertise leemann et al. / journal of business strategies (2021) 38: 95-124 111 internally. as a result of sensing-by-seizing, axel springer gained exclusive expertise that was otherwise not available externally. “[axel springer] could not rely on external parties but had to build up know-how internally. for example, classifieds, i am very sure that over time competencies were developed that probably wouldn’t even have been available on the market because there haven’t been that many transactions really and when you participated, you effectively built up this know-how inhouse.” (former manager) the firm defined its corporate strategy to become an internet company retrospectively. as such, the strategy was a result of various sensing-by-seizing activities rather than a masterplan defined ex-ante. 5.4 managing digital assets at distance once axel springer had seized the digital assets, it developed a distinctive dynamic capability to integrate and manage them. they were kept structurally separate from the legacy business and managed by a small portfolio management team. any interference from the legacy business was forbidden. consequently, the firm waived any synergy potential from their acquisitions. central functions were only used by request but not as a corporate mandate. the digital assets were allowed to openly compete with the legacy business. accordingly, “self-cannibalization” became a positive mantra. “the approach was by no means to delight the newly acquired digital assets with services from the headquarters and to integrate them. […] to the contrary, the headquarters should learn from these acquisitions how digitalization works.” (former manager) this approach was a stable pattern and as such, it was much appreciated by the management of the digital assets, as one manager remembers: “my impression was that they left us alone in a positive sense. […] they looked at us as the experts in the online job industry. […] i personally experienced [axel springer] as bringing us into the next era and opening quite a lot of doors.” (former manager) to secure knowledge sharing despite this structural separation, axel springer introduced up to 20 expert groups for specific technical topics (e.g., seo, cloud solutions, agile working). their members were subject matter experts on a working level rather than management, something which secured genuine expert dialogue. 112 leemann et al. / journal of business strategies (2021) 38: 95-124 “we started early on to bring the digital employees together in specific groups so they could get to know each other and exchange on certain topics. […] these expert networks still exist.” (current manager) axel springer did not approach the acquired companies as a “conqueror” that changed the management team once the transaction was closed. on the contrary, the firm tried to keep onboard the former team, often consisting of the founders, as managers and shareholders. this maintained valuable knowledge and secured an entrepreneurial management style. “we developed an acquisition formula that was the key success factor in our acquisition strategy: we acquire 75% and the founders stay onboard and keep 25%, for which we have call options. so, we can be sure not to buy a shell for which we do not have the management and cultural capabilities.” (current manager) 5.5 safeguarding stability and continuity it seems paradoxical amid the need for change but most informants emphasized stability and continuity as success factors. this regarded the shareholder structure, the corporate heritage and principles, and the management. “when you are dealing with a changing environment and you realize that your commercial basis begins to crumble […] it helps when you have a certain foundation you can build on and hang onto.” (peer) during the entire observation period, axel springer had one anchor shareholder that guaranteed a great deal of stability and continuity. the management describes this relationship as very trustful and supporting. they were able to focus on managing the firm and not get distracted by shareholder issues. this trust and backing were especially evident after the unsuccessful transactions with p7s1 and pin group. “the most impressive moment was when this whole pin-story failed. then the supervisory board said: we are not going to fire the entire board. they made a mistake. they didn’t make it alone. we in the supervisory board also went on with the decision. and we get out of this mess together.” (current manager) leemann et al. / journal of business strategies (2021) 38: 95-124 113 table 3. representative quotes underlying aggregate dimensions second-order themes quotes transforming step-by-step and layer-by-layer reconfiguring the management team “[the ceo] reformed the leadership team. he made this very thoroughly. he was mocked in the public for his “boy group” because he hired many young managers.” (current manager) “then he fired [a person]. that really was an intriguing guy with a very bad reputation. […] this signaled a fresh start.” (current manager) establishing a liberal mindset “if you would have mentioned [the political past] with [the former ceo], you would have been fired immediately.” (peer) “this willingness to discuss in an open-ended way was decisive for the development of the team. […] board meetings were never held with a preconceived opinion.” (current manager) signaling radical need for change “that was the moment to say it is not sufficient to have acquired some selective digital assets. […] everybody has to become digital.” (current manager) profitizing and streamlining the legacy business developing new revenue streams “we developed bild into a marketing machine by repositioning it and, thus, opening it up to new advertisers.” (current manager) “the switch from free to paid content was the next revolution.” (former manager) downsizing cost structures “we developed a restructuring case that included several painful measures.” (current manager) exiting large parts of the legacy portfolio “[the ceo] diverged categorically from anything that had eaten up capacities and was loss-making. […] i think this was decisive because unnecessary management ballast was eliminated.” (former manager) table continued on following page 114 leemann et al. / journal of business strategies (2021) 38: 95-124 table 3. representative quotes underlying aggregate dimensions (continued) second-order themes quotes sensing-by-seizing assessing various scattered investment proposals “you don’t believe how many shi**y proposals i had to get off the table.” (former manager) “it was an enormous multitude of m&a targets that were assessed, very remarkable for a company of this size.” (former manager) failing with two major acquisitions “this was a decisive phase with these two failures. both have really shaken up the company.” (current manager) “after [p7s1] was not possible, we completely changed course without communicating this too hard and explicitly.” (former manager) learning by assessing acquisition targets “we learned enormously from these acquisitions. […] with everything we have learned […] new acquisition opportunities opened up for us.” (current manager) “we have the capability to make brave decisions based on the current state of knowledge but we also know that the decision base can change significantly within just a few years.” (current manager) formulating strategy around assessed investment options “it now looks as if everything was planned, but of course it wasn’t.” (current manager) “major strategic moves […] were always opportunities and not the result of a systematically defined strategy.” (former manager) managing digital assets at distance protecting digital assets from hq and legacy business “we always said: each integration into the corporate structures means the lingering death of any young startup.” (current manager) “that was an internal culture war. they needed to fight against all the controllers and other corporate departments.” (current manager) table concluded on following page leemann et al. / journal of business strategies (2021) 38: 95-124 115 table 3. representative quotes underlying aggregate dimensions (concluded) second-order themes quotes managing digital assets at distance securing knowledge sharing through expert groups “we were linking people together in specific expert groups.” (former manager) “i think it is an important factor that we used the word synergies very seldom but worked more in a business and experience exchange mode.” (current manager) keeping entrepreneurs aboard as shareholders and managers “[we did] not acquire as conquerors and integrate entire teams that wanted to explain to them how the world works.” (current manager) “we seldom acquired one hundred percent, rather step-by-step.” (former manager) safeguarding stability and continuity securing a supporting shareholder structure “the management was able to focus on the strategy and didn’t have to manage shareholder issues.” (current manager) “i spent maybe two percent of my time on company politics.” (former manager) using corporate principles and founder figure as focal point “there are a lot of people from the digital scene that want to work with or sell their company to axel springer because they say: they have a soul.” (current manager) “in this age of digitalization and when everything important emerges in the silicon valley – what would our founder have done?” (current manager) safeguarding continuity in the management team “the people that he hired, they stayed very long.” (current manager) “back then i got a contract with a termination period of one year. […] i wanted to have a shorter period. […] but he insisted because he wanted to have continuity […].” (former manager) 116 leemann et al. / journal of business strategies (2021) 38: 95-124 the firm has historically been driven by the “springer-values”, a set of principles that was defined many decades ago. for example, journalists have to stand up for a united europe or uphold the principles of a free market economy. these principles and the omnipresent founding figure were skillfully used by management to explain and advocate the need for change while referencing their heritage. the ceo staged a theater play in which he played the founder in today’s world. he dressed up in a hoodie and a t-shirt, like a startup founder, and thought out loud how to disrupt the media. this signaled both appreciation of the past and the need for change. after the initial reconfiguration, management has remained very stable. rather than placing vacancies with external candidates, internal managers were developed and assumed different roles. therefore, management tenures often stretched over large parts of the observation period (cf. table 1), which in turn preserved stability and continuity. in conclusion, axel springer was capable of managing the balancing act between stable reference points, such as corporate principles and key personnel on one side and major business change on the other. in this case, the former is paradoxically a key success factor for the latter. 6. conceptual model our examination of the axel springer case has shown that its dynamic capabilities have iterated, overlapped, and interconnected over time. axel springer began transforming the firm before sensing or seizing any opportunities. the transformation of key management posts and the corporate mindset was followed by profitizing and streamlining the legacy business to be able to finance seizing opportunities in new business areas. the firm developed a dynamic capability to manage its new business that allowed it to thrive vis-àvis the legacy business. later, a more radical round of transforming allowed to adapt the entire firm. despite a heavy burden of change on the organization, it maintained a dynamic capability to safeguard stability and continuity. based on these findings, we constructed the “dynamic capabilities in incumbent adaptation model” depicted in figure 2. it represents the “conceptual leap” that generalizes our findings (gioia et al., 2012). by bringing research and practice together, this conceptual model shall also contribute to advance strategic management as a discipline (cox et al., 2012). leemann et al. / journal of business strategies (2021) 38: 95-124 117 the model is embedded in the overarching strategic challenge to convert the firm from a declining legacy business (in gray) into a new business. for axel springer, this conversion was from printed to digital media. however, shifts in consumer behavior that pose a strategic challenge to incumbents also occur in other contexts. for example, e-commerce in the retail industry, carsharing in the automotive industry, online bookings in the travel industry, battery-operated household appliances in the electronics industry, or online banking in the banking industry. our research has shown that particular transforming activities stand at the beginning of the incumbent adaptation process (labeled “transformation a”), which are the essential condition for all following adaptation activities (links 1). for axel springer, this was the reconfiguration of the top management and the establishment of a liberal mindset. in other cases, transformation a might encompass other activities, for example setting up a sustainable financing structure, resolving looming legal issues, or creating awareness of market realities. in any case, we argue that particular transforming activities need to be performed before any further activities can be initiated. as such, transformation a suggests some degree of linearity in the concept as it always stands at the beginning. figure 2. dynamic capabilities in incumbent adaptation model n e w b u si n es s t ra n sf o rm at io n b safeguarding stability and continuity 2 profitizing and streamlining the legacy business t ra n sf o rm at io n a l e g ac y b u si n e ss managing new business at distance sensing-by seizing 4 3 5 1 1 2 118 leemann et al. / journal of business strategies (2021) 38: 95-124 “transformation a” is to be distinguished from “transformation b”. whereas the former only addresses the immediate essential conditions, the latter aims at radically transforming the entire firm. axel springer postponed transformation b for many years. this bridged a period in which the strategy was still rather fuzzy and relieved the organization from energy-consuming transforming during this unclear period. once a feasible strategy had emerged from sensing-by-seizing, axel springer launched “transformation b” for the entire organization (link 2). between the two transforming activities, axel springer put the legacy business under a strict profitizing mandate to invest in new businesses with the sensing-by-seizing approach (link 3). the firm focused on acquisitions. in other cases, however, new business may also emerge from sensing-by-seizing via internal venturing, research and development, or new product development, among other processes. when it comes to managing the new business (link 4), axel springer followed a distinct form of structural separation. we conceptualized our model accordingly. the ambidexterity literature describes similar approaches as “structural ambidexterity” (e.g., carter et al., 2013; o’reilly & tushman, 2013). finally, we integrated safeguarding stability and continuity into the model (link 5). as axel springer has shown, the strong foundation of the firm in its heritage and people was crucial in the adaption process. this aspect should, we argue, be flexible enough to facilitate necessary change. 7. discussion changing environments have required axel springer to exercise dynamic capabilities to convert from a print publisher to an internet company. the conversion began at the point when print markets started to decline in 2000 until the present when the firm reports a digital revenue share of 73% (cf. table 2a-c). by examining this longitudinal case of incumbent adaptation to changing environments, we studied the interplay of sensing, seizing, and transforming over time. empirical research has typically relied on sensing, seizing, and transforming (teece, 2007) to study dynamic capabilities (schilke et al., 2018), with some suggesting a linear sequence and clear distinction between them (e.g., gebauer, 2011; mousavi & bossink, 2017; vézina et al., 2019). our study confronts this concept with the “messy” reality of organizational phenomena. it finds that, leemann et al. / journal of business strategies (2021) 38: 95-124 119 first, the firm iterates between the different procedural dimensions of dynamic capabilities, and second, that there are overlaps and interconnections between sensing, seizing, and transforming. axel springer began its adaptation process with initial transforming activities followed by iterating between and combining seizing and sensing, ongoing smaller transforming activities and, later, transforming radically. moreover, some of the dynamic capabilities identified cannot be discretely mapped onto sensing, seizing, and transforming. for example, “managing new business at distance” integrates seizing (i.e., asset integration), transforming (i.e., securing knowledge sharing), and sensing (i.e., screening for further digital targets). axel springer did not perform any systematic or regular sensing activity; rather, it aimed to seize various opportunities within strategic priorities. by doing so, the firm has sensed opportunities and threats as a by-product in a concrete and reliable way that could not have been possible had it used standard sensing activities. therefore, we introduce the concept of sensing-byseizing defined as sensing opportunities and threats at the same time as seizing concrete opportunities within defined strategic guidelines. this concept is a novel perspective on dynamic capabilities, as the literature has not dimensionalized them by integrating analytical (i.e., sensing) and actionable (i.e., seizing) capabilities. one could argue that sensing-by-seizing is a form of “ad hoc problem solving” (winter, 2003). however, evidence from our case supports the contrary, as sensing-by-seizing was performed regularly and systematically by dedicated personnel. the lessons learned from sensing-by-seizing projects were openly and critically discussed and internalized, and thus articulated and codified. sensing-by-seizing can therefore be characterized as a “learned and stable pattern” (zollo & winter, 2002, p. 340) and a “repeated practice” (eisenhardt & martin, 2000, p. 1114). the literature has often stated that the dynamic capabilities concept lacks managerial applicability, which has hindered practitioners from making practical use of the concept (schilke et al., 2018). bearing this issue in mind, our study makes two contributions. first, the model conveys the building blocks of incumbent adaptation stating, for example, that transforming activities must be considered at the outset of the process. second, we identified specific and applicable dynamic capabilities for incumbent adaptation (e.g., sensing-by-seizing). 120 leemann et al. / journal of business strategies (2021) 38: 95-124 8. limitations and future research our research has been conducted following a high theoretical and methodological standard. however, we acknowledge some limitations and avenues for future research. first, the single case study approach represents a standard limitation (e.g., industry, geography, company size). we argue, however, that axel springer is the critical case (flyvbjerg, 2006; yin, 2018) to study our research question. by examining two decades and accessing several top managers, we were able to gain very rich and insightful data. second, the results of our study might be biased toward a positive account of axel springer’s accomplishments, as the key data source was internal informants. however, triangulation was done by interviewing peers and former managers that partly see the firm with a critical eye as well as analyzing secondary data. third, although we examined our case at several points in time, the interviews were all conducted ex-post. we solved this problem by triangulating with secondary data that originated at these points in time (e.g., newspaper articles, social media) and interviewing former managers active in earlier periods. we have found that axel springer has performed particular transforming activities at the outset that were the essential conditions for the entire incumbent process (termed “transformation a”). we acknowledge that transformation a looks different from case to case; however, we suggest that it might occur in every incumbent adaptation case. future research should examine the activities and micro-foundations of transformation a in qualitative case studies. the concept of sensing-by-seizing is one of the main findings of our study. future research may revise or extend this concept qualitatively. furthermore, quantitative studies could measure the outcomes of this concept as it might be (a) more cost-effective, as sensing occurs as a by-product of seizing; (b) more insightful, as assessing concrete options is more informative than simple sensing; and (c) allow faster incumbent adaptation, as concrete opportunities can be seized simultaneously to sensing. finally, managerial cognition research proposes that organizational development is shaped by the manager’s interpretations of the environment (eggers & kaplan, 2013). as concrete investment proposals supposedly garner higher management attention than simple sensing, future research may examine if the sensing-by-seizing approach can lead to better-informed management. leemann et al. / journal of business strategies (2021) 38: 95-124 121 references axel springer se. (2020). timeline. [online] available at: https://www.axelspringer.com/en/company/history [accessed 29 december 2020]. barney, j. (1991). firm resources and sustained competitive advantage. journal of management, 17(1), 99-120. https://doi.org/10.1177/014920639101700108 carter, w. r., davis, p. e., herchen, j. l., & chandna, v. (2013). pitfalls and paradoxes: coping with the capabilities-rigidities dilemma in whole networks. journal of business strategies, 30(2). 97-119. https://doi.org/10.54155/jbs.30.2.97-119 corbin, j. & strauss, a. (1990). grounded theory research: procedures, canons and evaluative criteria. zeitschrift für soziologie, 19(6), 418-427. https://doi.org/10.1515/zfsoz-1990-0602 cox, m. z., daspit, j., mclaughlin, e., & jones, r. j. (2012). strategic management: is it an academic discipline? journal of business strategies, 29(1), 25-42. https://doi.org/10.54155/jbs.29.1.25-42 danneels, e. (2010). trying to become a different type of company: dynamic capability at smith corona. strategic management journal, 32(1), 131. https://doi.org/10.1002/smj.863 dixon, s., meyer, k. & day, m. (2014). building dynamic capabilities of adaptation and innovation: a study of micro-foundations in a transition economy. long range planning, 47(4), 186-205. https://doi.org/10.1016/j.lrp.2013.08.011 eggers, j. p. & kaplan, s. (2013). cognition and capabilities: a multi-level perspective. academy of management annals, 7(1), 295-340. https://doi.org/10.1080/19416520.2013.769318 eisenhardt, k. m. (1989). building theories from case study research. the academy of management review, 14(4), 532-550. https://www.jstor.org/stable/258557 eisenhardt, k. m. & martin, j. a. (2000). dynamic capabilities: what are they? strategic management journal, 21(10-11), 1105-1121. https://doi.org/10.1002/1097-0266(200010/11)21:10/11<1105::aidsmj133>3.0.co;2-e ellonen, h.-k., jantunen, a. & kuivalainen, o. (2011). the role of dynamic capabilities in developing innovation-related capabilities. international journal of innovation management, 15(3), 459-478. https://doi.org/10.1142/s1363919611003246 https://www.axelspringer.com/en/company/history https://doi.org/10.1177/014920639101700108 https://doi.org/10.54155/jbs.30.2.97-119 https://doi.org/10.1515/zfsoz-1990-0602 https://doi.org/10.54155/jbs.29.1.25-42 https://doi.org/10.1002/smj.863 https://doi.org/10.1016/j.lrp.2013.08.011 https://doi.org/10.1080/19416520.2013.769318 https://www.jstor.org/stable/258557 https://doi.org/10.1002/1097-0266(200010/11)21:10/11%3c1105::aid-smj133%3e3.0.co;2-e https://doi.org/10.1002/1097-0266(200010/11)21:10/11%3c1105::aid-smj133%3e3.0.co;2-e https://doi.org/10.1142/s1363919611003246 122 leemann et al. / journal of business strategies (2021) 38: 95-124 flyvbjerg, b. (2006). five misunderstandings about case-study research. qualitative inquiry, 12(2), 219-245. https://doi.org/10.1177/1077800405284363 gebauer, h. (2011). exploring the contribution of management innovation to the evolution of dynamic capabilities. industrial marketing management, 40(8), 1238-1250. https://www.dora.lib4ri.ch/eawag/islandora/object/eawag%3a6902 gehman, j. et al. (2018). finding theory-method fit: a comparison of three qualitative approaches to theory building. journal of management inquiry, 27(3), 284-300. https://doi.org/10.1177/1056492617706029 gioia, d. a., corley, k. g. & hamilton, a. l. (2012). seeking qualitative rigor in inductive research: notes on the gioia methodology. organizational research methods, 16(1), 15-31. https://doi.org/10.1177/1094428112452151 helfat, c. e. et al. (2007). dynamic capabilities: understanding strategic change in organizations. london: blackwell. makkonen, h., pohjola, m., olkkonen, r. & koponen, a. (2014). dynamic capabilities and firm performance in a financial crisis. journal of business research, 67(1), 2707-2719. https://doi.org/10.1016/j.jbusres.2013.03.020 mousavi, s. & bossink, b. a. (2017). firms’ capabilities for sustainable innovation: the case of biofuel for aviation. journal of cleaner production, 167, 1263-1275. https://doi.org/10.1016/j.jclepro.2017.07.146 o’reilly, c. a. & tushman, m. l. (2013). organizational ambidexterity: past, present, and future. academy of management perspectives, 27(4), 324-338. https://www.jstor.org/stable/43822033 pandit, d., maheshkumar, p. j., sahay, a. & gupta, r. k. (2018). disruptive innovation and dynamic capabilities in emerging economies: evidence from the indian automotive sector. technological forecasting & social change, 129, 323-329. https://doi.org/10.1016/j.techfore.2017.09.035 penrose, e. t. (1959). the theory of the growth of the firm. new york, ny: john wiley & sons. prescott, m. e. (2014). big data and competitive advantage at nielsen. management decision, 52(3), 573-601. https://doi.org/10.1108/md-092013-0437 protogerou, a., caloghirou, y. & lioukas, s. (2012). dynamic capabilities and their indirect impact on firm performance. industrial and corporate change, 21(3), 615-647. https://doi.org/10.1093/icc/dtr049 schilke, o., hu, s. & helfat, c. e. (2018). quo vadis, dynamic capabilities? a content-analytic review of the current state of knowledge and https://doi.org/10.1177/1077800405284363 https://www.dora.lib4ri.ch/eawag/islandora/object/eawag%3a6902 https://doi.org/10.1177%2f1056492617706029 https://doi.org/10.1177/1094428112452151 https://doi.org/10.1016/j.jbusres.2013.03.020 https://doi.org/10.1016/j.jclepro.2017.07.146 https://www.jstor.org/stable/43822033 https://doi.org/10.1016/j.techfore.2017.09.035 https://doi.org/10.1108/md-09-2013-0437 https://doi.org/10.1108/md-09-2013-0437 https://doi.org/10.1093/icc/dtr049 leemann et al. / journal of business strategies (2021) 38: 95-124 123 recommendations for future research. academy of management annals, 12(1), 390-439. https://doi.org/10.5465/annals.2016.0014 teece, d. j. (2007). explicating dynamic capabilities: the nature and microfoundation of (sustainable) enterprise performance. strategic management journal, 28(13), 1319-1350. https://doi.org/10.1002/smj.640 teece, d. j., pisano, g. & shuen, a. (1997). dynamic capabilities and strategic management. strategic management journal, 18(7), 509-533. https://doi.org/10.1002/(sici)1097-0266(199708)18:7<509::aidsmj882>3.0.co;2-z vézina, m., selma, m. b. & malo, m. c. (2019). exploring the social innovation process in a large market based social enterprise: a dynamic capabilities approach. management decision, 57(6), 1399-1414. https://doi.org/10.1108/md-01-2017-0090 wernerfelt, b., 1984. a resource-based view of the firm. strategic management journal, 5(2), 171-180. https://doi.org/10.1002/smj.4250050207 winter, s. g. (2003). understanding dynamic capabilities. strategic management journal, 24(10), 991-995. https://doi.org/10.1002/smj.318 yin, r. k. (2018). case study research and applications – design and methods. 6th edition. los angeles: sage. zollo, m. & winter, s. g. (2002). deliberate learning and the evolution of dynamic capabilities. organizational science, 13(3), 339-351. https://doi.org/10.1287/orsc.13.3.339.2780 https://doi.org/10.5465/annals.2016.0014 https://doi.org/10.1002/smj.640 https://doi.org/10.1002/(sici)1097-0266(199708)18:7%3c509::aid-smj882%3e3.0.co;2-z https://doi.org/10.1002/(sici)1097-0266(199708)18:7%3c509::aid-smj882%3e3.0.co;2-z https://doi.org/10.1108/md-01-2017-0090 https://doi.org/10.1002/smj.4250050207 https://doi.org/10.1002/smj.318 https://doi.org/10.1287/orsc.13.3.339.2780 124 leemann et al. / journal of business strategies (2021) 38: 95-124 can crude oil futures predict spot retail unleaded gasoline prices? vance ginn texas tech university • lubbock, tx ronald d. gilbert texas tech university • lubbock, tx abstract the motivation for this paper began with casual empiricism regarding the brief distributed lag of retail gasoline prices behind crude oil futures. we developed a model consistent with our hypothesis and tested it with econometrics using statistical data that include the sharp decrease in crude oil price futures in late summer 2008. we found that our model is a consistent and efficient estimator of the actual gasoline prices over most of our sample period. however, random shocks to gasoline prices, like hurricane ike in 2008, cause the model to have problems accurately predicting gas prices. we conclude that our estimated model and simulations provide reasonable support for our hypothesis that crude oil price futures can predict spot retail unleaded gasoline prices. introduction and background the motivation for this paper began with separate instances of casual empiricism by the two authors in the community where we live and work. one author made a habit of noting near-term futures prices of unleaded gasoline on the new york mercantile exchange (nymex), adding sixty cents to those prices, and being able to predict what discount retailers would charge for regular unleaded gasoline that week in our local markets. the other co-author spent one and one-half years tracking crude oil futures prices on the nymex and their correlations with retail gasoline prices at a brand name outlet in our local market. this led to the creation of a formal model to forecast future changes in spot retail unleaded gasoline prices at the local outlet. this model can be expressed as follows: a numerical example illustrates this model. assume that the retail unleaded gasoline price (g() is $3.00, and the change in the futures price of crude oil 192 journal of business strategies (ot 0 ti) is a $1.00 increase to $80 in time period (t). the model predicts that spot unleaded gasoline will increase from $3.00 to $3.0375 in time period (t+ 1) which is one day later than (t). while these casual empiricisms gave us a good indicator of where our research and model were headed, we decided it was necessary to expand our ideas and formulate a linear model from our additional findings. the first of these findings was the four major components of the price of a gallon of gasoline. these components are distribution and marketing, refining costs and profits, federal and state taxes, and crude oil (see figure 1). we look at each of these four components as a percentage of the average retail price of a gallon of unleaded gasoline. as figure i shows, the average retail price of a gallon of regular unleaded gasoline has increased 136% from january of 2000 to august of 2008. from the findings in chouinard and perl off (2002), we note that there is a consistent rise in the percentage that is related to crude oil prices relative to the price of gas. as the price of oil moved close to $145 a barrel in 2008, the crude oil price contributed 73% to the price of a gallon of gas compared to 46% in 2000 and 58% in 2007 . this signals that there is a direct and persistent relationship between higher crude oil prices and higher retail gasoline prices. although refining costs have also increased during the last few years due to an increase in the cost of raw materials, as a percentage, these costs have been reduced over time. over the last several years the tax rates on gasoline at the state and federal government levels have remained relatively unchanged, but the percentage of the cost from these taxes on retail gasoline prices has fallen as crude oil prices have risen. distribution and marketing costs in dollar terms have risen due to the higher price of gasoline and increased expenditures by oil companies on ad campaigns in defense of an industry that was criticized as retail prices of their products increased. however, these costs over time have also decreased as a percentage of retail gasoline prices. collectively, we have evaluated this information and concluded that the price of crude oil is the most significant variable affecting the national retail gasoline price. given this fact, we needed to find the best way to show this. one may look at either the spot price or the nymex futures price of oil. from our findings and from our literature review, we conclude that the futures price of crude oil is the best measure to use to predict future spot retail unleaded gasoline prices. this makes sense since the retailers will have to make pricing decisions at the margin when it comes to their overall costs. since crude oil, as a percentage, is the number one component in a gallon of gas, future costs of crude oil will allow rational store owners to expect that their costs will change and consequently decide to change their price volume 26, number 2 193 of gasoline. these changes in gas prices sum together on a national scale to make up the national average price of gasoline. while there are many implications of being able to correctly predict future energy prices, such as gasoline, we would only like to evaluate our findings from the model and provide forecasts to determine whether the model does a good job at modeling the behavior of the actual national average of retail gasoline prices. figure 1 average yearly retail gas components r---.-----------------------------retail gasoline per gallon price averages each year $1.49 $2.27 $2.57 $2.80 $3.52 iii crude oil • federal & state taxes ~ distribution & marketing • refining costs i & profits i 2000 2005 2006 _ ___ 2_0_07 _______ 2_0_08 ________ j source : energy information administration, washington, dc information for 2008 is from january 2008 to august 2008 several recent studies have considered asymmetries. these include both asymmetries in retail gasoline price dynamics and asymmetries in the responses of macroeconomic variables to increases in oil prices, as opposed to decreases in oil prices . important examples are borenstein, cameron, and gilbert (1997) who showed that gasoline prices increase more rapidly when crude oil prices increase 194 journal of business strategies than they decline when crude oil prices decrease. they also contended that unbranded gasoline outlets change their prices in a similar fashion to branded gasoline stations (those with company-specific additives and with the right to use the refiner's name at resale). the price differential is rarely more than one cent over unbranded gasoline prices . asymmetry is prevalent for both spot and futures prices. changes in oil prices today may be a good determinate for predicting future changes in gas prices, but inventories may also be a contributor. a model was formulated in the paper to estimate the responses of gasoline prices to oil price changes, and to look at the asymmetry between the two. the model is expressed as r = (f> 0 + (f>, c + e, where r is the retail gasoline price per gallon, c is the price of crude oil per gallon, and e is a normal and i.i.d. error term. while their model is similar to the model that we are using, they looked at the responsiveness of the change in crude oil price to the change in gas price to note the asymmetry between the two and not as a formal way to model the price change itself from the futures price of crude oil. the deltas (2005) paper used monthly 1988-2002 data for the 48 contiguous states (except nevada) to test the hypothesis of asymmetric responses of retail gasoline prices to changes in wholesale prices. price increases are passed on to the retail customer more quickly than price decreases. asymmetry is also dependent on the average retail-wholesale margin of a state. larger margin states experience greater asymmetries than smaller margin states. a different type of asymmetric behavior was examined by brown, yucel, and thompson (2003). they found that economic expansion over the business cycle from a decrease in oil prices is not as large as the decrease in economic activity when the oil prices rise. monetary policy seems to be less accommodative when oil prices increase due to inflation pressures and when oil importing countries experience slower growth due to decreased demand when prices increase. the davis and hamilton (2004) paper looked at the causes of price stickiness and determined which has the greatest impact on gas prices. the cost due to administrative expenses associated with changing a posted price called "menu costs" was the first cause they looked at. the next explanation deals with the costs due to lack of perfect, timely information that gives rise to a firm committing to capacity constraints before they know what supply shocks occur. third, competition discourages price changes due to the possibility of losing market share. they conclude that the most important factors entering the decision to change or not change prices are menu costs and expected reactions of customers and competitors. the chouinard and perloff(2002) study estimated a model to determine what significance taxes, pollution regulations, mergers, market power, and market condivolume 26, number 2 195 tions have on the changes in gas prices. their findings show that over the last several decades the main contributor to changes in gas prices has been increases in the prices of crude oil. also, they found that a tax decrease on gas is the only way to significantly decrease the price of gas in the short run. borenstein and shephard (1996) researched a form of tacit collusion between retail gasoline markets. collusion may be possible in the gasoline markets even though there are a large number of sellers, because these stations sell a product that is differentiated by brand, service, and location. retail margin is defined as the retail price minus the wholesale price of gasoline. they estimated that approximately twothirds of the eventual pass-through of crude oil price changes occurred in the first two weeks following the shock. the results showed lower margins when demand is expected to decline next period than when it is expected to increase, and margins are higher when wholesale prices are expected to decline next period than when they are expected to increase. also, there is more incentive to raise prices in a timely fashion than lower them. lewis (2004) suggests that there is less incentive to reduce retail prices than increase them. consumers engage in fewer searches for low prices when prices are falling. therefore, retailers experience less competition. he also suggests that consumers may not gain anything from a more intensive search when prices are rising since there is an opportunity cost of time used in the search process. during the summer of 2007, we continued to make an effort to gain institutional knowledge of retail gasoline pricing decisions by asking local owners and managers what caused them to change retail gasoline prices. a local owner of five retail outlets selling unbranded product was willing to talk with us, as was the pricing manager of a branded product line with numerous retail outlets locally and in the region. both indicated that retail prices are far more "sticky" than wholesale prices, and neither uses futures markets to hedge against possible increases in the cost of gasoline. both buy in the spot market daily at a price set by refiners at 6:00 p.m. for tomorrow's delivery. both pay a great deal of attention to the prices that their competitors charge, so a form of tacit collusion may exist. profit margins are very small with an attempt to net 6 cents per gallon over substantial periods of time before the cost of credit card use, which is both common and costly, in that it reduces the attempt to net 6 cents by 50 percent. an interesting aspect of the unbranded retailer's management is an attempt to generate positive profits by controlling costs from a refinery. this is done by shopping the numerous wholesale outlets in the state of texas on a daily basis. sometimes 196 journal of business strategies the price differences are as high as 18 cents per galion, so it may be less expensive to buy in san antonio (400 miles away) and pay the freight costs, and still net 3 cents over local outlets. the branded retailer has less flexibility because he agrees to buy only from the refinery that adds his brand 's additives. in exchange, he is guaranteed a daily supply of gasoline while the unbranded outlet is sometimes "out. " while our discussions with the two enhanced our understanding of the retail gasoline market, we left with a sense of loss regarding who sets prices and what prices are based on. we did corroborate the sticky price models that exist in the literature and that individual outlets feel subject to the pressures of a highly competitive market. we are left with attempting to predict gas prices and the change in gas prices from the futures prices of crude oil. model and data in determining the behavior between these two variables it is neces sary to observe their relationships and possible synchronization over time. the levels of retail gasoline prices and the futures prices of crude oil can be seen in figure 2 for the 1990-2008 sample period. using this figure, it is clearly apparent that there is a significant positive relationship between the two variables . at first glance, we find that it is a bit less clear on whether the futures prices of crude oil move before or after the retail gasoline prices. this can be tested properly using a granger causality test which we complete in the next section. the data we used were obtained from the energy information administration (efa) website from august 20, 1990 to august 25 , 2008 . our data include weekly crude oil future contracts priced in dollars per barrel at cushing, ok, weekly average prices of retail gasoline in the united states, and the percentage that each component contributes to the price of a gallon of gasoline. these components were discussed above. based on our assumption that, at the margin, shocks to existing retail gasoline prices come from changes in futures prices of crude oil, and futures prices predict spot retail unleaded gasoline prices; the model that we specify here is as follows: g = a l + aoo + a.o + c (i = 1 3) t p t p i t-i t g t is the national retail weekly average of regular unleaded gasoline prices in time period t. 0 t is the weekly average futures price of crude oil in week tone-month before delivery. c t is the i.i.d. error term. volume 26, number 2 197 figure 2 weekly average retail gasoline and crude oil futures prices ~--------------------------------------~$5 $160 $120 $80 $40 --crude oil futures prices national average retail gasoline price note : the values used in this figure are the levels of the weekly average prices of a galion of retail gasoline and the weekly average of futures prices of a barrel of crude oil from august 20, 1990 to august 25,2008. values on the left y axis are the levels of the average weekly crude oil futures priced in dollars . values on the right y axis are retail the levels of the average weekly retail gasoline priced in dollars . we then investigated which fonn of these variables would provide us with meaningful results. to detennine this, we look at the stationarity issue of our variables. if the variables are nonstationary, we will be left with meaningless results because there is a trend in the data based on time. the values that we identified that were stationary were the first differences of the logged values of the two variables, because both the levels and logged values appeared to be nonstationary. after transfonning these variables into first differences of the logs and examining the character198 journal of business strategies istic roots in relationship with the unit circle, we were able to have a tested assumption that the first differences of the logged values are stationary. these transformed variables are used in our evaluations of the model in this paper. estimation results as mentioned in the previous section, we want to test to be confident of causality from oil to gas prices. we did this using a granger causality test. since one of our key assumptions is that futures prices of crude oil cause spot retail unleaded gasoline prices to rise, then this test is essential for us to move forward. while it is still possible that oil prices may cause gas prices to rise or fall, this test would increase the level of confidence that we have in our evaluation. after completing the granger causality test, we can reject the hypothesis that the futures prices of crude oil fail to granger cause gas prices. the test provides a reasonable basis to use the futures prices of crude oil to forecast spot retail unleaded gasoline prices over the sample period that we have chosen. table 1 presents the results of two ols regressions. these results consist of a linear regression model that regresses the current weekly average national retail prices of gas on the current weekly average futures prices of crude oil and crude prices two or three weeks prior to the current week. in analyzing the results in table 1, we determine that the schwarz bayesian criterion (sbc) is the best measure to evaluate the goodness-of-fit of our model. while the r2 measure gives a value that provides a better fit with a fourth lagged variable of the futures price of crude oil, the sbc begins to increase when this variable is added to the model. the increase in the sbc shows that the extra variable increases the penalty and does not increase the model's performance. therefore, we find that three lagged periods of the futures prices of crude oil gives us the best fit, and provides a statistically significant model to evaluate the accuracy of predicting the future spot retail unleaded gasoline prices. this model allows for parsimony and a sufficient closeness of fit between the actual and fitted first values. these results and the residuals are found in figure 3. therefore, it appears that using the current and three previous periods of the futures prices of crude oil is the best model to provide econometric testing of our ability to predict spot retail unleaded gasoline prices. since all of our variables are expressed as the percentage change from one period to the next, the estimated coefficients are the elasticity measures with respect to each independent variable. from these coefficient values, we can state that a 10% increase in the current weeks average of the futures prices of crude oil will have a positive 2% effect on the current volume 26, number 2 199 weeks average of spot retail unleaded gasoline prices. a 10% increase in each additional past weekly averages of futures prices of crude oil, including the previous three weeks, will have a 1%, 0.7%, and 0.7% increase in gas prices respectively. summing up, the current weeks average change in oil prices will have the biggest effects on gas prices, but the other weeks included in the model will be significant as well. table 1 estimates of gas price expectations u sing the first difference of the logged values variable coefficient std. error canst 0.000579 0 .000482 °t 0.210254 0.012398 ••• °'_1 0.101589 0.012405 *.* °'_2 0.082453 0.012289 * • • r2 = 0 .324757 sbc = -5.578 013 variable coefficient std. error const 0.000475 0 .000473 ° t 0 .204354 0.012244 .*. ° t_1 0 .108747 0.012302 .*. °'_2 0.072072 0.012228 .*. °'_3 0.077.643 0.012085 .*. r2 = 0.353728 sbc= -5.613580 note: the data set that was used is the first difference of the logged values of the weekly average prices of a gallon of retail gasoline (g,) and the weekly average of futures prices of a barrel of crude oil (ot) from august 20 , 1990 to august 25, 2008. et is a normal and i.i.d . error term. * •• statistically significant. 200 journal of business strategies figure 3 fitted and actual values from r---------------------------------------------r .2 .1 .20 .0 .15 .10 -.1 .05 -.2 .00 -.05 92 94 96 98 00 02 04 06 08 --residual actual fitted note: the values used in this figure to attain the fitted and actual values from the model are the first difference of the logged values of the weekly average pri ces of a gallon of retail gasoline (olog(rg)) and the weekly average of futures prices of a barrel of crude oil (olog(co)) from august 20, 1990 to august 25 , 2008 . values on y axis are percentages . using the data from august 20, 1990 to august 25, 2008 , a dynamic forecast was studied. this forecast is shown in figure 4. the findings during this time period for the actual and forecasted weekly average of gas prices seem to show a consistent measurement for these changes. figure 4 also shows that there seems to be a break between the actual retail gasoline prices and the forecasted gas prices that should have prevailed if our model is accurate. the model does a very good job of replicatvolume 26, number 2 201 ing the swings in gas prices inside the confidence interval from 1990 to 2000. from 2000 to 2008, the forecast of gas prices from the model has deviated more noticeably from the actual gas prices relative to the former time period. there are many possible reasons for this break in accuracy of our model between the two time periods. while the explanation of the reasoning behind the break in these time periods is not in the scope of this paper, it is necessary to break up our entire sample period into these two time periods and see how well our model does. after separating these two time periods, we used the 1990-2000 period to forecast what our model would have estimated on a weekly basis for gasoline prices and related it to the actual gasoline prices in figure 5. our model provides pleasing results using this sample period to forecast what the gasoline prices will be relative to the actual gasoline prices until 1999. this is the essential reason why we have decided to split the entire sample period up in 2000 . during this period, from 1999 to 2000, there may have been a shift in the way in which gasoline prices and oil prices were tied together. in further analyzing this information, we took the 2000-2008 period and used our model to forecast what the gasoline prices should be. after attaining this information, we compared it with the actual gasoline prices during this period. this comparison can be found in figure 6. using this sample period to forecast predictions of gas prices has been improved upon relative to forecasting over the entire sample period. beginning in 2000 until the middle of2005, our model does a good job offitting closely with the actual gasoline prices. after the summer of2005, over the next three years our model seems to have trouble accurately predicting gasoline prices. one key to this time period has been random shocks from the anticipation of hurricanes and actual hurricanes, such as hurricane katrina, that have caused numerous shutdowns of refineries in the gulf of mexico. these sorts of random shocks to the system are just that, random, and our model is not capable of taking into account these effects that are not caused by a sudden increase in the prices of oil. while this may be the case, the actual gasoline prices do move in the direction of where our model shows that the price should be in a short period after the refineries have been put back online. finally, we look at the period from april 28, 2008 to september 22, 2008. during this period of time, oil prices and gas prices have fluctuated rather dramatically. the futures prices of crude oil reached a high around $145 a barrel in july, and shortly after, decreased to $91 a barrel. this fluctuation in oil prices has had significant effects on the price of gasoline as well. the national average of retail gas prices during this time hit a high of above $4 a gallon and then fell far below $4 as the price 202 journal of business strategies of crude oil decreased. figure 7 tells the story that once again our model was a good indicator of where the gas prices should be and eventually will be as actual prices rose then fell with a lag relative to crude oil futures. near the end of this sample period the actual gas prices average has diverted from the model's predictions. this is clearly due to another random shock to the system with hurricane ike in the gulf of mexico. many refineries were shutdown along the texas and louisiana coast causing supply disruptions in the gasoline industry. while the forecast and actual gasoline prices diverted from each other, we have seen that actual gasoline prices have converged to what the model has predicted as refineries got back online and supply disruptions were eased. figure 4 dynamic forecast and actual retail gasoline prices $4.4 ....,----------------------,$4.4 $4.0 {i $4.0 $3.6 $3.6 $3.2 $3.2 $2.8 $2.8 $2.4 $2.4 $2.0 $2.0 $1.6 $1 .6 $1.2 $1 .2 $0.8 92 94 96 98 00 02 04 06 08 --forecasted retail gasoline prices actual weekly retail gasoline prices note : the values used in this figure to attain the forecast for the period 1990-2008 from the model are the first difference of the logged values of the weekly average prices of a gallon of retail gasoline (g) and the weekly average of futures prices of a barrel of crude oil (0) from august 20, 1990 to august 25 , 2008 . values on y axi s are percentages . volume 26, number 2 203 figure 5 dynamic forecast and actual retail gasoline prices from 1990-2000 $1 .6 ~--------------------r$1.6 $1 .5 , $1.5 , , , ~ , ,i, $1.4 , . $1.4 , , , , , $1.3 , '\ , , i , , i , i '1' i : i i $1 .2 i , i , h , i i v, ~ i .', " $1.1 i 1 f\' \ j v , i $1 .3 $1 .2 $1.1 i i i ," i, • $1.0 i~ $1 .0 $0.9 91 92 93 94 95 96 97 98 99 ---actual gasoline prices forecasted gasoline prices note : the values used in this figure to attain the forecast for the period 1990-2000 from the model are the first difference of the logged values of the weekly average prices of a gallon of retail gasoline (g) and the weekly average of futures prices of a barrel of crude oil (0) from august 20,1990 to december 31,1999. values on the y axis are the levels of the average weekly retail gasoline prices in dollars. as crude oil prices fell 75 percent from their july 2008 highs to their february 2009 lows, consumers often questioned why retail gasoline prices were not falling as fast and as much as crude oil prices. what happened to actual gasoline prices versus what our model predicted during this period can be seen in figure 8. during september and october of2008, consumers ' questions were on target. using current and lagged crude oil prices, our model forecasted lower gasoline prices than existed. however, during the last two months of2008, the opposite happened. then from the end of the year until mid-february 2009, retail gas prices reverted to what our model forecasted. that is, they increased until they were within three cents of our forecast. what consumers did not seem to understand was that early in 2009, retail gas prices 204 journal of business strategies increased as crude oil prices continued to fall because earlier gasoline prices had decreased more than the decrease in crude oil prices would have predicted. figure 6 dynamic forecast and actual retail gasoline prices from 2000-2008 $4.5 $4.5 $4.0 $4.0 $3.5 $3.5 i, i, i i $3.0 j ' $3.0 j i ,'1'/ i , $2.5 $2.5 i ,,, i .' , ,1 $2.0 $2.0 $1.5 $1.5 $1.0 $1.0 00 01 02 03 04 05 06 07 08 --actual gasoline prices forecasted gasoline prices note: the values used in this figure to attain the forecast for the period 2000-2008 from the model are the first difference of the logged values of the weekly average prices of a gallon of retail gasoline (g) and the weekly average of futures prices of a barrel of crude oil (0) from january 1, 2000 to september 22, 2008 . values on the y axis are the levels of the average weekly retail gasoline prices in dollars. volume 26, number 2 figure 7 dynamic forecast and actual retail gasoline prices from april 28, 2008 to september 22, 2008 205 $4.2 -r---------------------,-$4.2 $4.1 $4.1 $4.0 $4.0 $3 .9 $3.9 $3.8 $3.8 $3.7 $3.7 $3.6 $3.6 $3.5 5/5 6/2 717 8/4 9/1 --actual gasoline prices forecasted gasoline prices note: the values used in this figure to attain the forecast for the period april 28, 2009 to september 22, 2009 from the model are the first difference of the logged values of the weekly average prices of a gallon of retail gasoline (g) and the weekly average of futures prices of a barrel of crude oil (0) from april 28, 2008 to september 22 , 2008. values on the y axis are the levels of the average weekly retail gasoline prices in dollars . 206 journal of business strategies figure 8 dynamic forecast and actual retail gasoline prices from september 9, 2008 to february 9, 2009 $4.0 -,-----------------------,$4.0 $3 .5 $3.0 ................. .-..... " , $2.5 $2.0 , , , , " ... $3 .5 $3.0 " $2 .5 $2.0 $1 .5 +-..---,--,--,---.--,--,--,---,----,----r-...,.---,--,--,r-'-t--r----.------,---,----,---,--+ $1 .5 9/1 10/6 11/3 12/1 1/5 2/2 -actual gasoline prices forecasted gasoline prices note: the values used in this figure to attain the forecast for the period september 1, 2008 to february 15, 2009 from the model are the first difference of the logged values of the weekly average prices of a gallon of retail gasoline (g) and the weekly average of futures prices of a barrel of crude oil (0) from september 1, 2008 to february 15, 2009. values on the y axis are the levels of the average weekly retail gasoline prices in dollars. conclusion our paper began with a question, "can crude oil futures prices predict spot retail unleaded gasoline prices?" our econometric evidence supports an affirmative response to this question. both the percentage change in weekly unleaded gasoline prices and the rate of change in those prices can be predicted with current and lagged futures prices of crude oil. since we have a linear model , we are able to evaluate the elasticity of an increase in the futures prices of crude oil relative to the retail gasoline prices; therefore, we can conclude from our model that a 10% increase in the current volume 26, number 2 207 weeks average futures prices of crude oil will cause an increase in the current weeks average retail gasoline prices of about 2%. in addition, the lags appear to be very brief with lengths of three weeks being sufficient to achieve a very good fit. these results were even better than we expected, given our discussions with owners of unbranded and branded gasoline outlets in our area. they indicated that they do not use futures markets in determining their pricing behavior of gas. it may be that these outlets focus more on transportation and refining costs while larger outlets pay more attention to futures prices. if this is the case, this would allow our assumption to hold true as the larger outlets make up a bigger portion of the gasoline market; therefore, the futures prices are prevalent in the decision making process. we are aware that while our model predicts well on average over our sample period, predicting future gasoline prices may be difficult at times due to exogenous shocks that are not included in our model. some of the possible exogenous shocks have been discussed in this paper. other shocks that may have an impact would include gasoline inventories, fiscal policy changes, and an assortment of other possibilities. these exogenous shocks are random in nature and will not be able to be properly modeled in the short run. even though this may be the case, in the medium to long run gas prices seem to move more in line with our model. future research will include providing an error correction model that will allow for the speed in which gas prices return to their estimated trend. this would help in reducing the deviation between actual and estimated gasoline prices. since there has been a significant amount of volatility recently with crude oil futures and gasoline prices, it will be necessary to continue to compare the model versus the actual gasoline prices. ifwe are able to accurately model the direction and magnitude of gasoline prices on a consistent basis, the implications will lead to having a better idea of how random shocks affect energy prices, how the predictions affect business cycles, how this would affect monetary policy, and a host of other possible research topics arising from predicting the average weekly retail unleaded gasoline prices. it is our goal to allow for a better understanding of gasoline prices and how the price changes occur to allow for other solutions to come about. thus far, our conclusion is that the weekly average futures prices of crude oil can predict spot retail unleaded gasoline prices. 208 journal of business strategies references american petroleum institute. (2008). gasoline taxes. retrieved october 8, 2008 , from www.api.orgistatistics/fueltaxes/uploadioctober_ 2008 _gasoline_and _ diesel_ summary j)ages. pdf. borenstein, s. (1991). selling costs and switching costs: explaining retail gasoline margins. rand journal of economics, 22, 354-369. borenstein, s., cameron, a. c., & gilbert, r. (1997). do gasoline prices respond asymmetrically to crude oil price changes? the quarterly journal of economics, 112(1), 305-339. borenstein, s., & shephard, a. (1996). dynamic pricing in retail gasoline markets. rand journal of economics, 27,429-451. brown, s., yucel, m. k., & thompson, j. (2003). business cycles: the role of energy prices. the federal reserve bank of dallas. research department. working paper 0304. chouinard, h., & perl off, j. m. (2002). gasoline price differences: taxes, pollution regulations, mergers, market power, and market conditions. retrieved september 1,2007, from are.berkeley.edu/~perloff/pdf/gasoline.pdf davis, m. c ., & hamilton, j.d. (2004). why are prices sticky? the dynamics of wholesale gasoline prices. journal of money, credit, and banking, 36(1), 17-37. deltas, g. (2007). asymmetries in retail gasoline price dynamics and local market power. retrieved september 1,2007, from www.physics.fst.usp.ac.fj /fileadmin/ files/schools/ssed/economics/workingj)apers/2005/wp2005 _ii.pdf. energy information administration. (2008). gas stocks (u.s. weekly finished gasoline ending stocks (thousand barrels)). retrieved september 28, 2008, from tonto.eia.doe.gov/dnav/petipet_ sum _ sndw _ dcus _nus _ w.htm. energy information administration. (2008). weekly crude oil prices (cushing, ok crude oilfuture contract 1 (dollars per barre!)). retrieved september 28 , 2008, from tonto.eia.doe.gov/dnav/petipetj)ri_ fut_ s 1_ d.htm. energy information administration. (2008). weekly retail gasoline prices (u.s. regular all formulations retail gasoline prices (cents per gal/on)). retrieved september 28, 2008, from tonto.eia.doe.gov/dnav/pet/petj)ri_gnd _ dcus _nus _ w. htm. energy information administration. (2008). a primer on gasoline prices. retrieved september 28, 2008, from tonto.eia .doe.gov/oog/info/gdu/gasdiesel.asp. haubrich, j. g ., higgins, p., & miller, j. (2004). oil prices: backward to the future? the federal reserve bank of cleveland. economic commentary. volume 26, number 2 209 herce, m., parsons, j. e., & ready, r. c. (2006). using futures prices to filter shortterm volatility and recover a latent, long-term price series for oil. center for energy and environmental policy research. working paper 06-005. jones, d. w., leiby, p.n. , & paik, 1. k. (2004). oil price shocks and the macroeconomy: what has been learned since 1996. the energy journal, 25(2). lewis, m. (2004). asymmetric price adjustment and consumer search: an examination of the retail gasoline market. competition policy center. working paper no. cpc04-47. nosal , e. (2001). how well does the federal funds futures rate predict the future federal funds rate? the federal reserve bank of cleveland. economic commentary. williams, j. l. (2005). oil prices and analysis. retrieved february 6, 2007, from www.wtrg.com/prices.htm. biographical sketch of authors vance ginn is a third year ph.d. student in economics at texas tech university. his interests include macroeconomics and public policy, especially energy policy. ronald d. gilbert, ph.d., is an economics professor at texas tech university where he teaches and does research in monetary theory and policy. he is especially interested in conventional and unconventional central bank monetary polices as they relate to the global financial crisis. he has recently published in applied economics and journal of economics. 210 journal of business strategies can crude oil futures predict spot retail unleaded gasoline prices? ignoring rules of succession: how the board reacts to ceo illness announcements wallace n. davidson iii southern illinois university carbondale, il shenghui tong siena college loudonville, ny dan l. worrell university of arkansas fayetteville, ar wei rowe university of nebraska omaha omaha, ne abstract rules of behavior guide decisions, and succession rules guide ceo selection. when ceo turnover is unanticipated, succession rules may not be able to guide the board. we examine unanticipated successions that occur when a ceo becomes ill or injured. these unanticipated successions are associated with a greater likelihood of former-ceo successors than when the successions are anticipated. the stock market reacts positively to former-ceo succession announcements. while this type o.fsuccession may not be consistent with succession rules, it may be consistent with their functions by reducing internal conflict and allowing directors to maintain fiduciary responsibili(y. leadership is an important component of successful corporate governance. ceo succession has received considerable attention in the extant literature. succession planning's importance may need to be given top priority by boards of directors (shen & cannella, 2003). ocasio (1999) analyzed the succession process and the rules that govern it. he argued that rules of behavior exist throughout all areas of corporate activity providing regularity and structure to corporate decisions. the succession process provides an interesting case in which we can observe how boards rely on formal and informal rules to make decisions. there may be cases in which companies are unable to utilize succession rules because the need for succession is unanticipated and occurs suddenly. 94 journal ofbusiness strategies vol 23, no.2 there are a number of ways in which unanticipated events could lead to the immediate need for succession. for example, a ceo could suddenly decide to quit the company leaving the board with an immediate succession decision. however, in these cases, it may not be possible to determine if it was the ceo's decision or a forced turnover. alternately, a ceo could die while in office or become ill or injured. we examine unanticipated succession decisions following ceo illness/injury announcements rather than ceo death, because when a ceo dies there is no choice; the board must appoint a successor. however, when a ceo is ill or injured, the executive and board may have a choice. they can appoint a successor or depending on the severity of the affliction let the ceo attempt to continue. we examine both the successions that occur after injury or illness announcements and decisions to let the ceo continue in office. the pressures and responsibilities of a senior executive combined with the age of most senior executives can lead to serious illness. what happens when a ceo becomes injured or ill and the affliction is serious? when would the board replace the afflicted ceo and who assumes the vacated positional responsibility? unanticipated succession decisions may prohibit the board from relying on its normal rules of succession. vancil (1987) defines several styles of internal succession including relay and horse-race successions. each type of succession would have its own informal or formal rules guiding the process. what these succession types have in common are that the board promotes a successor ceo from a position below the ceo in the corporate hierarchy. in other successions, the ceo comes from outside the firm. for the purposes ofth1s paper, we define normal succession to include both outside succession and successions in which the successor is promoted from below in the corporate hierarchy. however, when the succession is unanticipated such as when an executive becomes ill, the board may not find the normal rules of succession to be useful. when an executive is unable to function, a successor may be needed to both run the company and show the outside stakeholders that someone is in charge. we propose that in unanticipated successions boards may appoint someone from the board such as the board chair or former ceo. such an appointment would likely show stakeholders that there will be continuity in company operations and that an experienced executive is in charge. theoretical background in this section, we examine rules of behavior and how they impact succession decisions. we then propose that companies will be more likely to violate these rules when there is a sudden and forced need for succession. rules of behavior rules of behavior are integrated into all corporate activities and actions. reliance on these informal or formal rules guides rational decision-making, organizational rules guide rational choices by providing a framework or basis for decisions. fall 2006 davidson et al: ignoring rules ofsuccession 95 people make decisions by evaluating alternatives and their consequences under the context of rules. following rules suggests that corporate executives utilize a rational process or mechanism to make decisions. following rules guide behavior and lead to an outcome, and they help to maintain organizational equilibrium. an organizational decision may be considered more appropriate if it does not violate the organization's rules that are appropriate to the situation, but decisions made that seemingly violate rules may be considered less appropriate and legitimate (march, 1994). reliance on rules has been integrated into theories of the firm, and rules may help protect shareholder interests and help ensure organizational survival (ocasio, 1999). rules of behavior serve at least three functions in an organization (ocasio, 1999). first, rules provide a type of routine for programs of actions (march & simon, 1993). here, rules guide the day to day business of the organization as well as provide routine solutions to the out-of-the ordinary decisions. second, rules allow decision-makers to meet their responsibilities. decision-makers are accountable for their actions and when decisions have been made based upon rules of behavior, they are easier to defend (clark, 1991). in corporations, boards have a fiduciary responsibility to stakeholders, in general, and to shareholders, in particular. when board members rely on rules in their decisions, they can justify the decisions as rule-appropriate and more easily argue that the decision meets their fiduciary responsibilities. third, following rules may lessen political conflict in corporations. following rules signals the appropriateness of a decision and reduces the basis for conflicts (nelson & winter, 1982). rules of behavior and succession one of the major functions of a board of directors is the hiring and firing of senior managers such as the ceo. as such, ceo succession decisions are under the purview of the board. presumably, the board will appoint who they believe is the best person to lead and run the company as well to as represent the company with various stakeholder groups. the board often decides when a ceo succession is to take place and who the successor will be. how boards make succession decisions and the process that board members follow has been the subject of considerable work. ocasio (1999) argues that rules of behavior guide the succession decision process. different styles of succession in organizations lead to different rules of succession. vancil (1987) defines several succession styles including relay succession and horse race succession. in relay successions an heir-apparent serves a training period and is groomed to become the new successor. at the appropriate time, the heir steps in and becomes the new ceo. the rules may be different in other styles of succession. for example, in a horse race succession, internal candidates compete for the top spot. this process has been described as an economic contest (chan, 1996). the winner of the horse race assumes the ceo position. zhang and rajagopalan (2004) find that when there are a large number of internal candidates, the likelihood of relay succession decreases, and 96 journal ofbusiness strategies vol. 23, no.2 so a large number of potential candidates may increase the likelihood of a horse race style succession. even though the internal rules vary for these different styles of succession, in both relay and horse race succession, the successor is promoted from a position below the ceo in the corporate hierarchy. following rules may be more appropriate and more common in ordinary situations. for example, in normal anticipated succession decisions such as when a ceo retires, boards will often select internal successors who are chosen pursuant to the organization's rules (kesnor & sebora, 1994). shen and cannella (2003) document that the stock market reacts positively to succession when a designated heir-apparent becomes the successor ceo. naveen (2000) finds similar results and shows that inside succession is more likely when the board adopts a formal succession plan. another type ofsuccession occurs when the board hires an outsider. the hiring of an outsider would be inconsistent with a planned internal succession process. chan (1996) argues that only when the need arises or when a clearly superior outside candidate is available would succession planning rules be violated and an outsider hired. outside succession may occur when there is organizational stress, such as poor performance (parrino, 1997; cannella & lubatkin, 1993). during these times of stress, the company may need to show that it is changing directions and bringing in an outsider to initiate changes although the presence of a large proportion of inside directors on the board and a ceo with short tenure in the job may overcome the tendency to hire an outsider (shen & cannella, 2002). while the presence of a large proportion of outsiders on boards makes the choice of an outside successor more likely in both normal successions and those following ceo dismissal (borokhovich, parrino & trapani, 1996). succession rules may, therefore, be situationally determined and include various types of internal and external successions. in these cases, boards have had time to plan the succession process, influence the timing of the succession and choose the most suitable candidate. we propose that following the rules of succession and utilizing the planned succession process may not be possible in situations requiring an immediate and unanticipated succession. in an unanticipated succession, the rules may need to be adapted or ignored when there is need for immediate board action in maintaining a leadership structure for the firm. for relay succession to take place, a previously, designated and appropriately trained heir-apparent is necessary. in a horse race, there needs to be ample time for "one horse to take the lead". to hire an outsider requires time to develop a slate of suitable candidates and to evaluate their potential. when the succession is unanticipated, it may not be possible to follow the normal rules of succession for either an internal or an external search. when there is an immediate and unanticipated need for a successor, the board may look to a candidate with the experience and knowledge to step into the position and assume the reins of command. here it may be that the board will appoint a former ceo or the board chair to take over the corporation's leadership. this type of succession may be more consistent with the three functions ofruies even though it does not follow the normal rules of succession. fall 2006 davidson et al.: ignoring rules ofsuccession 97 rules function to permit routine decisions. history and precedence guide rules under ambiguity (zucker, 1977), and a sudden and unanticipated succession will produce this ambiguity. by hiring a former ceo or board member with top executive experience, the routine of the company can continue and ambiguity will likely lessen. if a designated heir is adequately prepared or if the horse race is far enough along to have produced a clear leader, then the board may be able to follow the normal succession rules and promote the candidate. hiring an heir-apparent that is possibly inadequately trained or selecting the horse race winner when the race is not complete could actually increase the perceived ambiguity, but hiring the former ceo whose record is known should serve to reduce the ambiguity. following rules may help decision makers to meet fiduciary responsibility. in a sudden succession, when the normal rules of succession are not appropriate, hiring a former ceo or the board chair may be the lower risk choice that serves to allow the board to meet its fiduciary responsibility. selecting the possibly under-trained heir-apparent in relay succession or the horse race winner of the unfinished horse race may not be perceived as the appropriate decision and as a possible violation of the board's fiduciary responsibility. following rules lessens potential for conflict. in an unfinished horse race the successor to a sudden succession may engender bitterness in the losers. bitterness can lead to internal political conflict. an heir-apparent that is perceived to be under trained could also cause internal political strife. on the other hand, in these sudden and unanticipated successions, hiring the former ceo or chair to be the successor could lessen the potential for internal political conflict. one type of unanticipated decision that may require an immediate succession decision is when a top executive falls seriously ill or receives major injuries in an accident. here, the board must decide whether to replace the ill executive or to allow them to continue in their position. certainly the severity of the illness or injury will influence the decision. however, there may be other considerations such as the impact of the decision on the company's stakeholders. an immediate or at least timely decision may be needed so the normal rules of succession may not apply. in the crisis, the reappointment of a former ceo may seem the most prudent decision. the familiar face may reduce anxiety in the financial, product and supply markets as well as within the organization and provide the perception of continuity. we, therefore, propose: hypothesis i: in situations requiring unanticipated and immediate succession such as when the ceo becomes ill or injured, rather than following a planned succession process that is consistent with normal rules (~rsuccession, the board will more likely select aformer ceo or board chair than when the succession is likely anticipated. ceo authority and unanticipated successions dual leaders, those that are both ceo and chair, are considered by some to be unambiguous leaders providing unity of command and authority over the firm 98 journal ofbusiness strategies vol. 23, no.2 (massie, 1965). a leader that is unambiguous may help a company to obtain resources in the market place (andrews, 1971: finkelstein & d' aveni, 1994). social choice theory suggests that problems may occur when authority is divided between people (e.g. separate ceo and chair) making it difficult to pinpoint causes of problems (arrow, 1963; sen, 1970) and causing intra-company asymmetric information problems (brickley, coles & jarrell, 1997). when such an unambiguous leader is not able to continue in their role because the executive has fallen ill, they may choose to give up various duties that can lessen their authority and ultimately reduce the benefits derived from this leadership style. however, giving up authority and stepping aside may be unpalatable to the dual executive for several reasons so the dual executive may stay in the position until he/she can no longer physically perform their duties. first, giving up authority may reduce the executive's self-perceived personal power. byallowing someone to take over even part of his or her duties, the executive shows weakness. second, giving up authority may lessen the appearance of having an unambiguous leader to stakeholders and reduce the benefits that this leadership style conveys. third, when a ceo is also chair, the executive is less likely to be fired by the board even when performance is poor (goyal & park, 2002) because the dual position gives the executive greater power. even when ill, the dual ceo/chair will likely have more clout with the board and would be less likely to be forced out. therefore, a dual ceo/chair will be more likely to attempt to maintain their positions and remain in power when ill or injured than under a non-dual leadership structure. by maintaining his or her dual positions, the dual ceo/chair allows the functions of rules to be maintained. this decision will allow the normal routine to be followed. the board can argue that keeping the unambiguous leader serves shareholder interests and that they have maintained their fiduciary responsibility and lessened the possibility of internal strife and political problems caused by an unanticipated succession. certainly, the severity ofthe injury or illness will influence whether an executive steps aside. some illnesses/injuries may leave an executive physically unable to perform while in other cases, the board and executive will need to decide if the executive can continue to function in their position or to give the appearance that they are functioning. we, therefore, propose: hypothesis 2: in situations requiring possible immediate and unanticipatedsuccession such as when an executive becomes ill or injured. a dual ceo/chair will more likely retain their position than will a non-dual ceo even when controlling for the severity of the affliction. stock market reaction worrell, davidson, chandy, and garrison (1986) find that the stock market reacts negatively to sudden death announcements of ceos. here, a non-routine turnover has occurred and the organization must adapt. worrell and davidson fall 2006 davidwn et al.: ignoring rules ofsuccession 99 (1987) find that following the ceo death, when an insider is appointed, there is an offsetting positive stock market reaction. placing an insider into the deceased executive's position may signal the market that the company is continuing to rely on rules to guide them. by relying on the rules, the corporation has signaled the market that the situation is under control, and the market responds positively. putting an experienced leader in the position will avoid the appearance or reality of promoting the heir-apparent before they are ready. shen and cannella (2003) find that the market reacts positively to news of a relay succession process. here, the stock market reinforces the reliance on rules by reacting positively to the announcements that indicates that rules of succession have been followed. in other words, by signaling that normal rules of succession have been followed, the company shows that the situation is under control. naveen (2000) argues that firms manage the succession process to minimize the succession and transition costs. when there is a non-normal succession requiring immediate board action, such as when a ceo becomes ill, it may be less costly to hire the former ceo or board chair. there would likely be less disruption since the former ceo's style is known. we, therefore, propose that the stock market will reward the company for decisions that may violate the normal rules of succession but that are consistent with the functions of the rules. therefore: hypothesis 3: the stock market will react more positively to unanticipated succession announcements, such as when a ceo becomes ill or injured, when a former ceo or the chair assumes the ceo position. method in this paper, we examined the succession process in corporations when the ceo or chair becomes ill or injured. by examining ceo illness/injury rather than other causes of unanticipated succession, we examined situations when the board had the choice to name a successor or not. we also examined the stock market reaction to the succession announcements to determine how the stock market views board of director response to the injury/illness announcement. sample we located our sample by performing a key word search in news reports in lexis-nexis. we developed several key word strings such as executive and ceo combined with words such as illness, sickness, injury, cancer, heart disease, etc. from this search, we were able to find 113 stories which indicated that a ceo or chair had become ill or injured over the years 1992 to 2002. we then obtained the news stories that contained the announcements and were able to find the required information (see below) for 105 announcements. these 105 announcements became our final sample. we used the all news files on lexis nexis to ensure that the news announcement is the first story. there was often a delay in reporting an executive's illness. in our sample, seventy-nine percent of the 100 journal ofbusiness strategies vol. 23, no.2 companies made the announcement within one week of the executive becoming ill. ninety percent of the companies made the announcement within one month of the illness's onset and ninety-five percent within 90 days. there were three companies that waited at least one year to make an announcement. title of iii executive: type of replacement: table 1 sample characteristics ceo 6 5.7% ceo & president ii 10.5% ceo & chair 53 50.5% ceo, chair & president 19 18.1% chair ~ 15.2% total 105 100.0% no replacement 33 31.4% inside executive (heir) 54 51.4% chair or board member ~ 17.2% total 105 100.0% ceo& ceo& ceo, chair ceo president chair & president chair total no replacement i i 18 9 4 33 inside replacement 4 7 29 7 7 54 chair or board member replacement -l -.1 ~ -.j. -2 1li total 6 11 53 19 16 105 permanent replacement": 44 of the 72 (61.1 %) replacements illness: not life-threatening 36 34.3% potentially life threatening 69 65.7% total 105 100.0% " the proportion of potentially life-threatening illnesses did not vary between the temporary and permanent replacement sub samples. from the news stories we obtained several pieces of information. this data is summarized in table 1. table i also shows the titles of the ill executives. there are 6 ceos, 11 ceos & presidents, 53 ceos & chairs, 19 ceos, presidents fall 2006 davidson et al.: ignoring rules ofsuccession 101 & chairs, and 16 chairs. the table also contains information on the type of replacement. in 33 cases, the executive was not replaced. in 54 cases, the executive was replaced by another inside executive such as the president, chief operating officer, or a vice president. these successors were most likely heir-apparent for the ceo. in 18 cases the ill executive was replaced by the chair of the board or other board member that was a retired ceo of the company with continued presence on the board. it is important to note that in our sample of unanticipated successions, the boards appointed no outside candidates. the next section of table 1 shows the type ofreplacement divided by executive title. we will utilize this information later. we also found that 44 of the 72 replaced executives were permanent replacements and 28 were only temporary. we based this designation on the wording in the news stories and assumed a succession was permanent unless the news story specifically states that it was temporary. we designated an illness as life threatening if the news story indicated that it was, or designated it as not life threatening if the news story specifically said it was not. in addition, if the news story made no such indication, we classified heart problems and cancer as potentially life threatening. we found no statistical difference in the types of replacement by whether or not the illness was life threatening or by any measure of type of illness. to test hypotheses 1 we compared the successor types in our sample of ceo illness announcements to normal succession types resulting from other than sickness or death. we, therefore, needed a comparison group of succession announcements that occur for other reasons. we developed two separate control samples. for the first control sample, we identified 1017 ceo successions and the year of the succession from the execucomp data base. we then searched news stories and proxy statements for each of the successions and ensured that they did not result from illness, injury, or death of the predecessor and to determine the successor type. we were able to obtain complete information for anticipated 738 successions. this first control sample allowed us to compare our sample of illness/injury related successions to a large number of successions unrelated to illnesslinjury of the predecessor. for our second control sample, we identified the primary four digit sic code of each sample firm. using compustat, we identified other firms with the same four digit sic codes. we then determined the firm from this list that was closest in size (based on total assets) to the sample firm. the firms that we identified with this matching procedure were the industry matched control firms. for each of these firms, we determined the origin of the most recent ceo succession. statistical method to determine how the stock market reacts to the news announcements, we used standard event methodology (fama, fisher, jensen & roll, 1969). as this method is well known and commonly utilized in research, we only summarize our procedure here. we defined day 0 as the date the news story first appears in the press. 102 journal of business strategies vol. 23, no.2 to estimate normal stock returns, we estimated the market model for each firm using days -290 to -90 relative to the announcement date, day o. the market model was a regression with the company's daily stock returns as the dependent variable and the equally weighted market index as the proxy for the market's returns and as the independent variable. we then applied the estimated regression parameters from the market model to the actual daily stock market returns on days -1,0 and 1. this computation produces the security's normal (or expected) stock return. the normal return would be the return that is expected for the company given the overall movement of the market and the security's risk. we compare the normal returns to the actual returns to produce the abnormal returns. in the absence of information that impacts a company's value, abnormal returns are expected to be zero. we utilize t-statistics to determine if the abnormal returns are non-zero. results replacement of iii executives table 2 contains frequency analyses and comparisons for the replacement decisions of top executives. in panel a we test hypothesis 1. here, we show that in our sample there are 60 executives with the title of ceo that become ill/injured and do not retain their position. we have, therefore, eliminated the 33 ill or injured executives that retained their position. we also eliminate the 16 executives with the chair title (four executives are in both eliminated sub samples leaving 60 ill/injured ceos. we obtain the sub sample of 60 as follows: 105 33 16 + 4 = 60). there are 47 (78.3%) replacements with another inside executive (president/coo/vice presidents), but there are 13 (21.7%) that are replaced by the chair or another board member (former ceo). to test hypothesis 1, we need to determine if the frequency of chair or other board member successors is greater than normally occurs. we first compare our sample to the anticipated succession control sample. in our sample, 47 of the 60 (78.3%) unanticipated succession are inside executives while 13 (21.7%) are the chair or a board member. from the 738 anticipated successions, 50 (6.7%) are replaced by board members including the chair (25), former chair (5) or vice-chair (20). if our sample firm successions behaved as those in the control sample, 56 of the 60 sample firms (93.3%) would be an insider and only four would be the chair or other board member. we define these numbers to be the expected frequency for our sample and compare the actual frequency to the expected frequency. the resulting chi-square is 21. 70 and is significant at better than the 0.001 level. this evidence is consistent with hypothesis 1. when a ceo becomes ill, the board will bypass the normal rules of succession more often than if the succession had been anticipated. here, the board selects an experienced executive such as the board chair or board member that is a former ceo. we next compare the frequencies from our sample firms to the industry matched control sample. in the industry matched control sample, 54 (90%) of the 60 successors are either insiders promoted from below or are outsiders. only six (10%) table 2 analysis of replacement decisions when an executive becomes iii "tj e. n o o 0\ percent industry matched sample expected frequencyfrequency panel a: comparison to anticipated succession sample (excludes chair-only iii executives) sample firms anticipated succession sample" expected frequency percent frequency percent frequency ~ :t:) ~ .;; ~ a ;:: tl:>...... r1q ;:: a "i: ~. :::tl =: ~ ~ ~ (") (") ~ c.., o' ;:: 54.0 6.0 60.0 x 2 =9.1** 90.0% 10.0% 100.0% 54 -.2 60 93.3% 33.6 32 90.0% 32.0 6.7% 2.4 --1 10.0% 4.0 100.0% 36.0 36 100.0% 36.0 x2 = 13.9*** x2 = 4.5* percent 688 50 738 frequency 72.7% 27.3% 100.0% percent 28 ~ 36 frequency inside executive chair or board member total test statistic inside executive 47 78.3% 688 93.3% 56.0 chair or board member 11 21.7% 50 6.7% 4.0 total test statistic 60 100.0% 738 100.0% 60.0 x 2 = 21.70*** panel b: comparison of permanent replacements to anticipated successions (excludes chair-only iii executives) permanent replacement anticipated succession sample matched sample expected expected frequency frequency percent frequency o w table 2 continued analysis of replacement decisions when an executive becomes iii panel c: comparison of temporary replacements to anticipated successions (excludes chair-only iii executives) temporary replacement anticipated succession sample matched sample expected expected frequency percent frequency percent frequency frequency percent frequency o ~ inside executive 19 79.2% 688 93.3% 26.1 22 chair or board member -.2 20.8% 50 6.7% ~ -.l total test statistic 24 100.0% 738 100.0% 24 24 x2 = 9.7** panel d: replacement comparison by dual versus non-dual executiveb executive title stayslreplaced frequency ceo or ceo & president stays in position 2 replaced l5. total 17 ceo & chair plus ceo, chair & president test statistic stays in position replaced total 27 45 72 percent 11.8% 88.2% 100.0% 37.5% 62.5% 100.0% expected frequency na na 8.5 63.5 72.0 x2 = 45.65*** 90.0% 10.0% 100.0% 22.0 2.0 24.0 x2 = 3.3t ~ :;:: "': ~ l::.l-~ ~ e; s· t1:l ""'""' ~ ~ ~. ~ a we also compared our sample firms to the sample in nemec (1995). her sample of 124 inside ceo successions includes 122 successions of inside executives and only 3 cases of the chair or former ceo taking the ceo position. using her sample as the expected frequency and comparing our sample to this expected frequency produced a chi-square of 146.4 which is significant at the 0.00 i level. our sample produces a significantly greater number of cases in which a former ceo or board chair assumes the ceo position than when compared to her sample. b we find no statistical difference in the number of life-threatening illnesseslinjury based on executive title or duality. *** p < 0.001, ** p < 0.01, * p < 0.05, t p < 0.10 ~.....n w z o n fall 2006 davidson et al.: ignoring rules ofsuccession 105 are former ceos or the board chair. we define these frequencies from the control sample to be the expected frequency for our sample and compare the expected frequency to the actual frequency. the resulting chi-square statistic is 9.1 (significant at 0.01). this evidence is consistent with hypothesis 1; the frequency of successions of former ceos and board chairs is greater following ceo illness/injury announcements than occurs from either of our control samples. it is possible that the successor ceos not promoted in the normal fashion would be temporary successors. to examine this issue, in panel b, we repeat the tests for the 36 permanent succession appointments from the sample. when we compare the actual frequency from our sample (28 normal successions, 8 former ceo/chairs) to the expected frequency from our anticipated succession control sample, the chi-square is 13.9 (significant at 0.001). when we compare the sample frequency to the industry matched control sample, the chi-square is 4.5 (significant at 0.05). the evidence for permanent successions is consistent with the predictions of hypothesis 1. in panel c, we compare the frequency of the normal successions from our sample to the frequency from the anticipated succession control sample (chisquare is 9.7, significant at 0.01) and to the industry matched control sample (chi-square is 3.3, significant at 0.10). these results for temporary succession announcements are consistent with the predictions of hypothesis 1. thus, the temporary/permanent nature of the succession announcements does not qualitatively change our findings. in panel d, we show the comparison of ceo successions following sickness announcements for executives in a dual position (ceo & chair, and ceo, chair & president) and those not in a dual position (ceo or ceo plus president). here, we test hypothesis 2 and show the comparison based on whether the ill executives stay in their positions versus when they do not. when a sick executive is in a non-dual position, two of the 17 (11.8%) remain in their positions. for the executives in the dual positions, 27 of the 72 (37.5%) retain their positions. if the dual executives stayed in their positions in the same proportion as the non-dual executives, 8.5 would have stayed and 63.5 would not have. we can compare the actual occurrence to the expected occurrence with a chi-square test. the chi-square is 45.65 and is significant at 0.001. these results are consistent with h 2 • we find a greater incidence of dual executives retaining their positions than do non-dual ceos. these results could be driven by dual executives having less-severe illnesses or injuries. based on our designation of life-threatening, we cannot find evidence that the severity of the affliction is related to the executives' titles. of the 17 non-dual ceos, 6 (35.3%) had non-life-threatening afflictions while 11 (64.7%) had life-threatening problems. for the 72 dual executives 23 (31.9% had non-life-threatening afflictions while 49 (68.1 %) had life-threatening problems. market reaction to unanticipated succession announcements in table 3, we show the abnormal returns for days -1, 0, and 1. the first column shows the results for the total sample. all three day's abnormal returns 106 journal ofbusiness strategies vol 23, no.2 are nominally negative, but only day 0, the announcement day, has a significant abnormal return (marginally significant at the 0.10 level). table 3 cumulative abnormal returns who replaces executive total executive stays inside chair or anova day sample in position executive director f-statistic -1 -0.0010 -0.0010 0.0101 -0.0042 1.32 (-0.20) (-0.20) ( 1.13) (-0.73) 0 -0.0056 -0.0063 -0.0136 0.0175 6.68** (-1.70)t (-1.68)t (-3.10)** (1.75)t -0.0027 -0.0197 0.0019 0.0137 1.72 (-oal) (-1.09) (0.39) (0.98) **p<o.oi t p <0.10 in the next three columns, we divide the sample based on the replacement decision. when the ill executive stays in their position, the day aabnormal return is negative and only marginally significant (at the 0.10 level). when the board selects an inside candidate, the abnormal return is negative and significant (at the 0.01 level). however, when the board replaces the ill executive with the chair or board member (usually a former ceo) the abnormal return is positive and only marginally significant (at the 0.10 level). we compare these means using an anova test. the value off on day ais 6.68, and it is significant at 0.0 1. the market reacts negatively when the executive stays in their position or when an inside executive replaces the ill ceo and positively when a more experienced executive takes the corporate reigns, and the difference in the day zero abnormal returns is highly significant. we also compare the market reaction to the types of successors with regression analysis. this approach allows us to compare the market reactions to the succession decisions while controlling for other factors that may influence the market reaction. we control for the number of delays in announcing the illness, whether the succession is permanent or temporary, and whether the illness is life-threatening or not. finally, we control for the ill executive's title. we classify title in a manner similar to the "ceo power curve" in vancil (1987, p. 225). we classify a ceo as 1, a ceo & president as 2, ceo & chair as 3, ceo, chair & president as 4, and a chair as 5. we also experimented with other title classifications such as whether the executive served in a dual capacity or not, but this did not materially influence the results. panel a of table 4 contains a correlation matrix of the control variables, test variable and the dependent variable. "tl table 4 tllcorrelations and regressions n 0 0 0\ panel a: correlation matrix 1 2 3 4 5 6 7 8 1. days delay 1.00 2. who replaces 0.01 1.00 3. pennanent replacement 0.10 0.27** 1.00 \) t:l 4. title -.:: 0.07 -0.03 -0.12 1.00 §: 5. illness -0.15 0.23* 0.09 0.13 1.00 0::l 6.roa -0.02 -0.06 -0.23* 0.07 -0.20* 1.00 (l).... 7. log(sales) 0.14 -0.21 * -0.06 0.01 -0.28** 0.22* 1.00 t:l:8. caro -0.04 0.20 -0.03 0.16 -0.03 -0.06 -0.08 1.00 o'q ::l 0 "'l panel b: regression analysis: dependent variable is caro s· ~ who days permanent :;:.;,:::: constant replaces delay replacement title illness roa log(sales) r2f ..... (l) c., modell -0.0133 -----0.0000 -0.0027 0.0080 -0.0051 -0.0002 -0.0010 3.2% ~ (-0.76) (-0.56) (-0.41 ) (2.57)* (-1.17) (-0.89) (-0.71) (1.48) vl:::: (") model 2 -0.0137 0.0093 ----------------3.1% (j ~ (-2.62)* ( 1.99)* (3.92)* c.,-.0 mode13 -0.0211 0.0092 -0.0000 -0.0058 0.0083 -0.0061 -0.0001 -0.0007 6.3% ::l (-1.20) (1.92) t (-0.63) (-0.87) (2.69)** (-1.44) (-0.71) (-0.45) (1.86) t **p<o.oi, *p<o.os, tp<o.lo ...0 -.,j 108 journal ofbusiness strategies vol. 23, no.2 panel b of table 4 presents the regression analysis with the day 0 car as the dependent variable. modell estimates the relation between the dependent variable, caro' and the control variables. only the estimated coefficient for title has even a marginally significant coefficient (significant at 0.10). in model 2, we present the regression results for our test variable, "who replaces". we code this variable as 0 if the board does not replace the ill executive, i if an inside (heir-apparent) executive is the successor, and 2 if it is the chair or other board member. the estimated coefficient of this variable is significant at the 5% level. this result suggests that the market reacts more positively to an experienced executive taking the job and less positively when the ill executive is not replaced. in model, 3, we include the test variable and control variables. the estimated coefficient for who replaces is positive and significant at the 5% level. even after adding the control variables to the model, the results from model 2 hold. these results are consistent with hypothesis 3. summary and conclusions findings we hypothesize and document that in times when an immediate succession decision is needed because a key executive becomes ill, the normal rules of succession are not always followed and must be adapted to the situation. none of the boards in our sample selected an outside candidate as successor. in addition, we find that when ceos become ill that they are more likely replaced by a board member that is a former ceo than would be the case under more normal succession decisions. that is, the heir-apparent and horse-race succession processes are less likely to occur than in ordinary circumstances because the ceo's illness makes an immediate decision necessary. the decision to bring back a former ceo can be consistent with the functions of rules. this decision may allow for continued routine operations to continue, allow board members to give the appearance that they have met their fiduciary responsibility and may lessen internal political conflict if the heir-apparent has not been designated or is not ready to fulfill the responsibilities of the ceo position. our results also show that some ceos retain their job after announcing their illness. the retention of their position is more likely to occur if the ceo is also the board chair. in these cases, the dual executive may have the power and clout with the board to retain their positions. or, since the executive is in a dual position, there may not be anyone else on the board with the required experience so the dual executive must continue in the position. this also appears to be consistent with the functions of rules since quickly finding a replacement for both the chair and ceo could be both difficult and lead to outcomes that are inconsistent with the functions of rules. finally, we find results that are inconsistent with those in other research (shen & cannella, 2003). they document that when an heir-apparent succession occurs that the stock market responds positively. we find that the market responds fall 2006 davidson et al.: ignoring rules of succession 109 more positively when a former ceo and board member assumes the ill or injured ceo's position. this difference appears to be related to the maintenance of the rules and their functions. in the ordinary succession process, the heir-apparent assumes the ceo position and the market responds positively to a board action that is consistent with the normal rules of succession (shen & cannella, 2003). in our sample, the normal succession process that would be consistent with succession rules may not be applicable. the immediacy and urgency of the succession decision and the market reaction we find suggest that the market responds positively to a board decision that is consistent with the functions of the rules. in both the shen and cannella (2003) study and here, the market responds to decisions that are consistent with the functions of rules. the non-normal situations require different decisions. contributions theoretical contributions we provide new insights into the theories of choice, board succession decisions and how rules of succession are employed or ignored in special circumstances. rules become part of an organization's culture, and rules of succession are the rules that guide the board in making succession decisions. while the normal rules may be the appointment of an heir-apparent or the appointment of the winner of a horse race, we argue that when an immediate and unanticipated turnover occurs that the normal rules of succession are not applicable. when such a situation occurs the board is faced with a potential dilemma. board members must create new rules or adapt the old ones to have an outcome that is consistent with the functions of the rules. rules are designed to help maintain routine, help decision-makers meet their responsibilities, and lessen internal conflict. boards must make an immediate decision that at least maintains the functions of the rules. the succession decision must, therefore, allow for the continued operations of the company to be maintained, must allow the board to meet its fiduciary responsibilities or at least give this appearance, and not cause unnecessary internal conflict. contributions to practice our results also have practical implications. they suggest that there is a need for succession planning. a recent wall street journal article argues that finding a ceo on short notice is very difficult for a board and that corporations must prepare for the possibility that "they will be left unexpectedly without a leader" (carey & ogden, 2000, p. a22). this same article points out that few companies prepare adequately for succession. this lack of succession planning occurs because current ceos, for various reasons, hesitate to appoint and groom a successor. the positive stock market reaction to heir-apparent successions found by shen and cannella (2003) suggests that the financial marketplace rewards companies that do make and execute succession plans. the negative 110 journal ofbusiness strategies vol. 23, no.2 reaction that we find to inside executives replacing an ill or injured ceo and the large incidence of former ceos replacing an ill or injured ceo, suggests that the market does not believe these companies to have adequately prepared internal successors. the need for an experienced replacement has been documented in bigley and wiersema (2002). they argue that when heir-apparent successors have had more experience in the president or coo position, that they are more effective at generating strategic change. since our results show that following ceo illness announcements that an heir is often not appointed, we interpret this to imply that either the heir has not been adequately trained and prepared for the ceo position or that the board is afraid that the outsiders to the company would perceive this to be the case. rehiring a former ceo puts an experienced executive in the position and may help to ensure the marketplace that the business will continue as usual. our results, therefore, suggest that the board of directors must manage the succession planning process. this process is an on-going and continual process in which successors must be groomed. boards must also have plans in place so that when a sudden and unexpected need for succession occurs they are prepared. limitations and future research others have documented that in non-normal situations that the normal rules of succession may be violated such as following poor performance and ceo dismissal (kesnor & sebora, 1994) and following ceo death (worrell & davidson, 1987). we have documented an additional situation in which the normal rules are not generally applied. however, our findings may not be generalized to other types of unanticipated succession. future research on this issue is needed. another limitation of our findings is that we were not privileged to the medical records of the ill ceos. we relied on the public announcements to determine the severity of the illness or injury. based on the news reports, the severity or type of illness/injury did not seem to influence our results. if better information on the severity of the illnesses and injuries can become available, future research may be needed to measure how the severity of the incident impacts our results. references andrews, k. r. (1971). the concept ofcorporate strategy. homewood, il: irwin. arrow, k. j. (1963). social choice and individual values. new york: wiley publishers. bigley, b. a., & wiersema, m. f. (2002). new ceos and corporate strategic refocusing: how experience as heir apparent influences the use of power. administrative science quarterly, 47, 707-727. borokhovich, k. a., parrino, r., & trapani, p. (1996). outside directors and ceo selection. journal of financial and quantitative analysis, 31,337-355. fall 2006 davidson et al.: ignoring rules ojsuccession 111 brickley, j. a., coles, j. l., & jarrell, g. (1997). leadership structure: separating the ceo and chairman of the board. journal ofcorporate finance. 3, 189-220. cannella, a. a. jr., & lubatkin, m. h. (1993). succession as a sociopolitical process. academy of management journal, 36, 763-793. carey, d. c., & ogden, d. (2000, july 31). what if your ceo gets promoted to vp? wall street journal, pp. a22. chan, w. (1996). external recruitment versus internal promotion. journal of labor economics, 14, 555-570. clark, r. c. 1991. agency costs versus fiduciary duties. in j. w. pratt & r. j. zeckhauser (eds.), principles and agents: the structure ofbusiness. (pp. 55-79). boston: harvard business school press. fama, e. e, fisher, l., jensen, m. c., & roll, r. (1969). the adjustment of stock prices to new information. international economic review, 10, 1-21. finkelstein, s., & d'aveni, r. a. (1994). ceo duality as a double-edge sword: how boards of directors balance entrenchment avoidance and unity of command. academy of management journal, 37, 1079-1108. goyal, v. k., & park, c. w. (2002). board leadership structure and ceo turnover. journal ofcorporate finance, 8, 49-66. kesnor, i. e, & sebora, t. c. (1994). executive succession: past, present & future. journal ofmanagement. 20, 327-372. march, j. g. (1994). a primer on decision making: how decisions happen. new york: free press. march, j. g., & simon, h. a. (1993). organizations (2nd ed). cambridge, ma: blackwell business. massie, j. l. (1965). management theory. in j. g. march (ed.). handbook oforganizations. (pp. 387-422). chicago: rand-mcnally. naveen, l. (2000). management turnover and succession planning in firms (working paper, arizona state university). nelson, r. r., & winter, s. g. (1982). an evolutionary) theory ofeconomic change. new york: mcgraw-hill nemec, c. r. (1995). executive plurality: relationship with firm financial performance, external regulations, and the role ofthe board of directors (unpublished dissertation, southern illinois university, carbondale, il). 112 journal of business strategies vol. 23, no.2 ocasio, w. (1999). institutionalized action and corporate governance: the reliance on rules of ceo succession. administrative science quarterly, 44,384-416. parrino, r. (1997). ceo turnover and outside succession: a cross sectional analysis. journal offinancial economics, 46 (2), 165-197. sen, a. (1970). collective choice and social welfare. san francisco: holden-day publishers. shen, w., & cannella, a.a. (2002). power dynamics within top management and their impacts on ceo dismissal followed by inside succession. academy of management journal, 45, 1195-1206. shen, w., & cannella jr., a. a. (2003). will succession planning increase shareholder wealth? evidence from investor reactions to relay ceo successions. strategic management journal, 24, 19] -198. vancil, r. m. (1987). passing the baton. boston: harvard university press. worrell, d. l., & davidson iii, w. n. (1987). the effects ofceo succession on stockholder wealth in large firms following the death of the predecessor. journal ofmanagement, 13,509-515. worrell, d. l., davidson iii, w. n., chandy, p. r., & garrison, s. (1986). management turnover through deaths of key executives: effects on investor wealth. academy of management journal, 29. 674-694. zhang, y, & rajagopalan, n. (2004). when the known devil is better than an unknown god: an empirical study of the antecedents and consequences of relay ceo successions. academy ofmanagement journal, 47, 483-500, zucker, l. g. (1977). the role of institutionalization in cultural persistence. american sociological review, 42, 726-743. wallace n. davidson iii is the henry rehn research professor of finance at southern illinois university at carbondale. his research interests include corporate governance and control and executive succession. he has published in the academy of management journal, strategic management journal, the journal offinance, the journal offinancial and quantitative analysis, and financial management. among others. shenghui tong is assistant professor of finance at siena college. he got his ph.d. in finance from southern illinois university carbondale in 2004. his research interests include corporate governance and control. fall 2006 davidson et at.: ignoring rules ofsuccession 113 dan l. worrell is dean and sam m. walton leadership chair for the walton college of business at the university of arkansas, fayetteville. dan received his ph.d. from louisiana state university in management. his research interests include an investigation of the antecedents and consequences of major organizational events involving key executives. he has published in the academy of management journal, strategic management journal, and journal of management, among others. wei rowe is associate professor of finance at the university of nebraska omaha. she has done research in the areas of corporate governance, mutual funds, and chinese financial market and economy. her work has appeared in academic journals such as financial review, international journal of finance, journal of corporate ownership and control, and china economic review, among others. she is a member of american finance association and serves on the editorial board of asbbs e-journal. 114 journal ofbusiness strategies vol 23, no.2 ignoring rules of succession: how the board reacts to ceo illness announcements a theoretical and empirical analysis of the strategic value of beyond compliance occupational health and safety programs daniel j. corcoran joshua d. shackman touro university international cypress, ca abstract the present study examines the application of resource dependence theory and institutional theory relative to company involvement in an important voluntary, governmentally sanctioned employee safety program that goes by the acronym vpp. utilizing this combined theory approach. the study empirically demonstrates, through a design incorporating correlation and multiple regression analysis, that institutional theory is useful for predicting program prevalence within a given industry, though resource dependence theory complements the former by offering an accounting ofstrategicfirm behavior. companies consider adoption of beyond compliance safety programs as a strategy to manage the expression of resource control power on the part ofpowerful stakeholders, while institutional theory helps to explain the mechanisms by which such programs proliferate through a given institutional field. introduction the present study explores the efficacy of resource dependence theory (rot) and institutional theory (it) as a theoretical foundation for understanding why organizations participate in beyond compliance safety and health programs. these two theories have frequently been used in concert in various attempts to explain organizational phenomena (lucas, avi-itzhak, robinson & morris, 2005; peng, 2004) due, in part, to the shortcomings in each of the two perspectives that the other is capable of satisfying. institutional theory, for instance, has been criticized in the past for focusing primarily on organizational adaptations resulting from institutional pressures including social values, norms and expectations imposed by the external environment without a great deal of consideration given to the influence of active agency and external exchange relationships that playa part in driving organizational change (oliver, 1991; pfeffer & salancik, 1978; abernethy & fong, 1996). rdt, on the other hand, complements institutional theory in that active agency is essentially a fundamental tenet of the theory which also focuses specifically on exchange relationships with the external environment as they relate to resource inter50 journal ofbusiness strategies vol. 24, no. 1 dependence between the firm and various stakeholder groups (oliver, 1991; pfeffer & salancik, 1978). the present paper considers the marriage of these two theoretical perspectives as they relate to the emergence and growth of beyond compliance safety and health (s&h) programs within institutional fields. the focal program evaluated in this study provides governmental recognition to employers for exemplary performance in their safety and health endeavors. this program, known as osha's voluntary protection program (vpp) was created by the occupational safety and health administration (osha) in the early 80s and requires that employers go well beyond what is minimally expected of them by osha standards (osha, n.d. (a)). participants, for instance, are required to implement sophisticated health and safety management programs similar to those found in management systems prescribed to enhance product quality such as iso quality standards, six-sigma, and malcolm baldridge award criteria (levine & dyjacka, 1997; manuele, 2003). the intent behind vpp, therefore, is to provide recognition to employers that successfully protect their employees from workplace injuries and illnesses through the utilization of sophisticated management systems. thus, consideration for the employee stakeholder group weighs heavy in the decision to participate in vpp. however, participation also impacts the perception of the firm by other stakeholders having power to control resources important for firm survival. these include not only employees, but also the government, local community, customers, suppliers and other important stakeholder groups as well. likewise, vpp has become a recognized, legitimate socially responsible endeavor and has proliferated within a number of industries. this proliferation in certain industries makes vpp a good candidate for evaluation from an institutional perspective. the combined explanatory efficacy of rdt and institutional theory will subsequently be utilized in the present paper to explore the phenomena of vpp proliferation within industries, literature review resource dependence theory resource dependence theory grew out of the work of pfeffer and salancik and was first clearly explicated in their seminal book on the topic published in 1978 (recently republished in 2003). the theory is essentially based on the premise that resource interdependence relationships exist between organizations and their stakeholders. an imbalance in this relationship, where one actor is disproportionately more dependent on the other, creates a resource dependence power imbalance. thus, a given resource dependence relationship can be one where the firm and stakeholder are highly dependent on each other, or one where circumstances create an imbalance resulting in one of the actors having resource control power over the other (pfeffer & salancik, 1978). in their book, pfeffer and salancik (1978) describe firm strategies for dealing with resource dependence ranging from mergers and acquisition to co-opting and spring 2007 corcoran & shackman: theoretical and empirical analysis 51 lobbying powerful stakeholders. since the publication of this book, a number of studies have been published attesting to the explanatory efficacy of rdt for understanding strategic decision-making in the firm. lawahar and mclaughlin (200 i), for instance, argue that companies choose from among several different strategies (ranging from proactive to reactive) for dealing with different stakeholders, depending on the organization's resource needs, which may fluctuate according to the developmental stage in the lifecycle of the firm. in another interesting paper, jeff frooman (1999) used rdt to propose a range of strategies that might be used by external stakeholders to control the resources of the firm depending on the degree to which a given firm is dependent on a given stakeholder group for resources necessary for survival. this perspective is consistent with the present paper in that we argue firms will themselves undertake strategy to influence relationships with stakeholders that could act to impinge upon the flow of resources through the firm. institutional theory not unlike rdt, institutional theory views the firm as being influenced by, or more appropriately, embedded in an external environment. however, rather than focusing on power relationships, institutionalism focuses on the existence of institutions external to the firm such as laws, regulations, and norms and the influence these institutions have on molding organizations in search of social legitimacy (scott, 1995; prakash, 200 1). dimaggio and powell (1983) further argued that organizations subjected to similar environments or 'fields' (such as firms within an industry), will respond to similar pressures in similar ways and may subsequently begin to resemble each other structurally or, in other words, become more homogenous or "isomorphic" in response. the authors termed this phenomenon 'institutional isomorphism' and proposed three primary mechanisms to explain why isomorphism occurs. these include coercive, mimetic, and normative mechanisms. coercive isomorphism "results from both formal and informal pressures exerted on organizations by other organizations upon which they are dependent and by cultural expectations in the society within which organizations function" (dimaggio & powell, 1983). mimetic isomorphic mechanisms include the tendency for companies to model other organizations when faced with an environment of ambiguity and uncertainty. essentially, organizations will tend to model successful firms, or model strategies that are universally accepted by most firms in a particular sector. normative isomorphism refers to professional influences on the firm resulting from professional training and education and influence from involvement with organizations such as professional associations outside the firm (dimaggio & powell, 1983). rdt and institutional theory as complementary theories christine oliver (1991), in one of the earlier attempts at combining resource dependence theory with institutional theory, pointed to differences in the funda52 journal of business strategies vol. 24, no. i mental underpinnings or foci ofthe two theories and described means by which the two theoretical perspectives could be combined to account for difficulties posed by a purely institutional viewpoint that arguably lacks means of accounting for active choice behaviors on the part of the firm. thus, by incorporating a resource dependence perspective into the institutional framework, an accounting of strategic responses to the institutional environment can be made (oliver, 1991). empirical studies only a handful of empirical attempts have been made in the past decade demonstrating combined explanatory efficacy of the two theories in support of oliver's framework. rdt and institutional theory, for instance, have been used to provide a theoretical basis for demonstrating strategic implications of in corporating accounting control systems as a part of overall management control systems. (abernethy & fong, 1996). other studies have been recently been published using rdt and it as a theoretical basis for framing empirical research as well (peng, 2004), including one such investigation which utilized the combined theory approach to establish a theoretical foundation for demonstrating the extent to which the external environment influences adoption oftotal quality management initiatives in nursing homes (lucas, avi-itzhak, robinson & morris, 2005). this latter study is instructive in that it provides an evaluation of the proliferation of a prescribed, beyond compliance management system within a highly regulated industry based on a combined rot! institutional framework. not unlike the study performed by lucas et al. (2005), the current paper uses the combined theory framework to ground an empirical evaluation of the emergence and proliferation of beyond compliance management programs in an otherwise regulated arena. and despite calls to consider this combined theoretical approach in evaluating strategy underlying the proliferation of environmental safety and health (es&h) programs as far back as 1997 out of "an urgent need for definition and theory building" (tsai & child, 1997) a review of the literature suggests a combined theoretical approach has not been specifically employed in pursuit of this call. nor have any attempts been made to examine specifically occupational safety and health (often regarded an es&h sub-discipline) programs from a strategic perspective regardless of theoretical approach. the present study will help to fill these deficiencies by: i.) providing an empirical demonstration of the efficacy of the combined theory approach, an area sparsely populated with such demonstrations, 2.) providing a look into the extent to which this approach may help us to understand how beyond compliance programs such as vpp emerge and proliferate through institutional fields, and 3.) providing an in-depth evaluation of the perceived strategic value of occupational safety and health programs, an area largely unconsidered in the strategic management literature. vpp and the external environment one aspect ofthe external environment that many organizations must cope with in the present age is that of activism and the media coverage that accompanies spring 2007 corcoran & shackman: theoretical and empirical analysis 53 activism. according to jeff frooman (1999), activism may be employed as an indirect strategy on the part of some stakeholder groups that otherwise would have no power to impact the activities of the firm. their power, therefore, is exercised indirectly, by influencing stakeholders often by way of mass media who provide resources necessary for the survival of the firm. nor is activism necessarily restricted to the impact it may have on the firm, but entire industries as well (shepard, betz & o'connell, 1997; milstein, hart & york, 2002; king, lenox & barnett, 2002). indeed, companies often find themselves in industries receiving a great deal of negative publicity and subsequently engage in strategies, such as participating in beyond compliance programs to demonstrate social responsibility; thereby setting themselves apart from their tarnished industry (milstein et ai., 2002). this may occur out of a concern that activism and negative public attention may cause more powerful stakeholder groups to respond by exercising control of resources they make available to the firm (e.g., customers choose to shop elsewhere) (frooman, 1999). companies in industries that receive a great deal of negative public attention are subsequently compelled to do something to set themselves apart by behaving responsibly, and one strategy for doing so is involvement with programs such as vpp. through time, we would also expect an increase in vpp sites in a given industry due to mimetic and normative isomorphic mechanisms as described by dimaggio and powell (1983) as more companies in a given industry became aware of the program due to other vpp participants in the industry, and as managers' awareness of the program increased through educational opportunities. thus, we hypothesize the following: hypothesis l: vpp commitment in an industry is positively associated with the level of negative publicity in the industry. the community as stakeholder according to besser (1999, p. 16), "the enlightened self-interest model of corporate social responsibility predicts that businesses that support their local communities will be more successful." besser (1999) then goes on to demonstrate a link between community involvement in small towns and the perceived success of the businesses demonstrating that the community is instrumental in providing resources necessary to the success of the firm including a supply of workers, utilities, and legitimacy for continued operations. facilities that may be viewed as hazardous to a given community, therefore, will need to pay considerable heed to community concerns due to the inherent hazards associated with their operations. a large industrial facility that spews toxic pollutants into the atmosphere, for instance, may have difficulties winning over the community and this environmental threat will likely cause concern on the part of the firm resulting in strategy designed to appease the surrounding community. thus, we subsequently suspect that the community will likely be seen as an important and powerful stakeholder in facilities such as these. these facilities will subsequently attempt to win overthe community by enhancing firm 54 journal ofbusiness strategies vol. 24, no. i legitimacy by not only focusing on environmental concerns, but also though the implementation of other socially responsible strategies as well. hence: hypothesis 2: vpp commitment is positively associated with community environmental threats. employees as stakeholders employees are an important primary stakeholder group that are likely to be seen as particularly powerful relative to the groups' power to control organizational resources. larger companies in small communities will likely provide incentives to retain their existing force and entice employees from near-by communities in response to this power. and although some employers may hold what seems like monopoly power as the primary employer in a given community, failure to provide adequate incentives to maintain a limited labor force is not conducive to long term sustainability. not all employees, for instance, are compelled to remain in a given community and when employees are scarce, companies are best not to provide incentives for emigration. rather, incentives to inspire immigration would be more beneficial. vpp participation, thus, may be considered as among the set of strategic tools that may be employed to enhance the attractiveness of employment a given firm. this will be particularly so when dependence on labor is high. thus, we hypothesize: hypothesis 3a: vpp commitment is positively associated with community labor dependency. another way to look at employee stakeholder power, of course, is to consider the proportion of unionized facilities within a given industry. one would expect, for instance that higher unionization within a company would tend to lead to strategies that would limit the exercise of resource control power on the part of the employee stakeholder group given their increased collective power. companies within such an industry would, therefore, work to implement strategies to accommodate the organized labor group in order to prevent employees from withholding human resources either by strike or other means. thus, another hypothesis for determining whether there is a relationship between employee stakeholder power and industry vpp commitment is as follows: hypothesis 3b: vpp commitment is positively associated with the level of unionization. one could also argue that the level oftechnical competence may playa role in determining which industries become highly populated with vpp sites. that is to say, perhaps industries that require a technically skilled labor force tend to become vpp sites more often than low skill industries. it's plausible to assume, for instance, that employers who expend resources to train employees in a spring 2007 corcoran & shackman: theoretical and empirical analysis 55 complex industrial skill will be more likely to tend to the concerns of employees in order to retain them (and the company's investment) than companies having front line employees where such an investment need not be made. likewise, employees that acquire such skills should be duly compensated. certainly one would expect a pharmaceutical chemical batch mixer to receive greater earnings than one who sweeps the workshop floor or plucks chickens at the company across the street. we subsequently used wage as a proxy for skill or technical competence. hypothesis 3c: vpp commitment is positively associated with employee wages. injury rate prevalence to further test these relationships, it is important to consider whether companies having high injury rates account for increased vpp commitment within industries. this is important to determine whether injury rate has an effect and, if so, how significant an effect to discount the possibility of injury rate as an intervening or spurious variable. that is to say, companies in high-risk industries may choose to participate in vpp to lower their injury rates. if these industries also happen to be industries having large numbers of employees, or industries particularly scrutinized by osha or others due to their high rates, one could argue the existence of spuriousness, which would considerably water down the practical significance ofthe other relationships to be tested. thus, to test the effects of this potentially intervening variable: hypothesis 4: vpp commitment is positively associated with injury and illness rates. the government as stakeholder finally, in this study it is important that we consider the role of government. osha, for instance, is capable of a.) directly withholding company resources by imposing monetary penalties which have the potential of ranging into the tens of millions of dollars, b.) indirectly withholding resources by inciting other stakeholders to act due to osha's tendency to publicize large dollar penalties, and c.) controlling organizational resources through the promulgation ofstandards and administrative directives. osha frequently focuses on hazardous industries using a multi-pronged approach that includes tough but fair, focused enforcement, in addition to employing other strategies within the industry such as partnerships and alliances in an attempt to focus industries on significant safety and health issues inherent in their respective industries (skrzycki, 2005). thus, despite arguments suggesting a weak osha, the agency does wield considerable power in influencing the actions of employers brought into their field of vision. and given that osha tends to increase its inspection activities in industries exhibiting poor safety and health performance, the incidence of osha inspections within each 56 journal o/business strategies vol. 24, no. 1 given industry was selected as a construct for quantifying osha's focus within each industry. we subsequently hypothesize: hypothesis 5: vpp commitment is positive(v associated with the level ofosha inspections. methods a correlational, non-experimental design was used to test multiple hypotheses relating to relationships between stakeholder influence constructs and company vpp commitment. methods of statistical analyses included correlation and multiple regression analysis using spss grad pack, version 11.0. sample selection data obtained from companies in this study included those possessing a vpp designation as of february 23, 2003 (the week the vpp data base was obtained). the data obtained from osha was arranged into two data sets for analysis. the fitst data set, made of companies at the 2-digit standard industrial classification (sic) level, was used to test the first hypothesis. this data set was comprised of all industries (2-digit sic excluding construction and metal and mineral mining) that were eligible to participate in vpp. sic codes were used as opposed to other classification schemes (e.g., naics) due to the way the information was reported by osha. some industries were combined due to peculiarities in the sic coding structure (corcoran, 2003). a total of 60 industries remained for testing after these manipulations were completed. in this data set, the 2-digit sic level was chosen due to constraints posed by the data sources. thus, the first hypothesis was tested at the 2-digit sic level. information was available at the 3-digit sic to test to the remaining hypotheses and thus, the second data set made use of this more specific information for the remaining comparisons. this data set was comprised ofall manufacturing industries having vpp sites at the 3-digit sic level, plus two utility industries (sics 491 and 493) due to limits imposed by one of the primary independent variables (corcoran, 2003). thus, all manufacturing and relevant utility and warehousing industries (3-digit sic) having vpp sites were included in the data set except that two primary metal industries were excluded as outliers (corcoran, 2003). this resulted in an industry population of 90 3-digit sic industries. vpp commitment was measured by looking at each industry at the 2-digit and 3-digit sic level, depending on the comparison being made. vpp commitment within each industry was determined at the firm and establishment level. at the finn level, the number of multiple facility vpp firms in each industry was divided by the number of all firms (derived from census data, u.s. census bureau, n.d. (a» in each respective industry. at the establishment level, the total number ofvpp sites within each industry, was divided by the number of all establishments in each respective industry. a value of 0.1 was added to the numerator as a placespring 2007 corcoran & shackman: theoretical and empirical analysis 57 holder for those industries having no sites or zero values. histograms, means and standard deviations for these two variables at both the 2 and 3-digit sic level are depicted are depicted in figure i. current data for vpp industry prevalence are available on osha's web site (osha n.d. (b)) at the 2, 3 and 4-digit level. figure 1 histograms and descriptive statistics for dependent variables 2 digit sic dependent variables 3 digit sic dependent variables 14 14 12 12 10 10 sid o~v "-283 stc!. de",,, 2,10 mean =-2.2 me-an" -,84 n"'60,o n=90,o ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ '1 ,co? 0 '<f l() 10 firm variable o 0 0 0 0 0 0 0 0 0 0 0 0 0 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ 0 ~ n m esti'lt>. variable slo. dey" 3.52 mean = -3.7 n = 60.0 20 10 firm variableo 0 0 0 "7 0 .,...n eslab. varii'lble std, dev, " 1.74 mean" 3,25 n '= 90,0 figure i depicts histograms, means, and standard deviationj(jr firm and establishment dependent variablesjijr both the 2 and 3 digit sic comparisons. negative public attention constructs negative public attention [from hypothesis 11: this variable construct was measured based on the amount of bad press a given industry sustained. to operationalize this construct, the number ofnegative press news articles for each industry were analyzed to identify the relative number published over a threeyear span oftime, from 2000 through 2002. these values were tabulated for each industry, then divided by the number of firms and number of establishments in each respective industry, using 0.1 as a numerator place-holder for zero values. articles were randomly selected from two sources, first using a boolean key word search of the umt, proquest data-base which utilized an es&h related key word search string. second, articles were selected from among those collected by www.corpwatch.com.this advocacy group has a research staff that collects 58 journal ofbusiness strategies vol. 24, no. i negative press from various newspapers around the world on a daily basis. in both cases, all bad press articles were included in their respective tallies. in the latter case, a number of articles tied to bad press were included resulting from organizational misconduct unrelated to environmental safety and health. thus, use of these two article sources included constructs that both included and excluded bad press unrelated to es&h. articles were tallied for each industry group at the 2-digit sic code level excluding construction. the 2-digit sic level was chosen due to the nature of newspapers to focus on larger industry sectors (e.g., the 'oil industry') as the focus of their articles and the articles could not subsequently be coded at a more specific level (e.g., 3-digit sic level). community environmental threat (from hypothesis 2): one way in which a facility may pose a threat to a given community can be measured in the amount of toxic substances they release into the environment. the worst, single polluter in each 3-digit sic was identified from among the top 100 polluting companies in each 2-digit sic from the epa's toxic release inventory web page (u.s. epa, n.d.). their total toxic emissions into the environment were recorded as representative of their industry. three, 3-digit industries did not rank in the top 100 of their 2-digit sic. a value equal to the order of magnitude ofthe 100th ranked polluter in their respective 2-digit industries was assigned to these industries (corcoran, 2003). labor dependency / scarcity (from hypothesis 3a]: this was the first of three constructs for gauging relative resource control power of the employee stakeholder group. this variable was measured by determining the number ofthose employed at each vpp site per county population, and then averaging the resulting values for each industry. employee populations were derived from osha's internal vpp data-base. county populations were determined from 2001 census estimates (us census bureau, (n.d. (b)). this variable subsequently reflects the average labor availability for vpp sites in each respective industry. unionization (from hypothesis 3b]: unionization included the proportion of unionized vpp sites in each 3-digit sic industry. unionization was chosen as a variable for measuring the degree of employee resource dependence power in that labor unions provide the employee stakeholder group with collective power the group would not otherwise have. wage (from hypothesis 3c]: wage was determined by dividing the total payroll in each industry by the number of employees in each industry from data obtained from the us census bureau (n.d. (a)). nineteen ninety seven data was used since this appears to be the last year that the sic classification system was used. injury and illness rates, (from hypothesis 4): the total injury and illness rate for each of the industries having vpp companies were obtained from the bureau of labor statistics (bls) from 2001 (bls, 2002) at the 3-digit sic code level. this incidence rate is determined by the number of injuries and illnesses, multiplied by 200,000, divided by the total number of hours worked in the year. spring 2007 corcoran & shackman: theoretical and empirical analysis 59 these rates reflect industry averages and typically serve as a benchmark average for a given industry. these rates also provide an indication of the relative magnitude of the hazards inherent in the work performed in a given industry as compared to other industries. oshaattention to industry ifrom hypothesis 5): this comparison included the number of inspections conducted by osha over one year ranging from march of2002 to march of2003. this information was taken from osha's inspection statistics web page at the 3-digit sic level and was obtained by entering the appropriate sic code on the site. only data from the year previous to the date of entry can be obtained through this internet interface (osha, n.d. (c». analysis the data for the majority of the variables collected for this investigation were not distributed normally. this was particularly true of the dependent variables. all variables except for the variable measuring industry injury rate (coded injurat in this analysis) were subsequently log normalized yielding approximately normal distributions. pearson's correlation and multiple regression analyses were conducted to test the hypotheses. results introduction table i depicts the results from correlation analyses for the 2-digit sic comparisons. recall from hypothesis 1 that the independent variable constructs included the "negative public attention" constructs for both the advocacy group and proquest articles. these variables were coded as advoc and proqu respectively. the dependent variables included firm level and establishment level vpp commitment variables at the 2-digit sic, and were coded firm and estab respectively. these coefficients indicate moderately strong to strong correlations for all possible comparisons between the independent variables and both dependent variables thereby confirming the relationship proposed in hypothesis 1. 3-digit sic comparisons results from the simple correlation analysis for the 3-digit sic comparisons are depicted in table 2. note from table 2 that all major 3-digit sic hypotheses were confirmed through pearson correlation analyses except for hypothesis 4 which predicted a positive relationship between vpp prevalence and injury rate. injury rate, however, was not positively correlated with either dependent variable as anticipated. in fact, a moderate inverse relationship was noted, which will be discussed further in relation to regression results. the construct for measuring community environmental threat (coded as envir), however, indicated a weak to moderate correlation with both dependent variable constructs. likewise, the employee constructs including 60 journal of business strategies vol. 24, no.1 labor dependency, union prevalence and wage (coded labor, unio, and wage) resulted in weak to moderate significant correlations. table 1 pearson's correlation coefficient matrix for 2 digit sic comparisons firm estab advoc proqu firm pearson correlation .952** .800** .816** sig. (2-tailed) .000 .000 .000 estab pearson correlation .694** .721 ** sig. (2-tailed) .000 .000 advoc pearson correlation .864** sig. (2-tailed) .000 proqu pearson correlation sig. (2-tailed) * p < .05 ** p<.oi note: n = 60 table 2 pearson's correlation coefficients for 2 digit sic comparisons for firm and estab dependent variables for 3 digit sic comparisons envir labor osha injurat unio wage firm pearson correlation .432** .281 ** .292** -.474** .434** .288** sig. (2-tailed) .000 .007 .005 .000 .000 .006 estab pearson correlation .394** .277** .349** -.422** .408** .247* sig. (2-tailed) .000 .008 .001 .000 .000 .019 * p < .05 ** p<.oi note: n = 90 spring 2007 corcoran & shackman: theoretical and empirical analysis 61 regression analysis introduction multiple regression analyses were conducted with the variables presented in hypotheses 2 through 5 above. analysis of residuals, tolerances, and tests for linearity between independent and dependent variables indicated that regression assumptions were generally met and multicollinearity was ruled out. the only exception to the regression assumptions was that the unio variable did not have an approximately normal distribution, though analysis of residuals for equations including this variable did not appear to be affected. various combinations of the community, employee and government stakeholder variables were regressed against the firm level dependent variable as depicted in table 3. note that the introduction of the envir variable obscured the contribution of the labor and osha variables (columns / equations 1 & 2). this may be due to shared variation related to employer size as large facilities are more likely to emit large quantities of chemicals, have need for more employees, and are more likely to get the attention of osha. likewise, although not included in this presentation of the results, the addition of the envir variable completely obliterated any contribution made by the wage variable discussed in the previous section. this latter variable was subsequently omitted from the presentation of results. table 3 standardized coefficients for various multiple regression equations for the firm level dependent variable firm firm level 1 2 3 4 5 6 labor .261 * .185 .261 ** osha .273** .166 .355*** .325*** .158 .239* envir .329*** .241** .238** .269** injurat -.599*** -.527*** unio .235** .323** .403*** r2 .153 .243 .565 .550 .303 .245 adj. r2 .133 .216 .544 .529 .278 .227 * p < .05 ** p < .01 *** p < .001 (2-tailed) table 3 depicts standardized coefficients for 6 multiple regression equations. the variables included in each equation are determined by the vertical columns. all regression equations were significant at p < .001. rc values are also provided. 62 journal of business strategies vol. 24, no.1 of particular interest in examining the equations presented in table 3, however, is what happens in the third equation when the injurat variable was added to the mix of variables considered in equation 2. this variable appears to exhibit a unique range of variation considerably increasing the r2 va lue of the equation from .243 in equation 2 to .565 in equation 3. the standardized coefficients of the stakeholder variables are enhanced as well in the latter equation and the standardized coefficient for the injurat variable (-.599) suggests an important contribution for this variable. utilizing other arrangements ofthe stakeholder variables confirm the importance ofthe injurat variable is important for explaining the variation in the dependent variable as evidenced by a marked increase in r2 values when the injurat variable is added. note the comparison, for instance, between equations 4 and 5. in this latter equation the unio construct was used in lieu of the labor construct as the employee stakeholder variable. in essence, therefore, the various equations considered in this post hoc analysis suggest that there is combined explanatory efficacy in using the employee, community, and governmental stakeholder constructs developed in this study. in addition, the inclusion ofthe injurat variable considerably enhances the usefulness ofthese regression equations in predicting vpp industry prevalence. establishment level equations note that the relationships between the various arrangements of independent variables included in table 4, when regressed against the estab dependent variable, are essentially similar to those described in table 3. that is to say, changes in coefficients and significance follow very similar trends between tables. thus, we will limit our discussion to differences between the findings described by the two tables. one of the first marked differences between tables can be noted in equation 2. in table 3, only the envir variable standardized coefficient is significant. in table 4, however, all three variables are significant. however, the contribution to the regression in table 3 of labor and osha were not far from a significance level of .05, and would certainly have been significant at 0.1. indeed, this seems to be the case for all variables that did not appear significant in table 3, but appeared as significant at p < .05 in table 4. perhaps what is of more interest then is the greater level of significance in the envir variable in table 3 as compared to table 4. indeed, this difference in significance is apparent in all regression equations that include this variable. however, it does seem to make sense, and has been previously demonstrated, that companies belonging to industries identified as socially irresponsible (e.g., known for polluting and engaging in other irresponsible activities) would tend to work toward improving their corporate image to separate themselves from the 'bad actors' in their respective industries. the differences between the tables relative to this variable subsequently suggests that the envir variable may be too broad a construct to limit its explanatory value solely to the threat posed to the community due to pollution. rather, it's likely a given industry will receive spring 2007 corcoran & shackman: theoretical and empirical analysis 63 significant poor press from being an excessive polluter, which may also help to account for an increase in vpp companies in that industry. indeed, this may be particularly so relative to multi vpp companies as strategy is undertaken at the corporate level to alter the image of the entire firm as opposed to individual establishments. table 4 standardized coefficients for various multiple regression equations for the establishment level dependent variable estab establishment level 1 2 3 4 5 6 labor .252* .193* .264** osha .330** .246* .424*** .344*** .237* .300** envir .262* .. .179* .108* .210* injurat -.567*** -.497*** unio .224** .306** .369*** r2 .185 .242 .531 .510 .290 .255 adj. r 2 .166 .216 .509 .487 .266 .238 * p < .05 ** p < .01 *** p < .00 i (2-tailed) table 4 depicts standardized coefficients for 6 multiple regression equations. the variables included in each equation are determined by the vertical equations. all regression equations were significant at p < .001. r-' values are also provided. aside from these differences, the trends identified in the two tables were essentially identical and were to be expected given a high degree of correlation noted in pearson's correlations between the two dependent variables (r = 0.96, p < .001). thus, regression analyses for both dependent variables describe a set of relationships where stakeholder power constructs, combined with the injurat variable, help to explain a great deal of variation in the dependent variables. discussion and conclusion discussion one of the most interesting aspects of the findings of this investigation is that all the hypotheses examined were confirmed by correlation analysis save for the injurat variable. this suggests value in the combined use of rot 64 journal ofbusiness strategies vol. 24, no.1 and institutional theory for explaining and predicting the prevalence of beyond compliance safety and health programs within a given institutional field. that is to say, organizations faced with powerful, primary stakeholders that have the potential of withholding or otherwise controlling resources flowing through the firm are compelled to consider strategy designed to preempt such action. this study demonstrates the existence of direct relationships between the prevalence of a given strategy iikely adopted to appease certain stakeholder groups and the relative power inherent in those groups. organizations, of course, need not invest resources to recreate the wheel in developing strategy to address potential concerns ofimportant stakeholder groups, particularly when strategies have been successfully implemented elsewhere within the same or in a similar institutional field. rather, it is more likely organizations will scan the external environment to identify strategies proven successful in a given institutional field in order to match strategy with the institutional environment (elenkov, 1997). hence, mechanisms such as mimesis, coercion, and normative isomorphic paths described by dimaggio and powell (1983) may be helpful in describing or predicting the prevalence of a given strategy within a given field. however, the firm's need for considering a given strategy will be more likely tied to survival and organizational success via the unhindered flow of resources than adoption for the sake of conformance within the field. this perspective is consistent with oliver's (1991) combined theory model. strategy grows from active choice behavior rooted in active agency with the success of the organization in mind. conformance for the sake of conformance in a quest for social legitimacy is insufficient for describing why firms elect to undertake resource intensive beyond compliance initiatives such as participation in vpp. also important to the findings of this investigation are the strong relationships noted between the negative public attention variables and vpp industry prevalence. this finding adds credence to assertions that mimesis is likely to occur in response to uncertainty generated by activism (dimaggio and powell, 1983; shepard et ai., 1997), and that socially responsible programs are likely to occur in tarnished industries as companies seek to set themselves apart from the crowd as exemplars of responsible management (shepard et ai., 1997; king et ai., 2002). examining the question of uncertainty, however, raises the question 'uncertain of what?' and this uncertainty can be ultimately tied to survival and success. what does it matter that a company is accused of malfeasance if there are no repercussions relative to the flow of resources through the firm as a result of powerful stakeholders such as customers, stockholders, and employees choosing to exercise that power? thus, strategies such as vpp participation are ultimately chosen out ofconsideration for powerful stakeholders, though they may be adopted via mechanisms best described by institutional theory. finally, some discussion is warranted of the injurat variable given the significant role played by this variable in the regression results. recall that although the primary stakeholder influence variables utilized in the regression equaspring 2007 corcoran & shackman: theoretical and empirical analysis 65 tions made significant contributions to the overali equation, the addition of the injurat variable predicted a great deal of variation in the dependent variable, and also impacted other relationships in the equation. the role of this variable suggests that vpp participation is more prevalent in safer industries. and given the very limited impact the current low prevalence of vpp participation would have in driving industry rates (corcoran, 2003), it is likely the perceived costs within high rate industries necessary to meet vpp participation standards may preclude vpp as the most cost effective means of gaining stakeholder support. thus, the meat packing industry consisting of plants that employ thousands, experience high turnover, and require thousands of strenuous job tasks preformed by employees working shoulder to shoulder wielding razor sharp knives may be less inclined to consider vpp in their mix of socially responsible programs than the pharmaceutical industry that requires sophisticated control systems already be in place regardless ofvpp participation. conclusion the present study suggests value in a combined theoretical approach for explaining and predicting the prevalence of programs akin to vpp within a given industry. tests utilizing resource dependence based variables, for instance, suggest that stakeholder resource control power influences organizational decision making. companies tend to engage in programs that will reflect them in a positive light in the eyes of more powerful stakeholders. likewise, companies will tend to adopt programs utilized by other organizations within their industries that are believed to be effective in reflecting them in such a light. thus, the tests conducted in the present study suggest that the theoretical approaches of rdt and it compliment one another in helping to explain the proliferation of programs like vpp within industries. one difficulty inherent in the study, however, is the cross sectional nature of its design. this limitation imposed by the data available at the time the study commenced warrants caution when considering the cause and effect relationships supposed in this study. the inability to consider the impact of time and sequence on the relationships between independent and dependent variables limits, to a degree, the inferential value of the tests presented in this paper and makes it di fficult to discern the relative impact of the three primary mechanisms leading to isomorphism proposed by dimaggio and poweli (1983). we are limited, rather, to observing the sum impact of these mechanisms at work. regardless, the crosssectional correlations found in this paper do provide positive evidence of causality, though longitudinal data would provide stronger evidence and would help to establish the relative impact of coercive, mimetic, and normative isomorphic mechanisms in relation to vpp proliferation within industries. finaliy, these limitations do not entirely emasculate the findings of this work. the fundamental theoretical arguments undergirding this research, rather, tend to be supported by the findings. in addition, important relationships ofpractical significance were disclosed providing a foundation for further thought and study. indeed, 66 journal of business strategies vol. 24, no. i the present study provides the strategic management practitioner some insight as to how socially responsible action might be utilized as a strategic tool in dealing with powerful stakeholders. such disclosure provides more overt consideration of the strategic value of beyond compliance programs in the decision making process. in scanning the environment for opportunity and strategic advantage, responsible action now looms as a potential stratagem for gaining stakeholder support due to this and many other studies designed to uncover how and why firms choose the socially responsible path to management. considering these strategic implications in terms of stakeholder resource control power and contemplating likely mechanisms by which industries respond to this power can only help strategic managers in making more conscious, well informed strategic decisions references abernethy, m. a., & fong, c. w. (1996). a field study of control system "redesign": the impact of institutional processes on strategic choice. contemporary accounting research, 13, 569-603. besser, t. l. (1999). community involvement and the perception of success among small business operators in small towns. journal of small business management 37, 1680. bls, bureau of labor statistics. (2002). industry injury and illness data. retrieved august i, 2003 from www.bls.gov/iifioshsum.htm. corcoran, d. j. (2003). the applicability of resource dependence theory and institutional theory to voluntary, beyond compliance occupational health and safety programs. doctoral dissertation, tomo university international. dimaggio, p., & powell, w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48, 147-160. elenkov, d. s. (1997). strategic uncertainty and environmental scanning: the case for institutional influences on scanning behavior. strategic management journal, 18, 287-305. frooman, j. (1999). stakeholder influence strategies. the academy of management review, 24, 191-205. jawahar, j. m., & mclaughlin, g. l. (2001). toward a descriptive stakeholder theory: an organizational life cycle approach. academy 0.( management review. 26,397-414. king, a., lenox, m., & barnett, m. (2002). strategic responses to the reputation commons problem. in a. j. hoffman & m. j. ventresca (eds.), organizations, policy, and the natural environment (pp. 393-406). palo alto, ca: stanford university press. spring 2007 corcoran & shackman: theoretical and empirical analysis 67 levine, s. p., & dyjacka, d. t. (1997). critical features of an auditable management system for an iso 9000-compatible occupational health and safety standard. american industrial hygiene association journal, 5, 291-298. lucas, j. a., avi-itzhak, t., robinson, j. p., & morris, c. g. (2005). continuous quality improvement as an innovation: which nursing facilities adopt it? gerontologist, 45,68-78. manuele, f. (2003). on the practice of safety (3rd ed.). hoboken, nj: john wiley & sons, 369-389. mills, d. (1994). labor management relations (5th ed.). new york: mcgraw-hili. milstein, m. b., hart, s. l., & york, a. s. (2002). coercion breeds variation: the differential impact of isomprphic pressures on environmental strategies. in a. j. hoffman & m. j. ventresca (eds.), organizations. policy. and the natural environment (pp. 151-172). palo alto, ca: stanford university press. osha(a). voluntary protection programs: an osha voluntary program. retrieved may 13, 2005, from www.osha.gov/dcsp/vpplindex.html. osha(b). industries in the vpp federal and state plans as of 3/3 i/2005. retrieved may 13,2005, from www.osha.gov/dcsp/vpp/sitebysic.html osha(c). frequently cited osha standard5. retrieved march 11,2003, from www.osha. gov/pls/imis/citedstandard.html oliver, c. (1991). strategic responses to institutional processes. academy ofmanagement review, 16, 145-179. peng, m. w. (2004). outside directors and firm performance during institutional transitions. strategic management journal, 25, 453-471. pfeffer & salancik. (1978). the external control oforganizations: a resource dependence perspective. new york: harper and row. prakash, a. (2001). why do firms adopt 'beyond-compliance' environmental policies? business strategy and the environment, 10,286-299. prakash, a. (2000). greening thefirm: the politics ofcorporate environmentalism. new york: cambridge university press. scott, r. w. (1995). institutions and organizations. thousand oaks, ca: sage. shepard, 1. m., betz, m., & o'connell, l. (1997). the proactive corporation: its nature and causes. journal ofbusiness ethics. 16, 100 i-i 010. 68 journal of business strategies vol. 24, no.1 skrzycki, c. (2005, august 30). agency alliances with industry growing. the washington post, p. d1. tsai, s. h., & child, j. (1997). strategic responses of multinational corporations to environmental demands. journal of general management, 23, 1-23. u.s. census bureau. numher affirms, number ofestablishments. employment, annual payroll, and receipts by employment size o[the enterprise for the united states, all industries 1997. retreived july, 15, 2003, from www.census.gov/csd/susb/usalli97.xls. u.s. census bureau. state and coun~v quickfacts. data retrieved july, 1993, by searching for county population by vpp site zip code at quickfacts.census.gov/cgi-bin/lookup. u.s. epa. triexplorer. tri values retrieved on july 18,2003, trom www.epa.gov/triexplorer/facility.htm. daniel j. corcoran is the assistant area director of the kansas city area osha office and is an assistant professor of business administration at touro university international. he received his ph.d. from touro university international in business administration and a master of public administration degree at the university of nebraska at omaha, where he also received his b.s. in biology. joshua d. shackman is an associate professor of business administration and health sciences at touro university international. he received his ph.d. from the university of california, los angeles in economics, and his b.a. in economics from the university of michigan. a theoretical and empirical analysis of the strategic value of beyond compliance occupational health and safety programs the unique nature of chinese corporate governance practices van liu louisiana tech university • ruston, la guclu atinc drake university • des moines, ia mark kroll university of texas brownsville • brownsville, tx abstract this study investigates a fairly broad array of factors which may influence chinese corporate governance and examines the relationships between firm age, top management team age, board structure, ownership structure and firm performance in publicly-listed chinese firms. as we anticipated, owing to the unique context of corporate china, results support a negative relationship between firm age and firm performance, a positive relationship between percentage of independent directors and firm performance, and a positive relationship between the presence of foreign blockholders and firm performance. this study also found a positive relationship between the percentages of shares owned by the state as a blockholder and firm performance, but found that neither private nor institutional blockholders influence firm outcomes. results also indicate that the relationship between top management age and firm performance is mediated by firm size. the expected negative relationship between ceo duality and performance and positive relationship between board size and firm performance is not supported. these results indicate that there are some unique features of chinese governance practices that need to be considered by researchers seeking to test the applicability of western theories in the chinese context. introduction in 1949, when mao zedong and his comrades formed the people's republic of china, they probably never imagined that china would one day have a dynamic market-based economy measured in the trillions of dollars. in the early 1990's the transition to a market economy began with the liberalization of business practices, the privatization of small and medium-sized state owned enterprises, and the preparation of large institutions for private ownership. with the transition from state to private ownership have come issues of corporate governance and leadership, as well as the potential for agency problems. 30 journal of business strategies the separation of ownership by principals and decision control by hired managers creates the classic agency relationship, which has long been thought to materially influence the welfare of principals (jensen & meckling, 1976). in a centrally-planned economy, most state owned firms pursue goals other than wealth maximization. the agency relationship and its costs are neglected in such situations as enterprises essentially act as subsidiaries of the only market player, the state. while agency concerns were moot in the communist system, as china has moved toward a market economy, agency problems have become more of an issue (hua, misesing, & li, 2006). today, governance issues commonly confronted by western firms are becoming more and more familiar to both private and partially state-owned chinese firms. we believe there are some unique issues related to corporate governance that need to be considered vis-a-vis chinese firms. researchers suggest that the composition of the board, the experience of the top management team (tmt), the firm's ownership structure and even the firm's history within the transitional economy may affect the performance of newly-formed, for-profit enterprises (sun, li, & zhou, 2005; firth, fung, & rui, 2006a & b, 2007;chen, 2001;wei, lau, young, & wang. 2005). for chinese companies, some of the prescriptions of western literature should hold, while others may not, owing to the unique dynamics of china's business climate where business processes include both western governance practices along with traditional socialist views. china is a rapidly emerging economic power. the widely-held assumption appears to be that this transformation has been proportional to the chinese government's movement toward laissez faire economic policies. it is, however, also possible that a portion of china's success is owing to the government's continued involvement in the private sector--its middle way to privatization of the economy. a better understanding of the unique governance practices of china should be interesting to business scholars, given the increasing importance of china's economy in the global marketplace. this study seeks to explore the unique blend of corporate governance mechanisms employed in china, why they may be so employed, and what their impact is on firm performance. literature review and hypotheses one of the most popular theories of western literature, institutional theory (scott, 1995) talks about firms' legitimization efforts in the eyes of its stakeholders. firms engage in the process of isomorphism and adopt practices due to normative standards, mimicking and coercion (dimaggio & powell, 1983). chinese companies may mimic western counterparts as they seek to integrate themselves into the volume 28, number 1 31 global business community. hence, the greater the western orientation of a chinese company, the better it might perform as such firms are likely to replicate governance practices of successful western counterparts based on the isomorphism concept. in addition, as many chinese companies are exporters to the west and have extensive ties, their inclination to employ western governance practices may well be reflected in their performance. we believe firm age will be one of the main determinants of this orientation and anticipate younger, less bureaucratic firms are more western oriented, more inclined to adopt western governance practices, and perform better as a result. this expectation may run counter to more traditional views, as generally it is assumed that as firms gain experience and size, their cost structures are likely to improve relative to their competitors (hofer, 1975). in the early years, companies learn about their internal and external environment, rationalize processes, adjust to their markets, attract customers to their products, and complete needed investment activities. for these reasons, normally, young companies do not report high profits (biggadike, 1979). however, this situation may not always be the case (hatch & dyer, 2004). stinchcome (1965) argued that "the organizational inventions that can be made at a time in history depend on the social technology available at that time" (p. 153). thus, an organization's performance is, to a degree, a reflection of the environment at the time of founding. baum and shipilov (2006) suggest that during a period of rapid environmental change, opportunities are created for new entrants because they fit the environment well. nevertheless, for established organizations, environmental change can undermine their competitive positions, increase internal friction, and impede action and performance. the market economy in china is now beyond the primitive stage and is still changing rapidly. before the transition began, all chinese companies were owned by the state and had insufficient corporate governance practices. chinese firms that are relatively young are those that have been founded since the transition began. the cultures in these firms have more of a western conceptualization of the firm's purpose and focus more on shareholder wealth creation as the appropriate measure of performance (ralston, gustafson, terpstra, & holt, 1995). compared to older firms, younger firms are likely to be more responsive to shareholder expectations, while older chinese firms retain more of a statist culture. this means that younger firms in china may perform better when compared to older firms (chen, 2001). hence, owing to differences in orientations, firm age should be negatively associated with firm performance for chinese firms. 32 journal of business strategies hi: younger, publicly-listed chinesefirms will outperform older public firms. top management team and firm size demographic characteristics of the top management team may also influence firm performance (hambrick, nadler, & tushman, 1998). wei and colleagues (2005) conducted a series of interviews with chinese executives. as a result of these interviews, they found that according to chinese top managers, executive age plays an important role in determining firm performance. they outlined several reasons for this relationship, but the most important ones are: age facilitating close relationships with the government, accumulation of experience with complex chinese business practices, and less risky behaviors by older executives. their empirical analysis confirms their hypothesis of a positive relationship between executive age and firm performance. going beyond their findings, we propose the executive age-performance relationship to be mediated by firm size. in a high context culture like china, one might expect the interpersonal ties and networking (guanxi) to be central elements of chinese business practices and firm governance (peng & luo, 2000). older executives are obviously more aware of the elements of guanxi, and have more densely developed networks of relationships. furthermore, in a traditionally socialist economy, it is logical to expect larger companies to have tighter connections with the government. larger companies, regardless of their ownership status, would likely want to have strong ties to the government in order to secure the approval of major strategic initiatives, especially given the state's equity interests in so many firms. securing such endorsements may facilitate access to resources and enhance survival prospects. older executives, with their expert knowledge of the gradual development of the chinese economy, may facilitate this relationship. larger companies, with the need to be involved in guanxi, are in a position to more fully utilize these experienced executives. younger firms, by their nature, are not likely to be as actively involved in networks, or guanxi. larger firms are likely to enjoy the benefits of their ties, or guanxi through their experienced executives. granovetter's (1985) explanation of embeddedness in social relationships supports this notion. he argues that most economic behaviors are embedded in networks of interpersonal relations. we believe that older executives should enhance firm performance in a positive way, but this impact will take place only ifthe firm is large enough to facilitate such a relationship. at least in china, we anticipate that larger firms will perform better than smaller volume 28, number 1 33 finns, which may be attributed to more experienced top managers who have cultivated guanxi which is thought to positively affect finn perfonnance (peng & luo, 2000). h 2 : the average age of chinese tmts will be positively related to firm performance, but the impact oftmt age will be mediated throughfirm size. boards of directors a key element of corporate governance is the board of directors, and an important focus of the governance literature is board composition (daily & dalton, 1992). though the results were far from consistent (dalton, daily, johnson, & ellstrand, 1999), a number of studies have demonstrated the impact of board composition on finn outcomes. walsh and seward (1990) propose that outside directors, due to their independence, will do a better job of monitoring and controlling executives who are ultimately responsible for finn perfonnance. for instance, barnhart, marr and rosenstein (1994) and schellenger, wood and tashakori (1989) found a positive relationship between outside directors and finn perfonnance in u.s. finns. in china, the introduction of boards of directors took place after the economic transition began. today, practices such as including outside directors on the board have become commonplace in china. chinese board structure, however, is unique in tenns of the differences in roles of outside directors and independent outside directors vis-a-vis western countries. in the u.s., sarbanes-oxley requires companies to have a majority of outsiders on their boards. the chinese securities regulatory commission (csrc) issued guidance back in 200 i, suggesting publicly listed firms have at least two independent directors on their boards. researchers in the west make the distinction between independent outsiders and gray, or less than truly independent directors (ryan & wiggins, 2004). the role and definition of independent and outside directors in china relative to the west is not always the same, nor are their categorizations so easily made. clarke (2006) contrasts the independent director structure of chinese finns with those of gennan firms. in germany, board members, both inside and outside, have the power to appoint and dismiss members of the management, while in china outsiders theoretically act only as supervisors of the management. the appointment of management is done by the full time inside directors. clarke goes on to explain that in chinese companies, there is a tradition of independent directors not being active in the decision making process, while affiliated outsiders may be. in addition, the traditional western definition of outsiders is not as clearly delineated in china. most of the outsiders in china are actually affiliated with the finn 34 journal of business strategies and are not likely to be strong mitigating factors of agency costs, at least according to western literature (jensen & meckling, 1976). researchers need to make a careful distinction between independent directors and outsiders in chinese finns. by definition, independent directors are those who do not have any affiliation or business ties with the finn whatsoever, and only serve on the board as a director, while outsiders are those who do not hold any executive position with the firm. this means some outside directors may be independent while others maybe affiliated. in the chinese context, companies often specifically report directors as being independent, but it is very hard to detennine the independence of other outside directors not so designated. by western standards, these directors mayor may not be affiliated directors, even though they have not been designated as independent. we believe our focus should therefore be on independent directors and not outside directors. we anticipate finding a positive relationship between independence of boards and perfonnance arising from the percentage of independent directors on the board. the foundation of our hypothesis is the need for independence for better monitoring of executives as previously proposed by western scholars (daily & dalton, 1992; walsh and seward, 1990; barnhart et ai., 1994; schellenger et ai., 1989), recommended by the csrc in china, and mandated by the sarbanes oxley act of2002 in u.s. though clarke (2006) reports independent directors may not be active in chinese finns, the impetus for their involvement may have increased in recent years. adding to the need for more independent board monitoring is the fact that the market for corporate control does not really exist in china, which means this ultimate defense of shareholders' interests, which exists in western economies (harford, 2003), is not available. h3: for chinese firms, the percentage of independent directors on the board will positively influence firm performance. board size board size is another frequently studied corporate governance variable that may relate to finn outcomes. the number of directors on the board is an important predictor variable in several milestone studies (e.g. pfeffer & salancik 1978; jensen, 1986). for instance, dalton et al. (1999) found a positive relationship between board size and firm perfonnance. pearce and zahra (1992) also found a positive relationship between board size and financial perfonnance. there are, however, studies that contradict these findings. eisenberg, sundgren, and wells (1998) found a negative correlation between board size and profitability in small to medium sized finnish finns. according to yennack (1996), smaller boards are more effective in increasing volume 28, number 1 35 the market value of the firm because it is easier for smaller boards to reach agreement and signal change to the market quickly. in a more recent study, cole, daniel and naveen (2008) found that the relationship between firm performance and board size is u-shaped, thus either very small or very large boards are optimal. although both sides of the ongoing debate have empirical findings to support their positions, given the current state of chinese corporate governance practices, we anticipate larger boards being beneficial. hoftstede (200 i) describes china as a culture characterized by large power distance and a collectivist orientation. in large power distance cultures, the acceptance of authority occurs relatively easily. on the other hand, in collectivist cultures, group norms are important and individuals adjust positions within groups and consensus is reached rapidly. since for the chinese it is easier for subordinates to accept the authority of a large number of superiors and those superiors can more easily unite in critical decisions, having large boards in chinese companies should increase firm performance. given the earlier arguments that as the number of monitors increases, the effectiveness of monitoring practices should improve, along with the quality of executive decision making, larger boards should provide better monitoring. as agency theory contends, better monitoring produces better outcomes (booth & deli, 1996; jensen & meckling, 1976). given these expectations, we believe board size should be positively related to firm performance. h 4 : for chinese firms, board size positively affects firm performance. ceo duality ceo duality refers to the same person performing the duties of both ceo and chairman of the board. the debate concerning the merits of ceo duality has been ongoing for some time (desai, kroll, & wright, 2003). some scholars have found its effect to be beneficial for shareholders offirms other than those controlled by families (braun & sharma, 2007). stewardship theory supporters like davis, schoorman, and donaldson (1997) argue that duality creates better performance because single person leadership insures consistency and unity of purpose. on the other hand, agency theorists argue that separation of roles is needed for more efficient corporate practices (rechner & dalton, 1991; jensen & meckling, 1976). in the uk, the cadbury commission report recommended separation of chairman and ceo positions (park, 1994). looking at the issue from an agency theory perspective, we anticipate a negative relationship between duality and firm performance in chinese firms. the dynam36 journal of business strategies ic business environment of a developing economy like china may require input from several sources rather than relying solely on the expertise of the ceo. organizational structures of chinese companies are still adapting to the dynamics of a free-market economy, so for the time being, corporate governance mechanisms may be too weak to control ceos who also chair their boards of directors. executives should be supervised by directors so that the rapid growth of their firms may be monitored. chinese companies with duality situations should conform to agency theory expectations, and we anticipate lower performance to be associated with ceo duality. hs: ceo duality in chinese firms will be negatively related to firm performance. blockholder ownership several scholars hypothesize that the presence of blockholder owners (those owning 5% or more of a firm's stock) positively influence firm performance (jensen & meckling, 1976; hansen & hill, 1991). unlike western companies, in china, traditionally the state is the major blockholder. as a traditional socialist system, which is moving towards a free market economy, the state's impact on the market is still pervasive (li & tong, 2004). in many cases, the state is the major blockholder in publicly-held firms; it gives such firms greater access to additional low-cost funding from the state. as the transition to a market economy has progressed, private sector blockholders with western style financial capabilities have emerged. concentrated ownership may facilitate better monitoring of management; hence provide improved performance (dalton, daily, certo, & roengpitya, 2003). in the west, this concentrated ownership primarily takes the form of institutional or individual blockholder ownership. in china individual or institutional blockholder ownership is also allowed but the state aims to hold a certain interest in the majority of publicly traded companies. with that in mind, rather than looking at concentrated ownership collectively, it is better to look at blockholder positions held by the state separately and anticipate its influence having a positive impact on firm performance. we anticipate that the state does not want to lose its influence owing to its traditional socialist, gradualist mindset. this situation is by itself unique to chinese governance mechanisms. in the west, very few, if any publicly traded companies have government ownership. in china, however, without the state the chance of survival for a company is not high. thus, the state's impact should be analyzed separately. in parallel to that, it seems that a distinction should also be made between private and institutional blockholders to make the appropriate comparison between volume 28, number 1 37 chinese and western companies. in their annual reports, in addition to state owned shares, chinese companies also distinguish between individual shareholders (private owners) and organizations (institutional owners) with 5 percent or more shares. it is possible that, these private and institutional owners may have different affects on the decision making process (chan, ling, & zhang, 2007). we therefore have to consider state, institutional and private blockholder ownership separately in order to explore the unique chinese context. if the contentions of the western literature hold, then concentrated private ownership should result in better performance. if chinese governance practices are unique, distinct impacts resulting from state ownership, relative to private or institutional ownership should be observed. altogether, we anticipate a positive relationship between blockholder ownership and firm performance but expect to observe the above mentioned uniqueness. h6a: the percentage of state blockholder ownership is positively related to firm performance. h6b: the percentage of private blockholder ownership is positively related tofirm performance. h6c: the percentage of institutional blockholder ownership is positively related to.firm performance. foreign ownership today's business environment is global, where the physical boundaries of countries mean little. any company from any part of the world is now pretty much free to sell its products anywhere on the planet. china is one of the world's biggest markets and most dynamic economies (xua, pan, wu, & vim, 2006). this reality results in tremendous foreign investment each year. chinese companies have made great progress in adjusting to global financial markets, and international ownership means more access to external financial markets for funding, and access to the experience of global players. mcguinness & ferguson (2005), who recently studied chinese companies with foreign ownership, were unable to observe any significant effect of foreign ownership on firm performance. we argue that the non-significant results of their study were due to very small sample size (i.e., 66 firms), and because they only studied firms listed on hong kong and american stock exchanges. our larger sample consisting of firms listed on chinese stock exchanges might be more representative of local practices. contrarily, instead of looking at the impact of international shares in absolute terms, 38 journal of business strategies this paper chose to consider the presence of international owners with 5 percent or more shares in the company as a governance mechanism impacting firm performance. in their annual reports, chinese companies report the amount of international ownership. the reported international ownership is in either b-type or h-type shares. firms with over 5 percent foreign blockholder ownership may be considered to be influenced by foreign investors. regardless of the type of shares, these international owners have a stake in the focal companies and probably monitor their interests. for that reason, the presence of international blockholder ownership may have consequences for firm outcomes. local knowledge combined with global expertise may produce positive outcomes for shareholders. we propose that international blockholder ownership in chinese publicly listed firms with mixed ownership will have a positive impact on firm performance. h7: for chinese .firms, the presence of international blockholders should be positively related to performance. figure 1 represents the above discussion and table 1 summarizes the above discussion concerning the hypothesized relationships within the chinese context and its comparison to the western context (firm performance is the dependent variable): temporal variables executive age (h 1 -) temporal variables firm age (h 2 +) board characteristic variables: proportion of independent directors (h 3 +) total of directors (h4+) duality (h 5 +) ownership variables: state ownership (h 6a +) private ownership (h6b +) institutional ownership (h6c +) international ownership (h7+) figure 1 firm performance -measures: roa ros table 1 ~ comparison between the chinese context and the western context -;: ~ f1l independent note expected relationship in chinese and western contexts tv 00 hypotheses variable chinese western ~ ~ h1 firm age negative better established, more experienced firms are known to have better ~ chances of survival. ~ f1l ""! ..... h2 average mediated by positive experienced executives can be considered as valuable resources but tmt age firm size the mediation effect of firm size and the deep impact of guanxi (chinese network) is not tested. h3 percentage of positive independence is known to have a positive impact on firm outcomes but independent sarbanes oxley requires companies to have an independent majority directors on the board so the impact of independence cannot easily be observed anymore h4 board size positive findings are mixed; cultural effects may show differences in china. h5 duality negative long-time, ongoing debate. in a dynamic environment like china, input from multiple sources is hypothesized to have a positive impact on firm outcomes. h6a, h6b, h6c blockholders positive state ownership is not considered. private and institutional ownership are known to have a positive impact on firm performance. h7 presence of only positive more multinational investors are present in the west as the business international blockholders practices are more integrated. the presence of international blockholders blockholders are considered in china is hypothesized to have a positive impact on firm performance due to their expertise in the global business arena and access to financial resources. w <0 40 journal of business strategies methodology sample the sample for our study comes from publicly available data for listed chinese companies in 2004. the initial data was extracted from multiple sources which include: sina.com a leading online media company and value-added information service provider for china and for global chinese communities, the official websites of the shanghai stock exchange and the shenzhen stock exchange, and the china stock market and accounting research database (csmar). most data collected from these sources came from annual reports published in the china securities regulatory commission official newspapers, which are the shanghai securities daily and the securities daily. the total number of chinese companies listed on these two exchanges was 1,293 as of december 31 st, 2004. we collected data for 650 randomly chosen companies to form our sample. out of these 650 companies, we exclude companies which lack data needed or lack valid audit reports, and ended with a final sample of 635 firms. the total number of firms with non-zero state ownership was 539 and the total number of companies with foreign ownership was 123. in order to account for sample bias, we conducted analysis of variance using roa, roe, ros and firm age variables between the companies included and not included in our study and did not observe any significant differences between the two groups. additionally, given that better performing firms may be able to attract more outside board members, as well as foreign investors, we felt it important to use lagged performance measures in order to address the issue of reverse causality. variables dependent variables, firm performance: there have been a number of measures of firm performance used in the management literature. selected studies of chinese companies typically employed return on sales (ros), return on assets (roa), changes in sales, and tobin's q to measure firm performance (firth et ai., 2006a and 2006b). corporate governance-related studies involving performance have relied on profit-based indicators such as roa and market based measures, such as tobins's q (wright, kroll, lado, & elenkov, 2005; ocasio, 1994). we also choose to use profit-based performance indicators, including return on assets (roa) and return on sales (ros) because they are less susceptible to manipulation by managers (firth et ai., 2006a). in order to observe the impact of various corporate govervolume 28, number 1 41 nance mechanisms on performance, we chose to use one year lagged performance measures (2004 independent variables regressed on 2005 performance measures). independent variables: three categories of independent variables are employed in our study: our temporal variables include firm age and average age of the top three executives. firm ages represent the total number of months since firm founding as of december, 2004. the tmt age variable is the average age of the top three executives as reported in the 2004 annual report. board characteristics variables include the proportion of independent directors, total number of directors on the board, and ceo duality. the proportion of independent directors is calculated as the number of such directors divided by the total number of directors. duality is coded as a dummy variable, which has a value of i if the chairperson of the company is also the ceo of the company and has a value of 0 otherwise. ownership variables include the percentage of shares owned by state, private, and institutional blockholders. a dummy variable was used to represent the presence of international blockholders as we hypothesized international blockholders presence to have a positive impact on firm performance. the two non-state blockholder groups, individuals or institutional owners who own at least 5% of the company's stock, are represented by the percentage of shares outstanding they control, while state ownership is represented in the same manner. to test hypothesis 2, we also included the log of sales for 2004 as a proxy of firm size which has been used in many previous studies (e.g. dalton et ai., 1999). this data was gathered from company annual reports or csmar as reported in chinese yuan. a logarithmic transformation was used to account for potential normality issues. control variables: while we anticipate the above variables might affect firm performance, we recognize that industry conditions may also have an affect on firm performance. we therefore include five dummy variables as control variables to indicate six categories of industry (i.e. finance, information technology, utilities, transportation, energy, and others). in addition, we also added a dummy variable to represent the situations in which the state is the largest shareholder to account for the state's impact on firm performance in such companies, we also included a variable to represent the number of years since the initial public offering of the company to account for the potential impact of the ipo process on firm performance. 42 journal of business strategies analytical method the method we use to analyze our data is least squares multiple regression. we estimated the following four models to test our hypotheses hi' h 3 , h 4 , h 5 , him' h 6b , h 6c ' and h7 respectively. model 1 (control variables): roa/ros = /3 0 + /3 1 information technology + /3 2 finance + /3, utilities+ /3 4 transportation + /3 5 energy + /3 6 state as the largest shareholder + /37 years since ipo + e model 2 (temporal variables): roa/ros = /3 0 + /3 1 information technology + /3 2 finance + /3 3 utilities + /3 4 transportation + /3 5 energy + /37 state as the largest shareholder + /3r years since ipo + /39 firm age +e model 3 (board characteristics variables): roa/ros = /3 0 + /3 1 information technology + /32 finance + /33 utilities+ /34 transportation + /3 5 energy + /3 6 state as the largest shareholder + /37 years since ipo + /3 8 ceo duality + /3 9 percentage of independent directors + /310 total directors + e model 4 (ownership variables): roa/ros = /3 0 + /3 1 information technology + /32 finance + /33 utilities + /34 transportation + /35 energy + /3 6 state as the largest shareholder + /37years since ipo + /3 8 presence of international blockholdership + /3 9 percentage of shares owned by state blockholder + /310 percentage of shares owned by private blockholder + /3 11 percentage of shares owned by institutional blockholder + e; as hypothesis h2 proposes that the impact of tmt age on firm performance will be mediated through firm age, we undertake a mediated regression analysis suggested by baron and kenny (1986). results table 2 includes the means and standard deviations of our measures of the dependent and independent variables. pearson's correlations are also shown in table 2. some variables are correlated, but in our estimated regression models, none of the variance inflation factor statistics exceeded 2 so multicollinearity is not a major problem in our models. , table 2 ~ descriptive statistics and pearson's correlations -~ ~ "" variables means s.d. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 tv 00 ~ 1 . log of sales 2004 ~ 9.16 .58 ~ ~ "" 2. dummy it 0.05 .21 001 ""i ~ 3. dummy finance 0.02 .12 0.00 -003 4. dummy utility 0.06 .23 -.09' -0.05 -0.03 5. dummy transportation 0.01 .11 -.11" -003 -001 -0.03 6. dummy energy 0.01 .11 .10' -0.04 -0.02 -0.03 -0.01 7. dummy representing state as the largest shareholder 0.76 .43 .10' -.11" -.11" .on 0.06 0.01 8. number of years since ipo 6.39 3.15 0.01 -001 0.03 .13" -0.04 .01' -.12" 9. firm age 113.9 44.50 -0.04 0.03 .12" -0.03 0.03 -.11" -.20" .6r' 10. average tmt age 49.22 502 .34" -0.04 .08' -002 0.01 0.04 .14" -0.06 -0.08' 11. duality 0.1 .29 -0.01 -0.q2 -0.04 -0.01 0.06 -004 0.01 -0.02 0.04 -002 ~ w table 2 descriptive statistics and pearson's correlations cont'd. variables means s.d. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 12. percentage of independent directors 0.34 .05 0.05 0.02 0.04 0.02 0.06 -0.02 -0.07 -0.01 0.06 -0.04 0.05 13. total number of directors 10.08 2.37 .13" -0.03 .22" .12" -0.03 0.05 0.04 .10' -0.06 .09' -0.02 -.11" 14. presence of international blockholdership (dummy) 0.18 .38 .24" -0.03 0.01 -006 -0.05 0.01 -0.09 .17" .17" .14" -0.01 002 .10' 15. percentage of shares owned by state blockholder 41.2 25.06 .13" -.10 -.14" .08' 0.07 0.0281" -.25" -.36" .18" -006 -0.06 0.01 -.14" 16. percentage of shares owned by private blockholders 2.26 8.32 .08' 0.05 0.03 -.on -003 -0.03 -.20" -.078t -0.01 .10' -0.05 005 -0.01 .36" _.19" 17. percentage of shares by instititional blockholders 12.15 19.74 -.14" 0.06 0.04 -003 -0.06 0.02 -0.79" 0.06 .11" -.19" 0.02 0.02 -002 -0.03 -.77" -on 18. return on asset (2005) -003 .25 .18" -008t 0.00 0.05 0.03 0.05 .20" -004 _.13" .12" 0.00 0.02 .072t 0.06 .21" 0.03 -.17" 1 9. return on sales (2005) -0.0969 .21" -0.05 0.03 0.05 0.05 0.03 .12" -0.07 -.11" .14" 001 .15"076t 0.07t .170" 003 -.14" .58" n= 619-633 tp <.10 'p < .05 "p <.01 19 -"" -"" ~ ~ ""! ;:: ;:. ~ ~ ~ .,. .... ;:: "' .,. .,. vl ..... ~ ..... ~ .... "' .,. table 3 ~ regression analysis of modell to model 4 with roa (2005) and ros (2005) as dependent variables -~ ;l ~ modell model 2 model 3 model 4 n 00 variables roa ros roa ros roa ros roa ros ~ ~ dummy it -.052 -.030 -.047 -.026 -.052 -.032 -.045 -.24 ;l '="' ~ dummy finance .023 .042 .038 .050 .007 .017 .040 .056 '"t ..... dummy utility .031 .033 .042 .042 .022 .016 .036 .038 dummy transportation .017 .039 .028 .047 .017 .030 .020 .040 dummy energy .052 .028 .046 .024 .050 .030 .049 .025 dummy representing state as the largest shareholder .198*** .109** .181 *** .096* .198*** .117** .156* -.056 number of years since ipo -.008 -.044 .102t .036 -.002 -.036 .026 -.019 firm age -.165** -.119* duality .000 .001 percentage of independent directors .036 .166*** number of total directors .060 .079t presence of international blockholdership (dummy) .074t .091* .jo>. (jl table 3 regression analysis of modell to model 4 with roa (2005) and ros (2005) as dependent variables cont'd. variables percentage of shares owned by state blockholder percentage of shares owned by private blockholder percentage of shares owned by institutional blockholder model f statistic model r2 ~r2 model 1 roa ros 4.552*** 1.996t .050 .022 n= 619-633 tp < .10 * p < .05 **p < .01 model 2 roa ros 5.174*** 2.328* 0.064 0.030 .014** .008* ***p < .001 model 3 model 4 roa ros roa ros .210* .235** .091t .033 .124 .008 3.434*** 3.314*** 4.110*** 2.723** 0.054 0.052 0.069 0.047 .004 .03** .019* .025* "'" cj) ~ ~ ;:: ;:. ~ 1:0 ~ ii> ;i' ... ii> ii> c/:j ..... ~ ..... ~ . ... ii> volume 28, number 1 47 tests of hypotheses h11 h3' h4' h!j1 h6a' h6b, h6c and h7 table 3 includes regression results of our tests of hypotheses hi' h3, h4 , hs' h 6a , h 6b , h6c and h7 (h2 results are reported separately), as mentioned above, four models are used to test the hypotheses, and regression results are reported for these models with return on assets (roa) and return on sales (ros) as dependent variables respectively, hi is supported in terms of the regression results of model 2, the relationship between firm age and our two measures offirm performance, roa (2005) and ros (2005), are significantly negative (roa: [3= -.165, p < .01; ros: [3= -.119, p < .05). these results support our expectation that younger, publicly-listed chinese firms outperform older public chinese firms. the regression results of model 3 are also reported in table 3. h3 focused on the positive impact the percentage of independent directors might have on performance. this hypothesis is not supported when roa serves as the dependent variable, but we found significant support when ros was used as the dependent variable (roa: [3= .036, p > .10; ros: [3= .166, p < .001). hence, we have partial support for h 1 . h 4 , which anticipated a positive relationship between the total number of directors and performance, is not supported for roa and received only marginal support when ros served as the dependent variable (roa: [3= .060, p> .10; ros: [3 = .079, p < .10). these results provide only limited support for h 4 . hs' which considers the impact of duality, is not supported in the context of either dependent variable. the results of model 4 which tests h 6a , h6b hoc and h7 are reported in table 3 as well. the positive impact of state blockholder ownership hypothesized in h6a received strong support in both of the models (roa: [3= .210, p < .05; ros: f3 = .235, p < .0 i). hoc which considered institutional blockholders, received no support in either of the models, and hob which anticipated private blockholder ownership would have a positive impact on performance received marginal support only in the roa model (roa: [3 = .091, p < .10; ros: [3 = .033, p > .10). finally, h 7 , which considered the impact of international blockholder ownership on performance received marginal support when roa served as our dependent variable, and is supported when we used ros (roa: [3= .74, p < .10; ros: [3= .091, p < .05). in short, we were able to find support for both state and international blockholder ownership positively influencing firm performance. table 4 .i>-(xl hierarchical regression for testing hypothesis 2 dependent variable roa (2005) or ros (2005) dependent variables step 1 step 2 step 3 independent variables log of sale 2004 roa ros roa ros roa ros dummy it .027 -.052 -.030 -.050 -.028 -.054 -.033 dummy finance -.019 .023 .042 .014 .032 .017 .030 dummy utility -.087* .031 .033 .034 .037 .048 .055 dummy transportation -.119** .017 .039 .017 .039 .037 .064 dummy energy .089* .052 .028 .045 .020 .030 .001 dummy representing state as the largest shareholder .069t .198*** .109** .185*** .091 * .174*** .077t number of years since ipo .034 -.008 -.044 -.004 -.039 -.010 -.047 'c" average tmt age .331 *** .090* .117** .038 .052 ;: ~ ;:: ;:. log of sales 2004 .163*** .202*** ~ model f statistic 13.792*** 4.552*** 1.996t 4.644*** 2.809** 5.880*** 5.094*** o:;j ;: '" ... model r2 .150 .050 0.022 .057 .036 .080 .070 ;:: ... '" '" ~r2 .007* .014** .023*** .034*** v:l ..... ~ ;:. ..... n = 619-633 tp < .10 * p < .05 **p < .01 ***p < .001 ~ ... ... '" volume 28, number 1 49 test of hypotheses h2 as shown in table 4, evidence of mediation exists because the average tmt age is significantly associated with the hypothesized mediator, log of sales for 2004, in the first step (f3= .331, p < .001); the average tmt age affects both dependent variables, roa and ros, in the second step (roa: f3 = .090, p < .05; ros: f3 = .117, p < .05); and in the third step, log of sales for 2004 affects performance (roa: f3 = .163, p < .001; ros: f3 = .202, p < .001), and the effect of average tmt age on firm performance decreases significantly from the second step (from significant to insignificant at any meaningful level). therefore, h2 is supported. discussion agency theory has been tested in western countries for many years. the universal applicability of agency theory has been questioned by a number of scholars (e.g. dalton, et. ai, 2003; lane, cannella, & lubatkin, 1998). our research tests several agency theory assumptions in china's unique cultural and economic context, and provides insights regarding the effects of boards and ownership configurations on firm performance for chinese publicly listed companies. china's market economy reform process has been experimental and gradual. since this reform started in 1978, there has been remarkable growth in the chinese economy. by the beginning of the 1990's, hundreds of companies were privatized and stock exchanges were opened (sun et ai., 2005). privatization and the possibility of trading shares introduced the chinese economy to western business practices. while newly formed firms were growing rapidly, traditional socialist firms exhibited relatively slow progress. our first hypothesis proposed that younger firms would outperform older firms. our logic was that younger firms would be newly formed, western oriented, profit seeking entities, while older ones would still be in the early stages of the corporate governance improvement process. the statistical results reported confirm this logic. in the west, one might expect better performance from a well established, more experienced company, especially in light of the accountingbased performance measures we employ. our results indicate that this is not the case in china. younger chinese firms seem to be better prepared for the dynamic global business environment. as the chinese economy progresses, researchers may observe the reverse in the future. for the time being, this finding represents a unique feature of chinese corporate reality. the other temporal variable tested was the average age of the top executives. our starting point was to test the impact of tmt ages on firm outcomes because 50 journal of business strategies demographic characteristics of the top management team may also influence firm performance (hambrick, nadler, & tushman, 1998). nevertheless, we were also aware of the wide range of sizes of publicly-traded chinese firms. our suspicion was that the demographics of the executives would be influenced by company size; that larger companies would attract the more experienced professionals as they addressed their need to have active ties with the chinese business and social network (guanxi). in high context cultures like china, network relationships are more important than in western ones. researchers in the area have acknowledged the importance of guanxi in firm outcomes of chinese companies (peng & luo, 2000). if these close ties are of vital importance, then the executives with the densest network of relationships are valuable resources for chinese companies. we anticipated larger firms to have more of these executives for several reasons. first, larger firms may be more attractive to older executives because they can offer more stable and powerful positions to those people rich in social resources. second, in china, people prefer to work for a company for a relatively long time. additionally, in larger firms, it takes longer for managers to ascend to the top of their companies. at the same time, when managers stay with a firm for a long time, they can develop strong network ties in that industry, obtain more experience in the industry, and cultivate the ability to attract more resources. thus, executives heading larger firms likely have more network access, along with more political and market knowledge which they employ to enhance firm performance. in statistical terms, these relationships can be explained by the mediation effect of firm size on the relationship between executive age and firm performance. in other words, we hypothesized experienced executives would have a positive impact on firm outcomes but only if the relationship is facilitated with the appropriate firm size. controlling for such factors as the state being the largest stockholder, the number of years since ipo and industry effects, our results supported this contention. to our knowledge, this relationship has never been tested either in the chinese or western context and should be of interest to studies of corporate governance both in china and other countries. there is an ongoing debate as to whether board configurations affect the performance of chinese companies (tian & lau, 1997; he & wang, 2000). especially in the case of independent directors, many researchers have argued such directors have no effect on firm performance in china because of the restrictions on independent directors in the performance of their duties. even though independent directors only made up 20% to 30% of the boards, we found that 99.7% of the companies in our sample had at least 1 independent director on their boards in 2004. those independent directors included such persons as business experts, professors, or retired government officers who may be able to provide helpful suggestions and monitoring volume 28, number 1 51 (pfeffer & salancik, 1978). in collecting our data, we found some companies even reported the varying opinions independent directors had regarding issues confronting their firms. in contrast to previous studies conducted in 1996, 1997 and 2000 (clarke, 2006), which found no relationship between independent directors and firm performance, we observed a significant positive relationship with one of our dependent variables. based on our results we can say that chinese companies with more board vigilance profit more from their sales. this finding is parallel to one of the fundamental propositions of agency theory. in the u.s., publicly traded companies are now required to have a majority of independent board members, though the evidence of outsiders' presence producing better performance is scant. in china, at least for the time being, independent directors seem to positively influence performance with regard to return on sales. the total number of directors on the board proved only marginally related to firm performance. scholars seem to argue both ways concerning the effect of board size. some anticipate larger boards result in better monitoring, while others see large boards as a source of distraction. in supplemental analyses not reported, we observed a positive link between the number of directors and firm performance when state ownership was not controlled. once we controlled for state blockholder ownership, the number of directors lost its significance. it appears state oversight may trump board control in chinese firms. our results hint at the possibility that board size is context specific and should be further examined in different contexts in chinese firms. expectations concerning the impact of ceo duality on firm performance differ among scholars. agency theory perspectives dominate this research, so our discussion of duality adopted the agency perspective. we therefore expected companies with duality configuration to perform less well. our findings did not support this view. given we found neither a positive nor negative relationship between ceo duality and firm performance, it appears in the chinese corporate setting duality is not as much an isuues as it is in the west. our findings related to the ownership structure of chinese companies illustrate the uniqueness of chinese corporate governance mechanisms. in the west, concentrated ownership, either in the form of private or institutional blockholder ownership, has been shown to have a positive impact on firm outcomes (dalton et ai., 2003). the logic behind these findings is that blockholders will be more inclined to monitor firms in which they are so heavily invested. in china, at least according to our results, neither private nor institutional blockholders are able to influence firm performance. rather, the state is still the major player (li & tong, 2004). the results 52 journal of business strategies indicate that, unlike the situation in western economies, the state is still a catalyst for success in china. these results also reveal that business practices in china are still deeply affected by its statist views. in a traditional socialist economy, the state is the major, ifnot the only player in the market. in today's china, while it is known to be on its way to becoming a free market economy, the state still has ubiquitous influence over corporate china. in addition to state, private, and institutional blockholdership, we also examined the impact of the presence of international blockholders on firm outcomes. we expected a positive relationship between the presence of international blockholders and firm outcomes. given the country's growth rate, foreign companies are competing with each other for access to this market. at the same time, for chinese companies to grow they must tap fresh financial resources which foreign companies can often access. in addition, chinese companies still need the competence and expertise offoreign firms in order to compete in the international arena. our hypothesis concerning foreign ownership was based on these two needs. in addition, chinese companies with international ownership should enjoy more exporting opportunities. china is one of the few countries in the world with a foreign trade surplus. it has a competitive advantage in many of its product categories. our results indicate that, unlike private and institutional ownership, when international blockholders are present in the ownership structure, chinese companies performed better. in free market economies, most international investors would be reluctant to invest in companies with state blockholders. in the chinese context, it seems international investors are well aware of the market mechanisms of china concerning the state's presence. these international owners, together with the state, positively influence firm performance. it once again illustrates the uniqueness of chinese companies, which blend local knowledge, the power of the state, and global expertise together. like all studies, our research has its limitations. the period of our study is confined to a single time frame and does not reflect longitudinal changes. although measuring changes in corporate governance and firm performance in the long run was beyond the scope of this study, a future direction for researchers would be to verify or contradict our findings using firm performance and corporate governance data over several years. the second limitation is that we only studied publicly-listed companies. it is possible that the "new firms" studied here may be "old new firms" which are late in the process of emergence (baum & shipilov, 2006). since most firms listed on china's exchanges were reorganized and reformed from old state owned firms, they may report the day they were reformed, reorganized, or publiclylisted as their founding date, although their initial formation date may go back for volume 28, number 1 53 some time. baum and shipilov (2006) suggested that "if researchers were able to obtain data on organizations earlier in the founding process, liability of newness findings might be stronger" (p. 67). third, our dependent variables may be criticized for not being representative of the market perceptions about these companies. firm performance variables like tobin's q and holding period returns may be used for future researcher to replicate our results. we anticipated that chinese stock markets are different from their western counterparts. in the west, rampant speculation in the stock markets is less likely to occur. in developing nations, due to the vulnerability of markets to periods of severe speculation, stock prices are considered to be less representative of real value of the firms (zhang, sun and wang, 2008). conclusion in summary, we were able to explore the uniqueness of chinese corporate governance practices with regard to ownership and temporal variables. in addition, we were able to demonstrate the mediation effect offirm size on the relationship between executive age and firm performance. our results suggest that while younger firms are more successful in china, the state is still the dominant player and will likely be so for some time. unlike the west, private and institutional ownership do not make that much of a difference in terms offirm performance. in addition, duality and board size are not determining factors while board vigilance has minimal impact. on the other hand, international ownership is as important as state ownership and larger companies enjoy the benefits of hiring executives imbued with guanxi. in closing, as global business practices are still relatively diverse, both researchers and practitioners should be alert to differences in governance practices across different societies. references barnhart, s., marr, m., & rosenstein, s. (1994). firm performance and board composition: some new evidence. managerial and decision economics, 15(4),329340. baron, m. r., & kenny, a. d. (1986). the moderator-mediator variable distinction in social psychological research: conceptual, strategic, and statistical considerations. journal of personality and social psychology, 51(6), 1173-1182. baum, 1., & shipilov, a. (2006). ecological approaches to organizations. in clegg, hardy, lawrence, & nord (eds.). the sage handbook of organization studies. london: sage publications. 54 journal of business strategies biggadike, r. (1979). the risky business of diversification. harvard business review, 57(3), 103. booth, j. r., & deli, d. n. (1996). factors affecting the number of outside directorships held by ceos. journal of financial economics, 40, 81-104. braun, m., & sharma, a. (2007). should the ceo also be chair of the board? an empirical examination of family-controlled public firms. family business review, 20(2), 111-126. clarke, d. c. (2006). the independent director in chinese corporate governance. delaware journal of corporate law, 3i (1), 125-228. coles, j. l., daniel, n. d., & naveen, l. (2008). boards: does one size fit all. journal of financial economics, 87(2),329. csrc. (2001). guidelines for introducing independent directors to the board of directors of listed companies. china securities regulatory commission. chan, k. h., lin, k. z., & zhang, f. (2007). on the association between changes in corporate ownership and changes in auditor quality in a transitional economy. journal of international accounting research, 6( i), 19-36. chen, j. (2001). ownership structure as corporate governance mechanism: evidence from chinese listed companies. economics of planning, 34, 53-72. daily, c., & dalton d. (1992). the relationship between governance structure and corporate performance in entrepreneurial firms. journal of business venturing, 7,375-386. dalton, d., daily, c., johnson, j., & elistrand, a. (1999). number of directors and financial performance: a meta-analysis. academy of management journal, 42(6), 674-686. dalton, d., daily, c., certo, t., & roengpitya, r. (2003). meta-analysis of financial performance and equity: fusion or confusion? academy of management journal, 46(1), 13-26. davis, j. h., schoorman, f. d., & donaldson, l. (1997). toward a stewardship theory of management. the academy of management review, 22(1), 20-47. desai, a., kroll, m., & wright, p. (2003). ceo duality, board monitoring, and acquisition performance: a test of competing theories. journal of business strategies, 20(2), 137-156. dimaggio, p., & powell, w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48, 147-160. eisenberg, t., sundgren, s., & wells, m. t. (1998). larger board size and decreasing firm value in small firms. journal of financial economics, 48, 35-54. volume 28, number 1 55 firth, m., fung, p., & rui, m. o. (2006a). corporate performance and ceo compensation in china. journal of corporate finance, 12, 693-714. firth, m., fung, p., & rui, m. o. (2006b). firm performance, governance structure, and top management turnover in a transitional economy. journal of management studies, 43, 6. firth, m., fung, p., & rui, m. o. (2007). how ownership and corporate governance influence chief executive pay in china's listed firms. journal of business research, 60, 776-785. granovetter, m. (1985). economic action and social structure: the problem of embeddedness. american journal of sociology, 3,481-510. hatch, n., & dyer, 1. h. (2004). human capital and learning as a source of sustainable competitive advantage. strategic management journal. 25(12), 11551178. hambrick, d., nadler, d., & tushman, m. (1998). navigating change: how ceos. top teams. and boards steer transformation. boston: harvard business school press. hansen, g. s., & hill, c. (1991). are institutional investors myopic? a timeseries study of four technology-driven industries. strategic management journal, 12(1), 1. harford, j. (2003).takeover bids and target directors' incentives: the impact of a bid on directors' wealth and board seats. journal of financial economics. 69(1), 51-83. he, w. t., & wang, j. q. (2002). woguo duli dongshi zhidu de shizheng fenxi [an empirical analysis of china's independent director system]. calma 0 jingji, 9,61-64. hofer, c. w. (1975). toward a contingency theory of business strategy. the academy of management journal, 18(4), 784-810. hofstede, g. (200 i). culture's consequences: comparing values. behaviors. institutions. and organizations across nations. thousand oaks, ca: sage publications. hua, j., miesing, p., & li, m. (2006). an empirical taxonomy of soe governance in transitional china. journal of management and governance. 10(4),401-433. jensen, m. c., & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3,305360. jensen, m. c. (1986). agency costs of free cash flow, corporate finance and takeovers. american economic review, 76(2),323-329. 56 journal of business strategies lane, p. j., cannella, a. a., & lubatkin, m. h. (1998). agency problems as antecedents to unrelated mergers and diversification: amihud and lev reconsidered. strategic management journal, 19,555-578. li, k., & tong, l. (2004). chinese industrial policy and the reduction state-owned shares in china's listed companies. pacific economic review. 9(4),377-393. mcguinness, p., & ferguson, m. (2005). the ownership structure of listed chinese state-owned enterprises and its relation to corporate performance. applied financial economics, 15(4),231-246. ocasio, w. (1994). political dynamics and the circulation of power: ceo succession in u.s. industrial corporations, 1960-1990. administrative science quarterly, 39(2), 285. parker, h. (1994). the chairman/ceo separation: view one. directors and boards, 18(3),42,44+. pearce, j. a., & zahra, s. a. (1992). board composition from a strategic contingency perspective. the journal oj management studies, 29(4), 411. peng, m. w., & luo, y. d. (2000). managerial ties and firm performance in a transition economy: the nature of a micro-macro link. the academy of management journal, 43(3),486-501. pfeffer, j., & salancik, g. r. (1978). the external control of organizations: a resource-dependence perspective. new york: harper and row. ralston, d. a., gustafson, d. j., terpstra, r. h., & holt, d. h. (1995). pre-post tiananmen square: changing values of chinese managers. asia pacific journal oj management, 12(1), 1-. rechner, p. l., & dalton, d. r. (1991). ceo duality and organizational performance: a longitudinal analysis. strategic management journal, 12(2), 155. ryan, h. e., & wiggins, r. a. (2004). who is in whose pocket? director compensation, board independence, and barriers to effective monitoring. journal oj financial economics, 73(3),497-524. schellenger, m. h., wood, d. d., & tashakori, a. (1989). board of director composition, shareholder wealth, and dividend policy. journal oj management, 15(3), 457-467. scott, w. r. (1995). institutions and organizations. thousand oaks, ca: sage. shanghai stock exchange. retrieved from www.sse.com.cn. shenzhen stock exchange. retrieved from www.szse.cn sina finance. retrieved from finance.sina.com.cn. stinchcome, a. l. (1965). social structure and organizations. in j. g. march (ed.), handbook ojorganizations.chicago: rand mcnally, 153-93. volume 28, number 1 57 sun, l., li, t., & zou, l. (2005). state ownership, corporate performance, and parameter heterogeneity: a quantile analysis on china's listed companies. journal of economics, discussion paper 60. tian, j. j., & lau, c. m. (200 i). board composition, leadership structure and performance in chinese shareholding companies. asia pacific journal of management, 18, 256-260. walsh, j., & seward, j. (1990). on the efficiency of internal and external corporate control mechanisms. a cademy of management review, 15(3), 421-458. wei, l., lau, c., young, m., & wang, s. (2005). the impact oftop management team demography on firm performance in china. asian business and management, 4,227-250. wright, p., kroll, m., lado, a., & elenkov, d. (2005). influences of relative rewards of top managers on firm performance. strategic organization, 3,311-335. xua, d., pan, y., wu, c., & vim, b. (2006). performance of domestic and foreigninvested enterprises in china. journal of world business, 41(3),261. yermack, d. (1996). higher market valuation of companies with smaller board of directors. journal of financial economics, 40, 185-211. zhang, z., sun, w., & wang, h. (2008). a new perspective on financial anomalies in emerging markets: the case of china. applied financial economics, 18(21), 1681. biographical sketch of authors van liu is a doctoral candidate of management in the department of management and information systems at louisiana tech university. she received her m.b.a from louisiana tech university in 2009 and her b.s. in computer science from nanchang university in china. in 2006, van liu joined the management doctoral program at louisiana tech university as a student and teaching assistant. during her five years of study in management doctoral program, she has developed a broad range of research interests, including proactive behavior, leadership, organizational justice, deviance behavior as well as corporate governance mechanisms of chinese organizations. guclu atinc is an assistant professor of management at drake university. his current research interests are in the area of upper echelons and boards of directors in young entrepreneurial firms and on the impact of environment in strategic decision making. his research appeared in journals like organizational research methods and journal of managerial issues. 58 journal of business strategies mark kroll is the dean of the college of business at the university of texas at brownsville. he received his d.b.a. from mississippi state university. his research interests include firm governance and strategic leadership of entrepreneurial firms. the unique nature of chinese corporate governance practices service provision and product differentiation: a comment to "a note on the strategic use of service" james boswell auburn university montgomery • montgomery, al evan moore auburn university montgomery • montgomery, al abstract hegji and moore (2005, p. 140) state, "the bottom line for managers is that although the provision of service may at times seem attractive, in that increased services allow for higher prices, price competition should be considered the preferred long-run strategy." contrary to their result we find that service provision is profitable in the long run and can be associated with lower prices. additionally, we discuss the value of product differentiation. our paper builds on their results in three ways: providing an additional setting of homogeneous goods duopoly, providing the profits under the three scenarios (hegji and moore's monopoly and differentiated price duopoly, and our homogeneous goods duopoly) with and without service provision, and a discussion of the managerial implications in terms of both service provision and product differentiation. introduction hegji and moore (2005) present a model of service provision under two settings: a monopoly and a differentiated price duopoly. their results indicate that prices are greater in the case ofthe duopoly, which is unexpected as monopoly pricing is typically greater than that of other market structures. they then discuss the implications of the model in terms of consumer surplus rather than profitability. we build on their results in three ways: we provide an additional setting of homogeneous goods duopoly, we provide the profits under the three scenarios (hegji and moore's monopoly and differentiated price duopoly, and our homogeneous goods duopoly) with and without service provision, and we discuss the managerial implications in terms of both service provision and product differentiation. contrary to hegji and moore's conclusion that " ... the provision of service may at times seem attractive, in that increased services allow for higher prices, price competition should be considered the preferred long-run strategy," we find that service provision is profitable in the long run and discuss the value of product differentiation. 212 journal of business strategies additionally, our results reveal necessary restrictions on the differentiated price duopoly model presented by hegji and moore. these findings provide insight as to whether product differentiation is worthwhile. much of the remainder of the paper is of a technical, or mathematical, nature. we would like to briefly mention some of the managerial implications at this point for those readers who are not interested in the technical details. contrary to the findings of hegji and moore, our results indicate that managers should consider product differentiation as a means for increasing profitability if they are competing in markets where the product has accompanying service provision that is of value to consumers. however, if product differentiation is not possible, then managers should determine if demand for their product is affected by the level of service associated with the product being sold. our results indicate that if demand is indeed affected by the level of service, then service provision can lead to greater profitability with lower prices for non-differentiated goods. this result provides a counterpoint to hegji and moore's claim that increased services results in higher prices. according to the framework used in this paper, and those of hegji and moore (2005) and pepall, richards, and norman (2002), the increased profitability occurs as increasing service leads to increases in consumer willingness to pay. this increase can induce a consumer who was not previously buying the product, but seriously considering purchasing, to now buy the product; this potential buyer is known in the economics literature as a marginal consumer. as the number of marginal consumers increases, there is generally a greater return to service provision. the remainder of the paper is organized as follows. section ii presents the results of duopolists providing services in a strategic setting involving homogeneous, i.e. identical, goods. section iii presents the profits under the three scenarios with service provision and discusses the limits of differentiation. section iv presents the profits under the three scenarios without service provision, allowing for a comparison with the results in section iii revealing that profitability likely increases with service provision. finally, we conclude with a summary and implications for managers. the provision of services under a homogeneous goods cournot duopoly a critical assumption in hegji and moore's work involves the derivation of the demand specification for the bertrand price setting. these authors assume that if the firms are producing non-differentiated or homogeneous goods, then each of the duopolists begins with half of the monopoly's share of the market. their differenvolume 26, number 2 213 tiation parameter, 13, indicates that differentiation occurs if 13 > 0 and homogeneous goods occur if 13 = o. as such it is then no surprise that the results of their duopoly model simplify to that of the monopoly outcome when 13 = o. however, in a competitive environment with firms producing homogeneous goods, it would be unusual to find a duopoly behaving collectively as a monopolist in a static setting, and this is even more unusual given the firms' cost structures in their model. in many instances this could easily be viewed as a collusive arrangement. l as such, hegji and moore's framework is reasonable for differentiated goods but does not accurately capture the nature of competition with homogeneous goods. a cournot type of modeling approach is more appropriate in this setting. let us now consider such a cournot duopoly, with each firm having costs of tc j = q/c + cps) as in hegji and moore. begin by expressing quantity demanded for firm i's product as qj = s/a p), and aggregating across both firms . since firms compete over output or quantity, in a cournot framework this equation is expressed in its inverse demand form (ql + q2) p=a---s, +s2 using (1) results in the profit function for firm i (ql + q2) ti.(q ., s) = (a )q (c + cps)q. i i i s +s i i i 1 2 differentiating (2) with respect to qj yields the reaction function (a cpsj c)(s, + s2) qj q = -j 2 2 . solving (3) results in firm and market outputs of (a 2cpsj + cp~ c)(sl + s2) 3 2(a cp(s) c)(sl + s2) q, + q2 = -------3 (1) (2) (3) (4) (5) the optimal level of customer service is obtained by differentiating (2) with respect to sj' which yields the condition jilj q, +q2 ~ = qj(sl + s2r] cpq; = o. (6) 214 journal of business strategies solving (6) and use of (5) yields the optimal level of total service for the coumot duopoly (a c) s*=s +s = --i 2 2rp and, use of (5) in (7) results in the market price a+c p = -2 (7) (8) as with the monopoly and bertrand models discussed in hegji and moore, price in the coumot duopoly is a markup above production and service costs. as expected, the coumot price is less than the monopoly price and, therefore, lower than prices in the bertrand market. the level of service in the coumot duopoly has some interesting features. note that total level of service provided by the two firms is determined in equilibrium, but the distribution of service between the duopolists, at first glance, is indeterminate. a natural assumption to make is that each duopolist provides one half of the total market level of service. given that the coumot duopolists charge the same price, if either firm offers a lower level of service than its competitor, then customers will purchase the product from the firm offering higher services. therefore, in an efficient equilibrium the firms will offer identical levels of service as customers will not be searching for a firm offering a higher level of service. under the assumption of equal service provision, each duopolist provides less service than the monopoly provider of service. compare one half of equation (7) with hegji and moore 's equation (4hm), s* = (a 3c). 2 this is expected in a market with two firms producing a homogeneous good. the tendency is for each firm to provide less service than if it were the only producer since the market price is lower for each firm in the duopoly. given the findings of hegji and moore, it is no surprise that the price and level of service in the coumot model are lower than those in the bertrand case. however, while service provision is lower in the coumot duopoly than that of the bertrand case, consumer surplus is greater in the cournot case. the loss in consumer welfare due to lower service provision is more than offset by the gain due to the accompanying lower prices. in their model of service provision as service hours, shy and stenbacka (2006, p.763) find that service is h ••• inefficiently low from a social point of view." our results suggest that lower levels of service can be welfare enhancing if prices are suitably lower. this could alternatively be interpreted as the volume 26, number 2 215 bertrand model ofhegji and moore resulting in service levels, and ultimately prices, that are inefficiently high from asocial point of view. profits of service provision under three settings it is a straightforward exercise to calculate the profits of the monopolist (tim) and each bertrand duopolist (ti b ) using the results of hegji and moore. the profit for a coumot duopolist (tic) is calculated using the findings above. the per firm profits are (a c)3 (a c+ (jc)3 (a c)3 n = n = n =-m 27qj ' b 2qj(2 + 2(j)3' c 32qj' (9) a comparison of the profits under each scenario reveals some insights. note that the profitability of a bertrand competitor (i1b) is equal to yz of that of the monopolist (11m) when (j = o. however, without any differentiation between products, the profits are more accurately presented by those of a coumot competitor (l1c) , which are considerably greater than those of the bertrand case with no differentiation. a comrarison of the rofits of the bertrand and coumot competitors reveals that (j > (2.y~~~1~)~ _-~ must hold true for the profits from differentiation to exceed those of provi~ing homogeneous goods. if the firms cannot achieve this threshold level of differentiation then our result is similar to that of egli (2007) in that profit maximizing firms would prefer zero product differentiation. this result also supports the findings of zanchettin (2006, p .999) that product differentiation can reduce profits, " . . . implying that a local incentive towards less differentiation may arise." nevertheless, it is evident that for a firm engaged in any degree of product differentiation, increasing differentiation is l2!pfitable as the derivative ofilb with re(j . dil n 3(la + c)(a + (p 1 )c) h' h . . . th" d d spect to is d(j 2 (3 _ 2(j)4 , w ic is positive. is is a stan ar result for symmetric firms (zlnchettin, 2006, p. 999) . hegji and moore note that consumer surplus in the bertrand market decreases " ... as (j increases from 0 to 1." however, a closer inspection of their equation (iohm) cs (a c + (jcp(a(1 2{j) 9 i h h ' 'bl , b-2 (3 _ 213)3 , revea stat t e maximum possi e value for (j is yz . to be more specific, (a c) (j-::'=-2a (10) when the equality in (10) holds, consumer surplus in the bertrand market (cs b ) is zero . for any value of {j that exceeds (a c)i2a, the consumer surplus would be 216 journal of business strategies negative indicating that consumers would not purchase the good. these findings e...j16 3)(a c) p a c restrict the plausible values of 13 to (2 _ 3...j16)c _ 2a < ::; 2a , such that consumer surplus in the bertrand market decreases and profits increase as p increases in the range . suppose the bertrand competitors achieve the highest possible level of differentiation such that equation (10) results in equality. in this case the profits for a bertrand competitor are nb = (a16 c)3. this is the highest possible profit, assuming no cost of differentiating, which is realized by maximizing differentiation . this finding supports the principle of maximum differentiation presented by d' aspremont, gabszewicz, and thisse (1979). these profits are markedly higher than those of a single monopoly firm or for the coumot competitors for homogeneous goods. in fact, the bertrand competitors' profits are double those of the coumot competitors. profits without service provision under three settings to provide a basis for comparison, consider the scenarios presented above in the standard context without firms providing services. this results in demand func tions of q = a p in the monopoly case and q; = (100 p; + p)l2 in the bertrand market, and an inverse demand function of p = 100 q j -q 1 in the coumot market. the cost function for any firm is tc; = cq;, the resulting equilibrium profits are (a c)2 (a + 2c(p 1)(a + pc) (a cy (i i) 7r:m = ---" 7r:b = ---------, 7r:c = --4 2(p 2)2 9 comparing these profits with those under service provision indicates that service provision is profitable for likely values of (i . and in an interesting twist, note that in the case of homogeneous goods provision the profits for each of the coumot competitors more closely approximate the profits of the monopolist. without service provision a cournot firm earns 4/9 of the monopolist's profits, yet with service provision his profit increases to 27/32 of that of the monopolist. service provision may indeed be profitable. an underlying feature of the scenarios presented in hegji and moore is that the markets discussed involve barriers to entry; i.e. monopoly and two versions of duopoly. hence, their discussion of entry by possible competitors is not relevant; if entry is possible, it would occur as the firms in both of their settings are earning positive economic profits. volume 26, number 2 217 summary and managerial implications hegji and moore (2005, p.140) conclude with, "the bottom line for managers is that although competition in the provision of service may at times seem attractive, in that increased services allow for higher prices, price competition should be considered the preferred long-run strategy." the findings presented here suggest something different in that managers should consider product differentiation as a means for increasing profitability assuming the necessary threshold level can be obtained. we have also shown that increasing the level of differentiation can increase profits.4 additionally, allowing for the necessary barriers to entry that give rise to the two firm bertrand market, the provision of services can indeed be a profitable endeavor in the long run. however, suppose product differentiation is not an option for managers. our results indicate that managers of firms selling homogeneous goods should closely consider the nature of demand for their products. if demand for the product is indeed a function of service provision then, contrary to the quote above from hegji and moore, competition in the provision of services is both profitable for the firms and coincides with lower prices for the consumers. this is due to the nature of demand as in equations (lhm), q(p,s) = s(a p) and (5hm), qi = sj(a pi + fjp)12 ofhegji and moore, and equation (1) above where" ... an increase in the service level ... increases consumer willingness to pay for the good, and the increase is proportionately greater for the marginal consumer" (pep all et ai., 2002, p. 487). in both the differentiated and homogeneous goods cases, service competition can indeed be a viable and profitable long run strategy. appendix conditions regarding rp and profits: in the monoeoly gase, profits under service provision will exceed those with. 'f 4 a-out service i <p < 27 in the bertrand case, profits under service provision will exceed those without . . (f3 2)2(a + (f3 1 )cy service if <p < (3 + 2fjy(a 2 + a(3fj 2)c + 2(/3 l)fj0) . in the coumot case, profits under service provision will exceed those without . 'f 9(a c) service i <p < 32' 218 journal of business strategies references d' aspremont, c., gabszewicz, j. , & thisse, j. (1979). on hotelling's "stability in competition." econometrica, 47, 1145-1150. egli, a. (2007). on stability in competition: tying and horizontal product differentiation. review of industrial organization, 30, 29-38. hegji, c. & moore, e. (2005). a note on the strategic use of service. journal of business strategies, 22, 135-141. mankiw, n. (2009). principles of economics (5th ed.). florence, ky: south-western cengage learning. pepall, l. , richards, d., & nonnan, g. (2002). industrial organization: contemporary theory and practice (2nd ed.). mason, oh: mason south-western. shy, 0 ., & stenbacka, r. (2006). service hours with asymmetric distributions of ideal service time. international journal of industrial organization, 24, 763-771. zanchettin, p. (2006). differentiated duopoly with asymmetric costs . journal of economics & management strategy, 15, 999-1015 . endnotes i . particulary if the finns have constant marginal costs of production. mankiw's (2009, p. 367) textbook, among many textbooks and articles, uses an example where a collusive outcome leads to a market that is, " ... in effect served by a monopoly." however, in the cournot model presented in this paper the collusive agreement would not be to split the monopolist's output and service; this is due to the quadratic nature of production costs. while not the focus of this paper, a glance at the profits in equation (9) reveals that a cournot competitor would rather engage in competition, earning iic' than a collusive agreement earning half of the monopolist's profits, y2 ii m • note that the cournot competitors would each produce more than half of the monopolist's output in a collusive agreement in our model. 2. to aid the reader, equations from hegji and moore (2005) that are referred to in the current paper are denoted as (#hm) , where # is the equation number. 3. it is possible for service provision not to be more profitable, but unlikely. the necessary values of rp for this not to be the case are provided in the appendix. 4. this is contingent on the marginal revenue being greater than or equal to the marginal cost of increased differentiation. volume 26, number 2 219 biographical sketches of authors james boswell obtained a b.s. in mathematics with a concentration in economics in december of 2008. he will begin graduate study in economics in the fall of 2009. his research interests include industrial organization, game theory, and mathematical economics. dr. moore joined the department of economics at auburn university montgomery in 2002. he is currently an associate professor and head of the department. his primary teaching interests are industrial organization, game theory, and microeconomic theory. his primary areas of research include industrial organization and experimental economics. he has published in a variety of journals including the american economic review. service provision and product differentiation: a comment to "a note on the strategic use of service" a fine-grained analysis of director dependence: examining board composition in detail jonathan l. johnson & alan e. ellstrand university of arkansas fayetteville, ar catherine m. dalton & dan r. dalton indiana university bloomington, in abstract past corporate governance research that has incorporated the concept of directors' dependence on the ceo has operationalized dependence in numerous ways, often aggregating various indicators into a single construct. we extend this research with an examination of individual indicators of director dependence by partitioning director relationships into six categories. relying on agency theory in combination with other organizational theories, we test hypotheses about relationships between the different categories ofdirector dependence and the presence ofantitakeover provisions and golden parachutes. wefind that reciprocated interlocks are positively associated, and inside directors are negatively associated. with the presence ofantitakeover provisions. implications for theory, method. and practice are discussed. introduction the relationships that corporate board members share with the ceo and/or the corporation itself have been of interest to researchers and governance activists for years. in both realms, the conventional wisdom holds that directors who are in some way dependent on the ceo are more likely to be derelict in their fiduciary duties to stockholders than wholly independent directors. researchers, most of whom rely on agency theory, have formalized the argument and operationalized its constructs in myriad, but largely unsystematic, ways. corporate governance activists agitate for independence, frequently by asking or demanding that directors with specific kinds of relationships with the ceo or the organization be precluded from serving on the board. although these arguments are grounded in well-accepted theory, and activists have been quite successful in bringing about change, the empirical record on the consequences of board composition is mixed 112 journal ofbusiness strategies vol. 21, no.2 (e.g., dalton, daily, ellstrand, & johnson, 1998; westphal & milton, 2000; zahra & pearce, 1989). in this paper, we investigate one factor that may help account for the inconsistent findings across studies alternative and potentially conflicting operationalizations of the director dependence construct. the confusion associated with the conflicting operationalizations has theoretical, methodological and practical implications. the theoretical underpinnings vary for the different forms of director dependence on the ceo. for example, dependence that arises from directors who are related to the ceo is likely to be qualitatively different from that expected from directors who are also current officers. different relationships may connote fundamentally different interests that are being represented on the board. methodologically, the inconsistent operationa1izations of the dependence construct across studies may account for the mixed empirical record, rendering tests of theory inconclusive in cases where the central construct is measured differently (dalton, daily, & johnson, 1999). practically, the need to disentangle the different forms of director dependence are important iffor no other reason than that corporate governance activists, many of whom wield considerable market power, continue to agitate for the removal of several classes of directors. institutional investors have become very willing to engage in publicized conflicts with the managers of specific firms in public and private forums (serwer, 1996; useem, 1993); activists publish books (e.g., monks & minow, 1995) and distribute other materials that detail their recommendations for board composition (e.g., minow & bingham, 1995); governmental agencies and stock exchanges impose reporting requirements to explicitly disclose the variety of potentially conflicting relationships (daily & dalton, 1994); and the business press commonly publishes stories and commentary devoted to issues of corporate governance (e.g., byrne, 1997; colvin, 2001; lavelle, 2001). thus, a more detailed examination of the kinds of relationships that exist between directors, the ceo, and the corporation itself may provide theoretical and practical insights for those interested in corporate governance. in this study, we examine the correspondence between six classes of director relationships and an outcome often associated with managerial expropriation of stockholder interests, the presence of antitakeover defenses. theory and hypotheses managerialism and agency theory consider the board's primary role to be managerial oversight, although they differ in their predictions regarding the degree to which the board actually carries out this role. while managerialism suggests that the large majority of boards are in place to support the self-interested behavior of top executives, agency theory proposes that in the presence of efficient markets, directors will be forced to take their fiduciary responsibilities seriously and act in the best interests of shareholders (bazerman & schoorman, 1983; fama & jensen, 1983). of the two perspectives, the recent literature favors agency theory (johnson, daily, & ellstrand, 1996; zahra & pearce, 1989), primarily because it fall 2004 johnson et al: fine-grained analysis 113 holds out the possibility for functional boards, which managerialism dismisses outright. agency theory also provides a detailed theoretical framework for explaining circumstances under which directors can carry out their fiduciary responsibilities. we rely on the most popular application of agency theory to corporate governance, which is built on a decision management model explained in detail by fama and jensen (1983). the model involves a four-step decision process. professional managers are responsible for the decision management role which includes the first (decision initiation) and third (decision implementation) steps in which decision alternatives are created and developed, and if approved by the board, implemented. the board, as a fiduciary of the stockholders, is responsible for steps two (decision ratification) and four (monitoring), the decision control role, which involves reviewing and accepting or rejecting alternatives proposed by management and monitoring the implementation of approved decisions. the sine qua non of the model is the independence between the two classes of actors who are responsible for these roles. according to fama and jensen: without effective control procedures, such decision managers are more likely to take actions that deviate from the interests of residual claimants. an effective system for decision control implies, almost by definition, that the control (ratification and monitoring) of decisions is to some extent separate from the management (initiation and implementation) of decisions (1983: 304). the model is predicated on the assumption of fundamental conflicts between managers' and directors' interests. according to the agency view of the firm, however, as long as the prescribed parties exclusively own the rights inherent in these roles, the governance of publicly held corporations will remain balanced. the theory further predicts that in competitive markets, only economically efficient complex corporations will survive. because agency costs are nontrivial, the survivors will be governed by decision controllers and decision managers whose interests are independent excepting those formally prescribed by the model. when the independence between these two roles is violated, especially if the director is under the influence of the ceo in some way other than rational persuasion, the decision management process is unbalanced, agency costs will become excessive, and the firm will suffer in the financial and corporate control markets. there are a variety of ways that the prescribed independence between these roles may be violated, each of which has, in varying degrees, been the focus of past research and corporate governance activist concern. perhaps the most direct violation of the prescriptions from the decision management model occurs with the appointment of current officers of the corporation to the board. with such appointments, the decision management and decision control roles are not only linked, but united in the same person. the individuals who are responsible for developing and implementing corporate policy also ratify and 114 journal o.lbusiness strategies vol. 21, no.2 monitor those decisions. for certain kinds of decisions, the conflicts of interest are clear enough that inside directors are precluded by some institutions ~ typically stock exchanges ~ from participating in certain roles, such as service on the audit or nominating committees or in determining top managers' salaries. no institution prohibits inside directors from advocating and voting on the adoption or rescission of antitakeover provisions, and certis paribus, each director may directly benefit from the job security that these policies provide. many firms include insiders in addition to the ceo, each of whom may be intimidated into voting with the ceo who, as their boss, exercises considerable control over their professional positions. because of these potential conflicts of interest, the inside/outside director dichotomy is the most common operationalization of director dependence, although it is frequently combined into an aggregate variable with other indicators (cf., dalton, et al, 1999). the insider variable has been used in several studies that relate to takeover activities. singh and harianto (1989), for example, found that the percentage of outside directors corresponded positively with the adoption of golden parachute contracts. kosnik (1987) found that the proportion of outside directors was negatively associated with the payment of greenmail, although neither davis (1991) nor mallette and fowler (1992) found a relationship between their operationalizations of director dependence and the adoption of poison pills. the outsider variable has also been studied in relation to market reactions to the adoption of antitakeover provisions (brickley, coles, & terry, 1994; sundaramurthy, mahoney, & mahoney, 1997). for example, sundaramurthy, mahoney and mahoney found that greater outsider representation on the board increased negative market reactions to the adoption of antitakeover provisions, suggesting that investors may feel betrayed by outside directors who do not take their fiduciary responsibilities seriously. while the existing literature reports conflicting findings concerning the relationship between the inside/outside director dichotomy and the adoption of antitakeover measures, consistent with agency theory we propose: hypothesis i: the proportion ofdirectors who are currently employed by the corporation will be positively associated with the presence ofantitakeover provisions and golden parachutes. the logic underlying the separation of decision management and decision control roles also applies to directors who are affiliated with firms that are involved in economic relationships with the focal corporation. directors who represent banks, law firms, suppliers, or customers of the corporation hold dual allegiances, one as fiduciaries of the stockholders, the other as agents of their employer. presumably, when the interests of both parties are in conflict, their allegiance will be to their employer who exercises more direct control over their individual interests as their primary source of income. most researchers regard these directors as dependent on the assumption that the ceo has discretion over the contracts that the firm enters into, and could thus sever lucrative contracts with firms represented by an obfall 2004 johnson et al: fine-grained analysis 115 stinate director (cf., mizruchi, 1983). in the context of the decision management model, this kind of relationship gives the primary decision manager, the ceo, power over the decision controller, potentially compromising the role of vetoing questionable management proposals. moreover, in the event of a hostile change of control, the relationship that exists between the firm represented by the director and the focal corporation may also be put in jeopardy, which may provide further motivation for the director to ratify proposals that fail to serve the shareholders' interests. these forms of relationship are regarded as suspect by any number of agencies, including the sec (which requires such relationships to be reported in great detail), stock exchanges, and institutional activists (including the council of institutional investors). hypothesis 2: the proportion ofdirectors affiliated with banks, lawfirms, customers, or suppliers that have contracts with the corporation will be associated with the increased likelihood ofthe presence ofantitakeover provisions and golden parachutes. not all research on director dependence has relied exclusively on economic or legalistic arguments. business management is conducted in an arena in which both economic and social forces operate (granovetter, 1985). as davis has noted, theories of management that ignore the social context "are at best incomplete and at worst misguided" (t 991: 584). four kinds of frequently investigated director relationships rely at least in part on social explanations. the first is the appointment of former officers of the corporation to the board. several governance researchers have included former officers in their operationalizations of director dependence, including studies of the adoption of antitakeover measures (e.g., cochran, wood, & jones, 1985; kosnik, 1987; mallette & fowler, 1992), and virtually all governance activists include former employees in their identification of dependent directors (lrrc, t 994). the rationale for classifying former employees as dependent is less straightforward than that of inside or affiliated directors, but the underlying logic is often not explicated (for exceptions, see baysinger & butler, t 985; o'reilly, main, & crystal, 1988; wade, o'reilly, & chandratat, 1990). while the ceo has no direct influence over these directors' employment or economic interests outside of their membership on the board and perhaps the value of their stockholdings in the firm, there may be reasons to expect that a compromising relationship may exist between the ceo and former officers. a former officer of the corporation who may well have served as ceo of that corporation is likely to strongly identify with the current ceo and have a similar worldview (westphal & milton, 2000; westphal & zajac, 1995). in the case of a ceo who was selected from within the organization, the ceo and director will have had very similar experiences, having shared the same or similar jobs within the same corporation. the current ceo may have developed "recipe behavior" in which the executive models his/her current actions based on the beliefs and values 116 journal of business strategies vol. 21, no.2 of past organizational leaders (castrogiovanni, baliga & kidwell, 1992). in addition, a friendship or mentoring relationship may have formed between the former officer and the current ceo if they had previously worked together as officers of the corporation. indeed, it is possible even likely that the former ceo (a former officer and current board member) was instrumental in the appointment of the current ceo. such a relationship fits coleman's (1990) profile of an "affine agency" relationship, in which one party internalizes the interests of the other. even in the case of an external ceo, the parties may have shared similar experiences and have developed an affinity for each other. in either case, the director's identification with the ceo would lead the director to take on the ceo's interests, and the decision controller's independence of the decision manager is breached. hypothesis 3: the proportion ofdirectors who areformer employees of the corporation will be positivezv associated with the presence ofantitakeover provisions and golden parachutes. two corporations occasionally exchange officers and directors; that is, an executive of each firm sits on the other's board (kosnik, 1987; vance, 1983). in reciprocated interlocks, the director/officers involved may exchange favors, creating an arrangement of "mutual deference and forbearance" (kosnik, 1987: 170). the decision controller of one board is the decision manager of the other, and vice versa. in this case, explicit quid pro quo exchanges may arise that compromise the decision making safeguards on both boards. the nature of the relationship between the officers involved may go beyond simple social exchange, as well. useem (1984) found evidence that the interlocking directorate led to the formation of social ties. researchers working in marxist traditions (e.g., domhoff, 1979) have long assumed that social relationships exist between the ceo and many concurrent directors prior to their appointment to the board. with reciprocated interlocks, this is a near certainty, excepting the unlikely case that the two officers were appointed to each other's boards simultaneously. such directors are likely to act as affine agents for one another. kosnik (1987) examined reciprocated interlocks in her study of the payment of greenmail and found that they led to an increase in the likelihood of the payment of greenmail, and we expect that will generalize to other forms of antitakeover defenses. thus, we would expect these directors to support the ceo in taking steps to defend his or her position with the firm. hypothesis 4: the proportion of directors who are involved in reciprocated interlocking directorships will be positively associated with the presence ofantitakeover provisions and golden parachutes. social forces are most pronounced in the case of directors with kinship ties to managers. directors who are related to management may have been appointed to the board specifically to provide support for the managers (coleman, 1990; fall 2004 johnson et al: fine-grained analysis 117 kosnik, 1987). such relations are very likely to involve identification between the director and officer, an identity based on family ties rather than homophily, and thus likely to be very strong. the agency theory decision control model is again violated if the director's (decision control) objectivity regarding management (decision management) proposals is compromised. beyond personal relationships and individual loyalties, hostile takeovers are also likely to jeopardize the social status of controlling families, potentially pitting the director's individual interests against those of the stockholders at large. for these reasons, we expect that the presence of directors with kinship relations to favor policies that will thwart hostile takeover attempts. hypothesis 5: the proportion ofdirectors with kinship relationships will he positively associated with the presence ofantitakeover provisions and golden parachutes. directors who were appointed after the ceo's tenure began may also be dependent on the ceo (wade et ai., 1990; boeker, 1992). researchers incorporating this operationalization of director dependence have argued that ceos generally exercise substantial influence in the selection of outside directors and will favor nominees who they know are sympathetic to their own views and desires. many directors who are asked to serve on boards have prior social relationships with the ceo, as well (e.g., domhoff, 1979; westphal & zajac, 1997). the personal affiliation violates the assumption of independence between the decision making roles in agency theory. the lack of dependence may be further exacerbated if the director feels a sense of obligation to the ceo, insofar as the appointment to the board confers individual financial and social benefits (useem, 1984; wade et ai., 1990). in this social exchange perspective, the director may feel obliged to return the favor at some point in the future by voting to ratify a proposal that favors the ceo. wade et ai. (1990), for example, found that the proportion of directors appointed during the current ceo's tenure (referred to as "loyal directors" in this study) was positively associated with the adoption of golden parachute contracts. hypothesis 6: the proportion ofloyal directors will be positively associated with the presence ofantitakeover provisions and golden parachutes. methods and analysis sample the sample consisted of 200 randomly selected fortune 500 corporations. data were collected on 2,310 individual directors from the sample firms' proxy statements in 1991. we selected 1991 as the sample year for our study as it was late in a period of significant hostile corporate takeover activity. as such, corporate takeover defenses were widely established, yet not ubiquitious among large, american corporations (useem, 1993). thus, our sample provided the substantial 118 journal of business strategies vol. 21, no.2 variance required to study our dependent measure, the adoption of anti-takeover provisions that protect managers from market discipline, an indicator of opportunism. descriptive statistics and correlations are in table 1. dependent variables although subject to some debate, antitakeover provisions are regarded as valid indicators of managerial opportunism (e.g., davis, 1991). such provisions may be used at management's discretion in attempts to thwart hostile bidders, and the presence of an arsenal of antitakeover defenses suppresses the initiation of takeover activities (rosenbaum, 1993). the antitakeover provisions included in the study were on the books in 1991, and included (the number of sample firms adopting each ofthe provisions is in parenthesis): anti-greenmail provisions (25), classified boards (118), cumulative voting with significant stockholders (33), dual class common stock (21), fair price provisions (73), limitations on stockholder meetings (89), non-confidential voting (29), poison pills (138), and requirement ofa supermajority approval vote (40). a detailed description of each of these antitakeover provisions may be found in rosenbaum (1993). table 2 lists the number of antitakeover provisions adopted by firms in the sample. another takeover related corporate policy that may pit managers' interests against those of the stockholders, golden parachutes, was included in the study. golden parachutes (gps) are contracts between top officers and the corporation that provides the officers with substantial compensation packages in the event of a change in corporate control. of the 200 firms in the sample, 120 had adopted a golden parachute by 1991. data for antitakeover amendments and golden parachutes were collected from the investor responsibility research center's corporate takeover defenses 1993 publication (rosenbaum, 1993). independent variables directors employed by the corporation during the sample period were coded as inside directors. directors were coded as consultants if granted a personal consulting contract with the corporation. directors affiliated with any supplier, client, bank, or law firm of the organization were classified as organizational contract directors. outside directors employed by the corporation within the five previous years were coded as former officers. kinship directors consisted of individuals related by blood or marriage to managers or directors. directors involved in officer-director swaps were coded as reciprocated interlock directors. outside directors were classified as loyal if appointed to the board after the current ceo's tenure began. each of the variables was expressed as a proportion of the entire board. while independent variables in regression models need not conform to any particular statistical distribution, nonlinear transformations may increase the power of the tests (tabachnick & fidell, 1996). we used the most common transformation of data expressed as ratios (cohen & cohen, 1983), the arcsine transformation ( = 2 * arcsine[ratio 1!2]), for each of the proportional variables. ""i'j table 1 ~ correlations and descriptive statistics n 0 0 .4 mean sd 1 2 3 4 5 6 7 8 9 10 11 12 i number provisions 2.83 1.49 2 number of directors 1l.55 3.05 0.01 3 assets (log) 14.63 1.41 0.09 0.49*** 4 institutional holdings 0.53 0.16 0.19** -0.05 0.11 ~ ~ 5 major stockholdings 0.21 0.22 -0.34** -0.12 -0.29***-0.27** ;::: '"a 6 director equity 0.03 0.10 -0.06 0.06 -0.05 -0.17* 0.25** ;::: ~...... 7 dual leadership 0.79 0.41 0.10 0.16* 0.21 ** 0.06 -0.08 -0.03 i::l::8 current insiders' 0.25 0.12 -0.23** -0.01 -0.07 -0.24** -0.06 -0.02 0.03 '-r] s· 9 kinship relations' 0.06 0.11 -0.18* 0.07 -0.12 -0.26** 0.20** 0.38** -0.12 0.23** ~, 10 former officers' 0.06 0.07 -0.03 0.12 0.03 -0.11 0.08 0.09 0.05 0.08 0.15* cl ""! i::l-. 11 organizational contracts' 0.04 0.07 -0.08 0.03 -0.11 0.04 0.08 0.19** 0.05 0.04 0.12 -0.13 ;::: ~ 12 reciprocated interlocks" 0.02 0.05 0.07 0.24** 0.16* -0.06 0.07 0.09 -0.q2 0.02 0.11 -0.06 0.05 l:l... ::.:... ;::: 13 "loyal" directors' 0.31 0.23 0.01 0.02 -0.04 -0.01 0.04 -0.03 0.18* -0.13 0.00 -0.17* 0.10 0.14 i::l ~ '"-.'", means and standard deviations are average proportions of directors in each category across all firms. arcsine transformations of proportions were used in the correlations. b note that in spite of the low average proportion for some of the reciprocated interlock variable, 41 of the 200 firms had at least one such director on the board in 1991. * p< .05 **p<.oi *** p < .001 ....... ....... '-0 120 journal ofbusiness strategies table 2 firms' adoption of antitakeover amendments vol. 21, no.2 number antitakeover provisions o i 2 3 4 5 6 number of firms 9 34 41 50 39 18 9 proportion 4.5% 17.0% 20.5% 25.0% 19.5% 9.0% 4.5% control variables firm size. firm size may act as a de facto takeover defense due to the volume of capital that must be raised in order to tender an offer (davis, 1991). firm size was measured as the log of total assets. we used the log transformation of this variable to correct for the high degree of skewness in firm size, thus ensuring that the data were properly distributed. stock ownership concentration. ownership concentration in corporations increases the power of shareholders and provides incentives for individual stockholders to act against managerial opportunism (demsetz & lehn, 1985). the variable was expressed as the percentage of stock held by owners of at least five percent of the firm's stock. data were collected from the firms' proxy statements. institutional ownership. institutional investors are often regarded by managers as fickle owners willing to dump large blocks of stock at a moment's notice (useem, 1993). managers of firms with large institutional stockholdings may be especially wary. data were collected from the compact d/sec database (compact disclosure, 1991, 1992), and expressed as the percentage of stock held by institutional investors. director equity. directors' and stockholders' interests are aligned when the directors have significant stockholdings. such directors will likely favor takeovers to earn the typical premiums. this variable was expressed as the percentage of stock held by all directors. number of directors. all of the board variables share a common term, the board size denominator. we included this variable as the relative percentage of any director type may be an artifact of the size of the board. board size is the total number of directors on the board. analysis the analysis proceeded in two stages. in the first stage, the sum of antitakeover provisions adopted by each corporation, not including golden parachutes, fall 2004 johnson et al: fine-grained analysis 121 was used as an index of management entrenchment. the index is distributed approximately normally with insignificant skewness (1.48, standard error = .172) and kurtosis (-.594, standard error = .342). the number of anti take over defenses was regressed on the control variables and hypothesized variables in a multi-step ordinary least squares (ols) regression. the first block contained control variables, followed by the introduction of a block containing all independent (board) variables of theoretical interest. hypotheses were evaluated in terms of the significance of the additional variance explained and by the significance of individual path values in the regression model. in the second stage, logistic regression models predicting only poison pills and golden parachutes were estimated. poison pills are often singled out from other antitakeover provisions because they are typically adopted without stockholder approval. golden parachutes were estimated separately because they also typically circumvent the proxy process, and because they are qualitatively different in terms of intent from the other antitakeover provisions. the logistic regressions were also conducted hierarchically in the same order as the ols hierarchical regressions. chi-square tests were conducted to determine if the variables accounted for significant additional variance. path significance was determined using the ratio of the wald statistic to the standard error of the coefficient, which translates to a z; statistic (tabachnick & fidell, 1996). results results from the ols regression and two logistic regression models are shown in tables 3 through 5. the first hypothesis predicted that the proportion of current inside directors would positively covary with the overall number of antitakeover amendments (table 3), poison pills (table 4), and golden parachutes (table 5). the findings are contrary to expectations across all three models. the percentage of current insiders was significantly related with the number of anti takeover provisions adopted (b = -1.32"'), the presence of poison pills (b = -2.90**'), and the presence of golden parachutes (b = -2.87'**), but opposite from the predicted direction. the presence of former officers of the corporation on the board of directors was predictive of the adoption of golden parachutes (b = -1.13 '), but again, in the direction opposite from expected. former officers were not significant in the other models. the proportion of directors involved in reciprocated interlocks explained significant variance in the number of antitakeover provisions (b = .77*), and in the intended direction, providing partial support for hypothesis 4. interlocks were not predictive of the presence of poison pills or golden parachutes. discussion the assumption, held by many researchers and practitioners alike, that directors who are not strictly independent of the ceo will capitulate to the ceo's in122 journal ofbusiness strategies table 3 hierarchical linear regression predicting the number of antitakeover provisions vol. 21, no.2 modell model 2 constant 3.03*** 5,81*** 1.18 1.34 number of directors -0,01 * -0.02 0.04 0,04 assets (log) -0,02 -0.09 0.09 0,09 institutional holdings 0.96 0.35 0.64 0.66 major stockholdings -2.27 -2.60*** 0.51 0.51 director equity 0.62*** 0,86 1.07 1.12 dual leadership 0.29 0.38 0.25 0.25 current insiders' -1.32*** 0.38 organizational contracts" -0.24 0.30 former officers' 0.12 0.28 reciprocated interlocks' 0,77* 037 kinship relations' -0.24 0.26 "loyal" directors' -0,08 0.16 r~ f change 0.137 0.218 5.09*** 3.245** 'arcsine transformations of proportions * p < .05 ** p< .01 *** p< .001 fall 2004 johnson et al: fine-grained analysis table 4 hierarchical logistic regression predicting the presence of poison pill amendments 123 modell model 2 constant 4.04* 9.27*** (1.98) (2.58) number of directors -0.11 -0.11 (0.07) (0.08) assets (log) -0.26 -0.36* (0.14 ) (0.16) institutional holdings 4.29*** 3.17* ( 1.18) (1.26) major stockholdings -3.19*** -4.05*** (0.95) ( 1.06) director equity -5.44 -4.43 (3.00) (3.44) dual leadership 0.64 0.85 (0.43) (0.48) current insiders" -2.90*** (0.80) organizational contracts' -0.47 (0.56) former officers" -0.13 (0.53) reciprocated interlocks' 0.21 (0.76) kinship relations' -0.29 (0.46) "loyal" directors' 0.17 (0.32) chi-square 53.67*** 19.99** (dt) (6) (6) cox & snell r' 0.235 0.308 "arcsine transformations of proportions * p < .05 **p<.oi *** p < .001 124 journal ofbusiness strategies table 5 hierarchical logistic regression predicting the presence of golden parachutes vol. 21, no.2 modell model 2 constant 6.33** 13.09*** (1.97) (2,66) number of directors -0.03 ·0,01 (0.06) (0.07) assets (log) -0.46** -0.63*** (0,14) (0.16) institutional holdings 1.85 0,29 (1.02) (1.20) major stockholdings -1.82* -2.31 * (0,81 (0.92) director equity -3.41 -1.61 (2.29) (2.52) dual leadership 0.87* 1.27** (0.38) (0.45) current insiders" -2,87*** (0.73) organizational contracts" -0,64 (0.52) fonner officers" -1.l3* (0.49) reciprocated interlocks" -0.40 (0.65) kinship relations" -0.74 (0.43) "loyal" directors" -0.24 (0.30) chi square 30.93*** 33.62*** (df) 6 6 cox & snell r2 0.143 ,276 , arcsine transformations of proportions * p < ,05 *'p<.o! ••• p < .001 fall 2004 johnson et al: fine-grained analysis 125 terests and against those of the stockholders, was not strongly supported by these tests. in fact, the strongest pattern of relationships involved inside directors, and was contrary to expectations. in only one case was a hypothesized relationship found significant. the hypotheses, grounded in the decision management model that undergirds agency theory, were largely disconfirmed. in explaining these predictive failures, one might first look to specific exceptions that are allowed by the theory. fama and jensen (1983) provide a rationale for one exception to the independence argument, allowing for a limited number of officers to serve on the board, although their interpretation is often ignored among empirically oriented governance researchers. fama and jensen argued that inside directors may playa functional role on the board insofar as they provide a conduit of information to outside directors that circumvents the ceo about the internal workings of the firm. their argument assumes the presence of strong alternative monitoring mechanisms including an efficient market for corporate control and the unrestricted alienability of stockholdings (both relevant to the dependent variables in this study) and also assumes that the board will protect officer directors from sanctions by the ceo. our findings are consonant with this view if the assumptions hold, especially so with respect to antitakeover provisions. ocasio (1994) notes that while "inside board members are direct subordinates of the ceo ... they are also potential rivals to the ceo's power" (p. 291). insiders may oppose antitakeover defenses if they insulate the ceo from the discipline imposed by the market for corporate control and thereby decrease their opportunities for promotion. a similar explanation may apply to the case of former officers, who were negatively associated with the presence of golden parachutes. as with inside directors, former officers will likely have firm specific knowledge that is useful in decision making in the corporation, and thus serve a functional role on the board. in other words, the presence of a former officer on the board is not an automatic signal of managerial expropriation. moreover, the ceo is likely to have even less direct power over this kind of director than insiders, in which case the former officer has no personal interest in granting the ceo a golden parachute. it may be that the former officer's psychological attachment is to the corporation itself rather than to the current ceo, and thus, because golden parachutes may encourage the ceo to approve a takeover, the director might oppose its approval. only in firms where one or more directors was engaged in a reciprocated interlock was there significant positive covariance with the presence of multiple antitakeover provisions, as predicted by agency theory. there is clearly an opportunity for collusion between the ceo/directors involved in officer-director swaps. for most of the other relationships included in this study, a credible argument can be made that they could justifiably be appointed to the board for reasons other than the entrenchment of the ceo. no such argument is apparent in this case. explaining the other results is more easily accomplished by reference to alternative governance theories. while agency theory provides an elegant mechanism for the governance of complex organizations, the functioning of most corporate 126 journal ofbusiness strategies vol. 21, no.2 boards is more complex than that implied in the decision management model. in reality, directors serve multiple roles, including not only their fiduciary obligations as emphasized in agency theory, but also providing information and advice to the ceo, procuring critical resources, and enhancing organizational legitimacy (pfeffer & salancik, 1978; johnson et ai., 1996; zahra & pearce, 1989). the fulfillment of such roles will often involve the appointment of directors who may have the appearance of dependence on the ceo. a ceo who uses a board to facilitate access to scarce critical resources (pfeffer & salancik, 1978), salient information (e.g., useem, 1984), and expertise (westphal & zajac, 1997) would be more indicative of a management acting to enhance, not expropriate, stockholders interests. this is in keeping with stewardship theory, which holds that ceos are more likely to be stewards of corporations rather than mere self-interested economic agents (donaldson & davis, 1991). as such, most would be inclined to act in shareholders' interests irrespective of the effectiveness of the board as a monitoring mechanism. the view that directors who are in some way dependent on the ceo may also be beneficial to the firm, and thus its stockholders, does not fit neatly within the agency theory framework. such directors are entangled in a complex of motivations, dependencies, and competing interests that extend beyond those of agency theory's clearly delineated principal and agent roles. one researcher has even suggested that directorships involving representatives of banks or suppliers may actually empower the director relative to the ceo, opposite from the more common interpretation (mizruchi, 1983). similarly, westphal (1999) has shown that social ties between outside directors and the ceo may not only facilitate the advisory role of the board, but may actually contribute to more effective monitoring as well. in other words, it is wholly possible that directors who may in some way be dependent on or socially linked to the ceo may provide other benefits to the board that offset the loss in independence that may compromise the fiduciary role. it may even be that larger boards can accommodate a certain number of directorships oriented toward the resource dependence, legitimacy, and advisory roles without losing the capacity, as a board, to carry out the fiduciary role (dalton, daily, johnson, & ellstrand, 1999). methodologically, the inconsistent results reported across the different variables corroborate the conclusions of dalton, daily, and johnson (1999), who found that the multiple operationalizations of director dependence that are found in the literature may help to account for the mixed empirical findings in investigations of relationships between board composition and a variety of outcomes. this study demonstrates in more detail how distinct operationaliz3tions of director dependence may lead to different results for dependent variables of interest. we would not suggest that one operationalization of board independence or another is invariably superior, but rather that research in the future should employ separate operationalizations based in theory relevant to each kind of relationship studied. with this, we are recommending a more complex view of the board, one that considers multiple forms ofrelationships between directors and officers. this is in fall 2004 johnson et al: fine-grained analysis 127 keeping with recent empirical findings (e.g., westphal, 1999) and the suggestions of reviews (e.g., johnson et al., 1996; zahra & pearce, 1989) that have argued for multiple roles for the board. while less accurate than studies that directly measure the nature of the relationships that exist between the ceo and directors (e.g., westphal, 1999), looking for indicators of different kinds relationships that can be gleaned from proxy materials and other publicly available information sources would be much less costly, and would enable researchers to examine all publicly traded firms. three limitations must be taken into consideration when interpreting these results. first, the degree to which antitakeover provisions represent an expropriation of stockholder interests is an open debate. recent research has shown that certain antitakeover provisions may serve stockholders' interests as well as those of management (e.g., brickley et al., 1994). certain events (e.g., eckbo, 1990), ownership structures (agrawal & mandelker, 1990), or board attributes (brickley et al., 1994) may attenuate negative stock market reactions to the adoption of antitakeover provisions, or even change the direction of the reaction (e.g., brickley et al., 1994). on the other hand, negative abnormal returns have been associated with the adoption of antigreenmail provisions (eckbo, 1990), classified-board amendments (jarrell & poulsen, 1987), supermajority amendments (agrawal & mandelker, 1990), cumulative voting amendments (bhagat & brickley, 1984), and poison pills (e.g., ryngaert, 1988). although comment and schwert (1995) concluded that poison pills did not substantially deter the takeover wave of the 1980s and 1990s, they did find that stock prices declined for most firms following the announcement of the adoption of such provisions. given that stockholders view the individual antitakeover amendments negatively, we believe that a strong case can be made that an arsenal of provisions is evidence for opportunism. managers armed with a host of takeover defenses are more likely to be more interested in entrenchment than increasing shareholder wealth. second, the current takeover market has changed in important ways from the time this data was collected (1991). the current market is less characterized by unwelcome bids, and such differences may limit the generalizability of these findings. also, as noted above, comment and schwert (1995) concluded that the most infamous of the antitakeover amendments, poison pills, had no substantive effect on the wave of takeovers in the 1980s and early 1990s. thus, while antitakeover provisions may have been a valid indicator of managerial opportunism in the context of the time of the study, the specific outcomes may be less clearly indicative of managerial opportunism in today's market than at the time of the study. future studies should examine these propositions against other measures of managerial opportunism. the cross-sectional design of this study is a third limitation. the design precludes making strong inferences with respect to causal direction. moreover, we are measuring the existence of such provisions, not the adoption, per se. [t could be argued that the adoption of the amendment constitutes the real expropriation. however, while the adoption event is clearly of interest, we also believe that the 128 journal of business strategies vol. 21, no.2 mere presence of such amendments may act against stockholder interests inasmuch as they may suppress the initiation of takeover activity, and in such case, they may be used at the discretion of management to thwart the attempt (rosenbaum, 1993). boards are free to rescind any of these provisions at any time. nonetheless, these limitations leave open alternative explanations for our findings that must be taken into consideration and addressed in future research. conclusion in this study, we partitioned director relationships into more precisely defined categories, based on economic and social influence theories, than have been used in past research. we found that different classes of director relationships had different implications. practically, these findings may suggest that relationships between directors and firm managers are sufficiently complex that board governance prescriptions based largely on simple inside/outside director distinctions are underspecified. we would not, however, suggest that governance activists' efforts to improve corporate governance are invalid. on the contrary, the variety of relationships between board members and managers merits more attention, not less. relationships such as reciprocated interlocks, for example, provide the opportunity for opportunism with few, if any, offsetting benefits. most other relationships that have been considered suspect including inside directors and representatives of interdependent organizations may provide benefits to the organization and its stockholders that offset the dangers of interdependent directors in certain contexts. our results may underscore the complexity of manager-director relationships. perhaps the dynamic milieu in which corporate managers operate is not well captured by any single theory of corporate governance. boards of directors playa variety of roles in different theories of the board (e.g., baysinger & butler, 1985; mintzberg, 1983), and each of these accounts will view the relationships that exist among officers and directors on boards differently. it may be that some of those differences will be better understood by a finer-grained approach to director dependence. references agrawal, a. & mandelker, g. n. (1990). large shareholders and the monitoring of managers: the case of antitakeover charter amendments. jourjlj11 of financial and quantitative analysis. 25, 143-161. baysinger, b. d., & butler, h. n. (1985). corporate governance and the board of directors: perfonnance effects of changes in board composition. journal of law, economics, and organization, i, 101-124. bazennan, m.h. and schoorman, f.d. (1983) a limited rationality model of interlocking directorates, academy of mal].agement review, 8,206-217. fall 2004 johnson et al: fine-grained analysis 129 bhagat, s. & brickley, j. a. (1984). cumulative voting: the value of minority shareholder voting rights. journal of law and economics, 27,339-365. boeker, w. (1992). power and managerial dismissal: scapegoating at the top. administrative science quarterly, 37,400-421. brickley, j. a., coles, j. l., & terry, r. l. (1994). the board of directors and the enactment of poison pills. journal of financial economics, 35, 371-390. byrne, j. a. (1997). the best and worst boards. business week, december 8, pp. 90-98. castrogiovanni, gj., baliga, b.r, & kidwell, jr., r.e. (1992). curing sick businesses: changing ceos in turnaround efforts. academy of management executive, 6, may, pp.26-41. cochran, p. l., wood, r. a., & jones, t. b. (1985). the composition of boards of directors and incidence of golden parachutes. academy of management journal. 28, 664-671. cohen, j. & cohen, p. (1983). applied multiple regression/correlation for the behavioral sciences, 2nd. ed. hillsdale, new jersey: lawrence erlbaum associates, inc. coleman, j. s. (1990). foundations of social theory. cambridge, massachusetts: the belknap press of harvard university press. colvin, g. (200 i). value driven. forbes, february 5, p. 46. comment, r. & schwert, g. w. (1995). poison or placebo? evidence on the deterrence and wealth effects of modem antitakeover measures. journal of financial economics, 39,3-43. compact disclosure. (1991). compact d/sec. bethesda, md: disclosure incorporated. compact disclosure. (1992). compact d/sec. bethesda, md: disclosure incorporated. daily, c. m. & dalton, d. r. (1994). bankruptcy and corporate governance: the impact of board composition and structure. academy of management journal. 37, 1603-1617. dalton, d. r., daily, c. m., ellstrand, a. e., & johnson, j. l. (1998). meta-analytic reviews of board composition, leadership structure, and financial performance. strategic management journal. 19, 269-290. dalton, d. r., daily, c. m., & johnson, j. l. (1999). on the measurements of board composition: poor consistency and a serious mismatch of theory and operationalization. decision sciences. 30, 83-106. dalton, d. r., daily, c. m., johnson, j. l., & ellstrand, a. e. (1999). number of directors on the board and financial performance: a conceptual synthesis and meta-analysis. academy of management journal. 42,674-687. 130 journal ofbusiness strategies vol. 21, no.2 davis, g. f. (1991). agents without principles? the spread of the poison pill through the intercorporate network. administrative science quarterly, 36, 583-613. demsetz, h. & lehn, k. (1985). the structure of corporate ownership: causes and consequences. journal of political economy, 93, 1155-1177. domhott, g. w. (1979). the powers that be: processes of ruling class domination in america, new york: random house. donaldson, l. & davis, j. (1991). stewardship theory or agency theory: ceo governance and shareholder returns. australian journal of management. 16,49-64. eckbo, b. e. (1990). valuation effects of greenmail provisions. journal of financial and quantitative analysis, 25, 491-505. fama, e. f. & jensen, m. c. (1983). separation of ownership and control. journal of law & economics, 26, 301-325. granovetter, m. (1985). economic action and social structure: the problem of embeddedness. american journal of sociology, 91,481-510. irrc (investor responsibility research center) (1994). background report on boards of directors. washington, d.c.: investor responsibility research center. jarrell, g. a. & poulsen, a. b. (1987). shark repellents and stock prices: the effects of antitakeover amendments since 1980. journal of financial economics, i, 127-168. johnson, 1. l., daily, c. m., & ellstrand, a. e. (1996). boards of directors: a review and research agenda. journal of management, 22, 409-438. kosnik, r. d. (1987). greenmail: a study of board performance in corporate governance. administrative science quarterly, 32, 163-185. lavelle, l. (2001). shh! you'll wake the board. business week, march 5, p. 92. mallette, p. & fowier, k. l. (1992). effects of board composition and stock ownership on the adoption of "poison pills." academy of management journal. 35,1010-1035. minow, n. & bingham, k. (1995). the ideal board. in corporate governance (eds. monks, r. a. g. & minow, n.), cambridge, massachusetts: blackwell publishers: 496-501. mintzberg, h. (1983). chapter6: the board ofdirectors. power in andaround organizations. englewood clitts, nj: prentice-hall. mizruchi, m. s. (1983). who controls whom? an examination of the relation between management and boards of directors in large american corporations. academy of management review, 8, 426-435. fall 2004 johnson et al: fine-grained analysis 131 monks, r. a. g. & minow, n. (1995). corporate governance. cambridge, ma: blackwell business. ocasio, w. (1994). political dynamics and the circulation of power: ceo succession in u.s. industrial corporations, 1960-1990. administrative science quarterly, 39, 285-312. q'reilly, c. a., iii, main, b. g., & crystal, g. s. (1988). ceq compensation as tournament and social comparison: a tale oftwo theories. administrative science quarterly, 33, 257-274. pfeffer, 1. & salancik, g. (1978). the external control of organizations: a resource dependence perspective. new york: harper & row, publishers, inc. rosenbaum, v. k. (1993). corporate takeover defenses 1993. washington, dc: investor responsibility research center. ryngaert, m. (1988). the effect of poison pill securities on shareholder wealth. journal of financial economics. 20, 377-417. serwer, a. e. (1996). mr. price is on the line. fortune, 134, 70-88. singh, h. & harianto, f. (1989). management-board relationships, takeover risk, and the adoption of golden parachutes. academy of management journal, 32, 7-24. sundaramurthy, c., mahoney, 1. m., & mahoney j. t. (1997). board structure, antitakeover provisions, and stockholder wealth. strategic management journal, 18,231-245. tabachnick, b. g. & fidell, l. s. (1996). using multivariate statistics, third edition. new york: harpercollins publishers. useem, m. (1984). inner circle: large corporations and the rise of business political activity in the u.s. and u.k. oxford: oxford university press. useem, m. (1993). executive defense: shareholder power and corporate reorganization. cambridge: harvard university press. vance, s. c. (1983). corporate leadership: boards, directors, and strategy. new york: mcgraw-hill book company. wade, j., o'reilly, c. a., iii, & chandratat 1. (1990). golden parachutes: ceos and the exercise of social influence. administrative science quarterly, 35, 587-603. westphal, j. d. (1999). collaboration in the boardroom: behavioral and performance consequences ofce)-board social ties. academy of management journal, 42, 7-24. westphal, j. d. & milton, l. p. (2000). how experience and network ties affect the influence of demographic minorities on corporate boards. administrative science quarterly, 45, 366-398. 132 journal ofbusiness strategies vol. 21, no.2 westphal, j. d. & zajac, e. j. (1995). who shall govern? ceoiboard power, demographic similarity, and new director selection. administrative science quarter~, 60-83. westphal, j. d. & zajac, e. j. (1997). defections from the inner circle: social exchange, reciprocity, and the diffusion of board independence in u.s. corporations. administrative science quarterly, 42. 161-183. zahra, s. a. & pearce, j. a.. ii (1989). boards of directors and corporate financial performance: a review and integrative model. journal of management, 15, 291-334. catherine m. dalton is the david h. jacobs chair of strategic management in the kelley school of business, indiana university. she received her ph.d. in strategic management from indiana university. her research interests include corporate governance, compensation, strategic leadership, and ownership structures. dan r. dalton is the harold a. poling chair of strategic management and director of the institute for corporate governance in the kelley school of business, indiana university. he received his ph.d. from the university of california, irvine. his corporate governance research focuses on option repricing, equity holdings, stock-based compensation, and initial public offerings. alan elistrand is the director of mba programs and associate professor in the sam m. walton college of business. university of arkansas. he received his ph.d. from indiana university. his research interests include corporate governance, top management teams, and the influence of the national political system on business operations. jonathan l. johnson is an associate professor in the sam m. walton college of business, university ofarkansas. he received his ph.d. from indiana university. his research interests include corporate governance and social networks within and between firms. a fine-grained analysis of director dependence: examining board composition in detail on the viability of a multilateral trade agreement: a political-economy approach 1 danilo r. trupkin universidad de montevideo • montevideo, uruguay abstract the big picture issue this paper intends to address is on the incentive aspects of a multilateral trade liberalization. the paper builds on a framework originally introduced in grossman and helpman's the politics of free-trade agreements (1995). the aim of that work was to explain the viability of free trade agreements (ftas) between two countries in a political-economy framework. a simple extension to a three-country setting allows us to analyze whether ftas are "building blocs" or "stumblirig blocs." an illustration with specific functional forms serves to find conditions under which ftas are, somehow, partial building blocs, i.e., a bilateralliberalization can be feasible when multilateral liberalization is not. introduction a large number of preferential trade agreements (pta) do exist nowadays all around the world. according to the world trade organization (wto), more than 200 are in effect today. almost all major countries are members of at least one pta, and, most importantly, the majority of these agreements were originated during the last decade. bhagwati (1995) has called this scenario a "spaghetti bowl" of tariffs in which countries impose different tariff rates on the same good depending on its origin. in an earlier paper, bhagwati (1991) addresses this issue by analyzing whether freetrade agreements (ftas) are building blocs oi: stumbling blocs to the achievement of a broad multilateral agreement. since viner's (1950) analysis on the welfare effects of customs unions, research interests in this topic have considerably caught the attention of international trade theorists. viner pioneered the static analysis of trade agreements providing the message that these arrangements could harm both a member country and world welfare, i.e., they can be "trade diverting."2 there have been concerns recently in regards to the viability of a successful multilateral trade liberalization in a world that is largely populated by potentially harmful ftas.3 in this line, krishna (1998) asks the political-economy question of whether ftas have incentives to keep expanding with more members toward a multilateralliberalization, or, instead, they wish to keep new members out. on the other 54 journal of business strategies hand, aghion et al. (2007) address the question of regionalism versus multilateralism by investigating whether multilateral bargaining or sequential bargaining are more likely to lead to global free trade. the "stumbling-bloc" view of ftas has been supported, among others, by bhagwati (1991, 1993) who finds that, even though ftas may generate static welfare gains, they finally reduce the incentives to seek posterior trade liberalization. yet, others such as summers (1991) argue that deeper integration within a subset of countries may raise the chances for successful multilateral negotiations. an interesting recent work by saggi and yildiz (2006) finds both stumbling-bloc and building-bloc effects, and illustrates cases in which trade agreements are "partial building blocs," i.e., ftas can improve welfare when multilateral liberalization is not attainable. the focus of this paper is both on the incentive aspects that explain the formation of trade blocs and on the viability of a multilateral agreement. the approach followed belongs to the political-economy theory literature on international trade. in particular, this paper builds on a framework, first introduced in grossman and helpman (1995). they analyze the viability of an fta between two countries approaching the political-economy problem by emphasizing the interaction between lobbies and an incumbent government. that paper considers both the case when the fta must cover all bilateral trade and the case when some politically sensitive industries can be excluded from the agreement. in grossman-helpman (1995), international relations involve two distinct stages of strategic interaction. in the initial stage, political competition among special interests in each country the lobbies determines the government's trade policy preferences. the second stage involves the bargaining process between the governments, which ultimately shapes the equilibrium agreement. the initial stage in which lobbies in a single country compete for the government's external policy makes use of the analytical framework previously introduced in grossman and helpman (1994). in that earlier model, lobbies offer policy-contingent campaign contributions to politicians, who make decisions on the basis of their own objectives. thus, a country's policy stance reflects, on the one hand, the relative force of its special interests and, on the other hand, the government's concern for the welfare of the average voter. according to this approach, an agreement may emerge when it creates profit gains for exporting sectors in excess of the losses incurred by import-competing sectors and any welfare losses to the average voter. naturally, an fta requires that the two governments give consent to the agreement. in this setting, the agreement is most likely to emerge when there is relatively balanced trade between both countries, and when the agreement provides mostly enhanced protection exporting volume 27, number 1 55 sectors receiving high domestic prices in the partner country rather than reduced protection import-competing sectors receiving a lower domestic price product of the fta. it turns out that reduced protection may involve some trade creation whereas enhanced protection generates only trade diversion. thus, the grossman-helpman analysis of ftas establishes that the features raising the viability of an agreement also raises the likelihood that this agreement finally reduces social welfare. they also show that a set of industry exclusions might make an otherwise infeasible fta politically viable. they study the determinants of the size of this set and identify the sensitive industries.4 this paper develops a three-country political-economy representation model in order to find conditions for the viability of a multilateral agreement. first, the model takes the two-country fta game as the starting point to evaluate the prospects of ulterior multi-lateral negotiations. second, the model studies the prospects of multilateral liberalization, departing from the status quo. a three-country set up allows us to move the focus ofthe analysis toward the question of whether trade blocs are building blocs or stumbling blocs. an illustration with specific functional forms serves to find conditions under which ftas are, in some way, partial building blocs, i.e., a bilateral trade agreement can be feasible when multilateral liberalization is not. the paper proceeds as follows. section 2 describes the grossman-helpman's model of ft as in order to introduce the framework used throughout the paper. section 3 extends this model to a three-country setting in which the viability of successful multilateral negotiations is analyzed. this section extends formally the general analysis introduced in the preceding section. section 4 assumes particular functional forms so as to illustrate how that model works in a world with the possibility of multilateral liberalization. section 5 concludes. the grossman-helpman model of ftas a review of the analytical framework consider two small countries and the rest of the world. each country charges non-discriminatory most-favored-nation (mfn) tariffs, following wto rules. there is a numeraire good 0 that is untaxed in each country, and n other goods. initially, some of these goods are imported by one or both of these countries while others may be exported. neither export subsidies are allowed in the model in recognition ofwto rules nor are export taxes. international prices are normalized to 1, thus domestic export prices are simply 1. as for the import goods, these may be subject to 56 journal of business strategies import tariffs. let ri represent 1 plus the initial tariff rate on good i in country j, for j j = a, b. by normalizing international prices to 1, then these are the domestic prices of import goods in country j . assume that, after the conclusion of an fta, the initial external tariff levels continue to apply to imports from nonmember countries. this is made according to wto rules which establish that these tariffs must be no higher than those imposed before the agreement. 5 article xxiv of the general agreement on tariffs and trade (gatt) permits certain exceptions tothe principle ofmfn, provided that the agreement covers "substantially all trade". although the interpretation of this article could be somewhat misleading, the first part of this model analyzes the viability of an fta requiring that all goods be freely traded between the members. the second part will consider exclusions of sectors that might be sensitive to the agreement. each country has a (voting) population of 1. individuals in each country have identical preferences (i) where c i denotes consumption of good i, and uk) is an increasing and concave function. consistent with these preferences, there are n per capita demand for the n goods, dh), and one per capita demand for good o,y l 7=1 qph), where qi is the domestic consumer price of good i and y is the individual's spending. the production of a unit of good 0 requires only one unit of labor whereas each of the n goods is produced under constant returns to scale with labor and a sector-specific factor. since the domestic price of good 0 is normalized to i, the competitive wage must equal 1 provided there is some production of this good initially. denote with ~(p) the profits earned by the specific factor in sector i, where pi is its domestic producer price. denote by xi the aggregate supply of good i, which is given by ~(p) = ii~(p) > 0 for each i. assume that the ownership of specific factors is highly concentrated and consider the extreme case where these factor owners are a negligible fraction of the population. also, assume that in each sector i these factor owners form a special-interest group (a lobby) which takes political action so as to maximize their joint welfare. the incumbent government has as its only function the decision on trade policy, which, in this case, reduces to whether accept or reject the fta. politicians in the government receive contributions from the lobbyists who seek to influence their decision. the government does not only value these contributions, but also cares about aggregate welfare. volume 27, number 1 57 assume that the government's objective has a simple linear form (2) where c j is the contribution of lobby i, w is aggregate welfare, and a is a non-negative parameter reflecting the government's welfare maximizing behavior relative to contributions. in tum, the individual's surplus from consuming good i is (3) the consumer also receives a lump-sum transfer from the government determined by the equally rebated, total tariffrevenues. finally, aggregate welfare is given by where the first term, l, is the aggregate labor supply, and ~ are imports in sector i. remember that if the wage is i, then w will be the sum of labor income, profits, tariff revenues, and total consumer surplus. since factor owners capture only a negligible fraction of the consumer surplus and receive only a negligible fraction from tariff revenues, the objective of these owners may be approximated by ~(p) cp i.e., profits net of contributions. the domestic political game comprises two stages. in the first stage, lobbies make their move, offering financial support the contributions to the incumbent government. these contributions are directly linked to the government's policy, which is simply the acceptability or rejection of the trade agreement. in the second stage, the government has two choices: whether to pursue the fta or not. in the end, a factor-owner policy-contingent contribution schedule will only encompass two numbers: c jn' representing the contributions in favor of the status-quo, and cjf' representing the contributions in favor of the fta. finally, assume that each lobby offers in contributions no more than what it stands to gain if the government were to follow its bidding. effects of an fta consider the effects of an fta on the interests of the different economic agents. to begin with, focus on a single industry i where, without loss of generality, assume that "1 > ,,~~ 1. that is, the domestic price in country a is greater than that 58 journal of business strategies in country b, which in fact is no lower than that prevail ing in the rest of the world. figure 1 depicts the demand for imports by country a and three possible locations of country b 's supply curve -locations that depend on the endowments of the specific factor used in this industry. figure 1 the free trade agreement p; consider two effects of an fta on country members. on the one hand, if country b's supply of good i is relatively small to suffice country a's import demand, as the case of xf [1] then the equilibrium producer price received by industries in the lower-tariff country will rise toward 1'04. this is the case of enhanced protection. i in contrast, the endowment of specific factor in country b may be so large that it suffices to satisfy a's import demand at the lower price 'rfi situation depicted by supply curve x~ [3]. in this case, a's import-competing industries see their price falling as well as their profits. this is the case of reduced protection. there is also an intermediate case whenever the supply in country b lies between the higher and the lower price, with the results being a combination of the two previous effects. in order to illustrate the two extreme cases, consider now an industry that experiences enhanced protection. producers in b benefit from their preferential access to a's market whereas producers in a are unaffected, given that their domestic price does not change. regarding the welfare in a, the only effect is the decrease in tariff revenues, which is an adverse effect product of the diverted trade from the more efficient rest of the world to the partner b. the total welfare change in a is volume 27, number 1 59 (5) in country b, aggregate welfare necessarily rises because of two components : first, profits of the export sector increase given the higher price received in market a; second, the country substitutes domestic supply with international supply, thus gaining from an increase in tariff revenues. the total welfare change in b is (6) it is straightforward to show that the welfare loss in a exceeds the welfare gain in b, which reveals the global efficiency cost of the trade diversion effect. as for the reduced protection case, one can see that exporters in b gain nothing from the agreement, while producers in a bear the increased import competition. since all imports in a come from b now, tariff revenues from this sector fall to zero. however, average voters in this country gain as consumers, since the domestic price in a decreases toward t~. the change of aggregate welfare in a is (7) which may be positive or nonpositive. country b receives only the extra tariff revenue generated by the partial substitution of domestic supply with foreign supply. welfare change in b is l1w~ = (t~ l)m1(t~) . (8) it is easy to see that welfare gains for the fta members are assured in the reduced protection case. this arises from the trade creation effect of trading blocs in this set up. as regards to the intermediate case, it simply combines features of the first two scenarios, and the result is ambiguous in terms of the joint welfare of the bloc. equilibrium ftas without exceptions first, i look for the conditions under which an fta will be unilaterally supported in each country. then, i study the conditions under which the negotiations between countries lead to an equilibrium agreement. 60 journal of business strategies suppose that no exclusions (or side-payments) are allowed, so that either all industries are included in the fta or the status quo prevails . under this setting, a necessary and sufficient condition for an fta equilibrium to occur is that both countries unilaterally favor it. thus, consider first a game between lobbies and the government in each country determining the conditions for a unilateral stance that either favors the agreement (outcomes will be denoted with subscript f), or favors the status quo (outcomes will be denoted with subscript n). at this point, i will apply a simplified version of grossman-helpman's model developed by goldberg and maggi (1999) . in this version, a unilateral stance equilibrium results simply from the maximization problem of the joint surplus of the government and domestic lobbies ~ which i loosely call the "political welfare". therefore, the government unilaterally will favor an fta if and only if, (9) thus, the government will simply favor the agreement if the political welfare under the fta weakly exceeds the political welfare under the status quo. it is certainly possible that inequality (9) fails to hold in either of the two countries, making the fta infeasible. it is shown that the viability of an fta that does not allow for industry exclusions depends on how balanced is the trade between potential members of the agreement. in words ofgawande et al. (2005), "an fta among countries is most likely when trade between them is sufficiently 'balanced '. " in showing this result, grossman and helpman consider a special case with specific functional forms and parameters. in fact, i will work on that example below in order to put some structure to the general specification of the three-country setting. equilibrium ftas with exceptions grossman and helpman (1995) show how industry exclusions may make an otherwise infeasible fta politically viable. at this stage, consider the game between lobbies and the government in which a unilateral stance for an fta with exclusions is determined. denote as e(t) the set ofpoliticauy optimal exclusions, where tis assumed to be the maximum number of excluded industries. 6 if there was no such limit t, then all industries having the joint welfare of lobby and government higher in the status quo than under the fta would belong to that set. for future consideration, denote the change in joint welfare of sector i as volume 27, number 1 61 (10) where l1h = h f h n and l1w = w,. w n • notice that if no restrictions were imi i i 1 ir 1 posed, the set of exclusions would comprise all industries for which gi < o. consider the case where there is indeed a constraint t on the number of exclusions. then, it is not hard to see that when this constraint binds, the t excluded industries would be those with the most negative joint welfare change. grossman and helpman show that a unilateral stance for an fta does exist if and only if the central finding is that while (9) may fail to hold, inequality (l i) can be satisfied. that is, whereas a unilateral stance favoring an fta without exclusions may fail, a unilateral stance for an fta in which the most sensitive industries can be excluded may favor the agreement. following gawande et ai. (2005), one can rewrite (9) as lsi 2: 0, and (j i) as l ihg; 2: o. since the latter excludes the sectors with most negative joint welfare changes, it is clear that inequality (11) is easier to be satisfied. in this stance, import-competing industries are the most politically sensitive sectors in the economy. thus, they are the first candidates to push the government for being excluded from the agreement. tn contrast, industries that can eventually export to the partner country at the expense of the rest of the world are the most favored by the agreement and they make contributions to the government in order to be included. consider now the next stance where both governments negotiate for the agreement. assuming that unilateral stances iii each country favored an agreement, at this stage both governments bring their lists of exclusions to the bargaining table in order to get a favorable fta with their sensitive sectors excluded. in this sense, lobbies anticipate each possible outcome in making their bids. now, the question is which sectors will be granted exclusions in an equilibrium agreement. to solve this problem, grossman and helpman treat the negotiation process as a cooperative bargaining game and apply a simple nash bargaining solution. therefore, an equilibrium agreement will be designed so that it maximizes a weighted average of the surpluses of the two negotiating governments. since both governments have always the option to reject the agreement, their surpluses are calculated with respect to the status quo. technically, the "threat point" in the nash problem will be the joint welfare of government and domestic lobbies under the pre-fta scenario. 7 62 journal of business strategies from the resulting equilibrium, it follows that exclusions are granted to industries for which the weighted difference between the political benefits in the exporting country and the political costs in the importing country is most negative. one can also identify the sector excluded through an ordering that depends only on aggregate conditions and on supply and demand characteristics. it turns out that the same factors that determine the politically optimal set of exclusions in each country at a unilateral stance also enter into the configuration of the set of exclusions in the negotiation between partners. the following section compares these results with the results one finds in a three-country model. the multilateral trade agreement in the previous section, i described the grossman and helpman 's (1995) model of ftas, where the analysis is centered on two small countries and the rest of the world. now, i consider a world of three countries denoted by a, b, and c, and study the viability of a multilateral trade agreement. the first subsection will assume that two of them are already members of an fta. the second subsection will evaluate the prospects of a multilateral agreement, starting from the status quo. the next task is to compare which of both positions (either fta or status quo) are closer to the possibility of global free trade. i could have alternatively considered a more general problem with endogenous formation of either an fta between any two countries or a multilateral agreement. however, since my interest is to characterize the prospects of multilateral liberalization both before and after the formation of an fta, it is beyond the scope of this study to endogenize the country's choice of a partner or group of partners. in particular, my final goal is to analyze the effects of preferential trade agreements formed in the grossman-helpman 's context on the viability of a multilateral liberalization. multilateral liberalization with ftas as in the preceding section, i begin here with the analysis of the viability of a trade agreement without exceptions. first, consider the game between lobbies and the government. also as before, the maximization problem of the joint surplus of government and domestic lobbies brings about a unilateral stance equilibrium in each country. assume, without loss of generality, that countries a and b are members of an fta. then, governments a and b will unilaterally favor a multilateral agreement (outcomes are denoted with subscript m) if and only if, volume 27, number 1 63 (12) i.e., if the political welfare from multilateral liberalization is greater than that from the fta in each country. country c will unilaterally favor a multilateral agreement if and only if, ~lle + we > ~lle + we ~i im a m ~i in a n' (13) i.e., country c will favor an agreement if and only if the political welfare under multilateralliberalization is greater than the one under status quo. the analysis of the viability of a multilateral trade agreement with no exceptions turns out to be straightforward. now, consider the viability of an equilibrium multilateral trade agreement with industry exclusions, by first introducing the game between lobbies and government at a unilateral stance. i denote by e(t) the set of politically optimal exclusions to the multilateral agreement. this set may differ with respect to the previous set of exclusions from the fta the set e(tj.8 continue denoting the change in joint welfare by gi = !j.~ + a!j.w;, where the changes are expressed with respect to the fta in countries a and b, and with respect to status quo in c. rt is straightforward to replicate inequality (11), which shows the conditions for a unilateral stance bilateral agreement with exclusions, for the multilateral case. thus, the multilateral liberalization is favored in countries a and b if and only if ~. (lli. + awi-j +~ . (ip + aw)) >~. (ip + aw) ) + ~/e£ in rn ~lee 1m 1m .4..jie£ /iv in lih(llfr· + aw!r-), (14) forj =a, b. on the other side, country c favors the agreement if and only if the subscript "ir in expression (14) is used to distinguish between the outcome of industries excluded from the multilateral agreement and that of industries excluded from the fta expressed with the subscript "n". notice that a particular sector in either of countries a or b can contribute in two ways for an exception to the multilateral agreement. it can contribute to continue with the behavior as in status quo prevailing before the fta was approved, as an industry already excluded 64 journal of business strategies from the fta. or, it can contribute to stay "inside" the fta, which still is a possible scenario ifthe multilateral agreement is rejected. once again, one can observe that, while inequality (13) for country c may fail to hold, inequality (is) can hold if one allows for the most sensitive industries to be excluded. notice that this may not be the case for countries a and b, since inequality (14) introduces two sets of exclusions, one arising from the fta and the other arising from the multilateral agreement. now consider the next stage where all the governments bargain for the multilateral agreement. as in grossman and helpman (1995), each government exposes its list of exclusions at the bargaining table. as in the previous section, i will analyze the negotiation process through the implementation of a nash bargaining problem. it has been proved that the properties of a nash bargaining solution with two players continue to apply in an nplayer bargaining game (see krishna and serrano, 1996). then, the equilibrium agreement will be designed to maximize a weighted average of the "surpluses" of the three negotiating governments. since the governments always have the option to reject the agreement, their surpluses are calculated, in the cases of countries a and b, with respect to the fta and, in the case of country c, with respect to status quo. in other words, the "threat points" of the nash problem will be the joint welfare of government and domestic lobbies before the multilateral liberalization is negotiated.9 similar to the result obtained in grossman-helpman's fta model, we find that exclusions are granted to industries for which the weighted difference between the political benefits in the exporting countries and the political costs in the importing countries is most negative. i further look for identifying the industry exclusions by performing an ordering that depends only on aggregate conditions and on supply and demand characteristics. once again, it turns out that the same factors that determine the politically optimal set of exclusions at a unilateral stance also determine the set of exclusions in the multilateral negotiation process. multilateral liberalization from status quo what are the chances that the three countries liberalize trade multilaterally, provided that none of them is member of an fta? in this case, governments a, b, and c will favor a multilateral agreement without exclusions if and only if, lfifm + aw~ ~ lpfn + aw£, forj = a, b, c, (16) volume 27, number 1 65 i.e., if the political welfare from multilateral liberalization is greater than that from status quo in each country. furthermore, the multilateral liberalization with exclusions is described by means of a nash bargaining problem, where the surpluses of the three governments are calculated with respect to the status quo.1o the question, however, is whether the countries have more incentives to liberalize trade departing from the fta position or from status quo. for this analysis, naturally, it is sufficient to consider the pure cases, i.e., the cases without exclusions to either the fta or the status quo. this is so because, for each case, we must compare the changes in the political welfare toward global liberalization. if we, for example, consider exclusions at the stage of negotiations for the fta, then the changes in political welfare from the fta position will be such that those corresponding to the excluded industries will cancel out with the changes in political welfare from the status quo position. if we, for example, consider exclusions at the stage of negotiations for the multilateral liberalization, then we will find the following scenario. suppose that, without exclusions permitted, the prospects of multilateral liberalization are higher from the status quo position than from the fta position. then, for a particular set of exclusions at the fta that help favor the multilateral agreement (the most sensitive ones), we would also find another set of sectors excluded at the status quo level that help favor the global agreement (also the most sensitive ones), and will enhance the prospects to reach the accord. the reverse case also holds. following the preceding reasoning, and operating on (12), (13) and (16), one obtains the natural answer that the sole presence of a political-welfare improving fta will lower the prospects for multilaterauiberalization with respect to the status quo [inequality (9) must hold for both a and b]. in the next section, i will show that under certain conditions an fta is viable (with and without exceptions), yet, the multilateral liberalization is not feasible under any circumstance. an illustration in order to narrow the set of general results found in the preceding section, i will work here with a particular specification of the model introduced originally in grossman and helpman (1993). i will depart from that setting to study both the determinants of ftas and the determinants of multilateral liberalization. 66 journal of business strategies suppose that households in the three countries share identical utility functions, where all the non-numeraire goods enter symmetrically and each u;(.) is quadratic. then, the aggregate demand for any good i in country j has the linear form d j (.qi) = d bqj, , , , (17) for i = 1, . .. , nand j = a, b, c, where d and b are both positive parameters. assume that the supply of each good is symmetrically inelastic in both countries a and b. the first country has supply x~ = ex in s x n industries, and x~ = (1 e)x in (l s) x n industries. the second country has supply x~ = (l e)x in s x n industries, and x~ = ex in (1 ~ s) x n industries. the parameter s indicates the fraction of a type of industries in each country, whereas the parameter measures output imbalance in anyone sector, i.e., the relative size of output in any sector in each country. without loss of generality, consider e > 112 and s ~ 112. assume that country c is an exporter of all goods, and that it can supply any quantity at given world prices standardized at i. this assumption is introduced in the illustration in order to avoid tenns of trade effects created by externalities that may emerge from the formation of any agreement. the illustration consists of two stages. in the first stage, i will analyze the economic effects of an fta between a and b. as one expects, this does not affect country c's welfare since the international price is unchanged. later, i will focus on the viability of multilateral liberalization between a, b, and c. it is clear that, once again, this will not affect outcomes in c, thus this country will be indifferent toward the agreement. further, i will study the scenario where countries a, b, and c evaluate their prospects for multilateral agreement, starting from status quo. finally, i will contemplate the cases in which sets of industries are allowed to be excluded from the agreements. the viability of any agreement, whether bilateral or multilateral, depends on the initial structure of mfn tariffs. in this sense, assume that tariffs initially protecting the import-competing industries in each economy result from a lobbying game as derived in grossman and helpman (1994). further, suppose that politicians in each country place the same weight a on aggregate welfare. thus, given the set of assumptions made so far, we obtain the following domestic prices in a and b: ~ orj= l+-' 0; ab ' (18) volume 27, number 1 67 for j = a, b , and for all sectors in which imports are positive in the initial equilibrium . regarding country c, remember that being the exporter of all goods implies that r<:' = 1 for all i. i grossman and helpman (1995) emphasize that different types of outcomes may emerge in this example depending on the parameter values. according to this idea, we can examine three different sets of parameter restrictions illustrating some relevant cases that may appear. i will focus on one of those sets of parameters in order to study the case in which an fta certainly emerges in the first step. this is the case in which all sectors experience enhanced protection. for the remaining sets of parameters, all sectors experience reduced protection, and an fta will not be feasible, even with exceptions. moreover, it is clear that a multilateral liberalization will not be feasible either, as they would also imply reduced protection for all industries, in both countries a andb. viability of an fta suppose that a and b start negotiating on an fta. consider the following restriction on the parameters ii bx x < d-b(l +-). ab (19) under this condition, all n goods are imported in both countries in the initial equilibrium. country a has the higher import tariff in the fraction s of industries where its supply is bx, while country b has the higher import tariff in the remaining sectors. under an fta, each country will .import from its partner all goods on which their mfn tariffs are higher. then, a would import from b a fraction s of goods, while b would import from a the remaining goods. also, the restriction above implies that output in the low-tariff country would not suffice to satisfy import demand in the partner country at its pre-fta domestic price. as a result, all sectors will experience enhanced protection. one can calculate the contribution of both types of industry to the change in the joint welfare of government and lobbies from the agreement. given these contributions, one finds that an fta is supported in country b for every s 2: 112, while country a will favor the agreement if and only if 1 b 112 s < + < 1 2 2b 1 + 2ab . (20) 68 journal of business strategies notice that inequality (20) will only be satisfied for s sufficiently close to 1/2. consider now the possibility that governments grant exclusions to a number of sensitive industries. the grossman-helpman's approach provides, through this illustration, the idea that exceptions can save an otherwise unfeasible fta. consider the proposal to exclude a number £a of sectors in which a would import from b, and a number eb of sectors in which b would import from a, and let ea + eb ~ e be the wto rule. recalculating the joint welfare change of government and lobbies in country a under the possibility of exclusions, we obtain the following range of values of s for which an fta would be feasible: 1 b 112 ab£a (2b 1 + ab)eb s <+ + -------2 2b 1 + 2ab n(2b 1 + 2ab) (21 ) it can be shown that if ea > (2b 1 + a b)ebla b, then inequality (21) implies an expansion of the range of s for which the agreement is accepted by a. at the same time, if ea < [£rab + (2s -1)nab + sn(2b 1)}/(2b 1 + ab), then the fta with exclusions is also supported by government b. this is roughly illustrating the fact that there are values of s for which the fta would be rejected without sectors exclusions, but favored with them. in particular, one can show that if (2s 1) < eln, then the fta with ea = (2s 1)n and £r = 0 satisfies wto rules and politically dominates the status quo. however, this is not the only set of exclusions that allow for an equilibrium agreement. so far, we have revisited a particular specification of the model analyzed in grossman and helpman (\993). through this illustration, it is shown that there are cases in which an fta would fail if all trade has to be included, while it might be preferred if exclusions are allowed. it remains to show that both governments engage indeed in an efficient negotiation process. however, one can be safe from this particular issue, because there are in fact different alternatives assuring that a certain negotiation process would eventually lead to an equilibrium set of exclusions and, consequently, to the acceptance of the agreement in both countries . 12 the viability of a multilateral agreement now, i will study the viability of a multilateral agreement among countries a, b , and c. first, i consider the prospects for multilateral liberalization, taking as given that an fta between a and b has been formed already. for this purpose, i will continue with the assumption that bilateral agreement arises from (and creates) enhanced protection. i will begin by studying the viability of an agreement on all volume 27, number 1 69 trade and, later on, i will analyze the case where a set of industries can be excluded from the agreement. second, i consider the prospects for multilateral liberalization, starting from status quo, i.e., assuming that the three countries engage in only one round of multilateral negotiation. in the first case, notice that all industries in country a and b will experience reduced protection after the multilateral agreement, since all goods are exported by the low-price country c. as a result ofthe multilateral liberalization on all trade, the contributions of the two types of sectors to the change in the joint welfare of both countries are negative, for any previously configured set of sectors excluded from the fta. this gives us the first result from this illustration. 13 result 1: the multilateral trade agreement without exceptions is not favored either in a or b, for any set of exceptions that may have arisen in the equilibrium fta. consider now the possibility of allowing for exclusions to the multilateral liberalization. in this case, the wto rule would admit ea + eb + ec :s e. however, country c will be indifferent about the agreement as it is the exporter country. thus, one can further set ec = o. according to the previous discussion, now assume that the first-step negotiation on the fta provided the least set of exclusions: ea = (2s l)n and eb = o. one expects that the industries excluded from the original fta continue to be excluded from the multilateral liberalization, given their relative high cost to the welfare of both a and b. denote as e~ c ea the set of exclusions to the multilateral agreement, out of the set of exclusions from the fta stage. setting the least set of exclusions possible, e~ = (2s -l)n, we find that there is no ea and eb such that the joint welfare changes in both countries a and b are positive at the same time. this leads to the second result from this illustration. result 2: the multilateral trade agreement with industry exclusions is not favored either in a or b, for any set of exceptions that may have arisen in the equilibrium fta. this result comes from the fact that any increase in the set of exclusions that may favor the agreement in a leads to a rejection by country b, and vice versa. roughly, this occurs because both countries experience reduced protection in all industries from the multilateral liberalization. 70 journal of business strategies now the question is, was the multilateral liberalization feasible before countries a and b have engaged in an agreement? in other words, did the fta between these two countries impede the multilateral agreement? in what follows, i will analyze the viability of a multilateral agreement starting from status quo. we will arrive at the conclusion that, beginning from a position where no country has a trade agreement, the status quo is preferred to the multilateral liberalization in both countries, while country c is still indifferent. furthermore, the rejection of the agreement arises because countries a and b experience reduced protection in all their industries. in this sense, even though aggregate welfare increases in both countries as a result of a fall in: prices, the decrease in profits from the importcompeting industries is high enough to make the political welfare changes negative. if one allows for exclusions to the grand accord, rejection results do not change. this leads to the third result from this illustration. result 3: the multilateral trade agreement, either with industry exclusions or without them, is not f easible from the status quo position. given results 1 and 2, the third result completes the set of (political) conditions supporting the view of ftas as being partial building blocs, i.e., these agreements can be feasible when the multilateral agreement is not. to summarize, i have revisited a particular specification first appeared in grossman and helpman (1993), where an fta between two countries (a and b) is feasible under certain conditions. they show that the prospects for a bilateral agreement increase when one allows for a number of exclusions in the sensitive import-competing sectors. afterwards, i have analyzed the viability of a multilateral agreement by introducing a third country (c) . based on the assumptions made above, it is not required that country c be active in the negotiations process because it is indifferent about any agreement. in spite of this simplicity, this setting allows us to think about the possibilities that arise for country a and b to coordinate a reduction of tariffs. we have observed that the political conditions do not help in providing a good reception toward the agreement in either a or b (with exclusions and without them). the reason is the presence of a reduced-protection effect in all sectors in both economies. however, global free trade was not feasible from status quo either. as such, one can assert that, for a special characterization of the grossman-helpman framework , ftas become partial building blocs. volume 27, number 1 71 concluding remarks the big picture issue of this paper is related to the dynamic path of trading blocs and whether preferential trade agreements are building or stumbling blocs. to address this issue, i have initially departed from grossman and helpman's (1995) model of ftas. that model was designed to explain the viability of a free trade agreement between two small countries where governments not only maximize aggregate welfare but also take into account the contributions from domestic special-interest groups. the model also provides the conditions needed for the agreements to be politically viable with some exceptions on sensitive industries. i have taken that approach to explain a bilateral formation and have extended it to study the viability of a grand accord with a third potential partner. the extension is intended to investigate the conditions for multilateral liberalization to be politically viable both from a position where an fta already exists and from status quo. we have observed that an extension to the model's general form does not help us to determine whether an fta is a building or a stumbling bloc. however, we do find that, provided an fta exists, the chances for favoring a multilateral agreement will fall. one might guess that finding a global agreement with exclusions is less likely than finding an fta with exclusions. this stems from the fact that the set of outcomes in which an agreement is favored on a multilateral bargaining must shrink. this conjecture is not proved here, and is left for future research. however, an illustration with specific functional forms helps us characterize the viability of a multilateral liberalization. for a set of restrictions on the parameters, reduced protection arises on all industries if the fta is formed. in these cases, results are not appealing since a bilateral agreement does not emerge in the first stage and neither multilateral agreement is feasible from status quo. this happens because of the assumptions made on the two negotiating countries, and in particular, because reduced protection leads industries to successfully pressurize the government in favor of status quo. for another set of restrictions, enhanced protection arises from the fta. in these cases, alternatives exist in which an fta is feasible and, furthermore, these alternatives expand when exclusions are permitted. nevertheless, i have shown that, at a second-stage, a multilateral liberalization is not viable under any circumstance: with exclusions or without them. the multilateral liberalization is also not feasible from status quo. to sum up, there exists a set of conditions under which an fta acts, in a limited sense, as a partial building bloc: when the global accord is not feasible under 72 journal of business strategies any scenario, a political-welfare improving fta can be attainable. a bilateral agreement does not raise aggregate welfare for it generates enhanced protection. neither it serves for the signing countries to get closer from multilateral liberalization. yet, the results imply that, under certain conditions, this is the situation to which countries would eventually converge. that is, there will be a scenario with a large number of ftas, where governments and lobbies maximize their joint welfare. in order to have a more robust answer regarding the viability of a multilateral trade agreement, we must relax the strong assumptions made in the illustration. nonetheless, i believe this work constitutes a step forward in our understanding ofthe dynamic-path issue of trading blocs from a political-economy perspective. notes 1. this is a shortened version of a paper written under a grant from the private enterprise research center at texas a&m university. i am grateful to kishore gawande for numerous conversations on this topic. i also thank amy glass, kamal saggi, the editor, an anonymous referee, and seminar participants at texas a&m university and sam houston state university for helpful comments. all errors are my own. 2. in what follows, i will use indistinctly the terms fta and pta. the latter is more general in the sense that it implies a reduction of external tariffs among members (including, of course, the possibility of lowering tariffs to zero), whereas the former implies the simple elimination of members' tariffs. since this work will treat any agreement as simply removing barriers, then both agreements are identical. note that, in addition, one may consider other types of trade agreements such as a customs union (an agreement whereby all members impose a common external tariff), yet, i restrict the analysis here to the fta case. 3. see panagariya (2000) for a survey of this literature. 4. in practice, the size of the set of exceptions should not violate the wto clause which states that an fta should cover isubstantially all trade". 5. grossman and helpman (1995, pp. 669) recognize the importance of relaxing this assumption. in a paper related to this literature, a different approach taken by ornelas (2005) allows for external tariffs to be endogenous after a trade agreement. he shows that strategic and distributive effects of an fta reduce the importance of politics in defining a multilateral trade liberalization. an extension on this line, however, is beyond the scope of this paper. volume 27, number 1 73 6. this restriction, which in a sense is obeying wto rules, can be more general. for instance, another restriction could be expressed as a limit on the fraction of excluded trade. 7. the reader may find the details of the formal problem in grossman and helpman (1995). 8. assume, for simplification, that the number of restrictions t is the same as the one for the ft a. 9. the formal problem is described in a technical appendix, which can be obtained from the author upon request. 10. the formal problem is described in the technical appendix. ii. see grossman and helpman (1993) for the details regarding the origin of these restrictions. 12. grossman and he1pman (1993) suggest that this bargaining process can be modeled as an alternating bargaining game a la binmore et al. (1986). on the other hand, as i mentioned above, grossman and helpman (1995) solve this bargaining problem by applying a nash solution. 13. the detailed proofs of these results can be obtained from the author. references aghion, p., p. antras, & helpman, e. (2007). negotiating free trade. journal of international economics, 73(1), 1-30. bhagwati j. (1991). the world trading system at risk. princeton, nj: princeton university press. bhagwati, j. (1993). regionalism and multilateralism: an overview. in j. de melo & a. panagariya (eds.), new dimensions in regional integration. cambridge: cambridge university press. bhagwati j. (1995). us trade policy: the infatuation with free-trade areas. in j. bhawati & a. kruger (eds.) the dangerous drift to preferential trade agreements. washington, dc: american enterprise institute for public policy research. binmore, k., rubinstein, a., & wolinsky, a. (1986). the nash bargaining solution in economic modeling. rand journal of economics, 17, 176-188. gawande, k., sanguinetti, p., & bohara, a. (2005). exclusions for sale: evidence on the grossman-helpman model offree trade agreements, mimeo. 74 journal of business strategies goldberg, p., & maggi, g. (1999). protection for sale: an empirical investigation. american economic review, 89, 1135-1155. grossman, g., & helpman, e. (1993). the politics offree-trade agreements, nber working paper no. w4597. grossman, g., & helpman, e. (1994). protection for sale. american economic review, 84, 833-850. grossman, g., & helpman, e. (1995). the politics of free-trade agreements. american economic review, 85,667-690. krishna, p. (1998). regionalism and multilateral ism: a political economy approach. the quarterly journal of economics, 113, 227-252. krishna, v., serrano, r. (1996). multilateral bargaining. review of economic studies, 63, 61-80. ornelas, e. (2005). rent destruction and the political viability of free trade agreements. quarterly journal of economics, 120(4), 1475-1506. panagariya, a. (2000). preferential trade liberalization: the traditional theory and new developments. journal of economic literature, 38, 287-331. saggi, k., & yildiz, h. m. (2006). bilateral trade agreements and the feasibility of multilateral free trade, mimeo. summers, l. (1991). regionalism and the world trading system. policy implications of trade and currency zones. federal reserve bank of kansas city, 295-301. viner, j. (1950). the customs union issue. new york: carnegie endowment for international peace. biographical sketch of author danilo r. trupkin is a professor of economics at the universidad de montevideo, uruguay. his research interests are in the areas of macroeconomics, monetary economics, and international trade. he is the editor of revista de ciencias empresariales y economia. dr. trupkin has collaborated as a researcher in a number of projects on international trade policy at torcuato oi tella university and the undersecretariat of foreign trade at the ministry of economy of argentina. he earned his ph. d. in economics from texas a&m university, college station (tx). on the viability of a multilateral trade agreement: a political-economy approach risk propensity, trust, and transaction costs in relational contracting john k. masters louisiana state university shreveport shreveport, la grant miles derrick d'souza university of north texas denton, tx john p. orr mckendree college lebanon,il abstract critics of transaction cost economics (tce) argue that tce is not able to explain variations in governance arrangements between the extremes of market and hierarchy. they further dispute the assumptions of opportunism and risk neutrality underlying the theory. while tce proponents have developed approaches that address each of these criticisms separately, we propose that combining the approaches to simultaneously address both challenges alters the nature of the predictions. we explore the roles of risk propensity and trust within a tce framework. we then test the ability of these variables to predict variations in governance between the extremes afmarket and hierarchy. the increasing prevalence of a broad class of organizational forms that are neither market nor hierarchy has challenged traditional notions of organizational relationships. perhaps nowhere are these challenges more clearly seen than within the study of transaction cost economics (tce) (coase, 1937; williamson, 1975). critics have challenged both the market/hierarchy dichotomy that originally served as the foundation for tce and the behavioral assumptions that underlie the theory. in response to these challenges, researchers have proposed modifications to the basic tce theory. proposed adjustments include moving from a dichotomy to a continuum, where hybrids fall between the end points of market and hierarchies (williamson, 1985; 1991), and the inclusion of behavioral variables as moderators within the model rather than as underlying assumptions (chiles and mcmackin, 1996). while each of these proposed modifications is built on a reasonable logic, there has been little, if any, empirical assessment of the 48 journal of business strategies vol. 21, no.1 predictions. more importantly, because each modification was proposed independently, the effect of concurrently including both of the modifications within the model has not been considered. when they are, the predictions ofthe model may be very different from what either would individually propose. to help advance our understanding in this area, then, the current study includes trust and risk propensity in a tce framework and examines their influence on the form of governance taken within a particular exchange relationship between firms. we begin by briefly reviewing tce and its assumptions regarding opportunism, risk, and the role of trust. next, we explore alternative ways that these concepts might be handled within a tce context and develop hypotheses regarding the role of each of the variables. we then describe an empirical test of the hypotheses and discuss the results. a discussion of the implications of the results both for tce in particular and for organizational forms in general concludes the paper. literature review in transaction cost economics (tce), three characteristics of a given transaction are purported to influence the choice between market and hierarchical governance mechanisms: the need for transaction-specific investment, the likelihood of repetition, and uncertainty of performance (coase, 1937; williamson, 1975). as the level of each characteristic increases, the transaction becomes more likely to be governed using hierarchical rather than market governance mechanisms. three assumptions regarding human nature are critical to this calculus. bounded rationality addresses managerial behavior which is "intendedly rational, but only limitedly so" (simon, 1961: xxiv). under bounded rationality, decision makers do not possess or are not able to process complete information. opportunism, defined as "self-interest seeking with guile" (williamson, 1975: 26), requires not that all actors behave opportunistically, only that some do and that it is difficult or costly to determine which actors will behave opportunistically. risk neutrality means that decision makers are indifferent between certain and uncertain returns as long as the expected value of the uncertain returns is equal to that of the certain returns over the longer term (aoki, 1984). modifications to tee while a number of critics have challenged this traditional conception of tce, the criticisms can be broadly grouped into two areas. the first group of critics challenge the behavioral assumptions underlying tce. while the assumption of bounded rationality has not been challenged, both the notions of risk neutrality and opportunism have prompted considerable debate. that decision makers have variable risk preferences has been well established (e. g., kahneman and tversky, 1979; march and shapira, 1992; sitkin and pablo, 1992). further, these risk preferences have been shown to substantially influence decision outcomes (sitkin and pablo, 1992; tversky and kahneman, 1992). spring 2004 masters et al: relational contracting 49 even williamson acknowledges that the risk preferences of decision makers, "for some purposes can be of utmost importance" (1985: 389). he nevertheless adopts an assumption of risk neutrality in tce. critics have also challenged tce's underlying behavioral assumption of opportunism (pratten, 1997). at a general level, these critics charge that trust is a more realistic characterization of economic actors than is opportunism (bradach and eccles, 1989; granovetter, 1985; hosmer, 1995). in this view, trust goes beyond simple self interest seeking and suggests a willingness to do business with a party even when that other party may be in a position to take advantage. williamson (1993) has argued that the social relations necessary to produce such trust are likely to be found only in very close personal relationships and not in economic exchange. there is, however, at least some empirical evidence to suggest that trust goes beyond self-interest and is in fact found in economic relationships (tyler and degoey, 1996). other researchers have shown that trust can change perceptions regarding opportunism (nooteboom, berger, and noorderhaven, 1997). chiles and mcmackin (1996) have suggested that both risk propensity and trust can be handled within a tce framework. they proposed that, rather than treating these variables as underlying behavioral assumptions, trust and risk propensity may actually serve as moderators of the relationship between tce variables and governance mechanisms. they argued that markets work as a governance mechanism because, in the face of opportunistic behavior, either party to the transaction can switch to another transaction partner. the need for transaction specific investment, though, creates a condition of small numbers bargaining. having invested in assets specific to the exchange, at least one of the parties involved cannot walk away from the deal and revert to a free market exchange without giving up some part of the value of those investments. this condition, in turn, increases the risk of opportunistic behavior by the other party and brings pressure to internalize the transaction by moving from the market to a hierarchy governance structure. this risk of opportunistic behavior resulting from transaction specific investment links tce with both risk propensity and trust. speaking particularly to the case of asset specificity, chiles and mcmackin (1996: 82) presented a model showing that the level of asset specificity necessary to trigger the shift from market to hierarchy would be higher for those firms whose managers are risk seeking and lower for those firms whose managers are risk averse (the common notion of risk neutral managers falls in between these extremes). similarly, they posited that increasing levels of trust would further increase the level of asset specificity necessary to bring about the shift from market to hierarchy. this conceptualization, though, is predicated on tce's original view of governance as a choice between market or hierarchy. a second group of critics have challenged this view. critics of this polarization of governance into a dichotomy of markets and hierarchies (e.g., hennart, 1993; noorderhaven, 1994; robins, 1987) note 50 journal of business strategies vol. 21, no. i that many transactions are governed neither by market nor by hierarchy, but rather reflect characteristics of both forms. these hybrid forms have proven to be relatively stable over time (eccles, 1981). studies in support of tce (e.g., klein, crawford and alchian, 1978; masten, meehan and snyder, 1989; monteverde and teece, 1982; walker and weber, 1984), the critics assert, are unable to explain differences in the levels of integration between firms (hennart, 1993; mcwilliams and gray, 1995). the critics view as a central failing of tce its apparent inability to account for multiple organizational forms to govern seemingly similar transactions. to address the challenge of organizational form, tce theorists have introduced the notion of hybrid transactions into the governance model, making the pure market and the pure hierarchy the extremes of a continuum (williamson, 1985, 1991, 1999). hybrid transactions are based on the notion of relational governance, in which the formal contract serves as a framework for development of a long-term relationship (heide, 1994; macneil, 1978, 1980; williamson, 1985, 1991). the concept of quasi-integration (blois, 1972; mcwilliams and gray, 1995) has proven useful in viewing tce as a continuum. quasi-integration refers to the strength of ties between firms. the ties between firms may be stronger, resembling a hierarchy, or weaker, as expected under market governance. the strength of these ties is thought to be predicted by the same transaction characteristics posited in the traditional tce model. risk and trust in relational contracting the proposals set forth by williamson (1985, 1991, 1999) and by chiles and mcmackin (1996) both present interesting ways of addressing the challenges to tce. each of these arguments, however, deals with one of the criticisms of tce while ignoring the other. on the surface, combining the proposals would appear to be a straightforward task since williamson's modification alters the outcome variable while chiles and mcmackin's proposals focus on the inclusion of moderators. as asset specificity increases, firms would move from market governance into hybrid arrangements and, at sufficiently high levels of asset specificity, into a formal hierarchy. such movement would be moderated, though, by the risk propensity of the managers involved in the decisions and the level of trust they have in their partners. incorporating the view of tce as a continuum, though, changes the logic on which chiles and mcmackin (1996) based their propositions. they argued that markets work as a governance mechanism because the ability to act opportunistically is vitiated by the threat that the parties to the transaction can freely switch to a different transaction partner. the need to invest in transaction-specific assets limits this ability to switch by creating a condition of small numbers bargaining. consequently, firms move to hierarchical governance under conditions of high transaction-specific investment. in relational contracting, though, this movement creates a conundrum. firms move toward hierarchical governance without moving to hierarchical goverspring 2004 masters et al: relational contracting 51 nance. by creating close ties with a transaction partner, the parties have limited the power of the market to govern the transaction. they have not, however, entered the safety ofhierarchical governance until they truly integrate, creating a superordinate authority. ring and van de yen (1994) built on social comparison theory (kelly and thibault, 1959) to contend that close inter-organizational relationships foreclose opportunities for developing alternative relationships, thereby limiting the power of the market to govern exchange. this foreclosure of alternatives comes from the nature of relational contracting. relational contracting differs from both market contracting and authoritybased (hierarchical) governance. market contracting is characterized by clear, complete, essentially simultaneous exchange. since no future transactions influence the exchange, the parties reach agreement based on an evaluation of the equality of exchange in the current transaction (macneil, 1980; ring and yan de yen, 1992). relational contracting, in contrast, does not anticipate that the individual transaction is complete in itself. relational contracts anticipate a series of uncertain, open-ended, incomplete exchanges over a moderate to long term. the relational contract is evaluated based on equity rather than equality. at any given time, one party may have given more than they have received (macneil, 1980; ring and van de yen, 1992). constant monitoring to see which party is ahead in the game can undermine the relational contract. in a longitudinal study of several inter-organizational relationships, van de ven and walker (1984) found that excessive monitoring and the use of formal safeguards led to distrust among the parties and increased the likelihood that the relationship would be severed. over time, the transactions become more socially em bedded and informal psychological contracts increasingly substitute for formal contractual safeguards. "investments include not only economic and technological resources of participating firms, but also social commitments and entanglements of individual agents" (ring and van de ven, 1994: 106). moreover, these commitments tend to persist in spite of growing inefficiencies or escalating risks associated with the relationship. a longitudinal study of three inter-organizational relationships that were showing increasingly poor results supported the social embeddedness effect. despite the increasing evidence of the failure of the relationships, none of the parties took steps to end the relationships. in each case, the eventual termination required the intervention of outsiders not previously associated with the relational contract (yan de yen, et. ai., 1989). as granovetter (1985) noted, the emergence oftrust does not guarantee trustworthy behavior and may even increase the potential for opportunistic behavior. by choosing a relational form, then, firms create their own condi tion of small numbers bargaining. we propose that this movement increases the risk of opportunism. in relational contracting, where close ties with a single transaction partner are developed without entering the safety of the hierarchy, the parties put themselves at greater risk of opportunistic behavior by their transaction 52 journal ofbusiness strategies vol. 21, no.1 partners. this risk would increase as the firms developed closer ties until the firms truly integrated their operations. the result of this movement can be pictured as a kinked risk curve (see figure 1). figure 1 the kinked risk curve h risk of opportunism l markets ....liilf---quasi-integration --... hierarchies l closeness of the ties between firms h the predictions of chiles and mcmackin (1996) that applied to the pure market and the pure hierarchy would not hold true for the hybrid forms occupying the middle ground. the contrast between this new view oftce in hybrid relationships and the previous views of tce from which it is derived are depicted in figure 2. figure 2a depicts the traditional tce view of asset specificity, with risk neutrality and opportunism assumed. figure 2b incorporates the views of chiles and mcmackin (1996) where risk propensity and trust function as moderators that decrease the likelihood that firms will switch from market to hierarchy in the face of transaction specific investment. the impact of combining the chiles and mcmackin model with the view oftce as a continuum is shown in figure 2c. here, the increased risk of opportunism resulting from developing close ties with a single transaction partner is illustrated as a feedback loop. by choosing closer ties with a single transaction partner, the firms create a condition of small numbers bargaining, thereby exposing themselves to an increased potential for spring 2004 masters et af: relational contracting 53 opportunistic behavior. consequently, decision makers with a higher tolerance for risk, or who have higher levels of trust in their partners, would be more willing to develop close ties with those partners. figure 2 the evolution of transaction specific investment, risk propensity and trust in tee figure 2a: traditional view transactionsmall risk of shift from specific ...... numbers ...... opportunisti market to investment bargaining behavior hierarchy figure 2b: chiles and mcmackin's (1996) view trust transactionsmall risk of (shift from specific ...... numbers ...... ppportunisti market to investment bargaining behavior (hierarchy risk tolerance figure 2c: the impact of risk and trust in ~ relational contracting trust closer ties transactionsmall risk of (+ between specific ...... numbers ...... opportunisti firms (increased investment bargaining behavior (+ quasiintegration risk tolerance i formalizing the predictions of this third model (figure 2c) is now a straightforward matter. ignoring for the moment the impact of risk propensity and trust, the straight-line portion of the model applies the traditional tce logic to the case of relational contracting. here, higher levels of each of the three tce variables are associated with increased levels of quasi-integration. that is: 54 journal ofbusiness strategies vol. 21, no. i hypothesis i: firms will develop closer ties as the levels of asset specificity, likelihood of repetition, and uncertainty increase. as shown in the model, however, these relationships may be moderated by the risk propensity ofthe decision maker. in keeping with chiles and mcmackin (1996), we formally address only the case of asset specificity. hypothesis i suggests that increased asset specifity will lead to closer ties between firms. these closer ties between firms, though, feed back into the model to exacerbate the small numbers bargaining problem and increase the risk of opportunism. now, the decision makers are assessing the level of risk associated with developing closer ties as well as the risk associated with asset specificity. contrary to chiles and mcmackin's (1996) proposition, the preceding argument suggests that, at a given level of asset specificity, risk seeking managers will be more likely rather than less likely to develop close ties with their partners while risk averse managers will be more likely to retain the safety of the market as a fall back position. thus, we predict that: hypothesis 2: risk seeking decision makers will choose closer tiesfor theirfirms at a given level ofasset specificity than will risk averse decision makers. in addition to the moderating effect of variable risk preferences, decision makers also bring pre-existing feelings regarding trust to the table when determining the choice of governance mechanism for any given transaction. it has been argued that trust can be seen as offsetting the perceived risk of opportunism. that is, the more one trusts the transaction partner, the less concern there is about the partner behaving opportunistically (nooteboom, berger, and noorderhaven, 1997). consequently, a higher level of trust in the transaction partner should lead, ceteris paribus, to a greater willingness to adopt governance structures that might increase the potential for opportunism. said more formally: hypothesis 3: firms whose decision makers have a high level oftrust in their transaction partners will develop closer ties at a given level ofasset spec!ficity than willfirms whose decision makers have a low level of trust. methods to test these hypotheses, we investigated motor carrier-shipper logistic alliance relationships. logistics alliances are hybrid relationships that focus on the interface between the motor-carrier and the shipper who coordinates logistics (bowersox, 1990; gentry, 1996). they focus not just on the transacspring 2004 masters et al: relational contracting 55 tion at hand, but rather on building a relationship in which transactions can take place. as such, these alliances provide a particularly fertile ground for the current investigation. we received permission from the council of logistics management to use their national-level membership list of13,000 members to select key informants for the study. based on preliminary power analyses, we mailed a questionnaire following the principles outlined in alreck and settle (1995) and dillman (1978) to operations managers in 1,260 firms (630 carriers and 630 shippers) randomly selected from the membership list. of the 1,260 firms receiving the questionnaire, 324 returned usable replies a response rate of 24.9%. where possible, we selected measures that had been tested and validated in previous research. except as otherwise noted, all the measures used 7 point likert-type scales, with multiple items in each scale reverse-coded. higher scores indicate higher levels of the construct. independent variables asset specificity represents the extent to which assets involved in a transaction can be shifted to an alternate use without loss of value. we measured asset specificity using the ego asset specificity scale developed by nooteboom and his colleagues (nooteboom, et. ai., 1997). in this scale, respondents evaluate the extent to which assets could be converted to alternate uses without reducing their productive capacity. confirmatory factor analysis revealed the expected four dimensions. reliability analysis of the four sub-scales, however, indicated an inter-subscale reliability of .78 and an overall reliability of .83. consequently, we elected to use an average of the scale items as a single entry in the study. williamson (1985) conceptualized uncertainty as performance ambiguity, the degree to which one party to a transaction can monitor the contracted performance of the other party. for this study, uncertainty was measured using the mean of the four-item performance ambiguity scale developed by heide and miner (1992). respondents are asked to evaluate their firm's ability to assess performance in terms of direct supervision, standardized inputs, standardized processes, and standardized outcomes. this measure loaded on the expected single factor and showed an acceptable reliability (a = .72). following zaheer and venkatraman (1994, 1995), we used the duration of the logistics alliance in months as a proxy for likelihood of repetition. ample evidence exists for the view that past experience relates to future likelihood of repetition (heide and miner, 1992). for example, heide and john (1990) and parkhe (1993) found historical length of relationship to be a significant indicator of intent to continue purchasing alliances. moderator variables chiles and mcmackin (1996) define risk propensity as the tendency of a manager to be either risk averse, risk neutral, or risk seeking in dealing with 56 journal o.lbusiness strategies vol. 21, no.1 risk situations. drawing on the work of maccrimmon and wehrung (1986), we developed a five item risk propensity scale for a logistics-alliance context. factor analysis of data from a pilot-test of the questionnaire produced a twofactor measure of risk propensity which we labeled pre-decision risk propensity and post-decision making risk perceptions. factor analysis of the risk items in the final data set also indicated a two-factor solution, with reliability levels of .61 and .51 respectively. these sub-scales appear to be measure two different constructs (inter-sub-scale reliability = .18). given its higher reliability and our focus on the a priori choice of structure and process, we elected to use the trait measure of pre-decision risk propensity in the study. we coded the items such that higher scores indicate risk seeking while lower scores indicate risk averslon. we measured trust using the 12-item organizational trust inventory developed by cummings and bromiley (1996). this scale was originally developed using the theoretical underpinnings of tce as applied to interorganizational relationships (bromiley and cummings, 1995). in this scale, respondents evaluate the focal partner in terms of three areas of trust (negotiates honestly, keeps commitments, and avoids opportunism). a reliability analysis ofthe three sub-scales of the instrument revealed acceptable reliability levels for all three of the theorized sub-scales and an inter-sub-scale reliability of. 77. we entered the sum of the trust scale as a single variable in the study. dependent variables the closeness of the relationship in a hybrid governance arrangement has been conceptualized as having two dimensions: structure and process (macneil, 1980; williamson, 1985; zaheer and venkatraman, 1995). structure is the extent to which two firms link their systems in ways that approximate integration in hierarchical relationships. in our study, structure was operationalized as the extent of electronic integration (the percentage of shipper-carrier transactions within the logistics alliance which take place via on-line data exchange or remote access to each other's computers). this measure is consistent with operationalizations by zaheer and venkatraman (1994) in the insurance industry and venkatraman and christiaanse (1996) in the airline industry. process, which focuses on the extent to which firms act together, was measured using the arithmetic mean of the three-item joint-action scale developed by heide and miner (1992) and used to good effect in zaheer and venkatraman's work (1995). confirmatory factor analysis of the joint-action survey data revealed the theorized single dimension. while structure and process are viewed as separate dimensions, higher levels of either dimension should relate to governance structures more closely resembling hierarchical integration. control variables this study controlled for two situation-specific characteristics: differences due to industry and differences between the responses of shippers versus carriers. spring 2004 masters et al: relational contracting 57 industry has often been used in alliance studies as a control variable (maltz, 1994; parkhe, 1993). we operationalized industry as the primary, two-digit standard industrial classification (sic) of the shipper (e.g., heide and john, 1990; maltz, 1994). this control variable did not prove significant in the present study, though, and was omitted from the final analysis. since we were examining both parties to the transaction, we also controlled for any differences in the responses of shippers versus those of carriers in the study. we coded each respondent as 0 (for shippers) or 1 (for carriers). these differences proved significant with respect to the measures of governance and we included this control variable in the final models. finally, we asked the respondents to rate their relationship with the focal shipper or carrier according to three descriptions of alliances developed by bowersox (1990). the least closely allied firms were described as having agreed to work together, but had not made any changes in their day-to-day operations. the most closely allied firms were those in which the parties had formed a true logistics alliance. in the analysis that follows, we excluded the middle form in order to heighten the differences between firms. however, we also conducted the analyses with all three forms. the results were not different in significance level or direction, but the r 2 for all models was lower. results following adjustments for non-usable replies, the survey yielded a net overall response rate of 24.9 percent. the 324 responding firms represented a broad range oflocations and industries, with 39 states and 41 different two-digit sics represented in the data set. the years of employment with the firm of the key informants ranged from one to 37 years, with an overall mean of 10.4 years. to assess the likelihood ofnonresponse bias influencing the results, we compared the results for early responders with those of late responders (armstrong and overton, 1977). the comparison revealed no significant differences between the two groups. table i contains the means, standard deviations and correlations for the variables in the study. the significant correlations were generally consistent with our hypotheses and with previous conceptualizations of the relationships between the constructs. each of the tce variables was significantly correlated with both dimensions of governance, as was risk propensity. also as hypothesized, risk propensity was significantly correlated with asset specificity. contrary to our expectations, though, trust was not significantly correlated with either governance dimension or with asset specificity, but was significantly positively correlated with both uncertainty and likelihood of repetition. to test the hypotheses, we conducted regression analyses on the two dependent variables. the results of these regressions are presented in table 2 (for the structure measure) and table 3 (for the process measure). the body of each table presents standardized beta coefficients with asterisks indicating significant vl table 1 00 means, standard deviations and correlations standard carrier or asset risk electronic variables mean deviation shipper? duration uncertainty specificity propensity trust integration% carrier or shipper? .46 .50 1.000 duration 64.49 70.84 -.077 1.000 ~ l:: '"": uncertainty 4.33 .91 .050 .014 1.000 ~ t.lasset specificity 3.94 1.08 -.141(*) .086 .299(**) 1.000 ~ttl l:: c., risk propensity 42.91 21.84 -.346(**) .052 .058 .122(*) 1.000 s· (':l '"'" trust 5.39 .93 .087 .123(*) .256(**) .053 .030 1.000 ~ '"": t:::...,. electronic integration % 42.82 39.74 -.096 .160(**) .138(*) .151(**) .270(**) .021 1.000 ~..... (':l c., process 3.35 1,45 -.250(**) .053 .286(**) .251(**) .153(**) .085 .159(**) n = 324 * correlation is significant at the 0.05 level 2:** correlation is significant at the 0.01 level n ....... ~ z ~spring 2004 masters et al: relational contracting 59 table 2 results of regression for structure (electronic integration %) (values in cells are standardized beta coefficients) variables steps in the regression analysis 1 2 3 4 5 6 shipper or carrier? -.16** -.14* -.04 -.04 -.04 -.03 duration .15* .14* .13* .13* .13* uncertainty .15* .12t .15* .16* .16* asset specificity .12t .09 -.23* -.23* -.31 * risk propensity .29*** -.36* -.35* -.26 risk propensity * asset specificity .80*** .80*** .68** trust -.03 -.11 trust * asset specificity .16 r2 .024 .095 .164 .223 .224 .226 change in f 5.60* 5.88** 18.64*** 16.69*** .26 .82 t p. <.10 * p.<.05 ** p.<.oi *** p. <.001 table 3 results of regression for process (joint action) (values in cells are standardized beta coefficients) variables steps in the regression analysis 1 2 3 4 5 6 shipper or carrier? -.26*** -.26*** -.25*** -.25*** -.26*** -.25*** duration .07 .07 .06 .05 .06 uncertainty .27*** .27** .29*** .27*** .27*** asset specificity .14* .14* -.06 -.06 -.17 risk propensity .04 -.35* -.37* -.23 risk propensity * asset specificity .49** .49** .32 trust .07 -.04 trust * asset specificity .24 r2 .069 .190 .192 .213 .218 .224 change in f 17.47*** 11.56*** .38 6.27* 1.43 1.84 t p. <.10 * p.<.05 ** p.<.ol *** p. <.001 60 journal ofbusiness strategies vol. 21, no.1 effects. in both tables, the focus is on steps 2, 4, and 6, which represent each of the three hypotheses respectively. structure the initial regression focused on structure as the dependent variable. in step 2 of this analysis, we added the variables derived from the tce perspective to the control variable entered in step one. the addition of the tce variables did result in a significant change in the f statistic (p. < .0 i), but showed a relatively low r2 of .095. both likelihood of repetition and uncertainty were significant predictors of electronic integration (p. < .05). asset specificity, though functioning in the predicted direction, was only significant at a relaxed level (p. < .10). in step 4 of the analysis, we tested the interaction between risk propensity (entered in step 3) and asset specificity as a predictor of electronic integration between firms. the change in f was again significant (p. < .001) and the variance explained by the model increased substantially (r2 = .223). more importantly, the interaction term was significant (p. < .00 i) and in the predicted direction. further examination of the interaction confirmed an interpretation in line with our predictions. firms which were risk seeking were more closely quasi-integrated at a given level of asset specificity than were risk averse firms. taken together, these results support the view of risk propensity as a moderator of the relationship between asset specificity and the strength of the ties between firms (hypothesis 2). the remaining steps in table 2 did not support the third hypothesis. the addition of trust and its interaction with asset specificity did not influence the relationships seen in the earlier models. duration, uncertainty, asset specificity, and risk propensity remained significant, but the model's predictive ability was not enhanced by the addition of the remaining variables. it is also interesting to note that in both step 4 and step 6 asset specificity and risk were both significant predictors but the sign of each was reversed from what it had been in previous models. while it is tempting to speculate as to the meaning of this, we take a conservative approach and assume that the presence of the interaction term makes interpretation of individual terms problematic. process the results of the regression with respect to process, presented in table 3, are similar to those for structure. uncertainty, asset specificity, and the interaction of risk propensity with asset specificity were all significant predictors of joint action, the measure of process quasi-integration. for process, however, we found no significant effect for likelihood ofrepetition in the model. analysis of the interaction showed the same pattern as with structure. there was a significantly more positive association between asset specificity and process for high risk propensity decision makers than for low risk propensity decision makers. again, trust had no significant effect. spring 2004 masters et al: relational contracting 61 viewing the results of both regressions together, we see support for hypotheses 1 and 2. in each model, the interaction of risk propensity with asset specificity was significant and in the predicted direction. trust was not significant in either model, however, so hypothesis 3 was not supported. discussion and conclusion the results presented above provide general support for tce as a predictor of the closeness of the ties between firms. treating risk propensity and trust as important variables in the process rather than as underlying assumptions, though, adds a new dimension to the analysis. we examined the influence of these variables in the context of relational contracting rather than in the discrete choice between market or hierarchy. contrary to the predictions of chiles and mcmackin (1996) that focused on the discrete choices, we posited that relational contracting would add an additional risk of opportunism and thus higher risk propensities would be necessary for closer ties between firms to develop at a given level of asset specificity. in the present study, firms with risk seeking decision makers did exhibit closer ties with their alliance partners at a given level of asset specificity than did firms with risk averse decision makers. these findings are consistent with our contention that the risk of opportunism in relational contracting comes not just from transaction-specific investment, but from the organizational form itself. the findings regarding risk propensity also raise serious questions regarding the conceptualization of tce governance mechanisms as a linear continuum. ifhybrid relationships actually fall on a linear continuum between markets and hierarchies, such findings would not be expected. instead, one would expect to see a pattern in which there was a consistent influence of variables across the continuum. we introduced the notion of a kinked risked curve depicted in figure i as a possible alternative logic to that of chiles and mcmackin. with the inclusion of risk propensity, the influence of transaction specific investment differs not only in strength but also in direction as firms develop closer and closer ties. rather than driving firms away from developing close ties, risk seeking decision makers do appear to select closer ties. our findings suggest that tce variables do serve as predictors of the governance structure chosen. the addition of risk preferences into the model, however, indicates that the influence of the tce variables may differ depending on the level of risk that decision makers are willing to assume and, in the case of hybrids, on risks associated with the governance choice itself. while such a notion is intriguing and clearly worthy of further study, we would urge some degree of caution in generalizing these results. we cannot claim to have tested the notion of a kinked risk curve. our focus in this study was on tce's ability to predict the finer-grained distinctions between levels of quasi-integration in relational contracting. other research has supported tce's ability to predict the extremes of market and hierarchy and our sample 62 journal ofbusiness strategies vol. 21, no.1 did not include those extremes. further testing of this notion which includes the full range of organizational relationships from market to hierarchy would be informative. the role of these behavioral variables, if any, in the extreme forms remains untested. the current study focused on shipper-carrier logistics alliances and the relationships found here may not be found in other hybrid arrangements. vertical integration through the rent chain represents only a fraction of the purposes behind hybrid arrangements. whether these findings would hold true for other sorts of alliances (e.g., those initiated for the purpose of knowledge creation or transfer) remains to be seen. that said, logistics alliances seemed particularly fertile ground for study since they represent a hybrid form in which distinct firms develop relatively enduring relationships. further, these alliances have been viewed as relational in nature, with an emphasis on interorganizational trust. still, many other hybrid forms will need to be examined. the role of trust in the choice of organizational relationship also requires further specification. our contention that trust would further moderate the closeness of ties between firms was not supported in the present research. we did, however, see significant positive correlations between trust and likelihood of repetition and between trust and uncertainty. bradach and eccles (1989) proposed that trust may represent a separate governance mechanism distinct from the price and authority mechanisms of market and hierarchy. they viewed markets as being governed by price, hierarchies by authority mechanisms, and posited that trust would represent a third governance mechanism. ouchi (1980) used the term clans to describe this third governance choice. the pattern of correlations we found would be consistent with that view. it would also be useful to examine these relationships over time. in addition to the standard disclaimers about correlation and causality, the effect of duration on trust bears consideration. work by sitkin and pablo (1992) and sitkin and weingart (1995) has suggested that, under conditions of high performance ambiguity, repeated positive experiences with a transaction partner increase perceptions of trust. the pattern of correlations we found would be consistent with that view as well. the current research clearly represents a beginning rather than an end. while we believe the results of this study add considerably to our understanding of organizational relationships, the precise relationships between tee, risk propensity, and trust remain to be explained. still, the present study, with its emphasis on the role of risk in relational contracting, suggests a very different view of the mechanisms used to organize transactions from that in the literature to date. we encourage future research to focus both on replicating these findings in other contexts and on furthering our understanding of the precise mechanisms driving this process. spring 2004 masters et al: relational contracting references 63 alreck, p. l. & settle, r. b. (1995). the survey research handbook. (2d ed.). chicago: irwin. armstrong, j. s. & overton, t. s. (1977). measuring nonresponse bias in mail surveys. journal of marketing research, 14, 396-402. aoki, m. (1984). the cooperative game theory of the firm. new york: oxford university press. blois, k. j. (1972). vertical quasi-integration. journal of industrial economics, 20, 252-272. bradach, j. l. & eccles, r. g. (1989). price, authority, and trust: from ideal types to plural forms. annual review of sociology, 15,97-118. bowersox, d. j. (1990). the strategic benefits of logistics alliances. harvard business review, 68, 4, 36-45. bromiley, p. & cummings, l. l. (1995). transaction costs in organizations with trust. in r. beis, b. sheppard, & r. lewicki (eds.) research on negotiations in organizations, 5, 219-247. chiles, t. h. & mcmackin. j. f. (1996). integrating variable risk preferences, trust, and transaction cost economics. academy of management review, 21, 73-99. coase, r. h. (1937). the nature of the firm. economica, 4, 386-405. cummings, l. l. & bromiley, p. (1996). the organizational trust inventory (oti): development and validation. in r. m. kramer & t. r. tyler (eds.) trust in organizations. (pp. 302-329). thousand oaks, ca: sage. dillman, d. a. (1978). mail and telephone surveys: the total design method. new york: wiley. eccles, r. (1981). the quasi-firm in the construction industry. journal of economic behavior in organizations, 2, 335-357. gentry, j. j. (1996). the role of carriers in buyer-supplier strategic partnerships: a supply chain management approach. journal of business logistics, 17,2,35-55. granovetter, m. (1985). economic action and social structure: the problem of embeddedness. american journal of sociology, 91, 481-510. heide, j. b. (1994). interorganizational governance in marketing channels. journal of marketing, 58, 71-85. 64 journal ofbusiness strategies vol. 21, no. i heide, j. b. & john, g. (1990). alliances in industrial purchasing: the determinants of joint action in buyer-supplier relationships. journal of marketing research, 27, 20-35. heide, j. b. & miner, a. s. (1992). the shadow of the future: etfects of anticipated interaction and frequency of contact on buyer-seller cooperation. academy of management journal, 35, 265-291. hennart, j. (1993). explaining the swollen middle: why most transactions are a mix of market and hierarchy. organization science, 4,529-547. hosmer, l. t. (1995). trust: the connecting link between organizational theory and philosophical ethics. academy of management review, 20, 379-403. kanneman, d. & a. tversky (1979). prospect theory: an analysis of decision making under risk. econometrica, 47, 262-291. kelly, h. h. & thibaut, j. w. (1959). the social psychology of groups. new york: wiley. klein, b., crawford, r. g., & alchian, a. a. (1978). vertical integration, appropriable rents, and the competitive contracting process. journal of law and economics, 2.1, 297-326. maccrimmon, k. r. & wehrung, d. a. (1986). taking risks: the management of uncertainty. new york: free press. maltz, a. (1994). outsourcing the warehouse function: economic and strategic considerations. logistics and transportation review, 30, 245-265. march, j. g. & shapira, z. (1992). variable risk preferences and the focus of attention. psychological review, 99, 172-183. macneil, i. r. (1978). contracts: adjustments of long-term economic relations under classical, neoclassical, and relational contract law. northwestern university law review, 72, 854-905. macneil, l. r. (1980). the new social contract: an inquiry into modern contractual relations. new haven, ct: yale university press. masten, s. e., meehan, j. w., & snyder, e. a. (1989). vertical integration in the us auto industry: a note on the influence of transaction specific assets. journal of economic behavior and organization, 12,265-273. mcwilliams, a. & gray, s. (1995). understanding quasi-integration. journal of business strategies, 12,69-85. spring 2004 masters et al: relational contracting 65 monteverde, k. & teece, d. j. (1982). supplier switching costs and vertical integration in the automobile industry. bell journal of economics, 13, 206-213. n oorderhaven, n. (1994). transaction cost analysis and the explanation of hybrid vertical inter-firm relations. review of political economy, 6, 19-36. nooteboom, b., h. berger, h., & noorderhaven, n. g. (1997). effects of trust and governance on relational risk. academy of management journal. 40,308-338. ouchi, w. g. (1980). markets, bureaucracies and clans. administrative science quarterly, 25, 129-141. parkhe, a. (1993). strategic alliance structuring: a game theoretic and transaction cost examination of interfirm cooperation. academy of management journal, 36, 794829. pratten, s. (1997). the nature of transaction cost economics. journal of economic issues, 31,781-803. ring, p. s. & van de ven, a. (1992). structuring cooperative relationships between organizations. strategic management journal. 13,483-498. ring, p. s. & van de ven, a. (1994). developmental processes of cooperative interorganizational relationships. academy of management review, 19, 90-118. robins, j. a., (1987). organizational economics: notes on the use of transaction cost theory in the study of organizations. administrative science quarterly, 32, 68-86. simon, h. a. (1961). administrative behavior, (2nd ed.). new york: macmillan. sitkin, s. b. & pablo, a. 1. (1992). reconceptualizing the determinants of risk behavior. academy of management review, 17, 9-38. sitkin, s. b. & weingart, 1. r. (1995). determinants of risky decision-making behavior: a test of risk perceptions and propensity. academy of management journal, 38, 1573-1592. tversky, a. & kahneman, d. (1992). advances in prospect theory: cumulative representation of uncertainty. journal of risk and uncertainty, 5, 297-323. tyler, t. r. & degoey, p. (1996). trust in organizational authorities: the influence of motive attributions on willingness to accept decisions. in r. m. kramer & t.r. tyler (eds.) trust in organizations. (pp. 331-356). thousand oaks, ca: sage. van de ven, a. h., venkatraman, s., polley, d., & garud, r. (1989). processes of new business creation in different organizational settings. in a. van de ven, h. angle, & m. s. poole (eds.) research on the management of innovation: the minnesota studies, (pp. 221-298). new york: ballinger/harper & row. 66 journal ofbusiness strategies vo1.21,no. i van de ven, a. h. & walker, g. (1984). the dynamics of interorganizational coordination. administrative science quarterly, 29, 598-621. venkatraman, n. & christiaanse, e. (\996). electronic channels for expertise exploitation: an empirical test of airline-travel agency relationships, academy of management proceedings, cincinnati, oh. walker, g. & weber, d. (\984). a transaction cost approach to make-or-buy decisions. administrative science quartej:l~l2., 373-391. williamson, o. e. (1975). markets and hierarchies: analysis and antitrust implications. new york: free press. williamson, o. e. (1985). the economic institutions of capitalism: firms, markets, relational contracting. new york: free press. williamson, o. e. (199\). strategizing, economizing and economic organization. strategic management journal. 12, 75-94. williamson, o. e. (1993). calculativeness, trust, and economic organization. journal of law and economics, 36,453-486. williamson, o. e. (1999). strategy research: governance and competence perspectives. strategic management journal, 20, 1087-] 108. zaheer, a. & venkatraman, n. (1994). determinants of electronic integration in the insurance industry: an empirical test. management science, 40, 5, 549-566. zaheer, a. & venkatraman, n. (1995). relational governance as an interorganizational strategy: an empirical test of the role of trust in economic exchange. strategic management journal. \6, 373-392. john k. masters is associate professor of management at louisiana state university in shreveport. he earned his ph. d. at the university of north texas. his research interests include organization-environment relationships and the blurring of organizational boundaries. his research has been published in the academy of management journal, the journal of business ethics and other leading outlets. grant miles is associate professor of management in the college of business administration at the university of north texas. he received his ph.d. from the pennsylvania state university. his research interests are linked around a primary focus on organizational adaptation and the role of knowledge, learning and collaboration in this process. his research has been published in a number spring 2004 masters et al: relational contracting 67 oftop academic and practitioner outlets including the academy of management journal, strategic management journal, and california management review. dr. derrick e. d'souza is associate professor of management at the university of north texas and is president at executive renewal, an od consulting firm. he consults, researches and teaches in the areas of strategic business integration, organizational architecture. operations flexibility and international business. he has published widely in both academic and practitioner journals, and is co-author of a toolbook for strategic business integration, 4th ed. he can be reached at dsouza@unt.edu. john patrick orr earned his ph.d. from the university of north texas in organization theory & policy. he is currently assistant professor of management at mckendree college in lebanon, illinois. his teaching interests include business ethics, operations management, strategy, and international business; also, he has taught in both western europe and russia. dr. orr researches trust, governance, and cross-cultural issues in strategic alliances, with a focus on logistics alliances. footnotes i the authors wish to thank john beard and several anonymous reviewers for their comments on an earlier version of this paper presented at the 2000 annual meeting of the south west academy of management 68 journal of business strategies vol.2i,no.l risk propensity, trust, and transaction costs in relational contracting impact of internet aided self-managed teams on quality of work-life and performance dean elmuti eastern illinois university charleston, il abstract the impact of participation in an internet aided self-managed (iasm) teams program on employee quality ofwork life attitudes, and on petjormance was studied among employees in a manufacturing firm for a 36-month period. the attitudinal results indicate that iasm teams improved participants' quality of work life. the perfonnance results document a positive and substantial impact on employee productivity, efficiency, quality, and overall perf()rmance. however, implementation of iasm teams is a complex task that requires time and commitment of resources to reap potential rewards. in addition, the research findings suggest that using this program gives employees the authority to act and make decisions on their own, making their jobs more demanding and challenging at the same time. introduction the development of the internet and the information technology industries has forever changed the way that companies do business and create value. in light of the recent growth in "electronic commerce" (i.e., internet or web-based systems and the information technology (it) industries), many private forecasts made just a year ago have been revised upward. in early 1998, forecasters were suggesting that business-to-business (b2b) e~commerce might rise to $300 billion by 2002 (holtz, 1996; kezsbom, 2000). most forecasters now consider that estimate to be too low. for example, forrester research (forrester, 1998) estimates that business~to-business e~commerce will rise to $1.3 trillion by 2003. cyber dialogue (thompson-jones, 1999) estimates that the value of off-line orders influenced by the internet was approximately $51 billion. there were estimated 400 million people worldwide using the internet in 2001. projections called for 600 to 700 million internet users globally by 2003 (thompson and strickland, 2003). in addition, many organizations are using self-managed terms programs in conjunction with the internet as a tool to communicate effectively and to improve performance (kezsbom, 2000; alwang, 1998; mays, 1999). almost ten years ago, the idea of a team working together from remote locations was nonexistent. today, technology, globalization, and the need for fast responses to marketplace demands have dramatically changed the way business is conducted. approximately 137 million workers worldwide will be involved in some form of remote electronic work by 2003 (solomon, 2001). 120 journal of business strategies vol. 20, no.2 in allowing employees to participate in problem-solving-giving them the authority to act and make decisions on thcir own-they develop a renewed interest in their organization's performance and therefore in improving their own performance. management delegates authority to self-managing teams who execute the work faster and with fewer delays than were possible in the traditional organizational structure. using the internet as a tool to communicatc cffectively with each other and with teams in different locations (kezsbom,2000; townsend, demarie and hendrickson, 1996; alexander,200 1), allows the decentralization of decision making and authority while simultaneously support centralized control (harvey, 1999; turban, rainer and porter, 2000). it is not an end in itself, but the means of achieving greater performance and improved employee quality of work life perceptions. with the increasing us of iasm teams in work organizations and the convergence of many high-technology fields, broad longitudinal teams in work organization and the convergency of many high-technology fields, broad longitudinal investigation is needed to provide insights into the understanding of its impact on the business environment. therefore, this article discusses a longitudinal and experimental field study that compares changes in perceptions of quality of work life and performance for participants in an internet aided sclfmanaged teams program. literature review internet technology provides automation, allows business to be conducted in different locations provides flexibility in manufacturing, and permits quicker delivery to customers. reducing cycle time is extremely important for increasing productivity and competitiveness (turban, rainer and porter, 2000; king, 1998; cayne, 1997). at the same time, the use of this technology has potentially adverse effects on employees such as alienation, anxiety, stress, and frustration (king, 1998; bill, 2000). while there is little consensus about what changes occur, there is general agreement that an understanding of the consequences that information technologies (it) have on employees' jobs is a significant and unresolved topic of investigation and research. early studies on the impact of it on cmployees were characterized by speculation of one sort or another. several studies noted that the use of it changed the nature of the employees' job (bradley, 1977; massey, 1986; kling, 1996). a frequent criticism oftraditional data processing systems has been their negative effect on people's individuality. such systems have long been criticized as being impersonal; they dehumanized and depersonalized the activities that were computerized (kling, 1996; ramsey, 2000). however, several studies (rossman, 1986; stokes and stewart, 1991; zawacki and lackow, 1998) offered several suggestions to avoid "the pitfalls" of computerization, and one of the suggestions was to gain employee support by soliciting input from them by forming self-managed work teams. self-managed work teams are groups of employees (5 12) with all the technical skills and the fall 2003 elmuti: internet aided self-managed teams 121 authority needed to direct and manage themselves (dumaine, 1997; forrester and drexler, 1999). that is, they are appointed to manage themselves because the team members are those employees most familiar with a particular aspect of the company (kirkman and rosen, 2000; herrenkohl, judson and heffner, 1999). self-managed teams have been credited with saving hundreds of millions of dollars, achieving conceptual breakthroughs, and introducing an unparalleled number of new products (anthony, kacmar and whitfield, 1995; brucker, 1995; brunelli, 1999). self-managed team activities are also expected to lead to improved working conditions by offering greater opportunities for expression and self-development for participating employees (specifically, aspects of the "psychological quality of work life") (holpp, 1994) as well as increased productivity and market share, improved pricing, and cost reduction (reid and reid, 1999). the self-managed work team a product of the quality circle movement in global manufacturing companies is beginning to be used by information systems (is) departments and smaller firms across a variety of settings that are willing to gamble on internal reorganization for the sake of increased flexibility, increased creativity motivation and quality, reduced employment, and reduction in overhead costs (stokes and stewart, 1991); mcdonough and cedrone, 2000). virtual teams are also becoming more and more popular in the business world today (kezsbom, 2000; demarie and townsend, 1998). virtual teams, whose members are in different locations, frequently belong to different functional areas or different organizations, and communicate electronically. internet technology plays a critical role in empowering team members and providing the necessary communication links among teams (turban, rainer and porter, 2000). a virtual team's members are united by the tasks on which they are collaborating, not by geography or membership in a larger organization (kezsbom, 2000). the technology is clearly available to make virtual teams possible, and the number of firms beginning to explore the potential of virtual teaming is increasing. already companies such as hewlett-packard, price-waterhouse, lotus development, and whirlpool have implemented some type of internet aided virtual teams (alexander, 2001; townsend, demarie and hendrickson, 1996). one of the most highly publicized example of a company that transformed itself to a self-managed team structure aided by internet technology is ge (general electric corporation) of canada. from the beginning the steering committee that planned the transformation recognized the role of internet technology and teams as critical factors in the transformation-both for communication and collaboration among teams, and as tools to support the whole organization. the results of the ge effort were dramatic indeed. the number of employees was reduced by 50%, while the productivity of the company and the quality of its operations were drastically improved (turban, mclean and wetherbe, 1999). despite the frequency with iasm teams programs have been adopted in work organizations (cayne, 1997; forrester and drexler, 1999) there is a paucity of knowledge generated by independent evaluators using rigorous 122 journal of business strategies vol. 20, no.2 methods as to the impact on employee attitudes and behaviors. the available studies are limited to testimonials from managers and consultants who have implemented iasm teams programs (alwang, 1998; fister, 1999; reid and reid, 1999; mays, 1999). the central theme that runs through most of these studies reflects a common belief that the use of self-managed teams programs generally improves organizational effectiveness (mcdonough and cedrone, 2000; townsend, demarie, and hendrickson, 1996). a study conducted at the ibm plant in lexington, ky showed that iasm team participation led to improvement in employee productivity, efficiency, quality, and a steady stream of innovations (flanagan, 1994). a recent report on cisco systems indicated that cisco has special teams that work with other companies to provide better customer service, to develop new technologies, and to help other companies implement cisco programs. currently, a cisco team on network technology is partnering with intel to deliver enhanced capabilities for virtual local area networks (vlan's) to help companies reduce the costs and eliminate many of the problems that come along with managing large client/server computer networks (alwang, 1998; mays, 1999). research methodology research site and participants this research was conducted in one of the subsidiaries of a large, diversified, non-unionized, multidivisional pharmaceutical corporation located in an urban area in the north eastern united states. the company had a work force of 920 employees at the time of the study. production operations were primarily assembly using a batch process. the company is presently engaged in production, processing, distributing, and marketing its products and services worldwide. revenues for 1998 derived from the company's three core businesses (vitamins and fine chemicals, flavors and fragrances, and diagnostics). the company was not doing well financially primarily due to intense competition from low wage countries in asia, low productivity, limited access to new markets, high costs of advertising, and limited customer service and support. to address these problems the company management decided to utilize the iasm teams program. this was done on an experimental basis before its implementation in the entire company. a consulting group was invited to train managers and employees at all levels of the organization and to assist in the implementation of the program. the consulting group made it clear from the beginning that success depended to a large degree on the cooperation and participation of all job holders and support from senior and middle management. as indicated earlier, the plant had a work-force of920 employees at the time the study was planned. four hundred and sixty employees from different functions in the plant such as production, clerical, accounting, sales, distribution functions, and newly hired internet networks personnel were selected to participate in 45 self-managed teams at the start of the program. the number increased over a 3fall 2003 elmuti: internet aided se~rmanagedteams 123 year period to include all full time employees in the plant. the self-managed teams that were established ranged in size from eight to twelve members. top management agreed to commit resources to improve operations, develop and train employees, build team work aided by internet technology, and open communication channels. all levels of employees, including senior managers, middle managers, first line supervisors, sales staff, production workers, and machine operators were trained by the consulting group for a few weeks prior to the implementation of the internet aided by self-managed teams program. in order to have an accurate assessment of the consequences of the program, it was necessary to have a control or a comparison group. this control group was to consist of 460 of the 920 employees in the plant who were not selected or chose not to participate. software/system and training the primary responsibility of the consulting group was to select a suitable internet technology that allows empowered employees self-managed teams to access data, information, and knowledge they need for making good decisions quickly by using the internet or intranets (corporate networks that use internet technologies). in addition, internet technology allows team members to communicate effectively with other teams in different locations, to purchase and market goods and services over the internet, to maintain customer service channels, to recruit future employees, and to coordinate finances. goals were set, the web site was built and placed on a web server, and efforts were made to promote the site and maintain it by the self-managed teams. in conjunction with the internet, electronic data interchange (edi) played an important role in teams performance and supply chain management activities. edi make information flow automatically in the supply chain and eliminates some labor-intensive processes, like data entry and re-entry between customers and suppliers (shore, 2001). edi has not a single universal standard. for small firms, it is very expensive to establish their edi system. now, because of the development of the internet, edi has been integrated with the internet, and the cost of establishing an edi system has been significantly decreased while the edi capabilities have been increased. in addition, the teams communicated through custom-designed and accesscontrolled lotus notes discussion forums. lotus notes is the world's leading groupware solution package and a widely used system and application development platform (weiss, massey and song, 2001). lotus notes combines messaging, groupware, and the internet. through the use of lotus notes, corporations can implement virtual or actual teams that use e-mail, digital white boards, and data sharing. in addition, lotus notes enables dispersed asynchronous work by classifying entries into main topics and responses. every message has a time stamp reveals the identify of the author. all participants accessed the forums via a web browser and were able automatically to open and close the lotus notes databases, according to a predefined schedule. 124 journal o.lbusiness strategies vol. 20, no.2 the isam teams training program included training in communication for effective meetings and planning, skills for cross-functional teams, and training for quality improvement including methods of identifying problems, setting priorities, discovering causes, and implementing solutions. a first line supervisor or a systems analyst usually served as team leader. each team had its own leader to coordinate its internal workings and to represent the team with outside entities. measures the following two major hypotheses have been developed to test the data from this study: hypothesis 1: participants in internet aided self-managed teams will show higher levels ofimprovement in quality of work life aspects than non-participants. hypothesis 2: participants in internet aided self-managed teams will report higher overall performance than nonparticipants. the hypotheses are all stated to reflect the claims made by internet aided seifmanaged teams proponents, and the findings from the literature on organizational behavior and internet applications. measures of quality of work life perceptions a questionnaire, archival data, and follow-up interviews were used to accomplish this study. the questionnaire was designed to tap a wide range of quality of work life facets, with measures derived from the michigan organizational assessment package. the michigan instrument has been shown to have acceptable levels of reliability and validity across a variety of settings (marks, mirvis, hackett and grady, 1986; lawler, 1979; mirvis and lawler, 1984). responses were reported on seven-point scales, ranging from one (low) to seven (high) for all measures. included in the questionnaire were measures of each of the researched quality of work life areas. measures of participation and communication available from the questionnaire were: a self-report of the frequency with which suggestions were offered at work; an item assessing satisfaction with opportunities to take part in decisions; and, scales of work team communication. the population sampled included all full-time employees: production workers, machine operators, supervisors, clerical, accounting personnel, sales reps, distributors, managers, and senior managers from different functional areas. a total of 920 employees were sent questionnaires via company mail. one survey was conducted at the research site just prior to the implementation of the selfmanaged team approach in conjunction with the internet based systems program fall 2003 elmuti: internet aided selfmanaged teams 125 in order to assess employee attitudes and perceived quality of work life in the firm. seven hundred thirty employees returned questionnaires, generating a 76% rate. a second survey was conducted 30 months after the program had begun in order to assess any changes on employee perceptions. six hundred four employees returned the questionnaires, generating a 67% rate. twenty questionnaires were not acceptable, however, and the response rate was lowered to 64%. a demographic description of the survey respondents was compared to that of the whole population of the organization. in this way, it could be determined if the actual sample was representative of the population. the results of that comparison indicated that the demographic characteristics of both the sample and the whole population was similar in all respects. measures of organizational performance actual data actual organizational data from the surveyed firm (productivity, quality and other performance indicators) was used to assess the impact of (iasm) teams on employee performance. productivity was measured by the ratio of output produced to resources used. three productivity measures were available from organizational records: percentage of hours spent on production actual number of hours spent on production divided by total number of available hours, efficiency rate number of products produced within quality specifications divided by industrial engineering output rate, and overall productivity-number of actual pieces of product produced divided by number of pieces of product expected to be produced divided by total hours paid (marks, mirvis, hackett and grady, 1986; daft, 1999). additionally, records of quality were collected from an internal quality audit and the number of defects per finished product per 1,000 units were added and averaged per six months (crosby, 1979). other performance measures included net income return on investment, growth market share rates, and export growth (daft and marcie 1998; daft, 1999). data for each performance measure were collected for a 36 month period, ranging from six months prior to the adoption of the iasm teams program to 30 months after the program began. this length of measurement provided adequate time to assess the impact of the program on employee performance and the quality oftheir products. average rates were then computed for six month intervals and compared before and after the program began. period 1 represents the average rate for the six months prior to the program implementation; period 2 is the average rate for the first six months the program was operational; period 3 is the average rate for months 7 12; period 4 is the average rate for months 13 18; period 5 is the average rate for months 19 24; and, period 6 is the average rate for months 25 30. follow-up interviews were then conducted with the plant manager, human resource manager, operations manager, information systems manager, and controller in this manufacturing facility. the purpose of the interviews was to obtain a deeper perspective of the effects of the (iasm) teams program on 126 journal of business strategies vol. 20, no.2 employee performance as well as to assess the effectiveness of the program relative to its costs. furthermore, the interviews were used to rule out alternative explanations for changes in employee performance in the plant. during these interviews, the participants responded to the seven-item questionnaire. results analysis of quality of work life perceptions table 1 presents the mean scores of the quality of work life measures for participants and nonparticipants before and after implementation of the internet aided self-managed teams program. the results of the t-test indicate that participants reported significant increases in all work life areas. the pearson product-moment correlation® was also calculated for program and quality of work life dimensions to measure the strength, direction, and statistical significance of relationships for internet aided self-managed teams program and the quality of work life dimensions. univariate f-tests were also employed across time periods for each variable to evaluate the hypotheses. as table 2 shows, there were significant differences over time for each of the variables in the participant group before and after program implementation. the table also illustrates significant differences from program initiation between the two groups with respect to quality of work life and performance. the influence of participation in the iasm teams program on quality of work life perceptions and performance was examined through use of multiple regression analysis. this analysis determines the proportion of variance in quality of work life perceptions and performance scores explained by iasm teams program scores. two major variables were identified as being significant for the purpose of this study: (i) the elements used to measure the independent variables are the mean scores of all iasm teams program dimensions such as activities of identifying relevant problems and attending to their solution in a systemic and ongoing way through iasm teams program. lasm teams program allow team members to communication with each other effectively, as well as, to communicate with other teams in different locations through the internet (forrester and drexler, 1999; weiss, massey and song, 2001). the second variable used to measure the dependent variables are the mean scores of quality of work life perceptions and performance dimensions. hi = r (iasmqp) > 0 (substantive hypothesis) ho = r (lasmqp) = 0 (null hypothesis). table 3 presents the results of this analysis, which indicates positlve relationship between measures of quality of work life and performance and iasm teams as reflected in the multiple regression ratios. results show that 46% of the variation in quality of work life and 52% of the variation in performance are fall 2003 elmuti: internet aided self-managed teams 127 table 1 mean difference between period 1 and period 6d quality of work life scores for participants and nonparticipants in internet aided self-managed teams program period 1 period 6 t value mean std. mean std. (or quality-of-work-iife measure score dev. score dev. t statistic) suggestions offered • participants 4.40 1.14 6.30 .96 3.78** • nonparticipants 4.38 1.18 4.98 1.11 2.45* participation in decision making • participants 2.71 1.24 5.26 1.66 2.98** • nonparticipants 2.73 1.38 2.98 1.38 -1.55** work group communication • participants 3.90 1.24 6.20 1.33 3.89** • nonparticipants 3.90 1.33 3.94 1.17 -1.27* organization communication · participants 3.38 1.49 5.44 1.89 3.40** • nonparticipants 3.72 1.77 3.10 1.72 -1.31* meaning • participants 4.40 .88 6.10 1.88 3.08** • nonparticipants 4.70 1.32 4.30 1.62 -1.64* challenge • participants 4.44 1.72 5.88 1.66 3.33** • nonparticipants 4.39 1.74 4.20 1.42 -1.78* personal responsibility • participants 4.47 .66 6.22 .58 2.44** • nonparticipants 4.45 .71 4.49 .72 1.57* accomplishment • participants 4.50 1.44 5.95 1.09 3.18** · nonparticipants 4.42 1.38 3.98 1.26 -2.09* advancement · participants 4.76 1.80 5.10 1.66 1.28** • nonparticipants 4.88 1.66 3.62 1.42 -2.28* * all p < .05 ** all p <.01 d period i is prior to the implementation of the internet aided self-managed teams program and period 6 is after the program's inception. explained by linear regression on the iasm teams program dimensions. the fratios indicate that linear associations are statistically at the 0.05 level. it is, therefore, appropriate to reject the null hypotheses, and to state, with more than 95% confidence, that a positive relationship was found between quality of work life and performance measures and internet aided self-managed teams program. 128 journal of business strategies vol. 20, no.2 table 2 results of univariate f-tests for differences between participants and non-participants in internet aided self-managed teams program dependent variables composite measures of quality-of-work-life and performances perceptions communication (organization/teams) • participants • nonparticipants participation (suggestions/participation in decision making) • participants • nonparticipants job characteristics (meaning/challenge/responsibility) • participants • nonparticipants growth needs (accomplishmenuadvancementl • participants • nonparticipants performance indicators (productivity. quality, others) • participants • nonparticipants before the adoption of the program* (n = 920) 3.38 3.40 3.20 3.22 3.10 3.05 3.28 3.22 3.52 3.47 thirty months after the program began (n =900) 5.95 3.59 5.99 3.47 6.10 3.28 5.78 3.38 6.05 3.58 f-value* 4.26** 1.37* 2.38** 1.24* 5.47** 1.17* 2.72** 1.04* 4.98** 1.19* *p < .05 **p < .01 n = numher of employee dropped from 920 to 900 cmployces in thc plant table 3 multiple regression analysis of the relation between participation in internet aided self-managed teams perceptions of quality of work life and performance dependent variables quality of work life performance *p < 0.05 multiple regression 0.60 0.71 regression square (rz) 0.46 0.52 f-ratio* 4.75 6.40 fall 2003 elmuti: internet aided selj~managedteams 129 an attempt was made, through an interview with participants in the project, to assess the impact of participation in internet on performance and quality of worklife without considering the influence of participation in a self managed teams program. self-reports were used for this measure. respondents were asked: (i) to what extent the quality-of-work-life and performance gains were due to the internet; (2) whether traditionally implemented self-managed team program would achieve the same results; and (3) whether it was possible that internet technologies could achieve the same results without self-managed teams. table 4 presents the results that indicate a positive relationship between measures of internet based and quality of work-life and performance as reflected in the multiple regression ratios. however, the results show only 22% of the variation in quality-of-work-life, and only 28% of the variation in performance was explained by linear regression on the internet based technologies dimensions. the f-ratios indicate that the linear associations are statistically significant at p < 0.05. the findings also indicate that it was not possible that internet based technologies could achieve the same results without the aid of self-managed teams, as reflected in a significant decrease in resulting r-squares for the quality-of-work-life and performance measures. table 4 multiple regression analysis of the relation between participation in internet based technologies and perception of quality-of-work-life and performance dependent variables quali ty -ofwork -i i fe performance * p < 0.05 multiple regression 0.46 0.54 regression square (rz) 0.22 0.28 f-ratio* 4.72 3.35 analysis of organizational performance impacts table 5 presents average six month rates for the performance measures beginning 6 months prior to the adoption of the internet aided self-managed team program until 30 months after the program began. for each measure the average percentage of hours spent on production went from 44% to 76% an increase of 73%; efficiency rate went from 56% to 78% an increase of 39%; overall productivity average rate went from 64% to 81 % an increase of 26.5%; the average number of defects per 1,000 units went from 222 to 110 a decrease of more than 50%; net income average rate went from 4% to 10% an increase of 1.5%; return on investment average rate went from 2% to 3.6% an increase of 0.8%; market share average rate went from 2% to 3% an increase of 0.5%; and, export growth average rate went from 0% to 8%. 130 journal (?f business strategies vol. 20, no.2 table 5 data from organizational records before after program program implementation implementation performance prdl prd2 prd3 prd4 pros prd6 prd2-6 dimensions avg % avg% avg % avg % avg % avg% avg% percentage of hours spent on production 44 67 72 76 82 82 76 efficiency rate 56 70 73 78 84 85 78 overall productivity rate 64 73 79 84 83 85 81 quality given in number of defects per 1,000 units 222 164 122 96 90 78 110 other performance indicators • net income 4 6 8 10 12 14 10 • return on investment 2 2 3 4 4 5 3.6 • market share 2 2 3 3 3 4 3 • export growth 0 0 i 3 6 8 8 executive follow-up interviews during follow-up interviews, the plant manager, the human resource manager, the operations manager, the information systems manager, and the plant controller all expressed overwhelming support for the internet aided self-managed teams program. they also claimed that the program was making a contribution to organizational performance, quality of products produced, and quality of work life in the plant. the plant manager indicated that his plant gained 12,000 hours in the production area due to reduced absenteeism and active participation by teams. he claimed that the proportion of employee days missed dropped from 16% per year to less than 7% for the whole plant. the human resource manager, the operations manager, and the information system manager considered the program to be a highly successful method of controlling employee turnover, unproductive time, production costs, and advertising costs. the human resource manager stated that his firm was able to save $600,000 in turnover related costs in two years due largely to the internet aided self-managed teams program. fall 2003 elmuti: internet aided self-managed teams 131 all managers expressed confidence that improvements in quality and performance in their plant were made possible by the implementation of the internet aided self-managed teams approach. they also indicated that there had been no other major changes in activities or incentives in their plant for the past several years that could account for these gains. they also remarked that there were no major shifts or changes related to the state of the economy or the competitive environment within their region. further analysis of the impact of the program on organizational performance was accomplished through the use of the plant-reported cost saving data. the plant controller estimated that the total costs of the program 30 months after it began was about $3.9 million, $3 million of which was the cost of maintenance and equipment including the hardware and software. the hardware and software were under maintenance contract that included training for the first year. other cost items included $260,000 in fees for the consulting group, $300,000 for the original training, and $340,000 to implement several of the recommendations. he also estimated that in the 30 month period, the plant had realized $2.5 million in one-time saving, and approximately $1.9 million per year in continued cost savings from recommendations by the consulting group and decreased customer complaints. other advantages as a result of the implementation can be seen in the reported management control over production costs, advertising costs, reduced number of defective products, and improved performance. furthermore, during the 30 months since the project began, the plant was able to reduce operating expenses by 9% while the plant's gross-return increased almost 11 %, and sales increased by 20%. summary and conclusion several significant findings emerged as a result of this study. first, the attitudinal results of this research support claims that iasm team program can improve the quality of work life. statistical analysis indicates that involvement in the program was positively related to perceived changes in satisfaction with opportunities for employees to accomplish something worthwhile at work while enhancing skills needed for advancement in the organization. furthermore, participation in the program was positively related to perceived changes in communication throughout the organization, as well as job meaningfulness, challenge, and personal responsibility for work. statistical analysis also substantiate the research hypotheses that predicted that participants in an iasm teams program would report higher levels of improvement of performance and quality of work life than would nonparticipants. second, the performance measures also indicate a positive impact on employee performance. participants in the iasm teams program tended to increase the percentage of time spent on an actual production and produced better quality products. the link between these favorable changes and the iasm teams program was supported further in the follow-up interviews with key managers in the plant. all of those interviewed indicated that the program made a contribution to the 132 journal (~l business strategies vol. 20, no.2 organizational productivity, quality of products produced, quality of work life, and overall performance. the bottom line for these managers, then, was that the iasm teams program was effective to date. they also indicated that the dollar savings and indirect benefits generated by the program were greater than the costs of running it. the program was generally believed to help enhance morale, decrease employee absenteeism, and contribute to organizational goals of increased performance, reduced costs, and improved quality of work. indications are that those benefits will continue to accrue for the foreseeable future. these findings coincide with the claims of many academicians that implementation of iasm teams can reduce costs, increase productivity, increase employee motivation and commitment, and sustain high performance (king, 1998; kirkman and rosen, 1999, mays, 1999; mohrman, cohen and mohrman 1999). finally, the research findings suggest that this team approach tends to make clerical and managerial jobs more demanding since the pace of the job and the work load increases. from the project discussion, self-managed teams heighten quality, time and cost awareness, and interest among all employees. iasm teams aided self-managed teams provided employees with the training and opportunity to analyze problems, as well as the tools to develop solutions. some employees learned how to correct and solve problems on their own, how to implement changes, and how to get involved in the decision-making process; all these responsibilities make clerical and managerial jobs more demanding, yet at the same time challenging. there are obvious limitations to the perceptual and self-reported data collected in this study, as well as with correlation analysis of such data. interview responses from the key managers could be biased since the program was one that they may have personally requested or supported. thus, even though the results from this study may not be generalizable beyond the organization studied, they are generally consistent with and support many of the positive conclusions about iasm teams program already present in the literature. at the same time, to be fair, this research evaluated one iasm teams intervention. a major change occurred in the organization soon after the iasm teams program was implemented and the fact that the company was performing poorly at the outset of the study which could have placed pressure on workers to make sure that iasm teams worked, both may have influence survey results. however, the iasm teams program was implemented and monitored by a consulting group with substantial experience in team-based systems. in this sense, the study offers further encouragement for those who are considering such programs in their organizations. a practical conclusion drawn from this study indicates that the introduction of a iasm teams program into an organization further requires the introduction of multifaceted changes in person-job relationships and organizational operations. these changes include training in a variety of new skills, a greater degree of goal setting and feedback for specific tasks, team approaches to problem solving, and the structuring of communication flow between workers and management. fall 2003 elmuti: internet aided self-managed teams references 133 alexander, s. (200 i). virtual teams going global communication and culture are issues for distant team members. info world, (nov. ij), 22,55. alwang, g. (1998). instant groupware. pc magazine, (february 10). anthony, w. p., kacmar, m. k., & whitfield, m. j. (1985). evaluation of team-based management: a case study. journal of organizational change management, 8.2, 17-28. bill, d. t. (2000). contribution influences on an individual's attitude toward a new technology in the workplace. http://www.centurionsys.com/rtcl47.html. (july 13), 1-7. bradley, g. e. (1977). computerization and some psychosocial factors in the work environment. managing job stress, hew, u.s. government documentation center, washington, 3-9. brucker, d. (1995). spurring on reengineering, fortune. (june 26), 15. brunelli, m. (1999). how harley-davidson uses cross-functional teams. purchasing. 127,7, 1-44. cayne, d. (1997). the emerging star: the internet. forbes, (september 22), 512. c.rosby, p. (1979). quality is free: the art of making quality free, new york: mcgrawhill, 25-45. daft, r. & marcie, d. (1998). understanding management, 6th ed., new york: dryden publishing co., 51-52. daft, r. (1999). organization theory and design, 8th ed., st. paul mn: west publishing co., 47. demarie, s. m. & townsend, a. (1998). virtual teams: technology and the workplace of the future. the academy of management executive, (august), vol. 12 no.3, 17. dumaine, b. (1997). the trouble with teams. fortune, (september 5), 86-92. fister. s. (1999). a lure for labor. training, (february 9), 36,2 56-62. flanagan, p. (1994). ibm one day, lexmark the next. management review, (january), 38-44. forrester research (1998). u.s. online business trade will soar to $1.3 trillion by 2003. http://www.forrestelcom or http://ecommerce.gov 6/30/2000, (december). 134 journal of business strategies vol. 20, no.2 forrester, r. & drexler, a. (1999). a model for team-based organization performance. the academy of management executive. vol. 13 no.3, (august), 28-49. harvey, b. (1999). technology, diversity, and work culture key trends in the next millennium, hr magazine. 4, ii, 58-59. herrenkohl, r., judson, t., & heffner, j, (1999). defining and measuring employee empowerment. journal of applied behavioral science, vol. 35 no.3, (september), 373-389. holpp, l. (1994). applied empowerment. trainin~, (february) 39-44. holtz, s. (1996). lntranets, communication world, (june/july), vol. 13 no.6, 54. kezsbom, d. (2000). creating teamwork in virtual teams. cost en~ineering, 33, king, w. r. (1998). it enhanced productivity and profitability. information systems management, (winter), 64-66. kirkman, b. & rosen, b. (1999). beyond self-management: antecedents and consequences of team empowerment. academy of management journal, 42.1, 58-71. kirkman, b. l. & rosen, b. (2000). powering up teams. organizational dynamics, (winter), 48-65. kling, r. (1996). computerization at work. cmc magazine, (august), 1-25. lawler, e. e. (1979). measuring the psychological quality of working life. in l. davis and a. cherns (eds.) the quality of work life, i, new york: free press, 123-133. marks, m, i., mirvis, p. h., hackett, e. j. & grady, jr., j. f. (1986). employee participation in a quality circle program: impact on quality of work life, productivity, and absenteeism. journal of applied psychology, 71,2, 61-69. massey, jr., t. (1986). computers in small business: a case of under-utilization. industry week, (fall), 51-58. mays, w. (1999). project management meets the internet. http://users.ids.net/~brim/ sdwth.html or http://www.cisco.com/warp/public (march 3). mcdonough iii, e. f. & cedrone, l. (2000). meeting the challenge of global team management, research technology management, 12. mirvis, p. h. & lawler, e. e. (1984). accounting for the quality of work life. journal of occupational behavior. 5, 197-212. fall 2003 elmuti: internet aided self-managed teams 135 mohrman, s. a., cohen, s. g., & mohrman, a. m. (1999). designing team-based organizations: new forms for knowledge work. san francisco: josey-bass publishers, 40-58. ramsey, r. d. (2000). how much technology is too much? strategies for humanizing a high-tech workplace. supervision, 6, i, (january). reid, r., reid, m., & associates (1999). characteristics of high performing teams. http://www.improve.org/teams.html. rossman, r. j. (1986). avoiding the pitfalls in implementing a system. the office, (october) 35. shore, b. (200 i). information sharing in global supply chain systems. journal of global information technology management,. vol. 2 no.3, 27-50. sirkin, h. l. (1993). the employee empowerment scam. industry week, (october) 58. solomon. c. (200 i). managing virtual teams. workforce, vol. 6 no.2, 60-65. stokes, jr., s. l. (1991). is without managers, information strategy: the ex.ecutive's journal. (fall) 11-15. thompson, a. a. & strickland, a. j. (2003). strategic management concepts and cases. boston: mcgraw-hili irwin, 226. thompson-jones, m. (1999). only half of net purchases are paid for online. the industry standard, (march i), http://www.thestandard.com/metrics. townsend, a., demarie, s. & hendrickson, a. (1996). are you ready for virtual teams. hrm magazine, (september) 123-126. turban, e., mclean, e., & wetherbe, j. (1999). information technology for management, new york: john wiley & sons, inc. turban, e., rainer, k., & porter, r. (2000). introduction to information technology, new york: john wiley & sons, inc. weiss, m. m., massey, p. a., & song, m. (2001). getting it together: temporal coordination and conflict management in global virtual teams. academy of management journal, vol. 44 no.6, 1251-1262. weston, r. (1997). manufacturers turn to net for improved supply chain. computerworld, (november 3), 12. zawacki, a. r. & lackow, h. (1998). team building as a strategy for time-based competition. information systems management, (summer), 36-39. 136 journal o{ business strateries vol. 20, no.2 dean elmuti, ph.d. is a professor of management and management discipline coordinator in the school of business at eastern illinois university. previously, he was employed for several years by multinational corporations in the middle east and the united states. he has published over 60 articles in diverse journals such as journal of applied business research, journal of business strategy, quality progress, journal of small business management, production and inventory management journal, and etc., in the area of quality, strategy, and global competitiveness. impact of internet aided self-managed teams on quality of work-life and performance an inquiry into chinese initial public offerings from a corporate governance perspective guclu atinc drake university • des moines, ia yan liu united states university • san diego, ca mark kroll university of texas at brownsville • brownsville, tx bruce a. walters louisiana tech university • ruston, la abstract using longitudinal data, this study investigates the impact of managerial ownership, director ownership, state ownership, firm size, and blockholders on initial public offerings (ipos) of chinese listed companies from 1991 to 2007. underpricing of ipos is examined at three specifically identified time periods which we call the primitive stage, the development stage, and the maturity stage. our results indicate that those corporate governance factors we examined in this study exhibit different characteristics at different stages for chinese publicly listed companies which signify a need to assess the impact of governance mechanisms on ipo processes of emerging economies from a different perspective. introduction this study examines the initial public offerings of chinese publicly traded companies and illuminates some of the unknowns of this dynamic economy. the process of china’s market economy reform has been experimental and gradual. since the reform started in 1978, there has been remarkable growth in the chinese economy. since the two chinese stock markets were formed in the early 1990s, hundreds of companies have been privatized and have gone public (sun, li, & zou, 2005). although the idea was to create a free market economy in which business practices reflect those of western counterparts, scholars call for more in-depth studies about the uniqueness of the chinese quasi-free-market structure (firth, fung, & rui, 2006; 2007). popular research areas such as corporate governance of listed firms (chen, 2001) and state-owned-enterprises (hua, miesing, & li, 2006) have been investigated, while initial public offerings (ipos) and related issues have only recently received attention (deng & dorfleitner, 2008; kao, wu, & yang, 2009). sanders 100 journal of business strategies and boivie (2004) proposed that in emerging industries, there are qualitative factors rather than objective factors that serve as signals for the valuation of firms. the authors argue that “in highly uncertain environments investors attempt to reduce their uncertainty through screening firms and sorting their valuations based on new firms’ use of observable agency control mechanisms” (sanders & boivie, 2004: 170). going beyond that, this study considers some of these observable mechanisms and makes a connection between them and ipo firm performance in china. there is evidence characterizing the chinese ipo market as one in which there is a prevalence of uncertainty and information asymmetry (ma, 2007). as china is considered a rising star in the 21st century, assessing the progress of the ipo process in china is important. particularly, this study assumes that different governance mechanisms may have different impacts on firm valuation at different points in time in the evolution of the chinese new issue market. although the study is retrospective, the results may provide insights into the future of the chinese ipo market and ipo markets in other emerging economies. this study examines the impact of managerial ownership (kroll, walters, & le, 2007), director ownership (kroll, walters, & wright, 2008), firm size (dalton, daily, johnson, & ellstrand, 1999), state ownership (sun et al., 2005), and blockholders (daily, dalton, & rajagopalan, 2003) on ipo underpricing (arthurs, hoskisson, busenitz, & johnson, 2008) at three specific points in time. a review of the literatural indicates that an explanation of the temporal changes in the relationships between firm governance and ipo performance has not been done. this study provides a road map for academicians in analyzing the impact of governance issues on ipos in emerging economies and provide fresh insights into the impacts of various corporate governance devices in emerging economies that are likely to differ from earlier findings related to mature western markets. conceptual development classical agency theory proposes that executives act as agents of the shareholders or principals (jensen & meckling, 1976). the theory suggests that more vigilance by the board should result in better monitoring of the agents and ultimately better performance (kroll, wright, & elenkov, 2002). however, some scholars consider the presence of executives on the board to be positively related to ipo performance for younger entrepreneurial firms (kroll et al., 2007). the contention of this study is that there are other exceptions to the general prescriptions of agency theory involving transition economies. volume 29, number 2 101 we divide the development process of the chinese primary market into three different eras. the first era starts with the formation of shanghai and shenzhen stock markets from the end of 1990 through 1995. the second era begins in early 1996 and goes through the end of 2000. finally, the third era starts in 2001 and ends in 2007. note that in all three stages, companies were operating in a stable environment initially; then enter a period of rapid change, and then return to stable environments as proposed by the punctuated equilibrium theory, (gersick, 1991) although our intention is not solely to rely on this theory to explain the differences between the three stages. the companies going public in the first stage experienced the dynamism of the move to a free market economy, while in the second stage, companies experienced the asian currency crisis. the companies going public in the third stage also experienced an economic downturn following the turn in the millennium. further support for this distinction is also documented in the literature. first, ibbotson, sindelar, and ritter (1988) reported that market cycles can be identified by taking the relationship between ipo activity and initial returns (underpricing) into consideration. furthermore, popular ipo studies make use of at least five-year data to account for macroeconomic conditions (e.g. jain & kini, 1994). zhou and zhou (2011) reported the differences in the number of ipos between the first fiveyear period and the remaining time frames of the chinese stock markets. in another study, the same authors documented the sudden changes in ipo markets after 2001 due to relaxation of the use of foreign currency in stock price determinations (zhou & zhou, 2010). china’s entry into the world trade organization in december 2001 also sets this year as a milestone. finally, the chinese securities and exchange commission restricted the ipo activities from the second half of 2005 to the first half of 2006. hence, considering the 2001-2007 period as a whole is not only useful from a theoretical perspective but also makes practical sense by accounting for the sudden cessation of ipo activities as well. in summary, we propose that in the chinese market, market players, such as the investors, the underwriters and the executers of corporate governance, were initially inexperienced and started to learn about market mechanisms during the first era. as those market players gained practical knowledge and enhanced their level of experience, they were able to make more intelligent decisions. by the time the last era arrived, market players became well aware of the market mechanisms just like their western counterparts, indicating that the chinese market had reached a level of maturity, and henceforth, participants are likely to behave more like their western counterparts. le, kroll, and walters (2010) developed a framework for assessing the applicability of various corporate governance mechanisms across three stages that transition economies experience. in an article, the 102 journal of business strategies authors adopted an institutional theory perspective to demonstrate the effectives of different corporate governance mechanisms in three different stages of transitional economies. building on their work, we adopt primarily a signaling theory perspective to demonstrate how the behavior of market players differ in each of the three stages and then provide a road map for academicians and practitioners to assess the transition process in emerging economies in terms of corporate governance mechanisms and ipo performance. during the first stage, we speculate that companies going public suffer from the “liability of newness” (stinchcombe, 1965) as managers of those companies are inexperienced about being publicly traded and have to cope with the legal requirements of the governing bodies which are also inexperienced with regard to regulating market transactions. in this case, one can speculate that classical contentions of agency theory about the board of directors are less likely to apply (kroll, et al., 2007). in the chinese context, at least initially, the board characteristics that western scholars assume to be important, such as meeting the board vigilance requirements of agency theory (kroll et al., 2008), may not be fulfilled. for example, in the first era there were not enough experienced outsiders to adequately staff the boards of directors of all the firms going public. therefore we anticipate chinese firms, on average, started with a relatively greater number of executives on their boards. as market participants such as executives, board members, regulatory bodies, outsiders, and other shareholders learned through interaction with their western counterparts and more executives gained oversight experience, the popularity of outside board members increased. in fact, as with the sarbanes-oxley act of 2002 in the united states, the chinese securities regulatory commission (csrc) now recommends that at least two independent outsiders be present on corporate boards. in summary, chinese companies likely started with more executives (insiders) on their boards and moved towards board independence along the way. this probably happened naturally as the chinese companies mimicked their western counterparts due to institutional isomorphism (dimaggio & powell, 1983). in parallel to this, companies should also have started with little or no executive ownership but moved toward more executive ownership, which is gathered through more performance based compensation schemes (wright & kroll, 2002). western scholars recommend some amount of executive ownership to mitigate conflicts of interest between the executives and shareholders (buchko, 1992). wang (2005) investigated whether different types of owners have different impacts on chinese firms’ performance. he reports that, as a socialist country, volume 29, number 2 103 most chinese publicly traded companies were originally state owned enterprises (soes) and their ownership structure is deeply affected by that fact. in china, companies sell some of their shares to employees, some to legal entities (i.e., other privatized firms and chinese investment funds), and, public investors. however, it is a well-known fact that the state is still the primary shareholder in a majority of the publicly traded companies (liu, atinc, & kroll, 2011). in other words, especially in the initial years, the state did not transfer blockholder ownership (over 5%) to any of the former soe executives. in effect, during the primitive stage the executives of the ipo firms were more like government agents, rather than professional executives like their western counterparts. market players, including the state, learned about different compensation schemes of the west, such as stock options as time passed executives were awarded with more shares in the company as they became more professional. consistent with the underlying theme of this study, the governance practices have become more westernized as the market matured. to summarize, although the percentage of executives on the board should have declined as the market moved away from the primitive stage, the percentage of the shares owned by executives should have increased. these changes in the top management team (tmt) structure are considered to be unique for transitional economies and indicate the important connection between the financial improvements at the country level and the corporate governance changes at the organizational level. this study assumes that this connection should be investigated further. the following two hypotheses are based on this discussion: hypothesis 1: the percentage of executives on the boards of chinese listed companies declined as the market moved from one era to the next. hypothesis 2: the percentage of shares owned by executives has increased as the market has moved from one era to the other. ipo underpricing is one of the most popular topics studied concerning. underpricing refers to the difference between the ipo offer price set by the underwriters and the first day closing price (arthurs, et al., 2008). when an ipo is first announced, an underwriter acts as the assessor of the value of the firm. following that, the underwriter sets the offer price and investors are allocated shares by the offering syndicate before the company starts trading. at the end of the first day, what is widely thought to be the true perceived value of the company by the market emerges. if the ipo price is less than its first day closing price, the company’s shares were 104 journal of business strategies underpriced bu the underwriters in the ipo (heeley, matusik, & jain, 2007). ritter (1991) referred to this situation as “management leaving money on the table.” in the primitive stage, we assert that underpricing is more likely to happen. in the first years of the chinese stock markets, the ipo mechanisms were not clear and both the underwriters and the investors had little confidence in those mechanisms. on one hand, there was a tremendous amount of information asymmetry between companies and investors so investors had little faith in the price set by underwriters (fischer & pollock, 2004) on the other, underwriters had little confidence that there were sufficient investors who were willing to put their money into early stock offerings. furthermore, the western-oriented underwriters acted more like agents for investors, rather than investment experts shepherding the focal companies through their ipos (arthurs, et al., 2008). for these reasons, underpricing was probably much greater in the primitive stages versus the late 1990s to early 2000s. the effect of information asymmetry between issuing firms and investors on underpricing is tremendous (rock,1986). in the primitive years, china’s socialist system was opening stock markets and companies were going public for the first time. there were great information asymmetries concerning the values of these firms. in such a context, firms were likely-to be perceived as being worth much less than they might have actually been worth. however, this situation should have gotten better as time passed and as investors in china better understood the process while gaining more experience with market mechanisms. based on the above discussion, we speculate that in emerging economies underpricing is much higher in the initial stages but declines as the market matures. the following hypothesis summarizes this proposal: hypothesis 3: underpricing of ipos in chinese markets declined as the market matured through the three stages of development. firm demographic characteristics have been investigated by various scholars over the years. for instance, in a western setting, ibbotson, sindelar, and ritter (1988) observed firm size (measured by total revenue) to have a significant influence on the success of the ipo process. gu (2003) reported firm size (measured by total sales of the issue year) to be positively related to the ipo performance of chinese companies, contrary to the case in western companies. we extend his finding by considering three different stages of development in the chinese economy. specifically, this study proposes that firm size matters more as the market matures. our choice of firm size as a determinant variable may be questioned. there are other variables (e.g., beta for risk assessment) that can be used as determinant variables volume 29, number 2 105 in ipo-related studies. a review of the literature, though, show firm size to be one of the most widely used and accepted variables in corporate governance-related ipo studies over the years (gu, 2003; hand, 2007; ibbotson, et al., 1988). in emerging economies, especially in the initial years, people have few investment options. in fact, empirical evidence reflect that in the initial years of the stock market’s development in china, investors did not have many firms in which they could invest (chau, ciccotello, & grant, 1999). until 1993, there was no formal regulation by the governing bodies regarding information disclosure. for instance, prospectus statements of several of the first companies traded on the shanghai stock exchange covered only one and a half pages on shanghai securities daily. in addition, until 1994, the accounting practices in china were primarily influenced by the old soviet standards which made published information incompatible for the application of western data-based signaling theory assumptions (su, 2004). this meant people knew little of firm successes or failures in the years prior to their ipo. one might argue that, even if investors have few options, they would go with the larger firms in order to offset some of their uncertainties. in a western setting, that argument makes intuitive sense. in the chinese setting, the lack of available investment options during the first few years of the market made firm size an irrelevant signaling factor. rather than considering the signaling effects of firm size in a western setting where there are many alternatives, in china, there were few companies offered to market players for investment. as a consequence, firm size did not constitute a factor heavily weighted in the valuation of firms at the initial stage. in other words, the impact of firm size on underpricing should be relatively minor for firms in the primitive stage because investors cannot really distinguish the signaling effects of such a factor due to lack of knowledge. this factor mean more as the market matured and investors became more sophisticated. after january 1994, “enterprise accounting systems” were put into effect which brought the published documents of publicly traded companies more in line with the western practices (su, 2004). as the regulatory systems of the stock markets became more active, companies were required to disclose more information. following that, we contend that market players started to consider potential signaling factors such as firm size. this would be the case in transitional economies. in these kinds of economies, the market players start with less knowledge and very little experience, not to mention little confidence in the market. as the market matures, as in the chinese case, some of the negative or positive signaling effects applicable to western companies become relevant for them as well. the following hypothesis is based on this discussion: 106 journal of business strategies hypothesis 4: in chinese markets, the impact of firm size on ipos became more important as the market matured. the final sets of hypotheses relate to the ownership structure of chinese firms. as a traditional socialist economy, the state’s influence on the chinese market is still pervasive (li & tong, 2004). not surprisingly, the chinese government tends to be the largest blockholder in a majority of the listed companies (liu, et al., 2011). in western literature, although the results are mixed, several scholars have proposed a positive relationship between concentrated ownership and firm performance using accounting-based or market-based measures (dalton, daily, certo, & roengpitya, 2003). hence, in the chinese context, one might assume that state ownership would be viewed positively by investors during the initial public offerings. however, given that the government may have a different agenda versus that of investors (e.g., job creation and expansion into targeted industries), state ownership might trigger a negative signaling effect from investors. gu’s (2003) findings support this contention. in an investigation of 68 chinese ipos in 1994, he found that state ownership had a negative effect on short-term ipo performance. building on that, the influence of state ownership may differ across the three time frames mentioned in this study. first, in the primitive stage, the state’s presence might be viewed favorably due to lower perceived risk about the ipo firm. in effect, the state’s presence might be seen as a valuable resource for the company thus decreasing the amount of underpricing; so the offer price set prior to the initial trading is assumed to reflect more accurately the real value of the firm. as far as the state and employee owners are concerned, such an ipo may be considered successful (ritter, 1991). in the second stage this effect should fade because of the movement towards a market economy and ultimately lead to more underpricing in the final stage. in the final stage, the presence of heavy state ownership might be associated with a bureaucratic, non-innovative managerial style (kornai, 1997) which is likely to trigger a negative signal about the company. based on signaling theory, this negative signal should be reflected in the offer price (ritter & welch, 2002) such that the underwriters will set the price lower to account for risks associated with new publicly traded firms — a situation that is theorized by the risk-averse underwriter hypothesis (reilly, 1973). in the case of ipo firms, with high state ownership, underwriters would likely account for risks associated with such firms by valuing these companies lower than what they are really worth. the result in this case will be more underpricing which is actually negative ipo performance as far as the original owners are concerned, since they just left some money on the table as (ritter, 1991). volume 29, number 2 107 the situation should be reversed in the case of firms with traditional blockholders other than the state. as the market matures, just like its western counterparts, the state is expected to move away from its active role in the market if china is really on its way to becoming a free market economy and traditional blockholders, such as those in western economies (e.g., mutual funds or multinational corporations), should step in. the ipo stage of such a company structured along the lines of its western counterparts should be more successful as the presence of such blockholders may trigger a more positive signal. thus, as the chinese market matured, firms with more blockholder ownership should have experienced less severe underpricing. the last two hypotheses are built based on this discussion: hypothesis 5a: the state’s presence will be negatively associated with underpricing in the first stage, become neutral in the second stage, and become positively related to underpricing in the final stage. hypothesis 5b: as the market matures, firms with more blockholder ownership will face less underpricing in initial public offerings. table 1 summarizes the proposed relationships and the specific differences we believe to be present among the three stages. in the next section, the sample data collection process is discussed and then it will be followed by the variables employed and the statistical methods used. we conclude the study by reporting the results followed by a discussion of these results and their implications. 108 journal of business strategies table 1 summary of hypothesized relationships stages primitive stage development stage maturity stage percentage of insiders highest lower lowest percentage of shares owned by executives lowest low higher underpricing of ipos highest lower lowest impact of firm size on ipo underpricing unimportant moderately important important impact of presence of the negative impact on no impact on positive impact on state on ipo underpricing underpricing underpricing underpricing impact of blockholder positive impact on no impact on negative impact on ownership on ipo underpricing underpricing underpricing underpricing methods sample creation as previously discussed, we divided the development of the chinese stock markets into three separate time frames. the first one, what we consider to be the primitive stage, starts with the opening of stock markets at the end of 1990’ the beginning of 1991 and ends in 1995. the second stage, which we call the developmental stage, starts at the beginning of the year 1996 and continues to the end of the year 2000. the third stage, which we call the mature stage, begins in 2001 and goes all the way to the end of 2007. we were able to randomly select a sufficient number of companies from each time period. we randomly selected 120 companies which went public in each stage from a total of 360. due to missing or corrupted data in our data sources, our final sample of companies were 105 for the first stage, 117 for the second stage, and 112 for the third stage — a total of 334 companies. the china stock market and accounting research (csmar) database was used to gather stock and accounting data. the annual reports of the companies were gathered from various sources such as sina. com and the official website of the shanghai and shenzhen stock markets. the companies were sorted into the three time frames based on the year in which their volume 29, number 2 109 shares were first traded. we ensured that no single industry dominated our sample by taking the industry codes specified by the chinese regulatory bodies into account (via a frequency analysis for each industry). to be more specific, most of the companies did not have their primary industries specified in the archival database. finance, information technology, utilities, and energy sectors represented 2%, 6%, 2%, and 2% percent of the companies in our sample. the remaining companies are marked as others. variables dependent variable underpricing: several variables have been used in finance literature to assess ipo performance. in our study we chose to employ underpricing as the dependent variable. underpricing is defined as the difference between a firm’s ipo issue price and its first day closing price (arthurs, et al., 2008). if this variable is negative, it means the first day closing price is larger than the initial offer price, so the company’s shares were offered at a price less than the market’s imputed value of the firm, and the management has left money on the table. if the situation is reversed, then the ipo is successful from the company’s standpoint in that original investors initially paid more money than the company is worth. rather than concentrating solely on ipo performance, the purpose of this paper is to show the connection between the changes in corporate governance mechanisms of the firms and the happenings in the stock market. this study assumes that the recognition of this connection is important for understanding the stages as emerging economies develop. the underpricing variable is readily available and can be used to demonstrate the differences between these stages. hence, this variable is used as the dependent variable in the following models. one valid argument against our choice of underpricing as a focal variable would be whether the trend of underpricing in other countries was similar to what we observed in china. in order to address this, we compared the first day returns of the ipos in united states during the past 20 years with the ones in our sample. in china, during the time period this study covers and looking at the randomly selected companies, the average underpricing was almost 200% (which means the average first day closing price is double the opening price) while that number was around 22 percent in the united states (ritter, 2011). in fact, this big difference between the two markets is also a support for our argument about the uniqueness of the chinese ipo market and the related corporate governance mechanisms. 110 journal of business strategies independent variables percentage of executives on the board: this variable is used to test hypothesis 1. the variable is computed by using the number of executives on the board divided by the total number of directors. percentage of stock owned by executives on the board: this variable is used to test hypothesis 2. the csmar database includes a variable representing the percentage of shares owned by the executives of listed firms and that variable is used to operationalize executive ownership. firm size: this variable is used to test hypothesis 4. the log of total assets reported for the ipo year proxies for firm size (gilson, 1997). state ownership: we chose the percentage of shares owned by the government as the state ownership variable. these data are reported in company annual reports. blockholders: shareholders who control 5 percent or more of a firm’s outstanding shares are considered blockholders (kroll, wright, toombs, & leavell, 1997). in order to test the contention in hypothesis 5b, we used percentage of shares owned by blockholders as the independent variable. control variables international ownership is used as a control variable in our models. although the results are mixed concerning foreign ownership’s influence on chinese stock markets (mcguinness & ferguson, 2005), we suspect that it has a potential impact on underpricing due to underwriters’ potential relations with international investors. chinese publicly traded firms report the amount of international ownership separately (liu et al., 2011). the percentage of shares owned by international owners is used to operationalize this variable. as a second control variable, a dummy variable is included representing the stock market the firm is traded on (shanghai = 1 and shenzhen = 0) since the two markets have different types of companies just like their counterparts in the u.s. (i.e., new york stock exchange ‘nyse’ and the national association of securities dealers automated quotations ‘nasdaq’). statistical techniques in order to test hypotheses 1, 2, and 3, we used anova and scheffe’s method to identify the differences among the three groups. anova only tells if the groups are different from one another. scheffe’s method, in parallel with anova, was used to identify how different each group was from the others. volume 29, number 2 111 ordinary least squares were used to test the remaining hypotheses. first, the control variables were entered in the models and then the corresponding independent variables. for the purpose of investigating the differences attributed to time frames, three different regression models were estimated reflecting the three different groups of companies previously discussed. below is the model that was used for each time period: underpricing = international ownership + stock market dummy + log of assets + state ownership + percentage of shares owned by blockholders. results table 2 includes results of the anova and scheffe’s that we used to test hypotheses 1, 2, and 3. the mean values of percentage of executives on the board in each time frame were statistically different from one another (at p < 0.001). based on the results of the scheffe’s test, we can say that the number of executives on the board was higher in the primitive stage, declined slightly in the development stage, and still went down even further in the maturity stage. these results provide support for hypothesis 1. in terms of hypothesis 2, although the three groups displayed a numerical difference with regard to percentages of shares owned by the executives (p < .10), the scheffe’s test results did not demonstrate a significant statistical difference, and therefore hypothesis 2 is not supported. for hypothesis 3, the anova results are statistically significant for the difference among the three time frames (at p < 0.001). the mean values seem to decline as we moved from the primitive stage, to the development stage, and then to the maturity stage. scheffe’s test results also provided support for this contention. in sum, hypothesis 3 received support. for the regression models, first the durbin watson statistic was used to check for autocorrelation and variance inflation factor values were estimated to test for multicollinearity. neither of these values exceeded the critical values mentioned in the literature (durbin-watson score was around 2 for all groups, while the largest variance inflation factor score was around 1.7). table 3 includes the pearson’s correlations and descriptive statistics. table 4 includes the regression results for our various models. the results indicate that firm size is not a statistically significant determinant of underpricing in the primitive stage (β = -.143, p > .10). in the development stage that variable becomes significant (β = -.303, p < 0.01). in the most advanced maturity stage the firm size variable is still significant (β = -.369, p < 0.01). the negative sign signifies that larger companies are underpriced less as we hypothesized. thus there is support for hypothesis 4. 112 journal of business strategies t ab le 2 r es ul ts o f a n o v a a nd s ch ef fe ’s t es t s ch ef fe ’s t es t s ta nd ar d s o ur ce o f s um o f m ea n s ig ni fic an ce va ri ab le n m ea n d ev ia ti o n va ri at io n s q ua re s d f s q ua re f va lu e p er ce nt ag e of g ro up 1 97 0. 45 0. 27 b et w ee n g ro up s 3. 00 2 1. 50 32 .7 7* ** 0. 00 0 ex ec ut iv es o n g ro up 2 11 6 0. 42 0. 22 w ith in g ro up s 14 .6 3 32 0 0. 05 0. 00 0 th e bo ar d g ro up 3 11 0 0. 37 0. 15 to ta l 17 .6 2 32 2 0. 00 0 p er ce nt ag e of g ro up 1 92 0. 00 0. 00 1 b et w ee n g ro up s 0. 01 2 0. 00 3 2. 72 † 0. 15 7 st oc ks o w ne d by g ro up 2 11 5 0. 00 0. 00 1 w ith in g ro up s 0. 39 31 0 0. 00 1 0. 11 4 ex ec ut iv es o n g ro up 3 10 6 0. 01 0 0. 06 1 to ta l 0. 40 31 2 0. 11 4 th e bo ar d g ro up 1 10 5 3. 27 6. 17 b et w ee n g ro up s 32 2. 42 2 16 1. 21 10 .1 2* ** 0. 00 0 u nd er pr ic in g g ro up 2 11 7 2. 01 3. 31 w ith in g ro up s 52 70 .3 6 33 1 15 .9 2 0. 08 5 g ro up 3 11 2 0. 83 0. 62 to ta l 55 92 .7 8 33 3 0. 08 5 p er ce nt ag e of g ro up 1 98 46 .6 9 24 .7 7 b et w ee n g ro up s 2. 50 2 32 0. 13 0. 54 0. 76 0 st oc ks o w ne d by g ro up 2 11 7 50 .0 7 24 .3 5 w ith in g ro up s 2. 25 32 3 58 9. 27 0. 96 3 th e st at e g ro up 3 11 1 49 .1 8 23 .7 4 to ta l 2. 25 32 5 0. 96 3 volume 29, number 2 113 table 3 pearson’s correlations and descriptive statistics variables means s. d. 1 2 3 4 5 6 7 1. underpricing 2.01 4.10 2. percentage of 0.37 .23 .13* executives on the board 3. percentage of .004 .04 -.03 -.07 stocks owned by executives 4. international 5.61 11.91 -.04 -.06 -.04 ownership 5. stock market .72 .45 -.08 -.16** -.00 .15** dummy 6. log of assets 9.25 .81 -.21** -.19** .04 .38** .21** 7. percentage of 60.45 14.05 -.05 .01 -.02 -.04 .03 .10† stocks owned by blockholders 8. state 48.75 24.24 -.07 .08 -.15** -.18** .02 .13* .49** ownership table 4 multiple regression results primitive development maturity variables stage stage stage international ownership .04 .04 .23* stock market dummy -.03 -.01 -.17† firm size (log of assets) -.14 -.30** -0.37** percentage of stocks owned by blockholders .12 -.21† -.29** state ownership -.03 .04 .21† r-square 0.03 0.15 0.19 f-value .55 3.74* 4.97*** 114 journal of business strategies table 4 also includes the results for hypotheses 5a and 5b. the percentage of shares owned by the state did not prove to be a significant predictor of underpricing other than being moderately significant (p < .10) in the maturity stage. the coefficient sign was positive in the maturity stage which signifies a negative influence by the state’s presence on ipos as the market matured. in addition, we ran a regression model in which we replaced the state variable with a binary variable indicating the state was or was not a major blockholder. however, we did not find any significance (we do not report the results of that step). furthermore, we used anova to test for differences among the three time frames with regard to state ownership but did not observe any significant difference. the mean values of the percentages of shares owned by the state were very close to one another, indicating the state’s role in the market remained stable over the years. this will be further discussed in the next section. in short, hypothesis 5a is only partially supported. the percentage of stock owned by blockholders did not prove to be significantly related to underpricing in the primitive stage (β = -.116, p > .10), but was moderately significant in the development stage (β = -.211, p < .10) and strongly significant in the maturity stage (β = -.286, p < .01). these results provide strong support for hypothesis 5b. our findings can be summarized as follows: – hypotheses 1, 3, 4, and 5b are supported. – hypothesis 5a is partially supported. – hypothesis 2 is not supported. before moving on to the discussion section, there is one other variable that is worthy of mentioning. looking at the results reported in table 3, international ownership was not a determinant factor during the first and second stages. however, during the third stage, this variable has a positive impact on underpricing (β = -.226, p < .05). this finding will also be discussed in the next section. discussion hypothesis 1 proposed that the percentage of executives on the board declined as the market matured in china. we predicted that with certain recent regulations and the popularity of board independence in the west (as recommended by agency theorists [e.g., fama, 1980]), the boards of chinese listed companies would become more vigilant. our results supported this prediction. there is strong support in the west for the positive effect of board independence (kroll, et al., 2008). a theoretical explanation can be made through the use of the propositions of the volume 29, number 2 115 institutional theory (dimaggio & powell, 1983). at the beginning, when the mechanisms were weak, market players started with the traditional ways of doing business because they lacked experience. as the market matured, chinese companies chose to mimic their western counterparts’ business practices when they observed their success. therefore, those companies moved away from traditional owner-managercontrolled firms toward shareholder-controlled firms. in fact, as mandated by the sarbanes-oxley act of 2002 in the united states, the recommendation made by csrc concerning having two outsiders on the board is an indication of this trend. support for this hypothesis is a good demonstration of the process emerging economies experienced with regard to their ipo processes. however, hypotheses 2, which proposes that the percentage of shares owned by ipo firm executives rose as the market matured, is not supported. we did find that executive ownership is definitely higher in the maturity stage. once again, chinese companies are probably starting to adapt performance-based compensation schemes for their upper echelons (hambrick & mason, 1984) as is the case for western firms. this trend is not obvious in the development stage but it is definitely present in the maturity stage. obviously, due to potential effects of the state (li & tong, 2004), performance-based pay for executives is not very active. the indication in our dataset is of an increase in executive ownership. as the market becomes more mature, researchers might observe a trend toward greater insider ownership continuing. this might be an area for future research. hypothesis 3 anticipated that underpricing would decline as the chinese market matured. we found strong support for this contention. going back to the information asymmetry argument made by rock (1986), investors did not have any meaningful experience with market mechanisms and firm valuation in the primitive stage. this asymmetry probably started to dissipate as the market matured and the players gained experience and greater knowledge of chinese companies and their businesses practices. in the future, as the chinese market evolves to more closely parallel western markets, other factors such as underwriter prestige may begin to affect underpricing. this may be applicable to most of the emerging economies. the information asymmetry and weak signaling mechanisms are probably the main reasons for underpricing of the firms in emerging economies. as these markets mature, they may become developed economies where the market players have access to enough information and signaling effects. hence, assessing the development processes of emerging economies’ ipo structures should be done from this perspective. both investors and academicians should expect underpricing at the beginning and should observe that underpricing may fade as the market progresses. 116 journal of business strategies hypothesis 4, which anticipated that the impact of firm size on underpricing would increase over time, is supported. in the primitive stage, firm size did not matter at all. previous research showed that investors in the initial years of the chinese stock markets did not have many alternatives (chau, et al., 1999) so the most common determinants of underpricing in other markets did not matter at that point. the data revealed that this situation changed as the chinese market matured. this phenomenon is probably unique to transitional economies. investors, particularly the local ones, have information about the market and how it functions at the outset. the information asymmetry concerning new firms going public is at its greatest during these times. furthermore, underwriters, in order to attract investors, mark down ipo prices so as to assure reasonable returns for those who are brave enough to invest despite so many unknowns. “the ipos in china represented a process of transferring ownership from government to individual investors” (gu, 2003: 104). in the initial stages, that is probably why firm size did not matter. however, as the market matured, investors began to have more confidence in larger firms due to their potential for survival. this may be the reason why firm size and underpricing came to have a significant negative relationship in the development and maturity stages. if firm size has a positive signaling effect, regardless of the state’s influence in the chinese context, investors chose to use firm size as a proxy to reduce information asymmetries in the 2nd and 3rd stages. furthermore, the effect of size is even larger in the third stage (β = -.369 in the maturity stage versus -.303 in the development stage) although the percentage of shares owned by the state remained the same over the years. our final set of hypotheses concerns the impact of state and blockholder ownership. the hypotheses predicted that the state’s influence on underpricing will be negative in the first stage, will fade in the second stage, and will become positive in the third stage. in the first stage we were unable to observe any significance. in the second stage, there was not any significance either but in the third stage a moderately strong positive effect was observed. it shows that at the beginning, the state’s impact did not matter. in other words, investors did not see the state as a negative or positive influence. the lack of significance continued in the second stage, but in the development stage the state’s presence began to trigger negative perceptions about the value of the ipos. in table 2, we also report the anova results for state ownership across the three different time frames. the results show that the percentage of shares owned by the state in the companies going public has stayed constant over the years. it suggests that as the major player in what is still in many ways a socialist economy, the chinese government is reluctant to give up its influence. thus, investors’ negative perception about the presence of state ownership due to its association volume 29, number 2 117 with a bureaucratic, non-innovative managerial style (kornai, 1997) is becoming more apparent. the last hypothesis, which focuses on blockholder ownership, was strongly supported. at the beginning, concentrated ownership did not mean much for the investors, once again due to lack of options and information asymmetry. as the market matured, a moderately significant negative association between underpricing and percentage of shares owned by blockholders was observed. if the percentages of shares owned by the state stayed constant over the years as shown in table 2, then this observation may easily be attributed to private blockholder ownership. hence, firms with concentrated ownership started to be more highly valued. in the third stage, the impact of concentrated ownership became even stronger. considering the moderately significant positive impact of the state in this last period, the strong negative relationship between concentrated ownership and underpricing tells us that strong blockholders represent a positive signaling effect on firm value. this should be of interest not only to the researchers of the area but to the chinese government, or to any other emerging market government for that manner. it appears that as the market matures, powerful blockholders are wanted by investors just as in the west. future assessment of these relationships as the market becomes even more mature may provide more complete results. researchers in the field should continue to investigate the state’s influence as the market moves towards even more mature stages. looking at the effect of international ownership, the percentage of shares owned by international owners was not significantly related with underpricing during the primitive and development stages. however, during the maturity stage, higher international ownership resulted in less severe underpricing. this situation has two implications. first, it is a support for our argument about different factors acting differently during the three stages. second, in transition economies, international ownership is considered to be a positive determinant of firm valuation as the market matures and the market players value those companies with international ownership more positively. as this finding is beyond the scope of this study, future researchers may choose to further investigate that topic. conclusion analyzing chinese listed companies with regard to their governance structure has been of interest to management scholars for the past decade (chen, 2001; firth, et al., 2006; 2007). we sought to contribute to this research stream through an investigation of ipo underpricing across different time periods. specifically, we divided 118 journal of business strategies the history of the chinese stock markets into three different time periods. the first, the primitive stage, involved a period when public ownership was new, the players did not know a great deal about the market, and the rules were being established. we called the second period the development stage, when the mechanisms started to become more transparent and the players gained some experience. the third and the final stage, the maturity stage, covers the recent years during which the market has evolved to emulate its western counterparts and the players are aware of the mechanisms of the market given more than a decade of experience. this distinction across time has not been made in other studies. the results of this study indicates that the number of insiders on the boards of chinese listed companies decreased as the market matured, but the percentage of shares owned by those executives did not move in parallel to that, although moderate significance in the last stage can be an indication of potential support in future studies. ipos were less severely underpriced as the market matured due to better information flow, more experienced investors, and the establishment of market mechanisms. firm size mattered much more in the development and maturity stages, indicating the applicability of signaling theory (spence, 1973). finally, the state is still an active shareholder in a majority of companies but its presence is starting to trigger negative perceptions about the values of the firms while powerful blockholders are expected by the market players. this is an indication of china moving away from a quasi-socialist economy and trying to adapt more free market characteristics. it is now the chinese government’s job now to facilitate this transition. we believe it is legitimate to analyze the chinese stock market’s development in different stages as is true for other transitional economies. the results show that the values of our dependent variables change among the three different stages, which we believe is a natural result of the distinctiveness of three time periods. replication of this segmentation in other economies and analyzing the chinese market from this perspective might help scholars shed new light on the unknowns of developing economies. furthermore, based on our sample, we can say that investors might expect severe underpricing in the initial stages with larger firms gaining more in a typical ipo in transitional economies. also, it would be too optimistic to expect the state to give up its influence over the market in the near future. we consider this issue a potentially fruitful research area. the main limitation of this study is that we only considered the difference between the ipo price and first day closing price to be an ipo performance determinant. use of 3rd day, 1st week, 1 month, 6 months, 1 year, and 3 years of returns is also popular in finance and management literatures. future extension of this study volume 29, number 2 119 should include analyzing different time periods after the initial listing. the second limitation is that the dataset only contained companies from chinese markets. in the future, data from other emerging markets should be used to validate this segmentation so that the results may become more generalizable. finally, rather than crosssectional analysis, time-series analysis may provide more promising results. for instance, analysis of the relationship between the change in corporate governance structures throughout the years and change in firm valuation after the ipo process may be used to illustrate the gradual process chinese companies are facing. references arthurs, j., hoskisson, r., busenitz, l., & johnson, r. (2008). managerial agents watching other agents: multiple agency conflicts regarding underpricing in ipo firms. academy of management journal, 51(2), 277-294. buchko, a. (1992). employee ownership, attitudes, and turnover: an empirical assessment. human relations, 45, 711-733. chau, c., ciccotello, s. c., & grant, c. t. (1999). role of ownership in chinese privatization: empirical evidence from returns in ipos of chinese a-shares, 1990-1993. advances in financial economics, 4, 51-78. chen, j. (2001). ownership structure as corporate governance mechanism: evidence from chinese listed companies. economics of planning, 34, 53-72. daily, c., dalton, d., & rajagopalan, n. (2003). governance through ownership; centuries of practice, decades of research. academy of management journal, 46(2), 151-158. dalton, d., daily, c., certo, s., & roengpitya, r. (2003). meta-analyses of financial performance and equity: fusion or confusion? academy of management journal, 46, 13-26. dalton, d., daily, c., johnson, j., & ellstrand, a. (1999). number of directors and financial performance: a meta-analysis. academy of management journal, 42(6), 674-686. deng, h., & dorfleitner, g. (2008). underpricing in chinese ipos-some recent evidence. applied financial economics, 18(1), 9-. dimaggio, p. j., & powell, w. w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48(2), 147-160. fama, e. f. (1980). agency problems and the theory of the firm. journal of political economy, 88(2), 288-307. 120 journal of business strategies firth, m., fung, p., and rui, m. (2006). firm performance, governance structure and top management turnover in transitional economy. journal of management studies, 43(6), 1289-1330. firth, m., fung, p., & rui, m. (2007). how ownership and corporate governance influence chief executive pay in china’s listed companies. journal of business research, 60, 776-785. fischer, h. m., & pollock, t. g. (2004). effects of social capital and power on surviving transformational change: the case of initial public offerings. academy of management journal, 47(4), 463-481. gersick, c. (1991). revolutionary change theories: a multilevel exploration of the punctuated equilibrium paradigm. academy of management review, 16(1), 10-36. gilson, s. c. (1997). transactions costs and capital structure choice: evidence from financially distressed firms. the journal of finance, 52(1),161-196. gu, y. a. (2003). state ownership, firm size, and ipo performance: evidence from chinese “a” share issues. american business review, 21(2), 101-108. hand, j. r. (2007). determinants of the round-to-round returns to pre-ipo venture capital investments in u.s. biotechnology companies. journal of business venturing, 22(1), 1-28. hambrick, d. c., & mason, p. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review, 9(2),193-206. heeley, m. b., matusik, s. f., & jain, n. (2007). innovation, appropriability, and the underpricing of initial public offerings. academy of management journal, 50(1), 209-225. hua, j., miesing, p., & li, m. (2006). an empirical taxonomy of soe governance in transitional china. journal of management and governance, 10(4), 401-433. ibbotson, r., sindelar, j., & ritter, j. (1988). initial public offerings. journal of applied corporate finance, 1, 37-45. jain, b. a., & kini, o.(1994). the post-issue operating performance of ipo firms. journal of finance, 49, 1699-1726. jensen, m., & meckling, w. (1976). theory of the firm: managerial behavior, agency costs, and ownership structure. journal of financial economics, 3, 305-360. kao, j., wu, d., & yang, z. (2009). regulations, earnings management, and postipo performance: the chinese evidence. journal of banking and finance, 33(1), 63-. kornai, j. (1997). editorial: reforming the welfare state in postsocialist societies. world development, 25(8), 1183-1186. volume 29, number 2 121 kroll, m., walters, b., & le, s. (2007). the impact of board composition and top management team ownership structure on post-ipo performance in young entrepreneurial firms. academy of management journal, 50(5), 1198-1126. kroll, m., walters, b., & wright, p. (2008). board vigilance, director experience, and corporate outcomes. strategic management journal, 29(4), 363-382. kroll, m., wright, p., & elenkov, d. (2002). acquisition returns, increase in firm size, and chief executive officer compensation: the moderating role of monitoring. academy of management journal, 45, 599-608. kroll, m., wright, p., toombs, l., & leavel, h. (1997). form of control: a critical determinant of acquisition performance and ceo rewards. strategic management journal, 18, 85-96. le, s., kroll, m., & walters, b. (2010). the impact of institutional changes on corporate governance mechanisms in transition economies. journal of management & governance, 14(2), 91+. li, k., & tong, l. (2004). chinese industrial policy and the reduction of state-owned shares in china’s listed companies. pacific economic review, 9(4), 377-393. liu, y., atinc, g., & kroll, m. (2011). the unique nature of chinese corporate governance practices. journal of business strategies, 28(1), 29-58. ma, s. (2007). information asymmetry and valuation uncertainty, the determination of china’s ipo allocation procedures. applied financial economics, 17, 271-284. mcguinness, p., & ferguson, m. (2005). the ownership structure of listed chinese state-owned enterprises and its relation to corporate performance. applied financial economics, 15(4), 231-246. reilly, f. (1973). further evidence on short-run results for new issue investors. journal of financial and quantitative analysis, 8, 83-90. ritter, j. (1991). the long-run performance of initial public offerings. journal of finance, 46, 3-27. ritter, j., & welch, i. (2002). a review of ipo activity, pricing, and allocations. the journal of finance, 57(4), 1795-1829. ritter, j. (2011). jay ritter’s web-site. retrieved december 16, 2011, from bear.warrington.ufl.edu/ritter/ipodata.htm rock, k. (1986). why new issues are underpriced? journal of financial economics, 15, 187-212. sanders, w. m., & boivie, s. (2004). sorting things out: valuation of new firms in uncertain markets. strategic management journal, 25(2), 167-186. 122 journal of business strategies spence, a. (1973). job market signaling. quarterly journal of economics, 87, 355-379. stinchcombe, a. (1965). in j. g. march (ed.), social structure and organizations. chicago: rand mcnally. su, d. (2004). adverse selection versus signaling: evidence for the pricing of chinese ipos. journal of economics and business, 56, 1-19. sun, l., li, t., & zou, l. ( 2005). state ownership, corporate performance, and parameter heterogeneity: a quantile analysis on china’s listed companies. journal of economics, 60+. wang, c. y. (2005). ownership and operating performance of chinese ipos. journal of banking and finance, 29(7), 1835-1856. wright, p., & kroll, m. (2002). executive discretion and corporate performance as determinants of ceo compensation, contingent on external monitoring activities. journal of management and governance, 6(3), 189+. zhou, z., & zhou, j. (2010). chinese ipo activity, pricing, and market cycles. review of quantitative finance & accounting, 44, 483-503. zhou, z., & zhou, j. (2011). chinese ipo market cycles. the chinese economy, 44(5), 55-71. biographical sketch of authors guclu atinc received his d.b.a. from louisiana tech university. he is an assistant professor of management at drake university. his current research interests are in the area of upper echelons and boards of directors in young entrepreneurial firms and on the impact of environment in strategic decision making. his research appeared in journals like organizational research methods, journal of managerial issues and journal of business strategies. yan liu received her d.b.a. from louisiana tech university. she is an assistant professor of management at united states university. her research interests include proactive behavior, leadership, organizational justice, deviance behavior as well as corporate governance mechanisms of chinese organizations. mark kroll is the dean of the school of business at the university of texas at brownsville. he received his d.b.a. from mississippi state university. his research interests include corporate governance, post-ipo firm performance, and strategic leadership of entrepreneurial firms. bruce a. walters is the edward l. moyers professor of management and department chair of management and information systems at louisiana tech univolume 29, number 2 123 versity. he received his ph.d. from the university of texas at arlington. his current research interests include young entrepreneurial firms, corporate governance, and strategic decision processes. his research has appeared in several journals, including academy of management journal, strategic management journal, journal of management, strategic organization, and journal of business research. 124 journal of business strategies an inquiry into chinese initial public offerings from a corporate governance perspective journal of business strategies special issue on finance perspectives of foreign direct investment in the new millenium balasundram maniam william hadley leavell sam houston state university huntsville, tx fdi continues to playa crucial role around the world and its importance to the global economy cannot be understated. researchers from different disciplines are pursuing their work in fdi to better understand, explain and report the most recent findings. hence, with that in mind, we, the guest editors, put a call for papers in the early part of fall 2002 for a special issue ofthe journal of business strategies on foreign direct investments with a submission deadline of november is, 2002. we present in this issue four articles that were accepted from that call. these papers reflect the diverse work done in area offoreign direct investment. the role of fdi businesses invest all over the globe to access markets, technology, and talent. foreign direct investment (fdl) has been on the rise around the world since the 1970s. in the 1980s and 1990s, foreign direct investment continues to expand rapidly, enlarging the role of international production in the world economy. fdi grew by 18 percent in 2000 alone, faster than other economic aggregates like world production, capital formation and trade, reaching a record $1.3 trillion (unctad, 200t). the contribution of fdi to economic growth has been debated quite extensively in the literature. fdi is accompanied by costs and risks as well as benefits and opportunities. despite this, fdi has been recognized as playing an important role in economic growth. it provides not just needed capital for the host country, but also essential technology transfers and managerial and marketing know-how. the global expansion of investment flows is now driven by more than 63,000 transnational corporations with over 800,000 affiliates abroad. developed countries remain the prime destination of fdi, accounting for more than threequarters of global inflows. cross-border mergers and acquisitions remain the main stimuli behind fdi, and these are still concentrated in the developed countries (unctad, 200 i). as a result, inflows to developed countries increased by 21 percent and amounted to a little over $1 trillion. while fdi 2 journal of business strategies vol. 20, no. i inflows to developing countries also rose, reaching $240 billion in 2000, their share in world fdi flows declined for the second year in a row, to 19 percent, compared to the peak of 41 percent in 1994. within the developed world, the united states remained the world's largest fdt recipient country as inflows reached $281 billion as well as the largest contributor to fdi outflows around the world. the united kingdom is still the largest recipient offdi in europe. for instance, about 40 percent of all u.s. fdi into europe goes to u.k., partly because the u.k. has a long history of stability and good relations with the u.s. in general, fdi flows to developed countries dropped over 50 percent in 200 i from the previous record high from over $1 trillion to $0.5 trillion. virtually all of the major developed countries experienced a downturn in 200 i. in asia, fdi inflows reached a record level of $143 billion in 2000. the greatest increase took place in east asia. china, in particular, experienced an unprecedented fdi boom, with int10ws amounting to $64 billion, making it the top fdi recipient in asia as well as in developing countries. this upsurge in inflows can be explained in a couple of ways. first, the upsurge reflects a recovery from the economic turmoil of the recent past. second, tncs planned investment into china finally materialized (after "parking" funds in hong kong in anticipation of china's entry into the world trade organization (wu, 2000). fdi flows to china, at $41 billion, remained fairly stable. int10ws to other southeast asia (e.g. asean-i 0) remained below the precrisis level. the sub-region's share in total fdi flows to developing asia continued to shrink, and stood in 2000 at 10 percent, as compared with over 30 percent in the mid-1990s. this was largely due to rising inflows into other countries in the region and significant divestments in indonesia since the onset of the financial crisis. south asia witnessed a drop in fdi inflows by one percent over the previous year. india, the largest recipient in the subcontinent, received $2 billion. the opportunity for fdi in asia/pacific in general has never looked more appealing than it does for the next decade. in contrast to the experience in most other parts of the world, inflows to the african continent declined in 2000 (for the first time since the mid-1990s), from $10.5 billion to $9.1 billion. as a result, the share of the african continent in total fdi flows fell below one percent. the decline was mainly related to two countries: south africa and angola. in the former country, fewer privatization and mergers and acquisitions (m&a) deals caused the slowdown, while in the latter, inflows in the petroleum sector declined. after tripling during the second half of the 1990s, fdi flows into latin america and the caribbean also fell in 2000, by 22 percent, to $86 billion. this was mainly a correction from 1999 when fdi inflows into the region were greatly affected by three major cross-border acquisitions of latin american firms rather than a shift in the underlying trend. privatization slowed down in 2000, but continues to be important as a factor driving inward fdi. in terms of sectors, fdi into south america was mainly in services and natural resources, spring 2003 maniam and leavell: perspectives of fdi 3 while mexico continued to receive the largest share of inflows in manufacturing as well as in banking (unctad, 200 i ). however, according to world investment report (unctad, 2001), the world fdi inflows are estimated to have dropped by 40% in 2001, down to $760 billion from over $1.3 trillion in 2000. it attributed the decline mainly to a slowdown of world economic growth (1.3%, as compared with 4.0% in 2000) and to a decrease in cross-border m&as. the value of cross-border m&as in 2001 stood at barely $600 billion for less than 6,000 deals, versus $1.1 trillion for some 7,900 deals in 2000. the slump is aggravated by the tragic events of the 11 september terrorist attacks on the united states. all the estimates also provided a similar picture for the year 2002 (maniam, 2003). four aspects of fdi the first paper, "wealth effect for u.s. acquirers from foreign direct investments," by halil kiymaz investigates u.s. firms during the period of 1989-2000 using the traditional brown and warner event study methodology with crossborder acquisitions data in four different regions and 24 countries. he found that the u.s. acquirers experienced statistically significant wealth gains of 0.57 percent around the announcement of acquisitions, although the wealth effects do vary with location of target firms and acquirers' industry affiliation. the second paper "geography matters: kohonen classification of determinants of foreign direct investment in transition economies," by joel deichmann, abdolreza eshghi, dominique haughton, selin sayek, nicholas teebagy, and heikki topi examines the non-spatial determinants of foreign direct investment (fdi) using the kohonen algorithm utilizing central and eastern european data. the result suggests a strong link between geography, fdi inflows, and economic and social conditions of the recipient country, without depicting specific causal relationships. the authors not only highlighted the importance of spatial proximity in determining the determinants of fdi in the region, but they also demonstrate the application of kohonen map as a useful tool in visualizing a dataset that is otherwise too difficult to conceptualize. the third paper, "u.s. executives' perceptions of "hems" as fdi options," by troy a. festervand examines the collective and individual positions of the ten big emerging markets using the perceptual mapping technique. using survey data, the author found that fdi executives indicated that some big emerging markets have positioned themselves strategically in terms of their availability of and access to markets and resources. the perceived position of the ideal market/nation also was captured by the study's findings. the stability of a market's/ nation's political and economic environments, as well as business environment, also contributes to a nation's perceived position. the study also finds that some big emerging markets are better positioned to take advantage of their strengths, whereas others face long-term fdi obstacles. 4 journal of business strategies vol. 20, no. i the final paper, "openness and economic growth: empirical evidence on the relationship between output, inward fdi, and trade," by e. m. ekanayake, richard vogel, and bala veeramacheneni, looks at the relationship between openness and economic growth in developed and developing countries. they employed a vector autoregressive (var) model and error correction technique to examine for the nature and existence of the causal relationship between inward fdi, output level, and exports between developed and developing countries. using the data from 1960 to 200 i for five countries, they found a bi-directional causality between export growth and economic growth in two of the five countries tested, fdi and economic growth and exports growth and fdi for just one country each. conclusion while these four papers tackle different issues offdl, they as a whole provide a better understanding of the various aspects of fdi in today's interdependent global economy. these articles indicate positive wealth effects for u.s. pdi, an improved aspect for continuing fdi in emerging nations. empirical evidence also supported the importance of special proximity, and political, economic and business environments. finally, the research supports, in some instances, causality between imports and economic growth which is an important support for countries seeking fdi. in conclusion, the special issue editors would like to thank each ofthe reviewers for the helpful comments and suggestions. no issue is possible without the time and effort of these generous reviewers. we are also very thankful to the journal editor, dr. jo ann duffy, for her relentless support and guidance. last, but not least, we are also grateful to eric j. thomas at the gibson d. lewis centerfor business and economics development at sam houston state university. references maniam, b. (2003). perspectives of foreign direct investments revisited. work in progress unctad (200 i). world investment report 200 i: foreign direct investment and the challenge of development. new york and geneva: united nations. dr. balasundram maniam (ph.d., university of mississippi) is associate professor of finance at sam houston state university. dr. maniam teaches graduate and undergraduate courses in finance and international finance and worked for an international bank prior to that. dr. maniam has published more than 50 journal articles, more than 100 articles in various proceedings, and more than 160 papers at regional, national and international conferences. dr. maniam spring 2003 maniam and leavell: perspectives of fdi 5 is the recipient of the scholar of the year in the college of business administration at texas a&m international for 1996-1997, nine distinguished research awards, and distinguished teacher award for 200 i from the academy of educational leadership. his current research areas include fdis, trade agreements, and electronic trading. dr. hadley leavell (dba, louisiana tech university) is associate professor of finance at shsu. dr. leavell has recei ved three distinguished research awards, while publishing over 10 journal articles, in excess of 20 articles in proceedings and presenting 25 papers at conferences. dr. leavell's areas of research include fdis, dollarization, and small business finance. 6 journal of business strategies vol. 20, no.1 perspectives in foreign direct investment in the new millenium immigrants in the u.s. economy: a host-country perspective pia m. orrenius , ph .d. federa l reserve bank of dallas • dallas, tx michael nicholson federal reserve bank of dallas • dallas, tx introduction the contributions of immigrants are many, particularly when it comes to the pace of economic growth. i immigrants both power and grease the engines that run the economy. in fact, just over half of the increase in the u.s. labor force over the last decade was the result of immigration legal and illegau immigrants' labor force contributions will continue to be important in the near future as the u.s. workforce ages and the baby boomers retire. immigration also plays a key role in the business cycle. immigration is prq-cyclical, meaning foreigners come in greater numbers when u.s. job growth accelerates and in fewer numbers when it wanes. in a similar vein, immigrants help resolve bottlenecks and shortages that arise in growing regions and sectors by moving to areas and industries experiencing high labor demand. despite immigrants' contributions to economic growth and efficiency, policymakers will continue to debate the costs and benefits of immigration because, while economic growth makes the economy bigger, a larger economy does not necessarily nake u.s. natives better off. for example, the economic benefits oflow-skilled immigration for u.s. natives are offset to a certain extent by the adverse fiscal impact that an increased number of poor households have on taxpayers. globally, the reallocation of workers from lowto high-income countries still has huge benefits but, because most of these benefits accrue to the migrants, the effect on host-country natives is far less positive. in this way, the perspective from which immigration is viewed makes all the difference to the conclusions of the analysis. worker migration that is globally optimal and beneficial to the origin country may have negative implications for the host country in certain cases. u.s. immigrants: how many? the foreign-born population reached a 20th century low point in 1970. since then , the u.s . has witnessed over three decades of mass immigration with large effects on economic growth. between 1970 and 2007, the foreign-born population 36 journal of business strategies rose from 9.6 to 38.1 million and, as a share of the population, immigrants increased from 4.7 percent in 1970 to 12.6 percent in 2007 (chart 1). chart 1 foreign-born share of population near historic peaks millions 45 40 35 30 25 20 15 10 5 0 1850 number percent of total population • 1870 1890 1910 1930 1950 1970 1990 source: census bureau percent 16 14 12 10 8 6 4 2 0 2007 by 2007, immigrants made up 15.6 percent of the u.s. labor force.) over the last decade or so, foreign-born workers have contributed roughly half of annual labor force growth. natives have had a shrinking role in labor force growth due to many factors, notably their declining labor force participation rates. as the nativeborn population ages and the baby boomers retire over the next twenty years, the foreign-born contribution to labor force growth is expected to stay high or even increase. the retirement of baby boomers is expected to result in 80 million workers leaving the u.s. workforce over the next two decades (social security administration, 2007). the influx of workers on the high and low ends of the skill distribution has made the growth and evolution of certain industries and occupations increasingly dependent on foreign-born professionals and laborers. immigrants' contribution to job growth is highest in sectors such as construction and extraction that require little formal education. the foreign-born made up about 64 percent of job growth in this sector between 2003 and 2007 (chart 2). volume 26, number 1 37 chart 2 foreign-born share of employment growth by selected occupations construction and extraction computer and mathematical transportation healthcare support total protection legal o 20 source: bureau of labor statistics; authors' calculations. note: change over the period 2003-2007. 40 60 80 100 percent immigrants also made up a large share of job growth in many high-skilled occupations; they were responsible for 63 percent of job growth in computerand mathrelated occupations between 2003 and 2007. bear in mind that although foreign workers make up high shares of net job growth in an occupation or industry this does not imply that u.s.-born workers are not in those professions. natives may be the majority of workers in an occupation, but because they are exiting at a high rate relative to the rate at which they are entering, they make a small contribution to net growth. this is the case in many math, science and engineering fields. low entry rates are in part due to talented american students who pursue professional degrees rather than graduate school given the shorter education and faster rate of real wage increases in business and law occupations relative to jobs in science, engineering and math (freeman, 2005). immigrants are also important drivers of growth in many other occupations. in healthcare support, for example, which includes nursing, about 43 percent of growth was due to the influx of the foreign-born during this period. overall, during 2003-2007, the foreign-born made up 39 percent of total employment growth. occupations with below-average immigrant participation often require u.s. citizenship (e.g., jobs in law enforcement or other protective services) or present substantial institutional and language barriers (e.g., legal professions). 38 journal of business strategies u.s. immigration: how has it changed? during the last forty years or so, changes in immigrant characteristics and immigration policy have accompanied the dramatic rise in immigration. two changes stand out both with regard to their effects on immigration dynamics and their implications for ongoing policy debates. first, the education distribution of foreignborn workers has become increasingly bimodal and, second, illegal immigration has grown so quickly that it overtook legal immigration for several years. as mentioned above, immigrants have played an important role in the growth of both high and low-skilled occupations. this is largely because they are disproportionately represented on the extremes of the education distribution (chart 3). between 1980 and 2004, the share of foreign-born among workers who lack a high school degree tripled, rising from 10.5 to 32 percent. at the same time, the share of foreign-born among workers who have a masters or professional degree doubled (from 7.5 to 15.5 percent) and the share with a doctorate increased 13.5 percentage points (from 14.5 to 28 percent). chart 3 share of foreign-born by education level of workers percent 35 d 1980 30 .2004 25 20 15 10 5 0 o to 11 years 12 years 13 to 15 16 years master, doctorate (high school years (college professional grads) grads) degree source: gianmarco ottaviano and giovanni peri (2006). where do native-born workers fall in the educational distribution? they are overwhelmingly concentrated in the middle of the distribution the average education among u.s.-born workers age 25 and over is about 13 years. only 5.2 percent volume 26, number 1 39 lack a high school degree and 35 percent have a bachelors degree or higher. in other words, since labor demand for foreign workers is likely highest where native workers are scarce, it makes sense that foreign-born workers tend to have either very low or very high levels of education. the second important change with regard to u.s. immigration over the last few decades is the rise of illegal immigration. jeffrey passel of the pew hispanic center has developed estimates of the yearly net flow oflegal and illegal immigrants into the u.s. since 1990 (chart 4) (passel & suro, 2005; passel & cohn, 2008). the graphic is striking in that undocumented flows (grey) rivaled legal flows (black) from 1990 to 2004. on average over this period, net undocumented immigrant inflows numbered 518,000 annually as compared with legal immigrants (green card recipients) who numbered 608,000. illegal inflows dropped to an average of 275,000 from 2005 to 2008 due to slowing economic growth in the u.s. as a result of many years oflarge undocumented worker inflows, 30 percent ofthe 2008 foreign-born population was thought to be made up of undocumented immigrants (about 11.9 million people) (passel & cohn, 2008). thousands 1600 1400 1200 1000 800 600 400 200 o chart 4 volume of illegal inflows rivals legal !:,. unauthorized _ legal (permanent) 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 source: jeffrey passel & robert suro (2005); jeffrey passel & o'vera cohn (2008). note: 1990-2004 annual data from passel & suro; 2005-2008 averaged data from passel & cohn. why the rise in illegal immigration? the rise of illegal immigration is in some ways as much about the change in u.s. immigration policy as it is about a change in immigration patterns. most illegal 40 journal of business strategies immigrants come from mexico, but immigration from mexico is not new. in the early 1900s, mexican workers migrated to the west and southwest to fill in for the chinese and japanese laborers who had essentially been banned. as more restrictive immigration policies targeting southern and eastern europeans were passed in the early i 920s, mexican immigration soared. during world war ii and in the years following, the bracero program brought in over 200,000 mexicans annually for agricultural and other work. the 1965 immigration and nationality act amendments exempted the western hemisphere, including mexico, from country quotas (annual caps of 20,000 green cards) that were applied to the rest of the world. throughout most of the 20th century then, u.s. immigration policy accommodated immigration from mexico in one way or another, partly in recognition of the dependence on mexican labor in the american west. the turning point vis-a.-vis preference for mexican immigration came in 1977 with the end of this 'western hemisphere exemption. ' at about the same time as legal immigration from mexico was curtailed through the imposition of country caps, many mexicans were opting to settle permanently in the u.s. rather than continue the traditional pattern of return migration. this decrease in return migration, together with policies that curtailed opportunities for legal settlement, spurred the rise of illegal immigration. at the root of the change was a large cohort of young mexicans coming of age at a time that the mexican economy was waning and u.s. labor demand growing, particularly in the service and manufacturing sectors. for mexican migrants, the change from seasonal agriculturebased work to year-round employment meant fewer trips home, longer stays, and an increased incidence of permanent settlement. worsening economic conditions in mexico in the 1980s continued to be a push factor. and once the mexican migrant population was firmly in place in gateway cities in the u.s ., its social networks caused families and friends to follow. 4 u.s. immigrants: why do they come? most u.s. immigration, whether familyor employment-based, is economically motivated in that immigrants leave their homelands in search of better economic opportunities. this stands in contrast to many other oecd nations western european nations, for example where non-european immigration has traditionally been reserved for refugees and asylum seekers and the government's strong social safety net has attracted such foreigners . in the u.s., while familyand employment-based immigrants share motivations, they differ in other respects. emvolume 26, number 1 41 ployment-based immigrants have higher levels of education and typically hold at least a college degree . . consistent and strong economic growth has attracted immigrants to the u.s. this can be seen at the national level, comparing economic expansions to rises in visa applications and admissions, and also at the regional level by comparing state gross domestic product (gop) growth to state foreign-born population growth. chart 5 shows the fifty states in shades of grey where darker shades correspond to higher rates of foreign-born population growth. between 1990 and 2007, the foreign-born population grew the fastest in north carolina, georgia, arkansas, tennessee, and nevada. over this same time period, the foreign-born population posted the slowest growth in hawaii, maine, vermont, and montana. chart 5 growth in the foreign-born population (% change) 1990-2007 source: census bureau legend ,. 099 .... . 100 199 " .. -~'.--' ff.~l%~ 200 299 _ 300-448 the states with the fastest pace of immigration between 1990 and 2007 also generally experienced the most rapid economic growth. chart 6 divides the fifty states into four groups and shades them accordingly. states shaded black had aboveaverage real economic growth (gop growth above the 61 percent median rate) and above-average foreign-born growth (foreign-born population growth above the 127 percent median rate). states shaded white had below-average growth in both cat42 journal of business strategies egories. thirty-five states were shaded either black or white, implying that aboveaverage (below-average) immigration rates coincided with above-average (belowaverage) economic growth. in other words, immigrants are drawn to states where jobs are plentiful and wages are rising and tend to avoid states experiencing slower growth. chart 6 state gdp growth drives foreign-born population growth 1990-2007 source: census bureau ; bureau of economic analysis legend _ fb growth + gop + _ fb growth + gop wo~tj fb growth gop + n fb growth gop what about the in-between states in chart 6? if immigrants are drawn to growth, why did some slow-growing states have above-average immigration? these states are colored dark grey in the map and include alabama, indiana, kansas, kentucky, missouri, mississippi, and oklahoma. generally, these are states where the native-born workforce is growing very slowly or contracting, perhaps because older workers are retiring and younger, more-educated workers are leaving for fastergrowing states in the southeast, southwest · and mountain west. in fact, according to the census bureau, between 1995 and 2000 these states either experienced net population outflows (kansas) or minimal net in-migration at a rate of 10 percent or less (alabama, indiana, kentucky, missouri, mississippi, and oklahoma). despite low population growth, growing industries located in many of these states because of the favorable business climate. instead of relying on native labor, industries such volume 26, number 1 43 as meatpacking in kansas and oklahoma and poultry processing in alabama, were staffed with mostly immigrant workers . migration and the business cycle immigration rates are correlated not only with long-term growth trends, as discussed above, but also with the business cycle. migrants respond to short-term fluctuations in economic conditions in both their home and their prospective destination country. these cyclical patterns in migration are best reflected by real-time migration data, such as border patrol apprehensions of illegal immigrants. because unauthorized immigrants are not encumbered or delayed by visa processing or other red tape, their migration patterns appear to clearly reflect changes in u.s. labor demand. chart 7 plots monthly border patrol apprehensions of undocumented migrants along the southwest border from 1991 to 2007. the steep rise in apprehensions during the 1995 mexican recession, dubbed the tequila crisis (represented by the first grey column), illustrates how a home-country crisis serves as a catalyst for emigration. between december 1994 and december 1995, the mexican peso fell 30.5 percent against the dollar in real terms and mexico's gdp contracted by 6.7 percent. hundreds of thousands of mexicans headed north and apprehensions rose 121 percent. chart 7 real-time migration, u.s. and mexican recessions thousands 200 180 160 140 120 100 80 60 40 20 o +-----r-.----rmigrant apprehensions 19911992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 20072008 source: customs and border patrol , department of homeland security; authors' own calculations. note: shaded bars represent recessions. apprehensions are seasonally adjusted. 44 journal of business strategies in late 2000, the reverse occurred. as the u.s. economy began to slow, apprehensions began to fall. by march 2001, the u.s. had officially entered a recession (represented by the second grey column) and apprehensions had fallen 33 percent from their high in january 2000. they fell even further in the wake of the 9/11 terrorist attacks. since 2000, apprehensions never returned to the highs of the midto late1990s. this is the result of both more intense border enforcement, which has raised crossing costs, and a gradual slowdown in u.s. employment growth. payroll employment grew at an annual average rate of 2.4 percent in 1995-2000 but slowed to 0.5 percent in 2001-2008, weakening the economic incentives for immigration. chart 8 documents the close correlation of de-trended u.s. employment (the employment level minus its long-run trend) with a 6-month lag of apprehensions, suggesting illegal immigration lead.s overall job growth. chart 8 migrant apprehensions track u.s. labor demand thousands 180 160 140 120 100 80 60 40 20 apprehensions o +--r~--~-r~r-~-.--r-.-~ employment thousands 1500 1000 500 o -500 -1000 -1500 -2000 -2500 r-~~--r-~~--~-+-3000 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 source: bureau of labor statistics, department of homeland security; authors' own calculations. note: shaded bars represent recessions. employment expressed in deviations from long-run trend; apprehensions are lagged 6 months; apprehensions and employment are seasonally adjusted. the current recession has caused steep declines in employment, which has put downward pressure on illegal migrant flows . between december 2007 and december 2008, u.s. employment fell by 2.2 percent. employment in the construction sector, a major source of employment for undocumented migrants, declined 8.9 percent. furthermore, real u.s. gdp contracted 1 percent from the fourth quarter volume 26, number 1 45 of 2007 to the fourth quarter of 2008 . this persistent slowdown has weakened migrants' employment prospects. hence, inflows have dropped off and apprehensions are down 18.2 percent. it is likely that apprehensions will be low as long as economic growth remains weak. u.s. immigration: effects on natives immigration has a positive effect on u.s. employment and output growth. u.s. gdp is substantially higher as a result of immigration and, although the bulk of gdp gains go to the immigrants themselves in the form oflabor income, the nativeborn population also benefits from the immigrant influx. estimates suggest the gain to natives' incomes is about $30 to 60 billion per year, which is less than 0.5 percent of gdp. the benefits of immigration accrue to native-born consumers in the form of lower relative prices of goods and services and to investors, business owners, and landowners in the form of higher return to capital and land. several factors detract from the natives' economic gains from immigration, however. first, the distribution of gains is problematic; gains from immigration disproportionately benefit investors, midand high-income consumers, and educated workers, groups which policymakers might already consider to be "doing well." meanwhile, low-skilled native workers are often the most adversely affected as competition with immigrants depresses their wages. second, immigration's fiscal impact may detract from its economic benefit if immigrants are low-income workers with families who use more in public services than they pay in taxes. u.s. immigration: wage effects there is a large literature on the wage effects of immigration. the consensus seems to be that the biggest negative wage impacts are on prior immigrants, not natives, because prior immigrants are the most substitutable for new immigrants. the size of the wage impact also depends on the time period over which it is measured. in the short run, with a fixed capital stock, wage effects can be negative and significant. however, wage effects diminish in the medium to long run as the capital stock grows. recent estimates based on 1990-2006 data suggest that immigration has pushed down the wages of natives by less than 1 percent in the short run, while native wages have risen slightly in the long run (ottaviano & peri, 2008). this analysis also suggests that prior immigrants have sustained much higher wage losses than natives, on the order of 6 percent. other studies find larger negative effects on native workers. in a 2003 paper, george borjas estimates that 46 journal of business strategies immigration between 1980 and 2000 lowered average native wages by about 3 percent (borjas, 2003). u.s. immigration: fiscal effects another factor detracting from the economic gains of immigration is the fiscal costs of low-skilled immigration, which includes most illegal immigrants. immigrants benefit from publicly-provided services, such as roads, police and fire protection, public schooling and emergency medical care. the bulk of these services are provided by state and local governments, which ultimately absorb much of the fiscal cost of immigration. eligible legal immigrants who have lived in the united states for five years or more also sometimes receive welfare assistance from federal programs and joint federal-state programs such as food stamps, tanf (temporary assistance to needy families), and medicaid. the u.s.-born children of immigrants, as u.s. citizens, are eligible for these welfare programs under the same conditions as other americans. immigrant households are more likely to participate in public assistance programs than natives. in 2007, 33 percent of immigrant-headed households participated in at least one major welfare program, compared with 19 percent of native households (camarota, 2007). much of this difference stems from medicaid usage as immigrants are more likely than natives to work in jobs that do not offer health insurance or where the cost of health insurance is prohibitive. it is not the case that low-income immigrant-headed households use more welfare programs because they are more likely to be out-of-work or unemployed; low-wage immigrant men have much higher employment and labor force participation rates than less educated native men despite earning lower wages. government outlays are offset by immigrants' contributions to public coffers through income, payroll, sales and property taxes. the net fiscal impact of immigration is the difference between immigrants' tax contributions and the value of public services they consume. in a 1997 book, the national research council demonstrates that the fiscal cost of immigration depends on the education level of the immigrant and the time frame over which taxes and welfare receipt are measured (smith & edmonston, 1997). during their lifetimes, low-education immigrants, such as those who lack a high school degree, impose a net fiscal cost on u.s. government, while high-education immigrants, those with a college degree or higher, are a large fiscal boon. as is the case with low-wage natives, immigrants who earn relatively low wages tend to contribute less in taxes than they use in publicly provided goods and volume 26, number 1 47 services.s in the very long run, however, the contribution of descendants of immigrants make up for this initial fiscal deficit, and the net negative impact of the leastskilled immigrants gets close to zero. of course, the faster generations assimilate, the sooner the government recoups its costs, which is one reason economic assimilation is so important. the nrc study also notes that the average fiscal impact of immigration masks large differences across states. due to generous welfare programs and a large low-income immigrant population , californians likely bear the highest tax burden as a result of immigration. while texas has a large low-income immigrant population, welfare programs are less generous and thus less costly to administer than in many other states. while there are few reliable estimates of the fiscal cost of illegal immigration, it is generally accepted that undocumented immigrants cost less than low-skilled, legal immigrants because they are eligible for fewer public programs. meanwhile, survey data suggests the majority of illegal immigrants work "on the books," contributing payroll and income taxes as well as property and sales taxes. in terms of public expenditures, much of the cost of illegal immigration falls on local schools and hospitals. 6 as is sometimes the case for legal immigrants, children of undocumented immigrants require special attention in schools due to their lack of english proficiency. hence, a congressional budget office study suggests that the net fiscal effect of unauthorized immigration on state and local budgets is likely negative but modest (congressional budget office, 2007). as the benefits and costs of immigration are being compared , it is important to note that immigration has other important benefits that are more difficult to quantify and are not included in conventional estimates. some of these benefits include the positive gains in innovation (particularly from skilled immigrants), on u.s. firms' competitiveness (from cheaper or more-skilled workers), on the diversity of goods and services available, on cultural diversity, and on remittances of cash to immigrants' home countries. again, as noted in the introduction, the largest gains from immigration accrue to immigrants themselves, and those are excluded from typical benefit-costs calculations which focus on the effect on hostcountry natives. immigration policy: 9/11 effects and beyond u.s. immigration policy became more restrictive in the post-9/il era with most of the additional security measures affecting foreigners applying for temporary 48 journal of business strategies visitor visas (tourists, businessmen) and undocumented immigrants. the effects on high-skilled workers and students have been less severe, although visas for highskilled workers are in short supply. permanent settlement in the form of naturalization rates and green card issuances increased after 9/1 i . chart 9 shows annual averages of visa issuances by category in the preand post-2000 periods . touristlbusiness visas (shown here divided by ten) saw the largest decline of all major visa categories following 9/11; they averaged 2.9 million from 200 i to 2008, substantially lower than the 1995-2000 annual average of 4.3 million. these declines in visitor visa issuances stem in part from post-9/ll security reforms, such as tougher background checks on visa applicants that resulted in much higher rejection rates as compared to the 1990s. chart 9 lpr, work visas rise; visitor visas fall after 9/11 thousands 1200 1000 800 600 400 200 o lprs students b1/b2* .1995-2000 02001-2008** h-lb h-2b source: department of homeland security; office of visa statistics; department of state. note: annual average visa issuances; b1ib2 visas divided by 10; lawful permanent resident visas are from 2001-2007. student visa issuances dropped off steeply following 9/1 i as well, but have since rebounded to even higher levels. from 2001 to 2008, student visa issuances averaged 27 i ,000 per year, slightly more than the 1995-2000 average of 262,000. total visa issuances for high-skilled and low-skilled temporary workers under the h-lb and h-2b programs, respectively, increased in the 200 i -2008 period. these visa programs are designed to meet specialized labor demand and require employer sponsorship. state department refusal rates are thus low for the h visas volume 26, number 1 49 relative to other visa categories and the more stringent background checks after 9111 had little impact. for example, in fiscal year 2002, 86.1 percent of h-ib visa applications and 80.5 percent ofh-2b applications were approved as opposed to only 66.4 percent of student visa applications and 60.3 percent of tourist and business visa applications. legal permanent settlement also increased after 2001. green card issuances rose, averaging 1.0 million per year post-2000 as compared with 762,000 in 19952000, partly because so many individuals entered the u.s. with h-l b visas in the 1990s and were eligible for green cards by the 2000s (i.e., most of the post-2000 increase does not reflect new arrivals but rather status adjusters). current immigration policy: binding constraints most u.s. immigrants enter on the basis of family relationships, not employment. u.s. immigration policy limits employment-based immigrants by placing quotas both on employment-based green cards and on temporary nonimmigrant work visas, such as h-lbs and h-2bs. the limits tend to be arbitrary and outdated and do not grow with the economy. for example, h-ib visa caps for the private sector were set at 65,000 as part of the immigration act of 1990. since then, the economy has grown by 64 percent in real terms and employment has grown 25 percent, but the caps have not changed.7 as a result, the supply ofh-lb visas is too low relative to demand for workers in these categories. in fact, the government has run out of h-j b visas every year since 2004. in fiscal year 2008 , the h-l b allocation of 65,000 visas for the private sector was reached in less than a week as u.s. citizenship and immigration services received just over twice as many applications as it had visas to issue under the cap. the additional 20,000 h -1 b visas reserved for foreign graduates of u.s. universities were also used up within a week. temporary nonimmigrant visas reserved for low-skilled seasonal workers, such as h-2bs, have also run out in each of the last 4 years. the government issues 66,000 such visas each year, and for two years allowed an exemption from the cap for returning h-2b workers. that exemption was not renewed in 2007. while in place, it allowed a little over 100,000 h-2b workers into the u.s., suggesting the current cap is set below demand by about 50,000 workers. another post-200 1 development is the apparent decline in illegal immigration, particularly since 2006. although we cannot directly observe illegal immigration , border patrol apprehensions of unauthorized migrants are a good proxy for fluctuations in the flow. total border patrol apprehensions in fiscal year 2007 were 50 journal of business strategies down 19.1 percent from 2006. they fell another 18.4 percent from fiscal year 2007 to 2008 . the collapse of the residential construction sector that began in spring 2006 decreased demand for these migrants. at the same time, under the later years of the bush administration, interior enforcement reached unprecedented highs, making it tougher for migrants to find and keep jobs. chart 10 shows worksite arrests from 2002 to 2008. while still quite low relative to the size of the u.s. labor market, the nearly 4-fold increase in total arrests from 2005 to 2008 signaled to employers that the department of homeland security (dhs) had made worksite enforcement a priority. 6000 5000 4000 3000 2000 1000 o +-2002 chart 10 worksite arrests jump after 2005 i2ti criminal arrests • administrative arrests 2003 2004 2005 2006 source: department of homeland security 2007 2008 the no-match letter program is another example of the government's desire to get tough on illegal immigrants and the employers that hire them. the dhs safe harbor guidelines, which took effect on september 14, 2007, but were placed under a court injunction shortly thereafter, require that employers fire workers with unresolved no-matches within 90 days. no-matches are cases where the employee's name does not match his social security number (ssn) or the ssn was never issued . under the new guidelines, employers who fail to act in accordance with the suggested procedure would be assumed to have had 'constructive knowledge' that they were employing illegal immigrants should the employer be prosecuted. despite the issuance of a revised rule in october 2008, the initial rule is still in volume 26, number 1 51 litigation and the court injunction remains valid for the moment, stalling the implementation of the beefed-up no-match program. regardless , the dhs's initiatives in this area send a clear message to employers that the penalty for hiring illegal immigrants is going up. where do we go from here? immigration plays a vital role in the american economy and is likely to do so for years to come. immigrants migrate to growing regions and industries and frequently fill jobs that natives shun. immigrants are now the main source of growth in sectors as disparate as construction, hospitality, engineering, and health sectors that rely heavily on low-level or high-level skills which are relatively scarce among native-born workers. despite this, the limits on immigration are growing tighter, not looser, and the disconnect between policy and economic reality is getting bigger. the debate over illegal immigrants is paralyzing policy reform in areas that concern legal immigration; although related, the two issues have different fiscal , economic and social implications. disclaimer the views expressed are those of the authors and do not necessarily reflect those of the federal reserve bank of dallas or the federal reserve system. notes i. we use the terms ' immigrant' and 'foreign-born' interchangeably in this article to refer to all individuals residing in the u.s. who were born abroad to non-u .s. parents. immigrants thus include legal and illegal, temporary and permanent residents. 2. for an overview of the economic effects of immigration, see chapter 4 of the erp (2005). 3. for up-to-date characteristics of foreign-born workers , see bureau of labor statistics publication (2008). 4. for seminal work on the role of networks in mexican migration see douglas s. massey, rafael alarcon, jorge durand and humberto gonzalez (1987). 5. for annual estimates of the net fiscal costs of low-skilled immigrant households, see robert rector and christine kim (2007). 52 journal of business strategies 6. a 2006 texas study by the state's comptroller indicates that local governments bear the majority ofthe costs related to illegal immigration and estimates a net fiscal benefit at the state level. see strayhorn (2006). 7. since 2005,20,000 visas for foreign students who graduate from u.s . universities with advanced degrees were made exempt from the cap. references borjas, g. (2003). the labor demand curve is downward sloping: reexamining the impact of immigration on the labor market. quarterly journal of economics, 1j8,1335-1374. bureau of labor statistics (2008). foreign-born workers: labor force characteristics in 2008. retrieved march 26, 2009, from www.bls.gov/news.release/pdf/forbrn. pdf. camarota, s. (2007). immigrants in the united states, 2007: a profile of america 50 foreign-born population. center for immigration studies . retrieved november, 2007, from www.cis.orglimmigrantsyrofile_2007. congressional budget office (2007). the impact of unauthorized immigrants on the budgets of state and local governments. retrieved december, 2007, from www. cbo.gov/ftpdocs/87xx/doc87i 1i12-6-immigration.pdf. council of economic advisers (2005). economic report of the president. washington, dc: government printing office. freeman, r. b. (2005). does globalization of the scientific! engineering workforce threaten u.s. economic leadership ? nber working paper 11457 (july). massey, d. s ., alarcon, r., durand, j., & gonzalez, h. (1987). return to aztlan: the social process of international migration from western mexico . berkeley and los angeles, california: university of california press. ottaviano, g ., & peri, g. (2008). immigration and national wages: clarifying the theory and empirics. nber working paper 14188 (july). ottaviano, g., & peri, g. (2006). rethinking the effects of immigration on wages. nber working paper 12497 (august). passel, j., & cohn, d. (2008). trends in unauthorized immigration. retrieved october 2, 2008, from www.pewhispanic.org/reports/report.php?reportid=94. passel , j. , & suro, r . (2005). rise, peak and decline: trends in u.s. immigration 1992-2004. retrieved september 27 , 2005 , from pewhispanic.org/files / reports/ 53.pdf. volume 26, number 1 53 rector, r., & kim, c. (2007). the fiscal cost of low-skill immigrants to the u.s. taxpayer. the heritage foundation leadership for america, special report 14. smith, j. p., & edmonston, b. (1997). the new americans: economic, demographic, andfiscal effects of immigration. washington, dc: national academy press. social security administration (2007). nation s first baby boomer files for social security retirement benefits online! retrieved october 15,2007, from www. ssa.gov/pressoffice/pr/babyboomerfiles-pr.htm. strayhorn, c. k. (2006). undocumented immigrants in texas: a financial analysis of the impact to the state budget and economy. texas comptroller of public accounts, special report. retrieved december, 2006, from www.window.state. tx. us/ specialrpt/undocumented/. biographical sketch of authors pia orrenius is senior economist and policy advisor at the federal reserve bank of dallas and adjunct professor at the hankamer school of business, baylor university. her research focuses on the labor market impacts of immigration, illegal immigration, and u.s. immigration policy, and her work has been published in the journal of development economics, labour economics, industrial and labor relations review, demography, among others. dr. orrenius is a research fellow at the tower center for political studies at southern methodist university and at the institute for the study of labor in bonn, as well as a member of the council on foreign relations. dr. orren ius was senior economist on the council of economic advisers in the executive office of the president, washington d.c . in 2004-2005. she received her ph.d. in economics from the university of california at los angeles and b.a. degrees in economics and spanish from the university of illinois at urbana-champaign. mike nicholson is a research analyst at the federal reserve bank of dallas. he is a frequent contributor to southwest economy, a quarterly dallas fed publication. nicholson graduated from the university of pennsylvania in 2005 with majors in economics and international relations. he spent the 2005-2006 academic year at koy university in istanbul, turkey, where he was a fulbright scholar. 54 journal of business strategies immigrants in the u.s.: a host-country perspective the impact of a propensity for relationalism and market growth on distribution channel outcomes gregory s. black donna k. peeples texas a&m university corpus christi corpus christi, tx abstract this research investigates the effects of an organization:" propensity for relationalism and its product line market growth on the distribution channel outcomes of actual relationalism and relationship endurance. using a sample of 160 industrial equipment distributors, propensity for relationalism is shown to have an influence on both actual relationalism and relationship endurance. further. evidence is found that market growth enhances the impact propensity toward relationalism has on relationship endurance. introduction as the world of business and the state of economy become more uncertain, long-term relationships between distribution channel partners are becoming increasingly more attractive as part of a company's long-term strategy (ellinger, ellinger, and keller 2002; mentzer, flint, and hult 2001). organizations rely on these ongoing relationships more and more as part of their long-term strategies. by definition, relational exchange between organizations involves a partnership orientation. it may be argued that a transactional strategy, where an organization concentrates on single transactions rather than ongoing relationships with channel partners, is more flexible and thus better than aa long-term relational relationship. contrarily, current literature continues to find support for relational exchange. most organizations with this long-term perspective see their channel partners as first-line customers and partners. they practice strong relationship management to forge long-term partnerships with channel members. this creates a marketing system that meets the needs of both the company and its channel partners (anderson and narus 2003; kotler and armstrong 2006). trust and commitment between these partner organizations dominate these arrangements and trust has been shown to be an important factor to make a channel relationship work in a relational fashion (batt 2003; cavusgil, deligonul, and zhang 2004; hewett and bearden 2001; zhang, cavusgil, and roath 2003). also, in relational exchange, the relationship takes on value that exceeds the benefits resulting from any single transaction or set of transactions (berthon, pitt, ewing, and bakkeland 2003; dwyer, schurr, and oh 1987; morgan and hunt 1994; siu 2002). thus, relational exchange, and channel support activities related to 120 journal ofbusiness strategies vol. 22, no.2 this relationalism, offer distribution channel partners many advantages, such as enhanced efficiency, streamlined interactions, channel member motivation, channel member satisfaction, and growth (hausman, 2001; mehta, dubinsky, and anderson 2002; paswan 2003). tn addition, partners in relational exchanges cooperate to enhance effectiveness and productivity in the distribution channel (frazier, spekman, and o'neal 1988, paswan 2003). despite the recent trend in many industries toward strategic alliances involving competitors. alliances involving channel members rather than competitors result in more customerorientation and lead to more overall organizational performance (rindfleisch and moorman 2003). researchers have empirically verified the viability of relational distribution arrangements and the presence of relational norms (e.g., coughlan and grayson 1998; heide and john 1992; kaufman and dant 1992; noble, sinha, and kumar 2002; paswan, pappu, and young 2002). further, the effects of relationalism on important channel phenomena, such as influence wielding (boyle, dwyer, robicheaux, and simpson 1992) and trust and commitment (zhang, cavusgil, and roath 2003), have been established. despite these advances, a number of important gaps remain in our understanding ofthe role and effects ofrelationalism in marketing channels, including the effects of actual relationalism on channel outcomes and the role that a propensity toward relationalism may play. with few exceptions (e.g., johnson and black 1996; noordeweir, john, and nevin 1990), the impact of relationalism on distribution channel performance remains largely unexplored. this constitutes an important gap, given that these relational exchanges are so important to an organization's long-term strategy. the impact of an organization's propensity to engage in these relational channel partnerships has thus far received no research attention. in addition, these types oflong-term relationships require significant resources to develop and maintain, so, this propensity for relationalism makes it more likely for an organization to commit these resources and efforts to establish and maintain these long-term channel partnerships. if returns from such arrangements cannot be demonstrated, the competitive position and viability of both the individual organization and the distribution channel eventually will erode. thus, both researchers and practitioners would benefit from more assessment of the effects of relationalism on interfirm outcomes. to address this gap in knowledge, this study investigates how an organization's general tendency, or propensity, to engage in relational exchange, rather than discreet transactional exchanges, influences channel outcomes. this research includes duration of the channel relationship and market growth of the major supplier's product line as additional variables of interest for investigation. these variables were selected for several reasons. with regard to supplier's market growth, financial performance is unarguably always a consideration for channel managers. this market growth dimension offinancial performance is particularly appropriate for consideration in conjunction with actual relationalism because it is logically related to distributor-supplier joint efforts in market development. fall 2005 black and peeples: relationalism and market growth 121 duration of the relationship is included in this study because it indicates the closeness and success of the relationship in a general sense. channel partners cannot enjoy the rewards ofthe relationship unless they can rely on its endurance (anderson and weitz 1989). in the following sections, relevant literature is reviewed and the concepts included in this research are developed, leading up to a set of hypotheses. an explanation of the methodology is offered and then the results ofhypotheses testing are presented. finally, implications of the research findings conclude the paper. hypotheses distribution channel outcomes (dependent variables) distribution channels fundamentally form to facilitate exchange processes between producers and final customers of products (alderson 1954). relational exchange in these channels provides a means of significantly enhancing the smoothness and efficiency of these exchange processes. relationalism implies that the channel relationship holds value for the participants above and beyond any gains from individual discreet relationships (macneil 1980). relationalism is manifest in norms which consist of expectations about patterns of behavior that are shared among the participants in a complex exchange relationship. these relational norms provide for routinized and efficient exchange in channel relationships (dwyer, schurr, and oh 1987). in particular, relational norms provide the organization with flexibility and stability in its interactions with its exchange partners. further, they provide a way to enhance the benefits or modify the risks associated with distribution channel participation (stafford 1992). in essence, relational norms are mechanisms that allow channel participants to structure and mold exchange relationships into a desirable framework and these types of relationships take time, resources, and commitment of both partners to develop and succeed (heide and john 1992; kaufman and dant 1992: paswan and young 1999). in various forms, the durability or endurance of the channel relationship has received considerable attention in the literature. several authors have investigated channel relationship endurance in terms of continuity expectation (e.g., anderson and weitz 1989; heide and john 1990; noordeweir, john, and nevin 1990) which constitutes a future-oriented approach. ganesan (1993, 1994) investigated relationship endurance as long-term orientation of the channel participants. as with continuity expectation, an emphasis on long-term orientation is looking to the future; however, it also involves a general preference for enduring relationships. kumar, stern, and achrol (1992) address this facet of interorganizational performance as stability, suggesting that inducing continued membership of channel participants is an important objective for an effective channel member. other researchers have included age of the channel relationship as a measure of relationship endurance (e.g., anderson and weitz 1989; heide and john 1990; heide 1994). age of the channel relationship indicates stability and closeness. 122 journal (~f business strategies vol. 22, no.2 the longer a distribution relationship has survived, the more likely partners have come to terms with problem areas in the relationship and the more likely they have worked out systems of coordination and cooperation. in addition, relationship age serves as a proxy for the future-oriented component of relationship endurance. channel participants who have successfully worked together over time will not readily dismiss the relationship, and will experience significant replacement costs if the relationship fails. to summarize, the two distribution channel outcomes (dependent variables) investigated in this research are actual relational ism or the extent to which a firm is engaged in relational exchange agreements, and relationship endurance between the distributor and supplier in the distribution channel. the following paragraphs present hypothesized relationships between these channel outcomes and some predictor variables. figure 1 shows a model summarizing the hypothesized relationships examined in this research. figure 1 model of predictors of distribution channel outcomes market growth h3propensity toward relationalism h1 relational endurance 1 actual relationalism influences on distribution channel outcomes (independent variables) like individuals, organizations mayor may not have a propensity to engage in these long-term relational arrangements. individual people may trust others and engage in many close friendships, while others tend to be untrusting of others and have few close relationships. this general propensity to engage in fall 2005 black and peeples: relationalism and market growth 123 close and long-term relationships also occurs for organizations and is based on experiences with other partner organizations in the past, personalities of its top managers, and other intraorganizational factors, such as corporate culture (black, moore, and vogt 2000). thus, if an organization possesses a high propensity to engage in relationalism, or the tendency to engage in long-term distribution channel relationships, there is more of a likelihood that its relationship with any distribution channel partner will be longer than for organizations not having this propensity for relationalism. this influence of propensity for relationalism on relationship endurance should be enhanced by the market growth of the product line that is shared between the channel partners. while financial performance alone does not provide a complete picture of distribution channel performance, it is a necessary concern for channel participants. the organization's perception of its performance orientation is likely to influence its decisions regarding distribution channel management behavior and related activities. in other words, organizations that stress financial goals are likely to result in adopting different distribution channel support activities than organizations that focus on marketing-oriented factors (noble, sinha, and kumar 2002; paswan 2003; pelham 1997). researchers often address financial performance in terms of profits, revenues, contribution to profits or revenues, or market share (kerin, mahajan, and varadarajan 1990). another critical, but perhaps somewhat neglected, dimension of financial performance is market growth of a product or product line (goodman and pennings 1980; pelham 1997; pelham 2000). in an in-depth investigation of reseuer performance from the supplier's perspective, kumar, stern, and achrol (1992) considered the organization's ability and need to adapt as an important element of performance. they included growth as one dimension where the firm can demonstrate its ability and willingness to adapt. this suggests that to be effective, channel members must consider growth issues in financial performance. success in this type of financial performance will further encourage organizations with the propensity toward relationalism to remain in channel relationships for longer durations. thus far, with few exceptions (e.g., johnson and black 1996), the relationship between relationalism, relationship endurance, and market growth remain largely unexplored. one noteworthy advantage ofrelational exchange is the streamlined interaction that results. the increased efficiency from streamlined interaction directly translates into reduced distribution costs. in a relational channel arrangement dominated by trust, commitment. and norms of stability, flexibility, and reliability, partners are encouraged to cooperate in joint efforts that reduce distribution costs (frazier, spekman, and o'neal 1988). channel partners realize they can invest resources in such cost reducing programs because they will reap both joint and individual benefits from the relationship in the future. reduced distribution cost allows distributors to offer end users more and better products for the purchase price. enhanced product value should spur market development and market share growth. if the channel partners perceive that these goals are 124 journal ofbusiness strategies vol 22, no.2 actually being met, their efforts will be justified and the relationship is more likely to endure. thus, actual performance, such as market growth, will enhance the relationship between propensity toward relational ism and relationship endurance. therefore, the following hypothesis is offered. hypothesis 1: the positive effect of the propensity toward relationalism on relationship endurance increases for industrial distribution channel relationships that have higher market growth. this general tendency to engage in relational exchange (propensity toward relational ism) has important implications in the distribution channel. a propensity toward relational ism means that a channel participant sees significant advantage in actual relationalism and seeks relational types of arrangements. this propensity also suggests that the channel member will build and maintain multiple relational arrangements, perhaps even on multiple fronts, for example, in both input and output sectors. for distributors, a propensity for relationalism signals that the distributor values and desires enduring relationships with suppliers. it indicates that the stability offered by long-term channel relationships is important and that the distributor believes in the advantage of an enduring relationship. therefore, the resources will be expended and the commitment will be present to establish the relational norms needed to engage in actual relational ism. from a transaction cost perspective, channel partners are not likely to commit resources or relationship-specific investments in relationships they do not expect to last (heide and john 1990; rokkan, heide, and wathne 2003). organizations with a propensity toward relationalism will be more likely to seek out long-term relationships and expect them to last. channel partners make investments in these relationships because relationalism allows them to realize significantly enhanced economic rewards over the lifetime of the relationship (dwyer, schurr, and oh 1987). additionally, having committed substantial resources to the relationship, those resources also act as an exit barrier for participants (heide and john 1992; rokkan, heide, and wathne 2003). based on this reasoning, the following is hypothesized. hypothesis 2: greater propensity toward relationalism in industrial distribution channel arrangements results in a higher level of actual relationalism. as organizations remain in channel partnerships for longer durations, the value placed on the relationship and the investments distribution channel participants make in relational distribution arrangements are likely to increase (noordewier, john, and nevin 1990). because of the perceptions of effectiveness and efficiency in relational exchange, and the significant replacement costs, participants are less likely to exit such arrangements (dwyer, schurr, and oh 1987). high levels of fall 2005 black and peeples: relationalism and market grmvth 125 relationship endurance and the accompanying investments of resources in the relationship comprise an important component in the development of relational exchange in distribution channels ( dwyer, schurr, and oh 1987). thus, the following hypothesis is proposed. hypothesis 3: a higher level of relationship endurance in industrial distribution channels results in a higher level of actual relationalism. method sample and data collection supplier-distributor relationships in the industrial equipment industry provided the research setting for this study. the setting was limited to distribution relationships in this one industry to restrict extraneous sources of variation, as suggested by previous research (e.g., heide and john 1992). the industrial equipment distribution channels were deemed appropriate for this study for several reasons. first, through a review of trade publications, it was determined that the constructs and processes being investigated were relevant in this industry. second, this industry provided a setting where size discrepancy between buyers and sellers was minimized. third, structures in both the supplier and purchaser markets did not seem to exhibit any anomalies that would bias the study findings. fourth, these distributors carry an appropriately narrow product line which controls for extraneous factors (e.g., breadth of line) that may impact the level of growth of a single supplier's market share and bias the research findings. finally, recent research suggests a relational exchange approach becomes even more important among members of a channel that is distributing more complex products (brait 2004; gosain and palmer 2004). given that the industry consists of smaller firms in which a single manager performed all or most of the relevant processes, data were collected from single key informants. qualified key informants were identified through extensive telephone screening. as recommended by campbell (1955), the informants were qualified on the basis oftheir specific experience with the phenomenon under investigation and their ability and willingness to communicate their knowledge. instrument development where possible, questionnaire items were derived from relevant literature, with some adjustments for the specific research setting. multiple items were used to assess actual relational ism, while single items assessed a propensity toward relationalisrn, growth of the supplier's market share, and relationship endurance. the preliminary questionnaire draft was administered to several channel participants over the telephone and was adjusted accordingly. next, the refined questionnaire was reviewed by a panel of questionnaire development experts and 126 journal of business strategies vol. 22, no.2 industrial experts. on the basis of the experts' recommendations, the questionnaire was further refined and was pretested. from the mailing list of697 firms, a systematic random sample of60 distributors was selected for the pretest. the key informant screening process yielded 50 potential respondents. the pretest mailing resulted in 13 completed and usable responses for a response rate of 26%. though pretest results were generally favorable, they led to the elimination of several items and the rewording of several other items. this new version of the questionnaire was again reviewed by the panel of experts used in a previous step and was further refined. in addition, the pretest was used to modify and refine the telephone screening procedures. data collection the initial sampling frame was a national list of every u. s. industrial distributor in this industry. the list consisted of 637 firms, after elimination ofthe firms used in the pretest. all firms on the sampling frame were screened by telephone. this preliminary screening served two purposes. first, the qualified key informant was identified. second, having identified the key informant, the telephone contact enhanced the response rate by obtaining prior commitment to participate in the study. telephone screening resulted in 400 potential respondents. the data were then collected through a mail survey which proceeded in several stages. first, potential respondents were mailed a pre-notification letter that reminded them of their agreement to participate and described the nature of the research. second, several days later, the actual questionnaire along with a cover letter and a postage paid return envelope was sent. the cover letter reminded them about the study and assured confidentiality. the initial mailing resulted in 135 responses. one month later, a reminder letter was sent and as a result, an additional 42 responses were received for an overall response rate of 45%. this response is well within the acceptable response rates achieved in similar research (e.g., boyle et ai., 1992; heide and john 1990, 1992). of the 177 returned questionnaires, 160 were usable for analysis. to further insure the quality of the data, two independent tests for response bias were conducted. first, early (up to four weeks after the initial mailing) and late respondents were compared on sales volume, number of employees, age of the relationship, and percentage of sales accounted for by the supplier's products. second, using secondary data, respondents and non-respondents were compared on sales volume and number of employees. in both cases, t-tests indicated no significant differences. thus, response bias does not appear to present a problem in this study. measures multiple item measures. while some researchers (e.g., dant and schul 1992; kaufmann and dant 1992) have operationalized relational ism in terms of individual relational norms, as outlined by macneil (1980), this research followed the recommendation ofboyle et al. (1992) and used a global measure ofrelationalism. fall 2005 black and peeples: relationalism and market growth 127 five items derived from two previous studies (boyle et al. 1992; kaufmann and dant 1992) were used to assess the level of relational ism. respondents indicated the extent of their agreement or disagreement with the items on a one (strongly disagree) to seven (strongly agree) likert scale. the measure included statements, such as "1 consider my firm and our major supplier's firm to be partners in the industry," and "in our business relations with our major supplier, the more powerful firm will use whatever means it can justify to get its own way" (reverse coded). single item measures. the study also included three single-item variables. the measure of the propensity toward relational ism was derived from information provided by the respondents. first, based on their responses to the relationalism scale, the relationship was classified as relational or discreet. [fthe relationship was classified as discreet, the propensity toward relational ism score became zero. if the relationship was classified as relational, the propensity toward relationalism score was based on the response to the question, "with how many other organizations do you have similar relations?" a single question with a categorical response was used to assess growth of the supplier's market share. the question was "since you began doing business with our major supplier, what is the market growth of the main product line which you get from it?" respondents indicated their answers by making a check mark in one of seven categories: 1) more than 10%,2) 8% to 9.99%, 3) 5% to 7.99%, 4) 3% to 4.99%,5) 1% to 2.99%, 6) 0% to 0.99%, and 7) no growth, but market shrinkage. finally, respondents indicated relationship endurance by answering the question "how long has your organization been doing business with this major supplier?" data used to assess this variable was the actual length of time indicated by responses to this question. data analysis validity and scale unidimensionality were assessed for the multiple-item measure for relational ism using exploratory factor analysis. reliability for this multiple item measure was also assessed using cronbach's alpha. the hypothesized relationships were tested using ols regression analysis. results measure validation preliminary measure validation consisted of assessments of internal consistency and reliability. exploratory factor analysis and reliability assessment indicated that the one of the original five items used to measure relationalism should be dropped for the analysis ofthe hypotheses. after dropping the item, the resulting four-item measurement scale had an acceptable reliability (cronbach's alpha = .75), according to the suggested acceptable level of at least .70 (nunnally 1978). in addition, exploratory factor analysis with varimax rotation provided evidence 128 journal ofbusiness strategies vol. 22, no.2 of scale unidimensionality. the results strongly suggest a single factor solution. this single factor explained 57.3% of the variance in the relational ism scale and all item loadings were above .63. hypothesis testing table 1 reports the results of the ols regression analysis used to test the three hypotheses of this study. in hi' the effect of an organizational propensity toward relationalism on relationship endurance was expected to be enhanced by market growth of the shared product line. first, support was found for propensity toward relationalism positively impacting relationship endurance (t = 2.496, p:=:: .0 i). as seen in table i, when the contingency relationship (propensity toward relationalism * market growth) was added, the relationship was enhanced (t-.f = 2.381, t-.r2 = .133, p:=:: .05). thus, hi was fully supported. table 1 results of hypotheses testing hypothesis independent variables dependent variable test statistic * ** propensity toward relationalism relationship endurance t = 2.496** propensity toward hi relationalism x relationship endurance ~f = 2.381 * market growth propensity toward h2 relationa1ism actual relationalism t = 1.985* h3 relationship endurance actual relationalism t = -0949 p < .05 p < .ot in addition, the propensity toward relational ism was predicted to positively impact actual relational ism in h 2 . support was found for this relationship (t = 1.985, p :=:: .05), supporting this hypothesis. finally, h, predicts that relationship endurance will have a positive impact on the development of actual relational ism. table 1 indicates no support for this hypothesis. discussion and implications this research extends our understanding of relational ism and its role in distribution channel relationships. this study demonstrates that actual relationalism is fall 2005 black and peeples: relationalism and market growth 129 a worthwhile outcome in distribution channels. specifically, the results indicate that an organization's propensity toward relationalism results in a higher likelihood that the organization will be involved in an actual relational exchange in an industrial distribution channel. another interesting finding is that relationship endurance does not have a significant impact on the actual development of relational partnerships. surprisingly and contrary to expectations, a long-term relationship in an industrial distribution channel does not necessarily invoke the commitment of resources to develop relational norms and trust. one possible reason for this is that certain channel partners in the industrial equipment industry may be so specialized or have so much expertise that there are few alternatives. this situation would result in long relationship endurance, but not necessarily the development of a relational arrangement between the channel partners. perhaps other factors (e.g., uncertainty of power asymmetries) not included in this study moderate the relationship. another possibility is that relationship endurance alone does not provide a sufficiently refined measure of relationship durability. a more complete picture of relationship durability which includes continuity expectations or long-term orientation might reveal more. these concepts disclose more about participants' psychological states regarding the channel relationship. however, this result still seems anomalous since these psychological states should be manifest in behaviors; for example, positive psychological states should induce a continued relationship. as expected, a firm's general tendency to engage in relational exchange influences relationship endurance. it may be true that firms with a proclivity for relational arrangements may find themselves spread thin in managing and maintaining multiple intense and close relationships that require large amounts of resources. however, firms that are successful in developing and maintaining many productive relationships with distribution channel partners likely possess certain skills and knowledge in managing these relationships that overcome the shortage of resources that may occur. these organizations believe in the payoff of relational exchange and make the necessary commitments, perhaps even in multiple sectors of their business. the impact of the propensity toward relationalism on relationship endurance is enhanced by performance (market growth). if an organization has high propensity toward relationalism, enhanced performance will likely reinforce this part of the organization's character or culture. this positive psychological reinforcement likely extends to the channel members that contributed to the performance. this, in tum, makes it more likely that the channel relationships between firms with the propensity for relationalism that are actually financially successful are likely to last longer. for managers, perhaps the major implication of this study is the payoff of relational exchange, both the propensity for relationalism and actual relationalism. it is indeed worthwhile to commit time and resources to developing and maintaining close working relationships with distribution channel partners. actual performance enhances the likelihood of firms with a tendency to engage in 130 journal ofbusiness strategies vol. 22, no.2 relational exchanges to be in more long-term distribution channel relationships. these relational arrangements may even occupy a position of strategic importance in the organization's overall position (webster 1992). as with all important strategic investments, these relationships should be a top priority for managers, particularly in situations of high firm interdependence. in fact, scholars predict the emergence of networks of functionally-specialized organizations in which the marketer will be only one participant. interactions among the firms in this network will be largely driven by relational norms and dominated by relational exchange (achrol 1991). an organization's penchant for and belief in relational exchange will facilitate the building of more long-term channel relationships. as managers engage in and build more of these relationships, their skills and knowledge in developing and managing relational exchange will increase. the subsequent use ofthis skill and knowledge will serve them well in other channel relationships. managers will learn how to make more enduring partnerships with other channel participants. as in all research, this study has its limitations. the study was limited to one industry, so the findings may not be completely generalizable to distribution channels in other industries. this limitation becomes more significant if the industry studied in this research is dominated by highly-specialized channel partners so few alternatives are available. these findings should be replicated in other industries and other research settings, such as those involving consumer products. in addition, there is still very little knowledge about dependence and relational exchange in international distribution relationships. references achrol, r. (1991). evolution of the marketing organization: new forms for turbulent environments. journal of marketing. 55, 77-93. alderson, w. (1954). factors governing the development of marketing channels. in r.m. clewett (ed.), marketing channels for manufacturedproducts (pp. 5-22). homewood, il: richard d. irwin publishing company. anderson, e. & weitz, b. (1989). determinants of continuity in conventional industrial channel dyads. marketing science. 8, 3 10-323. anderson, j.c & narus, l.a. (2003, july). supply chain challenges. harvard business review, 65-73. batt, p.1. (2003). building trust between growers and market agents. supply chain management, 1(8),65-78. berthon, p., pitt, l.f., ewing, m.t., & bakkeland, g. (2003). norms and power in marketing relationships: alternative theories and empirical evidence. journal of business research, 56(9),699-711. fall 2005 black and peeples: relationalism and market growth 131 black, g.s., moore, r.t., & vogt, j.f. (2000). dispositional trust: a key for international partnering. academy of business administration~' 2000 global business trends conference proceedings, 10-15. boyle, b., dwyer, f.r., robicheaux, r., & simpson, j. (1992). influence strategies in marketing channels: measures and use in different relationship structures. journal of marketing research, 29,462-473. brait, r.a. (2004). transactional aspects of corporate intellectual property strategy. the canadian business law journal. 41, 19-26. campbell, d. (1955). the informant in quantitative research. american journal of sociology, 60, 339-342. cavusgil, s.t., deligonul, s., & zhang, c. (2004). curbing foreign distributor opportunism: an examination oftmst, contracts, and the legal environment in international channel relationships. journal of international marketing, 12, 7-21. coughlan, a.t. & grayson, k. (1998). network marketing organizations: compensation plans, retail network growth, and profitability. international journal 0.[research in marketing, 15(4),401-426. dant, r. & schul, p. (1992). conflict resolution processes in contractual channels of distribution. journal of marketing. 56,38-54. dwyer, f., schurr, p., & oh, s. (1987). developing buyer-seller relationships. journal of marketing, 51,11-27. eliinger,a.e., ellinger,a.d., & keller, s.b. (2002). logistics manager's learning environments and firm performance. journal ofbusiness logistics, 23(1), 19-37. frazier, g., spekman, r., & o'neal, c. (1988). just-in-time exchange relationships in industrial markets. journal of marketing, 52,52-67. ganesan, shankar. (1993). negotiation strategies and the nature ofchannel relationships. jmr. journal ofmarketing research. 30(2), 183-203. ganesan, shankar. (1994). determinants of long-term orientation m buyer-seller relationships. journal ofmarketing, 58(2), 1-19. goodman, p. & pennings, j. (1980). critical issues in assessing organizational effectiveness. in e.e. lawler, d.a. nadler, & c. cammann (eds.), organizational assessment: perspectives on the measurement oforganizational behavior and the quality ofwork life. (pp.185-215). new york: john wiley and sons,. gosain, s. & palmer, j.w. (2004). exploring strategic choices in marketplace positioning. electronic markets, 14(4),308-318. 132 journal ofbusiness strategies vol. 22, no.2 hausman, a. (200 i). variations in relationship strength and its impact on performance and satisfaction in business relationships. the journal of business & industrial marketing. 16(6/7), 600-616. heide, j. (1994). interorganizational governance in marketing channels. journal of marketing. 58,71-85. heide, j. & john g. (1990). alliances in industrial purchasing: the determinants of joint action in buyer-seller relationships. journal ofmarketing, 52,20-35. heide, j. & john, g. (1992). do norms matter in marketing relationships? journal of marketing, 56, 32-44. hewett, k. & bearden, w.o. (200 i). dependence, trust, and relational behavior on the part of foreign subsidiary marketing operations: implications for managing global marketing operations. journal of marketing, 65, 51-66. johnson, j.l. & black, g.s. (1996). the effects of relationalism and supplier replaceability on industrial distribution channel outcomes. journal of marketing channels, 5(2),25-44. kaufmann, p. & dant, r. (1992). the dimensions of commercial exchange. marketing letters, 3(2), 171-185. kerin, r., mahajan, v., & varadarajan, p. (1990). contemporary perspectives on strategic market planning. boston: allyn and bacon. kotler, p. & armstrong, g. (2006). principles of marketing, (i jlh ed.). upper saddle river, nj: prentice-hall. kumar, n., stern, l., & achrol, r. (1992). assessing reseller performance from the perspective of the supplier. journal o/marketing research, 29,238-253. macneil, 1. (1980). the new social contract. new haven, ct: yale university press. mehta, r., dubinsky, aj., & anderson, r.e. (2002). marketing channel management and the sales manager. industrial marketing management, 31 (4),429-439. mentzer, j.t., flint, dj., & hult, g. t.m. (2001). logistics service quality as a segmentcustomized process. journal of marketing, 65, 82-104. morgan, r. & hunt, s. (1994). the commitment-trust theory of relationship marketing. journal of marketing, 58,20-38. noble, c.h., sinha, r.k., & kumar, a. (2002). market orientation and alternative strategic orientations: a longitudinal assessment of performance implications. journal ofmarketing, 66,253-259. fall 2005 black and peeples: relationalism and market grmvth 133 noordeweir, t. john. g., & nevin, j. (1990). performance outcomes of purchasing arrangements in industrial buyer-vendor relationships. journal of marketing, 51, 80-93. nunnally, j. (1978). psychometric theory. new york: mcgraw hill. paswan, a.k. (2003). channel support activities and perceived goal orientation: an exploration in the indian market. asia pacific journal of marketing and logistics, 15(4), 19-4 l paswan, ax., pappu. m., & young, j.a. (2002). relational norms and goal orientation in the indian market. journal ofinternational consumer marketing, 15(1),53-67. paswan, a.k. & young, la. (1999). an exploratory examination of the relationship between channel support mechanisms and relational norms in an international context. the journal of business & industrial marketing, 14(5/6),445a59. pelham, a.m. (2000). market orientation and other potential influences on performance in small and medium-sized manufacturing firms. journal o/small business management, 38(1),48-67, pelham, a.m. (1997). mediating influences on the relationship between marketing orientation and profitability in small industrial firms. journal of marketing theory and practice. (summer), 55-76. rindfleisch, a. & moorman, c. (2003). interfiml cooperation and customer orientation. journal of marketing research. 40, 421-432. rokkan, a.!., heide. l8., & wathne, k.h, (2003). specific investments in marketing relationships: expropriation and bonding effects. journal of marketing research, 40,210-223. siu, w.s. (2002). marketing activities and performance: a comparison of the internetbased and traditional small firms in taiwan. industrial marketing management. 31(2),177-188. stafford, e. (1992). implications of strategic alliance structure: a cooperative strategy! relational exchange framework. american marketing association :" summer educators' enhancing knowledge development in marketing conference proceedings. 3,101-107. webster, f.e., jr. (1992). the changing role of marketing in the corporation. journal of marketing, 56, 1-17. zhang, c.w., cavusgil, s.t., & roath, a.s. (2003). manufacturer governance of foreign distributor relationships: do relational norms enhance competitiveness in the export market? journal ofinternational business studies, 34(6), 550-559. 134 journal of business strategies vol. 22, no.2 gregory s. black is assistant professor of marketing at texas a&m university corpus christi. he holds a ph.d. in marketing from washington state university and an mba from brigham young university. he also holds bas in both international relations and korean from brigham young university. he has been studying distribution channel phenomenon for over a decade, beginning with his doctoral dissertation. donna k. peeples is assistant professor of management at texas a&m university corpus christi. she holds a ph.d. from texas a&m university college station and an mba from texas a&m university corpus christi. her research interests include management strategy, consumer behavior, and consumer and internet privacy. the impact of propensity for relationalism and market growth on distribution channel outcomes the 2007 leegin decision on resale price maintenance and its implications for firms' distribution strategies joseph m. jadlow oklahoma state university • stillwater, ok abstract with its leegin decision in june 2007, the u.s. supreme court adopted a much more permissive judicial attitude toward businesses' use of vertical price restraints than had been the case for almost a century. in most instances, manufacturers will now be able to use minimum resale price maintenance when dealing with retailers without violating federal antitrust laws. this should increase the efficiency of product distribution. some firms are unlikely to be able to take full advantage of these more efficient distribution methods, however, because the antitrust laws of some individual states are likely to conflict with the new federal rules. introduction in late june 2007, the u.s. supreme court announced an antitrust decision that is likely to change the distribution methods that many businesses use to market their products. the case was leegin creative leather products v. psks (2007) and it reversed a court precedent that had stood for close to a century. with this recent decision, the court adopted a much more permissive judicial treatment of resale price maintenance than had been the case before. the purpose of this paper is to examine how leegin alters the distribution methods that firms have at their disposal and to analyze the likely effects on the efficiency of the distribution process. the paper finishes by identifying some lingering antitrust concerns for business that temper the increased distribution flexibility and efficiency precipitated by leegin. the leegin decision the u.s. supreme court had ruled in the dr. miles (1911) case that all resale price maintenance is per se illegal under section 1 of the sherman act. resale price maintenance (rpm) is when an upstream firm, such as a manufacturer, requires an independent downstream reseller, such as a retail dealer, to agree to restrictions on the price at which the dealer resells the firm's product. more specifically, minimum rpm is an agreement that the product will not be resold at a price below a specified 160 journal of business strategies level while maximum rpm is an agreement that the product will not be resold above a given price. the per se prohibition meant that rpm was automatically illegal, i.e. there were no justifications that the courts would consider in defense of a defendant who had employed it. minimum rpm remained per se illegal under dr. miles until the 2007 leegin decision. the rule of reason was adopted for maximum rpm in a 1997 supreme court opinion (state oil co. v. khan); the reason for the latter is explained in a section below. in late 2002, the manufacturer of brighton brand products, leegin creative leather products, inc., learned that an independent retailer in lewisville, texas was selling the entire line of brighton products at prices 20 percent below those recommended by leegin; in response, leegin quit supplying the product label to the retailer and the retailer filed a law-suit against leegin for per se illegal minimum rpm. on the last day of its 2006-2007 term, a 5-4 majority of the supreme court overruled the dr. miles precedent with its leegin (2007) decision that held that all vertical price restraints are to be judged by the rule of reason, i.e. on a case-by-case basis that weighs the competitive benefits and costs in each instance. business reasons for firms to use vertical restraints it is frequently the case that the manufacturer of a differentiated product prefers its dealers to provide various services that will increase the demand for its product. for example, it might want stores to have trained sales personnel who are knowledgeable about its product, its advantages over other brands, warranty issues, the expected life of the product, and other product-specific information . it also may want retailers to carry certain types of store displays for the product, maintain a given type of shopping-environment, maintain minimum inventory levels, provide various post-sale services, do local advertising, and have a reputation for selling high-quality products (elzinga & mills, 2007; ippolito, 1991 ; marvel & mccafferty, 1984). such services are costly but the manufacturer may expect that if each of its retailers offers them, they will more than pay for themselves by increasing the overall demand for his product. if it does not protect itself, however, the manufacturer may encounter the well-known "free rider" problem (telser, 1960) as some of its retailers begin to cut back on services so as to reduce costs, discount their prices, and gain market share. the full-service retailers whose services helped create the expanded demand suffer the direct effects of the free riding as they lose sales to the discounters and eventually are forced to eliminate services themselves so that they can charge low enough volume 26, number 2 161 prices to maintain their market shares. the net effect is the overall demand for the manufacturer's product falls and so do its profits . there are various possible ways that the manufacturer might try to solve the problem but, of course, in doing so it would want to be both efficient and lawful. one possibility is that the manufacturer vertically integrates and sells the product at retail itself. the manufacturer could do this by acquiring retail stores through a series of mergers or it could build its own network of retail stores. if the manufacturer does vertically integrate, this solves the free rider problem because the producer gains direct control of the services that its retail outlets provide as well as the prices they charge. while in most instances it seems unlikely that a firm's decision to vertically integrate would be found to violate the antitrust laws, it is also true that vertical integration would not be cost-effective for most firms . an alternative to vertical integration is to assign exclusive sales territories to the various retail stores with whom it deals and to make each dealer's provision of specified services a contractual requirement for continuing to have an exclusive territory. this provides an incentive for each dealer to offer the desired services because any additional sales prompted by the dealer's services are internalized with the dealer (rather than spilling over to free riders selling the same brand) since no other dealers are allowed to market the brand in the same geographic territory. the business practice of assigning exclusive sales territories to downstream dealers is a non-price vertical restriction that has been governed by the rule of reason since the supreme court's continental t. v., inc. v. gte sylvania inc. (1977) decision and its use will rarely be found to be illegal; the main rationale given by the court for its adoption of the rule of reason for such restraints was the free rider problem. a side-effect of assigning exclusive territories is that it gives the dealer increased market power and an incentive to raise the price it charges above the level that maximizes the profits of the manufacturer. the manufacturer can solve this doublemargin problem by using maximum rpm to force the dealer to charge a price no higher than what is optimum for the manufacturer (blair & kaserman, 1985, pp. 342-347). because the use of maximum rpm results in lower prices, higher outputs, and increased consumer welfare, the supreme court held in its khan (1997) decision that it was adopting the rule of reason for evaluating this business practice, and it is unlikely that its use will ever be found to violate the antitrust laws. the leegin decision has made available another option for the upstream firm the use of minimum rpm. by requiring downstream dealers to agree that they will not sell the product for less than a minimum price specified by the manufacturer, the manufacturer can attempt to attract good dealers to sell and promote its product 162 journal of business strategies brand by promising them sizable price-cost margins that will not be threatened by discounters. in its contracts with dealers, the manufacturer can make clear the nature and quality of the services that the dealers are expected to provide in retailing the product and, by its effective use of minimum rpm, the manufacturer can ensure that dealers' profit margins are large enough so that they can cover the costs of the desired services. if the manufacturer is a new firm with a new product or if it is an old firm that wants to enter a new market, its use of minimum rpm can be especially important in attracting strong dealers and in facilitating its overall success (elzinga & mills, 2007, p. 7). prior to the leegin decision, any firm that used minimum rpm and was the subject of a formal antitrust complaint was very likely to be found to have committed a per se violation of the sherman act except in some very special circumstances. the latter exceptions resulted from a series of supreme court decisions that identified a few roundabout ways for de jacto rpm to be used without committing a per se violation. for example, the court ruled in colgate (1919) that an upstream firm could announce and then carry out a unilateral policy of refusing to sell to dealers who charged prices below its suggested retail prices but there could be no haggling with dealers to get them to abide with the price floor. then in general electric (1926), the court held that in a true consignment arrangement an upstream firm (principal) could determine the price at which a dealer (agent) sold the product because ownership remained with the upstream company until sale to the final consumer was completed. later in monsanto (1984) and in business electronics (1988), the court issued rulings that made it very difficult for a plaintiff to prove per se illegal minimum rpm based mainly on evidence that the plaintiff had been terminated as a dealer after a competitor of the plaintiff complained about him to the manufacturer. the rule of reason was applied in all of these de jacto rpm situations. while the empirical evidence is limited, the above discussion suggests that before leegin, the dr. miles precedent limited the distribution options of firms. for example, in situations where the use of minimum rpm would have been the cheapest way to get good full-service dealers and keep them, some manufacturers either had to forego this method entirely (so as to avoid being charged with per se illegal minimum rpm) or attempt to use one of the more costly and risky de jacto rpm approaches such as the unilateral policy permitted by colgate; other producers may have chosen to vertically integrate even when it was less efficient than the use of minimum rpm. in citing these perverse effects of the dr. miles per se rule, the supreme court concluded that the rule " ... hinders competition and consumer welvolttme 26, nttmber 2 163 fare because manufacturers are forced . . . to choose second-best options to achieve sound business objectives" in distributing their products (leegin, 2007, pp. 23 and 25). thus, by permitting a wider range of distribution options than were previously available, the 2007 court decision seems likely to increase the overall efficiency of product distribution in the economy. caveat venditor: "let the seller beware" while leegin has expanded the distribution options available to companies, there are some strong cautionary warnings for them to keep in mind. first, there continue to be instances where the use of minimum rpm may be found to violate federal antitrust law under the rule of reason (denger & lipton, 2007). for example, it is generally recognized that a dealer cartel or a manufacturer cartel could try to use minimum rpm as a method of preventing members of the cartel from cheating. ordinarily manufacturers would have no incentive to facilitate the cartel efforts of dealers but if the impetus for the use of rpm appears to be from dealers or even from one dominant retailer, antitrust enforcement agencies are likely to scrutinize behavior carefully. similarly, the supreme court has emphasized that if the adoption of rpm is widespread throughout an industry or if a dominant producer with market power introduces rpm, close scrutiny is likely (leegin , 2007). the second and most important concern, however, is the uncertainty about how the individual states will treat minimum rpm in the wake of leegin. notably, the attorneys general of thirty-seven states asked in an amici brief in leegin that the per se rule of dr. miles be kept. 1 this does not mean that all these states will adopt a per se rule at the state-level since the views of state courts or legislatures may differ from those of the state attorneys general. but it does indicate that businesses should proceed with care. two antitrust lawyers have attempted to anticipate the rpm policies of various states and they recommend that firms move cautiously in forming new rpm programs; they conclude that minimum rpm agreements would be "riskiest for businesses" in california, new york, and new jersey (wofford & limarzi, 2007, p. 7). another legal expert has suggested that companies that had a colgate-type unilateral pricing policy before leegin may want to continue that policy and ones that never adopted such a policy because the "perceived risk was too great" may now want to consider adopting one because the risk has fallen somewhat because of leegin (lindsay, 2007, p. 36). 164 journal of business strategies summary and conclusions the supreme court's recent decision to move to rule of reason treatment for all resale price maintenance has expanded the choice set of companies for distributing their products and, as described above, this should result in some lowering of firms' costs and increased efficiency in providing distribution services to consumers. the fact, however, that the leegin decision only bears directly upon the enforcement of the federal antitrust laws, limits the scope of its benefits to firms and the economy. it is important that companies thinking of changing their distribution methods in response to leegin should first consider state antitrust laws and policies toward minimum rpm that are relevant for their business. if a company wants to use minimum rpm but is uncertain about how it will be treated under state antitrust laws, the colgate unilateral pricing policy may suit its purposes. note 1. the states are alaska, arkansas, connecticut, delaware, florida, hawaii, idaho, illinois, iowa, kansas, kentucky, louisiana, maine, maryland, massachusetts, michigan, minnesota, mississippi, missouri, montana, new york, nevada, new hampshire, new jersey, new mexico, north carolina, ohio, oklahoma, oregon, pennsylvania, south carolina, south dakota, utah, vermont, washington, west virginia, and wyoming. (brief of states, 2007) references bork, r. h. (1978). the antitrust paradox. new york: basic books. blair, r. d., & kaserman, d. l. (1985). antitrust economics. homewood, il: richard d. irwin, inc. brief of states as amici curiae supporting respondent, leegin creative prods., inc. v. psks, inc., no. 06-480, wl 621851(127 s. ct. 2705 2007). business electronics corp. v. sharp electronics corp., 485 u.s. 717 (1988). continental t. v, inc. v. gte sylvania inc., 433 u.s. 36 (1977). denger, m. l., & lipton, 1. (2007). the rule of reason and "leegin policies": the supreme court's guidance. antitrust, 22(1), 45-50 . dr. miles medical co. v. john d. park & sons co., 220 u.s. 373 (1911). elzinga, k. g., & mills, d . e. (2007). the economics of resale price maintenance. in w. d. collins (ed.), issues in competition law and policy. american bar association. retrieved september 26,2007, from ssm.com/abstract=926072. volume 26, number 2 165 hovenkamp, h. (2005). the antitrust enterprise. cambridge, ma: harvard university press. ippolito, p. m. (1991). resale price maintenance: empirical evidence from litigation. journal of law and economics, 34, 263-94. kleit, a. n. (1993). efficiencies without economists: the early years of resale price maintenance. southern economic journal, 59, 597-619 . . leegin creative leather products v. psks, 551 u .s. _ (2007). lindsay, m. a. (2007). resale price maintenance and the world after leegin. antitrust, 22(1), 32-40. marvel, h. p., & mccafferty, s. (1984). resale price maintenance and quality certification. rand journal of economics, 15, 346-59. monsanto co. v. spray-rite service corp., 465 u.s. 752 (1984). scherer, f. m., & ross, d. (1990). industrial market structure and economic performance (3rd ed.) boston: houghton-mifflin co. state oil co. v. khan, 522 u.s. 3 (1997). telser, l. g. (1960). why should manufacturers want fair trade? journal of law and economics, 3, 86-105. united states v. colgate & co., 250 u.s. 300 (1919). united states v. general electric co., 272 u.s. 476 (1926). wofford, jr., m.r., & limarzi, k. c. (2007). the reach of leegin: will the states resuscitate dr. miles? the antitrust source. american bar association. retrieved october 19, 2007, from www.antitrustsource.com. biographical sketch of author joseph m. jadlow is professor of economics at oklahoma state university, stillwater. he received his ph.d. from the university of virginia. his research interests include antitrust economics, rent seeking behavior, public choice, history of economic thought, and law & economics. he has published in the journal of finance, public choice, bell journal of economics, antitrust law & economics review, and managerial and decision economics, among others. 166 journal of business strategies the 2007 leegin decision on resale price maintenance and its implications for firms' distribution strategies and what about the family back home? international migration and happiness in cuenca, ecuador fernando borraz banco central del uruguay and universidad de la republica montevideo, uruguay· susan poz0 1 western michigan university • kalamazoo, mi maximo rossi universidad de la republica • montevideo, uruguay abstract in this study we use data on subjective well being and migration of family members in cuenca, one of ecuador's largest cities, to examine the impact ofmigration on the happiness of the family left behind. while a cursory examination of the data suggests that the heads of households that have experienced the migration of one or more family members are less happy, a more careful analysis reveals otherwise. households that have been impacted by migration express equal levels of happiness as those households that have not been affected by migration. one plausible explanation for our finding is that the remittances that households receive following the migration of loved ones counteract the downsides to family emigration . introduction international migration can be motivated by a number of factors. some migrate in order to escape dire poverty. others go into exile in search of religious or political freedoms. some move to invest in education, others to join relatives abroad, and still others in pursuit of adventure and new opportunities. while a great deal of research has analyzed the short-run and long-run outcomes for those who move to new areas (e.g. borjas, 2002; chiswick, 2002; smith, 2003; card, 2005), in this paper we tum our focus to the family left behind. in particular, we consider whether international migration of one or more family members serves to increase or decrease the level of "happiness" of household members who remain in the home community. understanding how migration affects migrants and their families is of considerable interest given that migration will likely touch increasing numbers of individuals in the world. first, according to demographic information, the incidence of migration has been rising. in 1970, about 2.2 percent of the world's population lived 8 journal of business strategies in a country other than their country of birth. in contrast, by 2005 , the foreign born accounted for 3 percent of the world's population. 2 second, emigration impacts more than those moving to another country. legal, cultural, and monetary barriers to migration often make it difficult for whole families to migrate. the incidence of migration-impacted households can therefore easily change with public policy which ultimately accentuates family separations and dislocations. for example, massey (2006) has noted that increased enforcement at the us/mexico border implemented to stem illegal immigration has had the unintended effect of extending the stay of unauthorized immigrants who would normally periodically return home. longer stays by unauthorized immigrant are likely to lead to longer-lasting and permanent family separations. a third reason for expecting migration to touch larger portions of the world population stems from policy shifts in immigration legislation toward preferences for skilled labor migration at the expense of family reunification. if legislation continues to be developed along these lines, it follows that a larger circle of individuals will be affected by migration due to longer-run family separations. finally, rapid technological progress ofthe sort observed in the more recent decades is likely to continue, further reducing transportation and communication costs, easing travel, facilitating international migration and therefore increasing its incidence. 3 given the expectation of greater family dislocations via migration, what are our priors on the impact of migration on happiness? we hypothesize that migration reduces happiness levels of the family left behind. the emigration of a household member is likely to directly cause disruptions in the household since the absent household member may have been contributing to the household via market or home production. thus, in addition to discomfort stemming from the absence ofloved ones, household and monetary responsibilities now need to be assumed by other family members. the reallocation of household chores and market work is likely to be costly for the remaining family members, reducing happiness levels. it is also conceivable, however, that migration positively affects happiness levels. for example, as suggested and described by cardenas, di marco, and sorkin (2009), the migration of family may increase the spatial dispersion of income sources. this, in turn, may raise the subjective well-being of the family because of the "insurance" this dispersion may buy, which, in effect, reduces the income vulnerabilities of the family. in this paper we seek to examine the impact of migration on the happiness of the family left behind by exploiting information contained in the discrimination and economic outcomes survey undertaken in ecuador in 2006. the survey contains information from 665 households: 480 in cuenca and 185 in san fernando. in this volume 27, number 1 9 paper, we only include households residing in cuenca because the san fernando sample contains too few non-migrant households from which to draw the comparisons. cuenca is the third largest city in ecuador with nearly a half million inhabitants while san fernando is a very small town with approximately 3,000 inhabitants.4 if the household does claim a migrant member, limited information on that migration is collected. furthermore, a question that assesses the subjective well-being or "happiness" of the survey respondent is asked despite its geographic limitations, cuenca is of interest to migration scholars owing to its long history of international migration to the united states. this migration was initiated shortly after wwii on account of the decline in use and therefore export demand for panama hats (which despite the name, were produced in cuenca and its surrounding areas in ecuador). the hat manufactures in cuenca had business contacts in new york, and when faced with declines in the traditional business, exploited those networks to migrate to the new york area. the subsequent development of those migration networks has produced significant migratory flows to the united states from the region (gatton, 2005). literature and measurement concerns our intent is to try and measure whether international migration has impacted subjective well-being or happiness for the family remaining in the home community using the survey referred to above. 5 before outlining the methodology we use to link migration to happiness levels, it is appropriate to ask as to what extent is it possible to discern "happiness" from surveys such as the one in question? di tella and macculloch (2005) note that other social scientists including psychologists have relied upon happiness data much like the data included in the discrimination and economic outcomes survey that we are working with. they claim that, " . .. well-being data pass what psychologists sometimes call validation exercises." pavot (1991), for example, finds that respondents who report that they are very happy tend to smile more, an act that arguably is correlated with true internal happiness. layard (2005) further rationalizes the use of happiness data by noting research in neuroscience (davidson, 2000) which has found that different regions in the brain are associated with positive and negative effects. thus, when people describe their feelings there is some biological basis and their claims are not purely subjective. furthermore, self-reported happiness is correlated with others' assessments of happiness. as such, many argue that happiness can be measured and can be compared between individuals and over time. 10 journal of business strategies we measure the respondent's well-being by considering whether he or she responded that he or she was "very satisfied," "fairly satisfied," "not satisfied," or "very unsatisfied" with his or her life.6 table i presents some basic information on household heads in cuenca along with their self described level of happiness as reported in the survey database. about 68 percent of household (29 + 39) report that they are satisfied or very satisfied with their lives. we sum these two categories and classify these households as "happy." in contrast, we classify 32 percent of households as "not happy," as they claim to be either "not very satisfied" (29 percent) or "not at all satisfied" (3 percent) with their lives. table 1 self-reported happiness levels of household heads in cuenca, ecuador level of satisfaction with life n percent very satisfied 138 28.9 satisfied 186 38.9 not very satisfied 138 28.9 not at all satisfied 15 3.1 the literature on happiness suggests that a number of demographic, cultural, and economic factors playa role in individual's happiness. a review of the empirical literature appears to concur with common expectations regarding the relationship between personal variables and happiness. for example, separated individuals and divorced individuals are found to be less happy (clark & oswald, 1994; blanchard & oswald, 2000). happiness decreases with age but eventually rises as individuals get older. in contrast, education and happiness are found to be inverse u-shaped. more education increases happiness, but education can be "too much of a good thing," since beyond a certain point, additional levels of education are found to contribute negatively to happiness levels (hartlog & oosterbeek, 1997). other variables are found to have less obvious and sometimes even counterintuitive impacts on happiness. for example, absolute income levels do not seem to be important as determinants of happiness (easterlin, 1974; blanchflower & oswald, 2000; rayo & becker, 2007). relative income or wage standing, instead, appear to affect happiness levels (frank, 1985 ; easterlin, 2001, miles & rossi , 2007). interestingly, self-employment is found to increase happiness for individuals in developed economies, while having the opposite effect for individuals residing in developing economies (graham & pettinato, 200 i). volume 27, number 1 11 a number of other variables have been found to affect happiness, but with less robust findings. for example, while it has been reported that women are happier than men, the reported happiness among women is found to be declining over time. and while religious denomination does not appear to impact happiness, religiosity, measured by attendance at religious ceremonies, seems to be correlated with greater levels of happiness (blanchflower & oswald, 2000). our intent is to contribute to this literature by assessing the impact of migration on happiness using the data from cuenca, ecuador. in an earlier publication, cardenas et al. (2009) explore this relationship using the gallup world poll survey and latinobarometro to analyze households from up to 20 latin american and caribbean countries . to this end, they estimate an equation of the following form: h = a+f1:p + 8m. + c. i . 1 j i (1) and attempt to explain the happiness of respondent i (h) which is presumed to depend on a vector of variables describing the characteristics (p) of the household i and respondent. the model is augmented with a migration related variable m. for i example, a dummy variable specifying whether or not the household claims that one of its members has emigrated. of interest is the estimated value for 8, the coefficient on the migration variable. the estimated value for 8 along with information on its statistical significance is used to determine whether migration reduces, increases, or leaves unchanged the happiness of a family member left behind. while (i) may seem a reasonable specification, we note that it may not be appropriate if one cannot justify that all right hand side variables in equation (1) are exogenous that there is no correlation between the right hand side variables and the error term. this proves problematic for several reasons. consider, for example, a very simple migration variable a dummy variable assuming the value ")" for households that claim that one of its members is a migrant and "0" otherwise . correlation between the migration dummy variable and the error term might very well exist on account of reverse causality. while we are presuming that migration impacts happiness (e.g. , family remaining behind miss the migrant and perhaps their former contributions), it is also conceivable that happiness affects migration. for example, a very unhappy household head may "drive family away." in addition to endogeneity originating from reverse causality, unobserved heterogeneity may also playa role. migrant households are not likely to be randomly selected from the population, and it may be difficult to observe and control for that selection.? for example, it may be that migrants tend to originate from households 12 journal of business strategies willing to indulge in risk-taking behavior. but risk attitudes may also playa role in determining happiness. tfwe cannot control for risk attitudes on the right hand side of (i), the migration variable and error term will be correlated and our inferences regarding migration and happiness will be biased. non-migration regressors in equation (i) may also suffer from endogeneity. one obvious candidate is income. positive work attitudes may very well be a factor in determining income, but work attitudes are also likely to affect happiness. if we do not observe and, therefore, control for work attitudes, this will be reflected in the error term which will now be correlated with income, biasing the coefficient on income and incorrectly assessing income's impact on happiness. cardenas et al (2009) conclude that, overall, households are made better off by migration. but they also note that household 's subjective well-being appears to vary according to their vulnerabilities. households that are nutritionally vulnerable are made worse-off by migration . while these results are interesting and have made in-roads into the issue of migration's impact on happiness level, we argue, as do cardenas et ai. (2009), that endogeneity has not been accounted for in the above methodology, thus, bringing into question the final conclusions. our intent is to analyze migration's impact on happiness using the data from cuenca, ecuador, while accounting for the endogeneity problem discussed above. a common solution for endogeneity is to find instruments for the endogenous variables in question. by finding variables that are correlated with the endogenous right hand side variable yet not related to the dependent variable, we can purge the effects of endogeneity and thereby obtain consistent estimates that reliably describe how the right hand side variables affect happiness. in many cases, however, instruments are difficult to obtain. furthermore, once we find what may appear to be a reasonable candidate, diagnostic tests of its suitability are sometimes of questionable reliability, making it difficult to justify its use. while we might venture to use instrumental variables to correct for one endogenous regressor, we feel less confident about finding and justifying instruments for all the regressors in equation (i) that are likely to be endogenous. for this reason, we seek an alternative technique to assess the impact of migration or migration related variables on happiness. methodology the gold standard for assessing causality from variable "m" (for example, the migration of household members) to outcome variable "h" (in our case happiness) is to perform a randomized experiment. in a randomized experiment subjects volume 27, number 1 13 are chosen at random from the population . we refer to the random sample as the experimental or treatment group. since these subjects have been selected at random, they must be, on average, identical in characteristics to the "control" group. the experimental group is then "treated" with migration. next, we compare outcomes (e.g. happiness) in the experimental group with the control group. any differences observed in the two can be attributed to the treatment since the two groups were identical before treatment. in this manner we avoid the selection bias problem, permitting us to assess causality from treatment m (having a migrant family member) to outcome h (happiness). unfortunately, controlled random experiments are expensive and less likely to be undertaken in studies of international migration. 8 as a substitute, we employ a matching technique we in effect find a "control group" that matches the "experimental group" the set of families who have been touched by migration. that is, we simulate a randomized experiment by finding a control group among those households who are not migrant households. we work backwards in comparison to a randomized experiment. we are presented with a treated group. our job is to find a control group that matches the treated group and use the "matched control" group to derive comparisons with the "treated" group. in this way we can discern causality from migration to happiness and thereby make inferences about the effect of migration on happiness. while such a technique limits our conclusions (we do not get any information concerning how the other variables e.g., income, age, education affect happiness), potential endogeneity on the part of these other variables will not compromise our conclusions about migration on happiness. in this way we eliminate selection bias that exists with respect to the comparisons of treated and non-treated groups and assess causality from "m" to "h" in our case, from migration to happmess. we use propensity score matching (psm) to obtain an artificially generated control group that is similar to the treatment group in every aspect except that the persons in the control group do not have a family member abroad. rosenbaun and rubin (1983) show that it is not necessary to perform the match with respect to the vector of personal characteristics. it is enough to match the propensity score, that is, the predicted probability of treatment receipt (migration). we assume that treatment participation depends on a vector of observable variables x. in order to obtain the artificially created control group, one needs to first obtain the propensity score for each observation that "orders" observations along a set of observable variables. for each treated observation we find the non-treated observation that is closest to the treated observations to serve as the corresponding control observation. that is, we obtain 14 journal of business strategies predicted probabilities from a probit that predicts migration and then use these predicted probabilities to match non-migrant households to migrant households. typically, for each treated observation, psm selects one similar non-treated observation and adds this observation to the control group. in our case, we use the k-nearest neighbor matching method (setting k equal to i or more) to select the matched control group. setting k to (say) 1 or 2 controls involves a tradeoff. bias will be smallest with one matching observation (with k=i), but we can reduce the variance if we choose k to be larger and hence choose more matches per treated observation. as we explain in more detail below, we choose k based on the size of the available control group. the actual algorithm employed to match the potential control observations to the treated observation is psmatch2, version 3.0.0 by leuven and sianesi (2003). hypotheses and data our prior is that migration reduces happiness levels for the family left behind. this prior is based on the notion that migration, and in particular international migration, disrupts the family. mothers and fathers long for their children and children miss their siblings and parents. grandparents regret missing grandchildren's milestones. nieces and nephews yearn for advice from a favorite aunt. disruptions to the family, however, may extend beyond "missing the company" of a loved one. for example, family chores that had previously been undertaken by the migrant need to be assumed by remaining family members. the monetary resources of the household may also be strained owing to the possibility that the household financed the migration. or it may be that the previous income contributions of the now absent household member are missed. in order to get a preliminary sense of the impact of migration on happiness, we tabulate the proportion of "migrant household" who report that they are "happy" relative to non-migrant households. we define the head to be happy if he or she reports that he or she is very satisfied or somewhat satisfied with life. these simple descriptive statistics are presented in table 2. in the top portion of the table we divide households into those that claim to have at least one migrant member and those with no migrants belonging to the household. migrant households appear less happy in the aggregate as the percent that claim to be happy is significantly less at the 1% level or better. the difference in percentage of happy households is 13 with a standard error of 4.9. if we restrict the definition of a migrant household to households claiming to have a "close" family member abroad a spouse, parent, or child we volume 27, number 1 15 find again that families with "close" family migrant members are also statistically less happy than the families with no migrants (or only distant family as migrants) with a 12 percentage point difference in happiness and a standard error of 5.6. table 2 happiness and migration n % happy difference no migrants in household 115 78 13 household has one or more distant or close family members 362 65 who is a migrant ---_. no close migrants in household 396 70 12 family has one or more close family members who 81 58 is a migrant se 4.9 5.6 note: happy is defined as reporting to be very satisfied or satisfied with life. t-value 2.74 *** 2.10** while the results of table 2 suggest that migration of family members does impact the household negatively by reducing levels of happiness, such a conclusion is not necessarily warranted. households that have migrant member could be inherently less happy and that would mean that there is no causal relationship from migration to happiness. hence, we move on to more conclusively determine whether migration causes unhappiness by using the matching method described earlier. results for our "migration experiment" we first estimate a probit model to explain migration using the full sample. the pro bit model is used to obtain propensity scores in order to match controls to treated observations. the model is as follows: (2) where ~ is a dummy variable assuming the value" i" if the head of household i claims at least one parent, child, or spouse living abroad. the vector f; represents 16 journal of business strategies the set of head and household characteristics which predicts households' status with respect to migration. we include in this vector the head's age and its square (to allow for non-linear life-cycle effects), marital status of the head, his or her schooling, gender, and race/ethnicity. we restrict the probit to these right hand side variables because they are most likely to satisfy the exogeneity condition that they predict migration but that migration does not, in tum, influence these variables. for example, while race may help predict which households send migrants abroad, migration of a family member does not change the race of the family. in contrast, while household income may predict migration, we cannot include household income in the probit because it is likely to be influenced, should a family member emigrate. with this equation we estimate the probability that the household is a "migrant household," meaning that the head claims to have a family member who is currently an international migrant. at this juncture, a comment is in order regarding the definition of the dependent variable, "migrant household." we limit migrant households to household heads claiming to have a spouse, parent, or child living abroad. in essence, we are limiting our definition of migrant household to those with "close" family abroad. undoubtedly, "close" is rather arbitrarily defined. we include parents but not siblings. however, given the pervasiveness of migration in this community (75% of all households surveyed claim to have a relative abroad) and given that all respondents are at least 18 years old, we felt that restricting "close family members" to parents, children, and spouses is justifiable by way of reasoning that there is a qualitative difference between having, say, a spouse abroad versus a cousin abroad. using this narrower definition, 16 percent of households in cuenca are migrant households. some simple descriptive statistics summarizing the sample variables used for this analysis are displayed in the appendix. the average household head in this survey is 41 years of age and households on average consist of 4.3 members. sixtythree percent of household heads claim to be married (or partnered), 45 percent work full time, and 44 percent are self employed. education is coded into 7 categories with the data revealing that on average household heads in this survey have some secondary schooling. per capita income in this community averages us $1,637. most household heads are mestizo and ii percent are white. the results of estimation of equation (2), the probit equation used to obtain predicted probabilities of being a migrant household, is displayed in table 3 and indicates that older heads are less likely to claim a migrant household member. in this population, migration selects negatively on schooling. an additional step in the 7 volume 27, number 1 17 category schooling variable reduces the likelihood of having a close family member abroad by 4 percentage points at the mean. table 3 probit to predict that the respondent has a close family migrant member. (dependent variable: respondent claims that a child, parent, or spouse is living abroad) coefficient se z marginal effect constant 0.8386 0.5520 1.52 age -0.0630 *** 0.0231 -2 .62 -0.0143 age squared 0.0007 *** 0.0003 3.08 0.0002 schooling -0.1741 *** 0.0532 -3 .27 -0.0397 married -0.2024 0.1600 -1.26 -0.0476 female 0.1586 0.1615 0.98 0.0351 white 0.0351 0.2287 0.15 0.0081 indigenous or black -0 .8386 0.5341 -1 .57 -0.1219 chi 2 (prob) 38.35 (0.0000). sample size = 443 observed p (predicted p) 0.17 (0.15) notes: * signifies statistically different from 0 at the 10% level or better, ** signifies statistically different from 0 at the 5% level or better, *** signifies statistically different from 0 at the 1 level or better. n=462 the propensity score is used to rank all observations, both selected and not selected, into migration. these ranking are used to "match" observations (non-migrant observations) to serve as controls for the migrant sample. given that we have 78 "close migrant households" and 384 "non-migrant households,"9 we allow for 2 control observations per treated observation; that is we use k = 2 neighbor matching. 10 we now use the set of matched controls to make comparisons with the treated group. the matched controls are presumably an appropriate comparison group to the treated except for the fact that they are not treated. hence, we can infer causality from the treatment by simply comparing the mean values for the treated group to the mean values for the matched controls and thereby attribute differences in the two to the treatment. of particular concern in any study using non-experimental data is whether indeed the control group serves as a good comparison for the treated group. can we "after the fact" demonstrate that the control group resembles the treated group in the pre-treatment time period? how accurate is our matching? do the matched controls true1y serve as counterfactuals to the treated group? to gain some insights into the comparability of the treated groups with the matched controls we report on a series 18 journal of business strategies of descriptive statistics for the groups. these are i) the treated group migrant households; ii) the untreated group non-migrant households ; iii) the matched controls a subset of the untreated non-migrant households those with propensity scores closest to the scores of the treated group. the results in table 4 reveal that in many cases there are significant differences in mean values for the treated and the untreated group. those differences, however, get smaller and all of the significant differences disappear between the treated and matched controls. take, for example, the case of schooling. the non-treated group has almost one year more of schooling (x t x nt = -0.82) and this difference is statistically different from zero (see table 4, column 4). but this difference gets smaller (xt x mc = 0.09) and its significance disappears when we compare the treated with the matched controls (table 4, column 5). table 4 means and proportions for the treated, the not treated and the matched control groups migration treatment treated not treated matched xr xnr control xmq (xr-x nr) (xr-xmc) age 46.74 40.02 47 .02 6 .72*** -0.28 schooling 3.86 4.68 3.77 -0.82**' 0 .09 married 0.59 0 .64 0.65 -0.05 -0.06 per cap ita income 1385 1743 1699 -358 -314 fulltime 0 .30 0.48 0.36 -0.18* ** -0.06 household size 4.31 4.28 3.81 0.03 -0.50 female 0.68 0.62 0.66 0.06 0 .02 white 0.14 0.11 0.18 0.03 -0.04 indigenous or black 0.01 0 .04 0.01 -0.03 0.00 happiness 0.59 0.72 0.61 -0.12** -0.02 notes: * signifies statistically different from 0 at the 10% level or beuer, ** signifies statistically different from 0 at the 5% level or better, *** signifies statistically different from 0 at the 1 % level or better. note that while some of the variables displayed in table 4 correspond with the variables used to undertake the "matching" (see variables included in the probit equation), not all were included in the probit model. that is, some of the descriptive statistics in table 2 indicate that the two groups match well along dimensions not even directly considered in the matching algorithm. for example,fulltime (employment) is not included in the probit model used to select the matched controls. nonevolume 27, number 1 19 the less, before matching, the difference in proportion of heads working fulltime was -0.18 and is statistically different from zero at the 1 percent level or better. after matching, the difference is only -0.06 and statistically indistinguishable from zero. of particular interest to us is the test of di fferences in mean happiness levels . for respondents claiming to be in migrant households versus matched non-migrant households. that is, (3) against the alternative (4) results for this test are displayed in the final row of table 4. ifwe simply compare migrant households to all the other non-migrant households, there is a statistically significant difference in the proportion who claim to be happy. non-migrant households, on average, are happier. but if we instead compare the migrant households to matched controls, the difference disappears . families with close migrants are no less or more happy than families without close migrants. assuming that our matching procedure has successfully identified a counterfactuala set of households similar in all characteristics with the non-migrant households with the exception of claiming to have an emigrant family member the results indicate that the two samples, on average, experience the same level of happiness. it is interesting that a straight comparison of households by migration status (a statistically incorrect and naive comparison) would yield us a very different conclusion. the naive comparison suggests that migration reduces happiness while the more comparable sample suggests otherwise, that on average the level of happiness for migrant households and non-migrant households are equal. discussion our expectation was that the migration of a family member would reduce happiness . levels of the family left behind. simple descriptive statistics regarding subjective happiness levels of the heads of households that have experienced migration of a family member and of non-migrant households are consistent with that suspicion; however, such a conclusion is not necessarily warranted due to selection into migration with the implication that causality from migration to happiness cannot be 20 journal of business strategies established by simply comparing the two groups. in order to purge the data of selection biases, we use matching methods to draw a "control" group which could assign causality from migration to happiness . this exercise, however, resulted in an unexpected conclusion . there is no difference in the levels of happiness of migrant and non-migrant households. the apparent difference in happiness levels is erased once we evaluate non-migrant households who are comparable to migrant households. why may it be that we find no differences in the happiness levels of migrant families relative to non-migrant families? we think that this may be because we have not taken into consideration that there is a second factor that often accompanies migration that is not accounted for in our analysis. migrant families are often the recipients of remittances from abroad. if remittances contribute toward happiness levels then it may be that, in fact, we have not been able to clearly assess the impact of migration on happiness because the household is impacted by two activities, the outmigration offamily and the receipt ofremittances from abroad. while the outmigration of family is expected to reduce happiness levels, the inflow of remittances might be expected to increase happiness levels and in some respects compensate for the absence of loved ones. in order to test to see if indeed this may be the case, it would be necessary to determine whether remittances increase happiness levels. on a purely descriptive level we can divide households into those that receive remittances and those that do not, conditioned on whether they are a migrant household and compare happiness levels. this is done in table 5. in this matrix we see that in the aggregate happiness levels are lowest for households that claim a migrant member yet do not receive remittances only 52 percent claim to be happy. in contrast, households with migrant members but who receive remittances, display more happiness in the aggregate (59 percent are happy), suggesting that there is some tradeoff between the physical presence of a family member and the receipt of remittances. remittances may be compensating for the absence of a loved one. table 5 happiness levels by migrant household and remittance recipient receives remittances does not receive remittances percent of migrant households claiming to be happy 59 52 percent of non-migrant households claiming to be happy 56 73 volume 27, number 1 21 in an ideal world, we could separately test for the impact of remittances and migration on happiness. but in order to do so we would need considerably more information both on the household and on the migrant. given the lack of data, it is not possible to statistically establish separate effects of remittances and migration on happiness and hence, we can only speculate on their different impacts. we are limited to assessing how migrant families are, broadly speaking, affected by some combination of migration and remittances. there are, of course, other possible explanations for finding no differences in subjective well-being with respect to the migrant and matched control groups. our sample size may be too small or bias may persist. it might also be the case that some households' subjective well being is enhanced with migration while others are reduced. for example, migrant household who have experienced the emigration of children may report that they are unhappy, while those who's spouse has emigrated might report instead that they are happy. the two impacts may be cancelling out in the average statistics that we compare. conclusions in this paper we set out to study the impact of migration on the happiness of the family left behind. we exploit the results of a survey conducted in cuenca, ecuador in 2006 that collects information on the subjective well-being of the family head along with migration related variables for the family. as such, this survey allows us to explore the impacts of migration on subjective well being. as in any study of happiness, the primary challenge is to correct for endogeneity. given selectivity in terms of who migrates, unobserved heterogeneity is likely to complicate the assessment of migration on happiness. dealing with this endogeneity is essential if we are to obtain credible and reliable results. in our case, we choose to deal with the endogeneity by using matching methods. to assess the impact of migration on happiness we first estimated a propensity score for migration. these scores were then used to find matched controls for those observations that were "treated" with migration. while we attempt to solve the endogeneity problem by using matching methods, we note a second challenge to studying the impact of migration on happiness. this has to do with the fact that when communities are touched by migration, a second phenomenon occurrs simultaneously. remittances, a by-product of migration, often (but not always) flow to the family back home. now, if migration and remittances always take place together, it would not matter and measuring the ef22 journal of business strategies fect of one would provide us with ample understanding of how this phenomenon in the aggregate impacts households. however, while it is true that remittances often follow migration, it is not the case that all migrant households receive remittances. similarly, households that receive remittances are not necessarily migrant households (using our definition of a migrant household). in fact, in our sample, 17 percent of households are migrant household while 28 percent of households receive remittances. there are, evidently, many households who receive remittances from (presumably) distant relatives and friends. thus, we make a number of tentative conclusions. first, households that claim to have migrant members seem to differ from households that do not have migrant members, complicating any assessment into how migration affects happiness levels. this selection into migration seems to account for at least some of the differences in average levels of happiness observed in the migrant and non-migrant household groups. that is, the observed discrepancy in happiness levels between migrant and non-migrant households seems to be due, at least in part, to inherent differences in these two groups. second, some migrant households receive no remittances from their family abroad while others do. we tentatively suggest that happiness levels differ for migrant households according to whether they receive remittances from abroad or not. migrant households that receive remittances may report greater satisfaction than those migrant households that do not receive remittances. it may be that remittances, to some degree, "compensate" migrant households who are less happy explaining why we observe no differences in happiness levels across the two groups of households. what is the mechanism by which remittances raise happiness levels? is it because the monetary transfers truly compensate for the absence of the loved one? or are the remittances a re-affirmation of the loyalties of a now absent household member? our analysis cannot answer these questions. but we note that the close link between migration and remittances and the disentangling of the two is an important issue for migration scholars to tackle in order for us to obtain a more accurate assessment of the effects of international migration on households around the globe. notes i. corresponding author 2. according to the united nation's population database, world population in 2005 stood at 6.5 billion (united nations,world population prospects: the 2008 revisions). in the same year, the united nations estimated that there were 195 million migrants (united nations, trends in international migrant stock: the 2008 revision). volume 27, number 1 23 3. see undp (1999) for more on this point. it should also be noted that over the longer run it is conceivable that technological innovations reduce migration. technology may facilitate that work take place across international borders without the need for workers to move abroad to take advantage of work opportunities. 4. almost all households in san fernando are migrant households. as will become evident in the methodology section of this paper, it is not possible to employ the methodology we use for households residing in san fernando since there are too few non-migrant households to draw from to obtain our counterfactual comparison group. 5. in this paper we will refer to those responding that they are satisfied with live as "happy" and those not satisfied with life as "unhappy". note that using the terminology happy or unhappy as synonymous with being satisfied or not with life is not strictly appropriate. as a referee pointed out, "just the fact that somebody is 'satisfied with life' doesn't translate into a happy person. the person may be, for instance, resigned to live a life of misery." we use the term "happy" as a convenience and ask the reader to note this convention in this paper. 6. the exact wording for this question in the original is: ;,en terminos generales, usted diria que estti muy satis/echo con su vida, bastante satis/echo con su vida, no muy salis/echo 0 para nada salis/echo? 7. the received wisdom is that there is considerable selectivity with respect to a host of migrant characteristics (see chiquiar and hanson (2005) and feliciano (2005) for examples). this selectivity is likely to spillover into the characteristics embodied by the households from which the migrants originate. 8. while migration experiments tend to be rare, there are several important exceptions. for a few examples see stillman, · mckenzie, and gibson (2009) and aycinema, martinez, and yang (2009). 9. recall, non-migrant households may have migrants, but they are not "close" fam ily members. a cousin, for example, is not defined to be a close family member in this paper. 10. our results remain mostly intact when we allow for only 1 matched observation per treated observation. 24 journal of business strategies references aycinema, d., martinez, c. a., & yang, d. (2009). the impact 0/ remittances fees on remittance flows : evidence/rom afield experiment among salvadorian migrants (unpublished manuscript). university of michigan. blanchflower, d., & oswald, a. j. (2000). well-being over time in britain and the usa . nber working paper # 7487 . borj as, g. (2002). homeownership in the immigrant population. journal 0/ urban economics, 52(3), 448-76. card, d. (2005). is the new immigration really so bad? economic journal, 115(507), f300-f323. cardenas, m., di maro, v., & sorkin, i. (2009). migration and life satisfaction: evidence from latin america . journal o/business strategies , 26(1), 9-34. chiquiar, d., & hanson, g. h. (2005). international migration, self-selection, and the distribution of wages: evidence from mexico and the united states . journal o/political economy, 113(2), 239-281 . chiswick, b. (2002). speaking, reading, and earnings among low-skilled immigrants. in k. f. zimmermann & t. bauer (eds.), the economics o/migration. volume 2. assimilation 0/ migrants (pp. 429-50). cheltenham, uk and northampton, ma: elgar. clark, a. e., & oswald, a. j. (1994). unhappiness and unemployment. economic journal, 104(424),648-59. davidson, r. j. (2000). affective style, psychopathology, and resilience: brain mechanisms and plasticity. american psychologist, 55(11), 1196-12 i 4. ditella, r., & macculloch, r. (2005). partisan social happiness. review 0/ economics studies, 72(2),367-393 . easterlin, r. (1974). does economic growth improve the human lot? some empirical evidence. in p. a. david & m. w. reder (eds.), nations and households in economic growth: essays in honor 0/ moses abromowitz (pp. 89i 25). new york: academic press. easterlin, r. (200 i). income and happiness: toward a unified theory. economic journal, 111(473),465-84. feliciano, c. (2005). educational selectivity in u.s. immigration: how do immigrants compare to those left behind? demography, 42(1), 131-152. frank, r. (1985). choosing the right pond. new york: oxford university press. gatton, b. (2005). ecuador en la historia de la migraci6n internacional imodelo 0 aberraci6n? in g. herrera, m. c. carrillo, & a. torres, (eds.), la migraci6n ecuatoriana: transnacionalismo, redes e identidades. quito, ecuador: flasco. volume 27, number 1 25 graham, c., & pettinato, s. (2001). happiness, markets and democracy: latin america in comparative perspective. journal of happiness studies, 2(3),237-268. hartlog, 1., & oosterbeek, h. (1997). health, wealth, and happiness: why pursue a higher education? working paper. department of economics, university of amsterdam. international organization for migration. (2005) . costs and benefits of international migration. world migration report 2005 (p. 379). geneva: international organization for migration. layard, r. (2005). "happiness and public policy. discussion paper n° 14, lse. leuven, e., & sianesi, b. (2003). psmatch2: stata module to perform full mahalanobis and propensity score matching, common support graphing, and covariate imbalance testing. retrieved from http://ideas .repec.org/c/boc/bocode/ s43200i.htm!. massey, d. (2006, april 4,). the wall that keeps illegal workers in. new york times, p.23 . miles, d., & rossi, m. (2005). learning about ones' relative position and subjective well-being. applied economics, 39(13), 1711-18. pavot, w., diener, e., colvin, c., & sandvik, e. (1991). further validation of the satisfaction with life scale: evidence for the cross-method convergence of wellbeing measures. journal of personality assessment, 57( i), 149-161. rayo, l., & becker, g. (2007). habits, peers, and happiness: an evolutionary perspective. american economic review, 97(2),487-491. rosenbaum, p., &d rubin, d. (1983). the central role of the propensity score in observational studies for causal effects. biometrika, 70(1),41-55. stillman, sn, mckenzie, d., d gibson, j. (2009). migration and mental health: evidence from a natural experiment. journal of health economics, 2(3), 677-87. soruco, x., piani, g., d rossi, m, (2006). what emigration leaves behind. the situation of emigrants 'families in ecuado. fundaci6n sur, ecuador, and decon, uruguay. mimeo. smith, j. (2003). assimilation across the latino generations. american economic review, 93(2), 315-319. undp, (1999), united nations development programme, human development report. united nations, department of economic and social affairs, population division. (2009). trends in international migrant stock: the 2008 revision. (united nations database, pop/dbimig/stocklrev.200). 26 journal of business strategies united nations , department of economic and social affairs, population division . (2009) . world population prospects: the 2008 revisions. retrieved from (united nations database, http://esa.un.orglunpp/index.asp?panel=l) appendix descriptive statistics for variables discussed and used in the analysis cuenca,ecuado~2006 standard variable mean deviation minimum maximum ---happiness 0.68 0.47 0 1 age 41.12 16.65 18 86 schooling 4.46 1.57 1 7 fulitime 0.45 0.49 0 1 self employed 0.44 0.49 0 1 married (or partnered) 0 .63 0.48 0 1 household size 4.29 2.06 1 15 per capita income 1637 1823 0 13200 "mig rant " household 0.76 0.43 0 1 "close migrant" household 0 .17 0.37 0 1 black household 0 .00 0 .07 0 1 indigenous household 0 .03 0.18 0 1 mestizo hou sehold 0.85 0 .36 0 1 white household 0.11 0.31 0 1 receives remittances 0.28 0.45 0 1 notes: 478 households , from discrimination and economic outcomes survey, latin ameri can a nd ca ribbean research network, inter-america n development bank . bigraphical sketch of authors fernando borraz holds the title of senior researcher at the banco central del uruguay and universidad de la republica, uruguay. his research is in applied microeconometrics. he has published in cuadernos de economia, well-being and social policy, global economy journal, and journal of economic development. in 2004, he received the national prize in economics (first prize) awarded by the universidad de la republica. he earned his ph. d. in economics from georgetown university, usa. susan pozo is a professor of economics at western michigan university, kalamazoo (mi). she has published numerous articles on migration, remittances, volume 27, number 1 27 and international finance in reputed journals including american economic review, applied economics, applied financial economics, harvard international review, international migration review, international review of economics and finance, journal of development studies, journal of international money and finance, journal of macroeconomics, journal of population economics, review of development economics, review of economics and statistics, review of international economics, southern economic journal, world development, and world economy. she earned her ph.d. in economics from michigan state university, east lansing (m!). maximo rossi is a professor of microeconomics at the universidad de la republica, uruguay. he has published articles in applied economics, international journal of public opinion research, journal of applied economics, journal of money, credit and banking, and trimestre economico among others. he holds a ph.d. in economics from the universidad de granada, spain. 28 journal of business strategies and what about the family back home? international migration and happiness in cuenca, ecuador the impact of horizontal strategic alliances on the u.s. steel industry lucy ojode texas southern university houston, tx abstract despite the popularity ofstrategic alliances amongfirms, the public is ambivalent about the industry impact of horizontal alliances. it is not apparent that the benefits ofalliances to the firm also accrue to the industry. this paper examined the u. s. steel industry data from 1977 to 1997 to determine the potential impacts of capability horizontal alliances on industry competitive structure. the results are indicative ofpositive impacts on industry competitiveness (profitability and productivity) and competitive structure (price competition and declining industry concentration). a capability hypothesis is offered that posit that horizontal alliances that enhance partnerfirms 'capabilities may diffuse critical capabilities or 'best practices' within an industry thereby raising the average level ofcompetitiveness in the industry and inducing competitive pressures that can result in price competition and erode industry concentration. strategic alliances are the "relatively enduring inter-firm cooperative arrangements that involve flows and linkages that utilize resources and/or governance structures from autonomous organizations, for the joint accomplishment of individual goals linked to the corporate mission of each sponsoring firm" (parkhe, 1991: 581). investors generally view alliance announcements favorably (das, sen, and sengupta, 1998) since alliances enable firms to share resources, manage risk, and create value (chan et ai., 1997). however, consumers are wary of horizontal alliances or cooperative arrangements between competing firms that could result in anti-competitive maneuvers as partner firms seek to manage industry-induced uncertainties (burgers, hill, and kim, 1993). yet, horizontal alliances also provide proximity to competitor capabilities and expose these capabilities as 'templates' that partners could use in 'learning-by-doing' in developing new capabilities while leveraging current stock of capabilities (hamel, 1991). therefore, horizontal alliances that enhance capabilities such as process technologies (mueller and herstatt, 2000) could diffuse best practices or innovation and induce competitive rivalry within an industry. while economic literature is elaborate on the anti-competitive consequences of horizontal alliances, competitive consequences have been confined to scale economies (e.g., williamson, 1968). the potential to diffuse capabilities and induce industry competition is relatively unexplored, a lack this paper addresses by examining 150 journal ofbusiness strategies vol. 21, no.2 the potential impact of horizontal alliances on industry competitive (pricing and concentration) structure. horizontal alliances and organizational capabilities capabilities are routines or repeated complex organizational patterns ofresource and activity coordination that enables efficient functioning (nelson and winters, 1982). capabilities are embedded in organizational factors such as physical characteristics ofproduction capacity that symbolize the potential economies of scale and scope determined by throughput. "such economies depend on knowledge, skill, experience, and teamwork-on the organized human capabilities essential to exploit the potential of technological processes" (chandler, 1990:24). firms focus on capabilities embedded in intangible or information resources such as, technology, consumer trust, brand image, control of distribution, corporate culture and management skills that have a significant potential for sustaining competitive advantage (barney, 1991). however, such intangible resource based or' strategic' capabilities are costly to assemble and maintain (chi, 1994; teece and pisano, 1994). firms generally lack ancillary capabilities necessary for all activities in the production chain mandating outsourcing of some capabilities. although such capability outsourcing can be consummated in arms-length market transactions, collaborative modes or hybrid organizational forms such as horizontal strategic alliances often economize on transaction costs (chi, 1994; dyer, 1997). alliances entail interdependence that reduces the risk of opportunism and repeated access to a partner's array of capabilities enhances transferability of tacit knowledge and complex non-codified routines and information-based capabilities (kotabe and swan, 1995). horizontal alliances thus provide access to desired capabilities and reduce partner costs for assembling new or enhancing existing capabilities while providing opportunities for firms to influence competitive environment (kogut, 1988). as partners absorb competitor routines, critical industry capabilities (e.g., best practices) may diffuse across partners within an industry. consequently, extensive horizontal alliancing that result in enhanced individual partner capabilities such as improved cost structures and average competitiveness can diffuse critical capabilities and induce industry rivalry. this pro-competition capability horizontal alliance conjecture is contrary to the 'winner-take-all' zero-sum game competitive disposition of rent seeking firms, but is consistent with rent-seeker's quest for synched competitive and cooperative advantages (lado, boyd, and hanlon, 1997). literature review and hypotheses development resource-based and competitive models a growing resource-based and capabilities literature (e.g., mahoney and pandian, 1992; penrose, 1959; teece, pisano, and shuen, 1990; wernerfelt, 1984) focuses on firm resources to explain sustainable competitive advantage (barney, fall 2004 ojode: horizontal strategic alliances 151 1991). however, the resource-based perspective is silent on competitive dynamics (schoemaker, 1993). competitive models on the other hand, 'match'firm resources to environmental (industry) opportunities or conjure up defensive reactions to environmental threats. such models match independent internal (firm resources and capabilities) and external (industry) analyses as if managers perform these tasks independently. yet, in practice decision makers often adopt strategies that address firm resources and competitive positioning simultaneously. such strategies include horizontal alliances that can enable partners to internalize competitor capabilities to provide quality products efficiently and lor reduce risks hence cost of capital while monitoring competitor moves simultaneously. horizontal alliances as competitive tools understanding capability-based horizontal alliances as a competitive tool resides in the assumption that firm capabilities determine competitiveness. that is, the creation and maintenance ofan economic rent stream depend upon inimitable, idiosyncratic, rare and non-substitutable resources or capabilities (barney, 1991). competitiveness then entails maintaining superior capabilities that are costly to imitate and less substitutable, but such capabilities are costly to develop and maintain, hence the resort to horizontal alliances to hasten capabilities development or through which to borrow in cases of capability gaps (leonard-barton, 1995). however, horizontal alliances expose capabilities that underlie a firm's competitiveness to learning race competitors and even when an alliance enhances capabilities for all partners, some partners may still consider the relationship disadvantaging due to high inter-partner competition (hamel, 1991). consequently, alliance value may also depend on gains that firms perceive as accruing from the relationship vis-a-vis their partner's gain and the level of trust in the partners (hamel, 1991; jennings et a1., 2000). thus, capability-based horizontal aliiances must enhance partner capabilities and add value beyond perceived partner costs to sustain mutual support (mariotti, 1996). despite such delicate within-alliance negotiations, horizontal alliances can precipitate efficient resource utilization as firms outsource non-core resources from partners while focusing on core capabilities. for instance, partners can share production facilities to increase utilization and create efficiencies that promote industry productivity. aliiances also enable firms to share cost of developing technical knowledge that can increase the level of resources dedicated to knowledge acquisition, thereby enhancing chances of successful innovation (goes and park, 1997; kotabe and swan, 1995). for example, firms that are endowed with capital but that lack technological prowess may partner with less resourced but technologicaliy agile competitors to overcome mobility barriers into certain industry segments. for instance, the u.s. steel-nucor direct reduced iron (dri) project provided opportunity for the capital-endowed but technologically inept integrated steel producer to spearhead the development of the dri technology in conjunction with the relatively capital poor but technologically agile minimil\. the joint effort boosted u.s. steel's modernization efforts and nucor's integrated steel produc152 journal ofbusiness strategies vol. 21, no.2 tion capabilities. similarly, alliances can promote industry competitiveness by spreading best practices and triggering competitive benchmarking as partner firms learn, absorb, and leverage more successful routines and procedures resulting in innovative products, improved revenue generation and/or efficiency. for instance, the nucoryamato kogyo alliance enabled nucor to increase labor productivity to one person-hour a ton in 1991, about three times the integrated producers average productivity (iron age, may 1991). two years later, birmingham steel benchmarked nucor's feat and raised its labor productivity to 1.4 person-hours a ton (iron age, aug. 1993). the ensuing minimill rivalry triggered revolutionary cost cutting and quality enhancement programs among the integrated producers thereby raising industry productivity. uncertainty management horizontal alliances firms may adopt horizontal alliances to manage uncertain environments. research advances that alliances hold potential as flexibility mechanisms for investing in the option to expand in risky markets (kogut, 1991) and as a risk buffer (burgers, hill and kim, 1993). as flexibility mechanisms, alliances enable partner firms to expand or to divest at minimal cost (hurry, 1993) and as a risk buffer, alliances spread risk between partners and reduce partners' cost of capital or discounting rate. therefore, lower cost results whether partner firms adopt alliances for strategic flexibility or risk buffer. horizontal alliances and foreign competition horizontal alliances tend to increase industry capacity by lowering mobility and entry barriers. for instance, otherwise marginal firms that possess limited critical capabilities may capitalize on these capabilities by partnering with competitors that have enabling complementary resources such as financial capital. foreign competitors in particular may partner with domestic firms in order to evade tariffs and lower entry costs (hurry, 1993). while such resource pooling alliances may enhance partners' competitiveness (mueller and herstatt, 2000), they may also raise industry capacity and induce rivalry that could impact industry profitability negatively. in summary, the discussion on horizontal alliances indicates that the strategy enables partners to absorb and leverage routines and procedures that result in improved revenue generation and/or efficiency. alliances also increase resources dedicated to innovation pursuit and enable efficient risk management. however, potential increase in industry capacity may moderate these productivity and efficiency gains at the industry level. hypothesis 1: horizontal alliance intensity will be positively related to industry performance. horizontal alliances: capability diffusing or market power driven'? despite the recognition that a balance between conflict and cooperation is an ;nt~~ral part of competitive dynamics (schelling, 1980), competitive models fall 2004 ojode: horizontal strategic alliances 153 tended to preclude co-operation (e.g., porter 1980). as a result, horizontal alliances were regarded as compromising industry competition (stuckey, 1983), hence, the market-power hypothesis that viewed the strategy as manipulative anti-competitive maneuvers that benefited producers at consumer expense. such maneuvers are attended by industry consolidation and a general appreciation in prices for commodity or homogenous product markets (bhaskar, manning, and to, 2002). thus, market power driven horizontal alliances could be linked to a general appreciation in product prices and increasing market concentration (stuckey, 1983). however, if horizontal alliances provide efficiencies, make partner firms more competitive, and diffuse desirable capabilities within an industry, then the behavior could raise the average level of competitiveness that could induce rivalry in the industry. as partner firms' preferences for successful routines and procedures coalesce to diffuse 'best practices,' the efficiency gains and diffused capabilities can increase mobility and rivalry that can induce competitive pressures conducive to price competition (goolsbee and chevalier, 2002). the likelihood of price competition increases for capital-intensive excess capacity mature industries (grant, 1991). therefore, capability driven horizontal alliances are likely to be associated with a general decline in product prices. hypothesis 2: horizontal alliance intensity is inversely related to product pricing within an industry. lfmarket power driven, then horizontal alliance partners would increase market share at the expense of non-alliance competitors (berg and friedman, 1981). however, if capability and efficiency driven, then horizontal alliances will enhance partner firms' capabilities and improve market position in the long run (since capability development takes time) but not in the short run (berg and friedman, 1981). also, widespread capability horizontal alliances that enhance individual partners' competitiveness can diffuse capabilities (best practices) among industry incumbents and boost capabilities for effective presence in industry segments thereby enhancing mobility and diluting market concentration. similarly, horizontal alliances can lower mobility and entry barriers to otherwise marginal and even foreign firms thereby preventing market domination. lower entry barriers could potentially increase capacity and dilute dominant incumbents' market shares thereby dampening industry concentration. industry capacity could also arise from new establishments. for instance, competing alliance partners that establishjoint ventures usually establish new facilities (hamel, 1991). therefore, widespread horizontal alliances can diffuse capabilities thereby induce mobility, rivalry, market entry and increase capacity that can dilute industry concentration. hypothesis 3: horizontal alliance intensity is inversely related to industry concentration. 154 journal ofbusiness strategies methods vol. 21, no.2 data the industry impact ofhorizontal alliances was estimated through least-squares multiple regression models ofthe u. s. steel industry's longitudinal data from 1977 to 1997. this period is ideal for an investigation of the steel industry since it traverses monumental changes from the 1970's decade ofcrises, the 1980's decade of catastrophe, and the 1990's renaissance (stubbles, 1995). the 1997 demarcation is appropriate since a major source of industry data, the u.s. census bureau, changed data classification systems from the standard industrial classification (sic) to the northamerican industry classification (naic) in 1997. these changes make pre and post-1997 industry data incomparable. two sets of models were developed to evaluate the impact of horizontal alliances. the first set represents the impact of horizontal alliances on industry economic performance or profitability and efficiency whi ie the second represents the impact on industry structure or industry concentration and product pricing within various segments ofthe u.s. steel industry. capability horizontal alliances measuring capability horizontal alliances posed a challenge because of the difficulty of estimating organizationally embedded and complex intangible resources such as capabilities (godfrey and hill, 1995). therefore, we used horizontal equity j oint ventures to estimate capability alliances (e.g., berg and friedman, 1977). horizontal joint ventures provide access to competitor capabilities and may signify partners' motives to leverage and/or develop idiosyncratic resources (chi, 1994; hamel, 1991). in particular, the level of a partner's equity involvement in a joint venture may signify desire for control that may symbolize the strategic significance of the underlying resources (oj ode, 2000). partner firms could target competitors' critical capabilities to enhance their own. thus to counter such 'learning race' motives or to reduce their impacts, joint venture partners maintain concurrent in-house capability development efforts (hamel, 1991). consequently, firms that invest in capability horizontal alliances also tend to support in-house developed capabilities. berg and friedman (1977) used this linkage between in-house development efforts and joint venture activities to substitute joint venture intensity for r&d expenditures, arguing that: "joint ventures represent a potential source of supply for the required technical inputs which reduces the time-lag and risks from the levels associated with exclusively in-house r&d activities ... [thus] joint ventures can be viewed as substitutes for expenditures on in-house r&d and pilot production facilities ... so that highly innovative industries would be seen to engage in both more internal r&d and more joint ventures, although these two remain substitutes." the u.s. steel industry's equity joint venture data was collected from various issues of the american metal market publication, metal bulletin, steel alert, new york times, wall street journal, u.s. irc steel industry reports, the business wire, and iron age publications. to avoid counting non-operative alliances, fall 2004 djode: horizontal strategic alliances 155 only joint ventures that were corroborated through company records to have been operating for more than a year were included in the study. figure i below provides an overview that indicates increasing incidence of horizontal equity joint ventures in the u.s. steel industry during the 1977-1997 period. other industry data came from census of manufacturers surveys. previous industry studies such as, acs (1984), barnett and crandall (1986), berg and friedman (1978), and hogan (1994) also provided a rich source of qualitative data on the u. s. steel industry's structural characteristics from 1960s to 1990s. figure 1 1979 1983 1985 1987 1989 1991 1993 1995 1997 .---.-../,... / / / . / . //1/...../ ..../ ~ .,' .......-.-.,.-'~_-..-....-.:...7:=...::,:,.. :<=, ...... .~ .... steel jvs minimill jvs integrated mill jvs 90 80 70 (/) ~ 60 ::j...... c 50 ~ c 40 '0...., 30 20 10 1977 years industry performance the four-digit sic classification 3312 was adopted to define the u. s. iron and steel industry. this classification covers steel works and blast furnaces, including coke ovens and rolling mills. it is representative of the iron and steel industry since firms in this category produce more than 90% of three-digit sic classifications 331 and 332 products. industry economic performance and status data were obtained from standard & poor's industry surveys. these surveys provide periodical industry reports including income statement and balance sheet as well as industry financial ratios from information gathered through trade associations such as the american iron & steel institute (aisi). industry structure the impact of horizontal alliances on the competitive structure of the u.s. steel industry was estimated through steel product prices and industry concentration trends from 1977-1997. price data were drawn from the 3-digit sic classifications 331 and 332 composed of the 4-digit sic 3312 (defined above), 3313-electro-metallurgical products, 3315-steel wire and related products, 3316-cold finishing and steel shapes, 3317-steel pipe and tubes, 3321-gray 156 journal of business strategies vol. 21, no.2 iron foundries, 3322-malleable iron foundries, and 3325-steel foundries. out of these classifications nine most common steel products (beams or structural steel, steel plates, hot-rolled sheet, cold-rolled sheet, galvanized, stainless, coldfinished, reinforcing bar, and wire rod) were identified. these nine products had mill-based prices listed in various issues of the iron age and the purchasing publications from 1977-1997. list prices are more appropriate than transaction prices because they only incorporate the underlying industry factors to offer a better estimate of price behavior in the u.s. steel market (acs, 1984). industry concentration data were drawn from census of manufacturers statistical abstract estimates and from standard & poor's industry surveys. analysis performance it was argued in the first hypothesis that horizontal alliances could result in enhanced competitiveness of partner firms from acquired capabilities and from efficiencies due to costs, information, and risk sharing. if alliances enhance capabilities, provide efficiencies (through shared resources and increased capacity utilization), and increase partner firms' competitiveness, then pervasive horizontal alliancing could have a positive impact on the economic performance of an industry. however, if horizontal alliances increase industry capacity rather than capacity utilization (efficiency) then the positive impact on performance may be lower. therefore, the alliance-performance relationship is modeled as follows: industry performance t = a + [13iindustry performance + 13)oint venture intensity + 13,new capital expenditure/sales + 13}ndustry acquisitionst, + e where subsequent industry performance is a function of current performance and capability horizontal alliances within an industry. however, since capabilities may also be developed through in-house r&d or new capital expenditures or through mergers and acquisitions, we control for these alternative resource mobilization strategies. economic performance in the model is represented by profitability--measured as return on assets (roa) and productivity --measured as manufacturing value added per production worker hour (mva/pwh). return on sales (ros), return on equity (roe) and operating margin performance measures were used for model robustness. table i following provides summary statistics indicating that profitability averaged -0.58% (roa), -0.21 %(ros), and -2.46%(roe) while manufacturing value added averaged $45.83 per production worker hour, and operating margin averaged 9.83% in the industry during the 1977-1997 period. the industry averaged 0.94 joint ventures per firm a year (alliance intensity), 3.60% of sales invested in new capital equipment, 7.43 horizontal acquisitions, 100 million fall 2004 gjode: horizontal strategic alliances 157 table 1 summary statistics and correlation matrix for performance model dependent variable: steel industry profitability and productivity (n=20) the first number represents the estimated correlation and the second number represents the p-value under the hypothesis of zero correlation. mean s.d. 6 7 8 9 10 ii 12 13 i. industry return on assets -o.5g% 6.69% 0.162 0.208 -0.032 0.108 0.275 0.259 0.184 -0. iii (roa) 0.503 0.390 o.ng 0.653 0.25g 0.285 0.447 0.646 2. industry return on sales -0.21% 5.62°/'] 0.162 0.222 -0.033 0.lg8 0.269 oj51 0.162 -0.016 (ros) 0.503 0.358 0.889 0.435 0.267 0.147 0.503 0.944 3. industry return on equity -2.46% 47.79% 0.143 0.168 -0.059 0.195 0.178 0.289 0.110 0.026 (roe) 0,555 0.490 0.810 0.424 0.465 0.234 0.653 0.912 4. dollar amount of $45.83 $1.38 ·0.022 0.059 0.014 0.962 -0.358 0.856 -0.742 0.289 mfg. value added 0.928 0,1;10 0.952 0.000 0.139 0000 0.003 0.234 per production worker hr. (mva!pwh) 5. operating margin 9.83% 3.54% 0,326 0,368 0.213 0.105 0.452 0,309 0.168 -0.099 (revenues production 0.180 0.129 0,379 0.667 0.063 0.204 0.490 0.682 costs as a pctg. of revenues) 6. lagged industry return on -0.58% 6.68% 1.000 0.979 0.880 0.067 0.582 0.219 0.070 0.255 assets (roa,) 0.000 0.000 0.000 (l.779 0.016 o.36r 0.772 0.294 7. lagged industry return on -0.23% 5.61% l.ooo 0.872 0.140 0.585 0.320 0,(j67 0,328 sales (ros,) o.oo(l 0.000 oj62 0.016 0.187 0.779 0.177 x. lagged industry return on -4.98% 45.75% ].000 0.188 0.329 0.]99 0.016 0.206 equity (roe,) 0.000 0.435 0.174 0.412 0.944 0,395 9. lagged manufacturing $43.05 $1.43 1.000 -0.280 0.856 -0.779 0,352 value-added (mva/pwh,.i) 0.000 0.250 0000 0.001 0.147 10.lagged operating margin 9.67% 3.13% 1.000 -0.105 0.404 0.064 (opmgn,) 0.000 0.667 0.095 0.795 ii.joint venture intensity-.ivi 0.94 0.17 1.000 -0.561 0.47r (lagged numher ofjoint d.ooo 0.021 0.049 ventures per firm indu~try) 12.new capital expenditure! 3.60% 0.97% 1.000 -0.120 industry shipment (lagged) 0.000 0.624 13.acquisitions (lagged nalural 7.43 2.23 1.000 log of numher of horizontal 0.000 acquisitions and mergers) 158 journal ofbusiness strategies vol. 21, no.2 tons in domestic shipment and capacity utilization (76.71 %) per year between 1977 and 1997. table 1 also indicates high positive correlation between alliance intensity and productivity (mva/pwh) and acquisitions although industry profitability and alliance intensity are uncorrelated while alliance intensity and capital expenditure are negatively correlated. despite potential for multicollinearity in the model, no remedy was necessary since potential impact on the theoretically important alliance variable did not reduce t-statistics for its coefficient below the critical level of 2 that requires correction (kennedy, 1992). impact on industry competitive structure: price model it is argued in hypothesis 2 that capability horizontal alliances that enhance individual partner capabilities could diffuse critical capabilities (best practices) within an industry thereby inducing rivalry and potential for price competition or a general declining trend in product prices. the following is a model that estimates price of steel as a fwlction of industry joint venture intensity (jvi) controlling for input costs, capacity utilization, and demand as follows: lnprice it ~o + ~1[jvit_l] + ~2lncostil + ~,cutilt + f3 4 lndmnd t+ ~5lnimptt + f.l.llnsubs + £ p" .t i where price it is the average annual list price (adjusted for inflation) of steel product i at time t. industry alliance intensity, jvl t is the average number of horizontal joint ventures per firm in the industry at time t. reflective of variation in industry competitive structure, the trend of steel prices is inversely related to alliance intensity in the industry. costs (direct production labor and raw material requirements) constitute the largest components of a manufacturing product and form the base price criterion (acs, 1984). the variable cost of producing product i at time t, lncost it is therefore expected to relate positively to the trend of product pricing. this variable is measured as the sum of natural logarithm of the list price of scrap and the average cost of electricity whenever i is a minimill product, but the sum of natural logarithm of real price of iron are and the average cost of fuel whenever i is an integrated mill product. the minimill and integrated costs are averaged whenever i is a specialty product. industry capacity utilization represents potential supply since the price mark-up over costs is a function of the pressure of demand on capacity. a higher capacity utilization reduces production costs and could boost supply and induce price reduction. the lndmnd j (natural logarithm ofthe value ofsteel shipments plus net imports at time t) represents demand that is endogenous in the model above since price is a function of both demand and supply. supply on the other hand is a function of imports, costs, and other industry factors as described above. following is a simultaneous equation that reflects this endogeneity: q" = f(price, imports, substitute price) q = f(price. industry joint venture intensity. capacity utilization, costs) s fall 2004 gjode: horizontal strategic alliances 159 the identified simultaneous equation is solved through a two-stage least-squares technique, a special case of instrumental technique that uses the best instrumental variables (kennedy, 1992). thus, in the equations above, demand is instrumented with imports, substitute price, and price. the estimated demand is then used with other exogenous variables to estimate price. a good instrumental variable is highly correlated with the regressor for which it is acting as an instrument (kennedy, 1992). therefore, demand is considered a good instrumental variable in the model above since it is highly correlated with the price and import variables. lnlmpt t (natural logarithm of the value of steel imports at time t) represents imports and lnsubs[ (natural logarithm of the list price of the corresponding aluminum product at time t) represents price of substitute products. table 2 following provides summary statistics for the model. table 2 shows average real producer price (1987 dollar) per short ton ranging from $335.54 for reinforcing steel bar (rebar) to $1,736.20 for stainless steel during 1977-1997 period. the table also shows that prices of integrated mill products (numbers 1-5 & 7) were less volatile than those of the minimill products (reinforcing bars or rebar and wire rods) while stainless steel (a steel processor's product) price volatility was higher than for all integrated products save for hot-rolled sheet, but lower than minimill products price volatility. of integrated products, cold-rolled sheet and cold-finished steel (numbers 4 & 7) prices were least volatile. these products represented the least contested steel market segment during the 1990s (iron age, august 1993). table 2 also indicates positive correlation between alliance intensity and capacity utilization, alliance intensity and production costs, production costs and substitute prices, capacity utilization and demand, and between imports and demand. however, the import and substitute variables are incorporated in the models indirectly to instrument the demand variable. therefore, potential multicollinearity resulting from the correlation between demand and capacity variables are reduced since the actual demand used in model estimation is instrumented. potential 'leftover' multicollinearity resulting from correlation between the other independent variables is addressed by estimating a set of three models (a full model and two reduced models) for each of the nine products and by the 2sls technique's robustness and tolerance to high correlation (kennedy, 1992). industry concentration concentration trends provide indications about the competitive structure of an industry (scherer, 1980). for instance, high concentration characterizes mature or traditional industrial markets where competition entails price and market share battles (grant, 1991). hypothesis 3 argues that capability horizontal alliances can induce industry mobility, rivalry, and market entry that can increase capacity thereby dilute industry concentration. thus, we can model industry concentration as a function of horizontal alliances, capacity, and production costs: concentration[ = f(horizontal alliance intensity, capacity, costs). 160 journal of business strategies vol. 21, no, 2 table 2 statistics and correlation matrix for steel prices model (n=20) the first number represents estimated correlation, the second p-value under the hypothesis of zero correlation. mean' s.d, 10 ii 12 13 14 15 16 17 i. beams or structural steel $381.86 $101.25 -0.493 -0.822 0.019 0.103 0.280 -0.366 -0.871 0.438 0.042 0.001 0.936 0.674 0.250 0.131 0.000 0.070 2. steel plates $394.10 $98.76 -0.398 -0.743 0.100 0.079 0.305 -0.159 -0.687 0.332 0.101 0.000 0.682 0.741 0.208 0.509 0.005 0.171 3 3. hot rolled sheet $344.44 $98.77 -0.542 -0.7r3 0.031 -0.076 0.258 -0.150 -0.688 0.273 0.026 0.001 0.897 0.757 0.289 0.535 0.005 0.258 4. cold rolled sheet $443.45 $105.84 -0.278 -0.687 0.295 0.150 0.506 -0.088 -0.716 0.472 0.250 0.005 0.222 0.535 0.037 0.719 0.003 0.051 5. galvanized $522.58 $135.83 -0.325 -0.632 0.299 0.055 0.522 -0.070 -0.702 0.457 0.180 0.009 0.219 0.818 0.032 0.772 0.004 0.060 6. stainless $1736.20 $483.07 0.299 -0.261 0.643 0.625 0.768 -0.082 -0.60 i 0.774 0.219 0.280 0.008 0.010 0.001 0.734 0.013 0.001 7. cold finished $423.44 $97,98 0.000 -0.581 0.306 0.447 0.516 -0.154 -0.713 0.550 1.000 0,016 0.208 0.066 0.033 0.529 0.003 0.023 8. reinforcing bar $335.54 $123.09 -0.63 i -0.895 -0.198 -0.290 0.083 -0.124 -0.675 0.000 0.009 0.000 0.412 0.230 0.734 0.610 0.005 1.000 9. wire rod $340.78 $107.51 -0.535 -0.819 -0.017 -0.278 0.215 -0.034 -0.609 -0.002 0.027 0,001 0.944 0.250 0.373 0.889 0.012 0.992 io.joint venture intensity 0.94 0.17 1.000 0.632 0.693 0.499 0.535 0.403 0.358 0.249 (number of jvs per firm) 0.000 0.009 0.005 0.039 0.027 0.097 0.139 0.303 ii.capacity (% rate) 76.71 12.10 1.000 0.329 0.245 0.062 0,380 0.676 -0.004 0.000 0.174 0.312 0.795 0.116 0.005 0.984 12.total cost (direct lahar $248.30 $58.41 1.000 0.505 0.920 0.356 0.032 0.597 and material costs per ton) 0.000 0.038 0.000 0.142 0.897 0.014 13.1ntegrated cost (direct $343,78 $83.63 1.000 0.533 -0.295 -0.244 0.777 labor and material costs 0.000 0.d28 0.222 0.312 0.001 per ton) 14.non-integrated cost $152.82 $33.18 1.000 0.257 -0.243 0.630 (direct labor and 0.000 0.289 0.317 0.009 material costs per ton) 15,imports (natural log of 21.12m 1.25m 1.000 0.611 -0.227 imports in million tons) 0.000 0.012 0.347 16.demand (natural log of 100.48m 11.78m 1.000 -0.432 shipment in million tons) 0.000 0.075 17.substitute price (mean $1654.00 $641.00 1.000 $ price of competing 0.000 aluminum material) 'price amounts are per short ton real prices in 1987 dollar. fall 2004 ojode: horizontal strategic alliances 161 where concentration ratio eight (crg)-combined market share of the leading eight steel producers was used to estimate the model and cr 4 combined market share of the leading four steel producers, was used for robustness check. the alliance variable is defined as the average annual horizontal joint ventures per firm and capacity was estimated by the natural logarithm of the average annual rate of capacity utilization. total costs were estimated by the natural logarithm ofthe average annual production costs (material inputs and labor) per ton ofoutput; material costs by the natural logarithm of the average annual material input costs per ton of output; and labor costs by the natural logarithm of the average annual production workers' wages per ton of output. table 3 following summarizes the data. table 3 correlation matrix for the concentration model dependent variable: concentration ratio eight (n=20) the first number represents estimated correlation, the second p-value under the hypothesis of zero correlation. mean* s.d. 2 3 4 5 6 7 i. concentration ratio eight 57.2% ]5.2[% \.000 0.000 2. concentration ratio four 3r.6% x.9% 0.x12 1.000 0.001 0.000 3. joint venturc intensity (numher of 0.94 0.17 -o.xn -0.953 ].000 joint ventures per finn) o,()o] 0.000 0.000 4. capacity (i/naturallogarithm of 76.71% 12.] 0% 0.26r 0.684 -0.576 1.000 industry capacity utilization rate) 0.125 0.003 0.009 0.000 5. total cost (natural logarithm of $24luo $5ral -o.64x -o.n! 0.253 0.313 1.000 anllual production costs per ton) 0.005 0.169 0.137 0.09\ 0.000 6. material cost (natural $198.69 $49.0r -0.6x5 -0.266 0.298 0.262 0.996 1.000 logarithm of annual raw 0.003 0.126 0.100 0.130 0.000 0.000 material costs per ton) 7. lahor cost (natura] logarithm $49.61 $11.14 -oa13 0.015 0.016 0.524 0.919 ox79 1.000 of annual production lahor costs) 0.042 0.944 0.944 0.0] 5 0.000 0.000 0.000 *price amounts arc per shari ton real prices in 19x7 uollar. table 3 indicates a mean cr h of 57.2% and cr 4 of 38.6%. the table indicates highly correlated alliance intensity and capacity that in turn is correlated with production labor costs. a pair ofmodels (a full model with the alliance and capacity variables and a reduced model without the capacity variable) was estimated for the three production cost categories to control for potential multicollinearity. 162 journal ofbusiness strategies results vol. 21, no.2 tables 4 and 5 following provide regression results for the performance models. the profitability model (table 4) shows a statistically significant f-statistics for the ros measure although f-statistics for the roa and roe measures are not significant. table 5 shows statistically significant f-statistics for the productivity and operating margin models. the tables indicate positive association between alliance intensity and industry profitability and productivity over the 1977-1997 period. similarly, table 4 indicates a positive association between new capital expenditure and industry roa and ros although table 5 indicates a negative association between new capital expenditure and industry productivity. the intriguing association of capital investment with low productivity may be explained by the structure of the u.s. steel industry. the 1990s saw heavy investment in capital equipment by the u.s. integrated steel producers that faced declining labor productivity due to entrenched labor table 4 regression of trend of industry profitability on horizontal joint venturing (n=20) dependent variable: return on assets return on equity return on sales independent parameter tparameter tparameter tvariables estimate statistic estimate statistic estimate statistic ~": intercept -32.88 -2.36** -228.73 -2.18** -31.52 -2.68** ~,: lagged industry returns 0.07 0.30 -0.17 -0.69 0.03 0.13 (roa,.,. roe,." and ros,.,) ~,: lagged joint venture 28.46 2.56** 185.11 2.18** 26.65 2.87** intensity (number of horizontal joint ventures per firm) ~,: lagged industry new 3.83 2.11 * 23.45 1.71 3.43 2.30** capital expenditure/sales ~": lagged acquisitions -3.52 -1.74 -12.74 -0.82 -2.51 -1.52 (natural logarithm of number of horizontal mergers and acquisitions) adjusted r' 0.18 0.06 0.24 f-value for regression 2.06 1.29 2.53* durbinwatson statistic 1.61 + 1.88+ 1.64+ **parameter is significantly different from zero at the 5% level, using a two-tailed test. *parameter is significantly different from zero at the 10% level, using a two-tailed test. + statistical indications that the time series data are not autocorrelated at (t =0.01 significance level. fall 2004 djode: horizontal strategic alliances 163 unions and high legacy costs (s&p, july 1999 industry survey). on the other hand, minimill producers enjoyed high labor productivity but had limited capital investment (s&p, january 2002 industry survey). therefore, interaction between the integrated producer's high capital expenditure-low productivity characteristic and the minimill's low capital expenditure-high productivity characteristic may have confounded the true capital expenditure-productivity relationship. table 5 also shows a negative acquisition coefficient in the operating margin model indicating that horizontal acquisitions may have temporal negative impact on industry operations. tables 6, 7, and 8 provide results for the industry structure models. table 6 provides regression results for the nine steel product prices. all the nine models exhibited significant f -statistics and relatively independent residuals. r2 (adjusted) for the full model indicates that variability in alliance intensity, input costs, capacity, and demand trends accounted for 61 % to 89% of variability in the trend of real price (1987 dollar) of steel products. in all but three products, the full model exhibited statistically significant negative coefficients for the alliance variable. table 6 shows that all else equal, a i% increase in horizontal alliance intensity was followed by a 0.6% drop in steel beam prices, a 0.8% drop in hotrolled sheet prices, 0.5% drop in cold-rolled sheet prices, and a 1% drop in galvanized steel prices. it also shows that a i% increase in alliance intensity was followed by a 0.7% drop in reinforcing bar prices and a 0.6% drop in wire rod prices. the following section discusses the parallels between these results and the structure of the steel industry. steel producers versus processors table 6 indicates statistically insignificant alliance coefficients for processor products, cold finished and stainless steel in the full model, although the coefficients are positive and statistically significant in the reduced models. that is, for steel processors or maximills, horizontal alliances were followed by increase in real prices as opposed to the declining prices of integrated and minimill products. the opposite behavior ofprocessor prices is consistent with the industry structure. unlike steel producers, steel processors mainly add value to producer products by focusing on difficult steel applications. thus primary production capacity has no impact on processor prices and processors can maintain profits even when primary (integrated and minimill) producers are unprofitable. for instance, processors can profit through tolling (treating customers' steel for a fee) even when primary producers resort to price cuts. since steel producers supply the processors, alliances that enhance primary producers' capabilities to complete difficult applications reduce tolling opportunities for steel processors. without tolling opportunities and facing competitive pressure from producers that had integrated downstream into difficult applications, steel processors may have found price hikes to be the only avenue for survival. thus, horizontal alliances that enhance steel producers' capabilities also enable them to encroach into the processor domain thereby squeezing processor margins and compelling price hikes among processors. the following section links the results to the structure of the producer segment. 164 journal afbusiness strategies vol. 21, no.2 table 5 regression of trends of industry productivity and operating margin on horizontal joint venturing (n=20) productivity model operating margin model parameter tparameter tindependent variables estimate statistic independent variables estimate statistic f\: jntercept 3.20 10.19*** 1\; intercept -9.92 -1.66 1\ lagged joint venture 1.26 4.93*** fl ,; lagged o[h.:rating intensity (number of margin (%) 046 2.ng* horizontal joint ventures per firm) ~,; lagged industry new -(),12 -2,92*** p,: laggedjoint venture capital expenditure/sales intensity (numher of horizontal joint ventures per firm) 15,72 3,20*** 13,; lagged acquisitions -(uj3 -0,73 p,: lagged industry new (natural log of numher of capital expenditure/saks 1.44 1.66 horizontal mergers & acquisitions) adjusted r' fvalue for regression durbin-watson statistic i),: lagged acquisitions (naturallol! ofnumher of horizontal mergers & acquisitions) o,g i adjusted r' 2749*** fvalue ii.lr regression 1.56+ durhinwatson statistic -2,(11 -2.23 ** 0.41 436** ***parameter is significantly different from zero at the i% level, using a two-tailed test. **parameter is significantly different from zero at the 5% level, using a two-tailed test. *parameter is significantly dilten:ntlrom zero at the i()% level, using a two-tailed test. + statistical indications that the time series data are not autocorrclatcd at ex =0,0 i significance level. integrated versus minimill producers table 6 also indicates that horizontal alliances had greatest impact on the price of galvanized steel and hot-rolled sheet --the most lucrative of the integrated product segments and the least contested by domestic minimills. a cursory view of the raw data reveals that a large number of alliances between foreign competitors and integrated producers entailed galvanization process and the hot-rolled sheet category. i horizontal alliances thus induced competition in the integrated fall 2004 ojode: horizontal strategic alliances 165 table 6 two-stage least squares regression of the trend of steel products prices, horizontal alliances, and industry costs -demand is instrumented with imports, substitute price, and the steel product price (n=20) dependent variable: independent variables intcrccpt joint venture intensity production costs capacity dcmand adjustcd r' fval uc for rcgrcssion durbinwatson statistic intercept joint venture intensity production costs capacity demand adjusted r' fval ue for regression ourbinwatson statistic intercept joint venture intensity production costs capacity demand adjusted r' f-value for regression durbinwatson statistic beams (natural logarithm of price per ton) (full model) (reduced model-jvi) (reduced model-costs) parameter tparameter tparameter testimate statistic estimate statistic estimate statistic 10.57 6.<)<)*** 15.12 12.78*** 15.<)4 <).91 *** -0.60 -2.78** -0.19 -1.14 0.61 2.98*** -0.06 -0.45 -0.] 9 -0.62 -11 ] -2.60** -1.96 -7.46*** -2.10 -7.49*** 0.85 0.74 0.71 n.13*** 32.23*** 28.67*** 2.15+ 1.94+ 2.06+ dependent variable: steel plates 6.59 3.14*** 13.38 7.60*** 14.58 5.82*** -0.34 -1.15 -0.02 -0.09 0.76 2.65** -0.17 -0.75 -0.90 -2.12* 0.28 oa8 -1.60 -4.11*** -1.65 -4.29*** 0.63 0.37 0.38 9.26*** 9.10*** 9.2<)*** 1.281.31+ 1.38+ dependent variable: hot rolled sheet 5.24 2.78* * 14.08 7.26*** ]5.45 6.16*** -0.80 -3.00* -0.24 -0.92 1.07 4.17*** -0.14 -0.75 -0.95 -2.50** 0.49 0.9] -1.74 -4.05*** -1.91 -4.34*** 0.78 0.42 0.39 18.21*** jo.16*** 9.41*** 1.59+ 1.37+ 1.48+ ***parameter is significantly dillerent from zero at the 1% level, using a two-tailed test. **parameter is significantly ditl'erent from zero at the 5% level, using a two-tailed test. *parameter is significantly diltcrent from zero at the 10% level, using a two-tailed test. ~ inconclusive evidence lor autocorrelation in the time series data at u =0.0 i significance level. + statistical indications that the time series data are not autocorrelated at u =0.0 i significance level. 166 journal ofbusiness strategies vol. 21, no.2 table 6 continued two-stage least squares regression ofthe trend ofsteel products prices, horizontal alliances, and industry costs -demand is instrumented with imports, substitute price, and the steel product price (n=20) dependent variable: independent variables intercept joint venture intensity production costs capacity demand adjusted r' f-value for regression durbinwatson statistic intercept joint venture intensity production costs capacity demand adjusted r' fvalue for regression durbin-watson statistic intercept joint venture intensity production costs capacity demand adjusted r' fvalue for regression durbinwatson statistic cold-rolled sheet (natural logarithm of price per ton) (full model) (reduced model-jvl) (reduced model-costs) parameter tparameter tparameter t· estimate statistic estimate statistic estimate statistic 6.71 4.44*** 13.70 h.32*** 12.55 6.23*** -0.49 -2.04** 0,15 0.70 0.h7 4.79*** 0.12 0.81 -076 -2.25 -0.18 -0.39 -1.68 -4,60*** -1.56 -4.41*** 0.78 0.43 0.46 18.04*** 10.68* ** 11.31*** 1.97+ 1.40+ 1.2h+ dependent variable: galvanized steel 8.07 4.65*** 14.56 7.65*** 14.43 6.10*** -0.95 -3.69*** 0.04 0,16 0.99 4.69** -0.002 -0.01 na na -1.18 -4.08*** -1.81 -4.29*** -1.77 -4.28*** 0.76 0.40 0.41 22.56*** 9.62*** 9.56*** 1.68+ 1.041.00dependent variable: stainless sheet 13.89 6.03*** 17,86 8.94*** 12.11 6.95*** 0.50 1.48 1.09 4.19*** 0,74 2.71 ** 1.05 5.73*** na na -2.24 -5.76*** -2.47 -5.57*** -2.05 -6.04*** 0.74 0.59 0.74 22.0 i*** 19.69*** 33.45*** 2.11+ 1.43+ 2.09+ ***parameter is significantly different from zero at the i% level, using a two-tailed test. **parameter is significantly different from zero at the 5% level, using a two-tailed test. *parameter is significantly dit1erent from zero at the 10% level, using a two-tailed test. -inconclusive evidence for autocorrelation in the time series data at a =0,01 significance level. + statistical indications that the time series data are not autocorrelated at a =0.0 i signilicancc level. fall 2004 ojode: horizontal strategic alliances 167 table 6 continued two-stage least squares regression of the trend of steel products prices, horizontal alliances, and industry costs -demand is instrumented with imports, substitute price, and the steel product price (n=20) dependent variable: independent variables intercept joint venture intensity production costs capacity demand adjusted r' f-value for regression durbinwatson statistic intercept joint venture intensity production costs capacity demand adjusted r! fvalue for regression durbinwatson statistic intercept joint venture intensity production costs capacity demand adjusted r! f-value for regression durbinwatson statistic cold-finished steel (natural logarithm of price per ton) (full model) (reduced model-jvi) (reduced model-costs) parameter tparameter tparameter testimate statistic estimate statistic estimate statistic 8.03 5.79*** 13.94 9.15*** 11.91 7.25*** 0.34 1.10 0,43 2.14** 0.59 2.22** 0.37 2.14** na na -0.94 -3.76*** -1.80 -5.32*** -1.64 -5.16*** 0.61 0.51 0.54 10.70*** 14.51*** 15.25*** 1.201.86+ ].66+ dependent variable: reinforcing bar 5.71 3.26** * 14.9] 6.78*** 16.55 5,47*** -0.65 -2.60** -0.55 -1.79* 0.98 4.14*** -0.24 -0.60 -2.09 -5.90*** 1,47 2.96** -1.87 -3.84*** -2.19 -4.03*** 0.89 0,49 0.39 38.24*** 11.21 *** 8.24*** 2.54+ 0.880.89dependent variable: wire rod 4.15 2.54** 13.19 6.04*** 13.14 4.66** * -0.60 -2.34*** -0.30 -1.01 0.93 4.77*** 0.08 0.21 -2.04 -5.58*** 1,48 3.03*** -1.54 -3.19*** -1.64 -3.24*** 0.84 0.34 0.29 26.\\*** 6.75*** 5.87** 2.02+ 0.960.93***parameter is significantly ditlerent from zero at the i% level, using a two-tailed test. **parameter is significantly different from zero at the 5% level, using a two-tailed test. *parameter is significantly different from zero at the 10% level, using a two-tailed test. -inconclusive evidence lor autocorrelation in the time series data at a =0.01 significance level. + statistical indications that the time series data are not autocorrelated at a =0.0 i significance level. 168 journal of business strategies vol. 21, no.2 table 7 two-stage least squares regression: the differential impact of horizontal alliances on the integrated and minimill steel prices-demand is instrumented with imports, substitute price, and the steel product price (n=147) dependent variahle: integrated and minimi ii steel products (natural logarithm of price per ton) independent variables intercept joint venture intensity (numher ofjvs per firm) production costs (natural logarithm of direct labor and material costs minus average costs per ton) capacity (natural logarithm of production capacity utilization rate minus average capacity utilization rate) demand (instrumented with the natural logarithm of: shipment and imports in million tons and the natural logarithm of product and substitute prices per ton) adjusted r' fvalue for regression parameter estimate 4,65 1.10 -0.04 -2,21 -0.06 t-statistic 4,65*** 2.r5*** -1.7r* -2,20** -0,55 0.16 r,20" * '**parameter is significantly different from zero at the 1% level, using a one-tailed test. **parameter is significantly dilferent irom zero at the 5% level. using a one-tailed test. *parameter is significantly ditlerent irom zero at the 10% level. using a one-tailed test. segments that hitherto experienced minimal competitive pressures. the table indicates moderate alliance impact on the minim ill-infiltrated beams segment and the minimill domain (rebar and wire rods) in consistence to competitive dynamics in these segments. horizontal alliance impact on steel pricing trends therefore mirrors the minimill induced pressures on steel prices such as these producers entry into the steel beam segment that dipped beam prices by $70 to $80 a ton (iron age, august 1993: 19). table 6 also indicates a statistically significant capacity coefficient that switches with the demand coefficient that might indicate a multicollinearity problem in the models (neter, wasserman, and kutner, 1990). alternatively, such switching might mean that integrated producers responded to declining demand by contracting output. if multicollinearity caused such switches, then both minimill and integrated product prices would exhibit similar patterns. however, if the switches resulted from differential producer response to demand fluctuations, fall 2004 djode: horizontal strategic alliances 169 then minimills would exhibit a different pattern since these producers' response to demand fluctuations differs from the integrated response. the table indicates statistically significant positive demand coefficients and negative capacity coefficients with t-statistics above the critical "2" (kennedy, 1992) for the minimill products. that is, minimill producers may have responded to demand fluctuations through .flexprice, hence the exhibited positive relationship between the trends of demand and price and a negative relationship between the trends of capacity utilization and price. further, minimills' capacity utilization coefficients are more than double those of the integrated potentially indicating that minimills passed on efficiency gains from increased capacity utilization to their customers more than their integrated counterparts. the lack of statistical significance of the capacity coefficient in some models could also result from the way demand and capacity variables were measured. demand and capacity utilization variables for individual steel products were estimated by industry demand and capacity utilization. yet, demand for individual products may not correspond to the average industry demand. also, the use of the price of aluminum as a universal substitute proxy for all steel products may have interfered with the instrumental role of the price of substitutes variable in estimating the demand for products for which aluminum is not a substitute. similarly, the amalgamated industry capacity utilization rate may vary significantly from the real capacity utilization rate for different products. the industry capacity utilization rate may also have less relevance to certain products besides cold-finished, galvanized, and stainless steel. table 7 following explores further the differential impact of alliances on the producers. table 7 provides results of a cross sectional 2sls regression model of steel prices with the five integrated products collapsed into one category and the two minimill products collapsed into a second category (integrated category =1 and minim ill category = 0). this model attempts to tease out the differential impact of horizontal alliances on the producers. therefore, our focus is the direction rather than the actual value of estimated coefficients. however, we mean-centered the costs and capacity variables into deviation scores from their respective means before performing the regression analyses (aiken and west, 1991). this remedial action reduces potential multicollinearity from the previously noted inter-correlations and increases chances of obtaining unbiased estimates ofthe alliance, costs, and capacity coefficients. the demand variable was not mean-centered since the modeled demand was instrumented with the imports and substitute price. table 7 indicates that alliance intensity had greater impact on integrated steel prices than on minimill steel prices. this could indicate that the integrated segment adopted more horizontal alliances than the minimills perhaps with foreign competitors seeking entry into this lucrative segment. similarly, integrated producers did not appear to pass efficiency gains (lower production costs or efficient use of production capacity) to customers through lower prices as the minimills. following is a discussion of the impact of horizontal alliances on industry concentration. 170 journal ofbusiness strategies vol. 21, no.2 steel industry concentration table 8 provides regression results for the industry concentration models. all the models exhibited significant f-statistics and relatively independent residuals. save for potential autocorrelation, the reduced (jvl only) and full (jvi and capacity) models exhibit similar explanatory power for the trends ofcrg for all production cost categories. however, the full model offers a slightly better explanation for the trends ofcr 4 • the alliance coefficient is negative and statistically significant in both models for all production cost categories although it is almost 20 percent larger with labor cost in the cr g model. the cost coefficient is also negative and statistically significant in the crg model but insignificant in the cr4 model while the capacity coefficient is insignificant in the crg model but significant in the cr 4 model. these results suggest a general use of horizontal alliances in managing high costs in all segments but a specific focus on horizontal alliances for increasing capacity utilization among major or integrated producers (most of whose market share constitute) the cr 4 measure. the results render support to the idea that horizontal alliances may have reduced industry concentration. conclusion the study examined the impact of horizontal alliances on the u.s. steel industry's competitive structure and found indications of positive impacts on industry competitiveness (profitability and productivity) and indications of declining prices and industry concentration. while non-modeled factors may also influence industry performance and competitive structure, the indicated link with horizontal alliances is consistent with the capability hypothesis that steel firms may have adopted horizontal alliances in pursuit of capabilities rather than market power alone. a capability hypothesis encompasses dual motives. that is, firms may adopt horizontal alliances in the quest for competitive and cooperative advantages simultaneously (lado, boyd, and hanlon, 1997) and that competitive needs may dictate the dominant motive. for instance, steel producers may have found horizontal alliances efficacious for monopoly pursuits in the insulated markets of mid-twentieth century (fusfeld, 1958) but market power may not have been the main motivator two decades later (berg and friedman, 1978). it is likely that the increasingly open and competitive markets of the later decades made the quest for capabilities a dominant motive among domestic alliance contenders. the following section discusses horizontal alliances in the context of excess capacity horizontal alliances and excess capacity the results indicate that despite its potential to increase capacity, steel producers adopted horizontal alliances in the face of worldwide excess capacity.2 such seeming contradiction is better understood by reviewing the condition of the u.s. steel industry at the time of these alliances. the u.s. steel market became the focal point of the transitioning and emerging economies' producers in 1990s. yet, major domestic producers' diversification response to dwindling demand in the table 8 regression of trend of steel industry concentration on horizontal joint venturing (n=20) dependent variable: concentration ratio eight (cr8) concentration ratio four (cr4) "t] ~...... n o o +:-. modeit)'pe (jvi & cap. u) (jvlonly) (jvi & cap. u) (jvlonly) parameter estimate t-statistic parameter estimate t-statistic parameter estimate t-statistic parameter estimate t-statistic ***sig @ 0.1 %; **sig @ 0.5%; *sig @ i% (two-tailed test) statistical indications that the time series data may be autocorrelated at a = 0.0 i significance level. inconclusive evidence for autocorrelation in the time series data at a = 0.0 1 significance level. + statistical indications that the time series data are not autocorrelated at a = 0.0 i significance level. independent variables (total costs) intercept joint venture intensity total production costs capacity adjusted r: f-value for regression durbin-watson statistic independent variables (material input costs) intercept joint venture intensity material input costs capacity adjusted r~ f-value for regression durbin-watson statistic independent variables (labor input costs) intercept joint venture intensity labor input costs capacity adjusted r~ f-value for regression durbin-watson statistic 2.74 -0.58 -0.28 -0.01 2.61 -0.57 -0.27 -0.00 2.35 -0.68 -0.27 -0.01 9.73*** -5.65*** -4.59*** -0.18 0.86 43.17*** 0.8510.49*** -5.59*** -4.77*** -0.07 0.87 45.30*** 0.868.24*** -5.96*** -3.17* -0.12 0.81 29.00*** 0.852.73 -0.59 -0.28 2.60 -0.57 -0.27 2.35 -0.69 -0.27 10.07*** -8.47** * -5.66*** 0.87 68.42*** 0.8410.80*** -8.24*** -5.86*** 0.88 71.92*** 0.858.54*** -8.56*** -4.19*** 0.82 46.02*** 0.830.83 -0.36 -0.04 -0.09 0.80 -0.36 -0.03 -0.09 0.81 -0.37 -0.05 -0.10 7.52*** -8.96*** -1.62 -3.29** 0.93 95.33*** 1.278.01*** -8.83*** -1.52 -3.22* 0.93 93.77*** 1.268.75*** -9.92*** -1.81 -3.40** 0.94 98.75*** 1.340.78 -0.45 0.01 0.79 -0.46 0.01 0.77 -0.45 0.01 5.74*** -12.98*** 0.29 q c 0.90 ~ 89.07*** ~1.33+ "': n' 6.37*** c:::: -12.81 *** .... ~-.... 0.27 s(l "': 0.90 ~.... 89.02*** ~ 1.33+ o' ::t..-.... 6.65*** -.... 15' -13.39*** :::: (") 0.43 (1;)too 0.90 89.63*** 1.32+ --l-' -....] 172 journal ofbusiness strategies vol. 21, no.2 seventies had eroded capital resources for investment in steel production (acs, 1984; scheuerman, t 986). therefore, domestic facilities contrasted sharply with the modem facilities of foreign producers such as the german and the japanese (liebennan and johnson, 1995). at home, the waning steel influence, large legacy costs, pressure from efficient minimills, and the flooded global market compounded the integrated producers' woes. however, integrated producers attempts to close the capability gap were bogged by the costly to run old coke ovens that were expensive to rebuild and that produced harmful emissions into the environment. individual producers found required investment for equipment replacement to be overwhelming leading to persistent calls for collaborative efforts to hasten resource mobilization within the industry (a common theme in the 1982t 992 issues of aisi's iron age publication). in 1986 for instance, even the giants u.s. steel and bethlehem steel had to solicit the u.s. department of energy for capital for the joint 'hazelett stripcasting' project. as producers scrambled to reorganize, a series of tariffs and voluntary restraint agreements sprang up to hold the tide against cheap imports. the restrictions are believed to have contributed to import reduction by as much as twenty percent from 1992:1 however, the pressure on steel imports pushed foreign producers to seek direct investment that could sidestep tariffs. thus, foreign producers sought entry into the u.s. market while integrated producers resorted to 'minimillization' and rationalization programs resulting in massive industry restructuring that coincided with increased alliance activity (madhavan and prescott, 1995). figure 1 for instance indicates a jump in horizontal alliances among integrated producers as occurring about 1990 as voluntary restraint agreements (vra) gave way to tariffs and quotas that engulfed even foreign producers. alliances appeared to have provided the beleaguered foreign producers a 'safe' mode for participation in the u.s steel market. the following section highlights a few of the steel alliances to illustrate their role in the industry. the role of horizontal alliances in the industry horizontal alliances matched the needs of domestic and foreign producers by enabling integrated producers to mobilize the requisite capabilities to face foreign and minimill induced competitive pressures and by providing foreign firms means of entry into the lucrative but high capacity industry. domestic partners pursued capabilities such as thin-slab casting to distinguish them in the increasingly crowded and interdependent competitive environment. for instance, the canadian producer algoma steel partnered with u.s producers on a new steel making process that combined thin-slab rolling with conventional blast furnace technology. the technology blends the blast furnace advantages of low cost and clean liquid steel with the low conversion cost and superior tolerances of thinslab-casting resulting in cost savings of $18 to $20 per ton over conventional methods. examples of alliances during the study period included the 1995-97 alabama-based trico joint venture project between integrated steel producers ltv corporation (u.s), british steel, and sumitomo (japan); the top u.s. integrated fall 2004 ojode: horizontal strategic affiances 173 steel producer u.s. steel and the minimill paragon nucor steel's joint direct reduced iron (dri) project in trinidad; the canadian integrated dofasco and the u.s. minimill co-steel's 50/50 stake in gallatin steel at carrollton, kentucky; the japanese nippon steel's ten percent equity in oregon steel's cf&i, and the u.s. steel (uss) and the korean pohang iron and steel (posco) joint venture. old versus modern facilities despite excess capacity in the industry, steel producers doubled alliance intensity from the earlier decades (berg and friedman, 1978) in order to establish modern production facilities since the old integrated facilities (that still counted as production capacity) were too costly to modernize for effective production. that is, alliance partners may have found it efficient to establish modern facilities while maintaining idle or underutilized (old) capacity. not only did the alliances create more capacity but competition as well since partners competed with each other and with their joint facilities. for instance, the uss-posco's pittsburg plant obtained its steel from three sources: u.s. steel's gary (indiana) works, u.s. steel's fairfield (alabama) works, and pohang iron and steel (posco) in korea. posco shipped its hot-band coils some 6,000 miles across the pacific ocean into the sacramento river/san joaquin river delta (40 miles east of san francisco bay). the complex material sourcing arrangement required readjustments at uss-posco (the joint venture) since the three sources of steel (gary, fairfield, and posco) made bands with different yield capabilities. steel from fairfield yielded about 1,000 pounds per inch of width; gary, 1,100; and posco, 1,150. fairfield's coils also had more crown than those from gary or from posco. consequently, the pittsburgh mill adapted processing to handle the differential capabilities making the facility one ofthe most complex integrated plants in the u.s. these complexities required uss-posco management to devise "an adaptive system" that allowed for equipment movement and shifts to synchronize the multiple material sourcing from competing partners (american metal market, 1997 archived). conflict versus co-operation uss-posco also confronted competition from the parents firms-u.s. steel and posco: "u.s. steel owns 50 percent, and they look at us in terms of what is best for u.s. steel. posco owns 50 percent, and they are looking out for what's best for posco. at uss-posco, we have to look out for what's best for us. [further,] u.s. steel competes with us by shipping tin plate" (american metal market, 1997 archived). the ensuing rivalry between the parent firms and between the parents and uss-posco impacted the joint venture's initial performance adversely. after four-years of losses however, uss-posco finally pulled a profit in 1992 and achieved $80 million operating income in 1993 over the 1990 period. workforce productivity rose and integrated yield increased by 17 percent for tin products and by 12 percent for sheet. uss-posco management attributed much of the increased yield to the high quality and uniformity of the hot band steel that posco shipped that aided gauge control at its california mill. uss-posco 174 journal ofbusiness strategies vol. 21, no.2 (the j oint venture) therefore aided posco's entry into the u. s steel market and enabled u.s. steel to raise productivity. technological breakthroughs since the early 1980's when nucor spearheaded the revolutionary compact strip production (csp) technology, the u.s. steel industry observers considered the industry ripe for technological breakthrough and touted the drl technology as csp's successor (aisi, 1997). the technology was superior to the blast furnace method of iron making. for instance, an experimental direct-process plant in pittsburgh that had been in operation since the late eighties yielded five tons of steel an hour and shaved about 20% off conventional steel making. the facility used a coal-based, continuous in-bath melting process that substituted a single vessel for coke ovens, blast furnaces, and basic oxygen furnaces. widespread implementation of dri process was expected to reduce costs by eliminating old coke ovens that polluted the environment and that were expensive to rebuild. however, the dri technology was expensive for a single firm to develop. consequently, the nucor-u.s. steel joint effort teamed the top producers' complementary resources in spearheading the development of the most likely revolutionary solution to problems caused by the capital-intensive nature of the integrated steelmaking process. through the alliance, nucor obtained access to financial capital for r&d into drl technology while u.s. steel gained access to nucor's pragmatic technological agility. this study documents potential impacts of capability horizontal alliances on industry profitability and competitiveness and is particularly timely for u.s. steel firms that confront mounting competitive pressures with ineffectual political strategies such as tariffs (schuler, 1996). although popular among steel firms, these strategies are limited in addressing competitive pressures from foreign firms with direct domestic investment and the minimill-induced competitive pressures (moore, 1994). rather, this study suggests that capability horizontal alliances may offer a better strategic alternative for the industry. the study offers a capability hypothesis that does not preclude simultaneous competitive and co-operative alliance motivations, but is contrary to conventional wisdom that eschews horizontal alliances as market power driven and therefore anti-competitive. stakeholders may take comfort in the sufficiency of competitive element in horizontal alliances to safeguard against' over-cooperation.' references acs, z. j. (1984). the changing structure ofthe u. s. economy: lessons from the steel industry. new york: praeger publishers. aiken, l.s. & west, s.g. (1991). multiple regression testing and interpreting interactions. newbury: park sage. fall 2004 djode: horizontal strategic alliances 175 american iron & steel institute (aisi). (1997). steel survival strategies xii meeting. new york: steeinet.com, accessed august 1997. barnett, d.f. & crandall, r. w. (1986). up from the ashes: the rise of the steel minimill in the united states. washington, d.c: the brookings institution. barney, j.r (1991). firm resources and sustained competitive advantage. journal of management. 17, 99-120. berg, s. & friedman, p. (1977). joint ventures, competition, and technological complementarities: evidence from chemicals. southern economic journal, 1330-1337. berg, s. & friedman, p. (1978). joint ventures in american industry. mergers & acquisitions, summer, 28-41. berg, s. & friedman, p. (1981). impacts of domestic joint ventures on industrial rates of return: a pooled cross-section analysis. the review of economics and statistics, 293-298. bhaskar, v., manning, a., & to, t. (2002). oligopsony and monopsonistic competition in labor markets. journal of economic perspectives 16(2), 155-174. burgers, wp., hill, e. w, & kim, we. (1993). a theory of global strategic alliances: the case of the global auto industry. strategic management journal. 14(6), 419-432. chan, s.h., kensinger, j.w, keown, a.j., & martin, j.d. (1997). do strategic alliances create value? journal of financial economics 46(2), 199-221. chandler, a.d. (1990). scale and scope: the dynamics of industrial capitalism. cambridge: harvard university press. chi, t. (1994). trading in strategic resources: necessary conditions, transaction cost problems, and choice of exchange structure. strategic management journal, 15(4), 271-290. das, s., sen, p.k., & sengupta, s. (1998). impact of strategic alliances on firm valuation. academy of management journal. 41 (i ), 27-41. dyer, j.h. (1997). effective inter-firm collaboration: how firms minimize transaction costs and maximize transaction value. strategic management journal, 18(7), 535-556. fusfeld, d.r. (1958). joint subsidiaries in the iron and steel industry. american economic review, 48, 578-587. godfrey, p.e. & hill, c. w. (1995). the problem ofunobservables in strategic management research. strategic management journal. 16, 519-533. 176 journal of business strategies vol. 21, no.2 goes, b.j. & park, h.s. (1997). inter-organizational links and innovation: the case of hospital services. academy of management journal, 40(3), 673-696. goolsbee, a. & chevalier, j. (2002). measuring prices and price competition online: amazon and barnes and noble. working paper # 9085, national bureau of economic research. grant, r.m. (1991). contemporary strategy analysis. cambridge: blackwell publishers. hamel, g. (1991). competition for competence and inter-partner learning within international strategic alliances. strategic management journal. summer special issue, 83-103. hogan, w.t. (1994). steel in the 21st century: competition forges a new world order. new york: lexington books. hurry, d. (1993). restructuring in the global economy: the consequences of strategic linkages between japanese and u. s. firms. strategic management journal. 14,69-82. jennings, d.f., artz, k., gillin, l.m., & christodouloy, c. (2000). determinants oftrust in global strategic alliances: amrad and the australian biomedical industry. competitiveness review, io( i). kennedy, p. (1992). a guide to econometrics. boston: the mit press. kogut, b. (1988). joint ventures: theoretical and empirical perspectives. strategic management journal. 9(4), 319-332. kogut, b. (1991). joint ventures and the option to expand and acquire. management science, 37(1 ), 19-33. kotabe, m. & swan, k.s. (1995). the role of strategic alliances in high-technology new product development. strategic management journal, 16(8), 621-636. lado, a.a., boyd, n.g., & hanlon, s.c. (1997). competition, cooperation and the search for economic rents: a syncretic model. academy of management review, 22( i ), 110141. leonard-barton, d. (1995). wellspring ofknowledge: building and sustaining the sources of innovation. cambridge: harvard university press. lieberman, m. b. & johnson, d. r. (1995). comparative productivity of japanese and us steel producers, 1958-1993. working paper s&o 95-7 # 034, university of california at los angeles. madhavan, r. & prescott, j .e. (1995). market value impact of joint ventures: the effect of industry information-processing load. academy of management journal, 38(3)' 900-915. fall 2004 djode: horizontal strategic alliances 177 mahoney, j.t. & pandian, j.r. (1992). the resource-based view within the conversation of strategic management. strategic management journal, 13. 559-584. mariotti, j.l. (1996). the power of partnerships. boston: blackwell publishers. moore, m.o. (1994). "steel protection in the 1980s: the waning influence of big steel? working paper # 4760, national bureau of economic research. mueller, c. & herstatt, c. (2000). interfirm cooperation: a brief overview of current theoretical findings and issues for future research. international journal of human resources development and management, 1(1),48-67. nelson, r.r. & winter, s.g. (1982). an evolutionary theory of economic change. cambridge: harvard university press. neter, j., wasserman. w. & kutner. m.h. (1990). applied linear statistical models. howewood: richard d. irwin inc. ojode, l.a. (2000). a resource-based view of strategic alliances: organizational capabilities, governance, and performance (doctoral dissertation, university of illinois at urbana-champaign, 2000). parkhe, a. (1991). interfirm diversity, organizational learning and longevity in global strategic. journal of international business studies. 22(4), 579-601. penrose, e.t. (1959). the theory of the growth of the firm. london: wiley. porter. m.e. (1980). competitive strategy. new york: free press. schelling, t.c. (1980). the strategy of conflict. cambridge: harvard university press. scherer, f.m. (1980). industrial market structure and economic performance. chicago: rand mcnally. scheuerman, w. (1986). the steel crisis: the economics and politics ofa declining industry. new york: praeger publishers. schoemaker, pj. (1993). strategic decisions in organizations: rational and behavioral views. journal of management studies, 30,107-129. schuler, d.a. (1996). corporate political strategy and foreign competition: the case of the steel industry. academy of management journal, 39(3), 720-737. stubbles, j.r. (1995). the new north american steel industry. iron and steel makers, dec., 19-27. stuckey, a. (1983). vertical integration and joint ventures in the aluminum industry. cambridge: harvard university press. 178 journal ofbusiness strategies vol. 21, no.2 teece, d.j. & pisano, g. (1994). the dynamic capabilities offinns: an introduction. industrial and corporate change, 3, 537-556. teece, oj., pisano, g., & shuen, a. (1990). firm capabilities, resources and the concept of strategy. working paper # 90-9, university of california at berkeley. wernerfelt, b.a. (1984). a resource-based view of the finn. strategic management journal, 5, 171-181. williamson, a.e. (1968). economies as an antitrust defense: the welfare tradeoffs. american economic review, 58, 18-36. footnotes 1 ojode (2000) provides sample description of steel alliances, partner stated objectives, and related data. 2 i am thankful to the anonymous jbs reviewer who raised the issue of horizontal alliances and excess worldwide steel production capacity. 3 by the end of the vra in early 1990s, u.s steel firms filed more than eighty suits against foreign steelmakers for dumping leading to new tariffs across the board that covered even foreign firms with direct investment in the u.s. by 2003 the steel industry was still struggling with 8-30 percent tariffs. dr. ojode obtained her doctorate in business administration (strategic management and international business) from the university of illinois in 2000. an assistant professor of management at texas southern university, she teaches business policy/strategy to undergraduate and mba students. she has also taught business policy/strategy and international business at indiana university and at the united states international university in nairobi, kenya. her research interests revolve around resource-based perspectives; transaction costs economics; strategic alliances and international business strategies. the impact of horizontal strategic alliances on the u.s. steel industry the impact of risk and uncertainty on remittances into latin american economies bien solomon grand valley state university • grand rapids , mi abstract this study investigates the effects of exchange rate uncertainty and political risk, after controlling for the conventional macroeconomic detenninants, on remittances transfers into eight latin american countries during the period of 1990-2006. the results suggest that an increase in exchange rate uncertainty reduces remittances flows into these countries. furthennore, an increase in political risk seems to have a negative but statistically insignificant impact on remittances transfers. based on the findings of this paper, we can say that governments of the remittance receiving countries can influence the inflow of remittances by means of adopting appropriate macroeconomic policies to reduce exchange rate uncertainty and also by improving their political environments. introduction remittances have become an increasingly important and fast growing source of external finance for many developing countries.) by 2005, the total remittances inflows into developing countries reached $167 billion. this amount had more than doubled from its value of$58 billion in 1995 (united nations habitat, 2006). the increase in remittances flows into developing regions is welcomed because remittances have a potentially significant impact on the recipient country's economy. first, remittances are a more stable source of external finance as opposed to capital flows which tend to rise during favorable economic cycles and fall during less favorable ones. this acyclical nature of remittances exerts a stabilizing influence, and thus helps insulate vulnerable countries from economic shocks (ratha, 2003; global economic prospects, 2006). moreover, remittances increase the recipient country's foreign exchange reserves and promote economic growth if households use remittances for investment. if they are used for consumption, they can also generate positive multiplier effects, offsetting some of the output losses that a developing country may suffer from emigration of its highly skilled workers (ratha, 2003). by 2005, latin america and the caribbean (lac) were the largest remittances destination in the world, with inflows around $53.6 billion . this amount exceeded, for the third consecutive year, the combined flows of all net foreign di100 journal of business strategies rect investment (fdi) and official development assistance (oda) to the region (inter-american development bank, 2006). because of their increasing volume and their potential to reduce poverty and enhance economic growth, remittances are receiving growing attention from policymakers in the developing countries of latin america. there is a wide range of important issues related to remittances. in this study, we focus on a very important issue, namely, the determinants of remittances to latin american countries. assuming that remittances have a positive effect on the recipient economy, what are the determinants of remittances into latin american economies? the remittances literature is divided into two broad categories. the first category of determinants deals with microeconomic determinants of remittances such as the social and demographic characteristics of migrants and their families, while the second category considers macroeconomic variables of the host (sending) as well as home (receiving) countries. our study fits into the second category as we investigate the macroeconomic determinants of remittances into nine latin american countries. 2 generally, studies that investigate the determinants of remittances assume that migrants are risk neutral in their preferences with respect to risk and return in that they do not include risk variables in their regressions (higgins et ai., 2004). however, remittances for investment would be influenced by risk and return considerations. ratha (2003) reviews cross-country studies on remittances and reveals that remittances are affected by the investment climate in recipient countries in the same manner that capital flows are; though to a lesser degree. therefore, determinants of remittances in an investing framework would have to include rates of return to investment and the risk of investing in the home (receiving) country such as political risk and/or exchange rate uncertainty. however, to our knowledge, only one study (higgins et ai., 2004) has considered risk variables as determinants of remittances and no study has used the rate of return to investment measure that we use in this study. 3 we employ a measure of political risk that captures multiple facets of risk faced by investors in the latin american countries. we use the political risk index from the international country risk guide (icrg) that measures the combined effects of political and institutional instabilities faced by investors. we also include a garch measure of exchange rate uncertainty to investigate the exchange rate risk faced by investors. these risk variables are included in addition to the traditional determinants used by other studies. thus, this paper contributes to the literature by filling a long-standing void in exploring the links between remittances, risk and return in latin america. volume 26, number 1 101 the rest of the paper is organized as follows. section 2 discusses some basic facts about remittances inflows into latin american countries and provides a brief literature review. the sources of data and the variables used in the study are discussed in section 3. section 4 outlines the empirical methodologies and discusses the empirical findings. conclusions and policy implications are included in section 5. facts about remittances to latin america and brief literature review facts about remittances to latin america in 1995, the share of remittances going to latin america and the caribbean accounted for 23.2% of the total world remittances, but by the year 2005 this share had increased to 31% ,making it the largest remittance recipient region in the world. in dollar terms, lac received about $53.6 billion in remittance transfers in 2005. out of the $53.6 billion sent, an estimated $20 billion were sent to mexico, nearly $6.4 billion were destined to brazil, and about $4.1 billion were sent to colombia (inter-american development bank, 2006). in most latin american countries, remittances have exceeded official development assistance and other capital inflows such as fdi (see table 1). table 1 remittances (for 2003) relative to foreign direct investment (fdi) and gdp, and remittances per capita country remi % foi remi%gop remi. per capita argentina 15% 0 .09% 6.42 bolivia 835% 1.05% 10.73 brazil 46% 0.33% 11.43 colombia 111% 3.40% 68.64 mexico 178% 2.26% 130.96 nicaragua 270% 10.44% 80.87 peru 117% 1.49% 31.68 venezuela 18% 0.5% 10.23 source : inter-american development bank (2006) some key factors could explain the tremendous growth seen in remittances inflows into latin american countries over the last decade. one of the most impor102 journal of business strategies tant reasons has been the increase in emigration of workers from latin american countries to regions with demand for labor such as the u.s. and western europe. the inter american development bank estimates that in 2005 over 25 million latin american born adults were living outside their countries of origin. out of these 25 million migrants, approximately 65% send money home on a regular basis. the amount of money they send typically ranges between $100 and $300 a month (lnteramerican development bank, 2006). the main source of remittances to latin america is the u.s. as about 75% ($40 billion) of latin american remittances originate in the u.s. the next largest source of remittances is western europe with a share of almost 15% (about $7.5 billion). brief literature review there is a wide range of important issues related to remittances. in this study, we focus on the macroeconomic determinants of remittances to latin american countries. however, much of the remittances literature has focused on the microeconomic determinants of remittances (for example, see lucas & stark, 1985; russell, 1986; djajic, 1989; hoddinot, 1992; durand et al., 1996; ilahi & jafarey, 1999; agarwal & horowitz, 2002). the studies that have recognized the importance of the macroeconomic determinants of remittances include straubharr (1986), faini (1994), ei-sakka and mcnabb (1999), chami et al., (2003), higgins et al., (2004), and vargas-silva and huang (2006). these studies investigate the impacts of home (receiving) and host (sending) country variables such as inflation, income, exchange rates, wage levels, interest rates, and interest rate differentials on remittances flows. studies have found mixed evidence on the impacts of these variables on remittances flows. for example, a higher host country interest rate compared to the home country rate (a high premium) is expected to discourage remittances flows. however, straubhaar (1986), using data of remittances from germany to turkey, finds that interest rate differentials between the host and home countries have no effect on remittance flows. similarly, elbadawi and rocha (1992), using data from western europe and north africa, find the interest rate differential to have no significant impact on remittances. in contrast, katselli and glytsos (1986), and ei-sakka and mcnabb (1999) argue that interest rates and interest rate differentials significantly affect remittances inflows into greece and egypt respectively. the real exchange rate (xr) also has the potential to affect remittances. many studies have investigated the impact of exchange rates on remittances. these volume 26, number 1 103 studies have found exchange rates to be important in explaining remittances flows (see chandavarkar, 1980; amuedo-dorantes & pozo, 2004; higgins et ai., 2004). most studies expect the depreciation of the real exchange rate to encourage the flow of remittances from the host to home country (see higgins et ai., 2004). intersetingly, amuedo-dorantes and pozo (2004) also find that surges in workers' remittances may contribute to real exchange rate appreciation . furthermore, higgins et al. (2004) show that exchange rate volatility (a measure of risk) is an important determinant of remittances. the macroeconomic variables mentioned above have also been used to test the altruistic versus self-interest motive for remitting. if downturns in the receiving economy prompt workers to increase remittances to their home countries, then their motives can be thought of as altruistic. if, on the other hand, immigrant workers are self-interested, remittances will respond positively to economic conditions in the receiving country. faini (1994) and glytsos (1997), using income to measure the economic condition of the receiving country, find that workers motives are altruistic because downturns in the home economy prompt workers to increase the amount they remit. in contrast, higgins et al. (2004) find evidence for the investment or selfinterest hypothesis since they find favorable economic conditions at home increase remittances inflows into the home country. this paper investigates if risk and return variables, in addition to the conventional macroeconomic determinants, have a role in determining remittances flows into latin american countries. data description our analysis covers nine latin american countries between 1990 through 2006.4 the variables used in this study are annual in frequency; however, the exchange rates used to generate the conditional variances are monthly. 5 the data sources for our variables are the world development indicators (wdi), the international financial statistics (ifs) cd-rom, the u.s. census data, the immigration and naturalization services (ins) statistical yearbook, and the international country risk guide (icrg). all variables except the political risk indicators, were retrieved from the world bank's world development indicators (wdi) and the international financial statistics (ifs) cd-rom. the political risk indicators were taken from the icrg dataset. it should be noted that some problems exist in the measurement of remittances. one of the problems is that there is no consensus on the boundaries of the phenomenon under study. that is, should only workers' remittances be counted, 104 journal of business strategies or should compensation of employees and migrant transfers be included as well (ratha, 2003)? in this study, we use the definition of migrant remittances used by the world bank, which is the sum of workers' remittances, compensation of employees, and migrant transfers. another problem arises because many types of informal remittances flows go unrecorded due to weakness in data collection (jongwanich, 2007). for example, money transfers through informal channels such as family members are rarely documented. if remittances sent through informal channels are included in official remittances data, total remittances could be as much as 50% higher than the official record (world bank, 2006). however, the collection of remittances data is improving. for example, ratha (2003) shows that countries such as mexico have improved their system of unrecorded portion of remittances which has significantly increased the remittances statistics. another potential problem arises because the available data on remittance flows does not identify the source (host) country of these flows. however, remittances literature identifies macroeconomic variables in the sending as well as the receiving country as being important determinants of remittances. to incorporate both the sending and receiving countries' macroeconomic variables, we use data from latin american countries since 75% of latin american remittances are sent from the u.s. for this reason, for latin american countries, it is reasonable to assume that the error is relatively small. in order to investigate the determinants of remittances into latin american countries, we use the following variables:, the share of remittances in gop (remg), the stock of immigrants in the us. (for each latin american country) (immi), per capita income of each of the nine latin american countries (y), median hispanic income in the u.s. (mhi), real exchange rate (xr), rate of return to investment (rr), exchange rate uncertainty (garch), and political risk (polrisk).6 the median hispanic income in the u.s. (mhi) is used to measure economic well being of migrants in the host (sending) country.7 an increase in the income of migrants (i.e. an improvement in their well-being) is expected to increase remittances sent by these migrants to their native countries. other studies have used the host country's gop as well as the unemployment rate of the host country in order to measure the economic well being of migrants in the sending country. the per capita incomes (y) of the nine latin american countries are used to measure the economic well-being of the home (receiving) countries. the home country's gdp per capita may affect remittances either positively or negatively. however, the stock of immigrants (immi) in the host country is expected to have volume 26, number 1 105 a positive relationship with remittances flows, that is, an increase in the number of immigrants in the host country will increase the money sent back home. the real exchange rate (xr) also has the potential to affect remittances. the depreciation of the real exchange rate is expected to encourage the flow of remittances from the host . to home country (higgins et ai., 2004). some studies highlight the fact that some governments in developing countries have devalued the exchange rates in order to encourage remittances inflows (wahba, 1991). in addition to the variables mentioned above, measures for rate of return (rr) to investment, macroeconomic uncertainty (garch), and political risk (polrisk) are included in our regressions. most studies take account of the rr by using the interest rate differentials between the host and home countries. however, we take account of rr by using log ofthe inverse of the real gop per capita. 8 this substitution is made since market interest rates for most of the selected years are not available. in addition, the reported interest rates in many of these countries do not reflect true asset returns (higgins et ai., 2004). therefore we use our measure of the rate of return to investment. this variable is expected to have a positive relationship with remittances inflows if the motive to remit is for investment. on the other hand, garch measures of the real exchange rates are used to proxy exchange rate uncertainty.9 increases in exchange risk will decrease the level of remittances assuming that a part of these flows in fact are private investment flows made by immigrants (higgins et ai., 2004). the overall political risk indices (polrisk) for each home country are used to proxy the political risk prevailing in the countries. the icrg provides a composite political risk index (for each country) that is made up of particular components of political instability as well as home country institutional quality. the unpredictability and volatility in the political environment of the home country increases the perceived risk and uncertainty experienced by the migrant. as a result, a negative relationship between political risk and remittances inflows is to be expected. estimation methodology and results exchange rate uncertainty specification and results the arch/garch measure of uncertainty involves obtaining the variance of the unpredictable part of the series. unlike the ad-hoc measures of uncertainty such as rolling variances, the arch/garch approach is obtained on the basis of an estimated econometric model. this method captures volatility in each period more 106 journal of business strategies accurately. the arch model characterizes the distribution of the stochastic error conditional on the realized values of the set of variables that may include lagged values of the conditional variance. the generalized arch model, the garch (p, q) model, is specified as follows: yt = f(x t; 8) + et e/ 'i't.1 ~d(o, h/ ) (4.1.1) q p h 1 = a + ~a.e l + ~8h 1 (4.1.2) i 0 ~ i i -i k.j , i-i i= 1 ;= 1 where f (x t ; 8) refers to the conditional mean, x t is a vector of explanatory variables that may include lagged y,'s, 8 is a mxl vector of parameters, 'l't-i is the information set that contains all the information available through time t-l , and e t is the error term which follows, conditional on 'l't-i' a d-distribution. that is, the conditional errors have zero mean and time varying variance, h/the conditional variance follows a garch process as in (4_1.2). the conditional variance, h/ , the proxy for uncertainty, is the one period ahead forecast variance based on the past information. it is a function of three terms: the mean level of volatility a o' the arch term £,./ and the garch term h 1 . 10. 11 ,-i to generate measures of uncertainty, monthly real exchange rates for each of the countries were used. before estimation of our arch/garch models, we conducted some preliminary data analysis such as checking for the presence of unit roots. the results from the augmented dickey fuller (adf) test for unit roots suggest that the log of the real exchange rates for all the countries under consideration are l(l) processes . that is, the real exchange rate for each country has a unit root in levels while they are difference stationary. as a result, to ensure the stationarity of our variables, we use the first differences to fit arch/garch models and to generate the conditional variances. argentina, boliva, colombia, nicaragua, and venezuela had fixed exchange rate regimes during a portion of our period of study. therefore, in order to account for this fact , we include dummy variables in the garch estimations. the dummy variable for each country is defined as i if the country had a fixed exchange rate regime during the period of study, and 0 otherwise. table 2 presents the coefficients of the garch (p, q) estimation. as can be seen from table 2, the coefficients of the garch (p, q) have the expected theoretical signs. figure 1 shows a plot of exchange rate uncertainty (h,) for each country in our study. once the monthly exchange rate uncertainty measures (h,) are obtained, volume 26, number 1 107 they are aggregated to produce annual series, and included into our regressions. table 2 arch/garch models of the log difference of exchange rates (monthly) ar ma countries process process c ~ a2 ~1 argentina ar(8) ma(2) 0.0019 1.0025 (0.0257)*** bolivia ar(1) ma(1) 0.0005 0.3610 0.3184 (0.0010) (0.0431) *** (0.0950)*** brazil ar(3) 0.0182 0.4123 (0.0082)*** (0.1268)*** colombia ar(3) 0.0012 1.0430 (0.0001)*** (0.2001)*** chile ar(3) 0.0008 0.1863 0.0957 (0.0008) (0.4855)*** (0.1449)*** mexico ar(3) 0.1900 0.2592 0.5799 (0.0035)*** (0.0385)*** (0.0514)*** nicaragua ar(3) 0.0101 0.1239 0.6000 (0.0026)*** (0.0031) *** (0.0083)*** peru ar(3) 0.0100 0.4452 0.7181 (0.0005)*** (0.0584)*** (0.0119) *** venezuela ar(3) 0.0047 1.0001 (0.0049)*** (0.0037)*** 108 jour nal of business strategies figure 1 conditional variances of the exchange rates 05 ,-----------, '.0.,,-------------, ob os 02 02 00 ·.2 "2 ie .. '" " .. .. .. oj .. .. (ii [ --~~~.wa ." ." 00; .ro .... .. " 0; .. 90 " .. .. " ro .. .. .. 1brad codiortii ~~ 0 " .... 0.'" 0.003 0.00 .. '" ."" .., ... 0.(1)1 .., .. .... ,000 .. .. 90 92 .. .. .. ro .. .. '" ccdrtiii ~1cnii v..w-o. ] 2. '.2,------------, , .. ' .0 lo .. 05 '5 o. ~~,~ 0 .. .. , .. .. 90 " .. .. .. ro '" .. .. ~o::n::ii:nllvifwi: . -1 •• '" .2 ., 0.0 .. , ii! ... iii 92 .. .. .. <xl '" .. 06 ~otdt~v""" .. =:1 volume 26, number 1 estimation methodology and results for the determinants of remittances 109 in this paper, the arellano-bond dynamic panel gmm estimator is the method of choice. using this estimator has many advantages. first, it includes the lagged dependent variable as an additional regressor and therefore addresses the problem of autocorrelation of the residuals. in addition, it deals with the fact that some of the control variables are endogenous. for example, remittances may increase the home country's capital stock and boost gop growth rates in addition to boosting gop per capita. as a result, in order to take the endogeneity issue into account, we employ this instrumental variable type approach, namely arellano-bond dynamic panel generalized method of moments (gmm). one of the basic assumptions for applying the arellano-bond estimator is no second-order serial correlation in the residuals of the differenced specification. therefore, before we employ the arellano-bond gmm dynamic panel estimator, we have to test for second order serial correlation of our residuals. in addition, the overall appropriateness of the instruments is verified by the sargan test of overidentifying restrictions. before estimation we also check for the stationarity properties of our variables. a fisher type test for panel unit root is first applied to examine the null of a unit root in the variables under consideration. the fisher test combines the p-values of unit root tests for each cross section i as proposed by maddala & wu (1999) and choi (2001). based on the p-values of individual unit root tests, fisher's test assumes that all series are non-stationary under the null hypothesis against the alternative that at least one series in the panel is stationary. the results suggest that 4 of the variables (namely, y, rr, garch, and immi) are 1(1) processes. that is, these variables have a unit root in levels while they are difference stationary.12 as a result, to ensure the stationarity of our variables, we use the first differences in our regression. all the remaining variables are 1(0) processes. the results are reported in table 3. our model specification uses remittances share in gop as the dependent variable. all the variables included are in real terms and, therefore, we do not include the home and host country inflation rates. thus, the model to be estimated is as follows: remg it = ~o + ~lmhiit_ l + ~2llyit_! + ~3llgarchit_! + ~4llrrit_! + ~5xrit_1 + p 6 polriskit _! + pflimml it _! + cjt (4.2.1) 110 journal of business strategies where, is the country specific fixed-effect. the right-hand variables are as defined in section 3.13 table 3 fisher test for panel unit root variable remg median hispanic income (mhi) exchange rates (xr) gop per capita (y) rate of return to investment (rr) uncertainty (garch) political risk (polrisk) immigrant stock (immi) notes : ho: series non-stationary t statistic 69.2808 79.7396 68.4213 0.5272 15.9693 16.2994 30.3325 19.4291 p-value 0.0000 0.0000 0.0000 1.0000 0.5947 0.5717 0.0343 0.4490 tables 4 shows the arellano-bond dynamic panel gmm estimation results with robust standard errors. this table shows that all of the variables have their expected signs and are mostly significant. for example, the coefficient for growth of the median hispanic income (mhi), which measures the economic well-being of a migrant, is significant. this result is to be expected because a migrant's income is an important determinant for the money they send back home. the result implies that as the income of migrants in the u.s. increases; they are more likely to increase the remittances they send to their home countries. this is supportive of previous studies that show remittances respond directly to the ability of the remitter to send earnings home (loser et ai., 2006). for comparison with other studies, we used the u.s. gop as well as u.s. unemployment rate to measure the economic well being of migrants in the u.s. the results, though not significant, show that u.s. unemployment is negatively related to remittances inflows into latin american countries. this is consistent with previous studies such as higgins et al. (2007). volume 26, number 1 table 4 arellano-bond dynamic panel gmm estimation results using remittances per immigrant dependent variable: remittances per gdp variable (1) lagged rem ittances per gop 0.4476 (0.0678)*** median hispanic income (mhi) 0 .7795 (0.2182) *** exchange rates (xr) -0.0088 (0.0210) gop per capita (y) 0.0131 (0.0101) rate of return to investment (rr) 0.1301 (0 .3107) uncertainty (garch) -2 .0028 (0.8741 )*** political risk (polrisk) -0.2586 (0.1015)*** immigrant stock (immi) 0.0089 (0.0051 )* observations 144 countries 8 sargan test 0.2724 second order serial correlation test 0.1590 111 notes : standard errors are in parenthesis and ***, ** and * denote significance at 0.01 , 0.05 , and 0.10 levels respectively. the null hypothesis for the sargan test is that the instruments are valid (p-values are reported above) . the nullhypothesis for the second order serial correlation test is that the errors don't exhibit second order serial correlation (reported above are the p-values) the estimated coefficient of the growth of the gdp per capita (y) of the home countries indicates that this variable is positively (but not significantly) related to remittances. the result suggests that a higher growth of income in home country increases remittances sent home by immigrants. that is, remittances increase when economic activity in the home country accelerates and they decrease when economic conditions worsen. this result is contrary to the commonly held belief that remittances are used to smooth out fluctuations in economic activity. in our case, immigrants choose to keep more of their money in the host country during 112 journal of business strategies periods of economic trouble in the home country due to a possible loss of confidence in their country's economic situation. in addition, a change in the rate of return to investment is positively related to remittances inflows into the selected latin american countries. a few studies have attributed these results to the investment motive to remit. a high rate of return to investment and high income in the home country would both encourage more investment (see, for example, higgins et ai., 2004). this in turn would increase remittances for investment purposes. however, the estimated coefficient is not statistically significant. furthermore, as expected, the growth of the immigrants (immi) in the host country shows an increase in the money sent back home. the coefficient for real exchange rate return (xr) is not significant. however, it indicates that remittances tend to increase when the exchange rate depreciates. this result shows that remitters choose to send more to their home country when the currency oftheir home country depreciates. this is because exchange rate depreciations permit the remitter to buy more home currency with a given level of host currency thereby getting 'more credit for the transfer' (amuedo-dorantes & pozo, 2007; higgins et ai., 2004; wahba, 1991). one of the main variables of interest, namely, the exchange rate uncertainty (garch) is significant. this result indicates that as exchange rate volatility increases, the level of remittances per immigrant decreases. the result supports the hypothesis that uncertainty in the exchange rate lowers the level of remittances sent for investment purposes (for similar results, see higgins et ai., 2004). the migrant will ignore investing opportunities in the home country if he/she expects a high variability of the exchange rate. in addition, exchange rate volatility would reduce remittances because exchange rate volatility decreases confidence in the home country's financial system. similarly, the political risk (polrisk) is found to be negatively and significantly related to remittances inflows. this result shows that when the political situation in the home country worsens remittances flow decrease. immigrants may choose to keep more of their money in the host country during periods of political turmoil in the home country due to lack of belief in their country's political system. concluding remarks the latin america and the caribbean region is the largest remittances destination in the world. by 2005, remittances inflows exceeded the combined flows volume 26, number 1 113 of all net fdi to the latin american countries (inter-american development bank, 2006). because of their increasing volume and their potential to reduce poverty, remittances are and should be receiving growing attention from policymakers in the region. there is a wide range of important issues related to remittances. in this study, we focus on investigating the macroeconomic determinants of remittances to nine latin american countries. the empirical evidence presented in this paper shows that for the period of 1990-2006, macroeconomic variables of the host as well as home countries affected remittances inflows. host country variables such as median hispanic income in the u.s. significantly affected remittances inflows. in addition, the results show that home country risk variable such as exchange rate uncertainty is an important determinant of remittances to latin american countries. an increase in political risk seems to have a negative but insignificant impact on remittances. based on the findings of this paper, we can say that governments of the home countries can influence the inflow of remittances by stabilizing their currency and by improving their institutional and political environments. because government institutions and political instability matter for the manner in which remittances are used, governments should try to encourage remittances to be utilized for productive investment and thereby economic growth. the best way for these countries' governments to ensure that remittances contribute to positive economic growth is to foster better quality of institutions, political stability, and stable currency. notes i. remittances are the portion of international migrant workers' earnings sent back from the country of employment to the country of origin. world bank defines international flows of remittances as the sum of three items, namely, worker remittances, income (compensation) of migrant workers, and migrant savings (the net wealth of migrants when they return home). 2. the countries included in this study are: argentina, bolivia, brazil, chile, colombia, mexico, nicaragua, peru, and venezuela. these countries were chosen due to data availability. 3. most studies take account of the return to investment by using the interest rate differentials between the host and home countries. in this study, we use the inverse of the log of gop per capita to account for the rate of return to investment. for an explanation on how to construct this rate of return to investment variable, see aseidu, 2002. this substitution is made since market interest rates for most of the 114 journal of business strategies selected years are not available. in addition, the reported interest rates in many of these countries do not reflect true asset returns (higgins et ai, 2004). 4. the selection of the lac was based on data availability. 5. we aggregate the monthly conditional variances into annual frequency to obtain our annual volatility measures. 6. the stock of immigrants in the us. for each of the sample country was constructed from us. census data and annual data on us. immigration flows from each of the sample countries. 7. most studies use us. gdp to measure the economic well being of the migrants. however, mhi more closely maps the us. income of this group. mhi measures income of hispanic households (migrant and us. nationals) in the us (loser et ai, 2006). 8. for explanations of how to construct this variable see asiedu (2002). 9. we use the real rather than the nominal exchange rate, since uncertain price levels as well as exchange rates are relevant for long-term investments. all real exchange rates used in this chapter are bilateral exchange rates vis-a-vis the u.s. dollar. the real exchange rates are calculated by multiplying the ratio of prices in the united states relative to national prices by the nominal exchange rates. thus an increase in the real exchange rate index would indicate an appreciation of the us. dollar. 10. the arch term is the lag of squared errors from the mean equation or news about volatility from the previous period. 11. to ensure a well-defined process, all the parameters in the infinite order ar representation must lie outside the unit circle. for a garch (1,1) process this will be the case if a l and 01 are non-negative. it is also required that a l + 01 > 1 for covariance stationarity. 12. the results for the differenced variables' unit root tests are available upon request. 13. the variables with the presence of unit roots have been first-differenced. therefore they are in growth terms. volume 26, number 1 115 references agarwal, r., & horowitz, a. (2002). are international remittances altruism or insurance? evidence from guyanna using multiple-migrant households. world development, 30, 2033-2044. amuedo-dorantes, c., & pozo, s. (2007). remittances and the macro economy: the case of small island developing states. san diego state university, department of economics. working papers 0018. amuedo-dorantes, c., & pozo, s. (2004). worker's remittances and the real exchange rate: a paradox of gifts. world development, 32, 1407-1417. asiedu, e. (2002). on the determinants of foreign direct investment to developing countries: is africa different? world development, 30(1), 107-119. chami, r., fullenkamp, c., & jahjah, s. (2003). are immigrant remittance flows a source of capital for development? imf working paper 03/189. chandavarkar, a. g. (1980). use of migrants' remittances in labor-exporting countries. finance and development, 17,6-39. choi, 1. (2001). unit root tests for panel data. journal of international money and finance, 20(2), 249-272. djajic, s. (1989). migrants in a guest-worker system: a utility maximizing approach. journal of development economics, 31,327-339. durand, j., kandell, w., parrado, e., & massey, d. s. (1996). international migration and development in mexican communities. demography, 33(2), 249-64. elbadawi, i., & rocha, r. (1992). determinants of expatriate workers' remittances in north africa and europe. world bank working paper series 1038. el-sakka, m., & mcnabb, r. (1999). the macroeconomic determinants of migrant remittances. world development, 27, 1493-1502. faini, r. (1994). workers remittances and the real exchange rate: a quantitative framework. journal of population economics, 7,235-245. global economics prospects (2006). glytsos, n. p. (1997). remitting behavior of "temporary" and "permanent" migrants: the case of greeks in germany and australia. labour, 11, 409-435. hoddinott, j. (1992). modeling remittance flows to kenya. journal of african economies, 1, 206-232. higgins, m. l., hysenbegasi, a., & pozo, s. (2004). exchange-rate uncertainty and workers' remittances. applied financial economics, 14, 403-411. 116 journal of business strategies ilahi, n ., & jafarey, s. (1999). guestworker migration, remittances and the extended family: evidence from pakistan. journal of development economics, 2,485-512. inter-american development bank (2006). international country risk guide (icrg) (2006). jongwanich, j. (2007). workers' remittances, economic growth and poverty in developing asia and pacific countries. unescap working paper (wp/07/01). katseli, l. t., & glytsos, n. (1986). theoretical and empirical determinants of international labour mobility: a greek-german perspective. centre for economic policy research working paper 148. loser, c., lockwood, c., minston, a., & balcazar, l. (2006). the macro-economic impact of remittances in latin america: dutch disease or latin cure? interamerican dialogue. lucas, r., & stark, o. (1985). motivations to remit: evidence from botswana. the journal of political economy, 93,901-918. maddala, g., & wu, s. (1999). a comparative study of unit root tests with panel data and a new simple test. oxford bulletin of economics and statistics, 61, 631-652. ratha, d. (2003). worker's remittances: an important and stable source of external development finance. global development finance, 157-172. russell, s. (1986). remittances from international migration: a review in perspective. world development, 14,677-696. straubhaar, t. (1986). the determinants of workers' remittances: the case of turkey. weltwirtschaflliches archiv, 122, 728-740. united nations habitat (2006). vargas-silva, c., & huang, p. (2006). macroeconomic determinants of workers' remittances: host versus home country's economic conditions. journal of 1nternational trade & economic development, taylor and francis journals, 15( 1), 81-99. wahba, s. (1991). what determines workers' remittances? a framework for examining flows from migrant workers, with a focus on egypt's experience in the 1980s. finance & development, 28(4),41-4. world bank (2006). volume 26, number 1 117 biographical sketch of author bien solomon was born in addis ababa, ethiopia and started her college education at addis ababa university in 1996-97. at the end of her first year, she transferred to lawrence university in appleton, wi where she received her b.a. in 2000. she received her m.a. in economics in 2004 and her ph.d. in economics in 2007 from western michigan university. currently, she has a visiting position at grand valley state university. 118 journal of business strategies the impact of risk and uncertainty on remittances into latin american economies special issue on migration and remittances: an introductory note hiranya k. nath sam houston state university • huntsville, tx introduction the history of humankind has been the history of constant movements of people across natural as well as man-made boundaries. the adventure of discovery, the search for a better life in the face of destitution and misery caused by natural and man-made calamities, and above all, an indomitable human spirit have pushed people around over the centuries. the progress of human civilization is inconceivable without these movements. therefore, migration has been an intriguing area of study for researchers from a wide range of disciplines: history, geography, anthropology, sociology, psychology, and economics. according to the united nations estimate, the total stock of immigrants in the world was 190.6 million or 3% of the world population in 2005. the top 10 destination countries for international migration include the united states, russia, germany, ukraine, france, saudi arabia, canada, india, the united kingdom, and spain. the top 10 emigration countries are: mexico, russia, india, china, ukraine, bangladesh, turkey, the united kingdom, germany, and kazakhstan. ) note that both groups include developed as well as developing countries. furthermore, countries such as russia, germany, ukraine, india, and the united kingdom, have experienced large-scale in-migration as well as out-migration. these movements of people across national boundaries have important impact on the society, polity, and economy of both home and host country. one of the most significant developments related to international migration, especially from developing to developed countries, is that the migrants transfer a large sum of money to their family and friends back home. according to world bank (2008), the estimated total of officially recorded remittance inflows reached usd 317.7 billion in 2007. this amount represents a three-fold increase from usd 101.6 billion in 1995. the developing countries received a total of usd 239.7 billion or about 75% of the amount in 2007. however, the actual size of remittances, including unrecorded flows through formal and informal channels, is much larger. the top 10 remittance recipient countries in 2007 are: india, china, mexico, philippines, france, spain, belgium, the united kingdom, germany, and romania. the top remittance sending countries include the united 2 journal of business strategies states, saudi arabia, switzerland , germany, russian federation, spain, italy, luxembourg, netherlands, and malaysia. these remittances have been a major source of a wide range of benefits in the recipient countries. the recent surge in world-wide remittance flows has attracted the attention of the researchers towards understanding the causes and consequences of these transfers. given the amount of money involved and their potential impact, this research agenda has important policy implications. this special issue of the jaurnal a/business strategies includes six research articles that address various issues related to migration and remittances with a focus on latin america. this selection has been made out of a pool of papers presented at the conference on regional trade agreements, migration, and remittances with special focus on cafta and latin america, organized in spring 2008 by the department of economics and international business, in collaboration with gibson d. lewis center for business research and economic development at the college of business administration, sam houston state university. the research findings presented in these articles have important implications for public policies and business strategies in the u.s., the host of the largest immigrant population, as well as in the home countries of these immigrants. there will be another special issue ofthe journal, scheduled to be published in spring 2010, that will include research articles primarily concerned with regional trade agreements and a few additional topics related to remittances. the selection is being made out of the same pool of papers as mentioned above. migration the first three articles in this issue deal with three important topics related to international migration from latin america. while cardenas, di maro, and sorkin demonstrate that migration has positive net effects on the well-being of family members of migrants in home countries, orren ius and nicholson highlight the negative effects of immigration, particularly of illegal immigration, in the host country. molina and jewell focus on the remigration decisions of the mexican illegal immigrants in the united states. a home country perspective cardenas et al. examine how migration affects the well-being of the family members left behind by the migrants in their respective home countries in latin america and the caribbean. this paper contributes to the existing literature on the volume 26, number 1 3 relationship between migration and well-being by analyzing the effects of migration on "subjective measures of well-being". 2 the primary finding of this investigation, based on micro-level data from the gallup world poll and latinobar6metro, is that in most cases migration enhances the well-being of the migrant-sending families . controlling for remittance-augmented income, often recognized as the strongest direct channel of positive impact of migration on well-being through higher level of consumption, the study finds that households with migrant family members are more satisfied than households with no family members abroad. the authors argue that this additional positive impact can be attributed to the role of remittances as an insurance to consumption against income shock, a channel that has also been recognized in the literature. another channel uncovered by the analysis is that remittances are often spent on items such as education or health that make a greater direct contribution to life satisfaction (well-being). furthermore, the authors argue that migration might affect satisfaction through changes in expectations. in particular, the observation of a better life for the migrant family member might increase hopes among other members who are left behind for their own future. however, the study finds that those households that are nutritionally insecure, and hence the most vulnerable, are made worse off by migration. this result is at odds with the pro-poor effects of migration found in other studies and leads the authors to suggest that the social safety net in poor areas , particularly those with heavy outflows of migrants, should be strengthened . this study also adds to the current literature by making clear distinction between three types · of insecurities: nutritional, personal, and employment, among the migrantsending families. a host country perspective orrenius and nicholson, in their article, present a host country perspective on immigration into the u.s .3 recounting the changes in the nature of immigration over the 20th century, they observe two important recent trends among the immigrants in the u.s. first, the education distribution of foreign-born workers has become highly bimodal: either they are highly educated or they have very little education . however, the authors contend that this pattern complements the educational pattern among the native workers who are overwhelmingly concentrated in the middle of education distribution. second, illegal immigration, particularly from mexico, has grown quickly in recent years and has come to constitute a significant proportion of the foreign-born population. they ascribe this rise in illegal immigra4 journal of business strategies tion to a combination of factors : changes in the u.s. immigration policy over the years and relative economic conditions in mexico and the u.s. although the article recognizes that global re-allocation of workers through migration from developing to developed countries benefits the world as a whole, it argues that the effects of migration on host-country natives are far less positive. in general, immigration has a positive effect on employment and output growth and benefits the native-born consumers by lowering relative prices of goods and services, and the investors, business owners, and landowners by increasing the returns on capital and land. however, there are at least two ways in which it affects the natives adversely. first, the gains from immigration disproportionately benefit investors, midand high-income consumers, and educated workers groups that are considered to be "doing well." low-skilled native workers are the most adversely affected as competition with immigrants lowers their wages. second, low-income immigrants with families who use more in public services than they pay in taxes put an enormous fiscal burden on the governments and this cost may outweigh the economic benefit of immigration to the society. re-migration molina and jewell present an analysis of mexican migrants to the u.s ., focusing on their decision to re-migrate. using data from the mexican migration project, this study analyzes the remigration decision of male, undocumented migrants. in particular, the authors assess the relative importance of various market and nonmarket factors such as income, remittances, and migration networks. it may be noted that the existing literature has shown these factors to be important determinants of initial migration decision. the results of this study indicate that these factors have significant effects on the remigration decision as well. the authors argue that these results have significance for the current migration policy proposals. for example, the authors believe that policies (like the bush administration's 2004 proposal) designed to match temporary migrants with u.s. jobs based on skills might lead to more illegal immigration rather than less. from the mexican perspective, u.s . policies that encourage temporary, repeat migrations will lead to higher remittance flows into mexico. therefore, it may be in the best interest of both the u.s. and mexico to establish bilateral immigration policy. volume 26, number 1 5 remittances the last three articles focus on remittances. ruiz and vargas-silva survey the economics literature that examines causes and consequences of remittances. while solomon's paper examines how exchange rate uncertainty and political risk affect the flows of remittance transfers into selected latin american countries, valerogil addresses the question if remittance transfers are targeted towards household's health care expenditures in mexico. determinants and consequences of remittances: a survey ruiz and vargas-silva present an extensive survey of the empirical literature on the determinants and consequences of workers ' remittances. it may be noted that the scope of migration and remittances research extends beyond economics and into other social sciences. the survey focuses on the economics literature. there are two main strands of this literature: one is concerned with the factors that determine the flows of remittances, and the other investigates the consequences of remittances. each of these two strands can further be subdivided into microeconomic studies and macroeconomic studies. the micro studies are mainly based on survey data on various household and migrant characteristics and the macro studies are based on time series or panel data on macroeconomic variables. the theoretical literature has identified four plausible motives for remittances, namely, altruism care for family members in home country, self-interests investment or possibility of inheritance in home country, insurance against risks that migrants are exposed to, and repayment of loans that facilitated migration. most empirical micro studies examine these motives using data collected through surveys of households and migrants. this paper also discusses the macro level determinants of remittance transfers such as exchange rates, gop, and interest rates in home as well as host countries that have been examined in the literature. the empi rical studies on the determinants of remittances indicate that no single motive for remittances is consistently selected over others across countries and over time. the literature on the consequences of remittances explores both positive and negative effects of remittances. at the macro level, there is evidence of remittances enhancing economic growth directly through alleviation of credit constraint and an increase in investment or indirectly through an increase in aggregate demand. among the negative effects, the existing studies provide evidence of appreciation of the local currency in the recipient country, leading to a dutch disease type phenomenon. the literature also provides evidence of differential effects of remittances 6 journal of business strategies on prices of different types of goods and services. the impact on the distribution of income has been examined and the results are mixed. the microeconomic studies examine the effects of remittances on the consumption, investment, and savings behavior of remittance receiving households in different countries. the findings cover a wide range of plausible impacts that are discussed in the survey. uncertainty and remittances solomon's paper contributes to the strand of literature that examines the determinants of remittances. in particular, she examines the effects of exchange rate uncertainty and political risk, after controlling for the conventional macroeconomic determinants, on remittance transfers into eight latin american countries between 1990-2006. the results of her empirical analysis suggest that an increase in exchange rate uncertainty reduces remittance flows into these countries. the effect of political risk on remittances is negative but statistically insignificant. based on these results, the author suggests that governments of the remittance receiving countries can influence the inflow of remittances by means of adopting appropriate macroeconomic policies to reduce exchange rate uncertainty and also by improving their political environments. targeted remittances valero-gil investigates the effect of remittances on household's health expenditures (hhe) and his paper represents a contribution to the literature on the consequences of remittances. by differentiating the effect of remittances on hhe from that of other income sources, this paper examines if remittances are especially targeted towards household's health expenditure in mexico. the empirical analysis of the data obtained from the national income expenditure survey of households of mexico for 2004 reveals that there exists a statistically significant effect of remittances on hhe and that has been interpreted as evidence of targeted remittance transfers. this effect is found to be more pronounced for households without access to the employment's medical insurance. notes 1. see world bank (2008) 2. the results presented in this paper were a part of the keynote address delivered by dr. mauricio cardenas, then executive director of fedesarrollo, bogota, colombia, volume 26, number 1 7 at the conference on regional trade agreements, migration, and remittances with special focus on cafta and latin america on april 12, 2008. 3. this paper has been adapted from the invited lecture delivered by dr. pia orrenius, senior economist and policy advisor at the federal reserve bank of dallas, at the conference on regional trade agreements, migration, and remittances with special focus on cafta and latin america on april 12, 2008. reference world bank. (2008). migration and remittances factbook 2008. washington, dc: econ.worldbank.org/wbsite/externallextdec/extdecprospects 10"contentmdk:21352016~pagepk:64165401 ~pi pk: 64165026~thesitepk:476 883,00.html 8 journal of business strategies special issue on migration and remittances: an introductory note assessing the performance impacts of information systems from the resource-based perspective: an empirical test of the indirect effect of is michael j. zhang sacred heart university fairfield, connecticut abstract research into the strategic impacts of information systems (is) from the resource-based view of competitive advantage has increasingly embraced the indirect effect ofis onfirm pe,:formance; that is, is interact with other complementary organizational resources in influencingfirm performance. using both survey and archival data, this study set out to test the indirect effect ofis and determine the complementary organizational resources contributing to is impacts on firm performance. the results provide additional evidence in support ofthe indirect performance effect ofis. specifically, the studyfound that the peiformance impacts of is arose from their interactions with firm-specific knowledge, information, vertical integration and related diversification that complemented is. introduction over the past decade, the resource-based view of competitive advantage has emerged as a popular approach to examining the strategic roles of information systems (is) (mata et ai., 1995; powell & dent-micaleff, 1997; lado & zhang, 1998; bharadwaj, 2000; byrd, 200 i; keams & lederer, 2003; wade & hulland, 2004; zhang, 2005). one critical issue in the resource-based inquiry of the strategic impacts ons is whether is alone can lead to competitive advantage or they must work in conjunction with other organizational resources in order to provide strategic benefits (wade & hulland, 2004). the former suggests a direct effect of is on firm performance, whereas the latter implies an indirect effect of is. while researchers have increasingly embraced the latter by arguing that is complemented by certain organizational resources may lead to competitive advantage and superior performance (feeny & ives, 1990; clemons & row, 1991; powell & dent-micaleff, 1997; lado & zhang, 1998; bharadwaj, 2000), there has been relatively less empirical attention to testing the indirect effect of is. since the indirect effect of is has become more and more influential in current thinking of how to evaluate and manage is resources (powell & dent-micaleff, 1997; wade & hulland, 2004), more empirical evidence is needed to ascertain this effect. furthermore, even though the indirect effect of is generally exists, we still don't know enough about what specific organizational resources complement is 142 journal ofbusiness strategies vol. 24, no.2 in influencing a firm's competitive position or performance (wade & hulland, 2004). while the normative literature proposes a number of potential organizational complements to is (feeny & ives, 1990; clemons & row, 1991; kettinger et al, 1994; powell & dent-micaleff, 1997), the performance impacts of many of those complementary resources have not been assessed in prior empirical research (kettinger et al., 1994; powell & dent-micaleff, 1997). discerning the influence of different is complements on the is-performance relationship would then increase our knowledge of what represents a relevant set of complementary resources that interact with is in affecting firm performance (wade & hulland, 2004). the purpose of this study was twofold. first, it provided another assessment of the indirect effect ofis on firm performance. second, by testing the relationships between three sets of firm-specific complements to is and firm performance, the study sought to empirically determine what organizational resources complement is in influencing firm performance. the remainder of the paper is organized as follows. the next section reviews the indirect effect of is within the resourcebased research on is impacts, as wel! as the existing empirical evidence. this is followed by an examination of the potential performance impacts of three types of organizational resources (unique organizational culture and structure, unique vertical integration and related diversification, and unique knowledge and information) that complement is. the methodology section describes the empirical analysis, including the sample and data collection procedure, the measurement of the variables of interest, and the results. the discussion section presents the implications of the research findings, the limitations ofthe study, and some suggestions for future research and practice. the last section provides a summary and conclusions for the study. literature review and hypotheses the resource-based view of competitive advantage as a popular theoretical perspective in the strategic management literature, the resource-based view ofcompetitive advantage suggests that firms with unique and difficult to imitate or substitute resources and capabilities can gain sustainable competitive advantage and superior performance (barney, 1991). over the past decade, the resource-based research has placed increasing emphasis on bundling a firm's resources and capabilities in creating and maintaining competitive advantage (eisenhardt & martin, 2000; demel! et al, 2003; lippman & rumelt, 2003). lippman and rumelt (2003), for example, have developed and used the notion of payments (costs to a resource) to show that superior organizational performance is achieved by finding the most valuable combination of a firm's resources and bargaining over the marginal contribution of combining the resources. drawing upon the concept of resource complementarity (the presence of a resource enhances the strategic values of other resources it complements) (teece, 1986), resource-based researchers further posit that firms exploiting the complementarity among their resources and capabilities can create complex refall 2007 zhang: performance impacts ofinformation systems 143 source/capability networks as barriers to imitation, thus enhancing the potential of achieving durable competitive advantage (collis & montgomery, 1998; barney, 2002; colbert, 2004). recent empirical studies have shown that the combinative effects of complementary resources and capabilities influence the competitive performance of firms (carmeli & tishler, 2004; song et ai., 2005). song et a1. (2005), for instance, found a synergistic effect between two complementary organizational capabilities (marketing-related and technology-related) on firm performance in the high turbulence environment. the resource-based view of the strategic roles of is since the early 90s, is researchers have turned to the resource-based view in examining the strategic roles of is and explaining the 'productivity paradox" regarding the strategic impacts of is (feeny & ives, 1990; clemons & row; 1991; mata et ai., 1995; powell & dent-micaleff, 1997; lado & zhang, 1998; bharadwaj, 2000; byrd, 2001). the early resource-based analyses viewed is as commodity-like resources that are generally neither unique nor difficult to imitate, hence rarely resulting in sustainable competitive advantage (clemons, 1986; clemons & row, 1991; mata et ai., 1995). in the literature, this perspective is known as the "strategic necessity hypothesis" (clemons & row, 1991). while acknowledging that the direct effect of is rarely exists, more recent resource-based inquiry has shown that is may still have an indirect effect on a firm's competitive position or performance. that is, despite lacking the characteristics required for sustainable competitive advantage, is may exert positive influence on firm performance through their relationships with other organizational resources. following the logic of resource complementarity (teece, 1986), is and strategy researchers have argued that firms whose is are complemented by other firm-specific and hard-to-copy organizational resources are in a better position to defend their is-derived competitive advantage than those that lack such resources (feeny & ives, 1990; clemons & row, 1991; powell & dentmicaleff, 1997; bharadwaj, 2000; tippins & sohi, 2003). according to this line of reasoning, though the necessary software and hardware used by a firm's is can be easily imitated, it is more difficult for its competitors to copy the unique and intangible resources the firm uses in implementing and exploiting its is. moreover, blending is with other organizational resources may create a complex set of complementary resources that are not easily matched by competitors, thus sustaining is-based advantage (bharadwaj, 2000). despite gaining acceptance among researchers who analyze the strategic impacts ofis from the resource-based perspective, the indirect effect ofis has not been subject to close empirical scrutiny. since it was first proposed in the early 90s, the indirect effect ofis has been tested in only two studies. in a longitudinal study of thirty is considered as 'classic' cases of strategic use of information technology in the literature, kettinger et a1. (1994) explored the potential influence of a number of organizational factors on the sustainability of the is-based competitive advantage. they found an established technological base and sub144 journal ofbusiness strategies vol. 24, no.2 stantial capital availability as two main organizational resources that differentiated the is producing sustained superior performance from the is resulting in only temporary superior performance. these findings seem to provide initial evidence for the indirect effect of is, although the effects of several resources (e.g., competitive scopes and information resources) that might potentially affect is-derived advantage were not tested due to lack of data availability. in a subsequent study, powell and dent-micallef (1997) investigated the indirect effect of is with cross-sectional data collected from 67 u.s. retailers. they examined and tested the relationships between three sets of organizational resources (information technology resources, complementary human resources, and complementary business resources) and perceived firm performance. the complementary human resources under study included open organization, open communications, organizational consensus, ceo commitment, organizational flexibility, and it-strategy integration. the complementary business resources encompassed supplier relationships, it training, business process design, team orientation, benchmarking, and it planning. powell and dent-micalleffound that it resources alone did not explain significant firm performance. they further found that some retailers gained performance advantages from using complementary human resources. since the empirical testing of the study focused on bundles of complementary resources, the performance effects of individual complementary resources were not closely checked. moreover, it remains unclear whether the complementary human resources under study were unique to the firms. while generally supporting the indirect effect of is, the empirical works by kettinger et al. (1994) and powell and dent-micallef (1997) were insufficient in identifying a relevant set of complementary organizational resources contributing to the indirect effect of is. the following sections examine three types of distinctive organizational resources (unique organizational culture and structure, unique vertical integration and related diversification, and unique knowledge and information) and their interactions with is in affecting firm performance. these complementary resources were selected as the foci of this study because they not only may contribute to is-based competitive advantage, but also tend to be firm-specific and hard to copy. as noted above, a firm is in a better position to protect its is-based advantage if its is are complemented by other organizational resources that are idiosyncratic to the firm and difficult to imitate (clemons & row, 1991; bharadwaj, 2000). unique organizational culture and structure that complement is organization and strategy researchers have long recognized the key roles of organizational culture and structure in developing and leveraging resources and capabilities for competitive advantage (amit & schoemaker, 1993; miller & whitney, 1999; galbraith, 2001; barney, 2002; miller, 2003). barney (2002) argues that, without supportive organizational culture and structure, a firm is less likely to exploit the full competitive potential of its resources and capabilities. miller (2003) showed how citicorp, under the leadership of john reed, used fall 2007 zhang: performance impacts ofinformation systems 145 different cultural and structure mechanisms (e.g., a collaborative culture, project teams and cross-functional committees) to tum its international branch network into a source of sustainable competitive advantage. besides complementing other organizational resources and capabilities, organizational culture and structure tend to be imperfectly imitable. it is well recognized in the resource-based literature that idiosyncratic and valuable organizational cultures are difficult to duplicate because they represent socially complex phenomena (barney, 1986b; 1991; fiol, 1991; lado & wilson, 1994). as barney (1991) notes, even though firms lacking certain attributes of a valuable organizational culture may understand how these attributes contribute to competitive performance, systematic efforts to create those attributes typically require simultaneous manipulation of complex social relationships, hence making imitation costly. research into the organizational impacts of organizational structure has also shown that duplicating effective organizational structures is difficult in that they are often context-bound (i.e., they must be properly matched with the particular organizational situations) and require synergistic integration ofdifferent organizational elements (e.g., processes, systems and capabilities) (miller & whitney, 1999; galbraith, 1995; 2000; 2001). to illustrate the complexity involved in designing and adopting an organizational structure, galbraith (2000: 173) makes the following observation regarding the difficulty multinational firms may face in designing a transnational structure: "it is not simply a matter of distributing regional and global mandates. rather it involves the creation of global management teams for the top group, as well as other key groups like product-development teams; the design of global business processes and information systems; the creation of new measurement and reward systems; and, finally, the use of managers with a global mind-set and team skills." it is evident from several streams of research that a firm's organizational culture and structure are instrumental in influencing its ability to derive strategic benefits from is. the absence oforganizational culture and structure supporting the smooth implementation and use of is has been documented as a major cause of many system failures in the is implementation and adoption literature. several empirical studies, for instance, have found relatively low system use among firms lacking a culture and reward systems that support is adoption (zuboff, 1988; constant et ai., 1996; goodman & darr, 1998). the business process reengineering research also demonstrates that firms whose structures and processes are not aligned with their new is have experienced difficulty in reaping the benefits of the is (hammer & champy, 1993; keen, 1993; boar, 1994). moreover, recent research on organizational barriers to knowledge management suggests that firms may not be able to tum data and information into useful knowledge and organizational results from their is without a supportive organizational culture and structure (davenport et ai., 2001). even if new knowledge is created from employing is, sharing the new knowledge may be limited by cultural and structural constrictions (zuboff, 146 journal ofbusiness strategies vol. 24, no.2 1988; ciborrra & patriota, 1998). aside from affecting the economic impacts ofis, firm-specific organizational culture and structure make it difficult for competitors to imitate the is they complement because organizational culture and structure tend to be socially complex and hence difficult to imitate, as noted above. hypothesis 1: is complemented by unique organizational culture and structure are positively related to firm performance. unique vertical integration and related diversification that complement is strategy scholars have long argued that competitive advantage can be achieved with competitive scope (porter, 1991; christensen, 2001). among several dimensions of competitive scope are vertical integration and related diversification. the former describes the extent of a firm's integration into the businesses of its buyers or suppliers, while the latter refers to the range of related businesses the firm competes in (porter, 1985). both vertical integration and related diversification have been shown as potential sources of sustainable competitive advantage in the strategic management literature. research based on transaction cost economics, resourcebased theory and knowledge-based view ofthe firm suggest that vertical integration may confer economic value by allowing the firm to avoid market exchange costs arising from opportunism, uncertainty and asset specificity (williamson, 1985) and better manage and utilize its unique and hard-to-copy skills and knowledge in certain functions (conner & prahalad, 1996; barney, 2002). moreover, barney (2002) has recently examined the roles of governance skills in vertical integration and argued that firms with superior governance skills (e.g., ability to analyze uncertain and complex economic transactions) that are rare and costly to imitate may increase and sustain competitive advantage derived from vertical integration. the related diversification literature indicates that related diversification based on sharing related activities or competencies is generally associated with superior firm performance (markides & williamson, 1994; palich et al., 2000; tanriverdi & venkatraman, 2005). further, certain types of related diversification tend to be more firm-specific and harder to duplicate. in his analysis of the potential linkage between related diversification and sustainable competitive advantage, barney (2002) notes that related diversification that exploits rare and costly to imitate economies of scope (e.g., core competencies) is more unique and immune from direct imitation than one based on common and less costly to imitate economies of scope (e.g., shared activities and risk reduction). is researchers adopting the resource-based perspective note that firms can create and maintain competitive advantage from merging is with unique related diversification or vertical integration (feeny & ives, 1990; clemons & row, 1991; kettinger et al., 1994). clemons and row (1991) identify three ways is can be deployed to exploit a firm's unique diversification scope for competitive advantage. first, firms with wider ranges of related businesses may achieve a scale advantage from using is to improve coordination of similar activities and resources across various markets, putting their rivals with more limited business scopes at fall 2007 zhang: performance impacts ofinformation systems 147 a cost disadvantage. second, by facilitating the transfer and sharing of critical skills and knowledge among multiple businesses, is give a firm with a broader industry scope better leverage of its expertise and hence competitive advantage. third, is may be used to generate synergistic effects (i.e., creating more value for the customer from combining different, but complementary resources in different lines of business). firms may also exploit variations in vertical integration to derive more performance benefits from is. a firm performing more vertically related activities can design and deploy is to leverage unique information and knowledge resources from its upstream or downstream businesses, hence creating an advantageous position over its less vertically integrated competitors (feeny & ives, 1990). in a classic case, otis (once an independent company of elevator manufacturing and service) installed a remote diagnostic computer system in the elevators it produced to capture and provide critical information to its service database. such unique information created by the system enabled otis to obtain competitive advantage over other elevator service providers (neumann, 1994). on the other hand, firms with shorter value chains may use is to form a network of "quasi-vertical" or "virtual" integration with their trading partners (clemons & row, 1991; lei et al., 1996). is-based virtual integration allows individual firms within the network to enjoy operational benefits of vertical integration (e.g., higher efficiency and increased coordination), while also reducing the transaction costs and risks associated with vertical integration and realizing the production economies available to separate, specialized firms (konsynski & mcfarlan, 1990; clemons & row, 1991). although competitors with full vertical integration may potentially match the level of operational integration, it is not as easy for them to match the production economies and flexibility of independent and specialized firms that are connected together by is (clemons & row, 1991). hypothesis 2: is complemented by unique vertical integration and related diversification are positively related to firm performance. unique knowledge and information that complement is it is widely recognized today that knowledge and information represent the most important resources of competitive advantage (itami 1987; nonaka & takeuchi, 1995; quinn et al., 1996; spender & grant, 1996). knowledge and information not only increasingly add value to products and services (davis & botkin, 1994), but also playa vital role in transforming resources and capabilities into dynamic core competencies (prahalad & hamel, 1990; leonard-barton, 1995; grant, 1996). moreover, because organizational knowledge tends to be tacit, socially complex, embedded in firm-specific routines and processes, and nontradeable in strategic factor markets, the knowledge-based advantage is difficult to copy and thus sustainable (polanyi, 1967; barney, 1986a; reed & defillippi, 1990; nonaka, 1994). like knowledge, firm-specific information can be hard to imitate (itami, 1987). for instance, proprietary databases (e.g., customer databases) may 148 journal ofbusiness strategies vol. 24, no.2 take years to build, and their development and access are often specific to a firm's interactions with its business environments (feeny & ives 1990; king & grover, 1991, siguaw & enz, 1999; winter, 2001). it is evident in the literature that the successful implementation and exploitation ofis to achieve such operational benefits as production efficiency, product flexibility and close cross-functional coordination depend upon a firm's knowledge resources (kotha, 1995; upton, 1995; lei et ai., 1996; hitt et ai., 1998). research on advanced manufacturing technologies (amt) such as computer-aided design (cad) and computer aided manufacturing (cam) demonstrates that the richness of a firm's tacit knowledge (the insights, heuristics and experience of the firm's employees) applied in the procedures and workflows supported by amt influences the long-term implementation success of amt (lei et al., 1996). for example, upton (1995) argues that manufacturers with workers adept at carrying out quick changeovers and responding to the demands of new customers are more likely to create a manufacturing system that combines it and employee skills to make is-based flexibility work. parthasarthy and sethi (1992) posit that firms whose employees possess the skills for selecting, processing and transmitting complex information quickly would enjoy greater economic gains from is-based flexibility. kotha's (1995) case study of how national bicycle industrial company (nbic), a japanese bicycle manufacturer, developed and implemented mass customization for competitive advantage revealed that access to highly trained workers and substantial in-house expertise in engineering and manufacturing played a critical role in nbic's ability to develop and deploy is to offer a great variety of bicycles at low costs. the study also showed that the same knowledge resources enabled nbic to use is to integrate different functional activities and establish a close information network with its customers and suppliers. the competitive advantage derived from combining human expertise with is is harder to duplicate because employee skills and knowledge that complement is are often unique and contingent on firm-specific organizational routines developed over an extended period of time. in their resource-based analysis of several it-related resources, mata et al. (1995) concluded that managerial skills in building, implementing and managing it are rare among firms, require long periods of practice and learning, and involve complex social relations. the mass customization experience ofnbic mentioned above showed that the main rivals of nbic had a hard time trying to imitate its approach to mass customization because nbic's is that supported its mass customization operation was built with in-house engineering and manufacturing expertise accumulated over many years (kotha, 1995). furthermore, firms blending their is with unique knowledge resources may be able to create a complex set ofcomplementary resources that are not easily matched by competitors (lado & zhang, 1998; bharadwaj, 2000). a firm is also in a better position to derive is-based advantage if the firm possesses unique information resources (feeny & ives, 1990). the presence of a proprietary database may create more strategic opportunities the firm can exploit with its is (sabherwal & king, 1991; kogut & zander, 1992). for instance, kraft fall 2007 zhang: performance impacts ofinformation systems 149 general foods developed a repertoire of usable promotion programs, products, value-added ideas, and selling tools from employing a centralized is to access and analyze sales and consumer data collected from 30,000 food stores nationwide (treacy & wiersema, 1993). in a more recent example, boston's fairmont copley plaza hotel provides its concierges with a guest-history database and street information through a computerized system to expedite guest service at the concierge desk. this is support has consistently boosted the concierge's guest-satisfaction index close to 90% and promoted loyalty among the hotel's core group of guests (siguaw & enz, 1999). further, the possession of firmspecific information not only increases the value of is, but also makes imitation difficult (hami, 1987; feeny & ives, 1990). while competitors may build similar is easily, it is harder for them to develop the comparable database that may take a long time to build. hypothesis 3: is complemented by unique knowledge and information are positively related to firm performance. methodology sample and data collection the data for this study came from two sources. the data tapping the independent variables were gathered via a mail survey administered in 1998, and the data about the performance and control variables were obtained from the research insight (formerly known as compustat) database. the target respondents ofthe survey were senior is executives in large (fortune and forbes) firms in the u.s. most of the respondents held the positions of either vice presidents of is or chief information officers. the senior is executive was chosen as the single informant in this study because of his or her familiarity with both is and strategic management issues. several previous studies have found increasing involvement of senior is executives in strategic planning and control activities of firms (applegate & elam, 1992; earl & feeny, 1994). furthermore, a recent study found the information offered by key is executives consistent with the insights obtained from other senior members of management (palmer & markus, 2000). hence, is researchers have increasingly relied on senior is executives as single informants in gathering data about strategic is issues (karimi et ai., 1996; palmer & markus, 2000). the contact information of the senior is executives was obtained from the directory oftop computer executives compiled by applied computer research inc. from this source, a sample of879 firms that had financial data in the research insight database was identified. before being mai led to the target respondents, the survey instrument was pre-tested and refined for content validity and item clarity with senior is executives from five fortune 500 companies headquartered in a midwestern state. one hundred and one questionnaires were undelivered or returned because the is executives were no longer with the companies. twenty-nine firms 150 journal of business strategies vol. 24, no.2 declined to participate in the study in writing, on the phone, or through e-mail. to boost the response rate, two follow-up mailings and one reminder letter were initiated after the first mailing. of the 778 firms that received the questionnaires, a total of 164 responses were received, out of which 16 responses were unusable. the effective response rate was thus 19% (148 responses). such a response rate is comparable to those reported in similar studies using senior is executives in large firms (sethi & king, 1994; powell & dent-micallef, 1997; byrd & turner, 2001; keams & lederer, 2003). to test for potential nonresponse bias, the respondent firms were compared to their non-respondent counterparts with respect to sales and number of employees. t-test results showed no significant differences between the two groups: sales (t = -1.227, p > .22) and number of employees (t = -1.308, p > .19). in keeping with armstrong and overton (1977), another nonresponse bias check was conducted by comparing early with late respondents. t-tests of the mean differences for the three explanatory variables failed to reveal any significant differences: unique organizational culture and structure that complement is (t = 1.042, p> .304), unique vertical integration and related diversification that complement is (t = 1.226, p > .228), and unique knowledge and information that complement is (t = -.875, p > .388). together, these checks provided some evidence for the absence of non-response bias in the data set. measures independent variables. based on the works by feeny and ives (1990), clemons and row (1991), and kettinger et ai. (1994), six items were developed to measure the six different unique organizational resources that complement is. for each of the six items, the respondents were asked to indicate the extent to which the use and implementation of their is required each of these resources on a five-point, likert-type scale with anchors ranging from "very great extent" (=5) to "no extent" (=1). to assess the construct validity and unidimensionality of the scale, a principal components factor analysis with varimax rotation was performed on the six items. the factor analysis (table 1) revealed three factors explaining about 77.8% of the total variance and corresponding with the three proposed sets of complementary resources, respectively. dependent variables. two popular measures of profitability, return on sales (ros) and return on assets (roa), were employed to measure the performance impacts of the unique organizational resources that complement is. both profitability ratios have been frequently used in previous assessments of the strategic impacts ofis (kettinger et ai., 1994; brown et ai., 1995; tam, 1998; li & ye, 1999). to smooth annual fluctuations and reduce short-term effects to some degree, a two-year (1998-1999) average was used for both variables. control variables. since the firms participating in this study came from a variety of industries, it was necessary to control, to some degree, the different industry conditions under which the firms operated. to control for the industry effects, sic codes were first used to classify the firms into four groups: 1) manufacturtable 1 factor analysis of unique organizational resources that complement is please indicate the extent to which your information systems require each of the following complementary assets (resources which are used in conjunction with the systems): item description 1. proprietary databases 2. firm-specific knowledge or skills 3. unique vertical integration between your company and your suppliers, customers or distributors 4. unique range of related industries in which your company competes 5. unique organizational culture 6. unique organizational structure eigen value % of common variance explained cronbach alpha unique organizational culture & structure .895 .914 2.40 28.55 .83 unique vertical integration & related diversification .797 .881 1.31 25.36 .68 unique knowledge & information .860 .805 .96 23.92 .57 'tj t: n o o -...l ~ ~ ~.. ~ ~ cl ~ ~ ::: (0 \ii ....... ~ ~ (0 c;;~ ~ ~ ~ ~-o' ::: ~ '"-\ii ~ '" ....... vi 152 journal of business strategies vol. 24, no.2 ing, 2) transportation and public utilities, 3) wholesale and retail trade, and 4) service. where a firm operated in more than one industry, the firm's sic code was determined by identifying the industry from which the firm received the largest percentage of sales and the corresponding sic code. three dummy variables (each with values of 0 or i) were then created for the second (transportation and public utilities), the third (wholesale and retail trade) and the fourth (service) groups offirms. for each dummy variable, a firm was assigned a value of i ifit belonged to a group. the fourth control variable was firm size, which has frequently been used in previous studies involving firm performance as a dependent variable (kivijarvi & saarinen, 1995; tam, 1998; li & ye, 1999). in keeping with kettinger et al. (1994), firm size was measured with total assets. the fifth control variable was technological resources. a firm 's technological resources may influence its ability to develop is for sustainable competitive advantage (kettinger et ai., 1994). while a preferable measure of technological resources is r&d intensity, the research insight data for r&d intensity were missing for many firms in the sample. an alternative measure (investment intensity operationalized as invested capital to sales), as recommended by kettinger et al. (1994), was then used for technological resources. the last two control variables represent two types of financial slack: available slack and potential slack (daniel et ai., 2004). reflecting a firm's ability to generate cash flow for reinvestment (chakravarthy, 1986), financial slack needs to be controlled due to its influence on the firm's financial performance as well as its ability to invest in and develop is (kettinger et ai., 1994; daniel et ai., 2004). following convention (bourgeois, 1981; daniel et ai., 2004), available slack was measured as the current ratio (current assets to current liabilities) and potential slack as the debt to equity ratio. analyses to test the hypotheses, two sets of two-stage regression analyses were performed, using ros and roa as the dependent variables. in the first stage of each set of the analyses, the seven control variables were entered into the regression model as a set. in the second stage, the three independent variables were added to the equation. to avoid potential multicollinearity among the three independent variables, their factor scores were calculated from the factor analysis and used in the regression analyses. results table 2 reports the means, standard deviations and bi-variate correlations for all the variables. unique knowledge and information that complemented is were positively correlated with ros (r = .17, p < .05), while unique vertical integration and related diversification that complemented is were positively associated with roa (r = .20, p < .05). unique organizational culture and structure that complemented is were not significantly correlated with either ros or roa. table 3 displays the results of the hierarchical regression analyses. hypothesis 1 '"rj table 2 to--means, standard deviations and correlation coefficientsa tv 0 0 -j variable mean s. d. 1 2 3 4 5 6 7 8 9 10 11 1. return on sales .05 .06 2. return on assets .04 .05 .52 ~ 3. industry dummy 1 .08 .28 -.02 -.01 ~ ;:s 4. industry dummy 2 .16 .37 -.22 -.06 -.14 ~ 5. industry dummy 3 .26 .44 .42 -.20 -.18 -.26 '1:l~ 6. total assets (in billions) 13.73 31.07 .20 -.02 -.01 -.12 .25 -;,cl 7. invested capital/sales .75 .62 .44 -.14 .25 -.29 .49 .26 ""l ~ 8. current assets! ~;:s current liabilities 1.89 3.02 .01 -.04 -.09 -.04 .22 .02 -.01 ~ ~ 9. debt/equity 1.47 5.30 -.03 -.09 .04 .06 .02 .16 .18 -.05 ~ 10. unique organizational "l:;j ~ ~ culture & structure that t;;complement ish 0 1 .07 .07 -.13 .19 -.01 .02 .01 -.04 .01 ~ 11. unique vertical integration '-tso & related diversification 0""l that complement ish 0 1 -.01 .20 .17 .02 -.19 .02 -.16 -.14 -.03 0 ~ ~ 12. unique knowledge -....0 & information ;:s that complement isb 0 1 .17 .14 .11 .09 .01 .08 -.09 .06 .07 0 0 ~ "'"-~ • n = 148. correlations greater than or equal to .14 are significant at the .10 level; r 2: .16 are significant at the .05 level; r 2: .21 are significant at ~ "'"the .01 level; r 2: .26 are significant at the .001 level; all two-tail tests. b the statistics of these variables are based on their factor scores. ....... vi w 154 variables journal ofbusiness strategies table 3 regression results8 roa ~odell ~odel2 vol. 24, no.2 ros ~odel3 ~odel4 industry dummy i -.05 -.12 industry dummy 2 -.13 -.17+ industry dummy 3 -.23* -.25* firm size (total assets) .04 .01 investment intensity (invested capital/sales) -.05 .02 current ratio (current assets/current liabilities) .01 .02 debt/equity -.07 -.08 unique organizational culture & structure that complement is .10 unique vertical integration and related diversification that complement is .18* unique knowledge & information that complement is .19* r2 .06 .13 .6r2 .07 f 1.43 2.10* .6f 3.49* an = 148. standardized regression coefficients are shown. +p < .10, * p < .05, ** p < .01, *** p < .001 -.07 -.06 .22* .08 .34*** -.05 -.10 .27 7.51*** -.13 -.09 .19* .04 .39*** -.05 -.11 .06 .10 .21 ** .33 .06 6.60*** 3.54* predicts that is complemented by unique organizational culture and structure are positively related to firm performance. models 2 and 4 show that unique organizational culture and structure that complemented is were not significantly associated with either roaor ros. therefore, hypothesis 1 was not supported. hypothesis 2 states that is complemented by unique vertical integration and related diversification are positively related to firm performance. the same models reveal that unique vertical integration and related diversification that complemented is were positively related to roa (b = .18, p < .05), but not ros. hypothesis 2 was thus partially supported. hypothesis 3 suggests that is complemented by unique knowledge and information are positively related to firm performance. as shown in models 2 and 4, unique knowledge and information that complemented is were positively associated with both ros (b = .2l,p < .01) and roa (b = .19, p < .05), hence supporting hypothesis 3. fall 2007 zhang: performance impacts ofinformation systems discussion 155 overview and research implications of the findings this research sought to empirically test the indirect effect of is on firm performance and identify several firm-specific, complementary organizational resources contributing to that effect. the results indicate that firms whose is were complemented by unique knowledge and information enjoyed gains in ros and roa. is complemented by unique vertical integration and related diversification could also lead to higher roa. consistent with the normative literature (feeny & ives, 1990; clemons & row, 1991) and the empirical work by kettinger et a1. (1994) and powell and dent-micaleff (1997), these findings provide additional evidence in support ofthe resource-based argument that is influence on firm performance arises from their interactions with other firm-specific and hard-to-copy organizational resources. while confirming the indirect effect of is, this study differed from the previous studies by finding empirical support for the roles of unique knowledge, information, vertical integration and related diversification that complemented is in affecting the relationship between is and firm performance. one possible fruitful extension to the research on the indirect effect of is is to identify and examine other distinct organizational resources that could potentially enhance is impacts on firm performance. another possible direction for future inquiry in this line of research is to investigate the interrelationship between is and organizational knowledge/information. since is are capable of helping firms develop valuable and firm-specific organizational knowledge and information (trybula, 1997; lado & zhang, 1998) that in tum can be used to facilitate the implementation and utilization of is, a firm can create a reciprocal relationship between these two types of organizational resources, which could then increase the complexity of the resource complementarity and hence make imitation more difficult. contrary to the expectations and the findings by powell and dent-micaleff, (1997), the study found no evidence for the performance influence of firm-specific organizational culture and structure that complemented is. this unexpected non-finding might be due to the coarse measures used in the study (see the limitations of the study below). another possible explanation is that some unique organizational cultures and structures in the sample might not exhibit certain desirable characteristics such as open organization and open communications (powell & dent-micaleff, 1997). consequently, even if those organizational cultures and structures were perceived as firm-specific and complementary to is, their interactions with is did not exert positive influence on firm performance. it then appears that more in-depth studies that draw from comprehensive analyses of organizational culture and structure (e.g., o'reilly et ai., 1991) are needed to identify specific aspects or types of organizational culture and structure, which are not only conducive to the implementation and exploitation of is, but also unavailable to competition. 156 journal ofbusiness strategies vol. 24, no.2 managerial implications the findings from this research have practical implications for the strategic management ofis. while firms these days are investing heavily in building and deploying is to improve their competitive positions, the performance impacts of such is investments depend on the presence of certain firm-specific resources that complement the is. a firm is more likely to reap economic benefits (gains in profitability) from its is investment if it possesses firm-specific knowledge, information, vertical integration and related diversification that facilitate is implementation and exploitation. hence, creating and utilizing unique knowledge and information that increase the effectiveness ofis investments are as important as making the is investments. moreover, aligning is with a firm's unique vertical integration and related diversification may increase the performance contributions of the is. the results presented here can be interpreted to imply a larger role for is in helping firms gain competitive advantage than that suggested by those who question the strategic value ofis (mata et ai., 1995; martinsons & martinsons, 2002). contrary to the growing skepticism towards whether is can be more than a "strategic necessity," the findings suggest that is can be a source of competitive advantage and superior economic performance if they are complemented by certain distinct organizational resources. accordingly, the critical issue facing firms and their managers is not whether they should invest in is, but how to manage the complementarity between is and other organizational resources to maximize is payoffs. limitations of the study the findings in this study need to be interpreted within its limitations. first, the study relied on perceptual data collected from single informants in measuring organizational resources that complemented is. data collected in such a manner might be influenced by the respondents' cognitive biases and distortions, although objective measures were used to reduce similar biases and inaccuracies in collecting the data for the performance and control variables and avoid potential common method variance. another measurement limitation lies in the use of single-item scales to measure the is complements. these general measures might be insufficient to fully capture the complexity in certain complementary resources (e.g., unique organizational culture, and unique organizational structure) and subject to different interpretations by different respondents. the coarseness of the measures might then have contributed to the non-finding for unique, complementary organizational culture and structure as well as the low reliability of unique, complementary knowledge and information. therefore, future research on the performance impacts of complementary organizational resources ofis need to develop and use multi-item scales with higher validity and reliability to measure these resources. while the study controlled for a number of industry and organizational factors, there might be other potential performance determinants whose effects were not fall 2007 zhang: performance impacts ofinformation systems 157 taken into account due to the lack of data and the small sample size. the exclusion of those variables might have resulted in overestimating or underestimating the contributions of the unique, complementary organizational resources to the indirect effect ofls (berry & feldman, 1985). whenever possible, future studies need to include other environmental and organizational attributes related to firm performance in order to obtain more accurate assessments of how unique, complementary organizational resources interact with is in affecting firm performance. as another limitation, the response rate (19%) for the survey used in this research was relatively low. while comparable to those of similar studies, this response rate may limit the generalizability of the study results. obtaining a high response rate for sensitive information concerning the strategic use of is continues to be a challenge for researchers. summary and conclusions this study tested the indirect effect of is on firm performance, which has received increasing attention in the resource-based research on the strategic roles of is. among three potential types of complementary organizational resources contributing to the indirect effect of is, the study found that unique knowledge and information complemented is in improving profitability. although to a lesser degree, the study also found the presence of unique, complementary vertical integration and related diversification positively associated with profitability. on the other hand, unique organizational culture and structure which have been often deemed as critical to is effectiveness and contributions to firm performance were not found to have any significant effect. together, the results from this study not only provide empirical evidence that the indirect effect of is may exist, but also increase our knowledge of is complements that are more likely to contribute to is-based competitive advantage. while representing one of the few empirical endeavors to assess the indirect effect of is and identify what types of complementary organizational resources contribute to that effect, this study suggests that additional research based on more rigorous methodology is needed to help us fully understand what represent a relevant set of is complements that affect the is-performance relationship. references amit, r. p., & schoemaker, j. h. (1993). strategic assets and organizational rent. strategic management journal, 14, 33-46. applegate, l. m., & elam, j. j. (1992). new information systems leaders: a changing role in a changing world. mis quarterly, 16(4),469-490. armstrong, j. s., & overton, t. (1977). estimating nonresponse bias in mail surveys. journal of marketing research, 14,396-402. 158 journal ofbusiness strategies vol. 24, no.2 barney, j. b. (2002). gaining and sustaining competitive advantage. upper saddle river, nj: prentice hall. barney, j. b. (1991). firm resources and sustained competitive advantage. journal of management, 17(1),99-120. barney, j. b. (1986a). strategic factor markets: expectations, luck, and business strategy. management science, 86, 1231-1242. barney, j. b. (1986b). organizational culture: can it be a source of sustained competitive advantage? academy of management review, 11, 656-665. berry, w., & feldman, s. (1985). multiple regression in practice. newbury park, ca: sage. bharadwaj, a. s. (2000). a resource-based perspective on information technology capability and firm performance: an empirical investigation. mis quarterly, 24(1), 169196. boar, b. (1994). information technology and business alignment: a strategic assessment. in b. voss, & d. willey (eds.), handbook ofbusiness strategy. new york: faulkner & gray. bourgeois, l. (1981). on measurement of organizational slack. academy ofmanagement review, 6(1),29-40. brown, r. m., gatian, a. w., & hicks, 1. 0., ji. (1995). strategic information systems and financial performance. journal of management information systems, 11 (4), 215-248. byrd, t. a. (2001). information technology: core competencies, and sustained competitive advantage. information resources management journal, 14(2),27-36. byrd, t. a., & turner, d. e. (2001). an exploratory analysis of the value of the skills of it personnel: their relationship to is infrastructure and competitive advantage. decision science, 32(1),21-54. carmeli, a., & tishler, a. (2004). the relationships between intangible organizational elements and organizational performance. strategic management journal, 25, 1257-1278. chakravarthy, b. (1986). measuring strategic performance. strategic management journal, 7(5),437-458. christensen, c. m. (200 i). the past and future of competitive advantage. sloan management review, 42(2), 105-109. ciborra, c. u., & patriota, g. (1998). groupware and teamwork in r&d: limits to learning and innovation. r&d management, 28( 1), 1-10. fa112007 zhang: performance impacts ofinformation systems 159 clemons, e. k. (1986). information systems for sustainable competitive advantage. information & management, 11(3), 131-136. clemons, e. k., & row, m. c. (1991). sustaining it advantage: the role of structural differences. mis quarterly, 15(3),275-292. colbert, b. a. (2004). the complex resource-based view: implications for theory and practice in strategic human resource management. academy of management review, 29(3),341-359. collis, d. j., & montgomery, c. a. (1998). corporate strategy: a resource-based view. boston: irwinimcgraw-hill. conner, k., & prahalad, c. k. (1996). a resource-based theory of the firm: knowledge versus opportunism. organizational science, 7,477-492. constant, d., sproull, l., & kiesler, s. (1996). the kindness of strangers: on the usefulness of weak ties for technical advice. organization science, 7(2), 119-135. daniel, e, lohrke, e, fomaciari, c., & turner, r. (2004). organizational slack and firm performance: a meta-analysis. journal of business research, 57, 565-574. davenport, t. h., harris, 1. g., de long, d. w., & jacobson, a. l. (2001). data to knowledge to results: building an analytic capability. california management review, 43(2), 117-138. davis, s., & botkin, j. (1994). the coming ofknowledge-based business. harvard business review, 72(5), 165-170. denrell, j., fang, c., & winter, s. g. (2003). the economics of strategic opportunity. strategic management journal. 24,977-990. earl, m. j., & feeny, d. e (1994). is your cio adding value? sloan management review. 35(3), 11-20. eisenhardt, k., & martin, j. (2000). dynamic capabilities: what are they? strategic management journal. 2i, 1105-1121. feeny, d. e, & ives, b. (1990). in search of sustainability: reaping long-term advantage from investments in information technology. journal of management information systems, 7,27-46. fiol, c. m. (1991). managing culture as a competitive resource: an identity-based view of sustainable competitive advantage. journal ofmanagement, i7( 1), 191-211. galbraith, j. (2001). building organizations around the global customer. ivey business journal, 66(1), 17-24. 160 journal ofbusiness strategies vol 24, no.2 galbraith, j. (2000). designing the global corporation. san francisco: jossey-bass. galbraith, j. (1995). designing organizations: an executive briefing on strategy, structure, and process. san francisco: jossey-bass. goodman, p. s., & darr, e. d. (1998). computer-aided systems and communities: mechanisms for organizational learning in distributed environments. mis quarterly, 22(4), 417-440. grant, r. m. (1996). prospering in dynamically competitive environments: organizational capability as knowledge integration. organization science, 7(4),375-387. hammer, m., & champy, j. (1993). reengineering the corporation: a manifesto for business revolution. new york: harper business. hitt, m. a., keats, b. w., & demarie, s. m. (1998). navigating in the new competitive landscape: building strategic flexibility and competitive advantage in the 21 st century. academy of management executive, 12(4),22-42. hami, h. 1987. mobilizing invisible assets. cambridge, ma: harvard university press. karimi, j., gupta, y. p., & somers, t. m. (1996). the congruence between a firm's competitive strategy and information technology leader's rank and role. journal of management information systems, 13(1), 63-88. keams, g. s., & lederer a. l (2003). a resource-based view of strategic it alignment: how knowledge sharing creates competitive advantage. decision sciences, 34(1), 1-30. keen, p. (1993). information technology and the management difference: a fusion map. ibm systems journal. 32, 17-39. kettinger, w. j, grover, v., guha, s., & segars, a. h. (1994). strategic information systems revisited: a study in sustainability and performance. mis quarterly, 18(1), 31-58. king, w. r., & grover, v. (1991). the strategic use of information resources: an exploratory study. ieee transactions on engineering management, 38(4),293-305. kivijarvi, h., & saarinen, t. (1995). investment in information systems and the financial performance of the firm. information & management. 28, 143-163. kogut, b., & zander, u. (1992). knowledge of the firm, combinative capabilities, and the replication of technology. organization science, 3(3),383-397. konsynski, b. r., & mcfarlan f. w. (1990). information partnerships shared data, shared scale. harvard business review, 68(5), 114-120. fall 2007 zhang: performance impacts ofinformation systems 161 kotha, s. (1995). mass customization: implementing the emerging paradigm for competitive advantage. strategic management journal, 16, 21-42. lado, a. a. & wilson, m. c. (1994). human resource systems and sustained competitive advantage: a competency-based perspective. academy of management review, 19(4),699-727. lado, a. a., & zhang, m. j. (1998). expert systems, knowledge development and utilization, and sustained competitive advantage: a resource-based model. journal of management, 24(4),489-509. lei, d., hitt, m. a., & goldhar, j. d. (1996). advanced manufacturing technology: organizational design and strategic flexibility. organization studies, 17(3),501-517. leonard-barton, d. (1995). wellsprings ofknowledge: building and sustaining the sources of innovation. boston: harvard business school press. li, m., & ye, r. (1999). information technology and firm performance: linking with environmental, strategic and managerial contexts. information & management, 35,4351. lippman, s. a., & rumelt, r. p. (2003). the payments perspective: micro-foundations of resource analysis. strategic management journal, 24,903-927. markides, c. c., & williamson, p. j. (1994). related diversification, core competencies and corporate performance. strategic management journal, 15, 149-165. martinsons, m. g., & martinsons, v. (2002). rethinking the value of it, again. communications ofthe acm, 45(7),25-26. mata, f. 1., fuerst, w. l., & barney. j. b. (1995). information technology and sustained competitive advantage: a resource-based analysis. mis quarterly, 19,487-505. miller, d. (2003). an asymmetry-based view of advantage: towards an attainable sustainability. strategic management journal, 24( 10), 961-976. miller, d., & whitney, j. o. (1999). beyond strategy: configuration as a pillar of competitive advantage. business horizons, 42(3), 5-14. neumann, s. (1994). strategic information systems: competition through information technologies. new york: macmillan college publishing company. nonaka, i. (1994). a dynamic theory of organizational knowledge creation. organization science, 5(1), 14-37. n onaka, i., & takeuchi, h. (1995). the knowledge creating company. new york: oxford university press. 162 journal ofbusiness strategies vol. 24, no.2 o'reilly, c., chatman, l, & caldwell, d. (1991). people and organizational culture. academyofmanagementjournal. 34,487-516. palich, l. e., cardinal, l. b., & miller, c. c. (2000). curvilinearity in the diversificationperformance linkage: an examination of over three decades. strategic management journal, 21(2), 155-174. palmer, j. w, & markus, m. l. (2000). the performance impacts of quick response and strategic alignment in specialty retailing. management science, 11(3),241-259. parthasarthy, r., & sethi, s. p. (1992). the impact of flexible automation on business strategy and organizational structure. academy of management review, 17( i), 86-111. polanyi, m. (1967). the tacit dimension. garden city, ny: anchor. porter, m.e. (1991). towards a dynamic theory of strategy. strategic management journal, 12,95-117. porter, m. e. (1985). competitive advantage. new york: free press. powell, t. c., & dent-micallef, a. (1997). information technology as competitive advantage: the role of human, business, and technology resources. strategic management journal, 18(5),375-405. prahalad, c. k., & hamel, g. (1990). the core competence of the corporation. harvard business review, 68(3), 79-91. quinn, l b., anderson, p., & finkelstein, s. (1996). leveraging intellect. academy of management executive, 10(3), 7-27. reed, r, & defillippi, r. (1990). causal ambiguity, barriers to imitation, and sustainable competitive advantage. academy of management review, 15, 88-102. sabherwal, r., & king, w r. (1991). towards a theory of strategic use of information resources. information & management, 20, 191-212. sethi, v., & king, w r. (1994). development of measures to assess the extent to which an information technology application provides competitive advantage. management science, 40(12}, 1601-1627. siguaw, j. a., & enz c. a. (1999). best practices in information technology. cornell hotel and restaurant administration quarterly, 40(5),58-71. song, m., droge, c., & hanvanich, s. (2005). marketing and technology resource complementarity: an analysis of their interaction effect in two environmental contexts. strategic management journal, 26, 259-276. fall 2007 zhang: performance impacts ofinformation systems 163 spender, j. c., & grant, r. m. (1996). knowledge and the firm: overview. strategic management journal, 17(winter special issue), 5-9. tam, k. y. (1998). the impact ofinformation technology investments on firm performance and evaluation: evidence from newly industrialized economies. information systems research, 9( i), 85-98. tanriverdi, h., & venkatraman, n. (2005). knowledge relatedness and the performance of multinational firms. strategic management journal. 26, 97-119. teece, d. j. (1986). profiting from technological innovations: implications for integration, collaboration, licensing, and public policy. research policy. 15,285-305. tippins, m. j. & sohi, r. s. (2003). it competency and firm performance: is organizational learning a missing link? strategic management journal, 24, 745-761. treacy, m., & wiersema, f. (1993). customer intimacy and other value disciplines. harvard business review, 71, 84-93. trybula, w. j. (1997). data mining and knowledge discovery. annual review ofinformation science and technology, 32, 197-229. upton, d. m. (1995). what really makes factories flexible? harvard business review, 82,74-84. wade, m., & hulland, 1. (2004). the resource-based view and information systems research: review, extension, and suggestions for future research. mis quarterly, 28(1), 107-142. williamson, o. e. (1985). the economic institutions of capitalism. new york: free press. winter, r. s. (2001). a framework for customer service relationship management. california management review, 43(4), 89-105. zhang, m. j. (2005). information systems, strategic flexibility and firm performance: an empirical investigation. journal ofengineering & technology management, 22, 163184. zuboff, s. (1988). in the age of the smart machine. new york: basic books. michael j. zhang is an associate professor in the department of management at sacred heart university. he received his doctor of business administration degree from cleveland state university. his current research focuses on the strategic roles of information systems from the resource-based perspective of competitive advantage, including the performance impacts of is support for organizational competencies, knowledge management, organizational learning, and 164 journal ofbusiness strategies vol. 24, no.2 organizational innovation. dr. zhang has published in journal of management, journal ofmanagerial issues, journal ofengineering and technology management, international journal ofknowledge management, and technovation. his email address is: zhangm@sacredheart.edu assessing the performance impacts of information systems from the resource-based perspective: an empirical test of the indirect effect of is the effects of customer-firm interaction on innovation and performance in service firms tammy r. huffman utah valley university • orem, utah bruce c. skaggs university of massachusetts amherst • amherst massachusetts abstract understanding innovation in services has always been complicated by the intangibility of the underlying offering and hence the ease of imitation by rivals. this study extends the transaction cost approach by investigating how the switching costs created by the interaction between a service firm and its customers impact the level of innovation activity by the organization. using data obtained from a sample of 221 service firms, the findings suggest that when organizations structure their service production processes in a manner that requires a high degree of direct face-to-face interaction with the customer, the resulting impact is an increase in customer switching costs. this, in tum, acts as competitive protection for these firms , inducing them to pursue greater levels of innovation. in addition, we found that certain combinations of customer-firm interaction and innovation activity led to superior performance. introduction numerous studies in the management literature have supported the idea that an emphasis on innovation can increase firm performance by leveraging dynamic capabilities (pittaway, robertson , munir, denyer, & neely, 2004); capturing market share (kerin, varadarajan, & peterson, 1992), exploiting experience and learning curve effects (lee, smith, grimm, & schomburg, 2000; porter, 1985), preempting scarce resources (lieberman & montgomery 1988), creating reputation effects (hitt, bierman, shimizu, & kochhar, 200 i), and adopting a service dominant logic (lusch, vargo, & o'brien, 2007). however, scholars also acknowledge that such an emphasis may not always result in higher levels of firm performance (lieberman & montgomery, 1998; lumpkin & dess, 1996). this contrasting stream of research suggests that when rivals are able to imitate the products or services of a first-mover, it can adversely affect the ability of the innovator to sustain an advantage, as the imitator may be able to avoid development costs, pricing mistakes, and learn from the first mover's experience (lee, et ai. , 2000; lieberman & montgomery, 1998; porter, 1985). 152 journal of business strategies the extant services literature proposes that this is of particular concern for innovators within service organizations because protecting new service innovations is difficult due to the intangibility of the offering (i .e., the service is typically a process, not a tangible product) (e.g. , song, oi benedetto, & zhao, 1999). as a result, these types of firms typically cannot depend on patents or other legal protections to ensure the efficacy of their innovations (e.g. , sundbo, 1997). thus, in order for these firms to increase their commitment to innovation, other barriers must be in place to reduce the impact of ease of imitation by rivals. one competitive barrier in services that has received much attention in the literature is the existence of a relationship between the service firm and the customer (gotlieb, levy, grewal, & lindsey-mullikin, 2004; klemperer, 1995; lehmann & neuberger, 2001; mills & margulies, 1980). in this study we are specifically interested in the direct face-to-face interaction between service firms and their customers. a customer-firm interaction (cft) occurs when there is direct face-to-face contact between the consumer and the service firm (mills, 1986; mills & margulies, 1980). interaction to varying degrees is typical for service organizations, since the simultaneous production and consumption of the offering requires these firms to interact with their customers to a greater degree than manufacturing firms (mills, 1986; normann, 1984). with today's technological advances, however, there are many different ways for firms to interact with customers (i .e. internet or automated communication). organizations must decide upon the level of direct face-to-face (cfi) interaction they will have with customers during service production. thus, the degree of cfi is a firm-level decision and is the result of how a service organization structures its production process (skaggs & huffman, 2003) . for example, some insurance companies structure service production so that there is little in the way of customer interaction, performing most of their transaction via the internet or telephone. other insurance companies open numerous branch offices and require face-to-face interactions with customers. therefore, within the same industry firms have varying levels of cft. when cft occurs, customers are better able to gain knowledge about the abilities of their particular service provider (mills & margulies, 1980). if the interaction between the customer and the provider is indirect or cosmetic (i.e., when cfi is low), the amount of knowledge the customer can gain about the provider 's abilities is limited , since there is restricted interaction with the production process (durkin, mccartan-quinn, o ' donnell , & howcroft, 2003) . however, if interactions are intense (i.e., when cfi is high), then a greater degree of knowledge regarding the provider's abilities at service production is acquired by the customer (durkin , et ai. , volume 27, number 2 153 2003). this knowledge reduces customers' perceived uncertainty surrounding the service oftering as well as their search and evaluation costs when considering future purchases (jones, mothersbaugh, & beatty, 2000). together, these act to increase the customer's perceived cost of switching to a ri va l's offering (e.g., kahneman, knetsch, & thaler, 1991; rumelt 1987; williamson, 1979). tn addition, jones, et at. (2000) found that these switching costs lead customers to stay with their current provider, even when the satisfaction with the current provider is seen as low. thus, service organizations with high levels of cfi are more likely to retain their current customers, as the switching and evaluation costs of considering alternate suppliers, deter buyers from leaving their current provider (rumelt, 1987). given that competitive barriers can increase a firm's chances for sustaining advantages from innovations, and that the level of cfi is a significant element of service transactions that can act as such a barrier, it is surprising that there has been little research investigating this relationship as defined in this paper. thus, the present study seeks to address this deficiency by examining the impact of cfi on service firm commitment to innovation. in doing so, we incorporate elements of transaction costs analysis and prospect theory to address the following two questions: 1) does the level of cfi impact a service firm 's level of innovation activity? and 2) will a "fit" between cfi and the level of innovation result in superior firm performance? we begin by discussing cfi and its impact on customer-firm transactions in service organizations. next, we discuss the influence cfi can have on a service firm 's commitment to innovation. in doing so, we develop and test hypotheses that relate cfi to innovation activity, as well as the interaction of these variables to firm performance. we end with a discussion of our findings and offer directions for future research. theory and hypotheses customer-firm interaction and services the literature on cfi has its origins in the unique nature of services. one of the most often cited aspects of service organizations is the simultaneous production and consumption of the offering. because of the intangible nature of services, these firms must interact to a greater degree with their customers than their manufacturing counterparts (mills, 1986; normann, 1984). during service production, an interaction occurs between the firm and its customers where information is exchanged for the purposes of producing the offering (mills & margulies, 1980). the amount 154 journal of business strategies of information exchanged is a byproduct of the level of customer-firm interaction, which is determined by how a service firm chooses to structure its production process (skaggs & huffman, 2003; tansik, 1990). thus, the degree of these interactions, and hence the level of information exchanged, varies among service providers (mills & margulies, 1980; shostack, 1987; skaggs & huffman, 2003). some service organizations may choose to produce their service in a manner such that little cfi is required, with interactions being generally indirect or automated. for service organizations that structure the production of their offering in this manner, the relationship is not so much about the production of services, but rather the dispensing of them (mills, 1986). past research on cfi has been chiefly concerned with its impact on the efficiency and effectiveness of service delivery. the impetus for this concern lies in the seminal work by thompson (1967), where he states that organizations should buffer their technological core from external disturbances in order to achieve greater effectiveness in production. since simultaneous production and consumption in services reduces the possibility of buffering, information generated from cfi became viewed as an external disturbance that created uncertainty in the service production process (skaggs & huffman, 2003 ; tansik, 1990). using thi s lens, researchers began to investigate ways to adapt to and/or reduce the level of the customer-induced uncertainty in service production. areas of investigation have included the impact of this uncertainty on service production design (skaggs & huffman , 2003), on service quality (berry, parasuraman, & zeithaml, 2003), and on the level of human capital required in service production (skaggs & youndt, 2004). while we believe this research has given us insight into cfl, we also believe that its focus on the firm's response to uncertainty has limited the application of this construct. as discussed above, differing levels of customer-firm interaction impart different amounts of information and uncertainty into the firm. however, we also know that during this same interaction customers gain information about their provider (mills, 1986). when cfi is high , the in-depth interactions lead to personal exchanges between the customer and the firm (mills, 1986 ; normann 1984). while these exchanges allow the firm to access needed information from the customer, they also allow the customer to obtain greater information about the organization (eriksson & vaghult, 2000). the information obtained from direct interactions allows customers to acquire knowledge regarding such things as their provider 's skills, abilities , and level of commitment in providing the service in question ; in short, it gives customers knowledge about the firm 's overall ability at service production . con versely, low levels of cft grant customers minimal involume 27, number 2 155 formation regarding the provider. as a result, customers of these types of firms know comparatively little about the abilities of the provider. we suggest that this difference in the information resulting from the level of cfi has implications for a service firm 's innovation activity. cfi, switching costs, and innovation when customers are considering the purchase of a service among competing providers, they will use available information to inform their choice. if the customer has a relation ship with an existing provider, then , all else being equal, this will lead the customer to be predisposed towards the existing service firm. this is due to the customer 's tendency to minimize search costs (williamson, 1985). since the customer has access to free information regarding his/her knowledge of the current provider, and seeking knowledge of new providers would entail some type of cost (either in money, time, and/or effort), the customer will be inclined not to change providers. thus, any provider-specific knowledge can act as a switching cost for the customers of service firms (bolton, lemon, & verhoef, 2004; ouchi, 1984; rumelt, 1987; williamson, 1985) and these switching costs have been shown to impact buyer behavior. however, what compounds this predisposition is the loss aversion bias that is present in a consumer's calculation of switching costs. prospect theory, a well established theory in the economics literature, states that losses have much more of an impact on people's decisions than similarly sized gains (kahneman, et ai., 1991 ; kahneman & tversky, 1979). as a result, people tend to value the assets they have more than those that they do not have, for giving up the asset in their possession for another would introduce uncertainty and hence the potential for loss. the impact of thi s phenomenon is that people overstate the costs of giving up an asset in their possession for another, thereby leading to a status quo effect (i.e., holding on to their current asset) (kahneman, et ai., 1990). this phenomenon is exacerbated when the relative level of uncertainty between the two assets is high; that is, when people fully understand the benefits of the asset in their possession in relation to the asset they would be trading for. however, when people have little understanding of the benefits of the asset in their possession, then the status quo effect, although still present, is reduced. thus, the degree of the status quo effect is impacted by the relative level of uncertainty between the two assets in question. in transaction costs terms, the status quo effect that results from uncertainty and the loss aversion bias is actually the result of increased perceived switching 156 journal of business strategies costs on the part of customers (williamson, 1985). numerous studies using physical products have shown that customers tend to stay with their existing product rather than switch to that of a competitor, even though the competing product may be marginally superior (e.g. , kahneman , et ai., 1991). here, the physicality of the product in their possession allows customers to have an understanding of its benefits. the thought of adopting a new product introduces uncertainty and hence increases perceived switching costs, thereby inducing customers to stay with their current product (gourvilie, 2007). however, services are somewhat different. because of the intangible nature of services where what is sold is typically a process, it is the knowledge of this process that will aid in customers ' determination of the benefits derived from their current provider (cf. mills 1986). stated differently, what a customer gives up when switching providers is his/her familiarity with the existing provider 's abilities in service production. when this familiarity is high , the benefits from the current provider are well understood. this increases the relative level of uncertainty involved in switching providers, thereby increasing the perceived switching costs . however, when knowledge of the current provider's production abilities is low, the level of relative uncertainty between current and potential providers is reduced, which in tum reduces perceived switching costs. thus, while we know that customers generally tend to overweight their relationship with their current provider (gourville, 2007 ; kahneman , et ai., 1991), we believe this effect to be greater for organizations where there are high levels of cfi. here customers have amas sed a much larger amount of knowledge and familiarity with the production process. therefore, the perceived costs associated with switching providers will be much higher. as stated previously, the desire of service firms to innovate is tempered by the lack of competitive barriers (sundbo, 1997). we believe that high levels of cfi can serve as a sufficient barrier. by increasing the perceived switching costs for customers , high levels ofcfi enhance the status quo effect and thereby act as an isolating mechanism for these organizations (rumelt, 1987). because of this competitive barrier, we believe that firms that have constructed high cfi production processes will have a greater predisposition towards innovation activity for two reasons. first, since customers overweight the benefits from their current provider, they are more likely to adopt the innovations the firm develops (brush & artz, 1999). second, due to this overweighting of benefits and hence the perceived cost of switching, customers are unlikely to change providers when other firms copy the innovation (john & weitz, 1988; rumelt, 1987). in fact, switching is only likely to occur when the competing innovation is seen as vastly superior (gourville, 2007). the result of these two factors is that the risks associated with innovation are reduced . volume 27, number 2 157 thus, we believe that service finns that utilize high levels of cfi in their production process will engage in higher levels of innovation. hypothesis 1: a positive relationship will exist between a service .firm:slevel of cfj and its level of service innovation. hypothesis 2: a positive relationship will exist between a service firm:slevel of cfi and its level of delivery innovation. we have hypothesized that the perceived switching costs associated with the level of cfi will influence a service finn ' s commitment to innovation. however, investing in innovation can be a costly endeavor. the expenses in research and development, marketing, altering the delivery process, retraining of employees, and the like can amount to rather large investments on the part of the organization. given the costs, it is suggested that efficient finns will make just enough of an investment in innovation as is warranted by their level of cfi (cf. williamson, 1979). for example, an insurance agency that requires high levels of cft with its policy holders may be able to increase its perfonnance via innovation due to the presence of high perceived switching costs by customers. on the other hand, an agency that requires less cfllacks this competitive barrier. as a result it may be more likely to maximize its perfonnance by saving on the expense of investments in innovation. therefore, we suggest that service finns that possess a match between their level of cfi and innovation activity will have greater perfonnance. based on the expected association between cff and innovation detailed in hypotheses 1 and 2, we suggest the following moderated relationships: hypothesis 3: the level of cfj will moderate the relationship between service innovation and pe~formance. hypothesis 4: the level of cfj will moderate the relationship between delivery innovation and performance. methods sample to test our hypotheses we collected data through mail surveys and then analyzed the responses utilizing hierarchical regression. we collected data directly from service finns. we considered only those service finns that were publicly held in order to obtain published data pertaining to finn perfonnance. next, in accordance 158 journal of business strategies with previous innovation strategy research, we only included firms with more than $ 10 million in sales and more than 50 employees in order to enhance the possibility that the organizations possessed the resources to pursue innovation activities (o'brien, 2003). finally, we limited our sample to only those service firms that received a minimum of70% of their sales from a single industry (rumelt, 1974). this restriction was applied to increase the likelihood that a firm's level of cfi and innovation activity occurred in the same industry, as well as to decrease the possibility of multiple levels of cfi within a particular firm. using global access, a database containing in-depth financial information on over 12,000 companies, we identified 1,712 service organi zations that met our screening criteria. in accordance with miller (1991) and dillman (1978), multiple mail surveys were conducted involving the highest-ranking executive in each firm (usually the ceo, but in a few cases the president or chief operating officer). although difficult to retrieve information from top management, it is presumed that these individuals are most knowledgeable about their firms ' innovation investments and structure (barringer & bluedorn, 1999). a total of 1,712 questionnaires were mailed. [n response, 221 organizations representing 62 different industries returned usable questionnaires, representing a 13 % response rate. though this is somewhat low, it is consistent with other studies that have used ceos as their sample population (e.g. skaggs & huffman, 2003) . furthermore, an analysis of respondent-nonrespondent bias using one-way between-groups analysis of variance involving both the number of employees and performance showed the two groups were not significantly different on either of these dimensions (f = .679, p < .10 and f = 1.216, p < .10). this result indicates that there were no significant difference between companies that responded and companies that did not. thus, even though the response rate may be relatively low, the lack of bias indicates that the sample is representative of the broader population of firms . measures there are inherent challenges to measuring innovation in service organizations . due to the intangible nature of services, very few of these organi zations pursue patents, thus rendering patent counts ineffectual as a means for measuring innovation (miles, 2007) . also, a low percentage of these firms have stand-alone r&d departments, which makes the use of accounting-based r&d measures problematic (miles, 2007 ; sundbo, 1997). finally, since innovation in services tends to occur throughout the organization rather than in a stand-alone r&d department, identivolume 27, number 2 159 fying the specific number of innovations can be difficult (miles, 2007). for these reasons , and in accordance with previous innovation research, we opted for the use of perceptual measures in our survey aimed at ascertaining the level of commitment a service firm has to innovation. to add granularity, we directed our commitment questions toward the two broad types of innovation that are found in the innovation literature: product and process (e.g., barris, 1986; damanpour & shanthi , 2001) . barris (1986) differentiates the two types by suggesting that a "product" is a good or service offered to a customer, while a "process" is the method of production and delivery of the good or service. these two broad types of innovation were chosen because of their consistency with the services marketing literature, which states that the two main components of the service encounter are the "outcome" dimension (the actual service that the customer receives), and the "process" dimension (how the service is delivered) (parasuraman, zeithaml, & berry 1985 ; smith, boiton, & wagner, 1999). based on this classification we identified and measured two distinct dimensions of commitment to innovation within service firms: service innovation, which is the actual service the customer is purchasing, and delivery innovation, which is the process of producing and delivering the service. thus, service innovation pertains to a service firm's level of commitment to innovation activity aimed at improving the actual service offering. this construct was measured using a six-item scale based on innovation questions developed by miller and friesen (1978). cronbach 's alpha coefficient was .94, indicating that the six items were highly correlated and thus , are measuring the same thing, indicating internal consistency. delivery innovation refers to a service firm's commitment to activity in finding new ways to deliver its services (parasuraman, et ai., 1985). this variable was measured using a three-item scale with an alpha coefficient of .83. customer-firm interaction (cfj) involves both the quantity and quality of direct interaction between the customer and the firm in terms of the information exchange and the level of customer involvement during the exchange (mills & margulies, 1980). based on the typology by mills and margulies (1980), a four-item scale was developed to measure the level of cfl during transactions (alpha = .80). firm performance was measured by creating a composite index that included firm roa, ros, and market-to-book ratio (zhang & rajagopalan, 2004). this measure was developed by standardizing and summing two years of data (2002-2003) for these three performance indicators. raw data were obtained through thomson ana[yties database. the years 2002-2003 were chosen to reduce the anomalous effects of anyone year and to create a lag between the innovation variables and performance. cronbach 's alpha for this measure was .73. 160 journal of business strategies control variables a number of firm-level variables have been found to have a potential impact on innovation and performance. therefore, our study includes several control variables to ensure that the significance of our models is the direct result of our variables of interest rather than an extraneous variable. extant research in the area of strategy has found that the size of a firm may have an impact on firm perfonnance due to an increase in market size and available resources (e.g., huselid, 1995). in addition , these resources may also allow larger firms to engage in more innovation than smaller firms. in order to control for the effects offirm size, we calculated the natural log of the number of emp loyees . number of employees was used rather than sales, as it is believed to be a more accurate proxy of firm size in the service sector (normann, 1984, skaggs & huffman, 2003). it is also possible that the scope of a service firm 's strategy could impact its level ofcfl, as well as its relationship to innovation activity and performance (craft 2004). to control for market scope, we used a three-item scale developed by dess, lumpkin, and covin (1997) that measures the degree of focus of a firm's strategy (alpha = .623). lastly, the innovation literature as well as research concerning organizational change has found that ceo tenure can impact the level of innovation a firm undertakes (bantel & jackson, 1989). as a result, the survey asked for the number of years the ceo had been with the company. a number of industry-level variables have also been found to impact innovation activity and firm performance. to control for the effects of differing levels of industry performance, we developed a composite measure by combining the twoyear averages (2002 and 2003) of roa , ros, and market-to-book ratio for each industry at the 6-digit naics code level. utilizing the approach by boyd (1990), we controlled for munifzcence by calculating the regression slope coefficient divided by mean sales va lue found when regressing time against industry sales within a five year period (1997-2002) (boyd, 1990; subramaniam & youndt, 2005). in order to control for industry dynamism , we once again regressed time against industry sales over a five year period. we then took the standard error of the beta and divided it by mean sales for each industry. finally, industry complexity was assessed using the minl formula of sales concentration (subramaniam & youndt, 2005) . data used in these calculations were obtained from the census bureau's industry reports. to address the validity and reliability of our perceptual measures, we performed a confirmatory factor analysis using lisrel software. the comparative fit index (cfi) = .94, goodness of fit (gfi) = .88, the non-normed fit index (nnfi) = .93 , and the normed fit index (nfl) = .93. taken together these indices suggest volume 27, number 2 161 good model fit (lance & vandenberg, 2002). construct reliability was assessed by calculating cronbach's alpha for each of the constructs. all of the scales reached the.70 a suggested by nunnally (1978). moreover, the standardized loadings of all measurement items to their respective constructs were significant at the p < .05 level, suggesting that the scales for the constructs had convergent validity, indicating that the items for each scale were measuring the same thing (fornell & larcker, 1981). in addition to testing convergent validity or the internal consistency of a new measure, campbell and fiske (1959) stressed the importance of assessing discriminant validity to show that the items of a measure are not highly correlated to other measures and therefore are distinct theoretical constructs. to assess the discriminant validity of our measures, we examined the squared inter-construct correlations for each pair of constructs and compared them to the average shared variance for each construct, as suggested by f ornell and larcker (1981). the average shared variance for each construct was greater than the squared inter-construct correlations, thus suggesting an acceptable level of discriminant validity (fornell & larcker, 1981). in addition, none of the confidence intervals of the phi values contained a value of one (p < .0 i), again suggesting that the constructs possessed discriminant validity (bagozzi & phillips, 1982). one concern regarding our methodology was that while different sources were used to measure the independent and dependent variables in hypothesis 2, hypothesis 1 used a single source. in order to reduce the possibility of common response bias, a number of precautions were taken. following recommendations which can be found in podsakoff, mackenzie, lee, and podsakoff (2003), we pretested the items to reduce the possibility of confusing language in the field survey. next, to reduce the possibility of social desirability bias, respondents completed the questionnaire absent the presence of a surveyor and were assured of confidentiality. finally, none of the items elicited affective states, which helps to control for any mood-state bias. in addition to these precautions, we used harmon's single factor test to assess the presence of common methods bias (podsakoff, et ai., 2003). the emergence of three distinct, a priori factors suggests a reduced likelihood of this type of bias influencing our findings. given the results of the confirmatory analysis, the precautions, and tests taken to address common methods bias, we have high confidence in the validity of our findings . correlations, means, and standard deviations for all variables in the study are shown in table i . questionnaire items with factor loadings can be found in the appendix . table 1 -" 0> t\) correlations, means, and standard deviations std. servo del. dynafirm ceo ind mkt. mean dev. cfi inn. inn. perform mism. size tenure perf scope complex munif. cfi 5.109 1.226 service innovation 4.062 1.114 .161 delivery innovation 4.278 1.527 .227 .591 performance .132 2.145 .193 -.110 -.031 dynamism .119 .010 -. 097 .106 .057 -.179 firm size 2333 7023 .023 .170 .017 .068 -.156 ceo tenure 7.635 6.894 .116 -.053 -.034 .044 .040 -.1 67 industry '0performance 3.004 4.034 .011 -.030 -.010 .243 -.096 -.034 -.005 ~ "'t market scope 3.904 1.370 -.031 .046 -.004 -.010 -.027 -.060 -.039 -. 075 ;::: ;:. complexity -19.54 555.1 .058 .092 .019 -.038 -.035 -.003 -.027 -.048 .008 ~ b;j ~ munificence .052 .077 .001 .014 .053 -.009 .159 -.077 .001 -.028 .117 -.098 '" s· ~ correlations> .141 are significant at the p < .05 level. n = 221 '" '" while the data were centered to compute the interaction terms, the means reported were derived from uncentered data. ~ ~ ~ ~ . '" volume 27, number 2 163 results hierarchical regression analysis was performed to test the hypotheses of this study. this methodology allows us to assess the degree to which a change in the independent variables affects the dependent variable. the analysis required a multistep process. in the first step we included only the control variables as the independent variables . next, we added the variables of interest into the equation as additional independent variables. this technique allows us to identify the additional significance provided by the variables we hypothesize will affect the dependent variables. we used spss to conduct an ordinary least squared regression analysis to test the cfr innovation hypotheses (hypothesis 1 & hypothesis 2). as predicted, a significant relationship was found between cfi and service innovation (b = . 162, p <.0 i; see table 2). in addition, the direction of the relationship was, as predicted, suggesting that higher level s of cfr do lead to increasing commitment to service innovation. furthermore, we also found a significant relationship between cfi and delivery innovation (b = .241 , p < .01 ; see table 3) . the positive beta shows a relationship in the hypothesized direction such that higher levels of cfi result in higher levels of commitment to delivery innovation by service firms . taken together, these finds give full support to hypotheses i and 2. control firm size dynamism industry performance ceo tenure complexity munificence market scope main effects cfi table 2 regression results for service innovation step 1 .190** .144* .000 -.013 .101 .010 .043 .058 2.005 step 2 .181 * .159** -. 002 -.034 .091 -.005 -.045 .162** .087 .029** 2.420** 5.667** vif 1.061 1.062 1.034 1.035 1.032 1.056 1.029 1.030 164 control firm size dynamism industry performance ceo tenure complexity munificence market scope main effects cfi , p < .05 ; ** p < .01 journal of business strategies table 3 regression results for delivery innovation step 1 .034 .075 .022 -. 034 .037 .055 -. 008 .012 .359 step 2 .020 .097 .019 -.065 .023 .000 .241 .241 ,. .068 .056** 1.87 1* 12.316** vif 1.062 1.07 1 1.034 1.051 1.036 1.056 1.030 1.030 to test our hypotheses examining how the fit between cfi and innovation activities influences organizational performance, we performed moderated hierarchical regression analysis. while the model is significant we must next determine if the relationships are in the hypothesized directions. to understand the specific relationships between cfi, innovation activity, and performance, we graphed the significant interaction terms in the regression equations (see figures i and 2). table 4 shows the results of our analysis. for both innovation variables the results were as anticipated . as predicted, we found a significant, positive relationship between the interaction of cfi and commitment to service innovation and performance (b = .502, p < .001; see table 4). a graph of this interaction confirms our belief that higher performance will be associated with firms that combine higher levels of cfi with increasing levels of service innovation (see figure i). on the other hand, service firms that posses low levels of cfi see decreasing performance from their service innovation activity. similarly, the interaction of cfi and delivery innovation , and firm performance was also significant and positive (b = .207, p < .01). a graph of the interaction shows that for those service firms requiring high levels of cfi, increasing levels of volume 27, number 2 165 delivery innovation activity also lead to greater performance (see figure 2). and again , firms low in cfl experience decre ased performance from their pursuit of deliver y innovation . therefore, hypothes is 3 and hypothes is 4 are supported . table 4 regression results for cfi-innovation interactions and performance control and main effects step 1 step 2 vif firm size .081 .073 1.1 14 dynamism -. 11 7* -.096 1.103 industry performance .228** .192** 1.045 ceo tenure .033 -.002 1.065 complexity -.006 -.034 1.056 mu nifi cence .020 .033 1.060 market scope -.01 7 -.035 1.136 cfi .193** .240** 1.145 service innovation -.144* -.183** 1.666 delivery innovation .01 5 .059 1.626 interactions cfi x service innovation .502** 2.021 cfi x delivery innovation .207** 2.042 r2 .137** .280** llr2 .143** f 3.209** 6.480** llf 19.842** * p < .05; ** p < .01 figure 1 service innovation x cfi 0.5 -cii ",,~ u " c: 0 i'll ... " e " -0 .5 " .g " " cii q. -1 '. -1.5 service innovation 166 journal of business strategies figure 2 delivery innovation x cfi 0.6 cii 0.4 cj 0.2 c::: i'll e 0 .g -0.2 cii 0.. -0.4 -0.6 delivery innovation discussion we believe these findings have significant implications for both the study and practice of innovation within service firms. while much of the past research suggests that it is in the best interest of all firms to pursue innovation, recent thinking on this subject casts doubt on this prescription (e .g., dess, et ai., 1997; wiklund, 1999). indeed, scholars such as yoon (1998) have observed that some firms may benefit more from innovation activities than others. this is particularly true for service firms, given that the intangible, process-oriented nature of their offering makes it difficult to protect innovations from imitation by competitors (song, et ai., 1999). thus, only the presence of barriers to imitation can make innovation a desirable activity (makadok, 1998). by extending transaction cost analysis to include the customer, our findings suggest that cfi can act as a barrier to imitation for service firms by creating status quo effects through increased switching costs for customers. in particular, we found cfi to be positively related to the commitment of two distinct types of service firm innovation activity (service and delivery), and that a proper fit among these variables was associated with positive changes in firm performance. as predicted in hypotheses i and 2, cfi was positively and significantly related to increased levels of service and delivery innovation. taken together, these findings bolster the argument that when a service firm has intensive interactions with its customers, it impacts the perceived switching costs for its buyers . these costs become isolating mechanisms that induce firms to invest more in innovation activivolume 27, number 2 167 ties, for customers are more likely to adopt new services and/or delivery methods since they can do so without a lengthy and expensive evaluation search, and they will also be less likely to switch when a rival imitates the offering. in addition, our findings support a contingency explanation regarding the benefits of innovation activity. results of hypotheses 3 and 4 suggest that performance is increased when commitment to either service or delivery innovation is coupled with high levels of cft. however, when high levels of cfl are not present, either type of commitment results in lower performance. additional support for this contingency approach can be found by examining the relationship between service innovation and performance in the regres sion analysis in table 4. though not hypothesized, a significant, negative relationship was found to exist between commitment to service innovation and performance (b = -.144, p < .05). this suggests that, in general, higher activity levels in service innovation lead to lower levels of performance; it is only when this commitment is coupled with the appropriate level of cfl that performance is increased. firms with high levels of cfi create competitive barriers, thereby allowing them to profit from their investments in innovation. on the other hand, service firms with low levels of cfl can apparently increase performance by economizing on such investments. thus, the implication here is that managers within the service sector should resist the temptation to jump onto the innovation bandwagon without carefully considering the presence or absence of competitive barriers resulting from their firm's particular level of cfi. given the utility of cfi in understanding the pursuit and benefits of innovation activity in service organizations, there are a number of implications from our findings that involve extending the role of cfl into other areas of services. though not hypothesized, we found a direct, positive relationship to exist between cfi and performance (b = .193 , p > .01 ; see table 4). one possible explanation for this finding involves an extension of the switching costs argument. it may be that the creation of isolating mechanisms resulting from higher levels of cfi could afford such service organizations greater pricing power in general. future research could examine whether there is a relationship between the level of cfi and prices differences among competing service firms . a second implication involves the potential impact of cfi on the growth of a service firm ; in particular, its ability to expand geographically. service production processes that require high levels of cfi are typically more difficult to replicate than those requiring low levels of cfi (mills & margulies, 1980). as a result, the geographic growth potential of high cfi service firms may be limited as compared to those low in cfi. thus, a tradeoff may exist between cfi and geographic expan168 journal of business strategies sion. however, given that our findings strongly link cfi to innovation , the tradeoff for managers may boil down to a choice between growth through geographic expansion and growth through innovation. using the cfi concept, future research could examine its impact on the nature of growth in service organizations. up to this point we have viewed cfi from the perspective of the level of firm-specific information gained by the customer. however, during this interaction the service firm is also acquiring and acting on information generated by its buyers (e.g., skaggs & huffman, 2003). we believe it is likely that firms with high levels of cfi will be faced with processing a greater depth and variety of customer information. if true, then future research could examine whether the use of information technologies, such as customer relationship management (crm) (hansotia, 2002), are found to be present more often in these types offirms, and whether their presence leads to a performance advantage. one additional avenue for future study would involve the relationship between business level strategies and the type of innovation service firms engage in . the present study controls for business level strategy by including market scope but it would be interesting to pursue the idea that differentiation strategies engage in service innovations while cost leadership strategies focus on delivery innovations. though we believe the present study provides support for our extension of cfi as a competitive barrier that can induce innovation activity in service firms , there are some limitations. first, we assumed that during their interaction with the firm , customers acquire knowledge about the firm. therefore, we only measured the intensity and frequency of the interaction and not the actual knowledge that customers obtained. while the literature strongly suggests, and our data supports, the idea that intense interactions lead to this type of knowledge acquisition (e.g., durkin, et ai. , 2003 ; lengnick-hall , 1996; mills, 1986), we, nevertheless, did not directly measure it. second, we assumed that service firms possessed an overall level ofcfi with their customers. while this is true for many service organizations, it is possible that a firm could have multiple "ports" available to the customer, each with different levels of cfi. at issue is not the validity of our cfl measure. given the continuous nature of the construct, we feel confident that ceos offirms with multiple ports can reasonably derive an overall level ofcfi for their firms. furthermore, the sample restriction of single-industry dominant firms further helps to reduce the occurrence of multiple ports. rather, at issue is whether a more narrowly-focused measure ofcfi could uncover more specific, fine-grained relationships . for example, by ascertaining the levels of cfl for each port of entry into a service firm , one could determine whether particular ports are more essential in creating switching costs for custom170 journal of business strategies barris, r. (1986). towards a theory of innovation in services. research policy, 15, 161-173. berry, l., parasuraman, a., & zeithaml,v. (2003) . ten lessons for improving service quality. marketing science institute, report no. 93-104. bolton, r. n ., lemon, k . n., & verhoef, p. c. (2004) . the theoretical underpinnings of customer asset management: a framework and propositions for future research. journal of the academy of marketing science, 32, 271-292. boyd, b. (1990). corporate linkages and organizational environments: a test of the resource dependence model. strategic management journal, 11 , 419-430. brush, t. h. , & artz, k. w. (1999). toward a contingent resource-based theory: the impact of information asymmetry on the value of capabilities in veterinary medicine. strategic management journal, 20, 223-250. craft, s . h.(2004). the international consumer market segmentation managerial decision-making process. sam advanced management, 69, 40-46. damanpour, f., & shanthi, g. (2001). the dynamics of the adoption of product and process innovations in organizations. journal of management studies , 3, 23-42. dess , g . g. , lumpkin, g . t. , & covin, j. g. (1997). entrepreneurial strate gy making and firm performance : tests of contingency and configurational models. strategic management journal, 18, 677-695 . dillman, d . a. (1978). mail and telephone surveys: th e total design method. new york: wiley. durkin, m., mccartan-quinn, d. , o ' donnell, a ., & howcroft, b . (2003) . retail bank customer preferences : personal and remote interactions. international journal of retail & distribution management, 31 , 177-190. eriksson, k. , & vaghult, a. l. (2000). customer retention , purchasing behavior and relationship substance in professional services. industrial marketing management, 29, 363-372 . fornell , c. r. , & larcker, d. f.(1981). two structural equation models with unobservable variables and measurement error. journal of marketing research, 18, 39-50 . gotlieb , j ., levy, m. , grewal, d. , & lind sey-mullikin; 1. (2004) . an examination of moderators of the effects of customers ' evaluation of employee courtesy on attitude toward the service firm . journal of applied social psychology, 34, 825847. gourville, j. t. (2007 , june). eager sellers and stony buyers : understanding the psychology of new-product adoption. harvard business review, 98-106 . hansotia, b. (2002). gearing up to crm : antecedents to successful implementation . th e journal of database marketing, 10, 121-123. volume 27, number 2 171 hitt, m. a, bierman, l. , shimizu, k. , & kochhar, r. (2001). direct and moderating effects of human capital on strategy and performance in professional service firms: a resource-based perspective . academy of management journal, 44, 1332. hu se lid, m. a. (1995). the impact of human resource management practices on turnover, productivity, and corporate financial performance. academy of management journal, 38, 635-673. john , g., & weitz, 8. (1988, fall). forward integration into distribution: empirical test of transaction cost analysis. journal of law, economics, and organizations, 121-139. jones, m. a., mothersbaugh, d. l., & beatty, s. e. (2000). switching barriers and repurchase intentions in services. journal of retailing, 76(2),259-274. kahneman, d. , knetsch , j. l., & thaler, r. h. (1991) . anomalies: the endowment effect, loss aversion, and status quo bias. journal of economic perspectives , 5, 193-206. kahneman, d., & tversky, a (1979). prospect theory: an analysis of decision under risk. econometrica , 47, 263-291. kerin , r., varadarajan, r.r., & peterson, r. ( 1992). first-mover advantage: a synthesis, conceptual framework, and research propositions. journal of marketing, 56, 33-52 . lance, c. e. , & vandenberg, r. j. (2002). confirmatory factor analysis . in f. drasgow & n. schmitt (eds.), advances in measurement and data analysis (pp. 221254). san francisco : jossey-bass. lee, h. , smith, k. g. , grimm, c. m. , & schomburg, a (2000). timing, order and durability of new product advantages with imitation. strategic management journal, 21, 23-30. lehmann, e., & neuberger, d. (200 i). do lending relationships matter? evidence from bank survey data in germany. journal of economics behavior and organizations, 45(4),339-360. lengnick-hall, c. a (1996). customer contributions to quality: a different view of the customer-oriented firm. academy of management review, 21,791-824. lieberman, m. 8. , & montgomery, d. b. (1988). first-mover advantages. strategic management journal, 9, 41-58. lieberman, m. b., & montgomery, d. b. (1998). first-mover (dis)advantages: retrospective and link with the resource-based view. strategic management journal, 19, 1111-1125. 172 journal of business strategies lumpkin, g. t., & dess, g. g. (1996). clarifying the entrepreneurial orientation construct and linking it to perfonnance. academy of management review. 21, 135-172 . makadok, r. (1998). can first-mover and early-mover advantages be sustained in an industry with low barriers to entry/ imitation? strategic management journal, 19,683 -696. miles, 1. (2007). research and development (r&d) beyond manufacturing: the strange case of services r&d. r&d management , 37, 249 . miller, d . c. (1991) . handbook of research design and social measurement. newbury park, ca: sage. miller, d., & friesen, p. h . (1978). archetypes of strategy fonnulation. management science. 24, 921-933. mills, p. k. (1986). managing service industries: organizational practices in a postindustrial economy. cambridge, ma: ballinger. mills, p. k., & margulies, n. (1980). towards a core typology of service organizations . academy of management review. 5. 255-265. nonnann, r . (1984). service management: strategy and leadership in service businesses. chichester: wiley. nunnally, j . c. (1978). psychometric theory. new york: mcgraw-hill. o ' brien, j.p. (2003). the capital structure implications of pursuing a strategy of innovation. strategic management journal, 24,415-431. ouchi, w.g. (1984) . the m-form society. reading, ma: addison-wesley. parasuraman, a., zeithaml, v. a ., & berry, l. l. (1985). a conceptual model of service quality and its implications for future research. journal of marketing, 49,41-50 . podsakoff, p. , mackenzie, s., lee, j., & podsakoff, n. (2003). common method biases in behavioral research: a critical review of the literature and recommended remedies. journal of applied psychology, 88, 878-904. porter, m. (1985). competitive advantage. new york, ny: free press. rumelt, r. p. (1974). strategy. structure, and economic performance. cambridge, ma: harvard university press . rumelt, r . p. (1987). theory, strategy, and entrepreneurship. in d . j. teece (ed.), th e competitive challenge: strategies for industrial innovation and renewal. cambridge, ma: ballinger. shostack, g. l. (1987) . service positioning through structural change. journal of marketing, 51, 34-43. volume 27, number 2 173 skaggs, b. c., & huffman, t. r. (2003). a customer interaction approach to strategy and production complexity alignment in service firms. academy of management journal , 46, 775-787. skaggs, b. c., & youndt, m. (2004). strategic positioning human capital and performance in service organizations: a customer interaction approach. strategic management journal, 25,85-99. smith, a. k., bolton, r . n., & wagner, j. (1999). a model of customer satisfaction with service encounters involving failure and recovery. journal of marketing research, 36,356-372. song, x. m., oi benedetto, c. a. , & zhao , y. l. (1999). pioneering advantages in manufacturing and service industries: empirical evidence from nine countries. strategic management journal, 20, 811-836. subramaniam, m., & youndt, m. (2005). the influence of intellectual capital on the types of innovative capabilities. academy of management journal, 48,450-463. sundbo, j. (1997). management of innovation in services. the service industry journal, 17,432-455. tansik, o. a. (1990). balance in service systems designs . journal of business research, 20, 55-6\. thompson, j. o. (1967). organizations in action. new york, ny: mcgraw-hili. wiklund, j. (1999). the sustainability of the entrepreneurial orientation-performance relationship. entrepreneurship theory and practice, 24, 37-48. williamson o. e. (1979). transaction-cost economics: the governance of contractual relations. journal of law and economics, 22, 232-261. williamson, o . e. (1985). the economic institutions of capitalism: firms, markets, relational contracting. new york 0: the free press . yoon, s. (1998). a successful strategy of fohow the leader combined with cultural adaptation : a food company case. international studies of management and organizations, 28, 49-57 . zhang, y, & rajagopalan , n. (2004). when the known devil is better than an unknown god: an empirical study of the antecedents and consequences of relay ceo successions. academy of management journal, 47,483-500. 174 journal of business strategies appendix questionnaire items and factor loadings* 2 3 service innovation relative to our competitors ... 1. my firm allocates substantial financial resources to developing new innovative services. .796 .268 2. in the past 5 years my firm has developed many new innovative services. .840 .208 3. my firm is very often the first to introduce new services into the market. .891 .113 4. my firm is considered to be "cutting edge" when it comes to developing new services. .885 .185 5. developing unique service offerings is a priority of this firm . .805 .129 .339 6. our firm strives to develop new services that are different from our competitors ' offerings. .796 .296 delivery innovation relative to our competitors .. . 1. my firm is committed to developing better ways to deliver our services to our customers. .278 .131 .804 2. my company strives to develop unique ways to deliver our services. .403 .128 .785 3. in the past 5 years my fi rm has increased its overall commitment to developing innovative ways to deliver our services. .242 .816 customer -firm interaction (qfi) relative to our competitors, during service production ... 1. employees producing the service spend the majority of their daily working time in face-to-face contact with customers. .776 2. employees producing the service spend a lot of time dealing directly with the customer. .843 3. our firm more often meets directly with our customers to exchange information when producing the service. .819 .127 4. the service we provide requires that customers work closely with employees within this company. .733 .106 eigenvalues 5.84 2.71 1.18 % of variance explained 44.94 18.57 9.06 *loadings < .1 were excluded all items were on a seven-point scale ranging from "not accurate" (1) to "very accurate" (7). volume 27, number 2 175 biographical sketches of authors tammy huffman is an associate professor of management at the woodbury school of business at utah valley university. she received her ph.d. from the gatton college of business and economics at the university of kentucky. dr. huffman's recent research has focused on changes in information asymmetry and its impact on service industries. bruce skaggs is an associate professor of strategic management at the isenberg school of management at the university of massachusetts amherst. he received his ph.d. from the smeal college of business at the pennsylvania state university. much of dr. skaggs' research involves examining how service organizations identify and leverage their competencies to achieve competitive advantage. he is also currently involved in projects that explore how these firms build and leverage knowledge. 176 journal of business strategies the effects of customer-firm interaction on innovation and performance in service firms the journal of business strategies: the first twenty-five years sanjay s. mehta sam houston state university • huntsville, tx donald bumpass sam houston state university • huntsville, tx abstract the historical publishing pattern of the journal ofbusiness strategies (jbs) is examined. authors from 171 institutions have written over 262 articles from spring 1984 to fall 2008. contributions to the journal were studied in terms of numbers of schools represented, number of authors per article, diversity of articles, breakdown of gender of authors, types of citations, and empirical orientation of the articles. findings indicate that publications in jbs represent a significant scholarly contribution to the field of business strategy. few differences were detected between jbs and other selected journals. recommendations to enhance jbs are based on quantitative and qualitative analysis. introduction the publication of this issue ofthejournal ofbusiness strategies (jbs) marks the end of twenty-five years of publication. with a journal reaching such an important milestone, it is appropriate to look at the journal's history as part of its plans for the future (malhotra, 1996; hyman & steiner, 1997; muncy, 1991). summary articles of single journals have been written for many well-established business journals. for example, the journal ofadvertising (muncy, 1991), journal ofaccounting education (lehman & street, 1990), journal of international business studies (inkpen & beamish, 1994; chandy & williams, 1994), journal of the academy of marketing science (malhotra, 1996), journal of consumer affairs (geistfe1d & key, 1986), journal ofeconomic psychology (van raaij, 1986), journal ofmarketing education (clark & hanna, 1986), journal ofbusiness communication (koch, 1979; reinsch & lewis, 1993), journal ofmarketing (grether, 1976; marquardt & murdock, 1983), journal of finance (schweser, 1977; heck, cooley, & hubbard, 1986; schroeder, langrehr, & floyd, 1995), journal of macromarketing (finn & mcquitty, 1994), journal ofapplied business research (urbancic, 1994), journal ofbusiness and entrepreneurship (hyman & steiner, 1997), journal ofpurchasing and material management (williams & oumlil, 1987), journal ofpersonal selling 10 journal of business strategies and sales management (swan, powers & sobczak, 1991), and journal ofbusiness strategies (mehta, maniam & leipnik, 1999). for the fifteen year anniversary of jbs, a retrospective article looked at the first fifteen years of jbs. for the twentyfifth anniversary it seems an appropriate time to update that earlier effort. this paper will once again trace the evolution of jbs from conception to present. more specifically, the article will provide a detailed look at specific aspects of the oldest business strategy journal. a pluralistic research methodology will be utilizing (i.e., both quantitative and qualitative), as it is a more robust than using either one by itself. this article will provide an update to the previous endeavor, which was done a decade ago. evaluating the current state and statute of jbs is critical in 2008 for two reasons. first, the original editor of jbs, william b. green, was recently renamed the new editor after twenty-one years. second, the journal has had a successful twenty-five year history, a silver jubilee of sorts. history jbs was founded in 1982 at the center for business and economic research, sam houston state university (shsu). since its inception, jbs has been published semiannually (i.e., spring and fall) by shsu. the first issue of jbs was published in spring 1984 under the editorship of william b. green. the first issue mainly contained invited articles from reputable authors to insure that the jbs started off with some quality articles. an important initial objective of jbs was to attract quality articles and to position jbs as a relevant publication appealing to both practitioners and academicians within the business community. beginning with the second issue, all articles were double blind reviewed by selected members of the editorial board. editorial board members are reviewed regularly. twenty-five years later, the editorial review board includes a diverse group of academic and practitioners from disparate disciplines at reputed institutions. over the years of its existence, the quality of the editorial board has been sustained and continuously improved. during the first fifteen years, the outstanding editorial board has elevated jbs's reputation and established it as a high quality journal with ever improving manuscripts. if there is one criticism that could be alleged, it is the fact that the editorial board has lacked adequate international representation. susan a. simmons took over editorial duties in spring 1986 and served through the fall 1986 issue. no significant changes were observed during simmons' short tenure as the editor of jbs. most of the articles published during both green's and simmon's tenure as editor were focused in the area of management strategy. volume 25, number 2 11 in spring 1987, george d. greenwade became the third editor of jbs. he immediately instituted three major changes. first, jbs took on a glossy look and changed the binding from saddle-stitch to perfect binding so as it would be more appealing to practitioners. second, the fall 1987 issue contained a cumulative index of previously published articles. this strategy was important to help increase subscriptions to jbs. the practice of indexing previous articles continued for three years. third, the fall 1988 issue contained the only paid advertisement in jbss history. jo ann duffy became the fourth editor of jbs in fall 1990. with one exception, the status quo was maintained during duffy's tenure as the editor. for the first time, biographical sketches of the authors were published in fall 1991. in fall 1992, roger d. abshire became the fifth editor ofjbs. during his brief tenure as editor (i.e., two issues), the center for business and economic research, where the journal was housed, was renamed the gibson d. lewis center for business and economic development. while this change had a significant impact on the institution, it had no impact on jbs and its editorial staff or board. jo ann duffy was reappointed the editor in fall 1993 issue and she remained the editor through the fall 2007 issue. during duffy's second tenure as the editor, she implemented three significant changes. once again, the cover of the journal received a timely update. second, a web site (www.shsu.edu/~coba/jbs/board.html) was created for readers and researchers to read articles online and order articles from past issues. unfortunately, the website is not continuously updated and still lacks the ability to search specific words. third, current business topics were placed in "special issues" of the journal. according to duffy, "our first two special issues focused on the significant issue of 'services marketing' and 'banking,' where the journal was able to address needs of practitioners." the success and discrimination of the first two special issues was followed by several additional special issues. the next special issue of jbs addressed the timely topic of "internet marketing and e_commerce." due to aggressive marketing of the "call for papers" by the guest editors, douglas kline and sanjay s. mehta, the journal received over thirty-five quality submissions. after an extensive review process, it was determined that there were ten articles worthy of publication in the special issue. due to size and page limitation of jbs, two special issues were devoted to the topics of internet marketing and e-commerce (i.e., five articles in each issue) in fall 2001 and spring 2002. william b. green was once again appointed the editor ofjbs (i.e., prior to the publication of the spring 2007 issue). as jbs prepares for the next decade, green's 12 journal of business strategies long-tenn goals are two-fold. first, to attract articles that are appropriate for business practitioners. second, identify relevant business topics that justify a "special issue" of jbs. findings output during its first twenty-five years, 262 articles from 573 authors have been published in jbs. as shown in table 1, the average length of the article was 14.56 pages and the average articles per issue were 5.35. however, over the twenty-five years, there has been a noticeable trend toward longer articles (as measured by number of pages per article). for example, in 1984 the average pages per article were 8.80 and 2007 it was 21.33 pages. this increase in number of pages per article reflects a growing emphasis on the literature review and increased rigor in the methodology section. the average length of the article is consistent with others journals (14.56 pages for jbs versus 10.5 pages for other journal within business). the mean difference of 4 pages could be attributed to the smaller size (9x7 in) of jbs. next, the average number of articles published per issue is about the same as other journals (malhotra, 1996; hyman & steiner, 1997). in fact, jbs has attributes similar to other journals, such as number of issues per year and total number of pages per issue. authorship many studies use authorship with respect to institutional affiliation or the affiliation tally to gauge the diversity of authors and/or institutions that have published in a particular journal. it is an appropriate measure because institutions of higher education provide various resources and incentives to encourage greater productivity among faculty. because authorship with respect to institutional affiliation can enhance image and reputation of an institution, many serial retrospectives list the most common institutional affiliations of authors (hyman & steiner, 1997; carnaghan, flower-gyepsi & gibbins, 1994; clark, hancock & kaminski, 1987; clark & hanna, 1986; fields & swayne, 1988; geistfeld & key, 1986; gentry, allen & vellenga, 1995; goldsmith, 1983; hoverstad, shipp & higgins, 1995; reinsch & lewis, 1993; swan, powers & sobczak, 1991; wheatley & wilson, 1987). while authors from 138 different institutions have published articles in jbs, table 2 lists the top twenty-seven institutions (i.e., institutions with four or more articles published in the first 49 issues). the table indicates two methods of measurvolume 25, number 2 table 1 jbs output per year from 1984 to 2008 13 year number of articles· total number of pages· pages per article 1984 5+5=10 41+47=88 8.80 1985 5+4=9 47+41=88 9.78 1986 5 + 5 = 10 51 + 44 = 95 9.50 1987 5 + 5 = 10 47 + 40 = 97 9.70 1988 6 + 8 = 14 52 + 66 = 118 8.43 1989 8+7=15 77+84=161 10.73 1990 7 + 8 = 15 65 + 67 = 132 8.80 1991 6+8=14 76+71=147 10.50 1992 9 + 8 = 17 85 + 11 0 = 195 11 .47 1993 6+7=13 78+89=167 12.85 1994 6 + 6 = 12 82 + 101 = 183 15.25 1995 6 + 4 = 10 98 + 82 = 180 18.00 1996 5 + 5 = 10 106 + 91 = 197 19.70 1997 5 + 4 = 9 82 + 73 = 155 17.22 1998 4+4=8 72+75=147 18.38 1999 5 + 5 = 10 105 + 83 = 188 18.80 2000 5 + 4 = 9 86 + 88 = 174 19.33 2001 5+6=11 99+91=190 17.27 2002 5+4=9 93+93=186 20.67 2003 5+4=9 72+100=172 19.11 2004 4 + 4 = 8 94 + 88 = 182 22.75 2005 4+4=8 73+68=141 17.63 2006 5 + 4 = 9 91 + 79 = 170 18.89 2007 5 + 4 = 9 104 + 88 = 192 21 .33 2008 4 71 17.75 total 262 3816 14.56 (mean) * the first number and second number represent the first and second issues respectively. ing institution affiliations of jbs authors: unweighted and equal weighted authorship. we constructed the unweighted values by assigning weights equal to 1 for first, second, and third authors. the equal weights were constructed by assigning 0.5 and 0.5 for two authors; 0.34, 0.33, and 0.33 for three authors; and 0.25, 0.25, 0.25, and 0.25 for four authors. this technique of using unweighted and equal weighted measurement techniques have been previously used (mehta, manian & leipnik, 1999) and provides a consistent method of measurement to identify trends and promote a better understanding of the journal. five universities with the highest authorship in jbs are: sam houston state university, mississippi state university, new mexico state university, auburn uni14 journal of business strategies versity and louisiana tech university. some of these institutions are doctoral granting institutions and all of them are located in the southern half of united states. while this may give the impression that the jbs is only a publication outlet for universities in the south, a look at the entire list, shows that the jbs has published articles from universities located in more than 40 of the 50 states. sam houston state university authors have the highest number of publications over the twenty-five year history. while this gives the impression that jbs may be an in-house outlet for sam houston faculty, a close examination of articles, shows that 4 of the 10 articles were "introductions to special issues" that were edited by sam houston state university faculty members. table 2 institution affiliation of authors institution unweighted sam houston state university 10 mississippi state university 9 new mexico state university 8 auburn university 8 louisiana tech university 7 university of texas at san antonio 7 louisiana state university baton rouge 6 lamar university 6 texas a&m university college station 6 southeastern louisiana university 6 kansas state university 6 university of texas tyler 5 eastern illinois university 5 iowa state university 5 southern illinois university 5 florida atlantic university 5 clemson university 5 university of north carolina at charlotte 5 indiana university 5 university of north texas 5 east carolina university 4 middle tennessee state university 4 university of illinois at chicago 4 georgia state university 4 texas a&m international university 4 university of arkansas 4 university of tennessee at chattanooga 4 equal weights 7.84 5.84 7.25 4.84 6.15 4.50 3.00 2.67 2.50 2.40 2.28 4.25 3.17 2.49 2.25 2.10 2.00 2.00 2.00 2.00 2.33 1.97 1.67 1.42 1.34 1.00 1.00 volume 25, number 2 diversity 15 given its name and longevity, jbs attracts manuscripts from diverse disciplines. using hyman and steiner (1997) categories of academic areas, table 3 shows the most published disciplines in jbs are management/organization behavior, finance and marketing. specifically, 58.4% of the articles are about management and organizational behavior, 13.0% are about finance, and 13.0% are about marketing. two likely reasons for the high percentage of management and organizational behavior articles in jbs are: (1) its title gives the impression that it is a management strategy journal; (2) the longest serving editor of jbs, duffy, has a ph.d. in management and is professor of management. it could be argued that she tended to favor and accept greater number of articles within the management sub-discipline. contrasting these percentages with those from the fifteen anniversary issue, there continues to be a slight increase of publications in the areas of management and organization behavior. this increase can also be partially attributed the jbs's brief partnership with the southern managementassociation. generally, since authors tend to do research in their area of specialization or home disciplines (geitfeld & key, 1986), it is safe to conclude that most authors in jbs are from management, finance, and marketing-related disciplines. unfortunately, because biographical sketches of the authors were not published prior to 1991, no further conclusion can be drawn regarding the authors primary area of research and teaching. table 3 academic area of jbs articles academic area frequency percent management! organization behavior 15 marketing 34 accounting 13 finance 34 insurance/ small business entrepreneurship 9 economics 7 international business 4 unknown and others 8 total 262 58.40 12.98 4.96 12.98 3.44 2.67 1.53 3.05 100.00 16 gender of authors journal of business strategies another criterion used to evaluate journals is the ratio of male to female authors. similar to other journals, where the ratio of male to female authors is about 4 to 1 (mehta, manian & leipnik, 1999), the ratio for jbs is roughly the same. table 4 shows the gender of authors in jbs and indicates that out of 573 authors, 465 (81.15%) are male. from the table, it shows the female authors are increasing accordingly because the population growth in female is faster than male. also, further analysis found that like other comparable journal authors, jbs authors also tend to choose coauthors of the same gender (mcdowell & smith, 1992). table 4 gender of authors in jbs gender male female co-authorship frequency 465 108 percent 81.15 18.85 a growing percentage of articles published in business journals have multiple authors. as noted by hyman and steiner (1997), an increasing percent of business and psychology articles published annually are coauthored (barnett, ault & kaserman, 1988; dufrene & nelson, 1990, mcdowell & melvin, 1983; presser, 1980; schroeder, langrehr & floyd, 1995). this can be attributed to the fact that many recently accredited institutions do not discriminate (i.e., in terms of merit and promotion) between single and multiple author articles. urbancic (1992) also concluded that two thirds of accounting articles from 1978 to 1988 that were written by reputable and well-known accounting authors were also coauthored. similarly, mcdowell and melvin (1983) found that in the area of economics, there is a positive correlation in experience and the probability of co-authorship. in other words, the higher the experience, the higher the probability of coauthoring. we believe that this trend may partly ~e attributed to the increasing number of schools seeking greater research output from their faculty (i.e., "publish or perish" mentality). many institutions, especially smaller universities, do not or cannot provide the necessary tools for such productivity (e.g. database, reduced teaching assignment, graduate research assistant). therefore, co-authors tend to be faculty members from different institutions. volume 25, number 2 17 in jbs, only 27% of the articles (71 out of262) had one author, 37.6% (99 out of 262) had two authors, 28.5% (75 out of 262) had three authors, and only 6.8% (18 out of 262) had four or more authors. the percentage of single-authored articles in jbs is significantly lower than in other selected business journals (see table 5). in fact, the closest journal to jbs is the journal ofpersonal selling and sales management (jpssm) with 49.6%; all others are above 50%. on the other hand, the percentage of two author articles in jbs is twice as much as all other journals, except jpssm (25.2%). this indicates that authors in jbs contribute fewer single author articles and more two author articles than authors who contribute to other journals. the average number of authors per article for jbs is 2.10 (370/176). the highest average was in 1991, at 2.5, and the lowest average was in 1987, at 1.4. table 5 single and multiple authorship in jbs and selected serials author jbs jbe* jm* jm* jams* jcr* jmr* ms*jpssm* jme* econ* freq. pet. pet. pet. pet. pet. pet. pet. pet. pet. pet. pet. one 71 27.0 77.6 77.5 77.7 76.6 67.2 70.1 64.0 49.6 90.0 57.7 two 99 37.6 15.4 14.1 14.3 15.4 18.8 15.8 19.0 25.2 9.0 16.4 three 75 27.8 3.7 5.4 5.1 4.2 6.4 7.8 9.0 11.1 1.0 7.1 four 14 4.0 1.4 1.3 1.3 1.9 3.9 2.7 4.7 7.9 0.0 4.4 five or more 4 1.1 2.0 1.7 1.6 1.9 3.7 3.6 3.3 6.2 0.0 14.4 no. of different 565 299 955 447 520 563 526 300 405 199 13576 authors mean mentions 2.15 1.4 1.4 1.4 1.4 1.6 1.6 1.7 2.0 1.1 2.0 per author years published 198419891960198419841984198419841980197919632008 1996 1981 1993 1993 1993 1993 1993 1993 1985 1988 note: jbe is journal of business and entrepreneurship jm is journal of marketing jams is journal of the academy of marketing science jcr is journal of consumer marketing jmr is journal of marketing research ms is marketing science jpssm is journal of personal selling and sales management jme is journal of marketing education econ is percentages for top 20 economics journals *hyman & steiner (1997) 18 references journal of business strategies the impact of other researchers and disciplines on research trends can be analyzed by citation analysis (hyman & steiner, 1997; chandy & williams, 1994; reinsch & lewis, 1993). the average number of references used in an article can reveal how much jbs authors draw from other researchers. the formal definitions of the various citations are given in table 6 below. table 6 definitions of citations* term citation serial book (scholarly only) trade press/ magazines/newspaper proceedings/conference presentation other * hyman & steiner (1997) definition publication listed among references at the end of an article periodical published annually or more frequently that contains articles on various topics one-time publication devoted to one topic (including readings book (essay collection), and handbooks newspaper or specialty magazine devoted to narrow topic (the wall street journal, financial times, forbes, business week) published conference proceedings or working paper or presentations from academic conference general interest magazine or other source table 7 shows that jbs authors referenced an average of 23.85 citations per article. while the mean number of citations for jbs is lower than journal ofinternational business studies (35.8) and journal ofbusiness communication (32.3), it is higher than journal ofbusiness and entrepreneurship (20.6), journal ofaccounting education (11.2), and home economics research journal (16.9) (hyman & steiner, 1997). upon further examination, it is interesting to note that there is an upward trend in the number of references cited from 1984 to 2008 in jbs. at the very least it does indicate that jbs authors are using a greater number of references to support their studies. volume 25, number 2 table 7 references and number of articles in jbs 19 year 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 total number of references 33 + 71 = 104 76 + 48 = 124 59 + 60 = 119 90 + 77 = 167 90 + 110 = 200 173 + 178 = 351 134 + 140 = 274 11 2 + 103 = 216 177 + 237 = 414 122 + 196 = 318 230 + 192 = 422 252 + 147 = 399 215 + 227 = 442 187 + 132 = 319 183 + 147 = 330 312 + 173 = 485 137 + 220 = 357 234 + 170 = 404 172 + 275 = 447 155 + 202 = 357 173 + 189 = 362 271 + 190 = 461 275+137=412 263 + 223 = 486 164 8,133 number of articles 5 + 5 = 10 5+4=9 5 + 5 = 10 5 + 5 = 10 6 + 8 = 14 8 + 7 = 15 7 + 8 = 15 6 + 8 = 14 9 + 8 = 17 6 + 7 = 13 6 + 6 = 12 6 + 4 = 10 5 + 5 = 10 5+4=9 4+4=8 5 + 5 = 10 5+4=9 5 + 6 = 11 5+4=9 5+4=9 4+4=8 4+4=8 5+4=9 5+4=9 4 262 average number of references per article 10.40 13.78 11.90 16.70 14.29 23.40 18.27 15.43 24.35 24.46 35.17 39.90 44.20 35.44 41.25 48.50 39.67 36.73 49.67 39.67 45.25 57.63 45.78 54.00 41.00 31.04 comparing citation by outlet type for jbs and other selected serials, table 8 shows that jbs authors cite a larger percent of serials. serial citations in jbs are 71.8%, compared to 48.9% for journal ofbusiness and entrepreneurship, 55.7% for journal ofinternational business studies, and 55.7% for journal ofbusiness communication. jbs authors cite a far smaller percentage of books/monograph citations. books/monographs citations injbs is 6.9%, compared to 22.4% for journal ofbusiness and entrepreneurship, 37.4% for journal of international business studies, and 36.0% for journal ofbusiness communication. the difference can be attributed to the fact that serial citations may be more valuable to business strategy issues, since scholarly books can become obsolete and outdated rather quickly. 20 journal of business strategies table 8 citations of jbs citations jbs frequency percent jbs frequency percent serials books/ monographsffrade press magazines/ newspaper proceedings conference presentations papers dissertations/ theses other total number of articles year published 2934 71.81 281 6.88 239 5.85 536 13.12 1 0.02 95 2.33 4086 100.00 176 na 1984-1998 2705 68.90 202 5.15 372 9.48 570 14.52 1 0.03 76 1.94 3926 100.00 86 na 1999-2008 the only other difference noted (see table 8) is thatjbs articles have a higher percentage (13.1 %) of proceedings/conference presentations papers compared to 4.1 % for journal of business and entrepreneurship, 2.0% for journal of international business studies and almost no such citations for journal of business communication. jbs has a higher percentage of trade press/magazines and newspapers (5.8%) compared to journal ofinternational business studies or journal ofbusiness communication, which has none. only journal of business and entrepreneurship has a higher percentage (14.6%) than j13s. this is in part due to the fact that both jbs and journal of business and entrepreneurship are more practitioner-oriented than other journals (e.g., journal ofinternational business studies). similar to other journals, jbs cites very few dissertations or other publications. empirical articles about 48.25% (126 out of262) of the articles in jbs are empirical. while this is an increase from 43.75% ten years ago, but this percentage is still somewhat lower than the other surveyed journals. for instance, the journal ofbusiness and entrepreneurship had about 63.5% empirical articles (hyman & steiner, 1997), journal of accounting education had 53% (lehman & street, 1990), and journal ofeconomic psychology had 66%. only the journal of macromarketing had a somewhat lower percentage (37.5%) than jbs (finn & mcquitty, 1994). while the empirical articles use various methodologies, most of them are relatively easy to comprehend. this is consistent with the scope of jbs which is orientated to both academicians and practitioners. volume 25, number 2 conclusions 21 a survey of jbs for a twenty-five year period reveals that many authors are affiliated with regional institutions and that a relatively small number of the authors published more than one article. it also shows that co-authorship is getting increasing common, a trend noticed by others who have written summary articles (schroeder, langrehr & floyd, 1995). also, authors are citing an increasing number of references and a larger variety of sources. also, the number of pages per articles has been constantly increasing. the largest percentage of citations in jbs is serial publications. the diversity of the articles suggests that the articles are mainly about management, marketing and finance. similar to other academic journals, jbs is dominated by male authors. the mean number of authors in jbs is 2.10, which is comparable with other journals. when william b. green, the first and current editor, was asked about the future of jbs, he said "he is confident that the journal will continue to produce quality articles and that it will be successful in the long run." but he also emphasized that jbs must maintain its current focus of both theoretical and practical orientation in order to be of interest to both academicians and practitioners. recommendations personal interviews were conducted with a convenient sample of several editorial board members of jbs. their recommendations and views have been aggregated and summarized below. the primary concern expressed consistently by many of the board members was the similarity in the name between jbs and another journal with an analogous name (i.e., journal of business strategy). in our view, either the editorial board must consider a name change or position jbs differently. it is obvious the william b. green has decided to pursue the latter. further, the editorial board members felt that jbs must attempt to increase its circulation among both academics and practitioners. one possible solution to help boost circulation would be to consider publishing more special issues, and/or increase the number of issues per year from two to three or even four. another recommended approach to increasing the readership and dissemination of knowledge is to persuade additional abstracting service to either index the abstract or the entire journal. this strategy could be augmented with greater emphasis on maintaining an updated website that is searchable and offers articles for free. based on personal interviews with selected editorial board members and the analysis of both past issues of the jbs and other comparable journals, here are some 22 journal of business strategies additional recommendation that warrant consideration. these include but are not limited to: printing the title, author(s), and abstracts of the forthcoming articles in the current issue; printing the call for papers for special issues in the current issue; securing paid advertisement from large publishers or consulting firms in the business strategy area; adding an editorial preface and introduction to each issue. to make jbs appeal to a wider audience, some new sections could be incorporates into the journal, such as book reviews and software reviews. considering the high cost of printing and circulating a journal, one possible solution to offset these expenditures, would be to increase the annual subscription fee (it is presently at $25.00). similar to many other journals, an alternative could be to offer a three-tier subscription fee (i.e., individuals, institutions and libraries). to generate additional revenues, another option would be to charge a submission fee for the review process and/or publication fee for all accepted articles. finally, an annual business strategies conference chaired by the editor would significantly help jbs in generating revenues as well as increasing the visibility of the journal. some of these recommendations will be easy to implement while others may require some additional resources. for instance, the call for papers for the special issue can either be published in the biannual issues or mailed out to various institutions whereas hosting an annual conference or increasing the number of issues per year may undertake additional resources. to determine the feasibility of implementing some of the above mentioned recommendations, jbs could hold an annual meeting of the editorial board members at one of the conferences which a majority of the board members attend. finally, to bring about greater notoriety to the journal, sam houston state university may want to consider appointing an "external editor" (i.e., someone from another institution) who is well established and known within the field of business strategy. limitations and future research this study has two key limitations. first, because jbs did not publish biographical sketches of the authors prior to 1991, several other summary and comparisons cannot be undertaken. for instance, the rank of the authors who published in jbs cannot be easily determined. also, the area of specialization of the authors or area of expertise cannot be determined directly. second, the study did not attempt to assess how well jbs is received by its readers. a formal survey would have provided these insights. volume 25, number 2 23 references barnett, a. h., ault, r. w., & kaserman, d. l. (1988). the rising incidence of coauthorship in economics: further evidence. review of economics and statistics, 70(august),539-543. carnaghan, c., flower-gyepsi, j., & gibbins, m. (1994). a profile of contemporary accounting research: fall 1984-spring 1994. contemporary accounting research, 11(summer),251-270. chandy, p. r., & williams, t. g. e. (1994). the impact of journals and authors on international business research: a citational analysis of jibs articles. journal ofinternational business studies, 24(4), 715-728. clark g. l., hancock, w., & kaminski, p. f. (1987). an analysis ofleading contributors to the journal of marketing research: 1964-1985. in 1987 ama summer educators' conference proceedings (susan douglas, et. ai., eds.). chicago: american marketing association, 250-253. clark, g. l., & hanna, n. (1986). an analysis ofthe sources of articles in the journal of marketing education since its foundation in 1979. journal of marketing education, 8(summer), 71-74. dufrene, d. d., & nelson, b. h. (1990). effective co-authoring for business communication academicians. bulletin ofthe associationfor business communications, 53(june),68-71. fields, d. m., & swayne, l. e. (1988). publication in major marketing journals: 1960-1986. journal ofmarketing education, 10(fall), 36-48. finn, a., & mcquitty, s. (1994). empirical research in macromarketing. journal of macromarketing, 14(fall), 63-68. geistfeld, l. v., & key, r. (1986). a decade in perspective 1975-84: focus and trends in the journal ofconsumer affairs. journal ofconsumer affairs, 20(summer), 65-76. gentry, 1. 1., allen, b. 1., & vellenga, d. b. (1995). affiliation of authors in transportation and logistic academic journals-revisited. transportation journal, 34(spring), 54-62. goldsmith, e. b. (1983). an empirical analysis of the home economics research journal. home economics research journal, l1(march), 207-214. grether, e. t. (1976). the first forty years. journal ofmarketing, 40(july), 63-69. heck, 1. l., cooley, p., & hubbard, c. m. (1986). contributing authors and institutions to the journal of finance: 1946-1985. journal of finance, 41(december), 1129-1140. 24 journal of business strategies hoverstad, r., shipp, s. h., & higgins, s. (1995). productivity, collaboration, and diversity in major marketing journals: 1984-1993. marketing education review, 5(summer),57-65. hyman, m., & steiner, s. (1997). the journal of business and entrepreneurship: the first eight years. journal ofbusiness & entrepreneurship, 9(march), 1-31. inkpen, a., & beamish, p. (1994). an analysis of twenty-five years of research in the journal ofinternational business studies. journal ofinternational business studies, 24(4), 703-714. koch, j. e. (1979). a citation analysis for business communication, journal ofbusiness communication, 16(summer), 45-56. lehman, m. w., & street, d. l. (1990). a taxonomy of content and citations in the journal of accounting education (1983-1989). journal of accounting education, 8(spring),63-75. malhotra, n. k. (1996). the impact of the academy of marketing science on marketing scholarship: an analysis of the research published in jams. journal of the academy of-marketing science, 24(fall), 291-298. marquardt, r. a., & murdock, g. w. (1983). analysis of authorship in the journal of marketing 1960-1981. journal ofmarketing education, 5(fall), 53-57. mcdowell, j. m., & smith, j. k. (1992). the effect of gender-sorting on propensity to coauthor: implication for academic promotion. economic inquiry, 30(january), 68-62. mcdowell, j. m., & melvin, m. (1983). the determinants of coauthorship: an analysis of the economic literature. review of economics and statistics, 65(february), 155-160. mehta, s. s., manian, b., & leipnik, m. r. (1999). the journal of businesses strategies: the first fifteen years. journal ofbusiness strategies, 16(spring), 89-105. muncy, j. a. (1991). the journal ofadvertising: a twenty year appraisal. journal of advertising, 20(december), 1-11. presser, s. (1980). collaboration and the quality of research. social studies ofscience, 10,95-101. reinsch, jr., n. l., & lewis, p. v. (1993). author and citation patterns for the journal of business communication: 1978-1992. journal of business communication, 30(october), 435-462. schroeder, d. m., langrehr, f. w., & floyd, s. w. (1995). marketing journal coauthorship: is it a hit or a miss with coauthors? journal of marketing education, 17(summer), 45-58. schweser, c. (1977). the doctoral origins of contributors to the journal of finance from 1964 through 1975. journal offinance, 32(june), 908-910. volume 25, number 2 25 swan, j. e., powers, t. l., & sobczak, p. m. (1991). utilization of sales management knowledge and identification of contributors: an analysis of jpssm 19801990. journal ofpersonal selling & sales management, 11 (winter), 5-16. urbancic, f. r. (1994/1995). an analysis of the institutional and individual authorship sources of articles in the journal of applied business research: 1985-1993. journal ofapplied business research, ii(winter), 108-116. van raaij, w. f. (1986). the first five years of the journal of economic psychology. journal ofeconomic psychology, 7(march), 1-15. wheatley, 1. 1., & wilson, l. c. (1987). the origins of published marketing research in the 1980's. in 1987 a.ma summer educators' conference proceedings (susan douglas, et. al. eds.). chicago: american marketing association, 260-265. williams, a. 1., & oumlil, b. (1987). a classification and analysis of jpmm articles, journal ofpurchasing and material management, 23(fall), 24-28. acknowledgement we are grateful to ms. mary yiu, graduate student in the gibson d. lewis center for business and economic development, for her assistance in updating the last ten years of articles published in the journal of business strategies. her assistance and suggestions improved the quality of our paper. biographical sketches of authors sanjay s. mehta (m.s., ph.d., university of north texas) is currently professor of marketing at sam houston state university and winner of the "2005 excellence in research" award. he has presented over 125 papers at regional, national, and international conferences and served as track chair, session chair, discussant, and reviewer at many of these conferences. he has published over 75 articles in various proceedings/journals including: journal ofasian business, the cornell h.r.a. quarterly, journal ofprofessional services marketing, health marketing quarterly, journal of customers services in marketing and management, southwest decision science institute proceedings, southwestern marketing association proceedings, academy of international business proceedings, academy of marketing science proceedings, american marketing association proceedings, society offranchising proceedings, atlantic marketing association proceedings, and others. he holds a b.s. in mathematics and an mba in management from angelo state university. donald l. bumpass (ba, ms, phd, oklahoma state university) is currently professor of economics at sam houston state university. dr. bumpass has published over 30 articles in numerous journals including atlantic economic journal, 26 journal of business strategies review ofindustrial organization, american economist, antitrust law & economics review, journal ofeconomic education, and journal ofeconomics. his research interests include regional economic development and energy. the journal of business strategies: the first twenty-five years competition in search engine market wugang zhao stanford university • stanford, ca edison tse stanford university • stanford, ca abstract google has been very successful in becoming the dominant search engine platform in the us and western countries. in contrast to its success in the us and western countries, google does not have much luck in some asian countries such as china and korea. google is far behind in terms of search market share in china and korea. in this paper, we model the search engine market as a two-sided markets model and analyze the industry structure and competition of the search engine market. first, we present a mathematical model for a general search engine two-sided market. then we use the model to analyze the search engine history and explain why multiple search engines could co-exist in the early days of the search engine history. we also explain how google, a latecomer in the search market, could become the leading search engine, and how google has strengthened its leading position. next we apply the model to china and korea’s search markets and analyze how google could lose the game to local search companies. in the end, we propose some strategies on how search engine market leaders could maintain and strengthen their leading positions. introduction the world wide web has experienced exponential growth since its inception in early 1990s, and it continues growing rapidly (w3c, 2000). today, it is used in almost every aspect of our everyday life, such as searching for online shopping sites, company and product information sites, online social networking sites and online news sites. google was estimated to index around 20 billion web pages in oct. 2010 (kunder, 2010). netscraft reported that the total number of websites reached 232 million in oct. 2010 (netcraft, 2010). these data indicate that there are huge amount of information out there on the internet, with millions of websites and billions of web pages. search engines hold the key to the wealth of information available on the internet. users spend a significant amount of time on search engines looking for relevant information (gandal, 2001). very often a user starts with a search engine to get to a desired website. for example, an online consumer who wants to buy a digital camera may go to google, search for digital camera, browse the products and reviews of the candidate sites, and pick one to make the purchase, or a researcher 124 journal of business strategies who is looking for a paper may go to a search engine, search for the title of the paper, and download the paper from a target site. search engines play a critical role in disseminating web site information on the internet and they have a powerful position in the web space. according to alexa, search engines are among the most actively visited sites on the internet. for example, google ranks #1 in the most visited site in 2010 and several other search engines are among the top 25 (alexa, 2010). with the central role search engines are playing, they have become very attractive options for online advertising and target marketing. in the early days of the search engine history, there were many different search engines in the market. google’s entrance into the search engine market changed the market structure and competition landscape. google, a latecomer in the search engine market, was founded in 1998 and rose to prominence for its advanced search technology in 2000. google surpassed yahoo as the leading search engine in 2002 and has strengthened its market leadership position since then (searchenginewatch; netmarketshare, 2010). google also expanded into international search markets after it established its lead position in the us. compared to its huge success in the us and western countries, google did not have much luck in some of the major asian countries such as china and korea. in china, which has the largest internet population and potentially the largest internet market in the world, google is far behind the local search market leader baidu. baidu holds around 70% of the search market while google has only around 21%. in korea, the local market leader naver has 62% search market share and google only has 4% (bonfils, 2010; markettheglobe, 2010; visualeconomics, 2010). in this paper, we will model the search engine market as a two-sided markets model and derive some insights from it. the two-sided markets model has attracted a lot of interest among researchers (armstrong, 2004, 2005; csorba & hahn, 2003; eisenmann, et al. 2006; ferrando et al. 2004; rochet & tirole, 2003, 2004, 2006; roson, 2005; rysman, 2000). we will use a similar two-sided markets model presented by zhao and tse (2011) to model the search engine market. based on the model, we come up with some general strategies for a search engine to compete in the market. we will then use different variations of this model to explain the history and industry structure of the search engine market. we will explain why searchers tended to use multiple search engines to conduct the same search query in the early days of the search engine history and how google could emerge as a leading search engine. we then use the model to analyze google’s failure in china and korea. we point out that chinese users are in a different market segment from users in the us volume 28, number 2 125 and western countries and chinese language contents and related services are more relevant to them. focusing on chinese users and offering more chinese language contents and related services gave baidu an edge when competing with google in china. in korea, the lack of korean language contents created a special market condition. the local company naver took advantage on this by creating a knowledge sharing service and keeping it closed. this enabled naver to accumulate large amount of content in its private database, which google does not have access to. this gives naver an advantage over google in the korean search market. finally, we will propose some strategies for google and local search engine market leaders on how they could keep and strengthen their lead positions. search engines have attracted many research activities. lawrence, giles, bradlow and schmittlein pointed out that each search engine only indexed a small portion of the whole web space, and different search engines indexed a different set of web pages (bradlow & schmittlein, 1999; lawrence & giles, 1998, 1999). combining the results from multiple search engines can greatly improve the coverage, as was done with meta search engine such as metacrawler (www.metacrawler.com). a searcher would switch to another search engine if he/she fails to find the information he/she is looking for from one search engine. a user will do this because the low switching cost. switching cost for search engine is low due to two major reasons. first, search engine service is free for search users and search engine companies make money from advertisers. the revenue they can make from advertisers depends on the number of users who visit the particular web site (chatterjee & novak, 1995; hoffman & novak, 1996). second, search engines usually have the same user interfaces and the knowledge in using one search engine can be easily applied to another search engine. in another paper published by lawrence and giles in 1999, they expanded the research and found out that search engines did not index sites equally, they indexed a biased sample of the web, and they may not index new pages for months (lawrence & giles, 1999). the brand effect and first mover advantage have also been investigated in search engine competition literature. mukhopadhyay et al. pointed out that the incumbent search engine has a first-mover advantage, and, unless the new entrant has a cost advantage, the incumbent will emerge as the leader in equilibrium (mukhopadhyay, rajan, & telang, 2002; telang, rajan, & mukhopadhyay, 2004). telang et al. (20004) found that users develop loyalty for a given search engine. but simple search users do not develop strong loyalty. they showed that good quality search results are essential for repeated engine use. a poor quality engine cannot hope to develop a loyal base (telang, mukhopadhyay, & wilcox, 2000; telang & mukho126 journal of business strategies padhyay, 2005). gandal (2001) examined the evolution of and competition in the internet search engine market and found that while early entrants (yahoo, lycos, excite, infoseek, and altavista) still have an advantage, the pure brand effect advantage has been declining over time (gandal, 2001). jansen, zhang, and zhang (2007) investigated the effect of brand awareness on search engine competition results. they found that even though different search engines have similar technology and similar user interfaces, the majority of search traffic is directed to a small number of search engines. in this paper, we propose some strategies that help a first mover keep its leadership position. one important strategy is to build a new two-sided markets platform with strong positive cross network effect by leveraging its existing customer base. the paper is organized as follows. we first introduce the mathematical model and the key players in a search engine two-sided market in mathematical model. then we use the model to analyze the search engine market in analysis of the search engine’s history of development. we analyze why searchers tended to use multiple search engines to conduct a search query in the early stage of the search engine history. then we explain how google, a latecomer in the search engine market, could emerge as a market leader. in analysis of google’s failure in china and korea, we analyze why google failed in china and korea. in proposed strategies for market leaders, we come up with some strategies for local search leaders and google based on our model analysis and google’s failure in china and korea. conclusion and discussion summarizes and discusses the limitation of our research as well as the potential future research. mathematical model a search engine connects searchers (information seekers) and web sites (information providers). the web sites contain different kinds of information. for example, a company’s web site that has the product’s information, or an online catalog that has many research papers and books. searchers try to find the information from the web sites. due to the huge amount of information available on the internet, it’s hard for a searcher to quickly find the information he/she is looking for without the help of a search engine. a search engine stores and indexes the web pages so it can help a searcher quickly find the information. a search engine creates a two-sided markets platform, on one side are the searchers (information seekers), and on the other side are the web sites (information providers). there are positive cross network effects between the two sides: the more volume 28, number 2 127 searchers that use a search engine to search for information, the more benefit for the web sites owners (since the information published to the web sites can be viewed by more people); the more web sites publish information on the internet and these pages are indexed by a search engine, the more benefit to the searchers since they are more likely to find the information they are looking for. figure 1 shows a diagram of a general search engine two-sided markets platform. in this diagram, s stands for the whole web space, the universe. “web sites” on the right hand side are the web pages indexed by the search engine. “searchers” on the left hand side are the users who come to the search engine platform to conduct the search queries. “+” signs refer to the positive cross network effect between the searchers and web sites. figure 1 a general search engine two-sided markets platform the two-sided markets platform a search engine creates possesses some unique characteristics. first, a search engine has access to all the web sites that are publicly accessible on the internet. so a search engine platform does not face the chicken-and-egg problem faced by a general two-sided markets platform since a search engine can easily index a large set of web pages to build one side of the platform. second, search engines offer the service free of charge for both the searchers and web sites because they make money from advertisers. the users that are attracted to a search engine portal are the most valuable assets to the search engine platform. this revenue model is similar to that of the television network (beebe, 1977; steiner, 1952). figure 2 shows the diagram of a general search engine two-sided markets platform with advertisers. in this diagram, we can see that the searchers have positive cross network effect on the advertisers since the more searchers come to a search engine platform, the more likely the advertisers will get sales through advertising on the search engine platform. on the other hand, the advertisers have s searchers (information seekers) m: indexed web sites (information providers) search engine + + 128 journal of business strategies negative cross network effect on the searchers because the advertisements on the search engine may distort the search results or disturb the searchers. usually search engines display advertisements separately on the right hand side of the search results to minimize the negative impact on the searchers. figure 2 a general search engine two-sided markets platform with advertisers we can use a similar two-sided markets model as described by zhao and tse (2011). let u be the utility a searcher derives from using the search engine platform, nb be the net benefit, and c be the cost of using the service. the utility a searcher derives from using the search engine platform depends on the quality of the search platform itself, the amount of web pages indexed, and how relevant the search result pages are. the quality of the search platform includes things like the usability of the site, response time of processing a user’s query, etc. we will use a single variable q to denote the comprehensive quality of the search platform. comprehensive quality captures all the factors that determine the quality of the platform. the amount of web pages determines how likely the user will get the results he/she is looking for. the more web pages indexed by the search platform, the more likely the user will find the information. we will use m to denote the set of pages the search platform indexes. as shown in figures 1 and 2, s refers to the total set of web pages on the internet. another critical factor is the capability of the search platform to find the relevant web pages the user is looking for from the huge amount of web pages it indexes. we will call this relevance factor, and denote it as s searchers (information seekers) m: indexed web sites (information providers) search engine + + advertisers + volume 28, number 2 129 r. the greater r is, the better the search engine. r is determined by the search technology and it is a critical factor in determining how much value a searcher derives from using a search engine. even if a search engine platform indexes huge amount of web pages (large |m|), if the relevance factor r is low, it won’t offer much value to the searchers, since the page a searcher is looking for will be buried in a lot of irrelevant pages. with the above definitions and notations, we have: usearcher = (1 γ)f(q) + γrg(|m|). here γ is a constant, and γ ∈ [0,1] (2.1) r is positive. |m| is the cardinality of set m and the size of the indexed web pages. a searcher’s value comes from two sources: the search engine platform itself and the indexed web pages. γ is a parameter to denote the percentage of a searcher’s value that comes from the indexed web pages. since a searcher comes to a search engine platform to look for web sites or pages with the information he/she is looking for, the majority of a searcher’s value comes from the indexed web pages and how relevant the returned results are. the quality of the search engine platform is important, but not as important as the indexed web pages and how relevant the returned results are. no matter how good the ui of the platform is and how fast the search engine can return the results, if it does not have the page the searcher is looking for or cannot return the relevant page, there is not much value to the searcher. so is large (between 0.5 and 1. in general, indicates the strength of the positive cross network effect between the two sides of a two-sided markets model. the larger is, the stronger the positive cross network effect). f and g are monotonic increasing functions. to simplify the analysis, we can assume that f(q) is in proportion to q, and g(|m|) is in proportion to |m|, we can write u as: usearcher = (1 γ)αq + γβr|m|. γ is a constant, and γ ∈ [0,1], α,β are positive constants (2.2) let c be the cost incurred from using a search platform. the cost of using a search engine platform is determined by the time spent searching and browsing the search results (since the search platform is free to searchers in real world). we have nbsearcher = (1 γ)αq + γβr|m| c. γ is a constant, and γ ∈ [0,1], α,β are positive constants (2.3) 130 journal of business strategies rappa (2009) listed four key elements that a searcher uses to pick a search platform: relevance, comprehensiveness, freshness and speed. we capture the relevance through relevance factor r, comprehensiveness through m. freshness and speed are captured by comprehensive quality q. the searchers have positive cross network effect on the advertisers. advertisers come to a search platform since their advertisements can be viewed and clicked by searchers and potentially be converted into purchases. the value an advertiser derives from joining a search platform depends on three key factors: the number of searchers, the number of advertisers, and the relevance factor. the more searchers on the search platform, the more likely the advertisement will be viewed and clicked; the more advertisers, the less likely the searchers will see the advertisement from an individual advertiser; the larger the relevance factor, the more likely the search platform will display the advertisement that interests the searchers. we use x to denote the number of searchers, k to denote the number of advertisers. so we have uadvertiser = δr x k , δ is a positive constant (2.4) here we assume uadvertiser is a linear function of r x k , δ is the coefficient. let p be the price an advertiser pays to the search platform, we have nbadvertiser = δr x k p, δ is a positive constant (2.5) if we consider all the advertisers as a whole, we have uadvertisers = δrx, δ is a positive constant (2.6) let ptotal be the total price advertisers pay to the search platform, we have nbadvertisers = δrx ptotal , δ is a positive constant (2.7) uadvertisers and nbadvertisers are the total utilities and net benefits for all the advertisers on the search engine platform, respectively. based on the above model, a search engine platform can adopt the following strategies to attract more searchers to use its service. • increase the number of web pages indexed, this will increase m. • improve on the relevance of the search results, to improve the relevance factor r • increase the quality of the search engine platform itself, such as improve on usability, reduce response time for processing a user’s query, etc. volume 28, number 2 131 • consolidate search results from several search engines to increase the coverage, e.g., metasearch. • merge with and acquire other search companies to increase the coverage of the total indexed web pages. • reduce the negative impact of advertisements on the search results and searchers. • offer free service to searchers and make money from other sources. analysis of the search engine’s history of development the early stage today, there are only a few major search engines in the market. from u.s. search engine market share data in june 2011, google was in a dominant position with 84.58% market share, yahoo had 8.13%, bing had 5.38%, and the rest had no more than a 1% market share (karma snack, 2011). in the early stages of the search engine history, the market was very fragmented. there were many search engine platforms in the market, many of which no longer exist today. due to the limitation of technologies, each search engine only covered a small portion of the total web space, and searchers may have used multiple search engine platforms during one query session (bradlow & schmittlein, 1999; lawrence & giles, 1999). for example, in 1997, yahoo led the market with around 34% market share, infoseek had 18%, excite had 17.6%, lycos had 11.4%, altavista had 10.9%, webcrawler had 7.4%, and there were many of others with smaller market shares (gandal, 2001). to explain this with the model we built in figure 2, let’s assume that there are two search engine platforms: se1 and se2 and they have same quality q and same relevance factor r. let the sets of web pages indexed by these two search engines be . if the searchers only use one of the search engines, as shown in figure 3, the net benefits are as follows: nb1 = (1 γ)αq + γβr|m1| c1 nb2 = (1 γ)αq + γβr|m2| c2 132 journal of business strategies figure 3 searchers only use one search platform searchers only use search engine platform 1 searchers only use search engine platform 2 if the searchers use both search engines for their queries at the same time, as shown in figure 4, the net benefit will be nb = (1 γ)αq + γβr|m| c1 c2. so nb nb1 = γβr(|m| |m1|) c2 = γβr(|m1 ∪ m2| |m1|) c2. when m1 and m2 each is a small subset of s, and there is not much overlap between them, |m1 ∪ m2| ≈ |m1| + |m2|. so nb nb1 ≈ γβr|m2| c2. since most of a searcher’s value comes from the indexed web pages, γβr|m2| c2 > 0. so we have nb nb1 > 0, similarly we have nb nb2 > 0. in this case, searchers would use both search engines to conduct the same search query. when m1 and m2 is a large subset of s, we have |m1| ≈ |m2| ≈ | m1 ∪ m2 | ≈ |s|. so nb nb1 ≈ c2 < 0. similarly we have nb nb2 < 0. in this case, searchers would only use one search engine to conduct the search query. the same deduction applies to the case with more than two search engines, and the case in which different engines have different quality and relevance factors. so in the early stages of search engine history when the coverage of each individual search engine was low compared to the whole web space, the searchers could derive more value by using multiple search engines at the same time. also, a metasearch engine could offer greater values to searchers by combining the search results from several other search engines. the entry barrier was also low due to the s searchers m1search engine + + s searchers m2search engine + + volume 28, number 2 133 limited coverage of search engines in the market. a new search engine could bring additional value to searchers since it could improve on the coverage of the indexed web pages. based on the above analysis, we can tell that the searchers were multi-homing since they tended to use multiple search engines at the same time in the early stage of the search engine history. with the advancement of technology, search engines could greatly improve on the search relevance and the sets of indexed websites. m1 and m2 can then be increased to close to s, so |m1| ≈ |m2| ≈ |m1 ∪ m2| ≈ |s|. in this case, nb nb1 < 0 and nb nb2 < 0. in this case, searchers would use one search engine to conduct a search query. so the tendency of multi-homing is low when the each search engine can cover most of the web. figure 4 searchers use both search engine platforms how google became successful and why it’s so powerful google is a latecomer in the search engine market. it was founded in 1998 and rose to prominence in 2000 for its advanced technology. google invented pagerank, an algorithm used by its search engine to assign a numerical weighting to a web page to indicate the importance of that page in the web space (hammonds, 2003). pagerank greatly improved the relevance factor r of google’s search engine and this greatly improved the relevance of the search results. the improvement in search relevance also helped google to display the advertisements to the searchers that they are likely interested in. google also invested massively in the search infrastructure. it built its own servers from components it bought directly from their manufacturers. according to drummond, google now operates the world’s largest distributed computer system (ventureblog, 2010). these investments enabled google to index and store a much larger set of web pages than its competitors could. so google greatly s m searchers m1search engine + + m2 134 journal of business strategies increased the size of m, and thus increased |m|/|s|. the technology investments also enabled google to process search queries much more quickly. it was reported that an average search query used to take 3 seconds, and google optimized it to 0.2 second (hammonds, 2003). compared to the search engine platforms on the market, google’s search engine platform had better comprehensive quality: it had a very nice and neat user interface with a single search box, it could process a search query very quickly and show the results in no time, it kept the indexed pages up to date, and it showed the advertisements to the right hand side of the search results so the searchers won’t be disturbed by advertisement. google’s search engine also had a much larger relevance factor r, and larger set of indexed web pages m. all these factors enabled google to offer a much larger net benefit to searchers, and searchers quickly moved to google and chose google as their favorite search engine. in 2002, google surpassed yahoo and became the no.1 search engine in the us (hitwise). google has experienced exponential growth in the past ten years and it has been successful in maintaining and strengthening its leadership position. in 2010, google had 72% search market share in the us. google has also expanded into other countries and has been successful. except for a few countries, google is the leading search engine platform across the world (visualeconomics, 2010). can other search engines surpass google? zhao and tse (2011) pointed out several key advantages of the two-sided markets model compared to the value chain model. one of the key advantages of the two-sided markets model over the value chain model is that the positive cross network effect between the two sides of the two-sided markets model can help the market leader to keep its lead position. it’s a lot harder, if not impossible, for a new entrant to a two-sided market to catch up and surpass the market leader (zhao & tse, 2011). as we have described earlier, the general search engine business model is a two-sided markets model, but a special one. the specialness lies in the fact that every search engine has access to all the publicly accessible web space. as long as a web page is publicly accessible, a search engine can index that page and make it part of the search engine’s set of indexed web pages. because of this specialness, there is no chicken-and-egg problem for a search engine platform with a good search technology. a new entrant search platform can index a large set of web pages to build one side, and attract searchers to join the platform to build the other side. so the lead search engine does not have the advantage over new entrant in terms of having volume 28, number 2 135 a large set of indexed web pages, because the new entrant can index a comparable large set of web pages. whether a searcher joins a search platform or not depends on the search platform’s comprehensive quality and relevance factor. in this sense, a general search engine business model is similar to a value chain model. for example, if a new search engine platform can invent a new and much better search technology than google’s, it will greatly increase the comprehensive quality and relevance factor. since it can index the same amount of web pages, it can offer searchers much greater net benefits than google can. since the switching cost is zero, the searchers will move away from google to join this new search platform and google will lose its market lead position. once the searchers have moved away from google, advertisers will move away too due to the strong positive cross network effect the searchers have on the advertisers. based on the theory proposed by zhao and tse (2011), google needs to introduce a new positive cross network effect to its search platform to help keep its lead position. this is exactly what google has done. as shown in figure 5, google has attracted partner web sites to join its platform. the partner web sites are independent third party web sites, and each has its own user base and has accumulated some site traffic. since google is the leading search engine platform and there are many advertisers on google’s platform, the partner sites can monetize their site traffic by working with google. through google’s platform, the partner sites can display google advertisements to users who visit their sites. for advertisers, they benefit from partner sites since they will reach to users beyond google’s own user base. there are strong positive cross network effects between advertisers and partner sites. google has created a win-win situation for them. based on our theory, the strong positive cross network effect between partner sites and advertisers will help google keep its lead position. by attracting partner sites to google’s platform, google’s customers include not only searchers who go to google directly, but also those who visit google’s partner sites. in 2010, 31% of google’s advertising revenue was from its partner sites (google, 2010). the strong positive cross network effect between partner sites and advertisers helps google to maintain and strengthen its lead position and makes it a lot harder for its competitors and new entrants to surpass it. the most recent and powerful challenger of google is bing, owned by microsoft. bing is an improved search engine compared to msn search. it offers a similar user interface and has comparable response time to google. so bing and google have similar comprehensive quality q. as for search relevance, some people believe bing’s search results are better, some believe google’s search results are better, and 136 journal of business strategies some believe they are similar (chou, 2011; finin, 2009; kopp, 2011; parr, 2009; pogue, 2009). since it’s hard to differentiate the results from google and bing, we can consider that bing has comparable search relevance factor r as google. also, google has larger size of indexed web pages than bing, so google has larger m (kunder, 2010). based on our model, google would offer larger net benefit than bing could offer to searchers. therefore, bing will not be able to replace google as the leading search engine. however, since it improved a lot over msn search and the market share of msn was low, bing would be able to increase microsoft’s search market share, and this is what had happened since its release in june 2009 (mcgee, 2010). figure 5 a search engine two-sided market platform with partner web sites analysis of google’s failure in china and korea google’s failure in china google established its leadership position in the search engine market in the us in 2002 and has been successful in strengthening its lead position and expanding into many other countries outside the us. powered with cutting-edge technology, s searchers web sitessearch engine + advertisers +site 1 site 2 site n partner site 1 partner site 2 partner site n + + + + + + + volume 28, number 2 137 huge financial resources, intellectual property and a track record of success, google was considered almost insurmountable when it entered chinese search market in 2006. google thought it would conquer chinese search market the same way it did in other western countries. even though google has achieved huge success in many markets outside the us, it failed to compete with the local chinese search engine company baidu. in 2010, baidu held 63% market share in chinese search market, compared to google’s 27% (markettheglobe, 2010). baidu was founded in 2000 when the chinese internet was just beginning to burgeon. it successfully established its strong position by offering something that google did not offer initially: links to pirated songs, tv shows and movies from chinese web sites. baidu claimed this was legal because the media files were not on its own computers. google did not offer a similar service until 2009, when it finally introduced a free online music service with the permission of the music labels, but it has never managed to make up the lost ground (barboza & stone, 2010). even after google introduced the free music download service, the service was often problematic (salibra, 2010). daltorio (2010) attributed google’s failure in chinese market to its neglect of the most important rules of any business: know your market. google tried to impose its western vision of the web onto the chinese internet users and ended up creating a mess for itself and easy profits for local competition. its arrogance made it ignore free music downloads, the popular service that baidu offered and chinese internet users valued. also, daltorio (2010) pointed out some facts that showed google expected chinese users to adapt to it, instead of adapting itself to chinese users. for example, the us search box did not fit chinese characters very well and google did not bother learning that chinese internet users spend most of their online time on entertainmentas compared to europeans and americans, who use it more for workrelated purposes. in this section, we will use the two-sided markets model to model google and baidu’s competition and explain google’s failure in chinese search market. figure 6 shows the competition between google and baidu in the chinese local search market. in above sections, we simply assume that the indexed web pages are homogeneous and they are equally likely to be accessed by search users. this assumption is valid when we analyze a single homogeneous market in which users have the same needs and do similar search queries. but in reality, users in different markets may have quite different preferences and queries. chinese users are in a different market segment from users in the us and western countries, and they place more value on chinese language contents and related services. for example, 138 journal of business strategies chinese users may search for free mp3 music download, some local movie stars or historical figures, and the western users don’t. to analyze the competition between google and baidu in chinese search market, we divide the indexed web pages into two categories: web pages with chinese language contents and web pages with non-chinese language contents, as denoted by s and s', respectively. mg denotes the web pages with chinese language contents indexed by google, mb denotes the web pages with chinese language contents indexed by baidu, m'g refers to the web pages with non-chinese language contents indexed by google, m'b refers to the web pages with non-chinese language contents indexed by baidu. as we have described earlier, baidu knows more about the chinese users and offers more chinese language contents and related services to the chinese users compared to google, so |mb| >> |mg|. since google has a strong position in the us and western countries, |m'g| > |m'b|. here we also define p, the probability that a chinese user searches for chinese language contents. 1 p will be the probability that a chinese user searches for non-chinese language contents. p will be close to one since most of the times a chinese user searches for web pages with chinese language contents. figure 6 google vs. baidu s': web pages with non-chinese language contents s: web pages with chinese language contents chinese users m' g google china + + m' b m g baidu m b + + + + + + volume 28, number 2 139 we define: nbg,c : net benefit of a chinese search user if search through google’s search engine nbb,c : net benefit of a chinese search user if search through baidu’s search engine qg,c : quality of google’s search platform for chinese users qb,c : quality of baidu’s search platform for chinese users rg,nc : relevance factor of google’s search platform for web pages of nonchinese language contents rg,c : relevance factor of google’s search platform for web pages of chinese language contents rb,nc : relevance factor of baidu’s search platform for web pages of nonchinese language contents rb,c : relevance factor of baidu’s search platform for web pages of chinese language contents since baidu’s search platform is more tailored to chinese local users, we have qb,c > qg,c. since google has better general search technology and higher relevance factor, so rg,nc > rb,nc, but for web pages with chinese language contents, baidu has an advantage since it knows better about chinese language, characters, and culture, so rg,c ≤ rb,c. then we have nbg,c = (1 γ)αqg,c + γβ((1 p)rg,nc|m'g| + prg,c|mg|) nbb,c = (1 γ)αqg,c + γβ((1 p)rb,nc|m'b| + prb,c|mb|) p and is close to 1, so we have nbb,c nbg,c ≅ γβp(rb,c|mb| rg,c|mg|) ≈ γβ(rb,c|mb| rg,c|mg|) > γβrb,c(|mb| |mg|) > 0 140 journal of business strategies similarly we can have nbb,c rb,c|mb|—— ≅ ———— > 1 nbg,c rg,c|mg| so we can see that baidu’s search engine platform offers much greater net benefit to chinese local users, compared to google’s search engine platform. this is why baidu won over google and became the leading search engine platform in china. similarly, we can derive that google’s search engine platform offers much greater net benefit to western country users, or those who have needs similar to users in western counties. this is why google is so successfully in the u.s. and western countries. even the chinese local users are not homogeneous. different segments of chinese users have different preferences. google is the preferred search engine among highly educated chinese, particularly those who have studied in western countries (wang, 2010). this observation complies with our model, in which google offers larger net benefit to western users and those who have similar needs as western users google’s failure in korea google started its korean site in 2000, much earlier than the time when it entered chinese search market (herman, 2006). in 2010, ten years after google’s entrance to korean search market, google still did not have a strong foothold in korea. google was reported to only capture 4% of the search market in korea (bonfils, 2010). the top three are naver, daum, and nate, all local companies in korea. they have market shares of 62%, 21%, and 10%, respectively (bonfils, 2010). naver was founded in 1999, and became the leading search engine in 2003 (chun, 2007). it has been able to strengthen its lead position since then, and has become the dominant search platform in korea. naver’s success is often attributed to its popular knowledge sharing service, which was launched in 2002. the knowledge sharing service allows naver users to post questions on any subject to its site, and select the best answers from those provided by other naver users. in 2007, 44,000 questions were posted by naver users and 110,000 answers were received each day, making naver the world’s fifth largest search portal (choe, 2007). naver’s knowledge sharing service was copied by other internet companies and has become the must-have feature for internet portals in korea. the internet portals keep the volume 28, number 2 141 questions and answers in their private databases not shared with other portals or with search engines like google. when a user conducts a web search, the search engine yields relevant items from its own q&a database along with traditional search results from web pages on the internet (choe, 2007). by july 2007, naver’s usergenerated database had accumulated 70 million entries (choe, 2007). why has google, the most powerful search engine on this planet with the most advanced technology, huge financial resources and well-known brand name, only captured a mere 4% of search market share in korea ten years after its entrance? google’s failure in korea has some similarities and differences compared to its fate in china. as in china, google competes in a market with quite different language, culture in korea compared to the us and western countries. one example is the design of the home page of the search site. google’s bare bone design of home page with a single search box is very popular in western countries, but in korea, people like web pages with rich contents. korean users prefer naver’s way of homepage design, a page with detailed category listings, animated pictures, online shopping and new headlines so users can find a lot of information on one page easily (herman, 2006). google tried to impose the same minimal design of web page to korean users but it failed to do so. recently, almost ten years after google’s entrance to korea, google korea changed its home page design to be more like other korean local web sites, to cater for the preferences of korean users (qut, 2010). one key difference of korea’s search market compared with china and western countries is the lack of korean language contents (herman, 2006). when google entered korea, the number of web sites in korean language was relatively small, compared to web sites in english and chinese. with this unique characteristic, no matter how powerful google’s search engine is, there are not enough korean language contents for google to search on to satisfy korean users. google’s strength is to find the answer when the content is rich, but this is not the case in korea. google’s advantage in advanced search technology was greatly reduced. naver’s knowledge sharing service helped it to combat the lack of korean language contents on the web. by leveraging the user-generated contents, naver can better satisfy the users who search for information on the internet. next we will apply the two-sided markets model to analyze the competition between naver and google korea to show that naver offers greater net benefit to korean users compared to google korea. in previous sections, we always assumed that all search engines have equal access to all the web sites on the internet. in the competition between google and naver in korea, it is not the case. besides the publicly accessible web sites in korean language, there is some proprietary database that 142 journal of business strategies is owned by one company and is not shared with others. as in naver’s case, naver has its own knowledge sharing database that holds large number of questions and answers and it does not share with other companies. we model the competition between google and naver as a two-sided market competition in figure 7. mp denotes the pages in korean language that are publicly accessible, mc denotes the contents stored in naver’s private database that only naver’s users have access to. in the early stage, since there were not enough web sites in korean language, mp was pretty small. mc was initially zero, but it has grown very fast and today mc has a lot more contents than mp. google only has access to mp, naver has access to both mp and mc. figure 7 google vs. naver we define nbg : the net benefit of a korean user if use google’s search platform nbn : the net benefit of a korean user if use naver’s search platform qg : quality of google korea’s search platform qn : quality of naver’s search platform rg : relevance factor of google korea’s search platform on korean contents rn : relevance factor of naver’s search platform on korean contents r'n : relevance factor of naver’s search platform on its own private database korean users google korea m p naver + m c + + + volume 28, number 2 143 so we have nbg = (1 γ)αqg + γβrg|mp| nbn = (1 γ)αqn + γβ(rn|mp| + r'n|mc|) based on our analysis above, qn is larger than qg since naver knows more about korean language and culture and can better cater for the needs of korean users. rg has about the same value as rn because google has advanced technology in search in general contents but naver knows more about korean characters, and contents. γ is large due to the strong positive cross network effect. at the early stage of the competition, |mp| was small due to lack of korean language contents on the internet, |mc| was close to zero since the service was just launched and there were not much contents. so we have nbg = (1 γ)αqg + γβrg|mp| nbn = (1 γ)αqn + γβrn|mp| nbg would have similar value as nbn, meaning that naver’s understanding of korean users, language, and culture offsets google’s technology advantage in search. with the launch of the knowledge sharing service by naver, we have observed exponential growth of this service and |mc| has become larger and larger. |mp| also grew since more web pages in korean language became available, but at a much slower pace, because knowledge sharing service has been so popular in korea. by july 2007, naver’s user-generated database had accumulated 70 million entries (choe, 2007). even though we could not accurately estimate the value of |mp| and |mc|, it is reasonable to estimate that |mc| quickly surpassed |mp| and has widened the gap since then, thus we have |mc| >> |mp|. so we have nbn > > nbg. that means naver can offer much greater net benefit to korean users compared to google korea after it has accumulated a lot of questions and answers in its private knowledge sharing database. this explains google’s failure in korea. another observation about google korea is that it not only failed to be the market leader, but it was also left far behind. google korea is the no. 4 search platform in korea. besides naver, daum, and nate, the no. 2 and 3 search platforms, also offer knowledge sharing service and have their own private knowledge sharing databases, though not as large as naver’s. so daum and nate can achieve a similar competitive advantage over google korea with their knowledge sharing services and thus they have greater market shares. 144 journal of business strategies proposed strategies for search market leaders based on the mathematical model and our two-sided markets model analysis for the search engine market competition in previous sections, we propose the following strategies for google and local market leaders. strategies for local market leaders • don’t copy google’s way. understand local customers and make the site tailored to them. • offer other services that local customers value and that can increase the stickiness. • work with local partner web sites to extend customer base beyond searchers coming to its own site and include those searchers coming to its partner web sites. • offer a service that can build a private database that is only accessible from its own site. for example, add a knowledge sharing service. ♦ if it already has such a service and is open, make it closed. • leverage existing customer base and build new two-sided markets platform with strong positive cross network effect. strategies for google • continue to maintain and strengthen leadership in search technology. • catch up in search technology in other languages such as chinese and korean. • understand customers in each market and offer service that is tailored to the needs of local customers in each market. • work with local partner sites to extend customer base beyond searchers coming to its own site and include those coming to its partner web sites. • in a local market that lacks contents in local language, build a knowledge sharing service for people to get answers to their questions. • offer service that can build a private database that is only accessible from its own site. for example, knowledge sharing service. • leverage its dominant position in the us and western countries to better serve local merchants/businesses. volume 28, number 2 145 ♦ for example, some chinese and korean local companies may want to expand to markets where google is a search market leader, so google has an advantage in helping them compared to baidu and naver. • leverage existing customer base and build new two-sided markets platform with strong positive cross network effect. for example, google android, google checkout, google adsense. conclusion and discussion google has achieved huge success in the us and western countries but failed to compete in some major asian countries such as china and korea. in this paper, we modeled the search engine market as a two-sided market to analyze the search engine market competition, and applied the two-sided markets model to analyze the competition in various scenarios. first we pointed out that the search engine market is a special type of twosided market. the specialness lies in the fact that all search engines have access to all the publicly accessible web pages, so a search engine can easily overcome the chicken-and-egg problem by indexing a large set of web pages. given this specialness, a general search engine market competition is similar to the competition in a market with a value chain model. we then used the two-sided markets model to analyze and explain the market competition in the early stage of the search engine history, why google could emerge as the market leader, and why google is so powerful. in the early stages of the search engine history, each search engine only covered a small and different portion of the total web space. through the model analysis, we showed that searchers could derive more value by using more than one search engines during one search query. this is why multiple search engines could co-exist in the early stage of the search engine history. google, a late comer in the search market, with advanced search technology, greatly improved the search relevance and thus rose to dominance. google also worked with partner web sites to build a new two-sided markets platform, adsense. we pointed out that this strategy would introduce strong positive cross network effect between partner web sites and advertisers and thus help strengthen google’s market lead position. in general, we suggested that a search engine market leader should create new two-sided markets platform with strong positive cross network effect by leveraging its existing customer base. next we applied the two-sided markets model to analyze google’s failure in china and korea. in chinese local search market, baidu has an advantage in under146 journal of business strategies standing the chinese local users and offers services that the chinese local customers value. baidu also has advantage in chinese language. chinese users are in a different market segment and google’s advantage in general search technology and huge indexed web pages lost value in this market segment. failure to understand chinese local users and provide services they value is one of the critical reasons for google’s failure in china. google’s failure in korea is different from its experience in china. compared to the us and china, there were not enough contents in korean language when google entered korean search market. to fill that gap, local search company naver offered knowledge sharing service, which allows the users to post and answer questions online. the online knowledge sharing service grew rapidly and enabled naver to provide better search results compared to google, who only had access to the public web space. in general, when the contents on the internet are scarce, building a knowledge sharing service and keeping it closed will give a search engine platform an advantage over its competitors. in the end, we proposed some strategies to google and local search market leaders on how they could maintain and strengthen their leadership positions in their respective markets. one key strategy is to build a new two-sided markets platform with strong positive cross network effect by leveraging existing customers. the paper has some limitations. one limitation of our analysis in this paper is that we make quite a few linear assumptions on the functions used in the model. this won’t impact the results in this paper since a linear function is a monotonic increasing function. but a more complex function could improve and make it more realistic. for example, we assume that g(m) is a linear function to simplify the analysis. but in reality, the marginal value of m decreases. when m is large, the same amount of increase in m would have much less impact on the value searchers derive compared with the case when m is small. in this paper, we devised strategies for search engine market leaders. future potential topics include developing strategies for new entrant search engine companies and discussing how a new entrant search engine company should compete in a search engine market under different market conditions. another future potential research topic is to examine other countries in which google does not have leadership position, to understand why that happened and derive some insights from that. did google fail with similar reasons as in china and korea, or did something different happen? volume 28, number 2 147 references alexa. (2010). top sites in united states. retrieved from www.alexa.com/topsites/ countries/us. armstrong, m. (2004). two-sided markets: economic theory and policy implications. paper prepared for encore workshop on competition issues in twosided market, oct. 28, 2004. armstrong, m. (2005). competition in two-sided markets. industrial organization, econwpa. barboza, d., & stone, b. (2010). china, where u.s. internet companies often fail. retrieved from www.nytimes.com/2010/01/16/technology/16failure.html. beebe, j. (1977). institutional structure and program choices in television markets. quarterly journal of economics, 91(1), 15-37. bonfils, m. (2010). search around the world: south korea. retrieved from searchenginewatch.com/3640458. bradlow, e., & schmittlein, d. (1999). the little engines that could: modeling the performance of world wide web search engines. marketing science, 19(1), 43-62. caillaud, b., & jullien, b. (2001). chicken & egg: competing matchmakers. rand journal of economics, 34(2). chatterjee, p., hoffman, d., & novak, t. (1995). commercial scenarios for the web: opportunities and challenges. journal of computer mediated communication, special issue on electronics commerce, 1(3). choe, s. h. (2007). south koreans connect through search engine. retrieved from www.nytimes.com/2007/07/05/technology/05online.html. chou, t. (2011). bing vs. google: which is better? retrieved from www.businessinsider.com/bing-vs-google-which-is-better-2011-3. chun, g. (2007). naver — myth of internet age success. retrieved from www.koreaittimes.com/story/3083/naver-myth-internet-age-success. csorba, g., & hahn, j.-h. (2003). functional degradation and two-sided network effects: an application to software markets. jel. daltorio, t. (2010). the number one reason why google failed in china… and it’s a big one. retrieved from www.investmentu.com/2010/january/google-fails-inchina.html. finin, t. (2009). blindsearch evaluates google, bing and yahoo search engines. retrieved from ebiquity.umbc.edu/blogger/2009/06/07/blindsearch-evaluatesgoogle-bing-and-yahoo-search-engines/. gandal, n. (2001). the dynamics of competition in the internet search engine market. international journal of industrial organization, 19(7), 1103–1117. 148 journal of business strategies google. (2010). google quarterly report retrieved from biz.yahoo.com/e/101029/ goog10-q.html. hammonds, h. k. (2003). how google grows... and grows... and grows, fast company? retrieved from www.fastcompany.com/magazine/69/google. html?page=0%2c0. herman, b. (2006). google fails to make inroads in south korea retrieved from www.usatoday.com/tech/news/2006-04-30-google-south-korea_x.htm. hitwise. (n.d.). search engine market share. retrieved from www.hitwise.com/us. hoffman, d., & novak, t. (1996). a new paradigm for electronics commerce. the information society. jansen, b., zhang, m., & zhang, y. (2007). the effect of brand awareness on the evaluation of search engine results. computer human interaction 2007 conference. karma snack. (2011). search engine market share retrieved from www.karmasnack.com/about/search-engine-market-share/. kopp, c. (2011). weekly web watch: bigger better bing? retrieved from www.minyanville.com/businessmarkets/articles/google-search-microsoft-bing-yahoosearch/2/15/2011/id/32815. kunder, d. m. (2010). the size of the world wide web. retrieved from www.worldwidewebsize.com/. lawrence, s., & giles, l. (1998). searching the world wide web. science, 280(3), 98-100. lawrence, s., & giles, l. (1999). accessibility of information on the web. nature. 400. liebowitz, s. j., & margolis, s. e. (1994). network externality: an uncommon tragedy. journal of economic perspectives, 8(2), 133-150. markettheglobe. (2010). search engine leader by country retrieved from www. marktheglobe.com/seo-usa. mcgee, m. (2010). bing hits all-time high market share: nielsen retrieved from searchengineland.com/bing-hits-all-time-high-market-share-nielsen-38280. mukhopadhyay, t., rajan, u., & telang, r. (2002). competition between internet search engines. hawaii international conference on system sciences. netcraft (2010). october 2010 web server survey. retrieved from news.netcraft. com/archives/2010/10/12/october-2010-web-server-survey.html. netmarketshare. (2010). search engine market share. retrieved from marketshare.hitslink.com/search-engine-market-share.aspx?qprid=4. volume 28, number 2 149 parr, b. (2009). google vs. bing: the blind taste test. retrieved from mashable. com/2009/06/07/blindsearch/. pogue, d. (2009). bing, the imitator, often goes google one better. retrieved from www.nytimes.com/2009/07/09/technology/personaltech/09pogue.html. qut. (2010). why has google failed in korea? retrieved from asiancorrespondent. com/31699/why-has-google-failed-in-korea/. rappa, m. (2009). case study: google, managing the digital enterprise. retrieved from digitalenterprise.org/cases/google.html. rochet, j., & tirole, j. (2003). platform competition in two-sided markets. journal of the european economic association, 1(4), 990-1029. rochet, j., & tirole, j. (2004). two-sided markets: an overview. rand journal of economics. rochet, j., & tirole, j. (2006). two-sided markets: a progress report. the rand journal of economics, 37(3), 645-667. roson, r. (2005). two-sided markets: a tentative survey. review for network economics, 4(2). rysman, m. (2000). competition between networks: a study of the market for yellow pages. review of economic studies. salibra, l. (2010). google’s china lessons: forbidden fruit & face saving retreat. retrieved from larrysalibra.com/2010/01/13/googles-china-lessons-forbiddenfruit-face-saving-retreat/. searchenginewatch. (n.d.). google’s market share in the past. retrieved from askville.amazon.com/google%27s-market-share-2006-2005-2004-2003-2002/ answerviewer.do?requestid=5588947. steiner, p. (1952). program patterns and preferences, and the workability of competition in radio broadcasting. quarterly journal of economics, 66(2), 194-223. sun, m. c., & tse, e. (2007). sustainable growth of payment card networks: a twosided market approach. journal of business strategies, 24(2). telang, r., mukhopadhyay, t., & wilcox, r. (2000). an empirical analysis of internet search engine choice. working paper, carnegie mellon university, pittsburgh, pa. telang, r., & mukhopadhyay, t. (2005). drivers of web portal use. electronic commerce research and applications, 4, 49-65. telang, r., rajan, u., & mukhopadhyay, t. (2004). the market structure for internet search engines. journal of management information systems, 21(2), 137-160. ventureblog. (2010). 4 keys to google’s success. retrieved from www.ventureblog. com/2003/05/4-keys-to-googles-success.html. 150 journal of business strategies visualeconomics. (2010). planet google: from philosophies to market shares. retrieved from www.visualeconomics.com/2010-02-03-planet-google-fromphilosophies-to-market-shares/. w3c. (2000). a little history of the world wide web. retrieved from www.w3.org/ history.html. wang, t. (2010). my suggestions for making google’s services more relevant for non-elite chinese users. retrieved from culturalbytes.com/post/340498962/ googleandchina. white, a. (2008). search engines: left side quality versus right side profits. working paper, toulouse school of economics. zhao, w. g., & tse, e. (2011). advantages of the two-sided markets model. manuscript submitted for publication. biographical sketch of authors wugang zhao is a senior engineering manager at paypal inc.. he received his ph.d. from stanford university. his research interests include entrepreneurship, innovation, competitive analysis, two-sided markets. edison tse (ph.d., massachusetts institute of technology) is an associate professor of management science and engineering, stanford university. he received the donald eckman award from the american automatic control council. he had served as an associate editor of the ieee transactions of automatic control, and a co-editor of the journal of economic dynamics and control, which he co-founded. he designed and directed a stanford executive certificate program in china, a stanford policy analysis certificate program for chinese government officials, and a stanford financial engineering certificate program in hong kong. his current research interest is in new business model innovation and how it is applied to business and industry transformation. competition in search engine market u.s. executives' perceptions of "bems" as f.d.i. options troy a. festervand middle tennessee state university murfreesboro, tn abstract in this study, perceptual mapping was used to identify the collective and individual positions of ten big emerging markets or "bems" as they are more commonly called. the perceived position of the" ideal" market or nation also was captured by the study's findings. fdi executives who were surveyed indicated that some "bems" have positioned themselves strategically in terms of their availability of and access to markets and resources. the stability of a market's or nation's political and economic environments, as well as business environment, also contributes to a nation's perceived position. some "bems" appear better positioned to take advantage of their strengths, whereas others face long-term fdiobstacles. introduction foreign direct investment (fol) is an integral component of the globalization of the world's economy, as well as a key aspect of every nation's economic development efforts. virtually all nations are eager to attract fdi, as evidenced by the immense financial investments that developing and developed nations have attracted and continue to attract (jenkins, 1995; un 1998 and 1999). indeed, the success of a gi ven nation in attracting foreign capital is a direct result of that nation's market or resources attractiveness, or both, and the presence and availability of investment opportunities (aitken, et al., 1997). in recent years, the social, economic, and political environments governing foreign direct investment in many previously closed economies have undergone something of a metamorphosis (boycko, et al., 1994; kamm, 1992; sachs and warner, 1995). these nations have changed from essentially closed economies or markets advocating protectionism, subsidies, and increased regulations to more market and growth-oriented positions espousing regulatory reform, market expansion, and private sector development. in turn, these changes have encouraged many foreign direct investors to revise their list of nations considered desirable fdi candidates. while still largely comprised of developed nations, many foi lists now include nations known as "bems," big emerging markets. in this instance, a big emerging market's status is not a function of its per capita gnp, but relies on economic and 46 journal of business strategies vol. 20, no. i demographic measures that cut across all four stages of economic development (garten, 1997). "bems" consist of nations located around the globe that have experienced rapid economic growth for the past decade (keegan and green, 2003). it is because of this rapid growth and the resulting market opportunities that the columbia journal of world business dedicated a special issue to "bems" (1996).1 ten countries generally are recognized as big emerging markets. these nations include china, india, indonesia, south korea, brazil, mexico, argentina, south africa, poland, and turkey (garten, 1997). in the past, the us has invested mightily in emerging nations, both big and otherwise. however, us investment in emerging nations has dwindled in recent years. while various reasons may explain this trend, perhaps the most apparent reason is the delicate balance that often exists between risk and reward (ramcharran, 2000). this balance has proven tenuous in emerging nations. while conspicuous in form and magnitude at times, in other instances, the risk associated with an emerging nation often is intangible and based largely upon perception. given the previous comments and the limited amount of empirical information that exists concerning the relative and/or perceived market position of various big emerging nations as fdi alternatives, this research was conducted. the basic purpose of the research was to identify the market position of the ten big emerging nations as perceived by american business executives experienced in foreign direct investment decisions. specific objectives of the study were to: 1. empirically establish the perceived market position ofthe ten big emerging nations; 2. develop perceived profiles of each individual nation; 3. develop an aggregate profile of the ideal nation vis-a-vis the ten big emerging nations studied. background the issue of foreign direct investment can be approached from the perspective of investing companies, as well as from that of recipient countries. there seems to be a consensus in the literature that multinational enterprises invest in foreign countries to either create a competitive advantage or sustain the competitive advantage that they were able to create in their domestic markets (cho and moon, 1998; clark 1996; ensign, 1993; hill and jones, 2000; hitt 1996). this is possible because investing in foreign countries allows companies to both expand their sales and realize locational advantages. expanding sales can help increase a company's market power and profits, and enhance its low cost position. companies also can achieve competitive advantage by benefiting from such national resources as abundant and cheaper raw materials, readily available labor supply, lower transportation costs, and financial incentives (earle and estrin, 1996; estrin and meyer, 1998). spring 2003 festervand: u.s. executives' perceptions 47 however, what is unclear is the role fdi plays in the recipient countries' economic development efforts. research has resulted in conflicting conclusions as to whether foreign direct investments are more productive than similar investments by domestic companies (taylor, 2000). still, it is widely recognized that fdi is playing an increasing role in the global economy. according to a united nations report, beginning in the early 1980s, fdi increased at an unprecedented compound annual rate of 29%, reaching a world stock of fdi of $1.7 trillion at the end of 1990 (un, 1992). though most of the foreign direct investment outflows go to developed economies, fdi has become a critical ingredient ofthe gross domestic product and gross fixed capital formation for developing economies (dunning, 1993). as a result, fdi is increasingly becoming an important policy issue (taylor, 2000). as noted earlier, the 1990s witnessed a bevy of governmental initiatives that codified changes in public policies toward free enterprise and foreign direct investments in many emerging nations (jones, 2000; orton, 2000; ramcharran, 2000). several east and central european governments (e.g., poland and turkey) enacted competition laws and bilateral investment treaties aimed at encouraging foreign investments (ei-said and mcdonald, 2001; hobeika, 200 i; middle east executive reports, 1999; parsons, 2002; tatoglu and glaister, 1998). in turn, the success of these countries in their efforts to develop market-oriented economies has made them candidates for the european union (mccrary, 2000; orton, 2000). clearly, nations such as these, which have initiated market-oriented economies, offer the best opportunities for multinationals seeking to invest in emerging countries. besides these nations, india also has launched, albeit with limited success, an assault on the remnants of their old command economies (azzam, 2001; dhume, 2000). the last decade of the twentieth century offered ample opportunities and challenges for foreign direct investments in emerging economies. the fall of the berlin wall in 1989 and the disintegration of the soviet union marked a turning point in the role that both multinational enterprises and national governments played in facilitating the creation of a sustainable and balanced economic environment. now, there is virtual agreement among these, and all other nations, that foreign direct investment is beneficial (wallace, 1990). though much of the interest of multinational investors remains focused on developed countries, big emerging markets have been and continue to be attractive fdi alternatives (dunning, 1988 and 1993). despites the progress that has been made in reforming political and economic systems, a number of challenges continue to impede the flow of foreign direct investments into emerging nations. as dunning (1993) suggests, the most important of these challenges are the political systems, values, and ideologies that most emerging nations inherited as a result of a centralized economy. these nations still have several obstacles that need to be eradicated in order to develop market-oriented economies and attract foreign investments (ramcharran, 2000). 48 journal of business strategies vol. 20, no.1 for decades, fdi was perceived as a threat to national sovereignty. as a result, government policy and legislation were devised to severely restrict foreign investments, particularly from the united states. despite recent pro fdi changes, many emerging countries continue to suffer from this legacy (jones, 2000). despite its ambitious efforts, india (one of the largest bems) is still unable to bolster investors' confidence. the indian ministry of industry has issued new guidelines on joint ventures that while easing local ownership requirements, continue to force foreign investors to waste months or even years in negotiations with indian partners (viswanathan, 2000). while most big emerging nations have put in place democratic or pseudodemocratic institutions, many continue to suffer institutional instability. to implement market economies, new democracies may impose hardships on a population accustomed to the welfare state. in turn, this reliance leads to a rise in the popularity of political parties that threaten new democratic and marketoriented institutions. thus, the prospect that these nations can at any time fall back into political and economic instability can negatively affect the perceptions that foreign investors have of these nations (middle east executive reports, 2001; townsend, 2002). while the preceding comments explain why us firms historically have chosen to invest in western europe, this practice changed somewhat during the i 990s as us emphasis shifted to developing asian and latin american nations, most notably china and brazil (both bems). investment in each of these countries could be justified by the scope of the market opportunity alone, especially china, which has essentially retained its centralized economy. however, generally absent from this new investment mix were other, less desirable big emerging nations. various reasons may be posited as to why us firms have taken such a cautious approach to foreign direct investment in other big emerging nations. as noted earlier, real or perceived risk remains the most viable explanation. for example, in a global study of risk, the big emerging nation of india received overall risk composite scores of 55 (scores range from 1-100, with lower scores representing higher risk). in contrast, switzerland received the highest overall composite risk score (94) (erb, harvey, and viskanta, 1996). three different types of risk often are associated with a nation as a firm considers making a direct investment in that country. these risk types include the political and economic environment, domestic conditions, and economic relations (dichtl and koglmayr, 1986; ramcharran, 2000). in all instances, executives charged with the responsibility for making the fdi decision must achieve "a more thorough understanding of the likelihood of various problems and opportunities in a country" (kotabe and helsen, 1998). this understanding, while informed, is based upon the perception(s) ofthat nation, region, or market. these perceptions form what is commonly known as "market position or location." in marketing terminology, the product's "location" is its position in the mind of a consumer. in this instance, the consumer is the foreign direct investor who spring 2003 festervand: u.s. executives' perceptions 49 is concerned with how a product (i.e., a given nation and its "bundle of attributes") is perceived. more specifically, for foreign direct investment purposes, position refers to the investor's perception of a nation vis-a-vis a competing nation as an investment option. positioning: concept and application the positioning concept received its first application over thirty years ago. since that time, it has enjoyed myriad applications ranging from consumer products, to political campaigns, to job placement. according to ries and trout (1981), "positioning should not be confused with strategy, even though the two are inextricably related." "positioning starts with a product. a piece of merchandise, a service, a company, an institution, or even a person ... , but positioning is not what you do to a product. positioning is what you do to the mind of the prospect. that is, you position the product in the mind of the prospect." positioning is the act of defining the product's image and value offer so that the segment's customers understand and appreciate what the product stands for in relation to its competitors (scanlon, 1994). stated in more pragmatic terms, for a product, business, or investment option to establish an appropriate, desirable position in the marketplace, it must demonstrate to its potential stakeholders how it differs from competing options. in so doing, the host entity (i.e., each big emerging nation) is attempting to establish a competitive advantage. empirically establishing the position of ten big emerging markets as fdi options was the purpose of this research. information gleaned may offer some insight as to how and why us foreign direct investors have made their investment decisions. these findings also may contribute to future fdi investment research, as well as provide some assistance and/or direction to potential fdi recipients seeking to enhance their position as a fdi destination. methodology data for this research were obtained via a mail survey of a randomly selected sample of 500 executives chosen from the membership of the industrial development research councif (ldrc 199912000). while membership in the idrc includes representatives from virtually all sectors, only representatives of domestic, for-profit organizations were included in this study. a four-page, selfadministered questionnaire was developed, tested, and distributed to potential respondents with a cover letter explaining the project. the questionnaire obtained measures that identified the positions of the ten big emerging markets, as well as specific nation-related attributes. in alphabetical order, the ten big emerging markets studied included argentina, brazil, china, india, indonesia, mexico, poland, south africa, south korea, and turkey. 50 journal of business strategies vol. 20, no.1 the most common method for quantifying the position of an entity (i.e., a nation) vis-a-vis competing entities (i.e., nations), is through the technique of multidimensional scaling (mds). this procedure converts ratings of perceived similarities to a geometric representation of several positions relative to one another. by measuring the preference concerning available options, the "ideal" option also can be portrayed on a perceptual map created from perceived similarities (green, 1975). one advantage of using mds in positioning research is that, instead of evaluating each nation on a list of dimensions created by the researcher, the respondents indicate the dimensions considered when comparing foreign direct investment options. in turn, the perceptual map created is based upon multiple dimensions, representing the salient "top-of-mind" attributes the respondents associated with the bems studied. to allow development of the perceptual map, respondents were asked to rate each of the ten big emerging markets with respect to similarity on a five-point likert scale (i =very dissimilar to 5=very similar). respondents then indicated which nation they preferred, as well as the primary factor upon which that rating was based. a paired-comparison format was used. a total of 112 usable responses were received, for an overall response rate of 22.4%. to detect any potential nonresponse bias, a telephone survey was conducted with 25 randomly selected nonrespondents. nonrespondents were asked to indicate the extent of their familiarity with each of the ten nations studied. comparisons between respondents and nonrespondents, based upon a chi-square analysis, revealed no significant (p<.1 ) differences. while some extrapolation of these findings may be possible given the minimal nonresponse bias, the questionable role that the respondents may actually play or have played in the fdi decision (this study identified only fdi experience) suggests that may limit the study's findings. as table 1 indicates, respondents include a variety of professionals from organizations located in all areas of the country. manufacturing executives represented 71 % of all respondents. fdi experience was divided approximately equally between executives with ten or more years of experience (51 %) and those with less than ten years of experience (49%). most respondents (45%) were at the vp level, while directors/managers (25%) and presidents/ceos accounted for the remainder (30%). perhaps due to a greater regional concentration, respondents from the eastern portion of the us are over represented (51 %) compared to all other regions. thus, these findings do reflect a regional, manufacturing bias, the impact of which remains in question. familiarity with big emerging markets respondents were asked to indicate their familiarity with each of the ten big emerging markets using bipolar adjectives, either extensive or limited. extensive familiarity with a nation indicated that a respondent (his/her firm) was familiar with and had considered selecting or had selected a particular nation as spring 2003 region east central south west fdi experience less than 10 years over 10 years festervand: u.s. executives' perceptions table 1 description of respondents 51% 18% 17% 14% 51% 49% 51 type of organization manufacturing non-manufacturing position in organization vice president director/manager president/ceo 78% 22% 45% 25% 30% the recipient of a foreign direct investment. limited familiarity with a nation indicated that a respondent (his/her firm) was familiar with, but had not considered that emerging nation for a foreign direct investment. fdi decisions (as well as countless other types of decisions) should be based upon objective data. however, preliminary decisions often are influenced by perceptions of reality (ries and trout, 1981; scanlon, 1994). thus, while the development of a measure of fdi executives' "intent to invest" in each nation would have been desirable, the goal of this study was to assess nation perceptions. by assessing the respondents' familiarity with each nation, the perceptual basis for subsequent fdi responses, either favorable or unfavorable, was obtained. as expected, all respondents were familiar with the ten big emerging markets studied. however, the degree offamiliarity with each nation varied. as indicated in table 2, respondents were most familiar with china and mexico. respondents were least familiar with the big emerging markets of argentina, indonesia, and poland. substantial familiarity was associated with all remaining bems. perceptual map of big emerging markets the perceptual map of bems that was developed exhibited three dimensions. these are portrayed in figure i as stability of political and economic systems, availability of and access to markets/resources, and business environment. these factors are of note because they differ from dunning's (1988) "oli" factors (i.e., ownership, location, and internationalization), which are widely recognized as and purported to be the basic determinants of fdi. 52 journal of business strategies vol. 20, no. 1 table 2 degree of familiarity with big emerging markets nation a argentina b brazil c china 1india in indonesia mmexico ppoland sa south africa sk south korea t turkey extensive familiarity (%) 78 83 93 88 77 97 74 88 87 87 limited familiarity (%) 22 17 7 12 23 3 26 12 13 13 in reviewing the findings presented as figure 1, some clarification may be necessary. the perceived positions of all nations studied, as well as that of the ideal nation, are identified as relative points located along and above (denoted by a solid line) or below (denoted by a dotted line) the three axes (line length denotes the extent above or below the midpoint of each axis). these findings indicate that several nations appear to be clustered together on similar dimensions. one group of nations consisting of china, india, and mexico appear to be clustered together and are perceived as occupying the most desirable positions. all are perceived as possessing the greatest availability of and access to markets/resources. india and mexico also are seen as offering a more accommodating environment, whereas, china suffers on this dimension. none of these three nations enjoy perceived political and economic stability. a second group of nations, this one consisting of brazil, indonesia, poland, and turkey appear to be clustered together and are generally perceived as possessing adequate market/resource availability and access (poland is an exception on this dimension), but are severely lacking on the dual dimensions of political and economic stability and offering an accommodating business environment. a final group of nations consisting of argentina, south africa, and south korea appear to be clustered together and are perceived to occupy an essentially neutral position overall. all three nations are seen as offering somewhat limited marketslresources, a marginally stable political and economic environment, and a somewhat accommodating business environment. most interestingly, india appears to occupy a unique and strategically opportunistic position. perhaps because of the relatively recent removal of strict local ownership requirements and the fact that india has almost a billion consumers, india is viewed as a being a prime bem/fdi destination. as can be observed in figure 1, india's most pressing need appears to be in reaffirming the long-term spring 2003 festervand: u.s. executives' perceptions figure 1 perceptual map of big emerging markets more accommodating business environment 53 greater availability of and access to markets! resources • ! more stable political and economic environment less stable political and economic environment @]t ~t.. :....tj~~ .~!... i! "" .. i .... i. i " : .... t·f"inl i " .... ~ t ~ i r;1 .. limited t l.:..j", availability of and• ii access to marketsj ~ ~ ~ : resources i less accommodating business environment a argentina i india p poland t turkey b brazil in indonesia sa south africa c china m mexico sk south korea stability of its political and economic systems. perhaps because of its involvement in nafta, mexico occupies a perceived position much like that of india. as a strategic alternative, perhaps mexico should position itself as "the gateway to south america," thereby enhancing its availability and access to markets and resources. additional political and economic stability also would positively contribute to its continued fdi growth. at a nation specific level, several findings were of note. argentina, south africa, and south korea, despite their dubious pasts, are regarded as enjoying a relatively accommodating business environment, modest markets and resources, and stable political and economic systems. however, none of these bems distinguish themselves on any of these dimensions. in turn, these findings 54 journal of business strategies vol. 20, no. 1 suggest that these nations may enjoy the greatest array of strategic alternatives and opportunities to improve fdi. brazil and poland may be considered "fdi outliers." each occupies a somewhat unique position. brazil is seen as having desirable markets and resources, but appears to suffer badly from political and economic instability, as well as a less accommodating business environment. likewise, poland occupies a position that easily may be considered the weakest of any of the bems studied. given its location on all dimensions, poland appears to hold this dubious distinction. however, two other nations appear to face significant fdi challenges. these nations include indonesia and turkey. respondents perceive the ideal nation as possessing overall qualities that can be construed as acceptable on most dimensions and conservati ve in the area of political and economic stability. while not specifically ascertained, it appears that fo[ respondents place far greater emphasis on this latter dimension. as noted earlier, india and china appear most strategically positioned relative to the availability of and access to markets and resources. most other nations, except for argentina, poland, and south africa, appear to occupy an acceptable or neutral position on the availability and access dimension. half of the nations studied are perceived as possessing business climates or environments that are less than accommodating. brazil, china, indonesia, poland, and turkey are perceived as being somewhat deficient in this area. while this research did not ascertain the specific elements that comprise the business environment, this area arguably represents a strategic area of need (kamm, 1992). [n contrast, the most difficult and traditionally dubious dimension that can be addressed is the political and economic environments of emerging nations. three of the bems studied are perceived as having relatively stable environments. those nations include india, mexico, and south africa. two other nations, argentina and south korea occupy only slightly negative positions on this dimension. all other nations studied are perceived as having less stable environments, especially brazil and poland. two nations, indonesia and south korea appear poised to potentially improve their positions on this dimension. given the overall ideal point perceived by respondents, at least two and perhaps as many as five nations appeared poised to take greatest advantage of repositioning opportunities. most immediately, those nations include india and mexico, with opportunities also available for argentina, south africa, and/or south korea (via greater economic and political stability). several nations including brazil, china, and turkey appear to possess desirable markets and resources, but suffer mightily from unstable political and economic environments, as well as unaccommodating business environments. an effort to improve in either of these areas has the potential to generate much more fdi interest. further, while each of these nations generally must pursue different repositioning strategies, all possess one or more qualities that make them potentially desirable foreign direct investment options. spring 2003 festervand: u.s. executives' perceptions conclusion 55 foreign direct investments generally are recognized as providing an opportu~ nity for nations, governments, society, and business to improve economically. as such, most nations around the globe are pursuing (to some extent) direct investments by foreign governments, companies, and private investors. the pursuit of these foreign direct investments is highly competitive. to be successful, a nation must position itself as being more desirable than another nation, especially other similar, competing nations. this study was undertaken to determine how foreign direct investment executives perceived ten hems. overall, these findings demonstrate where and how each of the ten hems studied is perceived individually and collectively. in turn, the foreign direct investment challenge and opportunity for each of these nations lies in its desire and ability to affect meaningful and enduring change. if this commitment can be achieved, then each nation must develop an economic development program designed to capitalize on and/or ameliorate each aspect of their perceived position. references aitken, b., hanson, g. h., & harrison, a. e. (1997). spillovers, foreign investment, and export behavior. journal of international economics, 43, 1-2. azzam, h. t. (200 i). business indicators private capital flows to the arab countries in 2001 and 2002. middle east executive reports, 24, 5 (may), 22. boycko, m., shleifer, a., & vishny, r. w. (1994). voucher privatization. journal of financial economics, 35, 2, 34-37. clark, c. (1996). privatization and industrial policy as u.s. competitiveness strategies: lessons from east asia. advances in competitiveness research, 4, 101-118. cho, dong-sung, & moon, chang (1998). a nation's international competitiveness in different stages of economic development. advances in competitiveness research, q,5-19. dichtl, e., & koglmayr, h. g. (1986). country risk ratings. management international review, 26, 4, 6. dhume, s. (2000). india's awakening. far eastern economic review, (january), 36-38. dunning, j. h. (1988). the eclectic paradigm of international production: a restatement and some possible extensions. journal of international business studies. 19, i, 131. 56 journal of business strategies vol. 20, no.1 dunning, j. h. (1993). the globalization of business: the challenge of the 1990's. routledge, london, england. earle, j. s., & estrin, s. (1996). employee ownership in transition. in r. frydman, c.w. gray, and a. rapaczynski (eds.), corporate governance in central europe and russia, 2, world bank/ceu press, london, 1-61. ei-said, h., & mcdonald, f. (2001). institutions and joint ventures in the middle east and north africa: the case of jordan. journal of transnational management development, 6, i & 2, 65. ensign, p. c. (1993). a system theory of foreign direct investment: advantages of being multinational. advances in competitiveness research, 1. 67-77. erb, c. b., harvey, c. r., & viskanta, t. e. (1996). expected returns and volatility in 135 countries. journal of portfolio management, 22, (spring), 46. estrin, s., & meyer, k. e. (1998). opportunities and tripwires for foreign investors in eastern europe. thunderbird international business review, 40, 3 (mayljune), 209-234. fdi in tunisia: restrictions easing but emphasis is still on offshore export-oriented foreign investment. middle east executive reports, 24, 6 (june 200 1),4. garten, j. e. (1997). the big ten: the big emerging markets and how they will change our lives, basic books, new york, ny. green, p. e. (1975). marketing applications ifmds: assessment and outlook. journal of marketing, 39, (january), 24-31. hill, c.w.l., & jones, g. r. (2000). strategic management theory, houghton-mifflin company, boston, ma. hitt, m. a. (1996). problems and potential solutions to strategic competitiveness in global market. advances in competitiveness research, 4, 4. hobeika, l. g. (200 i). economic growth, privatization, trade and competition in lebanon. middle east executive reports, 24, 9 (september), 7. international membership and resource directory (1999-2000). international development research council, atlanta, ga. jenkins, g. (1995). investment funds in cuba: an upcoming caribbean tiger. columbia journal of world business, 30, 1, (spring), 42. jones, c. (2000). hungary: post-communist belle of the ball. the banker, (july), 29-31. spring 2003 festervand: u.s. executives' perceptions 57 kamm, t. (1992). latin links. the wall street journal, (september 24), r6. keegan, w. j., & green, m. c. (2003). global marketing, prentice hall publishers, upper saddle river, nj. kotabe, m., & helsen, k. (1998). global marketing management, john wiley & sons, inc. new york, ny. mccrary, e.s. (2000). turkey rises to the eu challenge. global finance. (june), 49-58. orton, c.w. (2000). eastern europe meets west. world trade, (april), 76-80. parsons, n. (2002). turkey seeks partners for the long term. global finance, (june), 12. ramcharran, h. (2000). foreign direct investments in central and eastern europe: an analysis of regulatory and country risk factors. american business review, (june), 1-8. ries, a., & trout, j. (1981). positioning: the battle for your mind. new york: mcgrawhill. sachs, j. d., & warner, a. (1995). economic reform and the process of global integration. in w. c. brainard and g. l. perry (eds.), brookings papers on economic activity. 1, washington, dc: brookings institute, 1-18. saudi arabia's investment climate: debating revisions to encourage more private foreign investment. middle east executive reports (1999) 22, 7, 8. scanlon. j. r. (1994). site selection and design for the growth industries. industrial development, (march/april), 26-29. taylor, c. t. (2000). the impact of host country government policy on us multinational investment decisions. the world economy, (may), 635-647. tatoglu, e., & glaister, k. w. (1998). determinants of foreign direct investment in turkey. thunderbird international business review, 40,3 (may/june), 279-314. townsend, d. (2002). slowly does it. petroleum economist, 69, 4 (april), 26. united nations (1992). world economy survey. the economist, (september), 17. united nations (1998). economic survey of europe, 3, geneva: united nations. united nations (1999). economic survey of europe. i, geneva: united nations. viswanathan, a, (2000). is india being fair to foreign investment? international financial law review, (january), 21-23. 58 journal of business strategies vol. 20, no. i wallace, e.d. (1990). foreign direct investment in the 1990s: a new climate in the third world. martinus nijhoff publishers, dordrecht, netherlands. 1 see multiple articles on bems in the summer 1996 edition of the columbia journal of world business 31, 2. 2 the sample was drawn from the membership of the lore. however, that organization did not sponsor or endorse the project. troy a. festervand is associate dean for graduate and executive education and professor of marketing at middle tennessee state university where he teaches industrial marketing and international marketing. he received his ph.d. in 1980 from the university of arkansas. in addition to publishing his research in numerous journals, he is actively involved in industrial consulting and professional activities. u. s. executives' perceptions of "bems" as f.d.i. options driving forces of international pharmaceutical firms' fdi into china fuming jiang the australian national university canberra, australia abstract this paper presents the results ofan exploratory investigation into the factors that drove the internationalpharmaceuticalfirms to makeforeign direct investment (fdi) into the chinese pharmaceutical manufacturing industry during the period from 1980 to 1998. research results show that international pharmaceuticalfirms' fdi into china was predominantly motivated by china s specific location factors. china smarket size, with its great potential, played the most important role. the factors of rapid economic development and growth, china s open-door policy, and relatively stable political conditions were also found to be importantfactors. the incentive policies provided by china had limited impact on pharmaceutical firms fd1 decisions. the results suggest that fdi decisions of early entrants who started fd1 before 1992 were more likely to consider the open-door policy as the second most important factor, whereas late entrants whose fdi started since 1992 seemed more likely to consider the chinese economic development and growth as the second most important factor. the results also suggest that relatively stable political conditions in china have had a stronger positive influence on the fdi decisions ofthe late entrants. low labor and establishment costs in china as well as cultural relatedfactors were notfound to be significant factors/or international pharmaceutical investors. introduction china has attracted substantial foreign direct investment (fdi) since the passage ofthe chinese-foreign equity joint venture law by the national people's congress of china in 1979. as shown in figure 1, the growth trends offdi have undergone two major phases. during the period of 1979-1991, the fdi flow into china was slow and the actual investment showed no significant growth ti111991. beginning with a 25 percent growth in 1991, china has since attracted a greatly increased amount of fdi. a sharp increase (approximately 152 percent over the previous year) occurred in 1992 and an fdi inflow in 1992 (usd 11.007 billion) was just slightly lower than the total fdi (usd 12.103 billion) in the entire first decade (1979-1989). by 1998, this 1992 level was surpassed four times over (ssbprc, 1988-1999). the country had been second only to usa as the major recipient of fdi from 1993 to 1997 and ranked in the third position in 1998 in the world. during the period 1992 to 1998, china had hosted almost 10 percent 22 journal ofbusiness strategies vol. 22, no. i of the total world fdi inflow in the world and absorbed over 28 percent of the total foi inflow to developing countries and over 46 percent of total fdi inflow to asian countries or regions. south east asian countries or regions attracted about uso 480 billion fdi flows from 1992 to 1998. approximately 50 percent of this went to china (un, 1996-1999). figure 1 fdi inflow to china (1979-1998) 50 45 40 35 iii 30i:: .2 iii 25 <it lj) 20:j 15 10 5 0 _.--------1.802 3.487 c") '<t l() (0 ..... co 0) 0 ..-n c") '<t 00 00 00 00 00 00 00 0) 0) 0) 0) 0) en 0) 0) 0) 0) 0) 0) 0) 0) 0) 0) 0)..... ..-0) 45.463 l() (0 ..... 00 0) 0) 0) 0) 0) 0) 0) 0) us$ billions source: figures extracted from ssbprc, 1988-1999 the popularity offoreign direct investment activities in china applies notably to the pharmaceutical industry. the chinese pharmaceutical industry has become one of the first groups of industries that established enterprises using foreign investment. by the end of 1998, china had established over 1,500 pharmaceutical companies with foreign investment, including investment by the majority of large multinational pharmaceutical groups from north america, western europe and asia. foreign invested pharmaceutical companies were distributed across almost every part of china. they produced a wide range of products, including, for example, bulk pharmaceutical chemicals, preparations, diagnostic reagents, medical dressings, pharmaceutical machinery and health care products (ccpie, 1995; ntob, 1996; mims, 1998; spgc, 1999). with foreign cooperation and the successful introduction of foreign investment, china's pharmaceutical industry has expanded at a very fast rate, with annual market growth posting an average double-digit growth for the past two decades. analysts anticipate that china will be the world's largest pharmaceutical market by year 2020 and the world's leader of pharmaceutical manufacturing during the 2011 to 2050 period (wang, spring 2005 jiang: driving forces 23 1999). this study, by means of both qualitative and quantitative approaches, investigated the determining factors that affected international pharmaceutical firms' for into china and explored the relationships between the importance of determinant variables and the timing of for decisions by taking the year of 1992 as a cutting point. while china formally permitted the participation offoreign investors in 1979, there were relatively little activity until 1991. the year 1992 became a turning point in china's political-legal and economic reforms. this followed the muchpublicised tour of the former leader, deng xiaoping, to the southern provinces of china early that year and his call for the acceleration of economic reform and the opening up of the economy to the outside world. the central government adjusted its economic policy in order to speed up economic reform and to further open the economy to foreign investment. the chinese government announced the adoption of the 'socialism market economy' strategy and began to build a legal framework to standardize market operation. regulations covering corporation law, bankruptcy law, individual income law, stock trading law, and some other commercial regulations have been passed since 1993. other reform measures included changes to the tax system and permitting the conversion of chinese currency. this created a favourable business environment and facilitated the functioning of market mechanism. in addition, privatization of state-owned enterprises (by selling the government share to the public) and lowering tariffs for imports have been important measures further liberalizing the chinese economy. these measures promoted high economic growth and a favourable business environment for foreign investment into the country (sun, 1998). the dramatic changes in chinese politics and economic policies since 1992 appear to have had significant impact on international pharmaceutical firms' for into china. therefore, firms whose for into china was prior to 1992 were classified as early entrants and those that started their fdls since 1992 as late entrants. a comparison offdi decision patterns between the pre-1992 period (early entrants) and the post-1992 period (late entrants) should provide a better understanding of fdi theories and practices in china. literature review the theories offoreign direct investment have traditionally emphasised market imperfection (hymer, 1960), location specific advantage (franko, 1971; vernon, 1977), internalization theory (buckley & casson, 1976) and transaction cost theory (williamson, 1975, 1985; buckley & casson, 1976; caves, 1982; anderson & gatignon, 1986). dunning's (1988) "eclectic paradigm" denoted that a firm's fdi decision is influenced by three types offactors: ownership-specific factors ofa firm, location-specific factors ofa market and internalization advantages of integrating transactions within the firm. taggart (1993) suggested that the three main divisions offdi theory (three-division theory), via approaches based on domestic market imperfections, firm specific advantages and location specific advantages were 24 journal ofbusiness strategies vol. 22, no. 1 generally more appropriate reasons for why multinational pharmaceutical firms invest abroad rather than in their home countries or regions. location-specific advantages, including market size (kueh, 1992; tesai, 1994; lardy, 1995; wang & swain, 1995, 1997; milner & pentecost, 1996; broadman & sun, 1997; park, 1997; qu & green, 1997; fittock & edwards, 1998; sun, 1998; wu, 1999; yan, 2000), stage of economic development (tesai, 1994; zhang & yuk, 1998), openness of the economy (singh & jun, 1995; walder, 1996), political stability (walder, 1996), host country's incentive policies (zhang & yuk, 1998; li & li, 1999) and labor cost considerations (tesai, 1994; wei & christodoulou, 1997; li & li, 1999) have recently attracted considerable research attention in explaining why fdi occurs in china. li and li (1999) clarified that foreign investors with new technology and new management skills were primarily attracted by china's huge potential domestic market and geared mainly towards long-term strategic considerations, whereas the foreign investors who made investments in laborintensive production geared towards export were mainly aiming for china's cheap labor costs. zhang and yuk (1998) asserted that fdi patterns in china are most likely to be determined by the location specific advantages such as large market size and low labor costs. however, the existing literature does not address whether the timing of foi has any significant impact on firms' fdi decisions into china, although china's economic system has been in a gradual transition process from the centrallyplanned economic system to what is termed socialism-market economic system in a 'learning-by-doing' process since 1979 (dfimftecprc, 1995). this comprehensive (and complicated) experimental process has been accompanied by essential political/legal and economic environmental changes in china that might have influence on international investors' fdi decisions to enter china. in fact, foi inflow into china has experienced two main distinctive patterns during the period of 1979-1998; that is, following a slow growth period from 1979 to 1991, foi inflow has increased dramatically since china's former leader oeng xiaoping's south china tour in 1992. in addition, the general strategic literature on the timing of entry has focused on the early mover advantages and disadvantages (conner, 1991; kalyanaram, robinson, & urban, 1995; vanderwerf & mahon, 1997; makadok, 1998; luo & peng, 1998; song, oi benedetto, & zhao, 1999) and the impact of timing of entry on firms' performance (kerin, varadarajan, & peterson, 1992; shaver, myles, mitchell, & yeung, 1997; lieberman & montgomery, 1998; luo, 1998; peng , li & tse, 1999; isobe, makino, & montgomery, 2000). therefore, a comparison between the impacts ofthe driving forces on the foi decision making processes of early and late entrants should contribute to the understanding of the temporal fashion of fdi into china during the different periods. furthermore, the existing literature also remains controversial in relation to the variables of incentive policies, low labor cost and market size. a number of the empirical studies (hartman, 1984; boskin & gale, 1987; slemrod, 1990) revealed that specific incentives such as lower tax have no major impact on foi decisions. wu (1999) also argued that large market size and low labor cost are not unique spring 2005 jiang: driving forces 25 to china. india, for example, is also a large nation and cheap labor is accessible there, as in developing countries. thus, the international pharmaceutical firms' fdi in the chinese pharmaceutical manufacturing industry remains unexplained in the existing literature, although the international pharmaceutical groups have been actively pursuing and evaluating avenues of access to what could become the world's largest drug market. this study, therefore, aimed at overcoming the shortcomings of previous studies by taking an exploratory approach to investigate the determining factors that drove international pharmaceutical firms' foreign direct investment into china during the period of 1980-1998 and the impact of timing of fdi on firms' fdi decisions. research method population and sample a total of 117 international-pharmaceutical-firm-invested pharmaceutical companies (lpfipcs) in mainland china were defined as the population for the research, based on four major sources: 1) the catalogue of chinese pharmaceutical enterprises with foreign investment (published by the china centre for pharmaceutical international exchange (ccpie, 1995), an agency of state pharmaceutical administration of china); 2) the market reports of national trade data bank of the united states of america (ntdb, 1996); 3) mims asia (mims, 1998); and 4) the report of shanghai pharmaceutical (group) corporation (spgc, 1999). pharmaceutical companies that had capital investment by non-pharmaceutical firms (for example, business trading companies and investment development firms) were not included in the research population. the key difference between the pharmaceutical and non-pharmaceutical firms is that the non-pharmaceutical firms do not have the technology advances in pharmaceutical research and product development as do the pharmaceutical firms, and these technology advances may have significant influences on foreign investors' fdi decisions. within the population, ninety-nine firms (84.6%) chose a joint venture entry operation with a local chinese partner as their entry mode for the chinese market and the remaining firms (15.4%) established 100 percent foreign-owned sole venture operations in china. the local chinese partners were mainly state-owned chinese pharmaceutical firms or government agencies. over 84 percent of ipfipcs were located in east china's thirteen provinces and municipalities including hainan, guangdong, fujian, zhejiang, shanghai, jiangsu, anhui, shangdong, hebei, tianjin, beijing, liaoning and hellongjiang. the east china region was the priority area for the chinese government to initially practice the policy of opening to the outside world for foreign investment. china's five special economic zones (sezs), fourteen coastal open cities and the shanghai pudong new development area are all located in this region, whose investment environment is relatively advantageous over china's middle and west areas. in august 1980, china created the four sezs of shenzhen, zhuhai, shantou and xiamen in south east china's coastal area. in 1988, hainan province, the china's 26 journal of business strategies vol. 22, no.1 largest island province was defined as the fifth special economic zone. the sezs are comprehensive experimental sites for china's economic restructuring and opening to the outside world. they also serve as a special channel for china to use foreign investment, to import advanced technology and enter international markets (dfimftecprc, 1995). in april 1984, the chinese government defined a total of fourteen cities as coastal open cities including tianjin, shanghai, dalian, qinhuangdao, yantai, qingdao, lianyungang, nantong, ningbo, wenzhou, fuzhou, guangzhou, zhanjiang and beihai. in an effort to support these cities in bringing their advantages into full play (for example, existing industrial and technological bases, harbour transportation, scientific research and education, increasing international economic links and accelerating economic development) the central chinese government has offered these cities policy preferences. these include the power to make decisions independently on foreign economic and trade activities, preferential treatment for foreign-funded enterprises and technical transformation of old enterprises. in investing in these cities, foreign investors can enjoy preferential treatment on taxation. for example, the income tax on productive enterprises with foreign investment is levied at a reduced rate of 24 percent and the income tax on foreign-funded enterprises undertaking projects encouraged by the state is levied at a reduced rate of 15 percent (dfimftecprc, 1995). in june 1990 the chinese government approved a plan to authorize the municipality of shanghai to develop and open the pudong new area and to exercise some policies in the area analogous to those applied in the sezs. as the most economically developed areas of china, the east china region proves to be a decisive force in the national economy and social development of china (ecprcy, 1999). as a result, a majority offoreign-funded businesses in china have been established in this region. foreign-funded projects in mid-western china are relatively few. this also applies to the locations of international pharmaceutical firms' fdi in china. a total of 98 ipfipcs that were distributed in the three major regions in east china and accounted for 83.76 percent ofthe population were defined as the sample size for this research. these ipfipcs in the sample include twenty-nine in south east region (ser), thirty-eight in middle east region (mer) and thirty-one in north east region (ner). the ser comprise of guangdong and fujian provinces. the mer covers shanghai municipality, jiangsu, anhui and zhejiang provinces. the ner consists ofbeij ing and tianjin municipalities, liaoning, shandong and hebei provinces (ccpie, 1995; ntdb, 1996; mims, 1998; spgc, 1999). data collection a questionnaire was designed in both english and chinese and was reviewed by two bilingual speakers. one reviewer was a graduate from a chinese university in china with a major in english studies and had received an mba degree from an australian university. another held an australian master's degree in marketing. the questionnaire was also pre-tested by six respondents using four personal interviews, one mail questionnaire survey and one telephone survey. ofthe six pretesting respondents, four had received mba degrees from australian universities spring 2005 jiang: driving forces 27 and had worked for foreign invested companies in china for a number of years in senior management positions. two of them had worked for lpfipcs in china. the rest were senior managers of a large chineseus j oi nt venture pharmaceutical company in china at the time the pre-testing took place. the fieldwork began in early april 1999 and was conducted over a 3-month period. the data were collected, in the main, from personal interviews and complemented by mail questionnaire surveys. personal interviews were conducted with senior executives of foreign business partners in ipfipcs in china and the postal questionnaires were addressed to foreign senior executives in lpfipcs in china. in line with the logic ofjohn (1984), who argues for selecting knowledgeable informants, the choice of this rather exclusive respondent group is based on the belief that people in these sensitive positions are the most cognizant about global investment projects and the dynamics ofthe overall foreign entry decision process (kim and hwang, 1992; chandprapalert, 2000). in total, 44 companies participated in this research and 82 percent of completed questionnaires were obtained through personal interviews. of the 44 responding ipfipcs, 43 firms provided useful data for the research question. these firms include 16 firms that were established in china before 1992, and 27 that have been set up since 1992. amongst 16 early entrants, 10 ipfipcs had investment by asian firms mainly from hong kong, taiwan and japan. the remainder of the early entrants were mostly from usa and western european countries. the western firms also comprised about 60 percent ofthe late entrants. about 62 percent of the firms in the sample invested less than usd20 million in china1. over 81 percent of early-entrants committed to this smaller scale of investment and the same percentage applies to the proportion of late entrants who invested more than usd20 million in china. in the sample, three companies, including two in guangdong and one in jiangsu, were found to have ceased operations during the fieldwork. in addition, one company in guangdong had the foreign partner's share sold to its chinese partner before this survey was conducted. therefore, the real sample size was reduced from an estimated 98 to 94 lpfipcs, resulting in a 45.74 percent response rate. data analysis and results respondents were asked to describe why their parent firms made fdi decisions to invest in china. the responses were categorized in a similar way prescribed by walsh, wang, and xin (1999), and coffey and atkinson (1996). that is, following the scanning of data a number of times, bulk groups of data sets were created, based on those with most appropriate meaning. each bulk group of data set then was condensed into analyzable units by creating categories and each category was treated as an independent variable (factor) for statistical analysis. in total, ten categories were identified, including china s market size with great potential (for pharmaceutical products); rapid economic development andgrowth, china 50 opendoor policy, relatively stable political conditions, low cost olestablishment o.fplant andfacility, incentive policies, low labor cost in china, traditional contacts and linkages, similar culture and language, and continuation o.lprevious business. 28 journal of business strategies vol. 22, no. 1 the quantitative data analysis procedures were performed with spss (version 10) following data categorization. the descriptive analysis was carried out, first, to summarize the frequency percentages for each factor considered by foreign firms with respect to their fdi decision into china. variables considered as important factors by firms were coded as 'i '; those not considered were coded as '2'. the figure 2 presents the descriptive results of the number of firms that considered each particular factor. it reveals the existence of four distinctive patterns. the primary concerns of the ten factors were strongly associated with china's political, economic, social and culture conditions. the first two most important factors, china~' market size with great potential and rapid economic development andgrowth are connected with china smarket and economic conditions and the second two most important factors, china s open-door policy and stable political conditions are related to the government's policy on business and economic activities. of these, china s open-door policy seems to be more important than relatively stable political conditions to foreign investors' fdi decisions. incentive policies provided by china tended to have a minor impact on the pharmaceutical firms' fdi decisions to invest in china. the remaining five factors, including low cost ofestablishment ofplant andfacility, low labor cost, traditional contacts and linkage, similar culture and language and continuation ofprevious business turned out to be insignificant in the context of international pharmaceutical firms' fdi into china. each participating firm reported more than one factor that influenced its fdi decisions to invest in china. on average, the number of factors reported, per firm, was 2.88. the independent sample t-test suggested that there was no significant difference between early and late entrants vis-a-vis the average number of factors per firm reported (mean = 2.75 for early entrants and mean = 2.96 for late entrants, p > .05, t = -0.5822). this may suggest that the decisions of the international pharmaceutical firms' fdi into china were determined by a combination of factors. the second level of analysis took consideration of the relatively small sample size used for this research. the simple logistic regression (slr) technique was used to investigate whether any associations existed between the importance of determinant factors and timing of fdi (pre-1992 vs. post-i 992). the slr is appropriate for a two-by-two table comparison, instead of using pearson's chi-square test 2• the pre-1992 period (early entrants) was coded as 'i' and the from-l 992 period (late entrants) was coded as '2'. the outcome of the slr is shown in table i and indicates that there was a significant positive relationship between the factor of china sopen-door policy and the timing offdi (~ = 1.376; p < 0.05). a significant negative relationship was identified between the factor of china s economic development & growth and the timing of fdi (~ = -2.260; p < 0.01); and a significant negative relationship was shown between the factor of relatively stable political conditions and timing offdi (~ = -1.722; p < 0.05). a positive beta (~) indicates a positive relationship between the importance of factors and the timing offdi and means the factor was important in pre-i 992 (early entrants). conversely, a negative beta (~) indicates a negative relationship spring 2005 jiang: driving forces 29 between the importance of factors and the timing of fdi and means the factor was important in from-1992 (late entrants). thus, the results reveal that early entrants viewed china sopen-door policy to be more important than did the late entrants. on the other hand, the late entrants were more likely to consider china s economic development and growth and relatively stable political conditions as important positive factors to their fdi decisions. figure 2 exploratory variables by frequency of participating firms (n = 43) variables (factors) china's market size with great potential rapid economic development & growth china's open-door policy relatively stable political conditions incentive policies provided by china low labor cost in china low cost of establishment of plant & facility traditional contacts & linkages similar culture & language continuation of previous business frequency (%) 97.7 67.4 41.9 320 23.0 :::::::sa 7 :::::::sa 7 ::::j 4.7 ::::j 4.7 :::l2.3 o 20 40 60 80 100 table 1 simple logistic regression by exploratory variables dependent variable: timing of fdi (early entrants vs. late entrants) variables china's market size with great potential rapid economic development and growth china's open-door policy relatively stable political conditions low cost of establishment of plant & facility incentive policies provided by china low labot costs in china traditional contacts & linkage similar culture & language continuation of previous business 6.7162 -2.2600 1.3758 -1.7222 -7.7970 1.2384 1.3120 .5500 .5500 -6.7162 sig. .8546 .0025** .0390* .0426* .8232 .0980 .3011 .7046 .7046 .8546 * p < .05; ** p < .01; *** p < .001 a positive beta 13 means important in pre-1992 period for early entrants a negative beta 13 means important in from-i 992 period for late entrants 30 journal of business strategies conclusion and discussion vol. 22, no. 1 the purpose of this research was to examine the determinants of international pharmaceutical firms' foi into china during the period from 1980 to 1998. it differentiated itself from similar studies on foi into china by investigating the determinants of international pharmaceutical firms' fdi into the chinese pharmaceutical industry and the possible changes in importance of determining factors through time. as such, the study advances the understanding ofthe industry specific nature of fdi and the temporal fashion of foi into china during the different periods. the research results suggest that international pharmaceutical firms' fdi into china was determined predominantly by china's location-specific factors. this finding partially supports dunning's (1988) eclectic paradigm and taggart's (1973) three-division theory on multinational pharmaceutical firms' foi activities. however, it was consistent with most recent studies on multinational firms' decisions to invest in china. the research results reveal that four factors, namely china smarket size with its great potential, rapid economic development and growth, china sopen door policy and relatively stable political conditions have been the major motivations in attracting international pharmaceutical firms' direct investment into the chinese pharmaceutical manufacturing industry during the period from 1980 to 1998. incentive policies provided by china had no major impact on firms' fdi decisions. the low labor cost and social-cultural related factors appeared to be insignificant to international pharmaceutical firms' foi decision into china. steady gdp growth, increase ofincome per capita, consistent increase of per capita annual expenditure on medicine and medical service, together with over 1.2 billion people make the factor of china's market size with its great potential the most important motivation among the four major factors. the importance of the other three important factors depends on the timing of fdi into china. china sopen-door policy played the second most important role in encouraging international investment particularly during the early stage of china's economic reform and socialism market development. the promulgation ofthe law ofthe people srepublic ofchina on joint ventures using chinese and foreign investment in july 1979 was a momentous event in china's opening up of the economy. the gradual implementation of the open door policy represented a breakthrough from the past in china's economic development strategy. the open door policy was a strong signal to the outside world and indicated china's intention to break out of its international isolation and become aggressively involved in the world economic activities after three decades of isolation and central planning of the economic system. the open door policy brought new opportunities for foreign investors who intended to develop business in the chinese market. the rapid economic development and growth, combined with the relatively stable political conditions in china, has had significant impact on international investors' decisions to make direct investment in the country particularly since 1992. the speeches of china's former leader, deng xiaoping, published in 1992, have accelerated the processes of the chinese economic reform and opening up spring 2005 jiang: driving forces 31 the economy for foreign investment, which have had positive impact on economic development and political conditions in the country, in tum contributing to the late entrants' foi decision to invest in china. economically, china has achieved an average of double-digit growth in gop during the period 1979-1998 and the growth rate was higher during the from1992 period (10.7%) than that in the pre-1992 period (9.1 %). more importantly, since 1992 the country has achieved economic stability and sustained growth with controlled inflation, this having followed a number of dramatic fluctuations in gop rates during the pre-1992 period of its economic reform and development (ssbprc, 1999). the strong, balanced, economic growth and control of inflation, rather than the attainment of rapid growth at all costs, remain the government's prime objectives (hatheway, 1998). the country claimed significant success in macroeconomic management with controlled consumer and retail price inflations at 2.8% and 0.8% respectively, in 1997. the central chinese government has also successively established and opened a series of 'coastal open areas' and has introduced the policy of 'opening cities on rivers and borders' for foreign investments since 1992. consequently, 6 port cities on the yangtze river, as well as 13 inland border cities and capitals of provinces and autonomous regions have been opened and offered preferential policies. these include tax reduction similar to those for coastal open cities and/or special economic zones defined and created by the chinese central government before 1992 to serve as a special channel for china to use foreign investment and to import advanced technology and enter international markets (ofimftecprc, 1995; li & li, 1999). therefore, the rapid economic development and growth, together with the central chinese government's stronger commitment to the economic reform, have created a more promising market with greater potential and a more favourable investment environment to better facilitate foi into the country since 1992. a number of recent studies on timing of market entry revealed that the early entrants may have the advantages in market growth (kalyanaram, et ai., 1995; vanderwerf& mahon, 1997; makadok, 1998; song, et ai., 1999), pricing strategies (makadok, 1998), technological leadership, creation ofbuyer switching costs and positive economic benefits (lieberman & montgomery, 1998) and development of valuable and non-substitutable resources (conner, 1991; makadok, 1998). in the context offoi in china, the early movers may outperform the late entrants in market growth and asset efficiency and enjoy the benefit from more pre-emptive market opportunities and business potentials than they would in the home market. in contrast, the early entrants encountered greater risks than the late entrants did in the start-up phase of international expansion. china is an economy in the process of transformation, which could present daunting challenges to the unwary investors (luo, 1998). foreign investors, in general, were concerned about china's political instability, especially during the pre-l 992 period when the 1989 tiananmen square incident occurred after a number of failures in the transformation of chinese leadership. many foreign investors were unsure of the direction the country was taking. most complaints from foreign investors 32 journal ofbusiness strategies vol. 22, no. 1 in china in the early stage of economic reform and development related to the uncertainty and opacity of local laws, rules and government policies on foi (national council, 1991). the political and social uncertainties arising in the transitional stage often reinforce variations in contextual conditions (peng & heath, 1996). in addition, far-reaching changes in industry and market structures in the early stage of structural transformation caused substantial variance in the investment environment that could lead to the instability of foreign invested firms in china (luo, 1995). the superiority of the advantages to early investor's accrued at the expense of high operational risk in the local environment (luo, 1998). therefore, in addition to the possible advantages the early investors might be able to take (as revealed in previous studies), there are a number of possible factors that contributed to the early entrants' decisions on the timing of entry into the chinese market by the international pharmaceutical firms. first, approximately two-thirds ofthe early investors were from hong kong, taiwan and japan, who might have a better understanding of the china's overall investment environment and the skills to cope with the uncertainty in the environment. second, over fourfifths of the early entrants committed a smaller scale of capital investment in the china ventures. furthermore, the international pharmaceutical firms introduced conventional drug technology, rather than the latest innovative technology, to the chinese market. this was achieved by transferring the manufactured conventional drugs from the operations in their home countries to the china ventures, then marketing the drugs into the chinese market. these factors could be viewed as a first step to test the market in the early stage offdi activities in china, which brings into line with williamson's (1985) transaction cost theory suggesting that when uncertainty is high, the firm should minimise its commitment to the environment. third, the large majority of international pharmaceutical firms formed joint ventures with local chinese partners. a competent local chinese partner can assist the ventures in reducing the risks associated with the uncertainty by using their country-specific knowledge. this applies even more so for early entrants since they had a better chance to choose a more competent partner while more alternative partners were still available to them in the early stage of foi activities. finally, the early investors concentrated their investments in sezs or open cities. as luo (1998) pointed out, ventures located in those open areas are able to foster risk reduction in china. the four attributes deal with investors' capability (local environment know-how) and investment strategies (partner selection, venture location selection within china and scale of investment). this may suggest that, other things being equal, a firm's early entry decision into a politically uncertain international market like china also depends on what the firm can do (capability) and how to do it (investment strategies). since 1992, a collective leadership rather than a single, predominant leader has governed china. political stability and economic development and reform have been priority objectives of the central chinese government. also since 1992, an upsurge of foreign investment swept across the country and the introduction of foreign investment underwent a new, substantial development, both in breadth spring 2005 jiang: driving forces 33 and depth. since then, a legal framework governing foreign investment activities and a market-oriented system has been established. most notably, china has made significant progress in implementing intellectual property rights regulations, education and enforcement, as international pharmaceutical firms were sensitive to, and concerned about the weak intellectual property rights protection. after a few years ofnegotiation between china and the united states ofamerica, the two countries signed a bilateral agreement on the protection of intellectual property rights in february 1995 and the agreement injune 1996 on procedures for ensuring its effective implementation. the economic transition proceeds and the chinese markets are becoming more and more integrated with the global economy; and the contextual risks and uncertainties have been therefore gradually diminishing over time. overall, the political environment for international investors has been improved significantly. outstanding economic performance has provided the late entrants with a relatively stable investment environment for their long-term business development in china. these improvements may also explain in large part why china was more attractive than other nations that also have low labor costs and potential large market size advantages. this study also demonstrated that the incentives provided by the chinese government would most likely be treated as an additional benefit by most international pharmaceutical firms, rather than a decisive factor on their fdf decisions to china. this finding supports previous studies primarily based on fdi in the usa (hartman, 1984; baskin & gale, 1987; slemrod, 1990), although contrasts findings ofrecent studies based on foi in china (zhang & yuk, 1998; li & li, 1999). this may be because the pharmaceutical industry is more technologybased, rather than a labor-intensive industry. international pharmaceutical firms who invested their capital and technology into china were primarily aiming to access china's potential huge market for their products. usually, export-oriented fdf have invested mainly in labor-intensive industries. therefore, the incentives may be significant for export oriented investments in labor-intensive industries in china. for similar reasons, cheap labor, low establishment costs and social cultural related factors would not have significant effects on international pharmaceutical firms' fdi decision into the chinese pharmaceutical manufacturing industry. this finding supports li and li's (1999) clarification about the impact of china's low cost oflabor on foreign firms' decision to invest in the country. limitations and future research directions there are three main limitations in this research. this research suggests that the timing of fdi had significant impacts on fdi determinants. the changes in investment environments and other conditions in china are continuing, as the political/legal and economic reforms in china are still on unfolding. this study was conducted in a particular time period and only gives insights into the situation at that moment in time (1980 to 1998). second, most of the pharmaceutical companies with foreign investment in china are firms that have investment by 34 journal of business strategies vol. 22, no. i international non-pharmaceutical firms (ccpie, 1995; mims, 1998). therefore, further research into fdi of international non-pharmaceutical firms would be expedient and meaningful. in addition, a comparison of determinants between pharmaceutical and non-pharmaceutical firms fdi in the pharmaceutical industry would further add to the understanding of how fdis operate. finally, future research studies may also extend to other industries rather than just the pharmaceutical industry, as international investors have also been actively engaging in other industries in china. reference anderson, e., & gatignon, h. (1986). modes of foreign entry: a transaction cost analysis and propositions. journal of international business studies, 17(3), 1-26. baskin, m.l, & gale, w.g. (1987). new results on the effects of tax policy on the international location of investment. in m. feldstein (ed.) the effects of taxation on capital accumulation. chicago: university of chicago press. broadman, h.g., & sun, x. (1997). the distribution offoreign direct investment in china. the world economy, 20(3),339-362. buckley, p.j., & casson, m. (1976). the future of the multinational enterprise. london: macmillan. caves, r.e. (1982). multinational enterprises and economic analysis. new york: cambridge university press. ccpie (china centre for pharmaceutical international exchange). (1995). catalogue of chinese enterprises with foreign investment. beijing: ccpie. chandprapalert, a. (2000). the determinants of u.s. direct investment in thailand: a survey on managerial perspectives. multinational business review, 8(2), 82-88. christensen, r. (1997). log-linear models and logistic regression, (2nd ed.). new york: springer. coffey, a., & atkinson, p. (1996). making sense of qualitative data: complementary research strategies. thousand oaks: sage publications. conner, k. (1991). a historical comparison of resource-based theory and five schools of thought within industrial organization economics: do we have a new theory of the firm? journal of management. 17, 121-154. dfimftecprc (department of foreign investment ministry of foreign trade and economic co-operation people's republic of china). (1995). the china investment guide, 5th ed. hong kong: citic publishing house. spring 2005 jiang: driving forces 35 dunning, j.h. ( 1988). the eclectic paradigm ofinternational production: a restatement and some possible extensions. journal of international business studies, 19( 1), 1-31. ecprcy (editorial committee ofpeople 's republic ofchina yearbook). (1999). people's republic of china yearbook. beijing: xinhua news agency. fittock, c.s., & edwards, w.r. (1998). the determinants of australian direct investment in china. journal of asian business, 14(3), 41-51. francis, g. (1999). introduction to spss for windows, version 7.5,8.0 with notes for studentware, (2nd ed.). sydney: prentice hall. franko, l.g. (1971). joint venture survival in multinational corporations. new york: praeger publisher. hartman, d.g. (1984). tax policy and foreign direct investment in the united states. national tax journal, 37, 475-88. hatheway, l. (1998). china: political transition, gradual reform, coping with slower growth. new horizon economies, (1 st quarter), 30-31. hymer, s. (1960). the international operations of national firms: a study of direct foreign investment. phd dissertation. massachusetts: mit press. isobe, t., makino, s., & montgomery, d.b. (2000). resource commitment, entry timing, and market performance of foreign direct investment in emerging economies: the case of japanese international joint ventures in china. academy of management journal, 43(3), 468-484. john, g. (1984). an empirical investigation of some antecedents of opportunism in a marketing channel. journal of marketing research 12(3),278-289. kalyanaram, g., robinson, w., & urban, g. (1995). order of market entry: established empirical generalizations, emerging empirical generalizations, and future research. marketing science, 14, 212-221. kerin, r.a., varadarajan, p.r., & peterson, r.a. (1992). first-mover advantage: a synthesis, conceptual framework, and research propositions. journal of marketing, 56,33-52. kim, w.c., & hwang, p. (1992). global strategy and multinationals' entry mode choice. journal ofinternational business studies 23(1 ),29-53. kueh, y.y. (1992). foreign investment and economic change in china. china ouarterly, 131,637-689. 36 journal ofbusiness strategies vol. 22, no. 1 lardy, n.r. (1995). the role of foreign trade and investment in china's economic transformation. china quarterly, 144, 1065-1082. li, f., & li, 1. (1999). foreign investment in china. houndmills: macmillan press ltd. lieberman, m., & montgomery, d. (1998). first mover (dis)advantage: retrospective and link with the resource-based view. strategic management journal, 19, 1111-1125. luo, y. (1995). business strategy, market structure, and performance of international joint ventures: the case of joint ventures in china. management international review, 35, 241-264. luo, y. (1998). timing of investment and international expansion. journal ofinternational business studies, 29(2), 391-407. luo, y, & peng, m.w. (1998). first mover advantages in investing in transitional economies. thunderbird international business review, 40(2), 141-163. makadok, r. (1998). can first-mover and early-mover advantages be sustained in an industry with low barriers to entry/imitation? strategic management journal, 19, 683-700. milner, c., & pentecost, e. (1996). location advantages and us foreign direct investment in uk manufacturing. applied economics, 28(5), 605-616. m ims asia. (1998). china medicines and chemical reagents booklet: manufacturers, distributors, representative offices. hong kong: mims asia. national council for us-china trade. (1991). special reports on us investment in china. washington, dc: department of commerce. ntdb (national trade date bank). (1996). market report. national trade data bank of united states of america. park, j.d. (1997). the special economic zones of china and their impact on its economic development. westport: praeger. peng, m.w., & heath, p.s. (1996). the growth of the firm in planned economies in transition: institutions, organizations, and strategic choice. academy of management review, 21, 492-528. peng, m.w., li, s., & tse, d.k. (1999). the impact of order and mode of market entry on profitability and market share. journal ofinternational business studies, 27(1), 1-26. qu, t., & green, m.b. (1997). chinese foreign direct investment: a subnational perspective on location. aldershot: ashgate. spring 2005 jiang: driving forces 37 shaver, lm., mitchell, w., & yeung, b. (1997). the effect of own-firm and other firm experience on foreign direct investment survival in the united states. strategic management journal. 18(2),325-342. singh, h., & jun, w.k. (1995). some new evidence on determinants of foreign direct investment in developing countries. policy research working paper, no. 1531. slemrod, j. (1990). tax effects on foreign direct investment in the united states: evidence from a cross-country comparison. in a. razin, & j. slemrod (eds.) taxation in the global economy. chicago: university of chicago press. song, x., di benedetto, m., & zhao, y. (1999). pioneering advantages in manufacturing and service industries: empirical evidence from nine countries. strategic management journal, 20, 811-835. spgc (shanghai pharmaceutical group corporation). (1999). shanghai pharmaceutical group corporation (report). shanghai: spgc. ssbprc (state statistic bureau of people 's republic of china). (1999). china statistical yearbook. beijing: china statistical publishing house. (and previous issues 1988 1998) (in both chinese and english). sun, h. (1998). foreign investment and economic development in china, 1979-1996. aldershot: ashgate. tabachnick, b.g., & fidell, l.s. (1996). using multivariate statistics. (3rd ed.). new york: harpercollinscollegepublishers. taggart, j. (1993). the world pharmaceutical industry. london: routledge. tesai, p.l. (1994), determinants of foreign director investment and its impact on economic growth. journal of economic development. 19(1), 137-163. un (united nations). (1999). world investment report: foreign direct investment. new york: united nations. (and previous issues 1996-1998). vanderwerf, p., & mahon, j.f. (1997). meta-analysis of the impact of research methods on findings of first-mover advantages. management science, 43, 1510-1519. vernon, r. (1977). storm over the multinationals. cambridge: harvard university press. walder, p. (1996). china's transitional economy. england: oxford university press. walsh, p., wang, e.p., & xin, r.k. (1999). same bed, different dreams: working relationships in sino-american joint ventures. journal of world business, 34, 6970. 38 journal ofbusiness strategies vol. 22, no. i wang, yf. (1999). china meets the medicine market: the addition of a market economy in china is bringing new opportunities and challenges for its pharmaceutical industry. chemistry and industry, 12, (june), 462-467. wang, z., & swain, n.j. (1995). the determinants offoreign direct investment in transforming economies empirical evidence from hungary and china. weltwirtschaftlichesarchiv, .l..1l.(2)., 359-382, wang, z., & swain, n,j. (1997). determinants of inflow of foreign direct investment in hungary and china: time-series approach. journal of international development. 2(2l, 695-726. wei, h. c. & christodoulou, c. (1997). an examination ofstrategic foreign direct investment decision process: the case oftaiwanese manufacturing smes. management decision. 35(8), 619-630. williamson, o.e. (1975). markets and hierarchies. new york: the free press. williamson, o.e. (1985). the economic institutions of capitalism. new york: the free press. wu, y (1999). fdi and economic growth: an introduction. in y, wu (ed.) foreign direct investment and economic growth in china. cheltenham: edward elgar. yan, y (2000). international joint ventures in china. new york: macmillan. zhang, x., & yuk, h.p. (1998). determinants of hong kong manufacturing investment in china: a survey. marketing intelligence & planning. 16(4),260-267. footnote i. a usd20 million investment is usually regarded as a rather small scale of investment for international pharmaceutical firms. 2. pearson's chi-square test is only appropriate ifthere is sufficient data (francis, 1999). pearson's chi-square is equivalent to the simple logistic regression which uses the pooled estimate of the standard error (christensen, 1997: 27). logistic regression is relatively free of restrictions, with the capacity to analyse a mix of all types of predictors (continuous, discrete and dichotomous) the variety and complexity of data sets that can be analysed is almost unlimited (tabachnick & fidell, 1996: 578). spring 2005 jiang: driving forces 39 jiang fuming is a researcher and lecturer in international business in the school of business & information management at the australian national university. he received his ph.d. in international business/strategic management from the australian graduate school of entrepreneurship at swinburne university, australia. his research interests include internationalization strategies ofchinese firms and foreign direct investment strategies of multinational corporations in china and australia. 40 journal ofbusiness strategies vol. 22, no. 1 driving forces of international pharmaceutical firms' fdi into china the effects of the sarbanes-oxley act of 2002 on audit fees sarah b. cosgrove university of massachusetts dartmouth n. dartmouth, ma m. scott niederjohn lakeland college sheboygan, wi abstract the sarbanes-oxley act of2002 was intended to improve corporate governance and increase the transparency offinancial audits. the legislation also could have significant effects on the public accounting industry. this study finds evidence of higher auditfees across allfirms resultingfrom compliance with the law. however, after accounting for self-selection of auditors, we do not find evidence that the size ofthe audit firm affects the magnitude ofthe auditfee increase. introduction and background in july of2002, congress passed the sarbanes-oxley act (sox) in response to a wave of corporate governance scandals. this paper will investigate the impact that the sox act has had on the audit fees in the public accounting industry and will attempt to determine if that impact differs with the size of the audit firm. this legislation was designed to increase the oversight and regulation of the accounting profession. with the goals of strengthening corporate governance and increasing the transparency of financial audits, the act aimed to restore public confidence in corporate america following the scandals at enron, arthur andersen, tyco, worldcom, global crossing, among others. the major provisions of the sox act include: • the establishment of the public company accounting oversight board (pcaob) to set auditing standards. • a stricter definition of auditor independence that restricts the types of consulting services an auditing firm may provide their clients. • stricter criminal penalties for corporate fraud. • more detailed and timely disclosures of financial information. many researchers have noted that the sox legislation was passed very quickly, perhaps too quickly, and that the law's costs of compliance may exceed its ben32 journal ofbusiness strategies vol 25, no.1 efits. zhang (2005), for example, estimates that the private costs of complying with the sox act total $1.4 trillion. a large proportion of this cost comes from the increased costs of audits in order to comply with the law. studies have also found that the sox law has motivated many public firms to go private (or reconsider going public) as a way of avoiding the costs of complying with this law (hartman, 2005; block, 2004; engel, hayes & wang, 2004). one report also raised the concern that foreign firms may be shunning u.s. financial markets to stay clear of this new legislation (marshall, 2006). the apprehension overseas firms feel toward sox has been widely reported (darned sox, 2006). recently, a committee, led by former white house economic advisor r. glenn hubbard and goldman sachs executive john thornton, was initiated to propose changes to the law and correct the perceived flaws (sissell, 2006). sox legislation was passed at a time when the u.s. public accounting market was becoming increasingly concentrated. in fact, as part of the sox legislation a united states general accounting office (gao) study was mandated on the public accounting market (gao, 2003). this study raised the concern that very few audit firms are capable of auditing large u.s. clients and that this problem raises potential choice, price, quality, and concentration risk concerns. the current public accounting market consists of a "big 4", a middle tier and a lower tier. the big 4 firms are deloitte & touche, ernst & young, pricewaterhousecoopers and kpmg. as ofthe 2003 gao study, these four firms audited over 78 percent of all u.s. public companies and 99 percent of all public company revenue. big 4 firms have traditionally dominated the large company audit market due to a number offactors, including the auditors technical skills, reputation and capacity (doogar, fargher & hong, 2005). literature review and hypotheses the additional work required of an auditor to comply with sarbanes-oxley is likely to increase the cost, and therefore, price of audits. this additional work is primarily due to section 404 of the act, which requires firms to include an internal control report in their annual report (rittenberg, evenson, martens, 2006). the internal control report must contain h(i) a statement of the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) an assessment, as of the end of the company's most recent fiscal year, of the effectiveness of the company's internal control structure and procedures for financial reporting."1 section 404 also requires the auditor to attest to, and report on, management's assessment. thus, compliance with this section of the act imposes both extra work as well as a new risk on the auditor contributing to the higher cost of the audit. further, the price of audits could increase due to self-correction of cross-subsidization ofservices. the wall street journal postulated that large accounting firms may have been using their auditing services as a loss leader to attract consulting business (coleman & bryan-low, 2002). according to the u.s. securities and spring 2008 cosgrove & niederjohn: sarbanes-oxley act of2002 33 exchange commission's (sec) final rule2 on auditor independence required by sox, auditors are prohibited from providing nine categories of services to firms whose external audits they perform. some of these categories are: bookkeeping services, financial information systems design and implementation, management functions or human resources, and outsourcing of internal audit services. thus, if auditors were using external auditing services as a loss leader before sox, this practice would likely be limited or cease post-sox as they would not have as great an opportunity to recover their auditing costs with fees for consulting and other services. while articles have discussed an increase in audit fees between 2000 and 2002,3 no research that we know of has yet shown an increase in audit fees over the time period in which sox could be tested specifically as the culprit (asthana, balsam & kim, 2004). this result will be an important starting point for more interesting analysis on the post-sox industry. moreover, this study will examine audit fees as well as audit-related fees to attempt to assess the effects of sox on cross-subsidization of audit services with other services. hypothesis i: the implementation of sox has increased the costs of corporate audits. of less trivial concern, some question exists as to how sox might affect the different segments ofthe u.s. audit market. research indicates that while the big 4 firms supply the majority of the market, price competition between auditors in the industry had not been impaired prior to the first sox compliance deadline (gao 2003; chaney, jeter & shivakumar, 2004). that is, while prices for big 4 audits are higher, in general, the price difference is attributable to quality differences. the middle and small tier accounting firms are price followers and discount compared to the big 4 to account for differences in breadth and depth of subject matter expertise and proficiency (gao, 2003). moreover, chaney et. a1. (2004) found that what was previously identified in the literature as a price premium for the largest tier of auditors disappears when they control for auditee self-selection bias. they base their results on a sample of privately held audit clients in the united kingdom, thus while their technique is relevant, their results may not be generalizable to the us market for publicly-held firms. however, ireland and lennox (2002) find that the premium earned by large audit firms is more than twice as large when selectivity is considered. that is, the authors posit that companies are not randomly assigned to audit firms. rather, large auditors experience benefits from working with high quality auditees and the data exhibit this selection bias. the present research investigates the premium differences for big 4 firm.s and smaller auditors in the post-sox environment. any analysis of the price effects from sox must consider the segmentation of both the suppliers and the buyers in this industry. as mentioned, the suppliers are split into three segments: big 4 auditors, middle tier auditors, and small tier auditors. the big 4 firms are clearly defined as deloitte & touche, ernst 34 journal ofbusiness strategies vol 25, no.1 & young, kpmg, and pricewaterhouse coopers. this study defines the middle tier to include all non-big 4 audit firms with 2004 revenues exceeding $250 million, according to public accounting report's top 100 for 2004. this definition includes: rsm mcgladrey (minneapolis), grant thornton (chicago), bdo seidman (chicago) and crowe chizek & co (indianapolis). these comprise all non-big 4 firms with more than 100 sec clients. all other firms are classified as small tier firms. similarly, buyers of audit services divide themselves into segments (chaney et. a1. 2004; ireland & lennox 2002, simunic & stein 1996; copley, gaver & gaver 1995). for example, it is likely that many very large national and multinational firms will not even consider buying audit services from any non big 4 firm because their investors require the "brand name" and reputation that a big 4 audit carries. 4 while the largest auditees likely have highly inelastic demand for a big 4 audit, the next tier of auditees, in terms of size and complexity, choose between big 4 and middle tier auditors for services. as chaney et. a1. (2004) postulate, the largest auditors structure themselves to most efficiently serve their client segment by investing more heavily in technology, training, and facilities than smaller auditors. these investments result in higher fixed costs which smaller clients may find too costly for the marginal benefit of a big 4 audit. similarly, small auditees are likely to choose middle tier or small tier auditors whose cost structures are most efficient for the type of audit they require. if the first hypothesis is accurate, sox influenced the cost structures of auditors of all tiers and, consequently, may lead to changes in auditee's choice of auditor tier. the different demand elasticities of the buying segments could influence the pricing power of the auditor tiers. given that the large national or multinational auditees likely have a highly inelastic demand for a big 4 audit, even if sox results in higher audit fees, these buyers are unlikely to change their demand for a big 4 audit. as a result, sox has likely resulted in big 4 firms' ability to pass on any additional cost to their largest clients in the form of higher prices. a small portion ofbig 4 clients before sox may switch to middle tier auditors as discussed above in response to significantly higher actual or expected prices; however, most auditees will still have highly inelastic demand and few substitute providers. therefore, big 4 auditors will be able to charge higher prices post-sox. the middle tier auditor segment may increase pricing power following sox implementation given the demand elasticities ofthe buying segments. consistent with a differentiated market, consumers of the higher quality and higher cost product initiauy have a more inelastic demand and are willing to pay higher prices. however, as audit fees from all providers hypothetically rise following sox, auditees' demand becomes more elastic and some of these auditees who previously chose big 4 auditors may opt for middle tier auditors, increasing the middle tier's residual demand curve and increasing audit fees charged by this tier of audit providers. indeed, evidence of a recent increase in firms switching to smaller tier auditors is consistent with this idea. table 1 outlines auditor switches by tier. specifically, in each of the five years prior to 2003, fewer than 8 percent spring 2008 cosgrove & niedeljohn: sarbanes-oxley act of 2002 35 of auditor switches were from big 4 to middle tier auditors and fewer than 15 percent of auditor switches were from big 4 to small tier auditors. however, in 2003, 20.6 percent, or 44 of 214, auditor switches were from big 4 auditors to middle tier auditors and 22.9 percent, or 49 of 214, switches were from big 4 to small tier auditors. in 2004, 29.4 percent, or 84 of 286, switches were from big 4 to middle tier auditors and 31.8 percent, or 91 of286, switches were from big 4 to small tier auditors. while no firms were required to be compliant with sox until fiscal 2004, the legislation and its requirements were known as of july 2002. 5 thus, middle tier auditors may win additional audit clients following sox as some auditees' demands become more elastic at higher prices. table 1 auditor switches by tier total big 4 to big 4 to big 4 to switch description switches big 4 middle tier small tier other mean of annual switching 212.3 103 11.3 22.7 75.3 data for 1998-2001 48.5% 5.3% 10.7% 35.5% 2002 753 597 59 61 36 79.3% 7.8% 8.1% 4.8% 2002 switches from 605 548 31 25 1 andersen* 90.6% 5.1% 4.1% 0.2% 2003 214 83 44 49 38 38.8% 20.6%, 22.9% 17.8% 2004 286 70 84 91 41 24.5% 29.4% 31.8% 14.3% • switches in 2002 are separated to illustrate compulsory switches from andersen after the firm closed. in addition to buyers choosing to employ auditors of different tiers, evidence suggests that some auditors playa role in choosing their clients. these supply side effects may disproportionately impact big 4 and smaller tier audit fees in the post-sox environment. one study (doogar et ai., 2005) indicated that some big 4 firms have "fired" their clients in the wake of sox because the risks or costs of providing audit services are too high. these clients are then forced to choose a different big 4 provider that also might be unwilling to accept them as a client, or select a smaller tier auditor. moreover, big 4 auditors may also shed some audit clients so that they can continue to provide consulting services to these clients without violating independence constraints that are now more strictly enforced. if audit services were loss leaders, as suggested previously, the auditor would prefer to retain the consulting business when forced to choose between providing consulting services or audit services. 36 journal ofbusiness strategies vol. 25, no.1 one study also found that many small tier auditing finns have exited the market in order to avoid the costs of registering with the public company accounting oversight board (pcaob), possibly decreasing competition for small audits and raising their prices (asthana, et at. 2004). another contends that the pcaob's one-size-fits-all rules actually create a barrier to entry for small tier auditors (beckstead, 2006). even with this decline in supply of small auditors, significantly more competition still exists among auditing firms for small clients. consider the fact that while only four finns are capable of auditing large multinational finns, more than 1600 finns have registered with the pcaob as of march of2006. 6 theory supports the idea that both big 4 and middle tier auditors should be able to increase their pricing power following sox, but it is unclear whether the proportional increase will differ between these two market segments. if big 4 auditors are shedding some clients due to the higher risk in serving as their auditor under the new laws and the overall increased workload in the industry or the desire to continue serving them as consultants rather than as auditors, the residual demand curve facing the middle tier auditors would increase by more than the increase in market demand for the big 4 firms. this larger increase would allow the middle tier auditors to increase their prices proportionately more than big 4 firms. hypothesis 2: auditfees ofthe big 4 and middle tier auditors increase more than those of the small tier; the percent increase in middle tier audit fees exceeds the percent increase in big 4 audit fees. data and sample the majority of the data were retrieved from the compustat database. cross sectional data from fiscal years 2003 and 2004 for active us companies, excluding american depository receipts, were retrieved.? all observations with missing data, observations with the auditor code for unaudited, and firms with only one year of data were deleted leaving 8638 observations. although the sarbanes-oxley compliance act became effective july 31, 2002, no firms were required to be compliant with section 404 until fiscal 2004. as of fiscal 2004, all accelerated filers,b essentially companies with public float of$75 million or more who were not eligible to use the small business forms for annual and quarterly reports, were required to comply with section 404. to create a binary variable for sox implementation, the auditors' reports for 2004 were examined. firms whose auditors conducted audits on internal controls andlor stated that the finn was required to be compliant with sox section 404 for fiscal 2004 take a value of one. all other observations take a value of zero. audit fees and auditors' reports were retrieved from the securities and exchange commission's electronic data gathering, analysis, and retrieval system, edgar. finns are now required to report their annual audit fee data in their spring 2008 cosgrove & niederjohn: sarbanes-oxley act of 2002 37 proxy statements. due to the manual and time-consuming process of collecting audit fee data, 1000 firms were randomly selected from this sample and audit fee data were collected from edgar for these 1000 firms for fiscal year 2003 and 2004. excluding observations for which no audit fee data were available resulted in 1934 observations. although the requirements for reporting audit fees have changed over time, the reporting requirements for the timeframe studied here are consistent. starting in 2003, firms were required to disclose not only their audit fees, but also audit related fees, tax fees, and all other fees. the sec's final rule states that the audit fees category should include "fees for services that normally would be provided by the accountant in connection with statutory and regulatory filings or engagements" as well as "fees for services necessary to perform an audit or review in accordance with gaas" [generally accepted accounting standardsp fees for consulting on internal controls, performing due diligence, tax services, and all other services are excluded from the audit fees variable. the audit-related fees category, created to increase transparency about the auditor/auditee relationship, should include "assurance and related services... that traditionally are performed by the independent accountant"hl data on audit fees, audit-related fees as well as their sum are used in this study. empirical methodology to test the first hypothesis that audit fees have increased as a result of sox, an ols model was used. the model takes the following form: inauditfeesil = ~o + f3 j lnassetsil + f3invrecil + ~3sqrtbusil + l\sqrtgeoil + ~/tdtair + ~6roair + 13 7 y2004r+ r3asox;r + fit (i) where lnauditfees is the log of audit fees ofthe ith firm in the t1hyear, lnassets is the log of total assets, invrec is the sum of inventories and receivables divided by total assets, sqrtbus is the square root of the number of business segment areas, sqrtgeo is the square root of the number of geographic segment areas, ltdta is the financial leverage ofthe firm calculated as long term debt divided by total assets, roa is the return on assets, y2004 is a binary variable marking 2004 observations, sox is a binary variable marking the compliance with sox legislation, and e is the error term. table 2 displays descriptive statistics for these variables. as stated, audit fee data are available from firm proxy statements. given the new reporting guidelines, equation 1 was estimated using the logs of audit fees, audit related fees, and their sum (total audit fees) as dependent variables. similar to previous studies of audit fees, variables included in the model control for audit size, complexity, and risk (menon & williams, 2001; simon & francis, 1988; asthana, et a1. 2004). the log of total assets, a well-established determinant of audit fees, provides a control for the size of the audit. the propor38 journal ofbusiness strategies vol. 25, no, 1 tion of inventories and receivables to total assets is included. in the literature, this variable has been used to account for risk and complexity associated with the audit and it addresses specific audit procedures pertaining to inventories and receivables (menon & williams, 2001). the square root of the number ofbusiness segments serves as a proxy for the number of subsidiaries. compustat defines business segments as an industry segment or product line reported by the firm. presumably, more subsidiaries result in a more complex and, thus, costlier audit. similarly, the square root of the number of geographic segment areas is included to capture complexity from audits spanning multiple countries. 11 as an additional measure of the financial condition of the firm, the ratio of long term debt to total assets is included. finally, return on assets is included as a measure of client profitability and, therefore, risk. 12 given that each of these variable measures the size, complexity, and/or risk of the audit, the coefficients are expected to be positive on all of them except for roa which is expected to be negative. each ofthe control variables chosen is supported by hay, knechel, and wong's (2006) meta-analysis on the supply and demand attributes of audit fees. table 2 descriptive statistics standard variable sample size mean median deviation minimum maximum audit fees 1934 1,078,270 397,500 2,339,331 7,300 40,900,000 inaudit 1934 12.96 12.89 1.31 8.90 17.53 audit related fees 1934 169,900 27,480 591,417.9 ° 12,500,000inauditrelated 1431 11.03 11,00 1.58 6.55 16,34 total audit fees 1934 1,248,170 455,685 2,714,951 11,365 43,800,000 intotaudit 1934 13.08 13.03 1.33 9,34 17.60 total assets (in odds) 1934 2,383.41 237.84 11,870.66 1.01 315,920 inassets 1934 5.51 5.47 2.19 0.01 12.66 invrec 1934 0.25 0.20 0.21 0.00 1.00 sqrtbus 1934 1.40 1.00 0.48 1.00 3.16 sqrtgeo 1934 1.57 1.41 0.44 0.00 2.24 itdta 1934 0.18 0.10 0.29 0.00 7.96 roa 1934 -7.18 2.52 47.87 -1409.22 59.59 y2004 1934 0.50 0,50 0,50 0.00 1.00 sox 1934 0.22 0.00 0.42 0.00 1.00 big 4 1543 0.80 1.00 0.40 0.00 1.00 the primary variable of interest is the binary variable identifying the impact of sox. as explained above, the sox variable takes a value of one for observations in fiscal 2004 if the firm was required to be compliant with the sox legislation. the coefficient on this variable is expected to be positive reflecting the increase in fees from the legislation. a binary variable for fiscal spring 2008 cosgrove & niederjohn: sarbanes-oxley act of2002 39 2004 is also included so that a distinction can be made between annual effects and the effects of sox. 13 to test the second hypothesis, substantial extensions to the initial model are required. for the purposes of comparison, first a simple ols model is estimated using equation 1 with the addition of a binary variable for auditees using big 4 firms (big4) to control for the effects of the different tiers of the audit market. due to an insufficient number of middle tier and small tier observations in the sample, all auditees using non-big 4 firms remain as the base. in addition, an interaction term between the big 4 dummy and the sox variable (soxbig4) is added so that the total impact of sox can be explained for each tier. these additions result in the following model: lnauditfeesfl == 1\ + f\sqrtassetsi/ + 132invreci/ + f\sqrtbusi/ + 134sqrtgeoil + 13itdtai/ + 136roait + 137y20041 + ~8s0xi/ + 139big4it+ 13!osoxbig4i/ €ir (2) however, this is an inappropriate model given that auditees are not randomly assigned to audit firms and that once a firm chooses an auditor, the audit fee they would have been charged by an auditor from the other tier is unobservable. as discussed thoroughly in ireland and lennox (2002) and chaney et at (2004), ignoring auditor selection effects could lead to biased estimates. furthermore, chaney et at (2004) illustrate the importance of allowing both the intercepts and the slope coefficients to vary across the auditor tier reflecting the differences in investments by the audit firm and the consequent selection by auditees of the most cost-effective auditor given their firm's characteristics, as discussed above. to account for the endogeneity of the choice of audit tier and the truncation of observations, a two-stage selection model is required. this analysis uses the two-stage heckman approach outlined by chaney et a1. (2004) with the inclusion of a sox binary variable to assess the effects of the regulation on auditor tier. the first stage is an auditor choice probit model from which the inverse mills ratios are calculated and used as an additional explanatory variable in the second stage, an audit fee regression estimated by ols. the self-selection model is as follows: probit: big4" == ~o + 13 1sqrtassets il + 13 2invrecif + 13 3sqrtbus il + 134sqrtgeoil + 13itdtaif + ~6roai/ + 13;>revyrbig4+ 1\ (3) ols: lnauditfeesit == 13ao + 13alsqrtassetsi/ + f3ainvrecil + 13a3sqrtbusit + 13a4sqrtgeoi/ + 13aitdtait + f3a6roait + f3a7y2004t + 13asyrenddecit + 13a9s0~t+ 13aaaai + tit . (4) where the previously defined variables have the same definition and a equals one for firms using big 4 auditors and zero for firms using non-big 4 auditors, 40 journal ofbusiness strategies vol. 25, no.1 sqrtassets equals the square root of year-end total assets, 14 prevyrbig4 is a binary variable with a value of one if the firm employed a big 4 auditor in the previous fiscal year and zero otherwise, yrenddec is a binary variable with a value of one if the firm's fiscal year end occurs in december and zero otherwise. a brief discussion of the variables in the context of this model is worthwhile. in the probit equation, the expectation on each of the variables except itdta and roa is that they will have a positive sign when big 4 equals one reflecting the relationship between the increased likelihood of choosing a big 4 auditor the greater the size or complexity of the audit. the expectations on ltdta and roa are somewhat less predictable. are high quality or low risk firms more likely to choose (or be accepted as clients by) big 4 auditors than smaller tier auditors? the results in the literature are mixed (chaney et a1. 2004; ireland & lennox 2002; hay et ai. 2006). on one hand, the higher the risk, the more necessary is a high quality audit. on the other hand, the lower the quality the less likely is a big 4 firm to accept the auditee as a client, as discussed above. the prevyrbig4 binary variable is included in the probit for identification. while an understandable concern would be that this variable would dominate the equation, the pseudo r2 with this variable included is 0.65 so this does not appear to be a problem. in the ols equation, the expectations on the previously defined variables remain consistent but expectations need to be stated for the new terms. first, the self-selection model can only be estimated if the probit and ols equations have elements that are not common to satisfy the identification condition. the prevyrbig4 variable identifies the probit and additional variables are required to identify equation 4. consistent with prior research, the binary yrenddec variable is included to control for peak period pricing. because most firms end their fiscal years on december 31, substantially more work must be completed in the following months compared to other months throughout the year, which may lead to a price premium. in addition, the year dummy for 2004 and the sox variable are included in the audit fee equation to account for higher audit fees in 2004 and in sox compliant firms. the coefficients ~ao and /3 u in the ols regression are the inverse mills ratios from the probit equation. table 3 contains descriptive statistics for these variables by auditor tier as well as univariate tests for differences between auditees using big 4 and non-big 4 auditors. spring 2008 cosgrove & niederyohn: sarbanes-oxley act of 2002 table 3 descriptive statistics by auditor tier 41 big4 non big 4 number of obs. 1543 391 mean median mean median lnaudit 13.285* 13.200* 11.653 11.580 totassets 2955.880* 420.580* 124.251 22.090 invrec 0.235* 0.190* 0.305 0.240 sqrtbus 1.427* 1.000* 1.287 1.000 sqrtgeo 1.605* 1.410* 1.458 1.410 ltdta 0.181 0.116* 0.176 0.049 roa -3,454* 3.234* -21.897 -2.311 yrenddec 0.732 1.000 0.714 1.000 y2004 0.487* 0.000** 0.550 1.000 sox 0.261* 0.000* 0.077 0.000 * denotes significance at the 1%level •• denotes significance at the 5% level results the estimation of the first equation supports the first hypothesis. complete results are available in table 4. while the model appears to be a reasonably good fit for audit fees and total audit fees, with r2 values similar to other studies, the model is not a good fit for audit-related fees. more discussion on this will follow. as expected, the coefficients on the log of assets, the ratio of inventories and receivables to total assets, the square root of business segments, and the square root of geographic segments are all positive and significant for the audit fees equation. these results are consistent with expectations that firms with larger or more complex audits incur higher audit fees. also as expected, the coefficient on roa is negative and significant reflecting that firms of higher profitability and thus lower risk face lower audit fees. interestingly, the ratio of long total debt to total assets has a negative effect on audit fees. perhaps this result signifies that big 4 auditors choose not to serve some higher risk customers. thus, these auditees must use smaller auditors who also tend to charge lower average fees. this question will be re-examined with the second model where auditor tier information is included. the binary variable for 2004 is positive and significant for audit fees and the sum of audit and audit-related fees. this result may be due to increased litigation risk in the wake of sox. another possible explanation is the increased preparatory work some firms are doing in anticipation of their compliance deadline with sox in the near future. 15 42 journal of business strategies vol. 25, no.1 table 4 estimation of equation 1 in auditfees in auditrelatedfees in allauditfees parameter (standard errors) (standard errors) (standard errors) in assets 0.4345* 0.4541* 0.4496* (0.0091) (0.0190) (0.0091) invrec 0.2296** -0.0210 0.2244** (0.0801) (0.1737) (0.0806) sqrtbus 0.1770* 0.2115* 0.1762* (0.0356) (o.0705) (0.0358) sqrtgeo 0.4090* 0.2329* 0.4146* (0.0379) (0.0764) (0.0381) ltdta -0.1154** 0.0603 -0.0864 (0.0590) (0.1147) (0.0593) roa -0.0028* -0.0021* -0.0029* (0.0004) (0.0007) (0.0004) y2004 0.2017* 0.0494 0.1863* (0.0384) (0.0823) (0.0386) sox 0.5113* -0.0903 0.4519* (0.0487) (0.0984) (0.0490) constant 9.3966* 7.589' 9.4510' (0.0775) (0.1666) (0.0779) r2 0.7170 0.3904 0.7215 adj r2 0.7158 0.3869 0.7203 * denotes significance at the 1%level. .. denotes significance at the 5% level. *** denotes significance at the 10% level. most importantly, it is clear that sox has had a highly significant positive effect on audit fees. given the semilog model, the coefficient is the partial elasticity. thus, audit fees are approximately 51 percent higher after sox than before. this result is consistent with the a priori expectation presented in the first hypothesis. with regard to the audit-related fees model, some of the results are not surprising. for example, the ratio of inventories and receivables to total assets is not significant in the audit-related fees equation, but this variable was included because inventories and receivables require special treatment during an audit thus, insignificance is actually the expected result. the bigger issue with this model is the documented confusion of auditors in the classification of services into the new fee categories. skantz and dickins (2005) surveyed auditors regularly responsible for preparing fee disclosures and asked them to classify 25 spring 2008 cosgrove & niederjohn: sarbanes-oxley act of2002 43 different services under the new rules. they found that "fourteen of the services were classified consistently less than 75 percent of the time:' in sum, evidence suggests that much confusion surrounds the classification of services, making the audit-related fees category an unreliable dependent variable for the years included in this dataset. as a result, for the second hypothesis, only audit fees will be considered as the estimation of audit related fees provides very little useful information and likely reflects different interpretations of which services should be included in tbis category. complete results of the estimation of the equation 2 are available in table 5. this equation is presented strictly for comparison to the more appropriate selection model. as expected, the big 4 coefficient is positive and significant, indicating that big 4 auditors charge higher audit fees than smaller tier audit firms. according to this model (eq 2), the marginal effect on audit fees of using a big 4 auditor after the implementation of sox is given by: be[audit fees isox, big4] 6s0x (5) thus, the marginal effect ofsox on audit fees when a big 4 auditor is used is 0.6798 with a standard error of 0.0555, which is significant at the 1% level. this model suggests that the marginal effect ofsox on audit fees when a smaller tier auditor is used is 0.8249. a wald test on the marginal effects confirms that tbese coefficients are not significantly different from each other. however, given the self-selection bias, these results may not accurately characterize the marginal effects of sox. table 5 estimation of equation 2 parameter sqrtassets invrec sqrtbus sqrtgeo ltdta roa y2004 sox big 4 soxbig4 constant in auditfees 0.0140* 0.2242** 0.3080* 0.5546* 0.3615* 0.0002 0.1996* 0.8249* 1.0382* -0.1451 10.0482* standard error 0.0005 0.0900 0.0397 0.0418 0,0642 0.0004 0.0431 0.1512 0,0502 0.1560 0.0913 • denotes significance at the 1% level. •• denotes significance at the 5% level. r2 = 0.6488 adj r2 :: 0.6470 44 journal ofbusiness strategies vol. 25, no. i table 6 shows the results ofthe estimation ofthe auditor choice probit equation. as expected, larger firms (sqrtassets) and firms with more geographic segments are more likely to employ big 4 auditors. the number of business segments is not a significant driver in choosing between big 4 and smaller tier auditors. the coefficients on roa, though insignificant, and ltdtq are consistent with higher quality and lower risk firms having a greater likelihood of using big 4 auditors. while the signs on these variables were not known a priori, their outcomes are reasonable and in line with previous research and the popular press (ireland & lennox 2002; coleman & bryan-low 2002). the sign on invrec is somewhat surprising because the literature suggests that firms with more complex audits prefer big 4 firms; however, this result is consistent with the descriptive statistics for the sample used here. using the output from the probit and assuming that if the probability of choosing a big 4 auditor exceeds 50 percent, then the firm will choose a big 4 auditor, observations are correctly classified 94.6 percent of the time. table 6 estimation of equation 3 auditor choice model parameter sqrtassets lnvrec sqrtbus sqrtgeo ltdta roa prevyrbig4 constant 6ig4 0.0458* -0.7136* 0.0138 -0.0989 -0.6233' 0.0011 2.9899* -1.6764* standard error 0.0055 0.2532 0.1331 0.1251 0.2068 0.0015 0.1405 0.2772 , denotes significance at the 1% level. •• denotes significance at the 5% level. .,. denotes significant at the 10% level. %correctly classified: 94.6 %using big 4: 79.8 the audit fee regression results, correcting for self-selection, are presented in table 7. equation 4 is estimated separately for big 4 and non-big4 auditees to allow the slope coefficients to vary across the groups, per chaney et al. (2004). in addition, the inverse mill's ratio from the first stage 0'01 or ali) is included in this stage to control for self-selection bias. the significance of the coefficients on the lambda terms indicates the self-selection bias. the control variables all take expected signs and are significant, except for roa and yrenddec which have unexpected signs but are insignificant. the coefficient on the variable of spring 2008 cosgrove & niederjohn: sarbanes-oxley act of2002 45 primary interest, sox, is positive and significant for both big 4 and non-big 4 firms, though the magnitude is larger for the big 4 firms. table 7 estimation of equation 4 audit fee model adjusting for selection bias big 4 non big 4 number of obs. 1543 391 in auditfees std. error in auditfees std. error sqrtassets 0.0127* 0.0005 0.0421" 0.0049 invrec 0.2217* 0.1134 0.4594" 0.1527 sqrtbus 0.3230* 0.0449 0.1522** 0.0917 sqrtgeo 0.5680* 0.0476 0.4482" 0.0935 ltdta 0.4799" 0.0926 0.1907** 0.0869 roa -0.0009 0,0008 -0.0004 0.0005 yrenddec -0.0095 0.0499 -0.0608 0.0838 y2004 0.1797* 0.0511 0.2905* 0.0745 sox 0.6645" 0.0641 0.4919" 0.1515 constant 11.1612* 0.1091 10.1212* 0.1907 lambda -0.6948* 0.0869 0.1015*** 0.0548 * denotes significance at the 1%level ** denotes significance at the 5% level ***denotes significance at the 10% level. the next task is to examine the effects of sox on audit fees by tier of auditor, using the results of the model corrected for self-selection. first, to determine whether the increase in audit fees is significantly different before and after sox for each tier, the estimated coefficients are used to predict inauditfees for all auditees in the sample that were required to be compliant with sox in 2004. ttests are performed comparing the predicted big 4 audit fees pre and post-sox. the mean and median predicted audit fees for big 4 auditees pre-sox were $859,055 and $507,545, respectively and the mean and median predicted audit fees for big 4 auditees post-sox were $2,096,126 and $1,188,776, respectively. the post-sox fees for big 4 auditees are significantly higher with a t-value of 5.61. likewise, for the non-big 4 auditees, the mean and median predicted audit fees pre-sox were $198,180 and $107,751, respectively, and the mean and median predicted audit fees post-sox were $611,466 and $256,872. as with big 4 auditees, the post-sox fees for non-big 4 auditees are significantly higher with at-value of2.26. finally, predicted values are compared to determine whether sox affected big 4 audit fees differently than non-big 4 audit fees. specifically, the percent change in predicted audit fees between 2003 and 2004 are calculated for all firms 46 journal ofbusiness strategies vol. 25, no. 1 that were required to be compliant with sox in 2004. these percent changes are then tested to see if they are statistically different across auditor tier. the mean and median predicted audit fee percent increases for sox compliant firms using big 4 auditors are 1.482 and 1.371 , respectively, and the mean and median predicted audit fee percent increases for sox compliant firms using non-big 4 auditors are 1.581 and 1.248. while the average percent increase in predicted audit fees is larger for non-big 4 auditees, the percent increases in big 4 audit fees and non-big 4 audit fees from sox are not statistically different. the results of this analysis are not strong enough to uphold the second stated hypothesis ofthis paper. however, it is plausible that a longer timeframe ofanalysis is required to determine how this market is truly changing after the advent of sox legislation. furthermore, these results should be interpreted cautiously because the post-sox audit fee data are only from accelerated filers. these filers are larger firms which would be more likely to use a big 4 auditor and have an inelastic demand for a big 4 audit. conclusion in the recently burgeoning world of corporate governance, questions about the costly impact of regulatory reactions require answers. moreover, in the public accounting industry, where market concentration and the ability of firms to exert monopoly power are issues of concern, any regulatory action that could alter or enhance market concentration is worthy of examination in this light. this study sheds light on the magnitude of audit fee increases in the first year of compliance with sox and examines whether the different segments ofthe audit market displayed different degrees of pricing power. as the first study to empirically test audit fees affected by sox, the results indicate that audit fees were approximately 51 percent higher in the first year of compliance with sox across the entire spectrum of accounting firms. this study also contributes to the existing literature in the field with its assessment of audit-related fees and the potential effects of sox on audit-related fees. unfortunately, the audit-related fees variable is a poor dependent variable given documented auditor confusion on what categories of servlces should be included in this category. in addition to an analysis across all accounting firms, this research is the first to attempt to parse out any differences in the way audit fees changed by tier of auditor in the post-sox environment. the self-selection model employed confirms that auditors are not randomly assigned to auditees, consistent with existing literature in the field. moreover, after controlling for this self-selection bias, the model illustrates that audit fees for both big 4 and non-big 4 auditees were higher following the implementation of sox and the increases were statistically significant. while the average percent increase in predicted audit fees is larger for non-big 4 auditees than for big 4 auditees, suggesting that non-big 4 auditees may have gained some pricing power following sox, the changes in spring 2008 cosgrove & niederjohn: sarbanes-oxley act of 2002 47 audit fees are not statistically different between big 4 auditors and non-big 4 auditors after the implementation of sox. this result is interpreted with caution due to the limitations of the post-sox data that are available. several areas for future research stem from this work. first, as audit fee data for non-accelerated filers required to comply with sox become available, the question of the effects of sox on pricing power by tier of auditor should be re-examined. the addition to the dataset of more small firms that may have a greater price elasticity could influence the outcome. another area for future research is the recent increase in auditees switching auditors and the shift of more firms to middle and small tier auditors from big 4 auditors. given the timing of the increase in switches, one must question whether sox has played a role in the number and types of these switches. moreover, if audit fees are increasing regardless of auditor tier and are not significantly higher for one tier or another, the question remains why would firms opt to switch auditors? finally, interesting questions remain regarding the extent to which audit firms cross-subsidized between audits and consulting services and what changes, if any, occurred in the joint pricing of those services in the wake of sox. references asthana, s., s. balsam, & s. kim. (2004). the effect of enron, andersen and sarbanesoxley on the market for audit services. working paper. rutgers university. june 2004. beckstead, b. (2006). sarbanes-ox1ey: the impact on smaller firms. accounting today, 20(16),6-9. block, s. (2004). the latest movement to going private: an empirical study. journal of applied finance, 14( 1), 36-44. bureau oflabor statistics. producer price index industry data. series 10: pcu5412115412114. retrieved february 2007, from http://data.bls.gov. chaney, p., jeter, d., & shivakumar, l. (2004). self-selection of auditors and audit pricing in private firms. the accounting review, 79(1), 51-72. coleman c., & bryan-low, c. (2002). audit fees rise, and investors may pay price. the wall street journal august 12: c 1. copley, p., gaver, j " & gaver, k. (1995). simultaneous estimation of the supply and demand of differentiated audits: evidence from the municipal audit market. journal ofaccounting research, 33( 1), 137-155. darned sox. (2006). the economist, 380(8495), 84. 48 journal of business strategies vol 25, no. i davidson iii, w., jirapom, p., & dadalt, p. (2006). causes and consequences of audit shopping: an analysis ofauditor opinions, earnings management, and auditor changes. quarterly journal o/business and economics, 45(1-2),69-87. doogar, r., & easley, r. (1998). concentration without differentiation: a new look at the determinants of audit market concentration. journal 0/accounting and economics, 25, 235-253. doogar, r., fargher, n., & hong, k (2005). leveling the playing field, or crumbs from the table? the contestability ofthe audit market to middle tier firms. working paper. university of illinois. may 2005. engel, e., hayes, r. m., & wang, x. (2004). the sarbanes-oxley act and firms' going private decisions. working paper. university of chicago. may 2004. frances, j., & simon, d. (1987). a test of audit pricing in the small-client segment of the u.s. audit market. the accounting review, 1, 145-157. government accounting office (gao) (2003). public accounting firms: mandated study on consolidation and competition. united states general accounting office report to the senate committee on banking, housing, and urban affairs and the house committee on financial services gao-03-1158. hartman, t. (2005). the cost of being public in the era of sarbanes-oxley. foley and lardner presentation. june 2005. hay, d. c., knechel, w. r., & wong, n. (2006). audit fees: a meta-analysis ofthe effect of supply and demand attributes. contemporary accounting research, 23(1), 141-91. ireland, j. c., & lennox, c. s. (2002). the large audit firm fee premium: a case of selectivity bias? journal 0.(accounting, auditing and finance, 17(1), 73-91. johnson, c. (2005). higher audit fees, more accountability; sarbanes-oxley, three years later. the washington post. july 30, 2005, dol marshall, j. (2006). are foreign issuers shunning the u.s.? financial executive, 22(8), 25-28. menon, k., & williams, d. d. (2001). long-term trends in audit fees. auditing: a journal a/practice and theory 20(1), 115-136. rittenberg, l, evenson, m., & martens, f. (2006) internal control: no small matter. internal auditor, 63(5),47-51. sankaraguruswamy, s., & whisenant, s. (2003). an empirical analysis of voluntary supplied client-auditor realignment reasons. retrieved september 2003, from ssrn http://ssm.com/abstract=246096. spring 2008 cosgrove & niederjohn: sarbanes-oxley act of2002 49 skantz, t., & dickins, d. (2005-2006). can fee disclosure be trusted? regulation, 28(4), 46-47. simon, d. t. (1997). additional evidence on the large audit-finn fee premium as an indication of auditor quality. journal ofapplied business research, l3(4), 21-29. simon, d. t., & francis, j. r. (1988). the effects of auditor changes on audit fees: tests of price cutting and price recovery. the accounting review, 63(2),255-269. simunic, d. a. (1980). the pricing of audit services: theory and evidence. journal of accounting research, 18( 1), 161-190. simunic, d.a., & stein, m. t. (1996). the impact oflitigation risk on audit pricing: a review of the economics and the evidence. auditing: a journal of practice and theory, 15 supplement, 119-134. sissell, k. (2006). committee to recommend changes to sarbanes-oxley act. chemical week, 168(31), 14. taub, s. (2005). audit fees double due to sarbox. cfo.com. retrieved february 11,2005, from http://www.cfo.com/article.cfm/3661477?f.."search. vue, l. (2006). audit fees for sarbanes-oxley compliance keep rising. crain:s chicago business. retrieved june 19, 2006, from http://www.chicagobusiness.comlcgi-bin/ news. pi?id=21 03 5&seenit= 1. zhang, l (2005). economic consequences ofthe sarbanes-oxley act of2002. dissertation. university of rochester. january 2005. footnotes 2 3 4 www.sec.gov/rules/proposed/33-8138.htm www.sec.gov/rules/final/33-8183.htm for example see: "audit fees for sarbanes-oxley compliance keep rising," (yue, 2006); "audit fees double due to sarbox," (taub, 2005); "higher audit fees, more accountability; sarbanes-oxley, three years later," (johnson, 2005). prior to the sox legislation, evidence on the number of auditees that chose to hire a different big 4 auditor following the demise of andersen supports this idea. using a sample of3312 us firms for whom data are available from compustat, 90.6 percent, or 548 ofthe 605 firms in the sample who used andersen in 2001, switched to another big 4 auditor for service in 2002. this result suggests some auditees' strong preference for a big 4 audit even in light of concerns that may have arisen following the demise of andersen. these statistics are based on a sample of 3312 us firms for whom data are available in compustat. clearly, there are numerous reasons for firms 50 journal of business strategies vol. 25, no. 1 9 10 ii 12 13 to switch auditors (see davidson, jiraporn & dadolt 2006, sankaraguruswamy & whisenant 2003). these data do not control for any of the reasons for switching auditors and are merely suggestive. the effect of sox on switching is outside of the scope of this paper and is an area for future research. for more information please see: http://pcaob.com/registrationlindex.aspx after excluding adrs, two firms (4 observations) remained with an sic code beginning with 60 for financial services. consistent with other research in the field these firms were also excluded from the dataset (simunic 1980). accelerated filers had to meet each of the following criteria as of the end of their fiscal year: "the issuer had an aggregate market value of voting and non-voting common equity held by non-affiliates of the issuer of $75 million or more, as of the last business day of the issuer's most recently completed second fiscal quarter; the issuer had been subject to the reporting requirements of section 13(a) or l5(d) of the exchange act [15 u.s.c. 78m(a) or 780(d)] for a period of at least 12 calendar months; the issuer previously had filed at least one annual report; and the issuer was not eligible to use forms 10-ksb and 10-qsb [17 cfr 249.310b and 17 cfr 249.308b] for its annual and quarterly reports." www.sec.gov/rules/final/ fr33-8644.pdf. the definition of accelerated filers changed december 27, 2005 to divide the accelerated filers into two groups. this change does not affect the present study. www.sec.gov/rules/final/33-8183.htm. p39-40. www.sec.gov/rules/final/33-8l83.htm. p40. this variable was chosen over foreign sales and foreign sales as a percentage of revenue due to a very high number of missing values for these alternate variables. consistent with prior research (simon, 1997) square roots of business segments and geographic segments are used over logs of these values because some observations contain zero values for the number of geographic segments. an alternative specification was attempted using logs of these two values with 0.000 1 in place of the zero values resulting in very similar estimates. while some prior studies (simon & francis, 1988) have used the auditor's opinion as a measure of risk, the variation in this variable is so minimal that it would not likely measure risk. an alternative specification was also considered using only time series data for accelerated filers, firms required to comply with sox in fiscal 2004. since the sox binary variable is equivalent to a year binary variable in this specification, all values must be adjusted to 2004 levels using a price deflator to attempt to control for other factors in 2004 that affected audit fees. the bureau of labor statistics producer price index for auditing was used with hesitation as it may remove exactly some of the price variation being examined. results arc available in appendix 1. spring 2008 cosgrove & niederjohn: sarbanes-oxley act of 2002 51 14 15 this model uses sqrtassets rather than lnassets due to a collinearity problem between big 4 and lnassets in the probit equation. alternative specifications using lnassets and using total assets rather than sqrtassets were examined. given the collinearity with lnassets and the linearity of total assets, the presented specification was deemed to be the most appropriate; however, the estimated coefficients on the sox variable are positive and significant in all specifi cations. although fees for consulting on internal controls should not be included in the reported audit fees, many firms directly stated in their proxy statement that they were included. appendix 1 table la alternative specification of hypothesis 1: time series data of accelerated filers only in adj auditfees parameter (standard errors) in adjassets 0.4368* (0.0163) adjinvrec 0,3003** (0.1495) sqrtbus 0,2091* (0.0519) sqrtgeo 0.5505* (0.0588) adjltdta -0.0833 (0.1094) roa -0.0078* (0.0015) sox 0.6837" (0.0496) constant 9.1152" (0.1314) r2 0.6346 adj r2 0.6316 52 journal of business strategies vol. 25, no.1 dr. sarah b. cosgrove is assistant professor ofeconomics at university of massachusetts dartmouth where she studies the effects of regulation on imperfectly competitive markets and government regulation of transportation. dr. m. scott niederjohn is the charlotte and walter kohler assistant professor of economics and business and the director ofthe center for economic education at lakeland college. dr niederjohn conducts research in the areas of economic education, labor markets and public policy studies. the effects of the sarbanes-oxley act of 2002 on audit fees a note on the strategic use of service charles hegji evan moore auburn university montgomery montgomery, al abstract we develop a model ofoptimal service provision and pricing in which the level ofservice is not viewed as a capacity choice. we study the provision o.fservices in both a non-strategic setting, characterized by a monopoly, and in a strategic setting, a differentiated price duopoly. we find that in both settings increased services lead to increased prices. however, unlike other models, the strategic setting results in greater services than the non-strategic case. additionally, we discuss the welfare effects for consumers and find that any gains in consumer surplus from increased service provision in the strategic setting are more than offco;et by the associated higher equilibrium prices. a problem that has received attention in the literature is the level of customer service provided by retailers. one vein of research has hnked the provision of service by retailers to fair trade laws and resale price agreements between sellers. this is exemplified by the work of telser (1960, 1990) and that of marvel and mccafferty (1996). the argument is that since resale price agreements provide price floors in the resale market, they prevent retailers from selling at low prices to customers that have obtained product information from other sellers. such agreements, therefore, encourage the provision of service in the form ofadditional product information by retailers. an implication of this reasoning is that higher service levels are generally associated with higher retail prices. an alternative strand of research has been to regard the level of service provided by retailers as a strategic weapon. de vany (1976), de vany and saving (1983), koenigsburg (1980), kalai et al. (1992), stidham (1992), li and lee (1994), and i1makunnas (2002) adopt this approach. earlier work in this area centers on service level as the firm's primary choice variable. more recent work, such as the papers of stidham (1992), li and lee (1994), and i1makunnas (2002), study the simultaneous use of price and service capacity as strategic instruments. i1makunnas, for instance, develops a model of service capacity choice in which firms, after choosing capacity, compete using price in bertrand fashion. in the ilmakunnas model, capacity choices have a negative impact on competitors, since added capacity in one firm decreases the full price (price plus waiting cost) and leads to a flow of customers from the other firm. two implications of this approach are a negative correlation between service 136 journal ofbusiness strategies vol. 22, no.2 capacity and price, and an underinvestment in service capacity compared to the non-strategic case. the present note extends this second line of research in two ways. first, we develop a model of optimal level of service in which service is not viewed as capacity. second, we study the provision of services in a non-strategic setting characterized by a monopoly and in a strategic setting, a differentiated price duopoly. we find that in both settings increased services lead to increased prices. however, unlike the ilmakunnas model, the strategic setting results in greater services than the non-strategic case. additionally, the effects on consumer welfare are discussed. we conclude with a summary and implications for managers competing in the strategic setting. the provision of services under two settings consider the following demand facing producers q(p,sj = s(a-pj, (1) where p is price, s is the per unit level of service provided in the market, and a is a shift parameter corresponding to the intercept on a linear demand curve. l according to (1 ), quantity demanded is inversely related to price and increases with the per unit level of service provided. note, however, that since service is multiplied by the difference (a-p), demand does not shift parallel with an increase in service, but rather, rotates around the price axis. this is reasonable, since it suggests that the customer must purchase the good for service to have an effect on demand. alternatively, if p = a so that producers price themselves out of the market, the effect of service on demand will be zero. this multiplicative form is not overly restrictive, with the interaction of price and service extending capacity models of service. such models use an additive demand curve with separate service price and final product price, and assume that the only service provided by firms is the capacity to reduce buyer waiting times in equilibrium. this type of service is similar to added check-out lines in grocery stores. the multiplicative form of demand assumed in (l) involves service that is more closely bundled to the product and covers such things as information on product assembly or product repair. it can also cover new and attractive store displays and other types of service where costs are incorporated into product price. the good, for sake of simplicity, is assumed to be supplied at constant marginal cost c. service (s) is assumed to be supplied at constant cost per unit of service <po these assumptions result in a total cost of output plus service tc = q( c + qjs). we begin with the provision of service by a monopoly seller of the product. this situation is a simplification of a non-strategically operating price-setting firm. for the monopoly, begin with the profit function n(p,s) = pq(p,s) c(q,s) = ps(a pj (qj + c)s(a pj, (2) fall 2005 hegji and moore: strategic use a/service 137 the monopolist maximizes (2) with respect to price and level of service. differentiating (2) with respect to p results in the monopoly price of p* 2a + c, 3 (3) differentiating (2) with respect to s and using (3) obtains the equilibrium level of service provided by the monopolist of a c, s* = 3rp (4) equation (3) reveals that, as expected, the monopolist prices above cost. in addition price increases with the marginal cost of production and the unit cost of providing services. equation (4) shows that the level of services provided by the monopolist decreases both with the marginal cost of providing services q> and the unit cost c of providing the good. note that an increase in demand and price, resulting from an increase in the parameter a, leads to an increase in the optimal level of service. service and price are therefore positively correlated in this non-strategic setting. next consider the following differentiated price bertrand setting. assume that for i,} = 1, 2 demand is given by qi = s/a pi + pp)i2, where 0 < f3 < 1. (5) the above specification is derived by assuming that without strategic interaction between firms h3 = 0 and sj at the normalized value i), each firm begins play with one half of the monopoly's market share. output produced by firms i and} are substitutes with an increase in competitor price (p) resulting in an increase in own quantity demanded (q). the usual assumption is that demand is more sensitive to own price effects, such that p< i. note that by the above specification demand in market i is a function of services provided in that market only. an interpretation is that the level of service s, appearing in (5) represents the net services provided by firm i relative to firm}. the present situation can be thought of as a two-stage game. in the first stage, firms independently and simultaneously choose price. given the equi librium price, each firm determines its optimal level of service. begin with profits of firm i: 2rr,(p"s) =: s/a pi + pp)pi s/a pi + pp)(c + cps) (6) 138 journal ofbusiness strategies vol. 22, no.2 differentiating (6) with respect to price results in firm i's reaction function p= i a + c + qjs + /3p" i i 2 (7) differentiating (6) with respect to the level of services s, yields the relationship s (p c)l2qj. use of this relationship and (7) results in the equilibrium price i , and level of service in the differentiated price bertrand model: p = p = p* = 1 2 2a + c, 3 2/3 (8) a c + f)c, s = s = s* = 1 2 cp(3 _ 2/3) (9) equation (7) shows that, as in the monopoly model, firms engaged in differentiated bertrand price competition set price above marginal production cost and the total cost of providing service. this reaction function shows that, as in the nonstrategic case, price and service are positively correlated. this positive correlation is also evident in the equilibrium price and level of service in equations (8) and (9). both service and price increase with an increase in the demand parameter a. the level of service provided by a bertrand firm decreases as the marginal cost of providing service cp increases. note that since 13 < 1, the level of service provided also decreases with the marginal production cost c. 2 both price and the amount of service provided by the bertrand firm relative to the monopoly are immediately apparent. a comparison of equations (3) and (8) reveals that the equilibrium price for the bertrand firms is higher than in the non-strategic case. this characteristic of the differentiated price bertrand model is well known, its source being evident in the bertrand reaction function. equation (7) shows that the firm's price responds positively to an increase in the competitor's price. this complementarity of strategic responses results in higher equilibrium prices than in the non-strategic case. comparing equations (5) and (8) reveals that the equilibrium level of service in the bertrand model is greater than in the non-strategic case. this differs from ilmakunnas' (2002) model and is a direct result of service being bundled to the product rather than sold as capacity units. suppose that the competitor increases service provided to its customers. this allows the competitor to increase price. since the firm's own price is complementary to the competitor's price, the firm will increase its price allowing the firm to increase service to compensate for the corresponding decrease in quantity demanded. the end result will be a level of service greater than the non-strategic monopoly case. fall 2005 hegji and moore: strategic use of service 139 a related question is whether the consumer benefits from this strategic competition. consumers gain from the competition in the differentiated price bertrand model due to greater service, but lose due to higher prices compared to the nonstrategic case. without an explicit consumer utility function in goods and service, a reasonable approximation of consumer welfare is consumer surplus. for the monopoly this is given by cs = (l/2)(a p*)q*, where p* and q* are the profitmaximizing price and quantity, where quantity is a function of service provided by the monopoly. the consumer surplus for the differentiated bertrand model is similarly computed, with q* being the sum of the quantities produced by both firms, quantity again being a function of the level of service provided by the firm. the total consumer surplus for the bertrand firms (cs b ) and of the monopoly market (csl.) are (a c + /3cp(a(1 2/3) c), 2q:j(3 2/3y (10) (11 ) by design css = csm when 13 = 0. 3 however, as ~) increases from 0 to i the consumer surplus in the bertrand market decreases. this is evident as the derivative of (1 0) with respect to /3 is /3(2a + c)2(a + (/3 i )c) q:j(3 2~)4 (12) which is negative. in other words, the consumer surplus in the bertrand market is less than that of the non-strategic monopoly setting for all feasible values of /3.4 an inspection of equation (12) also reveals that the decrease in cs b increases as 13, a measure of product differentiation, increases. gains to consumers from increased service provision are more than offset by price increases in the bertrand market. summary and managerial implications in this note we have developed a model of optimal service level provision in which service is not viewed as capacity. the demand function used in the analysis involves a multiplicative relationship between service and pricing. such a function allows service to be viewed as more closely bundled to the product as opposed to an offering that can be purchased in addition to the product. we find that the service provision and prices in the strategic bertrand market are greater than that of a non-strategic monopoly market. we show that any gains 140 journal ofbusiness strategies vol. 22, no.2 in consumer surplus from increased service provision in the bertrand market are more than offset by the associated higher equilibrium prices. this analysis reveals that consumer surplus is greater in the non-strategic case. additionally, consumer surplus is further decreased in the bertrand market as product differentiation increases. managers of firms competing in the bertrand markets realize higher profits due to the strategic complementarities of pricing and service. however, although higher service levels lead to higher equilibrium prices in this strategic setting, consumer surplus decreases. as consumers become aware of their decrease in welfare due to the higher product price, product switching may begin to occur. additionally, higher prices due to higher service levels may encourage entry into the market by new firms. 5 this would likely hurt the long run profitability of existing firms. the bottom line for managers is that although competition in the provision of service may at times seem attractive, in that increased services allow for higher prices, price competition should be considered the preferred long-run strategy. references de vany, a. (1976) uncertainty, waiting time, and capacity utilization: a stochastic theory of product quality. journal of political economy. 84,523-542. de vany, a., and saving, t. ( 1983) the economics ofquality. journal ofpolitical economy, 9/,979-1000. ilmakunnas, p. (2002) strategic behavior in a service industry. managerial and decision economics, 23, 69-82. kalai, e., kamien, m., and rabinovich, m. (1992) optimal service speed in a competitive environment. management science. 38, 1154-1163. koenigsburg, e. (1980) uncertainty, capacity, and market share in oligopoly: a stochastic theory of product quality. journal of business. 53, 151-164. li, l., and lee, ys. (1994) pricing and delivery time performance in a competitive environment. management science. 40, 633-646. marvel, h., and mccafferty, s. (1996) comparing vertical restraints. journal ofeconomics and business, 48,473-486. pep an, l., richards, d., & norman, g. (2002) industrial organization: contemporary theory and practice. (2 nd ed.). mason: south-western. stidham, jr., s. (1992) pricing and capacity decisions for a service facility: stability and multiple local optima. management science, 38, 1121-1139. fall 2005 hegji and moore: strategic use ofservice 141 telser, l. (1960) why should manufacturers want fair trade? the journal of law and economics, 3, 86-105. telser, l. (1990) why should manufacturers want fair trade ii? the journal of law and economics, 33,409-417. footnotes i a close variant of this demand has been suggested as a vehicle for studying customer service by pepall, richards, and norman (2002, p. 487). the multiplicative demand function has been used in models for quality as well. this type of demand indicates that increases in services raise consumer reservation prices and the maximum market size. 2 this restriction (~ < 1) is standard with differentiated bertrand models indicating that responsiveness to changes in the product's own price is greater than responsiveness to changes in the rival's price. 3 see the discussion surrounding equation (5). 4 we point out that while 0 < 13 < 1 is a standard assumption, 0 < 1.5 is necessary to ensure positive equilibrium prices. 5 although the model presented is static, this is the likely result in a dynamic model with entry. dr. charles hegji, ph.d. (washington university s1. louis) is a distinguished research professor in the department of economics at auburn university montgomery. he has been with the department since 1985 and is currently a full professor. his primary teaching interests are in managerial economics, principles of microeconomics, and statistics. his primary area of research is in firm strategy and market structure. he also enj oys publishing electronic music; you may listen to his music at www.acidplanet.com under the artist name drh. dr. evan moore, ph.d. (virginia polytechnic institute and state university) joined the department of economics at auburn university montgomery in 2002 and is currently an assistant professor. his primary teaching interests are industrial organization, principles of microeconomics, and the economics of decision making. his primary areas of research include industrial organization and experimental economics. he has a coauthored work forthcoming in the american economic review. a note on the strategic use of service volume 32, number 2 71 recency effects in justice and organizational citizenship behavior: the impact of coping style juliana lilly sam houston state university • huntsville, texas meghna virick san jose state university • san jose, california kamphol wipawayangkool sam houston state university • huntsville, texas abstract the present study examines the incremental effects of interpersonal and informational justice over three time periods on organizational citizenship behavior (ocb). fairness heuristic theory and uncertainty management theory are used to examine whether initial justice perceptions are consistently influential over time on ocb creating a primacy effect, or if later justice perceptions are more influential on ocb than initial ones creating a recency effect. results indicate a possible recency effect in longitudinal justice perceptions. additionally, two individual coping styles, approach and avoidance, were examined as moderators of the justice/ ocb relationship. it was hypothesized that higher levels of avoidance coping would make justice perceptions more influential in predicting ocb, but higher levels of approach coping would make justice perceptions less influential in predicting ocb. the hypotheses were mostly supported for ocb directed toward individuals, but not for ocb directed toward the organization. keywords: justice over time, organizational citizenship behavior, uncertainty management theory, coping introduction the justice literature has slowly begun to examine the dynamic nature of justice, with some studies attempting to predict within person differences of justice perceptions over time (holtz and harold 2009; lilly, virick, and hadani 2010) and other studies focusing on the incremental impact of justice over time on outcome variables (ambrose and cropanzano 2003; hausknecht, sturman, and roberson 2011; kim, lin and leung 2015). despite the interest in longitudinal justice effects, there still remains a dearth of studies on the topic and a lack of clear focus on applicable theory. 72 journal of business strategies this study contributes to the literature by examining the impact of longitudinal justice perceptions on organizational citizenship behavior (ocb), a critical component in healthy organizational functioning (podsakoff, mackenzie, paine, and bachrach 2000), and investigating the impact of individual coping style to ascertain if individual coping style ameliorates the fairness effect which proposes that fair procedures tend to override negative reactions to unfavorable decision outcomes (folger, rosenfield, grove, and corkran 1979; lind 2001). the purpose of this study is to examine whether initial justice perceptions are consistently influential over time on ocb, creating a primacy effect, or if later justice perceptions are more influential on ocb than initial ones, creating a recency effect. in addition, we examine whether (a) approach coping, or trying to change the situation by confronting the situation, and (b) avoidance coping, or trying to avoid dealing with the situation (roth and cohen 1986) decrease the impact of justice on ocb. studying the effects of justice over time on ocb along with coping moderators of this relationship may help explain with more clarity specific situations in which the impact of justice is decreased. for example, are there some circumstances in which justice perceptions create a primacy effect? in other words, once initial justice perceptions are formed, do they continue to influence attitudes and behaviors over time or does the influence weaken over time? do individual traits such as coping style reduce the fairness effect? from a theoretical perspective, answers to these questions may provide conceptual insights not currently addressed by theory. from a practical perspective, answers may provide managers with more tools to use when trying to manage employee behavior. literature review the influence of justice in the workplace justice perceptions have always been important because of their influence on important behavioral outcomes, such as ocb. ocb is helping behavior in organizations that is commonly broken into two categories: (a) behavior directed toward the overall organization; and (b) behavior directed toward particular individuals in the organization (mcneely and meglino 1994; williams and anderson 1991). organizational justice is generally considered an antecedent of ocb (fassina, jones, and uggerslev 2008; moorman and byrne 2005), and researchers have suggested that ocbs are related to organizational effectiveness (see podsakoff, et al. 2000, for a review). we chose ocb as the outcome variable of interest because of its long volume 32, number 2 73 history of being related to justice perceptions and because of its importance in the effective functioning of an organization. thus, any research that helps to clarify the antecedents of ocb is a worthwhile endeavor. to this end of clarifying antecedents, we focus on two dimensions of justice – interpersonal justice and informational justice. interpersonal justice refers to the person implementing the decision process and concerns whether the person demonstrated respect and politeness while implementing the process. informational justice concerns issues such as explaining the decision procedures thoroughly and in a timely manner. we believe interpersonal and informational justice are the most relevant in the current study for reasons outlined below. interpersonal and informational justice, although susceptible to incorrect perceptions about the individuals involved, focus on the people involved in implementing and communicating processes and outcomes, people who often are the only person employees see representing organizational policies. in fact, studies have linked interpersonal justice to extra-role behaviors such as those found in ocb (aquino 1995; colquitt 2001). colquitt and rodell (2011) suggest that informational justice is critical in creating reciprocating exchanges in the form of ocbs. thus we believe interpersonal and informational justice represent the true nature of employee perceptions of justice as it pertains to examining ocb under potential uncertainty. justice over time a number of justice studies have suggested that justice over time is important in the workplace, with some research examining the impact of initial justice perceptions on subsequent events and perceptions. for example, researchers have found that justice measured at time 1 has an impact on perceptions of test fairness three weeks later (bauer, maertz, dolen, and campion 1998), on actual turnover measured three years later (tekleab, takeuchi, and taylor 2005), and on the acceptability of arbitrators by disputing parties three months later (posthuma, dworkin, and swift 2000). these studies suggest that initial perceptions of justice are somewhat constant over time. in contrast to these studies, other researchers have examined how justice perceptions over time tend to fluctuate depending upon favorability of a particular outcome (ambrose and cropanzano 2003; thornhill and saunders 2003). studies have also focused on explaining specific within-subject differences in justice over time (holtz and harold 2009; kim, et al. 2015; lilly et al. 2010) or the incremental impact of justice over time (hausknecht et al. 2011). 74 journal of business strategies a common element seemingly prevalent in more recent studies is that they have struggled to find a unifying theory of justice that fully accounts for justice over time. part of the problem may be due to the various uses of time itself in justice research. for example, does justice over time refer to justice perceptions of a single event measured at different points over time? does it refer to initial perceptions of justice impacting other variables over time? does it refer to perceptions of both current and future events impacting perceptions of justice as time unfolds? the reference point for justice (initial and ending) along with the variables impacted may lead to various theories being used to account for justice over time. earlier studies using social exchange theory (blau 1964), equity theory (adams 1963), or organizational justice theory based on the fairness effect (lind 2001) were primarily interested in examining how initial perceptions of justice influenced later variables (bauer et al. 1998; posthuma et al. 2000; tekleab et al. 2005; thornhill and saunders 2003). thus, the stability found in social exchange relationships, equity comparisons, and the fairness effect was sufficient in explaining the results. recent studies, however, have focused more on explaining within-subject differences in justice over time or on the incremental impact of justice over time on specific outcome variables. we believe it is more difficult for researchers to use social exchange theory, equity theory and the fairness effect when studying changes in perceptions over time. for example, assume a researcher predicts justice perceptions of an initial event to fluctuate from high to low over several time periods. using the norm of reciprocity in social exchange as the basis of a hypothesis, the researcher would have to predict the exchange relationship itself somehow changed at each measured time period. using equity theory, the researcher would have to predict the equity fraction used for comparison changed at each measured time period. using the fairness effect would not work at all, since the premise of the fairness effect is that once individuals perceive fair procedures at work, perceptions of fairness would carry over to other aspects in the workplace, regardless of sporadic events over time that could alter previous fairness perceptions. the question, then, concerns whether perceptions of justice over time are stable, creating a primacy effect created by initial perceptions, or whether perceptions of justice change over time, creating a recency effect by which later perceptions of justice are more influential than initial perceptions. lilly et al. (2010) tested a primacy and recency effect in a study that examined changes in individual justice perceptions over time concerning a positive or negative work decision outcome. their results indicate that perceptions of procedural justice volume 32, number 2 75 may change over time, while perceptions of interpersonal justice do not change over time. thus, both a primacy and a recency effect were observed in their data for different types of justice. the present study also examines primacy and recency effects in justice, but our definition of justice over time refers to the influence of overall perceptions of justice (initial reference point) on a dependent variable at three time periods. because the initial reference point originates shortly after a major hurricane, we believe the “honeymoon” period of helping behavior that often occurs after disasters will gradually dissipate. thus, fairness heuristic theory (lind 2001) and uncertainty management theory (lind and van den bos 2002; van den bos and lind 2002) are used to develop an argument stating that a recency effect should occur in this particular situation. fairness heuristic theory. fairness heuristic theory (lind 2001) has been used at least partially to explain longitudinal effects of justice over time (lilly et al. 2010). fairness heuristic theory (fht) focuses primarily on the ability of individuals to use past fairness decisions to develop a heuristic about future decisions. studies have shown that the fairness heuristic is formed quickly (van den bos, vermunt, and wilke 1997), and that first impressions of justice influence subsequent perceptions of justice resulting in a primacy effect. fht does account for phase-shifting events that could cause perceptions of justice to change at a later time, however. for example, when a relationship changes or fairness information becomes known that is contrary to previously formed heuristics, the trust factor that is so important in forming the fairness heuristic may be altered to reflect a new reality of justice perceptions that is different from before resulting in a recency effect. thus, fht could support either a primacy or a recency effect in longitudinal justice. we believe fht supports a recency effect in the context of our study due to the data collection having occurred in the aftermath of a hurricane. if the problems caused by the hurricane are considered to be uncontrollable by the victims (e.g., loss of power, water, phone service), some researchers suggest that people are more likely to help others (marjanovic, struthers, and greenglass 2012; mcmanus and saucier 2012). this implies that a natural disaster could be a phase-shifting event in which perceptions of justice change as former “strangers” at work become more familiar with one another through hurricane stories and sharing (or not sharing) resources to get through the hardship. the uncertainty of the hurricane situation for everyone, along with the potential relationship changes that occur as people actively help one another through the disaster, could alter the previous fairness heuristic to reflect a new reality of justice perceptions. uncertainty management theory provides additional support for a recency effect. 76 journal of business strategies uncertainty management theory. uncertainty management theory (lind and van den bos 2002; van den bos and lind 2002) suggests that individuals rely on justice judgments most when they are experiencing uncertainty. the theory is built on the idea that fairness, or justice, allows individuals to experience some control over their situation. seminal works on process control, for example, propose that individuals will accept unfavorable outcomes if they are allowed some control over the process through voice, or reliance on consistent and unbiased procedures (folger et al. 1979; greenberg and folger 1983). when uncertainty is present, individuals use justice judgments to manage their reactions to the situation, and the salience of uncertainty increases the influence of justice perceptions on other aspects of the organization. studies using uncertainty management theory have found that mistreatment in an environment of uncertainty amplifies the negative reactions from employees to a larger degree than when mistreatment alone is considered (tangirala and alge 2006; thau, aquino, and wittek 2007; thau, bennett, mitchell, and marrs 2009). some element of uncertainty is ever-present in most workplaces, and this may be the reason that justice effects are so powerful. in addition, some individuals may experience higher levels of uncertainty than others, and these individuals report stronger negative reactions as well (thau et al. 2007). for example, an alpha change, which occurs when respondents change their standing on a construct, should occur when levels of uncertainty fluctuate. as uncertainty increases and becomes more salient to an individual, an alpha change in justice perceptions should occur that causes justice perceptions to become more influential. in the context of a natural disaster, as uncertainty about the situation increases or decreases at different time periods, an alpha change in justice perceptions should also occur, and the impact of justice perceptions on a dependent variable at different time periods should change also. the impact of justice on ocb over time. studies that have specifically examined the effect of justice over time on job attitudes (ambrose and cropanzano 2003; hausknecht et al. 2011; kim, et al. 2015) have found that temporal changes in justice perceptions are associated with employee attitudes beyond the influence of current justice perceptions. because the future is almost always uncertain and the present is often uncertain, uncertainty management theory (umt) supports the premise that perceptions of interpersonal and informational justice should influence constructs such as ocb that are theoretically related to justice at all time periods. volume 32, number 2 77 few people can predict the future with 100% accuracy. as a result, uncertainty is ever-present when contemplating future events. umt suggests this uncertainty of future events will trigger individuals to use fairness heuristics in the present time period to manage their uncertainty about the future. past events are often certain – that is, they are analyzed and understood so that uncertainty about the past is less salient than uncertainty in the present or the future. thus, if uncertainty is low or absent, umt suggests individuals are less likely to use fairness heuristics to manage uncertainty because the uncertainty is already under control. essentially, umt supports the idea that past situations or events with no uncertainty will not influence the fairness effect (folger, et al. 1979; lind 2001), but situations or events occurring at the present or future time with some level of uncertainty will influence the fairness effect. as a result, we hypothesize there should be a recency effect of justice over time on individual work attitudes and behaviors such that later perceptions of interpersonal or informational justice will be associated with later perceptions of ocb beyond the effect of earlier interpersonal or informational justice perceptions. for example, time 2 justice perceptions will be associated with time 2 ocb beyond the effect of time 1 justice perceptions, and time 3 justice perceptions will be associated with time 3 ocb beyond the effect of time 1 and time 2 justice perceptions. h1: there will be a recency effect of justice over time on ocb, such that later perceptions of interpersonal (informational) justice will be related to ocb after controlling for previous perceptions of interpersonal (informational) justice. the moderating role of coping style research has shown that certain individual characteristics influence how people respond to uncertainty (gibbons and buunk 1999; tobin and raymundo 2010). in this study, we look at another individual characteristic that could enhance uncertainty – coping style. a number of studies suggest the way individuals cope with stress can impact their reactions to a particular situation. roth and cohen (1986) describe two basic categories of coping responses: (a) approach coping, or trying to change the situation by confronting the situation, and (b) avoidance coping, or trying to avoid dealing with the situation. the coping strategy chosen by the individual depends partly upon the individual’s appraisal of the situation. if the appraisal indicates something can be done about the situation, approach coping is dominant. if the appraisal indicates 78 journal of business strategies nothing can be done about the situation, avoidance coping is dominant (lazarus 1993, p. 239). generally speaking, greater approach coping is associated with better psychological outcomes, while greater avoidance coping is associated with poorer psychological outcomes (holahan and moos 1990, 1991; vitaliano, maiuro, russo, and becker 1987). researchers in coping often examine the antecedents and consequences of coping to better understand how individual coping style impacts the situation. for instance, some studies have found that fear, anxiety and depression are positively related to avoidance coping (barker 2007; duhachek and oakley 2007; pakenham 2006), while self-esteem is negatively related to avoidance coping (barker 2007). studies examining approach coping have found that anxiety was not significantly related to approach coping (pakenham 2006). however, anger was positively related to approach coping (duhachek and oakley 2007) and feelings of threat were negatively related to approach coping (scheck and kinicki 2000). in general, studies on coping report that avoidance, or escapist coping strategies are consistently associated with poor mental health outcomes, while approach coping strategies are sometimes associated with negative outcomes, sometimes positive outcomes, and sometimes neither (folkman and moskowitz 2004, p. 747). umt states the impact of justice perceptions is most influential in times of uncertainty; thus, the effects of justice on outcome variables such as ocb depend upon the extent to which people perceive the situation as uncertain. based on the coping literature, it seems reasonable to expect an individual responding to uncertainty using an approach coping style may perceive the situation as less uncertain than an individual responding to uncertainty using an avoidance coping style. this reasoning is based on the premise that individuals engaged in an approach coping style generally will not experience increased fear and anxiety (duhachek and oakley 2007; pakenham 2006), and will approach the situation to resolve it. indeed, barclay and keifer (2014) found that positive emotions, such as being happy and optimistic, significantly mediate the relationship between overall justice and the helping behaviors of altruism and participation. individuals engaged in approach coping remove some uncertainty simply by acting upon the situation, are likely to be at least somewhat optimistic, and therefore, may rely less on fairness heuristics and more on their own actions and the actions of others to form perceptions of justice. on the other hand, individuals engaging in an avoidance coping style generally believe nothing can be done about the situation (lazarus 1993). as a result, fear and anxiety are increased (barker 2007; duhachek and oakley 2007; pakenham 2006), and avoidance of the situation leaves it unresolved. by choosing not to act upon the volume 32, number 2 79 situation, and allowing it to proceed without resolution, the individual essentially allows uncertainty to continue, and therefore, may rely more on fairness heuristics to form perceptions of justice. indeed, barclay and keifer (2014) found that negative emotions such as being anxious and frustrated significantly mediate the relationship between overall justice and psychological withdrawal. although some research in organizational justice suggests a causal relationship between justice and psychological health such that justice impacts psychological health (e.g., greenberg 2006; judge and colquitt 2004), there is some evidence that psychological health influences perceptions of justice. for example, lang, bliese, lang and adler (2011) found that depressive symptoms influenced subject perceptions of justice three months and six months later in a sample of soldiers deployed on peacekeeping missions or activated in the wake of 9/11. given this recent finding and the research on coping, we hypothesize that individuals who engage in an avoidance coping style will allow justice perceptions to influence their attitudes and behavior more than individuals who engage in an approach coping style. coping style will moderate the effects of justice on ocb such that: h2: there will be a positive moderating effect between perceptions of justice and an avoidance coping style on ocb. h3: there will be a negative moderating effect between perceptions of justice and an approach coping style on ocb. figure 1. hypothesized model. method the data for the study were collected after a recent hurricane using a snowball collection method, and the context of a natural disaster allowed us to presume levels of uncertainty existed within the sample. the hurricane also allowed us to presume 80 journal of business strategies that stress and coping would be a salient issue with respondents, and thus, measures of coping would be particularly relevant. students in management classes were given an opportunity to receive extra credit by asking a full-time employee over the age of 30 to complete a series of three surveys about a recent hurricane and their experience in returning to work after the hurricane. snowball data collection has been used frequently by researchers in recent years (eaton and struthers 2002; jandeska and kraimer 2005; rotondo, carlson, and kincaid 2003; treadway, hochwarter, kacmar, and ferris 2005). in a study of hurricane-induced stress, hochwarter, laird and brouer (2008) collected data in one sample by giving undergraduate students course credit for distributing five surveys to full-time employees, similar to our method of asking students after a hurricane to distribute surveys to full time employees over the age of thirty. because we wished to measure employee attitudes within four weeks of the hurricane, a snowball sample allowed us to meet this deadline. the four week time period was to ensure that uncertainty surrounding the hurricane and its aftermath were not forgotten. indeed, many people and businesses in a large area surrounding the school were still without power and running water several weeks after the storm. the cover sheet to the survey was entitled, “employee reactions to hurricane ike,” and stated that the purpose of the survey was to learn about individual experiences in returning to work after hurricane ike. participants were thus given an appropriate frame of reference for their responses. the thirty year age requirement was to ensure that respondents were more likely to have a stable job in which uncertainty caused by a hurricane would be a major disruption to their normal work routine. younger respondents, such as college students who often move from job to job during school, would be less likely to see a major disruption at work since their work schedules are often unstable to begin with. the hurricane made landfall in the us on september 13, and classes resumed at the university on september 22. the first survey was distributed and completed between october 2 and october 9; the second survey was distributed and completed between november 4 and november 11; and the third survey was distributed and completed between december 2 and december 9. out of a total of 324 questionnaires distributed, 255 were returned, yielding the response rate of 78.7%. after screening for missing data, we eliminated 42 responses, resulting in a final sample size of 213. respondents were from 14 different industries. average age was 43.35, and approximately 49% were men and 45.5% were women (5.5% did not respond). all had been affected by the hurricane, although only 1.2% reported that either they or one of their family members suffered from actual physical injury as a result of volume 32, number 2 81 the hurricane. many lost power (86.7%), with 39.9% reporting they were without electricity for over six days. although 35.2% of the respondents returned to work two days after the storm, 23.9% did not return to work until after september 19, seven days after the storm hit. the other 40.9% of respondents returned to work somewhere between three days and six days after the storm, with 12.5% returning after three days, 15.7% after four days, 8.3% after five days, and 4.4% after six days. in december, 31% of the respondents reported that people were still talking about the hurricane at work three months later. measures all variables were measured using either a 7-point or a 5-point likert scale. for the organizational behavior scales and the coping scales, the items asked how often respondents engaged in certain behavior or how often they reacted a certain way to stress episodes. the response format for these two scales was, 1 = never and 7 = always. the justice scales asked respondents to what extent supervisors engaged in certain behaviors. following the example of colquitt (2001), these items used a 5-point scale with 1 = to a very small extent and 5 = to a very large extent. coping response. items measuring coping response strategies were measured at time 1 and were taken from the coping response inventory (moos, 1993). coping strategies are categorized into two main dimensions – (a) approach or avoidance and (b) cognitive or behavioral. for approach coping strategies, we used two subscales: positive reappraisal (a cognitive strategy) and problem solving (a behavioral strategy). for avoidance coping strategies, we used the following two subscales: cognitive avoidance (a cognitive strategy) and emotional discharge (a behavioral strategy). these four subscales were used by valentiner, holahan, and moos (1994) as representatives of approach and avoidance coping; thus, we follow their example and do the same in the present study. each subscale consisted of 6 items, and sample items include the following: “try not to think about the problem” (cognitive avoidance); “yell or shout to let off steam” (emotional discharge); “make a plan of action and follow it” (problem solving); and “try to see the good side of the situation” (positive reappraisal). the cognitive avoidance and emotional discharge scales were added together to get one score for the avoidance coping and the problem solving and positive reappraisal scales were added together to get one score for the approach coping scale. justice. the items for interpersonal justice and informational justice were measured at all three time periods and were taken from colquitt’s (2001) scale. 82 journal of business strategies interpersonal justice was measured with four items, and informational justice was measured with five items. sample items include, “to what extent does your supervisor treat you in a polite manner” (interpersonal justice), and “to what extent does your supervisor explain work procedures thoroughly at work” (informational justice). organizational citizenship behavior (ocb). sixteen items were used to measure ocb, with eight items representing ocb directed toward the individual (ocbi) and eight items representing ocb directed toward the organization (ocbo). these items were measured at all three time periods and were taken from lee and allen’s (2002) scale. respondents were asked how often they engaged in behaviors such as “share personal property with others to help their work” (ocbi) and “take action to protect the organization from potential problems” (ocbo). results we used smartpls 2.0 m3 (ringle, wende, and will 2005) to analyze the measurement and structural models. unlike a covariance-based structural equation modeling (sem) used in lisrel, partial least squares (pls), a component-based sem, was chosen because it is more flexible in terms of both distribution assumptions (e.g. multivariate normality is not necessary) and sample size requirements (chin, marcolin, and newsted 2003). considering the purpose of the study and the ratio between the number of the constructs in the models and the sample size, we believed that using pls would be a more appropriate choice. measurement model we validated psychometric properties (i.e., discriminant validity, convergent validity, and reliability) of the constructs using smartpls. as a result of the first run, using 0.6 as a cutoff value, we eliminated six items of the approach construct (3 items from positive reappraisal and 3 items from problem solving) and six items of the avoidance construct (3 items from cognitive avoidance and 3 items from emotional discharge). it is not uncommon to have low internal consistency in coping scales, because using one coping response could reduce the need to use other responses from the same category (holahan, moos, holahan, and brennan 1997; moos and holahan 2003; timko, cronkite, and moos 2010). indeed, in a study of stressors and avoidance coping, timko et al. (2010) created an avoidance coping scale by combining two items of a cognitive nature with six items of a behavioral nature. our scales thus combine three cognitive items and three behavioral items for both the volume 32, number 2 83 approach coping style and the avoidance coping style. noticeably, the results of the subsequent run improved, in that they attested discriminant validity, convergent validity, and reliability of all the constructs as described below. as shown in table 1, the square root of the average variance extracted (ave) of each of the constructs was greater than its correlation with all the other constructs, thus demonstrating discriminant validity (gefen and straub 2005). in addition, while there were still some cross-loading items between those of informational justice and those of interpersonal justice, we decided to retain the items, because not only were the differences of the loadings very small (from 0.10.3), they also had been well validated by previous researchers (e.g., colquitt 2001). furthermore, the majority of the items in fact reasonably loaded (> 0.6) on their own factors (see table 2), showing evidence of discriminant validity (gefen and straub 2005). the t-statistics of all the items loading on their respective factors (ranging from 7.48 to 123.2) were significant at the 0.001 level, strongly exhibiting a high degree of convergent validity (gefen and straub 2005). finally, both composite reliability and cronbach’s alpha coefficients of all the constructs exceeded 0.8, indicating satisfactory reliability (fornell and larcker 1981; nunnally 1978). taken together, these results demonstrated the quality of the measurement model. thus, we then turned to examine the structural model. 84 journal of business strategies ta bl e 1 m ea ns , s ta nd ar d d ev ia ti on s, b iv ar ia te c or re la ti on s, r el ia bi lit ie s, a nd s qu ar e r oo ts o f t he a ve ra ge v ar ia nc e e xt ra ct ed m ea n (s d ) c r c a 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 ap pr oa ch 5. 11 (0 .9 8) 0. 88 0. 86 . 76 2 av oi da nc e 2. 89 (0 .9 9) 0. 87 0. 85 .3 7* * .6 8 3 in fo rm t 1 3. 68 (0 .9 7) 0. 92 0. 89 . 36 ** .1 0 . 83 4 in fo rm t 2 3. 69 (0 .8 3) 0. 91 0. 88 . 20 ** .0 2 . 46 ** .8 2 5 in fo rm t 3 3. 73 (0 .8 3) 0. 92 0. 88 . 14 * .0 7 . 50 ** .5 2* * . 83 6 in te r t 1 4. 06 (0 .9 5) 0. 93 0. 90 . 36 ** .1 6 . 75 ** .3 6* * . 38 ** . 88 7 in te r t 2 4. 04 (0 .8 3) 0. 93 0. 90 . 20 * .1 1 . 41 ** .7 4* * . 48 ** . 44 ** .8 8 8 in te r t 3 4. 03 (0 .8 2) 0. 93 0. 90 . 23 ** .2 1* * . 50 ** .5 0* * . 68 ** . 49 ** .6 0* * .8 8 9 o c b i t 1 5. 04 (0 .9 8) 0. 92 0. 90 . 43 ** .3 2* * . 24 * .1 5* . 10 . 17 .1 6* .1 1 .7 7 10 o c b i t 2 5. 14 (0 .9 0) 0. 89 0. 86 . 22 ** .2 5* * . 17 .3 6* * . 13 . 14 .3 6* * .2 7* * .4 6* * .7 2 11 o c b i t 3 5. 14 (0 .8 9) 0. 90 0. 88 . 13 .1 7 . 17 .2 8* * . 21 * . 14 .2 4* * .3 0* * .3 3* * .5 8* * .7 3 12 o c b o t 1 5. 27 (1 .1 6) 0. 94 0. 92 . 52 ** .3 1* * . 34 ** .1 8* * . 14 * . 34 ** .2 5* * .2 2* * .6 3* * .3 2* * .2 1* * .8 0 13 o c b o t 2 5. 33 (1 .1 1) 0. 93 0. 92 . 25 ** .2 0* * . 22 * .4 0* * . 27 ** . 20 * .4 2* * .3 6* * .3 6* * .5 9* * .4 3* * .5 6* * .8 0 14 o c b o t 3 5. 30 (1 .0 6) 0. 93 0. 91 . 24 ** .1 2 . 22 * .2 7* * . 36 ** . 14 .2 6* * .4 0* * .2 6* * .3 8* * .5 9* * .4 6* * .6 9* * .7 9 n ot e. s d = s ta nd ar d de vi at io n; c r = c om po si te re lia bi lit y; c a = c ro nb ac h’ s al ph a; th e di ag on al v al ue s ar e th e sq ua re ro ot o f t he a ve ra ge v ar ia nc e ex tra ct ed (a ve ) f or e ac h co ns tr uc t; ** p < 0 .0 1 (2 -t ai le d) ; * p < 0 .0 5 (2 -t ai le d) . n = 2 13 . volume 32, number 2 85 ta bl e 2 c on fir m at or y f ac to r a na ly si s r es ul ts ap pr oa ch av oi da nc e in fo rm t 1 in fo rm t 2 in fo rm t 3 in te r t 1 in te r t 2 in te r t 3 o c b i t 1 o c b i t 2 o c b i t 3 o c b o t 1 o c b o t 2 o c b o t 3 t1 ca 1 -0 .1 7 0. 62 0. 04 0. 11 0. 04 -0 .0 5 -0 .0 6 -0 .0 6 -0 .1 8 -0 .1 2 -0 .1 0 -0 .1 9 -0 .1 3 -0 .1 2 t1 ca 4 -0 .1 6 0. 66 -0 .0 3 0. 10 0. 02 -0 .1 3 -0 .0 2 -0 .1 5 -0 .1 1 -0 .0 6 -0 .0 1 -0 .2 2 -0 .1 1 -0 .0 9 t1 ca 6 -0 .2 3 0. 71 -0 .0 3 0. 03 -0 .0 4 -0 .0 9 -0 .0 5 -0 .1 4 -0 .1 2 -0 .1 2 -0 .0 4 -0 .2 1 -0 .1 2 -0 .1 0 t1 ed 1 -0 .2 8 0. 71 -0 .0 5 0. 01 -0 .0 6 -0 .0 9 -0 .0 5 -0 .1 3 -0 .3 0 -0 .2 1 -0 .1 6 -0 .2 4 -0 .1 3 -0 .0 5 t1 ed 2 -0 .3 2 0. 74 -0 .0 8 -0 .0 3 -0 .0 4 -0 .1 4 -0 .1 5 -0 .1 6 -0 .2 6 -0 .1 8 -0 .1 4 -0 .2 1 -0 .1 3 -0 .0 5 t1 ed 4 -0 .2 8 0. 64 -0 .1 6 -0 .0 4 -0 .1 3 -0 .1 4 -0 .1 0 -0 .1 9 -0 .2 8 -0 .2 8 -0 .1 8 -0 .2 2 -0 .1 8 -0 .1 2 t1 ij1 0. 30 -0 .2 1 0. 65 0. 31 0. 27 0. 90 0. 40 0. 42 0. 16 0. 11 0. 11 0. 31 0. 17 0. 10 t1 ij2 0. 37 -0 .1 5 0. 71 0. 35 0. 38 0. 94 0. 41 0. 46 0. 20 0. 15 0. 13 0. 32 0. 19 0. 14 t1 ij3 0. 31 -0 .1 4 0. 68 0. 33 0. 37 0. 91 0. 39 0. 43 0. 17 0. 12 0. 14 0. 34 0. 21 0. 12 t1 ij4 0. 27 -0 .0 9 0. 61 0. 28 0. 31 0. 76 0. 34 0. 40 0. 07 0. 13 0. 12 0. 23 0. 14 0. 13 t1 in fj1 0. 33 -0 .1 3 0. 76 0. 35 0. 39 0. 69 0. 40 0. 46 0. 21 0. 16 0. 23 0. 29 0. 20 0. 19 t1 in fj2 0. 32 -0 .0 8 0. 87 0. 37 0. 52 0. 57 0. 35 0. 46 0. 22 0. 14 0. 13 0. 31 0. 21 0. 26 t1 in fj3 0. 33 -0 .1 4 0. 86 0. 39 0. 42 0. 67 0. 35 0. 48 0. 19 0. 18 0. 13 0. 27 0. 18 0. 17 t1 in fj4 0. 27 -0 .0 2 0. 85 0. 40 0. 37 0. 60 0. 30 0. 35 0. 18 0. 12 0. 09 0. 24 0. 12 0. 15 t1 in fj5 0. 25 -0 .0 3 0. 81 0. 39 0. 38 0. 57 0. 30 0. 31 0. 20 0. 11 0. 13 0. 29 0. 20 0. 16 t1 oc bi 1 0. 41 -0 .3 0 0. 20 0. 12 0. 05 0. 16 0. 08 0. 11 0. 70 0. 32 0. 18 0. 44 0. 22 0. 11 t1 oc bi 2 0. 43 -0 .3 0 0. 28 0. 13 0. 12 0. 18 0. 14 0. 10 0. 84 0. 40 0. 30 0. 54 0. 31 0. 21 t1 oc bi 3 0. 14 -0 .0 6 0. 07 0. 05 -0 .0 1 0. 01 0. 04 -0 .0 4 0. 69 0. 32 0. 22 0. 37 0. 20 0. 13 t1 oc bi 4 0. 37 -0 .2 9 0. 17 0. 11 0. 09 0. 12 0. 20 0. 12 0. 74 0. 28 0. 24 0. 51 0. 27 0. 23 t1 oc bi 5 0. 46 -0 .3 8 0. 24 0. 18 0. 11 0. 19 0. 23 0. 19 0. 81 0. 36 0. 30 0. 58 0. 38 0. 28 t1 oc bi 6 0. 33 -0 .2 7 0. 22 0. 09 0. 09 0. 20 0. 12 0. 08 0. 85 0. 39 0. 30 0. 53 0. 31 0. 26 86 journal of business strategies t1 oc bi 7 0. 28 -0 .2 0 0. 14 0. 13 0. 08 0. 09 0. 08 0. 06 0. 75 0. 39 0. 25 0. 45 0. 22 0. 16 t1 oc bi 8 0. 20 -0 .1 3 0. 12 0. 10 0. 07 0. 07 0. 08 0. 01 0. 74 0. 34 0. 24 0. 39 0. 23 0. 16 t1 oc bo 1 0. 30 -0 .1 1 0. 20 0. 09 0. 00 0. 11 0. 04 0. 06 0. 56 0. 31 0. 18 0. 69 0. 40 0. 29 t1 oc bo 2 0. 39 -0 .2 4 0. 24 0. 16 0. 12 0. 29 0. 20 0. 20 0. 49 0. 25 0. 21 0. 80 0. 44 0. 35 t1 oc bo 3 0. 34 -0 .2 0 0. 27 0. 16 0. 17 0. 24 0. 19 0. 20 0. 49 0. 24 0. 20 0. 85 0. 50 0. 43 t1 oc bo 4 0. 42 -0 .2 6 0. 36 0. 20 0. 22 0. 36 0. 33 0. 27 0. 52 0. 26 0. 19 0. 87 0. 51 0. 43 t1 oc bo 5 0. 35 -0 .2 8 0. 24 0. 11 0. 08 0. 23 0. 15 0. 12 0. 56 0. 28 0. 18 0. 70 0. 35 0. 25 t1 oc bo 6 0. 50 -0 .2 9 0. 29 0. 17 0. 14 0. 32 0. 28 0. 24 0. 47 0. 25 0. 11 0. 87 0. 48 0. 40 t1 oc bo 7 0. 52 -0 .2 9 0. 30 0. 13 0. 12 0. 31 0. 20 0. 23 0. 48 0. 20 0. 19 0. 83 0. 47 0. 46 t1 oc bo 8 0. 48 -0 .3 6 0. 26 0. 15 0. 03 0. 31 0. 17 0. 09 0. 50 0. 25 0. 12 0. 81 0. 45 0. 34 t1 pr 3 0. 76 -0 .3 2 0. 30 0. 16 0. 11 0. 31 0. 16 0. 20 0. 28 0. 17 0. 11 0. 39 0. 20 0. 18 t1 pr 5 0. 68 -0 .1 7 0. 25 0. 09 0. 14 0. 25 0. 13 0. 15 0. 21 0. 12 0. 12 0. 24 0. 10 0. 16 t1 pr 6 0. 68 -0 .2 2 0. 17 0. 10 0. 19 0. 17 0. 07 0. 18 0. 20 0. 14 0. 17 0. 25 0. 11 0. 20 t1 ps 1 0. 79 -0 .2 8 0. 31 0. 17 0. 11 0. 28 0. 18 0. 22 0. 45 0. 23 0. 11 0. 48 0. 28 0. 22 t1 ps 2 0. 83 -0 .3 7 0. 27 0. 17 0. 04 0. 29 0. 18 0. 15 0. 39 0. 20 0. 09 0. 48 0. 21 0. 19 t1 ps 3 0. 82 -0 .2 9 0. 36 0. 20 0. 09 0. 31 0. 18 0. 16 0. 40 0. 15 0. 03 0. 44 0. 17 0. 15 t2 ij1 0. 23 -0 .1 3 0. 36 0. 72 0. 44 0. 41 0. 95 0. 60 0. 17 0. 35 0. 23 0. 24 0. 40 0. 24 t2 ij2 0. 17 -0 .1 0 0. 39 0. 71 0. 44 0. 41 0. 93 0. 54 0. 14 0. 29 0. 19 0. 18 0. 35 0. 21 t2 ij3 0. 21 -0 .1 1 0. 40 0. 66 0. 45 0. 39 0. 90 0. 53 0. 17 0. 32 0. 22 0. 23 0. 37 0. 26 t2 ij4 0. 08 -0 .0 5 0. 31 0. 50 0. 34 0. 33 0. 73 0. 44 0. 09 0. 31 0. 21 0. 23 0. 36 0. 23 t2 in fj1 0. 18 0. 03 0. 44 0. 80 0. 39 0. 37 0. 68 0. 43 0. 19 0. 35 0. 25 0. 27 0. 37 0. 26 t2 in fj2 0. 14 -0 .0 5 0. 41 0. 83 0. 43 0. 33 0. 56 0. 39 0. 11 0. 25 0. 26 0. 05 0. 27 0. 16 t2 in fj3 0. 21 -0 .0 1 0. 38 0. 86 0. 47 0. 29 0. 69 0. 46 0. 13 0. 32 0. 19 0. 13 0. 33 0. 21 t2 in fj4 0. 18 0. 04 0. 37 0. 84 0. 44 0. 29 0. 54 0. 34 0. 10 0. 25 0. 25 0. 17 0. 32 0. 26 t2 in fj5 0. 10 0. 09 0. 28 0. 78 0. 42 0. 20 0. 53 0. 41 0. 08 0. 28 0. 20 0. 12 0. 37 0. 23 volume 32, number 2 87 t2 oc bi 1 0. 18 -0 .2 1 0. 13 0. 24 0. 12 0. 10 0. 20 0. 15 0. 24 0. 68 0. 36 0. 21 0. 37 0. 22 t2 oc bi 2 0. 18 -0 .2 0 0. 17 0. 33 0. 10 0. 18 0. 35 0. 17 0. 32 0. 76 0. 40 0. 25 0. 44 0. 26 t2 oc bi 3 0. 11 -0 .1 5 0. 07 0. 18 0. 00 0. 05 0. 10 0. 06 0. 32 0. 65 0. 34 0. 22 0. 36 0. 21 t2 oc bi 4 0. 31 -0 .2 9 0. 20 0. 29 0. 11 0. 15 0. 29 0. 21 0. 41 0. 75 0. 42 0. 34 0. 48 0. 30 t2 oc bi 5 0. 28 -0 .2 8 0. 23 0. 31 0. 16 0. 19 0. 40 0. 26 0. 27 0. 68 0. 39 0. 26 0. 49 0. 30 t2 oc bi 6 0. 15 -0 .1 6 0. 10 0. 26 0. 07 0. 08 0. 23 0. 20 0. 41 0. 81 0. 46 0. 23 0. 47 0. 34 t2 oc bi 7 0. 03 -0 .0 8 0. 08 0. 26 0. 10 0. 07 0. 23 0. 25 0. 27 0. 75 0. 47 0. 05 0. 37 0. 24 t2 oc bi 8 0. 04 -0 .0 9 0. 01 0. 17 0. 10 0. 02 0. 23 0. 21 0. 36 0. 63 0. 47 0. 22 0. 40 0. 28 t2 oc bo 1 0. 16 -0 .1 1 0. 06 0. 26 0. 12 0. 00 0. 20 0. 21 0. 26 0. 49 0. 40 0. 35 0. 66 0. 51 t2 oc bo 2 0. 30 -0 .2 5 0. 17 0. 36 0. 14 0. 25 0. 33 0. 27 0. 28 0. 49 0. 42 0. 44 0. 78 0. 52 t2 oc bo 3 0. 17 -0 .1 6 0. 23 0. 33 0. 24 0. 21 0. 31 0. 34 0. 28 0. 44 0. 34 0. 51 0. 84 0. 62 t2 oc bo 4 0. 25 -0 .2 3 0. 27 0. 38 0. 23 0. 26 0. 44 0. 36 0. 31 0. 50 0. 34 0. 55 0. 87 0. 56 t2 oc bo 5 0. 15 -0 .1 2 0. 14 0. 27 0. 19 0. 09 0. 22 0. 19 0. 33 0. 54 0. 36 0. 40 0. 73 0. 51 t2 oc bo 6 0. 23 -0 .2 0 0. 25 0. 40 0. 31 0. 24 0. 47 0. 38 0. 29 0. 45 0. 29 0. 49 0. 85 0. 54 t2 oc bo 7 0. 20 -0 .1 4 0. 14 0. 28 0. 28 0. 09 0. 34 0. 30 0. 30 0. 45 0. 33 0. 43 0. 82 0. 58 t2 oc bo 8 0. 14 -0 .0 4 0. 14 0. 28 0. 22 0. 13 0. 33 0. 24 0. 25 0. 46 0. 29 0. 41 0. 84 0. 55 t3 ij1 0. 20 -0 .2 0 0. 46 0. 48 0. 61 0. 43 0. 59 0. 94 0. 12 0. 26 0. 29 0. 17 0. 31 0. 33 t3 ij2 0. 25 -0 .1 9 0. 50 0. 47 0. 66 0. 50 0. 55 0. 93 0. 09 0. 24 0. 31 0. 21 0. 31 0. 39 t3 ij3 0. 26 -0 .2 1 0. 47 0. 46 0. 65 0. 45 0. 53 0. 91 0. 14 0. 28 0. 27 0. 22 0. 36 0. 38 t3 ij4 0. 08 -0 .1 3 0. 30 0. 32 0. 47 0. 32 0. 44 0. 72 0. 04 0. 14 0. 20 0. 20 0. 29 0. 30 t3 in fj1 0. 21 -0 .1 5 0. 38 0. 38 0. 74 0. 29 0. 36 0. 60 0. 22 0. 17 0. 21 0. 17 0. 26 0. 28 t3 in fj2 0. 12 0. 03 0. 39 0. 47 0. 86 0. 31 0. 39 0. 51 0. 04 0. 12 0. 17 0. 09 0. 25 0. 30 t3 in fj3 0. 06 -0 .0 5 0. 46 0. 50 0. 89 0. 37 0. 44 0. 60 0. 05 0. 09 0. 14 0. 07 0. 21 0. 28 t3 in fj4 0. 13 -0 .1 2 0. 45 0. 40 0. 81 0. 34 0. 41 0. 56 0. 08 0. 13 0. 18 0. 11 0. 17 0. 26 t3 in fj5 0. 07 0. 01 0. 39 0. 41 0. 82 0. 27 0. 37 0. 54 0. 04 0. 05 0. 19 0. 15 0. 23 0. 35 88 journal of business strategies t3 oc bi 1 0. 07 -0 .0 8 0. 20 0. 31 0. 20 0. 16 0. 23 0. 28 0. 24 0. 44 0. 78 0. 11 0. 34 0. 42 t3 oc bi 2 0. 14 -0 .2 2 0. 26 0. 35 0. 33 0. 26 0. 31 0. 36 0. 25 0. 47 0. 78 0. 18 0. 34 0. 44 t3 oc bi 3 -0 .0 2 -0 .0 4 -0 .0 3 0. 01 -0 .0 1 -0 .0 3 0. 01 0. 02 0. 09 0. 34 0. 62 0. 00 0. 11 0. 29 t3 oc bi 4 0. 09 -0 .1 8 0. 15 0. 22 0. 19 0. 09 0. 24 0. 29 0. 22 0. 54 0. 78 0. 21 0. 46 0. 52 t3 oc bi 5 0. 23 -0 .2 1 0. 20 0. 22 0. 21 0. 14 0. 24 0. 35 0. 31 0. 46 0. 74 0. 26 0. 41 0. 54 t3 oc bi 6 0. 06 -0 .0 9 0. 07 0. 14 0. 09 0. 03 0. 08 0. 14 0. 33 0. 43 0. 78 0. 17 0. 29 0. 44 t3 oc bi 7 0. 06 -0 .0 6 0. 04 0. 16 0. 09 0. 04 0. 06 0. 13 0. 23 0. 36 0. 72 0. 08 0. 21 0. 40 t3 oc bi 8 0. 10 -0 .0 1 0. 00 0. 12 0. 02 0. 01 0. 10 0. 04 0. 25 0. 29 0. 65 0. 15 0. 22 0. 32 t3 oc bo 1 0. 12 -0 .0 1 0. 11 0. 09 0. 09 0. 03 0. 02 0. 13 0. 13 0. 25 0. 51 0. 27 0. 39 0. 58 t3 oc bo 2 0. 18 -0 .1 9 0. 13 0. 16 0. 33 0. 07 0. 17 0. 29 0. 17 0. 23 0. 44 0. 34 0. 52 0. 78 t3 oc bo 3 0. 15 -0 .1 2 0. 25 0. 22 0. 31 0. 15 0. 19 0. 32 0. 22 0. 31 0. 50 0. 42 0. 57 0. 83 t3 oc bo 4 0. 26 -0 .1 9 0. 28 0. 24 0. 36 0. 19 0. 30 0. 45 0. 26 0. 36 0. 51 0. 46 0. 62 0. 87 t3 oc bo 5 0. 24 -0 .1 5 0. 09 0. 23 0. 21 0. 05 0. 21 0. 25 0. 23 0. 38 0. 54 0. 28 0. 49 0. 73 t3 oc bo 6 0. 20 -0 .0 7 0. 17 0. 24 0. 31 0. 07 0. 25 0. 35 0. 24 0. 33 0. 42 0. 42 0. 59 0. 84 t3 oc bo 7 0. 17 -0 .0 2 0. 19 0. 27 0. 31 0. 17 0. 28 0. 38 0. 20 0. 28 0. 43 0. 33 0. 55 0. 82 t3 oc bo 8 0. 18 -0 .0 1 0. 14 0. 22 0. 25 0. 11 0. 18 0. 27 0. 16 0. 26 0. 42 0. 37 0. 54 0. 81 volume 32, number 2 89 structural model to examine the significance of the paths in smartpls, we performed a bootstrapping procedure (n = 213 with 500 samples). running one model for interpersonal justice and another separate model for informational justice, we found the results appeared to be somewhat similar. in the pls models, we controlled the effects of justice and ocb over time by linking those at earlier times to those at later times; for example, ocbi and ocbo t1 was linked to ocbi t2, ocbo t2, ocbi t3, and ocbo t3; justice t1 was linked to ocbi t2, ocbo t2, ocbi t3, and ocbo t3; justice t2 was linked to ocbi t3 and ocbo t3. the moderating terms were generated using an algorithm demonstrated in the work of chin et al. (2003). the first hypothesis states that there will be a recency effect of justice over time on ocb, such that later perceptions of justice will be related to ocb after controlling for previous perceptions of justice. to test this hypothesis, we examined the beta coefficients and p-values between justice at each time period and ocb at each time period. if the beta coefficients between justice and ocb have greater significance (lower p-values) at later time periods than in earlier time periods, there is evidence of an incremental effect of justice over time on ocb, suggesting a possible recency effect triggered by uncertainty. additionally, there is evidence of an incremental effect of justice over time if the beta coefficients between justice and ocb are significant at later time periods, but not significant at earlier time periods. for example, if the beta coefficient between justice at time 1 and ocb at time 2 is not significant, but the beta coefficient between justice at time 2 and ocb at time 2 is significant, there is evidence that time 2 justice perceptions are associated with ocb at time 2 beyond the effects of time 1 justice perceptions.1 relation between interpersonal justice and ocb. regarding interpersonal justice (see figure 2), interpersonal justice at time 1 overall explained about 19% of the variance in interpersonal justice at time 2, and accounting for the effect of time 1, interpersonal justice at time 2 overall explained about 36% of the variance in interpersonal justice at time 3. at time 1, interestingly, none of the relationships were significant except for the direct relationship between interpersonal justice and ocbo (b = .17, p < .001). 1 this procedure is similar to that used by ambrose and cropanzano (2003) in a longitudinal study in which they hypothesized perceptions of justice will be related to job attitudes after controlling for previous perceptions of justice. we also tested hypothesis 1 using their method of multiple regression analysis and found similar results. 90 journal of business strategies figure 2. results of path analysis for interpersonal justice. note: * p < 0.05, ** p < 0.01, *** p < 0.001 in one-tailed tests. dashed line represents insignificant path. this figure has been simplified from the model run in smartpls e.g. the paths of ocbi and ocbo from earlier to later times, as control variables, are not shown for clarity. at time 2, interpersonal justice was found to be a significant predictor of both ocbi (b = .29, p < .001) and ocbo (b = .29, p < .001). comparing this result to the relationship between interpersonal justice at time 1 and ocb at time 2, we found that interpersonal justice at time 1 was not a significant predictor of ocbi at time 2 (b = -.1, ns), but was a significant predictor of ocbo at time 2 (b = -.12, p < .05). since the p-value is not significant for ocbi and is weaker for ocbo (p < .05 versus p < .001), this indicates the effects of interpersonal justice at time 2 on ocb at time 2 are greater than the effects of interpersonal justice at time 1 on ocb at time 2, supporting hypothesis 1. at time 3, interpersonal justice was also found to be a significant predictor of both ocbi time 3 (b = .16, p < .01) and ocbo time 3 (b = .16, p < .01), while the relationship between interpersonal justice at time 2 and ocb at time 3 were insignificant (b = -.13, ns for ocbi; b = -.15, ns for ocbo). this again indicates a recency effect of justice over time on ocb in support of hypothesis 1. relation between informational justice and ocb. regarding informational justice (see figure 3), we found that informational justice at time 1 overall explained about 21% of the variance in informational justice at time 2, and accounting for the volume 32, number 2 91 effect of time 1, informational justice at time 2 overall explained about 27% of the variance in interpersonal justice at time 3. at time 1, informational justice was found to be a significant predictor of both ocbi (b = .2, p < .001) and ocbo (b = .3, p < .001). figure 3. results of path analysis for informational justice. note: * p < 0.05, ** p < 0.01, *** p < 0.001 in one-tailed tests. dashed line represents insignificant path. this figure has been simplified from the model run in smartpls e.g. the paths of ocbi and ocbo from earlier to later times, as control variables, are not shown for clarity. at time 2, informational justice was also found to be a significant predictor of both ocbi (b = .32, p < .001) and ocbo (b = .32, p < .001). comparing this result to the relationship between informational justice at time 1 and ocb at time 2, we found that informational justice at time 1 was not a significant predictor of ocbi at time 2 (b = -.1, ns), but was a significant predictor of ocbo at time 2 (b = -.13, p < .05). since the p-value is not significant for ocbi and is weaker for ocbo (p < .05 versus p < .001), this indicates the effects of informational justice at time 2 on ocb at time 2 are greater than the effects of informational justice at time 1 on ocb at time 2, supporting hypothesis 1. finally, at time 3, informational justice was found to be a significant predictor of both ocbi (b = .13, p < .05) and ocbo (b = .18, p < .001). comparing this result to the relationship between informational justice at time 2 and ocb at time 3, we 92 journal of business strategies found that informational justice at time 2 was not a significant predictor of ocbi at time 3 (b = .01, ns), but was a significant predictor of ocbo at time 3 (b = -.13, p < .05). again, the comparison shows either a non-significant result for ocbi or a weaker significance value for ocbo (p < .05 versus p < .001), indicating support for hypothesis 1. avoidance coping as a moderator. hypothesis 2 stated there would be a positive moderating effect between perceptions of justice and an avoidance coping style on ocb. the interaction terms were generated in smartpls, using an algorithm in line with the interaction approach demonstrated in the work of chin et al. (2003), and the hypothesis was tested at each time period. as seen in figure 2, there was no interaction effect between perceptions of interpersonal justice and avoidance on ocb at time 1 (b = -.22, ns for ocbi; b = -0.13, ns for ocbo). however, at time 2, there was a positive interaction between interpersonal justice and avoidance on ocbi at time 2 (b = .2, p < .01), but not on ocbo at time 2 (b = .12, ns). there was also a positive interaction between interpersonal justice and avoidance at time 3 on ocbi time 3 (b = .14, p < .05), but not on ocbo time 3 (b = -.06, ns). the results for informational justice found similar results as shown in figure 3. there was no interaction between perceptions of informational justice and avoidance at time 1 (b = -.23, ns for ocbi; b = -.13, ns for ocbo), but there was a positive interaction between perceptions of informational justice time 2 and avoidance on ocbi time 2 (b = .17, p < .01) and no interaction on ocbo time 2 (b = .15, ns). at time 3, there was a positive interaction between informational justice and avoidance on ocbi at time 3 (b = .19, p < .05), but not on ocbo at time 3 (b = -.07, ns). approach coping as a moderator. hypothesis 3 stated there would be a negative moderating effect between perceptions of justice and an approach coping style on ocb. the hypothesis was tested in each time period. as shown in figure 2, there was no interaction effect between perceptions of interpersonal justice and approach on ocb at time 1 (b = -.1, ns for ocbi; b = -.05, ns for ocbo). at time 2, there was a negative interaction between interpersonal justice time 2 and approach on ocbi at time 2 (b = -.12, p < .05), but not on ocbo at time 2 (b = -.08, ns). at time 3, there was a negative interaction between interpersonal justice time 3 and approach on ocbi at time 3 (b = -.14, p < .05), but not on ocbo at time 3 (b = -.08, ns). volume 32, number 2 93 for informational justice shown in figure 3, there was no significant interaction between informational justice and approach on ocb at time 1 (b = -.07, ns for ocbi time 1; b = -.08, ns for ocbo time 1) nor at time 2 (b = -.04, ns for ocbi; b = -.08. ns for ocbo). at time 3, there was a significant interaction between informational justice time 3 and approach on ocbi time 3 (b = -.18, p < .001), but not on ocbo time 3 (b = -.13 ns). comparing the findings on interpersonal and informational justice, we found that the results appeared to be rather similar, except that: at time 1, while the relationship between interpersonal justice and ocbi was not significant, the relationship between informational justice and ocbi was strongly significant. at time 2, while the relationship between interpersonal justice and ocbi was negatively moderated by approach coping style, the relationship between informational justice and ocbi was not. nature of the significant interaction effects. to illustrate the nature of the significant interaction effects, we plotted the relationship between coping styles and ocbi at a high and low level of both interpersonal and informational justice (i.e. the mean ± sd) (see figure 4-figure 7). the plots of the interaction effects between interpersonal justice and approach on ocbi at both time 2 and time 3 indicated that the positive relationship between interpersonal justice and ocbi was weaker when approach was high than when it was low (see figure 4a and 5a), thus confirming that approach negatively moderated the relationship at both times. this finding was even more prominent on the relationship between informational justice and ocbi at time 3 (see figure 7a). on the other hand, both the relationship between interpersonal justice and ocbi and the relationship between informational justice and ocbi at both time 2 and time 3 were much stronger when avoidance was high than when it was low (see figure 4b, 5b, 6b, and 7b), therefore confirming that avoidance positively moderated such a relationship at both times. 94 journal of business strategies figure 4. plots of significant interaction effects between interpersonal justice t2 and coping styles on ocbi t2. (4a) interaction effect between interpersonal justice t2 and approach on ocbit2 interpersonal justice t2 (4b) interaction effect between interpersonal justice t2 and avoidance on ocbit2 interpersonal justice t2 volume 32, number 2 95 figure 5. plots of significant interaction effects between interpersonal justice t3 and coping styles on ocbi t3 (5a) interaction effect between interpersonal justice t3 and approach on ocbit3 interpersonal justice t3 (5b) interaction effect between interpersonal justice t3 and avoidance on ocbit3 interpersonal justice t3 96 journal of business strategies figure 6. plot of significant interaction effect between informational justice t2 and avoidance coping style on ocbi t2. informational justice t2 figure 7. plots of significant interaction effects between informational justice t3 and coping styles on ocbi t3. (7a) interaction effect between informational justice t3 and approach on ocbit3 informational justice t3 volume 32, number 2 97 (7b) interaction effect between informational justice t3 and avoidance on ocbit3 informational justice t3 common method variance to examine whether common method variance biased our findings, we performed harman’s single-factor test by using principal component analysis, both unrotated and rotated with varimax rotation, with all the items for avoidance, approach, ocbi, ocbo, interpersonal justice and informational justice at different times (podsakoff et al. 2003). we found that the first factor explained merely about 30% of the total variance of 66% at time 1, about 27% of the total variance of 68% at time 2, and about 25% of the total variance of 66% at time 3. thus, this result suggested that no general factor accounting for the majority of the covariance in the variables existed and that common method variance was unlikely to confound the findings. discussion the first hypothesis stating there will be a recency effect of justice over time on ocb was supported. we believe uncertainty management theory and fairness heuristic theory help explain this finding because uncertainty in current time periods should be more prevalent or salient than uncertainty in past time periods. presumably, some issues with uncertainty are resolved as time progresses and more information becomes available to individuals allowing them to better understand the past. because of this, perceptions of justice in the current time period with higher levels 98 journal of business strategies of uncertainty were more influential in the current time period than perceptions of justice in past time periods. this finding is similar to that found by holtz and harold (2009) and lilly et al. (2010), but contradicts the findings reported by hausknecht et al. (2011). while the holtz and harold (2009) and lilly et al. (2010) studies suggest a recency effect occurs due to within-person changes over time, hausknecht et al. (2011) suggest that a primacy effect may occur such that perceptions of justice are formed through a series of experiences over time, thus forming a fairness heuristic that acts as a template for evaluating future judgments. we believe the context of uncertainty due to disruptions at work and at home may have created a phase-shifting event in which fairness heuristics were re-formed. rather than using a fairness heuristic template formed by past events that would indicate a primacy effect in justice perceptions, individuals re-formed fairness heuristics at each time period based on the uncertainty at that time period, indicating a recency effect in justice perceptions. experimental studies on uncertainty management theory have found that when uncertainty was made salient, justice manipulations were stronger than when uncertainty was not salient (van den bos 2001; van den bos and miedema 2000). essentially, any kind of uncertainty can boost the influence of justice, not just uncertainty in the workplace. indeed, one study in support of uncertainty management theory created feelings of uncertainty by asking participants to consider their feelings about death (van den bos and miedema 2000). because uncertainty appears to be influential in forming justice perceptions, the context of a natural disaster used in the present study allowed us to take advantage of uncertainty in two different contexts – at home, and at work. we believe the uncertainty created by a natural disaster increased the influence of justice perceptions as described by uncertainty management theory and fairness heuristic theory. indicators of uncertainty felt by respondents included the following facts: many participants (39.9%) reported losing power for over six days; 23.9% reported not returning to work for six days; and 31% of respondents reported that people at work were still talking about the hurricane three months later. cleanup in the state of texas was still not complete after six months, and the cleanup effort affected both homeowners and organizations in texas (fema, aug 11, 2010). thus, at each time period, respondents as a whole were not “finished” with the hurricane; therefore, uncertainty at each time period could have caused perceptions of justice in the current time period to be more influential than past perceptions of justice. volume 32, number 2 99 the high level of uncertainty felt by the general population should have created a context in which justice perceptions become more salient; however, individual reactions to uncertainty may also influence perceptions of justice or individual behavior. thus, the premise of hypotheses 2 and 3 take into account individual reactions to stressful situations, which could increase or mitigate feelings of uncertainty. the second hypothesis stated there will be a positive moderating effect between perceptions of justice and an avoidance coping style on ocb. prior literature on coping suggests that fear, anxiety and depression are positively related to avoidance coping (barker 2007; duhachek and oakley 2007; pakenham 2006). in addition, individuals engaging in an avoidance coping style generally believe nothing can be done about the situation (lazarus 1993). we argue the combination of fear, anxiety, depression, and the belief that nothing can be done creates a condition in which individuals will allow the situation to continue without resolution, essentially prolonging any uncertainty that exists. thus, individuals engaged in avoidance coping may be more likely to rely on fairness heuristics to form perceptions of justice, meaning that justice perceptions become more influential in determining future behavior and perceptions of organizational variables. hypothesis 2 was supported for ocbi, but not for ocbo. the third hypothesis stated there will be a negative moderating effect between perceptions of justice and an approach coping style on ocb. this hypothesis is based on literature stating that individuals engaged in an approach coping style generally will not experience increased fear and anxiety (duhachek and oakley 2007; pakenham 2006). thus, these individuals will approach the situation to resolve it. by acting upon the situation, individuals are removing some of the uncertainty and may be less likely to rely on fairness heuristics to form justice perceptions, meaning that justice perceptions become less influential in determining future behavior and perceptions of organizational variables. hypothesis 3 was supported for ocbi at time 3 for interpersonal justice and informational justice, but only for ocbi at time 2 for interpersonal justice. the finding that coping style is a significant moderator only for ocbi, and not for ocbo, indicates that coping style and justice perceptions may be more influential at the individual level and less influential at the organizational level. the reason for this finding may be due to the context of the study, a natural disaster. natural disasters are experienced at the individual level by people in close proximity to one another. it is difficult to ignore the hardships of people right next to you; thus, the most noticeable behaviors may be those specifically related to individuals. many 100 journal of business strategies of the ocbi items fit directly into the types of helping behavior one might see at work after a disaster (e.g., “show genuine concern and courtesy toward coworkers, even under the most trying business or personal situations”). in contrast, the ocbo items may seem much less important after a disaster (e.g., “show pride when representing the organization in public”). the finding that individuals engaged in an approach coping style were less influenced by informational justice perceptions at time 3 than at time 2 may be explained by using uncertainty management theory. it is not unreasonable to assume that uncertainty created by the hurricane was stronger at time 2 than at time 3, causing justice perceptions to have more impact in earlier time periods. during the four week period from time 2 to time 3, at least some repairs and cleanup would have been completed, reducing overall uncertainty to some degree at time 3. however, uncertainty could be very salient at time 2 for people trying to juggle work duties with home repairs, especially regarding informational justice issues such as explanations about altered work procedures or schedules in response to the hurricane. if individuals engaging in an approach coping style cannot get closure on the hurricane, the resulting uncertainty could lead to more reliance on justice perceptions in predicting ocb. indeed, uncertainty management theory states that fairness will matter more for employee behavior when employees are experiencing uncertainty (lind and van den bos 2002). as overall uncertainty is reduced at time 3 (and individuals engaging in approach coping are likely to take an active role to reduce uncertainty), justice perceptions become less influential in predicting employee behavior. although overall uncertainty is likely to be stronger at time 2 as discussed above, the interpersonal aspects of being treated politely and with respect may not be very meaningful to individuals focused on solving problems associated with the hurricane if there is a general societal expectation of polite treatment. this statement is based on results showing a direct positive relationship between interpersonal justice and ocbi, but a negative interaction of interpersonal justice x approach coping style on ocbi. individuals using an approach coping style may be less concerned with interpersonal justice, in general, and more concerned with concrete results. interpersonal justice perceptions are based partly upon making social comparisons with how others are treated. for example, individuals judge whether a particular action is respectful or not based on observing examples of both respectful and disrespectful behavior. gibbons and buunk (1999) proposed that individuals who engaged in high levels of social comparisons were chronically uncertain, while thau et al. (2007) found that people who are high in social comparison orientation react volume 32, number 2 101 more strongly to fairness information than those who are lower in social comparison orientation. thus, people who experience low levels of uncertainty, such as those who engage in approach coping, are less anxious and are likely to make fewer social comparisons in interpersonal justice judgments. therefore, they are less likely to let justice perceptions influence their organizational behavior regardless of time period. conclusions and future study studies of justice over time are rare, perhaps because good quality longitudinal data is difficult to obtain. however, the robust nature of organizational justice suggests that longitudinal justice studies may enhance our understanding of how to utilize this construct in a practical and meaningful way in the workplace. for example, cross-sectional studies often refer to the fairness effect (folger et al. 1979) in which individuals who believe a decision process or outcome is fair are more accepting of the outcome than those who do not believe the process or outcome is fair, but does this effect continue over time? the present study and some earlier studies have found that either the effects of justice perceptions or the perception of justice itself may change over time (ambrose and cropanzano 2003; hausknecht et al. 2011; holtz and harold 2009; lilly et al. 2010; thornhill and saunders 2003). one limitation of the present study includes attrition. the first survey administration produced 255 surveys, the second produced 218 surveys (85.4% retention rate), and the third produced 213 surveys (83.5% retention rate). to deal with participant attrition, and to ensure no self-selection or possible participant non-random bias had occurred, we used a procedure recommended by goodman and blum (1996). specifically, a dichotomous variable was created to differentiate between participants who responded to all three surveys (stayers) and participants who responded only to time 1 (leavers). logistic regression was performed using the dichotomous variable of stayer/leaver as the dependent variable and interpersonal justice time 1, informational justice time 1, ocbi time 1, and ocbo time 1 as the independent variables. results indicated that none of the regression coefficients were significant (p < .84 for interpersonal justice; p < .79 for informational justice; p < .19 for ocbi; p < .10 for ocbo), suggesting there was no non-random bias in the data. although there was no direct measure or manipulation of uncertainty, we believe the context of a natural disaster provides an environment of uncertainty that can be assumed when using fairness heuristic theory and uncertainty management theory as the basis for hypotheses. indeed, lind and van den bos (2002) suggest that times of turmoil (e.g., the aftermath of a hurricane) create a level of uncertainty most 102 journal of business strategies likely to need fairness-related actions. one practical implication of the present study for managers is the knowledge that employee coping style may increase or reduce the influence of fair procedures in the workplace. presumably, organizations will want employees to engage in approach coping strategies at work since this coping behavior focuses on resolving the situation for the individual employee as well as others affected by the stressful situation. training employees in approach coping strategies might be useful, therefore, in reducing response time to customer complaints or reducing the time needed to resolve typical workplace issues such as interdepartmental disputes. however, employees engaged in approach coping behavior tend to be less influenced by justice perceptions, possibly making major investments in fair procedures and the communication of those procedures to employees a costly endeavor with fewer benefits than expected. of course, for ethical reasons and legal reasons, managers should attempt to create and implement fair procedures in the workplace. however, early studies on the fairness effect (folger, et al., 1979) suggesting that fair procedures ameliorate negative employee reactions to work decision outcomes may be too comprehensive in scope by painting a majority of employees with one brush. future research should focus on providing a unifying theory of justice over time. we believe fairness heuristic theory and uncertainty management theory are good starting points for this discussion, and greater understanding of longitudinal justice perceptions will enhance our ability to bring academic research closer to practical management application. we specifically acknowledge the contribution by lind and van den bos (2002) suggesting there is a cost to fair procedures; sometimes it is more efficient and more cost-effective to use procedures that are less fair. thus, researchers need to develop a more comprehensive perspective of how justice influences individuals over time, so that organizations will not waste an investment of time and resources into procedures that may not be beneficial. references adams, j. s. (1963). toward an understanding of inequity. journal of abnormal and social psychology, 67(5), 422-436. ambrose, m. l., & cropanzano, r. (2003). a longitudinal analysis of organizational fairness: an examination of reactions to tenure and promotion decisions. journal of applied psychology, 88, 266-275. volume 32, number 2 103 aquino, k. (1995). relationships among pay inequity, perceptions of procedural justice and organizational citizenship. employee responsibilities and rights journal, 8(1), 21-33. barclay, l. j. & kiefer, t. (2014). approach or avoid? exploring overall justice and the differential effects of positive and negative emotions. journal of management, 40(7), 1857-1898. barker, d. b. (2007). antecedents of stressful experiences: depressive symptoms, self-esteem, gender, and coping. international journal of stress management, 14(4), 333-349. bauer, t. n., maertz, c. p., dolen, m. r., & campion, m. a. (1998). longitudinal assessment of applicant reactions to employment testing and test outcome feedback. journal of applied psychology, 83(6), 892-903. blau, p. (1964). exchange and power in social life. new york, ny: wiley. chin, w. w., marcolin, b. l., & newsted, p. r. (2003). a partial least squares latent variable modeling approach for measuring interaction effects: results from a monte carlo simulation study and an electronic-mail emotion/adoption study. information systems research, 14(2), 189-217. colquitt, j. a. (2001). on the dimensionality of organizational justice: a construct validation of a measure. journal of applied psychology, 86(3), 386-400. colquitt, j. a., & rodell, j. b. (2011). justice, trust and trustworthiness: a longitudinal analysis integrating three theoretical perspectives. academy of management journal, 54(6), 1183-1206. cropanzano, r., prehar, c. a., & chen, p. y. (2002). using social exchange theory to distinguish procedural from interactional justice. group & organization management, 27(3), 324-351. duhachek, a., & oakley, j. l. (2007). mapping the hierarchical structure of coping: unifying empirical and theoretical perspectives. journal of consumer psychology, 17(3), 216-233. eaton, j., & struthers, c. w. (2002). using the internet for organizational research: a study of cynicism in the workplace. cyberpsychology & behavior, 5(4), 305313. fassina, n. e., jones, d. a., & uggerslev, k. l. (2008). relationship clean-up time: using meta-analysis and path analysis to clarify relationships among job satisfaction, perceived fairness, and citizenship behaviors. journal of management, 34(2), 161-188. 104 journal of business strategies fema. aug 11, 2010. hurricane ike six months later: confronting the challenges – in partnership. http://www.fema.gov/hazard/hurricane/2008/ike/anniversary. shtm folger, r., rosenfield, d., grove, j., & corkran, l. (1979). effects of “voice” and peer opinions on responses to inequity. journal of personality and social psychology, 37(12), 2253-2261. folkman, s., & moskowitz, j. t. (2004). coping: pitfalls and promise. annual review of psychology, 55, 745-774. fornell, c., & larcker, d. f. (1981). evaluating structural equation models with unobservable variables and measurement error. journal of marketing research, 18(1), 39-50. gefen, d., & straub, d. (2005). a practical guide to factorial validity using plsgraph: tutorial and annotated example. communications of the association for information systems, 16, 91-109. gibbons, f. x., & buunk, b. p. (1999). individual differences in social comparison: development of a scale of social comparison orientation. journal of personality and social psychology, 76(1), 129-142. goodman, j. s., & blum, t. c. (1996). assessing the non-random sampling effects of subject attrition in longitudinal research. journal of management, 22(4), 627652. greenberg, j. (2006). losing sleep over organizational injustice: attenuating insomniac reactions to underpayment inequity with supervisory training in interactional justice. journal of applied psychology, 91, 58-69. greenberg, j., & folger, r. (1983). procedural justice, participation, and the fair process effect in groups and organizations. in p. b. paulus (ed.), basic group processes (pp. 235-256). new york, ny: springer-verlag. hausknecht, j. p., sturman, m. c., & roberson, q. m. (2011). justice as a dynamic construct: effects of individual trajectories on distal work outcomes. journal of applied psychology, 96(4), 872-880. hochwarter, w. a., laird, m. d., & brouer, r. l. (2008). board up the windows: the interactive effects of hurricane-induced job stress and perceived resources on work outcomes. journal of management, 34(2), 263-289. holahan, c. j., & moos, r. h. (1990). life stressors, resistance factors, and improved psychological functioning: an extension of the stress resistance paradigm. journal of personality and social psychology, 58(5), 909-917. volume 32, number 2 105 holahan, c. j., & moos, r. h. (1991). life stressors, personal and social resources, and depression: a 4-year structural model. journal of abnormal psychology, 100(1), 31-38. holahan, c. j., moos, r. h., holahan, c. k., & brennan, p. l. (1997). social context, coping strategies, and depressive symptoms: an expanded model with cardiac patients. journal of personality and social psychology, 72(4), 918-928. holtz, b. c., & harold, c. m. (2009). fair today, fair tomorrow? a longitudinal investigation of overall justice perceptions. journal of applied psychology, 94(5), 1185-1199. jandeska, k. e., & kraimer, m. l. (2005). women’s perceptions of organizational culture, work attitudes, and role-modeling behaviors. journal of managerial issues, 17(4), 461-478. judge, t. a., & colquitt, j. a. (2004). organizational justice and stress: the mediating role of work-family conflict. journal of applied psychology, 94(5), 1185-1199. kim, t., lin, x. & leung, k. (2015). a dynamic approach to fairness: effects of temporal changes of fairness perceptions on job attitudes. journal of business and psychology, 30, 163-175. lang, j., bliese, p. d., lang, j. w. b., & adler, a. b. (2011). work gets unfair for the depressed: cross-lagged relations between organizational justice perceptions and depressive symptoms. journal of applied psychology, 89, 395-404. lazarus, r. s. (1993). coping theory and research: past, present and future. psychosomatic medicine, 55, 234-247. lee, k., & allen, n. j. (2002). organizational citizenship behavior and workplace deviance: the role of affect and cognitions. journal of applied psychology, 87(1), 131-142. lilly, j. d., virick, m., & hadani, m. (2010). the dynamic nature of justice: influential effects of time and work outcomes on long-term perceptions of justice. social justice research, 23(1), 37-59. lind. e. a. (2001). fairness heuristic theory: justice judgments as pivotal cognitions in organizational relations. in j. greenberg and r. cropanzano (eds.), advances in organizational justice (pp. 56-88). stanford, ca: stanford university press. lind, e. a., & van den bos, k. (2002). when fairness works: toward a general theory of uncertainty management. in b. m. staw & r. m. kramer (eds.), research in organizational behavior (vol. 24, pp. 181-223). boston, ma: elsevier. marjanovic, z., struthers, c. w., & greenglass, e. r. (2012). who helps naturaldisaster victims? assessment of trait and situational predictors. analyses of social issues and public policy, 12(1), 245-267. 106 journal of business strategies masterson, s. s., lewis, k., goldman, b. m., & taylor, m. s. (2000). integrating justice and social exchange: the differing effects of fair procedures and treatment on work relationships. academy of management journal, 43(4), 738-748. mcmanus, j. l., & saucier, d. a. (2012). helping natural disaster victims depends on characteristics and perceptions of victims. a response to “who helps natural disaster victims?” analyses of social issues and public policy, 12(1), 272-275. mcneely, b. l., & meglino, b. m. (1994). the role of dispositional and situational antecedents in prosocial organizational behavior: an examination of the intended beneficiaries of prosocial behavior. journal of applied psychology, 79(6), 836-844. moorman, r. h., & byrne, z. s. (2005). how does organizational justice affect organizational citizenship behavior? in j. greenberg and j. a. colquitt (eds.), handbook of organizational justice (pp. 355-380). mahwah, nj: erlbaum. moos, r. (1993). coping responses inventory – adult form manual. odessa, fl: psychological assessment resources. moos, r. h., & holahan, c. j. (2003). dispositional and contextual perspective on coping: toward an integrative framework. journal of clinical psychology, 59(12), 1387-1403. nunnally, j. c. (1978). psychometric theory (2nd ed.). new york, ny: mcgrawhill. pakenham, k. i. (2006). investigation of the coping antecedents to positive outcomes and distress in multiple sclerosis. psychology & health, 21(5), 633-649. podsakoff, p. m., mackenzie, s. b., paine, j. b., & bachrach, d. g. (2000). organizational citizenship behaviors: a critical review of the theoretical and empirical literature and suggestions for future research. journal of management, 26(3), 513-563. podsakoff, p. m., mackenzie s. b., lee j., & podsakoff n. p. (2003). common method biases in behavioral research: a critical review of the literature and recommended remedies. journal of applied psychology, 88(5), 879-903. posthuma, r. a., dworkin, j. b., & swift, m. s. (2000). arbitrator acceptability: does justice matter? industrial relations, 39(2), 313-335. ringle, c. m., wende, s., & will, s. (2005). smartpls 2.0 (m3) beta [software]. available from http://www.smartpls.de/ roth, s., & cohen, l. j. (1986). approach, avoidance, and coping with stress. american psychologist, 41(7), 813-819. rotondo, d. m., carlson, d. s., & kincaid, j. f. (2003). coping with multiple dimensions of work-family conflict. personnel review, 32(3), 275–296. volume 32, number 2 107 scheck, c. l., & kinicki, a. j. (2000). identifying the antecedents of coping with an organizational acquisition: a structural assessment. journal of organizational behavior, 21(6), 627-648. tangirala, s., & alge, b. j. (2006). reactions to unfair events in computer-mediated groups: a test of uncertainty management theory. organizational behavior and human decision processes, 100(1), 1-20. tekleab, a. g., takeuchi, r., & taylor, m. s. (2005). extending the chain of relationships among organizational justice, social exchange, and employee reactions: the role of contract violations. academy of management journal, 48(1), 146-157. thau, s., aquino, k., & wittek, r. (2007). an extension of uncertainty management theory to the self: the relationship between justice, social comparison orientation, and antisocial work behaviors. journal of applied psychology, 92(1), 250-258. thau, s., bennett, r. j., mitchell, m. s., & marrs, m. b. (2009). how management style moderates the relationship between abusive supervision and workplace deviance: an uncertainty management theory perspective. organizational behavior and human decision processes, 108(1), 79-92. thornhill, a., & saunders, m. k. (2003). exploring employees’ reactions to strategic change over time: the utilization of an organizational justice perspective. irish journal of management, 24(1), 66-86. timko, c., cronkite, r. c., & moos, r. h. (2010). do parental stressors and avoidance coping mediate between parental depression and offspring depression? a 23year follow-up. family relations, 59(2), 121-135. tobin, s. j., & raymundo, m. m. (2010). causal uncertainty and psychological well-being: the moderating role of accommodation. personality and social psychology bulletin, 36(3), 371-383. treadway, d. c., hochwarter, w. a., kacmar, c. j., & ferris, g. r. (2005). political will, political skill, and political behavior. journal of organizational behavior, 26(3), 229-245. valentiner, d. p., holahan, c. j., & moos, r. h. (1994). social support, appraisals of event controllability, and coping: an integrative model. journal of personality and social psychology, 66(6), 1094-1102. van den bos, k. (2001). uncertainty management: the influence of uncertainty salience on reactions to perceived procedural fairness. journal of personality and social psychology, 80(6), 931-941. 108 journal of business strategies van den bos, k., & lind, e. a. (2002). uncertainty management by means of fairness judgments. in m. p. zanna (ed.), advances in experimental social psychology (vol. 34, pp. 1-60). boston, ma: elsevier. van den bos, k., & miedema, j. (2000). toward understanding why fairness matters: the influence of mortality salience of reactions to procedural fairness. interpersonal relations and group processes, 79(3), 355-366. van den bos, k., vermunt, r., & wilke, h. a. m. (1997). procedural and distributive justice: what is fair depends more on what comes first than on what comes next. journal of personality and social psychology, 72(1), 95-104. vitaliano, p.p., maiuro, r. d., russo, j., & becker, j. (1987). raw versus relative scores in the assessment of coping strategies. journal of behavioral medicine, 10(1), 1-18. williams, l. j., & anderson, s. e. (1991). job satisfaction and organizational commitment as predictors of organizational citizenship and in-role behaviors. journal of management, 17(3), 601-617. brief biographical sketch of authors juliana d. lilly is a professor of management at sam houston state university. she holds degrees in hotel/restaurant management (b.s.), organizational management (m.b.a.), and organizational behavior (ph.d.). after ten years of industry experience, she entered graduate school and was awarded the ph.d. in business administration from the university of texas at arlington. dr. lilly’s research interests include organizational justice, psychological contract violations, and outsourcing. she has presented research at numerous international, national, and regional academic meetings. her publications appear in journals such as journal of organizational behavior, social justice research, current psychology, and journal of behavioral and applied management. meghna virick is a professor at san jose state university, specializing in human resource management. she earned her ph.d. from the university of texas at arlington, a masters in industrial relations from xlri, india, and an mba from texas christian university. her areas of research include unemployment/ underemployment, as well as gender and age related issues in hr practices such as talent and succession planning. her academic work has been published in journals such as the journal of organizational behavior, human relations, group & organization management, journal of applied psychology, and human resource management journal. her comments on current hr issues have been the topic of volume 32, number 2 109 numerous stories in print and broadcast media. kamphol wipawayangkool is an assistant professor of management information systems at sam houston state university. he received his ph.d. in information systems from the university of texas at arlington, m.s. in management information systems from university of houston-clear lake, and b.s. in computer science from prince of songkla university, thailand. his research has appeared in knowledge management research & practice, journal of information & knowledge management, journal of knowledge management practice, and issues in information systems. note: an earlier version of this paper was presented at the southwest academy of management meeting in albuquerque, nm, march 2013. corporate governance and the abnormal returns to acquisition announcements mark swanstrom northwestern state university natchitoches, la abstract this paper investigates the relationship between afirm scorporate governance structure and the abnormal returns associated with acquisition announcements. based on a sample of294 acquisitions occurringfrom 1994 through 1998, it is found that acquiringfirms have significant two-day abnormal returns of-2. 71%. a multiple regression model that includes corporate governance variables has an adjusted r-squared of14.2% with board size, the sensitivity ofthe ceo swealth to changes in share price, method ofpayment, and acquiringfirm size all being significant explanatory variables. the modern corporation is a complex organization of interlocking relationships. for publicly held companies, one of the most important relationships is between the owners and managers of the firm. this relationship is a classic example of the principal-agent relationship and is characterized by a potential misalignment of goals where the agent may behave in his own interest instead of acting in the principal's interest. a firm's corporate governance structure can be used to reduce the total agency costs of a firm through the monitoring of management actions and by aligning the managers' self-interests with those of shareholders. the board of directors has the responsibility to represent shareholders by monitoring top management. they do this by hiring and firing management, designing the executive compensation contract, and voting on major firm decisions. however, recent events from enron to worldcom indicate that the board may not always adequately monitor management. these events have stirred calls for board reform and the effect of board structure on corporate decision making is an important and widely debated topic. a firm's compensation policy should be designed to attract and retain quality managers and also to align the managers' incentives with shareholders. executive compensation is primarily composed of a base salary, a bonus often tied to accounting returns, and equity-based incentives. stock option grants are an increasingly important component of compensation and can align interests by making compensation and overall wealth more sensitive to shareholder performance. this study investigates the relationship between corporate governance and agency costs by examining the abnormal returns to acquisition announcements. while there are a variety of explanations for acquisitions that increase share116 journal ofbusiness strategies vol. 23, no.2 holder wealth, many acquisitions actually reduce shareholder wealth in both the short-run and the long-run. one explanation is that shareholder wealth reducing acquisitions are the result of the failure of corporate governance mechanisms to properly align managers' interests with those of shareholders. the following section of this paper reviews the literature on corporate governance and mergers. the third section presents the data and methodology, followed by the empirical results in the fourth section. the final section summarizes the findings with suggestions for further research. literature review the existing literature investigating the relationship between managers' interests and mergers examines the issue from varying perspectives. morek, shleifer, and vishny (1990) test managerial self-interest indirectly by arguing that self-interested managers will either diversify or buy growth firms. since these types of acquisitions were found to be more likely to reduce shareholder wealth, they concluded that they were driven by self-interest. kroll, simmons, and wright (1990) found that ceo compensation increased following acquisitions due in part to the increased size of the firm. ceo shareholdings and incentive plans were found to be positively related to announcement cumulative abnormal returns (cars) by travlos and waegelein (1992). ueng (1998) also found that managers with large stockholdings relative to salary are more likely to make acquisitions that increase shareholder wealth. datta, iskandar-datta, and raman (2001) find that the proportion of equity-based compensation (ebc) leads to higher abnormal returns in mergers. all of these papers support the idea that managers may behave in their own interest in merger decisions as opposed to focusing on shareholders' interest. this paper differs in that it tries to take a broader perspective of corporate governance. ifthe corporate governance structure is effective, then the manager is less likely to make shareholder-wealth reducing decisions, including acquisitions. however, the question arises as to what factors affect governance effectiveness. the variables used in this study include the proportion of the board represented by independent outsiders, the size of the board of directors, and the sensitivity of the ceo's equity-based wealth to stock price. the role of the board of directors in modern corporations has become increasingly important in recent years. critics have pointed to scandals at enron, worldcom, and tyco uust to name a few) as evidence that boards have become too lax in their duties and simply rubberstamp the actions ofceos. these failures of corporate governance have opened the door to government involvement such as sarbanes-oxley or eliot spitzer. while there have been many suggestions for board reform, reducing board size and increasing board independence are two of the most common and tested recommendations. fama (1980) and fama and jensen (1983) recommend the use of independent outsiders on the board of directors. as support, weisbach (1988) finds that the relationship between executive turnover and performance is stronger for outsiderfall 2006 swanstrom: corporate governance 117 dominated boards. byrd and hickman (1992) find that tender offer bidders are best served when outsider representation is close to 60% ofthe board. rosenstein and wyatt (1990,1997) find that the share price response was positive to announcements of outside directors and insignificantly negative to the addition of inside directors. thus, there is some empirical evidence that supports the argument that outside representation on the board might result in better monitoring. this leads to the first hypothesis of this paper stated in null form. hypothesis 1: acquisition abnormal returns are unrelated to the proportion of outside directors. board size has also been suggested as a possible factor affecting monitoring quality by lipton and lorsch (1992) and jensen (1993). yermack (1996) finds that the log of board size is negatively related to tobin's q. core, holthausen, and larcker (1999) find that ceos are able to extract greater pay from larger boards. however, there is also evidence that large boards do a better job. grinstein and hribar (2004) find that larger boards tend to pay smaller m&a bonuses to managers. the effect of board size then becomes an empirical question tested in the second hypothesis. hypothesis 2: acquisition abnormal returns are unrelated to board size. while the structure of the board is part of corporate governance, one must also examine what the board does. one ofthe most important functions of the board is determining the compensation of executives and the degree to which a manager's wealth is tied to shareholder wealth. while setting compensation is not the only monitoring function of the board, it is a function that has been criticized as an example ofceos having excess influence over the board. other monitoring functions might involve the threat of firing managers for inferior performance and the level of effort put forth by outside directors in evaluating firm decisions, including mergers; however, these functions cannot be observed and measured as easily as the compensation sensitivity. jensen and murphy (1990), among others, argue that compensation is not effectively related to share performance for many firms. baker, jensen, and murphy (1988) and rose and shepard (1997) show that factors such as firm size and degree of diversification also affect compensation levels. thus, a manager might be better off if an acquisition increases size and/or diversification even if shareholder wealth is reduced. since compensation structure may change dramatically from year to year, the use of a single year's compensation may not capture the true alignment between the manager's wealth and shareholder wealth. to better capture this, a measure of the sensitivity of the ceo's total firm-related wealth to changes in share price is included. if abnormal returns to acquisitions are positively related to the 118 journal of business strategies vol. 23, no.2 sensitivity of the ceo's total wealth to changes in share price, then this would provide evidence that greater wealth sensitivity results in better alignment between managers and shareholders as tested in the third hypothesis. hypothesis 3: acquisition abnormal returns are unrelated to the sensitivity of the ceo s total wealth to changes in share price. these hypotheses investigate agency conflict within firms by examining its effect on acquisition decisions. in addition to the above variables, control variables representing whether the acquisition was made with cash and the size of the acquiring firm are also included. these variables have been found to be related to merger returns and are included to isolate the effects of the tested variables. data and methodology this study basically involves a two-step procedure. first, an event study on acquisition announcements is used to determine the acquiring firm's abnormal returns. second, these abnormal returns are used as the dependent variable in regression models in order to explain the cross-sectional variation in abnormal returns. the sample includes 294 acquisitions that were completed from 1994 to 1998. in order to be included in the sample, the acquisition could not involve regulated utility or financial firms, foreign firms, or privately-held firms. sufficient data for the companies also had to be available from crsp, compustat, and proxy statements. in order to reduce the level of noise in the findings, the target firm had to have a market value of at least 10% of the acquiring firm, there could not be a preexisting relationship between the firms, the acquiring firm could not have made an earlier acquisitions in the same fiscal year, and there could be no confounding events around the two-day event window. table 1 summarizes the sample selection process and reasons for exclusion. table 1 sample selection summary 2,173 1,006 435 319 43 43 14 ------.l2 294 firms delisted from crsp due to acquisition from 1994-1998 regulated utility (4000's) or financial (6000's) firms acquiring firm common stock data not on crsp market value of target firm less than 10% of value of acquiring firm preexisting relationship between firms missing other data from proxies or compustat acquiring firm had prior acquisition in same fiscal year confounding announcement around two-day event window final sample of acquisitions for two-day event window fall 2006 swanstrom: corporate governance 119 the market model approach was used to calculate abnormal returns to acquiring firm shareholders. the parameters for the model are estimated from day -135 to day -16, where day 0 is the first newspaper report of the acquisition. the initial announcement date was determined by searching the lexislnexis database and the wall street journal index. the crsp equal-weighted index is used as a proxy for the market return. r = a + ar + £ .ii .i tj.i ml .it (1) the estimated parameters are then used to determine a security's expected return given the market return. the expected return is then subtracted from the security's actual return to determine the abnormal return for each day in the event window. ar = r (a. + a.r ) .it ]t j tjj mt (2) the cumulative abnormal return for a given security is simply the sum of daily abnormal returns over the event window. car=lar .i .it (3) the cars are then used as the dependent variable in a regression model using corporate governance variables as independent variables. for each acquiring firm in the sample, the proxy statement for the fiscal yearend preceding the first announcement of the merger is collected. the number of directors is found and directors are classified as being independent if they have never been employed by the firm nor had any other outside business dealings with the firm such as being employed as the firm's lawyer, accountant, banker, or consultant. executives of other firms that do business with the acquiring firm are treated as being affiliated. cross directorships, where the director of the acquiring firm is a ceo of a firm that has the ceo of the target firm as a director, are also treated as being affiliated. the independent variables used are defined as the number of outside, unaffiliated, independent directors divided by the total number of directors (outdir) and the natural log of the number of directors (brdsiz). another independent variable measures the sensitivity ofthe ceo's firm-related wealth to changes in the firm's stock price (wthsen). the proxy statement lists the number of shares owned, the number and intrinsic value of exercisable stock options, the number and intrinsic value of unexercisable stock options, and the number and exercise price of stock options granted in the past year. this data is provided for the firm's top five managers, but only the data for the ceo at the time when the merger is announced is used. valuing executive stock options and their delta sensitivity to changes in stock price is a difficult process. since these options are non-tradeable, an option pric120 journal of business strategies vol. 23, no.2 ing model has to be used. the merton modification of the black-scholes option pricing model is used to value the stock options. c = e,ois*n(dl) xe-rl *n(d2) (4) the stock prices are taken as of the fiscal year-end preceding the merger announcement. the exercise price for new grants is given in the proxy statement, but the weighted average exercise price for old grants must be estimated. first, the intrinsic value of the new grants is calculated as the difference between the fiscal-year end price and the exercise price multiplied by the number of new option grants. tf the fiscal year end price is less than the exercise price, then the intrinsic value is zero. (s x) * number of new grants = intrinsic value of new grants (5) second, this value is deducted from the total intrinsic value of all option grants as given in the proxy statement leaving the intrinsic value of the old option grants. to find the number of old option grants, simply deduct the number of new grants from the total number of grants as reported in the proxy statement. finally, the weighted average exercise price for old option grants can be estimated by solving for x using the following formula. (s x) * number of old grants = intrinsic value of old grants (6) the return of the continuously compounded 10-year and 5-year crsp us government bond fixed term index series is used to estimate the risk-free rate of interest, r. the time to expiration, t, is assumed to be 10 years for new grants and 5 years for existing grants. finally, e is the base ofthe natural logarithms and n(*) is the cumulative probabilities for the following unit normal variables: s 0'2 in (x) + t [r 0 + ci)] dl = -------u:.jt s 0'2 in (x) + t [r 0 + ci)] d2=--------a.jt (7) (8) where 0 represents a constant dividend yield gathered from compustat for the fiscal year prior to the merger announcement and 0' is the standard deviation of the stock's return calculated during the market model estimation period discussed earlier. fall 2006 swanstrom: corporate governance 121 by summing the value of the stock held by the ceo, the value of the new grants, and the value of prior grants, we can estimate the ceo's total wealth related to the value of the firm's stock. the ceo will likely have some of his wealth invested in other assets, and while this may have some effect through the correlation between the value of the firm and the value of the ceo's other assets, this effect is believed to be small enough to allow it to be ignored. the ceo's wealth sensitivity is then calculated as the change in the ceo's firm-related wealth given a 1% change in the stock price scaled by the ceo's total firm-related wealth (wthsen). guay (1999) suggests that the sensitivity of compensation and wealth is more likely to affect decision making than just the level of wealth. by using the valuation models, it is possible to calculate the change in value for a given i% change in the firm's stock price. for stock this is an obvious calculation a 1% change in the firm's stock price will change the value ofthe ceo's stock holdings by 1%. however, option values are more sensitive to changes in share price, and greater option holdings relative to stock holdings will increase the wealth sensitivity measure. in addition to the test variables described above, an indicator variable identifying primarily cash transactions (cshpmt) and the natural log of the market value of the acquiring firm (logsiz) measured sixteen days prior to the merger announcement are included. these control variables have been found to be significant explanatory variables in previous studies. other variables that have been found to be significant, such as premium paid and whether or not the target firm is in the same industry, are not included. the reasoning for this is that their inclusion distracts from the purpose of this study and ultimately leads to the same questions. for example, ifhigh takeover premiums tend to have lower abnormal returns, why would the acquiring firm and its managers be willing to pay such high premiums? empirical results in this section, the empirical results ofthe event study on acquisition announcements and hypotheses tested are given. table 2 contains descriptive statistics on the model parameters, abnormal returns for each day in the event window, and the cumulative abnormal returns (cars). two-day abnormal returns on acquisition announcements averaged -2.71 % and ranged from a high of 19.72% to a low of -32.38%. the mean abnormal returns on days -1 and 0 are -1.27% and -1.44%, respectively. the mean car and both daily abnormal returns are significantly different from zero at the 1% level and are consistent with prior findings of negative returns to acquirers. the next part of the study takes the car's for each acquiring firm and uses them as the dependent variable in a regression model. table 3 contains summary statistics of the independent variables, table 4 shows the correlations between the independent variables, and table 5 shows the regression results. 122 journal ofbusiness strategies vol. 23, no.2 table 2 summary statistics of event study abnormal returns mean median st. dev. max min alpha -0.0003 -0.0003 0.0026 0.0094 -0.0099 beta 1.3900 1.2426 0.9109 4.6280 -0.5371 car(-l,o) -0.027]*" -0.0222 0.0748 0.1972 -0.3238 day-l -0.0127'" -0.0095 0.0565 0.2186 -0.1986 day 0 -0.0144'" -0.0085 0.0504 0.1298 -0.2938 tests for significant differences from zero were conducted for the car and the daily abnormal returns. significance at the 10%,5%, and 1% levels are indicated by '*', '**, and '***', respectively. table 3 summary statistics of independent variables mean median st. dev min max outdir 0.529 0.556 0.193 0 0.900 brdsiz 2.064 2.079 0.322 1.099 2.833 wthsen 0.012 0.011 0.002 0.010 0.019 cshpmt 0.299 0 0.459 0 i logsiz 20.207 20.282 1.615 16.525 24.533 for all tables, outdir is the proportion of unaffi hated outsiders on the board of directors. brdsiz is the natural log ofthe number of directors on the board. wthsen is the percentage change in the value of the ceo's total firm-related wealth given a i % increase in the firm's fye share price. cshpmt is a dummy variable equal to one ifthe acquisition was financed by cash. logsiz is the natural log of the market value of the acquirer measured 16 days prior to the acquisition announcement. table 4 correlations among independent variables variable outdir brdsiz wthsen cshpmt logsiz outdir 1.0000 0.1163 0.2361 0.1274 0.1464 brdsiz 0.1163 1.0000 0.3258 0.2607 0.4691 wthsen 0.2361 0.3258 1.0000 0.2443 0.3740 cshpmt 0.1274 0.2607 0.2443 1.0000 0.0573 logsiz 0.1464 0.4691 0.3740 0.0573 1.0000 fall 2006 swanstrom: corporate governance 123 table 5 ols multiple regression results modell model 2 model 3 outdir -0.026 -1.209 brdsiz 0.051 3.416'" wthsen 8.803 9.373 9.565 3.337'" 3.573'" 3.915'" cshpmt 0.031 0.038 3.296'" 4.042'" logsiz -0.010 -0.006 -3.485'" -2.323" adj. r-sq 0.142 0.109 0.047 f-stat. 10.700'" 12.962'" 15.329'" results represent a single regression of the form car(-i,o\ = ~(j + ~ixli + ~2x2i + ... + ~jx5i + ei where xi is the variable of interest. ols estimates of each ~ are given along with the t-statistic for testing the null hypothesis of ~ = o. adjusted r-squared's and f-statistics for testing the null hypothesis of ~i = ~2 = ... = ~j = 0 are given at the bottom. significance at the 10%, 5%, and 1% levels are indicated by '*', '**, and '***', respectively, using two-tailed tests. while there is some correlation among the independent variables, the strongest correlations are between the test variables and the firm size control variable. firm size and board size are highly correlated, but it is important that both variables remain in the model as we want to capture the effect that board size has that is independent from the effect of firm size. as seen in table 5, these two variables actually have opposite effects on abnormal returns. the overall model is highly significant with an f-value of10.7 and an adjusted r-squared of 14.2%. among the independent variables, wealth sensitivity, board size, method of payment, and acquiring firm size are all significant at the 1% level. the wealth sensitivity measure was positive and significant as expected, but the strength of the relationship warrants some attention. in a similar study, datta, iskandar-datta, and raman (2001) regress two-day abnormal returns on a measure of equity-based compensation (esc) along with acquiring firm size and a dummy variable for cash acquisitions. their model 1 shows a significant, positive relationship between esc and abnormal returns and the model has an adjusted r-squared of 1.25% and an f-statistic of 2.45. using wealth sensitivity instead of esc in this study results in model 2 with an adjusted r-squared of 10.9% and an f-statistic of 12.96. using just wealth sensitivity by itself in 124 journal ofbusiness strategies vol. 23, no.2 a simple regression results in an adjusted r-squared of 4.7% and an f-statistic of 15.33 for model 3. these results suggest the importance of the ceos overall wealth as opposed to just examining a single year's compensation as motivation to the acquisition decision. independent outside directors made up an average of 52.9% ofthe boards for this sample offirms. this proportion is somewhat higher than the 39.2% mean figure found in byrd and hickman (1992), but is similar to the 56% found in shivdasani (1993). the regression results in table 5 indicate that the proportion of outside directors on the board is not a significant predictor of abnormal returns. this result is in contrast to byrd and hickman's (1992) finding of a positive but nonlinear relationship in their study of abnormal returns to tender offers where the acquiring firm is listed on the nyse or amex. however, when byrd and hickman use proportion of independent directors as their variable, they also find no significance. they do find a positive, significant relationship when they use a dummy variable for boards with greater than 50% independent directors. when they use a piecewise regression, they find a positive and significant relationship when independent directors make up 40-60% of the board and a negatively significant relationship for boards with greater than 60% independent board members. in an effort to further investigate the difference in the results, the cars are calculated for different proportions of outside representation and are presented in table 6. the results provide no evidence of a relation between outside directors and abnormal returns, and regressions that include a dummy for independent boards and piecewise regressions also yield no significant results. table 6 outside directors and cumulative abnormal returns variable occurrences car outdir less than 40% 71 -2.09% outdir 40% to 50% 71 -2.96% outdir 50% to 67% 87 -3.02% outdir over 67% 65 -2.70% the average board size for the firms in this sample is 8.31 directors (average log of board size is 2.064). this figure is considerably lower than the 12.1 directors in byrd and hickman (1992) based on a sample ofnyseiamex firms and the 12.25 directors in yermack (1996) based on a sample from the forbes 500 list of largest u.s. public corporations. however, the figure is more in line with the 9.35 directors found in denis, denis, and sarin (1999) who used a random sample of all firms covered by crsp. based on the regression results, it is possible to reject the null hypothesis of no relation between board size and abnormal returns at the 1% significance fall 2006 swanstrom: corporate governance 125 level suggesting that larger boards do a better job of monitoring firm managers in acquisition decisions. the positive finding between board size and abnormal returns goes against suggestions that large boards are less effective at monitoring made by lipton and lorsch (1992) and jensen (1993). however, the empirical evidence on this matter was somewhat mixed and warrants additional investigation. table 7 shows the average cars for different board sizes. while this shows some evidence of a decline for boards of 12 or more, the greater evidence is that small boards do a poor job. table 7 board size and cumulative abnormal returns variable occurrences car brdsiz less than 5 45 -6.10% brdsiz equals 6 36 -3.70% brdsiz equals 7 56 -2.90% brdsiz equals 8 31 -2.70% brdsiz equals 9 38 -2.80% brdsiz equals 10 24 -1.80% brdsiz equals 11 24 1.10% brdsiz equals 12 23 -0.15% brdsiz more than 12 19 -1.12% the two results involving the board of directors differ from some previous findings, but there are some possible interpretations and explanations. first, this sample is considerably different from previous studies. most previous studies focused on large firms by sampling from nyse/amex firms, forbes 500 firms, or firms with data on s&p's execucomp. in a more recent article covering mergers between 1993 and 1999, grinstein and hribar (2004) also find evidence against the superiority of smaller boards in their analysis ofm&a bonuses. they speculate that the differences in their findings might be due to a greater proportion of new-economy firms. this might also be the case here, although it is uncertain why new-economy boards would behave differently from old-economy boards. a second possibility involves the different dependent variables used in the studies. yermack (1996) found a negative relationship between board size and tobin's q, whereas i find a positive relationship between board size and acquisition announcement cars. theoretically, tobin's q should reflect the market's estimate of the present value of all of a firm's future investment opportunities, including acquisitions. under this idea, the different findings might reflect the market's high expectations offirms with small board sizes and independent boards and the market's subsequent disappointment when the acquisition is announced. 126 journal ofbusiness strategies vol. 23, no.2 a third possibility is the different roles taken by the board of directors. in studies of ceo turnover, both yermack (1996) and wu (2000) find that the relationship between turnover and performance is stronger for firms with smaller boards. in turnover decisions, it seems reasonable that greater independence between the board and the ceo would benefit shareholders. however, in acquisition decisions, shareholders might be better served by a closer relationship between the board and the ceo. larger boards might contribute additional knowledge about the target firm and the industry overall. this distinction between the monitoring and advisory roles might explain why larger boards seemed to perform better in this paper and in grinstein and hribar (2004). the cash payment and firm size control variables are both significant explanatory variables in the model. thirty percent of the acquisitions are financed by cash and there is a positive relation with the cars that is significant at the 1% level. this is consistent with findings that stock swaps are viewed less favorably by the market. the average size of acquiring firms is $2.2 billion (average log of firm size is 20.2) and there is a negative relation that is significant at the 1% level suggesting that large firms make worse acquisition decisions. in order to evaluate any possible changes in the variables over time, table 8 presents the mean variable values for the mergers announced in the different years from 1993 through 1998. there does not appear to be any obvious trends in the data and a regression model that includes dummy variables for the years in addition to the existing variables does not yield any relevant insights. table 8 variable averages for different years year 1993/94 1995 1996 1997 1998 occurrences 39 46 58 92 59 car(-l,o) -0.0280 -0.0411 0.0043 -0.0226 -0.0534 outdir 0.5139 0.5454 0.5220 0.5119 0.5582 brdsiz 2.1125 2.0972 2.1510 2.0171 1.9961 wthsen 0.0117 0.0118 0.0119 0.0113 0.0116 cshpmt 0.2564 0.3043 0.3966 0.2609 0.2881 logsiz 20.3054 20.0858 20.2856 20.0390 20.4232 conclusion the first contribution of this paper is simply the use of data from the 1990's and the inclusion of smaller, new-economy firms in the sample. holmstrom and kaplan (2001) contrast merger activity in the 1980's and 1990's and suggest that improved corporate governance has made the 1990 's much less hostile. they fall 2006 swanstrom: corporate governance 127 note the rise in equity-based compensation to top executives and a 1993 change in tax laws that encouraged the use of incentive compensation as evidence that firm managers are more responsive to shareholders. they also mention improved monitoring as evidenced by a decline in board sizes and increased shareholder activism by calpers and other institutions. while corporate governance may have resulted in a less hostile market for corporate control, this has not translated into improved returns to acquiring firms. i find two-day abnormal returns of -2.71 % when acquisitions are announced. if corporate governance has improved in the 1990's, why are firms still making acquisitions that reduce shareholder wealth? the most interesting finding in this paper is the strength of the relationship between ceo's wealth sensitivity and acquisition announcement cars. the other two findings add to the muddled results regarding boards of directors and firm performance. in a survey article, hermalin and weisbach (2003) conclude that the relationship between board charcteristics and firm performance may be spurious as both may be driven by other factors. the results in this paper agree that board composition is not a determining factor and that smaller boards may not be the cure imagined. references baker, g., jensen, m., & murphy, k. (1988). compensation and incentives: practice vs. theory. journal of finance. 43,593-616. byrd, .i. w. & hickman, k. a. (1992). do outside directors monitor managers? journal offinancial economics, 32, 195-221. core, j., holthausen, r., & larcker, d. (1999). corporate governance, chief executive officer compensation, and firm performance. journal of financial economics. 51, 371-406. datta, s., iskandar-datta, m., & raman, k. (2001). executive compensation and corporate acquisition decisions. journal 0/finance, 56, 2299-2336. denis, d., denis, d., & sarin, a. (1997). ownership structure and top executive turnover. journal o/financial economics, 45, 193-221. fama, e. (1980). agency problems and the theory of the firm. journal 0/ political economy, 88,288-307. fama, e. & jensen, m. (1983). separation of ownership and control. journal oflaw and economics. 26,301-325. grinstein, y. & hribar, p. (2004). ceo compensation and incentives evidence from m&a bonuses. journal offinancial economics, 73, i] 9-] 43. 128 journal ofbusiness strategies vol. 23, no.2 guay, w. (1999). the sensitivity of ceo wealth to equity risk: an analysis of the magnitude and determinants. journal offinancial economics. 53,43-71. hermalin, b. & weisbach, m. (2003). boards of directors as an endogenously determined institution: a survey of the economic literature. economic policy review, 9 (l), 726. holmstrom, b. & kaplan, s. (200 i). corporate governance and merger activity in the u.s.: making sense of the 1980s and 1990s. mit dept. o/economics working paper no. 01-ji. retrieved june 10,2001, from ssrn database. jensen, m. (1993). the modern industrial revolution, exit, and the failure of internal control systems. journal offinance. 48, 831-880. jensen, m. & murphy, k. (1990). performance pay and top-management incentives. journal ofpolitical economy, 88,225-264. kroll, m., simmons, s., & wright, p. (1990). determinants of chief executive officer compensation following major acquisitions. journal of business research, 20, 349-366. lipton, m. & lorsch, j. (1992). a modest proposal for improved corporate governance. the business lawyer, 48,59-77. morek, r., shleifer, a., & vishny, r. (1990). do managerial objectives drive bad acquisitions? journal of finance. 45, 31-48. rose, n. & shepard, a. (1997). firm diversification and ceo compensation: managerial ability or executive entrenchment? rand journal of economics, 28,489-514. rosenstein, s. & wyatt, j. (1990). outside directors, board independence, and shareholder wealth. journal offinancial economics, 26, 175-192. rosenstein, s. & wyatt, j. (1997). inside directors, board effectiveness, and shareholder wealth. journal offinancial economics. 44, 229-250. shivdasani, a. (1993). board composition, ownership structure, and hostile takeovers. journal ofaccounting and economics, 16, 167-198. travlos, n. & waegelein, j. (1992). executive compensation, method of payment, and abnormal returns to bidding firms at takeover announcements. managerial and decision economics, 13,493-501. ueng, j. (1998). manager incentive and returns to shareholders of acquiring firms. review a/business, 19,27-30. weisbach, m. (1988). outside directors and ceo turnover. journal offinancial economics, 20,431-460. fall 2006 swanstrom: corporate governance 129 wu, y. (2000). honey, calpers shrunk the board! retrieved june 10,2001, from ssrn database. yermack, d. (1996). higher market valuation of companies with a small board of directors. journal offinancial economics. 40, 185-211. mark swanstrom is assistant professor of finance at northwestern state university of louisiana. his research interest is in corporate governance, mergers and acquisitions, and international investments, 130 journal ofbusiness strategies vol. 23, no.2 corporate governance and the abnormal returns to acquisition announcements managing for value: developing a performance measurement system integrating economic value added and the balanced scorecard in strategic planning harold d. fletcher, ph.d. darlene brannigan smith, ph.d. loyola college in maryland timonium, md abstract economic value added (e va) systems and the balanced scorecard (bsc) have generated a tremendous interest in corporate america recently as approaches to performance management. implementation of these methodologies has not proven to be easy. this paper introduces the analytical hierarchy process and shows how this methodology addresses the limitations ofeva and bsc by integrating them into one comprehensive system. a case study is used to illustrate this methodology. introduction managing for value has become the mantra of to day's executives as the reality of today's competitive environments force businesses to focus on improving profitability. firms, both large and small, are implementing value-based measures using measures such as economic value added (eva). all too often, however, these initiatives are interpreted merely as an advance in metrics and measurement and not a tool for strategy development. this narrow interpretation and use suggests little fundamental change in the behavior of the many people responsible for the decisions and actions that create long-term value and has brought only mediocre results to some firms. to improve the implementation of value based management (vbm), firms need to move beyond narrow metrics to the utilization of eva as a strategic decision tool. it must be linked to broad process reforms including the identification of value drivers, the integration of budgeting with strategic planning, and development of a comprehensive performance measurement system. this is the objective of our paper. we focus on the development ofa complementary system of managerial metrics linking the eva system to the balanced scorecard (bsc) using analytical hierarchy processing (ahp). the importance of managing for value is discussed and potential limitations identified. the balanced scorecard as a vehicle for identifying value drivers and drilling down into the operations of the firm is presented. then, these two complementary frameworks are combined, using the ahp methodology, to develop a comprehensive measurement system for 2 journal of business strategies vol. 21,no. 1 assessing the overall performance of the organization. a case study is used to illustrate this methodology. economic value added a paramount objective of management should be the creation of value for the firm. thus, it is essential in strategic planning to manage the firm's resources with an objective of increasing the firm's market value (hawawini and viallet 2002; eccles and pyburn 1992). from an eva perspective, the ultimate success of a firm is not measured only by its capacity to grow its sales, produce profits, or generate cash from its operations, but whether the firm's activities are creating value for its owners (ehrbar 1998). according to economic theory, a firm is creating value if the net present value of all its investments is positive. quite simply, eva is a measure that enables managers to see whether they are earning an appropriate return on the capital under their control. it is a measure of profit less the cost of capital employed (eva calculations are provided in exhibit 1) and is the one measure that properly accounts for all the complex trade-offs, often between the income statement and balance sheet, in creating value (pettit 2000). exhibit 1 eva equations net sales operating expenses -' operating profit (or earnings before interest and taxes, ebit) taxes = net operating profit after tax (nopat) capital charges (invested capital x cost of capital) eva the eva metric is not only a measure of financial performance but should serve as the centerpiece of a strategy development and implementation process. putting value based management into practice, however, has been found to be more complicated than some of its proponents suggest. haspeslagh, nada and boulos (2001) found a number of characteristics associated with the successful implementation of value based management (vbm). successful vbm companies keep the technical accounting aspects of eva simple, making very few changes to their accounting practices. they invest time and effort in identifying and assessing the operational factors, or value drivers, that have the greatest influence on the creation of economic profit. these firms integrate their entire system into a single process including the continual monitoring and alignment of compensation to performance. and, perhaps equally important, successful firms spring 2004 fletcher & smith: performance measuring system 3 institute broad based vbm training so that all frontline employees and managers understand the concept of value creation and their role in the process. eva is not without its limitations. a major limitation is its over-reliance on historical, financial measures such as profit margin, asset turnover, cost of money, and level of capital invested in the firm. recent research has shown that these lagging, financially oriented measures are not necessarily indicative of future performance. in many industries, in a range of business sectors, leading drivers (le., forward-looking drivers) have shown to more important in predicting future eva than current eva, but they are not directly included in most eva systems (ittner, larcker and rajan 1997; epstein and manzoni 1998; banker, potter, srinivasan 2000). these leading drivers are often nonfinancial in nature and encompass such factors as product innovation, customer satisfaction and loyalty, employee productivity, product quality, brand equity, etc. (lynch and cross 1995). the importance of focusing on these value drivers is twofold. not only do they focus the activities of frontline employees on value creation, but also they tend to push the management team to develop its strategies with much greater clarity. the question becomes how to integrate financial and non-financial drivers (i.e., leading and lagging indicators) into the planning and valuation process. the balanced scorecard the balanced scorecard (bsc) is a performance management tool that has been used to foster a more integrated perspective of the organization and the valuation process. developed by kaplan and norton (1992), it is based on the concept that managers must manage and evaluate their business from at least four major perspectives: customers, internal business process, innovation and learning, and financial. these four perspectives encourage management to develop an integrated strategy around the following four questions: 1. how do customers view the firm? (the customer perspective is measured in part by indicators of customer satisfaction, on-time delivery, share of key accounts' purchases, ranking by key accounts.) 2. what business processes must the firm improve and exceed at? (the internal business perspective is measured in part by indicators such as cycle time, unit cost, yield, and quality.) 3. can the firm continue to learn and innovate? (the innovation and learning perspective is measured in part by indicators such as percent of sales from new products, development time for the next generation of products, quantity and quality of employee suggestions, and employee skill development.) 4. how does the firm appear to its shareholders? (the financial perspective is measured in part by such indicators as cash flow, return on equity, market share.) the scorecard takes a balanced look at the organization because it focuses on (1) leading and lagging drivers of performance, (2) financial and non-fi4 journal ofbusiness strategies vol. 21, no.1 nancial measurements, and (3) quantitative as well as qualitative measures of performance. if properly implemented, it is an excellent management framework to help managers track the many factors that influence performance. the ability of the bse to provide this view depends upon the construction of a set of performance measures that track how successfully a firm is carrying out its strategies, objectives, and overall mission. financial performance, whether measured by eva or some other metric, should always be the end goal, but the balance scorecard reminds us that financial measures are lagging indicators. they tell us how the company performed after the fact (young & o'byrne 200 i, fisher 1992). delivering ever increasing amounts of eva requires that we understand the leading indicators of value; the measures that signal value-creation or value-destroying behavior before the results over show up in eva. a limitation of the bse, however, is that it lacks a single focus for accountability. what the bse does not do but what management needs is one comprehensive index to summarize the interaction between these leading and lagging measures of performance. while the bse may tell us what measures to look at, it does not tell us how to look at them or their relative importance. integrating eva and the balanced scorecard although the balanced scorecard was not explicitly created with eva in mind, the framework has proven to be highly complementary to it (young & q'byrne 2001). in practice, eva and bsc must be viewed as an integrated system representing a continuum going from leading indicators such as employee satisfaction and morale, quality, and customer satisfaction to lagging indicators such as eva. the strength of eva is that it focuses the firm on its fundamental mission of value creation. the strength of bsc is that it focuses management attention on the key causal pathways to value creation. all too often, firms invest in decision support tools such as the balanced scorecard and the eva but do not use them effectively, mainly because managers have difficulty in relating them directly to ongoing operations. exhibit 2 organizes performance indicators in a causal chain. this strategic map shows that indicators can be thought of as a continuum. customer satisfaction is a leading indicator of eva, but it may also be a lagging indicator of on-time delivery. in other words, better on-time delivery improves customer satisfaction, which leads to higher sales and the speedier collection of receivables, which in turn lead to higher eva. while on-time delivery is a leading indicator of customer satisfaction, it may also be lagging indicator of production cycle time and the quality of both the manufacturing process and the product themselves. process and product quality, rework rates, and cycle times are, in turn, lagging indicators of employee skills and morale. the balanced scorecard focuses management attention on these causal relationships leading to higher eva. spring 2004 fletcher & smith: performance measuring system exhibit 2 causal chain 5 financial customers internal business process learning and growth economic value added / " operatingexpenses lagging leading the key to integrating these two systems is quantifying the relative importance of the firm's leading and lagging indicators and meshing them into one comprehensive performance index. we propose employing the multi-criteria decision-making technique known as the analytical hierarchy process (ahp) as the tool to facilitate this linkage, to develop an integrated performance index, and to monitor its implementation. ahp has been increasingly used to link qualitative and quantitative measures in an integrating framework (liberatore et al 1997, pineno 2000). it has been applied to business problems and is particularly useful for allocating resources, planning, analyzing the impact of policy and resolving conflicts (saaty 1996). 6 journal of business strategies the ahp-based valuation framework vol 21, no.1 the ahp developed by saaty is a proven method for structuring and analyzing complex, multilevel decision-making problems (saaty 1996). basically, the ahp is a method of breaking down a complex situation into its component parts; arranging these parts (or variables) into a hierarchic order; assigning numeric values to subjective judgments on the relative importance of each variable; and synthesizing the judgments to determine which variables have the highest priority and should be acted up to influence the outcome of the situation. ahp incorporates judgments and personal values in a logical way. it depends on imagination, intuition and knowledge to structure the hierarchy of a problem and on logic, intuition and experience to provide judgments about the relative rankings. an important feature ofahp is that it provides an effective structure for group decision making by imposing a discipline for the group's thought processes. this feature is ideal for strategic planning because ideas and judgments can be questioned and strengthened or weakened by evidence that other people present. in addition, the necessity of assigning a numeric value to each variable of the problem helps managers to maintain strategic patterns and to reach a conclusion. the consensual nature of group decision-making improves the consistency of managers' judgments and enhances the validity and reliability of the ahp as a decision-making tool. in the context of strategic planning, ahp begins by structuring a strategic plan into a hierarchy (step i). the highest level is the overall objective (e.g., enhancing eva). the secondary level encompasses the strategic alternatives i options for the firm. the tertiary level identifies the value drivers and their associated metrics (i.e., frontline activities of the firm that will contribute positively to the overall objective of increasing value). after developing the hierarchy, the next step is for the planning team to judge the relative weight or importance of each ofthese value drivers to the firm's ability to succeed in achieving its eva objective (step 2). the relative weights of the performance metrics are then used to create an overall index of performance for the firm, which collectively uses the key performance measures to monitor and assess performance (step 3). as with any strategic planning process, those responsible for implementing this methodology should be prepared to deal with such problems as inequality of power and expertise among members, unequal desire to express preferences, frequent change of expressed preferences, and the unwillingness of some to reveal their preferences or the true strength of their preferences (saaty 1996). most of the problems in applying the ahp occur in the priority-setting stage, particularly when the process is being used for the first time. it is important to recognize that consensus is not essential at the lower levels of the hierarchy, but it is needed at the higher levels, where the priorities drive the rest of the hierarchy. in conducting planning sessions, the facilitator should be concerned about these problems but through careful preparation, good examples, and sensitivity to group dynamics, these problems can be overcome. spring 2004 fletchcr & smith: pcrformancc measuring system 7 the advantages and disadvantages of the ahp have been extensively debated. a series of articles in management scicncc examines the theoretical strengths and weaknesses of ahp (dyer 1990a, dyer 1990b, harker and vargas 1990, saaty 1990, winkler 1990). recent developments in the ahp literature have addressed and effective resolved the principal objectives. this research illustrates that ahp has been widely and successfully applied in a variety of decision-making environments (wasil and golden 1991; vargas and zahedi 1993; liberatore et al 1997). lavas: a case study· to illustrate the integration of eva and bsc using ahp, we worked with an east coast food distribution firm developing its strategic plan, monitoring its implementation and assessing its performance. lavas foods corporation (lavas) is a privately-held company that enjoys a solid reputation in its industry for providing specialized distribution of over 7,200 restaurant products. it has generally been considered one of the industry leaders in its market segments. the organization views itself as having several distinctive characteristics. it is a small, lean organization with few middle management personnel, allowing easy access to top decision-makers. the company has many long-term employees and its labor force is entirely non-union. it has a family oriented corporate culture with second and third generations of the family owning and managing the business. senior executives maintain tight controls on the work product through hands-on contact and are the individuals primarily responsible for strategic planning. the strategic planning committee consists of eight members: the chairman of the board, president, chief financial officer, director of information systems, and the vice presidents of distribution, marketing, operations and purchasing. in early 2000, lavas found its sales growth had been stunted due to an increase in competition from large, well-financed national distribution companies, increased merger and acquisition activity, and slower growth in some market segments. while lavas had always enjoyed a fine reputation, it had only recently achieved renewed profitability. lavas's strategic plan articulated that its mission was to "maximize stakeholder and stockholder value by being the industry leader in niche markets with a goal of achieving an eva of $1.2 million". to meet this goal, management determined that it had to aggressively market to its existing customers, cultivate new customers, develop new products, improve its efficiency and productivity, and increase profitability in order to attract new sources offinancing. this latter initiative was particularly important given lavas was highly leveraged because of substantial recent investment in its production and distribution facilities. lavas has utilized a value based management approach for several years but had difficulty aligning the frontline activities of the firm to enhance profitability and value creation. in the previous year it began implementing a balanced 8 journal of business strategies voi.21,no.l scorecard management system to augment the development of key performance measures in the key areas of finance, customer, internal processes, and innovation i learning. a difficulty arose, however, because the scorecard was not directly integrated in the value based management system, the budgeting process and the compensation structure. the current planning cycle sought to integrate the entire strategic planning system into a single process driven by value based management. lavas' current strategic plan identified four primary objectives: sales growth, profitability, customer satisfaction and retention, and employee satisfaction and retention. its balanced scorecard framework is shown in exhibit 3. the ahp framework was used by management to prioritize the relative importance of each of these strategic drivers and develop an index to monitor overall organizational performance. a discussion of this process and its use by lavas follows. step 1constructahp linking the firm's eva mission and objectives to the balanced scorecard expert choice 2000 is a user-friendly ahp software package that enables the user to quickly and easily structure hierarchies, enter all necessary judgments, and automatically compute the alternative and criteria weights. using standard ahp nomenclature, an ahp model must have an explicit goal, and in the case of lavas foods it was to achieve an eva target of $1.2 million. a hierarchy is constructed to link the goal to alternatives. alternatives can be viewed as strategic options for achieving the goal. the criteria are then identified. they represent the measures used to access the performance of lavas' financial and non-financial drivers of value. this hierarchy is illustrated in exhibit 3 and is translated as follows: 1. goal: maximize stakeholder and shareholder value by achieving an eva of $1.2 million. 2. strategic alternatives i objectives: each of lavas' strategic objectives are explicitly identified: (1) grow sales, (2) enhance profitability, (3) satisfy and retain customers and (4) satisfy and retain employees. 3. criteria: key performance measures are presented under each oftheir bsc respective perspectives (i.e., finance, customer, internal business, innovation i learning). identifying each measure to its underlying bsc perspective is one way ofensuring that each perspecti ve has been taken into consideration in the strategy development and performance management process. step 2 use the ahp to determine the "weights" or relative importance of the individual key performance measures ahp models use pairwise comparisons to assess the relative importance of each of the strategic objectives and the importance of each of the criteria (i.e., the bsc performance measures) in meeting the eva goal and each strategic objective. these comparisons are entered using one ofseveral modes, including spring 2004 fletcher & smith: performance measuring system exhibit 3 ahp-balanced scorecard framework 9 goal: maximize stockholder value (eva = $1.2 mil.) i i i i i objective i ohjective 2 objective 3 objective 4 customer retention employee retention sales growth profitability and satisfaction and satisfaction i t i i i i i i financial customer internal learning business and perspective perspective perspective growth perspective i i i i 15% 95% retention 2.0% 5% of revenue of out-of-stock from rona profitable customers rate new products i i i i 12% sales 20% of sales 95% accuracy employee training growth from in time new accounts order delivery (10 days/person) i i i i 30% revenue pick efficiency employee 13% from wacc value-added of suggestions partnerships 98% (8% increase) i i i i inventory turnover 95% 25% 85%of 16.5 times on-time delivery product returns employee retention i accounts receivables of 18 days verbal, numerical and graphical approaches. the results are synthesized. expert choice automatically computes the weights and a measure of the consistency of judgments. 10 journal ofbusiness strategies vol. 21, no.1 lavas' management team met over the course of several weeks to debate the relative priorities of these value drivers. once a consensus was obtained, the management team consulted its outside board of advisors to validate their judgments. this iterative process led to subsequent refining of the priorities. ultimately, management's pairwise comparisons yielded differential weights for the four strategic objectives as well as the four components of the balanced scorecard. the weights shown below are based on management's evaluation of the significance of the performance measure to lavas' unique competitive environment. as a small firm, competing in a mature market against large national competitors, customer and sales oriented objectives and measures were higher priorities than financial measures. it was important to grow sales and to retention its customers in order to enhance its ability to capture competitor's customers. lavas' relative priorities balanced scorecard perspectives 31.7% customer perspective 27.1% internal business perspective 26.2% financial perspective 15.0% innovation & learning strate2ic objectives 29.8% sales growth 29.7% customer satis. (retention 25.6% profitability 14.9% employee satis. (retention exhibit 4 summarizes the relative weights of the 17 key performance measures as calculated by the ahp model. these weights relate the relative importance of each performance measure to lavas' efforts to meets its overall goal of achieving an eva of $1.2 million. for example, rona has a relative weight or importance of 5.9% (among all the performance measures), sales growth has a weight of 6.3%, wacc has a weight of 4.6%, and so on. note that the relative weights of the full set sum to 100%. the baseline or targeted values in exhibit 4 provide an index score that can be used to track the firm's progress. step 3 use key performance measures to construct an index to monitor overall firm performance lavas then tracked performance on each measure and monitored the firm's overall performance using the index. by individually tracking each performance measure from quarter to quarter, and quantifying the relative effect of each change, we can construct an index to monitor the firm's progress toward its strategic targets. weights below the targeted ahp measure indicate problem areas; weights equal to or greater than the targeted ahp measure indicate that lavas met or exceeded its targeted goal. exhibits 5 through 8 compare each quarter's performance to target using the ahp-driven performance index. "percent of target" for each measured in spring 2004 fletcher & smith: performance measuring system exhibit 4 performance measurement index 11 firm performance measure target ahpweight financial perspective i. rona 15.0% 5.9% 2. sales growth 12.0% 6.3% 3. wacc 13.0% 4.6% 4. inventory turnover 16.5 4.8% 5. accounts receivable days 18 4.6% customer perspective 6. customer retention rate 95.0% 8.2% 7. sales from new accounts 20.0% 7.3% 8. revenue from value-added partnerships 30.0% 6.4% 9. on-time delivery 95.0% 9.8% internal business perspective 10. out-of-stock (%) 2.0% 5.9% ii. accuracy in delivery order (%) 95.0% 7.1% 12. pick efficiency time 98.0% 3.9% 13. product returns (%) 2.0% 5.4% 14. % of revenue from new products 5.0% 4.8% innovation and learning perspective 15. employee training days 10.0 5.8% 16. employee suggestions (% increase) 8.0% 4.3% 17. employee retention 85.0% 4.9% baseline performance index 100.0% calculated by dividing the quarter results by the target times 100. for example in quarter one rona was 14.5% and the goal was 15.0%. this results in an index of96.7% (14.5/15.0 x 100). this "percent of target" is then multiplied by the measure's ahp weight to calculate its relative value in the "performance index". thus, the first quarter rona rate had a performance index of 5.7% (96.7% x 5.9%f. as shown in exhibit 5, quarter 1 yielded a performance index of 94. 7% suggesting that lavas fell short of its target. it met 7 of its bsc targets (wacc, customer retention rate, revenue from value-added partnerships, on-time delivery, out-of-stock percent, accuracy in delivery order i pick rate, and employee training days). it fell short on the other 10 targets. "sales growth" was only 83% of target, achieving a 10% growth rate instead of its targeted 12%. "product returns" had a target of 2% but 3% of products were actually returned exceeding its target by 50%. revenue from new products grew by 4.2%, short of its target of 5.0%. corrective actions were taken early in quarter two. for example, a telephone survey of key accounts was conducted to assess reasons for product returns. based on these findings, an enhanced monitoring system was implemented which resulted in lavas exceeding its second quarter 12 journal ofbusiness strategies vol. 21, no.1 exhibit 5 quarter 1 performance compared to targeted performance ahp percent target qtr 1 of perf. firm perfomance measure weight data target index i. rona 5.9% 14.5% 96.7% 5.7% 2. sales growth 6.3% 10.0% 83.3% 5.3% 3. wacc 4.6% 13.0% 100.0% 4.6% 4. inventory turnover 4.8% 15.5 93.9% 4.5% 5. accounts receivable days 4.6% 20.0 88.9% 4.1% 6. customer retention rate 8.2% 96.0% 101.1% 8.3% 7. sales from new accounts 7.3% 18.0% 90.0% 6.6% 8. revenue from value-added partnerships 6.4% 31.0% 103.3% 6.6% 9. on-time delivery 9.8% 96.0% 101.1% 9.9% 10. out-of-stock (%) 5.9% 1.5% 125.0% 7.4% ii. accuracy in delivery order (%) 7.1% 96.0% 101.1% 7.2% 12. pick efficiency time 3.9% 97.0% 99.0% 3.9% 13. product returns (%) 5.4% 3.0% 50.0% 2.7% 14. % of revenue from new products 4.8% 4.2% 84.0% 4.0% 15. employee training days 5.8% 10.0% 100.0% 5.8% 16. employee suggestions (% increase) 4.3% 7.0% 87.5% 3.8% 17. employee retention 4.9% 78.0% 91.8% 4.5% performance index (%) 100.0% 94.7% target. to increase sales from new products, the sales team doubled the number of "taste testings" to stimulate interest in new products, yielding significantly higher second quarter results of 98% of target. while these corrective actions improved some key performance areas as shown in exhibit 6, overall results in quarter 2 were disappointing (91.5% performance index) because of slippage in other areas. management was particularly concerned about worsening sales growth (75% of target), an increase in the number of out-of-stock items, and the decline in employee development (training and suggestions). a company-wide meeting, more like a pep rally, was held to help motivate people and to improve employee's involvement in the day-to-day operations. the meeting yielded a number of implemental ideas to reduce out-of-stock conditions. the vice-president of sales met with each salesperson to better focus sales efforts. the results of these corrective actions began to appear in quarter 3 (exhibit 7) with overall performance increasing from 91.5% to 94.1 % of target. while still short of the target, the evidence indicated a rebound. out-ofstocks were reduced and sales increased, including sales from new accounts. one significant problem area, on-time delivery representing 9.8% of our target index, continued to plague lavas. to correct this deficiency, some routes were re-drawn and two new drivers were added. by quarter 4 (exhibit 8) the corspring 2004 fletcher & smith: performance measuring system 13 exhibit 6 quarter 2 performance compared to targeted performance ahp percent target qtr2 of perf. firm perfomance measure weight data target index i. rona 5.9% 15.5% 103.3% 6.1% 2. sales growth 6.3% 9.0% 75.0% 4.7% 3. wacc 4.6% 13.0% 100.0% 4.6% 4. inventory turnover 4.8% 17.0 103.0% 4.9% 5. accounts receivable days 4.6% 17.0 105.6% 4.9% 6. customer retention rate 8.2% 93.0% 97.9% 8.0% 7. sales from new accounts 7.3% 19.0% 95.0% 6.9% 8. revenue from value-added partnerships 6.4% 28.0% 93.3% 6.0% 9. on-time delivery 9.8% 93.0% 97.9% 9.6% 10. out-of-stock (%) 5.9% 3.0% 50.0% 3.0% 11. accuracy in delivery order (%) 7.1% 93.0% 97.9% 7.0% 12. pick efficiency time 3.9% 96.0% 98.0% 3.8% 13. product returns (%) 5.4% 1.8% 110.0% 5.9% 14. % of revenue from new products 4.8% 4.9% 98.0% 4.7% 15. employee training days 5.8% 6.0 60.0% 3.5% 16. employee suggestions (% increase) 4.3% 6.0% 75.0% 3.2% 17. employee retention 4.9% 81.0% 95.3% 4.7% performance index (%) 100.0% 91.5% rective actions previously instituted begin to take hold. a performance index of 97.8% was achieved. it ended the year with an eva of $1.1 million. the lavas case study illustrates how scorecard drivers can be integrated into a value based management system using the analytical hierarchy process to develop an integrated performance measurement system. this approach enabled lavas to better develop strategy and monitor its implementation and performance. while many of the decisions and subsequent results reported in this paper are short term in nature, this should not diminish the benefits of this methodology, which for lavas were four-fold. lavas was able to link daily operational performance to goals and systematically measure performance over time. management intervened only when performance drivers appeared to go off track or needed to be revised in light of changes in the marketplace. they reduced the propensity to set budgets and short-term activities that were contradictory to the long-term strategic plan. their frontline employees had a shared understanding of what created success in various parts of the business in both the short and long term and who in the organization could affect those drivers. in a lean organization with many long-term employees, this shared philosophy is critical to sustained success. the total process (managing for value, using a scorecard approach in developing strategy and identifying metrics, continuous monitoring) encouraged top management to listen more 14 journal of business strategies vol. 21, no.1 exhibit 7 quarter 3 performance compared to targeted performance firm perfomance measure 1. rona 2. sales growth 3. wacc 4. inventory turnover 5. accounts receivable days 6. customer retention rate 7. sales from new accounts 8. revenue from value-added partnerships 9. on-time delivery 10. out-of-stock (%) ii. accuracy in delivery order (%) 12. pick efficiency time 13. product returns (%) 14. % of revenue from new products 15. employee training days 16. employee suggestions (% increase) 17. employee retention performance index (%) ahp target weight 5.9% 6.3% 4.6% 4.8% 4.6% 8.2% 7.3% 6.4% 9.8% 5.9% 7.1% 3.9% 5.4% 4.8% 5.8% 4.3% 4.9% 100.0% qtr3 data 14.0% 12.0% 13.0% 14.0 21.0 98.0% 21.0% 27.0% 92.0% 2.0% 96.0% 96.0% 2.1% 5.5% 7.0 4.0% 85.0% percent of target 93.3% 100.0% 100.0% 84.8% 83.3% 103.2% 105.0% 90.0% 96.8% 100.0% 101.1% 98.0% 95.0% 110.0% 70.0% 50.0% 100.0% perf. index 5.5% 6.3% 4.6% 4.1% 3.8% 8.5% 7.7% 5.8% 9.5% 5.9% 7.2% 3.8% 5.1% 5.3% 4.1% 2.2% 4.9% 94.1% effectively to their employees and to share information with them. this was a critical factor in its success. conclusion if it is true that behavior is determined by what is measured and rewarded, traditional financial measures of performance no longer reflect the realities of today's environment where innovation, quality and a customer focus are the rules of the game. long-term success requires a performance assessment framework that monitors and reports on the value of efforts across the entire business. we have presented a framework for improving the implementation of value based management by using the balanced scorecard to identify value drivers and developing a comprehensive performance measurement system quantitatively linking them to the firm's objectives of maximizing shareholder value. eva and the sse are two approaches to performance management. the limitation of eva is its lack ofleading indicators. the limitation of the bse is its lack ofa well-defined measurement system. we have presented a framework to address these limitations. the increased accuracy and timeliness provided by an ahp valuation framework enhances the ability of the firm to monitor strategy implementation on a real-time basis. spring 2004 fletcher & smith: performance measuring system 15 exhibit 8 quarter 4 performance compared to targeted performance firm perfomance measure 1. rona 2. sales growth 3. wacc 4. inventory turnover 5. accounts receivable days 6. customer retention rate 7. sales tram new accounts 8. revenue from value-added partnerships 9. on-time delivery 10. out-of-stock (%) 11. accuracy in delivery order (%) 12. pick efficiency time 13. product returns (%) 14. % of revenue from new products 15. employee training days 16. employee suggestions (% increase) 17. employee retention performance index (%) ahp target weight 5.9% 6.3% 4.6% 4.8% 4.6% 8.2% 7.3% 6.4% 9.8% 5.9% 7.1% 3.9% 5.4% 4.8% 5.8% 4.3% 4.9% 100.0% qtr3 data 16.0% 12.5% 13.0% 18.0 19.0 91.0% 19.0% 29.0% 96.0% 2.5% 94.0% 97.0% 2.0% 6.1% 10.0 5.0% 84.0% percent of target 106.7% 104.2% 100.0% 109.1% 94.4% 95.8% 95.0% 96.7% 101.1% 75 .. 0% 98.9% 99.0% 100.0% 122.0% 100.0% 62.5% 98.8% perf. index 6.3% 6.6% 4.6% 5.2% 4.3% 7.9% 6.9% 6.2% 9.9% 4.4% 7.0% 3.9% 5.4% 5.9% 5.8% 2.7% 4.8% 97.8% the methodology overcomes some of the difficulty managers often have in relating non-financial performance measures to the overall objectives and mission of the firm. a limitation of the research is that this approach has only been used for a family-owned and controlled firm. future research is needed to assess the implications for different ownership forms. an organization with widely held stock with a substantial institutional ownership might face different performance pressures than a family-owned or family-controlled company. we do not present this methodology as a panacea for every problem in applying value-based management organizations but it is an approach that shows potential for providing a solid platform for sustained growth and profitability. references banker r. d., potter, g. and srinivasan, d. (2000). an empirical investigation of an incentive plan that includes non-financial performance measures. the accounting review. january, 65-92. dyer (a), j. s. (1990). remarks on the analytic hierarchy process. management science. 36 (3), (march), 249-258. 16 journal of business strategies vol. 21, no.1 dyer (b), j. s. (1990). a clarification of 'remarks on the analytic hierarchy process'. management science, 36 (3), (march), 274-275. eccles, r. g. and pyburn, p. j. (1992). creating a comprehensive system to measure performance. management accounting, october. ehrbar, a. (1998). eva: the real key to creating wealth. new york, ny: john wiley & sons. epstein, m. and manzoni, j. f. (1998). implementing corporate strategy: from tableaux de bord to balance scorecards. european management journal, april, 199-203. expert choice, inc., version 2000, pittsburgh, pa. fisher, j. (1992). use of non-financial performance measures. journal of cost management. (spring). harker, p. t. and vargas, l. g. (1990). reply to 'remarks on the analytic hierarchy process' by j. s. dyer. management science, 36 (3), (march), 269-273. hawawini, g. and viallet c. (2002). finance for executives: managing for value creation. (2nd edition). south-western! thomson learning. haspeslagh, p., nada t. and boulos, f. (2001). managing for value: it's not just about the numbers. harvard business review, 79 (july-august), 65-73. kaplan, r. s. and norton, d. p. (1992). the balanced scorecard: measures that drive performance. harvard business review. 70 (jan-feb), 71-79. ittner, c. d., larcker, d. f. and rajan, m. v. (1997). the choice of performance measures in annual bonus contracts. the accounting review. april, 223-255. liberatore, m. j. & miller, t. (1998). a framework for integrating activity-based costing and the balanced scorecard into the logistics strategy development and monitoring process. journal of business logistics. 19 (2), 131154. liberatore, m. j., monahan, t. f., & tymon, w. g. (1997). a framework for integrating a balanced scorecard to company strategy. corporate controller, (winter), 24-29. lynch, r. l. & cross, k. f. (1995). measure up! (2nd edition). cambridge, ma: blackwell publishers, 47. pettit,1. (2000). eva and strategy. evaluation, (april), 1-18 pineno, c. j. (2000). the balanced scorecard: an incremental approach to product lines and distribution. journal of contemporary business issues, 8 (2), 77-83. spring 2004 fletcher & smith: performance measuring system 17 saaty, 1'. l. (1996). the analytic hierarchy process. pittsburgh, pa: rws publications. saaty, t. l. (1990). an exposition of the ahp in reply to the paper 'remarks on the analytic hierarchy process'. management science, 36 (3), 259-268. vargas, l. g. and zahedi, f. (1993). special issue on the analytic hierarchy process. mathematical and computer modeling, 17,4-5. wasil, e. a. and golden, b. l. (1991). public sector applications of the analytic hierarchy process. socia-economic planning sciences. 25 (2). winkler, r. l. (1990). decision modeling and rational choice: ahp and utility theory. management science, 36 (3), 247-248. young, s, d. and q'byrne, s. f, (2001). eva and value-based management. new york: mcgraw-hill. footnotes i name changed to protect the privacy and confidentiality of the organization. it should be noted that an alternative equation is used to calibrate the points for performance measures in which a decrease in the measure's value represents an improvement. the formula is: 200 [(current quarter value / target) x 100]. three of lavas' measures fall in this category: accounts receivable days, out-of-stock, and product returns. harold d. fletcher is professor of finance at loyola college in maryland with over twenty-five years of experience in teaching and consulting. his focus is primarily on the fields of managerial finance and strategic planning. he holds a bs in accounting from western kentucky university, an ma in economics from the university of kentucky and a ph.d. in finance from the university of illinois, champaign-urbana. darlene brannigan smith is associate professor of marketing and academic director of graduate business programs at loyola college. she holds a ph.d. in marketing from the university of maryland and an mba in finance from the university of baltimore. her teaching focus is in the fields of marketing strategy and strategic planning. she is an active consultant focusing primarily in the areas of market planning, needs assessment, and client i customer satisfaction studies. 18 journal ofbusiness strategies vol. 21, no. 1 managing for value: developing a performance measurement system integrating economic value added and the balanced scorecard in strategic planning outsourcing the human resource function: environmental and organizational characteristics that affect hr performance juliana d. lilly sam houston state university huntsville, tx david a. gray meghna virick the university of texas at arlington arlington, tx abstract a theoretical model is presented that identifies environmental and organizational characteristics that affect human resource (hr) performance in an organization. specifically, we address the issue of when and under what circumstances does hr outsourcing contribute value to thefirm by attempting to identify environmental and organizational characteristics that affect hr department performance and how hr outsourcing mediates that relationship. we propose that supplier competition in the hr provider market has a direct effect on the amount of hr outsourcing which in turn has a direct effect on hr performance. environmental uncertainty (primary, competitive, and supplier) is proposed to moderate the relationship between amount of hr outsourcing and hr performance while asset specificity is proposed to moderate the relationship between supplier competition and amount ofhr outsourcing. an earlier version of this paper was presented at the southwest academy ofmanagement meeting in houston, texas, march, 2003, and received the 2003 irwin/mcgraw-hill distinguished paper award. introduction human resource outsourcing has become a major part of human resource (hr) operations for the last few years. a 2004 joint study conducted by the society for human resource management (shrm) and the bureau of national affairs (bna) found that two-thirds of hr executives surveyed say their hr departments outsource at least one hr activity (bureau of national affairs, 2004), with this activity expected to increase. proctor & gamble (p&g), for instance, signed an agreement with ibm that took effect in january 2004 and led to the outsourcing of p&g's worldwide hr services, valued at $400 million to ibm. despite the increased activity, however, there is recognition that careful planning should be employed before making the decision to outsource. in fact, a separate 56 journal of business strategies vol. 22, no. 1 2004 shrm human resource outsourcing survey found that in some cases hr outsourcing led to a decrease in customer service (25% of respondents), a less personal relationship with employees (37% of respondents), and a decrease in employee morale (6% of respondents). the information contained in these two recent surveys seems to indicate that a good understanding of the factors that drive hr outsourcing and a good understanding of the expected outcomes is necessary to ensure that organizations fulfill their hr functions in a manner that allows them to remain competitive in their respective industries. literature review in many studies that discuss outsourcing, cost benefits appear to be a compelling argument for contracting out services previously performed internally (e.g., anderson & weitz, 1986; belous, 1989; greer, youngblood, & gray, 1999; gupta & gupta, 1992; kakabadse & kakabadse, 2002; lever, 1997), and vining & globerman (1999) note that empirical data from government agencies outsourcing to private suppliers generated savings in the range of 20-30% in production costs. however, some of these same studies caution that cost should not be the only factor considered in the decision to outsource. other factors to consider include vendor expertise, customer and employee satisfaction (barthelemy, 2003; greer, youngblood & gray, 1999; gupta & gupta, 1992), and loss of strategic advantage (anderson & weitz, 1986; greer, youngblood & gray, 1999, gupta & gupta, 1992; lever, 1997). in a more recent study, adler (2003) notes that a review by the gartner group listed six factors that are important in outsourcing decisions: dependency risk, spillover risk, trust, relative proficiency, strategic capabilities, and flexibility. the first four of these are classified as shortterm factors, whereas the last two can be considered more long-term or strategic. however, no clear formula exists that identifies when outsourcing is most efficient and effective. there are also very few empirical studies that examine the performance implications of make or buy decisions (e.g. leiblein, reuer, & dalsace, 2002). rather, studies seem to concentrate on the reasons organizations outsource, how to outsource, or the impact of outsourcing on the organization and its employees. notably absent from the literature is the question of when outsourcing is most appropriate or under what circumstances an organization should outsource to increase human resources (hr) performance. in other words, are there internal and external forces that are conducive to hr outsourcing? if these forces can be identified, they may provide some clues concerning the appropriate action to take when outsourcing is being considered. this is especially important since 67% of hr departments outsourced one or more functions in 2004 (bureau of national affairs, 2004). we specifically address the issue ofwhen and under what circumstances does hr outsourcing contribute value to the firm by attempting to identify environmental and organizational characteristics that affect hr performance and how hr outsourcing mediates that relationship. spring 2005 lilly et al.: outsourcing the human resource function 57 a separate issue concerning the current outsourcing research is the absence of studies looking at the hr function in organizations. although there are numerous theoretical and empirical articles on outsourcing organizational functions such as information systems and accounting, the academic literature on outsourcing the hr function is almost non-existent. although klaas (2003) developed a framework that helps analyze hr outsourcing factors in small and medium-sized enterprises (smes) by explicating on the relationship between smes and the professional employer organizations and gainey and klaas (2003) analyze hr outsourcing specifically in the context oftraining and development, these studies are the exception rather than the rule. this fact is surprising given that many hr functions such as payroll, benefits, training, and recruiting are often outsourced by organizations (gilley, greer & rasheed, 2004; lever, 1997). the shrm human resource outsourcing survey report, released in june 2004, found that hr functions that are entirely outsourced are generally background checking, employee assistance/counseling, and flexible spending account (fsa) administration. the functions that are partially outsourced include administration of health care benefits, pension benefits administration, and payroll. despite this increase in hr outsourcing activity, to date, the empirical articles on outsourcing hr functions focus on the impact of organizational characteristics (klaas, mcclendon & gainey, 200 i), the role of transaction costs (gainey & klaas, 2003; klaas, 2003; klaas, mcclendon & gainey, 1999), the relationship between hr department size and outsourcing activity (pommerenke & stout, 1996), and the rationale and consequences ofhr outsourcing (greer, youngblood & gray, 1999; lever, 1997). the question concerning when to outsource hr practices based on the internal and external forces driving the firm to consider outsourcing, however, is not directly addressed, although klaas, mcclendon & gainey (1999) come close in their analysis of moderator variables in the relationship between amount of hr outsourcing and perceived benefits from outsourcing. a separate article by klaas, mcclendon and gainey (2001) also touches on certain organizational characteristics that lead firms to outsource hr activities, but does not consider hr performance as a dependent variable. as such, it is necessary to address the question of when to outsource the hr function by looking into the theoretical issues of outsourcing in the literature representing disciplines other than hr to form a basis for hr outsourcing. however, a brief discussion of definitions and hr activities is presented first. [n this paper, the term outsourcing will refer to the action of allowing external vendors to perform an entire hr activity (such as training, payroll, etc.) for an organization. the term insourcing will refer to the action of the organization performing the entire hr activity in-house, and the term co-sourcing will refer to the action of allowing an organization's hr generalist to work with external vendors on some activities, or to the action of allowing hr specialists to work as consultants to line managers who actually perform hr duties. 58 journal of business strategies the hr value chain vol. 22, no. 1 the hr functions perfonned in an organization can be thought of as a chain of events or tasks that start with the planning of the organization's staffing needs and end with an employee's exit from the organization. figure 1 illustrates the e qi... '">. l/)... l: qi e qi cl ell l: ell :::e = .. qi.. qi <n .. .:= ell-u (.)q,l cal. q,l ::::l ::::l l: 0al0 ~~ :;::: ell .!::! ~ qi l: == ell e cl i= .. 0 c c::.q w roe ~ .!: :t::e 0"x i5 qi >.ctl w 0::: f-l t r::: >.0 c c uctl ~ 0 0 co. ~ q)~ ctl~iii qlcr::: 2l.~ mol >m >wqi ._ c::ie .£: ~qi ._ 0>c. e <i=c :::jo. ~ce <1>.<l>c:: ale c::._>. c::e cc q)~u c0 ctl <l>u <l>ctl ><0 cou a... o)ctl 0)0.. uju _u t cij wuu r::: ue ca ectlc q) 0> 0> e ~ g2 c c e'c.. 1"...to 0.. e .9.g oc:::j '5 (.)'ccctl c qi olctl(1j m 0 q) c. a...o..ii'i is () :2 t ol c:'e c <i>>. wol q)ol ..q c cl ee q)e 0.0 l: olo. >.0. e-=0>0 0 0 <l>lb l:: ctl-c w o..~ ~§5'j; ctl>.. :2~ eol ~'§luju t 0> 0> c c cl l:: .~ l:: w :e ol 0 el:: 'n!e 2 .~ ol(.) .$ <i> uca w a> ctlii) 0:: .f: (j) c::: cl l:: l:: 0> ~ "en m q) u 0 q) .0.... a a ll -, spring 2005 lilly et al.: outsourcing the human resource function 59 chain of events as they occur in an organization. these events form the basis of the hr function and serve as a guide for determining which specific hr functions may be eligible for outsourcing. it is important to distinguish between those functions that are a core element ofthe organization/employee relationship (those that create value for the organization) and those that are not. two typologies are used to illustrate this point. gilley, greer, and rasheed (2004) discuss a strategic typology ofhr activities developed by alan speaker (greer, 2001) in which hr activities are classified as having either high or low strategic value and as being either transactional or relationship-oriented in nature. their resulting typology shows the quadrant containing relationship-oriented activities with high strategic value to the firm to include several hr activities related to training and performance evaluation. in addition, the quadrant containing transactional activities with high strategic value includes activities related to staffing, benefits planning, and compliance. their article suggests that high strategic value activities and relationship-oriented activities might not be good candidates for outsourcing activity. rather, they suggest that low strategic value activities that are transactional in nature such as payroll, benefits administration, employee records, and relocation administration are the best candidates for outsourcing. a separate, but similar, typology is lepak and snell's (1998) model of virtual hr in which hr activities are classified as either high or low in uniqueness and high or low in value. a high value activity is one that is directly instrumental for achieving organizational objectives, while a low value activity is one that is primarily administrative or transactional in nature. an activity that is low in uniqueness is one that is routine, while an activity high in uniqueness is considered idiosyncratic. lepak and snell (1998) argue that the quadrant representing high value and high uniqueness contains core hr activities that are most likely to be carried out internally to obtain a competitive advantage. thus, these activities should not typically be outsourced. but other routine administrative activities located in other quadrants might be outsourced to the growing supply of external vendors specializing in these activities. when the hr activities iisted by gilley, et ai. (2004) are located in the hr value chain, it becomes obvious that portions of each major hr function are potential candidates for outsourcing. however, three functions in particular, training, performance planning and evaluation, and compensation, deal specifically with an organization's current relationship with its employees. as soon as the employee is hired, he or she receives some type of training, is informed ofjob performance evaluation processes, and is informed of compensation issues related to pay and benefits. if an employee stays with the organization, the cycle of training, performance, and compensation repeats itself many times throughout the course of the employee's tenure with the organization. the professionalism and fairness with which an organization performs these activities is directly related to how employees feel about the organization. thus, these three functions comprise an organizational career management system and are crucial in developing corporate 60 journal ofbusiness strategies vol. 22, no. 1 strategies concerning employee retention, employee value to the organization, and employee productivity. as such, outsourcing in these three major hr functions should be considered carefully before any final decisions are made. the proposed model because hr outsourcing has received such scant attention in the literature, it is necessary to address the question of when and under what circumstances hr outsourcing contributes to firm performance by looking at the literature representing disciplines other than hr. in particular, theory from economics, organizations, and strategy will be used to develop the proposed framework. figure 2 depicts the proposed model of the relationship between competition, amount of hr outsourcing and hr performance. moderator variables, asset specificity and three types of environmental uncertainty, are also used to help determine the conditions under which hr outsourcing may affect hr performance. figure 2 model of hr outsourcing asset specificity primary uncertainty competitive uncertainty p3 supplier + i hr i + hr competition 1------. outsourcing ---------.. peliormance . p2 p1 p6 supplier uncertainty supplier competition and outsourcing when people and organizations agree to conduct business together, a process emerges that helps determine demand, supply, and prices for particular goods and services. as the number ofpeople and organizations involved in business transactions increases, the potential for competition between these groups also increases. for instance, when the number of sellers in a particular market increase, buyers have more freedom to pick and choose the organizations with whom they want to conduct business than they do ifthere are few sellers. because large numbers of sellers are trying to capture the same market share, the sellers will compete with one another in an attempt to obtain as much market share as possible. the resulting competition may cause the sellers to differentiate their services in terms of price, quality, or customer service. spring 2005 lilly et al.: outsourcing the human resource function 61 when competition is limited, a decreased quantity of goods and services is available, and the prices of those goods and services tend to increase. for example, lynk (1995) found that mergers between hospitals led to significantly higher prices in health care service, indicating an exploitation of market power created by a reduction of competition. in contrast, as competition increases (with more firms entering the market) the quantity of goods and services available to potential buyers should also increase. because neoclassical economic theory assumes the buyer to be rational and informed, buyers should choose the product that best meets their needs and price concerns, thereby choosing the alternative that is most efficient. therefore, as competition between external hr provider firms increases, the quantity of goods and services available to corporate buyers should also increase with buyers choosing the most efficient alternative. in the five forces model of competition (porter, 1980), five competitive forces determine the state of competition in an industry. three of these forces, potential new entrants into a market, substitute products, and rivalry among competing sellers in a market, often lead to new technology, improved products, and lower prices. thus, a firm wishing to outsource hr functions in a strong competitive vendor environment is likely to benefit from a strong bargaining position. an organization performing a particular hr activity in-house may not be able to compete effectively with firms offering the same service externally, {larticularly if an external provider has a competitive advantage unavailable to others. in this situation, marginal analysis would help determine if the hr activity is costing more than the worth ofthe hr activity's contribution to total organization output. marginal analysis looks at the changes in costs and benefits that occur when changes from the status quo are proposed. these marginal changes in the costs and benefits are the basis for rational economic choice (ekelund & tollison, 1991). in a competitive situation concerning employee wages, for example, marginal analysis would determine if an employee is worth keeping. if the employee being analyzed is paid more than the worth of his or her contribution to total output, it is economically unsound to keep the employee on the payroll. in the same vein, if an insourced human resource activity costs more to operate than it is contributing to total output of the organization, it is economically unsound to continue operating the hr activity internally. transaction cost theory (coase, 1937) helps explain this idea further. transaction cost refers to the cost of organizing information, protecting the interests of all parties in the transaction, monitoring the transactions, and other similar costs involved in a transaction (aubert, rivard & patry, 1996). in a discussion of transaction costs, coase (1937) noted that "a firm will tend to expand until the costs of organizing an extra transaction within the firm become equal to the costs of carrying out the same transaction by means of exchange on the open market or the costs of organizing in another firm," (coase, 1937, p. 341). in other words, when internal transaction costs equal the cost of purchasing the same good or service on the open market, the organization will tend to stop producing internally and purchase from the open market. 62 journal ofbusiness strategies vol. 22, no. 1 williamson (1975) suggests that a buyer who is dependent upon one supplier for goods will be less able to resist or avoid opportunism by the supplier than a buyer who has several suppliers from whom to purchase goods. the lack of alternative suppliers may create a small numbers bargaining problem for the buyer, thus creating an incentive for the buyer to vertically integrate (levy, 1985). from an outsourcing perspective, when competition for suppliers of a particular good or service increases, the number of choices increase, and the ability of a supplier to engage in opportunistic behavior decreases. the increased level of competition creates an environment that is more favorable to the buyer in terms of choice and the ability to use alternate suppliers if necessary. without several alternatives, it is doubtful that outsourcing would occur at all since firms would be hesitant to place themselves in a situation that forces them to be dependent upon a single supplier. this concept of transaction cost falls in line with theories of competition, cost leadership and differentiation strategy (porter 1980). an organization cannot afford to compete effectively when it pays more for services or goods than its competitors unless it differentiates itself clearly from other market providers. if business competitors use a less expensive but equal method to operate their hr activities, the organization that continues to pay more for the same service may be at a competitive disadvantage by not utilizing a cost strategy. additionally, as external hr provider firms increase in number, competition among these contract providers will likely lead to new technology, improved products, and economies of scale not available to organizations not specializing in the hr activity. external hr provider firms that exploit either cost advantages or special differentiated services through improved technology and products may entice many organizations to outsource. indeed, in a study of semiconductor firms, leiblen, et al. (2002) found that number of suppliers correlated with greater outsourcing activity. in summary, increased hr vendor competition may create positive benefits for organizations purchasing their services. from a neoclassical economic perspective, increased levels of external supplier competition should lower the costs of externally produced goods causing the rational consumer to purchase the goods externally rather than producing them internally at a higher cost. therefore: proposition i: there is a positive relationship between supplier competition in the external hr provider market and amount ofhr outsourcing. the relationship between outsourcing and hr performance because firms outsource to increase performance, hr outsourcing should lead to increased hr performance such that hr outsourcing acts as a mediator between supplier competition and hr performance. the decision to make or buy is based on a number of elements in the internal and external environment (white, 2000), and the idea of competing based on the amount of hard assets owned has shifted to competing on the basis of intangible assets and capabilities (gottfredson, spring 2005 lilly et al.: outsourcing the human resource function 63 puryear & phillips, 2005). as a result, the amount of outsourcing in areas such as production and information processing has increased tremendously in the last several years in an attempt to compete by using the most attractive opportunities inside and outside the organization. outsourcing is attractive to upper management because it improves some ofthe metrics used to judge company performance. for instance, "shedding specific assets allows a company to increase return on assets (roa) and return on investment (rot), and decreasing the head count increases revenue per employee," (rossetti & choi, 2005, pp. 48-49). another benefit of outsourcing includes reducing prices of goods provided, which in tum leads to higher price to earning ratios. tn summary, firms that outsource any function do so with the idea that the firm's performance will increase. several sources indicate that this is indeed the case (ellram & carr, 1994; smeltzer, manship & rossetti, 2003; velocci, 2001), and thus we expect that an increase in hr outsourcing will result in an increase in hr performance. proposition 2: there is a significant mediating effect ofamount ofhr outsourcing on the relationship between supplier competition and hr performance. asset specificity williamson's (1985, 1986) work on transaction costs expands coase's (1937) original theory by defining key aspects of a transaction cost framework. one key aspect is that of asset specificity, or the investment in assets that are specific to the requirements of a particular exchange relationship. research has shown that asset specificity reduces the degree of outsourcing (jensen & rothwell, 1998; monteverde & teece, 1982). for example, in an hr context, asset specificity is high in a transaction where software is designed to perform a specific hr task for a specific organization. transaction costs are likely to be high in this instance since the software cannot be used in other organizations. both purchaser and vendor will desire protections from each other if something goes wrong, thus increasing costs of the transaction. if asset specificity is low, however, market transaction costs are likely to be lower and many suppliers should then effectively compete (vining & globerman, 1999). in this scenario, as the number of external hr provider firms offering basic, non-specific service that all organizations need (e.g. payroll administration) increases, external vendor competition should increase and cause internally produced services to be more costly to administer. the key is to determine which activities in the hr value chain have low asset specificity and can be outsourced without damaging the organization/employee relationship. the specific hr tasks or services being outsourced can have an impact on the relationship proposed in proposition one, particularly if an hr service that creates a competitive advantage for the firm is outsourced. the concept of asset specificity is very similar to klaas, mcclendon and gainey's (2001) concept of idiosyncratic practices developed by firms to create a strategic hr advantage. 64 journal ofbusiness strategies vol. 22, no.1 these idiosyncratic practices are often firm-specific, based on tacit firm knowledge, and can limit the ability of an external hr provider firm to provide the same level of service as an internal hr department. as such, asset specificity should be accounted for in the competition/amount of hr outsourcing relationship. since prior research has shown that asset specificity reduces the amount of outsourcing (jensen & rothwell, 1998; monteverde & teece, 1982), we propose that asset specificity moderates the relationship between supplier competition and amount of hr outsourcing. proposition 3: there is a negative moderating effect ofhr task asset specificity on the relationship between supplier competition and amount ofhr outsourcing. environmental uncertainty and outsourcing seminal works in the area of environmental uncertainty suggest that the most effective firms tend to use mechanistic or bureaucratic designs in stable, predictable environments while organic designs are used by effective firms in unstable, turbulent environments (bums & stalker, 1961; lawrence & lorsch, 1967; thompson, 1967). in other words, the type of organizational design used should match the organization's environment. although much has been written about the relationship between environmental uncertainty and organizational design, some scholars have looked specifically at the role information processing plays in this relationship (daft & lengel, 1986; galbraith, 1974; huber, 1991). arguments have been made suggesting that the level of analysis for information processing should be the subunit or departmental level rather than the organizational level because organizations are composed of subunits which are interdependent (e.g. tushman & nadler, 1978). information processing is important because an organization's ability to process information is tied to environmental uncertainty. the more uncertain the environment, the more difficult information processing becomes, and the more likely it is that an organization developing better methods for processing information will obtain a competitive advantage. considering the hr department as a subunit in an organization, it is appropriate to analyze the structure and process of the hr function in the theoretical vein suggested by the studies mentioned previously. seminal research clearly suggests that in stable, predictable environments, a bureaucratic structure is the most effective design to use. therefore, when labor demand and supply are stable and predictable, outsourcing the hr function, even a bureaucratic one, seems unnecessary since all market competitors have fairly complete information in an unchanging market. it would be difficult to obtain a competitive advantage for hr under these conditions since the resource in question (labor market information) is not limited to one organization. indeed, such information is often compiled by government agencies and dispensed publicly to all interested parties. a more recent view of environmental uncertainty suggests that uncertainty is divided into three distinct components primary, competitive, and supplier spring 2005 lilly et al.: outsourcing the human resource function 65 (sutcliffe & zaheer, 1998). the first component, primary uncertainty, refers to "uncertainty arising from exogenous sources, such as natural events, from changes in preferences, as well as from regulatory changes, such as those involving standards or tariffs," (sutcliffe & zaheer, 1998, p. 3). competitive uncertainty is defined as "the uncertainty arising from the actions of potential or actual competitors ... ," (sutcliffe & zaheer, 1998, p 4). these two forms of uncertainty are somewhat similar in an hr outsourcing context in that a firm must deal with the effects of these types of uncertainty after they occur. for instance, changes in department of labor regulations concerning the status of exempt versus nonexempt employees and the calculation of overtime have caused many hr departments to recreate the entire timekeeping process to avoid potential legal problems. when competitors raise or lower the average wage level for a particular area, hr departments must decide if they should or should not match the competitor's wage and the impact that will have on their workforce. because primary and competitive uncertainty create a situation in which the firm must react after the event has occurred, it is expected that high levels of primary and competitive uncertainty will enhance the ability of firms specializing in hr outsourcing to outperform internal hr departments. the reasoning for this assumption is based on the idea that firms specializing in hr services will have more ability to focus on specific hr issues and will be able to respond more quickly when changes occur. proposition 4: there is a positive moderating effect ofprimary uncertainty on the relationship between amount ofhr outsourcing and hr performance. proposition 5: there is a positive moderating effect of competitive uncertainty on the relationship between amount ofhr outsourcing and hr performance. the third type of uncertainty proposed by sutcliff and zaheer (1998) is supplier uncertainty, defined as the behavioral uncertainty of an exchange partner firm. supplier uncertainty is related to possible opportunism by the supplier, and is expected to have a negative moderating effect on the relationship between hr outsourcing and hr performance. in an hr outsourcing context, an increase in supplier uncertainty would suggest that the external hr provider firms are in a position to act in self-serving ways at the expense of the contracting organization. thus, an increase in the ability of external hr provider firms to engage in opportunism could lead to a decrease in hr performance. proposition 6: there is a negative moderating effect of supplier uncertainty on the relationship between amount of hr outsourcing and hr performance. 66 journal ofbusiness strategies vol. 22, no. i model limitations the propositions presented are intended to give some solid theoretical background for determining when the hr function should or should not be outsourced. it is well and good to discuss competitive advantages and employee reactions concerning outsourcing, but defining the appropriate situation in which to act to increase hr performance has not yet been established. the proposed model is a starting point for connecting outsourcing activities to hr performance. a potential difficulty with the model, however, is adequately defining and measuring what is meant by hr performance. in firm-level studies of outsourcing, profitability and earnings per share may be appropriate measures of performance, but performance in the hr function is more difficult to quantify in dollar amounts, although some authors have made progress in this regard (becker, huselid & ulrich, 200 i). basic operating cost comparisons can be made easily, but intangible functions such as creating the appropriate organizational culture or ensuring that employees feel valued and supported by the organization are difficult to measure and difficult to translate into dollar amounts. these intangible factors, however, need to be quantified in order to obtain a valid measure ofhr performance. if the goal of outsourcing is to improve the function being outsourced, valid measures must be available to determine whether the outsourcing is successful. perhaps each component in the hr value chain can be analyzed to determine specific measures for each function that can then be compiled into an overall measure of hr performance. the measures might include both operating costs and behavioral components translated into dohar amounts. in addition, since the dependent variable is hr performance, the knowledge, skills, and abilities (ksas) of individuals performing the work are most likely part of the hr performance measure. the model, however, does not account for individual contributions to hr performance. just as hr performance is difficult to measure, individual ksa contributions to an organization are also difficult to measure. for instance, the labor relations manager who convinces the local union to avert a strike certainly has ksas that contribute value to the firm, but how should the manager's ksas be measured? perhaps colleagues, subordinates, and supervisors could give a reasonable measure ofthe manager's ksas as some 360-degree performance evaluations require, but obtaining 360-degree feedback for all hr department employees can be impractical, and performance ratings are often inflated and inaccurate. thus, although hr performance is likely to be a function of employees' skills and abilities, employee ksas are not included in the model. another limitation concerns other functions and departments within the organization. because hr performance often depends upon the willingness of other departments to follow organizational policy and procedure, individuals outside of the hr function may have an impact on hr performance. for example, assume the hr department adequately conducts sexual harassment workshops and has tried without success to discipline a vice-president who informs his managers to ignore all complaints from female employees. the vice-president is a personal spring 2005 lilly et at.: outsourcing the human resource function 67 friend of the ceo, and simply refuses to take sexual harassment seriously. lawsuits resulting from sexual harassment complaints may count against hr performance even though hr employees have done everything possible to stop sexual harassment. the factors discussed above and others are likely to contribute to hr performance that are not considered in the proposed model, and any test of the model will most likely yield a small r-square value because of the missing variables. despite this limitation, the model is adequate as a starting point for determining how outsourcing affects the relationship between external forces of competition and hr performance. ifthe model is significant, it would indicate that the amount ofhr outsourcing does have an impact on hr performance under certain conditions. since the goal of outsourcing any task is to reduce costs, gain expertise and control over processes, and improve quality of service (shelgren, 2004), knowing that hr outsourcing may add value to the firm is a positive step in determining ways to capitalize on any potential benefits of outsourcing. conclusion a number of organizations have begun to outsource the hr function, and it would be helpful to understand the impact of outsourcing on firm performance. electronic data systems will combine forces with towers perrin to create an hr outsourcing company that is expected to bring in $600 million in annual revenues (fuquay, 2005), and consulting firm nelsonhall says the worldwide market for hr outsourcing services is expected to grow 21 % annually to $7 billion by 2008 (mcdougall, 2005). the sheer size ofthe market for hr outsourcing suggests that firms should be aware of the forces that indicate outsourcing to be beneficial or detrimental to the organization. the research to date on hr outsourcing has not yet determined the circumstances under which hr outsourcing would be most beneficial, and part of the problem lies with the inability of researchers and firms to grasp an overall, widely accepted measure of hr performance. many hr functions may not lend themselves to outsourcing, and changing the dependent variable from hr performance to hr function performance for specific functions such as payroll or employee development may help determine which functions should or should not be outsourced. the hr value chain illustrates in a timeline fashion how certain hr activities become tied to an employee's value to the organization. training leads to better performance which leads to higher compensation, and the cycle of training, performance and compensation repeats itself throughout the life of the employee in the organization. because an organization has invested time and money in training employees, the decision to outsource should not be made lightly. if conditions in the environment and in the organization are conducive to outsourcing, the amount of time and money invested in the hr professional employees who are to be downsized should be considered for the sake of the organization as well as for the sake of the employee. 68 journal ofbusiness strategies vol 22, no. i u nl ike an outsourced manufacturing process, where the cost ofgoods and quality metrics can clearly show if the outsourced process is successful in meeting numeric goals of production, hr practices are typically intertwined together to form a coherent overall strategy that is more di fficult to tease apart and measure individually. the literature on hr bundles illustrates this point (see macduffie, 1995, for a specific manufacturing example). forinstance, an overall strategy that claims, "people are our most important asset," would suggest that all hr practices from recruiting to retirement focus on the individual employee to make them feel like a valued part of the organization. if a specific hr function such as benefits administration is outsourced to an external provider, however, the employee may feel more like a number than like a valued employee. at this point, there is a potential breakdown in the overall strategy, and metrics showing the amount of money saved by outsourcing benefits administration may look promising, but employees themselves may feel less committed to the organization. as a result, other hr performance measures that are typically not calculated in benefits administration, such as turnover or absenteeism, may increase. hr management is concerned with the management of people in an organization throughout all phases of the employment process, and improving one part at the expense of another part makes little sense. thus, the emphasis earlier in this paper on core hr activities with high strategic value is not misplaced, and the authors who caution that cost should not be the only factor in the decision to outsource have good reason for their arguments (anderson & weitz, 1986; greer, youngblood & gray, 1999; lever, 1997). the field of hr management has transformed over the past few decades from being primarily a record-keeping function to a strategic function that helps develop strategies for fitting hr practices with the overall organization's strategy. the old record-keeping functions tend to be routine, bureaucratic, and have low strategic value; thus, they can probably be outsourced with little effect on the individual employees of the organization. however, some people do not see the value of "new" and strategic hr departments because they see all of the hr function as a bureaucratic, record-keeping function that adds nothing to the firm's bottom line. thomas stewart (1996), for example, suggests that most hr departments are 80 percent routine administration with no value-added, so the entire hr department should be abolished; not improved, but completely eliminated. the problem with stewart's suggestion is that many researchers have decided that the acquisition and management of human capital can become a strong competitive advantage for an organization ifhandled appropriately (barney, 1995; barney & wright, 1998; brockbank, 1999). since most managers are kept busy with typical tasks such as production or sales, few have extra time to devote to the human resource component of the business. this situation means that someone needs to develop the hr practices that are critical to creating and sustaining a competitive advantage with human capital. it also means that decisions to outsource the hr function must be made with the appropriate information, and the research in this area needs more development and clarity. spring 2005 lilly et ai.: outsourcing the human resource function 69 future research should focus on other organizational characteristics or environmental characteristics that affect hr performance based on the amount of outsourcing. other organizational characteristics might include organization structure and design, particularly in the hr department itself, or the size of the organization. other environmental characteristics might include boundary spanning capabilities of the organization or the level of resource dependence the firm experiences. learning more about the conditions under which hr outsourcing affects specific hr functions would help hr departments plan accordingly when making decisions to outsource. although the purpose of this paper is to identify characteristics of the organization or environment that determine when to outsource hr and subsequent performance, another valuable component of determining whether outsourcing is successful concerns the individuals performing the work. a more complete model would include organizational, environmental, and individual employee characteristics that all work in concert to determine the appropriate situation in which to outsource. references adler, p.s. (2003). making the hr outsourcing decision. mit sloan management review, 45,53-60. anderson, k & weitz, b. a. (1986). make-or-buy decisions: vertical integration and marketing productivity. sloan management review. 27, 3-20. aubert, b. a., rivard, s. & patry, m. (1996). a transaction cost approach to outsourcing behavior: some empirical evidence. information and management. 30, 51-64. barney, j. (1995). looking inside for competitive advantage. academy of management executive. 9, (4),49-61. barney, j. & wright, p. (1998). on becoming a strategic partner: the role ofhuman resources in gaining competitive advantage. human resource management. 37, (i), 31-46. barthelemy, j. (2003). the seven deadly sins of outsourcing. academy of management executive, 17, (2), 87-100. becker, b. k, huselid, m. a. & ulrich, d. (2001). the hr scorecard: linking people, strategy, and performance. boston: harvard business school press. belous, r. s. (1989). human resource flexibility and equity: difficult questions for business, labor, and government. journal of labor research, 10,67-72. brockbank, w. (1999). ifhr were really strategically proactive: present and future directions in hr's contribution to competitive advantage. human resource management, 38, (4), 337-352. 70 journal ofbusiness strategies vol. 22, no.1 bureau ofnational affairs. (2004). human resource department benchmarks and analysis survey 2004. a bnajshrm collaboration. burns, t. & stalker, g. m. (1961). the management of innovation. london: tavistock publications. coase, r. h. (1937). the nature of the firm. economica, 4,386-405. reprinted in g. 1. stigler & k. e. baulding (eds.) readings in price theory 1952. chicago: irwin. daft, r. l. & lengel, r. h. (1986). organization information requirements, media richness and structural design. management science. 32, 554-571. ekelund, r. b. & tollison, r.d. (1991). macroeconomics, third edition. new york: harper collins. ellram, l & carr, a. (1994). strategic purchasing: a history and review of the literature. international journal of purchasing and materials management, 33,13-20. fuquay, j. (2005). eds joins outsourcing venture. january 19, 2005, business section, fort worth star telegram. gainey t.w., & klaas, b.s. (2003). the outsourcing of training and development: factors impacting client satisfaction. journal of management 29, (2),207-229. galbraith, j. r. (1974). organization design: an information-processing view. interfaces, 1,28-36. gilley, k. m., greer, c. r. & rasheed, a. a. (2004). human resource outsourcing and performance in manufacturing firms. journal of business research, 57, 232-240. gottfredson, m, puryear, r. & phillips, s. (2005). strategic sourcing from periphery to the core. harvard business review, 83, (february), 132-139. greer, c. r. (2001). strategy and human resources: a general managerial approach, 2nd ed. upper saddle river (nj): prentice-hall. greer, c. r., youngblood, s. a., & gray, d. a. (1999). human resource management outsourcing: the make or buy decision. academy of management executive, 13, 85-96. gupta, u. & gupta, a. (1992). outsourcing the is function: is it necessary for your organization? information systems management, (summer), 44-50. huber, g. p. (1991). organizational learning: the contributing processes and the literatures. organization science, 2, 88-115. jensen, j. & rothwell, g. (1998). transaction costs, regulation, and subcontracting at nuclear power plants. journal of economic behavior and organization, 36, 369-381. spring 2005 lilly et al.: outsourcing the human resource function 71 kakabadse, a., & kakabadse, n. (2002). trends in outsourcing. european management 1ournal, 20, 189-198. klaas, 8.s. (2003). professional employer organizations and their role in small and medium enterprises: the impact of hr outsourcing. entrepreneurship theory and practice, 28, 43-61. klaas, b. s., mcclendon, 1. & gainey, t. w (1999). hr outsourcing and its impact: the role of transaction costs. personnel psychology. 52, 113-136. klaas, 8. s., mcclendon, j. a. & gainey, t. w (2001). outsourcing hr: the impact of organizational characteristics. human resource management, 40, 125-138. lawrence, p. r & lorsch, j. w (1967). differentiation and integration in complex organizations. administrative science quarterly. 12,1-47. leiblein, mj., reuer, 1.j., & dalsace, f. (2002). do make or buy decisions matter? the influence of organizational governance on technological performance. strategic management journal, 23, 817-833. lepak, d. p. & snell, s. a. (1998). virtual hr: strategic human resource management in the 21 st century. human resource management review, 8, 215-234. lever, s. (1997). an analysis of managerial motivations behind outsourcing practices in human resources. human resource planning, 20,37-47. levy, d. t. (1985). the transactions cost approach to vertical integration: an empirical examination. the review of economics and statistics, 67, 438-445. lynk, w1. (1995). non-profit hospital mergers and the exercise of market power. journal of law and economics, 38,437-461. macduffie, j. p. (1995). human resource bundles and manufacturing performance: organizationallogic and flexible production systems in the world auto industry. industrial and labor relations review, 48, (2), 197-221. mcdougall, p. (2005). eds likely to open hr center in china. feb 16 informationweek. www.informationweek.com/story/showarticle.j html ?articlei d=6040 1263 monteverde, k., & teece, d. (1982). supplier switching costs and vertical integration in the automobile industry. bell journal of economics, 13,206-213. pommerenke, p. l. & stout, s. k. (1996). human resource departments and hospital labor strategies. hospital & health services administration, 41, 77-90. porter, m. (1980). competitive strategy: techniques for analyzing industries and competitors. new york: free press. 72 journal ofbusiness strategies vol. 22, no. 1 rossetti, c. & choi, t. y. (2005). on the dark side of strategic sourcing: experiences from the aerospace industry. academy of management executive, 19, 46-60. shelgren, d. (2004). why hr outsourcing continues to expand. employment relations today. 31,47-53. smeltzer, l., manship, 1. & rossetti, c. (2003). strategic sourcing and negotiation planning: an integration of processes. journal of supply chain management 39,16-26. society for human resource management. july (2004). human resource outsourcing survey report. alexandria, virginia: shrm research. speaker, a. w. address at texas christian university, forth worth, tx (1999). stewart, t. a. (1996). taking on the last bureaucracy. fortune, january 15, 105-108. sutcliffe, k. m. & zaheer, a. 1998. uncertainty in the transaction environment: an empirical test strategic management journal. 19 (1), 1-23. thompson, j. (1967). organizations in action. new york: mcgraw-hill. tushman, m. l. & nadler, d. a. (1978). information processing as an integrating concept in organizational design. academy of management review. 3, 613-624. velocci, a. (200 1). strategic sourcing mostly a neglected opportunity. aviation week & space technology, (april), 70. vining, a. & globerman, s. (1999). a conceptual framework for understanding the outsourcing decision. european management journal. 17, (6), 645-654. white, s. (2000). competition, capabilities, and the make, buy, or ally decisions of chinese state-owned firms. academy of management journal. 43,324-341. williamson, o. e. (1975). markets and hierarchies: analysis and antitrust implications. new york: free press. williamson, o. e. (1985). the economic institutions of capitalism. new york: free press. williamson, o. e. (1986). economic organization: firms. markets and policy control.new york: new york university press. organizational career management system meghna virick is a visiting assistant professor at the university of texas at arlington. she joined the faculty in 2003, after she completed her doctorate in business administration from the university of texas at arlington, specializing in human resource management and organizational behavior. she earned her spring 2005 lilly et al.: outsourcing the human resource function 73 masters in industrial relations and personnel management from xlri, india, and an mba from texas christian university. since january, 2003, dr. virick has been serving as research director of the north texas technology council (nttc), a non-profit organization that promotes north texas as a leading and varied technology region. her research interests are in the area of job loss, diversity, and work family conflict. she has published in journals such as journal of applied psychology and human resource management review. she has made numerous presentations at the academy of management and society of industrial and organizational psychology. david a. gray is associate dean of the college of business and professor of management. he was awarded the ph.d. in business administration from the school of management at the university of massachusetts in 1974. his research interests have focused on aspects of human resource management and the labor relations process. more specifically, he has researched strategic and operational rationales of human resource outsourcing; the linkage of the hr value chain to the employee-employer psychological contract and the performance impact of various hr practices; and union management conflict and cooperation before and after labor-management relations by objectives, or rbo. the results of these and other research efforts have been published in the academy of management review, academy of management executive, california management review, omega: the international journal of management science, journal of labor research, journal of collective negotiations in the public sector, journal of business research, and national proceedings of the academy of management and industrial relations research association. juliana lilly is an assistant professor of management at sam houston state university. she was awarded the ph.d. in business administration from the university of texas at arlington in 2001. dr. lilly's research interests include organizational justice, psychological contract violations, outsourcing, and layoffs. she has published injournals such as journal of business and public affairs, managerial finance, and journal of applied school psychology, and has made numerous presentations at the academy of management and regional affiliates. outsourcing the human resource function: environmental and organizational characteristics that affect hr performance the implications of a south-south customs union on tariffs, welfare, and the prospect of global free trade' hiranya k. nath sam houston state university • huntsville, texas halis murat yildiz ryerson university • toronto , ontario abstract following the failure of multilateral trade negotiations at the cancun meeting and the doha round, developing countries have pursued an alternative in socalled "south-south" trade agreements. since these agreements lead to trade diversion from efficient north (developed) countries to less efficient south (developing) partners, there have been widespread concerns regarding their welfare implications. using a three country oligopoly model of trade, we first examine statically the implications of a south-south customs union (cu) on the pattern of tariffs and welfare. we find that south countries always have incentives to form a cu that reduces the welfare of the north country. moreover, when south firms are sufficiently inefficient relative to north firms, a south-south cu leads to a large trade diversion effect and reduces world welfare. we further show that, in a repeated interaction model, free trade is less likely to be sustainable under the south-south cu relative to no agreement. introduction by permitting a group of member countries of the world trade organization (wto) to form a preferential trade agree.ment (pta) wherein these countries extend tariff concessions to each other but not to other wto member countries, article xxiv of the general agreement on tariffs and trade (gatt) provides an important exception to the most-favored-nation (mfn) clause (contained in article i of gatt). i since the notion of non-discrimination as specified by the mfn clause is at the heart ofthe wto system, the existence of article xxiv has not been without controversy. 2 pt as are so widespread today that mfn treatment appears to be more of an exception rather than a norm and, thus, far from playing a pivotal role in multilateral trade liberalization. according to the wto (2009), there are over 200 ptas in force today and almost all major countries participate in one or more ptas of various types. prominent examples of ptas include the north american free trade agreement (nafta), the south american common market (mercosur), the association of 76 journal of business strategies south east asian nations (a sean) free trade area, the andean pact, and numerous agreements ofthe european union with other countries. the failure of multilateral trade negotiations at the cancun meeting and the doha round led the developing countries to look for an alternative in so-called "south-south" ptas. as stiglitz (2003) argues, even though there is more to gain from north-south trade in theory, just as north-north trade agreements have intensified, there is no question that south-south trade agreements can also flourish. bhagwati and panagariya (1996), ray (1998), and das and ghosh (2006) contend that the majority of the ptas have been formed between similar countries (so-called north-north agreements between developed countries and south-south agreements between developing countries) rather than between developed and developing countries (north-south agreements). this paper aims at addressing the following questions. what are the implications ofa south-south customs union (cu) on the pattern of tariffs and the welfare of the member and non-member countries and the world as a whole? do these agreements facilitate multilateral trade liberalization process? to address these questions, we develop a three-country oligopoly trade model with one north (developed) and two south (developing) countries. we begin with the premise that the north firms have a superior production technology compared to that of south firms.3 that the above questions are important is evident from the recent proliferation of ptas between developing countries . as per wto, the number of ptas between developing countries has increased dramatically over the last two decades: 70 new such agreements have been formed between 1990 and 2003 and they account for more than 50 percent ofal! new trade agreements, including those not notified to the wto . important examples include mer co sur in south america, south asia free trade area (safta), the group of three, and south africa customs union (sacu). recently, three major south countries : india, brazil, and south africa, have taken major steps leading to south-south cooperation. in the literature, following jacob viner's (1950) classic analysis, economists as well as policy-makers have extensively discussed the static and dynamic distortions created by preferential trade liberalization. it has been argued that ptas can lead to trade creation if member countries switch from inefficient domestic producers and import from more efficient producers in other member countries of the pta. on the other hand, trade diversion takes place when member countries substitute efficient, low-cost imports from non-member countries with less efficient imports from member countries. the net welfare effect of a pta depends upon which of these two effects dominate. since south member countries substitute efficient imvolume 27, number 1 77 ports from non-member north countries with less efficient imports from south partners, there has been widespread concern regarding the welfare implications of southsouth cu. grossman and helpman (1995) claim that the formation of trade diverting ptas is the most likely case. further, schiff and winters (2003) argue that a pta between two small developing countries is likely to generate only trade diversion and no trade creation. the rationale for this argument is that the increased export profits in such a pta stem mainly from trade diversion via an inefficient transfer of tariff revenue to the bloc's exporters. this argument is contested by ornelas (2005) who shows that the exporting rents generated by exchanging preferential market access and coordinating external tariffs under a cu can offset trade diversion losses. it is important to note that ornelas (2005) uses the same oligopoly set-up as here but assume that countries are completely symmetric with respect to production technology, but asymmetric with respect to market size. unlike ornelas (2005), we examine the dynamic implications of cus on the multilateral tariff cooperation. in order to tie our results with those in the existing literature, we first consider a two-stage static game. in the first stage, given the agreement in place, countries choose their optimal tariffs. then, firms compete in a cournot fashion. we find that, even when the external tariff of the member countries fall under cu relative to no agreement (tariff complementarity effect as required by article xxiv of the gatt), the formation of a south-south cu reduces the welfare of the north country. moreover, when south countries are sufficiently inefficient relative to the north, south-south agreement leads to a large trade diversion effect and thus reduces world welfare. by adding an initial stage to the above game where south countries decide whether to form a cu or not, we can show that south countries always have incentives to form a cu since they benefit from exchanging market access at the outsider's expense. we then analyze infinite repetition of the above two-stage static game to allow countries to cooperate multilaterally over free trade and show that multilateral cooperation over free trade is less likely to be sustainable when south-south cu is formed relative to no agreement. these results suggest that, when the cost asymmetry across regions is sufficiently high, the concerns over the negative impact of a south-south cu on the world welfare and the prospect of global free trade are legitimate. basic model we develop a simple oligopoly model of trade in which each country has a unilateral incentive to impose rent extracting tariffs on those trading partners with 78 journal of business strategies whom it does not have any trade agreement. there are three countries: one is a north country (n) and the other two are south countries (s and s). two goods are produced in each country: x and y. good x is produced by a single profit-maximizing firm in each country at a constant marginal cost in terms of the numeraire good y that is produced under perfect competition with constant returns to scale technology. the gains from trade stem from reduced market power in the domestic industry. to this end, the monopoly assumption is not crucial but is the simplest way to represent market power. note that, for notational simplicity, whenever we say firm i , it refers to country i's firm. the north and south countries are asymmetric with respect to their marginal costs of production. for simplicity, we assume that c = c_ = c > c = o. the assumps s n tion that marginal cost is constant implies that there is no advantage in establishing more than one plant. if marginal costs were rising, firms have the incentive to build several plants to serve the foreign markets. in order to exclude prohibitive cost levels and guarantee market access of south firms, we assume that c ::: ~ holds hereafter. preferences over the two goods are quasilinear: u i (x f y) = u(x) + y i (1) furthermore, u(x) is assumed to be quadratic so that the demand curve for good x is linear in country i: (2) where xji denotes the output sold by country j's firm in country i, while xi is the total output sold in country i : xi == l/jr note that a represents the reservation price for a representative consumer above which there is no demand for the non-numeraire good. next, we consider a two-stage static game that compares no agreement and a south-south cu with respect to external tariffs and welfare levels. static game we examine a two-stage game under two distinct trade regimes : no agreement ( {<i>} ) and south-south cu ({ s}). the game proceeds as follows. in the first stage, given the trade agreements, countries simultaneously choose their tariff schedules. then, firms compete in a cournot fashion in the product markets. we solve the above game backwards in order to obtain subgame perfect nash equilibrium (spne). volume 27, number 1 79 no agreement ({tp}) since article i of the gatt (the mfn clause) forbids tariff discrimination, we restrict our attention to symmetric external tariffs by each country. let tfbe the tariff imposed by countries where i = n, s, s. firms' effective marginal costs of exporting equal: = +t¢t1 ll·..j..· ci; ci }' ora it). then, export profit functions can be written as: where ll denotes firm i's export profits in country j. lj (3) (4) first order conditions (focs) for profit maximization for exporters are: + ' ti n·t· pi p/ij-cij' ora i}. (5) the above foes, together with an analogous condition for the local firm, can be easily solved for equilibrium output levels and profits: 4 _2 -2ft ll·..j..· tr,i xu' 7rij xii' or a it). (6) due to the symmetric nature of south firms, we denote a typical south country (firm) by s from hereon. the following comparative static results are standard: dx. dx dx zi 0 /i d 1 0 h ..j.. . < < ; an < were z t i. dt¢ dt¢ dt¢ (7) 1 1 1 in other words, a country's tariff lowers imports from other countries to its domestic market, increases the sales of its local firm, and lowers the total output sold in its market. welfare of country i is defined as the sum of its domestic surplus and total export profits: (8) where 80 journal of business strategies (9) since markets are segmented, strategic independence of trade policies is obtained. thus, country j's tariff choice problem reduces to: the optimal tariffs are given by 3a-2c tp=-i 10· south-south cu ({s}) (10) (11 ) due to market segmentation, the north country solves the same problem as in (10) and thus imposes the same optimal tariff as under ( {<i>}) : t: = t!. when south countries form a cu with each other, they abolish tariffs on each other and impose a common external tariff(~ on north firm's export. therefore, under ({s}), the problem in (10) is modified as follows : the following optimal tariff levels solve the above problem: 5a+2c 1[= 19 · (12) (13) under complete symmetry (c = 0), when south countries form a cu, export of the south member country increases while that of north non-member decreases. as a result, compared to ({<i>}), south members' incentive to impose a tariff on the north non-member decreases since the north non-member country becomes a less important source for rent-extraction. this result is known as the tariff complementarity effect in the literature (see bagwell & staiger, 1997, 1998). however, when cost of production is sufficiently asymmetric across regions, the tariff complementarity effect does not necessarily hold : 7a t~ tt! > 0 lwfjc > --. s s 58 (14) volume 27, number 1 81 it is important to note that in order to minimize the potential harmful effects of ptas, article xxiv requires that member countries should not raise tariffs on non-members relative to tariffs under no agreement. s to this end, hereafter we assume that t[= 3~02c when c > ~~ holds. based on these optimal tariffs, the comparison of welfare yields the following result: 6 proposition 1: suppose that c ~ ~ holds. then, the following results are obtained: (i) south countries always have an incentive to form a cu with each other: wls) > wl([j) for all c; (ii) south-south cu always reduces the welfare of north countries: wjs,) < w/([j) for all c, and (iii) world welfare is lower under ({s}) relative to ({([j}) if the cost asymmetry is sufficiently large: ww (s) ~ ww (([j) iff c ~ cww = ~~~. the first part of the above proposition provides a support to the idea that, as north-north trade agreements have intensified, there is no question that south-south trade agreements can also flourish. in other words, south countries always have an incentive to form a cu excluding the efficient north country. the second part of the above proposition argues that the non-member country is worse offunder ({s}) relative to ( {<d}) since while its domestic surplus stays unchanged, its firm is discriminated in each of the south country markets against its rival exporter. finally, when the cost asymmetry across regions is sufficiently high, the concerns over the negative impact of such agreements on the world welfare are legitimate. the intuition behind the last part of the proposition is as follows . since south member countries have free access in each other's market while the north country's firm faces an external tariff, they substitute efficient imports from the non-member north country with less efficient imports from south partners. as a result, trade diversion effect arises and it increases as the cost asymmetry rises. thus, as represented in figure 1, world welfare is lower under ( {s} ) relative to ( {<d} ) when south firms are sufficiently inefficient relative to the north firm. next, we employ infinite repetition of this one-shot game in order to examine the implications of south-south cu on the prospect and sustainability of global free trade. 82 journal of business strategies figure 1 world welfare comparison (ex = 1) ww(s) ww(f/j) 0.006 0.004 0.002 o+-~--~~~----~------~------~------~ ·0.002 ·0004 sustainability of cooperation over free trade in order to determine whether multilateral cooperation over free trade under ({s}) is easier or harder to sustain relative to ({ <d}), we analyze infinite repetition of the above one-shot game. as in riezman (1991), bagwell and staiger (1997a, 1997b, 1998), bond, syropoulos, and winters (2001), and saggi (2006), such cooperation is required to be self-enforcing: each country balances the current benefit of deviating from the cooperative tariff against the future losses it suffers under the permanent trade war that results from its defection. similar to saggi (2006), we assume that cu is permanent by nature so that members retain zero tariffs on each other, even if cooperation with the non-member breaks down. tariff cooperation over free trade under ({tp}) suppose each country employs a zero tariff until someone defects, in which case cooperation breaks down with countries switching to their mfn tariffs forever. in order to proceed, it is useful to discuss the costs and benefits of multilateral volume 27, number 1 83 cooperation for all countries. under free trade, the per period welfare of a country equals: (15) let wf(tf,tz = 0) denote the welfare of a country that defects from free trade to its optimal tari ff, t t: (16) it is immediate from the above equations that defection from free trade benefits the defecting country by increasing its domestic surplus through the ability to impose optimal tariffs. one period benefit from defection for south countries equals b /c/)l = wd/t¢ t = ol wf/t = ol s\' / s (j s' z '/ s (j '/ (17) = s/t~ sit, = 0) [3a 2el' h = 160 > 0, were z t s. similarly, one period benefit from defection for the north country equals b (c/)) = wd(t¢ t = ol wf(t = 0) n nn'z '/ n (18) =s/t¢l_s(t =ol ntjnj n n '/ f3a-2el' 0 h = 160 > ,w ereztn. it is important to note that one period benefit from defection falls as the degree of asymmetry between south and north firms rises: _db_s_( (/j_~ = db i tp) < 0 dc dc next, we consider the per period cost of defection. when cooperation breaks down, from next period on, countries use their mfn tariffs. the per period cost to a south country of the breakdown of cooperation is given by: c (tp) = wf(t = 0) w ((/j) s ii s (19) = -b/(/j) + [l7rjt: = 0) llljt:)] fj3a62eu3a2el h ..j. = 800 ,were z 1" s. 84 journal of business strategies the lower the production cost of its trading partner, the smaller is the increase in export profits enjoyed by a country due to the trade liberalization undertaken by its partners, and the larger is the loss in local profits suffered by the domestic firm due to its own trade liberalization. as a result, cost of defection to a country depends negatively (positively) on its own (rivals') cost: dc (f/j) s < 0 dc (20) this result suggests that when south firms are sufficiently high cost relative to north firm, cost of defection may even become negative: j3a c (f/j l < 0 iff c > ccr = s "i . 62 (21 ) since benefit of defection is always positive for south countries, it is immediate from (21) that, when c :::: c<r holds, cooperation over free trade is never sustainable. that is, there is always an incentive for south countries to defect in this case. on the other hand, cost of defection is always positive for the north country and gets larger as the cost asymmetry between the two regions increases: c (f/j) = wf(1 = 0) w (f/j) n n n (22) = -b/4>j + [l7ljlz = 0) l7ljlz = i!)] [l3a+98cj[3a-2cl h -i= 800 ,were z -r n. and dc (f/j) n > 0 dc (23) more importantly, the per period cost of the breakdown of cooperation to a south country is lower than that to a north country: c (f/j) ~ c (f/j). 5 n (24) for cooperation to be sustainable, the current benefit of defection must be less than the discounted life-time cost of defection for each country. in other words, the incentive compatibility (ic) constraint must hold for each country as follows: volume 27, number 1 85 o b/<p) ::; 1-0 c/<p) for all i (25) where 0 denotes the discount factor and /0 c/<p) measures the trade war's cost to each country under ({<l>}). for each country, the critical discount factor, of, above which cooperation over free trade is self-enforcing is obtained when b/<p) = c/lp) holds. from the expressions (17), (18), and (24), the following is immediate (see figure 2): proposition 2: under ({ <p}), the range 0/ discount/actors above which north country is willing to cooperate over free trade is larger than that above which south countries are willing to cooperate. it implies that: 8t ~ 8!. thus, multilateral cooperation over free trade is sustainable if and only if 8~ 8t· figure 2 critical discount factors under no agreement (ex = 1) 0.2 -'-----,0"".05;----".0.::-' ---;;:0.""5---0;;':;.2:----;::,,0.25 c the above proposition suggests that since the benefit of defection is the same while the cost of defection is smaller for south countries relative to the north country, the critical discount factor above which south countries are willing to cooperate over free trade binds for the sustainability of multilateral cooperation over free trade. 86 journal of business strategies tariff cooperation over free trade under ({5}) now, we consider how the fonnation of a south-south cu alters incentives for multilateral tariff cooperation. to this end, we discuss how the costs and benefits of multilateral cooperation for all countries change. it is straightforward to argue that when countries cooperate over free trade, the per period welfare of the north country stays the same under ({s}) as in (15) under ({<p}). therefore, the benefit of defection from cooperation for the north country remains the same under ( {<t>}) and ( {s} ). next, consider the cost of the defection of the north country. when cooperation breaks down, from the next period on, the north country responds by raising its tariff on imports from south c!=luntries from zero to it as under ({<p}). in contrast, north country faces t;'(instead of t~) in the south countries that abolish tariffs between each other. it follows immediately from the second part of the proposition 1 that: lemma 1: the per period cost to a north country of the breakdown of cooperation is higher under ({s}) than under ({l/>}), while the benefit of defection stays the same under these two regimes. the above lemma implies that a south-south cu makes north countries more willing to cooperate multilaterally over free trade. next, we consider the incentives of south countries for multilateral tariff cooperation: note that, by the nature of the institution, defection from cooperation by a cu involves defection by both members. in the following discussion, the welfare per cu member is considered. let w~(t;~, t; = 0) denote the welfare of a south country that defects from zero tariff to its optimal tariff t; under ({s}): (26) thus, one period benefit from defection for south countries under ({s}) equals (27) [5a+ lei'> 0 if < 7a 608 , ic 58 [3a-le~[43a + 781' > 0 if > 7a 100 , i c _ jr. on the other hand, one period cost of defection to south countries under ({s}) is given by : volume 27, number 1 87 c (s) = wf(t = 0) w (s) s s s (28) = -b,(s) + [lnjt; = 0) ln;/t;) ]. the first part of proposition 1 implies that the cost of defection is unambiguously lower under ({s}) relative to ({<i>}) and gets negative when south firms are sufficiently high cost (multilateral cooperation is never sustainable). similar to the analysis under ( {<i>}), the incentive compatibility (ic) constraint must hold for each country for multilateral cooperation to be sustainable: (29) let of denote the critical discount factor above which cooperation is selfenforcing for country i under ({s} ).the following result is depicted in figure 3: proposition 3: under ({s}), the range of discount factors above which north country is willing to cooperate over free trade is larger than that above which south countries are willing to cooperate. it implies that: 0;::': 0;. thus, multilateral cooperation over free trade is sustainable if and only if: 0::': 0;. figure 3 critical discount factors under south-south cu (a = 1) 06 0.2 002 0,04 olli 0.08 0.1 c 0.12 88 journal of business strategies the above proposition has a similar implication as proposition 2 in the sense that south countries' choices are binding for the sustainability of multilateral cooperation. next, we ask whether south-south cu makes multilateral cooperation over free trade easier to sustain or not. to this end, figure 4 compares ot and 0;. figure 4 sustainability of multilateral cooperation (a. = 1) 02 l---~0.~~---=o.i~--~o=. 15~--~o~'----=o.~c proposition 4: multilateral cooperation over free trade is harder to sustain under ( {s} ) relative to ({ l/j}).' os > o¢. s s the major implication of proposition i and proposition 4 is that when south finns are sufficiently high cost relative to north finns, the fonnation of a south-south cu not only reduces world welfare statically via trade diversion but also makes multilateral cooperation over free trade harder to sustain. these two results suggest that the concerns regarding the impact of south-south agreements on world welfare and the prospect of global free trade are legitimate. conclusion over the last few decades, the proliferation ofptas has been the visible trend in the international trading system. according to the wto, on an average, each country belongs to six ptas and mongolia is the only country that does not belong to a pta. jagdish bhagwati (1991) famously raised concern about the potential adverse effects ofthe pursuit ofptas on the pattern of tariffs, welfare, and the prospect volume 27, number 1 89 of multilateral trade liberalization . his work led to a rich body of research that has examined the implications of preferential trade liberalization along several fronts. since jacob viner's (\950) classic analysis, the static and dynamic distortions created by preferential trade liberalization have received substantial attention from economists and policy-makers alike. the net welfare effect of a pta depends upon the relative dominance of the trade creation effects and the trade diversion effects of the ptas. since south member countries would substitute efficient imports from non-member north countries with less efficient imports from south partners, there have been widespread concerns over the welfare implications of south-south ptas. this paper addresses two interrelated questions: what are the static implications of a south-south pta on the pattern of tariffs and the welfare of the pta member countries and the world when pta is in the form of a customs union? do these agreements facilitate multilateral cooperation over free trade dynamically? these questions are important since the number of ptas among developing countries has increased dramatically over the last two decades. we show that south countries always have incentives to form a cu among themselves, under which the north country is always worse off relative to no agreement. more importantly, when the degree of cost asymmetry between developed and developing countries is sufficiently high, the concerns regarding the adverse impact of such agreements on the world welfare are legitimate. we further show that the multilateral cooperation over free trade is less likely to be sustainable under a south-south customs union relative to no agreement. notes 1. the mfn clause states that: "under the wto agreements, countries cannot normally discriminate between their trading partners. grant someone a special favour (such as a lower customs duty rate for one of their products) and you have to do the same for all other wto members. this sounds like a contradiction. it suggests special treatment, but in the wto it actually means non-discrimination treating virtually everyone equally .... each member treats all the other members equally as "most-favoured" trading partners. if a country improves the benefits that it gives to one trading partner, it has to give the same "best" treatment to all the other wto members so that they all remain "most-favoured""(wto webpage: http://www.wto. org/english/thewto _ e/whatis _ e/tie e/fact2 _ e.htm#seebox) 2. to minimize the potential harmful effects ofptas, article xxiv requires that: (i) a pta must cover almost all trade between its members; (ii) pta members must 90 journal of business strategies fully eliminate tariffs and other trade restrictions on each other; and (iii) they should not raise tariffs (or any other trade restrictions) on non-members. 3. in a similar set-up, das and ghosh (2006) employ an endogenous coalition formation model to provide a rationale for why trading blocs among similar countries may arise as an equilibrium phenomenon. 4. note that, in order to guarantee positive output levels for the south firms in the north countryis market, we assume that c ~ ~ holds. 5. see hoekman and kosetcki (2001) for an extended discussion of article xxiv. 6. for detailed proof of the propositions, the readers may contact the corresponding author. references bagwell, k., & staiger, r. w. (1997a, february). multilateral cooperation during the formation of customs unions. journal of international economics, 42, 91-123. bagwell, k., & staiger, r. w (1997b). multilateral cooperation during the formation of free trade areas. international economic review, 38, 291-319. bagwell, k., & staiger, r. w (1998). will preferential agreements undermine the multilateral trading system? economic journal, 108, 1162-1182. bhagwati, j. (1991). the world trading system at risk. princeton, nj: princeton university press. bhagwati, j. & panagariya, a. (1996). preferential trade areas and multilateralism: strangers, friends or foes? in bhagwati, jagdish, & a. panagariya (eds), the economics of preferential trade agreements (pp. 83-100). washington: aei press.bond, e. w, syropoulos, c., & winters, l. a. (2001). deepening of regional integration and multilateral trade agreements. journal of international economics, 53, 335-362. das, s., & ghosh, s. (2006). endogenous trading bloc formation in a north-south global economy. canadian journal of economics, 39(3), 809-830. grossman, g. m., & helpman, e. (1995). the politics of free-trade agreements. american economic review, 85, 667-690. ornelas, e. (2007). exchanging market access at the outsiders' expense: the case of customs unions. canadian journal of economics, 40(1), 207-224. ray, d. (1998). development economics. oxford press. riezman, r. (1991). dynamic tariffs with asymmetric information. journal of international economics, 30, 267-283. volume 27, number 1 91 saggi, k. (2006). preferential trade agreements and multilateral tariff cooperation. international economic review, 47, 29-57. schiff, m., & winters, l. a. (2003) regional integration and development. world bank and oxford university press. stiglitz, j. (2003). global trade agreements are at a dead end. new perspectives quarterly. viner, 1. (1950). the custom union issue. new york: carnegie endowment for international peace. world bank. (2009). regional trade agreements. retrieved from http://www.wto. org/english/tratop _ e/region _ e/region _ e.htm biographical sketch of authors hiranya k. nath is an associate professor of economics at sam houston state university. he has published on inflation and relative price behavior, the growth of transition economies of central and eastern europe, the growth of bangladesh, and information economy in refereed journals including applied economics, applied economics letters, applied financial economics letters, california management review, comparative economic studies, economics letters, journal of international trade & economic development, journal of macroeconomics, journal of money, credit and banking, and review of development economics. he earned his ph.d. in economics from southern methodist university, dallas (tx). hatis m. yildiz is an associate professor of economics at ryerson university, toronto, canada. he has published on international trade policy, foreign direct investment, trade and environmental policy in reputed journals like canadian journal of economics, economics letters, indian growth and development review, international economic journal, international review of economics and finance, journal of environmental economics and management, journal of international economics, journal of international trade & economic development, and review of international economics. he holds a ph.d. in economics from southern methodist university, dallas (tx). 92 journal of business strategies the implications of a south-south customs union on tariffs, welfare, and the prospect of global free trade the strategic planning process and performance relationship: does culture matter? richard c. hoffman salisbury university salisbury, md abstract given the growth of multinationals, it is important that managers learn whether strategic planning enhances firm performance in cross-cultural situations. using an international sample affirms, this study found that the general planning-performance model is relevant across the cultures sampled while there appears to be little direct relationship between culture and planning, culture did moderate the planning-performance relationship. furthermore, specific cultural values were found to account for some of the cross-cultural d(fferences in the planning-performance relationship. implications for management and fi/ture research are discussed. introduction concerns of increased international competition abound not only in the u.s. but also in europe with the further expansion of the european union and in asia and latin america with increased economic integration (rugman, 2003) in those regions. theorists (gob & rasheed, 1997; brews & hunt, 1999) have argued that firms should respond to environmental changes, such as increased competition, by engaging in more systematic strategic planning to anticipate and respond to changing events. there is evidence that u.s. firms have responded to greater environmental uncertainty and complexity with more extensive planning (javidan, 1984; kukalis, 1989). furthermore, it appears that formal strategic planning enhances firm performance although the relationship is not unequivocal (boyd, 1991; capon, farley & hulbert, 1994; miller & cardinal, 1994). it is worth noting that, as firms in other regions of the world are confronting increasingly volatile environments, there is a need to extend planning research to firms representing a diversity of national and cultural settings (brock, barry & thomas, 2000). such research will help ensure that current prescriptions concerning the use of planning have external validity in a variety of locales. thus, the purpose of this study is to examine the relationship between strategic planning and firm performance among a group of firms representing different cultural regions. 28 journal ofbusiness strategies strategic planning processes vol. 24, no. 1 strategic management seeks to align the firm's activities with its external environment. at the heart of this management approach is the strategic planning system. as firms face increased environmental change (e.g., more globalization) theorists (grant, 2003) argue that firms benefit from strategic planning. for over thirty years, a plethora of studies have examined formal long range or strategic planning. many of these studies have found that firms that plan possess different characteristics than non-planners. in particular, many studies have sought to examine the relationship between planning and firm performance (boyd, 1991 ). a review of much of the literature suggests that strategic planning can be described along two broad dimensions, planning content or ends and planning processes or means (boyd, 1991; brews & hunt, 1999; miller & cardinal, 1994; ramanujan & venkatraman, 1987). planning content refers to the ends of the planning process such as: goals, mission statements, environmental information programs (veliyath & shortell, 1993), and internal resources. much ofthis content helps distinguish strategic planning from that which is purely operational planning. planning processes focus on the means or methods by which the planning process is carried out. characteristics such as commitment, system maturity, comprehensiveness, time horizon, and importance are typical examples of such system or process characteristics (capon, farley & hulbert, 1994; ramanujam & venkatraman, 1987; rhyne, 1986). this study focuses on planning processes or system characteristics because these processes have been examined far more in the literature (boyd, 1991; miller & cardinal, 1994) on planning and performance. this makes it easier to compare this study to the stream ofliterature that has preceded it. second, culture is believed to affect planning processes (haiss, 1990). as brock et al. (2000) note, cultural values shape acceptable organization processes such as planning and decision making. furthermore, hofstede (2001) has observed that planning processes often reflect the dominant values of a culture. previous studies have examined the planning and performance relationship in non-u.s. settings, but the results have been mixed. there was no consistent relationship between formality of planning and firm performance among swedish firms (rhenman, 1973), canadian firms (sheehan, 1975), or british firms (grinyer & norburn, 1975). however, positive relationships between formal planning and performance have been observed between planning importance/impact and performance among australian firms (burt, 1978), finnish firms (harju, 1981), and another sample of british firms (smith, 1980). thus, planning processes other than formality do appear to be related to performance in these latter studies. similarly, u.s. planning and performance studies suggest significant correlations between strategic planning processes and relevant measures offirm performance (boyd, 1991; miller & cardinal, 1994; shrader, tay lor & dalton, 1984) when the planning processes other than the formality ofthe system are examined (brews & hunt, 1999). since strategic planning helps the firm focus its attention on salient spring 2007 hoffman: strategic planning process 29 environmental trends and define the firm's goals, the act of going through such a process should enhance the firm's performance. in the case of multinationals facing multiple changing environments (brock & barry, 2003; goll & rasheed, 1997; grant, 2003; miller & cardinal, 1994), planning should have a positive effect on firm performance. taken as a whole these studies suggest that strategic planning may be related to performance for most multinationals in today's changing global markets. hypothesis 1: strategic planning processes will be positively related to performance among multinational firms representing a variety of social cultures. culture and planning previous research (brews & hunt, 1999; goll & rasheed, 1997; miller & cardinal, 1994) has indicated that the firm's context may mitigate the planningperformance relationship, such factors as company size, industry, environmental change, and firm strategy. in a cross-national setting another contingency likely to affect this relationship is social culture. culture is defined as the values, attitudes and behaviors shared by the peoples of a region (hofstede, 2001). a culture represents assumptions, values, and behaviors that have enabled people to successfully adapt to their external environment. since strategy is the means by which firms seek to adapt to their environments, a link between culture and strategy appears likely (schneider & barsoux, 2003). culture may influence the strategic planning process (brock et al., 2000) and, thereby, firm performance in the following ways. first, culture shapes the way people think, behave, and evaluate (hofstede, 2001; schneider & barsoux, 2003). this, in turn, affects decision processes such as planning. second, cultures vary along critical values and beliefs that affect a variety of management processes including planning. the concept of culture is broad, making assessment difficult (leung, bhagat, buchan, erez & gibson, 2005). there are essentially two means of assessing culture: culture-centered and personality-centered approaches (clark, 1990; lenartowicz & roth, 1999). culture-centered approaches use qualitative anthropological approaches to describe a single culture in terms of its ethnology, religion, customs, etc. this approach is suitable when studying a single culture. personality-centered assessments use quantitative measures. some of these can be proxies such as nationality or place of birth. another personality-centered method is the use of value inferences based on either primary or secondary measures. this study uses two personality-centered assessments because they provide quantitative secondary measures, capture different aspects of culture, and enable us to compare across multiple cultures. the primary assessment of culture used in this study is based on ronen and shenkar's (1985) cultural clusters. these were empirically derived from eight major studies of goals, values and norms in work settings. this measure reflects 30 journal of business strategies vol. 24, no.1 that cultures extend beyond national boundaries by grouping nations based on similarity of goals, values, and norms. our secondary assessment is an indirect values inference measure based on hofstede's (200 l) value dimensions of power distance (degree of status differences), uncertainty avoidance (fear of unknown and risk taking), assertiveness (emphasis on results versus process), and self-orientation (individual versus collective self-identity). this assessment of culture has been widely used in management research (leung et ai, 2005; sivakumar & nakata, 200 i) but to a much lesser extent in planning research (haiss, 1990). brock et al. (2000, p. 689) have described these value dimensions, " ... as perhaps the most straight forward means to describe systematic cultural variation ..." and, therefore, particularly applicable for examining planning in the multinational firm. the use of these two assessments of culture makes it easier to relate this study to previous research (haiss, 1990; hoffman & hegarty, 1993). employing cultural clusters is a coarser measure in that nations are grouped into a cluster based on a variety of information regarding prevailing work goals and values. it is coarser because it is essentially a nominal measure. this is our primary cultural assessment because this study is exploratory and not much is known about how specific cultural characteristics impact planning. our second assessment ofculture is based on hofstede's (200 i) values data for the nations in our sample. this measure permits us to examine an exploratory hypothesis regarding the potential effects of specific cultural values on the planning-performance relationship. given that firms from the triad nations (north america, europe, and japan) lead the world in international business activities (rugman, 2003), cultures from western europe and north america were selected as the focus ofthis study because they represent two of the three prongs of the triad. in addition, specific nations were selected to provide cultural diversity and because of their accessibility for data collection. based on ronen and shenkar's (1985) typology, the following cultural groups are represented in the study: anglo (the u.k., usa), germanic (germany, switzerland), and nordic (denmark, finland, netherlands, norway, and sweden). this study emphasizes cultural rather than national differences because culture transcends national boundaries and appears to cause more variations in managerial attitudes and activities (hofstede, 200 i). cultures that perceive a greater control over their environments and that can tolerate ambiguity tend to use a more rational/analytic, top down approach to strategy making (schneider & barsoux, 2003). individuals operating in cultures with the opposite value profile perceive they have less control over their environment so strategy making follows a less methodical approach. compared to the higher uncertainty avoidance germanic culture, "managers from nordic and anglo countries are less likely to see environments as uncertain," and more likely to believe environments can be analyzed and known through rational processes such as strategic planning (schneider & barsoux, 2003, p. 122). since the anglo and nordic cultures are similar on the beliefs most associated with rational strategic planning processes, we expect the following: spring 2007 hoflman: strategic planning process 31 hypothesis 2: managers from anglo and nordic cultures will place a stronger emphasis on various strategic planning processes than those from germanic cultures. planning, performance and culture culture has been found to moderate strategic decision processes (hoffman & hegarty, 1993) and perceptions of strategic strengths and weaknesses (schneider & de meyer, 1991). while strategic planning and performance has been examined in non-u.s. locales, only a few of these studies have examined strategic planning in a cross-national setting. horovitz (1980) found that german and british firms engaged in long-range planning more than french firms. haiss (1990) found that certain planning process characteristics (e.g., planning horizon, use of quantitative methods, types of plans, etc.) and planning content (e.g., objectives, forecasts) varied among banks within ten different nations; he speculated that cultural ditlerences were the reasons behind his observations. recently, a study among smaller firms found that the relationship between detailed planning and non-financial firm success was moderated by culture (rauch, frese & sonnentag, 2000). these studies suggest that the strategic planning process and the planning performance relationship do differ among cultures. insights regarding why or how planning and performance differs across cultures investigated here are provided by a few studies. since strategy enables the firm to adapt to its environment, how managers perceive and react to environmental uncertainty is relevant to strategy making. previously, we noted that anglo and nordic cultures believe the environment can be analyzed and known (schneider & barsoux, 2003). as a result, managers from these cultures are attracted to analytical approaches to strategic planning. case studies of nordic firms from denmark (schneider & barsoux, 2003) and sweden as well as u.s. (anglo) firms (schneider, 1989) have noted the use rational/analytic approaches to strategic planning. differences in strategic planning processes between anglo (e.g., u.k. and u.s.) and germanic (e.g., german) firms have been observed in two other studies. horovitz (1980) found that british firms, compared with german firms, used planning that was more strategically versus operationally oriented, used a longer time horizon, and placed more emphasis on performance. haiss (1990) found that, compared to u.s. firms, german firms used a longer planning horizon, planned on a less regular basis, and conducted planning more as a staff versus a line function. the overall planning process among the u.s. firms was rational and analytical; whereas, the germans employed a more political process. taken together, these studies suggest that the strategic planning processes of anglo and nordic firms appear to be similar to each other while the processes within german firms appear to differ from the rational/analytical planning model. the planning process characteristics examined in this study are typical of the rational/analytical approaches to strategic planning. moreover, most ofthe studies 32 journal of business strategies vol. 24, no.1 relating planning to firm performance have described rational/analytic approaches to strategic planning. thus, the following hypothesis is offered: hypothesis 3: culture will moderate the relationship between strategic planning andfirm performance: hypothesis 3a: strategic planning processes will be positively related to performance within the anglo and nordic cultures, and hypothesis 3b: strategic planning processes will exhibit a weaker relationship to firm performance within the germanic culture. in this section we briefly explore some possible relationships that hofstede's (2001) value dimensions might have with planning and its subsequent impact on firm performance. schneider and barsoux (2003) have argued that uncertainty avoidance affects the overall planning process; whereas, power distance is likely to affect the degree to which the planning process is structured (hofstede, 200 1). self-orientation seems to affect the managerial relationships among those engaged in the planning process (schneider & barsoux, 2003). high power distance cultures are expected to have a top-down highly structured planning approach (brock et ai., 2000). uncertainty avoidance may be associated with: increased planning activity (hofstede, 2001), the perceived importance of planning, and the length of planning time horizon (haiss, 1990). for example, low uncertainty avoidance cultures tend to favor more flexible, short-term strategic planning processes (brock et ai., 2000). individualist values affect planning relationships as well as the comprehensiveness of the planning system (schneider & barsoux, 2003). individualistic cultures allow for more varietylflexibility in the planning process; whereas, collective cultures pursue cooperation and expect all to conform to the same process (brock et ai., 2000). in competitive, masculine cultures tight, structured planning processes are preferred to insure desired results (steensma, marino & weaver, 2000). feminine cultures prefer planning processes that are flexible and bottom-up (brock et ai., 2000). the above discussion suggests that these cultural values appear to be associated with differing characteristics of the planning process. thus, we propose the following exploratory hypothesis: hypothesis 4: formal strategic planning processes will be positively related to firm performance given the following cultural values: hypothesis 4a: higher levels o.lpower distance hypothesis 4b: lower levels of uncertainty avoidance. hypothesis 4c: higher levels of individualism. and/or hypothesis 4d: lower levels o.l masculinity. as noted previously, different contingencies, in addition to the firm's culture, are likely to affect the planning-performance relationship. thus, the tests of the spring 2007 hoffman: strategic planning process 33 hypotheses will control for three primary contingencies as identified in previous research. these contingencies include industry and company size which were identified as variables affecting firm performance in meta-analyses (boyd, 1991; miller & cardinal, 1994) of the planning and performance relationship. firm strategy has emerged more recently as an important contingency variable (schneider & barsoux, 2003; veliyath & shortell, 1993) when examining the strategic planning and performance relationship. as one study recently noted, "strategy moderates the relationship between planning and firm performance," (rogers, miller & judge, 1999, p. 574). following this latter study, strategy is represented by miles and snow's (1978) typology because it has been found to be valid in a variety of firms and industries (james & hatten, 1995; shortell & zajac, 1990; zahra & pearce, 1990). the typology classifies firms as pursuing one of the following four strategies: defender (narrow focus and efficiency), prospector (innovativeness), analyzer (operating in multiple environments), or reactor (no consistent strategy). research methods sample and data the data for this study were collected by using a mailed questionnaire sent to a stratified (by country and size) random sample of 150 manufacturing firms selected from national directories of major multinationals. firms had to be of sufficient size to increase the likelihood of their familiarity with formal strategic planning and to insure ample publicly available data on firm and performance characteristics. questionnaires were mailed to the corporate planner or senior executive in each firm most familiar with the firm's strategic planning processes as designated by the ceo. prior to translations, the questions were pre-tested with managers from each of the three cultural groupings for congruence in understanding. minor changes were made to insure the meaning was consistent across cultures. the questionnaires were available in english and german. translations were verified and pre-tested using the multi-step, back-translation procedure developed by hoffman and hegarty (1983). data on firm size, industry, age, and objective firm performance were obtained from secondary sources directories providing business and financial information. an international sample of 75 firms provided data (18 firms chose not to participate for a variety of reasons; 2 provided incomplete data), yielding a 57.7% net response rate; this sample size compares favorably with similar studies of this type (rauch et ai., 2000; ramanujam & venkatraman, 1987). ninety-one percent of the responding managers were born and educated in the country/culture in which their firm was located. one of the non-natives received most of his education in his current country of work. furthermore, 94% of the top management teams of the firms were native to the culture of their firm's location. this provides some confidence that perspectives of each culture are represented in our respondents. additional statistical tests were conducted to further insure that 34 journal of business strategies vol. 24, no. i our cross-cultural results are not confounded by other factors. a comparison of the responding firms with non-respondents revealed no systematic differences in terms of size, industry or nationality. the firms are located in eight european countries (denmark, finland, germany, netherlands, norway, sweden, switzerland, and u.k.) and the united states. on average the sample firms produce durable goods, generate $6.1 billion in sales, employ about eighteen thousand people, have been in existence for almost a century, and tend to pursue more proactive analyzer and prospector strategies. nevertheless, the proportion of firms pursuing each strategy falls well within the ranges observed in other studies (rogers et ai., 1999; zahra & pearce, 1990). table i also breaks down the firm characteristics by cultural grouping. variable measurement strategic planning processes were assessed using several variables/dimensions and were all subjective measures. we selected planning scales used by studies cited in the meta-analyses of past planning and performance studies (boyd, 1991; miller & cardinal, 1994). the use of previous scales provides measures with criterion-related validity and permits comparisons with previous studies. planning maturity was assessed using rhyne's (1986) single item scale (1 = new system, 3 = basic system with annual changes, 5 = mature system). planning impact was assessed using two items (alpha = .90) one drawn from rhyne (1986) concerning the value of long range planning and an effectiveness item relating to the usefulness of the system (ramanujam & venkatraman, 1987). planning horizon was adapted from one item (1 = less than a year to 5 = 10+ years) drawn from rhyne (1986). planning importance was assessed by a 4 item (alpha = .80) scale (1 = not important to 5 = extremely important) also taken from rhyne (1986). finally, planning commitment was a planning process variable developed for this study at the suggestion of managers used in the pretests to capture the finn's commitment to the planning process now and in the future. the commitment scale is comprised of two items pertaining to the use of formal strategic planning now and in the future (i = not important to 5 = extremely important). these items were factor analyzed and comprised a single factor so they were averaged to provide a single measure for planning commitment, exhibiting good reliability, alpha 88. culture was assessed by two methods as discussed earlier. the first method was the use of country clusters based on the work of ronen and shenkar (1985). the nine nations were classified into three cultural groups (nations, number of firms): anglo (united kingdom 7, united states 23), germanic (germany 11, switzerland 10) and nordic (denmark i, finland 4, netherlands 9, norway 2, sweden 8). culture was operationalized as two dummy variables germanic and nordic, a zero on both of these variables represents the anglo culture in the analyses. the second method was the use of hofstede's (2001) value indices for four social values of power distance, uncertainty avoidance, individualism, and masculinity. these indices range from 0-115 and were drawn spring 2007 hoffman: strategic planning process 35 from hofstede's data for each country in our sample. the two measures of culture capture different aspects of the concept as revealed by the low average intercorrelation among the two methods used of r = .22. table 1 firm characteristics: means and percentages (n = 75) total sample sales: $6.1 bin. ($30 mil 76.4 bin) i employees: 17,583 (375 368 k) firm age: 98.7 yrs (21-248) country (no. offirmsf: denmark (1) n sweden (8) n finland (4) n switzerland (10) g germany (11) (i united kingdom (7) a netherlands (9) n usa (23) a norway (2) n industry: durable goods: (42) 56% non-durables: (33) 44% strategy 3: defenders analyzers prospectors reactors (7) 9.69% (35) 46.7% (25) 33.3% (6) 8.2% culture: anglo germanic nordic no. firms 30 21 24 sales $1.4 bin $7.4 bin. $9.9 bin countries 2 2 5 employees 10.6k 29.5k 14.8k firm age (yrs) 95.4 103.2 98.4 industry: durables (19) 63% (11 ) 52% (12) 50% non-durable (11) 37% (10) 48% (12) 50% strategy: 3 defenders (3 ) 10% (2) 9.5% (2) 8.3% prospectors (9) 30% (9) 42.9% (7) 29.2% analyzers (16) 53% (10) 47.6% (9) 37.5% reactors (i) 3% (5) 20.8% i k = thousands; mil = millions; bin = billions. cultural group: a = anglo culture; g = germanic culture; n '" nordic culture. ) two firms did not provide data. 36 journal of business strategies vol. 24, no. 1 furthermore, as a validity check for our first measure based on cultural groupings, hofstede's (2001) value data for each country were averaged by country cluster and means were compared using anaya's. there were significant differences for all four values across the three cultural groups (f = 25.6 to 1142.4, all at p < .000 i) indicating that the three cultural groups are significantly different on these values (see appendix). moreover, these results reveal that hofstede's (200 1) values do help discriminate among the cultural groups in our sample. firm financial performance was assessed in two ways using subjective as well as objective measures. subjective measures were chosen given the difficulty of obtaining complete objective financial data in a multinational sample of firms. the four-item scale developed by dess and robinson (1984) has the respondents assess a firm's return on assets (roa), return on sales (ros), 5-year sales growth, and overall performance relative to similar firms in its industry and region (1 = lowest 20% to 5 = top 20%). the subjective measures of ros, roa, and sales growth were significantly correlated with objective measures of these same performance measures among a sub-sample of firms for the year preceding the data collection (mean r = .30 range .22 to .42, p -'s .03). this correlation with current performance is consistent with the findings of dess and robinson, (1984). the four subjective measures loaded on a single factor (eigenvalue = 2.81, variance accounted for 70.1 %, alpha =. 88), and therefore, were averaged as a single measure of subjective firm performance. sufficient data were obtained for the year of data collection and three years following our survey to provide objective measures of sales growth and return on assets averaged over this same four year period. these objective measures were not significantly correlated (mean r = .06, range -.11 to .01) with their subjective counterparts suggesting that they tap different aspects of future firm performance relative to the data collection period. on the other hand, the subjective performance data appears to reflect current performance (correlated with objective measures near the time afdata collection). these objective measures were selected because of their prevalence in previous planning-performance studies (boyd, 1991) and their availability in secondary sources. strategy was subjectively measured by the respondents using miles and snow's (1978) self-typing procedure; wherein, the respondent classifies their firm's strategy as either defender (narrow product line and emphasis on efficiency of operation), prospector (search for new opportunitieslinnovations), analyzer (operate in stable and changing markets simultaneously), or reactor (lacks a consistent strategy). this strategy measure has been found to have considerable criterion-related validity (james & hatten, 1995). these strategic classifications were converted to an interval-type scale as developed by shortell and zajac (1990) providing a measure of the firm's strategic orientation (i = reactor, 3 = defender, 5 = analyzer, and 7 = prospector). the remaining control variables of industry and size were objective measures obtained from archival sources. since all firms were in manufacturing, they were classified as manufacturers of either durable (e.g., electronics, vehicles) or nonspring 2007 hoffman: strategic planning process 37 durable goods (e.g., food, chemicals), so industry was represented by a dummycoded variable. size was measured as the average number of employees over the same four-year period as the objective performance measures. analysis prior to testing the hypothesis, additional tests were run on the data to insure that responses were not confounded by factors not already accounted for in our tests. these tests revealed that responses to planning processes were not affected by the managers' country of citizenship, education level, nor years working for their firm (hotehing's t ranged from .08-.16 at p levels of .35-.65). furthermore, the planning process did not differ based on firm performance (p s .25) indicating that firm performance did not appear to affect the use of planning processes. thus, it does appear that higher performance does not necessarily lead to differential planning processes. the first hypothesis concerning the stability of the planning-performance relationship across cultures was assessed with regression analysis. subjective performance was regressed on planning characteristics while controlling for culture, industry, firm size and strategy. the second hypothesis regarding the differences in planning process characteristics was assessed using multiple analysis of covariance (mancoya) with the five planning process variables as the dependent variables, culture as the independent factor, and the control variables (i.e., firm size, industry, and strategy) as the covariates. the third hypothesis concerning variations in planning-performance across cultures was assessed by dividing the sample into three cultural sub-samples. within each cultural grouping, partial correlation coefficients were calculated between each planning process variable and both subjective and objective (i.e., sales growth and roa) measures of firm performance while controlling for industry, firm size, and strategy. support for this hypothesis is established when one or more of the planning process variables is significantly related to one or more of the measures of firm performance. significant partial correlation coefficients were compared across cultures using fisher's z test for correlation coefficients. the fourth hypothesis concerning the moderating effects of cultural values on the planning-performance relationship was assessed with a series of five moderated regression analyses, one for each planning variable. the control variables (size, industry, strategy), cultural values, and a planning variable were entered first into each equation followed by four interaction terms of each cultural value (score standardized to minimize multicollinearity) multiplied by the planning variable in the equation. it can be expressed as follows: yperf = (c size + c ind + cstral) + (vpd + vu• + v idv + vmj + p1anx + (p * v + p * v + p * v. + p* y ) x pd x ua x idv x mas where c = control variables, v = 4 values (pd, ua, idv, mas), p x = one of five planning processes, and p x * v f the interaction term between each value and the planning process investigated. 38 journal ofbusiness strategies vol. 24, no.1 for each moderated regression equation, the dependent variable was subjective firm performance (\erf) given the need for adequate sample size, objective performance measures had too many missing values for these analyses. significant interaction terms (p * v ) would indicate a moderating effect for the associated x x cultural value. results the first hypothesis concerning the positive relationship between strategic planning and firm performance does appear to be relevant across all three cultures, supporting the hypothesis. subjective (s) performance was regressed on the planning process variables controlling for culture, industry, size, and strategy, the results are displayed in table 2. the overall equation is significant (f = 2.18, dfl0, 64, p:::; .03). two of the five planning process variables, planning system maturity and planning impact, were significantly and positively associated with firm performance. these relationships hold up across all three cultural groups, therefore, partially supporting the hypothesis for subjective firm performance, two of the control variables were significantly associated with performance firm size and strategy. neither culture nor industry had a direct effect on firm performance. the results were the same for both cultural measures so only those for the cultural grouping measure are displayed in the table. similar tests were not conducted for objective performance measures due to insufficient data and sample sizes. table 2 performance regressed on planning processes across cultures (n = 75) controls: planning: f=2,18*(dfl0,64) ** p. < ,01 * p < ,05 + p < .10 variables industry german nordic size strategy maturity impact horizon importance use beta .08 .09 .10 .22+ ,30** ,21+ ,31 * -,12 -,14 -,04 spring 2007 hoffman: strategic planning process 39 the second hypothesis concerning the planning emphasis of anglo and nordic cultures was marginally supported. the results of man cava (see table 3) were marginally significant (hotelling's t = 0.31, f = 1.86, p :s .06). one way ancovas revealed cultural differences only for the planning horizon dimension (f = 7.48, p:s .00 l). post hoc tests (lsd) revealed that germanic firms used a longer planning horizon (mean = 4.70) than firms from either anglo (mean = 3.54) or nordic (mean = 3.50) cultures contrary to the hypotheses. there is no significant difference among the cultural groups for any of the other four planning system characteristics, contrary to the hypothesis. table 3 mean differences in planning processes across cultures mancova" hotellings t = 0.31, f = 1.86, p::; .06. anovaresults: anglo (n=30) germanic (n=21) nordic (n=24) planning: maturity 3.36 impact 3.68 horizon* 3.54 importance 1.97 commitment 3.88 3.40 3.83 4.70 2.30 3.85 3.23 3.52 3.50 2.14 3.67 .. covariates were industry, size, and strategy + ps.l0 * p s .05 the third hypothesis concerning stronger planning-performance relationships among the anglo and nordic cultures was partially supported, and the results are presented in table 4. partial correlation analysis within cultural groups, controlling for industry, firm size, and strategy, reveal more significant positive correlations between planning process variables and firm performance within the anglo (4/15 correlations or 27%) and nordic (3/15 correlations or 13%) cultures as compared to the germanic culture (1/15 correlations or 7%), as hypothesized (see table 4). in total 18% of the planning~performance correlations were significant. planning system maturity was not significantly related to any measure of firm performance among the anglo sample but was positively related to subjective performance (sp) within both the germanic and nordic samples. however, in both 40 journal of business strategies vol. 24, no, 1 of these cultures, system maturity was also negatively related to sales growth. the difference between the two positive correlations was significant (z = 5,16, p:s .00 i) indicating that system maturity was more strongly related to performance among the germanic firms, contrary to the hypothesis, the significant negative correlations were not significantly different from each other. overall, the results for system maturity do not support the hypothesis. planning system impact was significantly and positively related to the three measures of performance within the anglo culture and negatively related to sales growth within the nordic culture. planning impact was not significantly related to finn perfonnance within the germanic sample, providing some support for the hypothesis. planning horizon was not significantly related to any performance measure within the anglo and germanic samples but was positively related to roa within the nordic culture providing partial support for the hypothesis regarding the nordic sample, the hypothesis regarding planning importance was not supported. there was only one significant relationship to subjective performance within the nordic culture, but it was negative, contrary to the hypothesis. finally, planning commitment was positively related to at least one performance measure within the anglo (sales growth) and the nordic (roa) samples but not within the germanic sample. these results support the stronger relationship between planning and performance within the anglo and nordic cultures, as hypothesized. table 4 partial correlations of planning and performance by culture controlling for industry, size, and strategy culture: anglo germanic nordic planning/performance: sales sp l growth roa maturity -.09 ,03 -,19 impact .47* .48* .48* horizon .15 -,17 -.16 importance .21 ,07 .10 use -.13 .36+ -.13 i sp = subjective performance ** p<.ol * p < .05 + p < .10 sales sales sp l growth roa spi growth roa ,39+ -.44+ -,26 ,30+ -.40+ .31 -.19 .32 ,22 ,11 -.57* * .14 -.04 .33 -,23 -.44* -.52* .44+ -.28 .01 -,24 -,60** -.18 -.24 -.06 .17 ,39 ,02 .09 .41+ spring 2007 hoffman: strategic planning process 41 in those instances where a given planning process variable was significantly related to the same performance measure, the differences were not always significant. for example, system maturity was negatively and significantly related to sales growth within the germanic and nordic cultures, but the differences in the correlation coefficients between the two samples were not significant (z = -.096, p :s .93). however, planning impact was positively and significantly related to sales growth among anglo firms but negatively related to sales growth among nordic firms, the difference in correlations was significant (z = 2.52, p::s .02). forty-three percent (6 of 14 ) of the significant correlations were negative and most of these negative planning-performance relationships were within the nordic sample. these results reveal the lack of a simple relationship between planning and different performance measures across cultures. there was some support for hypothesis 4 concerning the moderating effects of cultural values on the planning-performance relationship. the moderated regressions for three of the five planning processes on subjective firm performance were significant, see table 5. the moderated regressions for planning maturity and planning horizon were not significant once the interaction terms were entered into the equation, indicating no cross-cultural difference in the planning performance relationship for these processes contrary to hypothesis 4. the moderated regressions for each of the other planning processes were significant after the interactions between planning and cultural values were entered into the equations, in support of the hypothesis. for planning impact the interaction terms with power distance were significant and positive (partial corr. or pr = .24) while that for uncertainty avoidance was highly significant and negative (pr = -.32). these results indicate that planning impact is more strongly related to firm performance in cultures having higher levels of power distance and lower levels of uncertainty avoidance, supporting hypotheses 4a and 4b. there were no findings in support of hypotheses 4c and 4d for planning impact. the moderated regression for planning importance was also significant. the interaction between planning importance and uncertainty avoidance was highly significant and negative (pr = -.21) while that for masculine values was significant and positive (pr = .28). this suggests that planning importance is more strongly related to performance in cultures having lower levels of uncertainty avoidance supporting hypothesis 4b and higher levels of masculinity contrary to hypothesis 4d. hypotheses 4a and 4c were not supported for planning importance. finally, the moderated regression between cultural values and planning commitment was also significant. only the interaction term for power distance was significant and positive (pr = .22) indicating that planning commitment is more strongly related to firm performance in cultures having higher levels of power distance supporting hypothesis 4a. the results for planning commitment did not support the other parts of hypothesis 4. thus, some support was found for the moderating effect of three ofthe four cultural values on at least one of the planning processes examined. only individualist values did not moderate the relationship between any of the planning processes 42 journal ofbusiness strategies vol. 24, no.1 table 5 moderated regressions examining the effects of cultural values on the planning-performance relationship dependent variable: subjective performance (df full model 12,62) planning process model: maturity impact horizon importancecommitment equation statistic f = 1.26 r2 = .09" f = 2.46* r2 = .19 f= 1.48 r 2 = .07 f= 2.25* r2 = .17 f = 1.92* r2 = .13 interaction term partial corr. (pr) pdx uax idyx masx a adjusted r2 ** p s .01 * p:::: .05 + p:::: .10 .14 .24+ .08 .07 .22+ -.08 -.32** -.11 -.21+ -.08 -.15 -.19 -.08 .07 -.18 .04 .02 .20 .28* -.03 and firm performance measures investigated. it does appear that differences in cultural values can partially explain the planning-performance relationship across national cultures. summary and conclusions this study helps establish the validity of a systematic planning-performance relationship among firms from different cultures. the results of this study found support for three of the four hypotheses investigated. the perceived use of planning system characteristics investigated here did not vary much across the three cultural groups examined. however, when controlling for industry, firm size, and strategy, strategic planning processes were positively and significantly associated with subjective firm performance. these results establish the validity of the planning-performance relationship among multiple cultures. in the investigation of the second hypothesis, culture had little direct or independent relationship to planning. however, the results of testing the third hypothesis reveal that the strength of the planning-performance relationship does indeed vary by culture. moreover, it appears that culture has a moderating effect similar to that found in other studies (hoffman & hegarty, 1993) of strategic decision processes. spring 2007 hoffman: strategic planning process 43 in this study, the planning-performance relationship appeared strongest within the nordic culture with three of the five planning system characteristics positively related to one or more measures of firm performance. two of the planning characteristics were positively related to performance among the anglo culture while only one was significantly related to performance within the germanic culture, thus, supporting the hypothesis. the significant planning-performance relationships within the anglo culture were all positive, similar to that found in the majority of u.s. studies (boyd, 1991; miller & cardinal, 1994). however, within the germanic and especially the nordic samples, the planning -performance relationship was often negative. furthermore, a planning characteristic such as time horizon had a negative relationship with sales growth and a positive relationship with roa in the nordic culture. it may be that the planning horizon in nordic cultures is more directed toward the long-term as opposed to more immediate short-term growth. more needs to the known about the relative emphasis placed on certain performance measures in different regions of the world. the results of testing our final hypothesis indicate that specific cultural characteristics such as values may help explain what aspects of culture moderate the planning-performance relationship. three of the four values were found to moderate the relationship between firm performance and three of the five planning processes investigated. most ofthe significant interaction terms were in the predicted direction. these findings provide empirical support for prior observations (haiss, 1990) and conceptualizations (brock et ai., 2000; brock & barry, 2003) regarding cultural values and planning. this study is subject to a number of limitations. the sample size is somewhat small reflecting the cost and difficulties of cross-cultural data collection. the cultures sampled reflect only western industrialized nations, again due to access and cost of international research. furthermore, the planning measures focus only on perceptions of system characteristics. the measures used were previously validated and most were assessed with multiple items revealing strong reliability. furthermore, objective as well as subjective measures of performance were used. additional safe-guards included assessing for response bias and controlling for rival hypotheses or other variables in the firm's context known to affect firm performance. the implications of this study for practice are somewhat speculative because these results need to be replicated and because of the limitations noted above. strategic planning processes do seem to matter to firms across various regions and national borders. strategic planning processes also seem to vary by culture and by performance measure. these conclusions are depicted in figure 1. controlling for other contingencies, culture has little direct influence on planning processes and performance; however, it does moderate the planning-performance relationship. broadly speaking, culture was found to moderate the relationship between planning processes and both subjective and objective measures of performance as indicated by the solid arrows in figure l for example, subjective performance 44 journal of business strategies vol. 24, no. 1 appears to be positively affected by the maturity of the planning system in more than one culture. sales growth is positively affected by both the maturity and the perceived impact of the planning process while roa is not significantly affected by any of the processes examined in more than one culture. furthermore, certain planning processes are more likely to lead to improved (subjective) performance depending on the prevailing values in the culture as depicted by the arrow in figure 1. for example, at higher levels of power distance, planning impact and commitment have a more positive effect on performance. planning impact and importance have a positive performance effect in cultures having lower levels of uncertainty avoidance; whereas, planning importance has a positive effect on performance where masculine values predominate. thus, multinationals are wise to consider a multidimensional planning system and multiple performance indicators if they hope to be able to see bottom line benefits from their strategic planning process in a variety of locales. figure 1 effect of culture on the planning-performance relationship: a summary model culture-/ i general " --i / [ " values -.... "i / planning process content performance subjective objective other contingencies: industry, firm size, and strategy future research should strive for: larger sample sizes, more divergent cultural groups, and incorporating assessments of strategic planning content as well as spring 2007 hoffman: strategic planning process 45 process in replicating and extending the results found in this study. research on the preferences for or priorities assigned to certain firm performance measures appears to be warranted. managers in some cultures may value growth to profitability or short versus long-term performance measures. in addition, the use of specific cultural characteristics should help determine which aspects of culture are particularly germane in explaining the planning-performance relationship. such research might help further identify the planning and performance characteristics multinationals need to manage in conducting business globally. references boyd, b. k. (1991). strategic planning and financial performance: a meta-analytic review. journal of management studies, 28(4). 353-374. brews, p. j., & hunt, m. r. (1999). learning to plan and planning to learn: resolving the planning school/learning school debate. strategic management journal, 20(10), 889-913. brock, d. m., & barry, d. (2003). what if planning were really strategic? exploring the strategy-planning relationship in multinationals. international business review. 12(5), 543-561. brock, d. m., barry, d., & thomas, d. c. (2000). "your forward is our reverse, your right, our wrong": rethinking multinational planning processes in light of national culture. international business review. 9(6). 687-701. burt, d. n. (1978). planning and performance in australian retailing. long range planning, 14(2), 62-66. capon, n., farley, j. u., & hulbert, j. m. (1994). strategic planning and financial performance: more evidence. journal of management studies. 31 (1), 105-110. clark, j. (1990). international marketing and national character: a review and proposal for an integrative theory. journal (~r marketing. 54 (oct.) , 66-79. dess, g. g., & robinson, r. b. (1984). measuring organizational performance in absence of objective measures. strategic management journal, 5(3). 265-274. goll, 1., & rasheed, a. m. a. (1997). rational decision-making and firm performance: the moderating role of environment. strategic management journal, 18(7). 583-591. grant, r. m. (2003). strategic planning in a turbulent environment: evidence from the oil majors. strategic management journal. 24(6). 491-517. grinyer, p. h., & norburn, d. (1975). planning for existing markets: perceptions of executives and financial performance. journal of the royal statistical society, 138(!), 70-97. 46 journal ofbusiness strategies vol. 24, no.1 haiss, p. r. (1990). cultural influences on strategic planning. heidelberg, germany: physicaverlag. harju, p. (1981 ). attitude ofstrategic managers toward formalized corporate planning. turku, finland: school of economics. hoffman, r. c., & hegarty, w. h. (1993). top management influence on innovations: the effects of executive characteristics and social culture. journal of management, 19(3).549-574. hoffman, r. c., & hegarty, w. h. (1983). a model for development of a data collection instrument. proceedings of the annual meeting ({( the academy of management. dallas, tx. hofstede, g. (200 i ). culture:5 consequences (2nd ed.). beverly hills, ca: sage. horovitz, j. (1980) top management control in europe. london: macmillan. james, w. l., & hatten, k. j. (1995). further evidence on the validity of self-typing paragraph approach: miles and snow strategic archetypes in banking. strategic management journal, 16, 161-168. javidan, m. (1984). the impact of environmental uncertainty on long-range planning practices of the u.s. savings and loan industry. strategic management journal. 5(4), 381-392. kukalis, s. (1989). the relationship among firm characteristics and design of strategic planning systems in large organizations. journal of management, 15(4),565-579. lenartowicz, t. & roth, k. (1999). a framework for culture assessment. journal oflnternational business studies, 30(4), 781-798. leung, k., bhagat, r. s., buchan, n. r., erez, m. & gibson, c. b. (2005). culture and international business: recent advances and their implications for future research. journal ofinternational business studies, 36(4).357-378. miles, r. e" & snow, c. c, (1978), organizational strategy. structure and process. new york: mcgraw hill. miller, c. c., & cardinal, l. b. (1994). strategic planning and firm performance: a synthesis of more than two decades of research. academy of management journal, 37(6).1649-1665. ramanujam, v., & venkatraman, n. (1987). planning system characteristics and planning effectiveness, strategic management journal, 8, 453-468, spring 2007 hoffman: strategic planning process 47 rauch, a., frese, m., & sonnetag, s. (2000). cultural differences in planning/success relationships: a comparison of small enterprises in ireland, west germany, and east germany. journal ofsmall business management. 38(4), 28-41. rhenman, l. (1973). organization theoryfor long range planning. new york: wiley. rhyne, l. c. (1986). the relationship of strategic planning to financial performance. strategic management journal. 7. 423-436. rogers, p. r., miller, a., & judge, w. q. (1999). using information processing theory to understand planning/performance relationships in the context of strategy. strategic management journal. 20(6). 567-577. ronen, s., & shenkar, o. (1985). clustering of countries on attitudinal dimensions: a review and synthesis. academy of management review, 10(3). 435-454. rugman, a. (2003). the regional solution: triad strategies for multinationals. business horizons. 46(6). 3-5. schneider, s. c. ( 1989). strategy formulation: the impact of national culture. organization studies, 10(2), 149-168. schneider, s. c., & barsoux, j. l. (2003). managing across cultures (2nd ed.). new york: prentice hall. schneider, s. c., & de meyer, a. (1991). interpreting and responding to strategic issues: the impact of national culture. strategic management journal. 12(4),307-320. shrader, b., taylor, l., & dalton, d. r. (1984). strategic planning and organizational performance: a critical appraisal. journal of management. 10(2), 149-171. sheehan, g. (1975). long-range strategic planning and its relation to firm size, firm growth, and firm growth variability: an explorative, empirical investigation. unpublished doctoral dissertation, university of westem ontario, canada. shortell, s. m. & zajac, e. 1. (1990). perceptual and archival measures of miles and snow's strategic types: a comprehensive assessment of reliability and validity. academy of managementjournal. 33(4), 817-832. sivakumar, k., & nakata, c. (2001). the stampede toward hofstede's framework: avoiding the sample design pit in cross-cultural research. journal ofinternational business studies, 32(3), 555-574. smith, g. (1980). planning for productivity. long-range planning. 13. 52-63. steensma, h. r., marino, l. & weaver, r. m. (2000). attitudes toward cooperative strategies: a cross-cultural analysis of entrepreneurs. journal of international business studies, 31(4). 591-609. 48 journal of business strategies vol. 24, no.1 veliyath, r., & shortell, s. m. (1993). strategic orientation, strategic planning system characteristics and performance. journal of management studies, 30(3), 359-381. zahra, s. a., & pearce, j. a. (1990). research evidence on the miles-snow typology. journal of management, 16(4), 751-768. appendix cultural groups and their value dimensions (means) values! anglo germanic nordic power distance2 38.8 h 34.5' 33.4' (low) (low) (low) uncertainty 43.4' 61.7h 44.5" avoidance (low) (med.hi) (low) se if-orientati on 90.5' 67.5 b 73" (lndiv.) (lndiv.call.) (indiv.) assertiveness 62.9' 67.9b 12.5" (masc.) (masc.) (fern.) source: hofstede (2001). within each row values with the same letters are not significantly different from each other based on least significant difference (lsd) post hoc tests. richard c. hoffman, (ph.d., indiana university) is a professor ofmanagement in the perdue school of business at salisbury university. his teaching and research focuses on strategic and international management. he has published in such journals as business horizons, decision sciences, journal ofinternational business studies, journal of management, and long range planning. dr. hoffman has held visiting positions in asia and europe and has served as the chair of the academy ofinternational business-northeast. the strategic planning process and performance relationship: does culture matter? high performance work practices and human resource management effectiveness: substitutes or complements? orlando c. richard university of texas at dallas richardson, tx nancy brown johnson university of kentucky lexington, ky abstract the human resource management literature has implicitzv treated high performance work practices (hpwps) and human resources management (hrm) efjectiveness as substitutesfor one another with respect to their relationship with .firm per.ft)rmance. we contend that hpwps and hrm effectiveness act both as substitutes and as complements. main effects reveal that only human resource management effectiveness affects market perfihmance and that hpwps affect innovation. however, interacting hpwps with hrm effectiveness positively relates to both market performance and innovation in support of our hypothesis. the results suggest that effective hrm can offset hpwp :,. expense and that hpwps can enhance the flexibility ofeffective hrm systems. high perfonnance work practices (hpwps), through significant investment in employees, have been touted as a way to make organizations more flexible and effective. often hpwps are viewed as an alternative to traditional productions systems that are finnly rooted in fredrick taylor's scientific management and subsequent fordist principles. however, we contend that having effective human resource structures (hrm effectiveness) can enhance the return on hpwps because hpwps require a heavy investment in human capital, that is lost if the firm cannot attract and retain quality employees. conversely, effective hrm systems can benefit from the innovative capabilities of hpwp that enhance the organization's ability to adapt and change. hence, we address the question, "are hpwps and effective hrm systems complements or substitutes?" we empirically test this question using data from the banking industry. first, we review the literature that supports these predictions. 134 journal ofbusiness strategies literature review and hypotheses vol. 21, no.2 high performance work practices no one has consistently defined, or even uniformly named hpwps (baker, 1999; becker & gerhart, 1996; delaney & goddard, 1997; wood, 1999). they have been called "high performance work systems," "alternate work practices," and "f1exi ble work practices" (delaney & goddard, 2001). despite the name variances, many of these programs share common elements including rigorous recruitment and selection procedures, incentives based upon performance, and extensive training programs focused on the needs ofthe business (becker, huselid, pickhus, & spratt, 1997). essentially hpwps require heavy investment in human capital that is intended to enhance employee skills, knowledge, motivation, and flexibility with the expectation that the employer is providing employees the ability and the opportunity to provide input into workplace decisions (van buren, & werner, 1996). companies expect this empowerment to enable employees to adapt quickly and readily to rapidly changing product and labor market conditions, and to improve operational efficiency and firm performance (becker & huselid, 1998; cappelli & neumark, 1999). although high performance work practices (hpwps) have often been touted as being good for both employers and employees, these practices require significant investments in human capital via training, coordination of initiatives, and time for managerial and employee input. because of the large investment in human capital, the value of these practices may be lost if the investment is not offset by increased efficiency and effectiveness. among others, cappelli and neumark's (1999) review of the literature (delaney & goddard, 2001; kling, 1995; u.s. department oflabor, 1993) suggests, on average, that hpwps are associated with increased productivity. however, cappelli and neumark (1999) caution that by examining only productivity effects, researchers ignore the cost side of the equation. despite this caution, numerous other studies also find a strong relationship between hpwps and firm performance studies that do consider both the costs and the benefits of hpwps (huselid, 1995; macduffie (1995). baker (1999: 28) concludes after extensively reviewing the literature, "the association of various practices with strong financial performance has been firmly established by a stream of relatively solid research." delaney and goddard's (2001) review also ascertained that most research, with two exceptions, also finds an association between hpwps and finn performance. interestingly, the cappelli and neumark's (1999) study was one of two that found the costs did not offset the benefits but they concluded that the effects were neutral (neither positive nor negative for the employer). for our purposes, we use a perceptual measure of performance on four dimensions: marketing, sales growth, profitability, and market share. in sum, the bulk of the evidence is that hpwps are associated with increased firm performance. thus, we hypothesize: fall 2004 richard & johnson: high performance work practices 135 hypothesis 1: more extensive use o/high performance work practices will be positively associated with market performance. nicholson, rees, and brooks-rooney (1990) argue that human resources have an important role to play in facilitating innovation. hpwps are focused upon such objectives as enabling people to think for themselves and to manage their own work (lawler, 1986; pfeffer, 1994). high performance work practices can increase innovation by: decentralizing management in order to allow employees to discover and use knowledge; encouraging team practices that allow learning to grow through increased multi-disciplinary knowledge; and putting that knowledge to good use (laursen, 2002). that thinking is consistent with the seminal work of burns and stalker (1961) who argued that the more organic the organizational form the more it stimulates organizational innovation. hpwps systematically try to create organic organizations by moving decision-making downward. laursen (2002) presents evidence that supports this contention. if the organizational objective is efficiency, more effective hrm systems are likely to increase firm performance, because hrm effectiveness focuses on building better production or service-delivery systems. in contrast, when a firm pursues innovative activities they are more likely to benefit from hpwps since they move the level of decision making downward, making the organization better able to respond to environmental changes. recent banking innovations have been associated with the ability to collect fees, and so we operationally define innovation as the proportion of non-interest income to total income. hypothesis 2: more extensive use ofhigh performance work practices will be positively associated with increased organizational innovation. human resource management effectiveness pfeffer (t 994) argues that sustained competitive advantage emerges from effective human resource management. huselid, jackson, and schuler (1997) define hrm effectiveness as "the delivery of high-quality technical and strategic hrm activities." operationally, we define hrm effectiveness as human resource management satisfaction with various human resource activities. these notions of effectiveness are premised on the fact that it is difficult to implement hrm policies and practices successfully. the general assumption of the hpwps literature is that firms implement these practices in a holistic, meaningful, and effective manner. however, as noted by kling (1995) many firms implement these practices in a piecemeal fashion, which means that their efficacy is eroded by inconsistency and a lack of supporting hrm systems. further, firms may adopt hrm practices for institutional reasons in contrast to adopting and implementing practices to provide a potent organizational force (huselid, et al., 1997). russo and fouts (1997) note, for example, that what matters is how a firm employs its organizational capabilities and its ability to manage human resources because 136 journal ofbusiness strategies vol. 21, no.2 resources or practices do not produce on their own. further eroding firm effectiveness is an organizational environment confronting typical problems of turnover, absenteeism, and other workplace dysfunctions -particularly given the high level of investment in human capital that is required. thus, hpwps are by no means synonymous with effective hrm systems. traditional hrm systems, predicated on an efficiency objective, offer stable procedures and protocols with set processes for dealing with routine employment problems such as absenteeism, discipline, and discharge. as noted by perrow (1986, p. 4), "bureaucracies are set up to deal with stable routine tasks; that is the basis of organization efficiency." traditional hrm systems establish rules and procedures that promote consistency and fairness throughout the organization. thus, an effective hrm system should enhance the firm's ability to attract and retain qualified employees and promote efficiency. however, effective hrm practices most likely lack the flexibility of hpwps. lfthe firm is pursuing an innovation objective, then effective hrm practices may interfere with this goal by focusing on routines and rules that do not provide an environment conducive for stimulating innovation. further, organizations that are structured to deal with stable routine tasks are less able to adapt to uncertain, dynamic environments. consequently, we expect that: hypothesis 3: perceived human resource effectiveness will be positively associated with market perjhrmance. hypothesis 4: perceived human resource effectiveness will be negative(v associated with innovation. the interaction of hpwps and hrm effectiveness many organizations today face complex environments. lawler (1986) notes that firms' management strategies must adjust and conform to the existing business environment. the present business environment demands that firms respond to change and, at the same time, promote efficiency. thus, firms that can combine effectiveness and flexibility objectives may be in the optimal strategic position whether they are pursuing objectives of innovation or market performance. contingency theories posit that the relationship between the relevant independent and the dependent variables vary by different levels of a critical contingency variable. the organization's strategy remains the primary contingency factor in the human resource management literature (delery & doty, 1996). numerous studies support the contingency perspective, which remains a viable approach to human resource management (arthur, 1994; ichnowski, shaw, & prennushi 1997; kochan & osterman, 1994; youndt, snell, dean, jr., & lepak, 1996). for example, youndt, et al. 's (1996) results reveal that manufacturing strategy moderates the hrm practice-performance relationship, and thus, supports the contingency approach. while noteworthy, none of the previous studies have focused on the use of internal contingencies in looking at hpwps and their fit with fall 2004 richard & johnson: high performance work practices 137 external contingencies such as business strategy. internal contingencies include those factors encompassed by the hrm system such as types of human capital, hrm processes, hrm practices, technical hrm effectiveness, and strategic hrm effectiveness (ferris, arthur, berkson, kaplan, harrel-cook, & frink, 1998; ferris, hochwarter, buckley, harrel-cook, & frink, 1999). we posit that the alignment of internal factors, in our case hpwps and hrm effectiveness, relates to additional performance gains above and beyond main effects. thus, hypothesis 5: more extensive use ofhigh perfhrmance work practices with hrm effectiveness will he positively associated with market per.ihrmance. hypothesis 6: more extensive use ofhigh performance work practices with hrmeffectiveness will be positively associated with organizational innovation. methodology data to examine within-industry differences, we studied a single industry, banking. the banking industry has become a highly competitive environment because of banking industry deregulation. the regulatory changes coincided with such technological advances as atms, telephone banking, pc-based banking, and information system advances. the industry responded to the changes by a significant wave of consolidation that reduced the industry from 12,000 to 8,000 banks between the years 1987 to 1995 (berger, kashyap, and scalise, 1995). regulation essentially prevented firms from implementing the full range of strategic choices (johnson, sambharya, & bobko, 1989). deregulation freed financial institutions to exercise strategic choice. the firm was the unit of analysis for this study. we employed both secondary data sources and a questionnaire. the questionnaire provided information on hpwps, hrm effectiveness, and market performance. we drew objective measures of organizational innovation and the four control variables from the sheshunoff bank search database. the sheshunoff database contains data from financial reports that the government is mandated to gather. banks in california, kentucky, and north carolina were surveyed to gain greater variation across dependent measures (e.g., market performance). after we pre-tested and modified the questionnaire, we contacted each bank to obtain the name of the human resource director. when possible, we contacted those directors directly and asked them to participate. in week one, we telephoned 576 banks, but 100 contacts initially refused to participate, so we mailed 476 surveys. in week two, we sent a reminder card. in week three we sent another survey. in week four we repeated the process with the same set of firms that we used in round i, starting with a telephone call to ask for their participation again. 138 journal ofbusiness strategies vol. 21, no.2 an additional 83 hrm executives declined to participate in the second round mainly due to (1) time constraints posed by the volatile nature of the banking industry (mergers, acquisitions) and (2) unwillingness to provide organizational demography (race and gender composition) data that was a separate component of the survey. eighty surveys were returned, presenting a 20 percent overall response rate from those agreeing to be surveyed and 13.8 percent response rate for the entire sample. we sought to assess whether characteristics of individual banks made their hrm managers less likely to complete and return the survey. following the work of osterman (1994) as well as delery and doty's (1996) banking study, we used a logistic regression, with the dependent variable defined as a dummy variable coded 1 if the hrm director responded and 0 if the director did not. following delery and doty (1996) we used holding company affiliation and total assets. organizational innovation was included as one of our independent variables because that is one of the key variables of interest in this study and we did not want our sample limited to the most innovative banks. none ofthe variables were significant and that indicates a lack of support for a response bias. dependent measures table 1 lists the variables with their individual items where appropriate, their data source, and their coding. lumpkin and dess (1996) note that research testing hypotheses should include multiple performance measures to avoid misleading descriptive and normative theory building. such measures should include intermediate and bottom-line measures of firm effectiveness. we collected perceived market performance assessment measures directly from the hrm executives. following delaney and huselid (1996), we asked the respondents the following: "compared to other organizations that do the same kind of work, how would you compare your organization's performance over the last three years (i.e., 1994, 1995, 1996) in terms of: i) marketing, 2) growth in sales, 3) profitability, and 4) market share. each item was measured on a four-point likert-type scale ranging from 1 = worst to 4 = much better and averaged to form the composite measure of acceptable reliability (a = .81). marketing refers to the success in targeting and reaching a larger customer base. although related, this process is distinct from actual market share or growth in sales. from a measurement standpoint, a company can tell by an increase in customer interest in products (i.e., service inquiries). again, this does not refer to the increase in customers which would be market share. this perceptual bottom-line measure was associated with an objective measure, return-on-equity (r = .40, p < .01). organizational innovation is our other dependent measure. since deregulation, many banks have introduced new products and services that do not fit the traditional margin-maximizing schema where margin is the difference between the loan rate and the deposit rate. instead, fee income such as origination fees from corporate cash management accounts, letters of credit, and home mortgages have become an increasing important source of bank revenues. hence, the proportion of total variable name table 1 variables, data sources, and measures variable source coding >-r:j e.-n o o -+:>total assets dummy code where i = holding and 0 ~ other california ~ i and other states = 0 ~ kentucky = i and other states = 0 g. sum of the ten items percentages. ~ re ~ ~ ~ c:: ;:s size holding company atlliiated california dummy control kentucky dummy control high performance work practices (a = .90) what percentage of the work force ... • is included in a formal information-sharing program (e.g., newsletter)? • hold jobs that have been included in a formal job analysis? • is regularly administered attitude surveys? • participate in quality of life (qwl). quality circles (qc). and/or labor management participation programs? • is eligible for company incentive plans. profit-sharing plans, and/or gainsharing plans? • received training by an experienced employee (i.e.• someone employed more than one year)') • has access to a formal grievance procedure and/or complaint resolution system'.' • has their merit increase or other incentive pay determined by a performance appraisal? • receives formal performance appraisals? • are promoted based primarily on merit (as opposed to seniority)? human resource management effectiveness (0. =.89) satisfaction with the results being achieved with their employee participation and empowerment teamwork workforce planning-flexibility and deployment advanced issue identification-strategic studies management and executive development succession and development planning workforce productivity and quality of output employee and manager communications market performance (0. = .81) compared to other organizations that do the same kind of work, how would you compare your organization's performance over the last 3 years in terms of marketing, gro\\'1h in sales, profitability, and market share innovation sheshunoff database sheshunotr database sample selection sample selection survey survey survey sheshunoff database each item was on a five point likert scale ranging from i = highly satisfied to 5~ vel)' dissatisfied, reversed coded. and summed, average of the four performance items on a four point likert scale ranging from 1=worst to 4 ~ much beller. ratio of net·interest income to total income. :::j:: oti' ~ ~ ~c:: ~ ~ ~ *~ c q a' ..w '0 140 journal olbusiness strategies vol. 21, no.2 income generated by these alternative fee-based products and services represents an important measure of banking innovation. this measure was obtained from the sheshunoff bank database by calculating the ratio of non-interest income/total income consistent with richard and johnson (1999). independent variables we used a ten-item scale validated and deemed reliable by huselid (1995) to capture high performance work practices. by using an existing scale, we avoid the criticism that comes from employing a new and inconsistent set of hpwps that do not allow comparison to previous research (becker & gerhart, 1996). we asked the respondents to indicate what percent of time they devote to ten hpwps. these percentages were then summed to comprise the hpwp measure. we also found the scale to have internal reliability (a = .90). human resource management effectiveness was measured from a scale derived by huselid, et al. (1997). the operational definition includes activities that align the human capital pool with long-term business needs. the human resource managers were asked to use a five-point scale to report their satisfaction with the results being achieved with employee participation and empowerment, teamwork, workforce planning-flexibility and deployment, advanced issue identification-strategic studies, management and executive development, succession and development planning (managers), workforce producti vity and qual ity ofoutput, and employee and manager communications. the items were measured on a likert-type scale ranging from ( 1) highly satisfied to (5) very dissatisfied and were reversed coded to ease interpretation. the sum of all eight items measured effectiveness. there was acceptable internal reliability (a = .89). controls several control variables were used. we operationalized firm size by using the total dollar value of assets obtained from sheshunoff. previous research has shown a relationship between size and profitability in the banking industry (delery & doty, 1996; ramaswamy, 1997). sheshunoff also provided the data used to construct an indicator variable that was included to measure whether the bank is part of a holding company (= i if holding company; = 0 other). two dummy variables controlled for state differences (california = 1; other= 0; and kentucky = 1; 0 =other leaving north carolina as the omitted state. analysis hierarchical regression analysis was employed to test the hypotheses. in the first step, the control variables were entered. the second step, hrm effectiveness and hpwps were added to test hypotheses 1 through 4, which examined whether hpwps and hrm effectiveness related significantly to the dependent measures after accounting for the controls. step 3 tested the interaction effects proposed in the fifth and sixth hypotheses. fall 2004 richard & johnson: high performance it()rk practices results 141 correlations table 2 provides descriptive statistical information (e.g., means, standard deviations, and correlations) for all measures. table 3 shows the results ofour hierarchical regression for market performance and organization innovation. hypothesis i states that there will be a positive relationship between hpwps and market performance. in the second step of the outcome regression, with total assets, holding company ownership, and state controlled, hpwps were not significantly related to market performance (13 = .08, p = .25). thus, no support was found for this hypothesis. the second hypothesis posits a positive relationship between hpwps and innovation. in step 2 of the regression, after entering the control variables, hpwps were significantly and positively related to organization innovation (13 = .22, p = .03), lending support for this hypothesis. the third hypothesis predicted that hrm effectiveness would positively relate to market performance and, after entering the control variables, this hypothesis was supported (13 = .24, p = .03). hypothesis 4 predicted that hrm effectiveness would relate negatively to innovation. in the second step of the organization innovation regression, the coefficient was only marginally significant but in the predicted negative direction. thus, this hypothesis received minimal support (13 -.19, p = .07). hypotheses 5 and 6 state that hpwps and hrm effectiveness will influence market performance and organizational innovation through a positive interaction effect. in the third step, the interaction effect significantly resulted in a change in r' increase for both market performance (13 .35, p .017) and organization innovation (f3 = .33, p = .019). the results suggest that internal alignment between hpwps and hrm effectiveness increase both market performance and organization innovation, supporting the last two hypotheses. in sum, we received support for the second, third, fifth and six hypotheses. the fourth hypothesis received marginal support. discussion many have viewed hpwps as a substitute for traditional hrm, believing that firms must choose either to implement hpwps or to approach hrm in the textbook manner consistent with traditional bureaucratic organizations. this view, consistent with the strategic approach, suggests that firms must match their human resource management practices with their business strategy to achieve superior results. based upon this reasoning, we hypothesized and found support for the argmnent that hpwps are associated with increased innovation, hrm effectiveness is associated with increased performance, and together both hpwps and hrm effectiveness is associated with both goals. however, we took strategic theory further to argue that although hpwps and hrm effectiveness are typically viewed as substitutes, they may complement each other. thus, hpwps -table 2 ~n correlations standard variable mean deviation 1 2 3 4 5 6 7 8 i. size 11.72 1.41 1.00 2. holding .48 .50 .34** 1.00 ~ ::: 3. california .... .66 .48 -.01 -.22** 1.00 :::; t:l-4. kentucky .i8 .38 -.05 .36** -.64** 1.00 ~ tj::i ::: 5. hpwps 508 158 .30** .26* -.01 .05 1.00 '""s;. l1:> '""6. hrm effectness 28 5 .19 .08 .28* -.19 -.02 1.00 '""s1.... 7. market performance 3 .65 .15 .14 -.24* .19 .09 .26* 1.00 t:l..... ~ 8. organizational innovation .43 .40 -05 -.06 1"** -.02 .22 -.21 -.18 1.00 ~. . .) '"" * p< .05; ** p< .01 (two-tailed tests) n=74 ~n-~ z ? n fall 2004 richard & johnson: high performance work practices 143 table 3 simultaneous hierarchical regression results for dependent outcomes variable step i: controls size holding california kentucky step 2: main effects hpwps hrm effectiveness step 3: interaction hpwps x hrm elfectiveness n adjusted r' equation p-value market performance innovation r' change ~ rl change 13 .or 04 .11 .11 .04 -.01 -.19 .23t .05 .12 .06t .07* .08 .22* .24* -.19t .06* .05* .35* "'*--)j 7r 78 .20 .16 .11 .07 2.27* 1.84t standardized betas reported tp<·l0 * p < ,05 ** p < .01; one.tailed tests. apparently yield more benefits in an environment where hrm is managed well, and hr management is enhanced because hpwps lend flexibility. our results are consistent with this view. hrm researchers have suggested that hpwps uni versally benefit all employers (pfeffer, 1994; huselid, 1995). the contingency theorists contend that strategic fit is crucial for superior performance so that firms must match their hrm practices with their business strategies. they argue that high investments in training and employees will payoff in terms of employee commitment and work effort. however, because hpwps do not come cheaply, firms either need to offset these expenses with productivity increases or operate in an innovative environment that can absorb these costs (cappelli & neumark, 1999). thus, hpwps are less compatible with firms pursuing efficiency objectives and more compatible with firms whose success is more dependent on innovation as opposed to efficiency. a major benefit of hpwps is to move the level of decision making downward to reduce the need for formal supervision so that employees are to think for themselves. these objectives may be of great importance for employers seeking to 144 journal ofbusiness strategies vol. 21, no.2 innovate or provide a responsive service, but may be problematic for employers pursuing efficiency objectives. notably, employers who have highly developed hierarchical and formal structures that follow an evolved model of scientific management may not benefit from hpwps. these employers have designed formal rules and procedures specifically to avoid employees thinking for themselves. thus, we argued that employers with innovation objectives would benefit more from hpwps than would employers seeking a market efficiency objective. on the other hand, employers who are seeking market efficiencies would directly benefit more if hrm were implemented effectively. our results support these suppositions. market performance correlated with hrm effectiveness but there was no evidence of hpwps having direct effects on market performance. this is consistent with the general research trend that finds either positive or neutral effects of these work practices on performance (for example, cappelli & neumark, 1999). thus, this suggests that performance objectives are best met through effective management and that hpwps alone are not the panacea to performance concerns. on the other hand, hpwps correlated strongly with innovation objectives suggesting that they are much more consistent with generating ideas rather than efficiencies. weak evidence hinted that innovation may be stymied by hrm effectiveness, after controlling for hpwps, suggesting that effectiveness alone may be too rigid to enhance innovation. interestingly, we also found significant moderating effects suggesting that well designed and integrated hrm systems with hpwps may enhance both performance and innovation objectives. thus, these results modify the strategic human resource management notion of fit the idea that firms must match their hrm objectives with the firm's business strategy. our results send a powerful message to firms: if you can do only one thing well (e.g., hrm effectiveness) then pursue an hrm system that fits with the firm's strategic objective (e.g., performance). thus, fit is important if your capabilities are not well developed. however, if you can effectively use human capital and implement hpwps, then do both. porter (1980) deemed that some organizations are "stuck-in-the middle" they lack a clearly defined strategic position, take a defensive position, react to the environment, and drift along without specific goals and objectives. at best they muddle along; at worst they fail. he argued that these groups, trying to be all things to all people, are instead nothing to everyone. although those arguments are compelling, our results suggest that having a combined focus, if done well, can work and pays off it depends upon how well the multiple strategies are executed. clearly, doing one thing well will provide a return if it is consistent with business strategy. but doing two things well is even better and enables organizations to perform on multiple dimensions. as resource-based scholars suggest, it is hard to implement effective management practices. our research findings imply that employers may want to first establish their objective, focus on hrm policies and practices to achieve that objective, and then work to expand their capabilities to incorporate alternative fall 2004 richard & johnsofl' high peliormance work practices 145 practices that will enhance their primary strategy. given these findings, we answer the question posed in the title ofthe paper hpwps and hrm effectiveness may be both substitutes and complements, the main effects suggest that they are substitutes as they relate to different dependent variables, but the interactions show that if hpwps and hrm effectiveness are combined they can also have complementary effects. these results are subject to the limitation ofcommon method variance because one of the dependent variables, with the exception of innovation, and the key independent variables were collected from the same respondent at the same time. hence, future studies will need to examine these questions using more objective performance measures to see if these relationships hold. in sum, this research suggests that finns first need to concentrate their efforts on fit. once fit is established, then the firms can extend their hrm practices to other domains. firms that have both hpwps and hrm effectiveness are the most successful on both innovation and market performance measures. although scholars have indicated that doing both is hard, our results indicate that it may be well worth it. references arthur, j. b. (1994). effects of human resource systems on manufacturing performance and turnover, academy of management journal, 37, 670-87. baker, t. (1999). doing well by doing good. washington, d.c.: economic policy institute. becker, b., & gerhart, b. (1996), the impact of human resource management on organizational performance: progress and prospects. academy of management journal, 39, 779-802. becker, b. & huselid, m.a (1998). high performance work systems and finn performance: a synthesis of research and managerial implications. in g.r. ferris (ed,) research in personnel and human resource management, vol. 16, (pp, 53-10 i). stamford, ct: jai press. becker, bb., huselid, m.a., pinkhaus, p.s. & spratt, m.f. (1997). hr as a source of shareholder value: research and recommendations. human resource management, 36,39-47. berger, an., kashyap, ak. & scalise, j.m. (1995). the transformation of the u.s. banking industry: what a long, strange trip it's been. brookings papers on economic activity,~, 55-218. burns, t., & stalker, g. m. (1961). the management of innovation. london: sage. 146 journal ofbusiness strategies vol. 21, no.2 cappelli, p. & neumark, d. (1999). do high performance work practices improve establishment-level outcomes? cambridge: national bureau of economic research working paper 7374. delaney, j. t., & goddard, j. (200 i). an industrial relations perspective on the high-performance paradigm. human resource management review, 11, 395-429. delaney, j. t., & huselid, m. a. (1996). the impact of human resource management practices on perceptions of organizational performance. academy of management journal, 39, 749-70. delery, j. e., & doty, d. h. (1996). theoretical frameworks in strategic human resource management: universalistic, contingency, and configurational perspectives. academy of management journal, 39, 802-35. ferris, g. r.,arthur, m., berkson, h. m., kaplan, d. m., harrel-cook, g., & frink, d. d. (1998). toward a social context theory ofthe human resource management-organization effectiveness relationship. human resource management review, ~, 235-264 ferris, g. r., hochwarter, w. a., buckley, m. r., harrel-cook, g., & frink, d. d. (1999). human resource management: some new directions. journal of management, 25, 385-15. huselid, m. a. (1995). the impact ofhuman resource management on turnover, productivity, and corporate performance. academy of management journal, 38, 635-72. huselid, m. a., jackson, s. e., & schuler, r. s. (1997). technical and strategic human resource effectiveness as determinants of firm performance. academy of management journal, 40: 171-88. ichniowski, c., shaw, k. & prennushi, g. (1997). the effects of human resource management practices on productivity: a study of steel finishing lines. american economic review, 87, 291-313. johnson, n.b., sambharya, r.b. & bobko, p. (1989). deregulation, business strategy, and wages in the airline industry. industrial relations, 28, 419-430. kling, j. (1995). high performance work systems and firm performance. monthly labor review, ill(5), 29-37. kochan, t. a., & osterman, p. (1994). the mutual gains enterprise: forgoing a winning partnership among labor, management, and government, boston: harvard business school press. laursen, k. (2002). the importance of sectoral differences in the application of complementary hrm practices for innovation performance. international journal of the economics of business . .2, 139-156. fall 2004 richard & johnson: high performance work practices 147 lawler, e. e. iii. (1986). high-involvement management. san francisco: jossey-bass. lumpkin, g. t., & dess, g. g. (1996). clarifying the entrepreneurial orientation construct and linking it to performance. academy of management review, 21, 135-72. macduffie, j. (1995). human resource bundles and manufacturing performance: organ izationallogic and flexible production systems in the world auto industry. industrial and labor relations review, 48, 197-221. nicholason, n. & rees, a., brooks-rooney, a. (1990). strategy, innovation, and performance. journal of management studies. 27, 511-534. osterman, p. (1994). how common is workplace transformation and who adopts it? industrial relations and labor relations review, 47, 173-188. perrow, c. (1986). complex organizations. new york: mcgraw-hill. pfeffer, j. (1994). competitive ,advantage through people. boston, ma: harvard business school press. porter, m. (1980). competitive strategy. new york: free press. ramaswamy, k. (1997). the performance impact of strategic similarity in horizontal mergers: evidence from the u.s. banking industry. academy of management journal, 40, 697-715. richard, o. c. & johnson, n. b. (1999). making the connection between formal human resource diversity practices and organizational effectiveness: beyond management fashion. performance impact quarterly, 11, 77-96. russo, m. v, & fouts, p. a (1997). a resource-based perspective on corporate environmental performance and profitability. academy of management journal, 40,534-559. u.s. department oflabor. (1993). high performance work practices and firm performance. washington, dc: us dol. van buren, m. e., & werner, j. m. (1996). high performance work systems. business and economic review, 43, 15-35. wood, s. (1999). human resource management and perfonnance. international journal of management reviews, 1,367-413. youndt, m. a, snell, s. a., dean, j. w., lepak, d. p. (1996). human resource management, manufacturing strategy, and firm performance. academy of management journal, 39, 836-66. fall 2004 richard & johnson: high performance work practices 148 nancy brown johnson earned her ph.d. in business from the university of kansas in 1986. since that time she has been a member of the management faculty at the university of kentucky. her primary research interests relate to compensation and justice topics including deregulation and wages, international compensation, and justice and union participation. she has published articles in industrial and labor relations review, industrial relations, human resource management review, and the british journal of industrial relations. orlando c. richard is an assistant professor of management at the university of texas at dallas. his research interests include cultural diversity and its organizational impact and human resource management system effects. high performance work practices and human resource management effectiveness: substitutes or complements? consumer perception of e-service quality: from internet purchaser and non-purchaser perspectives zhilin yang city university of hong kong • kowloon, hong kong minjoon jun new mexico state university • las cruces, nm abstract this exploratory study expands the knowledge concerning service quality dimensions in the context of internet commerce, from the differing perspectives of two groups: internet purchasers and internet non-purchasers. six primary service quality dimensions perceived by internet purchasers were uncovered: reliability, access, ease of use, personalization, security, and credibility while seven dimensions were discovered for internet non-purchasers: security, responsiveness, ease of use, reliability, availability, personalization, and access. when examining the relative importance of each dimension affecting overal1 service quality assessment, the "reliability" factor was found to be the most important dimension for internet purchasers while internet non-purchasers consider "security" as their most critical concern. introduction the internet commerce industry has gone through an initial period of focusing on new customers to the present stage of both retaining and attracting customers. instant price comparisons on the web, brought by powerful search engines, make non-price competitive advantages, such as service quality, ever more critical in retaining and attracting customers (griff & palmer, 1999; jarvenpaa & todd, 1997; uu & arnett, 2000). what brings online customers back, primarily, is a sense ofloyalty that comes from an internet company: offering better service than anyone else (hoff, mcwilliams & saveri, 1998). to offer better services, it is necessary for internet companies to investigate what existing and potential customers expect for service quality. in the context of internet commerce, existing customers are those who have utilized the internet as a channel to purchase products and services. potential customers, for internet commerce industry as a whole, are generally those who have utilized the internet as a source to search for information about desired products and services but have never purchased through the internet (i.e., they prefer to purchase through traditional channels), for purposes of this study, these two types of consumers are coined "internet purchasers" and "internet non-purchasers" respectively. 60 journal of business strategies the ideal action for internet companies is to improve and maintain all service quality attributes that satisfy both existing and potential customers' needs and wants. however, given that both large and small online companies have limited resources, priorities must be set among alternative service attributes in making investment decisions based on a company's business strategies. if online companies can understand the similarities and differences of key service quality dimensions perceived by internet purchasers and internet non-purchasers, different service offering strategies can be applied to retain existing internet customers and attract potential customers. therefore, it is necessary to understand both internet purchasers' and non-purchasers' perceptions of service quality attributes related to internet purchasing. nevertheless, no empirical attention has been given to examining the service quality attributes in the context of internet commerce from the perspectives of internet purchasers and internet non-purchasers. this article, therefore, intends to expand the body of knowledge relating to the service quality construct within the internet commerce context. three specific research questions are investigated: • what are the key underlying dimensions of service quality within the framework of internet commerce as perceived by internet purchasers and nonpurchasers? • are there any differences between the two groups' perceptions of service quality dimensions? if any, what are they? • which service quality attributes most significantly impact the overall service quality as assessed by internet purchasers and non-purchasers? conceptual background internet purchasers versus internet non-purchasers internet purchasers and non-purchasers are somewhat interchangeable. an internet non-purchaser tends to be an internet purchaser if she/he feels purchasing through the internet is the best option. meanwhile, an internet purchaser can be 'transformed' into an internet non-purchaser after unhappy or even painful experiences. for instance, many online consumers were adversely impacted due to poor order fulfillment and delivery (gray, 2000; jedd, 2000). consequently, they may keep searching for information through the internet but may stop online purchasing. as mittal and katrichis (2000) argued, the service quality attributes important to new customers might not be the ones that are important to loyal customers; the volume 25, number 2 61 same rule may apply to internet purchasers' and internet non-purchasers' different perceptions of service quality dimensions. with competition only a click away, internet companies strive to retain their customers and are struggling to convert their web site visitors to online purchasers. although hybrid companies (traditional companies with a transactional web site option) can influence internet non-purchasers to visit their stores physically, they still would like their customers to complete purchasing transactions through their web sites to ensure that orders are placed. therefore, for both internet-only companies and hybrid companies, the key issues are: (1) how to retain these relatively disloyal internet purchasers; and (2) how to turn internet non-purchasers into internet purchasers. perceived service quality dimensions perceived service quality can be defined as "a global judgment or attitude relating to the superiority of a service." (parasuraman, zeithaml & berry, 1988) over the past three decades, researchers have attempted to discover the global or standard attributes of a service that are important to the customer and that contribute significantly to customers' quality assessment. sasser, olsen, and wyckoff(1978) reported seven major attributes in the context of the service industry: security, consistency, attitude, completeness, conditions, availability, and training. later, ten dimensions were revealed in an exploratory study conducted by parasuraman, zeithaml, and berry (1985): tangibles, reliability, responsiveness, communication, credibility, security, competence, courtesy, understanding the customer, and access. based on these ten dimensions, parasuraman et al. (1988) further purified and distilled these ten dimensions of service quality to five: tangibles, reliability, responsibility, assurance, and empathy. these five service quality attributes constitute the basis for global measurement of service quality, namely, servqual. since that time, servqual has been applied to various service industries, although it has received some criticism (for a comprehensive review, see cronin & taylor, 1994; dabholkar, thorpe & rentz, 1996). the primary concerns raised by many scholars are that: (1) there is difficulty in measuring different types of expectations (cronin & taylor, 1994) and (2) service quality dimensions tend to be context-bounded and service-type-dependent (bienstock, 1997; van dyke, kappelman & prybutok, 1997). alternatively, cronin and taylor (1994) have argued that perceived service performance (servperf) would be a better indicator of service quality. 62 journal of business strategies during the past several years, a number of conceptual and empirical studies have attempted to address key attributes of service quality directly or indirectly related to internet commerce. rice (1997) examined what made users revisit a web site and discovered that the most important variables are design features, such as content, layout, ease offinding information, navigability, and emotional experience, such as enjoyable visits. hoffman and novak (1997) pointed out that personalization is the essence by which internet firms valorize the internet as a unique consumer market when investigating the web sites of the top 100 u.s. retailers, griffith and krampf (1998) mentioned that the lack of prompt responsiveness, especially to email inquires, was the most common phenomenon in cyberspace. they pointed out that customer service access through the web sites needed enough staff support to satisfy their customers. balfour, farquhar, and langmann (1998) put emphasis on transaction security and personal information privacy when examining consumer needs in global electronics. dellaert and kahn (1999) conducted four computerbased experiments to understand how waiting time of information download negatively affects consumers' perception of the performance of the web site. liu and arnett (2000) identified information quality, system use, system design quality, and playfulness as four major determinants for the success of web sites in the context of internet commerce. based on the survey of 250 online banking and securities brokerage users, sohn (2000) found that trust, interactiveness, ease of use, content/functionality of web sites, reliability, and speed of delivery were the six significantly important service quality dimensions perceived by customers. kaynama (2000) assesses the service quality of online travel agencies in terms of attributes such as content, access, navigation, design, response, background, and personalization and customization the aforementioned service attributes, however, were discovered either within a narrowly defined domain or on the basis of internet purchaser perspective only. no empirical study has been conducted to date to systematically and extensively uncover the underlying key dimensions of service quality in the internet commerce setting, at least not from the perspectives of both internet purchasers and non-purchasers. relative importance of service quality attributes not all service quality dimensions have the same effect on consumers' perceptions of service quality. the key is to find, among various service quality attrivolume 25, number 2 63 butes, which dimensions are more crucial to enhancing the level of service quality, and to what degree they do so. in this manner, an organization can understand what service areas should be emphasized to most effectively improve quality while avoiding investing valuable resources in providing service quality attributes that may not payoff (oliva, oliver & macmillan, 1992). in examining the relative importance of service quality attributes to the overall service quality as perceived by customers, a number of researchers adopted servqual in various service industries. for example, rosen and karwan (1994) identified the significant attributes in four different service industries. such as: "understanding the customer" for restaurants, "assurance" and "reliability" for health care, "reliability" and "tangibles" for lecture teaching, and "assurance" for bookstores. johnston (1995) identified "responsiveness" as an important factor at the industrial level. in the context of internet commerce, few studies have addressed the relatively important attributes in determining consumers' perception of overall service quality. though sohn (2000) uncovered six service quality dimensions perceived by online financial service customers, the author did not further investigate which attributes were most important for customers to evaluate overall service quality. this study attempts to fill the gap by addressing the following research question: what are the most influential online service quality attributes to achieve high levels ofoverall service quality perceived by internet purchasers and nonpurchasers? methodology the debate between the servqual and servperf scales has been focused on whether expectation should be used and how it should be measured. although expectations do play a vital role in traditional perceived service quality, personal interviews with online customers in this study revealed that most of the participants did not have a clear conception of whatexpectations they held for online service. this viewpoint is consistent with the results of six in-depth focus group discussions with online consumers conducted by zeithaml, parasuraman, and malhotra (2001). they state: "unlike focus group participants who articulated with ease the nature and the source of their expectations for traditional sq (parasuraman, zeithaml & berry, 1985; zeithaml, berry & parasuraman, 1993), participants in our study often seemed at a loss to articulate their e-sq expectation when it came to issues of order fulfillment" (p. 15). the main underlying reason is that the internet as a new information technology device is still a relatively new service channel. even 64 journal of business strategies highly experienced customer groups encounter difficulty in shaping definitive preconsumption expectations (zeithaml, parasuraman & malhotra, 2001). from this perspective, perceived performance of service attributes has been widely used in measuring information system quality (dabholkar, thorpe & rentz, 1996). additionally, even though certain expectations do exist for some online customers, there have been few research efforts that provide conclusive evidence in choosing appropriate types of expectations in the setting of internet commerce. given that (1) perceived performance measurement methods have been shown to be highly effective in measuring technology-based services and (2) difficulty existed in measuring online customer expectations, this study utilized customer perceived performance, instead of both expectation and perceived performance, as the determinant of service quality. in other words, customer perceived performance is suitable for measuring service quality. measures in this study, internet purchasers are defined as those who purchased at least one product or service through the internet during the last 12 months. internet nonpurchasers refer to those who have utilized the internet to search for information on products and services, but who have not actually purchased through the internet during the last 12 months. a semi-structured interview questionnaire was developed based on an extensive review of service quality and internet commerce literatures. to further understand consumers' perception ofinternet purchasing service quality, face-to-face personal interviews were conducted with four customers. these four persons were selected from participants in an e-commerce program and voluntarily attended the interviews. two of them were experienced internet purchasers. the other two had surfed the internet for more than three years, but had not purchased any items on the internet during the last 12 months. one of them did buy severa! items approximately two years ago and subsequently ceased internet shopping. each interview lasted from 15 minutes to one hour. the two experienced internet purchasers were asked to think about their most recent purchase experience on the internet. the author prompted them to discuss several key questions, including: (1) what aspects of their purchasing led to their positive or negative experiences; (2) what specific criteria did they use in assessing the service quality provided by the web site; (3) what did they expect from internet companies and where did these expectations originate; and (4) what did they like most/least about internet purchasing. the interviewee who ceased internet volume 25, number 2 65 purchasing explained her bad purchasing experiences and the main reasons she had stopped shopping online. the other non-purchaser discussed major obstacles that had prevented him from using the internet as a transactional channel. both of them were encouraged to elaborate on their perceptions of the weaknesses of internet purchasing. they also commented on what kind of service quality improvements should be made in order to attract them to online purchasing. besides literature review and personal interviews, we also adapted and modified several dimensions of servqual proposed by parasuraman, zeithaml and berry (1985), such as reliability, responsiveness, and access, to fit the setting of internet commerce. as a result, fifty items of service quality for internet purchasers, and forty-eight items for internet non-purchasers were initially developed. three academicians who have research interests in e-commerce were asked to review all 98 items to examine if each item reflected the dimension it was designed to measure. based on their suggestions, 13 scale items were further deleted and 10 were reworded. thus, the pretest questionnaire had a total of 41 items of perceived service quality for internet purchasers and 44 for internet non-purchasers. next, nine students participating in a doctoral seminar course were asked to take a pretest survey. as a result of their written comments, several ambiguous scale items in the survey questionnaire were further reworded. the finalized survey questionnaire consisted ofthree parts. part i included 41 items concerning consumers' experiences and perceptions of online purchases and the overall perceived service quality measure. part ii contained 43 items on internet non-purchasers' experiences or perceptions of information searching, and the overall perceived service quality measure. part iii consisted of general information about respondents' backgrounds. the respondents were requested to assess each of the scale items in regard to perceived service quality. a likert-type six point scale was used for each statement, where 1 = strongly disagree, 2 = disagree, 3 = neutral, 4 = agree, 5 =strongly agree, and 6 = not available. data collection the sampling frame for the data set consisted of a list of 1600 subscribers to a regional internet service provider (isp) company in an area located in the southwestern united states. questionnaires were mailed to 950 subjects randomly selected from the mail list of 1600 isp subscribers. at the beginning of the questionnaire, three screening questions were asked to identify which group subjects belonged to (1) internet purchasers, (2) internet nonpurchasers, (3) others such as 66 journal ofbusiness strategies those who have used the internet as a personal communication means only (i.e. checking personal e-mail), but not for any activities related to product and service purchasing and information searching within the last 12 months. then, internet purchasers were asked to complete parts i and iii based on their most recent experience with internet purchase of a product or service. internet non-purchasers were asked to complete parts ii and iii in terms of their decision of not choosing the internet as a channel to purchase a product/service after an information search. respondents who only selected "others" were not required to complete the survey questionnaire. after 10 days of the initial mail-out, two follow-up e-mail messages were sent to remind targeted subjects at weekly intervals. only 13 questionnaires were returned as undeliverable. of the 285 returned questionnaires, three were unusable due to incomplete information, while ten respondents claimed that they were "others." as a result, the effective number of questionnaires was 271 with a response rate of 28.5%. since the focus of this study was on internet purchasers and internet non-purchasers' different perceptions of online service quality dimensions, their personal user and demographic profiles were omitted. analysis and findings identifying key service quality dimensions because of the exploratory nature of this study, a principal component factor analysis was utilized to identify key underlying service quality dimensions. the highly recommended varimax rotation with kaiser normalization was used (nunnally & bernstein, 1994). missing values were replaced by means. after deleting two scale items with low inter-item correlations in the purchaser group, the initial analysis extracted ten factors that were evident on the scree plot and had eigenvalues greater than 1. items that were cross-loading were further eliminated. after four iterations, eighteen additional items were deleted. the retained 21 items were factor analyzed again. six factors emerged and accounted for 67.4% of the total explained variance (see table 1). the reliability of each factor was estimated by computing its cronbach alpha, which was 0.89, 0.78, 0.81, 0.73, 0.77, and 0.59, respectively. using a similar process for the internet non-purchaser group, seven dimensions were generated and accounted for 69.83% of the total explained variance. the reliability of each factor was estimated by computing its cronbach alpha, which table 1 ~-~ factor analysis results on perceived service quality for internet purchasers ~ ~ n dimensions cronbach items component y' ~alpha 1 2 3 4 5 6 ~ 1. reliability 0.89 the quantity and quality of the product/service i received was 0.83 0.12 0.17 0.03 0.08 0.01 <:'"' ~ exactly the same as that i ordered. "'t n the product/service i ordered was delivered to me within the time 0.81 0.02 0.23 0.05 0.13 -0.03 promised by the internet retailer. the billing process was accurately handled and its records were 0.79 0.17 0.20 0.15 0.18 -0.01 kept accurately. when the internet retailer promised to e-mail or call me by a 0.68 0.27 0.24 0.23 0.15 0.05 certain time, it did so. 2. access 0.78 if i want to, i could easily contact a customer service 0.15 0.75 0.11 0.11 0.16 0.06 representative over the phone. the web site showed its street and e-mail addresses, and phone 0.02 0.74 -0.05 0.07 0.23 0.24 and fax numbers. the internet retailer offered multiple ordering options such as 0.27 0.73 0.31 0.00 0.04 -0.10 phone or mail options. for more information, i could turn to the internet retailer's chat 0.07 0.58 0.11 0.24 -0.21 0.04 rooms, bulletin boards, or others. 3. ease of use 0.81 the organization and structure of online catalogs was logical and 0.20 0.13 0.79 0.17 0.08 0.02 easy to follow the cyberspace address was easy to remember. 0.21 0.09 0.78 0.06 0.15 0.04 all the terms and conditions (e.g., payment, warranty, return 0.29 0.02 0.61 0.35 0.09 0.08 policies) were easy to read/understand. the contents in the web site were concise and easy to understand 0.23 0.43 0.61 0.08 0.16 -0.01 (» -....j table 1 continued factor analysis results on perceived service quality for internet purchasers dimensions cronbach items component alpha 1 2 3 4 5 6 4. personalization 0.73 the internet retailer gave me a personalized or individualized 0.06 0.12 0.07 0.84 0.21 0.07 attention. the web site had a message area for customer questions and 0.04 0.32 0.21 0.64 0.13 -0.09 comments. i received a personal "thank you" note via e-mail or other media 0.25 0.00 0.19 0.62 -0.01 0.24 after i placed an order. 5. security 0.77 i felt secure in providing sensitive information (e.g., credit card 0.17 0.07 0.22 0.19 0.80 0.08 number) for online purchase. i felt the risk associated with online purchase was low. 0.23 0.12 0.13 0.11 0.79 0.05 6. credibility 0.59 the web site showed how long the internet retailer has been -0.18 0.28 0.11 -0.06 0.00 0.80 in this online business. i received special rewards and discounts from oc doing 0.15 -0.05 -0.02 0.23 0.12 0.76 businesses with the internet retailer. percentage of variance explained by each dimension 15.55 13.27 12.80 10.06 8.48 7.24 (total 67.40%) notes: a. extraction method: principal component analysis. b. rotation method: varimax with kaiser normalization. c. rotation converged in 7 iterations. 0> ex> ~ ;: "'t ;:t $:i~ b:l ;: ii>... ;:t n ii> ii> en ~.... ~... ~ volume 25, number 2 69 was 0.89, 0.88, 0.81, 0.68, 0.80, 0.74, and 0.78, respectively. for both groups, each item represented an independent attempt to measure a particular construct. all items within a given scale were strongly loaded on one factor and weakly on all the other factors, thereby satisfying the requirements of convergent and discriminant validity of a constructs. additionally, these factors had relatively high reliability and were deemed appropriate for further analyses. as shown in table 1, the six factors identified with the internet purchaser group were reliability, access, ease of use, personalization, security, and credibility. four items were related to attributes of "reliability", namely: the correctness of order fulfillment, prompt delivery, accurate billing, and reply to customers' inquiries within a promised time frame. the "access" factor included four items: (1) the list of company's street and e-mail addresses, phone and fax numbers; (2) accessibility of service representatives; and (3) availability of chat rooms, bulletin boards, and other communication channels. as a unique dimension in the context of internet commerce, "ease of use" related to items like: ease-of-remembering url address, well-organized/structured and easy-to-follow catalogs, and concise and understandable contents, and terms and conditions. the "personalization" attribute consisted of such items as individualized attention and personal thank you notes from online retailers, and availability of a message area for customer questions and comments. the "security" factor included security for providing personal information, and online purchase risk. finally, the "credibility" factor referred to the business history of online retailers and special rewards or discounts offerings. the seven dimensions identified in the internet non-purchaser group, as shown in table 2, embrace security, responsiveness, ease of use, availability, reliability, personalization, and access. the security dimension included high risk associated with online purchase, continuous credit card charges, sensitive information, and distrustful internet retailers. the "responsiveness" dimension included slow internet speed, online jam, slow responses from online retailers, slow information retrieval, and delayed responses. the "ease of use" attribute was related to difficulties in following the organization and structure of online catalogs, understanding content, grasping terms and conditions related to products and services, and the lack of sufficient product/service description. the "availability" dimension referred to limited product and service selection, hard-to-find desired products and services, and out-of-date information contained in online catalogues. the "reliability" attribute was related to failure to e-mail or call customer by a promised time, uncertainty of delivering the right products, and worry concerning incorrect charges. the "personalization" dimension referred to the difficulty in receiving personalized table 2 -.....j0 factor analysis results on perceived service quality for internet non-purchasers dimensions cronbach items component alpha 1 2 3 4 5 6 7 1. security 0.89 i felt the risk associated with online purchase was high. 0.83 0.18 0.12 0.26 0.00 0.04 -0.02 i worried about the internet retailer continuing to 0.79 0.27 0.06 0.02 0.02 0.01 0.10 charge my credit card, even after i cancel an order. the security issue of sensitive information was a major 0.79 0.04 -0.16 0.09 0.10 -0.02 0.30 obstacle to my online purchase. i felt insecure in providing sensitive information 0.78 0.05 -0.01 0.09 -0.06 0.19 -0.15 (e.g., credit card number) for online purchase. i couldn't trust the internet retailer. 0.61 0.26 0.12 0.21 0.09 0.04 0.17 2. responsivenesso.88 the internet speed was too slow particularly at the 0.26 0.83 0.17 0.04 0.09 0.14 0.05 peak time of its usage. i often encountered online jam in searching for 0.24 0.77 0.01 0.20 -0.10 0.08 0.05 product/service information. i often felt frustrated about slow response time in using 0.27 0.72 0.07 0.09 0.12 0.27 0.13 ~ online stores. ~ ""t the system of the web site didn't rapidly retrieve 0.09 0.68 0.30 0.29 0.23 -0.02 0.26 ~$:l the information i requested. -..a. the internet retailer didn't respond to my inquiry promptly. -0.02 0.57 0.04 0.06 0.12 0.39 0.32 o:l ~ ii>-. ~ n ii> ii> l:i:l..,. ~..,. ~-.n ii> table 2 continued ~-~ factor analysis results on perceived service quality for internet non-purchasers ~ f'll n dimensions cronbach items component y' ~alpha 1 2 3 4 5 6 7 ~ 3. ease of use 0.81 the organization and structure of online catalogs was 0.08 0.00 0.86 0.16 -0.04 -0.18 0.03 ~f'll not logical and easy to follow. "'t n the contents in the web site were not concise and -0.03 0.07 0.75 -0.10 0.19 0.20 0.07 easy to understand. all the terms and conditions (e.g., payment, warranty, -0.03 0.16 0.69 0.19 0.24 0.18 0.08 return policies) were not easy to read/understand. the product/service description in the web site was not 0.16 0.26 0.61 0.27 0.17 0.21 0.00 enough to make a purchase decision. 4. availability 0.68 the wide selection of products/services offered by 0.13 0.13 0.10 0.77 0.02 -0.13 0.21 the internet retailer didn't meet my needs. desired products/services were not easily found using 0.21 0.12 0.19 0.69 0.18 0.32 0.07 a keyword search option in the web site. the online catalogs containing information about price, 0.34 0.25 0.13 0.64 0.18 0.13 0.13 model, and others were not updated quickly. 5. reliability 0.80 when the internet retailer promised to e-mail or -0.05 -0.03 0.27 0.09 0.82 0.07 -0.01 call me by a certa.in time, it didn't do so. i was not sure that the internet retailer would deliver 0.06 0.27 0.05 0.30 0.79 -0.12 0.10 the right products/services i order. i was not sure that the internet retailer would charge 0.21 0.08 0.34 -0.17 0.54 -0.04 0.19 me correctly for my purchase order. -.....j...... table 2 continued factor analysis results on perceived service quality for internet non-purchasers dimensions cronbach items component alpha 1 2 3 4 5 6 7 6. personalization 0.74 it was difficult to receive personalized customer 0.12 0.23 -0.01 0.03 -0.16 0.80 0.10 service from an internet retailer. it was not easy to interact with internet retailers 0.08 0.18 0.28 0.09 0.10 0.77 0.10 real-time for their product/service questions. 7. access 0.78 i couldn't easily contact a customer service 0.26 0.20 0.21 -0.01 -0.16 0.02 0.73 representative over the phone. it was not easy to access the internet retailer since it had 0.01 0.09 -0.05 0.24 0.27 0.09 0.71 no toll free phone number, street address in the web site. for more information, i couldn't easily tum to the 0.05 0.20 0.05 0.30 0.06 0.30 0.54 internet retailer's chat rooms, bulletin boards, etc. percentage of variance explained by each dimension 14.44 12.87 10.77 8.65 8.17 7.70 7.24 (total 69.83%) notes: a. extraction method: principal component analysis. b. rotation method: varimax with kaiser normalization. c. rotation converged in 8 iterations. -....i i\) ~ ~ ""l ~ +:l~ b:l ~ '"s· n '"'"en ~.... ~-.n '" volume 25, number 2 73 customer service and interacting with internet retailers in real time for questions. lastly, the "access" attribute embraced inaccessibility of retailers, customer representatives, and online help sources such as chat rooms and bulletin boards. examining the relative importance of service quality dimensions two regression analyses were used to examine the relative importance of the various dimensions of perceived service quality, along with three demographic variables: age, gender, and education levels, affecting overall perceived service quality for both internet purchasers and internet non-purchasers, respectively: sqp = ~o+ ~ifaci + ~lac2 + ~lac3 + ~4fac4 + ~l3fac5 + ~lac6 + ~age + ~gedu + ~9gender + e sqnp = yo+ y1fac1 + ylac2 + ylac3 + ylac4 + ylac5 + ylac6 + ylac7 + ygage + y 9 edu + yiogender + e where: faci = reliability; fac2 = access; fac3 = ease of use; fac4 = personalization; fac5 = credibility; fac6 = security; fac1 = security; fac2 = responsiveness; fac3 = ease of use; fac4 = availability; fac5 = reliability; fac6 = personalization; fac7 = access; edu = education levels; sq = internet purchasers' perceived overall service quality; p sqnp = internet non-purchasers' perceived overall service quality; and ~i and ~ represent the parameters to be estimated. pursuant to the initial regression run, we examined the standardized residual in order to identify and delete outliers, but none were found. the mean of all scale item ratings within a given factor was utilized to form measures of the independent variables. the overall perceived service quality for two groups was entered as two dependent variables. the stepwise method was used to run the linear regression. when the regression analysis was repeated with 70%, 80%, and 90% randomly selected cases from the total sample for both groups, the parameter estimates were stable. this finding, along with the clean factor loadings of explanatory variables, suggests that multicollinearity is unlikely to affect interpretation of the findings. table 3 demonstrates the results of the regression analysis. the coefficients of determination (r2) of the internet purchaser and internet non-purchaser equa74 journal of business strategies table 3 a. regression analysis results between internet purchasers' perceived service quality and service quality dimensions1 standardized independent variables coefficients beta t-value p-value2 reliability 0.563 5.495 0.000*** personalization 0.530 5.886 0.000'** ease of use 0.246 2.255 0.014* access 0.199 2.568 0.029* security 0.069 0.809 0.423 credibility 0.034 0.457 0.650 age 0.078 0.971 0.337 gender 0.078 1.115 0.271 education level -0.048 -0.668 0.508 note: 1. dependent variable: internet consumers' perceived overall service quality (f = 43.143, d.f. = 4, significant = 0.000, r2 = 0.801, adjusted r2 =0.782) 2. * p < 0.05 ** p < 0.005 *** p < 0.001 b. regression analysis results between internet non-purchasers' overall perceived service quality and service quality dimensions1 standardized independent variables coefficients beta t-value p-value2 security 0.564 4.058 0.001** personalization 0.295 2.605 0.018* access 0.338 2.435 0.026* responsibility 0.082 0.052 0.607 ease of use 0.042 0.331 0.745 availability 0.032 0.210 0.836 reliability 0.053 0.444 0.663 age 0.146 1.187 0.251 gender 0.067 0.538 0.598 education level -0.017 -0.125 0.902 note: 1. dependent variable: internet non-purchasers' perceived overall service quality. (f = 20.048, d.f. = 3; significant = 0.000, r2 = 0.770, adjusted r2 =0.731) 2. * p < 0.05 ** p < 0.005 volume 25, number 2 75 tions were 80.1%, and 77.0%, respectively, while the f values of both equations were 43.14 and 20.05 (significant at 0.000 level). therefore, the regression equations achieved a satisfactory level of goodness offit in predicting the variance of both internet purchasers' and internet non-purchasers' perceived overall service quality in relation to respective service quality dimensions and three demographic variables. as far as the relative importance of the service quality dimensions is concerned, the reliability factor carried the heaviest weight for internet purchaser's perceived service quality, followed by personalization, ease of use, and access. two factors, security and credibility, along with three demographical variables, namely age, gender, education level, appear not to be statistically significant in affecting either consumers' perceived survey quality or overall satisfaction. for internet nonpurchasers, the most significantly important factor in affecting their perceptions of online service quality was found to be security, followed by personalization and access. dimensions such as responsiveness, ease of use, availability, and reliability do not significantly impact overall service quality assessment. discussion the following section will elaborate on derived service quality dimensions for both internet purchasers and internet non-purchasers, and on the relative importance of these dimensions affecting overall service quality assessment. derived perceived service quality dimensions six underlying service quality attributes perceived by internet purchasers were identified: reliability, access, ease of use, personalization, credibility, and security. seven dimensions were uncovered for the internet non-purchasers: security, responsiveness, ease of use, availability, reliability, personalization, and access. upon close examination of these factors, it can be inferred that the two groups share much common ground, .gonsidering that the dimensions of reliability, personalization, security, and access are important attributes. as predicted, there still exist several different attributes perceived by the two groups. except for the slightly different content for each similar dimension, two dimensions, availability and responsiveness, are unique to internet non-purchasers. it is interesting to compare traditional service quality dimensions to those of internet-based service quality. most traditional service quality dimensions proposed by parasuraman, zeithaml, and berry (1985), such as reliability, access and customization, are also demanded by online customers. the newly identified fac76 journal of business strategies tors, such as ease of use and security, are internet-based related. while some dimensions contain many traditional service quality aspects, they do have some unique characteristics related to the internet commerce setting. a more detailed discussion of each dimension follows. reliability both internet purchasers and internet non-purchasers require online companies having the ability to perform the promised service accurately and in a timely manner. they expect to be billed and charged correctly. of equal importance is order delivery. the quality of delivery should include promptness and ensure that both correct and intact products and services are delivered, in ordered quantities, at times convenient to customers. consumers will not tolerate goods arriving late or damaged, being misplaced, or having the wrong product shipped to them in error. consumers also prefer to have increasing access to information about the progress of their order. in reality, product and service fulfillment still remains a big challenge for online suppliers and most online consumers feel frustrated with the poor service reliability provided by virtual stores (jedd, 2000). the primary reasons reside in the lack of strong internal and external collaboration. internal collaboration includes tight integration of web sites with customer service operations and communication among different functional departments. external collaboration means integration of supply chain partners (i.e., suppliers, packaging and shipping companies). irrespective ofthe operational models of warehousing and shipping, what counts, as the most important factor, is the quality of the management system (gray, 2000). for instance, replenishment systems should have the capacity to forecast demand for particular items and order them in time. some measures, dealing particularly with packaged connectors to third-party systems (such as erp and customer relationship management (crm) applications, and formal partnerships with vendors of third-party software) can be taken to implement effective backend integration. responsiveness consumers expect internet retailers to respond to their inquiries promptly. prompt responses help consumers resolve their problems and make decisions in a timely fashion. however, compared with physical stores, internet retailers often lack real-time interaction with customers. for instance, e-mail is a very common means for online consumers to communicate with retailers; but a recent study shows volume 25, number 2 77 that 42% ofthe top-ranked web sites took longer than five days to respond to a customer's e-mail inquiry, never responded, or were not accessible bye-mail (wilcox, 1999). other unique aspects concerning the responsiveness dimension include information retrieval speed and internet speed. internet consumers want to find desired information quickly and accurately. studies have revealed that there is a significant positive correlation between information download speed and web user satisfaction (hoffman & novak, 1996). the negative effects of slow information download can be attenuated by providing the consumer with notice of download duration time wherever download waiting occurs and by reducing unexpected waiting occasions and times to a minimum (dellaert & kahn, 1999). further, to increase the navigation speed, internet retailers should choose an efficient host server and avoid using extensive high-resolution graphics (doherty, ellis-chadwick & hart, 1999). access both internet purchasers and internet non-purchasers have a desire to access various sources provided by internet companies for help. consumers expect that a site will have a street and an e-mail address, plus a toll free phone and fax numbers available for them to contact customer representatives easily (burke, 1997). in addition, online consumers favor multiple order channels, such as phone and mail order. finally, accessing help from other consumers is very important in the sense that consumers tend to acquire knowledge from each other. therefore, providing both traditional and online communication channels such as chat rooms and bulletin boards is a necessity (berthon, pitt & watson, 1996), ease of use ease of use is a prominent factor in determining customers' decision to adopt a new information technology (davis, 1989). thus, web-based stores should make it easy for customers to proceed through the whole purchasing process by minimizing technical difficulties, more specifically, an easy-to-remember cyberspace name is important for online consumers to revisit or locate a firm since the internet has grown to include a tremendous number of competitors. both groups purchasers and searchers grant priority to on-screen information concerning products and services. since the web site functions as an information system, the organization and structure of online catalogues should be easy to follow and navigate. most importantly, contents 78 journal of business strategies of the web site should be concise and easy to understand. all terms and conditions concerned with products and services should be easy to read and comprehend. as rice (1997) concluded, for internet-based shopping to achieve mass-market penetration, it must be made substantially easier for consumers to navigate and locate information or content. personalization consumers long for personalized or individualized attention and expect to receive a personal "thank you" note as confirmation after they place an order. a message area in which consumers may ask questions and post comments is also a necessity. the lack of real-time interaction tends to prevent potential customers from purchasing through the internet. only by managing all forms of interaction web hits, e-mails, phone-and fax-based contacts in a single framework, can internet companies shift their staffing and service priorities as customer preferences change. in other words, it is critical for businesses to engage customers in personalized dialogue and to learn more about their needs to better anticipate their future preferences. certain techniques such as a "rules engine" that can drive personalization based on information from the database, are critical to satisfy individual customers. in addition, to show a human face to customers, internet companies may add personal support to staff telephones, answer e-mail, and train customers in the use of the internet medium. credibility consumers are well aware of the history of online retailers and whether they receive special rewards and discounts offered is an important index for evaluating the credibility of online retailers. given the intensive competitive business environment, the history of an online business is a good indicator of its prospects, providing special rewards and discounts for consumers as promised often demonstrates that the firm possesses basic integrity and credibility in relation to its customers. security both internet purchasers and internet non-purchasers appear to be worried about the risk associated with online purchase, especially with respect to secure credit card transactions and privacy of sensitive information. for internet non-purchasers, trustfulness of internet retailers is also a concern. volume 25, number 2 79 the perceived lack of security on public networks is definitely a stumbling block (balfour, farquhar & langmann, 1998). personal information such as credit card numbers transmitted to vendors from consumers can be coded and decoded by other people using encryption algorithms. additionally, consumers often want to retain some level of privacy or anonymity for their activities. a web server, however, can track the identity of the user's computer through "cookies," a text file placed on a user's hard drive. online shoppers arc concerned about web sites that don't provide clear and prominent statements about privacy and security matters. these disadvantages facing consumers require internet vendors to be very responsible for both consumer transaction activities and personal information. availability this identified dimension is unique to internet non-purchasers. availability refers to a limited range of products and services, failure to find desired items and/ or updated information regarding them. customers often look for products and services unavailable in their local stores. limited selection of products and services or outdated information is most likely to keep internet non-purchasers from purchasing online. in a survey of 220 consumers from austin, texas, jarvenpaa and todd (1997) uncovered that the main impediments to consumer acceptance of internet shopping were difficult-to-find specialty items, and limitation of the offerings of individual sites. importance of service quality dimensions the regression results show that both personalization and access factors are considered significantly important to service quality perceived by both groups. in reality, increasing the level of accessibility requires sufficient staff support, which adds more costs to the internet firm. in order to be personalized, internet commerce needs effective techniques such as pull and push personalization skills (luedi, 1997), and requires installation of a crm system. thus, achieving an adequate trade-off of self-service against personalization is an art-form, in the sense that internet companies can maintain a high level ofcustomer satisfaction while keeping costs in a minimum. it is interesting to note the different perceptions of both groups related to the most important factor in determining overall service quality. internet purchasers consider the reliability attribute to be the foremost critical factor for achieving high levels of service quality; this is consistent with other traditional service quality 80 journal of business strategies studies (bitner, booms & tetreault, 1990; parasuraman, zeithaml & berry, 1988). online consumers also regard ease of use as a significant factor that affects overall service quality assessment. in contrast to the prevailing viewpoint, online security and privacy are not significant factors in determining service quality perceived by online purchasers. however, internet non-purchasers did put the security attribute in the most important position. risks involving internet purchasing and the truthfulness of internet companies are, indeed, the major reasons preventing mere internet non-purchasers from becoming internet purchasers. conclusions and limitations focusing on service quality has been a priority and one of the primary concerns in internet commerce (griffith & krampf, 1998). this study reveals that, to better understand consumers' assessment of online service quality, it is beneficial to investigate the key underlying dimensions perceived by both internet purchasers and internet non-purchasers. internet companies should focus on such service quality dimensions as reliability, personalization, ease of use, and access; these are desired by both internet purchasers and internet non-purchasers, and their focus should be customized to specific requirements. while credibility is solely related to internet purchasers, availability is the unique dimension related to internet nonpurchasers. based on their different business strategies, internet companies can devote valuable corporate resources to the important service quality attributes uncovered by this study. for instance, improvement ofthe level of personalization and access constitutes a necessity for both retaining and attracting customers, since these factors significantly affect overall service quality assessment. to retain existing customers, the first priorities are high service reliability and prompt responsiveness. furthermore, internet companies have to take measures to help potential internet customers such as internet non-purchasers overcome their foremost concerns: security and trust. caution should be taken when generalizing the findings of this study. a methodological concern is the sample from a regional isp provider. due to geographical limitations, participants may possess certain attributes that differ from those in other parts of the united states. future research may use more diversified random samples to verify the dimensions developed in this study. the generalization of online service quality dimensions also requires numerous studies crossing different online industries including financial services, health care and other online volume 25, number 2 81 services. further, based on this pilot study, formal hypotheses about online consumers' perceived service quality and overall satisfaction can be established, tested, verified or modified, in future studies, through more rigorous methodologies such as the structural equation model. notes 1. for this study, the term "internet-only company" means that a company conducts business solely through the internet without any physical stores or branches. the term "hybrid company" refers a company which has physical stores or branches with the transactional web sites options. the term "internet company," also called "online company," is defined as a company which has transactional web sites. it can be either internet-only or hybrid companies. references balfour, a., farquhar r, & langmann g. (1998). the consumer needs in global electronic commerce. electronic markets, 8(2),9-12. berthon, p., pitt l., & watson r. (1996). marketing communication and the world wide web. business horizons, 39(september-october), 24-32. bienstock, c. c. (1997). measuring physical distribution service quality. journal of the academy ofmarketing science, 25(1),31-44. bitner, m. 1., booms, r h., & tetreault m. s. (1990). the service encounter: diagnosing favorable and unfavorable. journal ofmarketing, 54(january), 71-84. burke, r. r. (1997). do you see what i see? the future of virtual shopping. journal ofacademic ofmarketing science, 25(4), 352-360. cronin, 1. 1., & taylor, s. a. (1994). servperf versus servqual: reconciling performance-based and perceptions-minus-expectations measurement of service quality. journal ofmarketing, 58(january), 125-131. dabholkar, p. a., thorpe, d. 1., & rentz, 1. o. (1996). a measure of service quality for retailing stores: scale development and validation. journal of the academy ofmarketing science, 24(1),3-16. davis, f. d. (1989). perceived usefulness, perceived ease of use, and user acceptance of information technology. mis quarterly, 13, 318-340. dellaert, r g., & kahn, r e. (1999). how tolerable is delay?: consumers' evaluations of internet web sites after waiting. journal of interactive marketing, 13(1),41-54. 82 journal ofbusiness strategies doherty, n. e, ellis-chadwick, e., & hart, c. a. (1999). cyber retailing in the uk: the potential ofthe internet as a retail channel. international journal ofretail and distribution management, 27(1),22-36. gray, r. (2000). e-tail must deliver on web promises. marketing, (march 2),37-38. griff, d. a., & palmer, 1. (1999). leveraging the web for corporate success. business horizons, 39(january-february), 3-10. griffith, d. a., & krampf, r. a. (1998). an examination of the web-based strategies of the top 100 u.s. retailers. journal of marketing theory and practice. 6(3), 12-23. hoff, r. c., mcwilliams g., & saveri, g. (1998). the 'click here' economy. business week, (june 22). hoffman, d. l., & novak, t. p. (1996). marketing in hypermedia computer-mediated environments: conceptual foundations. journal of marketing, 60(july), 50-68. hoffman, d. l., & novak, t. p. (1997). a new paradigm for electronic commerce. the information society, 13, 43-54. jarvenpaa, s. l., & todd, p. a. (1997). is there a future for retailing on the internet? in peterson, r. a. (ed.) electronic marketing and the consumer. thousand oaks, ca: sage publications. jedd, m. (2000). fulfillment: a crucial e-business challenge. logistics management and distribution report, (april), e25-e26. johnston, r. (1995). the determinants of service quality: satisfier and dissatisfiers. international journal ofservice industry management, 8(5),53-71. kaynama, s. a. (2000). a proposal to assess the service quality of online travel agencies: an exploratory study. journal of professional services marketing, 21(1),63-88. liu, c., & arnett, k. p. (2000). exploring the factors associated with web site success in the context of electronic commerce. information & management, 38(october), 23-34. luedi, a. f. (1997). personalize or perish. electronic markets, 7(3),22-25. mitral, v., & katrichis, 1. m. (2000). distinctions between new and loyal customers. marketing research, 12(1),26-32. nunnally, 1. c., & bernstein, i. h. (1994). psychometric theory (3rd ed.). new york: mcgraw-hill. oliva, t. a., oliver, r. l., & macmillan, i. c. (1992). a catastrophe model for developing service satisfaction strategies. journal of marketing, 56(july), 83-95. volume 25, number 2 83 parasuraman, a., zeithaml, v. a., & berry, l. l. (1985). a conceptual model of service quality and its implications for future research. journal of marketing, 49(5),41-50. parasuraman, a., zeithaml, v. a., & berry, l. l. (1988). servqual: a multipleitem scale for measuring consumer perceptions of service quality. journal of retailing, 64(1), 12-40. rice, m. (1997). what makes users revisit a web site. marketing news, 31(6), 1213. rosen, l. d., & karwan, k. r. (1994). prioritizing the dimensions of service quality: an empirical investigation and strategic assessment. international journal ofservice industry management, 5(4),39-52. sasser, w. e., olsen r. p., & wyckoff, d. d. (1978). management ofservice operations: text and cases. boston: allyn & bacon. sohn, c. s. (2000). customer evaluation of internet-based service quality and intention to re-use internet-based services. unpublished dissertation, southern illinois university: carbondale, il. van dyke, t.p., kappelman, l.a. & prybutok, vr. (1997). measuring information systems service quality; concerns on the use ofthe servqual questionnaire. mis quarterly, 21(june), 195-208. wilcox, n. (1999). the months ahead. kiplinger's personal finance magazine, (january), 19-20. zeithaml, v. a., berry, l. l., & parasuraman, a. (1993). the nature and determinants of customer expectations of service. journal ofthe academy ofmarketing science, 21(1), 1-12. zeithaml, v. a., parasuraman, a., & malhotra, a. (2001). a conceptual framework for understanding e-service quality: implications for future research and managerial practice. working paper, cambridge, ma: marketing science institute. biographical sketches of authors dr. zhilin yang is an assistant professor of marketing at city university of hong kong. this manuscript was completed when he was a doctoral student at new mexico state university. his research interests include internet-based services marketing, customer relationship management, international marketing, and supply chain management. he has published in international marketing review, marketing health care, and various chinese journals. dr. minjoon jun is an associate professor in the management department at new mexico state university. he holds a ph.d. in operations management from 84 journal of business strategies the georgia state university. his research interests include total quality management, service operation management, supply chain management, and operations strategy. consumer perception of e-service quality: from internet purchaser and non-purchaser perspectives global corporate social responsibilities management in mncs anupama mohan university of warwick warwick, uk abstract the management of global corporate social responsibilities (csr) in mncs is less understood this paper presents an analysis of csr management in the global operations of two mncs of british origin, operating in diverse sectors, the paper presents in-depth empirical analysis ofcsr practices in routine stakeholder relations ofthese mncs, across multiple levels within the mnc and across multiple levels of its context. the study reveals that global csr management resultedfrom interplay offirms'strategic choices. internal design processes, as well as irifluences of regulatory, normative and cognitive environment at the multiple levels ofthe mnc context. introduction mncs are under increasing pressure for socially responsible behavior in their global operations. however, global corporate social responsibility and the management of csr behaviors in global operations remains less understood (wood and pasquero, 1997; wartick and wood, 1998; freeman, 1997). the national business environments are increasingly promoting csr (for example, see bondy, matten, moon, 2004; moon, 2004). furthennore, there are several emerging global guidelines and voluntary initiatives seeking to improve csr in global operations (waddock, bodwell, graves, 2002). these trends in mncs' environmental context need to be further supported by investigation of management of csr in the global operations ofmncs and the environmental drive that influence global csr management in mncs. the present paper meets this gap by providing empirical study of management of global csr in two mncs of british origin. it provides a multilevel analysis of management of csr in these firms, revealing several influences ofthe local, national and global environments on csr management in these mncs. mncs are complex differentiated networks marked with internal heterogeneity and with the complexity of managing across globally dispersed, diverse units (bartlett and ghoshal, 1989; ghoshal and nohria, 1989, hedlund 1986, hedlund & rolander, 1990). mncs are faced with diverse stakeholder environments across their international operations. this has several implications for mncs' management of stakeholder relations across the multiple levels and diverse contexts of its operations. global csr management also involves cross-border transfer and 10 journal of business strategies vol. 23, no.1 management ofcsr practices, from one part of the mnc to another, as well as the management of local csr practices suited to the local context of the subsidiary units. the management of csr in the global operations of mncs, discussed in this paper, is an empirical in-depth investigation using an embedded sample of eight case studies across two mncs of uk origin, and across four stakeholder dimensions within these mncs. the analysis of self-reported csr practices in these mncs revealed the globally-managed csr practices and their transnational management processes, as well as several csr practices not transnationally managed across multiple units and levels of the mnc and also several local csr practices. the review of literature presents the existing understanding of management of global csr and several arising unanswered questions. it notes that the management of csr in global firms involves internal coordination processes, as well as environmental influences at multiple levels of mnc operations, however these are less understood. the exploratory study undertaken for this research, using multiple embedded case studies is then briefly presented. the empirical findings of mncs' management of csr in routine stakeholder relations, with employees, consumers, environment and communities are presented. influences of the home country environment in the uk, as well as the global and local environments faced by these mncs are analyzed. then contributions of this research in advancing our understanding of csr management in international operations are presented. finally, the limitations of this research and avenues for future research are outlined. conceptual background business is an inseparable and embedded part of the society. in addition to its economic role in society, business also has several other roles and responsibilities towards society (see preston and post, 1975; davis and blomstrom, 1971; carroll, 1979; margolis and walsh, 2001), viz. responsible conduct of business activities while pursuing economic gains; the social and environmental responsibilities of the business towards its stakeholders; and business's contributions that would benefit the society at large (margolis and walsh, 2001; sethi, 1975). business responsibilities have been thus discussed in reference to the stakeholders of business (see freeman, 1984; clarkson, 1991; 1995) and the wider society. the socialized view of business challenges the overtly 'economic-institution' or 'market-system' view of business held in the neo-classical economic traditions (e.g., levitt, 1958; friedman, 1970; jensen, 1998). however, debates continue on csr definitions, its scope (see carroll, 1979; schwartz and carroll, 2003), and the motivations that guide csr actions of business, i.e., business might be motivated by the instrumental role that csr could play in achieving business interests (mcwilliams and siegel, 2001; waddock and smith, 2000a), or businesses might undertake csr actions for their intrinsic good (weaver et ai., 1999). spring 2006 mohan: global corporate social responsibilities 11 the term, csr, in this paper, refers to a business organization's responsibility for integrating stakeholder concerns in routine business activities for primary stakeholders (employees, customers, suppliers), as well as environment (see starik, 1995) and communities (see burke, 1999) often are considered extensions of the primary stakeholders of the firm. the international business domain offers a challenging context for inquiry into firm's csr and ongoing stakeholder relationship management since there are many more and diverse stakeholders of international business firms (wood and pasquero, 1997). the mncs are faced with wider csr expectations, and mncs are under increasing pressure for socially responsible behavior in their global operations. the numerous and diverse stakeholders ofmncs include global customers, investors, creditors, global employees (chamberlain, 1982; amba-rao, 1993; gynawali, 1996; amba-rao, 1989); 'supra-national' level stakeholders, e.g., the un and its agencies, the european commission, the oecd; a variety of cross-border interest and activist groups, international ngos championing issues such as consumer-protection, environment, safety, health-care, labour rights (doh and teegen, 2002; sethi and steidl meier, 1990); local communities in home country as well as host countries; and the environment at the global as well as the local level. the communities in developing countries and the environment are often called 'weak,' or 'silent' stakeholders (amba-rao, 1993; logsdon and wood, 2002). moreover, csr practices and stakeholder expectations vary across countries (mohan, 2001; maignan and ferrell, 2001; yoshimori, 1995; broberg, 1996) and cultures, as values vary across cultures (hampden-turner and trompenaars, 1993; fukuyama, 1995; hofstede, 1980; 1983). with varied underlying sociological and institutional paradigms, the societies may be monistic, dualistic or collectivist, individualist or communitarian (lodge, 1978; vogel, 1992; sethi and votaw, 1973) leading to divergent perspectives on the role and relationship of business with society, and hence the dominant definition of csr in that society. furthermore, stakeholder expectations, critical social issues, norms, and values, and institutional and sociological requirements also change over time. csr is behavior that is "congruent with prevailing social norms, values and expectations of performance" (sethi, 1975 p. 62). the temporal patterns of social issues (lawrence et ai., 2001) are also context specific. for example, while in the developed countries, some social issue might have been already addressed, and the related corrective and preventive business actions already institutionalized. at the same time, these issues might be still unknown, or only emerging in developing countries (see reed, 2002; khanna and palepu, 1997; 2000; amba-rao, 1992; mohan, 2001). thus, the social issues, social acceptance and societal expectations are differentiated across the world, both in space and in time. in operating across the spatially and temporally differentiated definitions and expectations ofthe 'role of business in society' across the globe, mncs need to simultaneously manage across these diversities. 12 journal of business strategies vol. 23, no.1 furthermore, mncs' plural environments are collective and interconnected (xu and shenkar, 2002; hart, 1992; rosenzweig and singh, 1991; sundaram and black, 1992; westney, 1993). the complex legitimacy issues faced by mncs (see kostova and zaheer, 1999; hawkins and waiter, 1981) across these diverse political, economic, institutional and sociological environments are also discontinuous and marked with uncertainty and preclude universal corporate policies because what may be acceptable in one country or at a time may run counter to public policies or acceptable norms elsewhere or at other times (logsdon and wood, 2002; sethi, 1975; walter, 1975). csr in global operations is also influenced by several forces seeking to homogenize csr across the world so that fundamental and universal social values are protected and upheld. these homogenizing forces include a variety of policy regimes at the global and national level. they include international guidelines (kolk et ai., 1999), bilateral or multilateral agreements among nation states, and trade treaties, e.g., nafta, wto (sanyal, 2001; sethi, 2003). several nonnative and descriptive standards of global csr performance have emerged; such as the human rights principles and responsibilities for transnational corporations and other business enterprises (un sub-commission on the promotion and protection of human rights 2002), the tripartite declaration of principles concerning multinational enterprises and social policy (ilo 1977), and, the oecd guidelines for multinational enterprises (oecd 2000). similarly, several voluntary initiatives and market based standards are emerging, such as the iso, emas, sa, 8000, aalooo and the ori, that seek to provide basic social and environmental standards for business operations across the world. however, the discussions of international dimensions of csr still remain in their infancy (carroll, 1996; amba-rao, 1993; wartick and wood, 1998; nehrt et al., 1970; toyne and nigh, 1997; wood and pasquero, 1997). most existing models of csr management in international business domain have focused on either social issues, crisis management (e.g., brewer, 1992; nigh and cochran, 1987), or the attitudinal predispositions of firms' responsiveness, e.g., the roap proposed by walter (1975) and gladwin and welles (1976). little is known about mncs' strategies for managing stakeholder relations with a multitude of stakeholders of varied salience, interfaced at multiple levels of the mnc. international business operations involve responsiveness to differentiated local environments for some behaviors, and integration of behaviors across units for some other behaviors (prahalad and doz, 1981; doz and prahalad, 1991; bartlett and ohoshal, 1989). typically, the hr and marketing practices are more locally responsive and therefore decentralized and differentiated, while the finance or accounting practices and procedures are more internally consistent and integrated across the mnc (rosenzweig and nohria, 1994). the differentiation/integration ofmnc practices across the diverse environments involves the use ofa combination of control and co-ordination mechanisms (martinez and jarillo, 1989) by the mnc for achieving integrated or differentiated practices in seeking legitimacy or efficiency gains. spring 2006 mahan: global corporate social responsibilities 13 many years ago hawkins and walter (1981) related management design and planning to csr management in the mnc. in-depth analysis of organization design ofcsr management and csp ofmncs however still remains missing. more recently, logsdon and wood, (2002) typify mnc's csr orientation as 'globally integrated' or 'multi-domestic' and suggest a 'hybrid strategy' of uniform globally applicable credos, and well defended local policies and codes to implement 'hypernorms' or universal values. hansen (2002), based on a survey and case-studies of european mncs' subsidiaries in malaysia, china, and india, reported several elements of organization design of cross-border environment management, and proposed organizational typologies, drawing upon bartlett & ohoshal (1989), i.e., 'decentralised' (no cross border management), 'international compliance,' 'centralised' (compliance to company-wide standards instead of local regulation), and 'globally integrated' (environment care initiatives stem from any unit). adopting the 'stakeholder orientation' perspective of csr, post et a!. (2002) examined some global stakeholder relations in three mncs of us origin and their operations in china, focusing on a variety of business activities across several stakeholder groups. a rigorous analysis oftransnational management ofcsr practices in routine (i.e., non-crisis) relations with stakeholders would further require a systematic inquiry into the mnc design and coordination mechanisms within the mnc and the environmental influences across the multiple levels ofthe mnc. moreover, the csr practices have a normative basis, and those practices are both values-based and contextually determined. the csr expectations, definitions and meanings are drawn from the context within which these occur. this peculiar nature of csr practices makes their cross-border management difficult. achieving consistent csr practices across global operations involves not only the transfer of the csr practice, but also the transfer of its underlying value and meaning. while, at the same time, faced with contextually diverse stakeholder expectations and local csr requirements, mncs also need to practice differenti~ ated csr at their local sites, in response to the local context. how mncs meet these competing demands for managing csr in their global operations and what determines their choices remains less discussed. an empirical analysis of the management of stakeholder relations in mncs was undertaken using a relational concept ofcsr, i.e., on-going stakeholder relations in non-crisis situations, in routine business activities. this involved a within firm inquiry of csr practices and their management in international operations, as well as a multi-level contextual analysis of influences in mncs' environment. findings from this study are presented and discussed here. data and the context an in-depth study (yin, 1984; denzin & lincoln, 2002) through multiple case studies (eisenhardt, 1989; yin, 1994) was conducted of eight embedded cases in two mncs drawn from diverse business sectors. the embedded multiple case study design was adopted as a research strategy to study the phenomenon em14 journal (~f business strategies vol. 23, no. i bedded in its nested multilevel context and to draw analytical and inferential generalizations (yin, 1994; gummeson, 2000). the cross-sector sampling (pharmaceutical health-care, and aviation-travel) ensured sufficient diversity of csr sensitivities of the firms and diversity of stakeholder issues across the industry sectors (post & berman, 2001). the home and host country context influences were minimized by drawing companies of the same country of origin (uk) and their operations in same host-country (india). this provided an illustrative case of global operations of mncs and the opportunity to study multiple subsidiaries of the same mnc within a country. two diverse contexts were also thus obtained for study, the developed country context (uk home country) and the developing country context (india host country). multilevel access was obtained within these mncs, at the head quarters (hq), the subsidiary units in india, and the regional offices (ros), and across the stakeholder dimensions. this resulted in a sample of eight embedded cases studies in the two mncs: xa (aviation-travel sector) and xb (pharmaceutical health-care sector). the names of the companies have not been disclosed in order to preserve their anonymity. thus, csr practices for stakeholder relations in non-crisis situations described by the managers at multiple levels within these eight cases were studied. the global management of these csr practices was traced and pieced together from multiple data sources: key-informants' interviews across multiple levels, corroborated by documentary data sources across levels, departments, and functions along with investigation of relevant contextual influences at multiple levels of the context. the contextual analysis (pettigrew, 1985; 1995) provided an overview of the contextual setting that embeds the firms, and the institutional regulations, social norms and cognitive perceptions in the environment (kostova, 1997; 1999; scott, 1995) that influence csr practices, at the global, national (uk and india), sectoral, industrial level (health-care, aviation-travel) and organizational levels. the analysis of these interconnected and embedded contexts revealed a longstanding emphasis on csr in the national business environment in the uk and in india, as well as contemporary normative, regulatory and cognitive dimensions of the institutional context in these countries. determinants of csr conduct of international business organizations were also evidenced in several recent and emerging regulations and voluntary standards in the global business environment. sector specific concerns and influences on csr behavior were also noted. data analysis involved successive stages of coding, and patterns and themes matching within and across the two companies, across the eight cases and finally across csr practices, following rigorous steps to ensure validity and reliability of research. empirical findings and analysis the data reveal a variety of csr practices within the mncs, as well as systematic variation in global management of csr practices. several csr practices were globally managed across the mnc levels; and several csr practices difspring 2006 mohan: glohal corporate social re.~ponsihilities 15 fered across the mnc units or were specific to the local operations. csr practices within the mncs varied across the stakeholder dimensions and within stakeholder groups. csr practices also varied across mnc's subsidiaries in different countries and across mnc subsidiaries within the same country. in the vision, mission and goals statements these mncs stated their business objectives were to contribute to the wider societal benefit as well as to business returns. at the policy level these mncs made a commitment to csr in all their operations. for example, xa addressed the future viability of its business; the caring role of the company and xa stated its community relations and environment policy. in xb, corporate citizenship was part of the company's values statement. csr practices of these mncs addressed socio-political, ecological, and environmental issues at the corporate level. furthermore, these mncs collaborated and partnered with governments and non-government organizations to address negative impacts of business activities and to solve several social problems. these firms also made corporate level commitment to transparency and social reporting and adopted at the hq level, internationally recognized standards, such as aaiooo, gri, and icc charter for sustainable development. xa's hq reported the management of stakeholder relations across employees, customers, suppliers, shareholders, communities, and the environment in the global operations of xa, as well as xa's initiatives for promoting responsible tourism and various other social responsibility activities in the uk and in its international operations. xb's hq reported environment, health and safety performance for the group, and its initiatives to protect biodiversity, animal rights and transparency of r&d and clinical trials. global policies for management of csr across business operations were set at the corporate level in these mncs. for example, in xa, sustainable business unit (sbu), a corporate level department was set up to integrate social and environmental responsibility across functions in xa-uk and to transfer these practices to xa's sites world-wide. an environment and social council was set-up in xa at the board level that reviewed cross-functional issues and reported xa's csr to the top management team. these mncs engaged in the review of csr implications for their choices of the lines of business, use of resources and suppliers. for example, the social and environmental impact of aviation, travel and tourism, and phannaceutical manufacturing businesses at the local operating sites, as well as at the global level were reviewed. similarly, corporate level strategies that determine major lines of business of the mnc and the ways in which mnc links with its peers, investors, and suppliers, guided the decisions about choosing business lines and investments, e.g., minimize depletion of natural resources and pollution. the lines of business that had adverse effects were divested. corporate-level decisions in these mncs included the choice of technology, selection and guidelines for screening of suppliers, and waste management. these decisions were primarily taken by the hq in xa. in xb, these decisions involved close consultation between the hq and the subsidiaries. 16 journal ofbusiness strategies vol. 23, no.1 implementation of csr practices in global operations the implementation of csr practices in global operations in these mncs involved a variety of approaches, with varying involvement of the hqs and the subsidiaries. the csr practices and their management in these mncs are detailed below, across four stakeholder dimensions. employee dimension while the hr functions tend to be largely decentralized and more locally managed in mncs (rosenzweig and nohria, 1994), the hqs ofxa and xb had significant involvement in the management of some hr-related csr practices in their global operations, often to varying extents of effectiveness. for example, xa's global policies for equal opportunities, bullying and harassment were available across the global operations through xa's intranet. xa-uk reported its employee safety performance centrally, and employee training and employee satisfaction surveys were managed internationally in xa. the health and safety of employees in xb was globally managed in an integrated way through the xbwms (integrated global manufacturing system of xb) and xbhelps (xb's integrated system for management of health, safety, and environment, quality, and responsible procurement and supplies). the group policy on hse, equal opportunity and diversity, quality, policy on the use of animals in r&d, the iso standards, and the ifpma guidelines were adopted across xb-hq and all group operations. on the other hand, csr in most hr practices was largely locally managed. for example, in xa, equal opportunity practices, salary and benefits packages, or training and development of employees were largely locally managed by xa's local offices, often with a close involvement ofthe ros. in xb, several hr-related csr practices, e.g., salary and benefits, were locally managed and implemented in accordance with the local norms. while the group-wide equal opportunity policy ofxb was laid by the hq, it did not require xb's local subsidiaries to report their performance by this policy. customer dimension marketing, like human resource management, is often decentralized in the mncs (rosenzweig & nohria, 1994) in order for the local units to meet the differentiated needs of the local customers. the mncs in this study illustrate variety of integration of csr in global marketing practices. in both xa and xb, csr towards customers significantly involved the hq through centralized or integrated management. customer safety and security in xa were centrally co-ordinated through routines set by the hq based on global regulations. in addition, the national regulations and norms were followed by the units. customer feedback procedures comprised a mix of formal routines set by the hq. customer satisfaction and customer relations were globally managed through centralized it networked processes, which were often outsourced services opspring 2006 mohan: global corporate social responsibilities 17 erating centrally designed templates. the brands and various 'point-of-contact' practices were standardised through global manuals and guidelines alongside which the local norms and approaches were also informally followed by xa's units. in xb, the product portfolio of a unit was determined through the xbwms, and the internal buyer supplier arrangements within the xb network. 'product recall' was centralized, as were world wide drug donation practices. product pricing was locally managed by xb units, often regulated by the national governments. however, when xb's units in africa were faced with the issue of access and affordability of life saving drugs, xb-hq centrally introduced several initiatives for improved access and subsidized pricing in developing countries through hqlevel partnership with un and national agencies. environment dimension the existing discussions of environment care management in mnc operations (hansen, 2003; shrivastava, 1987a, b) place the responsibility for environment care somewhere between the hq's and the local operations. in xa and xb the hqs were clearly accountable for the environmental performance of the global operations. the hqs took several measures to ensure implementation of environment care at the local sites either directly by the hq, or by the local units. xa and xb hqs centrally reported their global environment care performance. in addition, xb's local units reported their environment care initiatives locally. environment care in xa was integrated by the hq into functional areas, viz. global procurement, product design, and technical operations. these practices were primarily uk-centred with little involvement of xa's units even when these activities were done at an international local site. xa's annual environment report provided details of the regular monitoring and measure of the key characteristics of xa activities that may impact the environment in xa's global operations. these included reporting on global nox, c02 emissions, waste and noise control in its worldwide technical operations, global impact of tourism, compliance of international regulation in aviation, and several local issues in the uk, such as addressing congestion near airports in the uk. there were no significant environment care practices ofxa's local sites. xa-uk was involved in a variety of wider environment care activities, e.g., initiatives to promote responsible tourism, preservation of ecosystems and partnership with the world wild fund for nature. these were directly managed by xa's uk-based departments without involving xa's local offices in the countries where these initiatives were conducted. care and protection of natural resources and biodiversity was adopted by xb's units as well as its suppliers, and third party contractors across xb's world wide operations as these practices were built into global manufacturing, r&d and supply procurement procedures. environment care in global operations of xb involved extensively integrated multilevel internal reporting and audit. these systems operated alongside xb's processes for participating voluntarily in numerous 18 journal ofbusiness strategies vol. 23, no. i local environment care issues. xb-uk's membership in the wbcsd and icc's business charter on sustainable development guided xb's environment-care initiatives and bio-diversity protection. these principles were encoded in the hse, helps, and quality procedures for manufacturing and procurement. xb's units were, in addition, members of similar sustainable development and csr organizations in the local countries. community dimension community care by firms is typically localized at the sites of operation, i.e., the hq and the subsidiaries in the case of mncs. the mncs studied here reveal several patterns of localization and centralization of community work. the uk operations of these mncs had several impressive community care activities to their credit. in xa and xb some international community initiatives were centrally managed by the hq. xa and xb also illustrated some shared themes of community csr practices across the global sites. xa-uk adopted several community care initiatives throughout the uk. xa's local units similarly conducted charity and community support activities locally without the involvement of xa-hq or other xa units. the 'charity' and 'care' themes were followed throughout xa's global operations. xa-un programs were managed internationally, directly by the hq even when these activities were conducted at xa's local sites, and these projects did not involve xa's local units. xa-hq reported centrally, its worldwide community activities. xa's units were required to report their local projects to xa's central community contributions report towards xa's percent club membership in the uk, although xa-hq was not involved in implementing or managing these activities at the subsidiary's sites. xb-uk undertook several community care initiatives at its offices in the uk. xb-uk was also involved in several global social development programs such as access to medicines in developing countries, health care and awareness. several of the programs were directly undertaken by the hq in its worldwide operations. some csr practices were shared across xb-hq and its international units, e.g., the campaigns against counterfeit drugs, hiv-aids. within xb, community activities, though apparently decentralized, were globally integrated through xb's corporate culture and awards, e.g., the chairman's corporate citizenship awards. csr practices were integrated into manufacturing, marketing, xbhelps, and quality procedures. xb's units locally undertook activities such as innovative rural marketing for providing access to medicines for the poor people in remote villages. discussion: the management of csr in global firms it is evident that these mncs managed some csr practices in their global operations. several features of the 'csr environment' in the uk influenced these firms to manage csr in their global operations. similarly, several factors in the global environment, emphasizing responsible business practices across internaspring 2006 mohan: global corporate social re.\ponsibilities 19 tional operations, also influenced global csr management in these mncs. host country, as well as sector-specific, influences on global csr were also evident. finn level strategic choices of the mnc for global csr management were also noted. the global management of csr practices involved implementing or transferring hq's csr practices to its local units. in addition the local units followed their own csr practices. however, the hqs did not transfer or implement all csr practices globally. only select csr practices were prioritized to be globally managed. a variety of reasons influence the selection of csr practices for global management. evidently these mncs adopted a variety of approaches for the global management of csr practices. these approaches ranged from centralized, direct management, to integrated management, to decentralized management. mncs' approaches varied across practices. employee, customer, environment, or community-related csr practices were not decentralized like hrm and marketing functions that are typically more decentralized. on the contrary, some select csr practices within these functions were managed directly by the hq or were centrally integrated. the reasons these mncs accorded such importance to some csr practices are discussed later. moreover, the csr practices of the hq often differed from those of the local units, when these practices were not linked across global operations. thus, hq's csr practices were embedded in the local home country context, while the units followed the host country norms and csr practices. csr practices at the hq level also differed from the csr practices at the local units, even when these practices were transferred or implemented across the global operations. practices were modified as they were adapted to the local environment. this local embeddedness of the local units is further discussed in a later section. the preceding analysis ofcsr practices in the global operations of two mncs reveals interplay of several firm-level factors and national, global, and sectoral influences. a significant role of the hq is evident in the global management ofcsr, particularly in setting the guiding philosophy and corporate level policy for management of csr in global operations of the mnc. also, the hq and the subsidiary units jointly participated in decisions regarding the social and environmental implications of business activities and the implementation ofcsr practices. this was evident in xb and in some cases in xa. the uk-based operations of the mnc had several csr practices that were often not transferred across operations and were limited to the uk. the local operations adopted several local csr practices relevant to the local context. furthennore, in these mncs, committed to managing csr in their global operations, the implementation of global csr practices involved a variety of approaches, ranging from direct management by the hq to varying extents of integration of csr practices across the global units. evidently, only some csr practices were selectively managed across the global operations in these mncs. for example, while hr management was largely decentralized, the health and safety of employees was globally managed with 20 journal of business strategies vol 23, no.1 the hqs being accountable for this performance. the selective prioritization of csr practices for their global management within the mnc was influenced by the global and national factors, as well as mnc's own strategic priorities. the 'macro-global' homogenizing forces of the wider external interconnected environment lead to globally managed csr practices. the csr practices dominant in the home (uk) country were globally managed across the units by these mncs. the global context with its international guidelines, universal standards for performance and emerging legislation on several aspects of csr practices also determined selective prioritization ofcsr practices for their global management, e.g., the who directive on marketing practices which is followed by all units of xb worldwide and coordinated through lfpma and its national and local chapters. the market-based certificates and voluntary standards for international business, viz. the iso standards, and the grt influenced the social and environmental performance reporting in these mncs. xa-uk supported tcao, the un body responsible for setting environmental standards for civil aviation and noise standards for aircraft, as well as research and development on climate change and impact of aviation on the global atmosphere. xa-uk signed the icc charter for sustainable development and evaluated its performance for the year, against the tcc principles of sustainable development. similarly, xa-uk supported research and innovation on issues such as european emphasis on noise around airports, night-time restrictions, eu's hushkit regulation (1999) of marginally-compliant aircraft, global emissions and fuel efficiency, and waste management in the uk and europe. the context thus influenced prioritization of select practices and provided the formal definition and standards for csr. global homogenizing forces included the multinational clients and global business partners. tn the xa example they were common contractors and partners across the xa network, the global interest groups and non-governmental organizations (oxfam's role in the case ofxb's drug-pricing issues), and mnc's membership networks such as the percent club. at the national level, the home country national environment in the uk for these mncs was marked by several factors promoting csr including several uk legislations (moon, 2004), viz. the sex discrimination act (1975), the equal pay act (1970), the race relations act (1976), the disability discrimination act (1995), the code of practice for employment of disabled people (1984), the employment relations act (1999), the human rights act (1998), and the health and safety work act (1974) that impose duties on the employers to ensure the health and safety (h&s) of their employees and to ensure that the h&s of other persons is not adversely affected by the employer. moreover, the firms followed requirements of the ukla's combined code (1992); uk listing authority guidelines, comprising principles of good corporate governance (1998) and code of best practice; and the turnbull report (1999) that further expanded the combined code and provided guidance for the directors to include the internal control requirements of the combined code. this required the boards to identify and review the risks faced by their business operaspring 2006 mohan: global corporate social responsibilities 21 tions across the world as well as to introduce monitoring and control processes and annually report the compliance to these, to their shareholders. all london stock exchange listed companies are required to report in their annual report and accounts their adherence to these guidelines. for example, following the combined code, principles of good governance and code of best practice (1998) issued by the london stock exchange for its listed companies, xb reported its internal control in global operations, including financial, operational and compliance controls and risk management procedures, to its shareholders. similarly, xa and xb also annually published an hse performance report. hse has been a growing concern since the bhopal tragedy in 1984 where union carbide's plant leaked methyl isocyanate gas killing over 15,000 people in india. however, these reports portrayed the hse management in the global operations to varying extent in these mncs. the uk national context is also marked by an active ngo and civil society influence on the normative and cognitive dimensions of csr of british companies in their overseas operations. for example, amnesty international business group, oxfam, uk, the prince of wales international business leader's forum, the percent club, and the business in the community principles are some prominent ngo initiatives. the role of the department for international development (dfid) is part of the government initiatives to promote csr of british mncs. recent surveys of consumer and public opinion in the uk on csr also report rising trends of consumer concern in the uk (mori csr survey, uk, 2002, and the annual mori polls since 1990). csr is reported as an important consideration in the purchase decisions. consumer activism, boycotts of products over concerns for environment and human rights have also been widely witnessed in the uk. consumers and the public in the uk are noted to be sensitive to business practices in their overseas operations, e.g., recent campaigns against the use of child labour, bribery and corruption, and concern for environment-care, ethical sourcing, and workplace practices of overseas operations of british mncs. at the sectoral level, selective prioritization of some csr practices for their transnational management was determined by the criticality of the issue within the sector or industry. chemical and pharmaceutical industries focused on health and safety, and ethical marketing practices; while the travel-service sector focused on passenger security and safety. implementation of these csr practices was required by the sector specific institutions. the host country environment also influenced selective prioritization of csr practices. in many cases mncs took selectively greater care to implement csr in the host countries where institutional mechanisms to ensure responsible practices were lax, e.g., where the enforcement of environmental care was not up to world class standards. similarly, in areas where child labour is rampant, the mncs monitored their units as well as third party suppliers and contractors to ensure against incidences of child labor at worksites. at the firm level, strategies of the mnc influenced the selective prioritization of some csr practices for their global management, e.g., xa prioritized pas22 journal of business strategies vol. 23, no.1 senger, staff and aircraft safety and security, and its charity work; xb focused on quality and hse, covering a variety of practices within these themes, which it integrated network-wide through specially designed management systems and cultural processes. at the local level, influenced by the local context, several csr practices of the local units of these mncs were more isomorphic to the practices of the local firms, perhaps in an attempt to compete more effectively in the local markets (normative isomorphism) or to 'fit in' by imitating local practices (mimetic isomorphism) (dimaggio and powell, 1983), while instances of 'coercive isomorphism' for the legally stipulated behaviors were evident in local unit practices, such as the provision of provident fund, pensions, work-hours regulation, or training budgets for employees across global operations. for example, the subsidiary units in india followed several csr practices consistent with the institutional, social or cultural norms of business behavior in india. several non-statutory practices, such as employee-benefits given by local indian businesses, were followed by the units of xa and xb. examples include structuring salary packages, employee benefits such as the provision of private medical and health-care for employees and their families, housing and related amenities, conveyance and transport facilities, or support for children's education. these practices of the local units were nonisomorphic to the parent hq or other units of the mncs. these practices were planned, implemented and reviewed by the local managers in the country, sometimes with a close involvement of the ro. xb-india followed local pollution and emissions regulations, and xa-india followed the safety and security procedures required by the national civil aviation authorities. several hror customer-related csr practices, well established in the ukbased operations of these mncs, were not practiced in the international operations. often there were no regulatory or other stakeholder pressures for conducting these practices globally, so their transnational management appeared to slack. for example, the normative and cognitive expectations predominant in the uk's national environment made it imperative for these mncs to manage health and safety care towards their employees in global operations. however, these normative and cognitive expectations were missing in both the uk national, as well as the local country environment, for practices such as equal opportunity and investor-in-people. therefore these practices were not followed across the global operations in xa or xb. regulatory constraints preventing global csr practices were also evident. strict waste disposal and health and hygiene regulations in the uk constrained the donation of unused in-flight food to local charities in the uk while, at the initiative of cabin crew, this was easily done upon arrival of xa aircraft at the airports in india. similarly, the national legal and financial institutions were noted to restrict employee share ownership in the international operations of these mncs. in all countries, the law stipulated the conduct of employment relationships, but the varying scope of regulation across countries resulted in diverse behavior across the units within the mnc. for example, the working time, pay determination, recspring 2006 mohan: global corporate social responsibilities 23 ognition of employee unions, consultative structures, and redundancy provisions, were defined by local legislation. furthermore, many practices, though designed to be managed transnationally, could not be implemented in the global operations, as these did not appear to 'fit' with the cultural or institutional contexts of the subsidiaries. xa's units did not find employee counseling, bullying and grievance procedures, or the customer listening forums promoted by the hq to 'fit' with the local business environment. the above analysis of empirical findings across global and local csr practices in these two mncs reveals a fine-grained interplay of global, national-home country, host country level environmental factors, and firm's strategic choices and design for the management of csr in global operations. hansen's (2003) typologies for configuration of cross-border management of responsibility in mncs (i.e., decentralised, international compliance, centralised, and globally integrated) are not evident as neat distinct types in this study. this fine-grained analysis on the other hand reveals these configurations to coexist as mosaic-like patterns within each mnc. the evidence suggests that within the typically decentralized functions, some csr practices were much centralized, while some otherwise centrally controlled csr practices, were not included in the international operations. it is evident from this study that only select csr practices were globally managed in these tncs. the 'hybrid strategy' of uniform globally applicable credos, and well defined local policies and codes to implement 'hypemorms' suggested by logsdon and wood (2002) appears to be in place in these mncs but only for select csr practices. thus, mnc's strategy for global management of csr as 'globally integrated,' or 'multi-domestic' may not be firm level strategic orientation. the strategies vary across csr practices. thus, strategic csr orientation may be described as a practice level orientation, varying from practice to practice, with some csr practices of the mnc managed through a hybrid strategy, while, centralized or decentralized, global or multilocal approaches are followed for some other csr practices. this study suggests that the normative prescriptions for increased global csr benefit from the recognition that global management of csr requires strategic and systematic design for global management of csr practices. furthermore, the study suggests global csr requires supportive environmental factors throughout the mnc's multilevel environment, i.e., the regulatory, normative and cognitive elements of the institutional environments at multiple levels of the mnc need to collectively support csr practices for their global management. conclusion this research looks within the mnc, and across its multilevel context, to report empirical and analytical findings of global management of csr practices in two mncs, across four stakeholder dimensions. 24 journal ofbusiness strategies vol. 23, no. 1 this paper contributes to the understanding of global csr, of which there was only scant existing discussion (freeman, 1997; wood and pasquero, 1997; logsdon and wood, 2002). the current csr management discussions are thus taken into the realm of international business, cross-border managerial issues, mnc design, and the heterogeneity and multiplicity of contexts in global operations. these rigorous, empirically grounded and theoretically validated findings, have advanced the existing discussions of design and cross border management (walter, 1975; hawkins and walter, 1981; hansen, 2002; post et ai., 2002; logsdon and wood, 2002). these fine-grained findings reveal that global csr management results from the interplay of firm's strategic choices, internal design processes, as well as the influences of regulatory, normative and cognitive environment across multiple levels of the mnc context global, national, home country, local host country, and sectoral level. the present study provides an account of global csr management in mncs of uk origin; future cross-country comparative studies would further extend this understanding. similarly, future studies could include mncs from other sectors in order to compare and contrast global csr management approaches. the patterns, determinants and consequences of global csr management identified in this exploratory study may be further extended through larger sample studies and large scale surveys. references amba-rao, s. c. (1989). whither bhopal: technological hazards and social responsiveness in the third world. social development issues, 12, 11-22. amba-rao, s. c. (1992). business social policy for the third world: response of the multinational corporate management. in k. e. bauzon (ed.), development and democratization in the third world: myths. hopes. and realities. new york: taylor and francis amba-rao, s. c. (1993). multinational corporate social responsibility, ethics, interactions and the third world government: an agenda for the i 990s. journal ofbusiness ethics 12, 553-572. bartlett, c. a. & ghoshal, s. (1989). managing across borders: the transnational solution. boston: harvard business school press. bartlett, c.a. & ghoshal, s. (1995). rebuilding behavioral context: tum process reengineering into people revitalization. sloan management review fall. 11-23. bondy, k, matten, d., & moon j. (2004). the adoption of voluntary codes of conduct in mncs: a three-country comparative study. business and society review, 109 (4), 449 477. spring 2006 mohan: global corporate social responsibilities 25 broberg, m. p. (1996). corporate social responsibility in the european communities the scandinavian viewpoint. journal ofbusiness ethics j5, 615-637. burke, e. m. (1999). corporate community relations: the principle of the neighbour of choice. westport ct: quorum press. carroll, a. b. (1979). a three-dimensional conceptual model of corporate social performance. academy of management review 4,497-505. carroll (1996). landmark5 in the evolution ofthe business and society field. sim doctoral consortium. chamberlain, n. w. (1982). social strategy and corporate structure. new york: macmillan publishing company. clarkson, m. e. (1991). defining, evaluating, and managing corporate social performance: the stakeholder management model. in l. e. preston (ed.), research in corporate social performance and policy (pp. 331-358). greenwich: ct: jai press clarkson, m. e. (1995). a stakeholder framework for analysing and evaluating corporate social performance. academy of management review, 20, 92-117. davis, k. & blomstrom, r. (1971). business, society and environment: social power and social response. new york: mcgraw-hill. denzin, n. k. (1989). the research act: a theoretical introduction to sociological methods. englewood cliffs, nj: prentice-hall. denzin, n. k. & lincoln, y. s. (2002). handbook ofqualitative research. thousand oaks, ca: sage. dimaggio, p. j. & powell, w. w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review 48. 147-160. doh, j. p. & teegen, h. ( 2002). nongovernmental organizations as institutional actors in international business: theory and implications. international business review, j1, 647-663. doz, y. 1. & prahalad, c. k. (1991). managing dmncs: a search for a new paradigm. strategic management journal, 12, 145-164. eisenhardt, k. m. (1989). building theories from case study research. academy of management journal, 14, 532-550. eisenhardt, k. m. & bourgeois ill, l. j. (1989) building theories from case study research. academy ofmanagement review, j4, 532-551. 26 journal ofbusiness strategies vol. 23, no. 1 epstein, e. m. (1976) the social role of business enterprise in britain: an american perspective part-l. the journal ofmanagement studies. 13, 213. epstein, e. m. (1998). business ethics and corporate social policy: reflections on an intellectual journey, 1964-1996. business and society. 37, 7-40. etzioni, a. (1961), a comparative analysis of complex organizations. new york: free press. freeman, r. e. (1984). strategic management: a stakeholder approach. boston: pitman. freeman, r. e. (1997) managing the global economy: from relativism to multiculturalism, in b. toyne & d. nigh (eds.), international business: an emerging vision (pp. 131139). columbia, sc: university of south carolina press. friedman, m. (1970, september 13) a friedman doctrine the social responsibility of business is to increase its profits. the new york times magazine, 32-33, 126. fukuyama, f. (1995). trust: the social virtues and the creation ofprosperity new york: free press. gladwin, t. n. & welles, j. g. (1976). environmental policy and multinational corporate strategy. in i. walter (ed.), studies in international environmental economics. new york: john wiley & sons, glaser, b. & strauss, a. l. (1967). the discover.v ofgrounded theory: strategies for qualitative research. chicago: aldine. ghoshal, s. & nohria, n. (1989). internal diflerentiation within multinational corporations. strategic management journal, io, 323-337. gummeson, e. (2000). qualitative methods in management research. london: sage. gupta, p. p. & dirsmith, m. w. (1994). coordination and control in a government agency: contingency and institutional theory perspectives on gao audits. administrative science quarterly, 39, 264-284. gynawali, d. r. (1996). corporate social performance: an international perspective. advances in international comparative management. i1, 251-273. hampden-turner, c. & trompenaars, f. (1993). the seven cultures of capitalism. value systems for creating wealth in the united states, britain. japan. germany, france. sweden, and the netherlands. london: piatkus. hansen, m. w. (2002). managing the environment across borders: a study oftnc affiliates' environmental practices in china, malaysia and india. denmark: samfundslitteratur. spring 2006 mohan: global corporate social responsibilities 27 hawkins, r. g. & walter, i. (1981 ). planning multinational operations. in p. c. nystrom & w. h. starbuck (eds.), handbook oforganizational design (pp. 253-267). new york: oxford university press. hedlund, g. (1986). the hypermodern mnc: a heterarchy? human resource management, 25, 9-36. hedlund, g. & rolander, d. (1990). action in heterarchies: new approaches to managing the mnc. in c. a. bartlett, y. doz, & g. hedlund (eds.), managing the global firm (pp. 15-46). london: routledge. hofstede, g. (1980). culture.5 consequences: international differences in work-related values. beverly hills, ca: sage. hofstede, g. (1983). the cultural relativity of organizational practices and theories. journal ofinternational business studies, 14, 75-89. jensen, m. c. (1998). purpose of change. in m. beer & n. nohria (eds.), breaking the code of change (pp. 35-58). boston: harvard business school press. khanna, t. & palepu, k. (1997). why focused strategies may be wrong for emerging markets. harvard business review, 75.41-51. khanna, t. & palepu, k. (2000). the future of business groups in emerging economies: long-run evidence from chile. academy of management journal, 43, 268-285. kolk, a., tudler, r., & welters, c. (1999). international codes of conduct and corporate social responsibility: can transnational corporations regulate themselves'? transnational corporations, 8, 143-180. kostova, t. (1997). country institutional profile: concept and measurement. best paper proceedings of the academy of management, 180-184. kostova, t. (1999). transnational transfer of strategic organizational practices: a contextual perspective. academy of management review. 24, 308-324. kostova, t. & roth, k. (2002). adoption of an organizational practice by subsidiary of multinational corporations: institutional and relational effects. academy of management journal, 45. 215-233. kostova, t. & zaheer, s. (1999). organizational legitimacy under conditions of complexity: the case of the multinational enterprise. academy of management review, 24, 64-81. lane, c. (1992). european business systems: britain and germany compared. in r. d. whitley (ed.), european business systems: firms and markets in their national context. london: sage. 28 journal ofbusiness strategies vol. 23, no.1 lawrence, t. r., winn, m. 1., & jennings, p. d. (2001). the temporal dynamics of institutionalization. academy ofmanagement review, 26, 624-644. levitt, t. (1958). the dangers of social responsibility. harvard business review, 34, 4170. lincoln, y. s. & guba, e. g. (1985). naturalistic inquiry. beverly hills, ca: sage. lodge, g. c. (1978). the new american ideology. new york: knopf. lodge, g. c. (1987), introduction: ideology and country analysis. in g. c. lodge & e. f. vogel (eds.), ideology and national competitiveness: an ana(vsis of nine countries (pp. 1-28). boston: harvard business school. logsdon, j. m. & wood, d. j. (2002). business citizenship: from domestic to global level of analysis. business ethics quarterly, 12, 155-187. maignan, 1. & ferrell, o. c. (2001). antecedents and benefits of corporate citizenship: an investigation of french business. journal 0.[ business research, 51. 37-51. margolis & walsh (2001). misery loves companies: shareholders, scholarship, and society. academy of management annual meeting, 2001. martinez, j. 1. & jarillo, 1. c. (1989). the evolution of research on coordination mechanisms of multinational corporations. journal of international business studies, 20, 489-514. martinez, j. i. & jarillo, j. c. (1991). coordination demands of international strategies. journal ofinternational business studies, 22, 429-444. mcwilliams, a. & siegel, d. (2001). corporate social responsibility: a theory of the firm perspecti ve. academy ofmanagement review, 26, 117-127. miles, m. b. & huberman, a. m. (1984). qualitative data analysis: a source book ofnew methods. beverly hills, ca: sage. miles, m. b. & huberman, a. m. (1994). qualitative data analysis: an expanded sourcebook. beverly hills, ca: sage. mohan, a. (2001). corporate citizenship: perspectives from india. the corporate citizenship journal, 1, 107-117. moon, j. (2004). government as a driver 0./ corporate social responsibility: the uk in comparative perspective. paper presented at the academy of management meeting, new orleans. nehrt, l. c., truitt, j. f., & wright, r. w. (1970). international business research: past, present andfuture. bloomington, in: indiana university press. spring 2006 mohan: global corporate social responsibilities 29 nigh, d. w. & cochran, p. l. (1987). issues management and the multinational enterprise. management international review, 27, 4-12. nohria, n. & ghoshal, s. (1994). differentiated fit and shared values: alternatives for managing headquarters-subsidiary relations. strategic management journal, 15, 491503. pettigrew, a. m. (1979). on studying organizational cultures. administrative science quarterly, 24, 570-581. pettigrew, a. m. (1985). contextualist research: a natural way to link theory and practice. in e. e. lawler iii, a. m. mohrman jr., s. a. mohrman, g. e. ledford jr., & t. g. cummings (eds.), doing research that is usefulfor theory and practice (pp. 222-295). san francisco: jossey-bass pettigrew, a. m. (1987). context and action in the transformation of the firm. journal of management studies, 24, 649-670. pettigrew, a. m. (1995). longitudinal field research on change: theory and practice. in g. p. huber & a. van den ven (eds.), longitudinal research methods: studying the processes oforganizational change. london: sage. post, j. e. & berman, s. l. (2001). global corporate citizenship in a dot.com world: the role of organizational identity. in j. andriof & m. mcintosh (eds.), perspectives on corporate citizenship. sheffield, uk: greenleaf pub., 66-82. post, j. e., preston, l. e. & sachs, s. (2002). redefining the corporation: stakeholder management and organizational wealth. palo alto, ca: stanford business books. prahalad, c. k. & doz, y. l. (1981). an approach to strategic control in mncs. sloan management review, 22, 5-13. preston, l. e. & post, j. e. (1975). private management and public policy. englewood cliffs, nj: prentice hail quazi, a. m. (1997). corporate social responsibility in diverse environments: a comparative study of managerial attitudes in australia and bangladesh. business and professional ethics journal, 16,67-84. reed, d. (2002). employing normative stakeholder theory in developing countries: a critical theory perspective. business & society, 41, 166-207. rosenzweig, p. m. & nohria, n. (1994). influences on human resource management practices in multinational corporations. journal of international business studies, 25, 229-251. rosenzweig, p. m. & singh, 1. v. (1991). organizational environments and the multinational enterprise. academy of management review, 16, 340-361. 30 journal ofbusiness strategies vol. 23, no.1 sanyal, r. n. (200 i). the social clause in trade treaties: implications for international firms. journal of business ethics. 29. 379-389. schwartz, m. s. & carroll, a. b. (2003). corporate social responsibility: a three-domain approach. business ethics quarterly. 13, 503-530. scott, w. r. (1987a). the adolescence of institution theory. administrative science quarterly, 32, 493-511. scott, w. r. (1987b). organizations: rational. natural, and open systems. englewood clitfs, nj: prentice-hall. scott, w. r. (1995). institutions and organizations. thousand oaks, ca: sage. sethi, s. p. (1975). dimensions of corporate social performance ~ an analytical framework. california management review, 17, 58-64. sethi, s. p. (2003). setting global standards: guidelines for creating codes of conduct in multinational corporations. hoboken, nj: john wiley & sons, inc. sethi, s. p. & steidlmeier, p. (1990). a new paradigm of business/society relationship in the third world: the challenge of liberation theology. in w. c. frederick & l. e. preston (eds.), business ethics: research issues and empirical studies (pp. 279-293). greenwich, ct: jai press inc. sethi, s. p. & votaw, d. (1973). a berkeley view of business and society. california management review, 16, 95-100. shrivastava, p. (i 987a). bhopal. anatomy ofa crisis. cambridge, ma: ballinger. shrivastava, p. (1987b). managing industrial crises: lessons o.fbhopal. new delhi: vision books. silverman, d. (2000). doing qualitative research: a practical handbook. london: sage. smircich, l. (1983). concepts of culture and organizational analysis. administrative science quarterly. 28. 339-358. starik, m. (1995). should trees have managerial standing? toward stakeholder status for non-human nature. journal o:fbusiness ethics, i4, 207-217. sundaram, a. k. & black, j. s. (1992). the environment and internal organization of multinational enterprises. academy 0;[ management review, i7. 729-757. toyne, b. & nigh, d. w. (1997). business and society perspectives and international business. in b. toyne & d. nigh (eds.), international business: an emerging vision (pp. iii-lis). columbia, sc: university of south carolina press. spring 2006 mohan: global corporate social responsibilities 31 vogel, d. (1992). the globalization of business ethics: why america remains distinctive. california management review, 35,30-49. waddock, s., bodwell, c. b., & graves, s. (2002). responsibility: the new business imperative. academy (~rmanagement executive, 16. 132-148. waddock, s. & graves, s. 8. (1997). quality of management and quality of stakeholder relations: are they synonymous? business and society. 36, 250-279. waddock, s. & smith, n. (2000a). corporate responsibility audits: doing well by doing good. sloan management review. 41, 75-83. waddock, s. & smith, n. (2000b). relationships: the real challenge of corporate global citizenship. business and society review, 105, 47-62. walter, i. (1975). a guide to social responsibility of the multinational enterprise. in j. backman (ed.), social responsibility and accountabilizv (pp. 146-192). new york: new york university press. wartick, s. l. & wood, d. j. (1998). international business and society. malden, ma: blackwell. weaver, g. r., trevino, l. k., & cochran, p. l. (1999). integrated and decoupled corporate social performance: management commitments, external pressures, and corporate ethics practices. academy of management journal, 42. 539-552. westney, e. d. (1993). institutional theory and the multinational corporation. in s. ghoshal & d. e. westney (eds.), organizational theory and the multinational corporation (pp. 53-76). new york: st. martin's press. wood, d. j. & pasquero, j. ( 1997). international business and society: a research agenda for social issues management. in b. toyne & d. nigh (eds.), international business: an emerging vision (pp. 139-159). columbia, sc: university of south carolina press. xu, d. & shenkar, o. (2002) institutional distance and the multinational enterprise. academy ofmanagement review, 27, 608-618. yin, r. k. (1984) case study research: design and methods. beverly hills, ca: sage. yin, r. k. (1994). case study research: design and methods. thousand oaks, ca: sage. yoshimori, m, (1995). whose company is it? the concept of the corporation in japan and the west. long range planning, 28, 33-45. 32 journal ofbusiness strategies vol. 23, no. i anupama mohan obtained her ph.d. degree at warwick business school, uk. her research is across international business management, organization theory institutional theory, and strategy. she researches and teaches in business schools across europe. her work focuses on international dimensions of corporate responsibilities, transnational management of corporate responsibilities in global corporations, csr in developing countries, and globalization and poverty. global corporate social responsibilities management in mncs wealth effect for u.s. acquirers from foreign direct investments halil kiymaz university of houston-clear lake houston, tx abstract this study investif?ates the wealth effects offoreign direct investments on us. firms during the period of 1989-2000. overall findings indicate that us. acquirers experience statistically significant wealth gains of0.57 percent around the announcement of acquisitions. the wealth effects do vary with location (~f target firms and acquirers' industry affiliation. acquisitions in europe yield significant positive wealth gains while acquisitions in asiaipac(f'ic, north america, and latin/central america regions yield negative wealth gains. the highest wealth gains to us. acquirers occur when they acquire targets in france followed by acquisitions in the uk. canadian acquisitions, on the other hand, yield negative sign~ficant wealth gains. the highest wealth gains are also observed in the services industry followed by acquisitions in the manufacturing and food industries. acquisitions in mining/extraction, paper products, and communications sectors, on the other hand, yield statistically significant negative wealth gains to acquirers. introduction the u.s. foreign direct investment (fdr) has increased to $66 billion in 2000 from $33 billion in 1994. europe and latin america are the largest recipients of the u.s. foreign investments. there are studies (i.e. zhang, 2001; and ramirez, 2002) investigating the determinants of foreign direct investment at the macro level by using real gdp, the real exchange rate, and political factors. foreign direct investment in the form of mergers and acquisitions (m&as) constitutes an important part of foreign direct investment. given the growth in fdr flows to foreign countries over the years, one would expect to observe certain benefits accruing to firms involved in acquisition activities. various studies have investigated the wealth effects to both the target and bidding firms involved in domestic acquisitions. the general conclusion for domestic acquisitions is that shareholders of target firms receive the largest gains from corporate takeovers while the evidence regarding the premium received by acquiring firms' shareholders is inconclusive (i.e. malatesta, 1983; dennis and mcconnell, 1986; dodd, 1980; and asquith and kim, 1982). 8 journal of business strategies vol. 20, no.1 cross-border acquisitions can provide benefits to acquiring firms that might not be fully realized by their shareholders through cross-country portfolio diversification. therefore, cross-border acquisitions may increase the value of a firm. these benefits arise from firms' greater ability to use their strategic advantages in international financial and product markets, which result from differences in such items as tax structures, markets for corporate control, government regulations, and technology. for example, manzon, sharp, and travlos (1994) show that u.s. multinationals derive incremental benefits through foreign acquisitions by using their international financial networks to selectively repatriate dividends in a tax-beneficial manner. heston and rouwenhorst (1994) find that diversification across countries within an industry is a much more effective tool for risk reduction than industry di versification within a country. several studies have investigated the wealth gains in international acquisitions. among them, vasconcellos, madura, and kish (1990) and connell and conn (1993) examine the mergers between u.s. and the u.k. firms; kang (1993) and pettway, sicherman, and spiess (1993) focus on mergers between u.s. and japanese firms. fatemi (1984) and doukas and travlos (1988) probe u.s. firms engaged in foreign acquisitions. harris and ravenscraft (1991) and cebenoyan, papaioannou, and travlos (1992) investigate u.s. targets of foreign firms. dewenter (1995) compares the wealth effects of u.s. targets (chemical and retail industries) of domestic acquirers versus those of foreign acquirers. cakici, hessel, and tandon (1996) and kiymaz and mukherjee (2000) show that country diversification plays an important role in determining wealth gains to merger participants. an overwhelming majority of studies either focus on only two countries, or else they lump all foreign countries together and thus do not examine country and industry specific differences in wealth effects. this study examines the wealth effects that result from acquisitions announcements for u.s. firms involved in cross-border acquisitions in four different regions and 24 countries during the period of 1989-2000. specifically this study investigates the following questions: 1) do acquisitions by u.s. firms in the form offoreign direct investment benefit their shareholders? 2) are there any differences in wealth gains to acquiring firms with respect to regional and country location of target firms? 3) are there any differences in wealth gains to acquiring firms with respect to their industry affiliation? findings of this study indicate that u.s. acquirers experience statistically significant wealth gains of 0.57 % around the announcement of acquisitions. the wealth effects depend on both location of target firms and acquirers' industry affiliation. while acquisitions in europe yield positive wealth gains of 1.53%, acquisitions in asia/pacific, north america, and latin/central america regions yield negative wealth gains of -0.39, -1.90, and -0.50%, respectively. the highest wealth gains to u.s. acquirers occur when they acquire targets in france (2.68%) followed by acquisitions in the u.k. (2.09%). canadian acquisitions, on the other hand, yield significant negative wealth gains (-1.90%). with spring 2003 kiymaz: wealth effect 9 respect to industry affiliation, the services industry experiences the highest wealth gains (3.2%), followed by manufacturing (2.01 %) and food (1.23%) industries. acquisitions in mining/extraction (-2.89%), paper products (-2.17%), and communications (-1.36%) sectors, on the other hand, yield statistically significant negative wealth gains to acquirers. the remainder of the paper is organized as follows: section two reviews the relevant literature. section three describes data and methodology employed. section four presents and analyzes the wealth effects for u.s. acquirers involved in foreign direct investment, and the final section concludes the paper. literature review the question of whether stockholders reward firms that increase their foreign involvement continues to be a focus of attention in finance literature. most studies in this area have been concerned with performance of multinationals, which may be viewed as a portfolio of internationally diversified assets, relative to the performance of domestic firms. the empirical evidence is inconclusive and unable to show that multinational involvement enhances value of firm. if capital markets are segmented internationally or if it is more costly for individuals to obtain portfolio diversification directly, international corporate diversification may increase the value of firms. adler and dumas (1975) argue that diversification by multinational firms may provide a service to investors, which may not be available when capital markets are not fully integrated. thus, theoretically as a form of international diversification, multinational acquisitions may be value-enhancing activities. agmon and lessard (1977) suggest that investors can achieve their international diversification objectives by holding multinational stocks. brewer (1981) tests whether there is any difference between the performances of domestic and multinational firms and reports no statistical difference in the risk-adjusted performance of domestic and multinational firms. fatemi (1984) reports no difference in the rate of return realized by the shareholders of multinational firms relative to those purely domestic firms except when multinational firms operate in competitive foreign markets. hisey and caves (1985) show that the choice between related and unrelated acquisitions bears little relation to the acquirer's base activity in the u.s. but it is somewhat affected by transaction costs and the firm's previous experience in the host country. doukas and travlos (1988) investigate the impact of corporate multinationalism, through foreign acquisition, on the market value of the firm in an attempt to provide evidence on whether foreign direct investment .~~ a wealthincreasing corporate decision. the empirical findings indicate that shareholders of internationally expanding domestic firms experience insignificant positive abnormal returns at the time of announcement of the acquisition. conn and connell (1990) analyze the effects that international mergers have on shareholders of participating firms in u.s.-u.k. mergers and show that both u.s. and u.k. acquirers experienced either positive or normal returns in the year preceding the month of first public announcement of the merger. 10 journal of business strategies vol. 20, no. i harris and ravenscraft (1991) examine direct foreign investment by studying u.s. firms acquired during the period 1970-1987. the findings indicate that cross-border takeovers are more frequent in research and development intensive industries than are domestic acquisitions, targets of foreign buyers have significantly higher wealth gains than do targets of u.s. firms, and while cross-border effect on wealth gains is not we)] explained by industry and tax variables, it is positively related to the weakness of the u.s. dollar, indicating a significant role for exchange rate movements in foreign direct investment. cebenoyan, papaionnou, and travlos (1992) investigate the wealth effects of the announcement of acquisition bids made by foreign bidders to u.s firms, and compare it with domestic takeovers. the results indicate that the market competition variable is the most dominant and consistent explanation of the difference in wealth gains between foreign and domestic takeovers of u.s. firms. kang (1993) and pettway, sicherman, and spiess (1993) investigate mergers between japanese and u.s. firms and find significant wealth gains for both japanese bidders and u.s. targets. cakici, hessel, and tandon (1996) compare wealth effects of u.s. bidders acquiring foreign firms with those of foreign bidders acquiring u.s. firms. they find significant wealth gains to both groups of bidders. kiymaz and mukherjee (2000) also report significant wealth gains to u.s. bidders and show that wealth effects are inversely related to the degree of economic co-movement between the two countries. milman, d' mello, aybar, and arbelaez (200 i) show that many latin american countries use acquisitions in the u.s. as an effective way of competing in the global environment. kiymaz and mukherjee (200 i) examine the changes in risk of u.s. firms involved in cross-border acquisitions. the results show that the risk of u.s. firms declines and its level of significance varies across countries. gleason, mathur, and singh (2000) examine the wealth gains from the acquisitions offoreign divested assets by u.s. firms. the results indicate that the market views these divestments as value generating activities. ueng, kim, and lee (2000) provide evidence of wealth gains from international joint ventures. the findings indicate that shareholders of u.s. multinational firms benefit from such activities. these benefits are directly related to the level of ownership. data and methodology table i reports the u.s. foreign direct investment during the 1994-2000 period. the amount of fdi has increased sharply from $33 billion to $66 billion. the rapid increase in fdf flows has been accompanied by increasing portion of these fdi being directed to developing countries. for example, europe's share declined from 70% in 1994 to 50% in 1999 while latin america's share increased from 15% to 25% during the same time period. the u.k. receives the most foreign direct investment by u.s. firms followed by canada and germany. spring 2003 kiymaz: wealth effect 11 table 1 us foreign direct investment abroad panel a: foreign direct investment with respect to regionsjcoumries (millions oldollars) 1994 1995 1996 1997 1998 1999 2000 europe 22,608 27,073 14,641 24,220 38,681 39,044 44,795 germany 2,877 2,539 479 1,040 2,414 1,232 2643 france 2,950 v~59 na 1,405 2,594 952 966 netherlands 3,838 1,238 1,428 2,939 4,776 -299 1081 uk 3,808 8,312 5,312 14,617 24,242 26,740 25,197 others 9,135 12,125 7,422 4,219 4,655 10,419 14,908 asia pacific 3,768 5,224 2,918 5,422 7,923 9,775 4,667 australia -56 3,546 2,126 212 4,363 2,375 367 japan 486 418 -1,325 103 2,138 2,262 1,891 others 3,338 1,260 2,117 5,107 1,422 5,138 2,409 latin/central america 4,974 5,908 5,565 8,682 16,506 20,345 11,394 argentina 522 859 98 921 1,152 1,189 629 mexico 1,678 1,273 698 2,398 2,836 1,212 1,444 brazil 370 na 1,934 2,962 3,944 4,952 1,945 venezuela 16 na na na 259 581 2,035 other 2,388 3,776 2,835 2,401 8,315 12,411 5,341 north america 1,442 2,023 2,143 860 6,043 10,160 3,339 canada 1,442 2,023 2,143 860 6,043 10,160 3,339 panel b: foreign direct investment with respect to industry classifications (millions (~l dollars) 1994 1995 1996 1997 1998 1999 2000 all industries 33,659 40,485 27,533 40,792 72,447 79,183 66,088 petroleum 1,108 591 -796 4,905 7,319 5,072 3,926 food 852 751 501 2,713 2,277 1,050 798 chemical 1,635 12,072 773 556 2,105 2,208 781 machinery/ equipment 1,036 1,470 420 d 1,576 1,892 1,559 electronics -501 2,620 529 899 1,868 473 9,908 wholesale trade 6,727 574 2,513 364 1,846 -4,923 1,868 financials 10,801 8,317 9,028 16,561 25,456 32,035 19,710 services 4,126 1,069 115 1,566 5,924 5,757 1,698 others 7,875 13,021 14,450 13,228 24,076 35,619 25,840 source: bureau of economic analysis. the sample selection for empirical study is outlined in table 2. the initial sample includes all foreign acquisitions of u.s. firms reported in merger and 12 journal of business strategies table 2 sample selection vol. 20, no.1 this table presents the sample selection and the selected characteristics of u.s. acquirers. panel a: sample selection u.s. acquirers m&as reported less: no news less: no data net sample panel b: frequency of sample by country/ret:ion country and regions # of acquisitions europe 90 germany 9 france 9 netherlands 9 uk 49 others 14 asia/pacific 19 australia ii asia 8 latin/central america 20 mexico 7 latin america 13 north america 19 canada 19 total 148 panel c: frequency of sample by industry classification industry classification # of acquisitions sic 10-13 mining/extraction 8 sic20-21 food 14 sic26-27 paper products/publishing 8 sic28-29 chemicalslpetroleum 17 sic32-38 manufacturing 35 sic48 communications 15 sic49 utilities 23 sic50 retailftrade 6 sic60 financials 14 sic70 services 8 total 148 186 22 26 148 % of acquisitions 60% 6% 6% 6% 33 % 9% 13% 8% 5% 14% 5% 9% 13 % 13 % 100% % of acquisitions 5% 10 % 5% 12% 24% 10% 16% 4% 9% 5% 100% spring 2003 kiymaz: wealth effect 13 acquisitions almanac issues during the period of 1989-2000. the following screening criteria are then applied to the initial sample. first, firms in the final sample should be traded on the nyse or amex. this is to ensure that stock returns of firms can be retrieved from the center for research in security prices (crsp) database. second, firms with incomplete data on the crsp are eliminated. finally, firms with no news in the wall street journal are eliminated. the net sample consists of 148 firms. the sample includes acquisitions in europe (france, germany, netherlands, the uk, italy, switzerland, sweden, ireland, norway, belgium, and denmark), in asia/pacific (australia, japan, pakistan, and hong kong), in latin/central america (argentina, brazil, venezuela, mexico, and peru) and in north america (canada), panels band c of table 2 show selected characteristics of the acquiring firms. in terms of the acquired firm's location europe ranks first with 90 acquisitions (60%), followed by latin/central america with 20 acquisitions (14%), in term of country, the u.k. ranks first, with 49 acquisitions (33%) and canada is a distant second with 19 acquisitions (13%). panel c of table 2 reports the frequency of sample by industry classification. of the total 148 acquisitions, 35 (24%) are in manufacturing (sic32-38), 23 are in utilities (sic49) (16%), and 17 (12%) are in chemicals/petroleum (sic28-29) industries. standard event study methodology is used to measure the wealth effect of acquisitions announcements on acquiring firms. the following single-market model is employed in parameter estimation: (1) where: r. =/,/ r =d.r ~i,d = u =i £. = '.i the rate of return on security i on day t, the rate of return on the market value weighted rrsp index, the slope of the regression line of the firm i's returns against the returns on the market value crsp index, the intercept term, the residuals. an abnormal return (wealth effect) for common stock of firm i on day t is defined as: ~ ar = r r t.t /,1 u where, r. = u. + ~ d • r[r,f i i, j,i (2) (3) 14 journal of business strategies vol. 20, no. i in which u j and ~i,i) are estimated market model parameters obtained by using the pre-estimation period (t = -316 to t = -61).1 the cumulative abnormal returns of firm i (car) are obtained by accumulati ing ari,t's over a k-trading period running from day d[ to day d 2 : d, car,= dr,,{ (4) for a sample of n firms, a daily abnormal return for each day t is obtained: n aar{ = (£). laru (5) finally, the cumulative average abnormal returns (car) for a sample of n firms across a k-day event window are calculated as follows: car = d, n (£) ·llar", i=d, ;=/ (6) the expected values of abnormal returns and average abnormal returns are zero in the absence of abnormal performance. 2 empirical results the impacts of foreign acquisitions announcements on u.s. acquiring firms are reported in table 3 through table 5. first, the behavior of abnormal returns is displayed for the entire sample of 148 acquiring firms. panel a, table 3, outlines average daily abnormal returns (aars) during the 21 days surrounding the announcement of acquisitions (t = 0). the aars are 0.44% on day -i and are statistically significant at the i % level. this would indicate that foreign direct investments of us firms are perceived to be good news on average. the positive and statistically significant aars on days -4 and -2 might imply information leakage prior to the announcement. panel b, table 3, reports six different cumulative abnormal returns (cars) for the acquiring firms. for (-1,0) and (-1,1) windows, the cars for the entire target sample are 0.57% and 0.50% on average. both are statistically significant. most firms experience positive wealth gains from an acquisition announcement. cars in the remaining windows are all positive but not statistically significant. overall results show that markets evaluate u.s. acquiring firms involvement in foreign direct investment positively. the sample is then grouped into sub-samples based on the geographic location of the target firms in terms of both regions and countries. table 4 reports spring 2003 kiymaz: wealth effect 15 table 3 abnormal returns surrounding foreign acquisitions announcements of us acquirers this table presents the abnormal return to u.s. aequircrs surrounding the announcement of crossborder acquisitions. the null hypothesis is that the average abnormal returns are nut statistically different from zero. panel a: average daily abnormal returns (aars) u.s. acquirers days aars (0/0) t~value positive: negative generalized sign test -10 0.11 1.08 73:75 0.33 -9 -0.07 -1.15 67:81 -0.65 -8 -0.18 -0.64 74:74 0.50 -7 0.16 0.88 71:77 0.00 -6 0.22 1.30 73:75 0.33 -5 -0.26 -1.60' 64:84 -1.15 -4 0.25 2.01" 81:67 1.65* -3 0.01 -1.16 67:81 -0.65 -2 0.37 2.04" 72:76 0.17 -i 0.13 0.44 69:79 -0.33 a 0.44 3.09**' 80:68 1.48 +1 -0.07 -0.22 64:84 -1.15 +2 -0.15 -0.57 59:89 -1.97' +3 -0.17 -1.40 59:89 -1.97' +4 0.22 1.60' 80:68 1.48 +5 0.12 1.09 74:74 0.50 +6 0.06 0.03 68:80 -0.49 +7 -0.08 -0.01 61:87 -1.64' +8 -0.13 -0.88 73:75 0.33 +9 0.09 0.19 70:78 -0.16 +10 0.16 1.07 75:73 0.66 panel b: cumulative abnormal returns (cars) u.s. acquirers windows cars (0/0) t-value positive: negative generalized sign test (-1,0) 0.57 2.50" 78:70 1.15 (-i, i ) 0.50 1.91' 75:73 0.66 (-5,5) 0.90 1.62 81:67 1.65' (-10,1 0) 1.23 1.58 75:73 0.66 (-10,2) 0.96 1.53 82:66 1.81 ' (+1,6) 0.02 0.22 73:75 0.33 .. , " and' indicate statistical significance at the 1%, 5% and 10% levels, respectively. 16 journal of business stratef?ies vol. 20, no. i both the daily average and cumulative abnormal returns for acquiring firms surrounding announcement date. in terms of regions, u.s. direct investments in europe yield the highest positive wealth gains. in this region, aars are 1.06% and 0.47% in days -1 and 0 respectively. cars for windows (-1,0) and (-10,2) are 1.53% and 2.48% respectively. these results are statistically significant at 1% level. firms with acquisitions in the remaining regions (asia/pacific, north america, and latin/central america) experience negative wealth gains. for example, the daily average abnormal returns on day -1 are -0.69%, -0.88% and -0.32% in each ofthe regions. similarly, cars for window (-1,0) are -0.39% for asia/pacific region, -1.90% for north american region, and -0.50% for latin/ central american region. with respect to the locations of target firms, the wealth effects exhibit significant variations as well. the highest wealth gains are obtained in acquisitions in france and the u.k. for example, acquisitions in france yield wealth gains of 2.68% followed by wealth gains of 2.05% in u.k. by using cars (-1,0) window. acquisitions in canada, on the other hand, bring negative wealth gains of -i. 90% during the same event window. overall, the u.s. acquiring firms experience positive wealth gains in their involvement in cross-border acquisitions and the magnitude and level of significance vary from one country/region to another. the highest gains occur when u.s. firms acquire french firms followed by acquisitions of u.k. firms. acquisitions in other regions and countries yield negative wealth gains. table 5 reports both average and cumulative abnormal returns for acquiring firms according to industrial classification. the findings show variations in wealth gains to acquiring firms. the highest wealth gains occur to firms in the service industry (sic70) with an average abnormal return of2.17% on the day of announcement. the second highest abnormal returns are observed in the manufacturing (sic32-38) industry. the 10westaars occur in the mining/extraction industry (sic i0-13) with -2.65%, followed by financials (sic60-67) with -1.04%. cumulative abnormal returns exhibit similar patterns. six of the ten industry sub-groups experience positive wealth gains. for example, for the window (-1,0), the highest wealth gains are in the service industry (sic70) with a cumulative abnormal return of 3.22% followed by manufacturing (sic32-38) with 2.01 %. the lowest cars in (-1,0) window are observed in mining/extraction (sic 10-13) industry with -2.89% followed by paper products/publishing (sic26-27) with -2.17%. overall, this study finds statistically significant wealth gains accruing to u.s. firms involved in foreign direct investment. the magnitude of gains and significance level vary for each region, country, and industrial affiliation. these findings are in line with most of the recent studies but are not supported by earlier studies. for example, while doukas and travlos (1988) and conn and connell (1990) report insignificant wealth gains to u.s. acquirers, kang (1993), pettway, sicherman, and spiess (1993), cakici, hessel, and tandon (1996), and kiymaz and mukherjee (2000) find statistically significant positive wealth gains occurring to u.s. acquirers. this study further finds that the wealth effects do vary spring 2003 kiymaz: wealth effect 17 table 4 abnormal returns to u.s. acquirers by region/country location of foreign acquisitions this table presents the abnormal return to u.s. firms surrounding the announcement of cross-border acquisitions based on region/country location of targets. average abnormal returns cumulative abnormal returns (aars) (%) (cars) (%) window window window day (-1) day (0) day (+1) (-1,0) (-/0,+2) (+1,+6) europe: 0.47 1.06 -0.02 1.53 2.48 0.74 (2.37)'" (5.27)'" (0.49) (5.41) '" (3.35)'" ( 1.63)* gennany -0.45 0.50 1.53 0.06 0.20 5.35 (-0.43) (1.04 ) (1.99)" (0.43) (0.33) (3.04)'" france 0.66 2.02 0.52 2.68 5.56 1.33 ( 1.15) (3.51)*" (1.40) (3.30) '" (3.23)"" ( 1.25) netherlands-o.91 0.38 0.99 -0.53 2.78 0.47 (-1.28) (0.50) ( 1.85)* (-0.55) (1.25) (0.06) uk 0.64 1.41 -0.44 2.05 2.32 -0.34 ( 1.93)* (4.75)'** (-1.63)* (4.72)'** (1.53) (-0.12) others 1.22 0.04 -0.52 1.26 2.33 1.34 (2.85)'" (0.43 ) (0.09) (2.32) " (1.77)* (0.87) asia pacific -0.69 0.30 -0.31 -0.39 -2.86 -0.17 (-2.(7)" (0.87) (-1.55) (-0.85) (-2.48)*" (-oj)) ) australia -0.65 0.34 -0.27 -0.31 -1.64 -0.31 (-1.25) (0.58) (-1.(0) (-0.47) (-1.34) (-0.10) others -0.74 0.25 -0.38 -0.50 -4.54 0.01 (-1.73)* (0.66) (1.21 ) (-0.75) (-2.25)** (0.10) north america: canada -0.88 -1.02 -0.02 -1.90 -0.60 -2.00 (-1.83)* (-1.82)* (0.23) (-2.58)*" (0.09) (-1.28) latin/central america 0.32 -0.81 -0.11 -0.50 -0.79 -1.08 (-0.02) 1(-1.86)* (-0.37) (-1.33) (-0.61 ) (-1.60)* mexico -0.45 -0.69 -0.38 -1.14 -2.07 -1.27 (-0.82) (-1.32) (-0.72) (-1.51) (-1.34) (-1.24) latin america 0.73 -0.88 0.03 -0.15 -0.10 -0.98 (0.57) (-1.34) (0.07) (-0.54) (0.23) (-1.07) .... hand' indicate statistical significance at the 1%, 5% and 10% levels, respectively. 18 journal of business strategies vol. 20, no.1 table 5 abnormal returns to u.s. acquirers by industrial classification this table presents the abnormal return to u.s. firms surrounding the announcement of cross-border acquisitions based on primary standard industry classification of acquircrs. industries average abnormal returns cumulative abnormal returns (aars) (%) (cars) (%) window window window day (-1) day (0) day (+1) (-1,0) (-10,+2) (+1,+6) sicio-13 -0.24 -2.65 -0.04 -vn 1.35 -4.08 (-0.30) (-3.29)'** (0.11 ) (-2.54)" (0.86) (-2.20)" sic20-21 0.01 1.22 0.60 1.23 1.49 0.28 (0.13) (2.16)" ( 1.65)' ( 1.62)' (0.77) (0.20) sic 26-27 -1.56 -0.61 -0.33 -2.17 -4.98 ..,1.28 (-1.90)' (-0.72) (-0.45) (-1.85)' (-1.04) (0.60) sic28-29 0.66 0.03 -0.20 0.69 0.32 0.79 ( 1.62)' (0.26) (-0.32) (1.33) (0.06) (0.56) sic32-38 0.65 1.36 -0.09 2.01 1.60 0.98 (2.51 )'** (4.66)'" (-d.08 ) (5.07)'** (1.56) ( 1.12) sic48 -0.66 -0.70 -0.50 -1.36 1.41 -1.04 (-2.17)'** (-1.37) (-0.71 ) (-2.50)'* (0.32) (-0.52) sic49 0.44 0.57 -0.24 1.01 0.29 0.78 (0.51 ) ( 1.33) (-1.15) ( 1.30) (0.25) ( 1.42) sic50 0.86 1.05 1.42 1.91 5.26 1.15 (0.23) (0.39) ( 1.23) (0.44) (0.61 ) (0.07) sic60 -1.04 0.03 -0.35 -1.01 -0.20 -1.84 (-2.37)** (0.34) (-0.63) (-1.43) (-0.45) (-1.46) sic70 1.05 2.17 0.07 3.22 3.95 -1.15 (1.36) (3.12)*** (0.54) (3.17)*** (1.60)* (-0.72) *h". and * indicate statistical significance at the 1%.5% and 10% levcls, respectively. with location of target firms and acquirers' industry affiliation. while acquisitions in europe yield positive wealth gains, acquisitions in asia/pacific, north america, and latin/central america regions yield negative wealth gains. the wealth gains are highest when acquisitions take place in france and the u.k., and lower when it takes place in canada. firm's industry affiliation also appears to be a source of variation in wealth gains with firms in the services industry experiencing the highest wealth gains and firms in mining/extraction industry having the lowest wealth gains. summary and conclusion the u.s. foreign direct investments have increased sharply in recent years. foreign direct investment in the form of mergers and acquisitions (m&as) spring 2003 kiymaz: wealth effect 19 constitutes an important part of foreign direct investment by u.s. firms. this study investigates the wealth effects for u.s. firms involved in crossborder acquisitions of foreign firms during the period of 1989-2000. the sample consists of 148 acquisitions in four different regions and 24 different countries. overall findings indicate that u.s. acquirers experience statistically significant wealth gains of 0.50 % on the day of announcement. the wealth gains further differ with respect to the location of target and the industry affiliation of acquirers. acquisitions in europe yield the highest wealth gains of 1.53% while acquisitions in asia/pacific, north america, and latin/central america regions yield statistically significant negative wealth gains. the highest wealth gains to u.s. acquirers occur when they acquire targets in france (2.68%) followed by acquisitions in u.k. (2.05%). acquisitions in canada, on the other hand, yield negative significant wealth gains (-1.90%). there are also differences in wealth gains with respect to industry affiliation of acquirers. the highest wealth gains are observed in services industry (3.22%) followed by acquisitions in manufacturing (2.0 1%) and food (1.23%) industries. acquisitions in mining/extraction (-2.89%), paper products (-2.17%), and communications (-1.36%) sectors, on the other hand, yield statistically significant negative wealth gains. generally, this study finds that foreign direct investments by u.s. firms in the form of acquisitions are wealth-creating activities for u.s. firms. the magnitude and the level of significance of wealth gains vary from one countrylregion to another. furthermore, the benefits obtained from these acquisitions are different for each sector. references adler, m. & dumas, b. (1975). optimal international acquisitions. journal of finance 20, 1-19. agmon, t. & lessard, d. r. (1977). investor recognition of corporate international diversification. journal of finance 32, 1049-1055. asquith, p. & kim, e.h. (1982). the impact of mergers bids on the participating firms' security holders. journal of finance. 1209-1229. brewer, h.l. (1981). investor benefits from corporate international diversification. journal of financial and quantitative analysis 16, 113-126. brown, s.j. & warner, j.b. (1985). using daily stock returns: the case of event studies. journal of financial economics 14, 3-31. cakici, n., hessel, c. & tandon, k. (1996). foreign acquisitions in the united states: effect on shareholder wealth of foreign acquiring firms. journal of banking and finance 20, 307-329. 20 journal (~f business strategies vol. 20. no. 1 cebenoyan, a.s., papaioannou, g. j., & travlos, n.g. (1992). foreign takeover activity in the u.s. and wealth effects for target firm shareholders. financial management zl, 58-68. conn, r.l., & connell, f. (1990). international mergers: returns to u.s. and british firms. journal of business finance and accounting 17, 689-711. connell, f. & conn, r.l. (1993). a preliminary analysis of shifts in market model regression parameters in international mergers between u.s. and british firms: 19701980. managerial finance 19,47-77. dennis, d.k. & mcconnell, j.j. (1986). corporate mergers and security returns. journal of financial economics 16, 147-187. dewenter, k.l. (1995). does the market react differently to domestic and foreign takeover announcements? evidence from the u.s. chemical and retail industries. journal of financial economics 37, 421-441. dodd, p. (1980). merger proposals, management discretion and stockholder wealth. journal of financial economics 8, 105-137. doukas, j. & travlos, n. (1988). the effect of corporate multinationalism on shareholders' wealth: evidence from international acquisitions. journal of finance 23, 11611178. fatemi, a.m. (1984). shareholder benefits from corporate international diversification. journal of finance 39, 1325-1345. gleason, k., mathur, i. & singh, m. (2000). wealth effects for acquirers and divestors related to foreign divested assets. international review of financial analysis 9, 520. harris, r.s. & ravenscraft, d. (1991). the role of acquisitions in foreign direct investment: evidence from the u.s. stock market. journal of finance 46, 825-844. heston, s.l. & rouwenhorst, k.g. ( 1994). does industrial structure explain the benefits of international diversification? journal of financial economics 36, 3-27. hisey, k.b. & caves, r.e. (1985). diversification and choice of country. journal of international business studies 16, 51-65. kang, j. k. (1993). international market for corporate control. journal of financial economics 34, 345-371. kiymaz, h. & mukherjee, t.k. (2000). the impact of country diversification on wealth effects in cross-border mergers. financial review 35, 37 -58. spring 2003 kiymaz: wealth effect 21 kiymaz, h. & mukherjee, t.k. (2001). parameter shifts when measuring wealth effects in cross-border mergers. global finance journal 12, 249-266. malatesta, p.h. (1983).the wealth effect of merger activity and the objective functions of merging firms. journal of financial economics ii, 155-181. manzon, g.b., sharp, dj. & travlos, n.g. (1994). an empirical study of the consequences of u.s. tax rules for international acquisitions by u.s. firms. journal of finance 49, 1893-1904. milman, c., d'melio, j. aybar, b. & arbelaez, h. (2001). a note using mergers and acquisitions to gain competiti ve advantage in the united states in the case of latin american mncs. international review of financial analysis 10, 323-332. pettway, r. h., sicherman, n.w. & spiess, d.k. (1993). japanese foreign direct investment: wealth effects purchases and sales of u.s. assets. financial management 22, 82-95. ramirez, m.d. (2002). foreign direct investment in mexico during the 1990s: an empirical assessment. eastern economic journal 28,409-423. ueng, c.j., kim, s. & lee, c. (2000). the impact of firm's ownership advantages and economic status of destination country on the wealth effects of international joint ventures. international review of financial analysis 9, 67-76. vasconcellos, g.m., madura, j. & kish, r.j. (1990). an empirical investigation of factors affecting cross-border acquisitions: u.s. vs. u.k. experience, global finance journal 1. 173-189. zhang, k.h. (200 i). what attracts foreign multinational corporations to china? contemporary economic policy, 336-346. i most event studies employ a pre-estimation period to estimate the market model parameters. the length of estimation period varies between 180 and 270 days. this study uses 255 days to estimate model parameters and 60 days for event-window to analyze wealth effects. 2 the test of significance is performed by following brown and warner ( 1985) and is not illustrated here. 22 journal (~lbusiness strategies vol. 20, no.1 dr. halil kiymaz is assistant professor of finance at university of houston clear lake. he obtained his ph.d. from university of new orleans. he also holds the cfa designation. prior joining the uhcl faculty, he has served on the faculty of bilkent university in turkey. his research has been published in journal of banking and finance, financial review, journal of economics and finance, applied financial economics, journal of multinational financial management, global finance, journal of research in finance, journal of emerging markets, and journal of economics and business studies, among others. wealth effect for u.s. acquirers from foreign direct investments alternative measures of performance for e-companies: a comparison of approaches esmeralda garbi florida atlantic university boca raton, fl abstract understandingfirm performance is as important in the new economy as it was in the old one. it seems difficult, however, to make a judgment about which measures ofperformance are good predictors offuture success for e-companies. this paper contrasts indicators ofasset productivity, shareholder value, growth, survival, and cyberspace usage, exploring how these different indicators reflect performance for a sample ofe-companies, and compares them with a sample of brick-and-mortars competing in the same industries. results suggest that multiple indicators are more necessary than ever to capture the variability of outcomes in the internet economy. introduction one of strategic management's main challenges as a field has been the conceptualization and measurement of firm performance (barney 1997; venkatraman & ramanujam 1986). several authors have highlighted the importance of firm performance for the field of strategy (day, farley & wind 1990; prahalad & hamel 1994; rumelt, schendel & teece 1994) and have also pointed out the inadequacy of most indicators to capture its complexities (jacobson 1987; march & sutton 1998; venkatraman & grant 1986). now, the transformation of business models accompanying the new economy seems to be making it even more challenging to find indicators that can help managers and researchers predict a firm's future success based on its current operations. the e-commerce environment seems to complicate the measurement of firm performance and, at the same time, seems to offer new opportunities for developing new performance indicators. on one hand, the emphasis on information-based operations and on the use and exploitation of intangible assets that characterize the new economy suggests that e-companies performance cannot be measured with traditional accounting or assets productivity indicators such as roaand roe. also, the condition of "newness" of these firms precludes the use of profitability ratios to assess their future potential of success. on the other hand, this same emphasis on interactive information and the access it provides to direct customer data has created opportunities for the development of new performance indicators, such as accessibility, web presence, and usefulness. 2 journal of business strategies vol. 19, no.1 understanding, explaining and predicting firm performance is, nevertheless, as important in the new economy as it was in the old one, why do firms perform differently? what are valid and useful measures of firm performance? what indicators allow us to predict when an operation is on the right track, and when it is not? how can we distinguish a strong industry performer from a weak one? questions such as these are still fundamental, especially if we want to develop theories that are useful and that offer effective recommendations for managers. when discussing performance of e-commerce firms, some of the prevailing arguments do not seem to offer very useful answers to these questions, we frequently find a position of skepticism about the future of internet-based firms, more now that the optimism and enthusiasm characteristic of the e-commerce initial boom (fox 1999) have turned into widespread pessimism (chen & linsday 2000; kedrosky 2000) as many companies have been unable to survive the inevitable shakeout (choi & whinston 1998; leduff 2000; useem 2000), if we take this position, the answer to the question will be not to bother studying and analyzing these companies since most of the "no-profit" companies are going to die anyway. another stance regarding e-companies performance is to argue that not enough time has passed yet in order to be able to understand and predict what is going on; that it is better to wait before attempting to value the performance of firms in the ecommerce world (warren buffett, as cited by de figueiredo 2000). this position seems to assume that, with time, it will be possible to develop performance measures for e-companies and to value their results, this position also supposes that it is not necessary to understand and predict performance ex ante and that it is better to wait to see what happens and then analyze the situation ex post. the problem with these two approaches is that, in one case, it applies old economy conceptualizations of performance, based on a manufacturing era, that are not necessarily reflective of performance in the information age. in the other case, by waiting for the situation to develop, we are missing the opportunity of observing and gathering real time data. gathering data and attempting to understand the phenomena now is important, however, and will open the path and set the bases for future knowledge in the field. we should not forget, though, that the evaluation of firm performance in an embryonic industry calls for special considerations, and that e-commerce has important particularities in its value creation activities. this paper addresses these issues by comparing and contrasting traditional measures of performance with alternative measures that seem especially relevant for an industry in its embryonic/growth phase. the paper identifies and discusses multiple indicators of performance such as accounting and profitability ratios, inflow/outflow net growth ratio, growth and survival indicators, as well as ecommerce specific measures such as web presence growth and indicators of cyberspace brand and presence. some of these indicators are applied to a sample of thirty e-companies and compared with a sample of thirty traditional (brickand-mortar) companies in the same group of business activities. spring 2002 garbi: alternative measures of performance traditional definitions of firm performance 3 strategic management as a field of study pursues the building of theories that explain and predict differences in firm performance (rumelt, schendel & teece 1994). why are firms different? why do firms perform differently? those are fundamental research questions for strategic management scholars (prahalad & hamel 1994; rumelt, schendel & teece 1994). in a sample of strategic management journal current issues (january-august 2000), approximately sixty percent of articles dealt with performance as a dependent variable. similarly, about forty percent of articles published during the last two years in the journal of business strategies assessed firm performance as the researcher's dependent variable. within the field, there are many definitions of firm performance and not a general agreement on particular definitions. one approach that seems to be widely followed, however, compares the value that an organization creates using its productive assets with the value that the owners of these assets expect to obtain. it addresses the feasibility and survivability of the firm, assuming that owners of the productive assets will continue to make those assets available to a particular firm only if the value it creates is at least as large as the value they expected. a firm's level of performance is determined by its ability to generate the expected value. a firm can perform according to expectations, below expectations, or above expectations. firms performing above normal will enjoy competitive advantages to attract productive assets in their industry. this perspective for defining firm performance is the one adopted by most authors in strategic management (porter 1980; rumelt 1984) and the resource-based view of the firm (amit & shoemaker 1993; barney 1986; 1991; 1997; michalisin & kline 2(00). within this approach, firm performance has been measured as survival, or operationalized using accounting, stakeholder, or present-value indicators. profitability ratios such as roa and roe are by far the most commonly employed accounting measures of firm performance in strategic management research. other traditionally used accounting measures are revenues and sales growth, as well as stock price and stockholder value. market value, market-to-book value, and tobin's q (a firm's market value divided by its replacement cost) are used to address market capitalization and market valuation, as well as strategic actions and moves. some authors address other stakeholders' interest, as suggested by cameron (1986) and others, evaluating performance from the employees side (turnover, growth in employees, employee satisfaction), the customer side (market share, sales growth, customer loyalty), as well as other performance aspects assumed to reflect the long term potential of a firm such as innovative ness and learning (percentage of sales generated by new products, time to innovation, time to market). the following sections discuss traditional indicators of finn performance, organized in three different groups of measures; asset productivity indicators, shareholder value indicators, and growth and survival indicators. each section 4 journal of business strategies vol. 19, no.1 briefly addresses and discusses the applicability and limitations of these indicators for the case of e-companies. asset productivity indicators most accounting measures of performance are based on the assumption that a business firm's efficiency of operations is the best way to assess goal attainment. the criteria for performance in this case is how much the company obtains as returns from the amount invested on its operations. one of the most commonly used measures of firm performance is the return on investment (roi) or return on assets (roa), which is simply the result of dividing net income before taxes by total assets. besides its limitations for capturing real and long-term firm performance (amply discussed in barney 1997; jacobson 1987; march & sutton 1998; venkatraman & grant 1986) there are clear limitations to the use of assets productivity measures of performance as indicators of performance for new ecompanies. one characteristic of e-business firms is that they utilize distribution technologies to render their service or to make their products accessible to a large base of customers. hence, the proportion of variable costs for e-companies is expected to be smaller than that of equivalent traditional companies. thus, the margins obtained could more appropriately be considered a function of the distribution capability and reach of the e-commerce channel, as opposed to inherent efficiencies dependent on use of assets. in the sale of downloaded software or content, for example, the developmental costs and expenses remain fixed but the amount of such software or content being downloaded and paid for will depend on the effectiveness of the e-commerce presence of the software firm. new internet-based companies, on the other hand, are characterized by the typical expenses and negative profits of new companies in a new industry, as well as by the volatility associated with an embryonic stage. by incurring in less than zero numerators, mathematical comparability is meaningless for most profitability ratios in regards to the new internet-based companies. shareholder value indicators for an industry in its embryonic period, a common proxy used for financial performance is shareholder value. indicators of shareholder value as measured by market capitalization, market-to-book value, share price or others could be estimated, but might be misleading for industries in initial stages of growth and, as in the case of e-commerce, with highly speculative investment. it is in the components that make up the shareholder value that financial and other operation indicators should focus. a direct financial indicator that can be used as a performance proxy for companies in this stage is the rate of revenue growth over the rate of costs and expenses growth, or inflow/outflow net growth ratio. if it is or longitudinally tends to be greater than one, it can be deemed as an indicator of positive performance, even if profits are negative. this measure has spring 2002 garbi: alternative measures of performance 5 to be "net", however, i.e. not including extraordinary income from investors, credit or other "liquidity event". another indicator of value used in traditional managerial accounting is the value of the brand and other components of goodwill. the method estimates the value of the brand by calculating the market-to-book value. a high market-tobook value is considered to be an indicator that the market attaches a high value to the brand. for pure-play start-up e-companies, however, that have not yet developed strong brand names, the goodwill value is ascribed more to the market expectations of its business plan. a value related indicator that can be used then for this stage is the power of business design, as defined by rappaport (1986), which is measured by dividing the market value by the gross revenues. the greater the number, the more powerful is the business model as perceived by the market and the investors. the incredibly high market capitalizations of e-commerce companies (venkatraman 2000) reflect a high perception of their business models by investors. this seems to be the argument used to explain why a majority of e-commerce related web sites have a high cost of marketing, for which popular literature establishes a ratio of at least 30% of expenses dedicated to marketing in the first year as the minimum required for building a web company. how important are, however, these high market capitalizations as indicators of future success? even though recent publications on the perfonnance and strategy of e-business firms present brand equity as one important source of first mover advantages and entry barriers (de figueiredo 2(00) the reality seems to show the contrary in terms of success and survivability of first movers. we see day after day many highly recognized companies, with high market capitalizations, such as pets.com or webvan, filing for bankruptcy. this situation indicates that measures of performance based on market valuation reflect speculation rather than real future potential of success; hence, they are not good indicators of long-term performance. growth and survival indicators e-commerce firms in general, and e-startups in particular are characterized by its newness and, as all new things, by its growth. while it seems abysmal to incur in growing negative profits quarter after quarter, enthusiasm is generated among executives and investors by the growing revenues of e-businesses; the losses generated by the growing costs and expenses are dismissed as investment. key perfonnance indicators are, hence, those related with growth. undoubtedly, the inflow/outflow net growth ratio described earlier can be an indicator of growth trends and financial health in this context, by assessing the value to the consumer market of the business proposition over a certain period of time. the rate of dot-com failure is probably one of the most publicized aspects of the internet economy recently. companies such as furniture.com, garden.com, mortgage.com have made the headlines as very notorious failures. bankruptcy or the discontinuing of operations can obviously be used as indicators of negative 6 journal of business strategies vol. 19, no. i perfonnance, though they are ex post indicators.akey potential indicator of survival (or the threat of failure) is the burn rate, i.e., speed at which the company is spending money. this rate detennines when the capital raised will run out. the recent stock market movement away from dot-corns has highlighted this indicator, as many companies were expecting additional rounds of financing to raise "burned" capital required to sustain the company until revenues exceeded costs and expenses to allow for self-sustained reinvestment. the indicator measured is in effect "time before money runs out", which equals the cash reserves of the company divided by the bum rate. if the bum rate is adequately timed, with financing rounds allowing for market volatility, it is more probable that the finn will be likely to survive market fluctuations. an important and useful indicator, it is usually available to investors and venture capitalists but not publicly available. an additional survival indicator can be extracted from the resource attraction and retention scheme typical of the e-commerce activity. due to its initial speculative nature, great amount of talent and resources where attracted to ecompanies by following a vesting options scheme. the volatile nature of these ventures has made many of these options lose value to a great extent. risk averse talent as well as consulting and governance resources are in fact leaving firms where a high ratio of compensation was based on these options. typical of this situation are the recent talent departures from priceline.com, where even its high profile spokesman, william shatner, reportedly ended his contract after his options declined from a value of more than $20 million to less than $300,000. . companies with high reliance on resources through equity options have a greater survival risk than companies that do not have this high reliance. e-commerce-specific indicators of firm performance because e-commerce has as its critical interface the computer screen, it is important to consider indicators related to accessing and viewing. two companies in particular gather and analyze data on web presence and traffic: gomez.com and jupiter media metrix. because cyberspace is growing more and more crowded, the "stake of the web claimed" is an important factor impacting the success of e-companies. it can be considered as another indicator of first mover advantages for a company. some specific indicators developed to measure web presence are page views (the amount of times a page is loaded onto a computer screen), as wen as measures of frequency such as recurring visits and the rate of unique visitors (which identifies the number of visitors that have accessed a site for the first time). these indicators are numeric and easy to understand, but might not be publicly available for many companies. the rate of unique visitors is however available through jupiter media metrix (2000). a brief list of the most commonly used indicators of cyberspace presence is included in the appendix. spring 2002 garbi: alternative measures of performance data 7 with the purpose of assessing the applicability to e-companies of some of the measures discussed above, and to compare the results to a sample of traditional firms, this paper studies two randomly selected samples of thirty companies each, composed bye-companies and brick-and-mortar companies. for the sample selection, two lists of companies were built from the standard & poor's register of corporations. only u.s. public companies with available financial data and that had been incorporated after 1992 were included in the original list. the original set of companies was limited to fifteen sic codes (4724, 5735, 5912,5942,5945,5961,5963,5999,6162,6211,7311,7389,7812,7999,8099) which included several categories of retail, security brokers, mortgage and loan correspondents, and entertainment, business and travel related services. adiverse set of activities was necessary in order to attain a large enough list from which to randomly select the two sets of thirty companies. the selection of industries was based on the industries represented by the e-companies included in the fortune e-50 list (1999), excluding those sic codes for which there were no clearly identifiable traditional companies performing the same business activity (information retrieval services, computer related services, computer programming, and prepackaged software). e-companies are defined as those that conduct most commercial transactions with other businesses and buyers over the internet (mahadevan 2000). to classify firms as e-companies, information about the company business activity from the s&p corporation records, and the company's description of activities in its two latest annual reports (sec filings of 10-k) was used. companies were considered to be e-companies if: a) the company was listed as a fortune e-50 companies; or b) the s&p corporation records specifically included the term "on-line" as part of the business description and the company's 10ks reported that the company was performing most of its operations on-line. this second criterion was very clear in some cases, for which the business description and the annual reports described a firm that was conducting most of its business transactions on-line. obviously, just having a website was not considered enough to classify a firm as an e-company, since many traditional companies have incorporated websites without making any substantial changes to the way in which they conduct their business. for some companies, however, the situation was not as clear and those cases were dropped from the list to avoid misrepresentation. to classify companies as brick-and-mortars, a search of key words (internet, on-line, website) was conducted on the companies latest 10-k. companies were classified as brick-and-mortars if they did not have mention of any of these words regarding their business activity in their io-k report. the financial indicators used for descriptive statistics and analyses were: roa, roe, market value, market-to-book value, market value/revenues (power of business design), growth in revenues, income and costs and 8 journal of business strategies vol. 19, no.1 expenses, the inflow/outflow net growth rate, employee growth, and the rate of unique visitors as a measure of cyberspace presence. indicators of age (years since incorporation) and size (number of employees, revenues and assets) were also included. accounting and financial indicators of performance were obtained from the company financials section of sec filings, lo-k reports and disclosures. hoovers' company profiles and financial reports were used for the few private companies in the sample for which sec filings were not available. the rate of unique visitors for ecompanies was obtained from jupiter media metrix. to classify companies as survivors or not survivors, sec bankruptcy filings as well as a search for newspaper and business journals publications was conducted, using abi informs and lexis-nexis. firms that have entered bankruptcy, that have been acquired and have downsized most of their employees, or that have changed names and area of activity were considered non-survivors for the effect of the analyses. results table 1 summarizes descriptive statistics, comparing the group of survivors and the group of non-survivors within the sample of e-companies. a one-way anova comparison shows no significant differences between the means for the two groups of companies for most indicators. the only two indicators for which significant differences were reported are the 1999 rate of unique visitors and the size in assets. e-companies that have survived and are still in business by early 200 i were those with higher volume of unique visitors and with higher level of assets. table 2 shows a t-test comparison of means for the two samples (e-companies and brick-and-mortars). interestingly, only few indicators present significant differences between the two samples. as it was expected, considering the highly publicized market capitalizations of e-commerce companies, especially for the year 1999, market values of e-commerce firms were significantly higher than those for brick-and-mortars. the situation a year later changed, however, and no significant differences were found for the same two samples for the year 2000. the market valuelrevcnues indicator was also, as expected, significantly higher for e-companies. this reflects the much-publicized over-valuation of "new business models" associated with e-companies during the year 1999. the growth in revenues was significantly higher for e-companies, with an average of more than 500% yearly increase in revenues (1998 to 1999). the growth in costs and expenses was also substantially higher for e-companies. e-companies show an average growth in costs and expenses of 31 0% between 1998 and 1999. no other indicators between the two samples show significant differences. the two samples are similar in terms of age and size of the companies, as well as in terms of profitability ratios. spring 2002 garbi: alternative measures of peiformance 9 table 1 descriptive statistics and anova test: comparison of e-companies survivors and non-survivors by end of 2000/beginning of 2001 indicator l survivors non-survivors mean s.d. mean s.d. roa ( 13.2) 51.6 (0.9) 0.7 roe ( 13.3) 51.6 (1.3) 1.6 market value 1999 ($m) 3,778.5 4,174.0 1,176.7 2,260.1 markeho~book value 30.1 73.7 4.6 6.1 market value/revenues 37.2 70.9 32.5 64.5 i ~year revenue growth (%) 655.4 2,005.3 388.2 344.3 i-year net income growth (%) 251.6 4,763.3 (406.6) 290.2 i-year cost & expense growth (%) 305.8 531.0 317.5 224.0 inflow/outflow net growth 1.3 0.9 (9.5) 31.2 i -year employee growth (%) 355.7 754.5 82.8 79.9 unique visitors (m) 10.8* 5.7 5.2* 2.4 age (years since incorporation) 3.2 1.7 2.5 1.9 size in number of employees 1,360 1,869 509 701 size in revenues ($m) 237.9 422.7 110.5 190.3 size in assets ($m) 470.9* 701.0 136.4* 180.6 n 16 14 differences are statistically significant at * p < 0.05; ** p < 0.01; *** p < 0.001 ifigures for 1999 unless otherwise specified. tables 3 and 4 report the correlations between these different indicators for the two samples. as shown in table 3, the rate of unique visitors shows significant correlations with measures of market value (.65 and .47), net income growth (.51), employee growth (.51), age of the firm (.48) and size in assets (.77). other correlations that should be noted are the negative but significant correlations between market-to-book value (and indicator of goodwill value) and roa (-.98), roe (-.98), and positive significant correlations between market-to-book value and revenues growth (.97), cost and expenses growth (.92), and employee growth (.96). again, these correlations seem to indicate that these companies' valuation were based on the visibility of revenues volume, growth in employees, as well as the already noted rate of accessibility to customers (unique visitors). e-companies show a high and positive correlation between revenues growth and cost and expenses growth (.95) and between revenues growth and employees growth (.95). the more they make, the more they expend and the more they grow. these relationships seem to explain also the significant negative correlations between profitability ratios, roa and roe, and revenue and employee growth (-.99 and -.96 respectively). 10 journal of business strategies vol. 19, no. i table 2 descriptive statistics and t-test for equality of means: comparison of ecompanies and brick-and-mortars incorporated after 1992 indicator l e-companies brick-and-mortars mean s.d. mean s.d. roa (7.7) 38.3 (0.1 ) 0.7 roe (8.0) 38.2 (0.1 ) 0.7 market value 2000 $m) 538.4 780.3 165.9 381.8 market value 1999 ($m) 2,873.5*** 3,865.8 126.0*** 353.6 market-to-book value 218 59.5 2.3 4.4 market value/revenues 35.6* 67.3 3.1 * 7.5 i-year revenue growth (%) 542.4* 1,522.3 50.0* 97.6 i-year net income growth (%) (166) 3,637.4 3.8 127.2 i-year cost & expense growth (%) 310.5** 428.2 32.0** 69.2 inflow/outflow net growth (2.8) 19.2 4.1 14.5 i-year employee growth (%) 256.5 610.4 22.2 54.2 unique visitors (m) 6.9 5.0 n.a. n.a. age (years since incorporation) 3.0 1.8 3.8 15 size in number of employees 979.5 1,505.8 1,593.6 2,9959 size in revenues ($m) 178.4 335.9 159.4 311.0 size in assets ($m) 431.0 706.7 265.5 436.8 survivors by end of 2000 16 22 n 30 30 differences are statistically significant at * p < 0.05; ** p < 0.01; *** p < 0.001 (z-tailed, equal variances not assumed). 'figures for 1999 unless otherwise specified. in terms of market value. besides correlations with unique visitors that were already discussed, it is interesting to notice the significant and positive relationships with size in employees (.62 and .70 for 1999 and 2000. respectively) and with size in assets (.68 and .57). a positive and significant correlation with age of the firm is only present for the market value of 2000 (.62), which seems to reflect the adjustment of the market in the year 2000. some differences between e-companies and brick-and-mortars can be established by comparing the correlations shown in table 4 with those of table 3. in particular. the differences between the two groups appear in the lack of significant correlations between revenues growth and market-to-book value, as well as no negative correlations between revenue growth and profit ratios. other noticeable difference is that. for traditional start-ups. revenue growth is negatively correlated with age (-.46), which seems to indicate a typical characteristic of new ventures. for which the rate of revenue growth is expected to decline as the firm ages. table 3 c/.l "0 :l. pearson's correlation matrix of performance indicators: e-companies' ~(}q n 0 indicator 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0n i.roa 1.00 2. roe 1.00** 1.00 c'} 3. market value (2000) .16 .16 1.00 i::> 4. market value (1999) .16 .16 .85** 1.00 ~ 5. market-to-book (.98)** (.98)** (.03) .01 1.00 >-....t1:> 6. market value/revenues .10 .11 .10 .19 (.12) 1.00 ~ 7. revenue growth (.99)** (.99)** (.19) (.19) .97** (.10) 1.00 i::>.... ~. 8. net income growth .06 .06 .19 (.03) (.12) (.46)* (.08) 1.00 t1:> 9. c & e growth (.91)** (.91)** (.26) (.21) .92** (.01) .95** (.13) 1.00 ~ t1:> i::> 10. inflow/outflow growth (.07) (.07) (.07) (.10) (.10) (.08) .05 .03 .18 1.00 '"":::: ii. employee growth (.96)** (.96)** (.17) (.07) .96** (.11) .95** (.07) .87** .05 1.00 (\! '"" 12. unique visitors .33 .21 .65* .47* .38 (.28) (.22) .51 * (.20) .03 .51 * 1.00 ~ 13. age .12 .12 .62* .33 (.09) .19 (.18) .21 (.22) (.01 ) (.14) .48* 1.00 "tl t1:> 14. size (employees) (.26) (.26) .70** .62* .40 (.10) .22 .06 .16 .02 .30 .45 .38 1.00 ~ 15. size (assets) .13 .12 .68** .57* (.02) (.13) (.16) .40* (.23) .01 (.09) .77** .55* .63* 1.00 ~i::> ;:s t"\ t1:> note: 'correlations estimated for sample of e-companies (n = 30) * correlation is significant at p < 0.05 (2-tailed) ** correlation is significant at p < 0.01 (2-tailed) -table 4 tv pearson's correlation matrix of performance indicators: brick-and-mortarsb incorporated after 1992 indicator 1 2 3 4 5 6 7 8 9 10 11 12 13 14 i. roa 1.00 2. roe 1.00** 100 3. market value (2000) .08 .08 1.00 4. market value (1999) .06 .06 .99** 1.00 ..... 5. market-to-book (.52)**(.52)**16 23 1.00 a ;;;: 6. market value/revenues (.34) (.34) (.09) (04) .32 1.00 ;; i:l 7. revenue growth .15 .15 (.16) (.08) (.03) (.11 ) 1.00 <q., 8. net income growth .06 .06 .12 .09 .10 (24) .16 1.00 t:tl 9. c & e growth (.15) (.15) (02) .06 ;;;: (00) .20 .68** .24 1.00 ""s· 10. inflow/outflow growth (.39)* (.39)* (.10) (.05) .15 (os) .03 (.03) (.08) 1.00 '"""ii. employee growth .27 .27 .00 .05 .11 (.15) .29 .23 .41 * (28) 1.00 ""v} 12. age (.29) (.29) (.04) .07 .30 (.04) (.35) (02) 1.00 -( .12) (.46)* (.07) 2l 13. size (employees) .15 .15 .81 ** .79** .12 .10 .13 (.06) .43* .09 1.00 -(.16) .05 '"\xl 14. size (assets) .28 .28 .79** .78** .02 (.16) (.04) .02 (.03) (.11 ) .06 .04 .61 ** 1.00 ~. "" note: ·correlations estimated for sample of brick-and-mortar competitors, with year of incorporation after 1992 (n=30) * correlation is significant at p<0.05 (2-tailed) ** correlation is significant at p<o.oi (2-tailed) 2: .... \0 z 0 spring 2002 garbi: alternative measures of performance conclusions 13 the analyses and results presented in this paper are descriptive and exploratory in nature, given the small size of the sample. in that sense, the analyses did not attempt to explain a particular outcome or dependent variable but to compare indicators within and across samples. an interesting difference found through these comparisons refers to the rate of unique visitors, which appears much higher for those companies that seem to be surviving the shakeout that the ecommerce environment has experienced during the past two years. survivors are also larger in their asset base, which seems to agree with the observed trend of dot-corns enlarging their tangible asset base in order to survive competition with established large competitors. the comparison between e-companies and brick-and-mortars suggests also interesting differences between the two groups of companies. the significant differences between both groups in terms of market valuations for 1999 and the lack of difference for the year 2000 reflects the e-commerce boom, the high expectations of investors and analysts regarding the dot-com business model, and then the adjustment of the market to a more traditional view of the industry as one in an embryonic stage. e-companies, as much speculated in the popular press, do appear to behave differently than traditional brick-and-mortars regarding their rates of revenues and expenses. e-companies have been able to grow a lot faster than traditional competitors, and have been expending these resources at a much faster rate also. an interesting indicator, the inflow/outflow net ratio, which is positive for brick-and-mortars but negative for e-companies, seems to suggest the same conclusion. this difference, however, as well as a similar observation regarding survivors and non-survivors, does not appear large enough to be significant in this sample. this could be attributed to two factors: the sample size and the high variability around the mean. in terms of profitability, though e-companies seem to have larger losses than traditional brick-and-mortars, the differences do not appear significant in this sample. e-companies losses are, however, much more noticeable by the public and press. while most new ventures of any type have an initial period of negative profits, the peculiar attractiveness of e-companies has also allowed them to sustain these typical initial negative profits, garnering wide attention from the media, analysts and investors. the also normal failure rate of new businesses, when applied to these firms has impacted capital and venture markets to a greater extent given the large amounts invested which, combined with the high profile media scrutiny, generated greater volatility. the nature of the industry studied does not allow, still, for definite answers regarding profitability and sustainability measures. the experiment is still ongoing. the discussion and analyses shown in this paper could, nevertheless, offer some guidance to managers of e-commerce ventures on the need to look at 14 journal of business strategies vol. 19, no.1 indicators of value, growth and usage in combination. developing a large customer base appears as one key source of sustainability. how much should a manager expend in order to attain that customer base is, however, still a question mark. results in this study do not show significant differences between companies that expended beyond their inflows in order to obtain potential customers (unique visitors). managers should be cautious, however, since some of the results found seem to suggest that healthier firms (regarding their inflows/outflows ratios) have higher probability of survival, even though the sample did not show significance for this difference. cyberspace is only one component of a successful e-commerce operation. some of the limitations of the study relate to the short history of the companies and to the relative small number of companies within industries that could be classified as pure play dot-corns or pure play brick-and-mortars. hence, the newness of the e-commerce environment makes difficult to study larger samples of companies and precludes longitudinal studies of historical windows larger than two or three years of data. the data available for these companies is also relatively limited. it would be desirable, for example, to count with disclosure information for these companies that could allow for better classifications regarding their incomes and expenses by type of activities (on-line versus off-line). this could help to more precisely classify companies between those that are e-companies, those that are pure traditional brick-and-mortars, and those that belong to a mixed group that combines e-commerce and traditional channels (click-andmortars). the present study purposely excluded click-and-mortars since they did not clearly belong to either of the two groups analyzed (e-companies versus brick-and-mortars). these and other limitations should not discourage future research attempts in the field. on the contrary, increasing interest and research efforts are going to build a much stronger base of propositions and data from which to work from. also, time will provide a larger base of information available on companies' actual performance. a caveat is important here, however, and it is to reinforce the need to collect data while it still exists, because the embryonic nature of the industry will inevitably make many of the current companies disappear, along with the interesting data they have generated. to overcome survivor bias analyses, this is the time to gather the information, and this need highlights the importance of intensifying our research efforts to provide useful answers to questions of performance, even more so when changes in the general business environment challenge us to reconsider conventional concepts and metrics of performance. spring 2002 garbi: alternative measures of peljormance references 15 amit, r. & shoemaker, p.j .h. (1993). strategic assets and organizational rent. strate~ic management journal, 14,33-46. barney, j. b. (1986). strategic factor markets: expectations, luck, and business strategy. management science, 332,1231-1241. barney, j. (1991). firm resources and sustained competitive advantage. journal of management. 17,99-120. barney, j. b. (1997). gaining and sustaining competitive advantage. boston, ma: addisonwesley. cameron, k. s. (1986). effectiveness as paradox: consensus and conflict in conceptions of organizational effectiveness. management science, 32, 539-553. chen, c. y. & lindsay, g. (2000). missing the boat on internet riches. fortune, 142,26466. choi, s. y. & whinston, a. b, (1998). is it spring time for internet "tulips"? working paper: center for research in electronic commerce. university of texas at austin. day, d. l. , farley, j. & wind, j. (1990). the state of art in theory and method in strategy research. management science (special issue), 36. de figueiredo, j, m. (2000). finding sustainable profitability in electronic commerce. sloan mana~ement review, summer, 41-52. fortune, (1999), the fortune e-50. december 6,141-168. fox, j. (1999). who wants to be an internet billionaire? fortune, 140,40. jacobson, r. (1987). the validity ofroi as a measure of business performance. american economic review. 77, 470-478. jupiter media metrix. (2000). http://www.mediametrix.com. kedrosky, p. (2000). manager's journal: dot-corns won't die alone. wall street journal, nov. 14, a-26. leduff, c. (2000). what a long, strange trip: pseudo. com to dot.nowhere. new york times, oct. 27, b.1. mahadevan, b. (2000). business models for internet-based e-commerce: an anatomy. california management review. 42, 55-69. 16 journal of business strategies vol. 19, no. i march, j. g. & sutton, r. i. (1998). organizational performance as a dependent variable. organization science. 8, 698-706. michalisin, m. d. & kline, d. m. (2000). intangible strategic assets and firm performance: a multi-industry study of the resource-based view. journal of business strategies, 11,93-117. porter, m. e. (1979). the structure within industries and companies' performance. review of economics and statistics. 61, 214-227. porter, m. e. (1980). competitive strategy: techniques for analyzing industries and competitors. new york: free press. prahalad, c. k. & hamel, g. (1994). strategy as a field of study: why search for a new paradigm? strategic management journal. 15,5-16. rappaport, a. (1986). creating shareholder value: the new standard for business performance. new york: the free press. rumelt, r. p. (1984). towards a strategic theory of the firm. in r. lamb (ed.) competitive strate~ic mana~ement (pp. 556-570). englewood cliffs, nj: prentice-hall. rumelt, r. p., schendel, d.e. & teece, d. j. (1994). fundamental issues in strategy and afterword. in rumelt, r. p, schendel, d.e. & teece, d. j. (eds.) fundamental issues in strategy; a research agenda. (pp. 9-47 and 527-555). boston, ma: harvard business school press. useem, j. (2000). dot-corns; what have we learned? fortune. 142, 82-104. venkatraman, n. & grant, n. (1986). construct measurement in organizational strategy research: a critique and proposal. academy of management review, 71-87. venkatraman, n. & ramanujam, v. (1986). measurement of business performance in strategy research: a comparison of approaches. academy of management review, 11,801-814. venkatraman, n. (2000). five steps to a dot.com strategy: how to find your footing on the web. sloan management review, spring, 15-28. spring 2002 garbi: alternative measures of peiformance appendix cyberspace presence indicators for e-companies 17 page views. page views is defined as the amount of times a web page is loaded onto a computer screen, every time a web page from any site gets downloaded onto any user's computer, the site's server keeps a count. this is a popular measure and it has been used as an advertising price benchmark, likening it to the cpm standard of performance for advertising reach when pricing advertisement on websites. it measures "eyeballs" on the page. stickiness. a measure of recurring visits and use for a particular website. a key measure of the site's effectiveness, it is driven by economic switching costs incurred for two main reasons: (l) users increasingly familiar with a particular site will be more reluctant to learn navigation in other similar sites, and (2) users having inputted private data or otherwise committed information or money in or through a site may also be reluctant to repeat the process in other similar sites. stickiness could be considered a major component of barriers to entry in cyberspace. unique visitors. measures new viewers (caned unique viewers) to a website. the server can identify which dns user has accessed the site and its pages. it is called "unique" because it counts an individual viewer only once, when it is identified as a new visitor to the website. click-through rate. measures people connecting from one website to another through a link on the original site. conversion rate. the ratio of page views to actual transactions carried through. considers the "usefulness" of the site to its visitor indicated by the visitor actually inputting data, purchasing or otherwise exchanging private information or money in the site. esmeralda garbi is assistant professor in the department of management and international business at florida atlantic university. she received her ph.d. from the university of california at los angeles in 1998. her current research interests include corporate strategy, learning and knowledge management, as well as the application of different conceptual perspectives from strategic management and organization theory to e-commerce and e-business strategies. 18 journal of business strategies vol. 19, no. 1 alternative measures of performance for e-companies: a comparison of approaches an analysis of mexican remigration to the u.s. david j. molina university of north texas • denton, tx r. todd jewell university of north texas • denton, tx abstract this paper presents an analysis of mexican migrants to the u.s. and their decisions to remigrate. we concentrate on the relative impacts of market and nonmarket factors such as income, remittances, and migration networks. we analyze the remigration decision of male, illegal migrants using data from the mexican migration project. current migration proposals are geared towards policy that would allow for some type of temporary workers. the empirical model presented here allows for a comparison of the relative impacts of market and non-market factors on the decision to choose among different remigration options. the results indicate that income, remittances, and migration networks have significant effects on the remigration decisions of male, undocumented migrants. introduction the 2,000-mile border shared by mexico and the u.s., as well as the extensive differences in per capita income and demographic characteristics between the two countries, has provided the setting for large migration flows throughout the past century. the migration flows from mexico have been generally constant with the exception of the j 930s and the 1950s when there were considerable decreases in the numbers of both legal and illegal mexican migrants to the u.s. (briggs, 1975). u.s. policy with respect to migrants from mexico has varied between policies that encourage temporary migration and those designed to impact the legal status of permanent migrants. for instance, the bracero program, initiated during world war ii, was based on providing rural, temporary employment for mexican migrants. more recently, the immigration reform and control act of 1986 provided amnesty and legal status to immigrant workers who could prove they had been in the u.s. for an extended period. the current emphasis of u.s. policy appears to have shifted back toward temporary migration. 1 migration policy is obviously important to the mexican government as well. an aspect of immigration that receives more attention in mexico than in the u.s. is the impact that remittances from the u.s. have on the development of the mexican 56 journal of business strategies economy. due to the fact that the remittances of migrants represent a huge inflow of money into the mexican economy, migration policy is defacto development policy for the mexican government. these remittances totaled $us 20 billion in 2005, equivalent to 118 percent of foreign direct investment or 71 percent of oil revenues (mexico's largest export); in addition, remittances were equal to 25% of the wages in the formal sector that year (bank of mexico, 2006).2 the issue of mexican migration to the u.s. has been studied extensively using a variety of models and data. 3 however, most of these studies evaluate the initial migration or treat each migration decision in the same way. we analyze the remigration decision separately from initial migration decisions. the focus of this paper is to analyze the remigration decision for individuals who have already made one migration from mexico to the u.s ., concentrating on the relative impacts of market and non-market factors . cornelius (1990) and the binational study on migration (tovar et ai. , 1997) used the terms "sojourner" and "settler" that have become standard in describing migrants. to most readers, these terms would indicate someone who migrates frequently (sojourner) and one that is a more permanent migrant (settler) . however, the binational study classifies migrants as "sojourners" if they consider mexico to be their place of residence and a "settler" if they habitually reside in the u.s. (p. 14). cornelius (1990, p. 30) indicates that some migrants consider themselves "sojourners" even though by the standard definition they are actually " settlers." we avoid this conflicting interpretation of migrant types by constructing the following categories: those who choose to make repeated, temporary remigrations are termed "multiple-trip migrants," while those who make a more permanent remigration are labeled "stayers." we analyze the remigration decisions of male, illegal migrants (i.e., those without entrance visas) who reside in communities that have been traditionally a source of migrants from mexico to the u.s. in our analysis, the remigration decision requires that the potential migrant choose between three outcomes: (1) do not remigrate; (2) be a multiple-trip migrant; or (3) be a stayer. the determinants of this three-outcome remigration decision will be evaluated empirically using a multinomiallogit model. we concentrate on undocumented migrants since the u .s. policy concentrates on this group and since u.s. policy makes documented immigration different in almost every aspect than undocumented immigration (massey & espinosa, 1997). for instance, undocumented migration is much more hazardous than documented migration (gao, 2006) . in addition, there are approximately 5.9 million undocumented, mexican immigrants, accounting for 57% of the total undocumented population. furthermore, approximately one-half of all mexican immigrants are undocumented volume 26, number 1 57 (passel, 2005). the majority of research on mexican migration to the u.s. has concentrated on male migrants since most mexican migrants have been male. although this is still true today, the percentage of migrants that are female has been steadily increasing (donato, 1993; cerrutti & massey, 2001). as is the case for undocumented and documented workers, we expect that the decision to migrate will be different for women and men. for instance, evidence suggests that women migrate for family reasons much more often than men (cerrutti & massey, 2001). although it is important to study the migration behavior of both women and men to fully understand the impact of any policy, we concentrate on male migrants since men still comprise over two-thirds of mexican undocumented migrants to the u.s . migration researchers have analyzed the effects of both market and non-market factors. the introduction of market factors to models of migration began with the work of todaro (1969) and harris and todaro (1970), where the concept of the opportunity cost of migration is introduced. the opportunity cost of migration is a function of available wages, since migration means giving up income in the home location for income in the destination location and not migrating means giving up income in the destination location. non-market factors have increasingly been used to explain the decision to migrate. the most commonly used non-market factors are migration networks. 4 migration networks are connections established between the home location and the destination location that facilitate migration. the results from this study indicate that income potential, networks, education, age, and other variables impact which of the remigration decision and that there are characteristic differences among remigrants who choose to become multiple-trip migrants and those who choose to be stayers. remigration decision and data this paper attempts to shed light on the differences between mexicans who make a single migration to the u.s. and those who are either multiple-trip migrants or stayers. based on past literature, we expect that the choice of remigration type will be a function of home and destination wages (as in the harris-todaro model) and migration connections (as in the network model). with respect to wages, a higher wage in the u.s. relative to mexico increases the benefit of migration and the benefit associated with longer migration durations, increasing the probability of remigration and leading to longer stays in the u.s. migration network connections will affect the remigration decision by increasing the probability of obtaining a post-migration job and lowering migration costs. therefore, increased network connections are pre58 journal of business strategies dieted to increase the probability of remigration. in addition, migration networks may lead to longer stays due to increased familiarity with the u.s. the data used in this study is from the mexican migration project (mmp).5 the mmp is a collaborative research project based at princeton university and the university of guadalajara. mmp data include information from surveys conducted in 93 communities in mexican states that have shown to be a source of large numbers of migrants to the u.s. the surveys ask respondents to include retrospective information on a variety of economic, demographic, and migration issues, such as the number and timing of past migrations. therefore, mmp data include individual longitudinal information for years up to the survey year, making it possible to obtain individual demographic information at the time of first migration for all those respondents who migrated at some point prior to the survey year. we analyze remigration decisions that occurred over the period 1965 to 1996 for undocumented male migrants. dependent variable we separate potential remigrants into three types: single-trip migrants, stayers, and multiple-trip migrants. categorizing single-trip migrants necessitates ajudgment of the appropriate time period to study. analysis of the data reveals that 90% of all repeat migrations occur within five years of the initial migration . thus, we choose a five-year window for the remigration decision. 6 consequently, iffive years has passed since the first migration without a return trip to the u.s., the migrant is categorized as a single-trip migrant. alternatively, if five years had passed since the migrant first migrated and he has remained in the u .s., the migrant is categorized as a stayer. a migrant is categorized as a multiple-trip migrant ifhe has made multiple migration trips over the five-year window used in this study. independent variables the harris-todaro model utilizes the differential between income in the destination and home locations as a measure of the monetary benefit from migration. in the present study, we cannot use this variable since multiple-trip migrants make multiple migrations, which each may be impacted by different income differentials. instead, we use an individual's age and level of education at the time of first migration to indicate income-earning potential. to further indicate potential income in mexico, we include the variables minwage and agriculture, community-level variables that represent, respectively, the percentage of males earning less than the mexican minimum wage in the year of first migration and the percentage of males working in the volume 26, number 1 59 agriculture sector in the year of first migration. we expect that these percentages will be negatively correlated with the average wage in the mexican community. an additional piece of information concerning earning potential can be gathered from a comparison of the migrant's job in mexico and his job in the u.s. 7 specifically, a migrant may earn more if his u.s. job is similar to his mexican job, since the skills should be easily transferred. we include a measure,jobmatch, equal to one if the job obtained in the initial migration is in the same category as the longest employmenttype in mexico. if jobmatch = i, we assume the probability of remigration and the preferred duration will increase. as in previous studies, we use the migration history of an individual's family and his community as of his initial migration to measure migration network connections. the variable sibmigrate is a dummy variable equal to one if at least one of the individual's siblings has u.s. migration experience. commigrate is a community-level measure indicating the percentage of residents in an individual's community that have u.s. migration experience. we include a measure of family risk diversification by including the number of living siblings (taylor, 1986). in addition, married men will face higher costs of remigration, and we expect that the probability of remigration will be lower for this group. finally, we include a dummy variable indicating whether a migrant remitted money to mexico during at least one of his migrations (remit). a migrant's remittance of money to mexico can be interpreted as evidence that he has strong connections to his mexican community. we expect that those migrants who send money home to mexico will have lower probabilities of being stayers, but they also may have higher probabilities of being multiple-trip migrants since the ability to supplement his family's mexican income may be a strong incentive to remigrate. we also consider the effect of country-level variables, which are designed to measure the impact of changes in the economies of mexico and the u.s. at the year of initial migration these measures include the percentage difference in the u.s. and mexican gdp growth rates, gdpgrowth, and the real level of foreign direct investment in mexico,forinvest. a linear time trend (year) and its square (year) are included to indicate any long-term trends in remigration not measured by other variables. for instance, u.s. policy has made it more costly over time to make multiple illegal migrations and has led to longer stays (reyes, 2004). summary statistics for all variables are included in table 1. note that some of the independent variables may be endogenous to the remigration decision and that it is not feasible to correct for endogeneity using the mmp data. thus, our model must be viewed as a reduced form. and the empirical results cannot be interpreted as indicative of structural relationships. 60 journal of business strategies table 1 descriptive statistics n = 2,538 standard variable description mean deviation remigrate 1 = "single-trip migrant" : no remigration last 5 ye ars (n = 717) 2= "multiple-trip migrant" : remigration 1.759 0 .516 last 5 years (n = 1,715) 3= "stayer": no remigration last 5 years and still in u.s. (n = 106) age age in years 25.08 7.948 education education in years 5.435 3 .528 min wage adult males earning less than the mexican minimum wage (%) 0.521 0 .207 agriculture adult males employed in agricultu re (%) 0 .569 0.234 jobmatch 1 = job in u.s . matches job in mexico 0.467 0.499 sibmigrate 1 = sibling migrated to u.s . in the past 0.511 0.500 commigrate adults in community with u.s. migration experience (%) 0.226 0.130 siblings total number of siblings 2.039 2.016 married 1 = yes 0.498 0 .500 remit 1 = migrant remitted to mexico from u.s. 0.689 0.463 gdpgrowth difference in u.s. and mexican gop growth rate 5.825 0.667 forinvest amount of real foreign direct investment in mexico (billions $us) 3.262 2.153 year time trend (1965 = 1) 15.69 7.138 results and discussion we estimate a multinomial logit model of the probability that a migrant belongs to one of the three remigration types. 8 our results are listed in table 2, where the base category is single-trip migrants; thus, the coefficients are relative to remigrate = 1.9 we first consider the variables that indicate income potential, the signs and significance of which are consistent across remigration outcomes. men who are older at their first migration are less likely to be multiple-trip migrants and stayers, volume 26, number 1 61 possibly due to lower potential income in the u.s. versus mexico. however, it is more likely that age is picking up the effect of migration costs, i.e., older men who wait longer to have their first migration will have greater ties to the community and higher costs of repeated migration and a higher cost of settling in the u.s. men who come from relatively poor mexican communities (as measured by minwage) are also less likely to be stayers. thus, only the probability of staying is affected by the distribution of income in the mexican community. this result gives support to the stark and taylor (1989, 1991) "relative deprivation" hypothesis. as expected, men who come from mexican communities with more agriculture-based job markets are more likely to be both multiple-trip migrants and stayers. this result matches the finding of reyes and mameesh (2002). it is interesting that education is consistently insignificant. however, based on the above results our findings in general would support the statement made by the binational study on migration (p. 16) that "(s)ojoumer migrants tend to be young males with little schooling who work in agriculture." a migrant whose job in the initial u.s. migration was in the same category as his mexican job is more likely to make repeated migrations and more likely to stay in the u.s. the estimated sign of jobmatch indicates that u.s. policymakers must carefully consider the type of workers who will qualify for a temporary migration program. specifically, if the migration program is designed to match the job skills of potential migrants with available jobs in the u.s., then our results indicate that a policy that is successful in matching skills to jobs will have the unintended side effect of encouraging more (illegal) remigration from these mexican workers who are allowed to legally enter the u.s. in terms of the migration network variables, commigrate is consistently significant and positive as expected, while sibmigrate is significant for multiple-trip migrants but insignificant for stayers, although the coefficient is positive for both and sibmigrate is jointly significant in the entire model. this result supports the notion that household risk diversification plays a role in the migration decision. taylor (1986, p. 159) argues that "the relatively low opportunity cost of migration for large families and the consumption strain that large household size can place on household resources have similar predicted (positive) effects on migration decisions." married men have a lower propensity to stay in the u.s.; although the coefficient in the multiple-trip migrant category is insignificant, married is jointly significant in the model. as expected, remit is a significant determinant of the remigration decision, with remitters being more likely to be multiple-trip migrants and less like to be stayers.l0 this result is interesting for several reasons. first, it indicates that if a temporary migrant policy is enacted, then the end result could be an increase of the already high 62 * ** *** journal of business strategies table 2 mlogit results: dependent variable = remigrate n = 2,538 remigrate = 2 (multiple-trip migrant) variable coefficient standard error constant 0 .703 0.925 age -0.036*** 0 .007 education -0.009 0.017 minwage -0.784 0.494 agriculture 1.579*** 0.422 jobmatch 0.300*** 0.111 sibmigrate 0.310** 0.137 commigrate 1.268** 0.581 siblings 0.188*** 0.033 married -0 .177 0 .118 remit 0.438* ** 0.115 gdpgrowth -0 .001 0.013 forinvest 0.019 0 .041 year -0.063* 0.033 year'! 0.175 * 0.106 remigrate = 3 (stayer) constant -0.730 1.806 age -0.043** 0 .021 education 0.017 0.036 min wage -2 .390* 1.267 agriculture 3 .081 *** 1.058 jobmatch 1.036*** 0 .299 sibmigrate 0 .350 0.313 commigrate 2.924** 1.465 siblings 0 .086 0.071 married -0.802*** 0 .289 remit -0 .823 *** 0.252 gdpgrowth 0.028 0 .028 forinvest -0.211 * 0.128 year -0.007 0 .084 year'! 0.238 0.259 pseudo f12 0.1684 significant at 10% level significant at 5% level sig nificant at 1 % level volume 26, number 1 63 levels of remittances entering mexico. second, it provides evidence that the definitions used here of multiple-trip migrants and stayers is different from the standard terms of "sojourners" and "settlers." for instance, lozano (2005) finds that nearly 60% of the household receiving remittances would have been from "settlers." there is only one country-level indicator that is a (marginally) significant determinant of the remigration decision: real foreign direct investment (fdl) . our results suggest that the larger the value of fdi in mexico, the lower the probability that a migrant will choose to be a stayer. the effect ofjorinvest is insignificant for multiple-trip migrants and the model as a whole. this result would suggest that greater economic integration between mexico and the u.s. will tend to reduce permanent migration. interestingly, fdl has no significant effect on the probability of being a multiple-trip migrant, and fdi is not significant in the model as a whole. the coefficients on y ear and yea"; show that there has been a general trend of decreasing the probability of staying and making multiple trips over the sample period; the time trend for stayers is insignificant, but year and yea"; are jointly significant in the entire model. simulated marginal effects the coefficients reported in table 2 can inform us as to the direction of the effect of independent variables, but they can tell us little about the magnitude of the effects, as is the case in any nonlinear estimation. to measure marginal effects, we could evaluate the impact of changes in the independent variables at the sample means. alternatively, we could simulate changes in these variables for each person and then compute the aggregate effect on the entire sample. simulating marginal effects .is more appealing than measuring the effects at sample means, because a simulation incorporates information on the entire distribution of outcomes instead of just the mean. therefore, we choose to analyze the magnitudes of the marginal effects via simulations. table 3 reports the marginal effects and the simulated changes, concentrating on variables that are either individually or jointly significant in table 2. note that the marginal effects are interpreted as changes in the probabilities of being in each category associated with the simulated change. consider the marginal change in remigration probabilities associated with a 10% increase in age. this change is predicted to bring about an increase in the probability that any individual will choose to be a single-trip migrant, while decreasing the probabilities of both being a multiple-trip migrant and a stayer. note that the marginal changes must offset, so that any increase in one category necessitates an 64 journal of business strategies equal-sized decrease in other categories. in this case, we observe a 0.016 increase in the probability of being a single-trip migrant, offset by a 0.015 decrease and a 0.001 decrease in the probability of being a multiple-trip migrant and a stayer respectively. note that the marginal impacts on category 2 and 3 correlate with the signs presented in table 2, but the relative magnitudes do not. specifically, the majority of the impact of increasing age at first migration should be seen in a shift from multiple-trip migrant to single-trip migrant status, leaving the probability of being a stayer relatively constant. table 3 simulated marginal effects marginal effects variable simulated change pr(1) pr(2) pr(3) age** * +10% 0.016 -0.015 -0.001 min wage * +10% 0.007 -0004 -0003 agriculture ** * +10% -0.014 0.011 0.003 jobmatch*** all observations assigned jobmatch = 1 -0.032 0.017 0.015 sibmigrate* all observations assigned sibmigrate = 1 -0.030 0.028 0.002 commigrate** +10% -0.004 0.003 0.001 siblings *** +10% -0.005 0.005 0.000 married** all observations assigned married = 1 0.017 -0.004 -0.013 remit*** all observations assigned remit = 1 -0.017 0.032 -0.015 forinvest +10% 0.002 0.000 -0002 year ** +10% -0.004 -0.001 0.005 * jointly significant at 10% level using chi-square test ** jointly significant at 5% level using chi-square test *** jointly significant at 1 % level using chi-square test next, consider the impact of changingjobmatch. 11 assigning every individual in the sample jobmatch = 1 shows that there will be a reduction in the probability of being a single-trip migrant, offset by increases in the probability of being a multiplevolume 26, number 1 65 trip migrant and the probability of being a stayer that are essentially equal. consequently, any policy that provides legal entry to those that can match their skills with jobs available in this country is likely to increase the number of mexicans seeking either permanent residence status or who will be involved in repeat migration. an increase in the percentage of men who work in agriculture in a mexican community is predicted to reduce the probability of being a single-trip migrant, with most of the offsetting positive impact seen in the probability of being a multiple-trip migrant. while there is a difference of opinion on the impact that nafta has had on agriculture employment in mexico, it is clear that many of these jobs have been lost; thus, our model suggests that nafta may have lead to an increase in illegal multiple-trip migrants. 12 simulating changes in the network connection variables, sibmigrate and commigrate appear to indicate that increases in network connections have larger impacts on multiple-trip migrant probabilities than on stayer probabilities. this suggests that any policy that fosters the development of migration networks may lead to more repeat migration without having much effect on the probability that any mexican migrant or remigrant will settle in the u.s. the marginal impact of being married also has an interesting policy-related implication: the simulated marginal effect of married clearly suggests that any migrant policy that encourages married individuals to apply is likely to decrease the number of migrants that will want to become stayers but should not have a large impact on the number of multiple-trip migrants. there is evidence that some migrants choose to migrate based on the ability to earn money in the u.s. and send it back to mexico. our simulations suggest that any increase in the number of migrants who remit money to mexico, possibly due to a decrease in the institutional barriers to sending money from the u.s. to mexico, will lead to a relatively large increase in multiple-trip migrants and a smaller decrease in stayers. 13 increasing the amount of foreign direct investment is predicted to decrease the probability of settling with no effect on the probability of being a multiple-trip migrant. conclusion as the u.s. reevaluates its migration policy vis-a-vis mexico, understanding the natural flows of migration will continue to be an important issue for u.s. and mexican policyrnakers. the study of migration, as a multidisciplinary study, utilizes a variety of theories in an attempt to understand and explain the migration decision. our study, based on the behavior of undocumented male migrants, is a reduced-form 66 journal of business strategies attempt to compare and contrast the relative importance of several factors within the context of the remigration decision. the majority of the literature on migration from mexico to the u.s. has shown that absolute and relative income and migration networks are important determinants of the initial migration decision. the results presented here indicate that these factors are also significantly correlated with the remigration decision. in addition, our results give evidence that both income and networks have important impacts on the decision of choosing between remigration options. in u.s. policy terms, the most important result in this study is the estimated relationship between remigration outcomes and having a u.s. job that matches the mexican job. specifically, male, illegal, mexican migrants with job skills that are matched in the u.s. are more likely to be repeat migrants and are also more likely to stay in the u.s. consequently, policies (like the bush administration's 2004 proposal) designed to match temporary migrants with u.s. jobs based on skills, might lead to more illegal immigration rather than less. from the mexican perspective, u.s. policies that encourage temporary, repeat migrations by those males with migration experience should be correlated with more remittance behavior; thus, mexico may find that repeat migration, whether illegal or legal, leads to greater foreign capital inflows in terms of remittances. therefore, it may be in the best interest of both the u.s. and mexico to establish polices designed to reduce repeat migration behavior that leads to u.s. settlement, an implication which defines common ground for bilateral immigration policy. notes i. interestingly, the reason that policy makers are concerned about migration issues appears to be changing. prior to the terrorist attacks of9/ 11 /2001, reducing undocumented migration was seen as mainly an economic issue. however, after the attacks, migration policy has been driven by national security issues (meyers & papademetriou, 2002; loven, 2003). furthermore, recent attempts by the u.s. congress to formulate a temporary worker program have stalled due to border security issues (ap, 2006). 2. only india and china receive more remittances than mexico. as a percentage of gop, remittances to mexico are the largest in the world at 2.61 % (bank of mexico, 2006). 3. massey et al. (1993) provide an extensive list of the various approaches taken by economists and other social scientists, attempting to reconcile seemingly disparate methodologies. see massey and espinosa (1997) for a complete survey of this literavolume 26, number 1 67 ture, especially as it relates to mexican migration. 4. there is an interesting debate in the literature on whether migration networks are truly non-market factors. for instance, munshi (2003) argues that "economists have taken a very favorable view of non-market institutions" in their use of migration networks to explain migration. on the other hand, davis and winters (2001) argue that networks are a form of "social capital" in which potential migrants make an economic decision to invest. winters, de janvry, and sadoulet (2001), curran and rivero-fuentes (2003), and davis, stecklov, and winters (2002) are among the recent studies that analyze the effect of migration networks on mexican migration. see taylor (1986), massey (1990), gurak and caces (1992), davis and winters (200]), winters, de janvry, and sadoulet (2001), munshi (2003), and curran and riverofuentes (2003) for more complete discussions of the impact of migration networks on immigration. 5. the mmp web site (mmp.opr.princeton.edu) contains a more-detailed description of the data. as orrenius and zavodny (2000) point out, a disadvantage of mmp data is that it tends not to include household heads who do not migrate permanently to the u.s., and it contains a high concentration of lower-educated individuals than those that applied for the amnesty program of the 1986 irca. on the other hand, the mmp data has a longitudinal component not found in any other data currently available. even though one might expect there to be some error in the reporting on this retrospective information, massey (1985) has shown that the data is remarkably accurate. 6. reyes and mameesh (2002) find an 80% probability of mexican migrants returning to mexico within five years. while we use the same data and a similar sample, they restrict their study to ranges around census years. a five-year threshold is also used by lozano (2005). our own sensitivity tests showed little variation between timeframes of three and seven years. 7. the job categories are professional, administrative, agriculture, manufacturing, sales, and domestic service. an alternative measure of earning potential is the wage earned in the previous trip to the u.s. however, this information is not consistently recorded in the mmp data. 8. the estimation also includes dummies for mexican job type, u.s. job type, mexican state of residence, and mexican city of residence type (rural, suburban, urban, capital city); these coefficients are excluded for parsimony but are available upon request. 68 journal of business strategies 9. one must exercise caution when interpreting the significance of independent variables in an mlogit model. the levels of significance reported in table 2 are for the effect of changes in the independent variables on the probability of being in each category relative to the base category. however, these levels of significance do not directly indicate whether the independent variable is significant in the entire model. to establish overall significance, it is necessary to test the joint significance of each dependent variable for both multiple-trip migrants (relative to single-trip migrants) and stayers (relative to single-trip migrants). for any independent variable, if it is significant for both multiple-trip migrants and stayers, then it will be jointly significant. however, lack of indiv idual significance does not imply lack of joint significance. the joint significance levels are reported in table 3. 10. a model was also estimated without remit, with no substantive changes to the results presented here. models were also estimated with squares for age and education , as well as education categories and interactions between education and other independent variables . in all cases, no substantive changes in the model were found. all results are available upon request. 11. presenting marginal effects of changing dummy variables in non-linear models presents challenges since, by definition, "marginal" implies a small change and dummy variables take on only discrete values. a common solution is to present the "marginal" effects of assigning everyone in the sample a value of one. although not a perfect solution, it does allow for investigation of the changes in probabilities among the remigration options. note that the size of the marginal effects of dummy variables cannot be compared to the size of the marginal effects of continuous variables. 12 . a world bank report (lederman et ai. , 2003) indicates that agriculture has decreased in mexico since nafta but attributes the decrease to other factors . on the other hand, fujii (2001) estimates that in staples such as com, the number of agricultural labor hours lost due to nafta imports was greater than the increase due to local demand. 13. one such decrease in institutional barriers is the following: banks with branches in both countries (such as banamex, a subsidiary ofcitigroup) now allow deposits in the u.s. to be used by debit cards in mexico. volume 26, number 1 69 references associated press. (2006). congress debates immigration bill. retrieved september 20, 2006, from www.nytimes.com/aponline. bank of mexico. (2006). informe annual. briggs, v. m., jr. (1975). mexican migration and the u.s. labor market: a mounting issue for the seventies. austin, tx: university of texas. cerrutti, m., & massey, d. s. (2001). on the auspices of female migration from mexico to the united states. demography, 38, 187-200. cornelius, w. (1990). california immigrants today. keynote presentation to the conference on california immigrants in world perspective sponsored by the immigration research program. ucla, april, 26-27. curran, s. r., & rivero-fuentes, e. (2003). engendering migrant networks: the case of mexican migration. demography, 40,289-307. davis, b., stecklov, g., & winters, p. (2002). domestic and international migration from rural mexico: disaggregating the effects of network structure and composition. population studies, 56,291-309. davis, b., & winters, p. (2001). gender, networks, and mexico-us migration. journal of development studies, 38, 1-26. donato, k. m. (1993). current trends and patterns of female migration: evidence from mexico. international migration review, 27, 748-771. fujii, g. (2001). apertura comercial y empleo agricola en mexico, 1993-1998. momento economico, 115,45-56. gao. (2006). illegal immigration: border-crossing deaths have doubled since 1995; border patrol's efforts to prevent deaths have been not fully evaluated. gao, 06,770. gurak, d. t., & caces, f. (1992). migration networks and the shaping of migration systems. in m. kritz, l. l. lim, & h. zlotnik (eds.), international migration systems: a global approach. oxford, uk: clarendon press. harris, j. r., & todaro, m. p. (1970). migration, unemployment, and development: a two-sector analysis. american economic review, 60, 126-142. lederman, d., maloney, w. f., & serven, l. (2003). lessons from nafta for latin america and the caribbean countries: a summary of research findings. office of the chief economist for la c, world bank. loven, j. (2004). bush calls for immigration overhaul. associated press. retrieved january 7, 2004, from customwire.ap.org. 70 journal of business strategies lozano, f. (2005). hogares receptors de remesas en mexico: limites y possibilidades para el desarrollo local y regional. working paper # 05-02n, center for migration and development, princeton university. massey, d. s. (1985). the settlement process among mexican migrants to the united states: new methods and findings. in d. b. levine, k. hill, & r. warren (eds.), immigration statistics : a story of neglect. washington, dc: national academy press. massey, d. s. (1990). the social and economic origins of immigration. annals of the american academy of political and social science, 510, 60-72. massey, d. s., arango, 1., hugo, g., kouaouci, a ., pellegrino, a., & taylor, j. e. (1993). theories of international migration: a review and appraisal. population and development review, ]9,431-466. massey, d. s., & espinosa, k. e. (1997). what's driving mexico-us migration? a theoretical, empirical, and policy analysis. american journal of sociology, ]02, 939-999. meyers, d. w, & papademetriou, d. g. (2002). the u.s.-mexico immigration relationship: operating in a new context. migration policy institute. retrieved july 23,2003, from www.migrationpolicy.org. munshi, k. (2003). networks in the modem economy: mexican migrants in the u.s. labor market. quarterly journal of economics, ]]8, 549-599. orrenius, p. (2001). illegal immigration and enforcement along the u.s.-mexico border: an overview. federal reserve bank o/dallas economic and financial review, winter, 2-11. orrenius, p., & zavodny, m. (2000). self-selection among undocumented immigrants from mexico. federal reserve bank of dallas working paper, 00-05. orrenius, p., & zavodny, m. (2003). do amnesty programs reduce undocumented immigration? evidence from irca. demography, 40,437-50. passel, 1. s. (2005). estimate of the size and characteristics of the undocumented population. pew hispanic center. reyes, b. (2004). changes in trip duration for mexican immigrants to the united states. population research and policy review, 23,235-257. reyes, b. , & mameesh, l. (2002). why does immigrant trip duration vary across u.s. destinations? social science quarterly, 83,580-593. stark, 0., & taylor, j. e. (1989). relative deprivation and international migration . demography, 26, 1-14. stark, 0., & taylor, 1. e . (1991). migration incentives, migration types: the role of relative deprivation. economic journal, ]0], 1163-1178. volume 26, number 1 71 sze, m., goss, s., & de leon, j. g. (1998). effect of aging population with declining mortality on social security of nafta countries. north-american actuarial journal, 2, 83-107. taylor, j. e. (1986). differential migration, networks, information, and risk. in o. stark (ed.), research in human capital and development, vol. 4, migration, human capital, and development. greenwich, cn: jai press. todaro, m. p. (1969). a model of labor migration and urban unemployment in less developed countries. american economic review, 49, l38-148. tovar, e. m. l., martin, s., et al. (2002). migration between mexico and the united states. the mexico/united states binational study on migration. washington, dc. winters, p., de janvry, a., & sadoulet, e. (2001). family and community networks in mexico-us migration. journal of human resources, 36, 159-84. zabin, c. (1997). u.s.-mexico economic integration: labor relations and the organization of work in california and baja california agriculture. economic geography, 73,337-355. biographical sketch of authors david j. molina received a ph.d. in economics from texas a&m university 1983, and he is currently an associate professor at the university of north texas. he has also taught at new mexico state university in las cruces, nm. he has also been a researcher at louisiana state university and at colegio de la frontera in monterrey. he has is a past president of the association of borderland scholars. in addition to immigration from mexico to the u .s., his research interests include mexican micro-enterprises and remittances, income distribution in mexico, consumer behavior in mexico and of hispanics, wages of hispanics in the u.s., u.s. mexico border economic issues and the economics of sports. todd jewell received a ph.d. in economics from the university of california at santa barbara in 1992, and he is currently an associate professor at the university of north texas. he has also taught at uc-santa barbara, clarion university of pennsylvania, and the university of texas at dallas. during the fall semesters of 2004 and 2007, he was a visiting researcher at the universidad de la republica in montevideo, uruguay (2007 funded by fulbright senior specialists program). in addition to immigration from mexico to the u.s., his research interests include mexican micro-enterprises and remittances, the economics of sports, economics of education, and health economic issues in latin america. 72 journal of business strategies an analysis of mexican remigration to the u.s. employee perceptions of the relationship between strategy, rewards and organizational performance richard s. allen, ph.d. the university of tennessee at chattanooga chattanooga, tn marilyn m. helms, d.b.a., cfpim, cirm dalton state college dalton, ga abstract this study explores the relationship between organizational strategy, reward practices. andfirm performance. researchers have not extensively investigated this potentially important topic. this paper presents some initial empirical evidence that supports the notion that different types of reward practices more closely complement different generic strategies and are significantly related to higher levels of perceived organizational performance. employee perceptions of the relationships between strategy, rewards and organizational performance results of previous research regarding the efficacy of various business strategies has been confusing and contradictory. we suspect that certain reward practices may be associated with stronger organizational performance based on the type of strategy being used by the firm. the use of reward practices which logically complement a specific organizational strategy should serve to motivate employees to help the organization perform at a higher level. while reward practices may facilitate the successful implementation of organizational strategies, theorists and practitioners, for the most part, have largely ignored this potential relationship (lawler, mohrman, and ledford, 1995; lawler, 1994; gomez-mejia and balkin, 1992; and ledford, 1995a). clearly from both a practitioner and an academic viewpoint, exploratory research on the relationship between reward practices, firm performance and organizational strategies is warranted. it is hoped that this initial exploratory analysis will spur future research into this important research question. relevant literature in the next sections, (l) generic organizational strategies; (2) the potential relationship between generic strategies and performance; (3) firm performance measures; and (3) reward practices are discussed. 116 journal of business strategies vol. 19, no.2 generic strategies while various types of organizational strategies have been identified over the years (miles and snow, 1978; chrisman, hofer, and bolton, 1988; porter, 1980) porter's generic strategies remain the most commonly supported and identified in key strategic management textbooks (see for example, david, 1999; miller, 1998; thompson and stickland, 1998) and in the literature (kim and lim, 1988; miller and dess, 1993). porter (1980) proposed three generic strategies that can yield competitive advantage, namely cost leadership, product differentiation, and focus. porter (1980) suggests to ensure long-term profitability, the firm must make a choice between one of the generic strategies rather than end up being "stuck in the middle." cost leadership. lower costs and cost advantages result from process innovations, learning curve benefits, economies of scale, product designs that reduce manufacturing time and costs, and reengineering activities. a low-cost or cost leadership strategy is effectively implemented when the business designs, produces, and markets a comparable product more efficiently than its competitors. the firm may have access to raw materials or superior proprietary technology which help to lower costs. product differentiation. product differentiation fulfills a customer need and involves tailoring the product or the service to the customer. this allows organizations to charge a premium price to capture market share. the differentiation strategy is effectively implemented when the business provides unique or superior value to the customer through product quality, features, or after-sale support. firms following a differentiation strategy can charge a higher price for their products based on the product characteristics, the delivery system, the quality of service, or the distribution channels. the quality may be real or perceived based on fashion, brand name, or image. the differentiation strategy appeals to a sophisticated or knowledgeable consumer who wants a unique, quality product and is willing to pay a higher price. focus. focus, the third strategy, is based on adopting a narrow competitive scope within the industry. focus strategies grow market share through operating in a niche market or markets that are either not attractive to, or are overlooked by, larger competitors. these niches arise from a number of factors including geography, buyer characteristics, and product specifications or requirements. a successful focus strategy (porter, 1980) depends upon an industry segment that is large enough to have good growth potential but is not of key importance to other major competitors. market penetration or market development can be an important focus strategy. midsized and large firms use focus-based strategies but only in conjunction with differentiation or cost leadership strategies, however focus strategies are most effective when consumers have distinct preferences and when the niche has not been pursued by rival firms (david, 1999). fall 2002 allen & helms: strategy and rewards 117 according to porter (1985) focus can be based on (i) differentiation that targets a specific segment of the market with unique needs that are not being met by others in the industry or (2) cost focused where the company has access to specialized production and operations equipment that can save costs in smaller production lots or runs. as research addressed the relationship between strategy and performance, some studies concluded that only 'pure' strategies (i.e. generic strategies of cost minimization or differentiation) resulted in superior performance, while other research found combination strategies (i.e. low-cost and differentiation) were optimal. generic strategy and performance the strategy literature provides numerous theories, research methodologies, and ideas on the strategy-performance relationship. strategy research has its roots in industrial organization (10) theory. within bain (1956) and mason (1939), the 10 framework of industry behavior, firm performance or profitability is seen as a function of the industry structure. industry characteristics rather than firm-based issues are found to determine firm performance (see also barney, 1986). this structure-conduct-performance model from 10 and economics has been used in industries with high concentrations and in similar firms (seth & thomas, 1994). some studies, however, have not found a link between strategy and performance (mcgee & thomas, 1986, 1992). others have found the link between strategy and performance lessened by situational variables including a focus on manufacturing and profitability (davis & schul, 1993; zahra, 1993). to investigate the strategy and performance relationship, many researchers began utilizing approaches found to be generalizable across industries, specifically those proposed by porter (1980, 1985, and 1987). pure generic strategies. some researchers found support for porter's (1980, 1985) original generic strategies (dess & davis, 1984; hambrick, 1981, 1982; hawes & crittendon, 1984; nayyar 1993; parker and helms 1992; reitsperger, daniel, tallman, parker & chismar, 1993). dess & davis (1984) examined industrial products businesses and suggested performance was achieved through the adoption of a single strategy. hambrick (1983) investigated capital goods producers and industrial product manufacturers and found support for generic strategies. ross (1999) also supported two distinct focus strategies including low-cost and differentiation one aimed at distinct needs in terms of cost in a narrow target market and the other at distinct customization requirements in a narrow target market. parker and helms (1992) found superior performance associated with mixed and reactive strategies as well as with single generic strategies. combination generic strategies. other researchers found combination strategies to be optimal and associated with superior performance (buzzell & gale, 1987; buzzell & wiersema, 1981; hall, 1983; hill, 1988; murray, 1988; phillips, chang, & buzzell, 1983; white, 1986; wright, 1987; wright, kroll, tu, & 118 journal of business strategies vol. 19, no.2 helms, 1991). several studies have suggested that in higher performing businesses, low cost and differentiation strategy may be adopted simultaneously (gupta 1995; slocum, mcgill, & lei 1994). in an attempt to investigate whether low cost and differentiation are mutually exclusive or whether they can be adopted simultaneously. helms, dibrell, and wright (1997) found that business units that simultaneously compete on low cost and differentiation strategies (combination strategies) have higher returns on investment. thus, gaps remain in the research. ironically, some of the research supporting singular generic strategy also produces results that sow seeds of doubt about the relationship between singular generic strategy and superior performance. it appears some businesses succeed only when they combine differentiation and low cost generic strategies (hill 1988; murray 1988). for example, white (1986) found that 19 of the 69 business units he examined had the highest roi and achieved competitive advantage based on combined cost and differentiation strategies. similar support for a combination strategy was found by phillips, chang, and buzzell (1983). wright and parsinia (1988) identified successful firms using combined generic strategies in fragment industries like banking, retailing, distributing, and creative businesses. as a result of these studies and other work, hill (1988) proposed the generic business-level strategies of differentiation and overall cost leadership are not incompatible but may be combined in some firms to achieve competitive advantage. in summary, the strategy literature reveals contradictory results on the link between singular generic strategy and performance. as campbell-hunt (2000) points out, the dominant paradigm of competitive strategy is now two decades old, but it has yet to prove its adequacy as a descriptive framework or progress its propositions about the performance consequences of different strategic designs. we believe that the relationship between strategy and performance may be influenced by the type of reward practices used by the organization. this may help to explain some of the confusing and contradictory findings reported in prior stategy-performance studies. thus, exploratory research on the relationship between strategy, rewards and firm performance is clearly warranted. reward practices there is a substantial body of theoretical literature linking organizational strategy, human resource (hr) practices, and performance (balkin and gomez-mejia, 1987; hambrick and snow, 1989; lawler, 1986a; lawler, i986b; ulrich and lake, 1990; waldman, 1994, zingheim and schuster, 2000). this literature typically suggests that human resource practices should be selected which complement and support an organizational strategy. more specifically, the reward system should be aligned to motivate employee performance that is consistent with the firm's strategy, attract and retain people with the knowledge, skills, and abilities required to realize the firm's strategic goals, and create a supportive culture and structure (galbraith, 1973; kilmann, 1989; nadler and tushman, 1988). fall 2002 allen & helms: strategy and rewards 119 furthermore, the literature argues that alignment of the reward system with organizational strategy helps to determine organizational effectiveness. a review of the literature which links organizational strategy and human resource practices by becker and gerhart (1996) suggests the human resource system can be a unique source of competitive advantage, especially when its components have a high degree of internal and external fit. another review by gomez-mejia and balkin (1992) contends that the old model of compensation (with pay structures based on job analyses, descriptions, specifications, and classifications) is no longer effective in today's business environment. they conclude modern organizations must align their reward system practices with their organizational strategy in order to achieve higher levels of performance at both the individual and organizational level. but this research has remained mainly at the theoretical level. empirical exploration of these assertions is necessary. firm performance while researchers may not always agree on the best strategy, or strategy combination, most if not all, support the long-term benefits of strategic planning for the successful performance of an organization or business unit. however, measuring the performance of a company is challenging. researchers (e.g., see buckley, pass, and prescott 1988; littler 1988; day and wensley, 1988) disagree about how to both define and operationalize performance. most studies on organizational performance use a variety of success measures both financial and non-financial. researchers employ financial measures such as profit (saunders and wong 1985; hooley and lynch 1985; baker, black, and hart 1988), turnover (frazier and howell 1983), return on investment (hooley and lynch 1985), return on capital employed (baker, black, and hart 1988), and inventory turnover (frazier and howell 1983). non-financial measures include innovativeness (goldsmith and clutterbuck 1984) and market standing (saunders and wong 1985; hooley and lynch 1985). when performance is measured at a variety of levels (e.g., national, industry, company, and product), comparison of results is difficult. (baker and hart, 1989; buckley, pass, and prescott 1988; and frazier and howell, 1983). lusch and laczniak (1989) define business performance as the total economic results of the activities undertaken by an organization. walker and ruekert (1987) found primary dimensions of business performance could be grouped into the three categories of effectiveness, efficiency, and adaptability. however there is little agreement as to which measure is best. thus, any comparison of business performance with only these three dimensions involves substantial trade-offs; good performance on one dimension often means sacrificing performance on another (donaldson, 1984). measures of firm performance generally include such bottom line, financial indicators as sales, profits, cash flow, return on equity, and growth. it is 120 journal o,j'business strategies vol. 19, no.2 important to determine how a firm compares with its industry competitors when assessing firm performance (dess and robinson, 1984). because of the multitude of competitive environments faced by firms in differing industries, knowing only absolute financial numbers such as sales, profits, cash flow, etc., is not very illuminating unless it is put into the context of how well the firm is doing compared to their competition. furthermore, if only a single industry is studied, the impact of a major economic downturn (or upturn) in that particular industry can overwhelm the effects of any specific variables being studied. therefore, it is important to use an industry comparison approach when making assessments of firm performance and include organizations from a wide variety of industries in an exploratory study. this approach was used in the study described in this article. the research focus and hypotheses some limited exploratory survey and empirical work has also been done in this area. in general it has been supportive of the idea the reward system needs to be aligned with the chosen organizational strategy. allen & kilmann (200 i) found different types of reward practices exhibit a significant effect on the relationship between a total quality management based strategy and organizational performance. still other research (see for example lawler, mohrman, & ledford, 1995) examined a very limited range of four reward practices in a composite index of rewards with regards to employee involvement and tqm. as will be discussed shortly, the present research study explored a much wider range of reward practices and organizational strategies. blackburn and rosen (1993) and knouse (1995) provide anecdotal support for the proposition of a link between reward practices, strategy, and firm performance in their investigation of quality-focused strategies. they investigated the hr practices of national, state, and local quality award winning organizations and found these organizations, which have been recognized by independent expert examiners as having been successful with their chosen tqm implementation, have typically made changes in their reward systems to make them more supporti ve of the strategy. accounts of other successful organizations (anfuso, 1994; schonberger, 1994) give further anecdotal support to the notion the reward system must be aligned to support the successful implementation of a quality-focused strategy. in summary, the literature has remained mostly at the conceptual level in discussing the potential relationship between organizational strategy, the reward system and firm performance. these propositions have remained largely untested and there is a recognized need for exploratory empirical work in this area (lawler and jenkins, 1994; ledford, 1995a; waldman, 1994). therefore, the goal of the present study is to begin to empirically explore the potential relationship between the four generic strategies (i.e., cost leadership, product differentiation, focus-cost, and focus-differentiation), a wide range of reward practices and organizational performance. fall 2002 allen & helms: strategy and rewards 121 the present study considers whether different reward practices used by an organization are related to perceptions of firm performance for organizations utilizing different forms of strategy. organizational strategy, as noted earlier, can be grouped into four key generic strategies. a priori, we expect higher levels of organizational performance will be associated with different types of reward practices based on the different strategies. our a priori hypotheses regarding each of porter's (1985) generic strategies are listed as: hypothesis 1: for a product differentiation strategy, spec(fic reward practices (for example, practices that encourage individuals to innovate, develop new products and enhance existing products) will be associated with higher perceived leveb; or organizational performance. hypothesis 2: for a cost leadership strategy, spec(fic reward practices (for example, group based incentives which encourage cost reduction and control. responsibility and authority) will be associated with higher perceived levels ofperformmice. hypothesis 3: for a focus-cost leadership strategy, specific reward practices (that emphasize a balance of both customer service as well as cost control) will be associated with higher perceived levels of organizational performance. hypothesis 4: for a focus-product differentiation strategy, specific reward practices (emphasizing customer service for a unique niche as well as marketing and creativit}' rewards) will he associated with higher perceived levels of organizational performance. the sample a convenience sample of 226 employees enrolled in either an evening mba or weekend executive mba program at an urban university were administered the questionnaire. the survey asked respondents to report their perceptions because actual data is often not available, particulary in private firms. previous research has used a similar approach for studying reward practices (see allen and kilmann, 200 1; lawler, mohrman, and ledford, 1995; and wellins, ginnodo, day, colteryahn, mussitsch and price, 1993). a pilot of the survey instrument was conducted with a sample of students, not included in the final results, to ensure respondents understood the questions and had enough organizational knowledge to accurately answer. based on the pilot test and post administration interviews it was determined that a respondent needed at least six months of experience working at 122 journal (~f business strategies vol. 19, no.2 the organization in order to have sufficient organizational knowledge to effectively answer all the questions. five respondents were deleted because they had less than six months of work experience at a single organization, resulting in a final sample size of 221 and a 97% response rate. the remaining respondents had an average of four years work experience, and the time employed ranged from six months to 27 years with a standard deviation of 4.37 years. position level was also considered as a potential screening device, but pilot and post administration interviews did not uncover any difficulty in completing the survey based on position. thirty-eight percent held professional or technical positions in their organization, 16% were in middle management, 16% were in administrative roles, ii % were front-line managers, and 6% were senior managers. all reported adequate organizational knowledge to accurately answer the survey questions. the organizations included in the sample had a mean number of 1,467 employees with a range from 3 to 57,000. sixty-two percent were service organizations, 28% were manufacturing, and 10% were in the government/nonprofit sector. seventeen percent of the organizations were unionized. based on these findings it was concluded that the sample adequately represented the mix of organizations in the region surveyed and closely represented the national population. methodology research instrument a questionnaire was developed to explore these hypotheses. existing scales and items were utilized or adapted where applicable to develop the questionnaire. new items and likert-type scales were composed when appropriate existing items or scales did not exist. the instrument was pilot tested with a small group of mba students to verify the understandability of the instrument and to insure that a typical working mba student had enough organizational knowledge to reasonably answer the questions. post-pilot interviews were used to refine the instrument. the questionnaire included a cover page to explain the purpose of the survey and asked respondents to select a single organization as a point of reference to answer the survey questions. respondents were guaranteed anonymity. if the organization under study had multiple divisions or subsidiaries, respondents were asked to base their answers on the specific division or subsidiary in which they worked. respondents were given ample time to complete the survey and researchers were on hand to personally administer the questionnaire. strategy questions. a review of the strategy literature uncovered no appropriate preexisting scales to measure which type of porter's generic strategy an organization uses. therefore it was determined that an appropriate scale would need to be developed for the purpose of this research. a section of twenty-five questions fall 2002 allen & helms: strategy and rewards 123 regarding the various elements of strategy used by the organization was composed. these items were developed to operationalize each of the four generic strategies based on porter (1980, 1985) and parker and helms (1992). respondents were asked to estimate how frequently the various strategic practices are used by their organization. below are samples of the strategy questions and the scale used: almost about none none some half most almost all (0%) (1-20%)(21-40%)(41-60%)(61-80%)(81-99%)( 100%) vigorous pursuit of cost reductions 2 3 4 :; 6 7 providing outstanding customer service 2 3 4 :; 6 7 improving operational efficiency 2 3 4 :; 6 7 controlling the quality of products/services 2 3 4 :; 6 7 intense supervision of front -line personnel 2 3 4 5 6 7 developing brand or company name identification 2 3 4 5 6 7 targeting a specific market niche or segment 2 3 4 5 6 7 providing specialty products/services 2 3 4 :; 6 7 reward practice questions. a section asking respondents about the various types of reward practices used in their organization followed the strategic practices section. the reward practice items were developed after a literature review uncovered a list of practices which may impact the success of an organization's strategy. twenty-four items were adapted to measure a myriad of both monetary and non-monetary reward practices based on existing questionnaires and research by lawler, mohrman and ledford (1995); wellins, ginnodo, day, colteryahn, mussitsch and price (1993); and allen and killmann (200 i). the respondents were asked to estimate the percentage of employees in the organization who were covered by or eligible for various types of rewards. example questions are shown below: 124 journal of business strategies vol. 19, no.2 almost some about most almost never never times half times always always (0%) (1-20%)(21-40%)(41-60%)(61-80%)(81-99%)( 100%) employee stock ownership plan employees are rewarded with company stock, thus, giving them an ownership stake in the organization. 2 3 4 5 6 7 individual based performance system performance appraisals, pay increascs, bonuses and promotions are bascd primarily on individual achievements as opposed to work group/team accompli.lhment.l. 2 3 4 5 6 7 regular expressions of appreciation by managerslieaders to employees such as praise or "pats on the back" to acknowlcdge achievement of strategic goals. 2 3 4 5 6 7 special amenities wherein special bonuses or perks are used to attract and retain employees (such as signing bonuses, extra vacation time, special work space. company sponsored club memberships. etc ... ) 2 3 4 5 6 7 organizational performance questions. the sample included a broad range of both publicly and privately held organizations. as such, objective measures of financial and performance were not available. furthermore, since the sample contained a wide variety of industries purely objective financial data would not be comparable across the sample. therefore it was necessary to use a more perceptual approach to estimating firm performance. firm performance was measured using a subjective scale of five items originally developed by dess and robinson (1984). the five point, likert type scale asked respondents to rate how their organization compared to their competitors on a series of key objective performance indicators including total revenue growth, total asset growth, net income growth, market share growth, and overall performance/success. respondents were asked to compare their organization's level of performance to competitors for each of the five items. strategy scales: factor analysis the strategy items were subjected to a factor analysis to test whether the items naturally grouped into porter's (1980, 1985) generic strategies. using spss principal component analysis with a varimax rotation and kaiser normalization, a four-factor solution emerged that explained 51.2% of the variance with an eigenvalue of 1.38. fall 2002 allen & helms: strategy and rewards 125 further analysis found these factors conceptually correspond with porter's (1980, 1985) framework of four generic organizational strategies. items which loaded at .35 or higher were included in the four factors. four of the original 25 items did not load strongly onto a single factor and were excluded from further analysis, leaving 21 strategy items. the items and factor loadings for each factor are summarized in table i. table 1 factor analysis factor loadings for different strategies strategy focusproduct cost differentiation leadership focuscost product leadership differentiation innovation in marketing technology and methods .800 developing brand identification .738 utilizing advertising .709 refining existing products/services .708 developing a broad range of new products/services .659 forecasting new market growth .658 forecasting existing market growth .626 extensive training of marketing personnel .594 building a positive reputation within the indui;try for technological leadership .5 i8 building high market share controlling the quality of products/services providing outstanding customer service improving operational efficiency extensive training of front-line personnel intense supervision of front-line personnel vigorous pursuit of cost reductions tight control of overhead costs targeting a specific market providing specialty products/services dropping unprofitable customcrs producing products/services for high price market segments .458 .806 ,749 .642 526 .372 .872 .833 .626 .623 .571 .538 cronbach alphas were computed to check for the reliability of the scales. the product differentiation factor of ten items has an alpha of 0.89; the focus! 126 journal of business strategies vol. 19, no.2 cost leadership factor of five items had an alpha of 0.77, the cost leadership scale consisted of two items with an alpha of 0.86, and the focus/product differentiation factor with four items had an alpha of 0.57. while the alpha for factor 4 was not as strong as the other three factors, it is still within the expected range for a broad construct established by van de ven and ferry (1980) and was deemed acceptable. likewise, the average inter-factor correlations were low and within the acceptable range established by van de ven and ferry (1980). the focus strategies concentrate on smaller, unique, or niche markets and are combination strategies (with differentiation or cost leadership). thus, they experience more conceptual over-lap in strategic positioning than do the pure forms of cost leadership or product differentiation. therefore, their alphas would be expected, a priori, to be lower than the purer forms of strategy. product differentiation factor. because a product differentiation strategy emphasizes the uniqueness of a product or service and attempts to make the product or service unique in the mind of the customer, we would expect marketing related actives to predominate. all factor loadings are indeed marketing related and emphasize developing or refining products and services and planning for market growth. by fostering innovation as well as building a reputation of technological leadership a firm should be assured of a stream of new innovations to attract the interests of new customers as well as to meet existing customer's demands for uniqueness. focus-cost leadership factor. for this factor we would expect an emphasis on reducing costs while at the same time meeting the needs of an undeveloped niche. the items which loaded highly on this factor support this strategy. by providing outstanding customer service a previously neglected market segment is catered to. the variables of improving operational efficiency and controlling quality emphasize the overarching cost objecti ves. quality is important to insuring low costs because producing a product or delivering a service right the first time eliminates rework and scrap costs. extensive training and supervision of front-line personnel will also serve to meet customer needs by streamlining processes to provide for cost efficiency. cost leadership factor. only two items loaded on the cost leadership factor. it would have been preferable if more items represented this strategy, but the two item results make conceptual sense. a deep discount retailer which uses a pure, cost minimization strategy, for example, stresses ongoing cost reductions and tight control of overhead costs to exclusion of almost any other organizational issues. this is contrasted with a focus-cost leadership retailer that also competes on the basis of providing outstanding customer service and quality in addition to low costs. it was also determined that adding additional items to this scale reduced the chronbach alpha. as such, it was concluded that these two items adequately captured the essence of a cost leadership strategy. focus-product differentiation factor. the focus-product differentiation factor again emphasizes a unique product or service but to smaller, possibly undefined or overlooked specialty niches. variables important to this stratfall 2002 allen & helms: strategy and rewards 127 egy would be the ones that loaded on this factor. first, targeting a specific market and providing them with specialty products and service is by definition, the focus product differentiation strategy. dropping unprofitable customers ensures an even tighter focus, while providing products and services for high price market segments further focuses the strategy on customers with unique needs. organizational performance scale. the cronbach alpha for the organizational performance scale was computed to be 0.95. this compares favorably to previous research using this scale to measure organizational performance of 0.93 (allen & kilmann, 2001). analysis and results descriptive statistics and correlations are presented in table 2. the correlation matrix indicates that there are some strong correlations between many of the variables, but these correlations make conceptual sense and were expected. real organizations rarely follow one of the generic strategies to the letter. most organizations strategies are a hybrid of the generic strategies. for example, there is a .49 correlation between the product differentiation and focus-product differentiation strategies. these two strategies, by definition have a great deal of conceptual overlap as previously discussed in this article. likewise, there is a strong correlation between use of the four strategies and firm performance. this is also understandable because organizations, which implement a discernable strategy are more likely to be successful than those that are stuck in the middle. our original list of twenty-four reward practices had a lot of correlations between reward practice items. this also made conceptual sense. an organization employing one particular type of reward practice is likely to use another similar reward practice. for example, an organization which places an emphasis on teamwork is likely to use such related reward practices as work group incentives, employee stock ownership, profit sharing and gain sharing. in order to help control for possible multi-collinearity in our data and explore the relationships between the variables a stepwise variation of multiple regression was utilized. organizations that scored above the mean on each ofthe four strategy scales were included in a regression equation along with the reward practices as independent variables and firm performance as the dependent variable. the regression analysis found that eight ofthe original 24 reward practices were associated with significantly higher levels of performance for the different types of strategies. sixteen insignificant reward practices were discarded by the step-wise regression as not adding significant explanatory power regarding the variance in firm performance. the regression results for the four hypotheses are summarized in table 3. -table 2 n00 descriptive statistics and correlation matrix mean sd n 1 2 3 4 5 6 7 8 9 10 11 12 1. product differentiation 45.91 12.30 206 2. cost leadership 9.78 3.10 218 .32** 3. focus-cost leadership 25.95 5.25 219 .52** .34** 4. focus-product differentiation 16.96 4.64 212 29** ...... ,49** .30** a::: 5. individual based perfonnance ;ji::l system 4,86 2.06 218 .26** .03 .23** .10 "~ 6. employee stock ownership 2.43 2.11 217 .33** .16* .10 .20** .26** ti:l ::: 7. regular expressions of ""s· appreciation by "1:> ""managerslleaders to employees 4.48 1.78 218 .39** ,06 .41 ** .21 ** .26** .12 ""~..... 8. increased job autonomy 3.66 1.68 215 .26** .10 .29** .14* .19** .17* .44** '"'l i::l..... (':l 9. special amenities 2.69 1.86 214 .25** -.01 .16* .19** .21 ** .26** .27** .34** (»o-. (':l 10. narrow pay bands 4.42 1.69 215 .07 .l! .15* .07 -.06 -.30 .11 .12 .08 "" ii. position based pay system 5.32 1.70 217 .19** .15* .12 ,07 .28** .12 .04 -.04 -.01 .09 12. developmental based performance appraisals 3.63 1.94 216 .39** .il .39** .21 ** .26** .22** .42** 040** .34** ,14* .17* ~ 13. firm performance 17.63 5048 177 .55** .34** ,48** .30** .35** .39** .42** .35** .35** .14 .05 .37** ---\0 **p < om *p < 0.05 z 0 n fall 2002 allen & helms: strategy and rewards 129 table 3 stepwise regression results standardized beta coefficients focusfocusproduct cost cost product strategy differentiation leadership leadership differentiation individual based performance system 0.216* 0.280** employee stock ownership 0.254* 0.300** 0.204* regular expressions of appreciation by managers/leaders to employees 0.232* 0.244* 0.281 ** increased job autonomy 0.239* 0.236* special amenities 0.195* 0.184* narrow pay bands 0.208* position based pay system -0.200* developmental based performance appraisals 0.223* r2 0.241 0.296 0.321 0.391 f-statistic 9.656*** 13.206*** 8.503*** 14.611 *** *p < 0.05; **p < 0.01; ***p < .001 discussion and conclusions hypothesis 1, regarding the product differentiation strategy, resulted in three reward practices being associated with higher levels of organizational performance. these three reward practices were: (i) an indi vidual based performance system in which pay increases, bonuses and promotions are based on the accomplishment of individual goals, (2) employee stock ownership, and (3) regular expressions of appreciation by managers/leaders to employees such as praise or "pats on the back" to acknowledge the accomplishment of strategic goals. the use of both monetary (performance rewards such as raises and bonuses) and non-monetary rewards (promotions, stock and recognition) logically bolster both the extrinsic and intrinsic motivation of employees to innovate and achieve a differentiated product or service. because the product differentiation strategy stresses tailoring the product or services to the customer who is willing to pay a higher price for the service, we would expect individual and/or company incentives or rewards based on sales growth to be particularly effective. likewise, a differentiation strategy hinges on the ability of the organization to innovate to provide unique products or services. a reward system that recognizes and rewards individuals for developing new ideas and innovations would logically support this sort of strategy. we suspect having both individual based performance systems as well as an employee stock ownership plan would encourage employees to achieve both short term and long term goals. the reward of regular expressions of appreciation by managers or leaders to employees 130 journal of business strategies vol. 19, no.2 would also be important as a mechanism to recognize employees who provide excellent or exceptional customer service. hypothesis 2, regarding the cost leadership strategy, shared two reward practices with the product differentiation strategy. first, consistent with behavior modification and reinforcement theory (skinner, 1953; luthans & kreitner, 1985) regular expressions of appreciation by managers and leaders to employees are important to encourage behavior of employees that helps move the organizations towards reaching strategic goals regardless of the goal or strategy chosen. here rewarding employees for ideas to minimize or eliminate costs would be more important. also employee stock ownership programs would motivate employees towards helping the organization achieve their long-term strategy. in this instance, the long-term nature of stock ownership would ensure an ongoing cost reduction emphasis. finally, the unique reward practice of increased job autonomy in which employees are rewarded with increased decision making and control is important to allow employees freedom to investigate, locate, and correct product or service defects or procedures at their source. this reward is well supported in the quality literature of deming (1982), juran (1992), and crosby (1979). these well-known quality theorists support increased job autonomy, allowing employees the freedom to make changes in their job to improve quality and efficiency and thereby reduce costs. for example, assembly line workers in many auto plants have the authority to stop the line in order to correct a quality problem. the significant reward practices for hypothesis 3 (regarding a focus-cost leadership strategy) again indicated the importance of regular expressions of appreciation by managers and leaders to employees, regardless of the strategy chosen. consistent with organizational behavior literature (pfeffer, 1998; luthans & kreitner, 1985; kerr, 1975), recognition serves to motivate employees to reach higher levels of performance. table 3 identifies four other reward practices important for a focus-cost leadership strategy. because this strategy emphasizes serving a unique niche, special amenities may be necessary to attract and retain the type of employees who have the requisite skills to cater to the unique customers targeted by this strategy. likewise, in keeping with a cost leadership philosophy, the provision of perks like special parking spaces, club memberships and special workspace may actually cost less than the constant recruiting and replacement of workers with the specialized skills necessary to perform in this market niche. the final three reward practices supporting the focus-cost leadership strategy deal exclusively with pay issues: (l) narrow pay bands, (2) position-based pay systems, and (3) employee stock ownership. as previously discussed, stock ownership encourages appropriate long-term oriented behavior. the use of position based pay systems (which pay people primarily based on the level they hold in the organization) can have an adverse impact on total payroll expense and thus, deter a cost leadership strategy. employees in this system are paid based on the position they hold, rather than for their performance. accordingly, the use of this pay system was negatively correlated with firm performance. fall 2002 allen & helms: strategy and rewards 131 the use of narrow pay bands (few differences in pay for a given position) should result in cost containment as payroll costs are held in check as contrasted with performance based or skill based pay plans which reward people with higher salaries based on their performance or skills acquired. narrow pay bands should also help achieve a perception of relative pay equity among employees (adams, 1965) thus, keeping absenteeism, turnover, and low morale costs down. for the final hypothesis, concerning the generic strategy of focus-product differentiation, we find an individual-based performance system to be supportive. this is consistent with the generic product differentiation strategy discussed earlier. this pay system would encourage product or service differentiation, but within a niche market. in agreement with the other focus strategy, focus~cost leadership, special amenities are necessary to attract and retain employees with the specialized skills required to effectively target the niche market's customers. development-based performance appraisals, being more future oriented than strictly past performance based appraisals, should enable employees to gain the skills necessary in the future to allow them to better differentiate their products and services to niche customers. as shown in table 3, the increased job autonomy reward was important for this strategy as well. in this case, more autonomy should empower employees with the appropriate decision making latitude to provide the level of customer service required for their unique market niche and to be permitted to make the necessary decisions to allow their organization's service to be sufficiently differentiated from the competition. limitations of this study little research has investigated the relationship between strategy, rewards, and performance. this research used a convenience sample to begin to explore this important research question and develop hypothesis. as such, future research may be strengthened by using a sample comprised of more senior managers and upper-level administrators, thus, limiting variability in the sample and controlling for experience, organizational level, industry type, and other diversities. the wide variability in the types of organizations participating this sample helped to bolster the generalizability of the findings, but precluded using objective measures of firm performance. while this sample adequately mirrored the regional business community, future research designs may be improved by studying a single industry and utilizing objective, measures of performance. this would necessitate using only publicly held firms in a single industry as the sample. the downside to this approach would be less generalizability of findings and the greater potential for an industry specific event (i.e., upturn or downturn) to mask the relationships. a longitudinal research design should also be considered in future research. the presently used cross-sectional approach precluded cause-and-effect conclusions because data was collected at one time from a single source. future 132 journal of business strategies vol. 19, no.2 research should collect data on a longitudinal basis to aid in drawing causal inferences. considering these limitations, the findings and conclusions of the present study should be viewed as exploratory and tentative. stronger research designs and methods should be used in the future to verify the findings of the present study. implications for managers even though this study was exploratory in nature, the results are interesting for executives and top managers and match much of the popular literature and discussions about aligning rewards to strategy for optimal organizational performance. the popular press urges us that "what gets measured gets done" and "what gets rewarded gets accomplished" so the notion of matching rewards to strategy are intuitively appealing to practitioners as well as academicians. our findings have important, practical implications for senior managers and others responsible for the implementation of strategies and rewards in organizations. top managers must work closely with lower-level managers as well as human resources professionals to craft reward systems that are consistent with motivational concepts and at the same time support their chosen organizational strategy. the relationship between strategy and rewards needs to be clearly communicated to the employees so that they understand the organization's strategy as well as the linkages between their rewards and strategy. human resource professionals should be closely involved in the strategy formation and implementation process. top managers should consider involving cross-functional teams in developing both strategic plans and supportive reward practices. more specifically, managers should implement policies and programs that link performance to the accomplishment of strategic objective at all organizational levels supported by reward practices which foster rather than hinder the espoused organizational strategy. based on the current research, one would expect that strategies must be clearly articulated and then effectively deployed throughout the organization. at the same time, the reward system must be continually adapted to provide corresponding reinforcement and advancement of the chosen strategy. areas for further research more than anything else, this study underscores the importance of tailoring reward systems for the strategy espoused by the organization. this set of findings reinforces lawler's (1991) comments about the important relationship between reward systems and all change efforts including the overall organizational strategy. clearly, this exploratory study should encourage others to proceed with further empirical research on the inter-relationship between strategy, rewards and performance. the preliminary findings of this research need to be verified and more deeply studied to uncover the psychological underpinnings that are responsible fall 2002 allen & helms: strategy and rewards 133 for the results reported in this study. future research should be designed to test whether or not these different reward practices actually moderate the performance of organizations. for example, is there an interaction effect between the use of increased job autonomy and a cost leadership strategy to produce higher levels of organizational performance? as with any exploratory research, more interesting and important research questions have been uncovered. for example, why do individual based performance systems appear to be supportive of both the differentiation strategies (product and focus), but not the two cost leadership forms of strategy? why were esops supportive of all but the focus-product differentiation strategy? why were some highly regarded forms of rewards like profit sharing, gainsharing, team-based incentives, skill-based pay, group celebrations, and other non-monetary forms of recognition not significantly linked with any type of strategy? these are all areas for future research. moreover, we encourage researchers to improve on the limitations to the present study. to begin with, a more geographically diverse sample ofindividuals and organizations should be included in subsequent studies. the use of a convenience sample served our initial theory-building aims but reaching a broader geographic range of organizations is needed. furthermore, rather than relying on the recall of employees, as we did, other studies could access the actual formal strategic and financial documents of organizations so they can be content analyzed independently of other data and, thereby, neither rely on recall nor the possibilities of common variance from all data being provided by the same respondents. perhaps a series of case-study efforts could be made to work with several organizations willing to supply not only their formal documents, but also allowing researchers to interview employees concerning their strategic and reward system practices as well. this exploratory study is a start, but it has only touched the tip ofthe iceberg on this important research question. our understanding of strategies and rewards can be significantly improved by further study of their relationships. references adams, j.s. (1965). inequity in social exchange. in l. berkowitz (ed.) advances in experimental social psychology. 2, (pp. 267-299). new york: academic press. allen, r.s. & kilmann, r.h. (2001). the role of the reward system for a total quality management based strategy. journal of organizational change management, 14(2), 110-131. anfuso, d. (1994). at l. l. bean, quality starts with people: 1994 optimas award winners. personnel journal, 73( 1), 60. bain, j.s. (1956). barriers to new competition. cambridge, ma: harvard university press. 134 journal of business strategies vol. 19, no.2 baker, m.j., black, cd., & hart s. (1988). the competitiveness of british industry: what really makes the difference? european journal of marketing, 22(2), 70-85. baker, m.j., & hart s. (1989). marketing and competitive success. hemel hempstead: philip allan. balkin, d.b. & gomez-mejia, l.r. (1987). toward a contingency theory of compensation strategy. strategic management journal, 8, 169-182. barney, j.b. (1986). types of competition and the theory of strategy: toward an integrated framework. academy of management review, 110, 791-800. becker, b. & gerhart, b. (1996). the impact of human resource management on organizational performance: progress and prospects. academy of management journal, 39(4), 779-801. blackburn, r. and rosen, b. (1993). total quality management and human resources management: lessons learned from baldrige award winning companies. academy of management executive, 7(3), 49-66. buckley, p., pass, c.l. & prescott, k. (1988). measures of international competitiveness: a critical survey. journal of marketing management, 4, 175-200. buzzell, b.t. & gale, b.t. (1987). the pims principles: linking strategy to performance. new york: the free press. buzzell, r.d. & wiersema, ed. (1981). successful share building strategies. harvard business review, 59(1), 135-144. campbell-hunt, c. (2000). what have we learned about generic competitive strategy? a meta-analysis. strategic management journal, 21 (2), 127-154. chrisman, j., hofer, c, & bolton, w. (1988). toward a system for classifying business strategies. academy of management review, 13,413-28. crosby, p.b. (1979). quality is free. new york: new american library. david, e (1999). strategic management concepts and cases. new jersey: prentice-hall. davis, p.s. & schul, p.l. (1993). addressing the contingent effects of business unit strategic orientation on relationships between organizational context and business unit performance. journal of business research, 27(3), 183-200. day, g.s., & wensley, r. (1988). assessing advantage: a framework for diagnosing competitive superiority. journal of marketing, 52, 1-20. deming, e.w. (1982). out of the crisis. cambridge, ma: massachusetts institute of technology center of advanced engineering study. fall 2002 allen & helms: strategy and rewards 135 dess, g.g. & davis, p.s. (1984). porter's generic strategies as determinants of strategic group membership and performance. academy of management journal, 26(3),467488. dess, g.g. and robinson, r.b., jr. (1984). measuring organizational performance 'in the absence of objective measures. strategic management journal, 5, 265-273. donaldson, g. (1984). managin/i); corporate wealth. new york: praeger. frazier, g.l., and howell, r.d. (1983). business definition and performance. journal of marketing, 47, 59-67. galbraith, j .k. (1973). controls or competition what's at issue? review of economics and statistics, 55(4),524-538. goldsmith, w., & clutterbuck. d. (1984). the winning streak: britain's top companies reveal their formulas for success. london: wei den field and nicolson. gomez-mejia, l.r. & balkin, d.b. (1992). compensation, organizational strategy, and firm performance. cincinnati, or: southwestern publishing company. gupta, a. (1995). a stakeholder analysis approach for inter-organizational systems. industrial management & data systems. 95(6),3-7. hall, w. k. (1983). survival in a hostile environment. in r. g. hammermesh (ed.) strategic management. (pp. 151-169). new york: john wiley & sons. hambrick, d.c. (1981). strategic awareness within top management teams. strategic management journal, 2(2), 263-279. hambrick, d.c. (1982). environmental scanning and organizational strategy. strategic management journal, 3( 1), 159-174. hambrick, d.c. (1983). some tests of the effectiveness and functional attributes of miles and snow's strategic types. academy of management journal, 26( 1),5-26. hambrick d.c. and snow, c.c. (1989). strategic reward systems, in c.c. snow (ed.) strategy organizational design and human resource management. (pp. 929-964) greenwich, ct: jai press. hawes, j,m. & crittendon, w.e (1984). a taxonomy of competitive retailing strategies. strategic management journal, 5(2), 275-287. helms, m.m., dibrell, c. & wright, p. (1997). competitive strategies and business performance: evidence from the adhesives and sealants industry. management decision, 35,678-92. 136 journal of business strategies vol. 19, no.2 hill, c.w.l. (1988). differentiation versus low cost or differentiation and low cost: a contingency framework. academy of management review, 13(3), 401-412. hooley, g.i., & lynch, j.e. (1985). marketing lesson's from the uk's high-flying companies. journal of marketing management, 1,65-74. juran, j.m. (1992). juran on quality by design. new york: the free press. kerr, s. (1975). on the folly of rewarding a, while hoping for b. academy of management journal, 18, 769-783. kilmann, r.h. (1989). managing beyond the quick fix. san francisco, ca: jossey-bass. kim, l. and lim, y. (1988). environment, generic strategies, and performance in a rapidly developing country: a taxonomic approach. academy of management journal, 31, 802-827. knouse, s.b. (1995), the reward and recognition process in total ouality management. milwaukee, wi: asqc quality press. lawler, e.e., iii. (1991). the new plant approach: a second generation approach. organization dynamics, 20( i), 4-15. lawler, e.e., iii. (1986a). high involvement management. san francisco, ca: josseybass. lawler, e.e., iii. (1986b). reward systems and strategy. in j. r. gardner, r. rochlin & h. w. sweeney (eds.) strategic planning handbook. new york: wiley. lawler, e.e. iii. (1994). total quality management and employee involvement: are they compatible? academy of management executive, 8(1), 68-76. lawler, e.e., iii & jenkins, g.d. (1994). strategic reward systems. in m. d. dunnette & l. m. hough (eds.) handbook of industrial and organizational psychology. (2nd ed., pp. 3-94.) palo alto, ca: consulting psychologist press inc. lawler, e.e., iii, mohrman, s.a. & ledford, g.e., jr. (1995). creating high performance organizations: practices and results of employee involvement and total quality management in fortune 1000 companies. san francisco, ca: jossey-bass. ledford, g.e., jr. (1995a). pay as an organizational development issue. academy of management odc newsletter, summer, 1-6. ledford, g.e., jr. (1995b). designing nimble reward systems. compensation and benefits review, july-august, 27,46-54. littler, d. (1988). perspectives on competitiveness. marketing education group proceedings of the 21 st annual conference, huddersfield polytechnic, 3, 57 -72. fall 2002 allen & helms: strategy and rewards 137 lusch, rf., & laczniak, g.r. (1989). macro-environmental forces, marketing strategy and business performance: a futures approach. journal of the academy of marketing science, 17,283-95. luthans, f. & kreitner, r. (1985). organizational behavior modification and beyond. glenview, il: scott foresman. mason, e.s. (1939). price and production policies of large-scale enterprises. american economic review, 29( i), 61-74. mcgee, j. & thomas, h. (1986). strategic groups: theory, research and taxonomy. strategic management journal, 7(1), 141-160. mcgee, j. & thomas, h. (1992). strategic groups and intra-industry competition. international review of strategic management, 3, 77-98. miles, r.e. & snow, c.c. (1978). organizational strategy, structure. and process. new york: west. miller, a. (1998). strategic management. (3rd ed.). new york: irwin mcgraw-hill miller, a. & dess, g. (1993). assessing porter's (1980) model in terms of its generalizability, accuracy, and simplicity. journal of management studies, 30, 553585. murray. a. 1. (1988). a contingency view of porter's generic strategies. academy of management review, 13(3), 390-400. nadler, d. & tushman, m. (1988). strategic organization design. glenview, il: scott, foresman. nayyar, p.r. (1993). on the measurement of competitive strategy: evidence from a large multiproduct us firm. academy of management journal, 36(6), 1652-1669. parker, r, & helms, m.m. (1992). generic strategies and firm performance in a declining industry. management international review. 32(1), 23-29. pfeffer, 1. (1998). six dangerous myths about pay. harvard business reyiew, 76, 108119. phillips, l.w., chang. d.r. & buzzell. rd. (1983). product quality, cost position, and business performance: a test of some key hypotheses. journal of marketing, 47(2), 26-43. porter, m.e. (1980). competitive strategy. new york: free press. porter, m.e. (1985). competitive advantage: creating and sustaining superior performance. new york: free press. 138 journal of business strategies vol. 19, no.2 porter, m.e. (1987). from competitive advantage to corporate strategy. harvard business review, 65(3), 43-59. reitsperger, w.d., daniel, sj., tallman, s.b., parker, b. & chismar, w.g. (1993). product quality and cost leadership: compatible strategies? management international review, 33, 7-21. ross, d.n. (1999). culture as a context for multinational business: a framework for assessing the strategy-culture 'fit'. multinational business review, 7( 1), 13-19. saunders, j., & wong, v. (1985). in search of excellence in the uk. journal of marketing management, i, 119-37. schonberger, rj. (1994). human resource management lessons from a decade of total quality management and reengineering. california management review, 36(4), 109-124. seth, a & thomas, h. (1994). theories of the firm: implications for strategy research. journal of management studies, 31 (2), 165-191. skinner, b.p. (1953). science and human behavior. new york: free press. slocum, j.w. jr., mcgill, m., & lei, d. (1994). the new learning strategy: anytime, anything, anywhere. organizational dynamics, autumn, 23(2). 33-48. thompson, a. & strickland, a. (1998). crafting and implementing strategy. new york: irwin mcgraw-hill. ulrich, d. & lake, d. (1990). organizational capability. new york: john wiley and sons. van de ven, ah., & ferry, d.l. (1980). measuring and assessing organizations, new york: john wiley and sons. waldman, d.a. (1994). designing performance management systems for total quality implementation. journal of organizational change management, 7(2), 31-44. walker, o.c., jr., & ruekert, r.w. (1987). marketing's role in the implementation of business strategies: a critical review and conceptual framework. journal of marketing,51,15-33. wellins, r.s., ginnodo, w.l., day, c.r. jr., coiteryahn, k.l., mussitsch, k. & price, d. (1993). tom: forging ahead or falling behind? a study of quality practices. pittsburgh, pa: development dimensions international. white, r.e. (1986). generic business strategies, organizational context, and performance: an empirical investigation. strategic management journal, 7(2), 217-231. fall 2002 allen & helms: strategy and rewards 139 wright, p. (1987). a refinement of porter's strategies. strategic management journal, 8(1),93-101. wright, p. & parsinia, a. (1988). porter's synthesis of generic business strategies: a critique. industrial management, may-june, 20 23. wright, p., kroll, m., tu, h. & helms, m. (1991). generic strategies and business performance: an empirical study of the screw machine products industry. british journal of management, 2(1), 57-65. zahra, s.a. (1993). environment, corporate entrepreneurship, and financial performance: a taxonomic approach. journal of business venturing, 8(3), 319-340. zingheim. p. k. & schuster, j.r. (2000). total rewards: pushing the pedal to the metal. the journal of business strategy, july/august. 21 (4), 15-17. richard allen is the dc foundation assistant professor of management at the uni versity of tennessee at chattanooga. his research interests include organizational development and the strategic use of rewards. prior to entering academia, he spent over 15 years in a variety of corporate management, training and consulting roles. marilyn helms is the sesquicentennial endowed chair and professor of management at dalton state college in dalton, ga. her research interests include manufacturing strategy, quality, and international management. she has international experience teaching in tokyo, japan; and directing study abroad programs teaching at manchester business school and at kings college-kensington (london); cairns and sydney, australia; and dublin and galway, ireland. she was awarded the fulbright teaching and research award and taught at the university of coimbra, portugal from april to june 2000. employee perceptions of the relationship between strategy, rewards and organizational performance porter's generic strategies: an exploratory study of their use in japan richard s. allen the university of tennessee at chattanooga chattanooga, tn marilyn m. helms dalton state college dalton, ga margaret b. takeda california state university san bernardino, ca charles s. white the university of tennessee at chattanooga chattanooga, tn abstract while the use of porter :~, generic strategies have been well documented in america and europe, no studies have assessed their use in japan. this research investigates if japanese companies are indeed following porter :" generic strategies or continuing to follow more traditional "japanese" management strategies. using a survey to operationalize porters generic strategies, japanese managers were questioned about theirfirm :" current strategic practices. a factor analysis revealed japanese firms are following only two strategies that could be identified as those of porter. a cost leadership strategy was the most frequently used strategy, and the d~fferentiation strategy was used the least. there was no evidence of organizations wiing a focus strategy. interestingly. two additional strategies emerged that did not!it porter s research but are in line with traditional japanese strategies including a supply chain focus and a training based strategy. introduction japan is experiencing a shrinking economy, failing stocks, rising unemployment, restructuring and job cuts. without reforms, the economy is only predicted to grow 0.8% a year from 2006 to 20 10 according to country advisors (lorange & turpin, 2004). layoffs, such as 800 workers from mitsubishi, have caused a change of attitude as many young people are abandoning hopes of landing life70 journal of business strategies vol. 24, no.1 time jobs (wiseman, 200 i). bankruptcies are soaring and leaving behind a record level of debt in the country ("japan corporate failures up," 2001). a study team at japan's economy, trade and industry ministry even called for improving disclosure rules for initial public offerings of venture firms to emphasize future business plans, rather than past performance ("report seeks to improve," 200 i). in their groundbreaking and controversial article, "fixing what really ails japan," porter and takeuchi (1999) both of harvard university, presented the cogent argument contending it was not government oversight of industry leading to the global success of japanese companies, but rather operational effectiveness and strategy. they further blame the current long period of japanese economic stagnation on the lack of discernable business strategies practiced by japanese firms. based on these propositions of porter and takeuchi (1999), the study presented in this article explores the following important related questions: • what types of discernable strategies are japanese companies currently using? • do these strategies fit the porter typology? • what is the relative frequency of use of japanese business strategies? literature review traditional japanese management practices traditional japanese management is frequently cited as the cause ofthese problems. historically, since ww ii, all employees of a company share risks and gains of the operation. even during economic crisis, layoffs are a last resort remedy. lifetime employment, particularly for men in large companies, is the norm. upper and lower management have similar responsibilities and product research is continuous as is the encouragement of new ideas and personal productivity. japan's industrial system is characterized by interdependent relationships among government, private, non-profit and community organizations. the keiretsu, or "lineage" system consists of a parent firm and trading company with the main bank as the institutional triumvirate guiding the activities of the entire keiretsu system. each ofthese primary resource and power centers maintains close relationships with counterparts in the public sectors. the bank is guided by the ministry of finance (mof); the trading company aligned with the ministry of economy, trade and industry (metl); and the parent firm guided by other government and non-private institutions (ministry of education or major universities). companies such as national telecom (ntt), for example, are closely tied with the ministry of posts and telecommunications (mopt). other examples of these institutional relationships include the company labor unions and the keidanren and nikkeren (advisory councils) with both public and private sector participants (okimoto & rohlen, 1988). these institutionalized practices are in place to help maintain informal ties between government and business. the often cited reason for japan's inability to react quickly to changes in market forces is the entrenched nature of group decision-making and the formalized sysspring 2007 allen et at.: porter:s generic strategies 71 terns that seem to slow down even the most urgent of "causes" (ishikawa, 1988). japanese organizations practice nemawashi which is the process ofpreparing others through persuasion and sharing of information for a decision-making process. nemawashi is a time consuming process which results in a fait accompli. ringi (group decision-making through memos, meetings and formalized information and authorization gathering which results in a consensus decision) is another example of an institutionalized practice that results in long decision-making times and resistance to short-term change. habatsu (informal and formal cliques of people which form in order to maintain information flows, control and power in stratified cross-sections of the organization) creates formal social structures resistant to ideas that threaten their autonomy. kaizen or "continuous improvement" is yet another example of a way of life in japanese companies that purposely inhibits "rash" action, or changes in the way things get done (rohlen, 1974; cole, 1989, whitehill, 1991; ishikawa, 1988, porter & takeuchi, 1999). limitations of japanese management and strategic challenge japanese group decision making structures are driven by a sense of total commitment of group members to their leader and vice-versa (ishikawa, 1988; hamabata, 1990; whitehill, 1991), this level of commitment has the potential to hinder the system's ability to identify and to react appropriately when the system is following a failing course-of-action. japanese are reluctant to abandon such a system (kahneman & tversky, 1979). prospect theory suggests those "sunk cost effects" (arkes & blumer, 1985) naturally occur once an investment in money, effort or time has been made, and individuals have a "personal stake" in the outcome, and choose not to alter their actions (staw, 1976, 1981). when individuals become committed to a failing course-of-action, negative consequences will actually cause decision makers to increase their commitment of resources and undergo the risk of further negative consequences. this can evolve into a structurally supported behavior if an individual's group, organization or institution supports their behavior (brockner & rubin, 1985; ross & staw, 1986; staw & ross, 1989; whyte, 1993). today, the is-year long "recession" in japan has finally begun to take its toll on japanese managers' faith in the japanese "system." recently, firms have begun to search for other ways to break out of their decades long commitment to the traditional japanese management system and have discovered michael porter's (1980, 1985) generic strategies as a possible impetus for corporate change and renewal. according to porter and takeuchi (2000), the japanese economy will emerge from more than a decade of recession only if japanese firms become more competitive in the global marketplace. recently, the adoption of generic strategies has received much attention in public discussions in japan. japan's experience after the bubble economy with the chronic asian financial crisis highlighted concerns as to whether japan's once celebrated prosperity can be regained. the slow change and growth rate of new venture creation in japan can be attributed to the conventional japanese 72 journal a/business strategies vol. 24, no. i business culture, lifetime employment, the seniority system, labor unions inside companies, tight regulatory policies of the government, and the group-oriented risk adverse proclivity of the population. these cultural characteristics were developed from the past asian agriculture system, a mono-national culture of an island country, and confucianism. the porter prize for japan porter and takeuchi (1999) argue it was precisely the governmental policies designed to macro manage industrial growth in japan and globally which lead to the eventually downfall of the japanese economy. porter and takeuchi point to examples of honda, sony, nintendo and sega as companies considered to be "mavericks" in japan because they bucked government attempts at intervention. they consider these organizations to be the true japanese success stories. the authors further argue these organizations rise to global dominance is explained by their well developed and defined corporate strategies, in addition to their operational excellence. since the publication of the article, and the subsequent book "can japan compete?" (porter & takeuchi, 2000), the japanese ministry of economic trade and industry (meti, formerly miti) established the "porter prize" to recognize japanese companies achieving and maintaining superior profitability in their industry by implementing unique strategies based on innovations in products, processes, and ways of managing. the porter prize has the sole purpose of improving competitiveness of japanese corporations. the evaluation criteria are originality, consistency, and high profitability of corporate strategies. the prize has been awarded to japanese companies choosing to compete by delivering unique value based upon innovation and management. while the award is intended to motivate japanese firms to develop clear, concise and manageable strategies, the degree to which the award is having an impact on strategic policy in japanese companies as a whole has not been tested. to date, the porter prize recipients represent small to medium size firms in well defined niche markets. these companies do not represent the corporate base typically cited as creating the japanese miracle, namely large keiretsu-based manufacturing conglomerates (smothers, 1990). the organizing body of the porter prize, the graduate school of international corporate strategy at hitotsubashi university, is the first "professional" graduate school established in japan in april 2000 by the government with the single aim of improving competitiveness of japanese firms in the global marketplace. this prestigious, well-funded program offers a full-time mba program, taught entirely in english by many highly regarded american and european business professors. by applying for the porter prize, it is hoped japanese firms will become more attuned to the principles of competitive strategy. through the application process, company managers are forced to consider important questions. for example, are we delivering a "unique value proposition" (a differentiated product or service targeted for a specific market niche)? have we maintained strategic continuity spring 2007 allen et at.: porter:\' generic strategies 73 over time? have we innovated in ways that enable the strategy? have we sustained superior profitability? it is intended that, similar to its predecessor the deming award for quality, the application process alone can serve as an impetus to rethink the current strategy or to pave the way for implementing distinctive strategy in the future. benefits to the winners of the prize include recognition as a leader in strategy, increased public relations ability, and recruiting exposure. the winners are also featured in a case study series for hitotsubashi business review (published by toyo keizai inc.) and in other publications and strategic management textbooks (hitt, ireland & hoskisson, 2005). among the first porter prize winners were matsui securities and mabuchi motor as corporations in the single business category and canon's lens division and two divisions of hoya vision care as corporations in the multiple business category. matsui securities was highly regarded for the clear definition of "jobs-notto-do" in its business strategy. established in 1931, this long-life securities firm ceased operations of its sales branches and telemarketing centers to specialize in online trading services. the firm has realized high rates of return on invested capital by focusing on the individual investors who have significant experience in stock exchanges (asia biz tech, 200 i). porter's generic strategies while various types of organizational strategies have been identified over the years (chrisman, hofer & bolton, 1988; porter, 1980), porter's generic strategies remain the most commonly supported and identified in key strategic management textbooks (dess, lumpkin & taylor, 2004; david, 2003; wheelen & hunger, 2004; thompson & stickland, 2003) and in the literature (miller & dess, 1993). porter (1980) proposed three generic strategies yielding competitive advantage, namely cost leadership, product differentiation, and focus. porter (1980) suggests for long-term profitability, a firm must make a choice between one of the three generic strategies rather than end up being "stuck in the middle." cost leadership. lower costs and cost advantages result from process innovations, learning curve benefits, economies of scale, reductions, product designs that reduce manufacturing time and costs, and reengineering activities. a low-cost or cost leadership strategy is effectively implemented when the business designs, produces, and markets a comparable product more efficiently than its competitors. the firm may have access to raw materials or superior proprietary technology to lower costs. product differentiation. product differentiation fulfills a unique customer need by tailoring the product or the service, allowing organizations to charge a premium price to capture market share. the differentiation strategy is effectively implemented when the business provides unique or superior value to the customer through product quality, features, or after-sale support. the quality may be real or perceived based on fashion, brand name, or image. firms following a differentiation strategy can charge a higher price for their products based on the product characteristics, 74 journal of business strategies vol. 24, no. 1 the delivery system, the quality of service, or the distribution channels. the differentiation strategy appeals to a sophisticated or knowledgeable consumer who wants a unique, quality product and is willing to pay the higher price. focus. focus, the third generic strategy, is based on adopting a narrow competitive scope within the industry. focus strategies grow market share through operating in a niche market or markets not attractive to, or overlooked by, larger competitors. these niches arise from a number of factors including geography, buyer characteristics, product specifications, or requirements. a successful focus strategy (porter, 1980) depends upon an industry segment large enough to have good growth potential but not of key importance to major competitors. market penetration or market development can be an important focus strategy. porter (1985) also asserts focus can be based on (1) differentiation targeting a specific segment of the market with unique needs not met by others in the industry or (2) cost focused where the company has access to specialized production and operations equipment to save costs from smaller production lots or runs. midsized and large firms use focus-based strategies only in conjunction with differentiation or cost leadership strategies. focus strategies are most effective when consumers have distinct preferences or competitors overlook the niche (david, 2002). the need for japanese strategy research to date, no research has been conducted with a sample of japanese organizations to determine to what extent they are following porter's generic strategies. this may due in large part to the difficulty of outsiders gaining access to japanese organizations, as well as the barrier of translating research instruments into a language and format suitable for japanese respondents. our research represents the first exploratory attempt to remedy this deficiency in our understanding of the current state of japanese business strategies. tn summary, the japanese government has been attempting to convince their firms to enact porter based business strategies in an attempt to improve japanese international competitiveness. there would appear to be strong forces for change in japanese strategic planning practices. considering the long-term japanese recession, government backing of the porter prize, and the role-model examples of successful japanese businesses with better defined corporate strategies, one would presume that japanese organizations should be primed for porter-styled strategic planning. understanding the degree to which japanese companies are embracing strategic management "porter style" is essential to understanding the future ofthe japanese economy. a significant shift in strategic policy is necessary for a successful transition from the traditional japanese system to a more company-based, strategic thrust encouraged by porter. the important issue is determining the current state of japanese strategic planning. has the emphasis on porter begun to take root in japan? or is japanese strategic planning still stuck in their traditional practices of the past? the main purpose of this study, therefore, is to assess what discernable spring 2007 allen et al.: porter:s generic strategies 75 business strategies japanese companies are currently using, the relative frequency of use, and whether these strategies mirror porter's generic strategies. the research question this study considers whether japanese firms are enacting porter's generic strategies. organizational strategy, as noted earlier, can be grouped into key generic strategies. a priori, higher adherence to porter's strategies is expected in japanese firms, particularly given the government's emphasis on the porter prize and desire to reverse the country's current economic position. thus, the research question becomes: are porter's generic (1985) strategies being used in japan and if so, what is their frequency of use in japanese organizations? the sample to test the research question, a sample of 101 managerial employees working in japanese companies in tokyo, japan was surveyed. the subjects represented a broad cross-section of working adults. for inclusion in the final study, it was determined a respondent needed six months of employment at the organization under study to have adequate organizational knowledge to accurately complete the questionnaire. respondents had an average of eight years work experience. the time employed averaged 7.9 years (ranging from six months to 35 years) with a standard deviation of 8.6 years. over 84% of the respondents were employed full-time. the sample included senior managers (3.0%), middle managers (16.2%), frontline managers (7.1 %), professional/technical (21.2%), administrators (4.0%), and others 22.8%. twenty-two organizations with an average of633 employees were included in the sample. (note: only 40.6% of the subjects reported their firm's name on the questionnaire. this information was presented as "optional" in order to increase the confidentiality and response rate ofthe survey.) fifty-three percent were service organizations, 21 % were manufacturing, and 27% were in the government, non-profit, other category. fifty-six percent of the organizations were unionized (in japan unions are "company unions" in which all employees belong to a union within the company). methodology research instrument in a previous study of american organizations, allen and helms (2002) developed and tested an appropriate scale based on porter (1980, 1985) and parker and helms (1992) using a set of twenty-five questions regarding various strategic practices in order to operationalize porter's generic strategies. this instrument was adapted for the japanese survey. respondents were asked to determine how frequently their organization uses the various strategic practices. samples ofthe strategy survey questions are shown in table 1. 76 journal (~f business strategies vol 24, no.1 table 1 sample of survey questions almost some about most almost never never times half times always always (0%) (1-20%) (21-40%) (41-60%) (61-80%) (81-99%) (100%) vigorous pursuit of cost reductions 2 3 4 5 6 7 providing outstanding customer service 2 3 4 5 6 7 improving operational efficiency 2 3 4 5 6 7 controlling the quality of products/services 2 3 4 5 6 7 intense supervision of front-line personnel 2 3 4 5 6 7 developing brand or company name identification 2 3 4 5 6 7 targeting a specific market niche or segment 2 3 4 5 6 7 providing specialty products/services 2 3 4 5 6 7 the questionnaire included a cover page explaining the purpose of the survey and asked respondents to select a single organization to use as a point of reference in answering the survey questions. respondents were guaranteed anonymity. if the organization under study had multiple divisions or subsidiaries, respondents were asked to base their answers on the specific division or subsidiary in which they worked. respondents were given ample time to complete the survey and researchers were on hand to personally administer the questionnaire. the questionnaire was translated and then pilot tested for clarity in language and meaning. based upon the feedback from the pilot study minor adjustments were made to clarify meaning. the final japanese version was then back translated into english to make sure no meaning was changed from the original english version. analysis responses to the 25 strategy items were subjected to a factor analysis to test whether the items naturally grouped into any of porter's (1980, 1985) generic strategies. using spss principal component analysis with a varimax rotation and kaiser normalization, a four-factor solution emerged explaining 58.8% of the vanance. spring 2007 allen et al.: porter :5' generic strategies 77 items loading at 0.40 or greater were included in the resulting four factors. three of the original 25 items did not load strongly onto a single factor and were excluded from further analysis, leaving 22 strategic practice items. the items and factor loadings for each factor are summarized in table 2. the resulting four factors were then further interpreted for their meaning. based on the items comprising the factors, two factors represent porter generic strategies; namely, cost leadership and product differentiation. the focus strategies were not represented. two alternative strategies also emerged from the data. the first appears to represent the traditional japanese supply chain management, while the second appears to represent a training based strategy. in order to determine the frequency of use of the four strategies identified by the factor analysis, an additional procedure was performed. each item in the questionnaire was rated on a likert-type scale ranging from one through seven with a score of five or better indicating significant use of the strategy. (thus respondents indicating "most times," "almost always," or "always," were included.) the scores on the respective questions loading on each of the four previously identified factors (cost leadership, product differentiation, supply chain management, and training) were then summed. the resulting summated scale was used to assess which of the four strategies each respondent used. if a company scored above the cutoff score calculated by the product of the scale response (one through seven) times and the number of questions used to define the respective factor (for example, differentiation loaded on eleven questions), then the company was considered to be using the strategy. in a number of cases respondents reported the use of more than one major strategy which resulted in the percentages of strategy usage totaling to greater than 100%. this conceptual overlap is to be expected because many of the strategic practices are not entirely exclusive to each respective strategy identified in the factor analysis. the results of this analysis are summarized in table 3. discussion and conclusions based upon the factor analysis, four major strategies emerged from the data. only two of porter's generic strategies were apparent in the japanese organizations. in the following discussion, the two porter strategies in use in japan, namely, product differentiation and cost leadership are outlined, while introducing the additional strategies which emerged from the data ~ the supply chain strategy and the training strategy. table 2 factor analysis of japanese strategies --..l 00 strategy product differentiation* cost leadership* supply chain** training** innovation in marketing technology and methods .593 developing brand identification refining existing products/services developing a broad range of new products/services forecasting new market growth forecasting existing market growth extensive training of marketing personnel building a positive reputation within the industry for technological leadership .407 .708 .659 .532 .665 .594 .518 ~ :;: ""l ::s l:l-.. ~ b:.1 ~ s· ~ """" ~ i:s ji (t;" "" building high market share providing specialty products/services producing products/services for high price market segments * ** corresponds to a porter (1980) generic strategy new strategy observed in japan .458 .619 .608 &n ~.+:-. z o table 2 cont'd. factor analysis of japanese strategies strategy controlling the quality of products/services product differentiation * cost leadership* .534 supply chain** training** ci.l "0 ""l s' ctq n o o -..l providing outstanding customer service improving operational efficiency vigorous pursuit of cost reductions tight control of overhead costs partnering with suppliers utilizing advertising strategy competitive pricing intense supervision of front-line personnel extensive training of front-line personnel extensive training of marketing personnel .529 .769 .732 .667 ~.............. ('() ;:: ('()..... s:j :-"'ti q "'l..... .751 ~ "'l "'. .754 c) ('() ;:: .706 ('() "'l-. ~ .722 v:l...... "'l s:j..... .801 ~-.("tl .442 '" * ** corresponds to a porter (1980) generic strategy new strategy observed in japan -..l \0 80 journal ofbusiness strategies table 3 frequency of use of strategies in japan vol. 24, no. 1 strategy cost leadership supply chain training differentiation strategy percent of companies using strategy* 41.4% 36.2% 33.8% 7.6% * in a number of cases respondents reported the use of practices that represent more than one strategy which resulted in the percentages for the four strategies totaling greater than 100%. again, please note that some firms reported using strategic practices that fit into multiple strategic factors. this is to be expected because few real world organizations implement pure strategies. because of this the overall percentages do not add to 100%. the factor analysis was not amenable to providing more factors to sub-divide the sample so that all subjects would report using practices that represent only a single factor. it would have been highly improbable for this to occur since many of the strategic practices overlap. cost leadership strategy. the most common strategy evidenced in japanese organizations was porter's cost leadership strategy. this strategy was being used in 41.4% ofthe organizations sampled. a cost minimization strategy stresses ongoing cost reductions and tight control of overhead costs to the exclusion of almost any other organizational or strategic issues. this is evidenced in the items of vigorous pursuit of cost reductions, tight control of overhead costs and improving operational efficiency. the items comprising this factor clearly describe strategic practices which have been associated with the rise of japanese products in the 1980s. for example, japanese manufacturers were able to make great inroads internationally into such markets as consumer electronics, automobiles and steel. their vigorous control of both costs and quality, along with outstanding customer service allowed japan to export and compete globally in these markets. in japan, customer service is defined somewhat differently than in the west and this may explain its presence ofthis factor's make-up (miyagawa & yoshida, 2005). customer service results from a product's value as well as its on-time delivery. customers often cite japanese-made cars as offering better service due to the infrequent need for repairs. thus good quality leads to low cost and the low cost leader (schonberger, 1994), by providing a valued product, is in tum offering good customer service. inversely, offering a poor quality product or a product at an inflated price would be seen as poor or even unethical customer spring 2007 allen et al.: porter sgeneric strategies 81 service. it seems many japanese companies are currently using one of porter's generic strategies cost leadership. but which of the other strategies were evidenced in the data? product differentiation strategy. this porter strategy emerged in the factor analysis, but is being used much less frequently than any of the other strategies identified. in fact, a mere 7.6% of the organizations appeared to be utilizing this strategy. the failure of the japanese banking system has been widely cited as the cause of the bursting of the japanese economic bubble. but perhaps, as porter contends, the relative lack of use of his generic strategies could be partially responsible for the inability of the japanese economy to rebound. when analyzing the items loading on this factor it is interesting to note most are marketing related. since a product differentiation strategy emphasizes the uniqueness of a product or service and attempts to make the product or service special in the mind of the customer, one would expect marketing related activities to predominate. by fostering innovation as well as building a reputation of technological leadership a firm should be assured of a stream of new innovations to attract the interests of new customers as well as to meet existing customer's demands for uniqueness. part of japan's recent economic malaise might be attributable the inability of japanese companies to effectively differentiate their products from those of their competition. the entire country of japan has operated under a strategic focus on steel, consumer electronics and automobile production since the end of ww ii. their core international markets for these products have been invaded by other nations over the past few decades. for example, american mini-mills as well as former soviet bloc and other developing countries are now able to compete with japanese steel, the koreans and chinese now compete in consumer electronics, and the americans and europeans have rebounded in their ability to compete in the automobile markets. japan no longer enjoys a differentiated position in these markets. as such, very few organizations in the sample evidenced such a strategy. perhaps japan, an island nation dependent on exports, needs to regain a differentiated edge in some new markets if their economy is to rebound? focus strategy. none of the emerging strategic factors appeared to represent a focus strategy. practices typically associated with a focus strategy either did not clearly factor into a discernable strategy (i.e., "dropping unprofitable customers") or loaded onto the differentiation strategy (i.e., "providing specialty products or services" and "producing products/services for high price market segments"). since japanese firms are not utilizing porter's focus strategies, this may be part of the reason for japan's inability to rebound economically. perhaps japanese firms need to focus on specific product/service niches as well as develop new markets in which they can compete globally. this may be an important first step towards economic recovery. in the literature on focus strategies, there is discussion of the focus strategy as one strategy or two. when discussed as two strategies focus/low cost or focus/differentiation the focus strategies are on a continuum with low cost at 82 journal ofbusiness strategies vol. 24, no.1 one end of the differentiation strategy and low-cost at the other end. it may be possible that some of the japanese organizations that are in the cost leadership category are indeed practicing a focus-low cost type of strategy, but the data did not specify this. supply chain strategy. the first non-porter strategy identified appears to be a traditional of japanese supply chain strategy. this is not unexpected as the japanese are well known for their passion of managing supply chains to optimize efficiency through such tactics as long-term supplier relationships, inventory minimization, and providing suppliers with predictable schedules of stable orders and regular demand (liker & yu, 2000; helper & sako, 1995). these high levels of japanese supply chain collaboration have been created by deliberate policies to work with suppliers both individually and collectively in a circle of improvement and mutual benefit to increase cash flow and reduce operational costs of manufacturing (nick & peter, 1997; hines, 1994; lamming, 1993; womack & jones, 1996; andersen consulting, 1994; smitka, 1991). the results of the factor analysis indicated this strategic preference very clearly. three items representing a supply chain approach, namely, partnering with suppliers, focus on advertising, and competitive pricing all loaded onto this factor at or greater than 0.7. this strategy was the second most frequently used by 36.2% of the organizations. the unique keiretsu or interlocking-directorate relationship of japanese firms to their japanese supplying organizations has led to a unique management linkage not typically seen and often illegal in other countries. this relationship has led to excellence in supply chain management. this tightly linked sharing of production and profit information among suppliers and manufacturers is easier in japan due to their unique joint-ownership. with the linked supplier joint-ownership relationship practice it is understandable partnering with suppliers would exist on this factor. studies report japanese automotive and high technology firms frequently engage in cost sharing with smaller suppliers (asanuma & kikutani, 1992; kawaskai & mcmillan, 1987). others report the sharing of costs is brought about through investments in customizing assets and supplier support services and training (dyer & ouchi, 1993; chalos & sung, 1998; kakabadse & kakabadse, 2000). quinn and hilmer (1994) found japanese companies outsource primarily to improve the efficiency and quality of their own processes through focusing on a very few suppliers and building close interdependent relationships and supporting value-adding activities critical to quality. the advertising strategy and competitive pricing can be partially explained by tight supply chain linkages (asanuma & kikutani, 1992). competitive pricing is only possible in a complex product if all suppliers understand the cost structure and use a version of target costing to set a consumer market price and work backwards from this price to reduce costs of production along the supply chain. only with long-term and familial-like relationships is the greatest cost reduction possible and leadership in this area has long been attributed to japanese spring 2007 allen et al.: porter :~ generic strategies 83 management. advertising too is part of the supply chain strategy not only for the marketing reasons of co-op advertising and cost sharing, but also backed up by a corresponding and correct production and operations strategy. the american production and inventory control society (apics) dictionary (blackstone & cox, 2004, p.l) defines sales-and-operations planning (sop) as: a process to develop tactical plans that provide management the ability to strategically direct its businesses to achieve competitive advantage, sop integrates customer-focused marketing plans for new and existing products with the management of the supply chain. the process brings together all the plans for the business (sales, marketing, development, manufacturing, sourcing, and financial) into one integrated set of plans. the process must reconcile all supply, demand, and new-product plans at both the detail and aggregate levels and tie to the business plan. executed properly, the sales and operation planning process links the strategic plans for the business with its execution and reviews the performance measurements for continuous improvement. thus for the effective utilization of an advertising strategy, production must be in line with the advertising in order to manufacture and distribute the goods to meet consumer's demands, and, more importantly, these consumer demands have been formed by advertising. the japanese are recognized for their passion of managing supply chains to optimize efficiency through such tactics as long-term supplier relationships, inventory minimization, and providing suppliers with predictable schedules of stable orders and regular demand (liker & yu, 2000; helper & sako, 1995). these high levels of japanese supply chain collaboration have been created by deliberate policies to work with suppliers both individually and collectively in a circle of improvement and mutual benefit to increase cash flow and reduce operational costs of manufacturing (nick & peter, 1997; hines, 1994; lamming, 1993; womack & jones, 1996; andersen consulting, 1994; smitka, 1991). large percentages (36.2%) of the organizations surveyed are still clinging to this traditional business strategy. while the practices associated with this strategy did not fit a traditional porter generic strategy, one could assert the supply chain strategy is an attempt to move toward an adoption of a focus-low cost strategy. the key tenets of supply chain collaboration are to reduce operational costs of logistics, distribution and production while minimizing raw materials, work-in-process and finished goods inventories. in a focused or niche environment, the supply chain strategy can work to lower costs below other competitors thus creating a market advantage. training strategy. the other strategy operating in japanese organizations was a training strategy. the items loading on this factor included: 1) extensive training of front-line personnel, 2) intense supervision of front-line personnel, and 3) extensive training of marketing personnel. this strategy was evidenced 84 journal of business strategies vol. 24, no.1 in 33.8% of the organizations surveyed; making it the third most frequently used strategy. this is the second non-porter strategy identified. like the supply chain strategy, it too appears to be a traditional japanese strategy. japan is well known for intense, company-wide training as well as supervision of all employees in a rigid, hierarchical structure. many researchers have attributed japan's success to their unique style of management, structure, and training. thus the supervision and training of front-line personnel and marketing personnel emerged as a separate strategic factor due to the rich history and adherence to "japanese management" within many of the companies operating in japan. this training and management style worked so successfully during the 1980s in the heyday of japan's industrial success and companies follow this proven strategy today. the key features of japanese management are the seniority-based wage scale and promotion ladder, the traditional system of lifetime employment, and the concentration of power in middle management (ghosn, 2003). hull, hage, and zuumi (1985), in their study of the differences between the us and japanese approaches to management, also revealed japanese factories tend to invest relatively more in employee training, including more group processes such as the quality circle. they also found suggestions per employee were higher in japanese factories. clegg and kono (2002), in their study of trends in japanese management, offer a historical and cultural explanation for the intensive employee training. after ww ii, skilled laborers were needed and japan's lifetime employment encouraged such skill formation. training costs were invested in secure personnel who would remain in the firm. the long-term employment fostered commitment and managers were free to invest funds into training employees with a view toward more long-term performance. with the decline of the concept oflifetime employment in japan, this strategy may no longer be appropriate. an outsourcing type of strategy may be more competitive in today's international business climate. again while not a porter generic strategy, it could be argued the training strategy is an attempt by japanese managers to move toward the focus-differentiation strategy. the intense training results in either a standardized customer service and service delivery process for service firms or a quality manufacturing process with an attention to and elimination of process defects in a production environment. in either case service or manufacturing the result is a quality service or product. quality products and services can command a premium price from customers and are thus perceived as a differentiated product, particularly in narrow market segments. are porter's strategies being used in japan? given the four strategies, it appears japanese businesses may be beginning to make a transition to porter-based strategies, but the traditional japanese business strategies remain. for example, the japanese use porter's cost leadership strategy the most (41.4%), but the product differentiation strategy was infrequently used (7.6%) and a clear focus strategy did not emerge in the factor analysis. spring 2007 alien et al.: porter:~ generic strategies 85 clearly there is much room for improvement if japanese organizations hope to achieve the ideals of the porter prize. as shown in table 2, the large percentage of japanese firms following a cost leadership strategy can be easily explained as a natural reaction to the decade long economic slump and the necessity for cutting costs. japanese labor is among the highest paid in the world, imports on raw materials remains high despite attempts to reform the system, and the japanese are increasingly competing with chinese and other asian conglomerates for business that was once theirs exclusively. for these and other reasons, a cost leadership strategy is a means of survival. interestingly 70% of firms are still clinging to strategies linked to traditional japanese management (36.2% for supply chain and 33.8% for training). this evidence further indicates a national strategic transition is incomplete. the traditional japanese management strategies of training and supply chain management support porter's (1996) assertion past japanese success was based on operational effectiveness, the development of logistics to improve quality and cut costs, and on marginal product differentiation easily transferable to other companies. even the high use of the cost leadership strategy lends further support to the notion the japanese are stuck in the strategies of the past since cost control was vital to the previous success of japanese industries in a global marketplace. this exploratory study represents an attempt to identify current strategies in use in japanese companies and the degree to which japanese management is embracing the porter prize in japan. while porter asserts japanese companies, "have no strategy" and this tradition will be hard to break, the fact that such a large scale effort is underway to "infect" japanese companies with the "strategy bug" serves as a firm foundation for on-going inquiry and interest. while japanese companies do indeed have discernable strategies, they do not fit neatly into porter's typology. these strategies tend to be rooted in the past. it remains to be seen whether or not a transition to porter's generic strategies alone is possible for japan. limitations and areas for future research to date there have been no studies specifically designed to test whether porter's strategies are in use by japanese firms operating in japan. this research used a convenience sample consisting of management employees from mostly large, institutionalized japanese firms. future research may be strengthened by using a sample comprised ofa more diverse set of japanese firms, including entrepreneurial firms, women-owned businesses, and even foreign firms operating in japan. another approach would be to conduct a longitudinal comparative study among firms competing for the porter prize to identify specific practices and their relationship with strategies and performance and assess if their strategic practices mirror the questionnaire constructs for the generic strategies. the underlying assumption ofthe porter prize is winning companies will be "successful". since the current study does not address performance, future research should collect data on a longitudinal basis to aid in drawing causal inferences and validating the efficacy 86 journal ofbusiness strategies vol. 24, no. i of porter's strategies in use. future studies should also investigate the relative effectiveness of these various strategies in japanese firms. for example, which strategies are associated with higher levels of organizational performance? from this research two unique strategies emerged from the japanese management style and economic model, relevant only to japanese companies operating in the country. future research on strategies in japan should examine the population of strategies being used. if global japanese firms adapt strategy to their local environments, assessing the strategy ofjapanese owned business operations operating outside japan will help explain companies' global strategies. as with any exploratory research, other important research questions have been uncovered. for example, what are the reasons japanese firms are not adopting porter's generic strategies? are they too focused, too limiting to the traditionally open and fluid japanese management system? are japanese companies too locked into quality improvement processes, lean manufacturing and productivity enhancements to shift toward more differentiation and other, more market driven strategies? are the japanese firms concentrating only on large markets and ignoring profitable niche markets and the corresponding focus strategies? is the japanese management tradition ofevolutionary change and bottom-up consensus or team management antithetical to a top-down, rigid planning approach favored by porter? all are areas for future research as in linking the particular strategies used to performance. finally the problems experienced in japan need further research to determine the role of strategies or lack thereof in the current economic crisis. for example, what part of the problem is due to external and economic factors and what part is due to internal organizational strategies? also when japanese firms set up operations in the us, what strategic styles do they use and do they differ from the strategies used by the same organization in japan. this exploratory research is a first attempt to ascertain the current state of japanese strategy. future studies may use this as a baseline to see if the push towards porter-based strategies in japan is actually having an impact on japanese business strategies. it will be interesting to see if this transaction is ever enacted and, if so, how long it will take. references asia biz tech. (200 i). matsui securities co .. ltd. received the first porter prize award for its excellent corporate strategies. tokyo: nikkei news on-line. allen, r. s., & helms, m. m. (2002). employee perceptions of the relationship between strategy, rewards and organizational performance. journal of business strategies, 19(2), 115-139. andersen consulting. (1994). the second world-wide lean enterprise benchmarking report. london: andersen consulting. spring 2007 allen et al.: porter s generic strategies 87 arkes, h. r., & blumer, c. (1985). the psychology ofsunk cost. organizational behavior and human decision processes, 35. 124140. asanuma, b., & kikutani, t. (1992). risk absorption in japanese sub-contracting: a microeconomic study on the automobile industry. journal ofjapanese and internationa/economics. 6(1),1-9. blackstone, j. h., & cox, j. f. iii. (2004). apics dictionary (lltlt ed.). alexandria, va: apics the association for operations management. brockner, j., & rubin, j. z. (1985). entrapment in escalating conflicts: a social psychological analysis. new york: springer verlag. chalos, p., & sung, j. (1998). outsourcing decisions and managerial incentives. decision sciences. 29(4), 901-920. chrisman, j., hofer, c., & bolton, w. (1988). toward a system for classifying business strategies. academy of management review. 13,413-28. clegg, s., & kono, t. (2002). trends in japanese management an overview ofembedded continuities and disembedded discontinuities. asia pacific journal 0/management. 19(2-3),269-278. cole, r. (1989). strategies for learning: small group activities in american. japanese. and swedish industry. berkeley, ca: university of cali fomi a press. david, f. (2002). strategic management: concepts (9th ed). upper saddle river, nj: prentice-hall. dess, g. g., lumpkin, g. 1'., & taylor, m. (2004). strategic management: textandcases. new york: mcgraw-hill higher education. dyer, j. e, & ouchi, w. g. (1993). japanese-style partnership: giving companies a competitive edge. sloan management review, 35(1),51-63. ghosn, c. (2003). japanese-style management and nissan's revival japan echo. ]0(5), 15i8. hamabata, m. m. (1990). crested kimono: power and love in the japanese business/amily. ithaca, ny; cornell university press. helper, s. r., & sako, m. (1995). supplier relations in japan and the united states: are they converging? sloan management review, 36(3), 77-84. hines, p. (1994). creating world class suppliers: unlocking mutual competitive advantage. london: pitman. 88 journal of business strategies vol. 24, no. 1 hitt, m. a., ireland, r. d., & hoskisson, r. e. (2005). strategic management competitiveness and globalization, concepts and cases (6th cd.). new york: south~western publishing. hull, f. m., hage, 1., & zuumi, k. (1985). r&d management strategies: america versus japan. ieee transactions on engineering management, 2, 78-84. ishikawa, h. (1988). kaizen. new york: penguin books. jiji press. (200\, november 14). japan corporate failures up ii percent in october. jiji press english news service, 1-2. tokyo. jiji press. (2001, december 7). report seeks to improve venture disclosure rules. jiji press english news service, 5-6. tokyo. kahneman, d. & tversky, a. (1979). prospect theory: an analysis of decision-making under risk. econometrica. 47, 263-291. kakabadse, n., & kakabadse, a. (2000). critical review outsourcing: a paradigm shift. the journal of management development, 19(8),670-728. kawasaki, s., & mcmillan, 1. (1987). the design on contracts: evidence from japanese subcontracting. journal ofjapanese and international economics, 1(3),327-45. lamming, r. (1993). beyond partnerships: strategies for innovation and lean suppzv. hemel hempstead, england: prentice-hall. liker, 1. k., & yu, y. c. (2000). japanese auto makers, u.s. suppliers and supply-chain superiority. mit sloan management review, 42(1), 81-93. lorange, p., & turpin. d. (2004). how can japan grow? mit sloan management review. 45(2),96. miller, a., & dess, g. ( 1993). assessing porter's ( 1980) model in terms of its generalizability, accuracy, and simplicity. journal of management studies, 30, 553-585. miyagawa, m., & yoshida, k. (2005). an empirical study oftqm practices in japaneseowned manufacturers in china. the international journal of quality & reliability management, 22(6), 536-554. nick, r., & peter, h. (1997). supply-chain management and time-based competition: the role of the supplier association. international journal of physical distribution and logistics management, 27(3-4),21 0-225. okimoto, d., & rohlen, t. (eds.). (1988). inside the japanese system: readings on contemporary society and political economy. los angeles: stanford university press. spring 2007 allen et al.: porter :5 generic strategies 89 parker, b., & helms, m. m. (1992). generic strategies and firm performance in a declining industry. management international review. 32(1). 23-29. pearce, j. a. ii, & robinson, r. 8., jr. (2003). strategic management: formulation, implementation and control of competitive strategy (8th ed.). new york: mcgraw-hili higher education. porter, m. e. (1980). competitive strategy. new york: free press. porter, m. e. (1985). competitive advantage: creating and sustaining superior performance. new york: free press. porter, m. e., & takeuchi, h. (1999). fixing what realiy ails japan. foreign affairs. 6681. porter, m. e., & takeuchi, h. (2000). can japan compete? boston: harvard business school press. quinn, j. b., & hilmer, f. g. (1994). strategic outsourcing. sloan management review. 35(4),43-55. rohlen, t. (1974). for harmony and strength: japanese white collar organization in anthropological perspective. berkeley, ca: university of california press. ross, j., & staw, b. (1986). expo 86: an escalation prototype. administrative science quarterly. 31,274-297. schonberger, r. (1994). human resource management lessons from a decade oftotal quality management and reengineering. california management review, 36(4), 109-134. smitka, m. (1991). competitive ties: subcontracting in the japanese automotive industry. new york: columbia university press. smothers, n. p. (1990). patterns ofjapanese strategy: strategic combinations of strategies. strategic management journal, i j(7), 521-534. staw, b. m. (1981). the escalation of commitment to a course of action. academy of management review. 6,577-587. staw, b. m. (1976). knee-deep in the big muddy: a study of escalating commitment to a chosen course of action. organizational behavior and human performance, 16, 27-44. staw, b. m., & ross, j. (1989). understanding behavior in escalating situations. science. 246,216-220. thompson, a., & strickland, a. (2003). strategic management: concepts and cases (13th cd.). new york: mcgraw-hili higher education. 90 journal of business strategies vol. 24, no.1 whitehill, a. m. (1991). japanese management: tradition and transition. london: routledge press. wiseman, p. (200 i, september 10). japan enters "danger zone." usa today, p. 3b. wheelen, t., & hunger, j. d. (2004). strategic management and business policy (9th cd.). new york: prentice hall. whyte, g. (1993). escalating commitment in individual and group decision-making: a prospect theory approach. organizational behavior and human decision processes, 54,430-455. womac, j., & jones, d. (1996). lean thinking. new york: simon and schuster. richard allen is the uc foundation associate professor of management at the university of tennessee at chattanooga. he received his ph.d. in strategy, environment and organizational studies from the university of pittsburgh. his research interests include organizational development and the strategic use of rewards. prior to entering academia, he spent over 15 years in a variety of corporate management, training and consulting roles. marilyn helms is the sesquicentennial endowed chair and professor of management at dalton state college. she earned her doctorate of business administration degree from the university of memphis. prior to joining dsc, she was the george lester nation professor of management at ut-chattanooga. she was a fulbright teaching and research award to coimbra, portugal. her research interests include manufacturing strategy, quality, and international management. margaret takeda is an adjunct professor at california state university, san bernanrdino. she earned her ph.d. in international business/human resource management from the university of pittsburgh. prior to joining the csu faculty, she was an associate professor of management at the university of tennessee at chattanooga, and associate professor of international business at aoyama gakuin university, tokyo, japan. her research interests include international human resource management, international business, spirituality and leadership, and japanese management. charles s. white holds the uc foundation and hart professorships in management at the university of tennessee at chattanooga. he received his ph.d. in management from arizona state university in 1981. dr. white teaches in the areas of general management, organizational behavior, small business, and research methods. porter's generic strategies: an exploratory study of their use in japan kicking up dust: growth as an irrational market response troy a. voelker university of houston, clear lake • houston, tx abstract this paper introduces the concept of irrational growth, defined as a growth strategy that cannot (or will not) succeed in generating economic profits. growth is a frequently utilized performance indicator, yet examining strategy research, the relationship between growth and economic profits is complex. a theoretical foundation based on institutional theory suggests that growth is adopted regardless oflikelihood of positive economic outcomes. propositions for testing an institutional bias towards growth are developed and research directions are suggested. introduction researchers recognize that firm performance is a complex multidimensional measure (baum & wally, 2003). in the process of understanding performance, researchers often use recognized performance indicators (combs, crook, & shook, 2005; farjoun, 2002; a. d. meyer, 1991; venkatraman & ramanujam, 1986). two frequently examined performance indicators include economic profitability and firm growth. while the pursuit of growth and profitability differ, an assumption of bus iness literature states that growth ultimately, or perhaps eventually, creates profitability. for instance, in a prescriptive study examining competition in the new millennium, business practitioners are advised to grow to succeed in globally competitive markets (ireland & hitt, 2005). without challenging the prescription of 'grow to succeed,' we know that growth sometimes leads to excess. we need look no further than recent activity in the housing and financial sectors to observe growth fueled exuberance leading to ruin. such episodes appear rather predictably in our markets the most recent bubble will not be the last just as it was not the first. given this, why do we unequivocally treat growth as a positive measure of performance? why do our sophisticated markets and talented business leaders create and recreate growth fueled bubbles which inevitably burst? the question posed examines a potential paradox within extant business literature (poole & van de ven, 1989). knowing that some firms grow to excess, why do we explore growth as a positive performance indicator? should we not rather ask which conditions enable growth to lead to success and under which might growth 2 journal of business strategies lead to excess? while some exploration of a growth/performance paradox occurs in diversification and agency studies (10 & kim, 2008; o'brien & david, 2010; sun & cahan, 2009); in general business research treats growth as a desirable, positive performance outcome. indeed, sales growth or some other growth measure often appears side by side with economic profitability in examination offirm performance (combs et ai., 2005). we know that growth itself is multi-dimensional and that, within one dimension of growth (e.g. sales growth), different and contradictory relationships between growth and other organizational measures manifest depending on how (and for how long) growth is measured (weinzimmer, nystrom, & freeman, 1998). accepting that growth, profitability, market performance, and survival are all routinely deployed performance measures (combs et ai., 2005), one would expect a significant positive relationship to exist between growth and profit indicators. as shall be demonstrated in the following section though, the relationship between growth and profitability is, at best, complicated. if the relationship between growth and profitability is not clear cut, research could generate a substantial contribution by embracing the complexity and variety of firm performance indicators (venkatraman & ramanujam, 1986). rather than simultaneously using growth and profitability as separate but desirable goals, research should examine the conditions through which growth leads to profitability (combs et ai., 2005; weinzimmer et ai., 1998). it is incorrect to suggest that growth is an inappropriate performance measure. indeed, a sound theoretical foundation in resource dependency (pfeffer & salancik, 2003) and industry impact (dess, ireland, & hitt, 1990) each demonstrate distinct paths between growth and profitability. however, in addition to these paths, there likely exist a number of alternates by which the growth agenda never reaches profitability, or worse wherein the growth agenda precludes profitability. in the following sections, an argument will be advanced and developed that growth itself may at times represent an irrational environmental response. i argue that, our market emphasis on growth and even our own research use of growth as a positive performance metric may hinder our ability to diagnose healthy growth from unhealthy growth. worse yet, it is likely that our market infatuation with growth obstructs routine attempts to separate healthy and unhealthy market growth. specifically, the purpose of this paper is to identify the obfuscating mechanisms preventing practitioners and academics from diagnosing irrational growth. using an institutional theory perspective (j. w. meyer & rowan, 1977), several such mechanisms shall be identified along with possible research directions. it is the intent and hope of the author that such a contribution might stimulate more frequent investigation into the relationship between two commonly used performance measures (kimberly, 1976). volume 28, number 1 3 growth and profitability valid reasons for advocating firm's pursuit of growth strategies abound in the literature, but a comprehensive review of rational growth strategies is beyond the scope of this paper. however, a brief review of rational growth strategies is useful in both demonstrating the value of growth and creating the foundation for an institutionalized growth agenda developed later. the first of the two growth paths consists of growth as a means to an end, via resource control. the second path examines growth as an indicator of relative performance. the third path explores the legitimizing value of sales growth for nascent firms. resources, power; and market control from a resource control standpoint, growth emerges as a critical means to a profitability ends objective. essentially, growth in this format provides one of two different benefits. first, through growth firms may acquire enough power to exert influence over their markets (pfeffer & salancik, 2003). the second positive outcome from growth involves the ability to achieve economies of scale. these growth outcomes are not mutually exclusive and often operate concurrently. the field of industrial organization (10) economics has long suggested size and growth strategies generate positive profitability outcomes for firms. significantly large firms are generally more powerful vis-a-vis smaller suppliers and purchasers and can thus exert greater influence over the five forces than can smaller competitors (porter, 1979). further, within a given industry firms of similar size and disposition which are able to successfully enact barriers enjoy super-normal profits while simultaneously barricading themselves from incursion of smaller competitors or outside entrants (porter, 1980). empirical evidence suggests that such strategies are effective, although such barriers may backfire and prevent the once dominant firm from moving to a better fitting position during periods of technology transition (siggelkow, 2001). while growth and market share are not identical, they are overlapping concepts (venkatraman & ramanujam, 1986). from the resource dependence perspective, firm growth is a means to an endgame objective of profitability via market dominance. growth eventually leads to a size benefit (derfus, maggitti, grimm, & smith, 2008) which may entail economies of scale, a superior portfolio of resources, or power achieved via resource dominance. in all cases, the growth strategy is one to position the firm for superior performance in some latter stage. 4 journal of business strategies firm growth given industry and environmental effects where growth is a means to achieving profitability under a resource control perspective, growth represents an important indicator of a firm's relative performance given specific industry conditions. it is recognized that industry profitability and environmental conditions such as munificence playa major role in the growth and profitability of firms and researchers are strongly advised to control for such effects in their studies (dess et ai., 1990). as an example, high-growth industries experience greater divergence in firm-growth rates and firms who identify markets with fewer direct competitors are often able to grow faster than competitors in more saturated markets (greve, 2008). additionally, firms who traditionally grow faster than the industry average often retain their relative high-growth status (hall & tochterman, 2008). taken together, the ratio offirm sales growth to industry sales growth likely provides a meaningful distinction between growth and value firms. greve (2008) cautions though, that firms who are economically troubled often evidence rapid sales growth rates. we can assume that a firm's growth relative to its industry possibly reflects the firm's advantageous positioning and strategic orientation towards growth. in this case, firm growth is a solid candidate for performance indicators in single-industry studies or when controlled or compared against industry and environmental conditions. these recent findings echo the position advanced by dess, ireland and hitt (1990), yet many multi-industry studies continue to use firm growth as a stand-alone indicator (combs et ai., 2005). growth and nascent firms a third path exists for which growth represents a commonly used performance metric. specifically, in the evaluation of start-ups, the development of sales growth represents one performance indicator used by investors (heirman & clarysse, 2005). start-up firms face a higher mortality rate than established firms, often lack financial performance metrics comparable to established firms, and generally require evaluation of potential rather than performance (singh, tucker, & house, 1986). for the start-up firm, presence of legitimizing factors help overcome the liability of newness (certo, 2003). in this area of study revenue growth is treated as a sign of legitimacy alongside prestigious firm connections, mature board structures, and other characteristics more common of established firms (certo, 2003; heirman & clarysse, 2005; singh et ai., 1986). that sales growth functions as a legitimizing factor suggests an institutionalization of growth, given ambiguity nascent firms evidencing growth conform to a market norm. volume 28, number 1 5 the growth-profitability conundrum in the preceding section, growth manifests as a means to future profitability and as a corresponding outcome given industry and environmental conditions. this was not an exhaustive listing of the reasons or paths linking growth and profitability. instead, these positions illustrate that growth and profitability are rationally linked concepts within the literature. recognizing that there exist numerous paths to rationally link growth and profitability, one might expect a clear positive relationship between growth and profitability in business research. unfortunately, a sampling of business research suggests that the relationship between growth and profitability is anything but clear-cut. table 1 depicts the results of thirty-two studies which included measures for some aspect of size/growth and some aspect of profitability. in each case, the pearson correlation between the growth or size measure and the profitability measure appears. the correlations range from slightly negative to moderately positive. in many ofthe studies, the correlation between growth and profitability is nearly zero. one observation is that the approaches used to measure performance vary greatly. while many studies use standard financial ratios like return on assets for profit indicators, others use differing techniques. that such variance in measures exists is recognized in the strategy literature with prior studies examining various dimensions (venkatraman & ramanujam, 1986) and approaches to investigate (farjoun, 2002) performance or effectiveness (steers, 1975). indeed, in a comprehensive review of performance measures, combs and colleagues (2005) determine that growth is one of four distinct dimensions of organizational performance alongside profitability, market returns, and survival. to that end this paper continues the established tradition of strategic management introspection on our use, focus and application of certain firm measures (oess et ai., 1990). interestingly with the size/growth measures, one-year, three-year, five-year, and cross-sectional size measures manifest (although size typically functions as a control not a performance indicator). thus, some of the complexity in resolving the growth-profitability conundrum involves determination of appropriate measurement metrics (see weinzimmer et. al (1998) for a discussion of ramifications for varying measurements of growth dimensions). the use of size as a control raises an interesting and perplexing observation. given that the relationship between size is inconsequential (gerhart & milkovich, 1990) and even negative (balkin, markman, & gomez-mejia, 2000), one wonders why an indicator of increasing size (growth) would be a valid and useful performance variable? table 1 o'l sample of growth/size vs. priofitability measures performance authors year journal sample growth measure correlation measure notes pearce et al 1987 smj 42 subjective .54 roa self report slater and olson 2000 smj 278 self report .49 market self report garg et al 2003 smj 105 self report .46 roa self report russo and fouts 1997 amj 486 1-year sales .45 roa sarkar et al 2001 smj 70 self report .43 roa industry centered lumpkin and dess 1995 amj 32 self report .36 roi cronin and page 1988 ejom 101 2-year sales index .33 roa 1-lndustry crossland and hambrick 2007 smj 1464 1-year sales growth .30 roa u.s. firms brown and perry 1994 amj 234 3-year sales .29 roa fortunes "most admired" brush et al 2000 smj 3320 1-year growth .25 roa ~ balkin et al 2000 smj 74 1-year sales .23 roa ~ "": ;:: geringer et al 2000 smj 324 10-year .22 roa japan ;:. finkelstein and boyd 1998 amj 600 5 -year std sales .2 roa ~ ~ crossland and hambrick 2007 smj 1464 1-year sales growth .19 roa german firms ~ '" -. ;:: crossland and hambrick 2007 smj 1464 1-year sales growth .18 roa japanese firms "' '" '" hambrick and cannella 2004 smj 3168 1 year sales growth .17 roa v':l ..... "": gedajlovic and shapiro 2002 amj 334 5-year sales .17 roa japan ;:. ..... ~ derfus, maggitti, grimm and smith 2008 amj 281 1-year sales .15 roa 11-industries -. "' '" table 1 ~ sample of growth/size vs. priofitability measures cont'd. -;: ~ .,. performance tv 00 authors year journal sample growth measure correlation measure notes ~ baum and walley 2003 smj 318 4-year growth .13 roa self report ~ ~ rajagopalan and datta 1996 amj 410 4-year sales .13 composite .,. ~ ...... love and nohria 2005 smj 100 1-year reduced slack .1 roa peng 2004 smj 1211 1-year growth .09 roe china jensen and zajac 2004 smj 1329 acquisition activity per year .06 roa hambrick and cannella 2004 smj 3168 1 year acquisition .05 roa liao 2005 comprev 107 reduction of force .05 roa richard and shelor 2002 ijohrm 4774 1-year sales -.01 roa gerhart and milkovich 1990 amj 70,684 1 year sales -.05 roa coombs and gilley 2005 smj 406 1-year sales -.06 roa nixon et al 2004 smj 364 sales per employee -.06 market durand and vargas 2003 smj 162 2-year growth -.09 composite dea efficiency nixon et al 2004 smj 364 reduction of force -.1 market robinson and mcdougal 2001 smj 115 3-year average -.13 ros arthaud-day, certo, dalton and dalton 2006 amj 485 1-year sales growth -.15 roa restated financials 1998-1999 balkin et al 2000 amj 90 1-year sales -.17 roa '" 8 journal of business strategies additionally, there is a valid long-standing question as to what constitutes an appropriate measure of growth or size (kimberly, 1976). the majority of the studies sampled appear to emphasize size as a function of sales, although some exceptions exist. growth is often a focus on change in sales, although the relevant time dimension varies from i-year to larger increments. what is important though is a consistent utilization of size (typically via sales) and growth (typically via change in sales) as a resource control proxy or performance indicator respectively. as strategists, we generally eschew use of raw financial numbers favoring ratios stated in reference to some other format. yet in research practice most of the studies sampled utilize raw metrics some exceptions clearly exist, nixon et al. (2004) use a productivity measure of sales per employee rather than a static single indicator. the sample presented here produces remarkably similar findings to other more complex studies of growth measures (weinzimmer et ai., 1998). studies continue to use one-year or raw metrics over more complex growth measures (e.g. weinzimmer et. al (1998) recommend a growth slope measure), which is perplexing given evidence that different methods of measuring sales growth produce different and sometimes contradictory linkages to other commonly used organizational measures. the emphasis on sales as an indicator of size or increased sales as an indicator of performance should be confusing. using sales, is a firm with greater sales larger or more productive than their competition? the single indicator sales may not adequately answer that question without comparison of other relevant measures such as the firm's assets or industry growth (dess et ai., 1990). tackling sales growth as an indicator of performance is equally confusing. if a firm experiences sales growth, has it increased productivity of its assets or perhaps shifted its business model from a volume driven to margin driven model (or vice versa)? does the resulting change imply improvements to the profitability of the firm or merely change the relative importance of margin/volume as roa performance drivers a function ascertained through du pont analysis (bums, sale, & stephan, 2008). in practice we apply a number of ratios in examination of firms, as educators we mandate their use, as theorists we argue for complex and multidimensional investigation of performance (dess et ai., 1990; venkatraman & ramanujam, 1986), yet in research we often utilize raw figures of sales as proxies for size and performance. this is, in part, the critique offered by combs et al (2005) when they call for multiple measures for single constructs (such as growth), more complex mediating models examining antecedents of performance, along with a challenge researchers to "build a body of knowledge around each dimension," (p. 281) of organizational performance. given the heightened sophistication of statistical modeling techniques available today, is volume 28, number 1 9 our predilection towards raw numbers for sales and sales growth an indicator of an institutional bias towards sales growth? changing focus towards the correlations evidenced in the research, there are several patterns. first, several of the strongest positive correlations between growth and profitability occur in studies using one or more self-reported measures. this suggests that senior executives believe a relationship exists between growth and profitability, a point which i address later in this paper. when asked to evaluate their growth or profitability, executives consistently link these concepts together in their survey responses. the implication here is that an implicit theory of the growth/profitability linkage exists in corporate management. that this belief is both widely held is evidenced by the self-reporting studies, but not clearly linked in archival studies of accounting or market performance, offers strong evidence of an institutionalized growth agenda in management. i return to this argument in this paper's first two propositions. second, the next group of strongest positive correlations appear in samples which restricted access along some specific parameter such as appearance on a most admired company list (brown & perry, 1994), restriction to a single industry (cronin & page, 1988), or restriction to japanese firms (gedajlovic & shapiro, 2002; geringer, tallman, & olsen, 2000). third, the wildest fluctuation in correlations appear in studies using a one-year growth measure, in these studies the correlation ranges from quite positive (russo & fouts, 1997) to moderately negative (balkin et al.,2000). perhaps the most intriguing observation to emerge from this sample of studies is something which does not appear in table i. while all of the studies used some measure of sales, growth, or size alongside economic performance only two of the listed studies theorized on the relationship between the two, and one only in passing. baum and walley (2003) initially intended to use a single construct of 'firm performance' which would have consisted of financial reporting measures for sales growth and economic profits. in their description of their dependent variables, they note that the factor analysis for the intended scale failed to solidify to a single dimension. this resulted in the decision to use separate dependent variable measures for growth and profitability. in the other situation, the relationship between growth and profitability was the specific motivation for the study (brush, bromiley, & hendrickx, 2000). taking an agency theory perspective, brush et al. theorized that slack resources might explain the difference between rational (i.e. profitable) growth and growth without profit (or worse, growth resulting in economic losses). brush et al demonstrated that 10 journal of business strategies when growth occurred without free cash flow, profitability ensued. for firms with free cash flow, growth resulted in little more than 'kicking up dust.' that is, growth for firms with free cash flow seemingly consists of managerial action to justify use of the slack resources even though the actions themselves are valueless (or worse erode value) for shareholders. in the latter case, the growing firms wound up worse off than their pre-growth condition. these findings provide evidence for the existence of irrational growth, providing suboptimal economic benefits to the shareholders. the simple table of studies presented here mirrors the results of a more complex meta-analysis on organizational growth developed by combs et al. (2005). they find a significant, albeit modest, positive correlation between sales growth and accounting measures of profitability. they also note a stronger significant, positive correlation between sales growth and subjective measures of firm performance. additionally, they find a similarly strong positive correlation between subjective measures of firm performance and accounting based profitability measures. combs and colleagues (2005) conclude that sales growth and accounting profitability each distinctly signal positive performance to heads of firms. the table presented in this study then, echoes their more deliberate investigation of performance measurement growth in sales "feels" like positive performance to practicing managers. however, given the far weaker (albeit positive) relationship between sales growth and accounting profitability, there is clearly non-overlapping domain space wherein sales growth diverges from profitability. combs and colleagues (2005) challenge researchers to examine the boundaries of performance measures, in this study an institutional framework is offered as an explanation of why those boundaries (for sales growth) have yet to be explored. irrational growth is an understudied phenomenon in the literature. the remainder of this paper examines the institutionalized positive disposition towards growth, provides a discussion of some of the possible causal agents for irrational • growth, and includes a series of propositions for studying institutional biases towards irrational growth. growth strategies should not be abandoned, but study of both rational and irrational growth is needed. the institutionalization of growth obfuscates examination and identification of the pathways towards irrational growth. exploration of the mani festations of an institutionalized growth agenda should produce a more comprehensive series of prescriptions from the strategy and organizational theory literature. volume 28, number 1 11 the institutionalization of growth one of the primary reasons for the existence of the firm is to create wealth for the ownership of the firm. this position is most strongly advocated amongst shareholder theorists (aupperle, carroll, & hatfield, 1985) who, taken to an extreme, argue that creation of shareholder wealth is the sine quo non of the firm (friedman, 1970). an alternate explanation is offered by stakeholder theorists (prahalad & hamel, 1994) who argue that the firm exists to balance the needs of myriad diverse stakeholders, of whom the shareholder represents only one interested party. while these positions are often argued in opposition, evidence suggests that a successful stakeholder focused strategy generates economic profits, thereby satisfying both shareholder and stakeholder theorists (waddock & graves, 1997). under each theory, the firm is accepted as profit seeking. while differing from classical economic expectations of profit maximization nelson and winter (1982) argue that, under conditions of uncertainty and bounded rationality in evolutionary economic systems, profit seeking represents the ultimate objective of the firm. it is from this position that the boundaries for rational and irrational growth emerge. the easier of the two to define, rational growth exists when the growth agenda of the firm successfully leads to the generation of long-term profits. irrational growth, by contrast, involves situations where the growth agenda either will not, or cannot, result in the generation of profits. at the risk of diverting the reader into theories of fraud and malfeasance, enron reported substantial revenue growth for consecutive years up to its eventual bankruptcy. fraudulent reporting of growth is an overly simplistic example of irrational sales growth. it bears mention because of the reason the fraudulent depictions of sales growth continued for years at enron. within our market system, growth is a sign of organizational health or a return to organizational health. such extreme deception as that exposed for enron and similar organizations provides some indication of just how deeply our institutions trust growth as a performance indicator. indeed a significant negative correlation exists between firm sales growth and return on assets for firms issuing restatements of their financial data (arthaudday, certo, dalton, & dalton, 2006). while arthaud-day and colleagues (2006) specifically focus on years prior to the enron scandal, their study evidences a linkage between sales-growth projections and problematic firms. a similar finding in greve (2008) notes that high sales growth is a characteristic of economically troubled firms. when firms face economic troubles, they appear to emphasize sales growth which may simply grow but not fix their problems. 12 journal of business strategies beyond the obvious cases of irrational growth via fraudulent reporting, there also likely exist a number of firms engaged in growth patterns for which profit is simply unreasonable. it is not the intent of this author to opine on exactly where the boundaries between rational and irrational growth specifically lie. rather, it is the intent to argue that such a line exists and that existing theory may help uncover both the general locations for such boundaries as well as the institutionalized sources leading to selection of irrational growth strategies. institutional theory institutional theory examines how society imbues meanings upon the structures and processes of an enacted social environment beyond their objective functions. institutionalization, alternately, represents the process by which individual actors come to accept shared meanings of society (scott, 1987). growth, via socioeconomic expansion, has been an institutionalized social objective emerging as a response to changing cultural values following world war ii (schofer & meyer, 2005). shofer and meyer (2005) observe that these changes included increased educational system utilization, increased prominence of scientific institutions, increased democratization, and increased world polity. growth objectives have been explained as a function of the agency-owner interaction designed to avoid the trap of low firm performance (m. w. meyer & zucker, 1989). if growth has been institutionalized, institutional theory posits that growth will become part of the rationalized society and organizations which enact policies and procedures aligned with these institutionalized values will be rewarded and legitimized (j. w. meyer & rowan, 1977). for much of its history, institutional theory has focused on the emergence and use of structures within a society (tolbert & zucker, 1996), however its original conception also incorporated the institutionalization of processes (j. w. meyer & rowan, 1977). from an institutionalized perspective the processes, procedures, and strategies considered appropriate become institutionalized and firms which conform to these prescriptions are generally recognized as more legitimate than non-conformers (oeephouse, 1996). effectiveness is a necessary, but not sufficient prerequisite for institutionalization. indeed, for rationalization to occur it only requires that effectiveness can be demonstrated in some discreet set of circumstances (tolbert & zucker, 1996). growth is not inherently irrational, but some firms pursue growth for irrational reasons. indeed, there are certainly examples which link growth and profitability and the preceding sections of this paper advance theory-driven explanations of a volume 28, number 1 13 positive relationship between growth and profitability. this meets apreconditionfor the institutionalization of growth; growth is rational, viable, and desirable in certain circumstances. institutional theory explains why rational, effective growth once institutionalized leads to the adoption of growth strategies for irrational reasons. a number of explanations describe why firms comply with institutionalized expectations. recognizing that ideas gain legitimacy because they are perceived to be effective (1. w. meyer & rowan, 1977) and demonstrate effectiveness in some settings (tolbert & zucker, 1996), organizations are legitimized for conforming to institutionalized behaviors. from a growth perspective, this is to say that firms evidencing growth will be viewed as valued, proper, and behaving in a rational manner (1. w. meyer & rowan, 1977). this suggests, in part, that firms might enact an irrational growth strategy simply because growth is recognized as rational and, therefore, the firm and its managers are rewarded for pursuing a valued behavior (scott, 1987). alternately, uncertainty influences the salience of institutionalized behaviors. dimaggio and powell (1983) observe that "when goals are ambiguous, or when environment creates symbolic uncertainty, organizations may model themselves on other organizations" (pg. 151). certainly, in complex, dynamic business environments goals and outcomes become abstract and uncertain. in such settings the economizing firm might simply choose to imitate strategies of fellow companies rather than investigate alternative options (nelson & winter, 1982; tolbert & zucker, 1996). while institutionalization suggests that coercive (pressure by legitimizing institutions), mimetic (voluntary adoptions of perceived effective practices), and normative (professionalization) isomorphic processes influence homogeneity (scott, 1987), this does not suggest that conformity itself is rational from an efficiency standpoint. because of bounded rationality (march & simon, 1958; roberts & greenwood, 1997), firms are at best efficiency seeking as opposed to efficiency maximizing (nelson & winter, 1982; roberts & greenwood, 1997). the strategies which are rationally efficient for some firms may not be rational for all firms; nonetheless legitimacy ensures adoption (tolbert & zucker, 1996). because isomorphic firms are legitimized and rewarded by the environment (deephouse, 1996), firm survival itself relies on factors other than efficient coordination and control of resources (j. w. meyer & rowan, 1977). this view differs substantially from traditional theories of competition which suggest that market forces weed out inferior competitors (barney & hesterly, 1996). under an institutional perspective, isomorphic firms may survive despite inferior economic performance, resulting in permanently failing firms (m. w. meyer & zucker, 14 journal of business strategies 1989). undermining confidence in the market as an efficient corrective mechanism, it is suggested that markets are only effective at selection during the earliest years of an industry (dimaggio & powell, 1983). in later stages, social connections to influential parties and other factors enable otherwise ineffective firms to persist. in such cases, the market may not correct inefficiency for prolonged periods of time. the preceding paragraphs advance institutional theory as an explanation for the blanket acceptance of sales growth as a valid indicator of performance. the argument also demonstrates that economically rational efficiency is not a prerequisite for legitimacy under an institutional framework. having established this, i tum to more detailed examination of the processes and mechanisms through which an institutionalized growth agenda manifests and reifies business practice. this examination focuses on ramifications for managers, markets, and academics with appropriate propositions emerging for each. managerial outcomes as previously indicated, some studies have investigated growth strategies as an irrational outcome. particularly brush et al (2000) use an agency theory perspective arguing that conflict between the goals of the agent and goals of the owner lead to selection of irrational growth strategies. the agency perspective appears as a routine explanation in studies conducted by finance and accounting scholars (10 & kim, 2008; o'brien & david, 2010; sun & cahan, 2009). while recognizing that agency explanations offer important insight into managerial behavior, it is also quite possible that managers acting in ambiguous situations make decisions apparently rational because of mimetic isomorphism. in this paper, the institutional perspective emerges as an alternative, or perhaps parallel, explanation. under an institutional perspective, managers may elect growth for efficient reasons. however, irrational growth, under an institutional perspective may be chosen for legitimacy, normative pressure, or reward reasons (corcoran & shackman, 2007; heugens & lander, 2009). in essence, under the institutional perspective, the agent-manager may elect irrational growth because it is perceived as the correct course of action and not necessarily to maximize agent benefits at owner costs (brush et ai., 2000). two institutional arguments for managerial actions are advanced, both of which stem from the assumption that managers perceive an expectation to generate economic profits. first, the manager perceives an expectation to generate economic profits but is uncertain of exactly how to achieve this outcome. lacking certainty in attainvolume 28, number 1 15 ing the objective and facing increasingly complex competitive environments replete with heightened ambiguity and dynamism, managers face extreme difficulty in linking potential strategies to economically profitable outcomes. particularly when the managed firm may not conform to the profitability-norm, the uncertain manager often relies on common industry recipes (mcdonald & westphal, 2003). one such recipe is the growth strategy. through growth the firm signals its intention for profitability since there are examples of firms (1. w. meyer & rowan, 1977) where rational growth generates profitability. because the institutional environment (in this case the business segment) perceives the growth signal as an intent to comply with the profitability norm, the institutional environment rewards isomorphism signaling behavior even where rational profit efficiency fails to manifest. under this assumption, the manager complies with the isomorphic growth agenda because the reward system signals the manager that the growth agenda is sanctioned and considered proper and adequate (1. w. meyer & rowan, 1977). this suggests that: proposition i: managers conforming to the isomorphic growth agenda will be compensated commensurably regardless of degree of economic profitability while the afore-mentioned situation applies to managers of firms below industry-leading profitability standards, a more profound situation confronts managers of unprofitable firms. in this second case, rather than facing difference by degree of isomorphism, the manager faces complete non-compliance with the profit-norm. this sends signals to the business sector and owners of the deviancy of the manager from the role specific expectations which results in general downgrading of perception of the manager and firm (oeephouse, 1996). faced with the inconsistency of their performance vis-a-vis institutional expectations, the manager must confront and address this dissonance. in this case, the manager is likely to indicate their intent to conform to the institutional expectation via reform (1. w. meyer & rowan, 1977). as the firm is already out of compliance with the profit-norm and lacking certainty of outcomes from selected strategies, the agent-manager is likely to signal their intent for compliance via isomorphism with institutionally recognized prescriptions, in this case the growth agenda. one of the common ways an actor conveys intent to reform is through rhetoric (sillince, 2005). in this case, one might expect public statements and documents to contain rhetoric which signals intent to comply with the growth agenda. common forums for such signaling activity include letters to shareholders, press releases, and interviews with 16 journal of business strategies news media. both the frequency and language utilized in such activities will signal intent for future isomorphism. therefore: proposition 2: managers of unprofitable firms will utilize reform rhetoric replete with isomorphic growth language more frequently than will managers of rationally efficient firms. market outcomes in this section, attention turns towards the market as an enforcement mechanism. a fundamental assumption of classical economics is that markets are at least semi-strong efficient (barney & hesterly, 1996), that is to say that markets do a relatively effective job at discriminating between effectiveness and ineffectiveness. institutional theorists question this assumption, noting that an aggregation of boundedly rational, satisficing individuals is unlikely to add up to a rational effective market (dimaggio & powell, 1983). rather, markets reward isomorphic tendencies which may, or may not, reflect efficiency. the firm is thus rewarded for social compliance as much as for efficient and effective means of production (j. w. meyer & rowan, 1977). several institutional theorists directly address issues of market effectiveness in the face of institutional pressures. dimaggio and powell (1983) argue that the selection processes in markets work best in nascent markets or during the earliest years of a markets existence. meyer and rowan (1977) argue that markets are normally efficient where output is easily measurable and they theorize that all organizations exist on a continuum anchored by measurability and ambiguity of performance outcomes. however, they caution "it is important not to assume that an organization's location on this continuum is based on the inherent technical properties of its output" (pg. 354). the position asserts that complexity, dynamism, and ambiguity may cause even a relatively 'objective' measure such as sales and profitability to become complex and difficult enough to require trust and confidence in the adherence to institutionally prescribed roles and behaviors. because of this, markets themselves may become ineffective in weeding out inefficient firms. additional evidence suggests that markets are, at best, weak mechanisms for controlling inefficiency. specifically, the era of corporate conglomerates in the united states represents a prolonged model of corporate inefficiency which required decades to correct (davis, diekmann, & tinsley, 1994). for a number of years following world war ii, u.s. firms engaged in a pattern of unrelated acquisition leading to highly diversified conglomerates. this strategic approach was embraced at volume 28, number 1 17 virtually all levels of business with a number of prominent models for managing the firm-as-portfolio developed (hofer & schendel, 1979). davies et al (1994) note that by 1980 only 25% of all fortune 500 firms operated in a single sic industry while over 50% operated in three or more. this trend in unrelated diversification continued unabated in the face of mounting evidence that such practices generated sub-optimal economic profits (amihud & lev, 1981; bettis, 1981; rumelt, 1982). a unique industry emerged in the late 80's which specialized in buying, splitting, and selling off diversified firms (davis et ai., 1994). even as this correction began, corporations continued unrelated diversification strategies (davis et al., 1994) and institutions continued to argue the legitimacy of conglomeration in some form or fashion (hill, hitt, & hoskisson, 1992; prahalad & bettis, 1986; ramanujam & varadarajan, 1989). ultimately by 1990, most of the conglomerate mania had subsided and the majority of fortune 500 firms operated in one or two sic codes (davis et ai., 1994). this episode of irrational growth persisted for well over 3d-years, providing an example of market inability to control irrational, institutionalized practices. while the current market has learned the lessons of conglomerate growth, markets, regulating agencies and public perception still reward isomorphism (deephouse, 1996). these rewards include legitimacy which can lead to increased access to and reduced costs for resources (1. w. meyer & rowan, 1977). as was argued with managers, markets are ill equipped to determine ex ante which strategies and firms will prosper. thus, markets will reward institutionally compliant strategies and signaling activities. these rewards persist regardless of whether economic profits emerge as the outcome of institutionally prescribed strategies. this argument is consistent with the position of hall and tochterman (2008) who argue that investors are likely to overstate future values for growth firms, thus leading to inappropriate market pricing. to the extent that growth strategies are an isomorphic legitimate activity markets will consider growing firms as signaling compliance with profitnorms whether or not those firms actually generate requisite profits. thus, i expect: proposition 3: firms whose growth patterns fail to achieve profitability standards will receive similar market rewards as firms whose growth patterns lead to profitability. proposition 4: market analysts will classify less profitable firms similarly to profitable firms to the extent that each firm manifests similar growth rates. 18 journal of business strategies academic outcomes institutional theorists argue that education and academia play an important role in the maintenance and propagation of institutional prescriptions. the education system performs an important role in the sedimentation of prescriptions. educational systems provide crucial means by which institutional prescriptions are treated as a given by institutional newcomers (tolbert & zucker, 1996). as emerging best practices move to trends through mimetic isomorphism (dimaggio & powell, 1983), professional and educational organizations incorporate these practices into the curricula taught to entering members. in this manner, these prescriptions become legitimized through the adoption of the education system (1. w. meyer & rowan, 1977). the educational process produces people who tend to view the same things the same way (dimaggio & powell, 1983). dimaggio and powell (1983) further note perrow's commentary that educational systems produce a pool of interchangeable people. this is consistent with observation that the old world order has been replaced with a new educated elite order replete with common knowledge derived from common institutional backgrounds (schofer & meyer, 2005). defending the argument that the institutionalization of growth manifests in business education requires evidence supporting the positive evaluation of growth by academics. while a comprehensive examination of growth as an institutionalized academic force is beyond the scope of this paper, a perusal of research suggests that such evidence exists. schofer and meyer (2005) argue that a socioeconomic growth agenda forms the foundation of post world war ii institutional change. growth strategies receive significant coverage in textbooks, possibly more so than operational strategies. a growth orientation is demanded for competing in the emerging global economy (ireland & hitt, 2005). firms that successfully become market leaders may achieve the distinction of also becoming celebrity firms (rindova, pollock, & hayward, 2006). mishina, pollock and porac (2004) argue that growth is "a performance variable worth considering" (p. 1179). firms following an internal or external grand strategy for growth are perceived as better performing than firms following a retrenchment or stability strategy (pearce, robbins, & robinson, 1987). growth to achieve increased market share is thought to reduce overall risk to the firm (woo, 1987). growth is considered as a valid strategy to stave off acquisition (hanson, 1992). the literature treats growth positively, yet not without caveats. ireland and hitt (2005) note the importance of alignment of resources and compatibilities in volume 28, number 1 19 fulfilling the growth objective. market share turns out to not reduce risk in all categories as originally theorized (woo, 1987) and the stability strategy, while lower in performance, did not differ significantly in self reported performance evaluation (pearce et a!., 1987). academics are often among the first to observe the irrational trends in business as noted in the conglomerate episode (amihud & lev, 1981; bettis, 1981; rumelt, 1982). thus, the key to the institutional function of growth isn't the universal recommendation of growth, but rather the overall positive glow attached to growth. because growth receives an overwhelmingly positive treatment within education systems, emerging practitioners confronted with ambiguous and uncertain environments are likely to consistently utilize strategies and prescriptions which they have been taught are effective (if only in some circumstances ). dimaggio and powell (1983) assert that individuals educated in the same institutional system are likely to perceive things the same way. financial elites, matriculating from a system which emphasizes portfolio theory, are more likely to pursue unrelated diversification strategies (jensen & zajac, 2004). ceo's are likely to mirror the strategies of peers during periods of below-par returns (mcdonald & westphal, 2003). american educated managers are likely to prefer the same generic strategies and their selection heuristic differs notably from japanese educated counterparts (song, calantone, & di benedetto, 2002). mba educated cohorts and business educated elites are more likely to center on contingency-fit criteria than are non-business educated elites or non business educated graduate students (priem & rosenstein, 2000). each of these studies provides some indication that the prevailing logic of institutional prescriptions taught in business academics influence the choices of tools and strategies employed by business elites. to the extent that growth is one of the prescriptions receiving positive regard in business curricula, we should expect that business educated individuals will prefer the growth agenda relative to other options. proposition 5: business educated students will typically regard the growth strategy as more preferable to other strategies proposition 6: business educated students will typically regard growing firms more positively than firms using retrenchment or stability strategies. 20 journal of business strategies research directions the preceding sections advance an argument for the existence of irrational growth strategies. this paper offers institutional theory as the explanation for the election of irrational growth strategies and the theory also explains why firms may perceive growth as rational and effective regardless of outcome. therefore, a research agenda should explore business and academic manifestations of institutionalized growth. the first four propositions argue for the existence of an institutionalized growth prescription within the business sector. archival research opportunities abound for investigation of these propositions. proposition i (involving managerial compensation) and proposition 3 (involving market valuation) are each testable using publicly available financial data. support for each of these propositions requires evidence that firms and managers enacting growth strategies fare as well with respective indicators regardless of profitability outcomes. partial support exists iffirms, and managers of firms, matching the growth norm but lacking in the profitability norm exceed indicators for firms who match the profitability norm but lack in the isomorphism to the growth norm. proposition 2 (executive rhetoric) and proposition 4 (analyst and media evaluations) are each testable using content analysis techniques for published documents and transcripts. letters to shareholders, media interviews, changes in analyst recommendations, and media portrayal of firms and managers of firms each offer insight into the way the manager interacts with the public as well as the way the business sector as a whole regards the firm and firm managers. broad support for these propositions will include evidence indicating that poor performing managers more prominently signal growth strategies. additionally evidence of strong support exists if analysts and the media react more positively to growth rhetoric and signaling than to other strategic options regardless offirm profitability. partial support suggests that managers of poor performing firms invoke growth rhetoric at least as often as other reform strategies or if analysts and the media evaluate high growth but low profitability firms more preferably than low growth and high profitability firms. the second suggested research direction emerging from this paper is an examination of the institutionalization of growth within education, particularly business education. proposition 5 (preferred strategy) and proposition 6 (organizational evaluation) each suggest that business educated students will more frequently endorse growth orientation. both of these propositions lend themselves to experimental analysis using various groups of students and practitioners (priem & rosenvolume 28, number 1 21 stein, 2000). broad support manifests if business educated students routinely prefer growth oriented solutions regardless of economic performance. partial support suggests that students prefer high-growth, low-profitability scenarios over low-growth, high-profitability scenarios. the general depictions of the institutional propositions lend themselves to examination of u.s. educated practitioners. however, promising research options involving analysis of practitioners and students outside the united states also exists. particularly given findings that japanese managers utilize a different preference sequencing in regards to strategy selection than do u.s. and european managers (song et ai., 2002), it is possible that the general perception of growth strategies may differ contextually between cultural groups. given the general success of foreign firms, such distinctions may shed some light on the boundaries between rational and irrational growth. the final research direction suggested by this paper does not evolve from the propositions as much as from the evidence examined. table i details a panel of studies each using some measure of growth or size with correlations to a performance measure. given the data provided and pulling in additional studies, the relationship between growth and performance is fruitful grounds for meta-analysis. this recommendation echoes the charge from combs et al. (2005) to explore the boundaries of performance dimensions. following the advice of combs et al. (2005), researchers should explore which combinations of operational performance indicators correspond to firms with rational growth agendas as well as which combinations align with irrational growth agendas. this paper only drcw observational inferences from the table, for example self-reporting evidenced highly positive correlations even so, the observational inferences presented here are similar to the analysis of performance dimensionality presented by combs et al. (2005). it was not the purpose of this paper to determine which types of growth more likely produced profits, but rather to offer an explanation for the ready acceptance of growth as a positive function despite theoretical and empirical evidence to the contrary. while the earlier research directions offer insight into studying institutionalized growth, a meta-analysis is a recommended direction for addressing decades old questions regarding the multi-dimensionality (venkatraman & ramanujam, 1986) and environmental impacts of performance (dess et ai., 1990). discussion this paper has introduced the topic of irrational growth as an area for research inquiry. irrational growth occurs when a growth strategy on the part of a firm 22 journal of business strategies fails to achieve profitability. using current business research, various measures of growth function as measures of firm performance. we treat growth as a positive outcome despite indications that increased size may decrease profitability and lacking clear-cut indication, that growth regularly translates to profitability. an institutional theory perspective offers the explanation for such favorable treatment of growth in the literature. institutional theory provides an understanding of why practices and structures which may only be useful in specific instances become imbued with meaning and value beyond their objective benefits and become standard prescriptions for valued behavior. using an institutional theoretical base, several empirically testable propositions have been advanced that would provide evidence of the existence and the extent of an institutional bias in favor of growth. for academics, the primary implication arising from this paper is the extended development of a common research area, firm performance (steers, 1975; weinzimmer et ai., 1998). taking guidance from poole and van de ven (1989), research should examine the paradoxical nature of growth in greater detail. further, using kimberly (1976) as a guideline, research may find value in a deeper investigation of a commonly utilized performance indicator. for practitioners and for students of business, the end result of such a research agenda involves a better series of prescriptions for the planning and implementation of rational growth strategies. from an educational standpoint, to the extent that academics influence the practices of future business leaders (ghoshal & moran, 1996), such research should be beneficial to the development of our field. growth is a commonly used performance indicator in business research. however, the relationship between growth and profitability is far from clear-cut. using the concepts of rational and irrational growth, a research agenda emerges which, ideally, shall prove informative within the business literature. it appears that a deeper understanding of the relationship between growth and profitability is crucial for increasing the quality of practitioner strategic formulation and implementation. references amihud, y., & lev, b. (1981). risk reduction as a managerial motive for conglomerate mergers. bell journal of economics. 12, 605-618. arthaud-day, m. l., certo, s. t., dalton, c. m. d., & dalton, d. r. (2006). a changing of the guard: executive and director turnover following corporate financial restatements. academy of management journal, 49(6), 1119. volume 28, number 1 23 aupperle, k. e., carroll, a. b., & hatfield, j. d. (1985). an empirical examination of the relationship between corporate social responsibility and profitability. academy of management journal, 28(2),446. balkin, d. b., markman, g. d., & gomez-mejia, l. r. (2000). is ceo pay in hightechnology firms related to innovation? academy of management journal, 43(6), 1118. barney, j., & hesterly, w. (1996). organizational economics: understanding the relationship beween organizations and economic analysis. in s. r. clegg & c. hardy (eds.), handbook of organizational studies. london: sage. baum, j. r., & wally, s. (2003). strategic decision speed and firm performance. strategic management journal, 24(11), 1107. bettis, r. a. (1981). performance differences in related and unrelated diversified firms. strategic management journal, 2(4),379. brown, b., & perry, s. (1994). removing the financial performance halo from fortune's "most admired" companies. academy of management journal, 37(5), 1347. brush, t. h., bromiley, p., & hendrickx, m. (2000). the free cash flow hypothesis for sales growth and firm performance. strategic management journal, 21(4), 455. bums, d. c., sale, j. t., & stephan, j. a. (2008). a better way to gauge profitability. journal of accountancy, 206(2), 38. certo, s. t. (2003). influencing initial public offering investors with prestige: signaling with board structures. academy of management review, 28(3), 432. combs, j. g., crook, t. r., & shook, c. l. (2005). the dimensionality of organizational performance and its implications for strategic management research. in d. j. ketchen & d. d. bergh (eds.), research methodology in strategy and management (vol. 2, pp. 259-286). okford, uk: elsivier. corcoran, d. j., & shackman, j. d. (2007). a theoretical and empirical analysis of the strategic value of beyond compliance occupational health and safety programs. journal of business strategies, 24(1),49. cronin, j. j., jr., & page, t. j., jr. (1988). an examination of the relative impact of growth strategies on profit performance. european journal of marketing, 22( i), 57. davis, g. f., diekmann, k. a., & tinsley, c. h. (1994). the decline and fall of the conglomerate firm in the 1980s: the de institutionalization of an organizational form. american sociological review, 59(4),547. deephouse, d. l. (1996). does isomorphism legitimate? academy of management journal, 39(4), 1024. 24 journal of business strategies derfus, p. j., maggitti, p. g., grimm, c. m., & smith, k. g. (2008). the red queen effect: competitive actions and firm performance. academy of management journal, 51(1),61. dess, g. g., ireland, r. d., & hitt, m. a. (1990). industry effects and strategic management research. journal of management, 16( i), 7. dimaggio, p. j., & powell, w. w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48, 147-160. farjoun, m. (2002). towards an organic perspective on strategy. strategic management journal, 23(7),561. friedman, m. (1970, september). social responsibility of business. new york times magazine, gedajlovic, e., & shapiro, d. m. (2002). ownership structure and firm profitability in japan. academy of management journal, 45(3),565. gerhart, b., & milkovich, g. t. (1990). organizational differences in managerial compensation and financial performance. academy of management journal, 33(4),663. geringer, j. m., tallman, s., & olsen, d. (2000). product and international diversification among japanese multinational firms. strategic management journal, 21(1),51. ghoshal, s., & moran, p. (1996). bad for practice: a critique of the transaction cost theory. academy of management. the academy of management review, 21(1), 13. greve, h. r. (2008). multimarket contact and sales growth: evidence from insurance. strategic management journal, 29(3),229. hall, j., & tochterman, m. (2008). persistence in growth versus market expectations. (cover story). australian journal of management, 33(1), 169. hanson, r. c. (1992). tender offers and free cash flow: an empirical analysis. the financial review, 27(2), 185. heirman, a., & clarysse, b. (2005). the imprinting effect of initial resources and market strategy on the early growth path of start-ups. paper presented at the academy of management proceedings. heugens, p. p. m. a. r., & lander, m. w. (2009). structure! agency! (and other quarrels): a meta-analysis of institutional theories of organization. academy of management journal, 52(1),61. hill, c. w., hitt, m. a., & hoskisson, r. e. (1992). cooperative versus competitive structures in related and unrelated diversified firms. organization science, 4(3), 501-521. volume 28, number 1 25 hofer, c. w., & schendel, d. e. (1979). strategy formulation: analytical concepts. st. paul, mn: west publishing co. ireland, r. d., & hitt, m. a. (2005). achieving and maintaining strategic competitiveness in the 21 st century: the role of strategic leadership. the academy of management executive, 19(4),63. jensen, m., & zajac, e. j. (2004). corporate elites and corporate strategy: how demographic preferences and structural position shape the scope of the firm. strategic management journal, 25(6),507. jo, h., & kim, y. h. (2008). financial leverage and growth opportunities in japan. international journal of business research, 8(5), 1. kimberly, j. r. (1976). organizational size and the structuralist perspective a review, critique, and proposal. administrative science quarterly, 21(4), 571. march,1. g., & simon, h. a. (1958). organizations. new york: wiley. mcdonald, m. l., & westphal, j. d. (2003). getting by with the advice of their friends: ceos' advice networks and firms' strategic responses to poor performance. administrative science quarterly, 48( 1), 1. meyer, a. d. (1991). what is strategy's distinctive competence? journal of management, 17(4), 821. meyer,1. w., & rowan, 8. (1977). institutionalized organizations: formal structure as myth and ceremony. american journal ofsociology(83), 340-363. meyer, m. w., & zucker, l. (1989). permanently failing organizations. newbury park, ca: sage. mishina, y., pollock, t. g., & porac, j. f. (2004). are more resources always better for growth? resource stickiness in market and product expansion. strategic managementjournal, 25(12), 1179. nelson, r. r., & winter, s. g. (1982). an evolutionary theory of economic change. cambridge, ma: harvard university press. o'brien, j., & david, p. (2010). firm growth and type of debt: the paradox of discretion. industrial & corporate change, 19(1), 51. pearce, j. a., ii, robbins, d. k., & robinson, r. 8., jr. (1987). the impact of grand strategy and planning formality on financial performance. strategic management journal, 8(2), 125. pfeffer, j., & salancik, g. (2003). the external control of organizations: a resource dependence perspective (stanford business classics) (1 st ed.): stanford business books. 26 journal of business strategies poole, m. s., & van de ven, a. h. (1989). using a paradox to build management and organization theori. academy of management. the academy of management review, 14(4),562. porter, m. e. (1979). how competitive forces shape strategy. harvard business review, 57(2), l37. porter, m. e. (1980). competitive strategy: techniques for analyzing industries and competitors. new york: free press. prahalad, c. k., & bettis, r. a. (1986). the dominant logic: a new linkage between diversity and performance. strategic management journal, 7(6),485. prahalad, c. k., & hamel, g. (1994). strategy as a field of study: why search for a new paradigm? strategic management journal, 15,5. priem, r. l., & rosenstein, j. (2000). is organization theory obvious to practitioners? a test of one established theory. organization science, 11(5),509. ramanujam, v., & varadarajan, p. (1989). research on corporate diversification: a synthesis. strategic management journal (1986-1998), 10(6),523. rindova, v. p., pollock, t. g., & hayward, m. l. a. (2006). celebrity firms: the social construction of market popularity. academy of management. the academy of management review, 31(1),50. roberts, p. w, & greenwood, r. (1997). integrating transaction cost and institutional theories: toward a constrained-efficiency framework for understanding organizational design adoption. academy of management. the academy of management review, 22(2),346. rumelt, r. p. (1982). diversification strategy and profitability. strategic management journal, 3(4),359. russo, m. v., & fouts, p. a. (1997). a resource-based perspective on corporate environmental performance and profitability. academy of management journal, 40(3),534. schofer, e., & meyer, j. w (2005). the worldwide expansion of higher education in the twentieth century. american sociological review, 70(6),898. scott, w r. (1987). the adolescence of institutional theory. administrative science quarterly, 32(4),493. siggelkow, n. (2001). change in the presence offit: the rise, the fall, and the renaissance of liz claiborne. academy of management journal, 44(4), 838. sillince, j. a. a. (2005). a contingency theory of rhetorical congruence. academy of management. the academy of management review, 30(3),608. singh, j. v., tucker, d. j., & house, r. j. (1986). organizational legitimacy and the liability of newness. administrative science quarterly, 31(2), 171. volume 28, number 1 27 song, m., cal antone, r. j., & oi benedetto, c. a. (2002). competitive forces and strategic choice decisions: an experimental investigation in the united states and japan. strategic management journal, 23(10),969. steers, r. m. (1975). problems in the measurement of organizational effectiveness. administrative science quarterly, 20, 546-558. sun, j., & cahan, s. (2009). the effect of compensation committee quality on the association between ceo cash compensation and accounting performance. corporate governance: an international review, 17(2), 193. tolbert, p. s., & zucker, l. (1996). the institutionalization of institutional theory. in s. r. clegg, c. hardy, & w. nord (eds.), handbook of organizational studies (pp. 175-190). london: sage. venkatraman, n., & ramanujam, v. (1986). measurement of business performance in strategy research: a comparison of approaches. academy of management review, 11(4),801. waddock, s. a., & graves, s. b. (1997). the corporate social performance-financial performance link. strategic management journal (1986-1998),18(4),303. weinzimmer, l. g., nystrom, p. c., & freeman, s. j. (1998). measuring organizational growth: issues, consequences and guidelines. journal of management, 24(2), 235-262. woo, c. y. (1987). path analysis of the relationship between market share, businesslevel conduct and risk. strategic management journal, 8(2), 149. biographical sketch of author troy a. voelker is an assistant professor in the school of business at the university of houston clear lake. he earned his doctorate at the university of north texas. his research interests are in the areas of strategy, inter-firm alliances, inter-firm networks and firm capabilities. 28 journal of business strategies kicking up dust: growth as an irrational market response ceo duality, board monitoring, and acquisition performance: a test of competing theories ashay desai university of wisconsin-oshkosh oshkosh, wi mark kroll louisiana tech university ruston, la peter wright the university of memphis memphis, tn abstract our paper presents an empirical examination of the relationship between ceo duality and acquisition performance. specifically, we address two related questions involving ceo duality under the auspices of agency and stewardship theories. the jlrst involves the extent to which ceo duality directly influences the pr(~fitability (~facquisitions. the second involves the influence ofduality and the nature of outside board monitoring on acquisition performance. our study tests competing hypotheses drawn from these two perspectives. we find that ceo duality affects performance negatively and there is an important interaction effect between outside board monitoring and ceo duality. due to the increasing importance of corporate governance in organizations, there has been a growing body of research on the utility of ceo duality particularly on the performance of firms that employ the dual structure. "ceo duality" refers to the situation where the same person serves simultaneously as ceo and chairperson of the board a dual responsibility that has been subject to continuing debate. according to stewardship theory, such ceo duality establishes strong, unambiguous leadership, and shareholder interests are maximized by the shared incumbency (chaganti, mahajan, & sharma, 1985; donaldson & davis, 1991; finkelstein & d' aveni, 1994). agency theorists argue such a leadership structure represents a conflict of interest, in that a ceo who is responsible for the overall management also is in a position to evaluate the effectiveness of that strategy (jensen & meckling, 1976; zajac & westphal, 1994). since these theoretical perspectives lead to opposing predictions on ceo duality, this study tests the direct and indirect performance effects of ceo duality, using arguments from both. a primary concern is whether ceo duality 138 journal of business strategies vol. 20, no.2 directly influences firm performance; i.e., whether there are differences in the financial performance of firms whose ceos also serve as board chairpersons and firms that have separate individuals in those roles. yet another issue is effective monitoring of ceos by the board of directors when the ceo is chairperson of the board. agency theorists suggest that boards of directors are a primary monitoring device protecting shareholder interests (fama & jensen, 1983). although boards are sometimes vigilant and exert significant influence on the organizations they oversee (dalton & daily, 1998; stiles, 2001), research shows that boards are not always effective stewards of organizational resources (dalton, daily, ellstrand, & johnson, 1998; donaldson, 1995). according to agency theory, duality promotes ceo entrenchment by challenging a board's ability to effectively monitor and discipline (allan & widman, 2000; dalton & daily, 1998). stewardship theory contends that additional monitoring by outside (individuals who are not current or former employees of an organization) directors is superfluous. the nature of board monitoring contingent on the presence or absence of ceo duality also may impact the profitability. our paper examines the effects of ceo duality and outside director monitoring on profitability of acquisitions. while mergers and acquisitions are clearly on the rise, most deals do not create value. a study by hayward and hambrick (1997) examining why premiums above the market price often are paid to acquire another firm conclude that "ceo hubris" was an important factor in such overpayments. related research does suggest that acquisitions are perhaps no better than break-even propositions for owners of acquiring firms (morek, shleifer, & vishny, 1990). moreover, target firm managers have become more skilled at extracting higher prices for their firms (bradley, desai, & kim, 1988). if acquisitions are not ordinarily beneficial for the shareholders of acquiring companies, then why are they made? according to agency theory, many acquisitions are made because they benefit the senior executives. indeed, top managers may pursue a variety of personal interests at the expense of stockholders. in support of this notion, amihud and lev (1981) describe managers' preferences for exaggerated firm size and diversity that are inconsistent with the profit maximization preferred by shareholders. under agency theory, the abuse of stockholder interests may be increased in the presence of ceo duality. on the other hand, stewardship theory proposes that ceo duality facilitates effective action by the ceo. the remainder of our paper is organized into several parts. first, we develop our hypotheses based on our review ofthe related literature. next we specify our sample and methodology and present our findings. finally, we discuss the results and their implications. literature review and hypotheses in the related literature, firm monitoring, ownership control, managerial discretion and performance of corporate strategies have been studied (e.g., dalton, daily, certo, & roengpitya, 2003; hoskisson, johnson, & moesel, 1994; fall 2003 desai et al: ceo duality 139 rechner, & dalton, 1991; stiles, 2001). agency theory has developed because an agency relationship is characteristic of the publicly held corporation. inherent in an agency relationship is the separation between the management of a firm and its shareholders. with such separation, there will be some divergence between the agent's pursuit of self-serving strategies and policies that would enhance the welfare of the principal (berle & means, 1932; jensen & meckling, 1976). because of this divergence in the pursuit of managerial interests versus owners' interests, monitoring managerial decisions becomes essential. consequently, boards of directors have been authorized to monitor ceo decisions to assure that the interests of shareholders are protected. stewardship theory finds its roots in organizational theory, specifically in psychology and sociology (boyd, 1995; donaldson, 1990, donaldson & davis, 1991), and suggests that there is no inherent conflict of interest or presence of opportunistic behavior. specifically, ceo duality structures will help executives attain superior performance as the ceo exercises complete authority over the organization and his/her decisions are unambiguous. such organizations enjoy the benefits of 'unity of direction' from an empowered leader. unlike agency theory, the focus is on empowering structures and not on self-motivation of the ceo. we expect differences in the profitability of acquisitions contingent on whether they are made to further the interests of stockholders or whether they are undertaken mainly to benefit the ceos. the presumption of our work is that the profitability of acquisitions may be systematically different due to the presence (or absence) of ceo duality and the resulting interaction between ceo duality and board monitoring. ceo duality. ceos have higher structural power, stemming from their hierarchical position and relational power, based in expertise and prestige, than other organizational members and non-executive (outside) directors (fama & jensen 1983, stiles, 2001). as suggested earlier, ceo duality refers to a ceo who also serves as the chair of the board. senior executives holding both positions achieve not only greater formal authority over board members, but also an increased informal influence over board processes (allan & widman, 2000). consequently, ceo duality has been criticized because it curtails monitoring effectiveness (finkelstein & d' aveni, 1994; zajac & westphal, 1994). a board controlled by the ceo, "signals the absence of separation of decision management and decision control." (fama & jensen 1983: 314). since the chairperson of the board has the greatest influence over the actions of the board, the separation of decision management and decision control is compromised when a chairperson is also the ceo of the firm. thus, requiring the chair and ceo positions to be held by different people will more effectively control the agency problems associated with the separation of ownership and control. indeed, demands for reformation of corporate governance structures stress the importance of vigilant monitoring afforded by the absence of ceo duality (lorsch & maciver, 1989). stiles (2001: 647) suggests that " ... chairman and 140 journal qf business strategies vol. 20, no.2 ceo are two separate and differing roles." this is itself a good reason to keep these positions split. given the significance of acquisitions and potential agency issues involved, under the auspices of agency theory, we expect that the ceo duality will be more likely to affect acquisition performance negatively. hypothesis 1: the presence of ceo duality will be neratively associated with acquisition performance. proponents of stewardship theory argue that constancy in leadership structure should have some advantages, as it allows for lucid delineation ofleadership and control responsibilities that over time are well understood by management, board members, and the investors (boyd, 1995; daily & dalton, 1997). donaldson and davis (1991) and mallette and fowler (1992) show that the roe returns to shareholders are improved by combining the role of the chair and ceo positions. stewardship theory yields a contrasting hypothesis regarding acquisition performance. if it is true that ceo duality results in more consistent strategy formulation and implementation and subsequently superior firm performance, then the acquisition announcement effects should be positive. table 1 shows a concise presentation of our hypotheses. hypothesis la: the presence of ceo duality will be positively associated with acquisition performance. table 1 hypothesized relationships between independent variables and acquisition performance (dependent variable). variables ceo duality in absence of ceo duality % of outside board members outside board stock ownership in presence of ceo duality % of outside board members outside board stock ownership agency theory negatively related (h i) negatively related (h2) hypothesis not offered positively related (h3) positively related (h4) stewardship theory positively related (hia) positively related (h2a) hypothesis not offered hypothesis not offered negatively related (h4a) ceo duality and board monitoring previous studies have examined the beneficial and/or detrimental effects of ceo duality directly rather than duality's moderating effect on performance variables (e.g., baliga, moyer, & rao, 1996; dahya & travlos, 2000; finkelstein & d' aveni, 1994; buchholtz, young, & powell, 1998). several studies (baysinger & butler, fall 2003 desai et al: ceo duality 141 1985; gilson, 1990) show the importance of outside directors on performance associated with significant firm events. other empirical evidence suggests that the presence of independent outside directors is in itself not adequate to ensure that acquisitions are undertaken in the shareholders' interests (subrahmanyam, rangan, rosenstein, 1997). we argue that the presence or absence of ceo duality affects the role of the outside board of directors. since the literature on effect of board monitoring on performance has been equivocal, studying board variables contingent on the presence or absence of ceo duality may provide further insights on the nature of board effectiveness. for our purpose, we are concerned with the impact of board monitoring on acquisition performance. percentage of outsiders. theoretical support for the importance of board monitoring is based in agency theory (jensen & meckling, 1976). according to this perspecti ve, the function of boards is to reduce agency costs resulting from the delegation of strategic decision making, or "decision management," to top executives by exercising "decision control," which involves monitoring managerial decision making and performance (fama & jensen, 1983: 303). in doing so, boards rely crucially upon outside directors, who are considered less likely than insiders to "collude with managers to expropriate residual claimants" (fama & jensen, 1983: 315). the formal independence possessed by outsiders is assumed to permit more objective evaluation. outside board members may pressure for improved corporate performance (fama & jensen, 1983). for example, in situations of firm under-performance, ceo dismissal is more likely with more outsiders on the board (weisbach, 1988). the implication is that outside board members may positively impact the profitability of firm acquisitions. other scholars have argued that inside board members (insiders) may enhance board effectiveness. for instance, mizruchi (1983) contends that insiders compete with each other for succession to the position of ceo. consequently, the insiders may be sensiti ve to appearing beholden to the ceo as they jockey for promotion, strengthening their resolve to control the behavior of the current ceo. consistent with these works, boyd (1994) finds that the percentage of insiders is positively associated with board monitoring. baysinger and butler (1985) suggest that outside directors serve primarily to exercise control and that inside directors are the main sources of advice on strategic issues. the implication of these contentions is that both outside and inside board members may positively affect the performance of corporate acquisitions. whether outsiders or insiders are positively or negatively associated with board effectiveness and acquisition performance, however, may be predicated on the presence or absence of ceo duality. alternative governance mechanisms can substitute for each other, suggesting that either mechanism by itself can resolve agency problems (rediker & seth, 1995; walsh & seward, 1990). rediker and seth (1995) find that there is a substitutability effect for the various monitoring mechanisms, such that some firms may find it unnecessary to have a higher proportion of outsiders for monitoring purposes. 142 journal o.fbusiness strategies vol. 20, no.2 agency theory suggests that a ceo's position moderates the effects of board involvement on firm performance to the extent that absence of ceo duality can partially substitute for outside board of director monitoring as a solution to the agency problem (jensen & meckling, 1976). such settings should lessen the need for outside directors' monitoring activity, reducing the relationship between monitoring and performance. moreover, in the absence of ceo duality, we expect the insiders to contribute to board effectiveness and firm performance. they may do so in subtle and in indirect ways so that their potential opposition to the decisions of the ceo may not be subject to documentation. for instance, possessing firm-specific knowledge, the insiders ostensibly may present both sides of issues, while carefully framing the alternatives in favor of one that may be opposed to the wishes of the ceo. subtly promoting corporate performance and the interests of shareholders may establish the senior executives not only as valuable board members, but also as enlightened managers. in turn, the probability of their upward mobility (if not within the firm, then with external employment prospects) may be boosted (stiles, 2001). thus, we expect the insiders to contribute to board effectiveness more in the absence of ceo duality, and we anticipate that insiders may detract from such effectiveness in the presence of ceo duality. the implication of these arguments is that, in the absence of ceo duality, a greater number of insiders would benefit a firm. in other words, using agency theory arguments, the percentage of outsiders may negatively impact the performance of acquisitions. hypothesis 2: in the absence ofceo duality, the percentage of outside board members will be negatively associated with acquisition performance. under the stewardship argument, absence of ceo duality results in diffused focus of long-term company objectives, and in a slower implementation of decisions. this is because in stewardship theory, pro-organizational and collectivist behaviors of managers provide greater utility (mueller & barker, 1997; dahya & travlos, 2000). separating the ceo and board chair positions results in diffused information processing and discourages any decisive action by the ceo to the detriment of the firm's shareholders (donaldson & davis, 1991; daily and dalton, 1997). in such situations, able outside directors through their network of external alliances, will benefit shareholders by offsetting the lack of unity of command. therefore, the percentage of outsiders may be positively related to the performance of acquisitions by augmenting the insiders. this may significantly contribute to board effectiveness. based on these arguments of stewardship theory, we offer the following hypothesis: hypothesis 2a: in the absence of ceo duality, the percentage of outside board members will be positively associated with acquisition performance. fall 2003 desai et al: ceo duality 143 when the ceo is also the chair of the board, we argue, under the tenets of agency theory, that the inside board members may be reluctant to disagree with the ceo's pre-dispositions. that is because the ceo could determine the future career prospects as well as the monetary and non-monetary rewards of senior executives of the firm. moreover, the ceo may have progressively approved the previous promotions of the senior managers to their present positions of authority. axiomatically, it may be in the private interest of each executive to support the decisions of the ceo, particularly in his or her presence. thus, we expect the insiders to promote the ceo's agenda while being ineffective monitors of corporate strategy in the presence of duality. in this setting, using arguments of agency theory, we expect the outsiders to contribute to ceo monitoring and corporate profitability. hypothesis 3: in the presence of ceo duality, the percentage of outside board members will be positively associated with acquisition perj'ormance. stewardship theory suggests that managers are not motivated by self-interested behavior, but are effective stewards of organizations whose goals are consistent with those of the shareholders (davis, schoorman, & donaldson, 1997). in the presence of ceo duality, stewardship theory suggests that there are potential operational and strategic benefits associated with a higher proportion of insiders on corporate boards (johnson, hoskisson, & hitt, 1993). in such situations, enhanced commitment to the organization generated by full-time employment and coupled with intimate knowledge of relevant environments results in effective board-level decision making. governance through outside directors would not provide additional effectiveness. therefore, there would be less need for additional governance. this implies that from the stewardship theory point of view, in the presence of ceo duality, the percentage of outside board members may not be directly related to acquisition performance. hence, we do not offer a hypothesis pertaining to this situation. outsider board stock ownership. in addition to the nature of board composition and ceo duality, the balance of power between the management and the board depends to a large extent on the board members' ownership stake. empirical evidence suggests that agency costs may be reduced, either due to the introduction of financial incentives, or from relatively small levels of incentive alignment (dalton et ai., 2003; rediker & seth, 1995; zajac & westphal, 1994). ownership plays a significant role as an incentive for outside board members to be responsive to the financial needs of shareholders (hambrick & jackson, 2000), and motivates the outside board members to monitor corporate strategy responsibly and to promote firm performance. that is because, with enhanced director vigilance and corporate performance, these board members may witness an increase in the value of their own equity stakes in the firm. consistent with this expectation, a number of empirical investigations have suggested that 144 journal of business strategies vol. 20, no.2 outside director ownership enhances board monitoring and appropriately motivates board members to pressure for corporate strategies that maximize firm value (dalton et a1., 1998; johnson et a1., 1993). we submit that by increasing proportions of ownership in a firm outside board members will have a personal wealth incentive to monitor managers, in addition to their fiduciary responsibility as members of the board of directors. however outside board stock ownership's contribution to board effectiveness may be contingent on the presence or absence of ceo duality. although enhanced board monitoring through ownership can help acquisition performance, if alternative governance mechanisms are operating properly, intervention by the outside board members may not be necessary, as the mechanisms can substitute for intervention (dalton et a1., 2003; rediker & seth, 1995). in the presence of ceo duality, consistent with the previous discussion under the auspices of agency theory, stock ownership may significantly motivate the outside board members to be more vigilant. that is because, in such a setting, the ceo may intervene to influence the nature of board monitoring. inside board members may yield to the influence of their ceos because they may be beholden to them. thus, they often may be reluctant to oppose the ceo's wishes when the ceo is the chair of the board, personally witnessing board processes. as donaldson explained, inside board members who persistently challenge the ceo "run the risk of finding themselves isolated and, in time, replaced" (1995: 100). therefore, with ceo duality, our presumption is that the effect of inside board members on board effectiveness and firm performance may not be robust. increasing ownership of outside directors, particularly in the presence of ceo duality, neutralizes the agency problem and increases the likelihood of contributing to acquisition performance. in such situations, an agency theory based hypothesis is: hypothesis 4: in the presence of ceo duality, outside board stock ownership will he positively associated with acquisition performance. while agency theory advocates that stock ownership can tip the balance of incentives, motivating outside directors to be more generous with their counsel and more vigilant in their monitoring (hambrick, & jackson, 2000), stewardship theory suggests that managers (and directors) are motivated by the intrinsic satisfaction of their work rather than by extrinsic rewards (davis et al, 1997). stewardship theorists argue that empowering structures and mechanisms are not only appropriate but also sufficient to align principal-agent goals. a ceos' proorganizational actions are best facilitated when the corporate governance structures give the ceo high authority and greater discretion. the resources that are necessary to guarantee pro-organizational behavior from an individualistic agent (i.e., monitoring and incentive costs) are diminished, because a steward is motivated to behave in ways that are consistent with organizational objectives. fall 2003 desai et at: ceo duality 145 in other words, regardless of the presence or absence of ceo duality, additional financial incentives to outside directors are not required to monitor and encourage goal congruence. indeed, additional control could prove to be counterproductive, as it may undermine the intrinsic pro-organizational behavior of the insiders. the following hypothesis is consonant with stewardship theory. hypothesis 4a: in the presence of ceo duality, outside board stock ownership will be negatively associated with acquisition performance. in the absence of ceo duality, our conjecture is that inside board members may significantly contribute to board effectiveness and corporate performance. in such circumstances, the impact of outside director stock on board vigilance may be less robust. this implies that under agency theory tenets, in the absence of ceo duality, outside board equity stakes may not be directly related to acquisition performance. the stewardship explanation for the utility of financial incentives (as explained above) also indicates that such incentives to outside directors would not enhance acquisition performance. manager's interests and utility motivations are directed to organizational rather than personal objectives. hence, we do not offer an agency theory or stewardship theory based hypothesis pertaining to this situation (absence of ceo duality). sample and methodology sample we obtained a list of manufacturing firms (four-digit industry classifications ranging from 1000 to 4999) completing major acquisitions during the 1980 through mid-1990s period from various issues of the almanac editions of mergers and acquisitions. we defined a major acquisition as one that increases the sales of the acquiring firm by at least 10 percent, as suggested by earlier research (tosi & gomez-mejia, 1989). the relative size of the acquisition is important, as only a major acquisition is likely to impact corporate value (franks, harris, & titman, 1991). because we designed this study to use the event methodology, the announcement date of an acquisition had to be available from the wall street journal index. we obtained ownership and compensation data from company proxy reports. only firms for which trading data were available from the crsp database were included. the sample consisted of firms that had not made other acquisitions during the year of their acquisition announcements. we used this criterion to ensure that outcomes associated with the announcements were not influenced by factors related to other acquisitions. excluding corporations that are primarily in services is meant to ensure that differences unique to service firms would not impact the analysis (bharadwaj & menon, 1993). our sample consisted of 149 publicly traded corporations. at the time ofthe acquisition announcement, 47 of 146 journal of business strategies vol. 20, no.2 these firms did not have ceos serving in both roles, while 102 firms did have ceos serving in both roles variables included in the study. we assessed acquisition performance using cumulative abnormal returns (cars) (brown & warner, 1985). the percentage of outside board members was determined by the number of board members who were not employed (in any form) by the firm on whose board they served, divided by the total number of board seats. outside board stock ownership represented the total number of each corporation's shares owned by its outside board members, divided by the total number of that firm's outstanding stock. the shareholding figures recorded for each director included all shares over which the director had voting power. these measures are consistent with those used by several researchers (zahra, 1996; hoskisson, johnson, & moese!, 1994). finally, our control variables included ceo ownership/compensation ratio, size, and relatedness of acquisitions. consistent with other works (e.g., kerr & kren, 1992), we estimated each acquiring firm's ceo ownership by the value of his or her common stock on the day prior to the acquisition announcement. we valued stock options using a heuristic approach, which essentially values options as the difference between the option's exercise price and the underlying stock price at the time of the valuation (lewellen, loderer, & martin, 1987). the heuristic approach does not overstate option values, as options with exercise prices greater that the prevailing stock price are assigned no value (kerr & kren, 1992). compensation included the ceo's salary and bonus in the year of the acquisition announcement. the ceo ownership/compensation ratio was determined by dividing the value of ceo common stock and option holdings by the amount of ceo salary and bonus received. as a variable, this ratio controls for the incentive value of ownership, since ceo equity stakes of even less than five percent will have substantial incentive value in firms with large capitalizations (ryan & wiggins, 2000). we used sales in constant 1987 dollars as a proxy for size. we controlled for size because of its potential impact on acquisition performance (franks et ai., 1991) and for relatedness. we used a dummy variable (scored 0 if the acquirer and the target did not share the same two-digit sic codes and 1 if they did) to represent relatedness. some researchers contend that related diversification may enhance performance (amihud & lev, 1981), while others suggest that unrelated acquisitions may contribute to high performance (lubatkin, 1987; walsh & seward, 1990). acquisition performance measurement. since we assessed acquisition performance utilizing the event-study methodology (brown & warner, 1985), we estimated cumulative abnormal returns (cars) for each acquiring firm and for two event windows (-1 to 0 and -3 to + 3 days). we defined the event date (day 0) as the day prior to the first appearance of the acquisition announcement in the wall street journal. this methodology has emerged as the dominant method for measuring the impact of various economically relevant events on the market value of corporations (caves, 1989; walsh & seward, 1990; wright, ferris, fall 2003 desai et al: ceo duality 147 hiller, & kroll, 1995). caves argues that the event-study methodology is a "genuine innovation theoretically well-grounded, cheap to execute, and able to evade the problem of holding constant other factors that plague ex-post studies of mergers' effects. a better product, available at a lower price, naturally swept the intellectual marketplace" (1989: 151). model estimation procedures. to test hypotheses 1 and 1a, we employed cochran's t-tests to determine whether statistical differences in cars existed between firms with ceo duality and those without. we performed t-tests for both event windows. in testing hypotheses 2, 2a, 3,4, and 4a, we employed a moderated cross-sectional regression analysis, in which acquisition performance (cars) was regressed against the percent of outside board members, percent of stock owned by the outside board members, sales, relatedness, and the ceo ownership/compensation ratio. it is recognized that when a moderator variable z, upon which the form of association between x and y is hypothesized to be contingent assumes only two values, regression equations should be estimated separately (stone-romero & anderson, 1994). in our study, the moderator variable is dichotomous firms with ceo duality represent one group and the remaining firms without ceo duality comprise a second group. results we present summary statistics and the correlation matrix for our data in table 2, and report the t-test results (table 3) of differences between acquisition performance levels for firms with ceo duality and those without duality for both event windows. the results in table 3 offer support for hypothesis 1. firms without ceo duality show positive cars, while firms with duality demonstrate negative cars. hypothesis la is not supported. tables 4 and 5 present the regression results for the two event windows testing our remaining hypotheses. while the percentage of outside board members is positively associated with acquisition performance in the presence of ceo duality, this ratio negatively impacts acquisition performance in its absence. these findings substantiate hypotheses 2 and 3. in hypothesis 4, we predicted that outside board stock ownership would be directly related to the performance of acquisitions in the presence of ceo duality. the findings support this hypothesis. we find no support for stewardship theory based hypotheses 2a and 4a. the results show that outside board stock ownership is positively related to acquisition performance in the absence of ceo duality as well. our results suggest that size and relatedness in acquisitions are insignificantly associated with acquisition performance. ceo ownership/compensation ratio, however, is directly related to the performance of acquisitions. discussion we examine the relationship between ceo duality and acquisition performance using agency and stewardship theoretical frameworks. although agency table 2 ~00 summary statistics and correlation matrix of regression models variable (1) (2) ( 3) (4 ) (5 ) (6 ) ( 7) (1) % of outside board members 1.000 (2) % of stock owned by outside board members .241 1.000 5"' (3) ceo ownership/compensation ratio -.016 .364 1.000 ::;: 31 i::l.... (4) sales .053 -.127 -.107 1.000 ~ ~ (5) related vs. unrelated acquisitions .144 .128 .179 .131 1.000 ::;: '"s· '"(6) acquisition performance (cars days -1 to + 1) .137 1.000 '"0421 .382 .315 -.132 '"v:l.... (7) acquisition performance (cars days -3 to +3) 0409 0433 .349 -.148 .119 .878 1.000 ~.... '"~ mean* 10.54 8.75 .65 -.279 ~' 45.92 5.61 -.555 ..., std. dev. 18.58 8.17 14.92 15.08 4.21 5.11 n=149; *ail values are percentages except compensation, which is in cloo's of 1987 dollars, and sales, which are in hundreds of millions of 1987 dollars. related ys. unrelated acquisitions are scored as "0" if unrelated and" 1" if related. 6tv 9 z ? tv fall 2003 desai et of: ceo dualitv table 3 cochran's t-tests means 149 cars -i to + i cars -3 to +3 'p <.10 *p <05 with duality (n = 1(2) -.740% -.176% without duality (n =47) 2.263% 1.414% t scores 2.89* 1.68' table 4 results of regression analyses: acquisitions performance (cars for -1 to +1 days) variable without ceo duality parameter estimate t value with ceo duality parameter estimate t value intercept % of outside board members % of stock owned by outside board members sales ceo ownership/compensation ratio related vs. unrelated acquisitions r2 f value n -.062 -.111 .249 -.000053 .068 .011 .223 14.00 47 -.92 -1.98* 2.11 * -1.28 2.01 * 1.42 -.003 .113 .173 -.000013 .0702 .009 .199 10.32 102 -.17 4.09** 1.91 * -1.34 2.44* 1.09 p <.05 **p <.05 theory imparts the theoretical basis for a greater part of research conducted in corporate governance (dalton et ai., 2003), alternative explanations must be considered for examining such relationships. it should be noted that theories differ significantly in their assessment of the effectiveness of ceo duality and of outside directors in performing their duties (daily & dalton, 1997; kosnik, 1987). stewardship theory provides a framework that presumes that managers are seeking to maximize organizational performance and suggests a positive role for ceo duality and considers the monitoring role of outside directors unnecessary. within the context of agency theory, outside directors are seen as providing more independent. shareholder-interested monitoring (daily & johnson, 1997; dalton & rechner, 1989). notably, in line with the competing theoretical research dedicated to ceo duality and outside directors, the empirical literature provides no consensus on the effects of these on performance (daily & dalton, 1997). 150 journal of business strategies vol. 20, no.2 table 5 results of regression analyses: acquisitions performance (cars for -3 to +3 days) variable without ceo duality parameter estimate t value with ceo duality parameter estimate t value intercept % of outside board members % of stock owned by outside board members sales ceo ownership/compensation ratio related vs. unrelated acquisitions r2 fvalue n .092 -.172 .495 -.000050 .094 .018 .2157 8.36 47 1.01 -2.04* 2.18* -1.29 2.02* 1.31 .099 .392 .669 -.000068 .084 .0i2 .231 9.31 102 1.47 3.13** 1.85* -1.12 2.38* 1.60 'p <.05 **p <.05 we find evidence supporting the notion that ceo duality structure intensifies the agency problem. contrary to the arguments of stewardship theory, having an independent chair leads to gains in shareholder wealth. specifically, our results are consistent with the premise that ceo duality may negatively impact the profitability of acquisitions in firms. additionally, we find that the relationship between leadership structure and shareholder benefit is contingent on board monitoring. although splitting the position of chairperson and ceo helps acquisition performance in general, a number of board variables may affect acquisition performance differently, depending on the presence or absence of ceo duality in firms. these include both the percentage of outside board members and outside board stock ownership. in line with the agency theory perspective on ceo duality, duality is related to board vigilance. the findings relating to select board variables are qualitatively different, depending on the presence or absence of ceo duality. for instance, the percentage of outside board members is negatively associated with acquisition performance in the absence of ceo duality, while outsiders are positively related to performance in the presence of duality. this provides additional support for the assertions of agency theory that, in the absence of duality, less monitoring is required by the outside directors. we add new evidence to the debate on the substitution-monitoring hypothesis (governance arrangements as substitutes on one another). this finding is particularly important since it implies that a focus on various elements in the corporate governance-firm performance nexus is likely to lead to considerable increase in performance. fall 2003 desai et al: ceo duality limitations, implications and conclusions 151 some limitations of the study should be acknowledged. other governance mechanisms exist. our paper does not include the role of institutional and blockholder ownership. given their equity positions, institutional investors could affect the relationship between ceo duality and performance. future studies could investigate the role of ownership structure as a moderator between the ceo duality and outside director relationship. our paper focuses on acquisition as a performance variable. numerous other performance variables can be included to study the combined effects of ceo duality and performance. the scope of this study is in a specific context, but our discussion of the results leads us to a number of conclusions and implications. independent leadership structure (separating ceo and chairperson of the board roles) is more beneficial for acquisition performance. [n the presence of ceo duality, monitoring through the outside board of directors, and incentive alignment through compensation contracts are other ways to ensure owner-interested action. 80% of u.s. public companies combine the jobs of ceo and chair (daily & dalton, 1997; allan & widman, 2000). only a small minority of corporations in the united states has installed an outside director as chairperson, but the practice has long been common in other countries (allan & widman, 2000). do the inherent conflicts of interests and the intimidating power of a ceo duality position manifest themselves in acquisition performance? from our finding, it appears to be so. recent concerns about the dual role of a ceo may be justifiable and need serious consideration. our study supports the counsel of those who call for the elimination of ceo duality as one way to enhance firm governance and performance. these views have been included in the cadbury committee report (1992) in the u.k. and by the conference board in the u.s.a. (dahya & travlos, 2000). the obvious implication is that ceo duality should be discouraged, and the demand for responsible corporate governance could be forwarded through shareholder or governmentally imposed measures. lorsch and maciver (1989) suggest ceo duality has power that primarily impedes outside directors from exercising their authority. our study shows that a larger percentage of outside directors, in the presence of duality, contribute more towards performance. consequently, we conclude that the probability of board members effectively protecting the interests of shareholders is boosted if outsiders are more numerous on the boards of firms with ceo duality. the implication may be that more outsiders should be recruited to serve on these boards. moreover, consistent with the results, it may be recommended that such board members be granted stock ownership in the firm, while limiting their level of compensation. on the other hand, possessing firm-specific knowledge, the insiders can playa positive role, but evidently more so in the absence of ceo duality. the suggestion is that in the presence of duality, assuring that a majority of board members are outsiders is prudent to ensure that acquisitions are properly aligned with the goals of the firm's shareholders. in the absence of duality, 152 journal of business strategies vol. 20, no.2 however, agency problems may be less, and inside directors who know the company and markets might be more valuable than outside directors. it may be advisable to have inside members comprise the majority of board membership in such firms. our findings suggest that not only is outside board ownership positively related to acquisition firm performance in the presence of ceo duality, such ownership is also associated with performance in the absence of duality. one interpretation of this relationship is that stock ownership affects director behavior, not because of the direct financial incentive, but because of the increased psychological bond to the corporation (lorsch & maciver, 1989; hambrick & jackson, 2000). this can motivate outside directors to be more liberal with their advice and more vigilant in their monitoring, regardless of duality structure. the implication is that granting outside board stock ownership may be advantageous regardless of the state of ceo duality. granting equity stakes to outside board members may not be costly and apparently has substantial benefits. in conclusion, ceo duality may be a negative attribute, detracting from effective board monitoring and profitable corporate strategies. forming effective boards may be subject to specificities at the firm level of analysis rather than to broadly based generalities. given the importance of acquisitions in particular and corporate performance in general, we are hopeful that further theoretical advancement and empirical studies using multiple perspectives are likely to be fruitful. references allan, p. & widman, a. (2000). a comparison of the views of ceos and public pension funds on the corporate governance issues of chairman-ceo duality and election of lead directors. american business review, 18 (i), 49-55. amihud, y. & lev, b. (1981). risk reduction as a managerial motive for conglomerate mergers. bell journal of economics, 12, 605-617. baliga, b., moyer, r., & rao, r. (1996). ceo duality and firm performance: what's the fuss? strategic management journal, 17,41-53. baysinger, b. & butler, h. (1985). corporate governance and the board of directors: performance effects of changes in board composition. journal of law, economics. and organization, 1, 101-124. berle, a. & means, g. (1932). the modern corporation and private property. new york: macmillan. bharadwaj, s. g, & menon. a. (1993), determinants of success in service industries: a pims-based empirical investigation. journal of services marketing, 7 (4), 19-40. fall 2003 desai et al: ceo duality 153 boyd, b. (1994). board control and ceo compensation. strategic management journal. 12, 335-344. boyd, b. (1995). ceo duality and firm performance: a contingency model. strategic management journal, 16 (4), 301-312. bradley, m., desai, a., & kim, e. (1988). synergistic gains from corporate acquisitions and their division between the stockholders of target and acquiring firms. journal of financial economics, 21, 3-40. brown, s. & warner, j. (1985). measuring security price performance. journal of financial economics, 8, 205-258. buchholtz, a., young, m., & powell, g. (1998). are board members pawns or watchdogs? the link between ceo pay and firm performance. group and organization management, 23 (i), 6-26. cadbury, sir a. (1992). committee on financial aspects of corporate governance, (hmso). caves, r. (1989). mergers, takeovers, and economic efficiency. international journal of industrial organization, 7,151-174. chaganti, r., mahajan, v., & sharma, s. (1985). corporate board size, composition and corporate failures in retailing industry. journal of management studies. 22, 400417. dahya, j. & travlos, n. (2000). does one man show pay? theory and evidence on the dual ceo revisited. european financial management, 6 (i), 85-99. daily, c. & dalton, d. (1997). ceo and board chair roles held jointly or separately: much ado about nothing? the academy of management executi ve. ii (3), 11-21. daily, c. & johnson, j. (1997). sources of ceo power and firm financial performance: a longitudinal assessment. journal of management. 23 (2), 97-117. dalton, d. & daily, c. (1998). corporate governance digest. business horizons. 41 (2), 6-8. dalton, d., daily, c., certo, s., & roengpitya, r. (2003). meta-analysis of financial performance and equity: fusion or confusion? academy of management journal. 46 (1), \3-26. dalton, d., daily, c., ellstrand, a., & johnson j. (\998). meta-analytic reviews of board composition, leadership structure and financial performance. strategic management journal. 19, 269-290. 154 journal of business strategies vol 20, no.2 dalton, d. & rechner p. (1989). on the antecedents of corporate severance agreements: an empirical assessment. journal of business ethics, 8,455-462. davis, j., schoorman, f, & donaldson, l. (1997). toward a stewardship theory of management. academy of management review. 22, 20-47. donaldson, g. (1995). a new tool for boards: the strategic audit. harvard business review. 73 (4),99-107. donaldson, l. (1990). the ethereal hand: organizational economics and management theory. academy of management review. 15, 369-381. donaldson, l. & davis, j. (1991). stewardship theory or agency theory: ceo governance and shareholder returns. australian journal of management. 16 (i), 49-64. fama, e. & jensen, m. (1983). separation of ownership and control. journal of law and economics, 26, 301-325. finkelstein, s. & d' aveni, r. (1994). ceo duality as a double-edged sword: how boards of directors balance entrenchment avoidance and unity of command. academy of management journal, 37, 10791108. franks, j., harris, r., & titman, s. (1991). the postmerger share-price performance of acquiring firms. journal of financial economics, 29, 81-96. gilson, s. c. (1990). bankruptcy, boards, banks and blockholders. journal of financial economics, 27 (2),355-387. hambrick, d. & jackson, e., (2000). outside directors with a stake: the linchpin in improving governance. california management review, 42 (4), 108-128. hayward, m. & hambrick, d. (1997). explaining the premium paid for large acquisitions: evidence of ceo hubris. administrative science quarterly. 42, 103-127. hoskisson, r., johnson, r., & moesel, d. (1994). corporate divestiture intensity in restructuring firms: effects of governance, strategy, and performance. academy of management journal. 37, 1207-1251. jensen, m. & meckling, w. (1976). theory of the firm: managerial behavior, agency costs, and ownership structure. journal of financial economics. 3, 305-360. johnson, r., hoskisson, r., & hitt, m. (1993). board of director involvement in restructuring: the effects of board versus managerial controls and characteristics. strategic management journal. 14,33-50. kerr, j. & kren, l. (1992). effect of relative decision monitoring on chief executive compensation. academy of management journal. 35 (2), 370-397. fall 2003 desai et al: ceo duality 155 kosnik, r. d. (1987). greenmail: a study of board performance in corporate governance. administrative science quarterly, 32, 163-185. lewellen, w., loderer, c., & martin, k. (1987). executive compensation and executive incentive problems: an empirical analysis. journal of accounting and economics, 2.(3), 287-310. lorsch, j. w. & maciver, e. (1989). pawns or potentates: the reality of america's corporate boards. boston: harvard business school press. lubatkin, m. (1987). merger strategies and stockholder value. strategic management journal, 8, 39-53. mallette, p. & fowler, k. l. (1992). effects of board composition and stock ownership on the adoption of "poison pills". academy of management journal. 35, 10101035. mizruchi, m., (1983). who controls whom? an examination of the relation between management and boards in large corporations. academy of management review, 8, 426-435. morek, r., shleifer, a., & vishny, r. (1990). do managerial motives drive bad acquisitions? journal of finance, 45, 31-48. mueller, g. & barker, v. (1997). upper echelons and board characteristics of turnaround and non turnaround firms declining firms. journal of business research, 39, 119134. rechner, p. l. & dalton, d. r. (1991). ceo duality and organizational performance: a longitudinal analysis. strategic management journal. 12, 155-160. rediker, k. & seth, a. (1995). boards of directors and substitution effects of alternate governance mechanisms. strategic management journal, 16, 85-99. ryan, h. & wiggins r. (2000). differences in the compensation structures of the ceo and other senior managers. the journal of business and economic studies, 6 (2), 22-39. stiles, p. (2001). the impact of board on strategy: an empirical examination. journal of management studies, 38 (5), 627-650. stone-romero, e. & anderson, l. (1994). relative power of moderated multiple regression and the comparison of subgroup correlation coefficients for detecting moderating effects. journal of applied psychology, 74, 3-10. subrahmanyam, v., rangan, n., & rosenstein, s. (1997). the role of outside directors in bank acquisitions, financial management, 26 (3), 23-36. 156 journal o.lbusiness stratef?ies vol. 20, no.2 tosi, h. l. & gomez-mejia. l. r. (1989). the decoupling of ceo pay and performance: an agency theory perspective. administrative science quarterly. 34, 169-189. walsh, j. p. & seward, j. k. (1990). on the efficiency of internal and external corporate control mechanisms. academy of management review. 15, 421-458. weisbach, m. (1988). outside directors and ceo turnover. journal of financial economics, 20, 431-460. wright, p., ferris, s., hiller, j., & kroll, m. (1995). competitiveness through management of diversity: effects on stock price valuation. academy of management journal 38,272-287. zahra, s. (1996). governance, ownership, and corporate entrepreneurship: the moderating impact of industry technological opportunities. academy of management journal, 39 (6),1713-1736. zajac, e. & westphal, j. (1994). the costs and benefits of managerial incentives and monitoring in large u.s. corporations: when is more not better? strategic management journal 15, 121-142. ashay desai is assistant professor of management in the college of business at the university of wisconsin-oshkosh. he received his ph.d. from the university of memphis. his current research interests include corporate governance and declining firms, competitiveness, and turnaround strategies. mark kroll is head of the management and marketing department and the maurice tatum professor of business administration at louisiana tech university. he received his dba degree from mississippi state university. his research interests include agency theory, corporate governance, and strategic leadership. peter wright is professor of management and the holder of the university of memphis endowed chair in free enterprise management. he received his undergraduate degree from ohio state university, and his m.b.a. and ph.d. degrees from louisiana state university. his research focuses on agency theory and the valuation of firm strategies. ceo duality, board monitoring, and acquisition performance: a test of competing theories corporate social responsibility in italy: state of the art francesco perrini stefano pogutz antonio tencati bocconi university milan, italy abstract the italian corporate panorama is permeated by various corporate social responsibilities initiatives, both at private and public level, that derive from different approaches and tools. the general framework for corporate social responsibility (csr) behavior and strategies consists of the green paper presented by the european commission in july 2001. within thisframework, the paper aims at analyzing three main issues: spontaneous experiences from companies and other players; the innovative project called corporate social responsibility social commitment, developed by the ministry oflabour and social affairs, which aims at promoting the involvement ofitalian enterprises in csr activities, with particular regard to small and medium sized enterprises; and lastly the main and most interesting outcomes ofa survey that is the starting point ofan ongoing process of investigation regarding csr attitudes in italy. introduction the paper presents the main results of a research project on corporate social responsibility (csr) issues developed by bocconi university for the italian ministry of labour and social affairs. by providing a summary picture of the csr situation in italy, it covers an introductory analysis of the csr literature and public documents and reveals the existence of several initiatives on csr, both at private and public level, involving companies and institutions. a specific part of the paper is dedicated to the examination of an innovative project developed by the ministry of labour and social affairs on csr, called corporate social responsibility social commitment (csr-sc). this initiative has the aim of promoting csr culture among businesses and guaranteeing citizens that the reporting of companies on ethical and social issues is not misleading. moreover the csr-sc project has defined a simple, flexible and modular standard that firms can adopt on a voluntary basis in order to implement csr policies and identify socially responsible companies. this standard is based on a list of key performance indicators to measure social performance. hence, this initiative dedicates particular attention to small and medium-sized enterprises (smes). the last part of the paper is directed towards providing a first overview of csr awareness in 66 journal of business strategies vol. 23, no. 1 italian companies. an investigation based on an empirical survey began in 2002. the survey comprises 395 enterprises with the aim of gathering descriptive data and information on csr attitudes. it is the starting point of an ongoing process of investigation regarding csr approaches in italy. thus, the purpose of this contribution is to give a description of the attitudes towards csr in italy, presenting the coexistence of different private and public approaches that actually reflect the complex nature of the italian economic system. this goal seems particularly relevant for two main reasons. at a european level, the sustainable development strategy for europe, approved in june 2001, where "in the long term, economic growth, social cohesion and environmental protection must go hand in hand" (commission of the european communities, 200la), opens up an interesting debate among different eu members on the development of national sustainability strategies. moreover, the green paper "promoting a european framework for csr" (commission ofthe european communities, 200lb) presented by the european commission in july 2001 states that corporate social responsibility is "a concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis." so far, this document defines a general framework for csr, influencing the behavior and strategies both in terms of public policies and private initiatives. starting from this point, the ambitious project launched in june 2002 by the italian ministry of labour and social affairs on social responsibility of enterprises aims at promoting csr among companies within this general european framework. the idea of providing a picture of the ongoing activities on csr in italy represents a helpful contribution to the international, and especially european, debate. furthermore, the characteristics of the italian economy in terms of smes and network organizations represent an unique background in which to explore the relationship between csr strategies and these two industrial specificities. with regard to this point, it may be opportune to recall that a comparison with average sized european companies in the industry, services and infrastructure sectors shows that the italian system has an average of 3.9 employees per company compared to an average of 6 overall for the 15 eu member states. in industrial spheres, enterprises with over 250 employees account for 19.7% of the total in italy whereas 34% of the total for the eu. another important feature is that the italian industrial system is characterized geographical1y in that its activity is concentrated in industrial districts in northern and central italy, along the adriatic coast and in a few areas of the south (becattini, 1987; goodman, bamford & saynor, 1989). in some traditional and engineering industries, these districts have a leadership position in the global market and overal1 account for over two-thirds of total national exports. finally, italian smes are an integral part of the local community and their success is often related to their capability to acquire legitimacy and consensus from local stakeholders such as employees, public authorities, financial organizations, banks, suppliers and citizens. these local networks are based on informal spring 2006 perrini et al.: corporate social responsibility 67 and tacit relationships, whose results are often not communicated or simply not measured. with regard to this point, it is possible to introduce the notion of social capital: "whereas physical capital refers to physical objects and human capital refers to the properties of individuals, social capital refers to connections among individuals social networks and the norms of reciprocity and trustworthiness that arise from them" (putnam, 2000, p. 19). moreover, "stocks of social capital, such as trusts, norms, and networks, tend to be self-reinforcing and cumulative. successful collaboration in one endeavor builds connections and trusts social assets that facilitate future collaboration in other, unrelated tasks. as with conventional capital, those who have social capital tend to accumulate more ... " (putnam, 1993b). in this perspective, the intangible assets in terms of reputation, trust, legitimacy and consensus related to the concepts of social capital are at the basis of the long-term performance ofitalian smes and their districts (lipparini, 2002). as shown and analyzed in a broad range ofliterature (azzone, bianchi & noci, 1997; gilardoni, 2000), the particular features highlighted above have historically influenced the diffusion of managerial tools and standards in italy. a well-known example was the low diffusion rate in our country of the iso standards on total quality management (iso 9001: 1994). despite the not always so broad diffusion of managerial tools, responsible business practices seem to be vital and hence an embedded element of the italian model of capitalism centered on smes. in light of the above, this study analyzes the different csr spheres in italy, the pros and cons as well as the ongoing debate italian firms are having in coming to grips with what is becoming an ever increasing strategic and competitive corporate theme. developing a definition of csr some relevant theoretical contributions there are many words connected to the csr concept (see figure 1) and consequently many definitions that permeate the literature. bowen (1953) provided the first modern contribution to this topic. he pointed out that corporate decision making processes have to consider not only the economic dimension, but the social consequences deriving from their business behavior as well. more specifically, bowen (1953, p. 6) proposed a definition of the social responsibilities of the businessman: "it refers to the obligations of businessmen to pursue those policies, to make those decisions, or to follow those lines of action which are desirable in terms of the objectives and values of our society." in bowen's opinion, businessmen are responsible for the consequences of their actions in a sphere somewhat wider than that covered by their profit-and-ioss statements (carroll, 1999, p. 270). the csr concept also evolved in the following years despite some skepticism (friedman, 1962, 1970) and many authors, especially drucker (1984) as well as porter and kramer (2002), have underlined the positive relationships between social responsibility and business opportunities in terms of market opportunities, 68 journal ofbusiness strategies figure 1 the "words" connected to csr concept vol. 23, no. 1 i corporate social rectitude corporate social performance corporate social responsiveness business philan~~~~~ i 1955 1960 1965 1970 1975 1980 1985 1990 1995 2002 (de bettignies, 2002) productivity, human competence and improvement of the competitive context, i.e., "the quality of the business environment in the location or locations where companies operate" (porter & kramer, 2002, p. 58). however, in the field of business ethics many authors are against a shared conception that csr is only an instrument "for improving business functioning" (zsolnai, 2002a, p. 1). we adopt a resource-based view (peteraf, 1993) and a stakeholder-based view (freeman, 1984, 2001; carroll, 1979; clarkson, 1995; donaldson & dunfee, 1999; mcwilliams & siegel, 2001) to define csr (de bettignies, 2002). managers of firms have obligations to a broader group of stakeholders than the simple shareholders; a stakeholder is "any group or individual who can affect or is affected by the achievement of the firm's objectives" (freeman, 1984, p. 46). stakeholder approach has many different interpretations, but stakeholder thinking means "both to explain and to guide the structure and operation of the established corspring 2006 perrini et al.: corporate social responsibility 69 poration" (donaldson & preston, 1995, p.70). corporate social responsibility "encompasses the economic, legal, ethical, and philanthropic expectations placed on organizations by society at a given point in time" (carroll, 1991; carroll & buchholtz, 2002). therefore, by pursuing economic, social and environmental objectives (carroll, 1979) the csr-oriented company increases its intangible assets ofknowledge and trust, which support the processes ofvalue creation (wood, 1991; joyner & paine, 2002). the stakeholder value (figge and schaltegger, 2000) created makes it possible to reward, in specific and appropriate ways, the different social stakeholders who contribute resources. sustainability therefore becomes the strategic objective ofsocio-economic systems and responsible companies (tencati, 2002b; perrini and tencati, 2003), which aim to pursue long-term economic development, consistent with promoting social needs and protecting the environment (margolis & walsh, 2003; walsh, weber and margolis, 2003). business activities and business operations need an ethical foundation, as the colossal downfall of major corporations has recently demonstrated both in the usa and in europe (zsolnai, 2002b). some relevant institutional and public contributions in any case, policy makers, citizens and companies are paying increasing attention to csr. according to the u.s.-based global business organization business for social responsibility (bsr), corporate responsibility (or corporate citizenship) means" ... operating a business enterprise in a manner that consistently meets or exceeds the ethical, legal, commercial, and public expectations society has of business." the world business council for sustainable development (wbcsd, 1999) proposed another definition of csr: "csr is the continuing commitment by business to behave ethically and contribute to economic development while improving the quality of life of the workforce and their families as well as of the local community and society at large." another interesting definition of csr comes from the prince of wales international business leaders forum: "csr means open and transparent business practices that are based on ethical values and respect for employees, communities, and the environment. it is designed to deliver sustainable value to society at large, as well as to shareholders." in order to promote the idea of corporate citizenship and socially responsible behavior, at the world economic forum in davos on january 31, 1999, united nations secretary-general kofi annan challenged world business leaders to embrace and enact a global compact of shared values and principles in the areas of human rights, labor and the environment. from an operational point of view, the initiative was launched on july 26, 2000 during a meeting at the un headquarters in new york with the participation of leaders from business, labor organizations and civil groups. the global compact is a voluntary initiative, open to the participation of companies and to the involvement of labor, human rights, environmental and development organizations (global reporting initiative, 2002). it encompasses nine principles, drawn from the universal declaration of human rights, the ilo declaration on fundamental principles and rights at work and the rio 70 journal ofbusiness strategies vol. 23, no.1 declaration on environment and development. if companies decide to participate in this initiative, the global compact asks them to act on these principles in their own corporate domains. thus the compact promotes good practices by corporations; it does not, however, endorse companies. the global compact asks business to support and respect the nine principles in the fields of human rights, labor standards and the environment. some of the most important firms in the world are among the participating companies, all of whom have sent a letter ofintent from the company ceo to the un secretary-general and who yearly submit evidence of efforts undertaken to advance the compact's nine principles. the european union is also dealing with the issues related to csr. on july 18, 200 i the ed presented the green paper "promoting a european framework for csr" (commission of the european communities, 2001 b). the european union is concerned with csr because it can be a positive contribution to the strategic goal adopted in march, 2000, during the european council in lisbon: "to become the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion" (commission of the european communities, 2001 b, p. 3). the document suggests an approach based on the strengthening of partnerships among all interested parties (for example, companies, ngos, social partners and local authorities). after the consultation process on the green paper closed on december 31, 200 i, the eu began work on a new document. the new official communication entitled "csr: a business contribution to sustainable development" was released on july 2, 2002 (commission of the european communities, 2002b). these two documents are the final outcomes of a long discussion, carried on for years in europe at both theoretical and institutional level, about the social implications of business activities and the social role of companies in supporting the local and national community development (banal et ai., 1981; petrella, 1995; the copenhagen centre, 1998; hutton, 2002). according to the green paper, "csr is essentially a concept whereby companies decide voluntarily to contribute to a better society and a cleaner environment" (commission of the european communities, 2001 b, p. 4) and "a concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis" (commission of the european communities, 2001 b, p. 6). an increasing number of companies recognize social responsibility as part of their identity. this responsibility affects employees and more generally all stakeholders (amongst others shareholders, customers, suppliers, banks and insurance companies, retailers, competitors, state and local authorities, civil society at large and the media) and this in tum can influence corporate success. the green paper identifies four factors, which lie behind the growing success of the csr concept: 1. the new concerns and expectations of citizens, consumers, public authorities and investors in the context of globalization and large scale industrial change; 2. social criteria, which are increasingly influencing the investment decisions of individuals and institutions both as consumers and as investors; spring 2006 perrini et al.: corporate social responsibility 71 3. increased concern about the damage caused by economic activity to the environment; 4. transparency of business activities brought about by media and modern information and communication technologies. the eu proposes a framework to better understand the different elements of csr: according to this approach, csr has an internal and an external dimension. the csr internal dimension encompasses the following: human resources management; occupational health and safety management; business restructuring; management of environmental impact and natural resources. the csr external dimension, which goes beyond the doors of the firm and involves many stakeholders, affects: local communities; business partners, suppliers, customers and consumers; protection of the human rights along the whole supply chain and global environmental concerns. therefore, in order to respond in an adequate way to the pressures coming from the society of which companies form integral part, firms should pursue economic, social and environmental goals on the basis of a co-ordinate approach. companies should integrate social and environmental concerns into their business strategies, their management tools and their activities. that means going beyond compliance and investing more in human, social and environmental capital. finally, the ed underlines the need for a holistic approach towards csr integrated management in order to include social and environmental aspects into corporate planning, measuring and controlling of processes and to define a long-term strategy which minimizes the risks linked to uncertainty. another interesting contribution to the international debate on csr came from the g8 evian summit 2003, where for the first time, a g8 summit document focused on csr. according to the g8 declaration "fostering growth and promoting a responsible market economy," "corporate integrity, strengthened market discipline, increased transparency through improved disclosure, effective regulation and corporate social responsibility are common principles that are the foundations for sound macro-economic growth." in the second paragraph headed "corporate social responsibility" the g8 representatives stated: "consistent with the outcomes of the world summit on sustainable development, we support voluntary efforts to enhance corporate social and environmental responsibility. we will work with all interested countries on initiatives that support sustainable economic growth, including the creation of an environment in which business can act responsibly. we also welcome voluntary initiatives by companies that promote corporate social and environmental responsibility, such as the oecd guidelines for multinational enterprises and the un global compact principles consistent with their economic interest. we encourage companies to work with other parties to complement and foster the implementation of existing instruments, such as the oecd guidelines and the ilo 1998 declaration on fundamental principles and rights at work" (g8 declaration, 2003). on the basis of this preliminary review the csr definition and approach proposed by the ed appear to be the most comprehensive and up-to-date: csr is 72 journal ojbusiness strategies vol. 23, no.1 "a concept whereby companies integrate social and environ-mental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis" (commission of the european communities, 2001b, p. 6). furthermore, they will continue to be a reference point for future decisions in the field of european public and private policies promoting corporate socially responsible behavior. thus we have decided to adopt the european csr framework as the theoretical basis for our research. analysis of the csr situation in italy a variety of structural (the predominance of smes and the role of local districts) and historical (e.g., importance of the cooperative movement) reasons have remarkably characterized the italian national economic system and its attentiveness to social relationships as a whole. in this context, several initiatives on csr have been promoted to face the rising attention paid by public opinion to environmental protection, product safety and the respect of human and workers' rights. these spontaneous experiences from companies and institutions have been reviewed and classified into three main groups: private, public and corporative association. the data for this investigation were collected through website analysis and interviews with specific organizations and institutions. more precisely, according to a descriptive approach we intend to give a representation ofthe present situation in italy in order to understand and define the reference framework into which italian efforts will then be measured up against. private sector experience with regard to the private sector, different ambits show a considerable interest in csr issues from companies and other players. depending on the tool adopted and its impact on corporate strategy and processes, we can divide the various initiatives into four main groups: reports/statements and other reporting activities; managing and certification systems; financial experience (ethical investment funds, rating); other initiatives (see table 1 for a representation of these experiences). public sector experience so far, many initiatives have been promoted within the pubic sector both at the regional and provincial level (table 2). entrepreneurial associations finally, the national system of chambers of commerce is particularly sensitive and attentive to promoting csr among companies working in italy. on the matter, the main initiatives are described in table 3. in the light of the above-mentioned initiatives, we can assert that the italian approach to csr implies a nationally widespread network of private and public interventions that are highly innovative. it is indeed true that many of the volspring 2006 perrini et al.: corporate social responsibility table 1 private sector experience 73 initiative content findings statementslreports and voluntary reporting initiatives · more than one hundred social other reporting activities on the csr activities by using reports manifold reference standards · more than one hundred and methods [e,g" gbs model environmental reports (gbs, 2001), q-res project · almost thirty sustainability/social(cele, 2002), abi model (ab!, environmental reports 2001)] managing and · csr managing system on all · 76 companies with a sa 8000 certification systems its components: environment, certification, out of 353 global human resources, suppliers, certifications safety, etc, • more than 3,000 companies with an · certification systems by third is014001 certification parties · 172 registrations for em as • environmental labels and · eco-label issued for more than 219 quality labels products financial experience initiatives and projects related to · a category called "ethical fund" the corporate financial area and introduced by assogestioni among evaluation processes its classes • ethical choice combined with traditional portfolio management systems in trading pension funds (previambiente, eurofer, etc,) · forum for the sustainable finance (ffs) founded to promote sustainable development among representatives of the financial community · two stock indexes ethical index euro® ed ethical index global® launched by e. capital partners spa · banca etica, founded in 1998, specialized in non-profit financing, solidarity economics, supporting civil society, etc. other initiatives • organizations, working · gruppo di frascatil groups and research citladinanzatliva, sodalitas, centers for csr issues, impronta etica, anima, etc. promoted by companies and · cause-related marketing activities, entrepreneurial associations in 2003, amounting to more than • increasing cause-related 45,500,000 euros, placed by almost marketing activities 110 different companies · creation of specific awards · csr awards, i.e. oscar di bilancio,· the role of banking oscar di bilancio di sostenibillta, foundations to promote sodalitas social awards, best and support non-profit workplaces italia organizations and local • bank foundations in 2002 disbursed communities 1.043 billion euros for social-related initiatives: cultural and artistic activities, training, assistance, philanthropy and charitable activities, health, research, promotion, local communities, the environment, sports, international as well as religious ones 74 journal of business strategies table 2 public sector experience vol. 23, no. i initiative content initiatives promoted at • fabrica ethica project activated by the tuscan region to promote the regional level sa bodo certifications among smes (starting from june 2000). the certification envisages the activation of supporting training and information services and the allocation of funds to companies • regional act n. 20 of 2002, approved by umbria region, for the creation of the regional register of sa bodo-certified companies • "chiaro, sicuro, regolare" program about occupational safety and quality promoted by emilia romagna region • the partnership between marches region and the cfm (centro formazione marche, center for education and training of marches region) aimed to establish an informative system on csr • the support of the sicilian region to the etiqualitas project and the involvement in the csr-vaderegio project funded by the eu. the csr-vaderegio project involves four organizations: agenda-social responsibility in scotland of edinburgh (scotland), the flemish ministry of labor (belgium, flanders), the novia salcedo foundation of bilbao (spain, basque region) and the euro association of palermo (sicily) initiatives promoted at • the involvement of the province of chieti in encouraging companies the provincial level to adopt more advanced managing tools on csr • the partnership between the province of leece, their university and assindustria to promote a system of ethical-social certification for the companies of the province • the sonar project promoted by the province of novara aimed at constructing a management system for the inclusion of the weakl disadvantaged into the labor market table 3 initiatives of the national system of chambers of commerce initiative content initiatives promoted by · the rebus project, shared by istud (istituto studi direzionali spa the national system of milan), sfera (servizi formativi emiliano romagnoli associati, a chambers of commerce consortium whose partners are the training bodies of entrepreneurial associations of emilia romagna) and formaper (special agency of the chamber of commerce of milan), aimed at investigating the attention levels paid by smes managers to csr · the lavoro etico network, established by cise (special agency of the chamber of commerce of forli-cesena), to communicate and disseminate the principles and management tools for sa bodo certifications untary activities carried out by companies, mostly smes, despite a strong relationship with the local community, are scarcely systematic; that is, they are not structured into formalized strategic processes, and they have low visibility outside the company. this approach to csr that can be defined as a sort of sunken csr is a frequent phenomenon, but cannot be appreciated and deeply enhanced from the competitive point of view, with traditional interpretation patterns suitable for multinational corporations. spring 2006 perrini et af.: corporate social responsibility 75 the ministry of labour and social affairs' project on csr one of the most important initiatives carried on during the last years has been the project called corporate social responsibility-social commitment (csrsq, launched by the italian ministry of labour and social affairs in june 2002. bocconi university was involved by the italian government as a technical partner to support the ministry' team in the definition of the csr-sc project. the main aims that the csr-sc project pursues are as follows: • promoting csr culture among companies; • defining a simple and modular standard that firms can adopt on voluntary basis in order to identify socially responsible behavior; • proposing a list of relevant performance indicators to measure the social performance of companies; • guaranteeing citizens that the reporting of corporate social commitment by companies is true and not misleading. during the third european conference on corporate social responsibility held in venice on november 14, 2003 and after eighteen months of work, the ministry of labour and social affairs proposed a two-level standard framework. common elements of the proposal are the following: • voluntary approach; • corporate self-assessment; • no traditional certification mechanisms; • a set of performance indicators. the first stage (csr level) is based on the set of performance indicators and on a system of guidelines in order to support companies in the self-assessment of their own social performance and in its reporting through a social statement. the main steps of this level are as follows: • a company decides, on a voluntary basis, to participate in the csr-sc project and present the social statement according to the set of indicators; • an independent authority, proposed by the ministry of labour and social affairs, is expected to be the party responsible for the final evaluation of social statements sent by participating companies; • a comprehensive database will be organized to collect and make available the relevant information on the initiative. the second stage ofthe project (sc level) is based upon companies undertaking a proactive role in supporting the welfare policies promoted by the government and local authorities. if a company, on a voluntary basis, decides to go beyond the csr level (presentation of the social statement and review carried out by the independent authority), it participates, through its own resources, in the projects of social intervention proposed by policy makers. the underlying perspective is to integrate private and public resources according to a modern welfare mix approach and the subsidiary principle. 76 journal ofbusiness strategies vol. 23, no. i this csr-sc system has the aim of promoting socially responsible behavior among companies. in order to guarantee standardization in data presentation and comparability between the results obtained by different companies, the set of performance indicators will serve as an optimal point of reference in preparing the social statement. this set is projected according to a flexible and modular approach. in general, it is possible to identify at least three categories of companies that can use these indicators: • publicly traded companies; • large private companies; • small and medium-sized private companies. listed companies should implement the most exhaustive reporting process according to a principle of broad disclosure (adopting the complete set of indicators). with regard to private companies, the purpose is to identify, within the framework, those measures which best meet information needs without requiring processing efforts which are beyond corporate capacity and resources: • smes should use a set of common indicators (at least 20 specific indicators covering the most important stakeholder categories); • large companies should also adopt some additional indicators. moreover, sector characteristics will require in-depth analysis in addition to the set of selected indicators. the possibility of adapting the information requirements of the social statement to the specific financial, size and industry characteristics of the companies reflects the flexible and modular approach that is a fundamental feature of the project. on the basis of the results of more than twenty pilot tests carried out in collaboration with pioneering companies of every size, the ministry of labour and social affairs proposal organizes the indicators according to a three-level framework (global reporting initiative, 2002): • categories: stakeholder groups which are specifically affected by clusters of indicators; • aspects: thematic areas monitored by groups of performance indicators related to a given category of stakeholders; • indicators: measurements that supply information related to a given aspect. they can be used to check and demonstrate organizational performance. the information can be qualitative, quantitative (physical and technical) or economic-monetary. the stakeholder categories identified are as follows: 1. human resources; 2. members/shareholders, financial community; 3. clients; 4. suppliers; spring 2006 perrini et al.: corporate social responsibility 77 5. financial partners; 6. government, local authorities and public administration; 7. community; 8. environment. the structure based on stakeholder categories focuses on the relationships and the related performance which companies, and especially smes, develop through their activities and behavior. in particular, as previously mentioned, in the italian context networks between companies and local stakeholders (community, environment, financial partners, etc.) affect in a direct way the overall corporate performance (zaheer, mcevily & perrone, 1998). during the current year, the ministry of labour and social affairs is implementing the project through the involvement of many stakeholders (business associations, trade unions, universities, ngos) and the network of unioncamere (the italian association of chambers of commerce). survey of csr: the research model the next part of the paper is directed towards providing an overview of csr in italy through an investigation based on an empirical survey. the survey, based on a sample of395 enterprises, was started in 2002 and had the aim of gathering descriptive data and information on the perceptions that italian entrepreneurs and managers had of corporate responsibility and their interpretations of it. in italy, in fact, little was known about the involvement of the industrial and economic world in managing these issues with the different categories of stakeholders (such as employees, shareholders, customers, suppliers, community and financial partners). although there has been much discussion on the topic among firms, industrial organizations, institutions and ngos no empirical evidence was found, despite a detailed analysis of the literature. therefore, before developing the proposal for a standard to foster socially responsible behavior in italian firms (the csr-sc project developed by the italian ministry of labour and social affairs with the technical support of bocconi university), it seemed opportune to conduct a first survey on the csr awareness and the attitude to it shown by italian companies. more specifically, the work aimed to focus on the following topics: 1. the attention paid by companies to csr issues; 2. the social activity promoted by companies within csr; 3. difficulties and obstacles in implementing csr; 4. perceived advantages related to the enforcement of csr; 5. factors that could lead to greater attention to the issue. methodology the approach taken to investigate these aspects was to select a sample of what might be thought of as "leading companies on csr" or "companies sensitive 78 journal of business strategies vol. 23, no.1 to csr." this assumption is related to the general goal of the research project developed for the ministry of labour and social affairs, which aimed to define a new standard of social responsibility, devoted at first to csr "best in class" firms. the sample was chosen with the support of "confindustria," the leading italian organization for manufacturing and service industries, and comprises 395 enterprises selected on the basis of the parameters of confindustria's associating system. moreover, the sample has been defined considering the distribution of the italian companies in terms of size (number of employees), sector of activity and geographical criteria. corrections were introduced to weight the relevance of smes in the sample. the questionnaire was formulated, based on current european and italian literature (commission of the european communities, 2002a; unioncamere and isvl, 2003), and was made up of two parts: a group of questions on company data (e.g., number of employees, turnover, sector, adoption of specific management programs and tools); 11 close-ended questions on csr. the questionnaires were sent to board chairmen, managing directors, chief executive officers and top managers of the sample companies. in a first phase, all the information collected was organized using simple statistical tools (e.g., weighted averages, percentile ranking and frequency distributions). 91 questionnaires were received, representing a response rate of approximately 25%. table 4 gives an overview of the distribution of the questionnaires received with regard to the size of the firms. although the sample was chosen among "best in class" companies according to the confindustria's parameters, the response rate of smes « 50 employees) was in any case lower than response of large companies. in a second step, data collected in this way was used to carryon a more in depth statistical analysis in order to define a more complete picture of the relationships and antecedents at the basis of corporate behavior in the csr field. the statistical tools adopted were linear and logistic regression: the choice was related to the type of dependent variables considered, i.e., activities on csr in which companies are involved, tools implemented to promote csr and companies' opinions on the dimensions of csr. these dependent variables were correlated with size and geographical location. the size of companies was measured as the number of employees; the geographical location was measured looking at the area where companies operate. in particular, north-east of italy has been coded as 1, north-west as 2, centre as 3 and south as 4. key findings of the first survey all the companies interviewed were somehow proactive in terms of their attentiveness to new managerial tools such as iso 9000: 1994, vision 2000, iso 14001, emas, sa 8000, responsible care, ethical codes, environmental reports, and social reports. generally speaking, companies' attention to csr issues and adoption ofcsr behavior seem quite high. the majority of the interspring 2006 perrini et al.: corporate social responsibility table 4 sample's distribution by number of employees (%) 79 no. of employees sample complete questionnaires received more than 500 19.5 35.6 250-499 6.6 12.2 50-249 248 22.2 20-49 21.8 17.8 0-19 27.3 12.2 100 100 viewees (84%) declared that they were involved and active in the area ofcsr. in addition, for 62 % of the firms the involvement in socially responsible activities is regular and related to business strategy. in detail, the initiatives most frequently realized in the sphere ofcsr are: training activities (89%); safeguarding employees' health (82%); initiatives in favor of the local community (72%); support of cultural activities (70%) and control of product safety and environmental impact (62%). on the other hand, these companies are not heavily engaged in the following activities: on-site child care facilities (only 2%); participation in fair trade (4%); equal opportunities policies (13 %); programs for protected categories (15%) and disadvantaged persons (27%) and control of the ethical and social aspects of products (17%) (table 5). table 5 activities on csr in which the company is involved activity percentage training activities 89 safeguarding employee health 82 local community involvement 72 support of cultural activities 70 product safety 67 controlling environmental impacts of products 62 support of sports activities 57 employee services 55 environmental protection activities 39 customer satisfaction 34 sourcing policies 29 initiatives for disadvantaged persons 27 controlling of ethical and social aspects of products 17 initiatives for protected categories 15 initiatives for equal opportunities 13 fair trade initiatives 4 on site child-care facilities 2 no answer 1 80 journal ofbusiness strategies vol. 23, no.1 with regard to the concrete tools and activities implemented by companies to promote csr, respondents are involved either in internal programs or in external ones (table 6). table 6 tools implemented to promote csr activity percentage employees involvement programs 83 sponsorship (regular and continuous) 75 donation (ad hoc in cash or kind) 51 direct investment 47 adoption of management systems 42 adoption of code of conduct 34 corporate campaigning 21 participation in csr programs 16 no answer 0 as a wide range of definitions have been given to csr, one survey question was structured in order to discover top managers' perception ofthe csr concept: "in your opinion, which dimensions does crs include?" in this case a 5-point likert scale was used. the results are reported in table 7. table 7 dimensions ofcsr: companies' opinions (%) strongly somewhat somewhat strongly nai agree agree disagree disagree do not with with neutral with with know respect of ethical principles 55 40 1 1 0 3 codes of conduct 36 50 7 1 0 6 quality of life 34 57 8 0 0 1 transparency 36 48 10 2 0 3 marketing 13 40 26 9 3 9 clients and suppliers selection 23 45 17 7 1 7 company reputation 42 43 9 1 0 4 local community initiatives 28 57 6 5 1 3 philanthropy and donations 7 26 31 15 5 17 human rights 43 41 9 1 2 3 equal opportunity 27 45 23 0 0 5 employee safety 74 24 1 1 0 0 environmental protection 60 39 0 0 0 1 evidence indicates that csr is considered a very broad concept, encompassing many different dimensions (no one answer was completely excluded by responspring 2006 perrini et al.: corporate social responsibility 81 dents). however, some aspects seem to be more linked to corporate responsibility than others: employee safety, environmental protection, respect of ethical principles and human rights, company reputation, adoption of conduct codes, transparency, attention to the quality of life and promotion of local community initiatives. out of the remaining choices, philanthropy, donations and marketing were those perceived as least relevant to the subject of the survey. interestingly, although the sample was selected among "sensitive to csr companies," chosen for their leading role inside confindustria's network, only 45% were familiar with the "green paper" on csr promoted by the ed. as for the reasons that encouraged a company to adopt socially responsible behavior, the most frequent advantages indicated are: benefits to company image (90%), opportunity to improve relations with the local community (76%) and specific motivations of top management (56%). meanwhile surprisingly only 1 company (1 %) indicated pressures from clients and suppliers and from ngos as a relevant reason to promote socially responsible initiatives. seventyfour questionnaires were analyzed, because not all firms involved answered this specific question. table 8 reasons that encouraged a company to adopt socially responsible behavior activity percentage company image 90 relation with local community 76 ethical motivation of top management 56 employees satisfaction 49 business partner relations 43 relation with public authorities 25 customer satisfaction and loyalty 22 ability to attract new employees 21 legal obligations 15 investor relations 13 market share 10 pressure from local community 9 public incentives 6 ability to attract financial resources 6 pressure from headquarters 4 pressure from public authorities 4 fiscal incentives 3 pressure from clients and suppliers 1 pressure from ngos 1 in addition, the companies were asked to identify obstacles in implementing csr. the lack of time and severe time pressure (61 %) and lack of human resources to address csr issues were the two principal barriers that emerged 82 journal ofbusiness strategies vol. 23, no. i from the survey. other difficulties in involvement in social responsible activities were lack offinancial resources and cost constraints (38 %) and little awareness of the topic (31 %). finally, we asked which factors could bring more attention to csr in the future. the main expectations of respondents were fiscal incentives (48%) followed by the spread of information on csr (47%) and benefits for company image (47%). in contrast, companies did not consider the possibility of obtaining greater access to financial resources (7%) and better relations with public authorities (17%) as factors likely to increase the involvement in csr in the future. moreover, 43% of the sample declared their intention to increase their involvement in csr over the next three years, while 58% declared that they would keep it at its current level. ifwe consider the more in depth statistical analysis, some interesting findings can be presented. here we describe the most significant results related to some of the categories we used to measure the dependent variables. in order to test the correlation between csr activities and firms' size and geographical location, a logistic regression has been implemented. results described in table 9 show some findings regarding activities on csr, in which companies are involved. in particular, geographical location is statistically significant (p < 0.01) and negatively correlated to the environmental protection activities (r = -0.493). environmental protection activities are also statistically significant (p < 0.05) and negatively correlated to firm size (r = -0.289). geographical location is statistically significant (p < 0.01) and negatively correlated to initiatives for equal opportunities (r = -0.647). local community involvement is statistically significant (p < 0.0 i) and negatively correlated to firm size (r = -0.338). finally, support of sports activities and cultural activities are statistically significant (p < 0.0 i) and negatively correlated to firm size (respectively r = -0.288 and r = -0.313). table 9 coefficient for the dependent variables: activities on csr environinitiatives mental for equal local support of support of protection opporcommunity sports cultural activities tunities involvement activities activities geographic location -0.493** -0.647*' 0.013 0.173 0.129 firm size -0.289* -0.285 -0.338*' -0.288** -0.313** p< 0.000 0.001 0018 0.036 0031 note: ** p < .01; *p < .05 in general, data suggest that activities which have a direct impact on the welfare of the local community (environmental protection, local community involvement, support of specific activities such as sports and cultural programs) are based on a stronger involvement of the smes. this is coherent with a view focused on the concept of social capital as a fundamental asset for the success spring 2006 perrini et at.: corporate social responsibility 83 of the italian companies: smes are crucial parts of the community where they are located and they maintain and strengthen their local trust relationships over time through a significative social commitment. furthermore, according to the negative correlation between environmental protection/equal opportunities and geographical location the social and environmental consciousness and awareness seem to be higher in northern italy. many data, with particular regard to environmental policies, confirm these results (a pat, 2003). with the aim of testing the correlation between the tools implemented to promote csr and firms' size and geographical location, a logistic regression has been run. table 10 presents some results on the relationship between tools and the independent variables. geographical location is statistically significant (p < 0.01) and negatively correlated to corporate campaigning (r = -0.573). direct investments are statistically significant (p < 0.0 i) and negatively correlated to firm size (r = -0.339). employee involvement programs are statistically significant (p < 0.01) and negatively correlated to firm size (r = -0.389). adoption of codes of conduct is statistically significant (p < 0.01) and negatively correlated to firm size (r = -0.390). moreover, it is marginally statistically significant (p < 0.1) and negatively correlated to geographical location (r = -0.306). these results suggest that companies located in northern italy are more interested in using advanced tools (corporate campaigning and codes of conduct) to foster socially responsible initiatives. smes seem to be more sensitive to actions (direct investments in the community, employee involvement programs and adoption of codes of conduct), which could directly affect in a positive way their relationships with the different stakeholder categories, especially at the local level. table 10 coefficient for the dependent variables: tools promoting csr employee adoption of corporate direct involvement code of campaigning investment programs conduct geographic location -0.573** 0.135 -0 116 -0.306t firm size -0.177 -0.339" -0.389** -0.390** p< 0.002 0.015 0.011 0.001 note: ** p < .01; *p < ,05; t p < .10 an ols regression model has been used to study the correlation between the companies' opinions regarding the dimensions of csr and firms' size and geographical location. table ii shows those results that are statistically significant. in particular, equal opportunity is statistically significant (p < 0.01) and negatively correlated to geographical location (r = -0.182). even if the model is marginally statistically significant (p < 0.1), local community initiatives are statistically significant (p < 0.05) and negatively correlated to geographical location (r = -0.133). 84 journal ofbusiness strategies vol. 23, no.1 table 11 coefficient for the dependent variables: dimensions of csr local equal community opportunity initiatives geographic location -0.182** -0.133' firm size 0.101 -0.054 p< 0021 0.100 note:" p < .01;·p < .05 as we expected, the findings have generally demonstrated that the definition of the csr concept (i.e., the different csr dimensions) is independent from the geographical location or the size ofthe companies. in any case, companies located in northern italy show a greater attention to the issues related to the respect of equal opportunities and local community initiatives. as previously underlined, this result could be related to a higher social awareness and to the fact that industrial districts and networks are more developed in northern and central italy. conclusions it could be useful to underline the contribution delivered by this paper to the international debate on csr. this is a first outline of the overall policies and initiatives carried on in italy in the csr field. therefore, our work tries to define the most up-to-date picture of the italian "state of the art" related to csr issue. the study clearly demonstrates that italy is at the forefront ofcsr initiatives in europe and despite the challenging global economic environment, the first signs of the kind of stable, economic growth that csr promotes are beginning to take place. the research synthesizes some critical elements that deserve mention here: • the existence of numerous spontaneous csr initiatives; • the relevance of european-wide guidelines; • the ministry of labour and social affairs's promotion towards a mature csr approach within a common framework; • the divide between smes and large companies (by size), but also interesting differences by geographical areas and industry. according to the findings of the survey, italian companies showed a positive attitude towards csr. despite an unclear definition of csr, firms seem to be engaged in socially responsible activities using several tools: specific programs on social issues, sponsorships, donations, direct investments and adoption of codes of conduct. the main reasons at the basis of the csr initiatives are related to company image and relations with local communities. in particular, the relationship between smes and local community seems to be fundamental in order to understand the choices carried out by the companies in this field. this spring 2006 perrini et al.: corporate social responsibility 85 could be explained if we refer to the concept of social capital as key-driver for the long-term success ofthe firms in the italian context. for this reason it is possible to talk about "sunk csr" if we consider behavior (e.g., local community initiatives and involvement) which companies have traditionally carried on in their own environment. the survey also identified internal and external barriers to the diffusion of csr among firms and factors that could lead to a deeper engagement in the near future. from a policy perspective, the need for public support is clearly pointed out by respondents as a critical factor in fostering csr behavior. more specifically, in addition to fiscal incentives, companies need information on corporate social issues (the lack of publicity on csr is considered one ofthe main obstacles to csr activities). public authorities have to develop and spread knowledge about csr in the business community through promotion and communication. however, it is useful to underline that the findings of this survey should not be misunderstood. the survey gives a picture of a group of "selected companies" (best in class companies) defined in coherence with the goals of the research project csr-sc that bocconi university carried out for the italian ministry of labour and social affairs. although the sample represents the overall population of italian enterprises in terms of size, sector and geographical distribution, it is not a random sample. meanwhile, for several companies csr is still an occasional topic, not closely related to the business strategy, as many business cases have demonstrated during the last years. in any case, the survey pointed out some specific spheres of interest that will be analyzed in depth through further research initiatives. references abi (associazione 8ancaria italiana) (2001). modello di redazione del bilancio sociale per il settore del credito. roma: bancaria editrice. alexander, g., & buchholtz, r. (1978). corporate social responsibility and stock market performance. academy of management journal, 21, 479-486. apat (italian agency for environment protection and technical services) & onr (national observatory on waste management) (2003). rapporto rifiuti 2003. roma. retrieved april 20, 2004, from www.sinanet.apat.it arlow, p., & gannon, m. (1982). social responsiveness, corporate structure, and economic performance. academy ofmanagement review, 7, 235-241. aupperle k. e., carroll, a. b., & hatfield j. d. (1985). an empirical examination of the relationship between corporate social responsibility and profitability. academy of management journal, 28,446-463. 86 journal ofbusiness strategies vol. 23, no.1 azzone, g., bianchi, r., & noci, g. (1997). implementing environmental certification in italy: managerial and competitive implications for firms. eco-management and auditing, 4, 98-108. becattini, g. (1987). mercato eforze locali: it distretto industriale. bologna: il mulino. bonal, j. (1981). responsabilita sociale e bitancio sociale d'impresa. milan: franco angeli. bowen, h. r. (1953). social responsibilities of the businessman. new york: harper and brothers. carroll, a. b. (1979). a three dimensional conceptual model of corporate social performance. academy of management review, 4, 497-505. carroll, a. b. (1991). the pyramid of corporate social responsibility: toward the moral management of organizational stakeholders. business horizons, 34, 39-48. carroll, a. b. (1999). corporate social responsibility. evolution of a definitional construct. business & society, 38, 268-295. carroll, a. b., & buchholtz, a. k. (2002). business & society: ethics and stakeholder management, 5th edition. mason, oh: thomson south western. cele (center for ethics, law & economics) (2002). the q-res project: the quality of the social and ethical responsibility of corporations. guidelines for management. castellanza: universita cattaneo. clarkson, m. b. e. (1995). a stakeholder framework for analyzing and evaluating corporate social performance. academy of management review. 20, 92-117. commission of the european communities (2001a). a sustainable europe for a better world: a european union strategyfor sustainable development. brussels: com(200 1) 264 final. commission of the european communities (2001 b). green paper promoting a european frameworkfor corporate social responsibility. brussels: com(2001) 366 final. commission of the european communities (2002a). european smes and social and environmental responsibility. luxembourg: observatory of european smes, no.4. commission of the european communities (2002b). corporate social responsibility: a business contribution to sustainable development. brussels: com(2002) 347 final. de bettignies, h. c. (2002). reviewing meanings and contexts of the role of business in society. paper presented, launch of the european academy of business in society. fontainebleau: insead. spring 2006 perrini et al.: corporate social responsibility 87 donaldson, t. (1989). the ethics ofinternational business. new york: oxford university press. donaldson, t., & dunfee, t. (1999). ties that bind: a social contracts approach to business ethics. cambridge: harvard business school press. donaldson, t., & freeman, r. e. (1994). business as a humanity. new york: oxford university press. donaldson, t., & preston, l. (1995). the stakeholder theory of the corporation: concepts, evidence, and implications. academy of management review. 20,65-91. drucker, p. f. (1984). converting social problems into business opportunities: the new meaning of corporate social responsibility. california management review, 26, 53-63. elkington, j. (1997). cannibals withforks. the triple bottom line of2 1st century business. oxford: capstone publishing. ethics officer association (2002). developing a business conduct guidelines standard. in g. brenkert (ed.), proceedings ofthe transatlantic business ethics conference. washington dc: georgetown university. figge, f., & schaltegger, s. (2000). stakeholder value: ein konzept, von dem aile profitieren k6nnen. in financial times deutschland. retrieved march 5, 2002 from www.ftd.de freeman r. e. (1994). the politics of stakeholder theory: some future directions. business ethics quarterly, 4, 409-421. freeman r. e. (200 i). a stakeholder theory of the corporation. rn t. l. beauchamp & n. e. bowie (eds.), ethical theory and business (6th ed.) (pp. 56-65). englewood cliffs: prentice-hall. friedman, m. (1962). capitalism andfreedom, chicago: university of chicago press. friedman, m. (1970, september 13). the social responsibility of business is to increase its profits. new york times magazine, 32-33. g8 declaration (2003). from www.g8.fr/evian/english/navagationi2003_g8_summit/summit_documents/fostering_growth_andpromoting_a_responsible_ market_economy_ -~a_g8_ declaration.html gbs (gruppo di studio per il bilancio sociale) (200 i). i principi di redazione del bilancio sociale. rome: adnkronos comunicazione. gilardoni, a. (ed.) (2000). health, safety & environment. indirizzi strategici e problematiche operative. milan: egea. 88 journal ofbusiness strategies vol. 23, no.1 global reporting initiative (gri) (2002). 2002 sustainability reporting guidelines. retrieved april 20, 2003, from www.globalreporting.org goodman, e., bamford, j., & saynor, j. (eds.) (1989). smallfirms and industrial districts in italy. london: routledge. hutton, w. (2002). the world we're in. london: little brown. joyner, b. e. & payne d. (2002). evolution and implementation: a study of values, business ethics and corporate social responsibility. journal of business ethics, 41, 297311. lanza, s., calcaterra, m., & perrini, f. (eds.) (2001). etica, finanza e valore d'impresa. milan: egea. lev, b. (2001). intangibles. management. measurement. and reporting. washington dc: brookings institution press. lin, n., cook, k., & burt, r. s. (eds.) (2001). social capital. theory and research. new york: aldine de gruyter. lipparini, a. (2002). la gestione strategica del capitale intellettuale e del capitale sociale. bologna: il mulino. lipparini, a., & lomi a. (1999). interorganizational relations in the modena biomedical industry: a case study in local economic development. in a. grandori (ed.). interfirm networks. organization and industrial competitiveness (120-150). london: routledge. margolis, 1. d., & walsh, 1. p. (2003). misery loves companies: rethinking social initiatives by business. administrative science quarterly, 48, 268-305. mcwilliams, a. & siegel, d. (2000). corporate social responsibility and financial performance: correlation or misspecification? strategic management journal, 21, 603-609. mc williams, a. & siegel, d. (2001). corporate social responsibility: a theory ofthe firm perspective. academy of management review, 26, 117-127. mills, r. w. & weinstein, b. (2000). beyond shareholder value reconciling the shareholder and stakeholder perspectives. journal of general management, 25, 79-93. ministry of labour and social affairs (2003). the italian contribution to csr promoting campaign developed at european level. proceedings of the european conference on corporate social responsibility the role ofpublic policies in promoting csr '. venice. retrieved march 12, 2004 from www.welfare.gov.it spring 2006 perrini et al.: corporate social responsibility 89 nahapiet, j. & ghoshal, s. (1998). social capital, intellectual capital and the organizational advantage. academy of management review, 23,242-266. pearce, j., raynard, p., & zadek, s. (1996). social auditing for small organizations. london: new economics foundation. perrini, f. (ed.) (2002). responsabilita sociale dell'impresa e finanza etica. milan: egea. perrini, f., calcaterra, m., pogutz, s., & tencati, a. (2002). research project for the italian ministry of labour and social affairs. proposal for a csr-sc standard. proceedings of the conference 'l 'impegno sociale delle imprese per un nuovo welfare'. milan: bocconi university. retrieved january 18,2003 from www.welfare.gov.it perrini, f., & tencati, a. (2002). corporate social responsibility and sustainability: the proposal for a new corporate performance evaluation and reporting framework. proceedings of the 5th annual corporate citizenship unit research conference. warwick: university of warwick. perrini, f., & tencati, a. (2003). corporate social responsibility and firm performance: managing sustainability and the need of a new corporate evaluation and reporting system in a knowledge economy. paper presented, 2003 academy of management conference. seattle, wa. peteraf, m. (1993). the cornerstones of competitive advantage: a resource-based view. strategic management journal, 14, 179-191. petrella, r. (ed.) (1995). gruppo di lisbona. llimiti della competitivita. roma: manifestolibri. porter, m. e. (2003). the corporation and society: the role of corporate philanthropy. paper presented, second eabis colloquium 2003. copenhagen. porter, m. e., & kramer, m. r. (2002). the competitive advantage of corporate philanthropy, harvard business review, december, 56-68. post, j. e., preston, l. e., & sachs, s. (2002). redefining the corporation: stakeholder management and organizational wealth. palo alto, ca: stanford university press. putnam, r. d. (1993a). making democracy work. civic traditions in modern italy. princeton, nj: princeton university press. putnam r. d. (l993b). the prosperous community, american prospect, 13,35-42. putnam, r. d. (2000). bowling alone. the collapse and revival ofamerican community. new york: simon and schuster. 90 journal ofbusiness strategies vol. 23, no.1 tencati, a. (2002a). sostenibilita, impresa e performance. un nuovo modello di evaluation and reporting. milan: egea. tencati, a. (2002b). managing sustainability. in l. zsolnai (ed.). ethics in the economy. handbook ofbusiness ethics (pp. 187-209). oxford and bern: peter lang academic publisher. the copenhagen centre (1998). the vision behind the copenhagen center. copenhagen. retrieved july 16,2002 from www.copenhagencentre.org unioncamere (italian union of chambers of commerce, industry, craft and agriculture) (2003). models ofcorporate social responsibility in italy, carried out in cooperation with isvi (lstituto per i valori d'impresa). research conducted within the csr-sc project of italian ministry of labour and social affairs and bocconi university. united nations commission on human rightssub-commission on the promotion and protection of human rights (2003). norms on the responsibilities of transnational corporations and other business enterprises with regard to human rights. geneva: office of the united nations high commissioner for human rights. walsh, j. p., weber, k., & margolis j. d. (2003). social issues and management: our lost cause found. journal of management, 29, 859-881. wbcsd (world business council for sustainable development) (1999). corporate social responsibility. meeting changing expectations. conches-geneva. retrieved july 21,2001 from www.wbcsd.org weiser, 1., & zadek, s. (2000). conversations with disbelievers. persuading companies to address social challenges. new york: the ford foundation. wood, d. j. (1991). corporate social performance revisited. academy of management, 16,691-718. zadek, s., pruzan, p., & evans, r. (eds.) (1997). building corporate accountability: emel~r;ing practices in social and ethical accounting, auditing and reporting. london: earthscan. zaheer, a., mcevily, b., & perrone, v. (1998). relational governance as an interorganizational strategy: an empirical test of trust in economic exchange. strategic management journal, 16,373-392. zsolnai, l. (2002a). new agenda for business ethics. in l. zsolnai (ed.), ethics in the economy. handbook of business ethics (pp. 1-7). oxford and bern: peter lang academic publisher. zsolnai, l. (2002b). future of capitalism. in l. zsolnai (ed.). ethics in the economy. handbook of business ethics (pp. 295-308). oxford and bern: peter lang academic publisher. spring 2006 perrini et al.: corporate social responsibility 91 francesco perrini is associate professor of management and innovation at the "g. pivato" department of management, bocconi university, milan, italy. he is also senior professor of corporate finance at the sda bocconi school of management. during 2004-05, he was visiting professor at the legal studies and business ethics department, wharton school, university of pennsylvania. his primary research interests are management of corporate development processes, corporate responsibility and social entrepreneurship. stefano pogutz is assistant professor of management at the "g. pivato" department of management, bocconi university, milan, italy. since 1997, he has been a member of the environmental management inter-faculty group of the master cems-mim (community of european management schools master in international management). his primary research interests include innovation and environmental management and corporate social responsibility. antonio tencati is assistant professor ofmanagement at the "g. pivato" department of management, bocconi university, milan, italy. since 2000, he has been a member of the business ethics inter-faculty group of the master cems-mim (community of european management schools master in international management). his primary research interests include management of sustainability and corporate social responsibility. corporate social responsibility in italy: state of the art multiple directorships and corporate misconduct: the moderating influences of board size and outside directors mel e. schnake robert j. williams valdosta state university valdosta, ga abstract this study examined the possible impact ofboth board size and the proportion ofoutside directors on the link between directors holding multiple directorships andfirm misconduct. the study utilized a sample of 181 firms drawn from the financial services sector during the 1999-2003 time period the results suggest that among thosefirms whose directors hold multiple directorships, the incidence of10k investigations initiated against those firms is significantly less in those firms having smaller boards. the results offer further evidence that smaller boards might be better monitors of their firms' behavior than larger boards. further, contrary to theory, no significant relationship was observed between proportion ofoutside directors, multiple directorships and the incidence of10k investigations. the implications of the findings and areas for future research are discussed. background there is an on-going debate within the area of corporate governance regarding the membership of directors on multiple boards and its potential impact on effective firm monitoring. in light of the recent scandals involving firms such as enron, worldcom, and tyco, effective corporate governance is seen by institutional investors and shareholder activists to be extremely important. while researchers have examined various governance issues, the potential consequence of multiple board membership by directors on monitoring their firms remains largely unexplored (ferris, jagannathan & pritchard, 2003). multiple directorships and director distraction there is some debate as to whether the service of directors on multiple boards will serve to either bolster or hinder proper firm monitoring, and serve to prevent firm misbehavior. some favor multiple directorships, arguing that firms can obtain valuable resources and vital information through board interlocks (business roundtable, 1997; schnake, fredenberger & williams, 2005; zahra & pearce, 1989). 2 journal of business strategies vol. 25, no.1 there is some evidence that board interlocks may be linked with effective capital acquisition (mizruchi & steams, 1988; steams & mizruchi, 1993). a board whose members serve on several other boards may enable the firm to gain access to needed resources and critical information through these multiple directorships (bhagat & black, 1999; zahra & pearce, 1989). interlocked directors may be able to observe investigations and legal proceedings brought against other firms on whose boards they serve. directors can then bring that vital information back to the other boards on which they serve, enabling these firms to take action to avoid similar legal pitfalls and litigation (schnake et ai., 2005). on the other hand, there appears to be a dominant belief among institutional investors and governance activists that, given their limited time and cognitive abilities, service on multiple boards may result in board members becoming distracted, and may reduce their abilities to effectively monitor their firms (ferris et ai., 2003; lipton & lorsch, 1992). through their service on several boards, directors may serve on fewer board committees and, therefore, may simply be too busy to properly monitor their firms (ferris et ai., 2003). thus, any informational advantages gained through service on other boards may be lost due to director distraction caused by being too busy and being spread too thinly. further, it is likely that directors who serve on multiple boards may serve on firms in different industry settings. having to face different industrial scenarios, the result is a greater demand on the director's cognitive abilities and more distraction for the director (schnake et ai., 2005). this notion of director distraction is often termed the "busyness hypothesis," and is linked by some to improper board oversight and its consequences. the council of institutional investors takes a position in line with the busyness hypothesis. the council is an association of approximately 130 public and private pension funds whose members collectively manage more than $3 trillion in pension assets. the council has argued that directors holding full-time positions should limit the number of boards on which they serve, and has argued strongly in favor ofrestricting multiple directorships due to director distraction. lo-k investigations those firms that are not properly monitored by their boards are far more likely to engage in illegal activity, and are often the target of investigations conducted by various state and federal agencies (schnake et ai., 2005). in many cases these investigations result in a prosecution ofthe firm as a means to sanction the firm, or to impose remedies resulting from certain illegal acts committed by the firm. a broad measure of possible firm misbehavior is reflected in the number of investigations reported in each firm's io-k reports. the term "investigations" is used in the present study because not all of these actions result in legal proceedings. the fact that a firm is being investigated for possible illegal activity, however, does indicate that the potential for wrongdoing is highly possible, and some party or parties feel(s) the need for litigation to remedy an actual or perceived illegal act on the firm's part. spring 2008 schnake & williams: multiple directorships 3 specifically, io-k investigations involve those investigations and legal proceedings instituted by the u. s. department of justice, the securities and exchange commission, the environmental protection agency, the federal trade commission, the equal employment opportunity commission, or similar agencies at the state level. if brought to fruition with sanctions levied against the firm, these proceedings could significantly impact the firm's long term financial position. these types of serious violations are the responsibility of the board to monitor and prevent, and may include investigations involving accounting fraud, product liability, environmental degradation, workplace discrimination, antitrust activity, and employee safety. while not all investigations culminate in legal sanctions against the firm, we feel that the sheer number of investigations does reflect the extent to which the firm's board is either properly performing or shirking its oversight duties. if directors become too busy or distracted to adequately monitor their firms, there will be a greater likelihood that illegal activity will increase within the firm. a firm led by directors who are distracted to some degree may well provide fertile ground for misbehavior and for the instigation of government investigations to uncover either actual or alleged wrongdoing. it can be argued that the link between director distraction resulting from multiple directorships and inadequate firm oversight should be moderated, to some extent, by both board size and the proportion of outside directors that serve on the firm's board. with respect to board size, however, there is no consensus among researchers as to whether larger or smaller boards are better equipped to provide effective firm oversight (dalton, daily, johnson & ellstrand, 1999; johnson, daily & ellstrand, 1996). board size and firm monitoring research on the possible influence of board size on firm behavior has been somewhat limited. nevertheless, some theoretical arguments favoring both larger and smaller boards have been established. those favoring large boards argue that larger boards are more diverse and less cohesive than smaller boards. this diversity may be beneficial, as it may encourage conflict and debate among directors and result in the formulation of a variety of decision alternatives (dalton et a1., 1999; johnson et a1., 1996). a larger board possesses a more diverse set of skills and opinions among its members, and may be better equipped to acquire and evaluate information about the firm and its environment (amason & sapienza, 1997). there is evidence that firms with larger boards experience lower variability in both accounting and stock market returns (cheng, 2008). this may result from the fact that larger boards require more compromise among members in order to reach consensus, thus, decisions made by larger boards may be less extreme, resulting in lower variability in firm perfonnance (cheng, 2008). some researchers take the opposite view on board size, and argue that smaller boards may be better equipped to monitor their firms than larger boards. smaller boards tend to encourage greater focus, more member participation, and cohesiveness, less social loafing, and more lively debate among board members than 4 journal ofbusiness strategies vol. 25, no.1 larger boards (firstenberg & malkiel, 1994; garg, 2007; hermalin & weisbach, 2003; lipton & lorsch, 1992; yermack, 1996). disagreements and fragmentation among board members tends to be more common in larger boards. when this occurs, the firm's top management team might gain relative advantage in power and influence through a number of political strategies, including coalition-building, selective channeling of information, and "dividing and conquering" (alexander, fennel & halpern, 1993). smaller boards, therefore, may be less subject to manipulation by the firm'8 top managers (alexander et ai., 1993; lipton & lorsch, 1992; yermack, 1996). using a sample of 452 large industrial firms from the 1984-1991 time period, yermack (1996) observed a link between firm value and small board size. yermack concluded that as boards increase in size they become less effective as a result ofthe problems of coordinating a large board. thus, the problems that arise with coordinating a larger board overwhelm the advantages from having more board members to draw on. while there is some anecdotal evidence linking board size with firm performance, there are only a few studies that have examined the possible link between board size and firm misbehavior. in one ofthe few studies that has examined this issue, williams, f adil & armstrong (2005) found an inverse relationship between board size and both osha and epa violations in 221 retailing and manufacturing firms from the 1998-2002 time period. this study was insightful, and its results support the notion that larger boards might provide better firm oversight than smaller boards. nevertheless, it is arguable as to whether the nature offirm misbehavior used in the williams et a1. (2005) study, namely osha and epa violations, would actually rise to the level of board oversight this type of illegal activity might fall, more realistically, under the auspices ofthe top management team. the measure offirm misbehavior used by williams et a1. (2005) may be more symptomatic of a sloppy management style, rather than inadequate firm monitoring by the board. in another study, schnake, fredenberger & williams (2005) found no direct link between board size and firm misconduct among sample firms in the financial services sector. schnake et al. (2005) did include the number of 10k investigations as their measure of firm misconduct, the first time such a measure has been used to measure firm misconduct. given the limited empirical research in this area, the authors' were swayed by the theoretical arguments involving the diminished effectiveness oflarger boards in monitoring their firms. further, given that schnake et a1. (2005) found no direct link between board size and firm misconduct, perhaps board size might better be viewed as a moderator between the number of boards served on and firm misconduct. theoretically, a larger board coupled with a higher level of multiple board membership by a firm's directors should promote both member distraction and diminished board focus, and should reduce a board's capacity for adequate oversight. this interaction may offset any advantages of board size in increased information flow and access to resources. in addition, by modeling board size spring 2008 schnake & williams: multiple directorships 5 as having more of a moderating effect, rather than a direct effect, on the number of boards served on and firm misconduct relationship, and by using a unique measure of firm misconduct (10k investigations), this study should build upon and extend the findings of both williams et al. (2005) and schnake et a1. (2005). thus, the following hypothesis is offered. hypothesis 1: boardsize moderates the relationship bern'een the number of total boards served on by a firm s directors and the number of 1ok investigations initiated against their firms, such that the number of 1ok investigations will increase among those firms having larger boards and whose directors serve on multiple boards. outside directors and firm monitoring outside directors on a firm's board may increase the breadth of experience and knowledge of the board allowing it to make more informed decisions. further, outsiders may be more independent from the ceo and/or top management team and, therefore, better able to protect shareholder interests. the trend in corporate governance has resulted in an increase in the proportion ofoutsiders on many firms' boards (wheelen & hunger, 2004). this trend toward more outsiders has resulted from the growing influence of institutional investors such as caipers, tiaa-cref, various pension funds, mutual funds, and insurance companies who are putting pressure on firms to improve performance (wheelen & hunger, 2004). wang & dewhirst (1992) found that outside directors are very committed to representing various stakeholders beyond just the stockholders. as a result, outsiders tend to be sensitive to environmental issues, women and minority issues, employee welfare, and firm behavior. outsiders are more likely to be knowledgeable about issues facing the firm and comply with legal requirements in order to avoid penalties and negative public relations (johnson & greening, 1999). beginning in november, 2003, the securities and exchange commission approved new listing standards that apply to firms listed on the new york stock exchange and nasdaq. these standards require that a majority ofa listed firm's board be composed of outside (independent) directors. in addition, section 301 of the sarbanes-oxley (sox) legislation of 2002 calls for an increased role for outside directors on a firm's board (lee & carlson, 2007). sox has mandated that at least one member of the board will be an outsider with financial expertise, and all members of the firm's audit committee will be outsiders. there has been significantly more research on the influence of outside directors on firm performance than has been conducted with board size and firm performance. further, the authors are aware of no studies that have examined the nature of the interaction of board size with the percentage of outsiders on the board, and how this interaction, if any, might affect firm monitoring. while of interest, the possible presence of this interactive effect was beyond the scope of the present study. 6 journal ofbusiness strategies vol. 25, no.1 given these arguments regarding the role played by outside directors, it is our contention that the percentage of outside directors on a firm's board should moderate the link between multiple board membership and firm monitoring. therefore, the following hypothesis is offered. hypothesis 2: the percentage ofoutside directors moderates the relationship between the number oftotal boards served on by afirm s directors and the number of1o-k investigations initiated against theirfirms, such that the number of10k investigations will decrease in thosefirms having a higher percentage of outsiders on their boards and whose directors serve on fewer multiple boards. methods sample firms in the financial services sector were selected for study. we confined our sample to all financial services firms that were continuously listed on the new york stock exchange during the 1999-2003 time period for which adequate information regarding both 10-k investigations and board data were available. the sample consisted of 181 firms drawn from the following industries within the financial services sector: (1) consumer financial services, (2) accident and health insurance, (3) life insurance, (4) property and casualty insurance, (5) investment services, (6) money center banks, (7) regional banks, (8) savings banks, and (9) miscellaneous financial services. this study was limited to firms within a single sector to reduce any possible industry effects that might influence the results. given that financial services firms are highly regulated by various federal and state agencies, the potential impact of various board characteristics on these firms should be of particular interest. measures board data. board composition data were gathered from the edgar database available from the securities and exchange commission. the sample firms' 10-k reports and def 14-a reports for the years 1999-2003 were the sources of the data. we were able to determine average board size (total number of directors), board composition (insiders versus outsiders), and the average number of total boards that each director served on during the study period. in addition, the logarithm ofaverage firm sales during the five year period served as a measure of firm size, and was obtained from hoover s company profiles. all of the variables represent averages over the five year study period. in determining whether a director was an insider or an outsider, we were aware of the lack of independence and potential inadequacies in firm monitoring posed by, so called, "gray" directors (helland & sykuta, 2005; ryan & wiggins, 2004). gray directors may be retired former directors or employees of the firm, spring 2008 schnake & williams: multiple directorships 7 or they may be family directors with family ties to the firm's founder and may hold large blocks of the firm's stock. in addition, gray directors may work for other affiliated firms that are large suppliers of the firm, or other firms that may handle the insurance, legal, or consulting work for the firm. while it is often difficult to identify gray directors, we did make a diligent effort to do so. in compiling the data, we opted to classify family directors, retired former directors and employees, and affiliated directors as insiders. while these directors were not technically insiders, their influence would, in all likelihood, exert the same level of independence as an insider. lo-k investigations. the number of investigations initiated against each firm was obtained from the sec database. detailed descriptions of these investigations, if any, are presented in item 3 of each firm's 10-k reports. the number of 10-k investigations reflect possible misbehavior, and reflect how well these firms are being monitored by their boards. only those investigations conducted between 1999-2003 were included. the possible types of misbehavior for which firms are investigated are frequently very serious in nature, and involve legal proceedings beyond the firm's ordinary business activity. in analyzing the lo-k reports, two raters were used to categorize the types and timing of the various investigations. in the vast majority of cases, the raters were in agreement as to the nature and time period in which the investigations were undertaken. in the few cases where agreement could not be reached, a third rater was used to settle the issue. it was observed that 94 of the 181 sample firms (52%) had encountered at least one investigation during the study period. analytical procedures table 1 shows the means, standard deviations and a correlation matrix of all variables included in the analysis. table 1 means, standard deviations and a correlation matrix mean std. dev. 1 2 3 4 5 1. 10k investigations .93 2.94 1.00 .17* ,31** .39** .08 2. board size 11,64 3.97 1.00 .07 .36** .30" 3. total number of boards served on 1.65 1.00 1.00 ,48** .24** 4. log average revenue 7,12 1.61 1.00 ,16* 5. percent of outsiders on board .73 .13 1.00 'p < .05 *.p < .01 n =181 8 journal ofbusiness strategies vol. 25, no.1 a stepwise regression analysis was used to test the interaction hypotheses. the logarithm of firm size (average revenue) was entered on step one as a control variable. then, for hypothesis 1, board size and total number of boards served on was entered on step two. on step 3, the 2-way interaction term (board size x total number of boards served on) was entered. for hypothesis 2, percentage of outside board members and total number of boards served on was entered on step two, followed by the 2-way interaction term (percentage of outside board members x total number of boards) on step three. a possible 3-way interaction (board size x percentage of outsiders x total number of boards served on) was similarly tested, with the 2-way interactions entered on step 3 and the 3-way interaction term entered on step 4. the results of the stepwise regression analysis appear in table 2. it should be noted that the 3-way interaction results were not significant (f change = .993, p < .32), and therefore, did not add to explained variance beyond the 2-way interaction effects. given the lack of significance in the 3-way interaction term, the result was not included in table 2. thus, it is appropriate to interpret any 2-way interactions. table 2 results of the regression analysis change in r2 step 1: log average revenue step 2: bdsize,totaibds,%outsiders step 3: two-way interactions model r2 =.23** beta coefficients oftwo-way interactions totalbds x bdsize totalbds x %outsiders bdsize x %outsiders .p < .05 up < .01 n =181 bdsize =board size totalbds = tota! number of boards on which directors serve %outsiders =percentage of outsiders on the board .151** .024 .05** .83** .40 .24 astepwise regression analysis entering the 2-way interactions at step 3 revealed the 2-way interactions to be statistically significant a review of the beta coefficients revealed that the total boards served on x board size 2-way interaction contributed a significant amount of explained variance in the number of 10k investigations (beta = .83, p < .01). the beta coefficients of the other 2-way interactions were not statistically significant. spring 2008 schnake & williams: multiple directorships 9 hypothesis 1 was supported. the control variable (log ofaverage revenue) was statistically significant on step one (~r2 = .15, p < .01). the 2-way interaction tenn was also statistically significant (8r2= .05, p < .01). aplot ofthe 2-way interaction of board size and total number of boards served on appears in figure 1. figure 1 plot of two-way interaction effect of board size and total number of boards served on and number of 10k investigations plot of board size x number of boards served on interaction 18 16 14 cfi l: 120 ;l a:s 10c) :;; ii) 8q)> .e 6~ 0 ""' 4 2 0 large board -.... size.. _... .......... .. '............ small board -.................... size..... .................. 1 few number of boards served on 2 many to interpret the 2-way interaction, a group (categorical) variable was created by splitting the board size and total boards served on variables at the mean. the bonferroni multiple comparison procedure was used to examine which groups were significantly different. this analysis revealed that larger boards with directors serving on a larger number of other boards had significantly greater numbers of 10k investigations than smaller boards with directors serving on fewer other boards, and larger boards with directors serving on fewer other boards. there was no significant difference between smaller boards with directors serving on many other boards and larger boards with directors serving on many other boards. thus, the total number of boards served on appears to dominate board size in its effect on the number of 10k investigations. hypothesis 2 was not supported. again, the control variable (log of average revenue) was significant (8r2 = .15, p < .0 i), however, there was no significant 2-way interaction effect nor any significant main effects observed. in the process 10 journal ofbusiness strategies vol. 25, no. i of conducting the analyses, we also examined a possible board size x percentage of outsiders on the board which was found to be non-significant. discussion there remains considerable debate as to the role that board size plays in influencing various firm outcomes. further, the extent to which directors might become too busy and distracted to properly discharge their board oversight duties as a result of multiple board memberships also remains speculative. the results of the present study, however, shed some light on a possible linkage between these two constructs. our findings suggest that if the busyness hypothesis is present in firms whose directors hold multiple directorships, the distraction and diminished focus of these directors might be greatly magnified ifthey serve on larger boards. a large board may become fragmented and its activities more difficult to coordinate. this might allow an opening fot the firm's top management team to gain relative advantage in power and influence in relation to the board. this factor, coupled with directors who are simultaneously holding multiple directorships, should result in further fragmentation of the board and hamper its ability to discharge its oversight function. the results do provide additional evidence in support of those who advocate the virtues of smaller boards. smaller boards may be better focused, more easily coordinated, and less susceptible to member fragmentation than larger boards. with respect to proper firm oversight, the results suggest that smaller boards would seem preferable among firms whose directors are serving on the boards of other firms. the proposed benefits resulting from the inclusion of outside directors on the board were not observed, at least with respect to the abilities of outsiders to reduce the number of investigations. outsiders do bring objectivity, diverse ideas, and external knowledge to a firm, and these might provide the firm with distinct performance advantages. nevertheless, our results suggest that with respect to firm oversight, the proposed benefits associated with outsiders may be overstated, at least for firms in the financial services sector. outside directors generally possess a higher level of independence than insiders. nevertheless, outsiders also possess less day-to-day knowledge of their firms' activities and, therefore, may not be in a position to sufficiently detect frim misconduct. there is a growing trend among institutional investors to prompt boards to appoint more outsiders. while the presence of outsiders did not reduce investigations among the financial services firms examined in this study, perhaps firms in other industries might experience fewer investigations as more outsiders are added to their boards. several limitations were evident in this study. first, by using the total number of investigations as reported by firms in their 10k reports, differences in the magnitude of the investigations was not considered. obviously, more minor spring 2008 schnake & williams: multiple directorships 11 violations might be committed more often than more serious violations. in fact, a firm having several minor investigations might be more a victim of sloppy management, rather than a gross violator of the law. still, sloppy management must be addressed and corrected by the board since the board is ultimately responsible for firm outcomes. in addition to the number of 10k investigations, it is recommended that other measures of firm behavior also be considered for use in this area of research. a second limitation involves the use of sample firms drawn exclusively from the financial services sector. there might be an industry effect present here, as firms in certain industries and sectors face more stringent government oversight. does this increased oversight that commonly occurs with financial services firms result in better behavior and/or the greater likelihood for the detection of misbehavior by government regulators? future studies might examine these same variables in firms drawn from other industries where government oversight might not be as stringent. another limitation involves the use of average data over the study period. averaging data reduces the influence of possible fluctuations in the variables over time. perhaps there is some delay between the time the board takes some action to reduce some actual or potential misconduct, and the action taken has the desired effect on influencing firm behavior. future studies might consider means to control for the lag effect of time. references alexander, j. a., fennel, m. l., & halpern, m. t. (1993). leadership instability in hospitals: the influence of board-ceo relations and organizational growth and decline. administrative science quarterly, 38, 74-99. amason, a. c., & sapienza, h. j. (1997). the effects of top management team size and interaction norms on cognitive and affective conflict. journal of management, 23, 495-516. bhagat s., & black, b. (1999). the uncertain relationship between board composition and firm performance. business lawyer, 54. 921-963. business roundtable. (1997). statement on corporate governance. washington, dc. cheng, s. (2008). board size and the variability of corporate performance. journal of financial economics, 87, 157-176. council of institutional investors. (1998). core policies, positions and explanatory notes. washington, dc. dalton, d. r., daily, c. m., johnson, j. l, & ellstrand, a. e. (1999). number of directors and financial performance; a meta-analysis. academy ofmanagement journal, 42, 674-686. 12 journal ofbusiness strategies vol. 25, no. 1 ferris, s. p., jagannathan, m., & pritchard, a. c. (2003). too busy to mind the business? monitoring by directors with multiple board appointments. journal offinance, 58, 1087-1111. firstenberg, p. b., & malkiel, b. g. (1994). the twenty-first century boardroom: who will be in charge? sloan management review, 36, 27-35. garg, a. (2007). influence of board size and independence on firm performance: a study ofindian companies. vikalpa: the journal for decision makers, 32. 39-60. helland, e., & sykuta, m. (2005). who's monitoring the monitor? do outside directors protect shareholders' interests? cfa digest, 35, 25-26. hermalin, b., & weisbach, m. (2003). boards ofdirectors as an endogenously determined institution: a survey of the economic literature. economic policy review, federal reserve bank ofnew york, 9, 7-26. hoover's company profiles. (selected years). hoover's, inc., new york. johnson, j. l., daily, c. m., & ellstrand, a. e. (1996). boards of directors: a review and research agenda. journal of management, 22, 409-438. johnson, r. a., & greening, d. w. (1999). the effects of corporate governance and institutional ownership types on corporate social performance. academy ofmanagement journal, 42. 564-576. lee, s., & carlson, l. (2007). the changing board of directors: board independence in s & p 500 firms. journal of organizational culture. communications & conflict, 11,31-41. lipton, m., & lorsch, j. w. (1992). a modest proposal for improved corporate governance. business lawyer, 48. 59-77. mizruchi, m. s., & stearns, l. b. (1988). a longitudinal study of the formation of interlocking directorates. administrative science quarterly, 33, 194-210. ryan, h. e., & wiggins, r. a. (2004). who is in whose pocket? director compensation, board independence, and barriers to effective monitoring. journal of financial economics, 73,497-524. schnake, m. e., fredenberger, w. b., & williams, r. j. (2005). the influence of board characteristics on the frequency of 10-k investigations of firms in the financial services sector. journal ofbusiness strategies, 22, 101-117. stearnes, l. b., & mizruchi, m. s. (1993). board composition and corporate financing: the impact of financial institution representation on borrowing. academy of management journal, 36. 603-618. spring 2008 schnake & williams: multiple directorships 13 wang,j" & dewhirst, d, h. (1992). boardofdirectorsandstakeholderorientation.journal ofbusiness ethics, ii, 115-124. wheelen, t. l., & hunger, j. d. (2004), strategic management and business policy. upper saddle river, nj: prentice-hall. williams, r. j., fadil, p. a., & armstrong, r. w. (2005). top management te'am tenure and corporate illegal activity: the moderating influence of board size. journal of managerial issues, 17. 479-493, yermack, d. (1996). higher market valuation of companies with a small board of directors. journal offinancial economics, 40, 185-211. zahra, s. a., & pearce, j. a. (1989). boards of directors and corporate financial performance: a review and integrative model. journal of management, i5. 291-334. dr. mel e. schnake, d.b.a. (mississippi state university), is professor of management in the langdale college of business at valdosta state university. dr. schnake's research has appeared in numerous journals including journal of management, journal ofapplied psychology, human relations, personnel psychology, journal ofapplied business research and journal ofoccupational and organizational psychology. dr. schnake's research interests include organizational citizenship behavior, organizational misconduct, work motivation, and leadership. dr. robert j. williams, ph.d. (florida state university), is associate professor of management in the langdale college of business at valdosta state university, valdosta, georgia. dr. williams' research has appeared in such journals as academy of management journal, human relations, journal of business research, journal ofapplied business research, journal ofmanagerial issues and journal ofbusiness strategies. dr. williams' research interests include top management teams, corporate governance, and business ethics. 14 journal ofbusiness strategies vol 25, no.1 multiple directorships and corporate misconduct: the moderating influences of board size and outside directors a framework for developing an effective mission statement daniel s. cochran mississippi state university • mississippi state. ms fred r. david francis marion university • florence, sc c. kendrick gibson deceased henderson state university • arkadelphia. ar introduction an increasing number of profit and nonprofit organizations across america are incorporating strategic management activities into their overall operations. strategic management can be defined as the formulation, implementation, and evaluation of actions that will enable a firm to achieve its objectives. the strategic management process is based on the belief that a firm should continually monitor key internal and external events and trends; firms should seek to pursue strategies that capitalize on internal strengths, take advantage of external opportunities, improve internal weaknesses, and minimize the effect of external threats. it is widely acknowledged today that the rate, magnitude, and complexity of changes that impact organizations are accelerating. these changes are creating a different type of consumer, different types of products and services, and consequently a need for different strategies. increased competitiveness worldwide, coupled with rapid social, technological, and economic changes, are major reasons why the strategic management process is being adopted by more and more firms. in a recent review of strategic management models, the mission statement was noted as being an essential first step in the strategic management process (david, 1984; staples & black, 1984). a mission statement can be defined as an enduring document of purpose that distinguishes one business from other firms of its type (pearce, 1982). a mission statement is a declaration of an organization's business or "reason for being." a clear statement of a company's mission is essential to effectively establishing objectives, formulating strategies, setting goals, devising policies, allocating resources, and motivating employees. a mission statement is thus an integral component of the strategic management process. as evidenced in the following quotation from peter drucker's classic book entitled management: tasks, responsibilities, and practices, a good mission statement makes strategy formulation, strategy implementation, and strategy evaluation much easier. unless the basic concepts on which a business has been built are visible, clearly understood, and explicitly expressed, an organiza28 journal of business strategies tion is at the mercy of events. not understanding what it is, what it represents, and what its basic concepts, values, policies, and beliefs are, a business cannot rationally change itself. only a clear definition of the mission and purpose of the business makes possible clear and realistic business objectives. the business mission is the foundation for priorities, strategies, plans, and work assignments. it is the starting point for the design of managerial jobs and, above all, for the design of managerial structures. structure follows strategy. strategy determines what the key activities are in a given business. and strategy requires knowing "what our business is and what it should be." (drucker, p. 75). the importance of a mission statement to effective strategic management is well supported in the management literature (staples & black, 1984). a mission statement may be the most visible and public part of a strategic plan. as such, steps should be taken to insure that the statement includes all of the essential components and attributes. in addition, a company mission should be evaluated to insure that it communicates clearly the desired feelings that will guide and motivate employees to action. the purpose of this article is to present a practical framework for developing an effective mission statement. a developmental model is presented and exemplified through application to actual organizations. the proposed mission statement developmental framework is presented in figure i, and includes the following four stages: orientation, component analysis, communication analysis, and applicability analysis. figure 1 steps in the development of an effective mission statement (ms) orientation • create a strategic planning task force • review the strategic planning process • review mission statement significance in strategic planning • review ms development process component analysis • identify desired components • draft ms including derived components communication analysis denotative analysis (readability) • write clear and concise • compute fog index • rewrite if necessary volume 25, number 2 connotative analysis • identify connotative feelings desired from reading ms • administer questionnaire to users (readers) • rewrite if necessary applicability analysis • identify likely situations where ms might be applied develop case • have users evaluate case based on mission statement • determine if mission statement can be applied 29 a strategic planning task force is an appropriate group to do the initial development of an organization's mission statement. however, if this group is too large, a sub-committee could be developed called a "mission statement committee" and charged with going through the suggested stages presented in this paper. orientation process the purpose of orientation is to insure that individuals in the strategic planning task force understand the strategic management process. this orientation training should raise the level of awareness about particular individual's significance and role in planning. a training session would include the following: an overview of the strategic management process, a review of the significance of the mission statement to strategic management, and an introduction into the development process used to design an effective mission statement for their organization. the process of developing a mission statement involves rendering differences of opinion. this is a vital part of achieving an appropriate mission statement for a firm. the task force must become aware that the process the organization goes through in coming to consensus in the development of the mission statement is as important as the output of the process the mission statement itself. component analysis given the understanding of what a mission statement is, the components of such a statement are important. the strategic planning task force must identify the major components to be included in their mission statement. pearce (1982) recently identified eight key components of mission statements: customers, products or services, markets, technology, concern for survival, growth, and profitability, philosophy, self-concept, and concern for public image. these components could be used as a guideline by the committee. according to pearce, a well conceived mission statement answers the following questions about an organization: 30 journal of business strategies 1. customers who are the enterprise's present and future customers? 2. products or services what are the firm's major products or services? 3. markets where does the firm compete? 4. technology what is the firm's basic technology? 5. concern for survival, growth, and profitability what is the firm's attitude towards economic goals? 6. philosophy what are the basic beliefs, values, aspirations, and philosophical priorities of the firm? 7. self-concepts what are the firms' major strengths and competitive advantages? 8. concern for public image what is the firm's public image? an actual example for each component is included in table 1. the mission statement committee would write a draft mission statement from their derived components. actual company examples of each component is included in table 1. the mission statement committee would use these components as a guide in developing their initial mission statement draft. various idea generation techniques* such as nominal grouping or brainstorming could be used to identify other important components for inclusion in this initial draft. table 1 identifying mission statement components: a compilation of excerpts from actual mission statements i. excerpts from corporate mission statements 1. customers 2. product or service 3. markets 4. technology we believe our first responsibility is to the doctors, nurses, and patients, to mothers and all others who use our products and services. (johnson & johnson) to anticipate and meet market needs of farmers, ranchers, and rural communities within north america. (cenex) amax's principal products are molybdenum, coal, iron ore, copper, lead, zinc, petroleum and natural gas, potash, phosphates, nickel, tungsten, silver, gold, and magnesium. (amax) we are dedicated to the total success of corning glass works as a worldwide competitor. (corning glass) control data is in the business of applying micro-electronics and computer technology in two general areas: computerrelated hardware; and computing-enhancing services, which volume 25, number 2 31 6. philosophy 7. self-concept 5. concern for survival 8. concern for public image include computation, information, education and finance. (control data) the common technology in these areas relates to discrete particle coatings. (nashua) in this respect, the company will conduct its operations prudently, and will provide the profits and growth which will assure hoover's ultimate success. (hoover universal) we are committed to improve health care throughout the world. (baxter travenol) we believe human development to be the worthiest of the goals of civilization and independence to be the superior condition for nurturing growth in the capabilities of people. (sun company) hoover universal is a diversified, multi-industry corporation with strong manufacturing capabilities, entrepreneurial policies, and individual business unit autonomy. (hoover universal) we are responsible to the communities in which we live and work and to the world community as well. (johnson & johnson) also, we must be responsive to the broader concerns of the public including especially the general desire for improvement in the quality of life, equal opportunity for all, and the constructive use of natural resources. (sun company) ii. excerpts from university mission statements 1. customers thus, winthrop fully accepts its role as a forum for public examination of issues as part of its responsibilities, not only to its students, but to all the citizens of south carolina. (winthrop college) 2. product or service 3. markets 4. technology 5. concern for survival the school of business administration has the role of providing at both the undergraduate and graduate levels a sound education and high quality professional training in the broad field of administration for prospective managers and staff specialists ... rendering professional public service in the form of educational programs, research, consultation and assistance to montana organizations .... (university of montana) to develop a partnership with business, community and government leaders and alumni in the detroit metropolitan area, serving one of the most influential industrial metropolitan areas in the world. (university of detroit) ... to expand the involvement of faculty in research endeavors in the various fields of business and economics by providing ... ample computer facilities .... (arkansas state university) use human and financial resources in creative ways to pursue academic excellence within acceptable levels of human cost. (georgetown university) 32 6. philosophy 7. self-concept 8. concern for public image journal of business strategies the school's approach is based on the belief that three cornerstones are essential to the development of a quality educational program: 1) the motivated student ... ; 2) a faculty dedicated to the highest standards in teaching and research ... ; and 3) a curriculum of sufficient depth, breadth, and flexibility to meet diverse student needs and expectations. (atlanta university) along with emphasis on academic quality goes an active effort to use the university's extraordinary locational advantage to build a strong interface with the business, banking, and professional groups in the city, as well as to develop an equally strong set of ties to leading foreign universities. (new york university) the overall goal of the university of miami school of business administration is to achieve and maintain a position of nationally acknowledged quality within the top fifteen private university schools of business administration in the united states .... (university of miami) more important, the strategy fits well into the demographic trends of the 80's, for it positions us among the 10 best undergraduate business schools in the nation, with only the wharton school at pennsylvania as a competitor in the northeast. (new york university) communication analysis even though the mission statement includes the necessary components, its communication effectiveness may be poor. recent writings involving "corporate culture" and successful companies have emphasized the significance of effective communications between the organizations many constituents. (peters & waterman, 1982; kennedy, 1984) kennedy reports: the companies and organizations that do the best job thinking through what they are all about, deciding how and to whom these central messages should be communicated and executing the communication plan in a quality way invariably build a strong sense of esprit within their own organization and among the many constituents they serve. (kennedy, 1983, p. 26) since written communication involves denotative as well as connotative meanings both are suggested as part of the community analysis for mission statement development. (bradley & baird, 1983) volume 25, number 2 denotative analysis 33 this aspect or stage is defined as determining the readability of the mission statement e.g., is it written in a clear and concise manner? a classic readability index called the fog index is an appropriate technique to measure readability (blundell, 1980). table 2 illustrates how the fog index computed. the mission statement committee would evaluate their drafted mission statement to determine its readability index. if the index was considered too high for their average readership they would rewrite the ms draft by reducing sentence length and usage of multiple syllabled words. table 2 steps in determining a mission statement's readability level 1. compute the number of words 2. compute the number of sentences 3. compute the average number of words per sentence (item 1 divided by item 2) 4. compute the number of hard words (treat as hard words all words of three or more syllables, abbreviations and symbols. do not count capitalized words, unless symbolized or abbreviated.) 5. compute the number of hard words per 100 words (item 4 divided by item 1 times 100) 6. compute the sum of the word average and the hard word percent (item 3 plus item 5) 7. compute the fog index which indicates the readability level (item 6 multiplied by 0.4) source: adapted from how to take the fog out of writing by robert gunning and dougles mueller, chicago, illinois: the dartnel corporation, revised edition, 1981. connotative analysis in their book entitled communication for business and professions, bradley and baird reveal that the connotative meanings and emotional aspects of a written document are important. relating this to development of a good mission statement, a mission statement should arouse one's feelings and emotions for an organization. that is, an effective mission statement results in feelings that a particular organization is successful, knows where it is going, and is worthy of the reader's time, support, and investment. a good mission statement does more than simply include the needed components; it is also inspiring and motivating. quinn (1980) states that such a statement should create elan or create an identity larger than the limits placed 34 journal of business strategies upon the firm by the individuals themselves. zaleznik (1970) has found that effective organizational "missions" help satisfy people's needs to produce something worthwhile, to gain recognition, help others, to beat opponents or earn respect. furthermore, according to quinn, the firms must distinguish themselves from all others in the competitive environment. so far, at least, the mission statement must transcend the criteria usually attributed to objectives such as measurable, achievable, etc. in that it should lift the firm above its present state. keller (1983) reminds managers that what is important is the quality, daring and sagacity of the strategy. this connotative step for the mission statement committee involves asking managers to evaluate the mission statement using words that describe the feelings management wanted to be communicated. the feelings/impressions that should be present are only briefly discussed in the literature. glueck (1980) mentions such things as coherence, agreed upon, top down, etc., while quinn (1980) includes elan in the description. other concepts/words may be more representative for a particular organization and may be developed by the management team; however, the following terms are offered as suggested words to use when measuring the "felling" that others perceive to be inherent in the mission statement, the connotative meanings. optimism the impression that while the goals are large they can be achieved certainty impressions of resoluteness, completeness, commitment aggressiveness impressions of assertiveness or competitiveness inspiration impression of vision, far reaching nature concreteness references to recognition of environmental influences, explicitness, and clarity activity impressions of implementation of ideas, motion forward to measure whether these feelings are present, managers should be asked to indicate their level of agreement or disagreement with several statements or questions related to these terms as reflected in their mission statement. table 3 suggests a format for measurement. volume 25, number 2 table 3 suggested method of measuring connotative feelings generated by mission statement scale used 1 = strongly disagree 2 = disagree 3 = neither agree nor disagree 4 = agree 5 = strongly agree 35 concept scale 2 3 4 5 1 2 3 4 5 12345 1 2 3 4 5 optimism (not shown on rating sheet) 1. this mission statement gives me the feeling that the university is on the verge of achieving great things. 2. i am hopeful for the future of our organization. 3. the mission of the organization is uninspiring. 4. the goals included in the plans for the future are too optimistic. aggressiveness/assertiveness (not shown on rating sheet) 1. we will find it difficult to be competitive in our area 1 2 3 4 5 in the future. 2. the future of our university will be insured by 1 2 3 4 5 following the ideas presented in our mission statement. 3. the goals we have talked about will help us achieve 2 3 4 5 little more than we presently are doing. 4. the direction we will be taking in the future is 1 2 3 4 5 much clearer to me. inspiration (not shown on rating sheet) 1. i cannot agree with much of what we have decided to do. 2. in my opinion, we will exceed our expectations of success by following the plans included in our mission statement. 3. it is better to be on the safe side than to try some of these ideas. 4. the foresight exhibited in this planning process will help us be prepared for the future better than other colleges i am aware of. applicability analysis 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 the fourth step of the process is to measure the extent to which the statement can be applied in a given situation. use of mini-cases to give the committee an opportunity to apply the direction of the mission statement is suggested to aid 36 journal of business strategies in the measurement of practicality. several mini-case situations should be prepared which would require managers to make a decision or recommendation concerning a situation with implications for the various component parts of the statement. the responses or decisions would indicate how well these managers understood the direction provided through the statement as well as their ability to apply the mission statement to the situation. (cochran & gibson, 1979) table 4 gives one example of such a situation for wallace women's college. table 4 wallace women's college* wallace's women's college is a small, exclusive women's college located in north carolina. its major purpose is to foster an understanding and appreciation of the intellectual and cultural heritage of man, cultivate the student's love of the beautiful and the good, and prepare graduates to live in society with happiness for themselves and helpfulness to others. this will be accomplished with classes to improve communication, such as math, languages, and music, classes to improve understanding of the human condition, such as literature, history, and philosophy, and classes on which to build professional and civic careers, such as nursing and education. the college will strive to provide quality education with a highly qualified and stable faculty and a high student/teacher ratio. the college will strive to be sensitive to the educational demands of the area, provide an atmosphere conducive to women's liberal education, and provide cultural activities for students and surrounding residents through student activity, concerts, and recitals. *rudolph e. koletic and lawrence r. jauch, "wallace women's college," in business policy and strategies management, 4th ed., by w.f. glueck, l. table 5 mini-case situation for wallace women's college wallace women's college has recently received an offer of a significant donation from the estate of a retired area businessman who had built a national reputation in his hardware wholesale distributorship. the donation is contingent upon the establishment of a school of business at the college. the college has been experiencing a decline in enrollment for some time, dropping from a total enrollment of over 900 to 600 over the last nine years. as a result, wallace women's college had been operating at a deficit and had been using it's endowment funds and borrowed funds for operating expenses. the proposed education program and endowment could keep the college's finances from deteriorating further and help support the schools of music and nursing. what should be the decision of wallace women's college? write your recommendation here and justify based on your understanding of your schools mission statement. from this example the college should not accept the donation under the given restraints since it violates the organization's mission statement. the college would need to either convince the donor to change the constraints to be in line with the volume 25, number 2 37 mission statement or change the mission statement. the point in this example is to see if the organization's mission statement can be applied to a typical situation regarding the strategic plan. summary the mission statement may be the most visible and public part of a firm's strategic plan. as such, steps should be taken to insure that the statement includes all those correspondents critical to the continued success of the organization. in addition, the statement should be critically evaluated to insure that it communicates both an understanding and the desired feeling that will guide or motivate managers to action. finally, it should be practical. this article proposes a four step process or model for strategic mission statements. this process may be utilized by "mission statement committees" in all types of organizations; it can be accomplished "in house" with only a minimum amount of time and resources. a process of self-evaluation of the mission statement should help managers view their planning concepts more accurately and help the organization to relate the desired planning direction in a positive and forceful way. carefully prepared missions have been the source ofsuccess for many companies. poorly formulated missions have brought disaster to some companies. revised missions have turned some companies around. a well developed mission statement can be a unifying and motivating light for all the stakeholders of an organization. an increasing number of organizations today are implementing strategic management concepts. as part of this process, more and more firms are striving to develop a clear and meaningful company mission statement. the framework presented in this article for developing and evaluating mission statements could enhance the strategic management process in organizations. this framework could also provide some direction for much needed empirical research on mission statements. references bennis, w. g. (1977). where have all the leaders gone? technology review, 79(march/april),37-46. blundell, w. e. (1980). confused, overstuffed corporate writing often costs versus much time-and money. the wall street journal, (thursday, august 28). bradley, p. h., & baird, jr., 1. e. (1983). communication for business and the professors (2nd ed.). dubuque, ia: wm. c. brown, co. 38 journal of business strategies budd, r. w., thorp, r. k., & donohew, l. (1967). content analysis ofcommunications. new york: macmillan co. cochran, d. s., & gibson, c. k. (1979). putting a square peg into a round hole: communication models and their application. journal ofbusiness communication, 17(fall), 27-36. cohen, k. 1., & cyert, r. m. (1973). "strategy: formulation, implementation, and monitoring." the journal ofbusiness, 46(july), 349-367. david, f. r. (1984). towards an integration ofstrategic management models. southern management association, proceedings, 195-197. drucker, p. f. (1974). management: tasks, responsibilities, practices. new york: harper and row. ferguson, c. r., & dickinson, r. (1982). critical success factors for directors in the eighties. business horizons, (may/june), 14-18. gardner, 1. w. (1961). excellence, can we be equal and excellent too. new york: perennial library, harper and row. gardner, 1. w. (1964). self renewal, the individual and the innovative society. new york: harper and colophon books, harper and row. glueck, w. f. (1980). business policy and strategic management (3rd ed.). new york: mcgraw-hill book co. goldhaber, g. m. (1983). organizational communication (3rd ed.). dubuque, ia: wm. c. brown co., 411. gunning, r. (1952). techniques ofclear writing. new york: mcgraw-hill publishmg. hanakawa, s. i. (1976). how words change our lives. in n. sigband (ed.), communication for management and business (2nd ed., pp. 489-496). flenview, il: scott foresman and co. hollowood,1. r. (1981). college and university strategic planning: a methodological approach. planningfor higher education, 9(summer), 8-18. jakobson, r. (1960). closing statement: linguistics and poetics. in t. sebok (ed.), style in language. cambridge, ma: the m.i.t. press. katz, r. l. (1970). management ofthe total enterprise. englewood cliffs, nj: prentice-hall, 19. katz, r. l. (1955). skills of an effective administrator. harvard business review, 33(january/february). kennedy, a. (1984). back-fence conversations: new tools for quality conversations. communication world, (november), 2630. volume 25, number 2 39 koprowski, eugene 1. (1981). exploring the meaning of good management. academy ofmanagement review, 6, 459-467. kotler, p. (1982). marketingfor nonprofit organizations (2nd ed.). englewood cliffs, nj: prentice-hall, inc. lazer, w., & cullev, 1. d. (1983). marketing management, foundations and practices. boston: houghton mifflin co. mcpherson, m. s. (1983). value conflicts in american higher education, a survey. journal ofhigher education, 54(may/june), 243-278. myers, 1. h., & warner, g. w. (1968). semantic properties of selected evaluation adjectives. journal ofmarketing research, v(november),408-412. ohmae, k. (1982). the secret of strategic vision. management review, (april), 9-13. pearce ii, 1. a. ii. (1982). the company mission as a strategic tool. sloan management review, (spring), 15-24. pearce ii, 1. a., & robinson, jr., r. b. (1982). strategic management, strategy formulation and implementation. homewood, il: richard d. irwin, inc. peters, t. 1., & waterman, r. h. (1982). in search of excellence: lessons from america's best-run companies. new york: harper & row. quinn, 1. b. (1980). strategies for change: logical incrementalism. homewood, il: richard d. irwin, inc. staples, w. a. & black, k. v. (1984). defining our business mission: a strategic perspective. journal ofbusiness strategies, 1, 33-39. vancil, r. f. (1977). strategy formulation in complex organizations. in p. lorange & r. f. vancil (eds.), strategic planning systems. englewood cliffs, nj: prentice-hall, 4-22. zaleznik, a. (1970). power and politics in organizational life. harvard business review, (may/june), 47-60. 40 journal of business strategies a framework for developing an effective mission statement the value of cheap-talk and costly signals in coordinating market entry decisions james a. sundali university of nevada, reno darryl a. seale university of nevada, las vegas abstract signaling occurs when a firm attempts to indicate, truthfully or not, its intended course o.laction. competitors often use signaling in market entry situations to coordinate actions, or possibly to deter entry by otherfirms. this paper examines the value ofcheap talk and costly signaling in a large group market entry game. eighty subjects, twenty in each offour groups, participated in a computer-controlled decision making experiment. after learning the capacity of the market, subjects were given an opportunity to signal their intentions to enter or stay out. followingfeedback ofaggregate signals, subjects were asked to estimate the aggregate number ofentry decisions they anticipated. following the estimation task, subjects had to decide whether or not to enter the market, which varied in size from trial to trial. results suggest that when no cost was imposed on signals (cheap talk), players significantly exaggerated their intentions to enter the market. when signals were costly, signaling behavior was more consistent with subsequent entry decisions. overall, however, neither cheap talk nor costly signaling had much effect on actual market coordination, and aggregate results generally are consistent with nash equilibrium predictions. the study concludes with a discussion of insights for researchers and management practitioners. title: the value of cheap-talk and costly signals in coordinating market entry decisions decisions to enter or not to enter markets are among the most important strategic choices firms face. these decisions often involve significant investments of capital and human resources, and questions of market positioning, which some researchers view as the "essence of strategy" (porter, 1996). though the economic solution to the problem of market entry is often overly simplified, indicating that a risk-neutral, profit maximizing firm should base its entry decision on the net present value of expected profits (oster, 1994), the strategy literature indicates there are countless ways a potential entrant might think about this type of decision and a myriad of variables or factors that may impact a firm's entry decision. given the diversity and inconsistency in market entry research, we have chosen to study a simple but fundamental problem that has not been addressed 70 journal ofbusiness strategies vol. 21, no.1 adequately in the literature: aggregate market entry coordination. aggregate entry decisions that are coordinated poorly may result in situations of over-entry or under-entry. if over-entry occurs, the market may be served, but firms choosing entry face significant competitive pressures and lower profits. ifunder-entry takes place, the market may not be fully served, and firms choosing entry face negligible competition and higher profits. we also have chosen to study a factor that might affect aggregate market entry coordination: signaling. signaling occurs when a firm or decision maker attempts to indicate, truthfully or not, its intended course of action (spence, 1974). signals often manifest in market entry situations that involve strategic interdependence (seale & sundali, 1999) where the outcomes or payoffs to the firm depend not only on its decision, but also on the decisions of its competitors. in these situations, signaling may be a valuable tool to either coordinate actions, or possibly to deter entry by other competitors. to be effective, signals, which may take the form of verbal or written communication, or overt action, must be easily observable and made well in advance of the decisions and actions of rival firms. firms routinely make market entry decisions, decide between types of signaling activities, and attempt to interpret the signals they receive from their competitors. considering this iterative process, several research questions are paramount. first, do decision makers use signaling, and, if so, do they use it strategically or truthfully? second, how do decision makers interpret and use the signals made by competitors? third, how does signaling affect market coordination? addressing these questions with traditional research methods using industry or firm level archival data presents several problems. first, many decisions, especially those not to pursue an opportunity, often are unobservable (rapoport & koput, 1993). second, what should researchers conclude ifa company decides not to enter? it may be that the firm determined entry would be unprofitable due to capacity constraints. but other confounding explanations are possible (e.g., a change in corporate leadership and strategy, lack of available capital, or the availability of other more profitable ventures). third, there is little control over exogenous variables. for example, how can we know if competitors are communicating with each other? due to possible legal concerns, communication, if any, is likely to occur discreetly and/or through unobservable channels. given these problems, it is not likely that traditional post-hoc analysis of cross sectional data can provide a complete and meaningful understanding of the relevant research questions. recognizing these difficulties, we adopted a research design based on gametheoretic modeling. such an approach has been gaining attention in strategic management, with some scholars welcoming its addition (camerer, 1991; saloner, 1994), and others cautioning its adoption, arguing that game theory comes with too much modeling freedom that can be used to justify and explain even irrational behavior (postrel, 1994). our interest here is not to join this discussion, or to add fuel to the fire. we hope simply to illustrate, with this particular problem, how game theory can inform strategic market entry decisions. spring 2004 sundali & seale: cheap-talk and costly signals 71 the rest of this paper is organized as follows. the next section characterizes the structure, payoffs and equilibrium concepts for the n-person market entry game. the third section lists eight research hypotheses. following the discussion of our research design and method, we characterize and compare the results of two experiments with large groups (n = 20) of subjects playing the market entry game with signaling. finally, we conclude with a discussion of insights for researchers and management practitioners and suggestions for future research. the n-person market entry game rapoport (1995) introduced the following n-person market entry game as a mechanism to test tacit coordination among large groups. consider a group of n symmetric players seated in a room where communication among them is controlled. on each trial (period), a different positive integer c is announced publicly. the parameter c, which varies from 1 to n, is interpreted as the "known capacity ofthe market." once c is announced, each player i must decide privately whether to enter (oj = 1) or stay out (oi = 0) of the market. individual payoffs are determined each period by the following formula: { v, h(o) = i k + r(c _ e), ifo;= 1 (1) where hi (0) is player i's payoff, given the vector of individual decisions for the period, and e (0 :s e :s n) is the number of market entrants. the parameters v, k, and r are real valued constants that remain fixed throughout the game. like the value of c, they are common knowledge. rapoport (1995) showed that when v = k, the pure strategy nash equilibrium prescribes e = c or e = c-l entrants. a nash equilibrium is a profile of strategies (decisions), one for each player, such that if this profile were to occur, no single player would have an incentive to deviate from his or her decision. to illustrate, assume that v = k = 1 and r = 2. if the market capacity (c) is 11, the nash equilibrium solution is for 10 or 11 players to enter. if 11 players enter, the payoff for entry is 1 + 2( 11 11) = 1. the payoff for the 9 players who chose to stay out is also 1. this outcome is in equilibrium because there is no incentive for any player to change his or her decision. if one of the 9 players that chose to stay out changes to enter, the payoff for entry will fall to -1(1 + 2(11 12)). if e = 10, the outcome is also a nash equilibrium. although the entry payoff is 3(1 + 2(11 10)), an additional entrant would reduce this payoff to 1, providing no incentive to enter. thus for either 10 or 11 entrants, no player has an incentive to change his or her strategy. rapoport, seale, erev, and sundali (1997; hereafter rses) also have shown that the nash equilibria prescribed in the market entry game are pareto deficient. 72 journal ofbusiness strategies vol. 21, no. 1 a comparison of equilibria and the pareto optimal outcomes reveals that unless c is very small, the number of entrants that maximizes total group payoff is approximately e/2. the difference in payoffs can be substantial. consider the market entry game with parameters n = 20, r = 2, k = 1, and v = 1. if c = 8, a pure strategy nash equilibrium is reached when e = 7, or e = 8, and total group payoff is 34«7 * (i + 2(8 7» + 13) or 20«8 * (i + 2(8 8» + 12), respectively, with the pareto optimal number of entrants (e = 4), the total group payoff increases to 52«4 * (l + 2(8 4» + 16). as c increases, these results are even more striking. for example, when c 17, the pareto optimal number of entrants is 8 or 9, and total group payoff increases to 164. clearly, group payoff increases substantially ifplayers can successfully coordinate entry decisions in the direction of pareto optimal outcomes. in most real-world market entry situations, some form of communication among competitors is not only possible, but also likely. this communication often is valuable because it can help resolve coordination dilemmas, possibly avoiding situations of over-entry and lost profits. however, while serving a coordination function, such communication also may be strategic an attempt to deter entry by potential competitors. in coordination games, like the market entry game, a signal constitutes a form of indirect communication where players, truthfully or not, attempt to indicate their type (farrell, 1995). after the signal is sent and received, players then decide on a course of action where the outcomes are dependent on the types and actions ofthe players. broadly defined, signals may be oftwo types costly signals, or cheap-talk. costly signals require the player to either (1) make a costly commitment to a course of action at the beginning of a game; or (2) communicate a signal without charge, but incur a charge if there is a change in this announced course of action, cheap-talk is a form of communication or signaling that is cost-less, non-binding and payoff irrelevant (farrell, 1995). to incorporate these ideas into the n-person market entry game, we introduced limited communication in the form of signaling by amending the game as follows. after observing the market capacity for the trial, each subject was required to choose one of three signals: enter, not enter, or no indication. after all n subjects made their signaling decisions, aggregate results showing only the number of players by type of signal were reported. each subject then was asked to make his or her individual entry decision. with the introduction of signaling, the market entry game is transformed into a two-stage iterated game. three signal choices combined with a binary entry decision results in the following six possible strategies: 1. signal enter and then enter. 2. signal enter and then do not enter. 3. signal not enter and then enter. 4. signal not enter and then do not enter. 5. signal no indication and then enter. 6. signal no indication and then do not enter. spring 2004 sundali & seale: cheap-talk and costly signals 73 each of the strategies allows for both costless (cheap talk) and costly signals. when signals are costless, the signaler is free to deviate from his or her announced plan of action, without penalty. costless signals are payoff irrelevant. as such, they do not change the equilibrium solution to the market entry game. regardless of which of the six strategies subjects choose, the outcome is in equilibrium if, and only if, e = c or e = c-l. a signal that is costly can affect one's payoff, and hence may be considered credible. in the present market entry game, we allow subjects to issue one of the three signals, and then impose a cost if, and only if, the subject's action differs from the signal. to determine the equilibrium solution for the case of costly signals, we proceed as follows. recall that from equation 1, the payoff for entry is k + r (c-e), and the payoff for not entering is v. assume that the cost of issuing a signal and then choosing a different action is equal to b. of the six pure strategies listed above, the cost b will be assessed only to strategies 2 and 3. a cost or penalty is not assessed if subjects signal "no indication." it then can be shown that if b > 0, strategy i dominates strategy 3, and strategy 4 dominates strategy 2. no matter what the outcome of a trial, a subject who takes an action that differs from his or her signal always will have an incentive to change to a strategy in which the signal and entry decision are consistent. with the four pure strategies that remain (1, 4, 5,6), an outcome of the iterated market entry game with costly signals is in (sequential) equilibrium, if, and only if, e = c, or e = c-1. research hypotheses although signaling often is not included in game-theoretic models, prior empirical research has shown that signaling can influence group decision behavior. studies of costly signaling have been conducted by ackerlof (1970), spence (1974), grossman (1981), milgrom & roberts (1982), and kreps (1994). as summarized by ochs (1995), much ofthis experimental research has focused on coordination games with multiple, pareto-ranked nash equilibria. the general conclusion drawn from this research is that, under certain conditions, costly signals can help groups coordinate on pareto dominant equilibria. cheap talk, a form of non-credible communication, also has been shown to affect group decision behavior (cooper, dejong, forsythe, & ross, 1989; cooper, dejong, forsythe, & ross, 1992). the logic for this effect is offered by farrell (1987): "suppose that players' announced plans would, if actually played, constitute a nash equilibrium. then, we suggest, that equilibrium becomes focal. moreover, if everyone expects such equilibria to be followed once announced, then cheap talk can help coordinate behavior to produce asymmetric equilibria" (pg. 35). following this logic, it is reasonable to expect that both cheap talk and costly signaling may help coordinate outcomes in the market entry game. hypothesis 1: signaling will improve group coordination of entry decisions. 74 journal ofbusiness strategies vol. 21, no.1 because credibility may be at issue when signals are costless and non-binding, we expect costly signals will have a greater effect on improving coordination, thus: hypothesis 2: costly signals will improve group coordination more than costless, non-binding signals. as costly signals imply greater credibility and impart more meaningful, less ambiguous information to decision makers, we expect subjects receiving costly market entry signals to be better able to forecast subsequent market entry decisions. accordingly, hypothesis 3: costly signals will result in more accurate estimates ofmarket entry. several experiments have examined variants of the n-person market entry game (rapoport, 1995; sundali, rapoport & seale, 1995 (hereafter srs); rapoport, seale & ordonez, 2002; rapoport, seale & winter, 2000; camerer & lovallo, 1999; and rses, 1997). although there are substantial differences among these experiments, consistent findings emerge. first, there is a remarkably high level of coordination (correlation) between the market capacity and the number of entrants, as predicted by the pure strategy nash equilibrium solution. this coordination is achieved early in the experimental sessions and does not diminish with repeated play. a second finding that is reported consistently in the market entry literature cited above is that subjects do not move away from equilibrium predictions over time in the direction of pareto optimal outcomes. despite the large payoff incentive associated with pareto outcomes (see previous section), the difficulty of tacit coordination increases exponentially in the number of players. with n = 20 players, we expect that the limited signaling abilities introduced in the present study will have no effect in moving the group toward pareto levels of entry, thus: hypothesis 4: signaling will not move group outcomes away from equilibrium predictions in the direction ofpareto optimal levels ofentry. perhaps the most important notions ofgame-theoretic reasoning are that players act rationally and attempt to maximize their expected utility. this reasoning assumes, in essence, that players behave strategically. although there are abundant empirical studies that cast doubt on this assumption, claiming that decision makers exhibit bounded or limited rationality, or are vulnerable to systematic biases in their reasoning, the preponderance of evidence in this vast literature supports the tenets of strategic play. additionally, while these key assumptions of rationality often are under attack, no powerful alternative theories have been spring 2004 sundali & seale: cheap-talk and costly signals 75 proposed (roth, 1995). at issue is not that players behave strategically, rather it is the degree of strategic behavior. thus, in the market entry game, we expect players to use signals strategically when signaling is costless and non-binding, and to signal truthfully when deviations from signals to actions are costly. hypothesis 5: players will attempt to use signaling strategically when signals are costless and non-binding. when signals are costless and non-binding, they have no effect on individual payoffs. game theory proposes that if a variable has no affect on payoffs, then it is not credible and should be ignored. thus, even though subjects will use such signals strategically, the signals should have no impact on the decisions of subjects. this leads to the next hypothesis: hypothesis 6: signals that are costless and non-binding will be ignored and will have no affect on the decisions ofsubjects. in addition to the six research hypotheses described above, the following two outcomes, which serve as manipulation checks for the experimental design, also are expected: hypothesis 7: the number of entry decisions will increase with the market capacity. hypothesis 8: with the introduction ofcostly signals, subjects will abandon dominated strategies (#2 and #3) where signal and subsequent behavior are inconsistent. design and method eighty subjects participated in the experiment. the subjects were divided into four twenty-person groups. two groups participated in a cheap talk (ct) condition, and two groups participated in a costly signaling (cs) condition. the subjects consisted of undergraduate and graduate students, and a few university employees who responded to an advertisement in the school newspaper.! the advertisement promised payoffs contingent upon performance, from $5 to $50 for participation in a two-hour computer controlled experiment in economic decision making. the experiment was conducted at the enterprise room at the university of arizona. the laboratory contained over twenty networked microcomputers, separated by both built-in features and wide aisles. as subjects entered the laboratory, they were seated randomly at one of the workstations and asked to read a copy of the instructions placed next to the workstation. the instructions welcomed subjects to the lab and informed them that if they 76 journal ofbusiness strategies vol. 21, no.1 made careful decisions, they had an opportunity to earn a considerable sum of money, which would be paid to them in cash at the end of the experiment.2 after all subjects read the instructions, one of the experimenters guided them through an example, highlighting the requirements of the task, and sample payoff calculation. after subjects were given an opportunity to ask questions, the experiment began. each subject then was given an endowment of20 francs (l franc = $0.25) and advised that his/her earnings (losses) accumulated during the experiment would be added to (subtracted from) this endowment. the experiment lasted 50 trials, with each trial consisting of three steps. in the first step, the computer announced the capacity of the market for the present trial, and subj ects had an opportunity to either (1) signal their intention to enter the market, (2) signal their intention to not enter the market, or (3) signal no indication regarding their intention. in condition ct, signals were costless and non-binding; there was no penalty when entry decisions deviated from entry signals. in condition cs, giving a signal also was costless; however, if subjects' subsequent entry decisions did not conform to their original signals, they were penalized y2 franc. note that subjects signaled "no indication" (option 3, above), they were free to enter or not enter without penalty. in the second step, after all subjects made their signaling decisions, the computer displayed the aggregate results of signaling (i.e., the total number of subjects signaling enter, not-enter, and no-indication). signaling decisions were not reported at the individual level. subjects then were prompted to estimate the total number of entrants for the current trial. to motivate accurate estimates, subjects were paid an additional $0.10 for every trial where their estimate was within ± 1 of the true number of entrants. in the third and final step of each trial, subjects were asked to make a binary decision enter or not enter the market based on the payoff formula given in equation 1. notice that subjects could guarantee themselves a positive payoff by not entering the market. the 50 trials were divided into 5 blocks of 10 trials each. in each block, the value of c was sampled without replacement from the set {i, 3, ... , 19}. to reduce the burden of computation, on each trial, subjects were presented with a table that summarized payoffs for all possible number of entrants, given the current value of c. after all subjects made their entry decisions, the computer displayed the number of entrants (e) for the trial, and their current and cumulative payoffs. after all subjects reviewed this feedback, the next trial began. subjects were given paper and pencil to make notes or record information they deemed important. at the conclusion ofthe experiment, subjects were paid individually in cash, thanked, and dismissed from the lab. each session lasted approximately two hours. note that there was no between-group treatment. conducting two groups per condition allowed us to assess the stability of group outcomes. spring 2004 sundali & seale: cheap-talk and costly signals results 77 the results are organized into three sections. first, we examine signaling behavior between conditions ct and cs. then, we summarize estimates of entry decisions between conditions and across experimental blocks. finally. we examine entry decisions between conditions, comparing our results to the srs (1995) market entry study conducted without signaling. the design of the current experiment is identical to srs, with three exceptions. in srs, subjects did not have the ability to signal, data were collected for three groups (n = 20) of subjects, and the game was played for 100 trials rather than 50. the fewer number of trials in conditions ct and cs was due to the increased demands of the signaling and estimating aspects of the task. signaling results to compare entry signals between conditions cs and ct, and to test for block effects, a condition by c by block (2 x lox 5) an ova, with block as a repeated measure, was conducted.3 the results, shown in table 1, show significant between subjects main effects for condition (f = 216.9, p = 0.000) and c (f = 22.9, p = 0.000) and a significant within subject interaction effect on block*c (f = 1.62, p = 0.038). the interpretation of these results is straightforward, and is illustrated in figure 1. this figure displays the mean number of entry, no-entry, and no-indication signals combined across group and block, by market capacity for the two conditions. condition ct appears as the solid line and condition cs as the dashed-line. the top panel of figure 1, consistent with the anova results, shows that the number of entry signals increased with market capacity, and the level of entry signaling was much greater in condition ct than in condition cs. there is no evidence that the number of entry signals changed over time (block) in either condition. the fact that the number of entry signals did not decline across blocks in condition cs indicates that many subjects chose to continue signaling even though they had the option of signaling no indication. note also that entry signals are over-specified for small values of c, and under-specified for large values of c. the mean number of signals indicating or ""ntry, shown in the middle panel of figure 1, declined with market capacity, and did not differ between conditions. no-indication signals, shown in the bottom panel of figure 1, occurred more frequently in condition cs, but did not vary by market capacity. clearly, the difference between conditions is the shift from entry to no indication signals between conditions ct and cs; with the introduction of costly signals, subjects generally ceased their exaggeration of entry signals. estimates of entry recall that subjects were motivated to estimate the number of market entrants accurately; they were paid $0.10 every time their estimate was within ± 1 of the actual number of market entrants. to test for block effects with the number of 78 journal ofbusiness strategies vol.21,no.1 accurate entry estimates as the dependent measure, a condition by c by block (2 x 10 x 5) anova, with block as a repeated measure, was conducted. this analysis, shown in table 2, revealed significant between subjects main effects for condition (f = 21.2, p = 0.000), c (f = 3.0, p = 0.020), and the condition*c interaction (f = 3.2, p = 0.014). there were also within subject effects on block (f = 11.2, p = 0.000), block*condition (f = 4.5, p = 0.003), block*c (f = 1.9, p = 0.008) and block*condition*c (f = 1.6, p = 0.036).4 again, the interpretation is straightforward and can been seen in figure 2. the top panel of this figure displays the mean number of subjects that estimated total market entrants accurately on each trial by value of c and condition. the data are averaged over block. it is clear that for all values of c, except i and 19, subjects in cs provided more accurate estimates of total entrants than subjects in ct, and that accuracy improved over time. additionally, the effect for c suggests that subjects in the ct condition made more accurate estimates for low and high values of c, while in the cs condition accuracy was better for middle values of c. the bottom panel of figure 2 captures the block by condition interaction. this interaction implies that not only did subjects in condition cs make more accurate estimates, but also that accuracy improved over time (block) at a greater rate. the main effects for c indicate that subjects' ability to forecast entry decisions accurately was dependent on the market capacity. table 1 repeated measures anova signals tests of hypotheses for between subject effects source df sum of squares mean square fvalue p value intercept i 22050.0 22050.0 2306.5 0.000 condition 1 2073.7 2073.7 2\6.9 0.000 c 9 1972.7 219.2 22.9 0.000 condition*c 9 160.0 17.8 1.9 0.\\9 error 20 19\.2 9.6 tests of hypotheses for within subject effects source df sum of squares mean square fvalue p value block 4 12.6 3.\ 0.92 0.458 block*condition 4 24.4 6.\ 1.78 0.141 block *c 36 199.8 5.6 1.62 0.038 block*cond*c 36 75.9 2.\ 0.62 0.946 error(b\ock) 80 273.8 3.4 spring 2004 sundali & seale: cheap-talk and costly signals 79 figure 1 mean number of signals by condition and market capacity 20 enter signals >. 16 0 ------c 12 --q) ---------::j ... ...c" 8 ...q) ....... ---ll ---------4 ---' 0 1 3 5 7 9 11 13 15 17 19 20 not enter signals >. 16 0 c 12q) ::j c" 8 ---...q) --....... >ll ...4 ..... _--------= "'-----0 1 3 5 7 9 11 13 15 17 19 20 no indication >. 16 u c 12q) ------------::j -----c" 8 ---q) ----.... ----.. ll 4 0 1 3 5 7 9 11 13 15 17 19 market capacity -ct cs figure 3 diagrams the mean and standard deviation of entry estimates by market capacity and condition. it is apparent that the variance of the estimates of subjects in the ct condition is significantly higher than in the cs condition. some subjects in the ct condition gave estimates that were far from the market capacity. for example, for c values of 1, 3, 5, and 7, the high estimate for the number of entrants in the ct (cs) condition was 15, 15, 19 and 19 (7, 14, 10, 13), respectively. thus, not only are there fewer accurate estimates in the ct condition, but the magnitude of error in the ct condition also is significantly higher. 80 journal ofbusiness strategies vol. 21, no. i table 2 repeated measures anova estimates tests of hypotheses for between subject effects source df sum of squares mean square fvalue p value intercept i 21197.4 21197.4 1005.3 0.000 condition i 447.0 2073.7 21.2 0.000 c 9 569.0 219.2 3.0 0.020 condition*c 9 611.0 67.9 3.2 0.014 error 20 421.7 21.1 tests of hypotheses for within subject effects source df sum of squares mean square fvalue p value block 4 475.8 118.9 11.2 0.000 block*condition 4 189.1 47.3 4.5 0.003 block *c 36 735.0 20.4 1.9 0.008 block*cond*c 36 624.1 17.3 1.6 0.036 error(block) 80 848.8 10.6 to examine the relationship, ifany, between estimates of entry and subsequent entry decisions, we grouped subjects' estimates into one ofthree categories: the estimate was (1) greater than the market capacity, (2) equal to the equilibrium prediction of c or c-l, or (3) less than the equilibrium prediction. then, we computed the proportion of estimates by whether or not the subject entered the market. these proportions are reported in the top panel of table 3. averaged across conditions, the percentage of subjects that chose to enter when their estimate was greater (less) than the market capacity (c) was 28% (75%). this indicates that subjects' entry decisions were highly correlated with their estimates of whether or not entry would be profitable. when the estimate of number of entrants was equal to c or c-l, the average nash equilibrium prediction, 62% of subjects chose entry; interpretation of this result is not straightforward since it is unknown if a subject included her or himself in the aggregate entry estimate. an anova on entry decisions with estimate category and condition (3x2) as independent variables produced a main effect for estimate category (f = 299.7, p = 0.000), no main effect for condition (f = 0.0, p = 0.892), and an estimate category by condition interaction effect (f = 6.08, p = 0.002). in sum, the accuracy of estimates was better in the cs condition, and subject estimates of the number of likely entrants was highly correlated with entry decisions in a predictable and rational manner. spring 2004 sundali & seale: cheap-talk and costly signals 81 figure 2 mean number of accurate estimates of entry decisions by condition ----,-----------------~ 12 q) ~ 8 4 ol..------------------------------' 20 r-----------------------------, accuracy by market capacity 16 1 3 5 7 9 11 13 market capacity 15 17 19 20 r-----------------------------, accuracy by block 16 ..----------------------c---~ 12 q) ~ 8 4 ol..------------------------------' 1 2 3 block 4 5 -ct cs entry decisions to analyze entry decisions and compare these results to srs, we conducted a condition5 by c by block (3 x lox 5) anova, with block as a repeated measure. this analysis, reported in table 4, revealed a significant main effect for c (f = 464.6, p = 0.000), no main effect for condition or block, and significant interaction effect on block*c (f = 1.67, p = 0.020). this analysis argues that the frequency of entry decisions depends greatly on c and does not differ by signaling condition. the number of entry decisions by condition and market capacity is reported in figure 4. these data (reported only for the first 5 blocks of srs) show that the number of entrants is highly correlated with c. more detailed analysis (not shown here) reveals that, with a single exception, the correlation between c and e exceeds 0.90 for all three conditions across the five blocks. 82 journal ofbusiness strategies table 2 repeated measures anova estimates vol. 21, no.1 tests of hypotheses for between subject effects source df sum of squares mean square fvalue p value intercept 1 21197.4 21197.4 1005.3 0.000 condition 1 447.0 2073.7 21.2 0.000 c 9 569.0 219.2 3.0 0.020 condition*c 9 611.0 67.9 3.2 0.014 error 20 421.7 21.1 tests of hypotheses for within subject effects source df sum of squares mean square fvalue p value block 4 475.8 118.9 11.2 0.000 block*condition 4 189.1 47.3 4.5 0.003 block *c 36 735.0 20.4 1.9 0.008 block*cond*c 36 624.1 17.3 1.6 0.036 error(block) 80 848.8 10.6 to examine ifsignaling was effective in moving the groups away from equilibrium predictions in the direction of pareto optimal outcomes, we computed two additional measures: mean distance from equilibrium, and mean subject payoff. mean distance from equilibrium was computed from equation #2 below: l imin (e c; e c 1) i 10 (2) where the minimum of e c or e ~ c 1 accounts for the two entry values that are in equilibrium for a single value of c. the results of this analysis are displayed in figure 5. although the results for srs are shown over 10 blocks of trials, they are directly comparable to the signaling conditions through the first 5 blocks. for srs, the mean distance from equilibrium fell from 2.1 in block 1 to 0.8 in block 2, then averaged to less than 1.0 throughout the remaining blocks. in condition ct, the mean distance measure initially rose for the first few blocks, then declined to less than 1.0 by block 5. although the mean distance measure was consistently smaller in condition cs, a condition by c by block (3 x lox 5) anoya, with block as a repeated measure, indicated that these differences were not significant. thus, there is no evidence that the signaling groups performed better or worse than the srs groups, or any indication that the mean deviation decreased with experience. spring 2004 condition ct sundali & seale: cheap-talk and costly signals table 3 the effects of estimates on entry decisions entry percentage 83 estimate category estimate> c estimate c or c i estimate < c i condition cs estimate category estimate> c estimate c or c i estimate < c i not enter 73.9'% 34.9% 21.0% not enter 70.5% 42.0% 29.5% entry percentage enter 26.4% 65.1% 79.0% enter 29.4% 58.0% 70.5% anova estimate affects on entry decisions source df sum of squares mean square fvalue p value model 5 137.8 26.6 122.3 0.000 condition i 0.0 0.0 0.0 0.892 estimate category 2 130.1 65.1 299.1 0.000 estimate category'" c 2 2.6 l3 6.1 0.002 our final analysis of entry decisions tracks the mean subject payoff per trial. since the payoff formulas between the two studies were identical, with the exception of the possible signaling penalty in cs, the results are directly comparable through the first 5 blocks. a condition by c by block (3 x lox 5) anova, with block as a repeated measure, indicated no significant effects. figure 6 clearly shows that, with the single exception of block 4 in condition ct, the mean subject payoff per block approaches 1.0, the equilibrium payoff. again, there is no evidence that the signaling groups performed better or worse than the srs groups, or any signs that the mean subject payoff changed over time. further, combining the results presented in figures 5 and 6 shows that there was no movement toward pareto optimal outcomes; such a movement would result in an increase in the mean distance measure (figure 5) and mean subject payoff (figure 6). 84 journal ofbusiness strategies vol. 21, no.1 table 4 repeated measures anova entry decisions tests of hypotheses for between subject effects source df sum of squares mean square fvalue p value intercept i 33525.4 33525.4 14977.8 0.000 condition 2 3.2 1.6 0.7 0.498 c 9 9358.2 1039.8 464.6 0.000 condition*c 18 34.8 1.9 0.9 0.621 error 40 89.5 2.2 tests of hypotheses for within subject effects source df sum of squares mean square fvalue p value block 4 7.0 1.7 0.57 0.687 block*condition 8 11.1 1.4 0.46 0.886 block *c 36 183.6 51.0 1.67 0.018 block*cond*c 72 306.7 4.3 1.39 0.045 error(block) 160 489.8 3.1 figure 4 mean number of entry decisions by condition and market capacity 7 9 11 13 market capacity (c) srs ct cs 15 17 19 the results suggest that signaling did not affect aggregate market coordination. given this, an obvious question arises why did subjects continue to signal when they had the option of not indicating a signal? one explanation is that subjects may be signaling strategically attempting to discourage entry by others in the experiment. an alternative explanation is that subjects may be attempting to signal to improve overall group coordination. to explore these alternative explanations further, we examine in table 5 the relationship between signaling and subsequent entry decisions. spring 2004 sundali & seale: cheap-talk and costly signals 85 figure 5 mean distance from equilibrium by condition and block ...................................................... ----:--_-~----3.0 ,....-----------------------------, 2.5 q) o ~ 2.0 "iii (5 1.5 c as ~ 1.0 .5 ol....--------------------------' 2 3 4 5 6 block 7 8 9 10 srs ct cs figure 6 mean payoff per trial by condition and block 3.....-------------------------...... 2 1 o "".-:..:;..~-~-.:-~::::_--..--...;-7~i':o;';.:--------~ ~.,.,c i·~··' ~......... ..... ...,........... ..,.~ •• or ••..• ~1 '---------------------------' 1 2 3 4 5 6 block 7 8 9 10 -srs ct cs table 5 reports the number of entry and no-entry decisions by type of signal. conditions ct and cs are shown on the top and bottom halves of the table, respectively. in each condition we examine 2000 signals (2 groups x 20 subjects x 50 trials). the table organizes entry signal by subsequent entry decision. in condition ct, subjects signaled no enter 389 (19%) times, signaled enter 1372 (69%) times, and signaled no indication 239 (12%) times. in condition cs, there is a similar frequency (376, 19%) of no entry signals. however, consistent with the results reported in figure 1, there is a pronounced shift from entry signals (728, or 36%) to no indication signals (896, or 45%). even more interesting is the measure of consistency between signal and decision by condition. in condition cs, signals and decisions were consistent 97% «358 + 712)/(376 + 728» of the time; entry signals were consistent with entry decisions 98% of 86 journal ofbusiness strategies vol. 21, no.1 the time, while no entry signals were consistent with no entry decisions 95% of the time. when signaling was costless and non-binding, consistency dropped to 64%, with entry signals consistent with entry decisions 60% of the time, and no entry signals consistent with no entry decisions 78% of the time. this finding, combined with the shift from entry to no indication signals described earlier, clearly shows that a large number of subjects in condition ct engaged in strategic signaling. analysis of data at the subject level (not reported here) confirms this result. thus, some subjects attempted to signal strategically when there was no cost or penalty for inconsistent action. when a cost was imposed, subjects retreated to no indication signals. table 5 entry decisions by types of signal condition ct enter decision no enter enter total condition cs signal not enter enter no indication total 302 550 147 999 87 822 92 1001 389 1372 92 2000 enter decision no enter enter total not enter 358 18 376 signal enter no indication total 16 621 995 712 275 1005 728 896 2000 discussion of hypotheses we briefly discuss the empirical support for each hypothesis and summarize the findings in table 6. spring 2004 hypothesis sundali & seale: cheap-talk and costly signals table 6 support for hypotheses outcome 87 i. signaling will improve group coordination of entry decisions. 2. costly signals will improve group coordination more than cost less, non-binding signals. not supported not supported 3. costly signals will result in more accurate estimates of market entry. supported 4. signaling will not move group outcomes away from equilibrium predictions in the direction of pareto optimal levels of entry. 5. players will attempt to use signaling strategically when signals are costless and non-binding. 6. signals that are costless and non-binding will be ignored and will have no affect on the decisions of subjects. 7. the number of entry decisions will increase with the market capacity. 8. with the introduction of costly signals, subjects will abandon dominated strategies (#2 and #3) where signal and subsequent behavior are inconsistent. supported supported not supported supported supported hypothesis 1: signaling will improve group coordination ofentry decisions. (not supported) there was no evidence to suggest that group coordination improved from prior experiments. there was no significant difference in the number of entrants or the correlation between c and e across ct, cs or srs. hypothesis 2: costly signals will improve group coordination more than costless, non-binding signals. (not supported) there was no evidence that any type of signaling improved group coordination, and none to suggest it was different between ct and cs. hypothesis 3: costly signals will result in more accurate estimates of market entry. (supported) there was significant statistical evidence that subjects in cs made more accurate estimates than subjects in ct. there also was evidence to show that accuracy improved over time. hypothesis 4: signaling will not move group outcomes awayfrom equilibrium predictions in the direction of pareto optimal levels of entry. (supported) the analysis showing no change in the mean difference in 88 journal ofbusiness strategies vol. 21, no. i entry from equilibrium predictions across conditions and the analysis showing no change in the average payoffs across condition confirm that there was no movement toward pareto optimal outcomes. hypothesis 5: players will attempt to use signaling strategically when signals are costless and non-binding. (supported) the data showed that only 64% of subjects in ct were consistent in signal and action, compared to 98% in cs. this is clear evidence that the ct subjects were signaling strategically. hypothesis 6: signals that are costless and non-binding will be ignored and will have no affect on the decisions ofsubjects. (not supported) there was exaggerated entry signaling in the ct condition. subjects in the ct condition were less accurate than cs in estimating entry. estimates were highly correlated with entry decisions. thus, the evidence suggests that cheap talk was not ignored. • hypothesis 7: the number of entry decisions will increase with the market capacity. (supported) this manipulation check was clearly supported. • hypothesis 8: with the introduction of costly signals, subjects will abandon dominated strategies (#2 and #3) where signal and subsequent behavior are inconsistent. (supported) again, subjects were consistent 98% of the time in cs, providing clear support for this game theoretic prediction. discussion in this discussion we address the research questions that were posed initially, provide suggestions for future research, and conclude with advice for management practitioners. the three research questions addressed in this paper were: i) do decision makers use signaling, and, ifso, do they use it strategically or truthfully? 2) how do decision makers interpret and use the signals made by competitors? 3) how does signaling affect market coordination? the results show that signaling was used frequently, and that when signals were costless and non-binding, many subjects signaled strategically. the results also indicate that exaggerated signaling in condition ct did not diminish with time. why not? recall that game theoretic reasoning on the use of signaling suggests that it can be used to improve group coordination and payoffs. clearly there was no evidence the group was moving towards pareto optimal outcomes. why continue to signal when such efforts were not improving group coordination? one explanation is simply that subjects were introducing noise into the system to make things more difficult for other participants. a second explanation is that subjects believed that entry signals could deter other entry and leave profitable entry opportunities. neither of these explanations is consistent with game theoretic predictions. if cheap talk is not going to be used to coordinate a group on a pareto superior outcome, then, game theory suggests, cheap talk spring 2004 sundali & seale: cheap-talk and costly signals 89 should be ignored since it is not a credible entry-deterring tactic. thus, while game theoretic predictions did amazingly well in predicting the aggregate number of entrants, the theory fared poorly in explaining individual behavior. subjects clearly used signaling results to estimate the number of market entrants. the lack of better estimates by subjects is a puzzling result for the following reasons. aggregate entry was highly correlated with market capacity in both ct and cs conditions. this high correlation was achieved in the early rounds of the experiment and persisted throughout. subjects were paid in every trial for accurate estimates and entry decisions and received immediate feedback regarding outcomes and payoff. given the incentives and relevant feedback, subjects should learn quickly that the best estimate of the aggregate number of entrants was the market capacity (c) for that trial. as the results show, there was significant estimate error and the error was greater in the ct condition. the most plausible explanation for these results is that subjects were being influenced by signaling results, and the exaggerated entry signals in the ct condition made the estimation task even more difficult. the aggregate effect of signaling on market coordination was minimal. although signaling has been shown to have an effect in simpler, two-person coordination games, our findings suggest that signaling was oflittle consequence in this game; aggregate entry decisions tracked closely the levels predicted by nash equilibrium. however, this result should be viewed with caution. in the three srs groups used for comparison and the four signaling groups reported in the present study, the correlations between c and e across block ranged from 0.77 to 0.99. clearly, there was little room for much improvement toward the equilibrium prediction. finally, we find no evidence that signaling moved the group toward pareto optimal levels. signaling clearly was not used as a coordinating mechanism to improve overall group payoffs. the experimental design employed here allowed us to track signal, estimate, and entry decisions at the individual level. this collection of individual data provides a much richer data set than could be gathered with archival data. unfortunately, the current design was limited in that it only allowed us to suggest aggregate correlations and was not able to better illuminate the individual decision making process. the design prevented conclusions to be drawn regarding exactly why subjects chose to enter or how subjects interpreted competitor signals. these shortcomings suggest directions for future research. first, future studies should attempt to better tease out the cognitive processes subjects are using in making entry decisions. the strictly rational approach of game theory is insufficient to explain individual decision making and should be supplemented with other theoretical paradigms. these studies also might consider collecting more detail data onjudgment and decision processes. second, to better assess the affects of signaling on coordinating aggregate group outcomes, future research efforts should consider making subjects aware ofpareto optimal outcomes. since subjects in the present study likely did not recognize opportunities for improving group coordination, the use of signaling appears to have been primarily 90 journal of business strategies vol. 21, no.1 strategic. third, to allow for reputation building to increase signal credibility, future designs should report the consistency in signaling and entry decisions at the individual level. fourth, group size could be varied, as coordination always is more difficult in large groups. fifth, the types of signals available to decision makers can be manipulated. for example, a cost could be imposed for making a signal, rather than deviating from a signal, as in the present study. finally, to ensure better generalizations, our results could be augmented by those of field researchers interested in the dynamics of market entry. what insights can we draw from these results for management practitioners? practitioners that actually must make market entry decisions know how risky such decisions can be. entry decisions depend on many variables such as market size, expected demand growth, barriers to entry, technological developments, and ultimately the number of other likely entrants. we cite just one example of how difficult and costly mistakes can be. in the 1990s technology boom, many firms rushed to enter and build fiber optic networks to carry internet traffic. these entry decisions were driven by overly optimistic growth rates of internet traffic and an incomplete understanding of how much capacity was being added by competitors. the net result is that as of 2002, only 2.7% of the installed fiber actually is being used, and some believe that much ofthe capacity never will be used (dreazen, 2002). clearly this market failed to optimally coordinate market entry decisions, and that has led to numerous bankruptcies in the telecom sector. given the importance of market entry decisions, we offer suggestions to practitioners based on the results of our experiments. it is generally in the interests of all involved that market coordination is achieved and substantial over-entry avoided. signaling can be very useful when it provides vital information to the market that allows others to make better and more rational decisions. our results show that costly and credible signals provide valuable information to participants, which allows them to make more accurate estimates of the likely number of entrants. we suggest that practitioners should provide costly signals to the market to indicate credible intentions. this will allow others to take such information into account when making entry decisions. we further suggest that practitioners should be very careful in the use of costless signals as a strategic tool. the positive motivation for using costless signals is to deter other entry so that the market is under served and excess returns are then available. in our experiments, we find no evidence that costly signals were effective in deterring entry. we suspect that cheap talk is even less effective in influencing seasoned market participants than it was in influencing college students in a laboratory experiment. the negative consequences of using cheap talk are that it introduces noise into the system, increases the difficulty of the estimation task, and increases the probability of significant over-entry, and thus low returns, for all in the market. thus, we suggest that the cost and potential risks of using cheap talk significantly outweigh the possible short-term benefits that it might provide. finally, it may be very difficult for managers to identify coordination opportunities spring 2004 sundali & seale: cheap-talk and costly signals 91 that yield pareto superior outcomes. our results suggest that decision makers either did not recognize alternative outcomes that were superior, or were unable to achieve them because the communication channels were flawed. given this, we suggest that market participants try to recognize and appreciate that some situations of under entry may be, in fact, pareto superior outcomes. rather than rushing to enter markets that provide normal returns, participants might want to learn to be smart competitors and share different markets that provide pareto superior returns. finally, we suggest participants broaden and deepen communication channels to allow for the most effective signaling. references ackerlof, g. (1970). the market for lemons: quality uncertainty and the market mechanism. quarterly journal of economics, 84, 488-500. ashton, r. h. & kramer, s. s. (1980). students as surrogates in behavioral accounting research: some evidence. journal of accounting research, 1-13. campbell j. p. (1986). lab, fields, and straw issues. in e. a. locke (ed.). generalizing from laboratory to field settings (269-279). lexington, ma: lexington books. camerer, c. f. (1991). does strategy research need game theory? strategic management journal. 12, 137-152. camerer, c. f. & lovallo, d. (1999) overconfidence and excess entry: an experimental approach. american economic review, march. cooper, r., de jong, d., forsythe, r., & ross, t. (1989). communication in the battle of the sexes: some experimental results. rand journal of economics, 20 (4), 568587. cooper, r., de jong, d., forsythe, r., & ross, t. (1992). communication in coordination games. quarterly journal of economics, 53, 739-771. dreazen, yj. (2002). telecom carriers were driven by widely optimistic data on internet's growth rate. wall street journal, september 26, b i-b8. farrell, j., (1987) cheap talk, coordination, and entry. rand journal of economics, 18, 34-39. farrell, j., (1995). talk is cheap. american economic association and proceeedings, may, 186-190. . fudenberg, d. & kreps, d. m. (1993). learning mixed equilibria. games and economic behavior, 5, 320-367. 92 journal ofbusiness strategies vol. 21, no.1 gordon, m. e., slade, l. a., & schmitt, n. (1986). student guinea pigs: porcine predictors and particularistic phenomena. academy of management review, 12 (1), 160-163. greenberg, j. (1987). the college sophomore as guinea pig: setting the record straight. academy of management review, 12 (1),157-159. grossman, s. (1981). the role of warranties and private disclosure about product quality. journal of law and economics, 24, 461-83. gulati, r. (1995) does familiarity breed trust? the implications of repeated ties for contractural choices in alliances. academy of managementjournal, 28 (1),85-112. kreps, d. (1994). signaling. in r. aumann & s. hart (eds.) handbook of game theory with economic applications. new york: elsevier. locke, e. a. (1986). generalizing from laboratory to field: ecological validity or abstraction of essential elements. in e. a. locke (ed.). generalizing from laboratory to field settings (269-279). lexington, ma: lexington books. milgrom, p. & roberts, j. (1982). limit pricing and entry under incomplete information. econometrica, 50,443-459. nash, j. f., jr. (1951). non-cooperative games. annals of mathematics. 54, 289-295. ochs, j. (1995). coordination problems. in j. h. kagel anda. e. roth (eds.), handbook of experimental economics. princeton, nj: princeton university press. oster, s. (1994). modern competitive analysis, 2nd edition. oxford, new york. porter, m. (1996). what is strategy? harvard business review. november-december 1996. postrel, s. (1994). burning your britches behind you: can policy scholars bank on game theory. in r. rumelt, d. schendel, and d. teece (eds.), fundamental issues in strategy. boston, ma: harvard business school press. rapoport, a. (1995). individual strategies in a market entry game. group decision and negotiation, 4, 117-133. rapoport, a. & koput k. (1993). market entry and the emergence of new industries: experimental studies. national science foundation grant proposal, october. rapoport, a., seale, d., erev, i., & sundali, j. (1997). equilibrium play in large group market entry games. management science, 44 (1),119-141. spring 2004 sundali & seale: cheap-talk and costly signals 93 rapoport, a., seale, d., & ordonez, 1. (2002). tacit coordination in choice between certain outcomes and endogenously detennined lotteries. journal of risk and uncertainty, 25 (1), 21-45. rapoport, a., seale, d.a., & winter, e. (2000). an experimental study of coordination and learning in iterated two-market entry games. economic theory, 16, 661 687 roth, a. (1995). introduction to experimental economics. in j. h. kagel & a. e. roth (eds.), handbook of experimental economics. princeton, nj: princeton university press. saloner, g. (1994). game theory and strategic management: contributions, applications, and limitations. in r. rumelt, d. schendel, & d. teece (eds.), fundamental issues in strategy. boston, ma: harvard business school press. seale, d. & sundali, j., (1999). cheap talk in a large group coordination game. in budescu, d., erev, i., & zwick r. (eds.), games and human behavior. essays in honor of amnon rapoport, pp. 173-200, lawrence erlbaum associates, new jersey. spence, a. m. (1974). market signaling. cambridge, ma: harvard university press. sundali, j., rapoport, a., & seale, d. (1995) coordination in market entry games with symmetric players. organizational behavior and human decision processes. 64 (2), 203-218. footnotes l since the use of student subjects in experiments is controversial to some, we offer the following comments. campbell's (1986) seminal paper, where he concluded that "perhaps college students really are people... why their disguise fools many observers into thinking otherwise is not clear" (p.276), led to a number of papers addressing the external validity of behavioral experiments. gordon, slade and schmitt (1986) found that there are between group differences in experiments using students and nonstudents, and based upon this finding concluded that journal gatekeepers should be careful in accepting such research. greenberg (1987) countered that gordon et al. (1986) missed the fundamental point of laboratory research and that one study using any homogeneous group of subjects was not generalizable to a universal population. while this broad debate continues today, our view is that experiments requiring domain-specific knowledge or experience may not be suitable tasks if the goal of the research is to generalize results from students to professionals. however, there is also much evidence (ashton & kramer, 1980) that shows that when the experimental task involves basic information processing and/or decision making skills, college students make decisions very similar to those of the general population, including professional managers. locke (1986) argued that if the purpose of a laboratory experiment is to study fundamental psychological or cognitive 94 journal ofbusiness strategies vol. 21, no. i processes, then the similarities between students and employees are greater than are the differences between the groups. in the research presented here, we believe the fundamental contribution is the development and testing of a rigorous game theoretic model. as such, our subject pool of students is appropriate since their basic cognitive processes are more important to the internal validity of the study than is their domain specific knowledge. c in advertisements for the experiments subjects were told they could earn up to $50 by participating in a two-hour experiment. we consider a wage of $25 per hour for most students to be "a considerable sum of money." 3 in subsequent analyses, the data were collapsed over groups since tests showed no significant group effect on signals or entry decisions. a small but significant group effect existed in the costly signaling condition on estimates, but there was no group effect in the cheap talk condition on estimates. additional analysis determined this one group effect to be irrelevant to the analyses of interest. 4 an additional anova not reported here showed that subjects in the ct condition had slightly higher estimates of the number of entrants across both market capacity and block than subjects in the cs condition. 5 to compare our results directly to srs, we treated their data as a third condition. the differences between the experiments were discussed above. james a. sundali is associate professor of strategic management at the university of nevada, reno. in addition to teaching courses in strategic management, he offers electives in bargaining and negotiation, and leadership insights from film and literature. his research interests include experimental economics, behavioral finance, and gaming. darryl a seale is associate professor of management at the university of nevada las vegas. he received his ms and phd from the university of arizona, and his mba from penn state. his research has been supported by grants from the national science foundation, and the hong kong university of science and technology. his research interests are in behavioral game theory, strategic decision making and bargaining. he has published articles in management science, games and economic behavior, economic theory, organizational behavior and human decision processes, and journal of economic behavior and organization. the value of cheap-talk and costly signals in coordinating market entry decisions remittances and the household's expenditures on health jorge n. valero-gil universidad aut6noma de nuevo leon • monterrey, mexico abstract this paper considers the effect of remittances on the share of health expenditures in total household expenditure in mexico. the main purpose of this paper is to investigate if remittances are especially targeted towards household's health expenditure in mexico. using iv tobit and regression models we find a statistically significant effect of remittances on the household health expenditures shares. this effect is even more pronounced for households without access to the employment's medical insurance. introduction this paper analyzes the impact of remittance transfers on health expenditure of mexican households. using data from the national income expenditure survey of households of mexico (enigh) for the year 2004, this paper examines if remittances are intended to spend on healthcare for the migrant-sending families in mexico. the basic idea is to test the fungibility hypothesis that posits that a dollar is a dollar and the household will expend it on the good with the highest marginal utility, irrespective of its origin. this will be done by making a distinction between the marginal impact of an increase in income and that of targeted remittances and by presenting their respective estimates. the results are expected to have potential public policy implications for remittances. note that health expenditure is an attractive area to study the impact of remittances. according to the data generated by the mexican migration project for the period 2005-2007, while 43.3 percent of people covered in the study reported that the most important motive for sending remittances is food and sustenance, other 35.8 percent considered health expenditure to be the most important reason. amuedo-dorantes et al. (2007) report that 46 percent of the people remitting money consider household's health expenditures (hhe) to be the most important motive for sending remittances. according to the world health organization (2007a), national expenditure on health in mexico was 6.5 percent ofgdp: government expenditures account for 3.0 percent and private expenditures account for 3.5 percent. furthermore, the proportion of remittances in national income has been increasing in mexico over the years: 120 journal of business strategies from 3,673 million u.s . dollars (uso) in 1994 to 16,613 million in 2004, according to banco de mexico (banxico, 2005). table i presents data on hhe, out-ofpocket expenditure, and remittances for the countries of the central america free trade agreement (cafta) and mexico. total expenditure on health as a percentage of gdp cannot be explained by general government expenditure or by remittances alone. out-of-pocket expenditure on health seems to be directly related to remittances but this relationship is not the same for each country. table 1 health expenditure and remittances for selected countries general total government out-ol-pocket expenditure expenditure expenditure out-ol-pocket on health as on health as as% expenditure remitances % 01 gross % 01 total 01 private as % 01 gross as % 01 gross domestic expenditure expenditure domestic domestic product on health on health product product (2003) (2003) (2003) (2003) (2005) (1 ) (2) (3) (4) (5) costa rica 7.3 78 .8 88 .7 1.4 1.8 dominican republic 7.0 33.2 70.8 3.3 9.1 ei salvador 8.1 46.1 93.5 4.1 17.1 guatemala 5.4 60.3 91 .9 3.0 9.3 honduras 7.1 56 .5 85 .8 2.6 21 .2 mexico 6.2 46.4 94.2 3.1 2.8 nicaragua 7.7 48.4 95.7 3.8 16.9 columns (1) to (4) are from the world health organization (2007b, table 2, p . 180). column (5) is from the inter-american development bank (2005) . most research on the relationship between remittances and health that utilizes household data finds a strong link between them. some research focuses on the relationship between remittances and health outcomes. for example, acosta et al. (2007) find that children from households that report receiving remittances tend to exhibit higher health outcomes than those from non-recipients in the cases of guatemala and nicaragua; lopez-cordoba (2006) finds that an increase in remittances lowers infant mortality rates in mexico at the municipal level. other studies the relationship between migration and health. for example, hildebrand and mckenzie (2005) study the channels through which migration may affect health outcomes and find evidence volume 26, number 1 121 that migration improves children 's health through raising the health knowledge of mothers, in addition to the direct effect on health of higher wealth after migration. rubalcava et al. (2008) find little evidence in support ofthe hypothesis that migrants are positively selected in terms of health. the current research is about the relationship between remittances and hhe. cardona and medina (2005) study this relationship in colombia using, as in this paper, the proportion of health expenditure as the dependent variable but do not find any significant effect of remittances on health expenditures. amuedo-dorantes et al. (2007) use hhe as dependent variable and find a positive relationship with remittances in mexico. both studies use ordinary least squares (ols) and instrumental variable (iv) methods. using a two-tiered tobit model, amuedo-dorantes and pozo (2008) further find a positive relationship between hhe and remittances. our strategy is to use the 2004 enigh sample data to estimate tobit and regression models, that control for the household's expenditure per capita, which allows us to separate "income" and "remittance" effects. note that we use per capita expenditure over per capita income. it has been argued that expenditure is measured better than income and, therefore, it is more reliable.) the choice of hhe share in total household expenditure (not hhe per se) as the dependent variable in our empirical analysis is dictated by the fact that it allows us to relate our model to a cost function as will be discussed later. further, the heterocedasticity problem that arises when hhe is used (because high income people tend to have higher hhe variances compared to low income people) can be avoided. the tobit model also allows us to distinguish between private and social effects of remittances. we examine the differential impacts based on whether households have access to the employment's medical insurance (emi) or not. in addition, we look for the ultimate sampling unit (cameron & trivedi, 2005) in order to control for unobserved heterogeneity such as prices, distance to the health center, and other community specific factors . mckenzie (2007), and mckenzie and sasin (2007) emphasize the importance of using a migration variable to study a particular household outcome, such as health expenses, because of the difficulty of disentangling the effects of migration and remittances. 2 to separate these effects we use a proxy variable for migration. we address the endogeneity issue by introducing instruments that are consistent with the existing literature. we contribute to the literature on hhe and remittances in several ways. we measure the income (expenditure) effect and remittance effect on health expenditure separately. another major contribution is the measurement of the effects of remittances on household health expenditures for households with and without access to employment medical insurance. the control for migration in the model that ad122 journal of business strategies dresses an important heterogeneity issue is an additional contribution of this article. the discussion on private and social measurement of the effects of remittances on health expenditure is also new to the existing literature. the data our source of data is the national income expenditure survey of households of mexico (enigh) for the year 2004. the households' expenditure in the enigh is composed of two parts: a monetary and a non-monetary component. the non-monetary component refers to expenses that are not an out-of-pocket expenditure, but are estimated expenditures on household production, gifts, labor payments in kind, and non-monetary support from institutions. we do not include the non-monetary component because the interest of this study lies in the relationship between remittances (a monetary transfer) and health expenditures . the labor market in mexico is divided into two parts: a formal sector that complies with the law and has access to emi, and an informal sector. in the formal sector, the government workers and their children have access to emi through the instituto de seguridad y servicios sociales de los trabajadores del estado (issste), the private industry workers through the instituto mexicano del seguro social (lmss), and some other workers through their firms' medical services. 3 we infer this labor market division by considering whether a household does or doesn't have access to the medical services provided by the formal sector, i.e., to emi. in general, the workers without access to emi are in the informal sector or in the agricultural sector and their labor income is unreported to tax authorities. we consider a household as having access to eml if the head of the family or the spouse has access to at least one of the above mentioned medical insurance institutions. the enigh sample has 22,595 households and 31.6% of these households have access to em! if we consider the head's access only, and 35.4% if we consider the head and/or the spouse. an alternative we use is to take the households with at least one household member having access to emi (45.2%). but it is a weaker measure as the emi access of the son or daughter cannot usually be extended to their parents, brothers, and sisters. however, the empirical results with this alternative measure are qualitatively similar showing their robustness. there are three issues to consider while using data on remittances in mexico. first, there are differences in the amount of remittances between the data provided by banco de mexico (banxico), the central bank of mexico, and the household data collected by enigh.4 the total amount of worker remittances, according to volume 26, number 1 123 banxico (2008), during the third quarter (july september) of 2004 is usd 4,551 million and the remittances reported by enigh during the period augustoctober 2004 are usd 1,037 million. second, both data sources show that some of the more industrialized states, such as distrito federal, state of mexico and jalisco, are among the most important recipients of remittances. it indicates that remittance transfers do not necessarily have anything to do with rural community or with poverty. finally, the remittance transfers to the households are largely constant over time . as enigh reports, transfers for the last six months before the household's interview, we find a correlation coefficient between remittances in the first three months and in the last three months to be 0.996 and the correlation coefficient for transfers from institutions to be 1.0. this shows that transfers, including remittances, are continuous flows and they are not just a response to emergency need for money, as likely to happen with a health problem in the household. table 2 sample means and standard deviations all access to emi no access to emi mean std. dey. mean std. dey. mean std. dey. w 0 .033 0 .073 0.024 0.053 0.038 0.081 x 20937 27236 27906 26442 17125 26909 inx/n 8 .27 0 .97 8.66 0 .82 8.05 0.97 lnn 1.27 0.55 1.30 0.46 1.25 0.59 rem 414 16128 80 1351 598 20032 insti 339 1412 127 917 456 1608 mig 3.36 3.86 2.88 2.95 3 .62 4.26 emi 0.45 0.50 w: proportion of expenditure on health . x: expenditure . n: soze of the household . rem: remittances. insti: transfers from institutions . mig: fraction of migrants . in table 2, we present selected summary statistics for the data that will be used in the study. the number of households in the sample is 22,547 from a population of25 million households. the table shows the means and standard deviations of the variables separated by whether the household has access to emi or not. the proportion of monetary expenditures on health is 3.3%, but it is 2.4 % for households with access to emi and 3.8% for households without access. households without access to emi have a higher proportion of total expenditure devoted to health, a lower 124 journal of business strategies expenditure per capita, a smaller household size, higher transfers from remittances and from institutions, and are in localities with a higher percentage of migrants. the model the basic model specification in order to study the target effect of remittances on hhe, we require a model that relates the share of expenditures in health (w) to remittances (rem) and total household's expenditure per capita (x), and that simultaneously controls for access to emf and for migration (mig). to control for migration, we use as a proxy variable: the percentage of households with family migrants in the united states in last five years, at the municipality level. this information is obtained from tuinin et al. (2002) and it refers to the year 2000. we also control for the size and composition of the household and other characteristics . in order to control for differences in prices and unobserved heterogeneity between localities such as distance to the health center and other factors, we use the ultimate sampling unit to form clusters (c). we consider just one price in every locality, but we allow the price to vary among clusters as in deaton's (i 997) model. we require localities to be as small and as distant from each other as possible because each locality has just one price for goods related to health. besides localities we use sample expansion factors to expand from the sample to the population in order to build as many clusters as possible.s note that we use these expansion factors just to distinguish one cluster from another. as these clusters come from a sample and we want to extend the results to the population, we use a random effects model and consider the clusters to be randomly distributed in the sample. we specify the model as an engel function which relates the fraction of total household expenditures devoted to health with total household expenditure per capita, as in working (1943). this model, discussed by deaton (1989), has been widely used (e.g. gibson & rozelle, 2004; hong & kim, 2000) and variants can be found in atkinson, gomulka and stem (1990), and valero-gil (2006) for mexico. the model is as follows: 6 wch = :qh = f3 0 + f3 1in(xin)ch + f3 2 [ln(xin)ci,]z + f3 3lnnch + h 1j/emch + 1j[emc/ + 1j3emlch + 1j4emfch * in(xin) ch+ 1jsemlch * remch + 1j6migch + ±/j ( :cjh ) + () ·zch + uc + th (i) j~1 ch volume 26, number 1 125 the left hand side of the equation is the fraction of total expenditure x on health pq h' where p are prices and q h quantities of "health goods" consumed by the household h. the subscripts c and h indicate cluster and household respectively. the expenditure on health, pq", is observed but not p and qh separately, in(x/n)h is the natural logarithm of the expenditure per capita of household h, n h is the size of the household, remittances are denoted by rem which are censored at zero in 95.6% of the cases and cannot be included in logarithm. the proxy for a migrant in the household is denoted by mig and access to em! by emf. we also interact em! with total expenditures per capita and with remittances. different prices and heterogeneity in each cluster are indicated by u/ the stochastic error e has zero mean, con stante variance, and is assumed to be independently and identically distributed among households. in order to control for the age and sex of the members of the household, we define ten groups, one for people 0 6 years of age and one for 66 years and above, and four more groups for each sex according to the age groups 7 15, 16 24, 25 54 and 55 65. with these groups we define the composition of the family as nln, where j represents each of the ten groups, n . the number of people in group j and ) nln the proportion of people in group j. we also utilize a vector of control variables ) zch' that includes sex and marital status of the head of the household, four different geographic regions, and four different sizes of the localities. our null hypothesis is that tl j' tl2 and tl5 are equal to 0, implying that remittances do not have any effect on the hhe share. in order to compare the effect of remittances on hhe with the effect of other transfers, we run a similar regression using transfers from institutions (insti) instead of remittances. this is important because it considers whether any extra income from transfers could have the same effect on hhe as do remittances; in particular, the specification allows us to test whether households expend a dollar on the good with the highest marginal utility per dollar, independently of whether the dollar comes from remittances, institutional transfers, or other sources. endogeneity there is a well known concern about the endogeneity problem in the literature: the possibility that an increase in hhe increases remittances even though, as we have discussed in the last section, that remittances behave as a continuous flow. to correct this problem we can use instrumental variables, which should be related to remittances but unrelated to the error term. these variables will also correct the 126 journal of business strategies measurement error problem in remittances discussed in the last section. one way to consider this is to think of a variable related to remittances but unrelated to hhe. based on the population census of 2000, tuinin et at. (2002) present information about the percentage of return migration between 1995-2000, at the municipalleve\. we use this variable as an instrument because although health expenditures could be a cause of migration and of remittances, they being a cause of return migration is much weaker. we calculate the percentage of return migration and obtain its median . then we introduce a dummy variable that takes the value of 1 if the percentage is greater than the median and the value of 0 otherwise. we calculate the spearman 's rank correlation coefficient and find that the correlation between the return migration dummy and remittances is significantly different from zero at a level lower than 0.00 i percent, but the correlation between the return migration and the health expenditures share is much weaker. we further consider the distance between the locality where the household resides and the border with the united states as an alternative instrument. 8 but its correlation either with rem or with w is found to be statistically insignificant. the distance to the border variable has been used by lopez-cordoba (2006) and amuedo-dorantes and pozo (2008) but has been criticized by mckenzie and sasin (2007). to estimate equation (i) we use two instrumental variable (iv) procedures: a two-stage predictor substitution model (2sps) and a two-stage residual inclusion model (2sri). in both cases the first stage involves an estimation of remittances using both the exogenous and the instrumental variables. in the second stage, we substitute the estimated remittances in equation (1) in the case of2sps , and we include the error of the first stage as an additional variable in the case of 2sri. terza et at. (2008), following the work of hausman (1978), smith and blundell (1986), and others, show that the use of2sri generates better results than 2sps in the estimation of nonlinear models with endogenous regressors. tobit model and marginal values. the proportion of health expenditure is censored at zero for 35% of the households and for this reason we follow a tobit model specified as follows: w * = 8'x + e ch ch ch w = 0 zifw * < 0 and w = w * zifw * > 0 ch ch ch ch ch (2) volume 26, number 1 127 in this model w ch is the observed variable and wch* is the threshold variable. this model generates two marginal values ow/ax, one for e[ w c / ix ch ] and the other for e[wc/,ix ch ] which equals e[wc/ixch' we/ > 0]. intuition suggests that we should consider e[ wchlxch] since we never observe health expenditures lower than zero. we could consider the values for weh * < 0 if we want to evaluate health expenditure as a social problem. for example, we can think that the poor will not expend any part of an extra peso on health. this would be the case of people in poverty or of people wanting to sell their health in order to obtain other goods.9 the relationship between poverty and the probability of incurring health expenditures is well documented, as in wagstaff (2002), ochoa-diaz et al. (1999), and smirez-berenguela (2000). however, if we want to evaluate health expenditure as a private problem, such as in the case of the private sales of a medical service or product, it could be more relevant to use e[wehlxchl even in the sales scenario, debb and trivedi (2002) have shown that for the case of count data on health expenditures, a threshold model using w* is preferred to a two-step model that separates the cases between weh = ° and wch > 0. the relationship between both marginal values generated by e[wehlxch) and e[we/lxch ) is given by 8' ckx'p/(j€) where x'p are the estimated values and if> refers to the standard normal distribution. following the literature, we will refer to the total values generated by e[ w eh *lxch ] and marginal values generated by e[ wehlxch] as social and privates values respectively. 10 results in table 3, we present results from the following estimation methods: the tobit model without using instrumental variables for remittances, the tobit model with instrumental variables for remittances using the 2sps procedure, the tobit model with instrumental variables for remittances using the 2sri procedure, and two gls models, one for w > 0 and one for w 2: 0, for comparison purposes. in every case we use random effects to control for heterogeneity by locality, but the use of these effects do not alter the results in a significant way, perhaps because we are using a full set of variables. columns (1) to (5) present the results for the tobit models while columns (6) and (7) present the results for the gls models. column (1) refers to the tobit model without instrumental variables and shows that there is a positive effect of remittances on a household's health expenditure: higher remittances to the household are accompanied by a larger share of expenditure on health. the coefficients for expenditures per capita, remittances, and emi are all significantly different from zero. 128 journal of business strategies heterogeneity related to migration increases the share of household 's health expenditures (hhe) : households with migrants could have a higher propensity to expend in healthcare. in the second part of the table the marginal values are presented. as discussed above, they refer to the case e[ w ch *ix ch ' w c ,,* > 0]. the marginal values are lower when compared to the total values. !fwe use transfers from institutions (inst) in place of remittances, shown in column (2), we find that this type of transfers do not significantly affect hhe. therefore, our findings indicate that remittances are "earmarked" and that the relationship between remittances and hhe cannot be extended to other types of transfers. all of the results in table 3 show that remittances have a positive impact on the fraction of health expenditures by the household, but as expected, this effect is significantly smaller for households with employment's medical insurance. in column (3) we re-run the same regression as in column (1) using an alternative definition of households with/without medical insurance as a robustness check. in this specification, we define a household as having access to employment's medical insurance if at least one member of the household has access to emi. our results are robust to this alternative definition of household access to em!. as discussed above, to deal with the endogeneity problem, we estimate the model with the percentage of return migration as an instrument.. the results of the iv tobit model are presented in column (4) for the 2sps procedure and in column (5) for the 2sri procedure. the estimated coefficients of remittances from the 2sps procedure reported in column (5) are smaller in magnitude than those in column (4) and the coefficient for rem2 changes sign. however, the 2sri generates coefficients similar to those of column (i). ii as discussed above, according to terza, basu and rathouz (2008), the 2sri procedure is consistent and produces better results than the 2sps procedure in non-linear case like ours. 12 in the last two columns, the gls regression results are presented : for the case w> 0 in column (6) and for the case w ~ 0 in column (7). the results for w > 0 are comparable to the marginal effect results because they apply to the households with w> o. the results for w ~ 0 measure the quantity demanded for health including actual consumers and non-consumers, as suggested by deaton (1997), as an additional result for comparison purposes. to test i fthe partial derivatives evaluated at the means owlorem and owl oln(xln) , are significantly different from zero, we use the information of equation (i) and the mean values of rem and lnxln of table 2 .13 table 4 presents the effects on the means using the estimates of the iv tobit and gls models shown in column (4) to (7) of table 3. the results from ftest for significance of differences between the mean table 3 ~ -;: effects of variables in the share of health expenditure ~ n tv (1) (2) (3) (4) (5) (6) (7) 0\ ~ tobit tobit tobit iv tobit tobit gls5 gls ~ instj1 emi2 2sri3 2sps4 w>o w?o ~ <:i"' n insti1 emi2 2sri3 2sps4 w>o glsw ? 0 "'t '-' constant -0.426 -0.417 -0.439 -0.422 -0.382 0 .157 -0.052 (-11.58) (-11.45) (-12 .28) (-11 .72) (-10 .53) (3 .95) ( -2.27) inx/n 0.084 0.081 0.087 0 .082 0 .080 -0 .016 0.015 (9.53) (9.25) (10 .15) (9 .01 ) (8.61 ) (-1.71) (2 .78) (inx/n)2 -0 .003 -0 .003 -0.004 -0.003 -0 .003 0 .001 0.000 (-6.53) ( -6.02) (-7.03) ( -5 .64) ( -5.22) (2.46) (-0.47) rem 1.45e-06 -6 .40e-07 1.53e-06 1.49e-06 2.64e-07 1.25e-06 1.32e-06 (4 .61 ) (-0.76) (4.65) (4.57) (1 .78) (4.21) (5.73) rem2 -4 .88e-13 5.25e-13 -5 .20e-13 -5 .20e-13 6.75e13 -4.23e-13 -4.44e-13 ( -3.7) (0.03) (-3 .77) (-3.95) (2.08) (-3.41) ( -4.58) emi -0.065 -0.047 -0.060 -0.068 -0 .076 -0 .0 18 -0.011 (-4 .04) (-3 .18) (-4 .02) ( -4.3) ( -4 .06) (-1 .09) ( -0 .96) inx/n* emi 4.93e-03 2.65e-03 4. 13e-03 0 .005 4.93e-03 5.77e-04 -2.57e-04 (2 .66) (1.51 ) (2.38) (2 .73) (2.35) (0 .3 1) ( -0 .2) rem ' emi -1.55e-06 2.80e-07 -1 .1 0e-06 -1 .60e-06 -5.77e-08 -1.40e-06 -1.46e-06 ( -1.8) (0. 2 1 ) (-1.56) (-1 .85) (-1 .16) (1.77) (-2.31) mig 1.60e-03 1.67e-03 1.55e-03 1.74e-03 1.3 1e-03 7.46e-04 9.40e-04 ~ (6.62) (6.94) (7 .59) (3.73) (2.61 ) (3 .68) (6.44) i\) <0 --" table 3 cont'd w 0 effects of variables in the share of health expenditure (1 ) (2) (3) (4) (5) (6) (7) marginal values inx/n 0.032 0.031 0.030 (inx/n)2 -0 .001 -0.001 -0001 rem 5.47e-07 5.63e-07 9.94e-08 rem 2 -1.84e-13 -1 .96e-13 2.55e-13 emi -0.023 -0.024 -0.027 inx/n*emi 0.002 0.002 0.002 rem*emi -5 .85e-07 -603e-07 -2.18e-08 mig 6.04e-04 6.55e-04 4.96e-04 log likehood 8507 8078 9437 8689 8980 '0" r-sq : within 0.060 0.047 ~ -t ~ between 0.112 0.112 ~ overall 0.078 0.062 ~ i:x:i ~ sigma se 0.094 0 .092 0.093 0 .093 0.094 .082 1 .070 '" ... _ . ---~ "' '" notes: t-statistics in parentheses , number of observations ; 21139 , censored: 7440 , uncensored 13,694; number of groups 3,074. other '" vl control variables used are sex and marital status of the head of the family, 9 variables for composition of sex and age of the members of the .... -t household , 3 for geographic zone and 3 for size of the locality. 1 in col umn (2) the variable remi was substituted by the variable insti (trans~ .... fers from institutions). 2 in column (3) the variable emi was changed considering access to emi if at least one member has access to em!. 3 ~ ... iv refers to instrumental variables and 2sri to the method of two-stage residual inclusion. 4 2sps refers to two-stage predictor substitution . "' '" 5 gls , generalized least squares, refers in this case to the technique of ordinary least squares plus random effects. volume 26, number 1 131 coefficients of remittances with/without emi groups are also presented. the results show a positive sign for the effect on the mean for remittances if the household does not have access to emi and in most cases a negative sign if the household has access. this reinforces the conclusion that remittances have a target effect of increasing the proportion of health expenditures for households without access to emi. table 4 effects on the means methods effects on the means prob> f rem expenditure rem expenditure iv tobit 2sri access to emi -1.10e-07 0.030 0.90** 0.00*** no access to emi 1.49e-06 0.029 0 .00** 0.00*** iv tobit 2sls access to emi 2.06e-07 0.029 0.05 0.00*** no access to emi 2.65e-07 0.028 0.00 0.00*** glsw> 0 access to em i -1.50e-07 0.008 0 :83* 0.07 no access to emi 1.25e-06 0.006 0.00* 0.03 glsw ~ 0 access to emi -1.40e-07 0.012 0.82** 0.63 no access to em i 1.32e-06 0.013 0.00" 0.64 the coefficients of the effects on the means for the groups with and without access to emi are significantly different at 1% level (***), 5% level (**), 10% level(*). in table 5, we present an example to illustrate the use of our results by considering the effects of a 10% increase in remittances, and the difference between effects of household expenditures and of "earmarked" remittances on hhe. first, the table shows the effects of a 10% increase in remittances for households with and without emi, estimated by using the iv tobit with 2sri (column 1-2), the iv tobit with 2sls (column 3-4) and gls with w:::: 0 and w > 0 (column 5-6). the first three rows of table 6 are taken from table 2: the share of hhe in total expenditures, w, health expenditures w*x and remittances rem. row 4 shows that a 10% increase in remittances amounts to $8 (mexican pesos) for the households with access to emi and $59.8 for households without access to emi. the elasticity ofhhe with respect to remittances is given in row 5. row 6 shows the increase in hhe due specifically 132 journal of business strategies to increase in remittances: $0.02 out of $8 for households with access to emi and $3.49 out of $59.8 for households without access to emi, which indicate increases of 0.25% and 5.836% respectively, as shown in row 10. row 7 presents the estimated elasticity ofhhe with respect to total expenditure, and row 8 the increase in hhe due to increase in household expenditures. the increase of $0.431 for households with access to emi and $4.300 for households without access represent increases of 5.383% and 7.190% respectively, as shown in row 1 \. adding both effects, the remittance and expenditure effects, the total increase in hhe is $0.451 for households with access to emi and of$7.789 for households without access, representing increases of 5.633% and 13.026% respectively. if the money fungibility hypothesis held, we would expect the remittance effect to have been zero. note that these results represent the social value of remittances because they include values for w* < 0 that are generated in our model by households with lower expenditures per capita. note that differences in the results arise from the distinction between households with/without access to emi and not from the particular measurement method used. only in the case ofgls using all observations (w:::: 0), a regression suggested by deaton (1997), we obtain lower coefficients because many zeroes are included. rows 14 through 20 of table 5 follow the same order as rows 6 to 12 and they measure the marginal effects or private values in this case, as they only consider the cases for w > 0 . we find that an increase of 10% in remittances increases hhe by 3.799% for people with access to emi and by 9.457% (row 20) for households without access. the total 9.457% is divided in 4.378% due to "earmarked" remittances and 5.079% due to the increase in expenditure. in other words, the availability of an extra peso will generate an increase of5.079 % in hhe, but if that peso comes from remittances it will generate an additional increase of 4.378% in hhe. in general, the results ofthe marginal effects range from 8.7% to 9.9% for households without access to emi and from 3.4 to 3.8% for households with access. these results measure the private value of remittances. our results show that even when the elasticity of health expenditures with respect to total expenditures is greater than one, the effect of remittance transfers generate an even greater effect on health expenditure for households without access to emi. given the importance of health expenditure on social welfare and on the formation of human capital, there should be a public policy aimed at reducing the cost of receiving remittances, especially in the regions with high poverty. such a policy will indirectly promote health expenditure among those without access to emi, leading to a society with better health. table 5 interpretation of results: an example fv tobit 2srf fv tobit 2sls without without emf emf emf emf (1 ) (2) (3) (4) w (%) (1 ) 2.4 3.8 2.4 3.8 health expenditure w*x (quarter) (2) 669.7 650.8 669 .7 650 .8 remittances (3) 80 598 80 598 10% increase in remittances (4) 8.0 59.8 8 59.8 elasticity of hhe wrt' remittances (5) 0 .002 0 .058 0.004 0.039 hhe increase due to remittances (6) 0.020 3.490 0.028 2.337 elasticity of hhe wrt total expenditure (7) 2.243 1.892 2.219 1.872 health expenditure increase due to total expenditure (8) 0.431 4.300 0.426 4.255 total hhe increase (9) 0.451 7.789 0.455 6.592 % increase in hhe remittances (10) 0 .250 5.836 0.355 3.909 % increase in hhe expenditures (11) 5.383 7.190 5.326 7.115 % increase in hhe -total (12) 5.633 13.026 5.682 11.024 glsw~o without emf emf (5) (6) 2.4 3.8 669.7 650.8 80 598 8 59.8 0.002 0 .056 0.019 3.330 1.516 1.331 0 .291 3 .025 0 .310 6 .355 3.879 10.627 0.240 5 .568 3.639 5 .059 ~ -~ ~ n n ?'~ ~ <l'" n "'t ;... ..... w w table 5 cont'd interpretation of results: an example marginal effects elasticity of hhe wrt remittances (13) 0 .003 0.044 0.003 hhe increase due to remittances (14) 0 .022 2.618 0.025 elasticity of hhe wrt total expenditure (15) 1.469 1.337 1.460 health expenditure increase due to total expenditure (16) 0 .282 3.037 0.280 total hhe increase ( 17) 0.304 5.655 0.305 % increase in hhe remittances (18) 0.273 4.378 0 .313 % increase in hhe expenditures (19) 3.526 5.079 3.504 % increase in hhe -total (20) 3.799 9.457 3.816 1 hhe wrt: household 's health expenditures with respect to. glsw> 0 0.036 0.002 0.055 2.182 0.019 3.264 1.329 1.344 1.173 3.020 0.258 2.665 5.202 0.277 5.929 3 .649 0 .237 5.458 5.050 3.226 4.457 8.699 3.462 9.915 ..... w ~ ~ ~ ~ $:l ~ t:;!:j ~ .,. ;i' ." .,. in en .... "'i $:l .... ~ ~' .,. volume 26, number 1 135 conclusion this paper examines the relationship between remittances and the households' expenditure on health, using data from mexico for the year 2004. we study this relationship by controlling for the household's total monetary expenditure, migration, composition and size of the family, marital status and sex of the head of the household, and region and size of the locality. the most important control variable is the one related to household's expenditure that measures availability of resources. as remittances are a part of total household expenditure, a positive relationship with the proportion of the household's expenditure on health would indicate that the proportion devoted to expenditure on health is increasing with remittances. therefore, we can conclude that health expenditure is a target of remittances and we can reject the hypothesis that money is fungible, since even when a dollar is a dollar, a dollar from remittances is being devoted in part to health expenditures. this result is true for households without access to employment's medical insurance, that is, for households in the agricultural and in the informal sectors of the mexican economy, which are the sectors with a high prevalence of poverty. this result suggests there are welfare benefits from implementing a strategy which would reduce the cost of receiving remittances in poor regions. in order to compare the effects of institutional transfers with the effects of remittances, we also study the relationship between institutional transfers to the households and the proportion of expenditure on health, but we do not find a statistically significant relationship. the positive relationship between remittances and the proportion of the household's health expenditures together with the lack of a similar relationship for institutional transfers suggest that it is mainly remittances, and not institutional transfers, that contribute to a household's share of expenditure on health. these suggest that while money is not fungible in the case of remittances, the same cannot be said about money from institutional transfers. the results are robust to changing the definition of access to employment's medical insurance. notes i. see condouel et at. (2002) and deaton (1997). 2. mckenzie (2007) argues that we must find a variable related to the migration of a member of the household and one that explains why a household with a migrant household member receives more remittances than another similar household. we look for answers to these questions considering the probability of the household receiving remittances and the probability of migrating. 136 journal of business strategies 3. usually when the father or mother of a family have emi in their job, their children also have access to it. but even if the head of the family or the spouse have access to emi, this does not imply that other members would also have access. therefore, this measure is only an approximation, but even with this broad definition we find differences in the means and in the estimated parameters of the two groups. 4. see robilliard and robinson (1999) for a discussion of the differences between household surveys and national accounts data and a methodology to reconcile them. 5. the enigh has information about 32 federal states, 503 localities, 4 strata (size ofthe locality) and 1,687 expansion factors that could be repeated in different states, localities or strata. this information allows us to distinguish 3,074 clusters or ultimate sampling units which for 22,595 observed households gives us an average of 7.4 households by cluster. 6. this function appears in deaton (1997, pp. 268-69) and is derived from a cost function, c(u,p,n) = nsa(p )u~(p) where u is the utility function, e is a parameter to control for scale economies in the household, a(p) is linearly homogeneous and p(p) is homogeneous of degree zero in prices. considering that olnclop i = w i and taking lna(p) = 1:aklnpk and lnp(p) = 1:pklnpk the system of demands will take the form of a working equation wj = a j* + p)n(x/ns) = a j* + pjln(x/n) + pp e)lnn, which is the equation that is being used here. 7. the u c is the deviation from the average w at the locality c. it is assumed that these deviations are normal with mean zero and constant variance in the random effects (re) model. we use the stata's program instructions xttobit for the tobit model and xtreg for the gls model with quadrature equal to 12 to do our estimations. 8. we calculate distances to the border of 79 localities. when we do not know the distance from the locality to the border we use the distance between the state 's capital and the u.s . border. 9. the derivability of equation (1) from a cost function allows us to interpret the marginal effects as the distance to a threshold or as originated in a utility function. this distance to the threshold w ch * = ° measures the amount the household is to give in order to obtain other goods. 10. we also try to manage the problem of censored data as a case of self selection in an equation for remittances, but the obtained inverse mills-ratio or heckman's volume 26, number 1 137 lambda is not significantly different from zero. this implies that it is not convenient to use the self selection methodology to obtain corrected estimates. 11. the additional variable included in the 2sri procedure was not significantly different from zero, but the theoretical reason to use instrumental variables still persists: health expenditure could be generating remittances. the additional variable, obtained in the first step of the procedure, looses significance when the control variable for migration enters into the model indicating the possibility that both variables are collinear. 12. we control for the problem of heterogeneity through the inclusion of different kinds of variations, such as the composition of the family, total expenditure, scale effects, migration, and so on. with regards to the adequacy of using the tobit model, johnston and dinardo (1997) suggest comparing the relationship wcr for the probit and tobit models. we find that with the exception of two variables the iv tobit 2sri and the probit models maintain the same signs, but when comparing the iv tobit 2sls with its respective probit model the remittances variable changes sign. therefore, we feel confident that the 2sri model is well specified as a tobit model. to save space, we do not report the results. interested readers may obtain the results from the author. 13. the effects on means are estimated through equation (1). for example, for remittances we will have: ow/&em = 1], + 21][em + 1]5em1. the elasticities of health expenditure with respect to total monetary expenditures (constant size of the household) and with respect to remittances, ex and e r , are defined as: ow e = olnq = oln(xin) + 1; x inx w 8lnq rem ow rem e = =-. --+-r olnrem w orem x where the term remix is the expenditure effect because it assumes oxlorem = 1. references acosta, p., fajnzylber, p., & lopez, j. h. (2007). the impact of remittances on poverty and human capital: evidence from latin american household surveys. world bank, policy research working paper wps 4247. aires, b. (2005). transforming labor markets and promoting financial democracy. inter~american development bank, remittances 2005. 138 journal of business strategies amuedo-dorantes, c., & pozo, s. (2008). new evidence on the role of remittances on healthcare expenditures by mexican households. working paper. amuedo-dorantes, c., sainz, t. , & pozo, s. (2007). remittances and healthcare expenditure patterns of populations in origin communities: evidence from mexico. intal ltd, working paper 25. atkinson, a. b., gomulka, j., & stern, n. h. (1990). spending on alcohol: evidence from the family expenditure survey 1970-1983 . economic journal. 1 00(402), 808-827. banerjee, a. v., & dufio, e. (2007). the economic lives of the poor. journal of economic perspectives. 21(1),141-167. banxico (banco de mexico). (2005). balanza de pagos. remesasfamiliares. retrieved from www.banxico.gob.mx/einfofinancieraifsinfofinanciera.html. banxico (banco de mexico). (2008). balanza de pagos. lngresos por remesas familiares. distribuci6n por entidad federativa: banco de mexico. cameron, a. c., & trivedi, p. k. (2005). microeconometrics: methods and applications (lst ed.). new york: cambridge university press. cardona, l., & medina, c. (2005). migration as a safety net and effects of remittances on household consumption: the case of colombia. banco de la republica, economic research unit. coudouel, a., hentschel, j. s., & wodon, q. t. (2002). poverty measurement and analysis. in j. klugman (ed.), a sourcebook for poverty reduction strategies (vol. 1, p. 1260): world bank. deaton, a. (1989). looking for boy-girl discrimination in household expenditure data. the world bank economic review, 3( i), 1-15. deaton, a. (1997). the analysis of household surveys: a microeconometric approach to development policy. world bank: washington, dc. the john hopkins university press. debb, p., & trivedi, p. k. (2002). the structure of demand for health care: latent class versus two-part models. journal of health economics. 21(4),601-625. gibson, j., & rozelle, s. d. (2004). is it better to be a boy? a disaggregated outlay equivalent analysis of gender bias in papua new guinea. journal of development studies. 40(3), 115-136. hausman, j. a. (1978). specification tests in econometrics. econometrica. 46(6), 1251-1271. hildebrandt, n., & mckenzie, d. j. (2005). the effects of migration on child health in mexico. world bank, policy research working paper wps 3573. volume 26, number 1 139 hong, g . s., & kim, s. y. (2000). out-of-pocket health care expenditure patterns and financial burden across the life cycle stages. journal of consumer affairs, 34(2),291-313. johnston, j. , & dinardo, j. (1997). econometric methods. new york: mcgraw-hill, higher education. lopez-cordova, e. (2006). globalization, migration and development: the role of mexican migrant remittances. inter-american development bank. mckenzie, d. j. (2007). beyond remittances: the effects of migration on mexican households. in c. ozden & m. schiff (eds.), international migration, remittances & the brain drain. world bank. mckenzie, d. j., & sasin, m. j. (2007). migration, remittances, poverty, and human capital: conceptual and empirical challenges. world bank. ochoa-diaz, h., hector, s. p., ruiz-flores, m. , & fuller, m. (1999). social inequalities and health in rural chiapas, mexico: agricultural economy, nutrition, and child health in la fraylesca region. cad saude publica, 15(2), 261-270. robilliard, a. s., & robinson, s. (2001). reconciling household surveys and national accounts data using a cross entropy estimation method international food policy research institute. rubalcava, l., teruel, g., thomas, d ., & goldman, n. (2008). the healthy migrant effect: new findings from the mexican family life survey. american journal of public health, 98(1), 78-84. smith, r. j., & blundell, r. w. (1986). an exogeneity test for a simultaneous equation tobit model with an application to labor supply. econometrica, 54(3),679685. smirez-berenguela, r. (2000). health system inequalities and inequities in latin america and the caribbean: findings and policy implications. world bank, working paper prepared for the health and human development division of the pan american health organization world health organization. terza, j. v., basu, a., & rathouz, p. j. (2008). two-stage residual inclusion estimation: addressing endogeneity in health econometric modeling. journal of health economics. tuiran, r. , fuentes, c., & avila, 1. l. (2002). indice de intensidad migratoria mexico-estados unidos. mexico: consejo nacional de poblacion. valero-gil, j. (2006). estimacion de elasticidades e impuestos optimos a los bienes mas consumidos en mexico. estudios economicos, 21(2), 121-176. wagstaff, a. (2002). poverty and health sector inequalities. bull world health organ, 80(2),97-105. 140 journal of business strategies working, h. (1943). statistical laws offamily expenditure. journal of the american statistical association, 38(221), 43-56. world health organization. (2007a). national health accounts. retrieved from www.who.intlentity/nhaicountry/mex.xls. world health organization. (2007b). the world health report. retrieved from www. who.intlwhr/enl. biographical sketch of the author jorge n. valero-gil is a professor of economics at universidad aut6noma de nuevo leon, monterrey, mexico. he received his ph.d. in economics from the university of california at santa barbara in 1989. his current research focuses on household expenditures, informality, poverty, and on the influence that the legal system has on the formation of an informal sector in the mexican economy. his email address is jvalero@faeco.uanl.mx. remittances and the household's expenditures on health migration and life satisfaction: evidence from latin america mauricio cardenas brookings institution • washington , dc vincenzo di maro inter-american development bank • washington , dc isaac sorkin brookings institution • washington, dc abstract using data from the gallup world poll and latinobarometro, we examine the relationship between life satisfaction, vulnerabilities, and migration in latin america. we look at three kinds of insecurities: nutritional, personal, and job insecurity. we find that controlling for income, migration experience by a household member increases life satisfaction of the respondent. we also find , however, that nutritional insecurities interact negatively with migration. in other words, hunger has a devastating effect on happiness, especially in households where a member is absent due to migration. introduction migration is an issue of major importance in latin america. in data we discuss below, approximately a third of latin american households report they either have a family member living abroad, or have hada family member living abroad in the last five years. the impact of migration on the individuals who remain is of obvious interest. the bulk ofthe existing literature has looked at the effects of migration (and remittances) on some socioeconomic dimensions of the remaining family members. for example, cox-edwards and ureta (2003) show that in ei salvador children in households receiving remittances are less likely to leave school, hildebrandt and mckenzie (2005) find that in mexican households with migrants, newborns are more likely to have higher birth weight and to be delivered by a professional doctor, and lopez-cordova (2005) concludes that in mexican municipalities with more remittances infant and child mortality rates are lower. however, some papers show that migration has negative consequences such as less investment by parents in some health inputs or worse academic and social performance for children with one or both migrant parents (hildebrandt & mckenzie, 2005; world bank, 2006; and the citations therein). there is an intense controversy over these results in part 10 journal of business strategies because the standard econometric problems of reverse causality and selection bias that plague this literature. a comprehensive assessment of migration is even more complex because some of its effects go beyond the realm of economic choices. even if migration brings greater material opportunities, family disintegration can have negative effects on the quality oflife. for example, gunatilleke (1990) finds that in a sample of families from sri lanka who had a migrant, one-fifth reported new difficulties with children, including unruly behavior, poorer health, and signs of grief or depression. evidence of this sort underscores the importance oflooking at effects of migration on subjective self-assessments of well-being. in this vein, while not looking at migration directly, the inter-american development bank's remarkable synthesis of work on the "economics of happiness" as it applies to latin america demonstrates the insights that can be gained from considering subjective assessments (lora, 2008). for example, the "paradox of unhappy growth" suggests an explanation for why successful growth-promoting policies are not popular, even when they are pareto-optimal: growth induces increases in expectations for economic prosperity that outstrip the recorded growth. understanding the impact of migration on societies requires moving beyond externally verifiable measures to examine how people perceive their experiences. the "economics of happiness" has launched a broad array of definitions of well-being or happiness (or life satisfaction). the goal is to craft policies to improve a broad definition of "quality of life," including domains ranging from employment to health to education. there is much variation in how researchers actually implement the notion of "quality of life" (qol). a typical definition, from the european foundation for the improvement of living and working conditions (e.g. fahey, nolan & whelan, 2003), considers qol as the ability ofpeopje to attain the goals and choose the lifestyle that they want. in this paper, we use questions from polling data that ask for an overall evaluation of the respondents lives (we report the precise wording below). we will use "happiness," "satisfaction," and " well-being" interchangeably throughout in referring to this evaluative measure . the relationship between happiness and migration is complex . the main direct channel through which migration can positively affect well-being is remittances, which provide income.1 apart from this effect, which we control for by including household income in the regressions, the other main direct effect is likely to be the insurance of consumption. for example, yang and choi (2007) show that in filipino households having a migrant family member insures consumption against income shocks. migration might have a negative impact on happiness similar to volume 26, number 1 11 "loss of friendships," due to family fragmentation. as the inter-american development bank (idb) volume documents (chapter 4), the loss of all friendships for the "average" person in latin america has an impact on happiness equivalent to income falling to one-seventh the previous level. therefore, migration could on net have a positive or negative impact on happiness of those left behind. in addition to these two effects, it is possible that some vulnerabilities are exacerbated by family disintegration and the lack of immediate support. in this context, we are interested in the way in which migration indirectly affects happiness through the experience of vulnerabilities. in previous work, we looked at nutritional, job and personal (safety) insecurities and found that they negatively affected happiness, with nutritional insecurity having the strongest effect and personal safety insecurities the weakest (cardenas, di maro & mejia, 2008). in this paper we extend that work to look at the interaction effects of migration and vulnerabilities. while it is the case that migration might affect the experience of other socioeconomic factors that contribute to happiness, like age and education, we think that the interaction with vulnerabilities is one of the most interesting. this is because the main direct channels of migration on happiness income and insurance are likely to have strong indirect effects on vulnerabilities. in addition, the effects of actual occurrences of hunger, fear of job loss, or victimization on happiness can vary depending on whether the individual has a fragmented family. to provide a preliminary answer to some of these questions, this paper explores the relationship between happiness and migration by examining representative individual and country-level data from the majority of latin american and caribbean countries. the data allow us to examine the impact of the different channels of migration on happiness: the loss of friendship channel and the income/insurance channel. in our empirical work we look at two measures of migration: having or having had a family member abroad and whether the household expects to receive help from abroad. we look at their impacts on happiness and also whether they exacerbate or mitigate the impacts of a variety of types of insecurities personal, job and nutritional on happiness. we find that the "insurance" channel appears to dominate the "loss of friendship" channel and migration has a positive impact on the happiness of those left behind. looking more closely at vulnerabilities, we find that migration increases the negative impact of nutritional insecurity on happiness but reduces the negative impact of job insecurity on happiness. though we do control for a "personality factor," because we are not able to control for the selection process of individuals into migration, our results should be interpreted with caution. 12 journal of business strategies the finding of a positive impact of migration on the life satisfaction of migrants households is at odds with recent findings by borraz, pozo and rossi (2008) on migrants from ecuador. they find that migration reduces the happiness of those left behind and that remittances do not compensate for the family disintegration. they use data from only two communities in ecuador and so our results are potentially more representative of the "typical" latin american experience. our results are, however, consistent with the bulk of the literature that shows positive impacts of remittances and migration (difficult to separate in most cases) on an array of socioeconomic variables. data we primarily use the gallup world poll survey. the poll includes questions on a wide range oflife satisfaction dimensions (overall satisfaction with life, satisfaction with one's standard of living and satisfaction with freedom to choose what to do with one's life, among others). the poll also includes two kinds of questions related to migration and several measures of nutritional, personal and job insecurity. though two waves of data are available for latin american and caribbean countries 2006 and 2007 unfortunately each survey covers different households so that the data does not have a panel structure. the survey covers 20 lac countries: argentina, belize, bolivia, brazil, chile, colombia, costa rica, dominican republic, ecuador, el salvador, guatemala, guyana, honduras, mexico, nicaragua, panama, paraguay, peru, uruguay, and venezuela. the survey includes about 1000 observations per country. we use data from both waves. specific questions are discussed below. we also use data from latinobarometro. this is an annual survey with more specialized questions for studying perceptions in latin america. we use the pooled cross section from 1995 to 2005 for 17 lac countries (all of those in the gallup survey except belize, dominican republic and guyana). as described in the introduction , we are interested in the relationship between insecurity, migration and happiness. the gallup world poll and latinobarometro provide a number of measures of each. we report and discuss the wording of each of the measures that we use. we use three "satisfaction" measures from the gallup world poll: • overall satisfaction with life (normally referred as the ladder question): from zero to ten , where do you personally feel at this time, assuming that the higher score the better you feel about your life, and the lower score the worse you feel about it? volume 26, number 1 13 • satisfaction with liv ing standards: are you satisfied or dissatisfied with your standard of liv ing, all the things you can buy and do? • satisfaction with freedom: [in your country] are you satisfied with the freedom to choose what you do with your life? these questions each refer to a different aspect of "well-being." the first question is the most framed of the three questions and aims to capture the most comprehensive view of how an individual perceives his or her life (it has been shown by graham et ai. , 2008 that this quest ion is more correlated with income than the others). it is the only one of these three questions that allows more than a yes or no answer. the second question.tries to focus more narrowly on economic well-being, rather than general well-being, in that it frames the issue as one of standard of living, rather than satisfaction. the ladder (or life satisfaction) question is distinct from an open ended satisfaction with living standards question . however, both provide useful information and capture different features of the overall well-being of the individual. given their complementary nature we use both in the analysis that follows . the third question focuses on the opportunities that individual's perceive in their home country. in the context of migration, this allows us to explore whether having a family member leave the country is correlated with one's expectations of the home country. we use one satisfaction related question from latinobar6metro: • are you satisfied with life? how much? [answers from 1, " not satisfied at all" to 4, "very satisfied"] this question is very similar to the gallup " ladder" question, and aims to capture a comprehensive view of how an individual perceives his or her life. we use three migration related questions from the gallup world poll: • have any members of your household, aged 15 to 60, gone to live in a foreign country permanently or temporarily in the past five years? two variables: family abroad 1 (yes, still there), family abroad 2 (yes, still there and yes, has returned) • do you have relatives or friends who are living in another country whom you can count on to help you when you need them, or not? (help from abroad) • is the city or area where you live a good place or not for immigrants from other countries? 14 journal of business strategies the first two questions are the core migration related questions. they allow us to know whether the household has or has had experience with migration. the difference between currently having a family member abroad and having a returned family member is crucial. it is possible that a returned family member brings not only financial capital to the household, but also human capital, though it could also be the case that migrants who return were less "successful" abroad than those who do not return. at the same time, it means that the family member has returned and so the "loss of friendship" effect is no longer there. the third question picks up on the perceived insurance benefit of having a family member abroad. the final question is of a different nature as it looks at the opportunities that an individual perceives in their locality for outsiders . this is likely to be correlated with opportunities that an individual perceives for themselves at home and thus might pick up on the relationship between migration experience and expectations. we also use one migration related questions from latinobar6metro: • have you and your family considered moving abroad? this question is the happiness parallel to the positive and negative selection debate in terms of migrants' skill: are those who migrate more or less satisfied? as mentioned in the introduction, we are interested in figuring out whether families with migration are affected differently by vulnerabilities or insecurities. in particular, we consider three types of insecurities: nutritional, job-related and victimization episodes. we use two measures of nutritional insecurity from the gallup poll: • have there been times in the past twelve months when you did not have enough money to buy food that you or your family needed? (nt money, not enough money) • have there been times in the past 12 months when you or your family have gone hungry? (ni hungry, gone hungry) these measures reflect different aspects of insecurity. someone who answers yes to the first but no to the second has outside sources of help. answering yes to both implies that not only are they economically insecure, but that there is also no safety net. we use measures of job insecurity from two different surveys: • do you think you could lose your job in the next six months? (job_insec) which is available in the gallup poll. volume 26, number 1 15 • how worried you are of losing your job or staying unemployed in the next 12 months? "not worried," "just a bit worried," "worried," "very worried" (latinobarometro) • do you think the labour regulation protects workers in this country? "not protected at all," "just a bit protected," "quite protected," "very protected" (latinobarometro) • from i to 10 where i is "completely secure" and 10 is "no job security at all" how much job security do you feel you have currently? ... you had 5 years ago? (latinobarometro) the job insecurity question from the gallup world poll provides a summary measure of all sources of worries about employment, including worries due to idiosyncratic factors, business cycle worries, or firm specific worries. as a result, it provides a measure of how economically vulnerable the respondent feels . the first latinobarometro question refers to perceptions of the economic climate. the second picks up perceptions of the regulatory environ ment as it relates to labor. a higher score is likely correlated with "rigid" labor markets. the final question combines the two and is a summary measure of perceptions of both the legal and economic environment. in principle, one would expect that individuals with more unstable jobs would be more likely to migrate. in practice, however, the respondents to these questions are the family members left behind who might worry less about the local labor market conditions if they have support from abroad. we now turn to the issue of personal insecurity where we use five different measures from the gallup world poll: • do you feel safe walking alone at night in the city or area where you live? (safe walking) • have you had money or property stolen from you or another household member within the past 12 months? (stolen) • have you been assaulted or mugged within the past 12 months? (mugged) • are there gangs in the area where you live? (only in the 2007 wave) (gangs) • are there illicit drug trafficking or drug sales in the area where you live? (only in the 2007 wave) (drug) the measures of personal insecurity ask about perceptions and experience. the first question measures the individual's perceptions of safety, whereas the second and third gather information on actual experiences of the respondent or their 16 journal of business strategies family member with criminal activity. in principle, the answers to these questions should be highly correlated, but it may be the case that an individual's perceptions of lack of safety lead to compensating behavior that reduce their vulnerability to theft. in this case, the individual's well-being would be negatively affected though they would not actually be victims of a crime. the question on theft includes other household members because sometimes it is ambiguous to whom household property belongs. the questions on gangs and drugs like the first question reflect sources of personal insecurity that may affect well-being but not be measured in the other questions. again, it is possible that migration and victimization episodes are correlated, an issue that we discuss below. data summary simple tabulations reveal that about 15% of households have a family member stili living abroad, while 18% have had a family abroad who has returned. this means that a total of 33% of households have in the last five years had a migration experience. 40% of households feel that they can count on someone living abroad for help. en q) en c~ o a. en ~ enc') ~ o figure 1 summary of migration related questions family abroad 1 family abroad 2 help from abroad note : black bar is average value, white bar is standard deviation . source : authors ' calculations using gallup world poll 2007 wave. looking at between country variation in rate of migration experience, smaller economies have more migration. this likely has to do with the greater variety volume 26, number 1 17 of economic opportunity in larger countries, it may also be related to the alesina and spolaore (2003) finding that smaller countries are more "open" economically. migration experience is highest in belize, bolivia, guyana and paraguay. on both variables the yes responses are over 25%, and for guyana exceed 40%. argentina, brazil and chile have the lowest experiences of migration in the data. about half of migrants have returned , indicating a mix of permanent and transitory migration. figure 2 "have any members of your household, aged 15 to 60, gone to live in a foreign country permanently or temporarily in the past five years?" (proportion that answered yes, still there) arg slz sol bra chl col cri dam ecu gtm gu y hnd mex nic pan per pry slv ury 0 .1 .2 .3 .4 family abroad 1 source: authors' calculations using gallup world poll 2007 wave. confirming that migration provides a source of financial stability to households, the "help abroad" question at the country level is quite highly correlated with the migration experience variable. in particular, argentina, brazil and chile have the lowest share of households who can count on friends and relatives for help, and belize and guyana have the highest share. 18 journal of business strategies figure 3 "have any members of your household, aged 15 to 60, gone to live in a foreign country permanently or temporarily in the past five years?" (proportion that answered yes, stili there and returned) arg blz bol bra chl col cri dom ecu gtm guy hnd mex nic pan per pry slv ury o .1 .2 .3 family abroad 2 source: authors ' calculations using gallup world poll 2007 wave. a .5 the gallup world poll also contains data on whether the place where you live is a good place for immigrants from other countries. this picks up whether people perceive there to be opportunities for outsiders in their locale, and, as a result, whether they perceive that they have opportunities (since the information that they will use to answer this question is their own experience). the answers to this question have much lower correlation to the migrant questions than the correlation among the migrant questions. this suggests that the more salient driver of migration is perceptions of opportunity abroad, rather than at home. there appears to be some positive selection of migrants. the level of the migration variables is increasing in the income quintile, as is help from abroad. interestingly, so is the "good place for immigrants" variable. this implies that migrants come from more privileged locales. volume 26, number 1 19 figure 4 "do you have relatives or friends who are living in another country whom you can count on to help you when you need them, or not?" (proportion that answered yes) arg blz bol bra chl col cri dom ecu gtm guy hnd mex nic pan per pry slv ury o .2 .4 .6 help abroad source: authors' calculations using gallup world poll 2007 wave. .8 looking at the relationship between life satisfaction and "help abroad," there appears to be a u-shaped relationship. using country-level variation in the value of the "help abroad" variable, the lowess-smoothed curve shows that life satisfaction initially declines until the share of the population with help from abroad is about 20% and then starts increasing at 30%. this might be because at low levels of migration, increases in the percentage of households with migration can reduce life satisfaction as they reflect worsening socioeconomic conditions in the respective country. once migration is sufficiently high, the support from abroad effect dominates overall wellbeing perceptions. in other words, at some point, the people who benefit from migration in the form of increased security outweigh those who consider that migration reflects more limitations than opportunities. 20 journal of business strategies figure 5 "is the city or area where you live a good place or not a good place to live for immigrants from other countries?" arg blz bo l br a chl co l cri cub dom ecu gtm guy hnd hti mex ni c pan per pri pry slv n o ury ven 0 (proportion that answered good place) .2 4 goodpl ace .6 sourc e : authors' calculations using gallup wo rl d poll 2007 wave . .8 volume 26, number 1 21 figure 6 m igration r elated questions by income quintile n o source: authors' calc ulations using gallup world po ll wave 2007 wave. notes: first bar is "family abroad 1," second bar is "fami ly abroad 2," third bar is "he lp from abroad," fourth bar is "good place for immigrants ." figure 7 l ife satisfaction increases if person has a relative or friend abroad he can count on i'c 0 l!) ;: u <0 iii -.!!! -iii en <0 q) := oj l!) l!) l!) o bandwidth :0 .8 lowess smoother • cri • pan • mfx .b~ ~~btt ......... ury~ • chl • • per .s f-v • ~on • c(.;u. dom, nic .1 .2 • bu / ~ i ... r./ v • ~ol • pry .3 .4 source : au th ors ' ca lc ulations using gallup world poll 2007 wave. uy 22 journal of business strategies econometric results in this section we use a regression framework to better understand the impact of migration on happiness. to do this we add migration-related variables to a standard happiness regression framework. the outcome variable of interest is perceptions of well being, and we control for measures of insecurity and other variables. our basic regression framework is: where i is individuals, j is countries, y is a measure of well-being, ins is a measure of insecurity, m is a measure of migration, exp is a vector of alternative explanatory variables, and x is a vector of controls. we also interact the insecurity variables with the migration variables. our alternative explanatory variables, which we only use in some regressions, are the availability of social networks, the status of unemployment, the presence of health problems, whether the respondent thinks that religion is important, being married, being widowed, and experiencing depression. depending on which survey we are using we have a different set of controls. in the gallup pool we use country and time fixed effects, the income bracket of the individual, and the age of the respondent. the income question asks for income over the previous month from all sources, including remittances (which it mentions explicitly). all our major regressions include the income control, which means that we are measuring the effect of migration on happiness above and beyond the income effects of remittances. when we use the latinobarometro data we include country fixed effects, socioeconomic level of the respondent, type of job the head of household, assets, and a dummy for whether the respondent is interested in politics. there are two methodological issues in running these regressions. first, the outcome of interest is a categorical variable. respondents report their life satisfaction on a cardinal, discrete, scale and so standard ols is not correct. they report "7," where they could mean 6.8 or 7.2. we use procedures from van praag and ferrer-i-carbonnell (2008) to ordinalize the data. the essence of the corrected ordinary least square (cols) method is to add an error term drawn from a normal distribution to each observation such that the respondents who report a "7" have, for the purposes of the regression, life satisfaction ranging from 6.5 7.5, with the plurality of the observations still at 7.0. we also use pooled ordinary least square (pols), which is essentially an ordered probit. volume 26, number 1 23 the second major methodological concern is that individuals have unobserved psychological traits that affect their level of happiness and might bias results. to correct for this, we use methods from van praag and ferrer-i-carbonnell (2008). they note that the psychological traits that affect answers to one question are likely to affect answers to all questions . therefore, the ways in which an individual's responses vary from the mean response conditional on other characteristics contains information about their idiosyncratic psychological traits. in practice, we take the residuals from regressions of each life satisfaction variable on the same set of explanatory variables. we calculate the principal component of the residuals for each individual and use this as a measure of the unobservable psychological traits. while it is a little unclear what precise psychological trait this captures, it is roughly "optimism/pessimism" in outlook that affects all other responses. our first set of regressions reports the effects of migration on life satisfaction using the cols method that ordinalizes the life satisfaction variable. because of high correlation among the migration variables, we enter each into separate regressions. we also show results with and without the "personality trait factor." our alternative explanatory variables have signs and relative magnitudes that we expect. as elsewhere in the literature, the availability of social networks has a very large and positive impact on satisfaction, indicating the importance of friendship in happiness. experiencing depression is of opposite sign but equal magnitude. health problems also reduce happiness, but by less than half the amount as depression. thinking that religion is important increases happiness, by roughly the same magnitude as health problems decrease it. being employed increases happiness by about half as much as thinking that religion is important. interestingly, in some regressions being a widow increases happiness, and by about as much as being employed. finally, being married exerts a negative influence on happiness, but the magnitude is quite small, and the variable is statistically insignificant in all regressions. the family abroad variables are positive and of the same magnitude and significance as the "status of unemployment" variable. having, or having had , a family member abroad, appears to have roughly the same impact on life satisfaction as being employed . currently having a family member abroad has a larger impact than having had a family member abroad in the past. when we control for the personality factor the statistical significance goes away. the " help from abroad" variable shows up as significant even when we control for the personality factor. it is roughly twice the magnitude of the family abroad variable. the greater magnitude and significance of the "help from abroad" variable confirms what the remittance literature suggests: the major impact on well-being of migration is through the abil24 journal of business strategies ity of the migrants to provide economically for family and friends at home. in these regressions we control for income, so this reflects an effect on happiness in addition to the increase in income, likely the insurance channel. table 1 life satisfaction (ladder question) and migrationfamily abroad 1 family abroad 2 help from abroad personality trait factor availability of social networks status of unemployment presence of health problems think religion is important being married being widow experienced depression number of observations r2 note: .01 ***; .05 **; .1 * gallup, individual data 1 2 3 4 5 6 ols ols ols ols ols ols 0.108** 0.061 (0.053) (0.046) 0.082* 0.052 (0.048) (0.047) 0.240*** 0.128*** (0.052) (0.045) 1.007*** 1.007*** 1.005*** (0.013) (0.013) (0.013) 0.630*** 0.631 *** 0.727*** 0.727*** 0.595*** 0.706*** (0071) (0.071) (0.059) (0.059) (0.070) (0.059) 0.114** (0.049) 0.114** 0.056 (0.049) (0.044) 0.056 0.111** (0.044) (0.049) 0.053 (0.044) -0.260*** -0.260***-0.211*** · -0.211*** -0.258*** -0.212*** (0.081) (0081) (0.048) (0.048) (0.082) (0.048) 0.250* ** 0.251*** 0.247*** 0.247*** 0.244*** 0.239*** (0.071) (0.071) (0.061) (0.061) (0.071) (0.061) -0.067 (0.052) 0.113 (0.101 ) -0.067 -0.050 (0.052) (0041) 0.114 0.140** (0101) (0.067) -0.051 -0.062 (0.041) (0.052) 0.140** 0.118 (0.067) (0.103) -0.050 (0.042) 0.145 ** (0068) -0.666*** -0.666***-0.654*** -0.655** * -0.654* ** -0.645**' (0.075) (0.075) (0.064) (0.064) (0.074) (0.062) 11,773 0.198 11 ,773 0.198 9,500 0.599 9,500 0.598 11,779 0.198 9,50b 0.598 notes: standard errors clustered at country level; country and time fi xed effects are included; control included: income gallup brackets; age categories the second set of regressions uses the pols method, which is essentially an ordered probit, and asks whether you are satisfied with living standards, rather volume 26, number 1 25 than to what extent. the qualitative results of this regression are similar to the re su lts from the cols regressions. the main change is that the difference between the magnitudes of the two "family abroad" variables increases. not surprisingly, having a family member abroad currently has more of an impact on happiness than having had one in the past. and the help from abroad variable is the largest in magnitude (fifty percent larger than the "status of unemployment" variable) and the only one that is statistically significant. table 2 satisfaction with livin g standards (1 if satisfied) and migration gallup, ind ividu al data 1 2 3 probit probit probit family abroad 1 0.020 (0.015) family abroad 2 0.011 (0.014) help from abroad 0.033 *** (0.012) availability of social networks 0.147*** 0.147*** 0.142*** (0 .019) (0.019) (0 .019) status of unemployment 0.022** 0.022 ** 0.021** (0.009) (0 .009) (0 .009) presence of health problems -0.068 *** -0.067 *** -0 .068*** (0015) (0 .015) (0.015) think religion is important 0.061 *** 0.061 *** 0.062** * (0.015) (0.015) (0.015) being married 0.027** 0.027* * 0.027* * (0.012) (0.012) (0.012) being widow 0.039 0.039 0.038 (0.026) (0 .026) (0.026) experienced depression -0.165*** -0.165*** -0 .1 64** * (0.017) (0 .017) (0.017) number of observations 11,861 11 ,861 11 ,866 r2 0.087 0.086 0.087 note : .01 ***; .05 ** ; .1 * notes: standard errors clustered at country level; country and time fi xed effects are included; controls inc luded : income gall up brackets ; age catego ries . 26 journal of business strategies the third set of regressions uses the cols method and a different set of controls. in these regressions the question is whether migration compensates for insecurity. having " help from abroad" increases life satisfaction by as much as being insecure in your job decreases life satisfaction . and both are statistically significant. the "family abroad" variables do not enter as significant, though they are of roughly similar magnitude as in the first set of regressions. using this set of controls explains more of the variation in life satisfaction than the previous set of controls . the fourth set of regressions interacts the migration variables with three insecurity variables: nutritional, job and personal. confirming our previous work (cardenas, di maro & mejia, 2008), nutritional insecurity has the strongest impact on life satisfaction followed by job insecurity and personal insecurity. in these regressions we are interested in the interaction effect: does having or having had a family member abroad migration experience or help from abroad exacerbate or mitigate the effect of negative effect of these vulnerabilities on life satisfaction? we find that if you are nutritionally insecure, then migration experience makes the occurrence of nutritional insecurity worse by a third . this negative effect on happiness from the interaction of migration and nutritional insecurity is larger than the positive direct effect on happiness of migration. thus, the net effect ofmigration on happiness is negative in the face of nutritional insecurity. in contrast, migration experience makes the experience of job insecurity positive when we control for the personal psychological trait: the positive interaction of job insecurity and migration outweighs the negative impact of job insecurity. combine that with the direct positive effect of migration, and the overall positive effect is quite strong. the regressions on personal insecurity find a very small direct effect on happiness (less than one-tenth the size of nutritional insecurity), that is never statistically significant and sometimes positive, which runs counter to expectations. the interaction with family abroad is negative, but never statistically significant, and on the same order of magnitude as the direct effect of migration experience. the direction of the interaction of migration and personal insecurity is thus consistent with what we found for nutritional insecurities, where the interaction of migration and insecurities is negative. a surprising finding is the difference on the sign of the interaction effects of migration and different vulnerabilities. here we expect consistent and negative signs across the three kinds of vulnerabilities because we pick up the same effect of family fragmentation making a given negative life experience harder to deal with. consistent with this theory the interaction of migration and nutritional volume 26, number 1 table 3 life satisfaction (ladder question), migration and types of insecurities family abroad 1 family abroad 2 help from abroad personality tra it factor nutritional insecurity job insec ur ity 1 victimization issue 2 victimization events 3 vict imization ev ents 4 victimization events availabili ty of social networks presence of health problems think religion is important being married being widow experienced depress ion number of observations r2 note: .01 *** ; .05 **; .1 * gallup, individual data 1 2 3 4 5 6 ols ols ols ols ols ols 0.054 0.081 (0.110) (0.083) 0.034 0.086 (0.091 ) (0.074) 0.212 *** 0.123* ** (0.073) (0.039) 0.992*** 0.992 *** 0.988*** (0.018) (0.018) (0.018) -0.638 *** -0.638** * -0.694 *** -0.694* ** -0.626*** -0.683*** (0.099) (0.099) (0.080) (0.080) (0.099) (0.080) -0.366 ** * -0.366 *** -0.157* -0.156* -0.354** * -0.150 * (0.094) (0.093) (0.084) (0.084) (0.090) (0.081 ) -0.047 -0.048 -0.140*** -0.141 *** -0.047 -0 ,135*** (0.093) (0.093) (0.052) (0.053) (0.092) (0.051 ) 0.008 0.008 -0.001 -0.002 0.000 -0.004 (0,088) (0.088) (0.060) (0.060) (0.087) (0.059) 0.048 0,049 0.103 0.101 0.018 0.089 (0.104) (0.105) (0.091) (0.092) (0.110) (0.095) -0.065 -0.065 0.164 0.163 -0,052 0.182 (0.168) (0,168) (0.115) (0 ,116) (0 .169) (0.124) 0.447 *** 0.447* ** 0.629 *** 0.628 *** 0.412 *** 0.611 *** (0.087) (0.086) (0.057) (0,057) (0.087) (0.057) -0.220* * -0.220 ** -0.178 *** -0,178*** -0,235 ** -0.191 *** (0.105) (0.105) (0.055) (0.055) (0106) (0.054) 0.251 *** 0.251 *** 0.238*** 0.238* ** 0.235 ** 0.228 *** (0.094) (0.093) (0.067) (0.067) (0,096) (0.069) -0.066 -0.065 -0.023 -0.023 -0.056 -0.020 (0.070) (0.070) (0.053) (0.054) (0.069) (0.053) -0.047 -0,047 0.142 0.141 -0.036 0.143 (0.205) (0.204) (0.159) (0.159) (0.201 ) (0.158) -0.537* ** -0,537* ** -0.563 *** -0,562 *** -0.521 *** -0 .549* ** (0.112) (0.112) (0.076) (0.076) (0.111 ) (0.074) 4,560 4,560 3,843 3,843 4,559 3,842 0.230 0,230 0.621 0,621 0.231 0.620 27 notes : standard errors clustered at country level ; country and time fi xed effects are included ; controls included : income gallup brackets; age categories. 28 journal of business strategies and personal insecurities are mostly negative, but the sign on the interaction of job insecurity and migration is positive, which is somewhat of a puzzle. the results on "help from abroad" confirm that it is family fragmentation rather than availability of insurance that is driving our results. in our baseline regressions, help from abroad was at least half as large in magnitude as the other two migration-related variables and always statistically significant. this roughly captures a strong insurance effect. however, in the regressions in table 4, the help from abroad variable when interacted with vulnerabilities is always insignificant and very small in magnitude. this suggests that it is not insurance that is important in the way migration interacts with vulnerabilities, but instead the effect of the lack of physical presence of a family member. the fifth set of regressions reports regressions on the effects of migration on the satisfaction with freedom to choose within your own country. having seen others migrate might reduce an individual's perceptions of freedom to choose within their own country because the observation of others' greater choices abroad might reduce perceptions of choices at home. the regression results bear this out in terms of sign, but the magnitudes are very small. a related set of questions is addressed in the sixth set of regressions. latinobarometro includes a question on whether you have considered moving abroad. respondents who have considered moving abroad report life satisfaction that is lower by an amount commensurate with feeling "just a bit worried" about losing their job. one natural interpretation of this result is that people who consider migration are dis-satisfied with their current circumstances. if this result carries over to those who actually migrate, then this would suggest that migration can be understood as one adaptation strategy to dissatisfaction with life. if this is the case, then migrants might be drawn from an unhappy population with greater aspirations. volume 26, number 1 29 table 4 life satisfaction (ladder question), migration and types of insecurities gallup, individual data 1 2 3 4 5 6 ols ols ols ols ols ols nutritional insecurity -0.616* ** -0.577** * -0.645** * -0.634*** -0.606*** -0.702*** (0.099) (0.098) (0.072) (0.071 ) (0.089) (0.065) x family abroad 1 -0.093 -0250 (0.180) (0.160) x family abroad 2 -0.294 -0.282* (0.194) (0.154) x help from abroad -0.034 0.070 (0.151) (0.131) job insecurity -0.411*** -0.420*** -0.207** -0.217** -0.327*** -0.166** (0.084) (0.086) (0.088) (0.088) (0.090) (0.081) x family abroad 1 0.294 0.332* -0.218** -0.218** (0.308) (0.176) (0.105) (0.105) x family abroad 2 0.319 0.357** (0.294) (0.166) x help from abroad -0.070 0.047 (0.173) (0.094) personal insecurity -0.040 -0.050 0.061 0.063 0.028 0.060 (0.077) (0.070) (0.070) (0.067) (0.085) (0.081 ) x family abroad 1 0.031 -0.155 (0.144) (0.145) x family abroad 2 0.083 -0 .149 (0.131) (0.126) x help from abroad -0.167 -0.069 (0.116) (0.106) familyabroad 1 0.020 0.144 (0.158) (0.104) family abroad 2 0.048 0.155* (0.146) (0.093) help from abroad 0.281 ** 0.114 (0.116) (0.076) personality trait factor 0.991 *** 0.991 *** 0.986*** (0.019) (0,019) (0,018) number of observations 4,551 4,551 3,834 3,834 4,550 3,833 r2 0.230 0,231 0.620 0,621 0.231 0.619 note: .01 ***; .05 **; .1 * notes: standard errors clustered at country level ; country and time fixed effects are included;t controls included: income gallup brackets ;t age categories. 30 journal of business strategies table 5 satisfaction with freedom to choose (1 if satisfied) and migration gallup, individual data family abroad 1 family abroad 2 help from abroad availability of social networks status of unemployment presence of health problems think religion is important be ing married being widow experienced depression number of observations r2 note : .01 ***; .05 **; .1 * 1 pro bit -0.003 (0.010) 0.075*** (0.015) 0.006 (0.008) -0.024*** (0.007) 0.057*** (0.016) 0.020* (0.011) 0.024 (0.016) -0.055*** (0.016) 11 ,569 0.045 2 5 probit probit -0 .003 (0.008) 0.016 (0.010) 0.075*** 0.071 *** (0.015) (0 .014) 0.006 0.007 (0.008) (0.008) -0. 024*** -0.024*** (0.007) (0.007) 0.057*** 0.058 *** (0.016) (0.016) 0.020* 0.021 * (0.011) (0.011 ) 0.024 0.021 (0.016) (0.015) -0 .055** * -0.054* ** (0.016) (0.015) 11 ,569 11,573 0.045 0.045 notes : standard errors clustered at country level ; country and time fixed effects are included ; controls included : income gallup brackets ; income country: countries grouped in 6 categories (highjncome_oecd; high_income_non_oecd; low income; lower_ middlejncome; upper middle income); age categories. volume 26, number 1 31 table 6 life satisfaction and migration proxy "have you and your family considered moving abroad?" latinobarometro, waves 2002, 2003 and 2004 1 2 3 4 ols ols ols ols considered moving abroad -0 .094** * -0 .078*** -0 .079*** -0.067*** (0.012) (0.011 ) (0 .018) (0.017) "worried of losing job? " step .1 "not worried " (omitted) step 2 "just a bit worried " -0 .067* ** -0 .064*** (0 .026) (0.020) step 3 "worried" -0.154*** -0 .147*** (0.024) (0.020) step 4 "very worried " -0.116*** -0.107*** (0.027) (0.022) married -0.005 -0.002 -0.014 -0.006 (0.009) (0 .009) (0 .013) (0.014) divorced -0.061** * -0.058*** -0.095** * -0.087** * (0.016) (0 .013) (0 .025) (0 .025) trust 0.098*** 0.085** * 0 .080*** 0 .068** * (0 .016) (0.016) (0.015) (0.015) democracy -0.041 *** -0 .035*** -0.041** ' -0.035*** (0.008) (0.006) (0 .010) (0.009) control for health satisfaction no yes no yes number of observations 35 ,211 34 ,729 19,084 18,845 r2 0 .105 0 .129 .0.114 0.137 note : .01 ***; .05 ** ; .1 * notes : standard errors clustered at country and year level ; sample: waves 2002, 2003 and 2004 for column 1 and 2, only 2003 and 2004 for column 3 and 4 ; "worried to lose your job" measure goes from 1 (least worried) to 4 (most worried) ; control variable for health satisfaction is a scale of satisfaction with health status (from 0 to 4); "social networks" refer to a question asking whether the respondent trusts other people ; controls included: country fixed effects , socia-economic level of respondent (as reported by the interviewer) , type of job of head, number of assets, dummy for whether respondent is interested in politics . 32 journal of business strategies conclusion the "economics of happiness" suggests the importance of analyzing both externally verifiable and subjective measures of well-being. this paper seeks to address the question of whether migration is pareto-improving: assuming that the migrants themselves are better off, what happens to the remaining household members? our primary finding is that in most cases migration is such an improvement. even controlling for income, which is likely the strongest positive channel of migration on well-being through remittances, households reporting migration experience are more satisfied than other households. this suggests that migration has positive impacts through other channels. one possibility, noted most strongly in the literature, is the insurance role of remittances. second, it might be that income received from remittances are spent on goods that make a greater direct contribution to satisfaction like investments in education or health than income earned from other sources. third, and much more speculatively, migration might affect satisfaction through changes in expectations. in particular, the observation of a better life for a family member might increase hopes for their own future. however, we also find that those households that are nutritionally insecure, and hence the most vulnerable, are made worse off by migration. because these regressions control for income, this is an upper bound on the negative effects of migration on well-being. this suggests that income-based measures of the pro-poor effects of migration found in adams and page (2005), among others, might overstate the pro-poor impacts of migration on well-being, particularly among the most vulnerable. this provides yet one more reason for strengthening the social safety net in poor areas, particularly those with heavy outflows of migrants. note 1. the relationship between income and happiness being itself a subject of much controversy. see, for example, graham, chattopadhyay, and picon, 2008. references adams, r., & page, 1. (2005). do international migration and remittances reduce poverty in developing countries? world development, 33(10), 1645-1669. alesina, a., & spolaore, e. (2003). the size of nations. cambridge, ma: mit press. volume 26, number 1 33 borraz, f., pozo, s., & rossi, m. (2008). and what about the family back home? international migration and happiness. universidad de la republica. department of economics working paper no. 03/08. cardenas, m., di maro, v., & mejia, c. (2008). vulnerabilities and the quality of life: an analysis based on different types of insecurities. in c. graham & e. lora (eds.), paradox and perception: measuring quality of life in latin america. washington, dc: the brookings institution, forthcoming cox-edwards, a. c., & ureta, m. (2003). international migration, remittances, and schooling: evidence from ei salvador. journal of development economics, 72, 429-61. fahey, t., nolan, b., & whelan, c. t. (2003). monitoring quality of life in europe. luxembourg: office for official publications of the european communities. graham, c., chattopadhyay, s., & picon, m. (2008). the easterlin and other paradoxes: why both sides of the debate may be correct. in e. diener, j. helliwell, & d. kahneman (eds.), international differences in well being. oxford: oxford university press, forthcoming. gunatilleke, g. (1990). sri lanka. in g. gunatilleke (ed.), migration to the arab world: experience of returning migrants. united nations university press. hildebrandt, n., & mckenzie, d. (2005). the effects of migration on child health in mexico. economia (journal of the latin american and the caribbean economic association), 6(1),257-289. lopez-cordova, e. (2005). globalization, migration and development: the role of migrant remittances. economia (journal of the latin american and the caribbean economic association), 6(1),217-256. lora, eduardo (2008). beyond the facts: understanding the quality of life. interamerican development bank and harvard university press. van praag, b., & ferrer-i-carbonell, a. (2008). happiness quantified: a satisfaction calculus approach. oxford university press. revised edition. world bank (2006). economic implications of remittances and migration. global economic prospects. yang, d., & choi, h. (2007). are remittances insurance? evidence from rainfall shocks in the philippines. world bank economic review, 21(2),219-248. biographical sketches of authors mauricio cardenas is director of the latin america initiative and a senior fellow at the brookings institution. formerly minister of economic development 34 journal of business strategies and transportation, and director of national planning of colombia, his research focuses on international and development economics. vincenzo di maro is a research fellow at the inter-american development bank. he is completing a phd from university college london with a thesis on the evaluation of development interventions. isaac sorkin is a research assistant in the global economy and development program at the brookings institution. migration and life satisfaction: evidence from latin america an examination of the impact of firm size and age on managerial disclosure of intellectual capital by high-tech companies blaise m. sonnier florida international university • miami, fl kerry david carson university of louisiana at lafayette • lafayette, la paula phillips carson university of louisiana at lafayette • lafayette, la abstract a sample of 143 high-technology firms was examined to determine if there were inverse relationships between the size and age of companies and their level of intellectual capital disclosure. weak inverse relationships were found between number of employees and level of disclosure and between total assets and level of disclosure. there was, however, a significant inverse relationship between firm age and level of disclosure. multivariate regression provided support that firm age was a significant predictor of level of intellectual capital disclosure. it appears that young companies use increased disclosure to signal to the market their real value and prospects. introduction in today's knowledge-based economy, a significant source of wealth and competitive advantage is derived from the creation and use of intangible assets and intellectual capital (canibano, garcia-ayuso, & sanchez, 2000; hall, 1992). in 2006, the world bank estimated that intangible assets comprise 78% of worldwide assets and 80% of assets in high-income countries (world bank, 2006). the terms "intangible assets" and "intellectual capital" have been used interchangeably and include patents, copyrights, trade secrets, processes, employee know-how, procedures, corporate culture, charismatic leadership, and customer loyalty (andriessen, 2004; lev, 2001). intellectual capital is difficult for other firms to replicate (barney, 1991; chakraborty, 1997; dierickx & cool, 1989; peteraf, 1993) because it is internally generated and has its own unique path to development (clulow, gerstman, & barry, 2003). additionally, the legal right to the exclusive use of particular knowledge such as patents, copyrights, and trade secrets make those intangible assets an invaluable resource to the firm (porter, 1980). 168 journal of business strategies it is expected that firms with superior intellectual capital will outperform their competitors (mcgrath, tsai, venkataraman, & macmillan, 1996; wiklund & shepherd, 2003). hope and hope (1998) concluded that more than half of the value created by a firm in today's economy comes from the management of the firm's intellectual capital rather than physical assets (guthrie & yongvanich, 2004). the most important assets of a firm in a knowledge-intensive industry are often internally-generated intangible assets which are not reported on the traditional balance sheet under u.s. generally accepted accounting principles or the international financial reporting standards (basu & waymire, 2008; canibano et ai., 2000; financial accounting standards board [fasb), 2001a; international accounting st~ndards committee [iasc], 1998). in november, 2006, the ceos of the world's six largest audit firms released a document in which they stated: clearly, a range of' intangibles' that are not well measured, or not measured at all, under current accounting conventions are driving company performance. investors and other stakeholders in business information want to know what those intangibles are, and how they might plausibly affect how businesses perform in the future. (dipiazza, mcdonnell, parrett, rake, samyn, & turley, 2006, p. 16). the current financial accounting standards relating to internally-generated intangible assets create numerous challenges for companies operating in knowledge-intensive industries. for example, stock price volatility can result from investors having difficulty in accurately estimating future payoffs and risk (garcia-ayuso, 2003). with insiders having more information about intangibles than outsiders, it may increase the risk of insider trading gains (aboody & lev, 2000; lev, 2001). still another problem is the increased cost of capital (botosan, 2006, 1997; sengupta, 1998; shi, 2003). in an effort to overcome or mitigate the challenges caused by current accounting standards, companies may voluntarily disclose information about their intellectual capital (lundholm & van winkle, 2006). the demand by investors, lenders, and other external stakeholders for information regarding a firm's intellectual capital or intangibles may compel firms to use methods other than the traditional financial statements to supply relevant information about these resources (e.g., amir & lev, 1996; gelb, 2002; tasker, 1998). management may use press releases, electronic and paper promotional literature, and voluntary publications as well as voluntary disclosures in quarterly and annual reports to convey this information (gelb, 2002). for new or young firms in the high-technology sector of the economy, the lack of an extensive operating history provides an even greater incentive to disclose volume 26, number 2 169 information regarding their intellectual capital. the objective of such disclosure is to " . .. close (or narrow) the gap between a company's potential intrinsic market value and its current market value." (kristandl & bontis, 2007, p. 577). the motivation of firms to voluntarily disclose information is explained by signaling theory. because insiders know more about a firm than outsiders, there is information asymmetry. when management discloses credible information (sends a signal), it reduces uncertainty for those outside the firm . thorough and reliable reporting oftangible and intangible assets can improve the firm's reputation, thus allowing it to compete more successfully in raising capital. managers are motivated to disclose intangible assets if hidden value is high (wolk, dodd, & rozycki, 2008). because the traditional accounting model fails to provide relevant and meaningful information regarding a firm's intellectual capital, voluntary disclosures are often the only way to signal the existence and significance of these resources to investors and lenders. in fact, the primary reason for companies to voluntarily disclose information is to increase the knowledge of investors in order to reduce the cost of capital (lundholm & van winkle, 2006). while there is debate about whether increased disclosure reduces the cost of capital, most research supports this inverse relationship (kristandl & bontis, 2007; botosan, 2006). for example, in an examination of the chinese capital markets, zhang and ding (2006) found that as voluntary disclosure increased, the cost of capital decreased. when there exists expanded and credible disclosure, the costs of capital go down, thus allowing firms to pursue positive net present value projects (khurana, pereira, & martin, 2006). for small firms that may be unknown or young firms that lack a history of operations, the disclosure of their intellectual capital is essential to attract interest in the firm by investors and financial institutions. anderson (1966) suggested that smaller firms are seen as higher risk and must pay more for their capital. more recently, hyytinen and pajarinen (2007) indicated that the cost of capital is higher for younger firms than for mature firms. in their sample of small businesses, they found that as the firm ages by one year, the cost of capital drops by i to 2 basis points. several published studies undertook an examination of the impact that firm growth may have on the level of its intellectual capital disclosure in its annual report. bozzolan, favotto, and ricceri (2003), guthrie, petty, and ricceri (2004), and petty and cuganesan (2005) each found a statistically significant positive relationship between the size of a firm and its level of intellectual capital disclosure. while 170 journal of business strategies bozzolan, favotto, and ricceri (2003) used sales as a proxy for size, guthrie et al. (2004) and petty and cuganesan (2005) used market capitalization. certain limitations of these three studies warrant mention. first, the sample size of bozzo ian et at. (2003), guthrie et al. (2004), and petty and cuganesan (2005) were relatively small at thirty, fifty, and fifty-three, respectively. second, each study selected its sample from the largest companies in the respective population. this sample selection was based on the stated assumption that larger companies will have a higher level of disclosure than smaller companies. each study assumed " ... that smaller companies will simply play 'follow-the-leader' by benchmarking their disclosure practices against those employed by larger firms" (guthrie et ai., 2004, p. 2). however, as firms grow, managers sequentially change their attention as to which goals are important (greve, 2008). the underlying assumption of these previous studies leaves unanswered the question of whether the smaller and younger firms in a given population disclose at higher or lower levels in their annual reports than larger and older firms in the same population. by including firms of all sizes in this study, this limitation of prior studies evaluating the level of intellectual capital disclosure in the annual report of firms is addressed. studies have also been conducted evaluating the intellectual capital disclosure of firms in their ipo prospectus (bukh, nielsen, gormsen, & mouritsen, 2005; cordazzo, 2007) and in presentations to financial analysts (garica-meca, parra, larran, & martinez, 2005). none of these studies limited their sample to companies in the high-technology sector of the economy. furthermore, the index used in these studies measured the number of intellectual capital items disclosed by the firm without regard to the frequency of such disclosure. in this study, the frequency of intellectual capital disclosure was central to the index employed as discussed in detail in the methodology section. despite the differences in the sample and index used to measure intellectual capital disclosure as compared to this study, these studies are mentioned because they evaluated the relationship between the size and age of the firm on its intellectual capital disclosure, though their findings are inconsistent. using market capitalization as a proxy for size, garica-meca et al. (2005) found a positive relationship between the size of the firm and the extent of its intellectual capital disclosure. cordazzo (2007), who analyzed all of the ltalian ipo prospectuses from 1999 to 2002 (0 = 86), found a positive relationship between a firm's total sales (as a proxy for firm size) and intellectual capital disclosure and also noted a non-significant negative association between age and intellectual capital disclosure. bukh et at. (2005), who studied all of the danish ipo prospectuses between volume 26, number 2 171 1990 and 200 i (n = 68), found no relationship between company size (expressed in terms of number of employees) or the age of a finn. there have been somewhat inconsistent relationships reported between size of the firm and voluntary disclosure (e.g., bozzolan et ai., 2003; bukh et ai., 2005; guthrie et ai., 2004; haniffa & cooke, 2005) and between age of the firm and voluntary disclosure (e.g., bukh et ai., 2005; cordazzo, 2007; haniffa & cooke, 2002). however, barnes and walker (2006) note that younger companies are more dependent upon external funds than more established firms, yet price-earnings, market-tobook, and price-to-sales multiples vary widely among young firms. therefore, nonfinancial information becomes very important in valuation (kim & ritter, 1999). these less established and typically smaller firms want to reduce uncertainty and raise stakeholder confidence (haniffa & cooke, 2002). signaling theory suggests that younger and smaner companies will engage in intellectual capital disclosure in an effort to increase valuation and improve investor perceptions. they want to attract investors by signaling to the market their underlying worth. based on the foregoing, the following hypotheses are suggested. hypothesis 1: an inverse relationship exists between the size of companies and their level of intellectual capital disclosure by management. hypothesis 2: an inverse relationship exists between the age of companies and their level of intellectual capital disclosure by management. methodology sample firms in the high-technology sector ·of the economy were selected as the subject of this study. while all finns rely on intellectual capital in the operation of their business, high-technology companies rely more heavily on such resources than traditional sector companies. traditional sector companies rely to a greater extent on physical or fixed assets (such as land, building, machinery, and equipment) to run their business as compared to high-technology finns. because the assets of traditional sector companies are reflected on their balance sheet, the financial statements of such companies provide investors and others with meaningful information. in contrast, high-technology finns rely heavily on intellectual capital in the operation of their business and in many cases it is the foundation of their success. despite the importance of these assets to high-technology companies, the costs of 172 journal of business strategies internally-generated intangible assets or intellectual capital are immediately writtenoff as expenses and not reflected as assets of the firm. high-technology firms were used in this study given the importance of intangible assets and intellectual capital to their business and the failure of the accounting model to reflect these as assets on their financial statements. the north american industry classification system (naics) was used to select high-technology companies. the naics industry codes used were 541 (professional , scientific, and technical services), 518 (internet service providers, web search portals, and data processing services), and 516 (internet publishing and broadcasting). the source of data was the mergent online™ database of approximately 1 0,000 publicly-traded firms in the united states. the 484 high-technology companies (naics code 541, 397 companies; naics code 518, 75 companies; naics code 516, 12 companies) were placed in alphabetical order and assigned numbers based on their order of appearance in the respective alphabetized list. one hundred fifty companies were selected for inclusion in this study by application of random tables. as further discussed below, to determine the level of intellectual capital disclosure of the sample firms a content analysis was performed on part i of the fiscal year 2000 and fiscal year 2004 security and exchange commission (sec) form 10-k of each firm. a box and whiskers plot generated for the 2000 fiscal year and 2004 fiscal year of the initial 150 companies indicated that seven companies had a level of intellectual capital disclosure that caused them to be outliers in relation to the other companies included in the sample . after elimination of the aforesaid firms, a sample of 143 companies remained in the study. in 2001, the financial accounting standards board issued a position paper encouraging firms to voluntarily disclose information about their intangibles and intellectual capital (i.e. fasb, 2001b). because of the significance ofthis event, we chose the year before this position paper (fiscal year 2000) and the most recent form 10-ks available when collecting the data (fiscal year 2004) as the years for our study. the sec form lo-k for each sample firm for the 2000 fiscal year and 2004 fiscal year was downloaded from the mergent online™ database. content analysis the level of intellectual capital disclosure of each sample firm for the fiscal years 2000 and 2004 was determined by a content analysis of their annual report for the respective year. publicly traded firms in the united states are to file annual reports (known as a "form 10-k") with the securities and exchange commission volume 26, number 2 173 (the "sec"). the form and content of the form lo-k is prescribed by the sec. a content analysis was performed on part i of the form 10-k of each firm for the two years studied. part i is a narrative description of the firm's business and includes, for example, a description of the business, the primary products produced and services provided by the firm, the power of the customer, and the competitive environment of the business. part i of the form 10-k is intended to provide meaningful and relevant information to investors, creditors, potential investors, and other external stakeholders. because the securities act of 1934 imposes civil penalties for misrepresentations contained in the form lo-k, this is a reasonably objective source. content analysis has been used in a number of studies to measure the intellectual capital disclosure in annual reports (e.g., abdolmohammadi, 2005; bontis, 2003; bozzolan et ai., 2003; brennan, 2001; goh & lim, 2004; guthrie, petty, & ricceri, 2004; vergauwen & alem, 2005; williams, 2001). the first step in conducting a content analysis is to compile a list of terms that represent intellectual capital (bontis, 2003; brennan, 2001; vergauwen & alem, 2005). in this study, a list of terms was developed for 5 intellectual capital categories which included customer capital, intellectual property, human capital, organizational capital, and supplier capital. the primary list of terms was used by bontis (2003), guthrie et al. (2004), and vergauwen and alem (2005) in their studies. in addition, the list was expanded to include terms used by brooking (1996); edvinsson and malone (1997); international federation of accountants [ifac] (1998); ordonez de pablos (2002); bozzolan et al. (2003); guthrie, boedker, and cuganesan (2005); and starovic and marr (2003). the list of intellectual capital terms was expanded from that used in prior studies to address vergauwen and alem's (2005) concern that the low level of intellectual capital disclosure as reported in academic studies may be attributable to a difference in vocabulary used in academia from that used in the corporate world. the final list included 121 terms and phrases. a sample of the terms and phrases is set forth in table 1. words tat, version 5.0, was used to perform the content analysis. the lo-ks were downloaded in microsoft word format from the mergent online™ database and then directly imported into wordstat for analysis. wordstat generated a report of the number of times that a term or phrase was used in the document. as with other studies (bontis 2003; vergauwen & alem, 2005), term frequency was used as the measure of the intellectual capital disclosure of that firm for that year. 174 term administrative systems alliances business collaborations business knowledge competitive intelligence corporate culture corporate learning corporate mission company reputation corporate vision customer database customer tracking customer turnover distribution channels employee retention rate franchising agreements human capital intellectual property knowledge management knowledge stock licensing agreements management philosophy market share organizational capability organizational culture (company culture) organizational routines organizational structure patents service marks staff turnover structural capital supplier knowledge supplier relations trademark trade secrets journal of business strategies table 1 intellectual capital disclosure terms source bozzolan, favotto, & ricceri (2003) guthrie, boedker, & guganesan (2005) guthrie, petty, & ricceri (2004); guthrie, petty, yongvanich , & ricceri (2003); ifag (1998) bontis (2002) bontis (2002) guthrie, boedker, & cuganesan (2005); guthrie, petty, & ricceri (2004); ifac (1998) ; brooking (1996) bontis (2002) starovic & marr (2003) guthrie, petty, yongvanich, & ricceri (2003); bontis (2002) starovic & marr (2003) brooking (1996) brooking (1996) bozzolan, favotto, & ricceri (2003) guthrie, boedker, & cuganesan (2005) ; guthrie, petty, & ricceri (2004); ifac (1998); brooking (1996) bozzolan, favotto, & ricceri (2003) guthrie, boedker, & cuganesan (2005); guthrie, petty, & ricceri (2004); ifac (1998); brooking (1996) bontis (2002) guthrie, boedker, & cuganesan (2005); guthrie, petty, & ricceri (2004); bontis (2002); ifag (1998) bontis (2002) bontis (2002) guthrie, boedker, & guganesan (2005); guthrie,petty, & ricceri (2004); ifac (1998) ; brooking (1996) guthrie, boedker, & cuganesan (2005); guthrie, petty, & ricceri (2004) ; ifac (1998); brooking (1996) guthrie, petty, yongvanich, & ricceri (2003) ; bozzolan, favotto, & ricceri (2003) edvinsson & malone (1997) guthrie, petty, yongvanich, & ricceri (2003) ; bontis (2002) starovic & marr (2003) guthrie, boedker, & cuganesan (2005) guthrie, petty, & ricceri (2004); ifag (1998) guthrie, petty, yongvanich, & ricceri (2003) ; ifac (1998) starovic & marr (2003) bontis (2002) bontis (2002) guthrie, boedker, & cuganesan (2005) guthrie, petty, yongvanich, & ricceri (2003) ; ifac (1998) guthrie, petty, yongvanich, & ricceri (2003) ; ifac (1998) volume 26, number 2 175 results table 2 presents descriptive statistics of the 143 companies included in the study. the mean (median) number of employees of the firms included in the sample were 4,206.79 (704) and 4,606.49 (798) in 2000 and 2004, respectively. the 72 sample firms with the smallest number of employees had a mean (median) number of employees of 305.49 (290) and 320.36 (285.50) in 2000 and 2004, respectively. the 71 sample firms with the largest number of employees had a mean (median) number of employees of 8,219 .56 (2,037.50) and 8,952.99 (2,533) in 2000 and 2004. the mean (median) of total assets and total revenue in 2000 of the sample firms was $752 million ($182.4 million) and $626 million ($118.8 million), respectively. the 72 sample firms with the smallest amount of total assets and total revenue, respectively, had a mean (median) of$77.5 million ($57.6 million) and $43 million ($37.8 million) in 2000. in 2000, the 71 sample firms with the largest amount of total assets and total revenue had a mean (median) of $1.436 billion ($365 million) and $1.226 billion ($398.8 million). the mean (median) of total assets and total revenue in 2004 of the sample firms was $1.068 billion ($182.7 million) and $823 .6 million ($143.5 million), respectively. the 72 sample firms with the smallest amount of total assets and total revenue had a mean (median) of $82.4 million ($77.8 million) and $65.9 million ($68.1 million) in 2004. in 2004, the 71 sample firms with the largest amount of total assets and total revenue had a mean (median) of$2.067 billion ($602.5 million) and $1.592 billion ($520.7 million). table 3 presents descriptive statistics regarding the level of intellectual capital disclosure of the firms in our sample in fiscal year 2000 and 2004. as discussed above, the number of times that a firm used a term or phrase related to the intellectual capital construct in its annual report is used as a measure of the firm's level of intellectual capital disclosure in this study. the mean (median) number of times that a firm in our sample made an intellectual capital disclosure in its annual report was 44.44 (40) and 43.97 (40) times in 2000 and 2004, respectively. as set forth in table 3, a univariate analysis of the level of intellectual capital disclosure by the smallest one-half and the largest one-half of the firms in the sample measured by total assets and total revenue, respectively, reveals that there is not a statistically significant difference in the level of such disclosure between them either in 2000 and 2004. while the smallest one-half of the firms measured by number of employees had a statistically significant higher level of intellectual capital disclosure in fiscal year 2000 than the largest one-half of the firms (t = l.97, p = .03), there was not a statistically significant difference in the level of disclosure of the smallest and 176 journal of business strategies largest one-half of the firms measured by number of employees in the sample in fiscal year 2004 (t = 1.3604, p = .09). the univariate analysis of the size variables used in this study does not support hypothesis 1. table 2 descriptive statistics of companies fiscal year 2000 lower upper all firms one-half one-half (n = 143) (n = 72) (n = 71) no. of employees: mean 4,206.79 median 704.00 st. oev. 13,352.48 age: mean 15.13 median 9.00 st. oev. 12.82 total assets: (in thousands of dollars) mean 752,050 median 182,396 st. oev. 2,069,184 total revenue: (in thousands of dollars) mean 626,006 median 118,809 st. oev. 2,091 ,229 305.49 8,219.56 290.00 2,037.50 192.61 18,222.89 6 .69 23 .69 7.00 19.00 1.56 13.53 77,509 1,436,091 57,551 365,284 53 ,642 2,782,060 42,990 1,225,680 37,793 398,754 33,720 2,866,346 fiscal year 2004 lower upper all firms one-half one-half (n = 143) (n = 72) (n = 71) 4,606.49 320.36 8,952.99 798.00 285.50 2,533.00 13 ,933.84 219.59 18,861.19 19.13 10.69 27.69 13 .00 11.00 23 .00 12.82 1.56 13.53 1,068,001 82,451 2,067,433 182,743 77,769 602,502 3,015,296 49,522 4,053,284 823 ,597 65 ,917 1,591 ,949 143,547 68,061 520,669 2,497,865 43,687 3,386,105 a univariate analysis of the level of intellectual capital disclosure by younger versus older firms supports hypothesis 2. in fiscal year 2000, the youngest one-half of the sample firms had a mean (median) level of intellectual capital disclosure of 53.22 (48) as compared to 35 .54 (30) of the oldest one-half of the sample firms. the difference in the level of intellectual capital disclosure was statistically significant (t = 4.0930, p < .0001). the results are consistent in 2004 where the youngest onehalf of the sample firms had a mean (median) level of intellectual capital disclosure of 49.33 (46.50), as compared to 38.52 (33) of the oldest one-half of the sample firms. again, the difference in the level of intellectual capital disclosure between the youngest one-half and oldest one-half of the sample firms was statistically significant (t = 2.6341 , p = .005). volume 26, number 2 177 table 3 descriptive statistics of intellectual capital disclosure fiscal year 2000 fiscal year 2004 lower upper lower upper one-half one-half one-half one-half (n = 72) (n = 71) (n = 72) (n = 71) no. of employees:" mean 48.85 39.97 46 .78 41 .11 median 45 .00 33.00 44 .00 34.00 st. dev. 28 .38 25.42 26 .35 23 .39 age: b mean 53.22 35.54 49.33 38 .52 median 48 .00 30.00 46.50 33.00 st. dev. 26 .69 24.92 25.50 23.42 total assets: c mean 43 .64 45.25 46.26 41.63 median 39.00 43.00 43.00 37.00 st. dev. 27.93 26.66 26.79 22.99 total revenue: d mean 46.99 41 .86 47.04 40.85 median 41 .00 38.00 44.00 37.00 st. dev. 28 .39 25.94 26.60 23.03 a the difference in the level of intellectual capital disclosure between the smallest and largest one-half of sample firms measured by number of employees was statistically significant in 2000 (t = 1.97, p = .03). the difference was not statistically significant in 2004 (t = 1.3604, p = .09). b there was a statistically significant difference in the level of intellectual capital disclosure between the youngest versus oldest one-half of the sample firms in fiscal year 2000 (t = 4.0930, p < .0001) and in fiscal year 2004 (t = 2.6341, p = .005). c there was not a statistically significant difference in the level of intellectual capital disclosure between the smallest and largest one-half of the sample firms measured by total assets in fiscal year 2000 (t = .3525, p = .36) and fiscal year 2004 (t = 4.177, p = .13). d there was not a statistically significant difference in the level of intellectual capital disclosure between the smallest and largest one-half of the sample firms measured by total revenue in fiscal year 2000 (t = 1.1276, p = .13) and fiscal year 2004 (t = 1.4868 , p = .07) . hypothesis 1 hypothesis 1 predicts that an inverse relationship exists between the size metries of a high-technology company and its level of intellectual capital disclosure. total assets, total revenue, and number of employees were used as proxies for the 178 journal of business strategies size of the firm. total assets, total revenue, and number of employees are often used in the business literature as a proxy for firm size (e.g., carcello & nagy, 2004; geiger & raghunanda, 2002; huang, mishra, & raghunanda, 2007; tang, 2008). the pearson's r correlation coefficient was used to test the relationship between the size and value metrics and level of intellectual capital disclosure. however, it should be recognized that while correlations are informative, they have limitations. a correlation is a simple statistic that describes the relationship between two variables. there are no controls over additional factors. therefore, while we offer correlation results, we follow up with regression analysis. for the fiscal year 2000, the data supported a finding of a statistically significant inverse relationship between the level of intellectual capital disclosure and total assets [r = -.1414, p = .046, n = 143], total revenue [r = -.1575, p = .031, n = 142], and number of employees [r = -.1768, p = .018, n = 142). likewise, for fiscal year 2004 the data supported a statistically significant inverse relationship between the level of intellectual capital disclosure and total assets [r = -.1387, p = .049, n = 143] and number of employees [r = -.1699, p = .021, n = 143]. a marginally significant inverse relationship was shown to exist between the level of intellectual capital disclosure and total revenue for the 2004 fiscal year [r = -.1356, p = .053, n = 143). the practical effect of the inverse relationship between the level of intellectual capital disclosure and each variable evaluated in hypothesis 1 is diminished by the 95% confidence interval for each combination which approached a finding of no correlation. likewise, as established by the multi-regression analyses below, none of the variables evaluated in hypothesis i contribute to the prediction of the level of disclosure of intellectual capital by high-technology companies. accordingly, while the data supports hypothesis i, the practical effect of that finding is limited. hypothesis 2 hypothesis 2 predicts an inverse relationship between the age of a high-technology company and its level of intellectual capital disclosure. the age of the firm was based on the year of its formation. for both the 2000 [r = -.3271, p = .000, 95% ci = -.420 to -.227, n = 143] and 2004 [r= -.2979, p = .000, 95% ci = -.393 to -.196, n = 143] fiscal year, a significant inverse relationship existed between the age and the level of intellectual capital disclosure by a high-technology firm . in addition, the pearson's r coefficient and the 95% confidence interval establishes that the relationship is strong to medium. given the foregoing, hypothesis 2 is supported. volume 26, number 2 179 multiple regression analysis of the four variables evaluated in the hypotheses, age was the variable that had the greatest practical effect on the level of intellectual capital disclosure as demonstrated by the pearson's r coefficient and the 95% confidence interval. accordingly, age is the foundation of the multivariable regression formulas of the size/ metrics variables evaluated in this study. the correlation matrixes for the 2000 fiscal year and the 2004 fiscal year are displayed in table 4 and table 5, respectively, for the age, number of employees, total assets, total revenue, and level of intellectual capital disclosure variables evaluated in this study. table 4 correlation matrix (2000) eoo taoo taoo r = .8103 n = 142 p = .01 [ .7695 to .8445] troo r= .9773 r= .7842 n = 141 n = 142 p = .01 p= .01 [.9719 to .9817] [.7386 to .8226] ageoo r= .1179 r = .1425 n = 142 n = 143 p= .09 p = .05 [.0098 to .2234] [.0351 to .2466] icdoo r = -.1768 r = -.1414 n = 142 n = 143 p = .02 p = .05 [-.280 to -.070] [-.246 to -.034] *95% confidence intervals are in brackets notes: e = number of employees t a = total assets tr = total revenue age = age of the firm icd = intellectual capital disclosure troo r = .1031 n = 142 p = .11 [-.005 to .2091] r = -.1575 n = 142 p= .03 [-.261 to -.050] ageoo r = -.3271 n = 143 p = .01 [-.420 to -.227] 180 journal of business strategies table 5 correlation matrix (2004) e04 ta04 ta04 r= .8434 n = 143 p= .01 [.8092 to .8720] tr04 r= .9772 r= .8568 n = 143 n = 143 p = .01 p = .01 [.9717 to .9816] [.8252 to .8831] age04 r = .1445 r = .1578 n = 143 n = 143 p= .04 p = .03 [.0372 to .2486] [.0508 to .2612] icd04 r = -.1699 r = -.1387 n = 143 n = 143 p = .02 p = .05 [-.273 to -.063] [-.243 to -.031] *95% confidence intervals are in brackets. notes: e = number of employees ta = total assets tr = total revenue age = age of the firm icd = intellectual capital disclosure tr04 age04 r = .1333 n = 143 p = .06 [.0258 to .2378] r = -.1356 r = -.2979 n = 143 n = 143 p= .05 p = .01 [-.240 to -.028] [-.393 to -.196] as demonstrated by table 4 and table 5, there is a high degree of correlation among number of employees, total assets, and total revenue (2000 fiscal year: .7842 to .9773 and 2004 fiscal year: .8434 to .9772). this prohibited the use of all variables in a single regression formula due to multicollinearity. to address the issue of multicollinearity, separate formulas were evaluated that included age as one predictor of intellectual capital disclosure and either number of employees (empl), total assets (ta), or total revenue (tr) as the second predictor. these formulas were evaluated for both fiscal year 2000 and fiscal year 2004. the following are the multivariate regression formulas evaluated in this study using the method of entering all variables simultaneously. the level of intellectual capital disclosure is the dependant variable for each of the formulas below. volume 26, number 2 (1) (2) (3) (4) (5) (6) 181 each equation significantly predicted the level of intellectual capital disclosure atp < .05 . the adjusted r2 of the equations ranged from 8.45% to 12.00%. the firm 's age was the only predictor that reached a level of significance at p s .05 and it did so in each equation. as predicted in hypothesis 2, equations (1) through (6) establish a statistically significant inverse relationship between the age of a firm and its level of intellectual capital disclosure for fiscal year 2000 and fiscal year 2004 . no other variable was a statistically significant predictor of the level of intellectual capital disclosure. table 6 is a summary of the results of each model represented by equations (1) through (6) above. the sample size in the regression analysis is slightly smaller than the original sample because the statistical technique eliminated cases with missing data. in order to test whether there was a nonlinear relationship between the age variable and the rate of intellectual capital disclosure, quadratic functions were created by adding age squared as a variable to equations (1) through (6) . none of the quadratic equations led to a significant improvement of the r2 as compared to the r2 of the original equations. based on the findings of each hypothesis and the multivariate analysis of the size variables above, it appears that age was the only variable that has a practical effect on the level of intellectual capital disclosure of high-technology companies. 182 journal of business strategies table 6 results multivariate regression formulas equation (1) icd2000 = 8 2000 + agezooc?<zooo + emplzooc?<zooo + e; no. of intercept age employees adjusted r2 f-stat p n 55.473 -.639 -.0003 11 .96% 9.444 .01 139 t = 3.736 t= 1.765 p = .01 p = .0798 equation (2) icd2004 = 8 2004 + age200)<z004 + emplzoo)<2004 + e; no. of intercept age employees adjusted r2 f-stat p n 53.276 -.545 -.0002 9.24% 8.227 .01 140 t = 3.455 t = 1.604 p = .01 p = .1110 equation (3) icdzooo = 8 zooo + age200c?<2000 + ta200c?<zooo + e; total intercept age assets adjusted r2 f-stat p n 55.469 -.666 -1 .273 10.35% 9.199 .01 140 t = 3 .903 t= 1. 206 p= .01 p = .2300 equation (4) icd2004 = 8 2004 + age20~2004 + ta20~2004 + e; total intercept age assets adjusted r2 f-stat p n 53. 153 -.552 -7.798 8.45% 7.551 .01 140 t = 3.481 t= 1.157 p= .01 p = .2493 equation (5) icdzooo = 8 zooo + agezooc?<zooo + trzoo c?<2000 + e; total intercept age revenue adjusted r2 f-stat p n 55.634 -.670 -1.635 11.00% 9.717 .01 139 t= 3 .937 t = 1.566 p= .01 p = .1195 equation (6) icdzoo4 = 8 z004 + age20~z004 + trzoo)<z004 + ej total intercept age revenue adjusted r2 f-stat p n 53.178 -.556 -9.770 8 .52% 7.614 .01 140 t = 3.518 t = 1.205 p= .01 p = .2300 volume 26, number 2 183 conclusion hypothesis 1 predicted an inverse relationship between the size metrics of companies and their level of intellectual capital. the metrics evaluated in connection with hypothesis 1 were total assets, total revenue, and number of employees. although a significant inverse relationship was demonstrated between each of these variables and the level of intellectual capital disclosure by high-technology companies, the practical effect and size of such inverse relationship were minimal in light of the pearson's r correlation and the 95% confidence interval for said variables. additionally, neither the total assets, the total revenue, nor the number of employees of the company were predictive of the level of intellectual capital disclosure. a study of the relationship of the level of intellectual capital disclosure by companies and their number of employees, total assets and total revenue by industry group (i .e. computer software firms, professional service firms, and biotechnology firms) within the broader high-technology company category may provide additional explanations regarding firm characteristics that impact the level of intellectual capital disclosure. in support of hypothesis 2, an inverse relationship between the age of the company and its level of intellectual capital disclosure was shown to exist by this research data. the practical effect and size of the influence of age on the level of intellectual capital disclosure was shown by the data to be sizable. the multi-regression analyses performed in connection with the hypotheses variables confirmed that age was a predictor of the level of the company's intellectual capital disclosure. of the variables examined in the study, the age of a firm was the single most influential factor on the level of disclosure of intellectual capital by companies. no prior study in the intellectual capital literature has examined the relationship between the level of intellectual capital disclosure and the age of firms in the high-technology sector of the economy in their annual report. while there are significant findings in this research, it should be noted that there are limitations with using of fixed list of terms in performing content analysis of a document. first, the words used by firms in communications to its stakeholders or potential stakeholders may be different to some degree than those used in the academic community. second, the context in which a word, term or phrase is used may have a different meaning than that contemplated when included on the list of words or phrases to denote intellectual capital. third, the methodology employed in this study assumed frequency of words as an indicator of the importance or intellectual capital to the firm without qualitatively evaluating the use of the term or phrase . 184 journal of business strategies some studies in the intellectual capital field have used a disclosure index that is a ratio of the number of intellectual capital indicators disclosed by the firm to the total number of indicators in the intellectual capital framework employed in the respective study (bukh et ai. , 2005; cordazzo, 2007 ; garcia-meca, parra, larran, & martinez, 2005) . if an item is disclosed by the firm , it is counted once in determining the disclosure index for the firm regardless of the number of times that a disclosure is made about the item. this index measures the extent or depth of a firm's disclosure of the intellectual capital construct employed by the applicable study. however, because this study is designed to compare the level of intellectual capital disclosure among firms in the high-technology sector of the economy and the relationship of the frequency of disclosure with age and size of the firm, the index used to measure the level of a firm's intellectual capital disclosure is based on the frequency of the use of predefined terms or phrases that represent the intellectual capital construct. despite some limitations in this research, the results of the study suggest that younger companies will disclose their intellectual capital at higher levels in order to compensate for their lack of operating history and the inability of the traditional accounting model to support quantification of the expenditures as the creation of an asset on the balance sheet for the firm's investment in intellectual capital resources. from a practical standpoint, managers can use the findings of this study when deciding to disclose the organization 's intellectual capital. for example, when the firm is young, executives may want to strategically reveal information in order to reduce the cost of capital. startup firms disclose their intellectual capital at higher levels than mature firms to present a better image to external stakeholders. lacking operating history, younger firms are likely to use disclosure to compensate for limitations of the traditional accounting model. this disclosure is essential for young firms to reduce their cost of capital. however, as the firm ages and grows, top management may want to be less forthcoming with information in order to conceal the intellectual capital which affords them a competitive advantage. age appears to be an important factor in explaining the level of intellectual disclosure. however, because it only explains about 10% of the variance, there are likely numerous other factors involved which include stock volatility, the nature of the ownership structure, and share concentration as well as others (e.g., almazan, harzell, & starks, 2005 ; botosan & plumlee, 2002; bushee & noe, 2000; cormier, magnan, & van veithoven, 2005) . this research leaves other unanswered questions regarding the relationship between the age of the firm and the level of intellectual capital disclosure . for example, its needs to be determined in which sectors of the economy this relationship exists or not. further, it would be interesting to examine volume 26, number 2 185 the level of management's intellectual disclosure through the latter phases of the organizational life cycle (maturity/decline and death). it seems plausible that when companies attempt to tum the decline phase into a renewal phase, there would be an increase in attention to investment in intellectual capital (e.g., the retraining of employees). as suggested in this study, young firms disclose their intellectual capital, but as they grow, they reveal less because they do not want to lose competitive advantage. in the renewal phase, however, it may be important for top management to convince external stakeholders about their investment in intellectual capital by increasing their level of disclosure. references abdolmohammadi, m. (2005). intellectual capital disclosure and market capitalization. journal ojintellectual capital, 6(3), 397-416. aboody, d., & lev, b. (2000). information asymmetry, r&d, and insider gains . journal oj finance, 55(6), 2747-2766. almazan, a., hartzell, j. c., & starks, l. t. (2005). active institutional shareholders and costs of monitoring: evidence from executive compensation . financial management, 34(4), 5-34. amir, e. , & lev, b. (1996). value-relevance of nonfinancial information: the wireless telecommunications industry. journal oj accounting and economics, 22 (1-3), 3-30. anderson, l. p. (1966). the influence of developments: the capital markets on fund acquisition by the firm . journal oj financial & quantitative analysis, 1(4), 98-\ 00. andriessen, d. (2004). making sense ojintellectual capital. oxford: elsevier. barnes, e., & walker, m. (2006). the seasoned-equity issues of uk firms: market reaction and issuance method choice . journal business finance & accounting, 33(1/2), 45-78. barney, j. (1991). firm resources and sustained competitive advantage. journal oj management, 17(1),99-120. basu, s., & waymire, g. (2008). has the importance of intangibles really grown? and if so, why? accounting and business research, 38(3), 171-190. bontis, n. (2003). intellectual capital disclosure in canadian corporations. journal ojhuman resource costing & accounting, 3(1 /2),41-60. botosan, c. (1997). disclosure level and the cost of equity capital. accounting review, 72(3),323-349. 186 journal of business strategies botosan, c. a. (2006). disclosure and the cost of capital : what do we know? accounting and business research, 36(3), 31-40. botosan, c. a., & plumlee, m . a. (2002). a re-examination of disclosure level and the expected cost of equity capital. journal oj accounting research, 40( 1), 21-40. bozzolan, s., favotto, f., & ricceri, f. (2003). italian annual intellectual capital disclosure: an empirical analysis. journal ojintellectual capital, 4(4),543-558. brennan, n. (2001). reporting intellectual capital in annual reports: evidence from ireland? journal oj intellectual capital, 14(4), 423-436. brooking, a. (1996). intellectual capital: core assets jor the third millennium enterprise. london: thomson business press. bukh, p. n., nielsen, c., gormsen, p., & mouritsen, j. (2005). disclosure of information on intellectual capital in danish ipo prospectuses. accounting, auditing & accountability journal, 18(6), 713-732. bushee, b. 1., & noe, c. f. (2000). corporate disclosure practices, institutional investors, and stock return volatility. journal oj accounting research, 38(3), 171-202. . canibano, l., garcia-ayuso, m., & sanchez, p. (2000). accounting for intangibles: a literature review. journal oj accounting literature, 19, 102-130. carcello, j. v., & nagy, a. l. (2004). audit firm tenure and fraudulent financial reporting. auditing: a journal oj practice and theory, 23(2), 55-69. chakraborty, k. (1997). sustained competitive advantage: a resource-based framework. advances in competitiveness research, 5(1),32-63. clulow, v., gerstman, j., & barry, c. (2003). the resource-based view and sustainable competitive advantage: the case of a financial services firm. journal oj european industrial training, 27(5),220-232. cordazzo, m. (2007). intangibles and italian ip prospectuses: a disclosure analysis. journal oj intellectual capital, 8(2), 288-305. cormier, d., magnan, m. , & van veithoven, b . (2005). environmental disclosure quality in large german companies: economic incentives, public pressures or institutional conditions? european accounting review, 14(1), 3-39. dipiazza, s. a., mcdonnell, d., parrett, w. g., rake, m. d., samyn, f., & turley, j. s. (2006). global capital markets and the global economy: a vision jrom the ceos ojinternational audit networks. retrieved june 15,2009, from www.globalpublicpolicysymposium.com/ceo_ vision.pdf dierickx, 1., & cool, k. (1989). asset stock accumulation and sustainability of competitive advantage. management science, 35(12),1504-1511. volume 26, number 2 187 edvinsson, l., & malone, m. s. (1997). intellectual capital: realizing your company s true value by finding its hidden brainpower. new york: harper collins. financial accounting standards board (200ia). goodwill and intangible assets. statement of financial accounting standards no. 142. norwalk, ct: fasb. financial accounting standards board (200 i b). improving business reporting: insights into enhancing voluntary disclosures. business reporting research project. norwalk, ct: fasb. garcia-ayuso, m. (2003). factors explaining the inefficient valuation of intangibles. accounting, auditing & accountability journal, i6( i), 57-69. garcia-meca, e., parra, i., larran, m., & martinez, i. (2005). the explanatory factors of intellectual capital disclosure to financial analysts. european accounting review, 14( i), 63-94. geiger, m. a., & raghunandan, k. (2002). audit tenure and audit reporting failures. auditing, 21(1), 67-78. gelb, d. (2002). intangible assets and firms' disclosure: an empirical investigation. journal of business finance & accounting, 29(3/4), 57-476. goh, p., & lim, k. p. (2004). disclosing intellectual capital in company annual reports: evidence from malaysi. journal of intellectual capital, 5(3), 500-510. greve, h. r. (2008). the behavioral theory of firm growth: sequential attention to size and performance goals. academy of management journal, 51(3), 470-494. guthrie, j., boedker, c., & cuganesan, s. (2005). the strategic significance of intellectual capital information in annual reporting. working paper. macquarie graduate school of management, sydney. guthrie, j., petty, r. m., & ricceri, f. (2004). external intellectual capital reporting: contemporary evidence from hong kong and australia. working paper. macquarie graduate school of management, sydney. guthrie, j., & yongvanich, k. (2004). intellectual capital reporting: comparsion of various frameworks. working paper. macquarie graduate school of management, sydney. hall, r. (1992). the strategic analysis of intangible resources. strategic managementjournal, 13(2), 135-144. haniffa, r. m., & cooke, t. e. (2002). culture, corporate governance and disclosure in malaysian corporations. abacus, 38(3),317-349. haniffa, r. m., & cooke, t. e. (2005). the impact of culture and governance on corporate social reporting. journal of accounting & public policy, 24(5), 391-430. hope, j., & hope, t. (1998). competing in the third wave: the ten key management issues of the information age. boston: harvard business school press. 188 journal of business strategies huang, h., mishra, s., & raghunandan, k. (2007). types of non audit fees and financial reporting quality. auditing: a journal of practice and theory, 26(1), 133-145. hyytinen, a., & pajarinen, m. (2007). is the cost of debt capital higher for younger firms? scottish journal of political economy, 54(1), 55-71. international accounting standards committee (1998). international accounting standard no . 38: accountingfor intangibles. london: iasc international federation of accountants (1998). the measurement and management of intellectual capital: an introduction. new york. khurana, 1., pereira, k. r., & martin, x. (2006). firm growth and disclosure: an empirical analysis. journal of financial and quanitative analysis, 41(2), 357-380. kim, m., & ritter, 1. r. (1999). valuing ipos. journal of financial economics, 53(3),409-437. kristandl, g., & bontis, n. (2007). constructing a definition for intangibles using the resource based view of the firm. management decision, 45(9), 1510-1524. lev, b. (2001). intangibles: management, measurement and reporting. the brookings institution. lundholm, r., & van winkle, m. (2006). motives for disclosure and non-disclosure: a framework and review of the evidence. accounting & business research, 36(3),43-48 . mcgrath, r.g., tsai, m., venkataraman, s., & macmillan, i. c. (1996). innovation, competitive advantage, and rent. management science, 42(3),389-403. ordonez de pablos, p. (2002). evidence of intellectual capital disclosure measurement from asia, eurpore and the middle east. journal of intellectual capital, 3(3),287-302. peteraf, m. (1993). the cornerstone of competitive advantage: a resource-based view. strategic management journal, 14(3), 179-191. petty, r., & cuganesan, s. (2005). voluntary disclosure of intellectual capital by hong kong companies: examining size, industry and growth effects over time. australian accounting review, 15(2),40-50. porter, m. (1980). competitive strategy. new york: free press. sengupta, p. (1998). corporate disclosure quality and the cost of debt. accounting review, 73(4),459-474. shi, c. (2003). on the trade-off between the future benefits and riskiness of r&d: a bondholders' perspective . journal of accounting & economics, 35(2), 227-254. volume 26, number 2 189 starovic, d., & marr, b. (2003). understanding corporate value: managing and reporting intellectual capital. london: chartered institute of management accountants. tang, 1. (2008). the effects offirm size on knowledge management in electrical and electronic manufacturing firms. international journal oj management, 25(2), 308-321. tasker, s. (1998). bridging the information gap: quarterly conference calls as a medium for voluntary disclosure. review oj accounting studies, 3(112), 137-167. vergauwen, p. g. m. c., & alem, f. j. c. (2005). annual report ic disclosures in the netherlands, france and germany. journal oj intellectual capital, 6(1), 89-104. wiklund, j., & shepherd, d. (2003). knowledge-based resources, entrepreneurial orientation, and the performance of small and medium-sized businesses. strategic management journal, 24(13), 1307-1314. williams, s. m. (2001). is intellectual capital performance and disclosure practices related? journal ojintellectual capital, 2(3), 192-203 . wolk, h. i., dodd, 1. l., & rozycki, j. j. (2008). accounting theory (7th ed.). los angeles: sage publications. world bank (2006). where is the wealth ojnations?: measuring capitaljor the 21st century. washington, d.c.: the world bank. retrieved june 15, 2009, from siteresources. worldbank.org/inteeii214578-111 08862589641207480341 all. pdf zhang, l., & ding, s. (2006). the effect of increased disclosure on cost of capital: evidence from china. review oj quantitative finance & accounting, 27(4), 283-401. biographical sketches of authors blaise m. sonnier, dba, jd, cpa, is an assistant professor in the school of accounting at florida international university, miami, florida, and is of counsel with the law firm of allen & gooch, lafayette, louisiana. he earned his juris doctorate from louisiana state university, baton rouge, louisiana, and his doctorate of business administration from grenoble school of management, grenoble, france. kerry d. carson, phd, sphr, ccp, grp, is a management professor at the university of louisiana at lafayette where he serves as the director of the quality enhancement plan for accreditation. he received his doctorate from louisiana state university in business administration. his research interests are in the areas of commitment, performance management, and international business. 190 journal of business strategies paula phillips carson, phd, sphr, ccp, grp, is a professor in the moody college of business at the university of louisiana at lafayette. she is also a special assistant to the provost on assessment and serves on the university's lead accreditation team. professor carson received her doctorate from louisiana state university in management. her research and teaching interests include nonprofits and compensation. an examination of the impact of firm size and age on managerial disclosure of intellectual capital by high-tech companies workers' migration and remittances in bangladesh khawaja a. mamun sacred heart university • fairfield , ct hiranya k. nath sam houston state university • huntsville , tx abstract bangladesh has sent more than 6.7 million workers to over 140 countries during a period of more than three decades since the mid-1970s. most of these workers temporarily migrated to work in middle east and southeast asia. this mass movement of temporary migrant workers has, to some extent, eased unemployment pressures on the over-burdened labor market in this highly populated country. more importantly, the remittance transfers received from these migrant workers have reached a phenomenal level of over 10 billion us dollars in 2009, approximately 12 percent of gdp in bangladesh. this paper analyzes the trends and various other aspects of workers' migration and remittances in bangladesh. it further discusses the micro and macroeconomic impacts of remittances. while most remittance transfers have been used by migrant-sending households for consumption, there is evidence to show that these transfers have helped reduce poverty in bangladesh. the analysis presented in this paper further indicates that these remittances may have significant effects on other macroeconomic variables as well. introduction a labor-abundant country, bangladesh has sent over an estimated 6.7 million migrant workers to more that 140 countries across the globe over a period of more than three decades since the mid-1970s.1 the countries of middle east and northern africa have been the major destinations for these migrant workers. in the recent past, there have been large flows of bangladeshi migrant workers to southeast asia particularly to malaysia and singapore as well. the natural resource based economic prosperity of the first group of destination countries since the 1970s has created a large demand mainly for unskilled and semi-skilled workers to work in different sectors of those economies. similarly, the economic boom ofthe southeast asian countries in the late 1980s and the 1990s generated demand for unskilled and semi-skilled workers. bangladesh with a large population and limited economic opportunities has decidedly taken advantage of economic growth and prosperity in those countries. these flows of migrants leaving the country have not only fulfilled the mandate of the government policy to encourage out-migration as a means of eas30 journal of business strategies ing unemployment pressure on bangladesh' ever exploding labor market, but also the remittances received from the migrant workers have had significant impact on the economy. with more than 10 billion u.s. dollars (usd) in remittances during 2009 alone, bangladesh has been among the major remittance-receiving countries in the world and it has maintained this status for last several years.2 this amount is about 12 percent of gdp and more than half of total export earnings. it may be noted that if the money remitted through informal channels are taken into account, the magnitude will be much larger. 3 furthermore, not surprisingly, the countries of middle east have been the major sources of these remittance transfers. as noted by an official associated with labor migration, "remittances have been causing a silent economic revolution in bangladesh."4 however, the broader impacts of remittances in the economy have not been fully assessed. there have been only a few studies that use micro-level survey data to examine the economic effects of remittances in bangladesh. to the best of our knowledge, there is hardly any work that systematically investigate the overall macroeconomic impact of remittances in bangladesh. 5 however, studies for other countries have shown that these remittance flows could have significant macroeconomic consequences. 6 this paper is intended to examine the dual phenomena of workers' migration and remittances in bangladesh. over the years, under the government patronage, the international migration of workers has taken some pressure off from the domestic labor market and has purportedly enhanced the economic well-being of the families left behind by the migrants. however, given the size of the remittance inflows primarily from these migrant workers relative to the total income generated in the domestic economy, there could be significant impacts of these inflows on the overall economy. intuitively, there are several ways in which these inflows may have macroeconomic impact in a poor country like bangladesh. for example, if a significant part of the remittances is used for saving and investment, it could lead to higher growth of the economy in the long-run. if the remittance-receiving families spend a significant amount of these transfers on education and health two important elements of human capital this may also contribute to long-run growth of the economy. furthermore, by alleviating foreign exchange constraint, remittances may facilitate imports of capital goods and other important raw materials that are used in the production processes. even in the short-run, remittances may contribute to the growth of output in the economy by augmenting aggregate demand if the remittance-receiving households spend most ofthese transfers on consumption. the rest of the paper is organized as follows. in section 2, we discuss various trends of international migration of workers from bangladesh. different aspects volume 27, number 1 31 of remittance transfers over last three decades are discussed in section 3. section 4 discusses the impacts of remittances in bangladesh. the discussion is divided into two subsection. in the first subsection, we report and discuss the findings of the previous micro-level studies. in the second subsection, we present the preliminary results from a vector autoregressive (var) macro model to shed lights on the macroeconomic impacts of remittances in bangladesh. the next section includes our concluding remarks and a brief outline of future research. international migration from bangladesh there are two major patterns in international migration from bangladesh: one to the industrialized west that includes the united kingdom and the united states, and the other to middle east and southeast asia. the migration to the industrialized countries is perceived to be long term or permanent in nature while migration to middle east and southeast asia is usually for short term. the bangladeshi immigrants living in the industrialized countries of europe and north america can be divided into two distinct groups: a group of well-educated, high or middle income people of bangladeshi origin, and the other belonging to the low income or unemployed segments of the population. the origins of migration to these countries can be traced back to the british colonial period. most of these early migrants were employed as low-skilled workers and there has been hardly any upward economic mobility. however, a very small number of bangladeshis during the colonial period moved to the u.k. to pursue higher studies. in recent years, larger number of students and professionals migrated to the u.k. and the u.s. and chose to live there permanently. the government does not have any systematic record of the extent and composition of this long-term migration. however, according to an unofficial estimate, over a million bangladeshi immigrants live in the industrialized countries of the west (siddiqui, 2004). international migration to the countries of middle east, north africa, and southeast asia took place mainly after the independence of bangladesh in 1971. the rise in oil prices in the 1970s increased the demand for low-skilled workers to work in the infrastructure development projects in the middle eastern countries. later, there were similar demands from the newly industrialized countries of the southeast asia. migration to these regions has been characterized by short-term employment with specific job contracts and migrants returning home after completion of the contract period. the bureau of manpower, employment and training (bmet) maintains a database on the short term labor migrants who officially go overseas for employ32 journal of business strategies ment. according to the official statistics, between 1976 and 2009, the total number of bangladeshis working abroad as short-term migrants stands at about 6.7 million. figure i presents the total number of migrant workers for each year between 1976 and 2009. the major destination countries for these short-term migrant workers include saudi arabia (ksa), the united arab emirates (uae), malaysia, kuwait, oman, singapore, bahrain, qatar, and libya (see figure 2). saudi arabia alone hosts about 40 percent of the total short-term migrant workers from bangladesh. figure 1 total number ofinternational migrant workers from bangladesh: 1976-2009 900 800 i!: 700 '" -" (; 600 ~"' _'0 c: c: 500 '" '" .~ ~ 400 ::. 0 l: ~ .~ 300 "'-.c e 200 :> z 100 • 0 -••••••••••••• year figure 2 international migrant workers from bangladesh by country of destination (in percentages): 1976-2009 40 i!: ., -" (; ~ 30 "e '" c, ~ '" 20 ;§ .s ~ '" 10 l: <jl "e '" e ., !l. 0 **********-..... '" ..... '" '" " '" n '" '" '" '" ro '" n m ro oj 0 '" .,. n "" " '" n ~ ~ iii '" c c '" "' w '" ~ '" 0 "§ ro >;;; :0 « iii ::j e 0. .0 .r: l!' => >'" 0 '" .r: a :.j 6 '" ol '" « n; c m u ::;; ui ::j '" (fj destination countries table 1 ~ -~ number of migrant workers from bangladesh by country of destination: 1976 2009 ~ "' n country ,>.l misc. total ~ year ksa uae kuwait oman qatar bahrain lebanon jordan libya sudan malaysia sing. s. korea uk italy japan eg ypt brunei maurit. romania others clear. empl·mt. 1976 217 1.989 643 113 1.221 335 173 1,396 6,087 ~ <31977 1,379 5,819 1,315 1.492 2,262 870 718 1,8 70 15.725 "' 1978 3,2 12 7,512 2,243 2,877 1,303 762 2,394 23 2,483 22,809 .... 19 79 6,476 5,069 2,298 3,777 1,383 827 1,969 110 2,586 24,495 f->. 1980 8,695 4,847 3,687 4}45 1,455 1,351 2,976 3 385 1,929 30,073 1981 13,384 6,418 5,464 7,352 2,268 1,392 4,162 1,083 14,264 55,787 1982 16.294 6,863 7,244 8,248 6,252 2,037 2,071 331 13,422 62,762 1983 12,928 6,615 10,283 11,110 7,556 2,473 2,209 23 178 5,845 59,220 1984 20,399 5,185 5,627 10,448 2,726 2,300 3,386 718 5,925 56,714 1985 37,133 8,336 7,384 9,218 4,751 2,965 1,514 792 5,601 77,694 1986 27,235 8,790 10,286 6,255 4,847 2,597 3,111 530 25 4,982 68,658 1987 39,292 9,953 9,559 440 5,889 2,055 2,271 4,558 74 ,017 1988 27,622 13,437 6,524 2,2 19 7,390 3,268 2}59 2 4,900 68 ,121 1989 39,949 15,184 12.404 15,429 8,462 4,830 1,609 401 229 3)27 101,724 1990 57,486 8,307 5,957 13,980 7,672 4,563 471 1,385 776 3,217 103,814 1991 75,656 8,583 28,574 23,087 3,772 3,480 1,124 1,628 642 585 147,131 1992 93,132 12,975 34,377 25,825 3,251 5,804 37 1,617 10,537 313 228 12 16 188,124 1993 106,387 15,810 26,407 15,866 2,441 5,396 37 1,800 67,938 1,739 328 12 347 244,508 1994 91,385 15,051 14,912 6,470 624 4,233 382 1,864 47,826 391 1,558 1,335 26 269 186,326 1995 84,009 14,686 17,492 20,949 71 3,00 4 406 1,106 35,174 3,762 3,315 2,659 229 681 187,543 1996 72,734 23,812 21 ,042 8,691 112 3,759 490 1,966 66,631 5,304 2,759 3,062 196 1,156 211,714 1997 106,534 54,719 21,126 5,985 1,873 5,010 907 1,934 2,844 27,401 889 303 238 1,314 231,077 1998 158,715 38 ,796 25,444 4,779 6,806 7,014 1,389 1,254 8 551 21,728 578 169 16 420 267,667 1999 185,739 32 ,344 22,4 00 4,045 5,611 4,639 219 1.744 16 9,596 1,501 7 1 139 181 268,182 2000 144,6 18 34,034 594 5,258 1,433 4,637 1,010 54 17,237 11 ,095 990 22 9 1.420 271 4 222,686 2001 137,248 16,252 5,341 4,561 223 4,371 450 153 4,921 9,615 1.561 19 3 2,958 272 1,017 188,965 2002 163,269 25,462 15,769 3,854 552 5,42 1 2 1,829 1,574 136 85 6,856 28 19 37 17 154 59 133 225,256 2003 162,131 37,346 26,722 4,029 94 7,482 3 2,128 2,855 784 28 5,304 3,7 71 166 28 12 26 980 301 254 ,190 2004 139,031 47,012 41,108 4,435 1,268 9,194 6,022 606 923 224 6,948 215 2,055 550 47 33 1,802 44 2,859 8.582 272 ,958 2005 80,425 61 ,978 47,029 4,827 2,1 14 10,7 16 14 9,101 972 885 2,911 9.651 223 2,793 950 79 207 191 1, 381 4,015 12.240 252 ,70 2 2006 109,513 130,204 35, 775 8,082 7,691 16,355 821 2,822 104 2,380 20,469 20,139 992 1,625 1,428 174 639 496 2,090 8,995 10,722 381 ,516 2007 204,112 226,392 4,212 17,478 15,130 16,433 3,541 494 1,480 1}26 273,201 38 ,324 39 972 10,950 164 1.068 1,186 3,658 1,827 10,222 832,609 2008 132,124 419 ,355 319 52.896 25.548 13.182 8, 444 682 5,067 170 131.762 56 ,5rl 1,521 952 6.928 133 1,891 1.054 3,071 830 1.631 10,914 87 5,055 2009 14,666 258,348 10 41.704 11,672 28,426 13,941 1,691 22,742 514 12,402 39 ,581 1,474 1,2 53 5,339 39 3,018 2,699 1,826 229 5,219 8.485 475 ,278 total 2,573,1291,587,483 479 ,571 360,524 155,723 191 ,181 30,633 24,769 83,062 7,749 698,736 279,597 21,414 9,816 26,192 733 6,911 21,025 13,540 1,059 107,175 61.165 6,741,187 % 38 .17 23.55 7.11 5.35 2.31 2.84 0,45 0.37 1.23 0.1 1 10.37 4.15 032 015 039 0.01 0.10 031 0.20 0.02 159 0.91 tv source: bureau 01 manpower, employmenl and trai ni ng (bmetj, bang ladesh tv 34 journal of business strategies as it is clear from figure 1 and table i , there have been year-to-year variations in total and country-wise composition of international migration from bangladesh. for example, there was a drop in migration to middle east during the gulfwar in the early 1990s. after the war was over, there was a greater demand for migrant workers to work in the post-war reconstruction efforts. similarly, there was a decrease in demand for bangladeshi workers in the southeast asian countries immediately after the financial crisis of 1997 . as recently as 2006 through 2008, there was a substantial increase in demand for migrant workers in the uae, presumably triggered by the economic boom caused mainly by manifold increases in oil revenue. during 2007, the demand for bangladeshi workers increased significantly in malayasia as well. the significant drop in the number of bangladeshi workers in 2009 is the direct fallout of the economic slowdown caused by the recent global financial crisis. despite the tremendous growth in overseas employment of bangladeshi migrant workers, the last few years have also witnessed increased competition from new migrant labor sending countries like nepal, cambodia, and viet nam (siddiqui , 2005). in terms of skill composition of the short-term migrant workers from bangladesh, professional workers like doctors, engineers, teachers, and nurses constituted less than 5 percent in 2004 and this ratio has drastically dropped to almost 0 in 2008. skilled workers such as manufacturing or garment workers, drivers, computer operators, and electricians accounted for about 32 percent, and semi-skilled workers like tailors and masons accounted for another 16 percent of the total migrants in 2008. unskilled workers accounted for the rest (about 52 percent). most of the short-term migrants are male and the female migrant workers accounted for less than 2 percent in 2008. this ratio was about 5 percent during 2005-06. 7 there are government restrictions on migration of female workers. further, according to a survey conducted by sharma and zaman (2009), the average duration of employment for the migrant workers is 6 years. they also find that migration increases with age and the level of education, and then declines beyond a threshold (44 years of age and 9 years of education). in addition, families with land holdings are more likely to migrate than do landless families. this is not unrealistic as there is high upfront cost associated with migration. 8 previous studies indicate that most international migration from bangladesh originates from the districts of sylhet, chittagong, noakhali, comilla, and dhaka (murshid et al. , 2002) .9 while it has its origin in history, it has some important implications for current emigration. for instance, there are some interesting links between destinations and origins. for example, the bangladeshi migrants in the tower hamlets in the u.k. mostly came from sylhet. similarly, migration to rome mostly volume 27, number 1 35 originates in faridpur district. this points to the strong network effects among the immigrants. these places also serve as the first stepping stone for international migration and, therefore, receive a lot of internal migrants who hope to eventually go abroad. in recent years, the recruiters of temporary migrant workers, who bear the burden of guaranteeing a smooth supply of adequately skilled and reliable workers, chose to minimize information asymmetries and moral hazard by recruiting within narrow social or community networks where information flows are better and labor contracts are easier to monitor and enforce (sharma & zaman, 2009). it is important to note that the government plays an important role in the outmigration of bangladeshi workers. the emigration ordinance of 1982 is the key regulatory instrument used by the government with respect to migration. however, several statutory regulatory orders and framed rules introduced subsequently have played complementary or supplementary roles to this instrument. five government ministries are involved in international labor migration: (i) the ministry of expatriates' welfare and overseas employment that was created in 2001; (ii) the ministry of home affairs; (iii) the ministry of foreign affairs; (iv) the ministry of finance; and (v) the ministry of civil aviation and tourism (siddiqui, 2005). the first of these five ministries is primarily responsible for the migration sector and it pursues the twin goals of creating employment opportunities overseas and addressing problems experienced by expatriates to ensure their well being. under this ministry, the bureau of manpower, employment and training (bmet) is the executing agency, responsible for a wide variety of functions ranging from control and regulation of migrant worker recruiting agents to organizing pre-departure briefing sessions for the migrant workers and resolving legal disputes. 10 the bangladesh missions abroad also play an important role in labor migration by performing the following tasks: (i) exploration of potential labor market; (ii) attestation of recruitment documents; (iii) consular services to bangladeshi workers; and (iv) ensuring the welfare of migrant workers. the bangladesh overseas employment services limited (boesl) is the government agency that is involved in direct recruitment of workers for international migration. during 1976-2003, less than 2 percent of the migrant workers were assisted by the government agencies (bmet and boesl) and about 41 percent received assistance from private recruitment agencies which are licensed by the government, and organized under the national umbrella organization called bangladesh association of international recruitment agencies (balra).i! however, more than 55 percent of migrant workers were recruited through individual initiatives and social networks. 12 36 journal of business strategies the international migrants from bangladesh face a number of problems in both home country and host country. for example, the initial cost of international migration could be prohibitively high. there are allegations of exploitation by recruitment agents and foreign employers. there are reports of racial and ethnic discrimination in host countries of middle east and southeast asia. both home and host countries are lax in formulating appropriate policy to protect the rights of the migrant workers and their families. most major destination countries have not ratified the 1990 international convention on the protection of rights of all migrant workers and members of their families. j3 remittance flows into bangladesh size, growth, and origins of remittances according to official statistics published by bangladesh bank, a total amount of usd 67.67 billion has been remitted to bangladesh from across the globe between 1975-76 and 2008-09. however, if we add the amount of remittances transferred through informal channels and therefore not captured in the official data, this number will be much higher. as figure 3 shows, except for a few years in early 1980s and one year around 2000, the remittance flow has been steadily increasing with an acceleration in the growth rate in recent years. the iran-iraq war seems to explain the slowdown in the growth of remittances in the early 1980s. similarly, the gulf war of the early 1990s may have been the reason for sluggish growth in remitt;mces during that period. it should be noted that the recent spur in the growth of remittances can partially be ascribed to increased use offormal channels of remitting money from abroad for a variety of reasons. they include increased efficiency and larger network of formal channels that involve both nationalized commercial banks (ncbs) and private commercial banks (pcbs), somewhat stricter enforcement of laws against informal channels like the hundi system (which are supposedly used for transfer of funds among terrorist groups) after the terrorist attack of september 11, 2001, and various government programs to encourage remittance transfers. 14 most remittance flows originate in middle east. figure 4 presents total remittance transfers by country of origin between 1998-99 and 2009-10. as the figure shows, saudi arabia alone is the source of more than usd 18 billion in remittance transfers to bangladesh between the fiscal years of 1998-99 and 2009-10. over the same period, the united states has been the second largest source of remittances with usd 8 billion, followed by the united arab emirates with usd 7.1 billion, kuwait with usd 5.7 billion, and the united kingdom with 4.8 billion. it is clear volume 27, number 1 37 from the figure that the largest share of th e remittances originate in countries that receive most of the short-term migrant workers . figure 3 remittance flows into bangladesh: 1976-2009 12 10 0 c/) ::;) 8 '5 '" c: ~ 6 ~ '" q) 0 c: ~ 4 -e q) a:: 2 o~~~====~ ____ _ n n ~ ~ 84 86 88 w ~ ~ 96 w 00 ~ 04 00 w yea r figure 4 remittance into bangladesh by country of origin: total between 1998-2009 20 0c/) ::;) 16 '5 '" c: ~ 12 ~ '" q) 0 c: 8 ~ -e q) a:: 4 0 ., « w -~ '" '" c ., c: >~ c >., 0> -~ c '" :0 if) « ::;) '" -c;; .~ ~ '" c: ~ c g >-~ ::;) ::;) ~ '" e >8. c. '" 0 0 ~ d :j a 0 '" .t:: '" '" e '" '" '" :::i « '" <ii '" ..., q; co 0> en 0> :j u ::; c: (!) c « :j cis 0 '" i uj w table 2 (xl workers' remittances into bangladesh by country of origin : 1998-99 2009-10 (millions of us dollars) 199819992000 2001200220 0320042005 200620072008 2009country 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 total bahrain 38 .94 41.8 4405 54 .12 63 .72 61 .11 67.18 61.29 79 .96 138 .2 157.43 9869 906.49 kuwait 230.22 245.01 247.39 285.75 338.59 361 .24 406 .8 454 .38 680.7 863 .73 970 .75 602 .67 5687.23 oman 91.93 9301 83 .66 103.27 114.06 118.53 131 .32 153 196.47 220.64 29006 218 .72 1814.67 qatar 63.94 63.73 63.44 90 .6 113 .55 113.64 136.41 161.43 233.17 289.79 343.36 222 .94 1896 ksa . 685.49 916 .01 919 .61 1147.95 1254.31 1386 .03 1510.46 1562.21 1734 .7 2324.23 2859.09 1985.13 18285.22 uae . 125.34 129 .86 144.28 233.49 327.4 373.46 442 .24 512 .64 804 .84 1135.14 1754.92 1100.45 708406 libya 0 .14 0.04 0.1 0 0.16 0 .13 0 .27 0.16 2.6 1 0 .3 6 1.25 1.01 6 .2 3 iran 0 .19 0 0 0 0 .22 0 .38 0 .52 1.68 2.36 3 .24 3.28 2 .74 14.61 sub total for 1236.2 1489.5 1502.5 1915.2 2212 2414.5 2695.2 2906.8 3734.8 49753 6380 .1 4232.4 35694 .51 middle east australia 0 0 0 2.28 3 .38 4.79 7.15 8.89 11.34 13.11 6 .78 5 .21 62 .93 hong kong 5 .13 5.15 3.96 3.99 4.77 5.92 5 .63 5.37 6.15 8 .1 909 5.46 68.72 ita ly 0 0 .22 0.41 0.35 19.32 27.16 41. 38 78.4 3 149.65 214.46 186.9 128 .3 846.58 malaysia 67.52 5404 30 .6 46 .85 41.4 37.06 25.51 1905 11.84 92.44 282.22 328 .13 1036 .66 singapore 13.07 11 .63 7.84 14.26 31 .06 32 .37 47.69 61.32 80.24 130.11 165.13 112.59 707.31 '0uk 54 .04 71.79 55 .7 103.31 220.22 297.54 375.77 517.39 886.9 896 .13 789 .65 524 .91 4793 .35 ;: u.sa 239.41 241.3 225.62 356 .24 458 .05 467.81 557.31 701 .37 930 .33 138008 1575.22 845 .35 797809 ~ ~ germany 5.14 4.7 3 .84 6 .11 9.57 12.12 10.1 10.95 14.91 2687 19.32 11.6 135.23 ;:. japan 39.42 34 .56 10.74 14.14 18 .24 18.73 15 .99 8 .71 10.17 16.29 14.12 9 .25 210.36 ~ s.korea 1. 87 0 .52 0.33 0 .79 3 .93 5 .19 18.41 16.4 17.08 1969 18.33 1525 117.79 i:x:; others 43 .95 35 .95 40.53 37.63 4002 48 .76 48 .15 92.56 12505 142.17 242 .36 267.19 1164.32 ;: '" ..... sub total for ~ regions other than 469 .55 459.86 379 .57 585 .95 849 .96 957.45 11 53 .1 1520.4 2243.7 2939 .5 3309 .1 2253 .2 17121 .34 ... '" '" midd le east ci) total 1705 .7 1949.3 1882.1 2501.1 3062 3372 3848 .3 4427.2 5978.5 7914.8 9689.3 6485 .6 52815.85 ..... ~ ;:. source : bangladesh bank ..... ~ .... . ... '" volume 27, number 1 39 determinants of remittances to bangladesh in general, the literature differentiates between micro and macroeconomic determinants of remittances. 15 among the microeconomic determinants, altruism towards the family left behind by the migrants in the home country, investment in home country by "self-interested" migrants, insurance against risks that migrants are exposed to in the host country, and payment back (return) to the family for the investment that it made on the migrant, have been extensively discussed and tested for various remittance receiving communities/countries around the world. at the macro level, movements of foreign exchange rate, differences in interest rates between host and home country, and business cycle fluctuations in host and home country of the migrants have been shown to be important determinants. there have been only a few studies that explore the determinants of remittance transfers to bangladesh. these studies seem to focus on macroeconomic determinants. for example, barua, mahumber, and akhtauzzaman (2007) show that income differentials between host and home country and devaluation of home country currency positively and high inflation rate in home country negatively affect workers' remittance decision. using a simple regression analysis, hussain and naeem (20 i 0) find that number of workers finding employment abroad every year, oil price, exchange rate, and gop growth are the key determinants of changes in the level of remittance inflow into bangladesh. according to their results, each additional migrant worker increase remittances by usd 816 annually. furthermore, a one dollar increase in oil price increases annual remittance transfers to bangladesh (mainly from middle east) by nearly usd 15 million. they also find that depreciation of exchange rate by one bangladeshi taka increases annual remittance by uso 18 million and that remittances are higher during periods oflow economic growth in bangladesh. the last result is consistent with the finding of sayan (2006) who shows that migrants from bangladesh increase their remittance transfers during times of economic hardship in their home country. economic impacts of remittances in bangladesh microeconomic impacts it has been a general conclusion of most micro-level studies that the remittance-receiving households use the largest fraction of remittances for consumption. however, purchase of land, construction and repair of houses, and repayment of loans have been some of the other important uses of remittances. 40 journal of business strategies table 3 percentage distribution of remittances by expenditure categories expenditure categories food and clothing purchase of land home construction and repair repayment of loans wedding and other social ceremonies education savings funding other peoplefs migration investment in business health care source: compiled from various studies range of percentage share of remittances spent 20-36 3-40 2-30 10-19 0-10 0-5 3-7 0-7 0-5 0-4 various survey-based studies indicate that family transfers account for up to 70 percent of the total household income. some studies (e.g., afsar et ai., 2002) suggest that over time households with overseas labor migrants become increasingly dependent on remittances. most surveys also indicate that remittances are mainly used for consumption (siddiqi & abrar, 200 i; afsar, 2003). depending on how consumption is defined, as much as 80 to 90 percent of remittances are used for this purpose. table 3 presents the percentage distribution of remittances spent by the most important expenditure categories. note that it presents the range of percentage shares of remittances spent on these items as reported by various micro-level studies. whether all items can be included in consumption is disputable. while it is not surprising that between l/5 th and l/3 rd is spent on basic items like food and clothing, it is interesting to note that up to 40 percent of remittances are spent on purchase of land. land is the safest way to invest in bangladesh. as siddiqqi and abrar (2001) argue, arable land provides direct economic return through crop production. furthermore, in a land-shortage economy like bangladesh, the value of land appreciates very quickly. repayment of loans also accounts for a large share of the total use of remittances . these findings are further corroborated by sharma and zaman (2009). they find that while the remittance-receiving families spend more on consumption of food and non-food items, the same is not true for health and education expenditure . they also note that their spending on home appliances and land are higher than non-migrant volume 27, number 1 41 families'. finally, remittance-receiving families save more and have more outstanding loans (resulting mainly from high upfront cost of migration). however, it also shows their credit-worthiness. in an interesting study, mohapatra, joseph, and ratha (2009) find that the remittance-receiving households in bangladesh had higher per-capita consumption than others after the devastating floods of 1998. based on household survey data, this study emphasizes the role of remittance transfers as a consumption smoothing mechanism in the face of natural disaster. there are instances of some non-resident bangladeshis (nrb) making individual contributions every year to mosques, orphanages, or madrassas. also, there are bangladeshi immigrants mainly in the usa and the uk who come from the same region/area and organize to pool money and transfer to the respective areas of their origin for charity or community development. the money is given for health care, religious projects, educational projects, construction and repair of roads and culverts, and the provisions of scholarships to students in the villages where the expatriates come from. however, the total transfer is very small and not well known to formal/government institutions in bangladesh. macroeconomic impacts of remittances to give a perspective on how important remittances could be for economywide impacts, table 4 presents comparisons of these transfers with gop, foreign direct investment (foi), total merchandize export earnings, and official foreign aid in bangladesh between 2000 and 2008. by 2008 , remittances are already more than 11 percent of gop. the remittances have far exceeded the official foreign aid and fdi into bangladesh. the flow of remittances as a share of total export earnings has increased over the years and was about 65 percent in 2008. these comparisons signify the importance of remittances for the overall economy in bangladesh. as most micro-level studies show, the remittances directly augment household income and increase consumption. thus, although remittances do not seem to have contributed to the macro economy, the increases in income and consumption at the household level have some significant macroeconomic consequences. for example, in a note prepared for the g8 outreach event on remittances in berlin, ratha and mahapatra (2007) state that remittance may have reduced the share of poor people in the population by 6 percentage points in bangladesh. in a recent study, raihan, khondker, sugiyarto, and jha (2009) further show that a 1.7 percentage point reduction in headcount ratio measure of poverty level between 2000-05 can be attributed 42 journal of business strategies to the growth in remittances. this finding is further corroborated by vargas-silva, jha, and sugiyarto (2009) who use several different measures of poverty. table 4 comparison of remittances with key macro variables remittances as a percentage share of year merchandise foreign gop foi exports aid .. ,------2000 4.1 5 337.88 34 .97 2001 4.41 584 .21 36.11 151.2805 2002 5 .98 867.44 52.32 197.4889 2003 6 .12 907.38 51 .01 200.4814 2004 6.30 774. 39 47.00 344.8075 2005 7.05 502.94 50.03 285 .0349 2006 8 .86 691 .56 47.08 2007 9.60 986.19 51 .61 402.6996 2008 11.37 826 .80 64.59 435.451 source: authors ' calculations using data obtained from unctao, bangladesh bank, and the world bank . furthermore, it is important to recognize that even though remittance receiving households may not directly invest the funds that they receive through transfers from the migrant member, the increase in consumption itself should work its way through multiplier effect on the aggregate demand and, therefore, should contribute positively to growth. also, it has been noted above that the remittance-receiving households save a part of their remittance transfers. further, there is some evidence that bangladeshi immigrants also transfer funds directly to the home country in order to save. over the years, ·government and banks have been able to attract savings from individual immigrants by creating a number of bonds and special savings accounts aimed at migrants (de bruyn & kuddus , 2005). however, the amount transferred directly for investment is very low. 16 but as long as the savings of the remittance-receiving households and the migrant workers enter the formal financial system in bangladesh, they are used to finance investment and, consequently, they contribute to long-run growth. in addition, increasing use of the financial system to transfer funds itself should channel some of these remittance flows into productive investment. volume 27, number 1 43 thus, to assess the macroeconomic impact of remittance transfers, we will present (i) an illustration of the multiplier effects of remittances on sectoral level output using the input-output framework; (ii) some tentative results from a vector autoregressive (var) macro model. the multiplier effects of remittances at the sectoral level stahl and habib (1989) analyze the impact of remittances at the sectoral level by using the input-output framework. they use survey data from a world bank study on the expenditure patterns of remittance-receiving households in bangladesh and match them to the 47 sectors comprising the input-output table for bangladesh. this sectoral distribution of expenditures is imputed to total remittances inflow data for the years between 1976 and 1988 to obtain corresponding sector-wise anticipated expenditures out of remittances. assuming these expenditures to be autonomous additions to final demand attributable to remittances, they are then multiplied by the output multiplier matrix [1 a + mll to obtain total output attributable to remittances. note that here a is the technical coefficient matrix given by the input-output table, and m is the diagonal matrix with import coefficients as the diagonal elements. the results for the most important sectors are summarized in table 5. if the remittances are spent on sectors that have strong forward and backward linkages with many other sectors, the overall impact on output is high. for example, according to our calculations, if a dollar of remittances is spent on forestry, it will lead to an increase of about usd 5 in output. forest products such as bamboos, woods , canes, are used as intermediate inputs to produce a variety of goods. thus, an initial expenditure on these products may lead to a much larger increase in overall output. 44 journal of business strategies table 5 remittance induced output in bangladesh rice other crop live stock fisheries forestry leather wood miscellaneous industries urban house rural house petroleum electricity transport service banking service other service increase in output when usd 1 of remittances is spent (in usd) 1.09 1.21 1.34 1.00 4.91 1.18 1.52 2 .67 1.10 1.04 1.73 1.42 1.74 1.37 1.11 source : authors ' calculations from the results reported in stahl & habib (1989). some tentative results on the macroeconomic effects of remittances from a var model17 we now examine the effects of remittances at the macro level by using a vector autoregression (var) macro model ofthe following form: 18 y=a +~p .dy.+e t 0 k.j/':::. t~1 h t (i) where y is an n x 1 vector of macro variables, ao is an n x i vector of constants, ai is an n x p matrix of autoregressive coefficients of lagged variables, and is an n x 1 vector of error terms. although we would like to include a number of important macro variables in this model, limited availability of data for bangladesh allows us to use the following variables only: industrial production, cpi, export receipts. import payments, mi money stock, remittances, and the nominal exchange rate of us dollar in terms of bangladeshi taka. for each variable, we use monthly data for volume 27, number 1 45 a period between july 1994 and december 2008. the data are seasonally adjusted. we conduct augmented dickey fuller (adf) test on each series to detennine its stochastic trending properties. except for ml and remittances, all other series are found to be unit root processes. therefore, we use their stationary fonns . that is, we use log first differences of all series including mi and remittances. we estimate equal lag length var with lags of up to 6 months.!9 we then derive the generalized impulse responses of each of the variables to a one standard deviation shock to remittance growth.20 figure 5 presents the generalized impulse responses for 12 months. as we see from the figure, a one standard deviation shock to the growth of remittances has significant positive impact on the growth of industrial production, export growth, and the change in nominal exchange rate in month 1. however, the effects quickly dissipate after the second month. 2 ! note that since we include cpi inflation in the model, these results should be interpreted as real effects of a shock to real remittance growth. it is hard to speculate on the actual mechanism through which these macro variables are affected by remittance growth in bangladesh without exploring more on the structure of the economy. also, it is imperative to use a more general var specification with additional endogenous macro variables. but given the data limitations, it is outside the scope of the current study. thus, the results presented in figure 5 should be taken to be indicative of potential effects of remittances on the overall economy and should not be overemphasized as evidence of precise effects on the respective macro variables. 46 .003 .002 .001 .000 '.001 " '.002 , .003 .06 .04 " , .02 " .00 -.02 -.04 -.06 journal of business strategies figure 5 generalized impulse responses from a vector autoregression macroeconomic model generalized impulse responses to a one s.d. shock to remittances inflation growth of indutrial production .020.,----------------, .015 \ " '. " / \ " " \ " '-""r~~ / / .000 . ' ," ·.005 --.... ~ . / ." -.0 10 i , v / -" ., -.015 2 3 4 5 6 7 8 9 10 11 12 2 3 4 5 6 7 8 9 10 11 12 export growth import growth .06.,..--------------, , ~ ~ ~~-~ ... '" ~"-' -.06 i----r--,--r---r--,--r---r--,--r---r--i 2 3 4 5 6 7 8 9 10 11 12 2 3 4 5 6 7 8 9 10 11 12 money (m1) growth exchange rate growth .10..----------------, .004,.-_____________ --, ." ,, --..., ',---_ .. / " " ..... / \ .05 .oo /a ii -.05 ,;"\, -.10 -_ .. _ --/ 1 2 3 4 '--_...... \ , ,, /'" / '., 5 6 7 8 .003 \, .002 .001 -.001 -.002 -.003 i----r--,--r--,---,--r--r--,--r---r--i 9 10 11 12 2 3 4 5 6 7 8 9 10 11 12 volume 27, number 1 47 concluding remarks the officially recorded number of migrant workers from bangladesh to over 140 countries during more than three decades since the mid-l 970s stands at over 6.7 million. most of these workers are temporary migrants working mainly in middle east and southeast asia. this mass movement of temporary migrant workers has, to some extent, eased unemployment pressures on over-burdened labor market of highly populated bangladesh. more importantly, the remittance transfers from these migrant workers have reached a phenomenal level of about 12 percent of gdp in bangladesh. the existing studies have shown that most of these remittance transfers augment household income and are used for consumption. however, there has been evidence to show that these remittances have helped reduce poverty in bangladesh. the analysis presented in this paper further indicates that these transfers may have significant effects on other macroeconomic variables as well. as pointed out in the paper, international migration of temporary workers from bangladesh has been a key strategy of the government's employment policy. a country with half of the u.s. population and less than 1 percent ofthe u.s. gop, bangladesh does not have too many options. emigration of a large segment of the population to high or middle income countries has been suggested as a way of eradicating abject poverty (moses, 2009). the remittances received from the migrant workers have been significantly large in recent years. it is important to understand how these transfers impact the economy at the macro level so that appropriate policies can be formulated to ensure their optimal utilization. furthermore, there is hardly any study that examines the overall impact of international migration of workers from bangladesh. for example, what is its impact on domestic labor markets in terms of employment and wages? how does it affect productivity and growth? our future research intends to examine in details the macroeconomic impacts of labor migration and remittances in bangladesh. notes i. this number almost exclusively includes temporary workers who have officially migrated for employment overseas, and does not include most bangladeshis who have permanently emigrated to europe and north america and/or those who illegally migrated to other countries, mainly to india. if those groups are included, the number of bangladeshi migrants will be several times larger. 2. according to the data obtained from the bureau of manpower, employment and training (bmet), the total remittances received in 2009 amount to uso 10.72 bil48 journal of business strategies lion while, according to bangladesh bank, the total remittance transfers amount to usd 9.69 billion during the fiscal year 2008-09 and usd 6.49 billion through the month of january during the fiscal year 2009-10. 3. bahar, sarker, and hossain (2006) cite an imf report to claim that over 59 percent of total remittance transfers between 1981 and 2000 came through informal channels. in contrast, world bank (2006) reports this share to be a 54 percent. 4. as quoted by de bruyn and kuddus (2005, p.42). 5. in a recent paper, vargas-silva, jha, and sugiyarto (2009) includes bangladesh in a panel study of26 countries from asia to investigate the macroeconomic effects of remittances on economic growth and poverty reduction. 6. for a survey of the literature, see ruiz and vargas-silva (2009). 7. see siddiqui (2009). 8. as de bruyn and kuddus (2005) note, the initial costs that include airfare, passport, visa, insurance, medical checkup, clothes, payment to recruitment agencies etc. may add up to usd 2,000 or more. 9. siddiqui (2009) lists brahmanbaria, chittagong, comilla, dhaka, and tangail as the highest migration prone districts with 5.67, 9.06, 11.48, 6.48, and 6.13 percent of the migrant workers respectively coming from these districts. 10. the government created bmet in 1976, much before the creation of the ministry of expatriatesi welfare and overseas employment, to ensure maximum benefit from labor migration to the national economy. since the enactment of the em igration ordinance of 1982, it has been responsible for implementing the ordinance. 11. there are more than 700 officially licensed private recruitment agencies. 12 . see table 3 in siddiqui (2005). 13. see bryun and kuddus (2005) and siddiqui (2005). 14. for a discussion on the hundi system and other informal channels through which remittances are transferred from east and southeast asia, see rahman and yeoh (2006) 15. for a detailed discussion, see ruiz and vargas-silva (2009) 16. the previous studies ascribe it to a host of reasons including lack of promotional support in terms of information, advisory, training and other services, lack of ideas about investment opportunities, lack of expertise in the remittance receiving housevolume 27, number 1 49 holds for running businesses, and high opportunity costs in terms of investment environment abroad. 17. we call these results "tentative" mainly for two reasons. first, the limited availability of data restricts the number of variables and the length of the sample period we could use in our var estimation. second, the quality of the data used are of suspect. sometimes data collected from two different agencies do not quite match. there are data discontinuities. data on some of the series are not documented well. 18. var macro models are very flexible (and, therefore, somewhat popular) in that they can be used to examine relationships between variables without subscribing to any particular theory about such relationships. however, the specification of the model as regards to what endogenous variables and how many lags of those variables are to be included is a contentious issue that the researchers must pay attention to. for a discussion on var models, see enders (2004). 19. because of the short sample period, we have used 6 lags. however, with 12 lags, the results do not change qualitatively. 20. one advantage of generalized impulse responses is that, unlike impulse responses derived from cholesky decomposition, they do not depend on the ordering of the endogenous variables. 21. these transitory effects are reminiscent of an aggregate demand shock. however, in the light of the existing literature, it is not clear why remittances would have a positive impact on export growth. the literature (e.g., amuedo-dorantes & pozo, 2004) argues that large remittances reduce export competitiveness through exchange rate appreciation. references afsar, r., yunus, m., & islam, a.b.m.s. (2002). are migrants after the "golden deer "? a study on cost-benefit analysis of overseas migration by bangladeshi labour. international organization for migration (10m), regional office for south asia, dhaka. afsar, r. (2003, june 22-24). internal migration and the development nexus: the case of bangladesh. paper presented at the conference on migration, development, and pro-poor policy choices in asia, dhaka. retrieved from: http://www. livelihoods.org/hot_ topics/docs/dhaka _ cp _ 6.pdf. al hasan, r. (2006). harnessing remittances for economic development of bangladesh. inafi bangladesh working paper series, no.1 50 journal of business strategies amuedo-dorantes, c., & pozo, s. (2004.) workers remittances and the real exchange rate: a paradox of gifts. world development, 32(8), 1407-17. bahar, h., sarker, a. a., & hossain, b. (2006). the flow of workers' remittances in bangladesh: performance, challenges and policy options. draft working paper, bangladesh bank, dhaka. barua, s., majumder, md. a., & akhtauzzaman, m. (2007). determinants of workers 'remittances in bangladesh: an empirical study. working paper series: wp 0713, policy analysis unit, bangladesh bank. de bruyn, t., & kuddus, u. (2005). dynamics of remittance utilization in bangladesh. 10m migration research series, no. 18. geneva, switzerland: international organization for migration. enders, w. (2004). applied econometric time series (2nd ed.). new york: john wiley & sons, inc. hussain, z., & naeem, f. (2010). remittances in bangladesh: determinants and 2010 outlook. end poverty in south asia blog. the world bank. retrieved from : http ://blogs. worldbank.orglendpovertyinsouthasis. joarder, m. a. m., & hasanuzzaman, s. (2008). migration decision from bangladesh: permanent versus temporary. asia europe journal, (6),531-545. mohapatra, s., joseph, g., & ratha, d. (2009). remittances and natural disasters: ex-post response and contribution to ex-ante preparedness. policy research working paper 4972. the world bank. moses, j. w. (2009). leaving poverty behind: a radical proposal for developing bangladesh through emigration. development policy review, 27(4),457 -479. murshid, k.a.s ., iqbal, k., & ahmed, m. (2002). a study on remittance inflows and utilization. international organization for migration (10m), regional office for south asia, dhaka. rahman, md. m., & yeoh, b. s.a. (2006). the social organization of remittances: channeling remittances from east and southeast asia to bangladesh. asian meta centre research paper series, no. 20. raihan, s., khondker, b. h. , sugiyarto, g., & jha, s. (2009). remittances and household welfare: a case study of bangladesh. adb economics working paper series, no. 189. asian development bank. ratha, d., & mohapatra, s. (2007, november 28-30). increasing the macroeconomic impact of remittances on development. note prepared for the g8 outreach event on remittances, berlin. ruiz, 1. , & vargas-silva, c. (2009). to send, or not to send: that is the question. a review of the literature on workers' remittances. journal of business strategies, 26(1), 73-98. volume 27, number 1 51 sayan, s. (2006). business cycles and workers' remittances: how do migrant workers respond to cyclical movements 0/ gdp at home? imf working paper: wp/06/52. shanna, m., & zaman, h. who migrates overseas and is it worth their while? an assessment o/household survey data/rom bangladesh. policy research working paper 5018 . the world bank. siddiqui, t. , & abrar, c. r. (2001). migrant worker remittances and micro-jinance in bangladesh. social finance programme working paper no. 38. international labour office. siddiqui, t. (2004). efficiency 0/ migrant workers ' remittance: the bangladesh case. manila: asian development bank. siddiqui, t. (2005). international labour migration/rom bangladesh: a decent work perspective. working paper no. 66. policy integration department, national policy group. international labour office, geneva. siddiqui , t. (2009, april 23). migrant workers' remittances to bangladesh: implications of global recession. lecture delivered at bangladesh institute of international and strategic studies (bliss), dhaka. (the slides are available at http:// www.biiss.org/tasnem.pdf.) stahl, c. w., & habib, a. (1989). the impact of overseas workers' remittances on indigenous industries: evidence from bangladesh. the developing areas, 27(3): 269-285. vargas-silva, c., jha, s., & sugiyarto, g. (2009). remittances in asia: implications for the fight against poverty and the pursuit 0/ economic growth. adb economics working paper series, no. 182. asian development bank. world bank. (2006). global economic prospects, washington : world bank. biographical sketch of authors . khawaja a. mamun is an assistant professor of economics at john f. welch college of business, sacred heart university, fairfield (ct). he has several publications in peer-reviewed journals including applied economics letters, journal o/international trade & economic development, journal o/urban economics, and public finance review. dr. mamun is also the moderator of bangladesh young economists and the treasurer of the association for economic and development studies on bangladesh (aedsb). he received his ph.d. in economics from southern methodist university, dallas (tx). hiranya k. nath is an associate professor of economics at sam houston state university. he has published on inflation and relative price behavior, the 52 journal of business strategies growth of transition economies of central and eastern europe, the growth of bangladesh, and information economy in refereed journals including applied economics, applied economics letters, applied financial economics letters, california management review, comparative economic studies, economics letters, journal of international trade & economic development, journal of macroeconomics, journal of money, credit and banking, and review of development economics. he earned his ph.d. in economics from southern methodist university, dallas (tx). workers' migration and remittances in bangladesh an examination of uncovered real interest rate parity in 18 distinct u.s. manufacturing industries wan shin moh chung yuan christian university • chung li, taiwan masha rahnamamoghadam texas tech university • lubbock, tx victor valcarcel texas tech university • lubbock, tx abstract in a departure from the standard literature, we consider micro-level data to draw inferences about the uncovered real interest rate parity in 18 distinct manufacturing industries across 25 countries. the real interest rates are computed based on trade weights at the industry level. we examine the time series properties of real interest differentials by employing a battery of unit root tests. using industry-specific quarterly observations on deposit and inflation rates, we find robust and statistically significant evidence in support of the uncovered real interest rate parity (uip) in every industry we consider across all 25 countries. introduction fluctuations in the foreign exchange market rely on the interest rate parity theorem, which relates domestic interest rates and exchange rates. as addressed by previous studies (frenkel, 1979; sachs, 1985; shafer & loopesko, 1983), if real interest rate parity holds across countries, then information from the real interest differentials will be helpful in explaining real exchange rate movements. in this paper we study the validity of the theory of uncovered real interest rate parity (uip) by examining the properties of real interest differentials when they are computed from the consumer price index and imputed trade weights for 18 distinct u.s. manufacturing industries. according to wu and chen (1998), unit root tests can be applied to evaluate the time series characteristics of real rate of return differentials among industries and/or countries. if real interest rate differentials are stationary, then they should have mean-reverting qualities, for the whole sample or at least over long regimes. in other words, a lack of persistence in fluctuations of these series might be consistent with the implication of real interest rate parity. thus, an empirical corollary of the theorem of real interest rate parity would entail answering the question: to 58 journal of business strategies what degree do real interest rates co-move across countries? if such co-movement were strong enough — so that by combining different rates across countries all persistence in the residuals vanished — then this would be consistent with interest rate parity. our objective in this paper is to empirically test whether the uncovered rate parity theorem holds for 18 different industries across 25 countries. we select the 18 industries that, according to bahmani-oskooee, mirzaie, and miteza (2007), constitute the largest trade industries in the us. we feel finding an answer to this important question would have salient implications for some of the more topical and vibrant debates in international economics — from the effectiveness of monetary policy in trade fluctuations to whether there is evidence of a global business cycle. however, to date, empirical evidence in favor of interest rate parity is mixed at best. many authors point to indexation and aggregation issues in the indicators that are typically used to test for interest rate parity as possible culprits for such lack of evidence (cumby & obstfeld, 1984; mark, 1985). to deal with possible issues that arise when using aggregate measures, two possible solutions can be broached: one would be to correct, econometrically, the biases in the aggregate indices themselves; and the other would be to disaggregate the rates and investigate the behavior at a micro-level. given that these biases arise from the aggregation and indexation process, we feel that opting for the second option renders the criticism as a non-starter. most of the research on international interest rate parity has involved aggregate measures. for example, mark (1985) employed cpi-based real interest rate data for six oecd countries to show a general failure to support the real interest rate parity hypothesis. dutton (1993) measures real interest rates in terms of trade to show evidence of parity. gagnon and unferth (1995) combine interest rate data from nine oecd countries. they show that the differentials between the combined “world” interest rate and that of most countries exhibit little serial correlation with the notable exception of the u.s. there has been a multitude of recent interest in macroeconomic studies that focus on disaggregated data. for example, boivin and giannoni (2006) posit that there may be substantial gains from expanding the information set in the estimation of general equilibrium macroeconomic models. they show that using a combination of aggregate and micro-level data may lead to more accurate predictions and even qualitatively different conclusions about key structural relationships. boivin, gianonni, and mihov (2009) include both aggregate and sector-specific data into their model and conclude that disaggregated price data is not as responsive to aggregate macro and monetary shocks and much more responsive to sector-specific volume 29, number 1 59 shocks. this important result could only be uncovered by considering disaggregated sector-specific data. balke (2010) posits that disaggregated data can bring additional explanatory power in identification beyond what is provided by aggregate variables alone. often, economic theory has implications for sectoral variables as well as for aggregate variables. discussions of exchange rate movements have often been based on aggregate trade-weighted exchange rates that use weighting schemes applied to tradepartner exchange rates as functions of all imports and exports of the u.s. economy. these aggregate exchange rate measures are useful at the macro-economic level. however, goldberg (2004)1 argues that the focus on national aggregates generally ignores industry-specific distinctions among trading partners. thus, the movements in specific bilateral exchange rates associated with changes in industry competitive conditions may not be captured appropriately by aggregate trade-weighted indexes. consequently, goldberg constructs industry-specific trade weighted indexes to explain differences in corporate profits in the u.s. and finds them to be an improvement over the aggregate measures. while the above referenced papers highlight a wealth of research in the parity issue by considering aggregate data and, more recently, there has been increasing literature that exalts the value of disaggregated data for macroeconomic models; to our knowledge, there has been little research advanced in the parity issue by considering disaggregated data. this paper contribution is bridging the two lines of research. thus, we follow goldberg’s methodology in constructing a specific exchange rate index for 18 different industries. our strategy, involve constructing multiple series of trade-weighted industry-specific real exchange rates and investigate whether the uncovered real interest rate parity holds for 18 industries ranging from the more consumer-oriented, such as furniture and fixtures, to more intermediate and primary levels such as plastics and chemicals. we examine the time series properties of these industry-level measures of trade-weighted real exchange rates. to that end, we employ a battery of unit root tests both in the univariate and multivariate realms. importantly, we find that for 18 different industries, there is strong and significant evidence in support of the uncovered rate parity among 25 countries.2 the rest of this paper is organized as follows. “interest rate parity” provides some motivation and background on the interest rate parity from a theoretical and empirical standpoint. “trade-weighted measures of exchange rates and inflation” expounds on the construction of industry-specific trade weighted measures of the nominal and real interest rates, for a (benchmark) domestic as well as a foreign 60 journal of business strategies country and describes the empirical strategy. “data” elaborates on some data issues, followed by “results” and “conclusion” which summarize our findings. interest rate parity the theory of real interest rate parity states that the difference between the domestic and the foreign real interest rates equals the expected depreciation of the domestic real exchange rate. in all cases, the real interest rate parity relationship must be satisfied because it is a restatement of the fisher equation. theoretical predictions and empirical evidence interest rate parity is, in essence, an arbitrage condition. given the rate of return on foreign interest-bearing assets and the domestic interest-bearing assets with identical risk, investors have two options: one is to enter the market and invest in the foreign currency and subsequently at the end of the investment period convert the realized earnings into the domestic currency. the second option is not to enter the market, purchase domestic interest-bearing assets and at the end of the investment period collect returns yielded by the domestic rate. according to standard models of finance, under an interest rate parity environment, no arbitrage opportunities should arise; which implies these two options should yield the same returns. while the theorem of real interest rate parity is relatively uncontroversial, cross-country empirical evidence is mixed. for example, some studies have shown that trade weights could possibly affect investors’ willingness to put their portfolio in a market. cumby and obstfeld (1984) and mark (1985) find that the international interest rate parity relationship does not hold among many countries. they point to measurement bias in the indicators used to calculate inflation and exchange rates as a possible explanation. chinn and frenkel (1995) find evidence supportive of real interest rate parity between japan and taiwan, the united states and taiwan, and the united states and singapore. wu and chen (1998) confirm the real interest rate parity across nine advanced economies.3 time horizons choosing an optimal time horizon for the spot exchange, inflation, and deposit interest rates to check the validity of uncovered interest rate parity (uip) across countries has been a focal point of attention in this literature. typically, there is little support for uip from studies that use data with frequencies less than volume 29, number 1 61 one year (baillie & bollerslev, 2000; bekaert & hodrick, 1993, 2001; mark & wu, 1998). conversely, many authors have concluded that uip holds better at longer horizons4 (cumby & mishkin, 1987; fujii & chinn, 2001; meredith & chinn, 1998; mishkin, 1984b; taylor, 1991). in an interesting contribution, bekaert, wei, and xing (2007) find that the failure of uip is independent of horizon and, instead, is currency dependent. in this paper we examine whether the uip holds over quarterly data.5 trade-weighted measures of exchange rates and inflation according to mishkin (1984a), if the real interest rate parity holds across countries, then the influence of domestic monetary authority on the real interest rate should be diminished or limited to the degree to which domestic policy impacts the world’s interest rates. our aim in this paper is to test whether interest parity holds at the industry level. to that end we select 18 distinct industries based on data availability. we posit that the nominal interest rate for a given industry is not only a function of the aggregate interest rate but, importantly, a function of how intensively are the goods in that particular industry traded around the world. thus, using contemporaneous trade data from several sources,6 we construct a trade-weighted, industry-specific, measure of the foreign nominal interest rates as follows: ext jc + imt jc i*jt = σc [[ ]• itc] , (1) σc(ext jc + imt jc) where i*jt is an index of the annualized nominal trade-weighted foreign interest rate for industry j7 at time t. ext jc and imt jc denote, respectively, the export and import volumes of industry j to country c at time t, and it c is the annual [aggregate] nominal interest rate in country c at time t. thus, in a two-country (domestic-foreign) model, we theorize that when the domestic country trades with foreign country c in industry j, the annual interest rate in country c at time t (it c) must be weighted by the volume of trade of industry j to country c. this allows us to generate a foreign annual nominal interest rate (i*jt) that effectively impacts industry j. similarly, we build an industry-specific measure of the annualized inflation rate for each industry j as follows ext jc + imt jc p*jt = σc [[ ]• ptc] , (2) σc(ext jc + imt jc) where p*jt is an index of the annualized trade-weighted foreign inflation rate for in62 journal of business strategies dustry j at time t, and p ct is the time t annual inflation rate in country c as given by the consumer price index (one-quarter ahead). we then compute the trade-weighted industry-specific foreign real interest rates (r*jt) by subtracting p * jt from i * jt . finally, we derive the ex-post real interest differentials (rt r * jt) 8 based on trade weights for each specific industry. if the uncovered real interest rate parity holds, then the real interest differentials between the u.s. and its trade-weighted foreign countries in a specific industry should equal the expected real dollar depreciation. once our industry-specific rate measures are computed, we investigate whether uip holds at the industry level for the 25 countries considered by examining the stationarity of rt r * jt . if the industry-specific real interest rate differential is stationary, then there should be no long-run impact on the rate differential, given a temporary shock to either the domestic or the foreign rate. in other words, given any nonpermanent shock to a country’s rate (whether it comes from domestic demand fluctuations or domestic monetary policy), deviations from parity in the trade-weighted industry-specific real interest may be more or less persistent but not permanent. thus the stationarity of the industry-specific real interest differentials is consistent with the implication of real interest rate parity. according to the standard model, the uncovered interest rate parity can be specified as etst+1 st = it i * t , (3) where it denotes the nominal interest rates in the home country; i * t represents a foreign country’s nominal interest rates; st represents the spot nominal exchange rates between the home and foreign countries; and et is the expectation operator conditional on information available at time t. equation (3) implies that nominal interest differentials between the home and foreign countries should equal the expected domestic nominal currency depreciation. empirically, uncovered interest rate parity between countries can be tested in the following form: st+1 st = α + β(it i * t) + εt , εt ~ n(0,σ). (4) under the null hypothesis, if uip holds, the constant risk premium term, α, should be zero; and β should be one. thus, under the null, the gap between realized home nominal currency depreciation and the nominal interest differentials are an i(0) process. with a standard application of the fisher equation, we re-write (4) as volume 29, number 1 63 qt+1 qt = (it pt) (i * t p * t ) + εt , (5) where qt denotes the domestic country’s real exchange rate against its trading partner. we assume that all industries in the domestic economy face the same nominal interest rates and inflation rates.9 however, each trading partner of the domestic economy has its distinct export and import shares in a specific manufacturing industry. real exchange rate fluctuations among industries may lead to biases in the aggregate uip measure. to address this issue, we use industry-specific trade weights in the computation of the foreign real interest rate as follows q̂jt+1 q̂jt = (it πt) (i * jt π * jt) + εjt , (6) where q̂t is the trade-weighted industry-specific real exchange rate index for a domestic country with its trading partners. equation (6) can be re-written as δq̂jt = rt r * jt + εjt . (7) once we have both equations (6) and (7), we posit that if industry-specific disturbances are well-behaved, and the ex-post industry-specific real interest differentials between the home country and its trading partners, rt r * jt , are stationary, then so is the realized industry-specific real dollar depreciation, δq̂jt . data data about the nominal interest rates and inflation rates are based on the three-month deposit rates and consumer price index, respectively, from various volumes of the international financial statistics (ifs) published by the international money fund. according to dutton (1993), the securities used to compute the interest rate differential across countries may be considered as traded goods, which are free from domestic monetary policy influence. wu and chen (1998) used the threemonth euro money-market rate as the nominal interest rate because it is not affected by reserve requirements or exchange controls in their countries. however, due to the lack of data availability, we use the three-month deposit rates which have free market rate properties where banks lend to and borrow freely from each other. thus, for the united states and its trading partners we use the 3-month deposit rates with annual percentage over quarterly horizon, collected from the ifs database from the 64 journal of business strategies imf. countries such as austria, belgium, finland, france, germany, ireland, italy, luxembourg, netherlands, portugal, and spain started to use the euro as their single currency after 1999, and since then some of them have used the conversion rates and no longer use deposit rates. however, there are missing data for some countries before the introduction of the euro. to address this, we compare the available deposit rates of these countries to the u.s. federal funds rates, then compute the average gap between each country’s deposit rates and the federal funds rates, and we finally set the missing rates to the sum of the federal funds rates and the average gap for each country’s deposit rates. in this model, we consider the u.s. as the domestic country and construct the trade-weighted industry-specific real exchange rates based on the trade share of u.s. main trading partners. in the previous section, we followed goldberg (2004) to build these measures of industry-specific rates. however, we opt not to use the available trade data for all the trading partners of the united states that goldberg used. we ultimately drop ten countries from the computation of the new series. argentina, brazil, chile, columbia, and mexico, are important trading partners of the united states. however, these counties experienced substantial financial and debt crises in the 1980s and 1990s resulting in extremely high deposit rates and inflation. furthermore, the institutions of lending and borrowing in some of these latin american countries, as well as india, israel, saudi arabia, and venezuela, did not function in a similar manner as those of the united states and western europe for much of the sample period we consider. due to data unavailability, we also drop trade data from hong kong. finally, as evidenced by table a1 and table a2, the trade volumes of these ten countries account for a fairly small share of those of the united states relative to the other 25 countries. therefore, we construct q̂jt for each manufacturing industry by the trade volume of australia, austria, belgium, luxembourg, canada, china, finland, france, indonesia, ireland, italy, japan, korea, malaysia, netherlands, philippines, portugal, singapore, south korea, spain, sweden, switzerland, thailand, taiwan, and the united kingdom. we compute the real interest differentials by using the annualized, ex post industry-specific trade-weighted real exchange and realized inflations rates which span 84 quarters from 1987 to 2008. results figure 1 displays (annualized) quarterly ex post interest rate differentials for the u.s. and its trading partners in 18 different industries between 1987 and 2008. volume 29, number 1 65 ta bl e a 1 u .s . e xp or t a nd i m po rt d es ti na ti on s by s ta nd ar d in du st ri al c la ss ifi ca ti on (s ic ) eu ro pe an la tin si c c od e c hi na ja pa n u ni on am er ic a h on g ko ng in di a is ra el sa ud i a ra bi a ve ne zu el a st an da rd in du st ria l c la ss ifi ca tio n 19 86 19 96 19 86 19 96 19 86 19 96 19 86 19 96 19 86 19 96 19 86 19 96 19 86 19 96 19 86 19 96 19 86 19 96 fo od a nd k in dr ed p ro du ct s 20 0. 00 7 0. 02 1 0. 15 7 0. 14 3 0. 34 9 0. 26 2 0. 12 7 0. 13 6 0. 01 4 0. 02 9 0. 00 5 0. 01 1 0. 01 0. 00 6 0. 01 1 0. 00 8 0. 01 0 0. 00 5 to ba cc o m an uf ac tu re s 21 0. 00 1 0. 00 02 0. 10 2 0. 38 5 0. 52 4 0. 39 9 0. 01 0 0. 02 7 0. 15 3 0. 02 8 0. 00 04 0 .0 01 0. 00 8 0. 01 5 0. 10 7 0. 04 8 0. 00 04 0 .0 01 te xt ile p ro du ct s 22 0. 08 0 0. 04 1 0. 12 1 0. 06 4 0. 26 0. 23 3 0. 06 6 0. 16 4 0. 09 6 0. 03 2 0. 03 2 0. 04 0 0. 00 5 0. 01 1 0. 01 2 0. 01 0 0. 00 7 0. 00 3 ap pa re l a nd r el at ed p ro du ct s 23 0. 11 3 0. 19 0 0. 03 2 0. 03 3 0. 11 8 0. 08 3 0. 05 3 0. 20 7 0. 20 4 0. 11 4 0. 02 4 0. 04 3 0. 00 2 0. 01 0. 00 2 0. 00 2 0. 00 1 0. 00 1 lu m be r a nd w oo d pr od uc ts , e xc ep t f ur ni tu re 24 0. 03 0 0. 02 5 0. 16 4 0. 18 0 0. 09 3 0. 09 1 0. 04 6 0. 06 4 0. 00 5 0. 00 5 0. 00 1 0. 00 1 0. 00 1 0. 00 1 0. 00 1 0. 00 1 0. 00 1 0. 00 1 pa pe r a nd a llie d pr od uc ts 26 0. 00 8 0. 03 1 0. 07 7 0. 06 4 0. 19 7 0. 17 1 0. 07 2 0. 11 4 0. 00 9 0. 01 9 0. 00 2 0. 00 3 0. 00 4 0. 00 4 0. 00 4 0. 00 5 0. 00 9 0. 00 4 pr in tin g an d pu bl is hi ng 27 0. 01 0. 04 1 0. 10 0 0. 05 9 0. 32 0 0. 24 6 0. 05 2 0. 09 2 0. 03 9 0. 05 1 0. 00 5 0. 00 4 0. 00 5 0. 00 5 0. 00 2 0. 00 3 0. 00 8 0. 00 2 pe tro le um r efi ni ng a nd r el at ed p ro du ct s 29 0. 01 4 0. 00 3 0. 05 6 0. 03 6 0. 23 3 0. 20 5 0. 14 1 0. 16 8 0. 00 2 0. 00 3 0. 02 2 0. 00 7 0. 00 3 0. 00 5 0. 03 8 0. 03 6 0. 20 3 0. 20 6 c he m ic al s an d al lie d pr od uc ts 28 0. 02 2 0. 02 9 0. 14 4 0. 10 6 0. 39 0 0. 34 3 0. 10 2 0. 11 9 0. 01 3 0. 01 5 0. 01 0 0. 00 8 0. 00 5 0. 00 9 0. 00 8 0. 00 8 0. 01 6 0. 00 9 ru bb er a nd m is c pl as tic s pr od uc ts 30 0. 00 8 0. 14 7 0. 15 6 0. 11 0 0. 24 0 0. 15 1 0. 10 3 0. 14 5 0. 03 0 0. 01 2 0. 00 3 0. 00 6 0. 01 0 0. 00 7 0. 00 5 0. 00 3 0. 00 5 0. 00 4 le at he r 31 0. 03 3 0. 38 4 0. 01 3 0. 01 6 0. 23 4 0. 20 5 0. 13 3 0. 15 3 0. 02 7 0. 02 3 0. 01 0. 01 7 0. 00 1 0. 00 2 0. 00 1 0. 00 1 0. 00 03 0 .0 01 st on e, c la y, g la ss , a nd c on cr et e pr od uc ts 32 0. 01 0 0. 08 9 0. 14 7 0. 10 4 0. 35 5 0. 29 2 0. 10 2 0. 13 8 0. 01 1 0. 01 2 0. 00 3 0. 00 6 0. 00 3 0. 00 4 0. 00 3 0. 00 2 0. 01 3 0. 01 2 pr im ar y m et al p ro du ct s 33 0. 00 4 0. 02 4 0. 14 6 0. 07 6 0. 25 8 0. 23 3 0. 10 0 0. 17 2 0. 00 3 0. 00 8 0. 00 3 0. 00 5 0. 00 3 0. 00 3 0. 00 2 0. 00 2 0. 01 1 0. 01 6 fa br ic at ed m et al p ro du ct s, e xc ep t m ac hi ne ry 34 0. 00 9 0. 05 4 0. 15 8 0. 10 7 0. 22 6 0. 19 8 0. 07 1 0. 16 0 0. 01 2 0. 01 0 0. 00 7 0. 00 9 0. 01 0 0. 01 3 0. 00 8 0. 01 0 0. 00 5 0. 00 4 an d tr an sp or ta tio n eq ui pm en t m ac hi ne ry , e xc ep t e le ct ric al 35 0. 01 4 0. 03 1 0. 22 1 0. 17 4 0. 35 4 0. 24 3 0. 06 7 0. 09 4 0. 01 8 0. 01 2 0. 00 6 0. 00 5 0. 00 6 0. 00 6 0. 00 8 0. 00 5 0. 01 3 0. 00 8 tr an sp or t e qu ip m en t 37 0. 00 5 0. 01 1 0. 31 5 0. 19 1 0. 22 5 0. 19 9 0. 04 4 0. 11 5 0. 00 3 0. 00 5 0. 00 1 0. 00 3 0. 00 5 0. 00 6 0. 00 8 0. 01 6 0. 00 4 0. 00 3 fu rn itu re a nd f ix tu re s 25 0. 00 8 0. 09 4 0. 04 2 0. 02 6 0. 23 1 0. 12 2 0. 09 6 0. 19 1 0. 01 2 0. 00 6 0. 00 04 0 .0 01 0. 00 5 0. 00 5 0. 00 7 0. 00 6 0. 00 04 0 .0 02 m is ce lla ne ou s m an uf ac tu rin g c om m od iti es 39 0. 03 0 0. 24 1 0. 11 7 0. 10 0 0. 26 2 0. 19 0 0. 03 1 0. 05 8 0. 09 8 0. 04 5 0. 05 0 0. 04 9 0. 08 8 0. 08 9 0. 00 2 0. 00 1 0. 00 2 0. 00 1 66 journal of business strategies ta bl e a 2 u .s . e xp or t a nd i m po rt d es ti na ti on s by n or th a m er ic an i nd us tr y c la ss ifi ca ti on s ys te m (n a ic s) n ai c s u ni te d eu ro pe an la tin co de c hi na ja pa n ki ng do m u ni on am er ic a h on g ko ng in di a is ra el sa ud i a ra bi a ve ne zu el a n ai c s 20 07 20 07 20 07 20 07 20 07 20 07 20 07 20 07 20 07 fo od m an uf ac tu rin g 31 1 0. 07 9 0. 06 9 0. 01 4 0. 10 2 0. 21 1 0. 01 2 0. 01 2 0. 00 5 0. 00 7 0. 00 4 be ve ra ge s an d to ba cc o pr od uc ts 31 2 0. 00 4 0. 05 8 0. 10 2 0. 46 6 0. 17 5 0. 00 2 0. 00 1 0. 00 3 0. 00 5 0. 00 1 te xt ile s an d fa br ic s an d te xt ile m ill pr od uc ts 31 33 14 0. 32 5 0. 02 5 0. 02 0 0. 10 0 0. 18 8 0. 01 0. 08 3 0. 01 1 0. 00 3 0. 00 1 ap pa re l a nd a cc es so rie s 31 5 0. 49 0. 00 6 0. 00 6 0. 05 0 0. 11 0 0. 03 9 0. 06 1 0. 00 4 0. 00 03 0. 00 1 w oo d pr od uc ts 32 1 0. 12 9 0. 01 1 0. 01 1 0. 09 5 0. 13 8 0. 00 3 0. 00 3 0. 00 1 0. 00 1 0. 00 1 pa pe r 32 2 0. 09 5 0. 04 0 0. 01 9 0. 13 7 0. 15 3 0. 00 7 0. 00 5 0. 00 4 0. 00 3 0. 00 2 pr in tin g, p ub lis hi ng , a nd s im ila r p ro du ct s 32 3 0. 18 6 0. 02 8 0. 09 2 0. 09 9 0. 10 6 0. 02 3 0. 01 1 0. 00 3 0. 00 2 0. 00 2 pe tro le um a nd c oa l p ro du ct s 32 4 0. 00 8 0. 02 2 0. 07 1 0. 24 7 0. 18 8 0. 00 03 0. 01 9 0. 00 6 0. 01 1 0. 08 3 c he m ic al s 32 5 0. 05 1 0. 05 8 0. 07 4 0. 35 5 0. 11 7 0. 00 6 0. 01 7 0. 01 5 0. 00 4 0. 00 8 pl as tic s an d ru bb er p ro du ct s 32 6 0. 18 9 0. 06 1 0. 02 8 0. 11 4 0. 18 8 0. 01 0. 00 7 0. 00 9 0. 00 2 0. 00 4 le at he r a nd a llie d pr od uc t m an uf ac tu rin g 31 6 0. 65 7 0. 01 2 0. 00 4 0. 10 9 0. 11 7 0. 01 3 0. 01 1 0. 00 1 0. 00 04 0. 00 03 n on m et al lic m in er al p ro du ct s 32 7 0. 21 0 0. 04 3 0. 02 4 0. 21 8 0. 18 7 0. 00 5 0. 02 1 0. 00 4 0. 00 2 0. 00 4 pr im ar y m et al m an uf ac tu rin g 33 1 0. 08 2 0. 04 8 0. 07 2 0. 12 2 0. 19 0 0. 00 4 0. 01 9 0. 00 3 0. 00 2 0. 00 7 fa br ic at ed m et al p ro du ct s 33 2 0. 18 8 0. 06 5 0. 03 9 0. 14 2 0. 17 0. 00 5 0. 01 7 0. 00 9 0. 00 5 0. 00 4 m ac hi ne ry , e xc ep t e le ct ric al 33 3 0. 11 2 0. 11 9 0. 04 5 0. 21 6 0. 13 8 0. 00 6 0. 01 2 0. 00 7 0. 01 4 0. 01 tr an sp or t e qu ip m en t 33 6 0. 03 7 0. 15 8 0. 03 9 0. 18 2 0. 16 3 0. 00 4 0. 01 5 0. 00 8 0. 00 6 0. 00 4 fu rn itu re a nd f ix tu re s 33 7 0. 52 8 0. 00 6 0. 01 2 0. 06 1 0. 07 2 0. 00 4 0. 00 4 0. 00 2 0. 00 1 0. 00 1 m is ce lla ne ou s m an uf ac tu rin g c om m od iti es 33 9 0. 27 6 0. 04 9 0. 03 2 0. 18 0 0. 08 2 0. 03 2 0. 05 8 0. 11 0. 00 1 0. 00 2 volume 29, number 1 67 figure 1 trade-weighted industry-specific real interest differentials (the united states is the base country) 21 figure 1: trade-weighted industry-specific real interest differentials (the united states is the base country) food manufacturing beverages and tobacco products textiles, fabrics and mill products apparel and accesories leather and allied product mfctr wood products paper printing and publishing products petroleum and coal products figure 1 (ctd) chemicals plastics and rubber products nonmetallic mineral products primary metal mfctr fabricated metal products machinery, except electrical transport equipment furniture and fixtures misc mfctr commodities -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 .05 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.04 -.03 -.02 -.01 .00 .01 .02 .03 .04 .05 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.06 -.04 -.02 .00 .02 .04 .06 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.06 -.04 -.02 .00 .02 .04 .06 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 .05 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.04 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 21 figure 1: trade-weighted industry-specific real interest differentials (the united states is the base country) food manufacturing beverages and tobacco products textiles, fabrics and mill products apparel and accesories leather and allied product mfctr wood products paper printing and publishing products petroleum and coal products figure 1 (ctd) chemicals plastics and rubber products nonmetallic mineral products primary metal mfctr fabricated metal products machinery, except electrical transport equipment furniture and fixtures misc mfctr commodities -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 .05 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.04 -.03 -.02 -.01 .00 .01 .02 .03 .04 .05 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.06 -.04 -.02 .00 .02 .04 .06 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.06 -.04 -.02 .00 .02 .04 .06 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.03 -.02 -.01 .00 .01 .02 .03 .04 .05 10 20 30 40 50 60 70 80 index quarters 40=1996q1 -.04 -.03 -.02 -.01 .00 .01 .02 .03 .04 10 20 30 40 50 60 70 80 index quarters 40=1996q1 1 the u.s. main trading partners in the member states of european union include austria, belgium, finland, france, germany, ireland, italy, luxembourg, the netherlands, portugal, spain, sweden, and the united kingdom. 2 the u.s. main trading partners in the latin american countries include argentina, brazil, chile, columbia, and mexico. 3 as of 2007, the u.s. main trading partners in the member states of the euro area include austria, belgium, finland, france, germany, ireland, italy, luxembourg, the netherlands, portugal, and spain. 68 journal of business strategies while we find no obvious trends in the real interest differentials for many of the industries considered, these sectoral rates seem to exhibit high persistence in their fluctuations, which may raise doubts about support for uip in these 18 different u.s. manufacturing industries. we investigate the stationarity of these series with four types of unit root tests. results for these tests are shown in table 2 and table 3. we, first, test the null of unit root in each industry’s real interest-rate differential series with the conventional augmented dickey-fuller (adf) test (1979). to ensure absence of serial correlation in the residuals, we let the number of lags in the autoregression term be determined by the schwartz information criterion (sic). we also allow for seasonal dummies to enter the adf regression given the mild seasonality we see in some of these series. columns (1) through (6) of table 2 report results of a battery of tests of the stationarity properties of the real interest rate differentials across 18 industries.10 the first column shows that the standard, the augmented dickey fuller (adf) test of the null of a unit root is rejected for 15 industries at the 10% significance level.11 it is well-known that the adf test may suffer from low power under certain alternatives. to address issues that may arise from residuals that might not be well-behaved, we conduct an extension of the adf test supported by a generalized least squares regression (adf-gls). elliot, rothenberg, and stock (1996) show that this test is more powerful than the conventional adf test when applied to finite samples with dependent errors. column (2) in table 2 shows that the null of a unit root is rejected at the 5% level for every sector.12 column (3) reports results for the kpss (1992) where we investigate the null hypothesis of stationarity in the dependent variable against the alternative of a unit root in these rates. the kpss test fails to reject the null of stationarity of the rate differentials for every sector. taken together, results from columns 1-3 suggest that industry-specific interest rate differentials across countries seem to be well-characterized by a stationary, albeit somewhat persistent, process. as we mentioned earlier, some of these unit root tests may suffer from low power under certainly alternatives. specifically, they may fail to distinguish the persistence characteristics of a unit root process from a stationary process in the presence of important structural breaks. structural change in interest rates over the sample we consider are a distinct possibility. thus, we apply the banerjee, lumsdaine, and stock (1992) test of a unit root in the presence of a single structural break (bls), and the lee and strazicich (2003) test of a unit root in presence of multiple structural breaks (ls), in columns (4) and (5) respectively. both tests show results consistent with those tests that abstracted from the possibility of structural change. volume 29, number 1 69 ta bl e 2 u ni t r oo t t es t f or th e tr ad ew ei gh te d in du st ry -s pe ci fic r ea l i nt er es t d if fe re nt ia ls (i n le ve ls ) (1 ) (2 ) (3 ) (4 ) (5 ) (6 ) ad f ad fg ls kp ss bl s ls ip s n ai c s se ct or n am es n ai c s (r r * j ) (r r * j ) (r r * j ) (r r * j ) (r r * j ) (r r * j ) fo od m an uf ac tu rin g 31 1 -2 .8 65 ** -1 .9 95 ** 0. 17 1 -2 .8 65 * -3 .9 46 ** -1 .9 80 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 4 ) (n = 1 0) (n = 0 ) be ve ra ge s an d to ba cc o pr od uc ts 31 2 -3 .5 67 *** -1 .9 15 * 0. 14 7 -3 .5 67 *** -5 .2 36 *** -3 .0 00 *** (n = 4 ) (n = 4 ) (n = 6 ) (n = 8 ) (n = 8 ) (n = 4 ) te xt ile s an d fa br ics a nd t ex tile m ill pr od uc ts 31 3/ 31 4 -3 .1 96 ** -3 .1 49 *** 0. 19 7 -3 .1 96 ** -4 .3 45 ** -3 .2 00 *** (n = 4 ) (n = 4 ) (n = 6 ) (n = 4 ) (n = 5 ) (n = 4 ) ap pa re l a nd a cc es so rie s 31 5 -3 .0 87 ** -2 .8 99 *** 0. 26 2 -3 .0 87 ** -4 .5 16 ** -3 .0 87 *** (n = 4 ) (n = 4 ) (n = 6 ) (n = 4 ) (n = 4 ) (n = 0 ) w oo d pr od uc ts 32 1 -2 .1 69 -2 .1 87 ** 0. 20 8 -2 .5 38 -4 .0 47 ** -2 .1 69 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 5 ) (n = 4 ) (n = 0 ) pa pe r 32 2 -2 .1 07 -2 .1 28 ** 0. 25 6 -2 .3 23 -3 .9 24 * -2 .1 07 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 1 ) (n = 1 0) (n = 0 ) pr in tin g, p ub lis hi ng a nd s im ila r p ro du ct s 32 3 -2 .6 11 * -2 .2 08 ** 0. 26 6 -2 .6 11 * -3 .2 34 -2 .1 84 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 4 ) (n = 4 ) (n = 0 ) pe tro leu m a nd c oa l p ro du ct s 32 4 -2 .1 07 -2 .1 24 ** 0. 25 5 -2 .4 17 -3 .6 14 * -2 .1 07 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 3 ) (n = 1 0) (n = 0 ) ch em ica ls 32 5 -2 .5 7* -2 .0 51 ** 0. 17 1 -2 .7 82 * -3 .3 79 -2 .1 03 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 4 ) (n = 1 0) (n = 0 ) no te s: c ol um ns (1 ) a nd (2 ) p re se nt th e au gm en te d di ck ey f ul ler a nd g en er ali ze d le as t s qu ar es e xt en sio n te st o f t he n ul l o f a u ni t r oo t. co lu m n( 3) s ho w s re su lts o f k w iat ko w sk i e t a l. te st s of th e nu ll o f s ta tio na rit y. co lu m n (4 )s ho w s th e ba ne rje e et al te st o f t he n ul l o f a u ni t r oo t i n th e pr es en ce o f a s tru ct ur al br ea k .c ol um n (5 ) s ho w s th e le e an d st ra zic ich u ni t r oo t n ul l t es t i n th e pr es en ce o f t w o st ru ct ur al br ea ks . c ol um n (6 ) s ho w s re su lts o f a im e t a l. pa ne l u ni t r oo t t es t. pa re nt he se s co nt ain n w hi ch d en ot e op tim al lag le ng th s ele ct ed b y ea ch te st . a n as te ris k (** *) de no te s sig ni fic an ce a t t he 0 .0 1 lev el, (* *) de no te s sig ni fic an ce a t t he 0 .0 5 lev el, a nd (* ) d en ot es s ig ni fic an ce a t t he 0 .1 le ve l. 70 journal of business strategies ta bl e 2 co nt ’d u ni t r oo t t es t f or th e tr ad ew ei gh te d in du st ry -s pe ci fic r ea l i nt er es t d if fe re nt ia ls (i n le ve ls ) (1 ) (2 ) (3 ) (4 ) (5 ) (6 ) ad f ad fg ls kp ss bl s ls ip s n ai c s se ct or n am es n ai c s (r r * j ) (r r * j ) (r r * j ) (r r * j ) (r r * j ) (r r * j ) pl as tic s an d ru bb er p ro du ct s 32 6 -2 .6 85 * -2 .0 53 ** 0. 11 2 -2 .6 85 * -3 .7 85 * -2 .1 53 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 4 ) (n = 8 ) (n = 0 ) le at he r a nd a llie d pr od uc t m an uf ac tu rin g 31 6 -2 .5 66 * -2 .3 64 ** 0. 30 8 -2 .9 49 ** -3 .5 88 * -2 .5 66 *** (n = 4 ) (n = 4 ) (n = 6 ) (n = 1 ) (n = 1 0) (n = 4 ) no nm et all ic m in er al pr od uc ts 32 7 -2 .5 87 * -2 .1 77 ** 0. 11 5 -2 .8 68 * -3 .5 98 * -2 .8 68 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 4 ) (n = 8 ) (n = 4 ) pr im ar y m et al m an uf ac tu rin g 33 1 -2 .6 92 * -2 .0 5* * 0. 13 6 -2 .6 92 * -3 .6 94 * -2 .1 12 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 4 ) (n = 1 0) (n = 0 ) fa br ica te d m et al pr od uc ts , n es o i 33 2 -2 .7 46 * -2 .1 87 ** 0. 12 7 -2 .7 46 * -3 .8 05 * -2 .3 44 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 8 ) (n = 8 ) (n = 0 ) m ac hi ne ry, e xc ep t e lec tri ca l 33 3 -3 .0 59 ** -2 .1 7* * 0. 07 8 -3 .0 59 ** -4 .0 74 ** -2 .3 11 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 8 ) (n = 8 ) (n = 0 ) tr an sp or t e qu ip m en t 33 6 -2 .8 52 ** -2 .0 02 ** 0. 09 1 -2 .8 52 * -3 .7 17 * -2 .2 03 *** (n = 0 ) (n = 0 ) (n = 6 ) (n = 8 ) (n = 1 0) (n = 0 ) fu rn itu re a nd f ixt ur es 33 7 -2 .8 9* * -2 .4 9* * 0. 18 3 -3 .1 57 ** -4 .0 02 ** -2 .5 70 *** (n = 6 ) (n = 6 ) (n = 6 ) (n = 5 ) (n = 5 ) (n = 6 ) m isc ell an eo us m an uf ac tu re d co m m od itie s 33 9 -3 .1 73 ** -2 .8 85 *** 0. 11 7 -3 .1 73 ** -4 .1 25 ** -3 .1 73 *** (n = 4 ) (n = 4 ) (n = 6 ) (n = 4 ) (n = 4 ) (n = 4 ) no te s: c ol um ns (1 ) a nd (2 ) p re se nt th e au gm en te d di ck ey f ul ler a nd g en er ali ze d le as t s qu ar es e xt en sio n te st o f t he n ul l o f a u ni t r oo t. co lu m n( 3) s ho w s re su lts o f k w iat ko w sk i e t a l. te st s of th e nu ll o f s ta tio na rit y. co lu m n (4 )s ho w s th e ba ne rje e et al te st o f t he n ul l o f a u ni t r oo t i n th e pr es en ce o f a s tru ct ur al br ea k .c ol um n (5 ) s ho w s th e le e an d st ra zic ich u ni t r oo t n ul l t es t i n th e pr es en ce o f t w o st ru ct ur al br ea ks . c ol um n (6 ) s ho w s re su lts o f a im e t a l. pa ne l u ni t r oo t t es t. pa re nt he se s co nt ain n w hi ch d en ot e op tim al lag le ng th s ele ct ed b y ea ch te st . a n as te ris k (** *) de no te s sig ni fic an ce a t t he 0 .0 1 lev el, (* *) de no te s sig ni fic an ce a t t he 0 .0 5 lev el, a nd (* ) d en ot es s ig ni fic an ce a t t he 0 .1 le ve l. volume 29, number 1 71 we take caution in drawing too much inference from results from any one test on its own but, taken together, a preponderance of the evidence would seem to suggest strong evidence of the stationarity of these 18 industry-specific interest rates. the univariate characteristic of these tests will generally omit cross-country information that a longitudinal-based unit root test might incorporate. to that end, we follow im, pesaran and shin (2003) to apply the ips panel-based unit root test. nj δyjt = αj + ρjyj,t-1 + σγjkδyj,t-k + εjt , j = 1,..., n t = 1,...,t, (8) k=1 for each industry j where the error terms εjt are with zero means and finite heterogeneous variances, σ2j. the ips evaluation tests if the null hypothesis h0 : ρj = 0 for all j against the alternative hypothesis that all series are stationary, h1 : ρj < 0, for some j. the t̄statistic constructed from the average adf t-statistics is in the following form: √n[t̄nt ant] zt = ⇒ n(0,1) (9) √bnt where t̄nt = 1 nσnj=1tjt ; ant = 1n ; bnt = 1n ; e[tjt(nj )] and var[tjt(nj)]. in line with previous univariate unit root tests, the ips test in the form of equation (8) without a linear time trend is used to evaluate the stationarity of 18 tradeweighted industry-specific real interest differentials. column (6) in table 2 presents the ips test results for the panel of 18 trade-weighted industry-specific real interest differentials. the null of a unit root is rejected at the 1% significance level for every sector. evidence from table 2 seem to be consistent with uip, when considering the united states as the base country, in 18 different industrial sectors. taken together, the dynamics in figure 1 and correlation estimates in table 3 suggest a strong rate co-movement among these industries which explains how the robust stationarity properties of these variables. our results seem to be in direct contradiction to the argument provided by gagnon and unferth (1995) who, in failing to reject the null of a unit root, they conclude that the u.s. real interest rate has the largest and most persistent deviations from the estimated world real interest rate. by disaggregating and focusing on industry-specific real interest rate differentials, we find no such evidence of persistence in u.s. industry-specific interest rate deviations from those of 25 other economies under study. the rejection of the null of a unit root in interest rate differentials 72 journal of business strategies ta bl e 3 c or re la ti on c oe ffi ci en ts a m on g th e tr ad ew ei gh te d in du st ry -s pe ci fic r ea l i nt er es t d if fe re nt ia ls n ai c s 31 1 31 2 31 3/ 4 31 5 32 1 32 2 32 3 32 4 32 5 32 6 31 6 32 7 33 1 33 2 33 3 33 6 33 7 33 9 31 1 1. 00 0 31 2 0. 81 6 1. 00 0 31 3 0. 95 5 0. 70 4 1. 00 0 31 5 0. 50 7 0. 10 0 0. 70 3 1. 00 0 32 1 0. 61 1 0. 21 9 0. 78 6 0. 94 8 1. 00 0 32 2 0. 96 7 0. 81 1 0. 88 6 0. 35 5 0. 46 9 1. 00 0 32 3 0. 94 8 0. 77 4 0. 86 1 0. 31 7 0. 44 4 0. 98 4 1. 00 0 32 4 0. 96 7 0. 73 3 0. 92 4 0. 46 1 0. 57 2 0. 96 2 0. 97 5 1. 00 0 32 5 0. 96 1 0. 77 7 0. 94 0 0. 52 5 0. 63 1 0. 92 1 0. 92 1 0. 94 5 1. 00 0 32 6 0. 96 2 0. 89 3 0. 88 1 0. 34 0 0. 47 4 0. 94 3 0. 94 0 0. 93 3 0. 94 5 1. 00 0 31 6 0. 97 9 0. 79 5 0. 94 1 0. 48 6 0. 62 2 0. 96 2 0. 95 3 0. 96 2 0. 95 1 0. 95 5 1. 00 0 32 7 0. 97 4 0. 85 7 0. 93 9 0. 46 9 0. 60 6 0. 93 9 0. 93 1 0. 94 0 0. 95 9 0. 97 9 0. 97 9 1. 00 0 33 1 0. 97 2 0. 85 9 0. 89 3 0. 34 2 0. 46 8 0. 98 4 0. 97 8 0. 96 1 0. 93 9 0. 97 5 0. 97 7 0. 96 9 1. 00 0 33 2 0. 98 1 0. 84 8 0. 93 1 0. 43 8 0. 56 2 0. 97 0 0. 95 8 0. 95 8 0. 93 6 0. 96 8 0. 98 6 0. 98 4 0. 98 7 1. 00 0 33 3 0. 95 6 0. 92 7 0. 87 5 0. 31 6 0. 45 0 0. 94 6 0. 92 6 0. 91 3 0. 90 8 0. 98 0 0. 95 5 0. 97 4 0. 97 7 0. 98 0 1. 00 0 33 6 0. 92 8 0. 90 5 0. 80 9 0. 19 0 0. 32 5 0. 96 2 0. 95 5 0. 91 2 0. 87 4 0. 96 0 0. 93 1 0. 93 5 0. 98 1 0. 96 2 0. 97 9 1. 00 0 33 7 0. 91 3 0. 64 4 0. 96 0 0. 70 7 0. 79 1 0. 87 1 0. 85 2 0. 89 8 0. 87 8 0. 83 2 0. 92 6 0. 90 9 0. 86 8 0. 92 2 0. 84 2 0. 79 5 1. 00 0 33 9 0. 93 1 0. 77 4 0. 95 4 0. 62 7 0. 75 8 0. 85 8 0. 82 9 0. 87 1 0. 90 9 0. 90 3 0. 95 1 0. 95 8 0. 89 1 0. 93 4 0. 90 9 0. 83 0 0. 93 2 1. 00 0 0. 90 0. 74 0. 89 0. 50 0. 58 0. 95 0. 93 0. 94 0. 93 0. 95 0. 96 0. 96 0. 95 0. 96 0. 93 0. 87 0. 97 volume 29, number 1 73 among 25 countries is supportive of relatively close interest rate co-movement at lower frequencies. thus, importantly, we find that for 18 different industries, there is strong and statistically significant evidence that the uncovered interest rate parity (uip) holds among 25 countries. conclusion the interest rate parity theorem relates domestic interest rates and exchange rates and explains how the difference between the domestic and the foreign real interest rates should equal the expected depreciation of the domestic real exchange rate. thus, if there is parity in real interest rates among countries, then the impact of domestic monetary policy on the domestic rate will be related to the degree to which policy affects interest rate fluctuations throughout the world. while the theoretical predictions of the interest rate parity are relatively standard and uncontroversial, uncovering this parity in the data has proved difficult. in this paper, we go about uncovering the parity by focusing on disaggregated micro-level data and considering the u.s. as the base country. we investigate the hypothesis of real interest rate parity by employing both univariate and panel-based unit root tests for 18 distinct series of industry-specific trade-weighted real interest differentials across 25 countries. in contrast to the many studies mentioned earlier, we are able to uncover the parity in real interest rates across countries by showing that these micro-level interest rates seem to be stationary in levels. however, most differentials seem to exhibit more persistence than what the theoretical prediction would seem to advance. accounting for such persistence undoubtedly constitutes an important extension which as yet remains unanswered. our results have important policy implications on two avenues: central bank policy and the business sector. regarding central bank policy, valcarcel (2011) — on related work — concludes that even if the great moderation had indeed been a result of better monetary policy, more forward-looking monetary prescriptions would not have had an effect on volatility reductions of the real exchange rate commensurate to that of economic activity. thus, he argues that policy prescriptions aimed at trade openness, terms of trade, and current accounts should probably take more of a center stage by central banks. our finding here of micro-level interest rate parity would be informative in that regard. in terms of the business sector, understanding whether interest rate parity holds at the micro level allows firms in these industries to better hedge against exchange rate fluctuations which, according to valcarcel (2011), have been on the rise since the 1980s. 74 journal of business strategies end notes 1. this work, however, does not specifically address the interest rate parity issue. 2. in our model, we consider the united states as the benchmark domestic economy. our results contrasts those of mark (1985) which lend further support to the idea that failure of aggregate tests of interest rate parity could be due to aggregation issues. 3. canada, france, germany, japan, italy, the netherlands, switzerland, the united states, and the united kingdom. 4. however, chaboud and wright (2005) find evidence in support of uip when considering exchange rate movements and interest differentials at much higher frequencies. 5. we focus on quarterly frequencies because studies of aggregate measures of the exchange rate have generally failed to support uip at those frequencies and we want to investigate here whether those results could be an artifact of aggregation issues. 6. the u.s. international trade commission, the feenstra’s trade database, international financial statistics (ifs), the board of governors, and bloomberg l.p., which is based on 24 trading partners in 18 manufacturing industries in the u.s. (refer to data section). 7. j represents any given one of 18 different u.s. manufacturing industries according to usic code. 8. where rt , the real interest rate in the u.s. at time t, represents the domestic rate in our model. 9. it is possible that each manufacturing industry faces different inflation because firms’ investment decisions are mainly involved in sales or cost of production. if a firm is concerned more about its sales than production cost, then exports trade share and consumer price index may be used to compute the real interest differential; and import share and producer price index are necessary if the firm considers its production cost more. this study just assumes that the 18 u.s. manufacturing industries face the same cpi-based inflation. 10. generally, these test results were not sensitive to the (in)exclusion of seasonal dummies. volume 29, number 1 75 11. given that relatively little was known about the time series properties of these industry-specific exchange rates, we test for the differenced series to verify that none of these series could be persistent enough to be characterized by an i(2) process. indeed, while we show evidence from the adf test that 15 of the 18 industries we tested can be characterized as level stationary, wood, paper, and petroleum and coal products seem to exhibit an order of integration higher than i(1) according to adf test. a preponderance of the evidence across all the tests we conducted would seem to suggest that most industry-specific interest rates are level stationary and all are difference-stationary. 12. except beverages and tobacco products which are rejected at the 10% instead. references balke, n. (2010). sectoral effects of aggregate shocks. southern methodist university working paper. banerjee, a., lumsdaine, r. l., & stock, j. h. (1992). recursive and sequential tests of the unit-root and trend-break hypothesis: theory and international evidence. journal of business and economic statistics, 10, 271-287. baillie, r. t., & bollerslev, t. (2000). the forward premium anomaly is not as bad as you think. journal of international money and finance, 19, 471-488. bahmani-oskooee, m., mirzaie, i. a., & miteza, i. (2007). sectoral employment,wages and the exchange rate: evidence from the u.s. eastern economic journal, 33(1), 125-136. bekaert, g., & hodrick, r. j. (1993). on biases in the measurement of foreign exchange risk premiums. journal of international money and finance, 12, 115138. bekaert, g., & hodrick, r. j. (2001). expectations hypotheses tests. the journal of finance, 56(4), 1357-1394. bekaert, g., wei, m., & xing, y. (2007). uncovered interest rate parity and the term structure. journal of international money and finance, 26, 1038-1069. boivin, j., & giannoni, m. (2006). dsge models in a data-rich environment. nber working paper, 12772. boivin, j., giannoni, m., & mihov, i. (2009). sticky prices and monetary policy: evidence from disaggregated u.s. data. american economic review, 99(1), 350-384. chaboud, a. p., & wright, j. h. (2005). uncovered interest parity: it works, but not for long. journal of international economics, 66, 349-62. 76 journal of business strategies chinn, m., & frankel, j. (1995). who drives real interest rates around the pacific rim: the usa or japan? journal of international money and finance, 14, 801-21. cumby, r. e., & mishkin, f. s. (1987). the international linkage of real interest rates: the european – u.s. connection. nber working paper, no. w1423. retrieved from papers.ssrn.com/sol3/papers.cfm?abstract_id=307862. cumby, r. e., & obstfeld, m. (1984). international interest rate and price level linkages under flexible exchange rates: a review of recent evidence. in j. f. o. bilson & r. marston (eds.), exchange rate theory and practice. chicago: university of chicago press. dickey, d. a., & fuller, w. a. (1979). distributions of the estimators for autoregressive time series with a unit root. journal of the american statistical association, 74, 427-31. dutton, m. m. (1993). real interest rate parity new measures and tests. journal of international money and finance, 12, 62-77. elliot, g., rothenberg, t. j., & stock, j. h. (1996). efficient tests for an autoregressive unit root. econometrica, 64(4), 813-36. fujii, e., & chinn, m. (2001). fin de siècle real interest parity. journal of international financial markets, institutions and money, 11, 289-308. frankel, j. (1979). on the mark: the theory of floating exchange rates based on real interest differentials. american economic review, 69, 610-22. gagnon, j. e., & unferth, m. d. (1995). is there a world real interest rate? journal of international money and finance, 14(6), 845-55. goldberg, l. (2004). industry-specific exchange rates for the united states. economic policy review, 10(1). international financial statistics database. international monetary fund. im, k. s., pesaran, m. h., & shin, y. (2003). testing for unit roots in heterogeneous panels, journal of econometrics, 115, 53-74. kwiatkowski, d., phillips, p. c. b., schmidt, p., & shin, y. (1992). testing the null hypothesis of stationarity against the alternative of a unit root. journal of econometrics, 54, 159-78. lee, j. & strazicich, m. (2003). minimum lm unit root test with two structural breaks. review of economics and statistics, 85(4), 1082-1089. mark, n. c. (1985). some evidence on the international equality of real interest rates. journal of international money and finance, 4, 189-208. mark, n. c. & wu, y. (1998). rethinking deviations from uncovered interest parity: the role of covariance risk and noise. the economic journal, 108(451), 16861706. volume 29, number 1 77 meredith, g., & chinn, m. (1998). long-horizon uncovered interest rate parity nber working paper, no.6797. mishkin, f. s. (1984a). are real interest rates equal across countries? an empirical investigation of international parity conditions. journal of finance, 39, 134557. mishkin, f. s. (1984b). the real interest rate: a multi-country empirical study. canadian journal of economics, 17, 283-311. sachs, j. d. (1985). the dollar and the policy mix: 1985. brookings papers on economic activity 1, 117-85. shafer, j. r., & loopesko, b. e. (1983). floating exchange rates after ten years. brookings papers on economic activity, 1, 1-70. taylor, m.p. (1991). testing real interest parity in the european monetary system. bank of england working paper. valcarcel, v. (2011). exchange rate volatility and the time-varying effects of aggregate shocks. texas tech university working paper. wu, j., & chen, s. (1998). a re-examination of real interest rate parity. canadian journal of economics, 31(4), 837-51. biographical sketch of authors wan-shin (cindy) moh is currently an assistant professor in the department of finance at chung yuan christian university. she received her ph.d. in economics from texas tech university in 2009. her interests lie in macroeconomics and time series. much of her recent research has explored monetary policy and transmissions between financial markets (i.e., stocks, bonds, and exchange rates) and commodity markets — including energy, non-energy, and precious metal. masha rahnamamoghadam is currently an associate professor in the department of economics at texas tech university. he received his ph.d. in economics in 1988 and his m.s. in mathematics in 1981 both from iowa state university. his research interests are in the areas of macroeconomics and international economics. he has published articles in journals such as southern economic journal, quarterly journal of economics and finance, the journal of economic areas, eastern economic journal, and the international journal of development. he has also coauthored a book entitled, “doing business in less developed countries,” published in 1996. victor (vic) valcarcel is currently an assistant professor in the department of economics at texas tech university. he received his ph.d. in economics from 78 journal of business strategies the university of kansas in 2008. his interests lie in macro-econometrics, monetary policy, and a historical perspective of macroeconomic fluctuations in industrialized economies. he has published work in various venues such as the journal of economics and business, eastern economic journal, economics letters... his research has explored time variation in the effects of monetary and fiscal policy, commodity prices — including oil — and trade. volume 29, number 1 79 80 journal of business strategies an examination of uncovered real interest rate parity in 18 distinct u.s. manufacturing industries digital knowledge networks: linking communities of practice with innovation patrice braun university of ballarat, ballarat, victoria, australia abstract with embedded knowledge flows and innovation linked to communities of practice as well as technology, australian small and medium size enterprises (smes) have the potential to both collaborate and compete by taking advantage of knowledge platforms founded on digital technologies and new relationships. a conceptual model is introduced that maps access to knowledge flows against limitations such as size and lack of interaction. it is suggested that fostering a culture of connectivity and trust amongst smes to initiate knowledge exchange may offer a potential solution to the possible loss of competitive advantage for smes in the digital economy. introduction today, with an economy enabled and driven by connectivity, a fundamental shift in business models is occurring whereby information, knowledge and relationships underpin competitive advantage. in order to compete in what some refer to as the new economy, companies must use technology-mediated channels, create internal and external value, formulate technology convergent strategies, and organise resources around knowledge and relationships (rayport & jaworski 2001). the dominant strategic management literature also orbits resource-based theory, focusing on integrated architecture through improved knowledge management systems (alavi & leidner 2001; kay 2000; maholtra 2000; chisholm 1998; davenport & prusak 1998; teece 1998; brown & duguid 1998; stewart 1997; nanoka & takeuchi 1995). the rise of information technology (it) and electronic information networks has led firms of all sizes to implement more technology driven solutions for improved productivity and information flow. malhotra (2000) identifies three general information management (1m) developments that have revolutionized company information processes over the last forty years. the first phase, the automation phase, increased company efficiency of operations. the second phase, the rationalization phase, streamlined those procedures by eliminating bottlenecks made apparent by the automation. the third phase, the business reengineering phase. radically redesigned information management processes through technology-intensive implementation of procedures in workflows and work processes (malhotra 2000). now we have reached a fourth phase, the 44 journal of business strategies vol. 19, no.1 knowledge management (km) phase that, if possible, is even closer associated with technology than business process reengineering. whereas technology may play an enabling part in km activities, the notion that it is seamlessly entwined with technology or that its success depends on it is, however, misguided (hildebrand 1999: online). information management vs. knowledge management the extant of technology gave rise to huge investments in information management systems, as they were considered a critical company resource. while many companies have implemented more technology driven solutions for improved productivity, research indicates that implementation of expensive information technology processes has not always yielded the desired results. strassman (1997) was unable to establish a relationship between company performance and computer expenditure. parc xerox director john seely brown (brown & guguid 1991) observed that levels of efficiency and effectiveness of knowledge workers in us industry were little improved despite investments in technology of over $1 trillion. initial managerial confusion between 1m and km appears to have generated much inappropriate investment in business process reengineering while over time technology solutions such as data warehousing proved too restrictive in terms of agility and flexibility (malhotra 2000). the prevailing view that network externalities such as the internet and new ecommerce technologies are necessary to transform business capabilities from a parochial to a global level, is leading the drive to modify initial enterprise resource networks and customer relations management systems (goolsbee 2000; murray & trefts 2000; davenport, jarvenpaa & beers 1996). by facilitating horizontal and vertical trading via automated e-commerce engines, the latest it solutions are being touted as collaborative e-commerce solutions or c-commerce in which strategic industry alliances are key. companies such as sap promote global focus solutions through customised supply chain interfaces in which 'customers, employees, suppliers and business partners work together in one virtual business environment as ifthey were all one company' (sap 2000: 16). many such solution providers are targeting large enterprises. in australia, where small and medium size enterprises (smes) make up 96 per cent of all australian enterprises in the private non-agricultural sector, integrated technology solutions providers are breaking out of the corporate straightjacket by also appealing to smes and start-ups to tap into intranet-based business tools (hayes 2001). in an attempt to implement new km strategies, many enterprises have initiated electronic km solutions such as a company intranet to encourage knowledge flow and collectively preserve, renew and augment their knowledge platforms (davenport & prusak 1998; zack 1999). a great deal of hope is vested in these km systems, but it is inaccurate to assume that information technology can overcome any knowledge flow barriers (brown & duguid 1998). although spring 2002 braun: digital knowledge networks 45 computer-based environments for companies and their knowledge workers are rapidly graduating from research prototypes to commercially available products, implementation of electronic knowledge systems 'does not automatically induce a willingness to share information and build a new intellectual capital' (gottschalk 2000: 117). to support the nature of today's work environment km systems need to not only facilitate the construction of new knowledge, but manage information and learning by serving as a collective community memory platform within constantly evolving collaborative contexts (lechner, stanoevskaslabeva & tan 2000; stahl 2000). communities of practice once the domain of special business units and cross-functional teams to perpetuate ideas and embed core competencies. a new form of collective community building is emerging through a spontaneous new knowledge exchange trend known as 'communities of practice'. what are communities of practice? burk (2000) simply calls them expansions of one-on-one knowledge sharing. theorists wenger and snyder (2000) describe them as informal groups of people who regularly share their expertise and experiences; are not formulated or controlled by management; set their own leadership; and follow their own agenda. one of the central benefits of these self-constituting communities is that they sidestep the "ossifying tendencies of large companies and develop rich, fluid non-canonical worldviews to bridge the gap between their organisation's static canonical view and the challenge of changing practice" (brown & duguid 1991 :50). this spontaneous think-tank mode of team bui iding through face to face meetings, email, knowledge sharing networks, intranets and technologymediated conferencing is an inherently innovative process and is proving to be a crucial aspect of organisational learning and km. in many ways communities of practice are the western adoption of the holistic japanese approach outlined by nonaka and takeuchi (1995) in acknowledging the importance of tacit company knowledge and transforming it into explicit company assets. most communities of practice are internal company networking groups. a recent study highlights a number of fortune 500 companies fostering shared learning groups and collaborative knowledge communities to encourage teambased incentives that directly influence company profits (best practices llc 2000). communities of practice can, however, also flourish with members from different companies. as exemplified by the ceos of different us companies who make up the business roundtable (wenger & snyder 2000). other interorganisational examples are internet-based companies such as amazon.com and e-toys who have successfully redefined the value of knowledge assets or intellectual capital by achieving valuation through information flows between organisations and industries (malholtra 2000). it should be noted that there are 46 journal oj business strategies vol. 19, no.1 many different forms of socia-cultural communities of practice proliferating in the virtual environment with objectives other than competitive advantage, discussion of which falls outside the scope of this paper. complementary relationships with the networked firm have been the subject of considerable empirical research in large enterprises (e.g., pfeffer & sutton 2000; evans & wurster 2000, 1999; davenport & prus~k 1998), yet studies on their role vis-a-vis smes are less abundant. networking is a recurring theme in european studies on sme positioning in the new economy (cooke & wills 1999; fariselli, oughton, picory & sugden 1999). while these studies associate social capital building with enhanced business, knowledge and innovation performance, sme networking appears contingent on favourable economic climates, e.g. government-sponsored external networks, with such institutional factors affecting the relationships amongst different economic actors (cooke & wills 1999; farisehi et at. 1999). similarly, a recent asian study which provides empirical evidence of successful cross-border sme collaboration between singapore and malaysia points to the importance of national and international innovation networks that provide smes with the resources to become global players (konstadakopulos 2000). building on the principle that successful sme global positioning needs to be supported by innovation networks and/or favourable government policies, this paper explores the potential of a timely synergy between connectivity and collaborative km business models vs. barriers faced by australian smes in embracing knowledge community practices. australian smes in line with the growing awareness that connectivity is unequivocally altering competitive advantage, australian federal and regional innovation policies are increasingly focused on building strategies and initiatives towards connectivity, the expansion of regional and rural business, technology-enabled capabilities and e-commerce. the emergence of networks and the development of regional economic communities are particularly favoured, whereby policy makers concerned with the performance of regional economies are seeking to foster a networked community culture (noie 2000). to that end, government is supporting both it infrastructure and industry initiatives (telecentre network connection 1999; western region 1999), while private network solutions as discussed above are also proliferating (hayes 2001). enhanced telecommunications infrastructure is integral to competitive advantage for australian smes and may prove to be a valuable resource in terms of building sme connectivity, provided that smes are adopting the technology. adoption of networked technologies by smes is directly related to the size and nature of smes and largely depends on their perception of affordability and opportunities for their business (oecd 2000). research indicates that smes in australia still hesitate to invest their time and money in a rapidly changing economy and fear spring 2002 braun: digital knowledge networks 47 isolation, competitor use of the internet, alienating intermediaries, uncontrolled growth, lack of technology skills and lack of a strategic sense of how to move forward as significant barriers. they also perceive innovation policies as pertaining to large firms and are hence suspicious of e-commerce regulations (nole 2000). these barriers tend to foster an element of inertia among australian smes in embracing networked solutions and may hence lead to possible loss of competitive advantage for the region and the australian economy as a whole (australian electronic business network 1998). while embracing connectivity through public or private initiatives is essential in reducing isolation of smes and facilitating the electronic linking to one another for potential business-to-business (b2b) and/or business-to-consumer (b2c) resource and information sharing, there is a another critical factor to consider in terms of potential knowledge exchange between australian smes and that factor is trust. the relationship between connectivity and companies should be seen as reciprocal because "telecommunications technologies and services not only have a significant impact on how inter-organisational relationships are developed but the structure and culture of an existing network of organisations itself also seems to have considerable predictive power for the way in which the telecommunications network is developed, implemented and used" (nouwens & bouwman 1995: online). hence knowledge flows between firms is contingent not on suitable technology alone but on informal social contexts as well (brown & duguid 1998). in the asian example of sme collaboration, information sharing and learning is in fact taking place based on prior existence of trust and in an atmosphere of continued trust building between stakeholders (konstadakopulos 2000). there is a considerable body of literature on inter-firm trust. sme fear of opportunistic behaviour from competitors has alliance literature scholars (gulati 1995; zaheer, mcevily & perrone 1998) stress the importance of trust and personal interaction in inter-firm alliances. the trust may be historical and already exist between individuals of different firms, as illustrated above, or it can be built during the relational exchange (gulati 1995; ring & van de ven 1992). others argue that alliances do not necessarily have to be based on trust as long as systemic mechanisms are in place which allow stakeholders to have confidence that alliance partners will exhibit cooperative rather than opportunistic behaviour and not take competitive advantage of knowledge-based exchanges (beamish 1987, das & teng 1997). in the past, australian smes have not been known for their collaborative approach to business (australian bureau of industry economics 1995). however, a relatively recent study of 2500 australian smes on their involvement in business networks noted a significant level of interest in networking or formulating networks in the future, indicating that networking is likely to be important in the business future of australian smes (dean & holmes 1997). two types of business networks, formal and informal networks, were identified whereby 48 journal of business strategies vol. 19, no.1 formal networks constituted formal arrangements between companies to consolidate resources and informal networks were seen as loose arrangements facilitating information exchange. service companies were notably more likely to be involved in formal and informal networking than manufacturing companies. lack of suitable partners and lack of financial assistance were cited as inhibiting factors for collaboration (dean & scott 1997). towards future sme viability there are obvious differences between large and small firms both in terms of availability of resources for connectivity and in terms of community of practice membership. network-wise, large firms with deep pockets have the ability to build their own integrated architecture, while smes have to rely on external funding. for australian smes access to a networked infrastructure can now be achieved by relying on the public purse, but while these networks are potentially exciting and sound e-business structures for smes, joining the global market as a sole trader, let alone becoming an inter-firm network stakeholder will entail an enormous conceptual leap into the future for many australian sme managers. network novices will hence need substantial encouragement and support to make them willing to take the e-business plunge. while social capital is an individual asset, company members join a community of practice for networking or learning purposes in their field of interest or expertise. as noted by coleman (1990) and nahapiet and ghoshal (in leana 1999) the resulting organisational social capital becomes a jointly owned asset and includes the perspectives and interests of the organisation (leana 1999). given the latter, it may be assumed that communities of common interest trust other company members in the exchange of explicit and tacit company knowledge for the 'public good' aspect and building of company assets. australian smes do not have a history of networking and knowledge sharing for the 'common good' and would more likely be looking to not only collaborate but also compete in a knowledge exchange milieu. a collaborative culture will hence need to be fostered and should be linked to tangible rewards for participating smes and/or clear mutual benefits. once trust is formed through participation in horizontal networks of association (putnam 1993) and organisational social capital is realised through cooperative individual and collective goal orientation (leana 1999), participation in a community of practice is likely to perpetuate trust amongst australian smes, which in turn will produce knowhow and economically beneficial outcomes for a region or industry. introducing a conceptual model, the author maps access to knowledge flows against limitations such as size and lack of interaction (figure 1) and suggests that fostering a culture of connectivity, cooperation and trust building amongst smes, to initiate and encourage community of practice type knowledge diffusion, may offer a potential solution to possible loss of competitive advantage. spring 2002 braun: digital knowledge networks figure 1 knowledge flow model 49 high infracommunimproved high high -.. large !-+ st ructu rei f-+ ities of f-+ knowledge 1"'-business data of >exchange practice innovation.... 0.;;; 'e cn ui 0.g) :::j c'" c ~ oal c 0 0 no infrano slow w0 -.. small r-+ structurel -.. commun-.. knowledge i-1"'-business data ities of of low exchange practice innovation low low the top of the knowledge flow model shows how a large company with high connectivity and an integrated infrastructure for information and knowledge exchange via communities of practice can lead to a high level of trust and subsequent innovation and competitive advantage. the bottom part of the knowledge flow model shows how an sme with low access to a networked infrastructure and a low level of knowledge exchange leads to a low level of trust in industry or alliance partnering, which in turn can lead to isolation and loss of competitive advantage in the new economy. although exact emulation of a large company community of practice may not be feasible or even desirable, a variety of models of tight and loose coupling can be examined to identify appropriate inter-firm alliances for smes and approximate desired community of practice results. in case of australian smes, trust building will require prolonged socialization and externalisation to assure stakeholder sincerity (nonaka & takeuchi 1995). trust between partners is said to reduce fear of opportunistic behaviour and improve collective learning (gulati 1995). von hippel (1988) and dyer and singh (i 998) also advocate close personal interaction and strong relational or social cooperation between firms to learn critical information and know~how from alliance partners. australian smes need to establish a high level of horizontal and vertical inter-firm cross-fertilisation of ideas, technical know-how exchange and collaborative learning through informal processes such as attending seminars, local association meetings or socializing with other firm managers. the latter can be accomplished in the form of a collaborative effort or 'innovation partnership' between government, academia and sme stakeholders with a focus on formulating appropriate economic frameworks for smes, creating awareness of networked opportunities and providing educational processes such as inter-firm relationship building and developing skills in using networked technologies. cooperative relationships are becoming one of the most important determinants of commercial viability and business success. with embedded knowledge flows and innovation linked to communities of practice as well as through linkages using technology, australian smes have the potential to both cohabo50 journal of business strategies vol. 19, no.1 rate and compete by taking advantage of e-commerce based connectivity and new relationships founded on the exchange and sharing of embedded knowledge. overcoming potential loss of competitive advantage for australian smes in the digital economy will require strategic sme community building with connectivity, trust and relational capital as pivotal building components. references alavi, m., & leidner. d.e. (200l). review: knowledge management and knowledge management systems: conceptual foundations and research issues. mis ouarterly. ~ (1),107·134. australian bureau of industry economics (bie) (1995) beyond the firm: an assessment of business linkages and networks in australia, research reports. productivity commission, retrieved online: http://www.indcom.gov.aulicpubslbiepubs/research/ rr67/ index.html,02/08/2000. australian electronic business network (1998). taking the plunge, commonwealth of australia. canberra: department of communications, information technology and the arts. best practices llc (2000). nurturing knowledge communities to leverage intellectual assets. pr newswire, 06/0512000, retrieved online: http://www.prnewswire.com. 13/0712000. beamish, pj (1987). joint ventures in ldcs: partner selection and performance. manaiement international review, 27,23-37. brown, j.s., & duguid, p. (1998). organizing knowledge. california manaiement review. 40 (3), 90-111. brown, j.s., & duguid, p. (1991). organizational learning and communities of practice: toward a unified view of working, learning and innovation. qfl~anization science. 2, 40-57. burk, m. (2000). communities of practice. public roads, 63 (6), 18-22. chisholm, r.e (1998). developing network organizations, learning from practice and theory. reading: addison wesley publishing company. coleman, j.s. (1990). the foundations of social theory, cambridge, mass: harvard uni· versity press. cooke, p., & wills, d. (1999). small firms, social capital and the enhancement of business performance through innovation programmes. small business ecqnqmic~. 13 (3), 219-34. spring 2002 braun: digital knowledge networks 51 das, t.k., & teng, b. (997). sustaining strategic alliances: options and guidelines. journal of general mana~ement. 22, 49-64. davenport, t.h.. & prusak, l. (1998). working knowledge, boston: harvard business davenport. t., jarvenpaa, s .• & beers, m. (1996). improving knowledge work processes. sloan mana~ment review. 37 (4), 53-66. dean, j., & holmes, s. (1997). understanding business networks: evidence from the manufacturing and service sectors in australia. journal of small business mana~e­ ment. 35 (i), 78-85. dyer, j., & singh, h. (1998). the relational view: cooperative strategy and sources of interorganizational competitive advantage. academy of manaiement revjew. 23 (4),660-679. fariselli, p., oughton, c., ncory, c., & sugden, r. (1999). electronic commerce and the future for smes in a global market-place: networking and public policies. small bysiness economics. 12 (3). 261-275. fukuyarna. f. (1995). ir.\rn. new york: free press. goolsbee. a. (2000). why the network effect is so striking. in j. pearson & t. dickson (eds) masterinl: strateg:y: the complete mba companion in stratel:y, (pp. 21-27). harlow: financial times prentice hall. gottschalk, p. (2000). strategic knowledge networks: the case of it support for eurojuris law firms in norway. international review of law. computers and technology. 14, (1), 115-130. granovetter, m. (1985). economic action and social structure: the problem of embeddedness. american journal of social psychology. 62. 989-1002. gulati, r. (1995). does familiarity breed trust? the implications of repeated ties for contractual choice in alliances. academy of manal:ement journal. 38, 85-112. hayes, s. (2001). oracle network for smes. the australian. it. may 1, 28. hildebrand. c. (1999). does km=it. cia enterprise, september 15. online: http:// www.cio.comlarchive/enterprise/091599_ic.html. retrieved 18/612001. kay, j. (2000). strategy and the delusion of grand design. in j. pearson & t. dickson (eds) mastering strategy; the £qrnplete mba companion in strategy. (pp. 5-11). harlow: financial times prentice hall. konstadakopulos, d. (2000). learning behaviour and cooperation of small high technology firms in the asean region. asean economic bulletin. 17 (1), 48-62. 52 journal of business strategies vol. 19, no. 1 koulopoulos, tm. (1997). corporate instinct: buildin~ a knowing enterprise for the 21 st century. new york: john wiley & sons. leana, c.r. (1999). organizational social capital and employment practices. academy of mana~ementreview, 24 (3), 538-556. lechner, u., stanoevska-slebeva, k., & tan yh. (2000) editorial. electronic marketscommunities & platforms, 10 (4). malhotra, y (2000). knowledge management for e-business performance: advancing information strategy to "internet time". information strategy. the executive's jourlli!!....lq (4), summer 2000, 5-16, murray r., & trefts, d. (2000). the it imperative in business transformation. infqrmation systems management. winter 2000, online: www.ebiztechnet.com/members/qnline/ 2oo702/alignment/alignmenc l.html,retrieved 25/0712000. nqnaka, i., & takeuchi, h. (1995). the knqwledge-creating company: how japanese companies create the dynamics of innovation. new york: oxford university press. nouwens, j., & bouwman, h. (1995). living apart together in electronic commerce: the use of information and communicatiqn technqlogy tq create netwqrk organisations. journal of computer-mediated communicatiqn. 1 (3), online: http://www.ascusc.orgl jcmc/vol1iissue3/nou wens.htm!. noie (2000). yellow pages small business index. commonwealth department of communications. canberra: information technology and the arts. oecd (2000). a global marketplace for smes. progress report by the industry committee working party on smes, oecd online publication. online: http://www.oecd.org, retrieved 20/0612000. pfeffer, j., & sutton, r.i. (2000). the knowledge-doing gap: how smart companies turn knowledge into action. boston: harvard business school press. putnam, r.d. (1993). making democracy work: civic traditions in modern italy. princeton, nj: princeton university press. rayport, j.f., & jaworski, bj. (2001). e-cqmmerce. boston: mcgraw-hill. ring, p.s., & yan de yen, a, (1992). structuring cooperative relationships between organizations, strategic management journal, .u (7), 483-498. sap (2000). delivery the business internet, special advertising promotiqn, the australian, special advertising promotion, july 25, 2000. spring 2002 braun: digital knowledge networks 53 stahl, g. (2000). collaborative information environments support knowledge construction by communities. al & society. 14,71-97. stewart, t.a. (1997). intellectual capital. the new wealth of organizations. new york: doubleday. strassman, p.a. (1997). the squandered computer: evaluating the business alignment of information technologies. new canaan: information economics press. tapscott, d. (1996). the digital economy, promise and peril in the age of networked intelligence. new york: mcgraw-hi!l teece, dj. (1998). capturing value from knowledge assets: the new economy, markets for know-how, and intangible assets, california management review, 40 (3), 55-80. telecentre network connection (1999). department of commerce and trade. perth: government of western australia publication. von hippe!, e. (1988). the sources of innovation. new york: oxford university press. weigand, h., aida, d., & heuvel, w. j. (2000). supporting the evolution of workflow patterns for virtual communities. electronic markets: communities & platforms. 10 (4). weir j. (2000). a web/business intelligence solution. information systems management. on 1ine: www.ebiztechnet.com/members/ani ine/200702/inte1ii gence/intell igence_1.html, retrieved 25/07/2000. wenger,e., & snyder w. m. (2000). communities of practice: the organizational frontier, harvard business review, 78 (l), 139-146. western region forum (1999). victoria's golden west: western region strategies for growth rural and regional strategy. state government victoria: melbourne. zack, m. h. (1999). developing a knowledge strategy, california management review. 41 (3), spring 1999, 125-146. zaheer, a., mcevily, 8., & perrone, v. (1998). does trust matter? exploring the effects of interorganizational and interpersonal trust on performance. organization science. 9 (2), 123-142. 54 journal of business strategies vol. 19, no.1 patrice braun holds a masters by research degree from james cook university of north queensland in information delivery via the internet for community use. ms. braun is an e-business lecturer and consultant and is currently undertaking doctoral research in regional connectivity andelectronic commerce with a focus on the adoption of technology and cooperative marketing towards building competitive advantage by small and medium sizeenterprises in regional australia. digital knowledge networks: linking communities of practice with innovation consequences of outsourcing strategies on employee quality of work life, attitudes, and performance dean elmuti eastern illinois university • charleston, illinois julian grunewald eastern illinois university • charleston, illinois dereje abebe eastern illinois university • charleston , illinois abstract outsourcing is the strategic use of outside resources to perform activities that are usually handled by internal staff and resources. the consequences of implementing outsourcing strategies in an industrial setting were studied using a field study. this study was designed to explore both the financial as well as the human aspects of outsourcing activities. the attitudinal results of this research indicated that the outsourcing strategies had a negative impact on the perceived quality of work-life dimensions. the performance results presented here provide, at best, circumspect support for the claims of outsourcing proponents that the technique improves participants' performance and productivity. although outsourcing can lead to certain gains for the organization, there are definitely human costs to be taken into account, and they should be considered as major factors contributing to the outsourcing debate , not just the financial aspects of organizations' decisions. introduction most corporations believe that in order to compete globally, they have to look at efficiency and cost containment rather than relying strictly on revenue increased (bartlett, 2004; drezner, 2004; farrell & rosenfeld, 2005; jasper, 2003). as companies seek to enhance their competitive positions in an increasingly global market place, they are discovering that they can cut costs and maintain quality by relying more on outside service providers for activities viewed as supplementary to their core businesses (baily & farrell, 2004; cassale, 1996; donahoe & pecht, 2003; irwin, 2004; li & barnes, 2008). the trend is for outsourcing relationships to function more as partnerships. outsourcing providers are taking increasing responsibility in realms that have traditionally remained as in-house, such as corporate strategy, information management, business investment, and internal quality initia178 journal of business strategies tives (engardio, 2006). according to gartner, an independent research company, the worldwide business process outsourcing segment will expand from $160.7 billion in 2007 to $235 .2 billion by 2011, a compound annual growth rate of 10.3% (musico, 2008). several authors agree that if outsourcing is implemented with prior planning, it can result in lowering cost, increased capacity and productivity, and sometimes can lead to downsizing (elmuti , 2003 ; casale, 1996; sinderman, 1995; outlay & ranganathan , 2005). perhaps the most common reason for taking noncore function s overseas in the united states is the lucrative cost-saving derived from allowing a job to be done by a professional employee(s) that are paid much lower than their u.s . counter parts (jasper, 2003). many companies that are taking manufacturing and service jobs from the u.s. also consider the lower tax rates , available in foreign countries compared to the higher rates in the u.s. (donahoe & pecht, 2003). although most of the outsourcing efforts made so far have been by big businesses, this dominance is starting to change in that smaller firms are also moving in the same direction in order to realize the benefits of outsourcing (mccracken, 2002). some companies view outsourcing as a fast track system for penetrating new regions rather than a trend for the future (mccracken, 2002). still others view outsourcing as a way to increase concentration on core-competencies, thus making it a more long-term approach (bender, 1999; corbett, 1996; drezner, 2004; engardio, bernstein, & kriplani., 2003 ; farrell & rosenfeld , 2005; hoffman & tibodeau, 2003). most of the criticism concerning outsourcing has been primarily in the areas of changing employment patterns, globalization of the labor force , and its effect on individuals and organi zations (klass, mcclendon, & gainey, 2001 ; dobbs, 2004). among the main causes considered to be the reason for job losses in manufacturing is increased productiv ity (stonecipher, 2004). outsourcing, by increasing productivity, may result in downsizing (outlay & ranganathan 2005). many us companies like harley-davidson, dell , and avago technologies have announced that they will reduce their workforce as part of their outsourcing program. however, the consequences of outsourcing are not limited to unemployment and the loss of capital (cnn money, 2004). it can also result in the deterioration of morale among employees , (engardio, 2006; kennedy, holt, ward, & rehg, 2002). displaced, unemployed workers have higher rates of child and spousal abuse, alcoholism, bankruptcy, divorce, etc (dobbs, 2004; jasper, 2003 ; engardio, 2006; weidenbaum, 2004). volume 27, number 2 179 most recent studies have focused on either the human aspects or the financial aspects of outsourcing but not on both aspects at the same time. therefore, we find it necessary to conduct a longitudinal and experimental investigation into the effects of outsourcing strategies on participants' attitudes (the human aspects) as well as job performance (the financial aspects) of the program. in addition , there is a need to assess managerial opinion as to the value of the program for enhancing performance in both the short and long run. this topic deals directly with corporate strategy and is current and relevant for both employers and employees and has farreaching implications that have not been fully considered in the past. literature review and research framework drawing on research findings , this study attempts to pull from theoretical literature to address the diverse perspectives on outsourcing strategies, performance measurements, and impacts. measuring both the financial as well as the human aspects of outsourcing represents an area in which scholars have devoted some time in the past. this study addresses, in a meaningful and a practical way, the strengths of such research tradition. several researchers have focused on developing a theoretical framework for outsourcing (geyskens, steenkamp, & kumar, 2006; griffiths, 2001 ; charara, 2004; narasimhan & jayaram , 1998). for instance, bolumole, frankel, and nasland (2007) developed a framework which was based on the transaction cost-based perspective which considers outsourcing as a way by which organizations use external parties in order to reduce internal transaction and production costs. on the other hand, kumar and eickhoff (2006) suggest that major drivers to outsourcing activities such as reduced labor cost are often overstated relative to others risks and issues such as intellectual property protection, quality, and supplier capabilities. when looking to outsource, an organization should be careful not to farm out work related to the core competencies of the firm. geyskens, et al. (2006) evaluated transaction cost-based empirical research on organizational boundary (make, buy, or ally) decisions. they found strong support for the theory for both make versus buy and ally versus buy decisions. on the other hand , moses and ahlstrom (2008) clarified how make or buy decision processes develop overtime and how they cannot be seen as a one-time implementation but rather as a process that needs both structure and flexibility. other researchers have focused on successful implementation of outsourcing strategy which has been credited with helping to cut cost, increase capacity, 180 journal of business strategies improve quality, increase profitability, productivity, and improve financial performance and growth (lau & hurley, 1997; corbett, 1999; crane, 1999; jasper, 2003; bartlett, 2004; farrell, 2004; drezner, 2004). narasimhan and jayaram (1998) focus on the notion that an integrated supply chain involves aligning sourcing decision in order to achieve manufacturing goals of responding favorably to needs of the customers. outsourcing is often used by firms to pursue quality, costs, flexibility, and dependability objectives. on the other hand , the outsourcing trend affects employees through the loss of fixed-employment opportunities and results in an increasing number of part-time and contract workers typically earning less pay than permanent workers and without health, life, shortand long-term disability, and retirement benefits (charara, 2004; crolius, 2006). it also implies a gradual structural change whereby a significant part of the workforce will be made up of part-time, temporary, freelance, or independent contractors (klass, et ai., 200l; khan, 2004). many researchers argue that the overall economic benefits of outsourcing are at the expense of the individual workers (charara, 2004; dobbs, 2004). outsourcing usually has an impact on the organized labor by intim idating the labor force, as employees are threatened by the prospect of jobs moving overseas and are not enthusiastic about unionizing (lazes & savage, 2000). kennedy, et al. (2002) viewed outsourcing in general, as a negative change, which therefore would create higher levels of dissatisfaction and increased likelihood ofleaving their positions. another study conducted by walsh and deery (2006) examined the effect of an outsourcing strategy on those who become employed as a result of that strategy. they found that the outsourcing contract created minimal job security for the new employees because the organization was not committed to these employees beyond the three-year contract. the study also found very limited opportunities for training and development, as well as promotions. outsourcing entails dramatic changes in the nature of work, control, and organizational design (lever, 1997; klass, et ai. , 2001; engardio, et ai. , 2003). the outsourcing process usually results in the loss of productivity. such lower productivity can exasperate an already unacceptable performance level and inspire additional outsourcing (lever, 1997; venkatraman , 2004; roberts, 2005). as the outsourcing strategy continues, employees begin to feel insignificant and level of participation in their respective work groups gradually declines. this might cause an increase level of anxiety and stress (kennedy, et ai., 2002). other empirical studies have shown that dissatisfied workers, after the implementation of outsourcing strategy, are more likely to leave the organization than their satisfied colleagues are (spector, 1997; charara , 2004). volume 27, number 2 181 the reaction of the employees who participate in the outsourcing program should also be taken into consideration. survivor syndrome, as defined in hr focus aug2009, "refers to a marked decrease in motivation, engagement, and productivity of employees that remain at the company as a result of downsizing and workforce reductions. it entails a series of complex psychological processes and subsequent behavioral responses." feelings of fear, anger, grief, guilt, insecurity, unfairness , depression, reduced risk taking, and motivation are expressions of survival syndrome. besides, "survivors" are expected to bring result soon, cover the extra work, and come up with new ideas (baruch & hind , 1999; hr focus, 2009; kiplinger, 2009). this additional pressure may lead to high turnover. employees will be affected from the unilateral "violation of psychological contract", which is the unwritten agreement between the employer and the employee in which the employer offers job security and stability at the exchange for loyalty and commitment (sahdev, 2004, baruch & hind, 1999). unless this situation is addressed immediately with an effective retention strategy, it will bring additional loss of productivity, confusion, and stress. (wood, 2009; hr focus , 2009; sahdev, 2004, baruch & hind, 1999). corporate outsourcing restructuring, downsizing and rightsizing what do these terms represent? according to the experts on wall street, these terms are euphemisms for management's recognition that it must layoff individuals (kiplinger, 2009; outlay & ranganathan, 2005; mol, 2007). it has been estimated that at current rates , 50% of u.s. manufacturing activities may be outsourced to firms in 28 emerging or developing countries by 2015. additionally, outsourcing of services by u.s. firm s is expected to lead to the migration of four million jobs to these nations by 2008-2010 (fitzpatrick & dilullo, 2007). more in-depth studies are needed despite the frequency with which outsourcing strategies have been adopted in work organizations, (corbett, 2002; reaser, 2004; engardio, et ai., 2003; dobbs, 2004) there is a paucity of knowledge generated by independent evaluators using rigorous methods as to the impact of participation in an outsourcing strategy on employee attitudes and behaviors. most available studies are limited to testimonials from managers and consultants who have implemented outsourcing strategies (cassale, 1996; corbett, 1996; crane, 1999; bender, 1999; farrell & rosenfeld, 2005; fraser, kane, & schaefer, 2004; feulner, 2004; irwin , 2004). the central theme that runs through most of the studies on outsourcing strategies reflects a common 182 journal of business strategies belief that they generally improve organizational effectiveness or may have a severe impact on organized labor force and deterioration of morale among employees (drezner, 2004; florida, 2004; jasper, 2003; engardio, et ai., 2003; charara, 2004). consequently, more information is needed to understand issues, directions, and implications of outsourcing strategies to both employers and employees and to study the effects of outsourcing strategies on participants attitudes (the human aspects) as well as job performance (the financial aspects) of the program . research framework the preceding discussion provides a basis to the research framework. it identifies several outsourcing measurement variables including cost, dependability, flexibility, quality and variety of products and services, quality of work-life indicators, suppliers' capability and performances. the casual linkages among these variables are assumed to influence organizational performance and customer responsiveness. the research model views these variables as important elements of effective outsourcing strategy and linked to organizational performance as shown in figure 1. both the financial and the human aspects of outsourcing and findings from organizational behavior knowledge suggest six research hypotheses to guide an investigation of the impact of outsourcing strategies on participant's attitudes and job performance: hypothesis 1: participants in outsourcing strategies will report lower levels of job satisfaction than will non-participants. hypothesis 2: participants in outsourcing strategies will report lower scores in quality of work life measures than will non-participants. hypothesis 3: participants in outsourcing strategies will report lower levels of organizational commitment than will non-participants. hypothesis 4: participants in outsourcing strategies will report higher intensions to quit than will non-participants. hypothesis 5: managers will report positive assessments of the contributions of outsourcing strategies to organizational performance. hypothesis 6: outsourcing strategies will provide measurable financial returns to the sponsoring organization. these hypotheses are tested in a longitudinal and experimental field study that compares changes in perceptions of quality of work life attitudes and job pervolume 27, number 2 183 formance, for participants and non-participants in an outsourcing program in an industrial setting. figure 1 conceptual model of strategic outsourcing performance measures flexibility: • product flexibility • volume flexibility • launch flexibility • access flexibility (2) quality of work-life indicators • participation • communication • motivation • accomplishment • advancement • commitment • job security (3) strategic outsourcing activities and decisions impact of outsourcing on overall organizational performance suppliers capability • switching costs • net income • number of suppliers • roi • number of substitutes • type of product • higher quality • delivery reliability (9) (4) (6) productivity • growth rate • market share • export growth turnover rate (7) [adapted from narasimhan & jayaram, 1998; kennedy, et ai., 2002; judge & dooley, 2005; geyskens, et al., 2006; kumar & eickhoff, 2006; bolumole, et ai., 2007.j 1 0.55, 2 0.54, 3 0.36, 4 0.35, 5 0.42, 6 0.62, 7 0.65, 8 0.52, 9 0.64. these numbers refer to the results of the multiple regression variations between performance and several variables in this study. methodology research sites and participants this research was conducted in two manufacturing plants of a large, diversified, non-unionized, multi-divisional corporation located in an urban area in the 184 journal of business strategies midwestern united states. the company has a total offour assembly plants located in three states. the two plants used for this study were located in the same state and produced a variety of electronic components, measuring and control devices , control panels, and auto parts components. plant "~' provided an experimental group of individuals who were already involved in several types of outsourcing functions (e.g. , upgrading their information technology capabilities, managing their logistics and their supply chain , administrating standard employee benefits, outsourcing some electronic components, transfer of staff and/or production functions to a more efficient location, and removing or adding new product lines) and who participated in implementing the outsourcing program in their plan. plant "b" within the same company provided a matched comparison group of individuals who did not adopt outsourcing programs for their plant and indicated that they did not anticipate wanting to seek such an adoption in the foreseeable future due to internal environmental issues and highly effective relationships between labor and management, which include participation of employees in decision making and having weekly meetings between labor and management. the experimental plant "a" had a workforce of 1,600 employees at the time the study was planned, but the workforce was reduced to 896 employees due to outsourcing activities such as logistics and supply chain, some electronic components, transfer of staff to different locations and outsourcing employee benefits. the comparison plant "b" employed 1,500 employees at the beginning of the study, and there was little change in the total number of employees during the same period of the study. both plants produced the same type of products, employed the same technologies, and had similar work forces. the participants in the outsourcing program and non-participants were comparable on most areas. both plants were in financial distress due to high operation costs . the participants in the outsourcing program included employees who stayed with the company and /or worked with those employees transferred from other locations within the company due to outsourcing decisions or laid off, were also known as "survivors." during the time of this study, the company (included both plant a and plant b) was in financial distress primarily due to high operation costs, low productivity, high reject rates , little export sales, and intensive foreign competition . in response to these problems and with an eagerness to increase export sales and cut cost, a new training and outsourcing programs were introduced in plant "a." the new program in plant "a" was actively keeping abreast of new trends in cost cutting techniques and practices, especially those associated with outsourcing programs and to some degree cost-cutting techniques. the outsourcing program was one technique that atvolume 27, number 2 185 tracted the attention of top managers because many industries are finding outsourcing strategies may be directly related to future survival. a consulting group was invited to train managers and employees at all levels of the organi zation and assist in the implementation of the outsourcing program. the consulting group made it clear from the beginning that success depended to a large degree on the cooperation and participation of all job holders and support from senior and middle management. measures of quality of work life and organizational commitment perceptions a questionnaire, archival data , and follow-up interviews were used to accomplish this study. the questionnaire was designed to tap a wide range of quality-of-work life facets , with measures derived from the michigan organizational assessment package and organizational commitment measures package. the michigan instrument and organizational commitment measures have been shown to have acceptable levels ofreliability and validity across a variety of settings (lawler, 1975; marks, mirvis, hacket, & grady, 1986; tett & meyer, 1993). responses were reported on seven-point scales, ranging from one (low) to seven (high) for all measures. included in the questionnaire were measures of each of the researched quality-of-work life areas. measures of participation and communication available from the questionnaire was a self-report of the frequency with which suggestions are offered at work, an item assessing satisfaction with opportunities to take part in decisions, scales of work team communication. measures of organizational commitment were measured with the 15-item scale. responses were reported on sevenpoint scales anchored by strongly agree and strongly disagree. the population sampled included all full-time employees in both plants: production workers, machine operators, supervisors, support staff in information technology, supply chain , human resources and managers from different functional areas, and senior managers. there were two surveys to accomplish this study. one survey was conducted at the research sites just prior to the implementation of the outsourcing program to assess employee attitudes and quality-of-work life facets in general in each plant. questionnaires were returned by 548 employees at plant ''pl' generating 34% participation rate. at plant "b," 540 employees returned the questionnaire, generating a 36% participation rate . a second survey was conducted 18 months after the program had begun to assess any changes on employee perceptions . 362 employees at plant "a" and 610 employees at plant "b" returned question186 journal of business strategies naires generating a 40% participation rate for both plants . a demographic description of the survey respondents was compared to that of the whole population at both plants. this way, it could be determined if the actual sample was representative of the population. the results of that comparison indicated that the demographic characteristics of both the sample and the whole population at both plants were similar in all aspects. the sample included 60% males and 40% females, who had a high school education or more and earned an average income of $24,000 a year. several variables were identified for the purpose of this study including independent elements such as cost, flexibility, dependability, quality, outsourcing activities, and suppliers power. other variables focu sed on dependent elements including organizational performance, quality of work-life dimensions , and customer satisfaction and outsourcing dimensions to enhance their credibility. the reliability of measuring scales used in this study was estimated at 0.73 , as determined by applying cronbach's alpha formula to mean inter-item correlation. although the magnitude of a reliable cronbach's alpha is addressed differently by researchers, a value greater than 0.70 is typically considerably good criterion for adequate scale reliability (cronbach , 1951 ; nunnally, 1987). measures of organization performance actual data actual organizational data from the surveyed firm (productivity, quality, flexibility, and other performance indicators) were used to assess the impact of outsourcing strategies on organizational performance. productivity was measured by ratio of output produced to resources used. four productivity measures were available from organization records: efficiency rate (number of products produced within quality specification divided by industrial engineering output rate) (beamon, 1999). system efficiency level includes personal requirement, equipment utilization energy usage and cost (chase, nicholas, & jacobs , 2000). flexibility measures can measure a system's ability to accommodate volume and schedule functions from supplier, manufacturers, and customers. flexibility is vital to the success of the outsourcing program in an uncertain environment (narasimhan & jayaram, 1998). overall productivity (total hours earned [number of actual pieces of product produced divided by number of pieces of product expected to be produced] divided by total hours paid) (marks, et ai., 1986; mott, 1972). volume 27, number 2 187 additionally, records of quality and customer complaints were collected from an internal quality audit and the number of defects per finished product per 1,000 units was added and averaged per six months (crosby, 1979). furthermore, records of return on trading assets and other performance indicators were collected from sales and financial statements and were reported in percentage to total sales (beamon, 1999). data for each of the performance measures were collected for a 24-month period , ranging from six months prior to the adoption of outsourcing program to 18 months after the program began. this length of measurement provided adequate time to assess the impact of outsourcing program on employee productivity, quality of their products, and return on trading assets. average rates were then computed for six-month intervals and compared before and after the program began. period 1 represents the average rate for the six months prior to the program implementation, period 2 is the average rate for the first six months after the program was operational , period 3 is the average rate for months 7 12 , and period 4 is the average rate for months 13 18 . managerial assessrnent in-depth and structural interviews were conducted with twenty managers and supervisors including the plant managers, human resources manager, several operations managers, frontline supervisors, and controller in this manufacturing facility. the purpose of the interviews was to obtain a deeper perspective of the effect of outsourcing program on productivity, cost, flexibility, customer responsiveness, quality, employee performance and turnover rate as well as to assess the effectiveness of the program relative to its costs. furthermore, the interviews were used to rule out other possible explanations for changes in employee performance in the plant. during the interviews, the managers and supervisors responded to a seven item questionnaire. another interview was conducted with five senior managers of the company to assess the effectiveness of the outsourcing program and to discuss how the company might be able to salvage employees who had difficulty adapting to outsourcing strategies. another issue discussed with senior managers was how to manage the "survival syndrome" and increase employees motivation and engagement as a result of changes in the organization. 188 journal of business strategies results and analysis of quality of work life perceptions to measure the quality-of-work life and organizational commitment perceptions , several statistical tests were employed to evaluate the research hypothesis, including univariate f-test across time periods for each dependent variable for differences between experimental and comparison groups and multiple regression analysis. table i presents the mean scores of quality-of-work life and organizational commitment perception measures for participants and non-participants before and after implementation of the outsourcing program. there were differences over time for each variable for the participant groups at plant "a" but not for the non-participant groups at plant "b." for example, there was a difference between the mean values for suggestions offered within the participant groups across the three time periods, but there were little differences between the mean values for the same variable within the non-participant groups. there were also some differences at periods 2, 3 and 4 between the two groups in mean values for suggestions offered, participation in decision making, work group communication, meaning, challenge accomplishment, advancement, and organizational commitment. table 1 summarizes the results, which show a clear pattern of changes in the means . the greatest and most consistent changes were between period i and period 4, when all quality-of-work life and organizational commitment dimensions in the participant groups decreased significantly. by period 4, however, all dimensions had decreased to a level significantly different from period 2. the overall preparticipation f-value (\.10) was not significant, but the post participation in the outsourcing program f-value (3.27) was significant at the .05 level. the f-values were also significantly different from each other at the .01 level. volume 27, number 2 189 table 1 results of univariate f-tests for differences between participants and nonparticipants in the outsourcing program dependent variables of period 1 period 2 period 3 period 4 change quality-of-work life prior to first 6 for months for months period 1 dimensions outsourcing months 7-12 13-18 period 4 f-value suggestions offered participants 2.90 1.30 1.20 1.20 1.20 3.60* nonparticipants 2.92 2.90 2.94 2.92 0.00 4.02 participation in decision making participants 3.88 2.30 2.20 2.20 1.50 4.28** nonparticipants 3.87 3.86 3.88 3.88 0. 05 2.70 work group communication participants 3.20 2.15 2.10 2.05 1.08 4.90* nonparticipants 3.25 3.20 3.25 3.30 0. 00 2.22* organization communication participants 2.60 1.85 1.60 1.66 0.83 4.92** nonparticipants 2.64 2.60 2.65 2.65 0. 01 3.80 meaning participants 3.77 2.1 0 2.05 1.95 1.68 5.25** nonparticipants 3.80 3.80 3.80 3.80 0.00 2.06 challenge participants 2.88 1.85 1.90 1.77 1.01 5.40** nonparticipants 2.90 2.90 2.85 2.95 0.00 3.68 personal responsibility participants 2.80 1.75 1.45 1.60 1.15 4.30** nonparticipants 2.84 2.80 2.88 2.85 0.00 3.80 accomplishment participants 3.66 1.70 1.60 1.40 1.50 4.40* ' nonparticipants 3.70 3.65 3.60 3.75 0.00 3.30 advancement parti ci pants 2.78 1.94 1.90 1.70 0.85 4.40*' nonparticipants 2.74 2.70 2.70 2.75 0.00 3.20 organizational commitment participants 3.20 1.60 1.40 1.30 1.40 4.60* nonparticipants 3.20 3.20 3.25 3.28 0.04 4.90* * p < .05; ** p < .01 further analysis of the relationship between the outsourcing system, qu alityof-work life, and organizational commitment was done with the use of multiple regression ana lysis. thi s ana lys is determine s the proportion of varian ce in qualityof-work life and organizational commitment scores explained by the outsourcing program scores. the principle behind an outsourcing program is farmin g out cer190 journal of business strategies tain activities or processes, usually performed by company employees, to external contractors specializing in such activities or processes. functions, or performance indicators, were used to measure the independent variables in this study as defined in the questionnaire. table 2 multiple regression of the relationships between participation in the outsourcing program and perceptions of quality-of-work life and organizational commitment independent variable dependent variables 1. participation in decision/making implementation 2. suggestion offered/implemented 3. work group communication 4. organization communication 5. job meaningfulness 6. job challenge/motivation 7. personal responsibility for work 8. perceived opportunities for accomplishment 9. perceived opportunities for advancement 10. perceived organizational commitment 11 . intentions to quit all p < .01 dependent variable at period 1* .0262 .2212 .0282 .2444 .2640 .2630 .2925 .2887 .2510 .2240 .2870 .2618 .2370 .2070 .2290 .2062 .2380 .2118 .2540 .2250 .1488 .1230 dependent variable f-ratio at period 4* average -.1426 -.1238 4.10 -.1566 -.1440 3.38 -.1678 -.1470 3.10 -.1830 -.1640 4.40 -.1 844 -.1630 3.38 -.1537 -.1420 4.22 -. 1487 -.1222 3.47 -.1588 -.1392 3.77 -.1820 -.1677 3.48 -.1850 -.1720 3.90 -.3880 -.3620 3.45 * period 1 prior to the implementation of the outsourcing program and period 4 after the programfs inception. the negative sign indicates negative variations or relationships . table 2 presents the results , of this analysis, which indicates a negative relationship between measures of the outsourcing program, quality-of-work life, and organizational commitment as reflected in the multiple regression rations (r2). the results show that more than -12.38% of the variation in participation in decision making, -14.40% of the variation in suggestion offered, -14.70% of the variation in group communication, -16.40% of the variation in organization communication, -16.30% of the variation in job meaningfulness, -14.20% of the variation in job challenge, -13.92% of the variation in perceived opportunities for accomplishment, -16.77% of the variation in perceived opportunities for advancement, and more than volume 27, number 2 191 -17.20% of the variation in the perceived organi zational commitment are explained by linear regression on the outsourcing program dimensions. the f-ratios indicate that these linear associations are statistically significant at the .01 level. these findings, as well as the univariate f-tests across time periods, provide evidence to substantiate the research hypotheses (1 to 4), and coincide with the claims of many academicians and authors that some of the consequences of job outsourcing not only culminate with unemployment but also the loss of capital. it can result in the deterioration of morale among employees, decrease quality-of-work life, and organizational commitment attitudes among employees as a consequence of outsourcing decision (engardio, et ai. , 2003; jasper, 2003; kennedy, et ai. , 2002 , charara, 2004; crolius, 2006; dobbs, 2004). analysis of organizational performance impacts table 3 presents the average six month rate s for the performance measures beginning six months prior to the adoption of the outsourcing program until 18 months after the program began. for each measure, the average percentage of production efficiency rate was 44%, system efficiency rate was 56%, overall productivity average rate was 64%, the average number of defects per 1,000 units was 222%, system flexibility rate was 50% , net income average rate was 4% , return on investment average rate was 2%, market share average rate was 2%, export grow th average rate was 0% , and turnover rate was 18% before the implementation of the outsourcing program. table 3 also presents the average rates 18 months after the program began. for each measure, the average rate for the two periods was different. as can be seen in the table, some degree of improvement was shown in each area after the program began. all except for turnover rate was increased, which means more employees are leaving or have the intent to leave the company due to outsourcing activities or feeling job insecurity. at the same time, there were negative or no significant differences for performance dimensions for the comparison group in plant "b" that did not adopt the outsourcing program in their plant as seen also in table 4. furthermore, the performance measures document a negative result for the non-participants group in areas such as system flexibility and efficiency and showed no improvement in areas such as net income, return on investment, market share, or expert growth. 192 j our nal of busin ess strategies table 3 data from organi zational records before program after outsourcing program adoption in implementation plant "a" after program implementation prd 1performance pro 1 prd2 pro 3 prd4 pro 2-4 avg4 dimensions in (%) avg% avg% avg% avg % avg% avg% production efficiency rate 44 52 58 58 56 27 inc. system efficiency level 56 58 60 62 60 7 inc. overall productivity rate 64 66 70 70 68 6 inc. quality given in number of defects per 1,000 units 222 180 171 170 174 21 inc. system flexibility 50 54 58 54 55 10 inc. other performance indicators net income 4 5 6 8 6.3 57 inc. return on investment 2 3 3 4 3.3 65 inc. market share 2 2 4 4 3.3 65 inc. export growth 0 4 100 inc. turnover rate 18 39 46 48 44 144 inc. table 4 data from organ izational records before after program implementation program avg % of increase or decrease implementation plant "a" plant "b" performance pro 1 pro 2-4 pro 2-4 dimensions in (%) avg% avg % avg% production efficiency rate 44 56 27 inc. 48 7.6 dec. system efficiency level 56 60 7 inc. 52 14 dec. overall productivity rate 64 68 6 inc. 62 6 dec. quality given in number of defects per 1,000 units 222 174 21 dec. 190 5.5 inc. system flexibi lity 50 55 10 inc. 52 3.8 dec. other performance indicators net income 6 6.3 57 inc. 4 20 dec. return on investment 2 3.3 65 inc. 2.2 2.6 dec. market share 2 3.3 65 inc. 2 0 export growth 0 4 100 inc. 0 0 turnover rate 18 44 144 inc. 42 8.6 dec. volume 27, number 2 193 relationship between outsourcing decisions and performance the relationship between outsourcing decisions and supplier power and organizational performance was examined through the use of multiple regression analysis. table 5 presents the results of this analysis. these results point to a positive relationship between measures of outsourcing decision and supplier power and the organizational performance, as reflected in the multiple regression ratios. the results show the variations (55% in cost (unit price), 35% in quality, 54% in flexibility, 42% in dependability, and 64% in overall performance) as explained by linear regression for the outsourcing decisions and supplier power dimensions. the f-ratios indicate that these linear associations are statistically significant at p < .oj. the causal link between outsourcing decision and organizational performance was statistically significant, confirming prior expectations and complementing previous studies (walsh & deery, 2006; chase, et ai., 2000). the study points to positive impact of outsourcing decisions and supplier power on the organizational performance in terms of low cost, high quality, flexibility, and dependability, thus improving competitiveness and profitability (narasimhan & jayasam" 1998; chase, et ai., 2000; vickery, jayaram, droge, & caiatone, 2003; roberts, 2006). these findings provided positive responses to hypotheses (5 and 6) of the study. table 5 results of regression analysis for outsourcing decision and supplier power and organizational performance dependent variable outsourcing decisions and supplier power cost (unit price) quality flexibility dependability (1 to 5) performance dimensions all p < .01 multiple regression 0.68 0.44 0.69 0.56 0.79 findings from follow-up interviews regression square (r2) f-ratio 0.55 5.60 0.35 3.42 0.54 5.40 0.42 4.75 0.64 9.64 in the interviews, all twenty managers and supervisors including the plant controller expressed overwhelming support for the outsourcing program. they also claimed that the program was making a contribution to organizational productivity, quality of products, and export sales. however, the outsourcing program 194 journal of business strategies had negative effects on quality-of-work life dimensions and turnover rates in the plant "a." the plant manager indicated that his plant gained 8,000 hours in the production areas due to reduced absenteeism. he claimed that the proportion of employee days missed dropped from 11% per year to less than 7% for the whole plant. the human resource manager, the operations manager, and the information system manager claimed the program to be a success in the areas offill rate, on-time deliveries, reliable delivery, customer responsiveness, quality, customer service, and production costs. however, the outsourcing program had negative effects on quality of work-life dimensions such as job security among employees, and turnover rates in the plant. most of the interviewed managers agreed that the consequences of outsourcing and job stress must be addressed directly. employees must be encouraged to reengineer their jobs and make them more manageable. all employees must be treated fairly. all twenty managers, engineers, supervisors, and the plant controller provided independent assessments of the effectiveness of the outsourcing program and expressed confidence in the program. they pointed to improvements in customer service and equipment performance and maintenance, including computer-internet, as well as online hardware and software components. these in-depth interviews also provide evidence to substantiate research hypothesis five (5), regarding managerial assessment of the contribution of the outsourcing program to organizational performance. furthermore, they indicated that there were no other major changes in activities, technologies or incentives in their plant for the 18 months following the program initiation that could have accounted for the gains. they also remarked that there were no major shifts or changes related to the competitive environment within their region. to make corporate outsourcing more effective in the future , most of the senior managers surveyed in this company suggested that their company should empower lower level employees with some of the corporation's decisions, taking advantage of potential opportunities overseas and establishing training, retaining and outplacement counseling programs . furthermore, these senior managers indicated that managers and employees in plant "b" were in financial distress and must adopt new cost cutting techniques and practices, especially those associated with outsourcing programs. for the effectiveness of operations, furloughs are preferable to layoffs. generally speaking, a furlough is a temporary unpaid leave of absence during which an employee would not perform his or her usual and customary job duties. volume 27, number 2 195 discussion the attitudinal results of this research found that outsourcing was a major change from the "normal" way of doing business. statistical analysis indicated that involvement in the outsourcing program in this case was negatively related to perceived changes in satisfaction with opportunities, for participation at work, to accomplish something worthwhile at work, and enhancing opportunities and skills for advancement in the organization. furthermore, participation in the outsourcing program was negatively related to perceived changes in communication throughout the organization, as well as job meaningfulness, challenge, and personal responsibility for work. these findings, as well as the statistical analysis across time periods, provide evidence to substantiate the research hypotheses (1 to 4) regarding the impact of outsourcing decisions on job satisfaction, quality of work life, organizational commitment, and employees' intentions to quit the organization. the overall preparticipation in the outsourcing program f-value (1.10) was not significant, but the post participation in the program f-value (3.27) was significant at the .05 level. it is therefore, appropriate to accept the research hypotheses (i to 4) in this study and to state with more than 95% confidence (p < .05) that a negative relationship was found between outsourcing program, job satisfactions (hypothesis 1), quality-of-work life (hypothesis 2), organizational commitment, (hypothesis 3) and higher turnover intentions (hypothesis 4) as shown in the research model figure 1 in this study. these findings coincide with the claims of many academicians that implementation of outsourcing activities can increase job dissatisfaction, increase turnover rates , and decrease employee motivation and commitment (kennedy, et ai., 2002; engardio, 2006; charara, 2004). the results indicated that of the participants with negative views of outsourcing, almost sixty percent of the participants were more dissatisfied with their jobs and the work environment, and they were more likely to leave the company as soon as they find a more reliable work environment. furthermore, outsourcing, specifically, has shown to evoke employee's fear of the unknown, anxiety over the future, nostalgia for the old days, and resentment over the loss of identity and job security. a new "psychological contract" is recommended to fill the gap created between employees and their employer. the contract will add more responsibility on workers' in terms of work load, additional time, creativity, team work at the exchange of greater payment, performance based reward, and training and development, which increases their employment opportunity (sahdev, 2004, baruch & hind, 1999). 196 journal of business strategies to manage the " survival syndrome" and increase workers' motivation and engagement, managers must work to improve the communication flow, encourage workers to participate in decision making, relate reward to performance, treat employee as individuals, build trust in leadership, and use other motivational methods (woodruff, 1995, hr focus , 2009). the performance measures, however, document a positive impact of outsourcing activities on employee performance. participants in the outsourcing program tended to increase the percentage of time spent on an actual production, produced a higher rate of products and increased export sales within industrial engineering specifications. the link between these favorable changes and the outsourcing program were supported further in the follow-up interviews with key managers in the plant. all of those interviews indicated that the outsourcing program made a contribution to the organizational productivity, quality of products produced, and performance dimensions. these in-depth interviews and these findings as well as the statistical analysis across time periods provide evidence to substantiate the research hypotheses (5 and 6) regarding the impact of outsourcing decisions on performance dimensions (efficiency, productivity, quality, flexibility, and other performance indicators). the overall postparticipation in the outsourcing program f-ratios indicate that these liner associations are statistically significant at the .05 level. it is therefore appropriate to accept the hypotheses (5 and 6) in this study and to state with more than 95% confidence (p < .05) that a positive relationship was found between outsourcing program and performance dimensions as shown in the research model figure 1. these changes can, at least in part, be attributable to the outsourcing activities. prior to the outsourcing program, for example, machine operators would wait for a set-up person to make a needed adjustment in a machine or other equipment. from outsourcing program discussions, some employees learned how to make these adjustments and increased the percentage of time spend on actual production. although the overall performance increased for the outsourcing program participants, little changes were found in the nonparticipant group, plant b. this may be a contamination effect as a result of the outsourcing activities, where outsourcing has shown to evoke employees' fear of the unknown, loss of jobs, and uncertainty over the future. people who had jobs may have increased their attendance and productivity at work in an effort to help insure keeping their jobs (charara, 2004; kennedy, 2002; engardio, 2006). volume 27, number 2 197 limitations there are obvious limitations to the perceptual and self-reported data collected in this study, as well as with correlation analysis of such data. interview responses from the key managers could be biased since the program was one that they may have personally requested or supported. [n addition to these limitations, a training program was conducted in plant "i>:' and plant "b." the training was directed to increase efficiency and improve quality which may have improved organizational performance. in this case, it was very hard, ifnot impossible, to distinguish between the effects of their outsourcing program from the training program in plant "a." however, significant observed performance improvements were reported in plant "a" not plant "e." in addition, the data is collected from only one firm, which means the results cannot be generalized to other firms. despite these limitations, this exploratory empirical investigation provides tentative avenues for increasing the probability of success of outsourcing projects and identifies areas that need further research . this study identified key dimensions of an outsourcing strategy and organizational performance dimensions in one firm in a manufacturing setting. nevertheless, further work is needed in a variety or industry settings to confirm a global outsourcing-supply chain management-performance linkages and should incorporate suppliers, customers, and other shareholders into the measurement and analysis process. conclusion and implications over the past decade, outsourcing and restructuring became the predominant reaction to global competition, low productivity, and increasing labor costs in corporate america. recessionary pressures have forced many businesses, including this corporation to maintain efficiency and reduced personnel in an attempt to retain bottom line and to increase profitability. outsourcing strategy has been prescribed as an important tool for attaining and maintaining a competitive advantage. in addition , outsourcing is growing in appeal to organizations because of the cost savings achieved in executing operations. it is also seen as a means to draw on the expertise and resources of a partner to shorten time to market, increase customer satisfaction, and to exploit fast-changing technology. at the same time , outsourcing has created two kinds of victims: workers who have lost their jobs and suffered the hardship oftrying to find new employment, and employees who have survived the outsourcing cuts but suffered the physical and 198 journal of business strategies psychological burdens of a downsized environment. to make corporate outsourcing more effective in the future , most of the senior managers surveyed in this company suggested that their company should consider adapting measures to prevent these negative developments. these efforts include not bulking up on layers of management in times of expansion, empowering lower level employees with some of the corporation's decisions, taking advantage of potential opportunities overseas, and establishing training, retaining and outplacement counseling programs. the senior management of this company indicated that they are willing and ready to combine the advantages of a cost effective strategy such as the outsourcing program in plant "a" and also harness the engine of full employee motivation and commitment as the case in plant "b." managers must work to improve the communication flow, encourage workers to participate in decisions-making, relate reward to performance and listen and take responsibility oftheir actions. managers must explain the criteria for job cuts. when possible, long-term strategies and innovation must be encouraged and the costs of outsourcing avoided. outsourcing strategies can be used as effective tools for competitive positioning when firms realize that people are business. however, they are not universal solutions to organizational problems and they are not simple or easy to develop and support. implementation is a complex task that requires time and commitment; however, the payoffs can be enormous. productivity, quality, customer satisfaction, and performance are likely to be improved by well implemented outsourcing programs tied to highly effective human resources strategies. references baily, m. n., & farrell, d. (2004, april). exploding the myths about offshoring. the mckinsey global institute 2004. retrieved from http://www.mckinsey.com/ mgi/publications/myths.asp baily, m. n. , & farrell, d. (2004). is your job headed for banglore? the myths and realities of outsourcing. the milken institute review. retrieved from http:// www.milkeninstitute.org/publications/reviewi2004 _12/33 _ 41 m r24. pdf bartlett, b. (2004, july). how outsourcing creates jobs for american. national center for policy analysis, 480. baruch, y. , & hind, p. (1999). perpetual motion in organizations: effective management and the impact of the new psychological contracts on "survivor syndrome." european journal of work and organizational psychology, 8(2), 295306. volume 27, number 2 199 beamon, b. m. (1999). measuring supply chain performance. international journal o/operations & production management, 19(3),275-292. bender, p. (1999). market momentum in managing manpower. outsourcing journal. retrieved from www.outsourcing_journal.comlissues bolumole, y., frankel, r., & nasland, d. (2007). developing a theoretical framework for logistics outsourcing. transportation journal, 46(2), 35-54. cassale, f. j. (1996). introduction to outsourcing. the outsourcing institute . retrieved from http://www.outsourcing.com/howandwhy/toplo/main.htm. charara, j. (2004). impact of outsourcing 'lasts years.' people management, 2(4), 15-18. chase, r. b., nicholas j. a., & jacobs, r. f. (2000). operations management for competitive advantage. chicago: irwin publishing co. corbett, m. f. (1996). redefining the corporation: bringing order to a new industry. outsourcing leadership forum, 1-7. corbett, m. f. (1999). multiple factors spur outsourcing growth. outsourcing journal. retrieved, from www.outsourcing-journal.com/issues/jan1999-index. html. corbett, m. f. (2002). executives reveal the future of outsourcing. firmbuilder. retrieved from http://www.firmbuilder.com. crane, d. (1999). renewed focus on financial performance. outsourcing journal. retrieved from www.outsourcing-journal.comlissues/. crolius, r. w. (2006, february). america's workforce crisis. american ceramic society, 2, 8. crosby, p. (1979). quality is free: the art of making quality contain. new york: mcgraw-hill. dobbs, l. (2004). exporting america: why corporate greed is shipping american jobs overseas. new york: time warner book group. dobbs, l. (2004, august 27). a home advantages for u.s. corporations. cnn retrieved from http://www.cnn.com/2004/us /08/27/home.advantagel. donahoe, d. n., & pecht, m. (2003). are u.s. jobs moving to china? ieee transactions on components and packaging technologies, 26(3), 682686. drezner, d. (2004, may). the outsourcing bogeymen. council of foreign relations: foreign affairs. retrieved from http: //www.foreignaffairs. org/2004050ifaessay83304/daniel-w-drezner/the-outsourcing-bogeyman.html. elmuti, d. (2003). the perceived impact of outsourcing on organizational performance. mid-american journal of business, 18(2). 200 journal of business strategies engardio, p. (2006, june 3). the future of outsourcing: how it's transforming whole industries and changing the way we work. business week, 3969, 50-58 . engardio, p., bernstein , a., & kriplani , m. (2003, february 3). the new global shift. business week online. retrieved from http: //www.businessweek.com/ magazine/content/03 _ 05/ b381800 i.htm. engardio, p., bernstein, a. , kripalani , m., balfour, f., grow, b., & greene, j. (2003, february 3). is your job next? business week, 3818,20-29. farrell, d. (2004). a richer future for india. the mckinsey quarterly. retrieved from http://www.mckinseyquarterly.com/article _page.aspx?ar= 1440&l2+ 7&l 3= i 0&srid= 6&g. farrell, d., & rosenfeld , j. (2005, december). us offshoring: rethinking the response. mckinsey global institute. retrieved from http: //www.mckinsey.com/ mgi/publications/rethinking.asp. feulner, e. j. (2004, august 20). the truth about outsourcing. th e central new york business journal. 25. fitzpatrick , w. m. , & dilullo, s. a. (2007). outsourcing and the personnel paradox. sam advanced management journal, 72(3), 4-12. florida, r. (2004). america's looming creativity crisis. harvard business review, 82(10), 122-136. fraser, a. , kane, t., & schaefer, b. (2004, april). ten myths about jobs and outsourcing. the heritage foundation. retrieved from http://www. heritage.orgi research/ tradeandforeignaid/w m467.cfm?renderforpri nt= i. geyskens, 1. , steenkamp, j. 8. , & kumar, n. (2006). make, buy, or ally: a transaction cost theory meta-analysis. academy of management journal, 49(3), 519543. griffiths, d. (2001). the theory and practice of outsourcing. stc proceedings, pp. 112-117. hoffman, t., & thibodeau, p. (2003, april 29). exporting it jobs. computerworld, pp. 10-14. hr focus . (2009, august). layoff: survivor stress, pp. 10-16. irwin, d. (2004, january 29). outsourcing is good for america. the wall street journal , 243(19), a16. jasper, w. (2003). your job may be next. the new american, 19(5), 28-29. judge, w. 0., & dooley, r. (2005). strategic alliance outcomes: a transaction-cost economics perspective . british journal of management. 17, 23-37. kahn , j. , & blumenthal, r . (2004, april 26). made in the usa? not anymore. the new york times upfront, pp.1o-14. volume 27, number 2 201 kennedy, j. f., holt, d. t, ward, m. a., & rehg, m. t (2002). the influence of outsourcing on job satisfaction and turnover intentions of technical managers. human resource planning, 25(1),23-31. kiplinger's personal finance. (2009, november). on the job and feeling guilty, pp. 5-8. klass, b. , mcclendon, j., & gainey, t (2001). outsourcing hr: the impact of organizational characteristics. human resource management, 2(15),45-54. kotabe, m., & murray, j. (1996). determinants of intra-firm sourcing and market performance. international business review, 5(2), 121-135. kumar, s., & eickhoff, j. (2006). outsourcing: when and how should it be. information knowledge systems management, 5, 245-259. lau, r. s., & hurley, c. n. (1997). outsourcing through strategic alliances. production and inventory management journal, 38(2), 52-57. lawler, e. e. (1975). measuring the psychological quality of working life. in l. davis & a. cherns (eds.), the quality of work life (pp. 123-133). new york: free press. lazes, p., & savage, j. (2000). embracing the future: union strategies for the 21st century. journalfor quality & participation, 23(4), 18-23. lever, s. (1997). an analysis of managerial motivations behind outsourcing practices in human resources. human resource planning, 20(2), 37-47. li, x., & barnes, i. (2008). proactive supply risk management methods for building a robust supply selection process when sourcing from emerging markets. strategic outsourcing: an international journal. 1(3),252-267. marks, m. i. , mirvis, p. h., hackett, e. j., & grady, j. f. (1986). employee participation in a quality circle program: impact on quality of work life, productivity, and absenteeism. journal of applied psychology, 17(2),61-69. mathur, n. (2006, january). the state of out sourced public services: a pain for the workers. pa times. retrieved from ebscohost at eastern illinois university. mccracken, b. (2002). new report: most small businesses save significant sums through hr outsourcing. outsourcing center. retrieved from http://www.outsourcing-hr.com/report.html. mol, m. j. (2007). outsourcing: design, process, and performance. cambridge: new york. moses, a., & ahlstrom, p. (2008). dimensions of change in make or buy decision processes. strategic outsourcing: an international journal, 1(3),230-251. mott, p. e. (1972). the characteristics of effective organizations. new york: harper and row. 202 journal of business strategies musico, c. (2008, january 30). worldwide outsourcing market to grow 8.1 % in '08. destinationcrm.com. retrieved from http://www.destinationcrm.com /articles/ crm-news/daily-news/. narasimhan , r., & jayaram, 1. (1998). casual linkage in supply chain management: an exploratory study of north american manufacturing firms. decision sciences, 29(3), 579-605. nunnally, c. 1. (1987). psy chometric theory (2nd ed.). new york: mcgraw-hill book company. overman , s. (1995 , march). saturn teams working and profiting. hr magazine, 72-74. outlay, c., & ranganathan, c. (2005). exploring the downside of it outsourcing: outsourcing tactics , layoffs, and organizational outcomes. americas conference on information systems (amcis) amcis 2005 proceedings, pp. 20-27. reaser, l. (2004). outsourcing of u.s. jobs: threat or benefit? aba banking journal, 96(2), 96. roberts, c. r. (2005). outsourcing after-effects. washington times, pp. 6-8. retrieved from http: //www.washingtontimes.com. sahdev. (2004). revisiting the survivor syndrome: the role of leadership in implementing downsizing. european journal of work and organizational psychology, 13(2), 165-196. shore, b. (1996). the legacy of downsizing: putting the pieces back together. business forum, 21(3 & 4),5-10. smith, p. c., kendall. , d. m. , & hulin, d. l. (1969). the measurement ofsatisfaction in work and retirement. chicago: rand mcnally. spector, p. e . (1997). job satisfa ction: application, assessment, causes, and consequences. thousand oaks, ca: sage. stonecipher, h. (2004). outsourcing: the real issue. executive excellence, pp. 6-9 study notes offshoring downside. (2004, march 4). cnn money. survey of current and potential outsourcing end users. (1998). th e outsourcing institute membership. the dobbs report: answers on outsourcing. (2004, march 12). cnn mon ey. tett, r. p. , & meyer, 1. p. (1993). job satisfaction, organizational commitment, turnover intention, and turnover: path analysis based on meta-analytic findings. personnel psychology, 46, 259-292 . venkatraman , n. (2004), offshoring without quilt: the debate about the ethics of offshoring misses the point that it represents the next generation of business practice. mit sloan management review, 45(3), 14-16. volume 27, number 2 203 vickery, s., jayaram, 1. , droge, c. , & calantone, r. (2003). the effects of an integrative supply chain strategy on customer service and financial performance: an analysis of direct versus indirect relationships. journal o/operations management. 21(5), 523 -539. walsh, j., & deery, s. (2006). refashioning organizational boundaries: outsourcing customer service work. journal 0/ management studies. 43(3), 557-582 . weidenbaum, m . (2004). outsourcing: pros and cons. business horizons. 48(4), 311 -315. wood. (2009). act now to prevent survivor syndrome. business forum. 8(2), 6-9. woodruff. (1995, may). motivation: after the downsizing, part 2. hr magaz ine. pp.40-43. biographical sketches of authors dean elmuti, ph.d. is a professor and coordinator of management discipline in the lumpkin school of business and applied sciences at eastern illinois university. previously he was employed for several years by multi-national corporations in the middle east. he has published extensively (more than 90 journal articles) in the areas of quality, team based management, outsourcing, human resource challenges, and global competitiveness. julian grunewald, mba, is currently a graduate student at eastern illinoi s university. he is currently working on leadership, outsourcing and supply chain management. during his studies, he has earned several awards and scholarships, in addition to being a graduate assistant. dereje abebe, mba, is currently a graduate student at eastern illinois university. he has worked in training and administration for several years . he is currently working on various researches including supply chain, entrepreneurship, and outsourcing. 204 journal of business strategies consequences of outsourcing strategies on employee quality of work life, attitudes, and performance openness and economic growth: empirical evidence on the relationship between output, inward fdi, and trade e.m. ekanayake bethune-cookman college daytona beach, fl richard vogel bala veeramacheneni farmingdale state university of new york farmingdale, ny abstract the relationship between openness and economic growth in developed and developinf? countries has been of continuing interest in both the theoretical and empirical literature. in this paper. we employ a vector autoref?ressive (var) model and error correction techniques to testfof the existence and nature afthe causal relationship between output level, inward fdi and exports across a cross-section ofboth developed and developinf? countries using datafrom 19602001. our main objective is to analyze the extent and sources of international linkages between openness and economic performance. the evidence supports hi-directional causality between exports growth and economic growth; the economic growth and fdi relationship has mixed results. introduction the relationship between export growth, foreign direct investment (fdi), and economic growth in both developed and developing countries is a question that continues to be of considerable theoretical and empirical interest. cross-country trade and capital flows, and interpreting the importance of these activities towards economic growth lie at the heart of the debate on economic development policy since the early literature on import-substitution to the current literature on openness and economic growth. recent literature has highlighted the role of both exports and fdi on economic growth. on the one hand, the export led growth (elg) hypothesis states that exports are the main determinants of overall growth. at the heart of the elg model are beliefs that (a) the export sector generates positive externalities on non-export sectors in the economy through more efficient management and production techniques (feder, 1983); (b) export expansion increases productiv60 journal of business strategies vol. 20, no.1 ity by creating scale economies (helpman and krugman, 1985; krugman 1997); (c) exports help to alleviate foreign exchange constraints and thus provide greater access to international markets (esfahani, 1991). endogenous growth theory extends this analysis by emphasizing the role of exports on technological innovation and dynamic learning (romer, 1986; lucas, 1988; grossman and helpmann, 1995; alisana and rodrick, 1999). on the other hand, empirical evidence in the last few decades indicates that foi flows have been growing at a pace far exceeding the volume of international trade. between 1975 and 1995, the aggregate stock of foi rose from 4.5% to 9.7% of world gdp, with sales of foreign affiliates of multinational enterprises substantially exceeding the value of world exports (barrell and pain, 1997). the effect of fdi on economic growth appears to have become quite explicit with multinational enterprises acting as the primary vehicle for the international transfer of technology (oeed, 1991). blomstrom and persson (1983) and blomstrom (1986) find that foi has created significant positive spillover effects on the labor productivity of domestic firms. it is argued that fdi plays a central role in the technological progress of recipient countries through the generation of productivity spillovers (borensztein, de gregorio, and lee, 1998; lim 2001). however, empirical work from both the elg literature and the foi and growth literature when studied in isolation show mixed results. this is mainly, due to the omission of a relevant mechanism through which openness or the re-structuring of an economy promotes growth. liberalization, in particular, is expected to increase not only trade but also foi. if a complementary relationship between foi and exports exists, then foreign investment may increase the volume of exports in specific and international trade in general. direct investment may encourage export promotion, import substitution, or greater trade in intermediate inputs, especially between parent and affiliate producers (goldberg and klein, 1998). along the same lines, blomstrom, globerman and kokko (2000) argue that the beneficial impact of fdi is only enhanced in an environment characterized by an open trade and investment regime and macroeconomic stability. in this environment, foi can playa key role in improving the capacity of the host country to respond to the opportunities offered by global economic integration. in the absence of such an environment, poi may impede rather than promote growth by enhancing the private rate of return to investment for foreign firms while exerting little impact on social rates of return in the recipient economy (balasubramanyam, salisu and sapsford, 1996). early studies supporting the elg hypothesis such as those by balassa (1978), heller and porter (1978) and tyler (1981) examined the simple correlation coefficient between export growth and economic growth, and based their conclusions based upon the high degree of correlation between the two variables. other studies, characterized by voivades (1973), feder (1983), balassa (1985), ram (1987), sprout and weaver (1993) and ukpolo (1994) find support for elg based upon growth and output regressions drawn from a growth accounting framework. these spring 2003 ekanayake, et al: openness and economic growth 61 studies make the 'a priori' assumption that export growth causes output growth without considering the direction of the causal relationship. a third group of studies has emphasized the issue of causality between export growth and economic growth. in this approach, exemplified by lung and marshall (1985), darrat (1987), and serletis (1992), the granger or sims causality test is applied to growth and export data to test the elg hypothesis. the causality tests are only valid if the original time series underlying the analysis are cointegrated. for a complete study on economic growth, the focus has to be not only on elg but fdi as well. therefore, the objective of this paper is to investigate the causal relationship between export growth, inward fdi and economic growth (measured as output growth) in developed and developing countries using the cointegration and error-correction models. these techniques, as successfully applied in studies by serletis (1992), bahmani-oskooee and alse (1993), dutt and ghosh (1996), rahman and mustafa (1998), islam (1998), cuadros, arts and alguacil (2001) and trevino, daniels, arbelaez, and upadhyaya (2002), demonstrate their econometric robustness and their ability to root out spurious relationships. so far, only a few studies have used this methodology to study the causality relation between export growth, economic growth, and fdi in both developed and developing countries. given the small number of studies conducted using this methodology, it is expected that this paper will contribute to this expanding body of literature. the rest of the paper is organized as follows. section 2 explains the methodology of the cointegration and error-correction models and a description of the data sources. section 3 contains the empirical results and comparison of our results with previous studies. finally, section 4 provides a discussion about the implication of the results and some summary conclusions. methodology and data methodology this paper uses the cointegration and error-correction models, to test the causal relationship between fdi, exports, and economic growth. we start by considering the three-variable vector autoregressive (var) model comprised of foreign direct investment 0, exports 0, and gross domestic product 0, all expressed in natural logs. as shown in equation (1), all variables are systematically and endogenously considered at first. where ao is a vector of constant terms, are all matrices of parameters (i = 1,2, ... , s), and c, ~ in (0,1). 62 journal of business strategies vol. 20, no.1 in order to analyze the causal relationship it is necessary to first check whether the variables are stationary. according to granger (1988), standard tests for causality are valid only if there exits cointegration. therefore, a necessary precondition to causality testing is to check the cointegrating properties of the variables under consideration. the cointegration and error-correction methodology is briefly outlined below. testing for cointegration among the three variables, real foi, real exports, and real gop (expressed in logarithmic form), is accomplished in two steps. first, following engle and granger (1987), the time series properties of each variable are examined by unit root tests. in this step, it is tested whether foi, exports, and gop are integrated of order zero, or in other words, that the three series are stationary. this is accomplished by performing the augmented oickeyfuller (aof) test. the aof test is based on the regression equation with the inclusion of a constant and a trend of the form r axt = f3n + f..u + 8,x1 ] + lf3jl1xlj + £( j=] (2) where ax, = x, xi] and x is the variable under consideration, p is the number oflags in the dependent variable (chosen so as to induce a white noise term), and £t is the stochastic error term. the stationarity of the variable is tested using the null hypothesis of iell = 1 against the alternative hypothesis of 18 1 1< i. if the null hypothesis cannot be rejected, it implies that the time series is non-stationary at that level and therefore it requires taking first or higher order differencing of the level data to establish stationarity. the optimum lag length (p) in the adf regression is selected using the minimum final prediction error (fpe) criterion developed by akaike and then the results were confirmed by the schwarz criterion. having tested the stationarity of each time series, the next step is to search for cointegration between infdi, inexp, and ingdp. this step investigates whether the stochastic trends in infdi, inexp, and ingdp that contained unit roots have a long-run relationship. in order to show that exports and economic growth have any type of causality, it is necessary to demonstrate that they are cointegrated in the granger sense. this is accomplished by using the johansen-juselius cointegration technique (johansen and juselius, 1990). since the johansen cointegration test is now well known it is not discussed here. engle and granger (1987) have shown that if variables such as infdi. inexp, and ingdp are integrated of order one, 1(1), and the stochastic error terms are both integrated of order zero, 1(0), then lnfdi, inexp, and ingdp are said to be cointegrated. when the variables are found to be both integrated of degree i( i), and cointegrated, then either unidirectional or bi-directional granger causality must exist in at least the 1(0) variables. if the variables are cointegrated then there must exist an error-correction representation that may take the following form: spring 2003 ekanayake, et al: openness and economic growth 63 k k k i1lnfdit = 'xi + jv,_j + l~il1lnfditl + l'i;,alnexp1_1+ lyii.i11ngdpti + £/, (3) i~j i~1 k k k i1lnexpt = eo + g~_1 + l el,.i11nexp,_ 1+ l e2,alngdpti + le3,.i11nfdi'i + £21 (4) i~1 ;=1 ;=1 k k k 111ngdp, = jt;) + hpt.1+ l7l'i,alngdp,_1 + l7l'2~lnexpi'1 + ~>3i.111nfdi'_1 + £3' (5) ;=1 ;=1 ;=1 where v l . i ' °/. 1 , and p t . j are the error-correction terms. the inclusion of errorcorrection terms in equations (3), (4) and (5) introduces an additional channel through which granger causality can be detected. however, in the absence of cointegration, a vector auto regression (var) in first-differences form can be constructed. in this case, the error-correction terms will be eliminated from equations (3), (4) and (5). if the series are cointegrated, then the error-correction models given in equations (3), (4) and (5) are valid and the coefficientsf, g, and h are expected to capture the adjustments of 111nfdi t , 111nexpt' and 111ngdp/ towards long-run equilibrium, while 111nfdi'.j' 111nexptl , and .i11ngdp, j and are expected to capture the short-run dynamics of the model data annual data for the period 1960-2001 are used for estimation. data on inward fdi, exports, and gross domestic product (gdp) for the selected developed and developing countries are from several issues ofthe unctad, world investment report, and international monetary fund's international financial statistics yearbook. the sample of countries consists of brazil, canada, chile, mexico, and united states. the choice of countries and span of data reflects data availability. nominal figures of foreign direct investment, exports, and gdp were deflated by the gdp deflator (1990= 100) for each country to express them in real terms. the gdp deflator was collected from the international monetary fund's international financial statistics yearbook. empirical results in the light of econometric methodology presented in the previous section, the cointegrating properties of the variables involved are examined and the empirical results are discussed in this section. table 1 presents the results of unit root tests obtained using the augmented dickey-fuller test. the results support the presence of unit roots in all of the series for all countries. this is confirmed by the fact that the null hypothesis that the series are non-stationary is not rejected at the levels for all variables. however, the null hypothesis is rejected in favor of the alternative hypothesis that the series are stationary when the first difference of the variables is taken. thus, their first difference 64 journal of business strategies vol. 20, no.1 is found to be stationary and hence, are all integrated of order one. in all cases, the null hypothesis that the series has unit roots cannot be rejected. the tests of unit roots support the unit root hypothesis at the 1%, 5 % or 10% levels of significance for all data series. having confirmed the existence of unit roots for all the data series, the next step involves applying the johansen-juselius cointegration test to check whether the three variables are cointegrated for each of the five countries. the optimum lag lengths are determined using the akaike final prediction error (fpe) criterion. the results of johansen-juselius cointegration tests are presented in table 2. the johansen-juselius cointegration test provides evidence for the existence of one cointegration vector implying that the three variables are cointegrated in these five cases. thus, the results of johansen-juselius cointegration test imply a long-run association between real exports, real foi, and real gop. therefore, equations (3), (4) and (5) have been estimated for these five countries including the error-correction terms. the empirical results of the estimated error-correction models are presented in table 3. beyond the analysis of the long-run relationship among the three variables in the system for each country, the short-run dynamics is also explored performing multivariate granger causality tests for the vector error-correction model. the f-statistics and probability (in parentheses) for the granger causality tests are presented in columns 2-4 in table 3. it also includes the t-statistics for error-correction terms for each of the three equations. for each variable in the system, at least one channel of granger causality is active, either in the shortrun through the joint tests of the lagged-differences or in the long run through statistically significant ect. our results are consistent with past time-series work with regards to the export-growth relationship. however, the results for foi-growth and foiexports relationships are mixed (table 4). in each of the five countries considered, there is evidence for the elg hypothesis in the short-run, although only canada provides evidence for elg in the long run. in the cases of canada and mexico, there is evidence for short-run growth-led exports granger causality. in fact, both canada and mexico show bi-directional causality between exports and growth. the evidence regarding the positive impact of foi on growth is limited. foi plays a significant role in brazil, mexico, and the united states. in the cases of canada and chile, the fstatistic on the lagged-foi variable is not statistically significant. however, chile and brazil show growth led foi. this is consistent with the fact that only since the mid-eighties have these countries attempted to improve their economies by stabilizing and opening up their economies to the world. brazil is the only country in the sample that showed bi-directional causality for foi and growth. similar to goldberg and klein (1998) and rodrik (1999) our analysis shows mixed results with regard to a complementary relationship between foi and trade. only the usa displayed bi-directional causality between foi and trade. spring 2003 ekanayake, et al: openness and economic growth 65 table 1 augmented dickey-fuller unit root test level inexp ingdp infdi country adf 1 adf 2 adf) adf 2 adf j adf 2 brazil -0.1209 -1.4922 -0.8987 -1.9952 -0.6923 -1.7541 canada -2.2528 -\.8608 -2.5698 -1.6612 -1.5515 -2.2133 chile -0.6840 -2.0577 -0.0561 -2.5097 -2.0557 -2.2679 mexico -0.7783 -\.8174 -0.2364 -2.0089 -0.3787 -2.1714 united states -1.3562 -2.7512 -1.0569 -2.7381 -0.7934 2.0634 first difference !j.lnexp !j.lngdp !j.lnfdi country adf 1 adf 2 adf) adf 2 adf j adf 2 brazil -2.6416* -3.2112* -3.4621 ** -4.0748** -2.8572* -4.9763*** canada -3.9361 *** -5.0946*** -2.8029* -3.9252** -4.3171*** -7.6965*** chile -4.1105*** -4.4926*** -3.5015** -3.4508* -4.4627*** -7.3178*** mexico -2.7181* -3.2041 * -3.0718** -3.2082* -3.9286*** -3.8777** united states -3.9069*** -4.6362*** -3.1874** -3.8792** -4.0381 *** -4.6104*** notes: m adf i tests hn : ell =:; 0 in i1lnx, =:; f3n + 8 11nx,r + di'j.lnx,j + £, m adf2 tests hn : el 2 =:; 0 in i1lnx, =:; rpo + rpllnx,.r + l~1'.lnx'_j + ~1 1=1 (6) (7) *, **, and *** denote statistical significance at the 10% 5%, and 1% levels, respectively. the critical values of adf) statistics as reported in engle and yoo (1987), for 50 observations are -3.58, -2.93, and -2.60 at 1%,5%, and 10% levels of significance respectively. the critical values of adf 2 statistics as reported in engle and yoo (1987), for 50 observations are -4.15, -3.50, and -3.18 at 1%,5%, and 10% levels of significance respectively. in the cases of brazil and mexico there are indications of a positive causal relationship for export led fdi. however, for canada and chile there is no evidence of causality. the findings of this study are consistent with the findings of selected studies (goldberg and klein, 1998; rodrik, 1999; cuadros, orts, and alguacil, 2001). however, since the coverage of countries varies from study to study no direct comparison can be made. in general, the differences in outcomes of these studies could be due to a number of reasons including different time periods, different sample intervals and different methodologies. 66 journal of business strategies vol. 20, no. i table 2 johansen multivariate cointegration tests trace test null hypothesis brazil canada chile mexico united states r=o 31.01 30.94 44.54 33.05 35.32 r? i 12.91 11.07 12.03 9.59 16.73 r~ 2 0.16 0.28 0.02 0.10 0.87 maximum eigenvalues test null hypothesis brazil canada chile mexico united states 18.10 19.87 32.51 23.46 18.59 12.75 10.79 12.01 9.49 15.86 0.16 0.28 0.02 0.10 0.87 cointegration equations normalized on 1nexpt null hypothesis brazil canada chile mexico united states constant -2.7645 -6.0122 -1.2124 -5.1818 -2.8392 ingd? 0.1032 1.1797 0.7831 4.4062 0.8779 r (0.389) (0.189) (0.024) (2.042) (0.310) infdi 0.8628 0.2474 0.2611 5.4206 0.1904 i (0.497) (0.097) (0.060) (2.931) (0.069) log likelihood 65.44 105.43 125.78 58.76 115.69 note: the 5% critical values r = 0, r 2. i, and r -;, 2 are 29.68, 15.41, and 3.76, respectively. figures in parentheses are standard errors. summary and conclusions the co integration and error-correction modeling techniques used in this paper have revealed that there is a bi-directional causality between export growth and economic growth in two of the five countries considered, fdi and economic growth and exports growth and fdi for just one country each. while there is evidence for export-led growth in all countries, the evidence for fdi led exports and economic growth or economic growth led fdi or exports is mixed. for the central question of this paper, whether fdi increases exports or vice versa, results are not consistent. the results in both developed and developing countries when studied separately have been mixed, indicating that the reasons spring 2003 ekanayake, et al: openness and economic growth 67 table 3 results of error correction models brazil source of causation (short run) ec /-1 ocp. variable t1exp ~gdp ~fd/ coefficient t-valuc ~exp 4.9136 4.7632 -0.1647** -2.3587 (0.426) (0.442) ~gdp 21.8269 7.9080 -0.0595 -0.6666 (0.000) (0.047) ~fdl 16.8877 12.2614 -0.5085*** -2.9966 (0.004) (0.031 ) canada source of causation (short run) ec'.i ocp. variable ~exp ~gdp ~fdi coefficient t-value ~exp 34.8140 8.3517 -0.1672** -2.3858 (0.000) (0.137) ~gdp 47.3521 2.5499 -0.1226** -2.3612 (0.000) (0.2794) ~fdl 6.6171 6.9968 -2.7663*** -3.1242 (0.250) (0.220) chile source of causation (short run) ee, 1 oep. variable ~exp ~gdp ~fdl coefficient t-value ~exp 3.3778 1.4044 -0.2069* -1.8380 (0.582) (0.923) tligdp 7.8829 5.2077 -0.2485 -0.2160 (0.049) (0.391 ) tlifdl 2.9948 17.0230 -0.5529* -1.8680 (0.559) (0.004) mexico source of causation (short run) ec/ i oep. variable t1exp ~gdp ~fd/ coefficient t-valuc tliexp 21.3171 4.5136 -0.0507 -0.7972 (0.000) (0.478) ~gdp 17.7278 11.7008 -0.0485 -0.7398 (0.003) (0.039) tlifd/ 10.4815 6.8381 -0.1843** -2.4650 (0.062) (0.232) united states source of causation (short run) ec'_i dep. variable ~exp ~gdp ~fdi coefficient t-value ~exp 5.2552 13.7511 -0.3710** -2.5276 (0.385) (0.017) ~gdp 9.6034 6.3666 -0.0464 -1.2472 (0.022) (0.094) tlifd/ 16.1757 7.2796 -2.0845*** -3.0745 (0.006 ) (0.201 ) notes: ec denotes the error-correction term. *, ** and *** indicate the statistical significance at the 10%,5% and 1% levels of significance respectively. figures in parentheses are p-values. 68 journal of business strategies vol. 20, no. i table 4 comparative evaluation of major findings (short·run causality) country bdc-eg elo ole bdc-fg flo olf bdc-ef elf fle brazil ./ ./ ./ ./ ./ canada ./ ./ ./ chile ./ ./ mexico ./ ./ ./ ./ ./ usa ./ ./ ./ ./ ./ notes: boc-eo denotes bi-directional causality for exports and growth, elg denotes export-led growth, and gle denotes growth-led exports. boc-fg denotes bi-directional causality for foi and growth, flg denotes foi-led growth and glf denotes growth-led foi. similarly, boc-ef denotes bi-directional causality for exports and foi, elf denotes export-led foi, and fle denotes foi-ied exports. -/ denotes the presence of causality and blank spaces indicate no evidence of causality. for the historical levels of development between nations should be observed elsewhere. new evidence from trevino et al. (2002), shows that foi is a function of current account balance, inflation, real exchange rate, market size, capital market liberalization and privatization values. therefore, the weak results between foi and exports are plausible. however, observing export led foi for brazil, mexico and usa would confirm that most multinational firms of the usa invest in these countries as export-oriented investment. in so doing, fdi has served to integrate national markets into the regional and world economy far more effectively than could have been achieved by traditional trade flows. the liberalization process in brazil, chile and mexico has increased not only trade but foi flows as well. this is particularly true in the latin american region, a major recipient of foi. therefore, due to the increasing importance of fdi, focusing only on trade as a proxy for openness may be misleading. also at a time when the countries of the western hemisphere are all set to form a trade block in the name of ftaa (free trade area of the americas) analyzing both the elg hypothesis and the foi-growth hypothesis for both the developed and developing countries, especial1y those that have been the main recipient countries of fdi in the western hemisphere, makes this study al1 the more interesting. spring 2003 ekanayake, et al: openness and economic growth references 69 akaike, h. (1974). a new look at the statistical model identification. ieee transactions on automatic control. ac-19, 716-723. alisana, a., & rodrik, d. (1999). distributive politics and economic growth. quarterly journal of economics. vol.i09, 443-465. bahmani-qskooee, m., & alse, j. (1993). export growth and economic growth: an application of co integration and error-correction modeling. journal of developing areas. 27(4), 535-542. balassa, b. (1978). exports and economic growth: further evidence. journal of development economics. 5, 181-189. balassa, b. (1985). exports, policy choices and economic growth in developing countries after the 1973 oil shock. journal of development economics. l8(2), 23-25. balasubramanyam, y.n., salisu, m., & sapsford, d. (1996). foreign direct investment and growth in ep and is countries. the economic journal, 106,92-105. barrell, r., & pain, n. (1997). foreign direct investment, technological change, and economic growth within europe. the economic journal, 107, 1770-1786. blomstrom, m., & persson, h. (1983). foreign investment and spillover efficiency in an underdeveloped economy: evidence from the mexican manufacturing industry. world development. 11, 493-501. blomstrom, m. (1986). foreign investment and productive efficiency: the case of mexico. journal ofindustrial economics. 15, 97-110. blomstrom, m., globerman, s., & kokko, a. (2000). the determinants of host country spillovers from foreign direct investment. cepr discussion paper no. 2350. borensztein, ej., de gregorio, j., & lee, j.w. (1998). how does foreign direct investment affect economic growth? nber working paper no. 5057. cuadros, a., orts, y., & alguacil, m.t. (2001). openness and growth: re-examining foreign direct investment, trade and output linkages in latin america. credit research paper no. 01/04, university of nottingham. darrat, a.f. (1987). are exports an engine of growth? another look at the evidence. applied economics. 19,277-283. dutt, s.d., & ghosh, d., (1996). the export growth-economic growth nexus: a causality analysis. journal of developing areas, 30, 167-182. 70 journal of business strategies vol. 20, no.1 engle, r.f., & granger, c.w.j. (1987). cointegration and error-correction: representation, estimation, and testing. econometrica, 55, 251-276. engle, r.e, & yoo, b.s. (1987). forecasting and testing in cointegrated systems. journal of econometrics, 35,143-159. esfahani, h.s. (1991). exports, imports and economic growth in semi-industrial countries. journal of development economics 35, 93-116. feder, g. (1983). on exports and economic growth. journal of development economics, .u.. 59-73. goldberg, s., & klein, w. (1998). foreign direct investment, trade, and real exchange rate linkages in developing countries. in reuven glick (eds.) managing capital flows and exchange rates: lessons from the pacific basin. cambridge university press. granger, c.w.j. (1988). some recent developments in a concept of causality. journal of econometrics, 39, 199-211. grossman, g., & helpman, e. (1995). technology and trade. in g. grossman, & k. rogoff, (eds) handbook of international economics, vol rii, (pp. 1279-1337) elsevier science, b.y. heller, p.s., & porter, r.c. (1978). exports and growth: an empirical re-investigation. journal of development economics, 5, 191-193. helpman, e., & krugman, p.r. (1985). market structures and foreign trade, cambridge: mit press. international monetary fund (imf): international financial statistic yearbook. various issues: 1981 200 i. washington, d. c. islam, m. n. (1998). export expansion and economic growth: testing for cointegration and causality. applied economics, 30,415-425. johansen, s., & juselius, k. (1990). maximum likelihood estimation and inference on cointegration with application to the demand for money. oxford bulletin of economic and statistics, 52, 169-210. jung, w.s. & marshall, p.j. (1985). exports, growth and causality in developing countries. journal of development economics, 18, 1-12. krugman, p.r. (1997). the age of diminished expectation, cambridge: mit press. lim, ewe-ghee. (200 i). determinants of, and the relation between, foreign direct investment and growth: a summary of recent literature. imf working paper wpi 011l75: international monetary fund. spring 2003 ekanayake, et at: openness and economic growth 71 lucas, r.e. (1988). on the mechanics of economic development. journal of monetary economics, 22, 3-44. oecd, (1991). technology and productivity: the challenge for economic policy. paris. rahman, m., & mustafa. m. (1998). dynamics of real exports and real economic growth in 13 selected asian countries. journal of economic development. 22(2), 81-95. ram, r. (1987). exports and economic growth in developing countries: evidence from time-series and cross-section data. economic development and cultural change, .3.qu.1. 5172. rodrik, d. (1999). the new global economy and developing countries: making openness work. policy essay no. 24, overseas development councils, washington, d.c. romer, p.m. (1986). increasing returns and long-run growth. journal of political economy, 94,1002-37. schwarz, g. (1978). estimating the dimension of a model. annals of statistics, 6, 461464. serletis, a. (1992). export growth and canadian economic development. journal of development economics, 38, 133-145. sprout, r.y.a., & weaver, j.h. (1993). exports and economic growth in a simultaneous equations model. journal of developing areas, 27(3), 289-306. trevino, l. j., daniels, j. d., arbelaez, h., & upadhyaya, k. p. 2002. market reform and foreign direct investment in latin america: evidence from an error correction model. the international trade journal, 16(4), 367-392. tyler, t. w. (1981). growth and export expansion in developing countries: some empirical evidence. journal of development economics, 9( i ), 121-130. ukpolo, y. (1994). export composition and growth of selected low-income african countries: evidence from time-series data. applied economics, 26(5), 445-449. united nations council for trade and development (unctad). world investment report yearbook. various issues: 1991 2001. new york. voivodas, c.s. (1973). exports, foreign capital inflows and economic growth. journal of international economics, 22, 337 -349. 72 journal of business strategies vol. 20, no. i ekanayake, e. m., is currently assistant professor of business and economics at the bethune cookman college in daytona beach, florida. he received his ph.d. from florida international university, miami, florida. previously he served as chief economist at enterprise florida an economics research unit of the florida and usa government. his research interests include development economics, international trade, and econometric issues. bala veeramacheneni is currently associate professor of economics at farmingdale state university of new york. he received his ph.d. from florida international university, miami, florida. previously he served as ceo of ecomdata, inc. a multinational technology consulting and research firm and prior to that he was the president of compufinance, inc. a computer economicsconsulting firm. his research interests include development economics, international trade, network economics, and technology related issues. richard vogel is currently associate professor of economics at farmingdale state university of new york. he received his ph.d. from florida international university, miami, florida, and previously served as a visiting assistant professor at the university of west florida. his research interests include development economics, regional economic development, and natural hazards analysis. publication guidelines the editorial review board of the journal of business strategies invites the submission of manuscripts to be considered for publication. these manuscripts should be concise, direct analyses of current problems and issues of interest to business decision makers. the emphasis of these papers is expected to be on new interpretations of, fresh insights about, or clearly stated solutions to problems faced by decision makers. the papers should be of practical value to business people and business educators. it should not be assumed that readers are completely familiar with the concepts and terminology of the specific subject under study. directness and clarity of presentation are desired. an editorial review board referees all manuscripts submitted to the journal of business strategies ensuring that articles appearing in the journal are consistent with its goals. all submissions are blindly refereed by at least three reviewers. style guidelines: four copies of double-spaced typed manuscripts should be submitted. the length of the papers should not exceed 25 pages, including tables, figures, appendices, and references. papers of less than 8 pages will be considered as a "note." a separate cover sheet indicating the title of the manuscript, as well as the name, affiliation, position, and address of the author should accompany each submission. an abstract of less than 100 words should be included. to facilitate blind review, the body of the text should include the title but not the author's name. the number of tables and figures should be kept to a minimum, stated simply as possible, and be placed on separate pages which indicate their corresponding number and title. the text should include notes suggesting the placement of the table or figure if it is not clear from the text. for example, "insert table 1 about here." should the paper be accepted for publication, the author will be asked in the editor's acceptance letter to supply a copy of the disk(s) containing the paper, tables, and figures in microsoft word or corel wordperfect. references: an alphabetical list of references cited in the text should be included on a separate page at the end of the manuscript. books: journals: cascio, w. f. (1995). managing human resources 4th ed. new york: mcgraw hill. lane, j. c. (1995). ethics of business students: some marketing perspectives. journal of business ethics, 14, 571-580. two or more authors: kvanli, a. h., guynes, c. s. & pavur, r. j. (1986). introduction to business statisticsa computer integrated approach. st. paul, mn: west publishing company. article in a book edited by another authorls: halbert, m. h. (1986). the requirements for theory in marketing. in sheth, j. n. & garrett, d. e. (eds.). marketing theory: classic and contemporary readings. (pp. xx) cincinnati, oh: south-western publishing co. address for submission: submissions editor journal of business strategies gibson d. lewis center for business and economic development sam houston state university huntsville, texas 77341-2056 journal of business strategies editor editorial assistant copy editors joann duffy eric j. thomas elsie ameen, donald bumpass, linda duvall, alice ketchand editorial board syed t. anwar, west texas a&m university stanley m. atkinson, universitv of central florida ed blackburne, sam houston state university dalton e. brannen, augusta state university russell briner, university of texas at san antonio stephen bushardt, university of southern mississippi shawn m. carraher, texas a&m univ. commerce branko cavarkapa, eastern connecticut state univ. sudhir k. chawla, anre/o state university daniel s. cochran, mis!;issippi state university roy a. cook, fort lewis college r. mike cudd, southeastern louisiana university ashay b. desai, universitv of wisconsin at oshkosh darla domke-damonte, coastal carolina university derrick e. dsouza, university of north texas dennis j. duchon, university of texas at san antonio dean elmuti, eastern illinois university joyce falkenberg, norwegian school of economics and business administration gary frankwick, oklahoma state university donald freeman, sam houston state university james e. groff, universitv of texas ill san antonio robert d. gulbro, athens state university william a. hailey, universitv of north alabama ernest h. hall, jr., university (!f southern alabama james l. harbin. texas a&m university texarkana michael harvey, univerl;ity of mi.\sissippi j. david hunger. lowa state university lawrence r. jauch, univ. of louisiana at monroe norman kangun, clemson universitv william e. kilbourne, sam houston slate university douglas kline, univ. otnorth carolina at wilmington mark j. kroll, louisiana tech universitv mark lengick-hall, univ. f!t texas at san antonio juliana lilly, sam houston state university thomas j. lipscomb, southeastern louisiana univ. franz t. lohrke, university o/'alabama granger macy, lthaca college farrokh g. mamaghani, st. john fi.\her college steven j. maranville, univ. of houston downtown edward k. marlow, eastern illinois university samia massoud, texas a&m at prairie view ruth c. may, university of dallas john p. mccray, university o/texas at san antonio abagail mcwilliams, university of illinois ill chicag sanjay s. mehta, sam hou.l'!on state university grant miles, university of north texas tim h. mills, eastern lllinois univer.\ity joseph l. morris, southeastern louisiana university rebecca j. morris, university ofnebmska at omahu jaideep g. motwani, grand valley state university matthew b. myers, university of tennessee john j. newbold, sam houston state university john a. parnell, univ. f!f north carolina pemhroke barbara parrish, university of central oklahoma ralph w. parrish, university of central oklahoma david p. paul iii, monmouth university marshall k. pitman, univ. o,ftexas at san antonio shane r. premeaux, mcneese state university a.k.m. matiur rahman, mcneese state university alan reinstein, wayne state university d. christopher risker, wehster university michael savoie, university of dallas jeffrey p. slattery, northeastern slate university denise t. smart, southwest texas state university victor sower, sam houston state university albert spalding, 1¥ilyne state university robert e. stevens, university (jf ujuisiana at monro, wayne h. stewart, jr., clemson university kelly c. strong, michigan technological university bruce swindle, mcneese state university lewisa. taylor, university of north texas mary s. thibodeaux, univasity 01' north texas v.k. unni, bryant college david d. van fleet, arizona state universitv west bruce walters, louisiana tech university peter wright, memphis state university $ > u r n a l o f f!1ju sin ess 9 j tra te g ie s g ib s o n d . le w is c e n t e r fo r b u s in e s s a n d e c o n o m ic d e v e lo p m e n t s a m h o u s t o n s t a t e u n iv e r s it y b ox 2 0 5 6 h u n t s v ille t x 7 7 3 4 1 ·2 0 5 6 n o n -p r o f it o r g a n iz a t io n u .s . p o s ta g e p a id h u n t s v il l e , t e x a s p e r m it n o . 26 openness and economic growth: empirical evidence on the relationship between output, inward fdi, and trade 31664_19x13(4up)-6x9-cutstack.pdf 62 journal of business strategies linkedin learning: a valuable resource for cpe credits jodi olson winona state university • winona, mn joann segovia winona state university • winona, mn abstract this article describes the continuing professional education opportunities available for cpas through linkedin learning training courses. practitioners will likely find the affordability, ease of use, and breadth of content valuable to them in their practice of public accounting for cpe, while also utilizing the resources for staff development and client services. key words: cpe, linkedin learning, nasba registry, qas self study introduction cpas may gain affordable, easily accessible continuing professional education (cpe) credits through linkedin learning, which has recently become a national association of state boards of accountancy (nasba) approved sponsor for training courses. nasba provides regulatory guidance, as much as possible, across state boards of accountancy to facilitate uniformity for educational requirements to sit for the cpa exam (mastracchio, 2008) and compliance with cpe to maintain credentials once an individual becomes licensed (humphrey, plunkett & herring, 1988). currently, variation exists among state boards for cpe rules, but many states require nasba or other authoritative approval of courses for at least a percentage of their cpas’ continuing education as a benchmark of quality (cpe requirements, n.d.). linkedin learning purchased lynda.com in 2015 which was founded in 1995 as a resource for helping students with academics and professional skills. trained experts provide video tutorials for online learning. in december 2018, linkedin learning became part of the nasba registry (porter, 2015; nasba registry, n.d.). linkedin learning now provides access to 700+ nasba approved courses to earn cpe credits (linkedinlearning.com). this paper describes this affordable, easy to use resource, with relevant content for cpas who need to fulfill cpe credits. volume 38 number 1 63 affordability and ease of use linkedin learning provides an unlimited potential for cpe at an affordable price. in addition, the membership allows users to access non-cpe related interests such as training for staff development or client services. an individual can subscribe to the linkedin learning website either on an individual or organizational basis. individuals can obtain a one-month free trial with a continuing membership fee of $29.99 per-month on a month-to-month basis, or $19.99 per month on an annual basis. governmental or corporate entities should call (844) 587-5735 for a customized quote based on number of employees served. a subscription includes unlimited use of 15,000+ courses available in five languages and linkedin learning adds and updates courses weekly (linkedinlearning. com). according to a live chat with a linkedin learning representative, (personal communication, november 17, 2019) the free trial period has no limitations on function, including earning cpe credits and printing certificates. the representative also verified that some libraries have subscriptions to linkedin learning and patrons can access courses using their library card. to earn cpe at a library, patrons create accounts using their library card under the library’s subscription and have full access to courses and cpe certificates. with a username and password, one can access the linkedin learning website from a computer or phone. then one can search for nasba approved courses by selecting “nasba” in a “continuing education units” filter. when considering videos, access the course overview information which clearly identifies nasba certifications, the cpe credits earned upon completion, and the “field of study” in the content (figure 1). figure 1 linkedin learning nasba approved course overview figure 1 linkedin learning nasba approved course overview 64 journal of business strategies figure 1 linkedin learning nasba approved course overview (continued) figure 1 linkedin learning nasba approved course overview figure 1 linkedin learning nasba approved course overview figure 1 linkedin learning nasba approved course overview figure 1 linkedin learning nasba approved course overview figure 1 linkedin learning nasba approved course overview volume 38 number 1 65 alternatively, users can access courses through the nasba registry course library and filtered base on subject matter (course library, n.d.). by choosing the course this way, linkedin learning retrieves the selected course. for firms wanting to preselect coursework for staff, administrators can develop playlists to share with their staff to assure the user views the desired content. also, because of linkedin learning’s affiliation with linkedin, new skills can transfer to individual linkedin profiles at the user’s discretion. upon completion of a course, users can easily download and print cpe certificates for cpe tracking by answering correctly 70% of the end of the course quiz questions. the website also tracks earned cpe for its members (linkedinlearning. com). see figure 2 for an example of a cpe certificate which clearly states relevant course information at the bottom, including field of study, earned cpe credits, and nasba approval. figure 2 linkedin learning cpe certificate figure 2 linkedin learning cpe certificate 66 journal of business strategies relevant content nasba and the american institute of certified public accountants (aicpa) jointly publish “the statement on standards for continuing professional education (cpe)”, as a framework for state boards to use in regulating cpe requirements. as last updated in december 2019, the statement refers to fields of study as “primary knowledge” needed to practice as a cpa (statement on standards, 2019; fields of study, 2019). the fields of study are published in a separate report, “fields of study that qualify for continuing professional education,” and separates the subjects into thirteen technical and seven non-technical groups (cpe requirements, n.d.). table 1 presents the thirteen technical fields of study with the number of nasba approved linkedin learning courses available for each. for each field, an example of a linkedin learning course with the related cpe credits available is provided (course library, n.d.). table 1 nasba technical fields of study (236 linkedin learning courses available) for the seven non-technical fields of study, 186 linkedin learning courses exist. table 2 presents the non-technical fields of study with 539 available linkedin learning courses (course library, n.d.). table 1 nasba technical fields of study (236 linkedin learning courses available) field # of available courses example of one available course within the field cpe hours accounting 5 quickbooks pro 2019 essential training 7.4 accounting (governmental) 0 auditing 1 audit and due diligence foundations 3.8 auditing (governmental) 0 business law 4 understanding copyright: a deeper dive 2 economics 2 excel: economic analysis and data analytics 2.4 finance 25 forecasting using financial statements 3.4 information technology 108 learning c 5.4 management services 31 enterprise agile: changing your culture 2.2 regulatory ethics 0 specialized knowledge 2 r programming in data science 2.6 statistics 10 data analytics for business professionals 2.8 taxes 0 volume 38 number 1 67 table 2 nasba non-technical fields of study (587 linkedin learning courses available) as of this writing, non-technical courses far outnumber technical courses, but a sizeable number exist in both categories. though many state boards do not put requirements on technical versus non-technical fields of study, some do have a minimum level of technical and non-technical cpe credits to be earned for each reporting cycle (cpe requirements, n.d.). practicing cpas will likely want to have certain technical skills updated, regardless of the rules of their jurisdiction; unfortunately, linkedin learning currently provides a limited number of courses in the accounting, auditing, and tax fields of study. however, given that most states require an average of 40 hours every year of cpe, linkedin learning’s content can provide some of the required hours. many states require a minimum number of ethics hours per reporting period. tables 1 and 2 show limited courses in the regulatory ethics and behavioral ethics fields of study, yet a search for nasba specific “ethics” courses within linkedin learning will yield many more results. linkedin learning labels these additional courses as other fields of study such as business management & organization or personal development. in addition to nasba approved linkedin learning courses, some state boards do allow self-study courses not on the nasba registry and users could use linkedin learning courses for these additional credits. for example, the lease course shown in figure 3 did not have nasba approval in the “accounting” technical area as table 2 nasba non-technical fields of study (587 linkedin learning courses available) field # of available courses example of one available course within the field cpe hours behavioral ethics 3 project management foundations: ethics 1.8 business management & organizations 53 measuring business performance 2.8 communications and marketing 124 brand & marketing integration 1.6 computer software & applications 209 excel 2019 essential training 4 personal development 109 learning to be approachable 1 personnel/human resources 59 managing organization changes for managers 2.4 production 9 lean inventory management 2 68 journal of business strategies of november, 2019, but now approval has been granted. a state board may have allowed the content for cpe back in 2019 before nasba approval, since gaap recently had changed accounting for leases and one of the instructors, a professor of accounting at brigham young university, had just developed the course (october 31, 2019). the topic seems quite relevant to those having leeway to take cpe courses outside of the nasba registry and would have qualified back in 2019. figure 3 accounting foundations: leases (linkedin learning course) figure 3 accounting foundations: leases (linkedin learning course) volume 38 number 1 69 figure 3 accounting foundations: leases (linkedin learning course), (continued) method of delivery linkedin learning marks all nasba approved linkedin learning courses as “quality assurance service (qas) self study”. nasba developed this standard to assess the value of self-study courses. each nasba approved course goes through an in-depth instructional design review to determine if the course meets the standards required for listing on the nasba registry (qas self study, n.d.) some state boards also put restrictions on self-study courses. they may limit the number of cpe credits to one-half of the number of hours needed in a reporting cycle while some jurisdictions allow 100% of a cpa’s cpe from a selfstudy delivery method. figure 3 accounting foundations: leases (linkedin learning course) 70 journal of business strategies client service opportunity cpas can better serve their clients with knowledge of linkedin learning training opportunities. clients may have professional staff that could use cpe credits for their area of expertise. linkedin learning offers approved cpe credit hours to earn or maintain credentials in project management, human resources, and business analysis. also, cpas can direct clients needing help with a certain software application to linkedin learning for help with microsoft products such as excel or access, or small business accounting software such as quickbooks or sage, or data analytics platforms such as tableau. clients can also obtain cpas’ recommendations for other learning opportunities such as help with determining which software or hardware to select or increasing soft skills needed for potential staffing issues or cultural challenges through linkedin. these recommendations from cpas could provide a valuable service to clients and save the cpa time. conclusion since state boards of accountancy review and approve cpe, one needs to understand their state’s requirements. however, the inclusion of linkedin learning as a sponsor in the nasba registry sends a clear message to the profession that these video tutorials can provide affordable, easily accessible cpe with a breadth of content. furthermore, given the free trial period and free access with a library card at a public library, the opportunity to assess this as a viable option for cpe credits comes at no risk to the practitioner. therefore, it is recommended that accounting practitioners consider linkedin learning for cpe, staff development, and client service. references course library. (n.d.). retrieved june 16, 2020, from nasba registry website: https://www.nasbaregistry.org/course-library?&searchterm=linkedin%20 l e a r n i n g & c a t e g o r i e s = 8 a c b 7 3 4 4 5 0 5 6 b 7 3 3 4 9 0 6 a b 6 8 9 4 5 a a a 39&searchgroup=00000001-course-library cpe requirements. (n.d.). retrieved june 16, 2020, from nasba website: https:// www.nasbaregistry.org/cpe-requirements fields of study. (2019, december). retrieved july 28, 2020, from nasba registry website: https://www.nasbaregistry.org/__media/documents/2019standards-and-fos/fields-of-study-document---december-2019.pdf humphries, f.a., plunkett, l. m., & herring, r. b. (1988). let’s make required cpe rules uniform. journal of accountancy, 166(6), 70-74. volume 38 number 1 71 nasba registry. (n.d.). national registry for cpe sponsors. retrieved june 16,2020 from nasba registry website: https://www.nasbaregistry.orgsponsorlist?&azletter=l&searchgroup=2099ec2e-exhibitors mastracchio jr., n. j. (2008). the role of nasba and state boards in accounting education. cpa journal, 78(3), 64-69. porter, j. (2015, april 27). from near failure to a $1.5 billion sale: the epic story of lynda.com. retrieved june 16, 2020, from https://www. fastcompanycom/3045404/from-near-failure-to-a-15-billion-sale-the-epicstory-of-lyndacom qas self study. (n.d.). retrieved june 16, 2020 from https://www.nasbaregistryorg/ preparing-to-apply/qas-self-study russel, m. (2018, december 3). cpas – earn your continuing professional education (cpe) units anytime, anywhere on linkedin learning. retrieved june16, 2020, from https://learning.linkedin.com/blog/whats-new/cpas-_-earnyour continuing-professional-education--cpe--units-a statement on standards. (2019, december). the statement on standards for continuing professional education (cpe). retrieved june 16, 2020, from nasbaregistry website: https://www.nasbaregistry.org/__media/documents/ 2019-standards-and-fos/statement_on_standards_for_cpe_programsdecember-2019.pdf. accessed 16 june 2020. biographical sketch of authors jodi olson is an assistant accounting professor at winona state university. she has a doctorate in business administration from metropolitan state university. she is a cpa and a cma. her research interests focus on accounting education. joann segovia, cpa, professor at winona state university, obtained her doctorate degree at texas tech. her research interests focus on accounting education and accounting information systems. 72 journal of business strategies 31664_19x13(4up)-6x9-cutstack.pdf volume 38 number 1 25 minimum wage laws and top income shares: evidence from a large panel of states mark w. frank sam houston state university • huntsville, tx abstract over the three decades prior to the onset of the great recession in 2007, the income share of the top 1% in the united states rose by over 150% (from 9.3% to 23.5%). during the same period, the real federal minimum wage fell by about 35% (from $8.92 to $5.76 in 2011 dollars). this paper uses a comprehensive panel of u.s. states to explore the effect of changes in the real minimum wage on top income shares. our findings indicate that the relationship between is negative in nature, but not robust to small changes in the econometric specification or in the measurement of inequality. jel classifications: d3, j3 keywords: income inequality, minimum wage laws, u.s. states introduction few issues in economics have received as much attention as the recent rise in income inequality, and in particular, the rise in top income shares. the seminal work by piketty and saez (2003) shows that the rise in income inequality experienced in the u.s. since the late-1970s has been primarily driven by income changes in the upper-end of the distribution (see also burkhauser, et. al. 2012, piketty and saez 2014). figure 1 illustrates this point by presenting recent trends in income shares at various points of the income distribution.1 when compared to the top 1%, the changes in shares from other parts of the distribution appear minor. even the increase in the income share of the top 10% is relatively pedestrian once the top 1% is removed (rising from 24.5% in 1977 to 28.5% in 2011). the top 1%’s income share, by contrast, rose from 9.3% in 1977 to 23.5% on the eve of the great recession in 2007. 1 data on the top 1% and top 10% income shares are from piketty and saez (2003), and updated from the webpage of emmanuel saez: http://eml.berkeley.edu/~saez/. data on the income shares of the bottom 60%, 40% and 20% are from the census bureau’s historical income tables: http://www.census.gov/hhes/www/income/data/historical/household/. 26 journal of business strategies figure 1 u.s. income shares policy reactions to this rise in top income shares have ranged from taxing capital (see piketty 2014), to calls for greater investment in human capital (see goldin and katz 2008), to measures aimed at shifting the balance of power in the workplace, such as strengthening worker unions or increasing the minimum wage (see stiglitz 2012). in this paper, we look at the later of these policy options: using minimum wage laws to redress the increase in top income shares. federal minimum wage laws in the u.s. are an interesting case because while the nominal minimum wage has increased, the real federal minimum wage fell about 35% over the three-decade period prior to the onset of the great recession in 2007 (see figure 2). notably, this fall in the real minimum wage correlates inversely with the rise in the top 1% income share shown in figure 1. many states, however, compensated for the real decline in the federal minimum wage by raising their own state minimum wage above the federal mandate (also shown in figure 2). in this paper, we use this variability unique to the state-level to help identify the income inequality effects from real minimum wage changes. we argue that given the frequency of changes at the state-level, states are, consequently, the proper unit-ofanalysis for investigating these effects. figure 1 u.s. income shares volume 38 number 1 27 figure2 federal and state minimum wage levels for changes in the real minimum wage to have a meaningful role in accounting for the rise in top income shares, these changes must go beyond a purely mechanical effect on wages. instead, they must have spillovers onto wages beyond those at (or near) the minimum. the previous literature is sparse in this regard, with only about a half dozen articles broadly investigating the impact of minimum wage laws on income inequality. most of this prior work has focused on spillover effects in the lower-half of the income distribution (see dinardo, fortin, and lemieux 1996, lee 1999, card and dinardo 2002, dickens and manning 2004, and autor, katz and kearney 2008). a notable exception, however, is autor, manning, and smith (2016); they find some evidence of spillovers into the upper-half of the income distribution (e.g., the 90/10 ratio). they do not consider spillovers into the upper-tail, however. as figure 1 illustrates, this is a significant omission given that increases in u.s. income inequality over recent years have been driven by income increases in the upper-tail (i.e., the top 1%). to our knowledge, this is the first paper to evaluate the impact of minimum wage changes on the rise in top income shares at the state-level. prior research has focused on other parts of the income distribution, and as a result, used state-level figure 2 federal and state minimum wage levels 28 journal of business strategies distributional data available from the march current population survey (cps). march cps data does not, however, account for much of the rise in the top 1% since it omits relevant information on capital gains, stock options, and bonuses (see burkhauser, et. al. 2012). thus, we depart from the use of march cps data, and instead use the irs-based top income shares constructed by frank (2009). we base our econometric approach on the voluminous literature testing the role of minimum wage laws on employment. much of this research is based on the seminal work of card and krueger (1994), and relies on the difference-in-differences estimation approach (see neumark and wascher 2007). although this literature is focused on questions of employment and employment growth, its methodology is a good candidate because it is well vetted in the state-level panel context, and is able to exploit the unique state-level variations present in minimum wage laws (as shown in figure 2). moreover, the contexts of employment and income distribution are necessarily related, as distributional changes are a consequence of changes in earnings and employment. while the initial results are promising, we ultimately conclude that the relationship between the minimum wage and top income shares is not particularly robust. though consistently negative in sign, we find that small changes in the econometric specification, as well as the measurement of income inequality, lead to statistically insignificant associations. hence, we conclude that changes in the minimum wage do not appear to have meaningful spillovers into the upper-tail of the income distribution, and fail to find support for the claim that increases in the minimum wage might lead to a lowering of top income shares. in the following section, we introduce our state-level panel. section iii then presents the difference-in-differences estimation and results from our empirical investigation. section iv offers a brief set of conclusions. data our sample consists of annual state-level data for the period 1977-2011. we include the district of columbia in the sample, meaning we have 51 cross-sections and 35 years of data (for a total of 1785 observations). descriptive statistics for all the variables used in the analysis are shown in table 1. the top income share measures are taken from the comprehensive panel of income inequality measures constructed by frank (2009).2 the state-level measures of frank are based on income data reported by the irs using individual tax returns, and follow the construction 2 available online at: http://www.shsu.edu/eco_mwf/inequality.html. volume 38 number 1 29 methodology of the national panel of top income shares constructed by piketty and saez (2003). though the focus of this paper is on top income shares, later in the analysis we extend our estimations to include the gini coefficient, a broad measure of income inequality. table 1 summary statistics table 1 summary statistics mean std. dev. median state minimum wage ($) 4.40 1.360 4.25 state minimum wage ($real) 7.09 0.916 6.89 income inequality measures: top 1% income share 0.14 0.0444 0.13 top 1% growth rate 0.025 0.0887 0.029 top 10% income share 0.38 0.0529 0.38 gini coefficient 0.56 0.0507 0.56 additional controls: gsp/capita ($real) 41,591.6 16,309.7 38,447.1 unemployment rate 6.03 2.101 5.70 population (thousands) 5,160.6 5,725.6 3,513.4 pop share aged 15-59 61.7 1.957 61.7 observations 1785 notes: the panel includes each state plus washington d.c. (n = 51) annually over the period 1977-2011 (t = 35). 30 journal of business strategies for the state minimum wage data, we use information provided by the u.s. department of labor.3 we also compared our data to that of meer and west (2013), and verified any differences with state-level sources. to assure proper casual ordering between the variables, we use the previous year’s value of the minimum wage (as of march 12th) in our panel estimations. for states that use a multi-track menu of minimum wages, we use the maximum wage in this menu, as is common in the literature. state-level price indexes are not available; hence we use the national cpi-u available from the bureau of labor statistics to the data into constant 2011 dollars. the other control variables we use in the analysis are widely available. the state-level real gross domestic product per capita is taken from the bureau of economic analysis’s regional economic accounts.4 state unemployment rates are taken from the bureau of labor statistic’s local area unemployment statistics division.5 total state population and the share of population aged 15-59 are from the census bureau’s population estimates division.6 estimation the use of state-level panels to explore the effects of minimum wages on top income shares is surprisingly sparse. without a direct literature to base our econometric approach upon, we take the view that the voluminous literature on minimum wages and employment is a strong substitute. this literature is based largely on the seminal work of card and krueger (1994), which uses the differencein-differences estimation approach (for an overview, see neumark and wascher 2007). while this literature is narrowly focused on the effect of minimum wages on employment and employment growth, its methodology is a good candidate because it is well vetted in the state-level panel context, and because income distributional changes are in part a consequence of the employer/employee relationship. hence, in the respect that changes in the minimum wage result in higher or lower earnings among employees, or less employment overall, then changes in the minimum wage may have an meaningful impact on the distribution of income within a population. the difference-in-differences approach contrasts a state’s level of income inequality before and after a change in its minimum wage, relative to the counterfactual change in the other states’ level of income inequality. the appropriate counterfactual 3 available online at: http://www.dol.gov/whd/state/stateminwagehis.htm. 4 available online at: http://www.bea.gov/regional/index.htm. 5 available online at: http://www.bls.gov/lau/home.htm. 6 available online at http://www.census.gov/popest/data/historical/index.html. volume 38 number 1 31 state is important here, as states are necessarily heterogeneous in their adjustment of the minimum wage and other socioeconomic factors. to improve the quality of the counterfactuals, we follow the minimum wage and employment literature in testing a variety of space and time effects, as well as business cycle controls (see meer and west 2013). accordingly, the first specification we use is the classic panel difference-indifferences estimator: inequalitys,t = β·ln(minwage)s,t + μs + τt + εs,t , (1) where μs is the time-invariant fixed effect for state s, τt is the state-invariant time effect for time t, and ε is the idiosyncratic, time and state-varying error term. different regions within the country, however, may face heterogeneous economic shocks correlated with changes in the minimum wage. hence, in specification (2), we allow for time fixed effects that vary across the four census regions (τr,t): inequalitys,t = β·ln(minwage)s,t + μs + τr,t + εs,t . (2) furthermore, to appropriately capture changes in inequality that might be correlated with changes in the state minimum wage, specification (3) adds state linear time trends (ηs·t): inequalitys,t = β·ln(minwage)s,t + μs + τr,t + ηs·t + εs,t . (3) finally, specification (4) adds additional control variables to capture variations in state-level economic climates: inequalitys,t = β·ln(minwage)s,t + μs + τr,t + ηs·t + α·xs,t + εs,t . (4) in this specification, xs,t is a vector of explanatory variables that includes real gross state product per capita, state unemployment rates, total state population, and the share of the state population aged 15-59. column [1] of table 2 shows the effect of minimum wages on the income share of the top 1% across the four specifications defined above. the results are small but fairly consistent across the econometric specifications, though statistically significant in only in the initial specification (row 1). taken together, the estimates in column [1] imply an elasticity between -0.16 to -0.14. that is, a real minimum wage increase of 10% reduces the income share of the top 1% by about 1.5 percentage points. 32 journal of business strategies table 2 effect of the minimum wage on top income shares dependent variable: model specification: [1] top 1% [2] top 1% growth [3] top 10% [4] gini obs. (1) μs, τt -0.0212** -0.0457** 0.0230 -0.0203 1785 (0.0083) (0.0216) (0.0167) (0.0151) (2) μs, τr,t -0.0214 -0.0338 0.0053 -0.0150 1785 (0.0132) (0.0234) (0.0180) (0.0164) (3) μs, τr,t, ηs·t -0.0218 -0.0713 -0.0123 -0.0355* 1785 (0.0167) (0.0441) (0.0100) (0.0186) (4) μs, τr,t, ηs·t, xs,t -0.0198 -0.0776 -0.0069 -0.0329* 1785 (0.0160) (0.0464) (0.0083) (0.0171) notes: * p < 0.1, ** p < 0.05, *** p < 0.01. robust standard errors are reported in parenthesis. sample uses annual state data from 1977-2011. model specification: μs is the time-invariant fixed effect for state s, τt is the state-invariant time effect for time t, τr,t is the census region time fixed effects, ηs·t is the state linear time trends, and xs,t is a vector of explanatory variables that includes real gross state product per capita, state unemployment rates, total state population, and the share of population aged 15-59. table 2 effect of the minimum wage on top income shares it is possible, however, that the dynamics of the top 1%’s income share are more appropriate to look at, given that transitions in the levels of inequality may be slow. with this in mind, column [2] evaluates the growth rate of the top 1%. the results are more volatile in magnitude, as one would expect given the higher standard deviation of the top 1% growth rate, but are statistically significant again in only the initial specification. recall that row (2) reflects changes relative to each region’s linear time trend, while rows (3) and (4) reflect changes relative to each state’s linear time trend. the statistically significant results for the top 1% from row (1) are then likely an artifact of ignoring state or regional time trends. column [3] of table 2 extends this exploration by instead using the income share of the top decile. here, the results are quite volatile (changing in both magnitude and sign), and none are statistically significant. finally, column [4] tests a fourth measure, the gini coefficient. unlike top income shares, the gini coefficient is a broad measure of income dispersion, capturing changes throughout the income distribution. the results here appear consistent in sign and magnitude, and are statistically significant when state linear volume 38 number 1 33 time trends are included (rows 3 and 4). the overall effect from these two cases, however, is quite small, with and implied elasticity of around -0.06. in table 3 we present several alternative specifications to assess the robustness of the results. as a reference, row (1) from table 3 reproduces the baseline results for each of the four inequality measures reported in row (4) of table 2. table 3 robustness checks for the effect of the minimum wage on top income shares table 3 robustness checks for the effect of the minimum wage on top income shares dependent variable: model specification: [1] top 1% [2] top 1% growth [3] top 10% [4] gini obs. (1) μs, τr,t, ηs·t, xs,t -0.0198 -0.0776 -0.0069 -0.0329* 1785 (0.016) (0.046) (0.008) (0.017) (2) census division -0.0128 -0.0803 0.0014 -0.0129 1785 (0.017) (0.053) (0.011) (0.019) (3) quadratic trend -0.0245 -0.0909* -0.0073 -0.0348** 1785 (0.016) (0.053) (0.006) (0.017) (4) non-indexing -0.0163 -0.0772 -0.0073 -0.0360** 1740 (0.016) (0.048) (0.009) (0.017) (5) pre-2008 only -0.0170 -0.0607 -0.0153 -0.0335 1581 (0.021) (0.063) (0.011) (0.020) minimum wage alterations: (6) mwt -0.0224 -0.0511 -0.0107 -0.0401* 1785 (0.020) (0.053) (0.010) (0.022) δmw 0.0008 -0.0084 0.0012 0.0023 (0.002) (0.008) (0.001) (0.002) (7) mwt -0.0169 -0.0565 -0.0128 -0.0240 1734 (0.016) (0.054) (0.008) (0.016) mwt+1 0.0040 -0.0188 0.0076 -0.0092 (0.010) (0.041) (0.007) (0.010) (8) mwt -0.0109 -0.0816* 0.0027 -0.0207 1734 (0.012) (0.048) (0.007) (0.013) mwt-1 -0.0142 0.0060 -0.0140** -0.0167 (0.016) (0.047) (0.006) (0.016) (9) mwt -0.0184 -0.0981** -0.0026 -0.0302* 1683 (0.014) (0.044) (0.008) (0.016) mwt-2 -0.0046 0.0581 -0.0141* -0.0063 (0.019) (0.058) (0.007) (0.020) notes: * p < 0.1, ** p < 0.05, *** p < 0.01. robust standard errors are reported in parenthesis. sample uses annual state data from 1977-2011. row (1) replicates row (4) from table 2. 34 journal of business strategies in row (2) we replace the four census regions time effects (τr,t) with time effects from the nine census divisions. with this specification change, we find that none of the estimated minimum wage coefficients are statistically significant, including that from the gini coefficient in column [4]. quadratic state-time trends are added to the baseline specification in row (3). allowing for nonlinear time effect appears beneficial as both the top decile and gini coefficient become statistically significant. the top 1% income share and growth rate, however, remain insignificant (as they are in the baseline results). in row (4) we drop all observations from states that shifted to indexing their minimum wage for inflation. this leads to the dropping of only 45 observations, as inflation indexing is a fairly new phenomenon. this does not appear to be a meaningful alteration, as the estimated results in row (4) are quite similar to the baseline results in row (1). in row (5), we instead use only the pre-great recession observations, as this period is marked by substantial volatility among the income inequality measures. with this specification change, we find that none of the estimated minimum wage coefficients are statistically significant. finally, rows (6)-(9) test several alterations of the minimum wage variable: row (6) adds a dummy variable for periods when the nominal minimum wage is changed, row (7) adds a one period lead of the minimum wage, and rows (8) and (9) include a oneand two-period lag of the minimum wage. lags are useful in picking up delayed effects that might result from a slow adjustment process following a minimum wage change. a lead, on the other hand, is useful if the adjustment process begins before the implementation of a minimum wage hike. given that there is often a delay between the passage of minimum wage legislation and its implementation, it is plausible that firms anticipate these changes and begin their adjustment process before legislative enactment. none of these alterations in the minimum wage appear to add much power to the original minimum wage coefficients. all previously insignificant minimum wage coefficients from the baseline specification (row 1) remain statistically insignificant. in addition, the estimates from the gini coefficient measure (column 4) become statistically insignificant when either a one-period lead or lag of the minimum wage is included. moreover, the alternative minimum wage variables are also generally statistically insignificant across the estimations. the only exception is with the top decile measure in column [3] when using either a oneand two-period lag (rows 8 and 9). volume 38 number 1 35 conclusion this paper has employed a state-level panel to evaluate the relationship between minimum wage laws and top income shares. our results indicate that the relationship is not particularly robust. while consistently negative in sign, we find that small changes in the econometric specification, as well as the measurement of income inequality, lead to statistically insignificant associations. in total, we report twelve alternative model specifications using three different measures of top income shares; of these 36 estimated minimum wage coefficients reported, only two are statistically significant at the p < 0.05 level ( see table 2 , row 1, columns 1 and 2). two is also approximately the same number one would expect to find falsely significant at a 95% confidence level, given the number of estimations conducted. however, the results are marginally more robust when the gini coefficient is used instead of a top income share measure (see column 4 in tables 2 and 3). this is less surprising given that prior empirical research has found positive effects from the minimum wage occurring within the lower-half of the income distribution (see dinardo, fortin, and lemieux 1996, lee 1999, card and dinardo 2002, dickens and manning 2004, and autor, katz and kearney 2008). one would expect such a result if minimum wage changes have spillover effects upon workers earning at and near the minimum wage. spillovers unto those in the upper-half of the income distribution have also been found (see autor, manning, and smith 2016). whether spillovers extend into the upper-tail (e.g., the top 1%) has not, to our knowledge, been considered prior to this paper. the lack of statistical robustness from our results thus casts doubt on whether increases in the minimum wage can help mitigate the rise in top income shares. in a broader sense, investing in education and skills may be a better long-term remedy for reducing income disparities (see goldin and katz 2008). the public’s appetite for long-term solutions, however, is famously fickle. this short-term focus may in fact be driving parts of the public discussion with respect to the minimum wage. the evidence presented here, nonetheless, would suggest caution is warranted in taking this view. 36 journal of business strategies references autor, d.h., katz, l.f. & kearney, m.s. 2008, trends in u.s. wage inequality: revising the revisionists.” the review of economics and statistics, 90 (2): 300-323. autor, d.h., manning, a. & smith, c.l. 2016, “the contribution of the minimum wage to u.s. wage inequality over three decades: a reassessment.” american economic journal: applied economics, 8 (1): 58-99. burkhauser, r.v., feng, s., jenkins, s.p. & larrimore, j. 2012, “recent trends in top income shares in the united states: reconciling estimates from march cps and irs tax return data.” the review of economics and statistics, 94 (2): 371-388. card, d. & dinardo 2002, “skill-biased technological change and rising wage inequality: some problems and puzzles.” journal of labor economics, 20 (4): 733-783. card, d. & krueger, a.b. 1994, “minimum wages and employment: a case study of the fast-food industry in new jersey and pennsylvania”. the american economic review, 84 (4): 772–93. dickens, r. & manning, a. 2004 “has the national minimum wage reduced uk wage inequality?” journal of the royal statistical society: series a (statistics in society), 167 (4): 613-626. dinardo, j., fortin, n.m. & lemieux, t. 1996, “labor market institutions and the distribution of wages, 1973-1992: a semiparametric approach.” econometrica, 64 (5): 1001-1044. frank, m.w. 2009, “inequality and growth in the united states: evidence from a new state-level panel of income inequality measures.” economic inquiry, 47 (1): 55-68. goldin, c. & katz, l.f. 2008, the race between education and technology, belknap press. lee, d.s. 1999, “wage inequality in the united states during the 1980s: rising dispersion or falling minimum wage?” the quarterly journal of economics, 114 (3): 977-1023. meer, j. & west, j. 2013, “effects of the minimum wage on employment dynamics.” nber working paper no. 19262. neumark, d. & wascher, w.l. 2007, “minimum wages and employment.” foundations and trends in microeconomics, 3 (1-2): 1-182. piketty, t. 2014, capital in the twenty-first century, harvard university press. volume 38 number 1 37 piketty, t. & saez, e. 2003, “income inequality in the united states, 1913-1998.” quarterly journal of economics, 118 (1): 1-39. piketty, t. & saez, e. 2014, “inequality in the long-run.” science, 344 (6186): 838-843 stiglitz, j. e. 2012, the price of inequality: how today’s divided society endangers our future, w.w. norton & company. biographical sketch of author mark w. frank is the chair and professor of economics and international business at sam houston state university. he received his ph.d. from the university of texas at dallas. his current research interests include income inequality in the united states and the teaching of economics a sociocognitive perspective of industry-level collective stakeholder action: the case of the scotch whisky industry natasha vijay munshi city university london london, uk abstract this paper explores industry-level, collective stakeholder action. it argues that industry stakeholders will act collectively at the industry level when they perceive change to be radically in conflict with their shared beliefs. although collective action may not be in their immediate economic selfinterests, this type of industry level collaboration is undertaken with the long-term interest of the collective industry in mind. the example ofthe scotch whisky industry is used here to illustrate such collaborative industry-level collective stakeholder action. introduction mancur olson's (1965) treatise 'the logic of collective action,' has long influenced the way economists have treated the subject of collective action. theorists such as olson have reasoned that the basis for collective action is a pure rational one oflooking out for one's own immediate self interest rather than the collective benefits that could result out of collaboration. if one was to use this rationalist perspective to study collective stakeholder action at the industry level, then one should observe collaborative action only when each 'rational' actor perceives his/her individual economic interest or stake to be in danger rather than that of the collective group. the self interest motive is the case in many instances of observed collective action. however, this perspective does not explain the collective action of actors who appear to be acting against their own immediate economic interests. by subsuming their own interests to those of the collective, these actors appear to be giving up their own economic gain in the short run. this paper's main purpose is to examine what drives collective stakeholder action at the industry level. it uses the sociocognitive perspective (fiske and taylor, 1991) as its theoretical lens to study this question in order to provide an alternative viewpoint to the rationalist economics based perspective of collective action. the paper next briefly reviews the relevant literature on how social cognition is involved in the evolution of industry structure. it also provides a short overview ofthe extant research on the stakeholder's perspective. this paper uses the extant stakeholder literature (freeman, 1984; frooman, 1999; mitchell, agle, and wood, 1997; rowley and moldoveanu, 2003) and the literature on the social and cognitive 34 journal ofbusiness strategies vol. 23, no.1 aspects of industries (abrahamson and fombrun, 1994; christensen and gordon, 1999; daniels, johnson, and chernatony, 2002; porac and thomas, 1995; porac, thomas, and baden-fuller, 1989; spender, 1989) as its theoretical underpinning in order to further investigate this research phenomenon. it then follows with a brief description ofthe events associated with the introduction ofthe cardhu pure malt whisky in the scotch whisky industry. the paper then discusses the factors contributing to industry-level stakeholder group action in traditional industries and concludes with implications of this study for scholars and for practitioners who are interested in learning more about the stakeholder concept. literature review prior research on firm-stakeholder relationships has focused mainly on managerial cognition, i.e., how managers perceive and manage their stakeholders (freeman, 1984; mitchell, agle, and wood, 1997; agle, mitchell, and sonnenfeld, 2000). however, relationships are embedded within their social context (rowley, 2000). studying a single firm's relationship with a single stakeholder doesn't capture the full complexity of the ettects of the social context on such relationships. a better understanding can only be gained when these interactions can be studied within the broaden context in which they are embedded. this paper addresses the issue of collective stakeholder action in one such context, namely the industry context, as not much is known about collective stakeholder action at this level of analysis within the extant stakeholder research. furthermore, there is a dearth of knowledge on the stakeholder's perspective of the relationship that has only recently been addressed by new research on stakeholder action (frooman, 1999; rowley, 1997, 2000; rowley and moldoveanu, 2003). frooman's (1999) study applied concepts from resource dependence theory to argue that stakeholders can act together by using either direct or indirect access to resources to influence the focal firm's behaviour. in another study that takes a stakeholder's perspective, rowley and moldoveanu (2003) examined stakeholder groups' propensity for action. they proposed that an interest based rationale is a necessary but insufficient condition for when stakeholder groups will mobilize to act. they concluded that when group identity is highly valued by the members of the group, this is likely to rally stakeholder groups to act even when there are no economic benefits to be obtained through such action. this line of research is built on to address collective stakeholder action at the industry level. the industry context to determine what are the boundaries of an industry, porter defined an industry as 'the group affirms producing products that are close substitutes for each other' (1980, p. 5). based on industrial organization (10) economics, porter's framework for industry analysis has pervaded academic and practitioner literature as a means by which to analyze industry competitive behaviour and profitability. porter inspring 2006 munshi: collective stakeholder action 35 eludes buyers, suppliers, potential and existing rivals within this framework as those actors that constitute part of an industry's immediate task environment. however, this conventional view of an industry's structure is limiting and does not provide an accurate picture of who constitutes a stakeholder of an industry. there is research to suggest that industries are not merely clusters of competing firms, but social and cognitive systems in their own right (porac and thomas, 1995; porac, thomas and baden-fuller, 1989; reger and huff, 1993). grinyer and spender's (1979) research, and later on, spender's dissertation work (1989) would suggest that industries generate 'recipes' or patterns of belief that rely on common knowledge and shared experiences. other research, by porac and colleagues (porac and thomas, 1995; porac, thomas and baden-fuller, 1989) on the scottish knitwear industry, provided empirical evidence that industries are socially constructed based on patterns ofbeliefs ofthose who perceive themselves as members. social cognition theories (fiske and taylor, 1991) inform us that social realities are constructed based on mutually shared perceptions between individuals. this paper hopes that the social constructionist perspective can help shed light on stakeholder group action in an industry context. more recent work on industry level social cognition tries to reconcile the economist's view with that of the cognitive view. this research suggests that the 'stickiness' of these underlying belief patterns of industry members may be at risk when economic opportunities arise (johnson and hoopes, 2003). it is possible then that the socially constructed beliefs of members will be challenged by any perceived innovative change that is radically different from the prevailing values and beliefs of intra-industry stakeholders, which could lead to potential for stakeholder action. tn the next section, the existing literature on the stakeholder's perspective is reviewed in brief to identify who might be considered industry stakeholders and why these actors act collectively at the industry level. the stakeholder's perspective stakeholder researchers (e.g., mitchell, agle, and wood, 1997; agle, mitchell and sonnenfeld, 2000) have been preoccupied with managers' perception of stakeholders and how to manage these stakeholders. however, freeman (1984) defines a stakeholder as "any group or individual who can affect or is affected by the achievement of the organization's objective" (p. 46). thus, it is important to clarify that stakeholders can act to influence a firmjust as well. until recently, not much was known about this stakeholder's perspective, especially in terms of how stakeholder groups can collectively act to influence a focal organization's behaviour. frooman (1999) notably used resource dependence theory to suggest that stakeholder influence strategies were based on gaining resource access. this original study concluded that stakeholders act either directly or indirectly to gain access to resources in order to influence the focal organization. rowley and his co-authors have also suggested there is a need to take into account the social context to study stakeholder-firm interactions within a network of relationships. for example, rowley (1997) took a social network approach 36 journal ofbusiness strategies vol. 23, no. i to study this research problem and found empirical support for the importance of the relational context (rowley, 2000). furthermore, rowley, behrens, and krackhardt (2000) noted the importance of industry context on such types of relationships. more recently, rowley and moldoveanu (2003) provide additional insight on when multiple stakeholders will mobilize for action, i.e., intention rather than actual action. they argued that stakeholders are most likely to take collective action when they are both protecting their interest and are bounded by their shared identity based on group membership. these works represent a significant advance in stakeholder literature as they attribute motives to observed behavior. this paper attempts to extend this line of research on when multiple stakeholders will act collectively by addressing the phenomenon at the industry level of analysis. rowley and moldoveanu (2003) use group membership as the basis for identifying what constitutes a stakeholder group. for the purposes of this paper, industry stakeholders are identified as those individuals and groups who perceive themselves and are perceived by other members as having a membership stake in the industry. it can be said then that industry stakeholders have a shared mental model of the industry that is based on mutually shared beliefs. below, the events that unfolded following the introduction of the cardhu pure malt whisky by diageo into the scotch whisky industry are used as an illustration of stakeholder action at the industry level. research setting in this study, collective stakeholder action is examined within the context of the scotch whisky industry. the specific example of multiple stakeholder action against the introduction of a new product by diageo, namely the cardhu 'pure' malt whisky is used as an illustrative example ofstakeholder action at the industry level. there are several reasons why the scotch whisky industry is useful in this paper in order to explain this phenomenon. for one, it is a traditional industry. industry stakeholders used to be bounded by traditions and norms that comprise commonly held beliefs. this has recently changed with the takeover of many smaller distilleries by large multinational corporations that are more concerned with global scale economies as they operate at the global level. this is an industry going through rapid changes, especially at the corporate level. but it is still bounded by traditions and commonly held beliefs at the production level, which makes this a fertile ground to observe industry level collective stakeholder action. this section is followed by a brief discussion of how social cognitive processes rather than purely rational motivations might have contributed to why stakeholders collectively acted at the industry level in this example. further illustrations are provided in the form of excerpts taken from first-person interviews with key industry actors such as distillery managers and distillery owners on the production end, expert sources such as whisky magazine, the scotch whisky association, and specialist retailers and whisky connoisseurs on the consumer spring 2006 munshi: collective stakeholder action 37 marketing end. these interviews were compiled as part of an ongoing research study on the scotch whisky industry. the scotch whisky industry and the cardhu pure malt whisky incident this main purpose of this paper is to examine collaborative stakeholder action at the industry level from a sociocognitive perspective. the scotch whisky industry is used as a case in point. according to the scotch whisky industry's trade association (swa), scotch whisky is one the top five exports from the uk as it makes up over 20% of uk food and drink exports with income exceeding £2 billion per year in the last decade (scotch whisky association, 2005). it is also noted by the swa that with over 10,000 employees drawn from local regions, the scotch whisky industry is a major manufacturing industry in scotland and furthermore, scotch whisky outsells its closest rivals by four times in terms of sales. in the production of scotch whisky, there are many actors involved in the process of delivering the final product to the consumer. these individuals can be found in various parts of the production process such as the malting, mashing, fermentation, distillation, maturation, and beyond that to the warehousing, blending, bottling and packaging processes, as well as in distribution, advertising and marketing. other industry members include the cereal producers and suppliers, energy producers, distributors, and retailers. in addition, there are other key stakeholders such as the experts and connoisseurs, the whisky clubs and other associations on the internet who also contribute in developing narratives and myths behind the scotch whiskies and are, therefore, also stakeholders in the social construction process. scotch whisky traditionally comprises the spectrum ofproduct categories from blended to single malt whiskies. prior to the cardhu incident, it was commonly understood that a blended whisky was made up of single malts and/or grain whiskies from several distilleries while a 'single' malt whisky was from just one distillery. a 'single' malt scotch whisky is the product of one scottish distillery, and by law, is required to be matured for a minimum of3 years in scotland prior to sale. in reality, most single malts are matured for a minimum of 10 years prior to being sold as single malts, which has raised serious concerns as demand has begun to outstrip supply due to the increasing global popularity of this product category (coyle, 2003). simply put, although the actual single malt product in the bottle maybe a 'vatting' or marriage of several different years, the whisky should have come from one distillery only to be called a 'single' malt the implicit and generally understood but unwritten rule was that, ifthe product was a mixture of single malts from different distilleries, then it was to be referred to as a vatted malt whisky or even a blend. for diageo cardhu distillery's parent company and the largest firm in the industry the introduction in april 2003 of the cardhu 'pure malt' whisky was seen as an innovative solution to the production shortage faced by the whisky industry in their fast growing single malt sector (diageo news release, 2003). 38 journal ofbusiness strategies vol. 23, no.1 the pure malt had been packaged and sold in cardhu's overseas markets in exactly the same way as its single malt whisky, although technically the 'pure' malt product had single malts from diageo's other distilleries in it as well and in the opinion of diageo 's competitors, should have been referred to as vatted malt. for diageo's brand director, jonathan driver, cardhu pure malt presented an opportunity in a fast growing market to increase product categories and generate greater revenues (diageo news release, 2003). it appeared that diageo's managers also thought that this pure malt category would be a revenue generator for other distillery owners facing similar shortage problems. discord on this issue, however, was based on what industry stakeholders perceived as a clash between diageo's representation of the pure malt and what the single malt whisky category stood for. one distillery manager commented on the dilemma faced by diageo: "that was a marketing whoopsie ... cardhu was so successful from a marketing perspective that it outsold its production. now given that there's a twelve year wait on production, you can't simply produce overnight for tomorrow, so had they (diageo) known twelve years ago that they were going to be as successful in spain, then they would have increased the size and capacity ofcardhu distillery. what they had originally was access to a market that wanted more cardhu and they looked at producing more cardhu simply by changing the goal posts and fundamentally changing the labelling on the whisky ... and that would have brought the whole malt whisky category into some disrepute around the world if it had been allowed to go ahead" (july 2, 2004) the problem was made worse by the fact that until this time, what constituted a 'single' malt and what constituted a 'blend' was based on common understanding rather than codified definitions (this definition has since been somewhat but not entirely resolved by the scotch whisky association, the trade organization for the scotch whisky industry). despite the fact that there was some short-term economic gain from the introduction of the pure malt concept for many of the individual distilleries facing production shortages, the general feeling was that this was a bad move for the industry. some stakeholders were reported to claim that the pure malt was bound to result in consumer confusion, which could lead to a dilution of the scotch single malt whisky's reputation (scotman.com, 2003). these stakeholders included not just diageo's main competitors, but also connoisseurs, consumers, retailers, media, the uk and european governments. as one distillery manager succinctly put it: " .. (single malt scotch) is the only one today people are going to because they have a bit of trust in the product" (july 2, 2004) the outcome of a much publicized intra-industry battle was that diageo finally pulled cardhu 'pure' malt off the markets in 2004. the final resolution of the issue was brought about through an swa initiated discussion and was generally spring 2006 munshi: collective stakeholder action 39 perceived as being an amicable one. ian meakins, the head ofdiageo's european marketing operation, issued a public statement stating among other reasons for this withdrawal: "we believe that we have acted consistently in the best interests of consumers, but acknowledge that we under-estimated the strength of feeling on this issue" (bbc news online, 2004). interestingly enough, many ofthe distillery managers interviewed perceived the entire problem as having originated on the marketing rather than the production side. one distillery manager who has been part of the industry for over 35 years stated: "from a production standpoint, we have our brotherhood where everybody helps one another. i think where marketing and sales is concerned is probably where it gets slightly more vicious. that's where the competition comes in! but i can go and speak to other distillers about what's going on at their distilleries, ask them questions about their production and so on, walk around the plant with them." (july 2, 2004) furthermore, the manager said: "i think initially we were embarrassed and after it was all tidied up, ] think there were little upsets ... but we're all part ofthe scottish whisky association of scotland and we all sit around the table together. .. we've still got work to do and we've still got things that we need to fight as a body beyond the cardhu incident..." (july 2, 2004) discussion the sociocognitive approach was used in this paper to demonstrate when stakeholders will act collectively at the industry level for the collective's interests at the expense of their own immediate short-term economic interests. there are several reasons for why this incident in the scotch whisky industry illustrates industry-level collective stakeholder action that evolves from social construction. first of all, it is an industry whose reputation is built on traditions held together by collective beliefs of the industry members. it is said that commonly held beliefs shape social construction of the industry (porac and thomas, 1995). one reason for why the intra-industry stakeholders acted in unison to oppose the 'pure' malt category was to prevent change in their commonly held beliefs in regards to what they perceived the product categories represented. it is plausible that the intra-industry stakeholders' expectations regarding what was best for the industry was based on their collective perception of what would be in the interest of the industry's long term viability. it can be argued that as the intra-industry stakeholders collectively tried to make sense of the pure malt product, the stakeholders perceived it to be inconsistent with their shared beliefs regarding what single malt category represented. furthermore, the scotch whisky industry's stakeholder actions were primarily driven by their collective identity (rowley and moldoveanu, 2003), which led to 40 journal ofbusiness strategies vol. 23, no. i their action on the cardhu pure malt whisky issue. it is argued here that in unique, traditional industries, the one reason why stakeholders are more likely to rally to action as compared to stakeholders in other industries, is because their individual identities are tied to those ofthe industry collective and this could take precedence over their economic interests. it is possible that one reason why intra-industry stakeholders were mobilized to act in this case is because their collective identity could be the coordinating mechanism enabling collective gains, as opposed to taking the short-term self interested option for individual gain. this paper puts forth one explanation for why traditional industries in particular are so idiosyncratic in their stakeholder actions. it suggests that industries' stakeholder action can be unique in themselves because of the interactions between socially constructed representations of actors and institutions, both internally and externally. these socially constructed representations in industries take the form of narratives and beliefs that stakeholders of the industry can collectively and individually identify with. as seen in the case of the scotch whisky industry, the production side of the whisky industry perceived as a 'brotherhood' among all the distillery producers with a shared tacit understanding of what the industry's products represent. these render a far more complex picture for why stakeholders mobilize than porter's industry analysis would allow for. to the extent then that industry stakeholders perceive change as being at odds with mutually shared beliefs, there is a greater likelihood of collective stakeholder action at the industry level. proposition: when industry stakeholders perceive change to be in discord with mutually shared beliefs, there is greater chance of collective stakeholder action at the industry level industries differ in the variety of stakeholders associated with them, in what these stakeholders value and how these stakeholders cognitively make sense of what constitutes the 'industry.' just as stakeholder maps exist for an individual firm that constitute a group of idiosyncratic stakeholders within a network ofrelationships, so too within a particular industry, there can exist industry stakeholders that have a shared mental schema or model of what the industry constitutes. it is possible that these stakeholders generate a socio-cognitive map that is closely tied to a collective identity, which when disturbed through the introduction of radically perceived change, could result in industry-level stakeholder action. it is said that commonly held patterns of beliefs make up the social construction of an industry (parac and thomas, 1995). it is plausible that these belief patterns would be strongly reinforced by stakeholders of traditional industries especially, where they perceive their values and beliefs as being closely identified with that of the industry. in the example of the scotch whisky industry, the industry stakeholders have similar beliefs and values that overlap to such an extent that as a result, any change that is perceived as being radically different and not in accordance with the existing cognitive schema will result in a higher likelihood spring 2006 munshi: collective stakeholder action 41 of stakeholder group action at a collective level. in contrast, it is plausible that in industries characterized by rapid changes such as nanotechnology or biotechnology, the industry schema is based on the introduction of radical innovations. one could say that there is a taken-for-grantedness about change that is incorporated into the cognitive schema of the stakeholder groups of these industries. thus, these stakeholders are less likely to act when they perceive radical change. interest based action (rowley and moldoveanu, 2003) is more likely to be the motive for stakeholder group action in such competitive industries. conclusion and implications this paper addresses collective stakeholder action at the industry level to better understand when stakeholders are motivated to act in a way that does not reflect a purely short-term economic reasoning for their actions. this paper illustrates this type of industry-level stakeholder action by using the example of the introduction of the cardhu pure malt whisky in the scotch whisky industry. it integrates stakeholder and sociocognitive perspectives on collective group action to explore when intra-industry stakeholders will act collectively at the industry level. it puts forth one explanation for why industry level stakeholder action can occur. it suggests that industries constitute socially constructed representations of individuals and groups that perceive themselves as having a membership stake in the industry. these socially constructed representations in industries take the form of shared narratives and beliefs with which stakeholders of the industry can collectively and individually identify. thus, changes that are perceived as being radically different from these shared mental models will increase the chances of industry level collective stakeholder action. the collective stakeholder action at the industry level demonstrates that the 'the tragedy of the commons' (hardin, 1968) is not always the case. the tragedy of the commons perspective argues that stakeholders will forsake their long-term collective benefits for their immediate short-term economic selfinterests. this perspective has also been the foundation for various game theoretical models of industry level competitive action. the sociocognitive approach developed in this paper showed that the tragedy of the commons framework does not help to explain stakeholder action in the scotch whisky industry. here we see that the stakeholders collaborated at the industry level in order to protect the reputation of the collective industry, subsuming any short-term economic gains they might have received from also going down the same road. the collective action of the scotch whisky industry's stakeholders at the industry level provides an intriguing example of what can be referred to as 'the joy of the commons.' although this paper is limited by its focus on a single industry, its contribution is that it provides a more fine-grained explanation for why stakeholders act collectively at the industry level than a simple industry analysis based on porter's five forces framework. the paper also provides further support for rowley and moldoveanu 's (2003) theoretical framework for collective stakeholder group action 42 journal of business strategies vol. 23, no. 1 that is identity based. one important implication of this study is that as firm level stakeholder action may be contingent upon industry effects, studying industry attributes might provide further clues for how firm-stakeholderrelationships evolve. for managers, this study also provides one explanation for why stakeholders will collaborate to act collectively against the focal firm. it also provides an insight into competitive strategies that are not purely driven by economic self interest as supported by rationalist economics driven theories. from the practitioners' point of view, using the social constructionist perspective developed here in addition to the rationalist economics based approaches achieves a more balanced approach to industry analysis and collective stakeholder action at the industry level. references agle, b. r., mitchell, r. k., & sonnenfeld, j. a. (2000). a report on stakeholder attributes and salience, corporate performance, and ceo values. in j. m. logsdon, d. j. wood, & l. e. preston (eds.), research in stakeholder theory. 1997-1998: the sloan foundation minigrant project. 39-54. toronto, on: clarkson centre for business ethics. abrahamson, e. & fombrun, c.j. (1994). macrocultures: determinants and consequences. academy of management review. 19. 728-756. coyle, m. (2003). ley stand-off in whisky row. bbc news online. retrieved november 7,2003, from news.bbc.co.uk/l/hilscotland/3249865.stm christensen, e. w. & gordon, g. g. (1999). an exploration of industry, culture and revenue growth. organization studies. 20. 397-423. daniels, k., johnson, g., & dechernatony, l. (2002). task and institutional influences on managers' mental models of competition. organization studies, 23, 31-62. diageo admits cardhu malt defeat. bbc news online. (2004). retrieved march 9, 2004, tram news.bbc.co.uk/i /hi/scotland/3546321.stm diageo news release.(2003). so is cardhu pure malt a threat to scotch whisky? retrieved november 17, 2003, from www.diageo.com/pageengine.asp?menu_id=o&site_ id= i&section_id=2&page_id= 1050 fiske, s. t. & taylor, s. e. (1991 ). social cognition. 2nd edition. new york: mcgrawhill, inc. freeman, r. e. (1984). strategic management: a stakeholder approach. boston: pitman. frooman, j. (1999). stakeholders influence strategies. academy afmanagement review, 24: 191-205. spring 2006 munshi: collective stakeholder action 43 grinyer, p. h. & spender, j-c. (1979). recipes, crises and adaptation in mature industries. international studies of management and organization, vol. ix (3), 113-133. hardin, g. (1968). the tragedy of the commons. science, 162. 1243-1248. johnson, d. r. & hoopes, d. g. (2003). managerial cognition, sunk costs, and the evolution of industry structure. strategic management journal. 24, 1057-1069. mitchell, r. k., agle, b. r., & wood, d. j. (1997). toward a theory of stakeholder identification and salience: defining the principle of who and what really counts. academy of management review, 22, 853-886. olson, m. (1965). the logic ofcollective action: public goods and the theory ofgroups, cambridge, ma: harvard university press. parae, j. f. & thomas, h. (1995). rivalry and the industry model of scottish knitwear producers. administrative science quarterly, 40, 203-228. porac, j. f., thomas, h., & baden-fuller, c. (1989). competitive groups as social communities: the case of the scottish knitwear manufacturers. journal ofmanagement studies, 26, 397-416. porter, m. e. (1980). competitive strategy: techniques for anazvzing industries and competitors. new york: the free press. post, j. e., preston, l. e., & sachs, s. (2002). managing the extended enterprise: the new stakeholder view. california management review, 45 (1), 6-28. reger, r. k., & huff, a. s. (1993). strategic groups: a cognitive perspective. strategic management journal, 14 (2), 103-123. rowley, t. j. (1997). moving beyond dyadic ties: a network theory of stakeholder influences. academy of management review, 22, 887-910. rowley, t. j. (2000). does relational context matter? an empirical test of a network theory of stakeholder salience. in j. m. logsdon, d. j. wood, & l. e. preston (eds.), research in stakeholder theory, 1997-1998: the sloan foundation minigrant project: 2 i -38. toronto, on: clarkson centre for business ethics. rowley, t. j., behrens, d., & krackhardt, d. (2000). redundant governance structures: an analysis of structural and relational embeddedness in the steel and semiconductor industries. strategic management journal, 21. 369-386. rowley, t. j., & moldoveanu, m. (2003). when will stakeholder groups act? an interestand identitybased model of stakeholder group mobilization. academy of managementreview, 28, 204-219. 44 journal ofbusiness strategies vol. 23, no.1 scotch whisky association. (2005). retrieved january 6, 2005, from www.scotch-whisky. org.uk spender, j-c. (1989). industry recipes, the nature and sources of managerial judgment. oxford: basil blackwell. whisky sour as deal leaves a nippy taste. 2003. scotman.com. retrieved december 5, 2003, from www.scotchwhisky.net/news/sour.php natasha vijay munshi, bsc, mcs, mba, phd, is an assistant professor in strategy at cass business school, city university london, and an advanced institute of management (aim) research scholar. she teaches, publishes and advises in the areas of technology strategy, leadership and innovation, corporate social responsibility and stakeholder relationship management a sociocognitive perspective of industry-level collective stakeholder action: the case of the scotch whisky industry logistics leverage donald j. bowersox michigan state university • east lansing, mi john 1. mentzer the university of tennessee • knoxville, tn thomas w. speh miami university • oxford, oh abstract it is the purpose of this paper to position marketing and logistics relationships in a strategic context. the strategic position of both areas is used to draw conclusions for the future relationships of marketing and logistics and to suggest the need to focus on creating "logistics leverage." logistics leverage the ability to achieve marketing advantage through logistics superiority is accomplished through the resolution of nine key issues. once resolved, logistics can be exploited to obtain and maintain significant competitive advantage. introduction much recent attention in both business and research has been devoted to the importance of interfunctional coordination (crittenden, 1992; deshpande & webster, 1989; kahn & mentzer, 1994; lichtenthal & wilson, 1992; o'reilly, 1991; ruekert & walker, 1987; st. john, 1991; st. john & hall, 1991). two areas that have received particular scrutiny have been marketing and logistics (granzin, 1980; granzin & bahn, 1989; mentzer, 1993; rinehart, cooper & wagenheim, 1989; voorhees & coppett, 1986; voorhees, teas, allen & dinkier, 1988). it is the objective of this paper is to examine the relationship between marketing and logistics within a strategic context. this examination is developed in four parts. in the first part, two catalysts to further integration of marketing and logistics are discussed. in the next part, the integration of marketing and logistics is projected into a strategic context. the third part introduces the concept of logistics leverage and the nine issues that must be resolved to accomplish it. finally, conclusions for marketing and logistics managers and researchers are presented. marketing/logistics integration catalysts although marketing and logistics often receive some degree of integration, two catalysts existing in the business environment are working to make logistics superiority, and its strategic integration with marketing, a necessity for many com86 journal of business strategies panies. understanding these catalysts better positions how logistics can be deployed as a key strategic resource. time and quality based competition time and quality based competition focus on eliminating waste in the form of time, effort, defective units, and inventory in manufacturing-distribution systems (larsen & lusch, 1990; schonberger & ei ansary, 1984; schultz, 1985). the most popular time and quality based concepts are just-in-time (jit) and quick response (qr). jit has many facets and touches almost all aspects of a business enterprise (bartholomew, 1984; daugherty & spencer, 1990; frazier, spekman & oh, 1987; jackson, 1983; rosenberg & campbell, 1985). as a result, purchasing, transportation, inventory, and manufacturing personnel all consider jit to be indigenous to their performance (yanacek, 1987). in reality, all these activities, plus marketing, are impacted by the adoption of a jit system within which logistics becomes the focal point of implementation. one of the effects of jit is to direct logistics attention toward an overall procurement, manufacturing, operating, and marketing orientation of the business. importantly, there are significant marketing benefits that can result from establishing jit competency for example, higher customer satisfaction from better quality products with zero defects, more consistent availability, and faster product delivery. typically, such benefits are fully exploited only if logistics managers are more attuned to internal, supply-side systems and cost control, while integrating with marketing programs and customer requirements. quick response (qr) systems are similar to jit programs (i.e., the required integration of marketing, purchasing, transportation, inventory, and manufacturing), but differ by the fact that they deal with the distribution of finished products from manufacturers to wholesalers and retailers (larsen & lusch, 1990). many of the principles of successful qr are similar to the logic that drives jit. because qr typically deals with finished product distribution, performance is an integral part of total customer service (dumaine, 1989). however, the drivers that make most existing qr programs successful are inventory velocity and total cost reduction. only a limited number of firms have begun to manage qr programs toward the goal of achieving competitive advantage (daugherty & spencer, 1990). the competitive impetus for such coordination of inventory velocity and cost control with customer satisfaction serves as a catalyst for marketing/logistics integration in finished goods channels. volume 25, number 2 87 more advanced forms ofqr, however, focus primarily on customer satisfaction. recently coined "service response logistics" (davis & manrodt, 1991, 1993; manrodt & davis, 1992), these programs tend to position logistical competency as the core activity aimed at achieving customer satisfaction through inventory availability, timely delivery, less product failure, and, thus, less lost sales or returns/ complaints (stalk, evans & shulman, 1992). the achievement of such customer satisfaction requires significant integration of logistical competency and marketing performance. the combined effect of time and quality based systems has been to emphasize the need for marketing/logistics integration as a competitive advantage. while both jlt and qr thrive on interorganizational and interfunctional coordination, such arrangements must be driven by a desire to reduce cost, improve asset utilization, and more effectively service customers. attention to service response logistics suggests that some significant breakthroughs that capitalize on the strategic impact of marketi ng/logistics integration are developing. efficiency and effectiveness logistics, by its nature, is quantitative in the measurement of efficiency delivery time, the number of short orders, inventory, and similar operational activities can be readily measured. as a result, logistics practice and research has been more operationally oriented and tended to focus more on economic or efficiency measures of performance. the absolute magnitude of logistics cost has directed many firms to control the expense side of logistics; that is, to manage the process to achieve a level of efficiency. although there has been considerable research in the logistics area concerning how logistics impacts customer service (for a review, see mentzer, gomes & krapfel, 1989), no accepted protocol for measuring customer responsiveness to logistics service levels exists. further, the traditional focus of logistics research on economic (efficiency) issues rather than behavioral issues has not brought the attention of behavioral researchers in marketing to bear on this problem. although much research in marketing has been devoted to the behavioral implications of service quality and customer satisfaction/dissatisfaction (for a review, see zeithaml, berry & parasuraman, 1993), iittle such research has addressed the behavioral implications of changes in logistics service quality as part of overall marketing strategy (mentzer, bienstock & kahn, 1993). 88 journal of business strategies however, cost control (efficiency) without recognition of customer service requirements (effectiveness) will doom any aspect of a marketing effort to failure. logistics is no exception. the need for a clearly defined linkage between logistics performance, marketing strategy, and their behavioral consequences provides the second, and perhaps most important, catalyst for the implementation of logistics as a strategic marketing tool. summary current developments in the business environment and the marketing literature suggest these catalysts are having an impact. there are increasing examples of firms such as wal-mart, target, and kmart establishing alliances with manufacturers to jointly reduce costs and leverage performance. further, the recent interest in the marketing literature with relationship marketing (anderson & weitz, 1992; anderson & narus, 1990; dant & schul, 1992; dwyer, schurr & oh, 1987; frazier, spekman & o'neal, 1988; heide & john, 1992; larsen & lusch, 1990) suggests progress in examining the strategic management of logistics issues in building relationships with customers. results of such alliances and research scrutiny suggest that issues of efficiency and effectiveness measurement can be jointly resolved and that logistical performance can be integrated into mainstream marketing strategy and research. the reality of such catalysts and the potential to be gained from them argue strongly for in-depth examination of logistical effectiveness in overall marketing strategy and a searching consideration of the key role that logistics plays in creating customer satisfaction. the marketing/logistics strategic linkage in porter's (1985) value chain, one ofthe four support activities (procurement) involves logistics and all of the five primary activities involve logistics (inbound logistics, operations, and outbound logistics), marketing (marketing activities), or both (service). it is interesting to note how these functions are so important and inextricably linked in the value chain and suggests that increased focus be placed on effectively coordinating their interaction. the foundation of future marketing and logistics integration is strategic. with this goal in mind, figure 1 utilizes the competitive advantage framework of day and wensley (1988) to develop the dimensions of the relationship and position the strategic importance of integrated marketing/logistics. volume 25j number 2 figure 1 integrated strategic planning 89 marketing focus effectiveness superior skills superior resources logistics focus efficiency superior skills superior resources catalysts to integration integration for superior customer value and lower relative cost strategic positioning logistics leverage performance outcomes competetive advantage the focus of logistics has been and will primarily continue to be upon cost drivers, i.e. skills and resources that generate efficiency. the integration of marketing and logistics is necessary to bring the logistics sources of advantage into the realm of effectiveness, or drivers of differentiation. this will only occur and result in positional advantages if the leverage logistics can bring to marketing is realized. this leverage can only be realized by recognizing and exploring, both within the practitioner and academic communities, the strategic linkage between marketing and logistics wherein logistics skills and resources are translated into effective drivers of differentiation. where this integration is accomplished, strategic positioning of the marketing/logistics integrated firm as cost efficient and customer effective 90 journal of business strategies will result. it will be incumbent upon marketing to emphasize these superior performance outcomes to achieve sustainable competitive advantage. firms that have successfully implemented such coordination are now building corporate strategies that exploit logistics competency (bowersox, daugherty, droge, germain & rogers, 1991). by focusing on logistics competency (e.g., one call for complete order status information, total flexibility in ordering to support either store direct or warehouse delivery, no order minimums), the leading logistics performers are providing tangible and significant benefits to customers. the net result is the creation of a meaningful competitive advantage. selected firms are beginning to realize that logistics excellence is a significant differential advantage that can be exploited in the marketplace (bowersox, et ai., 1991). logistics service is an effective tool for building closer relationships with key customers. although the expression "being easy to do business with" is over used, the fact remains that some firms are very difficult to buy products from and have poor response systems for providing information concerning such facts as order status and invoice discrepancy. other firms have state-of-the-art logistics information systems that enable maximum control (shapiro, rangan & sviokla, 1992; stalk, evans & shulman, 1992) a source of advantage which can be translated through integration with marketing into a positional advantage (day & wensley, 1988). the result is the performance outcome of significant customer impact. the final outcome of these superior logistics systems is an added positional advantage of preferred status for selected suppliers and such status draws directly from the logistics competency (even in situations where price, product, and promotion are undifferentiated or marginally higher in comparison to selected competitors). as day and wensley (1988) observed, "the sustainability of this positional advantage requires that the business set up barriers that make imitation difficult." the true positional advantage of logistics competency is that a chief executive officer cannot, by the whisk of a pen, mandate such competency and automatically obtain the facilities, systems, human resources, and information control necessary to produce a consistent level of logistical performance. as marketing strategies evolve toward greater market segmentation sophistication, the ability to provide customized logistics service to unique segments will become increasingly demanding. firms with high levels of logistical competence are better positioned to exploit such opportunities. volume 25, number 2 logistics leverage 91 the critical question is how to leverage the strategic benefits inherent in an effective logistics system for maximum competitive advantage. logistics leverage is the ability to effectively influence market demand through the application of excellent logistics systems, techniques, and programs. the term leverage indicates relatively high market returns may be gained from relatively small investments. significant sales, market share, and consumer satisfaction gains can be achieved if the firm consciously positions itself to leverage its logistics capabilities. it is not enough to have created the human resources, technical tools, and operational systems for effective logistics, the firm must be able to market and use its logistics expertise to achieve marketing goals. thus, logistics leverage is based upon successfully resolving nine issues. creation of value-added services the exploitation of logistics competence offers a meaningful way to create value-added services not achievable in other ways (cooke, 1990; mentzer, 1993; wittersdorf, 1991). such positioning requires defining critical business processes from a logistics perspective. such value-added processes have spawned the development of new channel institutions. logistics facilitation companies are one of the most rapidly growing marketing institutions. such facilitators do not view themselves as traditional wholesalers, retailers, warehousers, or transportation companies. their mission vision is one of being a service organization which satisfies a specific niche requirement. they provide logistics economies of scale, essential services, and time and quality based delivery. the combination of more effective delivery at a lower cost translates to increased value. thus, what have traditionally been logistics cost drivers are becoming drivers of differentiation (day & wensley, 1988; porter, 1985). again, the shift from cost driving logistics activities to logistics drivers of differentiation requires the integration of marketing and logistics activities and strategic plans. management vision top management must fully understand the real and significant market impact that results from logistics superiority. recent history has demonstrated that many of the successes achieved by large consumer goods firms with mass merchandisers resulted from the manufacturer's ability to lower logistics costs while increasing logistics service, resulting in increased final consumer satisfaction com92 journal of business strategies bined with reduced retailer inventory. these drivers of differentiation were accomplished through management's vision of the potential oflogistics and a commitment to leveraging their logistics system for their customers. management vision will achieve logistics leverage only if (1) top management applies resources to bring logistics expertise to their customers on a customer-by-customer basis (davis & manrodt, 1991), (2) the attitude of marketing customer satisfaction as a corporate core competency is nurtured by top management throughout the entire organization, not just in marketing, and (3) the logistics benefits of the manufacturer are communicated directly from the supplier ceo to the customer ceo. this latter point is an essential ingredient in the establishment of strategic alliances and partnerships. strategic alliances and partnerships the marketing value of exploiting logistics competency is demonstrated by the positional advantage available as a result of linking firms and their customers into strategic alliances and partnerships. the last decade has witnessed the growth of vertically-integrated marketing systems in a behavioral or relational sense (dwyer, shurr & oh, 1987; frazier, spekman & o'neal, 1988; narus & anderson, 1986). the strategic alliances that have evolved are broader in scope than simple out-sourcing because they include risk and reward sharing. a significant aspect of these newly created alliances is the central role typically played by logistics (bowersox, 1990). inventory management, direct-store delivery, warehousing, and transportation consolidation are typical logistics functions that are at the core of many partnerships. the efficient performance of these activities by specialists produces benefits shared by both partners. as frazier, spekman, and o'neal (1988) stated, the emphasis in such relationships is on "the notion of 'total cost of ownership' and the array of value-added services provided." strategic interfunctional teams logistics superiority as a driver of differentiation can be achieved only when all parties in the marketing organization are integrated in terms of the basic concept of customer satisfaction, the potential of logistics leverage to aid in obtaining customer satisfaction, how the message of logistics customer value needs to be communicated, and to whom this message should be delivered. team marketing approaches, typically composed of marketing, sales, logistics, finance, and production representatives, are common place and the norm in some industries, with significant volume 25, number 2 93 resultant advantages (hutt & speh, 1984). to achieve logistics leverage, marketing must recognize the role logistics plays in achieving customer satisfaction. without this recognition, the related promotional, pricing, and "service package" strategies to market logistics expertise to the customer will not be achieved. it falls to logistics to develop and deliver the logistics excellence that marketing has identified as important to customers. orientation of marketing for many firms, particularly in the consumer goods industries, the overriding emphasis in marketing personnel training is given to the product and promotional dimensions of marketing strategy. many factors reinforce this orientation: brand manager organizations; college marketing curricula with an emphasis on advertising, promotion, and product development; and corporate training programs where marketing personnel are given little exposure to logistics. to achieve logistics leverage, colleges and corporations need to rethink the manner in which marketing managers are developed. one step that can be taken by colleges in this leadership role is to make logistics courses required for all business students. organizational issues a major premise of this work is that logistics competency can be created, but unless the firm is positioned to exploit it, little strategic significance will result. one way to leverage logistics excellence is to establish hierarchies and reporting relationships that maximize the integrated potential. when marketing, sales, and logistics each report to a separate vice president, each with their own organization, more effort will be required to break down the inherent organizational barriers so that integration is achieved. customer teams and matrix management are commonly used to overcome organizational inflexibiltty (clark & wheelwright, 1992; gibson, ivancevich & donnelly, 1988; lawrence, kolodny & davis, 1977). however, since logistics is a customer satisfaction impacting function and its significance as a competitive marketing tool has been demonstrated, logistics should logically be more closely aligned organizationally with marketing. rather than a team approach, if logistics reports directly to marketing, the potential for maximum market impact oflogistics leverage is increased. 94 market intelligence journal of business strategies to achieve logistics leverage, information systems need to be restructured so that new and different types of information are routinely gathered and supplied to the marketing/logistics function. information on customer logistics problems and opportunities are required so the firm can quickly adapt their logistics expertise to meet these challenges. market research needs to expand from the traditional study of needs, attitudes, and behavior related to product, price, and promotional offerings to include the study of customer logistics needs that customers may not even be aware exist. in addition, environmental assessment studies to benchmark the efforts of those firms deemed to be leaders in logistics excellence will supply strategic information relative to the firm's extant logistics offering. channel member programs to effectively exploit logistics competence, significant efforts may be required to upgrade the logistics systems of other channel members. all channel members must share the vision of the potential market impact of logistics excellence. without that vision, there will be little hope of developing a marketing program with a logistical focus. further, logistics leverage can only be achieved in market segments served by channel members when those members possess the level of logistics excellence required by those customers. this excellence can be developed by careful selection of channel members by market segment, by transferring logistics excellence through strategic alliances, or outsourcing certain traditional channel functions to third party providers. sole-source relationships finally, the last several years have witnessed increasing efforts by firms to reduce their supplier base and move into sole-source relationships with key suppliers (bertrand, 1986; frazier, spekman & oh, 1988; purchasing, 1989). this trend underscores the need to refocus strategic thinking on the role logistics can play in establishing sole-source relationships. because of the impact of a vendor's logistics competence on the buyer's costs and operations gust-in-time delivery to production sites, damage-free products, error-free orders, and real-time information are all cost drivers that are potentially also drivers of differentiation for the firm), the vendor's logistics system may be the most effective way to create and support a sole-source relationship. volume 25, number 2 conclusions 95 the relationship between the related, but often independently managed, functions of marketing and logistics has been examined. the strength and longevity of the positional advantage from logistics excellence is impressive because of the difficulty of duplicating outstanding logistics systems and the significant benefits they provide to customers from a cost and quality standpoint. logistics leverage has to be consciously created through the actions of marketing and logistics managers within the firm. key issues to be resolved include the creation of value-added services, top management vision, strategic alliances and partnerships, interfunctional teams, the orientation of marketing, organization structure, marketing intelligence, channel member programs, and the nurturing of sole-source relationships. once these issues are resolved, the firm will be positioned to effectively integrate logistics competence into marketing strategy to create sustainable differential advantage. future research and management issues are very much related to the effort to create logistics leverage. managers and researchers alike need to become more concerned with the buyer behavior implications of changes in the marketing/logistics customer service package. buyer attitudes and behavior can be expected to change with integrated marketing/logistics efforts (mentzer, bienstock & kahn, 1993). whether this altered behavior will be for the good or detriment of the company, and in what degree, lies within the realm of buyer behavior and service quality research both applied and academic. measurement issues should continue to occupy the attention of researchers. without valid models and predictions of logistics impact on sales, costs, and profits, it is difficult to successfully plot the most meaningful role for logistics in the strategic thrust of a firm. more effective models are needed at two levels: within the channel and at the point of sales to the consumer. logistics service (in-stock levels, order cycle time, etc.) interacts with a variety of other marketing variables (price, boundary person relationships, location, brand name, advertising claims, etc.) to determine the customer's satisfaction. it will be necessary to expand research efforts to measure these interactions and isolate the specific effect of each variable. once these effects are better understood, marketing decision-making will be better positioned to make more effective decisions regarding the strategic positioning of logistics services within the overall marketing offering. the arenas of logistics and channels have long followed separate predominant paradigms economic for logistics and socio-psychological for channels. 96 journal of business strategies however, both areas of marketing address the same marketing phenomena distribution of products. the channels area typically addresses negotiation between channel members, whereas the logistics area addresses the operational interaction between these channel members. these two areas are not separate and cannot be meaningfully managed or researched without recognition of their interaction. the effect of negotiation upon operational reality and vice versa would seem a topic with rich potential for research and managerial creativity. in particular, the application of the transaction cost analysis paradigm (mcneil, 1980; williamson, 1975, 1985) to the effect of logistics transaction specific investments upon negotiation behavior would seem to be a research area immediately ripe for investigation. also within the tca paradigm, an area of increasing importance is the role of third-party logistics suppliers. effective logistics competency may be enhanced through the utilization of independent suppliers of a wide array of value-added logistics services. research, grounded in the transaction cost analysis paradigm, to evaluate the efficiency and effectiveness of out-sourcing logistics functions would help develop the dimensions of how logistics can contribute to maximum strategic impact. by out-sourcing some logistics functions (e.g. warehousing), a firm may gain cost and service advantages not available from internal performance, but incur additional transaction specific investments. as a result, the enhanced level of performance may create a differential advantage that otherwise would not have existed, but come at the cost of increased dependence upon a third party. being aware that an enhanced performance level is possible at the cost of increased risk permits decision-makers to more effectively assess the contributions of logistics to overall marketing success. references anderson, e., & weitz, b. (1992). the use of pledges to build and sustain commitment in distribution channels. journal of marketing research, 29(february), 18-34. anderson, j. c., & narus, j. a. (1990). a model of distributor firm and manufacturer firm working partnerships. journal ofmarketing, 54(january), 42-58. bartholomew, d. (1984). the vendor-customer relationship today. production and inventory management, (2), 106-21. bertrand, k. (1986). crafting 'win-win situations' in buyer-seller relationships. business marketing, 71(june),42-50. bowersox, d. 1. (1990). the strategic benefits of logistics alliances. harvard business review, 68(july-august), 36-45. volume 25, number 2 97 bowersox, d. 1., daugherty, p. 1., droge, c. l., germain, r. n., & rogers, d. s. (1991). logistical excellence: it's not business as usual. new york: digital press. clark, k. 8., & wheelwright, s. c. (1992). organizing and leading 'heavyweight' development teams. california management review, (spring), 9-28. cooke, p. n. c. (1990). value-added strategies in marketing. international journal ofphysical distribution and logistics management, 20(5), 20-24. crittenden, v. l. (1992). close the marketing/manufacturing gap. sloan management review, 33(spring), 41-52. dant, r. p., & schul, p. l. (1992). conflict resolution processes in contractual channels of distribution. journal ofmarketing, 56(january), 38-54. daugherty, p. 1., & spencer, m. s. (1990). just-in-time concepts, applicability to logistics/transportation. international journal of physical distribution & logistics management, 20(7). davis, jr., f. w., & manrodt, k. b. (1991). principles ofservice response logistics. proceedings. chicago: council of logistics management, 339-55. davis, jr., f. w., & manrodt, k. b. (1993). the evolution to service response logistics. international journal ofphysical distribution and logistics management, 22(9),3-10. day, g. s., & wensley, r. (1988). assessing advantage: a framework for diagnosing competitive superiority. journal ofmarketing, 52(april), 1-20. deshpande, r., & webster, jr., f. e. (1989). organizational culture and marketing: defining the research agenda. journal ofmarketing, 53(january), 3-15. dumaine, b. (1989). p&g rewrites the marketing rules. fortune, (november), 3448. dwyer, f. r., schurr, p. h., & oh, s. (1987). developing buyer-seller relationships. journal ofmarketing, 51(april), 11-27. frazier, g. l., spekman, r. e., & o'neal, c. r. (1988). just-in-time exchange relationships in industrial markets. journal ofmarketing, 52(october), 52-67. gibson, 1. l., ivancevich, 1. m., & donnelly, jr., 1. h. (1988). organizations: behavior, structure, and processes (6th ed.). plano, tx: business publications, inc. granzin, k. l. (1980). physical distribution: a description of its structure by means of second-order factor analysis. journal ofbusiness research, 8(2),213-223. granzin, k. l., & bahn, k. d. (1989). consumer logistics: conceptualization, pertinent issues and a proposed program for research. journal of the academy of marketing science, 17(winter),91-102. 98 journal of business strategies heide, 1. b., & john, g. (1992). do norms really matter? journal of marketing, 56(april), 32-44. hutt, m. d., & speh, t. w. (1984). the marketing strategy center: diagnosing the industrial marketers interdisciplinary role. journal of marketing, 48(fall), 5361. jackson, g. c. (1983). just-in-time production: implications for logistics managers. journal ofbusiness logistics, 4(2), 1-19. kahn, k. b., & mentzer, 1. t. (1994). norms that distinguish between marketing and manufacturing. journal ofbusiness research, 30, 111-118. larsen, p. d., & lusch, r. f. (1990). quick response retail technology: integration and performance measurement. the international review of retail, distribution and consumer research, (october), 17-34. lawrence, p. r., kolodny, h. e, & davis, s. m. (1977). the human side of the matrix. organizational dynamics, (summer), 47-62. lichtenthal, d. 1., & wilson, d. t. (1992). becoming market-oriented. journal of business research, 24, 191-207. manrodt, k. b., & davis, jr., f. w. (1992). the evolution of service response logistics. international journal ofphysical distribution and logistics management, 22(9),3-10. mcneil, 1. r. (1980). the new social contract: an inquiry into modern contractual relations. new haven, ct: yale university press. mentzer, 1. t. (1993). managing channels in the 21st century. journal of business logistics, 14(1),27-42. mentzer,1. t., bienstock, c. c., & kahn, k. (1993). customer satisfaction/service quality research: the defense logistics agency. journal of consumer satisfaction, dissatisfaction and complaining behavior, 6, 43-49. mentzer, 1. t., gomes, r., & krapfel, r. e. (1989). physical distribution service: a fundamental marketing concept? journal of the academy of marketing science, 17(winter), 53-62. narus, 1. a., & anderson, 1. c. (1986). turn your distributors into partners. harvard business review, 64(march-april), 66-71. o'reilly, c. (1991). corporations, culture, and commitment: motivation and social control in organizations. in r. m. steers & l. w. porter (eds.), motivation and work behavior. new york: mcgraw-hill, inc.: 242-254. porter, m. e. (1985). competitive advantage: creating and sustaining superior performance. new york: the free press. volume 25, number 2 99 purchasing. (1989). buyers keep trimming supplier base despite tight supplies, (february 23), 18. rinehart, l. m., cooper, m. b., & wagenheim, g. d. (1989). furthering the integration of marketing and logistics through customer service in the channel. journal ofthe academy ofmarketing science, 17(winter), 63-71. rosenberg, l. 1., & campbell, d. p. (1985). just-in-time inventory control: a subset of channel management. journal of the academy of marketing science, 13(summer), 124-133. ruekert, r. w., & walker, jr., o. c. (1987). marketing's interaction with other functional units: a conceptual framework and empirical evidence. journal ofmarketing, 51(january), 1-19. schonberger, r. 1., & ei ansary, a. (1984). just-in-time purchasing can improve quality. journal ofpurchasing and materials management, (spring), 1-7. schultz, d. p. (1985). just-in-time systems. stores, (april), 28-31. shapiro, b. p., rangan, v. k., & sviokla, 1. 1. (1992). staple yourself to an order. harvard business review, 70(july-august), 113-122. stalk, g., evans, p., & shulman, l. e. (1992). competing on capabilities: the new rules of corporate strategy. harvard business review, 70(march-april), 57-69. st. john, c. h. (1991). marketing and manufacturing agreement on goals and planned actions. human relations, 44(3),211-229. st. john, c. h., & hall, jr., e. h. (1991). the interdependency between marketing and manufacturing. industrial marketing management, 20, 223-229. voorhees, r. d., & coppett, 1. i. (1986). "marketing-logistics opportunities for the 1990's." journal ofbusiness strategy, 7 (fall): 33-38. voorhees, r. d., teas, r. k., allen, b. 1., & dinkier, e. t. (1988). changes in the marketing-logistics relationship. journal ofbusiness logistics, 9(1),34-48. williamson, o. e. (1975). markets and hierarchies, analysis and antitrust implications. new york: the free press. williamson, 0. e. (1985). the economic institutions ofcapitalism. new york: the free press. wittersdorf, r. g. (1991). adding value through logistics management. international journal ofphysical distribution and logistics management, 21(4), 6-8. yanacek, f. (1987). one more just-in-time. handling and shipping management, 28(may), 47. zeithaml, v. a., berry, l. l., & parasuraman, a. (1993). the nature and determinants of customer expectations of service. journal ofthe academy ofmarketing science, 21(winter), 1-12. logistics leverage sustainable growth of payment card networks: a two-sided market approach mingchun sun lehman brothers asia ltd. hong kong edison tse stanford university stanford, california abstract the payment card industry is a typical "two-sided market" where two groups of agents (i.e. merchants and cardholders) interact with each other via a common network platform (i.e. a card network) and the value ofparticipating in the network for agents in one group depends on the number ofparticipants from the other group. the positive network externalities across the two sides create the "chicken-and-egg problem": without sufficient merchants accepting a particular card network, few consumers are willing to apply for the card; without sufficient cardholders,few merchants are willing to accept the card. while economists have addressed the issuefrom social welfare perspective, we focus on business strategy implications. modeling network externalities in dynamic systems, we show that network platform owners could overcome the' 'chicken-and-egg problem" through strategies such as merger and acquisition, licensing, forming strategic alliance, as well as adjusting product and pricing strategies, etc. we provide a history of the u.s. payment card industry as empirical evidences to support ourfindings. introduction the payment card network has recently attracted much attention from researchers (chakravarti, 2003; rochet & tirole, 2002, 2003; schmalensee, 2002; wright, 2003a, 2003b, 2004) due to its special structure: two different groups of agents, the merchants and the consumers, interact with each other via the payment card networks; and the value of participating in a particular card network for agents in one group (say, merchants) depends on the number of participants from the other group (the consumers, correspondingly). for example, if more consumers carry visa card, merchants accepting visa card will be able to capture higher sales volume from these cardholders; on the other hand, if more merchants accept visa card, it will be more convenient for visa cardholders to pay for their purchases. such positive network effect also exists in other markets. for example, in yellow directory business, more advertising in a particular directory leads to more consumer usage, which in turn leads to more advertising in that directory 166 journal ofbusiness strategies vol. 24, no.2 (though in the next publication); in the pc industry, ifmore consumers use windows operating system, more software developers would like to write application software for this system, which will make the system even more appealing to consumers. similar phenomena can also be seen in the markets for academic journals, advertising, shopping malls, dating services and nightclubs, etc. markets with such cross-group network effect are termed as "two-sided markets" (armstrong, 2004; rochet & tirole, 2003). the cross-group network effect is a double-edge sword: it can either lead to spiral growth of the network or create the "chicken-and-egg problem." for example, if few consumers carry visa cards, few merchants would be willing to accept visa, which further discourages consumers from using this type of cards. unless the network has reached a critical mass in the number of participants, it cannot take off. while the "chicken-and-egg problem" in two-sided markets has been discussed in the economics literature, few focus on how to overcome it from business strategy perspective. in this paper, we use a dynamic system model to provide mathematical explanations to the "chicken-and-egg problem" and explore strategies for overcoming it. such strategies include merger and acquisition, licensing, forming strategic alliance, as well as adjusting product and pricing strategies, etc. we provide a historic account of the u.s. payment card industry to demonstrate relevance of our findings to business strategies in two-sided markets. the paper is organized as follows. we introduce the characteristics of twosided markets in section ii, followed by a brief literature review in section iii. in section iv, we present a dynamic system model of network growth and study the long-run behavior of the system. in section v, we propose business strategies for overcoming the "chicken-and-egg problem" based on model findings in the previous section. in section vi, we study the u.s. payment card industry and demonstrate the relevance of our propositions. section vii summarizes and concludes. characteristics of two-sided markets network structure in a two-sided market such as the payment card network, the two sides interact with each other through a common network platform. for example, in the payment card network, the electronic payment systems and equipment (e.g. point-of-sale (pos) terminals) are the platforms via which consumers interact with merchants; the hardcopy yellow directory provide a platform via which thousands of households find information about the merchants who advertise in the directory. besides the two sides, there is a third party who creates and services the network. we call it network pla(form owner or sponsor. visa, mastercard, american express, and discover are platform owners of the u.s. payment card network; sbc, verizon and other yellow directory publishers are platform sponsors in the yellow directory business; microsoft and apple computer are platform owners in the pc operating systems market. fall 2007 sun & tse: payment card networks 167 figure 1 illustrates the payment card network. merchants represent one side of the market and consumers represent the other side. each merchant installs a pas terminal in its store, which is linked to the electronic payment system owned by network platform owners (e.g. visa, mastercard). consumers can purchase goods or services from any merchants in the network. the platform owners operate the payment system and provide services to network participants (e.g. clearing & settlements, fund transferring, fraud protection). figure 1 the payment card network merchant 1 merchant 2 merchant 3 network platform owner (e.g. visa) consumer 1 consumer 2 consumer 3 consumer k (note: solid lines represent physical connection, dashed lines represent potential connection.) in many two-sided markets, there is also a 4th type of agents which has not been discussed in the two-sided market literature. we call them the distributors of a network. they are the agents who produce and sell network-specific products to participants on either or both sides of the market. in the payment card network, banks such as bank of america, wells fargo, chase, etc. issue visa or mastercard cards to consumers and sign up merchants. they are neither the network platform owner nor any side of the market. instead, they are the distributors of the corresponding network (i.e. visa or mastercard). the roles of network distributors are not essential in a two-sided network because a network platform sponsor may decide to take this role by itself and not allow any distributors in its network. for example, american express had been issuing its amex cards to cardholders solely by itself until 2004 when it started to allow distributors (i.e. banks) to issue amex-branded cards. discover, the owner of the fourth largest credit card network in the u.s., is still the only distributor of its proprietary discover card network as of today. although inessential to a two-sided network, network distributors may affect the diffusion speed of a network. their collective efforts in signing up network participants and in improving the quality and features of the network could have 168 journal ofbusiness strategies vol. 24, no.2 a critical impact on the growth and even survival of a network, as will be shown later in the paper. cross-group vs. within-group network externalities the defining characteristics of two-sided markets are the cross-group network externalities. for example, a consumer's decision to use visa card imposes positive externalities to merchants, while a merchant's decision to accept visa card imposes positive externalities to consumers. such cross-group network externality represents an instance of indirect network externalities (katz & shapiro, 1985). besides cross-group externalities, there could also be within-group externalities, either positive or negative, within either side ofthe market. for example, in the payment card network, negative externalities exist among merchants: given the number of cardholders, more merchants in a particular card network will lead to less incremental sales from accepting the card for an individual merchant. this is because merchants are competing against each other for businesses from the same cardholders. such negative within-group externality is called the congestion effect (rysman, 2004, p.484) and can also be found in other two-sided markets such as yellow directory, shopping mall, dating services, and pc operating system. fee structure usually, the two sides of the market can interact with each other without a network, though it will be at greater inconvenience. for example, a consumer could purchase goods from a merchant using cash or checks. however, such transactions are less convenient to both sides than using credit cards: consumers need to bring enough cash, sometimes in large amount, which could be beyond their current liquidities or could be easily lost or stolen; merchants may face the risk of returned checks or counterfeiting money as well as lost business due to consumer's lack of finance from credit cards. since the network platform provides added-value to both sides of the market, the platform owner can charge both sides for its service, either on lump-sum basis or on per-transaction basis. for example, payment card network owners (e.g. visa) charge merchants on per-transaction basis which is usually 2-3% of the transaction value. they could also charge cardholders a lump-sum membership fees, although most choose not to do so or only charge cardholders of certain risk profiles (e.g. those with low credit scores). literature review recent research on two-sided markets is an extension of research on network effects. according to katz and shapiro (1985, p.424), "there are many products for which the utility that a user derives from consumption of the good increases with the number of other agents consuming the good." the definition does not distinguish the cross-group network externality from within-group externality. fall 2007 sun & tse: payment card networks 169 recent literature on two-sided markets makes this distinction and focuses on the former. rochet and tirole (2003, pp.990-994) and armstrong (2004, pp.3-7) provide extensive review of literature on and examples of two-sided markets. examples of two-sided markets and related research include payment card systems, telecommunication (armstrong, 2002; wright, 2002), advertising/yellow directory (gabszewicz, lauussel, & sonnac, 2001; dukes, 2003; dukes & galor, 2003; rysman, 2004), matchmaker (caillaud & jullien, 2001, 2003), and shopping mall (pashigan & gould, 1998). the economics literature on two-sided markets focuses on entry and pricing decision of network owners in static equilibrium model settings. their major interests are market efficiency and social welfare. in other words, they ask whether the network owner, either in monopolistic or in competition scenarios, will charge more or less than the social optimal price; whether there is too much or too little competition in either or both sides of the market. the present paper differs from the economics literature in two aspects. first, instead of studying the welfare implications, we take the business strategy perspective. we seek for managerial solutions to overcoming the "chicken-and-egg problem." second, unlike the existing literature which uses static equilibrium modeling approach, we use dynamic system approach. in the static equilibrium approach, the positive feedback across the two-sides of the market is modeled through the "expected" size of the network, rather than the actual size. this is because that, given there is only one period in a static model, it is impossible to allow an agent's decision to be based on the network size in the previous period. therefore, the positive feedback loop can only be modeled in a simultaneous decision-making process where each agent forms an expectation of how many agents from the other side of the market will participate in the network at the end of the decision-making process. a higher expectation on other agents' participation decision will make an agent more willing to participate herself, which demonstrates the positive feedback loop. however, to find equilibrium for such static models, we need to assume that all agents have correct expectation, or "fulfilled expectation" (katz & shapiro, 1985, p.424), of other agents' participation decisions. the "chicken-and-egg problem" arises when agents have such low expectation of other agent's participation that nobody finds it worth participating. in equilibrium, nobody participates because nobody anticipates others to participate, which "fulfills" everybody's initial expectation. although the expectation on network size does play an important role in an agent's participation decision, we feel more appropriate to assume that most people make their decisions on what they have seen in the market instead of on what they expect to see in the market. in other words, they make participation decisions based on the actual size of the network, instead of the expected size. therefore, we use dynamic systems approach which assumes that an agent's decision in the current period depends on the actual network size in last period. such approach models the positive feedback loop across the two sides of the market in an explicit and sequential way. we focus on the long-term behavior of 170 journal ojbusiness strategies vol. 24, no.2 the dynamic system, which is analogous to the equilibrium concept in the static modeling approach. our modeling approach is most similar to tse (2002). tse models network effects in high-tech industry in the fonn of dynamic systems. his model involves both cross-group network effect and within-group network effect (such as wordof-mouth effect and bandwagon effect). we take similar approach but focus on two-sided markets with specific model settings relevant to markets such as payment card, yellow directory, pc operating system, and video game console. a dynamic system model for network growth in this section, we study the growth of a payment card network. though the model is based on the market structure of the payment card system, it is also applicable to other two-sided markets with similar structures such as yellow directory, and pc operating system. therefore, although we discuss the findings using the payment card industry as a background, the business insights in the propositions are stated in such as way that it is also applicable to other two-sided markets. basic model settings we assume there are infinite merchants and consumers in the market'. among them, x merchants and k consumers have joined the network. each consumer, either in or out of the network, will purchase $q (where q > 0) of goods or services from the merchants. therefore, the total spending of in-network consumers is $k*q. we assume in-network consumers will buy only from in-network merchants and their spending will be evenly distributed among these merchants. the spending of out-of-network consumers will be captured by both in-network and out-of-network merchants and be evenly distributed among all merchants. thus an in-network merchant will be able to capture more sales than an out-ofnetwork merchant and the difference is $ !jr. we assume that each consumer gets an incremental benefit of $b per dollar of purchase made in network. in the payment card example, the benefit might reflect the convenience ofusing credit cards for purchase, the purchase rebate offered by card issuers and/or the extra liquidity provided by the cards. in exchange for the benefit, the network owner/sponsor charges in-network consumers a lump-sum membership fee of $z. besides the benefits a consumer may obtain from each in-network transaction, there are also potential risks of using the network. for example, each transaction increases a cardholder's exposure to identity thefts as well as to hidden fees charged by credit card issuers. each transaction also increases the balance of the credit card account, which exposes the cardholder to higher probability of delinquency and/or personal bankruptcy in the future 2 • therefore, we should also account for such negative potentials in the model by assuming a risk factor jper transaction. thus the net benefit per in-network transaction for a consumer participant is (b -.f). fall 2007 sun & tse: payment card networks 171 on the merchant side, we assume the network owner/sponsor charges in-network merchants fees on both per-transaction and lump-sum basis. we denote the lump-sum fee as c f and the per-transaction fee as c v such fees are fixed and variable costs from the merchant's perspective. we assume that consumers and merchants are willing to join the network if the net benefits from joining the network are positive. for consumers, the benefit of joining the network is q(b j) z. however, since the number of in-network merchants is less than the total number of merchants, consumers need to incur incremental search cost and/or transportation cost in order to purchase from an in-network merchant. the larger the number of in-network merchants (i.e. x), the smaller the search/transportation cost is. as the number of in-network merchants grows, the search/transportation cost becomes smaller and smaller and it approaches to zero when x reaches infinity. this implies that the search/transportation cost is a convex function of x. for simplicity, we assume that the search/transportation cost function is a unit search cost t multiplied by the inverse of x; which can be interpreted as the normalized average distance between any two in-network merchants multiplied by a unit search/transportation cost. finally, we clarify that all the parameters mentioned above are non-negative numbers. willingness to participate after incorporating all cost and benefit factors, the net benefit for a consumer to become a network member (nbc) is (1) ifnb > 0, a consumer is willing to join the network. the larger the net benefit, c the stronger the incentive for consumers to join the network. it can be seen from (1) that the search/transportation cost is one of the sources of the cross-group network effect: the larger the number of in-network merchants, the larger the net benefit for a consumer to join the network. for merchants, the net benefit of being an in-network merchant (nb m) is (2) where r represents the profit margin from incremental sales. it can be seen from (2) that a larger k will make the benefit of being an in-network merchant larger, which gives the cross-group network externality on merchants by consumer's participation in the network. the function for nb m also reveals the negative 172 journal ofbusiness strategies vol. 24, no.2 within-group externality among the merchants: the higher the x, the lower the nb ai" this reflects the congestion effect mentioned earlier. network growth dynamics due to incomplete information, technical constraints, consumer inertia or other possible reasons, not every consumer or merchant willing to join the network will be able to do so altogether. instead, we assume that network adoption is a dynamic process and the changes in the number of in network consumer or innetwork merchants are positively related to the net benefit ofjoining the network. this defines a two dimensional non-linear dynamic system: (3) (4) where a > 0, 13 > 0 measure the speed of change per unit of nb m and nbc respectively. note that a, 13 can be affected by a network owner's actions such as advertising, marketing promotion, technological progress, etc. it is also affected by the number of distributors in the network. we also assume q(b j) z > 0 and r > c f because otherwise there will never be a chance for nb m > 0 or nb c > 0 no matter how large k or x is. in other words, if these assumptions are not satisfied, no consumer or merchant will ever be willing to join the network and the network will never exist. it can be shown that the system has a unique equilibrium point: ~ t x= q(b j) z k= c; q(r cv)[q(b j) z] (5) it is easy to see that the equilibrium is in the positive quadrant given that [q(b j) z] > 0 and r > cr to understand the stability of the equilibrium, we apply the linearization method around the equilibrium point and obtain the two eigenvalues of the corresponding linear system: fall 2007 sun & tse: payment card networks 173 _ [q(b j) z ][-ac f + -{(i2c/ + 4a13q(r cj[q(b j) z]] al 2t _ [q(b j) z ][-ac f .,jazc/ + 4a13q(r cj[q(b j) z]] az 2t (6) since [q(b -j) -z] > 0 and r > cv' the two eigenvalues have opposite signs which means that the equilibrium is a saddle point (sanchez, allen & kyner, 1988, pp. 493-494). therefore, there is a saddle path (the dashed curve in figure 2) that separates the space into two distinct regions. starting from any point above this curve, the system will grow forever; starting from any point below the curve, the system will eventually move to the negative quadrants; starting from any point on the curve, the system will converge to the equilibrium (x, k). figure 2 phase diagram for the growth of a network in two-sided markets x managerial insights k a ,,,, k=o ii , ,, x= 0 x the "chicken-and-egg" problem the dynamics shown in the phase diagram (figure 2) illustrate the "chickenand-egg" problem. if a network started with small numbers of merchants and 174 journal of business strategies vol. 24, no.2 consumer members, it can never move across the saddle path and its growth cannot be sustained. eventually, the network will shrink to zero as the small number of participants on one side of the market cannot provide large enough value to attract or keep participants from the other side. however, if a network can manage to gather enough participants on both sides of the market at the very beginning, the network will be able to grow to infinity on its own momentum. it is interesting to see from the phase diagram that a network needs not have large numbers of participants from both sides of the market in order to achieve sustainable growth. instead, as long as it has sufficient participants from one side of the market, it will be able to achieve sustainable growth. this is illustrated by point a (where x < x or k < k) and point b (where x < x or k < k) in figure 2. both points lie above the saddle path, even though there are fewer participants from one side of the market than in the equilibrium point. since any network starts from null, it can be imagined that the "chickenand-egg problem" will always be an obstacle for any new network platform. if a network can find a way to bring in participants from at least one side of the market, the problem will be much easier to solve. one way of achieving this is to leverage on the installed customer base from other businesses of the platform owner. it will be relatively easier for the platform owner to convert these customers into participants of the network than starting from scratch. for example, when american express started its charge card business in 1958, it leveraged on its existing global merchant network that were already accepting its traveler's checks. in the yellow directory business, telephone companies are the traditional and natural owners of the network because both sides of the market (consumer users/readers and the commercial users/merchants) are their existing clients. thus the existing customer base in the telephony business is the valuable resource that enables telephone companies to create a large initial network of the yellow directory business. proposition 1: to overcome the "chicken-and-egg" problem, firms entering two-sided markets as network platform owners should leverage on its existing networks or customer relationships from other businesses in order to boost the number of initial participants of the network. pricing and product strategies if a network cannot gather enough participants at the beginning, it may still achieve sustainable growth if it can substantially shift down the saddle path by adjusting product and pricing strategy. we can see from (5) that (x, k) is a function of the benefit, risk and fee parameters, which can be adjusted by the network owner. for example, x is increasing in z and/, and is decreasing in b. if the network owner reduces the membership fee z or provides more value b (say, increase purchase rebate in the credit card case) to consumer members, the equilibrium point will shift to the lower-left direction since x is now smaller. because k = q(r:c,jx , k will also be smaller. this means the equilibrium point fall 2007 sun & tse: payment card networks 175 and the saddle path will move toward lower-left which will expand the feasible region for sustainable network growth. similarly, the network owner can also shift the equilibrium and saddle path lower by reducing the fees charged to merchants since k is increasing in c f and cv' in figure 3, the initial equilibrium point is eo and the saddle path is cco a network starting at point a, which is below the saddle path, is unable to achieve sustainable growth. however, a reduction in c f or cvor both shifts the equilibrium point to e [. the corresponding saddle path is cc [. after reducing cfor cv' point a now lies above the new saddle path cc i : reducing charges to merchants makes it possible for the network to achieve sustainable growth. figure 3 shifting the saddle path k cgo _ k=o k o .... -.-------'" , ,, ,, ,,, ------------------------\.---------------\~ ..-e eo \ " ~ " a ~1'\',',....., , , ', " -'._:1 ~ '" ~,,( -----------/ i ,,--,~ : . xo x besides lower pricing, the network sponsor can increase the value ofthe network to its participants (i.e. increase band r) by providing added features or benefits to the existing network, which will also shift the equilibrium and the saddle path to the lower-left. for example, visa provides free rental car collision damage insurance, 24-hour cardholder enquiry services, emergency cash disbursement and card replacement services to all of its cardholders free of charge. these features provide consumers extra incentive to join the network. in addition, to reduce the potential risks of using credit card for payment, the network sponsor may also take actions to lower the value off for example, to 176 journal of business strategies vol. 24, no.2 reduce cardholders' worry about fraudulent transactions, visa provides "zero liability on fraudulent transactions" to all of its cardholders. they also set up 24-hour hotline for cardholders to report and replace lost or stolen cards. all these services are free of charge. to prevent over-borrowing and potential personal bankruptcies, card network sponsors have categorized the cards into different types and worked with card issuers to assign different credit lines to different type of cards. for example, mastercard has four types of credit cards: standard, gold, platinum, world. the credit limit of these cards varies from as low as a few hundred dollars (for standard and gold card) to no preset credit limit (for world cards). such credit line management not only helps card issuers to control the credit risk, but also helps cardholders to spend within their financial capability. proposition 2: platform sponsors oftwo-sided networks might overcome the "chicken-and-egg" problem by lowering priceijee, increasing the benefit and/or decreasing the potential risks faced by its participants. the drawback of these actions is the profit sacrificed by the network owner: reducing price/fee will lower revenue, and increasing benefits and/or decreasing potential risks will increase the cost of maintaining the network. however, such profit loss can be mitigated if the network owner reverses its pricing or product strategy after the network has reached a larger size. this is feasible because, with a larger network size, it can tolerate a higher saddle path now. therefore, as the network grows larger, the network owner will have more flexibility in its product and pricing strategies and can enjoy higher profits than in its initial stage. for example, when diners club started their charge card business, they sent out cards to consumers free of charge. soon after their business took off, they started to charge $3 (at 1949 price) annual membership fee. proposition 3: platform sponsors oftwo-sided networks can dynamically increase fees or lower the benefits it provides to network participants after the "chicken-and-egg problem" has been resolved. merger & acquisition, licensing and alliance if a network owner has little installed customer base to leverage on and has little room to adjust product and pricing strategies, it may overcome the "chickenand-egg problem" by other means such as merger and acquisition, licensing or forming strategic alliance with other networks. merger & acquisition. merger and acquisition between two small networks will help push the combined network beyond the saddle path. therefore, the combined network will be able to achieve sustainable growth even though the two small networks could not do so individually. this is illustrated in figure 4 as al and b 1 merged into a 2 , which lies in the sustainable growth region. fall 2007 sun & tse: payment card networks 177 figure 4 effects of m&a. licensing and alliance (sustainable a 2 , b 2 ; unsustainable at' bt) k .... ~ ~~l' , , , , ,~ .. ,, .... k x x licensing or forming strategic alliance. small networks might overcome the "chicken-and-egg problem" by forming strategic alliance among each other or obtaining license from a large network. by forming strategic alliance, small networks are linked together, which creates a larger network. this is illustrated in figure 4 as the alliance between al and b l leads to a larger network (aj by signing licensing agreement with a larger network, participants of a small network (licensees) can enjoy the large network of the licensor. the licensing agreement essentially combines the network of the licensor and licensees into one larger network. in figure 4, the licensing agreement among the licensor network (b 2 ) and two licensee networks (ai and b l ) leads to a larger network (aj though merger and acquisition, licensing, and forming strategic alliance are effective approaches to overcoming the "chicken-and-egg problem", they also have drawbacks because network owners need either to pay premiums for merger and acquisition, royalties for licensing or to share the profits from the alliance network instead of enjoying the monopoly profits. in the licensing and strategic alliance cases, the licensees and all members of the alliance essentially give up their independent control over the individual networks and have to share the profits (e.g. the interchange fees in the credit card case) with other members of the alliance. in fact, they change their roles from independent network owners/ sponsors to just distributors of the combined network. 178 journal ofbusiness strategies vol 24, no.2 the interesting insight is that, even after taking these cost factors into account, strategic actions such as m&a, licensing and forming alliance may still be worth taking. the positive feedback across the two sides ofthe market suggests that any increase in the number of participants would trigger spiral increase in the value provided to all participants. this means that in two-sided markets, "1 + 1 > 2" holds true: strategic actions such as merger and acquisition, licensing and forming strategic alliance allows networks to exploit rents that are unexploited otherwise. therefore, they are effective and mutually-benefiting ways of expanding network sizes in two-sided markets. proposition 4: two-sided networks with insufficient participants from either or both sides of the market might overcome the "chicken-andegg" problem through merger and acquisition, licensing or forming strategic alliance. search/transportation cost the positions of the equilibrium and the saddle path are also determined by the unit search and transportation cost t as is shown in (5): the lower the cost t, the lower the equilibrium and the saddle path, thus the easier for networks to overcome the "chicken-and-egg problem." as can be seen from (6), the search and transportation cost also affect the eigenvalues. it is easy to see that the dominant eigenvalue at is inversely related to t. therefore, the lower the search and transportation cost, the higher the a\. since the magnitude of a\ determines the speed at which the system converges to the dominant eigenvector, a lower search and transportation cost will also enable a faster growth of the network, if the network has already surpassed its saddle path. therefore, even if a network has already overcome the "chicken-and-egg problem," lowering the search and transportation cost will still benefit the network by enabling it to grow faster. to reduce the search cost, network sponsors can promote better information dissemination to cardholders on card acceptance. for example, both diners club and american express regularly announce in the monthly statements sent to cardholders the names of merchants who have recently joined their network. visa provides a directory of the merchants in its interlink debit card network on its website. cardholders can type in the merchant category and the location information on the website and search for all the merchants accepting visa debit cards. such information helps cardholders to reduce their search cost when they want to shop with the card. the proliferation of the internet also provides platform owners significant opportunities to reduce cardholders' search and transportation cost. as web retailing gets more and more popular in the united states and around the world, the use of credit cards becomes essential for consumers shopping online. since online shopping saves transportation cost both in terms of money and shopping time, enabling card acceptance by online merchants will help a card network to shift down its saddle path and/or increase the diffusion speed. in view of fall 2007 sun & tse: payment card networks 179 the importance of enabling credit card payment for online shopping, all of the four major card networks in the u.s. have been working hard to promote online payment. they not only invest heavily in the technology to ensure the security of online shopping, but also encourage cardholders to shop online by providing added security features as well as more information on web retailers. for example, to protect online shopping security, visa provides a special program called "verified by visa." visa cardholders can go to the visa website and enroll in the program. they will be asked to create personal passwords for future online shopping at participating online stores. to find those online stores in this program, visa provides a website where cardholders can easily search for participating stores either by their names or by merchant category. such program promotes online shopping and reduces cardholder's search and transportation cost. proposition 5: to overcome the "chicken-and-egg problem ji and/or increase the growth rate, two-sided networks should leverage on the new information technology and internet to reduce participant ssearch/ transportation cost. advertising, marketing and promotion a close look at the equilibrium point in (5) reveals the absence of the diffusion parameters a, ~. this is means that changes in these parameters, which are affected by advertising, marketing and promotion as well as by the number of distributors, do not have any impact on the position of the equilibrium. however, these parameters should affect the growth rate of the network as can be seen from the dynamic equations (3) and (4). it can be intuitively imagined that, as a, ~ increases, the system will grow faster if it has already surpassed the saddle path (or shrink faster if it starts below the saddle path). actually, this can be formally proved by showing that the dominant eigenvalue of the linearized system ai' which governs the speed of diffusion along the dominant eigenvector, is positively related to the diffusion parameters a, ~ (see appendix for the mathematical proof). since the diffusion parameters are affected by advertising, marketing and promotion, higher efforts on advertising and marketing promotion will enable a network to grow faster. this may explain why all payment card networks have been spending huge amount of money on advertising, marketing and promotion. for example, visa u.s.a. spends about 20% of its operating revenue on advertising, marketing and promotion, which amounts to more than $500 million in 2005 (visa, 2005). this was also why visa started a decade-long series of marketing campaign in 1985 to inform the public that visa cards were accepted by more merchants than american express cards. they used the following slogans in the campaign: "visa. it's everywhere you want to be" and "they don't take american express" (evans & schmalensee, 1999, pp.185-188). such advertising increased visa's diffusion speed by mitigating the impact of incomplete information on network adoption. 180 journal ofbusiness strategies vol. 24, no.2 marketing promotions also reduce people's adoption inertia by providing stronger incentives for people to join the network. for example, credit card issuers have been using direct mails and online application methods to make it convenient for potential cardholders to apply for the card. the solicitations usually include "pre-approved" or "pre-selected" offers with specified "up-to credit limits" to mitigate consumer's inertia to application due to potential failure to approval. many credit card issuers also provide a variety of one-time "sign-up bonus" for new cardholders. these incentives include instant cash back, sign-up reward points, sign-up gifts such as dvd players, etc. such incentives have played an important role in attracting new cardholders. as network platform sponsors, both visa and mastercard have been providing support to card issuers in these marketing activities. proposition 6: to increase the growth rate of the network, two-sided networks may resort to advertising, marketing andpromotion to mitigate the impact of incomplete information and inertia to adoption. the role of distributors another factor that affects the diffusion parameters is the number of distributors of the network. a network with more distributors will no doubt diffuse faster because the collective efforts made by the distributors to sign up merchants and consumers not only reduce people's inertia to adoption but also reduce the technical barriers to diffusion. in many cases, the technical barriers are lowered simply because these distributors have access to a larger population pool from their local bank customers, more merchants can be covered by their local banks, and card applications are easier to be approved if the applicants have had a relationship with the issuing banks. the important role of distributors can be seen from historic cases. in 1960s, american express was the leading payment card network in the u. s. payment card industry. it has been the sole distributor (i.e. issuer) of its own network platform until 2004. on the other hand, when visa and mastercard were formed in 1966, both had multiple issuing banks or distributors. they have been allowing more and more distributors to join their networks ever since. the collective efforts of these distributors made differences over time. as of 2000, visa and mastercard captures 50% and 26% of the us market share in terms of card volume while american express only has 17% 3. ifamerican express had allowed other banks to issue its proprietary card, its market share today could have been much larger. in view ofthe limitation of the "single-distributor" network, american express changed its business model in 2004 and started to allow other issuers to issue american express cards. mbna became the first third-party issuer ofamerican express card in 2004. other banks such as bank of america and citibank have also followed suit in 2005 and 2006. with more and more distributors of its card network, we can expect to see a faster growth of the american express card network in the years to come. fall 2007 sun & tse: payment card networks 181 proposition 7: to increase the rate ofnetwork growth, two-sided network platform sponsors should allow and encourage third-party distributors to distribute its network. a case study: the u.s. payment card industry in the united states, payment card is one of the most important payment instruments for consumers. according to the federal reserve board, about 70% of the u.s. households have at least one payment card in 2001. the volume of credit and debit card transactions amounted to $1.8 trillion in 2002, 60% higher than transactions paid in cash. at the end of 2004, americans carried more than 1.4 billion payment cards, which is equivalent to 5 cards per person or 15 cards per household4 • in the following subsections, we provide a history of the u.s. payment card industrys which provides empirical supports to the insights from our dynamic model. charge account programs: extremely limited acceptance in early twentieth century, merchants (including stores, restaurants, oil companies, etc.) started to set up charge accounts for their frequent patrons. these accounts provided payment convenience to their customers, which helped merchants to generate more sales. however, from consumer's perspective, a charge account was useful only with a particular merchant. if a consumer wanted to enjoy the payment convenience in other stores or restaurants, she had to set up a separate charge account with each of them. in other words, the acceptance of a charge account is extremely limited. in the framework of two-sided market, there is only one merchant on one side of the market while there are multiple consumers on the other side. such a network cannot achieve sustainable growth due to its small and skewed size. diners club: starting from scratch in 1949, frank mcnamara, ralph snyder and alfred bloomingdale launched diners club in new york city by giving away free charge cards to consumers and singing up restaurants in downtown new york. the card allowed cardholders to enjoy the benefit of charge accounts with several restaurants without setting up accounts individually. this small improvement in merchant acceptance brought instant success to diners club. inspired by the rapid business growth in new york, alfred bloomingdale started another card operation in los angeles, california. they soon decided to merge these two operations together and also expanded to boston by acquiring a similar operation there. within a year, diners club had signed up 285 merchants and acquired 35,000 customers. by the end of 1951, the annual charge volume had reached $6.2 million (mandell, 1990, pp.i-1 0). initially, diners club made money only from the 7% merchant discount (based on purchase volume), which is the same as the fees that restaurants paid to travel 182 journal ofbusiness strategies vol. 24, no.2 agencies for bringing travelers to them. it did not charge cardholders. soon after they saw their business on a healthy growth track, they started to charge a $3.00 annual membership fee. the membership fee did not stop customers from applying for the card. with a nationwide network (though only in three cities initially), diners club cards were appealing to many business travelers who didn't want to carry too much cash. as diners club expanded its business to hotels, retail stores and other lines of business, its merchant acceptance grew larger and larger. consumers who cared more about convenience were willing to pay the membership fee as merchant acceptance increased. the success of diners club shows that a network starting from scratch could achieve sustainable growth by appropriately setting its pricing strategy. recall the equilibrium point in (5), the initial zero membership fee strategy significantly lowered the equilibrium number of merchants (x). more importantly, since there was no fixed cost to merchants (i.e. c f = 0)6, the equilibrium k is zero. this means that the equilibrium point lies on the x axis in the phase diagram which, together with a small x , made it easy for diners club to push itself above the saddle path and achieve sustainable growth. diners club's practice also supports proposition 3: it increased fees to cardholders once it gathered enough momentum for growth. the benefit from merging diners club and the other two card networks in boston and los angeles provides empirical evidence for proposition 47 . early bank followers: small local networks the success of diners club attracted a lot of other businesses into the payment card business. between 1953 and 1954, nearly 100 banks introduced their own card plans, mostly for their own customers and within their local areas. however, most ofthem quitted the business shortly because the small-scale operations could not attract large enough participants to make the business profitable. since u.s. banking regulations prohibited banks from setting up out-of-state branches at that time, it was hard for banks to sign up merchants and cardholders in other states. as a result, their merchant networks were limited to local areas and cardholders couldn't use their cards when traveling out of the state. even within local territory, those cards were only accepted by small retail stores without charge account systems. big department stores rejected third party credit cards because they had their own charge card systems and didn't want third party cards to intrude their territories. the failures ofthese early banks in their card operations provide strong evidences of the "chicken-and-egg problem" in the payment card industry. american express: creating a large initial network in 1958, american express entered the charge card business. before that, american express had been in the travel and entertainment business since 1850. its traveler's checks, invented in 1890, were accepted globally. when it entered the charge card business, the first step it took was to acquire the universal travel card plan issued by the american hotel association, which contributed 4,500 fall 2007 sun & tse: payment card networks 183 merchants and 160,000 cardholders to american express' card operation. in addition, it put great efforts in signing up more merchants and marketing the card to consumers, especially by leveraging its existing travel-related network. within the first year of operation, it had already acquired 32,000 merchants and 475,000 cardholders. by 1976, american express had become number one card issuer with 6.3 million cardholders, well above diners club which had only 837,000 cardholders in the united states. by 1977, american express's sales volume had reached $8.3 billion which was ten times higher than diners club. the quick takeover of market leadership by american express from diners club showed the impact of network effect: a large initial network could lead to spiral growth in the future. with a larger initial network, american express charged 20% higher annual membership fee to cardholders than diners club without affecting the sustainable growth of its network. this is because the large initial network enabled it to lie above a higher saddle path than diners club. the acquisition of the universal travel card plan provides another empirical support to proposition 4. bankamericard: a true "credit" card in the same year that american express entered the card business, bank of america (boa), then the largest bank in the u.s., also jumped onto the bandwagon. though boa was not the first bank entering the credit card business, it was the first one that succeeded in that business. in contrast to other banks' card operations which failed to grow due to the federal ban on interstate branch banking, bank of america's was less affected by the regulation because of the geographical nature of california where bank of america operated. since boa had a large branch banking network in california, one of the largest states in the u.s., bankamericard was accepted over an extensive, well-traveled area. this made its card valuable to many cardholders. furthermore, unlike diners club and american express cards, bankamericard was a true "credit" card in the sense that it allowed cardholders to revolve the balances after the grace period. this additional attribute made its credit cards more valuable to consumers who need convenient debt financing for a longer maturity. using our dynamic model framework, such a feature corresponds to a higher value of b for bankamericard than the charge cards issued by diners club or american express, which lowered the equilibrium (x, k) and the saddle path and made it easier for bankamericard to overcome the "chicken-and-egg problem." visa: evolution from licensing realizing that a large initial network size was the key to overcoming the "chicken-and-egg problem," a few small banks asked bank ofamerica to license bankamericard to them. by issuing bankamericard, these small banks could enjoy a much larger network: their cardholders could get access to the bankamericard merchants, and the merchants they signed up could capture incremental sales from more bankamericard holders. since the licensing agreement essentially 184 journal of business strategies vol. 24, no.2 expanded the existing bankamericard network, it also benefited boa. in 1966, the licensing agreement was reached and a national merchant network was created for bankamericard (chutkow, 2001, pp. 69-70). thus the "chicken-and-egg problem" is no longer an issue to the licensee banks. the positive cross-group network externalities between cardholders and merchants propelled the growth of the bankamericard network. by 1970, more than 900,000 merchants were accepting the bankamericard. such rapid growth made licensing a less appropriate format for running the network because licensee banks wanted to exert more influences on the development of the network. under the pressure from the franchisees, bank of america spun off its bankamericard operation in 1970. a new organization, called national bankamericard, inc. (nbi), was formed as an independent association of the member banks. in 1976, nbi changed the name of bankamericard to visa. since then, the visa network has enjoyed exponential growth with merchant acceptance rising from about 2 million in 1980 to more than 4 million in 2001, and the number of visa cards in circulation rising from 60 million to 360 million. mastercard: alliance among member banks when bank of america started to license bankamericard to other banks in 1966, a few other u.s. banks viewed it as a threat to their individual card networks. they reacted immediately by merging their card networks and launched the interbank card association (lca) to compete against the bankamericard network. similar to the bankamericard licensing arrangement, the founding of ica created a national payment card network through which the cards issued by any member banks could be accepted by merchants signed up by other members. in 1969, ica bought "master charge" brand from western states bank card association in order to create a unique identity for its card. in 1979, ica changed the "master charge" brand to "mastercard." the history of mastercard provides another empirical support to proposition 4. discover card: a successful latecomer by mid-1980s, the u.s. credit card industry had become fairly mature. by 1988, merchant acceptance for bankcards (i.e. visa and mastercard) has reached 2.5 million in u.s. and 5.9 million worldwide. american express cards were accepted by 1.4 million merchants in u.s. and 2.1 million worldwide. given such large existing networks and strong network effects in this market, it was hard to imagine that a newcomer could successfully launch a new card. however, in 1986, a new proprietary card network was launched by sears roebuck & co. this was the discover card. before sears launched the discover card, it already had its own store card, which was accepted only by sears stores. with 55 million store card accounts, sears was already the largest issuer of credit cards in the world in 1986. after its acquisition of coldwell banker and the dean witter brokerage company in early 1980s, sears saw the launch of a universal credit card as an important opfall 2007 sun & tse: payment card networks 185 portunity to expand its financial services. through greenwood trust company, a delaware-based bank owned by sears, sears launched its proprietary discover card in 1986. when discover card was first introduced, there were lots of suspicions on its viability. given the large existing payment network of visa, mastercard and american express, and given the well known "chicken-and-egg problem" in this market, it was natural for industry analysts to doubt the fate of the discover card8 . however, sears seemed to have already realized these issues and took corresponding actions. first, it leveraged on sears store network and made discover card accepted by its own stores nationwide. second, to enlarge the initial network size, it signed up 75,000 merchants, including american airlines and holiday inns, even before the official launch of discover card. third, it set a low pricing strategy on the merchant side and charged lower merchant discount (i.e. lower cv in the dynamic model) than other card networks in order to persuade merchants to accept the discover card. fourth, it also set a low price on the consumer side and charged no membership fee (i.e. c f = 0 in the model). fifth, it offered up to 1% purchase rebate to cardholders, which is equivalent to a higher b in the dynamic model. as predicted by our model, all these strategies helped discover to overcome the "chicken-and-egg problem." even though the initial merchant base of the discover card was significantly lower than the other three card networks, it was large enough to generate the momentum for sustainable growth. by the end ofthe first year of operation, discover card had more than 12 million cardholders and was accepted by 550,000 merchants. by the end of the second year, its customer based had grown to 22 million, representing 5% of market share. the growth ofthe discover card network translated to significant profits. though sears lost $106 million on discover card in its first year of operation due to high marketing cost, it turned into profitability in 1988 ($19 million), 1989 ($80 million) and 1990 ($117 million)9. after two decades of operation, discover jo has become a solid player in the payment card industry in the u.s. its success indicates that a latecomer could still succeed as a network platform owner in a two-sided market if it follows appropriate strategies as specified in this paper. conclusion using a simple dynamic system model, we study the growth dynamics ofpayment card networks in a two-sided market framework. in particular, we show how the "chicken-and-egg problem" is created by the cross-group network effect and what strategies can be used to overcome the problem. in summary, network platform owners could leverage its existing networks or relationships with either side ofthe market, resort to merger and acquisition, licensing or strategic alliance, adjust product and pricing strategies and reduce search and/or transportation cost to overcome the "chicken-and-egg problem." in addition, they may also leverage on advertising, marketing and promotion as well as allowing and encouraging 186 journal ofbusiness strategies vol. 24, no.2 third-party distributors of its network to increase the speed of network growth. we use the u.s. payment card industry as an empirical background to support to our findings. the dynamic model in this paper describes the growth of an independent two-sided network. since we are concerned with the "chicken-and-egg problem" faced by any two-sided network even without facing competition, the impact of competition is not explicitly modeled in this paper. sun & tse (2006) provide a linear dynamic system model which involves network platform competition in two-sided markets. their research goal is to understand whether winners will take all in two-sided markets. they find that in certain two-sided markets where individual participants tend to join only one network, though different individuals may join different networks, only one network is likely to survive in the long-run; when individual participants tend to join multiple networks, multiple networks may co-exist as long as each of them can surpass their own saddle paths. the latter findings resemble what we find in this paper while the former findings indicate that the conditions for networks to survive are even more stringent when competition effects are combined with the "chicken-and-egg problem." though the model in this paper best reflects the payment card industry, the insights from the model are also applicable to a wide variety of two-sided markets where there is congestion effect on one-side of the market. for example, the pc operating system (os) is a two-sided network where pc users and software developers represent the two sides. on the software developer side, there are congestion effects because developers compete against each other for software sales. on the pc user side, the congestion effect is absent. in this market, we see dell, hewlett-packard and gateways as third-party distributors of microsoft windows system and apple as the sole distributor of its macintosh system. the slower growth of the macintosh system as compared to the windows system in the past two decades also reflects the important role of third-party distributors. since similar market structure also exists in the video game console markets, the vcr format networks, yellow directories, etc., network growth dynamics and insights from this paper can be applied to these two-sided markets as well. fall 2007 sun & tse: payment card networks 187 appendix proof of the relationship between "'1 and the diffusions parameters of a,~ ga, ga) proof: we need to show that da > 0 and d13 > o. gal d f [q(b j) z][-acf +~+ 4a13q(r c,)[q(b j) -z]] 1 d13 = d13l 2t [q(b j) z] 2t 4aq(r cv)[q(b j) z] x 2-{dc/ + 4a13q(r c,)[q(b -f) -z] gat = !.f [q(b j) z][-acf + ;)a2 c/ + 4a13q(r c,)[q(b j) -z]] 1 da da l 2t [q(b j) z] [ 2ac/ + 4~q(r cv)[q(b j) z] ] = 2t x -cf + 2;)a2c/ + 4a~q(r _c,)[q(b j) -z] [q(b-j)-z] since 2t > 0 by assumption, we only need to check the sign ofthe second term: 2a2c/ + 413q(r cv)[q(b j) z] = -cf + 2a;)a2c/ + 4a13q(r c,)[q(b -f) -z] 188 journal ofbusiness strategies vol. 24, no.2 1 [ acf ] 1 [..ja 2 c/ +4a13q(r-c,)[q(b-j)-z] ] =-c -1 +-c 2 f..ja2c/+4a13q(r-c,)[q(b-j)-z] 2 a f 1 [ acf ] 1 [..ja 2 c/+4a13q(r-c,)[q(b-j)-z]]=-c -1 +-c -1 2 f..ja2c/+4a13q(r-c,)[q(b-j)-z] 2 f a 1 [ acf ..ja 2 c/+ 4a13q(r-cj[q(b-j)-z] 1--c + 2 2 f..ja2c/ + 4a13q(r c,)[q(b -j) z] acf let ~a2c/ + 4a13q(rcj[q(b -j) -z] then 2ac/ + 413q(r c,)[q(b j) z] -c + _i f 2'1a2 c/ + 4a13q(r cv)[q(b j) -z] =~ c[ acf + ..ja2c/ + 4a13q(r cj[q(b j) z] _2] 2 f..ja2c/ + 4a13q(r c,)[q(b -j) z] acf 1 [(..jw=l) ] =-c >0 2 f ~ d'a therefore da' > 0 fall 2007 sun & tse: payment card networks references 189 armstrong, m. (2002). the theory of access pricing and interconnection. in m. cave, s. majumdar, & i. vogelsang (eds) handbook of telecommunications economics: volume 1. armsterdam: north-holland. armstrong, m. (2004). competition in two-sided markets. mimeo, university college london. bailey, j. (1988, feb. 10th). plastic pitfall: sears is discovering discover credit card isn't hitting pay dirt. wall street journal (eastern edition), p. c 1. caillaud, b., & jullien, b. (200 i). competing cybermediaries. rand journal ofeconomics, 45, 797-808. caillaud, b., & jullien, b. (2003). chicken and egg: competing matchmakers. rand journal of economics, 34, 309-328. chakravorti, s. (2003). theory of credit card networks: a survey of the literature. review ofnetwork economics, 2, 50-68. chutkow, p. (2001). visa: the power of an idea. chicago: harcourt press. dow jones & company inc. (1992, october 16). sears says discover card to lower interest rates. the wall street journal (eastern edition), p. cl7. dukes, a. (2003). the advertising market in a product oligopoly. journal of industrial economics, 52,327-348. dukes, a., & gal-or, e. (2003). negotiation and exclusivity contracts for advertising. marketing science, 22,222-245. evans, d., & schmalensee, r. (1999). paying with plastic: the digital revolution in buying and borrowing. cambridge, ma: mit press. gabszewicz, j., lauussel, d., & sonnac, n. (2001). press advertising and the ascent of the 'pensee unique.' european economic review, 45,641-651. higgins, k. (1991, may). sears can still do something right. credit card management. 4, pp. 68-69. katz, m., & shapiro, c. (1985). network externalities, competition, and compatibility. american economic review, 75,424-440. kuntz, m. (1986, january). sears discover plastic. working women, 11, pp. 52-53. mandell, l. (1990). the credit card industry: a history. boston: twayne publishers. 190 journal ofbusiness strategies vol. 24, no.2 pashigan, p., & gould, e. (1998). internalizing externalities: the pricing of space in shopping malls. journal of law and economics, 41, 115-142. rochet, j., & tirole, j. (2002). cooperation among competitors: the economics of payment card associations. rand journal 0.[ economics, 33, 1-22. rochet, j., & tirole, j. (2003). platform competition in two-sided markets. journal ofthe european economic association, 1, 990-1029. rysman, m. (2004). competition between networks: a study of the market for yellow pages. review of economic studies, 71, 483-512. sanchez, d. a., allen, r. c. jr., & kyner, w. t. (1988). differential equations (2nd ed.). new york: addison-wesley publishing co. schmalensee, r. (2002). payment systems and interchange fees. journal of 1ndustrial economics, 50, 103-122. sun, m., & tse, e. (2006). the diffusion of competing technology standards. in k. m. weaver (ed.), proceedings of the sixty-fifth annual meeting of the academy of management (cd), issn 1543-8643,2006. tse, e. (2002). grabber-holder dynamics and network effects in technology innovation. journal ofeconomic dynamics and control, 26, 1721-1738. visa u.s.a. (2005). 2005 annual report. wright, j. (2003a). optimal card payment systems. european economic review, 47, 587-612. wright, j. (2003b). pricing in debit and credit card schemes. economic letters, 80,305309. wright, 1. (2004). the determinants of optimal interchange fees in payment systems. journal 0.[ industrial economics, 52, 1-26. footnotes i we assume an infinite population to avoid the boundary conditions. this is a proxy of the real world cases where the population of consumers and merchants is very large from a network owner's perspective. 2 we are grateful to an anonymous reviewer who pointed out these potential risks. 3 source: visa usa website http://www.usa.visa.com/about_visa/newsroom/statistics. 4 source: carddata (www.carddata.com). feb. 25, 2005. fall 2007 sun & tse: payment card networks 191 5 payment cards include credit card, charge card and debit card. 6 there was no equipment investment on the merchant side for joining diners club network at that time, unlike today when merchants need to purchase electronic equipment in order to be linked to the electronic payment system. 7 diners club was acquired by citicorp in 1980. 8 for example, an article in wall street journal (eastern edition) on february 10, 1988 wrote: "the discover card, sears, roebuck & co. 's brash effort to take on visa and mastercard, is in danger of joining the edsel and new coke in the lineup of great product disasters" (bailey, 1988). 7 since sears is both the owner of the discover card network and a card issuer, its profit came both from the merchant discount and from the finance charges to cardholders on their revolving balances. 8 in 1993, dean witter, discover & company went public. in 1997, dean witter, discover & company merged with morgan stanley. so discover card services is a part of the morgan stanley dean witter today. mingchun sun is an economist and vice-president at lehman brothers asia limited based in hong kong. during 2002-2004, he worked for capital one financial and was responsible for the account management strategies for over five million credit card accounts. he received his ph.d. from stanford university in management science and engineering in 2006. his current research includes competition strategies in two-sided markets and macroeconomic developments in asia with special focus on china. edison tse is associate professor and director of asia center in the department of management science of engineering of stanford university. he received his ph.d. from mit in electrical engineering and won the 1973 donald p. eckman award for outstanding achievement in the field of automatic control. he cofounded the journal of economic dynamics and control and has been a member of its advisory board. his current research involves taking a system approach to problems in management, decision and policy. sustainable growth of payment card networks: a two-sided market approach an empirical test of customer retention-perceived quality link: strategic management implications dr. godwin onyeaso dr. chris adalikwu concordia college-university system selma,al abstract this paper employed times series econometric methods to test the theoretical(v-grounded link between customer retention and customer perceived quality. the results suggest that customer retention and quality have a stable positive link binding them together, which allows them to move together in the same direction over time. importantly, empirical evidence of long term granger-type causality running from quality to retention, was found in support of this positive link finally, customers 'perception ofquality yesterday has a positive impact on their level of retention today. it suggests that customers j memories of quality linger on beyond the current period to positively impact customer retention levels in the future. in this sense, quality is an intangible strategic asset in which service managers should invest their capital. in her strategic service management paper, zeithaml, (2000, p. 76) states that: "only a few research studies have been conducted that explicitly link service quality with customer retention (for exceptions, see rust & zahorik 1993)." consequently, our literature review revealed that, even among the few studies that linked service quality with customer retention, including those cited by zethaml (2000), none used time series data and methods as proposed in the current paper. second, related to the above, none of the studies used time series market-level aggregate data to investigate the hypothesized relationship linking consumer perceived service quality and customer retention. by market-level aggregate data, we mean data on all consumers of a particular service (e.g., consumers of pizza hut's pizza). stated another way, past research relied exclusively on individual-level (consumer-level) data to investigate the quality-retention link. this prompts the question: why should the differences between market-level and individual-level data sets have empirical significance in the quality-retention link? one important implication of the difference between the two data sets can be stated as follows: the veracity ofthe results ofpast research may be dependent on the individual-level data they used to investigate the nature ofthe functional form linking consumer perceived quality and consumer retention. the empirical question then arises: absent the use of individual-level data, would the conclusions of 54 journal ofbusiness strategies vol 25, no.1 past research still hold? stated another way, ifmarket-level aggregate time series data are used to explore the functional relationship linking consumers' perception of service quality and consumer retention, would the result be the same as the results obtained by researchers using individual-level data sets? this question is difficult to answer because the use of market-level aggregate data in this area of research is extremely scanty (johnson, anderson & fornell, 1995). another important empirical question is: does the level ofcustomers' perceived service quality today positively impact the level ofcustomer retention in the future? intangible strategic assets theory predicts that the accumulation of intangible strategic assets such as perceived quality should be path-dependent (dierickx & cool, 1989). by path-dependency we mean that the accumulation process of intangible strategic assets cannot be rushed without incurring an exponential increase in the cost of accumulation. this phenomenon has been dubbed time compression diseconomies (dierickx & cool, 1989). in the same vein, the dissipation of intangible strategic assets such as perceived quality should be path-dependent under what is called asset erosion (dierickx & cool, 1989). asset erosion of intangible strategic assets theory is equivalent to depreciation in physical assets (dierickx & cool, 1989). because erosion ofperceived quality is path-dependent, we expect that the impact of today's quality on future levels of customer retention will be positive and significant previous research on quality-retention could not investigate this dynamic impact because individual-level cross-sectional data have no information about the dynamic impact of quality on retention. what are the contributions of the present paper? the main contribution of this paper is fourfold. first, if market-level aggregate data, produce results that are consistent with those of past research that used individual-level data, then a contribution will have been made because we now know that the same results can be obtained by using both types of data sets. that is, we now have collaborative empirical evidence using market-level time series data. on the other hand, if different results are obtained than those of individual-level data sets used by past research, a contribution will have been made because we now have empirical evidence that market-level data yielded contrary results to individual-level data. either way, a contribution will have been made in the extant literature in this important area. third, even though a test of the quality-retention link is not new, the application of time series data and method to confirm this theoretically grounded link is new. finally, the intangible strategic assets theory (dierickx & cool, 1989; amit & shoemaker, 1993) predicts that the dynamic impact of today's quality on the future levels of customer retention should be positive and significant. we also investigate this hypothesis. this paper begins by presenting a condensed literature review leading to hypotheses. this is followed by a methodology section discussing data sources and construct measurement issues. then, the data analyses section discusses statistical methods used but relegated to the appendix. the paper concludes with a discussion of empirical results and managerial implications and conclusions. spring 2008 onyeaso and adalikwu: retention-perceived quality link 55 literature and hypotheses consistent with a stream of research in service management calling for theoretically driven service management research (e.g., dholakia, firat & bagozzi, 1980; ozanne & murray, 1991, 1995; gronroos, 1994; brownlie, saren, wensley & whittington, 1999; zeithaml, 2000; gummesson, 2001; burton, 2001), some service management strategists have argued that theory development in service management should begin with empirical tests of key service marketing constructs (gronroos, 1994; zeithaml, 2000; gummesson, 2001) rather than depend on theory from other disciplines (burton, 2005). in concurring with this view, zeithaml, (2000, p. 76) concluded that "many issues about customer retention still need to be examined." specifically, she urged service marketing researchers to empirically investigate the link between service quality and customer retention (zeithaml, 2000). as an empirical support to this view, earlier work suggested that service quality is related to customer retention through a reduction in customer defection rate (reichheld & sasser, 1990). thus, there is the impetus for further research in quality-retention link. from a marketing perspective, customer relationship equity postulates that a firm's value is a product of the totality of the discounted future profit streams from its retained customers (rust, zeithaml & lemon, 2000). according to this perspective, a high customer relationship equity arising from customers' perception of quality in a firm's offerings reduces customer defection rates and hence increases customer retention. in the same vein, rust and zahorik (1993) used a mathematical model to illustrate that customer satisfaction is a major driver of retention rate, and the latter is positively related to market share. stated differently, without customer satisfaction, the positive link between retention and market share will vanish. in their study of the effects of complaints-handling programs on customer retention, fornell and wernerfelt (1987, 1988) found a positive link between customer satisfaction and profit. it is noteworthy that these preceding studies focused on the role of customer satisfaction on retention and hence profit, with the implicit assumption that quality and satisfaction are interchangeable (a controversial topic). in one of the most comprehensive studies of the role of service quality, zeithaml, berry, and parasuraman (1996) conclude that service quality influences different consumer behavioral intentions: willingness to pay more, to recommend a business, and increased patronage. from the perspective of the economics of retention (reichheld, 1996a,b), marginal increases in retention rate can have phenomenal positive effects on corporate profits because the cost of retaining an existing customer is less than the cost of acquiring a new one. notably, existing customers patronize a firm more than new customers, and there are other exchange efficiencies associated with existing customers (fornell & wernerfelt, 1987, 1988; reichheld & sasser, 1990). to the extent that behavioral intentions of customer retention materialize in actual customer retention, a growing body of research suggests that the statistical evidence of quality-retention link is positively significant. it has been suggested 56 journal of business strategies vol. 25, no.1 that service quality has a direct effect on organizations' profits, since it is positively related with customer retention and with customer loyalty. because previous works also suggest that service quality is a major factor for building superior competitive advantage when marketing assets are deployed for superior service quality (ennew, reed & binks, 1993; zeithaml et ai., 1996) across industries (gronroos, 2000). consistent with this notion, because customer retention provides repeat purchase patronage as the bedrock of superior competitive advantage, customer perceived quality and retention are expected to be empirically linked, as supported by customer relationship research (reichheld, 1996a,b). finally, venetis and ghauri (2004) argue that service quality is linked to organizational profitability through two routes, and each ofthese routes involves customer retention. management can deploy a company's marketing assets to acquire superior service quality that differentiates the company from its competitors, and, in tum, leverage the company's competitive advantage through greater market share and profitability as the profit impact ofmarketing strategies (pims) studies indicate (buzzell & gale, 1987). in the second route, "service quality is viewed as an important means for customer retention" (zeithaml et al., 1996). all in all, the preceding discussion suggests the following hypotheses. hypothesis 1: customers 'perceived service quality and customer retention will be positively linked. hypothesis 2: given the positive link between quality and retention, both will move in tandem in the same direction. we now tum to another important empirical question: does the level of quality perceived by customers today have positive impact on the level of customer retention in the future? stated another way: does the level of quality perceived by customers yesterday have positive impact on the level of customer retention today? research in this dynamic view of quality as it impacts customer retention is scanty, albeit important. to see its importance, the architects of the pims studies aimed to uncover the long run dynamic impact of quality on behavioral outcomes such as return on investment (roi) via the positive impact of quality on customer retention. the panel form ofthe pims annual data was instrumental in these dynamic analyses (buzzell & gale, 1987). in this framework, the pims study examined causes of long run performance differences among strategic business units (sbus) across industries. the managerial motivation being that organizational performance and ultimate survival is predicated on the notion of long run profitability, and that is why managers craft corporate strategy (barney, 1991; porter, 1991). in the pims studies, market share is used as a proxy for product or service quality, the idea being that if customers do not perceive quality in a firm's product or service the firm's market share will vanish (buzzell, 2004) because retention is the principal component of market share as shown in defensive marketing spring 2008 onyeaso and adalikwu: retention-perceived quality link 57 strategy studies (fornell & wernerfelt, 1987, 1988; rust & zahorik (1993, p. 212). in the same vein, customers are retained because they see quality and hence value in a firm's services. in another study, 26% of the variance in the duration of the relationship between a customer and a service provider is explained by satisfaction of customers (bolton, 1998). likewise, research suggests that customers are willing to pay higher prices for quality rather than compromise quality, and they are willing to do so in a long run exchange relationship that keeps them retained for the firm under the rubrics of customer relationship management (sheth & parvatiyar, 1995; duncan & moriarty, 1998; cronin, brandy & hult, 2000; gramoos, 2000). in this latter framework, both quality and long run customer retention impact current changes in retention under the notion of exchange efficiency as the bedrock of customer relationship management (gromoos, 1993, 2000; kotler, 1994; sheth & parvatiyar, 1995). exchange efficiency, in turn, derives from long run customer retention economics because the longer the customer is retained the greater the expected cash flow trajectory to the company, and the lower the exchange cost the customer incurs (sheth & parvatiyar, 1995). because a retained customer has higher likelihood of being retained, past level of retention will positively impact current level of retention (gronoors, 2000). similarly, past levels of quality should positively impact current levels of retention according to key strands in kotler (1994). this prompts the question: does the level of quality perceived by customers yesterday have positive impact on the level of customer retention today? hypothesis 3: customers 'level ofperceived quality today will positively impact their level ofretention tomorrow. method data and the unit of analysis to test these hypotheses, a national chain fast food restaurant was used as the unit of analysis of this study because customer complaints arising from poor quality were rampant, suggesting that retention may be low in that industry (tax, brown & chandrasshekaran, 1998). the data were generously donated to us by university of michigan school of business under a binding anonymity contract. fornell, johnson, anderson, and bryant (1996) provide a detailed discussion of these data covering 1994 to 2003. the data were quarterized and logged (40 observations). finite sample bias correction was applied because of potential small sample problems, as discussed in the analysis section of this paper. even though fornell et a!. (1996) provide a detailed discussion of customer perceived quality and retention, we believe that it is necessary to present a brief discussion of the data and the measurement of these variables. begun in 1994, the acsi is "a uniform, national, cross-industry measure of satisfaction with the quality of goods and services available in the united states of america." "the acsi measures each company once in a year [and] the measure is cumulative 58 journal ofbusiness strategies vol 25, no. i in the sense that it aims to capture all relevant customer experience (with the product or service) to date" (fornell et ai., 2006, p. 6). the acsi uses a survey based on computer-assisted-telephone-interviewing (cat!) whereby customers are chosen randomly from national and regional probability samples of continental u.s. households. random-digit-dialing (rdd) allows the acsi to select households with listed and unlisted telephone numbers. the individual whose birthday is the most recent is picked as a respondent in each household. this way, acsi obtains a representative distribution of respondents in terms of gender, age and other demographic variables. for the acsi, the word "respondent" and "customer" are used interchangeably so that a respondent is a buyer of specific products or services within a specific time period. in this framework, a respondent customer is defined as "an individual chosen randomly from a large universe of potential buyers ... " for example, in the industry: restaurantlfast food pizza. carryout. the following question is used to identify a customer: "have you purchased food from a fast food restaurant or pizza restaurant, to eat in the restaurant, for carryout, or ordered for home delivery in the last three months'?" (if yes) "at which fast food restaurant have you most often purchased food to eat in the restaurant, for carryout, or ordered for home delivery in the last three months? (if more than one, emphasize most often)." measurement of perceived service quality perceived quality is the first determinant of cumulative customer satisfaction according to the acsi. acsi index states that perceived quality "is the served market's evaluation of recent consumption experience, and is expected to have a direct and positive effect on overall customer satisfaction" (fornell et ai., 1996, p. 9). specifically, acsi measures perceived quality based on "two primary components of consumption experience: (1) customization, that is, the degree to which the firm's offering is customized to meet heterogeneous customer needs, and (2) reliability; that is, the degree to which the firm's offering is reliable, standardized, and free from deficiencies" (fornell et ai., 1996, p. 9). measurement of customer retention according to acsi statisticians, the customer retention measure is an estimate "based on a non-linear transformation of the repurchase likelihood question." basically, the repurchase likelihood question asks the customer: "how likely are you to purchase from the same supplier in the future?" in this framework, "below a certain point on the repurchase likelihood question we assume the customer will definitely not be retained, and then recode the rest of the responses above this point on a 0-.9 scale." (morgeson, 2005). the measurement of customerretention construct used in this study was obtained using this method. spring 2008 onyeaso and adalikwu: retention-perceived quality link 59 reliability and validity of measures notably, the reliability (signal-to-noise ratio) and validity (the degree to which measures represent the underlying latent constructs) have been reported to be satisfactory for all the constructs in the acsi index, including the above constructs used in the present study (acsi methodology report, 2001, pp. 17-18). we may add that, interestingly, none of the past and recent studies that employed the acsi constructs attempted to discuss the acsi methodology and measures as done in the present paper (fornell et al., 2006; mittal, anderson, sayrak & tadikamalla, 2005; auh & johnson, 2005). analyses to enhance readability of this section, technical details are relegated to the appendix. cointegration analysis follows sequential steps. in the first step, an overview of cointegration methods is presented in appendix lao as discussed in that appendix, cointegration begins with an investigation of the order of integration of the variables in the study. the augmented dickey-fuller (adf) test was used to ascertain of integration of the variables, and the results of the adf tests are shown in table 1 in appendix ib (dickey & fuller, 1981). then, conditional on the results in table 1, the following three cointegration methods were used to analyze the data: the fully-modified ordinary least squares (fmols) of phillips-hansen (1990), the one-shot cointegration estimation approach proposed by banerjee, dolado, hendry and smith (1986, hereafter, bdhs), also called hendry's dynamic regression method, and stock and watson (1993) dynamic ordinary least squares (dols). the major superiority of the dols is that it is robust in small samples and simultaneity bias compared to other methods because it includes leads and lags of changes in the regressors to neutralize the effects of these biases. all in all, all three methods yielded the same substantive results which suggest that these results are not the artifacts of the methods used. however, to save space and keep technical details to a minimum, only the fmols results are reported in table 2 on the next page (technical details of the fm-ols are presented in appendix lc). readers interested in the results not reported here can obtain them from the authors. 60 journal ofbusiness strategies vol. 25, no. 1 table 2 phillips-hansen fm-ols long run and short run results long run results: customer retention is dependent variable regressors parameter estimate constant -2.83 (.22) lpq 1.62 (.004)* short run results: change in customer retention is dependent variable regressors parameter estimate constant .13 (.029)* phecm(-1) -1.28 (.006)* ~lcr (-1) 1.76 (.000)* ~lpq .99 (.004)* ~lpq (-1) 2.38 (.001)* ~lpq (-4) .97 (.008)* ~lpq (-7) .73 (.029)* diagnostic tests r-squared adjusted =0.67 serial correlation: f-version (4,12)=.38 (.81) normality c2(21 = 2.1 (.33) heteroscedasicity. f( 1, 27) =1.4 (.247) phecm (-1) t-ratio =-3.16 (.006). • p < 0.05. p-values are in parentheses. the negative coefficients on lags 4 & 7 of i1lpq can be ascribed to instability of reduced form equations (ecm) as the lag increases. summary of hypotheses hypothesis 1 hypothesis 1 proposes that customers' levels of perceived service quality and customer retention will be positively linked. the results of phillips-hansen fmols approach reported in table 2 suggest that quality and retention are positively related or linked (p < .05). again, the same results were obtained by the bdhs and dols methods, but to save space, they were not reported here. hypothesis 2 hypothesis 2 proposes that, given the positive link between quality and retention, both will move in tandem in the same direction. as can be seen in table 2, the positive association between quality and retention allows the inference that both will move in the same direction (engle & granger, 1987). again, the same results were obtained using bdhs and dols methods, but to save space, they were not reported here. spring 2008 onyeaso and adalikwu: retention-perceived quality link 61 hypothesis 3 hypothesis 3 proposes that customers' level of perceived quality today will positively impact their level of retention tomorrow. as can be seen, empirical evidence in tables 2 and 3 suggests that the effect of quality yesterday has positive impact on today's level of retention. again, the same results were obtained using bdhs and dols methods, though not reported to save space.. assessment of findings in this section, we assess the findings ofthis study and then discuss the managerial significance ofthe findings. this study was motivated by a neglected research gap and subsequent calls to fill it. specifically, zeithaml (2000. p. 76) remarked that honly a few studies have been conducted that explicitly link service quality with customer retention (for exception, see rust & zahorik, 1993). as a response to this call, the present study empirically tested whether service quality is linked to customer retention. unlike past research on quality-retention link, our study used a market-level time series longitudinal data set to investigate the dynamic relationships linking quality and retention, so that strategic insights useful to service industry managers would be uncovered. overall, the empirical evidence suggests that service quality is linked positively to customer retention as hypothesized. in addition, we found that there appears to be a permanent (long-term) granger-type causality between customer retention and quality. by granger-type causality we mean temporal causality. finally, empirical evidence of cointegrating relationship between these variables means that these variable move in tandem (engle & granger, 1987). we are not aware of any other study on quality-retention link that found granger-type causality among them. likewise, we are not aware of previous study that found dynamic impact of quality on retention. we now tum to the practical strategic management significance of this study's results to managers in the service industry with particular emphasis to fast food restaurants. managerial strategic management implications there is no shortage of verifiable evidence that the fortunes of service organizations are positively correlated with the extent their managers deploy their marketing assets to provide superior quality to their customers in the present competitive environment (parasuraman, zeithaml & berry, 1988; zeithaml, 1988,2000; reichheld & sasser, 1990; gronroos, 2000; zeithaml, berry & parasuraman, 1996; fornell & wernerfelt, 1987). because service quality can boost organizational perfonnance, it is an intangible strategic asset with key attributes such as path-dependent accumulation trajectory (dierick & cool, 1989; amit & shoemaker, 1993; michalisin & kline, 1997). notably, this inherent trajectory is reflective of an autoregressive behavior in the accumulation process as well as in the deployment and dissipation (asset erosion) process of quality as a strategic asset (dierickx & hanssens, 2000). 62 journal ofbusiness strategies vol. 25, no.1 by autoregressive we mean that the adjacent values of quality observed in discrete time are serially self-correlated over time. this phenomenon has two immediate implications for theory development with specific focus on quality and customer retention in the present paper..first, lagged effect of quality is a significant predictor of current quality as well as current customer retention levels as related work in terms ofthis autoregressive methodology attests (jacobson & aaker, 1987) . in other words, customers have memory because quality perceived by customers in past periods can help explain the level of quality they perceive in the current period as well as the level of retention in the current period. sadly, there is a shortage of verifiable evidence that service managers are aware of this strategic significance of quality. specifically, managers should know that: (1) quality is a strategic asset, (2) accumulation cannot be rushed, (3) once accumulated, quality has a long payback period far beyond the time and the cost of its accumulation, and (4) ex-post quality accumulation, quality as a strategic asset should be protected by the two so-calied ex-post limits to competition inimitability and non-substitutability. space constraint does not allow full discussion of the latter two strategic management terms (barney, 1991). limitations and directions for future research the functional form of the link between customer retention and quality was the primary purpose of this paper. the drivers of retention and quality were beyond the purpose of this paper, the investigation of the drivers is left for future research. because restaurants are ranked number one in the frequency of customer complaints due to low customer perceived quality (tax et ai., 1998), the study used a fast food restaurant as its unit of analysis. future research is encouraged to extend or replicate this study using other service industries in the usa or any other country. conclusions our literature review suggests that the customer retention-quality link is important but ill-understood and under-researched (zeithaml, 2000). this research void has implications in terms of theory development as well as practical managerial significance. consequently, this study employed recent advances in time series econometrics to investigate the functional form of the quality-retention link in the framework of three hypotheses tested, using market-level data on fast food patronage. overall, the empirical evidence suggests that service quality is linked positively to customer retention as hypothesized. in addition, we found that there appears to be a permanent (long-term) granger-type causality between customer retention and quality. by granger-type causality we mean temporal causality. finally, empirical evidence of co integrating relationship between these variables means that these variable move in tandem (engle & granger, 1987). we are not aware spring 2008 onyeaso and adalikwu: retention-perceived quality link 63 of any other study on quality-retention link that found granger-type causality among them. likewise, we are not aware of previous study that found dynamic impact of quality on retention. summing up, the findings ofthe paper have strategic management significance about quality and customer retention in terms of complementary, intangible strategic assets (amit & schoemaker, 1993). it draws from the intangible assets accumulation theory proposed by dierickx and cool (1989) in their response to barney (i986, 1989). references amit, r., & schoemaker, p. j. (1993). strategic assets and organizational rent. strategic management journal. 14, 33-46. arize, a. c., malindretos, j., & grivoyannis, e. c. (2003). inflation rate volatility and money demand: evidence from less developed countries. international review of economics & finance, (in press). arize, a. c., malindretos, j., & christoffersen, s. (2003). monetary dynamics, exchange rates and parameter instability: an empirical investigation. journal of economic studies, 30(5),493-513. auh, s., & johnson, m. d. (2005). compatibility effects in evaluations of satisfaction and loyalty. journal ofeconomic psychology, 26, 35-57. banerjee, a., dolado j., hendry d., & smith g. (1986). exploring equilibrium relationships in econometrics through static models: some monte carlo evidence. oxford bulletin of economics and statistics, 48(3),253277. barney, j. (1991). firm resources and sustained competitive advantage. journal of management, 17(1}, 99-120. barney, j. (1989). asset stock and sustained competitive advantage: a comment. managementscience,35,1511-1513. barney, j. (1986). strategic factor markets: expectations, luck and business strategy. management science, 32, 1231-1241. bolton, r. n. (1998). a dynamic model of the duration of the customer's relationship with a continuous service provider: the role of satisfaction. marketing science, 17( 1),45-65. brownlie, d., saren, m., wens ley, r., & whittington, r. (1999). marketing disequilibrium: on redress and restoration. in d. brownlie, m. saren, r. wensley & r. whittington (eds.), rethinking marketing. sage publication. 64 journal ofbusiness strategies vol. 25, no. 1 burton, d. (2005). marketing theory matters. british journal of management, 16, 5-18. burton, d. (200 i). critical marketing theory: the blueprint? european journal of marketing. 35(5/6), 722-743. buzzell, r., & gale, b. (2004). the pims program of strategy research: a retrospective appraisal. journal ofbusiness strategy, 54, 478-483. buzzell, r., & gale, b. (1987). the pims principles: linking strategy to peiformance. new york: free press. cronin, j. j., brandy, m., & hult, g. t. (2000). assessing the effects ofquality, value, and customer satisfaction on consumer behavioral intentions in service environments. journal ofretailing, 76(2), 193-218. dekimpe, m. g. & hanssens, d. m. (2000). time series models in marketing: past, present and future. international journal of research in marketing, 17(2-3), 183-193. dholakia, n., firat, a. f., & bagozzi, r. p. (1980). the de-americanization of marketing thought: in search of a universal basis. in c.w. lamb and p. m. dunne (eds.), theoretical developments in marketing, ama conference proceedings, 10-13 february, phoenix, az. dickey, d. a., & fuller, w. a. (1981), likelihood ratio statistics for the autoregressive time series with a unit root. econometrica, 49, 1057-1072. dierickx, i., & cool, k. (1989). asset stock accumulation and sustainability of competitive advantage. management science, 35(12), 1504-1513. duncan, t., & moriarty, s. e. (1998). a communication-based marketing model for managing relationships. journal ofmarketing, 62(april), 1-13. enders, walter. (2004). applied econometric time series. new york: wiley. ennew, c. t., reed, g. y., & binks, m. r. (1993). importance-performance analysis and the measurement of service quality, european journal of marketing, 27(2), 59-70. engle, r., & granger, c. w. j. (1987). cointegration and error correction: representation, estimation and testing. econometrica, 55, 251-76 fornell, c., & wernerfelt, b. (1987). defensive marketing strategy by customer complaint management: a theoretical analysis. journal ofmarketing research. 24(november), 337-346. fornell, c., & wernerfelt, b. (1988). a model for customer complaint management. marketing science, 7, 271-286. spring 2008 onyeaso and adalikwu: retention-perceived quality link 65 fornell, c., johnson, m. d., anderson, e. w., cha, j., & bryant, b. e. (1996). the american customer satisfaction index: nature, purpose and findings. journal of marketing, 60,7-18. fornell, c., mithas, s., morgeson iii, f. v., & krishnan, m. s. (2006), customer satisfaction and stock prices: high returns, low risk. journal of marketing, 70,3-14. granger, c. w. j., (1988). some recent developments in the concept of causality. journal ofeconometrics, 39, 199-211. granger, c. w. j., & newbold, p. (1974). economic forecasting: the atheist's viewpoint. in g.a. renton (ed.), modeling the economy. london: heinemann. gummesson, e. (200 1). are current approaches in marketing leading us astray? marketing theory, 1(1),27-48. gronroos, c. (1994). from marketing mix to relationship marketing towards a paradigm shift in marketing. management decision, 32(20), 1-19. gronroos, c. (1993). from scientific management to service management: a management perspective for the age of service competition. international journal ofservice industry management, 3(5),5-20. gronroos, c. (2000). service management and marketing: a customer relationship marketing approach. second edition. chichester, uk: wiley. gonzalo, j. (1994). five alternative methods of estimating long run equilibrium relationships. journal ofeconometrics, 60, 203-233. haug, a. (1996). tests for cointegration: a monte carlo comparison. journal ofeconometrics, 71, 89-115. hamilton, j. d. (1994). time series analysis. princeton, nj: princeton university press. harris, r. (1995). using cointegration analysis in econometric modeling. new york: prentice-hall. hendry, d. f. (1995). dynamic econometrics, new york: oxford university press. jacobson, r .• & aaker, d. a. (1987). the strategic role of quality, journal of marketing, 51(october),31-44. johansen, s., & juselius, k. (1990). maximum likelihood estimation and inference on cointegration with application to the demand for money. oxford bulletin ofeconomics and statistics, 52, 169-210. 66 journal ofbusiness strategies vol. 25, no, 1 johnson, m. d., anderson, e. w., & farnell, c. (1995). rational and adaptive performance expectations in a customer satisfaction framework. journal ofconsumer research, 21,128-140, kotler, p. (1994). marketing management: analysis, planning, implementation and control. englewood cliffs, nj: prentice-hall michalisin, m. d., smith, r. d., & kline, d. m. (1997). in search of strategic assets. the international journal of organizational analysis, 5(4),360-387. mittal, v., anderson, e. w., sayrak, a., & tadikamalla, p. (2005). dual emphasis and the long term financial impact of customer satisfaction. marketing science, 24(4), 544-555. morgeson, f. (2005). personal communication. ozanne, 1. l, & murray, j. b. (1991). the critical imagination: emancipatory interest in consumer research. journal ofconsumer research, 18(september), 129-144. ozanne, j. l, & murray, j. b. (1995). uniting critical theory and public policy to create the reflexively defiant consumer. american behavioral scientist, 38(4),516-525. parasuraman,a., zeithaml, v., & berry, l, (1988). servqual: a multiple-item scale for measuring consumer perceptions of service quality. journal of retailing, 64(2), 12-40. phillips, p. c. b., & hansen, b. e. (1990). statistical inference in instrumental variables regression with i (1) process, review ~feconomic studies, 57, 99-125. porter, m. e. (1991). towards a dynamic theory of strategy. strategic management journal, 12, 95-118. reichheld, f. f., & sasser, w. e. (1990). zero defection: quality comes to services. harvard business review, 68(5), 105-111. reichheld, f. f. (1996a). the loyalty effect, cambridge, ma: harvard business school press. reichheld, f. f. (1996b), learning from customer defections. harvard business review, march-april, 56-69. rust, r. t., zeithaml, v. a., & lemon, k. n. (2000). driving customer equity: how customer lifetime value is reshaping corporate strategy. new york: free press. rust, r. t., & zahorik, a. j. (1993). customer satisfaction, customer retention, and market share, journal ofretailing, 69(2), 193-215. spring 2008 onyeaso and adalikwu: retention-perceived quality link 67 sheth, j., & parvatiyar, a. (1995). relationships in consumer markets: antecedents and consequences. journal of the academy of marketing science, 23(4),255-271. stock, j. h., & watson, m. (1993). a simple estimator of co integrating vectors in higher order integrated systems. econometrica, 61, 783-820 tax, s. s., brown, s. w., & chandrasshekaran, m. (1998). customer evaluation of service complaint experience: implications for relationship marketing. journal of marketing, 62,60-76. thomas, r. l (1996). modern econometrics. new york: addison-wesley. venetis, k. a., & ghauri, p. n. (2004). service quality and customer retention: building long-term relationships. european journal of marketing, 38( 11-12), 1577-98. zeithaml, v. a. (2000). service quality, profitability, and the economic worth of customers: what we know and what we need to learn. journal ofthe academy o,fmarketing science, 28(1),67-85. zeithaml, v. a. (1988). consumer perceptions of price, quality, and value: a means-end model and synthesis of evidence. journal of marketing, 52(july), 2-22. zeithaml, v. a., berry l l, & parasuramann, a. (1996). the behavioral consequences of service quality. journal of marketing, 60(april), 3146. appendix la overview of cointegration approach cointegration methods were used to test the hypotheses because it has the statistical capability to test these hypotheses. cointegration analysis begins by recognizing that many time series variables, such as customer perceived quality and customer retention, are time dependent. this implies that they have time trend which renders them non-stationary with their means, variances and co-variances being time-dependent. as a consequence, direct application of ols and gls without differencing the variables results in spurious regression because these statistical methods are based on the assumption of stationary data (granger & newbold, 1974). therefore, the variables have to be differenced to make them stationary. for example, in this paper, let r t denote observation on customer retention in time t for a particular fast food restaurant, then !j..r 1 = r 1 r 1 is the first difference of r 1 which may be stationary, where stationary is labeled 1(0). if it is stationary with this first differencing, then retention is said to be integrated of order one, denoted as 1(1). but, if is not stationary on first differencing, more differencing will be needed to make it stationary so that, if it takes differencing the retention k times to make it stationary, then retention is said to be integrated of order k, 68 journal ofbusiness strategies vol. 25, no.1 denoted as i(k». in applied works, however, techniques are available to uncover the order of integration of each of the variables in a particular model. what is cointegration? from the above discussion, since we denoted retention at time t as r" let q t denote perceived quality at time 1. assuming that retention is a function ofquality, and that each of these variables is i( i) individually, then a long run equilibrium relationship between them exists which may be expressed as follows (1) the long run relationship in model (1) has a corresponding short run counterpart which may be expressed as follows (2) model (2) represents a linear combination ofretention and quality that is stationary, (i.e., 1(0» because it should not exhibit any tendency to increase with time. thus, even though each of these two variables is 1(1), a linear combination of them is stationary. therefore, retention and quality are cointegrated. in a nutshell, cointegration is a search for a linear combination that is 1(0) among a set of variables that are individually i( 1). however, space constraint does not permit a detailed discussion of cointgration in this paper, good discussion are elsewhere (hendry, 1995; enders, 2004; engle & granger, 1987; hamilton, 1994). appendix ib order of integration as discussed above, customer retention and perceived quality must be empirically shown to have the same order of integration before applying cointegration methods. to this end, the augmented dickey-fuller (adf) (dickey & fuller, 1981) test was used to ascertain the order of integration of these variables. the adf is based on the t-statistic on f in the following regression model n lly/:::: a o + alt + f~_j + scvjllyt_l + e, 1=1 (1) where ll is the first difference operator, r; is the series (retention and quality), e t is a white noise stationary error term, and n is made large enough to ensure that e/ is white noise. here, the null is that y t is a non-stationary series or a stochastic trend process, and the null is rejected when negative f is mathematically greater than the relevant critical values at the conventional levels, or negative f is greater than corresponding critical values in absolute terms. the results are shown in table 1. spring 2008 onyeaso and adalikwu: retention-perceived quality link 69 tablet adf unit root tests adf series: level/first diff with intercept & trend 95% critical value conclusion loger level -2.78 (1) -3.54 i (1) first diff. -4.94 (3) -3.54 i (0) logpq level -2.03 (1) -3.54 1(1) first diff. -4.25 (1) -3.54 1(0) notes: (.) denotes argumentation lags selected using akaike information criterion (aic) and/or schwarz bayesian criterion (sbc). cr is customer retention and po is perceived quality, these notations are used for all the tables. table 3 phillips-hansen fm-ols short run (ecm) results: white's heteroscedasticity adjusted standard errors. change in customer retention is dependent variable regressors parameter estimate constant .13 (.08) phecm (-1) -1.28 (.05)* ~lcr (-1) 1.76 (,001)* ~lpq .99 (.006)" ~lpq (-1) 2.38 (,006)* ~lpq (-4) .97 (.010)* ~lpq (-7) .73 (,066) phecm (-1) t-ratio =-3.16 (.006). • p < 0,05. p-values are in parentheses, the negative coefficients on lags 4 &7 of tllpq can be ascribed to instability of reduced form equations (ecm). appendix tc cointegration tests based on the evidence in table 1, customer retention and customer perceived quality are individually first difference stationary, that is 1(1). this is so because the null of no unit root could not be rejected (p < .05) for each of these variables on their levels, and the null no unit root was rejected (p < .05) on their first differences. conditional on these results, cointegration methods can then be applied. because cointegration methods differ in terms of their relative capabilities in accomplishing different tasks (gonzalo, 1994; haug, 1996), two cointegration methods were employed based on their relative capabilities. while we present a 70 journal ofbusiness strategies vol. 25, no.1 brief discussion of each method, the well known johansen and juselius (1990) method was not used in this study because its application is more appropriate in the case of more than two variables (harris, 1995). hendry's dynamic regression method this one-shot cointegration estimation approach estimates the short run and the long run parameters in one step rather than in two steps. the detailed discussion is provided by banerjee et al. (1986, hereafter, bdhs). our rationale for employing it is based on the following relative capabilities it has over other methods. first, according to bdhs, the small sample bias in the engle and granger two-step cointegration method can be at least minimized if the short run and the long run parameters are estimated in one step. second, bdhs used a simulation study to demonstrate the relative small sample superiority of their method over competing methods. finally, the bdhs method permits a test of cointegration by estimating their model and then testing whether the residual is stationary, according to thomas (1996). if it is stationary, there is cointegration among the variables. the next question is: if co integration exists among the variables, how many vectors are there? the reduced rank theory (johansen & juselius, 1990), states that the number of cointegration vectors (rank) in a model is one less than the number of variables in that model. consistent with this theory, in a bivariate system such as the present paper, the number of cointegration vectors must be one. phillips-hansen fm-ols method the fully-modified ordinary least squares (fm-ols) of phillips-hansen (1990) was also used in this paper to test the hypotheses. the fm-ols is one ofthe robust single equation cointegration methods suggested by some authors on the basis of their capabilities relative to other methods (haug, 1996; stock & watson, 1993). importantly, according to haug (1996), the fm-ols is asymptotically equivalent to the full information system-based estimator of johansen and juselius (1990). consequently, in the framework ofthe fm-ols, a truncation lag of5 with bartlett weights was applied to obtain the long run cointegration relationship between customer retention and perceived quality reported in table 2. evidence of cointegration automatically means that customer retention and quality have positive association which binds them together (granger, 1988; engle & granger, 1987). given the positive association between quality and retention, they must move together permanently in the sense of the long runs. to investigate the temporary immediate term (or short run) relationship between quality and retention, we estimated a general form of fm-ols error correction model (ecm) whereby the error correction term (ect) from the permanent (or long run) equation entered the ecm as one of the regressors (hendry, 1995; harris, 1995; arize, malindretos & grivoyannis, 2003; arize, malindretos & christoffersen, 2003). spring 2008 onyeaso and adalikwu: retention-perceived quality link 71 the general ecm results of the phillips-hansen fm-ols are reported in table 3 as the short run results. as you can see, table 3 has some encouraging results. first, one period lagged changes in customer retention (mer (-1 », is a significant predictor of current changes in customer retention. second, current changes in quality (mpq) explains current changes in customer retention. therefore, the empirical evidence suggests that customer perceived quality significantly explains current changes in customer retention. the managerial strategic management significance ofthis finding will be discussed in subsequent sections of this paper. finally, even though the diagnostic tests reported in table 2 suggest model adequacy, we felt that confidence in the results would be enhanced if the model was re-estimated with a heteroscedasticity-consistent estimator. as would be expected, the probability values of the white's heteroscedasticity-consistent estimates are somewhat larger but are significant at the five per cent level, as shown in table 3. acknowledgement we are grateful to ja duffy fonner editor for the assistance she gave us in writing this paper, and to the three anonymous reviewers for their valuable comments that improved the quality of the paper. godwin onyeaso is professor of strategic management and research methods at concordia college--university system, selma, alabama, usa. his primary research interest is on the influence of intangible strategic assets (e.g., spiritual capital) on the performance of family businesses and large corporations. his contributions are published in several peer-reviewed journals. chris adalikwu is professor and chair, division of business, concordia college-university system, selma, alabama, usa. as a fulbright scholar, he has extensive international experience in retailing and financial services management. he has researched and published in the workforce diversity management field in several peer-reviewed academic journals. an empirical test of customer retention-perceived quality link: strategic management implications chief executive background characteristics and environmental scanning emphasis: an empirical investigation arifin angriawan purdue university-calumet • hammond, in michael abebe the university of texas-pan american • edinburg, texas abstract this study empirically examined the relationship among chief executive officer's (ceo) industry tenure, intrapersonal functional diversity and the level of environmental scanning emphasis among 90 manufacturing firms in the computer and food processing industries. drawing from the managerial cognition and upper echelons theories, we hypothesized that ceos who have diverse intrapersonal functional background (generalists) and longer single industry tenure are more likely to emphasize scanning both the task and general industry environments. our findings generally support a positive relationship between the length of industry tenure, intrapersonal functional diversity and environment scanning emphasis. implications for further strategic decision-making research are discussed. introduction there is a general understanding among strategic management scholars that environmental scanning constitutes a preliminary step toward an effective strategy formulation process (hambrick, 1982; daft, sormunen & parks, 1988; garg, waiters & priem, 2003). aguilar (1967) defines environmental scanning as the process of gathering "information about events and relationships in a company's outside environment, the knowledge of which would assist top management in its task of charting the company's future course of action" (p.1). past environmental scanning research has mainly been anchored in the organizational adaptation and strategic choice perspectives (miles & snow, 1978; child, 1972) that emphasize the active role top executives play in analyzing and interpreting wide-ranging information about the business environment (kiesler & sproull, 1982; jackson & dutton, 1988; thomas, clark & gioia, 1993; garg et ai., 2003). much of the scholarly work in the scanning and strategic decision-making literatures focus on the chief executive officer's (ceo) primary responsibility in orchestrating systematic environmental 76 journal of business strategies scanning, interpretation and strategic action (e.g. daft & weick, 1984; thomas, litschert and ramaswamy, 1993; garg et at, 2003). despite such a significant role chief executives play in the environmental scanning process, there has been limited research that focuses on their background characteristics as a potential predictor of environmental scanning behaviors (hambrick, 1981; sutcliffe, 1994; cho, 2006 are the exceptions). in this study, we argue that examining chief executives' characteristics is particularly important for a number of reasons. first, since ceos face numerous constraints including 'bounded rationality' (march & simon, 1958) and significant resource limitations within the organization context (garg et at, 2003); their selective perception of external environmental stimuli largely depends on their professional background, experiences and idiosyncrasies that in turn determine their strategic choice (hambrick & mason, 1984). accordingly, by empirically examining the role of ceo's background characteristics, we will be able to enhance our understanding of not only the environmental scanning process but also the overall strategic formulation and strategic decision-making. second, we also believe that by studying ceo background characteristics, we will be able to focus on the view of top managers (and especially the chief executive) as the "information processing center" of the organization (haleblian & finklestein, 1993). in this study, we explicitly make the assumption that a significant amount of organizational level environmental scanning and interpretation is made by the senior management and specifically by the ceo (aguilar, 1967; daft & weick, 1984; garg et at, 2003).1 hence, we believe that examining the background characteristics of the ceo helps to better understand environmental scanning emphasis and ultimately the nature of strategic decision-making. consequently, our argument focuses on ceo's industry tenure and intrapersonal functional diversity and their possible influence on narrow (task environment) or broad (general environment) scanning emphasis. these two ceo background characteristics are specifically selected for two major reasons: first, an extensive scholarly work in the upper echelons and strategic decision-making literatures (see finklestein & hambrick, 1996 and carpenter, geletkanycz, & sanders, 2004 for extensive review) has empirically shown that executives' background characteristics influence their attention, information search and decision-making patterns. specifically, a number of upper echelons studies in the past (e.g. finklestein & hambrick, 1990; carpenter & frederickson, 2001; carpenter, 2002) have empirically examined executives' tenure, functional background and educational level as predictors ofvarious organizational outcomes. hence, we seek to build on this established literature stream and argue that studying these particular constructs in the context of environvolume 28, number 1 77 mental scanning could have a theoretically meaningful contribution to the extant literature. second, since these two particular constructs have not been effectively addressed by the extant scanning literature, we believe that we can contribute to our understanding of environmental scanning behaviors as it relates to executives' background characteristics. accordingly, our central research question is: "is there a relationship among ceo background characteristics (i.e. industry tenure and intrapersonal functional diversity) and the extent of environmental scanning emphasis?" in other words, does the length of industry tenure and functional background diversity (generalists or specialists) of executives relate to the scope (narrow vs. broad) of environmental scanning emphasis? we draw from the managerial cognition (walsh, 1995) and upper echelons (hambrick & mason, 1984; hambrick, 2007) theoretical frameworks in order to address this research question. theory and hypothesis development the main focus of this study is an empirical examination of the relationship between ceo background characteristics and environmental scanning emphasis. since we are arguing that the nature and extent of industry tenure and intrapersonal functional background influence how ceos scan and pay attention to the external business environment, we specifically draw from the managerial cognition and upper echelon/strategic leadership literatures. our theoretical focus, therefore, is explaining the cognitive attributes associated with industry tenure and intrapersonal functional background. in doing so, we seek to establish the theoretical framework that explains how these two predictors possibly influence ceo environmental scanning emphasis. in the following sections, we will discuss in detail the general arguments of these two theoretical frameworks and specifically develop theoreticallydriven hypotheses. executive cognition perspective the executive cognition perspective generally argues that executives often operate within the limits of bounded rationality and make decisions based on their subjective representation of the environment (simon, 1959; neisser, 1976; hambrick & mason, 1984; walsh, 1995). such subjective representations of the environment are also called strategic schemas (nadkarni & narayanan, 2007), cognitive bases (hambrick & mason, 1984), or, in general, knowledge structures. walsh (1995) defined knowledge structures as "mental templates consisting of organized knowledge about an information environment that enables interpretation and action in that en78 journal of business strategies vironment" (p.286). executives utilize their previously developed knowledge structures to process most of the information except novel information (walsh, 1995) or the one that is relevant to goal achievement (fiske & taylor, 1991; sutcliffe & huber, 1998). previous researchers have identified two distinct features of knowledge structures: complexity and focus (baum & wally, 2003; eden, ackermann, & cropper, 1992; nadkarni & narayanan, 2005). complexity refers to the content of knowledge structures in terms of variety of concepts and connectedness of these concepts (walsh, 1995). focus refers to the extent that a knowledge structure is centralized around a few core schemas (nadkarni & narayanan, 2007). for example, the complexity of an executive's knowledge structure of the environment depends on the numbers of task and general environment factors contained in the schema as well as his or her understanding ofthe relationships among these factors. focus refers to the dominating factors in the knowledge structure. in scanning literature, for example, task environment rather than general environment is considered to be the focus of executives' knowledge structure (daft, sormunen, & parks, 1988; sawyerr, 1993). executives' knowledge structures continue to evolve as their experiences with the external business environment increase (daft & weick, 1984; fiske & taylor, 1991; nadkarni & barr, 2008). previous researchers have also argued that dominant knowledge structures could be self-reinforcing (janis, 1972; neisser, 1976; weick, 1979). executives utilize previously developed knowledge structures to process environmental information which further reinforce the knowledge structure. this reinforced knowledge structure is then used to process similar information. this process will go on as a self-reinforcing process and could sometimes be dysfunctional. for example, executive focus on task environment could encourage a disproportionate emphasis on information processing related to major aspects of the task environment (such as customer, competitor and supplier segments) at the expense of the general environment. on the other hand, the executive cognition literature has also studied the benefits of complex knowledge structures. for example, mcnamara, luce and tompson (2002) found a positive relationship between complexity of top executives' strategic group knowledge structures and subsequent firm performance. they argued that executives with complex knowledge structures have more cognitive dimensions that can be used to understand and deal with competitors and uncertainties. nadkarni and narayanan (2007) found positive relationships between both knowledge structure complexity and firm strategic flexibility and firm performance. they defined strategic flexibility as "the ability to precipitate intentional changes and adapt to environmental changes through continuous changes in current stravolume 28, number 1 79 tegic actions, asset deployment, and investment strategies" (p. 245). hence, their overall conclusion was that executives' cognitive complexity promotes strategic flexibility which in turn improves firm performance. upper echelons theory (uet) in addition to the executive cognition perspective, we also draw from the upper-echelons theory (uet) to argue that executives' background characteristics affect their selective perception of environmental stimuli (environmental scanning emphasis). uet has two central tenets: first, executives' strategic choices and organizational outcomes are influenced by their values and cognitive base. second, these values and cognitive base are reflected by observable characteristics such as age, functional background, educational level, socioeconomic roots, financial position and group characteristics (hambrick & mason, 1984; hambrick, 2007). according to this theory, the observable (e.g. demographic) and cognitive characteristics of executives to a large extent influence their focus of attention. moreover, uet suggests that executives' strategic choices as well as decisions are largely constrained by cognitive limitations, personal values, and observable demographic characteristics that dictate the amount and type of environmental stimuli they can process and ultimately the types of decisions they make (carpenter et al., 2004). since organizational decision-makers are constrained by 'bounded rationality' (march & simon, 1958; cyert & march, 1963), they tend to search information and pay attention to specific aspects of the envi ronment that 'fits' their characteristics and idiosyncrasies (dearborn & simon, 1958; thomas, litschert & ramaswamy, 1991). in the last two decades, an extensive body of empirical work has examined the relationship among executives' background characteristics and various organizational outcomes. specifically, past studies have empirically examined the relationships among executive demographic characteristics (such as tenure, functional background and educational status) and strategic change (wiersema & bantel, 1992; boeker, 1997), diversification (michel & hambrick, 1992; carpenter & frederickson, 2001), innovation (bantel & jackson, 1989) and firm performance (smith, smith, sims, o'bannon & scully, 1994; certo, lester, dalton & dalton, 2006). executive tenure and functional background orientation are particularly two major demographic variables that received substantial scholarly attention in the uet literature (smith et al., 1994; carpenter et al., 2004). a significant number of the studies have examined firm and position specific average tenure of either the ceo or top management team (tmt) as an important predictor variable (e.g. katz, 80 journal of business strategies 1982; miller, 1991). this study seeks to extend the current literature by examining industry-level executive tenure (i.e. number of years in which executives held various managerial position working for different firms within a particular industry) as an important demographic predictor in environmental scanning process. similarly, uet researchers have extensively studied executive functional background orientation and heterogeneity as a salient predictor of various organizational outcomes. more specifically, past empirical research has explored the relationship between ceo or tmt functional background heterogeneity and organizational innovation (bantel & jackson, 1989), strategic change (wiersema & bantel, 1992), strategic decisions (hambrick, cho, & chen, 1996; jackson, 1992) and firm performance (carpenter, 2002). despite the substantial empirical work, the results have in general been inconclusive suggesting a positive impact of functional diversity in some instances and an adverse effect in others. such a lack of scholarly consensus on the effect of top team functional diversity has recently led some researchers to explore varying conceptualization of the diversity label (bunderson & sutcliffe, 2002; cannella, park, & lee, 2008). these scholars emphasize the need for a clear conceptual distinction between functional diversity among top team members (which they referred to as 'dominant functional diversity') and functional diversity of each of the top team members (i.e. 'intrapersonal functional diversity'). while the former (dominant functional diversity) focuses on the distribution of different functional background among team members, the later (intrapersonal functional diversity) " ... focuses on the extent to which the individuals on a team are narrow functional specialists with experience in a limited range of functions, or broad generalists whose work experiences span a range of functional domains" (bunderson & sutcliffe, 2002, p. 880). in the following section, we specifically discuss these two constructs (i.e. ceo industry tenure and intrapersonal functional diversity) and their proposed relationships with the scope of environmental scanning emphasis. ceo industry tenure ceo industry tenure is an important factor affecting information-processing and strategic decision-making patterns in organizations (hambrick, geletkanycz & frederickson, 1993; geletkanycz, 1997; henderson, miller & hambrick, 2006). in this study, we make a clear distinction between ceos' single and multiple industry tenures. they respectively refer to ceos' work experience at several firms within a single industry and more than one industry. here, we focus solely on single industry tenure as a predictor of environmental scanning emphasis. volume 28, number 1 81 we theorize that the length of ceo tenure in a single industry is positively associated with the extent of environmental scanning. we make the argument that the complexity of ceos' knowledge structure of environmental scanning increases with single industry tenure. ceos with longer single industry tenure often spend a considerable amount of time working for different firms within the same industry before landing on their current position. such a 'wealth of experience' generally includes extensive expertise on the dynamics as well as intricacies involved in successfully operating within a particular industry (spender, 1989). some studies have shown that longer-tenured executives indeed possess higher level of understanding of the industry's promises, challenges and complexities (bergh, 2001; henderson et ai., 2006). longer tenured executives in general are extremely competent in terms of industry-specific technical knowledge and expertise (henderson et ai., 2006). they develop, over time, a better understanding of the linkages among and the influences of various stakeholders on industry behaviors and actions. long industry tenure also leads to the development of 'industry recipes' or a 'common body of knowledge' (hambrick, 1982; spender, 1989). such in-depth knowledge is strongly tied to understanding supplier and competitor behaviors and customer demand patterns within the industry. most of them are well aware of the critical success factors determining profitability of firms operating in the particular industry environment. hence, it is likely that longer industry tenure improves the extent of external environmental scanning in general and specific environmental scanning (task vs. general environment) in particular. similarly, ceo industry tenure also influences a ceo's understanding of the impacts of general environment sectors. significant amounts of the professional experiences executives acquire during the industry tenure are accumulated in their knowledge structures. a ceo's knowledge structure becomes more complex as his/her industry tenure increases. such complex structures are then used to scan and interpret multiple and diverse environmental stimuli. consequently, the extent of ceo scanning increases with the complexity of the ceo knowledge structures. this is especially true for the focus or sub-schema of an executive's environment knowledge structure. previous researchers have argued that schematic information processing can be self-reinforcing. this suggests that executives have the tendency to process more and more task environment information. hence, we hypothesize that: hi: ceo single industry tenure is positively related to the scope environmental scanning. 82 journal of business strategies more specifically, h la : the extent of ceo task environmental scanning increases with the length of his/her single industry tenure. h lb : the extent of ceo general environmental scanning increases with the length of his/her single industry tenure. ceo intrapersonal functional diversity the effect of top management team functional diversity on organizational outcomes has been well-researched in the strategic leadership literature (barsade, ward, turner, & sonnenfeld, 2000; certo et ai., 2006). in this study, we primarily focus on intrapersonal functional diversity as a predictor of environmental scanning emphasis in organizations. accordingly, our emphasis will be on empirically testing the relationship between the types of intrapersonal functional diversity (i.e. whether a ceo is a functional specialist or generalist in his/her career experience) and the extent of environmental scanning. we theorize that higher intrapersonal diversity of ceos is positively associated with the extent of environmental scanning in organizations. ceos with high intrapersonal diversity (generalists) have substantial exposure in different aspects of the business and therefore are capable of confronting complex strategic issues (stone & tudor, 2005). generalist ceos have extensive knowledge and expertise in various functional specialties (e.g. marketing/ sales, administration, finance, accounting, operations) which in turn enables them to scan wide-ranging environmental sectors for relevant information. therefore, we expect that, due to their extensive functional area exposure, generalist ceos (with high intrapersonal diversity) engage in broader environmental scanning activity than their specialist (low intrapersonal diversity) counterparts. specifically, intrapersonal diversity could lead ceos to emphasize general environment scanning. for example, ceos with previous experience in marketing, operations, and finance would relatively have greater tendency to scan the different aspects of the general environment such as demographic (related to marketing), technology (related to operations), and economy (related to finance). hence, we hypothesize that: h 2 : the extent of ceo environmental scanning is positively related to his/her intrapersonal functional diversity. more specifically, volume 28, number 1 h 2a : the extent of ceo task environmental scanning is positively related to his/her intrapersonal functional diversity. h 2b : the extent of ceo general environmental scanning is positively related to his/her intrapersonal functional diversity. methods sample 83 in order to test the above hypotheses, we selected firms from two considerably different industries, because previous researchers have observed that top executives' knowledge structures vary by industries (bogner & barr, 2000; nadkarni & barr, 2008). for instance, bogner and barr (2000) argued that knowledge structures of top executives from hypercompetitive industries are significantly different from those of stable industries. they contend that the differences result from the different experiences of making sense and dealing with the different industries. similarly, nadkarni and barr (2008) found empirical support for their contention that there is dissimilar distribution of executive knowledge structures among different industries. accordingly, we selected the computer and packaged foods industries to represent turbulent and stable environments respectively. the computer industry (sic code 3570-3576) often represents rapid technological innovation, changing customer demand, shorter product life cycle and significant product differentiation (haleblian & finkelstein, 1993; henderson et ai., 2006). packaged foods industry (sic code 2000-2090), on the other hand, is characterized by fairly stable market demand, low level of disruptive technological innovation and predictable market share positions among competitors(geletkanycz, 1997; henderson et ai., 2006). we only selected firms that (1) are based in the united states, (2) are publicly traded in the u.s., and (3) are not highly diversified conglomerates or subsidiaries of a foreign company. we only focused on u.s. based firms because of issues of data availability and difficulty comparing organizational variables across different countries. highly diversified conglomerates were excluded because their top managers might have very different knowledge structures. for example, in such highly diversified firms, ceos' knowledge structures of environment are shaped by his previous experiences as well as current social influences from other members of top management teams (chattopadhyay, glick, miller, & huber, 1999). applying the aforementioned criteria, 44 firms in the computer industry and 46 firms in the packaged food industry were included in the final sample of the study. 84 journal of business strategies measures and data sources extent of environmental scanning: consistent with previous studies that categorize a firm's environment into task and general environments (cho, 2006; daft et ai., 1988; jackson & dutton, 1988), we defined the task environment to include competitor, supplier, and customer sectors. the general environment, on the other hand, consists of demographic, economic, political/legal, socio-cultural, and technological sectors. once the environmental sectors are identified, we used content analysis to measure the extent of environmental scanning emphasis within the sample firms. content analysis of organizational official documents such as annual reports has been used in the environmental scanning literature to examine executive attention and cognitive patterns (d'aveni & macmillan, 1990; abrahamson & park, 1994; cho, 2006). hence, we used the sample firms' form io-k annual reports (including letter to shareholders) to identify a list of words that can be categorized in each of the eight different environmental sectors mentioned above. two final steps were taken to measure the scope of environmental scanning activity: first, using a specialized computer assisted text analysis (ca ta) software, concordia (watts, 2004), we identified a list and frequency of words used in each firm's annual reports that correspond to each of the eight environmental sectors (i.e. customer, supplier, competitor, economic, technological, demographic, political/legal and socio-cultural sectors) for the year 2006. we chose this year due to the extensive availability of quantitative as well as qualitative archival data for each firm in the sample. the list of words we used in this study is consistent with previous literature (d'aveni and macmillan, 1990; cho, 2006). second, once the list and frequency of words in the annual report corresponding to each environmental sector was identified, we averaged the total number of words representing each sector to develop a composite measure of task, general, and overall environmental scanning (for instance, we calculated task environment scanning by averaging the number of words representing the customer, competitor and supplier sectors and similarly we averaged the number of words in the annual report representing the five sectors of the general environment specified in the definition above). similarly, we measured the extent of overall environmental scanning by adding both the frequency of words corresponding to each of the five general environment sectors and the three task environment sectors. ceo single industry tenure: following hambrick et al. (1993) and stone & tudor (2005), we measured ceo single industry tenure by the number of years he/ she spent working as the executive level within the current industry. dun & bradvolume 28, number 1 85 street reference book of corporate management and annual proxy statements were used to collect data on ceo industry tenure. lntrapersonal functional diversity: in order to measure ceo intrapersonal functional diversity variable, we first adopted eight dominant functional categories used in previous studies (cannella et ai., 2008; carpenter & fredrickson, 2001). these functional categories are marketing and sales; production and operation; accounting and finance; r&d and engineering; management and administration; law; personnel and labor relations and others. we then examined each firm's ceo functional background to determine the functional category he/she spent the most time in. accordingly, if he/she had spent the two-third of his or her career in a specific functional category, we categorize them as "specialists". conversely, if he/she had spent the last ten years of his/her career in two or more functional categories identified above, we categorize them as "generalists". we chose particularly the two-third threshold because executives serving for such period of time within a single industry will most certainly develop an established career path and expertise (spender, 1989; finklestein and hambrick, 1996). hence, we use "i" to code specialist ceos and "2" for all generalist ceos. ceo intrapersonal functional diversity data were obtained from dun & bradstreet reference book of corporate management, annual proxy statements of each firm and biographical records located in popular financial websites (e.g. google finance). control variables: we controlled for the effects of firm size, ceo firm tenure, total number of words in the annual and letter to shareholders, and ceo network ties. past research has shown that firm size and resources correlate with firm ability to scan. we measured firm size by the number of employees of sample firms. we measured ceo firm tenure by counting the number of years the ceo spent in an executive position in his/her current firm. finally, the type and frequency of contacts and social professional ties of executives could potentially affect their environmental scanning activity. both the environmental scanning and board interlock literatures strongly argue that executives' professional network ties, measured specifically in the number of boards they sit on, influence both the information acquisition and strategy formulation processes (geletkanycz and hambrick, 1997; westphal, boivie, chng, 2006). accordingly, we measured ceo network ties by counting the numbers of board of directors of firms both within and outside of the industry that the ceos of the sample firms sat on the prior to and including the 2006 calendar year. more specifically, we measured the extent of ceo network ties by counting the number of active board of directors' membership they currently have in 2006 in addition to past appointments before 2006. 86 journal of business strategies statistical analysis we used hierarchical multiple regression analysis to test our hypotheses. prior to proceeding to the analysis, we checked for multivariate assumptions such as linearity, normality and homoscedasticity (hair, black, babin, anderson & tatham, 2006). we also checked for the presence of multicollinearity and examined tolerance and variance inflation factors. accordingly, we did not find any major violations. we regressed each of the dependent variable on the control and predictor variables. results table 1 presents the means, standard deviations, and correlations of the variables in the study. the total sample size for the analysis consists of 44 firms from the computer industry and 46 firms from food processing industry for a total of 90 firms. to correct for a skewed distribution, we used a statistical transformation on the number of employees that is used to measure firm size. table 2 reports the findings of the hierarchical multiple regression analysis. in general, this study hypothesized that the extent of ceo environmental scanning, task environment scanning, and general environment increase with the length of ceo industry tenure and the breadth of ceo intra functional diversity. more specifically, hi predicted that the overall extent of ceo environmental scanning generally increases with longer industry tenure. as model 6 (table 2) shows, this hypothesis received strong support (b = 0.165, p < 0.05). hence, we found support for the positive relationship between ceos industry tenure and the extent of overall environmental scanning. more specifically, h la hypothesized a positive relationship between ceos length of industry tenure and the extent of task environment scanning. as can be seen below in model 2 (table 2), we found only a marginal support for this hypothesis (b = 0.167, p < 0.10). h 1b , on the other hand, proposed a positive relationship between ceos length of industry tenure and general environment scanning. the results of the analysis in model 4 (table 2) indicate no statistically significant relationship (b = 0.124, n.s.). hence, we did not find an empirical support for the relationship between ceos length of industry tenure and the extent of general environment scanning. h2 proposed a positive relationship between the extent of ceo overall environmental scanning activity and the level of his/her intrapersonal functional diversity. the results in model 6 (table 2) indicate only a marginal statistical support for hypothesis 2 (b = 0.150, p < 0.10). h 2a specified a positive relationship between table 1 means, and standard deviations, and correlations (n = 90) mean std. 1 2 3 4 5 6 1 firm size 3.44 4.94 1 2 total words in annual report 3934 749.35 -0.16 1 3 ceo firm tenure 8.21 8.58 -0.15 -0.16 1 4 ceo network ties 1.46 2.12 0.024 0.01 -0.17 1 5 ceo industry tenure 14.12 11.98 0.11 -0.07 -0.06 -0.08 1 6 ceo intrapersonal functional diversity 1.29 0.64 0.20* -0.10 -0.21 * 0.084 0.05 1 7 task environmental scanning 108.77 65.83 0.13 0.50*** -0.16 -0.17 0.17 0.10 8 general environmental scanning 50.61 32.17 0.19* 0.55*** -0.17 -0.14 0.13 0.17 9 external environmental scanning 159.38 91.01 0.16 0.56*** -0.18* -0.17 0.17 0.14 * p-value < 0.10 ** p-value < 0.05 *** p-value < 0.01 7 8 1 0.69*** 1 0.97*** 0.85*** 9 1 ~ -;: ;l '" tv 00 ~ ~ ;l i:s'" '" ""i "'" oj ---j 88 journal of business strategies the extent of ceo task environment scanning and the level of his/her intrapersonal functional diversity. the results of our analysis did not provide a statistically significant support for h 2a (b = 0.118, n.s.). finally, h 2b proposed a positive relationship between the extent of ceo general environment scanning and the level of his/her intrapersonal functional diversity. we found a strong statistically significant support for h 2b as shown in model 4 in table 2 (b = 0.184, p < 0.05). overall, the results of our hierarchical multiple regression analysis indicates strong empirical support for the positive relationship between executives' industry tenure and environmental scanning as well as the level of intrapersonal functional diversity (i.e. specialists vs. generalists) and general environment scanning. the significant results explained 45 and 46 percent of the variance in the criterion variables respectively as indicated in model 4 and model 6. discussion environmental scanning is an important step in the strategic formulation process. executive cognition and the upper echelons literatures have emphasized the importance of knowledge structures in environmental scanning. the extant literature postulates that executives make decisions based on their subjective knowledge structures and underlying cognitive biases. as mentioned earlier, researchers have recently found several benefits of the complexity of executives' knowledge structures (mcnamara et ai., 2002; nadkarni & narayanan, 2007). they particularly found a positive influence of complex cognitive structures on firm adaptation and profitability. in this study, we found that ceo industry tenure and intrapersonal functional diversity have positive impacts on the extent of environmental scanning emphasis. thus, the results suggest that ceos' knowledge structures become more complex and significantly associated with the length of single industry tenure and intrapersonal functional diversity. nadkarni and narayanan (2007) highlighted two possible ways of how complex knowledge structures could increase environmental scanning: cognitive inertia and discounting. they contend that complexity reduces cognitive inertia, because complex schemas increase executives' awareness of and ability to absorb environmental stimuli and simultaneously reduces cognitive discounting. discounting refers to the discrepancy of executives' subjective knowledge structure and the objective environment. this might suggest that industry tenure and intrafunctional diversity might increase ceos' ability to reduce cognitive discounting. table 2 results of multiple regression analysis! (n = 90) variables firm size dv = task environment scanning model 1 model 2 0.208** total number of words in annual report 0.521*** 0.174* 0.544*** -0.053 ceo firm tenure ceo network ties ceo industry tenure ceo intrapersonal functional diversity r2 llr2 f change -0.088 -0.192** 0.336 -0.182** 0.167* 0.118 0.376 0.04 2.69* dv = general environment scanning model 3 model 4 0.279*** 0.583*** -0.064 -0.156* 0.405 0.239*** 0.610*** -0.019 -.154* 0.124 0.184** 0.452 0.047 3.56** dv= environmental scanning model 5 model 6 0.249*** 0.583*** -0.086 -0.194** 0.414 0.210** 0.609*** -0.045 -0.186** 0.165** 0.150* 0.462 0.048 3.70** 1 standardized regression coefficients are shown * p-value < 0.10 ** p-value < 0.05 *** p-value < 0.01 ~ ;r ;:i ~ n 90 ~ ;:i ~ ~ ""i ~ 00 cd 90 journal of business strategies more specifically, we found that the extent of overall scanning, as well as task and general environment scanning emphasis increases with the length of ceo industry tenure and intrapersonal functional diversity. this might suggest that, as hypothesized, knowledge structures over time become more complex as well as focused. the overall increase in complexity is reflected in the significant increase in the overall environmental scanning while increase in focus are reflected in the increased emphasis in task and general environment scanning. however, the results of this study should be interpreted with caution. we mainly used the schematic information processing and uet theoretical frameworks. executive cognition researchers have argued that schematic information processing does not apply in novel situations or contexts. recent research has found that executives' foci of attention are situational. this suggests that executives attention and information processing on environmental scanning is not only guided by his or her previously developed structures related to environment but also other factors. for example, nadkarni and barr (2008) found that industry velocity had a positive relationship with managerial focus on the task sector while negatively related with focus on the general sector. thus executives' attentional focus on task environmental scanning is not only a product of his schematic information processing but also a result of situational factors such as industry velocity that continuously providing the managers with novel information. thus the study results would be more conclusive ifit had also examined the moderating effect of industry velocity and other related factors. limitation and future research we have discussed above the importance of examining situational factors that might have effect on the relationships between ceo tenure, intrafunctional diversity, and scanning behaviors. another limitation of the study is its cross-sectional approach. the results might have suggested that ceo tenure and intrafunctional diversity have linear relationships with regards to the extent of environmental scanning emphasis. however, there are possibilities that the relationships could also be curvilinear. for example, henderson et al. (2006) found that ceos in stable industry lost their touch with the environment after serving for more than 10 years and even faster for ceos from dynamic industries. hence, this might suggest that there is curvilinear relationship between ceo tenure and his or her environmental scanning emphasis. the findings of this study provide a number of future research implications. future research might want to examine the interaction effect of industry velocity with volume 28, number 1 91 executive background characteristics. we also did not examine a potential interaction effect of executives' single industry tenure and intrafunctional diversity on environmental scanning emphasis. this study only examined the differentiation aspect of knowledge structure complexity. according to walsh (1995), schematic complexity relates to both differentiation and integration (connectedness). differentiation refers to the variety of concepts embedded in schemas. integration refers to the degree of connectedness of various concepts contained in knowledge structures. we did not examine the impact of industry tenure and intrapersonal functional diversity on the integration aspect of knowledge structures. the integration aspect reflects managers' understanding of the causal logics of various strategic variables, i.e. relationship between technology and competition, contained in a schema. the examination is important because causal reasoning is the basis of decision making (fiske & taylor, 1991). future researchers can study relationship between executive's attentional focus and environmental scanning behavior. the attention-based view of the firm theorizes that individual decision-makers' actions are generally driven by their focus of attention and that such decisions and actions are influenced by the situational contexts that surround these decision-makers (ocasio, 1997). proponents of the attention-based view emphasize the important role of focused attention of decisionmakers in articulating the strategic direction as well as guiding routine tasks of the organization. in this study's context, the attention-based view of the firm would suggest that executives' focus of attention drives their environmental scanning patterns and that their scanning activities in turn shape strategic formulation (cho & hambrick, 2006; nadkarni & barr, 2008). in addition, based on the premise of situated attention articulated in the attention-based view of the firm (ocasio, 1997), executives' environmental scanning behavior may vary depending on the type of environment (i.e. stable or turbulent) their organizations operate in. thus, future researchers should examine the impacts of industry tenure and intra diversity on the integration and focus aspects of knowledge structures as well as the moderating impacts of the environmental turbulence and stability. end note 1. we used the concept of ceo environmental scanning and firm-level scanning interchangeably in this study. the majority of the scanning literature seems to argue that the ceo, along with his/her executive team, gather, analyze and interpret environmental stimuli in order to formulate effective business strategy (e.g. aguilar, 1967; hambrick, 1981; daft & weick, 1984; garg et ai., 2003). 92 journal of business strategies references abrahamson, e., & park, c. (1994). concealment of negative organizational outcomes: an agency theory perspective. academy of management journal, 37, 1302-l334. aguilar, f. 1. (1967). scanning the business environment. new york: macmillan. bantel, k. & jackson, s. (1989). top management and innovations in banking: does the composition of the top team make a difference? strategic management journal, 10, 107-124. barsade, s., ward, a., turner, 1., & sonnenfeld, 1. (2000). to your heart's content: a model of affective diversity in top management teams. administrative science quarterly, 45(4), 802-836. baum,1. & wally, s. (2003). strategic decision speed and firm performance. strategic management journal, 24(11), 1107-1129. bergh, d. (2001). executive retention and acquisition outcomes: a test of opposing views on the influence of organizational tenure. journal of management, 27, 603-622. boeker, w. (1997). strategic change: the influence of managerial characteristics and organizational growth. academy of management journal, 40(1), 152-170. bogner, w. & barr, p. (2000). making sense in hypercompetitive environments: a cognitive explanation for the persistence of high velocity competition. organization science, 11(2), 212-226. bunderson, 1. & sutcliffe, k. (2002). comparing alternative conceptualizations of functional diversity in management teams: process and performance effects. academy of management journal, 45(5), 875-893. cannella, a., park, 1.-h., & lee, h.-u. (2008). top management team functional background diversity and firm performance: examining the roles ofteam member colocation and environmental uncertainty. academy of management journal, 51(4), 768-784. carpenter, m. (2002). the implications of strategy and social context for the relationship between top team management heterogeneity and firm performance. strategic management journal, 23(3), 275-284. carpenter, m. & fredrickson, 1. (2001). top management teams, global strategic posture, and the moderating role of uncertainty. academy of management journal, 44(3), 533-545. carpenter, m., geletkanycz, m., & sanders, w. (2004). upper echelons research revisited: antecedents, elements, and consequences of top management team composition. journal of management, 30(6), 749-778. volume 28, number 1 93 certo, s., lester, r., dalton, c., & dalton, d. (2006). top management teams, strategy and financial performance: a meta-analytic examination. journal of management studies, 43(4), 813-839. chattopadhyay, p., glick, w., miller, c., & huber, g. (1999). determinants of executive beliefs: comparing functional conditioning and social influence. strategic management journal, 20(8), 763-789. child,1. (1972). organizational structure, environment, and performance: the role of strategic choice. sociology, 6, 1-22. cho, t (2006). the effects of executive turnover on top management team's environmental scanning behavior after an environmental change. journal of business research, 59, 1142-1150. cho, t & hambrick, d. (2006). attention as the mediator between top management team characteristics and strategic change: the case of airline deregulation. organization science, 17(4),453-469. cyert, r., & march, 1. (1963). a behavioral theory of the firm. englewood cliffs, nj: prentice hall. daft, r. l., sormunen, j., & parks, d. (1988). chief executive scanning, environmental characteristics, and company performance: an empirical study. strategic management journal, 9(2), 123-139. daft, r. & weick, k. (1984). toward a model of organizations as interpretation systems. academy of management review, 9(2), 284-295. d'aveni, r., & macmillan, 1. (1990). crisis and the content of managerial communications: a study of the focus of attention of top managers in surviving and failing firms. administrative science quarterly, 35,634-657. dearborn, d., & simon, h. (1958). selective perception: a note on the department identification of executives. sociometry, 21, 140-144. eden, c., ackermann, e, & cropper, s. (1992). the analysis of cause maps. journal of management studies, 29(3), 309-324. finkelstein, s., & hambrick, d. (1990). top-management-team tenure and organizational outcomes: the moderating role of managerial discretion. administrative science quarterly, 35(3),484-503. finklestein, s. & hambrick, d. (1996). strategic leadership: top executives and their effects on organizations. st. paul, mn: west publishing company. fiske, s. t, & taylor, s. e. (1991). social cognition. new york: mcgraw-hill. garg, v., walters, 8., & priem, r. (2003). chief executive scanning emphasis, environmental dynamism, and manufacturing firm performance. strategic management journal, 24, 725-744. 94 journal of business strategies geletkanycz, m. (1997). the salience of 'culture's consequences': the effects of cultural values on top executive commitment to the status quo. strategic management journal, 18(8), 615-634. geletkanycz, m. & hambrick d. (1997). the external ties of top executives: implications for strategic choice and performance. administrative science quarterly, 42,654-681. hair, jr., 1., black, w., babin, b., anderson, r., & tatham, r. 2006. multivariate data analysis. 6th ed. upper saddle river, nj: pearson-prentice hall. haleblian, 1., & finkelstein, s. (1993). top management team size, ceo dominance, and firm performance: the moderating roles of environmental turbulence and discretion. academy of management journal, 36(4), 844-863. hambrick, d. (2007). upper echelons theory: an update. academy of management review, 32(2), 334-343. hambrick, d., cho, t., & chen, m.-j. (1996). the influence of top management team heterogeneity on firms' competitive moves. administrative science quarterly, 41(4),659-684. hambrick, d., geletkanycz, m., & fredrickson, 1. (1993). top executive commitment to the status quo: some tests of its determinants. strategic management journal, 14(6),401-418. hambrick, d., & mason, p. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review, 9(2), 193. hambrick, d. (1982). environmental scanning and organizational strategy. strategic management journal, 3, 159-174. hambrick, d. (1981). specialization of environmental scanning activities among upper level executives. journal of management studies, 18(3),299-320. henderson, a., miller, d., & hambrick, d. (2006). how quickly do ceos become obsolete? industry dynamism, ceo tenure, and company performance. strategic management journal. 27(5), 447-460. jackson, s. (1992). consequences of group composition for the interpersonal dynamics of strategic issue processing. in g. b. mccabe (ed.), advances in strategic management 8, 345-382. jackson, s., & dutton, j. (1988). discerning threats and opportunities. administrative science quarterly, 33(3), 370-387. janis, i. l. (1972). victims of group think. new york: houghton mifflin. katz, r. (1982). the effects of group longevity on project communication and performance. administrative science quarterly, 27(1), 81. volume 28, number 1 95 kiesler, s., & sproull, l. (1982). managerial response to changing environments: perspectives on problem sensing from social cognition. administrative science quarterly, 27(4), 548-570. march, 1., & simon, h. (1958). organizations. new york: wiley. mcnamara, g., luce, r., & tompson, g. (2002). examining the effect of complexity in strategic group knowledge structures on firm performance. strategic management journal, 23(2), 153-170. michel, 1., & hambrick, d. (1992). diversification posture and top management team characteristics. academy of management journal, 35(1),9-37. miles, r., & snow, c. (1978). organizational strategy, structure and process. new york: mcgraw-hili. miller, d. (1991). stale in the saddle: ceo tenure and the match between organization and environment. management science, 37(1),34-52. nadkarni, s., & barr, p. (2008). environmental context, managerial cognition, and strategic action: an integrated view. strategic management journal, 29(13), 1395-1427. nadkarni, s., & narayanan, v. (2005). validity of the structural properties of textbased causal maps: an empirical assessment. organizational research methods, 8(1),9-40. nadkarni, s., & narayanan, v. (2007). strategic schemas, strategic flexibility, and firm performance: the moderating role of industry c1ockspeed. strategic management journal, 28(3), 243-270. neisser, u. (1976). cognitive psychology. englewood cliffs, nj: prentice-hall. ocasio, w. (1997). towards an attention based view of the firm. strategic management journal, 18, 187-206. sawyerr, o. (1993). environmental uncertainty and environmental scanning activities of nigerian manufacturing executives: a comparative analysis. strategic management journal, 14, 287-299. simon, h. (1959). theories of decision-making in economics and behavioral science. american economic review, 49(3), 253-283. smith, k., smith, k., sims jr, h., o'bannon, d., & scully, 1. (1994). top management team demography and process: the role of social integration and communication. administrative science quarterly, 39(3),412-438. spender, 1. c. (1989). industry recipes: the nature and sources of managerial judgment. oxford: basil blackwell. 96 journal of business strategies stone, w. & tudor, t. (2005). the effects of functional background experience, industry experience, generic executive management experience on perceived environmental uncertainty and firm performance. advances in competitiveness research, 13(1), 1-8. sutcliffe, k., & huber, g. (1998). firm and industry as determinants of executive perceptions ofthe environment. strategic management journal, 19(8), 793-807. sutcliffe, k. (1994). what executives notice: accurate perceptions in top management teams. academy of management journal, 37(5), 1360-1378. thomas, 1., clark, s., & gioia, d. (1993). strategic sensemaking and organizational performance: linkages among scanning, interpretation, action, and outcomes. academy of management journal, 36(2), 239-270. thomas, a., litschert, r., & ramaswamy, k. (1991). the performance impact of strategy-manager coalignment: an empirical examination. strategic management journal, 12(7), 509-522. walsh, 1. (1995). managerial and organizational cognition: notes from a trip down memory lane. organization science, 6(3), 280-321. watts, r. 1. (2004). concordance. retrieved november 20, 2008, from www.concordancesoftware.co.uk/ weick, k. (1979). cognitive processes in organizations. research in organizational behavior, 1,41-74. westphal, 1., boivie s., chng, d. (2006). the strategic impetus for social network ties: reconstituting broken ceo friendship ties. strategic management journal, 27, 425-445. wiersema, m., & bantel, k. (1992). top management team demography and corporate strategic change. academy of management journal, 35(1),91-121. biographical sketch of authors arifin angriawan is an assistant professor of management at purdue university calumet, hammond, indiana. his research interests include the impacts of top management team characteristics on firm strategic decisions and financial performance, determinants of executive beliefs, and e-commerce issues. michael a. abebe is an assistant professor of management at the university of texas-pan american, edinburg, texas. his research interests include organizational change and renewal, executive cognition, strategic decision-making process and social issues in minority entrepreneurship. journal of sam h.ouston state university a member of the texas state university system charlie amato, chairman san antonio donna n. williams, vice chairman arlington jaime r. garza san antonio kevin j. lilly houston ron mitchell horseshoe bay david montagne trisha pollard rossanna salazar michael truncale chris covo, student regent brian mccall, chancellor beaumont bellaire austin beaumont san marcos austin business strategies gibson d. lewis center for business and economic development non· profit org. u.s. postage paid hu ntsville, tx per mit no. 26 chief executive background characteristics and environmental scanning emphasis: an empirical investigation stages of corporate governance in transition economies son a. le louisiana tech university • ruston, la mark j. kroll university of texas at brownsville • brownsville, tx bruce a. walters louisiana tech university • ruston, la abstract we develop a model of corporate governance stages in transition economies, including bureaucratic control-based; relational; and rule, market-based corporate governance. we demonstrate how institutions shape stakeholders’ dominant sources of control power and firms’ dominant origins of resources within and across these stages. we then theorize how these driving forces influence the effectiveness of these corporate governance stages, and how the shift from one stage of corporate governance to another comes about. our paper therefore contributes to the understanding of the development and nature of corporate governance in transition economies. introduction transition economies are former socialist countries such as those that were part of the former soviet union, those in eastern europe, and east asia, which are transforming from central planning to free market competition (world bank, 2002). numerous studies of corporate governance in transition economies have recently been undertaken (e.g., andreff, 1999; aoki, 1994; berglof, 1995; dharwadkar, george, & brandes, 2000; estrin & angelucci, 2003; wright, filatotchev, buck, & bishop, 2003; young, peng, ahlstrom, & bruton, 2002). notably, transition economies account for a significant portion of the world’s population and economic activity, and corporate governance is central to the privatization of state-owned enterprises — a vital activity in their economic transformation (mccarthy & puffer, 2003; peng, 2004). these economies present a unique context for examining phenomena and theories well established in the setting of developed economies (hoskisson, eden, lau, & wright, 2000; peng, 2003). most prior studies are static in nature. given radical institutional changes and varying rates of progress occurring in different transition economies, research insights obtained from such static studies may be inconclusive and not reflective of temporal dimensions of corporate governance within and across transition econo152 journal of business strategies mies. for example, judge, naoumova, and koutzevol (2003) and peng (2004) found inconsistent results concerning the role of outside board members in russia and china. similarly, wright et al. (2003) and estrin and angelucci (2003) reported conflicting findings regarding the effectiveness of inside versus outside ownership. such inconclusive findings may lead some scholars to conclude that transition economies are heterogeneous and thus it is not feasible to develop a general model of corporate governance for transition economies. however, according to a number of transition economy researchers (e.g., boisot & child, 1996; le, kroll, & walters, 2010; mcmillan & woodruff, 2000; peng, 2003), these findings offer evidence that transition economies go through similar stages during their market-oriented transformation, and at a given point in time their corporate governance is dissimilar because they are in different transition stages. this paper is motivated by unresolved questions concerning corporate governance in transition economies: (1) does transition to a market-oriented economy generally progress through similar stages? (2) which modes of governance are likely effective in those stages? (3) how and when do privatized firms shift from one mode of corporate governance to another? we note that our focus is on corporate governance in privatized firms (firms that have their ownership transferred from a socialist state to private organizations and individuals), to which we refer as “firms” in the rest of the paper. previous studies (e.g., king, 2001; le et al., 2010; peng, 2003) indicate that the market transformation in transition economies can be temporally divided into three stages: (1) the early or bureaucratic control stage, (2) the intermediate or relational stage, and (3) the late or market stage. we suggest that, correspondingly, the prevalent mode of corporate governance likely shifts from bureaucratic control-based to relational corporate governance, then from relational to market-based corporate governance. drawing on agency, social and political, resource dependence, and neoinstitutional theories, we propose two primary determinants of the shifts in corporate governance modes: the sources of control power available to protect stakeholders’ rights (i.e., the power of the state, relational networks, or the market) and the origins of resources firms need to survive and grow (i.e., resources from the state, relational networks, or the market). we posit that a particular institutional framework gives rise to a certain dominant source of power and resources. those dominant sources determine the most prevalent and effective mode of governance. radical institutional changes alter the dominant sources of control power and resources, triggering a shift from one mode of governance to another. our paper offers the following contributions. first, we propose a general model of corporate governance that specifies the sequential prevalence of three govvolume 28, number 2 153 ernance modes (i.e., bureaucratic control-based; relational; and rule, market-based corporate governance). second, we provide insights into relationships linking institutions and institutional changes to sources of power and factors of production, and then to the effectiveness of corporate governance. finally, we shed light on which mode and related governance mechanisms are likely effective in various stages, as well as when a firm shifts from one governance mode to another. corporate governance in transition economies stages of market transformation transition economies are former centrally planned economies undergoing unprecedented, comprehensive transformations to market-driven economies (world bank, 2002). planned and market economies are opposing economic systems adhering to different institutional frameworks (king, 2001; martin, 2002; peng, 2003; williamson, 1995). an institutional framework is a set of formal constraints such as legal and regulative systems; and informal constraints such as social values, codes of conduct, norms of behavior, and conventions that regulate human behavior and economic activity (e.g., the use of norms of trade associations to regulate exchanges; social pressure to ensure that parties perform their duties) (north, 1990; scott, 1995). the institutional framework associated with a centrally planned economy, which we label the bureaucratic control institutional framework, principally underlies public ownership, state coordination, redistribution, and control (boisot & child, 1988; kornai, 1990). the institutional framework associated with a market economy (market institutional framework) principally underlies private ownership and market transactions (kornai, 1990; williamson, 1995). institutional theorists assert that the replacement of an institutional framework with a new one often occurs in three stages: dominance of the old framework, emergence of an interim framework with some elements of both frameworks, and finally prevalence of a new framework (benson, 1977; gerry, 2000; lachmann, 1979; north, 1990). we suggest transformation from bureaucratic control to the market institutional framework is likely to go through an interim (intermediate) stage, during which the formal rules associated with the centrally planned system weaken rapidly. the new market rules evolve slowly, forcing various constituents to rely on informal constraints (lachmann, 1979; mcmillan & woodruff, 2000; peng, 2003; peng & heath, 1996). the intermediate period therefore can be defined as the relational stage dominated by a relational institutional framework (peng, 2003). although one institutional framework is dominant in a particular stage, the three institutional 154 journal of business strategies frameworks tend to coexist during the transition process, and together constitute a larger societal institutional environment (benson, 1977; north, 1990). extant literature on transition economies documents the existence of three stages. the factors inherent in the bureaucratic control stage (i.e., state ownership, intervention, and redistribution) have been reported in various studies (e.g., andreff, 1999; king, 2001; kornai, 1990; mccarthy & puffer, 2003; stark, 1994; suhomlinova, 1999). andreff (1999) showed that in 1995, after six years of transition, the average state ownership in former socialist economies in central and eastern europe was 58 percent; among them the czech republic had the lowest level of state ownership (31%), and tajikistan and turkmenistan had the highest (85%). the existence of a relational stage is also well documented (e.g., king, 2001; mcmillan & woodruff, 2000; peng, 2003; peng & heath, 1996). these studies have demonstrated that widespread, relationship-based exchange tends to emerge systematically in transition economies due to the absence of formal, market-based laws and regulations. finally, some transition economies (e.g., those of the czech republic and poland) have now progressed to the late stage of transition as they now have an advanced market institutional framework (tihanyi & roath, 2002). we do not focus on the investigation of how transition economies progress. instead, we assume transition economies are committed to transforming to a market economy and are likely to go through the three stages we specify. we believe that bracketing the transition process into different stages with fairly distinct institutional trajectories is useful in examining the impact of institutions and institutional changes on corporate governance in transition economies. stages of corporate governance corporate governance can be thought of as a form of exchange as it provides an exchange structure for stakeholders (jensen & meckling, 1976; shleifer & vishny, 1997; williamson, 1985). literature indicates that different forms of corporate governance emerge in different stages of the transformation from centrally planned to market-based systems in transition economies (king, 2001; mcmillan & woodruff, 2000; peng, 2003). consistent with these transformation stages, there exist three forms of corporate governance, temporally including bureaucratic control-based, relational, and market-based forms. bureaucratic control-based corporate governance is characterized by hierarchical and bureaucratic structures and controls (boisot & child, 1988; eggertsson, 1990; kornai, 1990). for example, the state and its agencies directly control firms using bureaucratic regulations. relational govervolume 28, number 2 155 nance is the form of control in which stakeholders rely on informal constraints and self-enforcement (i.e., social relationships, social norms, and personal power) to create pressures and sanctions against opportunistic behaviors (mcmillan & woodruff, 2000; ouchi, 1979). market-based governance includes the market for corporate control and the managerial labor market described in mainstream governance literature (e.g., jensen, 1993; la porta, lopez de silanes, & shleifer, 1998; shleifer & vishny, 1997), and other mechanisms directly or indirectly based on market forces, formal rules, and third-party oversight and enforcement. the general model provides insights regarding societal or country-level corporate governance in transition economies. the message for firm-level governance is that privatized firms sequentially adopt bureaucratic control-based, relational, and rule-based governance as they move through the transition process. but firms are not likely to reach inflection points between the prevalent modes with the same speed because firms may be embedded in different institutional trajectories. in examining transition economies, therefore, we should identify which institutions have the most significant impact on corporate governance and their dynamics. institutions of corporate governance in transition economies to examine the impact of institutions on a focal issue, institutional theorists (e.g., hoffman, 1999; scott, 1995) recommend an “organizational field” perspective in setting the boundaries of institutions and constituents relevant to that issue. the corporate governance-based field consists of relevant stakeholders and institutions that impact governance, often referred to as institutions of corporate governance (e.g., garrod, 2000). major stakeholders include shareholders, managers, employees, customers, suppliers, and the state (prowse, 1995). significant institutions of corporate governance include formal constraints (legal, regulatory, and judicial systems), informal constraints (beliefs, norms, and routines), financial systems, product markets, managerial labor markets, and economic structures (jensen, 1993; la porta et al., 1998; prowse, 1995; mccarthy & puffer, 2003; roe, 1991; shleifer & vishny, 1997). we briefly review how those institutions influence governance and their dynamics during the transition process. legal, regulatory, and judicial systems provide legitimate power for stakeholders to pursue coercive enforcement of property rights, corporate law, and contracts (la porta et al., 1998). in the early stage, laws and regulations support state control and coordination of economic activities (boisot & child, 1988; king, 2001; kornai, 1990; stark, 1994). in the late stage, formal rules enforce property rights 156 journal of business strategies and market transactions (peng, 2003; williamson, 1995). in the intermediate stage, formal rules associated with both centrally planned and market-based systems are weak; so informal rules, private orders, and self-enforcement are typical. informal constraints exert social pressures and norms on stakeholders (mccarthy & puffer, 2003; ouchi, 1979). commonly shared informal norms and beliefs in the early stage (e.g., lack of appreciation of property rights, risk aversion, rule avoidance, and reliance on the state) are legacies of the former centrally planned system (kornai, 1990; peng & heath, 1996). in the late stage, actors are accustomed to an equity culture and formal rules (suhomlinova, 1999). the intermediate stage is characterized by norms and values that are relationship and network oriented (mcmillan & woodruff, 2000; peng & heath, 1996). financial systems include securities markets, banks, and other financial intermediaries. securities markets affect publicly listed firms by issuing listing requirements concerning governance and financial disclosure, assessing firm performance (through stock price changes), and creating a market for corporate control (takeovers [jensen, 1993]). banks and other financial intermediaries often serve as firm shareholders, so creditors, auditors, and analysts have a profound impact on corporate governance (berglof, 1995; mccarthy & puffer, 2003). product markets influence governance by exerting competitive pressure and bankruptcy threat on firms (jensen, 1993). labor markets influence governance by placing a value on managers’ and board members’ human capital (fama, 1980). financial systems, product markets, and managerial markets gradually develop along the transition process (less developed in the early stage and more so in the late stage). economic structures refer to the mix of various economic sectors, such as the public, private, and foreign sectors. private and foreign sectors account for an increasing portion of transition economies. the state-owned sector shrinks as transition unfolds (suhomlinova, 1999). changes in economic structures impact governance by affecting the degree of state intervention and the dominance of corporate governance practices associated with firms in different sectors (dharwadkar et al., 2000). table 1 summarizes the institutions in different stages of market transformation in transition economies. volume 28, number 2 157 table 1 institutions of corporate governance in transition economies institutions of corporate governance formal constraints (legal and judicial systems) early or bureaucratic control stage prevalence of administrative control-supporting institutions intermediate or relational stage lack of viable formal institutions late or market stage prevalence of rule, market based-supporting institutions informal constraints (norms, social pressures, expectations) associated with planned system lack of equity culture associated with social relationships and networks emerging equity culture associated with market system more developed equity culture financial system nascent securities markets banking system as state tool small, illiquid securities markets; underdeveloped banking system functioning securities markets; improved banking system product market unsophisticated demand, low competition low to medium competition medium to high competition managerial labor market nascent managerial labor market underdeveloped managerial market functioning managerial labor market economic structure dominant state ownership, increasing private ownership, small foreign ownership strong state intervention dominant private ownership, blurring ownership, decreased state ownership, increased foreign ownership medium state intervention dominant private ownership, sizable foreign ownership, small state ownership low state intervention we have specified three prevalent modes of corporate governance, their institutions, and their dynamics during the transition process. we now direct our focus to firm-level governance. in what follows, we examine factors that help determine when firms move from one stage of corporate governance to another. 158 journal of business strategies determinants of corporate governance modes the question of what determines how corporations are governed has been widely studied. agency theory, a dominant theme in governance research, proposes that the divergent interests of principals (shareholders) and agents (managers) make agency problems inevitable; and thus, the purpose of governance is to minimize agency costs (eisenhardt, 1989; jensen & meckling, 1976). resource dependence theory implies that corporate governance is structured to facilitate the acquisition of critical resources (hillman & dalziel, 2003; pfeffer & salancik, 1978). neo-institutional theorists argue that firms attempt to become isomorphic with their environment in order to obtain legitimacy, stability, and resources necessary for survival (dimaggio & powell, 1983; meyer & rowan, 1977). proponents of the political and social approaches to corporate governance change (e.g., davis & thompson, 1994; roe, 1991) argue that efficiency-oriented approaches (e.g., agency and resource dependence theories) fail to explain governance changes in a number of important situations (e.g., takeover barriers). they suggest stakeholders’ interests and power, which are politically determined, drive corporate governance (gouervitch, 2003), more for powerful stakeholders and less for weaker stakeholders (roe, 1991; seo & creed, 2002). drawing from these approaches, we suggest two major determinants of governance in transition economies: (1) the sources of control power stakeholders rely on to protect their interests in the firm, and (2) the origins or providers of resources stakeholders and their firm rely on for the firm’s survival and growth. stakeholders involved in a firm protect their interests, employing some form of power to prevent exploitation (fama, 1980; young et al., 2002). this power may come from various sources such as the stakeholders themselves, social networks and relationships, legal systems, and the market (jensen, 1993; ouchi, 1979). institutional changes arising from collective actions of one or more stakeholder classes or other exogenous factors may bring about a new dominant source of control power, changing the nature of governance (davis & thompson, 1994). in sum, the source of power stakeholders primarily rely upon to protect their interests helps determine the characteristics of that firm’s corporate governance. similarly, the dominant providers of resources strongly impact corporate governance. because of their interests in the firm, stakeholders are concerned about firm survival and growth. failure to access critical resources threatens firm survival and stakeholders’ interests. to acquire resources, a firm must establish links with primary providers of needed resources (pfeffer & salancik, 1978), and/or conform to volume 28, number 2 159 those providers’ expectations (dimaggio & powell, 1983; meyer & rowan, 1977). stakeholders and their firm likely adopt mechanisms that facilitate acquisition of needed resources (oliver, 1991). a particular provider of resources may require stakeholders and their firm to employ a particular mode of exchange and governance practices (suhomlinova, 1999). for instance, the divergence in corporate governance approaches in the u.s. versus japan is also based on the u.s. firms’ reliance on securities markets for capital, whereas firms in japan often obtain capital from their main bank (aoki, 1994). corporate governance change can be evolutionary and gradual or revolutionary and radical. evolutionary change occurs within a stage and within the context of an existing orientation or mode, whereas revolutionary change occurs at the points of inflection when one mode is abandoned in favor of another (greenwood & hinings, 1996; north, 1990). we suggest that within each stage or mode of governance, stakeholders rely on a particular dominant source of power, and their firms acquire resources from a particular dominant provider. within each stage, corporate governance undergoes evolutionary change through which stakeholders tailor their firm’s corporate governance in order to enhance their efficiency in employing control power and obtaining resources from existing dominant sources. when new sources of power and/or resources become more important to firms than the existing ones, stakeholders and their firms undertake revolutionary change in governance to accommodate the new dominant sources. as a result, firms shift their corporate governance from one mode to another. a number of japanese firms recently gave up their traditional relationships with their banks and turned to the securities markets for capital. they changed their corporate governance practices by providing more financial disclosure and changing their board structure (yoshikawa & phan, 2001). we posit that the shift from one mode of governance to another is motivated by changes in the dominant source of power, the origin of resources, or both. when governance stabilizes within a particular stage, the dominant sources of power and resources are likely to be the same. for example, when the market became the dominant source of capital for the previously mentioned japanese firms, the market tended to exert more control power over them than did their banks (yoshikawa & phan, 2001). the incompatibility of a firm’s dominant sources of control power and resources creates conflict in the firm’s corporate governance structure, triggering movement toward the convergence of these sources (seo & creed, 2002). 160 journal of business strategies proposition 1: in transition economies, changes in a firm’s dominant source of power and/or the origin of resources trigger the firm to shift from one mode of corporate governance to another. we next examine how institutions of governance and their dynamics during transition influence dominant sources of control power and resources, and thus determine which governance mode is effective in a particular stage and when a firm might shift from one prevalent mode to another. shifts in corporate governance modes during the market transition as described earlier, country-level corporate governance can be bracketed into three temporal stages: bureaucratic control-based, relational, and marketbased. generally, bureaucratic control-based governance is associated with state administrative power and state redistribution; relational governance is associated with control power and resources derived from networks and social relationships; and market-based governance involves control power and resources flowing from the market. during the institutional transformation process, the three institutional frameworks will to some extent coexist and be more or less prevalent at different stages. we suggest that in a particular stage, most firms adopt the correspondingly prevalent mode of governance, while others may adopt modes contingent on which institutional framework has the most impact on them in terms of resources and control power. not all firms will have the same combinations of sources of power and resources at a given point in time. nine possible combinations of three sources of control power (state, networks, and market) and three sources of factors of production (state, networks, and market) are shown in figure 1. of these, most of cell 3 (a combination of market power and state resources) and most of cell 7 (a combination of state power and market resources) are inconsistent with our assumption that transition states commit to market transformation; and they gradually phase out their micro-control over firms in order to facilitate market development. thus, the most likely combinations are within the shaded area in figure 1. lines t1 and t2 represent points of inflection at which a firm shifts from bureaucratic control-based to relational governance, and from relational to market-based governance, respectively. volume 28, number 2 161 figure 1 firm-level corporate governance during the market transition: combinations of sources of control power and resources, and the inflection points cell 1 cell 5 cell 9 cell 4 cell 8 cell 2 cell 3 cell 6 cell 7 state network market state network market source of control power sources of resources inflection point t 1 inflection point t 2 t 0 bureaucratic controlbased corporate governance relational corporate governance rule, marketbased corporate governance time 162 journal of business strategies the early stage: bureaucratic control-based governance in the early stage of transition, a state control-supporting institutional framework prevails. regardless of the transition approaches (shock therapy or gradualist), in the early stage, transition economies are still largely influenced by the legacies of the past centrally planned system, such as state control, state ownership, soft budgetary constraints, favorable contacts with the state, managerial risk aversion, and rule avoidance (boisot & child, 1988; king, 2001; kornai, 1990). laws and rules supporting market-based transactions are lacking or weakly enforced (williamson, 1995). economic actors are not accustomed to a culture based on equity and property rights (mcmillan & woodruff, 2000). the financial system that merely operated as the state budgetary unit in the old system is far from sophisticated enough to support a market economy (berglof, 1995; garrod, 2000). similarly, it takes time for product and labor markets, non-existent in planned economies, to function properly (peng & heath, 1996). therefore, in this stage the dominant sources of control power and resources of a firm are likely to be the state (the shaded area covering cell 1 and parts of cells 2 and 4 in figure 1). prior studies have demonstrated that transition states either have played or should play a major role in corporate governance in the early transition stage (e.g., mccarthy & puffer, 2003). transition economies’ privatization programs carried out using methods such as vouchers, employee/ manager buyouts, and auctions often resulted in concentrated groups of shareholders, such as the state or its designated agencies (e.g., national privatization funds and banks), employees, managers, and stakeholder shareholders (e.g., banks, suppliers, and customers). among them, the state, regardless of its ownership position in the firm, has the greatest power because of its residual bureaucratic control and redistributive powers (boisot & child, 1988; king, 2001; kornai, 1990). other shareholders’ power tends to be unbalanced. inside owner managers are typically central figures as they tend to leverage their positions and their ability to manipulate information in order to take control of their firms (dharwadkar et al., 2000; king, 2001). employee shareholders do not generally consider themselves owners of their firms (king, 2001; martin, 2002). outside shareholders find it difficult to monitor and discipline managers due to the absence of formal institutions of corporate governance, such as enforceable corporate laws, financial regulations, and market forces (berglof, 1995; garrod, 2000; king, 2001; martin, 2002). stakeholders have few alternatives but to rely on the state’s administrative power to protect their interests in the firm. the state also tends to be the dominant provider of resources due to residual state redistribution volume 28, number 2 163 practices (the collection, storage, and redistribution of goods and services by the state), the embeddedness of both the state and firms in such practices, and the inability of markets and informal networks to channel resources to firms (kornai, 1990; nee, 1992). the foregoing indicates that stakeholders should adopt bureaucratic controlbased mechanisms in the early stage to reduce agency problems and help their firms acquire needed resources from the state. evidence indicates that when states prepare adequately for the privatization of state-owned firms and maintain bureaucratic control in the early stage (e.g., china, poland, czech republic), agency problems are less rampant (king, 2001). otherwise, managers may loot firm assets and entrench themselves, resulting in severe agency problems (dharwadkar et al., 2000; martin, 2002). bureaucratic control-based governance has serious limitations, however, such as weak capability, corruption, and little motivation to monitor on the part of state officers (mccarthy & puffer, 2003; suhomlinova, 1999). the prevalence of this mode in the early stage is due less to its inherent effectiveness than to an absence of other modes of governance yet to come into effect. in sum, in the early stage, stakeholders and their firms should employ corporate governance mechanisms that help secure the state’s protection and resources. for example, board members from the state or its agencies, such as ministries and local governments, can help stakeholders to secure state administrative power to protect their interests and obtain firm resources from the state. stakeholders and their firms will also achieve these objectives by having state ownership, using debt from state-owned banks and financial institutions, and retaining membership in the state’s vertical hierarchical structures. thus: proposition 2: in the early stage of transition economies (cell 1 and a portion of cells 2 & 4), firms that are subject to state control-based corporate governance will attain better performance and a greater chance of survival than firms subject to relational or market-based corporate governance. the shift from bureaucratic control-based to relational corporate governance when truly committed to market-oriented reforms, transition states are expected over time to develop a market institutional framework and abandon bureaucratic control (williamson, 1995). toward the end of the early stage, the institutional framework supporting bureaucratic control will weaken, as will the state’s redistri164 journal of business strategies bution systems and administrative power over firms. meanwhile, institutions supporting market-based transactions are evolving but are still far from being capable of regulating economic transactions (mcmillan & woodruff, 2000). such institutional changes alter stakeholders’ dominant source of control power and the firms’ source of inputs, triggering the shift from bureaucratic control-based to relational governance. the weakening of state bureaucratic control and the absence of viable formal rules and third-party enforcement compel shareholders to create their own control power or seek control power from networks and relationships to protect their interests. powerless and unprotected employees and minority shareholders are likely to sell their positions to either managers or other powerful shareholders (king, 2001). incumbent managers use various tactics to accumulate ownership in their firms, and form alliances with state officials and other firms’ managers, further enhancing their power (dharwadkar et al., 2000; martin, 2002). large financial groups and investment funds emerge as powerful shareholders because of political connections and financial strength (mccarthy & puffer, 2003). firms are often controlled by small groups of blockholders with relatively equal power who, in the absence of formal legal constraints, tend to negotiate and establish informal, relational arrangements to prevent individual blockholders from engaging in opportunistic behaviors, thus driving firms to adopt relational corporate governance. toward the end of the early stage, state redistribution shrinks, forcing firms to form networks with suppliers, customers, and banks to obtain resources and dispose of outputs (king, 2001; peng & heath, 1996). due to mutually dependent relationships, firms often engage in cross-holdings and interlocking directorates to facilitate cooperation and safeguard interests (peng & heath, 1996). to obtain resources from networks, stakeholders and their firms are expected to shift from bureaucratic control-based to relational governance. they do so when they come to rely more on networks and social relationships to acquire power and resources than on the state (i.e., line t1 of figure 2). proposition 3.1: firms experience a point of inflection and transition from bureaucratic control-based to relational corporate governance when their dominant sources of power and resources change from those associated with the state to those associated with networks and relationships. not all firms likely experience this inflection point at the same time. in figure 1, we suggest that firms shift from bureaucratic control-based to relational govervolume 28, number 2 165 nance when they experience a diminution in state control power (as in cell 2 at t1), or a reduction in state resources (as in cell 4 at t1), or both (i.e., moving from cell 1 to cell 5). we suggest three primary reasons firms may confront the inflection point and the associated shift from one dominant source of control power and resources to another at different times. first, if firms are essential to state operations and economic and social stability, the state will likely maintain support and control over them (nee, 1992; suhomlinova, 1999); and the duration of the state’s role as the dominant source of control power and/or resources will be longer. examples are firms that are large, provide critical products and services, are major employers, and contribute significantly to state revenues. second, if firms and their stakeholders have the ability to influence the state politically, controlling ministries or state officers, they may shorten or lengthen the duration of state dominance to suit their interests (king, 2001; martin, 2002). for example, firms and their stakeholders may use political influence to obtain resources from the state for a period longer than would otherwise be warranted, or firms may manipulate the state to secure independence from state control sooner than would otherwise be the case. third, firms’ ability to operate without state control and resources also affects the time needed to reach the inflection point. for macro-economic and social stability reasons, the state is unlikely to abandon firms unable to operate and/or govern themselves independently (suhomlinova, 1999). on the other hand, firms that can stand by themselves may seek independence from state control sooner (king, 2001). firms’ ability to operate independently depends on the extent to which they were imbedded in former centrally planned systems and their ability and/or opportunity to acquire control power and/or resources from other sources (i.e., networks and social relationships). proposition 3.2: the more important a firm is to state operations and economic and social stability, the later it will confront the point of inflection from bureaucratic control-based to relational corporate governance. proposition 3.3: the relationship between a firm’s ability to influence the state and the length of time until it confronts the point of inflection from bureaucratic control-based to relational governance is moderated by the benefits of being associated with the state. proposition 3.4: the sooner a firm can operate independently, the earlier it will reach the point of inflection from bureaucratic controlbased to relational corporate governance. 166 journal of business strategies the intermediate stage: relational governance in the intermediate stage, the dominant sources of control power and resources are associated with networks and relationships (the shaded area covering cell 5 and parts of cells 2, 3, 4, 6, 7, and 8, bounded by lines t1 and t2 in figure 1). as they move away from the state’s coordination and redistribution system, firms become autonomous and must acquire inputs and dispose of outputs. a market institutional framework capable of providing needed market information and mechanisms to permit firms to trade with unknown parties has yet to emerge (mcmillan & woodruff, 2000; williamson, 1995); so firms rely on relationships with traditional customers, suppliers, and banks for resources in order to “muddle through the transition” (mccarthy & puffer, 1995). underdeveloped markets and a lack of legal infrastructure make resource acquisition from unknown parties costly or impossible (mcmillan & woodruff, 2000), forcing firms to establish and “internalize” transactions within networks (peng & heath, 1996). because firms are dependent on networks for resources, networks exert control power (pfeffer & salancik, 1978). without a viable legal infrastructure and state enforcement, stakeholders must form alliances and networks to create power to protect their interests (king, 2001; stark, 1994). at this stage, stakeholders and their firms likely rely on networks and relationships for control power and resources. relational governance mechanisms that can help stakeholders employ control power and acquire resources from networks and relationships include (1) multiple blockholders with equal power, (2) cross-holdings and interlocking directorates with shareholder stakeholders, and (3) borrowing from networks of stakeholders. multiple blockholders help prevent “principal-principal agency problems” occurring when legal protection of shareholders’ rights is weak. without a viable institutional framework, dominant shareholders may expropriate other shareholders’ wealth or manipulate the firm for their own purposes (young et al., 2002). multiple blockholders can suppress one another’s attempts to dominate and expropriate other shareholders’ wealth. because they have both ownership in and business relationships with the firm, stakeholder shareholders are motivated to monitor managers to protect their interests (stark, 1994). board membership helps stakeholder shareholders control managers and facilitates their relationships with the firm (aoki, 1994). similarly, borrowing from network members reduces cash flow managers might misallocate and enhances the network’s coordination and control over the firm (dharwadkar et al., 2000). volume 28, number 2 167 proposition 4: in the intermediate stage of transition economies, the firms that are subject to relational corporate governance will have higher performance and a greater chance of survival than firms that are subject to bureaucratic or market-based corporate governance. the shift from relational to market-based corporate governance toward the late stage, a market institutional framework is expected to take shape. formal rules (e.g., property rights, contract laws, and corporate laws) and state enforcement are more viable and can facilitate impersonal exchanges. financial systems (securities markets, banks, and financial intermediaries) are more sophisticated and can provide financial services for firms and investors (williamson, 1995). relational exchanges involve severe limitations for firms attempting to expand business activities beyond existing network boundaries (north, 1990; peng, 2003). relational transactions tend to create inefficiency, corruption, social unfairness, and disorder, so the state and its citizens will likely press for a more viable legal system and formal enforcement mechanisms to overcome the limitations of relational transactions (mccarthy & puffer, 2003; mcmillan & woodruff, 2000). following the formation of a market institutional framework, we expect firms will start obtaining resources from the market, and stakeholders will increasingly employ control power derived from the market (i.e., they will transition from cell 5 to cell 9, or across t2 in cells 6 and 8 as shown in figure 1). stakeholders’ and firms’ dominant providers of power and resources will shift from networks to the market, driving firms to the point of inflection between relational and market-based governance. as described earlier, firms form networks in the intermediate stage to obtain resources. in developed economies, firms network to create competitive advantage through long-term relationships (peng & heath, 1996). but in a transition economy, firms network mainly to survive and pursue stakeholders’ interests, especially managers’, rather than to obtain capabilities and achieve efficiency (king, 2001; mcmillan & woodruff, 2000). as product markets become increasingly competitive, firms must focus on building capabilities to survive and grow (peng, 2003). exchanges confined to a limited network may hinder firms’ efficiency and competitiveness. development of markets may make possible more efficient modes of exchange. firms extend their exchange relationships beyond their traditional networks when doing so increases profitability and capabilities. for example, firms may want to sell products to new customers, purchase from new suppliers, and obtain financing from new sources (suhomlinova, 1999). such inclinations precipitate a shift in the 168 journal of business strategies firms’ dominant sources of inputs as they move away from reliance on networks and toward the market. the firms’ dominant source of power also begins to shift from networks to the market. stakeholder shareholders may find alternative market exchange mechanisms more effective than direct ownership, and may be less interested in retaining ownership positions in, and business relationships with firms, thus loosening the networks and weakening their power over firms (yoshikawa & phan, 2001). new, more sophisticated investors will make investment decisions based on rational portfolio analysis rather than on relationships (belev, 2003). also, enhanced formal rules and enforcement bring more coercive power to bear on managers (la porta et al., 1998). finally, securities markets, the market for corporate control, and the managerial labor market take shape and start to exert their discipline on managers (belev, 2003). when the market becomes the dominant source of power and resources, firms will likely restructure corporate governance to accommodate that change. for example, firms are expected to become more transparent and provide more financial disclosure, install independent board members and blockholders (not necessarily stakeholder shareholders) to become cost-effective in monitoring managers, and use performance-based compensation to align managers’ and shareholders’ interests. in sum, the evolution of a market institutional framework facilitates a shift in the dominant sources of inputs and control power from networks to the market, driving the firm to the point of inflection from relational to market-based corporate governance. proposition 5.1: firms arrive at the point of inflection from relational to market-based corporate governance when their dominant sources of control power and resources change from those associated with networks and social relationships to those associated with the market. again, not all firms likely arrive at the same time. factors influencing the timing of the point of inflection include the rate of development of competition in a firm’s market, the effectiveness of the firm’s networks, and the extent to which the firm is imbedded in these networks. the development of market institutions and competition may vary across sectors and industries (suhomlinova, 1999). the earlier a firm confronts such institutional and market development, the earlier it will be under competitive pressure to focus on capabilities and competitive advantage, and the earlier it will access new opportunities brought about by market development. dominant sources of power and resources shift from networks to the market earlier. but the longer the firm’s networks help shareholders to maintain control power and the firm to acquire resources more effectively than the market does, the longer the volume 28, number 2 169 firm will postpone changing its corporate governance. sometimes firms are highly embedded in networks, and are operationally and/or financially locked into relationships with other network members, making it difficult to break out even when they experience network inefficiencies (yoshikawa & phan, 2001). thus: proposition 5.2: the sooner firms are influenced by market institutions and competition, the earlier they reach the point of inflection from relational to market-based governance. proposition 5.3: the more effective firms’ networks are in helping the firms and their stakeholders to acquire control power and resources, the later they reach the point of inflection from relational to marketbased corporate governance. proposition 5.4: the more firms are imbedded in their networks, the later they reach the point of inflection from relational to market-based corporate governance. the late stage: rule-based governance as described earlier, when transition economies advance to the late stage, a market institutional framework becomes dominant. the firm and its stakeholders tend to rely on the market for control power and resources, and thus market-based corporate governance becomes effective (cell 9 and a portion of cells 6 and 8 on the right of line t2 in figure 1). transition economies may take somewhat different paths and progress toward market economies with some degree of divergence (martin, 2002). as a result, their corporate governance systems may have distinct features such as ownership-diffused or ownership-concentrated systems, insideror outsideroriented systems, and/or securities market-based or bank-based systems (prowse, 1995). despite the potential for divergence, we argue that their governance will be largely based on formal rules and market forces. for example, german stakeholderoriented governance and american market-based governance are both built on a nexus of laws, regulations and formal enforcement mechanisms, rather than informal rules or state bureaucratic control. we consider governance mechanisms largely enforced by formal laws and subject to market discipline to represent rule, market-based governance. williamson (1985) contends that most exchanges in developed economies are realized through “private orders,” which in turn can be enforced by formal laws. some frequently observed rule, market-based corporate governance mechanisms (e.g., blockholders, 170 journal of business strategies the market for corporate control, the managerial labor market, independent outside board members, and outcome-based compensation schemes) are likely to be effective in the late stage in transition economies, regardless of the path taken (fama, 1980; jensen, 1993; kroll, wright, toombs, & leavell, 1997; prowse, 1995; shleifer & vishny, 1997). proposition 6: in the late stage of transition characterized by the prevalence of a market institutional framework, firms that are subject to rule, market-based corporate governance will have higher performance than firms subject to bureaucratic or relational corporate governance. discussion, implications, and limitations we assume transition states are committed to the transformation of their economies, and that the transformation process can be bracketed into early, intermediate, and late stages with the prevalence of state bureaucratic control, relational, and market institutional frameworks, respectively. these institutional frameworks imply the dominance of bureaucratic control-based, relational, and market-based corporate governance, temporally. based on the general direction of country-level corporate governance, we examine firm-level corporate governance in transition economies. we argue that two major determinants of firm-level corporate governance in transition economies are stakeholders’ sources of control power and firms’ origins of resources. in the early stage, the dominant sources of control power and resources are the state; and thus, bureaucratic control-based corporate governance tends to be effective. when the relational institutional framework has greater influence on firms than does the bureaucratic control framework, the firms’ dominant sources of control power and resources shift from the state to networks and relationships, driving firms to the point of inflection from bureaucratic control-based to relational corporate governance. firms’ role in their economies, ability to influence the state, and ability to operate independent of the state determine the length of time they take to reach the inflection point from bureaucratic control-based to relational corporate governance. during the intermediate stage, stakeholders and their firms likely employ control power and acquire resources from networks and relationships, and relational corporate governance is effective. as the transition progresses, a market-based institutional framework begins exerting more influence on firms than does the relational framework. accordingly, the firms’ dominant sources of control power and resources shift from networks and relationships to the market, driving firms to the point of volume 28, number 2 171 inflection from relational to rule, market-based governance. the time it takes for firms to reach the second point of inflection depends on such factors as the impact of market institutions and competition, the effectiveness of networks and relationships, and the degree of network imbeddedness. in the late stage, because a market institutional framework prevails, rule, market-based governance mechanisms become most effective. our paper offers several contributions and implications. first, we extend the corporate governance literature on transition economies (e.g., andreff, 1999; aoki, 1994; berglof, 1995; dharwadkar et al., 2000; wright et al., 2003; young et al., 2002) by providing a longitudinal, contingency view of governance. we argue that, given the rapid and comprehensive institutional changes that occur in transition economies, institutional frameworks vary from stage to stage, along with corporate governance. we submit that the most effective and thus the most prevalent mode of governance shifts, temporally, from bureaucratic control-based to relational and from relational to market-based corporate governance. we believe our model not only enhances our understanding of the evolution of governance in transition economies but also has implications for future research in this field. governance studies in transition economies could specify the transition stage to which they seek to generalize and examine. when conducting cross-sectional studies involving a number of transition economies, it is important to ensure that those economies are in the same stage of transition. when testing the explanatory power of theories established in developed economies in the transitional context, one should examine whether their underlying foundations exist in transition economies. for instance, theories premised on market institutions (e.g., the effectiveness of independent outside directors or a well-functioning managerial labor market) are not likely to hold in the early or intermediate transition stages. second, we provide insight into the dynamics of macro-institutions and their impact on changes in corporate governance. prior studies have paid less attention to institutions’ role in corporate governance (gouervitch, 2003). as described previously, we propose two major determinants (source of power and origin of resources) linking institutions and institutional changes to the effectiveness of, and changes in corporate governance. we draw from agency, resource dependence, and institutional theories, as well as the social and political perspectives of corporate governance, to explain the effects of institutions and institutional changes on these determinants, and in turn on the effectiveness of governance during transition. in the context of rapid institutional change, corporate governance is driven by various forces and should be explained using multiple perspectives. future studies could adopt other 172 journal of business strategies perspectives, such as ecology and neo-institutional theories, to identify potential forces and mechanisms that link macro-institutions with the evolution of transition corporate governance. third, we offer insight into which mode and related governance mechanism is likely effective at a given stage and when a firm is likely to shift from one mode of governance to another. these insights have practical implications for policy-makers and stakeholders in transition economies as they structure their firms’ corporate governance in various transition stages. for example, states in transition should take into account institutional developments in order to implement relevant policies concerning governance. the washington consensus approach of rapid elimination of state administrative control proved ineffective (martin, 2002). requiring firms to have independent directors in early or intermediate stages when managerial labor markets are still quiescent is likely ineffective (peng, 2004). at the firm level, our paper implies that stakeholders in transition economies should consider the dominant sources of control power and resources in structuring firms’ corporate governance during and across various stages. our paper also has limitations. our model is based on the assumption that states in transition commit to market reforms, and thus the transition process tends to move through the three stages. this assumption is consistent with evidence documented in the extant literature on transition economies (e.g., andreff, 1999; king, 2001; kornai, 1990; mccarthy & puffer, 2003; stark, 1994; suhomlinova, 1999) and with the economics perspective of institutional theory concerning institutional change (e.g., eggertsson, 1990; gerry, 2000; greenwood & hinings, 1996; north, 1990). market transformation in some transition economies may be inconsistent with our assumption due to state ideologies (e.g., retaining socialism) or political and social crises (e.g., state malfunctioning and social disorder). also, because of the scope and purpose of our paper, we only focus on examining the impact of macro-institutions on governance and do not assess the role of stakeholders and their firms as change agents of macro-institutions. finally, other types of firms such as private start-ups and foreign-owned firms play increasingly important roles in transition economies (peng & heath, 1996), and our model applies primarily to privatized firms. references andreff, w. (1999). privatization and corporate governance in transition countries: quantitative success and qualitative failure. management international, 4, 11-30. aoki, m. h. (1994). the contingent governance of teams: analysis of institutional complementary. international economic review, 35, 657-676. volume 28, number 2 173 benson, j. k. (1977). organizations: a dialectic view. administrative science quarterly, 22, 1-21. belev, b. (2003). institutional investors in bulgarian corporate governance reform: obstacles or facilitators? journal of world business, 38, 361-374. berglof, e. (1995). corporate governance in transitional economies: the theory and its policy implications in m. aoki and h. k. kim, (eds.), corporate governance in transitional economies: insider control and the role of banks. washington: the world bank, pp. 59-98. boisot, m., & child, j. (1988). the iron law of fiefs: bureaucratic failure and the problem of governance in the chinese economic reforms. administrative science quarterly, 33, 507-527. buck, t., filatotchev, i., demina, n. , & wright, m. (2003). insider ownership, human resource strategies and performance in a transition economy. journal of international business studies, 34, 530-549. davis, g. f., & thompson, t. r. (1994). a social movement perspective on corporate control. administrative science quarterly, 39, 141-173. dharwadkar, r., george, g., & brandes, p. (2000). privatization in emerging economies: an agency theory perspective. academy of management review, 25, 650669. dimaggio, p. j., & powell, w. w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48, 147-160. eggertsson, t. (1990). economic behavior and institutions. new york: cambridge university press. eisenhardt, k. m. (1989). agency theory: an assessment and review. academy of management review, 14, 57-75. estrin, s., & angelucci, m. (2003). ownership, competition and enterprise performance. comparative economic studies, 45, 173-188. fama, e. f. (1980). agency problems and the theory of the firm. journal of political economy, 88, 288-307. garrod, n. (2000). environmental contingencies and sustainable modes of corporate governance. journal of accounting and public policy, 19, 237-261. gerry, j. (2000). microprocesses of institutional change in the context of privatization, academy of management review, 25, 572-581. gouervitch, p. a. (2003). the politics of corporate governance regulation. the yale law journal, 112, 1829-1880. 174 journal of business strategies greenwood, r., & hinings, c. r. (1996). understanding radical organizational change: bringing together the old and the new institutionalism. academy of management review, 21, 1022-1055. hillman, a. j., & dalziel, t. (2003). boards of directors and firm performance: integrating agency and resource dependence perspectives. academy of management review, 28, 383-396. hoffman, a. j. (1999). institutional evolution and change: environmentalism and the u.s. chemical industry. academy of management journal, 42, 351-371. hoskisson, r. e., eden, l., lau, c. m., & wright, m. (2000). strategy in emerging economies. academy of management journal, 43, 249-267. jensen, m. c. (1993). the modern industrial revolution, exit, and the failure of internal control systems. the journal of finance, 48, 831-880. jensen, m. c., & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3, 305360. judge, w. q., naoumova, i., & koutzevol, n. (2003). corporate governance and firm performance in russia: an empirical study. journal of world business, 38, 385-396. king, l. p. (2001). the basic features of postcommunist capitalism in eastern europe: firms in hungary, the czech republic, and slovakia, westport, ct: praeger kornai, j. (1990). the road to a free economy. new york: norton. kroll, m. j., wright, p., toombs, l. a., & leavell, h. (1997). form of control: critical determinant of acquisition performance and ceo rewards. strategic management journal, 18, 85-96. la porta, r., lopez de silanes, f., & shleifer, a. (1998). corporate ownership around the world. journal of finance, 54, 471-517. lachmann, l. (1979) the flow of legislation and the permanence of the legal order in don lavoie (ed.) expectations and the meaning of institutions, essays in economics by ludwig lachmann. london: routledge. le, s., kroll, m., & walters, b. (2010). the impact of institutional changes on corporate governance mechanisms in transition economies. journal of management and governance, 14, 91-114. martin, r. (2002). politicized managerial capitalism: enterprise structures in postsocialist central and eastern europe. journal of management studies, 39, 823840. meyer, j. w., & rowan, r. (1977). institutional organizations: formal structure as myth and ceremony. american journal of sociology, 83, 440-463. volume 28, number 2 175 mccarthy, d., & puffer, s. (1995). diamonds and rust on russia’s road to privatization. journal of world business, 30: 56-69. mccarthy, d., & puffer, s. (2003). corporate governance in russia: a framework for analysis. journal of world business, 38, 397-416. mcmillan, j., & woodruff, c. (2000). private order under dysfunctional public order. michigan law review, 98, 2421-2458. nee, v. (1992). organizational dynamics of market transition: hybrid forms, property rights, and mixed economy in china. administrative science quarterly, 37, 1-27 north, d. c. (1990). institutions, institutional change and economic performance. cambridge, ma: harvard university press. oliver, c. (1991). strategic responses to institutional processes. academy of management review. 16, 145-179. ouchi, w. g. (1979). a conceptual framework for the design of organizational control mechanisms. management science, 25, 833-848. peng, m. w. (2003). institutional transitions and strategic choices. academy of management review, 28, 275-296. peng, m. w. (2004). outside directors and firm performance during institutional transitions. strategic management journal, 25, 453-471. peng, m. w., & heath, p. s. (1996). the growth of the firm in planned economies in transition: institutions, organizations, and strategic choice. academy of management review, 21, 492-528. pfeffer, j., & salancik, g. (1978). the external control of organizations: a resource dependence perspective. new york: harper and row. prowse, s. (1995). corporate governance in an international perspective: a survey of corporate control mechanisms among large firms in the united states, the united kingdom, japan and germany. blackwell, ma: cambridge. roe, m. j. (1991). a political theory of american corporate finance. columbia law review, 91, 1-67. seo, m., & creed, d. (2002). institutional contradictions, praxis, and institutional change: a dialectical perspective. academy of management review, 27, 222248. scott, w. r. (1995). institutions and organizations. london: sage. shleifer, a., & vishny, r. (1997). a survey of corporate governance. journal of finance, 52, 737-783. stark, d. (1994). recombinant property in east european capitalism. american journal of sociology, 101, 993-1027. 176 journal of business strategies suhomlinova, o. o. (1999). constructive destruction: transformation of russian state-owned construction enterprises during market transition. organization studies, 20, 451-483. tihanyi, l., & roath, a. s. (2002). technology transfer and institutional development in central and eastern europe. journal of world business, 37, 188-199. williamson, o. e. (1985). the economic institutions of capitalism: firms, markets, relational contracting. new york: the free press. williamson, o. e. (1995). the institutions and governance of economic development and reform. proceedings of the world bank annual conference on development economics 1994 (pp. 171-197). washington: world bank. world bank, (2002). world development report: building institutions for markets. washington: world bank. wright, m., filatotchev, i., buck, t., & bishop, k. (2003). is stakeholder corporate governance appropriate in russia? journal of management and governance, 7, 263-290. yoshikawa, t., & phan, p. h. (2001). alternative corporate governance systems in japanese firms: implications for a shift to stockholder-centered corporate governance, asia pacific journal of management, 18, 183-205. young, m., peng, m. w., ahlstrom, d., & bruton, g. d. (2002). governing the corporation in emerging economies: a principal-principal perspective. academy of management best paper proceedings. biographical sketches of authors son a. le is the john ed barnes endowed professorship in entrepreneurship at louisiana tech university. he received his d.b.a. from louisiana tech university. his research interests include entrepreneurship, corporate governance issues and strategies in entrepreneurial contexts and emerging economies. mark kroll is the dean of the school of business at the university of texas at brownsville and texas southmost college. he received his d.b.a. from mississippi state university. his research interests include firm governance and strategic leadership of entrepreneurial firms. bruce a. walters is the edward l. moyers endowed professor of management at louisiana tech university. he received his ph.d. from the university of texas at arlington. his current research interests include competitive advantage in dynamic environments, top executive characteristics, corporate governance, strategic decision processes, and business ethics. stages of corporate governance in transition economies academic journal ranking: important to strategic management and general management researchers? robert p. yuyuenyongwatana cameron university • lawton, ok shawn m. carraher cameron university • lawton, ok abstract this study explores two questions pertaining to research publications: the importance of publications, and the perceived ranking of strategic and general management journals. the reasons why research publishing is important are 1) it is part of the pursuit of knowledge, 2) it has extrinsic rewards to those publishing, and 3) it may increase the prestige of the institution with which the publishing faculty is affiliated. on the second question, the authors have conducted a survey of perceived journal rankings. the results from 50 journals suggest that there is a consensus of rankings. as such, an institution may reasonably use these rankings as a basis for evaluations of research quality. areas for future research are suggested. introduction the academic world places strong emphasis in research and subsequent publications of their findings. the field of management is no exception. why are research publications important? how important is the concept of journal ranking publishing academicians? this paper attempts to answer these two questions for strategic management and general management subspecialties. research is important to academic pursuit. demski and zimmerman (2000) suggested five reasons for research activities. first, research leads to "compression" of observed phenomenon into compact ideas, in order to better understand the world, and still retain key information. second, research creates "intensive social process," (p. 345) for it encourages debates of ideas, critiques each other's work, and other social interactions necessary in academic processes. third, academicians produce relatively few significant publications resulting in concentrated published works by a few notable authors. finally, research makes better teaching. it forces critical thinking. professors who do research and publish are often thought of as offering high standards in teaching and, therefore, may be better teachers. j publication productivity is often used as part of tenure, promotion, and faculty merit pay considerations. park and gordon (1996) found that in the field of 2 journal of business strategies strategic management, that at institutions with graduate programs in management, the average publication rate of faculty who received tenure was five journal articles, while the average publication record of those not receiving tenure was two journal articles. 2 gomez-mejia and balkin (1992) surveyed a sample of 352 management professors and found the most significant determinant of faculty pay levels at both doctorate and non-doctorate degree granting institutions was publications in toptier journals. as for merit awards, manning and barrette (2005) report that the school of business at the university of ottawa, canada, created a system in order to classify management journals in to a, b, and c categories (i.e., a-level journals being the highest, most prestigious, category) based upon the citation rates of articles published in the journals. faculty who published in a, b, and c-ievel journals would receive c$8,000, c$6,000, and c$3,000, respectively. the university also included "notabc" and practitioner categories for journals which were not eligible for the reward program. vikas, lawrence, and murshed (2008) used a sample of 298 marketing professors from 33 research-oriented public universities and found research productivity to have a positive impact on average annual salary among marketing faculty, confirming similar findings in other disciplines. specifically, they found that publication in a tier i marketing journal would add $2,176.25 to one's average annual salary, while publishing in a tier 2 journal would add $1,777.95 to one's average annual salary, and publishing a tier 3 journal would add $124.85. this compares well to the previously mentioned study by gomez-mejia and balkin (1992) where they found that in management a top tier publication would add $1,210 to one's average annual salary [in 1988 dollars] while publications in other journals did not increase average faculty salaries. research publications may also bring prestige and status to an institution (manning & barrette, 2005). reputable institutions, especially research oriented ones, often require that their faculty publish in top-tier journals. the publishing requirements further foster and enhance the prestige of these universities (kirkpatrick & locke, 1992). for instance, fogarty and ravencroft (1999) examined a population of accounting phds between 1986 and 1996. they found a strong relationship between the willingness of faculty to publish and the status of an institution. siemens, burton, jensen, and mendoza (2005) examined the relationship between top-tier business journals and university rankings conducted by us. news & world report between 1986 and 1998. they found that research productivity was significantly related to program rankings for the undergraduate business school by the us. news & world report. additionally, long, bowers, barnett, and white (1998) found a volume 25, number 2 3 strong relationship between research productivity [as measured by the number of publications in top-tier journals and citation counts] and institutional status. in order to increase the status of a university it is imperative that faculty publish more in top quality journals (long, et ai., 1998; manning & barrette, 2005). the above reasons make a strong case for the importance of publications. many benefits accrue to publishing in top-tier journals including promotions, tenure, possible merit raises, and increased organizational status. due to these issues many institutions engage in identifying and ranking journals in the business disciplines (chrisman, chua, kellermanns, matherne, & debicki, 2008; katz, 2003, 2008; kuratko, 2005; manning & barrette, 2005). therefore, in the current study, we examine the ranking of general management journals by faculty members from a wide spectrum of american universities. methodology the data used in this analysis was collected from a survey in which each participant was asked to rank each of 50 management journals using a likert-like scale from i (not top tier) to 9 (top tier). the data was collected at three management related conferences in 2008: the academy of management, small business institute®, and united states association for small business & entrepreneurship. of 700 conference participants sampled, 250 responses are deemed useful to be included in the study. all respondents are subjected to strict anonymity. on average 78% of the respondents were male, 55.8% were professors, was 55 years of age, had been teaching for 22.7 years and had 26.25 journal and .69 book publications. this study selected and ranked 50 journals that are closely related to strategic and general management. a mean rating scale was calculated for each journal utilizing a 9-point scale ranging from "top tier" (9) to "not top tier" (1). using this mean rating scale, the journals are then ranked with number one with the highest mean rating scale to number fifty with the lowest mean. the study also includes quartile calculation as an alternate way of looking at a journal standing in relation to group ranking (for example, bottom 25%, median, and top 25%). results and discussions table i shows the results of the survey. it reports listing of the 50 journals, their rankings, means, and standard deviations. table 2 shows quartiles of the means. for example, the results of the survey indicate a 12th ranking for the journal of business strategies (jbs). table 2 shows that jbs is in the top quartile ofjournals 4 journal of business strategies table 1 journal ranking of 50 management journals journal title ranking mean std. dev. quartile academy of management journal 1 8.75 .672 1 journal of applied psychology 2 8.69 .799 1 academy of management review 3 8.60 .891 1 strategic management journal 4 8.22 .980 1 management science 5 7.91 .774 1 journal of international business studies 6 7.73 1.448 1 journal of management 7 7.13 .838 1 administrative science quarterly 8 6.84 2.373 1 organization science 9 6.23 1.524 1 international journal of family business 10 5.79 2.323 1 case research journal 11 5.76 1.453 1 journal of business strategies 12 5.67 2.001 1 aom learning & education 13 5.61 1.623 1 journal of management history 14 5.57 2.553 2 aom perspectives 15 5.46 1.394 2 journal of management studies 16 5.33 1.311 2 public administration quarterly 17 5.22 1.983 2 california management review 18 5.22 2.289 2 international journal of sustainable 19 5.15 1.447 2 strategic management personnel review 20 5.15 1.969 2 journal of international entrepreneurship 21 4.92 1.872 2 international journal of production research 22 4.92 1.757 2 international journal of information technology 23 4.87 1.269 2 and management journal of international business 24 4.85 1.968 2 and entrepreneurship journal of technology management in china 25 4.66 1.986 2 organizational dynamics 26 4.66 2.332 3 management decision 27 4.65 1.476 3 international journal of technological innovation 28 4.64 1.301 3 and entrepreneurship baltic journal of management 29 4.61 2.261 3 international journal of entrepreneurship 30 4.60 1.376 3 journal of managerial issues 31 4.54 1.424 3 journal of strategic information systems 32 4.41 1.525 3 volume 25, number 2 5 organization studies 33 4.37 1.357 3 cornell hotel and restaurant administration 34 4.17 2.122 3 quarterly journal of international business 35 4.15 1.196 3 and enterprise development personnel 36 4.08 2.187 3 business horizons 37 3.98 1.971 3 international journal of entrepreneurship 38 3.87 1.455 3 development, education & training journal of asia entrepreneurship and sustainability 39 3.76 1.212 4 management studies 40 3.61 1.286 4 planning review 41 3.59 2.073 4 long range planning 42 3.57 1.731 4 international indigenous journal of 43 3.48 1.594 4 entrepreneurship advancement, strategy, & education small business and enterprise development 44 3.47 1.243 4 journal of enterprising culture 45 3.38 1.712 4 asian journal of business & entrepreneurship 46 3.27 1.242 4 international journal of commerce 47 3.16 1.544 4 and management public personnel management 48 3.07 .848 4 business journal for entrepreneurs quarterly 49 2.76 .893 4 central business journal 50 2.63 1.186 4 table 2 quartiles of the mean ratings maximum 8:75 quartile 75% (top 13 journals) 5.61 quartile 50% (median) 4.66 quartile 25% (bottom 12 journals) 3.87 minimum 2.63 an appropriate ranking in consideration of its 25 years of publishing quality research articles. of the 50 journals evaluated in this analysis the respondents ranked the academy of management journal as the number one journal (mean of 8.75 and standard deviation of 0.67). for the fifty journals the standard deviations ranged from 0.67 to 2.55 with an average standard deviation being 1.56. the rankings ofthe fifty journals show very little deviation, implying that there is more of a consensus of the rankings among the respondents. 6 conclusions journal of business strategies this study explores the two questions pertaining to research publications: the importance of publications and the perceived ranking of strategic and general management journals. the reasons why research publishing is important include 1) it is an important part of the pursuit of knowledge, 2) it has extrinsic rewards to those who are publishing [they typically earn more money], and 3) it increases the status and prestige of the institution with which the authors are affiliated. on the second question, the authors have conducted a survey of perceived journal rankings. the results of these 50 journals suggest that there is a consensus of rankings. as such, an institution may reasonably use these rankings as a basis for evaluations of research quality in management. future researchers could expand the sample size of respondents and journals in order to fully represent the spectrum of publishing outlets for business researchers (sturman & carraher, 2007). greater numbers of journals in all areas of management should be included, as well as journals from other areas of business. as jbs also publishes articles in other disciplines within business, we believe that the current findings likely underestimate the ranking of the journal across the business disciplines. finally, a survey should include questions that would explore reasons as to why a respondent would rank a particular journal at the level that they would rank it, how important the rankings are to him or her, and also seek to examine if prior publication experiences with journals have influenced respondents' impressions of the journals. we congratulate jbs on the publication ofthe 50th issue and look forward to the journal's continued rise in the future. end notes 1. tanner and manakyan (1992) found no significant link between teaching performance and research activity. the two variables are independent of one another. 2. they also found that institutions without graduate program tended to consider service and teaching to be more important to a decision to grant tenure. references chrisman, 1. 1., chua, 1. h., kellermanns, f. w., matherne iii, c. f., & debicki, b. 1. (2008). management journals as venues for publication of family business research. entrepreneurship theory and practice, 32(5),927-934. volume 25, number 2 7 davis,1. c., huston, 1. h., & patterson, d. m. (2001). the scholarly output of economists: a description of publishing patterns. american economic journal, 29(3), 341-349. demski, 1. s., & zimmerman, 1. l. (2000). on "research vs. teaching": a long-term perspective. accounting horizons, 14(3), 343-352. fogarty, t .1., & ravencroft, s. p. (1999). the importance of being "wordy": willingness to write and publication productivity among accounting academics. accounting education, 8(3), 187-202. gomez-mejia, l. r., & balkin, d. b. (1992). determinants of faculty pay: an agency theory perspective. academy ofmanagement journal, 35(5),921-955. katz, 1. (2003). the chronology and intellectual trajectory of american entrepreneurship education 1876-1999. journal ofbusiness venturing, 18, 283-300. katz, 1. (2008). fully mature but not fully legitimate: a different perspective on the state of entrepreneurship education. journal of small business management, 46(4), 550-566. kirkpatrick, s. a., & locke, e. a. (1992). the development of measures of faculty scholarship. group and organization management, 17, 5-23. kuratko, d. f. (2005). the emergence of entrepreneurship education: development, trends, and challenges. entrepreneurship theory & practice, 29(5), 577-597. long, r. g., bowers, w. p., barnett, t., & white, m. c. (1998). research productivity of graduates in management: effects of academic origin and academic affiliation. academy ofmanagement journal, 41(6), 704-714. manning, l. m., & barrette, 1. (2005). research performance management in academe. canadian journal ofadministrative sciences, 22(4),273-287. park, s. h., & gordon, m. e. (1996). publication records and tenure decisions in the field of strategic management. strategic management journal, 17(2), 109-128. siemens, 1. c., burton, s., jensen, t., & mendoza, n. a. (2005). an examination of the relationship between research productivity in prestigious business journals and popular business school rankings. journal of business research, 58(4), 467-476. sturman, m., & carraher, s. (2007). using a random-effects model to test differing conceptualizations of multidimensional constructs. organizational research methods, 10(1), 108-135. tanner, 1. r., & manakyan, h. (1992). management-faculty research productivity and perceived teaching effectiveness. journal ofeducation for business, 67(5), 261-265. vikas, m., feick, l., & murshed, f. (2008). publish and prosper: the financial impact of publishing by marketing faculty. marketing science, 27(3), 430-442. 8 biographical sketches of authors journal of business strategies robert yuyungyongwatana received his ph.d. in finance from north texas state university. he is professor of finance at cameron university. his recent publications have appeared in the international journal offamily business, global finance journal, journal ofderivatives, and the midwestern business and economic review. shawn m. carraher received his ph.d. in business administration from the university of oklahoma. he is the virginia brewczynski endowed chair and director of the small business institute® at cameron university. he has published over 100 journal articles and his most recent publications having appeared in the journal ofapplied psychology, organizational research methods, journal ofinternational business studies, journal ofapplied management and entrepreneurship, and the journal of business strategies. his research focuses on a variety of international entrepreneurship topics in the health care and tourism industries. academic journal ranking: important to strategic management and general management researchers? considering customer loyalty in developing service recovery strategies tina l. robbins & janis l. miller clemson university clemson, sc abstract customer loyalty has been an often suggested and supported consequence (~f effective service recovery manakement. we predicted that customer loyalty would also play an antecedent role in the recovery process by interacting with perceived unfairness in influencing subsequent reactions. we found that perceptions of both distributive and procedural./airness in recovery management had more significant influences on reactions by loyal customers. furthermore, the eflectiveness ofservice recovery had the strongest influence on loyal customers. implications ./br service recovery strategies are discussed. substantial evidence (e.g., tax & brown, 1998) supports the importance of effectiveness in the management of service recovery. service recovery has been defined (johnston and hewa, 1997) as the "actions of a service provider to mitigate and/or repair the damage to a customer that results from the provider's failure to deliver service as it is designed" (p. 467). examples offailures (bitner, booms, & tetreault, 1990) include unavailable service, unreasonably slow service and other core service problems (e.g., hotel room not clean, restaurant meal is cold, baggage arrives damaged, etc.). some studies (see dube and maute [1996] for areview) suggest that over half of brand switching in services is attributable to service failures and poor management of recovery. given the high costs (e.g., loss of both current and potential customers due to negative communications and poor reputation) associated with poor recovery, managers have begun to take steps to mitigate the negative consequences associated with failures in service firm-customer exchanges. much of the research on reactions in exchange relationships points to the importance of perceived fairness by parties to the exchange. a vast amount of literature (see greenberg [1990] for a review) suggests that perceptions offairness in exchanges with management are significant predictors of employee workplace attitudes and behaviors. past research has also established that attitudes about fairness are useful for analyzing and understanding customers' evaluations of services in their exchanges with providers. it has been suggested (berry, 1995) that customers' perceptions of fairness are inseparable from, and captured in all dimensions of service quality. 96 journal of business strategies vol. 21, no.2 equity or justice theory has also been used to explain reactions to specific experiences and conflicts in various (e.g., organization-employee, manager-employee, legal authority-citizen, parent-child) exchange relationships (folger & konovsky, 1989; tyler, 1989; tyler, 1994). more specifically, this framework has been useful for understanding customer reactions to service failures and subsequent recovery management (e.g., blodgett, hill & tax, 1997; hoffman & kelley, 2000; miller, craighead & karwan, 2000; tax, brown, & chandrashekaran, 1998). customer perceptions of distributive (outcomes and remedies offered), and procedural (policies used and followed in the process as well as interpersonal treatment of the customer) fairness in recovery management have been found to significantly influence customers' attitudes (trust and commitment) as well as behavioral intentions (repatronage, negative word-of-mouth) following the service failure (e.g., blodgett, et ai., 1997; tax, et ai, 1998). customer loyalty has been studied extensively in the management and marketing literatures and its benefits and link to profitability have been well established (see curasi and kennedy [2002] and rundle-thiele & mackay [200 1] for reviews). some studies (e.g., de ruyter & wetzels, 2000; johnston & hewa, 1997; tax & brown, 1998) have analyzed customer loyalty as a consequence of successful service recovery strategies. our purpose in this study is to analyze the potential for customer loyalty to play an antecedent role in service recovery by interacting with perceptions of unfairness to influence post-failure reactions. establishing customer loyalty as a significant antecedent to perceptions, attitudes and reactions to service recovery would have important implications for managers in devising strategies that minimize the costs associated with such failures. for example, recovery strategies might need to be contingent on how much the company may lose, given the significant relationship between customer loyalty and profitability (e.g., reichheld, 1996; reichheld & sasser, 1990; tax & brown, 1998). customer loyalty and fairness in service recovery social psychologists have determined that the processes, perceptions, judgments, and attributions that customers typically use to evaluate services are likely to be influenced by the degree of personalization or the type of relationship between the parties involved (goodwin & gremler, 1996). for example, interviews with both customers and service providers suggest that customer loyalty influences how quality is defined and what type of service delivery is preferred and appropriate. in service exchanges, loyal customers are likely to perceive their relationship with the service provider differently than those who are first-time or very infrequent patrons. exchange relationships may range from purely economic and transactional in nature to more social, relational or communal (blau, 1964; clark & mills, 1993; rousseau & parks, 1993). we believe relationships between loyal customers and service providers are more characteristic of social exchange and loyal customers are more likely to perceive their "psychological" contract with the service provider as relational since trust, loyalty and commitment form the basis for these relationships (konovsky fall 2004 rohhins & miller: considering customer loyalty 97 & pugh, 1994; rousseau & parks, 1993). with a more relational, as opposed to resource-based motive for justice (tyler, 1994), loyal customers are likely to place greater emphasis on procedural fairness than non-loyal customers since it is more personal and reflects respect for the relationship. the three relational concerns identified originally by tyler (1989) and supported in subsequent research (tyler, 1994; tyler, degoey & smith, 1996) include 1) standing or status, which refers specifically to politeness and respect for dignity, 2) the neutrality of the decision and 3) trust in those third parties to treat people fairly and reasonably. the intangible or symbolic outcomes of respect and concern that are exhibited with procedural justice may reflect ends in themselves (folger & konovsky, 1989) for loyal customers. on the other hand, customers with lower levels of loyalty should be less interested in the fairness of procedures and interpersonal treatment that form the basis for a longer-term relationship, particularly after experiencing a service failure early in the exchange. hypothesis i: customer loyalty moderates the relationship hetween proceduralfairness and customer reactions (i.e., change in customer opinion about the company, post~j'ailure loyalty and return intention) to the management of service recovery. specifically, the positive relationship hetween proceduralfairness and customer reactions will be strongerfor more loyal customers. customers who have not developed loyalty to the service provider are more likely to perceive their exchange relationship as more short-term, purely economic with lower expectations for fairness beyond the one-time encounter. past research (see goodwin & gremler [1996] for a review) has shown that non-loyal customers are more influenced by convenience and cost than loyal customers. we believe resource-based models of justice (tyler, 1994) are more applicable to non-loyal or new customers experiencing a service failure. those less loyal to the service provider are more likely to be concerned with a fair economic and tangible transaction (e.g., refund, credit, exchange) in the management of service recovery and less concerned about the relational, social elements. in contrast to procedural fairness, a fair outcome is the "typical metric" for judging fairness transactions in economic exchange relationships (konovsky & pugh, 1994). more loyal customers may overlook a single outcome or be willing to forgive what they perceive as an aberrant failure as long as the relational aspects support fairness over time in the exchange (tyler, 1989). however, less loyal customers are likely to be more concerned with the distributive, rather than the procedural fairness in service recovery management. hypothesis 2: customer loyalty moderates the relationship hetween distrihutive fairness and customer reactions (change in opinion of the company, post~j'ailure loyalty and return intention) to the management oj'service recovery. specifically the positive relationship hetween dis98 journal of business strategies vol. 21, no.2 tributive fairness and customer reactions will be stronger for less loyal customers. customer loyalty is most often considered an asset given its link to profitability (e.g., hoffman & kelley, 2000; reichheld & sasser, 1990) and other general benefits. customers in a closer relationship with the service provider have a higher volume of business (reichheld & sasser, 1990) are less price sensitive (reichheld, 1996) and report that they are less likely to consider alternatives or shop for lower prices (e.g., goodwin & gremler, 1996). it seems logical therefore that customer loyalty would temper negative reactions and consequences of service failure. the assimilation effect (brockner, ty ler & cooper-schneider, 1992) should lead customers to react in a way that is consistent with prior attitudes and in the event of a service failure, give the company the benefit ofthe doubt. a similar link between agency-client relational bonds and judgments of quality has been proposed (halinen, 1996) in professional services. although the findings are quite mixed, there is some evidence to support this relationship. for example, miller, et al. (2000) found that customer pre-failure loyalty had a positive effect on subsequent perceptions of the problem being solved to his or her satisfaction. similarly, tax et al. (1998) found that prior positi ve experiences with service firms mitigate the negative impact of poor complaint handling on subsequent levels of customer commitment. the successful experiences tend to counterbalance a failure (boulding, kalra, staelin, & zeithaml, 1993) for loyal customers. however, there is also evidence to suggest that customer loyalty may act as a liability in the context of service failures and we believe there are compelling arguments and evidence (e.g., brockner et ai., 1992; tax & brown, 1998) to support this interactive pattern. as proposed earlier, those who are loyal customers are more likely to value the relationship and perceive it as social, with the expectation of being treated fairly in interactions with the other party. these customers expect better or preferential treatment in exchange for their contributions such as continuous, loyal business (seiders & berry, 1998) in order to maintain equity in the relationship (kelley & davis, 1994). when they believe they have been treated unfairly, they are likely to react more negatively than those with less invested (brockner, et ai., 1992) prior to the service failure. in other words, the most damage will occur when expectations for service recovery are high but recovery is poorly managed (tax et ai., 1998). we therefore predict that while well-managed failures may have the most positive influence on loyal customers, the poorly managed failures experienced by loyal customers will lead to the most significant detriment in reactions. hypothesis 3: customer loyalty moderates the relationship between the effectiveness of recovery management and customer reactions (i.e., change in opinion about the company, post~failure customer loyalty and return intention). specifically. the positive relationship between manfa112004 robbins & miller: considering customer loyalty 99 agement effectiveness and customer reactions will be stronger for more loyal customers. methods the critical incident technique (flanagan, 1954), a method often used in the analysis of service encounters (bitner, et a\., 1990; bitner, booms & mohr, 1994; johnston, 1995a; hoffman, kelley & rotalsky, 1995; miller, et a\., 2000; youngdahl & kellogg, 1997) was used to collect the data for this study. a total of seventy undergraduate students served as subjects and each described and answered both open-ended and multiple-choice survey items about two service failures (critical incidents); for the first failure they described a successful resolution and for the second an unsuccessful resolution. these subjects described the company, the service failure, provided their evaluations of service recovery management and perceptions of the fairness of interactions and outcomes for both incidents. pre-failure variables (i.e., customer loyalty) as well as post-failure reactions (e.g., loyalty, repatronage intentions, etc.) were also assessed. a subset of the variables measured was used to test the hypotheses in this study. from this sample we obtained 134 usable responses, 67 resolved and 67 unresolved, from a variety of industries including restaurants (17), mail order/internet sales (16), phone/cable tv services (14), electronics retail and repair (13), airline/hotel/cruise (12) and auto sales/repair (11). common failures in restaurants were food not prepared and/or delivered as specified, incorrect products delivered or products that didn't meet expectations in mail-order and internet sales, service and billing problems for telephone and cable television companies, products that didn't operate as expected for electronic retail/repair and auto sales/repair, and delays and luggage problems for airline, cruise, and hotel services. measures customer loyalty. we used one item to directly inquire about the subjects' degree of loyalty prior to the failure. specifically, customers were asked their level of agreement (5-point strongly agree to strongly disagree) that they would classify themselves as a loyal customer prior to the service failure. single-item measures have been used in past research (e.g., flannery & may, 2000; fulk, 1993) and supported as reliable, particularly when measuring attitudes (e.g., wanous, reichers & hudy, 1997). but we also used a few indirect items to validate and corroborate our findings. these somewhat more objective items measured the length (first time, days, weeks, months or years) and number of times (0, 1,2-4, 5-19, 20 or more) the subject had used the services prior to the failure. by using reports of actual patronage to back up self-reported loyalty, we were able to assess the subjects' behavioral as well as attitudinal commitment (curasi & kennedy, 2002; rundle-thiele & mackay, 2001). distributive fairness. we used the sum oftwo items consistent with the literature in this stream of research (e.g., greenberg, 1990; hoffman & kelley, 2000) to measure perceptions of outcome fairness. one item asked the subject to rate the 100 journal of business strategies vol. 21, no.2 outcomes of the recovery process on a 5-point scale from very fair to very unfair. the second item assessed the subject's level of agreement (from strongly agree to strongly disagree) that the "outcomes of the solution process were appropriate." appropriateness has been used in past research (e.g., greenberg, 1993) as alternative terminology for assessing fairness perceptions. procedural fairness. we measured procedural fairness with the sum of three items based on prior operationalizations of this construct as dependent not only on the perceived fairness of the process, but also on the interpersonal behavior of those making the decision or those in positions of authority (e.g., brockner & weisenfeld, 1996). this operationalization is consistent with the group-value model of procedural justice, which suggests that identity-relevant information is communicated by the fairness of procedures and treatment (tyler, et ai., 1996). one item tapped the subject's perception of the fairness of the solution process and another the fairness of the personal treatment received during the process. a 5-point scale that ranged from very fair to very unfair was used for responses to these items. the other item measured the subject's level of agreement (from strongly agree to strongly disagree) that "the company was open and honest" during the solution process". effi:ctiveness o(,'ervice recovery management. customer evaluations of service recovery efforts were measured as the sum of two items, one that assessed the degree to which the subject felt the problem was solved fairly and the other the degree to which the company solved the problem to his or her satisfaction. customer satisfaction and perceived fairness have been the standards for evaluating the effectiveness of service recovery in this stream of research (e.g., goodwin & ross, 1992; hoffman & kelley, 2000; kelley & davis, 1994). the 5-point scale from very fair to very unfair was used for the first item and the 5-points from strongly agree to strongly disagree was used for the second item. reactions to service recovery management. customer reactions to service recovery efforts included the customer's change in opinion of the company following service recovery, post-failure loyalty toward the company, as well as repatronage intentions. customers were asked the degree (using the 5-point strongly agree to strongly disagree scale) to which they would classify themselves as a loyal customer and the degree to which their opinion had changed because of the management of recovery. repatronage intentions were assessed using a 5-point scale that ranged from "already have gone back to the company" to "being certain of never returning". data analysis means, standard deviations and correlations for all variables are shown in table 1. a confirmatory factor analysis was conducted and all indicator variables loaded significantly (p<.o l) on the hypothesized factors. the loadings ranged from .82 to .98 and the analysis supported the fit (cfl = .98, nfl = .96, rmsr = .03) of the five-factor model. the cronbach's alpha coefficients, also shown in table 1, provide strong support for the reliability of these measures as well. table i means, standard deviations, reliabilities and correlations for all variables ." p)-tv o o .j::,. variable n mean s.d. 1 2 3 4 5 1. customer loyalty 133 3.71 0,94 ~ ~ '" 2, distributive fairness ::;,133 6.47 3.03 0,25** 0,97 ::;,-.... :::s t;.., 3. procedural fairness 132 9.66 4,26 0.22* 0.92** 0,93 r<> g; 4. effectiveness of -...--!'t> service recovery management 134 6.11 3,15 0.20* 0.93** ""t 0.92** 0.98 .. (j '" 5. reactions to :::s t;..,.... service recovery management r'') 8.63 3,72 0.36** 0.83** 0,86** 0.85** 0.92 ~j_ ""t.... :::s -'it; * p < .05, one-tailed test 11l::: ** p < ,01. one-tailed test "".....'"alpha coetllcients on the diagonal :::: !'t> "l t""" ~ l:::l-... ,~ o 102 journal of bwdness strategies vol. 21, no.2 the three hypotheses were tested using linear regression with three independent variables: the independent variable of interest, customer loyalty and the interaction between loyalty and the first independent variable. to minimize multicollinearity between the predictor variables and the interactions, all variables were transformed to center the scales at zero by subtracting the mean (aiken & west, 1991). when we found a significant interaction, we plotted the relationship between the independent and dependent variable at three levels of loyalty as suggested by aiken and west (1991): loyalty at one standard deviation below the mean, loyalty at the mean and loyalty at one standard deviation above the mean. results we analyzed hypothesis i with the use of procedural fairness, customer loyalty, and the interaction of the two as predictors of customer reactions to service recovery management. the regression model was significant (r l = .77, f = 140, p < .01). main effects for both procedural fairness (b =.72, t = 18.67,p < .0 i) and loyalty (b = .80, t = 4.44,p < .01) support the direct importance ofthese variables in the management of service recovery. more relevant to our prediction is the marginally significant (b = .06, t 1.81,p <.10) interaction between customer loyalty and procedural fairness which lends moderate support for hypothesis 1. the nature of this interaction, illustrated in figure i, is also consistent with hypothesis 1 in that the influence of procedural justice on reactions to service recovery management was strongest for the most loyal customers. figure 1 interactions results .... c1)c uci) '> e "'ci) c1)cj lill'll ot: "'lll ~e .e~ "'glu> lllo c1)u ~!!! hypothesis 1 high loyalty interactional fairness glc ugl '> e "'4141 01 lil«l ot: "'«1 tile .§~ -gl u> lila gl u ~ci)... hypothesis 2 high loyalty distributive fairness hypothesis 3 low loyalty effectiveness of service recovery management although the interaction between procedural and distributive justice was not a main focus in this research, we included interactions between the two as well as each with loyalty in an analysis predicting reactions to service recovery. unlike the pattern prevalent in past organizational justice research (e.g., brockner & wiesenfeld, 1996), there were no significant interactions between distributive and fall 2004 robbins & miller: considering customer loyalty 103 procedural justice in the context addressed by our research (i.e., the management of service failures and recovery). hypothesis 2 was tested with the use of distributive fairness, customer loyalty and the interaction of the two in predicting customer reactions to the management of service recovery. this model was also significant (r 2 = .72, f = 110, p < .01) and main effects for distributive fairness (b = .98, t= 16.49,p < .01) and loyalty (b = .74, t = 3.67,p< .01) suggest a direct influence ofthese variables on customer reactions to service recovery management. the marginally significant (b = .10, t = 1.88, p < .10) interaction between distributive fairness and customer loyalty provides modest support for hypothesis 2. however, in contrast to our specific prediction (and as shown in figure i), the strongest relationship between distributive fairness and customer reactions was found for the most loyal, rather than the least loyal customers. in order to analyze hypothesis 3, effectiveness of service recovery management, customer loyalty, as well as the interaction of the two, were used as predictors of customer reactions. the resulting regression model was significant (r 2 = .77, f = 144, p < .01) as were main effects for both loyalty (b = .89, t = 5.04,p < .01) and effectiveness of recovery management (b = .97, t = 18.89, p < .01). more importantly, support for hypothesis 3 was indicated by a significant interaction (b = .10, t= 2.08,p < .05) between customer loyalty and effectiveness of service recovery management in predicting customer reactions. figure 1 illustrates the nature of the interaction that supports hypothesis 3. loyal customers were the most strongly affected by how the service recovery was handled. the results above reflect the findings when the use ofthe single-item attitudinal measure ofloyalty, described earlier, was used in the analyses. when the two behavioral measures ofloyalty were used, the findings were consistent with respect to the hypotheses, but resulted in stronger statistical support for the interactions between both procedural and distributive fairness with loyalty. discussion the results ofthis study support an important antecedent role for customer loyalty in the management of service recovery. both procedural and distributive fairness in recovery had stronger influences on subsequent reactions of customers with higher levels ofloyalty prior to the service failure. satisfaction of customers is dependent on the degree to which managers ofservices are aware of, and can meet the conditions of the psychological contracts they hold with the business (clemmer & schneider, 1996). a first step toward meeting those contracts is to understand the differences and expectations that vary with customer loyalty. perhaps recovery management is more significant for loyal customers because of higher expectations (kelley & davis, 1994). loyal customers expect some special treatment and do not want to be "treated as a number" (goodwin & gremler, 1996; kelley & davis, 1994). it appears that both procedural and distributive fairness are more significant components of the exchange relationship for loyal customers. loyal customers 104 journal ofbusiness strategies vol. 21, no.2 may perceive their psychological contracts as more relational (than transactional) however while socio-emotional and intrinsic elements are of greater importance with this type of implied contract, there is still an economic focus in this type of exchange (rousseau & parks, 1993). finding the same pattern of results with respect to both types of fairness may be attributable to the positive association between distributive and procedural justice in the context of service failures and recovery attempts. customers are more likely to perceive outcomes such as monetary funds, credits, etc., as fair if they are treated fairly and respectfully in interactions with managers and employees (see blodgett, et ai. [1997] and tax, et ai. [1998] for reviews). on the other hand, when procedural justice is low, outcomes are also likely to be perceived as unfair. past research (brockner & weisenfeld, 1996) suggests that in the case of procedural unfairness, individuals may redefine what was once a relational exchange, as more "businesslike". as with unfair procedures (brockner & wiesenfeld, 1996), the service failure itself may threaten the individual's self-esteem and change the element of group identification, in which case material outcomes become more important (brockner & wiesenfeld, 1996). the findings of this study suggest that the group-value model (e.g., tyler, 1989), used to explain reactions to justice perceptions in other types of exchanges (e.g., manager-employee), has potential for explaining the dynamics of the customer-service firm relationship. our findings are consistent with the group-value motive, in that those most committed to an institution care more about relational/procedural concerns (tyler, 1989). loyal customers are likely more concerned with their long-term relationship with the service firm, as assumed by the group-value motive for justice, which emphasizes the importance of social interactions that provide emotional support and a sense of belonging (tyler, 1989). also consistent with previous interpretations of the group-value motive, is the finding that the most loyal customers, even though they had the most positive reactions overall in this study, reacted most negatively when treated unfairly. "according to the group-value model, those who are more committed to the organization or institution beforehand have invested more oftheir sense of self-worth in their identification with the group" (brockner, et ai., 1992, p. 243). unfair treatment is likely to have a particularly detrimental effect for loyal customers, because of their investments with commitment, frequency of patronage, etc. as brockner et ai. (1992) explain, these indivi<;luals "had the most to lose". while organizations are beginning to pursue various service recovery strategies, there have been no specific suggestions, to our knowledge, that customer loyalty should playa role in the management of procedures and outcomes during service recovery. the results of this study suggest that business strategies and training programs should stress the importance of managing the fairness perceptions of loyal customers in particular. perhaps policies that empower employees during service recovery (e.g., tax & brown, 1998) should specifically allow employees to employ the full range of remedies when loyal customers experience a service failure. loyal customers should be treated with utmost respect and managers fall 2004 robbins & miller: considering customer loyalty 105 should take time to explain decisions leading to the outcomes of service recovery. unlike when responding to reported problems of non-loyal, problem customers or repeat complainers, the benefits of very liberal outcomes such as full refunds and guarantees (blodgett, et al, 1997) are most likely to outweigh the costs when provided to loyal customers. this is particularly true given that retaining loyal customers is often a more efficient strategy than pursuing new customers (hoffman & kelley, 2000). of course there are some limitations in this study. some might question the use of students as subjects in this research. however students are customers and their reactions to service failures are therefore comparable to other subject populations (e.g., greenberg, 1987). the use of a questionnaire for gathering all the data makes the analyses subject to common method variance. unfortunately, studies (e.g., clemmer & schneider, 1996; miller et al, 2000; tyler, 1994) addressing perceptions offairness in actual experiences with authorities and services providers have been prone to common method variance. but unlike many studies (e.g., blodgett, et al, 1997; de ruyter & wetzels, 2000; goodwin & ross, 1992; kelley & davis, 1994) that have analyzed hypothetical and experimental scenarios, we used actual experiences with service failure and recovery. given the potential ethical and practical problems with conducting a field experiment of this nature (de ruyter & wetzels, 2000) and the lack of external validity with the use of hypothetical scenarios, we felt the critical incident technique, although associated with the use of common methods, to be a good compromise as well as a complement to much of the earlier work on reactions to service failure and recovery management. cross-sectional data also preclude interpretations of causality although some of the more objective items measuring customer loyalty (i.e., actual patronage behavior prior to the service failure) should ensure temporal order on the part of this main predictor of interest. nonetheless, future research that employs different and/or longitudinal methods when analyzing antecedents and consequences of service recovery attempts would help to corroborate these findings. we aimed to more thoroughly develop the theoretical bases for our predictions and interpretations in order to address the lack of conceptual understanding in the management of service recovery (blodgett, et al, 1997; kelley & davis, 1994). our findings suggest that much of the theory on the role of fairness in other types of exchanges may be useful for understanding the justice motive in customer-service firm relationships. future research should attempt to directly measure variables associated with these conceptual underpinnings (perceived contracts, expectations, group-value motives) to confirm their validity for understanding the relationships. future research should also analyze customer loyalty as a potential common link among previously suggested (see de ruyter & wetzels [2000] for a review) contingencies of perceptions and reactions to service failure and recovery management: the seriousness of the service failure (kelley, davis & hoffman, 1993), whether the customer feels annoyed or victimized (johnston, 1995b), and customer equity sensitivity (oliver, 1997). 106 journal ofbusiness strategies vol. 21, no.2 because of their commitment and investment, loyal customers are likely to feel entitled to more than what is equitable (e.g., huseman, hatfield & miles, 1987). these customers may feel they are owed more because of their loyalty and are therefore more likely to perceive an unsuccessful recovery as serious and feel victimized by it. given the substantial benefits of effective recovery (e.g., hoffman & kelley, 2000; tax & brown, 1998), any practical way to improve management in the event of a service failure should have significant implications for the organization. business strategies that maximize these benefits while also exploiting the retention-loyalty-profitability linkage should have significant returns for the service firms. to this end, when developing recovery strategies, managers should pay particular attention to ensuring perceptions of fairness in the event that failures are experienced by loyal customers. references aiken, l., & west, s. (1991). multiple regression: testing and interpreting interactions. newbury park, ca: sage. berry, l.l. (1995). on great service: a framework for action. new york: free press. bitner, mj., booms, b.h., & mohr, l.a. (1994). critical service encounters: the employee's viewpoint. journal of marketing: 58(4).95-106. bitner, mj., booms, b.h., & tetreault, m.s. (1990). the service encounter: diagnosing favorable and unfavorable incidents. journal of marketing, 54. 71-84. blau, p. (1964). exchange and power in social life. new york: wiley. blodgett, lo., hill, 0.1., & tax, s.s. (1997). the effects of distributive, procedural, and interactional justice on postcomplaint behavior. journal of retailing, 73(2), 185-210. boulding, w., kalra, a., staelin, r., & zeithaml, va. (1993). a dynamic process model of service quality: from expectations to behavioral intentions. journal of marketing research, 30, 7-27. brockner, j., & wiesenfeld, b.m. (1996). an integrative framework for explaining reactions to decisions: interactive effects of outcomes and procedures. psychological bulletin, 120, 189-208. brockner, j., tyler, r., & cooper-schneider, r. (1992). the influence of prior commitment to an institution on reactions to perceived unfairness: the higher they are, they harder they fall. administrative science quarterly. 37, 241-261. clark, m.s., & mills, l (1993). the difterence between communal and exchange relationships: what it is and is not. personality and social psychology bulletin, 19, 684-691. fall 2004 robbins & miller: considering customer loyalty 107 clemmer, e.c, & schneider, b. (1996). fair service. in t. swartz, o. bowen, & s. brown (eds.) advances in services marketing and management (pp. 109-126). greenwich, ct: jai press. curasi, c.f., & kennedy, k.m. (2002). from prisoners to apostles: a typology of repeat buyers and loyal customers in service businesses. journal of services marketing, lli.4}.322-341. de ruyter, k., & wetzels, m. (2000). customer equity considerations in service recovery: a cross-industry perspective. international journal of service industry management, 11 91-108. oube, l., & maute, m. (1996). the antecedents of brand switching, brand loyalty and verbal responses to service failure. advances in services marketing and management. 2. 127-151. flanagan, lc (1954). the critical incident technique. psychological bulletin, 51, 327-359. flannery, b.l., & may, dk (2000). environmental ethical decision making in the u.s. metal-finishing industry. academy of management journal, 43, 642-662. folger, r., & konovsky, m.a. (1989). effects of procedural and distributive justice on reactions to pay raise decisions. academy of management journal, 32, 115-130. fulk, j. ( 1993). social construction ofcommunication technology. academy of management journal, 36, 921-950. goodwin, c, & gremler, d.o. (1996). friendship over the counter: how social aspects of the service encounters influence consumer service loyalty. advances in services marketing and management, 5, 247-282. goodwin, c, & ross, i. (1992). consumer responses to service failures: influence of procedural and interactional fairness perceptions. journal of business research, 25(2), 149-163. greenberg, j. (1987). the college sophomore as guinea pig: setting the record straight. academy of management review, 12, 157-159. greenberg, l (1990). organizational justice: yesterday, today and tomorrow. journal of management. 16,399-432. greenberg, j. (1993). stealing in the name of justice: informational and interpersonal moderators oftheft reactions to underpayment inequity. organizational behavior and human decision processes, 54, 81-103. halinen, a. (1996). service quality in professional services: a relationship approach. advances in services marketing and management, 5, 315-341. 108 journal of business strategies vol. 21, no.2 hoffman, k.d., & kelley, s. w (2000). perceived justice needs and recovery evaluation: a contingency approach. european journal of marketing, 34, 418-432. hoffman, k.d., kelley, s. w, & rotalsky, h.m. (1995). tracking service failures and employee recovery efforts. journal of services marketing, 9(2), 49-61. huseman, r.c, hatfield, j.d., & miles, e. w (1985). a new perspective on equity theory: the equity sensitivity construct. academy of management review, 12,222-234. johnston, r. (1995a). the detenninants of service quality: satisfiers and dissatisfiers. international journal of service industry management 6(5),53-71. johnston, r. (1995b). service failure and recovery: impact, attributes and process. advances in services marketing and management, 6(2), 46-61. johnston, t.c, & hewa, m.a. (1997). fixing service failures. industrial marketing management, 26, 467-473. kelley, s. w, & davis, m.a. (1994). antecedents to customer expectations for service recovery. journal of the academy of marketing science, 22, 52-61. kelley, s.w, davis, m.a., & hoffman, k.d. (1993). a typology ofretail failures and recoveries. journal of retailing, 69(4), 429-452. konovsky, m.a., & pugh, s.d. (1994). citizenship behavior and social exchange. academy of management journal, 37, 656-669. miller, j.l, craighead, cw, & karwan, k.r. (2000). service recovery: a framework and empirical investigation. journal of operations management, 18,387-400. oliver, r.l (1997). satisfaction, a behavioral perspective on the consumer. mcgraw-hill, new york, ny. reichheld, f.f. (1996). the loyalty effect. boston, ma: harvard business school press. reichheld, ef., & sasser, we. (1990, september-october). zero defections: quality comes to service. harvard business review, 68, 105-111. rousseau, d.m., & parks, j.m. (1993). the contracts of individuals and organizations. in l.l. cummings & b. staw (eds.), research in organizational behavior, 15 (pp. 1-47). greenwich, ct: jai press. rundle-thiele, s., & mackay, m.m. (2001). assessing the perfonnance of brand loyalty measures. journal of services marketing, 15, 529-546. seiders, k., & berry, l.l. (1998). service fairness: what is it and why it matters. academy of management executive, 12,8-20. fall 2004 robbins & miller: considering customer loyalty 109 tax, s.s., & brown, s. w ( 1998, fall). recovering and learning from service failure. sloan management review, 40, 75-88. tax, s.s., brown, s. w, & chandrashekaran, m. (1998). customer evaluations of service complaint experiences: implications for relationship marketing. journal of marketing, ~60-67. tyler, 1.r. (1989). the psychology of procedural justice: a test of the group-value model. journal of personality and social psychology, 57, 830-838. tyler, 1.r. (1994). psychological models ofthe justice motive: antecedents of distributive and procedural justice. journal of personality and social psychology, 67, 850-863. tyler, 1., degoey, p., & smith, h. (1996). understanding why the justice of group procedures matters: a test ofthe psychological dynamics ofthe group-value model. journal of personality and social psychology. 70, 913-930. wanous, l, weichers, a.e., & hudy, mj. (1997). overall job satisfaction: how good are single item measures? journal of applied psychology. 82, 247-252. youngdahl, we., & kellogg, d.l. (1997). the relationship between service customers' quality assurance behaviors, satisfaction, and effort: a cost of quality perspective. journal of operations management. 15, 19-32. tina robbins is an associate professor in the department of management, college of business and behavioral sciences at clemson university, where she teaches organizational behavior. she received her ph.d. in business administration from the university of south carolina. she has published in the journal of applied psychology, journal of management and human relations. her current research interest is organizational justice. she is currently serving on the editorial review board for the academy of management journal janis miller is an associate professor in the department of management, college of business and behavioral sciences at clemson university, where she teaches service operations, management science and statistics. she received her ph.d. in business administration from the university of missouri columbia. much of her recent work has been in the area of service recovery. her papers have appeared in the journal of operations management, academy of management journal and operations research. fall 2004 robbins & miller: considering customer loyalty 110 considering customer loyalty in developing service recovery strategies inter-partner credible threat and the survival of u.s.-china joint ventures jason duan cameron university lawton, ok norma juma washburn university topeka, ks abstract lnternationaljoint ventures (uvs) are perceived as essential strategic weapons by which firms can transfer the complex complementary competencies needed for competitive advantage within firms' core markets and technologies. this study attempts to explore the relationship of inter-partner credible threat and the survival ofuvs in china. the study found that the existence ofinter-partner credible threat, and high product relatedness between foreign parent and ijv, favorably influence the uv's long-term survival. introduction the proliferation of international joint ventures (ijvs) in emerging economies, particularly in china, in the last decade, has stimulated great research interest. they are perceived as increasingly important strategic weapons by which firms can transfer the complex complementary competencies needed for competitive advantage within firms' core markets and technologies (harrigan, 1986). beamish (1994) described joint ventures, the most common form of strategic alliance, as the dominant strategy used by multinational firms in emerging markets. international joint ventures have been widely considered as hybrid forms of organizations which aim to bring together complementary skills, know-how and resources of two or more parent firms to accomplish specific objectives. the cross-cultural and inter-firm nature ofijvs are key sources of the additional complexities and challenges in the management of an ijy. although ijvs have become increasingly important in emerging markets, a high level of dissatisfaction with actual outcomes relative to expectations has been reported (hitt, levitas, arregle & borza, 2000; madhok & tallman, 1998). ofthe particularly critical decisions, partner selection has been seen as especially important to a venture's success (geringer, 1988; saxton, 1997). in an international setting, differences in culture, infrastructure, economic development, and government policies increase the complexity and the vitality of the partner 92 journal a/business strategies vol. 24, no.1 selection (dacin, hitt & levitas, 1997). however, previous empirical studies on partner selection tend to focus on the organizational characteristics of partners, such as strategic symmetry (harrigan, 1988), inter-firm diversity (parkhe, 1991), match of partner characteristics (geringer, 1988), and inter-partner compatibility (beamish, 1988; hill & hellriegel, 1994; lnkpen, 1995; inkpen & currall, 1998). in essence, the emphasis is on the cooperative aspects of venture partners. the use of economic constraints and mechanisms such as the inter-partner credible threat in curbing opportunistic behavior of partners, and its impact on the venture's performance, have not fully been explored. following the tradition of game theory application in the study of joint ventures (heide & miner, 1992; parkhe, 1991), zhang and rajagopalan (2002) argued that inter-partner credible threat plays a more important role than partners' management control in determining partners' payoff in ijvs. he defines inter-partner credible threat as the certainty of either partner's retaliation given that the other partner cheated earlier (zhang & rajagopalan, 2002). the existence of inter-partner credible threat will not only reduce ijvs coordination costs, but also enhance partners' cooperative behaviors and result in better performance. coordination costs are the expenses in monetary terms, as well as managerial time and effort that the partners incur in the process of composing tasks and coordinating activities across organizational boundaries (zhang & rajagopalan, 2002). this study attempts to test the theoretical predications on the use of inter-partner threat and its impact on ijv performance. after the introduction, we briefly review the literature of joint venture partner selection and joint venture performance. then we develop our hypotheses. next we describe our sample and research method, followed by a discussion of the statistical analysis. then we conclude with the theoretical and practical implications of the study. international joint venture partner selection and performance the analysis of ljv performance determinants and their relationships with local partner selection has commanded considerable research efforts in the past. previous research has progressed along two main theoretical paths. first, some researchers have focused on resources exchange and the value of the resource accessed in an ijv (saxton, 1997). geringer (1988) argued that selection of an ljv partner should consider a fit, both for task-related characteristics (e.g., resources and skills) and for partner-related characteristics (e.g. size, objectives, and operating policies). harrigan (1986) proposed that ijv performance depends on strategic symmetry between the partners, which occurs when they "possess complementary strategic missions, resource capabilities, managerial capabilities, and other attributes that have a strategic fit such that the relative bargaining power of the partners is evenly matched" (harrigan, 1986, pp. ii). using variables of inter-partner relatedness, parent-venture relatedness, and the relative size, nationality, and ijv experiences of the parent firms, harrigan reported positive relationships between partners' strategic symmetry and venture survival (harrigan, 1988). hitt et al. (2000) provided some evidence to support spring 2007 duan & juma: inter-partner credible threat 93 the resource-based perspective as to why firms select particular partner. their study showed that emerging market firms emphasized the partner's financial assets, technical capabilities, and intangible assets, whereas developed market firms emphasized the partner's unique competencies and local market knowledge and access. other researchers have focused on the interactive nature of cooperation between the partners in the ventures (heide & miner, 1992; parkhe, 1991; saxton, 1997). researchers in this tradition emphasize the use of economic and social mechanism to sustain the ongoing relationship between the partners involved, not the resource per se. partners within ijvs are assumed to have the potential for opportunistic behavior (reich & mankin, 1986). the use of economic constraints, such as the investment of specific assets and other arrangements, may reduce the potential for opportunism by locking partners into a strategic alliance, with the expected long-term gains from maintaining the relationship exceeding the potential short-term gains from opportunism (parkhe, 1993). zhang and rajagopalan (2002) proposed that inter-partner credible threat, as defined as 'the certainty of either partner's retaliation given the other partner's earlier cheating,' may serve as an effective mechanism to curb the potential opportunism of partners, and consequently affect the venture's performance. in reviewing previous research, we have founded that insufficient attention has been paid to empirical study testing the effectiveness of economic constraints to enhance cooperative behavior of partners. in this study, we attempt to examine the inter-partner credible threat as a deterrence mechanism and its effect on the performance of ijvs. hypotheses to explore and identify the key ingredients of successful ijvs is of paramount importance to ijv researchers as well as to ijv practitioners. the measurement of the performance of ijvs itself has been an important research topic in the field of international management (arino, 2003; geringer & hebert, 1991; olk, 2002; yan & zeng, 1999). the validity of the different measures has been questionable (arino, 2003; olk, 2002). for example, many researchers have used the ijvs' survival as a proxy of their performance measure (harrigan, 1988; hennart, kim & zeng, 1998; li, 1995; makino & beamish, 1998). although geringer and hebert (1989) have found a significant positive correlation between objective measures using survival, stability and duration, and subjective measures of performance, arino (2003) argued that operational measures of strategic alliance performance, such as survival or longevity, can be related to performance only in particular instances. these instances require some knowledge of the temporal nature of the partners' goals for the tjvs. because exit/termination of an tjv may be anticipated or "planned" by the partners, from the outset (lnkpen & beamish, 1997), previous empirical studies that simply count the death rate, without the knowledge of the founding partners' intentions, were conceptually flawed (yan & zeng, 1999). therefore, in this 94 journal of business strategies vol. 24, no. 1 study, we use uvs' survival rates against a pre-determined duration to measure ijvs' performance. a detailed discussion of this measure will be presented in the following section. the construct, inter-partner credible threat, is derived from a game theory framework (zhang & rajagopalan, 2002). zhang and rajagopalan illustrates the inter-partner credible threat using a one-stage 'prisoner's dilemma' model and an infinitely repeated' prisoner's dilemma' model. in essence, the existence of credible threat in an ongoing cooperative relationship will reduce the coordination cost between partners, by aligning the incentive/payoff of partners. for instance, in the one-stage prisoner's dilemma, the two sponsoring firms simultaneously choose a strategy to control the tjv (high level control vs. low level control). if both partners choose the high level control strategy, then the payoff will be relatively low, due to the high coordination costs. on other hand, if both partners choose low level, then the payoff will be relatively high, due to the low coordination costs. since most ijv partners have different, and often conflicting interests, it is highly unlikely that they would voluntarily opt for the low level control. given these differences, each partner may choose to maximize their own payoffs rather than the overall payoffs. this reduces ijvs to 'forums ofrivalrous control' (zhang & rajagopalan, 2002). zhang and rajagopalan suggest that interpartner credible threat can break this circle of rivalrous control. partners will have to weigh the payoffs from cooperation and cheating. partners will tend to stick to the cooperative strategy as long as payoffs from cooperation outweigh those from cheating. this will increase the overall payoffs of the ijv and its overall performance and longevity. because this mechanism does not require substantial investment in relationship building and coordination, the long term economic efficiency can positively affect the ijv's performance. therefore, we developed the following hypothesis: hypothesis 1: the existence afcredible threat from either or both partners will have a positive influence on the jjv:~ survival. the effect of equity ownership on the survival of ijvs has been studied by many researchers (dhanaraj & beamish, 2004; makino & beamish, 1998). teece (1992) notes, 'equity stakes provide a mechanism for distributing residuals when ex ante contractual agreement cannot be written to specify or enforce a division of returns.' the commitment to jointly own the venture, and the degree of control over its operation, as decided by the equity position, places the partners in a mutual hostage situation, whereby opportunistic behavior of partners can be mitigated (dhanaraj & beamish, 2004; williamson, 1985). makino and beamish (1998) argued that the choice of desired ownership level reflects the interplay between the parent firms' desire to secure control and their attitudes towards investment risks. their empirical study showed that the ownership structures of japanese jvs have significant impact on ijvs' performance and survival. foreigner partners with significant equity shares ultimately have more control spring 2007 duan & juma: inter-partner credible threat 95 of the venture through voting rights, hence they do hold a credible threat over the local partners. the local partners, on the other hand, have the legislative backing of the chinese government. the cost of liquidating a venture in china can be quite high in terms of legal fees, time and effort (zhang & rajagopalan, 2002). hence, with or without a voting majority, the local partners in china do hold a credible threat. in the above given scenario, it is highly unlikely that either party will engage in opportunistic behavior. according to zhang & rajagopalan's (2002) framework, this scenario is likely to present a successful ijv, in which both partners cooperate and achieve balanced payoffs. therefore, we offer the following hypothesis: hypothesis 2: equity ownership ofthe foreign parentfirm in the ijv will be positively related to the jjv survival. previous studies have shown that a product diversification relationship between parent firms and the ijv can influence the venture's economies of scale and scope (harrigan, 1986; luo, 1997). this relationship may also affect the ijv's ability to develop the market and products in the host country or international markets, because product relatedness between the parent firm and the uv will determine the likelihood of how much industrial experience, parent firm's intangible assets available to the new venture, and product relatedness between the local firm and the ijv will determine the established distribution channels, production facilities and skilled labors utilizable by the new venture (geringer & herbert, 1989). therefore, we offer the following hypothesis: hypothesis 3: an jjv with a product related with that of its foreign parentfirm or its local parent firm has afavorable influence on the ijv survival. methodology in this study we test a sample of 216 u.s.-china joint ventures by using logistical regression model. the data consists of a sample of ijvs established in china prior to 1989 (excluding service ventures and those ijvs with multiple foreign partners). the data is compiled from the published almanac of china's foreign economic relations and trade (moftec 1984-1989 editions) and from a directory of u.s. firms operating in china (2000 edition). thus these ijvs represent the "early birds" of american investment in china. there are two reasons why this sample set is appropriate to this study. first, the tiananmen square incident in 1989 created an unexpected disturbance in the flow of foreign investment into china because investors began to doubt china's political stability. moreover, the chinese government launched an economic adjustment program in early 1989, which aimed to control rapidly rising inflation through a reduction in aggregate demand, leading to a halt of ali new investment projects and to the suspension or delay of the approval of negotiated foreign investment 96 journal of business strategies vol. 24, no. 1 agreements, including ijvs (zhang, 2001). therefore, we select 1989 as a cutoff point, as it clearly marked the first stage of foreign investment in china. second, in order to measure ijv performance, particularly using survival as a proxy of performance, the relative time frame needs to permit ijvs operating long enough to prove their performance. therefore, when we examine the sample ijvs' survival rate in 2000, the latest ventures formed in 1988 have twelve years to prove their performances. dependent variable the dependent measure in this study is the survival of ijvs established prior to 1989. by examining a directory of u.s. firms operating in china (2000 edition), we identify the exit/termination rate of u.s.-china joint ventures. several researchers have used the same method to investigate foreign investments in the united states and south asia (harrigan, 1988; makino & beamish, 1998; shaver, mitchell & yeung, 1997; yamawaki, 1997). among 216 entries ofijvs, 50 of them still exist, a survival rate of approximately 23 percent. however, we should take this seemingly low survival rate with caution. an ijv agreement in china usually stipulates a fixed duration. this is negotiated by the founding partners before approval of the agreement by the chinese government. the duration means that the foreign partners agree to liquidate their share in the ijv to the chinese partner (s) at a pre-specified time. the standard duration is 15-30 years. recently, the chinese government has changed the policy and allowed the contracted parties to extend the duration. by examining the non-survival ventures against their pre-determined contract duration, only 51 % (85 firms) of them were short-lived before their duration expired. 49% (81 firms) reached their expiry duration. although one can argue that a pre-specified duration may be a political necessity to please the chinese government, we believe that the length of duration negotiated in the ljv agreement does provide some information on the foreign partner's intention, at least in the venture's formation stage. therefore, we could not conclude that these 81 ijvs had failed because their poor performance. they may well serve the venture partners' initial strategic objectives and fulfill their mission to be a "real option" for their partners to get into an uncertain new market (chi & seth, 2002; kogut, 1991). the short-lived 85 ijvs, representing a 39% of total entries, were probably true failures. independent variables the major independent variable we use in this study is the existence of credible threat from either or both partners in the ijy. the variable is coded one if there is credible threat (or zero otherwise). based on a four cases study of japan-china joint ventures, zhang and rajagopalan (2002) have identified some specific sources of inter-partner credible threat in an ijv, such as asset specificity, business expertise, and political authority. in this study, we follow zhang and rajagopalan's approach, by examining asset specificity, business expertise, and political authority in each u.s.-china venture. our assessments are mainly based spring 2007 duan & juma: inter-partner credible threat 97 on information in an ijv agreement. archive information and case studies on some ijvs have also been used. the second independent variable is equity position of the foreign parent firm. we use the percentage of american parent equity in the ijv as reported by the data source. we use two independent variables to examine the product relatedness on the ijvs survival. the first measures the product relatedness between the american parent and the ijv, and the second measures the product relatedness between the chinese parent and the ljv both measures ofthe product relatedness are assessed based on the standard industry code at four-digit level. following previous empirical studies, we also use three control variables. one control variable is location. in an emerging economy, such as china, the level of establishment of a free market structure, and other institutional infrastructures varies across different regions. consequently, the degree of location advantage enjoyed by most ljvs may have differential impacts on their performance (pan & chi, 1999). since 1979, china has adopted the idea of "gradualism" in opening its door to foreign investments. starting with the experiments in the first four specialized economic zones (sezs), the chinese government has granted favorable economic policies, tax incentives and regulations with respect to foreign investments. later, the government has gradually expanded such favorable policies and regulations to the fourteen coastal cities and trade development zones. these designated locations offer various conveniences and incentives for foreign firms, thus increasing the likelihood that an ijv would survive. a dummy variable is coded one if the ljv is located in one of the special economic zones or original fourteen open cities (zero otherwise). the second control variable is the amount of the american partner's investment in the ijv the amount of investment may not only reflect the resource commitment and risk orientation ofamerican parent in the ljv, but also represent a hurdle factor for american parent to terminate the partnership pre-maturely. therefore we believe that the larger the amount an american parent invested in a venture, the more likely the venture would survive. finally, we use ijv duration as a control variable to gauge the survival of l1v as argued previously, an ljv's pre-determined duration should have a positive relationship with respect to the ljv survival, all other factors being equal. if an ijv is short-lived before its pre-determined duration expiry, it should be an indication of not very successful operations. if an ijv survives after its pre-determined duration, we can argue that the venture must be satisfactory to both partners, otherwise they can simply terminate the venture according to the agreement. a description of variables and their correlations is presented in table 1. regression results the dependent variable, survival, is a binary variable taking value one or zero only. we use a sas program to run the regression and report our results in table 2. 98 journal ofbusiness strategies vol. 24, no. i table t descriptive statistics and product moment correlations (216 cases) 1 2 3 4 5 6 7 8 1. survival 1 2. threat 0.81 1 3. equity 0.24 0.31 i 4. product i 0.46 0.40 0.22 1 5. product ii 0.00 -0.07 -0.19 -0.16 1 6. location -0.07 -0.04 0.07 0.05 -0.21 1 7. duration 0.29 0.27 0.37 0.46 -0.11 0.15 1 8. amount 0.28 0.24 0.19 0.32 0.09 0.17 0.35 1 mean 0.23 0.25 43.07 0.57 0.86 0.17 15.46 189.29 standard error 0.03 0.03 0.87 0.03 0.02 0.03 0.38 23.02 minimum 0.00 0.00 25 0.00 0.00 0.00 2 3 maximum 1.00 1.00 95 1.00 1.00 1.00 30 3198 table 2 binary logistic regression results variables intercept threat equity product i product ii location duration amount * p <0.0001 ** p < 0.005, estimate standard error 2.490 1.549 2.473* 0.375 0.030 0.029 1.725** 0.593 0.442 0.446 -0.393 0.491 -0.054 0.063 -0.002 0.001 the estimated coefficients of variable threat, product i are positively significant. therefore hypothesis 1 and hypothesis 3 are supported by the statistical tests. the estimated coefficients of other variables are not statistically significant. spring 2007 duan & juma: inter-partner credible threat 99 therefore we could not reject the null hypotheses that these variables have no influences on the ijv's survival. the results show that the existence of inter-partner credible threat, between the venture partners, contributes significantly to the survival of u.s.-china joint ventures. the relatedness of an uv's product to its american parent firm also has a positive influence on the venture's survival. however, our tests do not support the effect of equity ownership on the survival of an uy. one explanation is that, as presented by a recent study (dhanaraj & beamish, 2004), the relationship between equity ownership and mortality of ijv may be nonlinear and asymmetrical. therefore, our linear logistic regression model did not capture the nonlinear effect. with respect to the three control variables, we were surprised that none of them are statistically significant. our results are not consistent with the results of a previous study using financial measures of performance of ijvs (pan & chi, 1999). discussion and conclusions this study attempts to explore the relationship of inter-partner credible threat on the survival of international joint ventures. the study concludes that the existence of inter-partner credible threat, and the high product relatedness between the foreign parent and the ijv, favorably influence the ijv's long-term survival. the contributions of this study to the existing research are as follows. first, since the publication ofzhang and rajagopalan's theoretical work (2002), this study is the first to establish an empirical test to support their theoretical arguments. therefore, this study not only validates an important theory construct in ijv literature, but also contributes to our more comprehensive view of partner selection and ijv performance. second, this study is the first reported in the literature that has attempted to incorporate a control variable with the temporal nature of partners' expectations to measure performance. although the coefficient of this control variable is not statistically significant, the result answers the critique of using survival as a performance measure. third, this study has provided evidence to support the previous research that claims the relationship between foreign parent equity ownership and mortality rate of ijv may not be linear. therefore, a fine-grained analysis of the role of foreign equity ownership is warranted for future study. this study's empirical analysis will present important managerial implications. because the existence of inter-partner credible threat may serve as a self-reinforced mechanism to sustain partners' cooperative behavior and deter partners' opportunistic behavior, multinational firms may appropriately structure an ijv to minimize the cost of coordination and safeguard appropriation concerns simultaneously (zhang & rajagopalan, 2002). while previous studies emphasized resource sharing between partners, this study calls for carefully aligning the partners' incentives without resort to resource investment. however, there are many limitations in this study. first of all, the key variable, inter-partner credible threat, needs to be further refined. our assessment, 100 journal ofbusiness strategies vol. 24, no.1 based on partner's asset specificity, business expertise, and political authority, is subjective and preliminary. future research may test the variable, based on survey questions and using data on ijvs in other developing countries. second, because of the data constraints, some variables may have been omitted in our regression model. for example, trust is considered to be a central feature of a strategic partnership (mohr & spekman, 1994). doz (1996) found that alliances that have developed trusting relationships over time are more likely to survive for long~r periods of time. although zhang and rajagopalan (2002) argued that inter-partner credible threat is a more critical factor than trust in ijvs, a future study along this line may consider including variables such as trust to validate the results of this analysis. references anderson, e., & gatignon, h. ( 1986). modes offoreign entry: a transaction cost of analysis and propositions. journal ofinternational business studies. fall, 1-26. arino, a. (2003). measures of strategic alliance performance: an analysis of construct validity. journal of international business studies. 34(1), 66-79. beamish, p. w. (1994). joint ventures in ldcs: partner selection and performance. management international review. 2, 60-74. beamish, p. w. (1988). multinational joint i'entures in developing countries. new york: routledge. chi, t., & roehl, t. w. (1997). the structuring of interfirm exchanges in business knowhow: evidence from international collaborative ventures. managerial and decision economics. 18, 279-294. chi, t., & seth, a. (2002). joint ventures through a real options lens. in ej. contractor & p. lorange (eds.), cooperative strategies and alliances. (pp. 71-87). kidlington, uk: elsevier. dacin, m. t., hitt, m. a., & levitas, e. (1997). selecting partners for successful international alliances: examination of u.s. and korean firms. journal of world business. 32(1),3-16. dhanaraj, c., & beamish, p. w. (2004). effect of equity ownership on the survival of international joint ventures. strategic management journal. 25(3),295-306. doney, p. m., cannon, j. p., & mullen, m. r. (1998). understanding the influence of national culture on the development of trust. academy of management review. 23, 601-620. doz, y. (1996). the evolution of cooperation in strategic alliances: initial conditions or learning processes. strategic management journal. 17, 55-83. spring 2007 duan & juma: inter-partner credible threat 101 dunning, j. h. (1988). the eclectic paradigm of international production: a restatement and some possible extensions. journal ofinternational business studies. j 9(1), 1-31. erramilli, m. k. (1996). nationality and subsidiary ownership patterns in multinational corporations. journal ofinternational business studies. 27(3), 225-248. gatignon, h., & anderson, e. (1988). the multinational corporation's degree of control over foreign subsidiaries: an empirical test of a transaction cost explanation. journal oflaw, economics. and organization, 4(2), 305-236. geringer, j. m., & hebert, l.( 1989). control and performance of international joint ventures. journal of international business studies. 20, 235-254. geringer, j. m. (1991). measuring performance of international joint ventures. journal of international business studies. 22(2), 249-264. geringer, j. m. (1988). joint venture partner selection: strategies for developed countries. westport, ny: quorum books. harrigan, k. r. (1986). managing for joint venture performance. lexington, ma: lexington books. harrigan, k. r. (1988). strategic alliances and partner asymmetries. in f. j. contractor, & p. lorange (eds.), cooperative strategies in international business. (pp. 205-226). lexington, ma: lexington books. heide, j. 8., & miner, a. s. (1992). the shadow of the future: effects of anticipated interaction and frequency of contact on buyer-seller cooperation. academy of management journal. 35, 265-291. hennart, j. f., kim, d. j., & zeng, m. (1998). the impact of joint venture status on the longevity of japanese stakes in u.s. manufacturing affiliates. organization science, 9(3), 382-395. hennart, j. f. (1991). the transaction cost theory of joint ventures: an empirical study of japanese subsidiaries in the united states. management science, 37,483-497. hill, r. c., & hellriegel, d., (1994). critical contingencies in joint venture management: some lessons from managers. organization science. 5(4), 594-607. hitt, m. a., levitas, e., arregle, j., & borza, a. (2000). partner selection in emerging and developed market contexts: resource-based and organizational learning perspective. academy of management journal, 43, 449-467. inkpen, a. c., & beamish, p. w. (1997). knowledge, bargaining power and international joint venture instability. academy of management review. 22(1), 177-202. 102 journal ofbusiness strategies vol. 24, no.1 inkpen, a. c., & currall, s. c. (1998). the nature, antecedents, and consequences ofjoint venture trust. journal of international management, 4(1), 1-20. inkpen, a. c. (1995). the management ofinternationaljoint ventures: an organizational learning perspective. london: routledge. kogut, b. (1991). joint ventures and the option to expand and acquire. management science, 37(1), 19-33. li, j. (1995). foreign entry and survival: effects of strategic choices on performance in international markets. strategic management journal, 16, 333-351. luo, y. (1997). partner selection and venturing success: the case of joint ventures with firms in the people's republic of china. organization science, 8(6),648-650. madhok, a., & tallman, s. d. (1998). resources, transactions and risks: managing value through interfirm collaborative relationships. organization science, 9, 326-339. makino, s., & beamish, p. w. (1998). performance and survival of joint ventures with non-conventional ownership structures. journal of international business studies, 29(4), 797-818. mohr, i., & spekman, r. (1994). characteristics of partnership success: partnership attributes, communication, behavior and conflict resolution techniques. strategic management journal. 15, 135-152. olk, p. (2002). evaluating strategic alliance performance. in f. j. contractor, & p. lorange (eds.), cooperative strategies and alliances, (pp. 119-143). kidlington, uk: elsevier. pan, y. (1996). influences on foreign equity ownership level in joint ventures in china. journal ofinternational business studies, 27(1), 1-26. pan, y., & chi, s. k. (1999). financial performance and survival of multinational corporations in china. strategic management journal, 20,359-374. parkhe, a. (1991). interfirm diversity, organizational learning, and longevity in global strategic alliances. journal of international business studies, 22,579-601. parkhe, a. (1993). strategic alliance structuring: a game theoretic and transactional cost examination of interfirm cooperation. academy of management journal, 36, 794-829. reich, r., & mankin, e. (1986). joint venture with japan give away our future. harvard business review, 64, 77-86. saxton, t. (1997). the effects of partner and relationship characteristics on alliance outcomes. academy of management journal, 40(2), 443-461. spring 2007 duan & juma: inter-partner credible threat 103 schaan, 1. (1988). how to control a joint venture even as a minority partner. journal of general management, 14(1),4-[6. shan, w. (1991). environmental risks and joint venture sharing arrangements. journal of international business studies, 22(4), 555-578. shaver, j. m, mitchell, w., & yeung, b. (1997). the effect of own-firm and other firm experience on foreign direct investment survival in the united states, 1987-92. strategic management journal, 18, 811-824. teece d. (1992). competition, cooperation and innovation. journal ofeconomic behavior and organization, 18, 1-25. tung, r. l. (1984). business negotiations with the japanese. lexington, ma: lexington books. williamson, o. e. (1985). the economic institutions ofcapitalism. new york: free press. yamawaki, h. (1997). exit of japanese multinationals in u.s. and european manufacturing industries. in p. buckley & j. l. mucchielli (eds.), multinational firms and international relation, (pp. 220-237). cheltenham, uk: edward elgar. yan, a. (1998). structural stability and reconfiguration of international joint ventures. journal of international business studies, 29(4), 773-796. yan, a., & zeng, m. (1999). international joint venture instability: a critique of previous research, a reconceptualization, and directions for future research. journal of international business studies, 29(4), 773-796. zhang, y, & rajagopalan, n. (2002). inter-partner credible threat in international joint ventures: an infinitely repeated prisoner's dilemma model. journal of international business studies, 33(3), 457-478. zhang, k. h. (2001). what explains the boom of foreign direct investment in china? economia internatianale. 54(2),251-274. jason duan is an assistant professor of management at cameron university. he received his ph.d. and mba from the university of illinois at urbana-champaign. his primary research interests include technology entrepreneurship, international joint ventures, foreign direct investment and asian business. his articles have appeared in journals including asia pacific journal of management, journal of applied management and entrepreneurship, and midwestern business and economic review. norma juma received a bachelor of business administration (bba) from mysore university, india and masters in business administration (mba) from 104 journal of business strategies vol. 24, no.1 pondicherry university, india. her research interest includes intellectual capital, strategic alliances and topics pertaining to new ventures. norma's work has been presented at international, national and regional conferences. her research as appeared in the international journal of innovation management, international journal ofinformation technology and management amongst others and a number of conference proceedings. inter-partner credible threat and the survival of u.s.-china joint ventures the effect of impression management strategies on earnings release announcements d. elaine sanders, ph.d. jane l. coelho, c.p.a., m.b.a. university of texas at san antonio san antonio, tx abstract this study examines the effect of impression management on the reactions of individual decision-makers in the presence of positive or negative information. in a stock price prediction task void of impression management, inexperienced investors had a more pessimistic expectation for the future stock price when unfavorable financial results were presented than when favorable financial results were presented or when investment experience was present. predictions were also consistent with the theory ofdiminishing marginal sensitivity. impression management in the form of management commentary sigmjicqntly shifted stock price expectations in the loss domain but did not affect reactions in the domain of gains. the results were consistent across prior investment experience for both the reaction to diminishing marginal sensitivity and impression management. introduction investors have numerous sources of financial and financially related information available for use in their fundamental decisions. the first purpose of this research is to explore the similarities and differences between how individuals make investment-related decisions and the outcomes predicted by the prospect theory value function (kahneman & tversky, 1979; kahneman & tversky, 1984). this hypothetical value function is normative in nature; that is, it defines how individuals actually do make decisions rather than how they should make decisions. three basic tenets may be used to describe this value function. first, individuals are assumed to select outcomes based on their relation to some reference point (usually the status quo). second, an individual's reaction will be greater in the domain of losses than in the domain of gains. third, individuals experience diminishing marginal sensitivity within the domain of gains or losses (hogarth, 1989). management has some control over the frame through which an investor views financial infonnation. through the use of voluntary disclosures, management influences the reactions of investors to financial infonnation (e.g. earnings disclosures). this desire to present management's position in the most advantageous way and to 26 journal of business strategies vol. 18, no.1 suhsequently inl1uence investor behavior is commonly called impression management (giacalone, 1989; murray, rao & schmidt, 1995). the second purpose of this research is to explore the similarities and differences between how individuals make investment-related decisions and the outcomes predicted by the value function in the presence of additional disclosure by management. in the current study, an experiment was conducted to discern how the reactions of decision-makers to accounting data fit into the hypothetical value function and to observc thc impact of impression management on those reactions. specifically. the relation betwecn earnings reports and individual investor's opinions about potential changes in stock price is observed. this research extends extant research in the area of prospect theory by showing a practical application of the theory in a business environment. the research also extends existing accounting research hy suggesting that clements of prospect theory may enrich the understanding of accounting reporting issues (i.e., individuals don't react in a rational manner to reported gains/losses or increases/decreases to net income) and by showing how impression management may be used by management to control for reactions to financial information. the balance of the paper is organized as follows. the next section contains a discussion of the literature pertaining to the value curve and impression management. the third section contains the development of the hypotheses. the fourth and fifth sections provide a detailed description of the methodology used and the analysis of the experimental results. the final section contains a discussion of the results, the limitations of the study, and suggestions for future research. theoretical background for the fiscal years 1991, 1992, and 1993, american express company (annual report, 1992 and 1993) reported net incomes (in millions) of $789, $461, and $1,478. that is a loss in 1992 (relative to 1991 net income) of $328 and a gain (relative to 1992 net income) of $1,017. earnings per share (e.p.s.) for those same years were $1.59, $.88 (a loss of $.71 relative to 1991 e.p.s.), and $2.92 (a gain of $2.04 relative to 1992 e.p.s.). what if you were an investor in amercian express? how would you have felt about your investment in 1992? in 1993'1 the way decision-makers react to these gains and losses can, theoretically, be described using the value function in figure i. this value function was derived in partial explanation of the way individuals make risky choice decisions, and that explanation is referred to as prospect theory. prospect theory prospect theory is a descriptive economic theory developed by daniel kahneman and amos tversky as an extension to expected utility theory (kahncman & tvcrsky, ]979). these pioneers in behavioral economics observed that in situations marked by uncertainty, the underlying assumptions of both expected value and expected spring 2001 sanders & coelho: impression management strategies figure 1 the hypothetical value function units of value losses ---"":":.."= . neutral value function --hypothetical value function gains 27 utility theory were systematically violated. their observations led to the development of prospect theory, which attempts to explain the deviations from rational decision-making in conditions of uncertainty. the hypothetical value function presented in figure 1 depicts the tenets outlined in the prospect theory literature. the origin represents the neutral reference point or status quo. in our example, this would be last year's net income or last year's e.p.s. outcomes in the positive domain (upper-right quadrant) are deemed to be gains relative to the origin. outcomes in the negative domain (lower-left quadrant) are evaluated as losses. note that the slope of the hypothetical value function is steeper in the domain of losses than in the domain of gains as it moves away from the origin. this contrast depicts the second basic premise of this value function commonly known as loss aversion (kahneman & tversky, 1984). the concept of loss aversion relates to the intensity or severity of the reaction when comparing gain scenarios to loss scenarios. when individuals perceive themselves in the negative domain (a loss situation) their negative reaction is more severe than is their positive reaction to an equivalent gain (bazerman, 1990; mayer, 1995). as fuller (1996) succinctly stated, "the pain associated with a given amount ofloss 28 journal of business strategies vol. 18, no. t is greater than the pleasure derived by an equivalent gain." empirical evidence suggests that the reactions in the negative domain can be twice as great as reactions in the positive domain (kahneman, knetsch & thaler, 1990; tversky & kahneman, 1991). in our example, american express investors saw a loss of $.71 per share in fiscal 1992. according to the value function, investors would feel up to twice as unsatisfied with the $.71 loss in e.p.s. as they would have felt satisfied with a $.71 gain in e.p.s. for that same year. the hypothetical value function is concave in the domain of gains and convex in the domain oflosses with the curve becoming relatively flat as it moves away from the origin. the shape of the curve suggests diminishing marginal sensiti vity in both the positive and negative domains. stated simply, a gain/loss of $2 does not give twice the pleasure/pain of a gain/loss of $1. in fiscal 1993, our american express investors saw a $2.04 gain in e.p.s. relative to 1992. how different do you think their satisfaction level would have been if the gain had been $1.90 greater than 1992 e.p.s? $2.00? $2.1o? $2.50? $3.00? an important aspect of prospect theory that relates to this study is the effect of framing on decision making. in the american express example, what frame has been encouraged? the scenario has been framed as a change in e.p.s. problem. are e.p.s. changes the only factor that drives an investor's assessment of corporate performance? most probably nol framing, however, allows the discussion to be focused on preferred issues and away from other issues. framing relates to both the methods used to present information and the individual interpretation of that information (bazerman, 1990). in conditions of uncertainty, a decision frame is formed by an individual based on the information provided and reflects his or her personal interpretation of circumstances. in forming a decision frame, the individual defines what is important or significant in selecting among alternatives. as decisions are framed, individuals may compromise their potential to make optimal choices. a frame will eliminate information, which is deemed irrelevant or unimportant, relating to the problem. therefore, once a decision is framed, the individual may have a compromised perspective on the problem. this is a direct violation of the invariance axiom of expected utility theory (von neumann & morgenstern, 1947; luce & raiffa, 1957). the invariance axiom of expected utility theory requires that qualitative descriptions of alternatives will not affect decision making (e.g., the happiness generated by finding $10 on a sidewalk will be exactly equal to the unhappiness generated by finding that $10 you are carrying has blown away). by definition, framing results in an individual taking a certain posture or stance regarding a decision. this suggests that the framing of a problem will directly affect how an individual will respond to the situation. the framing of a decision problem will directly influence the perspective of the decision-maker and, therefore, the reaction that can be expected. while the positive or negative frame of the decision does not affect diminishing marginal spring 2001 sanders & coelho: impression management strategies 29 sensitivity, both reactions are affected. if a situation is framed positively, the decision will be viewed as a gain situation, and the decision-maker should exhibit a limited positive reaction to the information. if a situation is framed negatively, the decision will be viewed as a loss situation, and the decisionmaker should behave in a more pronounced negative manner. the decisionmaker in this frame should exhibit a greater reaction to the negative information than if the decision were positively framed (brockner, 1992). impression management impression management is defined as the tendency to present oneself in a socially desirable way (giacalone, 1989) or the process by which other people's reactions are manipulated (murray et al., 1995). impression management, sometimes called "strategic communication" (allen & caillovet, 1994), refers to the strategies used by organizations to create, maintain, or improve their public image. bromley (1993) describes the entire public relations function as the corporate equivalent of impression management. impression management can be used in a number of ways by management. the different strategies employed are a function of the various target audiences. employees, customers, competitors, shareholders and potential investors have vastly different perspectives in evaluating the performance of the organization. management recognizes these different needs and attempts to utilize the appropriate communication strategy. a vast amount of financial information is provided to the market as a result of regulatory requirements. financial statements, footnotes, and audit reports have very specific guidelines for presentation and disclosure. this information is limited in its potential for furthering the public image or perception of the corporation. voluntary disclosures, however, present a unique opportunity for the application of an impression management strategy. the market for corporate control motivates the voluntary disclosure of information (kaplan, pourciau & reekers, 1990). in the absence of voluntary disclosures specifically designed to control perception, stockholders or outsiders may perceive management to be incompetent or incapable. the ultimate end result could be a change in management. with the goal of maintaining shareholder support, management will utilize various impression management strategies. these efforts extend well beyond the skillfully written news release. to improve their image in the business community, most major corporations have established investor relations programs. corporations also make efforts to promote their social responsibility by supporting non-profit organizations. these programs are all part of a public relations campaign highlighting the skill, competence, and responsiveness of management. impression management strategies are characterized by their self-serving posture. a strategy that is self-serving is typified by one taking credit for positive outcomes and placing blame on others for negative outcomes. giacalone 30 journal of business strategies vol. 18, no.1 (1989) presents two types of impression management strategies based on the two elemental situations management will attempt to control "good news" and "bad news". demotion-preventative strategies are used in the negative or "bad news" domain, while promotion-enhancing strategies are used in the positive or "good news" domain. demotion-preventative strategies are used when blame avoidance is the desirable course of action. kaplan et al. (1990) discuss three categories of impression management strategies found in situations with negative outcomes: the "excuse" strategy, the "justification" strategy, and the "change" strategy. when management utilizes an "excuse" strategy, the explanation for the unfavorable outcome is directed externally. for example, unfavorable earnings could be attributed to a weak economy or an industry slump. an excuse strategy is a means of distancing management from the unfavorable event. a study conducted by wood and mitchell (1981) found that the intensity of the unfavorable reaction was decreased when an excuse was offered in the annual report. however, it should also be noted that the results of the kaplan et al. (1990) study indicate this strategy to be the least effective of the three strategies examined. a "justification" strategy is characterized by accepting responsibility for the unfavorable outcome. the action will then be justified by demonstrating how the benefits of the action exceed its cost. for example, management may emphasize new cost-effective measures placed into the system. in the short run, the cost of implementation may be high, but in the long run profits will increase. a third impression management strategy is referred to as the "change" strategy (chugh & meador, 1984). the change strategy avoids excuses or justification for the unfavorable outcome and merely focuses on the future. it employs a proactive approach to problem solving instead of a reactive approach. managers using this strategy would simply discuss the plans and strategies for the future and ignore the current unfavorable results. let's return briefly to our american express example. in 1992, with a decrease in net income of $328 and a decrease in e.p.s. of $.71, the letter to sha;eholders in the american express annual report began as follows: from a shareholder's perspective, 1992 was not a good year for american express. we met few of your or our expectations, particularly in terms of bottom-line financial results. our net income and return on equity were inadequate, and we had too many surprises of a financial and management nature. i'm disappointed in our performance, and i know you must be. lt is my objective to see that we do much better in the future. i believe we can. although we didn't meet shareholders' expectations in terms of financial performance, we did accomplish a number of significant things that augur well for the future. travel spring 2001 sanders & coelho: impression management strategies related services put in place the major elements of its strategy to fix its problems .... (annual report, 1992). 31 the letter was short, only six pages, to the point and contained a single photograph of president and c.e.o. harvey golub. where does this letter fit among the strategies just discussed? when financial results are favorable, giacalone (1989) states that promotionenhancing strategies are typically used. while these strategies are used less often than demotion-preventative techniques, managers still use them to enhance and strengthen their image to the shareholders. management wishes to emphasize their own role in producing favorable results (kaplan et al., 1990). impression management devices in favorable situations may include descriptions of new programs implemented, visual presentations (e.g. photographs, graphs, or charts), or plans for future successes. these strategies are less influential on investors than the strategies used to soften the severity of the investors' reactions to poor company performance (giacalone, 1989). the letter to shareholders in the 1993 american express annual report was nineteen pages in length, had three executive photographs, five promotional photographs, five graphs, and two tables. in this year, net income increased by $1,017 and e.p.s. increased by $2.04. the letter began as follows: 1993 was an extraordinary time for american express. we started the year in controversy and on the defensive. we finished the year with a long list of accomplishments including achieving some of the best financial results in our history, creating a new foundation for growth with highly-motivated, reenergized employees, and rebuilding relationships with important customer groups. as with all corporations, our overriding business objective is to create shareholder value. we believe the best way to accomplish this is to work toward maki ng american express the world's most respected service brand not out of a sense of arrogance or ambition but because brands have value and great brands like ours can have great value ... (annual report 1993). accounting narratives are the main vehicles for impression management used by organizations to control reaction to earnings announcements. accounting narratives include the president's letter and the management discussion and analysis found in annual reports, voluntary press releases, and all other forms of voluntary disclosures. using an impression management strategy, management can qualify every financial item reported on and use any of the above-mentioned techniques to attempt to control and influence investors' reactions. the accounting narrative, 32 journal of business strategies vol. 18, no. i being the most easily read and understood part of the annual report, offers management an opportunity to address the events that occurred during the year and that affected financial results (jones, 1996). in summary, managers have the motive, opportunity and ability to use impression management to influence shareholder reactions to earnings announcements. managers are motivated by their desire to maintain shareholder support. the opportunity to influence this perception is provided by the use of accounting narratives that are closely associated with mandatory earnings disclosures. through accounting narratives, managers get the freedom of unregulated commentary while enjoying the close association with regulated financial results. given this opportunity, managers wi11 present current earnings in a manner that maximizes the potential for continued support from the shareholders. hypotheses accounting is commonly described as the language of business. nowhere is this truism more aptly portrayed than in the media, where earnings and earningsrelated information serve as signals of the past and future profitability of a company. the financial information provided in earnings releases is the final product of accounting effort and has been empirically shown to affect shareholder behavior (for examples, see ball & brown, 1968; lev & ohlson, 1982; kormendi & lipe, 1987). managers have a vested interest in the way earnings are perceived by shareholders because earnings are an important signal of managerial ability. management teams wish to appear strong and in control of the future of the company, thus assuaging any inclination on the part of the shareholders or outside interests to make management changes. as a result, management will use voluntary disclosures to control (or attempt to control) the degree of reaction to earnings releases (king, pownall & waymire, 1990). if the value function can be transferred into investment decisions, in a controlled environment, investors will react more negatively to earnings presented in the negative (loss) domain than to earnings presented in the positive (gain) domain. that is, in an environment of only gain or loss information, reactions will be greater for losses than for gains. while the assumption that earnings will be presented without some discussion is unrealistic, especially in the domain of losses, the controlled experimental environment allows for the testing of the hypothetical value function (kahneman & tversky, 1979; kahneman & tversky, 1984). the first hypothesis, stated in the alternative, is hypothesis i: investors' reactions to losses will be greater than reactions to corresponding gains. spring 200 i sanders & coelho: impression management strategies 33 the value function also displays marginal diminishing sensitivity in both the positive and negative domains. from the perspective of an investor, a 5% or 10% increase in earnings (using last year's earnings as a reference point) would be equally as satisfying, while a 5% or 10% decrease in earnings would be equally as painful. in this case, prospect theory would support the null hypothesis of failure to support a change in reaction across levels of gain or loss. hypothesis 2: investors' reactions will be unaffected by the level of loss or gain. a growing body of literature supports the contention that the president's letter and management analysis and commentary in annual reports has a self-serving nature (kaplan et al, 1990). even so, the studies also show that investors are swayed by these reporting strategies (staw, mckechnie & puffer, 1983). the current study uses disclosures provided through financial publications (e.g. wall street journal). earnings reports typically contain both accounting numbers and commentary. the impression management literature suggests that the reaction to losses should be altered in the presence of commentary. that is, managers will actively work to frame a loss scenario in such a manner to minimize the reaction potential of investors. the disclosures provided will serve as an intervening variable in that the earnings release will be qualified before comparison to last year's earnings (the reference point). the literature suggests, however, that impression management is not used as frequently and is less effective in the domain of gains (giacalone, 1989) in these financial publications. in the presence of impression management, investors will be cautious and less willing to revise their opinions in the domain of gains. the third and fourth hypotheses of this study involve the effect of impression management in the domain of gains and losses. impression management will help reduce the impact of bad news but will not affect the impact of good news. hypothesis 3: impression management will reduce the impact of negative information. hypothesis 4: impression management will not affect the impact of positive il~formation. methodology design a between-subjects experiment was conducted to test the hypotheses. in a controlled laboratory experiment, all possible variables not pertinent to the immediate question being tested are kept at a minimum. this is done by reducing a real-world situation to its basic elements and then rigorously controlling the 34 journal of business strategies vol. 18, no.1 information subjects may use to make a decision. while the information provided may not be realistic from a real-world perspective, the information is carefully tailored to elicit and measure a reaction by a decision maker. the experiment contained a 2 x 2 x 4 design with two levels of domain (positive or negative), two levels of impression management (absent or present), and four degrees of change within domain (20%, 40%, 60%, or 80%). in addition, one cell was added to the design as a control. information from one of the seventeen total cells was distributed randomly to each subject. task in order to test the three hypotheses, the researchers developed a series of fictitious news releases. the releases were based on an actual article published in the wall street journal detailing the financial results of a major soft drink company. to maintain control over the scenarios, portions of the article were manipulated to obtain one release for each of the seventeen conditions discussed above. each release described the earnings results for fizzyco inc., a fictitious fast food and beverage conglomerate. eight news releases described favorable (positive) earnings results for the year. four of these releases provided only accounting data gross income, per share financial information and the percentage increase over the previous fiscal year. the other four scenarios provided commentary to support and describe the favorable results in addition to the numeric financial data. within each impression management condition (absent/present), the news releases described gains over the previous period in 20% increments up to 80%. examples ofthe with and without impression management scenarios in the gain domain are presented below: without impression management fizzyco inc. reported today that net income increased (20%, 40%,60%,80%) for the fiscal year ended december 31, 1996. the food and beverages giant reported net income of ($224, $262, $299, $336) million, or (13, 15, 18,20) cents a share. last year, fizzyco earned $187 million, or eleven cents a share. with impression management fizzyco inc., capping its best year in recent memory, said net income increased (20%, 40%, 60%, 80%) for the fiscal year ended december 31, 1996, reflecting phenomenal results in the company's restaurant and international beverage operations. spring 2001 sanders & coelho: impression management strategies the food and beverages giant reported net income of ($224, $262, $299, $336) million, or (13, 15, 18, 20) cents a share, including $323 million in charges. the one-time items were tied primarily to a restructuring of overseas beverage operations and the company's casual-dining business. as expected, fizzyco said yesterday that it plans to purchase several small dining chains. last year, fizzyco earned $187 million, or eleven cents a share, which included a one-time accounting charge of $384 million. fizzyco noted that two core divisions continental beverages and dippin' chips continued to perform well, posting profits up 16% each for the year. 35 conversely, eight news releases described unfavorable (negative) earnings results for the year. the wording was consistent for both favorable and unfavorable earnings. four releases provided no details regarding the losses (i.e. no impression management) while the remaining four provided commentary regarding the source of the losses. the eight news releases described losses up to 80% over the previous year in increments of 20%. examples of the with and without impression management scenarios in the loss domain are presented below: without impression management: fizzyco inc. reported today that net income decreased (20%, 40%,60%,80%) for the fiscal year ended december 31, 1996. the food and beverages giant reported net income of ($150, $112, $75, $37) million, or (9, 7, 4, 2) cents a share. last year, fizzyco earned $187 million, or eleven cents a share. with impression management: fizzyco inc., capping its toughest year in recent memory, said net income decreased (20%, 40%, 60%, 80%) for the fiscal year ended december 31, 1996, reflecting charges and poor results in the company's restaurant and international beverage operations. the food and beverages giant reported net income of ($150, $112, $75, $37) million, or (9, 7, 4, 2) cents a share, including $323 million in charges. the one-time items were tied primarily to a restructuring of overseas beverage operations and the company's casual-dining business. as expected, fizzyco said yesterday that it plans to sell several small dining chains. 36 journal of business strategies vol. 18, no.1 last year, fizzyco earned $187 million, or eleven cents a share, which included a one-time accounting charge of $384 million. fizzyco noted that two core divisions continental beverages and dippin' chips continued to perform well, posting profits up 16% each for the year. for the sake of consistency across all cells providing commentary, a single impression management strategy was selected. because both favorable and unfavorable results were being presented (depending on domain), a "justification" strategy was selected. kaplan et at. (1990) find this strategy to be effective for "enhancing judgments and decision about the firm" (page 77). this strategy allows for the provision of a loss explanation and discussion of overall results and future benefits in both domains. the control condition described the earnings results as stable or flat when compared to the previous year. only accounting numbers were presented in the control condition (i.e., no commentary was provided). the instructions asked subjects to assume they were investors in the conglomerate and to read the article regarding the company's most recent earnings results. they were then asked to predict the direction of the company's stock price based on the disclosure presented by marking a scale provided in the task. the task concluded with a written protocol of the decision process. subjects the experimental task was completed by 257 subjects. the subjects participating in the study were student volunteers currently enrolled in upper-level accounting courses at a southwestern university. accounting students were deemed appropriate participants for this experiment. the subjects had reasonable familiarity with the basic terminology contained in standard earnings releases. the researchers felt the subjects possessed the appropriate academic and analytical skills to reach a reasonable conclusion regarding the direction of the stock price. because the student subjects were not expected to proxy for actual experienced investors, the researchers did not feel that for purposes of this experiment an advanced level of investment knowledge was required. procedure the experiment was conducted during regularly scheduled class time. the subjects were under the direct observation of the researchers at all times. after a brief introduction, each subject was asked to complete and sign a statement of informed consent. the subjects were asked not to consult their textbooks, notes or each other while completing the instrument. once the consent forms were completed and collected, the researchers distributed the different versions of the task on a random basis. the instrument consisted of the task and the exit spring 2001 sanders & coelho: impression management strategies 37 questionnaire. there was no time constraint for completing the experiment. completion times varied due to the varying lengths of the news releases. analysis and results nine subjects were dropped from the analysis due to incomplete instruments. a total of 248 usable instruments were available for analysis in the seventeen cells. the exit questionnaire provided some insightful background information on the subjects. ninety-one percent of the sample consisted of juniors and seniors in the college of business. accounting students currently enrolled in graduate-level courses made up the remaining nine percent of the sample. the sample was almost evenly divided between males and females at 47% and 53% respectively. forty-two percent of the subjects had either current or prior experience with investments in stock. a macro analysis of these exit questionnaire variables (class level, gender, and investment experience) suggested no effect for the control variables. control condition fifteen subjects were assigned to the control condition. in this condition, subjects were given no commentary and were told that the financial performance of the firm was consistent with the prior year's performance. on a likert scale of +/-5, with 0 indicating no change in stock price, the average response of the subjects was -.81. this average response is statistically different (at a = .05, scheffe) from the average responses in three of the four general conditionspositive domain with and without impression management ()l = 1.03 and m = 1.65) and negative domain without impression management ()l = -1.55). the average response in the control group was not statistically different from the average response in the negative domain with impression management ()l = 0.11). this analysis suggests that the overall direction of the responses was consistent with expectations. tests of the hypotheses the basic proposition of the value curve is posited in hypothesis l. that is, the reaction to negative information will be greater than the reaction to positive information. to test hypothesis one, only the cells containing no impression management were examined. figure 2 presents the means for each degree of change for the positive and negative domains. to measure the difference in means, the four degrees of change in each domain were collapsed to measure the overall (average) degree of change between the positive and negative domains. in other words, was the overall average in the negative domain further from zero (in a negative direction) than the distance from zero to the overall average in the positive domain (in a positive direction)? 38 journal of business strategies figure 2 reaction to gains and losses (hypothesis 1) 4 3 -3 -4 group vol. 18, no.1 the absolute values of the means for the positive and negative domain were used to measure the difference in reaction to the positive and negative information reported. the difference in the absolute value of the means between the two domains was not statistically significant (f ::;: 1.72, p ::;: 0.4892) and fails to support the first hypothesis. the subjects, on average, did not have a more severe reaction to losses than to gains. prior research suggests that sophisticated and unsophisticated (experienced and inexperienced) investors may utilize information differently in assessing stock value (hand, 1990; burns, 1995; murray et ai., 1995; de bondt & thaler, 1985; de bandt & thaler, 1987). because of the possible mixed demographics of the subject pool (the university has large numbers of second career and full-time employed students), prior investment experience was controlled for through a series of questions in the exit questionnaire. information from the exit questionnaire suggested that 27% of the subjects in the positive domain had prior investment experience, and 58% who were in the negative domain had investment experience. the test of hypothesis one required subjects to make stock price change predictions based on a very limited set of information. subjects without investment experience may have used only the information provided in their decision process. subjects with investment experience, on the other hand, may have spring 2001 sanders & coelho: impression management strategies 39 realized that potential causes of the change could possibly exist. as one subject stated in the written protocol of the task, 'there could he reasons that are valid for the decline in income that the publication did not include." an an ova was used to test whether subjects with investment experience arrived at different predictions than subjects without investment experience. a statistically significant interaction (at ex = .10) was found between investment experience and domain (f = 4.38, p = .0583). the data were separated into investment experience groups and were reanalyzed to further test the first hypothesis. figure 3 presents a visual representation of the data separated by investment experience. the question of interest was again whether investor reactions would be greater in the negative domain than in the positive domain. the absolute values of the mean stock price predictions were again compared. statistically significant differences (/lpn, = 1.56, /lnl'g = .914) were not found within the group with investment experience. in the no investment experience group, however, the absolute mean differences of the two domains (/lpn, = 1.69, /lnl'g = -2.43) were statistically different (f = 6.42, p = .0445). the subjects without investment experience reacted more strongly to a loss than to a gain, while the subjects with investment experience treated losses and gains equally. figure 3 interaction effects of domain and investment experience 4 -4 group without investment experience with investment experience 40 journal (~l business strategies vol. 18, no.1 the second hypothesis tests the marginal diminishing sensitivity tenet of the value function. to test this hypothesis, four levels of gain or loss were presented to the suhject groups. the null hypothesis would be rejected if the subjects reacted differently based on the level of gain/loss (20%, 40%, 60%,80%). comparisons of the means were conducted within each domain. the results support the concept of diminishing marginal sensitivity. in both domains, the evidence did not suggest a difference in reactions to levels of positive or negative financial results (f = 1.24, p =0.3817; f =2.21, p =0.1620). the domains were plls nc!l further divided hy impression management (present/absent) and again by level of investment experience (prior experience/no prior experience). no statistical evidence was found to reject the hypothesis of no dilterence in reactions among levels of gain or loss, regardless of the number of qualifications made. the third and fourth hypotheses suggests an ordinal interaction between domain (positive or negative) and impression management (present or absent). specifically, hypothesis 3 posits that the use of impression management will significantly reduce the effect of negative information, and hypothesis 4 posits that the usc of impression management will not significantly improve the effect of positive information. the average response in each cell is presented in figure 4. the four levels of change in the positive and negative domains were collapsed to test the overall interaction of domain and impression management. the distance from zero was measured for each of the four cells. the interaction effects were tested using an anova. a statistically significant interaction was found he tween domain and impression management (f = 15.48, p =.0001). to directly test hypotheses three and four, the data were separated into two sets based on domain and tested for the effect of impression management. in the negative domain, the effect of impression management on the prediction of stock price changes was found to be statistically significant (f = 14.96, p = 0.0002), supporting hypothesis 3. that is, the average response was significantly reduced by the presence of commentary explaining the reason for the loss. in the positive domain, a statistically significant effect was not found (f = 2.52, p = .(151). this result supports hypothesis 4 in that the presence of impression management did not statistically increase the average response of the subjects. because of the effect of investment experience found in the statistical testing of hypothesis i, the data used to analyze hypotheses 3 and 4 were also divided between investment experience and no investment experience. if subjects with no investment experience are more sensitive to the information provided than subjects with prior investment experience, the results obtained above might be incomplete. no statistical support was obtained to indicate adding a variable for investment experience to the model affected the resul ts reported above (f = .73, p = 0.3942). within each experience group, an ordinal interaction occurred with statistically different means in only the negative domain. the means for each group by investment experience are presented in table 1. the interaction was spring 200 1 sanders & coelho: impression management strategies figure 4 the effect of impression management on investor reactions 4 3 41 -3 -4 group • • without investment experience • • with investment experience table 1 means of domain and impression management by investment experience level of impression investment domain management experience n jl (j positive absent absent 42 1.69 1.72 positive present absent 36 1.14 2.40 negative absent absent 23 -2.43 1.53 negative present absent 35 -0.04 2.13 positive absent present 17 1.56 2.28 positive present present 23 0.87 2.26 negative absent present 32 -0.91 2.70 negative present present 25 0.32 2.34 42 }ollnja{ of' business stratey;ies vol. 18, no. i statistically significant (at a::::o .10) both when the subjects had prior investment experience (f ::::0 3.59, p ::::0 0.0614) and when the subjects did not have prior investment experience (f::::o 17.50, p ::::0 0.000 i). within each investment experience condition, an ordinal interaction occurred with significant differences in the negative domain hut not in the positive domain. conclusions in this study, the value function, as defined hy prospect theory, and the role of impression management were tested in a business setting using accounting data. the experiment was based on individual investor reactions to earnings changes with or without supplemental information disclosures. the results are consistent with prior theory within certain limits. contrary to the theory of joss aversion, subjects' reactions to financial losses were not different from their reactions to financial gains. when the subjects were divided by investment experience, however, a difference was found in the reactions of the two groups. subjects were encouraged to utilize only the information provided in the instrument in reaching their predictions for stock price. however, in comparing the results of suhjects with investment experience to those without previous experience, hias was indicated. the participants with investment experience tended to respond less predictably than those without investment experience. this suggests that the respondents may have been biased by previous investment experiences or investment knowledge. the subjects with no investment experienee were willing to base their predictions of stock price changes on the information presented in the experimental scenario. subjects with prior investment experienee were less willing to accept the loss scenarios as presented in the simple scenarios used for this experiment and displayed a markedly reduced reaction to the information. the researchers were aware of the number of adult, second career and military personnel at this particular university. the researchers did not know, a priori, the large proportion of subjects who would have prior investment experience in these particular classes. the results indicate a difference in reactions between levels of investment experience. subjects self-selected into these conditions in the current study. a future study could more carefully control for investment experience differences hy selecting subjects specifically to fill the investment/ no investment experience cells. more specific investment experience (e.g. financial analysts or advisors) might also be desirahle. for every decision group, the average of all responses to earnings losses and gains was consistent with the concept of diminishing marginal sensitivity. within the domain of gains and the domain oflosses, the reactions were no greater given a range of gains/losses of 20% to 80%. a limitation is that the subjects in the current study were asked to assume the role of shareholders in a hypothetical eompany. no economic incentives were spring 200 1 sanders & coelho: impression management strategies 43 presented to motivate their interest in the value of the firm's stock. while the subjects were aware that the stock was in a loss situation, the authors did not have a measure to capture the pain (if any) felt by the loss. the theory supporting the second hypothesis (diminishing marginal sensitivity) supports a failure to reject the null hypothesis and could be affected by the limitation mentioned above. by biasing the results of hypothesis two toward the null hypothesis, false support could be added to the outcome. the results obtained for hypothesis two, however, are consistent with extant theory and support the null hypothesis in all comparisons: (1) when levels of gain/loss were compared within domain, (2) when levels of impression management (present/ absent) were compared within domain, and (3) when levels of investment experience (present/absent) within impression management group (present/absent) were compared within domain. a future study could use economic incentives to further investigate the lack of reaction to negative earnings information by experienced investors and to validate the results for diminishing marginal sensiti vity. finally, the reactions in conditions with impression management were less adverse than those without impression management in the domain of losses. when subjects were provided with some form of explanation for the unfavorable earnings results, their predictions were not as pessimistic as when only the negative financial results were presented. conversely, the results for the decision groups with positive earnings scenarios appeared to be unaffected by impression management. in summary, this research supports and confirms prior research in the areas of prospect theory and impression management. in addition, these areas are extended by introducing their concepts into a business environment and by using accounting numbers to elicit a reaction to net income changes. to the authors' knowledge, no published research exists in the accounting literature on this topic. further, this research shows that impression management in the form of additional management commentary can and will affect the interpretation of raw accounting numbers. references allen, m. w. & caillovet, r. h. (1994). legitimization endeavors: impression management strategies used by an organization in crisis. communication monographs, 4456. american express company. (1992). annual report. american express company. (1993). annual report. ball, r. & brown, p. (1968). an empirical evaluation of accounting income numbers. journal of accounting research, 159-178. 44 journal of business strategies vol. 18, no.1 bazerman, m. (1990). judgment in managerial decision making. (2nd ed.), new york: john wiley and sons. brockner, j. (1992). the escalation of commitment to a failing course of action: toward theoretical progress. academy of management review, 39-61. bromley, d. b. (1993). reputation. image and impression management. west sussex, england: john wiley and sons. burns, g. (1995). what's a small investor like you ... business week, april 17,83-84. chugh, l. c. & meador, j. w. (1984). break the barrier between you and your analysts. financial executive, september, 16-21. de bondt, w. f. m. & thaler, r. (1985). does the stock market overreact? journal of finance, 40, 793-805. de bondt, w. f. m. & thaler, r. (1987). new evidence on investor overreaction and january excess returns. journal of finance. 43, 557-581. fuller, r. j. (1996). amos tversky. behavioral finance and nobel prizes. financial analysts journal, july/august, 7-8. giacalone, r. a. (1989). image control: the strategies of impression management. personnel, may, 52-55. hand, j. r. m. (1990). a test of the extended functional fixation hypothesis. the accounting review, october, 740-763. hogarth, r. (1989). judgement and choice. new york: john wiley and sons. jones, m. (1996). accounting narratives: an emerging trend. management accounting, april, 41. kahneman, d., knetsch, j. & thaler, r. h. (1990). experimental tests of the endowment effect and the coase theorem. journal of political economy, 1325-1348. kahneman, d. & tversky, a. (1979). prospect theory: an analysis of decisions under risk. econometrica, 263-291. kahneman, d. & tversky, a. (1984). choices, values, and frames. american psychologill, 341-350. kaplan, s. e., pourciau, s. & reckers, p. m. j. (1990). an examination of the effect of the president's letter and stock advisory service information on financial decisions. behavioral research in accounting, 63-92. spring 2001 sanders & coelho: impression management strategies 45 king, r., pownall, g. & waymire, g. (1990). expectations adjustments via timely management forecasts: review, synthesis, and suggestions for future research. journal of accounting literature, 113-144. kormendi, r. & lipe, r. (1987). earnings innovations, earnings persistence, and stock returns. journal of business, 323-345. lev, b. & ohlson, j. a. (1982). market-based empirical research in accounting: a review, interpretation, and extension. journal of accounting research supplement, 249-322. luce, r. d. & raiffa, h. (1957). games and decisions. new york: john wiley and sons. mayer, p. c. (1995). electricity conservation: consumer rationality versus prospect theory. contemporary economic policy, april, 109-116. murray, l. h., rao, a. & schmidt, s. m. (1995). upward impression management. human relations, february, 147-166. staw, b. m., mckechnie, p. i. & puffer, s. m. (1983). the justification of organizational performance. administrative science ouarterly, 582-600. tversky, a. & kahneman, d. (1991). loss aversion and riskless choice: a reference dependent model. quarterly journal of economics, 1039-1061. von neumann, j. & morgenstern, q. (1947). theory of games and economic behavior. (2nd ed.), princeton, nj: princeton university press. wood, r. e. & mitchell, t. r. (1981). manager behavior in a social context: the impact of impression management on attributions and disciplinary actions. organizational behavior and human performance, december, 356-378. d. elaine sanders is an associate professor of accounting at the university of texas at san antonio where she teaches undergraduate and graduate courses in cost and management accounting. she received her ph.d. in accounting from the university of oklahoma after working in industry. dr. sanders has previously published in a number of journals including journal of business stratel:ies, journal of managerial issues, and orl:anizational behavior and human decision processes. jane l. coelho received her master of business administration from the university of texas at san antonio. mrs. coelho has worked in both public and corporate accounting. she is a certified public accountant and currently has a private practice in san antonio, texas. the effect of impression management strategies on earnings release announcements an interpretive perspective on the role of strategic control in triggering strategic change scott d. julian saginaw valley state university university center, mi elton scifres stephen f. austin state university nacogdoches, tx abstract rapidly changing environments press organizations to respond in an appropriate and timely fashion. strategic control plays an important role in this adaptation process through its identification and interpretation of "change triggers" critical events in the external environment that mandate an organization's response. we argue that giving more prominent place to data interpretation in the strategic control process facilitates the identification of factors that trigger change. we build a conceptual model around a three-step process of scanning/monitoring, data interpretation, and response combined with three different levels of strategic control (strategic surveillance. premise monitoring, and implementation control). the model assists managers by highlighting the factors that can cause type ii errors (not changing when change is required) and provides researchers with directions for future inquiry. introduction business leaders face an unprecedented level of market turmoil and dynamism. the globalization of markets, the liberalization of the former east-bloc economies, the increasing diversity of the workforce, and the rising ubiquity of the internet are only a few of the factors driving rapid change. such changes mandate responses on the part of individual businesses but this begs several questions of managers: do we need to respond, when should we respond, and what should be the nature of our response? while managers have faced similar questions in the past, there is growing agreement that the pace of change has quickened: managers have less time to respond to change. change triggers are events in the external environment of such importance and magnitude that they mandate an organization's response (napster had no choice but to respond to court rulings that it had violated copyright protection). these change triggers play an important role in strategic control. rajagopalan and spreitzer (1997) identified triggering strategic change as a "key unresolved issue" in the academic literature (p. 72), and called for more research into this 142 journal of business strategies vol. 19, no.2 important area. strategic changes are adjustments an organization makes to better align itself with its environment, improving the likelihood of successful strategy implementation. one reason triggering change remains unresolved is that the literature cited by these authors has generally not employed frameworks or concepts from research on strategic control. the strategic control literature has more directly addressed this issue of triggering change (muralidharan, 1997; picken & dess, 1997; preble, 1992). for example, schreyogg and steinmann (1987) identified three different ways in which the need for strategic changes can be identified: tracking performance indicators; challenging the validity of crucial assumptions underlying a particular strategy; and identifying emerging issues through macro-environmental scanning. we assert that the value of strategic control research in addressing the triggering of change can be enhanced by more fully integrating data interpretation into models of strategic control. while rajagopalan and spreitzer (1997) incorporated managerial cognition and data interpretation into their multi-lens framework of strategic change, these concepts have generally been overlooked in strategic control studies (fiegener, 1994,1997; and lorange, eta!., 1986 are notable exceptions). currently, no research has systematically applied cognitive and interpretive concepts to strategic control, nor has it attempted to present strategic control as essentially a data interpretation activity. we, therefore, consider strategic control from an interpretation perspective and then apply this interpretive framework to the issue of the timely triggering of strategic change. model of the strategic control process strategic control involves the monitoring and evaluation of plans, activities, and results with a view toward future action (goold & quinn, 1990; preble, 1992), providing a "warning bell" through diagnosis of data (quinn, 1996). the clear intent of strategic control is the triggering of appropriate changes in strategy, be they either tactical adjustments or strategic reorientations (lorange, et ai., 1986; lorange, 1988). this set of rational procedures strongly reflects what rajagopalan and spreitzer (1997) termed the "rational lens" perspective of strategic change. our working definition of strategic control, then, is "a set of monitoring procedures that provide information for triggering strategy modification." one could argue that identifying and interpreting change triggers is equivalent to testing hypotheses: the researcher faces the risk of both type i and type ii errors (boyd, dess & rasheed, 1993). an effecti ve strategic control system is one that triggers the appropriate response at the appropriate time, avoiding both types of errors. from a strategic control perspective, a type i error occurs when the situation does not require a tactical or strategic change yet managers misread signals and assume that such change is required. a type ii error occurs when the organization is too inert: managers fail to recognize the need for strategic change in situations where it actually exists. while type i errors are certainly possible, fall 2002 julian & sc~fres: triggering strategic change 143 given the current dynamic business environment, inertia-like type ii errors are the more likely problem. in statistics, type ii errors can be caused by a variety of factors. the sample size may too small to provide enough information or an adequate level of statistical power. we consider this a "data" issue. in strategic control, small sample size problems correspond to having an inadequate amount of the correct type of data. a given strategic control system may collect and disseminate a large amount of data, but if it is not appropriate data then an organization's decision-makers suffer the equivalent of a small sample size. alternatively, alpha, the point at which managers reject the null hypothesis that no change is required (thus, triggering change), may be set too low. we consider this a "decision" issue. various factors both inside and outside of an organization can affect trigger sensiti vity, related to the setting of alpha, or the point at which managers decide to reject the null hypothesis and trigger strategic change. we suggest that the structure of scanning and monitoring activities can cause data problems and that an organization's external and internal contexts can cause decision problems. such unrecognized data shortcomings and unintended sensitivity shifts can increase the risk of type ii errors whereby managers fail to trigger timely and appropriate change. model summary to trigger either tactical adjustments or strategic reorientations, decisionmakers must collect data, make a determination as to its meaning through comparison to preexisting standards or aspirations, and then respond in some way. it is, in other words, inherently a data interpretation process. this interpretation is more than simple analysis of data. it is an elaborate sense-making activity whereby organizational actors try to give meaning to complex, and possibly unordered, data (daft & weick, 1984; weick, 1995). through formal analysis, managerial judgment, intuition, and social information processing, organizational members make sense of the world around them. the strategic control model in figure i is based on this interpretive view of triggering strategic change and identifies a variety of factors potentially affecting inertia-like, type ii errors. we present strategic control as an interpretation process having three stages: scanning/monitoring; analysis/interpretation; and response (daft & weick, 1984; weick, 1995). scanning and/or monitoring of various factors in the external and internal environments is the first of these three. in the next stage, data analysis and interpretation, organizational members imbue data with meaning. depending on the results of the second stage, the organization takes some kind of action, or responds. in the content dimension of figure i, we represent strategic control as comprising three separate activities: strategic surveillance; premise control; and implementation control (muralidharan, 1997; preble, 1992; schreyogg & steinmann, 1987). this multi-faceted, and multi-level, approach captures the variety of tasks strategic control must involve given today's increasingly demanding business environments. additionally, these different tasks represent three different 144 journal of business strategies vol. 19, no.2 ways that strategic change can be triggered, each involving a different focus of attention and process. figure 1 model of the strategic control process \ external context • uncertainty • munificence process of strategic !l\ content control [ of strategic scanning! data control ....-_m_o_n_i_to_r_in_9_--, interpretation strategic issue assessment surveillance • threat system ----l....~ • urgency • formality • understanding • centralization • capability strategic surveillance • environment --r-----premise control • strategic assumptions premise monitoring system • formality • centralization ----l~~ premise validity • extent • criticality response • magnitude ... • immediacy • locus implementation control • performance targets implementation monitoring system • formality • centralization --'-------... threshold exception • extent • criticality v i internal context • strategy • structure • performance • resources strategic surveillance is broad-based monitoring of the environment whereby the organization interprets, analyzes, and responds to strategic issues (muralidharan, 1997; preble, 1992; schreyogg & steinmann, 1987). since the process of strategy planning and implementation normally tends to narrow the scope of awareness to a relatively few number of factors (miller, 1993), organizations need to broaden their scope of attention. strategic surveillance helps identify trends and developments emerging from areas not previously identified fall 2002 julian & sc(fres: triggering strategic change 145 as important (preble, 1992). decision makers package unordered data and stimuli from the environment into coherent and related sets called "issues" that they then can analyze and assess as to their potential impact (martins & kambil, 1999; sharma, 2000). premise control, the second strategic control component, concerns the underlying strategic assumptions made in earlier planning efforts regarding internal and external factors (lampel & shamsie, 2000; preble, 1992). during strategy formulation, executives identify critical assumptions underlying their strategy (lorange, 1988). once executives identify these assumptions, effective organizations design and implement monitoring systems to ascertain their continued validity. the strength of premise control is its feedforward nature, since it is able to identify potential problems while they are still minor and before they affect an organization's performance (schreyogg & steinmann, 1987). implementation control, the third strategic control component, requires monitoring strategy implementation performance, usually through milestones, critical success factors, budgets and thresholds, and takes the form of classic feedback control (preble, 1992; schreyogg & steinmann, 1987). its purpose is to aid managers in making a determination, based on strategy implementation, whether to alter the basic strategic direction. managers identify important milestones and set strategic thresholds to assist them in knowing when they should consider a change in strategy (muralidharan, 1997). thus, as indicated above, strategic change can be triggered in a number of ways. concerning strategic surveillance, some environmental changes have sudden and immediate impact. the discovery of mad cow disease in the uk in 2000 depressed beef sales in europe requiring fast food firms to promote alternati ve menus of chicken or fish. other environmental changes like deregulation emerge more slowly and have predictable consequences: increased competition, pricing pressures, and increased innovation to name but a few. astute managers respond forcefully to such change triggers. when the fcc decreed that telephone companies could transmit video signals over phone lines, many cable companies recognized the clear and immediate threat this created. the response of these firms was to merge or partner with telephone companies to reduce the effects of direct competition. at a more subtle level, slow and incremental changes in an environment can accumulate until they reach or pass a strategic change trigger. this was certainly the case of the fast food industry in the mid1990s. food researchers had discovered that as people age, their taste buds begin to die; older consumers required more flavor in order to receive the same positive taste experience they had as youth (taylor, et al., 2001). mcdonald's, recognizing a decline in share as its customer base aged, responded by creating the "arch deluxe" and positioning it as the hamburger for adults. regarding premise control and change triggers, managers will have identified specific assumptions, the falsehood of which would indicate the need for a strategic change. for example, gm had assumed that its saturn division could attain a certain level of costs and when it became apparent that it could not, gm's 146 journal of business strategies vol. 19, no.2 executives altered its "saturn strategy" (muralidharan, 1997). strategic change can also be triggered by the failure to attain certain levels of anticipated performance, and this occurs through the process of implementation control. the lagging far below aspirations of financial performance and market share indicators, for example, will likely generate some form of strategy modification in order to correct the situation. in other cases, firms may recognize that they are in a unique resource position that allows them to undertake dramatic new strategies. such was the case of aol, which used its inflated stock price at the end of the millennium to acquire time warner (drummond, 2000). in some instances, it may seem that strategic change has some other precipitating event, such as a new ceo (think of jack welch at general electric, for example, and the strategic changes that ensued). the changes such an individual initiates, however, are probably based on different interpretations of issues, divergent strategic assumptions, or higher aspiration levels, relating to the three strategic control components. data interpretation interpretation occurs in each of the three content components of the strategic control process, although in some cases it would seem that analysis would be cut-and-dried: either a milestone was missed or made, a threshold exceeded or not. in practice, managers frequently use discretion in such situations that may require their judgment (finkelstein & hambrick, 1996). researchers in strategic issue management have extensively explored the interpretation of important developments and trends identified in strategic surveillance. once organizational decision makers have assembled a confluence of related stimuli into a strategic issue (dutton, 1993), they make various assessments and categorizations. for example, decision-makers may assess the issue as an opportunity or a threat, influencing the organization's response (denison, et ai., 1996). they also assess the issue's urgency, the organization's understanding of the issue, and its capability to respond (dutton & duncan, 1987; ginsberg & venkatraman, 1995). data interpretation in premise control concerns the validity of premises that underlie the current strategy. data relating to this assessment addresses stakeholder behavior and may be equivocal, given the qualitative nature of many of these assumptions (preble, 1992). decision-makers must make judgments pertaining to the degree of violation and the criticality of that particular assumption. although all the assumptions by definition are "critical," some premises may be more important than others in the eyes of decision-makers, based on changing factors in the external and internal contexts (discussed later) and their potential strategic consequences. data interpretation for implementation control involves assessing whether an organization has missed milestones or exceeded thresholds. an organization's executives will have set these performance targets and identified critical success factors earlier during strategic planning (muralidharan, 1997). while deciding fall 2002 julian & scifres: triggering strategic change 147 if any negative variances or missed targets have occurred may be a relatively simple task, deciding what this data might mean may not. in some cases, managers properly resist alterations to strategy in order to avoid a type i error. decision-makers must assess the extent and criticality of exceptions, an interpretational process heavily dependent on what they might consider extenuating circumstances. organizational responses the factors affecting data interpretation are important because of the effect interpretation has on organizational responses. type ii errors are a concern in that they result in organizational responses that are either too slow in coming or of too little magnitude to adequately deal with problems at hand. we now briefly examine the effects of interpretation on both response and the internal context. data interpretation can influence the kinds of responses organizations take (e.g., ginsberg & venkatraman, 1995; thomas, clark, & gioia, 1993). we show this in figure 1 by the three arrows pointing from the data interpretation stage to response, each arrow representing interpretations relating to a different strategic control content component. research examining organizational responses to various issues and events has made extensive use ofthree particular dimensions: magnitude, the size of response; immediacy, the rapidity of response; and locus, the extent to which the response is outwardor inward-directed (ferrier, smith, & grimm, 1999; smith & grimm, 1991; thomas, et al., 1993). strategic surveillance responses depend on managerial assessments of issue threat, urgency, understanding, and capability. for example, the more urgent an issue, the greater the extent of response to it (ginsberg & vekatraman, 1995). responses relating to premise control depend upon assessment of premise validity. if decision-makers find strategic assumptions to be valid, a likely response will be to do nothing. if decision-makers find strategic assumptions to be invalid, the response would depend upon assumption criticality and the extent of assumption violation. responses relating to implementation control are similar to those corresponding to premise control. once an organization responds, the internal context of the firm changes since responses primarily consist of manipulating strategy, structure, and resources; factors often assumed to be under decision makers' control. these responses can indirectly affect the manner in which an organization carries out strategic control, the types of data interpretations made, or even perceptions of the external environment, depending upon the nature of the responses. these changes can then influence the kinds of responses made in the future as part of the strategic control process. in the preceding sections we have outlined the basic elements of our strategic control model. in the following sections. we attempt to explore the influence of various contextual factors on organizational response. specifically we shall offer a series of propositions that explore the influence of 148 journal of business strategies vol. 19, no.2 scanning/monitoring system characteristics, the external context, and the internal context. the influence of scanningimonitoring system characteristics the structure of the scanning/monitoring process and implementation systems can also affect data interpretation, and hence, the likelihood of type ii nonresponse errors. figure i indicates this by the arrows pointing from the various systems in the scanning/monitoring stage to the data interpretation stage. research has suggested that process formality and centralization are two important aspects of scanning/monitoring (dutton, 1993; sutcliffe, 1994). process formality is the rationalization of strategic control by standardized and routinized procedures and data sources, such as market studies, published statistics, budgets, and audits (band & scanlan, 1995; mintzberg, 1994, picken & dess, 1997). centralization refers to the degree to which individuals at higher levels in the organization's hierarchy perform scanning/monitoring activities (sutcliffe, 1994). our concern here is to identify the likely effects of formality and centralization on data interpretation and trigger sensitivity. to this end, we offer the following series of propositions. formality in strategic surveillance. formality in environmental scanning can influence assessments of strategic issues. it is generally not possible, a priori, to know what developments in, or sectors of, an environment will be the source of new critical contingencies. formalized strategic issue diagnosis prespecifies where to scan for strategic issues and this limits cognitive effort and restricts the search for information (dutton, 1993; starbuck & milliken, 1988). beyond this, such "automatic" information processing often leads to the use of ready made, though perhaps inappropriate, categories (dutton, 1993). inertia and lethargy in interpretation caused by formalization reduces awareness of, and responsiveness to, newly emerging issues. such routinization also leads, over time, to monitoring a more narrow set of environmental factors (mi11er, 1993). although he recognized some benefits of formalization, mintzberg (1994) criticized formal systems and the hard data they often produce. he argued that hard data lacks richness, is too aggregated, is often late, and may not always be reliable (pp. 259-264). those depending on such systems may fail to receive the proper amount of the right kind of data. a formal scanning system wi11 thus likely focus attention in the wrong direction and lead to the under collection of the correct type of data, corresponding to a low sample size problem. the experiences of ibm exemplify the problems with a high level of formality in strategic survei11ance (loomis, 1993). ibm instituted a mass of bureaucratic procedures to gain control of the confusion surrounding its introduction of the 360 mainframe computer in the mid-1960s. formalization proved less useful when applied, as it eventually was, to the collection and assessment of environmental data. focus on the process of analysis and decision making, rather than the meaning of the data itself, caused them to react slowly to emergfall 2002 julian & scifres: triggering strategic change 149 ing issues such as rise technology. based on the foregoing, we posit the following proposition. proposition 1: formal strategic surveillance systems increase the chance oj type ii errors. formality in premise and implementation monitoring. formalization should have an effect on trigger sensitivity relating to premise and implementation monitoring. system formality routinizes the collection and reporting of data, thus assuring its timely availability. formalization is effective in focusing attention, establishing participation, and ordering data (mintzberg, 1994), all useful functions in performance and premise monitoring. schreyogg and steinmann (1987) suggested that formalization be high to moderate in premise and implementation monitoring since prespecification of the factors on which managers should focus their attention is possible in these forms of strategic control. decision makers often do not detect poor performance or premise invalidity early enough to implement timely and effective responses (weitzel & jonsson, 1989), and in part we attribute such type ii errors to insufficient amounts of data. where the process of monitoring performance and premises is ad hoc and informal, decision makers may fail to receive an adequate amount of timely data: a low sample size problem. fiegener (1997) found that perceptions of strategic control effectiveness increased as system formality increased. the implication here is that formality increases trigger sensitivity level by increasing available data. thus, we posit the following proposition. proposition 2: formal premise and implementation monitoring systems decrease the likelihood oj type ii errors. centralization in strategic surveillance and premise monitoring. the effect of centralization on strategic surveillance and premise monitoring trigger sensitivity is influenced by the need for those so engaged to have understanding of the larger strategic context of the firm. when scanning is decentralized, for example, lower level personnel often will not know the relevance of information to which they have access or will fail to communicate it adequately to their superiors (shank, et ai., 1988; sutcliffe, 1994). individuals at higher levels in the firm's hierarchy are more likely to possess the necessary intimate knowledge of the strategic posture and its underlying assumptions, so they are the ones best suited for strategic surveillance and premise control. through more immediate comprehension of the significance of information gathered through strategic surveillance and premise control activities, centralization of these activities should lead to a reduced likelihood of type ii errors. this logic leads to the following proposition. 150 journal of business strategies vol. 19, no.2 proposition 3: centralized strategic surveillance and premise monitoring systems decrease the likelihood of type ii errors. centralization in implementation monitoring. schreyogg and steinmann (1987) recommended that centralization in implementation monitoring be moderate to low. lower level managers have immediate access to data addressing strategy implementation and are likely to be well aware of the importance of the pertinent milestones and thresholds. delays and distortions are often involved with communicating implementation control data up the corporate hierarchy and then communicating back higher-level manager's responses to that data, known as the serial transmission effect. centralization can also lead to executive complacency since they think they have higher levels of understanding due to their close involvement with the data, when in fact this data may be distorted (mintzberg, 1994). thus, centralization can lead to higher risks of type ii errors through both reducing the amount of relevant data and lowering alpha, the point at which managers recognize the need to change. therefore, we suggest the following proposition. proposition 4: centralized implementation monitoring systems increase the likelihood of type ii errors. the external context and its influence the interpretation process is subject to various contextual forces (dutton & ottensmeyer, 1987; sharma, et a1., 1999). according to our interpretive framework, both the organizational and the environmental contexts directly influence the strategic control process at the scanning/monitoring and the data interpretation stages. these contextual factors affect the risk of type ii errors primarily through low alpha problems, or reduced trigger sensitivity. the recent experiences of firms in the recording industry illustrate how external environmental shifts can increase the chances of type ii errors. startup firms, such as napster, saw the potential of the internet as a new distribution system more convenient and responsive to consumers' needs and interests. established recording firms, however, were slow to react to changes brought about by the world wide web, changes that could have completely bypassed the current system based on physical distribution and decentralized retailing. as it turns out, some firms, such as bertelsmann, are belatedly exploring new options made possible by the internet (leonard, 2001). had the courts not severely restricted this new distribution model, firms in the recording industry could have faced an uncertain and threatening future. generalizing from this example, we suggest that the external context, composed of organizational perceptions of the environment, can influence both scanning/monitoring and interpretation, as shown in figure 1. we focus on the direct effect of the external context on interpretation, though we recognize the external context can indirectly affect interpretation via the structure of and fall 2002 julian & scifres: triggering strategic change 151 emphasis on scanning/monitoring. two primary dimensions used to measure the external environment are uncertainty and munificence. uncertainty is the degree of unpredictability in an environment and consists of dynamism (the rate of change) and complexity (the number of factors that must be considered to understand an environment) (clark, et ai., 1994; sharfman & dean, 1991). munificence is the abundance ofresources in an environment needed by organizations operating within it (castrogiovanni, 1991; mcarthur & nystrom, 1991). the influence of these environmental dimensions is explored in the following proposi tions. increasing environmental uncertainty. environmental perceptions developed over time form a cognitive filter molding and influencing subsequent decision-maker understanding of data gathered during scanning/monitoring (boyd, dess, & rasheed, 1993). decision-makers who have operated in a relatively placid and simple environment, where change occurred slowly and predictably and the number of factors to be tracked was low, would tend to think there is plenty of time to deal with an emerging strategic issue, premise invalidity, or performance threshold exception. this view would seem plausible since there has always been time to adequately respond in the past and because the relative simplicity of the external environment lent itself to easy and rapid analysis. thus, previous experience in a certain environment would tend to increase the risk of type ii errors by lowered trigger sensitivity, particularly when environmental dynamism and complexity have recently increased. on the other hand, if dynamism has recently slowed, decision-makers might be more prone to type i errors: changing when it is not required. clearly, given the increasing rates of change in business in recent years, the former situation requires greater managerial attention in strategic control than the latter. thus, we posit the following proposition. proposition 5: the likelihood of type ii errors increases when organizational environments shift from certain (placid and simple) to uncertain (dynamic and complex). decreasing environmental munificence. environmental munificence can affect interpretations resulting from premise monitoring and implementation control. munificent environments have capacity and opportunity for growth (castrogiovanni, 1991) and are very forgiving in that survival and profitability are relatively easy. decision makers having previously operated in a munificent environment would be less likely to view invalidation of a premise or violation of a performance threshold as a critical or alarming event, given the "extenuating circumstances" of the bountiful external context. hence, type ii errors via lowered trigger sensitivity are made more likely by previous involvement with munificent environments, particularly when these environments have become 152 journal (~f business strategies vol. 19, no.2 more hostile. decision-makers in environments of increasing munificence, however, might be vulnerable to type i errors, as above. given that competition within many industry environments seems to generally be on the rise, however, the former situation is likely to require a greater amount of managerial attention than the latter. we, therefore, suggest the following proposition. proposition 6: the likelihood of type ii errors increase when an organization:~ environment shifts from munificent to hostile. the internal context and its influence the internal context, which includes strategy, structure, performance, and resources, also influences scanning/monitoring and interpretation activities as shown in figure i. again, our focus is on the impact of the internal context on interpretation, though an indirect effect mediated by scanning/monitoring can also exist. the following discussion explores the influence of strategy and performance on data interpretation and response. defender-type strategies. using the prospector/defender strategy typology as an example of the effect of internal context (ketchen, et ai., 1993; miles & snow, 1978), organizations with aggressive, prospector-type strategies are likely to differ from defenders in their interpretation of strategic issues. for example, prospectors are likely to rate highly their organizational capability in relation to emerging issues. since prospectors seek out change, and indeed, are often the originators of it, decision makers within these organizations are likely to feel very comfortable regarding their ability to deal with change, even if they do not control it. defenders avoid change, however, and this lack of comfort with change would lead to much lower assessments regarding capability to deal with new strategic issues. decision makers in defender firms are more focused on a narrow market niche, selected for its stability. such organizations are not structured for change (foxwolfgram, et ai., 1998), nor are they anticipating the need to change. because of this, such decision-makers in defenders firms may not view newly emerging strategic issues, for example, as very relevant for their organization. such lowering of trigger sensitivity increases the risk of type ii errors for defender firms. enron is a good example of how firms with a prospector-type strategy have a lower risk of type ii errors. this firm is well known for its aggressive and innovative market moves involving not only energy but also in the trading of commodities. enron recognized the significance of the internet in relation to its gas trading business and in a matter of months got a website up and running whereon clients could trade natural gas (hamel, 2000). based on the foregoing, we posit the following proposition. proposition 7: the likelihood of type ii errors is higher in defender firms than it is in prospector firms. fall 2002 julian & scifres: triggering strategic change 153 strong organizational performance. organizational performance, another internal context dimension, can also affect data interpretations. the risk-return paradox suggests that poorly performing firms are risk seeking while higher performing firms are risk averse (feigenbaum & thomas, 1988). our model suggests that interpretation mediates this linkage. high performance levels result in an interpretation context where managers are more likely to assess performance threshold exceptions, for example, as being of low criticality. since performance is strong, managers may be complacent and satisfied (audia, et ai., 2000), perceiving a larger margin for error than may actually exist, in effect lowering their trigger sensitivity. digital equipment corporation enjoyed strong performance in the 1970s through its reputation for building high quality, reliable computers. this success, however, resulted in a lack of sensitivity to the emerging trend of smaller size and user-friendliness in technology (miller, 1993). their entry into the personal computer market failed to incorporate these new customer demands and was a dismal failure. similar failures in commercialization led to the eventualloss of billions of dollars in the early 1990s. consistent with this logic and example, we posit the following proposition. proposition 8: the likelihood of type ii errors is higher when organizational performance is strong, table i summarizes these eight propositions. in addition, the model includes links to other relationships. since these are neither of direct nor central importance to the triggering of strategic change, we do not discuss them here. we include them so as not to imply that these linkages do not exist. table 1 factors affecting the likelihood of type ii errors proposition factors effect on type ii error strategic surveillance formality increase 2 premise monitoring formality decrease 3 strategic surveillance & premise monitoring centralization decrease 4 implementation monitoring centralization increase 5 increasing environmental uncertainty increase 6 decreasing environmental munificence increase 7 defender-type strategies increase 8 strong organizational performance increase 154 journal of business strategies vol. 19, no.2 summary and implications for future research through its scanning and interpretation components, strategic control represents a primary driver of strategic change. the increasingly discontinuous nature of today's business environments makes the discovery and interpretation of change triggers essential to proper strategic reorientations or tactical adjustments. thus, strategic control has an essential role to play in avoiding type ii errors: failing to change when change is required. by more fully integrating the concept of data interpretation into strategic control, one can facilitate the identification of the factors affecting trigger sensitivity and can more easily discern their likely effects. previous research has not sufficiently incorporated interpretation into conceptualizations of strategic control; this paper makes progress toward that end. rajagopalan and spreitzer (1997) recommended that researchers employ a variety of lenses, such as rational, cognitive, and learning. our strategic control framework employs all three perspectives: the rational approach of traditional strategic control; the cognitive approach that considers strategic control as a data interpretation activity; and the learning approach of the feedback loops from response to internal context and data interpretation to external environment. by using multiple viewpoints, our interpretive framework more effectively illustrates the pattern of influences operating on strategic control and affecting the risks of inertia-like, type ii errors. using our interpretive framework, practitioners can be more aware of the variety of factors that influence the operation of their strategic control system and therefore their company. timely and appropriate strategic change is more likely to occur when managers design and operate strategic control systems with these factors in mind. managers should exercise their choices regarding these structural characteristics while being mindful that formality and centralization can make type ii errors more or less likely, depending upon the type of strategic control activity. in addition, the framework suggests that trigger errors of either type are more likely to occur when there has been a dramatic shift in the external environment. given this increased potential for type i and type ii errors, managers could adjust the control system structure to compensate for these tendencies. testing our eight propositions would involve measuring both the dependent (type ii errors) and independent (structure, context) variables. the challenge in measuring the dependent variable is to identify situations where not only did an organization fail to initiate change, but to also specify when such changes were actually necessary. through the use of archival data (as done, for example, in ferrier, et al. [1999]), after-the-fact determination of whether a change was needed or not could occur through the use of a panel of either industry and/or academic experts. if a change in strategy was required but none initiated, for example, this situation could be coded as a type ii error. consultation of annual reports would enable measurement of some internal context variables (performance, for example; or certain indicators of strategy); whereas reference to fall 2002 julian & scifres: triggering strategic change 155 secondary data relating to industry conditions would enable measurement of the external context variables (uncertainty and munificence). measuring strategic control system structure, however, would be more difficult and could require the use of retrospective accounts. a possible and preliminary alternative to this would be to utilize a business simulation to generate the needed data, as done in audia, et al. (2000). in such a case, situational generalizability would have to be traded off against data availability and validity. given that the dependent variable would have two categories (change required, did change; change required, did not change), the data could be analyzed by using logistic regression. our interpretive strategic control model highlights some important areas for future research. for example, does the external context influence strategic surveillance activities more than it affects premise and implementation monitoring? does it influence them in different ways? does the internal context influence each component of control or the emphasis placed on each component? other issues relate to strategic control system performance (fiegener, 1994, 1997), and several questions appear particularly relevant. do organizations with certain types strategic control systems outperform those that do not have them? which component of strategic control has the most significant effect on performance and what environmental and organizational characteristics moderate this relationship? the interpretive model also captures the iterative and dynamic nature of strategic control, providing a useful background for viewing strategic control activities as complex adaptive systems (anderson, 1999). for example, the structure of an organization's scanning/monitoring systems influences interpretation, which influences organizational responses, which change the internal context and thus the scanning/monitoring system. being complex and adaptive, the state of any strategic control system at time t+ i is a function of its state at time 1. thus, it is entirely likely that slight differences in initial conditions can, over time and through continuous iteration, be magnified orders of magnitude by self-reinforcing and positive feedback loops. our model fits well within the burgeoning research on organizations as complex adaptive systems. future research along these lines using our interpretive model as a template might prove fruitful. references anderson, p. (1999). complexity theory and organization science. organization science, 10, 216-232. audia, p.g., locke, e.a., & smith, k.g. (2000). the paradox of success: an archival and a laboratory study of strategic persistence following radical environmental change. academy of management journal, 42,837-853. band, d.c., & scanlan, g. (1995). strategic control through core competencies. long range planning, 28(2), 102-114. 156 journal of business strategies vol. j9, no.2 boyd, b.k., dess, g.g., & rasheed, a.m.a. (1993). divergence between archival and perceptual measures of the environment: causes and consequences. academy of management review, 18, 204-226. castrogiovanni, g.j. (1991). environmental munificence: a theoretical assessment. academy of management review, 16, 542-564. clark, t., varadrajan, p.r., & pride, w.m. (1994). environmental management: the construct and research propositions. journal of business research, 29, 23-38. daft, r.l, & weick, k.e. (1984). toward a model of organizations as interpretation systems. academy of management review, 9, 284-295. denison, d.r., dutton, j.e., kahn, j.a., & hart, s.l. (1996). organization context and the interpretation of strategic issues: a note on ceo's interpretations of foreign investment. journal of management studies, 33,453-474. drummond, m. (2000). big music fights back. business 2.0, december 12, 154. dutton, j.e. (1993). interpretations on automatic: a different view of strategic issue diagnosis. journal of management studies, 30, 339-357. dutton, le., & duncan, r.b. (1987). the creation of momentum for change through the process of strategic issue diagnosis. strategic management journal, 8, 279-295. dutton, le., & ottens meyer, e. (1987). strategic issue management systems: forms, functions, and contexts. academy of management review, 12, 355-365. ferrier, w.j., smith, k.g., & grimm, c.m. (1999). the role of competitive action in market share erosion and industry dethronement: a study of leaders and challengers. academy of management journal, 42, 372-388. fiegenbaum, a., & thomas, h. (1988). attitudes toward risk and the risk-return paradox: prospect theory explanations. academy of management journal, 31, 85-106. fiegener, m.k. (1994). matching business level strategic controls to strategy: impact on control system effectiveness. journal of applied business research, 10, 25-34. fiegener, m.k. (1997). the control of strategy in dynamic versus stable environments. journal of managerial issues, 9(l), 72-85. finkelstein, s., & hambrick, d.c. (1996). strategic leadership: top executives and their effect on organizations. minneapolis/st. paul: west publishing. fox-wolfgramm, s.j., boal, k., & hunt, j.g. (l998). organizational adaptation to institutional change: a comparative study of first-order change in prospector and defender banks. administrative science quarterly, 43, 87-126. fall 2002 julian & scifres: triggering strategic change 157 ginsberg, a., & venkatraman, n. (1995). institutional initiatives for technological change: from issue interpretation to strategic choice. organization studies, 16, 425-488. goold, m., & quinn, j.j. (1990). the paradox of strategic controls. strategic management journal, ii, 43-57. hamel, g. (2000). driving grassroots growth. fortune, 142(5), 173-187. ketchen, d.j., jr., thomas, j.b., & snow, c.c. (1993). organizational configurations and performance: a comparison of theoretical approaches. academy of management journal, 36, 1278-1313. lampel, j., & shamsie, j. (2000). probing the unobtrusive link: dominant logic and the design of joint ventures at g.e. strategic management journal, 21, 593-602. leonard, d. (200 i). the music men are out of tune. fortune, 143(12), 144-148. loomis, c. (1993). dinosaurs? fortune, 127(9),36+. lorange, p. (1988). monitoring strategic process and ad hoc strategic modification. in j. grant (ed.), strategic management frontiers: 261-285. greenwich, ct: jai press. lorange, p., scott-morton, m.p., & ghoshal, s. (1986). strategic control systems. s1. paul, mn: west. mcarthur, a.w., & nystrom, p.c. (1991). environmental dynamism, complexity, and munificence as moderators of strategy-performance relationships. journal of business research, 23, 349-361. martin, l., & kambil, a. (1999), looking back and thinking ahead: effects of prior success on managers' interpretations of new information technologies. academy of management journal, 42, 652-661. miles, r.e., & snow, c.c. (1978). organizational strategy. structure, and process. new york: mcgraw-hili. miller, d. (1993). the architecture of simplicity. academy of management review, 18: 116-138. mintzberg, h. (1994). the rise and fall of strategic planning: reconceiving roles for planning, plans, planners, new york: the free press. muralidharan, r. (1997). strategic control for fast moving markets: updating the strategy and monitoring performance. long range planning, 30(1), 64-73. picken, j .c., & dess, g .g. (1997). out of (strategic) control. organizational dynamics, 26(1),35-48. 158 journal of business strategies vol. 19, no.2 preble, j.e (1992). toward a comprehensive system of strategic control. journal of management studies, 29, 391-409. quinn, j.j. (1996). the role of "good conversation" in strategic control. journal of management studies, 33, 381-394. rajagopalan, n .• & spreitzer, g .m. (1997). toward a theory of strategic change: a multi-lens perspective and integrative framework. academy of management review, 22,48-79. schreyogg, g., & steinmann, h. (1987). strategic control: a new perspective. academy of management review, 12, 91-103. shank, m.e., zeitham1, c.p., blackburn, r.s., & boynton, a.c. (1988). predictors of top management team environmental perception accuracy: a model and propositions. academy of management proceedings: 37-41. sharfman, m.p., & dean, j .w., jr. (1991). conceptualizing and measuring the organizational environment: a multidimensional approach. journal of management, 17, 681-700. sharma, s., pablo, & a., vredenburg, h. (1999). corporate environmental responsiveness strategies: the importance of issue interpretation and organizational context. the journal of applied behavioral science, 35, 87-108. sharma, s. (2000). managerial interpretations and organizational context as predictors of corporate choice of environmental strategy. academy of management journal, 43,681-697. smith, k.g., & grimm, c.m. (1991). a communication-information model of competitive response timing. journal of management, 17,5-23. starbuck, w.h. & milliken, f.i. (1988). executives' perceptual filters: what they notice and how they make sense of it. in d. c. hambrick (ed.), the executive effect: concepts and methods of studying top managers: 35-66. greenwich, ct: jai press. sutcliffe, k.m. (1994). what executives notice: accurate perceptions in top management teams. academy of management journal, 37, 1360-1378. taylor, m.l., puia, g.m., ramaya, k., and genglebach, m. (2001). outback goes international, in hitt, ireland, hoskission, strategic management, (4th ed.). cincinnati: south-western publishing co. thomas, j.b., clark, s.m., & gioia, d.a. (1993). strategic sensemaking and organizational performance: linkages among scanning, interpretation, action, and outcomes. academy of management journal, 36, 239-270. fall 2002 julian & scifres: triggering strategic change 159 weick, k.e. (1995). sensemaking in organizations. thousand oaks, ca: sage. weitzel, w. & jonsson, e. (1989). decline in organizations: a literature integration and extension. administrative science quarterly, 34, 91-109. scott d. julian is an assistant professor of management at saginaw valley state university. he received his ph.d. from louisiana state university. his current research interests involve interpretive and process issues associated with strategic control, the performance consequences of organizational certification/accreditation, and the strategic implications of diversity in organizations. elton scifres is an associate professor of management at stephen f. austin state university. he received his ph.d. from louisiana state university. in addition to strategic control, his current research interests are in the areas of management education and the application of multiple perspectives to managerial problem solving. 160 journal of business strategies vol. 19, no.2 an interpretive perspective on the role of strategic control in triggering strategic change emerging value propositions for m-commerce irvine clarke iii james madison university • harrisonburg, va abstract the proliferation of mobile internet devices is creating an unparalleled opportunity for e-commerce to leverage the benefits of mobility. mobile e-commerce, commonly referred to as m-commerce, is the ability to purchase goods anywhere through a wireless internet-enabled device. current e-commerce providers, engaged through mobile devices, will find advantage in developing unique m-commerce value propositions founded upon the specific dimensions of ubiquity, convenience, localization, and personalization. a consumer orientation that provides value-fortime functions to create a new value curve may achieve a competitive advantage over traditional e-commerce models replicated for mobile business. therefore, this paper investigates the value propositions, that engender a productive mobile e-commerce strategy to provide recommendations for managerial decision-making in this emerging wireless environment. introduction in the new decade, the call for information technology will be information, any time, any place and on any device. accordingly, e-commerce is poised to witness an unprecedented explosion of mobility, creating a new domain of mobile commerce. mobile commerce, or m-commerce, is the ability to purchase goods anywhere through a wireless internet-enabled device. mobile commerce refers to any transaction with monetary value that is conducted via a mobile network. it will allow users to purchase products over the internet without the use of a pc. "within five years, individual e-commerce services will be primarily delivered by wireless and the wireless terminal will become the window of choice to the transactional e-world," says neil montefiore, executive of singapore mobile operator ml (hoffman, 2000, p.20). this proliferation of wireless capability has created an emerging opportunity for e-commerce businesses to expand beyond the traditional limitations of the fixed-line personal computer. the magnitude of the mobile internet revolution will pressure current ecommerce business models, create apertures for new mobile internet companies, engender a stream of change among established e-commerce paradigms, and lead to a reconfiguration of value propositions in many industries (evans & wurster, 1997). however, m-commerce is still not without its limitations. the problems it must 42 journal of business strategies overcome include: uniform standards, ease of operation, security for transactions, minimum screen size, display type and bandwidth, billing services, and the relatively impoverished web sites. due to current technological limitations, limited service availability, and varying mobile consumer behavior patterns, business strategies developed for m-commerce applications will find it necessary to emphasize differing characteristics than traditional e-commerce strategies (barnett, hodges & wilshire, 2000; datamonitor, 2000). successful m-commerce providers will understand that consumers are unwilling to spend long periods "surfing" on these inherently less user-friendly wireless devices (albright, 2000). wireless users demand packets of hyper-personalized information, not scaled-down versions of generic information. therefore, technology-focused wireless internet business models will be replaced by models which best integrate the unique characteristics of wireless m-commerce. as such, the long-term success of e-commerce may be partially dependent upon the successful development of effective consumer-oriented m-commerce business strategies. "mobile commerce is per se not included in the traditional e-commerce market models. m-commerce will be able to increase the overall market for e-commerce, because of its unique value proposition of providing easily personalized, local goods and services anytime and anywhere" (durlacher, 2000, p.. 12). despite tremendous interest in the melioration of m-commerce there is little, if any, research that examines how to develop a comprehensive consumer-oriented mobile e-commerce strategy. therefore, the primary purpose of this paper is to explore the factors which compose an effective m-commerce strategy. first, this paper investigates the nonpareil benefits of mobile applications. then, this paper explores how managers can incorporate potential m-commerce value propositions into their overall e-commen;e strategies through creating new market space (kim & mauborgne, 1999). given the potential assemblage of wireless internet devices, an enhanced understanding of m-commerce could acutely improve a company's overall ability in e-business strategy formulation. background mobile devices have been the fastest adopted consumer products of all time with, last year, more mobile phones shipped than automobiles and pcs combined (chen, 2000; de haan, 2000). by 2003, there will be 1.4 billion mobile phones worldwide and half will be internet-enabled (zabala, 2000). nokia estimates that by 2002 a greater number of people will be linked to the internet via wireless connections than through traditional fixed lines (daitch, kamath, kapoor, nemiccolo, sahni & volume 25, number 2 43 varma, 2000).' fueled by such enabling technologies as 3g broadband capability, extensible markup language (xml), compact html (chtml), wireless markup language (wml), wireless application protocol (wap), general packet radio services (gprs) and internet ready mobile terminals, e-commerce is now poised to take advantage of the current growth of mobile devices. "the wireless world is a parallel universe almost as large as the net, and the two are beginning a fascinating convergence," said swapnil shah, director of inktomi europe, a search engine and caching solutions company (rao, 2000). however, u.s. providers have lagged in m-commerce development since the u.s. market has been pc oriented for internet technology. the u.s. leads the world in almost every e-commerce metric, while europe and japan have taken early leads in m-commerce. in fact some countries in europe, like spain and italy, may completely leap pc-oriented e-commerce, based on their veneration of mobile phones, directly to m-commerce. as many as 100 new m-commerce companies launch in europe each month (brandt, 2000). telefonica italy is already selling all cellular phones with a pre configuration for internet access. in japan, mobile phones penetrate about 50% ofthe market with ntt docomo's internet enabled i-mode service already connecting more than 5 million wireless users to the web. these markets continue to grow in appeal as docomo's i-mode is attracting about 12,600 new users per day, each generating about $26/month in additional revenue per user (schenker, 2000). commerce transpires as organizations introduce new methods to employ mobile devices to communicate, inform, transact and entertain using text and data via connection to public and private networks. this emergence of mobile commerce will happen even faster than the development of e-commerce in roughly the time between the invention of the first web browser and now (schenker, 2000). "if you look five to 10 years out, almost all of e-commerce will be on wireless devices," says jeff bezos chief executive and founder of amazon.com (mcginity, 2000). consequently, within the next 5-years, one-quarter of all electronic commerce will take place through wireless devices (zabala, 2000). forecasts estimate the wireless web to be as large as the wired web of today and worldwide mobile commerce exceeding $200 billion by 2004 (m-commerce times, 2000; shaffer, 2000). the potential of m-commerce is considerable for those willing to develop mobile-specific business strategies. as m-commerce matures, current mobile operators will rely less upon usage fees and increasingly derive revenues from content and services (datamonitor, 2000; kpmg, 2000). additionally, m-commerce is going to bring about a massive change in the way users consume products and services. 44 journal of business strategies "it is key that commerce companies recognize m-commerce as a completely unique service. cell phone users are more impatient than internet users. the paradigm here is not surfing; all services for the mass market have to be pitched at users in such a seamless way that they need not even be aware that they are accessing the net." cindy dahm, european director for phone. com (rao, 2000, p.2 ). those best able to provide value-added user experiences, through content aggregation and portal development, will achieve long-term success. merely extending the current internet presence will not be enough. "mobile internet customers will be more demanding. they will want personalized service to meet their individual wants and needs and will no longer be satisfied with being a mass market" (kpmg, 2000, p. 2). providers must take advantage of the characteristics which make m-commerce distinct from e-commerce to develop truly unique and compelling services rather than replicating current e-commerce models. current e-commerce strategy is based on a traditional paradigm of consumers as passive receivers of communication efforts with the service provider holding control of the "when" and "where" of information (mahadevan, 2000). with wireless internet enabled devices, consumers now have more discretion of "when" and "where" the information that is available, creating new market space and demand for a specialized mobile business offering. value propositions for m-commerce value propositions define the relationship between supplier offerings and consumer purchases by identifying how the supplier fulfills the customer's needs across different consumer roles (band, 2000; porter, 1998). specifically, it specifies the interdependence between the performance attributes of a product or service and the fulfillment of needs. the value proposition furthermore solidifies the relationship between the customer and various dimensions of product value. thus, customer satisfaction is merely a response to the value proposition offered by a specific product/service bundle. for e-commerce, the establishment of a value proposition is rudimentary to any consumer-oriented strategy creation (timmers, 1998). the mobility afforded wireless devices shapes m-commerce into a disparate entity from conventional e-commerce. consequently, value propositions are likely to be new, different and novel for mobile e-commerce. the primary advantage of volume 25, number 2 45 mobile devices is to provide a superior offering of value-for-time2 to users. that is, by accessing the internet through mobile devices, users will be able to realize additional value allowances for any specified period of time, which fixed-line users will not be able to achieve. information may now truly become available anytime, anyplace and on any wireless device. as such, value propositions of e-commerce will be forced to change to reflect the underlying dimensions of value-jor-time for users (figure 1). specifically, m-commerce differs from e-commerce on the following value proposition attributes: figure 1 value propositions of mobile commerce ubiquity what value offerings will be provided everywhere at the same time? personalization what individualbased target marketing can be employed? ubiquity / localization what locationbased marketing strategies can be / offered? convenience what factors create time and place utility? mobile devices offer users the ability to receive information and perform transactions from virtually any location on a real-time basis. m-commerce users will have a presence everywhere, or in many places simultaneously, with a similar level of access available through fixed-line technology. communication can take place independent of the users location. the advantages presented from the omnipresence of information and continual access to commerce will be exceptionally important to time-critical applications. 46 journal of business strategies mobile commerce businesses, for example, can leverage this value proposition by providing alert notifications, such as for auctions, betting, and stock price changes, which are specified by the user as an important part of relevant personal content. as such, the real-time, everywhere presence of m-commerce will offer capabilities uniquely beneficial to users. industries that are time and location sensitive, such as financial services and travel, are likely to benefit from businesses exploiting this value-added feature of mobile commerce. convenience the agility and accessibility provided from wireless devices will further allow m-commerce to differentiate its abilities from e-commerce. people will no longer be constrained by time or place in accessing e-commerce activities. rather, m-commerce could be accessed in a manner which may eliminate some of the labor of life's activities. for example, consumers waiting in line or stuck in traffic will be able to pursue favorite internet based activities or handle daily transactions through m-commerce applications. consumers may recognize a special comfort which could translate into an improved quality of life. one opportunity to increase value lies in m-commerce capabilities that allow consumers to shop where they are not located. this ability to obtain information and conduct transactions from any location is inherently valuable to consumers. as such, m-commerce offers tremendous opportunities to expand a client-base by providing value-added services to customers heretofore difficult to reach. by making services more convenient the customer may actually become more loyal. consequently, communication facilities within m-commerce are key applications for the delivery of convenience. consumers will be looking for m-commerce applications which can deliver functions like: sending and receiving e-mail, voice mail forwarding, conference calling, faxing, document sharing, instant messaging; as well as transactional based activities. localization knowing the location of the internet user creates a significant advantage for m-commerce over wired e-commerce. location-based marketing, via global positioning technology,3 will soon be available in all mobile devices. through gps technology, service providers can accurately identify the location of the user. utilizing this technology, m-commerce providers will he better able to receive and send information relative to a specific location. since mobile devices like cell phones are volume 25, number 2 47 almost always on, vendors will know the location of their customers and can deliver promotions based upon the likely consumer demands for that location.4 location-specific information leverages the key value proposition of mcommerce over traditional e-commerce by supplying information relevant to the current geographic position of the user. m-commerce providers will be able to both push and access information relevant to the users specific location. mobile websites may serve as points of consolidation of consumer information and disseminate the relevant information for a particular location based on profile data built on the user's past behavior, situation, profile and location. as such, real time discounting may become the "killer application" for m-commerce. for example, each time you visit your local grocery store, procter & gamble can send directly to your wireless device, through the designated mobile device, tailored promotional information on their products. advertising will also be profoundly influenced by the expansion of these wireless services. mobile phones provide another effective medium for advertising products and services with the second highest potential reach, after television (zabala, 2000). durlacher predicts that by the year 2003, advertising will be the leading mobile commerce application (reed, 2000). craig owensby, coo of spotcast says: "mobile phone technologies are changing with incredible speed. within two years, mobile phones will evolve into multimedia devices for m-commerce to offer personal video communications, receive customized information, access the internet on-line [24 hours a day] to order and shop, as well as for games, entertainment and chatting. soon advertising through a mobile phone will be as normal as advertising in newspaper or tv" (zabala, 2000, p. 35). applications based on this value proposition will expand the overall value frontier for mobile e-commerce as consumers recognize benefits from information relevant to the current geographic position. personalization mobile devices are typically used by a sole individual, making them ideal for individual-based target marketing. mobile offers the opportunity to personalize messages to various segments, based upon time and location, by altering both sight and sound. new developments in information technology and data-mining make tailoring messages to individual consumers practical and cost-effective. for example, upon employing your mobile internet device, advertising messages tailored to your individual preferences can be provided. relevance of material, and the "de-massing" of marketing becomes possible through the personal ownership of 48 journal of business strategies mobile devices. "a wireless device is a very personal device. so it becomes increasingly important that the ads you deploy are value added," says vic vasan, beyond interactive director of new technology (mack, 2000). additionally, personalized content is paramount in operating mobile devices because of the limitation of the user interface. relevant information must always be only a single "click" away, since web access with any existing wireless device is not comparable to a pc screen either by size, resolution or "surfability." therefore, subscriber profile ownerships is a key element in m-commerce success, as it will allow selectively targeted m-commerce and advertising. as such, the mobile database becomes a primary factor of m-commerce success by compiling personalized data bases and providing personalized services. one example, is the sim (subscriber identification module6 ) smartcards which serve as a mobile database allowing the user to run applications and operate secure transactions. such personalized information and transaction feeds, via mobile devices, offer the greatest potential for the customization necessary for long-term success. a value proposition is developed as superior consumer value is created through an increasingly targeted internet experience for mobile users. for m-commerce, the technological limitations magnify these value-for-time propositions. it has been estimated that every additional click-through, which a user needs to make in navigating through a commercial online environment with a mobile device, reduces the possibility of a transaction by 50% (durlacher research, 2000). providing the user with the desired, most relevant information without forcing a complex click-through sequence will significantly improve the effectiveness of any mobile ecommerce strategy. value-for-time propositions become maximized for those business strategies best able to implement m-commerce's distinguishing capabilities. m-commerce businesses will become differentiated from traditional e-commerce based upon their abilities to integrate and actuate the advantages germane to mobile devices. various applications may provide differing value for mobile internet users (figure 2). figure 2 illustrates some possible m-commerce applications which manifest the specified value propositions. each application provides the user with value that cannot be found through traditional e-commerce. for example, a person who is waiting to check-out at the local grocery, and therefore is unable to access conventional e-commerce, may exercise this time to use their wireless pda to: move monies between personal bank accounts (convenience), receive an e-mail reminder to pick-up their dry-cleaning (ubiquity), and watch a tailored promotion (personalization) for a product available at a nearby point-of-purchase display (localization). volume 25, number 2 49 in the past, the time of queuing has eluded e-commerce providers, but now, mobile devices offer this same person greater access to valuable services. figure 2 m-commerce applications value proposition ubiquity convenience localization personalization creating a new value curve application • news • sports scores • stock prices • travel information • weather • banking • communication • entertainment • gaming • mobile payment systems • retailing • videoconferencing • coupons • customer service • dispatch/scheduling • discounting • emergency services • supply chain management • advertising • database development • knowledge management systems e-commerce is becoming an increasingly competitive environment where value streams become the basis for business models and strategy development. ecommerce strategies focusing on customer value not on competition may provide market opportunities in this hyper-competitive marketplace (mahadevan, 2000). yet, creating new market opportunities will require looking outside the accepted e-industry boundaries to unoccupied territory where breakthroughs in value can be discovered. this newly discovered market space can be represented by the value curve a tool which visually represents a range of value propositions. all industries can be viewed as a collection of value offerings; the value curve is a tool 50 journal of business strategies used to differentiate the bundle of benefits offered to each market segment (kim & mauborgne, 1997; porter, 1998). the value curve is particularly useful to business managers, in that it creates a graphic depiction of the wayan industry configures its offerings to customers (kim & mauborgne, 1999). m-commerce expands the horizons of value offerings to internet users through its unique value propositions. however, the technological limitations of wireless devices also alters the overall value package provided to customers. overall, wireless capabilities present the potential to advance the value curve creating new strategic opportunities for m-commerce organizations. figure 3 offers a comparison of the plausible value curves for both e-commerce and m-commerce.7 by integrating the value propositions into a new value curve, the area of market opportunity becomes apparent. the value curve shows the relative value of m-commerce applications compared to more traditional e-commerce offerings. figure 3 value curves for m-commerce and e-commerce offerings • • _. m-commerce e-commerce wireless value area , ... "" "" ,,' . ,.... .. . ,i' .... ... '" (11) .............fixed linevalue area ....... ............... high low speed price ubiquity convenience localization personalization key value offerings the dissimilarity of the curves illustrates the fundamental differences in overall value propositions. clear advantages can be found for e-commerce in cost and speed. m-commerce provides for significant new value areas in ubiquity, localization, and convenience. innovative companies can breach the e-commerce competitive environment by claiming the fundamentally new market space developed by the value propositions of mobility. real value innovations are found in applications which emphasize the characteristics of the new m-commerce territory. the m-commerce value curve depicts the relative advantages along key success factors. the broadened goal for m-commerce companies is to offer more value volume 25, number 2 51 to clients and end-user customers along the dimensions most relevant to each market segment. ideally, m-commerce providers will take advantage of the opportunities germane to wireless devices to create product/service specific value curves which look preferable to traditional fixed-line pc-oriented e-commerce competition. by operating in this expanded frontier of value, fixed-line e-commerce competition will fail in attempts to replicate m-commerce value curves. implications the emergence of m-commerce specific value propositions has major implications in two different, but related ways. first, m-commerce will expose managers to a new consumer paradigm for decision making. value-for-time will be derived from the factors of mobility. as such, managers who can expand the value frontier offered through leveraging the advantages of mobility will be able to provide superior value propositions, and potentially receive greater satisfaction from mobile consumers. the m-commerce value frontier inherently expands the maximum performance currently feasible through ubiquity, convenience, localization, and personalization. innovative market space is developed as managers devise applications to exploit this new area under the value curve. second, the division ofm-commerce strategies based upon consumer-orientation value propositions provides e-commerce researchers a tool for modeling the complex issues that are unparalleled in the mobile internet. business implications since the success of m-commerce applications is dependent on the ease of use and the delivery of the appropriate information at the correct moment, valuefor-time propositions will be a key dynamic in determining the success of any mcommerce business. consumers utilizing wireless devices for internet access will come to expect improved value from their wireless experience. value-for-time will be accredited to those businesses which leverage the unique advantages of mobility. increased value-for-time propositions will enhance the success factors of mobile e-commerce businesses, with rewards to providers in increased user acquisition and retention. the implications for managers failing to develop effective consumeroriented m-commerce strategies may include: wasting company resources chasing the ever changing technological environment, consumer alienation, and erosion of e-commerce market share. therefore, prudent managers may select to ask the following questions prior to offering an m-commerce application. 52 journal of business strategies what is the value proposition provided from this wireless technology? managers must identify the industry value frontier and define the key value propositions. in this instance, the value offered to consumers must be germane to the mobility advantages of m-commerce. if the same application can be provided through fixed lines, and provide the same utility to consumers, the long-term success prospects would be limited. this does not mean that a comparable service cannot be provided through competing platforms, rather that the mobile application should offer additional value over the fixed line applications. what market segments are best able to monetize this value proposition? managers must select and define the most attractive value proposition for each consumer segment. simple messages, based on the most relevant value offering, are likely to achieve greater success than broad-based, general appeals employing every possible value proposition. accurate identification of the markets which could best utilize the benefits provided from a m-commerce strategy will improve the time frame for success. for example, consumers may use m-commerce based on lifestyle, segment application or professional use (kpmg, 2000). astute managers will leverage m-commerce capabilities to develop specific mobile strategies which appeal to these likely user groups. does this application have potential to become a "killer app"? managers must always be aware that one application is likely to drive their segment of the m-commerce industry. the "killer app," or application which drives the development of that m-commerce sector, will likely vary across industries. 8 managers must utilize these specific functionalities as consumers will expect such service as norm in wireless internet devices. is this value proposition congruent with other wireless applications currently provided? managers must find ways to organize and innovate to deliver the value proposition to consumers. thus, it becomes ever important to recognize that applications do not exist in isolation. 9 in the wireless world, users have less control over the aggregation of the services provided than in the pc world. as such, it becomes volume 25j number 2 53 imperative that managers are able to best identify the benefit provided and only offer new applications which fit the growing consumer-orientation. research implications the unprecedented growth in e-commerce has underscored the need for a better understanding of the successful mechanisms and business models. as new devices become available for internet-based business, the development of new frameworks, specific to the mode of commerce will help researchers to better understand the complex environment of the digital world. the generic typology discussed in this paper will allow for a better understanding of the consumer benefits derived from making e-commerce mobile. clearly the next step is to empirically test the relative value of these benefits to the overall success of the e-commerce business. specific research questions are: which value propositions are most highly related to profitability? are there interactions amongst these value propositions? which bundles of values are most attractive to various consumer segments? are these value propositions relevant to all industries? additionally, as m-commerce develops into a distinct discipline, detailed case studies can be developed to enhance our understanding and facilitate the implementation of successful m-commerce strategies. conclusion "the wireless web is truly the next major wave of internet computing ... its potential for bringing people together and expanding commerce is even greater than that of the wired internet." edward kozel, board member and former cta of cisco systems (alterego, 2000, p.12) e-businesses are currently being presented new mobile technologies for exercising the advantages of m-commerce. e-commerce applications that succeed on the desktop pc win not necessarily meet with a similar accomplishment in a wireless commerce. success will depend on the ability to integrate e-competencies of current business models with the unique features of m-commerce. long-term m-commerce business success is likely to come from consumer-oriented, rather than technologybased strategies. currente-commerce providers, engaged through mobile devices, will find advantage in developing unique m-commerce value propositions founded upon the specific dimensions of: ubiquity, convenience, localization, and personalization. a consumer-orientation that provides value-for-time functions can gain a competitive advantage over traditional e-commerce models replicated for mobile business. 54 journal of business strategies new and even more innovative applications, than those discussed here, will arise as more people connect to the web through wireless devices and additional content becomes available. as other functionalities such as file attachments, faster network speeds, bluetooth,lo speech recognition and e-commerce security features are added, more users will be attracted to this intriguing mobile marketplace. in the short-term, e-business managers must be mindful to operate within evolving technological constraints. in the end, these problems, much like the initial problems associated with e-commerce, will also be overcome. utilization of the appropriate value propositions will be fundamental to the success of mobile e-commerce. for m-commerce to reach its full potential of information available, anytime, anyplace and on any device, business models and strategies must offer the user maximum effectiveness and value through leveraging the unmatched advantages of wireless technology. if this is accomplished, and ecommerce business models are adapted for wireless internet technology, expect to see a second e-business revolution take place based on the mobility of commerce. notes 1. historically, most innovations suffer turbulence before the innovation prospers. technological, social and cultural considerations may impact the rate of diffusion (rogers, 1995). m-commerce will experience similar challenges as society adapts to these changes. therefore, m-commerce will not be the appropriate tool for all e-commerce operations. this paper indicates that m-commerce will best serve the organizations which can utilizes the benefits of mobility. 2. bellman, lohse and johnson (1999) provide an overview of the time critical applications for online behavior. 3. global positioning system (gps), time of arrival (toa), cell of origin (coo), enhanced observed time difference (e-otd), and location fixing schemes (lfs) are just some of the completing mobile location technologies which have capabilities of providing geographic specific value-added information. 4. issues of privacy may become a concern. intrusive messages could alienate consumers to product/service offerings. 5. services such as mobile aol explore consumer profile databases to find underlying characteristics which can be used for customer service. as database marketing matures, for mobile devices, expect greater use of such utilities. volume 25j number 2 55 6. sim, or subscriber identification module, refers to a smart card holding the user's identity and telephone directory. short messaging service applications may reside within these sims. 7. industry and product/service m-commerce value curves may require modification of the universal curve presented. 8. certainly "killer apps" are rare which make them such a precious commodity. downes and mui (1998) explain that a "killer app" is any convergence of technologies, products and services in a way which reshapes an industry and leads to market dominance. as such, managers must scan their particular industry to find the mobile functionality which industry associates demand. 9. managers would be wise to consider the broad range of organizational issues which may be a significant impediment to implementation. 10. bluetooth is a chip technology that enables seamless voice and data connections between a wide range of devices through short-range digital two-way radio. references alterego. (2000). building the intelligent internet: making the case for adaptive network services. retrieved from www.alterego.com. albright, 8. (2000). mobilize this! frontline solutions, (may), 28-32. band, w. (2000). creating value for your customer. sales and marketing management in canada, 31(2), 4-6. barnett, n., hodges, s., & wilshire, m. (2000). m-commerce: an operator's manual. mckinsey quarterly, 3, 162-171. bellman, s., lohse, g. l., & johnson, e. 1. (1999), predictors of online buying behavior. communications ofthe acm, 42(12),32-38. brandt, 1. r. (2000). dail 'm' for 'mobile'. industry week, (may 1),4. chen, p. (2000). broadvision delivers new frontier for e-commerce. m-commerce, (october), 25. daitch, 1., kamath, r., kapoor, r., nemiccolo, a., sahni, 1., & varma, s. (2000), wireless applications for business: business anytime, anywhere. kellogg techventure 2000 anthology, 88-120. datamon itor, (2000). the race for m-commerce: shifting paradigms in the world of mobile commerce strategy. retrieved from datamonitor.com. 56 journal of business strategies downes, l., & mui, c. (1998). unleashing the killer app: digital strategies for market dominance. boston: harvard business school press. de haan, a. (2000). the internet goes wireless. eai journal, (april), 62-63. durlacher research ltd. (2000). mobile commerce report. retrieved from www. durlacher.com. evans, p. b. & wurster, t. s. (1997). strategy and the new economics of information. harvard business review, 75(5), 70-82. hoffman, g. (2000). start game. communications international, (april), 18-22. kim, w. c. & mauborgne, r. (1997). value innovation: the strategic logic of high growth. harvard business review, 75(1), 103-112. kim, w. c. & mauborgne, r. (1999). creating new market space. harvard business review, 77(1), 83-93. kpmg. (2000). creating the new wireless operator. retrieved from www.kpmg. com. m-commerce times. (2000). m-commerce vital statistics, 1(16). retrieved from www.mcommercetimes.com. mack, a. m. (2000). beyond interactive to deploy wap-enabled ads. adweek, (june 12), 59. mahadevan, b. (2000). business models for internet-based e-commerce. california management review, 42(4),55-69. mcginity, m. (2000). the net/wireless meeting of the minds. inter@ctiveweek, (march 6), 2. porter, m. e. (1998). competitive advantage: techniques for analyzing industries and competitors. new york: the free press. rao, m. (2000). em-wire: e-commerce, m-commerce poised for rapid take-off in europe. electronic markets: the international journal of electronic commerce & business media, (april 6). retrieved from www.electronicmarkets. org/electronicmarkets/electronicmarkets.nsflpages/emw_0004_cell.html. reed, m. (2000). why the future will be wireless. marketing, (february 3), 22-23. rogers, e. m. (1995). diffusions ofinnovations (4th ed.). new york: free press. schenker. 1. (2000). europe's high-tech start-ups have stolen a march on silicon valley by launching new mobile services. time europe, (february 7), 1. shaffer, r. a. (2000). m-commerce: on-line selling's wireless future. fortune, (july 10), 262. timmers, p. (1998). business models for electronic markets. electronic markets, 8(2),3-8. volume 25, number 2 57 zabala, h. (2000). m-commerce, the next big thing? asian business, (june), 34-35. biographical sketch of author irvine clarke is head of the marketing department and wampler-longacre professor of marketing at james madison university and a research fellow at the commonwealth information security center. he earned a ph.d. from old dominion university in business administration with a major concentration in marketing. he has published in the journal ofinternational marketing, international marketing review, industrial marketing management, and the journal of international consumer marketing. he has previously taught at locations in canada, england, france, germany, malaysia, mexico, singapore and the peoples republic of china. he currently serves on the board of advisors for assorted wireless e-commerce compan ies and has 15 years private sector organizational experience in technology marketing. the author gratefully acknowledges the commonwealth information security center at james madison university for support of their research. 58 journal of business strategies emerging value propositions for m-commerce the engagement of employees in the strategy process and firm performance: the role of strategic goals and environment linda f. tegarden virginia tech blacksburg, va yolanda sarason colorado state university fort collins, co j. stephen childers radford university radford, va donald e. hatfield virginia tech blacksburg, va abstract de!>pite the call to engage employees in strategy making processes, empirical evidence that ties this engagement to financial performance has not been forthcoming. this study fills this gap by investigating whether involving employees in the strategy making process leads to a higher achievement ofstrategic goals and subsequently increased financial performance. our findings suggest that the link between strategy making processes and financial performance may be underestimated unless strategic goals are included as a mediator. we also find environmental dynamism moderates the relationships we investigate. under conditions of low dynamism, there is a stronger relationship between the engagement ofemployees and strategic goals related to innovation than under conditions of high dynamism. conversely, strategic goals related to quality have a stronger relationship with engagement of employees under conditions ofhigh dynamism when compared to conditions oflow dynamism. the importance of involving employees throughout an organization in the strategy making process has been recognized by traditional academic researchers (e.g. burgelman, 1991; floyd & wooldridge, 2000; hart, 1992), as well as consultants and practitioners (e.g. hamel & prahalad, 1994; kaplan & norton, 1996). one rationale behind the use of multi-level strategy processes is to provide employees with a better understanding of the company's strategy and build a 76 journal ofbusiness strategies vol. 22, no.2 stronger commitment to achieving the goals in the implementation of the strategy (floyd & wooldridge, 2000; hamel & prahalad, 1994; kaplan & norton, 1996). a company's strategy can also be facilitated by employee involvement because knowledge and information relevant to strategy making is dispersed throughout the organization (miller & monge, 1986). cognitive model theorists (anthony, 1978; frost, wakely & ruh, 1974) propose that when employees have more complete knowledge about their jobs and operations they can provide better information. involvement in strategy making also allows employees to know more about implementation of decisions. for example, ideas that support new innovations often come from those employees that are in direct contact with the customer (von hippel, 1988). in order for innovation to be a source of competitive advantage for a company, there must be organizational processes that allow these ideas to be brought forward and integrated into the activities of the company (burgelman,1983). despite the call for more investigations into the relationship between strategy making process and firm performance (chakravarthy & doz, 1992; huff& reger, 1987), there has been relatively little empirical research on this link, especially when strategy making processes involve multiple levels of the organization (floyd & wooldridge, 2000; rajagopalan, rasheed, & datta, 1993). while the intensity and use of employee involvement practices is on the increase, the strategic impact of such practices has not been adequately investigated. this may be because most studies focus on narrow definitions of employee involvement (ledford & lawler, 1994). our study uses a broad definition of employee involvement in strategy process to include information sharing, decision making, experimentation, understanding of company goals, and iterative strategy making that involves multiple levels of the organization. a broad definition captures the variety of involvement ranging from information sharing to actual decision making. we suggest that aspects of such involvement should relate to achievement of strategic goals. the two types of strategic goals tested in this study are quality and innovation. it is suggested that both require employee involvement and empowerment to make decisions (lawler, mohrman, & ledford, 1995; burgelman, 1991). in addition, these goals often create a tension between striving to have organizational processes that ensure consistent quality and organizational processes that facilitate creativity and innovation (brown & eisenhardt, 1998; jelinek & schoonhoven, 1990; miron, erez, & naveh, 2004). we also propose that multi-level strategy processes support the achievement of quality more than the achievement of innovation, since achievement ofthese goals require different levels of cooperation and competition among employees within an organization. these differences in the strength of the path relationships for quality and innovation are proposed to vary with levels of environmental dynamism (miller & friesen, 1983). this study contributes to the understanding of the relationship between strategy processes and financial performance by examining information and communication benefits derived from use of multi-level strategy processes. we fall 2005 tegarden et at.: engagement ofemployees 77 extend this work with insights from cognitive and communication models that focus on information and communication benefits associated with participative management (miller & monge, 1986; monge, cozzens, & contractor, 1992). we postulate that the relationship between multi-level strategy processes and firm financial performance is not a direct link. rather, we suggest that involving multiple levels of the organization in strategy processes enables higher commitment and achievement of strategic goals because the quality of information used in decisions and communication of what strategies and goals are important increases with organization-wide participation in strategy processes. moreover, it is the successful achievement of these strategic goals that leads to superior financial performance. thus, we propose that strategic goals are an essential mediating variable in understanding the multi-level strategy process financial performance link. figure 1 outlines the model we propose and test. figure 1 the link between multi-level strategy processes, strategic goals and firm performance and moderating role of environment strategy making processes involving multiple levels of the organization achievement of ~ strategic goals ~r (quality and innovation) firm performance environmental dynamism we begin with a discussion of the rationale leading to our hypotheses. subsequently, we describe the nature of our methodology and results. we end with a discussion of our conclusions and implications for research and managers. literature review and hypotheses strategy process research is concerned with how a firm's administrative systems and decision processes influence its strategic positions (chakravarthy & 002, 1992). there has been a call for more investigations of the links between firm performance and strategy processes in order that our understanding be more complete (floyd & wooldridge, 2000; huff & reger, 1987). forthe link between strategy process and firm performance to be made, there is a need to explicate the relevant mediating and moderating variables (rajagopalan et ai., 1993). we are 78 journal of business strategies vol. 22, no.2 proposing that strategic goals are important, yet overlooked, mediating variables in the strategy process financial performance relationship. we will begin with a discussion of the extant work on strategy processes and firm performance. there is emerging empirical work that illustrates the potential competitive advantage from the use of multi-level strategy making. for example, wooldridge and floyd (1990) find that greater participation and involvement by middle level managers in strategy formation results in greater commitment and understanding of strategy, as well as improved economic performance. monge et a1. (1992) finds that communication variables, like access to information throughout the organization, increase the number of innovations in a firm. powell (1992) shows that strategic planning processes, that are not available on the strategic factor market, can be sources of competitive advantage. miller and lee (200 i) give evidence that collaboration among employees toward decisions results in improved firm performance. tegarden, sarason, and banbury (2003) give evidence that processes drawing upon all employees are more 1ikely to have a greater influence on strategic performance rather than financial performance. finally, the use of participative management practices has been on the rise in organizations because most report success, especially with self-management teams (lawler, mohrman, & ledford, 1992) and for more complex tasks (ledford & lawler, 1994). while these studies have begun to open the organizational black box and provide growing evidence that use of multi-level strategy processes can help explain firm performance, there is still a gap in our understanding of how and why involving employees in the strategy making processes improves performance. we offer that involving employees in strategy making results in higher achievement of strategic goals because of higher commitment to such goals and it is this achievement of strategic goals that leads to higher financial performance. in order to support this argument, we draw from participation and empowerment literatures to establish the mediating role of strategic goals with multi-level strategy processes and firm performance. there is a plethora ofliterature that focuses on the outcome effects of employee involvement in organizations. multi-level strategy processes encompass the notions that involvement of employees and managers is beneficial to organization outcomes. both motivation and communication are central to the idea that employee involvement produces higher satisfaction and productivity. the emphasis is on outcomes that impact strategic position rather than financial performance. each set ofliterature is summarized below as to the links between greater involvement of employees and managers and its impact on organizational performance. involvement as a subject has a long history, dating back to mcgregor's (1960) idea that workers can contribute to governing their own situations. mcgregor's specification of theory x and theory y focus on beliefs about human nature and how they impact work to be done. likert (1961) described management models that went beyond the traditional command and control structure. the work of mcgregor (1960) and likert (1961) encouraged investigations on participative management during the 1960s. participative management "recognized the goodfall 2005 tegarden et al..' engagement ofemployees 79 will, interest, talent, and needs ofemployees, and encouraged open communication and cooperation between management and employees" (forrester, 2000: 67). during the 1980s, lawler and his colleagues (bowen & lawler, 1992; lawler, 1986, 1992; lawler et ai., 1995) extended this idea by identifying levels of involvement from low to high. the low end of involvement is idea generation, suggestions that employees give to managers on ways to improve operations. a higher level of involvement is giving employees the ability to determine the methods they employ on the job. the highest level of involvement is giving lower level managers and employees the ability to influence decisions beyond one's own job that affect the business at large. the major reason for involving employees in decision making is that it will improve organizational effectiveness. the empowerment literature focuses on empowerment as a motivational construct that affects individual and organizational outcomes (rudolph & peluchette, 1993). empowerment comprises individual cognitions and perceptions that constitute feelings of behavioral and psychological investment in work (conger & kanungo, 1988; spreitzer, 1995, 1996; zimmerman, 1990). these include meaning, self-determination, competence and impact. it describes "people's belief in their capabilities to mobilize the motivation, cognitive resources, and courses of action needed to exercise control over given events" (ozer & bandura, 1990, p. 472). empowerment also relates to a belief in self-efficacy and an expectation that effort will lead to performance (koberg, boss, senjem, & goodman, 1999). "empowerment implies the freedom and the ability to make decisions and commitments, not just to suggest them or be part of making them" (forrester, 2000, p. 67). it is recognized that organizations are characterized with an increasingly blurred distinction between managers and workers with a growing reliance on horizontal structures and peer networks (kantor, 1989; pfeffer, 1994). the importance of empowering employees is also discussed in the entrepreneurship literature (kuratko, hornsby, & corso, 1996; willard, krueger, & fesser, 1992). when the founder shifts from creation to exploitation, employees should be empowered with the ability to create and facilitate adaptation and change. the founder's shift to a more managerial role requires an increase in employees' roles in identifying and adapting to change. as such, empowerment has received increasing attention. empowerment has been shown to affect managerial and organizational effectiveness (spreitzer, 1995). perceptions of empowerment can enhance the value of work for individuals, increase job satisfaction and contribute to work productivity and success (eylon & au, 1996; fulford & enz, 1995; spreitzer, 1995). for example, koberg, et al. (1999) found that empowerment perceptions were associated with increased job satisfaction and work producti vity/effectiveness. the important point here is that outcomes studied in relationship to empowerment include worker effectiveness/productivity and job satisfaction, not a direct link to financial performance. another stream of research is the participation literature which focuses on participation's influence on satisfaction and productivity. the primary foundations ofthis literature are communication and affective models that predict the positive 80 journal olbusiness strategies vol. 22, no.2 relationship between participation and organizational outcomes, like innovation, productivity and job satisfaction (miller & monge, 1986; monge et ai., 1992; wagner, 1994). communication models assume that participation in decision making enhances the flow and use of important information in organizations. theorists (anthony, 1978; frost, et ai., 1974) propose that workers typically have more complete knowledge of their work than management; hence if workers participate in decision making, decisions will be made with better pools of information. in addition, it is suggested that if employees participate in decision making, they will know more about implementing work procedures after decisions have been made (maier, 1963; melcher, 1976). in essence, the role of information and communication is central to the positive relationship between participation and organizational outcomes. some support for this assertion is found in miller & monge's (1986) meta-analysis. stronger support is shown in the monge, et al. (1992) study of participation and organizational innovation. in addition to the communication predictors, participation literature also stresses the motivational predictors or affective models of participation, which are the foundations of the human relations school of management (blake & mouton, 1970; ritchie & miles, 1970) as well as the theory supporting empowerment. the relationship between participation and organizational outcomes is indirect. participation will enhance organization effectiveness through intervening motivational processes: participation fulfills needs, fulfilled needs lead to satisfaction, satisfaction strengthens motivation, and increased motivation improves worker's productivity. a small, but positive relationship is supported by the literature (cotton, vollrath, legnick-hall, & froggatt, 1990; wagner, 1994), yet most studies focus on trivial changes in complex systems (ledford & lawler, 1994). in any event, again, participation studies focus on its relationship to organizational outcomes and effectiveness and not financial performance. engaging employees at multiple levels ofthe organization in the strategy making process results in greater commitment to strategic goals (locke, latham, & erez, 1988), as well as the potential for improved decision making, either through use of more relevant information or higher satisfaction, which in turn leads to the greater motivation to achieve goals. while we recognize that commitment to strategic goals and achievement of strategic goals are two different constructs, we follow the logic of lock, et al. (1988, p. 24) that commitment to goals can be inferred from performance. as they state, "(w)hile performance cannot be a catch-all measure of commitment, since performance can be caused by other factors such as ability, judicious use of inference from performance seems both theoretically and empirically justified." consistent with this insight, salancik (1977) indicates that behavior or action is the ultimate proof of commitment and thus, by implication, the most accurate measure of it. thus, multi-level strategy making processes are directed toward the achievement of organizational goals, such as innovation, efficiency, and quality (what we call strategic goals). stated more formally: fall 2005 tegarden et al.: engagement of employees 81 hypothesis ia: the use olmulti-level strategy processes is positive(v related to the achievement ofstrategic goals. the literature on multi-level strategy process has traditionally focused upon commitment to goals or a strategy rather than financial performance. conventional strategy models always focus on strategy (a stream of actions) that can lead to superior strategic performance. when multi-level actions are "directed" by a commonly agreed on set of strategic goals, the result is higher financial performance. as such, we propose that: hypothesis i b: the achievement ofstrategic goals mediate the relationship of multi-level strategy processes andfinancial performance. type of strategic goal we investigate two types of strategic goals, goals that focus on the achievement of quality and goals that focus on the achievement of innovation. quality focuses on striving to be more effective and efficient, while innovation focuses on developing new products and services. we propose that the degree of internal cooperation and internal competition required to achieve these strategic goals differs. this difference impacts the effectiveness ofmulti-level strategy processes on firm performance. striving for quality requires organization members to collaborate and coordinate their decisions and actions (dean & bowen, 1994; powell, 1995). to achieve higher quality, organization members must coordinate their actions across functional and hierarchy boundaries (floyd & wooldridge, 2000). for example, the quality of a product should be tracked throughout the value chain of a firm, from inputs to manufacturing through sales and customer service. feedback and learning associated with the achievement of higher quality requires that the organization provides cross-functional communication, not only within the organization but also with suppliers and customers (hart, 1992). decisions reflect cooperation and tight coordination between related entities to achieve high quality. employees are empowered at multiple levels to make decisions that impact quality, but they must be orchestrated within a tight, cohesive system. a strong commitment to quality by all employees is necessary to achieve a goal of quality (bowles, 1992; gabor, 1990; port & smith, 1995). multi-level strategy processes include the aspects of learning and adaptation required to achieve greater quality. the relationship between multi-level strategy processes and the processes required to achieve quality are highly complementary in nature, as both require cooperation and coordination in the development of strategy and the implementation of quality. greater achievement ofthe strategic goal of innovation also requires multiple levels of involvement in strategy processes. as others have advocated (damanpour, 1991, kantor, 1988), it is important that individuals are encouraged to continually commit to product and process innovation in order for creativity not 82 journal of business strategies vol. 22, no.2 to be strangled. while innovation as a strategic goal requires employees at all levels ofthe organization to commit to new product development, there is a lesser need for systematic coordination across all levels and functions of the organization to achieve it. in contrast to those firms in pursuit of quality, firms striving for innovation use teams (usually multi-functional) that compete for resources (burgelman, 1983). thus, the innovation process is rooted more in competition rather than cooperation. because the overall coordination required to successfully implement innovation is lower, the effectiveness ofmulti-level strategy processes on innovation goals will be lower relative to quality goals. to summarize, high achievement of innovation requires a team-level goal commitment, more than an organizational-level goal commitment. in addition, for innovation, coordination is confined to fewer individuals in the organization and there is competition between teams for resources. in contrast, achievement of quality requires greater coordination across the entire organization. as such, the use of multi-level strategy processes is more effective when the goal requires broader coordination and communication across a greater number of organizational members. in the case of innovation, organization members need only to communicate with the specific team members involved in a specific innovation project. since multi-level processes facilitate cooperation and commitment, the fit between quality and multi-level processes is higher compared to the fit with innovation and multi-level processes. therefore, the link between multi-level strategy processes and firm performance will differ. we hypothesize that: hypothesis 2: the indirect relationship between multi-level processes andfirm performance is stronger when the strategic goal is quality rather than when the strategic goal is innovation. environmental dynamism as a moderator in order to test the strength of our predictions and argument, we investigate the role of environmental dynamism on the differences between quality and innovation. environmental dynamism is defined as both technological change and unpredictable instability (miller & friesen, 1983; powell, 1996) and has been an important variable in investigations of strategy processes and firm performance (hart & banbury, 1994; tegarden et al., 2003). while investigations have yielded mixed results (miller & cardinal, 1994; rajagopalan et al., 1993), there is growing evidence that strategy processes such as strategic planning (brews & hunt, 1999) and rational decision making (goll & rasheed, 1997) are more effective in dynamic environments. we predict that the role of environmental dynamism will depend on whether the strategic goal is quality or if the strategic goal is innovation. we propose that environmental dynamism will positively impact the multi-level strategy process when the strategic goal is quality. to be successful in dynamic environments, firms must adapt to unpredictable external changes. firms that strive for high quality have more connections with external actors because quality fall 2005 tegarden et al.: engagement of employees 83 requires extensive collaboration with both suppliers and customers. in addition, organization members are more connected to ensure that coordination and communication transpires. because of the greater number oflinkages implemented in an organization when quality is a priority, information regarding changes in the environment will transmit to a greater number of organization members faster. thus: hypothesis 3a: the strength ofthe relationship between multilevel strategic processes and the strategic goal of quality is greater when environmental dynamism is high compared to when environmental dynamism is low. we suggest that the relationship between multi-level strategy processes and the strategic goal of innovation will be negatively impacted by environmental dynamism. in contrast to the implementation mechanisms in place for quality, the number of communication and coordination links among employees is lower with the goal of innovation, resulting in less information being relayed about the changing environment. while a single project team can respond quickly to changes, the entire organization will take longer to absorb and determine the strategic impact of external changes. the use of multi-level strategy processes with processes that support innovation are more likely to generate multiple interpretations ofthe nature and impact of change because employees are often tied to individual projects with individual goals and reward structures. this is also more likely to result in greater negotiation to reach agreement about the company's future strategy. moreover, we suggest that under conditions of low dynamism it is even more important for firms to continually innovate to stay ahead of their industry's competitors. thus we predict effectiveness will decline with the use of multi-level strategy processes with the goal of innovation in more dynamic environments. we hypothesize that: hypothesis 3b: the strength ofthe relationship between multilevel strategic processes and the strategic goal of innovation is greater when environmental dynamism is low compared to when environmental dynamism is high. method ouf sample was obtained from the 1996 corptech directory of technology companies. this data set ofu.s. firms was published by the corporate technology information services. the range of these technology industries includes advance materials, biotechnology, defense, environmental, manufacturing equipment, transportation, and chemicals. the relationships being tested are not time dependent. following guidelines for strategy research, there is no reason for suspecting that the age of the data influenced the results in this study (robins, 2004). 84 journal of business strategies vol. 22, no.2 we randomly selected 2,000 organizations from among the firms provided by the corptech directory and mailed surveys to the chief executives of these firms. research indicates that top administrators provide reliable information about basic environmental and organizational characteristics of their organizations (miller & friesen, 1983). a total 01'377 surveys were returned for a 19% response rate. this response rate is not atypical for research using ceos as respondents (milliken, 1990). non-responding firms did not differ significantly from responding firms in the proportion of privately owned firms, number of employees, sales revenue, annual percentage growth in number of employees, or year of formation. we eliminated returned surveys with incomplete information, leaving the data from 335 surveys for use in our statistical analysis. most (80%) are private firms and over half of the firms report annual sales revenues of less than $2.5 million and employ fewer than 25 workers. less than 2% employ over 2,500 workers and about 3% have sales of over $500 million. approximately 8% of the firms in the sample have been in business for 25 or more years, approximately 36% for between 10 and 24 years, and the remaining firms have been in business for less than 10 years. measures. the scales used to construct the variables in this investigation have been standardized and validated by other researchers. the questions were presented on a five-point likert scale. variables are measured using averages across multiple items. multi-level strategy processes. multi-level strategy processes is measured using the average of five items developed by hart and banbury (1994). these strategy processes reflect engagement of employees at all levels of the organization. items in this measure include the questions: "strategy is made on an iterative basis, involving managers, staff and executives in an on-going dialogue." and "most people in this company have input into the decisions that effect them." the alpha coefficient for this measure is 0.74. strategic goalquality. quality as a strategic goal is measured using the average of three items developed by hart and banbury ( 1994). this measure included answers to questions focusing on whether the respondents' organization produced high quality of product (service) or if quality was a focus in the technical product! service design and development. the alpha coefficient for this measure is 0.61. strategic goal-innovation. innovation as a strategic goal is measured using the average of three items developed by hart and banbury (1994). this measure included answers to rating the company's performance over the last three years on activities such as the extent of product/service changes over the past five years and the number of new products/services in the next year. the alpha coefficient is 0.66. strategic goals combined. the items to measure the strategic goal of quality and the strategic goal of innovation were combined for an overall average of strategic goals. the alpha coefficient for this measure is 0.70. fall 2005 tegarden et al.: engagement of employees 85 financial performance. financial performance is measured as an average of a five-item scale developed by powell (1995). respondents are asked questions that reflect the extent that revenue, growth, or financial performance has exceeded their competitors' or has been judged outstanding by the respondent in the last three years. although the measures obtained are subjective, past research has validated the use of such measures for performance (lawrence & lorsch, 1967), and is appropriate for samples such as ours in which most (80%) of the firms are privately owned. the alpha coefficient for this measure is 0.91. environmental dynamism. environmental dynamism is measured as an average of five items from a scale developed by powell (1996) with questions related to the frequency of change in the environment and the predictability of this change (miller & friesen, 1983). respondents were asked the extent to which they agreed with statements such as "demand in our industry has been growing rapidly in the past 3 years" and "our industry is more unstable than most, changing more quickly and unpredictably." the alpha coefficient for this measure is 0.73. typically, alpha coefficients of multi-item measures should fall within a range of 0.70 and 0.90 for narrow constructs, and 0.55 to 0.70 for moderately broad constructs (van de ven & ferry, 1979). all of the coefficient alphas in this study are in these ranges and are consistent with those used in other studies using these variables (hart & banbury, 1994; tegarden et ai., 2003). results table 1 reports the descriptive statistics and correlations for the variables. results of the correlations show that financial performance is not significantly related to multi-level strategy processes or environmental dynamism. however, multilevel strategy processes is significantly related to the innovation strategic goal, quality strategic goal and the combined strategic goal. as would be expected, strategic goals are related to each other. interestingly, environmental dynamism is significantly related to each strategic goal, as well as the goals combined. hypothesis 1a states that the use ofmulti-level strategy processes is positively related to the achievement of strategic goals. to test this relationship we used regressions, with combined quality and innovation, quality alone, and innovation alone as the dependent variables and multi-level strategy processes as the independent variable. table 2 indicates that multi-level strategic processes are significantly related to the combination of quality and innovation as the strategic goal (f = 88.52, p < 0.001), quality as the strategic goal (f = 80.06, p < .001) and innovation as the strategic goal (f = 40.64, p < .001). thus, hypothesis la is supported. 86 journal o./business strategies vol. 22, no.2 table 1 means, standard deviations and correlations (n = 335) std. variables mean dev. 1 2 3 4 5 6 1. multi-level strategy processes 3.85 .58 1.00 2. quality strategic goal 4.08 .60 .44*** 1.00 3. innovation strategic goal 3.57 .73 .33*** .37*** 1.00 4. combined quality & innovation 3.82 .55 .46*** .79*** .86*** 1.00 5. financial performance 3.14 .96 .08 .19*** .26*** .28*** 1.00 6. environmental dynamism 3.61 .77 .26*** .27*** .28*** .33*** .07 1.00 one-tailed test: * p < .05 , ** p < .01, *** p < .001 table 2 regression model estimates to test hypotheses 1 a regression model for paths modell: dv: combined quality & innovation goals iv: constant iv: multi-level strategy processes r2 f model 2: dv: quality strategic goal iv: constant iv: multi-level strategy processes r2 f model 3: dv: innovation strategic goal iv: constant iv: multi-level strategy processes r2 f estimates 2.14*** .44*** .21 88.52*** 2.33*** .46*** .19 80.06*** 1.96*** .42*** .11 40.64*** one-tailed test: * p < .05, ** p < .01, *** p < .001 fall 2005 tegarden et al.: engagement of employees 87 hypothesis 1b states that the achievement of strategic goals mediate the relationship of multi-level strategy processes and financial pefformance. to investigate this relationship we employed the test for mediation developed by feedman and schatzkin (1992)1. this test is consistent with the recommendation for the investigation of a mediating relationship in strategy research outlined by venkatraman, (1989). that is, mediation specifies the existence of a significant intervening mechanism between an antecedent variable and the consequent variable and is carried out within a path-analytic framework. moreover, the mediator variable should account for a significant proportion of the relationship between the predictor and the criterion (venkatraman, 1989, p. 429). we test hypothesis i b with a series of regression models (see table 3), contrasting three strategic goal mediators with the unadjusted regression (multilevel strategic processes on financial performance). first, we tested whether the combined strategic goals of quality and innovation mediated the relationship between multi-level strategic processes and performance (model i v. model 2). subsequently, we test for the mediating ehect of the quality strategic goal (model i v. model 3) and then the innovation strategic goal (modell v. model 4). the results indicate a significant mediating relationship for the combined strategic goal (t = -5.12, p < .001), as well as a significant mediating relationship for the quality goal (t = -3.20, p < 0.001) and the innovation goal (t = -4.67, p < .001). this represents a complete mediation model, rather than partial mediation model, because the relationship between multi-level strategic processes and firm performance is not significant without the inclusion of strategic goals (venkatraman, 1989). we find positive support for hypothesis 1b with all three models, indicating support that strategic goals mediate the relationship between multi-level strategy processes and firm performance. hypothesis 2 states that the relationship between multi-level processes and firm performance is stronger when the strategic goal is quality rather than when the strategic goal is innovation. hypothesis 2 is tested using path analysis, a recommended statistical tool when examining theorized pathways (asher, 1983). path analysis uses the un standardized beta coefficients from the regression equations in table 4. hypothesis 2 would be supported if the indirect effects using quality (indirect path model a) are greater than those focusing on innovation (indirect path model b). hypothesis 2 was not supported as the indirect pathways of quality (.46 * .31 = .14) are less than the indirect effect pathways of innovation (.42 * .35 = .15). moreover, the quality pathway accounts for 49% of the indirect effect and the innovation pathway accounts for 51 % of the effect (trevino & youngblood, 1990)2, further evidence that our hypothesis is not supported. we test hypotheses 3a and 3b by comparing the regressions of multi-level strategy processes on the strategic goals of quality (hypothesis 3a) and innovation (hypothesis 3b) under conditions of high dynamism and low dynamism. hypothesis 3a states that the strength of the relationship between multi-level strategic processes and the strategic goal of quality is greater when environmental dynamism is high compared to when environmental dynamism is low. responses 88 journal ofbusiness strategies table 3 regression model estimates regression model estimates to test hypotheses ib vol. 22, no.2 model i: unadjusted regression for mlsp on financial performance iv: constant iv: multi-level strategy processes ('t') --~ -----standard error for mlsp parameter est. (0,.) r2 f 2.65*** .13 "~ .~ .09 .01 1.90 model 2: adjusted for combined quality & innovation goals iv: constant iv: multi-level strategy processes ('t) iv: combined quality & innovation goals . --~ --~ --standard error for mlsp parameter est.(o,l) r2 f mediation test (model i v. modell)! model 3: adjusted for quality strategic goal iv: constant iv: multi-level strategy processes ('1) iv: quality strategic goal standard error for mlsp parameter est. (u'2) r2 f mediation test (model iv. modei3)! model 4: adjusted for innovation strategic goal iv: constant iv: multi-level strategy processes (t) iv: innovation strategic goal standard error for mlsp parameter est. (a'3) r2 f mediation test (model i v. model 4) i i freedman and schatzkin test: t n-2= t -r' 1.52*** -.11 .53*** .10 .08 14.18*** -5.12*** 1.93*** -.02 .31*** .10 .04 6.10*** -3.20*** 1.98*** -.02 .35*** .09 .07 12.02*** -4.65*** ~a 2 , + a 2 t' 2al a f ~1p2 !<i where p xi = correlation between the independent and intervening variable one-tailed test: * p < .05 , ** p < .01, *** p < .001 fall 2005 tegarden et al..' engagement of employees 89 table 4 regression model estimates regression model estimates to test hypotheses 2 regression model for paths estimates model i: (direct effect) dv: financial performance iv: constant iv: multi-level strategy processes r2 f 2.65*** .13 .01 1.90 2.33*** .46*** .19 80.06***f indirect path model a: mlsp --)10. quality ------. financial performance model ai: dv: quality strategic goal iv: constant iv: multi-level strategy processes r2 modela2: dv: financial performance iv: constant iv: multi-level strategy processes iv: quality strategic goal r2 f 1.52*** -.02 .31 *** .04 6.10*** 1.96*** .42*** .11 40.64*** indirect path model b: mlsp -+innovation --)10. financial perf. model b1: dv: innovation strategic goal iv: constant iv: multi-level strategy processes r2 f model 82: dv: financial performance iv: constant iv: multi-level strategy processes iv: innovation strategic goal r2 f 1.98*** -.02 .35*** .07 12.02*** one-tailed test: * p < .05, ** p < .01, *** p < .001 90 journal olbusiness strategies vol. 22, no.2 below the median of the environmental dynamism variable are considered to be facing conditions of low dynamism, while those above the median are considered to be facing conditions of high dynamism. a subgroup analysis is appropriate with testing a moderating relationship (venkatraman, 1989). to test the sensitivity of our results, we also analyzed the relationships defining high and low dynamism as those being in the top third as well as the top quartile of responses. while the results using the fine grained definitions of dynamism were more significant, we conservatively report the results using the median as the cutoff. we employed a chow test (chow, 1960) to test the difference in variance explained between high and low dynamism (see table 5) for the strategic goal of quality. we found that the diflhence was significant (f "" 3.29, p "" .05), and in the direction predicted. thus, hypothesis 3a was supported. hypothesis 3b states that the strength of the relationship betlveen multi-level strategic processes and the strategic goal ofinnovation is greater when environmental dynamism is low compared to when environmental dynamism is high. the chow test for the strategic goal of innovation indicated that the difference was in the predicted direction and statistically significant (f 5.78, p < .001), giving support to hypothesis 3b. table 5 regression model estimates to test hypotheses 3a and 3b dv: strategic goal of quality dv: strategic goal of innovation test of hypothesis 3a test of hypothesis 3b full low high full low high sample dynamism dynamism sample dynamism dynamism (n=335) (ifc 174) (n=161) (n=335) (n=174) (n=161) intercept 2.32*** 2.44*** 2.36*** 1.95*** 1.85*** 2.52*** multi-level strategy processes .46*** .41*** .47*** .42*** .42*** .31 ** f (for regression model) 80.06*** 31.35*** 40.87*** 40.64*** 23.65*** 8.78*** r2 19.4% 15.4% 20.5% 10.9% 12.1% 5.2% sum of squared errors 96.56 59.37 35.30 159.84 82.16 72.29 chow test (f-statistic) 3.29* 5.78*** one-tailed test: * p < .05 , ** p < .01, *** p < .001 fall 2005 tegarden et al.: engagement ofemployees discussion 91 our intent with this investigation is to unravel the complex relationship between multi~level strategy processes, strategic goals and firm performance. we find that there is not a significant relationship between multi-level strategy~ making processes and firm performance when strategic goals are not included in the investigation. however, when strategic goals are included as a mediator, a significant relationship is found. ifthis study had only investigated the direct link, the relationship between multi-level strategy processes and performance would have been missed. this study reveals that the nature of the relationship between multi~level strategy process and financial performance is complex, and that this complexity needs to be incorporated in understanding the relationship between strategy process and firm performance. these results help underscore that indeed there may be a relationship between strategy processes and firm performance that has been here~to~fore underrepresented because of the complex sets ofrelation~ ships needed to be considered (rajagopalan et ai., 1993). while the importance of strategic goals has been discussed in strategic management, the insights from research of the organizational behavior scholars of goal formation have not been fully represented in the strategy field. our results provide evidence ofa tie between engaging employees in the goal setting process and achieving the goals. perhaps more importantly, we provide evidence that the engagement of employees in strategy processes can be related to financial perfor~ mance. the tie between basic management principles and firm performance has been hypothesized, but the empirical evidence has not been forthcoming. we provide a basis from which this important relationship can be further investigated. our findings support the prediction that environmental dynamism moderates the relationship between the engagement of employees and the type of goal being achieved. our rationale was that quali~v goals require more communication and coordination and innovation goals involve more competition among subgroups. therefore, we predicted differences in the strengths of the relationships depending on environmental dynamism. more specifically, our results supported our prediction that the positive relationship between engaging employees in goals of quality and achieving the goals is greater under conditions of higher environmental dynamism. thus, the payoff for the communication and coordination that is involved in quality goals is greater in more dynamic environments. moreover, while it is important to engage employees in goals focusing on quality, it is particularly effective in highly dynamic environments. it seems that the communication and coordination necessary for quality goals is particularly beneficial in more dynamic environments. consistent with our predictions, we found that involving employees is more effective in achieving the goal of innovation under conditions of low dynamism than under conditions of high dynamism. our rationale was that there is more competition for ideas among subgroups in innovative goals and less dynamic environments would result in more effective implementation of the strategy 92 journal of business strategies vol. 22, no.2 engagement process. implementing innovative goals at the organizational level takes longer than at the subgroup level. time is a luxury more available to firms operating in less dynamic environments. thus, while there is a positive effect in engaging employees toward innovative goals, it is more effective in less dynamic environments. moreover, it seems that the high speed that decisions need to be made in highly dynamic environments (bourgeois & eisenhardt, 1988), means that the investment in innovative goals at the organizational level is not as valuable as in less dynamic environments, but valuable nevertheless. the findings in this investigation help lay the foundation for future studies that link other types of strategy processes and performance. the mediating nature of strategic goals should be investigated with processes such as formal strategic planning. it has been argued that key insights regarding the conflicting evidence regarding the link between strategic planning and firm performance are to come from investigating the impact of mediating variables (boyd, 1991). we suggest that the mediating role of strategic goals be added to strategy processperformance studies. future investigations should also explore how firms can grow and yet continue to involve employees at multiple levels of the process strategy making processes. while it is relatively simple to engage the majority of employees in major decisions for sman entrepreneurial organizations, it is certainly more difficult as the company grows and matures. our investigation did not explore whether engaging employees in strategy processes results in better goals being formulated, which could lead to higher financial performance. future investigations could also unravel this explanation to our findings. certain caveats to our findings should be noted. our methodology used crosssectional survey data, and thus we can only investigate associations, not causality. the problem of reciprocal causality between strategy processes, strategic goals and firm performance is a limitation of other studies and is a limitation of ours as well. longitudinal investigations are needed to provide greater insight into the relationships that we are presenting. we suggest exploring the relationships between the engaging employees in strategy making processes to more populations to further the generalizability of our results. implications of our study to managers suggest that strategy formulation should be made on an iterative basis, involving managers and employees in ongoing dialogue. this is in direct contrast with the traditional models of strategy formulation in which a vision is generated by the leader and then communicated throughout the organization. involving organization participants in important strategic decisions leads to not only a greater commitment toward the strategic goals but better implementation of these goals. these intangible organizational processes are hard to imitate and can be a source of sustained competitive advantage. this means the political activities involved in strategic processes can be worth the time they entail and will have a payoff in the long run. managers should also take note that the level of environmental dynamism relates to the strength of the relationship between the engagement of employees and strategic goals. in highly dynamic environments, there will be a higher payoff for engaging employees in fall 2005 tegarden et al.: engagement ofemployees 93 decisions surrounding quality goals and in less dynamic environments, there will be a higher payoff for engaging employees in decisions surrounding innovative goals. however, our results suggest that whatever strategy a firms is pursuing, the benefits of engaging employees in the process can result in increased financial performance, whatever the environment. this is certain to get the attention of even leaders that run out of patience with the time and resources involved in strategic processes. our findings underscore the importance of how one travels on the road in business is as important as where the road leads. references anthony, w. p. (1978). participative management. reading, ma: addison-wesley. asher, h. b. (1983). causal modeling (2 nd ed.). beverly hills, ca: sage publications. blake, r. r., & mouton, j. s. (1970). the managerial grid. houston: gulf bourgeois, l. j., & eisenhardt, k. m. (1988). strategic decision processes in high velocity environments: four cases in the microcomputer industry. !v[anagement science. 34,816-835. bowen, d, e., & lawler, e. e. (1992). the empowerment of service workers; what, why, how, and when. sloan management reviel1: 33,31-39. bowles, j. (1992, april), is american management really committed to quality? management review. 81,42-46 boyd, b. k. (1991 ). strategic planning and financial performance: a meta-analytic review. journal of management studies, 28,354-374. brews, p. j., & hunt, m. r. (1999). learning to plan and planning to learn: resolving the planning schoolllearning school debate. strategic management journal. 20, 889-913. brown, s. l., & eisenhardt, k. m. (1998). competing on the edge: strategy as structured chaos. boston: harvard business school press. burgelman, r. a. (1983). managing the internal corporate venturing process: some recommendations for practice. administrative science quarterly, 28,223-244. burgelman, r.a. (1991). intraorganizational ecology ofstrategy making and organizational adaptation: theory and field research. organization science, 2,239-262. chakravarthy, b. s., & doz, y. (1992). strategy process research : focusing on corporate self-renewal. strategic management journal. 13, 5-14. 94 journal ofbusiness strategies vol. 22, no.2 chow, g. c. (1960). tests of equality between sets of coefficients in two linear regressions. econometrica, 28,591-605. conger, j. a., & kanungo, r. n. (1988). the empowerment process: integrating theory and practice. academy of management review. j3, 471-482. cotton, j. l., vollrath, d. a., legnick-hall, m. l., & froggatt, k. l. (1990). factthe form of participation does matter: a rebuttal to leana, lock, and schweiger. academy of management review. /5. 147-153. damanpour, f. (1991). organizational innovation: a meta-analysis of effects of determinants of moderators. academy of management journal. 34, 555-590. dean, jr., 1. w., & bowen, d. e. ( 1994). management theory and total quality: improving research and practice through theory development. academy of management review, j9, 392-418. eylon, d., & au, k. y. (1996). exploring empowerment cross-culture differences along the power distance dimensions. paper presented at the national academy of management meeting, cincinnati, oh. floyd, s. w, & wooldridge, b. (2000). building strategyfrom the middle. reconceptualizing strategy making process. beverly hills, ca: sage publications. forrester, r. (2000). empowerment: rejuvenating a potent idea. the academy of management executive. 14.67-80. freedman, l. s., & schatzkin, a. (1992). sample size for studying intermediate endpoints within intervention trials of observational studies. american journal ofepidemiology,136,1148-1159. frost, c. h., wakely, 1. h. & ruh, r. a. (1974). the scanlon planjor organization development: identify. participation. and equity. east lansing: michigan state university press. fulford, m. d. & enz, c. a. (1995). the impact of empowerment on service employees. journal of managerial issues, 7, 161-175. gabor, a. (1990). the man who discovered quality: how w edwards deming brought the quality revolution to america-the stories of ford. xerox. & gm new york: random house. gou, r., & rasheed, a. m. a. (1997). rational decision-making and firm performance: the moderating role of environment. strategic management journal. 18, 583-591. hamel, g., & prahalad, c. k. (1994). competing for the future. boston: harvard business school press. fall 2005 tegarden et al.: engagement of employees 95 hart, s. (1992). an integrative framework for strategy-making processes. academy ql' management review, j 7. 327-351. hart, s., & banbury, c. (1994). how strategy-making processes can make a difference. strategic management journal, 15, 251-269. huff, a., & reger, r. (1987). a review of strategic process. journal 01' management, 13(2), 211-236. jelinek, m., & schoonhoven, c. b. (1990). the innovation marathon. oxford, u.k,: basil blackwell. kantor, r. m. (1988). when a thousand flowers bloom: structural, collective, and social conditions for innovation in organization. research in organizational behavior, jo, 169-211. kantor, r. m. ( 1989), the new managerial work, harvard business revieh', 66, 85-92. kaplan, r., & norton, d, (1996, january-february), using the balanced scorecard as a strategic management system. hanoard business ret'iew, 74, 75-85. koberg, c. s.. boss, r. w., senjem, .i. c., & goodman, e. a. (1999). antecedents and outcomes of empowerment: empirical evidence from the health care industry. group and organization management. 24, 71-91. kuratko, d. f., hornsby, j. s., & corso, l. m. (1996, spring). building an adaptive firm. small business forum, j 4, 41-48. lawler, e, e. (1986). high involvement management, san francisco: jossey-bass. lawler, e. e. (1992). the ultimate advantage. san francisco: jossey-bass. lawler, e. e., mohrman, s. a., & ledford, g. (1992). employee involvement and total quality management: practices and results in fortune 1,000 companies. san francisco: .iossey-bass, lawler, e. e., mohrman, s, a., & ledford, g, (1995), creating high performance organizations. san francisco: jossey-bass, lawrence, p" & lorsch, j. (1967), organization and environment. boston: harvard business school press. ledford, g. e., jr., & lawler, e. e., iii. (1994). dialogue: research on employee participation: beating a dead horse? academy of management review, 19 (4), 633-636. likert, r. (1961). new patterns afmanagement. new york: mcgraw-hili. 96 journal ofbusiness strategies vol. 22, no.2 locke, e. a., latham, g. p., & erez. m. (1988). the determinants of goal commitment. the academy of management review, j 3(1), 23-39. mackinnon, d. p., lockwood, c. m., hohman, j. m., west, s. g., & sheets, y. (2002), a comparison of methods to test mediation and other intervening variable effects. psychological methods. 7(1), 83-104. maier, n. r. f. (1963). problem solving discussions and conferences: leadership methods and skills, new york: mcgraw-hili. mcgregor, d, (1960). the human side of enterprise. new york: mcgraw-hill. melcher, a. j. (1976). participation: a critical review on research findings. human resource management, j 5, 12-21. miller, c. c., & cardinal, l. b. (1994). strategic planning and firm performance: a synthesis of more than two decades of research. academy 0.1' management journal, 37, 1649-1665. miller, d., & friesen. p. h. (1983). strategy making and environment: the third link, strategic management journal. 4,221-235. miller, d., & lee, j. (2001). the people make the process: commitment to employees, decision making, and performance. journal of management, 27, 163-190. miller, k. & monge, p. r. (1986). participation, satisfaction, and productivity: a metaanalytic review, academy of management journal, 29,727-753. milliken, f, j. (1990). perceiving and interpreting environmental change: an examination of college administrators' interpretation of changing demographics. academy of management journal, 33, 42-63. miron, e., erez, m., & navch, e. (2004). do personal characteristics and cultural values that promote innovation, quality, and efficiency compete or complement each other? journal of organizational behavior, 25, 175-199. monge, p. r., cozzens, m. d., & contractor, n. s. (1992). communication and motivational predictors ofthe dynamics oforganizational innovation. organization science, 3,250-274. ozer, e. m. & bandura, a. (1990). mechanisms governing empowerment effects: a selfefficacy analysis. journal of personality and social psychology. 5, 472-486. pfeffer, j. (1994). competitive advantage through people: unleashing the power of the workforce. boston: harvard business school press. port, 0., & smith, g. (1995, january 14). the straining of quality. the economist, 55-56, fall 2005 tegarden et al.: engagement of employees 97 powell, t. c. (1992). strategic planning as competitive advantage. strategic management journal, 13, 551-558. powell, t. c. (1995). total quality management as competitive advantage: a review and empirical study. strategic management journal, 16, 15-37. powell, t. c. (1996). how much does industry matter? an alternative empirical test. strategic management journal. 17, 323-334. rajagopalan, n., rasheed, a. m., & datta, d. k. (1993). strategic decision processes: critical review and future directions. journal of management, 19, 349-384. ritchie, j. b., & miles, r. e. (1970). an analysis of quantity and quality of participation as mediating variables in the participative decision making process. personnel psychology. 23, 347-359. robins, j. a. (2004). when does the age of data matter? notes on the selection of data for strategy research. in oj. ketchen & d.o. bergh (eds.), research methodology in strategy and management, volume 1, 25 1-271. rudolph h. r., & peluchette, j. v. (1993). the power gap: is sharing or accumulating power the answer? journal ofapplied business research, 9, 12-20. salancik, g. r. (1977). commitment and the control oforganizational behavior and belief in 8.m. staw & g. salancik (eds.), new directions in organizational behavior (154). chicago: st. clair. spreitzer, g. m. (1995). psychological empowerment in the workplace: dimensions, measurement, and validation. academy of management journal, 38, 1442-1465. spreitzer, g. m. (1996). social structural characteristics of psychological empowerment. academy of management journal, 39,483-504. tegarden, l. f., sarason, y, & banbury, c. (2003). linking strategy processes to performance outcomes in dynamic environments: the need to target multiple bull's eyes. journal of managerial issues, 15, 133-153. trevino, l. k., & youngblood, s. a. (1990). bad apples in bad barrels: a causal analysis of ethical decision-making behavior. journal ofapplied psychology, 75,378-385. van de ven, a., & ferry, d. (1979). measuring and assessing organizations. new york: the free press. venkatraman, n. (1989). the concept offit in strategy research: toward verbal and statistical correspondence. academy ofmanagement review, 14 (3), 423-444. von hippel, e. (1988). the sources of innovation. new york: oxford university press. 98 journal of business strategies vol. 22, no.2 wagner, j. a., ill. (1994). participation's effects on performance and satisfaction: a reconsideration of the research evidence. academy of manarement review, 19,312-330. willard, g. e., krueger, d. a" & fesser, h. r. (1992), in order to grow, must the founder go: a comparison of performance between founder and non-founder managed highgrowth manufacturing firms. journal of business venturing, 7, 181-194. wooldridge, b., & floyd, s. w. (1990). the strategy process, middle management involvement and organizational performance. strategic management journal. jj, 231-241. zimmerman, m. a. (1990). taking aim on empowerment research: on the distinction between individual and psychological conceptions. american journal ofcommunity psychology. 18, 169-177. footnotes i the merits of this test are discussed by mackinnon, lockwood, hoffman, west and sheets (2002). 2 this contrast is calculated by dividing the path indirect effect by the total indirect effects. linda f. tegarden (ph.d., university of colorado at boulder) is an associate professor of strategic management. her research interests include the role of networks and geographic clusters in technology-driven environments, strategy process and strategic planning effectiveness in high velocity environments, the use and effectiveness of cognitive mapping in strategic planning processes. yolanda sarason (ph.d., university of colorado at boulder) is an assistant professor of strategic management and entrepreneurship at colorado state university. her research interests include organizational identity and structuration theory, strategy process in high technology and high velocity environments, and the role of cognition in the strategic management and entrepreneurship areas. j. stephen childers (abd, virginia tech) is an assistant professor of management at radford university. his research interests build upon the schumpeterian view of innovation; where change is recognized, organized, and achieved by entrepreneurial insight within organizations. mr. childers' interests in strategy and change were formed during his experiences working, managing, and consulting with firms both domestically and internationally. donald e. hatfield (ph.d., university of california at los angeles) is an associate professor of strategic management at virginia tech. his current interests deal with the interaction between the fields of economics, finance, organizational fall 2005 tegarden et al.: engagement of employees 99 theory, and strategic management. dr. hatfield's current research is focused upon how managers can deal with the uncertainty associated with technology, and the underlying factors driving geographic industrial clustering. the engagement of employees in the strategy process and firm performance: the role of strategic goals and environment swift trust and distrust in strategic partnering relationships: key considerations of team-based designs terry r. adler new mexico state university las cruces, new mexico abstract we explore the integration oftrust and distrust as defined by lewicki, mcallister, and bies (1998) with its effects on team-based designs. a hypothetical long-term contract simulation was used to study trust and distrust through a medium-term, qualitative analysis. results indicate that teams respond differently to trust and distrust perceptions in the development ofcontracts. discussion of the lewicki et al. (1998) model demonstrates that while trust served to loosen formalities between teams and led to higher perceived quality, the presence ofdistrust led to the development ofcompetition between teams, higher inter-team accountability and lesser perceived quality. introduction organizations have not only been witness to but active participants in a major phenomena over the past twenty years: the increasing use ofteams to develop and implement long-term contracts used in outsourcing organizational work (adler, 2004; barthelemy & adsit, 2003; benfratello & sembenelli, 2002; boswell, 2000; cohen & bailey, 1997; paladino, bates & da silveira, 2002; schilling & steensma, 200 i). an assumption behind outsourcing is that trust improves communication and cooperation between teams in the accomplishment of organizational work (boon & holmes, 1991; dasgupta, 1988; jeffries & reed, 2000; mayer, davis & schoorman, 1995). while it is clear that research has indicated a need for trust in partnering relationships, the study of how trust and distrust affect inter-team based designs is clearly understudied and, thus, underdeveloped. the purpose of this paper is to contribute to our understanding ofthe effects of trust and distrust perceptions on inter-team processes and outcomes. using lewicki, mcallister, and bies 's (1998) model of trust and distrust, we studied groups in a capstone business course to more fully understand how inter-team interactions are affected by the perception of simultaneous trust and distrust. this paper investigates two fundamental assumptions with regard to trust and distrust. first, we explore the basis for understanding how inter-team relationships are affected by simultaneous tmst and distrust. given the fast-paced nature of today's work environment, the formation of 'swift' trust and distrust implies that 106 journal ofbusiness strategies vol. 24, no.2 teams have to make quick decisions based on interdependence of work between teams. this study also provides a fundamental assessment of how simultaneous trust and distrust perceptions affect the formality and boundaries of inter-team interactions. since teams are being used more frequently and for more varied types of work, an investigation of lewicki et al. 's (1998) model is long overdue. do trust and distrust work together as hypothesized by lewicki et al. (1998)? this study provides insight into how teams parlay perceptions oftrust and distrust into a future partner relationship. the integration of trust and distrust in long-term contracting outsourcing typically involves some degree of negotiation between teams and research in the outsourcing of organizational work providing an intricate blend of information regarding team adaptation and communication (adler, 2004; bell, 1990; helewitz, 2003; robinson & volkov, 1998). outsource teams integrate individual, team, functional and organizational norms in negotiating long-term contracts (bazerman, 1983; knorr & knorr, 1978; lacity & willcocks, 1998; niederman, brangeay, & wetherbe, 1991), yet these teams are constrained by contextual factors like trust and distrust. teams develop long-term contracts based on perceptions of trust and distrust. the concepts of trust and distrust have been researched for over 40 years with an emphasis on the intentions and behaviors of those in which a trading relationship exists (deutsch, 1960; hosmer, 1995). key to understanding trust and distrust is the fact that these concepts are two unique conditions, not opposite ends of the same continuum (luhmann, 1979). consequently, there are unique elements of teams that contribute specifically to both the growth and decline of trust and distrust. partners may collaborate, but they may also compete and this leads to simultaneous trust and distrust (rousseau, 1995). trust and distrust are thus defined as positive and negative expectations, respectively, of another partner's future conduct while one's organization is vulnerable in the partnership (boon & holmes, 1991). these expectations are firmly established in how team members perceive a partnership with regard to the extent their own livelihood can benefit or be harmed. while team dynamics are worthy factors that affect simultaneous development of trust and distrust perceptions, most organizational contracts depend on inter-team interactions to design and fulfill organizational work (lewicki et ai., 1998). examples of simultaneous trust and distrust perceptions are provided in table 1 as adapted from the lewicki et a1. (1998) model. levels of trust and distrust in relational contracting early definitions of individual levels of trust are explained as a "belief in the goodness of others" (erickson, 1950), or as "an expectancy that is held by an individual or group that the word ... of another individual or group can be relied upon" (rotter, 1980). follow-on development of the trust concept included the fall 2007 adler: swift trust and distrust 107 confident expectation of the trustor that the trustee will help the trustor reach a goal in an environment of risk and uncertainty (mayer, davis, & schoorman, 1995). this environment of risk and uncertainty is also what provides the basis for trust and distrust in teams. zand (1972) refers to trust at the team level as generalized expectations for all team members. a key task of team members is to integrate varying individual trust and distrust expectations into a team-level perception of trust and distrust. therefore, we define trust as one group's positive perceptions of another group's conduct while in a working relationship. similarly, distrust is one group's negative perceptions of another team's conduct while in a working relationship (adapted from boon & holmes, 1991). the perceptions of trust and distrust form the basis for hard and soft contracting in relational contracting as described by williamson and ouchi (1981). the authors suggest that hard contracting is required when contract requirements are explicit. soft contracting is used when contract terms are less specific, measurable, and clearly stated, and usually in the form of tacit agreements. the underlying premise in relational contracting is that teams choose between hard and soft contracting as a framework to do work based on their perceptions of trust and distrust. this may not be a valid assumption without careful thought on how team processes affect the development of contract requirements. hard contracting is more precise and definitional in the terms that bound a business partnership. soft contracting tends to be less stringent and more informal, many times succumbing to the social dynamics of the business relationship. thus, soft contracting may have many more ambiguities in contractual terms but also more opportunities for off-contract partnering and conflict resolution. hard and soft contracting compose two competing views on how a partnership, as a relationship, should be arranged or governed (schilling & steensma, 2001; zuckerman & higgins, 2002). consideration of trust and distrust in relational contracting is required because these conditions affect how requirements are written in the contract (jeffries & reed, 2000). a long-term contract is nothing more than a medium by which the partnership is framed and subsequently governed. teams performing the task of developing a contract based on perceptions of trust and distrust greatly influence how teams interact and whether contracts end up 'hard' or 'soft' (adler, 2005). since teams form and adjourn quickly and regularly, meyerson, weick, and kramer (1996) suggest that organizational members develop' swift trust' perceptions based on little time to acquire information about an individual, team or organization. swift trust and distrust in team-based designs swift trust, a term coined by meyerson et al. (1996), can be the result oftemporary teams who are thrown together to work on important, complex tasks. teams are typically dependent on other teams but there is little time to determine if another team has a poor past performance (ancona & caldwell, 1992). as meyerson et al. (1996) stated, in order to trust a temporary group, the members must "wade in" as opposed to waiting until experience shows if a team is trustworthy. 108 journal of business strategies vol. 24, no.2 swift trust and distrust are, of necessity, formed quickly to manage issues of uncertainty, risk, and perceptions between teams. based on the concept oftemporary team-based designs, swift trust and distrust develops because ofthe diversity ofteam membership, limited history working together and task non-routineness, complexity and interdependence (meyerson et ai., 1996). larson and lefasto (1989) and mishra (1996) explain that in team-based designs, trust fosters inter-teamwork by allowing individuals to stay problemfocused, promoting more efficient communication and coordination, improving the quality of collaborative outcomes, and compensating other team members who are willing to pick up the slack if one team member fails. within a team, members are mutually accountable for the outcomes they construct (cohen & bailey, 1997) and trust would seem to be a factor that maximizes inter-team accountability. since teams are viewed as intact social entries embedded in one or more larger social systems, inter-team based efforts typically result in performance that is greater than the sum of those team parts. thus, the existence oftrust leads to the following proposition: proposition i: inter-team relationships should be perceived as ofhigher quality in high trust situations. although trust is obviously an important consideration, there is also a place for distrust perceptions in inter-team based designs. while distrust may lead to good risk mitigation a priori, distrust perceptions may also limit communication and create a priori paranoia between teams (adler, 2005; lewicki et ai., 1998). based on the potential for negative aspects of distrust between teams, the following proposition is offered: proposition 2: inter-team relationships should be perceived as of lower quality in high distrust situations. simultaneous trust and distrust perceptions create unique conditions in interteam frameworks as high trust perceptions should relax the explicitness of interteam formalities and boundaries teams tend work off-contract to get tasks done (i.e., soft contracting). informal compensating mechanisms like team-building, social networks and spontaneous work adjustment are typical soft contracting activities that characterize inter-team processes in high trust situations. high distrust perceptions, however, should harden contract requirements because teams stipulate the details of their partnership. many believe that stipulating future contingencies is impossible given the quick formation of teams working together to get work accomplished; however, many also believe that general contract work-around strategies can be identified a priori for resolving potential contract disputes. swift forming teams in high distrust conditions should escalate the rigidity of inter-team interactions making them more formalized and bounded. fall 2007 adler: swift trust and distrust 109 proposition 3: the higher trust perceptions are offuture trading partners, the less formal and less bounded inter-team relationships tend to be. proposition 4: the higher distrust perceptions are offuture trading partners, the more formal and more bounded inter-team relationships tend to be. research design methodology a qualitative, medium-term, scenario-based approach was employed where fifty student teams were exposed to four different scenarios in an outsourcing simulation (teams were divided nearly equally among the four scenarios). a medium-term simulation is one that takes more than one class day to do (le., a short-term approach) but less than a semester or quarter to complete (i.e. an extensive case study). this scenario approach took two weeks to collect data requiring four interview sessions with each team. the time span in collecting this data took place over three years. the scenarios were designed to convey a realistic setting oftrust and distrust. the simulation and results validating these scenarios are in adler (2005)1. scenarios were presented to each consulting team that incorporated trust and distrust conceptualizations that were consistent with previous research in studying social effects in teams (bond, leung, & wan, 1982; gomez, shapiro, & kirkman, 2000). to reduce the data and achieve some theoretical understanding, observers compared and discussed team perceptions with regard to how teams collectively viewed their colleague team. to assist reliability and validity of this data interpretation process, miles and huberman's (1984) procedures were followed as quotes were later transcribed and main themes were recorded in an ongoing journal. following pettigrew's (1990) lead, responses were coded for each team to ensure analytical themes were explicitly discussed, and data was reduced and presented accurately. in addition, teams were informed that their responses may be used as part of this study and as such were urged to give an honest assessment of the simulation with regard to their own perceptions of team interactions (glaser & strauss, 1967). notes were hand-transcribed by observers at the end of each presentation to avoid interrupting the interaction of team members, and key words were put into tabular form to maintain the integrity of the data (douglas, 1976; miles & huberman, 1984). team size typically ranged from four to six individuals. observers used table 1 based on lewicki et al (1998) and rotter's (1980) frameworks to identify perceptions that fit one of the four scenarios. we found consistent results in team perceptions within each scenario regarding how teams perceived a trust or distrust perception of their colleague team. again, the purpose of this study was to measure how teams dealt with their colleague team based on perceptions of trust and distrust. judgment calls had to be 110 journal ofbusiness strategies vol 24, no.2 made early in the data reduction and interpretation of team perceptions, however, this is not uncommon for qualitative research (glaser & strauss, 1967; spradley, 1979). observers threw out information that did not add to the purposes of our study. issues like how infonnation would be recorded and processed in teams, who would have ultimate decision authority, and team member roles, while important in other contexts, were not retained. individuals were also assessed after the simulation was completed with a written evaluation. the evaluation included questions ranging from how they would describe this simulation relative to how their teams parlayed perceptions into team interactions. individuals were asked to compile a 'lessons learned' folder to advise future teams on how to deal with colleague teams in the four different scenarios. individual answers were again analyzed for common factors to emerge as a result of the outsourcing simulation. at least two observers reviewed individual answers to document any inconsistencies between data collected through participant observation and interviewing. simulation background the complete outsourcing simulation used in this study can be found in adler (2005). the researcher explained the scenario for sam and betty construction (sbc) as follows: the draft work statement (e.g., a document that typically contains the contract requirements in a trading venture) and project definition worksheet (e.g., sbc's internal planning document) have been provided by the swift trust corporation, a potential partner of sbc, to fonn the basis for the partnership contract between the swift trust corporation and sbc. observers divided individuals into teams and then assigned two teams to one of the four trust and distrust conditions listed in table 1. each of these two teams formed a pair of colleague teams. one team was responsible for revising the draft work statement and the other team was responsible for developing the project definition worksheet. together, the teams must work to provide sbc a revised contract regarding how swift trust will provide architectural design support (see table 2). since sam and betty, co-owners of sbc, do not have much experience in architectural design, they have hired these two teams that specialize in project management. while the work statement is typically a binding document in the contract, the project definition worksheet is internally used at sbc to identify the major areas ofwork. some work statement requirements are typically tied to work planned in the project definition worksheet but not all are included. for instance, sbc responsibilities might be more appropriate as a project definition worksheet item rather than a contractual document. the reason for this distinction might be that it would be more beneficial for sbc to have fewer formalized items in the contract. in other words, to reduce risk, sbc would make swift trust responsible for many things as in a high distrust situation. thus, integration between the work statement and project definition work sheet is a must. teams were observed and individuals were interviewed to better understand how a scenario would affect integration between teams. fall 2007 adler: swift trust and distrust 111 table i' key characteristics of four simultaneous trust and distrust conditions characteristic 1. low trust/low distrust a. casual acquaintances b. limited interdependence c. bounded, arms-length d. professional courtesy 2. hij,:h trust/low distrust a. high-value congruence b. interdependence promoted c. opportunities pursued d. new initiatives 3. low trust/hij,:h distrust a. undesirable eventualities expected and feared b. harmful motives assumed c. interdependence managed d. preemption; best offense is a good defense e. paranoia 4. hi~h trustlhij,:h distrust a. trust but verify b. relationships highly segmented c. opportunities pursued and down-side risks/ vulnerabilities continually monitored definitions 1a. limited previous history so a new opportunity for everyone 1b. inputs and outputs between organization's processes are independent and not integrated 1c. emotional relationship and transaction attachment between trading partners is not a factor to consider 1d. respect for each other is expected and superficial 2a. expectations between trading partners align 2b. sharing of work between organizations is expected 2c. creativity and innovation is an outcome of the partnership and valued by both partners 2d. new strategies for maximizing the partnership are discussed openly and pursued by both parties 3a. history and reputational effects indicate the trading partner is not being honest in its relationship with your organization 3b. your organization is assumed to suffer in some way from this trading relationship 3c. boundaries are set in all ways regarding access to your organization's information and resources 3d. penalties for abuse to contractual terms and conditions are strong enough to mitigate potential trading partner opportunism 3e. worst case scenarios dominate your organization and team discussions regarding your potential trading partner 4a. focus is a positive trading relationship but anticipate potential trading partner opportunism and limit as best as possible 4b. partition information and resources are bounded to protect core competencies and discourage trading partner opportunism 4c. provide information sharing on team scouting and task coordination •adapted from lewicki et al. 's (1998) framework 112 journal ofbusiness strategies vol. 24, no.2 table 2 consulting task teams role in the sbc and swift trust partnership sam and betty construction (shc) -------,r,---------:.~ swift trust corporation consulting teams review and advise sbc about the outsource relationship (i.e., one task team for the work statement and one task team for the project definition worksheet) results in general, all propositions in this study were supported. managing trust and distrust perceptions between teams while planning project work were viewed as difficult topics and tasks to do. individuals stated that having colleague teams allowed them to better react to perceptions of trust and distrust more realistically. summarized comments and observed outcomes in each trust and distrust condition are now discussed. low trust and low distrust the low trust and low distrust scenario represents a situation where teams struggle to define the partnership between sbc and the swift trust corporation. the teams fall back on information provided in the simulation about whether a future trading partner might be worthy of trust or distrust. many of the teams even go interview home builders outside of the simulation in hopes of better defining an actual case oflow trust and distrust. interactions between teams, thus, lead to little emotional buy-in since teams find little to commit to in the sbc-swift trust business relationship. as lewicki et al. (1998) hypothesized, this is a situation where there is a lack of hope or confidence in the future trading partner. as a consequence, teams assigned to this scenario typically gave simplistic presentations to their instructor since there is so little information on which to base a contract or planning document. thus, teams varied greatly in the amount and quality of revisions to the work statement and project definition worksheet. some teams invent requirements for the work statement assuming this is what was meant by the strategic leadership. an example is when a team adds work that is out of the original scope of the project. many teams added work that had nothing to do with the original work statement in the simulation like adding a requirement to conduct a market survey of housing in other cities. outcomes for teams interacting in this scenario take on a 'checklist' mentality as teams struggle to 'fill in the blanks' by adding unnecessary project requirements into the contract. not only does this make team interactions more potentially unnecessarily complex, it is also dangerous because these added interactions may fall 2007 adler: swift trust and distrust 113 create a degree of distrust between teams that is incommensurate with the novelty oftheir current trading relationship. team outcomes that involve scope definition, communication planning, and leadership development revolve around keeping work independent and limited between sbc and swift trust. team outcomes reflect a casualness to the sbc and swift trust trading relationship that leaves team members wanting more to the simulation and, ultimately, more from other teams with regard to team contributions. high trust and low distrust the elements of high trust and low distrust are ones that have been proposed by researchers as the prototypical soft contracting scenario (williamson & ouchi, 1981). high trust and low distrust typically lead to less emphasis on the contract and more emphasis on what teams really want in the sbc and swift trust partnership. consequently, teams spend little time revising the work statement and project definition worksheet because of the generally held belief that swift trust could be relied upon. even when teams identify known copyedit problems with the work statement, these grammar or typo errors were not corrected and allowed to remain in team outputs. team members stated that they really enjoyed working with their colleague team in this scenario as they learned a lot about outsourcing, strategy planning, and the difficulties of communicating requirements. this is not what teams generally said in other scenarios in this simulation. the positive experiences of individuals working in teams in this scenario support proposition i because the heart of the matter is that when partners are viewed as trustworthy, team interactions reflect this positivism and work is viewed with a higher degree of quality. teams also typically explained that to address any particular issue all they would have to do is call swift trust and it could be worked out over the phone. thus, inter-team interactions focused more on the content of the sbc and swift trust relationship emphasizing what really mattered not the legalities or formalities of the contracting framework. as one individual reflected about her team philosophy, "sbc has an open door policy with swift trust. why wouldn't we trust them? we have a relationship with them that is effective in getting the job done." thus, the high trust and low distrust condition leads to more informal governance between colleague teams suggesting soft contracting is where value is maximized and strategy is achieved. these results provided support for proposition 3 where high trust situations lead to less bounded governance and formalization between teams. low trust and high distrust the paranoiac view ofa future business partner comes out clearly in this scenario supporting lewicki et al. 's (1998) assertion that the low trust and high distrust condition leads to all kinds of negative fantasies. thus, the focus of colleague teams is how to prevent swift trust from acting badly through the revision of work statement requirements to circumvent potential partner opportunism (i.e., 114 journal of business strategies vol. 24, no.2 transfer risk to swift trust when appropriate). individuals discuss how difficult team discussions are in this scenario because most teams do not like thinking so negatively. proposition 2 is supported because the high distrust in the shc-swift trust partnership engenders a lower perceived quality to inter-team interactions. team members take on an enforcement mentality that drains enthusiasm in interacting with their colleague team. it should also come as no surprise that revisions to the work statement tend to be extensive and generally focused on putting absolute control into the hands of sbc management. thus, proposition 4 is supported as a trend towards hard contracting. the absolute control aspect ofthis scenario is one key difference between it and the high trust and high distrust condition. for instance, in the draft work statement, adding "as accepted by sbc" to the end of the first sentence in paragraph 2.0 gives control to sbc. also, in paragraph 6.0, the statement "the seller's project manager shall support sbc planning efforts by attending meetings, conferences, and reviews and responding to requests for information" is generally changed to "the seller's project manager shall support sbc planning efforts as sbc management dictates." these typical changes reflect the team's distrust of swift trust in honoring the terms and spirit of the partnership contract. many teams also put penalty statements in the revised work statement. for instance, the penalty "failure to adequately identify all risk factors with accompanying assumptions makes this contract subj ect to termination by sbc" is a common type of sanction levied on swift trust if they do not comply. as predicted by lewicki et al. (1998), the work statement bounds the partnership taking on a very formal and arms-length transaction with swift trust. inter-team interactions are also more rigid and difficult since teams have think of every negative situation, contemplate every possible contractual loophole, and never relax in their pessimism of swift trust. colleague teams end up competing with each other to see who can identify the most loopholes and which loopholes might be the most egregious to sbc. as one individual stated, "we have to micromanage swift trust because they appear to not be able to manage themselves." high trust and high distrust the most common form of business relationship found today is the high trust and high distrust condition according to lewicki et al. (1998). one reason for this is the complex and differentiated aspects of businesses where work is divided and delegated to teams to meet organizational objectives. consequently, inter-team interactions result in detailed presentations and extensive revisions since not only does a team have to micro-manage swift trust's opportunism, they must also manage internal shc work found in project definition worksheet. teams in this scenario perceive degrees of low and high quality and formality and informality as predicted by lewicki et al. (1998). individuals described the necessity offrequent communication and individual contribution, as meyerson et al. (1996) noted, to the establishment of trust within fall 2007 adler: swift trust and distrust 115 the teams. many individuals expressed frustration with their colleague team who did not actively participate in inter-team meetings and discussions. propositions 1 through 4 were supported based on the degree to which team members made themselves available to discuss the complexities of the sbc and swift trust partnership. ifteam members made themselves available to meet, then they were viewed as being accountable and trust between teams grew. inter-team interactions were generally viewed with higher quality. as one team member stated, "it is hard enough to figure out what is important between sbc and swift trust. our colleague team, though, helped us figure out how to work around swift trust and present a good solution that met everyone's goals." relational contracting where teams operate through the social context to codify the sbc and swift trust partnership is clearly evident in this scenario. the binding together of each team's social contexts reflects a dynamic not evident in the other trust and distrust conditions. team members learn how to manage suspicions and develop relationships simultaneously in managing business risk in outsourcing. for instance, if sbc loses money, financial risk is increased since sbc may not be able to pay swift trust for services rendered. if sbc loses competitive ground due to swift trust's lack of adequate advice, then swift trust may not retain future business relations with sbc. teams struggled in how to protect both sbc and swift trust interests given the high trust and high distrust between the trading partners. this scenario adds some interesting strategic tension to the outsourcing decision where organizational and team boundaries become blurred and partnerships become more mature and complex. discussion and implications using contracts, agreements, or other documents to folmally bind organizations, divisions, and departments is a growing trend in organizations today. the outsourcing literature indicates that teams implement management decisions that have huge organizational implications (e.g., strategic ties; ang & straub, 1998; cheser, 1999). the use of team-based designs requires unique communication skills that many teams do not have nor do team members appreciate (adler, 2004; ancona & caldwell, 1992). teams often carry the responsibility for success or failure in implementing outsourcing decisions in provider selection and contract administration. successful contract negotiation between outsource partners assumes teams can communicate effectively. the results of this study indicate that teams have different types of interactions when faced with different simultaneous trust and distrust perceptions. this study provides evidence that management of simultaneous trust and distrust issues are not limited to the formal organizational partnership but also to how teams implement outsourcing decisions. the high trust and high distrust condition certainly represents many business relationships today. on an individual and team basis, many firms hire employees with a high trust and high distrust relationship either for reasons of security, 116 journal of business strategies vol. 24, no.2 or compartmentalization of access to parts of the finn, or for strategic human resource compliance in privacy or intellectual property protection. employee identification cards serve as a reminder that finns highly trust employees to do their job, but that access to other work may not be part oftheir job. in this study, teams viewed giving colleague teams access only to the necessary parts of their assigned responsibilities on an 'as necessary' need to fulfill the partnership contract. what was interesting is that teams in this scenario needed confirmation from their colleague team since the simulation scenario was too complex to manage by themselves. in addition, the high trust and low distrust scenario was indicative of teams where social context was the medium to get work done. many businesses operate this way where a contract may be necessary to partner, but the contract is a mere formality to the partnership itself. inter-team interactions represented low soft contracting characteristics in accordance with the williamson and ouchi (1981) framework. the low trust and high distrust condition represented many situations where organizations are forced to partner due to necessity, not choice. this may be the result of a sole source environment, management compliance, or a monopoly amongst suppliers. in either case, the buyer partner is many times at the mercy of the supplier partner and thus, over time, abuses to this relationship become engrained into a distrust perception. inter-team interactions took on a very competitive flavor as teams vied to be the winner in identifying the most loopholes or the loopholes with the largest potential damage to sbc. government contracting is a good example of this scenario. while not all government suppliers have done things to lead to distrust, many have, and once trust is violated, it is difficult to regain trust. the attempts by colleague teams to make sbc the absolute authority in the contract was surprising but lived up to the assumptions found in lewicki et a1.'s (1998) model when sometimes the best strategy is to make preemptive strikes against a unscrupulous partner. one can imagine a situation where the work statement would be negotiated by teams of lawyers regardless of the technical complexity of the project involved. thus, in a low trust and high distrust condition, success may depend more on how good your lawyers are relative to a partner's lawyer(s). loophole management becomes a critical skill in a high distrust and low trust scenario. many organizations have dealt with this issue by assigning multiple teams to review basic assumptions of every contract requirement. other finns may take a more 'hands-off' approach relying on their future business partner to deliver whatever is required (e.g., soft contracting). finns would be wise to challenge assumptions, expectations, and perceptions that lead to high and low trust and distrust when developing contract requirements. implications to researchers and practitioners this research may be limited since business students were used as the source for this study. commercial settings offer more legal maneuvering between orgafall 2007 adler: swift trust and distrust 117 nizations and teams and, thus, more potential for altering perceptions collectively by team members. however, as pettigrew (1990) notes, collecting and analyzing comparative data is a highly complex social and intellectual task. we believe that since this research was collected based on a validated outsourcing simulation used to investigate trust and distrust perceptions, our conclusions can be used in a variety of settings to understand how business relationships and team-based interactions occur. future research needs to consider top management's role in inter-team communication. a qualitative study of how trust and distrust perceptions change relative to organizational and team performance is also necessary and would be a logical extension of this research. this study is somewhat limited in that scenarios were used to simulate actual contract negotiations. further research should also study teams in their real environments to either corroborate or refute these findings. there are several implications for practitioners. this study highlights the need to understand external communication patterns of team designs. teams must integrate a plethora of interests that include team perceptions about other teams and future business partners. contrary to macneil's findings (1978), contracts, in some situations, are intentionally made more complete due to team distrust perceptions. complete contracts mayor may not be what organizations desire, or need, to fulfill strategic objectives like the outsourcing of work. clearly, tactical implementation by teams is multifaceted requiring effective management oversight. a better understanding of external team communication pattern effects is fundamental for managing team personnel and assessing team performance. conclusion a more robust understanding of the four scenarios in the lewicki et al. (1998) model was gained in this research. each of the scenarios can occur in business today and this study provides context in how teams interact based on differing combinations of trust and distrust. feedback indicates that the simultaneous 'high trust and high distrust' situation characterizes a complex business environment that teams viewed as both a blessing and a curse. in other words, most respondents hoped for trust but settled for distrust in how they viewed colleagues, other teams, and potential business partners. one interesting observation, in general, was the behavior of teams to mimic what they saw as the sbc and swift trust partnership. in other words, the framing of the shc and swift trust business partnership greatly influenced the interteam interactions with the teams actually becoming part of the trust and distrust scenario they were asked to manage. perceptions of trust and distrust exist for many reasons and are affected by how teams interact within an organization. how teams deal with these and other contractual issues affects how well organizations fulfill organizational goals like outsourcing. given the increasing demands placed upon managers today, a 118 journal ofbusiness strategies vol. 24, no.2 knowledge of how trust and distrust perceptions affect team interactions is fundamental to managing future business partnerships. practical application oftrust and distrust models must be further studied and developed as researchers have a duty to flesh out the factors that affect how teams frame information based on trust and distrust perceptions and how teams develop contractual requirements based on these perceptions. this medium-term, qualitative analysis provides insight into these demands. references adler, t. (2004). a study of external team communication effects on team member perceptions of trust and distrust. journal of behavioral and applied management, 5(3),245-279. adler, t. (2005). the swift trust partnership: a project management exercise investigating the effects trust and distrust in outsourcing relationships. journal of management education, 29(5),714-737. ancona, d., & caldwell, d. (1992). bridging the boundary: external activity and performance in organizational teams. administrative science quarterly, 37,634-665. ang, s., & straub, d. (1998). production and transaction economies and is outsourcing: a study of the u.s. banking industry. mis quarterly, 22(4),535-552. barthelemy, j., & adsit, d. (2003). the seven deadly sins of outsourcing. academy of management executive, 17(2), 87-101. bazerman, c. (1983). scientific writing as a social act: a review of the literature of thesociology of science. in p. v. anderson, r. 1. brockman, & c. r. miller (eds.), new essays in technical and scientific communication: research, theory, practice. farmingdale, ny: baywood publishing co. bell, b. (1990). two separate teams should be set up to facilitate strategic alliances. journal of business strategies, 11,63-65. benfratello, l., & sembenelli, a. (2002). research joint ventures and firm level performance. research policy, 31(4),493-507. bond, m., leung, k., & wan, k. (1982). how does cultural collectivism operate? the impact of task and maintenance contributions on reward distribution. journal of cross-cultural psychology, 13, 186-200. boon, s., & holmes, j. (1991). the dynamics of interpersonal trust: resolving uncertainty in the face of risk. in r. a. hinde & 1. grobel (eds.). cooperation and prosocial behavior (pp. 190-213), cambridge: cambridge university press. fall 2007 adler: swift trust and distrust 119 boswell, c. (2000). for albany molecular, proprietary technologies are key to success. chemical market reporter, 258(21), 29-35. cheser, r. (1999). when teams go to war against each other! quality progress, 32, 24-29. cohen, s., & bailey, d. (1997). what makes teams work: group effectiveness research from the shop floor to the executive suite. journal of management, 23(3),239-290. dasgupta, p. (1988). trust as a commodity. in d. gambetta (ed.). trust. making and breaking cooperative relations. (pp. 44-72). oxford: blackwell. deutsch, m. (1960). the effect of motivational orientation upon trust and suspicion. human relations, 13, 123-139. douglas, j. (1976). investigative social research: individual and team .field research. beverly hills, ca: sage publications, inc. erickson, e. (1950). childhood and society. new york: norton. glaser, b., & strauss, a. (1967). the discovery ofgrounded theory: strategies for qualitative research. chicago: aldine. gomez, c., shapiro, d., & kirkman, b. (2000). the impact of collectivism and in-group/ out-group membership on the evaluation generosity of team members. academy of management journal, 43(6), 1097-1107. helewitz, j. (2003). the art of negotiation. legal assistant today, 20,66-68. hosmer, l. (1995). trust: the connecting link between organizational theory and philosophical ethics. academy of management review. 20,379-403. jeffries, f., & reed, r. (2000). trust and adaptation in relational contracting. academy of management review, 25(4),873-898. knorr, k., & knorr, d. (1978). from scenes to scripts: on the relationship between laboratory research and published paper in science. research memorandum no. 132. vienna: institute for advanced studies. lacity, m., & willcocks, l. (1998). an empirical investigation of information technology sourcing practices: lessons from experience. mis quarterly, 22(3),363-408. larson, c., & lafasto, f. (1989). teamwork: what must go right/what can t go wrong. newbury park, ca: sage. lewicki, r., mcallister, d., & bies, r. (1998). trust and distrust: new relationships and realities. academy of management review, 23(3),438-458. 120 journal ofbusiness strategies vol. 24, no.2 luhmann, n. (1979). trust and power. chichester, uk: wiley. macneil, 1. (1978). contracts: adjustments of long-term economic relations under classical, neoclassical and relational contract law. northwestern university law review, 72, 854-906. mayer, r., davis, j., & schoorman, f. (1995). an integrative model of organizational trust. academy of management review; 20(3), 709-734. meyerson, d., weick, k., & kramer, r. (1996). swift trust and temporary groups. in r. m. kramer & t. r. tyler (eds.), trust in organizations: frontiers of theory and research (pp. 166-195), thousand oaks, ca: sage. miles, m., & huberman, a. (1984). qualitative data analysis. beverly hills, ca: sage publications. mishra, a. (1996). organizational responses to crisis: the centrality of trust. in r. m. kramer, & t. r. tyler (eds.), trust in organizations: frontiers oftheory and research (pp. 261-287), thousand oaks, ca: sage. niederman, e, brangeay, j., & wetherbe, j. (1991). information systems management issues for the 1990s. mis quarterly, 15(4),474-500. paladino, m., bates, h., & da silveira, g. (2002). using a customer-focused approach to improve quality across the value chain: the case of siderar. total quality management, 13(5),671-683. pettigrew, a. (1990). longitudinal field research on change: theory and practice. organization science, 1(3),267-292. robinson, w., & volkov, v. (1998). supporting the negotiation life cycle. communications ofthe acm, 41, 95-103. rotter, j. (1980). a new scale for measurement of interpersonal trust. journal ofpersonality. 35,651-665. rousseau, d. (1995). psychological contracts in organizations: understanding written and unwritten agreements. thousand oaks, ca: sage. schilling, m., & steensma, h. (2001). the use of modular organizational forms: an industry-level analysis. academy of management journal, 44(6), 1149-1169. spradley, j. (1979). the ethnographic interview. ny: holt, rinehart & winston. williamson, 0., & ouchi, w. (1981). the markets and hierarchies program of research: origins, implications, prospects. in w. joyce, &a. van de ven (eds.), organizational design. new york: wiley. fall 2007 adler: swift trust and distrust 121 zand, d. (1972). trust and managerial problem solving. administrative science quarterly. 17,229-239. zuckerman, d., & higgins, m. (2002). optimizing cross-organizational team performance and management. pharmaceutical technology, 26(6), 76-79. footnote 1 please contact the author for a full set of simulation materials terry adler is currently associate professor of management in the college of business at new mexico state university (nmsu). he received his ph.d. in strategy and information systems from the university of cincinnati in 1996. besides being widely published on such topics as trust and distrust and contracting issues, he was named the 2006 donald c. roush professor ofthe year. dr. adler has made over 200 international presentations to organizations throughout the world. 122 journal of business strategies vol. 24, no.2 swift trust and distrust in strategic partnering relationships: key considerations of team-based designs economic growth creation or diversion? the record of trade agreements in latin america gustavo barboza clarion university of pennsylvania • clarion, pa sandra trejosl clarion university of pennsylvania • clarion , pa abstract this paper examines the effects of preferential trade agreements (ptas) and gatt/wto membership on economic growth using a sample of seventeen latin american countries for the period 1950-2004. in general, the evidence indicates that the proliferation of bilateral and multi country regional and extra regional trade agreements has not resulted in faster economic growth. on the contrary, we find that ptas and wto only have a weak positive effect on increasing trade openness; but this relationship does not translate into faster economic growth when controlling for capital, labor force and trade openness. these results are robust to both static and dynamic model specifications, indicating that trade openness has a positive effect on per capita output growth, but pta and wto membership do not. integration via de facto increases output growth while integration via de jure does not. based on the results, ptas create a net diversion effect on economic growth. introduction economists are known for disagreeing in many things . however, when it comes to trade, there is an overwhelming consensus that free trade is good. more so, they convey that in most circumstances freer trade is preferred over restricted trade, and more trade is preferred to less. the underlying assumption is that trade is an engine for economic growth. in this regard, economic reform moves countries from protectionism to freer trade regimes. the recent reform process has been characterized by a predominant proliferation of preferential trade agreements (ptas) (both regional and extra regional), over multilateral negotiations along the lines of the gatt/wto. a part of the proliferation ofptas over multilateral liberalization is the result of a failure to achieve consensus as exemplified in the doha-round trade negotiations. however, with regard to ptas, the contentious issue is whether integration through agreements de jure generates greater gains in relation to integration through market de facto. in other words, do ptas substitute or complement multilateral trade integration and do ptas generate positive or pervasive 94 journal of business strategies effects on economic growth? thus, there exists much controversy on the effects of ptas on trade (diversion versus creation) and consequent effects on economic growth. latin america is one particular economic region of interest, because of its fast adoption of ptas. latin america and the caribbean is an economic region composed of about 34 countries with an estimated combined market size of 400 million people. according to cardoso and helwege (1995), the proliferation of preferential trade agreements in latin america, under the inward looking import substitution industrialization period, partially explains the underdevelopment observed in this region. it is during this period that regional preferential trade agreements, such as the central american common market (cacm) and the andean pact, were implemented .2 the growth paradox of these agreements is that while promoting more trade within the members , they were discriminatory to non-members, with the consequent degeneration into a net trade diversion effect. however, in an effort to restore the region's international competitiveness and promote dynamic industrial and service sectors, most latin american countries have decisively implemented market-friendly reforms since the early 1980s. the new mantra emphasizes the promotion of freer trade as the engine of economic growth. as a result of the new economic and political regimes , there has been a surge and proliferation of intra and extra regional trade agreements, making the region a showcase for trade liberalization (kuwayama, duran, & silva, 2005). the proliferation of ptas over multilateral agreements has been in part the result of specific applications of article xxiv of the gatt that allows for the formation of ptas, provided that those agreements cover substantial trade, free trade is the ultimate goal among members, and do not increase protection to the rest of the world (krueger, 1999). thus, as a result of this clause and the failure to move forward general agreements such as the doha round, there are currently about 200 ptas around the world. this number is projected to increase to about 400 in the next decade. saggi and yildiz (2008) indicate that countries are, freely and willingly, engaged in ptas over the alternative of multilateral liberalization. latin america is no exception as jurn and park (2002) and kuwayama et al. (2005) argue. however, a clear and relevant difference between multilateral liberalization and ptas is that the former gives symmetric treatment to all countries while the latter takes many forms ranging from intra-regional bilateral to extra-regional multi country, resulting in asymmetric preferences given to members over non-members . gouvea & hranaiova (2002) indicate that while these trade reforms are setting the ground for further integration toward the creation of the free trade agreement of the americas, much controversy remains as to whether this is the case. therefore, understanding volume 27, number 1 95 the impact that international trade reform, and, specifically, the role that freer international trade has on output growth in both short-run and long-run is of relevance to all parties involved. in this context, given the proliferation of preferential trade agreements (pta) as one of the main mechanisms to advance the trade reform process, the following questions become relevant: i) can ptas be equated with freer trade movements, stepping stones, or do they tum into stumbling blocks, moving economies away from multilateral free trade and further economic integration?, and, ii) are ptas trade creating or trade diverting in nature, and thus, do they promote or retard economic growth? this paper pays particular attention to the latter question, while acknowledging the relevance of the former. the paper uses conventional well known economic theory and econometric analysis (static and dynamic estimations) to address the posted question, looking at the latin america case. the originality of this paper rests on the relevance of its findings, as it provides a direct account of the effect and direction of ptas on the rate of growth of output, addressing the overarching question of whether ptas are economic-growth creating or economic-growth diverting. the paper is organized as follows. the next section provides a comprehensive review of the literature on trade openness and the role of ptas. section iii outlines the model specification under the static and dynamic conditions. section iv describes the data, presents the main findings and their corresponding analysis. section v concludes and provides policy recommendations and overall implications. on the goodness of free trade and freer trade reform. the role of ptas. from a theoretical point of view most economists agree that trade is good with open economies growing faster than otherwise.3 for instance, a large body of literature addresses the positive effects that export (trade) growth has in per capita output growth. 4 barboza (2007) provides an extensive review of the literature and notes that not only one should look at the favorable role of export on economic growth, but most importantly to the fact that if trade increases economic growth, other transmission mechanisms should be considered, such as the role of trade on: transfer of technology, generation of economies of scale, learning-by-doing and development of the r&d (see edwards, 1992; romer, 1986, 1990,1994; grossman & helpman, 1990, 1994; keller, 2002; dowrick & golley, 2004; among others). with the objective of obtaining the benefits of expanded trade as indicated above, developing countries have resorted to the implementation of ptas of various sorts in the wake of failed multilateral negotiations. kuwayama et al. (2005) are 96 journal of business strategies prompt to indicate that latin america is a showcase of ptas in this regard. however, viner's (1950) pioneering work on the welfare effects of custom unions warns of the possible negative effects of these agreements on both members and world welfare. in addition, as bhagwati (1991) indicates, the drawback of ptas is that they have the potential to create a trade-diversion effect over multilateral trade negotiations. in the words of bhagwati (1991), ptas have the potential to be either "stepping stones or stumbling blocks" to a more integrated and highly efficient trading system. therefore, countries pursuing economic integration through ptas may see an increase in trade flows for participating members, with a negative consequence on overall economic growth, as trade diversion substitutes cheaper imports from non-member parties. krueger (1999) points out that short term gains derived from ptas may compromise long term economic perspectives, ifptas move countries away from multilateralism. that is, ptas could divert trade from nonmember nations to members, given that the agreement takes away competitiveness from countries that do not belong to the agreement. consequently, the potential trade diversion effect, while increasing overall trade, may reduce economic wellbeing. an interesting consideration is brought forth by saggi and yildiz (2008). they indicate that countries engage in ptas endogenously over the unilateral and multilateral trade liberalization. soloaga and winters (1999) indicate that "the effect of ptas on trade is still an open question" (p2). in general, foroutan (1998) acknowledges that "belonging to a regional scheme constitutes neither a necessary nor a sufficient condition for an open and liberal trade regime (p.11). krueger (1999) also recognizes the fact that the effect of ptas on participants' wellbeing could result in asymmetric outcomes from a common trade agreement, depending on each country's own situation. relatively speaking, though, countries that are not part of the preferential agreement would lose trade, ceteris paribus. furthermore, krueger states that gains from trade agreements in terms of welfare are lower when countries with similar factor endowments trade, relative to when countries have different endowments. for instance, jurn and park (2002), studying mercosur, note the existing controversy about how the regional agreement is advancing the cause of multilateral liberalization . whether this is the case may be assessed by examining the net trade-creating or trade-diverting effects of the agreements (jurn & park, 2002). yeats (1997) finds significant evidence of trade diversion effects in the case of mer co sur, and indicates that the data analysis finds similar results at the aggregate macro level for the four founding members: brazil, argentina, uruguay, and paraguay. in the more general case of the entire latin america region, aminian et al. (2008), indicate that latin america has primarily used formal regional trade treavolume 27, number 1 97 ties as the main channel of integration. however, latin america is less integrated than is east asia, although the latter region has relatively less formal regional trade treaties .5 duran, mulder, and onodera (2008) find out that although latin america implemented tariff liberalization at an earlier stage than east asia, reductions in non-trade barriers were faster in east asia than in latin america. also, duran et al. (2008) discuss how the macroeconomic environment of overvalued exchange rates, high inflation and high interest rates combined with low and volatile growth may have reduced the effects of trade reform. finally, from an empirical point of view, the openness-output relationship has been studied traditionally using static model specifications. empirical results derived from static model specifications point out to the existence of a positive relationship between export (trade) growth and output growth, yet they are not conclusive. significant controversy remains as a key element when proposing trade reforms. with these considerations in mind we now turn to the model specification. model to determine the effects ofptas on output growth, let us start our analysis by outlining a static model specification similar to the one previous studies have used (feder, 1982; de gregorio, 1992; mbaku, 1989; kavoussi, 1984; ram, 1985; moschos, 1989; knight, loayza, & villanueva, 1993; tyler, 1981; and moran, 1983). we specify a simple production function that identifies the basic factors (labor and capital) that contribute to economic growth, augmented to include trade openness as an additional factor of production as presented in strauss and ferris (1996), among others. we assume that openness enables the exploitation of economies of scale, transfers technology, promotes reallocation of resources according to comparative advantage, and allows greater capacity utilization, and increased employment in labor surplus countries (grossman & helpman, 1990, 1991, 1994; aghion & howitt, 1998; harrison, 1996; edwards, 1992, 1993 ; ben-david & loewy, 1998). thus, the basic model is represented by the production function: (1) where q. is the real gross domestic product, k is the capital stock, l. is the labor if it if force and x is the degree of trade openness for country i in period t. total differenii tiation with respect to time and dividing through by equation 1, yields: 6 98 journal of business strategies y = a + f3k + 81. + 'fix. l,t l.f t,r 1. 1 (2) where y is the rate of growth of output, k is the rate of growth of capital stock, l, t 1, 1 (.i is the rate of growth of the labor force, and xu is the rate of growth of openness, where it is assumed that the rate of technological change is a linear function of the openness growth rate as expressed by 'ii. {3, 8, and 'flare the elasticities of output with respect to capital, labor, and trade openness respectively, and a is the growth rate of unexplained total factor productivity. by approximating the rate of growth of the capital stock by the investment-output ratio (ram, 1985; feder, 1982; and mbaku, 1989; among others) times the rate of growth of the capital stock, and replacing the change in the capital stock with the investment rate, i, we obtain , i y = ao + a. q'.l + 81. 1 + 'fix .1 1, 1 i , i , i,t (3) now a. is the marginal physical output of capital. expected parameter signs are: a. > 0 (more capital per worker increases labor productivity), 8 < 0 (more workers per unit of capital reduce labor productivity), and 'fi> 0 (more openness increases labor productivity). additionally, to expand and simultaneously control for the effects of the formation of ptas (bilateral and multicountry, both regional and extra regional) and wto (multilateral) membership, we include a set of categorical variables as indicated in equation 4 below. if ptas are growth-creating, then the corresponding coefficients will have a positive sign and if they are growth diverting, the coefficients will have a negative sign. finally, we add a time dummy variable for each decade between 1950-2004 to account for possible time effects (see aminian et ai., 2008). the resulting equation is, i 4 6 y = ao + a. q'.i + 8l + 'fix . + '" qjpta + ojwto + '" n.t + el 1, 1 l, t 1,/ ~ j }i,i t,f ~j j i.l j~l j= l (4) where cp. corresponds to each pta type,), with the null hypothesis that it is positive if j ptas are growth creating, and negative if they are growth diverting. oj corresponds to the effect that being a member of the wto has on output growth and we test the null hypothesis that multilateral trade agreements are growth creating, thus oj > o. finally, p could be positive or negative depending on the time-specific effects. j volume 27, number 1 99 dynamic growth effects the main limitation of static models, such as the one outlined in (4) above, is that they do not permit for a full decomposition of results between short-run and long-run. this decomposition is a primary interest of this paper, since we desire to determine the effects of ptas on output growth and their effect on factors of production as they relate to output growth . alternatively, a dynamic model specification is more appropriate to capture spillover effects deriving from investment, policy reform, and freer trade (francois, nordstrom, & shiells, 1996; and strauss & ferris, \996). with such a specification, we expect to capture the dynamic effects of trade reform in the degree of trade openness while simultaneously controlling for the time and type of pta formation . furthermore, a dynamic specification also allows determining the speed of adjustment toward the long-run equilibrium relationship between dependent and independent variables. thus, a dynamic specification of the model is outlined along the lines of strauss and ferris (1996) based on phillips and loretan (1991) with the corresponding modifications to account for the categorical variables relating to pta, wto, and time. equation (5) provides the basic dynamic specification: 4 6 y = ao + a y + a y 1 + a3y 1 + ~ <ppta + mwto + ~ "t + e 1,1 r .... i.1 7'" ;,11,1~ j jl,1 i,i .£..,i-"j j l,t j:1 j : 1 (5) where x is a vector of explanatory variables, and output in time t is now a function 1.1 of the lagged explanatory variables )(,.1 and lagged output >';.r following hendry, pagan, and sargan (1984), we subtract >';.1 from both sides and rearrange in terms of ~.i to construct an error correction model(ecm):7 4 6 dy = po + /3idx, + /3z(y;'.1 /3 y,. l + ~<ppta .. ,+ mwto, + ~"t + e, 1,1 i. i, j:l.i. v ~ j}i. i, ~j j i, j-i j-i (6) d represents the difference function, /3 1 corresponds to the short-run parameter, /3 3 = 1, and /3 2 is defined as the disequilibrium adjustment speed (hendry et al. 1984). the coefficient /3 2 is known as the ecm parameter, or the dynamic component of the productivity and growth model. wickens and breusch (1988) argue that in terms of the empirical estimation of the ecm, it is easier to express the model without 100 journal of business strategies imposing any restriction on the parameters, i.e. f3 3 = 1. expressing equation (6) in terms of y , results in: 1,1 4 6 ~" = fljpy,,1.1 + 0a,i rp~,1 + l<fjftajj" + (j)wtoj,1 + lpi~ + fluj = i j " i (7) in this reformulation, fiji corresponds to the convergence parameter, i.e., how long it takes to correct the disequilibrium situation; oj represents the long-run parameters; and r represents the short-run estimates. under (7), the expected parameter i , sign is fiji > o. oj and y; follow the same parameter distribution as the corresponding static estimations with labor force having a negative effect on per capita output growth (along steady state situations), capital accumulation affecting positively output growth and trade openness positively influencing output growth. it is expected that long-run coefficients have higher values than corresponding short-run coefficients in absolute terms, if trade openness promotes technological change and development. the effects of ptas should be reflected as positive coefficients, and once accounted for, the overall effects of trade openness should increase as well; provided that ptas are both trade creating and consequently growth creating. rn this framework of analysis, controlling for the existence of ptas allows to further decompose the relative contribution of each explanatory variable in both the short and the long runs. let us assume the case where ptas promote growth through larger trade openness, then one should expect positive and significant coefficients both from the categorical (pta) variables and trade openness. on the contrary, if pta agreements produce diverging effects, then the question becomes whether pta yields negative and significant coefficients, and how the openness coefficients react to that. we place particular interest in determining the existence of economic differences in magnitude and sign across ptas coefficients; whether they are bilateral and regional, bilateral and extra regional, multicountry regional (mercosur, cacm, andean), or multicountry extra regional (mercosur-efta), for instance. with these considerations in mind, we proceed to describe the data, estimations, and provide interpretation of the results. data and empirical analysis we obtain the data for this paper from several sources covering 17 latin american countries (see tables al and a2 in the appendix for a list of countries volume 27, number 1 101 included in the sample, and table a3 for corresponding descriptive statistics), for the period 1950-2004. economic data are from the penn world tables 6.2 and include the real gdp per worker ppp chain (dependent variable), population, real capital to output ratio, and real trade openness. while there are several alternative measures of openness, trade openness is measured as the ratio of exports plus imports to gross domestic product in constant prices, as it has been done in previous literature. this variable directly measures the amount of trade taking place and its relative importance to each economy's total output; it also makes comparisons across studies more convenient. to adjust the data to the model specification, all economic variables are expressed in natural logarithms, and first-differenced in order to obtain rates of growth. data for ptas come from duran et al. (2007) and aminian et al. (2008) (see table a i); whereas data for wto accession dates are from rose (2004) . as indicated earlier, we perform two sets of estimations: one static and one dynamic. for each specification, we estimate a basic productivity model without controlling for pta (bilateral-multicountry and regional-extra regional) , wto membership, or decade specific effects. we then expand the model to include the categorical variab les. the results of our estimations are reported in tables 1 and 2 respectively. in this regard, wto is a dummy variable that takes the value of one at the time of accession to the wto onwards. pta is a categorical variable represented in four possible categories, as discussed earlier. a first look at the descriptive statistics in table a3 in the appendix reveals some interesting facts. first, we observe that the degree of trade openness is normally distributed across the sample with a kurtosis of 3.154 and skewness of 0.07. real gross domestic product per worker is marginally leptokurtic and skewed to the left, indicating a high concentration of countries with relatively low income. the capital-to-output ratio is platykurtic and also skewed to the left. secondly, information regarding ptas indicates overwhelming preference across latin american countries for bilateral-intraregional agreements as the main mechanism to promote trade reform . this type of agreement has become the preferred choice in conjunction with the overall economic reform and liberalization process along the market-driven reforms (see aminian et al., 2008; kuwayama et al., 2005; and krueger, 1999). for instance, there is a maximum of eleven agreements for one country while the average per country is 0.305 agreements. this clearly illustrates the fact that ptas are concentrated in a few countries that have been more aggressive in their liberalization process, namely chile and mexico. on the other hand, latin american countries have only recently and, therefore, marginally engaged in the implementation of bilateral extra regional agreements, with a maximum of two and an average of only -'table 1 0 i\) pooled ls economic growth estimates with real gdp per worker ppp chain growth as dependent variable for 1951-2003 models 1 2 3 4 5 6 7 8 9 10 capital 0.049 0.046 0.045 0.046 0.046 0.044 0.045 0 .044 0 .044 0.044 (0.000) (0.000) (0 .000) (0.000) (0000) (0.000) (0.000) (0.000) (0.000) (0.000) population 0.447 0.439 0.524 0.440 0.437 0.736 0.451 0.755 -0.069 0.132 (0.000) (0.000) (0 .000) (0.000) (0.000) (0 .000) (0.000) (0 .000) (0.788) (0.611 ) trade openness 0.025 0.029 0.025 0.024 0.031 0.027 0 .028 0.025 0.023 (0.203) (0.130) (0.200) (0.210) (0.097) (0.167) (0 .127) (0 .153) (0.176) wto -0.005 -0.002 (0.093) (0.589) number of bilateral pta 0.000 0.006 0.005 (0.910) (0.004) (0.003) extraregional bilateral ptas 0 .007 -0.010 -0.009 'q" ;: "'t (0 .624 ) (0.561 ) (0.606) ;:: ;:. -number of multicountry pta -0015 -0017 -0.011 ~ (0.000) (0.000) (0.003) cx;j ;: '" extraregional multicountry pta -0.012 -0.01 2 -0.012 ... ;:: (0.063) (0.069) (0.060) ~ '" '" ~ dummy 1950-59 0.023 0.018 .... ~ (0.007) (0.038) .... ~ ... ~ '" table 1 (contd.) pooled ls economic growth estimates with real gdp per worker ppp chain growth as dependent variable for 1951-2003 models 1 2 3 4 5 6 7 8 9 10 du mmy 1960 -69 0.027 0.025 (0 .001 ) (0 .004) dummy 1970-79 0.023 0.025 (0.004) (0 .003) dummy 1980-89 -0.012 -0.009 (0 .092) (0.238) dummy 1990-99 0.004 0.008 (0 .544) (0 .384) dummy 2000-03 -0.007 0.001 (0.364) (0 .938) n° of obs 898 898 898 898 898 898 898 898 898 898 r2 0.080 0.083 0.087 0,083 0,083 0 ,1 20 0.088 0.130 0. 181 0.198 no constant reported values in parenthesis are p-values ~ -~ ~ n n .:-'i ~ ~ ~ n ~ i...... o w ..... table 2 0 oj>. ecm with gdp per worker chain ppp growth as dependent variable from 1952-2003 models 2 3 4 5 6 7 8 long-run estimates population 0.439 0 .532 0.440 0.438 0.745 0.453 0 .797 0.218 (0 .000) (0.000) (0000) (0.000) (0 .000) (0.000) (0.000) (0.305) capital 0.063 0.060 0.063 0.063 0 .058 0.061 0.057 0.056 (0.000) (0.000) (0 .000) (0 .000) (0 .000) (0.000) (0 .000) (0.000) trade openness 0.028 0.038 0.028 0.028 0.042 0.031 0.037 0.028 (0 .252) (0 .107) (0 .247) (0 .259) (0 .057) (0.198) (0 .096) (0.150) short-run estimates population 0.697 0.559 0 .693 0.702 0.235 0.644 0.254 0.521 (0 .170) (0 .267) (0 .171) (0.167) (0.635) (0 .203) (0 .605) (0.280) capital -0036 -0.034 -0036 -0.036 -0 .033 -0.035 -0 .033 -0.031 (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) ~ trade openness -0.028 -0.033 -0.028 -0.028 -0 .035 -0.028 -0.031 -0.027 ;: "'t (0.090) (0.039) (0.088) (0.092) (0 .020) (0.079) (0 .041) (0.048) ;: $:l ecm-dynamic 0.485 0.485 0.485 0.485 0.487 0.487 0.490 0.487 ~ (0.000) (0 .000) (0.000) (0.000) (0 .000) (0.000) (0.000) (0 .000) ~ wto -0.006 -0.003 -0.002 ;: '" ... (0 .026) (0 .222) (0 .505) ;: n. '" number of bilateral pta 0 .000 0 .007 0.007 '" ij.l (0922) (0.000) (0.000) .... "'t $:l extraregional bilateral pta 0.006 -0 .015 -0.015 .... ~ (0.619) (0 .231) (0.243) ... n. '" table 2 (contd.) ~ e"' ecm with gdp per worker chain ppp growth as dependent variable from 1952-2003 ;s "' n models ->l ~ 1 2 3 4 5 6 7 8 number of multicountry pta -00 15 -0. 017 -0011 ;s <::r' "' (0.000) (0.000) (0.000) "t i-< extraregional muticountry pta -0 .013 -0.015 -0.015 (0 .006) (0 .002) (0.001 ) dummy 1950-59 0.016 (0 .027) dummy 1960-69 0 .022 (0 .002) dummy 1970-79 0.023 (0.001 ) dummy 1980-89 -0.008 (0.198) dummy 1990-99 0.005 (0 .534) dummy 2000-03 0 .000 (0 .985) estimated speed of adjustment 2.061 2.061 2.061 2.061 2.053 2.053 2.041 2.053 (in years) n° of obs 881 881 881 881 881 881 881 881 r? 0.432 0.437 0.432 0.432 0.471 0.438 0.485 0 .541 no constant reported ..... 0 values in parenthesis are p-valu es 01 106 journal of business strategies 0.01 trade agreements per country. thirdly, multicountry agreements are less common for a variety of reasons such as a required higher number of countries involved, higher administrative cost and greater complexity of coordination (diseconomies of scale). in this regard, we observe an average of 0.53 intraregional agreements over 0.046 extraregional agreements per country. it is relevant to point out that the largest intraregional multicountry agreements were signed both in the context of the lsi process during the 1960s and with geographical proximity consideration in mind included countries that share common borders, like in the case of cacm and andean. mercosur shares these same characteristics but was signed in 1991 . finally, extraregional multicountry agreements have appeared most recently during the 1990s and 2000s, as a response to halted multilateral negotiations, such as the doha round, as mentioned earlier. this newest wave of ptas is slightly different from the previous ones as they now incorporate countries that do not necessarily have common borders. findings the results from the static and dynamic estimations are presented in tables 1 and 2, respectively. we make the following observations from the static model estimation results. first, the evidence confirms the null hypothesis that trade enhances growth. however, while the relationship is positive, it is statistically significant only after controlling for some categorical elements. for example, when controlling for membership to the wto, trade openness is positive but not statistically significant. furthermore the wto coefficient is both negative and significant at the 10% in estimation 3 but not in estimation 10 (see table 1). this result concurs with those reported by rose (2004, p.98). one common problem with model specifications such as the one used in this paper is the issue of endogeneity. in particular, trade openness could be endogenous to output growth. to check for the presence of endogeneity, we conduct the durbin-wu-hausman test and do not find supporting evidence to reject the null hypothesis of no endogeneity.8 we then proceed to control for the effects of ptas on output growth and observe two interesting results : a) the coefficient for trade openness increases or remains the same in magnitude and its statistical significance increases as we include the categorical variables for ptas; and b) the coefficients for all ptas control variables are negative and statistically significant in case of multicountry ptas while they are either significantly positive or negative and statistically insignificant in case of bilateral regional ptas . thus, our empirical evidence clearly indicates that multable 3 pooled ls ceteris non paribus economic growth estimates with real gdp per worker ppp chain growth as dependent variable for 1951-2003 models 1 2 3 4 5 6 wto 0.006 (0.146) number of bilateral pta 0.002 0.004 (0415) (0.087) extraregional bilateral ptas 0.013 -0.005 (0455) (0.799) number of multicountry pta 0.001 0.000 (0.321 ) (0.971 ) extraregional multicountry pta -0 .008 -0 .016 (0 .321 ) (0.050) wof obs 898 898 898 898 898 898 no constant reported values in parenthesis are p-values 7 0 .007 (0.043) 0.003 (0.178) -0 .003 (0 .865) -0 .003 (0.270) -0 .016 (0.042) 898 ~ .... ~ ~ !':> tv .>l ~ ~ ~ !':> ""t )00.0 -" o -...j 108 journal of business strategies ticountry ptas are not growth-creating but growth-diverting. when controlling for the presence ofptas we observe an increase in the magnitude of coefficient of trade openness. this seems to indicate that trade openness reduces the negative effect of ptas in the allocation of resources in most cases. this is to say that increases in trade openness resulting through markets de facto are growth enhancing, confirming our null hypothesis. in support of these results, we note that krueger (1999) provides evidence indicating that mercosur has greater potential for trade diversion; while kuwayama et al. (2005) find that trade liberalization in latin america shows no real evidence of output growth acceleration. finally, the decade-dummy variables have positive signs with the exception of the lost decade of the 1980s, as expected. the dynamic results in table 2 yield the same basic conclusions as the static ones do. however, the new estimations allow to decompose effects into short-run and long-run, while adding a dynamic speed of adjustment parameter. the dynamic specification increases overall explanatory power as indicated by consistently higher r2 values. our estimates for the ecm parameter are consistent across model specifications with a value of 0.48 and statistically significant at the i % level, indicating that it takes a little over 2 years for any deviation from the long term equilibrium relationship to dissipate. several aspects of the dynamic estimations are worth mentioning. first, longrun estimates for trade openness are greater than the corresponding short-run. this result indicates that there are significant long term implications of trade openness on output growth as economies in the region are able to derive positive effects in the form of technological development and/or transfer. nevertheless, the long-run positive gains from trade are obscured by short term losses, as the short term coefficients are negative in magnitude and statistically significant. this result becomes more obvious when the coefficients for ptas are either negative and statistically significant or positive but statistically insignificant. only bilateral preferential agreements are positive and significant, when controlling for all other categorical variables. to add to the robustness of the results, we observe that when controlling for the presence of preferential trade agreements, not only are long-run trade coefficients larger than corresponding short-run, but more importantly, long-run trade coefficients increase in magnitude compared to the model i with no controls in table 2. this is an interesting new result as the evidence appears to indicate that while ptas may result in increased trade among agreement members, this comes at the expense of economic growth from trade with nonmembers. yeats (1997) provides concurrent proof indicating that industrial policy within rtas is distortionary for resource allocation. in a volume 27, number 1 109 way, ptas create a raise to the bottom, as they appear to create immiserizing growth. our results seem to confirm this argumentation. further analysis of the separation of effects under the dynamic estimation reveals another interesting result. the fact that the short term coefficients are negative and larger in magnitude (larger in negative terms) when controlling for pta (which are negative), is an indication that short term trade openness is driving economies away from allocating resources according to comparative advantages. partial protectionism in the form of ptas results in trade diversion and relative inefficient resource allocation. despite being a puzzling scenario, one can bring forth the argument that ptas may be creating pervasive incentives for firms to sell to (and buy from) pta members when otherwise would not be economically efficient under market conditions. thus, the evidence overwhelmingly indicates that ptas are diverting trade, and more importantly, resulting in economic growth diversion from long term sustainable growth to short term cash flow away from comparative advantage allocation of resources. based on these results, we neither find support to the hypothesis that ptas are growth creating, nor find evidence supporting the fact that ptas increase trade openness along the lines of comparative advantage. it is only after we control for ptas that we observe an increase in the long-run trade openness effect on output growth. this is to say that trade outside ptas seems to be more relevant for sustained per capita output growth in the long-run. clearly integration via de facto creates growth, while integration via de jure appears to divert growth. we acknowledge that more empirical evidence is needed to fully confirm these results. to further explore the role of ptas and wto membership on output growth we conducted a third separate set of estimations, with only control variables and no factors of production (trade openness included). the results are reported in table 3 under the name of ceteris non paribus estimations. the idea behind this estimation is to determine what happens when we isolate the effect of categorical variables on output growth. the results, once again, are not encouraging for wto membership and ptas. the coefficients for the wto are now positive and statistically significant at the 15% level with no other controls and at the 4% level when all ptas are included. this is to say that wto creates growth only under ceteris non paribus conditions. pta coefficients are not statistically significant or have a negative sign, with the exception of bilateral ptas that are positive and statistically significant when combined with other types of ptas. on the positive side, this new set of estimates provides further evidence of the robustness of the previous pooled ls and ecm estimations. table 4 pooled ls estimates with trade openness growth as dependent variable for 1951-2004 models 1 2 3 4 5 wto 0 .020 (0 .002) number of bilateral pta 0.008 (0.006) extraregional bilateral ptas 0 .029 (0 .062) number of multicountry pta 0.0 13 (0.020) extraregional multicountry pta 0.022 (0.07 1 ) wof obs 907 907 907 907 907 no constant reported values in parenthesis are p-values 6 0.016 (0 .010) 0.003 (0.477) 0.004 (0 .833) 0.002 (0.732) 0.005 (0.710) 907 ...... ...... o 'c;: ""\ ;: :. ~ t:o ;: '" ... ;: .... '" '" en .... ""\ :. .... ~ ... .... '" volume 27, number 1 111 so far our results have uncovered that trade openness leads to faster growth , confirming the theoretical work outlined earlier in the paper. more importantly, the ecm estimations indicate that the long-run effects are positive and higher than their short-run counterparts, supporting the hypothesis that technology transfers facilitated by trade openness are more important than gains associated with static comparative advantages. this result becomes more relevant as it confirms yeats' (1997) findings for mercosur showing a major re-orientation of exports toward regional markets. based on the negative short term parameter estimates, it is possible to argue that some of this export reorientation has not been along the comparative advantage patterns. it is possible that while regional agreement members do export along the comparative advantage lines to non-member markets, this possible positive effect on economic growth is more than offset by the potential misallocation of resources that results from serving the regional market under pta agreement. at the same time, wto membership and ptas categorical variables display negative effects on growth or are not-statistically significant. there is, however, one more question that still remains unanswered. what are the effects of the categorical variables on trade openness? results from table i and particularly table 2, indicate that when controlling for wto membership and ptas, the positive effect of trade openness on output growth increases while categorical variables have negative or statistically insignificant coefficients in most cases. however, in order to gain more insights into the relationship between categorical variables and trade openness, we add one more set of estimations, where the rate of growth of trade openness is now the dependent variable. the results of these estimations are reported in table 4. individual estimations indicate that each of the categorical variables has a positive effect on trade openness at the 7% confidence level. when estimated together, only wto membership has a positive and statistically significant effect on trade openness growth, while the rest ofthe controls become statistically insignificant. rose (2004, p.lll) finds similar results and notes that "gatt/wto seems to have a huge effect on trade if one does not hold other things constant; the multilateral trade regime matters, ceteris non paribus ." these findings seem to imply that membership to preferential trade agreements and wto results in increased trade openness, but this positive effect does not translate into faster economic growth. faster trade openness growth is then the result of more trade among preferential agreement members at the expense of non-members. this, combined with the fact that output per worker does not grow faster when controlling for ptas and wto, indicates that the increased trade resulting from pta membership is diverting in nature. since memberships to ptas and wto have positive 112 journal of business strategies effects on trade openness growth (table 4), we proceed to re-estimate the output growth model in a two-stage process.9 we first extract the residuals from estimations in table 4, and then include them in the growth equations with ptas and wto categorical variables, in the hope that the residuals would have economic and statistical significance. however, these alternative estimations yield almost identical results to those already reported in tables 1 and 2. the results from the different sets of estimations then raise the question: why are ptas not positively related to output growth, even when they may have resulted in weak increased trade openness? several explanations are provided. while not all of them may apply directly or they are simply beyond the scope of our study, we present them here for clarification and illustration purposes. first, krueger (1999 p. 115) sheds some light by indicating that "the welfare effects for the countries within the preferential agreement are ambiguous." another possible explanation for the controversial nature of these results is found in duran et al. (2008), as they indicate that "latin america growth was low and volatile, the exchange rate overvalued during long periods, and inflation and interest rates high." (p.39) . in addition, soloaga and winters (1999), in regards to mercosur, argue "trade performance was dominated by currency overvaluation rather than trade policy" (p. 11). finally, yeats (1997) indicates "products recording the largest shift toward the region are those for which mercosur has not demonstrated an ability to export competitively elsewhere" (p.20). conclusions and recommendations empirical analysis of the effects ofptas and gattiwto membership on output growth using static and dynamic growth estimations is inconclusive. the results of this paper strongly suggest that trade reform based on the proliferation of ptas does not yield the expected positive results on output growth . this is true for latin american countries engaging in ptas. while further research is desirable, the evidence so far points to important policy implications. first, ptas in latin america appear to be dominated by trade diversion effects; and secondly, the proliferation of ptas creates an adverse effect on long-run per capita output growth. in other words, ptas create an economic growth diversion effect, moving economies away from efficient long term resource allocation. the redirection of trade resulting from preferential ruling among agreement members results, albeit weakly, in more trade openness; yet at the expense of faster economic growth. this result is puzzling and could be controversial. the decomposition of the effects into short-run and long-run under the bcm model provides a more comprehensive set of effects that are not present under the convolume 27, number 1 113 ventional static model. in this regard, the dynamic results indicate a significant larger positive effect of trade openness on output growth in the long-run over the short-run. these results are more interesting after controlling for ptas and gatt/wto membership, given that the long-run parameters increase in magnitude and significance, while categorical variables have negative or statistically insignificant effects on per capita output growth. further analysis of the data indicates the presence of a weak positive effect of ptas and gatt/wto membership on output growth ceteris non paribus. that is, only when we do not control for capital, labor, and degree of trade openness, we observe the hypothesized positive effect of integration via de jure. the implications of these results in terms of policy analysis and future research are vast. first, has latin america followed the wrong path (a race to the bottom) by promoting integration via de jure? or, are there other forces such as exchange rate overvaluation, economy-wide financial crisis, ptas intrinsic design conflicts, for instance, offsetting the likelihood of positive effects that could be derived from integration a fa pta? either way, it is clear that further research on the role of ptas on output growth is real and necessary. undoubtedly, our results signify the need for further research when attempting to assess the nature and corresponding output growth effects of ptas and wto (multilateral) membership. other relevant areas of research outside the scope of this current paper include the role that institutional factors may play in the reform process as they relate to exchange rate regimes, inflationary processes, the role of democracy, geography and other issues addressed in the literature. finally, another interesting avenue for future research is to analyze the relative importance of each pta as they relate to different countries and therefore could potentially have country specific effects on participating countries. notes l. we thank comments from participants at the regional trade agreements, migration and remittances conference at sam houston state university, 2008; and participants at the aea pipeline conference at the university of santa barbara 2008. we gratefully acknowledge the contributions of two anonymous referees, and funding provided through the college of business summer research grants at clarion university to complete this research. any remaining errors are the sole responsibility of the authors. 2. aminian, fung, and ng (2008) refer to this as the first stage of preferential trade agreements within the context ofimport substitution industrialization. 114 journal of business strategies 3. see ben-david and loewy( 1998); keller (2002); grossman and helpman (199\); harrison (1996); aghion and howitt (1998); edwards (1993); and romer (1990); among others. 4. see balassa (1978); barboza (2007); mbaku (1989); kavoussi (1984); tyler (1981); moschos (1989); de gregorio (1992); ram (1985); edwards (1992, 1993); harrison (1996); among many others . 5. a detailed summary of the evolution of the trade agreements in latin america is available in table a2. 6. see barboza 2007, ram 1985; feder 1982; and mbaku 1989; among others 7. see barboza (2007) for further details. 8. the results of the endogeneity test are available from the authors upon request. 9. we thank an anonymous referee for this suggestion. references aghion , p. , & howitt, p. (1998). endogenous growth theory. the mit press . aminian , n., fung, k.c., & ng, f. (2008, march). integration of markets vs. integration by agreements. policy research working paper wps 4546. the world bank. balassa, b. (1978). exports and economic growth: further evidence. journal of development economics, 5, 181-189. barboza, g. (2007). dynamic empirics of trade openness and economic growth in latin america. does fast reformers grow faster? journal of economic development, 32(2), 1-20. ben-david, d ., & loewy, m. (1998). free trade, growth and convergence. journal of economic growth, 3, 143-170. cardoso, e., & helwege, a. (\995). latin america s economy . the mit press. carvalho, a. , et. al. (1999). impactos da integracao comercial brasil estados unidos. texto para discussao (no 646). rio de janeiro: ipea. chang, w., & winters, l.a. (sep. , 2002). how regional blocks affect excluded countries : the price effects of mercosur. the american economic review, 92(4), 899-904. de gregorio , j. (1992). economic growth in latin america. journal of development economics, 39, 59-84. volume 27, number 1 115 dowrick, s., & golley, j. (2004). trade openness and growth: who benefits? oxford review of economic policy, 20(1), 38-56 . duran lima, 1., mulder, n., & onodera, o. (2008, february). trade liberalization and economic performance: east-asia versus latin america. oecd trade policy working paper no. 170. duran lima, j., de miguel, c. j., & schuschny, a. (2007, february). acuerdos comerciales entre los paises andinos y los estados unidos. cuanto se puede esperar de ellos? serie comercio internacional (77). cepa!. edwards, s. (1993). openness, trade liberalization, and growth in developing countries. journal of economic literature, xxxi, 1358-1393. edwards, s. (1992). trade orientation, distortions and growth in developing countries. journal of development economics, 39,31-57. faurioi, g., & weintraub, s. (2001). the century of the americas: dawn of a new century dynamic. the washington quarterly, 24(2), 139-148. feder, g. (1982). on exports and economic growth. journal of development economics, 12,59-73. foroutan, f. (1998, march) does membership in a regional preferential trade agreement make a country more or less protectionist? policy research working paper, the world bank. francois, j., nordstrom, h., & shiells, c. (1996). transition dynamics and trade policy reform in developing countries. world trade organization, rd-96-005. gouvea, r., & hranaiova, j. (2002). brazil and the ftaa: strategic trade options. multinational business review, 33-41. grossman, g., & helpman, e. (1990). comparative advantage and long-run growth. the american economic review, 80(4), 796-815. grossman, g., & helpman, e. (1991). trade, knowledge spillovers and growth. european economic review, 35,517-526. grossman, g., & helpman, e. (1994). endogenous innovation in the theory of growth. journal of economic perspectives, 8( 1), 23-44. hendry, d., pagan, a., & sargan, j. (1984). dynamic specification. in z. grichles & m. intrilagator (eds.), handbook of econometrics, (pp. 1689-1763). jum, i. , & park, h. (2002). the trade effects on the non-member countries of the regional integration: the case of the mercosur. multinational business review, 23-32. kavoussi, r. m. (1984). export expansion and economic growth: further empirical evidence. journal of development economics, 14, 241-250. 116 journal of business strategies keller, w. (2002). trade and the transmission of technology. journal of economic growth, 7,5-24. knight, m., loayza, n., & villanueva, d. (1993). testing the neoclassical theory of economic growth : a panel data approach. imf staff papers international monetaryfund, (40), 512-541. krueger, a. (1999, fall). are preferential trade arrangements trade-liberalizing or protectionist? journal of economic perspectives, 13(4), 105-124. kuwayama, m ., duran, 1., & silva, v. (2005, december). bilateralism and regionalism: re-establishing the primacy of multilateralism a latin american and caribbean perspective. serie comercio internacional (58). cepal. mankiw, g., romer, d., & weil, d. (1992). a contribution to the empirics of economic growth. quarterly journal of economics, 107,407-437. mbaku, j. m. (1989). export growth and economic performance in developing countries : further evidence from africa. journal of economic development, 14, 127-142. moran, c. (1983). export fluctuations and economic growth: an empirical analysis. journal of development economics, 12, 195-218. moschos, d. (1989). export expansion, growth and the level of economic development: an empirical analysis. journal of development economics, 30, 93-102. penn world tables mark 6.2. phillips, p., & loretan, m . (1991). estimating long-run economics equilibria. review of economic studies, 58,407-436. ram, r. (1985). exports and economic growth: some additional evidence. economic development and cultural change, 33,415-425. romer, p. (1986). increasing returns and long-run growth. journal of political economy, 94(5), 1 002-1037. romer, p. (1990). endogenous technological change. journal of political economy, 98(5-2), s71-s102. romer, p. (1994). the origins of endogenous growth. journal of economic perspectives, 8(1),3-22. rose, a. (2004, march). does the wto really increase trade? the american economic review, 94(1), 98-114. saggi, k., & yildiz, h. (2008). bilateralism, multilateralism, and the quest for global free trade. manuscript. soloaga, l., & winters, l.a. (1999, august) how has regionalism in the 1990s affected trade? policy research working paper 2156, the world bank. volume 27, number 1 117 solow, r. (1957). technical change and the aggregate production function. review of economics and statistics, 39, 312-320. strauss, j., & ferris, m . (1996). a dynamic estimation of world productivity growth. applied economics, 28, 195-202. tyler, w. g. (1981). growth and export expansion in developing countries: some empirical evidence. journal of development economics, 9, 121-130. wickens, m., & breusch, t. (1988). dynamic specification, the long-run and the estimation of transformed regression models. economic journal, 98, 189-205. yeats, a. (1997, february). does mercosur's trade performance raise concerns about the effects of regional trade agreements ? policy research working paper, the world bank. appendix table al latin american countries and year of accession to the world trade organization country year argentina 1967 bolivia 1990 brazil 1948 chile 1949 colombia 1981 costa rica 1990 ecuador 1996 ei salvador 1991 guatemala 1991 honduras 1994 mexico 1986 nicaragua 1950 panama 1997 paraguay 1994 peru 1951 uruguay 1953 venezuela 1990 source : selected countries form rose , andrew (2004) american economic review. 94.1. p 113. ...... ...... co table a2 economic cooperative agreements in latin america year of inforce type of agreement status bilateral agreements regional chile-argentina 1991 econ integration agreement implemented mexico-argentina 1991 econ integration agreement eia and free trade implemented chile-mexico 1992/98 agreement implemented chile-bolivia 1993 econ integration agreement implemented chile-venezuela 1993 econ integration agreement implemented chile-colombia 1994 econ integration agreement eia and free trade implemented mexico-bolivia 1994/95 agreement implemented chile-ecuador 1995 econ integration agreement implemented mexico-costa rica 1995 free trade agreement implemented ~ ;: mexico-peru 1996 econ integration agreement implemented "'t ~ $:i mexico-nicaragua 1998 free trade agreement implemented ~ chile-peru 1998 econ integration agreement implemented txi mexico-ei salvador 2001 econ integration agreement implemented ;: '" ... ~ mexicoguatemala 2001 free trade agreement implemented rio '" '" mexico-honduras 2001 free trade agreement implemented en ..... mexicobrazil 2002 econ integration agreement signed ~ ..... chile-costa rica 2002 free trade agreement implemented ~ ... rio chile-ei salvador 2002 econ integration agreement implemented '" table a2 (conl'd.) ~ economic cooperative agreements in latin america -;: ~ ~ year of inforce type of agreement status n ~ mexico-uruguay 2003 free trade agreement signed ~ ei salvadorpanama 2003 free trade agreement signed ~ <:" ~ "1 extra regional .... chile-canada 1997 free trade agreement implemented mexico-israel 2000 free trade agreement implemented costa ricacanada 2002 free trade agreement signed chile-korea 2003 free trade agreement signed chile-united states 2004 econ integration agreement signed multi-countries agreements regional cacm (costa rica,ei salvador, guatemala, honduras) 1961 customs union implemented caricom (inci. 15 caribbean countries) 1973/97 customs union and eia implemented laia (argentina, bolivia , brazil , chile, colombia, cuba, equador, mexico, paraguay, peru, venezuela) 1981 partial scope implemented andean (bolivia, colombia , ecuador, peru venezuela) 1969 cu stom union implemented mercosur (argentina, brazil , paraguay, uruguay, venezuela joined 2006) 1991/05 customs uni on implemented ~ ~ <0 table a2 (conl'd.) economic cooperative agreements in latin america year of inforce type of agreement status g3 (colombia, mexico, venezuela) 1995 free trade agreement implemented chilemercosur 1996 econ integration agreement implemented boliviamercosur 1997 econ integration agreement implemented mexicocentral america 2001 free trade agreement implemented mexicomercosur 2002 econ integration agreement signed perumercosur 2003 econ integration agreement signed extrarregional nafta (canada, mexico, united states) 1994 econ integration agreement implemented mercosureuropean countries 1999 cooperative agreement implemented mexico-european communities 2000 econ integration agreement implemented mexicoefta 2001 free trade agreement implemented chileeuropean communities 2003 free trade agreement signed mercosurindia 2003 econ integration agreement signed chileefta 2004 econ integration agreement signed dominican rep .central americaunited states 2006 free trade agreement signed sources: aminian, nathalie, k.c. fung and f. ng. integration of markets vs. integration by agreements. policy research working paper 4546 world bank . march 2008 p.15-16, & duran, jose et al . (2007) acuerdos comerciales entre los parses andinos y los estados unidos. cuanto se puede esperar de ellos? serie comercio internacional 77, cepal. i\) o ~ ;: ~ ;s ~ .... ..a. t:x:l ;: '" :i" f\> '" '" tn ~ .... ~ .... f\> '" table a3 ~ descriptive statistics for 17 latin american countries 1950-2004 -;: ~ "' natural logarithm bilateral ptas multicountry ptas tv ~ real real real gop ~ capital/ trade per worker wto extra extra ~ a-' "' population output openness chain ppp membership regional regional regional regional "'t ~ mean 8.968 2.551 3.596 9.433 0.487 0.305 0.011 0.536 0.046 median 8.720 2.572 3.608 9.500 0 0 0 1 0 maximum 12.112 3 .820 5.368 10 .307 1 11 2 3 3 minimum 6.765 -1 .656 1.882 8.371 0 0 0 0 0 std.oev. 1.236 . 0.502 0.686 0.439 0.500 1.107 0.114 0.567 0.273 skewness 0.574 -0.649 0.070 -0.202 0.050 5.668 11.515 0.528 7.246 kurtosis 2.572 7.521 3.154 2.158 1.003 40.576 150.845 2.712 63.273 jarque-8era 57.302 843.544 1.657 33.295 152.50 58728.70 853564 45.66 146510 probability 0.000 0 .000 0.437 0 .000 0 0 0 0 0 sum 8205.51 2334.52 3290.57 8631.59 446 279 10 490 42 sum sq. oev. 1397.10 230.39 430.11 175.97 228 .61 1119.92 11 .89 293 .59 68.07 observations 915 915 915 915 915 915 915 915 915 cross sections 17 17 17 17 17 17 17 17 17 data from the penn world tables 6.2, rose (2004) , aminian et.al (2008) , & duran et al (2007) . -" i\) -' 122 journal of business strategies biographical sketch of authors gustavo a barboza is an associate professor of administrative science at clarion university of pennsylvania. his research interests include international trade, micro credit, group dynamics, economic growth and cultural dimensions, and teaching and pedagogical topics in business. he holds a ph. d. in agricultural economics from oklahoma state university. sandra r trejos is a professor of economics at clarion university of pennsylvania. her research interests include economic education, economic development, public sector, and international economics. she earned her ph. d. in economics from oklahoma state university. economic growth creation or diversion? the record of trade agreements in latin america geography matters: kohonen classification of determinants of foreign direct investment in transition economies joel deichmann abdolreza eshghi dominique haughton selin sayek l nicholas teebagy heikki topi bentley college waltham, massachusetts abstract this exploratory study examines the extent to which non-spatial determinants of foreign direct investment (fdl) organize themselves in a manner that mimics the spatial proximity (~t' twenty-five eurasian transition economies. the kohonen algorithm is used to create a self-organizing map (soms) of a data set that features vectors of twenty-one socioeconomic variables. in this analysis, clusters emerge among the central european, balkan, baltic, and caucasus/central asian regions, leaving russia as a regional outlier. by introducing soms to the discussion of fdi and the factors governing its distribution, we demonstrate an untapped utility in the visualization and analysis (~f economic data. introduction an interesting development in the transition of central and eastern european and central asian states (hereafter "transition economies") is the division of the region into groupings by academics and practitioners alike. these sub-regional groupings of countries are made on the basis of di vergent initial conditions as well as the extent of political and economic reforms (demelo, denizer, gelb, and tenev, 1997). many of these groupings reflect the spatial proximity of countries (michalak, 1995), and some of the groups have formally organized themselves as "blocs" in an effort to coordinate their transitions. one example of this is the visegnid group (visegnid group, 2002), which has initiated 24 journal of business strategies vol. 20, no.1 collective cultural, economic, and political efforts highlighted by cooperation in european union (eu) accession talks. academic researchers have also identified geographic clusters of countries that share certain macroeconomic characteristics. for example, michalak (1995) subdivided the region into six distinct areas: the visegnid four (czech republic, poland, hungary, and slovakia), the balkans (former yugoslavia plus albania, romania, bulgaria, and moldova), the baltics (latvia, lithuania, and estonia), russia, the western ex-soviet republics (belarus and ukraine), and the southern ex-republics (the remaining states of south central asia and the caucasus). with the exception of the former yugoslavia, where fortunes have polarized between slovenia and croatia in the north and bosnia/serbia in the south, these zones remain coherent in their progress toward market economies and democratic reforms, a pattern that is mimicked by the inflows of fdi. most interestingly, each of these zones is fairly contiguous in its geography. perhaps the most consequential grouping of the transition economies is the one defined by the european union (eu, 2002), as it provides the blueprint for eu expansion during the first decade of the new millennium. the eu reports that the following countries fulfill the political criteria, and are on target to complete the other requirements for accession in 2004: cyprus, the czech republic, estonia, hungary, latvia, lithuania, malta, poland, slovakia, and slovenia2 . the commission identifies bulgaria and romania as the second tier of candidates, eligible to pursue the goal of 2007 membership. in this paper we attempt to determine the extent to which the distribution of foreign direct investment (fdi) in the region mirrors the geographic clustering of the countries under investigation. we start by removing all geographic references from the analysis, focusing instead on twenty-one non-spatial macroeconomic determinants of fdi. in order to group the transition countries according to their abilities to attract fdi, we employ a kohonen/self-organizing map (som) clustering algorithm. the resulting map shows that the distribution of the determinants of fdi, as well as fdi itself, closely mirrors the geographic clustering of the countries in the region. this result suggests a strong link between geography, fdi inflows, and economic and social conditions of the recipient country, without depicting specific causal relationships. the manner by which the countries are arranged on the self-organizing map in this study is of great interest, with implications for policy and our understanding of differential levels of progress among the transition economies. in addition, the results of this study provide decision makers at multinational enterprises with useful insights regarding the nature of the included countries as potential investment targets and their relative similarity based on a large number of socio-economic variables. moreover, this study provides a novel approach to the analysis of foreign direct investment in central and eastern europe and the former soviet union by clustering these countries on the basis of their suitability for capital inflows. spring 2003 deichmann, et al: geof!,raphy matters an overview of fdi in transition economies 25 the growth of foreign direct investment (foi) in the formerly communist states of eurasia introduces many important research questions by virtue of the recency and magnitude of this growth. the cross-sectional determinants of location choice by foreign firms in transition economies have been widely investigated and modeled using regression and factor analysis (deichmann, 200 1; t¢ndel, 200 i; garibaldi, mora, sahay, and zettelmeyer 200 i; oeichmann, eshghi, haughton, sayek, and teebagy, 2003). countries featuring abundant human capital, superior infrastructure, vast resources, and aggressive reform programs in addition to longstanding economic linkages with the triad states of north america, the eu, and the asian pacific are the early champions in attracting such investment, while those states lacking these characteristics stumble. the european bank for reconstruction and development (1999, p.79) reports that by 1998, central and eastern europe had accumulated a stock of $57.5 billion in fdi (led by poland with $15.1 billion), and the former soviet republics had attracted $23.7 billion (led by russia with $8.9 billion). as a share of gop throughout the region, annual inflows in 1998 represent as little as .4% (russia) or as much as 2.47% (azerbaijan), underscoring their varying economic importance to the host countries. the per capita cumulative value of fdi also varies wildly, from $1627 in hungary to merely $22 in tajikistan. the ebrd (1999) reports that investment inflows have grown consistently over the past decade, and represent as much as one quarter of gdp as was the case of azerbaijan in 1998. table i illustrates the importance of fdi in the economies of all transition countries under investigation, and highlights a clear gap between central and eastern europe vis-a-vis the states of the former soviet union. in the former group, foi in 2000 represented an average of 5.72% of gdp, while the corresponding figure for the latter was merely 1,48%. the potential for fdr to yield positive economic impacts is widely recognized, and as such, the sustained growth of investment over the past decade has generally been viewed favorably by recipient countries. in other words, the perceived benefits of fdi overshadow the costs and lead toward convergence within europe. accelerating fdi inflows and evidence toward convergence with western europe feed the optimistic economic scenarios for the region's future. as a corollary to the growth of fdl, the literature on fdr in the transition states continues to grow as well. an important question that prevails in this literature is what macroeconomic factors govern the spatial distribution of investment? poland, hungary, the czech republic, slovenia, and the baltics have dominated the regional investment scene, while most other former soviet republics (russia being the lone exception) have been unsuccessful in attracting foreign capital. several studies have attempted to explain the uneven distribution of fdi in the region. deichmann et al. (2003) find that the major factors distinguishing between these countries include professional skills, infrastruc26 journal of business strategies vol. 20, no. i ture development, natural resources, favorable investment climate, trade policy, and market reforms. garibaldi et al. (2001) find that the fdi patterns among the transition economies are best explained in terms of the standard set of economic variables, which include the level of economic reforms, trade liberalization, natural resource endowments, the privatization method, regulations regarding fdi flows and the local institutions. lansbury et al. (1996) study the factors affecting investment in the czech republic, slovakia, hungary and poland from the oecd countries, providing further evidence that the privatization programs, the unit labor costs and the local research intensity govern the fdi flows to the above-mentioned four transition economies. table 1 the magnitude of fdi flows to transition economies in 2000, cee compared to cis central and eastern europe former soviet republics foi pet fdi pet country name gdp* fdi ofgdp country name gdp fdi ofgdp albania 3752 143 3.81% armenia 1913 140 7.31% bulgaria 11,994 1001 8.35% azerhaijan 5266 130 2.47% croatia 19,031 926 4.87% belarus 29,949 90 0.30% czech rep 50,776 4583 9.03% georgia 3029 131 4.32% estonia 4969 387 7.79% kazakhstan 18,230 1,250 6.86% hungary 45,633 1692 3.71% kyrgyz rep 1303 (2.4) -0.18% latvia 7150 407 5.69% moldova 1285 128 9.96% lithuania 11,313 379 3.35% russia 251,105 2,713 1.08% macedonia 3573 175 4.91% tajikistan 991 24 2.42% poland 157,738 9342 5.92% turkmenistan 4403 na na romania 36,718 1025 2.79% ukraine 31,791 595 1.87% slovakia 19,120 2052 10.73% uzbekistan 7666 100 1.30% slovenia 18,128 175 0.97% cee total 389,90122,289 5.72% cis total 356,936 5299 1.48% all figures in us$ millions. data source: world bank (2002). the role of geography on economic factors the role played by geography in explaining economic policy choices, institutional development and, in turn, in explaining differences in levels of economic development has recently attracted significant attention among economists. the two strands of research focus on two different hypotheses: the "geography hypothesis" argues that geography plays a direct role in determining economic spring 2003 deichmann, et (ii: geography matters 27 policies and development, whereas the "institutions hypothesis" argues that institutions instead playa more significant role in the process, with geography playing a possible indirect role. gallup, sachs, and mellinger (1999) argue for the geography hypothesis, finding that location and climate, through their effects on economic policy choices as well us agricultural productivity, transportation costs, diseases, among other things, significantly affect the income levels and growth rates. along these lines, in explaining the underdevelopment of the tropics, sachs (200 i) argues that physical geography and climate, which he proxies by the distance from the equator, influences several dimensions that are important determinants of economic development. in testing the relative significance of geography, easterly and levine (2002) find that geography, proxied by tropics, germs and crops, affects economic development through institutions rather than directly. their study provides more support to the institutions hypothesis, where geography matters for institutional development and institutions matter for economic indicators. acemoglu, johnson, and robinson (200 i) distinguish between the role geography and institutions could play in explaining the income differences across countries, arguing that if the former is more significant, the income differences between countries should be persistent. if the latter factor, however. is more significant, the income distribution could change as institutional "reversal" occurs. the authors find supporting evidence for the "institutions hypothesis" by documenting the reversal of relative incomes during the 19th century. the following analysis does not take a position on the relative importance of geography and institutions, but rather allows the data to sort the countries on several dimensions, excluding geography, to see the correlation of this sorting with the geographic location of a country. fisher, sahay, and vegh (1998) undertake a parallel analysis of geography and economic conditions for several transition economies that our analysis focuses on. although not explicitly testing the geography versus institutions hypothesis, they conclude that economic variables that measure potential and likely timelines for convergence of the central european countries to ed resemble physical distance from brussels. they find that economic and physical distances are analogous, and that both affect the rate of convergence within the european continent. the present paper, along the lines of fischer et al. (1998), explores the relationship between geographic location and socio-economic indicators. it expands the analysis to include 25 transition economies and a wide range of social and economic indicators, including fdr. it should be noted, however, that the analysis below provides insight into the relative distance, both economic and physical, within the group of transition economies. unlike fischer et al. (1998), it does not explicitly discuss distance from the eu. the analysis that follows adds, however, to the discussion by employing a novel technique of data visualization in searching for a comparison of physical and economic distance. 28 journal of business strategies vol. 20, no. i specifically, the analysis employs kohonen maps to seek structures in a set of 21 macroeconomic indicators to provide better insights on the statistical clusters among countries, and then relates the resulting structures to the physical location of each country. we describe the methodology in more detail below. kohonen self-organizing maps a self-organizing map (som) is an exploratory data analysis technique that projects a multi-dimensional data set onto a space with a small dimension (typically a two-dimensional plane). an som thus allows for a convenient visualization of groups in the data set that share similar characteristics. the most commonly used algorithm for constructing soms is due to the work of kohonen. kohonen maps are known to be "topology preserving", so that observations with similar multi-dimensional vectors of variables find themselves positioned close to each other on the map. in addition a kohonen map is "self-organizing", so that the variables tend to vary along the map in a meaningful way. kohonen (2001) provides a comprehensive overview of som methods and case studies. the key demonstration of kohonen's technique is detailed in his extensive comparison with other methods of visualization and summarized by kaski and kohonen (1996). kohonen first used soms to build a biological model of the brain, retlecting the behavior of neural cells (kohonen 1982, 1984). since the introduction of soms by kohonen (1982, 1984) in the 1980s, several researchers have contributed to the technique's entry into the mainstream of disciplines ranging from statistics to economics and finance (deboeck, 1998; oja and kaski, 1999). the kohonen algorithm has also attracted the attention of probabilists concerned with establishing rigorous proofs of some of its properties. among such theoretical advances, we note the work of fort and pages ( 1996), who provide a very useful summary of current results on one-dimensional kohonen maps, such as convergence and self-organizing properties of the algorithm, and extend these results to the case of two-dimensional maps. burton and faris (1996) show that in the algorithm "all memory of the random initial state is lost" eventually, in some rigorous sense explicited in detail in the paper, and thus "the environment alone determines future history". of course in finite time it is possible that different maps might arise from different initial random states, an issue touched upon by varfis and versino (1992). deboeck (1998) provides a brief but instructive discussion of som applications in finance, economics, and marketing. the author supports this discussion with a financial data application of how mutual fund maps can be created and interpreted using the same grayscale lattice specification chosen for the present analysis. deboeck stops short of providing substantive ,analysis of his dataset, but makes constructive suggestions for wider study and supplicates interdisciplinary exploration of the technique. spring 2003 deichmann, et al: georraphy matters 29 varfis and versino (1992) compare soms to the well-established techniques of principal component analysis and hierarchical clustering; sequentially mining the same data set with each technique, they find that kohonen maps are a worthy alternative to the older techniques. in their kohonen map of european statistical territorial units (given a set of socioeconomic data), the authors discover that statistical units on the map cluster into distinct european geographic areas. the paper focuses mainly on the techniques themselves, and, unfortunately, the authors do not go into detail on the clustering of specific observations. for the purpose of the present study, the most instructive application of kohonen maps was made by kaski and kohonen (1996) in an effort to identify structures of welfare and poverty among countries of the world. using 39 welfare indicators, the authors map the countries on a two-dimensional grid. the self-organizing property of their map is clearly evidenced by the fact that the horizontal axis seems to indicate wealth, and the countries become poorer as one moves from left to right on the map. among the remarkable findings of this article is the fact that although no geographical information was entered into the computations, the organization of the countries on kaski and kohonen's map approximates their geographical organization. ponthieux and cottrell (200 i a) use the kohonen algorithm to group households according to living conditions, focusing on the technique's topology conservation property. using the french section of the european households panel, they find that living conditions tend to deteriorate as family size increases, as well as in cases where adults live alone. in an expansion of their previous work (200 i a), ponthieux and cottrell (200 i b) use kohonen maps both to identify groups of variables (characteristics of living standards) and to perform a series of classifications of households. first, the authors identify a group of households lacking in both comfort level and in the most basic consumer goods. second, the authors conclude that living conditions are best thought of as a complex system of factors rather than simply "levels" that can be defined quantitatively by such variables as income. they illustrate this argument through the inclusion of detailed frequencies of responses combined with the kohonen maps, elucidating the complexity that is often overlooked when classifying households according to simple categories. methods and data a self-organizing map (som) is a special case of a neural network that simultaneously summarizes a set of variables and clusters observations. it can be viewed as a principal components analysis combined with a cluster analysis, with both procedures influencing each other in the algorithm. the algorithm begins by assigning to each position i in a grid an arbitrary (random) vector m/o) with as many components as there are variables under study. at each time t the vector of variables x(t) corresponding to one of the 30 journal of business strategies vol. 20, no. i observations updates the current vectors m.(t) according to the formula m(t+ i) i i =mp) + hc;(t)(x(t) m/t)), where c = arg min/llx mill) and hu(t) is a function of t and of the geometric distance on the lattice between position i and position j. typically h .. -0 with increasing distance between i andj and increasing time. i) so the vector x(t) is allowed to update the vector m,(t) it is closest to as well as some neighboring vectors m(t). when the algorithm converges, the m. tend to be i i ordered along the lattice in a meaningful way. soms are superior to typical clustering techniques in that they preserve the topology of the initial high-dimensional data set by locating data points which have similar vectors of variables near one another on the map. following kaski and kohonen (1996), our map is computed to illustrate the structures in a complex set of socioeconomic variables. here, we use a data set resembling one collected and analyzed elsewhere (deichmann et ai., 2003) in a study of determinants of foreign direct investment in the same 25 countries. 3 in the present study, the measure of fdi is the value of fdi4 per capita, averaged over 199398. the data set includes 22 variables including fdi and is assembled from and justified by several other studies: demelo et al. ( 1997), ebrd (1999); kaufmann, kraay, zoido-lobaton (1999); and the world bank (1999, 2000). this inquiry differs from these investigations and deichmann et al. (2003) in that its purpose is to identify groups of countries that share a similar set of characteristics on the basis of their location and relative proximity on a two-dimensional hexagonal lattice. analysis the kohonen analysis yields several plots, a v-matrix (figure 1), and component plots (figure 3). each country on the v-matrix is positioned in that cell of a 4 x 6 grid whose estimated vector is closest to its own vector of indicators. intervening cells represent the distances between adjoining cells; for example, the mid-grey cell between kyrgyzstan/moldova and kazakhstan represents the distance between these two cells. shades of grey on the 4 x 6 cells represent the average distance between each cell and its neighbors; for example the dark grey for russia (with its label to the right for readability) represents the average distance between russia's cell and its neighboring cells on the 4 x 6 grid. dark cells indicate large distances or "walls" between observations, while light cells indicate close proximity between observations. the bars to the right of the map provide the values estimated by the kohonen algorithm that correspond to the shade assigned to each of the countries. perhaps the most outstanding feature of this graphic is the nature of clustering of the specific countries on the map, clearly reflecting spatial patterns in the vectors of non-spatial variables (see figure 2 for geographic locations). the distance between central asian republics vis-a.-vis those in central (czech republic, hungary, slovenia) and northern europe (latvia, lithuania, estonia) spring 2003 deichmann, et al: geography matters 31 figure i u-matrix of vectors based upon 21 variables and non-intervening fdi is clearly indicated by the distance between cells (as indicated by scales of gray). following work by kaski and kohonen (1996), no geographical data were entered into the model, but remarkably, the countries organized themselves in a manner that mimics their relative geographical locations. importantly, geographical neighbors and adjacent country pairs are often located on identical cells in the u-matrix, revealing very similar conditions. such pairs include tajikistan and turkmenistan, belarus and ukraine, and the czech republic and hungary. following a careful inspection of figure 1, five discrete and relatively homogeneous clusters can be identified. first, and in agreement with mainstream conceptualization of the region, group i includes the regional leaders of estonia, slovenia, czech republic, hungary, and slovakia. these countries approximate the grouping of visegrad states; all enjoyed strong linkages to western europe prior to world war ii. in addition, croatia, with small distances to both the slovakia and czech r.lhungary cells, can be considered as part of this 32 journal of business strategies figure 2 selimitations of area under investigarion vol. 20, no.1 group. in this context, it is interesting to note that croatia quickly turned its back on the complex difficulties with serbia and re-oriented itself toward the west, creating democratic governments and re-establishing economic linkages with italy, austria, and hungary during the early 1990s. while poland's position outside the group and slovakia's favored relative position may appear surprising, it should be remembered that most of the variables under consideration here are economic rather than political in nature. poland's democratic transition has driven its economic progress leaving considerable economic stagnation in the isolated eastern reaches of the country, while the opposite holds true for slovakia. estonia's membership in this group also merits some attention because its geographical neighbors are found in other clusters. estonia enjoys deep and longstanding cultural and economic relationships with its neighbor finland (huang, 1999), and these appear to play out in figure 1. group ii includes poland, albania, bulgaria, romania, and macedonia. although it features a high level of heterogeneity, this group roughly approximates the membership of michalak's (1995) "balkan" region, which is characterized by a slow but steady transformation and widely viewed as a pool for secondround ed expansion (barnard, 2000; ed, 2002). however, our map reveals several exceptions to a uniform balkan region. as noted earlier, croatia tends to cluster with group i. an additional caveat to representing group ii as a balkan region is poland, where enduring agrarianism, deficient infrastructure, and lagging human capital contribute to plausible separation from group i. finally, albania's membership in this group may surprise some observers. from a very spring 2003 deichmann, et al: geography matters 33 slow starting point in 1990 when its authoritarian government ended, albania has made great strides in terms of reforms and growth, areas that can be examined more closely given the maps of specific indicators in figure 3. group iii includes latvia and lithuania. toward an explanation of the clear separation between this group and estonia, it is worthwhile reiterating estonia's longstanding cultural and trade 1inkages with finland (laakso, 200 i). although both are among the next-round candidates for eu accession, neither latvia nor lithuania enjoys the geographic proximity to the eu that estonia possesses opposite helsinki on the gulf of finland. moreover, neither of these states has the cultural proximity to any eu member state that estonians have as part of the finno-ugrian language group. russia (group iv) is distinct from group iii by virtue of its superior resource endowments, less successful reforms, higher inflation, and inferior infrastructure. russia's outlier status is attributable to its geographical magnitude, which spans eleven time zones. moreover, its internal heterogeneity confounds membership in groups of smaller, homogeneous states. group v is a relatively homogeneous group in so far as it includes all of the remaining former soviet republics. nearly all of the indicators make it clear that these states remain laggards ten years after the demise of the ussr. there are a few exceptions, such as plentiful resources in the caucasus and central asia, and countries with positive investment climates and far-reaching reforms that have yielded few acquisitions to date, including moldova and kyrgyzstan. certainly, this cluster offers great potential given its substantial resources and reforms. however, as former republics of the ussr these countries suffer from the deepest impacts of the communist legacy, including trade dependency (in particular, remaining linkages with russia), high inflation, and negligible capital availability. figure 3 provides a closer look at the values estimated by the kohonen algorithm of the 21 components corresponding to each of the individual variables (as defined in appendix) at each position on the 4 x 6 grid. as a demonstration of kohonen map interpretation, the numher of years under communism ("communism") is highest toward the top of the map. toward an explanation of the scale to the right of each variable, the range in values of communism is 43.4 (soviet liberation and occupation of central european states after world war ii) to 70.4 (russia, the hub of the soviet union itself). again, the numbers vary slightly from the actual values in the dataset since they are estimated by the kohonen algorithm. similarly, gnp per capita prior to 1989 increases as we move along diagonals from the top left to the bottom right. an inspection of our dataset confirms that weak personal earnings in central asian repuhlics predate the razing of the iron curtain in 1989 and the demise of the ussr in 1991. figure 3 reveals insights on the positions of individual countries in clusters that do not match our expectations. the location on figure i of four countries in particular appears contrary to widely held notions of socioeconomic status in the 34 journal (~l business strategies vol. 20, no. i figure 3 the values of the 21 indicators, visualized on the self-organizing map .....•.........."j . •••••••• • ••• the acronyms and definitions of the variables are provided in appendix. the "d" underneath each legend indicates that the variable has been dc-normalized for the purpose of visual analysis. region. these outliers are slovakia, poland, albania, and russia. slovakia's membership in group i reveal the economic bias of our set of variables. since the demise of the czechoslovak federation in 1993, slovakia's progress toward democratization has lagged behind those of its visegnld neighbors, despite declared intentions of simultaneous eu accession (bernard, 2000; visegnld, 2002). however, in terms of economic measures slovakia has fared better than politically. the only economic variable clearly separating slovakia from the rest ofthe group is trade as a percentage of national income (tradepct). in other respects, slovakia performed well, and based on our predominantly economic variables it remains clustered with its declared visegrad allies. it is worth noting that with the defeat of xenophobic and nationalistic premier vladimir meciar in september 2002, the political obstacles that separated slovakia from the other countries in group i (and stood in the way of nato and eu membership) have, for all intents and purposes, fallen away (rebac, 20(2). leading the region in fdi, poland is widely heralded as a darling of western (particularly us and german) investors and an obvious candidate for the next round of eu expansion (deichmann, 200 i; eu 2(02). however, it is separated spring 2003 deichmann. et al: geography matters 35 from group i (estonia, slovenia, czech republic, hungary, slovakia and croatia) by a distinct wall in the u-matrix. in figures 1 and 2, poland appears in the lower left-hand hexagon. an inspection of figure 3 reveals that poland differs substantially from group i on the following variables: gnp/cap89, tradedep, tel! 1000, tradepct, schoolen, resscore, and air/1000. these variables roughly correspond to broader categories of infrastructure, human capital, and international linkages, all of which have been demonstrated as important considerations for investors (deichmann, 200 i; deichmann et al. 2003). in contrast to poland, albania's position on the u-matrix might be considered as surprisingly strong by regional experts. albania has traditionally been viewed as europe's poorest state, especially under the stranglehold of enver hoxha and immediately following his death in 1985 (vickers and petti fer, 20(0). while corruption, gangsterism, and drug trafficking continue to confound efforts at stabilization, albania performs fairly well on many of our economic variables, especially those quantifying external and internal reforms and economic growth. in figure 3, the characteristics appear under extref, intref, and gdpgrowth, respectively. figure 3 also sheds light on russia's position in the v-matrix of figure i. spanning eleven time zones and nearly half of the meridians in the northern hemisphere, russia possesses unmatched internal diversity within the group of countries included in this investigation and therefore confounds classification as a single country that either is or is not suitable for investment, eu expansion, or any other conceptual category. in spite of its internal heterogeneity, russia clearly varies from groups i, ii, and iii in several indicators. these include russia's 74 years under communism, and to a lesser extent rule of law rating (rol), investment climate (invclim, handicapped by organized crime and the informal sector), relatively shallow financial markets (mqm), and lagging reforms (extref, intfer, prsecgdp). only russia's vast resources (resscore) and suitable accessibility (air/1000) separate it from many of the other former republics of the ussr.) the discussion so far has concentrated on the socio-economic factors that are possible candidates in explaining the fdi distribution among the transition economies. in order to analyze the possible relationship between fdi and these socioeconomic factors governing the distribution offdi, we continue by mapping fdi in the region. figure 4 shows in detail the enlarged map of fdi per capita, divided by ten billion in order to decrease the variable's variance relative to the other standardized variables. as suggested by kaski (2002), this is a useful technique for plotting a dependent variable on the map while preventing its intervention in the construction of the u-matrix. figures 1,2 and 3 support the hypothesis that fdi is distributed, as are the socio-economic factors that influence the fdi decisions, so that the kohonen maps of fdi and its determinants mirror the regional physical map. this finding suggests a strong relationship, without any directional causality, between geography, policies and policy-driven fdi flows. 36 journal ()t" business strate~ies vol. 20, no. i figure 4 structured diagram of foreign direct investment (enlarged from figure 3 with countries labeled) conclusions and implications there is no question that foreign direct investments have been instrumental in accelerating the schumpeterian "creati ve destruction" of old structures in emerging markets of the region. they have played a critical role in transferring the much needed technological, marketing and management know-how, increasing the international competitiveness of the host countries and facilitated their access to world markets. (bod, 1998). in this paper we not only reaffirm the importance of spatial proximity in determining the distribution of fdi in the region, but we also demonstrate the application of kohonen self-organizing maps to gain a better understanding of the patterns offdi in central and eastern europe. more specifically, our kohonen maps provide an intuitively useful method of visualizing a dataset that is otherwise too amorphous and complex to conceptualize. most interesting is the fact that while no spatial variables, per se, were entered into the clustering exercise, the relative geographic location of many of the countries "re-appears" in our spring 2003 deichmann, et al: geography matters 37 maps, and clearly distinguishes between the central european and baltic states and the laggard states of the former soviet union. the first cluster includes slovenia, estonia, hungary, the czech republic, slovakia and croatia. all of these countries, including slovakia following the elections of september 2002 (rebac, 2002), are generally viewed as reformprogressive, and are in most cases geographically proximate. poland is positioned as the "leader" of group ii, which also includes albania, romania, bulgaria, and macedonia, representing economies that remain relatively more agrarian and struggle to establish the rule of law, carry out economic reforms, and address capital availability. latvia and lithuania form a group of their own (group ill), isolated from group i on the one hand, but also distinct from russia (group iv). the westernmost portion of russia enjoys many favorable conditions, but the rest of the country continues to struggle with the challenges of transition. group v includes all ofthe non-baltic former soviet socialist republics that cluster together with no substantial intervening walls. these clusters of states are remarkably consistent with the projected sequence of entry into the european union (eu, 2002), and categories established for the purpose of transition analysis by others (michalak, 1995). moreover, these observations are in accordance with geographic patterns identified in other projects undertaken without explicitly adding geographical variables (varfis and versino, 1992; kaski and kohonen, 1996). it is no surprise that the position of the countries on the maps (see figure i, the u-matrix) resembles the relative attractiveness of the countries in transition as indicated by their ability to attract foreign capital (deichmann, 2001; deichmann et ai., 2003). in short, the clustering exercise provides two significant results. first, the mapping of fdi mimics the mapping of the "combined economic policy and development" indicators; and second, the positioning of country groups in kohonen mappings of both fdi and the economic characteristics of the transition economies are representative of the geographic location of the region. these two results suggest that, with no indication of causation, fdi, economic characteristics, and the geographic location of the host country, are interlinked. as discussed below, theses findings have several implications for government policy and mne investment decision making. from the policymakers' perspective these findings once again reiterate the importance of improving economic conditions in attracting fdi. due to the perceived benefits of fdi, which include provision of additional capital, creation of employment, and positive spillovers from the advanced technology and managerial skills inherent in the act offdi, several transition economy governments have liberalized capital restrictions and even gone further by providing special incentives to foreign firms, to entice them to open shop within their economies'." our results confirm to the policy-makers that such efforts to attract fdi should include improving their domestic economic conditions. as the kohonen mapping of 21 variables suggests, these indicators include those related to economic development, infrastructure, macroeconomic stability, and reforms. 38 journal of business strategies vol. 20, no. i the case of poland provides supporting evidence that economic policies and fdt are related. according to our analysis, despite their geographic proximity, when considering hungary, the czech republic and poland as possible investment sites mnes prefer the former two transition economies to poland. in other words, in our analysis poland places in group ii, the second most attractive group, because its infrastructure, macroeconomic policies and internal reforms lag behind hungary and the czech republic. moreover, our results show that aspects of geography (proximity to export markets, access to open seas, access to eu, cultural and linguistic ties, etc.) play an instrumental role in attracting fdi. this is especially true where mnes pursue an export market-oriented as opposed to domestic market-oriented strategy. a case in point is estonia. as stated above, cultural and linguistic ties and convenient access to eu markets have played an important role in placing estonia in group t, while its neighbors, latvia and lithuania, lag behind in group iii. nation states blessed by favorable geography can leverage their favorable location to attract mnes that pursue export-market-oriented strategies on a regional or pan-european basis, strengthening the competitive advantage they already have among the nations in the region. on the other hand, the challenge for countries suffering from unfavorable geographic locations, such as landlocked nations, is to compensate for their location disadvantage by instituting domestic policies that are particularly hospitable to domestic market-oriented mnes. alternatively, these nations can leverage their unique advantages in certain factors of production, such as skilled labor force, to attract mnes that seek to rationalize their operations on a global basis. finally, our research allows for scrutiny of widely accepted groupings of the central and eastern european countries such as the multi-tiered sequence for ed accession. the european commission finalized this list of new-round candidates on 9 october 2002, with a timeline of just over one year for accession (eu, 2002). remarkably, the first cluster of states identified here (the czech republic, hungary, slovenia, estonia, slovakia and croatia), with the exception of croatia, falls completely within the list of most favored states for the first round of states for accession. moreover, the positioning on the hexagonal lattice of nearly all countries seems to depend upon their distance from brussels, in agreement with findings by fischer et al. (1998). future research after deliberately removing geographical variables, we discover that our clustering of states generally mimics the geographical location of states, leading us to conclude that geography and socioeconomic indicators are highly correlated in the context of the central and eastern european countries. however, additional confirmation of the link in other regions of the world is needed before we can reach a definite conclusion. spring 2003 deichmann, et al: geography matters 39 second, as the first regional application of kohonen maps, this paper demonstrates the utility of kohonen maps in understanding the overall pattern of foreign direct investments. past research has shown that geographic, economic, cultural, and administrative distances affect different industries in different ways (ghemawat, 200 i). therefore, an interesting application ofkohonen maps would be to examine the sectoral distribution of fdl in the region and its linkage with geography. finally, while kohonen clusters of economic characteristics of these countries closely mimic their geographic locations, there were some exceptions, notably poland and estonia. this raises the possibility that other types of distances such as cultural and administrative may influence country classifications. therefore, future research should include distance measures in addition to economic variables as explanatory variables in mapping the distribution of fdl using the kohonen algorithm. references acemoglu, d., johnson, s., & robinson, j.a. (200 i). reversal of fortune: geography and the institutions in the making of the modern world income distribution. national bureau for economic research. working paper, no. 8460. barnard, b. (2000). eu enlargement: continent could be unified by the end of the decade. europe. june. bod, p. a. (1998). the social and economic legacies of direct capital inflows: the case of hungary, in j. bastian (ed) the political economy of transition in central and eastern europe: the lightcs) at the end oithe tunnel. (pp.13-44). ashgate: brookfield, u.s.a. burton, r. & faris, w. (1996). a self-organizing cluster process. the annals of applied probability. !2, 1232-1247. deboeck, g. (1998). financial applications of self-organizing maps. american heuristics electronic newsletter. january, 1-7. deichmann, j. (200 1). distribution of foreign direct investment among transition economies in central and eastern europe. post-soviet geography and economics. 42, 2. deichmann, j., eshghi, a., haughton, d., sayek, s., & teebagy, n. (2003). foreign direct investment in the eurasian transition states. eastern european economics. forthcoming. 41, 5-34. demelo, m., denizer, c., gelb, a., & tenev, s. (1997). circumstance and choice: the role of initial conditions and policies in transition economies. washington d.c.: world bank. 40 journal of business strategies vol. 20, no.1 easterly, w. & levine, r. (2002). tropics, germs, and crops: how endowments influence economic development. nber. working paper, no. 9106. european bank for reconstruction and development. (1999). transition report: ten years of transition. london: ebrd. european union. (2002). towards the enlarged union: strategy paper and report of the european commission on the progress toward accession by each of the candidate cou ntries. internet: http://europa.eu. int/comm/en largement/report2002/ strategy en.pdf. accessed 9 october 2002. fisher, s., sahay, r., & vegh, c. (1998). how far is eastern europe from brussels? international monetary fund. working paper no. 98/53. fort, j-c. & pages, g. (1995). on the convergence of the kohonen algorithm with a general neighborhood function. the annals of applied probability. j,. 1177-1216. freudenberg, m. & lemoine, f. (1999). central and eastern european countries in the international division of labour in europe. cepil. working paper nos. 1999-05. gallup, j.l., sachs, j., & mellinger, a.d. (1999). geography and economic development. center for international development (cid). working paper. no i. garibaldi, p., mora, n., sahay, r., & zettel meyer, j. (200 i). what moves capital to transition economies? imf staff papers, 48, 109-145. ghemawat, p. (200 i). distance still matters: the hard reality of global expansion. harvard business review, september, 3-11. huang, m. (1999). the amber coast: a nordic freeze? central europe review. 28, 6. kaski, s. (1997). data exploration using self-organizing maps. mathematics, computing and management in engineering. finish academy of technology series. 82,157. kaski, s. (2002). email correspondence with dominique haughton, co-author. 2 may. kaski, s. & kohonen, t. (1996). exploratory data analysis by the self-organizing map: structures of welfare and poverty in the world. proceedings of the third international conference on neural networks in the capital markets, london, england. (pp.498-507). singapore: world scientific. kaufmann, d., kraay, a., & zoido-lobaton, p. (1999). governance matters. world bank policy research paper. no. 2196. kohonen, t. (1982). analysis of a simple self-organizing process. biological cybernet. 44, 135-140. spring 2003 deichmann, et at: geography matters 41 kohonen, t. (1984). self organization and associative memory. (3rd ed.). berlin: springerverlag. kohonen, t. (1995). self organizing maps. berlin: springer-verlag. kohonen, t. (200 i). self-organizing maps. (3rd cd.). berlin: springer-verlag. laakso, j. (2001). frequently asked questions about finno-ugrian languages. internet: http://www.helsinki.fi/~iolaakso/fufaq.html.accessed 16 october 2002. lansbury, m., pain, n., & smidkova, k. (1996). foreign direct investment in central europe since 1990: an econometric study. national institute economic review. lemoine, f. (1998). integrating central and eastern europe in the regional trade and production network, cepii. working paper. michalak, w. ( 1995). foreign aid and eastern europe in the "new world order." tijdschrift voor economische en sociale geografic. 86 . 260-277. oja, e. & kaski, s. (1999). kohoncn maps. amsterdam: elsevier science. ponthieux, s. & cottrell, m. (200 i a). neural classification and "traditional" data analysis: an application to households' living conditions. proceedings of the international work-conference on artificial and natural neural networks (lwann), grenada, spain, june 13-15.738-745. ponthieux, s. & cottrell, m. (200ib). living conditions: classification of households using the kohonen algorithm. european journal of economic and social systems. 15,69-84. rebac, l. (20()2). pro-eu parties win in slovakia. the prague post. internet: http:// www.pragueposlcom!p03/2002/arti0925/news3.php. accessed 8 october 2002. sachs, j. (200 i), tropical underdevelopment. nber working paper. no. 8119. t0ndel, l. (2001). foreign direct investment during transition: determinants and patterns in central and eastern europe and the former soviet union. michelsen institute. bergen, norway.working paper nos. 2001-9. varfis a. & versino, c. (1992). clustering of socio-economic data with kohonen maps. neural network world. june, 813-834. vickers, m. & pettifer, j. (2000). albania: from anarchy to a balkan identity. new york: new york university press. visegr<j.d group. (2002). visegnid group official homepage. http:// www. visegradgroup.org! accessed 19 september 2002. 42 journal 0.1" business strate ries vol. 20, no. i wheeler, d. & mody. a. (1992). international investment location decisions: the case of us firms. journal of international economics. 33, 57-76. world bank. (1999). world development report. new york: oxford university press. world bank. (2002). the 2002 world development indicators cd-rom, washington, dc: world bank. appendix variahles (except where otherwise specified, values represent means for years 1993-98) variable communism gnp/cap89 growth8589 repinflation tradedep tel/i 000 gdpgrowth gop/cap inflation pcturban tradepct schoolen invclim rol extref intref prsecgdp resscore mqm credprsec air/iooo fdicap description data source number of years under central planning demelo et al. 1997 1989 per capita gnp (in 1989 ppp us $) world bank 2002 gdp growth (annual %, mean 1985-89) world bank 2002 repressed inflation (1987-90f demelo et al. 1997 trade dependence, 1990 (% of gdp)x demelo et al. 1997 telephone mainlines per 1,000 people world bank 2002 gop growth (annual %) world bank 2002 gdp per capita, ppp (current international $) world bank 2002 inflation, consumer prices (annual %) world bank 2002 urban population (% of total) world bank 2002 trade as a percentage of gdp world bank 2002 school enrollment, secondary (% gross) world bank 2002 aggregate investment climate score ebrd 1999 rule of law (scale of -2.5 to 2.5)9 kaufmann et al. 1999 external reforms world bank 1999 internal reforms (price reforms) world bank 1999 private sector share ofgdp ebrd 1999 natural resources (o=poor, 1= moderate, 2=high) index using ebrd (1999) categories. money and quasi money (m2) as % of gop world bank 2002 credit to private sector (% of gdp) world bank 2002 number of air passengers per capita world bank 1999 mean annual fdi value per capita, 1993-98 world bank 2002 i selin sayek is affiliated with the international monetary fund (imf). the views expressed in this paper are those of the authors and do not necessarily represent those of the imf or imf policy. cyprus and malta are not included in the present analysis because they were not part of the soviet sphere of influence and are not considered to be among the transition economies. 3 the explanation of the variables and the data sources are detailed in the appendix. spring 2003 deichmann. et at: geography matters 43 4 foreign direct investment (fdi) is defined as "net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. it is the sum of equity capital flows, reinvestment of earnings, other long-term capital flows, and short-term capital flows as shown in the balance of payments" (world bank 1999, p.286) 5 while it is beyond the scope of this paper, it would be worthwhile to employ a similar methodology to have a closer look at russia's 89 complex internal entities, which include the two autonomous and westernized major cities of st. petersburg and moscow, 21 republics, ii okrugs, 49 provinces (oblasts), and six territories (krays). n according to hanson (200 i), between 1998-200 i, 103 countries had offered special tax concessions to foreign corporations to set up production or administrative facilities within their borders. 7 repressed inflation is calculated as percent change in real wage minus the percent change in real gop over 1987-1990 (demelo et al. 1997). h trade dependence is defined as the ratio between the average of exports and imports and gop. (demelo et al. 1997) 9 kaufmann et al. (1999) based these scores on survey responses from nongovernmental organizations, commercial risk rating agencies, and think tanks. higher scores represent better governance. joel i. deichmann is assistant professor of geography in the international studies department at bentley college. he received a ph.d. from suny buffalo in 1999. his research interests include flows of foreign direct investment, international trade, and tourism, with a regional specialization in central and eastern europe. he teaches regional geography courses as well as geographic information systems. abdolreza eshghi is associate professor of marketing and director of the center for marketing technology in the marketing department at bentley college. he received his ph.d. from the university of illinois in marketing/international business in 1984. professor eshghi's current research interests include customer relationship management and marketing strategy in eastern and central european countries. his most recent articles have appeared in the eastern european economics and journal of interactive marketing. dr. dominique haughton is professor of mathematical sciences at bentley college. she received her ph.d. in mathematics from mit in 1983. her research interests include model selection, statistics applied to marketing, data mining and the analysis of living standards surveys. she has published over twenty-five articles in refereed journals and has won prizes for research and for innovation in teaching. she is a co-editor on two books on the analysis of living standards in vietnam. 44 journal of business strategies vol. 20, no. i selin sayek is an economist at the international monetary fund. prior to joining the imf she was assistant professor at the department of economics, bentley college where she was a member of the data analytics research team (dart). she received her ph.d. in economics from duke university in 1999, and holds a b.sc. degree in economics from the middle east technical university. her research focuses on the determinants and effects of international capital flows. nicholas teebagy is associate professor of mathematical sciences at bentley college. he previously taught at northeastern university and babson college. he received his ph.d in applied statistics from boston university. dr. teebagy has published in such journals as decision sciences, sankhya, journal of interactive marketing, and eastern european economics, and presented papers at various professional meetings. he is the authored of the math behind wall street. heikki topi is associate professor of computer information systems at bentley college. his current research focuses mostly on usability in web search and other areas of information systems, but he is also interested in a variety of topics related to the utilization of information technology resources and patterns of global change. his research has been published in several information systems and information science journals, and he is the co-editor of the auerbach's is management handbook. geography matters: kohonen classification of determinants of foreign direct investment in transition economies strategic orientation and corporate social performance: an empirical examination roy l. simerly east carolina university greenville, nc anisya s. thomas florida international university miami, fl theoretical background the strategic choice perspective (child, 1972) suggests that the top managers of an organization determine its future direction by making important choices about products, markets and technologies. over time, strategies, or streams or patterns of major and minor decisions (miles and snow,1978; mintzberg,1978) contribute to the development of internally consistent configurations of systems and processes that guide an organization's interaction with, and response to the external environment. since corporate social performance (csp), has been defined as the identification ofthe domains ofan organization's social responsibility, the development of processes to evaluate environmental and stakeholder demands and the implementation of programs to manage social issues (carroll, 1979; warlick and cochran, 1985; wood, 1991a; wood, 1991b), it would seem logical to infer that the strategic orientation ofan organization influences its social policies and therefore its csp. typologies of strategy: the miles and snow framework typologies provide a means of classifying organizations in a comprehensive yet parsimonious framework for theory development (pinder and moore, 1979) because they reduce the myriad variables that characterize the organization to a manageable set of internally consistent ones. thus the primary benefit of the typological approach is that the evidence of a few significant characteristics in an organization's profile facilitates the prediction of others. the strategic management literature has developed a variety of strategic typologies that describe an organization's competitive posture in an industry. these typologies ofstrategy suggest that over time organizations develop configurations ofsystems and processes which contribute to the development of a distinctive competence and consequently competitive advantage (miles and snow, 1978; porter, 1980). prominent among these is the miles and snow (1978) typology of strategy which describes bundles of organizational characteristics that have been found to lead to successful performance. this typology has been the subject of extensive testing in the strategic management literature and has been judged to be reasonably valid (doty, glick and huber, 1993; zahra and pearce, 1990). miles and snow identify three viable strategies, prospectors, analyzers and defenders. while prospectors and defenders are maximally different forms, analyzers are 114 journal ofbusiness strategies vol. 11, no.2 hybrid strategies that exhibit some of the key features of both. prospectors are externally oriented organizations that compete by pioneering new products and developing innovative marketing techniques. since they are constantly involved in monitoring the external environment and developing alternative responses to emerging trends, they are the creators of change in an industry. in contrast defenders are internally oriented and focus on penetrating existing markets by improving operational efficiency. the main thrust of the defender strategy involves "the creation of a narrow, stable domain ... through a limited mix ofproducts and customers and aggressive efforts to "protect" the domain from competitors" (mcdaniel and kolari, 1987:39). we suggest that the manner in which prospectors, analyzers and defenders perceive and react to the needs of their manifold constituencies will be as distinct as their market approaches. since prospectors are externally oriented, they develop and value competencies that facilitate the scanning of the external environment and the early identification of trends. thus it is expected that prospectors are more adept at managing the needs of their stakeholders and are likely to achieve superior csp. in contrast, defenders operate in narrow and stable domains, are internally focussed and value efficiency above all else. the backgrounds and skills oftop managers reflect this orientation and tend to focus on activities that enhance productivity. consequently, defenders are less likely to assign much importance to factors outside the organization which in tum translates to less proactive social programs and policies and lower csp. based on this logic we propose the following hypothesis: hi: prospectors are more likely to achieve higher levels ofcsp than defendersl . method setting and sample the sample for this study was drawn from the 305 firms that comprise fortune magazine's list of most admired corporations. this list encompasses firms in the 32 industries included in the fortune 500 and fortune service 5002 . the initial sample comprised only manufacturing firms. to maintain a basic level of homogeneity in the sample, service fums were deliberately excluded as it is commonly recognized that they differ in their strategic approaches and competitive maneuvers (fombrun and shanley, 1990). industries with fewer than eight ftrms on the list were also eliminated. this step was necessary to ensure a minimum level of variance in the dependent measure, csp, which was described as reflecting a firm's performance relative to the mean of its industry. to justify the use of the miles and snow (1978) typology which is recognized as being applicable at the business level (hambrick, 1983), only firms that received more than 70 percent oftheir sales from a single industry were included in the sample (rumelt, 1974). this step is useful in selecting a sample of comparable firms and is consistent with methods employed in prior literature operationalizing the miles and snow typology (fhomas, litschert and ramaswamy, 1991). firms that were classifted as conglomerates, holding fall 1994 simerly & thomas: strategic orientation 115 companies, subsidiaries or those that had the majority of their sales or manufacturing outside the u.s. were excluded. these procedures resulted in the identification of 134 firms. data and measures strategy. ginn and mcdaniel (1987) note that an organization's strategy is reflective of all its systems, allowing a limited selection of theoretically relevant variables to capture strategic type. in this study, strategy was viewed as being implied :from behavior rather than stated by management. thus, the variables selected to operationalize the strategies represent a series of resource allocations and competencies necessary for their succ¥ssful implementation. the underlying assumption was that the value of these variables stems mainly from managers exercising choice (child, 1972). five different measures were used to operationalize the strategy types. since strategy is recognized as a stable phenomena which becomes established over time and is relatively immutable, four year averages (1985-1988) were used to describe each of the strategy measures. this step also ensures the stability of the data, smoothing the effects of temporary fluctuations in resource allocations due to unusual circumstances in an organization or its external environment. wherever possible, ratios were used to control for the possibly contaminating effect of firm size. the data for these measures were obtained primarily from compustat tapes, company annual reports, and 10-k reports. each of these measures is briefly discussed below. research and development (.r&d) expenditures: snow and hrebiniak. (1980) found that of all the distinctive competencies examined, emphasis on research and development most clearly differentiated between the strategic types. hence a ratio of r&d expenditures to total sales was used as a standardized indicator of a fmn's propensity to search for new products. this measure was derived from previous studies investigating the miles and snow typology (e.g. hambrick:, 1983; mcdaniel and kolari, 1987). since prospectors engage in greater amounts ofinnovative activity, they are expected to rank highly on this indicator. marketing ewnditures: a ratio of marketing expenditures to total sales were used as an indicator of the firm's market focus. typically marketing expenditures include direct promotion, advertising and other general selling expenses. in keeping with their external orientation, prospectors were expected to rank highly on this measure. net sales per employee: this ratio describes an organization's ability to produce and distribute goods efficiently. since the defender strategy is geared toward the maximization of efficiency, it is expected that these organizations would have higher scores. property plant and equipment expenditures: a ratio of property plant and equipment to total sales was used to describe the capital intensity of the business. derived from previous literature on the miles and snow typology (hambrick, 1983), this measure attests to an organization's investment in efficient production. thus, defenders were expected to rank highly on this measure. ceo experience in external and internal functions: the functional background of the ceo was coded as a categorical variable to reflect external or internal experience. 116 journal ofbusiness strategies vol. 11, no.2 external experience included backgrounds such as marketing and product research and development while internal experience included backgrounds in finance, engineering and manufacturing. the area where the ceo spent the longest amount of time, prior to obtaining the position at the helm of the corporation, was used to determine his or her functional background. previous research (e.g. chaganti and sambharya, 1987; thomas, litschert and ramaswamy, 1991) suggests that prospectors will have a greater proportion of externally oriented executives and that defenders will have a greater proportion of internally oriented executives. the data for this measure was obtained from dun and bradstreet's reference book ofcorporate management (1988). col1'orate social performance. each year fortune polls over 8000 senior executives, outside directors and fmancial analysts to evaluate the reputations of firms which comprise its list oflargest industrial and service corporations. these experts are asked to rank the corporations in their industry, using a scale from 0 (poor) to 10 (excellent) on eight qualitative perceptual dimensions3 . these scores are then combined to derive a composite number which determines a fums rank on the list of "most admired corporations". the raw data reflecting the evaluations of the industry specialists on each of the eight dimensions was obtained from fortune and used in this analysis. this data has similarly been used in a number of previous studies that attest to its validity (e.g. mcguire, sundgren and schneeweis, 1988; wokutch and spencer, 1987). the attribute community and environmental responsibility was used as a surrogate for csp as there are no widely recognized, objective measures to denote this construct. this measure has been used in a variety of previous studies over the past five years (boyd and carroll, 1993; fombrun and shanley, 1990; nayyar, 1992; wartick, 1992). wokutch and spencer (1987) suggest that it is particularly appropriate as it reflects the opinion of a wide range of industry experts. since the fortune survey has been conducted annually for a period of fourteen years, it can be assumed that the raters account for shifts in corporate social performance over time, and evaluate firms in a dynamic rather than a static fashion. to assess the reliability of the data, correlation analysis was performed on a sub-sample of firms in several industries over a three year period (1987, 1988, 1989). notwithstanding changes in economic and environmental conditions, the correlations were consistently positive and significant (ranging between 0.7 and 0.9). there was considerable variance in the csp measure across industries, with the firms in some industries ranking consistently high while those in others clustered at the bottom ofthe overall list. thus csp was independently defined within each industry context by comparing each frrm in an industry to the mean csp score for that industry. companies that ranked above or below the mean csp in their industry were classified as high csp frrms and low csp fums respectively. by classifying each fmn within its own industry, the problem of perceptual bias by raters of a specific industry was substantially reduced. since csp is understood to be an outcome of a variety of internal variables and resource allocations (fombrun and shanley, 1990), it was measured in 1989 following the classification of the strategies of the fums in the sample. fall 1994 simerly & thomas: strategic orientation 117 data analysis identifying strategic types: miles and snow (1978) contended that the three viable strategies, prospectors, analyzers and defenders should be found in every industry. this assertion has subsequently been validated by empirical research in multiple industries (snow and hrebiniak, 1980). however, there is no definitive evidence that details the numerical distribution for the three strategies in a particular context (smith and grimm, 1987; zahra and pearce, 1990). therefore a two-step process was used to identify prospectors and defenders. in keeping with the contentions of miles and snow, strategic orientation was operationalized as a continuumwith prospectors and defenders occupying the two extremes. to construct the continuum, a two variable criterion set (marketing expenditures/sales and research and development expenditures/sales) was used. these variables were specifically chosen for several reasons. according to miles and snow (1978), research and marketing define the external thrust of the prospector strategy. further previous research has identified these variables as having high predictive validity (zahra and pearce. 1990). finally, a correlation analysis empirically confirmed high convergence between these two measures (r=o.98). therefore the two measures were summed and the frrms arrayed in ascending order. a median split method was adopted to identify strategic types (see drazin and van de ven.1985; romanelli, 1989 for similar approaches). the top 25 percent (frrms having the highest summed score) and the bottom 25 percent (frrms having the lowest summed score) of the firms were respectively denoted as prospectors and defenders. this process resulted in two sets of 34 frrms each that were selected for further testing. nevertheless, it is recognized that such a procedure can result in classification errors at the margin. in other words, firms having the highest summed score in the defender sample and firms having the lowest summed score in the prospector sample could in fact be pursuing the hybrid analyzer strategy. to establish the reliability of the above strategy typing approach, the use ofmultiple methods testing for convergence was necessary. thus the next step in the analysis was one of validation. the remaining three strategy measures comprising the hold out set (sales per employee, property plant and expenses to revenues and functional background of the chief executive) were used for this purpose. as indicated in tables 1 and 2, directional t-tests and chi-square tests on these measures (as well as the ones used in the criterion set) revealed statistically significant differences between the two strategy groups. prospector firms were found to have a significantly higher proportion of r&d expenditures and marketing expenditures than defenders. they also had a significantly greater proportion of executives with externally oriented rather than internally oriented functional backgrounds. on the other hand, defenders exhibited higher levels ofemployee productivity and capital intensity. their ceo's also tended to have a greater proportion of experience in internal functions as compared to external functions. these findings parallel the conclusions of hambrick (1983) and thomas et. al. (1991) who reported similar patterns in their investigations of the miles and snow typology. 118 journal ofbusiness strategies vol. 11, no.2 table 1: summary of t-test results for strategy variablesa criterion set r&d expenses/sales marketing expenses/sales hold-out set sales/employee prop. plant and eqip. prospector (n=34) .0606*** (.0387) .3796*** (.0814) 119.04 (56.33) .3087 (.0858) defender (n=34) .0094 (.0120) .0689 (.0814) 303.93** (380.99) .4931 *** (.1891) a natural means reported. standard deviations are in parentheses. • •• •••p<o.05, p<o.ol, p<o.ool table 2: chi-square tests comparing functional area distributionsa functional area internal functions (%) external functions (%) chi-square prospectors defenders (n=34) (n=34) 26.5 67.6 73.5 32.4 7.53** 4.25* atest of ho : no significant differences within compared groups. • .110 p<o.05, p<o.ol, fall 1994 simerly & thomas: strategic orientation results 119 the hypothesis was examined through a chi-square analysis to test for significant differences in the level of csp between prospectors and defenders. the hypothesis was supported: the prospector group had a significantly higher proportion of firms with "high csp" than the defender group (chi square = 5.96; p<o.05). as shown in table 3, 59 percent of prospectors were classified as having "high csp." in comparison, only 29 percent of the defenders belonged to the "high csp" group. table 3 chi~square tests comparing distributions of strategy and csp csplevel highcsp (%) lowcsp(%) chi-square prospectors (n=34) 58.82 41.18 5.96* defenders (n=34) 29.41 70.59 atest of ho: high and low csp firms will be equally distributed among prospectors and defenders. •p<o.05 this finding, albeit exploratory and preliminary has some extremely interesting implications. it suggests that the strategic profile or competitive posture of an organization is a significant component of its propensity to engage in socially responsive behavior. firms that compete on the basis ofan external market focus seem to achieve superior levels ofsocial performance compared to firms that compete on the basis of an efficiency focus. the former with their emphasis on domain expansion through product introduction and innovative marketing probably have greater experience in boundary spanning and the diagnosis of environmental and market trends. as indicated by the analysis, their chief executives also have greater experience in external functions, thus reinforcing their basic thrust. in comparison, the internally focussed defenders who strive to increase profitability by cutting costs, focus on domain penetration. they compete in limited segments of the market and place primary emphasis on increasing the efficiencies and cost effectiveness of the production process. as a consequence their chief executives tend to have experience in cost-oriented functions such as finance and production. thus responding to external constituencies and achieving superior social performance is less important. 120 journal ofbusiness strategies vol. 11, no.2 contributions and limitations the primary contribution of this study has been the interdisciplinary approach to address a gap in the social performance literature. by drawing on the theory and methodology of strategic management, this study explored the relatively new arena of the intemal, organizational determinants of corporate social performance. although the miles and snow (1978) typology was used in this study, it should be noted that the theoretically specified linkage would allow the use of other typologies and conceptualizations of strategy as well. for example, strategic posture could be specified using dimensions such as corporate diversification or international expansion. regardless of the approach, the findings suggest that the intuitively appealing relationship between strategy and social performance is an intriguing one that deserves further investigation. the results obtained also offer encouragement for greater cooperation across disciplinary boundaries. rather than limiting investigations to narrowly defined social performance functions and issues, researchers should attempt to map the complex web of interrelationships between competitive profiles, leadership competencies, resource allocations and multiple dimensions of corporate [mancial and social performance. in this regard, the use of a configurational approach (meyer, tsui and hinings, 1993) may be especially relevant. such an approach would allow the investigation of the organization as a holistic entity and permit multidimensional inquiries between various internal organizational characteristics and outcomes. this study also has implications for practicing managers. it suggests that social performance is tightly woven together with other dimensions of organizational functioning. therefore superficial attempts to enhance an organizations responsiveness may not be effective. instead the entire strategic approach to the market must be evaluated and addressed. changes in social performance will only occur when fundamental internal, organizational adjustments are made. however, it is not our intention to suggest that defenders are doomed to chronically low social performance. rather, we wish to emphasize that internally focussed organizations are less equipped to read and respond to environmental demands and changes in the needs of constituencies. thus superior social performance for defenders will require a significant effort to develop, recruit and institutionalize scanning and response mechanisms. in this age of ecological consciousness, such an investment would indeed be worthwhile. despite its contributions, this study is not without its limitations. first, the fortune data has been criticized for being unidimensional and representing the firm's posture toward meeting fmandal rather than social responsibilities (ruf, muralidhar and paul, 1993). this issue is underscored by the results obtained by fryxell and wang (1994) who empirically illustrated some of the weaknesses of the fortune data. future research should attempt to relate organizational posture to multiple objective and subjective measures of social performance to validate the relationship uncovered in this study. the use of a cross-sectional design was also limiting as any conclusions about causality were precluded. longitudinal analysis and structural equation methodologies are needed to address this issue. fall 1994 simerly & thomas: strategic orientation 121 the range of firms represented in the sample was limited to the 10 largest firms on fortune 500 list. although these firms doaceount for a significant proportion ofsales in every industry, whether they are representative of the entire population is yet to be evaluated. it is likely that as the largest competitors in an industry they follow similar investment patterns in order to maintain similar cost structures and realize similar economies of scale. thus the variance may be limited and the linkage between social performance and strategy in emergent or entrepreneurial firms may be quite different. similarly, as suggested by previous literature (wartick, 1992), other factors such as the organizations visibility to consumer and stakeholder groups may explain its propensity to engage in socially responsible behavior. for example, in the disaster involving the space shuttle challenger, nasa bore the majority of the blame even though the defective part causing the accident was produced by morton thiokol. in other words, the implications of socially irresponsible behavior may be diluted for firms that primarily produce components and heightened for high-profile organizations, frequently in public view. thus future research using single industry samples with firms stratified by size and product are advocated. over time, such an approach will facilitate the identification and isolation of salient intervening and moderating variables, eventually resulting in the triangulation of findings and the development of robust theories and methodologies. conclusions this study represents a preliminary, broad-brush attempt to explore the logically appealing relationship between business strategy and corporate social performance. although a number of previous efforts have assumed that organizational policies and values were a reflection of the organization strategy, this contention had not been tested until now. the results suggest that the overall strategy of the organization may be a key indicator of its propensity to engage in socially responsible behavior. future research on this relationship will facilitate the development of a paradigm that will allow the prediction of csp. such advancements could significantly transform the business-society relationship as we know it today. endnotes lsince this is an exploratory effort, the hypothesis only includes the extreme strategic types. the validation of the relationship between prospector and defender profiles and csp will set the stage for the examination of the intermediate analyzers. 2 companies are classified according to the industry which represents the greatest volume of their sales. the list of industries is based on categories established by the u.s. office of management and budget and issued by the federal statistical policy and standards office. 3 these dimensions are quality of management, quality ofproducts and services, innovativeness, longterm investment value, financial soundness, ability to attract, develop and keep talented people, community and environmental responsibility, the use of corporate assets. 122 journal ofbusiness strategies vol. 11, no.2 references bhambri, a and j. sonnenfeld, 1988. "organization structure and corporate social performance: a field study in two contrasting industries." academy of management journal 31: 642-662. boyd, b. and w.o carroll. 1993. "corporate governance and social performance". paper presented at the 1993 strategic management society meetings, chicago, illinois. carroll, ab. 1979. "a three-dimensional conceptual model of corporate social performance." academy of management review 4: 497-505. chaganti, r. and r sambharya. 1987. "strategic orientation and characteristics of upper management." strategic management journal 8: 393-401. child, j. 1972. "organization structure, environments and performance: the role of strategic choice." sociology 6: 1-22. doty, d.h., w.h. glick, and g.p. huber. 1993. "fit equifinality and organizational effectiveness: a test of two configurational theories." academy of management joumal36: 1196-1250. drazin, r. and ah. van de ven.1985. "alternative forms of fit in contingency theory." administrative science quarterly 30: 514-539. epstein, e.m. 1987. "the corporate social policy process: beyond ethics, corporate social responsibilityand corporate social responsiveness." california management review 29(3): 99-114. fryxell, g.e. and j. wang. 1994. "the fortune corporate 'reputation' index: reputation for what'!." journal of management 20(1): 1-14. fombrun; c. and m. shanley .1990. "what's in a name? reputation building and corporate strategy." academy of management journal 33: 233-258. ginn, g.o. and rr. mcdaniel. 1987. "strategic adaptation in the hospital industry." academy of management best paper proceedings. 87-90. hambrick, d.c. 1983. "some tests of the effectiveness and functional attributes ofmiles and snow's strategic types." academy of management journal 26: 5-26. mcdaniel, s.w. and j.w. kolari. 1987. "marketing strategy implications of the miles and snow typology." journal of marketing, 51: 19-30. mcguire, j.b., a sundgren, and t. schneeweis 1988. "corporate social responsibility and firm financial performance." academy of management journal, 31: 854-872. meyer, a.d., as. tsui, and c.r hinings. 1993. "guest co-editors' introduction: configurational approaches to organizational analysis." academy of management journal. 36: 1175-1195. miles, r.e. and c.c. snow, 1978. organization strategy, structure and process. new york, ny: mcgraw-hill. fall 1994 simerly & thomas: strategic orientation 123 mintzberg, h.1978. "patterns in strategy formation." management science. 24: 934-948. nayyar, p. 1992. "performance effects of three foell in service firms." academy of management j journal, 35: 985-1009. pinder, c.c. and l.f. moore. 1979. ''the resurrection of the taxonomy to aid the development of middle range theories of organizational behavior." administrative science quarterly 24: 99~ 118. porter, m,e.1980. competitive strategy: techniques for analyzing industries and competitors. new york: free press. romanelli, e. 1989. ''environments and strategies of organizational start-up: effects on early survival" administrative science ouarterly, 34: 369-387. ruf, b., k. muralidhar, and k. paul. 1993. ''eight dimensions of corporate social performance: determination of relative importance using the analytic hierarchy process." academy of management best paper proceedings, 326-330. rumelt, r.p, 1974. strategy, structure and economic performance. cambridge, ma: harvard university press. smith, j.g and c.m. grimm. 1987. "environmental variation, strategic change and firm performance: a study of railroad deregulation." strategic management journal 8: 363-376. snow, c.e. and l.g. hrebiniak. 1980. "strategy, distinctive competence and organizational performance." administrative science ouarterly 27: 317-336. thomas, a.s., rj. litschert, and k. ramaswamy. 1991. "the performance impact of strategymanager coalignment: an empirical examination." strategic management journal, 12: 509522. wartick, s.l., and p.l. cochran. 1985. "the evolution of the corporate social performance model." academy of management review 10: 758-769. wartick, s. 1992. ''the relationship between intense media exposure and change in corporate reputation." business and society 13: 33-49. wokutch, r. and b.a. spencer, 1987. "corporate saints and sinners: the effects of philanthropic and megal activity on organizational performance." california management review 29: 62-77. wood, dj. 1991a. "social issues in management: theory and research in corporate social perfor mance". journal of management 17: 383-406. --. 1991b. "corporate social performance revisited." academyofmanagementjournal16: 691-718. zahra, sa. and j a. pearce. 1990. "research evidence on the miles and snow typology." journal of management 16: 751-768. strategic orientation and corporate social performance: an empirical examination the benefits of leader communication on part-time worker outcomes: a comparison between part-time and full-time employees using motivating language jacqueline mayfield milton mayfield texas a&m international university laredo, tx abstract this study presents findings on the differential effects that leader communication has on worker performance and job satisfaction for part-time and full-time workers. for both partandfull-time employees, structural equation model results indicate that leader communication, as measured through motivating language (ml) use, has the same significant and positive effect on job satisfaction. however, in the case ofperformance, leader ml use only has a significant relationship with the output offull-time workers. these results indicate a boundary condition to the effectiveness of leader communication, and suggest practical implications for management interventions with today s workforce. today's workforce has experienced dramatic changes in composition and structure during the past few decades, including an increased presence of parttime workers. this form of employment can be quite advantageous to business since it offers staffing arrangements that are more cost-effective and adaptable to economic conditions, can enhance morale, and boost retention of high quality employees who prefer nonstandard work hours (anonymous, 1996). recent estimates claim that approximately 16 to 18% of the u.s. workforce is now comprised of such employees, a substantial increase from 12.1 % in 1957 (bureau of labor statistics, 1998; stamper & van dyne, 2001; tilly, 1991). yet despite this growing reliance on part-time employees, both managers and management researchers know very little about the relevant best practices in motivation. as a result, many of the anticipated cost and performance advantages that have been associated with part-time work may be at risk (rotchford & roberts, 1982; stamper & van dyne, 2003). we addressed this knowledge gap by investigating the impact of leader communication on two key motivational markers for part-time employees, job satisfaction and performance. in brief, we compared structural equation model (sem) results for part-time and ful1-~ime employees to determine if there were notable differences between the groups. in the case of part-time employees, the results imply that leader communication significantly enhances job satisfaction, but not 132 journal ofbusiness strategies vol. 23, no.2 performance. in contrast, the sample of full-time workers showed significant improvements in both job satisfaction and performance when more positive leader communication practices were observed. these insights and their related implications will be discussed in the following sections: part-time employment trends, leader motivating language-including a model and hypotheses, methods, results, and discussion, which presents recommendations. part-time employment trends this section gives a short overview of important trends and demographics related to part-time workers including economic factors, definitions, gender, tenure, and status characteristics, variations among subcategories, and motivational research to date. to begin, many economic factors have led to the expansion of part-time employment in the last few decades. feldman and doerpinghaus (1992) identified some of these influences as attempts to reduce payroll costs, an economic shift towards 24/7 services, scheduling requirements oflabor dependent industries, andjust-in-time employment as a response to fluctuating business cycles. although part-time employees now constitute almost 20 percent of the u.s. work force, they often coexist or are confounded with other groups of nontraditional workers. thus, some definitions may be helpful to avoid potential confusion. part-time employees, technically those persons who work less than thirtyfive hours per week, are often included in the broader category of contingent work, a classification which the bureau of labor statistics also applies to such workers as the self-employed, contract personnel, on-call hires, leased employees, and temp agency workers (fairjobs.org, n.d.; levenson, 1996; polivka, 1996). however, unlike many temporary personnel, most part-timers are not engaged in short-term jobs. the majority of part-time employment occurs in the service industries, where such scheduling is an industry standard (mccomb, bourne & barringer, 2003; tilly, 1991). other important attributes of part-time workers include demographic factors such as age, gender, and tenure. not surprisingly, the largest share of part-time workers are women, many of whom find nonstandard employment to be a successful means of balancing work and family life. furthermore, a substantial number of older persons choose part-time employment. a bureau of labor statistics survey that targeted part-time workers found that 22% of these employees are over age 55 compared to 15% of full-time workers within the same age demographic (anonymous, 1996; bureau of labor statistics, 2005). this growth in the older part-time segment also raises age discrimination in employment act scrutiny since members of this group should not be unduly placed in part-time positions (aarp, 2006). similarly important, part-time work is a feasible option for disabled employees and their employers. the percentage of part-time disabled workers grew from 27% to 33% between 1984 and 2000, primarily during the years spanning the americans with disabilities act and its full operationalization, 1990-1994 (hotchkiss, 2004). fall 2006 mayfield and mayfield: ml and parttimers 133 despite the permanent structure of most part-time jobs, the national estimated turnover rate for these employees is generally high, with a u.s. average turnover rate in 2002 for part-time workers of 45.9% compared to 23.8% for full-time positions. this comparison can also be better understood in light of the pay differential. in 1997, the median hourly wage for part-time employees was only 56% of their full-time counterparts (employment policy foundation, 2002; king, 2000), roughly equivalent to the same statistic in 1989 (tilly, 1991). even more striking, the majority of these workers receive minimal or no benefits. doerpinghaus and feldman (1993) found that less than 25% of these workers are covered by health insurance, and that much smaller percentages are rewarded with other benefits such as life insurance or child care. similarly, part-time workers often receive less training (thus limiting competence and increasing the accident/injury potential) and fewer promotions. in addition, this same group is offered less protection under employment law, including the family and medical leave act, than their full-time cohorts (allan & sienko, 1997; fairjobs.org, n.d.; rotchford & roberts, 1982). within this general description, important variances among part-time employees exist that are closely linked to motivation related outcomes. the first such major within-group distinction occurs with voluntary and involuntary part-time employment. the latter classification refers to employees who prefer full-time work, but have been unable to successfully find these positions. (researchers have posited that the numbers of these persons will fluctuate inversely with labor market demand [jefferson & bohl, 1998]). over the long term, this respective category accounts for most of part-time employment growth since 1969 (tilly, 1991). moreover, the lack of choice associated with these employees has also been linked to such negative organizational citizenship behaviors as being less helpful than their voluntary full-time counterparts (stamper & van dyne, 2001; 2003). another perspective on the overall motivational status of part-time employees is gained in the difference between secondary and retention quality employment. secondary part-time employment refers to those positions that require few skills, offer low pay and minimal benefits, and are often involuntary; i.e., convenience store employees. these jobs are also characterized by low productivity and high turnover. conversely, retention quality part-time positions are created to attract highly skilled employees. as a result, these positions offer competitive pay and benefits, are most often voluntary, and are associated with high productivity and low turnover; i.e., an attorney who works 20 hours per week (cohany, 1997). while retention quality positions represent a minority of part-time employees, their numbers are growing, especially in knowledge management industries, such as information technology (jefferson & boh1, 1998; leonard, 2000). during the last decade, the conference board estimated that part-time professionals accounted for approximately 4.7 million employees representing about twenty percent of 23 million total part-time personnel (anonymous, 1996). in addition, more recent studies suggest that large employers are offering these workers a richer ar134 journal ofbusiness strategies vol. 23, no.2 ray of benefit choices including paid leave and some level of health care coverage (leonard,2000). beyond these configurations, the motivational territory of the part-time work force remains relatively unexplored. rotchford and roberts (1982) observed this knowledge gap and urged researchers to address the problem. in particular, these scholars called for future studies on how management practices and demographic variables might moderate productivity levels and other key outcomes for parttime workers. to fulfill this challenge, a few other behavioral researchers have made valuable contributions towards better understanding this employee group and their motivations. feldman and doerpinghaus (1992) discovered striking variance in reward demand among three diverse part-time subgroups, nurses, students, and retail salespeople. while pay was an important factor associated with job satisfaction in all subgroups, retention quality workers (mainly nurses) were more intrinsically motivated by their professional responsibilities and were even willing to trade off some salary for scheduling flexibility. on the other hand, retail employees were more motivated by financial incentives and less enthusiastic about the nature of the work itself. student workers were also motivated by financial rewards and did not equate their current employment with anticipated, "real" careers after their educational goals were attained. this emphasis on monetary rewards was also found in a study of part-time workers (students) who, in comparison to full-time employees, reported stronger economic exchange relationships and degrees of perceived organizational support (pos) the belief that an employee's work is valued by an employer. pos is also predicted to be manifest in a worker's increased commitment to her/his employer (gakovic & tetrick, 2003). in comparison, and as previously noted, stamper and van dyne (2001; 2003) observed that part-time employees displayed fewer helping behaviors when compared with full-time workers. this line of research has also focused on leadership abilities as potential means to improve part-time employee affect and outcomes, including performance and retention. among these interventions, managerial communication has been prominently cited. skinner (1999) surveyed both management and part-time staffers and found consensus that communication deficiencies specifically, information sharing and training ranked among the major disadvantages of part-time work. feldman and doerpinghaus (1992) concurred and recommended that part-time employers enhance informational communications and on-the-job training for their staffs. furthermore, the role of managerial communication in the form of realistic job previews (rjps; i.e., a pre-hire job description that includes the inherent disadvantages of a particular opening), has long been identified as an effective preemptive measure that reduces negative attitudes and behavioral outcomes in the full-time workforce. this form of information sharing might also have a similar positive impact on part-timers. (feldman & doerpinghaus, 1992). in addition to advocating rjps as an effective tool for managing the altered psychological contracts that have emerged with the changed structure of contemporary work, sims (1994) also advised hr professionals to train management in employee commufall 2006 mayfield and mayfield: ml and parttimers 135 nication skills. "today's psychological contract requires an emphasis on talking with people, not at people" (sims, p. 378, 1994). leadership motivating language motivating language theory (sullivan, 1988) predicts that intentional uses of leader speech can significantly enhance such critical employee attitudes and outcomes as job satisfaction, performance, and innovation (mayfield, mayfield & kopf, 1998; mayfield & mayfield, 2004). more specifically, this theory was conceptualized by sullivan (1988) to combine the basic linguistics of managerial communication, designated by three core speech acts (searle, 1969), to stimulate employee motivation, which will be subsequently expressed in worker behaviors that promote organizational goals. these three forms of speech acts are the following: 1) direction-giving (perlocutionary) language occurs when leaders clarify goals for subordinates and alleviate organizational uncertainty in the process. for example, a manager displays direction-giving language when she helps a subordinate prioritize the importance of each project within multiple assignments. 2) empathetic (illocutionary) language is expressed when leaders speak with emotional understanding to subordinates. a manager employs empathetic language when he offers enthusiasm or encouragement to a direct report. 3) meaning-making (locutionary) language happens when a leader transmits the rules of a particular organizational culture to a subordinate. for instance, a manager uses meaning-making speech when s/he gives a subordinate political suggestions for obtaining corporate buy-in on a project. cooke and rousseau (1988) observed that meaning-making language often is delivered indirectly in the form of stories, organizational folklore, and metaphors. the third component of the motivating language (ml) model, meaning-making language, is expected to serve as a major guidepost in the navigation of organizational change and cultural orientation. this form of talk also distinguishes ml from most well-known leadership communication paradigms which tend to emphasize the two factors of task elucidation and compassion. transformational leadership theory is an exception here since cultural transmission is one of its important hallmarks (avolio, bass & lung, 1999; bass, 1985; robbins, 2003; spreitzer & quinn, 1996). still, in many other ways, motivating language is well-steeped in predominant modem leadership theories. the more recent streams of research have focused on the relevance of leader communications in the nurture and maintenance of organizational commitment and trust (conger, 1991; fritz, 1999; goleman, boyzatis & mckee, 2001; 2002; reina & reina, 1999). equally important, most of these models incorporate managerial communication behaviors as channels between 136 journal of business strategies vol. 23, no.2 leadership goals and their requisite influence on others. for example, showing the connection between employee performance and rewards are core elements of major leadership theories, including the university of michigan, lmx, pathgoal, transformational, primal, expectancy, and ohio state schools (goleman, boyzatis & mckee, 2001; robbins, 2003; yuki, 1989). motivating language is also firmly rooted in three primary assumptions. first, ml pertains only to one sender and message direction, leader-tosubordinate. secondly, ml embodies the three basic speech acts from the science of linguistics (searle, 1969; sullivan, 1988). as a result, the theory is applicable to most forms of leader-to-subordinate speech. thirdly, the positive employee attitudes and behaviors that are linked with use of motivating language will be much more likely to occur when all three forms of ml are integrated strategically into leader communication. this assumption has also been borne out by previous research that found significant and positive relationships between employee outcomes and multiple types of managerial messages (petit, goris & vaught, 1997; sullivan, 1988). motivating language has received promising research support as a valuable technique to improve employee attitudes and behaviors. the three components of ml have been adopted into a scale with reliabilities and validity that were strongly corroborated (mayfield, mayfield & kopf, 1995). subsequent research has identified ml's positive influence on employee job satisfaction, performance, and innovation. these outcomes can be expected to increase by 7%, 2%, and 2%, respectively when a leader uses an extra 10% of ml in her/his communication practices with direct reports (mayfield, mayfield & kopf, 1998; mayfield & mayfield, 2004). these early findings encourage further research into motivating language's capacity to positively impact part-time worker performance. another helpful insight will come from examining the influence of ml on the job satisfaction levels of part-time workers. the management literature has found significant and positive links between job satisfaction and such critical employee behaviors as absenteeism (hackett & guion, 1985; mcshane, 1984; scott & taylor, 1985; robbins, 2003) and turnover (hom & griffeth, 1995; griffeth, hom & gaertner, 2000; robbins, 2003), both of which have important cost implications for an organization's bottom-line (cascio, 1998; 2000; robbins, 2003). to guide this study, the following hypotheses will be tested: hypothesis 1: leader motivating language use is expected to be significantly and positively related to full-time worker performance. hypothesis 2: leader motivating language use is expected to be significantly and positively related to full-time worker job satisfaction. hypothesis 3: leader motivating language use is expected to be significantly and positively related to part-time worker performance. fall 2006 mayfield and mayfield: ml and parttimers 137 hypothesis 4: leader motivating language use is expected to be significantly and positively related to part-time worker job satisfaction. hypothesis 5: the strength of the relationship between motivating language use and worker performance will significantly differ for part-time andfull-time workers. hypothesis 6: the strength of the relationship between motivating language use and worker job satisfaction will significantly differ for parttime andfull-time workers. please note that hypotheses 5 and 6 are stated as alternative hypotheses for congruence with the first 4 hypotheses, and to present these premises in a testable format. theory from the previous literature review indicates similar results for both full-time and part-time workers. these hypotheses will be evaluated by a corresponding structural equation model in the next section. method participants study respondents were canvassed in two phases from different groups to provide a mix of full-time and part-time employees. first phase respondents came from graduate and undergraduate management courses at a medium sized university located in the southwestern united states. the university's student body contains a large number of non-traditional students who either hold full-time work positions or who have returned to campus with substantial work experience. participation was voluntary, and survey completion did not effect student grades. students who did complete the survey were provided feedback on survey results, and given information on how they could interpret their responses in order to better understand their workplace situations. second phase respondents came from members of the association for business communication, and the decision sciences institute. this stage used an online data collection process. association members were sent an e-mail requesting survey participation, and those choosing to participate were directed to an online survey site. as in the previous data collection phase, these responses were anonymous. the overall participation rate from both phases exceeded 35% with 326 respondents who were full-time employees, and 121 respondents who were part-time employees. sample demographic characteristics showed some differences between the partand full-time workers. but these differences are not expected to effect the study variable relationships. full-time workers had spent an average of2.80 years working with their current boss, and part-time workers had spent an average of 1.75 years. while these periods vary, both sub-samples seem to have shared sufficient time with their respective leaders to establish stable motivating language 138 journal of business strategies vol. 23, no.2 relationships. similarly, the difference in mean organizational tenure between the groups (an average of 6.34 years for full-time workers, and 1.90 years for parttime workers) is not expected to play an important role in the superior-subordinate communication interactions examined in this study. differences also appeared for average respondent ages (34.41 for full-timers, and 22.89 for part-timers). however, subordinate age is not expected to effect the ml relationship. the fulltime sample was predominately female (62%) while the part-time sample was predominately male (72%). as could be expected, the full-time sample group had a higher education level than the part-time sample group. approximately 39% of full-time workers held masters degrees or higher, but only 9% of the part-time group had attained this educational level. interestingly, a slightly higher proportion of part-time workers held professional or managerial positions (49%) as compared to the full-time workers (32%). the remaining breakdown of position types is as follows: skilled work full-time 62% and part-time 36%; unskilled work full-time 6% and part-time 16%. the central question that these differences raise is their potential effect on the ml communication that the two worker types experience. if such differences exist, then this variance may be a threat to the study's validity. to check for such possible differences, a multivariate analysis of variance test was performed. the three ml facets were used as the dependent variables, and the worker's job status (part-time or full-time) was the independent variable. analysis results showed no significant differences between the two samples at the 0.05 alpha level. these results indicate that the groups are similar on the variable of interest. thus, there are no apparent validity issues in comparing the different worker types any relational differences between ml and the outcome variables are likely to arise from non-demographic factors. measures study variables were measured using three scales. leader motivating language use was evaluated by the motivating language scale (mayfield, mayfield & kopf, 1995). the instrument's reliability, validity, and generalizability have been tested and well-supported in a number of investigations (mayfield, mayfield & kopf, 1995; 1998). the ml components were measured through separate sub-scales, and each sub-scale demonstrated a reliability of 0.92 or better in this sample (churchill, 1979). worker job satisfaction was gauged using the hoppock job satisfaction scale (hoppock, 1935). worker performance was assessed through a modified version of the matt group performance scale (mott, 1972). the original scale has been shown to accurately capture group performance through a self-administered, individually completed questionnaire. this instrument provided the current authors with a good base for developing an individual performance measure. the individual performance scale was created by adapting mott's original survey so that it captured an individual's performance rather than a team's performance. this adaption was accomplished by changing the focus of each question from team performance to individual perfall 2006 mayfield and mayfield: ml and part-timers 139 formance. an additional question was added about the respondent's most recent supervisor rating. as with the ml scale, all dependent variable survey reliabilities (as tested using the current sample group) showed levels appropriate for our analysis. the job satisfaction scale had a cronbach's alpha score of 0.85, and the performance measure had a 0.93 reliability score. scale descriptives are presented in table 1, and variable correlations are presented in table 2. copies of the motivating language and performance measures are reproduced in appendix 1. table 1 scale descriptives measure direction giving language empathetic language meaning-making language performance job satisfaction mean 2.99 3.25 2.45 3.41 4.9 standard deviation 0.9 1.07 0.98 0.8 1.13 reliability 0.92 0.92 0.93 0.93 0.85 table 2 variable correlations for fulland part-time workers direction meaningjob giving empathetic making performance satisfaction direction giving 1.00 0.75** 0.69** 0.14* 0.36** empathetic 0.67** 1.00 0.57** 0.17** 0.47** meaning-making 0.67** 0.54** 1.00 0.10 0.26** performance -0.05 0.04 0.00 1.00 0.36** job satisfaction 0.30* 0.49** 0.19 0.06 1.00 note: correlations for full-time workers are presented above the diagonal, and correlations for parttime workers are presented below the diagonal. correlations significant at the 0.05 level are followed by i asterisk. correlations significant at the 0.0 i level are followed by 2 asterisks. procedures the effects of leader ml use on worker outcomes were tested through structural equation modeling (sem) using the methods outlined by joreskog and sorbom (1989). this analysis procedure allows a researcher to examine latent variables and test for relationships between these variables. latent variables are constructs that are not directly measurable, but whose properties can be estimated through 140 journal ofbusiness strategies vol. 23, no.2 other measurable, or manifest, variables (joreskog, 1993; shumaker & lomax, 1996). an example of a latent variable is a person's intelligence, which cannot be directly measured. for example, intelligence cannot be touched, weighed, felt, or seen. but it can be indirectly assessed through such means as an iq test. for this study, three latent constructs were measured: leader motivating language use, worker performance, and worker job satisfaction. all factors were captured by the attendant scales previously discussed in the measures section. in addition to enabling researchers to examine latent constructs through their manifest variables, sem also provides a way to simultaneously test the latent variable relationships' significance and strength. in addition, this technique gives diagnostic information on the fit between a theoretical construct and an actual data set. unlike many other inferential statistical methods, testing sem model quality does not rely on a single overall measure (such as an f-test with regression analysis). rather, model adequacy is determined by examining a set of statistical tests. the chi-square test is one such adequacy measure, and it is used to specifically check for discrepancies between the proposed model and the data the model should represent. ifthere are substantial differences between the model and data, then this test will be significant. therefore, a non-significant result shows evidence that the model does a good job in representing the underlying variable relationships. however, a potential chi-square measure problem is posed by its sensitivity to trivial discrepancies when samples sizes are large. consequently, the test may be significant even when the data are well represented by the model (browne & cudeck, 1993; joreskog, 1993; joreskog & sorbom, 1989; raftery, 1993; shumaker & lomax, 1996). in recognition of the chi-square test's sensitivity, other methods have been developed that are less effected by trivial model fit discrepancies. one such measure is the ratio of the chi-square statistic to the chi-square test's degrees offreedom. a model's fit with data is generally considered to be good if this ratio is less than 3.0 regardless of the test's p-value. another measure of the model's adequacy is the root mean square error average (rmsea). this statistic is based on the average difference between the original data set's correlation matrix and a correlation matrix reproduced from the proposed model. lower rmsea scores indicate a smaller discrepancy between the data and the model, and are generally considered to indicate a good fit when they are below 0.10 (browne & cudeck, 1993; joreskog, 1993; joreskog & sorbom, 1989; raftery, 1993; shumaker & lomax, 1996). several other measures collectively known as fit indexes also exist. these measures all range from 0.00 to 1.00, with higher numbers indicating a better fit between the model and data. the two most commonly used fit statistics are the goodness-of-fit index (gfi) and the adjusted-goodness-of-fit index (agfi). the agfi is analogous to the adjusted r-squared measure for regression. it is based on the gfi and provides a mechanism for reducing score "inflation" due to over-fitting a model. the gfi measure is considered to be good when it is above 0.95. the agfi is considered to be good when it is above 0.90. other fit indexes fall 2006 mayfield and mayfield: ml and parttimers 141 include the bentler-bonnet normed fit index (nfl), the tucker-lewis non-normed fit index (nnfi), and the bentler centralized fit index (cfi). scores above 0.95 for these measures are considered to be acceptable (browne & cudeck, 1993; joreskog, 1993; joreskog & sorbom, 1989; raftery, 1993; shumaker & lomax, 1996). all of these adequacy measures compare the data and model fit in slightly different ways. as such, no single metric can be considered to be a complete evaluation of the model appropriateness. rather, several measurement adequacy tests should be considered in deciding the model's ability to represent the underlying variable relationship structure (browne & cudeck, 1993; joreskog, 1993; joreskog & sorbom, 1989; raftery, 1993; shumaker & lomax, 1996). after a model's quality has been established, the usual procedure is to test for the significance and strength of the relationships between the latent variables. however, for this study the question of interest was not simply if there was a significant link between ml use and performance and job satisfaction, but if the strength ofthese relationships was the same for both full-time and part-time workers. accordingly, a method for comparing different subject groups was employed. conceptually for this method, both groups are initially fit using the same model. next, tests are applied to determine if significant differences exist between the group's variable relationships. more specifically, a sem analysis is run separately for the groups, and model adequacy and coefficient strength is noted. then one group is used as a reference group. the variable relationships (path coefficients) of interest in the other group are subsequently set to equal the values from the reference group, and the model for this second group is run again. ifthere are no significant differences between the two groups, then comparison tests will show that the second constrained model specification fits the data as well or better than the initial unconstrained model analysis. (the second analysis may fit the data better than the first test because extra-sample information is being used i.e. path coefficients in estimating the second model.) if there are significant differences, then the reformulated model will fit worse than the initial model. such a disparity means that the two groups' variable relationships differ in some important way. if discrepancies are indicated between the two groups, later tests can then determine where the differences occur. these tests are performed by fixing one coefficient of interest at a time and comparing the models as previously described. in order to implement this comparison technique, structural equation models were created for both full-time and part-time workers. a model was run for each group in order to determine if the proposed model offered a good fit to the data. after the initial models were run, the full-time workers' model was run again with the appropriate coefficients constrained to equal the part-time workers' model coefficients. more concretely, the full-time workers' model had the paths between the independent (ml) and dependent (performance and job satisfaction) variables' paths set to the part-time workers' coefficients. significant model differences between the original full-time worker analysis and this new analysis would 142 journal of business strategies vol. 23, no.2 indicate that ml has a divergent effect between fulland part-time workers for one of more outcomes. upon finding significant differences, each path could be independently constrained to determine where the variance occurred. the fulltime workers' model was chosen for testing due to its larger sample size. a larger sample size gives greater statistical power, and thus a greater likelihood of detecting any significant path coefficient discrepancies. results statistics from the initial structural equation models showed a good fit between the proposed model and the data for both fulland part-time workers. the gfi for the full-time worker model was 0.99, and the agfi was 0.96. the scores on all of the other fit indexes were 1.00. the part-time worker model showed similar results. the gfi for this model was 0.97, and its agfi was 0.90. the scores for this model on the other fit indexes were good, with the lowest score being a 0.98 on the tucker-lewis nnfi. the chi-square tests for both models showed no significant discrepancy between the models and the data at the 0.05 level. finally, the rmsea index for both groups was within the acceptable range for model adequacy. table 3 provides full information on fit results. variable relationships were next examined after model adequacy was established. for full-time workers, sem path results indicated a significant link between ml and worker performance, and a significant link between ml and job satisfaction. these findings supported hypotheses i and 2. in contrast, hypothesis 3 was not supported. results showed no significant link between ml and performance for part-time workers. however, as predicted in hypothesis 4, there is a significant link between ml and part-timer job satisfaction. figures i and 2 present model results graphically. (note: in both figures arrows point from the latent factors to the manifest variables. this depiction is in keeping with standard model presentation methods. such a representation indicates that the latent variables cause the changes in their attendant observable measures ~ the manifest variables are simply reflections of the underlying factors.) subsequent constrained model testing showed results similar to the initial fulland part-time model examination. a chi-square comparison indicated that the fully constrained model fit the data worse than the unconstrained model. this finding showed significant differences between fulland part-time workers for at least one of the two outcome variables. later tests revealed that when the performance path was set to equal the part-time workers' coefficient (and job satisfaction was not fixed), the model fit the data worse than the unconstrained model. this outcome contradicts the theoretical expectations formalized in hypothesis 5, and indicates significant differences between the groups in the ml-performance link. nonetheless, the model showed a good fit when only the job satisfaction path was constrained to fit the original model; a result that indicates no significant differences in the ml-job satisfaction link for either sub-group. this finding is congruent with the expectation presented in hypothesis 6. in sum, results imply that leader motivating language use effects full-time and part-time workers' job satisfaction fall 2006 mayfield and mayfield: ml and part-timers 143 similarly, but only significantly effects a full-time worker's performance. summary and comparison model results are presented in table 3. figure 1 structural equation model results for part-time workers motivating language perfomance job satisfaction note: path coefficients are standardized f' 2 19ure structural equation model results for full-time workers motivating language perfomance job satisfaction note: path coefficients are standardized 144 journal ofbusiness strategies vol. 23, no.2 table 3 model analysis results full-time: full-time: job full-time part-time full-time: performance satisfaction workers workers both fixed fixed fixed gfi 0.99 0.97 0.98 0.98 0.99 agfi 0.96 0.90 0,94 0.93 0.97 bentler-bonnet nfl 1.00 0.99 0.99 0.99 1.00 tucker-lewis nnfi 1.00 0.98 0.99 0.98 1.00 bentler cfi l.00 1.00 l.00 1.00 1.00 rmsea 0.07 0.10 0.09 0.10 0.05 mc -20 -j7 -24 -17 -27 x 2 statistic 9.7 8.8 20 20 9.8 x2d.f. 4 4 6 5 5 x2p-value 0.05 0.07 0.00 0.00 0,08 x2/d.f. 2.42 2.20 3.33 5.00 1.96 x2p-value for difference with unconstrained model na na 0.00 0.00 0.78 in reference to our hypotheses, propositions 1, 2, 4, and 5 were supported. as previously stated, hypotheses 1 through 4 were [onnulated to be consistent with developed ml theory. hypotheses 5 and 6 were worded to aid statistical testing, and proposed counter to theoretical expectations. therefore, while results from hypotheses 1, 2, 4, and 6 were in line with theoretical expectations, results for hypotheses 3 and 5 were not. table 4 presents a summary of hypothesis results and their meaning for the original theoretical development. because hypotheses 3 and 5, relating to the ml and part-timer perfonnance link, were not congruent with theoretical expectations, a question is raised. are there differences in the performance measure for full-time and part-time workers? if such differences exist, then it is possible that model discrepancies occur due to some factor other than simple group interaction. to explore this question, two tests were conducted: group performance means were compared through at-test, and group perfonnance variances were compared through an f-test. both of these tests returned non-significant results with a p-value of 0.12 for the t-test, and 0.16 for the f-test. based on these findings, it seems unlikely that substantial differences exist in the two group's performance levels. fall 2006 mayfield and mayfield: ml and part-timers table 4 hypothesis results 145 hypothesis hypothesis i: leader motivating language use is expected to be significantly and positively related to full-time worker performance. hypothesis 2: leader motivating language use is expected to be significantly and positively related to full-time worker job satisfaction. hypothesis 3: leader motivating language use is expected to be significantly and positively related to part-time worker performance. hypothesis 4: leader motivating language use is expected to be significantly and positively related to part-time worker job satisfaction. hypothesis 5: the strength ofthe relationship between motivating language use and worker performance will significantly differ for part-time and full-time workers. hypothesis 6: the strength of the relationship between motivating language use and worker job satisfaction will significantly differ for part-time and full-time workers. statistical result hypothesis supported hypothesis supported hypothesis not supported hypothesis supported hypothesis supported hypothesis not supported theoretical implications statistical result congruent with theoretical prediction statistical result congruent with theoretical prediction statistical result not congruent with theoretical prediction statistical result congruent with theoretical prediction statistical result not congruent with theoretical prediction statistical result congruent with theoretical prediction discussion the results of our study only partially conformed to expectations. the predictions about ml's positive influence on part-time worker job satisfaction in comparison to full-time employees were supported. nevertheless, the hypotheses about ml's relationship with part-time employee performance were not sustained. full-time workers who reported more leader use of ml also scored significantly higher increases in performance than did part-timers who perceived equivalent ml levels. these results make valuable contributions to both academic researchers and practicing managers. first, this investigation substantiates the relationship be146 journal of business strategies vol. 23, no.2 tween strategic leader language and job satisfaction for both fulland parttime employee groups. this disclosure is significant because it replicates previous ml research and sheds new light on the relatively unexplored world of part-time employees' motivation (allan & sienko, 1997). equally important, many parttime employees hold "front-line" positions that deal with the public in a service capacity. in this context, worker job satisfaction has been closely aligned with customer satisfaction by previous studies (mccomb, bourne & barringer, 2003). furthermore and despite the fact that part-time positions are often created to reduce apparent outlays, there are many "hidden costs" associated with negative job attitudes within this employee group, including turnover and potential litigation under such statutes as the americans with disabilities act and title iiv of the civil rights act of 1964 (allan & sienko, 1997). finally, the study also examined the rapport between motivational influences and performance levels for both sets of employees, which responds to the need for improved understanding about the impact that person-environment fit has on job performance (latham & pinder, 2005). yet the discrepancies between expected and actual outcomes raise compelling questions and help to shape the directions offuture research and new motivational interventions for the part-time work force. first and foremost, why did the parttime and full-time employees express different performance behaviors in response to ml? one possible factor may be demographics. a large number ofthis study's respondents were also students. as previously discussed, feldman and doerpinghaus (1992) found that this subgroup of part-time workers was much more likely to be motivated by financial rewards than their retention quality counterparts. furthermore, the same authors discovered that the student participants often did not consider their part-time positions as real, "career" jobs. in this perceptual context, talk may be cheap. these insights point to limitations in this study's research design, particularly regarding the sample group. the participants reported an average age for part-timers of about 23, with an approximate mean of 2 years work experience. thus, many part-time respondents were relatively youn,g and in the early stages of their work history, possibly reflecting significant experiential bias. also, while the study was conducted on a heterogeneous sample of organizational members, many respondents had a unique employer. this diversity strengthens generalizability potential, but allows for unrecognized organizational influences. along the same lines, the observed variance between part-time and full-time employee performance with leader ml use may also be indicative of within group differences that need to be factored into future research and practice. the performance of certain part-time employees; i.e., retention quality employees, may substantially benefit from ml, while the performance of secondary part-time employees may not. stafford (1998) asserted that many of today's employees exercise "garden variety", namely every day problem-solving, creativity in their jobs and may well be more receptive to extrinsic motivators such as benefits in lieu of managerial communication support for the quality of the work itself. fall 2006 mayfield and mayfield: ml and parttimers 147 many of these questions can be answered by future research that amends some of the current study's limitations. for example, new investigations could identify possible sources of organizational variance by targeting multiple subjects in multiple organizations. in other words, several organizations could be studied, and several subjects could be sampled within each organization. then subjects could be coded by respective employer, both facilitating the untangling of organizational and individual variances in the scale and easing the identification of member-organization moderators. in addition, new investigations could draw on a longitudinal design to track perceptions over time, especially through any possible periods of major organizational change. moreover, the surveys could be revised to better capture demographic characteristics that are associated with divergent subgroups of part-time employees. also, qualitative feedback on the relationship between ml and key employee outcomes could enrich insights and point the way to revised human resource policy design. finally, the current investigation's scope could be expanded to explore ml's influence on other key part-time employee behaviors such as absenteeism and turnover. in conclusion, this study has taken one step towards better understanding a large portion ofthe u.s. workforce that is relatively obscure. at the same time, the importance of this little known group is growing profoundly for employers due to such societal and industrial factors as increased demand for knowledge-workers, partial retirements, work-family balance, service quality, and the upcoming departure of baby-boomers from today's work place. for all of these reasons, future research on this subject can help both academics (through refined motivational models) and practicing managers (through improved management behaviors and strategic benefit reward system design). the rationale for these steps is clear. this little studied group may harbor many unrealized contributions to organizational goals if appropriate motivational incentives are discovered and incorporated into management practice. references aarp. (2006). best practices: avoid age discrimination when offering jobs. retrieved may 22, 2006 from http://www.aarp.org/money/careers/employerresourcecenterl bestpractices.html allan, p., & sienko, s. (1997). a comparison of contingent and core workers' perceptions of their jobs' characteristics and motivational properties. sam advanced management journal. 62. 4-9. anonymous (1996). part-timers becoming permanent fixture in the work force: survey. employee benefit plan review, 51, 57-58. avolio, b. 1., bass, b. m., & lung, d. i. (1999). re-examining the components of tran sformational and transactional leadership using the multifactor leadership questionnaire. journal of occupational and organizational psychology, 72, 441-462. 148 journal ofbusiness strategies vol. 23, no.2 bass, b. m. (1985). leadership: good, better, best. organizational dynamics. j3, 26-40. browne, m. w., & cudeck, r. (1993). alternative ways of assessing model fit. in k. a. bollen & j. s. long (eds.) testing structural equation models (pp. 136-162). beverly hills, ca: sage. bureau of labor statistics. (1998). the employment situation in news release: selected employment indicators. retrieved august 12, 2004 from http://stats.bls.gov/news.release/empsitt04.htm. bureau of labor statistics. (2005). household data annual averages. retrieved may 10, 2006, from http://www.bls.gov/cps/cpsaat8.pdf. cascio, w. f. (1998). managing human resources: productivity. quality ofwork life, prof its, 5th ed. new york: irwin mcgraw-hili. cascio, w. (2000). costing human resources: thefinancial impact ofbehaviors in organizations (4th ed.). mason, oh: south-western college publishing. churchill, g. (1979). a paradigm for developing better measures of marketing constructs. journal ofmarketing research, j6,64-73. cohany, s. r. (1997). employment options. monthly labor review, 9,49-50. conger, j. (1991). inspiring others: the language of leadership. academy ofmanagement executive. 1,31-45. cooke, r. a., & rousseau, d. (1988). behavioral norms and expectations: a quantitative assessment of organizational culture. group & organizational studies, 13,245-273. doerpinghaus, h. i., & feldman, d. c. (1993). employee benefit packages for part-time workers. benefits quarterly. 9. 72-82. employment policy foundation (2002, december). employee turnover a critical human resource benchmark. hrbenchmarks: contemporary issues in employment and workplace policy. retrieved may 15, 2006, from http://www.epf.org/research/newsletters/2002/h b20021203. pdf. fairjobs.org (n.d.). contingent workers fight for fairness: a report from the national alliance for fair employment. retrieved august 4, 2004, from http://www.fairjobs. org/report/whatis.php. feldman, d. c., & doerpinghaus, h. i. (1992). missing persons no longer: managing part-time workers in the '90s. organizational dynamics, 21, 59-72. fritz, r. (1999). the path of least resistance for managers: designing organizations to succeed. berkeley, ca: berrett-koehler publishers. fall 2006 mayfield and mayfield: ml and part-timers 149 gakovic, a., & tetrick, l. e. (2003). perceived organizational support and work status: a comparison of the employment relationships of part-time and full-time employees attending university classes. journal of organizational behavior, 24, 649-662. goleman, d., boyatzis, r., & mckee, a. (200 i). primal leadership: the hidden driver of great performance. harvard business review, 79, 42. goleman, d., boyatzis, r., & mckee, a. (2002). primal leadership: realizing the power ofemotional intelligence. cambridge, ma: harvard business school press. griffeth, r. w., hom, p. w., & gaertner, s. (2000). a meta-analysis of antecedents and correlates of employee turnover: update, moderator tests, and research implications for the next millennium. journal of management. 26, 463-488. hackett, r. d., & guion, r. m. (1985). a reevaluation of the absenteeism-job satisfaction relationship. organizational behavior and human decision processes, 35, 340-382. hom, w., & griffeth, r. w. (1995). employee turnover. mason, oh: south-western college publishing. hoppock, r. (1935). job satisfaction. new york: harper row. hotchkiss, j. l. (2004). growing part-time employment among workers with disabilities: marginalization or opportunity? economic review federal reserve bank of atlanta, 89, 25-40. jefferson, f., & bohl, d. (1998). cbr minisurvey: part-time and temporary employees demand better pay and more benefits. compensation and benefits review, 30, 20-24. joreskog, k. g. (1993). testing structural equation models. in k. a. bollen & j. s. long (eds.) testing structural equation models (pp. 294-316). berkeley, ca: sage. joreskog, k. g., & sorbom, d. (1989). usrel 7: a guide to the program and applications, 2nd ed. chicago: spss, inc. king, 1. e. (2000). part-time workers' earnings: some comparisons. compensation and working conditions, summer, 27-36. latham, g. p., & pinder, c. c. (2005). work motivation theory and research at the dawn of the twenty-first century. annual review of psychology, 56. 485-516. leonard, b. (2000). recipes for part-time benefits. hrmagazine, 45, 56-60. levenson, a. r. ( 1996). recent trends in part-time employment. contemporary economic policy. 14, 78-89. 150 journal ofbusiness strategies vol. 23, no.2 mayfield, j., mayfield, m., & kopf, j. (1995). motivating language: exploring theory with scale development. journal ofbusiness communication. 32, 329-344. mayfield, j. r., mayfield, m. r., & kopf, j. (1998). the effects of leader motivating language on subordinate performance and satisfaction. human resource management, 37,235-248. mayfield, m., & mayfield, j. (2004). the effects of leader communication on worker innovation. american business review, 22, 46-51. mccomb, s. a., bourne, k. a., & barringer, m. w. (2003). reconciling the paradox of part-time service work. organizational dynamics, 32, 342-356. mcshane, s. l. (1984). job satisfaction and absenteeism: a meta-analytic re-examination. canadian journal ofadministrative science, 1, 61-77. mott, p. (1972). the characteristics of effective organizations. new york: harper & row. pettit, j. d., goris, j. r., & vaught, b. c. (1997). an examination of organizational communication as a moderator of the relationship between job performance and job satisfaction. the journal ofbusiness communication, 34, 81-98. polivka, a. e. (1996). contingent and alternative work arrangement, defined. monthly labor review, 119, 3-9. raftery, a. e. (1993). bayesian model selection in structural equation models. in k. a. bollen & j. s. long (eds.) testing structural equation models (pp. 162-180). berkeley, ca: sage. reina, d. s., & reina, m. l. (1999). trust and betrayal in the workplace. san francisco: berrett-koehler publishers. robbins, s. p. (2003). organizational behavior, 10th ed. upper saddle river, nj: prentice hall. rotchford, n. l., & roberts, k. h. (1982). part-time workers as missing persons in organizational research. academy ofmanagement review, 7, 228-234. scott, k. d., & taylor, g. s. (1985). an examination of conflicting findings on the relationship between job satisfaction and absenteeism: a meta-analysis. academy ofmanagement journal, 28, 599-612. searle, j. r. (1969). speech acts. london: syndics of the cambridge university press. shumaker, r. e., & lomax, r. g. (1996). a beginner sguide to structural equation modeling. mahwah, nj: lawrence erlbaum associates. fall 2006 mayfield and mayfield: ml and parttimers 151 sims, r. r. (1994). human resource management's role in clarifying the new psychological contract. human resource management. 33,373-382. skinner, d. (1999). the reality of equal opportunities: the expectations and experiences of part-time staff and their managers. personnel review. 28. 425-433. spreitzer, g. m., & quinn, r. e. (1996). empowering middle managers to be transform ationalleaders. the journal ofapplied behavioral science. 32. 237-261. stafford, s. p. (1998). capitalizing on careabouts to facilitate creativity. creativity and innovation management. 7. 159-167. stamper, c. l., & van dyne, l. (2001). work status and organizational citizenship behavior: a field study of restaurant employees. journal of organizational behavior, 22, 517-521. stamper, c. l., & van dyne, l. (2003). organizational citizenship: a comparison between part-time and full-time service employees. cornell hotel and restaurant administration quarterly, 44. 33-42. sullivan, j. (1988). three roles oflanguage in motivation theory. academy ofmanagement review, 13,104-115. tilly, c. (1991). reasons for the continuing growth of part-time employment. monthly labor review, 114. 10-1 8. yuki, g. (1989). managerial leadership: a review of theory and research. journal ofmanagement. 15,251-289. appendix 1 motivating language scale the examples below show different ways that your boss might talk to you. please use the following selections to choose the answer that best matches your perceptions, and then place an x in the bracket beside the appropriate response. (all survey questions had response options as follows: "very little", "a little", "some", "a lot", and "a whole lot.") direction givingiuncertainty reducing language 1. gives me useful explanations of what needs to be done in my work. 2. offers me helpful directions on how to do my job. 3. provides me with easily understandable instructions about my work. 4. offers me helpful advice on how to improve my work. 5. gives me good definitions of what i must do in order to receive rewards. 6. gives me clear instructions about solving job related problems. 152 journal ofbusiness strategies vol. 23, no.2 7. offers me specific information on how i am evaluated. 8. provides me with helpful information about forthcoming changes affecting my work. 9. provides me with helpful information about past changes affecting my work. 10. shares news with me about organizational achievements and financial status. empathetic language 11. gives me praise for my good work. 12. shows me encouragement for my work efforts. 13. shows concern about my job satisfaction. 14. expresses his/her support for my professional development. 15. asks me about my professional well being. 16. shows trust in me. meaning making language 17. tells me stories about key events in the organization's past. 18. gives me useful information that i couldn't get through official channels. 19. tells me stories about people who are admired in my organization. 20. tells me stories about people who have worked hard in this organization. 21. offers me advice about how to behave at the organization's social gatherings. 22. offers me advice about how to "fit in" with other members of this organization. 23. tells me stories about people who have been rewarded by this organization. 24. tells me stories about people who have left this organization. individual performance every worker produces something in his or her work. it may be a "product" or a "service." please think carefully of the things that you produce in your work and how your performance compares to others in your work group. please place an x in the brackets beside the response that best describes your work compared to your colleagues' work. (all survey questions had response options as fonows: "below average", "average", "above average", "far above average", and "excellent.") (supervisor's rating) 1. which of the following selections best describes how your supervisor rated you on your last formal performance evaluation? (production: quantity) fall 2006 mayfield and mayfield: ml and parttimers 153 2. how does your level of production quantity compare to that of your colleagues' productivity levels? (production: quality) 3. how does the quality of your products or services compare to your colleagues' output? (production: efficiency) 4. how efficiently do you work compared to your colleagues? in other words, how well do you use available resources (money, people, equipment, etc.)? (adaption: anticipating problems and solving them satisfactorily) 5. compared to your colleagues, how good are you at preventing or minimizing potential work problems before they occur? (adaption: awareness of potential solutions) 6. compared to your colleagues, how effective are you with keeping up with changes that could effect the way you work? (adaption: promptness of adjustment) 7. how quickly do you adjust to work changes compared to your colleagues? (adaption: prevalence of adjustment) 8. how well would you rate yourself compared to your colleagues in adjusting to new work changes? (flexibility) 9. how well do you handle work place emergencies (such as crisis deadlines, unexpected personnel issues, resource allocation problems, etc.) compared to your colleagues? jacqueline mayfield is associate professor of management in the division of international business and technology studies at texas a&m international university. her research includes leader communication, human resources, and international management. the author has published in numerous journals including business horizons, human resource management, and the journal of business communication. she is on the editorial board for the journal ofbusiness communication, and earned her ph.d. in management from the university of alabama. milton mayfield is associate professor of management in the division ofinternational business and technology studies at texas a&m international university. his research interests include leader communication, organizational mortality, the international comic book industry, and business strategy. he has published in numerous journals including business horizons, human resource management, and the journal ofbusiness communication. he earned his ph.d.in management from the university of alabama. special thanks to mary rowley for all of her insights on part-time workers. 154 journal ofbusiness strategies vol. 23, no.2 the benefits of leader communication on part-time worker outcomes: a comparison between part-time and full-time employees using motivating language from end-state fit to fitting dynamic: implications for organizational studies janice a. black new mexico state university las cruces, nm abstract austrian economics is a disequilibrium-based understanding (~f how firms interact in markets. using basic concepts from austrian economics and the market dynamics implied from them, this paper presents a dynamic view of fitting as one (~f the implications for organization studies and highlights other critical areas including entrepreneurship, innovation, information processing and organizationallearnink and chanke. 'fit' has long been a central focus in the strategy and contingency literatures (van de ven and drazin, 1985; summer, bettis, dulhaime, grant, hambrick, snow & zeithaml, 1990). generally, fit has been conceptualized as a specific end-goal implyink an attainable fit is possible (i.e. fit measured against an ideal or best performer, (doty, glick & huber 1993». this conceptualization implies the following: i) that clear links exist between cause and effect (otherwise fit could not be the specific end-goal), 2) that conditions present in the environment will continue (otherwise what is useful now may not be in the future) and 3) that the use of negative feedback enables the determination of the set of requirements needed for fit (otherwise the distance from any specified set of requirements is useless). these assumptions correspond to those needed in an equilibrium-based market economy (stacey, 1995; hunt, 2000). recently the usefulness ofthe foundational assumptions of equilibrium-based economics has been questioned (mcwilliams and smart, 1995), austrian economics (kirzner, 2000; scarth, 1988; stacey, 1995;) or ideas based in austrian economics (peteraf & ferrier, 2002; mcwilliams and smart, 1995; hunt, 1995; 1998, 2000) have been offered as an alternative. yet there are implications for organizational studies, if we switch the assumption base, which have not been addressed. austrian economics is a disequilibrium-based system that has characteristics that mirror those of complex systems (stacey, 1995). such characteristics include: i) causal links are nonlinear, 2) results are partially planned and partially emergent, and 3) specific predictions of outcomes are problematic. this implies that we need to revisit our concept of fit because, as this paper develops. under these conditions. fit becomes an apparition that organizations chase. this paper presents the dynamics of the fitting process in a complex system based on the underlying explanation provided by austrian economics. it 158 journal of business strategies vol. 20, no.2 finishes with outlining some critical areas of research arising from exploring a disequilibrium-based understanding of market forces. fit, fitting and the impact of market dynamics fit when using a system that has a stable structure, it is possible to determine a stable end point, a goal at which to aim. the agent taking aim has to handle the uncertainly that is inherent in any future oriented action, but coping with that uncertainty is doable. this is the basis for decisions from an equilibriumoriented system. uncertainty that is present is a result of an error. certain actions lead predictably to an erosion of supra-normal returns and ultimately to equilibrium return levels (hunt, 2000). unlike in equilibrium systems, the existence of uncertainty is a base assumption of austrian economics (kirzner, 2000, 1982; mises, 1949; hayek, 1948b; schumpeter, 1934). under austrian economics imperfectly implemented plans contribute to uncertainty about the future (mises, 1949). people as economic agents cope with this uncertainty (kirzner, 1982; mises, 1949). reasonable people will still make mistakes, be inefficient and even fail, but this does not mean that they acted irrationally (mises, 1957). this view accords all action as being future oriented (kirzner, 1978); by this is meant that people see their actions as linked to a possible future result. this being the case, they will try to place themselves in the 'best' of equally available positions (kirzner, 1978). if that positioning attempt fails, then one of three possibilities has occurred. 1) the successful position was not available (attributable to an error in judgement or execution; kirzner, 1978). 2) the economic agent was not aware of the successful position (attributable to an error in collecting information; march and simon, 1992).3) the environment shifted changing the definition of a successful position (attributable to emergent or unpredicted systemic change (stacey, 1995~ mcwilliams & smart, 1995; mintzberg & waters, 1985; schumpeter, 1934). the second case requires further elaboration. even though the agent was not aware that the information was available, it is an example of the economic error of not acting upon information (jacobson, 1992). the existence of the element of unawareness is not impossible (as assumed in rational expectations in the keynesian view; scarth, 1988) because purposeful action by itself does not mean that all opportunities are instantaneously perceived (kirzner, 1978). purposeful action seeks out opportunities or tries to take advantage of them (o'driscoll, 1977), but it is unreasonable to expect that everyone will have similar perceptions, reactions or expectations about the results of actions (lachmann, 1977). some of the variance in perception, reaction, and expectation can be traced to variances in the way people perceive, receive, and interpret information (bamford, rogers, & miller, 1999). thus, a key issue in purposeful action is the acquisition and dispersal of information. the critical basis of these skills is not fall 2003 black: end-state fit to fitting dynamic 159 just related to the variation mentioned earlier but also because applied information or knowledge enables the management of the uncertainty inherent in any purposeful action, which addresses the future. to the austrian economist, the market is a 'process of learning and discovery, rather than an equilibrium state of affairs' (klein, 1992:2). the market assumption is 'not on human rationality, but on human ignorance' (klein, 1992:4). information is assumed to never be fully dispersed or completely utilized. the process of acquiring the information and acting upon it corresponds to the actions firms engage in to 'fit' with their environments. yet from the austrian perspective, the collective 'firm' is really the set of individuals acting in alignment. thus individual entrepreneurial actions are the appropriate level of analysis. entrepreneurial fitting in an unstable and unpredictable system, having specific end goals is problematic (mcwilliam & smart, 1995). thus, using a specific end goal as a directional guidance device may not be useful. when system changes are occurring, it may be more important to respond to and enact changes than strive towards a point determined earlier but which, as events unfold, appears to not be as attractive (argyres & mcgahan, 2002). action (or dynamism of the market) occurs via entrepreneurs according to austrian economics (kirzner, 2002, 1982). entrepreneurial activities are defined as the function of making decisions and taking actions in the face of an uncertain present or future environment and the realization of existing opportunities that have remained previously unnoticed (kirzner, 1982). venkatraman (1997) expands this definition and places it soundly in the academic realm by noting that the study of entrepreneurship is studying not only the who-does what-how aspect but also includes how the opportunities are discovered, evaluated and exploited. since it is reasonable to assume that the purposeful person is acting upon his imagined future (mises, 1949) and that his actions impact the actual future (giddens, 1979), the closer his imagined future is to the actual, the more successful his plans (kirzner, 1978). an individual's motivation to imagine a future as close to actuality as possible is the desire for the rewards generated by the successful completion of his plans. entrepreneurial alertness is the scanning of the environment and the interpreting of it to construct that envisioned future (kirzner, 1982). entrepreneurial alertness remains somewhat of a mystery (gaglio and katz, 200 i). alertness includes noticing and reacting to what is unfolding, as well as the taking of a proactive stance (one which initiates changes). this duality has caused problems in conceptualization (gaglio and katz, 2001) with equivocal empirical research resulting. while both passive and active elements are included in the definition that is used in this paper, it is the proactive nature of action-taking that is critical here. such proactive behavior is seen in imaginative and creative leaps offaith that can result in the creation of the imagined future for which the present 160 journal o.fbusinfss strategies vol. 20, no.2 acts were designed (the alignment of the imagined future with the actual future due to the entrepreneur's actions). not all such attempts will succeed and some successes will later be invalidated; nevertheless, this implies that the scope for entrepreneurial activity is provided by the degree of uncertainty about the future and that the correct use of entrepreneurial alertness is rewarded by the increased success of the entrepreneur's plans (kirzner, 1982). while the market is the byproduct of the entrepreneurs' activities, the entrepreneur can be said to have the market function of "bring(ing) different parts of the market into coordination with each other" (kirzner, 1982: 136). the degree to which the market is in equilibrium depends on the entrepreneur's activities (griner, 1977) which can also be seen as the act of 'fitting' the entrepreneur's firm to the environment. as a market equilibrium is reached, it reduces the range of entrepreneurial activity for that particular market (kirzner, 1979). this implies that the better the organization 'fits' the market (as revealed by higher 'returns' or 'rewards'), the more opportunities have been spotted and acted upon via individual entrepreneurial actions. organizational 'fit' is a by-product of these 'fitting' activities. impact of market dynamics from the above two discussions on the actions and results of actions in a marketplace, it is evident that the interactions in the market impact the goals and processes of the agents. specifically, it is in the market coordination efforts that goals can become displaced (hunt, 1995). because in the austrian school's perspective, the concept of market equilibrium is a reflection of the coordination process, change in the market is moved from being exogenous to endogenous. the change occurs as entrepreneurs make decisions and act upon them (kirzner, 1979). the market is shaped by these decisions and activities along with the diffusion of the knowledge revealed and created by the entrepreneurial activity (lachmann, 1977). this entrepreneurial seeking, collecting, acting upon and disseminating of knowledge results in a model that is based on a capital stock that is heterogeneous and which is integrated into a structure of production (garrison, 1978). the capital structure of any firm within the market is not assumed to be a miniature replication of the market but rather a reflection of the entrepreneur who created the combination of the elements of the capital structure (lachmann, 1977). these structures may be reshuffled as entrepreneurs realize better uses for their resources (schumpeter, 1934). their economic returns may be eroded as competition increases due to the other entrepreneurs' choice to compete based on those others becoming aware of the opportunity represented by the resource combination due to their alert scanning of the environment but they never reach equilibrium (hayek, 1948a). although the entrepreneurs attempt coordination efforts, they are impeded in the attempt time and time again by others attempting to do the same thing. in other words, the dissemination of knowledge, the inflow of new knowledge fall 2003 black: end-state fit to fitting dynamic 161 (technology changes, changes in human social tastes), and "the spontaneous action of the alert minds of participants inspired, but not compelled, by what they witness on the market scene around them" (lachmann, 1977: 40). thus from the above we see that economics actors both work towards coordination and against coordination. with this perspective, the market place is not characterized by a state of equilibrium but rather by a series of disequilibria that, as information is shared, moves closer to states of equilibria (kirzner, 1982). returns above the expected level of investors and the level needed for firm survival are probable in this disequilibrium-based market (mcwilliams & smart, 1995). this understanding allows us to realize that any 'fit' that has been attained is transitory. as individuals act, the impact of those actions changes the very system that inspired them. this means that focusing on sensemaking of the past actions and cause-effect relationships informs future actions only to the degree to which the 'system' has remained the same. in systems where change is the norm and where change is not rhythmically predictable, other decision rules than past-based sensemaking will be more appropriate (mcwilliams & smart, 1995). issues to consider from equilibrium versus disequilibrium focuses equilibrium focuses in an equilibrium-based system such as classical economics, the system has a 'center of gravity' to which prices gravitate, an equilibrium point (addleson, 1994). at the equilibrium point, sufficient profits are earned to reward the investor's expectation of return and allow firm survival (hunt, 1995; rumelt, schendel, & teece, 1991). by relaxing the assumptions of classical economics, rents (or excess profits) can be earned but only if barriers are in place to forestall movement towards the center of gravity. several types of potential blockages and their attendant higher than 'normal' returns have been identified in the past (monopoly, ricardian, pareto-marshal, and pareto rents; peteraf, 1993). ricardian, pareto-marshall, and pareto rents are earned in existing markets and are due either to superior resources (ricardian), to better use of the resources in the firm than generally known in the marketplace (pareto-marshall), or to efficiencies (pareto) in the use of the resources (peteraf, 1993). attempts to understand these rents and how they are generated and their strategic use have led researchers to develop transaction cost economics and agency theory, among others. these are perfectly appropriate theoretical orientations given the basis in an equilibrium understanding of the market and have provided useful viewpoints and increased our understanding of organizations and why certain decisions may be made in these conditions. however as presented earlier, this equilibrium view appears to be less useful in attempting to understand today's market characteristics and critical issues. 162 journal of business strategies vol. 20, no.2 disequilibrium forces in austrian economics, the market is in a state of disequilibrium, which provides opportunities to earn a variety of returns. while some argue that such returns are not rents because there is no long term equilibrium market upon which to calculate the average return (hunt, 1995), the stock market in many instances does provide information which if not longitudinal certainly enables the determination of an industry average return for any point in time. to ease communication, "rents" will be used to indicate returns greater than the industry average at any point in time. these rents are similar to the rents possible in neoclassical economics but also include schumpeterian rents and entrepreneurial rents (e-rents). schumpeterian rents occur as entrepreneurs take advantage of a revolutionary change in the market (mewilliam & smart, 1995). entrepreneurial rent is associated with the initial market structuring activities of the entrepreneur. these disequilibrium rents are not earned because of a barrier keeping the market from movement towards equilibrium but because of the result of the changed market structure. e-rents occur when a firm or entrepreneur enters or creates a previously unknown or unused competitive arena or market (peteraf, 1993) and attempts to coordinate the market factors (lachmann, 1977). the conditions (one or very few companies in the market) at this early stage mimic the conditions of a monopoly from equilibrium-based economic systems; however, monopolistic rents and entrepreneurial rents are distinctly different. while both entrepreneurial and monopoly rents are due to a restriction in competition by firms, e-rents differ from monopoly rents in three ways: 1) in the lack of the previous identification of the competitive arena, 2) in the lack of deliberate restriction of output, and 3) in the lack of specific barriers to keep others from entering the market. e-rents are the entrepreneur's reward for taking on the risk of market coordination. this risk is associated with creating the initial market structure (which is assumed to be in place in equilibrium systems but not disequilibrium-based systems). monopoly rents are obtained by deliberately attempting to hold the market process still. monopoly rents are not rents generated from dynamism but static rents created by barriers. schumpeterian rents are the result of market restructuring activity. they reflect the risk that the entrepreneur takes to re-pupose his or her assets in a new way. it too is a reflection of the risk of market coordination but as a re-structuring activity and not as an initial market structuring activity. yet it too is different from a monopoly rent in that the market is deliberately changed not deliberately refrained from movement. again, how are rents earned in this disequilibrium-based system? rents are not necessarily earned through the creation of 'barriers' but through the very dynamics of the disequilibrium system. for example, if better performance occurs because a firm has a relatively better fit with the competitive environment (due to the entrepreneurial activities), then the earning of rents occurs because the firm attains a better fit than is anticipated by the market (due to fall 2003 black: end-state fit to fitting dynamic 163 inadequate information diffusion). because of the lack of information, the complete set of fit requirements is not entirely known (see austrian economics discussion earlier), a variety of such better-fit surprises can occur; which, therefore, enables multiple firms to generate rent. however, with the generation of rents additional aspects of a current set of fit requirements are revealed (ricketts, 1992). as the information about the returns available for any given fit is dispersed throughout the market place, potential competitors have access to the information. as firms choose to enter the revealed market (thereby utilizing the dispersed information), the density of firms in the market increases (kirzner, 1982). it is this increased density coupled with a more complete diffusion of information about the market that enables each rent earned to be competed away. when there is increased market activity with a more complete diffusion of information, market dynamics are shifted to one that more closely resembles an equilibrium-based market. given the inherent limits in noticing, gathering, interpreting, judging and utilizing information (march & simon, 1993) and the entrepreneurial alertness described earlier (kirzner, 1982), the choice to enter or exit particular product markets is a result of the information use of entrepreneurs. thus the driving force behind the rent cycle is the diffusion and use of information (hayek, 1948b; young, 1995). it is interesting to note that the fit at the market level is inversely related to the fit at the firm level. the achievement of rents reveals that a relatively good fit for an individual firm has occurred. yet, when the level of analysis is changed to the market, the earning of rents indicates that the degree of fit across all organizations is still relatively poor. the erosion of rents indicates that there is convergence on a particular fit and indicates a better overall degree of fit in the market. this provides further support for fit being relative not absolute. the organization that earns rents has the relatively better degree of fit. because rents (both equilibrium and disequilibrium uses) are higher than normal (survival) returns, firms attempt to earn them. once earned and revealed to the competitive arena, the potential exists for what once conferred an advantage to become simply a needed element for competition (see above discussion of diffusion of information and also barney, 1991). if others utilize the revealed information, the initial firm's relative fit as revealed by market performance may worsen. the lower-than-previous-times returns spark a reevaluation and potential modification of fit by that initial firm. the firm can either choose to hone the firm's fit in the current market or to attempt an entrepreneurial fitting in a new market (black & farias, 2000). the first possibility is to hone a firm's fit in the current market, in other words, to converge on a potential equilibrium point and to pursue pareto, paretomarshall and ricardian rents (fabian and black, 2001). the firm initiates a series of innovation rounds. if this innovation 'fits' it is indicated by the earning of rents. as other firms notice and respond to the innovation (dimaggio & powell, 1983), the rate of return will decline to the degree that the competing firms have also created fit. when this happens, the firm can introduce innova164 journal of business strategies vol. 20, no.2 tion 2 and the fitting dynamic repeats. with each innovation, the firm hones its fit by converging on the unknown ideal fit (which changes with each innovation) and subsequently reveals more about that elusive fit. the entrepreneurial firm may continue to hone or refine this fit as long as it is warranted. several authors have argued that specific types of firm resources will be needed to engage in such convergence activities (black, 1998; fabian and black, 2001). when the return rate drops below an acceptable level the firm may either change its definition of evidence of an acceptable fit (accept a different return rate), or look for another marketplace to create or enter (with the potential of earning the higher e-rents again). using this second way of higher return generation (moving to compete in a previously empty marketplace schumpeterian rent seeking or to generate a brand new market entrepreneurial rent seeking), the firm creates a fit for itselfand reveals the new market structure. there are again specialized resources that enable these enterprising disequilibrium based actions (fabian & black, 2001; black and farias, 2000; black, 1998). potential competitors who become aware of this new market now find themselves in misfit with this expanded environment. as competitors enter the new market, the honing of fit begins anew. when a firm takes an early second mover orientation, both disequilibrium rents (entrepreneurial and schumpeterian) and equilibrium based rents (efficiency/effectiveness rents) may be simultaneously earned. this occurs when the firm both successfully competes (whether via a different micro-niche in that market or via an equivalent fit) and also earns ricardian, pareto-marshall or pareto rents. leapfrogging over the initial entrepreneurial firm can result in even larger total returns than those that the initial entrepreneurial firm earned when such activity reveals a much better fit with customers' needs and wants and is done much more efficiently (teece, 1987; gal-or, 1985). while the mechanisms of such returns can corne from either an understanding of equilibrium based systems (mitchell, 1991; rumelt et al., 1991; teece, 1987) or from an understanding of disequilibrium based systems (young, 1995), the point is that it is possible and reveals more information about that market. the seeking of specific types of rent can reflect different drivers of fitting (table 1). while ricardian rents related to the inherent value of the resource being used and pareto-marshall rents related to the use of resources in ways not previously anticipated by the markets can be used in either a convergent or divergent fashion (rent seeking of either efficiency/effectiveness or entrepreneurial), the efficiency/effectiveness rents arising from pareto rents reflect a convergent fitting process. both entrepreneurial and schumpeterian rent seeking reflects an orientation with a divergent fitting perspective since the new fit is differentiated from the previously identified fit. recall that all rent seeking acti vi ties result in competitors reevaluating their own degree of fit. the interaction of the rent seeking (entrepreneurial and efficiency/effectiveness), the competitive cycle (information dispersal and ultimately rent erosion) and the fitting processes (convergent and divergent) constitute the fitting dynamic. please note fall 2003 black: end-state fit to fitting dynamic 165 that within the same general markets but across time both equilibrium and disequilibrium forces may be in action. such activities reveal that markets are complex systems (anderson, 1999). as such, periods corresponding to defined patterns (equilibrium based assumptions more prominent) will alternate with periods of apparent chaos (disequilibrium based assumptions more prominent) (black & farias, 2000). a description of the dynamics is presented next. table 1 equilibrium-disequilibrium dynamics and rent generation dynamic driver convergence divergence types of rent ricardian. pareto-marshall, pareto. monopoly ricardian, pareto-marshall, entrepreneurial, schumpeterian the fitting dynamic and the marketplace the enacting of any organizations fitting choice in a marketplace causes the available information understood about that market as a whole to change. when noticed, this information stimulates competing organizations to reassess their degree of fit. the reassessment usually results in changes by the reassessing organizations; which, in turn, sparks reassessment by others. this type of a marketplace exhibits many features of a boolean network system (stacey, 1995). in such a system, anyone element is connected to and both sends and receives signals to the others in the system. the current state of any element 'changes from moment to moment according to the information or energy it receives and the rules it follows for converting these to action or outputs' (stacey, 1995; 487). this implies that the organizations in a competitive arena help create the changing or turbulent environment (albeit not all change in the environment is due to changes by the organizations inhabiting it). implications from the fitting dynamic for organization studies many organizational environments now are considered turbulent (huber & glick, 1993), so not only does an organization need to engage in fitting, it needs to also coordinate its rate of change with that of the environment. two illustrations of organizational fitting decision points beyond that of rent attenuation follow. first, a discontinuous change within a product-market environment (e.g. the advent of personal computers) will require a reassessment and a fitting dynamic choice of others within the market (brothers typewrites, etc.). such discontinuous changes act as additional sources that need to be responded to and can potentially increase environmental turbulence. second, if an organization changes its current product-market environment leaving market a for market b, it will simultaneously create better fit for the remaining current occupants of the market a environment, remove a source of information about market a, and decrease the turbulence in market a. the better 166 journal of business strategies vol. 20, no.2 fit occurs when the returns are spread over a smaller number of firms. the removal of the firm's actions reduce available information about that market, decreases the total number of potential respondents and responses, decreasing the stimuli that must be responded to by those who remain, finally resulting in a less turbulent environment. an example from the small business arena would be a used mobile home sales firm that chose to leave that industry and to move to the used car industry. by leaving the used mobile home sales industry, the firm allows the market share that it previously had to be split by the remaining firms in that industry in that area. there are thus fewer firms in the mobile home sales industry to pay attention to and to whom responses need to be made. thus turbulence in that industry is reduced. by entering the used car industry, the firm increases the potential sales in that industry; this reveals that many of the same resources from the used mobile home sales may be used in the used car industry and increases the number of firms available to service that used car market. turbulence is increased in the used car sales market. furthermore, the above two examples suggest that better fit may not be in the direction where the currently best performing organization is located now but in anticipating where it will be in the future. however, because the currently best performing organization reveals information about an environment, it reduces equivocality and will draw those who either cannot or choose not to reduce the equivocality and ambiguity inherent in the marketplace on their own. if successful, these secondary firms will also provide information about the market and help in the further spread of information about the market. it may not earn erents but may earn any of the other rents. this action again reinforces the idea that firms use and are satisfied with different definitions of fit. once moves are made, the remaining firms in the competitive arena reevaluate their fits and make their own moves. thus the fitting dynamic impacts the entire competitive environment. because of the differing firm resources used in rent seeking based on honing to an existing market and those based on creating a new market structure, the choice of rents reveals the choice of resources to be used by a firm. dynamic rents when considered in conjunction with a fitting process choice reveals resource-use implications (black & farias, 2000; fabian & black, 2001). when the type of rent seeking is explicitly known and the current use of a resource set is understood, a firm is in a better position to purposefully address the future. this information is valuable for decisions regarding both short and long-term issues and activities. just as an understanding of firm activity rooted in the equilibrium economic systems sparked streams of research to determine how effective that understanding was for both descriptive and predictive uses, a disequilibrium-based theoretical understanding should spark and/or reinvigorate streams even to the extent of possibly examining a new set of identified critical issues. for example, when focusing on a fitting dynamic instead of an end-state fit, critical areas include: information diffusion dynamics; continuing impact of technology espefall 2003 black: end-state fit to fitting dynamic 167 cially on communications; effective use of innovation and entrepreneurial activities; organizational learning; co-evolution of markets; the tensions between the potential results of strategies and specifics of implementations; the complex system nature of our environment and the implications for all involved. indeed scholarly thinking and research has already begun in these areas (anderson, 1999; balabanis & reynolds, 2001; bamford et ai., 1999; black, 1998; braun, 2002; engelland & alford, 2000; fabian and black, 200 i; garbi, 2002; peteraf et ai., 2002). these areas remain ripe for more research. conclusion because of the complex nature of the market, attainment of fit is elusive. fit no longer is defined as an attainable 'end state' but rather as a relative state that is a process and is explicitly dynamic. the fitting dynamic helps explain action in complex markets such as those based on disequilibrium theories. understanding the movement of firms in the market is possible by considering the two fitting dynamics of convergence and divergence and the resulting rent seeking activities. for example, consider the movements explained by examining the set of actions and reactions via the fitting dynamics involved of an entrepreneurial firm's fitting choices. if it chooses to converge on a current competitive arena fit, it may generate rents via the creation of the better fit while simultaneously causing the reevaluation by competitors of their own fits. the entrepreneurial firm may also choose to leave a current market for a new market. whether or not it creates a better fit for itself, by just revealing the market, it creates the misfit of others for that newly revealed market. by explicitly understanding that both convergence and divergence drivers are in play in the markets, opportunities to utilize resources thought only useful for convergence activities in divergence activities are more apparent. many of these resources are ones that we already have looked at in narrower frameworks. such resources needed for convergence activities include those associated with entrepreneurial awareness, thus early pattern recognition, information seeking, information gathering, information sifting/refinement to current uses, information dissemination, entrepreneurial opportunity spotting, entrepreneurship in its many forms, life-long learning skills, skills in shaping organizations to support such learning, and so on are typical organizational resources. such resources can be found in individuals associated with the organization and/or in organizational structures. examples of resources needed for divergence activities include full system understanding, power relationship understanding, creativity, innovation, entrepreneurship in its many forms, ability to vision, initiate, and successfully implement change and so on. the investment in and deployment of specific resources remains a task for the organization's leadership whether embodied in an individual or in each organizational member. this view of fit as the explicit fitting dynamic helps us to begin to explain organizational activity in a richer way than fit has previously been presented. it 168 journal (~l business strategies vol. 20, no.2 confirms and highlights the importance of several strategic issues and provides a way to more closely analyze and determine a firm's strategic orientation. the fitting dynamic perspective builds on the previous definitions of fit while demonstrating the usefulness of studying the dynamics of the attainment of fit. an important aspect of this dynamic is the explanation of how firms who seek rents provide the driving force of the economy. further areas of importance for new or renewed research include: i) entrepreneurship and innovation; 2) information processing dynamics including both technological incorporation and intra-personal perceptual issues; 3) management of strategies in conditions of environmental dynamism and complexity; and 4) organizational learning and change in response to environmental change and as proactive influences in environmental change. references addleson, m. (1994). competition. in peter j. boettke (ed.) the elgar companion to austrian economics. hants, england: edward elgar publishing limited. anderson, p. (1999). complexity theory and organization science. organization science. ]0 (3), 2]6-232. argyres, n. & mcgahan, a. m. (2002) an interview with michael porter. academy of management executive, 16 (2), 43-52. balabanis, g. & reynolds, n. l. (2001). consumer attitudes towards multi-channel retailers' web sites: the role of involvement, brand attitude, internet knowledge and visit duration. journal of business strategies. 18 (2), 105-132. bamford, c. e, rogers, p. r, & miller, a. (1999). transformation of strategic types: an examination of the internal antecedents to organizational change. journal of business strategies. 16 (2), 135-150. barney, j. b. (1991). firm resources and sustained competitive advantage. journal of management, 17, 99120. black, j. a. (1998). entrepreneur or entrepreneurs? justification for a range of definitions. journal of business & entrepreneurship, 10 (1),45-65. black, j. a. & farias, g. (2000). dynamic strategies: emergent journeys of entrepreneurs. emergence. 2 (i), 10 1-113. braun, p. (2002). digital knowledge networks: linking communities of practice with innovation. journal of business strategies, 19 (1),43-54. dimaggio, p. j. & powell, w. w. (1983). the iron cage revisited: institutional isomorphism and collective rationality in organizational fields. american sociological review, 48,147-160. fall 2003 black: end-state fit to fitting dynamic 169 doty, d. h., glick, w. h., & huber, g. p. (1993). fit, equifinality, and organizational effectiveness: a test of two configurational theories. academy of management journal. 36, 1196-1250. engelland, b. t. & alford, b. l. (2000). consumer learning and the creation of primacy advantages for followers. journal of business strategies. 17 (2), 145-162. fabian, f. h. & black, j. a. (2001). dominant strategic logic: fractals of entrepreneurial conation and cognition. proceedings of the 2001 southwest federation of administrative disciplines. southwest academy of management di vision, new orleans, la. gaglio, c. m. & katz, j. a. (2001) the psychological basis of opportunity identification: entrepreneurial alertness. small business economics, 16 (2), 95-111. gal-or, e. (1985). first mover and second mover advantages. international economic review, 26 (3), 649-654. garrison, r. w. (1978). austrian macroeconomics: a diagrammatical exposition. in louis m. spadaro (ed.) new directions in austrian economics. kansas city, ks: sheed andrews & mcmeel inc. garbi, e. (2002). alternative measures of performance for e-companies: a comparison of approaches. journal of business strategies. 19 (1), 1-17. giddens, a. (1979). central problems in social theory. london: macmillan. griner, w. (1977). in pursuit of the subjective paradigm. in w. grinder (ed.) capital expectations and the market process. kansas city, ks: sheed andrews & mcmeel inc. huber. g. p. & glick, w. (1993). sources and forms of organizational change. in g. p. huber & w. glick (eds.), organizational change and redesign: ideas and insights for improving performance, pp. 3-15. new york: oxford university press. hayek, f. a. (1948a). the competitive solution. in f. a. hayek (ed.) individualism and economic order (pp 181-208). chicago: university press. (reprinted from economica, 1940, 7, 125-149.) hayek, f. a. (i 948b). the use of knowledge in society. in f a. hayek (ed.) individualism and economic order (pp 181-208). chicago: university press. (reprinted from american economic review, 1945,35,519-530). hunt, s. e. (1995). the resource-advantage theory of competition: toward explaining productivity and economic growth. journal of management inquiry, 4 (4),3173332. 170 journal of business strategies vol. 20, no.2 hunt, s. d. (1998). toward synthesizing resource-based, evolutionary, and neoclassical thought: the contribution of resource-advantage theory. in j. j. foss and p. j. robertson (eds.) resources, technology and strategy. copenhagen: copenhagen business school. hunt, s. d. (2000). a general theory of competition: resources, competences, productivity, economic growth. thousand oaks, ca: sage publications. jacobson, r. (1992). the "austrian" school of strategy. academy of management review, 17 (4), 782-807. kirzner, i. m. (1978). economics and error. in louis m. spadaro (ed.) new directions in austrian economics, kansas city, ks: sheed andrews and mcmeel inc. kirzner, i. m. (1979). comment: x-inefficiency, error and the scope for entrepreneurship. in mario j. rizzo (ed.) time, uncertainty and equilibrium. lexington, ma: lexington books. kirzner, 1. m. (1982). uncertainty, discovery, and human action: a study of the entrepreneurial profile in the misesian system. in i. m. kirzner (ed.) method. process and austrian economics. lexington, ma: lexington books. kirzner i. m., (2000). (ed.) the driving force of the market: essays in austrian economics. new york: routledge. klein, p. g. (1992). introduction. in peter klein (ed.) the collected works of f. a. hayek. chicago: university of chicago press. lachmann, l. m. (1977). austrian economics in the present crisis of economic thought. in walter grinder (ed.) capital expectations and the market process. kansas city, ks: sheed, andrews and mcmeel inc. march, j. g. & simon, h. (1993) organizations. 2nd ed. new york: blackwell publishers. mcwilliams, a. & smart, d., (1995). the resource-based view of the firm: does it go far enough in shedding the assumptions of the s-c-p paradigm? journal of management inquiry. 4 (4),309-316. mintzberg, h. & waters, j. a. (1985). of strategies, deliberate and emergent. strategic management journal. 6 (3), 257-273. mitchell, w. (1991). dual clocks: entry order influences on incumbent and newcomer market share and survival when specialized assets retain their value. strategic management journal. 12 (2), 85-10 i. o'driscoll, g. p. (1977). spontaneous order and the coordination of economic activities. journal of libertarian studies, i, spring, 137-151. fall 2003 black: end-state fit to fitting dynamic 171 peteraf, m. a. (1993). the cornerstones of competitive advantage: a resource-based view. strategic management journal 14, 179-191. peteraf, m. a. & ferrier, w. j. (2002). conversations on the dynamics, context, and consequences of strategy: introduction to a special issue. managerial and decision economics. 23 (4/5), 149-156. ricketts, m. (1992). kirzner's theory of entrepreneurship: a critique. in b. j. caldwell & s. boehm (eds.) austrian economics: tensions and new directions. boston: kluwer, 67-94. rumelt, r. p., schendel, d., & teece, d. j. (1991). strategic management and economics. strategic management journal. 12,5-30. scarth, w. m. (1988). macroeconomics: an introduction to advanced methods. new york: harcourt brace jovanovich. schumpeter, j. (1934). the theory of economic development. cambridge, ma: harvard university press. stacey, r. d. (1995). the science of complexity: an alternative perspective for strategic change. strategic management journal. 16 (6), 477-495. summer, c., bettis, r, duhaime, i., grant, j., hambrick, d., snow, c., & zeithaml, c. (1990). doctoral education in the field of business policy and strategy. 12, 167-183. teece, d. j. (1987). (ed.) the competitive challenge: strategies for industrial innovation and renewal. cambridge, ma: ballinger pub. co. van de ven, a. & drazin, r. (1985). the concept of fit in contingency theory. in l. l. cummings & b. staw (eds.) research in organization behavior. 7, 333-365. new york: jai press. venkatraman, s. (1997) the distinctive domain of entrepreneurship: an editor's perspective. in j. katz and r. brockhaus (eds.), advances in entrepreneurship, firm emergence and growth. new york: jai press. von mises, l. (1949). human action: a treatise on economics. new haven: yale university press. von mises, l. (1957). theory and history: an interpretation of social and economic evolution. new haven: yale university press. young, g. (1995). comment: the resource-based view of the firm and "austrian" economics: integration to go beyond the s-c-p paradigm of industrial organization economics. journal of management inquiry, 4 (4), 333340. 172 journal of business strategies vol. 20, no.2 jauice a. black is associate professor in the department of management at new mexico state university and international researcher/presenter. her publication outlets include the strategic management journal, entrepreneurship, theory & practice, and advances in applied business strategy. her research is centered on the development of strategic implementation competencies such as entrepreneurship, creating a context for learning, leadership and strategic coherence. her research and consulting work focuses on r&d and service industries and strategic alliances. from end-state fit to fitting dynamic: implications for organizational studies a systems-based framework for continuous improvement: a service sector application richard a. reid university of new mexico albuquerque, nm elsa leong koljonen intel corporation chandler, az abstract based on the deming cycle and the jointer 7 step method, a new systemsbased framework for performing continuous improvement has been developed. this new conceptual framework embodies the systems concepts of leverage, synergy, and sensitivity analysis. this paper demonstrates how these systems concepts could be applied to improve customer satisfaction in a small, recentlyestablished, law firm. the resultant customer-focused action plan is designed to avoid any negative effects associated potential suboptimization that might occur when an improvement team focuses on a single organizational process. introduction the two major cornerstones of operations management are quality and productivity. from an internal perspective, managers concerned with the day-to-day operations have always sought to improve customer satisfaction through increasing the quality and productivity of the processes designed to perform work in organizations. the total quality management (tqm) philosophy with its major focus on continuous improvement (ci) has promoted the mobilization of process improvement teams. in many organizations, these teams of employees have been instrumental in advocating a never-ending process of performance improvement (cheney, et al., 1994). by improving processes by which work is performed, the focus is on continuously and incrementally improving everything associated with designing, creating, and delivering satisfaction to a firm's customers. the rationale for ci is that customer needs are not static, but are dynamic and change continually. as a result, although a firm's outputs and/or its processes may be considered innovative today, competitive forces may render them commonplace tomorrow. that is, today's "order winners" readily become tomorrow's "order qualifiers" (hill, 1994). thus, a firm is only able to maintain its competitiveness in a dynamic marketplace by continuously improving. in short, ci can be an effective operations strategy if it (1) addresses the needs of the customers, (2) seeks to improve on the 50 journal of business strategies vol. 17, no.1 competencies of the competitors, and (3) is able to reflect desired changes in the firm's internal capacities and capabilities (schonberger & knod, 1997). w. edwards deming has stated that managers must constantly and forever improve their production and service processes. furthermore, he notes that improvement is not just a "one-time effort" and that managers are obligated to continuously search for and implement ways to reduce waste and improve quality (walton, 1986). juran (1989) verbalizes his agreement in the following two imperatives: (1) "to maintain and increase sales income, companies must continually evolve new product features and new processes to produce these features", and (2) "to keep costs competitive, companies must continually reduce the level of product and process deficiencies." moreover, he believes that both customer needs and competitive cost structures are moving targets. from an international perspective, kaizen, is the name that the japanese have given to the concept of continuous incremental improvement. it is considered to be the single most important concept in japanese management and the key to their competitive success (lmai, 1986) because it is operationalized throughout the total organization and expected to be practiced by all employees at every level. kaizen means making changes for the better on an ongoing, never-ending, basis. continuous improvement is usually embodied in a structured approach which emphasizes the need to establish an organizational commitment to a systematic, continual improvement in capability, reliability, and efficiency of business processes (conway, 1993). this paper presents an alternative approach to structuring the ci process that incorporates systems thinking. based on the deming cycle and the jointer 7 step method, this new framework incorporates several concepts from systems theory. discussion is focused on the embodiment of these system concepts in the framework's procedures for creating a systems-oriented action plan. insights gained by sequentially applying these systems concepts are illustrated for a small, recently-formed, law firm in hong kong. some conclusions are drawn relative to the practical applicability of this approach. a systems perspective on continuous improvement although there are many approaches for structuring the implementation of ci, two of the most common include the shewhart or deming plan-do-check-act cycle (deming, 1982 and 1986) and the jointer 7 step method (jointer associates, 1990). both approaches focus on the goal of improving work-performing processes by increasing customer satisfaction. figure 1 displays the important characteristics and content of the four stages in deming's structured approach. figure 2 presents the jointer 7 step approach to ci. from problem identification to deep cause determination to solution determination to implementation to checking and standardization, the jointer method provides a comprehension guide to process improvement. both approaches emphasize an improvement logic that is inherent to implementing change by focusing on what to change, what to change spring 2000 reid & koljonen: systems-based framework 51 to, and how to cause change. moreover, each framework is designed to support a team-based approach to ci. figure 1 • standardize desired improvements • formalize "current best approach" • communicate results broadly • celebrate team success • identify next improvement • summarize and analyze data • evaluate results relative to targets • understand/document differences • review any problems/errors • record what was learned • specify any remaining issues or unintended consequences • assemble right people on team • gather all available data • understand customer's needs • describe the process that surrounds the problem • determine root cause(s) • design action plan • develop plan/train the people • implement the improvement on a pilot basis • collect appropriate data • measure progress • document results these two approaches provide a structure for improving organizational processes. it is common to describe a process as a series of interrelated tasks directed toward accomplishing a desired outcome. from this perspective, it is possible to consider any task as a component of one or more processes. it is noteworthy that a problem is often associated with a task or group of tasks, and therefore, resides within a process. this implies that solving a problem will usually involve some modifications of the problem's environment and that this may include changes in (1) neighboring tasks, (2) task interfaces or (3) linkages with other processes. thus, if a series of related tasks is considered to be a process, then it is appropriate to consider a group of related processes as a system (melan, 1993). since a system may encompass a large number of processes, it is often prudent for improvement teams to focus their efforts on a single process rather than a collection of processes. although there is some risk associated with suboptimizing, scholtes (1988) believes that team-based improvements have a great probability for success if the team focuses its initial efforts in a smaller single domain prior to consideration of the entire system. 52 journal of business strategies figure 2 define the problem study the current situation analyze potential causes implement a solution check the results ~ standardize the improvement establish future plans vol. 17, no.1 while it may not be effective to consider an entire system for team-based improvement efforts initially, it is possible to incorporate some system concepts into the process improvement approach. accompanied by a set of detailed guidelines for each of the seven steps, figure 3 presents a new conceptual framework for integrating some systems thinking into an approach to process improvement. this framework incorporates the underlying ci logic along with many of the concepts, ideas, and steps from the deming cycle and the jointer 7 step method. although each of the seven steps in the new framework is important, most improvement teams will spend most of their time and effort in project planning which encompasses the first four steps. spring 2000 reid & koljonen: systems-based framework figure 3 detailed guidelines 53 no yes define the scope and focus of the process improvement effort identify problem area(s) and determine underlying cause(s) use systems concepts to analyze tactics create systems-oriented action plan implement action plan on pilot basis and assess results reflect and act on results define new project with a reconstituted ci process team i. project tearn sets improvement goal 2. determine project boundaries 3. collect operations data on current situation i. summarize and analyze data 2. define problem area 3. prioritize problems 4. identify possible cause(s) for major problems i. identify solution alternati ves for major problems 2. determine high leverage improvement areas 3. perform sensitivity analyses 1. apply the concept of synergy 2. design action plan 3. establish performance targets i. follow plan and document results 2. review results relative to targets i. institutionalize desired changes 2. disseminate new knowledge throughout the organization 3. continue improvement effons 1. develop new initiative for improvement 2. assure lessons learned are preserved step 1define the project's scope. in this initial step, the improvement project's purpose and scope are established. this activity requires operations performance data to be collected relative to the current situation. although these data are neces· sary to provide an empirical base for assessing any problem areas, they often just 54 journal of business strategies vol. 17, no.1 document the symptoms of a problem. however, they help to narrow the project's focus and establish boundaries on the investigation by providing a preliminary indication on the location of current process failure(s). moreover, they may provide insight into an appropriate composition of knowledge, skills, and capabilities that are needed among team members. once established, the team may use various forms of brainstorming to help further define problems and identify issues of concern. step 2 identify problems and determine probable causes. data previously collected are summarized and analyzed in order to isolate the process that contains the problems or is responsible for the issues of concern. this allows the team to focus on a given process whose performance needs to be improved. next, the process is fully described, often with a flowchart, and suspect points of failure are identified. all problems are listed and major problem areas are prioritized relative to their importance. data reflecting customer satisfaction and/or opinions are often used to ascertain the relative importance of areas of concern. a variety of the team-based tqm tools (brassard & ritter, 1994) such as a fishbone chart and the interrelationship digraph may be utilized to describe all possible causes responsible for the problem areas. the why-why diagram (tague, 1995) may be used to help probe into the underlying causes responsible for the problem area(s). the designation of the underlying causes of the major problems is a primary output of this step. step 3 create and analyze solution alternatives. this step seeks to prescribe the tactics that will be used to address the major problem areas by generating and evaluating improvement alternatives. since effective cause analysis is a prerequisite for effective solution generation, it may be necessary to further analyze the identified problem causes and the current situation. this can be done by using theory of constraint logic tree tools such as the current and future reality trees, or the conflict resolution diagram (goldratt, 1994; dettmer, 1997). additionally, insight into potential solution effectiveness may be gained through imitating systemic behavior through simulation models (koljonen & reid, i 998a). those solution approaches considered to be high leverage are often the most desirable. leverage is a systems principle that supports the idea that small, well-focused, and timely action(s) can produce significant improvements (senge, 1990). after determining high leverage potential solutions, a sensitivity analysis of the assumptions or estimates underlying leverage computations is needed to establish their robustness. sensitivity analysis is a systems concept that can be defined as examining the impact on expected outcomes of reasonable changes in parameter value estimates (eschenbach, 1992). step 4 create action plan. the focus is on developing an effective action plan that considers addressing several major problems simultaneously by incorporating multiple alternatives within a coordinated set of actions. the key here is to look for some potential synergistic relationships among the various solution approaches to the identified major problems. synergy is a systems concept in which the effect of several actions is greater than the sum of their individual effects because the interaction between the actions creates a disproportional effect on the desired result (schoderbek, et al., 1990). the action plan needs to be specific enough to guide the change process. it usually includes scheduling the sequence of changes, identifying resources, assigning responsibilities, hiring new spring 2000 reid & koljonen: systems-based framework 55 staff, and/or training personnel. prior to implementation, it is necessary to set performance targets and establish methods to monitor the results of the planned changes. step 5 implement and assess pilot project. usually the action plan is implemented on a small scale or as a pilot project. during this step, it is necessary to: (1) follow the action plan, (2) document any changes to the plan along with the rationale for the change, and (3) measure improvement from both the customer's and the finn's perspective. these steps are suggested so that the ci team will maximize its learning from this experience. comparisons are made between actual and expected results of the implemented changes. the idea is to determine if the planned changes were successful in addressing the core problem and whether the symptoms have been diminished. equally important is the identification and mitigation any unintended negative consequence resulting from change. if the implementation was only partially successful, or worst, unsuccessful, then it is usually necessary for the ci team to reassess the situation and revisit one of the previously completed steps. for example, step 2 is revisited if the underlying cause(s) of any major problem(s) were incorrectly determined. step 3 is revisited if one or more solution alternatives were inappropriately conceived. step 4 is revisited if the action plan was poorly designed. finally, step 5 is revisited if the action plan was poorly implemented. obviously, the ci team would prefer not to have to revisit any of the previous steps. if results are acceptable relative to previously specified performance targets, then the team implements the next step. step 6 reflect on and institutionalize changes. in this step, emphasis is directed toward determining (l) what was learned, (2) what can be generalized for use in future improvement efforts, and (3) what remains dysfunctional. first, successful improvements are codified as the new standard operation(s). changes are institutionalized to assure that progress made is permanently captured in revised policies, procedures, and processes. moreover, the new, improved change is widely disseminated throughout the organization and selected aspects of the ci team's experience are documented and/or extrapolated for use in future improvement activities. the improvement process is continued by either (l) developing a new initiative for improving some aspect of the original process that did not totally measure up to prior expectations or (2) identifying a new problem area or issue of concern within the firm where improvement is sought or the new lessons learned can be applied. in the latter case, the ci team would go to the next step. step 7 define a new ci project. the focus of this step is to create a new ci initiative and bring together a knowledgeable and qualified team to plan and implement required process changes. in short, it is necessary to ceaselessly iterate through the new ci framework that incorporates systems thinking into a systematic approach to process improvement. moreover, this step requires that previous lessons learned are not lost but are documented and disseminated in an effective manner to other organizational units. continuous improvement can be an effective operations strategy for remaining competitive in a dynamic marketplace. as such, it is essential to address new arenas in need of process improvement and/or apply what has been learned to similar organizational situations. new arenas of application may require the ci team to have new knowledge and/or capabilities, which in tum, may necessitate the reconstitution of its membership. 56 journal of business strategies vol 17, no.1 as presented in figure 3, the new framework for process improvement seeks increased effectiveness by incorporating some systems concepts into its approach. in order to highlight the potential impact of these concepts, they will be applied to a small law firm in need of improved customer service. figure 4 provides a flowchart for sequentially using these concepts to help create an action plan. first, the major problem area(s) are identified. then a matrix is used to structure the determination of the potential leverage associated with each problem area. next, a sensitivity analysis is performed to determine the impact of reasonable changes in initial estimates used to compute leverage factors. finally, the situation is examined for potential synergistic relationships and the action plan is completed. figure 4 identify major problem areas determine high leverage problem area(s) perform selecti ve sensitivity analysis check for possible synergistic opportunities finalize action plan and implement case study: application in the service sector the purpose of this case study is to illustrate how the system concepts associated with a new framework for process improvement could be applied to improve customer satisfaction in small service sector firm. a recently~established law firm in hong kong specializes in patents and trade mark applications, commercial spring 2000 reid & koljonen: systems-based framework 57 contracts, and real estate transactions. it consists of three partners, three article clerks who are solicitors-in-training, three secretaries, two junior clerks, and two receptionists. for the most part, clients from the partner's previous practices provide the main customer base. under the laws of hong kong, lawyers are not allowed to actively solicit new business through traditional marketing approaches such as advertising. therefore, new clients are mainly generated by referrals from current customers. as a result, customer satisfaction is of paramount importance to the new firm's survival and future success. the firm solicited feedback from new customers over a recent three week period. based on interviews with the law firm's senior partners, selected clients, and a review of the service quality and system effectiveness literature, a survey instrument was designed and administered as part of performing a walk-through audit (wta) at the firm. a wta is a performance assessment tool designed to systematically evaluate customer perceptions of the complete service creation and delivery process and the total service package offered by a service organization (fitzsimmons & fitzsimmons, 1998; koljonen & reid, 1998b). based on new client experience, the responses to 25 questions were rated on a scale from 1 to 5, with 1 reflecting the lowest rating and worst possible outcome and 5 representing the best and most favorable scenario. major problems the client-based results of the wta revealed four major areas of concern asso~ ciated with the service delivery process. these problem areas, each receiving an average client rating of less than 4.0, are as follows: (1) appointment time convenience (3.53), (2) law office accessibility (3.67), (3) law office appearance (3.33), and (4) time delay estimate prior to meeting with legal staff (3.40). using the same survey method, a benchmark study at four well-established and highly respected hong kong law firms confirmed that the results from the study firm were indeed significantly lower in these four areas. on this basis, it was decided that service improvements should first be directed to these four areas. identify "ieh leverae:e improvement area(s) with limited resources and more than one area requiring improvement, it was necessary to concentrate planned change in the area where the most significant returns would be expected. the principle of "leverage" illustrates that small, wellfocused, corrective actions, if they are appropriately implemented both temporally and functionally and for a reasonable cost, can produce significant and enduring improvements in performance (senge 1990). thus, the issue of which of these four areas will provide the greatest leverage had to be determined. initially, it was thought that by focusing improvement efforts in the area with the greatest leverage would also provide the largest return on the effort expended, 58 journal of business strategies vol. 17, no.1 and so logically, the goal was to identify the problem area having the highest potential for improvement. at the law firm, however, there was not a significant difference in the importance ratings between the four areas of concern. in addition, it was noted that different options were potentially available for improving each of these four areas and each planned change was associated with a different expected level of effectiveness and cost structure. hence, even if one area was perceived to be significantly more important, the potential effectiveness and expected cost associated with improving it may eliminate it from further consideration. thus, along with a problem area's relative importance, the estimated impact and expected cost of each improvement option need to be incorporated when determining the leverage associated with potential planned change. to address these concerns, a "leverage factor" was developed. this simple measure states that the leverage factor (lf) for a proposed change is a function of the area's importance (i) times the ratio of the estimated effectiveness (e) to the expected cost (c) of the planned change. more specifically: lf = i x (£ic). table i illustrates the application of this relationship to two different options for addressing each of the four major areas of new client concern. by defining the importance (i) for an area of concern as the average of the clients' mean ratings from the benchmark firms' minus the new clients' mean rating for the study firm, its impact in this situation was greatly attenuated. effectiveness (e) estimates were made after the improvement team discussed their expectations relative to each proposed implemented change. a 1 to 5 scale was used with 1 representing a minor improvement and 5 being the most desirable outcome. this approach to estimating effectiveness metric seemed appropriate to minimize nonfunctional debate over the impact of a potential change on new client perceptions. with regard to determining the cost (c) estimate for each option, it seemed reasonable to use another 1 to 5 point scale with 1 representing the lowest cost and 5 reflecting the highest cost. this approach sought to minimize the delay associated with developing more accurate estimates of expected costs associated with implementing the proposed change. contrary to initial thinking, the results of this systematic approach to determining the highest leverage action identified a simple, low-cost, intervention that promised a relatively effective return. the option of sending a map to a new client that showed the firm's location provided the greatest leverage. this option had the greatest fic ratio, and consequently, became most desirable in this situation. thus, by employing a simple intervention which provided new clients with clearer directions to the firm's geographical location, the study firm was able to achieve the greatest impact in improvement efforts. it is interesting to note that this option addresses the location accessibility issue in an indirect, rather than a direct, manner. perform selective sensitivity analyses like most decision-aiding models, the lf computation relies on data that are estimated or averaged and that depend upon an expected, yet uncertain, future. in these table 1 c/l "0 ::1. (i) (e) ::sctcl importance estimated (c) (lf) n (difference between average suggested effectiveness expected cost leverage factor 0 0 major area of new for benchmarked improvement (scale: 1 to 5, (scale: 1 to 5 (larger number 0 client concern firm and new firm) option!alternative 5 = most effective) 5 = highest cost) means greater leverage) :=;, "'"e.: appointment 1.35 1. meet at clients' office 3 3 1.35 roo convenience (4.88-3.53) 2. meet after normal business hours 4 3 1.80 ~ ..:::c' ;::s "'":::l" ~ location 1.33 l provide map to client 3 i 3.99 '"~ accessibility (5.00-3.61) 2. relocate to central business district 5 5 1.33 ;:s '"~ t:l '"'t "1'1 appearance of i:1 1.33 l. new furnishings 4 3 1.71 ;:s office (5.00-3.61) 2. renovation by professional interior designer 5 4 1.66 "'"~ c * waiting time before meeting with staff 1.38 (4,18-3.40) i. secretary initiates meeting 2. solicitor initiates meeting 3 5 2 3 2.07 2.21 vi '0 60 journal of business strategies vol. 17, no.1 types of situations, it is incumbent upon the analyst to perform a sensitivity or "whatif' analysis. as previously noted, sensitivity analysis can be defined as the examination of the impact of reasonable changes on the estimated or expected variable values in a decision model (eschenbach, 1992). the lf for the improvement intervention "send map showing location of study firm for initial appointment with new client" has been calculated to be 3.99 which is about 1.8 time greater than the next most attractive action ("reduce client wait time by having the solicitor start the meeting"). while the cost estimate can be confidently estimated to have a value of i, there is some uncertainty surrounding the effectiveness rating of 3. if the effectiveness rating was reduced to 2, the selected intervention would have a lf of 2.66 and still be most favored. while additional "what-if' analyses can be performed to evaluate other possible or probable scenarios, the improvement team believed that the other estimates were "reasonable" and elected to not pursue sensitivity analyses further. check for syneri:istic relationships amoni: solution alternatives thus far, the focus has been on identifying and verifying the improvement alternative that has the greatest leverage. to this end, it has been assumed that each of the four problem areas was independent of any other area. however, in most organization settings, different factors are co-dependent and can dynamically influence one another, so it is relevant to design an action plan that will address multiple areas with a coordinated set of changes. thus, it is appropriate to consider the concurrent implementation of several improvement options in a systemic manner. synergy is an important concept in systems thinking. it involves the realization that a system's performance is often greater than the sum of the performance of its individual subsystems. in another words, due to the interaction between the components, the total effectiveness exceeds the sum of the effects obtained from the independent functioning of the components. thus, in the development of an action plan, it is necessary to select a set of options that will interact in a productive manner to achieve their individual goals while concurrently providing a disproportional gain in overall system effectiveness. this approach provides an overt recognition that a coordinated improvement strategy, as detailed in an action plan, will incorporate a set of mutuallysupportive methods that should positively influence one another. with regard to the development of an action plan for the study firm, synergy can be realized by identifying a set of mutually-reinforcing tactics which will address each of the four major areas of concern, plus increase the client's overall perception of the quality of services received. this process can be initiated by identifying several options for addressing at least two of the concerns and then creatively combining them into a coordinated policy. to illustrate, the following policy could be implemented to address the first two major areas of concern listed in table i, namely, "scheduling the initial appointment at a convenience time for the client" and "improving the client's accessibility to law firm's office"; instruct article clerks to be (1) extremely flexible in accommodating any reasonable respring 2000 reid & koljonen: systems-based framework 61 quest by a new client for an initial appointment (even scheduling it after normal business hours, or if all else fails, agreeing to meet at the client's office), and (2) fax the client (within the next hour) written confirmation of their appointment time and, whenever appropriate, a map detailing the office location and clear directions on how to travel to the facility. finalize action plan the resultant action plan would include a coordinated set of alternatives sequenced for implementation, implementation schedule, table of personnel and their respecti ve responsibilities, set of performance expectations, and a procedure for monitoring actual performance results emanating from the pilot project implementation. institutionalizing any policy change would occur after an assessment was made of the results from the pilot project. summary and conclusions while several conceptual frameworks are available to guide a ci team as they proceed systematically toward improving a process, two of the most popular do not incorporate some of the better-known concepts from systems thinking. based on the underlying logic for process improvement associated with the deming cycle and the jointer 7 step method, a new framework for process improvement has been developed. this new framework builds on the general sequence of steps associated with these well-known problem solving and process improvement approaches while incorporating several relevant systems thinking concepts. a case study was presented to illustrate how these systems concepts might be applied at a small law firm that is designing an action plan to improve customer satisfaction. after analyzing customer-provided audit information, the law firm was able to identify four areas where improvements were needed. this is a critical first step in designing and implementing an action plan to increase client satisfaction with the service process. the concept of leverage was considered by examining the relative effectiveness and cost of the proposed interventions in concert with the importance of the improvement area where they are focused. performing a sensitivity analysis of the relative, yet estimated, measures of expected benefits and costs provides some assurance that the results from using the high leverage factors assigned to preferred options are relatively robust. as a consequence, further refinement of these effectiveness and cost metrics was not necessary in this case study. the fourth step in developing the action plan is to employ the concept of synergy. this requires that multiple interventions designed to address several improvement areas be creatively coordinated to take advantage of positive interactions between improvement opportunities and options. finally, the action plan is solidifie,d and the implementation of a coordinated set of improvement actions is able to occur. 62 journal of business strategies vol. 17, no.1 relative to the study firm, several new policies were implemented as a result of this study. first, maps and directions were faxed to new clients immediately after appointment times were confirmed. second, meetings beyond normal business hours were approved by the senior partners in an effort to provide flexibility to meet client's preferences. third, in the event that the clients is unable to travel to the law office, arrangements could be made for the article clerk to meet with the client at his/her office. thus, policy changes have incorporated a highly desired set of mutually-reinforcing tactics. unsolicited feedback from law firm clients has been positive. one of the senior partners reports that business at the firm is growing at a healthy rate even during the recent recession in hong kong. currently, the principals are considering a potential new site for expansion. references brassard, m., & ritter, d. (1994). the memory jogger ii. methuen, ma: goallqpc. cheney, a.b., sims, h.p., & manz, c.c. (1994). teams and tqm. business horizons. 37 (5), 16-25. conway, e.c. (1993). basic concepts. in christopher, w.e, & thor, cg. (eds.), handbook for productivity measurement ang improvement. cambridge, ma: productivity press. deming, w.e. (1982). ouality. productivity. and competitive position. cambridge, ma: mit center for advanced engineering study. deming, w.e. (1986). out of crisis. cambridge, ma: mit press. dettmer, h.w. (1997). goldratt's thl;':ory of constraints. milwaukee, wi: asqc quality press. eschenbach, t.g. (1992). spiderplots versus tornado diagrams for sensitivity analysis. interfaces, 22 (6), 40-46. fitzsimmons, j., & fitzsimmons, m, (j998). service management: operations, stratei:y. and jnfonnation technology 2nd ed. new york: irwinlmcgraw-hill. goldratt, e.m. (1994). its not luck. great barrington, ma: nqrth river press. hill, t. (1994). manufacturing strategy 2nd ed. chicago: irwin. imai, m. (1986). kaizen: the key to japan's competitive success. new york: mcgrawhill. jointer associates. (1990). jointer 7 step method. madison, wi: jointer associates. spring 2000 reid & koljonen: systems-based framework 63 juran, j.m. (1989). juran on leadershjp for quality. new york: free press. koijonen, e.l., & reid, r.a. (l998a). synergy in toc thinking processes and system dynamic models. santa fe, nm: paper presented at poms98 conference. --(l998b). identifying service customer concerns: using a walk-through audit and the analytic hierarchy process. proceedini:s of the 29th national conference of the decision sciences institute. las vegas, nv: dsi. melam, e.h. (1993). process management. new york: mcgraw-hill schoderbek, p.p., schoderbek, c.g., & kefalas, a.g. (1990). management systems 4th ed. chicago: irwin. scholtes, p.r. (1988). the team handbook. madison, wi: jointer associates. schonberger, r.j., & knod, e.m. (1997). qperations management 6th ed. chicago: irwin. senge, p. (1990). the fifth discipline. new york: doubleday. tague, n. (1995). the quality toolbox. milwaukee, wi: asqc quality press. walton, m. (1986). the deming management method. new york: putnam publishing. richard a. reid is a professor of operations management in the anderson schools of management at the university of new mexico where he teaches undergraduate and graduate courses in systems and production/operations management. he received a ph.d in systems research and an mba from ohio state university, as well as a b8me from case institute of technology. dr. reid has published over 100 articles in national and international journals and is the co-author of a book entitled: competitive hospitals. he has been a consultant to private sector and governmental agencies in the application of total quality tools to address production, service, and delivery problems under the guise of process improvement. elsa l. koljonen received her bachelor of laws degree with honors from the university of hong kong. she was a legal practitioner in hong kong prior to emigrating to the united states in 1992. ms koljonen earned her mba in operations management from the university of new mexico in 1997. currently resid· ing in arizona, she is the commodity manager for the assembly capital equip· ment development group at the intel corporation. a systems-based framework for continuous improvement: a service sector application testing the applicability of porter's generic strategies in the digital age: a study of korean cyber malls eonsoo kim korea university seoul, korea dae-il nam lg economic research institute seoul, korea j. l. stimpert colorado college colorado springs, co abstract although traditional strategic management theory evolved in the context (~f brick and mortar firms operating in a physical space, we propose that porter's (1980) generic strategy framework is still applicable, albeit in need of some mod!fication, to competition in the digital age. this study tests that assertion in a sample of korean online shopping malls. in particular, it explores the following research question: do porter's (1980) generic strategies explain performance differences across business-to-consumer (b2c) firms? our results suggest that porter's generic strategies are applicable to ebusiness and that they indeed explain performance differences across firms. contrary to conventional wisdom, but consistent with the logic of business in the digital realm, the cost leadership strategy exhibited the lowest performance. firms pursuing a hybrid cost leadership/differentiation strategy exhibited the highest performance. interestingly, when a sub-sample ofall firms pursuing the hybrid strategy was analyzed for performance differences by firm type (pure plays vs. clicks-and-bricks), pure plays exhibited superior performance. our findings suggest that cost leadership and differentiation can be combined at the same time, and must be combined to be successful in e-business. the inexorable worldwide spread of the internet and unprecedented rates of adoption of computer and telecommunication technologies by firms in north america, western europe, and selected parts of asia continue to erode the relevance of traditional strategic weapons such as geographic location and favorable physical resources. the internet now allows firms located anywhere in the this study was supported by a korea university grant. 20 journal ofbusiness strategies vol. 21,no.1 world to project their influence in distant markets without creating a physical presence. likewise, computer and telecommunication technologies are making the possession of heretofore advantageous physical resources increasingly irrelevant. how is the new information age different from the machine age of the last 100 years? managers and scholars alike are struggling to understand how economic and business rules have changed and should change. many have claimed that the old concepts will not be applicable in this new environment. as scholars, we ask whether existing strategy frameworks, models, and tools are applicable in this new age. traditionally, one of the main streams of strategy research examines the relationship between strategy type and firm performance (carter et ai, 1994; dess & davis, 1984; kim & lim, 1988; mcdougall & robinson, 1990; miller, 1987; porter, 1980). these strategy types, sometimes called generic strategies (porter, 1980), archetypes, or gestalts (robinson & pearce, 1988), simplify a myriad of possible strategies into a limited set of strategy types. we do not know, however, whether these strategy types can be applied to e-businesses (smith et ai, 1999). this paper asks whether we can use conventional generic strategy concepts to understand, explain, and predict firms' strategic behaviors and performance outcomes in the internet age. while enthusiasm for e-business, especially 82c business, has waned since the internet boom period of the late 1990s, business activity on the internet continues to grow. although current management theories evolved in the context of brick and mortar firms, we propose that porter's (1980) generic strategy framework is still applicable, albeit in need of some modification, to competition in the digital age. this study tests that assertion using data from a sample of korean online shopping malls. in particular, the study explores the following research questions: 1. what strategy types are found among e-business firms? will they resemble porter's (1980) generic strategy types? 2. will we find performance differences among internet business firms using different strategy types? 3. will we find differences in the strategy-performance relationships of pure online firms (pure plays) and firms with both online and off-line operations (clicks and bricks)? generic strategies and e-business academicians have long been interested in the concept of strategy types (fahey & christensen, 1986). previous research on strategy types includes studies offering new typologies based on empirical analyses (abell, 1980; miles & snow, 1978; mintzberg, 1988; porter, 1980), replication studies (kotha & vadlamani, 1995; miller & dess, 1993; miller & friesen, 1986), and studies adding new variables (hambrick, 1983; kim & lim, 1988; miller, 1988). the spring 2004 kim et al: porter s generic strategies 21 most widely used strategy types are those developed by miles and snow and porter (douglas & rhee, 1989). we focus on porter's framework of generic strategies for the following reasons. first, porter's framework of generic strategies is inherently tied to firm performance. second, porter's framework overlaps with other typologies. for example, miles & snow's (1978) prospector is similar to porter's strategy of differentiation, and miles & snow's defender and hambrick's (1983) and dess & davis' (1984) cost leadership strategies are similar to porter's strategy of cost leadership. miller & friesen's (1986) niche innovator is similar to porter's strategy of focus. finally, porter's framework has received more research attention than any other concepts (kim & lim, 1988). in the sections below, we discuss the characteristics and extend the applicability of porter's generic strategies in e-business environment. cost leadership strategy cost leadership is believed to be a viable strategic choice in internet commerce as in off-line businesses. lower price has been a key selling point of ebusiness firms like expedia.com and cdnow in america and yes24 (an internet bookseller) in korea. the cost leadership strategy may be particularly appealing to online buyers who are price sensitive. in one study conducted in korea, 71 percent of 500 first-time online shoppers indicated that price was their most important consideration (kim & kim, 2000). the internet eliminates many traditional time and spatial barriers. early movers' strategies are easily imitated and entry barriers are much lower than in conventional businesses. as a result, lower costs can be an effective defensive measure against competitors, since firms can be profitable even in the face of fierce competition if their costs are low enough. and, the low prices offered by market leaders (based on their lower costs) can serve as an effective entry barrier against new entrants. the internet also allows firms to adjust their prices quickly so that internet firms can enjoy a higher level of pricing flexibility and more efficient price competition (bakos, 1998). the internet also helps consumers overcome bounded rationality in terms of price scanning. the long held cyert and march's (1963) satisficing argument may be less applicable in an internet environment since the speed and expansiveness of information search made possible by the internet enable consumers to quickly gather a wealth of data on price comparisons. price comparison sites drastically reduce search costs, so consumers may approach near-optimal price comparison (bakos, 1997). another characteristic of e-businesses is the law of increasing returns (arthur, 1996). for a firm to enjoy increasing returns, it must secure a critical mass of consumers as soon as possible. competitive pricing often offers the quickest and easiest way for a firm to secure the largest number of consumers. 22 journal o.lbusiness strategies vol. 21,no. 1 differentiation strategy a successful differentiation strategy can be built on many factors, including design, brand image, reputation, technology, product features, networks, and differentiated customer service, and true differentiation should be hard for competitors to imitate. many of these differentiating elements are applicable to an internet business. chang (1997) found that customers of internet bookstores in korea saw brand as more important than price as their buying criteria. he also reported that more people used these web sites to search for information and to find certain books than to compare prices. lynch and ariely (2000) found that price might be ignored as long as the product-customer fit is enhanced. they also found that buyers became less sensitive to price when they were given more information about how a particular product might meet their needs. a key aspect of internet marketing is not just offering differentiated products and services, but also differentiating the channel (kim & lim, 1988; miller, 1991). according to one recent study by netsmart america, brand is becoming more and more important, with 65 percent of the respondents to the firm's survey indicating that brand is the most important determinant of website visits (www. i-biznet.com, 8/3/2000). the survey also found that price was an important factor in purchasing decisions for relatively low price items such as books, entertainment, and toys, whereas brand was a more important consideration when purchasing computers, automobiles, furniture, banking, and security investments. lower switching costs on the internet also encourage differentiation. in traditional businesses, consumers often tolerate mediocre products and services due to high switching costs. in the e-business environment, however, consumers can get access to information previously impossible to obtain or to compare. as a result, consumers can more easily switch to firms that offer additional value through differentiated features (kim, 2000). in the e-husiness environment, in addition to the traditional factors such as brand image, product features, and customer service, speed of delivery, convenience, and the security of transactions are important elements of any differentiation strategy. although popular sites like amazon.com do not always offer the lowest prices, people are attracted to these sites because of their brand reputation and credibility (smith et ai, 1999). this suggests that many e-business consumers are more concerned about security or delivery than price. focus strategy firms pursuing a focus strategy target specific groups of buyers or product lines. within their more limited competitive scope, they emphasize either low costs or differentiated products and services. many internet companies are new entrants. these new entrants may choose to compete against large, established firms by focusing on a particular niche. concentrated management of a niche market should not only increase their chances of success, but should also serve as an entry barrier. in addition, the lower levels of investment required by many online businesses means that they enjoy lower break-even points. thus, tarspring 2004 kim et al: porter:s generic strategies 23 geting even small market segments can be viable, and consumers may be easily connected with producers that focus on niche markets due to the internet's search advantages. furthermore, the internet allows firms to customize their offerings to meet the specific wants and needs of their customers (bakos, 1998). customers are identified every time they visit a website, and a great deal of information about each customer can be accumulated over time. based on this information, firms can offer customized products or services for a particular customer. propositions types of strategies and their performance implications we do not know with certainty whether the new e-business environment represents a totally different, discontinuous change from the old business environment or whether the old and new environments will share many features and competitive imperatives. therefore, we have made several assumptions about the application of conventional generic strategies in the e-business environment. one critical assumption underlying this study is that electronic technologies create a platform to support existing business practices and at this point have not advanced to the point of precipitating a paradigm shift. although the internet provides an efficient means to order products, it is not entirely a new way of doing business. for example, the catalog retailers with toll-free numbers and automated fulfillment centers have been around for decades. the internet only changes the front end of the process (porter, 200 i). uu & arnett (2000) argue that, just as in off-line commerce, e-business firms should attract customers in the pre-sales phase, make purchasing happen in the on-line sales phase, and provide customer service and problem resolution in the after-sales phase. finally, one of the most obvious advantages of e-business seems to be lower cost due to the absence of physical locations. however, schlauch & laposa (200 i) found that pure on-line firms were not realizing real estate-related cost savings over their retailing competitors (brick and mortars and clicks and bricks). as a result, we assume that firms still view customers in terms of shared characteristics (i.e., market segmentation is possible), that different sets of customers have different needs and desires (i.e., opportunities for product differentiation exist), and that products and services exhibit different demand elasticities (i.e., firms may compete on price). and, as suggested in the previous section, we assume that each of porter's generic strategies can be applied to explain the behavior of internet business firms. hence, we offer the following proposition: proposition 1: e-business .firms will pursue a set of generic strategies similar to porter's generic strategies ofcost leadership, differentiation, and focus. 24 journal of business strategies vol. 21, no.1 cost leadership is widely practiced today among firms that sell standardized products and services such as cds (cdnow.com) and books (barnesandnoble. com). the benefit of cost leadership, typically manifested as price competitiveness, is a common competitive dimension among internet firms. and, among first-time online shoppers, price may well be the most important factor influencing their buying decisions (kim & kim, 2000). this may be partially attributable to ease of scanning and comparing prices on the internet (bakos, 1998), however, easy price comparisons and very low customer switching costs suggest that firms pursuing a strategy of cost leadership could easily become locked in a vicious cycle of price-cutting. therefore, differentiation based on either customizable products, a customized online experience, or both may be a more viable strategic weapon. firms that reduce customer search costs, engender trust, and offer products, services, and online experiences tailored to their users' needs are likely to elicit initial and repeat purchases. amazon.com, for example, uses collaborative filtering software to offer its users customized page views based on past searching habits. the software also permits amazon to engage in anticipatory marketing by suggesting titles that may appeal to customers. traditionally, cost leadership and differentiation or their equivalents were regarded as equally effective strategies (miles & snow, 1978; porter, 1980). we suggest otherwise. for obvious reasons, price competition will almost certainly intensify in the internet business environment, and firms with commodity-like products will face great pressure to keep their prices as low as possible. therefore, the logical strategy choice for firms wanting to survive on the internet would be differentiation. since focus strategies are only different from cost leadership and differentiation in terms of the scope of competition, they have been regarded as just as viable as the other strategies depending on the circumstances. in e-business, however, focus strategies may be more attractive than cost leadership strategies. as discussed above, the potentially low cost base and thus, low break-even point, coupled with the relatively smaller size of many e-business entrants, may give firms employing a focus strategy a better chance of success. on the other hand, it is difficult to argue that a focus strategy will be superior to differentiation. hence, we offer the following proposition: proposition 2: in e-business, the generic strategy of differentiation will be associated with higher performance than the generic strategies of cost leadership andfocus. hybrid or stuck-in-the-middie strategies porter (1980) argued that cost leadership and differentiation are such fundamentally contradictory strategies, requiring such different sets of resources, that any firm attempting to combine them would wind up "stuck-in-the-middle" and fail to enjoy superior performance. and, from a traditional business perspective, spring 2004 kim et af: porter s generic strategies 25 cost leadership and differentiation do seem incompatible. cost leadership requires standardized products with few unique or distinctive features or services so that manufacturing and production costs are kept to a minimum. on the other hand, differentiation usually depends on offering customers unique benefits and features, which almost always increase manufacturing and marketing costs. subsequent studies have both supported and called into question many of porter's claims. for example, hambrick (1983), using pims data, was able to identify firms pursuing cost leadership, differentiation, and focus strategies in two different capital goods industries. miller and friesen (1986) and miller (1988) also confirmed the existence of porter's generic strategies. dess and davis (1984) found that firms employing only one of porter's generic strategies outperformed firms pursuing elements of more than one strategy. robinson and pearce (1988), in their study of97 manufacturing firms, found that stuck-in-themiddle firms showed lower levels of performance. kim and lim (1988) also found firms pursuing porter's generic strategies in a sample of 54 high-growth electronic firms in korea, and they concluded that firms pursuing one of the generic strategies outperformed firms pursuing more than one of the strategies. many more recent articles and studies have, however, challenged porter's typology and questioned his claims about the exclusivity of the generic strategies. for example, hill (1988) challenged porter's claim about the exclusivity of cost leadership and differentiation, and argued that sustainable competitive advantage rests on the successful combination of these two strategies. murray (1988) critiqued porter's typology, and noted that the development of any successful business strategy must reflect the larger competitive environment. and, since industry environments do not specifically prescribe the need for cost leadership or differentiation, murray found little reason to conclude that only one strategy should be employed in response to any particular environment. similarly, a study by wright et al (1990) found that multiple strategies are needed to respond effectively to any business environment. miller and dess (1993) could not confirm the proposition that a combination strategy would be associated with lower performance. furthermore, it seems that turbulent environments (kim & mcintosh, 1999) and global environments (chan & wong, 1999) require flexible combinations of strategies. in a study by booth and philip (1998), only two out of sixteen successful sample firms employed a unitary generic strategy. the remaining firms in their sample employed flexible, multi-dimensional strategies combining elements of cost leadership and differentiation in order to meet the needs of customers. karnani (1984) proved that a combination strategy was feasible using game theory. and, more than a decade ago, glazer (1991) predicted that firms would not need to choose between strategies of low cost and differentiation. any incompatibility between cost leadership and differentiation may have held true in the midto late 1980s when business environments were relatively stable. rapidly changing competitive environments call for more flexibility as well as the ability to mix more than oile generic strategy. mass customization and the development of network organization concepts both demand and make 26 journal ofbusiness strategies vol. 21, no.1 possible the flexible combination of multiple generic strategies (anderson, 1997; goldman et ai, 1995; pine, 1993; preiss et ai, 1996). and, evans and wurster (1999) concluded that the internet disassembles traditional value chains, introducing new competitive imperatives and requiring new strategies. another major change is the disappearance of trade-offs between information richness and information reach. the internet's universality and its ability to reduce information asymmetries and transactions costs will also create opportunities to "rewrite the rules" on business strategy (afuha & tucci, 2001). therefore, we believe that a combination of generic strategies in e-business competitive environments is not only possible but may be required. thus, we offer the following proposition: proposition 3: hybrid strategies combining more than one generic strategy will be associated with higher performance relative to the strategies of differentiation or cost leadership. pure plays vs. clicks and bricks two broad types of internet businesses exist. one is the pure online firm (pure plays), and the other includes firms with both online and off-line businesses (clicks and bricks). during the earlier stages of e-business, many observers believed pure plays would be in a stronger competitive position. this thinking argued that pure plays would be more flexible and better able to leverage their first mover advantages. they would not be hindered by conflict between online and traditional marketing channels. they would also enjoy greater flexibility in pricing. a good example is provided by a pure online firm like netscape, which was able to seize a dominant share of the browser market by ignoring conventional "rules" (yoffie & cusumano, 1999). recent history has proven otherwise. the traditional off-line firms, which joined the internet as second movers, did struggle at first. by the end of 1998, however, many of them were becoming market leaders. in a market survey done by mediamatrix, clicks and bricks firms such as barnes & noble, toys 'r' us, and kbkids were included among america's top ten internet shopping sites (www.i-biznet.com). also, according to nielsen/netratings, eleven of the fifteen most frequently visited websites at the end of2000 were firms with both online and off-line operations such as toys 'r' us and barnes & noble (lee, 2001). since clicks and bricks firms are already familiar to customers and have credible brands, other things being equal, customers should prefer clicks and bricks internet sites to those of pure plays. furthermore, clicks and bricks can offer product returns and other customer services through their physical storefronts (griffith, 1999). zettlemeyer (1996) showed that clicks and bricks firms could enjoy higher performance by properly combining their online and off-line businesses, whereas the ability of pure plays to provide information would be limited to their online channel. brynjolfsson and smith (2000) concluded that the brand recognition, reputation, and credibility of clicks and bricks firms are important advantages that pure plays often lack. modahl (2000) argued that e-business will spring 2004 kim et al: porter ~~ generic strategies 27 be dominated by clicks and bricks, particularly by established firms that expand online by leveraging their off-line assets such as distribution channels, brand reputation, and credibility. also, many pure plays are realizing the advantages of adding off-line elements to their online business: it turns out that online retailing is not so different from traditional retailing, and it takes more than a glitzy web site to be successful... smart e-tailers realize that the only way to ensure quality customer service is to build and stock warehouses, pack the boxes, and have sufficient staff to handle customer calls and returns. e-tailers that rely on manufacturers and distributors to handle inventory and order fulfillment encounter product shortages and late deliveries ... amazon's recent shift in strategy is another good example of just how important warehousing is to e-business. amazon is building several enormous warehouses that send out merchandise in bulk to retail stores. amazon's warehouses and distribution network are designed specifically for online retailing and will allow merchandise to be sent out item by item to individual customers. several other internet retailers are also building warehouses and distribution systems (glover et ai, 2001:36-37). thus, at this stage, it appears that click and brick firms enjoy a number of advantages over pure plays. hence, we offer a final proposition: proposition 4: the relationship between strategy and performance will be moderated by type affirm, with click and brick firms enjoying performance advantages over their pure play counterparts. methods a questionnaire, drawing on previous studies of the relationship between generic strategies and firm performance, was developed. the questionnaire included questions about strategy and asked respondents for their subjective evaluations of performance. strategic variables seventeen of 20 strategy questions were derived from studies of brick and mortar businesses (carter et ai, 1994; dess & davis, 1984; kim & lim, 1988; kim & mc intosh, 1999; mcdougall & robinson, 1990; miller, 1986). the remaining questions about security, convenience of transaction, and speed of delivery were derived from smith et ai's (1999) study of digital businesses (table 1). 28 journal ofbusiness strategies table 1 list of strategic variables vol. 21, no.1 competitive method literature review'" scale cd @ @ @ ® 1. broad product range · · · · · 2. new product development · · · · 3. extensive customer service capabilities · · · • 4. expenditure on r&d · · · 5. response to market · 6. early catch on customer needs · · 7. breadth of customer type · · 8. continuing concern for lowest s&a expenses · · · 5-point 9. emphasis on niche market · • • 10. image building affirm and product · · • • · likert 11. emphasis on intangible asset including patent • 12. average age of major products · scale 13. serving special geographic markets · · 14. emphasis on specialized market · · 15. economy of scale • 19. efficient procurement • · • • 20. lower price · · • • • 16. online security 17. easy to pay 18. delivery speed "j (1) dess & davis, (2) miller, @ kim & urn, w mcdougall & robinson, (5) carter et al performance variables unfortunately, korean internet firms, like their american counterparts, provided objective financial performance data that were not highly reliable for assessing performance. at the time of the study, not so many profitable internet businesses existed, and due to the high level of early investments in development and marketing, any successful internet businesses were marginally profitable. and, in the case of clicks and bricks companies, it is often difficult to separate their online and off-line operations. although more reliable financial measures become available as e-business enters a more mature stage (business week, 5/12/2003), we decided not to collect objective measures for this study. lacking credible objective data, subjective measures that rely on respondents' perceptions become a viable alternative (brush & vanderwerf, 1992; murphy et ai, 1996; robinson & pearce, 1988). five subjective performance measures were adopted from the study by robinson and pearce (1988) revenue, rate of growth, growth potential, profitability, and overall firm performance. we asked respondents to indicate their perceptions of their firms' performance on these five dimensions using 5-point likert scales. spring 2004 kim et al: porter :'1 generic strategies 29 in addition to these self-report, subjective measures of performance, the study also used an objective measure of performance as suggested by murphy et al (1996). for this study, we used data on average site traffic and visits that were obtained from rankserv (www.rankserv.com). rankserv estimates the larger population's use oflnternet sites based on a sophisticated analysis of more than 40,000 computer users whose activities are monitored through the installation of a special program called ntaker. sample the questionnaire was pilot-tested using a small random sample of b2c online malls listed in the cyber shopping mall directory published by the korean chamber of commerce. after refinements were made and the survey instrument was finalized, it was emailed to the ceos of 1,009 firms included in either the cyber shopping mall directory or yahoo's korean site (www.yahoo.co.kr). in total, 77 questionnaires were returned, two of which were unusable, so the final sample included responses from 75 firms. although the study's response rate was low by traditional research standards, in light of the 15-second time limit beyond which online users become bored and lose interest, our response rate can be considered exceptionally high (williams & richard, 2000). and, a sample of 75 firms is not so small considering the samples used in previous studies of generic strategy. for example, kim and lim (1988) analyzed 54 firms, miller (1991) 52 firms, covin et al (1990) 57 firms, and sandberg & hofer (1987)just 17 firms. since this study is about business strategy and firm performance, we asked that the questionnaire be answered by a person who was knowledgeable of the firm's strategic direction, and we were gratified that 75 percent of the surveys were answered by senior level (or higher) executives. more than 50 percent of the sample firms were less than two years old. those firms over four years old 24 firms were all clicks and bricks firms. and, more than 80 percent of the sample firms had fewer than 300 employees. results reliability of the survey instrument the cronbach a of nearly every variable was higher than. 7, which suggests a high degree of reliability. the only variable with a cronbach a less than.7breadth of customer type was excluded from further analyses. correlations among the five subjective performance measures were all significant (p < .05), reflecting a great deal of internal consistency among the performance variables (table 2). 30 journal of business strategies table 2 corelations among performance variables vol. 21,no.1 sales growth rate growth potential profit overall finn perfonnance ***p > 0.01 revenue .803*** .370*** .622*** .806*** growth rate .515*** .585*** .754*** growth potential .457*** .581 *** overall firm profit performance .455*** identifying strategy types with little prior research on strategy types among e-businesses, we employed a two-step approach to derive strategic dimensions and strategy types (carter et ai, 1994; kim & lim, 1988; mcdougall & robinson, 1990). factor analysis was used to identity strategic dimensions based on the strategy variables. principal components analysis employing a varimax rotation produced five strategic dimensions (table 3). factor i is labeled "market leadership." this is a very broad strategic dimension that includes staying sensitive to market changes, promptly reflecting customer needs in products, and offering a high level of customer service. also included are a high level of investments in new product development and r&d, and charging competitive prices while maintaining brand reputation, and speed of delivery. factor 2 involves the variables specific to internet-based competition, which are differentiated from traditional off-line business factors. among the variables loading on factor 2 are security of online transactions and ease of payment. as a result, this dimension is consistent with efforts to differentiate by focusing on characteristics particular to e-business, and it is labeled "internet-specific differentiation." although security and ease of payment are also valuable in traditional industries as well as e-business, lack of physical elements (face-ta-face transaction in physical space) in e-business makes them particularly important. it should be noted that "internet-specific" does not mean "internet-only." variables loading on factor 3 include an emphasis on niche and specialized markets, while also emphasizing lower administrative expenses. this factor is labeled "focus." [/). table 3 '0 :1. results of factor analysis :=(jq n 0 variables factor 1 factor 2 factor 3 factor 4 factor 5 0.0:. vi. broad product range -0.55724 -0.21762 0.36193 0.11084 -0.33452 v2. new product development 0.77921 0.32298 -0.03628 -0.01794 0.06616 v3. extensive customer service capabilities 0.52482 0.47834 0.28653 -0.05255 0.10350 v4. expenditure on r&d 0.75255 0.03304 0.08277 -0.19600 -0.00122 >:; v5. response to market 0.69430 0.19035 0.40005 -0.04494 -0.06528 -. ~ v6. early catch on customer needs -0.70509 -0.20753 -0.25676 -0.08549 0.24449 ~.... vio. image building of firm and product 0.47672 0.39844 0.21590 -0.39713 -0.01869 ::::. ;-v18. delivery speed 0.46518 0.39084 -0.22546 0.06044 -0.03780 "i::lc) v13. serving special geographic markets -0.65581 "'l -0.18186 -0.02754 0.05398 0.16246 ....~ "'l v16. online security 0.27258 0.80141 0.03431 -0.02452 -0.12716 "'. v17. easy to pay 0.09571 0.82675 0.14435 0.03116 -0.00792 c::1 r;:, :::: v8. continuing concern for lowest s&a expenses -0.01672 0.29983 0.70185 0.15561 0.28919 f':l"'l-. v9. emphasis on niche market 0.15891 -0.04492 0.82693 -0.08592 -0.07440 r, ~ v14. emphasis on specialized market 0.31717 0.15556 0.47605 -0.30685 -0.32599 "'l::::..... vii. emphasis on intangible asset including patent 0.24272 0.38218 0.00647 -0.54203 0.38422 r;:, .crq vis. economy of scale -0.04751 0.06490 -0.04128 0.87194 0.05888 ~. '" v20. lower price 0.46948 0.06649 0.09411 0.45610 -0.14706 v12. average age of major products 0.04955 -0.15302 0.08948 -0.05280 0.74743 v19. efficient procurement 0.50615 0.15935 0.14787 -0.00448 -0.57061 eigen value 3.96519 2.84787 2.01093 1.61962 1.48784 ~ 32 journal of business strategies vol. 2], no.1 factor 4 is related to competitiveness based on costs and, in tum, price. variables loading on this dimension include an emphasis on economies of scale and lower costs and competitive prices. this factor is very similar to the generic strategy of "cost leadership," and thus we use this label. finally, factor 5 includes variables associated with the product life cycle. variables loading on this factor were efforts to shorten the product life cycle and efficient procurement. this factor is labeled "product proliferation." types of strategy cluster analysis was applied to the set of strategic factors previously identified by factor analysis in order to identify different strategy types and to examine the relationship between strategy type and firm performance. ward's method, an agglomerative hierarchical clustering procedure, was used. table 4 shows the result of cluster analysis. f values indicate that the five clusters or strategy types summarized in table 4 are meaningfully different from one another. the duncan grouping test also shows that there are significant differences among the ci usters. the first strategy type has the highest scores on three of the five strategic dimensions and it is also highly ranked on the two other dimensions. we labeled this "hybrid strategy," because firms pursuing this strategy type are engaged in diverse market domains with diverse products, take advantage of online specific differentiation factors, and, at the same time, pursue cost advantage. these firms may look like porter's (1980) stuck-in-the-middle companies, however, this strategy is totally different in that a high level of resources is committed on almost all of the strategic dimensions. similar combinations of strategic elements have also been found in other studies (carter et ai, 1994; kim & mc intosh, 1999; zajac & shortell, 1989). porter did mention the possible combination of differentiation and cost leadership, but only in the case of firms pursuing the focus strategy. since the integrated strategy found in this study has a negative value on focus (-.00824), we can conclude that this result represents a successful merging of broad differentiation and cost leadership. the largest number of sample firms (n =: 19) belonged to the second strategy type. this type has a positive and distinctive value only on the cost leadership dimension (.78757). (although it is ranked second on this dimension behind the hybrid strategy, the two groups are not statistically different according to duncan grouping test results.) with little emphasis on focus, market sensitivity, or product development, these appear to be electronic shopping malls competing solely on the basis of price. this strategy type was labeled "cost leadership." the third strategy type occupies a less than even mediocre position on every strategic dimension. other than the score on internet-specific differentiation, which is close to zero, all of the other strategic dimensions carry negative values. this may reflect lack of clear strategic direction and resource commitment, representing the prototypical "stuck-in-the-middle" case. still, 15 firms, or a table 4 u'j "'0 ""'t results of cluster analysis 5'(jq n 0 0 cluster i cluster ii cluster iii cluster iv cluster v duncan .4 (n'" 12) (n'" 19) (n'" 15) (n'" 12) (n =: 17) f value grouping integrated cost stuck-in-thefocusedonline test strategy leadership middle differentiation focus (a'" 0,05) market ~-. si leadership .7695125(1) -.1393342(3) -.2263747(4) .2004550(2) -.3292147(5) 2.916** 1iv, iv ii iii v ~.... :::, c"':' internet specific "'t1c ""i: differentiation .8348433(1) -.9024679(5) ,1973480(3) -,3685483(4) .5053612(2) 12.198*** i v, v iii, iii iv, iv ii .... ii) ""i: v,' c;) focus -.0082400(3) -.1102679(4) -1.2426947(5) .5683075(2) ,8243935(1) 19.316*** v iv, i ii, iii ii) ;:: ii) ""i:-, i") cost leadership .8428858(1) .7875768(2) -.5532913(4) -1.2178508(5) -,1273518(3) 24.242*** i ii, v iii, iv ~ ~.... product proliferation .1831842(3 ) ,8383542(1 ) -,9897694(5) 11.592*** ~ .5161492(2) -,1938967(4) iv i, i ii, lilli, v ri' v, *: p<.l **: p<.05 ***: p<.oi numbers in parentheses are ranks of scores in descending order v..> v..> 34 journal ofbusiness strategies vol. 21, no.1 full 20 percent of the sample, were pursuing strategies characterized by using this strategy type, and it may be a characteristic of the chaotic early e-business environment (kim & mc intosh, 1999). the fourth strategy type resembles porter's differentiation strategy. this type scores high on market leadership and product proliferation dimensions, indicating an emphasis on staying sensitive to customer needs through diverse products with short life cycle. since this type scores lowest (-1.21785) on the cost leadership dimension, it combines premium pricing with differentiated marketing efforts. it also, along with the fifth cluster, scores very high on the focus dimension. as a result, this strategy is labeled "focused differentiation." the last strategy type shows the highest score on the focus and internet-specific differentiation dimensions, while also ranking very low on the other dimensions. these firms do not appear to be concerned with price competition or overall market leadership. instead, they appear to aim at a small segment of online customers, emphasizing internet-specific factors such as transaction security and payment convenience. this strategy type is labeled "online focus." overall, we observe all of porter's strategy types in our analyses of data gathered from internet businesses, so we conclude that proposition 1 is supported. the major differences are the presence of the successful hybrid strategy type and the absence ofa pure differentiation strategy. emergence of the hybrid strategy draws our attention. twelve firms pursued the hybrid strategy, while fifteen firms were classified as stuck-in-the-middle. it indicates that hybrid strategy is an additional, distinctive strategy type in e-business, not just an anomaly. strategy types of pure plays and clicks and bricks we further divided the sample into pure plays and clicks and bricks to see ifany differences in the distribution of strategy types existed that could be explained by firm type. since these were nominal categorical variables, we used lambda value and chi-square tests and found no significant differences between the two groups (a, p = .437; xc, p = .557). whether a firm was a pure online or a brick and click player did not make a difference in the type of strategy it employed. relationship between strategy and performance the relationships between strategy types and performance are presented in table 5. the five separate subjective performance measures as well as an aggregated, or average performance measure are shown. also included is the objective performance indicator that is based on average web site traffic. according to the duncan grouping test, the five strategy types clustered into two meaningfully different groups for both the subjective and objective performance measures. based on our analysis, we can say 1) that firms using the cost leadership strategy were, without exception, the worst performers, and 2) those firm employing the hybrid strategy were the best performers. the performance of firms employing focus strategies was between these two groups. therefore, both propositions 2 and 3 were supported by our analyses. table 5 (/j "c.1 '"1 strategy types and performance s'll'q n 0 0 cluster i cluster ii cluster iii cluster iv cluster v duncan .j:;. (n = 12) (n = 19) (n 15) (n = 12) (n = 17) f value grouping integrated cost stuck-in-thefocusedonline test strategy leadership middle differentiation focus (a = 0,05) sales 45833(1) 3.6000(4) 3.6471(3) 4.0000(2) 3.3158(5) 3.27(p=.0 16) i, ivv iii ii ~..... ;:: ~ growth rate 4.4167(1) 3.4211(5) 4.0000(3) 4.1667(2) 3.9412(4) 2.01(p=.102) i, iv iii v ii ..... i::< :-:-growth potential 4.7500(2) 3.9474(5) 4.8667(1) 4.7500(2) 4.5882(4) 4.l7(p=.oo4) iii iv i v, ii ~"ii..... ~ "ii profit 4.3333( l) 3.2105(5) 3.6667(4) 3.8333(3) 4.1176(2) 3.35(p=.014) i v, iv hi ii ",' q ~ :::l overall finn ~"ii performance 4.5833(1) 3.5263(5) 4.2667(2) 4.2500(3) 3.9412(4) 2.93(p=.026) i, iii iv v ii 2;' v) ~ i::< subjective performanceal 4.5333(1) 3.4842(5) 4.0800(3) 4.2000(2) 4.0471(4) 4.05(p=.005) iiviiiv,n ~..... ~ objective performanceb' 5191(1) 15612(3) 11987(4) 17586(5) 15120(2) 2.11(p=.088) i, iii v ii iv a) average score offive performance measure items b) numbers in parentheses are ranks. the smaller the value, the higher the rank. w vi 36 journal ofbusiness strategies vol.2l,no.l this study found a successful hybrid strategy in addition to porter's (1980) concept ofa low-performing stuck-in-the-middle strategy. yet, firms pursuing a pure cost leadership strategy experienced even lower levels of performance than firms pursuing the low-performing stuck-in-the-middle strategy. firms pursuing the successful hybrid strategy enjoyed superior performance across all five subjective performance measures as well as the objective performance measure, while firms pursuing the cost leadership strategy ranked very low on every performance measure. when we further divided the sample by firm type (pure play and clicks and bricks) to produce ten distinct groups of firms, the pure play firms pursuing the hybrid strategy (group 2) were the best performers on the subjective performance measures. however, for the clicks and bricks firms, those pursuing the stuck-in-the-middle strategy (group 5) showed the highest performance. no significant performance differences existed between these two groups, however (table 6). pure online firms employing the cost leadership strategy (group 4) again showed the lowest performance. the differences between the firms in group 5 and group 6 draw attention. both sets of firms use the same strategy, stuck-in-the-middle, however, the clicks and bricks firms (group 5) showed the highest performance, while the pure play firms (group 6) showed distinctly lower performance, providing empirical support for proposition 4. discussion before discussing the results of this study, we must acknowledge its limitations. first, we studied korean cyber malls, which represent a rather narrow portion of the entire e-business space. additionally, cyber malls are representative of b2c commerce only, so our findings may not apply to b2b (business to business), b2g (business to government), g2c (government to consumer), and c2c (consumer to consumer) variants of e-business. and, the study's countryspecific focus suggests that it may not be applicable to other nations. the low response rate may also limit our study's findings. by taking advantage of the potential reach of an online questionnaire, this study surveyed the entire population of 1,009 online shopping malls, but the final sample was only 75 firms. during the ten-day period that followed the distribution of our survey, 215 questionnaires were returned unanswered either because the "firm no longer exists," or the "address changed," reflecting the volatile nature of e-business. since, we believed it would take ten minutes to complete the questionnaire. and considering the short attention spans that are a characteristic of cyberspace according to one study, attention spans rarely exceed 15 seconds (williams & richard, 2000) and the large amount of junk mail many internet users receive, our study's response rate may actually be surprisingly high. but still, the low response rate raises a concern regarding the representativeness of the sample firms. table 6 u'.l "0 '"1 strategy types and performance with type of firms considered ..... ::l oci tv 0 cluster i cluster ii cluster iii cluster iv cluster v 0 duncan .j::o. (n = 12) (n = 19) (n = 15) (n = 12) (n = 17) f value grouping integrated cost stuck-in-thefocusedonline test strategy leadership middle differentiation focus (a = 0,05) on& on& on& on& on& off on off on off on off on off on ~-. 1 2 3 4 5 6 7 8 9 10 ~ (':> 215871039 -i:::> sales 4.57 4.60 3.61 2.66 4.33 3.11 3.83 4.16 3.60 3.71 2.68*** 8710396 7;7103964 "i:lc 528110973 ~-(':> growth rate 4.14 4.80 3.76 2.66 4.83 3.44 3.83 4.50 3.90 4.00 2.8*** 81109736 ""j ",. 64 cl (':> growth potential 4.57 5.00 4.30 3.16 4.83 4.88 4.83 4.66 4.60 4.57 3.33* 2657891103 ;:s (':> ~ 4 -.<"'l profit 4.28 4.40 3.46 2.66 4.00 3.44 3.50 4.16 3.90 4.42 2.34** 1021859 ~ ~ 7364 i:::>..... overall firm 2581 ~-.(':> performance 4.42 4.80 3.69 3.16 4.66 4.00 4.00 4.50 4.00 3.85 1.81 * 7691034 '" 25 subjective performancea) 4.40 4.72 3.76 2.86 4.53 3.77 4.00 4.40 4.00 4.11 3.35*** 18109763 4 objective performanceb1 4433 5733 13906 19309 13242 11151 18358 16814 11735 19957 1.24 21 695387410 w -....) *: p <.1 **:p<.05 ***: p < .01 a) average score of five perfonnance measure items b) numbers in parentheses are ranks. the smaller the value, the higher the rank. 38 journal ofbusiness strategies vol. 21, no.1 our performance measures are another limitation. in particular, our objective measure is merely a numerical record of site visits, and so it cannot assess other important dimensions of performance such as the rate of repeated visits or the connection between site visits and actual purchase behavior, not to mention financial performance. however, there is a silver lining. garbi (2002), in a recent study, found that the rate of unique visitors, the e-business-specific measure, showed significant correlations with market value, net income growth, and employee growth. this implies that cyberspace-specific indicators, such as page views, stickiness, click-through rate, and conversion rate, may not be unreliable as performance measures. also, the subjective financial measures pose a potential common method bias problem. we can only guess that the subjective and objective measures are somewhat correlated based on the similar analysis results using either variable as the performance measure. direct comparison was not possible, since the subjective measures are discrete variables varying between 1 and 5, while the objective measure is a continuous variable ranging between 1 and 20,000. finally, cluster analysis is regarded as an art rather than a science, turning to the researcher for interpretation of the result to a large extent. although we stopped increasing the number of clusters when the semi-partial r" value noticeably diminished, the resulting clusters could be an inevitable consequence of cluster analysis. in spite of these limitations, we believe our study makes an important early contribution toward understanding the relationship between strategy and performance among e-business firms. a few of our findings are particularly noteworthy. first, our results lead us to conclude that, among e-business firms, a hybrid, integrated strategy is a must, and that a traditional cost leadership strategy is unlikely to be associated with success. our results also suggest that focused strategies those that are either narrowly defined differentiation strategies or those that focus on internet-specific characteristics such as security and convenience of transaction may have a better chance of success than cost leadership strategies. our findings could be explained in several ways. first, a high-performing hybrid strategy could be only a temporary phenomenon observed during the early stages of an industry life cycle (porter, 1980). as the industry matures and as firms begin to leverage the advantages of either a highly competitive cost structure or their ability to differentiate their products and services, firms pursuing a hybrid strategy could be weeded out. alternatively, our findings may offer evidence of an emerging economic paradigm represented by the internet. the internet radically reduces search and switching costs, enabling customers to search for optimal prices. at the same time, trust, credibility, and brand name recognition which are at the heart of differentiation become even more important in the e-business world where there is little or no physical contact between customers and company personnel. porter's argument with hybrid or integrated strategies was the potential for a lack of clear commitment to any spring 2004 kim et al: porter :~ generic strategies 39 set of strategic objectives. the successful hybrid strategies we identified were among firms that seem to be both integrating and emphasizing a number of diverse strategic objectives. the study also found that the relationship between strategy type and performance is moderated by firm type. while pure online firms enjoyed success when pursuing hybrid strategies, clicks and bricks firms did not fare as well when pursuing an integrated strategy. the contrasting results between pure plays and clicks and bricks firms may reflect the resource differences between those two groups offirms. most of the pure plays in our sample were new firms. lacking a significant infrastructure and brand recognition, these start-up pure play firms may have felt compelled to establish their strategic posture by offering both differentiated features and low prices. on the other hand, the clicks and bricks firms tended to be late-moving, established corporations that entered e-business only after they had found merit in the experiences of early-mover online firms. they may have compensated for any initial weaknesses in their online operations by leveraging their off-line operations. for example, barnes & noble appealed to customers by offering pick-ups of online orders at its off-line bookstores. this advantage of having both online and off-line operations may also have worked as a liability, however, since the clicks and bricks firms that pursued a hybrid strategy had, on average, lower levels of performance than the pure play firms. perhaps the lower performance of clicks and bricks firms with the hybrid strategy is due to conflicts between online and off-line components of the same company. conclusion our results suggest that porter's generic strategies are applicable to e-business and that they indeed explain performance differences across firms. the types of strategies found in this study are not different with some minor exceptions from those found in previous studies dealing with generic strategies in traditional industry settings. one newly observed strategy type is an internet-focused strategy emphasizing factors specific to internet firms, such as security of transactions, convenience of payment, and speed of delivery. these are regarded as critical success factors in any internet business (smith et ai, 1999). contrary to conventional wisdom, but consistent with the logic of business in the digital realm, the cost leadership strategy exhibited the lowest performance. firms pursuing the hybrid strategy combining cost leadership and differentiation exhibited the highest levels of performance. further analyses examined the mediating influence of firm type, and found that pure plays (exclusively online firms) pursuing this hybrid strategy outperformed all others. our results suggest that cost leadership and differentiation can be combined, and that perhaps they must be combined, for firms to be successful in e-business. ashmos et al (2000) found that hospitals, facing a complex environment, with higher strategic complexity outperformed those with lower strategic complex40 journal ofbusiness strategies vol. 21, no. i ity. in their study, higher strategic complexity means that a firm pursues "competitive advantage through a wider range of strategic activities (i.e., both cost leader and differentiator type activities), representing a more complex strategy (ashmos et ai, 2000: 587)." merrilees (2001) argues that some e-business firms have successfully employed a combination of two generic strategies. for example, amazon.com is very competent at all activities involving differentiation elements branding, innovation, and channel management as well as lowering costs. it is hard to classify amazon.com into either strategy-type. our major contribution is to provide early, preliminary data suggesting that the important existing strategy concept of generic strategies is relevant to and can be applied to a new business environment. considering the predominance of case studies in the e-business field, we hope this study can provide a useful platform for further rigorous, empirical studies that draw on large samples of ebusiness firms. the lack of performance measures and data may have prevented systematic empirical studies of e-business thus far, so another contribution of this study is its adaptation of existing subjective measures (robinson & pearce, 1988) and use of an objective measure for assessing the performance of e-business firms. we also found our online questionnaire to be a useful way of gathering survey data, superior to conventional mail surveys in terms of time, costs, and convenience. this study also offers some tentative implications for management practice. first, the results provide support for the viability and success of hybrid strategies for e-business firms. the study also suggests that the choice of strategy depends on firm type (pure play vs. clicks and bricks). possible synergies and potential conflicts between online and off-line operations, as suggested by this study, should be important considerations as incumbent firms develop their internet strategies. references abell, d. f. (1980). defining the business: the starting point of strategic planning. englewood cliffs, nj: prentice hall. afuha, a. & tucci, c. l. (2001). internet business models and strategies: text and cases. new york, ny: mcgraw-hill. anderson, d. m. (1997). agile product development for mass customization. chicago, il: irwin. arthur, w. b. (1996). increasing return and the two worlds of business. harvard business review, 74, 100-109. ashmos, d. p., duchon, d., & mcdaniel, r. r. (2000). organizational responses to complexity: the effect on organizational performance. journal of organizational change management. 13, 577-594. spring 2004 kim et al: porter s generic strategies 41 bakos, y. (1997). reducing buyer search costs: implications for electronic marketplace. management science, 43 (12), 1613-1630. bakos, y. (1998). the emerging role of electronic marketplaces on the internet. communications of the acm, 41 (8),35-42. booth, m. & philip, g. (1998). technology, competencies, and competitiveness: the case for reconfigurable and flexible strategies. journal of business research, 41, 29-40. brush, c. g. & vanderwerf, p. a. (1992). market information scanning activities of new manufacturing ventures. journal of small business management, october, 41-53. brynjolfsson, e. & smith, m. d. (2000). frictionless commerce?: a comparison of internet and conventional retailers. management science, april, 46 (4), 563-585. business week. the e-biz surprise. (2003). asian edition, may 12,44 49. carter, n. m., steams, t. m., reynolds, p. d., & miller, b. a. (1994). new venture strategies: theory development with an empirical base. strategic management journal. u,625-634. chan, r. y. & wong, y. h. (1999). bank generic strategies: does porter's theory apply in an international banking center. international business review, 8, 561-590. chang, j. s. (1997). a study of internet bookstore marketing strategies in korea. m.a. thesis. seoul, korea: yonsei university. covin, j. g., slevin, d. p. & covin, t. j. (1990). a conceptual model of entrepreneurship as firm behavior. entrepreneurship theory and practice, fall, 7-25. cyert, r. m. & march, j. g. (1963). a behavioral theory of the firm. englewood cliffs, nj: prentice hall. dess, g. g. & davis, p. s. (1984). porter's (1980) generic strategies as determinants of strategic group membership and organizational performance. academy of management journal. 27, 467-488. douglas, s. p. & rhee, d. k. (1989). examining generic competitive strategy types in u.s. and european markets. journal of international business studies, fall, 437463. evans, p. & wurster, t. s. (1999). blown to bits: howthe new economics oflnformation transforms strategy. boston, ma: harvard business school publishing. fahey, l. & christensen, h. k. (1986). evaluating the research on strategy content. journal of management. 12 (2),167-183. 42 journal ofbusiness strategies voi.21,no.1 garbi, e. (2002). alternative measures of performance for e-companies, a comparison of approaches. journal of business strategies. 19 (i), 1-17. glazer, r. (1991). marketing in an information-intensive environment. journal of marketing, october, 323-335. glover, s. m., liddle, s. w., & prawitt, d. f. (2001). e-business principles & strategies for accountants. upper saddle river, nj: prentice hall. p. 36-37 goldman, s. l., nagel, r. n., & preiss, k. (1995). agile competitors and virtual organizations: strategies for enriching the customer. new york: vnr. griffith, v. (1999). branding.com: how bricks-and-mortar companies can make it on the internet. strategy & business. 15, 54-59 hambrick, d. c. (1983). high profit strategies in mature capital goods industries: a contingency approach. academy of management journal, 26 (4), december, 687-707. hill, c. w. l. (1988). differentiation versus low cost or differentiation and low cost: a contingency framework. academy of management journal, 13 (3),401-412. karnani, a. (1984). generic competitive strategies: an analytical approach. strategic management journal. 5, 367-380. kim, b. (2000). e-business myths and traps (in korean). seoul: lg economic institute. kim, s. & kim, c. (2000). pricing strategy in the digital marketing age (in korean). seoul: lg economic research institute. kim, l. & lim, y. (1988). environment, generic strategies and performance in a rapidly developing country: a taxonomic approach. academy of management journal. 31, 802-827. kim, e. & mcintosh, j. c. (1999). strategic organizational responses to environmental chaos. journal of managerial issues. 11,344-362. kotha, s. & vadlamani, b. l. (1995). assessing generic strategies: an empirical investigation of two competing typologies in discrete manufacturing industries. strategic management journal. 16, 75-83. lee, m. j. (2001). "on-off hybrid": path to profit. dong-a daily news (in korean), jan, 8th. liu, c. & arnett, k. p. (2000). exploring the factors associated with web site success in the context of electronic commerce. information & management. 38, 23-33. lynch, j. g. & ariely, d. (2000). wine online: search cost and competition on price, quality, and distribution. marketing science-.j..2 (l), 83-103. spring 2004 kim et a/: porter s generic strategies 43 mcdougall, p. & robinson, r. b. (1990). new venture strategies: an empirical identification of eight 'archetypes' of competitive strategies for entry. strategic management journal, 11,447-467. merrilees, b. (2001). do traditional strategic concepts apply in the e-marketing context? journal of business strategies, 18 (2), 177-190. miles, r. e. & snow, c. c. (1978). organizational strategy, structure, and process. new york: mcgraw-hili. miller, a. & dess, g. g. (1993). assessing porter's(1980) model in terms of its generalizability, accuracy and simplicity. journal of management studies, 30 (4), 554585. miller, d. (1986). configuration of strategy and structure: toward a synthesis. strategic management journal, 7, 233-249. miller, d. (1987). the structural and environmental correlates of business strategy. strategic management journal, 8, 55-76. miller, d. (1988). relating porter's business strategies to environment and structure: analysis and performance implications. academy of management journal, 31 (2), 280-308. miller, d. (1991). generalists and specialists: two business strategies and their contexts. advances in strategic management, jai press, greenwich, ct, 7, 3-41. miller, d. & friesen, p. (1986). porter's generic strategies and performance: an empirical examination with american data. part i: testing porter. organizational science, 1 (1),37-55. mintzberg, h. (1988). generic strategies: toward a comprehensive framework. advances in strategic management. 5, 1-67. modahl, m. (2000). now or never: how companies must change today to win the battle for internet consumers. new york: harperbusiness. murphy, g. 8., trailer, j. w., & hill, r. c. (1996). measuring performance in entrepreneurship research. journal of business research, 36, 15-32. murray, a. i. (1988). a contingency view of porter's generic strategies. academy of management review, 13 (3), 390-400. pine, j. (1993). mass customization: the new frontier in business competition. boston, ma: harvard business school press. porter, m. e. (1980). competitive strategy. new york: free press. 44 journal of business strategies vol. 21, no. i porter, m. e. (200 i). strategy and the internet. harvard business review, march, 62-78. preiss, k., goldman, s. l., & nagel, r. n., (1996). cooperate to compete: building agile business relationships. newyork: vnr: 76. robinson, r. 8. & pearce, j. a. (1988). planned patterns of strategic behavior and their relationship to business-unit performance. strategic management journal, 9, 43-60. sandberg, d. e. & hofer, d. c. (1987). improving new venture performance: the role of strategy, industry structure, and the entrepreneur. journal of business venturing, 2 (1),5-28. schlauch, a. j. & laposa, s. (2001). e-tailing and internet-related real estate cost savings, a comparative analysis of e-tailers and retailers. journal of real estate research, 21 (i), 43-54. smith, m. d., bailey, j., & brynjolfsson, e. (1999). understanding digital markets: review and assessment. working paper. http://ecommerce.mit.edu/papers/ude. williams, s. & richard, v. s. (2000). business data communications. new york: prentice-hall. wright, p., kroll, m., caddie, 8., & pringle, c. (1990). strategic profile, market share and business performance. industrial management, iii: des plains, may/june, 23-28. yoffie, d.b. & cusumano, m. (1999). judo strategy: the competitive dynamics of internet time. harvard business review, january-february, 71-81. zajac, e. j. & shortell, s. m. (1989). changing generic strategies: likelihood, direction, and performance implications. strategic management journal. 10,413-430. zettlemeyer, f. (1996). the strategic use of consumer search cost. unpublished ph.d. thesis, sloan school of management, massachusetts institute of technology. eonsoo kim is professor of management at korea university. professor kim received his ph.d. from the university of illinois. his research interests focus on strategic change, process, and implementation. he has written on corporate and business strategy issues, including strategic responses to environmental change, downsizing and turnaround, network and project-based organizations, and application of military art of war to strategic management. daeil nam is senior consultant of management consulting center at lg economic research institute. mr. nam received his master's degree from korea university. his research and consulting realms focus on strategy formulation and implementation including industry consolidation, convergence marketing, global spring 2004 kim et al: porter s generic strategies 45 market strategy, corporate venture incubating, corporate governance, leadership appraisal, and vision. larry stimpert is professor of economics and business at colorado college. professor stimpert received his ph.d. from the university of lllinois. his research interests focus on top managers and their influence on strategic decision making and organizational strategies. he has written on many strategy issues, including managerial responses to environmental change and organizational decline, business definition and organizational identity, the management of corporate strategy and diversification, corporate governance, and company strategies following deregulation. 46 journal ofbusiness strategies vol. 21,no. 1 testing the applicability of porter's generic strategies in the digital age: a study of korean cyber malls relationship banking: a multinational bank's application of relationship marketing sanjay s. mehta sam houston state university huntsville, tx balasundram maniam sam houstoh state university huntsville, tx subhash c. mehta national university of singapore singapore abstract we are witnessing a paradigm shift in the focus of marketing from one that has been transaction-oriented to one that builds a value-enhancing relationship with the customer. one ofthe earliest industries to jump onto the bandwagon of "relationship marketing" has been the banking industry. this paper investigates a multinational bank's use of relationship marketing by using mckinsey & co. 's seven-s framework. the study identifies internal marketing, service quality, human resource system, information technology, and the role of the account manager as key factors in implementing a relationship marketing strategy. introduction while exchange is still sited as the ontology of the marketing disciple (houston & gassenheimer, 1987), we are witnessing a paradigm shift in the conceptualization and measurement of marketing transactions; this shift has been labeled relationship marketing. "relationship marketing refers to all marketing activities directed towards establishing, developing, and maintaining successful relationship exchanges" (morgan & hunt, 1994, p. 22). in explaining the relationship marketing concept in a business-to-business context, kotler (1997, p.8) contends that, "smart marketers try to build up long-tenn, trusting, 'win-win' relationships with customers .... that is accomplished by promising and delivering high quality, good service, and fair prices to the other party over time. it is accomplished by strengthening the economic, technical, and social ties between members of the two organizations." the relationship concept, when properly implemented, cuts down on transaction costs and time, thus providing organizations with a critical competitive edge (kotler, 1997; turnbull, 1983). the rela122 journal of business strategies vol. 16, no.2 tionship marketing concept has tremendous potential when developed and implemented in the banking context (thurman, 1992), where the emphasis is on selling "repeat" services (lovelock, 1996). banks realized early on that marketing is more than just acquiring new customers; it also involves retaining existing-customers and seuing them a wider assortment of products (i.e., goods and services). today's competitive banking environment demands an ever increasing consumer responsiveness. with deregulation, globalization, and automation, corporate customers now have a wide array of choices in banking services. these environmental changes, coupled with the saturated demand for banking products, have made most multinational banks marketing-oriented. marketing orientation is a philosophy that assumes that a sale depends on a customer's decision to purchase a product rather than on aggressive selling (lamb, hair, & mcdaniel, 1998). while much attention has been paid to the effect of deregulation, technological innovations, and competition in the banking industry, little consideration has been given to the bank-customer relationship and on how to enhance that relationship. for instance, vikkula (1992) studied the effects of deregulation on finnish banks and analyzed the competitiveness of these banks in the 1900s. he concluded that banks' competitive position will be threatened by stringent regulations, competition from foreign banks, and alternati ve products offered by companies outside the banking sector. he asserted that finnish banks can improve their competitiveness by concentrating on bank-customer relationships. several scholars in the past (donnej1y, berry, & thompson, 1985; eccles & crane, 1988; moriarity, kimball & gay, 1983) have discussed long-term relationships between banks and customers in connection with relationship marketing; appropriately labeled relationship banking. the relationship banking approadi is a contrast to the traditional approach of a bank as an "order-taker." watson (1996) recommended that banks must allocate resources to developing relationship banking, with an account manager responsible for each customer. similarly, turnbull (1982a and 1982b) and turnbull and gibbs (1986) emphasized the need for relationship banking as a viable long-term strategy. to effectively implement relationship banking, all the processes (e.g., people, information) must be in place (moriarity, kimball, & gay, 1983). keltner (1995) stressed this point in his cross-boundary study when he compared u.s. and german banks. he found that u.s.based banks were shifting away from relationship banking and encouraged customers to turn to other financial institutions to meet their banking needs. in contrast, german banks were being able to maintain a stable share of that country's financial services market. german banks were investing in human resources and organizational capabilities necessary to pursue strategies based on relationship banking. he also pointed out that u.s.-based banks can realize the benefits of relationship banking if they commit themselves to creating stronger internal labor markets and reducing employee turnover. keltner (1995) fall 1999 mehta, et al:relationship banking 123 concluded by stating that u.s.-based banks can go a long way towards rebuilding their capacity from relationship banking by simply emulating german banks' commitment to internally developed human capital there have been several studies directed towards the management of relationships between buyers and sellers (anderson & narus, 1984; crosby, evan, & cowles, 1990; donnelly, berry, & thompson, 1985; boyle, dwyer, robicheaux, & simpson, 1992; dabholkar, johnston, & cathey, 1994). using data from the banking industry, perrien, filiatrault, and ricard (1993) extended these studies by analyzing factors necessary for implementing relationship banking. they concluded that the implementation of a relationship marketing strategy impacted major corporate decisions (e.g., human resources' management, organizational structure). purpose in this study, we offer an international perspective of relationship banking. extensive literature review revealed that no previous study has looked at the consequence of a multinational bank's implementation of a relationship marketing strategy. specifically, the main objective of this paper is to investigate a multinational bank's application of relationship marketing (i.e., relationship banking), using mckinsey's seven-s framework (peters & waterman, 1982; waterman, peters, & phillips, 1991) (see figure 1). the seven-s framework encompasses the seven elements common to successful organizations: shared values, style, strategy, structure, staff, skills, and systems. depth interviews were conducted with a sample of forty-two (of the fortyfive presently employed) account relationship managers from a large multinational bank in singapore (see appendix for a copy of the questionnaire). while other qualitative (e.g., protocol analysis, projective techniques) and quantitative (e.g., a mail survey) research techniques were considered, the research design (e.g., population size, sampling and non-sampling error) warranted that depth interviews would be the most appropriate methodology (alreck & settle, 1995). this bank, which we will term delta bank, has more than one hundred years of international trade involvement. it is widely believed that delta bank is the best finance institution in asia. delta bank has a worldwide network of more than 700 offices in 50 countries. with more than 20 branches within singapore, delta bank is able to provide a wide range of services (e.g., stockbroking services, currency and commodity trading, corporate and private banking services, investments and fund management). we believe that perceptions and opinions of delta bank managers bring into focus the interrelationship between the mckinsey seven-s framework and relationship marketing strategy within the banking sector. 124 journal of business strategies figure 1 mckinsey's 7-s framework vol. 16, no.2 source: peters, t. j. & waterman, jr., r. h. (1992), in search of excellence: lessons from america's best-run companies seven-s framework as applied to delta bank mckinsey's seven-s framework was developed and proposed by peters and waterman (1982) and championed by waterman, peters, and philiips (1991) to explain organizational change. the traditional model of the organization is that strategy is the starting point in implementing any change and that structure and system flow from that (kotler, 1997). the central idea behind mckinsey's sevens framework is that organizational effectiveness stems from the interaction ofthe seven factors: strategy, shared values, style, system, structure, skills, and staff (see figure 1). mckinsey & co.' s research shows that top performing companies place emphasis on four additional elements (besides strategy, structure, and system). christopher, payne, and ballantyne (1991) suggest that the seven-s framework is idealiy suited for analyzing the feasibility of planned organizational change. they lay special emphasis on the application of this framework for evaluating a firm's relationship marketing strategy. strategy relationship banking is driven by the perceived impetus to enter into a longterm relationship (as opposed to a one-time transaction) with customers. the benefits to organizations arise primarily due to cross-seliing of products (especially fall 1999 mehta, et al:relationship banking 125 fee-based income products), thereby increasing the level of penetration. other resulting spin-offs from the relationship marketing strategy are higher margins and the conception of product development skills. the economics of retaining a customer vis-a-vis gaining a new one and the resulting word-of-mouth publicity are additional incentives. relationship banking helps the customers as well. they benefit from ready access to credit at relatively lower costs and risk. more important, the customer gets privileged personalized service and customized offerings. in order for relationship banking to succeed, it needs to be integrated with all facets of the organization. success is further enhanced through niche marketing where the bank identifies one key segment on which to focus its energy. accordingly, delta bank identified "trade financing" as its niche. the strategy is to mold this core service by customizing it to the needs of individual clients. having impressed upon the customer the bank's ability to solve special problems, the account relationship managers gains credibility. this serves to engender future purchases and the crossselling of the bank's product line. shared values shared values represent the "glue" responsible for bonding together the entire organization. in any relation exchange, solidarity is necessary for bonding a longterm relationship (mehta, 1999). delta bank's managers unanimously agreed that in order for relationship banking to succeed, organizations should place a premium on customer service. the organizational ethos should reflect the realization that satisfaction of customers' needs and wants are the very reason for the organization's existence (referred to as the marketing concept). account relationship managers concur that for relationship banking to succeed, the responsibility for customer service has to be equally accepted by both the marketing and the non-marketing personnel. the extent of conflict that exists between the account relationship managers and the operations unit suggests that developing long-term relationships with clients may be a high priority for the account relationship managers. our interactions with account relationship managers suggest that in order for relationship banking to become a part of a bank's shared values, top management needs to commit itself to service excellence. delta bank's managers believe that service excellence results from constant on-going training of all employees. communicating the firm's commitment to relationship marketing to employees at all levels goes a long way towards relationship banking. also evident from our interactions with delta bank's account relationship managers, was the need on the part of top management to exercise the same care and empathy towards the bank's employees as one would expect in the bank's dealings with customers. it is in this domain that internal marketing has a major role to play. internal marketing is "... the task of successfully hiring, training, and motivating able employees to serve the customers well" (kotler, 1997, p. 20). internal marketing dictates 126 journal of business strategies vol. 16, no.2 acceptance of a firm's employees as internal customers. chaston (1995) suggested that in order for a bank to do well with its external customers, they must first practice internal marketing. internal marketing is a philosophy for managing the organization's human resources based on a marketing perspective (kotler, 1997; lamb, hair, & mcdaniel, 1998). some activities necessary for implementing internal marketing include (berry & parsuraman, 1991): giving employees more freedom to make decisions, measuring and rewarding good performance, knowing employees' needs, stressing teamwork, and offering a vision. how the employees deal with customers is largely predicated by the employees' perceptions of how well they are treated by management. style the style of management is demonstrated by the actions of top managers. delta bank's managers felt that the management style of their organization has been historically very conservative. perpetuation of a hierarchical structure has resulted in an ossified management style that stifles decision making at the point of contact. it also inhibits an open flow of communication of information along the ranks. account relationship managers believe that such a management style gets in the way of good customer service. a related issue is the delegation of authority. in the banking context, empowerment of the frontline marketer is always difficult. but developing credibility and trust with the customer necessitates the ability on the part of the account relationship manager to make quick decisions. research has shown that trust among exchange partners is necessary for the implementation of a relationship marketing strategy (morgan & hunt, 1994). empowerment of the account relationship manager, as a crucial component of management style, will thus positively impact relationship banking. systems the main problems highlighted by delta bank's account relationship managers in relation to systems revolved around internal coordination. these include resolving conflicts with operating units, the evaluation process of employees, and recruitment of account relationship managers. while conflict may be an integral part of any exchange relationship, it is the resolution of the conflict that is important in a relationship marketing strategy (mehta, 1999). appropriate selection systems for account relationship managers will significantly impact their level of performance along the relationship marketing dimension. delta bank implemented the account relationship manager concept in 1987. prior to 1987, account managers were not allocated specific accounts. presently a typical account relationship manager handles up to 40 accounts. hislher job was to be market-oriented, to keep existing customers happy, to further cement the relationship, and to seek out new customers. operationally, the account relationship manager had to be involved in the relationship-buildfall 1999 mehta, et al:relationship banking 127 ing process at all stages: initiation, cultivation, and preservation (mehta, 1998). therefore, identifying and prospecting a new client, performing credit appraisal. undertaking the documentation, monitoring the loan, and recovering the loan, were necessary for account relationship managers. keeping in mind the boundary-spanning role of the account relationship man~ ager, it is necessary to recruit account relationship managers who possess high interactive skills and abilities, a belief in customer care, and knowledge of the bank's products and of the competitive environment. it was felt that lateral movement from operations to corporate banking would help the account relationship manager to gain both the knowledge and the appreciation of operations. generally, the rotation of non-marketing staff into customer contact positions serves to improve marketing orientation of the organization. the employees' appraisal processes currently in vogue at delta seem to be disproportionately bottom-line driven. in addition to operation-based efficiency measures (e.g., an account relationship manager's account profitability), soft qualitative assessment needs to be incorporated in the appraisal structure. such assessment might include "saving" a dissatisfied customer, making correct credit evaluations in not lending to a prospective customer, number of customer calls made, and the response time for customer enquiry. delta bank's managers viewed continuous training as invaluable to suc~ cessful relationship marketing. their perceptions are consistent with heskett's (1987) who said that, "... effective service requires people who understand the idea." employees need to view their job from a holistic perspective. this can best be achieved by training programs that emphasize the interrelationships between the various activities of an organization. training should also provide a common forum for account relationship managers and the operations staff, thereby providing opportunities for the cross-fertilization of ideas and enhancing mutual un~ derstanding. the systems aspect of mckinsey's seven-s framework also encompasses information systems. delta bank's managers felt the pressing need to develop a user-friendly reporting system which enables the account relationship managers to compute the viability of an account. delta bank already had a management information system and a decision support system to gather competitive and customer intelligence, but account relationship managers felt the need for further refinement in these systems as well. structure it was discovered that delta's existing organizational structure is flawed and that the structure breeds and encourages conflicts between the account relationship managers and the operational staff. the structure needs to be modified such that coordination between operations and the corporate banking staff can be facilitated. one possible solution to address the structure bottlenecks is rotation between operations and the relationship management staff. another method is to 128 journal of business strategies vol. 16, no.2 have account managers within product specialist areas. a third solution to resolve structure-based inefficiencies is to have a common chief for both operations and corporate banking. for example, in the existing setup within the corporate banking division, the account relationship manager is far removed from the approval authority. to facilitate a more rapid decision making process, a flatter structure may be more conducive to decision making. therefore, the account relationship manager will report directly to the individual approving the credit proposals. allocation of accounts to account relationship managers could be done on the basis of industry (kale & sudharshan, 1987). this would promote specialization in industry financing needs and make it easier for the account managers to better identify with their clients. in dealing with multinational corporations, however, account relationship manager allocation based on clients' markets, as is presently done, seems advisable. the size of the portfolio handled by each account relationship manager has implications on the quality of relationships. it is crucial that the portfolios are limited to 40 to 50 medium-sized clients or up to 100 small clients. the greater the client homogeneity in the portfolio, the easier it wili be for the account relationship manager to understand and appreciate client needs. skills the skills of the account relationship manager are crucial to the success of the relationship marketing strategy. the account relationship manager's boundary-spanning function between the bank and the client makes relationship banking happen. the account relationship manager thus needs knowledge of the bank's goods and services, knowledge of the client and its industry, and knowledge ofthe competitive environment. armed with knowledge of the bank's offerings, the account relationship manager can tailor products to the needs of specific clients. implicit in client interactions are the client's trust and confidence in the account relationship manager (morgan & hunt, 1994). delta bank's account relationship managers felt that good interaction skills were of paramount importance for a relationship manager. product knowledge and technical skills were also deemed important, but it was widely felt that these could be acquired with relative ease. staff at the very basic level, the account relationship manager is supported by the corporate account relationship manager team. the staff assistant provides backup in the account relationship manager's absence and also helps with documentation and data gathering. the credit management department provides support by ensuring that credit evaluations are in line with the bank's standards. the security documentation unit ensures that once a client facility is approved, the appropriate documentation is prepared. prior to actual disbursement, the account relationship manager had to confirm adequacy of the documentation. fall 1999 mehta, et al:relationship banking conclusion 129 research in service industries has shown that overall job satisfaction on the part of employees is positively correlated to their level of customer orientation (hoffman & ingram, 1992). the delta bank study confirms a similar relation~ ship in the banking context. this underscores the need for a strong internal marketing program on the part of bank management. management needs to constantly monitor the motivation and morale of the bank's employees. in the absence of a motivated workforce, relationship marketing will not yield positive results. periodic measurement of the level of service quality delivered will also impact the success of relationship banking. measuring service quality is important for service organizations with many intangible factors. researchers have identified a positive association between service quality and customer satisfaction (fitzsimmons and fitzsimmons, 1994). delta, like most banks, does not have an effective instrument with which to assess the quality of its services. instruments such as servqual (a 22-item scale that measures five dimensions of service quality) could be of immense benefit to banks desirous of practicing relationship marketing (parsuraman, zeithaml, & berry, 1985; parsuraman, zeithaml. & berry, 1988). the human resource systems of a bank are also a crucial determinant of its effectiveness in relationship banking. the bank needs to recruit and train people such that its customer orientation becomes ingrained in every employee. perfor~ mance appraisal measures should be broadened to incorporate an employee's commitment to the customers and hislher boundary performance with the clients. information technology can significantly add to the level of relationship banking. for example, on-line access to account profitability would help account relationship managers with their lending decisions. technology can be harnessed to build a management information system that provides meaningful and actionable data on current and potential customers. such a system would make client prospecting and rapport building easier for the account relationship managers. the bank needs to appreciate the key role played by the account relationship manager in relationship banking. the account relationship manager is a strategic resource that needs to be employed with flair and distinctiveness. in order to enable the account relationship manager to perform hislher role better, a bank needs to structure the job such that a reasonable amount of time is available for client interaction. relieving the account relationship manager of some of the documentation and other operations formalities will ensure proper attention to building client rapport. also, the account relationship manager needs to be given greater authority and easier access to the operations and support staff. having exclusive product specialists serving the account relationship manager may be one effective but expensive approach to better performance. this paper has been exploratory in its orientation. the key limitation of this study is the exploration of relationship marketing strategy using just one bank 130 journal of business strategies vol. 16, no.2 (i.e., a case study). future research should be based on empirical data using several banks across geographic boundaries (i.e., descriptive study). this will help researchers in uncovering the commonality in perceptions of respondents from various organizations. another limitation of the current study is that it assesses only the seller's perspective. relationship marketing should ideally be investigated using data from both sides of the management-customer dyad (mehta, 1998). these limitations notwithstanding, this study does bring into focus key aspects of relationship banking as explained by mckinsey's seven-s framework. based on the delta bank study, five key success factors for relationship banking were identified: internal marketing, service quality, human resource systems, information technology, and the role of the account relationship manager. the account relationship manager has to have a great deal of day-to-day interactions with officers in the various support departments. many times, the interests of the various individuals diverge. for instance, while client interest may be predominant for the account relationship manager, margins may be the driving motivation for the bank. such inevitable conflicts between the various staff can be effectively handled by imbibing a customer focus in every staff member. as one account relationship manager succinctly puts it, "undoubtedly, account relationship manager has to be market driven, but there has to be a cascading of this culture to the support staff. after all, a relationship cannot be developed solely on the basis of an account relationship manager." with increasing competition in the banking sector, relationship marketing will continue to grow in prominence. its success, however, is contingent on the level of consistency between the various factors discussed under the seven-s framework. references alreck, p. l., & settle, r. b. (1995). the survey research handboqk, (2nd ed). homewood, il: richard d. irwin, inc. anderson, j. c, & narus, j. a. (1984). a model of distributor's perspective of distributor-manufacturer working relationships. journal of marketin2. 54 (january), 42-58. berry, l. l., & parsuraman, a. (1991). marketing services. new york: free press. boyle, b., dwyer, r. f., robicheaux, r. a., & simpson, j. t. (1992). influence strategies in marketing channels: measures and use in different relationship structures. journal of marketing research. 29 (4),462-473. chaston, i. (1993). delivering customer satisfaction within the sme (small and medium size enterprise) client-banker relationship. service industries journal. 13 (1), 98ill. fall 1999 mehta, et al:relationship banking 131 christopher, m., payne, a., & ballantyne, d. (1994). relationshid marketing: brin2ing guality. customer service. and marketing together, (2nd ed). oxford: butterworth heinemarln. crosby, l. a, evans, k. r., & cowles, d. (1990). relationship selling in services selling: an interpersonal influence perspective. journal of marketing. 54 (july), 68-81. dabholkar, p. a, johnston, w. j., & cathey, a s. (1994). the dynamics of long term business to business exchange relationships. journal of academy of marketing science. 22 (spring), 130-145. donnelly, j. h., berry, l. l., & thompson, t. w. (1985). marketing financial servicesa strategic vision. dow jones-irwin, homewood, il. eccles, r. g., & crane, d. b. (1988). doing deals investment banks at work. harvard business school press. boston fitzsimmons, j.a, & fitzsimmons, m. j. (1994). service management for comdetitive advantage. mcgraw hill, new york heskett, j. (1987). lessons in the service sector. harvard business review. 65 (marchi april),118-126. hoffman, d., & ingram, t. (1992). service provider job satisfaction and customer oriented performance. journal of service marketing. 6 (2), 68-77. houston, f., & gassenheimer, j. b. (1987). marketing and exchange. journal of market.i.ng",2l (october), 3-18. kale, s. h., & sudharshan, d. (1987). a strategic approach to international segmentation. international marketing review, summer, 60-70. keltner, b. (1995). relationship banking and competitive advantage: evidence from u.s. and germany. california management review. 37 (4),45-72. kotler, p. (1997). marketing management. 9th ed., englewood cliffs, nj: prentice hall. lamb, c. w. jr., hair, j. f., &. mcdaniel, c. (1998). marketing. south-western college publishing, 4th ed. lovelock, c. h. (1996). services marketing. englewood cliffs, nj: prentice hall. mehta, s. s. (1999). continuity expectation in vertical marketing systems; a dyadic perspective of domestic and international franchising. unpublished dissertation, university of north texas. 132 journal of business strategies vol. 16, no.2 moriarity, r. t., kimball, r. c., & gay, j. h. (1983). the management of corporate banking relationships. sloan manaiement review, spring. morgan, r. m., & hunt, s. d. (1994). the commitment-trust theory of relationship marketing. journal of marketinfi. 58 (july), 20-38. parsuraman, a., zeithaml, v., & berry, l. (1985). a conceptual model of service quality and implications for future research. journal of marketini, (fall), 41-50. parsuraman, a., zeithaml, v., & berry, l. (1988). servqual: a multiple-item scale for measuring consumer perception of service quality. journal of retailing. 64 (l), 12-40. perrien, p., filiatrault, a., & ricard, t. (1993). the implementation of relationship marketing in commercial banking. industrial marketing management. 22, 141-148. peters, t. j., & waterman, r. h. jr. (1982). in search of excellence: lessons from america's best-run companies. warner books thurman, c. g. (1992). corporate banking: services and relationships. international journal of marketing. 10 (2),10-16. turnbull, p. w. (1982a). the purchasing of international financial services by medium and large sized uk companies with european subsidiaries. in turnbull, p. w. and lewis, b. r (eds). the marketing of bank services. mcb publications, bradford. 122-132. ---(i 982b). the use offoreign banks by british companies. in turnbull, p. w. and lewis. b. r (eds). the mllrketinli of bank services. mcb publications, bradford, 133-145. ----{1983). corporate attitudes towards bank services. international journal of bank marketinfil 1 (1),53-65. turnbull. p" & gibbs, m. l. (1986). marketing bank services to corporate customers: the corporate attitudes towards bank services. international journal of bank marketin~, 5 (0, 19-26. vikkula, k. (1992). the competitiveness of finnish banks in the 1990s. kamallis-osakepankki economic review, (l), 13-24. waterman, r., peters. t., & phillips, j. (1991). the seven·s framework. the strateay process: concepts, contexts, cases. h. mintzberg and j. quinn (eds), englewood cliffs, nj: prentice hall. watson, i. (1986). managing the relationship with corporate customers. international journal of bank marketjna, 4 (l), 19-34. fall 1999 mehta, et al:relationship banking appendix questionnaire for the depth interview 133 1. what is relationship banking as your bank sees it? is it a part of the overall strategy of the bank? 2. how do you segment the customer base? how does the bank benefit from the concept? 3. what does the customer stand to gain from such a relationship? do you believe it is appropriate for all your customers? 4. how do you decide whether a particular customer is worth being treated on a relationship basis? 5. what is the product strategy (i.e., to offer a full range of standardized products or customized products depending on the needs of the customer or a combination of both)? 6. how do you see the role of the account relationship manager'? 7. what do you believe are the most crucial aspects of the account management strategy'? 8. is it possible to ensure that the benefits offered by your bank are meaningful and are not copied by the competitor'? 9. what do you feel is the role of "internal marketing" (i.e., a service oriented culture to the success of such a program)? to. does your bank measure service quality on a on-going basis? 11. what are some of the more typical problems associated with the implementation of the relationship banking program? 12. how does the account relationship manager fit into the overall organizational structure? 13. what is the basis of the territory allocation? is there a problem in ensuring strict adherence to the territory? 134 journal of business strategies vol. 16, no.2 14. what according to you is the role of training in the success of a programs such as this one? what training do employees of your bank receive. 15. what kind of incentive plans are operative in your bank? 16. what are the kind of qualities/skills that should be sought for in a good account relationship manager? 17. what kind of internal support do you expect from departments? do you have any problems in obtaining this kind of support? 18. what do you feel is the future of the relationship management concept? what do you feel are the critical success factors? sanjay s. mehta (m.s., ph.d., university of north texas) is currently an assistant professor of marketing at sam houston state university. he holds a b.s. in mathematics and an mba in management from angelo state university. he has presented over 50 papers at regional, national, and international conferences and served as track chair, session chair, discussant, and reviewer at many of these conferences. he has published over 40 articles in various refereed proceedings and journals. balasundram maniam (ph.d., university of mississippi) is currently an assistant professor of finance at sam houston state university. he holds a b.s. in computer science and an mba in management from arkansas state university. he has presented over 55 papers at regional, national, and international conferences, he has published over 40 articles in various refereed proceedings and journals. subhash c. mehta (ph.d., university of missouri) is an associate professor of marketing at the national university of singapore. he has published over 150 articles in various refereed proceedings and journals. in addition, he has authored and co-authored several textbook in marketing. dr. mehta has over 30 years of international teaching and consulting experience. relationship banking: a multinational bank's application of relationship marketing to send, or not to send: that is the question. a review of the literature on workers' remittances isabel ruiz sam houston state university • huntsville, tx carlos vargas-silva sam houston state university • huntsville, tx abstract this paper reviews the empirical literature on workers' remittances. based on the empirical evidence, we are able to assess the facts and myths about the determinants and consequences of remittances. we also discuss the potential implications of our findings for the theoretical literature on remittances and account for the open-ended questions that still remain. the review suggests that there are several motivations to remit and it does not seem that one specific motivation has been consistently selected over the others. the literature also suggests that remittances have the potential to impact a large number of variables related to the recipient country and household. introduction the large increase in remittances (money transfers from migrants to family and friends back home) during the last two decades has stimulated a keen interest in understanding the nature and economic consequences of these flows. policymakers in developing countries and international organizations around the world have become interested in increasing the flow of remittances, finding ways to channel remittances into productive investments, and diminishing the possible detrimental impacts of these transfers. on the other hand, due to concerns regarding money laundering and terrorism support, policymakers in developed countries are interested in seeing a larger share of remittances sent through official channels. in fact, policymakers and government officials from countries that are host to large communities of migrants are encouraging increased supervision on the part of receiving countries on the use of remittances. the remittances phenomenon has also drawn attention from the private business sector. given the potential for profit in the money transfer business, there has been a proliferation of money transfer agencies. banks have also been encouraged to participate in the remittances market, not only by being more competitive in their fees and processes, but also by recognizing that offering remittance services can help in attracting migrants to open bank accounts in the host country. 74 journal of business strategies in this article we present a review of the empirical literature on remittances. that is, we want to assess the different conclusions that have been drawn from the data and evaluate what can be said with relative confidence about remittances. we also want to highlight the open-ended questions that still remain and ascertain the facts that are still in doubt. organization of the literature review the literature on remittances is divided into two main areas of study. the first area investigates the nature and determinants of these flows. we look at questions like: what prompts a migrant to remit? what factors determine the amount of remittances they send? the second area of study is concerned with the impacts and consequences of these money transfers. that is, we look at the impacts of these money flows on the receiving countries and on household behavior. we look at questions such as: how are these flows affecting family composition? what are the consequences for the distribution of labor? what are the impacts on prices, the exchange rate and the overall economy? to answer those and other related questions we review the extant literature and differentiate between the different studies that use data on the migrant, the household (or both) and those that use aggregate economic data. the literature on the determinants of remittances, our first area of study, is divided into two specific groups. the first group includes those studies that use microeconomic level data to study the determinants of remittance transfers. most of these studies make use of survey data on the emigrants and/or the receiving households. this type of study is usually interested in the relationship between remittances and individual specific factors such as income (household and migrant), gender, age, time abroad, marital status and household composition, among others. the second group includes those studies that use macroeconomic level data to study the determinants of remittances. this type of study is usually interested on how variables like interest rate differentials, political uncertainty, exchange rates and economic conditions (host and home country) impact remittances. time series data in one country or a panel of countries are typically analyzed in this literature. the literature on the impacts and consequences of remittances, our second area of study, is also divided into papers that use microeconomic level data and those that use macroeconomic data. the first group in this area includes those studies that are focused on the impact of remittances on variables related to the household, such as household consumption patterns, migration patterns, labor supply and investment decisions, among others. the other category of study analyzes the impact of remitvolume 26, number 1 75 tances on macroeconomic variables of the receiving country such as the exchange rate, gdp growth, income inequality, poverty levels and prices. it is important to note that this literature review concentrates mostly on articles that use economic theory and econometric techniques to study topics related to rem ittances. a large number of articles exist in other fields of the social sciences (e.g. sociology, political science, geography, psychology, among others) that study remittances from a different perspective. those articles, while beyond the scope of this review, contain important results and the reader is encouraged to consult them. neither is this review a complete list of papers in the remittance literature. we focus on some of the relevant works that we feel represent the general trend of the literature. finally, we are not doing a comprehensive review of the papers that we cite, but highlight what we think are the most interesting aspects on each of the papers cited. please refer to the original source for more details on these studies. an overview of remittance flows the impact of remittances varies vastly across regions of the world, due to differences in culture, migration patterns and the stage of economic development. according to the rnter-american development bank (idb), remittances received by latin america countries (lac) in 2007 reached over 66 billion u.s. dollars (idb, 2008). table 1 contains the share and amount of remittances received by the five largest recipients of remittances in latin america during that year. the main recipient of remittances (in terms of volume) was mexico with over 23 billion dollars and 36 percent of the total inflows, followed by brazil with about 7 billion u.s. dollars. while mexico and brazil receive a huge flow of remittance transfers, in terms of gdp the importance of remittances is relatively small (2.9 % for mexico and .3% for brazil). in contrast, in at least seven other latin american countries (ei salvador, guatemala, guyana, haiti, honduras, jamaica and nicaragua) remittances account for more than 10 percent of gop. most of these money transfers originate in the u.s., making remittances an important factor in the economic relationship between the u.s. and latin america. it is estimated that about 43 billion u.s . dollars were sent from the u.s . to lac in the year 2006 (idb, 2008). the information in table 2 shows that the remittance outflows from the u.s. come mainly from states with large concentrations of hispanics. five states alone (california, texas, new york, florida and illinois) sent more than 20 billion u.s. dollars in 2006. in total these five states accounted for about half of the total u.s. remittance outflows. 76 journal of business strategies table 1 worldwide remittance flows to latin america in the year 2006 in billions of u.s. dollars country percent of total $ amount mexico 36% 23.98 brazil 11% 7.01 colombia 7% 4.52 guatemala 6% 4.13 ei salvador 6% 3.69 total to lac 100% 66.50 (data source : lob) (data source: lob) table 2 remittances by state in the year 2006 in billions of u.s. dollars state california texas new york florida illinois $ amount 13.19 5.22 3.71 3.08 2.58 table 2 reports only on the aggregate amount of remittances sent from each state. an interesting question is, which state sends more money per migrant? for instance, there is a big gap between remittances sent by immigrants in california and remittances sent by immigrants in other states. are migrants in california more generous on average? in table 3 we list the five states that send the most money per migrant. none of the states in table 2 is included in table 3. this indicates that those states with large concentrations of hispanics are not the ones sending more money per migrant. in the aggregate, remittances are second to fdi as a source of external financing in developing countries. but in many regions and countries remittances have surpassed fdi as a source of external financing. in africa between the years 2000 and 2003 remittances averaged 17 billion u.s. dollars , while fdi averaged only 15 billion dollars. however, official development assistance (oda) still remains as africa's largest external source of financing with about 25 billion u.s. dollars per year (united nations, 2005). in latin america, however, not only have remittance volume 26, number 1 77 flows to the region surpassed fdi flows, remittances are more than oda in each single country in the region. table 3 remittances per migrant and state (or territory) in the year 2006 in u.s. dollars (data source: lob) state georg ia wash ing ton , d.c . maryland virginia pennsylvania $ amount 2.897 2,864 2,797 2,732 2,671 remittances to asia and oceania comprise the highest regional total in the world . according to international fund for agricultural development (ifad) (2006) asia and oceania receive more than u.s. 113 billion dollars in remittances annually. just india and china combined received about 45.6 u.s. billion dollars. it is also the case that remittances to smaller economies like indonesia, nepal and taijkistan, constitute a large portion of their per capita income. the evidence is quite strong that the large magnitude of remittances flows around the world is critically important for receiving countries. we can now proceed to discuss how the previous literature has studied these flows. the nature and the determinants of remittances microeconomic determinants of remittances there has been considerable debate about the migrant's motivations to remit. the most commonly accepted motivation for remittance transfers is altruism; that is, migrants care about the home household's well-being and remit to improve living conditions. if altruism is a motivation to remit, variables related to household well-being (e.g. household consumption) should enter the migrant's utility function. a change in variables affecting household well-being, for example a decrease in the household's income, should encourage more transfers. although intuitively appealing, altruism alone has failed to explain the totality of remittance transfers . another alternative explanation for remitting behavior 78 journal of business strategies is "self-interest" motives . one of the self-interest motives commonly mentioned is investment in the home country. perhaps the emigrant does not have good investment opportunities available in the host country and therefore decides to invest in the home country. it may also be the case that the migrant simply plans to retire in the home country and therefore concentrates his/her investments in that country. in a related argument, it has been argued that some emigrants send remittances because they hope to benefit from the household's gratitude when returning home. this gratitude may materialize as a portion of the household inheritance. if selfinterest is the motivation for remittances then changes in the expected return to investment in the home and host country, changes in the amount and possibility of inheritance, and related factors should affect the level of transfers. there is another set of studies that argues that remittances are sent for insurance purposes. the insurance motivation suggests that by leaving the household and moving to another region or country, the migrant will be subjected to risks that are mostly uncorrelated to those that the household faces ; hence, the migrant and the household are able to diversify their risks. the emigrant can buy insurance against bad economic times in the host country by sending remittances to the household or have a coinsurance agreement with the household in which the emigrant supports the household during tough economic times in the home country and the household supports the emigrant during tough economic times in the host country. there will be evidence of insurance motivations if remittances respond to risk variables (e.g. emigrant's income risk). the theoretical models of remittances and insurance typically include a von-neumann type expected utility function in which emigrant's and/or household income is uncertain. finally, there is a group of papers that makes the case that the emigrant is paying back to the household for the investment made in him or her when he or she was younger. in this case there is an implicit loan arrangement between the household and the emigrant. in the first stage the household invests in the emigrant and in the second stage the emigrant pays back with transfers. the initial investment can be in terms of educational expenses from the household or money to cover the costs of migration. if this theory is correct we expect to see that emigrants whose parents invested more in their children and those migrants who come from countries where the costs involved with migration are higher will remit more. in one of the first studies related to remittances, lucas and stark (1985) used information from botswana to study the determinants of remittance transfers. lucas and stark (1985) found evidence of the insurance and loan repayment motivations. strong evidence in favor of altruism was not uncovered. in order to test for the volume 26, number 1 79 loan repayment motivation, lucas and stark (1985), constructed a dummy variable equal to one if the emigrant was the son (daughter), nephew (niece) or grandchild of the household head , because educational investments are more likely to be made on these children relative to other children living in the house (e.g. sons-in-law and daughters-in-law). they interact this dummy variable with the education level of the emigrant. the results show that the interaction between the two variables is positively related to remittances. the authors take this result as evidence of the loan repayment hypothesis. the insurance motivation to remit was tested using data from a drought that occurred in botswana at the time of the survey. they differentiated regions by the seriousness of the drought (measured as rainfall in that year divided by the average rainfall in the last 30 years). they interact this variable with the log of the number of crop acres and number of cattle that the household owns. lucas and stark (1985) posited that if a coinsurance agreement was in place between the emigrant and the household, households with a higher risk oflosing crops or cattle, given the seriousness of the drought would receive more transfers (i.e. to gain access to more water sources). although their results support the insurance motivation for remitting, they note that, given the lack of enforceability of the insurance arrangements migrant's behavior may still imply that they acted in an altruistic manner.1 there has been a series of papers that, like lucas and stark (1985), did not find strong or exclusive evidence in favor of altruism and also find that migrant's motivations for remitting are more complex. brown (1997) distinguishes between demand-side variables (e.g. family location), supply-side variables that affect the migrant's capacity to remit (e.g. migrant's income) and motivational variables that account for the most commonly mentioned motives for remitting (e.g. economic condition of the household for altruistic transfers, expectation about inheritance and investment in the home country for self-interest transfers and financial aid received from the household for migrating for the loan repayment hypothesis). brown (1997) finds that in addition to altruistic intentions, migrants in the pacific islands of tonga and western samoa, have strong self-interest motives, mainly investment and asset accumulation, for remitting. 2 hoddinott (1994), using survey data from kenya, also rejects altruism as the sole motive to remit and finds evidence of interest in inheritance and loan repayment motivations. hoddinott (1994) argues that if emigrants remit because the household members are threatening (not necessarily exp/i:citly) the emigrant with losing his right to inheritance, then remittances should respond to the credibility of this threat. for example, if the emigrant is an only son then the credibility of this threat is weak. 80 journal of business strategies moreover, remittances should also respond to the availability of assets (e.g. land) by means other than inheritance. if land is widely available and affordable then there will be little incentive to remit in order to secure the inheritance of land from the household. for the specific region in which hoddinott's (1994) study was concentrated, the finality of transfers of land through sale is not universally accepted and vendors often try to reclaim land after selling it. this creates an additional incentive for the migrants to secure the inheritance of land directly from their parents (instead of purchasing the land) and therefore motivates remittances. 3 hoddinott (1994) found that as the number of adult sons ofthe household head increases (more competition for inheritance) remittances also increase.4 vargas-silva (2009) used data from colombia to find that remittances respond negatively after a household member was the victim of a crime. the author argues that because crimes may have an adverse effect on household assets and the return to investments in the home community, migrants may decrease transfers made for self-interested purposes such as future inheritance or investment. although his results suggest that a portion of transfers are sent for self-interest motives, vargas-silva (2009) cautions that variables related to the household indicate that altruism is also an important motivation for remitting. in distinction from the results obtained by most of these previous studies that do not find direct strong evidence of altruistic motives for remitting, agarwal and horowitz (2002), in a study using survey data for guyana, found evidence in favor of altruism. agarwal and horowitz (2002) used the impact of the number of migrants in each household on remittances as an indicator of altruism versus insurance. they argued that if the number of migrants from a single family increases and remittances sent by each migrant do not decrease, then individual migrants must be insuring themselves with the household. in other words, each migrant needs to "pay in" regardless of the total number of migrants. however, if the number of migrants increases and the amount of money sent by each migrant decreases, then remittances are likely made for altruistic reasons; that is, as more migrants begin to remit, the household's demand for support from individual migrants decreases. the results in agarwal and horowitz (2002) suggest that altruism is the main motivation for remittance transfers . a problem with survey data is that while it would be ideal to have information on the migrant and the household, surveys typically include information on the migrant or the household only. one study that overcomes this limitation is osili (2004). in her study, osili collected data in two stages. during the first stage she conducted interviews among nigerian migrants in chicago. during the second stage she used volume 26, number 1 81 the names and addresses supplied by the u.s. immigrants to conduct interviews of their families in nigeria. the result was a matched sample of migrants and households. her results suggest that wealthier families tend to receive fewer transfers (evidence of altruism). however, remittances sent to finance home investments are positively associated with household's weaith. 5 other papers have found evidence that remittances are in fact being used as insurance. one of the complexities of testing for the insurance motive for remitting is that the altruism and insurance motives for remitting are difficult to distinguish from one another. if the household's income in the home country decreases and remittances increase, the migrant may be behaving altruistically or may be responding to an insurance agreement. amuedo-dorantes and pozo (2006a) try to disentangle these two motives. using mexican survey data they found that increasing income uncertainty in the host country increases remittances. u.s. immigrants subject to greater levels of risk (as in the case of undocumented immigrants relative to documented immigrants) remit more. they argue that this result implies that migrants are risk-averse individuals who, in the face of greater earnings uncertainty, insure themselves by increasing transfers. however, given that increasing income uncertainty in the host country does not directly impact remittances sent for altruistic purposes (there is no additional need on the part of the household), this result can be useful as a measure of the insurance motive for remitting that is not mixed with the altruistic motive. the previous papers emphasize the role of variables strongly related to the traditional motives of remitting as determinant of remittances. other series of studies, however, have focus on indentifying patterns of remitting according to some demographic variables, such as gender. for instance, osaki (1999) reports that in thailand children are expected to repay their parents for time and money invested in raising them. under buddhist traditions, males can earn religious merit for their parents if they become ordained and spend a period oftheir lives in monkhood. this option is not available for females; thus, in thailand, it is expected that female immigrants are more likely to contribute financially to the household via remittances. osaki (1999) tests this proposition by including a gender dummy variable in her remittance equation. the gender dummy variable is not a significant determinant of remittances in the case of thai migrants. however, in separate estimations by gender, she finds differences in the coefficients for males and females for a number of conditioning variables. 6 do gender differences in remitting behavior exist for hispanics? previous empirical studies suggest they do exist. in a study of migration from the dominican 82 journal of business strategies sierras, de la briere et al. (2002) find that female migrants are more likely to remit to stabilize dominican household income when compared with male emigrants. moreover, blue (2004) studies cuban emigrants and finds that female migrants are more altruistic than their male counterparts. females are more likely to remit and the dollar amounts that they remit are on par with the amounts remitted by males, despite their generally lower earnings. hence, according to blue women remit more than men when looking at remittances as a share of income. blue (2004) also focuses on the political determinants of remittances by looking at remittances flows to cuba. by focusing on political ideology blue is able to show that there were no political disincentives in the flow of remittances to cuba. this is especially important for the case of cuba in which according to blue (2004) "right-wing cuban exiles have argued that remittances serve to prop up fidel castro's government." another idea that has received considerable attention in the literature is that if altruistic attachment decreases over time and altruism is the main motivation for remitting, then remittances should also decrease over time. this idea is known as the remittances decay hypothesis. if the remittances decay hypothesis is correct we should see a strong negative relationship between remittances and the time since migration took place. in terms of theoretical models this implies that the utility obtained by the emigrant for household consumption is decreasing over time. funkhouser (1995) uses survey data from ei salvador and nicaragua to uncover evidence on the remittances decay hypothesis. however, he cautions that given the size of the coefficients even if the migration rate decreases, remittances are going to fall only gradually. a sudden stop in migration will lead only to a gradual decrease in remittances.7 it is also possible that not only the length of the stay, but the planned duration of the stay can have an effect on remittances. merkle and zimmerman (1992) found that there is a negative relationship between remittances and the planned length of the stay of the emigrant in the host country. if the actual length of stay is included along with the planned length of stay, only the latter is found to be significant. the macroeconomic determinants of remittances in this section we discuss the macroeconomic determinants of remittances. previous studies have shown that the decision to remit may be influenced by the behavior of macroeconomic variables on both the source and host countries. along those lines, we discuss the different studies that have used macroeconomic varivolume 26, number 1 83 abies (exchange rates, interest rates, etc.) in uncovering the determinants of these money flows. migrants who settle in the u.s. earn money in u.s. dollars, but their transfers to family and others back home are usually converted into the domestic currency (e.g. mexican pesos). depreciations of the home currency can increase the purchasing power of remittances in the home country. moreover, if the household is converting remittances into local currency then immigrants should adjust the amount of the transfer in response to changes in the exchange rate. for instance, after a real depreciation of the domestic currency, each us. dollar of remittances will be worth more to the household. this means that the household needs fewer u.s. dollars to consume a certain bundle of goods. if the purpose ofthe transfer is to make a certain bundle of goods available to the household, then the emigrant should decrease the amount of u.s. dollars that he/she is sending back home. furthermore, if the immigrant is making a long-term investment with remittances or remitting to build a retirement nest-egg, then fewer us. dollars are required to reach certain target levels of investment. on the other hand, now each us. dollar of remittances is worth more in the home country. if the immigrant has investments in both countries, but plans to return eventually to the home country, then it may be useful to take of advantage of the depreciation by investing more in the home country. also, it is possible that the immigrant wants to send more because each us. dollar of remittances will benefit his/her family more. for instance, it is possible that after the depreciation the household will be able to send children to a better school by receiving some more u.s. doiiars. in sum, remittances may increase or decrease after a depreciation of the local currency depending on which of these two effects dominates. similarly increases in the interest rate of the home country relative to the interest rate of the host country increase the relative return to investment in the home country and can have contradictory impacts on remittances flows. the higher interest rates in the home country may encourage more transfers for investment purposes; however, the additional return on existing investments in the home country may discourage transfers and encourage consumption in the host country. we must rely on the empirical evidence to determine the impact of these macroeconomic variables. ei-sakka and mcnabb (1999) study the macroeconomic determinants of official remittances using macroeconomic level data for egypt. 8 their results show that home and host interest rate differentials and the difference between the official exchange rate and the black market exchange rate are significantly negative determinants of official remittances. the above result was in line with the findings 84 journal of business strategies by katseli and glytsos (1986). some countries peg their currency at levels that differ significantly from the market rate. as a consequence these countries will have an overvalued currency and an excess demand for foreign exchange. i f there is a black market premium the receiving households may decide to use the black market to convert remittances into local currency. this may induce the emigrant to send remittances through unofficial channels (where it will be easier to access the black market) instead of through official channels. yang (2008) takes advantage on information on migrants ' remittances during the 1997 asian financial crisis to study the impact of exchange rate shocks on remittances. filipinos migrate to a wide variety of countries . during the 1997 asian financial crisis, filipino migrants experienced sudden and heterogeneous changes in exchange rates . using this information yang (2008) is able to examine how migrants respond to a randomly-sized economic shock. his results suggest that appreciation of a migrant's currency against the philippine peso leads to increases in household remittances received from overseas. pozo and vargas-silva (2008) take a somewhat similar approach to yang (2008), but instead of studying one source country with multiple host countries, they focus on the case ofmuitiple source countries and only one host country. using information from migrants to the united states that participated in the immigration reform and control act (irca) of 1986 they study the impact of exchange rates on remittances using data from migrants from a broad array of countries.9 they find limited evidence that remittances respond positively to current home country real exchange rate depreciations and robust evidence that remitters remit less due to future weakening of the home currency. faini (1994) tests the importance of exchange rates and interest rates, among other macroeconomics variables, as determinants of remittances using data from emigrants in germany. results show that interest rate differentials (home host) and exchange rates (home currency vis-a-vis host currency) are positive and significant determinants of remittances . contrary to ei-sakka and mcnabb (1999), faini (1994) finds that home and host country gop are important determinants of remittances (home country gdp negatively impact remittances, while host country gop positively impact remittances). the result that interest rates and exchange rates are significant determinants of remittances is not universal. in one of the first macroeconomic papers about remittances swamy (1981), using data from greece, turkey and yugoslavia, found that most macroeconomic variables did not affect remittances. straubhaar (1986) found that interest rates and exchange rates did affect the flow of remittances to turvolume 26, number 1 85 key.1o vargas-silva and huang (2006), using data for various latin american countries, also provided evidence that several home country macroeconomic variables were not able to explain remittances. in general, vargas-silva and huang (2006) concluded that remittances respond more to host country macroeconomic variables than home country macroeconomic variables. other papers test for exchange rate uncertainty as a determinant of remittances. if emigrants are risk averse an increase in exchange rate uncertainty, which increases the uncertainty about the purchasing power of remittances in the home country, may have a negative effect on remittance flows. higgins et ai. (2004) study the effect of exchange rate uncertainty on remittances using data from nine countries. results show that an increase in the volatility of the exchange rate decreases remittances. in another study hysenbegasi and pozo (2008), using data for 23 latin american countries show that the timing of remittances responds to exchange rate crisis. specifically, they find that emigrants avoid remitting when the exchange rate is under pressure, which the authors interpret as evidence that remitters try hard to reduce their exposure to exchange rate losses by taking into account the expected future value of their transfers. a different strand of the literature asks if remittances respond to cyclical fluctuations in the home and host country. a clear understanding of the business cycle and its relationship with remittances is necessary for countries with large remittance inflows in order to react adequately to cyclical fluctuations in output. for instance, if remittances are countercyclical with respect to the home economy, receiving countries could potentially use remittances as part of their strategy to offset negative cyclical fluctuations in output. the relationship between remittances and the business cycle of the host country is also relevant. ifremittances are not responsive to the host country business cycle, then we should not expect drastic decreases in remittances after downturns in the host economy. alternatively, if remittances are strongly correlated with the host country business cycle, remittances can become another channel by which cyclical fluctuations in the host economy can impact the home country. roache and gradzka (2007) investigate whether remittances to latin america depend on the u.s. business cycle. their results suggest that remittance flows are, in general, insensitive to the u.s . business cycle. vargas-silva (2008), using data for mexico, reaches similar conclusions about the impact of the us business cycle on remittances. however, the results of vargas-silva (2008) suggest that remittances are countercyclical with respect to mexico's business cycle, although this last result is not robust to the use of different measures of remittances. 86 journal of business strategies the economic impacts and consequences of remittances the macroeconomic impact of remittances remittances have the potential to impact a large number of variables in the recipient country. therefore the literature that tries to assess the macroeconomic impact of remittances is vari ed in its scope and its conclusions. broadly speaking, remittances may have both beneficial as well as detrimental effects. while effects like augmentation of the capital stock through financing investment are conducive to growth, other impacts such a decrease in labor supply and a negative impact on the tradable sector have adverse consequences for the receiving country. one of the main arguments from those arguing that remittances have a positive impact on economic development is that remittances are often used for investment in the home country. for example, there is evidence that remittances are typically invested in housing and small businesses in receiving countries. 11 moreover, even if remittances are simply spent on consumption it can be argued that the additional demand for products in the home country can benefit the receiving economy. one of the main arguments of those arguing that remittances negatively affect economic development is that remittances can create inflationary pressures or cause a phenomenon similar to dutch disease. after receiving remittances in a foreign currency, the household will exchange these remittances for local currency. this can appreciate the local currency and crowd-out exports .12 as mentioned above, at the macroeconomic level remittances may impact several variables including prices and the exchange rate. amuedo-dorantes and pozo (2004a), using data for 13 latin american and caribbean countries, finds that remittances cause appreciation of the real exchange rate. using data for cape verde, bourdet and falck (2006) also find some evidence of remittances causing dutch disease type phenomenon: real exchange rate appreciation crowds out exports. vargas-silva (2009) provides further evidence of real exchange rate appreciation for the case of mexico. however, this last result about the impact of remittances on exchange rates is not universal. for instance, amuedo-dorantes et aj. (2007), focusing in the case of small-island developing states, show that while foreign aid tends to appreciate the real exchange rate, remittances do not have the same impact. 13 the impact of remittances on prices, however, has remained largely unexplored. exceptions include balderas and nath (2008) and nath and vargas-silva (2008) . balderas and nath (2008) provide some evidence of remittances driving volume 26, number 1 87 relative price variability in mexico, while nath and vargas-silva (2008) suggest that there are important differences in the responses of relative prices to remittances according to various categories of these items. while the prices of a number of nontradable service items such as housing consistently rise, the relative prices of several durable items such as furniture tend to fall in response to the remittance shock. other studies have focused directly on the relationship between remittances and economic growth. for example, chami et at. (2005) used data for 113 countries to find that remittances are negatively correlated with gdp growth. they argue that remittances are not intended to be a source for capital development, but are just compensatory transfers. giuliano and ruiz-arranz (2005) find that remittances promote growth in less financially developed countries. they argue that remittances provide an alternative way of financing investment and helping to overcome liquidity constraints. similarly, mundaca (2005) finds that remittances have a positive effect on growth. mundaca (2005) argues that financial market development may boost the long-run effects of remittances on growth. finally, ruiz et al. (2009) re-examined the relationship between remittances and economic growth placing special attention to the non-linearity of this relationship. they show that the relationship between remittances and growth is neither linear nor quadratic and propose the use of a semiparametric model to avoid the risk of misspecification bias from imposing an arbitrary functional form. their results suggest that there is a positive relationship between remittances and growth in parametric estimations; however, such relationship disappears when non-linearity is taken into account using nonparametric techniques. finally, glytsos (2001) used data for five mediterranean countries (egypt, greece, jordan, morocco and portugal) to find mixed evidence on the role of remittances in economic development. remittances were shown to be capable of boosting growth and of moderating recessions in some cases, while in others remittances affected growth negatively and accentuated recessions. 14 remittances can also have an impact on the distribution of income. findings are mixed on this issue. usually in countries (or villages) with a long history of migration remittances are found to decrease inequality but in countries (or villages) without a long history of migration remittances increase inequality. in the first stage of migration only those households with high income are able to cover the cost of migration and benefit from remittances. this would initially increase income inequality. but as migration becomes more frequent, the cost of migration decreases. this decrease in the cost of migration is the consequence of the development of a network of migrants in the host country. in this stage poor households will be able to send relatives abroad and benefit from remittances. this effect of remittances in 88 journal of business strategies inequality is important, among other reasons, because if remittances decrease inequality, then it can be even argued that remittances are politically stabilizing. stark et al. (1986) uses data for mexico and finds that the effect of remittances on inequality depends, indeed, on the composition of the village. their results show that in a village with a large proportion of internal migrants (migrants within the same country) remittances from the u.s. increase income inequality, while remittances from internal emigrants decrease income inequality. the opposite result was true for villages with a large proportion of emigrants to the u.s. 15 the microeconomic impact of remittances as mentioned in the discussion above, the effect of remittances on economic growth is strongly related to the way the household uses remittance money. if we treat remittances as a source of household income, other things being equal, an increase in remittances shifts the receiving household 's budget constraint outward by the amount ofthe transfer and therefore should have a positive impact on household consumption. however, the potential increase in consumption is not likely to be equal across the spectrum of all goods and services. in fact, previous studies suggest that remittances increase the consumption of some goods and services more than that of others. adams (2005), using data for guatemala, finds that the remittance receiving households spend more on education, health, and housing, and less on food than do other households. similarly, taylor and mora (2006), in a study using household level data from mexico, conclude that the propensity to invest appears to be considerably larger for households with migrants. zarate-hoyos (2004) shows that mexican remittance-receiving households devote a larger proportion of current expenditures to investment and savings, and have lower income elasticities for current consumption and for durable goods. the reasons for the differences in consumption behavior and the levels of investment and savings of remittance-receiving households and those of households that do not receive remittances are not clear. it is possible that the household sees remittances as a temporary stream of income instead of permanent income and that the deviations in consumption patterns are due to the temporary nature of these transfers. it may also be possible that remittances come with a constraint on their potential uses. that is, in order to remit the migrant might expect a certain pattern of consumption and savings from the household. however, some studies (especially earlier studies) conclude that remittance transfers are spent mostly on food. for instance, orozco (2003) argues that the mexvolume 26, number 1 89 ican families receiving remittances from abroad typically spend over 75% of that money on their daily needs such as food and clothing. orozco (2003) also presents similar evidence for nicaragua and el salvador, where over three-quarters of the population spent their remittances on food alone. remittances may also impact the labor supply of the receiving households. for instance, it is possible that after receiving remittances the labor supply of some household members decreases . after all , an increase in remittances is an increase in income and leisure is a normal good. thus, the household would be expected to demand more leisure after receiving remittances. hanson (2005), using survey data from mexico, found that the remittance receiving households are less likely to participate in the labor force. the result was stronger for women in the household. in contrast, amuedo-dorantes and pozo (2006b) find no evidence that mexican males reduce labor supply in response to remittances. instead the authors argue that mexican males tend to vary their allocation of labor supply across types of employment. for the case of females , amuedodorantes and pozo (2006b) argue that there is a drop in overall labor supply. there could also be a relationship between receiving remittances and having a small business in the home country. remittances can give the household the initial capital necessary to start a small business. this is especially important in developing countries where credit markets are not well developed. amuedo-dorantes and pozo (2006c) used data for the dominican republic to find that the probability of business ownership decreases with the receipt of remittances. however, business ownership does attract remittances suggesting that those businesses are helped by these inflows. in a study for mexico, woodruff and zenteno (2001) found evidence that remittances were affecting microenterprise development positively. moreover, they argue that remittances are responsible for almost 20% of the capital invested in microenterprises throughout urban mexico. there are a number of papers that study the impact of remittances on schooling in the home country. there are several hypotheses that support the notion that remittances may increase the education of children in the household . for instance, the receipt of remittances relaxes the budget constraint of the household allowing the household to cover the cost of sending children to school. also, the need for chi idren to be involved in income generating activities decreases as a result of the additional income. one additional possibility is that senders of remittances explicitly want the children in the household to attend school. if we see remittances as an intergenerational process, the emigrants may plan to retire in the home country and these children will be supporting them financially. one specific example can be 90 journal of business strategies found in the results obtained by edwards and ureta (2003). using data for ei salvador, they find that remittances affect school retention positively. the effect of remittances on school retention was stronger than the effect of other household income. somewhat different to these results, a study by borraz (2005) finds that, for the case of mexico, remittances have only a slight increase on child education. the issue of remittances and schooling can also be more complicated than what the previous discussion suggests. when one of the parents migrates there is a disruptive effect on the family and this can affect the education of the children negatively. but as mentioned above if the household receives remittances, then this relaxes the budget constraint of the household and they can afford to send children to school. it seems that migration of one parent (or maybe both) has a negative impact on schooling, but remittances have a positive impact. in a study for the dominican republic, amuedo-dorantes and pozo (2006d) found that indeed while migration had a negative effect on the schooling attainment of the children left behind, remittances had a positive effect on schooling. the result was stronger for girls than for boys.16 concluding remarks the purpose of this article was to review the empirical literature on workers' remittances. the aim was to determine what the data, so far, is telling us about the determinants and consequences of these flows. in doing so, our hope was to uncover what can be said with relative confidence about remittances and to assess facts and myths about remittance transfers. as we have shown in this review the results obtained in the remittance literature seem to suggest that there are several motivations to remit. some of the motivations to remit that are constantly mentioned in the literature include altruism, self-interest purposes (e.g. investment, inheritance), insurance and loan repayment motives. evidence for these motivations to remit are implied by the response of remittances to certain microeconomic variables such as income (migrant and household), cost of migration, investment in the education of the migrant and possibility of inheritance, among many others. along with these microeconomic determinants the literature also suggests that macroeconomic variables such as interest rates and exchange rates may also impact remittance flows. remittances have also been found to have an impact in a large number of microeconomic and macroeconomic variables that include, among others, the labor supply of the receiving household, exchange rates and output growth. the theoretical literature on remittance transfers has made strong assumptions about the motivations for remitting and the implication of remittance flows. volume 26, number 1 91 for instance, several papers studying the macroeconomic impact of remittances have assumed that remittances are altruistic transfers from migrants. our review of the literature on remittances suggests that while there is some evidence that a portion of remittances are altruistic transfers, results show that there are many other reasons for remitting. hence, assuming that remittances are purely altruistic transfers is unrealistic and holding that assumption may result in inadequate conclusions. several previous theoretical studies have also assumed a specific relationship between remittances and home country output in order to construct their models (e.g. output decreases and remittances increase). our review also suggests that the relationship between remittances and home country income is at best mixed. finally, we have seen that the uses of remittances on the part of the households are diverse and therefore, the theoretical models should not simply assume that remittances are equal to other sources of money. often, remittances flows come with conditions about the uses that remittance-receiving households can give to this money. in addition to the implications that this has for the budget constraint of remittance receiving households, several studies support the hypothesis that remittance-receiving households simply behave differently than their non-remittance receiving counterparts. overall, our suggestion is that future theoretical models of remittances should adjust their models so that they reflect the diversity of findings in the empirical literature. there are no established facts about the motivations for remittances; therefore, strong and static assumptions in theoretical models can be unrealistic. strong assumptions only imply that these theoretical models apply to some types of transfers and not necessarily to the case of remittance transfers in general. notes 1. gubert (2002) uses data for western mali to test for the possibility of a mutual insurance contract between the emigrant and the household. following the idea of lucas and stark (1985), the author develops a number of variables that are representative of shocks to household income, constructed using data from the crop production of the household. the author reports some evidence that remittances respond to these shocks variables, which he interprets as evidence of a coinsurance agreement between the household and the emigrant. 2. see also ahlburg and brown (1999), brown (1994) and connell (2000) for more on remittances in the south pacific. 92 journal of business strategies 3. in hoddinott's (1994) study, most migrants intended to return to their homes at some point. 4. see hoddinott (1992) for more on remittances in kenya. 5. see osili (2007) for more on remittances in nigeria. 6. vanwey (2004), in another study using data from thailand, found that women and migrants from poorer households behave more altruistically, while men and migrants from richer households behave more contractually. 7. contrary to this result, brown (1997) fails to find evidence of remittances decay overtime. 8. see feiler (1987) and wahba (2004) for other studies related to egypt. 9. the irca gave undocumented immigrants in the us. the opportunity to obtain amnesty and become legal permanent residents. the irca consisted of two phases. in the first phase about 1.8 million undocumented immigrants applied and qualified for temporary legal residency. one of the requirements to qualify was living in the us. prior to the year 1982. those who qualified were given 18 months to satisfy an english language requirement and to learn us. civic matters. the second phase consisted of acquiring legal permanent residency. about 1.6 million from this group successfully completed the second phase. 10. see sayan (2004) and tuncay et al. (2005) for more studies related to turkey. 11. for instance, in a study about egypt adams (1991) finds that about 54 percent of the remittance money that was spent on non-recurring items went into construction and repair of houses. 12. remittances might also affect the real exchange rate via their differential impact on traded versus non-traded goods. for instance, ifremittances are mainly spent on non-traded goods, increasing their price, there may eventually be an appreciation of the real exchange rate. 13. it is also important to note that the effect of remittances on the exchange rate is going to be influenced by the exchange rate regime (e.g. fixed or flexible) of the receiving country. 14. some authors argue that while the effect of remittances on economic growth is not clear, remittances can reduce poverty levels. adams and page (2003) use data from a cross-section of countries and show that on average a 10 percent increase in volume 26, number 1 93 remittances as a share of gdp will lead to a 1.6 percent decrease in the percent of people living in poverty. 15. taylor (1992), also using data for mexico argues that remittances have a short term effect on inequality in addition to a long term effect through long term asset accumulation. in a study using survey data from nicaragua, barham and boucher (1998) found that remittances do increase income inequality. milanovic (1987) found similar results for yugoslavia. for a theoretical treatment of the relationship between remittances and inequality see quibria (1997). 16. using data from mexico, hanson and woodruff (2003) found that remittances and migration to the us. were both positively affecting the education of the children. the effect ofmigration was stronger for those households were the mother had lower levels of education. references adams, jr., r. (1991). the economic uses and impact of international remittances in rural egypt. economic development and cultural change, 39, 695-722. adams, r. (2005). remittances, household expenditure and investment in guatemala. the world bank policy research working paper series 3532. adams, r., & page, 1. (2003). international migration, remittances and poverty in developing countries. world bank policy research working paper series 3179. agarwal, r., & horowitz, a. (2002). are international remittances altruism or insurance? evidence from guyana using multiple-migrant households. world development, 30( ii), 2033-2044. ahlburg, d., & brown, r. (1999). remittances in the south pacific. international journal of social economics, 26(1),325-344. amuedo-dorantes, c., & pozo, s. (2004a). worker's remittances and the real exchange rate: a paradox of gifts. world development, 32(8), 1407-1417. amuedo-dorantes, c., & pozo. s. (2006a). remittances as insurance: evidence from mexican immigrants. journal of population economics, 19(2), 227-254. amuedo-dorantes, c., & pozo, s. (2006b). migration, remittances and male and female employment patterns. american economic review, 96(2), 222-26. amuedo-dorantes, c., & pozo, s. (2006c). remittance receipt and business ownership in the dominican republic. world economy, 29(7), 939-56. amuedo-dorantes, c. , & pozo, s. (2006d). international migration, remittances and the education of children: the dominican case. working paper, western michigan university. 94 journal of business strategies amuedo-dorantes, c., pozo, s., & vargas-silva, c. (2007). remittances and the macroeconomy: the case of small island developing states. unu-wider research paper no. 2007/22. balderas, u., & nath, h. (2008). inflation and relative price variability in mexico : the role of remittances. applied economics letters, 15(3), 181-185. barham, b. , & boucher, s. (1998). migration, remittances, and inequality: estimating the net effects of migration on income distribution. journal of development economics, 55(2),307-331. blue, s. (2004). state policy, economic crisis, gender, and family ties: determinants of family remittances to cuba. economic geography, 80( 1), 63-82. borraz, f. (2005). assessing the impact of remittances on schooling: the mexican experience. global economy journal, 5(1), pp.i-9. bourdet, y, & falck, h. (2006). emigrant's remittances and dutch disease in cape verde. international economic journal, 20(3), 267-284. brown, r. (1997). estimating remittance functions for pacific island migrants. world development, 25(4),613-626. brown, r. (1994). migrants, remittances, savings and investment in the south pacific. international labour review, 133(3),347-367. chami, r., fullenkamp, c., & jahjah, s. (2005). are immigrant remittance flows a source of capital for development? imf staff papers, 52(1), 55-81. connell, j. (2000). migration and remittances in island microstates; a comparative perspective on the south pacific and the caribbean. international journal of urban and regional research, 24(1), 52-78. de la briere, b., sadouleth, e., de janvry, a., & lambert, s. (2002). the roles and destination, gender, and household composition in explaining remittances: an analysis for the dominican sierra. journal of development economics, 68(2), 309-328. edwards, a., & ureta, m. (2003). international migration, remittances, and schooling: evidence from el salvador. journal of development economics, 72(2), 429-461 . ei-sakka, m., & mcnabb, r. (1999). the macroeconomic determinants of migrant remittances. world development, 27(8), 1493-1502. faini, r. (1994). workers remittances and the real exchange rate: a quantitative framework. journal of population economics, 7(2), 235-245. feiler, g. (1987). scope and some effects of remittances of egyptian working in the arab oil-producing countries, 1973-1984. asian and african studies, 21(3), 305-325 . volume 26, number 1 95 funkhouser, e. (1995). remittances from international migration: a comparison of el salvador and nicaragua. the review of economics and statistics, 77(1), 137146. giuliano, p., & ruiz-arranz, m. (2005). remittances, financial development, and growth. international monetary fund working paper os/234. glytsos, n. p. (2001). dynamic effects of migrant remittances on growth: an econometric model with an application to mediterranean countries. centre of planning and economic research, 1-38. gubert, f. (2002). do migrants insure those who stay behind? evidence from the kayes area (western mali). oxford development studies, 30(3). hanson, g. h. (2005). emigration, labor supply, and earnings in mexico. nber working papers 11412. hanson, g. h., & woodruff, c. (2003) emigration and educational attainment in mexico. working paper, university of california at san diego. higgins, m., hysenbegasi, a., & pozo, s. (2004). exchange-rate uncertainty and workers' remittances. applied financial economics, 14,403-411. hoddinott, j. (1994). a model of migration and remittances applied to western kenya. oxford economic papers, 46(3),459-476. hoddinott, 1. (1992). modelling remittances flows in kenya. journal of african economies, 1(2), 206-232. hysenbegasi, a., & pozo, s. (2008) workers' remittances and currency crises. wellbeing and social policy journallbienestar y politica social, forthcoming . international fund for agricultural development (2006). retrieved from www.ifad. org/events/remittances/maps/asia.htm. inter-american development bank (2008). idb estimates of 2008 remittance flows to latin america and the caribbean. retrieved march, 2009 from www. iadb.org/exr/remittances. katseli, l., & glytsos, n. (1986). theoretical and empirical determinants of international labour mobility: a greek-german perspective . centre for economic policy research discussion paper, 148. lucas, r .. & stark, o. (1985). motivations to remit: evidence from bostwana. the journal of political economy, 93(5),901-918. merkle, l., & zimmerman, k. (1992). savings, remittances, and return migration. economic letters, 38(1), 77-81. milanovic, b. (1987). remittances and income distribution. journal of economic studies, 14(5), 24-37 . 96 journal of business strategies mundaca, g. (2005). can remittances enhance economic growth? the role offinancial markets development. unpublished, department of economics, university of oslo, oslo, norway. nath, r, & vargas-silva, c. (2008). remittances and relative prices. working paper, sam houston state university, huntsville, tx. orozco, m. (2003). remittances, the rural sector, and policy options in latin america usaid and basis collaborative research support program (crsp). osaki, k. (1999). economic interactions of migrants and their households of origin: are women more reliable supporters? asian and pacific migration journal, 8, 447-71. os iii, u. o. (2004). migrants and housing investments: theory and evidence from nigeria. economic development and cultural change, 52(4),821-849. osili, u. o. (2007). remittances and savings from international migration: theory and evidence using a matched simple. journal of development economics, 83, 446-465. pozo, s., & vargas-silva, c. (2008). immigrant's remittances and the exchange rate. working paper, (july 31). quibria, m. g. (1997). international migration, remittances and income distribution in the source country: a synthesis. bulletin of economic research, 49( i), 2946. roache, s. k., & gradzka, e. (2007). do remittances to latin america depend on the u.s. business cycle? imf working paper wp/07/273. ruiz, i., shukralla, e., & vargas-silva, c. (2009). remittances, institutions and growth: a panel semi-parametric approach. international economic journal, 23(1),111-119. sayan, s. (2004). guest workers' remittances and output fluctuations in host and home countries. emerging markets finance and trade, 40(6),68-81. stark, 0., taylor, e., & yitzhaki, s. (1986). remittances and inequality. the economic journal, 96(383), 722-740. straubhaar, t. (1986). the determinants of workers' remittances: the case of turkey. weltwirtschaftliches archiv, 122(4), 728-740 . swamy, g. (1981). international migrant workers' remittances: issues and prospects. world bank staff working paper no. 481. taylor, e. (1992). remittances and inequality reconsidered: direct, indirect, and intertemporal effects . journal of policy modeling, 14(2), 187-208. taylor, j. e., & mora, j. (2006). does migration reshape expenditures in rural households? evidence from mexico. world bank policy research working paper 3842. volume 26, number 1 97 tuncay aydas, 0., neyapti, b., & metzin-ozcan, k. (2005). detenninants of workers remittances: the case of turkey. emerging markets finance and trade, 41(3),53-69. united nations. (2005). retrieved december, 2005 from www.un .org. vanwey, l. k. (2004). altruistic and contractual remittances between male and female migrants and households in thailand. demography, 41(4), 739-756. vargas-silva, c. (2009). crime and remittance transfers. eastern economic journal, 35(2),232-247. vargas-silva, c. (2008) . are remittances manna from heaven? a look at the business cycle properties of remittances. the north american journal of economics and finance, 19(3),290-303. vargas-silva, c. (2009). the tale of three amigos: remittances, exchange rates and money demand in mexico. review of development economics, 13( i), 1-14. vargas-silva, c. & huang, p. (2006). macroeconomic detenninants of workers' remittances: host versus home country economic decisions. journal of international trade and economic development, 15( 1), 8\-99. wahba, j. (2004). does international migration matter? a study of egyptian return migrants. arab migration in a globalised world, geneva: international organization for migration. woodruff, c., & zenteno, r. (2001). remittances and microenterprises in mexico. working paper, university of california san diego. yang, d. (2008). international migration, human capital, and entrepreneurship: evidence from philippine migrants' exchange rate shocks. the economic journal, 118,591-630. zarate-hoyos, g. (2004). consumption and remittances in migrant households: toward a productive use of remittances. contemporary economic policy, 22(4), 555-565. biographical sketches of authors carlos vargas-silva is an assistant professor of economics at sam houston state university. one strand of his research examines the relationship between remittances and the macroeconomic variables of the remittance receiving countries. another analyzes the impact of demographic factors on the amounts remitted. he holds a bachelors degree and masters degree from the university of puerto rico, as well as a masters and ph.d. from western michigan university. isabel ruiz is an assistant professor of economics at sam houston state university. she has an special interest on exchange rates, time-series modeling of 98 journal of business strategies financial data, monetary policy in emerging markets, international capital flows and economic development in latin america. she holds a bachelors degree from universidad eafit in colombia, as well as a masters and ph.d. from western michigan university. to send, or not to send: that is the question. a review of the literature on workers' remittances do traditional strategic concepts apply in the e-marketing context? bill merrilees griffith university, gold coast queensland, australia abstract this paper explores generic marketing strategies and competitive market positioning in the context of the australian online book industry. the key research question is the extent to which traditional strategic concepts, like competitive market position and sustainable competitive advantage (sea), apply in the new world of e-marketing. the most important issue that emerges from the study is that the tools and concepts that are relevant for offline firms are equally applicable for online firms. different generic strategies call for a different market position and this is borne out in our case study. special attention is given to the importance ofa channel management generic strategy in the e-marketing context. firms contemplating this option need to have a high level of competency in relationship marketing skills. introduction the diffusion of the internet has revolutionized the business landscape. not only has the internet reconfigured the way companies do business and the way consumers buy goods and services, it has been instrumental in transforming the value chain from manufacturers to retailers to consumers, creating a new retail distribution channel (donthu & garcia, 1999). the initial wave of research has investigated piecemeal components of e-marketing, notably banner advertisements and consumer information search processes (ducoffe, 1996; hoffman & novak, 1996; novak, hoffman & yung, 2000; rowley, 2000). what is missing from this research platform are papers that address the organizationally broader, more strategic aspect of e-marketing. from this point of view, the current special issue of the journal of business strategies is very timely. the agenda of the current paper is deliberately broad. the emergence of a new marketing channel requires testing of the traditional strategic tools to see if they are still applicable. there is now a well-established kit of concepts that can be used to evaluate and/or develop a marketing strategy for a firm. the tool-kit includes: • overall marketing strategy, with an emphasis on distinctiveness • generic marketing strategy • competitive market position • key strengths and weaknesses • sustainable competitive advantage (sca) 178 journal of business strategies vol. 18, no.2 • supporting capabilities • the marketing mix, including the four-ps and overall branding of the company. cravens, merrilees and walker (2000) provide an exposition of the importance of these components of a marketing strategy. of course, it is essential that each component is coordinated and integrated in a holistic way. the central proposition in the current paper is that the same tools and concepts are equally applicable to online firms. there is some urgency to test our central proposition because most of the recent papers in both the e-commerce and e-marketing literature seem to be relatively piecemeal and not strategic. this is not a criticism ofthe literature; far from it, there is a need to answer many detailed questions, such as the impact of banner advertisements and whether rich media banner advertisements are more effective. relatively few of these papers have adopted an overall strategic framework. strictly speaking, we are in an agnostic position as to whether firms have acted in a strategic way. however there is a superficial impression that many of the new e-retail sites have adopted a "me too" approach, in that they do not seem to be highly differentiated from competitive sites. there are two research questions. firstly, can the standard strategic marketing management concepts and tools be used as a framework to analyze online strategies? secondly, to what extent have the three key firms in the australian online book industry adopted a strategic approach in the way they have done business? these questions are important because there are now dozens of books about internet marketing that emphasize that it is different to conventional marketing, suggesting that the answer to the first question is no. alternatively, there is some tendency to use the conventional strategic tools, in part at least, without fully testing whether they are valid and useful in the internet context (see dann & dann, 2001). the only way around this impasse is to conduct an in-depth study with the express purpose of examining how the strategic concepts work in the internet environment. the evidence to be used is partly the monitoring of this industry over the past two years and partly the conduct of a consumer-user survey of the three sites. the latter is particularly useful in the development of competitive position maps. the strategic framework used is that of cravens, merrilees and walker (2000). there are a number of slight differences used in the choice of strategic marketing framework. cravens et a1. (2000) strongly emphasize the importance of distinctiveness as a key characteristic of a marketing strategy. other scholars, such as kay (1993), do the same. cravens et al also emphasize the importance of competitive market positioning as a central feature of a marketing strategy, as does porter (1996). in this respect the current paper aims to highlight the usefulness of the "snake diagram" as a preferred way of illustrating a multiattribute competitive position. cravens et al. (2000) also replace the classic porter typology of differentiationllow-costlfocus, with an alternative four type fall 2001 merrilees: traditional strategic concepts 179 classification of generic strategy of branding, innovation, channel management and low cost-price. we will elaborate on these points of departure. distinctiveness: surprisingly, few strategic marketing texts emphasize the critical need to develop a distinctive strategy, though papers in the resource-based theory of strategic management usually emphasize the distinctiveness ofcapabilities (barney, 1991; conant, mokwa & varadarajan, 1990; grant, 1991; hunt & morgan, 1995; snow & hrebiniak, 1980). marketing strategy distinctiveness could be related to any aspect of the marketing mix (that is, anyone of the four-ps), with distribution having as much appeal as product as a way of achieving distinctiveness. equally, distinctiveness could be based on any new combination of the four ps, or linked in some way to a loyal base of customers. distinctiveness seems to be a potential area of neglect with some of the new e-retailers, in that firms seem obsessed by the need to develop a technological presence and may be giving less attention to the marketing nuances associated with these sites. snake position maps: the classic positioning map is an important tool to show how a firm is positioned against its competitors with respect to two key attributes. as such the map is an important way of depicting the nature of distinctiveness of a particular firm. but what if there are four or five key attributes to be compared across competitors? multiple maps could be used, but this would represent a partial, rather than a holistic picture of comparative positions. a better approach is to use the snake diagram. used in the past to compare the store image of different retailers (mcgoldrick, 1990), it is equally relevant as a competitive position map. to illustrate, we use this tool in figure 1. figure 1 snake position maps for three online booksellers -... 10 9 8 7 6 5 4 3 2 1 o ----"---.. ..... "\...~-._ .......:::-: .....~ -factors angus & --robertson dymocks amazon 180 journal of business strategies vol. 18, no.2 a new typology of generic marketing strategies: porter (1985) is the classic reference in the marketing strategy literature. the porter classification has received some criticisms. studies have shown some firms are ambivalent about cost leadership and differentiation by emphasizing both. this is fatal to the original concepts, but could be salvaged if a mixture of low cost and differentiation were added to the theory. this would suit the total quality movement that advocates that both quality and cost can be simultaneously pursued. another limitation of the porter typology is that there is only room for one or two firms to be cost leaders. this places pressure on differentiation to be the most common strategy. if nearly all firms are using the same generic strategy (differentiation), then it is too broad or blunt to help shape or filter an individual firm's strategy. a further limitation of the porter (1985) classification is that it is not as realistic as it could be. actual firms generally do not talk of a "differentiation" strategy, but rather their "branding" or "innovation" or "relationship-marketing" strategy. cravens et a1. (2000) offers an alternative typology based on branding, innovation, channel management and low-cost. thus the "low cost" strategy-type is retained, but porter's "differentiation" strategy-type has been replaced by three others. it is argued in cravens et a1. (2000) that this new typology is closer to the vernacular of actual firms. each of the new strategy types highlights one of the four ps as dominant. branding highlights promotion or communication; innovation highlights product; channel-management highlights distribution and low-cost highlights price. many fast-moving-consumer-goods (fmcg) are likely to have a predominantly branding strategy. however some fmcg firms have a dual strategy, combining branding and innovation in the example ofcadbury-schweppes. overall, the typology affords a fresh look at how generic strategies guide the formulation and implementation of a firm's distinctive strategy and competitive market position. there are other, broader, strategic typologies that are more related to strategic management rather than strategic marketing. these typologies include miles and snow (1978) and joyce and woods (1996). future work will develop the inter-relationships between the strategic marketing and the strategic management types. method the study has a two-part design using qualitative and quantitative methods. the first part was a watching brief, to monitor and analyze the australian online-book market over the two-year period, 1999-2000. sites were monitored directly, as were the media for reports on the relevant firms. key books and articles were reviewed; though these usually related to amazon.com (seybold, 1998; spector, 2000). the qualitative analysis of the generic marketing strategies used an expert panel of three academics who were expert in strategic marketing principles. all three were involved in teaching a subject called strategic marketing. the text for this subject was cravens et a1. (2000), which facilitated an understanding of the strategic concepts to be analyzed in the qualitative research. there was on-going debate as to the fall 2001 merrilees: traditional strategic concepts 181 most relevant generic marketing strategy for each e-retailer, with consensus the final arbiter. debate does not mean that there were major disagreements between the panel members. far from it, there was a high level of agreement in the attribution of generic marketing strategy to particular firms. the debate was stronger in classifying amazon.com for reasons that will be explained below. following yin (1994), it was deemed important to use a protocol to assist the qualitative research. a protocol is a tool akin to a questionnaire in a quantitative survey and ensures that the current team assesses the material in a consistent way. it would also facilitate a future research team arriving at the same conclusion. table 1 outlines the key protocol in terms of the essential features that are associated with each of the four generic marketing strategies. for example, a low price generic strategy requires a heavy emphasis on low prices. it also requires a more limited range of product, limited services and no frills (low budget) operations. the use of a protocol relates to reliability, one of four criteria for judging the quality ofresearch designs. yin (1994, chapter 2) was also used as a guide to facilitate the implementation of the other three criteria, namely construct validity, internal validity and external validity. table 1 protocol to attribute generic marketing strategy to a firm marketing activities associated with particular generic marketing strategies low-price generic strateer channel manaeement generic strateer very strong emphasis on low prices very strong emphasis on distribution limited services strong customer relationships limited range of product strong vendor relationships no frills (low budget) operations database marketing loyalty programs key account management category management brandin&: gfneric strateay innovation generic straten very strong emphasis on promotion very strong emphasis on products promotion features the brand constant flow of new products high rate of advertising spending constant flow of process changes integrated marketing communication advertising features innovativeness consistent image in all aspects of marketing more flexible work structures source: cravens, merrilees & walker (2000) the qualitative approach was augmented by the conduct of a survey of the three sites to evaluate the user-consumer perspective quantitatively. a convenience sample of 151 university students (average age 23 years; 51 percent female) was used. we should emphasize that this was not simply just a "student sample", but rather a group 182 journal of business strategies vol 18, no.2 of very well informed business students that had a good grasp of strategic concepts. thus it was almost a type oflarge-scale expert"panel. participants were required to explore the three sites in a simulated buying context and then assess the sites in terms of standard user-relevant attributes. the attributes were selected from the retail choice literature and included low prices, quality of goods and fast delivery, (chowdhury, reardon & srivastava, 1998; dabholkar, thorpe & rentz, 1996). the surveys were implemented in 1999. analysis the analysis will be presented in two parts. the first part focuses on thequajitative aspect that aimed to probe, analyze and determine what generic marketing strategies have been used by each of the three online bookstores. the second part quantitatively identifies the different competitive market positions of the three e-retailers. generic marketing strategies of the three online book retailers the two australian-based online bookstores, angus and robertson and dymocks. were readily allocated into one of our four-type generic marketing strategies. clearly, an'gus and robertson emphasized a low-price strategy. this was explicitly tagged throughout their site; with "ten percent off all books" being the dominant message. it was also implicit with respect to all of their other e-marketing activities that were very weak relative to competitors. there was limited online service and the site itself was not very streamlined or helpful. that is, a very "no frills" service was offered. the impression is almost a "me too" online store. broadly, the online service is just an added activity, a type of brand extension, to supplement their already strong brick and mortar operation, where they are the largest book retail chain in australia. dymocks, the second australian-based online book retailer, closely fits the channel-management strategy type. in part, there is a similarity between the two australian sites, in that both have strong bricks and mortar book stores, having the top two positions in market shares. however they differ markedly in terms of pricing strategies, with no discounts offered online by dymocks. additionally, in 1999 dymocks had comparatively high delivery charges, which accentuated the price differential between the two online stores. the two e-retail sites also differed in terms of customer management dymocks have a book club that builds up a long-term relationship with customers. in the second half of 2000, book club members were asked to participate in an online customer survey. the findings of their survey can be used by the firm to further improve the service to its customers. the site is much better designed, being easier to move through, find information and make purchases. in short, the online search and transaction experience in dymocks has been designed to take good account of consumer needs. the more consumer-friendly web-site design, greater online service, better returns policy and use of a loyalty-club program fits dymocks into the fall 2001 merrilees: traditional strategic concepts 183 channel-management strategy type. moreover, dymocks reduction of its delivery fees in 2000 as a response to customer criticism was another indicator of its strong channel management focus. both australian sites have relatively vague branding. so while branding policies were used, they were not powerful enough to warrant the description of a branding generic strategy. similarly, neither australian site was especially innovative, so we can also rule out an innovation generic strategy. amazon. com is a more difficult online retailer to classify by generic marketing strategy type. part of the problem in classifying amazon. com into a strategy type is that they are very competent at all four activity-types. this is understandable because they are considered to be one of the best e-retailers in the world. within australia they have a dot com address and not a dot com dot au address (au denoting australia). despite this limitation they generate more e-tail sales than any other site, in australia. amazon. com do have low prices, with lots of discounts being offered. they have also been very innovative. this partly arises because they were one of the first major pioneers (there were a couple of smaller american online bookstores ahead of them). the innovation continues with site development to a certain degree, but also through extension into other retail categories, such as cds. they have also been innovative in nurturing alliances with other online booksellers. branding is clearly very important because they are one of the world's best-known e-brands. channel management is very important because customization and personalization of the site are among their "trademarks". they have that familiar, "hello [name]" welcome when the customer revisits. personalized customer profiles are generated to assist book selection. prompt delivery within the usa is important and the entire site was designed on a basic five-step process that was meant to make the consumer shopping experience convenient and helpful. increasingly they have built additional warehouses to further facilitate speedy delivery within the usa and have also built up excellent alliances with suppliers. given the strength of amazon. com in all four areas, how do we allocate them to a particular strategy type? having strengths in all four areas of marketing does not preclude the need for tight focus on one or two areas. no organization can run full stearn in four different directions at the same time. tradeoffs and priorities are needed to effectively manage the organization's scarce resources (porter 1996). nonetheless, we did note in the introduction that some companies have successfully employed a combination of two generic marketing strategies, as argued by cravens et al. (2000). an innovation generic strategy was certainly critical to amazon.com in their initial years of business. the concept of internet selection and online purchase of books was novel in the early 1990s and amazon. com designed and implemented a new way of doing business. however, after 2-3 years of business, once it was better known, the company moved to a combined branding and channel management generic strategy. we cannot separate being one ofthe world's best-known e-brands from its generic strategy. however the channel management aspect is equally 184 journal of business strategies vol. 18, no.2 important. the emphasis on simplicity, helpfulness, convenience, reliability, trust, memory of past habits and customer-relationships generally evoke a powerful image of a customer-driven organization. indeed, there is a sense in which the customer-driven (channel management) aspect is the e-brand. if the channel management side did not work as well as it does then the brand of amazon. com would have a lot lower brand equity. the low price aspect is important, but not enough to make it a generic marketing strategy compared to competitors. the amazon.com experience highlights the dynamic nature of competitive strategy. it is important that firms adapt to new marketing environments, as well as developing their own growth trajectory. pioneer firms in particular are likely to enter markets with an innovative strategy, but this can evolve into some other generic strategy as conditions change. snake position maps for the three online booksellers we have alluded to the usefulness of snake diagrams as a more effective way of depicting the multi-attribute competitive market position of different competitors. the source of the ratings of the three online booksellers was the survey of 151 users. it is emphasized that a convenience sample has been used and therefore we cannot readily generalize the results to the population of all users of the sites. however, although there may be some discrepancies between the sample and the true population, our view based on our own perceptions is that the sample ratings have a high level of content validity and objectivity. the snake diagrams for seven of the key attributes, as shown in figure 1, demonstrates the general superiority of amazon. com, except on one attribute (fast delivery). the geographic distance between the usa and australia explains this exception. the snake diagram also shows the general inferiority of angus and-robertson relative to the other local competitor (dymocks), except on low prices. the snake diagram suggests that dymocks have been broadly modeled on the amazon.com prototype, especially in relation to channel management features. table 2 provides the numerical spreadsheet that underlies figure 1. it also shows the various anova tests comparing each attribute across the three sites. most of the mean differences across the sites were significant. usually at the onepercent level. table 3 shows the strength of the firms in terms of capabilities needed for successful channel management strategies. the high level of competence of channel management strength ofamazon. com is supported by appropriate capabilities. these capabilities include good two-way communication, interactivity, responsiveness and provision ofinformation to customers. dymocks was ranked as second in such capabilities and angus and robertson a distant third. the anova tests show that most ofthe mean differences across the three sites were significant, usually at the one-percent level. in general we see that the snake plots, as expected. reflect the three different generic marketing strategies. angus and robertson have a narrowly scoped fall 2001 merrilees: traditional strategic concepts table 2 average ratings of the three online booksellers across key buying attributes (10 point scale used/or ratings, 10 high) 185 angus & site image attribute robertson dymocks amazon. com low prices 7.41 6.50 7.90b,c latest books 7.86 8.13a 8. 71b,c wide selection of books 7.43 7.75a 8. 85b,c fast delivery 7.26 7.66a 5.96b fair & easy returns policy 6.58 7.60a 7.33b overall shopping experience 6.29 7.03a 7.32b,d close, personalized relationship 6.08 6.68a 7.02b,d ~: a. denotes that rating for dymocks was significantly greater than angus & robertson at the 0.01 level b denotes that amazon was significantly greater than angus & robertson, 0.01 level c denotes that amazon was significantly greater than dymocks, 0.01 level d denotes that amazon was significantly greater than dymocks, 0.05 level. table 3 average ratings of the three online booksellers across various channel management capabilities (10 point scale used/or ratings, 10 high) angus & channel management capability robertson dymocks amazon. com good two-way communication 6.48 6.81a 7.30b,c good interactivity between user and the firm 6.46 6.96a 7.60b,c queries or questions answered well 6.62 7.07a 7.32b privacy of customer information protected 7.51 7.74a 7. 96b,d wealth of information & ideas 6.43 7.19a 8.55b,c ~: a denotes that rating for dymocks was significantly greater than angus & robertson at the 0.0 i level b denotes that amazon was significantly greater than angus & robertson, 0.01 level c denotes that amazon was significantly greater than dymocks, 0.0 i level d denotes that amazon was significantly greater than dymocks, 0.05 level. 186 journal of business strategies vol. 18, no.2 generic strategy focused on low prices and this is shown graphically in the position map. the importance of channel management strategy to both amazon. com and dymocks is also mirrored in the snake plot. the additional and special significance of branding to amazon. com is not explicitly represented on the snake plot, but can be interpreted as the composite of the attributes shown. in this respect the very strong performance of amazon. com in six of the seven image attributes is a reflection of its overall e-brand strength. discussion the generic marketing strategy typology used here provides a useful framework to interpret the respective competitive market positions of the three online booksellers. both the strategy typology framework and the snake position map incorporate other elements of a marketing strategy. for example, the sustainable competitive advantage of amazon. com is primarily related to superior relationship marketing. a similar conclusion applies to dymocks in a comparison of the two local online booksellers. although not reaching the heights ofamazon. com, dymocks have been able to use customer-responsiveness, a convenient returns policy and their book club program to nurture their own loyal base of customers. we have also shown that the superior channel management strategies of both amazon.com and dymocks are soundly supported by appropriate capabilities. the overall model of strategic marketing management that we started with has been woven together by each of the firms. in the case ofangus and robertson, the "weaving" has spun a "no frills" cloth, but it has nonetheless been woven in a consistent, harmonious way. this is not to say that their low price strategy offers them a sustainable competitive advantage. far from it, it is an advantage that could be easily copied. our most important finding in this paper is that the traditional strategic marketing tools, including generic marketing strategy, competitive market position, sca, and capabilities, are readily usable in the e-marketing environment. the approach shown in this paper has the potential to be applicable to most markets in most countries. these tools can be used by academics to study different markets or by practitioners researching their own market. it is critical that practitioners firstly determine their generic strategy as this provides an over-arching guide to the remaining components of a marketing strategy, including their sca and competitive market position. the other important lesson here is that the components of the marketing strategy need to be suitably integrated with each other. different generic strategies require different integration tactics and capabilities. some generic strategies, like low price, require a fairly straightforward set of integrating tasks, namely to vividly display low prices and to run all other operations on a no frills costing basis. other generic strategies, like channel management, require more complex integration of tactics and capabilities. however the reward in the last cases is that a unique set of competencies are created that help sustain a competifall 2001 merrilees: traditional strategic concepts 187 tive advantage over a longer period of time. the study has additional practical importance in terms of its advocating a snake position diagram, rather the traditional two-attribute position map. the snake diagram should be particularly helpful for busy executives who often prefer a visual picture of where their business stands relative to competitors. a special benefit of the snake diagram is that it can potentially quickly reveal that a firm is a "me too" eretailer, with very limited distinctiveness. this was the case ofangus and robertson, where the snake diagram revealed that they had an inferior position in most areas. the snake diagram can guide firms to deliberately and purposefully redevelop their business so as to be better positioned against competitors. the analysis has some broader implications in that selection of a channel management generic strategy in the e-marketing context has much merit. we have already discussed the notion that this type of generic strategy is more likely to create a sustainable competitive advantage. importantly, the fact that a major competitor develops a competitive advantage using a channel management strategy does not preclude any other firm doing the same. the amazon. com and dymocks cases are testimony to this point. indeed, the channel management strategy lends itself to the development of distinctive (unique) capabilities, often inextricably linked to a loyal and satisfied customer base. in contrast, there is unlikely to be room for more than one or two low-price generic strategy firms and this may not be sustainable. similarly, at any time, there is likely to be only one or two really innovative firms and these fads may not be sustainable either. from the consumer's perspective, novelty may be fine for a short time, but in the long-term more practical aspects like reliability and time-saving convenience are likely to be more important. it is telling that our analysis provides some insight to the critical enduring qualities for e-marketing success. reliability, flexibility and convenience would seem to be the hallmarks of the excellent channel management firms. convenience rather than low prices is the most critical need of consumers in the new world of e-marketing and the more that the e-marketing strategies reflect this, the more successful they are likely to be. conclusions the study has analyzed the marketing strategies of the three leading firms in the australian online book retailing industry. the firm with the highest market share is american-based amazon.com, reflecting the global nature of internet markets. the other two firms are australian-based, where the online business is an add-on to very strong bricks and mortar operations. the three sites have been monitored over a two-year period using qualitative research. additionally, a quantitative component of the study used a convenience survey of 151 respondents, providing a user-consumer basis for the snake competitive position maps. snake maps are essentially image maps, showing how different firms were perceived from a consumer point of view. 188 journal of business strategies vol. 18, no.2 amazon.com was found to have a dual generic marketing strategy, combining branding and channel management. they are in an extremely strong position worldwide. their very strong position in the australian online book market is reflected in the snake position map. it was also shown that amazon. com support their market position with high performing, relevant capabilities, such as communication and technology. dymocks was found to be performing very strongly as well, with an well-articulated channel management generic strategy. this broad generic strategy has similarities to that of amazon.com, but dymocks have refined it in a way to develop their own distinctive competencies linked to a loyal base of customers. angus and robertson also have a clear image on the snake position map, namely that of a low-price online book retailer. we have argued that this is less likely to be a sustainable advantage in the long run, especially since their bricks and mortar outlets have a more upmarket position and therefore customers who accessed both received mixed messages from this inconsistency. the critical finding is not simply about the different strategies of three competitors in a given market, but the potential of the methodology for the analysis of any online market. it now seems likely that the conventional tools and concepts of strategic marketing can be applied to other online markets. in other words, strategic concepts such as generic marketing strategy, competitive market position, the snake position map and sea, can be readily and productively applied to the e-marketing environment. evaluating this proposition was the central purpose of the current paper. either academics or practitioners can use the concepts to give insight into how competitors compare. in particular, the snake position map might be seen as especially helpful as a visual aid to ensure that practitioners are not entrapped into inadequate "me too" e-positions. the other main lesson for e-marketing strategy in general is the potentially important role of a channel management generic strategy. it was argued that a channel management generic strategy is more likely to create a sustainable competitive advantage. through a program of relationship-management and technology management a firm can build their own distinctive competencies, linked to a loyal base of customers. at a more detailed level, quality relationships on the web can be managed through a greater understanding of sitecustomer communication and interactivity (merrilees, 2002). references barney, j. (1991). firm resources and sustained competitive advantage. journal of mana~ement. 17 (1), 99-120. chowdhury. j., reardon, j. & srivastava, r. (1998). alternative modes of measuring store image: an empirical assessment of structured versus unstructured measures. journal of marketingtheory and practice. 6 (2) (spring), 72-86. fall 2001 merrilees: traditional strategic concepts 189 conant, j., mokwa, m. & varadarajan, r. (1990). strategic types, distinctive marketing competencies and organizational performance: a multiple measures-based study. strategic management journal. 11 (5) (september), 365-383. cravens, d., merrilees, b. & walker, r. (2000). strategic marketing management for the pacific rellion. sydney: mcgraw-hili. dabholkar, p., thorpe, d. & rentz, j. (1996). a measure of service quality for retail stores: scale development and validation. journal of the academy of marketing science. 24 (winter), 3-16. dann, s. & dann, s. (2001). strategic internet marketing. brisbane: wiley. day, g. (1994). the capabilities of market-driven organizations. journal of marketing. 58 (october), 37-52. deighton, j. (1996). the future of interactive marketing. harvard business review. 74 (6), 151-161. donthu, n. & garcia, a. (1999). the internet shopper. journal of advertising research. 39 (3), 52-58. ducoffe, r. (1996). advertising value and advertising on the web. journal of advertising research. 36 (5), 21-35. grant, r. (1991). the resource-based theory of competitive advantage. california mana.gement review. spring, 114-135. hoffman, d. & novak, t. (1996). marketing in hypermedia computer-mediated environments: conceptual foundations. journal of marketing. 60, 50-68. homburg, c, workman, j. & jensen, o. (2000). fundamental changes in marketing organization: the movement toward a customer-focused organizational structure. journal of academy of marketing science. 28 (4),459-478. hunt, s. & morgan, r. (1995). the comparative advantage theory of competition. journal of marketing. 59 (april), 1-15. joyce, t. & woods, a. (1996). essential strategic mana&ement: from modernism to pra~matism. oxford: butterworth-heinemann. kay, j. (1993). foundations of corporate success. oxford: oxford university press. mcgoldrick, p. (1990). retail marketing. london: mcgraw-hili. merrilees, b. (2002). interactivty design as the key to managing customer relations in ecommerce. journal of relatiqnship marketing, forthcoming. 190 journal of business strategies vol. 18, no.2 miles, r. & snow, c. (1978). or~anizational strate~y. structure and process. new york: mcgraw-hill. novak, t., hoffman, d. & yung, y. (2000). measuring the customer experience in online environments: a structural modeling approach. marketing science. 19 (1). obert, t. & spencer, b. (1996). an exploration study of the link between strategic types and quality implementation. the journal of business strategies, 13 (1) (spring), 89-106. porter, m. (1985). competitive strategy. new york: free press. porter, m. (1996). what is strategy? harvard business review. 74 (6), 61-78. rowley, j. (2000). product search in e-shopping: a review and research propositions. journal of consumer marketing. 17 (1),20-35. seybold, p. (1998). customers.com. london: century business books. slater, s. (1996). the challenge of sustaining competitive advantage. industrial marketing management. 25, 79-86. snow, c. & hrebiniak, l. (1980). strategy, distinctive competence and organizational performance. administrative science quarterly. 25 (2) (june), 317-336. spector, r. (2000). amazon.com. sydney: harper. teece, d., pisano. g. & shuen, a. (1997). dynamic capabilities and strategic management. strate~ic management journal, 18 (7), 509-533. walsh, j. & godfey, s. (2000). the internet: a new era in customer service. european management journal, 18 (1), 85-92. yin, r. (1994). case study research. (2nd ed.). thousand oaks, ca: sage. bill merrilees has a ph.d. from the university of toronto, canada. currently he is professor of marketing & retailing at griffith university, gold coast, queensland, australia. dr merrilees has recently co-authored (with david cravens and rhett walker) a book on strategic marketing. most of his research and teaching is in the realm of strategic marketing, retailing, e-retailing, innovation and branding. do traditional strategic concepts apply in the e-marketing context? 124 journal of business strategies wilcoxen, 2002); and the united states' abstinence from the kyoto protocol will not protect it from the environmental and economic consequences of global climate change. if atmospheric carbon dioxide doubles by 2050, it will cost the u.s. an estimated $68 billion annually and the annual global cost will be approximately $304 billion (hoffman, 2005). although there has been much research examining the association between corporate environmental performance and organizational outcomes (e.g., bansal & hunter, 2003; margolis & walsh , 2003; orlitzky, schmidt, & rynes, 2003; russo & fouts; 1997; sharma & vrendenburg, 1998), there are no published empirical studies that specifically examine whether firms pursuing proactive climate change strategies financially outperform competitors that are less proactive. to-date, the extant literature has focused on firm motivations for pursuing climate change strategies ( levy & kolk, 2002; kolk & pinske, 2004, 2005, 2007b; okereke, 2007; porter & re inhart, 2007), corporate political lobbying strategies regarding climate change (kolk & pinkse, 2007a), and the degree to which global firms voluntarily commit to reducing their impact on climate change (stanwick & stanwick, 2006). the purpose of this study is to examine the relationship between proactive climate change strategies and accounting performance. in this paper, we describe how highly proactive firms typically engage in three broad climate-change initiatives aimed at reducing carbon dioxide and other greenhouse gas emissions: (1) by developing energy substitutes for oil and coal, such as wind and solar power, (2) by developing renewable energy sources (e.g., hydrogen and other fuel cells), and (3) by working collaboratively with firms, governments , non-governmental organizations (ngos), and other stakeholders toward large-scale climate-change solutions. we then show how these three climate-change initiatives are consistent with the logic embodied in the nrbv, a unique perspective of sea based on the inter-relationship between the firm and the natural environment (hart, 1995). it builds on the strengths of the rbv but addresses a deficiency inherent in rbv and many other management theories that constraints imposed by the earth's natural environment will impact a firm's resource-based advantage in the long run. as such, the theoretical section of the paper begins with an overview of the rbv , including its assumptions, prescriptions, and summary of rbv studies, followed by an overview ofthe nrbv and hart ' s (1995) original framework (founder of the nrbv). we use the logic embodied in hart ' s framework in identifying three strategic capability-based climate-change strategies that can be a source of sea in a way that reduces carbon dioxide and other greenhouse gas emissions. the linkages volume 27, number 2 125 between the proactive climate change initiatives, the three strategic capability-based climate-change strategies, and the source of sca provide the foundation for the "nrbv framework for proactive climate change organizations," shown in table i. the remainder of the paper describes the methodology of the study, the empirical results, the implications and limitations of the empirical findings, and possible avenues for future research . climate change initiatives carbon emissions and greenhouse gases: fossil fuels climate changes have, in large part, been linked to the global economy's heavy reliance on oil as an energy source. as a cheaper alternative energy source to oil, coal is vast and can last for generations (eta, 2006). however, coal-fired power plants release substantial amounts of carbon dioxide into the atmosphere (doe & epa, 2000) which conflicts with growing regulatory and societal pressure on countries and corporations to reduce their carbon dioxide emissions. even the united states, which is not a signatory to the kyoto protocol, is facing increasing regulatory pressure to address climate change. in 2007, the u.s . supreme court ruled that, "greenhouse gases fit well within the clean air act ' s capacious definition of air pollutant" (greenhouse, 2007), thus , paving the way for a carbon constrained future. in short, it is becoming increasingly unlikely that global firms will be able to escape regulatory mandates to reduce their emissions of greenhouse gases. renewable energy and fossil fuel substitutes firms are beginning to identify profitable market opportunities for developing technologies that assist organizations in transitioning from oil and coal to alternative energy sources. recent revenue projections from wind and solar power are expected to increase by a factor of five or six in the next several years and hydrogen fuel cells, which emit no greenhouse gases, are expected to increase by a factor of 15 from 2004 to 2014. in less than a decade, the estimated market value for these three energy sources is expected to reach $100 billion (makower, pemick, & wilder, 2005). the point is that market opportunities and not just regulatory pressures will motivate firms to find innovative ways to profit from these new energy-based market opportunities. another substitute for oil and coal is natural gas, and although it is a fossil fuel , it emits only half as much carbon dioxide as coal (epa, 2006a) and one third less carbon dioxide than oil (epa, 2006b). while these emissions are still greater 126 journal of business strategies than that generated by solar and wind power, natural gas can serve as a transitional fuel (greene, hopson, & li, 2006) from a high greenhouse-gas economy to a low greenhouse-gas economy. additionally, the world's natural gas reserves are vast and expected to last over 60 years (eia, 2006). thus, regulatory pressure for firms to reduce their carbon dioxide emissions coupled with the vast geophysical availability of natural gas provides firms with a viable, lower-greenhouse gas energy substitute for oil and coal. this presents opportunities for profit-driven entities to develop and market proactive gas-based energy solutions that reduce carbon dioxide and other greenhouse gases. solutions-based coalitions corporate efforts to reduce carbon dioxide and other greenhouse gases by adopting more environmentally efficient technology, shifting from oil and coal to 'cleaner' energy sources such as solar power, making transitional shifts in energy sources from coal or oil to natural gas, and developing next generation power sources such as hydrogen fuel cells are commendable. however, such efforts will not be sufficient to negate the increasing rate of carbon dioxide emissions and resultant increase in global temperatures. what is needed is the collective effort of individuals, corporations, and nations working in concert to address this problem (hendry, 2006; starik & rands, 1995). the intergovernmental panel on climate change notes that a "portfolio or mix of strategies that includes mitigation, adaptation, technological development (to enhance both adaptation and mitigation) and research" across multiple constituencies will be invaluable in decreasing the risks of climate change posed to humankind (ipcc, 2007, p. 20) . corporations must be highly proactive in such collaborative efforts because of the large amounts of carbon dioxide, greenhouse gases, and other toxins they emit into the earth's atmosphere (lovins, lovins, & hawken, 2007). indeed, a multitude of management scholars propound that corporations must change their current business practices in ways that sustain the planet's natural resources and interconnected ecological systems (gladwin, kennelly, & krause , 1995 ; hart, 1995 ; porter & reinhardt, 2007; shrivastava, 1995; starik & rands, 1995). such cutting edge practices include large-scale collaboration with various constituencies (governments, ngos, other firms , and other key stakeholders) in identifying ways to preserve planet's biosphere. volume 27, number 2 127 literature review nrbv is an extension of the rbv but focuses on identifying strategic resources and capabilities that are sources of both competitive and environmental sustainability. as such, we first describe the rbv, including its assumptions and prescriptions, as well as a summary of empirical tests of the rbv. then we discuss nrbv, its application to climate change strategies , and the hypothesis tested in the current research. resource-based view of the firm according to rbv , resources are the main determinant of firm performance, based on the logic that firms are unique bundles of valuable resources that, over time, become relatively immobile (barney, 1991). barney defines resources as "all assets, capabilities, organizational processes, firm attributes, information, knowledge, etc. controlled by a firm that enable a firm to conceive of and implement strategies that improve its efficiency and effectiveness" (p 10 i). barney includes capabilities in the definition of resources ; however, single resources (e.g., patents on environmental technologies, corporate reputation) and sets of resources used to perform integrated tasks, labeled capabi lities (e .g. , environmentally-friendly manufacturing systems and organizational processes), can be sources ofsca (amit & schoemaker, 1993 ; collis & montgomery, 1995). strategic assets and distinctive competencies are single resources and capabilities, respectively, that are simultaneously valuable, rare, difficult or costly to imitate, and nonsubstitutable (barney, 1991 , 2001; peteraf, 1993). strategic assets and distinctive competencies are valuable when they can be leveraged to exploit market opportunities or can thwart competitive threats. resources & capabilities (r&cs) that are valuable and rare can be sources of sca, unless competitors possess them or develop strategically equivalent substitutes (barney & mcewing, 1996). resource and capability based advantages are short-lived if competitors can imitate them at a reasonable cost. four impediments to competitor imitation are causal ambiguity, social complexity, unique historical conditions, and path dependency (barney, 1991 , 2001; dierickx & cool, 1989). such advantages are causally ambiguous when competitors cannot determine how resources (e.g. , environmentally-conscious corporate culture) and/or capabilities (e.g., environmental control systems and processes) create the firm ' s sca. socially complex resources, such as the inter-firm relationships among firm managers, ngos, and environmentally128 journal of business strategies oriented suppliers, are inimitable because they are based on the unique personalities and value systems of parties involved in the inter-firm relationships. unique historical conditions are contexts (time, location, etc.) that determine the relative importance of a resource or capability. path dependent resources, such as a strong environmentaliy-oriented corporate reputation, accumulate through stocks of strategic investments (e.g., conti.{luous inventions in green technology, eco-branding, philanthropic investments to improve the planet's ecosystems) over time that competitors cannot quickly replicate . acquiring the rights to path dependent resources (e.g., patented internally-developed cutting-edge green technologies) can be expensive, making it costly for the acquiring firm to reap superior financial returns. firms develop strategic assets and distinctive competencies by possessing the insight to identify critical environmental resources and capabilities ex ante and then limit competition for such resources and capabilities by erecting impediments to imitation (peteraf, 1993). empirical tests of rbv seem to demonstrate that it is a valid theory of sca. corporate-level rbv studies indicate that resources impact diversification decisions in ways that improve firm performance (e.g., farjoun, 1994; harrison, hitt, hoskisson, & ireland, 2001), that portfolio resource-relatedness positively impacts corporate performance (e.g., robins & weirsema, 1995), and that r&cs influence corporate-level strategic alliance decisions (e.g., eisenhardt & schoon hoven, 1996). business-level rbv studies show that a firm's resources and capabilities influence foreign investment decisions (e.g., collis, 1991), that resource coordination, learning capabilities, and dynamic capabilities are positively associated with firm performance (e.g., schroeder, bates, & junttila, 2002), that resource management impacts first mover advantages (henderson & cockburn, 1994; zott, 2003), that firms reconfigure and upgrade their resources and capabilities over time as firms interact with their competitive environments (e.g., sharma & vredenburg, 1998), that industryspecific competencies serve as isolating mechanisms in sustaining a firm 's competitive advantage (e.g., brush & artz, 1999), that environmental contexts impact the competitive value of a resource (e.g., mill er & shamsie, 1996), that firm characteristics are better predictors of firm performance than industry characteristics (e.g. , barney & arikan, 200 i), that constructive work relationships and social capital positively impact firm competitiveness (hitt, bierman, shimizu, & kochhar, 200 i), and that information technology and related competencies positively impact firm performance (zhu & kraemer, 2002; zhu, 2004). in short, these and other empirical rbv studies seem to support rbv 's main prescription and underlying assumptions. volume 27, number 2 129 natural resource-based view of the firm as the earth's natural capital diminishes and the earth's ecosystems change in ways that negatively affect society, finns need to examine the natural resources they use and how they use them for their own continued viability. otherwise, valuable and unique environmental resources and ecological services, most lacking strategically equivalent substitutes, will become scarcer. as finns recognize the constraints imposed by the natural environment, environmental sustainability will become an important part of the strategic management process in sustaining their reso urcebased advantage(s). nrbv builds on rbv logic in describing how finns gain a sca in ways that sustain the earth's natural resources and ecosystems, from which these natural resources are so delicately intertwined. hart (1995) proposed three interconnected nrbv strategic capabilities that firms can develop to achieve that objective: pollution prevention, product stewardship, and sustainable development. unfortunately, limited empirical research on nrbv has been occasioned and, to our knowledge, no nrbv -based studies have been conducted that assess whether firm's proactively pursuing climate change strategies outperform firms that. are less proactive . while not directly testing nrbv, some studies have examined the association between corporate environmental initiatives and organizational performance. orlitzky, schmidt, and rynes (2003) performed a meta-analysis of 52 studies linking corporate social responsibility and environmental responsibility with organizational outcomes. unfortunately, the findings were mixed, with some studies showing s ignificant positive associations and others showing either significant negative associations or no significant associations. russo and fouts (1997) discovered that a positive environmental-financial performance relationship was strengthened by industry growth; however, the change in explained performance variance was minimal. altuwaijri , christensen, and hughes (2004) found that firms with smaller levels of toxic emissions and effluents from manufacturing facilities were more likely to have higher levels of economic perfonnance. similarly, kassinis and vafeas (2006) analyzed the association between toxic discharge at manufacturing plants and community stakeholder pressure. they concluded that cleaner manufacturing facilities were more likely to be found in communities with greater financial and political power, which could be an indication that 'creating a shared vision' of a more sustainable future is possible but it should not be limited to only the wealthier sections of society. in short, these studies provide some evi130 journal of business strategies dence that a positive association between corporate environmental initiatives and organizational performance may exist. empirical research explicitly based on the nrbv has yielded similar results. based on case studies of three oil companies, hastings (1999) concluded that increasing social pressures caused all three firms to modify their operations to be more environmentally oriented and that those changes may have created a competitive advantage over competing firms that did not embrace such environmental initiatives. chan's (2005) nrbv-based empirical examination of foreign enterprises in china that manufacture clothing and electronics suggests that such enterprises can increase their financial performance through proactive environmental strategies. similarly, menguc and ozanne (2003) found that australian manufacturing firms that demonstrated a simultaneous commitment to entrepreneurship, corporate social responsibility, and the natural environment experienced higher levels of after-tax profit and market share; however, sales growth was negatively correlated. overall, the empirical evidence seems to indicate that a positive association exists between environmental performance and firm performance with some exceptions . unfortunately, these studies do not specifically address the linkage between proactive climate change strategies and firm performance. as such, the current research empirically tested the hypothesis that firms with proactive climate change strategies will have higher levels of accounting performance than comparable firms with less proactive climate change strategies. this hypothesis is theoretically grounded in the nrbv, the topic of the next section. theoretical development and hypothesis the three interconnected strategies (pollution prevention, product stewardship, and sustainable development) that hart (1995) proposed in his nrbv framework can be applied to different types of environmenta] issues, including climate change. the requisite strategic capabilities and resources will vary depending on the environmental initiative inherent in a particular strategy. table 1 adapted hart's (1995) framework in identifying the requisite strategic capabilities and resources needed for firms to proactively pursue climate change initiatives that can sim ultaneously achieve business and environmental sustainability. the following subsections detail the nrbv climate change framework. volume 27, number 2 131 table 1 nrbv framework for proactive climate change organizations proactive nrbv climate change strategic key initiatives capabilities resources reduce carbon emissions & other pollution continuous greenhouse gases prevention improvement renewable energy sources & stakeholder product stakeholder participation stewardship integration solutions-based sustainable shared coalitions development vision adapted from hart (1995). *from the kld global climate change 100 index methodology. pol/ution prevention strategic capabilities basis for sca lower costs preempt competitors future position kld selection criteria* -clean technology & efficiency -renewable energy future fuels -climate leader pollution prevention strategic capabilities help firms become more operationally efficient using modified tqm principles to minimize emissions, effluents, and waste through existing pollution control equipment, material substitution , recycling, incremental process innovations, developing and deploying climate-friendly production technology, reducing compliance and liability costs, and redesigning value-chain activities to reduce pollution (hart, 1995 ; kolk & pinske, 2004, 2005, 2007a, 2007b; porter & reinhardt, 2007) . low-cost advantages accrued from strategies based on pollution prevention strategic capabilities can be sustainable for several reasons. first, the firm's value chain cim be reconfigured in unique , valuable ways beyond the requirements of iso 14001 certification standards in effectuating activities within and across functions to further reduce waste, emissions of greenhouse gases, and other toxins (orsata, 2006). that, coupled with the complex vertical linkages with environmentally-conscious suppliers, customers and strategic alliance partners, would make this complex, biospheric-oriented value chain configuration difficult, if not impossible, for competitors to imitate (porter & reinhardt, 2007). second, internally developed low-emissions-based production equipment and systems are patentable, helping to protect them from imitation by competitors. third, learning curve advantages accrued through climate-based value chain reconfigurations , through the development of environmentally-based production systems and processes, and through other climate-change initiatives cumulate in path dependent 132 journal of business strategies ways over time under unique historical conditions, making it difficult and/or costly for new entrants to easily or quickly replicate. fourth, being proactive in lessening the inefficient use of natural resources and in reducing or eliminating harmful emissions into the earth's biosphere will help the firm avoid fines , liability costs, and other penalties levied by environmental regulatory bodies. last, an environmentallybased, cost-conscious corporate culture coupled with incentive systems that reward innovative environmental efficiencies promote continuous climate change efforts throughout the organization, helping to sustain the firm's environmentally-oriented cost-based advantage over competitors. product stewardship strategic capabilities product stewardship strategic capabilities help the firm gain a sca in ways that preserve the biosphere by soliciting the participation of firm stakeholders in developing "green" products (hart, 1995). in addition to seeking input on product specifications, firms gather information from stakeholders that can be used in developing systems, processes, procedures, and controls in producing "green" products and environmental innovations that reduce or eliminate emissions of carbon dioxide and other greenhouse gases (kolk & pinske 2004, 2005; orsata, 2006). firms employ a variety of analytic methods, such as life cycle analysis and greenhouse emission tracking tools, to determine their carbon footprint as a starting point in identifying ways to reduce the amount of nonrenewable resources incorporated in their products, to utili ze resources less detrimental to the atmosphere, to replenish the environment with renewable natural resources that lessen existing damage to the biosphere, to eliminate the use of toxic materials, and to recycle or reuse product parts at the end of the product's natural life, so that the firm can systematically track and manage its carbon emissions (esty, 2007; slater, 2007). because markets for climate-friendly products are still in their infancy, a firm can gain a competitive advantages in the following ways: (i) by being the first to enter viable "green" product market segments, (2) by designing green products that meet the specifications of environmentally-conscious customers, (3) by involving customers and other constituencies in designing "green" products and the requisite systems and production processes to minimize the impact on the biosphere (aragoncorrea & sharma, 2003), (4) by differentiating the firm 's products as being climatefriendly through eco-branding based strategic marketing efforts (esty, 2007 ; hart, 1995; orsata, 2006), (5) by gaining exclusive access to requisite climate-friendly supplies and working with suppliers to be climate conscious in designing and volume 27, number 2 133 producing critical supplies (correa, 2007), (6) by becoming the standard "green" product for climate-conscious customers, (7) by minimizing the price premiums in producing products through learning-curve effects, through reconfiguring key value-chain activities, and through rigorous life cycle analysis (porter & reinhardt, 2007), (8) by developing a reputation for being proactive in climate change initiatives through the participation of environmentally-conscious stakeholders (e.g., customers, government regulators, environmentalists) in designing and producing climate-friendly products (kolk & pinske, 2004, 2005; murray & montanari, 1986), (9) by developing alternative power sources (e.g., wind, solar, hydrogen cells) and developing technologies that increase the efficiency offossil fuels, and (10) by continuously scanning the environment for potential changes in the demands of environmental constituents, so that firm can make the requisite changes ex ante (schwart, 2007). indeed, with the growing awareness of customers, industry analysts, fund managers, environmental ngos, government agencies, and other regulator bodies about the impact of climate change on our planet and whether companies are being proactive in developing climate-friendly products and services, senior managers are becoming highly conscious of the impact on corporate reputation and resultant firm profitability of producing products that meet or exceed the environmental concerns of such constituencies (esty, 2007; roosevelt & llewellyn, 2007). moreover, savvy stakeholders are more capable of determining the validity of environmental claims, which can negatively impact the corporate reputation of firms engaging in greenwashing (schendler, 2007). product stewardship strategic capabilities can be difficult for competitors to replicate, and thus be a source of sca, because: (i) "green" market opportunities can occur in unique times and contexts, (2) the unique personalities of the multiple constituencies involved in developing the climate-friendly products are socially complex (barney, 1991), (3) the firm can shape environmental product standards through its proactive involvement with various government agencies (hoffman, 2007), (4) the firm can patent new climate-friendly products and the production methods used to bring them to fruition, (5) the link between the firm's performance and its unique climate-friendly value-chain is causally ambiguous to competitors, as highly innovative firm managers, employees, and various stakeholders work collaboratively to identify new ways to reengineer the firm's value chain activities in an effort to further reduce its carbon footprint (porter & reinhardt, 2007), (6) the dynamic capabilities underlying the development of new climate-friendly products accrue over time, and thus can not be easily imitated by competitors, and (7) a corporate reputation for being environmentally responsible 134 journal of business strategies to the planet ' s biosphere develops over long periods of time, and thus cannot be quickly replicated. sustainable development strategic capabilities sustainable development strategic capabilities constitute the highest level of environmental responsibility, where the firm ' s overall strategy is driven by a " strong sense of social-environmental purpose," (hart, 1995: 1002) calling for other firms (even competitors), governments (international , national, state, and local levels), environmentalists , academics, and others to work toward solving our global climate change problems. because such firms recognize the magnitude of the problems in the biosphere and their own internal limitations, they proactively organize research and technology consortiums to draw on the collective resources, skills, knowledge , and insights among multiple participants in deriving broad-based climate change solutions (kolk & pinske, 2007b) . firms that harness these potent strategic capabilities are highly proactive (1) in assisting countries where they operate in addressing environmental problems associated with greenhouse gas emissions, (2) in working with government officials toward stricter policies on air standards, and (3) in providing support to regions impacted by natural disasters (kolk & pinske , 2004, 2005 ; kolk & pinske, 2007a; schwart, 2007). in essence, these multinational leaders take a long-term view about the future state of the planet in which they operate and the role they play in promoting societal well-being. internally, ceos committed to sustainable development based strategies instill a shared sense of environmental responsibility among employees through oral and written communication, employee training programs, and posting mission statements throughout the company articulating the firm 's environmental commitment (way & rendlen, 2007 ; wad dock, 2006). the top management team crafts an organizational culture and admini strative context that promotes employee innovation and participation in identifying ways to restructure the firm and the industry to more effectively address climate change issues and, in the process, potentially change the competitive rules of the game (porter & reinhardt, 2007). the intensive internal and collaborative effort to produce environmentallyfriendly products encompasses the philosophies underlying both pollution prevention and product stewardship strategies . as such, the drivers ofsca associated with pollution prevention strategies and product stewardship strategies are embedded in sustainable development strategies (hart, 1995). moreover, the strategic capabilities underlying a sustainable development strategy strengthens a firm's strategic competvolume 27, number 2 135 itiveness in four additional ways. first, as the firm becomes recognized as a leader in working to solve the planet's climate change problems, its reputation may help the firm attract and retain highly talented employees that share similar values and convictions about corporate environmental responsibility (murray & montanari, 1986; waddock, 2006). second, the leading-edge competencies and insights on business and environmental sustainability gained from working collaboratively with multiple constituencies is a socially-complex and partly tacit in nature, making it difficult for competitors to easily replicate (reed & defillippi, 1990). third, the relationships developed in these collaborative efforts may give the firm exclusive access to critical suppliers offinite natural resources , provide access to countries that allow few if any foreign competitors, help the firm increase its market share of "green" customers, and all ow the firm to gain the political acumen needed to be at the forefront in crafting new environmental legislation (hoffman, 2007; porter & van der linde, 1995). because relationships develop over time and are based on the unique personalities of the constituencies involved, these relationship-based advantages would be difficult to replicate, lack strategically equivalent substitutes (barney, 1991), and thus be a source ofsca. last, the learning curve effects ofinternaily-deve1oped "green" technologies ; the coilaborate knowledge among consortium (and other partnership) members over time; a keen understanding of the language and issues associated with cap-and-trade programs, renewable energy credits, carbon-based emissions permits, renewable energy credits, verified emissions reductions, certified emissions reductions , emissions reduction units , european union allowances, the myriad of climaterelated biils, and the various national and international climate-related treaties and laws that can impact a multinational enterprise are complex and path dependent in nature, based on unique historical conditions across continents, and causally ambiguous to organizations seeking to replicate the . leader' s sustainable development strategy and resultant competitive strength (hoffman, 2007) . in sum, given that pollution prevention strategic capabilities, product stewardship strategic capabilities, and sustainable development strategic capabilities can be combined in whole or in part to create firm-level climate change strategies capable of capturing a competitive advantage, firms that are more proactive in implementing climate change strategies should outperform firms that are less proactive, as articulated in hypothesis i . hypothesis 1: firms with proactive climate change strategies will have higher levels of accounting performance than comparable firms with less proactive climate change strategies. 136 journal of business strategies methodology the sample in the current research came from the kld global climate change 100 index, consisting of 100 global publicl y-traded firms well recogni zed for being proactive in pursuing climate change strategies. the index includes firms from 14 different countries, most of which are headquartered in north america, western europe, or japan, and classified into nearly a dozen industries. since the index was created in july 2005, 16 of the original companies have been removed , thus leaving 84 firms for analysis. based on their industry experience and information they gathered from company web-sites, regulatory filing s, trade associations, professional journals, nongovernmental organizations, corporate officers, and from various experts, kld analysts identify companies engaged in one of three themes: (1) developing, generating, and consuming renewable energy, such as wind and solar energy (2) firms whose policies or products reduce the demand for fossil fuels through efficiency improvements, and (3) firms that are proactive leaders in 'future fuels,' such as hydrogen fuel cells, biofuels, and natural gas production and distribution. as shown in table i, these three themes are consistent with the three climate change strategies described in the previous section. since the purpose ofthe current research was to determine if firms with recognized proactive climate change strategies had higher levels of accounting performance than comparable firms with less recognized proactive climate change strategies, we used the pairwise-comparison method to determine if the accounting-based returns of the proactive firms were significantly greater than those of the less proactive firms. this technique has been performed in other studies of firms that differed in terms of other key environmental strategies (i.e., bansal & hunter, 2003). accounting performance data on the kld firms and their matched pairs were taken from the 2005 & 2006 "forbes 2000 index" ("2000" refers to the number of firms in the index, not the year of the data) so that we could evaluate differences in performance between the pairs across a two-year period. forbes index also provided various firm data (such as assets, sales, profits, and market value, as well as their country of origin and main industry in which the firm competes) that proved useful in the pairing process. we attempted to pair the remaining 84 firm s from the 2005 kld global climate change 100 index (gcioo) with firms that were similar based on their country of origin, industry, and size (based on reported assets for 2005). the first step was to eliminate kld sample firms that did not appear on both the 2005 and volume 27, number 2 137 2006 forbes index, the source from which the comparison firms would be selected. this resulted in the number of sample firms being reduced from 84 to 45 firms. we then compared the remaining 45 kld sample firms with firms on the forbes index to find comparable firms based on country of origin, industry, and size. we could not identify comparable firms (headquartered in the same country, operating in the same industry, and of similar size) for 14 of the 45 kld firms , thus reducing the number of pairwise comparisons to 31 . statistical and graphical analysis of the 31 pairs identified one outlier, resulting in 30 pairwise comparisons to test the hypothesis. ofthe remaining 30 pairs, the mean size (in terms of2005 assets) of the proactive climate change strategy firms is $32.2 billion and the matched pairs mean is $30.3 billion. inferential testing using spss showed there was no statisticallysignificant difference in the size of kld firms versus their matched pairs. in fact , the paired samples correlation (in terms of2005 assets) between the kld firm s and their matched pairs is .98, which is significant at p < .00 i. hence, the experimental design was effective in matching the firm s in terms of their country of origin, industry, and size. to test whether firms with greater emphasis on climate change would have higher levels of accounting performance than comparable firms with less emphasis on climate change, we tested the difference in accounting performance across the 30 pairs of firms using three performance metrics: return on assets (roa), return on sales (ros), and total asset turnover (tat = total revenuerrotal assets). roa and ros are common measures of accounting-based profitability while tat measures the efficiency of asset utilization (pugh, jahera, & oswald, 2005) . we measured roa, ros , and tat using a two-year average (2005-2006) based on the forbes index data. results the descriptive statistics and correlations appear in table 2. notice that the mean roa, ros, and tat of the kld firms are greater than those of the paired comparison firms. specifically, the proactive climate change firms earned an roa 93 % greater than their matched pairs (5.8% vs. 3.0% ), an ros 59% greater than their matched pairs (8 .6% vs. 5.4%), and a tat 18% greater than their matched pairs (72.4% vs. 6l.6%), thus providing preliminary evidence supporting our hypothesis. some of the performance variables are correlated ; however, this does not violate the assumptions underlying the pairwise comparison method (hair, anderson, tatham , & black, 1995). 138 journal of business strategies table 2 correlations and descriptive statistics variable mean s. d. 1 kld roa .058 .042 2 mp roa .030 .031 .44** 3 kld ros .086 .058 .71" 4 mp ros .054 .052 .26t 5 kldtat .724 .344 .37* 6 mptat .616 .311 .26t mp = matched pairs (for pairwise comparisons) t p < 0.10; , p < 0.05; ., p < 0.01 2 .25t .80" .12 .18 3 .13 -.23 -.07 4 5 -.05 -.28t .65" table 3 summarizes the pairwise comparisons between the kld firms and their matched counterparts. as shown, the mean difference in accounting performance (kld performance matched pairs) is statistically significant across all three paired sample tests. specifically, the mean roa for the kld firms exceeds the mean roa for their matched pairs by 0.028, which is significant at p < 0.001; the mean ros for the kld firms exceeds the mean ros for their matched pairs by 0.032, which is significant at p < 0.05; and the mean tat for the kld firms exceeds the mean tat for their matched pairs by 0.108, which is significant at p < 0.05. these results support hypothesis i. discussion and conclusions the empirical results support the hypothesis that firms with greater emphasis on climate change have higher financial returns than comparable firms with less emphasis on climate change. specifically, the kld firms outperformed their matched counterparts across all three performance metrics, which included measures of both firm efficiency and firm effectiveness. this has important implications for theorists, empiricists, and practitioners. for theorists, hart's (1995) seminal work informs us that firms with pollution prevention strategic capabilities attempt to gain a cost-based sea by continu ous efforts to control and prevent carbon emissions and other ghgs (greenhouse gases) using improved technologies and reconfiguring value chain activities to reduce direct and indirect ghg emissions. firms with product stewardship strategic capabilities seek to gain first mover advantages in the use of renewable energy sources and by working closely with customers, suppliers, and other stakeholders table 3 ~ pairwise comparisons e'" ~ ". paired samples tests tv .>l ~ ~ paired differences <:i"-". ""i 95 % confidence tv interval of the std . error difference mean std. deviation mean lower upper df sig. (2-tailed) pairing: kld roa mp roa .0277033 .0398106 .0072684 .0128378 .0425689 3.811 29 .001 paired differences 95% confidence interval of the std. error difference mean std. deviation mean lower upper t df sig. (2-tailed) pairing: kld ros mp ros .0315333 .0727040 .0132739 .0043852 .0586815 2.376 29 .024 paired differences 95 % confidence interval of the std. error difference mean std. deviation mean lower upper t df sig. (2-tailed) pairing: kld tat mp tat .1077833 .2749002 .0501897 .0051339 .2 10432 7 2.148 29 .040 mp = matched pairs (for paired comparisons) w <0 140 journal of business strategies in the vertical value chain in developing products sought after by climate conscious customers. pollution prevention strategies and product stewardship strategies are consistent with contemporary thinking that understanding and measuring the firm's carbon exposure, taking steps to reduce the firm ' s carbon footprint, and identifying opportunities to leverage the firm ' s climate-friendly products is essential in being competitive in an increasingly environmentally-conscious society (esty & winston, 2009; hoffman & woody , 2008). sustainable development-oriented firms possess pollution prevention strategic capabilities and product stewardship strategic capabilities but go further in their climate change efforts by working with other climate change leaders, government officials, legislative bodies, research consortiums, and other constituencies in solving the problems caused by climate change. climate change leaders can reap competitive advantages (1) by attracting highly talented employees that share similar convictions about the environmental (murray & montanari, 1986; waddock, 2006), (2) by developing unique socially-complex competencies on business and environmental sustainability through collaborative work with high-level constituencies, (3) by providing them access to finite natural resources and to market segments in countries that allow few if any foreign competitors, and (4) and by providing the firm with the political acumen needed to be at the forefront in crafting new environmental legislation (hoffman, 2007; porter & van der linde, 1995). this is also consistent with contemporary thinking that visionary leaders who have become highly recognized for their concern with the impact of climate change on the planet take steps to influence the policy-development process on climate change issues (esty & winston, 2009 ; hoffman & woody, 2008; lovins, el al., 2007). ultimately, sustainable development oriented firms want to be part of the policy-development process for climate change so that they know what climate change issues are being addressed and what political venues (e.g., international, national, state levels) will provide the greatest impact (hoffman & woody, 2008; porter & kramer, 2006). clearly, setting the rules rather than having the rules set for you will (i) help to assure that your vision of requisite climate change goals and objectives become part of government policy and (2) provide you (and thus the firm) with first mover advantages from the ex ante knowledge from participation in the policy setting process . for empiricists, nrbv is still in its developmental stages of empirical testing, and thus one contribution of this study is that it adds further support to the validity of nrbv. moreover, to our knowledge , there are no published nrbvbased studies that empirically examine whether firms with proactive climate change strategies have higher levels of financial (and/or accounting) performance than comvolume 27, number 2 141 parable firms with less proactive climate change strategies. and finally, this study contributes to the literature by testing the hypothesis using 30 pairs of firms from seven countries on three separate continents spanning 12 industries. in other words, the results were statistically significant across all three performance metrics using a global, multi-industry paired sample of comparable firms. however, because of the limitations discussed in the next section, readers should interpret these results with some degree of caution. firm executives seem to be recognizing the important linkage between environmental sustainability and business sustainability by their climate change initiatives. for example, from a pollution prevention standpoint, caterpillar has been using six sigma teams to improve heating and lighting efficiencies throughout its global operations to reduce its carbon intensity 36 percent per dollar of revenue in 2006 and 38 percent reduction in 2007, and now plans to reduce its absolute ghg emissions by 3 percent by 2015 (climatebiz, october 10,2008). walmart is reconfiguring its value chain activities in transportation and logistics and leveraging new technologies to reap cost efficiencies that reduce its ghg emissions in ways that are difficult for competitors to replicate (porter & reinhardt, 2007) . masisa, a forestry and wood-manufacturing company in chile, has taken important steps to reduce carbon emissions and other greenhouse gases by planting rapid-growth trees that capture ghg from the atmosphere, by burning biomass (saw dust and wood chips) to generate much of its energy, using combustion gases from boilers and thermal plants as fuel, and reducing the distance between equipment and work areas to reduce fuel costs (correa, 2007). companies with product stewardship strategic capabilities, such as monsanto, recognized that shrinking amounts of land to grow crops for food and for alternative fuel in the face of population growth called for creative biotechnology. as such, monsanto worked with its b2b stakeholders in developing genetically modified plant seeds of four crops (com, soybeans, cotton, and canola) that contain genes that kill insects and tolerate weed-killing pesticides. farmers pay a premium for monsanto's seeds (versus traditional seeds) but can save twice that amount by reduced spending on chemical insecticides and herbicides and by growing substantially more crops, some of which are used to produce biodiesel fuel. as a result, monsanto's net income has increased almost 44% from 2002 to 2007 (hindo, 2007). successful product stewardship oriented companies, such as tesco, also understand the importance of demonstrating their ability to measure their carbon footprint, sharing such information with the stakeholders and the public at-large (via voluntary emissions reporting), and soliciting stakeholder input on requisite changes needed to preserve 142 journal of business strategies and enhance their climate-friendly reputation and brand image in keeping and attracting customers (hoffman & woody, 2008; esty, 2007). and finally , companies like starbucks, fedex, kinko's , and johnson & johnson buy 5 to 10 percent of their energy from renewable energy sources as part of their efforts to reduce ghg emissions and become less dependent on energy from fossil fuels (esty & winston, 2009). in short, firms that develop product stewardship strategic capabilities engage stakeholders to find creative ways to produce desired products and services in ways that lessen ghg emissions, including the use of renewable energy resources. sustainable development oriented firms ' overall strategy is driven by a strong sense of environmental purpose to work with other firms (even competitors), governments, environmentalists, academics, and others in solving our climate change problems (hart, 1995). for example, intel was one ofthe first companies to take the epas challenge to be part of its project xl, asking intel to be a leader in pollution prevention above and beyond legal requirements (esty & winston, 2009). working closely with the epa and other high-level constituencies, intel developed stringent objectives and metrics to measure such objectives, which were reviewed regularly by the epa. intel's leadership won them state permits and quick environmental reviews needed for their expansion efforts. some of the largest companies in the u.s . including alcoa, caterpillar, duke energy, dupont, dow, ge, pg&e, and xerox formed a coalition called the u.s . climate action partnership that went to washington d.c. in 2007 to push for a federal cap on carbon emissions, showing that business leaders across various industries see the urgency of addressing the issues impacting climate change and are taking an active role in influencing government policy (esty & winston, 2009). limitations and avenues for future research this study used a tight systematic methodology in pairing firms based on criteria such as country of origin, industry, and size, so that our analysis was based on highly comparable firms to enhance the validity of our empirical findings . unfortunately , this limited our analysis to 30 pairwise comparisons. other studies can follow similar methods using larger samples of paired firms to strengthen the generalizability of the results. moreover, analyzing larger datasets using various multivariate techniques can produce more robust results than those produced by pairwisecomparisons. for instance, time-series analysis may prove useful in determining the linkage between the time it takes to implement proactive climate change strategies and resultant firm profitability. volume 27, number 2 143 kld's methodology has won various awards, which enhances the validity of the data used in this study. moreover, kld's climate-based measurements match-up fairly well with the nrbv framework of pollution prevention strategic capabilities (climate based efficiencies, climate-based efficient technologies), product stewardship strategic capabilities (use of renewable energy sources), and sustainable development strategic capabilities (identification of climate leaders and use of future fuels) developed in this manuscript. however, kdl does not identify which strategic capability (or capabilities) the firm is utilizing in its proactive climate change strategy in achieving superior profitability . future research may attempt to flesh out performance impacts from pursuing different climate strategies . this will prove challenging as the strategies are interlinked such that sustainable development based firms theoretically possess pollution prevention strategic capabilities and product stewardship strategic capabilities as well. in that vein, other datasets using different statistical techniques may prove more effective in such empirical endeavors. finally, although the matched pairs were not on the kld gcioo index, it does not necessarily mean that these firms are not pursuing any type of climate change strategy. thus, we cannot measure the distance between the climate change emphasis between the kld firms and their matched pairs. thus, for purposes of this study, we made the assumption that firms selected for inclusion on the kld gcl 00 index were more proactive in their climate change initiatives than their paired counterparts that were not selected for inclusion on the kld gc 1 00 index. future research can explore other measures that tap into the exact distance in climate change initiatives between firms in testing nrbv. in conclusion, a plethora of opportunities for testing nrbv from a climate change perspective abound (beyond the ones noted above), including the impact of computer technologies and building designs (e.g., geothermal heating, solar panels, structural architecture) on the firm's environmental capabilities and resulting performance. what is clear is that many firms are expending a great deal of time, energy, and resources creating and implementing strategies to address global climate change, and this preliminary study will hopefully generate additional interest in an important topic facing all of society. end note 1. kld has been recognized by third-party organizations for its social and environmental investment expertise. (www .tbli .org) 144 journal of business strategies references al-tuwaijri, s., christensen, t ., & hughes, k. (2004). the relations among environmental disclosure, environmental performance, and economic performance: a simultaneous equations approach. organizations & society, 29(5 /6), 447-472 . ambec, s ., & lanoie, p. does it pay to be green: a systematic overview. academy of management perspectives, 22(4),45-62. amit, r., & schoemaker, pj.h. (1993). strategic assets and organizational rents . strategic management journal, 14(1),33-46. aragon-correa, a. j., & sharma, s. (2003). a contingent resource-based view of proactive corporate environmental strategy. academy of management review, 28(1), 71-88 . bansal, p. (2005). evolving sustainability: a longitudinal study of corporate sustainable development. strategic management journal, 26(3), 197-218. bansal , p. , & hunter, t. (2003). strategic explanations for the early adoption of iso 1400l. journal of business ethics, 46(3), 289-299. barney, j . (1991). firm resource and sustained competitive advantage. journal of management, 1 7( 1),99-120. barney, j. (200 i ). resource-based theories of competitive advantage: a ten-year retrospective on the resource-based view. journal of management, 27(6), 643-651. barney, j. , & arikan, a. (2001). the resource-based view: origins and implications. blackwell handbook of strategic management (pp. 124-188). barney, j ., & mcewing, m . (1996). gaining and sustaining competitive advantage: theory and practice. addison wesley publishing company. brush, t. , & artz, k. (1999). toward a contingent resource-based theory : the impact of information asymmetry on the value of capabilities in veterinary medicine. strategic management journal , 20(3), 223-250. chan, r . y. k. (2005). does the natural-resource-based view ofthe firm apply in an emerging economy? a survey of foreign invested enterprises in china. journal of management studies, 42(3), 625-672. climatebiz staff. (2008, october 9). sun, caterpillar, mack trucks and pfizer honored for cutting ghgs. climatebiz. retrieved from www.climatebiz. com/news/200 8/ 1 0/ 09/ sun -caterpi ii ar -mack -trucks-and -pfi zer -honored -cutti n gghgs. collis, d. (1991). a resource-based analysis of global competition: the case of the bearings industry [special issue]. strategic management journal, 12, 49-68. collis, d. , & montgomery, c. (\995). competing on resources: strategy in the 1990s. harvard business review, 73(4), 118-128. volume 27, number 2 145 correa, m.e. (2007 , october). leading change in latin america. harvard business review, 40-42. department of energy & environmental protection agency (doe & epa). (2000, july). carbon dioxide emissions from the generation of electric power in the united states (joint report). dierickx, i., & cool, k. (1989). asset stock accumulation and sustainability of competitive advantage. management science, 35(12), 1504-1511. eisenhardt, k., & schoonhoven, c . (1996). resource-based view of strategic alliance formation: strategic and social effects in entrepreneurial firms. organization science, 7(2), 136-150. energy information administration (eta). (2006). international energy outlook 2006 (report #doe/eta-0484). department of energy forecast. environmental protection agency (epa). (2006a). electricity from natural gas. clean energy. retrieved from www.epa.gov/cleanrgy/natgas.htm. environmental protection agency (epa). (2006b). electricity from oil. clean energy. retrieved from www.epa.gov/cleanrgy/oil.htm. esty, d. c. (2007, october) . what stakeholders demand? harvard business review, 30-34. esty, d. c., & winston, a. s. (2009) . green to gold. danvers, ma: john wiley & sons. farjoun, m. (1994). beyond industry boundaries: human expertise, diversification and resource related industry groups. organization science, 5(2), 185-199. gladwin, t. , kennelly , j., & krause, t. (1995). shifting sustainable development: implications for management theory and research. academy of management review, 20(4),874-907. greene, d. l. , hopson, j. l., & li, 1. (2006). have we run out of oil yet? oil peaking analysis from an optimist's perspective. energy policy, 34(5), 515-531. greenhouse, l. (2007 , april 2). justices rule against bush administration on emissions. the new york times. retrieved from http://www.nytimes. com/2007 /04/02/washington/02cnd-scotus.html?ex= 1 176523200&en=428ge7 1 b5f77e689&ei=5070 . hair, j ., anderson, r., tatham, r ., & black, w. (1995). multivariate data analysis (4th ed.) . englewood cliffs, nj: prentice-hall. harrison, j., hitt, m., hoskisson, r., & ireland, r. (2001). resource complimentarity in business combinations: extending the logic to organizational alliances. journal of management, 27(6), 679-691. 146 journal of business strategies hart, s. (1995). a natural resource-based view ofthe firm . academy of management review, 20(4), 986-1014 . hastings, m. (1999). a new operational paradigm for oil operations in sensitive environments: an analysis of social pressure, corporate capabilities, and competitive advantage. business strategy and the environment, 8(5), 267-280. henderson, r., & cockburn, i. (1994). measuring competence? exploring firm effects in pharmaceutical research [special issue]. strategic management journal, 15, 63-84. hendry, 1. (2006). taking aim at business: what factors lead environmental nongovernmental organizations to target particular firms ? business & society. 45(1), 47-86. hindo, b. (2007, december 17). monsanto: winning the ground war. business week, 35-4l. hitt, m. , bierman, l., shimizu, k., & kochhar, r. (2001). direct and moderating effects of human capital on strategy and performance in professional service firms: a resource-based perspective. academy of management journal, 44(1) , 13-28 . hoffman, a. j. (2005). climate change strategy: the business logic behind voluntary greenhouse gas reductions. california management re view, 4 7(3), 21-46. hoffman, a j. (2007, october). if you are not at the table, you ' re not on the menu. harvard business review, 34-35 . hoffman, a 1., & woody, j. g. (2008). climate change: what's y our business strategy? boston, ma : harvard business school publi shing. intergovernmental panel on climate change. (2007, april 6th). climate change 200 7: climate change impacts. adaptation. and vulnerability (summary for policymakers ). kassinis, g ., & vafeas, n. (2006). stakeholder pressure and environmental performance. academy of management journal, 49( 1), 145-159. kolk, a , & pinkse, j. (2004). market strategies for climate change. european management journal, 22(3), 304-314. kolk, a, & pinkse, 1. (2005). business responses to climate change: identifying emergent strategies. california management review, 4 7(3), 6-20. kolk, a ., & pinkse, j. (2007a). multinationals' political activities on climate change . business & society, 46(1), 201-228. kolk, a, & pinkse, 1. (2007b). towards strategic stakeholder management? integrating perspectives on sustainability challenges such as corporate responses to climate change. corporate governance: the international journal of effective board performance, 7(4), 370-378 . volume 27, number 2 147 levy, d., & kolk, a. (2002). strategic responses to global climate change: conflicting pressures on multinationals in the oil industry. business & politics, 4(3), 275-301. lovins, a. , lovins, l., & hawken, p. (2007). a road map for natural capitalism. harvard business review, 85(7/8), 172-183 . makower, j., pemick, r. , & wilder, c. (2005). clean energy trends 2005. clean edge, inc . margolis, j., & walsh, j. (2003). misery loves companies : rethinking social initiatives by business. administrative science quarterly, 48(2), 268-305. mckibben , w. j . & wilcoxen, p. j. (2002). the role of economics in climate change policy. journal of economics perspectives, 16(2), 107-129. menguc, b. , ozanne, l. k. (2005). challenges of the "green imperative" : a natural resource-based approach to the environmental orientation-business performance relationship. journal of business research, 58(4): 430-438. miller, d., & shamsie, j. (1996) . the resource-based view of the firm in two environments: the hollywood film studios from 1936-1965. academy of management journal, 39(3), 519-543. murray, k. 8. , & montanari , j. r. (1986). strategic management of the socially responsible firm. academy of management review, ii, 815-827. okereke, c. (2007). an exploration of motivations, drivers and barriers to carbon management: the uk ftse 100. european management journal, 25(6), 475-486 . orlitzky, m., schmidt, f., & rynes, s. (2003). corporate social and financial performance: a meta-analysis. organization studies, 24(3), 403-441. orsata, r. j . (2006). competitive environmental strategies: when does it pay to be green? california management review, 18(2), 127-143. peteraf, m. a. (1993). the cornerstones of competitive advantage: a resource-based view of the firm. strategic management journal, 14(3), 179-191. porter, m. e. , & kramer, m . r. strategy & society: the link between competitive advantage and corporate social responsibility. harvard business review, 84( 12), 78-92. porter, m., & van der linde, c. (1995). green and competitive : ending the stalemate. harvard business review, 73(5), 120-134. porter, m. , & reinhardt, f. (2007, october 1). a strategic approach to climate. harvard business review, 1-3. pugh, w., jahera, j., & oswald, s. (2005). esop adoption and corporate performance: does motive really matter? journal of business & economic studies , 11(1),76-92. 148 journal of business strategies reed, r., & defillippi, r. (1990). causal ambiguity, barriers to imitation, and sustainable competitive advantage. academy of management review, i5( 1), 88102. robins, j., & weirsema, m. (1995). a resource-based approach to the multibusiness firm: empirical analysis of portfolio interrelationships and corporate financial performance. strategic management journal, 16(4),277-299. roosevelt, t., & llewellyn, j. (2007, october). investors hungry for clean energy. harvard business review, 38-40. russo, m., & fouts, p. (1997). a resource-based perspective on corporate environmental performance and profitability. academy of management journal, 40(3), 534-560. schendler, a. (2007, october). when beirig green backfires. harvard business review, 35-38. schroeder, r., bates, k., & junttila, m. (2002). a resource-based view of manufacturing strategy and the relationship to manufacturing performance. strategic management journal, 23(2), 105-117. schwart, p. (2007, october). investing in global security. harvard business review, 26-28. sharma, s. & vrendenburg, h. (1998). proactive corporate strategy and the development of competitively valuable organizational capabilities. strategic management journal, 19(8), 729-754. shrivastava, p. (1995). the role of the corporation in achieving ecological sustainability. academy of management review, 20(4), 936-960. slater, a. (2007 , october). global reporting initiative's director of strategy, on how disclosing emissions benefits companies. harvard business review, 32. stanwick, p., & stanwick, s. (2006). reducing greenhouse emissions: a comparison of united states and australian multi-nationals. problems & perspectives in management, 1, 48-57. starik, m., & rands , g. (1995). weaving an integrated web: multilevel and multisystem perspectives of ecologically sustainable organizations. academy of management review, 20(4), 908-935. waddock, s. (2006). leading corporate citizens (2nd ed.). new york, ny: mcgraw-hill. way, m ., & rendlen, b. (2007 , october). walking the talk at swisse re. harvard business review, 42. zhu, k. (2004). the complimentarity of information technology infrastructures and e-commerce capability: a resource-based assessment of their business value . journal of management information systems , 21(1), 167-202. volume 27, number 2 149 zhu, k., & kraemer, k. (2002). e-commerce metrics for net-enhanced organizations: assessing the value of e-commerce to firm performance in the manufacturing sector. information systems research, 13(3),275-295. zott, c. (2003). dynamic capabilities and the emergence of intraindustry differential firm performance : insights from a simulation study. strategic management journal , 24(2), 97-125. biographical sketches of authors michael d. michalisin is professor of management and program coordinator for the business program at penn state worthington scranton. he received his ph .d. in strategic management and macro-organizational theory from kent state university. his research, which includes corporate environmental strategies, resource-based competitiveness, supply chain management, and top management team dynamics, appears in various journals including decision sciences, group & organization management, and the journal of business research. bryan t. stinchfield received his ph.d. from southern illinois university where he studied strategic management and environmental policy and resources. his research and teaching interests include corporate social and environmental responsibility, climate change, and eco-preneurship. he currently is an assistant professor of organization studies at franklin & marshall college. 150 journal of business strategies climate change strategies and firm performance: an empirical investigation of the natural resource-based view of the firm compensation strategy and financial performance of community banks: an exploratory study dennis cahlik community bank and trust thrtle creek operations center beaumont, tx jack howard illinois state university bioomington-normal j il lynn godkin lamar university beaumont, tx abstract an exploratory study of52 banks with assets between $100 million and $300 million was conducted to determine the usefulness of incentive compensation systems to this segment of the industry. it wasfound that incentive compensation plans may be more appropriate when specific circumstances face a bank. variables most closely linked to the use ofcompensation plans were: (j) the strategic orientation ofthe bank, (2) unit or branch bank decision making, (3) the roles played by bank owners, and (4) slightly higher compensation per employee. implications of the case study findings are discussed. future directions of research are discussed. organizations of all types face the arduous task of developing a culture to achieve their desired goals and outcomes (appelbaum & shapiro, 1992; bowen, 1993; mccormick & rose, 1994; rose, 1991). research suggests that incentive compensation plans (icp) should improve employee motivation and, subsequently, bank performance in this environment (bird, 1992; cates, 1994; fuehrer, 1994; heneman, 1984; heneman, 1992; lawler, 1990; marshall, 1993). unfortunately, the influence of icps on financial performance, increased market share, or the motivation and retention of bank employees has been examined, but is largely unknown to date (lawler, 1981, 1984, 1990). the purpose of the present paper is to examine icps as they are used in organizations. this largely exploratory study of the use of icps in community banks addresses a number of issues, including the identification of the types of organizations that should install icps, identification of an appropriate business strategy-compensation plan match for organizations, the effects of separation of management from ownership, the effects of stock ownership by the chair, and the relationship between the icps and monitoring costs. 152 journal of business strategies vol. 16, no.2 incentive compensation one of the primary approaches to motivating employees is through compensation. while motivating employees may be difficult, the structure of an organization should be congruent with the business strategy of the organization, if it is to meet its goals (carroll, 1987; heneman, 1992). additionally, compensation plans should support and reinforce the business objectives and the behaviors that are needed for the business to be successful (lawler, 1990). support for these statements has been established through a variety of research findings. first, in a summary of studies evaluating merit-pay plans, heneman (1984) generally found that a positive relationship existed between motivation, performance, and satisfaction relative to the pay-performance relationship, when rewards were contingent upon performance. taking this idea a step further, given different organizational strategies, the key is to align a compensation plan with the overall strategy of the organization (lawler, 1990) given these results and guidelines, the strategies of organizations should influence which compensation plans are adopted. the following section of this paper specifically examines the relationship between the business strategy and characteristics of banks and their use of icps. additionally, the effects of both the business strategy and the use of icps will be examined to determine their influence on organizational performance. influences on banking compensation methods a considerable amount of literature focusing on compensation indicates that the environment, strategy, industry structure, management structure, task performance and reward systems pose difficulties to organizations in general (barkema & gomez-mejia, 1998; conhyon & peck, 1998; finkelstein & boyd, 1998; gomez-mejia & wiseman, 1997). this paper assumes that the banking industry faces these same difficulties. in this section we provide an overview of each of these factors as they relate to banking offering hypotheses. banking environment the nature, or causal texture (emery & trist, 1965) of an organization's environment results from the interaction of two dimensions: (i) environmental change, which ranges from stable to dynamic, and (2) environmental complexity, which ranges from simple to complex (duncan, 1972). it is not actual uncertainty, but the perception of environmental uncertainty which affects managers' decisions (milliken, 1987). environmental uncertainty influences compensation through the costs of sharing risk and gathering information (eisenhardt, 1988). finally, environmental conditions have been found to influence managerial activities, leading to higher ceo salaries (finkelstein & boyd, 1998). this might also influence the salaries of other employees. jobs which are "programmable," that is, simple and repetitious, allow for clear performance standards and easy monitoring. jobs having relatively low levels of programmability require greater use of performance-contingent compensation due fall 1999 cahlik, et al: compensation strategy 153 to the increased monitoring costs needed to evaluate employees. evidence exists that firms operating in highly volatile, uncertain environments pay higher compensation rates per full-time equivalent employee (ffe) than do other firms to compensate for a perceived increase in discretion and risk (eisenhardt, 1988, 1989; gerhart, minkoff & olsen, 1995; kren & kerr, 1993; rajagopalan & finkelstein, 1992). the purpose of increased compensation is to motivate employees to take the risks necessary to successfully perform their jobs (gerhart, minkoff & olsen, 1995). we propose that bank officers would follow a similar pattern. therefore, the following hypothesis is proposed: hypothesis 1: salaries per fte in banks where officers perceive a high degree of environmental uncertainty are significantly higher than those banks where officers do not perceive a high level of environmental uncertainty. strategy miles and snow (1978) place firms in four strategic categories. • prospectors aggressively seek growth opportunities through product and market development and innovation. • defenders work to improve operational efficiency and seldom need to adjust their technology, structure, or methods of operation. • analyzers normally operate in two product-market domains. one domain is a stable circumstance where analyzers operate routinely and efficiently through the use of formalized structures and processes. the other domain is a rapidly changing environment where managers watch competitors closely, adopting those ideas which appear promising. • reactors adjust structure and processes only when environmental pressure forces them to act. it has been suggested that specific corporate strategies and compensation strategies fit best together (finkelstein & boyd, 1998; gerhart, minkoff & olsen, 1995). building on the work of miles and snow (1978), rajagopalan and finkelstein (1992) have found that prospector firms in the electric utility industry paid employees significantly more than defenders or reactors and made greater use of outcome-based compensation plans. as the level of environmental uncertainty increased, similar finns adopted outcome-based compensation plans, paid a greater proportion of outcome-based cash compensation, and paid managers more. the aggressive sales and service culture u.s. bank presidents wish to foster in their institutions would suggest those particular banks would be categorized as prospectors (miles & snow, 1978). prospector banks should exhibit asset growth rates greater than those of defenders, analyzers, and reactors. finally, the aggressive nature of prospector banks would suggest higher financial performance, measured by better return on assets (roa) than banks employing other strategic options. thus, the following hypothesis is proposed: 154 journal of business strategies vol. 16, no.2 hypothesis 2: compensation per fte in banks characterized as prospectors is significantly higher than compensation per fte in banks characterized as defenders. analyzers, or reactors. banking structure firms may respond to complexities in the environment. however financial performance and the ability to pay may be influenced by industry level issues (finkelstein & boyd, 1998; gomez-mejia & wiseman, 1997). additionally, evidence exists that firms operating in highly volatile, uncertain environments pay higher compensation rates per fie than do firms in more stable environments (kren & kerr, 1993). to complete successfully in the volatile banking industry, the sales and service culture fostered in branch banking by management, is designed to increase deposits and loans, generate more fee income and provide perceived quality service. incentive compensation plans developed for branch banks reward employees for those deliverables. the higher salary may be used to compensate for increased discretion and risk assumed in turbulent environments (eisenhardt, 1988; kren & kerr, 1993; rajagopalan & finkelstein, 1992). therefore, it is expected that salaries would be higher in branched banks as opposed to unit banks because of the more unstable environment. given this circumstance, the following hypothesis is proposed: hypothesis 3: compensation per fte in branch banks having [cps is significantly higher than compensation per fte in unit banks having such systems. management structure the bank holding company act of 1956, a regulation of the federal reserve, defines three categories of ownership when filing regulatory applications: less than 10% denotes absence of control, 10% to 25% is categorized as a "presumption of control," and over 25% denotes the ability to direct or control the management of an institution. from this perspective, management structure in banks can be defined in terms of the chair-ceo relationships. pi and timme (1993) have found that banks where the chair was also the ceo performed worse in terms of cost efficiency and profitability than those banks where the chair was not the ceo. in banks where the chair was the ceo, there was no relationship between bank performance and percent of stock ownership of the chair. the level of bank performance in either case was unrelated to the level of stock ownership of the chair. stock options or ownership are a commonly used long-term incentive in compensation of executives (gomez-mejia, paulin, & grabke. 1995). rose (1992), from a study involving 6,400 small community banks, determined that as the chair's stock ownership percentage increases, bank expenses tend to increase fall 1999 cahlik, et al: compensation strategy 155 while profits decline. as the chair's portion decreases, non-interest expenses decline and employee productivity increases. this could be the result of ownermanagers selecting financial performance goals that maximize shareholder wealth while banks isolating the chair from ceo select goals that emphasize growth. the effects of owner-manager structures on the operation of the bank in terms of efficiency, profitability, and reward system selection also have been analyzed. (berger, hunter, & timme, 1993; pi & timme, 1993). banks where the chair is also ceo have lower efficiency due to increased operating expenses than do banks where these two roles are separate. since salaries and benefits can constitute nearly one-half the expenses of a bank, the implications for the effects of owner-managers are twofold. salaries may be higher because ohhe expense-preference behavior of the chair or the chair's ability to exert social influence on the board in a manner that increases his or her compensation (belliveau, o'reilly, & wade, 1996). alternatively, as stock ownership increases, other expense preference behaviors may become more important than salaries. pi and timme (1993) found that roa's of banks having owner-managers were less than banks having separation of these roles. as a result of these findings, the following hypothesis is proposed: hypothesis 4: overhead efficiency ratios and roa for ownermanager banks having [cps are significantly lower than those separate owner-manager banks having icps. task performance task performance refers to the manner in which jobs are performed (katz & kahn, 1978; motowidlo & van scotter, 1994) and to two classes of behavior (borman & motowidlo, 1993). the two behaviors include the execution of the organization's technical processes and the activities which maintain and service the institution's technical requirements. caruth (1984) studied banking jobs and found they were not amenable to the use of icps (finkelstein & boyd, 1999; rajagopalan & finkelstein, 1992). jobs in banking were believed to be knowledge intensive, requiring a high degree of individual discretion not amenable to management control. additionally, austin & simoff (1990) found that high performance in a high discretion job requires individual commitment and motivation. they conclude that in banking, tellers actually exercise lower levels of discretion than the officers, which exercise the highest levels of discretion. this might indicate that discretion varies across jobs in banking, and some jobs may be conducive to icps. bettinger (1986), in a study of icps in banks, has found customer jobs and knowledge jobs to be the highest in discretion. sherwood (1994) has found the measurement of sales and marketing success in the banking industry to be difficult due to the bundled services offered to the consumer. rewards must be related directly to outcome to achieve the desired performance (lawler, 1981, 1984, 1990). therefore, one could assume that bank 156 journal of business strategies vol. 16, no.2 managers perceiving a high level of task perfonnance and skill level among their employees would utilize icps to link behaviors to outcomes. thus, the following hypothesis is proposed: hypothesis 5: managerial perceptions ofthe skill level and task performance attributes ofemployees in cross selling bank products in banks having icps is significantly higher than management perceptions ofthe skill level and task performance of that group of employees in banks not having icps. reward systems schuster and zingheim (1986) studied high-performing banks that utilized goals, budgets, and forecasts to measure the progress of task performance. certain design elements were found among the best: (i) eligibility there was an ability to identify yardsticks that measure variations in performance; (2) participation the plan extended through much of the organization; (3) incentives the plans were used to achieve competitive pay levels and functioned as tools for recognition of performance; (4) emphasis the plans tied the employees' financial interest to the organization's success; (5) objectives forecasts, goals, and budgets were used to judge progress and whether cash compensation should be paid; and (6) timeliness performance periods coincided with the accomplishment of tasks and attainment of goals. incentive compensation plans are not only designed to increase organizational performance, but they have been found to increase the performance of employees (appelbaum & shapiro, 1992; finkelstein & boyd, 1998; gomez-mejia & balkin, 1989; rajagopalan & finkelstein, 1992). since icps are intended to motivate employees to higher levels of performance with a corresponding increase in compensation, there should be higher compensation levels per ftes observed in banks using icps. hypothesis 6a: financial performance ofbanks having icps is significantly higher than banks not having such plans. hypothesis 6b: total salary expenses per fte in banks having icps is significantly higher than salary expense per fte in banks not utilizing such plans. the purpose of the present paper is to explore if an appropriate match between strategic orientation and compensation strategy might exist in the banking industry. this will be investigated by testing the hypotheses presented in this section of this paper. in the next section of this paper, the methods use to test the hypotheses will be presented. fall 1999 cahlik. et al: compensation strategy method 157 sample and procedures the fdic stratifies banks into peer groups for financial analysis purposes. the fdic uses financial data to analyze banks during examinations to determine how they perform relative to others. also, would be investors (individuals and other bankslbank holding companies) can access that information through publishing services to analyze the banks as potential investments or acquisitions. one of the peer groups consists of banks having assets between $100 million and $300 million, comprising a small percentage of the total number of u.s. banks, since 80% of those banks are less than $100 million (rose, 1992). this group represents a specific peer group for analytical comparisons by the federal deposit insurance corporation, and are not considered "large" banks. banks are considered "large" by regulators once they reach an asset level of $500 million (rose, 1992). once at this level, these banks have strict internal control and risk management requirements placed on them. appropriate management structure should be in place when that level is reached. several important challenges arise along the growth wave between $100 million and $300 million in assets. an increased reliance on automation and technology occurs as marketing strategies strive to deliver banking products and services in the new sales and service culture being fostered in banks today. incentive compensation plans are being developed to support this new culture. these banks have the capital structure in place to support increased investments in data processing equipment that the smaller banks lack. also, new products are needed to attract and retain customers, requiring more professional type employees in the areas of lending, audit and governmental compliance to manage the growth of these banks. finally, this particular segment of banking faces a unique dilemma compared to banks with fewer or greater assets. banks with fewer assets may not have the ability to use icps, given their lack of resources. banks with greater assets have the financial resources to pursue this type of compensation plan. however, banks in this range face a more critical question when considering implementing icps, making this group of special interest. surveys (see appendix) were mailed to the presidents of 186 banks with assets between $100 million and $300 million. the surveys were mailed to all banks in a southwestern state meeting this criteria. of the surveys returned, 52 were usable, representing a response rate of 28 percent. a response rate of 28 percent is slightly higher than the normal rate of 19 percent for research targeting ceos or presidents of firms (barker & patterson, 1996; stimpert & duhaime, 1995). in addition to the surveys, banking structure information was obtained from the uniform bank performance report (ubpr) data. the average assets of the responding banks were $163,876,000, with an average compensation per fte of $32,725. average overhead efficiency of the sample 158 journal of business strategies vol. 16, no.2 was 64 percent. the average roa was 1.32 percent, while the asset growth rates averaged 6.92 percent. measures this survey was designed to obtain information from each bank president in the areas of perception of environmental uncertainty, strategic orientation, ownermanager data and stock ownership, perceptions of skill level, and reward system selection factors, including whether an incentive compensation plan was used. each survey question and what measurements of interest were needed for analysis are discussed below. perception of environmental uncertainty. duncan (1972) suggests that there are five components of environmental uncertainty; competitors, customers, suppliers, regulatory groups, and technology requirements of the industry. the bank presidents were asked to rate their perception of their level of uncertainty associated with these 5 factors in predicting the influence of each component on their bank by choosing among six measures with "1" being very unpredictable to "6" being strongly predictable. strategic orientation. detennination of strategic orientation was obtained by analyzing the bank president's responses to questions about their bank's competitive strategy, which included 5 areas of bank strategy: market penetration, market innovation, technological innovation, efficiency strategies, and domain expansion strategies. the bank presidents rated each measure by choosing their level of agreement or disagreement with each question. responses ranged from "1" being strongly disagree to "6" being strongly agree. following the methodology of rajagopalan and finkelstein, (1992) banks were grouped into 1 of 4 strategic orientations. based on the systematic responses to these questions, strategic orientation was identified as being prospectors, defenders, analyzers, or reactors. effects of owner-managers. bank presidents were asked to specify if their bank had a majority shareholder who acted as the chair and ceo or if those two roles were separate. next, the question asked for the chair's level of stock ownership. three choices were given: less than 10% (no control); between 10% and 25% (presumed control); over 25% (controlling shareholder). skill level. bank presidents were asked to indicate agreement or disagreement with questions regarding their perceptions of employee performance and skill level, monitoring information, and the influence of pay practices on employee retention, attraction, and motivation. perceptions could range from "1" being strongly disagree to "6" being strongly agree. reward system selection. a final group of items sought to determine the degree to which bank presidents considered employees' feelings and preferences for reward system selection and if job, skill, or timed based factors entered in the compensation practices. incentive compensation plan usage was assessed by the last part of the question. responses ranged from "i" being strongly disagree to "6" being strongly agree. fall 1999 cahlik, et al: compensation strategy 159 analyses analysis of variance (anova) was utilized to test for the significant differences in those hypotheses where differences between two or more groups were expected (hypotheses i, 2, 3,4,5, 6a and 6b). additionally, t-tests were conducted on hypotheses 2 to determine which strategic orientations may result in significant differences in levels of compensation per fte and asset growth rate. the t-tests were conducted assuming that the variances were not equal, which is more conservative than assuming that the variances are equal. this technique was conducted since the number of observations present in each strategic orientation compared were not equal. multiple regression was used to test the hypotheses in which multiple variables were expected to influence either overall compensation (hi) or roa (h6b). financial performance data used to test the hypotheses included: (l) roa, (2) compensation per fte, (3) total assets, (4) deposits per fte, (5) asset growth rates, and (6) overhead efficiency ratios. banking regulators and investors utilize these measures to compare a subject bank to its peer group and to evaluate the bank from a safety and soundness standard. finally, because of the exploratory nature of this study, nonparametric analyses will be conducted as an additional test of several of the hypotheses. these analyses further address the small sample size and the ordinal nature of some of the measures associated with this study (allen & yen, 1979). results greater levels of environmental uncertainty were not associated with higher levels of compensation per pte (f=.19, p=.83, df=51), thus hi was not supported. while the anova results clearly did not reach significance, a mannwhitney test on the effects of environmental uncertainty on compensation reached significance (w= 1378, p=.oo, df=51). additionally, the regression results approached significance (f=2.38, p=.08; df=51). these results indicate that a bank's assets, deposits and the uncertainty of the environment facing these institutions could explain a significant portion of the compensation provided at banking institutions, given a larger sample size. anova results indicated no differences in compensation by strategic orientation (f=1.95, p=.13, df=51). however, comparisons among mean compensation levels of the different strategic orientations revealed that analyzers received significantly higher compensation than prospectors (t=2.37, p=.03, df=14) and significantly higher than defenders (t=2.39, p=.oi, df=21). additionally, mannwhitney tests further supported the significant difference between analyzers and defenders (w=215, p=.03, df=21) (table i). this provides some support for h2, indicating that strategic orientation of a bank may influence compensation levels of employees. 160 journal of business strategies vol. 16, no.2 table 1 employee compensation by strategic orientation performance prospector defender analyzer reactor indicator 0=13 0=20 n=3 n=16 compensation per ffe p=.l3; f=1.95; df=51 $32,696 $32,675 $39,797 $32,736 h3, that differences in compensation between branched and unit banks existed from the use of an icp, received mixed support. the results of anova (f=.72, p=.41, df=25) indicate that banks using icps do not significantly vary based upon whether or not the bank is a unit or branched bank. mann-whitney test results, however, indicate that compensation at branched banks using icps was significantly higher than unit banks using icps (w=351, p=.oo, df:::::25). this provides partial support for hypothesis 3. h4, that differences in overhead efficiency and roa existed due to management structure and the use of an icp, demonstrated mixed results. banks managed by owner-managers were significantly less efficient (f= -4.33, p=.05, df=25) than banks which had separate owner-managers, supporting h4. additionally, mannwhitney tests results further supported this finding, with banks having owner-managers being less efficient than banks having separate owner-managers (w:::::4082, p=.oo, df=25). overhead efficiency was 71.83% for the owner-manager group and 61.70% for separate owner-manager banks. however, the roa measures did not indicate a significant difference (f=2.70, p=.20, df=25). as a result, hypothesis 4 received partial support. h5, that perceptions of the skill level and task performance attributes in banks having icps is higher than in banks not having icps, failed to receive support (f=.ol, p=.90, df:::51). this might indicate that the implementation of icps in community banks may not influence the perception of employee skill level. alternatively, this might indicate that banks in the asset range studied may not consider the perception of employee skill level when implementing icps. icp presence in banks was not found to significantly influence either the financial performance ofthe banks or the total salary expenses of the banks, thus hypotheses 6a and 6b were not supported. however, the results of the multiple regression indicated that assets, overhead efficiency, deposits per full time equivalent employee, and the use of an icp explain a significant amount of the variance of the roa, with overhead efficiency and deposits per fre each reaching significance. the regression was run on the sample banks. overhead efficiency and deposits per fre were each found to be significant predictors of roa. additionally, the independent variables explained 78.3 percent of the variance in roa, with p-value for the model of 0.000 (table 2). the correlation between use of icp and overhead efficiency was .06, ensuring that these items were not measuring the same concept. fall 1999 cahlik, et al: compensation strategy table 2 regression of roa for community banks 161 variable assets overhead efficiency deposits per fte use of icp r2 adjusted r2 f statistic p value n 52 regression weight -.000000 -.0442 -.000458 -.0188 78.3% 76.5% 42.5 .000 discussion t ratio -0.26 -12.63 -5.15 -.22 pvalue .798 .000 .000 .831 the present case study examined the effects of strategic orientation and icps on the financial performance of community banks as well as the conditions under which icps were most effective in influencing the financial performance of these same institutions. the results ofthis study provides insights into the effectiveness of strategic orientation and icps as they pertain to banking industry. while the anova results showed no significant relationship between compensation and level of environmental uncertainty, the mannwhitney test results were significant (p=.oo), providing some support for hypothesis 1. additionally, the multiple regression results approached significance, resulting in a p-value of 0.08 for the model. the combination of assets, deposits and environmental uncertainty could explain a significant portion of the variance in salaries of bank employees, as deposits significantly influenced the salaries. this is a finding which can be considered consistent with previous findings (eisenhardt, 1988; kren & kerr, 1993). in each of these studies, environmental uncertainty was linked to increased compensation. the present results seem to suggest that environmental uncertainty might lead to higher levels of compensation in the banking industry as well. the results of the exploratory case study are interesting for a variety of reasons. first, while community banks are quite different from the retail sales companies in the eisenhardt (1988) study, it does appear that compensation may be influenced by a variety of factors beyond the control of the organization. in the retail sales study, programmability of the job, supervisor span of control, uncertainty, type of merchandise, and age of the store chain were strong predictors of compensation policy. not all these factors may apply to jobs and employees in the banking industry, and those factors which are present may systematically differ from those in the retail industry. eisenhardt (1988) found that where retail job programmability was low, there was a greater use of salary and commission pay 162 journal of business strategies vol. 16, no.2 systems to offset the influence of uncertainty. as programmability of the job increased, variation in uncertainty resulted in greater use of salary plans, having no effect on overall compensation because job programmability was found to increase the organization's monitoring ability. even though job programmability in banking is high, the bank presidents surveyed indicated that their bank's monitoring information was not timely or available, and this information was not reliable to adequately evaluate their employees. thus, a lack of monitoring information available to evaluate employees having highly programmable jobs and the decision to use icps in situations better suited for straight salary may contribute to the inconsistent results. second, a difference between the retail and banking studies is that in the banking study, the "merchandise" is service and the product is fairly uniform throughout the banking industry. customers can go to virtually any bank and receive similar products or services. any differences in preferences could be based upon the quality of service and location as opposed to the variety available in retail establishments. retail establishments encompass a wide variety of stores, ranging from specialty merchandise, to major appliances, to department stores. as a result, depending on the product, a variety of outlets exists. while compensation per fte did not systematically vary based on the strategic orientation of the bank, the salaries associated with analyzer firms were considerably higher than the salaries associated with the other orientations, and reached significance in two of the three cases. compensation per fte was consistently about $7,000 higher in banks classified as analyzers. this might indicate that analyzers, given the nature of this type of strategic orientation, were more effective at studying the market. this may have led to higher profits, which were then shared with the employees. given the very small number of degrees of freedom, these results might consistently reach significance if a larger sample were analyzed. the trends found in the results suggest that strategic orientation may influence employee compensation, consistent with the suggestions made previously by gerhart, minkoff, and olsen (1995). banking structure might influence the effectiveness oficps at increasing compensation levels of employees. the results, while mixed, seem to suggest that employees of branched banks are compensated at higher levels. this might indicate that this type of bank is more profitable, or it could compensate for increased discretion and risk associated with the volatile environments that banks face, as others have suggested (eisenhardt, 1988; kren & kerr, 1993; rajagopalan & finkelstein, 1992). management structure was found to influence the overhead efficiency of the organization. this may indicate that bank performance is influenced by management structure, providing further support that owner-managers may exert influence on the institution's board in a way that increases his or her compensation (belliveau, o'reilly, & wade, 1996). additionally, holding the position of ownermanager may influence the individual to maximize shareholder wealth. this stratfall 1999 cahlik, et al: compensation strategy 163 egy could be very different from the strategy selected when the chair and ceo are separated. where growth is emphasized (rose, 1992). as a result, it may not only be that overhead efficiency is influenced, but that compensation strategy and strategic orientation of the bank might also be influenced as a result of the management structure. the final finding, which lends some preliminary support for matching appropriate compensation techniques with the circumstances facing a bank, concerns the multiple regression results associated with testing h6a and h6b. the model predicting roa was found to be significant. assets of the bank, overhead efficiency, deposits per pte and the use of an icp were the predictor variables, with overhead efficiency and deposits per ffe reaching levels of significance. while in none of these cases was the use of icp found to be a significant variable, overhead efficiency was found to be significant. nonetheless, the combination of these variables did explain a significant amount of the variance of the roa for the banks in this sample. this seems to indicate that the role of rcps might influence roa when coupled with overhead efficiency or deposits per pte. given the nature of the case study, the findings do provide some insight and encouraging support concerning the appropriate match of compensation strategy with strategic orientation for organizations. several steps could be taken to expand on the findings of this case study. first, a larger sample size could further reveal if ideal matches between compensation strategy and strategic orientation exist, enhancing the performance of organizations and their human resources. many of the results are believed to be diminished because of the small sample size. a second step which could further provide information about the appropriate match between compensation strategy and strategic orientation would be to gather a more diverse sample of organizations. a more diverse sample would allow for the comparison among types of organizations. it could be the case that matching compensation strategy with the strategic orientation of the firm is more effective in some types of organizations than in others. amore diverse sample would allow for the testing of these differences. finally, a closer examination of the interrelationships among management structure, compensation strategy and strategic orientation should be conducted. understanding these relationships could further revedl information about which circumstances contribute to a more effective match between compensation strategy and strategic orientation. it is very possible that the management structure itself may influence the effectiveness and appropriateness of both the strategic orientation of an organization as well as the proper compensation strategy for the combination of strategic orientation and management structure. the present case study provides preliminary evidence that appropriate matches between strategic orientation and compensation strategy may lead to increased firm and human resource performance. scholars and practitioners alike should carefully examine the environment, conditions surrounding an organization and 164 journal of business strategies vol. 16, no.2 the strategic orientation before selecting a compensation strategy. when the final decision is made regarding the compensation strategy, the strategy selected should complement the strategic orientation in a way that supports the pursuit of the strategic orientation. references allen, m. j., & yen, w. m. (1979). introduction to measurement theory. belmont, ca: wadsworth, inc. appelbaum, s. h., & shapiro, b. t. (1992). pay for performance: implementation ofindividual and group plans. management decision. 30 (6), 86-91. aspinall, k.w, & reichheld, ee (1994). building high loyalty business systems. journal of retail banking. 15 (4),21-29. austin, d. v., & simoff, p.l. (1990). strate~ic planning for banks: meeting the challenges of the 1990's. rolling meadows, il: bankers publishing co. barkema, h. g., & gomez·majia, l. r. (1998). managerial compensation and firm performance: a general research framework. academy of management journal. 41 (2), 135-145. barker, v. l. iii, & patterson, p. w., jr. (1996). top management team tenure and top manager causal attributions at declining firms attempting turnarounds. group and oq;anization management. 21 (3),304-336. belliveau, m. a., o'reilly, c. a. iii, & wade, j. b. (1996). social capital at the top: effects of social similarity and status on compensation. academy of management 1ournal. 39 (6),1568-1593. berger, a., hunter, w, & timme, s. (1993). the efficiency of financial institutions; a review and preview of research past, present, and future. journal of banking and finance. 17 (2),221-249. bettinger, c. (1986). incentive compensation works best with established guidelines. american banker. 18 (12), 6. bird. a. (1992). are community banks an endangered species? the bankers magazine. ill (6),77-81. borman, w c., & motowidlo. s. j. (1993). expanding the criterion domain to include elements of contextual performance. in n. schmidt & w. c. borman (eds.), personnel selection in organizations (pp. 71-98). san francisco: jossey-bass. fall 1999 cahlik, et al: compensation strategy 165 bowen, j. w. (1993). a systematic approach for increasing service quality in retail banking. in american bankers association (ed). customer retention strategies: five leading perspectives (pp. 21-35). washington, dc: american bankers association press. carroll, s. j. (1987). business strategies and compensation systems. in d. b. balkin & l. r. gomez-mejia (eds.), new perspectives on compensation, (pp. 343-355). englewood cliffs, nj: prentice hall. caruth, d. l. (1984). work measurement in banking. boston: bankers publishing company. cates, d. c. (1994). new compensation systems for retail banking. bankers magazine, 77 (2),42-47. conyon, m. j. & peck, s. i. (1998). board control, remuneration committees, and top management compensation. academy of mana2ement journal. 41 (2),146-157. duncan, r. b. (1972). characteristics of perceived environments and perceived environmental uncertainty. administrative science quarterly, 17 (3), 313-327. eisenhardt, k. m. (1988). agency and institutional theory explanations: the case of the retail sales compensation. academy of management journal. 31 (3),488-511. ---(1989) agency theory: an assessment and review. academy of management review. 14 (1),57-74. emery, f., & trist, e. (1965). the causal texture of organizational environments. human relations, 18 (i), 21-32. finkelstein, s. & boyd, b. k. (1998). how much does the ceo matter? the role of managerial discretion in the setting of ceo compensation. academy of management journal. 41 (2), 179-199. fuehrer, v. (1994). total reward strategy: a prescription for organizational survival. compensation and benefits review, 26 (i), 44-53. gerhart, b" minkoff, h. b., & olsen, r. n. (1995). employee compensation: theory, practice, and evidence. in g. r. ferris, s. d. rosen, & d. t. barnum (eds.), handbook of human resource management (pp. 528-547). cambridge, ma: blackwell publishers, inc. gomez-mejia, l. r., & balkin, d. b. (1989), effectiveness of individual and aggregate compensation strategies. industrial relations. 28 (3),431-435. 166 journal of business strategies vol. 16, no.2 gomez-mejia, l. r, paulin, g., & grabke, a. (1995). executive compensation: research and practical implications. in g. r ferris, s. d. rosen, & d. t. barnum (eds.), handbook of human resource management (pp. 548-569). cambridge, ma: blackwell publishers, inc. gomez-mejia, l. r & wiseman, r. m. (1997). reframing executive compensation: an assessment and outlook. journal of management. 23 (3), 291-374. heneman, r l. (1984). pay for performance: exploring the merit system. (work in america institute/studies in productivity #38). new york: pergamon. ---(1992). merit pay: linking pay increases to performance ratings. reading, ma: addison-wesley publishing company. katz, d. & kahn, r l. (1978). the social psychology of organizations (2nd ed). new york: wiley. kerr, j., & slocum, l.w. (1987). managing corporate cultures through reward systems. academy of management journal. 30 (2), 99-108. kren, l., & kerr, j. (1993). the effect of behavior monitoring and uncertainty on the use of performance-contingent compensation. accounting and business research, 23 (90), 159-167. lawler, e. e. (1981). pay and organizational development. reading, ma: addison-wesley publishing co. ---(1984). the strategic design of reward systems, in j. fombrum, n. m. tichy, & m. a. devanna (eds.), strategic human resource management (pp. 127-148). new york: wiley. ----(1990). strategic pay: aligning organizational strategies and pay systems. san francisco: jossey-bass. mccormick, j., & rose, s. (1994). forget the 80-20 rule. lournal of retail banking. 17 (2),5-9. marshall, h. 1. (1993). investing in human capital. the bankers magazine. 176 (4), 2227. miles, r. c, & snow, c c. (1978). organizational strategy, structure and process. new york: mcgraw-hill milliken. f. 1. (1987). three types of perceived uncertainty about the environment: state, effect, and response uncertainty. academy of management review. 12 (1), 133-143. fall 1999 cahlik, et al: compensation strategy 167 motowidlo, s. j., & van scotter, j. r. (1994). evidence that task perfonnance should be distinguished from contextual perfonnance. journal of applied psychology. 79 (4), 475-480. pi, l., & timme, s. g. (1993). corporate control and bank efficiency. journal of banking and finance. 17 (2),515-530. rajagopalan, n., & finkelstein, s. (1992). effects of strategic orientation and environmental change on senior management reward systems. strategic management journal. 13 (2), 127-142. rose, p. s. (1992). agency theory and entry barriers in banking. financial review. 27 (3), 323-353. ---(1991). fulfilling retail banking's profit potential: product repricing, improved cross-selling, and better customer segmentation are the keys. journal of retail banki.ng,jl (2), 5-8. schuster, j. r., & zingheim, p. k. (1986). designing incentives for top financial performance. compensation and benefits review. 18 (3), 39-48. sherwood, m. k. (1994). the measurement of service outputs. monthly labor review. 117 (3),11-19. stimpert, j. l. & duhaime, i. m. (1995). mail surveys sent to top managers oflarge firms: suggestions and research issues. manuscript, michigan state university, eli broad graduate school of management. appendix survey questions i. the following environmental factors (customers, suppliers, competitors, regulatory burden, and technological advances) can have dramatic influences on the way you manager your bank. by using the sliding scale below, please circle the numbered response to the right of each environmental factor that best describes your level of uncertainty in predicting the influence of each on your bank: 1= very unpredictable 2= unpredictable 3= somewhat unpredictable 4= somewhat predictable 5= predictable 6= strongly predictable a. customers 1 2 3 4 5 6 b. suppliers 1 2 3 4 5 6 c. competitors i 2 3 4 5 6 d. regulatory burden 1 2 3 4 5 6 e. technological advances 1 2 3 4 5 6 168 journal of business strategies vol. 16, no.2 3= somewhat disagree 6= strongly agree 2. think a moment about your bank's competitive strategy. please circle the numbered response for each strategy which best describes your agreement with each by using the following scale: 1= strongly disagree 2= disagree 4= somewhat agree 5= agree a. market penetration strategies my bank's strategy emphasizes cautious penetration and development of existing markets through following the lead of my competitors 1 2 3 4 5 6 b. market innovation strategies my bank's strategy seeks to develop new markets and products through aggressive, innovative marketing and product development i 23456 c. technological innovation strategies my bank's strategy emphasizes improved information and customer service through investment in the most up to date technology i 2 3 4 5 6 d. efficiency-orientation strategies my bank's strategy seeks to improve the efficiency of existing operations through cost-cutting measures and productivity improvements i 2 3 4 5 6 e. domain expansion strategies my bank's strategy seeks to develop new product markets through mergers and acquisition and geographical expansion i 2 3 4 5 6 3a. the following statements may apply to how your bank's management is organized and how central decision making is handled. please circle the response which best describes how your bank is organized. my bank has a separate chairman and separate ceo yes no at my bank, the chairman and the ceo are the same individual yes no 3b. the amount of stock the chairman owns of your bank or your bank's parent holding company is: (please circle the response i, 2, or 3 below which best describes your chairman's ownership) i = less than 10% 2 = 10% or more but less than 25% 3 = more than 25% 4. the following statements address the availability and reliability of information which can be used to evaluate employees. also addressed are your perceived performance of employees and the perceived effects of pay on employees. circle the numbered response factor which best describes your agreement with each by using the following scale: 1= strongly disagree 2= disagree 3= somewhat disagree 4= somewhat agree 5= agree 6;;;; strongly agree a. the reliability of informational reports provides enough information for the evaluation of the performance of my bank's tellers and new accounts employees in the areas of cross-selling banking services 1 2 3 4 5 6 b. the availability of informational reports is adequate for the evaluation of the performance of my bank's tellers and new account employees in the area of cross-selling banking services 1 2345 6 c. as bank president, the perceived performance of my bank's tellers and new accounts employees in the area of cross-selling bank products and services is high relative to those of my competitors 1 2 3 4 5 6 fall 1999 cahlik, et af: compensation strategy 169 d. in my bank's experience over the past three years, the pay policies and practices have greatly contributed to retention, attraction, and motivation of employees 1 2 3 4 5 6 sa. my bank has chosen its compensation system to provide the utmost in motivating employees and contributing to their retention. please rate the following statements for your level of agreement or disagreement with each by circling the number to the right of each statement. use the following scale for.your response: 1= strongly disagree 2= disagree 3= somewhat disagree 4= somewhat agree 5= agree 6= strongly agree i) employee feelings and preferences for various pay forms are taken seriously by management 1 2 3 4 5 6 ii) factors within the job are key determinants of the amount of pay 1 2 3 4 5 6 iii) individuals are rewarded in part for their mastery of job skills 1 234 s 6 iv) pay is based solely on how long the employee has held the job 1 2 3 45 6 5b. my bank uses an incentive type of compensation system: (please circle your response) yes no the authors would like to thank charles hawkins, john lust, and don robinson for their helpful comments on several earlier drafts of this manuscript. we would like to thank three anonymous reviewers for their comments on an earlier version of this paper. dennis cahlik is a c.p.a. serving the banking industry in beaumont, texas. he holds degrees from oklahoma city university (b.b.a.) and lamar university (m.b.a.). mr. cahlik received partial fulfillment for the requirements of his mba degree through development of his thesis concerning the use of incentive compensation plans in texas community banks. mr. cahlik also holds the certified internal auditor and certified information systems auditor designations. jack howard is an assistant professor of management at illinois state university. he received his doctorate from the institute of labor and industrial relations at the university of illinois. lynn godkin is chair of the management and marketing department in the college of business at lamar university. he is a graduate of the university of illinois at springfield (m.a.) and the university of north texas (ph.d.). compensation strategy and financial performance of community banks: an exploratory study predicting decision-maker momentum to change offerings in response to uncertainty: the case of the u.s. customs mod act carolyn m. jones carr strategic response technologies, inc. indianapolis, in charles b. shrader michael r. crumm iowa state university ames,ia e. james flynn wake forest university winston-salem, nc abstract the major concern (~f this paper is predicting decision-maker momentum to change product and service offerings in response to significant uncertainties as an antecedent to organizational change. from a survey of organizations in the national customs brokers and forwarders association ofa me rica (ncbfaaj, data were obtained on decision-makers' perceived uncertainties, and intent or momentum to change offerings in response to uncertainty created by the u.s. customs modernization and informed compliance act ~f 1993 (mod act). survey measures include uncertainties, organization revenue and age, decisionmaker age and experience, technological expertise. formal planning and formalization of procedures. the regression results indicate that organization revenue, decision-maker age and mod act uncertainty were associated with the ncbfaa customs brokers' momentum to change offerings in response to mod act uncertainty. because the survey can be adaptedfor industry-specific uncertainties, we propose the survey. model and its results can be used by decisionmakers of organizations within dynamic industries as they seek to realign to a new industry environment. introduction the organizational transformation process is usually regarded as a deliberate effort of an organization to move from a current to a desired organizational state to better 'fit" with a dynamic industry environment (mukherji, desai, & francis, 1999). researchers (bamford, rogers, & miller, 1999; lieberson & o'connor, 1972) maintain that beliefs and expectations of the dominant coalition (i.e., 96 journal (~tbusiness strategies vol. 20, no. 2 ceo, president, top management, and board members) arc formalized based on their perception of what environmental phenomena are relevant for the health of the organization. in their study of antecedents for organizational change, bamford et al. (1999) found that change in the dominant coalition is a significant antecedent to organizational change. this body of work shows the importance of decision-maker perceptions. additionally, hamel and prahalad's (1989) research on strategic intent, child's (1972) research linking strategic choice and strategic response, and hitt and tyler's (1991) argument that decision-makers use a set of objective criteria from the organization's external and internal environment to decide on an intended strategy, provide evidence that strategic intent can be seen as a first step to organizational change. based on this body of work, we propose that predicting decision-maker momentum to change offerings in response to environmental uncertainty may be seen as an antecedent for organizational change. dutton and duncan's "strategic issue diagnosis" conceptual model (1987) provides the theoretical framework for the empirical model. dutton and duncan's conceptual model focuses on how decision-makers' perceptions of unccrtainties and response feasibility may generate a strong or weak momentum for organizational change. in their work, they argue that decision-makers may recognize an uncertainty as significant for their organization's health. however, if response feasibility (i.e., resource availability and decision-maker risk propensity) is low, the overall momentum for organizational change may be low. furthering dutton and duncan's ( 1987) conceptual work, we develop and test an integrative model (rajagopalan & spreitzer, 1996) to predict decision-maker momcntum to change offerings in response to environmental and finn structure uncertainties. we also identify the specific environmental uncertainties and organization characteristics from those included in the model that are significantly related to decisionmaker momentum to change offerings in response to environmental uncertainty. moreover, burgelman and doz ( 1997) discuss the importance of models/tools decision-makers can use in performing complex strategic integration (cs1). according to burgelman and doz, more decision-makers are utilizing complex strategic integration tools in the development of corporate strategies to exploit new growth opportunities and better utilize knowledge resources across business units. consistent with burgelman and doz's comments on the importance of csi models and kent d. miller's 1993 study, this research develops and tests a perceived uncertainty measurement instrument grounded in strategic management theory. consistent with burgelman and doz, the proposed model can be useful to decision-makers of organizations during the transformation process as they seck to realign to a dynamic environment. for example, if decision-makers view an uncertainty as relevant for organizational change, but response feasibility is low, decision-makers can consider strategies for expanding resources (e.g., strategic alliances). in another example, if decision-maker risk tolerance is negatively related to decision-maker momentum to change offerings, then decision-makers fall 2003 carr et al: predicting decision-making momentum 97 may change the membership of the dominant coalition to include more risk tolerant members. in another example, if technological expertise is positively related to decision-maker momentum to change offerings, then decision-makers can consider strategies to increase technological expertise. moreover, if formal planning is positively related to decision-maker momentum to change offerings, then decision-makers may decide formal planning benefits the organization. in a final example, if no uncertainties were perceived as significant, decisionmakers may decide no organizational change is required. as noted by gersick (1994) decision-makers must make a complex but fundamental choice to change course or stay on the same path. in this study, we define organizational change as change in offerings. the population of interest is the ncbfaa because it is the largest customs brokers' association and all member organizations have equal access to information. we obtain perceptions of key decision-makers of member organizations during the period of uncertainty between passage of the mod act in 1993 and prior to the final implementation of the mod act rules expected in 1998. we develop and test a regression model with macro, industry and internal categories of environment variables (mukherji et ai., 1999) to predict decision-maker momentum to change offerings in response to environmental uncertainty. finally, we present conclusions and discuss implications for practitioners. the mod act the context for this study is the ncbfaa and its members' momentum to change offerings in response to the uncertainties created by the passage of the mod act. the mod act was enacted with the north american free trade agreement (the nafta) on december 8, 1993. however, the final rules of implementation and sub seq uent enactment of the mod act were not expected to be complete until 1998. the primary goal of the mod act legislation was to efficiently speed the processing of exports from and imports into the united states. implementation of the mod act was expected to directly impact the types of services demanded of u.s. customs brokers, the risk exposure for u.s. customs brokers, and the technology capabilities required of u.s. customs brokers. the customs broker function plays a significant role in the international supply pipeline. most formal import entries are handled by customs brokers who are licensed by u.s. customs to represent clientsindividuals and firmsin u.s. customs matters. the activities performed by customs brokers include assessing the admissibility, valuation and classification of merchandise, while maintaining the integrity of import/export laws and security of the u.s. at the time the mod act was passed, there were approximately nine thousand u.s. customs brokers working as agents or as members of customs broker organizations. prior to the passage of the mod act, it was estimated that automation of u.s. customs' clearances resulting from the mod act could decrease revenues from traditional services provided by u.s. customs brokers by as much as 80%. it was 98 journal of business strategies vol. 20, no.2 suggested by jones carr and crum (1995) that the mod act regulations could lead to organization failures and significant industry consolidation through mergers, acquisitions and strategic alliances. the mod act was expected to significantly affect u.s. customs broker efficiency in three key ways (jones, carr, & crum, 1995): 1) by reducing bottlenecks at ports, 2) by outsourcing certain responsibilities to others in the supply pipeline thereby reducing administrative costs, and 3) through increased automation and reduction of paperwork. the mod act streamlines the u.s. customs process by reducing both the number of entries requiring formal validation and the number of entries requiring the service of customs brokers. for more specifics on the intended service changes of the ncbfaa customs brokers at the time of the survey, see table 1. table 1 broker services expected to be offered by more than 50% more firms between 1993 and 1998 no. of firms % increase in no. of firms planning to service no. of firms offering in 1993 offer in 1998 trade compliance 40% 47 66 contract logistics 67% 21 35 shipper alliances 56% 27 42 cargo control 64% 28 46 shipment tracking 57% 37 58 purchase order tracking 208% 12 37 freight inventory control 150% 14 35 on-line invoicing 28% 13 50 ocean logistics 106% 18 37 global communication 6% 26 44 measuring decision-maker perceptions of uncertainties boyd, dess and rasheed (1993) make several recommendations for using perceptual measures. first, it is important to note in a study that environmental uncertainties vary across industries and within an industry over time. second, findings from a single study are situation specific and limited by the variables used in measurement of key constructs. third, measurement instruments should be validated over time. with respect to boyd, dess and rasheed's first and second recommendations, we propose that the model in this study can be used by decision-makers of organizations within industry associations to get a snapshot of specific uncertainties during a period of uncertainty as they seek to realign to a changing fall 2003 carr et al: predicting decision-making momentum 99 industry environment (e.g., regulatory change). with respect to boyd, dess and rasheed's third recommendation, we present prior research that supports our methodology. in miller's (1993) research on industry and country effects on decisionmakers' perceptions of environmental uncertainties, he describes a shortcoming in existing uncertainty literature as the tendency to isolate specific decisionmaker uncertainties to the exclusion of other uncertainties. researchers (miller, 1993; lewis & harvey, 2001; mukherji, desai, & francis, 1999) support three broad levels of decision-maker uncertainty variables in perceived uncertainty measurement instruments: i) macro, 2) industry, and 3) organization-specific. miller (1993) also describes the problem of aggregating decision-maker perceptions of uncertainties from a diverse range of environmental components into a single uncertainty measure (lawrence & lorsch, 1967; duncan, 1972). miller argues the pooling of perceived uncertainty scores from diverse components into a single scale presumes uncertainty is a one dimension construct. more recent research (miller, 1993; lewis & harvey 2001; hrebiniak & snow, 1980; mulford, shrader, & hansen, 1988; miles & snow, 1978) purports the view that decision-makers perceive differences in the levels of uncertainty associated with distinct environmental components. their measurement instruments reflect this view by using factor analysis loadings to aggregate uncertainties or by using individual constructs. consistent with this body of work, we use factor analysis loadings to aggregate external environment variables. all other variables in the regression model are distinct constructs. the specific macro, industry and organization-specific variables we included in the model are supported by miller's (1993) typology of uncertainties. according to miller, his uncertainty typology scale is most similar to miles and snow's (1978) uncertainty typology. recent research by lewis and harvey (2001) extends miller's scale to the natural environment. the uncertainty categories in miller's scale broadly include: 1) government and policies, 2) economy, 3) resources and services used by your company, 4) product market and demand, 5) competition, and 6) technology in your company. the regression model in this research incorporates variables that are consistent with miller's uncertainty typology. finally, consistent with boyd, dess, and rasheed's recommendations, recent research by carpenter and frederickson (2001) and hult, hurley, giunipero, and nichols (2000) suggests that organizational responses to uncertainty are best examined within specific demographics and within given functions. to this end this research examines u.s. customs brokers in the ncbfaa working within the u.s. customs function in context of mod act change during a period of uncertainty between the passage of the mod act in 1993 and its anticipated implementation in 1998. therefore, we hypothesize: hypothesis 1a: as perceived mod act (mod) uncertainty increases, the ncbfaa customs brokers' momentum to change offerings will increase. 100 journal of business strategies vol. 20, no.2 hypothesis 1b: as pe rceived othe r unce rta inty (env) increases, the ncb faa customs brokers' momentum to change offerings will increase. organization characteristics and decision-maker momentum to change offerings in this section we discuss the organizational characteristics we include in the model. the variables include organization size and age, formal planning, formalization of procedures and technological expertise. organization size variyam and kraybill (1997) and scherer (1970) suggest that smaller organizations generally face more financial uncertainty than larger organizations because of differences in market power. capital and labor constraints also limit small organizations' ability to adopt risky, innovative strategies in response to environmental uncertainty (e.g., wiersema & bantel, 1992; kimberly & evanisko, 1981). birnbaum (1984) also proposed that large organizations may have greater available resources because they have more capital and human assets. thus, a larger organization may have a greater capacity to respond to uncertainties. in particular, larger organizations may have a greater capacity to respond to technological recordkeeping and auditing requirements associated with regulatory changes where the cost burden may be prohibitive for small organizations. consistent with dutton and duncan's (1987) conceptual link between available revenue and response feasibility, we define organization size narrowly as revenue that can be utilized to increase both capital and knowledge resources. finally, based on boyd, dess and rasheed's (1993) article, the organization size measure is both archival and perceptual because we ask decision-makers with revenue knowledge to indicate a range that includes their organization's current annual revenue. organization age mulford et a1. (1988) found that older organizations do less planning than younger organizations. variyam and kraybill (1997) reported consistent findings and concluded that the relative lack of planning by older organizations in their study may partly explain their lower growth rates. variyam and kraybill also found that organization age helped to account for industry-specific knowledge resources accumulated within the organization. with respect to organization growth, jovanovic (1982) suggested that organization age represents the learning process as the organization adjusts output and size to efficiently respond to changes in demand. consequently, older organizations have been associated with greater industry-specific knowledge resources, and arguably, with greater decision-maker momentum to change offerings in response to environmental uncertainties. fall 2003 carr et al: predicting decision-making momentum 101 formal planning and formalization of procedures porter (1985) indicates that formal planning and scenario building may improve an organization's ability to develop and implement a well-defined strategic response. in particular, small organizations may benefit from formal planning (e.g., mulford, shrader, & hansen, 1988; shrader, mulford, & blackburn, 1989). while formal planning and formalization of procedures may benefit many organizations, it is important to note that many small organizations do not have formal plans or formalize procedures (e.g., mulford, shrader, & hansen, 1988; shrader, mulford, & blackburn, 1989). also, several researchers (tushman & romanelli, 1985; mintzberg, 1979; child, 1972; scherer, 1970) have concluded that as organization size increases, formal planning and formalization of procedures may increase complexity (quinn & cameron, 1983), decrease strategic thinking (mintzberg, 1979), and decrease innovation (child, 1972; scherer, 1970). moreover, researchers (papadakis, lioukas, & chambers (1998); thompson (1967); kukalis, 1989) found that rule formalization of procedures and propensity to adapt are negatively related in cases of high "decision" uncertainty because decision-makers tend to act in an "inspirational" manner rather than follow formal plans and procedures. because of the mod act's recordkeeping requirements, we hypothesize that both formal planning and formalization of procedures are more likely to be positively related to decision-maker momentum to change offerings in response to regulatory change. technology variyam and kraybill (1997) reported in their study that formal planning and the use of new or advanced technology are critical to small organization survival. also, link and bozeman (1991) found that larger organizations have a higher propensity to acquire technical knowledge and adopt new technology. thus, increasing technological expertise may be seen as a strategic intent that can be used to respond to perceived external environmental threats and opportunities. moreover, large organizations may be more likely than small organizations to succeed in increasing their technological expertise. based on the above discussion of organization size, organization age, formal planning, formalization of procedures and technology, we propose these hypotheses: hypothesis 2: as orranization size (size) increases, the ncbfaa customs brokers' momentum to chmllie ()fferings will increase. hypothesis 3: as organization age (agef) increases, the ncbfaa customs brokers' momentum to change (~fferings will if1crease. 102 journal of business strategies vol. 20, no.2 hypothesis 4: as formal planninf( (plan) increases, the ncbfaa customs brokers' momentum to change offerings will increase. hypothesis 5: as formalization (~l procedures (form) increases, the ncb faa customs brokers' momentum to change offerings will increase. hypothesis 6: as experience with technology increases (tech), the ncbfaa customs brokers' momentum to chanf{e offerings will increase. decision-maker characteristics and their momentum to change offerings a growing body of research provides support for the criticality of decisionmaker demographics in creating a fit between the environment and the organization (wiersema & bantel, 1992, wiersema & bantel, 1993; hambrick & mason, 1984; kimberley & evanisko, 1981; mulford, shrader, & hansen, 1988, norburn & birley, 1988). alternatively, lieberson and o'connor (1972) conclude that leadership influences corporate performance less than environmental or organizational factors. while arguably less critical than environmental uncertainty or organizational factors, decision-maker demographics are important in organizational realignment. as summarized by tushman and romanelli (1985): "where environments are changing and/or performance outcomes are low or declining, leadership's primary task is to intervene on ongoing patterns of commitment and exchange to redirect the character of an organization's relationship with its environment." hambrick and mason (1984) place primary emphasis on observable decision-maker characteristics as indicators of the alignment skills that decision-makers bring to their management positions. with this approach, they focus on broad tendencies for change. lastly, hitt and tyler's (l991) findings support the negative effects of age and the positive effects of decision-maker experience with respect to organizational realignment to environmental uncertainties. decision-maker age hambrick and mason (1984) found that younger decision-makers pursue riskier strategies than do older decision-makers. therefore, one may infer that decision-maker momentum to change offerings to environmental uncertainty is negatively related to decision-maker age. moreover, child (1972) found that youthfulness is related to risk propensity. additionally, hart and mellons (1970) found the ability to consider commercial solutions from a wider set of options is related to risk propensity. finally, schuman and scott (1989) support the proposition that the generational character of the events experienced by decisionmakers in their youth exerts an important influence on the weightings accorded to various decision criteria. thus, younger decision-makers might not only have fall 2003 carr et al: predicting decision-making momentum 103 a higher momentum for organizational change in response to environmental uncertainties, but might also weight criteria in the decision-making process differently from older decision-makers. hypothesis 7: as decision-maker age (agem) increases, the ncbfaa customs brokers' momentum to change offerings will decrease. decision-maker experience in a 1997 study, boeker examined how chief decision-maker characteristics interact with organizational performance to influence strategic change. his results support the contention that decision-maker experience and diversity positively impact strategic change. moreover, hambrick and mason (l984) argued that decision-makers' cognitive models are based in part on their career experiences. hitt and tyler (1991) and carpenter and frederickson (2001) contend that experience in multiple functions may enrich decision-makers' strategic decision-making abilities. hitt and tyler also found that the total career experience, possessed by a decision-maker, moderates the relationship between the decision criteria and decision-maker momentum for organizational change. based on this body of work, we hypothesize that more experienced decisionmakers would be more likely to be involved in the decision-making process. hypothesis 8: as decision-maker experience (expm) increases, the ncb faa customs brokers' momentum to change offerings will increase. model specification the regression model incorporates individual variables for mod act uncertainty and other uncertainty, organization size and age, decision-maker age and experience, technological expertise, formal planning and formalization of procedures. the dependent variable is decision-maker momentum to change offerings. the independent variables have been researched extensively regarding their connection to strategic change. the choice of variables included in this model has been discussed and the hypotheses have been presented. the following regression model was developed to reflect the aforementioned factors hypothesized to affect decision-makers' momentum to change offerings: decision-maker momentum to change offerings = mod + env + size + agef + plan + form + tech agem + expm where, decision-maker momentum to change offerings =the number of intended offering changes decision-makers perceive will occur between 1993 (mod act passed) and 1998 (when the final mod act rulings were expected to be complete); mod = mod act uncertainty; env = other environmental uncertainty; size = organization size; agef = age of organization; plan = formal 104 journal of business strategies vol. 20, no.2 planning; form = formalization of procedures; tech = technical experience of organization; agem =age of top decision-maker; expm =experience of top decision-maker. (please refer to table 2 for a summary of the sources of these measures. ) table 2 scales from previous research and new scales to be tested by questionnaire independent variables source mod modified from mulford, shrader & hansen (1988) definition mod act uncertainty env size agef plan form tech agem expm specific uncertainties/measure developed by jones carr (1997) modified from mulford, other uncertainties shrader, & hansen ( 1988) specific uncertainty factors/measure developed by jones carr (1997) birnbaum (1984) firm size variyam and kraybill (1997) age of firm mulford, shrader & hansen (1988) formal planning mulford, shrader & hansen (1988) formal procedures variyam and kraybill (1997) technological expertise hitt and tyler (1991) decision-maker age hitt and tyler (1991) decision-maker expenence momentum to respond jones carr ( 1997) number of service changes dependent variable the measure for decision-maker momentum to change offerings is defined as the absolute value of the intended changes in offerings between 1993 when the mod act passed into law and 1998 when the final mod act rulings were expected to be implemented. we chose this period of time, because it represented a period of uncertainty where decision-makers could adapt to the changes embodied in the mod act. the decision-maker momentum to change offerings measure was developed for this research by compiling a list of service offerings in the marketing and promotion literature acquired from randomly selected large customs brokerage organizations. ncbfaa survey respondents were asked to check those services they offered in 1993, 1995, and 1998 (planned). the absolute value of intended changes was then calculated for each respondent and used as fall 2003 carr et al: predictinf? decision-making momentum 105 the value for the dependent variable for each of the respondents. we use absolute value to calculate the dependent variable because we are interested in the level of momentum to change offerings, irrespective of whether decision-makers intend to add or subtract offerings. independent variables mod act uncertainty (mod) and other environmental uncertainty (env). these measures were modified from mulford, shrader and hansen (1988) and based on a thorough review of the strategic management literature, logistics trade literature and mod act legislative hearing reports. uncertainty resulted from four major changes contained in the mod act: 1) remote entry, 2) u.s. customs reorganization, 3) increased minimum values for formal entry, and 4) shifting responsibility and record-keeping requirements. extensive research identified these time-specific causes of industry uncertainty: 1) the organization's customers, 2) the organization's competitors, 3) global trade developments (i.e., eu, nafta, gatt/wto) , and 4) technological requirements. the respondents were asked to indicate how certain they were of the expected consequences of mod and env for their organization on a likert scale from one to seven where one was not sure and seven was sure. decision-maker age. this measure was modified from mulford, shrader and hansen (1988). the titles of the individuals who completed the questionnaire were reviewed to ensure that each was in a key decision-maker position. all respondents were ceos, owners, partners, presidents, vice presidents, or key decision-makers with responsibility for responding to changes in the environment. specifically, there were 38 presidents, 24 vice presidents, 14 import managers, 6 owners, 5 ceos and 2 treasurers. respondents were asked to indicate their age category: under 25, 26-35, 36-45,46-55, and over 55. these categories were translated into values from i to 5. decision-maker experience. decision-maker experience is measured as the number of years the decision-maker was in the customs broker industry or a related field. this measure represents a surrogate for decision-maker experience. formal planning. formal planning is an eight-item measure that was modified from a previously validated measure by mulford et al. (1988). the respondents were asked to circle the appropriate response. a reliability measure was developed for formal planning based on the mulford et ai. (1988) study. cronbach alpha was calculated to determine the maximum likelihood estimate of the reliability coefficient if the parallel model is assumed to be true. the measure for formal planning includes assigning a value of zero for those organizations that did not formally plan and a one for those organizations that did formally plan. for those organizations that did formally plan, all circled items for the following questions were summed. this value was then used in the regression model for formal planning. the measure includes these questions: 1) does your long-range plan include quantified objectives for any of the following: earnings, capital growth, salesl earnings ratio, return on investment, or share of the market? 2) does your long 106 journal o.lbusiness stratee;ies vol. 20, no.2 range plan include the following pro forma (future) financial statements: balance sheet, income statement or cashflow analysis? 3) does your long range plan include plans and budgets for the following: hiring/training management personnel, capital investments, advertising, or industry research? 4) does your long range plan specifically attempt to identify any of the following: political developments, social currents, personnel attitudes, technological breakthroughs, owner incomes, or global economic trends? formalization of procedures. formalization of procedures is a two-item measure that was developed for this research. for this measure, we assign a value of zero or one. the sum of the values for these two questions is the value used in the regression model. the questions for this measure include the yes/no questions: 1) are there written guidelines or a manual specifying agency procedures or organizational procedures for staff directly or indirectly involved in providing services? 2) is each employee supplied his or her own manual? organization size. noting the importance of organization size with respect to available resources in dutton and duncan's (1987) conceptual work, we utilized the small business administration's (sba) definition of a small business for this research. a small business is defined by the sba as one with $ 3.5 million annual revenue or less. we provided respondents with several revenue range categories and asked them to check the range for their organization's current annual revenue. the respondents' answers were collapsed into two categories based on the sba definition: 1) organizations with more than 3.5 million current annual income, and 2) organizations with less than or equal to 3.5 million in current annual income. values of zero for small organizations and one for large organizations were assigned for use in the regression model organization age. this measure was developed by mulford et a1. (1988). as in their study, we used age of organization in years in the regression model. technological expertise. this measure was modified from a measure developed by mulford et al. (1988). we asked the respondents to provide us with the number of employees in average full-time equivalents for the following employee categories: customs brokers, information system employees, regulatory advisors and logistics service employees. these categories were summed to provide a value for the regression model. methodology the sampling strategy and statistical methods used to analyze the uncertainty variables and other explanatory factors are discussed below. the results of this analysis reveal a fairly robust model that may have practical use for decisionmakers of organizations faced with a turbulent industry environment. sampling surveys were mailed to all 501 u.s-based members listed in the 19941995 directory of the national customs brokers and forwarders association fall 2003 carr et al: predicting decision-making momentum 107 of america (ncfaa). because we are focusing on the ncbfaa customs brokers and their perceived momentum to change offerings in response to environmental uncertainty, we will not make inferences with respect to a larger population of customs brokers. usable responses were received from 89 customs brokers for an effective response rate of 17.8%. because of our small population we believe this response rate is acceptable. however, only 64 complete responses were usable for regression analysis because of missing responses. two factors contributed to the low response rate: 1) the survey was lengthy to incorporate measures for two areas of research interest: logistics measures to explore channel integration, and measures to predict decision-maker momentum to change offerings, and 2) more effort needed to be undertaken to ensure respondents were aware that one blank response for any of the measures included in the regression analysis would eliminate all of the respondent's responses from the regression analysis. this is similar to a problem faced by miller (1993). the ncbfaa was chosen as the target sample because it is the largest association of customs brokers in the united states and because the association provides equal access to information to all of its members. this eliminated the need for a control variable (0' reilly, 1982). determining uncertainty constructs the eight uncertainty factors in mod and env were factor analyzed, as a group, to determine if these two measures indeed represent two different constructs. as reported in table 3, principal components factor analysis reveals that this is the case. the cronbach alpha values (0.86 for mod and 0.76 for env) provide further support that these two variables are measuring separate causes of uncertainty. factor analysis further identified remote entry as the single most important factor for mod and customer uncertainty as most important for env each of these factors was also the only one in its construct with an eigenvalue greater than one. an alternative to using the multi-factor constructs for uncertainty would be to utilize porter's suggestion that only the most important factor explains or determines strategic response. thus, mod was reduced to uncertainty resulting from remote entry (i.e., mod) and env was reduced to customer uncertainty (i.e., env). this finding is further supported by responses to a series of questions pertaining to perceptions of how organization strategy and industry structure might change in response to the mod act. remote entry clearly was viewed as the most influential factor by respondents. diagnosing multicollinearity because of several significant correlations examined in partial correlation coefficient analysis, we tested directly for multicollinearity (see tables 4 and 5) using the ridge method, principal components analysis and the durbin-watson test. with respect to the residual scatterplot, there was no visible pattern of correlation among variables, and all standard deviations were between zero and three. 108 journal of business strategies vol. 20, no.2 table 3 results of factor analysis of uncertainty variables % mean cronbach factors item loading eigenvalue variable (std) alpha mod 332.47 .857 (336.23) remote entry .934 2.981 74.5 103.14 (112.36) shifting resp. .867 .642 16.0 102.46 (109.80) reorg. .889 .209 5.2 55.97 (79.21 ) min. values .937 .168 4.2 70.90 (88.81 ) env 525.87 .757 (280.01) customer .965 2.418 60.4 192.90 (116.01) new technology .615 .657 16.4 148.50 (97.74) global trade .856 .609 15.2 98.59 (80.66) competitor .638 .316 7.9 85.87 (80.66) according to chatterjee and price (1977), "it is suggested that a vif (variance inflation factor) in excess of lois an indication that multicollinearity may be causing problems in estimation." chatterjee and price also state that when performing principal components analysis, one should look for big jumps in the eigenvalues. when collinearity statistics were evaluated, the vif's were between 1.082 and 2.041 for the nine dependent variables. based on chaterjee and price, since no vif was over 10, we can assume that mu1tico1inearity is not causing problems in estimation. furthermore, in examining eigenvalues in principal components analysis, there were no big jumps in eigenvalues. all eigenvalues were under 1 indicating that multicollinearity is not causing problems in estimation. finally, the durbin-watson statistic (d) is 1.86 at .05 level of significance. in a one-sided test against alternatives p > 0, d = 1.86 is higher than the upper limit of 1.76 for k = 9 and n = 64. thus, d is not significant and we conclude that there does not appear to be a problem in serial correlation. this analysis indicates there is no need to revise the proposed model. fall 2003 carr et at: predictin;; decision-makinr momentum 109 table 4 correlation matrix for independent variables 1 2 3 4 5 6 7 8 9 1.00 .077 .173 .090 .287" .356 11 .080 .207 .150 2 .077 1.00 .170 .032 .120 .100 -.020 .005 -.073 3 .172 .170 1.00 .6501> .083 .229 .147 .062 .232 4 .090 .032 .650" l.00 -.034 .141 .121 -.136 .034 5 .287 .120 .083 -.039 1.00 .405 11 .188 .411" .197 6 .356 '()96 .229 .141 .405" 1.00 -.005 .223 .116 7 .080 -.020 .147 .121 .188 h -.005 1.00 .163 .134" 8 .207 .005 .062 -.136 all .223 .134 .317" 1.00 "significant at p :,:: .05 h significant at p :::; .0 i i =mod act uncertainty; 2 =other uncertainty; :\ =decision-maker experience; 4 =decision-maker age; 5 =finn size; 6 =formal planning; 7 =business age: 8 =technology expertise; 9 =formalization table 5 results of multicollinearity diagnostics variable mod act uncertainty other uncertainty decisiolhllaker experience decision-maker age finn size formal planning business age technological expertise formalization vu' 1.205 1.082 2.041 1.894 10461 1.368 1.097 1.364 1.215 results eigenvalue .688 0402 .365 .316 .210 .144 .109 .002 .016 durbin-watson statistic d= 1.86 d"=1.76 regression analysis was conducted to test the hypotheses. the results of the regression analysis as shown in table 6 reveal that the proposed model is fairly 110 journal of business stratef-iies vol. 20, no.2 robust. its f value (3.45) is significant at p < .10 and the model explains 26% of the variability in the dependent variable (i.e., service changes). additionally, the regression coefficient signs for the statistically significant variables are in the expected direction. for this study, three of the hypothesized explanatory variables were statistically significant at p s .10. the variables include: i) mod act uncertainty, 2) organization size, and 3) decision-maker age. the standardized betas indicate that organization size (b = .32) has somewhat more predictive strength with respect to ncbfaacustoms brokers' momentum to change offerings than does mod act uncertainty (b = .22) and decision-maker age (b = -.26). however, all three have relatively moderate predictive power. thus, the regression results support hypothesis la, hypothesis 2 and hypothesis 7. that is, as perceived mod act uncertainty (remote entry uncertainty) and organization size increase, and decision-maker age decreases, the ncbfaa customs brokers' momentum to change offerings increases. table 6 results of regression analysis of independent variables effect on service changes independent variables fvalue sig f st. b sigt model 3.496 .263 firm size other uncertainty: customer formal planning mod act uncertainty: remote entry business age decision-maker age formalization decision-maker experience technological expertise " t significant at p < .10 i> f significant at p < .10 discussion and implications .3191> .168 .133 .220 -.082 -.263 -.170 -.096 -.176 .018" .141 .299 .070" .471 .083 .160 .538 .168 this study provides a model that examined ncbfaa decision-makers' perceived external environment uncertainties in light of organization and decisionfall 2003 carr et al: predicting decision-making momentum 111 maker characteristics to predict decision-maker momentum to change offerings to better "fit" a dynamic industry environment. the empirical findings include a fairly robust model and findings of significance for three dependent variables with respect to predicting decision-maker momentum to change offerings. these variables are: organization size, decision-maker age and mod act uncertainty. these empirical findings provide information to aid in answering the question: can a scientific process be used to predict decision-maker momentum to change offerings as an antecedent to realigning with a new industry environment? decision-maker momentum to change offerings most importantly, the empirical findings in this research provide support for dutton and duncan's conceptual theory that the level of decision-maker momentum to change offerings is related to both decision-makers' perceptions of uncertainty significance and response feasibility. in their work, they define response feasibility as, both, resource availability and risk propensity of decision-makers. it is interesting that the three significant dependent variables in this research are: mod act uncertainty (regulatory uncertainty creating a dynamic environment for the customs broker industry), decision-maker age (as an indicator of risk propensity) and organization size (with respect to available resources). furthermore, the findings for these three variables support previous literature mentioned in this article with respect to the direction of these relationships. those variables that were not significant predictors of ncbfaa decisionmaker momentum to change offerings are important because the model is designed to help decision-makers focus on: 1) the significant uncertainties culled from a list of key uncertainties for the industry at that point in time, 2) significant organizational and decision-maker characteristics, and 3) how the significant and nonsignificant findings may be useful to the decision-makers in the individual firms as they seek to realign to a new industry environment. for example, if organization size is positively related to decision-maker momentum to change offerings, then decision-makers of small organizations can use this information to identify resource alternatives if deemed necessary for the organization's health. mod act uncertainty and decision-maker momentum to change offerings the positive relationship between mod act uncertainty (i.e., remote entry uncertainty) and decision-maker momentum to change offerings is important for two reasons. first, the use of factor analysis in determining uncertainty significance provides a scientific method for inclusion of significant uncertainties in the regression analysis. to clarify, only perceptions of high uncertainty (eigenvalue> 1) are included in the regression analysis. those perceived to be of low uncertainty by the decision-makers are eliminated in factor analysis from inclusion in the model. it is important to note that while customer uncertainty in "other uncertainty" was significant in factor analysis, it was not significant in 112 journal of business strategies vol. 20, no.2 the model. the nonsignificant variables arc important because decision-makers can focus on the significant variables as they seek a timely response to uncertainty. this supports dutton and duncan's position that decision-makers must first determine a high or low significance for uncertainties prior to evaluating response feasibility. second, these findings support previous research with respect to regulatory and technological uncertainty creating dynamic environments. birnbaum (1984) states that regulatory and technological uncertainties create more dynamic and turbulent environments. he argues that a timely efficient response is required in order to sustain competitive advantage and avoid organization failure. because remote entry (increased automation) uncertainty was the one factor in four in the broad mod act uncertainty variable that was significant (with an eigenvalue greater than one), we find support for birnbaum's contention that regulatory and technological uncertainty do create a more dynamic environment. as a result, these uncertainties require a timely efficient response in order to sustain competitive advantage and/or avoid organization failure. organization size and decision-maker momentum to change offerings the positive relationship between organization size and decision-maker momentum to change offerings provides support for the body of literature presented with respect to resource availability. organizations with more available resources will have a higher decision-maker momentum to change offerings in response to a significant uncertainty. decision-maker age and decision-maker momentum to change offerings finally, the negative relationship between decision-maker age and decisionmaker momentum to change offerings supports the body of literature presented in this article taking the position that younger decision-makers are likely to have a greater risk propensity than older decision-makers in responding to a significant type of uncertainty. this finding also supports dutton and duncan's contention that risk propensity is an important factor when determining response feasibility. it is possible for an organization's decision-makers to perceive an uncertainty as highly significant. yet, because of either unavailable resources or low risk propensity decision-makers may be unwilling to enact many responses. the result of which may be a low decision-maker momentum to change offerings in response to a significant uncertainty where a response may be required for the organization's health. practical applications for predicting decision-maker momentum to change offerings the robustness of this model indicates decision-maker momentum to change offerings can be predicted. the f value (3.45) is significant at p < .10, and the model explains 26% of the variability in the dependent variable (i.e., service changes). we were pleased to find, through rigorous diagnostics for fall 2003 carr et af: predicting decision-making momentum 113 multicollinearity, that serial correlation did not appear to be present. these diagnostics included ridge regression analysis, principal components analysis, and a durbin-watson test. all three tests provided consistent findings that serial correlation was not present among the nine dependent variables in the proposed model. in answer to the question, "can predicting decision-maker momentum to change offerings in response to environmental uncertainty be an important antecedent to organizational change?" we answer "yes" and propose the model has practical implications for decision-makers as a complex strategic integration tool (burgelman & doz, 1997). we believe the model is especially useful for industry associations, where there is variation in decision-maker demographic variables, organization size, and organizational characteristics for regression analysis. decision-makers can benefit from the additional knowledge of uncertainties gained by surveying many industry members regarding their perceptions of uncertainties. this added information can be useful as decisionmakers aid their organization in realigning to the new environment. additionally, the flexibility of culling and modifying key uncertainties in the survey for the industry at a given point in time has practical value for decision-makers seeking to realign in a timely manner to specific environmental uncertainties. for example, if thorough research is done to identify a list of several uncertainties facing an industry at a particular point in time, and the results reveal that for the group of decision-makers surveyed, regulatory uncertainty and customer uncertainty were significant, then decision-makers can focus their organization's attention on these uncertainties. moreover, important insight can be gained by these organizations with respect to organizational and decision-maker demographics relative to their organization and their decision processes. for example, if technology is determined to be related to decision-maker momentum to change offerings, then small organizations that do not have the necessary technological expertise may explore ways to acquire more technological expertise (e.g., strategic alliances) to maintain or gain competitive advantage. thus, the proposed model may be seen as a link between complex strategic integration tools and management control systems for alerting decision-makers to perceived changes in the external environment, potential business risks or knowledge gaps in critical areas. future research may explore this link further. while this research generated information on perceived intended service changes, the scope of this research was limited to predicting decision-maker momentum to change offerings in response to environmental uncertainty. future research may wish to focus on how the ncbfaa members moved from strategic intent to strategic response through resource allocation to intended service changes. 114 journal of business strategies references vol. 20, no. 2 bamford, c. e., rogers, p. r., & miller, a. (1999). transformation of strategic types: an examination of the internal antecedents to organizational change. journal of business strategies. 16 (2), 135-149. birnbaum, p. h. (1984). the choice of strategic alternatives under increasing regulation in high technology companies. academy of management journal 27 (3),489-510. boeker, w. (1997). strategic change: the influence of managerial characteristics and organizational growth. academy of management journal 40, 162-170. boyd, b. k., dess, g. g., & rasheed, a. m. a. (1993). divergence between archival and perceptual measures of the environment: causes and consequences. academy of management review, 18 (2),204-226. burgelman, r. a. & doz, y. (1997). complex strategic integration in the lean multibusiness corporation. fontainebleau, france. insead working paper series. carpenter, m. a. & frederickson, j. w. (2001), top management teams, global strategic posture, and the moderating role of uncertainty. academy of management journal, 44 (3), 533-545. chatterjee, s. & price, b. (1977). regression analysis by example. new york: john wiley & sons, inc. child, j. (1972). organization structure, environment, and performance: the role of strategic choice. sociology. 6, 1-22. duncan, r. b. (1972). characteristics of organizational environments and perceived environmental uncertainty. administrative science quarterly, 17,313-327. dutton, j. e. & duncan, r. b. (1987), the creation of momentum for change through the process of strategic issue diagnosis. strategic management journal 8,279-295. gersick, c. j. g. (1994). pacing strategic change: the case ofa new venture. academy of management journal. 37 (1), 9-45. hambrick, d. c. & mason, p. a. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review. 9 (2) 193-206. hambrick, d. & finkelstein, s. (1987). managerial discretion: a bridge between polar views of organizational outcomes. research in organizational behavior. 9 (2), 269406. hamel, g. & prahalad, c. k. (1989). strategic intent. harvard business review, mayjune. 63-76. fall 2003 carr et al: predicting decision-making momentum 115 hart, p. & mellons, j. (1970). management youth and company growth: a correlation? mana~ementdecision. 4. 50-53. hitt, m. a. & tyler, b. b. (1991). strategic decision models: integrating different perspecti ves. strategic management journal. 12. 327-351. hrebiniak, l. g. & snow, c. c. (1980). strategy, distinctive competence, and organizational performance. administrative science quarterly, 25, 317-336. hult, g. t., hurley, r. f, giunipero, l. c., & nichols, e. l. (2000), organizational learning in global purchasing: a model and text of internal users and corporate buyers. decision sciences. 31. 293-325. jones carr, c. m. (1997). unpublished thesis (copyright tx5-013-120): the customs modernization and informed compliance act: the customs broker industry's perceptions of key changes, uncertainty and implications. ames: iowa state university. jones carr, c. m. & crum, m. r. (1995). the u.s. customs modernization and informed compliance act: implications for the logistics pipeline. the international journal of logistics management. 6, 67-81. jovanovic, b. (1982). selection and evolution of industry. econometrica, may. 649-70. kimberly, j. r. & evanisko, m. j. (1981). organizational innovation: the influence of individual, organizational, and contextual factors on hospital adoption of technological and administrative innovations. academy of management journal, 24 (4),689-713. kukalis, s. (1989). the relationship among firm characteristics and design of strategic planning systems in large organizations. journal of mana/lement, 15 (4), 565-579. lawrence, p. r. & lorsch, j. w. (1967). organization and environment: managing differentiation and integration. boston: harvard business school press. lewis, g. j. & harvey, b. (2001). perceived environmental uncertainty: the extension of miller's scale to the natural environment. journal of management studies. 38 (2),201-233. lieberson, s. & o'connor, j. f (1972). leadership and organizational performance: a study of large corporations. american sociological review. 37. 117-130. link, a. n. & bozeman, b. (1991). innovative behavior in small-sized organizations. small business economics. september. 179-84. miles, r. e. & snow, c. c. (1978) organizational strategy. structure. and process. new york: mcgraw hill. mintzberg, h. (1979). the structuring of organizations. englewood cliffs, n.j.: prenticehall. 116 journal of business strateries vol. 20, no.2 mukherji, a., desai, a., & francis, j. (\ 999). reclaiming the environment organization fit: matching turnaround strategies to environmental exigencies. journal of business strategies, 16,27-43. miller, k. d. (1993). industry and country effects on managers' perceptions of environmental uncertainties. journal of international business studies, 24, 693-714. mulford, c. l., shrader, b., & hansen, h. b. (1988). operational and strategic planning in small business. ames: iowa state university. north central regional center for rural development. norburn, d. & birley, s. (1988). the top management team and corporate performance. strategic management journal. 9, 225-237. o'reilly, c. a. (1982). variations in decision makers' use of information sources: the impact of quality and accessibility of information. academy of management journal 25 (4), 756-771. papadakis, v. m., lioukas, s., & chambers, d. (1998). strategic decision-making processes: the role of management and context. strategic management journal. 19, 115-147. porter, m. d. (1980). competiti ve strategy. new york: free press. porter, m. e. (1985). competitive advantage: creating and sustaining superior performance. new york: free press. quinn, r. e. & cameron, k. (1983). organizational life cycles and shifting criteria of effectiveness: some preliminary evidences. management science, 29, 33-51. rajagopalan, n. & spreitzer, g. m. (1996). toward a theory of strategic change: a multilens perspective and integrative framework. academy of management review, 22 (1),48-79. scherer, f. m. (1970). industrial market structure and economic performance. chicago. rand mcnally. schuman, h. & scott, j. (1989). generations and collective memories. american sociological review, 54, 359-381. shrader, c. b., mulford, c. l., & blackburn, v. l. (1989). strategic and operational planning, uncertainty, and performance in small firms. journal of small business management. 27 (4),45-60. thompson, j. d. (1967) organizations in action. new york: mcgraw-hill. tushman, m. l. & romanelli, e. (1985). organizational evolution: a metamorphosis model of convergence and reorientation. research in organizational behavior, 7, 171-222. fall 2003 carr et at: predicting decision-making momentum 117 tushman, m. l., o'reilly, c., & nadler, d. a. (1989). the management of organizations: strategies, tactics, analyses. new york: harper & row, publishers. variyam, j. & kraybill, d. s. (1997). small organizations' choice of business strategies. department uf agriculture. wiersema, m. f. & bantel, k. a. (1992). top management team demography and corporate strategic change. academy of management journal. 35 (i ), 91-121. wiersema, m. f. & bantel, k. a. (1993). top management team turnover as an adaptation mechanism: the role of the environment. strategic management journal. 14, 485-504. carolyn m. jones carr is president of strategic response technologies, inc. she has an msbas from iowa state university in business administrative sciences with an emphasis in strategic decision processes. her research and business interests include complex strategic integration models, collaborative learning models, risk management, bootstrap research and critical thinking training. she has industry experience in risk management, logistics and strategy. charles b. shrader, professor of management in the college of business at iowa state university, received his mba and ph.d. degrees from indiana university. his current research interests include formal strategic planning relationships with organizational performance, corporate social responsibility, social networks and organization structure, boards of directors, and moral reasoning. he is also interested in collaborative learning in groups, case teaching, and case writing. michael r. crum is a professor of transportation and logistics in the college of business at iowa state university, he received his mba and dba degrees from indiana university, his current research interests include employee safety issues and employee satisfaction/retention in the transportation industries, and inter-organizational relationships in the context of integrated supply chain management. e. james flynn, associate professor of management in the babcock graduate school of management, wake forest university, has bs and phd degrees from indiana university, along with an mba from the university of north carolina. his research includes the role of innovation in firm performance, building and sustaining multiple competitive advantages, and the management of knowledge workers, his teaching includes strategic management, the role of values in leadership practices and behavior, and social responsibility. 118 journal of business strategies vol. 20, no.2 predicting decision-maker momentum to change offerings in response to uncertainty: the case of the u.s. customs mod act discount retail profitability: a harbinger for e-commerce? richard skolnik state university of new york at oswego oswego, ny abstract expansion of electronic commerce has the potential to increase retail productivity. however, these gains may not translate into enhanced retailer profitability. this study examines profitability of the discount retail industry from 19811998, a period during which the industry realized significant productivity gains. although productivity measures like inventory turnover and sales per employee increased during this period, industry profitability did not increase. instead, consumers benefited from the increased efficiency through paying lower markups. the experience of the discount retail industry may indicate that retailers face a product price treadmill: gains in efficiency result in lower prices rather than higher profits. the projected efficiencies of the internet and the expansion of electronic commerce may portend lower retail profitability but greater savings for consumers. introduction at the end of the twentieth century, the potential of electronic commerce fueled investor optimism and helped propel u.s. equity valuation to historic heights. investors believed that productivity gains of network technology would generate increased corporate profitability for companies involved in electronic commerce. although the bubble has burst on internet valuations, the question remains about whether innovations that lower production costs will result in increased profitability. in a competitive market, lower costs produce lower prices. innovative firms may be able to capture abnormal profits before other firms in the industry adopt the new technology or business mode but once the innovation is widely diffused, sustained profitability is possible only if significant barriers to entry exist. this paper examines discount retailers, a category that includes firms like wal-mart and kmart, to determine whether increased efficiency attributable to improvements in distribution and inventory management have resulted in abnormal profits for retailers or lower prices for consumers. the fortunes of discount retailers during a period of technological innovation may be a harbinger of the financial impact that electronic commerce will have upon retailers. 150 journal of business strategies the internet, retailers and the treadmill vol. 18, no.2 this work is motivated by the uncertainty regarding valuations ofinternetbased retailers. in 1998 and 1999, financial analysts were discarding traditional price-earnings (pie) valuation models for other methods in order to justify the high valuations of etailers (laderman & smith, 1998). although many internet companies lost the majority of their market valuation when the nasdaq corrected sharply in 2000, analysts continue to disagree about the proper valuation of companies utilizing a new technology (trueman, wong & zhang, 2000; schwartz & moon, 2000). one of the arguments advanced for high market valuations of internet retailers is the increased efficiency and the reduced costs that the internet brings to businesses (johnson, 1999; tully, 2000). however, the benefits of cost saving technology may not accrue to the firm. instead, consumers may enjoy lower prices or a factor of production, like labor or landowners, may realize increased compensation. the agricultural economics and resource economics literature documents the equivocal results that technological innovation can have on producers. cochrane (1958) introduced the concept that farmers are on a product price treadmill. profits that result from the adoption of new technologies evaporate as increased competition drives price down. farmers constantly strive to improve their incomes by adopting new technologies. lower costs ensure that early adopters of the technology enjoy above average profits for at least a brief period of time. however, as more farmers adopt the technology, production increases and prices decrease. the product price treadmill benefits consumers through lower food prices, but farm profitability remains relatively low. a similar product price treadmill can exist in the retailing industry. growth in the retail industry is constrained by growth in consumer spending. for a given amount of consumer spending, retailing is a zero sum game. one retailer's gain becomes another retailer's loss. technological innovation can benefit the initial innovators, but as more firms adopt the technology, prices, and therefore profits, can decline through increased competition. the internet has, and will continue to have, a significant impact upon retailing. retailers use the internet as an efficient marketing medium, and for digitized products like software, as a distribution channel. however, if a treadmill exists in retailing, the internet may not benefit the industry through sustained increased profitability. in fact, the internet, through greater price transparency, may increase the speed of the treadmill by fueling competition (sinha, 2000). the effect of the internet upon retail profitability can only be measured with hindsight. nevertheless, the effect of previous technological innovations on retailers can be measured by studying historical retail profitability. fall 2001 skolnik: discount retail profitability innovation and profitability 151 retail innovations can take various forms. walters and laffey (1996) identify four categories of retail innovations: new delivery systems, new products or services, improvements in existing products, and the development of superior product or service attributes. process innovations straddle several of these categories: they allow retailers to modify delivery systems, decrease costs and improve the shopping experience for consumers. the information revolution has generated numerous productivity enhancing processes. throughout the 1980s and 1990s, retailers have exploited information technology (it) to decrease costs and improve customer service. some of these initiatives include synchronized consumer response, quick response, vendor-managed inventories, and demand-chain management solution (fioritio, may & straughn, 1995; simbari, 1996). retailers have implemented improvements in the management of goods and services continuously over the past 20 years. ultimately, investors would like to see innovation affect the profitability of the firm, which can be measured by the return on equity (roe). using the extended dupont relationship, roe can be partitioned into contributing components (selling & stickley, 1990): roe = ebitm * asset turnover * (1 interest and tax load) * (equity multiplier) the first two terms are operating outcomes. the second two terms are financial structure outcomes. earnings before interest and taxes margin (ebitm = ebit/sales), also known as operating profit margin, represents the portion of each sales dollar that a firm converts into operating profit. asset turnover (sales/assets) represents the sales dollars produced by one dollar of assets. the interest and tax load depend upon a firm's capital structure and tax management policies. the equity multiplier (assets/equity) measures the firm's financial leverage. adopting it to improve processes affects roe through operating performance, either due to increased profit margins or increased turnover. first, improved inventory management should decrease inventory levels resulting in lower asset requirements and higher asset turnover. second, it can increase worker productivity, leading to lower labor requirements per dollar of sales. a reduction in workforce requirements results in lower payrolls and higher profit margins. third, itcan result in better stock management leading to less stockouts, less obsolete products, and increased customer satisfaction. greater product availability can lead to increased customer spending resulting in higher turnover. stock management can also increase profit margins by decreasing the amount of merchandise that must be sold at clearance. 152 journal of business strategies vol. 18, no.2 although it should have a positive impact upon financial ratios, previous research has indicated that improved production techniques may not translate into superior financial performance. just-in-time production (jit) is a case in point. the resources that are freed up by more efficient inventory management need to be utilized for the firm to realize improved profitability (mia, 2000). balakrishnan, linsmeier, and venkatachalam (1996) studied the cross-sectional results of firms that adopted jit production compared to a control group that did not adopt jit. their results showed that firms which adopted jit did not, on average, have a significant return on asset (roa) response to jit adoption. mia (2000) found that jit profitability depends upon the provision of information in a firm's management accounting system. in summary, adopting a process innovation will improve a firm's financial performance only if the innovation is properly implemented. discount retailers and innovation in contrast to the mia (2000) and balakrishnan et al. (1996) studies, i do not measure the impact of a specific technology on individual firms, but rather the effect of a series of technological innovations on the entire industry. discount retailers, formally classified as variety retailers with a sic number of 5331, provide an ideal segment to study the effects of technological innovation, and hence the potential impact of the internet, on the retail industry. during this period, the industry has invested aggressively in it and has had dynamic growth. during the 1990s annual sales growth in the discount retail industry averaged 5.8 percent exceeding the 5.5 percent growth of general retailers (sack, 2000). the innovativeness of the discount retail industry leader, wal-mart, has even had an effect upon other retail channels by forcing firms to adopt new innovations for their survival (kaufman, 2000). this study examines operating performance variables to determine whether the industry has had a significant increase in efficiency and profitability from 1981-1998. inventory turnover, total asset turnover, sales per employee, operating profit margin, basic earning power and cost of goods sold as a percentage of sales are each analyzed for significant changes. each of the series was tested for stationarity by regressing the variables against time, with the following model: y/ = f3() + f3,/ = e, the null hypothesis of b 1 =0 implies a stationary or trendless series. a significant b) results in a rejection of the null hypothesis. a positive b) indicates an increasing trend; a negative coefficient indicates a decreasing trend. a priori, the following results are expected for each of the variables: inventory turnover: positive trend coefficient. investment in it and improved distribution and inventory management procedures should translate into higher inventory turnover. fall 2001 skolnik: discount retail profitability 153 total asset turnover: positive trend coefficient. a reduction in inventory should result in higher total asset turnover. sales per employee: positive trend coefficient. increased productivity should result in higher sales per employee. operating profit margin. indeterminate trend coefficient. the change in operating profit margin depends upon the industry structure. in a price-competitive industry, return on investment will trend toward an equilibrium, or normal, level. competition would ensure that innovations leading to increased total asset turnover would not increase return on investment. an increase in total asset turnover would be accompanied by a decrease in operating margin. in a less competitive industry, operating profit margin could increase as costs decrease in response to improved productivity. firms capture the gains of cost decreases through higher investment returns. if retailing is competitive, and a product price treadmill exists, operating profit margin would be expected to fall if total asset turnover increased. basic earning power: non-negative trend coefficient. operating returns should remain constant if retailing is competitive and there are no economywide trends in operating returns. if retailing has barriers to entry or other non-competitive characteristics, productivity improvements can translate into enhanced bep. cost ofgoods sold as percentage of sales: non-negative trend coefficient. in a competitive industry, consumers should realize the gains in retail efficiency through decreased retail mark-ups. cost of goods sold as a percentage of sales should increase. if the industry is not competitive, firms can capture increases in productivity for themselves, in which case, cost of goods sold as percentage of sales would be unchanged. data and results data from 1981-1998 were obtained from compustat active and research files for firms identified by the sic code of 5331 (variety stores). data collected included sales, cost of goods sold, earnings before interest and taxes (ebit), inventory turnover, total asset turnover, ebit/total assets, and number of employees. table 1 summarizes the data. statistics for sales, cost of goods sold, and total employees were calculated by summing variables for the entire industry within the sample. inventory turnover, total asset turnover, operating profit margin, and basic earning power were found by using a sales weighted average. as a quality check, the compustat data were compared to data from an industry report (discount merchandiser, 1997) for consistency. inventory turnover, total asset turnover, sales per employee, ebit margin, basic earning power (ebitm/assets), and cost of goods sold as a percentage of sales were regressed against time to test for stationarity. table 2 reports the table 1 vi.j:::.. summary financial ratios for the variety store industry (sic 5331) number of inventory total asset ebit basic earning cog/ sales/ total sales year firms turnover turnover margin (%) power (%) sales employee x 1000 (millions) 1981 28 4.70 2.64 4.16 11.00 0.73 $ 63.12 $36,238 1982 27 4.71 2.56 4.73 12.09 0.72 $ 71.08 $37,908 1983 27 4.91 2.60 5.98 15.55 0.72 $ 73.51 $43,230 <...., 1984 27 4.87 2.60 5.77 14.99 0.72 $ 74.24 $47,074 0 ;:: '""c 1985 31 4.80 2.48 5.36 13.30 0.73 $ 68.28 $51,671 ;:: >.:l..... 1986 32 5.11 2.58 5.39 13.88 0.73 $ 77.00 $61,578 <q., 1987 31 5.19 2.70 4.82 12.99 0,74 $ 84.23 $70,781 ~;:: 2.49 $ 82.80 $92,014 '"1988 29 4.75 5.03 12.52 0.74 s· ~ 1989 29 5.39 2.78 4.71 13.09 0.75 $ 89.76 $104,990 '"'" 1990 31 5.34 2.75 4.48 12.31 0.75 $ 95.08 $118,924 v)... 1991 34 5.66 2.77 4.49 12.41 0.76 $ 109.44 $138,899 ~... ~ 1992 36 5.20 2.48 4.48 11.11 0.78 $ 126.15 $172,417 ~-. ~ '"1993 33 5.40 2.52 4.31 10.87 0.76 $ 122.74 $173,163 1994 34 5.52 2.57 4.00 10,26 0.77 $ 116.57 $193,018 1995 32 5.36 2.54 3.24 8.23 0.78 $ 125.75 $209,693 1996 32 5.75 2.66 3.73 9.93 0.78 s 142.34 $225,483 t1997 31 6.09 2.74 4.22 11,55 0.78 $ 145.91 $246,702 ~ ...... 1998 25 6.45 2.79 4.58 12.80 0.78 $ 136.06 $270,902 00 z 0 source: compustat active and research files. calculations based upon a sales weighted average. tv fall 2001 skolnik: discount retail profitability 155 parameter estimate for the time variable value, its corresponding t statistic, and its significance level. table 2 tests for stationarity variable inventory turnover total asset turnover sales per employee ebit margin ebit margin/assets cog/sales parameter estimate 0.080 0.006 5.029 -0.084 -0.190 0,004 t statistic 7.622 1.166 14.421 ·3.370 -2.746 12.610 probability> 0 0.0001 0.2608 0.0001 0.0039 0.0144 0,0001 inventory turnover has a positive and significant coefficient indicating that discount retailers managed their inventory more efficiently in the sample period. turnover of 4.7 times in 1981 corresponds to an inventory period of 77.7 days. turnover of 6.45 times in 1998 corresponds to an inventory period of 56 days. the inventory period decreased 28 percent from 1981 to 1998. the parameter estimate of 0.080 indicates that the inventory period decreases by approximately 1.5 days per year. the increase in inventory turnover does not seem to have translated into an increase in asset turnover. the total asset turnover coefficient was positive but insignificant. the result is surprising, although consistent with the findings of balakrishnan et al. (1996) and mia (2000), since inventory constitutes approximately one third of assets for variety retailers. a significant decrease in inventory requirements should correspond to a decrease in total asset requirements. further study is needed to determine which asset categories increased to offset the decrease in inventory. increased productivity is evident through the considerable increase in sales per employee. the positive and significant regression coefficient for sales per employee indicates that discount retailers increased labor productivity during the 1981-1998 sample period. the regression coefficient of 5.029 implies that sales per employee increased approximately $5,000 per year. salaries constitute a significant portion of retail operating expense. increases in labor productivity decrease a firm's labor requirements and reduce salary expense. both ebit margin and bep have negative and significant regression coefficients, indicating that profitability for discount retailers deteriorated during the sample period. however, both ratios reversed their steady decline with increases from 1996 through 1998. perhaps competitive pressures in the industry have abated or perhaps the industry has begun to move to higher margin merchandise. increased efficiency in the variety retail industry has translated into gains for consumers. the regression parameter for cog/sales was positive and signifi156 journal of business strategies vol. 18, no.2 cant, indicating that consumers paid a smaller markup over the time period. the increase of 5 percent from 1981 to 1998 may seem relatively small but it represents significant savings for consumers. the variety retail industry had total sales of $256.3 billion in 1998, representing a cost of goods sold of $199.9 billion. if the mark-up of 1981 were applied to the 1998 cost of goods sold figures, consumer expenditures would have been $273.9 billion in 1998. without considering the impact that the discount retailers have had on other retailers, consumers saved approximately $17.6 billion in 1998 due to increased discount retail efficiency. although increased productivity does not seem to have translated into increased profitability for industry, consumers have benefited through lower prices. other potential benefits for consumers, including convenience, merchandise availability, and merchandise selection are not measured in this study. implications for retailers and electronic commerce discount retailers experienced a tremendous increase in efficiency in the 1981-1998 period. inventory turnover increased 37 percent and sales per employee increased 115 percent. unfortunately for the retailers, these gains did not translate into higher operating profits. operating profit margins remained trendless; margins fluctuated between four and five percent during the period. likewise, basic earning power was relatively flat, fluctuating between 11 percent and 15.5 percent. productivity gains translated into lower prices for consumers. cost of goods sold as a percentage of price increased steadily throughout the period. the effects of the internet upon retailing may be similar to the process efficiencies realized by discount retailers; customers may benefit but at the expense of firm profitability. the internet increases price transparency, which results in more competition. as sinha (2000) states, "the internet represents the biggest threat thus far to a company's ability to brand its products, extract price premiums from buyers, and generate high profit margins." the extent to which the internet benefits firms or consumers depends upon the nature of the product and the existing market structure of the industry. efficiencies will be generated in product categories in which the internet can increase inventory turnover and reduce product management expense. the cost-saving benefits of the internet will accrue largely to consumers unless a non-competitive market structure or substantial barrier to entry exists. conclusion the discount retail industry achieved significant increases in productivity from 1981-1998. the productivity increases did not improve industry profitability. instead, consumers benefited through lower markups. like agriculture, the fall 2001 skolnik: discount retail profitability 157 retail industry may be on a product price treadmill. productivity gains due to innovation lead to lower costs and lower prices, but profitability remains un· changed. innovations raise the standards that firms must meet firms either adopt the new technology or are forced out of the market. the internet has the potential to increase retail efficiency but firms can capture the gains only if the market lacks price competition. although this study examined overall productivity changes in the discount retail industry, other factors besides technological innovation can be responsible for changes in costs and profitability. in this study, innovations due to it are commingled with other effects, such as changes in consumer demand and changes in product and input costs. future studies may seek to measure the efficiency changes due to the implementation of specific technologies. such studies would need firm-specific data, including capital expenditures on it. references balakrishnan, r., linsmeier, t. j, & venkatachalam, m. (1996). financial benefits from j1t adoption. the accounting review, 71, 183-205. cochrane, w, w. (1958). farm prices: myth and reality. s1. paul: university of minne· sota press. demsetz, h. (1973). industry structure, market rivalry, and public policy. journal of law and economics. xvi (1), 1-9. discount merchandiser (1997). the true look: 1997 state of the industry report. 37 (6), 29-54. fioritio, s., may, e. g. & straughn, k. (1995). quick response in retailing: components and implementation. international journal of retail and distribution management, 23 (5), 12-21. hayashi. a. m. (1997). squeezing profits from it. datamation, 43 (7), 42-47. heard, e. (1994). quick response: technology or knowledge? industrial engineering, 26 (8), 28-30. johnson. j. (1999). bubble.com or valuing an internet company. management today, august, 60-63. kaufman, l. (2000, october 22). as biggest business, walmart propels changes elsewhere. new york times, 1. laderman, j. m. & smith, g. (1998). internet stocks: what's their real worth? business week, 12 (14), 120-124, 158 journal of business strategies vol. 18, no.2 mia, l. (2000). just-in-time manufacturing, management accounting systems and profitability. accounting and business research. 30 (2),137-151. sack, k. 1. (2000). retailing: general. standard & poor's industry surveys. 168 (21), 130. schwartz, e. s. & moon, m. (2000). rational pricing of internet companies. financial analysts journal. 56 (3), 62-75. selling t. l. & stickney, c. p. (1980). disaggregating the rate of return on common shareholders' equity: a new approach." accounting horizons, 4 (4), 9-17. simbari, d. j. (1996). competitive advantages. manufacturing systems, 14 (9), 92-96. sinha, i. (2000). cost transparency: the net's real threat to prices and brands. harvard business review, 78 (2),43-49. trueman, b., wong, f. m. h. & zhang, z. j. (2000). the eyeballs have it: searching for the value in internet stocks. working paper. haas school of business, university of california berkeley. tully, s. (2000). has the market gone mad? fortune, 141 (2), 80-84. walters, d. & laffy, d. (1996). managing retail productivity and profitability, london: macmillan press, ltd. richard skolnik (ph.d., rensselaer polytechnic institute) is an assistant professor of finance at the state university of new york at oswego. a chartered financial analyst, his current research examines the impact that operational factors have upon profitability. before academe, he worked for at&t as a market analyst in the international telecommunication group. in addition to a ph.d. in managerial economics, he has a m.s, in operations research and statistics. discount retail profitability: a harbinger for e-commerce? reconciling employee involvement programs with national labor law: some tentative guidelines c. ray gullett university of texas at tyler tyler, texas employee involvement programs (eips) are becoming an increasingly important force in american industry's struggle to increase employee productivity and commitment. these participation plans take many forms (ketchum & trist 1992). a recently published research review of employee involvement has exhaustively examined and cataloged the differing designs (cotton 1993). they include quality of work life programs, quality circles, scanlon and other gainsharing plans, representative participation such as membership on the board of directors, job enrichment, self-directed work teams, and employee ownership (cotton 1993). the study notes also that the term "employee involvement plan" is imprecise in that it may be used to refer to anyone of the above approaches or to some combination of them. accordingly, this paper examines quality circles and self-managed work teams since they have the most potential to clash with our nation's predominant labor law, the national labor relations (wagner) act of 1935 as amended by the labor-management relations (taft-hartley) act of 1947. the use of the term, employee involvement plan (eip) , will be used here to refer to these two forms of participation. while measurable results of eips are mixed, they are quite popular. although estimates vary, a survey by the general accounting office found that 70% of 476 large firms in this country have installed quality circles (business week 1989). while 7% of the work force of responding fortune 1000 firms was reported to be organized into self-directed work teams, over half of the companies questioned stated their intention to use them more in coming years (schilder 1992). currently, several hundred offices and factories are conservatively estimated to be using self-managed teams (denton 1992). the "reengineering" concept of work processes should further stimulate teamwork and cooperative action (hammer & champy 1993). to be effective, such teams must, however, be designed within the strategic context of an organization (cole, bacdayan & white 1993). eips provide firms with the opportunity to draw more fully on the knowledge of employees in dealing with quality and other productivity challenges. but these employee teams must understand the customer, the environment, and the way in which the organization is positioning itself to respond to these challenges (business week/reinventing america 1992). with group activity integrated into the organization's strategy, teams have the potential to provide significant additional value to products and services. they can also playa significant part in creating and maintaining a "learning organization" which adapts and repositions itself to meet new challenges and explore emerging opportunities (katzenbach & smith 1993) (perry 1991). 124 journal ofbusiness strategies vol. 10, no.2 participation and labor law the recent electromation (309 nlrb, no. 163 (1992)) ruling by the national labor relations board has created much concern among employers that these elps are in danger of elimination unless non-union firms are willing to couple them with union recognition and joint management of the plans. despite the publicity surrounding the case, electromation did not involve such a ruling. but it did provide tentative guidance regarding how eips may be designed to avoid violation of our nation's labor laws. two more recent decisions, research federal credit union (310 nlrb, no. 13 (1993)) and lb. du pont de nemours & co. (311 nlrb, no. 163 (1992)) have also addressed the issue, but electromation remains the definitive case at this time. to better understand the meaning of electromation it is helpful to look at the development of early forms of company sponsored employee committees and the labor legislation which followed. these plans and the legislative response to them provide the framework around which permissible involvement programs can be established today. employee representation plans employee representation plans (erps), sometimes described as plans of industrial democracy or company unions, were for the most part a phenomenon of the period between the two world wars. they were seen by some as practical idealism and an awakening of the new spirit of cooperation between the employer and employees (seger 1992). others viewed them simply as devices to circumvent unionization of the work force and as a disguised paternalism (green 1925). initiated by the employer, the plans involved some form of formalized management-worker dialogue, usually implemented through shop committees composed of representatives of management and workers. common problems, suggestions for changes in work methods, and grievances and requests of workers were typical issues of discussion in such meetings. representatives of both sides voted to determine their resolution. these company-created plans had given a semblance of collective representation to employees, but were in fact controlled by management in their design and administration. they were typically intended to combat the threat of unionization and in some cases to serve as a vehicle for the "welfare capitalism" of the era (lauck 1920), (rayback 1966) and (tead & metcalf 1920). additionally, they did provide a communication channel from workers to higher levels of management and appeared to encourage team spirit and closer identification with the firm (burton 1926). emphasis was placed upon issues related to wages, hours and working conditions. developing improved work methods, a major focus of most current-day involvement programs, was not a central issue in these early plans. evidence of their popularity among employers is found in their growth. in 1919 there were 196 plans with over 400,000 members. by 1928, the number had increased to 869, claiming a membership of 1,500,000. the national industrial recovery act of fall 1993 gullett: reconciling employee involvement programs 125 1933 (nira) further stimulated the growth so that between 1933 and 1935 approximately 400 new plans were established (mills & montgomery 1945) and (taft 1964). throughout their existence the erps were bitterly opposed by labor unions. they saw this form of representation as a sham designed to manipulate employees and to keep out real unions. in the 1930's, labor organizations played an active part in seeking legislation and court rulings which would eliminate employee representation plans. labor law passage mter the supreme court overturned the nira in 1935, senator wagner reintroduced and strengthened the former law's labor provisions as the national labor relations act (nlra). with the act's passage in 1935 and its subsequent affirmation by the supreme court in 1937 (nlrb v. jones & laughlin steel corporation, (301 u.s. 1 (1937», erps were identified as company-dominated labor organizations and were specifically prohibited. early in the legislative debate, senator wagner cited the need for this prohibition: genuine collective bargaining is the only way to attain equality of bargaining power....the greatest obstacles to collective bargaining are employer-dominated unions, which have multiplied with amazing rapidity since the enactment of [the national industrial recovery act]. such a union makes a sham of equal bargaining power. ...the very first step toward genuine collective bargaining is the abolition of the employer dominated union as an agency for dealing with grievances, labor disputes, wages, rates, or hours of employment [(309 nlrb, no. 163 (1992) at note 10)]. section 8(2) [later section 8(a)(2) of the revised taft-hartley statute of 1947] made the creation and support of such organizations an "employer unfair" labor practice. in tum, labor organizations were broadly defined in section 2(5) as "any organization of any kind, or any agency or employee representation committee or plan, in which employees participate and which exists for the purpose, in whole or in part, of dealing with employers concerning grievances, labor disputes, wages, rates of pay, hours of employment, or conditions of work" (49 stat. 449 (1935». using these provisions of the law as its authority, the newly-created national labor relations board ordered disestablishment of company-sponsored representation plans (3 nlrb, no. 10 (1938». based on its affirmation of the act, the supreme court upheld the board's right to take this action (303 u.s. 54 (1938». although most such plans disappeared from the industrial scene by the early 1940's, the issue of their right to exist has never been fully resolved. cases have continued to be heard by the board and the courts during the last 50 years centering on the legality of non-union employee committees. in essence, argument has continued over the two essential questions regarding a violation. first, what is a labor organization as defined by the law? and second, where such an organization is ruled to exist, what constitutes employer domination or interference? 126 journal ofbusiness strategies vol. 10, no.2 the answer to both of these questions bears directly upon the legal status of eips. legality has remained uncertain, with unions generally opposing the plans when unilaterally initiated and administered by management. pressure from both company and union representatives has been mounting for clarification of their legal status. the recent attention given the electromation case (309 nlrb, no. 163 (1992» reflects this continuing concern. to untangle the issues it is first necessary to briefly review the position of the board and the courts in past cases involving charges of company-dominated labor organizations. the board and employee committees it must first be noted that virtually all of the cases charging company-sponsored unionism brought before the board have not involved current-day eips. they have instead been concerned with variants of the erps of the 1920s and '30s. examining a sample of these cases can nevertheless provide insight regarding the standards used by the board to determine coverage and violation. past rulings exhibit a high degree of board consistency. despite changing membersmp and variation in statutory interpretation concerning many parts of the law, the nlrb has remained remarkably uniform in its approach to these cases. when a party charges that a company-dominated labor organization exists, the first question which must be answered is whether a "labor organization" is actually present. if the entity is not a "labor organization" as defined by the taft-hartley act [in section 2 (5)], the complaint must be dismissed. as noted earlier, this section of the law is written in broad language to allow inclusion of many types of collective relationships. the board has typically used this language to include most forms of employee committees. reinforced by the supreme court's 1959 cabot carbon decision (284 nlrb, no. 99 (1987», the nlrb has ruled that "dealing" under section 2[5] includes more than formal collective bargaining. thus, the test for coverage as a labor organization is met if employees are involved, if they serve on committees or in similar groups for the purpose of making proposals concerning employment conditions to the employer, and, when a formal employment representation plan exists, the committee speaks for other employees [(309 nlrb, no. 163 (1992) at note 8)]. in order to be covered it has not been necessary for an organization to have bylaws or a constitution, dues, formal membership, or group meetings between employee representatives and other employees [(309 nlrb, no. 163 (1992) at note 8)]. thus a lack of formal structure has not by itself provided exemption from the legal definition of a labor organization. nor do all issues typically discussed in collective bargaining need to be a part of the agenda. for example, a committee designed to negotiate employee grievances is sufficient for inclusion under the law (132 nlrb, no. 138 (1961». board exceptions to coverage have been limited. the most significant have been those which interpreted the role of employees as engaged in the performance of managerial functions. fall 1993 gullett: reconciling employee involvement programs 127 in mercy-memorial hospital (231 nlrb, no. 182 (1977» the employer placed employees on a committee which heard employee complaints and recommended disposition of each case. "dealing" was said not to have occurred since the committee was the third step of a multi-stage grievance procedure and could only make recommendations to higher management. in sears (274 nlrb, no. 230 (1985» the company established a suggestion system designed to improve organizational communication. employees were encouraged to use suggestion boxes to submit ideas to management. here again, this process did not meet the definition of a labor organization. perhaps the best known board exemption from coverage is general foods (231 nlrb, no. 122 (1977» in which the company created self-managed work teams in one of its plants. these teams were allowed to perform such functions as task assignments for members, performance evaluations, applicant interviewing, and training. labeling the teams as "administrative subdivisions" of the employer, they were exempted because no evidence of "dealing" was presented. it should be noted that general foods is the only form of current-day employee involvement program on which a ruling has been made. while such self-managed teams are growing in popularity, they are small in number when compared to the more prevalent "quality circle" designs found throughout industry today. the general foods ruling did not address the status of quality circles as labor organizations since they were not the basis for the complaint. once an employee plan has been classified as a labor organization as defined by law, a number of factors are then examined to determine unlawful employer involvement. these include employer-initiated suggestions that a representation committee be formed, employer involvement in the design of the representation plan, the payment of employees while they are involved in plan activities, the use of company premises for meetings, the furnishing of supplies and other materials to the committee, and company preparation of agendas and minutes of meetings (306 nlrb, no. 156 (1992». where a formal representation plan exists, additional considerations are the lack of a formal constitution or by-laws, no membership dues, lack of an independent treasury, absence of a written agreement with management, and no independent means of dispute settlement such as arbitration (taylor & witney 1987). it should be noted that no single characteristic is necessarily controlling; the totality of the circumstances determines the ruling. the board's decisions have, however, leaned strongly in the direction of finding a violation once the plan or committee has met the test of a "labor organization." the common employer defense that its plan is merely a means of communicating and/or cooperating with employees is rarely successful. a key to understanding this tendency to find a violation lies in the way employer domination was interpreted. the board's reasoning process appears to have been based on the belief that an employer's participation in the formation, design, and maintenance of a committee constitutes a ~ se violation. 128 journal ofbusiness strategies vol. 10, no.2 thus, the creation of a labor organization which exists only because of the encouragement and involvement of the employer and which would not exist without this continued support is assumed to be illegally controlled. no finding that employees feel dominated is necessary for any violation to occur. equally, the employer's intention in establishing a representation plan is not determinative. while violations (such as threatening employees with job loss if an outside union is voted in) may add additional weight to the charge of company domination, they are not necessary. the courts and employee committees unlike the board, the appeals courts have been more uneven in their treatment of these types of cases. in a number of instances they have reversed board rulings using standards rejected at the administrative (nlrb) level. differences with the board concerning what constitutes a labor organization have, however, been rare. the best known exception is that of scott & fetzer heard by the 6th circuit. in this case the court held that the employer-sponsored plan was not a labor organization because the employees did not perceive it to be one, that there was no evidence of employer hostility towards unionism, and that there was continuous rotation of committee members who spoke for themselves and not for others (691 f 2d 288 (6th cit. 1982». in almost all other instances the courts and the nlrb have agreed on the criteria for the existence of a labor organization. agreement on employer domination is another matter. when reversing, several circuits (but most notably, the 6th) have interpreted many of the above-described actions of the employer not as domination, but as cooperative behavior and as sincere attempts to improve communication with employees (68 lrrm 2332 (6th cit. 1968); 221 f 2d 165 (7th cir. 1955». varying arguments have been used to justify the legality of these arrangements. among them is the state of mind of the employees. if no evidence is presented that they feel their representation plan is controlled by the employer, no violation may be established. if employees are believed to feel free to reject their current plan and choose an outside representative, an absence of domination may be found (379 f 2d 201 (6th cir. 1967». another justification is a distinction between the ability of the employer to dominate a representation arrangement and actual proof that domination has occurred. employer involvement in plan design and maintenance may be discounted as "friendly cooperation" and as a desire to increase communications with the employees (221 f 2d 165 (7th cir. 1955». the absence of other labor law violations may add weight to these arguments (221 f 2d 165 (7th cir. 1955». in short, the appeals courts have frequently reversed findings of domination by interpreting the meaning of the term in ways the board has consistently rejected. while the board has typically used rather cut-and-dried rules to determine if domination has occurred, the appeals courts have often used a more subjective approach by looking for underlying motives, perceptions, and intentions of both the employer and employfall 1993 gullett: reconciling employee involvement programs 129 ees. so far, no case addressing modern-day employee involvement programs in the form of quality circles or self-managing work teams has reached the courts. electromation and employee participation while the nlrb has typically rejected non-union forms of collective representation, it has, as noted above, ruled on only one case of employee involvement, that of general foods. in this instance, self-managing work teams were exempted from coverage as labor organizations and were thus not subjected to further analysis concerning employer domination. no case before the board has, however, addressed the legality of employee quality circles or similar arrangements. electromation has been widely publicized as bringing this issue forward for a ruling (the wall street journal 1991; novak 1992). surprisingly, the facts in this case contradict this expectation (309 nlrb, no. 163 (1992». the company, in response to perceived employee dissatisfaction concerning several issues of employment conditions, established ad hoc "action committees" composed of management and employee volunteers. these committees were to discuss specific topics such as absenteeism, pay progression, and attendance bonuses. similar committees had been used by the company in the recent past. shortly after the action committees were formed, a union formally demanded recognition from the company. given notice of a representation question, the company withdrew from the committees, but told employees that they could continue to meet if they so chose. mter losing the representation election, the union charged that the company had interfered with the election process and was in violation of 8(a)(2) of the act through the formation and domination of an employer-sponsored labor organization. the nlrb's administrative law judge found no anti-union motive on the part of the employer. using common board analysis procedures, he did, however, rule that the action committees were labor organizations under the law and were illegally dominated by the employer (309 nlrb, no. 163 (1992». nowhere in the ruling was the issue of elp legality addressed. nevertheless, when the company appealed the ruling to the board, the case drew the attention of numerous interest groups. amicus briefs were filed by organizations both supporting and challenging the status of employee involvement programs as exempt from coverage as labor organizations and thus free from employer domination as defined by law. oral arguments were heard on september 5, 1991. a ruling was issued on december 16, 1992. in the decision there was little that could be called surprising. the ruling reviewed the history of the relevant portions of the national labor relations act, concluding that the committees were "labor organizations" under the act and that they were company designed and dominated. thus the administrative law judge's finding was upheld, and the company was ordered to dissolve the committees and to post appropriate notices informing employees of the violations (309 nlrb, no. 163 (1992». the company has stated that it will appeal the decision. 130 joumal ofbusiness strategies vol. 10, no.2 in a footnote, the ruling specifically stated that no decision was being made regarding quality circle programs since they were not present in this case. additionally, note was made that self-managed work teams were not at issue here, but that they maintained the status given them in general foods. in short, the electromation ruling did not resolve the legality of quality circles. it was instead seen as a rather "garden variety" company union case (309 nlrb, no. 163 (1992). chairman stephens had commented informally before the decision was issued that expectations for the outcome were greater than what would probably result (personal conversation with chairman stephens, southwestern legal foundation). his prediction was correct. three of the four sitting board members did, however, issue dicta (additional comments) regarding their views of eip's. the most instructive part of the case lies with these comments and provides clues concerning the future legal status of involvement programs. member comments the three concurring opinions reiterated the unanimous ruling that electromation's action committees constituted a labor organization as defined in section 2(5) of the act and that the company had violated section 8(a)(2) by dominating them. they also agreed that an elp was not present in this firm. however, each felt compelled to comment on the legality of eips in anticipation of future cases. each sought to explore how and why such participation plans would be free of violation. contained in these comments are tentative guidelines for establishing and operating involvement programs which are unlikely to run afoul of the law. nevertheless, there was some divergence of opinion regarding legal eip's. two of the three members who commented emphasized the importance of a plan to avoid the designation as a "labor organization" under section 2(5) of the law. as long as an involvement program does not meet the board's test as a labor organization, employer domination cannot be successfully charged under section 8(a)(2). member devaney read section 2(5) rather narrowly, seeing only two configurations which would qualify as labor organizations: independent unions and the traditional erps designed by employers as a substitute for unions. he noted that "normal relationships and innocent communications are not banned" (309 nlrb, no. 163 (1992)). three cases, mercy memorial hospital, general foods, and sears, were cited as board-approved examples of this position. following this line of thought, he further noted that while the law does not speak of employee input on such issues as efficiency and productivity, it does not condemn them either. if, on occasion, a mandatory topic of bargaining (i.e., an issue directly related to wages, hours, or working conditions) is discussed in an eip relationship, no violation is likely to occur since this is not the primary purpose of the plan (309 nlrb, no. 163 (1992». as long as the employees' rights to free choice of an employee bargaining representative are preserved, eip's are not in violation. fall 1993 gullett: reconciling employee involvement programs 131 member oviatt generally agreed, but based his analysis on an even stricter definition of a labor organization under section 2(5) of the law. to be exempt from violation, eip's must be designed so that they focus on such issues as joint solving of operating problems and the enhancement of communication flows. they must, however, avoid involvement in any form of "dealing," (le., discussing mandatory subjects of bargaining). if wages, hours, or other conditions of employment are even occasionally discussed, the joint relationship is seen as a labor organization and is assumed to be dominated by the employer. thus, protection from violation is based on never crossing the line into mandatory bargaining topic areas (309 nlrb, no. 163 (1992». this position was affirmed in the 1993 du pont ruling (311 nlrb, no. 88 (1993». the most controversial position was taken by member radabaugh. unlike his colleagues, he stated that eip's cannot avoid being classified as labor organizations under section (2x5) of the law since they meet the three standards it lists. their legality can only be established by showing the absence of employer domination. and this can only be done by reinterpreting the supreme court's early (1939) newport news decision which upheld the board's traditional interpretation of domination under 8(a)(2) (309 nlrb, no. 163 (1992». his rationale for this change was based on the passage of the labor management relations (taft-hartley) act of 1947 and a movement away from the adversarial model of labor relations since the 1930's. although section 8(a)(2) was not amended by tafthartley, employees' rights not to join a union were added to section 7 of the law (309 nlrb, no. 163 (1992». in addition, section 203 created the federal mediation and conciliation service to help resolve labor disputes, further suggesting a more conciliatory approach to worker-management relations. the national productivity and quality of worklife act of 1975 and the labor-management cooperation act of 1978 were cited as further evidence of a more cooperative industrial relations climate. given this shift, member raudabaugh maintained that the court would today reinterpret newport news to exempt eips from 8(a)(2) violation. accordingly, he established four tests for the legality of employee involvement plans: 1. the extent of employer control over the committee. although the employer may establish the eip and suggest policies and procedures of operation, employees must have the right to reject any or all parts of the plan. if the elp is acceptable, employees must have the freedom to select their own representatives and to consider all issues related to the committee's purpose, employer financial assistance would not be seen as a violation. 2. the purqose of the committee and the employees' perception of that purpose. the purpose must be to deal with the employer's entrepreneurial interests rather than as a substitute for true collective bargaining. employees must also see the elp as a productivity-enhancing device and not as a collective bargaining vehicle. 3. whether the employer has assured the employees of their section 7 rights to be represented in collective bargaining by a union. 132 joumal ofbusiness strategies vol. 10, no.2 4. the employer's motives in establishing the eip. the plan cannot be used to discourage an ongoing union campaign.the purpose must be to pursue legitimate business goals such as increased efficiency (309 nlrb, no. 163 (1992». it is of interest that the majority ruling and the two other concurring opinions expressly rejected this series of tests as a rewriting of the law that is beyond the board's delegated authority. it is also noteworthy that these criteria echo the reasoning of some appeals courts in earlier cases where the board was reversed. two 1993 nlrb cases also focused on permissible participation activities by employee groups. in research federal credit union the board found a situation quite similar to electromation. in both firms, the employer initiated and established committees to discuss matters relating to wages, hours, and conditions of employment. citing its previous ruling in electromation, the board reaffirmed its long-standing policy of finding a violation under these circumstances (310 nlrb, no. 13 (1993». in du pont, the company's "safety conferences" were held not to be in violation since employees' ideas regarding safety were not treated as proposals to which the company responded. topics such as improving communication to employees about safety were discussed using "brainstorming" to generate ideas. matters which involved bilateral negotiations with the union were excluded from discussions. six "joint safety committees" and one "joint fitness committee" were, however, judged to be employerdominated labor organizations. these committees excluded the union from participation but bargained over such mandatory topics as safety incentive awards and recreational facilities (311 nlrb no. 88 (1993». analysis and conclusions electromation, unhappily, did not live up to its advertising claims. clearly, the dispute was not about an eip. instead, it was a rather ordinary incident of a company-initiated lahar organization bargaining over conditions of employment. thus it did not formally decide the legal status of eips. although the precise boundaries of legal employee involvement have not been firmly established, some guidance has been provided by examining patterns of board and court rulings through the years. of special importance are the recent electromation, research federal credit union, and du pont cases. perhaps the clearest message that electromation sent was the board's desire to find ways to exempt eips from violation of the statute. although divergence of reasoning among the membership was obvious, all who commented agreed that involvement programs were not targeted for elimination by existing labor law. indeed, such plans were virtually non-existent when the law was enacted. more importantly, the commentators recognize that the spirit of the law and the changes in work place dynamics argue for eip exemption. the majority opinion also reiterated its support for its earlier general foods ruling exempting self-managed teams from inclusion as a labor organization. federal research credit union and du pont reinforced the electromation comments. fall 1993 gullett: reconciling employee involvement programs 133 these decisions, coupled with the tendency of appeals courts to look more favorably on company-initiated representation plans, provide the following tentative guidelines for lawful eip formation and operation: 1. self-managed work teams which are designed to perform typical managerial functions such as hiring and task assignments of members are likely to remain free of the labor organization designation. these work-group designs have not been seen by the board as engaging in "dealing." 2. although a definitive ruling on quality circles and related forms of involvement has not yet been made, it is likely that they can obtain exemption by limiting their discussions to topics such as productivity improvement, cost reduction, and other operating issues. mandatory bargaining topics should be avoided. if these topics do arise as by-products of the discussions, they should be separated from group deliberation and considered by management independently (or jointly with the union if one is present) and not in tandem with conclusions or suggestions made by the eip. 3. regardless of the type of eip instituted by the employer, it should be accompanied by a clear statement that the plan is not intended for collective bargaining purposes or other forms of employee representation. 4. consistent with the previous point, employees should not be designated as spokespersons for other workers. 5. the plan should be voluntary. no employee should be forced to participate if he or she chooses not to do so. 6. timing may have some effect on the legality of a plan. it is unwise to initiate an eip concurrent with a union organizing drive or while unfair labor practice charges are pending against the employer. while a number of interesting proposals have been made for amending the tafthartley act to strengthen support for eips, (heckscher 1988) and (hogler 1993), no substantial effort to do so is currently under way in the congress. employers should, therefore, design and operate their plans on the basis of current legislation and its interpretation. in mid-1993 the board's membership is changing with two terms expiring and one seat of the five-member body vacant. as presidential appointments are made, new members are likely to reflect somewhat differing views than those of their predecessors. given the new administration's backing of the employee teamwork concept (the wall street journal 1993), there is, however, strong reason to believe that involvement programs will be supported by the new board. definitive answers to the finer points of legality and illegality will require the processing of additional cases by both the nlrb and, ultimately, the supreme court. but employee involvement should not and cannot be eliminated in the meantime. as organizations face an increasingly fragmented, rapidly changing, and globally134 journal ofbusiness strategies vol. 10, no.2 competitive environment, their need for strategic, flexible response increases (business week/reinventing america 1992). flatter organizational structures with decentralized knowledge-based decision centers call for cooperative cultures with group-based knowledge sharing. by following the guidelines for eip formation and operation provided above> firms are quite likely to stay within the permissable limits of labor law. how well they use the resulting eips may well be a key to organizational survival and success in the challenging years ahead. references 3 nlrb 10 (1938). 49 stat. 449 (1935). burton, ernest richmond. 1926. employee representation. baltimore: wilkins & wilkins. 231. chicago rawhide mfg. co. v. nlrb. 221 f 2d 165 (7th cir. 1955). cole, robert e., paul bacdayan, and b. joseph white. 1993. "quality, participation, and competitiveness." california management review (spring): 68-81. cotton, john l. 1933. employee involvement. newbury park, calif.: sage publications, inc. denton, d. keith. 1992. "multi-skilled teams replace old work systems." hr magazine: (sept.): 48-56. e. i. du pont de nemours. 311 nlrb, no. 88 (1993). electromation. 309 nlrb, no. 163 (1992). "employee participation drives production." 1992. personnel journal (december): 37. f. m. transport inc. 306 nlrb, no. 156 (1992). federal-mogul corp. v. nlrb. 68 lrrm 2332 (6th cir. 1968). "finns need prodding to improve workplaces, labor secretary reich says," 1993. the wall street journal (july 6): 1a. general foods corporation. 231 nlrb, no. 122 (1977). green, william. 1925. "the challenge of the union." american federationist (march): 161-164. hammer, michael and james champy. 1993. reengineering the corporation. new york: harper business. chapter 4. fall 1993 gullett: reconciling employee involvement programs 135 heckscher, charles c. 1988. the new unionism. new york: basic books, inc. hogler, raymond l. 1993. "employee involvement and electromation, inc.: an analysis and a proposal for statutory change." labor law journal (may): 261-274. hertzka & knowles y. nlrb. 503 f 2d 625 (9th cir. 1974). katzenbach, jon r. and douglas k. smith. 1993. "the discipline of teams." harvard business review (march-april): 111-120. ketchum, lyman d. and eric trist. 1992. all teams are not created egual. newbury park, calf.: sage publications inc. "labor letter." 1991. the wall street journal (oct. 15): 1a. "labor-management teams pop up in most areas of the workplace." 1993. the wall street journal (jan. 19): 1a. lauck, w. jett. "labor and production." 1920. annals of the academy of political science (july): 91-92. memphis truck & trailer. 1987. 284 nlrb, no. 99. mercy memorial hospital. 1977. 231 nlrb, no. 182. mills, harry a. & royal montgomery. 1945. organized labor. new york: mcgraw-hill: 835. modem plastics corp. v. nlrb. 379 f 2d 201 (6th cir. 1967). nlrb v. cabot carbon co. 360 u.s. 203 (1959). nlrb v. jones & laughlin steel corporation. 301 u.s. 1 (1937). nlrb v. scott & fetzer co. 691 f 2d 288 (6th cir. 1982). newport news shipbuilding and dry dock company. 1938. 303 u.s. 54. novak, janet. 1992. "make them all form unions." forbes (may 11): 174. "paradigms for postmodern managers" 1992. business week/reinventing america: 62-63. perry, nancy j. 1991. "the workers of the future." fortune/the new american century. 6871. personal conversation with chairman stephens at the 39th annual institute on labor law. southwestern legal foundation, dallas, texas, october 15, 1992. 136 j oumal ofbusiness strategies vol. 10, no.2 rayback, joseph g. 1966. a history of american labor. new york: the free press. 304-305. research federal credit union. 310 nlrb, no. 13 (1993). schilder, jana. 1992. "work teams boost productivity." personnel journal (february): 67. sears roebuck & co. 274 nlrb, no. 230 (1985). seger, c. b. 1992. "employee representation and personnel work in a large scale organization with many plants." proceedings of the academy of political science (january): 545. taft, phillip. 1964. organized labor in american history. new york: harper & row. 454. taylor, benjamin j. & fred witney. 1987. labor relations (5th edition). englewood cliffs, n.j.: prentice-hall. 174. tead, ordway and henry metcalf. 1920. personnel administration. new york: mcgraw-hili. 421. "the payoff from teamwork." 1989. business week (july 10): 58. wahlgren magnetics. 132 nlrb, no. 138 (1961). reconciling employee involvement programs with national labor law: some tentative guidelines notes the inverted yield curve, the economy, and peaks in interest rates bruce kersey east texas state university commerce, texas periodically there are references and comments in financial and economic publications concerning the latest inversion of interest rates, which is defmed as a situation where short-term interest rates are higher than long-term interest rates [1]. this is an unusual situation since long-term interest rates are normally higher because a higher rate of return is demanded to offset the greater uncertainty and risk associated with their longer maturity. fuversions are frequently accompanied by increasing inflationary pressures, and the federal reserve tightens money to combat inflation [7]. this causes a shortage in short-term money which causes short-term interest rates to rise. long-term borrowers, such as corporations, are reluctant to borrow long-term at high rates; thus the demand for long-term funds slackens somewhat consequently, long-term interest rates do not rise as much as short-term interest rates. furthermore, inverted yield curves are unusual, occurring only at about every three-to-five-year intervals. the latest inversion in interest rates created such interest because inversions have historically preceded severe economic times [1]. this study was prepared to look at these relationships and, more specifically, to examine the timing between the inversions and certain important financial and economic events such as the economy and peaks in interest rates. the procedures followed for this study were to determine the months when shortterm interest rates rose above long-term interest rates, the months that the economy topped-out, and the months that short-term interest rates and long-term interest rates peaked. short-term interest rates were measured by three-month treasury bill rates, and long-term interest rates were measured by long-term government bond rates. because gnp is calculated only quarterly and because a more detailed calculation is desired, industrial production was used to represent the economy because it is calculated monthly. this study covers a 2q-year period from 1968 to 1989; and the first set of data that were examined appears in table 1, which presents the findings for the beginning dates of several interest-rate inversions, peaks in industrial production, and the time lags between these two data. these data appear in columns 1, 2, and 3 respectively. by comparing columns 1 and 2 in table 1, it is revealed in column 3 that the inversion of interest rates preceded the crest in industrial production by an average of about twelve months, ranging from a lead time of 4 months to 17 months. using the latest inversion beginning in early 1989 and the average lead time of 12 months, an 82 journal ofbusiness strategies vol. 9, no.1 average interval time indicated the economy would begin to decline in early 1990. table 1 (1) 1st month of rate inversion 4 68 7 73 9 78 10 80 (2) peak month in industrial production 9 69 11 73 2 801 7 81 (3) lag time in months for ind. prod. 17 4 17 9 one might easily believe that when the economy begins to decline, interest rates will also decline due to less demand for money and due to a decrease in the fear of inflation, which, in tum, should decrease the inflationary premium normally added to the regular interest rate. therefore, it would seem, that interest rates would decline simultaneously with the slow down of the economy [4]. however, upon investigation it was found that the time intervals between inversion of interest rates and interest rate tops are longer than time intervals between inversions of interest rates and peaks in the economy. this observation is borne out by comparing column 3 in table 1 with columns 4 and 5 in table 2. in seven out of eight instances, the time period between the inversions of interest rates and the crests in interest rates are longer than the time periods between the inversions of interest rates and the peaks in industrial production; that is, interest rates topped-out after the economy peaked, most of the times. apparently, even after the economy peaks, interest rates continue to rise for several months [4]. in the case of short-term interest rates, three-month treasury bill rates continued to rise for an average of about three months (using column 3 in table 1 and column 4 in table 2) after the economy began to decline. in the case of longterm interest rates, long-term govenunent bond rates continued to rise for an average of about five months (comparing column 3 in table 1 and column 5 in table 2) after industrial production peaked. in addition, the latest inversion period and an average lag time of 17 months (from table 2, column 5), can be used to determine when long-term rates may begin to decline. a number of important caveats can be added to this study. while the data follow logical financial and economic theory and while the sequence of the events repeated lindustrial pnxluction was slightly higher in march 1979; but there was not a substantial decline in the industrial production figure until february, 1980, so the latter figure was used as the beginning of the actual economic decline. spring 1992 kersey: the inverted yield curve table 2 83 lags in: 3-month long-tenn t-bills govern bonds (1) lst month of rate inversion (2) (3) peaks in rates for: 3-month long-tenn t-bills govern bonds (4) (5) 4 68 7 73 9 78 10 80 1 70 6 70 7 74 8 74 3 80 3 80 5 81 9 81 21 26 12 13 18 18 7 11 repeated practically every time, it should be observed that the ranges and thus the averagesdo not allow exact tools for timing purposes. for example, the lags between the inversion of interest rates and industrial production ranged from 4 months to 17 months. therefore, executives planning to change inventory levels or purchase new equipment need to keep this large range in mind likewise, governmental bodies affecting fiscal and monetary policy need to be similarly mindful of the large range. another caveat is that not every inversion of interest rates was immediately followed by a decline in the economy. for example. in the mid-1960's there were a couple of interest rate inversions that did not precede economic declines. however. it is believed that these exceptions do not lessen the importance of the [mdings from this study because during this period of time. the united states was in the vietnam war and johnson was spending heavily on his "great society" programs. the excess government spending probably kept the economy going for a short time longer. these inversions lasted, generally, only for short periods of time; and, a recession did in fact follow about 22 months later. another very important caveat is that the average lead time was used to roughly estimate the time of the next event. obviously. specific events do not periodically appear time-wise equal to the "average" time lag. each event has its own reasons for occurring: the "average" only provides a guideline. summary the goal of this study was not an attempt to pinpoint exact times that each of the above events might occur because the caveats explained above would preclude such accuracy. however. this study does provide two main benefits. flfst, it does give rough approximations when these events might occur. secondly, and probably more important, is that this study does reveal that there is a steady sequence of events. planning by government and businesses can be improved by this knowledge. thus. after a certain event takes place, decision makers at least know, with a good degree of probability, which event will occur next; and, therefore, appropriate plans can be 84 journal ofbusiness strategies inversion of interest rates was accompanied by important changes in financial and economic conditions. the patterns observed were, first the inversion of interest rates. the next event was the peak and resulting decline in the economy. the demise of the economy began, on average, about one year after the inversion of interest rates. the next occurrence was the eventual decline in short-tenn interest rates. the data reveal that they begin to decline, on average, about 15 months after an interest rate inversion. finally long-tenn interest rates began to decline about 17 months after the inversion of interest rates. references 1. edgerton, jerry and goodman, jordan e. "how to steer your investments around a twisting yield curve:' money (february 1989), p.7. 2. feldman, d. "the term stmcture of interest rates in a partially observable economy." journal of finance (july 1989), pp. 789-812. 3. kelly, susan. "strong employment data help flatten yield curve." american banker (december 5, 1988), p. 5. 4. laubacher, harry w. "lock in that yield." financial world (september 20, 1988), p.70. 5. lee, b. s. "a nonlinear expectations model of the term stmcture of interest rates with time varying risk premia." journal of money credit bank (august 1989), pp. 348-67. 6. liebermann, charles. "inversion a useful signal." pension & investment age (january 9, 1989), p. 15. 7. nathans, leah j. "why short-term rates are so sweet; the fed's war on inflation has turned yields upside down." business week (january 16, 1989), p. 86. 8. "rates throwing curves at trades." futures: magazine ofcornmodities and futures (february 1989), p. 32. 9. sharp, eric l. "what interest rates mean to commodity economic cycles." futures: magazine ofcornmodities and options (october 1989), p. 46. 10. spares, margaret. "yields may not respond despite decline in dollar:' american banker (october 17,1988), p. 16. 11. "the yield curve as a predictor of business cycle turning points." business economics (october 1989), p. 37. spring 1992 kersey: the inverted yield curve 85 12. tumovsky, s. j. '''the tenn structure of interest rates and the effects of macroeconomic policy." i. money credit bank (august 1989), pp. 321-47. 13. williams, f. "flat yield curve puts new wood under arps (adjustable rate preferred stock)." pension investment ar (april 1989), p. 2. the inverted yield curve, the economy, and peaks in interest rates volume 27, number 2 205 the triad: organizational cultural values, practices and strong social intra-firm networks faiza khoja university of houston-downtown • houston, texas abstract the primary purpose of this research paper is to demonstrate the role, strong organizational culture plays in transforming a loosely connected organization to one with strong ties. the results of this study indicate that business units are likely to get assistance from other sister business units to accomplish tasks in a timely manner and to be innovative . cultural practices, such as open communication and rewards incentivize units sufficiently to do so. it is found that cooperative values indigenously motivate units to develop strong networks and do not require the added inducement of collective rewards or open communication, as these practices seem to be resonant in values of cooperation . the relationship between organizational cultural values, practices and strong social intra-firm networks in the past decade, strategists have studied the pervasive phenomenon of social networks or social relationships at various levels of analysis both within and outside the organization (e.g. ahuja, 2000; brass, galaskiewicz, greve, & tsai, 2004; gulati , 1998; gulati & singh , 1998; hansen, 1999; kraatz, 1998; nohria & eccles, 1992; tsai & ghoshal, 1998; tsai, 2000 etc.). in this study, intra-firm or intra-organizational networks are analyzed, which allows units within an organization to develop new knowledge while cultivating existing know-how (khoja & maranville, 2009; tsai & ghoshal, 1998). intra-firm or intra-organizational networks are defined as 'a set of relationships among business units of the same legal firm that interact with each other to exchange resources, information, and/or services' (achrol & kotler, 1999). most of the research studies, to date, have primarily analyzed the characteristics of intra-firm networks or lateral linkages,! such as network centrality,2 structural holes ,3 tie-strength,4 network size,5 and network density6 to assess performance, innovation, resource (knowledge) accumulation, and sharing, to name a few. the associated independent variables studied are trustworthiness, shared vision, strategic relatedness , absorptive capacity, centralization , formalization, geo206 journal of business strategies graphic distance, internal competition, and, more recently, divisional subculture. the dependent variables under investigation have been knowledge and information sharing, organization learning, time for new product development, innovation , and performance, to name a few (gupta & govindrajan, 2000a; hansen, 1999, 2002; hansen & lovas, 2004; hansen, mors, & lovas, 2005; marx, lechner, & floyd, 2006; powell, 2003; skerlavaj & dimovski , 2006; tsai, 2000, 2001, 2002; tsai & ghoshal , 1998; walter, lechner, & kellerma, 2007). more recently, khoja and maranville (2009) found that strong intra-firm networks enhance intellectual capital and that this relationship is further strengthened by absorptive capacity7. in addition, hansen and nohria (2004) posited that although firms can create value for themselves through inter-unit collaboration , they do need to overcome certain barriers by using a few ' management levers.' the barriers include units' '(1) unwillingness to seek input and learn from others, (2) inability to seek and find expertise, (3) unwillingness to help, and (4) inability to work together and transfer knowledge.' the management levers include 'leadership behavior, shared values and goals, human resource procedure, and lateral cross unit mechanisms.' as organizational culture is the backbone of any organization and determines a firm's strategy and structure (deal & kennedy, 1999), it becomes imperative to learn about the role culture plays in establishing social networks within organizations that is likely to assist units to collaborate, share, and exchange resources to attain competitive advantage. the research question addressed in this study is: 'how does strong organizational culture facilitate strong intra-firm networks?' in this paper, the inter-relationships among the 'management !evers' of organizational culture that are depicted in their values, practices, and strong intrafirm ties are studied. research objectives the research objectives are to: (i) empirically test and extend existing line of research in the field of intra-firm networks, (2) highlight another plausible facet of organizational culture and its contribution in the prevalence of strong intra-firm networks, to help managers identify the benefits of the same, and (3) depict interdependencies among the values and practices of organizational cultural. the unit of analysis is a business unit, as the perspective of business heads and managers would truly depict the effectiveness of organizational culture. in the following sections, the constructs of intra-firm networks and organizational culture are explicated. hypotheses are then posited and partial least volume 27, number 2 207 square (pls) technique is used to determine the results, followed by the discussion section. theory the structural/content stream of research in the field of resource-based view states that the possession of key resources that may be rare or unavailable lead to firms' competitive advantage (barney, 1991). the process!capability stream of the theory acknowledges that it is the utilization of resources or knowing capabilities in the development of new knowledge and competencies that lead to firms' competitive advantage (lane, koka, & pathak, 2006). as knowledge is considered to be one of the key resources (grant, 1996), it is important to study how new knowledge can be developed and existing knowledge be nurtured within organizations. empirical studies conducted by khoja and maranville (2009), tsai (2001, 2002), and tsai and ghoshal (1998) have explicated how intra-firm networks can help organizations assimilate and integrate knowledge. strong intra-firm networks strong ties are associated with trust and exchange of fine-grained private knowledge but the information obtained through such network ties is likely to be redundant and, therefore, assumed not to be a channel for innovation (burt, 1992). on the other hand, weak ties lead to novel but sparse information exchange resulting in increased innovation (brass, et ai., 2004; hansen, 1999; hansen, et ai., 2005; mcevily & zaheer, 1999). researchers have also argued that tie strength has a curvilinear impact on a host of dependent variables. extremely strong and extremely weak ties provide diminished impact (kraatz, 1998; seibert, kraimer, & liden, 2001). in other words, non-redundancy is a necessary but not a sufficient condition for acquisition of diverse information. strong ties to these non-redundant contacts are also important to access closely held information and resources (nicolaou & birley, 2003). more recently, khoja and maranville (2009) have argued that units are likely to develop and possess new knowledge that they share and exchange even when they are part of a strong network, contrary to the common belief that knowledge shared within strong networks is redundant (brass, et ai., 2004). 208 journal of business strategies organization culture organizational culture, though a ubiquitous phenomenon, is an intangible resource. in this study, both the conceptual and operational definitions of the construct are synthesized and hence, it is defined as 'shared perceptions of organizational values and practices within organizational units that both exempl((y and reinforce the underlying assumptions and principles of an organization' (denison, 1990; van den berg & wilderom, 2004). researchers have argued that organizational cultural values and underlying assumptions are not as easily discernable as organizational practices or artifacts that are manifestations of the former (singh, 2007; van den berg & wilderom, 2004). research has also demonstrated that organizations show more differences in practices than in values, and hence, claim practices to be more responsible for bringing about cultural change than cultural values (hofstede, 2001). thus, the relationships between organizational values and organizational practices are conjectured in this study. several recent studies have tabulated the varying dimensions of organizational culture (e.g. detert, schroeder, & mauriel, 2000; tsui, wang, & xin, 2006; van den berg & wilderom, 2004) that show considerable similarity and overlap. however, after thorough literature review, consulting with academic experts, and rigorous pretesting, the various dimensions converged into five critical values and practices that are relevant to this studytask-orientation, risk-orientation, cooperation and practices of rewards (individual and collective), and open communication (deal & kennedy, 1982, 1999; detert, et ai., 2000; goffee & jones, 1996; hofstede, 1998; reynolds, 1986). hypotheses in this section, the relationships between cultural values and strong intrafirm networks mediated by cultural practices are hypothesized. practices: (i) individual and collective rewards and (ii) open communication units earn individual rewards when goals are achieved independently. collective rewards are earned when units achieve their goals in collaboration with other units and hence, share the rewards based on their level of contribution. both individual and collective rewards encourage units to grow independently as well as to share and co-develop resources to innovate and accomplish their objectives (fedor volume 27, number 2 209 & werther, 1995; gibson & zelhur-bruhn, 2001). hence, these may be considered extrinsic forms of motivation that the organization partakes to foster participation from business units. through the practices of open communication such as encouraging regular face to face meeting and/or developing intranets, units can update and share their goals and achievements within the organi zation, signaling willingness to exchange resources and information. for instance, organizations can develop electronic yellow pages that list experts within the organization by area and provide benchmark systems that allow employees to identify best practices in the company (hansen & nohria, 2004). task-orientation. this value focuses on organizational 'work' as an end in itself. the fundamental concern of taskoriented organizations is work accomplishment and productivity (deal & kennedy, 1999; detert, et ai. , 2000). in order to do so, units need to attain 'external knowledge' not resident within their own unit to fulfill tasks. it may be argued that units prefer to attain and assimilate information and knowledge from within the organization, whenever appropriate and available, as it is likely to reduce both appropriation and coordination costs (gulati, 1998). the continuous need-based exchange and sharing within the organization may help build strong relationships within the same. risk-orientation. this predisposition allows units to change products or procedures, particularly when confronted with new challenges and opportunities (deal & kennedy, 1982, 1999; detert, et ai. , 2000; gupta & govindrajan, 2000a; peters & waterman , 1982; reynolds , 1986). organi zations may encourage business units to be distinctive and idiosyncratic in their work contributions, thus creating a culture that values experimentation and innovation , which entails several risks and costs. by partnering and sharing intricate knowledge and information, business units not only dilute their risks and costs while hedging their bets, they are also able to access useful resources , that they them selves may jack, with minimum transaction costs (hansen, et ai. , 2005), and in the process developing strong networks within the organization. cooperation. this is considered an engaging factor that successfully helps in the exchange, assimilation , and integration of knowledge, competencies, and capabilities for collecti ve learning among business units (deal & kennedy, 1999; gupta & govindrajan, 2000a; reagans & mcevily, 2003), allowing the same to discuss initiatives and accomplishments (gupta & govindrajan, 2000b; storck & hill , 2000). some organizations place a premium on relationship building as a means to better decision-making and overall output (detert, et ai., 2000) besides 210 journal of business strategies the added advantage of reduced appropriation and coordination costs incurred by the units. relationship between organizational values and strong intra-firm networks mediated by organizational practices to fulfill tasks and to initiate experimentation in a timely and cost effective manner (cross, parker, prusak, & borgartti , 2001), business units may feel the need for external knowledge and partners but due to internal rivalry (khoja, 2008), "not-invented-here" (nih) syndrome (deal & kennedy, 1999), and/or threat of increased knowledge spillover, units might be hesitant to collaborate. however, organizational practices of collective rewards and open communication are likely to encourage business units t6 develop strong intra-firm networks and hence, attain common benefits (khanna, gulati & nohria, 1998). common benefits accrue to each unit from the collective application of the learning that occurs as a consequence of being part of a relationship (khanna, et ai. , 1998). on the other hand , units may be encouraged to form strong intra-firm networks by organizational offering of individual rewards to accomplish tasks and to experiment. strong ties can assist units to tap into knowledge and informational database of other units and use it for their individual advantage, thus achieving private benefits of strong relationships. private benefits are those that a unit can earn unilaterally by picking up skills and capabilities from its partners in a relationship and applying them to its own operations (khanna, et ai. , 1998). in short, units are likely to develop strong ties within the organizations to earn increased rewards (both individual and collective), as it may help units achieve their goals and objectives, as well as to share risks and costs of experimentation while innovating expeditiously. this may give units a competitive edge both within the organization and the industry. hence, compliance with organizational values of task and risk orientation allows units to improve their chances of success whilst allowing them to receive more rewards. hence, hypothesis la: th e relationship between task-orientation and strong intrafirm networks is positively mediated by individual rewards. hypothesis ib: th e relationship between task-orientation and strong intrafirm networks is positively mediated by collective re wards. hypothesis 2a: the relationship between the risk-orientation and strong intra-firm networks is positively mediated by individual rewards. volume 27, number 2 hypothesis 2b: the relationship between the risk-orientation and strong intra-firm networks is positively mediated by collective rewards. 211 it is further argued that due to dominant subcultures (deal & kennedy, 1999) units are generally more unit-centered than organization-centered and are interested in accumulating more private benefits than common benefits from a relationship, consequently fostering cooperation and encouraging units to develop strong relationships by offering collective rewards and opportunities for open communication within the organization . collective rewards provide the added incentive and open communication enhances ease and agility to share and exchange information and knowledge, hence favoring joint effort. thus: hypothesis 3a: the relationship between the cooperative norm and strong intra-firm networks is positively mediated by collective rewards. hypothesis 3b: the relationship between the cooperative norm and strong intra-firm networks is positively mediated by open communication. figure 1 hypothesized model: predictor, criterion, and mediation relationships cultural norms task-orientation ri sk-orientation cooperation methodology cultural practices strong intra-firm networks "company and business database" provides business and industry content bringing together company profiles, brand information, rankings, investment reports, company histories, chronologies, and journal articles. the sample was restricted to multi-divisional companies with at least 5 business un;ts or divisions 212 journal of business strategies with revenues of above $500,000 for the year 2000. surveys with a cover letter, a dollar bill, and a return envelope were mailed to 375 business unit heads (high level managers). the key informant approach has been successfully employed in several studies and high-level respondents are considered to be ideal candidates for such surveys (rindfleisch & moorman , 2001), and to make certain , two questions on the survey confirmed their knowledge about the ongoing relationships with other bus iness units within the organization and their involvement (johnson, sohi , & grewal , 2004). although most high level managers were not involved in the formation of networks per se, they were found to be very knowledgeable of relationship activities. sample in all, 75 surveys were returned out of which 74 could be used, giving a response rate of 23% . responses from varying divisions of 55 companies in 23 different industries were received. to test for non-response bias, differences between respondents and non-respondents were examined . a t-test showed no significant difference (p < 0.05) between the two group s based on the number of full-time employees and total sales and asset of the units. to analyze the data, partial least square technique (pls) is used. it is a second-generation method of analysis with minimal demands on measurement scales, consisting as it does of a series of ordinary least-square analyses (chin , 1998). the pls technique focuses on predictor specification and on the variance of dependent variables. no assumptions are made regarding the joint distribution of the indicators or the independence of the sample cases. because of its orientation to prediction, factors are determinate, and the unique case value s of the latent variables are estimated (chin, 1998; chin & newsted, 1999). recently, shaver (2005) highlighted the discrepancies in standard tests for mediating relationships as proposed by baron and kenny (1986). he noted that violation s of any of the assumption s on which the tests are built, such asuncorrelated error terms , mostly skew the estimates resulting in lack of desirable statistical properties that lead to incorrect conclu sion . as the pls technique makes no assumptions of joint distribution, the results of the mediating tests are less likely to be skewed, except for measurement error and missing variables. the interpretation of the results generated by pls is identical to that of traditional regression technique. effect size or r2 for the endogenous variables of the measurement model and corresponding standardized path estimate s are examvolume 27, number 2 213 ined and interpreted. to estimate the t-statistics for the weights and loadings of the indicators of the latent variables and the path coefficients of the measurement model , bootstrapping technique is used. bootstrap represents a non-parametric approach where 'n ' sample sets are created in order to obtain ' n' estimates of each parameter in the pls model and is an effective tool to assess mediation in small samples (shrout & bolger, 2002). to assess the internal con sistency for a given block of indicators, composite reliability is calculated . in addition , average variance extracted (a v e) attempts to measure the amount of variance that a latent variable component captures from its indicators , relative to the amount due to measurement error. all the constructs are measured using reflective items and with the exception of strong intra-firm networks, seven-point likert sca le items adapted from previous literature and in consultation with academic experts. strong intra-firm networks are measured using an interval items. in this study, factors of size, industry, and age of the units that reflect availability of organizational slack, experience, and industry volatility (anand & khanna, 2000; osborn & baugh , 1990; tsai, 2001) are controlled for. measurement items are provided in the appendix. results table i shows the correlation matrix with the diagonals indicating the square root of average variance extracted (ave) to check for discriminant validity, which ranges from 0.754 to 1.00. the latent variables are seen to be distinct from each other, as they share more variance with their own block of indicators than with another component representing a different block of indicators . table 2 highlights the composite reliabilities and aves of independent latent variables. in general, the composite reliabilities range from 0.769 to 1.00, indicating internal consistency oflatent variables. ave scores range from 0.568 to 1.00, which explain reasonable variance shared among the latent variables and their respective block of indicators . in this study, most of the dependent, independent, and mediating variables are moderately to highly correlated. consequently, tolerance and variance inflation factor (vif) are analyzed to test for multicollinearity. the results indicate that the minimum tolerance value from among all the latent variables was 0.7 and the maximum vlf value was 1.428, which are well above and below the common threshold values of 0.19 and 5.3 , respectively (hair, anderson, tatham , & black, 1998). variables 2 1intra-firm networks 0.941 2collective rewards 0.286** 0.95 5individual rewards 0.375** 0.473*** 6-0pen communication 0.287** 0.241* 7cooperative norm 0.331*** 0.770*** 8task-oriented norm 0.312"* 0.399*** 9risk-oriented norm 0.218** 0.62*** 10size 0.089 0.271* 12-age -0.052 0.003 table 1 correlation matrix' 3 4 5 0.822 0.552*** 0.754 0.598*** 0.222* 0.932 0.502*** 0.166 0.495*** 0.484*** 0.175 0.641*** -0.154 0.089 0.143 -0.061 -0.093 0.003 an = 74. standardized coefficients indicating two-tailed significance. * p < 0.5; ** p < 0.01; *** p < 0.005 6 7 8 0.887 0.612*** 0.815 0.098 -0.191 1.00 0.116 0.423*** 0.297'* 9 1.00 i\j ~ 'c;: "'\ ;s a. ~ b:i ;: .,. s· ~ .,. ~ '"t ;:. ~ ~. volume 27, number 2 table 2 composite reliabilities and average variance extracted (aves) of latent variables variables strong intra-firm networks collective rewards individual rewards open communication cooperative norm task-oriented norm risk-oriented norm size age modest composite reliability = 0.7 modest ave score = 0.5 mediating relationships composite reliabilities 0.939 0. 947 0.804 0.769 0.952 0.917 0.855 1.00 1.00 ave 0.885 0.91 2 0.676 0.568 0.869 0.787 0.664 1.00 1.00 215 hypotheses la and ib are fully supported as the magnitude and strength of the direct relationship between task-orientation and strong intra-firm networks (~1 = 0.337, p < 0.005) is completely mediated by practices of individual and collective rewards (~l a = 0.135, n.s.) and (~l b = 0.210, n.s.). task orientation strongly impacts individual rewards (~i a = 0.537, p < 0.005), which in turn significantly influences strong intra-firm networks (~i a = 0.352, p < 0.005). task orientation also influences collective rewards (~ib = 0.517, p < 0 .005), which in turn impacts strong intra-firm networks (~ib = 0.212 , p < 0.05). the r2 for the direct relationship is 0.13, explaining 13% variance and for the indirect relationships, 0.203 and 0.156, respectively. hypotheses 2a and 2b are also fully supported as the strong relationship existent between risk-orientation and intra-firm networks (~2 = 0.238 , p < 0.005) is completely mediated by individual and collective rewards (~2a = 0.029, n.s.) and (~2b = 0.06, n.s.). risk orientation strongly impacts individual rewards (~2a = 0.504, p<0.005), which in turn significantly influences strong intra-firm networks (~2a = 0.405, p < 0.005). risk orientation also influences collective rewards (~2b = 0.636, p < 0.005), which in turn impacts strong intra-firm networks (~2b = 0.281, p < 0.05). the r2 for the direct relationship is 0.071, explaining 7.1% variance and for the indirect relationships, 0.187 and 0.125, respectively. 216 journal of business strategies both hypotheses 3a and 3b are not supported, as the direct relationship between cooperation and strong intra-firm networks (~3 = 0.304, p < 0.005) is not mediated by either collective rewards (~3a = 0.323, p < 0.005) or open communication (~3 b = 0.250, p < 0.05). collective rewards do not significantly impact strong intra-firm networks (~3a = 0.076, n.s.), although the relationship between cooperation and collective rewards is significant (~3a = 0.773 , p < 0.005). similarly, cooperative norm significantly influences open communication (~3h = 0 .523, p < 0.005), but does not significantly impact strong intra-firm networks (~3h = 0.224, n.s .). the r2 for the direct relationship is 0.159, explaining 15.9% variance and for the indirect relationships are 0.16 and 0.173 , respectively. tables 3 summarize the hypothesi zed measurement models. discussion strong relationships are the "grease" of any organization (prusak, 1997). business gets done without them, but not for long and not very well. the mediating relationships between organizational values and organizational practices depict that the values instilled within the organization would not be effective if they were not followed by practices fostering them. for example, by encouraging business units to accomplish tasks in a timely manner and experimenting creatively, units are likely to obtain help from other sister business units that are culturally regulated and are less likely to behave opportunistically than partners outside of the organization. however, units are likely to build relationships to fulfill their tasks and risk-taking activities ifcultural practices, such as open communication and rewa rds incentivize them sufficiently to do so. it is found that cooperative values indigenously motivate units to develop strong networks and do not require the added inducement of collective rewards or open communication, as these practices seem to be resonant in values of cooperation . theoretical , empirical, and practical contributions to the existing strategic management literature and to social network research , in particular, are discussed in the following section . theoretical contributions in this study, the inter-related role of organizational cultural values and practices, and strong intra-firm networks are emphasized and evaluated. the study suggests that organizational culture instills within an organization the values, norms , and beliefs that help the organizations facilitate strong social intra-firm networks. table 3 ~ the interrelationships among organizational values, practices and strong intra-firm networks' ~ ~ .... dependent variablestrong intra-firm networks n ~ control variables ~ age -0.002 -0.038 0.011 0.019 -0.024 -0.026 -0.01 -0.008 0.013 0.029 ~ (l"' .... size -0.125 -0.001 -0.10 -0.007 -0.067 -0.109 -0.073 -0.131 -0.005 -0.10 ""i n industry 0.094 0.076 0.08 0.099 0.074 0.065 0.077 0.062 0.089 0.101 independent variables task-oriented norm 0.337*** 0.135 0.210 risk-oriented norm 0.238** 0.029 0.061 cooperative norm 0.304*** 0.323*** 0.25* individual rewards 0.352 *** 0.405*** collective rewards 0.2 12* 0.281** 0.076 open communication 0.176 r2 0.029 0.130 0.071 0.159 0.203 0.1 56 0.125 0.187 0.160 0.173 effect size f2 0.131 0.05 0.155 0.22 0.15 0.11 0.194 0.156 0.174 df 3,71 4,70 4,70 4,70 5,69 5,69 5,69 5,69 5,69 5,69 an = 74 * p < 0.5; ** p < 0.01; *** p < 0.005 t\,) ~ 218 journal of business strategies the dynamic view of social intra-firm network is discussed as it relates to the formation and development of networks through the organizational practices that are implemented within the organization. to some extent, it involves the evolution of strong intra-firm networks and a change in the overall functioning and structure of the organization. empirical contributions little empirical work has been conducted in the field of social intra-firm networks or intra-organizational linkages (brass, et ai., 2004), and researchers have commonly used it as a relational construct in one-site sampling scheme to test their hypotheses (gupta & govindrajan, 2000b; hansen, 1999; tsai, 2000, 2001; tsai & ghoshal, 1998). furthermore, very few studies have analyzed the antecedents of intra-firm networks in detail (hansen & lovas, 2004; tsai & ghoshal, 1998; tsai, 2002; walter, et ai., 2007). in this study, the findings are justified by administering a survey on a sample of business units from different organizations in various industries using likert scale measures. hence, shifting gears from simple binary considerations, such as the existence or non-existence of relationships to the importance and strength of the relationships (brass, et ai., 2004). use of multiple sites also enhance generalizability and reinforce validity for the theoretical model (gupta & govindrajan, 1984). practical contributions several practical implications can also be drawn from this. first, this research highlights the necessity of management levers such as organizational values and goals, human resource practices of reward structures, and cross unit mechanisms for open communication to enhance relationship development within organizations. in an era when advantages based on traditional economies of scope and scale are rapidly diminishing, the successful exploitation of strong relationships may hold the key for organizations to gain and maintain lead over their rivals. organizational culture plays an important role in establishing an organization's identity by giving it value, direction, and purpose in order to increase performance as well as enable firms to adapt to external environmental conditions (goffee & jones, 1996; tsui, et ai., 2006). this research highlights the important role organizational culture plays in building organization character and backbone by helping units achieve their potential and objectives by encouraging development of strong intra-firm networks. practices appear to have a more direct impact on orgavolume 27, number 2 219 nizational values and support the same. thus, managers should be vigilant to steer cultural values and practices to guide units and help them be successful. limitations while this research study advances the understanding of the development and role of social intra-firm networks, it is not without its limitations. first, only a few cultural values and practices that facilitate the promotion of social intrafirm networks are employed in this study, which does not necessarily portray the complete picture. second, in this study, cultural variables are measured through the lens of the business unit heads or managers and results may be influenced by the subcultures of individual business units. most likely because of the dominant subcultures that may overshadow organizational culture, some confounding results may be apparent when testing the mediating role of intra-firm networks. in addition, geographic proximity, that may influence the ease of reluctance to develop intrafirm networks is not taken into account (gansen, malter & rindfleisch, 2005 ; singh, 2005). lastly, due to subjective reporting of all the variables by a single respondent, business unit heads, or managers, measurement error and common method variance can be seen as another limitation of this study (collins & clark, 2003). future research this line of research can be developed further to make significant contributions to the existing literature on social intra-firm networks. future research should focus on collecting longitudinal data to test the predictive relationships between the independent and mediating variables measured above. this would allow researchers to analyze the changes within organizations in both volatile and stable markets and economic conditions. furthermore, other predictor variables that influence the development of social intra-firm networks, such as resource requirements and organizational structures can be studied, in addition to the consequences of the same, for example, objective and strategic performance. the extant literature on both inter-organizational and intra-organizational relationships has determined the advantages and disadvantages of cach independently, and hence, they could be studied together to compare which one is more favorable than another. also, previous literature has stressed the importance of informal networks for purposes of knowledge accumulation, sharing and exchanging resources, etc. research can compare formal and informal networks to ascertain 220 journal of business strategies the significance of each and their potential to tap into the tangible and intangible resources within the organization. conclusion this research study attains the primary objective of this study by empirically testing the relationship between organizational cultural values and practices and strong intra-firm networks. the results indicate that cultural values of task and riskorientation are positively related to strong intra-firm networks and these relationships are mediated by practices of open communication and individual and collective rewards. strong association between cooperative norms and strong intra-firm networks is not mediated hy any of the cultural practices. end notes i. relationships with other business units within organization (tsa i & ghoshal, 1998) 2. a central informational and/or control central position in a network (tsai, 2001) 3. non-redundnat contacts (burt, 1992) 4. bonding among business units (granovetter, 1973) 5. number of units constituting a network (gulati , 1998) 6. number of ties per unit (coleman, 1988) 7. capability to acquire and assimilate new knowledge gained from other sources (lane & lubatkin, 1998; tsai, 2001). references achrol , r ., & kotler, p. (1999). marketing in the network economy. journal of marketing, 63, 146-163. ahuja , g. (2000). the duality of collaboration : inducements and opportunities in the formation of inter-firm linkages. strategic management journal. 21(3), 317344. anand , b ., & khanna, t. (2000). do firms learn to create value? the case of alliances [special issue]. strategic management journal, 21(3), 295-315. barney, 1. (1991). firm resources and sustained competitive advantage. journal of management, 17, 99-120. volume 27, number 2 221 baron, r., & kenny, d. (1986). the moderator-mediator variable distinction in social psychological research : conceptual, strategic, and statistical considerations. journal of personality and social psychology, 51(6), 1173-1182 . brass, d. , galaskiewicz, j. , greve, h ., & tsai, w. (2004). taking stock of networks and organizations: a multi-level perspective. academy of management journal, 7(6),795-819. burt, r. (1992). structural holes: the social structure of competition. cambridge, ma : harvard university press. chin, w. (1998). the partial least squares approach of structural equations modeling. in g. a. marcoulides (ed .), modern methods for business research (pp. 295-336). mahwah, nj: lawrence erlbaum associates, publishers. chin, w., & newsted , p. (1999). structural equations modeling analysis with small samples us ing partial least squares. in r. hoyle (ed.), statistical strategies in small sample research (pp. 307-341). thousand oaks, ca: sage publishers. collins, c., & clark, k. (2003). strategic management resource practices, top management team , social networks and firm performance: the role of human resource practices in creating organizational competitive advantage. academy of management journal, 46(6), 740-752. cross, r., parker, a., prusak, l., & borgatti, s. (2001). knowing what we know: supporting knowledge creation and sharing in social networks. organ izational dynamics, 30(2), 100-120. deal , t., & ke nnedy, a. (1982). corporate culture. reading, ma: addison-wesley. deal , t. , & kennedy, a. (1999). the new corporate cultures: revitalizing the workplace afier downsizing, mergers and reengineering. reading, ma: peruses books. denison, d. (1990). corporate culture and organizational effectiveness. new york: wiley & associates. detert, j., schroeder, r. , & mauriel, j. (2000). a framework for linking culture and improvement initiatives in organizations. academy of management review, 25(4), 850-863. fedor, k. & werther, w. (1995). m a king sense of cultural factors in international alliances. organization dynamics, 23(4),33-49. ganeson , s., malter, a ., & rindfleisch, a. (2005). does distance still matter? geographic proximity and new product development. journal of marketing, 69, 44-60. gibson , c., & zellmer-bruhn, m. (2001). metaphors and meaning: an intercultural analysis of the concept of teamwork. administrative science quarterly, 46(2), 274-304. 222 journal of business strategies goffee, r. , & jones, g. (1996, november-december). what holds the modern company together? harvard business review, 133-148. granovetter, m. (1973). the strength of weak ties. american journal of sociology, 78, 1360-1380. grant, r. (1996). toward knowledge based theory of the firm [special issue]. strategic management journal, 27, 109-122. gulati, r. (1998). alliances and networks. strategic management journal, 19,293317. gulati, r. , & singh , h. (1998). the architecture of cooperation : managing coordination costs and appropriation concerns in strategic alliances. administrative science quarterly, 43(4), 781-814. gupta, a. , & govindrajan, v. (1984). business unit strategy, managerial characteristics, and business unit effectiveness at strategy implementation . academy of management journal, 27, 2s-41. gupta, a., & govindrajan, v. (2000a). knowledge management's social dimension : lessons from nucor steel. sloan management review, 42(1), 71-80. gupta, a ., & govindrajan , v. (2000b). knowledge flows within multinational corporations. strategic management journal, 21(4),473-496. hair, j., anderson, r. , tatham, r., & black, w. (1998). multivariate data analysis (sth ed.). upper saddle river, nj: prentice hall. hansen, m. (1999). the search-transfer problem: the role of weak ties in sharing knowledge across organization subunits. administrative scien ce quarterly, 44(1), 82-111. hansen, m. (2002). knowledge networks: explaining effective knowledge sharing in multiunit companies. organization science, 13(3),232-248. hansen, m. , & lovas b. (2004). how do multinational companies leverage technological competencies? moving from single to interdependent explanations. strategic management journal, 25, 801-822. hansen, m. , & mors , m. , lovas, b. (200s). knowledge sharing in organizations: multiple networks, multiple phases. academy of management journal, 48(s), 776-793 . hansen, m ., & nohria, n. (2004, fall). how to build collaborative advantage. m1t sloan management review, 21-30. hofstede, g . (1998). attitudes, values and organizational culture: disentangling the concepts. organization studies, 19(3),477-492. hofstede, g. (2001). culture's consequences: comparing values, behaviors, institutions, and organizations across nations. thousand oaks, ca: sage publishers. volume 27, number 2 223 johnson , 1., sohi, r., & grewal, r. (2004). the role of relational knowledge stores in interfirm partnering. journal of marketing, 66,21-36 . khanna, t., gulati, r., & nohria, n. (1998). the dynamics of learning alliances : competition, cooperation and relative scope. strategic management journal, 19, 193-200. khoja, f. (2008). is sibling rivalry good or bad for high technology organizations? journal of high technology management research, 19(1), 11-20. khoja , f. , & maranville, s. (2009). the power of social intra-firm networks. academy of strategic management journal, 8, 51-70. kraatz , m . (1998). learning by association? inter-organizational networks and adaptation to environmental change. academy of management journal, 41, 621643. lane, p. , koka, 8., & pathak, s. (2006). the reification of absorptive capacity: a critical review and rejuvenation of the construct. academy of management review, 31(4), 833-863. lane, p. 1., & lubatkin, m. (1998). relative absorptive capacity and inter-organizationallearning. strategic managem ent journal, 19, 461-477. marx, k. , lechner, c ., & floyd, s. (2006). intrafirm networks and the performance of strategic initiatives. academy of management best conference paper bps: ssi. mcevily, b., & zaheer, a . (1999). bridging ties: a source of firm heterogeneity in competitive capabilities. strategic management journal, 20, 1133-1156. nicolaou , n., & birley, s. (2003). social networks in organizational emergence: the university spinout phenomenon. management science, 49(12), 1702-1725. nohria, n. , & eccles, r. (1992). face-to-face: making network organizations work. in n . nohria & r. g. eccles (eds.), network and organizations: structure,form and action (pp. 288-308). boston : harvard business school press. osborn, r., & baugh, c. (1990). forms of inter-organizational governance for multinational alliances. academy of management journal, 33(3), 503-519. peters, t. , & waterman, r . (1982). in search of excellence: lessons from america's best run companies. new york: harper and row. powell , t. (2003). information sharing and its link to organizational sub-cultures in a manufacturing company. journal of applied business research, 19(2),67-75. prusak, s. (1997, september-october). unleashing the power oflearning. an interview with british petroleum's john browne. harvard business review, 147-168. 224 journal of business strategies reagans , r. , & mcevily, b. (2003). network structure and knowledge transfer: the effects of cohesion and range . administrative science quarterly, 48(2), 240268. reynolds, p. (1986). organizational culture as related to industry, position and performance: a preliminary report. journal of management studies, 23(3), 333345. rindfleisch, a., & moorman , c. (2001). the acquisition and utili zation of information in new product alliances: strength of ties perspective. journal afmarketing, 65(2), 1-18. seibert, s., kraimer, m. , & liden , r. (200\). a social capital theory of career success. academy of management journal, 44(2),219-237. shaver, 1. (2005). testing for mediating variables in management research: concerns, implications, and alternative strategies. journal of management, 31(3), 330353. shrout, p. , & bolger, n . (2002). mediation in experimental and non-experimental studies: new procedures and recommendations. psychological methods, 7(4), 422-445. singh, 1. (2005). collaborative networks as determinants of knowledge diffusion patterns. management science, 51(5), 756-770. singh, k. (2007). predicting organizational commitment through organization culture: a study of automobile industry in india. journal of business economics and management, 8(1),29-37. skerlavaj, m. , & dimovski , v. (2006). social network approach to organizational learning. journal of applied business research, 22(2), 89-97. storck, 1., & hill, p. (2000). knowledge diffusion through 'strategic communities.' sloan management review, 41(2),63-75. tsai, w. (2000). social capital, strategic relatedness and the formation of intra-organizationallinkages. strategic management journal, 21,925-939. tsai, w. (2001). knowledge transfer in intra-organizational networks: effects of network position and absorptive capacity on business unit innovation and performance. academy of management journal, 44(5),996 -1017. tsai , w. (2002). social structure of cooptation within a multiunit organization: coordination, competition and intra-organizational knowledge sharing. organization science, 13(2), 179-190. tsai, w., & ghoshal, s. (1998). social capital and value creation: the role of intrafirm networks. academy of management journal, 41(4),464-476. volume 27, number 2 225 tsui, a ., wang, h., & xin, k. (2006). organizational culture in china: an analysis of culture dimensions and culture types. managem ent and organization revie w, 2(3), 345-376. van den berg, p. , & wilderom, c. (2004). defining, measuring and comparing organi zational culture. applied psychology: an international review, 53(4),57-582. walter, j. , lechner, c., & kellermanns, f. (2007). knowledge transfer between and within alliance partners: private versus collective benefits of social capital. journal afbusiness research, 60, 698-710. appendix organizational culture is defined as "the shared philosophies, ideologies, values, assumptions, beliefs, expectations, attitudes and norms that knit a community together" (szilagyi & wallace, 1990: 639). organizational values (adopted from deal & kennedy, 1982; reynolds, 1986). task-orientation 1. our company places emphasis on improving work methods within business units. strongly disagree strongly agree 1 2 3 4 5 6 7 2. our company places emphasis on maintaining high standards of performance for business units. strongly disagree strongly agree 1 2 3 4 5 6 7 3. our company places emphasis on setting specific goals and achieving them. strongly disagree strongly agree 1 2 3 4 5 6 7 risk-orientation 1. our company is receptive to new ideas and suggestions coming from business units. strongly disagree strongly agree 1 2 3 4 5 6 7 2. our company allows the business units to be creative and innovative. strongly disagree 1 2 3 4 5 6 strongly agree 7 3. our company encourages business units to learn new competencies and new skills. strongly disagree strongly agree 1 2 3 4 5 6 7 cooperation 1. our company encourages business units to work together. strongly disagree 1 2345 2. our company encourages cooperation within business units. strongly disagree 12345 3. our company encourages business units to help out each other. strongly disagree 1 234 5 strongly agree 6 7 strongly agree 6 7 strongly agree 6 7 volume 27, number 2 organizational practices (adopted from deal & kennedy, 1982; reynolds, 1986). collective rewards 227 1. our company rewards business units adequately for working with other business units within the company. strongly disagree strongly agree 1 2 3 4 5 6 7 2. our company rewards business units for their collective efforts with each other. strongly disagree strongly agree 1 2 3 4 5 6 7 individual rewards 1. our company rewards business units rewards businesses for achieving our goals. strongly disagree strongly agree 1 2 3 4 5 6 7 2. our company provides additional resources when our business unit achieves its goals. strongly disagree strongly agree 1 2 3 4 5 6 7 open communication 1. our company holds meetings regularly where business units discuss their goals and achievements. strongly disagree strongly agree 1 2 3 4 5 6 7 2. our company encourages business units to share information with each other over the intranet. strongly disagree strongly agree 1 2 3 4 5 6 7 3. our company encourages face-to-face communication. strongly disagree 12345 strongly agree 6 7 intrafirm networks defined as 'a set of formal andlor informal relationships among business units of the same legal entity' over all, internal network relationships are: extremely weak -3 -2 -1 controls poor -3 -2 size (adapted from tsai, 2001) -1 neutral o neutral o number of employees working in our business unit is: industry use dummy coding for 24 industries (n-1) age when was your unit established? extremely strong 2 3 2 excellent 3 228 journal of business strategies biographical sketch of author faiza khoja, ph.d. is an associate professor of management at university of houston-downtown, college of business . she earned her ph.d. from university of houston in strategic management and her research interests are in the areas of social networks, intra-firm competition, buyer-supplier relationships, and developmental economics. she primarily teaches strategic management in addition to international management. the triad: organizational cultural values, practices and strong social intra-firm networks tile impacf of firm strategy type on transition time for m-form adoption robert j. williams bruce t. lamont james j. hoffman florida state university tallahassee, florida introduction historically, firms have utilized the functional form of structure in which the firm has been organized along such functional lines as marketing, finance, and engineering [24]. with organizational expansion, more and more firms have turned to the multidivisional structure (m-form) to better handle the more demanding information processing and decision making requirements ([4], [5], [6], [7], [19], [24]). chandler [3] has argued that a proper match between strategy and structure is necessary in order for firms to obtain optimal economic efficiency. therefore, the movement toward an m-form structure by diversifying firms should serve to enhance their operating efficiency. several studies ([1], [10], [15]) have examined the link between structural change and performance. these studies have confirmed the positive impact of m-form adoption on :firm performance using such accounting based performance measures as return on assets and return on investment. what is less understood is the length of time required by firms to complete the transitional period from the functional or holding company form to the m-form, and the effect of this time lag on estimates of post-change performance. the concept of transition time refers to length of time between the first actions to reorganize to the m-form and the completion of the multidivisional structure with centralized corporate staff, decentralized operations, and appropriate monitoring and control systems. to date, most studies have implicitly assumed that transition time is reasonably short and similar for all firms. this study explicitly examines the time period required for firms in three strategy categories to change their structures to the mform and the implications of different transition periods on estimates of post-change performance. the purpose of this study is two-fold. first, the present research determines whether m-form implementation time varies among firms. the determination of each firm's actual implementation time can be obtained only through extensive qualitative research via direct contact with the firms involved. the second purpose of this study is to document m-form implementation time by diversification strategy. hoskisson [10] found an increase in the average performance of unrelated diversified firms, a decrease in the average performance in vertically integrated firms, and no change in performance of fall 1992 williams, lamont & hoffman: impact of firm strategy type 115 related diversified firms. his transition time is the same for all firms. if m-form transition time does vary across strategy categories, then hoskisson's [10] findings that firms' post-change performance vary across strategy categories may be overstated, in that his findings fail to consider implementation time. the multidivisional structure the m-form structure was initially developed by general motors and the dupont co. in the 1920's [3]. while its adoption was initially slow, more and more firms have converted to this structure since world war ii [18]. the mid-1960's was a period of especially rapid conversion by firms from the transitional functional form to the m-form structure ([10], [18]). several studies have focused on the benefits of the m-form structure ([1], [10], [15], [24]). these studies suggest that the m-form overcomes many of the shortcomings of the traditional functional form by shifting operational decision making and responsibility to decentralized product or geographic divisions. this benefits the finn in two ways. first, it serves to improve the firm's efficiency as decisions are made by managers closer to the finn's production and distribution functions ([1], [8], [24]). second, it allows the separate divisions to be granted greater operational autonomy, thereby reducing the routine decision making activities of top managers. the separation of the general office from operational concerns allows top managers to concentrate on broad strategic issues, while not being burdened by the performance results or operational issues of the various functional parts [1]. the notion that the m-form improves performance among all firms adopting this structure was questioned in a study by hoskisson [10]. his study examined the effect that conversion to the m-form had on firm performance in three different strategy categories: vertical integration, related diversification, and unrelated diversification. hoskisson theorized that implementation of an m-form structure would lead to differences in performance for firms in the three categories. firms' average annual roa during the ten years before m-form adoption were compared to their average annual roa after adoption. it was assumed that the implementation time was one year for all firms. his findings revealed an average increase in performance, among unrelated diversified firms after adoption of the m-form, a decline in average performance for vertically integrated firms, and no change in performance for related diversified firms. his post-change performance results for both vertically integrated and related diversified firms failed to demonstrate the benefits of the m-form adoption for these strategy categories. although several explanations were offered by hoskisson for his findings, the role of m-form implementation time was not considered. implementation time was viewed as reasonably fast and similar across strategies. 116 journal of business strategies theory add hypotheses vol. 9, no.2 the relationship between a change in structure and a change in performance is an important area of study, since the process of changing structure and adopting the m-firm can be very disruptive for a firm. due to the disruptive nature of implementation, it is likely that firms desire to complete a structural change in the shortest possible time period, as the implementation phase might require a time period from one to several years to complete. the difficuilty that a firm encounters in implementing the m-form may be a function of the relationships among its various diversified activities. patterns of interdependence among a firm's functional units are a function of its diversification strategy [22]. an organization can possess from one to three types of interdependence among its parts: pooled, sequential, and reciprocal interdependence ([12], [22]). thompson states that the various types of interdependence are coordinated through different mechanisms. pooled interdependence among units is coordinated most effectively through standardization, sequential interdependence through planning, and reciprocal interdependence through mutual adjustment and feedback among units. the three types of coordination, in the order presented, placed increasingly heavy burdens of communication and decision making on the top management team. the various units in an unrelated diversified firm would predominantly possess a great deal of pooled interdependence. the utilization of the simplest mechanism of coordination, standardization, would be appropriate for a firm utilizing an unrelated diversification strategy. thus, it seems reasonable to assume that a firm using this strategy should have a relatively short m-form implementation time. a vertically integrated firm would exhibit pooled, as well as sequential interdependence, and would utilize planning as the mechanism for coordination for this strategy. following from these theoretical premises, the average transitional time required for structural change would be greater for the vertical integration strategy than for the unrelated strategy. finally, a related diversified firm would tend to possess all three types of interdependence among its units. the most sophisticated mechanism for achieving coordination, mutual adjustment, would seem appropriate for this strategy. mutual adjustment among the firm's various units implies extensive feedback and coordination in order to capture optimal operating efficiency. mutual adjustment involves additional administrative costs and coordination problems, and the effective coordination of the firm's units is often time consuming and difficult to obtain [12]. accordingly, the average transitional time required for related diversified firms to change their structures and adopt the m-form would appear to be greatest for this strategy category. thus, the following is hypothesized: hypothesis 1: the average transitional time period required for unrelated diversified firms to change their structures to the m-form will be shorter than for related diversified firms or vertically integrated firms. fall 1992 williams, lamont & hoffman: impact of firm strategy type 117 hypothesis 2: the average transitional time period required for vertically integrated firms to change their structures to the m-form will be shorter than for related diversified firms. research methods in order to test the hypotheses, an analysis of the transitional period was conducted by examining the length of the implementation period for each firm to complete the structural change to the m-form. this study provided a unique opportunity to apply both qualitative and quantitative research techniques. the qualitative aspect was achieved through personal contact and telephone interviews with company officials having access to information regarding their firm's process of m-form implementation. the factual knowledge, as well as the opinions and "best estimates" of these officials were solicited in order to develop an accurate assessment of each firm's change process. sample the sample consisted of firms pursuing three different strategy categories. the sample was obtained from the firms used in the armour and teece [1] and hoskisson [10] studies, since the prior studies have identified the dates that the sample firms initiated the change to the m-form and the firms' strategies. due to the unavailability of adequate data, four firms were dropped from the sample used in the hoskisson study. the firms included in the sample are presented in table 1, along with the corresponding transitional years that were obtained, as outlined below. table 1: firms aad related strategies l vertically integrated finns alcoa ('66-'68) b.f. goodrich ('50-'53) burlington ('62) cities service ('66) continental can ('50) crown zeuerback ('64-'68) getty oil ('59) int'l paper ('72-'73) kaiser aluminum ('58) kennecott copper ('64-'66) marathon oil ('60-'62) mobil oil ('59) occidental petroleum ('68-'71) phillips petroleum ('73-'74) shell oil ('60) standard oil (calif.) ('54) standard oil (ind.) ('56-'60) standard oil of ohio ('60-'61) st. regis paper ('68-'69) sun oil ('68-'70) union oil ('63) 118 journal of business strategies vol. 9, no. 2 table 1: firms and related strategies (continued) n. related divenilled. finns allied chemical ('71-'72) ashland oil ('67-'69) bendix ('65) borden ('68) burroughs ('66) celanese ('63) coca cola ('67-'68) cpc ('67) dow chemical ('62-'63) general foods ('49-'52) heinz ('67) m. umelated divenilled firms amp ('58) borg warner ('69-'70) brunswick ('69) colt industries ('67-' 68) dart industries ('61-'62) dayco ('66) fmc ('61) gulf & western (' 66-'67) honeywell ('62) mm ('65-'66) ingersoll rand ('63-'64) monsanto (,71) philip morris ('67) proctor & gamble ('66) quaker oats ('71) ralston purina ('68) r. j. reynolds ('69-'70) j. p. stevens ('71) white motor corp. ('68-'69) iti ('68) lear siegler ('62) ogden ('69) textron ('61-'62) u. s. industries ('69) raytheon ('59) scm ('61-'62) note: years in parentheses indicate transitional years. measures the transitional period consists of the period required for the firm to actually complete the change from the f-form, fs-form, or h-form to the m-form. the time period was identified by the formation of a corporate office with associated staff, decentralization to semi-autonomous divisions, and/or the indication of appropriate mform control such as cash flow allocation [11]. the transitional period was measured in ye8ls. identification of the transitional period data were required to determine the exact length of time it took for each firm in the three strategy categories to actually complete the transitional process and fully implement the m-form. this involved extensive qualitative research, and some judgment [16]. the number of years in the transitional period was determined by direct conversation with company archivists and individuals in the firms' investor relations departments, careful examination of annual reports and press releases, and reviews of moody's industria)§: and standard & poor's stock re.ports. fall 1992 williams, lamont & hoffman: impact of firm strategy type 119 the beginning of the transitional period was indicated by a decision by the firm's top management team to adopt the structural change. the decision to change structures was immediately reported in the financial press for 48 of the 58 :firms in the sample. the dates and general contents of the press releases were obtained through telephone conversations and written correspondence with company officials and archivists. data on the remaining 10 firms were obtained through (1) telephone conversations with the firms and (2) analysis of each firm's annual financial reports for the estimated year of change. no discrepancies between the two sources were found. the reliability of the data was aided by using both sources. the end of the transitional period was determined in a similar qualitative manner. company officials provided initial estimates as to the approximate date by which the restructuring had been accomplished. available press releases were obtained to confirm estimates provided by the firm. whenever a conflict arose between the sources as to the exact dates of restructuring, company officials were contacted to reconcile the differences. in the minority of cases (8 out of 62) in which data were unobtainable from one of the two sources (i.e., the firm or the financial press), the firm's financial statements for the selected years were carefully analyzed. in such cases, the year prior to the year in which accounting results were reported based upon a new divisionalized basis, was considered the final year of the transitional period. at this point, four firms were dropped from the sample due to discrepancies about the exact timing of the end of the transition period. based upon the need to rely upon accounting results in some of the cases, it was decided to use entire years as the basic unit of analysis for the length of the transitional period, rather than months. it seemed reasonable to expect the length of the transitional period to covary with firm size, irrespective of diversification strategy or its associated coordination problems. smaller firms may be able to implement the m-form faster than larger firms. 1berefore, the effect of firm size was controlled in the present study by using the firms' yearly sales at the beginning of the m~form transition period as a covariate. the sales figures were obtained from moody's industrials. results and discussion after obtaining the average number of years required by the firms in the sample to implement the m-form, a on~way analysis of covariance technique was used to test for significant differences in transition time for firms in the three strategy categories. the results are presented in table 2. 120 journal of business strategies vol. 9, no.2 table 2: m-fonn implementation time by finn strategy analysis of covariance source between groups comparisons vi vs. ud strategy vi vs. rd strategy ud vs. rd strategy covariate (sales) error (within groups) totals .p < .05 eta2 = .1056 df 2 5.03· 4.18· .39 1 54 57 ss 6.48 .24 54.62 61.34 ms 3.24 .24 1.01 f-statistic 3.20· .24 the results from the analysis provide support for hypothesis 1. unrelated diversified firms completed the transition to the m-form in the shortest time period, 1.40 years. the pairwise results were obtained by using the fisher lsd technique. an analysis of the pairwise contrasts of the transition times between the unrelated diversified firms (1.40 years) and vertically integrated firms (2.24 years), as well as the transition times between the related diversified firms (1.55 years) and vertically integrated firms was found to be statistically significant (p < .05). the difference in transition times between the unrelated and related diversified firms was not significant hypothesis 2 was not supported,. as related diversified firms were able to complete the transitional period more rapidly than the vertically integrated firms. it might be surmised that the large number of oil companies represented in the sample of vertically integrated firms might have heavily influenced the findings of this study, as well as the findings of the hoskisson study. this is because vertical integration within the oil industry implies vast and complex linkages between the various units connecting the production facilities to the elements of the distribution chain. it seems logical that changing to the m-form would be more difficult in such a scenario and would require a longer time period to adjust and bring together the various units with their own input and output requirements. this might explain the findings of the present study that, contrary to theory, vertically integrated fmos required the longest time periods to change their structures. this study has several limitations that should be considered. the use of a relatively small sample size is a possible limitation to the generalizability of the findings. an additional limitation involves the time frame 'of the study, as most firms in the sample adopted the m-form during the 1960's. with expanded information processing and decision making capabilities, firms in the 1990's might be able to restructure at more rapid speeds, with strategy type playing a reduced role in the process. due to factors not measured in this study, alternative explanations for the findings cannot be ruled out. as alluded to above, a firm's ability to implement the m-form fall 1992 williams, lamont & hoffman: impact of firm strategy type 121 may vary as a result of industry type, in addition to the influence of strategy type. industry type may be a significant moderating variable of strategy type. also, the quality of a finn's management and its ability to manage change might be a major factor influencing the results. these important issues await further research. conclusions the findings indicate that the time required for firms to implement the m-form is usually much longer than the one year period indicated in prior research. major structural reorganizations, such as the adoption of the m-form, apparently takes years, and sometimes several years, to complete. implementation time is an apparently important factor for researchers interested in the performance effects of such major structural changes. the results also indicate that implementation time varies by diversification strategy, providing an expanded explanation for hoskisson's [10] earlier findings. the combined results from the two studies show that vertically integrated firms had the poorest postchange performance, and at the same time required the longest time period to complete the structural change. the combined results also show that the related diversifiers had slightly better post-change performance than the vertically integrated firms and required less time to complete the change. finally, these results indicate that the unrelated diversifiers had the greatest improvement in post-change performance, while requiring the shortest time period to complete the change. the performance effects of m-form adoption, therefore, may depend upon diversification strategy, as it affects the length of the implementation time. the findings of the study should also prove useful to top managers contemplating m-form adoption. major structural reorganizations obviously take time, but the length of time may depend on the firm's diversification strategy. to the extent that transition time is a function of the complexity of the coordination problems that need to be resolved, it seems that structural reorganizations for vertically integrated firms may be far more complex and time-consuming than those for related and unrelated diversifiers. it would be prudent for managers of vertically integrated firms to weigh the possible benefits of m-form adoption against the costs to their time and energy, especially when it may be for protracted periods. the findings of this study, combined with those of hoskisson [10], also suggest that managers should attend to the possible performance effects of transition time. of . the firms that hoskisson identified as achieving the greatest performance gains from implementing the m-form, we found that they also managed the transition much more rapidly than other firms. while still speculative, faster may be better. anecdotal evidence ([3], [23]) indicates that major reorganizations can be very tumultuous and stressful for organization members, causing major disruptions in operations and subpar performance. the longer the transition time, the longer may be the period of subpar performance, combined with greater delays in achieving the performance benefits of the new structural form. to avoid excessive delays in m-form implementation and 122 journal of business strategies vol. 9, no.2 the negative consequences that may result, top management can take a more active role in speeding the implementation process. this may be especially critical in firms pursuing strategies that may otherwise require lengthy transition periods, such as vertically integrated or related diversified firms. in this study, previous assumptions about m-form implementation time were empirically examined, and contrary evidence was found. it seems useful for future research on the implementation of the m-form to examine the independent and joint effects of diversification strategy and implementation speed on firm performance. larger sample studies that could examine the possible moderating effects of industry, top management characteristics, and information technologies also appear to be warranted. overall, it is hoped that this study represents a useful extension of our understanding of m-form implementation and provides a basis for future research on this important topic. references 1. armour, h.o. and teece, dol. "organizational structure and economic performance: a test of the multidivisional hypothesis." bell journal of economics. vol. 9 (1978), pp. 106-122. 2. bettis, ra and hall, w.k. "diversification strategy, .aa:ounting determined risk, and accounting determined return." academy of many:ement journal. vol. 25 (1982). pp. 254-264. 3. chandler, ad. stratek! and structure. boston: the mit press (1962). 4. cheney, p.h. and dickson. g.w. "organizational characteristics and information systems." academy of manakement journal. vol. 25 (1982), pp. 170-184. 5. daft, r. l. and lengel, r.h. "organizational information requirements. media richness and structural design." manakement science. vol. 32 (1986). pp. 284-295. 6. dundas, k.m. and richardson. p.r. "implementing the unrelated product strategy." stratekic management journal, vol. 3 (1982). pp. 287-301. 7. galbraith. j. "organizational design: an information processing view." interfaces (1973). pp. 18-37. 8. galbraith. j.r. and kazanjian, r.k. stratek! implementation: structure. systems.. and process. sl paul: west publishing co. (1986). 9. hall, d. and saias, m. "strategy follows structure!" strate.pc manqement journal. vol. 1 (1980), pp. 149-163. 10. hoskisson. r.e. "multidivisional s~cture and performance: the contingency of diversification strategy." academy of management journal, vol. 30 (1987), pp. 625-644. fall 1992 williams, lamont & hoffman: impact of firm strategy type 123 11. hoskisson, r.e., harrison, j.s. and dubofsky, da "capital market evaluation of mform. implementation and diversification strategy." straten manas:ement journal, vol. 12 (1991), pp. 271-279. 12. jones, g. and hill, c. "transaction cost analysis of strategy structure choice." sid.: tegic management journal, vol. 9 (1988), pp. 159-172. 13. michel, a and shaked. i. "does business diveisification affect performance?" eiuo:. cia1 manas:ement, vol. 13 (1984), pp. 18-25. 14. moody's industrials. new york: moody's investors service, inc. 15. palmer, d., friedland, r., jennings, p.o. and powers, m.e. "the economics and politics of structure: the multidivisional form. and the large u. s. corporation." adminjstrative science quarterly, vol. 32 (1987), pp. 25-48. 16. pettigrew, am. "longitudinal field research on change: theory and practice." ora: nization science, vol. 1 (1990), pp. 267-292. 17. ramanujam. v.and varadarajan, p. "research on corporate diveisification: a synthesis." strateac manamnent journal. vol. 10 (1989). pp. 523-551. 18. rumelt, r.p. straten structure and economic performance. boston: harvard university (1974). 19. scherer, f.m. industrial market structure and economic performang::, chicago: rand mcnally (1980). 20. shepherd, w.g. market power and economic welfare. new york: random house (1970). 21. standard & poor's stock re.ports. new york: standard & poor's corp. 22. thompson, j. d. qrpniutions in action. new york: mcgraw-hill (1967). 23. tushman, m.l., newman, w.h., and romanelli, e. "convergence and upheaval: managing the unsteady pace of organizational evolution." california mana&mnmt review. vol. 29, (1986), pp. 1-16. 24. williamson, o.e. "the multidivisional structure." in j. barney and w. quebi (eds.). oipnizatjonal economics. san francisco: jossey-bass (1986). pp. 163-187. the impact of firm strategy type on transition time for m-form adoption why good things never seem to last: a dialectic perspective for long-term competitive advantage john a. parnell memphis state university memphis, tennessee augustine lado cleveland state university cleveland, ohio peter wright memphis state university memphis, tennessee introduction central to much of the strategy literature is the concept of sustainable competitive advantage ([4], [22], [23], [27]). however, a great deal of the research has adopted a static equilibrium view of competitive advantage and does not address whether or not competitive advantage can be sustained over time ([3], [7], [26]). this framework of analysis has often led to the belief that certain strategies are optimal in and of themselves and can lead to sustained superior perfonnance. thus, scholars have suggested that strategies emphasizing facets such as innovation [20], product differentiation [22], and quality [5], are means through which fmns may achieve sustained success. however, there is no guarantee that today's successful strategy will continue to yield benefits for the firm tomorrow. competitive advantage that is realized through the implementation of business strategy may not last indefinitely. while this phenomenon has been observed in practice, extensive attempts have not been made to explain why competitive advantage may not be sustained. this paper proposes that a beneficial strategy itself may simultaneously start a process which will culminate in the creation of its own disadvantage, leading to inferior perfonnance. that is, past or present organizational strategies that generate advantage may become sources of competitive disadvantage and organizational failure in the future. a basic premise of this paper is that a beneficial strategy may not be sustainable indefinitely. further, the emphasis placed on short-run perfonnance by some managers can actually prove counterproductive in the long run. the application of dialectical logic to strategy provides a justification for these tenets. first, an overview of the philosophy of dialectic inquiry is presented. then, the dialectic logic is applied to explanations of the notions of organizational strategy and sustained competitive advantage. finally, managerial implications are offered. spring 1992 parnell, £ado, & wright: why good things never seem to last 63 dialectic inquiry dialectic inquiry may be viewed as a correct means or manner for approaching greater understanding of phenomena [24]. a central tenet of this philosophy is the contention that there is no meaning without knowledge of an opposite [1]. left takes on meaning when it is viewed within the left-right context, good is only appreciated within the good-evil context, and so on. however, opposing ideas, alternatively refened to as thesis and antithesis, are predisposed to merge and become one, according to the dialectic logic. the newly merged idea (synthesis) must, to obtain meaning, subsequently create its own opposite. as is evident, this process continues, each iteration bringing one closer to the truth. absolute truth may never be attained but is pursued through the dialectical contradictions of theses and antitheses with their subsequent resolutions into syntheses [1]. thus, in the dialectic system of thought, no state of being is sustainable, even when managers might be aware of the environmental changes that may impact their strategies. although environmental scanning may enhance strategic decision making, it may place too much emphasis on information acquisition for coordination and control. however, since the procurement of infonnation about environmental changes does not prevent these changes from occurring, a series of short run successes and failures is inevitable. these short ron successes and failures are part of an essential process that will culminate in long term success. however, a series of short-term organizational successes may blind managers to the fact that "this prosperity, this pursuit of the good life will eventually bend back on itself and fracture before [them]" [29, p. viii]. on a broader philosophical front, vandenbrook warns: "but life, disconcertingly and reassuringly, is bigger than straight line logic; it confonns with a kind of curved logic which turns things around and often, before you become aware of it, turns them into their opposites. pacifists become militants. freedom fighters become tyrants. blessings become curses. labor saving devices become intolerable burdens. help becomes hindrance. more becomes less." [29, p. viii]. dialectics and organizational strategy a number of studies have supported the application of dialectical inquiry to strategy ([10], [15], [17], [18]). these studies have typically involved the development and presentation of conflicting strategies by management. opposing strategic alternatives are then integrated into a merged strategy which is supposedly superior to either of the original strategic alternatives. the merging process results from a debate among opposing parties and is facilitated by a third party, usually a manager, management team, or consultant. 64 journal ofbusiness strategies vol. 9. no.1 dialectic logic offers an explanation as to why the high business perfonnance of today may lead to poor perfonnance tomorrow. for example, a series of continued successes with a particular technology may result in a feeling of grandeur and invulnerability among members of the top management team [13]. this may lead to an unyielding strategic commitment to that technology. the technology that has led to success may tum out to be the organization's achilles' heel. thus, underwood, the leading player in mechanical typewriters, became so committed to the mechanical technology that it was blinded to technology leading to the introduction of electric typewriters and word processors. success that is technology-based may result from heightened innovation, but this may also lead to an over-commitment of organizational resources to a technology that will eventually become obsolete. as another example, texas instruments, once clearly the technological leader in the electronics and semiconductor industry, became blinded by its technological prowess to new rules of international competition (especially from japanese firms). the finn became vulnerable to the very technology that propelled it to its original leadership position. as yet another example, consider the plight of the united states textile industry. a common strategy has been for ftnns to establish plants in mrallocations to enjoy total control over an economical labor force. these low labor costs translated into success for a number of these firms. however, plants were often moved as low morale, unionization efforts, and complaints of poor working conditions mounted. while these finns were not pursuing process and quality-related innovations, foreign producers began to capitalize on even lower labor costs abroad. thus. the cost-driven strategy that resulted in a series of short-run successes for many irrms in the textile industry eventually led to the dissolution of many of these same finns. to extend these thoughts, let us consider the concept of organizational culture. barney [3] has proposed that one such attribute, organizational culture, can be a source of sustained competitive advantage, citing three characteristics of such a culture. frrst, the culture must be valuable to allow the ftnn to behave in ways that add ftnancial value. second, the culture must be rare and have attributes and characteristics not typically found in other finns. third, the culture must be imperfectly imitable. not allowing for duplication by competitors. this perspective focuses on developing a rare and valuable culture, with barriers to imitation that would result in sustainable competitive advantage. however, a culture that possesses these attributes may not generate sustainable competitive advantage. as a point of illustration, a culture that drives a successful diversification strategy may subsequently result in failure. that is, a finn that has adopted a diversiftcation strategy may demonstrate superior perfonnance for a period of time. as the company continues to grow, increased complexity associated with the numerous acquisitions can ultimately lead to its lower perfonnance [14]. alternatively, another ftnn· s culture that drives a successful internal growth strategy would have focused on its core business. however, this may lead to the continuous rejection of acquiring potentially profttable alternative businesses, leading to lower perfonnance in the future. thus, from a dialectic perspective. any strategy that provides initial competitive advantage may also lead to its own demise. dialectic logic requires spring 1992 parnell, lado, & wright: why good things never seem to last 65 that competitive advantage be viewed as a long run ideal that can only be pursued intermittently through short run successes that bring about failures that in turn lead to subsequent intermittent successes. culture is but one of many attributes that has been linked to sustainable success. participative management techniques have also been linked to superior perfonnance in the literature [9]. it has been suggested that subordinate participation improves decisionmaking effectiveness( [7], [9]). others have proposed that organizational effectiveness increases as the firm evolves toward a consensus approach [16]. however, participative decision making may lead to perceived managerial power loss and an inability to effectively implement future decisions that may be difficult or unpopular ([20], [28]). thus, the notion of full consensus as a necessary requirement for effective decision making may be flawed in that its realization can result in a decline in organizational effectiveness. just as internal (dialectic) change can turn success into failure, external forces in the environment, including competitors' strategies, can also undermine the prevailing prosperity. consider the tire manufacturer that develops and markets an economical tire that never needs replacement. competitors will likely follow suit with similar versions while the lack of repeat business results in a smaller market for tires. thus, the initial success enjoyed by the innovative ftml is replaced by failure. however, a manager who considers the likely long-term environmental and competitive responses to strategic alternatives may choose to forego strategies with short-run prospects for success in favor of those with long-run viability. in sum, dialectics may be viewed as the underlying mechanism that transforms successes into failures, and failures into successes. therefore, an enhanced understanding of this process is critical to the promotion of managerial behaviors that will engender long-run firm success. for example, strategic managers of successful businesses may become apathetic, ignorant of details, or may simply pay less attention to customers. an innovative firm may be successful in the short term through its fluid process, but may subsequently fail because an effective organizational structure is not established to meet its need for structural growth. likewise, another firm may also reap success from the introduction of an innovative product line. however, if strategic managers in the firm develop entrenched structures to support this product line, failure is imminent when future innovations by competitors render the product line and the accompanying structure obsolete. dialectics offers a key warning to strategic managers: reliance on the factors believed to have resulted in current organizational success will eventually lead to organizational failure. the road to long-term success is not necessarily a replication of short run successes. in the long run, dialectics is associated with success. however, this success can only be realized through a of series short-run successes and failures. implications for managers from the application of the dialectic logic to organizational strategy and competitive advantage, at least four managerial implications may be drawn. first, managers should 66 journal ofbusiness strategies vol. 9, no.1 recognize the danger of commibnent to the status quo. dialectic logic suggests that the prevailing formula for superior performance may itself become the cause of subsequent inferior performance. in other words, the assumption that implementation of a previously successful strategy will continue to result in superior performance runs counter to the dialectic perspective. just as chickens do not mistrust the farmer who has always fed and housed them, too many managers do not fear the roots of the strategies that have initiated their present successes. second, continuous qualitative change in strategy is essential if competitive advantage is to be enjoyed over the long term. managers can be instrumental in promoting qualitatively driven changes within their organizations [11]. the skeptics among the managers should be reminded that the beginning of life also marks the beginning of death, both in biological organisms and in organizations. however, at least in the case of organizations it is possible to suspend the process of decline through the managerial action leading to organizational renewal and revitalization. as donun and byles [8, p. 67] stated, "strategy formulation and implementation are more of a complex and inexact art than a science." proactive managers, through questioning and testing their strategic assumptions, can discern impending threats (antitheses), and translate them into opportunities. through "envisioning," they may steer their organizations toward new directions and new sets of assumptions [12]. by channeling rewards to innovative members, managers can assure organizational commibnent and engender organizational renewal and vitality [30]. managers may also select prospective employees who are innovators and who will actively promote the formulation and implementation of innovative strategies. third, according to the dialectic logic, prolonged success results from a series of short-run failures and successes. efforts to extend the factors that lead to short-run prosperity inevitably lead instead to organizational decline. thus, short-run failures may be just as much a requirement for long-run success as short-run successes. finally, the dialectic logic implies that a disproportionate concern with short-run profits can lead to organizational demise. thus, strategic managers should consider the long-term ramifications of their strategies. managers should also anticipate that at times, short-term losses may be necessary in order to invest in research and development upon their fruition, these invesbnents, as well as restructuring and efforts in qualitative improvements, can enable the firm to prosper in the future ([2], [19]). in summary, strategic managers should not panic in the face of short-run failures. conversely, they should not celebrate and become arrogant in the face of short-run successes. in the context of a long-term orientation, short-run successes and failures tend to be inevitable. the opposing forces of successes and failures can ultimately lead to a renewed organization. only by viewing success and failure within their appropriate temporal context can managers unlock the potential for their organization's renewal and vitality. spring 1992 parnell, lado, & wright: why good things never seem to last 67 references 1. adler, mj. dialectic. new york: harcourt, brace (1927). 2. aiken. m. and hage, j. "the organic organization and innovation." sociology, vol. 5 (1971), pp. 63-82. 3. barney, j.b. "organizational culture: can it be a source of sustained competitive advantage?" academy of manasement review. vol. 11 (1986a), pp. 656-665. 4. barney, j.b. "strategic factor marlcets: expectations, luck, and business strategy." manaaement science, vol. 32 (1986b), pp. 1231-1241. 5. buzzell, r. and gale, b. the pims principles. new york: free press (1987). 6. camerer, c. and vepsalainen, a. "the economic efficiency of corporate culture." strateeic manaeement journal, vol. 9 (1988), pp. 115-126. 7. dickson, j.w. ''top managers' beliefs and rationales for employee participation." human relations, vol. 35, no.3 (1982), pp. 203-217. 8. domm, d.r., and byles, c.m. "strategic success and member commitment." journal of business stratelies, vol. 7 (1990), pp. 67-75. 9. driscoll, j.w. ''trust and participation in organizational decision making as predictors of satisfaction." academy of management journal. vol. 21, no.1 (1978), pp.44-56. 10. emshoff, j.r. and finnel, a "defining corporate strategy: a case study using strategic assumptions analysis." working paper no. 8-78, university of pennsylvania, philadelphia (1978). 11. fiol, c.m. "managing culture as a competitive resource: an identity-based view of sustainable competitive advantage." journal of management, vol. 17 (1991), pp. 191-211. 12. hanna, d.p. designine or£anizations for high performance. reading, ma: addisonwesley (1988). 13. janis, il. victim!! of groqpthink. boston: houghton-mifflin (1972). 14. kusewitt, i.b., ir. "an exploratory study of strategic acquisition factors relating to performance." strate&ic management iouma1 vol. 6 (1985), pp. 151-169. 15. laurenco, s.v. and glidewell, i.c. "a dialectical analysis of organizational conflict" administrative science quarterly. vol. 20 (1975), pp. 489-508. 68 journal ofbusiness strategies vol. 9, no.1 16. likert, j.g., and araki, c.t. "managing without ~ boss: system five." leadership and organization development journal, vol. 7, no.3 (1986), pp. 17-20. 17. mason, rd. "a dialectical approach to strategic planning." management science, vol. 15 (1969), pp. b403-b414. 18. mitroff, 1.1., barabba, v.p., and kilmann, rh. "the application of behavioral and philosophical technologies to strategic planning: a case study of a large federal agency." management science, vol. 24 (1977), pp. 44-58. 19. pearce, j.l. and delbecq, a.l. "organization structure, individual attitudes, and innovation." academy of management review, vol. 2 (1977), pp. 27-37. 20. peters, t.j. and watennan, r.h., jr. in search of excellence. new york: warner books (1982). 21. pollock. m. and colwill, n.l. "participatory decision making in review." leadership and organization development journal. vol. 8, no.2 (1987), pp. 7-10. 22. porter, m.e. competitive advantage. new york: free press (1985). 23. reed, r and defillippi, ri. "causal ambiguity, barriers to imitation, and sustainable competitive advantage." academy of management review, vol. 15 (1990), pp. 88-102. 24. rychlak, j.f. (ed.). dialectic: humanistic rationale for behavior and sevelqpment new york: s. krager (1976). 25. schein, b.h. "organizational culture." american psychologist. vol. 45, no.2 (1990), pp. 109-119. 26. schoemaker, pj.h. "strategy, complexity, and economic rent" management science, vol. 36 (1990), pp. 1178-1192. 27. siehl, c. and martin, j. "organizational culture: a key to financial performance?" in b. schneider (ed.), organizational culture and climate. san francisco: jossey-bass (1990), pp. 241-281. 28. tannenbaum, a.s. "control structure and union function." american journal of sociology, vol. 61 (1956), pp. 536-545. 29. vandenbrook, g. (ed.). less is more: the art of voluntaiy poverty. new york: harper & row (1978). 30. walton, r. innovating to compete. san francisco: jossey-bass (1987). why good things never seem to last: a dialectic perspective for long-term competitive advantage building commitment through strategic involvement: the mediating role of procedural justice mary lemons university of tennessee-martin martin, tn j. barry gilmore the university of memphis memphis, tn abstract although many researchers assert the importance of involvement in strategic planning for gaining employee commitment to strategic formulation and implementation, neither the existence of this relationship nor the strength of the effect of involvement on commitment is clear. using a sample of top-, middle-, and lower-level managers, this study found significant results which suggest that proceduraljustice partially mediates the relationship between strategic involvement and commitment. building commitment through strategic involvement: the mediating role of procedural justice strategic management theorists assert that planning is an essential tool for managers (herold, 1972; malik & karger, 1975; oswald, mossholder, & harris, 1994, 1997; thune & house, 1970). however, most planning research examines the differences in performance between planners and non-planners with little attention given to the actual planning process (rhyne, 1986). this is an unfortunate occurrence as much criticism revolves around the manner in which planning is carried out (rhyne, 1986). in addition, researchers suggest the importance of involvement in the strategic planning process for obtaining commitment to strategic formulation and implementation (oswald, et ai., 1994). nevertheless, little empirical research addresses why or how strategic involvement may enhance employee commitment. because "successful strategy formulation and implementation require the commitment and involvement of managers at all levels" (oswald et ai., 1994: 477), it is important that researchers fully understand the relationship between these variables (mintzberg, 1990; rhyne, 1986). one concept that may partially explain the relationship between strategic involvement and organizational commitment is procedural justice. procedural justice in strategic planning refers to the perceived fairness of the procedures 92 journal of business strategies vol. 15, no.2 used during the planning process (greenberg, 1990). although labeled "process control" or "voice," involvement is a key component in procedural justice perceptions (bies, 1987; greenberg, 1990; leung & li, 1990). process control refers to the opportunity participants have in communicating their views and opinions in a decision-making process. the greater the process control allowed to participants, the more likely they regard the decision-making procedures as fair (leung & li, 1990). thus, as employee involvement in the planning process increases, perceptions of procedural justice in strategic planning should also increase. most procedural justice research has examined the effect of justice perceptions on employee attitudes, revealing that procedural justice affects many important outcomes, such as employee commitment (robertson, lies, gratton, & sharpley, 1991; sweeney & mcfarlin, 1993), job satisfaction (dailey & kirk, 1992; mcfarlin & sweeney, 1992), pay satisfaction (folger & konovsky, 1989; mcfarlin & sweeney, 1992; sweeney & mcfarlin, 1993), intent to turn over (dailey & kirk, 1992), and post-hire attitudes and behaviors (e.g., recommendation intentions) (gilliland, 1993, 1994). one area that has received little attention, however, concerns the importance of justice perceptions in strategic planning. because researchers suggest that justice in the workplace may be a stronger predictor of behavioral manifestations (e.g., intent to turnover) than core work attitudes (dailey & kirk, 1992), it is important that companies recognize the factors that can lead to perceptions of workplace justice and their potential impact. thus, the purpose of this study is to examine the significance of procedural justice in the relationship between involvement in strategic planning and organizational commitment. specifically, it is proposed that procedural justice acts as a partial mediator in the relationship between these variables. theoretical foundation strategic involvement and organizational commitment the significance of both strategic involvement and organizational commitment have been examined in previous literature (floyd & wooldridge, 1992; guth & macmillan, 1986; kim & mauborgne, 1993; oswald et al., 1994; rhyne, 1986; wooldridge & floyd, 1990). organizational commitment refers to the strength of employees' identification with and involvement in the organization. commitment may be characterized by three factors: (1) acceptance of the goals and values of the organization; (2) the willingness to exert effort for the sake of the organization; and (3) the desire to remain a member of the organization (cammann, fichman, jenkins, & klesh, 1983). research indicates that low organizational commitment may contribute to high employee turnover (blau & boal, 1989; gaertner & nollen, 1989; meyer & allen, 1991; shore & martin, 1989; steers, 1977). factors influencing organizational commitment can be grouped into three categories: personal characteristics, such as age or education; job characteristics, fall 1998 lemons & gilmore: building commitment 93 such as task identity or feedback; and work experiences, such as group attitudes or organizational dependability (steers, 1977). many studies have examined the personal characteristics and job characteristics that might influence organizational commitment. for example, some researchers have found age to be positively related to commitment (steers, 1977) while marsh & mannari (1977) conclude that age, seniority, and job prestige are positively related to commitment. job characteristics that have been connected to organizational commitment include job involvement (blau & boal, 1989), the opportunity for optional social interaction while completing tasks (steers, 1977), and job scope (marsh & mannari, 1977). job involvement particularly affects work-related attitudes such as organizational commitment by playing a significant role in determining how employees view the psychological contract between themselves and the organization (farrell & stamm, 1988; hackett & guion, 1985). work experiences can also be "a major socializing force" that impacts the psychological attachment an employee might feel toward an organization (steers, 1977:48). for example, group attitudes toward an organization and perceptions of personal investment and personal importance to an organization may influence commitment, whereas organizational dependability and trust are also important factors. in addition, rewards and the realization of expectations are positively related to organizational commitment, and a significant negative relationship exists between commitment and racial and sexual discriminatory behaviors (niebuhr, 1992). research suggests that involving managers at all organizational levels in the strategic planning process may result in higher organizational commitment (oswald et ai., 1994). for example, involvement in strategic planning may increase employees' psychological attachment to the organization by increasing their organizational commitment, job satisfaction, and job involvement (oswald et al., 1994). dess (1987) asserts that involvement also enhances commitment to strategic implementation by providing opportunities for shared under,<;tanding. commitment may be enhanced by involvement through the disclosure of strategic information and strategic preferences (floyd & wooldridge, 1992). finally, a lack of strategic commitment may cause managers not to give implementation the attention necessary for success, while in some cases low commitment may cause managers to actually sabotage organizational strategy (guth & macmillan, 1986). thus, organizational commitment may influence compliance oftop managers regarding corporate strategies (kim & mauborgne, 1993). research indicates that employee involvement in the strategic planning process may influence levels of employee commitment; however, neither the existence of this relationship nor the strength of the effect of involvement on commitment is clear. because "mediators speak to how or why such effects occur" (baron & kenny, 1986: 1176), this study proposes that procedural justice partially mediates this relationship. procedural justice may be said to be a partial mediator if it partially accounts for the relation between involvement and commitment (baron & kenny, 1986). should this proposition prove true, the results herein should 94 journal of business strategies vol. 15, no.2 provide a deeper understanding of the importance of involvement for successful strategic planning. procedural justice: the partial mediation role procedural justice emerged as an attempt to describe the role of fairness in the workplace (greenberg, 1990). procedural justice, originally proposed by thibaut and walker as the result of a series of reactions to dispute-resolution processes, refers to the fairness or equity of the procedures used to make decisions or distribute rewards. as additional research was conducted in this area (for reviews, see lind & tyler, 1988; tyler, 1987), it became clear that thibaut and walker's findings were reflective of a more general tendency across a variety of settings. recent research in the area of procedural justice has examined a variety of themes, including survivors' reactions to layoffs (brockner et ai., 1994), employee reactions to selection decisions (gilliland, 1993, 1994), employee reactions to pay freezes (schaubroeck, may, & brown, 1994) and the effect of justice perceptions on organizational citizenship behaviors (bazerman, schroth, shah, diekmann, & tenbrunsel, 1994). strategic involvement may be important to perceptions of procedural justice because involvement relates to the procedural variable of process control. process control (or "voice") refers to allowing participants who might be affected by a decision to present information relevant to that decision (folger & greenberg, 1985). procedures granting some control over the process and outcome attainment tend to be perceived by participants as fairer than procedures that deny process control (greenberg, 1990). when the process is considered fair, participants are more likely to accept the authority's decision (lind, kulik, ambrose, & de vera park, 1993). in addition, when decision-makers communicate ajustification for the decision reached and the decision-maker is considered sincere, participants view the process as more fair (bies, 1987; richard & kirby, 1997). in the case of strategic planning, procedures used to make decisions include obtaining input from lower and middle-level managers by conducting formal or informal meetings or by requesting oral or written reports. employees allowed to participate in the formulation of strategic plans for the organization because of these procedures are more committed to and accepting of the final decisions regarding the plans for the organization (korsgaard, schweiger, & sapienza, 1995; oswald, mossholder, & harris, 1997). because commitment is necessary for managerial compliance, this can be especially important for successful strategic implementation (guth & macmillan, 1986). in their study of global strategy implementation, kim & mauborgne (1991) found that procedural justice of the global strategy formulation process affects commitment, trust, and social harmony as well as outcome satisfaction in subsidiary top managers. korsgaard and colleagues found that perceived fairness also partially mediates the effects of consideration and influence on decision commitment (korsgaard et ai., 1995). thus, procedural justice may enhance compliance fall 1998 lemons & gilmore: building commitment 95 directly and indirectly through the attitudes of commitment, trust, and outcome satisfaction (kim & mauborgne, 1993). on the other hand, perceptions of unfair procedures in strategic planning caused by a lack of involvement, may lower organizational commitment which, in turn, may lead to negative organizational outcomes such as absenteeism and turnover (aquino, griffeth, allen, & hom, 1997; hackett & guion, 1985; marsh & mannari, 1977). previous studies have established a positive relationship between procedural justice and organizational commitment (dailey & kirk, 1992; konovsky & folger, 1987; sweeney & mcfarlin, 1993), as well as a positive relationship between strategic involvement and organizational commitment (kim & mauborgne, 1991, 1993; korsgaard et a1., 1995; oswald et a1., 1994). this research is based on direct effects, whereby procedural justice is hypothesized as a direct antecedent of commitment and involvement is hypothesized as a direct antecedent of organizational commitment. little empirical research exists, however, to support the mediating role, or indirect effects, of procedural justice in the relationship between strategic involvement and organizational commitment. on the other hand, the studies mentioned above offer indirect support (kim & mauborgne, 1991, 1993; korsgaard et a1., 1995; oswald et a1., 1994). this study proposes that procedural justice is (1) an important partial mediator of the effects of strategic involvement on organizational commitment and (2) a more potent predictor of organizational commitment than strategic involvement. this is not to imply that the direct effect of strategic involvement on organizational commitment is insignificant; rather, the proposition is that the direct effect of strategic involvement on organizational commitment after controlling for procedural justice is mostly marginal compared with its "before" effects (e.g., before partialing the mediated effect of procedural justice). in this sense, procedural justice partially mediates the relationship between strategic involvement and organizational commitment. the following hypothesis was developed to test this proposed relationship. hypothesis i: perceptions of procedural justice in strategic planning panially mediate the relationship between strategic involvement and organizational commitment. method subjects the sample for this study consisted of top-, middle-, and lower-level management employees (deans, department chairs, and administrators) working fulltime at two large southern universities. the questionnaires were sent via campus mail along with a letter explaining the study and a self-addressed return envelope. of the 434 distributed questionnaires, 204 were returned (76 female, 129 male) for a response rate of 47 percent. although the letter explained that the survey 96 journal of business strategies vol. 15, no.2 was confidential, several respondents elected to use their own return envelopes, emphasizing the sensitive nature of the data. an examination of the data revealed that 63 percent of the respondents were over the age of 40, 86 percent had worked at the universities for three years or more, and 72 percent held graduate degrees. of the 204 respondents, 46 held upper-level positions, 99 held middle-level positions and 60 held lower-level positions. measures strategic involvement to measure strategic involvement, a modified version of oswald et al.'s (1994) involvement scale was used. this scale makes four statements regarding the extent of employees' involvement in the strategic planning process within their organization. subjects were asked to rate the extent they agree or disagree with each statement on a seven-point likert scale (1=strongly disagree, 7=strongly agree). one of the statements is reverse-coded to reduce the possibility of response set bias. strategic plans were described to the respondents in this study as plans formulated to achieve the goals of the organization (e.g., new markets, firm growth). an example of the scale format is: "currently, 1 am greatly involved in strategic planning for the organization." using cronbach's alpha, reliability for this scale was .90 in this study. procedural justice to measure procedural justice, a five-item scale was developed using a format similar to the price & mueller (1986) distributive justice index. the items were based on prior research in this area and included statements regarding the extent of communication, consistency, opportunity to refute the views of their superiors, and feedback. a similar study examining the mediating role of procedural justice used the same format and obtained reliability of .96 (korsgaard et ai., 1995). procedures used during the strategic planning process were broadly defined, with meetings and written reports listed as examples. an example of the item format is: "considering the extent of communication between you and your superior regarding strategic plans for your organization, how fair are the procedures used in strategic planning?" (l=very unfair, 5=very fair). using cronbach's alpha, reliability for the scale in this study was .94. organizational commitment organizational commitment was assessed using mowday & steers' (1979) organizational commitment questionnaire (ocq). this instrument consists of fifteen items, nine which are positively scored and six which are negatively scored. again, reverse-coding reduces the possibility of response set bias. the items ask workers to express their agreement or disagreement with various statements (e.g., "i am willing to put in a great deal of effort beyond that normally expected in fall 1998 lemons & gilmore: building commitment 97 order to help this organization be successful"), using seven-point scales (l=strongly disagree, 7=strongly agree). reliability for the scale in this study using cronbach's alpha was .89, which was comparable to previous studies. analysis and results table 1 shows the descriptive statistics, reliabilities, and correlations for the study's variables. with mediation models, the independent variable (strategic involvement) is assumed to cause the mediator (perceptions of procedural justice); thus, these variables should be highly correlated (alwin & hauser, 1975; baron & kenny, 1986; james & brett, 1984; rozeboom, 1956). as can be seen in table 1, the correlation between these variables is .61 (p < .00 1), which does indicate possible mediation. on the other hand, the dependent variable (organizational commitment) must not cause the mediator variable (justice perceptions). theory indicates that these are different and independent constructs (korsgaard et ai., 1995; mcfarlin & sweeney, 1992). in addition, sweeney and mcfarlin (1993) used path analysis to test the relationship between justice and commitment. the findings of these researchers also suggest the possibility of a mediational chain in the hypothesized direction. generally speaking, to test a mediational hypothesis, it has been suggested that one should estimate a series of three regression models (baron & kenny, 1986). first, the mediator variable must be regressed on the independent variable. second, the dependent variable is regressed on the independent variable. third, the dependent variable is regressed on both the mediator and the independent variable. these three equations provide the test for mediation. to provide support for the mediation model, the independent variable must affect the mediator in the first equation, the independent variable must affect the dependent variable in the second equation, and the mediator must affect the dependent variable in the third equation. when these conditions hold in the predicted direction, the effect of the independent variable on the dependent variable must be less in the third equation than in the second equation. for perfect mediation, this relationship will vanish entirely; with partial mediation, the independent variable still affects the dependent variable, but in a significantly reduced fashion (venkatraman, 1989). table 2 presents a more dynamic picture ofthe relationship among this study's variables. because managerial level and tenure might be expected to covary with involvement and commitment, the scheffe multiple range procedure was employed. the only significant difference revealed was between managerial level and level of involvement, with higher involvement levels reported by upper-level and middle-level managers than by lower-level managers. thus, the calculation of each equation included level of management as a control variable (see footnote at the bottom of table 2). using a series of multiple linear regression models, three equations were estimated. 98 journal of business strategies table 1 vol. 15, no.2 mean std.dev. rei. commit justice involve commit 5.31 .96 .89 1.00 justice 3.69 1.03 .94 .50*** 1.00 involve 5.34 1.02 .90 .52*** .61*** 1.00 *** significant at the .001 level, two-tailed test table 2 f value l r2 beta of involvement equation 1 f(2.202) =46.82*** .31 .40 equation 2 f(2.202) =26.68*** .22 .30 equation 3 f(3,201l =23.70*** .29 .19 *** significant at the .001 level, two-tailed test equation i = strategic involvement procedural justice equation 2 = strategic involvement organizational commitment equation 3 = strategic involvement procedural justice organizational commitment e and r2 values are reported after controlling for managerial level. first the mediator variable (procedural justice) was regressed on the independent variable (strategic involvement) to yield an r2 of .31, which was statistically significant (i!. < .001). thus, strategic involvement accounted for 31 percent of the variance in procedural justice. second, organizational commitment was regressed on strategic involvement to yield an r2 of .22, which was also significant (i!. < .001). this equation indicated that strategic involvement accounted for 22 percent of the variance in organizational commitment. finally, organizational commitment was regressed on both procedural justice and strategic involvement to yield an r2 of .29, which was statistically significant (i!. < .001). fall 1998 lemons & gilmore: building commitment 99 in a mediation model, the effect of the independent variable on the dependent variable should increase when the mediator is included in the equation (baron & kenny, 1986). the increase in r2 when the mediator was included (from .22 to .29) suggests that procedural justice may act as a partial mediator in the relationship between strategic involvement and organizational commitment in this study. in addition, an examination of the beta coefficients of strategic involvement reveals a decrease in the strength of the relationship between strategic involvement and organizational justice when procedural justice is included as a mediator (without the mediator, beta for involvement == .30; with the mediator included, beta for involvement == .19). if the relationship had disappeared completely, one might infer that procedural justice behaves as a total mediator in this relationship. however, since a small effect was present after holding procedural justice constant, procedural justice acts as a partial mediator in the relationship between strategic involvement and organizational commitment in this study. thus, the results of this analysis provide support for our hypothesis. discussion the hypothesis stating that perceptions of procedural justice in strategic planning partially mediates the relationship between strategic involvement and organizational commitment was supported in this study. these results support previous research suggesting that strategic involvement may affect managers' psychological attachment to their organizations (oswald et al., 1994). specifically, as involvement in the strategic planning process increases, organizational commitment may be positively influenced. this is an important finding for managers, since organizational commitment has been associated with many important outcomes, such as employee turnover and absenteeism (blau & baal. 1989; gaertner & nollen, 1989; meyer & allen, 1991; shore & martin, 1989; steers, 1977). in addition, the results of this study indicate that the relationship between strategic involvement and organizational commitment is largely due to the perception of procedural justice in the planning process. the structure of universities, with diverse groupings of disciplines and departments residing interdependently under one organizational roof, demands the inclusion of managers in the planning process (lipman-blumen, 1998). the result is higher expectations of significant involvement by university employees. further, in this changing era of diversity and interdependence, lipman-blumen (1998) suggests business leaders may be more successful engaging in patterns of "connective leadership"rather than traditional forms of authoritarian leadership. thus, the results of this study hold implications for practitioners wishing to implement this leadership style. first, with the recent influx of discrimination cases brought against organizations, managers are becoming more aware of fairness issues in the workplace (peterson & danehower, 1994). due to an interest in the glass ceiling for women 100 journal of business strategies vol. 15, no.2 (morrison & von glinow, 1990), as well as arguments regarding the fairness of affirmative action programs (heilman, 1994; kravitz & platonia, 1993), organizational justice will continue to be an issue of great concern for a large number of companies wishing to promote equality in an era of spiraling discrimination suits and workplace diversity. thus, managers wishing to avoid expensive legislation should be concerned with ways to increase their employees' perceptions of organizational justice. involvement in the planning process may be one avenue to this result. second, there is a compelling amount of evidence suggesting that organizational justice can have an impact on many organizational outcomes in addition to commitment (dailey & kirk, 1992; folger & konovsky, 1989; mcfarlin & sweeney, 1992). therefore, one way to influence job satisfaction, pay satisfaction, and recommendation intentions may be for managers to involve employees in the strategic planning process. finally, hart (1992) suggests that strategy-making be viewed as an organizationwide phenomenon. however, simply involving employees in the process may not provide the commitment needed for company success. while practitioners have been advised that involvement may affect commitment, they should also be informed that, although involvement may be necessary for employee commitment, it may also be insufficient. in addition to involving managers in the planning process, organizations must ensure that the involvement process is perceived as fair. because justification and sincerity increase the likelihood of fairness perceptions (bies, 1987), decision-makers should present logical arguments for their planning decisions in a sincere fashion that convinces employees of the fairness of the planning process. without the fairness dimension, involvement may be a wasted management effort. for researchers, the results of this study should provide a deeper understanding of why involvement in strategic planning affects outcome variables such as organizational commitment, an important construct in controlling other important variables, such as employee turnover (blau & boal, 1989; gaertner & nollen, 1989; meyer & allen, 1991; shore & martin, 1989; steers, 1977). this study also underscores recent admonitions for organizational researchers to duplicate laboratory studies to determine the generalizability of previous findings (cropanzano & folger, 1989). several limitations are inherent in this study. first, because the data collected were self-reported, some of the observed relationships may be exaggerated due to common-method bias or the priming effect (head et al., 1988). however, the results of a partial-correlation test did not indicate this to be a critical issue. partial correlation has been determined to be a stronger test for controlling selfreport problems than the harman's one-factor test (podsakoff & organ, 1986). nonetheless, future research might address the problem of common-method variance by relying on multiple methods of data collection, or by collecting data at different periods of time. fall 1998 lemons & gilmore: building commitment 101 second, while care was taken to ensure that only managers completed the questionnaires, another limitation of this study was the sample composition. the use of university employees may have caused an overestimation of the importance of strategic planning, thus resulting in a stronger significance level. these individuals may feel more strongly about workplace involvement, as well as the planning function, than a more diverse group of employees( lipman-blumen, 1998). additionally, unlike cross-sectional studies, the use of two non-profit organizations limits the generalizability ofthe results herein. without future research testing a variety of organizations in the private sector, it may be unwise to apply the results of this study to the general population. in addition, the sample was 90% caucasian. a more diverse group might yield different results. on the other hand, because previous research indicates that most individuals feel justice is an important issue (witt & nye, 1992), future research should confirm rather than refute the findings herein. finally, with regard to limitations based on the sample composition, the definition of the planning process may be perceived differently by university managers than by managers in the public sector. on the other hand, people's perceptions are their reality. thus, it is the perception of being involved in the strategic planning process that produces perceptions of fairness. even though public-sector respondents may hold different perceptions of what the planning process entails in their organizations, it is their perception of being involved that really counts, and not the definition of the planning process. however, future research should be conducted using public-sector organizations. implications for future research also include examining the mediating role of procedural justice in other strategic relationships. for example, the relationship between strategic involvement and implementation compliance (guth & macmillan, 1986) may be strengthened by adding procedural justice to the model. employee participation in strategic planning may increase feelings of "voice" in decisions, resulting in increased compliance during the strategic implementation stage (kim & mauborgne, 1993). additionally, because involvement explained a high percentage of the variance in procedural justice, outcome variables other than organizational commitment should be investigated (e.g., absenteeism, turnover) to determine whether they might also be affected using involvement as an independent variable and perceived fairness as a mediator. to summarize, this research investigates a long-neglected area of strategic management, the actual planning process (oswald et ai., 1994; rhyne, 1986). while research examining differences in performance between planners and nonplanners was the first step in establishing the importance of strategic planning, it is now time to develop a deeper understanding of how planning should be carried out (rhyne. 1986). this study provides support for the mediating role of procedural justice in the relationship between involvement and organizational commit~ ment and should provide an impetus for future research in this area. 102 journal of business strategies references vol. 15, no.2 alwin, d.f., & hauser, r.m. (1975). the decomposition of effects in path analysis. american sociological review, 40: 37-47. aquino, k., griffeth, r.w., allen, d.g., & hom, p.w. (1997). integrating justice constructs into the turnover process: a test of a referent cognitions model. academy of mana~ementjournal. 40 (5): 1208-1227. baron, r,m" & kenny, d,a. (1986), the moderator-mediator variable distinction in social psychological research: conceptual, strategic, and statistical considerations, journal of personality and social psychology. 51 (6): 1173-1182. bazerman, m.h., schroth, h,a" shah, p,p., diekmann, k.a., & tenbrunsel, a.e. (1994). the inconsistent role of comparison others and procedural justice in reactions to hypothetical job descriptions: implications for job acceptance decisions. organizational behavior and human decision processes. 60: 326-352, bies, rj. (1987). beyond "voice": the influence of decision-maker justification and sincerity on procedural fairness judgment. representative research in social psychology. 17(1): 3-14. blau, g., & boal, k. (1989). using job involvement and organizational commitment interactively to predict tturnover. journal of management. 15( 1): 115-127, brockner, j., konovsky, m., cooper-schneider, r" folger, r., martin, c., & bies, rj. (1994). interactive effects of procedural justice and outcome negati vity on victims and survivors of job loss. academy of management journal. 37 (2): 397-409. cammann, c., fichman, m., jenkins, g.d., & klesh, j.r. (1983). in j.l. price & c.w. mueller (eds.) handbook of organizational measurement. 1986. marshfield, ma: pitman publishing. cropanzano, r" & folger, r, (1989), referent cognitions and task decision autonomy: beyond equity theory. journal of applied psychology. 74 (2): 293-299. dailey, r.c., & kirk, dj. (1992). distributive and procedural justice as antecedents of job dissatisfaction and intent to turnover. human relations. 45 (3): 305-317, dess, g.g. (1987). consensus on strategy formulation and organizational performance: competitors in a fragmented industry. strategic management journal. 8: 259-277. farrell, d., & stamm, c.l. (1988). meta-analysis of the correlates of employee absence. human relations, 41: 211-227. floyd, s.w., & wooldridge, b. (1992). managing strategic consensus: the foundation of effective implementation. academy of management executive. 6 (4): 27-39. fall 1998 lemons & gilmore: building commitment 103 folger, r, & greenberg, j. (1985). procedural justice: an interpretational analysis of personnel systems. research in personnel and human resources manal:ement. 3: 141-183. folger, r, & konovsky, m.a. (1989). effects of procedural and distributive justice on reactions to pay raise decisions. academy of manal:ement journal. 32 (i): 115130. gaertner, k.n., & nollen, s.d. (1989). career experiences, perceptions of employment practices, and psychological commitment to the organization. human relations, 42 (ii): 975-991. gilliland, s,w. (1993). the perceived fairness of selection systems: an organizational justice perspective. academy of manal:ement review. 18 (4): 694-734. gilliland, s.w. (1994). effects of procedural and distributive justice on reactions to a selection system. journal of applied psychololiy. 79 (5): 691-701. greenberg, j. (1990). organizational justice: yesterday, today, and tomorrow. journal of manal:ement. 16 (2): 399-432. guth, w.o., & macmillan, i.c. (1986). strategy implementation versus middle management self-interest. stratel:ic manaliement journal. 7: 313-327. hackett, r,d., & guion, r.m. (1985). a reevaluation of the absenteeism-job satisfaction relationship. orl:anizational behavior and human decision processes, 35: 340381. hart, s.l. (1992). an integrative framework for strategy-making processes. academy of management review. 17 (2): 327-351. head, t.e" griffin, r.w., bateman, t.s" lohman, l., & yates, v.l. (1988), the priming effect in task design research. journal of manal:ement, 14(1): 33-39. heilman, m.e. (1994). affirmative action: some unintended consequences for work~ ing women. research in or~anizational behavior. 16: 125-169. herold, d.m. (1972). long-range planning and organizational performance: a crossvalidation study. academy of mana~ementjournal. 3: 91-102. james, l.r., & brett, j,m. (1984). mediators, moderators, and tests for mediation. j.mll:: nal of applied psychololiy. 69(2): 307-321. kim, w.c., & mauborgne, ra. (1993). procedural justice, attitudes, and subsidiary top management compliance with multinationals' corporate strategic decisions. academy of mana~ementjournal. 36(3): 502-526. 104 journal of business strategies vol. 15, no.2 kim, w.c., & mauborgne, r.a. (1991). implementing global strategies: the role of procedural justice. strategic management journal 12: 125-143 konovsky. m.a., & folger. r. (1987). relative effects of procedural and distributive justice on employee attitudes. representati ve research in social psychology. 17( 1): 15-24. korsgaard, m.a., schweiger, d.m., & sapienza, h.j. (1995). building commitment, attachment, and trust in strategic decision-making teams: the role of procedural justice. academy of management journal. 38( 1): 60-84. kravitz. d.a., & platonia, j. (1993). attitudes and beliefs about affirmative action: effects of target and of respondent sex and ethnicity. journal of applied psychology. 78(6): 928-938. lemons, m., & jones, c. (1995). an examination of the effect of procedural justice in promotion decisions on organizational commitment. paper presented at the southwest academy of management meeting, houston, tx: 104-108. leung. k.. & lit w. (1990). psychological mechanisms of process-control effects. journal of applied psychology. 75(6): 613-620. lind, e.a.. kulik, c.t., ambrose, m., & de vera park, m.v. (1993). individual and corporate dispute resolution: using procedural fairness as a decision heuristic. administrative science quarterly, 38: 224-251. lind, e.a., & tyler, t. (1988). the social psychology of procedural justice. new york: plenum. lipman-blumen, j. (1998). connective leadership: what business needs to learn from academe. change. 30 (1): 49-53. malik, z.a., & karger, d.w. (1975). does long-range planning improve company performance? management review. 9: 27-31. marsh, r.m., & mannari, h. (1977). organizational commitment and turnover: a prediction study. administrative science quarterly. 22: 57-75. mcfarlin, d.b., & sweeney, p.o. (1992). distributive and procedural justice as predictors of satisfaction with personal and organizational outcomes. academy of management journal. 35 (3): 626-637. meyer, j.p., & allen, n.j. (1991). a three-component conceptualization of organizational commitment. human resource management review. 1 (1): 61-89. mintzberg, h. (1990). the design school: reconsidering the basic premises of strategic management. strategic management journal 11 (3): 171-195. fall 1998 lemons & gilmore: building commitment 105 morrison, a., & von, glinow, m.a. (1990). women and minorities in management. american psychololiist. 45 (2): 200-208. mowday, r, & steers, r.m. (1979). in j.l. price & c.w. mueller (eds.) handbook of or!:anizational measurement. 1986. marshfield, ma: pitman publishing. niebuhr, r.e. (1992). measuring equal opportunity climate in organizations: an examination of the relationship to group cohesion and group performance. paper presented at the southern management association in new orleans, la. oswald, s.l., mossholder, k.w., & harris, s.g. (1994). vision salience and strategic involvement: implications for psychological attachment to organization and job. strate2ic manaliement journal. 15: 477-489. oswald, s.l., mossholder, k.w., & harris, s.g. (1997). relations between strategic involvement and managers' perceptions of environment and competitive strengths. group and organization management. 22 (3): 343-365. peterson, rc., & danehower, v.c. (1994). judicial decisions in promotion selection in employment: an empirical study of discrimination cases. paper presented at the southwest academy of management meeting in dallas, texas. podsakoff, p.m., & organ, d.w. (1986). self-reports in organizational research: problems and prospects. journal of management. 12 (4): 531-544. price, j.l., & mueller, c.w. (1986). handbook of organizational measurement, marshfield, ma: pitman. rhyne, l.c. (1986). the relationship of strategic planning to financial performance. strategic manaliement journal. 7: 423-436. richard, o.c., & kirby, s.l. (1997). african american's reactions to diversity programs: does procedural justice matter? journal of black psychology. 23(4): 388397. robertson, i., lies, p., gratton, l., & sharpley, d. (1991). the impact of personnel selection and assessment methods on candidates. human relations. 44: 963-982. rozeboom, w.w. (1956). mediation variables in scientific theory. psychological review. 63 (4): 249-264. schaubroeck, j., may, d.r, & brown, f.w. (1994). procedural justice explanations and employee reactions to economic hardship: a field experiment. journal of appljed psychology. 79 (3): 455-460. 106 journal of business strategies vol. 15, no.2 shore, l.m., & martin, h.j. (1989). job satisfaction and organizational commitment in relation to work performance and turnover intentions. human relations. 42 (7): 625-638. steers, r.m. (1977). antecedents and outcomes of organizational commitment. administrative science ouarterly. 22: 46-56. sweeney, p.d., & mcfarlin, d.b. (1993). workers' evaluations of the "ends" and the "means": an examination of four models of distributive and procedural justice. oq:anizational behavior and human decision processes. 55: 23-40. thune, s.s., & house, r.j. (1970). where long-range planning pays off. business horizons. 8: 81-87. tyler, t.r. (1987). procedural justice research. social justice research. 1: 41-66. venkatraman, n. (1989). the concept of fit in strategy research: toward verbal and statistical correspondence. academy of management review, 14 (3): 423-444. witt, l.a., & nye, l.g. (1992). gender and the perceived relationship between perceived fairness of payor promotion and job satisfaction. journal of applied psychology. 77 (6): 910-917. wooldridge, 8., & floyd, s.w. (1990). the strategy process, middle management involvement, and organizational performance. strategic management journal. ii: 231241. fall 1998 lemons & gilmore: building commitment appendix modified strategic involvement questionnaire 107 this section makes statements about the extent of your involvement in the strategic planning that occurs within your organization. strategic plans are formulated to achieve the goals of the organization (e.g., new markets, firm growth). how much do you agree or disagree with each statement? please respond by circling the appropriate number. 1. currently, i am greatly involved in strategic planning for the organization. strongly disagree i moderately disagree 2 slightly neither disagree slightly disagree nor agree agree 3 4 5 moderately agree 6 strongly agree 7 2. my job requires that i think about the long-term future of my organization. strongly disagree i moderately disagree 2 slightly neither disagree slightly disagree nor agree agree 345 moderately agree 6 strongly agree 7 3. i am greatly involved in strategic planning for my organization at the present time. strongly disagree i moderately disagree 2 slightly neither disagree slightly disagree nor agree agree 345 moderately agree 6 strongly agree 7 4. i have little say in determining the long-range plans of my organization. strongly disagree i moderately disagree 2 slightly neither disagree slightly disagree nor agree agree 345 moderately agree 6 strongly agree 7 building commitment through strategic involvement: the mediating role of procedural justice small is beautiful: the re-emergence of the convenience strategy richard metters southern methodist university dallas, tx michael ketzenberg university of north carolina chapel hill chapel hill, nc abstract for much ofthe lastfew decades it has appeared canonical that "bigger is better" in the physical size of retail stores. in practice, the grocery arui general mercharuiise categories have seen tremendous increases in average store size. academic literature points to many benefits of size. advances in information technology and logistics, however, have provided a platform for a cost and quality competitive small store format. the viability and strategicfunctional choices ofthe small store, "convenience" strategy is explored. introduction service sector strategies involving facility size and location have changed drastically throughout this century. prior to the widespread use of automobiles for shopping in the u.s., retail outlets such as grocers, banks, and general merchandise stores had to be physically close to the customer. the more primitive business practices than seen today also limited store size. many service sector finns did not keep even rudimentary accounting records, the logistics of procuring a large variety of goods and coordinating deliveries was difficult, and assortment and inventory decisions were complex enough so that the average drug store stock turned an average of only three or four times a year in the 1920s (strasser & tedlow, 1994). consequently, the additional complexity of increasing size could create diseconomies of scale. more recently, smaller numbers of ever-larger stores have been in vogue. for example, in the grocery industry the market leader in 1929 wasa&p, with 15,738 stores that averaged 1,134 sq. ft., and the three market leaders combined for nearly 24,000 stores (strasser & tedlow, 1994). no individual firm in the industry today has more than 3,000 stores and the average store size is 29,092 sq. ft. (sansolo & garry, 1994). further, the stated policies of today's market leaders is to increase the ratio of "superstores" of 50,000 sq. ft. (kroger 1997; strasser & tedlow, 1994), so average store size should continue to increase. this effect has not been limited to the grocery industry. the market leader in general merchandise, wal-mart, has seen average store size increase over 30% to 92,000 26 journal of business strategies vol. 17, no.1 sq. ft. from 1990 to 1997, and is increasing the ratio of supercenters which measure over 200,000 sq. ft. (lee, 1998). in terms of number of outlets, however, wal-mart pales with prior market entities: wal-mart's 2,500 stores may seem ubiquitous, but the 16,000 u.s. stores in the american druggist syndicate in 1913 must have been on every street corner (strasser & tedlow, 1994). the strategy of large stores has extensive support in the academic literature, which will be reviewed in the next section. our thesis, however, is that the combination of improved business practices, specifically the technical improvements in information systems and operational logistics and inventory advances, combined with increased consumer desires for convenience, has created an environment where networks of small stores can become a dominant paradigm once again. certainly, a strategy of small stores focused on iocational convenience has always been available, but with substantially higher costs and lower quality. a number of firms compete in that manner, such as jacoby & myers for legal services, h&r block for tax preparation, or motophoto (one hour film developers) for film developing. we argue that conditions have changed sufficiently that, done appropriately, a small store convenience strategy can be competitive on these other issues. current examples of firms that are cost and quality competitive, yet focus on a convenience strategy are: dollar general (a competitor of walmart, and opening 500 new stores per year) (berner, 1998); a revamped southland corporation (expanding by 300-400 new 7-11 stores per year) (lee, 1998): edward d. jones, a stockbrokerage headquartered in st. louis with 4,570 offices in the u.s., canada and england, typically manned by a single broker; and national commerce bankcorporation, where 85% of the retail bank branches are mini-branches within supermarkets and are manned by only two or three employees at a time. moreover, we contend that a small store strategy cannot simply be "grafted on" to a chain of large stores. the small store/convenience strategy has a coherent set of operational, marketing and human resource policies that are in conflict with those of large stores. after reviewing the fundamental arguments in favor of large stores, we present the basic arguments for small stores. subsequently, we recommend the different approaches that should be taken by small stores by various functional areas. arguments for size the strategy to increase store size has extensive support in the academic literature. this support comes from two directions: marketing research that indicates large stores are more attractive to customers and operations oriented work concerning cost reductions with larger size. spring 2000 metters & ketzenberg: small is beautiful customer attraction models 27 research suggests that the observed growth in store size in the grocery sector is a response to increased demand for one-stop shopping (messinger & narasimhan, 1995; 1997). larger stores are presumed to have greater category variety, thereby reducing the need for the number of shopping excursions. mathematical links between store size and customer attraction are seen in the facility location literature in gravitational models. the relationship between store size and customer attraction is typically quantified by an objective function that maximizes sales with store size as a model parameter. gravity models are an analog to the gravitational attraction in physics, where attraction is proportional to the product of their masses and inversely proportional to the distance that separates them. for example, from fitzsimmons and fitsimmons (1994) we have aij = sj / 1\ where aij = attraction to facility j for consumer i, sj =size of facility j, tlij =travel time from consumer i's location to facility j, and 1reflects the effect of travel time on various kinds of shopping trips (e.g., where a supennarket may have a 1=2, convenience stores would have a larger value). in such a model, the larger the facility or the more variety it holds the more attractive it becomes. grocers, for one, have heeded this advice, increasing the number of different items stocked in the average supennarket from 6,000 in 1960 to over 18,000 in 1993 (samsolo & garry, 1994). cost reduction and scale economies cost reductions accrue to larger facilities in both personnel and inventory due to variance reduction. for inventory oriented services such as clothing stores, general merchandise and grocers, the textbook theory is that less overall inventory needs to be carried in a centralized system. comparing a system of smaller stores to one large one with the same aggregate demand, the mathematics of how much inventory to carry benefits the single large facility according to the "square root" law of combining demand distributions (levy, zinn, & bowersox, 1989; moinzadeh & ingene, 1993). as a numerical example, consider demand distributed according to a nonnal distribution with mean 100 and standard deviation 25 [n(ioo, 25)] for each of 10 stores. safety stock of 10 stores x 25 x 1.65 =413 units would be required for a 95% service level for each store. if the demand for all 10 small stores were concentrated in one large store the demand distribution would be n(i000, 25*sqrt(lo) = 79), requiring only 79*1.65 = 130 units of safety stock to achieve a similar level of service. for services where inventory is not important, such as banks, barbers or travel agencies, similar savings can also be had in personnel staffing using the concept from waiting line theory that a single queue (or service pooling) is more efficient than multiple queues when serving the same population of customers. the specific numerical calculations are different, but the well known result is the same when it is applied to large versus small stores: a single large store, drawing an equal number of 28 journal of business strategies vol. 17, no.1 customers as many small stores, requires fewer overall workers to achieve the same service levels. arguments for convenience certainly, locational convenience is a strategy unto itself, regardless of other factors. so-called "convenience stores" have existed for some time. other services also find locational convenience to be highly important. for example, a bank administration institute survey found that a convenient location was the most significant factor of consumer choice of financial institutions, cited by 60% of respondents. the traditional model of a convenience store stands as a model of a trade-off: convenience is attained, but at the price of higher costs, lower service and lower quality. the model we are proposing is to attain convenience while remaining competitive on other strategic points. in the remaining sections we focus on functional policies to enact this. first, however, we discuss the deficiencies inherent in the preceding arguments for large units. customer attraction models the customer attraction models presented earlier suffer from two main flaws: a lack of consideration of the disutility of large stores and a lack of competitive effects in these models. for large stores, customers usually have a longer walk from a parking area to the store entrance and search costs in the store itself are higher than small stores. although obvious, these considerations do not appear in the customer attraction models. also, the attraction models are used in isolation and do not consider a competitive environment. given the attraction model cited earlier, aj =sj i t\j, the probability of a customer preferring one store over another is given as a ratio of each individual store's attraction level to the total attraction level of all stores (fitzsimmons & fitzsimmons, 1994). consequently, if a large store and a small store were an identical distance away from a customer, the large store would be preferred with a high probability. however, this misses the point of the convenience strategy, where the premise is to establish a network of stores in a given area. consequently, the vast majority of consumers will have a smaller travel time t;j to the smaller stores, balancing out the attraction of size. as noted by a wal-mart executive, "(w)e lose customers because the supercenter is too busy and not convenient" (lee, 1998). one of the firms wal-mart is losing customers to is dollar general dollar general has over 2,000 stores in the southeastern u.s., and is opening stores at a rate of 500/year. their strategy is to battle each 92,000 sq. ft. store ofwal-mart with a platoon of 6,000 sq. ft. stores (berner, 1998). dollar general benefits from both of the aspects mentioned above. it is physically closer to far more customers than a wal-mart, and it takes far less time to park and shop at a dollar general the convenience aspect is so strong that dollar general often locates spring 2000 metters & ketzenberg: small is beautiful 29 adjacent to a wal-mart or other similar competitor. this can be successful because dollar general can match wal-mart on price it has a far lower operating cost per square foot than wal-mart (berner, 1998). cost reduction and scale economies presence of size for attaining scale economies is a seemingly logical argument, but empirical studies have not agreed. past empirical studies of the grocery industry indicate that the growth in supermarket size has gone well above the minimum size required to take advantage of scale economies. most studies show increasing returns for small levels of operation. but show constant, or decreasing, returns for large levels of operation (douglas, 1962; good, 1984; mcclelland 1962; tilley & hicks, 1971). increasing returns appear to be exhausted in the range from 7,000 to 10,000 sq. ft. one-third the average store size. ratchford and brown (1985) reach corroborative conclusions that total factor productivity in the industry has remained constant or declined since 1979, when supermarket size began to accelerate. the most recent of these studies concludes that returns to scale is an insufficient explanation to the growth in store size (shaw, nisbet, & dawson, 1989). the cost reduction arguments proffered earlier also contain assumptions that may not hold or can be overcome in many cases. the "square root law" applied to inventory reduction holds in its pure form only when the demand is independent between stores. at the extreme, if the correlation of demand is one between stores, there would be no safety stock benefit whatsoever from having one large store. in the small geographic areas that we are concerned with, it stands to reason that demand correlations could be very high, though data must be analyzed for any particular business to determine if this indeed is the case. for example, demand variance that is unpredicted by a store can be caused by weather. on a day that it rains, more umbrellas are sold. when pollen abounds, hay fever medicines sell. these events tend to occur throughout the entirety of a small geographic area simultaneously, so the advantages of one location are small. further. this inventory model assumes periodic resupply. that is, it assumes that resupply comes from a distribution center once a day or week or month, and that emergency resupply is prohibitively costly. consequently, if an out-of-stock condition exists, it necessarily causes lost sales or backorders until the periodic order comes in. however, this does not have to be the case with a convenience strategy. because they are physically located close to each other, units can easily send either stock or employees to each other at little cost, bypassing the normal route of the distribution center. of course, a cost will still be incurred even in very close store-to-store transfers, and the relative costs of store-to-store versus distribution center-to-store transfers have not been carefully examined by any of the firms known to the authors who pursue this method. the results from traditional queuing models seem to strongly indicate that, overall, more employees will be needed in a small store network than in one large store to 30 journal of business strategies vol. i?, no.1 handle the same number of customers with the same service level. this logic, however, has two implicit assumptions that may not be true: that time not spent with customers is unproductive and that employees must be physically located at the same site the customer visits. queuing theory dictates that a multiple small store strategy requires a higher amount of idle time for the same service level as a large store. but this measure of idle time only reflects random customer arrivals. for all the activities in a service, business that require the presence of a customer, there are also many activities which can be completed without a customer present. the traditional service sector logic presented by chase (1978; 1981) indicates that such back-office activities should be segregated from front-office, customer oriented activities and performed by different, back-office workers away from the view of customers. to achieve reasonable costs, however, a convenience strategy firm should move enough of the back-office activities to the frootoffice to avoid excessive idle time. as an example of such a firm, the national bank of commerce has 84% of its branches in grocery stores (williams, 1997). these branches are much smaller than a typical bank branch, with only 400 sq. ft. of space and usually staffed by only two or three employees at a time and have a deposit and customer base much smaller than a traditional bank branch. their big bank competitors have backoffice personnel not located in branches who conduct such work as credit checks, employment verifications and document preparation. at the national bank of commerce, however, all these functions are performed by tellers at the branch during downtime between customers. lastly, with advances in technology, a network of stores does not necessarily mean a network of employees. at such large banks as mellon bank and first union, walk-in customers who wish to open an account or have a question are steered to video displays and phone banks. the bank employees at the other end are located, of course, in a central facility that can staff in accordance with the queuing benefits achieved by pooling demand. recommendations for implementation traditionally, small store formats and back-office support are set up with only convenience in mind. alternatively, large store formats and back-office support are set up to rely on the benefits of size discussed earlier. it is our position that, in order to succeed in a small store format at providing quality, flexibility, and low costs in addition to convenience, a different set of choices must be made for each functional area than in firms that focus on a large store strategy or in firms that focus solely on convenience, further, because of the conflicting sets of strategic parameters that are required, it is unwise to "graft on" a series of small stores to the back-office support structure of a predominantly large store firm. spring 2000 metters & ketzenberg: small is beautiful operations and information systems 31 a major operational challenge for inventory-oriented services is to ensure that a small store does not equate to a small selection of goods. certainly, a 1,500 sq. ft. 7-11 cannot have the breadth of selection of a 29,000 sq. ft. grocery store. but given tightly linked information systems and just-in-time logistics support, it can come close. largely, the vast inventories seen today in large retail stores are unnecessary. industry-wide in the grocery industry, an average of 26 days of inventory of dry grocery items is on display (kurt salmon ass., 1993), despite the fact that dry goods are typically resupplied 4-5 times per week. an analysis of a typical dry grocery category by the leading trade journal cited inventory levels on display at 49 days of inventory (thayer, 1991). there is evidence that european grocers stock at similar levels (fernie, 1995). the industry is aware of this problem, and many have adopted what they term "efficient consumer response" as a central organizing principle to get inventories throughout the supply chain under control, but progress has not been swift. this is not industry specific, however, as inventories throughout the retail sector are often set at seemingly extreme levels. anecdotally, inventories of cosmetics at department stores often tum over twice yearly (seshadri, 1996) and retail clothing stores attempt to set inventory levels at 100% service levels by stocking several weeks of demand (agrawal & smith, 1996). one of the reasons for such overstocking is poor systems integration. although all major grocers use scanner technology at cash registers, to date only one chain is using scanner information to order stock or pay suppliers, and only in a few trial stores (austin & mcfarlan, 1997). stock ordering is still done manually by employees visually checking shelf sets. further, information systems are not fully utilized for forecasting, and quantities ordered and quantities sold are not highly correlated. it is often the case that retailers order mounds of slow movers while keeping slim inventories of fast selling products. this is an all too common problem in the grocery industry, where 56% of dry grocery items average less than one unit in sales per week (kurt salmon ass., 1993). tightly linking information systems with inventory needs can even be done centrally. in the late 1980's mrs. fields' cookies electronically linked all 500 stores to computers in park city, utah, and the managerial decisions concerning not only supply ordering but hour-by-hour demand forecasting which cookies to make at different points throughout the day were performed centrally (ostrofsky & cash, 1993). part of the revitalization of the 7-11 brand, where massive store closings in the 1980's have turned into equally massive store openings now, has been a tightly linked inventory information system that is coupled with good logistic support for inventory resupply. large stores can afford the inefficiencies of poorly linked information systems and inventory positions more easily due to the traditional impact of diminishing returns. whereas the impact on consumer preferences in a large store between stocking 18,000 32 journal of business strategies vol. i?, no.1 versus 20,000 different items may not be large, customer attraction for a small store stocking 5,000 versus 3,000 different items is likely to be highly significant. human resources: job desien and reward systems by nature, small stores have few employees. consequently, each employee must be able to perform a wide range of tasks. this places a higher premium on small stores for cross-training. since greater training is invested in each employee, employee retention is more important at such firms. further, as discussed previously, more back-office tasks have to be performed by front-office personnel in small units than in large ones to off-set the higher customer related idle time that occurs in small units. this makes job design at a small unit vastly different from its larger counterparts. this design, however, has advantages. it is generally believed that internal motivation, job satisfaction and effectiveness are linked to the knowledge of the results of work activities, the degree to which a task seems to be an identifiable unit and the responsibility that an individual feels for the outcome of their work (hackman & oldham, 1980). being responsible for an entire process assists in seeing duties as an identifiable unit and thereby have a more intrinsic motivating influence. this has direct ramifications regarding service quality. the traditional structure of segregating tasks does not lend itself to accommodating the customer. front-office personnel may only see the customer. in the banking industry, customer information often is sent electronically or faxed to a geographically distant centralized unit where the next available person takes the work. the front-office personnel never meet nor even know the names of the back-office workers. similarly, the back-office workers never see either the customers or the front-office workers. because of this, the front-office worker may develop empathy with the customer, but the frontand back-office workers may not develop camaraderie within the company. this can lead to two related problems. primarily, front-office workers may make reasonable special requests that the back-office workers are not anxious to fulfill. back-office workers typically are rewarded on production, and special requests slow down the process, so they are less likely to accede to special circumstances. conversely, front-office workers may be willing to promise customers anything to get their business, even if they are aware that the backoffice cannot provide the service. the front-office worker thereby appears to give good service to the customer on the front end, and when the service is not delivered appropriately, blame can be shifted to the back-office facility. reward systems in a network of sman stores also should consider the larger network. in a small store network there are advantages to be gained by sharing personnel, local information, and inventory imbalances. reward systems should be structured so that personnel are looking for ways to contribute to the network, rather than just reacting to requests. spring 2000 metters & ketzenberg: small is beautiful marketine 33 for non-inventory oriented services, the fact that personnel have to learn a greater variety of tasks makes it difficult to have a broad, complex product line. for example, the small branch banks mentioned earlier typically do not handle corporate loans. the one-person stock brokerages of edward d. jones do not sell derivatives or penny stocks. front-office information systems can be extremely useful is this respect. due to the employees already being stretched by having to perform a wider range of processes, product development should be accompanied by very easy to use software with highly scripted service encounters. for many of the larger service firms where tasks are segregated and the unit is a collection of specialists, one of the specialties can be customer generation. for example, in many large banks the only task a loan officer has is to generate loan applications. they are expected to join local organizations and reach out into the community to attract demand by force of personality. for small units, however, the loan officer is also a teller, a bookkeeper, etc., and they are not expected to become prominent members of the community. consequently, the task of generating customers is up to a centralized marketing department. summary a strategy of smaller, more numerous and convenient services was a dominant strategy at the beginning of the 1900's. but the reason for this dominance was customer immobility and corporate inability to deal effectively with large scale organizations. we believe this strategy can once again become a dominant force, but for entirely different reasons. information systems and logistics have advanced to the point where the goals of quality, cost and flexihility can be achieved in small units, and customer intolerance of the inconvenience of large units is increasing due to demographic changes. small units, however, must be managed appropriately to be successful. due to the structural differences between small and large units, it would be difficult for a system of large units to simply add-on a network of small units. human resource policies, marketing challenges and the relationship between front-office and back-office personnel can be very different between such organizations. references agrawal, n., & smith, s. (1996). estimating negative binomial demand for retail inventory management with unobservable lost sales. naval research lol:istics, 43,839-861. austin, d., & mcfarlan, f. (1997). h.e butt grocety company: aleader in ecr implementation (8)' case 9-198-016, cambridge. ma: harvard business school publishing. 34 journal of business strategies vol. 17, no.1 berner, r. (1998). penny pinchers propel a retail star. wall street journal, march 20, 1998, bl. chase, r. (1978). where does the customer fit in a service operation? harvard business review, 56 (6), 137-142. chase, r. (1981), the customer contact approach to services: theoretical bases and practical extensions. operations research, 29 (4), 698-705. douglas, e. (1962). size of firm and the structure of costs in retailing, journal of business, 25, april, 158-190, fernie, j. (1995). international comparisons of supply chain management in grocery retailing. service industries journal. 15 (4), 134-147. fitzsimmons, j., & fitzsimmons, m. (1994). service manaljement for competitive advanta~e, new york: mcgraw-hill. good, w. (1994). productivity in the retail grocery trade. journal ofretailin~. 60 (3), 81-97. hackman, 1., & oldham, r. (1980). work redesifm. reading ma: addison-wesley publishing co., 90. kroger annual report. (1997). kurt salmon associates. (1993). efficient consumer response: enhancinl: consumer value in the grocery industa. kurt salmon associates. lee, l. (1998). facing superstore saturation, wal-mart thinks small. wall street journal, march 25,1998, bl. --(1998). southland plans to accelerate store openings. wall street journal, april 3, 1998,a15. levy, m., zinn, w., & bowersox, d. (1989). measuring the effect of inventory centralization! decentralization on aggregate safety stock: the 'square root law' revisited. journal of business lol:istics. 10 (1), 1-13 mcclelland, w. (1962). economics of the supermarket. the economic journal. 75, 154-170. messinger, p., & narasimhan, c. (1995). has power shifted in the grocery industry? marketinl: science. 14 (2), 189-223. --(1997). a model of retail formats based on consumers' economizing on shopping time. marketinl: science. 16 (1), 1-23. moinzadeh, k., & ingene, c. (1993). an inventory model of immediate and delayed delivery. maoaljement science. 39 (5), 536-548. spring 2000 metters & ketzenberg: small is beautiful 35 ostrofsky, k., & cash, 1. (1993). mrs. fields' cookies. case 9-189-056. cambridge, ma: harvard business school. ratchford, 8., & brown, 1. (1985). a study of productivity changes in food retailing. marketin~ science. 4 (3), 292-311. safeway annual report. (1997). sansolo, m., & garry, m. (1994). operations: the bottom line on performance. pro~ressive grocer, april, 34. seshadri, s. (1996). policy parameters for supply chain coordination. presentation at the 1996 multi-echelon inventory conference, dartmouth college, hanover, nh. shaw, s., nisbet, d., & dawson, j. (1989). economies of scale in u.k. supermarkets: some preliminary findings. international journal of retailinll. 4 (i), 12-26. strasser, s., & tedlow, r (1994). chain stores. case 9-391-251. cambridge, ma: harvard business school. thayer, w. (1991). four competitors tell how they'd reset the same shelf. pro~ressive grocer. 1sj. (2), 52-60. tilley, r, & hicks, r (197l). economies of scale in supermarkets. journal oflndustrial economics. 19, 1-5. williams, c. (1997). banks go shopping for customers. the regional economist, october, 1213. richard metters is assistant professor of operations management at the cox school of business, southern methodist university. he holds a ph.d. from the university of north carolina. he has previously published in journal ofservice research, production and operations management, lie transactions, journal ofoperations management, international journal of production research, european journal of operational research, journal of the operational research society, and production and inventory management journal. michael ketzenberg is a fourth year doctoral candidate at the kenan-flagler business school, university of north carolina at chapel hill. he holds an m.b.a. from vanderbilt university and a b.s. from carnegie mellon university. his research interests concentrate in supply chain management, value of information, and applied stochastic inventory models. small is beautiful: the re-emergence of the convenience strategy sfas no. 52 appucations in inflationary and non-inflationary environments ahmad hosseini sonoma state university rohnert park, california alan reinstein wayne state unversity detroit, michigan introduction overseas operations provide an increasing share of sales and profits for many american corporations. in its 1989 annual report, 3m reported that 45 percent of its sales were to foreign customers. coca cola reported that 80 percent of its total operating income in 1990 attributable to the soft drink business was generated outside the united states. many multinational companies (mncs) now strive for 50 percent foreign and 50 percent domestic sales. companies such as dow chemical generate more than half of their profits from foreign sales, even though domestic sales exceed 50 percent of their total sales. mnc operations have been steadily growing. exhibit i shows the trend in growth of sales by mncs from 1977 to 1988 [24]. in 1988, sales of mncs and their foreign affiliates grew by 7.5 and 13.5 percent, respectively. out of global sales of $4.022 trillion by mncs, $1.194 trillion was reported by the foreign affiliates of the mncs. determining the best method of reporting transactions denominated in foreign currencies in financial statements continues to be a complex and important issue. misstating reported foreign operations can impair the ability of mncs to raise capital at home and abroad. several studies have examined the implications of the current u.s. standard (e.g., [2], [14], [16]). other studies have offered a decision-making framework for managing foreign currency transactions (e.g., [3], [8], [17), [19]). since 1982, sfas no. 52 has governed accounting for the foreign operations of u.s. based mncs. doupnik and evans [5], surveying financial executives to determine how mnc subsidiaries have applied the provisions of sfas no. 52 in selecting their functional currency, showed that when the decision is complicated, management will be biased towards choosing the local currency as the functional currency. however, they failed to examine several significant factors affecting how mncs select functional currencies. moreover, no published study has yet investigated the variety of related hedging techniques available under sfas no. 52. after outlining briefly the history of u.s. currency translation and related hedging standards, this study examines how u.s. mncs with foreign operations apply key provisions of sfas no. 52, such as selecting their functional currencies, in both inflationary and non-inflationary environments. then, based upon a study sent to 400 fall 1992 hosseini & reinstein: sfas no. 52 applications exhibit 1: multinational companies (mncs) trend of sales by mncs from 1977·1988 155 3000 2000 tooo o 1977 1982 1983 1984 1985 1986 1987 1988 hr • parent company • affl1iate companies randomly selected financial executives of 1,000 of the largest mncs, conclusions are drawn on how these companies select their :functional currencies and perform various hedging techniques both in inflationary and non-inflationary environments. history of foreign currency translation chapter 12 of accounting research bulletin no. 43 [9] required current items to be translated at their current exchange rate and non-current items at their historical exchange rate. this process, known as the current/non-current method, was open to manipulation because it ignored the underlying attributes of the account to be trans156 journal of business strategies vol. 9 , no.2 iated. for example, foreign long-term debt obligations were reported at historical exchange rates regardless of fluctuations in exchange rates. apb opinion no.6 [10] allowed mncs to use a monetary/non-monetary method to report the results of foreign operations. monetary items such as accounts receivable were to be translated at their current exchange rate, non-monetary items at their historical exchange rate. however, this method ignored changes in the replacement values of non-monetary items (such as fixed assets or inventory), even when their underlying values declined dramatically. arb no. 43 was succeeded by sfas no.1 [11] which allowed mncs to use either the monetary/non-monetary or the currentlnon-current method, providing certain disclosures were made. however, as the foreign operations of u.s. mncs burgeoned, a new standard was introduced. in 1975, the financial accounting standards board (fasb) issued its statement no.8 [12], which utilized the temporal translation method (described below). statement no. 8 produced distortions in the reports because it ignored exchange rate fluctuations, creating volatile reported earnings. in 1981, the fasb issued statement no. 52 [13], which superseded statement no. 8. the statement generally dampened the recognition of currency fluctuations and the need for hedging techniques, but broadened available methods of hedging. statement no. 52, unlike all prior pronouncements relating to foreign currency transactions, also required management, within certain parameters, to select a functional currency to translate corporate international operations. tnmslatiod processes the temporal translation method of statement no. 8 assumed that the overall objective of foreign currency translation was to measure and express corporate assets, liabilities, revenue and expenses of foreign operations in u.s. d01lars and required that such transactions be measured and disclosed in accordance with u.s. generally accepted accounting principles (gaap). the theoretical underpinning of this method, known as the "measurement base" principle, is similar to that of the monetary/non-monetary approach of apb no. 6 [10]. all transactions were measured as if they occurred in u.s. d01lars, requiring the carrying of all fixed assets and inventory at past prices and historical rates. all gains or losses associated with translating foreign currency into u.s. d01lars were reported as a gain or loss on the parent company's income statement. thus, a company could recognize a loss when a foreign currency weakened relative to the u.s. dollar. all currency fluctuations were recognized immediately on the income statement. 'ibis practice often produced large, unpredictable, and uncontrollable variations in net income. allenman [1] found that these provisions caused itt's quarterly net income in 1981 to fluctuate from a drop of 119 percent to an improvement of 109 percent. the large swings in income resulted in widespread dissatisfaction in the financial community, often requiring expensive and time-consuming hedging techniques to minifall 1992 hosseini & reinstein: sfas no. 52 applications 157 mize these fluctuations. a 1978 sulvey of 117 executives experienced with sfas no. 8 found 60 who strongly wished to repeal it and 24 who wanted to modify it substantially [25]. sfas no. 52 statement no. 52 shifted from a temporal method to a "functional currency" perspective of recognizing foreign transactions and operating results in the currency used to generate and expend cash. financial statements now provide information compatible with foreign currency rate changes, while still reflecting world-wide economic results consistent with gmp. the translation process begins with choosing the functional currency and restating the financial statements of the foreign subsidiary in accordance with gmp. at this stage, if the entity's functional currency is its local reporting currency, the entity's translated financial statement is consolidated or accounted for under the equity method of accounting. if the entity's records are not maintained in the functional currency, the entity's records are restated in terms of its functional currency using the temporal method of translation. that is, the currency denomination of the related accounts is restated---but not their actual valuation. specifically, cash is measured as the amount owned at the balance sheet date; receivables and payables at amounts expected to be received or paid in the future; and all other assets and liabilities at the value that occurred after these items were acquired or incurred. the entity's remeasured financial statements are first translated into the reporting currency using the current rate method. the translated financial statements are then consolidated or accounted for under the equity method. exhibit d charts the translation procedure under sfas no. 52. the flowchart assists in determining the translation procedure to be adopted once the functional currency has been determined. first, the currency in which the financial statement is maintained is determined. if the currency is u.s. dollars, then no translation is required. if currency is foreign, the functional currency determines which of the following translation procedures need to be adopted. 1) translation when local currency is the functional currency. translation is carried out by the current rate method. 2) translation when local currency is not the functional currency. a) u.s. dollar is the functional currency. financial statements are translated to dollars using the temporal method originally advocated by sfas no.8. b) foreign currency is the functional currency. when a foreign entity's records are not maintained in its functional currency, remeasurement of the statement into the functional currency is required. next, as in step 1 above, the statement is translated using the current rate method. 158 journal of business strategies vol. 9 , no.2 exhibit 2: cbart of translation procedures for financial statements of foreign subsidiaries financial statement of a foreign subsidiary of an mnc i is statement drawn out in foreign currency? / " yes no determine the functional currency of the mnc no translation required i 1 is local currency the functional currency? / i yes translate to dollars no (* • current rate method) is dollar the functional currency? no .."" ............ yes remeasure from local to functional translate to change currency (·temporal method) then from foreign currency translate to dollars ("current rate method) to functional currency (·temporal method) translation rules-fasb 52 account type monetary assetlliabilities non-monetary assetslliabs shareholders equity revenues expenses: monetary expenses: non-monetary ·temporal method current rate historical rate historical rate average rate of period average rate of period historical rate • ·current rate method current rate current rate historical rate average rate for period average rate for period average rate for period functional currency designations of a company's foreign operations are a key feature of sfas no. 52 for two reasons. the functional currency determines: (1) the method used to translate foreign operations into u.s. dollars and (2) the extent to which changes in exchange rates affect consolidated operating results. fall 1992 hosseini & reinstein: sfas no. 52 applications 159 subsidiaries should report translation gains or losses on the income statement when selecting the u.s. dollar as functional currency and "suspend" them on the balance sheet when using a local functional currency. each foreign entity's financial statements should be recorded in that entity's functional currency and then adjusted, if necessary, to conform with u.s. gaap. the entity's financial statement must then be translated into the parent company's reporting currency (usually the u.s. dollar). thus, each foreign subsidiary must identify its functional currency and generally it is the currency in which the entity operates and generates cash flows. if the entity operates in only one country, the functional currency is obvious. but if it operates in two or more countries, the determination of the functional currency may be difficult. the pronouncement describes three situations where the choice of the functional currency is easily determined. first, if a foreign subsidiary is a self-contained entity, with its operations integrated within a country, the functional currency should be that country's currency. second, if a foreign subsidiary is little more than a sales branch of the u.s. parent corporation, then the functional currency should be the u.s. dollar. according to the pronouncement, if the subsidiary is domiciled in a country having a highly inflationary economy (defined as having more than 100 percent cumulative inflation in three years or less, e.g., in the mid-1980s, brazil, argentina or mexico), then the u.s. dollar must serve as the functional currency. however, the statement anticipated that the choice of the functional currency could be difficult because a foreign subsidiary's characteristics may not be delineated clearly, requiring considerable management judgment in selecting the appropriate functional currency. the fasb asked management to consider all relevant economic facts and circumstances in making this selection, including: 1. primary sources of the entity's cash flow (e.g., inparent's or subsidiary's currency). 2. sales price sensitivity to short-term fluctuations in exchange rates (e.g., influenced by local operating factors or by exchange rate changes or other international factors). 3. nature of the sales market for the entity's products (e.g., for subsidiary's or parent's market). 4. sources of expenses (e.g., goods acquired locally or from parent). 5. primary source of financing for the foreign operation (e.g., acquired locally or from parent; denominated in local or parent's currency). 6. the volume of intercompany transactions and arrangements (e.g., minor or major volume of transactions between parent and subsidiary). 160 journal of business strategies vol. 9 , no.2 hedges and other means of minimizing the impact of exchange gains and losses as mncs agree to exchange, at future specified dates, currencies of different countries, exposed asset and liability positions may arise. to minimize any adverse impact of currency fluctuations on these positions, mncs often agree to exchange currencies at predetermined rates on specific future dates. mncs generally use these forward exchange contracts to hedge their investments or commitments. if the mnc uses the u.s. dollar as functional currency, exchange rates gains and losses generally accrue only from foreign-denominated transactions or balances, such as italian lira receivables included in french franc financial statements and the translation of monetary accounts such as cash, receivables, payables and debt. however, exchange gains and losses resulting from u.s. dollar-denominated transactions included in foreign financial statements are exactly offset by the translation process and, therefore, do not affect income. to minimize the impact of these exchange gains and losses, a forward exchange contract could be used to sell italian liras at a future date, thereby creating a swiss franc liability to offset exactly the foreign receivable in the french financial statements. in addition, if a wholly owned french company holds net monetary assets of, say, 100,000 francs, a corporation might choose to liquidate franc assets or purchase franc liabilities of 100,000 francs. when the local currency is the functional currency, foreign denominated transactions including u.s. dollar trade accounts contained in overseas financial statements will produce exchange gains and losses in income. these foreign denominated transactions, particularly u.s. dollar accounts, are most likely to occur on intercompany activity between a multinational corporation's affiliated companies. to minimize this exchange impact, forward exchange contracts typically are purchased to permit the company to buy foreign currency forward at a fixed rate. the provisions of sfas no. 52 permit any foreign currency transaction, including those denominated in currencies moving in tandem, to hedge a commitment, whereas sfas no. 8 only permitted forward exchange contracts denominated in the same currency. statement of research propositions the research questions in this study were motivated primarily by prior findings on how mncs' subsidiaries applied the provisions of sfas no. 52 in selecting their functional currency. the following are the research hypothesis: h1: mncs select their functional currencies using similar bases in inflationary environments and similar basis in non-inflationary environments. h2: mncs selecting functional currencies weight indicatois used in the selection similarly in countries with similar economic conditions (i.e., inflationary/noninflationary environments). fall 1992 hosseini & reinstein: sfas no. 52 applications 161 h3: provisions of sfas no. 52 have significantly altered the use of forward exchange contracts, by broadening the spectrum of allowable hedging techniques. sample selection and survey instrument a questionnaire was developed based upon statement no. 52 to examine how financial executives of mncs select functional currencies and hedging techniques. the survey instrument was modified through in-depth interviews with five corporate treasurers, comptrollers and others responsible for making these functional currency selections, one banker and six academicians. revised questionnaires were sent to 400 randomly selected financial executives of the 1,000 largest u.s. mncs as determined by fortune magazine and cross-listed with dun and bradstreet's principal international business. the world mark.eting directory. follow-up questionnaires were sent out 30 days after the first mailing. a total of 109 valid responses were received, a 27 percent response rate. the responses were tested for a non-response bias by oppenheim's (1968) earlylate hypothesis. the results indicate no significant (p.<o.05) differences between early and late respondents, thereby minimizing the probability that the results contain nonresponse bias. results the respondents were first ask.ed to identify the functional currency selected for their foreign operation in six non-inflationary countries-britain, canada, france, germany, japan and switzerland, and three inflationary countries-brazil, mexico and argentina. the results are presented in table i. table i: identulcation of functional currency for different countries in two different en'vironments non-inflationary inflationary functional currency environment environment percent percent local currency 82 14 u.s. dollar 14 83 both u.s. dollar 4 3 & i.ocal currency total 100% 100% we first hypothesized that the sampled companies used similar bases to elect their functional currencies in the six non-inflationary and three inflationary economies. a 162 journal of business strategies vol. 9 , no.2 chi-square test was performed at the .05 level of significance, with the critical chisquare value of 21.026 (df = 12; seven countries and three responses) and a computed chi-square value of 14.3615. since the null hypothesis could not be rejected, the evidence indicates that the sampled companies selected their functional currencies similarly. eighty-two percent of the respondents identified the local currency as their functional currency in non-inflationary environments, with only 14 percent using the u.s. dollar. on the other hand, 83 percent of the respondents use u.s. dollars as their functional currency in the inflationary countries. fourteen percent of the respondents in inflationary countries used the local currency as their functional currency, a direct violation of the provisions of sfas no. 52. these respondents either failed to comprehend the provisions of the standard or-more probably-applied the incorrect provision to a minor subsidiary, where the differences between the two methods were immaterial. a possible explanation for management's choice in a non-inflationary environment between (1) reporting effects of foreign currency translations gains or losses on the income statement (required when the u.s. dollar is the functional currency) or (2) suspending them on the balance sheet (required when the local currency is the functional currency) is that financial executives generally favor using local currencies to reflect underlying changes in the local environment regardless of the provisions of sfas no. 52. the difficulty in delineating a foreign subsidiary's characteristics is that the criteria of selecting a functional currency, as outlined in sfas no. 52, require a great deal of "management judgment." the patterns followed avoided the volatile effects of translation gainsllosses in the determination of net income. selecting a functional currency each sampled company responded to the importance of the six indicators used in determining their functional currency on a four point scale, from "very unimportant" to "very important". table ii reports the results of these ratings. hypothesis hi states that the sampled companies placed similar importance on the indicators used to select the functional currencies in countries with similar economic characteristics (le., inflation rates). again, the critical chi-square values exceed the computed chi-square values, indicating no significant differences in the importance of functional currency indicators in countries with similar inflation levels. since the null hypothesis could not be rejected (p. <0.05), the results in table n present only the ratings of the indicators used to select the functional currencies categorized by inflation level (as opposed to rankings for each country). fall 1992 hosseini & reinstein: spas no. 52 applications 163 table ii: degree of importance of six indicators in selecting the functional currency in two different environments non-inflationary environment economic indicators summary score· cash flow: 1.03 sales market: .77 sales price indicators: .62 expense: .62 financing: .18 intercompany transactions: -.17 inflationary environment summary score· 1.34 .57 .96 -.28 -.67 -.40 *summary score equals the sum of multiplying all very important responses by 2, important responses by 1. unimportant by -1 and very unimportant by -2 and then dividing these results by the number of total responses received. while the absolute scores for the economic indicators in the two environments varied, the rankings and rank orders of the indicators between the two environments varied only slightly. the results suggest that mncs use similar indicators for selecting functional currencies in inflationary and non-inflationary environments. the ratings for non-inflationary environments indicate that cash flow, followed by the sales market and sales price indicator are considered to be the most important factors in selecting functional currencies. the ratings for inflationary environments also indicate that cash flow is the most important economic indicator. a subsidiary's cash flow directly impacts the parent's cash flow and is generally available for remittance through intercompany account settlement. the sales price indicator was rated as the second most important factor in an inflationary environment, because the sales price is responsive to changes in exchange rates. although not receiving a high rating, sales markets were easily the third most important factor. the positive summary scores for these three indicators under both environments indicates that mncs placed most importance on these factors. for both inflationary and non-inflationary environments, the other three variablesexpenses, financing and intercompany transactions-received either very low positive or negative summary scores, indicating that mncs viewed them as unimportant factors. thus, mncs generally favor the first three indicators for selecting their functional currencies. hedging techniques under sfas no. 52 before sfas no. 52, mncs hedged their earnings records with forward exchange contracts (i.e., agreements to exchange currencies at a predetermined rate at a prede164 ]oumal of business strategies vol. 9 , no.2 termined future date). research by evans, folks and jillings [6] and shank, dillard and murdock [20] suggests that firms entered into hedges because the provisions of statement no. 8 created large "unpredictable movements" in their reported earnings. houston and mueller [15], studying the impact of sfas no. 52 on the foreign currency hedging activities, found that the standard reduced, but did not cease, translation exposure hedging activities. our study further analyzes the impact of sfas no. 52 on hedging activities by identifying its effect on the popularity of the 12 major hedging techniques. statement no. 8 required mncs to meet rigorous conditions before employing a forward exchange contract. the contract terms of an identifiable foreign currency commitment had to coincide with the initial commitment date and extend at least to the payment date of the anticipated transaction. the contract also had to be denominated in the same currency as the commitment and be firm and uncancellable. h the contract were to hedge an exposed net asset or liability position, the discount or premium would be amortized on a straight line basis over the life of the contract, and the gain or loss on the balance sheet date would be included in the determination of net income. the provisions of sfas no. 52 altered significantly the use of forward exchange contracts by broadening the spectrum of allowable hedging techniques. for example, under statement no.8, inventories and capital assets did not produce exchange gains and losses, because they were translated at historical exchange rates. but under statement no. 52, u.s. dollar-reported equity in foreign financial statements can decrease significantly when exchange rates fall. thus, the nature of the forward exchange contract dictates the accounting treatment-by distinguishing among contracts (1) intended to hedge a foreign currency exposed net asset or net liability position, (2) intended to hedge a foreign currency commitment on an after tax basis, and (3) entered into solely for speculative purposes. in addition, the designation of a hedge is required for the first time under sfas no. 52, and transactions other thaj! forward exchange contracts may now be accounted for as hedges if they are designated as such. sfas no. 52 has revised the accounting treatment of translation gains or losses (for subsidiaries using the local currency as functional currency). gains or losses are now accumulated with other foreign currency translation adjustments in a separate portion of stockholder's equity until a complete liquidation occurs or until a permanent impairment of the net investment occurs, requiring the removal of the gain or loss from the equity section of the balance sheet and including it in the determination of net income. thus, the issuance of sfas no. 52 influenced management's use of forward exchange contracts as hedging techniques. the popularity of the 12 hedging techniques suggested in sfas no. 52 as applied by mncs in inflationary and non-inflationary environments was analyzed, and 12 hedging techniques were identified both from a review of the literature and discussions with six financial executives involved in international operations. the respondents were asked to indicate the degree of usefulness of each hedging technique in the two different economic environments on a three-point fall 1992 hosseini & reinstein: sfas no. 52 applications 165 scale (i.e., 1 = very useful; 2 = useful; and 3 = not very useful). the results of the rating are presented in table m. the forward exchange contract generated the highest summary score, 2.46, in noninflationary environments. accelerating or delaying the settlement of inter-subsidiary account payables (2.37) and accelerating or delaying the settlement of inter-subsidiary account receivable (2.35 and 2.36) received high summary scores. companies operating in inflationary environments ranked three hedging techniques as most useful: tightening credit to reduce local receivables and develop disposable cash (2.37), using forward exchange contracts (2.37) and accelerating/delaying the collection of inter-subsidiary accounts receivable (2.36). other highly rated useful hedging techniques include increasing sales prices (2.20), increasing/decreasing local currency borrowing levels (2.18) and delaying the payments of account payable and surrender discount if necessary (in soft currency). advancing accounts payable payments and taking purchase discounts (in hard currency) (2.33) also are considered useful tactical hedging tools. some "not very useful" responses included using back-to-back loans (summary score of 1.76), options (1.7), delaying collections of receivables denominated in hard currency and accelerating those denominated in soft currency (1.75), currency swaps (1.60) and increasing sales prices (1.75). thus, mncs generally favor older, more established hedging techniques over newer, more sophisticated ones. as stated earlier, statement no.8 required mncs to include translation gains or losses as a component of income, which often necessitated required using hedging techniques to reduce the variability of income. many commentators expected that those selecting the local currency as a functional currency under sfas no. 52 would be less concerned about differences among hedging tech.ni.ques because (1) translation gains and losses would be deferred to minimize net income fluctuations, (2) real hedging costs would become so important that firms would tend to look for less costly hedging methods, and (3) management is expected to pay more attention to economic reality since the burden of the accounting exposure has become less imminent houston and mueller [15] found that sfas no. 52 discouraged mncs from using hedging techniques for minimizing translation exposure. incorporating their findings with the results of this research generates a ranking of the financial executives' preferences of 12 available hedging techniques. these results should be of particular interest to financial executives who select effective functional currencies for their firms' foreign operations or for other financial managers. 166 journal of business strategies vol. 9 , no.2 table m: comparison of the degree of usefoldess of the twelve hedging techniques for ldflationary and nonaldflationary environment hed&inb techniques non-inflationary environment summary scores· inflationary environment summary scores 1 forward exchange contract 2.46 2 increaseldecrease borrowing 2.30 levels in local currency 3 accelerateldelay the settlement 2.37 of inter-subsidiary account payable 4 accelerated/delay the collection 2.35 of inter-subsidiary account receivable 5 accelerateldecelerate subsidiary 2.26 dividend payment or royalties 6 tighten credit so as to reduce local 1.90 receivables and develop disposable cash 7 delay the payments of accounts 2.00 payable, advance payable payments 8 increasing sales price 1.75 9 delay collection of accounts 1.75 receivable in hard currency/ accelerate collection in soft currency 10 back-to-back loans 1.72 11 currency swaps 1.60 12 option 1.63 2.37 2.18 1.92 2.36 1.89 2.37 2.32 2.20 2.20 1.76 1.86 2.21 ·summary score equals the sum of all "not very useful" responses by 1, "useful" responses by 2 and ''very useful" responses by 3 and dividing the results by the number of total responses. summary in non-inflationary environments, cash flow, sales market, sales price indicator and expenses are the most important factors in selecting functional currencies; in inflationary environments, cash flow is the most important economic indicator. in non-inflationary environments, the most useful hedging techniques are the forward exchange contract, and accelerating or delaying the settlement of inter-subsidiary account receivable. in inflationary environments, the three most useful hedging techniques are tightening credit to reduce local receivables and develop disposable cash, using forward exchange contracts, and accelerating or delaying the oollection of inter-subsidiary accounts receivable. these findings should be of use to accounting standard setters and to decision makers who select functional currencies and hedging techniques for mncs. fall 1992 hosseini & reinstein: sfas no. 52 applications references 167 1. allenman, raymond h. "why i1t likes fas 52." management accountinb, (1982), pp. 23-29. 2. hindon, kathleen ranney and schnee, edward j. "forward contracts: accounting and tax implications." cpa journal, vol. 56 (1986), pp. 38-50. 3. degler, william. "dealing with complex risk in currency markets." futures: the magazine of commodities & options, vol. 18 (1989), pp. 44-45. 4. demirag, istemihan. "overseas profits: can we find a happy medium?" accoun~ vol. 95 (1985), pp. 80-81. 5. doupnik and evans. "the functional currency determination: a strategy to smooth income." advances in international accounting, vol. 2 (1988), pp. 171-182. 6. evans, folks and jillings. "the impact of statement of financial accounting standards no. 8 on the foreign exchange risk management practices of american multinationals: an economic impact study." stamford, cf: fasb, (1988). 7. evans, thomas g. and doupnik, timothy. determining the functional currency under statement 52. stamford, cf: financial accounting standards board of the financial accounting foundation, (1986). 8. ferguson, p.r. "a decision making approach to the avoidance of foreign currency risk." management decisions. vol. 23 (1985), pp. 41-52. 9. financial accounting standards board, accounting research bulletin (arb) no. 43. restatement and revision of accounting research bulletins nos. 1-42. stamford, conn: financial accounting standards, (1953). 10. financial accounting standards board, accounting principles board (apb) no.6. status of accounting research bulletins. stamford, conn: financial accounting standards, (1965). 11. financial accounting standards board, statements of financial accounting standards (sfass) no.1. disclosure of foreign currency transaction information. stamford, conn: financial accounting standards, (1973). 12. financial accounting standards board, statements of financial accounting standards (sfass) no.8. accounting for the translation of foreien currency transactions and foreign currency financial statements. stamford, conn: financial accounting standards, (1975). 168 journal of business strategies vol. 9 , no.2 13. financial accounting standards board, statements of financial acc9untin~ standards (sfass) no. 52. foreian currency translation. stamford, conn: fmancial accounting standards, (1981). 14. kochanek, richard and norgaard, corine. "foreign currency translation sfas no. 52: requirements and implications." akron business and economic reyiew. vol. 16 (1985), pp.6-13. 15. houston and mueller. "foreign exchange rate hedging and sfas 52-relatives or strangers?" accountin~ horizons, vol. 8 (1988), pp. 50-57. 16. mccord, sammy o. "sfas no.8 vs. sfas no. 52: an assessment." mid-atlantic iqurnal of business, vol. 22 (1984), pp.51-54. 17. morris, kenneth e. 1984. "a hedging approach to foreign exchange risk." australian accountant. vol. 54 (1984), pp. 392-395. 18. oppenheim, abraham n. ouestionnaire desian and attitude measurement. new york: basic books, inc. (1968). 19. ross, derek. "managing foreign exchange: borderline cases." accountancy. vol. 102 (1988), pp. 109-110. 20. shank, dillard and murdock. "assessing the economic impact of fasb 8." fmancial executiyes research foundation new york, (1979). 21. someya, kyojira. "views from abroad: japan." journal of accountinlo auditinlo " finance, vol. 1, (1986), pp. 161-165. 22. stevenson, kevin. "accounting for foreign currency hedges under aas 20."~ lian accountant vol. 56, (1986), pp. 51-54. 23. tondkar and coffman. "teaching foreign currency translation: a flowchart approach." journal of accountine education vol. 2, (1984), p. 147. 24. u.s. department of commerce, survey of current business. washington d.c., (1990), p.31. 25. ziebart, david a and kim, david h. "an examination of the market reactions ass0ciated with sfas no.8 and sfas no. 52" the aocountina review, vol. 62, (1987), pp. 343-357. sfas no. 52 applications in inflationary and non-inflationary environments europe 1992: implications for american markets paul a. herbig jacksonville state university jacksonville, alabama joseph c. miller indiana university bloomington, indiana introduction one of the most significant happenings in the second half of the twentieth century is due to become effective on december 31, 1992: the elimination of hundreds of border restrictions upon goods, services, labor and capital between twelve western european countries and the establishment of unifonn procedures and practices for the entire western european market. this will be accomplished by the legislation of nearly 300 directives by the european parliament to be implemented by the end of 1992. this event has been nicknamed "europe 1992" even though it will not actually be operational until 1993. when europe 1992 is mentioned, the reference will be to this removal of restrictions and its effects. this process of free trade and its subsequent inevitable economic consolidations have already started to be seen in the mergers. acquisitions, and restructurings of european businesses as they attempt to jockey for position in the new open europe that will exist in 1993 and thereafter. as one european industrialist commented, "my grandfather was local, my father was national, and i have to become european . . . it is no longer true that you can remain local and survive" [15]. what he has learned, the rest of europe is quickly leaming. what are the implications of this removal of border restrictions and the application of uniform standards throughout the common market? what will change and what will not be affected by changes planned for europe in 1992? the strategic implications, and the implications for american marketers as a result of this phenomenon are reviewed in this paper. europe 1992: what it is the european single act which was adopted in 1987 reaffinned the member countries' commitment to european union; provided for institutional reforms involving the european council, european parliament, european supreme court, and the council of ministers; and provided for initiatives for a single internal market ([3], [6]). it is this third item that has the most significant economic implications as it remove obstacles to trade barriers and more importantly, removes numerous local regulations that encumber even the simplest of product standardization efforts between member 2 journal ofbusiness strategies vol. 9, no.1 countries. effective december 31, 1992, the flow of capital, labor, goods, information and services between member nations will be free, less restricted with fewer border obstacles. the key changes include: • abolishing all frontier controls that hinder the efficient movement of goods and people within the western european common market. a common two page form will allow transport of goods between the atlantic and the black sea. • removing thousands of often invisible trade barriers caused by different national product regulations and technical standards and the creation of uniform standards, environmental laws, health, safety and product regulations across western europe. • bringing greater uniformity to excise and value added taxes and exchange controls of all member nations • freeing flow of capital anywhere within the common market; abolish exchange controls; eliminate differences in property and bankruptcy laws; integrate the fmancial securities market • recognizing the rights of workers and professionals to hold jobs anywhere in the single european market; removal of residence requirements; provide intermarket respect of diplomas; uniform conditions for licensing of professionals, their certifications, and mutual respect across borders. • licensing restrictions in banking and insurance will be removed and competition in air transport introduced [4]. the expected results are that there will be increased economic growth without inflation, rising employment and industrial production, increased competition and lower prices to consumers, more economic and industrial efficiency, lower public sector deficits and improved external trade [5]. it has been estimated that by deleting barriers, $75 to 90 billion annually will be saved and increased competitiveness wi11lower costs to consumers by between $70 and 120 billion. however, the road to europeanization is not without its possible drawbacks and obstacles. two major problems are foreseen with the 1992 acts: member states must still implement the policy decisions and delays by various countries could result in uneven and delayed uniformity after the 1992 deadline. there is an inordinate amount of attention being given to the details of the implementation but very little on the policy level; this is analogous to designing a bridge but having no idea of where to construct it. europe 1992: what it isn't however, despite the nearly 300 legislative acts to become law as of 1993, some items crucial to a unified europe, a "united states of europe," will not soon be readily or speedily implemented [14]. these crucial items which were not originally on the agenda included no central bank, no common currency or uniform financial policy, no common sovereignty, no central language, and the member states' social legislation were spring 1992 herbig & miller: europe 1992 3 not to be affected. nationalism should still remain strong and perhaps a dominant force in europe for years to come. french, germans, english, or italians who have deemed themselves such for hundreds if not thousands of years are not likely to become 'european' overnight and put aside their ancestry and deep rooted regional feuds. even today, the french and germans consider the other country the major enemy--only this time the war is economic not military but the stakes are still the same: becoming the dominant power in all of europe. for both the short and long term, it is highly likely germans will think of themselves as germans first and europeans second and the rest of the european nationalities will view themselves likewise. there exists little analogy between europe 1992 and the consolidation of the thirteen colonies into the united states of america. the thirteen colonies had a common language, had successfully prevailed in a common war, and had a common heritage. the oldest colony had been in existence at most 150 years prior to the revolution. to compare the thirteen colonies to twelve european countries with as many languages, cultures, and over a thousand years of ingrained ethnic rivalries is simplistic. the consolidation if it were to occur (though 1992 does provide badly needed impetus) needs decades if not an entire century to jell and stabilize. the maastricht (the netherlands) conference in december 1991 was organized to specifically resolve the question of whether to proceed with "federalism" and a political union or to remain strictly an economic union of sovereign states. also discussed at that time was whether to commit the twelve countries to a single european currency. a single european fiscal policy, and a single european bank. regional languages and cultural specifics will still dominate throughout europe. the continued existence of language barriers and cultural differences together pose a challenge to marketers. if barriers tumble then marketers should not consider areas per their sovereignty (for example belgium, netherlands, or france) but per their common language and cultural ties: marketing regionally. one regional market could be france and the french speaking parts of belgium, switzerland, italy and spain. and likewise, marketers should think of creating other similar language and cultural zones across europe, and marketing to the tastes of each specific region. in an unrestricted market, as the united states can demonstrate, marketing to regional tastes is a very successful marketing tactic and europeans would be wise to emulate it. american marketers have learned that new york city, long island and rochester, despite being part of the same state, have sufficiently different markets that must catered to per their regional needs if a company is to prosper in all three areas. one should see (and have indeed started to view) strong interest by europeans in american maiketing techniques to learn how to better satisfy regional tastes. for all the europeanization, mobility across borders, and the increased speculation on homogenizing local tastes, regional tastes will not only survive but become more pronounced as a means to retain local flavor and ancestry. customization not globalization (standardization) should be the byword in coping with europe ([9], [19], [11]) for discussion of the globalization versus customization debate and why globalization may not always be the best strategy). successful maiketers will recognize 4 journal ofbusiness strategies vol. 9, no.1 local tastes and become expert at satisfying them, like nestle which markets more than a dozen varieties of nescafe' coffee, satisfying local tastes while building a paneuropean presence. implications for europe resulting from 1992: macro a very strong and highly likely implication arising from the 1992 consolidation involves those countries not currently integrated into the western european common market. these include the efta (european free trade association) countries of norway, sweden, finland, austria, switzerland, and iceland. it is extremely likely that these countries will eventually join the common market (for competitiveness sake) or risk becoming isolated and left behind economically (an island of want amidst the plenty) (arbose 1987). austria has already indicated its interest to join. norway is testing the waters. sweden is keeping a close eye on developments on the european mainland. the three scandinavian countries have expressed an interest in negotiating membership as a group. switzerland, despite its traditional neutrality, is rmding that european business connections may be more important than its prized neutral state. the efta has bowed to the inevitable. indicating their willingness to abide by the bec's legislative acts, the efta signed a de facto merger agreement with the common market in october 1991. hungary, with its rapid movement towards economic revitalization and its ancient ties with austria, may well be the ftrst east bloc country drawn into the western economic net (some say as early as 1995). czechoslovakia and poland will not be far behind, probably before the end of the decade.the other eastern european nations are looking forward to doing likewise and partaking in the economic success of the west. the movement to emulate the west's path in order to ftnd economic development and prosperity appears irrevocable for at least the former eastern european satellites, the baltic republics, and perhaps even an independent ukraine and byelorussia. this immense economic powerhouse (including the efta nations) would together be the greatest economic power in the world in terms of gnp and would possess a vast consumer market with a combined population approaching 350 million, the largest population of any of the newly forming triad trading blocs. the success of the western european common market was a major incentive for the eastern european nations in their drive towards true independence, capitalism and democracy during the winter of 1989. where free economies go, free politics can not help but follow. what the west was not able to achieve politically and militarily, may well have been accomplished through economic means. most of the next decade or even two is expected to be absorbed in resolving imbalances between members of the common market that currently exist. for example, between spain and germany, there exist considerable differences in labor rates. this is true of most north-south european countries. this has had unusual effects such as an european auto manufacturer building a new plant or adding capacity in spain while at the same time closing or eliminating capacity at its plant in germany. this will spring 1992 herbig & miller: europe 1992 5 cause regional antagonisms to develop (much like the sun belt-snow belt rivalry the united states had in the seventies). although this is not likely to stop the momentum towards consolidation, equitable resolution of this and other similar imbalances is necessary to maintain consolidation momentum. we do not expect full balance among all member nations but the severe imbalances that exist should become less so before true consolidation commences. and the fmal equilibrium should take into account those imbalances--iabor intensive industries located in the south while service intensive technical or professional industries in the high cost north region, again much like that seen in the united states. as a result of these disparities, dislocations of labor and capital will be occurring for decades to come. some version of "fortress europe" will likely be constructed; there exists a high likelihood of some degree of protectionist tendencies being erected by the european common market, especially towards japan and, to a lesser extent, the four tigers of southeast asia. quotas and local supplier content restrictions will likely be used to protect individual industries. in addition, great effort will be exerted to substantially open up the well protected markets of the far east nations. free trade is two way trade and the new consolidated europe of the mid and late 1990's will have sufficient economic power to open up locked foreign markets if the trading partners wish to reciprocate and compete in the european marketplace. however, the european community must avoid the temptation to protect themselves by erecting trade walls and barriers. otherwise a trade war with potentially disastrous international economic consequences could well come to pass. innovation during the last twenty or thirty years within the western european countries has been lackluster at best and usually ranks a distant third behind the efforts of the united states and japan. much of this inability has been due to high levels of bureaucracy, restrictive regulations, highly structured labor practices and protected national markets [15]. with the the removal of border restrictions via the europe 1992 process, the inevitable consolidation of businesses, and the large market available, larger, more potent, innovative oligopolistic competitors will result. one final macro implication needs elaboration. a consolidated europe should tend towards having common defense goals and unified forces. economic consolidation almost guarantees a push for a common defense to protect that economic powerhouse from external pressures. this is a mixed blessing. that europe wishes to have more say with policy decisions and involvement with common defense arrangements (principally nato) is encouraging since the united states has been requesting more active participation for the european partners. that increased position could mean a lessening of american military units and expense in the european theater. however with that increased power becomes a wish to be an equal partner with the united states on major decisions, including nuclear basing on european soil. the defense burden to the united states could mean less budgetary pressures, less trade imbalance, impact on the deficit, but also less influence. the proposals in 1991 for a franco-german defense force and for a pan-european defense force, in lieu of nato, indicates a drift towards increased european independence of uncle sam. 6 journal ofbusiness strategies implications for europe resulting from 1992: micro vol. 9, no.1 an immense number of mergers, consolidations, and industrial restructurings will occur between now and 1992 and even more so after the barriers have been removed. the numbers of domestic consolidations and cross border combinations has rapidly accelerated over the last five years (from fewer than 50 in 1984-5 and 140 national mergers to well over 100 in 87-88 and 225 national mergers among the top economic community companies [10]). there now exist large numbers of small nationalistic concerns protected within national borders [20]. their existence has been largely dependent upon national protectionism and a near monopoly of the small national market. with the advent of 1992, many of these inefficient concerns will go out of business or be merged into larger firms. it is felt that after all the consolidations have occurred, there will tend to be an oligopolist structure on the order seen in the u.s. (3 or 4 major pan-european based concerns instead of the 12-20 nationalistic competitive frrms within an industry as is seen today). europe has ten turbine generator businesses versus two in the u.s. for each of these smaller concerns, capacity utilization is a pallid 60%. sixteen locomotive manufacturers with utilization rates between 50 and 80% reside in europe versus only two in the united states for a roughly comparably sized market. eleven companies battle for the european market for central office telephone exchanges versus a mere few for the entire comparable united states market[lo]. those companies that do survive the consolidations of the nineties will be tougher, more competitive, and will become much more aggressive opponents for their u.s. and japanese competitors. economies of scale both in manufacturing and research and development will be the inevitable result of consolidations and national mergers. they will be more streamlined, cost conscious, marketing focused, and extremely able international competitors. formerly rather passive competitors will, by necessity, become aggressive and intense internationally. efforts by american and other non-european based firms to enter the western european common market within the next 3 years should increase drastically. those firms with plants and subsidiaries existing prior to january 1, 1993 will more likely be grandfathered and considered european in nature. these non-european frrms will enter the market as a hedge against possible protectionist policies that may result after 1993. it is a type of insurance policy; if a frrm has an european based facility and the walls go up, the firm is in; and has no worries; if nothing happens it still has a european presence and a chance to share an immense market. either way it is a win. merger and acquisition action is quickening; the longer one waits, the less desirable partner one will be inclined to get. thus the rush is on now to find partners. multinational frrms doing business within europe will be required to have up to 80-90% of their products composed of local content (supplied by frrms based within europe) to be considered a local supplier and receive all the benefits of the lowered barriers. a japanese copier firm importing copiers made in the united states was claimed to be in actuality an assembly plant and not a manufacturing site and thus spring 1992 herbig & miller: europe 1992 7 denied the benefits of having local content. the japanese will tend to be at a disadvantage as they seek to assemble japanese made sub-assemblies on the continent. the rules have yet to be totally finned up but it is likely the before mentioned cases will not be acceptable. this will result in an economic boom as manufacturers seek to fmd local suppliers or have their suppliers also build plants in europe [15]. export driven countries such as japan will be pressured to locate plants (not just assembly but full production facilities) in europe to obey the local content restrictions. this will require basic strategic changes in many japanese and east asian finns. the success of this strategy can be seen in the immense east asian investment and increased new plant activity seen on the continent. since most american firms with european subsidiaries already have a high degree of manufacture and local content in the goods made in europe, they need not be concerned. however for new finns contemplating entering the european marketplace or with a limited presence currently there, any expansion into the european market should be on a partnership, joint venture, or local manufacturing basis. to prevent problems with local content restrictions, those american based firms just now venturing into europe should attempt to add as much local content as possible. h one has only a single plant based in the states, perhaps the boeing approach---subcontraeting foreign frrms for a high percentage of the parts and subassemblies-would probably be sufficient to calm any european objections. in the short tenn (early part of 1990's) there should be a lessening of competition from western europe as consolidations and expansion to new markets take attention and resources. how long this consolidation takes is dependent upon the difficulties involved in economically uplifting the impoverished eastern european nations. however, as a result of these consolidations within europe, in the long tenn expect new tougher, more innovative, aggressive international competition where previously little or none had existed. competition in the nineties, especially the late 1990's must take into account these new pan european giants. their impact will be felt primarily after the consolidation phase has ended, around the end of the decade or the beginning of the next century. but one must begin today to prepare for the competition of the twentyfirst century. implications for american maketing managers product 1. the creation of unifonn product regulations, technical standards, environmental laws, testing and certification requirements, health and safety standards, and trademark registration procedures throughout the europe 1992 countries allows for greater product unifonnity throughout europe. products approved to the eurostandard by one country automatically becomes eligible for sale in all ec countries. nus greatly reduces the time, cost, and aggravation required to enter new markets. instead of different packaging, labeling, contents, health certificate requirements, and licensing as required by twelve different nations, a single product 8 journal ofbusiness strategies vol. 9, no.1 implying economies of scale via longer and more efficient production runs. resulting in lower costs, and greater quality and control can be offered to all europe 1992 cowltries. 2. this does not imply that globalization is automatically the correct approach. american firms must still be sensitive to cultural differences. even within an "united" europe, cultural nationalistic differences will exist. what this implies is that product strategy can now be dictated by market forces and not by political boundaries. for most products, an adaptation strategy would be the most appropriate, even for identical product contents. nestle sells camembert cheeses throughout europe under several brands and different size packages. as nestle has done, so need american firms (or any company interested in marketing in the new post-1992 europe) if they are to succeed and prosper. the sizes of these customized markets will vary and marketers must make determinations whether all, some or none of these customized markets are worth the effort. 3. product development should become more efficient. with the establishment of uniform technical standards, the time and effort previously required to adapt products to twelve different sets can be devoted to new products. single testing and trademark certification will enable new products to reach the market faster. the comparative ease of securing certification will allow more niche products to be launched. thus greater product variety and a greater number of individual products are likely to be required by any committed competitor in the market. 4. local customization and adaptation notwithstanding, the establishment of a ew'obrand should be seriously considered in addition to the customized local brands. with the free flow of labor, considerable mobility will result. the young, the affluent, and the mobile will be more inclined towards using a ew'o-brand. 5. as nato is realigned into equal partnership between europe and america, and troop withdrawals by the united states escalate, american influence in europe's defense affairs will decline. the military vacuum caused by the withdrawal of the soviet and american troops from europe will be filled by arms spending by the european cowltries. those firms heavily involved in arms and defense sales in the united states should examine the new opportunities which should exist in europe. promotion 6. american firms must use their knowledge of regional marketing to gain competitive advantage in europe. while political bowldaries will still exist; trade will be similar to interstate commerce domestically. marketing regionally into various cultw'es ignoring political bowldaries should be the most likely successful path. a company can roughly divide europe into 7 or 8 separate cultural regions and market separately to each a culturally mandated adaptive product and promotion strategy. these regions could include: scandinavia (denmark, norway, finland, and sweden), germanic (germany, austria, possibly the netherlands, and germanspeaking regions in switzerland, czechoslovakia, poland), french (france and french speaking portions of belgium, italy, switzerland), english (united kingdom and ireland), spanish, and italian. portuguese, greek, and slavic could also be spring 1992 herbig & miller: europe 1992 9 considered. these are smaller markets than the major seven. as most europeans are multi-lingual, concentrating on these major seven could well cover the majority, the most important markets. 7. for euro-brands, different package labels (in different languages) will suffice. paneuropean advertising copy will emphasize visual images over words, permitting voiceovers to be added easily in different languages. 8. development of a single ec broadcasting area will result through the deregulation of the media and uniform broadcasting codes. as part of the latter, uniform advertising regulations will ensue, resulting in easier and more efficient advertising plans by marketers. new satellite and cable services will appear. increased television viewing by consumers and increased availability of advertising will be the net effect. through economies of scale, this will result in lowering advertising and promotional unit costs. 9. nonetheless firms should expect marketing communications spending to increase as a result of greater competition and differentiation efforts by firms. to. regional antagonisms and rivalries will still exist cultural biases and fears will continue to exist even within the framework of an economically consolidated europe. these regional animosities present an advantage to american firms. the u.s. image, for most of europe, is neutral or positive, and by playing nationalistic firms against their long teno rivals, advantages can therefore be gained. place 11. the removal of custom barriers at borders and the establishment of a single administrative document will have significant effect upon european operations. driver and vehicle time wasted due to current barriers represents almost one-quarter of total operating costs. considerable transit cost savings will result from 1992 initiatives. increasing price competition should result from current excess capacity. a reduction in average transit rates should occur. 12. faster, more predictable transportation of goods across borders should enable companies to consolidate warehouses and reduce logistical/distribution expenses and investments while maintaining or even improving customer service quality and delivery times. 13. for those firms with a current european existence, the strategy must be to expand and penetrate all of europe. the objective is to become one of the survivors in the midst of the consolidations occurring. the europeans wish the survivors to be of european origin but an american division with european roots and a strong connection to europe will be considered for all practical purposes european. a pan-european network of distributors and transportation entities (truck, rail, air freight) should provide a europe-wide logistical capability and is a feasible entity as a result of the 1992 initiatives. 14. firms with divisions or distributors in many of the europe 1992 countries should examine a pan-european strategy of optimizing distribution in regards to all of europe instead of a country-by-country strategy, of centralizing rmance and accounting functions while regionalizing marketing functions to provide and satisfy 10 journal ofbusiness strategies vol. 9, no.1 regional marketing tastes. thus instead of allowing political boundaries to guide distributional and warehouse locational decisions, economic rationale can be utilized with the resultant time and cost savings. 15. the easing of border and communications restrictions between the europe 1992 countries is likely to fuel the growth of direct mail, telemarketing, and other nontraditional distribution channels. pricini 16. uniform regulations should result in a tendency towards common pricing within europe 1992 countries. increased competition should also result in downward pressure for prices throughout europe. the european commission bas estimated that the prices of goods and services within the ee could decrease by as much as 8% as a result of the lowering of barriers. 17. the ecu should eventually become the standard currency for the european market american firms would be wise to begin pricing products in both the national and supranational currencies. 18. some segments of the economy will be more sensitive to deregulation and uniformity of regulations. these include airlines, imancial services, trucking companies, and pharmaceuticals among others. price decreases will be considerably more than the average for these segments. 19. price cutting will be the most likely tactic used for gaining market share. the increased efficiencies gained as a result of 1992 uniform regulations will provide finns with some leeway on prices but margins may suffer if this tactic is continued for any prolong period of time. 20. cross-border shopping by consumers to secure better buys and parallel importing (grey marketing) by distributors to arbitrage products will occur with increased regularity in the near term. just as differences between gas taxes and sales taxes between american states cause considerable leakage, even the price leveling between member nations will not totally eliminate such activities. table 1 summarizes the recommendations for the 4p's for american marketers. table 1: summary of marketing implications product • greater product uniformity • eum-brands now feasible • greater number of new products and niche products • increased efficiency of new product development promotion • increased marketing communications expenditures • regional marketing instead of national • standardized advertising campaigns spring 1992 herbig & miller: europe 1992 11 • increased advertising effectiveness and usage place • • • • price • • • • considerable reduction in transit and warehousing costs fewer and economically rational selection of distribution centers appearance of european-wide retailers, distributors and transit entities growth of direct marketing and telemarketing eventual equalization of prices in europe decreased prices on average with some segments harder hit greater importance of ecd as a unit of currency cross-border shopping and grey marketing will increase summary the results of the single europe act has significant implications for competition. the consolidations and penetration of new markets~resulting from the europe 1992 should cause attention and resources of the surviving consolidated european-based frrms to be focused on europe for the rest of the decade. the immensity of the europe marketplace should cause high levels of technology to be transferred from the rest of the world to the europe market. in addition, the huge market, and protectionist tendencies, should result in massive plant construction by external firms and their suppliers. the effect of 1992 upon innovation capabilities by european based firms should generally be positive in nature and the direct result of the increased competitiveness required to effectively compete in the world markets. innovation, however, will be uneven throughout europe and is dependent upon the member state's particular economic and social policies. american based companies need to hop aboard the express today, for with the rapid pace of events in europe they may not have a second chance tomorrow. there exists an urgency to establish facilities, subsidiaries, joint ventures, or acquisitions in western europe during the next three years. those established prior to 1992 should be grandfathered from any protectionist legislation that may ensue. a push to fmd partners is on now. the longer companies wait to identify partners, the poorer the partners will be that they eventually get. with the advent of europe 1992, a truly global economy will exist. this will necessitate an international marketing ability to compete and survive, let alone prosper. if an american firm is not yet marketing internationally, selling, or being sold by foreign suppliers, or competing domestically with overseas based companies, it has not looked far enough. a firm that is not an international firm by the end of 1992 with overseas affiliates, joint ventures, partnerships, or distributors; or a finn that is ignoring foreign competition; or that has not been approached by overseas suppliers, will have a high probability of extinction by the time the next century rolls around. 12 journal ofbusiness strategies vol. 9, no.1 some say the 21st century will be the century of the pacific rim; but an increasingly consolidated europe should certainly give them a run for their money. references 1. achrol, ravi s. "evolution of the marketing organization: new fonus for turbulent environments." journal of marketing, vol. 55 (october 1991), pp. 77-93. 2. arbose, jules. "the anxious little fish of europe." international management (uk) vol. 42, no.6 (june 1987), pp. 24-33. 3. bruce, leigh. "1992 is upon us." international mangement (uk), vol. 43, no. 1 (january 1988), pp. 44-46. 4. cecchini, paolo. "study analyzes impact of 1992 internal market." europe (may 1988), pp. 18-19. 5. cecchini, paolo. the european challenge. 1992: the benefits of a single market. aldershot: brookfield, vertmont. 6. cheeseright, paul. ''towards a real common market." europe, issue 251 (sept/oct 1985), pp. 22-23. 7. corsten, hans and otmar lang. "innovation practice in small and medium sized enterprises: an empirical survey of the member states of the european community." technovation (netherlands), vol. 7, issue 2 (may 1988), pp.143-154. 8. . "using the results of research financed and conducted by public bodiesa comparative review of the situation in the member states of the european community." technovation (netherlands), vol. 6, no.3 (august 1987), pp. 155-167. 9. douglas, susan p. and yoram wind, 'the myth of globalization." the columbia journal of world business, 22 (winter 1987), pp. 19-28. 10. friberg, eric g. "1992: moves europeans are making." harvard business review (may/ june 1989), pp. 85-89. 11. glazer, rashi (1991). "marketing in an information-intensive environment: strategic implications of knowledge as an asset" journal of marketing, 55 (october 1991), pp. 1-19. 12. higgins, james m. and timo santalainen. "strategeies for europe 1992," business horizons, vol. 32, no.4 (july/august 1989), pp. 54-58. 13. lee, susan. "an impossible dream?" forbes (july 25,1988), pp. 78-83. spring 1992 herbig & miller: europe 1992 13 14. macgiilycuddy, conor. "europe heads for the open market." director. vol 41, issue 7 (feb 1988) pp. 56-58. 15. magee, john f. "1992: moves americans must make." harvard business review (may! junei989), pp. 78-84. 16. milmo, sean. "are you ready for 1992?" business marketing (september 1988) pp. 66-74. 17. mitchell, alan. "europe: the final frontier." marketing <uk) (march 1988), vol. 10, p. 15. 18. . "selling the single market" marketing <uk) (may 1989) vol. 19, p. 13. 19. mitchell, david. "1992: the implications for management." long range planning (1989) vol. 22, no. i, pp. 32-40. 20. onkvisit, sak and john j. shaw. "standardized international advertising: a review and critical evaluation of the theoretical and empirical evidence." the columbia journal of world business, vol. 22 (fall), pp. 43-55. 21. salama, eric. "eurovista." marketing (uk) (january 21, 1988), p.19. 22. starrels, john. "ec and comecon may seek new ties." europe (sept/oct 1988), issue 251, pp. 30-37. 23. taylor, robert "us firms benefit from ec programs." europe (june 1988), issue 257, pp. 24-25. europe 1992: implications for american markets consumer perception of e-service quality: from internet purchaser and non-purchaser perspectives dr. zhilin yang city university of hong kong kowloon, hong kong dr. minjoon jun new mexico state university las cruces, nm abstract this exploratory study expands the knowledge concerning service quality dimensions in the context of internet commerce, from the differing perspectives of two groups: internet purchasers and internet non-purchasers. six primary service quality dimensions perceived by internet purchasers were uncovered: reliability, access, ease of use, personalization, security, and credibility while seven dimensions were discovered for internet non-purchasers: security, responsiveness, ease of use, reliability, availability, personalization, and access. when examining the relative importance of each dimension affecting overall service quality assessment, the "reliability" factor was found to be the most important dimension for internet purchasers while internet non-purchasers consider "security" as their most critical concern. the internet commerce industry has gone through an initial period of focusing on new customers to the present stage of both retaining and attracting customers. instant price comparisons on the web, brought by powerful search engines, make non-price competitive advantages, such as service quality, ever more critical in retaining and attracting customers (griff & palmer 1999; jarvenpaa & todd 1997; uu & arnett 2000). what brings online customers back, primarily, is a sense of loyalty that comes from an internet company! offering better service than anyone else (hoff, mcwilliams & saveri 1998). to offer better services, it is necessary for internet companies to investigate what existing and potential customers expect for service quality. in the context of internet commerce, existing customers are those who have utilized the internet as a channel to purchase products and services. potential customers, for i for this study, the term "internet-only company" means that a company conducts business solely through the internet without any physical stores or branches. the term "hybrid company" refers a company which has physical stores or branches with the transactional web sites options. the term "internet company", also called "online company", is defined as a company which has transactional web sites. it can be either internet-only or hybrid companies. 20 journal of business strategies vol 19, no.1 internet commerce industry as a whole, are generally those who have utilized the internet as a source to search for information about desired products and services but have never purchased through the internet (i.e., they prefer to purchase through traditional channels), for purposes of this study, these two types of consumers are coined "internet purchasers" and "internet non-purchasers", respectively. the ideal action for internet companies is to improve and maintain all service quality attributes that satisfy both existing and potential customers' needs and wants. however, given that both large and small online companies have limited resources, priorities must be set among alternative service attributes in making investment decisions based on a company's business strategies. if online companies can understand the similarities and differences of key service quality dimensions perceived by internet purchasers and internet non-purchasers, different service offering strategies can be applied to retain existing internet customers and attract potential customers. therefore, it is necessary to understand both internet purchasers' and non-purchasers' perceptions of service quality attributes related to internet purchasing. nevertheless, no empirical attention has been given to examining the service quality attributes in the context of internet commerce from the perspectives of internet purchasers and internet non-purchasers. this article, therefore, intends to expand the body of knowledge relating to the service quality construct within the internet commerce context. three specific research questions are investigated: • what are the key underlying dimensions of service quality within the framework of internet commerce as perceived by internet purchasers and nonpurchasers? • are there any differences between the two groups' perceptions of service quality dimensions? if any, what are they? • which service quality attributes most significantly impact the overall service quality as assessed by internet purchasers and non-purchasers? conceptual background internet purchasers versus internet non~purchasers internet purchasers and non-purchasers are somewhat interchangeable. an internet non-purchaser tends to be an internet purchaser if slhe feels purchasing through the internet is the best option. meanwhile, an internet purchaser can be 'transformed' into an internet non-purchaser after unhappy or even painful experiences. for instance, many online consumers were adversely impacted due to poor order fulfillment and delivery (gray 2000; jedd 2000). consequently, they may keep searching for information through the internet but may stop online purchasing. as mittal and katrichis (2000) argued, the service quality attributes important to new customers might not be the ones that are important spring 2002 yang & fun: consumer perception 21 to loyal customers; the same rule may apply to internet purchasers' and internet non-purchasers' different perceptions of service quality dimensions. with competition only a click away, internet companies strive to retain their customers and are struggling to convert their web site visitors to online purchasers. although hybrid companies (traditional companies with a transactional web site option) can influence internet non-purchasers to visit their stores physically, they still would like their customers to complete purchasing transactions through their web sites to ensure that orders are placed. therefore, for both internet-only j companies and hybrid companies, the key issues are: (1) how to retain these relatively disloyal internet purchasers; and (2) how to turn internet non-purchasers into internet purchasers. perceived service quality dimensions perceived service quality can be defined as "a global judgment or attitude relating to the superiority of a service." (parasuraman, zeithaml & berry 1988) over the past three decades, researchers have attempted to discover the global or standard attributes of a service that are important to the customer and that contribute significantly to customers' quality assessment. sasser, olsen, and wyckoff (1978) reported seven major attributes in the context of the service industry: security, consistency, attitude, completeness, conditions, availability, and training. later, ten dimensions were revealed in an exploratory study conducted by parasuraman, zeithaml & berry (1985): tangibles, reliability, responsiveness, communication, credibility, security, competence, courtesy, understanding the customer, and access. based on these ten dimensions, parasuraman et al. (l 988) further purified and distilled these ten dimensions of service quality to five: tangibles, reliability, responsibility, assurance, and empathy. these five service quality attributes constitute the basis for global measurement of service quality, namely, servqual. since that time, servqual has been applied to various service industries, although it has received some criticism (for a comprehensive review, see cronin and taylor 1994; dabholkar, thorpe & rentz 1996). the primary concerns raised by many scholars are that: (1) there is difficulty in measuring different types of expectations (cronin & taylor 1994) and (2) service quality dimensions tend to be context-bounded and service-type-dependent (bienstock 1997; van dyke, kappelman & prybutok 1997). alternatively, cronin and taylor (1994) have argued that perceived service performance (servperf) would be a better indicator of service quality. during the past several years, a number of conceptual and empirical studies have attempted to address key attributes of service quality directly or indirectly related to internet commerce. rice (1997) examined what made users revisit a web site and discovered that the most important variables are design features, such as content, layout, ease of finding information, navigability, and emotional experience, such as enjoyable visits. hoffman and novak (1997) pointed out 22 journal of business strategies vol. 19, no.1 that personalization is the essence by which internet firms valorize the internet as a unique consumer market when investigating the web sites of the top 100 u.s. retailers, griffith and krampf (1998) mentioned that the lack of prompt responsiveness, especially to e~ mail inquires, was the most common phenomenon in cyberspace. they pointed out that customer service access through the web sites needed enough staff support to satisfy their customers. balfour, farquhar, and langmann (1998) put emphasis on transaction security and personal information privacy when examining consumer needs in global electronics. dellaert and kahn (1999) conducted four computerbased experiments to understand how waiting time of information download negatively affects consumers' perception of the performance of the web site. liu and arnett (2000) identified information quality, system use, system design quality, and playfulness as four major determinants for the success of web sites in the context of internet commerce. based on the survey of250 online banking and securities brokerage users, sohn (2000) found that trust, interactiveness, ease of use, content/functionality of web sites, reliability, and speed of delivery were the six significantly important service quality dimensions perceived by customers. kaynama (2000) assesses the service quality of online travel agencies in terms of attributes such as content, access, navigation, design, response, background, and personalization and customization the aforementioned service attributes, however, were discovered either within a narrowly defined domain or on the basis of internet purchaser perspective only. no empirical study has been conducted to date to systematically and extensively uncover the underlying key dimensions of service quality in the internet commerce setting, at least not from the perspectives of both internet purchasers and non-purchasers. relative importance of service quality attributes not all service quality dimensions have the same effect on consumers' perceptions of service quality. the key is to find, among various service quality attributes, which dimensions are more crucial to enhancing the level of service quality, and to what degree they do so. in this manner, an organization can understand what service areas should be emphasized to most effectively improve quality while avoiding investing valuable resources in providing service quality attributes that may not payoff (oliva, oliver & macmillan 1992). in examining the relative importance of service quality attributes to the overall service quality as perceived by customers, a number of researchers adopted servqual in various service industries. for example, rosen and karwan (1994) identified the significant attributes in four different service industries. such as: "understanding the customer" for restaurants, "assurance" and "reliability" for health care, "reliability" and "tangibles" for lecture teaching, and "assurance" for bookstores. johnston (1995) identified "responsiveness" as an important factor at the industrial level spring 2002 yang & fun: consumer perception 23 in the context ofinternet commerce, few studies have addressed the relatively important attributes in determining consumers' perception of overall service quality. though sohn (2000) uncovered six service quality dimensions perceived by online financial service customers, the author did not further investigate which attributes were most important for customers to evaluate overall service quality. this study attempts to fill the gap by addressing the following research question: what are the most influential online service quality attributes to achieve high levels of overall service quality perceived by internet purchasers and nonpurchasers? methodology the debate between the servqual and servperf scales has been focused on whether expectation should be used and how it should be measured. although expectations do playa vital role in traditional perceived service quality, personal interviews with online customers in this study revealed that most of the participants did not have a clear conception of what expectations they held for online service. this viewpoint is consistent with the results of six in-depth focus group discussions with online consumers conducted by zeithaml, parasuraman, and malhotra (2001). they state: "unlike focus group participants who articulated with ease the nature and the source of their expectations for traditional sq (parasuraman, zeithaml & berry 1985; zeithaml, berry & parasuraman 1993), participants in our study often seemed at a loss to articulate their e-sq expectation when it came to issues of order fulfillment" (p. 15). the main underlying reason is that the internet as a new information technology device is stili a relatively new service channel. even highly experienced customer groups encounter difficulty in shaping definitive pre-consumption expectations (zeithaml, parasuraman & malhotra 2001). from this perspective, perceived performance of service attributes has been widely used in measuring information system quality (dabholkar, thorpe & rentz 1996). additionally, even though certain expectations do exist for some online customers, there have been few research efforts that provide conclusive evidence in choosing appropriate types of expectations in the setting of internet commerce. given that (1) perceived performance measurement methods have been shown to be highly effective in measuring technology-based services and (2) difficulty existed in measuring online customer expectations, this study utilized customer perceived performance, instead of both expectation and perceived performance, as the determinant of service quality. in other words, customer perceived performance is suitable for measuring service quality. measures. in this study, internet purchasers are defined as those who purchased at least one product or service through the internet during the last 12 months. internet non-purchasers refer to those who have utilized the internet to 24 journal of business strategies vol 19, no.1 search for information on products and services, but who have not actually purchased through the internet during the last 12 months. a semi-structured interview questionnaire was developed based on an extensive review of service quality and internet commerce literatures. to further understand consumers' perception of internet purchasing service quality, face-to-face personal interviews were conducted with four customers. these fouf persons were selected from participants in an e-commerce program and voluntarily attended the interviews. two of them were experienced internet purchasers. the other two had surfed the internet for more than three years, but had not purchased any items on the internet during the last 12 months. one of them did buy severa! items approximately two years ago and subsequently ceased internet shopping. each interview lasted from 15 minutes to one hour. the two experienced internet purchasers were asked to think about their most recent purchase experience on the internet. the author prompted them to discuss several key questions, including: (1) what aspects of their purchasing led to their positive or negative experiences; (2) what specific criteria did they use in assessing the service quality provided by the web site; (3) what did they expect from internet companies and where did these expectations originate; and (4) what did they like most/least about internet purchasing. the interviewee who ceased internet purchasing explained her bad purchasing experiences and the main reasons she had stopped shopping online. the other non-purchaser discussed major obstacles that had prevented him from using the internet as a transactional channel. both of them were encouraged to elaborate on their perceptions of the weaknesses of internet purchasing. they also commented on what kind of service quality improvements should be made in order to attract them to online purchasing. besides literature review and personal interviews, we also adapted and modified several dimensions of servqual proposed by parasuraman, zeithaml and berry (1985), such as reliability, responsiveness, and access, to fit the setting of internet commerce. as a result, fifty items of service quality for internet purchasers, and forty-eight items for internet non-purchasers were initially developed. three academicians who have research interests in e-commerce were asked to review all 98 items to examine if each item reflected the dimension it was designed to measure. based on their suggestions, 13 scale items were further deleted and 10 were reworded. thus, the pretest questionnaire had a total of 41 items of perceived service quality for internet purchasers and 44 for internet non-purchasers. next, nine students participating in a doctoral seminar course were asked to take a pretest survey. as a result of their written comments, several ambiguous scale items in the survey questionnaire were further reworded. the finalized survey questionnaire consisted ofthree parts. part i included 41 items concerning consumers' experiences and perceptions of online purchases and the overall perceived service quality measure. part ii contained 43 items on spring 2002 yang & fun: consumer perception 25 internet non-purchasers' experiences or perceptions of information searching, and the overall perceived service quality measure. part iii consisted of general information about respondents' backgrounds. the respondents were requested to assess each of the scale items in regard to percei ved service quality. a likerttype six point scale was used for each statement, where 1 =strongly disagree, 2 = disagree, 3 = neutral, 4= agree, 5 =strongly agree, and 6 = not available. data collection. the sampling frame for the data set consisted of a list of 1600 subscribers to a regional internet service provider (lsp) company in an area located in the southwestern united states. questionnaires were mailed to 950 subjects randomly selected from the mail list of 1600 isp subscribers. at the beginning of the questionnaire, three screening questions were asked to identify which group subjects belonged to (1) internet purchasers, (2) internet nonpurchasers, (3) others such as those who have used the internet as a personal communication means only (i.e. checking personal e-mail), but not for any activities related to product and service purchasing and information searching within the last 12 months. then, internet purchasers were asked to complete parts i and iii based on their most recent experience with internet purchase of a product or service. internet non-purchasers were asked to complete parts ii and iii in terms of their decision of not choosing the internet as a channel to purchase a product/service after an information search. respondents who only selected "others" were not required to complete the survey questionnaire. after 10 days of the initial mail-out, two follow-up e-mail messages were sent to remind targeted subjects at weekly intervals. only 13 questionnaires were returned as undeliverable. of the 285 returned questionnaires, three were unusable due to incomplete information, while ten respondents claimed that they were "others". as a result, the effective number of questionnaires was 271 with a response rate of 28.5%. since the focus of this study was on internet purchasers and internet non-purchasers' different perceptions of online service quality dimensions, their personal user and demographic profiles were omitted. analysis and findings identifying key service quality dimensions because of the exploratory nature of this study, a principal component factor analysis was utilized to identify key underlying service quality dimensions. the highly recommended varimax rotation with kaiser normalization was used (nunnally and bernstein 1994). missing values were replaced by means. after deleting two scale items with low inter-item correlations in the purchaser group, the initial analysis extracted ten factors that were evident on the scree plot and had eigenvalues greater than 1. items that were cross-loading were further eliminated. after four iterations, eighteen additional items were deleted. the retained 21 items were factor analyzed again. six factors emerged and accounted for 67.4% of the total explained variance (see table 1). the 26 journal of business strategies vol. 19, no.1 reliability of each factor was estimated by computing its cronbach alpha, which was 0.89, 0.78, 0.81, 0.73, 0.77, and 0.59, respectively. using a similar process for the internet non-purchaser group, seven dimensions were generated and accounted for 69.83% of the total explained variance. the reliability of each factor was estimated by computing its cronbach alpha, which was 0.89, 0.88, 0.81, 0.68, 0.80, 0.74, and 0.78, respectively. for both groups, each item represented an independent attempt to measure a particular construct. all items within a given scale were strongly loaded on one factor and weakly on all the other factors, thereby satisfying the requirements of convergent and discriminant validity of a constructs. additionally, these factors had relatively high reliability and were deemed appropriate for further analyses. as shown in table 1, the six factors identified with the internet purchaser group were reliability, access, ease of use, personalization, security, and credibility. four items were related to attributes of "reliability", namely: the correctness of order fulfillment, prompt delivery, accurate billing, and reply to customers' inquiries within a promised time frame. the "access" factor included four items: (l) the list of company's street and e-mail addresses, phone and fax numbers; (2) accessibility of service representatives; and (3) availability of chat rooms, bulletin boards, and other communication channels. as a unique dimension in the context of internet commerce, "ease of use" related to items like: ease-of-remembering url address, well-organized/structured and easy-to-follow catalogs, and concise and understandable contents, and terms and conditions. the "personalization" attribute consisted of such items as individualized attention and personal thank you notes from online retailers, and availability of a message area for customer questions and comments. the "security" factor included security for providing personal information, and online purchase risk. finally, the "credibility" factor referred to the business history of online retailers and special rewards or discounts offerings. the seven dimensions identified in the internet non-purchaser group, as shown in table 2, embrace security, responsiveness, ease of use, availability, reliability, personalization, and access. the security dimension included high risk associated with online purchase, continuous credit card charges, sensitive information, and distrustful internet retailers. the "responsiveness" dimension included slow internet speed, online jam, slow responses from online retailers, slow information retrieval, and delayed responses. the "ease of use" attribute was related to difficulties in following the organization and structure of online catalogs, understanding content, grasping terms and conditions related to products and services, and the lack of sufficient product/service description. the "availability" dimension referred to limited product and service selection, hardto-find desired products and services, and out-of-date information contained in online catalogues. the "reliability" attribute was related to failure to e-mail or call customer by a promised time, uncertainty of delivering the right products, and worry concerning incorrect charges. the "personalization" dimension retable 1 en "t:l :::!. factor analysis results on perceived service quality for internet purchasers ;:l c1cl n 0 dimensions cronbach items component 0n alpha i 2 3 4 5 6 i. reliability 0.89 the quantity and quality of the product/service i received was exactly the same as that i ordered. 0.83 0.12 0.17 0.03 0.08 0.01 the product/service i ordered was delivered to me ~within the time promised by the internet retailer. 0.81 0.02 0.23 0.05 0.13 -0.g3 ;::: the billing process was accurately handled and its i)q records were kept accurately. 0.79 0.17 0.20 0.15 0.18 -0.01 ~ when the internet retailer promised to e-mail or call <...., :::: me by a certain time, it did so. 0.68 0.27 0.24 0.23 0.15 0.05 ~ <j <::l 2. access 0.78 if i want to, i could easily contact a customer service ;::: '"representative over the phone. 0.15 0.75 0.11 0.1\ 0.16 0.06 :::: ~ the web site showed its street and e-mail addresses, ~.., and phone and fax numbers. 0.02 0.74 -0.05 0.07 0.23 0.24 "'tl ~ the internet retailer offered multiple ordering options i=l such as phone or mail options. 0.27 0.73 0.31 0.00 0.04 -0.10 ~ for more infonnation, i could turn to the internet 5" retailer's chat rooms, bulletin boards, or others. 0.d7 0.58 0.11 0.24 -0.21 0.04 ;::: 3. ease of use 0.81 the organization and structure of online catalogs was logical and easy to follow 0.20 0.13 0.79 0.17 0.08 0.02 the cyberspace address was easy to remember. 0.21 0.09 0.78 0.06 0.15 0.04 all the tenns and conditions (e.g., payment, warranty, return policies) were easy to read/understand. 0.29 0.02 0.61 0.35 0.09 0.08 the contents in the web site were concise and easy to understand 0.23 0.43 0.61 0.08 0.16 -0.01 n -j table 1 continued factor analysis results on perceived service quality for internet purchasers n 00 dimensions cronbach items component alpha i 2 3 4 5 6 4. personalization 0.73 the internet retailer gave me a personalized or individualized attention. 0.06 0.12 0.07 0.84 0.2\ 0.07 the web site had a message area for customer questions and comments. 0.04 0.32 0.21 0.64 0.13 -0.09 <..... i received a personal "thank you" note via e-mail ~ ::::.... or other media after i placed an order. 0.25 0.00 0.19 0.62 -0.0\ 0.24 ::: >::l...... 5. security 0.77 i felt secure in providing sensitive information ~ (e.g., credit card number) for online purchase. 0.17 0.07 0.22 0.19 0.80 008 1:1;) :::: i felt the risk associated with online purchase '"s· was low. 0.23 0.12 0.13 0.11 0.79 0.05 ~ '"'" 6 credibility 0.59 the web site showed how long the internet v:i..... i:lretailer has been in this online business. -0.18 0.28 0.11 -0.06 0.00 0.80 -~ i received special rewards and discounts from oc doing businesses with the internet retailer. 0.15 -0.05 -0.02 0.23 0.\2 0.76 ~. '" percentage of variance explained by each dimension (total 67.40%) 15.55 13.27 \2.80 10.06 8.48 7.24 notes a. extraction method: principal component analysis. b. rotation method: varimax with kaiser normalization. c. rotation converged in 7 iterations. ~ -\0 z ? en table 2 "0:!. factor analysis results on perceived service quality for internet non-purchasers ;:l !)q tv 0 dimensions cronbach items component 0n alpha i 2 3 4 5 6 7 i. security 0.89 i felt the risk associated with online purchase was high. 0.83 0.18 0.12 0.26 0.00 0.04 -0.02 i worried about the internet retailer continuing to charge my credit card, even after i cancel an order. 0.79 0.27 0.06 0.02 0.02 0.01 0.10 the security issue of sensitive information was a ~ ;:l major obstacle to my online purchase. 0.79 0.04 -0.16 0.09 0.10 -0.02 0.30 c1q i felt insecure in providing sensitive information ~ (e.g., credit card number) for online purchase. 0.78 0.05 -0.01 0.09 -0.06 0.19 -0.15 .......:;::: i couldn't trust the internet retailer. 0.61 0.26 0.12 0.21 0.09 0.04 0.17 ;:l '. (j 0 2. responsiveness 0.88 the internet speed was too slow particularly at the ;:l '"peak time of its usage. 0.26 0.83 0.17 0.04 0.09 0.14 0.05 :;::: ~ i often encountered online jam in searching for (1)..... product/service information. 0.24 0.77 0.01 0.20 -0.10 0.08 0.05 "'tl i often felt frustrated about slow response time in (1) r:i using online stores. 0.27 0.72 0.07 0.09 0.12 0.27 0.13 (1)"'>:l the system of the web site didn't rapidly retrieve ....-. 0 the information i requested. 0.09 0.68 0.30 0.29 0.23 -0.02 0.26 ;:l the internet retailer didn't respond to my inquiry promptly. -0.02 0.57 0.04 0.06 0.12 0.39 0.32 tv '" w table 2 continued 0 factor analysis results on perceived service quality for internet non·purchasers dimensions cronbach items component alpha i 2 3 4 5 6 7 3. ease of use 0.81 the organization and structure of online catalogs was not logical and easy to follow. 0.08 0.00 0.86 0.16 -0.04 -0.18 0.03 the contents in the web site were not concise and easy to understand -0.03 0.07 0.75 -0.10 0.19 0.20 0.07 ;sail the tenns and conditions (e.g., payment, warranty, l::: return policies) were not easy to read/understand. -0.q3 0.16 0.69 0.19 0.24 0.18 0.08 ~ the product/service description in the web site was t:l-not enough to make a purchase decision. 0.16 0.26 0.61 0.27 0.17 0.21 0.00 ~ ttl l::: 4. availability 0.68 the wide selection of products/services offered by ""s· the internet retailer didn't meet my needs. 0.13 0.13 0.10 0.77 0.02 -0.13 0.21 ~ ""desired products/services were not easily found ""v) using a keyword search option in the web site. 0.21 0.12 0.19 0,69 0.18 0.32 0.07 the online catalogs containing infonnation about a-price, model, and others were not updated quickly. 0.34 0.25 0.13 0.18 0.13 0.13 ~0.64 ()o;;;. "" 5. reliability 0.80 when the internet retailer promised to e-mail or call me by a certain time, it didn't do so. -0.05 -0.03 0.27 0.09 0.82 0.07 -0.01 i was not sure that the internet retailer would deliver the right products/services i order. 0.06 0.27 0.05 0.30 0.79 -0.12 0.10 i was not sure that the internet retailer would charge ~ me correctly for my purchase order. 0.21 0.08 0.34 -0.17 0,54 -0.04 0.19 -..,;.0 z ? uj table 2 continued "'0 :!. factor analysis results on perceived service quality for internet non-purchasers ::lc1q n 0 dimensions cronbach items component 0n alpha 1 2 3 4 5 6 7 6. personalization 0.74 it was difficult to receive personalized customer service from an internet retailer. 0.12 0.23 -o.ol 0.03 -0.16 0.80 o.lo rt was not easy to interact with internet retailers ~real-time for their product/service questions. 0.08 0.18 0.28 0.09 0.10 0.77 0.10 ;:: ciq 7. access 0.78 i couldn't easily contact a customer service r<> representative over the phone. 0.26 0.20 0.21 -0.01 -0.16 0.02 0.73 ......;::: it was not easy to access the internet retailer since ;:: '. it had no toll free phone number, street address in (]i::> the web site. 0.01 0.09 -0.05 0.24 0.27 0.09 0.71 ;::c;., for more information, i couldn't easily tum to the ;::: ;:: internet retailer's chat rooms, bulletin boards, etc. 0.05 0.20 0.05 0.30 0.06 0.30 0.54 ('i>..... "'tl percentage of variance explained by '"~ each dimension (total 69.83%) 14.44 12.87 10.77 8.65 8.17 7.70 7.24 {5-o' ;:: notes a. extraction method: principal component analysis. b. rotation method: varimax with kaiser normalization. c. rotation converged in 8 iterations. !."oj32 journal of business strategies vol. 19, no. i ferred to the difficulty in receiving personalized customer service and interacting with internet retailers in real time for questions. lastly, the "access" attribute embraced inaccessibility of retailers, customer representatives, and online help sources such as chat rooms and bulletin boards. examining the relative importance of service quality dimensions two regression analyses were used to examine the relative importance of the various dimensions of perceived service quality, along with three demographic variables: age, gender, and education levels, affecting overall perceived service quality for both internet purchasers and internet non-purchasers, respectively: sqp:= f30+ f3lac i + f3lac 2 + f3 3fac3 + f3 4fac4 + f3 5f3 fac5 + f36fac6 + f3 7age + f38edu + f3 9gender +e sqnp =10+ 11fael + 12 fac2 + "(3 fac3 + 14fac4 + "(5 fac5 + 1jac6 +"(7 fac7 + 1mage + 19edu + "(to gender +£ where: fac i = reliability; fac2 =access; fac3 = ease of use; fac4 = personalization; fac5 = credibility; fac6 =security; fael = security; fac2 = responsiveness; fac3 = ease of use; fac4 = availability; fac5 = reliability; fac6 = personalization; fac7=access; edu =education levels; sq = internet purchasers' perceived overall service quality; i' sq = internet non-purchasers' perceived overall service quality; and np f3 i and "(, represent the parameters to be estimated. pursuant to the initial regression run, we examined the standardized residual in oeder to identify and delete outliers, but none were found. the mean of all scale item ratings within a given factor was utilized to form measures of the independent variables. the overall perceived service quality for two groups was entered as two dependent variables. the stepwise method was used to run the linear regression. when the regression analysis was repeated with 70%, 80%, and 90% randomly selected cases from the total sample for both groups, the parameter estimates were stable. this finding, along with the clean factor loadings of explanatory variables, suggests that multicollinearity is unlikely to affect interpretation of the findings. table 3 demonstrates the results of the regression analysis. the coefficients of determination (r2) of the internet purchaser and internet non-purchaser equations were 80.1 %, and 77 .0%, respectively, while the f values of both equations were 43.14 and 20.05 (significant at 0.000 level). therefore, the regression equations achieved a satisfactory level of goodness of fit in predicting the variance of both internet purchasers' and internet non-purchasers' perceived overall service quality in relation to respective service quality dimensions and three demographic variables. spring 2002 yang & jun: consumer perception 33 as far as the relative importance of the service quality dimensions is concerned, the reliability factor carried the heaviest weight for internet purchaser's perceived service quality, followed by personalization, ease of use, and access. two factors, security and credibility, along with three demographical variables, namely age, gender, education level, appear not to be statistically significant in affecting either consumers' perceived survey quality or overall satisfaction. for internet non-purchasers, the most significantly important factor in affecting their perceptions of online service quality was found to be security, followed by personalization and access. dimensions such as responsiveness, ease of use, availability, and reliability do not significantly impact overall service quality assessment. discussion the following section will elaborate on derived service quality dimensions for both internet purchasers and internet non-purchasers, and on the relative importance of these dimensions affecting overall service quality assessment. derived perceived service quality dimensions six underlying service quality attributes perceived by internet purchasers were identified: reliability, access, ease of use, personalization, credibility, and security. seven dimensions were uncovered for the internet non-purchasers: security, responsiveness, ease of use, availability, reliability, personalization, and access. upon close examination of these factors, it can be inferred that the two groups share much common ground, considering that the dimensions of reliability, personalization, security, and access are important attributes. as predicted, there still exist several different attributes perceived by the two groups. except for the slightly different content for each similar dimension, two dimensions, availability and responsiveness, are unique to internet non-purchasers. it is interesting to compare traditional service quality dimensions to those of internet-based service quality. most traditional service quality dimensions proposed by parasuraman, zeithaml, and berry (1985), such as reliability, access and customization, are also demanded by online customers. the newly identified factors, such as ease of use and security, are internet-based related. while some dimensions contain many traditional service quality aspects, they do have some unique characteristics related to the internet commerce setting. a more detailed discussion of each dimension follows. reliability. both internet purchasers and internet non-purchasers require online companies having the ability to perform the promised service accurately and in a timely manner. they expect to be billed and charged correctly. of equal importance is order delivery. the quality of delivery should include promptness and ensure that both correct and intact products and services are delivered, in 34 journal of business strategies table 3 vol 19, no.1 a. regression analysis results between internet purchasers' perceived service quality and service quality dimensionsl independent variables standardized t.value p-value2 coefficients beta reliability 0.563 5.495 0.000*** personalization 0.530 5.886 0.000·** ease of use 0.246 2.255 0.014* access 0.199 2.568 0.029* security 0.069 0.809 0.423 credibility 0.034 0.457 0.650 age 0.078 0.971 0.337 gender 0.q78 1.115 0.271 education level -0.048 -0.668 0.508 note; i. dependent variable: internet consumers' perceived overall service quality (f:::: 43.143, dj. :::: 4, significant:::: 0.000, r square :::: 0.801, adjusted r square:::: 0.782,) 2 * p< 0.05; ** p<0.005; *** p < 0.001. b. regression analysis results between internet non-purchasers' overall perceived service quality and service quality dimensions· independent variables standardized t-value p-value2 coefficients beta security 0.564 4.058 0.001** personalization 0.295 2.605 0.018* access 0.338 2.435 0.026* responsibility 0.082 0.052 0.607 ease of use 0.042 0.331 0.745 availability 0.032 0.210 0.836 reliability 0.053 0.444 0.663 age 0.146 1.187 0251 gender 0.067 0.538 0598 education level -0.017 -0.125 0.902 note: a. dependent variable: internet non-purchasers' perceived overall service quality. (f:::: 20.048, d.f.:::: 3, significant:;: 0.000, r square:::: 0.770, adjusted r square:::: 0.731) b. * p< 0.05; ** p<o.005; spring 2002 yang & fun: consumer perception 35 ordered quantities, at times convenient to customers. consumers will not tolerate goods arriving late or damaged, being misplaced, or having the wrong product shipped to them in error. consumers also prefer to have increasing access to information about the progress of their order. in reality, product and service fulfillment still remains a big challenge for online suppliers and most online consumers feel frustrated with the poor service reliability provided by virtual stores (jedd 2000). the primary reasons reside in the lack of strong internal and external collaboration. internal collaboration includes tight integration of web sites with customer service operations and communication among different functional departments. external collaboration means integration of supply chain partners (i.e., suppliers, packaging and shipping companies). irrespective of the operational models of warehousing and shipping, what counts, as the most important factor, is the quality of the management system (gray 2000). for instance, replenishment systems should have the capacity to forecast demand for particular items and order them in time. some measures, dealing particularly with packaged connectors to third-party systems (such as erp and customer relationship management (crm) applications, and formal partnerships with vendors of third-party software) can be taken to implement effective backend integration. responsiveness. consumers expect internet retailers to respond to their inquiries promptly. prompt responses help consumers resolve their problems and make decisions in a timely fashion. however, compared with physical stores, internet retailers often lack real-time interaction with customers. for instance, e-mail is a very common means for online consumers to communicate with retailers; but a recent study shows that 42% of the top-ranked web sites took longer than five days to respond to a customer's e-mail inquiry, never responded, or were not accessible bye-mail (wilcox 1999). other unique aspects concerning the responsiveness dimension include information retrieval speed and internet speed. internet consumers want to find desired information quickly and accurately. studies have revealed that there is a significant positive correlation between information download speed and web user satisfaction (hoffman & novak 1996). the negative effects of slow information download can be attenuated by providing the consumer with notice of download duration time wherever download waiting occurs and by reducing unexpected waiting occasions and times to a minimum (dellaert & kahn 1999). further, to increase the navigation speed, internet retailers should choose an efficient host server and avoid using extensive high-resolution graphics (doherty, ellis-chadwick & hart 1999). access. both internet purchasers and internet non-purchasers have a desire to access various sources provided by internet companies for help. consumers expect that a site will have a street and an e-mail address, plus a toll free phone and fax numbers available for them to contact customer representatives easily 36 journal of business strategies vol. 19, no, 1 (burke 1997). in addition, online consumers favor multiple order channels, such as phone and mail order. finally, accessing help from other consumers is very important in the sense that consumers tend to acquire knowledge from each other. therefore, providing both traditional and online communication channels such as chat rooms and bulletin boards is a necessity (berthon, pitt & watson 1996), ease of use. ease of use is a prominent factor in determining customers' decision to adopt a new information technology (davis 1989). thus, web-based stores should make it easy for customers to proceed through the whole purchasing process by minimizing technical difficulties, more specifically, an easy-to-remember cyberspace name is important for online consumers to revisit or locate a firm since the internet has grown to include a tremendous number of competitors. both groups purchasers and searchers grant priority to on-screen information concerning products and services. since the web site functions as an information system, the organization and structure of online catalogues should be easy to follow and navigate. most importantly, contents of the web site should be concise and easy to understand. all terms and conditions concerned with products and services should be easy to read and comprehend. as rice (1997) concluded, for internet-based shopping to achieve mass-market penetration, it must be made substantially easier for consumers to navigate and locate information or content. personalization. consumers long for personalized or individualized attention and expect to receive a personal "thank you" note as confirmation after they place an order. a message area in which consumers may ask questions and post comments is also a necessity. the lack of real-time interaction tends to prevent potential customers from purchasing through the internet. only by managing all forms of interaction web hits, e-mails, phone-and fax-based contacts in a single framework, can internet companies shift their staffing and service priorities as customer preferences change. in other words, it is critical for businesses to engage customers in personalized dialogue and to learn more about their needs to better anticipate their future preferences. certain techniques such as a "rules engine" that can drive personalization based on information from the database, are critical to satisfy indi vidual customers. in addition, to show a human face to customers, internet companies may add personal support to staff telephones, answer e-mail, and train customers in the use of the internet medium. credibility. consumers are well aware of the history of online retailers and whether they receive special rewards and discounts offered is an important index for evaluating the credibility of online retailers. given the intensive competitive business environment, the history of an online business is a good indicator of its prospects, providing special rewards and discounts for consumers as promised often demonstrates that the firm possesses basic integrity and credibility in relation to its customers. spring 2002 yang & jun: consumer perception 37 security. both internet purchasers and internet non-purchasers appear to be worried about the risk associated with online purchase, especially with respect to secure credit card transactions and privacy of sensitive information. for internet non-purchasers, trustfulness of internet retailers is also a concern. the perceived lack of security on public networks is definitely a stumbling block (balfour, farquhar & langmann 1998). personal information such as credit card numbers transmitted to vendors from consumers can be coded and decoded by other people using encryption algorithms. additionally, consumers often want to retain some level of privacy or anonymity for their activities. a web server, however, can track the identity of the user's computer through "cookies", a text file placed on a user's hard drive. online shoppers arc concerned about web sites that don't provide clear and prominent statements about privacy and security matters. these disadvantages facing consumers require internet vendors to be very responsible for both consumer transaction activities and personal information. availability. this identified dimension is unique to internet non-purchasers. availability refers to a limited range of products and services, failure to find desired items and/or updated information regarding them. customers often look for products and services unavailable in their local stores. limited selection of products and services or outdated information is most likely to keep internet non-purchasers from purchasing online. in a survey of 220 consumers from austin, texas, jarvenpaa and todd (1997) uncovered that the main impediments to consumer acceptance of internet shopping were difficult-to-find specialty items, and limitation of the offerings of individual sites. importance of service quality dimensions the regression results show that both personalization and access factors are considered significantly important to service quality perceived by both groups. in reality, increasing the level of accessibility requires sufficient staff support, which adds more costs to the internet firm. in order to be personalized, internet commerce needs effective techniques such as pull and push personalization skills (luedi 1997), and requires installation of a crm system. thus, achieving an adequate trade-off of self-service against personalization is an art-form, in the sense that internet companies can maintain a high level of customer satisfaction while keeping costs in a minimum. it is interesting to note the different perceptions of both groups related to the most important factor in determining overall service quality. internet purchasers consider the reliability attribute to be the foremost critical factor for achieving high levels of service quality; this is consistent with other traditional service quality studies (bitner, booms & tetreault 1990; parasuraman, zeithaml & berry 1988). online consumers also regard ease of use as a significant factor that affects overall service quality assessment. in contrast to the prevailing viewpoint, online security and privacy are not significant factors in determining 38 journal of business strategies vol. 19, no.1 service quality perceived by online purchasers. however, internet non-purchasers did put the security attribute in the most important position. risks involving internet purchasing and the truthfulness of internet companies are, indeed, the major reasons preventing mere internet non-purchasers from becoming internet purchasers. conclusions and limitations focusing on service quality has been a priority and one of the primary concerns in internet commerce (griffith & krampf 1998). this study reveals that, to better understand consumers' assessment of online service quality, it is beneficial to investigate the key underlying dimensions perceived by both internet purchasers and internet non-purchasers. internet companies should focus on such service quality dimensions as reliability, personalization, ease of use, and access; these are desired by both internet purchasers and internet non-purchasers, and their focus should be customized to specific requirements. while credibility is solely related to internet purchasers, availability is the unique dimension related to internet non-purchasers. based on their different business strategies, internet companies can devote valuable corporate resources to the important service quality attributes uncovered by this study. for instance, improvement of the level of personalization and access constitutes a necessity for both retaining and attracting customers, since these factors significantly affect overall service quality assessment. to retain existing customers, the first priorities are high service reliability and prompt responsiveness. furthermore, internet companies have to take measures to help potential internet customers such as internet non-purchasers overcome their foremost concerns: security and trust. caution should be taken when generalizing the findings of this study. a methodological concern is the sample from a regional isp provider. due to geographical limitations, participants may possess certain attributes that differ from those in other parts of the united states. future research may use more diversified random samples to verify the dimensions developed in this study. the generalization of online service quality dimensions also requires numerous studies crossing different online industries including financial services, health care and other online services. further, based on this pilot study, formal hypotheses about online consumers' perceived service quality and overall satisfaction can be established, tested, verified or modified, in future studies, through more rigorous methodologies such as the structural equation model. spring 2002 yang & jun: consumer perception references 39 balfour, a., farquhar b., & langmann g. (1998). the consumer needs in global electronic commerce. electronic markets. 8 (2), 9-12. berthon, p., pitt l., & watson r. (1996). marketing communication and the world wide web. business horizons, 39 (september-october), 24-32. bienstock, c. c. (1997). measuring physical distribution service quality. journal of the academy of marketin~ science. 25 (i), 31-44. bitner, m. j., booms, b. h., & tetreault m. s. (1990). the service encounter: diagnosing favorable and unfavorable. journal of marketing. 54 (january), 71-84. burke, r. r. (1997). do you see what i see? the future of virtual shopping. journal of academic of marketing science. 25 (4), 352-360. cronin, 1.1. & taylor, s.a. (1994). servperf versus servqual: reconciling performance-based and perceptions-minus-expectations measurement of service quality. journal ofmarketin~, 58 (january), 125-131. dabholkar, pa., thorpe, d.1. & rentz, j. o. (1996). a measure of service quality for retailing stores: scale development and validation. journal of the academy of marketing science, 24 (1), 3-16. davis, ed. (1989). perceived usefulness, perceived ease of use, and user acceptance of information technology. mis ouarterly, 13, 318-340. dell aert , b. g. & kahn, b. e. (1999). how tolerable is delay?: consumers' evaluations of internet web sites after waiting. journal of interactive marketin~. 13 (1),4 i -54. doherty, n. e, ellis-chadwick, e, & hart, c. a. (1999). cyber retailing in the uk: the potential of the internet as a retail channel. international journal of retail and distribution management. 27 (1),22-36. gray, r. (2000). e-tail must deliver on web promises. marketing. march 2, 37-38. griff, d. a. & palmer, j. (1999). leveraging the web for corporate success. business horizons. 39 (january-february), 3-10. griffith, d.a. & krampf, r. a. (1998). an examination of the web-based strategies of the top 100 u.s. retailers. journal of marketing theory and practice. q (3), 12-23. hoff, r. c., mcwilliams g., & saveri, g. (1998). the 'click here' economy. business week. june (22). 40 journal of business strategies vol. 19, no.1 hoffman, d. l. & novak, t. p. (1996). marketing in hypermedia computer-mediated environments: conceptual foundations. journal of marketin~. 60 (july), 50-68. hoffman, d. l. & novak, t. p. (1997). a new paradigm for electronic commerce. the information society, 13,43-54. jarvenpaa, s. l. & todd, p. a. (1997). is there a future for retailing on the internet? in peterson, r. a. (ed.) electronic marketing and the consumer. thousand oaks. jedd, m. (2000). fulfillment: a crucial e-business challenge. logistics management and distribution report, april, e25-e26. johnston, r. (1995). the determinants of service quality: satisfier and dissatisfiers. international journal of service industry management. 8 (5), 53-71. kaynama, s. a (2000). a proposal to assess the service quality of online travel agencies: an exploratory study. journal of professional services marketing. 21 (i), 63-88. liu, c. & arnett, k. p. (2000). exploring the factors associated with web site success in the context of electronic commerce. information & management. 38 (october), 2334. luedi, ariel f. (1997). personalize or perish. electronic markets, 7 (3), 22-25. mitral, v. & katrichis, 1. m. (2000). distinctions between new and loyal customers. marketing research. 12 (1),26-32. nunnally & bernstein (1994). psychometric theory. (3rd ed.) new york: mcgraw-hill. oliva, t. a., oliver, r. l., & macmillan, i. c. (1992). a catastrophe model for developing service satisfaction strategies. journal of marketing, 56 (july), 83-95. parasuraman, a., zeithaml, v. a., & berry, l. l. (1985). a conceptual model of service quality and its implications for future research. journal of marketing. 49 (5),41-50. parasuraman, a., zeithaml, v. a., & berry, l. l. (1988). servqual: a multiple-item scale for measuring consumer perceptions of service quality. journal of retailing. 64 (1), 12-40. rice, m. (1997). what makes users revisit a web site. marketing news. 31 (6), 12-13. rosen, l. d. & karwan, k. r. (1994). prioritizing the dimensions of service quality: an empirical investigation and strategic assessment. international journal of service industry management. 5 (4), 39-52. sasser, w. e., olsen r. p., & wyckoff, d. d. (1978). management of service operations: text and cases. boston: allyn & bacon. spring 2002 yang & fun: consumer perception 41 sohn, c. s. (2000). customer evaluation of internet-based service quality and intention to re-use internet-based services. unpublished dissertation, southern illinois university, il: carbondale. van dyke, t.p., kappelman, l.a. & prybutok, vr. (1997). measuring information systems service quality; concerns on the use of the servqual questionnaire. mis quarterly. 2 i (june), 195-208. wilcox, n. (1999). the months ahead. kiplinger's per~onal finance magazine. cjanu!id1, 19-20. zeithaml, v a., berry, l. l., & parasuraman, a. (1993). the nature and determinants of customer expectations of service. journal of the academy of marketing science, 21 (1), 1-12. zeithaml, v. a., parasuraman, a., & malhotra, a. (2001). a conceptual framework for understanding e-service quality: implications for future research and managerial practice. working paper, cambridge, ma: marketing science institute. dr. zhilin yang is an assistant professor of marketing at city university of hong kong. this manuscript was completed when he was a doctoral student at new mexico state university. his research interests include internet-based services marketing, customer relationship management, international marketing, and supply chain management. he has published in international marketing review, marketing health care, and various chinese journals. dr. minjoon jun is an associate professor in the management department at new mexico state university. he holds a ph.d. in operations management from the georgia state university. his research interests include total quality management, service operation management, supply chain management, and operations strategy. 42 journal of business strategies vol 19, no.1 consumer perception of e-service quality: from internet purchaser and non-purchaser perspectives drug testing: what are the rights of employees, employers, and unions? sharon l. oswald allison harrison william woerner auburn university auburn, alabama drug abuse in the united states has been a commonly recognized problem in the workplace for nearly two decades. a joint study by the national council of alcoholism and the research triangle institute suggested that the cost of substance abuse to the american economy ranges from $60 to $145 billion annually [3]. a '1985 american management association, study found that approximately 93 percent of all organizations surveyed faced employee drug abuse problems [21]. with the problem so pervasive, it is not surprising that as many as 168 fortune 500 companies have implemented some form of substance abuse screening or testing; and many more have plans to adopt such policies [3]. from a union-management standpoint, most collective bargaining agreements include rules providing disciplinary action for use and abuse of drugs; however, issues pertaining to drug usage and drug testing have only recently become components of collective bargaining agreements. while it is obviously in the best interest of both the employer and the employee to identify substance abuse problems, strong opposition to drug testing of employees continues to exist. the purpose of this paper is to examine recent interpretations of the law affecting drug testing, particularly where labor unions are involved, and to assess the implications for employers with collective bargaining agreements who wish to institute or continue the use of drug testing. the drug problem and drug testing drug abuse is related to low productivity; absenteeism; and, in some cases, increased sick leave; drug-related injury; increased health benefit costs; increased worker compensation payments; and increased costs for overtime, training, retraining, and security [3]. the use of drugs is also believed to compromise workplace safety, an issue that employers are restricted by law to insure. a national institute on drug abuse (nida) study reported that on-the-job drug and alcohol abuse by auto workers alone costs an estimated $175 per vehicle in lost productivity and increased injury claims [33]. it is estimated that the drug testing market in the united states has reached approximately $230 million. in the transportation department alone, random drug testing of the four million workers is expected to cost approximately 13 million in 1990; but savings in terms of fewer accidents and absentee hours are projected to be 28 journal ofbusiness strategies vol. 9, no.1 in the billions of dollars over the next ten years [11]. federal support of drug testing came on september 15, 1987, when president reagan issued an executive order for a drug-free federal workplace. as a result, the drug free workplace act of 1988 requires employers holding government contracts of $25,000 or more to meet six criteria in an effort to provide a drug-free workplace. later that same year, the department of defense established regulations requiring employers who seek or enter into contracts with the department of defense to include an additional clause guaranteeing that drug tests will be conducted on all employees in positions relating to national security or protecting the health and safety of others. drug testing and the nlrb in november 1987, the national labor relations board (nlrb) issued its position on drug-testing programs. a memorandum generated by rosemary collyer, nlrb general counsel, stated that a company has an obligation under federal law to bargain with the union before unilaterally implementing a required drug-testing program. the nlrb's position was based on an employer's duty to bargain over wages, hours, and tenns or conditions of employment as stated in the national labor relations act (nlra). for example, the adverse effect of drug testing may result in disciplinary action and therefore would affect the terms and conditions of employment [14]. the following points were stressed in the nlrb ruling: (1) drug testing for current employees and job applicants is a mandatory subject of bargaining; (2) implementation of a drug-testing program is a substantial change in working conditions, even if established work roles previously banned the use and possession of drugs in the plant. amoco oil company's drug-testing policy was challenged by the oil, chemical and atomic workers union in 1987 because it was not part of a collective bargaining agreement. the primary concern on the union's part was whether the employees would be protected from arbitrary and capricious actions on the part of management. while both sides consented to have an arbitrator determine whether the drug-testing policy must be considered by the joint labor-management health and safety committee, amoco implemented the program prior to arbitration. the union, under three separate actions (utah, north dakota, and wyoming), sought to enjoin the drug-testing practice pending arbitration. only the utah court upheld the union's demand. collyer's november memorandum made arbitration a moot point [38]. dmg testing as a part of the pre-employment examination has been questioned on two counts. first, title vn advocates suggest that pre-employment testing is a selection device; and, therefore, drug tests must be statistically validated if used as a pre-employment screening tool [13]. another concern arose when unions argued that pre-ernployment testing should be a mandatory bargaining issue. if an applicant must successfully complete a drug test in order to be hired, then drug testing again becomes a condition of employment. in two decisions during june of 1989, the nlrb clarified the question of mandatory bargaining issues in the implementation of substance-abuse testing programs [16]. in the star tribune [28] and johnson-bateman company [17], the nlrb found spring 1992 oswald, harrison, & woerner: drug testing 29 that employers must bargain over the establishment of drug and alcohol testing programs, as defmed by the national labor relations act the decisions were based on the fact that the creation and implementation of such programs clearly represent changes in tenns and conditions of employment. pre-employment testing was not considered a mandatory bargaining issue since applicants are not considered "employees" by the act. company rules and reasonable cause testing procedures can be classified in five general categories. pre-employment testing, as previously discussed, involves the testing of applicants seriously considered for employment or who have been offered employment positions. in a survey of private employers, way [35] found that half of all organizations surveyed utilized preemployment drug testing. random testing occurs when employees are unaware of who will be tested, when they will be tested, or the frequency of the testing. fitness-forduty testing involves the periodic testing of employees, generally occurring with their annual physical examinations. for-cause testing requires an employee to be tested following certain on-the-job accidents or incidents. suspicion-based testing requires the employer to show reasonable suspicion prior to subjecting the employee to substance-abuse testings [3]. for the employer to meet the "reasonable suspicion" clause, certain behavioral or physical indications of drug abuse must be identified by the employer. physical indicants may include reddening of the eyes, perspiration and nausea. behavioral signs may include euphoria, anxiety, suspicion, and paranoia [10]. in the absence of a well-defined drug testing policy. arbitrators may be asked to decide whether administering the test could be construed as arbitrary, discriminatory, or retaliatory [8]. these issues usually emerge when testing is left up to the discretion of the supervisor. denenberg and denenberg [8] reported that much of the arbitrator's decision is based on an examination of the principles of selection that govern the testing program. most testing programs are categorized as either random or suspicion-based testing. yet, according to verespej [34], in over a dozen cases courts have found random drug testing to be unconstitutional and that there must be "reasonable suspicion or probable cause" to test employees. defming "reasonable cause" is another gray area in suspicion-based drug testing. koven and smith [19] support the use of the set of seven just-cause standards universally accepted by arbitrators as a guideline for hearing cases. denenberg and denenberg [8] further found that in contracts where drug testing is stated to take place only "upon just and sufficient cause," the employer must prove impairment by "observing overt behavior or conduct of the employee relative to his job that establishes probable cause that the employee is under the influence of alcohol or drugs." a drug policy could state that reasonable cause "shall include, but not be limited to, management's personal observation of an employee's appearance, behavior, or speech." for example, the united states court of appeals for the third circuit upheld the philadelphia police department's right to test on "reasonable suspicion" and tenninate 30 journal ofbusiness strategies vol. 9, no.1 an officer based on drug test results. the court said there was "reasonable grounds" to suspect the officer of drug use based on a fellow officer's accusation and an earlier incident in which the grievant was found in the company of another officer who was allegedly selling drugs [5]. other cases have found that statistical indications, such as excessive absenteeism or tardiness, may not qualify as reasonable cause. the question arises, is there one appropriate standard for arbitrators to follow in drug-related cases? generally in a discharge case the arbitrator uses the standard "a preponderance of evidence." wynns [37] stated that in cases involving violation of the criminal code, it has been suggested that arbitrators should hold employers to a "beyond a reasonable doubt" standard of proof. random drug testing has also become a controversial issue. some collective bargaining agreements contain provisions limiting testing to situations in which reasonable cause exists. in the 1986 national football league players association case, management's attempts to impose a random-testing program were denied because such testing was not part of the contract clause defining drug testing. the decision suggests that if an established drug-testing program is limited to reasonable cause, employers will not be able to expand the scope of testing under the management rights argument [9]. in phelps dodge copper products company [25], arbitrator albert blum ruled that the company could not expand the existing drug-control policy to include random testing without bargaining with the union, even though the union had acquiesced in many other rules and rule changes involving mandatory bargaining issues. blum further stated that the company's action went beyond "expressions of residual managerial power evidenced in other rules." refusal of testing another area of controversy in drug testing involves discharge of an employee for refusing to submit to a test. if the collective bargaining agreement lacks specific provisions regarding testing, some arbitrators will not uphold a discharge for refusing a management order to take a drug test. in some cases, charges of insubordination for refusal to take a drug test were not upheld if the employer failed to show either that drugs caused problems in the plant or· that the employee displayed signs of drug use. invasion of privacy becomes an issue if the employer attempts to force an employee to submit to a drug test without probable cause [8]. attempts were made to clarify the probable cause issue in american standard [il, where the arbitrator held that the company must present clear and convincing evidence of the employee's intoxication. in other cases, failure to specify the penalty for refusal to submit to a drug test has been grounds for arbitrators to reinstate grievants [14]. in material service corporation [22], because the company did not have a valid drug policy, aibitrator james cox found that the employer did not have just cause to discharge an end-loader operator who refused to take a drug test after the supervisor allegedly smelled marijuana in the cab. while the company had previously discussed spring 1992 oswald, harrison, & woerner: drug testing 31 a drug policy with the union, no agreement had been made at the time of the incident. even in the absence of a stated policy, the company argued that they had the right to give a "reasonable cause" type test. cox disagreed on the grounds that the employee was not in a "safety sensitive" position. the privacy issue the emphasis on privacy has also become an important issue in arbitration. more specifically noted is the question of whether drug testing is a violation of fourth amendment rights. the fowth amendment to the bill of rights protects individuals from unreasonable searches and seizures of the individual's self, homes, papers, and effects. the amendment also states that search and seizme can only be conducted when probable cause exists and a warrant describing the person or place to be searched has been issued. in terms of how the fourth amendment applies to drug testing, several questions must be addressed. is a drug test a search and seizure; and, if so, is it legal? is a drug test unreasonable? is there probable cause for the drug test? several cases have addressed the issue of drug testing in the context on the fowth amendment. for example, in a northern illinois district court case, judge susan getzendanner held that the fomth amendment does not permit the requirement of all employees to submit to mandatory screening without reasonable suspicion of illegal drug use. in the case involving employees of the cook county department of corrections, judge getzendanner decided that compulsory mination and testing of the mine samples are considered searches and are subject to fomth amendment scrutiny. she added that the evidence was not such that drug problems in the corrections department were so pervasive that they could not be handled with less intrusive means [30]. likewise, a new york state appeals court ruled against a new york city police department mandate for random drug testing of officers, again indicating that random drug testing without reasonable suspicion violated the members' rights under the fowth amendment. the court, however, did not object to drug screening or drug testing as a part of the annual employee physical [6]. in texas utilities generating company, arbitrator samuel edes [31] found that the company improperly required the grievant to submit to drug testing. in this case, the grievant returned to work after his shift with two fellow employees. the grievant and the two employees were in possession of marijuana and had left some in the ashtray of the grievant's car. the grievant declined a drug test. edes reasoned that the grievant was not on company premises as an employee; therefore, the company was not permitted to test for any activities outside of the work relationship, again deeming this an invasion of privacy. the new york court of appeals held in patchoque-medford congress of teachers v. board of education of the patchoque-medford union free school district [24] that the school district's drug-testing plan was unconstitutional because it represented an unreasonable search and seizure. the court said the district needed reasonable suspicion that the teachers were using drugs before they could be tested. it further 32 journal ofbusiness strategies vol. 9. no.1 stated that searches were intended to serve the public interest, but in doing so should not undennine the public's interest in maintaining the privacy, dignity and security of its members. another aspect of the privacy issue revolves around requiring human observation to ensure the specimen is that of the subject in question [15]. this was a primary consideration in rejecting the patchoque-medford drug-testing program.. the court stated that this was "at least as intrusive as a strip search:' and should not be pennissible without reasonable suspicion of drug use. as early as 1966, in schmerher v. california [26] the courts found the use of the body's blood for determining alcohol content constituted a fourth amendment search. as recently as 1989, in skinner v. railway labor executives association [27], the supreme court reaffrrmed the schmerher decision. the court, however, found the skinner search to be reasonable despite the absence of individual suspicion. the search was deemed reasonable for a variety of reasons. the intrusive nature of drug testing was minimized by sample collection in a medical environment, absent any observers. also. the results of the tests were found to be treated in a confidential manner. the court concluded its justification for detennining the search reasonable by explaining that employees who chose to work. in a regulated industry where safety is crucial should expect a reduction in their privacy. specifically, supreme court judge kennedy stated that in issues concerning safety, the individual's interests were diminished by the united states governments' "compelling" interest in a safe environment. in a second landmark decision, national treasury employees union v. von raab [23], a testing program for the united states customs service, which called for testing of all employees who applied for or performed jobs requiring such duties as drug interdiction, carrying of firearms. and handling classified information, was upheld by the supreme court. the point of interest in this case was that the customs service had little evidence of an existing drug problem. in fact, only 5 of 3,600 employees tested positive for drugs. the court found drug testing to be a reasonable search and therefore lawful, due to the governments' compelling interest in the societal problems caused by drugs and drug smuggling. since the von raab and skinner decisions, the court has refused to hear drugtesting cases claiming fourth amendment violations. this refusal is indicative of the court's position that not all fourth amendment searches will be viewed as illegal. one point of clarity is that the fourth amendment is not applicable to private employers unless their actions are in response to government-mandated testing programs, as established by the drug free workplace act of 1988. while the skinner and von raab decisions are not directly applicable to private employers, they appear to have some implications for parties interested in defining a reasonable drug testing program. both programs were specific and carefully managed, and both were implemented for employees in sensitive jobs. the von raab decision makes it clear that an existing problem is not needed to justify a drug testing program. interestingly, in a 1988 case, stone container corporation [29], arbitrator richard ross suggested that it was not necessarily the arbitrator's place to detennine the spring 1992 oswald, harrison, & woerner: drug testing 33 reasonableness of the drug test but; rather to be concerned with the appropriate implementation of the test as it relates to employee rights. faulty test findings questionable findings on drug tests have been another issue closely examined by the courts, as well as arbitrators. much of the concern revolves around faulty testing procedures. in jones v. mckenzie [18] the employee submitted to a urinalysis test for drugs as part of the employer's testing program. the first test resulted in a positive reading. the test was repeated a second time and again gave a positive reading. the employee agreed to two additional tests both of which registered negative. despite the latter results, the employee was terminated. the district court ruled that the second test was merely a repeat of the first and that an alternative method should have been employed. this was supported by the drug test manufacturer's label warning that ''positive results should be confirmed by an alternative method." there is also a possibility' of a title vn violation as a result of false positives on drug tests. false positives may be caused by dark skin color. if the employee or applicant failing the drug test is dark skinned, he/she may have valid grievances on the basis of race or color [8]. other sources of false positives can include over-the-counter drugs such as contac, sudafed, aspirin; some foods and beverages, such as poppy seeds and herbal teas; and highly concentrated urine specimens [8]. due to the possibility of false positive results, the arbitrator is faced with deciding whether a positive test result should be relied upon as the sole or major piece of evidence against a grievant. the arbitrator must decide whether the positive result proves impairment and thus was discipline justified. denenberg and denenberg [8] suggest that the issue may be whether the totality of the evidence, not merely the test result, justifies the discipline. according to wilson [36], employers should be forced in arbitration to prove: (l) the illegal identity of the drug allegedly found; (2) that the employee was in fact "high;" (3) while on the job; (4) that this impaired job performance; and (5) that the lab that analyzed the specimen properly identified it as belonging to the disciplined worker, that the procedure used was reliable, and that the technicians were competent. additionally, wilson suggested that the grievant should be permitted to introduce his or her own independent test results. other legal concerns there are a number of legal issues surrounding urine testing which are being considered in arbitration hearings. gampel and zeese [12] listed the following: confinnation testine. it is necessary for urine tests to be confirmed because of problems in the chemistry that might arise. legally. the only acceptable type of test is a gas chromatography/mass spectometry. relationship to employment. urine tests do not measure impairment. the tests will provide employers with information about a person's drug use; however, with the 34 journal ofbusiness strategies vol. 9, no.1 exception of marijuana, no research studies have confmned that drug use outside of the work environment impacts on-site work performance. because urine tests do not measure impairment or the ability to perform a job, a positive result from a drug test is considered to be unrelated to employment. according to gampel and zeese [12], arbitrators have awarded employees their jobs back on this point. in fact, in the last ten years as many as two-thirds of the drug-related discharges cases arbitrated were overturned and the employee reinstated [4]. in union plaza hotel [32], the arbitrator ruled that the employer needed to show that the employee failing the drug test was under the influence at work. further, if the employer chooses discharge as the proper disciplinary action, the employer needs to show that the employee failing the drug test was under the influence while at work [1]. violation of employment contract many labor agreements have contract language concerning drug use, and most forbid on-the-job intoxication. a positive urine test is not proof of violation of any of these items; and, according to gampel and zeese [12], many arbitrators have reinstated employees on this issue. another legal issue arbitrators must resolve is to what extent the legal status of the drug should effect the arbitration award. should, for example, the "decriminalization" of a drug, such as marijuana, take away from the employer's ability to impose discipline upon an employee involved with the drug. the following are two arbitral views as reported by denenberg [7]: (1)" the arbitrator is mindful that there is a growing tolerance of marijuana, and that there may be further decriminalization. but at this point the arbitrator cannot very well say the company did not have proper cause to discharge the grievant merely because it does not choose to adopt a permissive view of grievant's conduct." (2) ''the company's right to discharge for marijuana use is fully recognized. however, the arbitrator does find that the company has the responsibility to consider this factor; i.e., the decriminalization, as well as the employee's overall record and his length of service in determining the appropriateness of the penalty. ... it must be concluded that although the grievant clearly violated the company rule concerning use of marijuana, the company's summary discharge was not for just and sufficient cause." obviously, a consensus approach does not exist dealing with drug arbitration cases. for example, in kroger company [20] a worker discharge was overturned because the employee's work performance did not appear to suffer despite evidence of cocaine in his bloodstream. while in another case, just the presence of marijuana was enough evidence to uphold a termination. other issues, such as not being able to distinguish between the use of on and off premise drug use as a result of a drug test, have been cited, as in the case of cps continental inc. [2], as reason to overturn a termination. conclusion as the limitations on drug testing are being questioned in both the courts and the arbitration arena, the rights of employees and employers are in a state of constant change. one thing is clear; there is less tolerance today than ever before for drug spring 1992 oswald, harrison, & woerner: drug testing 35 abuse, particularly in jobs deemed "sensitive" in nature. thus, the trend is toward mandatory testing of employees in jobs where safety or security is an issue. to date, the rulings of arbitrators and the courts can be summarized in four major points: 1. employers must bargain with the union prior to implementing a drug-testing program for the purpose of discipline but not for the purpose of pre-employment testing. 2. suspicion-based drug-testing programs have been viewed more positively by the courts and arbitrators; random testing has been given approval for safety-sensitive jobs. 3. drug testing is not considered to be an illegal search or seizure as long as it is conducted within reasonable procedures and guidelines. 4. off-site drug use, unless it is proven to have detrimental effects on the employee's work, cannot be questioned by the employer. while some clarification as to the rights of employees, employers, and unions has been established, many more questions still remain unanswered. when, for example, can companies implement drug-testing programs for safety-related jobs without the approval of the union? will the implementation of pre-employment drug tests be contingent on the validity of such a test predicting future job performance? is preemployment testing a violation of title vii as it relates to questionable results due to dark skin pigmentation? as americans become more involved in the war on drugs, employees are likely to be asked to yield more of their privacy rights for detection of drug users. just how much reduction in privacy will be permitted is yet to be seen. references 1. amoco oil company and ocaw local 4449. no. 171, dlr al (1988). american standard, 77 la 7085 (1981). 2. cfs continental inc., 86-1, arb 3293, (1986). 3. colosi, m.l. "'the labor relations of substance abuse." labor law journal (october 1989), pp. 642-653. 4. cone, l. a. "public policies against drug use: paperworkers v. misco." labor law journal (april 1989), pp. 243-247. 5. co.peland v. philadelphia police dept no. 49 dlr a-i (1988). 6. caruso v. ward. no. 217 dlr a-5, (1987). 7. denenberg, t.s. & d.v. alcohol and drugs: issues in the workplace. washington, d.c.: bna books (1983). 36 journal ofbusiness strategies vol. 9, no.1 8. denenberg, t.s. & d.v. "employee drug testing and the arbitrator: what are the issues'!" the arbitration journal (1987a), pp. 42, 20. 9. denenberg, t.s. & d.v. national football league players association and national football league management council (1987b). (r.. kasher, october 25, 1986). the arbitration journal, pp. 42, 20. 10. flannery, h.a. ''termination of employment for refusal to submit to a drog test." labor law journal (may 1989), pp. 293-301. 11. freuderheim, milton. "drug testing." new york times (january 3, 1990), dl:3. 12. gampel, j.c. & zeese, k.b. "are employers overdosing on drug testing'!" business and society review (1985), vol. 55, pp. 34-48. 13. gatewood, r.d. & feild, h.s. human resource selection 2nd edition. hinsdale, il: the dryden press (1990). 14. hartstein, b. a. "drug testing in the work places: a primer for employers," employee relations law journal (1987) vol. 12, pp. 577-604. 15. horton, n. "drugs in the work place." management review (1987), pp. 5-6. 16. individual employment rights manual. washington, d.c.: bureau of national affairs, inc. (1989). 17. johnson-batman co. 295 nlrb, no. 26 (1989). 18. jones v. mckenzie. 628 f. supp 1500 (1986). 19. koven, a.m. & smith, s. just cause: the seven tests. san francisco, ca: coloracre publication inc. (1985). 20. kroger company, 1340 la 4731 (1986). 21. masi, d. "company response to drug abuse from ama's nationwide survey." personnel (march 1987), pp. 40-46. 22. material services corporation and international brotherhood of teamsters local 330 fmsc. 94 la 37 (1989). 23. national treaswy emplqyees union v. von raab. no. 54 dlr a-7 (1989). 24. patchoqlle-medford conmss of teachers v. board of education of the patchoguemedford union free school district. no. 156 dlr a3-5 (1987). 25. phelps dodge copper products co. and international brotherhood of electrical workers local 583. fmsc. 94 la 393 (1990). 26. schmerber v. california. 384 us 757 (1966). 27. skinner v. railway labor executives association. no. 54 dlr a-4 (1989). spring 1992 oswald, harrison, & woerner: drug testing 37 28. star tribune. 295 nlrb no. 63 (1989). 29. stone container com. and united p~ workers local 531. fmcs. 91 la 1187 (1988). 30. taylor v. o'grady. no. 198 dlr a-9 (1987). 31. texas utility generating company. no. 82 la 6 (1983). 32. union plaza hotel. 88 la 528 (1988). 33. ver ploeg, c. "drug testing in the workplace." the bench & bar of minnesota (1986), pp. 14-20. 34. verespej, m.a. "drug testing: emerging set of rules." industiy wee~ vol. 23 (1987), pp. 20-21. 35. way, p.k. "divergent organizational responses to substance abuse." labor law journal (april 1987), pp. 521-526. 36. wilson, c.w. "from aids to z: a primer for legal issues concerning aids, drug testing, and alcohol in the workplace." the labor lawyer (1981), pp. 640-614. 37. wynns, p.a. "a profile of grievance arbitration cases." the arbitration journal, vol. 34 (1979), pp. 19-27. 38. "wyoming court is second to allow amoco drug program to proceed until arbitration!' daily labor report 226 (1986), a-6. drug testing: what are the rights of employees, employers, and unions? top management team risk taking propensities and firm performance: direct and moderating effects k. matthew gilley oklahoma state university stillwater, ok bruce a. walters louisiana tech university ruston, la bradley j. olson oklahoma state university stillwater, ok abstract we investi/?ate the influence of top management team (tmt) risk takin/? propensities on firm performance. diverginr from previous work on the risk taking-performance relationship, we rely on perceptual (rather than archival) measures o{ risk takin/? in addition to financial performance, we examine other performance outcomes of risk taking, such as innovativeness and stakeholder satisfaction. contrary to the findings of bromiley (1991 j and bowman ( 1980j, we .lind that risk taking has a strong positive influence on firm performance. in addition, the risk taking-performance relationship is moderated by the dynamism (~fthefirm's industry. more spec~fically, we find that the bene.fits of tmt risk taking are reduced in more dynamic environments. introduction an important component of the strategic management process is decisionmaking that involves risk. practitioners are inundated with choices that involve varying levels of risk; yet, strategic management researchers have not devoted as much attention to risk as have practitioners (ruefli, collins, & lacugna, 1999). furthermore, the studies that do analyze risk are inconclusive in their findings regarding the relationship between risk and performance (see aaker & jacobson, 1987; bowman, 1980). moreover, the bulk of studies that address risk taking and its effect on performance measure risk taking at the firm level by using various financial indicators as proxies for the firm's level of risk. perceptual measures of tmt risk taking propensities have been virtually ignored. because decisions influencing a firm's overall level of risk are made by the 96 journal (~rbusiness strategies vol. 19, no.2 firm's top management team, an examination of tmt risk taking propensities may shed additional light on the effects that top executive characteristics have on firm outcomes. we examine the effects of top management team risk propensities on a broad variety of firm performance criteria. [n addition to investigating the direct effects of tmt risk taking on firm outcomes, we also examine the potential moderating effects of the firm's industry environment. thus, both individuallevel and industry-level characteristics are used to explain firm-level outcomes. organizational performance has long been the primary dependent variable in strategic management research. indeed, perhaps a key contribution of strategy research is that it attempts to link various organizational characteristics to performance and survival (meyer, 1991). researchers have linked variables such as business-level or corporate-level strategy (miller, 1988; porter, 1980), organizational structure (burns & stalker, 1961; miller, 1988), choice of environmental domains (bourgeois, 1985; miller, 1992; prescott, 1986), and strategy-making processes (e.g., priem, rasheed, & kotulic, 1995) to various performance measures. in addition, a variety of scholars have considered the int1uence of top managers themselves on firm performance. population ecologists, for example, view the impact of managers on organizational outcomes as minimal (hannan & freeman, 1977). researchers in the tradition of ricardian economics accorded little role for managers as well, focusing instead on the "original, unaugmentable, and indestructible gi fts of nature" (ricardo, 1817). strategic choice advocates, on the other hand. have recognized the importance of the choices top managers make which set in motion processes that affect organizational outcomes (e.g., child, 1972). in the years since hambrick and mason's (1984) call for an "upper echelons" perspective on the study of organizational phenomena and gupta's (1984) suggestion that tmt characteristics are related to firm strategies and performance, researchers have attempted to explain a variety of strategy formulation, implementation, and performance issues using tmt characteristics. the results of these studies suggest that the characteristics of a company's top executives have important consequences for firm performance. a major assumption of this paper is that managers do, indeed, matter to organizational outcomes. as hamhrick and mason (1984) note, however, the majority of this research has focused on the characteristics of chief executive officers (ceos). although the characteristics of ceos are potentially important to firm outcomes, "abundant evidence exists that studying tmts, rather than ceos alone, provides better predictions of organizational outcomes" (finkelstein & hambrick, 1996: 117). thus, the current study is concerned with the risk taking proclivities of entire tmts and their effects on firm performance. fall 2002 gilley, et af: risk taking propensities literature review and theory development 97 risk taking and firm performance hambrick and mason (1984) proposed that observable and psychological tmt characteristics have the ability to influence both strategic choice and organizational performance. in addition, bantel and jackson (1989) found that tmts had at least four common characteristics: age, organizational tenure, education, and functional experience. yet strategy researchers have given relatively little attention to the risk taking proclivities, or, in other words, the risk taking tendencies, of top executives. it is likely that tmt risk proclivities have important implications for organizational outcomes. although there are various definitions of risk, an applicable definition is "the extent to which there is uncertainty about whether potentially significant and/or disappointing outcomes of decisions will be realized" (sitkin & pablo, 1992: 10). therefore, from a tmt perspective, risk taking propensity means the extent to which the tmt is willing to engage in behaviors with uncertain and significant outcomes for the firm. by way of definition, sitkin and pablo (1992: 10) define the term "uncertain" in terms of "the variability of outcomes (libby & fishburn, 1977), lack of knowledge of the distribution of potential outcomes (march, 1978), and the uncontrollability of outcome attainment (vlek & stallen, 1980)." moreover, the term "significant" denotes a full range of outcomes potentially affecting the firm, both positive and negative (sitkin & pablo, 1992). since the 1980s, a number of researchers have examined organization risk, and the vast majority of these have used financial measures of risk. in essence, prior research on the risk-performance relationship has examined the riskiness of an organization's iines of business or portfolio of business units. for example, miller and bromiley (1990) performed a factor analysis on nine financial performance items in an attempt to provide a simpler and more useful set of risk measurements. their analysis produced three overall factors. one is the income stream, which appears to be the most common measure used in risk studies, and is the fluctuation of financial ratios such as roe or roi. stock returns are also used to measure risk. finally, other financial ratios (such as debt-to-equity ratios) are used to measure risk, but appear to receive less attention in risk research. this lack of attention may be due to the promotion, by many scholars, of roi as an important measure of financial performance (chakravarthy, 1986). miller and bromiley (1990) proposed that these factors determine a firm's level of strategic risk, and they tied this to firm performance. they found a significant negative relationship between income stream risk and firm performance. other types of risk were not significant. again using the income stream approach, bowman (1980) also found a negative relationship between risk and organizational performance. using stock return risk, aaker and jacobson (1987) found results that were contrary to bowman's work. they discovered that, once risk was separated into the two categories of systematic or unsystematic risk, both types of risk had 98 journal of business strategies vol. 19, no.2 considerable positive effects on rol. conversely, bromiley (1991) found, in his analysis of the securities of 288 corporations, that risk had a strong negative effect on performance. these studies highlight several interesting issues'in the study of the relationship between risk and firm performance. first, while the research mentioned above examines risk, it does so only from a financial or portfolio perspective. second, the findings of risk-performance relationships are inconsistent; some studies show a negative relationship, while others show a positive one. some have suggested that these inconsistencies may arise because the traditional measures of risk lack face validity (ruefli, collins, & lacugna, 1999). or in other words, these measures may not capture risk that is conceptualized by managers (mcnamara & bromiley, 1999). other explanations of these inconsistent findings could be attributed to a failure to examine contextual factors, such as the environment, in the risk/return studies. finally, the underlying phenomenon that drives a firm's level of risk, namely top management team risk propensities, has been ignored by this stream of research. while researchers have examined organizational risk, they have failed to examine the tmt's willingness to take risks and its effect on a broad variety of firm outcomes. in fact, palmer and wiseman (1999) found that managerial risk is a distinct and separate construct from organizational risk. if these constructs are two distinct concepts then it is imperative to study risk from a perceptual basis to determine if there are different findings from the traditional measures of organization risk. for example, from a management perspective, psychology would dictate that risk would be positively related to performance. the reason given for this argument is that employees will anticipate negative consequences for risky decisions that did not provide the appropriate results. this risk-averse nature will then drive employees to demand higher returns for riskier decisions (mcnamara & bromiley, 1999). some researchers who have incorporated perceptual measures have obtained results supporting a positive relationship between risk and performance. one study in particular addressed the relationship between tmt risk taking and firm outcomes. gupta and govindarajan (1984) studied 58 strategic business units of eight parent companies to examine the influence oftmt characteristics and business unit strategy on the effectiveness of strategy implementation. specifically, they studied the tmt's length of experience in sales/marketing, its willingness to take risks, and its tolerance for ambiguity. their findings indicate that risk taking has a significant positive influence on effectiveness of strategy implementation for "build" subsidiaries and a negative influence on "harvest" subsidiaries. also, knight, durham, and locke (200 1) conducted a laboratory experiment to test the effects of many constructs, including risk assessment, on performance. one interesting finding was that they found a positive relationship with managerial risk assessment and task performance. thus, researchers have shown that managerial risk proclivities can have a positive influence on certain types of organizational outcomes. fall 2002 gilley. et al: risk taking propensities 99 we propose that, in general, a positive relationship exists between tmt risk taking and a broad variety of organizational outcomes. risk-averse top management teams are not likely to become involved in groundbreaking new ventures in an attempt to enhance organizational success. furthermore, highly risk-averse tmts will choose strategies that maintain the status quo, thereby decreasing the firm's level of innovation and reducing the firm's commitment to cutting-edge products and technologies. by contrast, risk-seeking tmts will be more likely to engage in behaviors that lead to process enhancements, highly competitive new products or services, innovative marketing techniques, and so on. thus, the behaviors of risk-seeking tmts should serve to enhance organizational performance. hypothesis 1: top management team risk taking has a positive effect on firm performance. environmental dynamism environmental dynamism is the rate of change and the unpredictability of change in a firm's competitive environment (dess & beard, 1984). dynamism appears to be an important moderator in relationships between organizational structure and performance (e.g., burns & stalker, 1961), business-level strategy and performance (e.g., miller, 1988), capital structure and performance (simerly & li, 2000), outsourcing and performance (gilley & rasheed, 2000), and the strategy making process and performance (e.g., priem, rasheed, & kotulic, 1995). with regard to risk taking, the dynamism in a firm's environment may have an impact on the degree to which risk taking behaviors influence firm performance. ifthe rate of change is extremely high and the direction unpredictable, risk taking may lead to ill-advised investments of resources into products or markets that do not prove viable. this environment may be difficult to analyze and accurately assess for risky investments. boyd and fulk (1996) found that environmental scanning declined when the environment was perceived to be less analyzable or predictable. the implication is that with less accurate information about the environment, risky behaviors may not payoff. thus, in more dynamic environments, the relationship between the risky behavior and the eventual outcome is more likely to be obscured. the probability of observing differences in performance attributable to risk taking is thus likely to be smaller than in stable environments. in stable environments, on the other hand, firms often have more latitude in terms of strategic decisions (decisions that directly impact an organization, commit large resources, and are often irreversible), including risk taking. these environments can accommodate more defensive types of behaviors as well as more aggressive ones (smircich & stubbart, 1985; weick, 1979). for instance, firms in stable environments are often focused more on internal efficiency than might be the case in dynamic environments. the perceived stability of the environment allows them to focus attention on process improvements. this 100 journal of business strategies vol. 19, no.2 inward focus may take attention away from potentially important external environmental trends, however, giving firms who engage in some risk taking an advantage. thus, firms in stable environments who continue to take some risks may benefit. also, stable environments may be more analyzable, and tmts may be better able to "enact" (weick, 1979) the environment to their advantage. as smircich and stubbart (1985: 724) note: " ... organizations are socially constructed systems of shared meaning (burrell & morgan, 1979; pfeffer, 1981; weick, 1979). organization members actively form (enact) their environments through their social interaction. a pattern of enactment establishes the foundation of organizational reality, and in turn has effects in shaping future enactments." a more stable and analyzable environment is likely more conducive to enacting behaviors (establishing patterns and future expectations), whereas a less predictable, turbulent environment presents less certainty about causeeffect relationships. indeed, in a banking simulation using tmts, waddock and isabella (1989) found that the more predictable or understandable the environment was perceived to be, the more proactive management was, and the higher the performance. it follows that if stable environments are easier to analyze, and tmts increase their levels of risk taking, performance should be enhanced. hypothesis 2: environmental dynamism moderates the relationship between top management team risk taking and firm performance such that, in more dynamic environments, the performance eitects of risk taking are reduced. research method sample and sampling procedures a survey methodology was used to test these hypotheses. the sample included the top executive (either the ceo or president) from independent, nondiversified manufacturing firms employing more than 50 people. these individuals received a cover letter explaining the research project and were asked to complete the enclosed survey. in return for their participation, the subjects were promised an executive summary of the study's results. follow-up letters were sent seven days after the initial mailing. these follow-up letters served as a "thank you" to participants and as a reminder to those who had not yet returned their completed surveys (dillman, 1978). twenty-one days after the initial mailing, non-responding firms were contacted by telephone. of 558 firms contacted, 94 (17%) returned usable surveys in time to be included in this study. while this response rate would appear to be somewhat below expectations, the length and complexity of the survey instrument itselflikely had a negative effect on our response. due to the nature of our overall data collection effort, the survey instrument was necessarily demanding on the respondents. the data collected for the tests reported in this study are from a much larger study of business strategy. one measure in particular (not reported in the current study) fall 2002 gilley, et al: risk taking propensities 101 required a multi-stage response format, and the tables completed by respondents were quite lengthy and complex, despite our best efforts to simplify them, given the relatively high non-response rate, we were careful to check for non-response bias. to test for this, differences in total number of employees and industry representation for responding and non-responding firms were examined. no significant differences were detected in either firm size (c2 = 6.13, df =4, p>.05) or industry type (c2 = 18.71, df = 15, p > .05). whi ie checks for non-response bias based on other factors (such as performance) would be optimal, the data for the firms in our sample were not available. the firms in the sample represent a total of sixteen industrial sectors. firms ranged in size from approximately 50 employees to 7,500. median firm size was 100 employees, and the average firm had been in operation for 38 years. the average respondent was 49 years old and had been with the firm for 14 years. measures risk taking. risk taking was measured with six items. the first two items were adopted from miller and friesen (1982) and asked respondents whether the firm's "top executives have a strong preference for high-risk projects," and the extent to which "bold acts are viewed as useful and common practice" by the firm's top executives. four other items were adopted from miller (1988) and asked whether their top executives (i) "prefer to carefully analyze a situation before moving", (2) "favor the tried and true", (3) have a "tendency to follow competitors instead of introducing new products oursel ves first," and (4) "prefer to let other firms in our industry assume the risk of product or process innovations before adopting them in our firm." responses were scored on a 7-point scale (i = strongly disagree to 7 = strongly agree). the reliability a global, combined risk taking measure was .63. an exploratory factor analysis, using principal axis extraction techniques and a varimax rotation in spss (see ford, maccallum, & tait, 1986), revealed that the risk taking measure was actually comprised of two factors: one for risk taking associated with introducing new products or processes ahead of competitors and another for more general risk taking. we labeled these two measures of risk taking "product/process" risk taking and "general" risk taking. the internal reliability coefficients for these two risk taking measures were .78 and .76, respectively. each has two items. the remaining two items were not used in the analyses due to their negative effect on reliability and significant cross-loadings in the factor analysis. those were the items dealing with favoring the tried and true and carefully analyzing a situation before moving. in each case, the items deleted were worded such that the focus was on risk aversion, while the remaining items were primarily focused on risk lakin!? this resulted in those two items not falling cleanly into the two factors found in the data. firm performance. multiple measures of performance were used to retlect the multidimensionality of the performance construct (cameron, 1978; chakravarthy, 1986). venkatraman and ramanujam (1987) suggest using a 102 journal of business strategies vol. 19, no.2 broad range of firm performance measures in strategy research. more specifically, miller and leiblein (1996) point to the need for research on risk-return relations to be extended beyond profitability measures to other organizational performance dimensions. thus, in addition to financial measures, we examined several other performance criteria with regard to the effect of risk taking. regarding financial performance measures, we expected most of the smal1 firms in the sample to be privately held. we therefore believed it unlikely, based on past experience, that the ceos would be willing to provide detailed, accurate accounting data on firm performance. subjective, self-reported measures of performance were thus used in this research. the ceos were asked to report their best subjective estimates of performance compared to similar firms in their industry on a five-point scale for each of the following: after tax return on total assets, after tax return on total sales, sales growth, and overall financial performance, al1 for the previous twelve-month period. measures such as these have been found to be highly correlated with objective measures of firm performance (e.g., dess & robinson, 1984; venkatraman & ramanujam, 1987). moreover, the literature suggests that subjective measures should be used when interest centers on capturing the perspective of organizational members (duncan, 1972) and when studying managerial behavior and decision-making (boyd, dess, & rasheed, 1993). the explicit performance comparisons to similar firms provided a form of control for differences in performance due to industry (dess, ireland, & hitt, 1990) and strategic group (hatten, schendel, & cooper, 1978) effects. to determine each firm's non-financial performance, respondents were asked to rate their firm's r&d and advertising outlays, stability/growth of employment, process innovations, product innovations, employee compensation, employee morale/job satisfaction, customer relations, supplier relations, and overal1 non-financial performance relative to their competitors. for both financial and non-financial performance, responses were coded on a 5-point scale (i =at the bottom of similar firms in the industry to 5 =at the top of similar firms in the industry). exploratory factor analyses (using the same techniques described above) revealed that performance had three distinct factors. the financial performance items comprise one factor. the non-financial performance items, however, created two separate factors. one non-financial performance factor deals with innovation performance, while the second factor concerns stakeholders. as a result of the exploratory factor analysis, the performance measure was split into financial performance (three items), innovation performance (three items), and stakeholder performance (four items). with the exception of stability/growth of employment and employee morale/job satisfaction, items loading significantly on multiple factors were removed. these two were retained to maintain the reliability of the stakeholder performance measure. a total of four performance items were removed, including sales growth (a "change" measure which did not fit well with the more static measures of financial performance collected), as well as overall non-financial performance and advertising outlays, which both fall 2002 gilley, et ol: risk taking propensities 103 failed to fit with either type of non-financial performance factor. the only remaining item removed from the analyses included employee compensation. surprisingly, it did not load cleanly on the stakeholder performance factor. this was likely caused by the financial connotations resulting from the term "compensation", which was not found in any ofthe remaining non-financial performance items. the internal reliability coefficients for the performance measures were .93 (financial), .80 (innovation), and .76 (stakeholders). confirmatory factor analysis (cfa) models were used to test the discriminant validity of the risk taking and petformance constructs. cfahas been widely used as a rigorous test of construct validity (spreitzer, 1995). the first model was designed such that each of the observed variables (the four risk taking items and ten performance items discussed above) was set to load on a single latent variable. a second model was developed such that there were two latent variables, one representing risk taking and the other representing firm performance. a third model was developed such that there were two latent variables representing risk and three representing petformance. as suggested in previous research (bollen, 1989; medsker, williams, & holahan, 1994) multiple indices were used to assess the fit of each model. the criteria examined included c2/df, a standardized measure where a smaller value represents a better fit; the bentler and bonett (1980) normed fit index (nfl); bollen's (1986, 1989) relative fit index (rfi) and incremental fit index (lfi); the tucker-lewis coefficient (tli); and bentler's (1990) comparative fit index (cfi). fit indices closer to 1.0 indicate a better model fit, except for c2/df, as mentioned above. each fit index (see table i) suggested that the model was a better fit to the data when risk and performance were treated as separate latent variables. in addition, there was even better model fit with two risk constructs and three performance constructs, providing additional support for the results of our exploratory factor analyses. thus it would appear that the risk items are, indeed, distinct from the performance constructs, providing support for divergent validity. in other words, it appears that respondents differentiated substantially between the risk and performance items despite some similarities in their wordings. table 1 comparison between one, two, and five factors for risk and performance items models xz/df nfl rfi iff tli eft model with two risk constructs and three performance constructs 1.97 .96 .95 .98 .97 .98 model with one risk construct and one performance construct 4.37 .91 .88 .93 .90 .93 model with one construct comprising four risk and ten performance items 5.00 .90 .86 .92 .88 .92 104 journal (~l business strategies vol. 19, no.2 environmental dynamism. environmental dynamism was measured using a scale developed by miller and friesen (1982). responses were coded on a 7point scale (i = strongly disagree to 7 = strongly agree). miller (1988) reported a reliability of this measure of .59. to increase reliability, two additional items concerning environmental dynamism were included, increasing the number of items in this scale to seven. the internal reliability coefficient of the dynamism measure was raised to .79. industry control variable. to control for potential industry effects, fifteen industry dummy variables (firms from sixteen industrial sectors were included in the sample) were developed using each firm's two-digit sic code. these were then included in the regression analyses. analytical techniques multiple regression analysis was used to test the hypothesis that top management team risk taking has a positive influence on performance. in addition, moderated hierarchical regression analysis was used to test the extent to which environmental dynamism moderates the relationship between risk taking and firm outcomes. to test the moderator hypothesis, linear-by-linear interaction terms were created by multiplying the proposed moderator (dynamism) by the two risk taking variables (stone & hollenbeck, 1988). after entering the main effects (product! process risk taking, general risk taking, and dynamism) and industry control variables into the equation, the multiplicative terms were added. the regression weights for the multiplicative terms were then examined for significance. following the advice of mcclelland and judd (1993), the p-values for the moderator tests were relaxed to .1 () because of the difficulty of moderator detection. results means, standard deviations, zero-order correlations. and internal reliability coefficients for the variables in our regression analyses can be found in table 2. table 2 descriptive statistics and correlations mean s.d. 2 3 4 5 6 i. financial performance 10.31 2.97 (93) 2. innovation performance 9.32 3.01 .30** (.80) 3. stakeholder performance i4.7s 2.60 .44*** .38*** (.76) 4. product/process risk taking 9..b 2.66 .04 .44*** .17 (761 5. general risk taking 6.13 2.66 .31 ** .64*** .42*** .37** (79) 6. dynamism 32.25 7.17 .17 .26* -.12 .21 * .18 (79) * p < .05 ** p < .01 ***p < .001 internal reliability coefficients are on the diagonal in parentheses. fall 2002 gilley, et af: risk taking propensities 105 table 3 highlights the findings of our tests for the direct effects of risk taking on firm performance. as shown, a linear combination of the two risk taking measures and the industry controls, adjusted for the number of independent variables, explains 29% of the variance in financial performance, 43% of the variance in innovation performance, and 16% of the variance in stakeholder performance. general risk taking (b = .24, p < .05) was a significant predictor of innovation performance. product/process risk taking was a significant predictor of financial (b = .34, p < .(01), innovation (b::;: .54, p < .001), and stakeholder (b::;: .46, p < .00 i) performance. these findings suggest that organizational risk taking, especially with respect to the firm's processes and products, has a strong, positive influence on a broad variety of financial and non-financial performance measures. thus, hypothesis i is supported. table 3 results of regression analyses for performance implications of top management team risk taking predictors general risk taking product/process risk taking f (full mode i) w adj, r~ df standardized regression cqefficient!! firm performance financial innovation stakeholders .03 .24* .04 .34*** .54*** .46*** 2.95*** 4,63*** 1.90* .44 .55 .33 ,29 .43 ,16 17,65 17.65 17.65 *p < ,05 ***p < ,001 industry dummy variables were omitled from this table for clarity of presentation. table 4 shows the results of our analyses for the moderating effects of environmental dynamism. our second hypothesis suggested that the effects of risk taking on firm performance would be contingent on the environment in which the firm was operating. our results provide moderate support for this notion. first, the effects of general risk taking on organizational innovation were found to be contingent on dynamism within the industry environment (b =-1.0 i, p < .10). the effects of product/process risk taking on financial performance appear to be contingent on environmental dynamism (b ::;: -.86, p < .10) as well. the effects of risk propensities on stakeholder performance appear not to be contingent on environmental conditions. nevertheless, our results show moderate support for the idea that the effects of risk taking are not the same for all firms. on the contrary, it would appear that organizational context (dynamism in this case) has an effect on the organization-level results of managerial risk taking behaviors. in other words, it appears that, in more dynamic environments, 106 journal of business strategies vol. 19, no.2 risky behaviors may have less of an impact on firm performance. conversely, in more stable environments, organizations may have more to gain through riskier behavior. thus, hypothesis 2 is moderately supported. table 4 results of regression analyses for moderating effects of environmental dynamism standardized regression coefficients firm performance predictors financial innovation stakeholders general risk taking -.54 product/process risk taking -.44 dynamism .68 general risk taking x -.67 dynamism product/process risk taking x -.86' dynamism f (fui! model) 3.76*** adj. r' df .41 20,61 -.62 .22 1.05* 24 .59* -.19 -1.01 ' .17 -.59 -.27 4.34*** j.74 .59 .36 .45 .15 20,6\ 20,6\ tp < .10 *p < .05 ***p < .001 industry dummy variables were omitted from this table for clarity of presentation. discussion with regard to the performance implications oftmt risk taking, our results suggest that tmt risk taking propensities have a significant influence on firm performance. more specifically, we found that tmts that take risk (especially with regard to process and product enhancements) achieve superior levels of financial and non-financial performance. in addition, we found that the effects of risk taking on firm performance are not the same for all firms. rather, the benefits of risk taking appear to be reduced somewhat by increasing levels of dynamism within the firm's industry environment. these results are discussed more fully below, as are the study's limitations and some suggestions for future research. risk taking, dynamism, and firm performance our results suggest that tmt risk taking has both a direct and an indirect effect on organizational performance. regarding direct effects, we found that risk taking by top management teams has a significant, positive influence on the fall 2002 gilley, et a/: risk taking propensities 107 performance of the firms they serve. thus, we have provided additional support for the notion that managers do indeed make a difference. this study challenges the population ecology perspective, and presents further evidence that tmts do influence organizational outcomes. other studies support this conclusion as well (e.g., daboub, rasheed, priem, & gray, 1995; hitt, nixon, hoskisson, & kochhar, 1999). our results indicate that risk-averse executives should increase the extent to which they choose innovative new strategies in an attempt to enhance their firms' performance. regarding indirect effects, we found that environmental dynamism partially moderates the effects of risk taking on firm outcomes. in more dynamic environments, the performance effects oftmt risk-taking proclivities had somewhat less of an efject on performance. conversely, tmt risk taking had a somewhat more positive effect on firm performance in less dynamic environments. these findings perhaps cast some doubt on lieberson and o'connor's (1972) findings about "inertial" organizations. our results also provide a different perspective on the risk and return paradox, by finding that risk is positively related to firm performance. to reach this conclusion, we used non-financial rather than financial measures to calculate risk. the traditional financial measures can provide some support that an organization, which is perceived to be risky (e.g. high variation in roe), is likely to have negative performance (e.g. high variation in roi). while these measures can provide some insight about organizational risk by illustrating the risk/return paradox, analysis of roi and roe does not capture the perceptual and cognitive aspects ofthe executive. thus, the traditional approach to measuring risk is likely more suitable for analyzing risk in the context of financial or outcome variability. behavior, however, is too complex to be measured by only a financial model or measurement (march & shapira, 1987). the psychometric measurement, therefore, calculates risk in a different context, which has lead to a different conclusion about the risk/return relationship. a recent study performed by mcnamara and bromiley (1999) incorporated such measures of perception that assess risk from the manager's perspective rather than from the traditional manner or measuring risk using income stream analysis. also, knight, durham, and locke (2001) used managerial risk assessment and found a positive relationship between risk and task performance. our findings have provided some insight as to the importance of tmts' risktaking tendencies and the effects of dynamism. these results can have practical applications for managers and their organizations. managers might benefit from determining the degree to which their environment is dynamic, and assessing the appropriateness of risky decisions. for those firms in more stable, predictable environments, our results suggest that some risk taking may prove fruitful, and that the competition may miss important opportunities that more aggressive firms can use to their advantage. 108 journal o!,business strategies vol. 19, no.2 limitations and future research this study has several limitations. first, the generalizability of this study's findings may be limited. although the sample was representative of the population of interest based upon firm size and industry type, there is a striking lack of representation of firms in various stages of industry development. there were no firms in introduction-stage industries and only one in a decline-stage industry (self-reported). in addition, all of the firms in our sample were manufacturers. future research should attempt to gather risk-taking data from executives in firms in introductionand decline-stage industries, as well as from those in service industries. these factors may play an important role in the relationships among risk taking, environmental dynamism, and firm performance. in addition, a better risk aversion measure is needed. while the reliabilities of the two risk-aversion measures used in this study are sufficiently high, they only contain two items each. a more comprehensive measure of risk aversion may shed additional light on the relationship between risk taking and performance. also, objective measures of performance were not available for the majority of firms in the sample because they are privately held. although prior research has indicated a strong relationship between archival and perceptual measures of performance (dess & robinson, 1984; venkatraman & ramanujam, 1987), there is no guarantee that this is the case in our sample. examining archival performance measures and their relationship to risk taking may add to our knowledge of this topic and is a suggestion for future research. also, given that our study is cross-sectional and correlational in nature, our conclusions of causation must be viewed with caution. while there are strong theoretical reasons for our assertions that risk taking will have an effect on subsequent firm performance, there is also the possibility that more successful top management teams make riskier decisions as a result of prior successes. another concern is that our interaction terms were only significant at p < .10. while recent research suggests that it is more difficult to find moderating effects in field studies than in experiments (aguinis, 1995; mcclelland & judd, 1993; stone-romero, alliger, & aguinis, 1994), our interaction results should be viewed with caution. a recurring theme for this difficulty in finding statistical significance is that field studies have more noise, and thus are less sensitive than experiments. power appears to be much lower in field studies. therefore, power is an important matter when dealing with moderated models. in fact, some researchers found that small, medium, and large moderating effects may go undetected with sample size of 120. our sample is 94 firms; thus power is likely low in this study. also, mcclelland and judd (1993) provide support that in field studies there is a greater likelihood to have an ordinal interaction than in experimental designs. the rationale is that in field studies, there are "theoretical constraints on the nature of the interaction", and thus ordinal interactions are more likely to occur than disordinal interactions. ordinal interactions make it more difficult to find significant interaction term variance. experimental studies are more sterile, and may not have these constraints and thus tend to have fall 2002 gilley. et al: risk takinr propensities 109 disordinal interactions. lastly, measurement errors in field studies are considerably greater than in experimental designs, and thus make it more difficult to find significant interaction effects (mcclelland & judd, 1993). finally, a general criticism of survey research is common method variance, because the independent and dependent constructs are often measured entirely with self-reported data (as was the case here). one cannot dismiss podsakoff and organ's (1986) admonition to avoid measuring the independent and dependent variables by the same source, since there is a potential for questionable results. this counsel is particularly important to consider, since the moderated relationship was only significant at a p-value of < .10. yet, common method variance may not be as much of a limitation as once thought, because although common method variance innates zero-order correlations, it also increases the shared variance among the independent variables (shaffer, harrison, & gilley, 1999). this makes it more difficult to find unique, significant beta weights (florey & harrison, 20(0) and reduces the chance that common method variance had a major effect on the conclusions of this study. additionally, in order to "secondguess" the hypotheses, subjects would have been required to purposefully match their responses to the environmental dynamism scale with the various risk taking and performance measures, without any cues as to the predicted "appropriate" matches required for superior performance. given the complexity of the hypotheses, it is unlikely that ceos could have somehow "structured" their responses to performance questions to reflect previous responses to the multiple items that measured the predictor variables (e.g., ooty, glick, & huber, 1993). nevertheless, one cannot absolutely rule out the possibility that respondents artificially answered in a consistent fashion. despite these limitations, one should be cautiously optimistic of our findings. our results on the linkage of risk and performance are promising, and the results on the moderated relationship are encouraging for further strategic research. the use of perceptual measures of risk is relatively new; hence, this study was performed to determine if risk could be positively related to return based on psychometric measures. therefore, while this study has provided some insight to the measurement of risk, it should be seen as a building block for more risk/return studies based on management risk. conclusion although researchers have devoted considerable attention to top management teams and their influence on firm outcomes, findings regarding the performance effects oftmt risk-taking proclivities are scanty. we have attempted to fill this gap in the literature by exploring the relationships among tmt risk taking, environmental dynamism, and firm performance. our results suggest that tmt risk taking has an important effect on a broad variety of organizational performance measures. in addition, we found that the relationship between risk taking and firm performance is moderated by environmental dynamism such 110 journal of business strategies vol 19, no.2 that, in more stable environments, the performance benefits of risk taking can be more easily realized. alternately, in more dynamic environments, risk taking has less of a positive impact on firm outcomes. references aaker, d., & jacobson, r. (1987). the role of risk in explaining differences in profitability. academy of management journal, 30, 277-296. aguinis, h. (1995). statistical power with moderated multiple regression in management research. journal of management, 21, 1141·1158. bantel, k.a., & jackson, s.e. (1989). top management and innovations in banking: does the composition of the top team make a difference? strategic management journal, 10, 107-124. bentler, p. ( 1990). comparati ve fit indexes in structural models. psychological bulletin, 107, 238-246. bentler, p.m., & bonett, d.g. (1980). significance tests and goodness offit in the analysis of covariance structures. psychological bulletin, 88, 588-606. bollen, k.a. (1986). sample size and bentler and bonett's nonnormed fit index. psychometrika, 51,375-377. bollen, k.a. (1989). structural equations with latent variables. new york: wiley. bourgeois, l.j. (1985). strategic goals, perceived uncertainty, and economic performance in volatile environments. academy of management review, 28, 548-573. bowman, e.h. (1980). a risklreturn paradox for strategic management sloan management review, spring, 17-31. boyd, b.k., dess, g.g., & rasheed, a.m. (1993). divergence between archival and perceptual measures of the environment: causes and consequences. academy of management review, 18, 204 226. boyd, b.k., & fulk, j. (1996). executive scanning and perceived uncertainty: a multidimensional model. journal of management, 22, 1-21. bromi ley, p. (1991). testing a causal model of corporate risk taking and performance. academy of management journal, 34, 37-59. burns, t., & stalker, g.m. (1961). the management of innovation. london: tavistock publishing. burrell, g., & morgan, g. (1979). sociological paradigms and organizational analysis. london: heinemann. fall 2002 gilley, et al: risk taking propensities 111 cameron, k. (1978). measuring organizational effectiveness in institutions of higher education. administrative science ouarterly. 23, 604-632. chakravarthy, b. (1986). measuring strategic performance. strategic management journal, 6, 437-458. child, j. (1972). organizational structure, environment and performance: the role of strategic choice. sociology, 6, 1-22. daboub, aj, rasheed, a.m., priem, r.l., & gray, d.a. (1995). top management team characteristics and corporate illegal activity. academy of management review, 20, 138-170. dess, g.g., & beard, d. (1984). dimensions of organizational task environments. administrative science quarterly, 29, 52-73. dess, g. g., ireland, r.d. & hitt, m.a. (1990). industry effects and strategic management research. journal of management, 16, 5-25. dess, g. g .. & robinson, r.b. (1984). measuring organization performance in the absence of objective measures: the case of the privately-held firm and the conglomerate business unit. strategic management journal, 5, 265-273. doty, d. r., glick. w. h., & huber, g. p. (1993). fit, equifinality, and organizational effectiveness: a test of two configurational theories. academy of management journal,36,1196-1250. dillman, d.a. (1978). mail and telephone surveys: the total design method. new york: wiley. duncan, r.b. (1972). characteristics of organizational environments and perceived environmental uncertainty. administrative science quarterly, 17,313 327. finkelstein, s., & hambrick, d. c. (1996). strategic leadership: top executives and their effects on organizations. st. paul, mn: west publishing. florey, a., & harrison, d. (2000). responses to informal accommodation requests from employees with disabilities: multistudy evidence on willingness to comply. academy of management journal, 43, 224-233. ford, j.k., maccallum, r.c., & tait, m. (1986). the application of exploratory factor analysis in applied psychology: a critical review and analysis. personnel psychology. 39,291-314. gilley, k.m. & rasheed, a. (2000). making more by doing less: an analysis ofoutsourcing and its effects on firm performance. journal of management, 26, 763-790. 112 journal of business stratef?ies vol. 19, no.2 gupta, a.k. (1984). contingency linkages between strategy and general manager characteristics: a conceptual examination. academy of management review, 9, 399-412. gupta, ak., & govindarajan, v. (1984). business unit strategy, managerial characteristics, and business unit effectiveness at strategy implementation. academy of management journal, 27, 25-41. hambrick, d.c., & mason, p. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review, 9, 193-206. hannan, m.t., & freeman, j.h. (1977). the population ecology of organizations. american journal of sociology, 82, 929-964. hatten, k. j., schendel, d.e., & cooper, a.c. (1978). a strategic model of the u. s. brewing industry. academy of management journal, 21, 592-610. hitt, m.a., nixon, r.d, hoskisson, r.e, & kochhar, r. (1999). corporate entrepreneurship and cross-functional fertilization: activation, process and disintegration of a new product design team. entrepreneurship theory and practice, spring, 145-167. knight, d., durham, c.c., & locke, e.a. (2001). the relationship of team goals, incentives, and efficacy to strategic risk, tactical implementation. and performance. academy of management journal, 44, 326 338. libby, r., & fishburn, p. c. (1977). behavioral models of risk taking in business decision: a survey and evaluation. journal of accounting research, 15, 272-292. lieberson, s., & o'connor, j .f. (1972). leadership and organizational performance: a study of large corporations. academy of management review, 9, 193-206. march, j. g. (1978). bounded rationality, ambiguity, and the engineering of choice. bell journal of economics, 9, 587-608. march, j.g., & shapira, z. (1987). managerial perspectives on risk and risk taking. management science, 33,1404-1417. mcclelland, g.h., & judd, c.m. (1993). statistical difficulties of detecting interactions and moderator effects. psychological bulletin, 2, 376-390. mcnamara, g., & bromiley, p, (1999). risk and return in organizational decision making. academy of management journal, 42,330-339. medsker, gj., williams, lj., & holahan, pj. (1994). a review of current practices for evaluating causal models in organizational behavior and human resource management research. journal of management, 20, 439-464. meyer, a.d. (1991). what is strategy's distinctive competence? journal of management, 17,821-833. fall 2002 gilley, et al: risk taking propensities 113 miller, d. (1988). relating porter's business strategies to environment and structure: analysis and performance implications, academy of management journal, 31, 280-308. miller, d. (1992). generic strategies: classification, combination and context. advances in strategic management, 8, 391-408. miller, d., & friesen, p. (1982). innovation in conservative and entrepreneurial firms: two models of strategic momentum. strategic management journal, 3, 1-25. miller, kd., & leiblein, mj. (1996). corporate risk-return relations: returns variability versus downside risk. academy of management journal, 39,91-122. miller, k, & bromiley, p. (1990). strategic risk and corporate performance: an analysis of alternative risk measures. academy of management journal, 33, 756-779. palmer, t.b., & wiseman, rm. (1999). decoupling risk taking from income stream uncertainty: a holistic model of risk. strategic management journal, 20, 1037-1062. podsakoff, p. m., & organ, d. w. (1986). self-reports in organization research: problems and prospects. journal of management, 12, 531-544. pfeffer, j. (1981). management as symbolic action: the creation and maintenance of organizational paradigms. in l. l. cummings & barry m. staw (eds.), research in organizational behavior (vol. 3, pp. 1-52). greenwich, ct: jai press. porter, m.e. (1980). competitive strategy: techniques for analyzing industry and competitors. new york: harper and row. prescott, j .e. (1986). environments as moderators of the relationship between strategy and performance. academy of management journal, 29, 329-346. priem, r.l, rasheed, a.m.a., & kotulic, a.g. (1995). rationality in strategic decision processes, environmental dynamism and firm performance. journal of management, 21, 913-929. ricardo, d. (1817). principles of political economy and taxation. london: j. murray. ruefli, t.w., collins, j.m., & lacugna, j.r. (1999). risk measures in strategic management research: auld lang syne? strategic management journal, 20, 167-194. shaffer, m.a., harrison, d.a., & gilley, km. (1999). dimensions, determinants, and differences in expatriate adjustment. journal of international business studies, 30, 557-581. simerly, r.l. & li, m. (2000). environmental dynamism, capital structure and performance: a theoretical integration and an empirical test. strategic management journal, 21, 31 49. sitkin, s.b., & pablo, a.l (1992). reconceptuajizing the determinants of risk behavior. academy of management review, 17, 9-38. 114 journal of business strategies vol 19, no.2 smircich, l., & stubbart, c. (1985). strategic management in an enacted world. academy of management review, 10, 724-736. spreitzer, g.m. (1995). psychological empowerment in the workplace: dimensions, measurement, and validation. academy of management journal, 38, 1442-1465. stone, e.e, & hollenbeck, j.r. (1988). clarifying some controversial issues surrounding statistical procedures for detecting moderator variables: empirical evidence and related matters. journal of applied psychology, 74, 3-10. stone-romero, e. e, alliger, g. m., & aguinis, h. (1994). type ii error problems in the use of moderated multiple regression for the detection of moderated effects of dichotomous variables. journal of management, 20, 167-178. venkatraman, n., & ramanujam, v. (1987). measurement of business economic performance: an examination of method convergence. journal of management, 13, 109122. vlek, c., & stallen, p.j. (1980). rational and personal aspects of risk. acta psychologica, 45,273-300. waddock, s.a., & isabella, l.a. (1989). strategy, beliefs about the environment, and performance in a banking simulation. journal of management, 15, 617-632. weick, k.e. (1979). the social psychology of organizing. reading: addison-wesley. k. matthew gilley is an assistant professor of management at oklahoma state university. he holds a ph.d. in strategic management from the university of texas at arlington. his research interests include outsourcing, top management teams, and corporate governance. his work has been published or is forthcoming in the journal (~f management, the journal of international business studies, the journal of business research, and others. bruce a. walters is an assistant professor of management at louisiana tech university. he received his ph.d. from the university of texas at arlington. his current research interests include competitive advantage, top executive characteristics, startegic decision processes, and business ethics. he has taught at the graduate and undergraduate levels, both domestic and international students, including executive mba programs. he has lectured for chinese municipal executives and strategy researchers involved in privatization efforts, and recently taught strategy in singapore for the singapore productivity association. bradley j. olson is a doctoral student at oklahoma state university. prior to entering the ph.d. program, he worked for a tax-law firm. his current research interests include top management teams, corporate governance, and venture capital. top management team risk taking propensities and firm performance: direct and moderating effects governance by committee: the influence of board of directors' committee composition on corporate performance alan e. ellstrand california state university long beach long beach, ca catherine m. daily indiana university bloomington, in jonathan l. johnson university of arkansas fayetteville, ar dan r. dalton indiana university bloomington, in abstract although a considerable amount ofattention has been devoted to examining the relationships between board of directors' composition and corporate financial performance, the vast majority ofthis research has focused on the board-atlarge. such a focus may be unfortunate, as a great deal ofboard decision-making occurs at the committee level. this study examines the relationship between the composition ofthree important board ofdirectors ' committees (audit, compensation, nominating) and firm performance. relying on multiple measures of board composition, multiple measures of corporate financial performance, and multiple time periods, we find no evidence ofsystematic relationships between board committee composition and corporate financial performance. introduction board of directors' composition has been the subject of a considerable amount of attention from both organizational researchers and the practitioner community in recent years. a primary focus of researchers has been the relationship between board composition and corporate financial performance (e. g., boeker & goodstein, 1993; cochran, wood & jones, 1985; dalton, daily, ellstrand, & johnson, 1998; davis, 1991; judge & zeithaml, 1992; kesner, 1987; mallette & fowler, 1992; schmidt, 1975, 1977; vance, 1983), as well as corporate survival (chaganti, mahajan & sharma, 1985; daily & dalton, 1994a. 1994b; daily & dalton, 1995). 68 journal of business strategies vol. 16, no. 1 while there are a number of examinations of this relationship, extant research does not provide unifonn prescriptions regarding which board composition configurations are associated with higher levels of perfonnance (see zahra & pearce, 1989, for an overview of this issue). what is clear, however, is that in the contemporary business environment interested stakeholder groups are holding boards of directors increasingly accountable for corporate perfonnance (dobrzynski, 1992). important stakeholder groups, such as institutional investors, have devoted considerable resources to seeking reapportionment of corporate boards (e.g., davis & thompson, 1994). these groups are relatively unifonn in their demands for boards which are composed exclusively or predominately of outside, independent directors. the primary rationale behind these demands is a belief that independent boards will enhance finn performance (biggs, 1995). in addition to prescriptions regarding the composition of the board-at-iarge, shareholder groups and regulatory bodies have either mandated or suggested specific configurations for certain committees of the board of directors. while some of the strongest language from the practitioner community and regulatory groups regarding board composition has been directed at board committees, researchers have devoted far less attention to investigations of the relationship between committee composition and corporate financial perfonnance, as compared to research developing linkages between composition of the board-at-large and corporate financial perfonnance (see bilimoria & piderit, 1994; dalton et al., 1998). this may be unfortunate, as some observers have suggested that board committees are crucial to the efficiency of the overall board (lorsch & maciver, 1989), and derivatively, to the firm. theoretical foundations theorists have suggested that the board of directors' ability to positively influence corporate operations and outcomes may be based on the directors' independence from corporate management (lorsch & maciver, 1989; oviatt, 1988; zahra & pearce, 1989). much of the framework for this belief is found in agency theory (see eisenhardt, 1989; jensen & meckling, 1976, for an overview of agency theory). agency theorists posit that board composition is especially relevant when ownership and control of the finn are disparate, as is the case in the modern business corporation (fama & jensen, 1983). these theorists contend that a board composed predominately of independent, outside directors is needed to properly safeguard the interests of corporate owners (fama & jensen, 1983). by extension, these same concerns apply to important board committees. in fact, concerns regarding the extent to which directors are more sympathetic to corporate management as compared to shareholders may be even more salient for critical board committees. the agency problem largely addresses the directors' monitoring function. board subgroups such as the compensation, audit, and nominating committees are central to effective monitoring. the compensation comspring 1999 ellstrand, et al: governance by committee 69 mittee, for example, is charged with structuring executive-level compensation packages which directly align managerial interests with those of shareholders. effective monitoring via the audit committee helps ensure that the corporation remains a going concern. the nominating committee is responsible for identifying those director candidates who are likely to effectively discharge all director duties, including the monitoring role. director independence has largely been determined through board composition. certain board composition configurations are believed to be more representative of independence than are others. outside (non-management) directors, for example, are valued for their objectivity (kesner, 1987; mizruchi, 1983). because of their potential for impartiality, outside directors may be better able to represent the interests of shareholders by acting as a part of a corporate check and balance system (rechner & dalton, 1991). these advantages provided by outside directors offer a measure of independence to the board of directors as suggested by agency theorists. this position is also affirmed by shareholder groups who actively seek the appointment of independent, outside directors to the boards of firms in which they hold significant investments (byrne, 1996; dobrzynski, 1992). as previously noted, to date, empirical work has not uniformly established the superiority of boards comprised predominately or exclusively of independent directors. while there are likely to be a variety of reasons for these sometimes contradictory findings, we have elected to focus on one specific explanation-the need for a focus on board committee composition. one commentator has suggested that a focus on the composition ofthe board-at-iarge "may be too subtle an indicator to adequately capture the importance of the outside director" (daily, 1994: 285). we are persuaded by this observation and believe that analysis of board composition at the committee level may lead to a better understanding of directors' overall contribution to the firm, specifically firm performance. governance experts contend that board committees play an essential role in the corporate governance process (carver, 1990; lorsch & maciver, 1989; vance, 1983; worthy & neuschel, 1983). the full board, certainly in the typical large corporation, is generally too large and unwieldy for the efficient disposition of the vast majority of board decisions. consequently, board committees, comprised of subsets of board members with specific expertise and a specific mandate, provide a means for more effective decision making. committee decisions are then presented to the board-at-iarge for discussion and ratification (bilimoria & piderit, 1994; kesner, 1988; lorsch & maciver, 1989). director independence and board committees corporate governance advocates strongly endorse the board committee as a critical part of the corporate governance process. committees help to facilitate the overwhelming information processing demands faced by corporate directors (carver, 1990; lorsch & maciver, 1989; vance, 1983; worthy & neuschel, 1983). 70 journal of business strategies vol. 16, no.1 as one director has noted, "if the whole board dwelt on every issue that the compensation or audit committee considers, we wouldn't have time to hold down jobs elsewhere" (lorsch & maciver, 1989: 59). since these subgroups focus on the committee's specific agenda, the committee level is where the majority of important board decisions are made. in contrast to the many examinations of composition of the full board, few studies have analyzed the composition and contributions of board committees. among the existing studies of board committees, two have focused on committee composition as a dependent variable. kesner (1988) found that key committee composition tended to include more long-tenured outside directors with business backgrounds than the board as a whole. she also found that women tended to be underrepresented on the nominating and executive committees. bilimoria and piderit (1994) found that, after controlling for experience, women were underrepresented on the compensation, finance and executive committees, but were preferred for membership on the public affairs committee. other studies have examined corporate outcomes associated with board committees. daily (1996), for example, investigated the relationship between audit committee composition and the incidence of a bankruptcy filing. she found no relationship between the percentage of affiliated directors on the audit committee and the incidence, type, or duration of corporate bankruptcy proceedings. o'reilly, main and crystal (1988) examined the influence of social comparison theory in the determination of chief executive compensation. these researchers found that chief executive compensation was positively related to the compensation level of members of the compensation committee. in another compensation-related study, singh and harianto (1989) found that, contrary to their expectations, the proportion of inside directors on the compensation committee was negatively associated with the number of executives in a firm receiving golden parachute contracts. finally, tosi and gomez-mejia (1989) found that compensation committees were active monitors of chief executive compensation in both owner and managercontrolled firms. the relatively modest attention to board committees by the academic community is in contrast to an increasing reliance on key board committees to facilitate the work of the overall board among the largest u. s. corporations. three committees, in particular, have been identified as critical to directors monitoring function. these committees are the audit, compensation, and nominating committees. in addition to their importance, these committees are also among the most prevalent. a report by heidrick and struggles (1990) found that 99.2 percent of firms maintain an audit committee, 92.8 percent of firms rely on a compensation committee, and 60.4 percent of firms use a nominating committee (see also anderson & anthony, 1986; daily, 1996; daily, johnson, ellstrand, & dalton, 1998). while the executive committee, too, is quite prevalent (e.g., heidrick & struggles, 1965, 1990), we exclude this committee from our analysis because this committee is designed to be a consultative group and independence is less of an spring 1999 ellstrand, et al: governance by committee 71 issue with regard to this committee. independence on the audit, compensation, and nominating committees is of paramount importance, however. the following sections will illustrate how these three key board committees can facilitate the activity of the larger board and ultimately contribute to overall firm performance. audit committee some observers have suggested that the audit committee is a critical safeguard in the corporate form of organization (anderson & anthony, 1986; daily, 1996; lorsch & maciver, 1989). this committee is responsible for selecting the outside auditor, overseeing the preparation of the financial statements and annual reports, ensuring the efficacy of internal controls, and investigating allegations of material, financial, ethical and legal irregularities (anderson & anthony, 1986). these activities, due to their complexity, are especially well-suited for action at the board committee level (lorsch & maciver, 1989). an objective audit committee serves as one of the foundations for the board's overall control function. as a result of its importance in ensuring the financial viability of the firm, as well as overseeing the reporting process, the independence of the audit committee is considered to be essential. as a measure of its importance, the securities and exchange commission, the american stock exchange, and the national association of securities dealers strongly suggest that corporate audit committees be composed of a majority of outside directors (kesner, 1988). the new york stock exchange has adopted an even more aggressive stance, requiring that audit committee members be comprised exclusively of independent, outside directors (donaldson, 1994). several benefits may be associated with an audit committee comprised of independent directors. such a configuration may signal to shareholders that their interests are being properly safeguarded (daily, 1996). in addition, a vigilant audit committee may act as an early warning system to alert the entire board to the potential for serious financial or legal problems before they fully develop. these important contributions may lead to improved firm performance. consequently, we hypothesize: hypothesis 1: the percentage ofindependent directors serving on the audit committee will be positively associated with firm peiformance. compensation committee the compensation committee is another important board subgroup. this committee is responsible for establishing the level of compensation for senior corporate executives and corporate officers. in addition, the compensation committee is charged with recommending appropriate remuneration for corporate directors (anderson & anthony, 1986; fisher, 1986). some compensation committees are also involved with the administration of stock option plans (vance, 1983). the 72 journal of business strategies vol. 16, no.1 composition of the compensation committee is a crucial element in ensuring the administration of an equitable corporate reward system, thus contributing to the control role of the board (fisher, 1986). determining an appropriate level of compensation for corporate executives and directors is a sensitive matter. critical decisions must be made to determine the appropriate amount, type, and mix of pay to properly reward top executives (finkelstein & hambrick, 1988). directors with ties to management or the firm may be placed in a potentially difficult position. here, the potential for personal loyalties to the chief executive officer, for example, may conflict with the directors' fiduciary responsibilities to shareholders. thus, to avoid even the appearance of divided loyalties in setting executive compensation, governance advocates recommend placing only independent directors on the compensation committee (anderson & anthony, 1986). we would also note that the internal revenue service mandates the placement of at least two outside directors on any given compensation committee (kesner, 1994). a reward system with the proper executive incentives may encourage managerial actions that positively influence firm performance (finkelstein & hambrick, 1988). therefore we hypothesize: hypothesis 2: the percentage ofindependent directors serving on the compensation committee will be positively associated with firm peiformance. nominating committee the nominating committee is charged with the identification, selection, and evaluation of qualified candidates to serve in key positions within the corporation. more specifically, this committee is responsible for the selection of the chief executive officer, directors, and other top corporate executives (vance, 1983). the nominating committee has become more active in influencing these critical personnel decisions in recent years (lorsch & maciver, 1989). as one director noted, "[t]he ceo used to make most of the suggestions for new directors and tried to create a board 'in his own image: but now this responsibility is shifting to the nominating committee.. ." (lorsch & maciver, 1989: 21). the nominating committee may playa key role in the board's control function by selecting appropriate candidates to serve as directors and top corporate executives. nominating committee composition is crucial in ensuring that directors select the most qualified candidates for executive vacancies, as well as board openings. independent directors may be more likely to make important personnel decisions based on merit, absent any influence as a result of internal political considerations. with their external focus, independent directors are also well positioned to be aware of the best candidates outside the organization to fill important executive-level positions. moreover, a nominating committee that is composed of independent directors may be more likely to appoint other independent directors who will be vigilant in spring 1999 ellstrand, et at: governance by committee 73 monitoring the ceo. vigilant, independent directors may be more likely to lead to better overall corporate performance. accordingly, we hypothesize: hypothesis 3: the percentage ofindependent directors serving on the nominating committee will be positively associated with firm peiformance. thus, our study seeks to examine the importance of the composition of these three vital board committees where the independence of the directors should be of greatest importance to the corporate governance process. the following sec~ tions discuss the methods we employed to test our hypotheses, our results and conclusions based on the study findings. methods sample the sample for this study includes 200 public1y~traded firms randomly selected from the 1992 fortune 500 listing. we selected these firms for a variety of reasons. first, a large proportion ofthe published studies which have investigated the relationship between board composition and corporate performance have re~ lied on samples oflarge, publicly-traded firms (e.g., cochran et ai., 1985; kesner, 1987; rechner & dalton, 1991; singh & harianto, 1989). thus, to ensure comparability with other studies, we selected a sample similar to prior research in this area. in addition, as publicly-traded corporations, these firms are subject to the securities exchange commission's public reporting requirements. as a result, data were readily available on committee composition, the nature of director relationships to the firm or firm management, and corporate performance. lastly, these are the very type of firms which have received the greatest scrutiny regarding their corporate governance practices. independent variables our review of the relevant corporate governance literature yields three operationalizations of board composition which differentially capture the extent to which directors maintain personal and/or professional relationships with the firm or firm management (e.g., daily, johnson & dalton, in press). perhaps the most common approach for identifying those directors operating independently of the firm or firm management is the outside director distinction. this measure is traditionally comprised of those directors not currently employed by the focal organization (schellenger, wood & tashakori, 1989). the proportion of outside directors serving on the audit, compensation, and nominating committees, then, is the ratio of non-management to total directors on each of these committees. a second approach for classifying directors relies on securities and exchange commission (sec) regulation 14a, item 6(b). here, the directors' independence 74 journal of business strategies vol. 16, no. 1 is determined by the extent to which they have personal and/or professional relationships with the firm, its subsidiaries, or firm management. these relationships are specifically identified by the sec and range from immediate past employment with the firm to association with a law firm engaged by the organization (see daily & dalton, 1994a for specific guidelines). these affiliated directors are arguably less independent than are non-management directors absent such ties. relying on sec 6(b) guidelines, we calculated the proportion of non-affiliated directors serving the audit, compensation, and nominating committees. the third approach for classifying director independence relies not on the extent of personal and/or professional associations, but on the timing: of the directors' appointments to the board (e.g., wade, o'reilly & chandratat, 1990). this distinction classifies those directors, regardless of their affiliations with the firm or firm management, as interdependent if they were appointed to the board during the tenure of the incumbent ceo and independent if their board appointment preceded the current ceo. here, too, we calculate the proportion of independent directors serving the audit, compensation, and nominating committees of the board. all board composition data were secured from corporate proxy statements filed with the sec in 1992. dependent variables there is little agreement among organizational researchers concerning what constitutes an appropriate measure(s) of corporate performance (e.g., cannella & lubatkin, 1993; chakravarthy, 1986; schellenger et ai., 1989). previous corporate governance research has typically relied on accounting measures such as return on equity (roe), return on investment (roi), and profit margin as indicators of corporate performance (e.g., baysinger & butler, 1985; cochran et ai., 1985; kesner, 1987; pearce & zahra, 1992). schellenger et ai. (1989: 458), however, note a limitation of an exclusive reliance on accounting-based measures: "non-market proxies do not measure the true financial performance of the corporation. the choice of inappropriate non-market proxy may even dictate the conclusions of the analysis." in response to such criticisms, some researchers advocate a reliance on both accounting and market-based performance measures (venkatraman & ramanujam, 1986). additionally, recent research has included risk in the measurement of market-based performance (cannella & lubatkin, 1993). finance theory indicates that risk consists of two components: systematic risk that is, the risk of the market and unsystematic risk, that portion of the risk that is attributable to the firm (brigham, 1985). to most broadly capture firm performance, we include both accounting-based and market-based measures of corporate performance. the accounting-based measure, roe, was selected to provide comparability to previous studies (e.g., baysinger & butler, 1985; cochran et ai., 1985; kesner, 1987; pearce & zahra, 1992). these data were obtained from the compustat database. each firm's spring 1999 ellstrand, et a1: governance by committee 75 return on equity was adjusted for industry effects by subtracting industry roe for each firm from the focal firm's roe. industry aggregates were created from the compustat industry classifications and aggregate data. market returns were assessed using each stock's beta. beta provides information on how a stock performs relative to the overall market. a positive beta indicates that the stock tends to move in the same direction as the market; a negative beta stock tends to move against the market. a beta value greater than one describes a stock that is more volatile than the market while a beta value less than one indicates that the stock is less volatile than the market (munn, garcia & woelfel, 1993). stock beta information was obtained from the worldscope database. a second measure of market return, jensen's alpha, was also used as a performance indicator. this measure is the intercept term from the capital asset pricing model (capm). jensen's alpha is a measure of the returns from holding a corporation's stock that are greater or smaller than the return adjusted for systematic risk, or the risk affecting all firms (chatterjee & blocher, 1992). jensen's alpha represents a firm's performance relative to that of an unmanaged portfolio of stocks of similar risk. a non-zero alpha implies that investors have revised their expectations about the firm's future cash flows (cannella & lubatkin, 1993). jensen's alpha was calculated using the regression equation on daily stock returns provided in nayyar (1992). an additional consideration relative to firm performance concerns the appropriate time lag required to properly evaluate the full influence of corporate initiatives (day & lord, 1988). this concern is especially relevant to corporate governance studies since directors' influences on corporate strategic decisions may take several years to be fully realized. thus to account for this potential time lag, the performance measures were examined annually over a three year period, beginning with a one-year lag, to better capture the prospective influence of board decisions. control variables we also provide three control variables commonly included in boards of directors research: firm size, industry classification, and board size. the log oflotal assets was employed as a measure of firm size. values for firm assets were obtained through the compustat database. a total of 14 industry groups were determined based on standard industry classification (sic) codes. finally, the board size was determined based on information included in corporate proxy statements. analysis hierarchical linear regression models were constructed to analyze the hypothesized relationships concerning board committee composition and firm performance. 76 journal of business strategies results vol. 16, no. 1 table i reports descriptive statistics and correlations for all study variables. tilis table indicates that the correlations between the three committee composition measures were high. given the overlap of directors for these measures (i.e., strong reliance on non-management directors ofdiffering types for each measure), this outcome is not surprising. moreover, given the limited number of directors on any board there will necessarily be overlap in board committee assignments. tables 2 through 10 report the results of the regression models. hypothesis i suggests that the percentage of independent directors serving on the audit committee will be positively associated with firm performance. the results of the regression analyses using jensen's alpha as a performance measure are reported in tables 2 through 4. a significant association was found in only one instancethe three year lag between the proportion of independent directors on the audit committee and jensen's alpha in year 1+3 (three year lag). we would note, however, that this relationship is opposite the hypothesized direction. the results of the regression analyses for beta are reported in tables 5 through 7. none of the findings were significant the results of the regression analyses relying on roe are reported in tables 8 through 10. here, too, no significant relationships were noted. given that only one significant finding emerged from the 27 analyses conducted and this finding was opposite the direction hypothesized, the first hypothesis is rejected. hypothesis 2 stated that the percentage of independent directors serving on the compensation committee would be positively associated with firm performance. the results for jensen's alpha are reported in tables 2 through 4. the relationships between the proportion of outside directors and jensen's alpha in the two-year lag (t+2) and independent directors and jensen's alpha in the threeyear lag (t+3) are the only significant relationships. the results of the regression analyses for beta are reported in tables 5 through 7, and the results for roe are reported in tables 8 through 10. in both cases no significant relationships were noted. given that only two significant findings in support of the hypothesis emerged from the 27 analyses conducted, hypothesis 2 is rejected. hypothesis 3 predicted that the percentage of independent directors serving on the nominating committee would be positively associated with firm performance. the results of the regression analyses for jensen's alpha are reported in tables 2 through 4. as with the results for the audit committee, only one relationship the three year lag for the proportion of independent directors was significant. this relationship was opposite the direction hypothesized. the results of the regression analyses for beta are reported in tables 5 through 7, and the results for roe are reported in tables 8 through 10. in both cases no significant relationships were noted. given that only one significant result was found among the 27 analyses conducted and this finding was opposite the hypothesized direction, hypothesis 3 is also rejected. table 1 vi'tj means, standard deviations and correlations for study variables , '"i :;' (jq-variable mean sd i 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1.01.0 1.0 1. aindep .56 .36 2. anonaff .85 .22 .04 3. aoul .99 .00 .07 .26' 4. cindep .63 .33 .77" -.07 .01 t't15. cnonaff .82 .23 .16' .42** -.12 .04 -6. coul .96 .12 .11 -.01 .14 .03 .46" ~~ 7. nindep .75 .22 .68" -.10 -.05 .73" .02 .04 ~ 8. nnonaff .84 .20 -.03 .39" -.06 .02 .36" .00 -.02 ;:it 9. noul .87 .16 -.11 .13 -.10 -.05 .22' .oll -.02 .63" ~~ 10. alpha92 .00 .00 .08 .03 .01 .02 .04 .21" .01 -.17 -.00 ~ ~ 11. alpha93 .00 .00 .13 .08 -.15' .06 .13 .21" .07 -.08 .02 .28" i:l-12. alpha94 .00 .00 -.21" -.07 .08 -.05 -.02 -.02 -.21' -.13 -.06 -.02 -.03 " c)13. bela92 .30 .12 .01 .02 .04 -.01 .11 .05 .11 .04 -.06 .08 -.24' .01 <:::i 14. bela93 .24 .11 .01 .00 .04 .02 .10 .09 .07 -.07 .02 .22" -.01 -.09 .66" -<: 15. bela94 .33 .11 -.06 .06 .01 -.03 .14 -.04 .01 .02 .07 .23" .23' .14 .51" .46" ~.... 16. roe92 -7.07 37.84 -.10 -.10 -.02 -.09 -.11 .00 -.06 -.11 -.03 .04 -.04 -.03 .14' .15' .02 ;:it i:l 17. roe93 -.51 23.88 -.01 .05 -.01 .02 -.15 -.21" .10 -.04 -.05 .04 -.01 -.08 .05 .12 .05 .17' ;:itt") 18. roe94 1.66 20.89 -.07 .07 -.01 -.os -03 .06 -.09 -.02 .06 .05 .16' .10 .04 .06 .11 .16' .37" ~ 19. assets 3.36 .57 .04 .10 .03 .04 .12 .05 .07 .02 .10 -.06 .06 .03 .45" .42" .59" .09 .08 .08 ~ 20. industry 7.66 3.71 -.04 -.os .07 .00 .02 .00 -.09 -.00 .02 -.03 -.30" -.01 .03 .03 -.17' -.11 .03 -.17' -.09 \) 21. bdsize 11.46 2.91 .10 .04 .05 .11 -.01 .02 .12 -.03 .03 -.07 .06 -.06 .27" .22' .2s" .07 .01 .11 .54" .05 0 'p .05 ;:: < ~.•• p < .1li --~·variable legend: ~ i. aindep: percentage of independent directors on the audit committee ii. alpha93: jensen's alpha for 1993 2. anonaff: percentage of non-affiliated directors on the audit committee 12. alpha94: jenscn's alpha for 1994 3. aout: percentage of outside directors on the audit committee 13. beta92: stock beta for 1992 4. cindep: percentage of independent directors on the compensation committee 14. beta93: stock beta for 1993 5. cnonaff: percentage of non-affiliated directors on the compensation committee 15. beta94: stock beta for 1994 6. (oul: percentage of outside directors on the compensation committee 16. roe92: industry-adjusted return on equity for 1992 7. nindep: percentage of independent directors on the nominating eommittce 17. roe93: industry·adjusted return on equity for 1993 g. nnonaff: percentage of non-affiliatcd directors on the nominating committee 18. roe94: industry·adjusted return on equity for 1994 9. nout: percentage of outside directors on the nominating committce 19. assets: total assets in 1992 ill. alpha92: jensen's alpha for 1992 20. industry: industry classification -j 21. bdsize: number of directors on the boan.! -j 78 journal of business strategies vol. 16, no.1 table 2 results of regression analyses: jensen's alpha performance measure one year time lag 1st step: control variables total assets industry board size outside operationalization -.032 -.031 -.051 non-affiliated operationalization -.032 -.031 -.051 independent operationalization -.032 -.031 -.051 2nd step: board committee audit compensation nominating r2 adjusted r1 f *p < .05 **p < .01 -.013 .089 .166 .220* .089 -.059 -.017 -.235* -.055 .054 .053 .018 .004 .003 -.oj4 1.085 1.062 .724 table 3 results of regression analyses: jensen's alpha performance measure two year time lag 1st step: control variables total assets industry board size outside operationalization -.013 -.305** .077 non-affiliated operationalization -.013 -.305** .077 independent operationalization -.013 -.305** .077 2nd step: board committee audit compensation nominating r2 adjusted r2 f *p < .05 up < .01 -.161 .047 .189 .228* .174 -.04" -.003 -.158 -.066 .163 .134 .112 .119 .089 .066 3.725** 2.958* 2.417* spring 1999 ellstrand, et at: governance by committee 79 table 4 results of regression analyses: jensen's alpha performance measure three year time lag outside non-affiliated independent operati onalizati on operationalization operationalization 1st step: control variables total assets .095 .095 .095 industry .010 .010 .010 board size -.113 -. 113 -.113 2nd step: board committee audit .078 -.035 -.326* compensation -.030 .032 .411 ** nominating -.056 -.132 -.284* r2 .020 .029 .1l5 adjusted r2 -.031 -.021 .068 f .400 .580 2.482* *p < .1\5 *"p < .01 table 5 results of regression analyses: beta performance measure one year time lag outside non-affiliated independent operationalization operationalization operationa1ization lst step: control variables total assets .443** .443** .443** industry .073 .073 .073 board size .028 .028 .028 2nd step: board conunittee audit .001 -.1l4 -.023 compensation .040 .092 -.157 nominating -.115 .043 .202 r2 .224 .224 .229 adjusted r2 .184 .183 .189 f 5.543** 5.522** 5.694** *p < .05 **p < .01 80 journal of business strategies vol. 16, no. 1 table 6 results of regression analyses: beta performance measure two year time lag 1st step: control variables total assets industry board size outside operationalization .438** .077 -.021 non-affiliated operationalization .438** .077 ~.021 independent operationalization .438** .077 -.021 2nd step: board committee audit compensation nominating r2 adjusted r2 f *p <: .05 **p <: .01 .007 -.035 -.030 .075 .092 -.024 -.036 -.095 .079 .189 .194 .185 .146 .152 .142 4.454** 4.621"'''' 4.339** table 7 results of regression analyses: beta performance measure three year time lag outside non-affiliated independent operationalization operationalization operationalization 1st step: control variables total assets .598** .598** .598** industry -.116 -.li6 -.116 board size -.042 ~.042 -.042 2nd step: board committee audit .011 -.032 -.110 compensation -.070 .093 .047 nominating .015 -.017 -.014 r2 .364 .366 .367 adjusted r! .331 .332 .334 f 10.963** lia33** 11.096** *p < .05 **p <: ,01 spring 1999 ellstrand. et af: governance by committee 81 table 8 results of regression analyses: roe performance measure one year time lag outside non-affiliated independent operationalization operationalization operationalization 1st step: control variables total assets .050 .050 .050 industry -.108 -.108 -.108 board size .052 .052 .052 2nd step: board committee audit -.017 -.067 -.078 compensation .005 -.059 -.029 nominating -.037 -.067 -.011 r2 .022 .042 .032 adjusted r2 -.029 -.008 -.018 f .423 .837 .634 .p < .05 **p < .01 table 9 results of regression analyses: roe performance measure two year time lag outside non-affiliated independent operationalization operationalization operationalization 1st step: control variables total assets .107 .107 .107 industry .046 .046 .046 board size -.048 -.048 -.048 2nd step: board committee audit .013 .145 -.120 compensation -.211* -.214* -.049 nominating -.048 .030 .223 r2 .057 .051 .032 adjusted r2 .008 -.002 -.018 f 1.160 1.034 .637 .p < .05 up < .01 82 journal of business strategies vol. 16, no.1 table 10 results of regression analyses: roe performance measure three year time lag outside non-affiliated independent operationalization operationalization operationalization 1st step: control variables total assets -.003 -.003 -.003 industry -.172 -.172 -.172 board size .115 .115 .115 2nd step: board committee audit -.005 .083 -.043 compensation .056 -.049 .091 nominating .059 -.032 -.163 r2 .048 .046 .059 adjusted r2 -.002 -.003 .010 f .957 .933 1.194 'p < .05 up < .01 discussion contrary to expectations, these results suggest there is no systematic relationship between the independent director composition of the three key monitoring committees of the board and corporate financial performance. notably, this finding is consistent regardless of the operationalization of director independence, the performance measure employed, or the time lag utilized. these results, however, are consistent with many of the studies examining the relationship between the composition of the larger board and firm performance (e.g., boeker & goodstein, 1993; davis, 1991; judge & dobbins, 1995; judge & zeithaml, 1992; mallette & fowler, 1992; schmidt, 1975, 1977). although agency theory provides a strong theoretical foundation in support of placing greater numbers of independent directors on key board committees, our findings suggest that board committee composition does not systematically influence corporate performance. there are several possible explanations that support our findings. first, it is possible that the compelling arguments in favor of independent directors are correct, but that the independent directors' objectivity and effective monitoring are counterbalanced by the need for information, time, and interest in firm operations provided by inside and affiliated directors. independent directors, certainly those not employed in a management capacity with the focal firm, commonly face significant pressures from their responsibilities spring 1999 ellstrand, et al: governance by committee 83 outside of the board room which may detract from their ability to contribute as directors. many non-management directors, for example, serve as ceos of other firms (lorsch & maciver, 1989), clearly, a time-consuming job. similarly, the expertise of inside directors may be offset by their lack of objectivity due to proximity to the ceo. these directors may feel compelled to support top management positions to protect or enhance their careers. thus, while inside and outside directors may provide valuable service to the firm through their committee work, the simple designation as inside or outside director may have little influence on the quality of individual directors' contributions. in addition, it is important to note that board committees may be too far removed from the center of daily decision making in the firm. as board researchers have established, even the most activist boards have been largely relegated to an oversight role (lorsch & maciver, 1989). moreover, the recommendations of board committees must be debated and approved by the full board before committee suggestions can be enacted. this process at the level of the full board may temper any suggestions/decisions made at the committee level. in addition, some observers have suggested that the influence of the board and its committees may be confined to direct incidents involving conflict between managers and stockholder's interests (kosnik, 1987). lastly, some researchers have noted the tenuousness of the causal link between top management and firm performance (murray, 1989). perhaps these concerns are exacerbated at the board level. given that we find little evidence to support a systematic relationship between the composition of key board committees and corporate performance, it may be appropriate for researchers to focus future attention on the relationship between committee composition and specific strategic decisions. the board committees included in our examination are responsible for strategic corporate decisions including executive compensation and succession, merger and acquisition activity, and corporate restructurings. perhaps the linkage to corporate performance is through these decisions. future attention should also be focused on identifying other director demographic characteristics that may be associated with higher levels of firm performance. finally, researchers should examine the processes that occur within key board comminees to better understand the dynamics of the decision making processes that take place within these groups. corporate governance advocates continue to emphasize the importance of board and committee composition. a recent business week article, "the best and worst boards," offered a lengthy list of recommendations to improve corporate governance practices. included among the recommendations is the need for boards comprised of at best two or three inside directors, with remaining directors corning from outside the management ranks. a further recommendation is that the three committees included in our study audit, compensation, nominating be comprised exclusively of independent directors (byrne, 1996). despite the fact that we are unable to establish the performance advantages of this latter recommendation, our data suggest that corporate boards are taking this advice seri84 journal of business strategies vol. 16, no.1 ously. our data indicate that the correlations between the composition of key committees, when relying of different measures of director independence, are very high. further analysis of these data, however, demonstrate that the interrelationships between the composition of these three board committees is significantly lower when relying on measures of insider versus independent boards. this may suggest that firms are assigning their most independent directors however measured to seats on important committees in accordance with the advice of governance experts and regulatory organizations. conclusion governance experts have empirically examined the relationship between board composition and firm performance for nearly 50 years (dalton et al., 1998). we are at the same time perplexed by the inability to support consistently theorized linkages between independent boards and corporate performance and encouraged by the opportunity to continue rigorous investigation of this important governance issue. furthermore, we are encouraged by the promise of investigating the extent to which board decisions moderate the relationship between the board and corporate financial performance. we hope this study serves to encourage other researchers along these same lines. references anderson, c. a., & anthony, r. n. (1986). the new corporate directors. new york: john wiley and sons. baysinger, b. d., & butler, h. (1985). corporate governance and the board of directors: performance effects of changes in board composition. journal of law. economics and qr~anization. 1, 101-134. biggs, j. (nov. 1995). why tiaa-cref is active in corporate governance. the partici12ill11j. bilimoria, d., & piderit, s. k. (1994). board committee membership: effects of sexbased bias. academy of management journal. 37, 1453-1477. boeker, w., & goodstein, j. (1993). performance and successor choice: the moderating effects of governance and ownership. academy of management journal. 36, 172186. brigham, e. f. (1985). financial management theqry and practice. chicago: the dryden press. byrne, j. a. (nov. 26, 1996). the best and worst boards. business week: 82-106. spring 1999 ellstrand, et al: governance by committee 85 cannella, a. a., & lubatkin, m. (1993). succession as a sociopolitical process: internal impediments to outsider selection. academy of mana~ementjournal. 36. 763-793. carver, j. boards that make a difference. (1990). san francisco: jossey-bass publishers. chaganti, r. s., mahajan, v., & sharma, s. (1985). corporate board size, composition, and corporate failures in the retailing industry. journal of management studies, 22, 400-417. chakravarthy, b. s, (1986), measuring strategic performance. strategic management jourrull....1,437-458. chatterjee, s., & blocher, j, 0, (1985). measurement of firm diversification: is it robust? academy of management journal. 35, 874-888. cochran, p. l., wood, r. a., & jones, t. b. (1985). the composition of boards of directors and the incidence of golden parachutes. academy of management journal, 28, 664-671, daily, c, m, (1994). bankruptcy in strategic studies: past and promise. journal of management. 20, 263-295. daily, c. m. (1996). governance patterns in bankruptcy reorganizations. strategic management journal. 17, 355-375. daily, c. m., & dalton, 0, r. (1994). bankruptcy and corporate governance: the impact of board composition and structure. academy of management journal. 37, 1603-1617. daily, c. m., & dalton, d. r. (1994). corporate governance and the bankrupt firm: an empirical assessment. strategic management journal. 15,643-654. daily, c. m., & dalton, d. r. (1995). ceo and director turnover in failing firms: an illusion of change? strategic management journal. 16,393-400. daily, c. m., johnson, 1. l., & dalton, d. r. on the measurements of board composition: if you have seen one, you certainly have not seen them all. decision sciences, (in press). daily, c. m., johnson, j. l., ellstrand, a. e., & dalton, d. r. (1998). compensation committee composition as a determinant of ceo compensation. academy of management journal. 41,209-220. dalton, d. r., daily, c. m., ellstrand, a. e., & johnson, j. l. (1998). meta-analytic reviews of board composition, leadership structure, and financial performance. strategic manaument journal. 19, 269-290. day, d. wo, & lord, r. g. (1988). executive leadership and organizational performance: suggestions for a new theory and methodology. journal of management. 14, 453-464. 86 journal of business strategies vol. 16, no.1 davis, g. (1991). agents without principles? the spread of the poison pill through the intercorporate network. administrative science quarterly. 36, 583-613. davis, g. e, & thompson, t. a. (1994). a social movement perspective on corporate control." administrative science quarterly. 39, 141-173. dobrzynski,1. h. (march 30, 1992). calpers is ready to roar, but will ceo's listen?~ ness week, 44-45. donaldson, w. h. (fall, 1994). "customize your governance." directors and boards, 811. eisenhardt, k. m. (1989). agency theory: an assessment and ..:vicw. academy of mana~ement review. 14,57-74. fama, e. f., & jensen, m. c. (1983). separation of ownership and control. journal of law and economics. 26, 301-325. finkelstein s., & hambrick, d. c. (1988). chief executive compensation: a synthesis and reconciliation. strateeic manaeement journal. 9, 543-558. fisher, 1. w. (winter, 1986). crafting policy for performance and rewards. directors and boards, 26-29. heidrick and struggles, inc. the changing board. chicago: heidrick and struggles, 1965. heidrick and struggles, inc. the changing board. chicago: heidrick and struggles, 1990. jensen, m. c., & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics. 3, 305-360. judge, w. q., & dobbins, g. h. (1995). antecedents and effects of outside director's awareness of ceo decision style. journal of management. 21, 43-64. judge, w. q., & zeithaml, c. p. (1992). institutional and strategic cnoice perspectives on board involvement in the strategic decision process. academy of management jourii.al....l.5., 766-794. kesner, i. f. (1987). directors' stock ownership and organizational performance: an investigation of fortune 500 companies. journal of management. 13, 499-507. kesner, i. f. (1988). directors' characteristics and committee membership: an investigation of type, occupation, tenure and gender. academy of mana~ementjournal. 31, 66-84. kesner, m. s. (spring, 1994). the compensation committee's destiny. directors and boards, 35-38. spring 1999 ellstrand, et al: governance by committee 87 kosnik, r. d. (1987). greenmail: a study of board performance and corporate governance. administrative science ouarterly. 32, 163-185. lorsch, j. w., & maciver, e. (1989). pawns or potentates: the reality of america's corporate boards. boston: harvard business school press. mallette, p., & fowler, k. l. (1992). effects of board composition and stock ownership on the adoption of 'poison pills.' academy ofmana~ementjournal. 35,1010-1035. mizruchi, m. s. (1983). who controls whom? an examination of the relation between management and boards of directors in large american corporations. academy of manaiement review. 8, 426-435. munn, g. g., garcia, f. l., & woelfel, c. j. (1993). encyclopedia of bankin& & finance. pasadena, ca: salem press. murray, a. (1989). top management group heterogeneity and firm performance. strate~ic management journal. 10, 125-142. nayyar, p. r. (1992). performance effects of three foci in service firms. academy of manaiement journal. 35,985-1009. o'reilly, c. a., main, b. g., & crystal, g. s. (1988). ceo compensation as tournament and social comparison: a tale ot two theories. administrative science quarterly. 33, 257-274. oviatt, b. (1988). agency and transaction cost perspectives on the manager-shareholder relationship: incentives for congruent interests. academy of mana~ement review. .u,214-225. pearce, j. a., & zahra, s. a. (1992). board composition from a strategic contingency perspective. journal of manaiement studies. 29,411-438. rechner, p. l., & dalton, d. r. (1991). ceo duality and organizational performance: a longitudinal analysis. strateiic manaiement journal. 12, 155-160. schellenger, m. h., wood, d. d., & tashakori, a. (1989). board of directors composition, shareholder wealth and dividend policy. journal of manaiement. 15,457-467. schmidt, r. (1975). does board composition really make a difference? the conference board record. 12,38-41. schmidt, r. (1977). the board of directors and financial interests. academy of manuement journal. 20, 677-682. 88 journal of business strategies vol. 16, no. 1 singh, h.• & harianto. f. (1989). top management tenure. corporate ownership structure and the magnitude of golden parachutes. strate~ic management journal. 10, 143156. tosi, jr., h. t., & gomez-mejia, l. r. (1989). the decoupling of ceo pay and performance: an agency theory perspective. administrative science quarterly. 34, 169189. vance, s. c. (1983). cqwqrate leadership: boards, directors, and strate~y, new york: mcgraw-hill. venkatraman. n., & ramanujam, v. (1986). measurement of business performance in strategy research: a comparison of approaches. academy of mana~mentreyiew. il,801-814. wade, j., o'reilly, c. a., & chandratat, i. (1990). golden parachutes: ceos and the exercise of social influences. administrative science quarterly. 35,587-603. worthy, j. c. & neuschel, r. p. (1983). emer~i",l issues in qqw0rate aoyernan~. evanston, il: northwestern university. zahra, s. a., & pearce, 1. a. (1989). board of directors and corporate financial performance: a review and integrative model. journal of manaaement. 15.291-334. alan e. ellstrand is an associate professor in strategic management and international business in the college of business administration at california state university, long beach. he received his ph.d. from indiana university. his current research interests include corporate governance, top management teams and the influence of business on the national political process. catherine m. daily is an associate professor of strategic management in the kelley school of business. indiana university. she received her ph.d. from indiana university. her research interests include corporate governance, strategic leadership, the dynamics of bankruptcy and business failure, and entrepreneurship. jonathan l. johnson received his ph.d. from indiana university in 1995. he is currently an assistant professor at the sam m. walton college of business administration at the university of arkansas. his current research interests include corporate governance and social networks within and between organizations. dan r. dalton is dean and harold a. poling chair of strategic management at indiana university. he received his ph.d. from the university of california. his research interests include corporate governance, corporate social responsibility, managerial ethics and research methods. governance by committee: the influence of board of directors' committee composition on corporate performance e-tailing: an analysis of web impacts on the retail market fang wang milena head norm archer mcmaster university hamilton, ontario, canada abstract the web has been changing the retail market in many ways. following a new marketframework, this paper analyzes the unique characteristics ofthe web for retail applications, examines its market effects, and presents two perspectives for business response strategies. the web can either be used as a marketing tool, which is integrated into traditional business strategies, or can be viewed as a new marketplace, which demands new business design. differences between these two views will have strategic and implementation implications for both traditional and startup retailers as they adapt to web marketing. finally, we propose some research issues and challenges that should be addressed to better our understanding and promote the success of this new marketplace. a web market framework electronic retailing, which involves the selling of goods and services to the consumer market via the internet, is also called e-tailing, e-retailing and electronic commerce (ec) in the business-to-consumer (b2c) market. the emergence of this electronic retail market has been rapid. dramatically expanding reach (people! location) and range (variety) of information, the world wide web can create benefits for both marketers and consumers. for consumers, the web can provide access to a wide range of products and services with low cost (bakos 1997), extensive and tailored information, at-home convenience for product comparisons, enhanced interactivity (cross & smith 1995), and facilitate the formation of virtual communities (internet users with common interests) (armstrong and hagel 1996). marketers can benefit from lower real estate-related expenses (schlauch & laposa 2001), improved market research (burke 1996; murphy et al 2001), new retail models, increased sales, and enhanced consumer relationships. during the past few years numerous e-tailing startups have appeared, seeking new market opportunities. however, market development has not been as successful and rapid as expected. troubled with a lack of profitability, many e74 journal of business strategies vol. 19, no.1 tailers, such as valueamerica.com, pets.com, iiving.com and furniture.com, were forced to close their businesses. unfortunately, these are not isolated cases, as other e-tailers may soon face this same fate. researchers have examined various aspects of b2c interactions to help businesses realize the potential benefits of e-tailing. to understand online consumers, wolfinbarger and gilly (2001) examined consumer motivations for online shopping, and bellman et al. (1999) addressed the personal characteristics that predict online buying behavior. to understand business techniques, web-based strategies are examined (graham 2000; griffith & krampf 1998); marketing techniques, such as interactive marketing and database marketing, are researched (jackson & wang 1995); the future of virtual shopping is analyzed (burke 1997; pellet 1996); new business models are reviewed (werbach 2000; gulati & garino 2000); and web-based information systems (wis) that facilitate online businesses, are emphasized (isakowitz 1998; wang & head 2001). before utilizing the above detailed research findings for strategic advantage, businesses first need to understand the basic web impacts on the retail market. to understand the opportunities and threats of this evolving retail marketplace, we present a new web market framework, shown in figure 1. this framework outlines the web characteristics that impact the retail market, the market effects from utilizing the web, and the business response strategies. the framework shown in figure 1 serves to organize the discussion of this paper. figure 1 web market framework web market the web • technology infrastructure • channel integration • information intensity business retail market • service perspective • new market participation model • changed distribution channels • view the web as a marketing tool • view the web as a new marketplace spring 2002 wang. head & archer: e-tailing characteristics of the web for retail applications 75 studying the characteristics of new media technology provides a structured context for understanding its social effects and a basis for media comparison (williams et al. 1994). the web is widely recognized for its openness, informality, and interactivity features (berthon et al. 1996). researchers have examined web characteristics from various points of view. deighton (1997) focused on the addressibility and responsiveness of the web for digital networked communication. hoffman and novak (1996) reviewed objective characteristics of communication media and developed a media typology along two dimensions: impersonal to personal, and static to dynamic. this paper addresses the major characteristics of the web for retail applications. these characteristics may differ from the features outlined in previous research, since we focus on those aspects that have the greatest potential to affect the retail marketplace. compared to the traditional market, the web market differs along three main dimensions: i) technology infrastructure; ii) channel integration; and iii) information intensity. table 1 summarizes these differences, which are discussed in the following subsections. this discussion is not meant to be complete and comprehensive, but rather a summary of some important characteristics that retailers should understand about the web market. technology infrastructure advances in technology have provided useful supportive tools in the conventional market. for example, television and radio have greatly facilitated oneway communication. various information systems can be used to process transactions, collect and analyze data. technology-based tools have helped marketers perform their marketing strategies more efficiently and effectively in the traditional marketplace. table 1 a comparison of web and traditional markets web market traditional market technology is a determinant for serves as a supportive tool market development and business strategies channels integrated separate market information intensive limited the web-based marketplace serves as a platform for advanced technology and applications. marketers who pioneer new web-based technology and commercial applications can gain substantial competitive advantage. 76 journal of business strategies vol. 19, no.1 the web opens a new space, cyberspace, for retailing. customers can visit virtual stores, browse through product offerings, and place orders as they do in traditional stores. in this new space, web technology supports market features inexpensively, such as 24x7 availability, fewer/no geographic boundaries, interactive two-way communication, customization, automation, search facilitation and information/knowledge sharing. these features help to attract customers and stimulate new market growth. the web impacts the market through customer satisfaction, product design, value generation, and decision processes. this helps marketers to serve larger audiences more efficiently. the web also helps to target specific consumer groups, which may be difficult in traditional markets due to high costs or an insufficient customer base. the availability of information gathered through customer interaction allows marketers to produce business intelligence to better support their customers. through the web, consumers can access more market information, by ways of company sites, independent evaluator or advisor sites, and through communities with other consumers that share their knowledge and experience. in an electronic environment such as the web, advanced technologies, such as multimedia, virtual reality, and software agents, may not only be employed as supportive tools, but can be the foundation for long-term market development. technology development may further change the market structure, expand the types of products or services suitable for web markets, affect consumers' behaviors, and dictate effective marketing strategies. disadvantages of web retailing, such as the inability to physically see and touch the merchandise, or concerns about security and privacy, may be alleviated through new technology development, application design, and improved policies and procedures. for example, a clothing retailer can provide a personalized virtual model that can tryon garments to aid consumer decision-making, and clearly stated privacy policies can help alleviate consumer concerns. developing and employing new technologies and applications may provide marketers with new business opportunities and advantages. marketers may explore new business models and target new market niches by developing new applications. early adoption of advanced technologies may build sustainable advantages, such as brand name recognition. for example, amazon was first to take large-scale advantage of the cyber-bookstore market. adopting the web as its storefront, amazon was able to list more than 10 million titles in its electronic catalog in spring 2000 (turban et al. 2000) and provide customers with extra service through its effective search engines, customer communities created through book recommendations and affiliate marketing, and reminder services using push technology. similarly, yahoo! was first to offer an extensive web directory, and provides users with the ability to personalize content. early and successful adoption of web technology has made amazon and yahoo! household names. spring 2002 wang, head & archer: etailing 77 channel integration the powerful integrated environment of the web can affect the marketplace in many ways. many business models, such as those similar to tv and catalog shopping, can be implemented readily online. different business tools and functions can be integrated. consumer orders can be automatically processed and routed to suppliers. information channels are integrated, with information flowing both ways between vendors and customers. this facilitates the gathering and sharing of market knowledge. for consumers, competitors are just a click away, allowing easy comparison of product offerings. more fundamentally, the web is a combined communication medium and distributionltransaction channel, which is quite different from traditional marketplaces. many researchers have recognized the web's basic characteristic as a communication medium (pellet 1996; griffith & krampf 1998). compared to information push from marketers to customers through traditional media such as television, the web is a "pull" medium where customers purposely search for desired information. the web can empower micro-segmentation marketing, even oneto-one marketing, unlike traditional communication mediums such as telephone, television, radio and newspaper. the web as a communication medium can be simplex (one-way), duplex (two-way), or multi-plex (multiple-way). the communication can be one to one, one to many, many to one, and many to many with the same or different time dimensions. the web may also serve as a distribution/transaction channel. the web is often considered a distribution channel for digital assets only, since physical goods must be handled offline. the underlying argument is that distribution and transaction functions are often differentiated (peterson et al. 1997), where the distribution channel is used for logistic operations and the transaction channel for sales. such a division helps to explain some business models in the conventional market, such as brokerages, where the brokers never physically handle or take title of products. according to walters (1977), distribution channels carry out two tasks: title movement and physical movement. this distribution channel principle includes both distribution and transaction concepts. after a customer completes an order and provides payment through a commercial web site, the title movement is completed. physical movement is the process of delivering products or services to the purchaser, which mayor may not happen through the web, depending on the nature of the product. in the electronic marketplace, more and more services and digital/information product providers employ the web as a full distribution channel. in the case of physical goods, while the web can not actually deliver the products, an important part of the distribution task, title movement, occurs at the web site. the web can also serve to facilitate the delivery process by allowing customers to access information such as delivery status. also, from the consumer's perspective, distribution and transaction channels may tend to converge. even in cases where merchandise is directly 78 journal of business strategies vol. 19, no.1 delivered from manufacturers and virtual retailers do not handle the goods, customers assign merchandise quality and delivery responsibility to the retailers. for these physical goods, the web may be considered a transactional channel or a (partial) distribution channel. the web marketplace is a unique combination of a communication medium and a distribution/transaction channel. this combination makes the web an integrated interactive environment, where consumers' communication and purchasing behaviors can be carried out through the same infrastructure. this differs from television and catalog sales, which serve as communication tools rather than marketplaces. the integrated web channel also facilitates consumer interaction and favors interaction marketing. this interaction includes information exchange (communication) before, during and after the purchase behavior (distribution). throughout the decision making process, manufacturers can interact directly with consumers and apply advanced marketing techniques. for example, the "made to order" concept, which was traditionally reserved for special product transactions in the business-to-business (b2b) market, can now be applied through mass customization in the web retail market. information intensity information availability is limited in the traditional market. while electronic techniques, such as pos, have been used to collect information for inventory management and customer analysis, they have limited potential. first, the information collected through these systems does not tend to be extensive, since it simply includes merchandise descriptions and quantities sold. while some stores also collect customer account data, valuable information generated through personal interaction with customers, such as their preferences, is typically lost. surveys and analysis by stores and brand manufacturers are generally conducted, if at all, on a limited sample basis. second, information collection and analysis in the traditional market is primarily performed from the marketer's point of view and for the marketer's use and purpose. information that directly facilitates consumers' information searching or market evaluation is not as easily available. electronic techniques used in the traditional retail market tend to be supportive tools, and do not emphasize the customers' views, roles or power. the web is a truly information-intensive environment. vast amounts of in formation can be collected, integrated, processed, presented, and accessed through the web by both marketers and consumers. marketers now can track detailed information for all e-tailing consumer interactions, not just select samples. however, soft market features, such as reputation and reliability, may be more difficult to gather and evaluate. consumers can gain more market knowledge for criteria comparison, however potential problems of information overload may increase perceived searching costs (head et al. 2000). marketers may provide spring 2002 wang. head & archer: etailing 79 tools to facilitate consumer information collection, but may have to redesign their marketing strategies since competitors can also accumulate market knowl·· edge and match price differences. market effects the web characteristics outlined in the previous section can create some fundamental changes to the retail market. this section analyzes these effects on the retail market, as shown in figure 1. the web adds an e-tailing service element, leads to a new market participation model, and can alter distribution channels. the service perspective what are the differences between buying online and offline? many products sold by online retailers are the same as offline merchandise. a book is a book and a toy is a toy. the primary attraction of online shopping is the service value perspective, where customers claim to enjoy rich information and convenience. service components are embedded in the online shopping channel. some researchers have realized the service components of product design in e-tailing and indicated that e-tailers are faced with a unique set of challenges in the management of their customers' perceptions (kolesar & galbraith 2000). service components are most prominent in information/knowledge and delivery aspects of e-tailing. e-tailers are faced with the challenge to design usable and useful web storefronts to facilitate customer navigation. many e-tailers feature a large portfolio of products, requiring powerful search tools/methods to tailor to the heterogeneity of consumer information requirements. the web encourages after-sales service by facilitating access to rich information and customer interaction. customer relationship management (crm) systems have become popular tools to support these relational interactions. crm systems can automatically record detailed consumer activities and can be used to build consumer profiles from various tangible and intangible activities. by understanding consumers better, marketers can employ relationship marketing techniques in the retail market to provide personalized services. consumers often view online shopping as being more risky than traditional shopping channels. orders are contracted before consumers receive, or in many cases physically evaluate, the merchandise. the delivery process may generate risk if consumers do not receive their orders in the time and conditions expected. consumers may also risk higher privacy loss. while enjoying personalization and enhanced service, most consumers view the misuse of market information as a violation (head & yuan 2001). marketers should solicit consumer permission to use market data, and must not compromise consumer privacy concerns. the value added from service components must outweigh the perceived risk of shopping online. 80 journal of business strategies vol. 19, no. i new market participation model due to its channel integration and information intensity features, a new participation model has emerged in the web market. figure 2 (a) illustrates a traditional market interaction model and figure 2 (b) shows the new web market participation model marketers and consumers interact through communication mediums and distribution channels. both the marketers and consumers perform information-processing and decision-making tasks. market participation is determined by interaction and information-processing/decision-making activities. figure 2(a) traditional market participation communication medium consumers information processing and decision making (passive) market participation active information processing and decision making (active) ~~ l..--' passi~ marketers distribution channel as figure 2(a) shows, in the conventional marketplace, the market participation of marketers is active while the participation of consumers is passive. information is pushed by marketers to consumers through traditional mass marketing mediums such as newspaper, television, and radio. consumers' information acquisition and processing are mostly passive and restricted. due to communication limitations, consumers tend to make decisions individually, or in small family groups, and then actively deliver their purchasing decisions to the distribution channel marketers then passively receive feedback information. several key points must be emphasized. first, it may be difficult to accumulate rich and valuable consumer information in the traditional market, since the communication medium and distribution channels are usually separated. second, the dashed line indicates that consumers seek information and marketers seek feedback actively, but to a limited extent. consumers may have limited access to valuable information, since most information in the traditional market is designed for the masses rather than the needs of the individual. seeking relevant and personalized information can be timeand cost-consuming, resulting in consumers' largely passpring 2002 wang, head & archer: e-tailing figure 2(b) web market participation 81 passive the web active imarketers i.. .. communication medium .. "iconsumersl distribution channel sive access of information. on the other hand, marketers are active during the communication phase but mostly passive during the feedback phase. consumers determine the amount of feedback they wish to provide, and this feedback may be buffered, distorted, and delayed as it must often pass several distribution layers. although there are some passive marketer activities, overall we consider marketers as active participants in the conventional market, which implies their greater power to influence this market. figure 2(b) shows the new participation model in e-tailing. the web is an integrated channel, which greatly facilitates information access, collection, and analysis for all market participants. both consumers and marketers can actively participate in the market in all interaction phases. while consumers can dramatically increase their market power, various marketers can also enhance their market capabilities. the communication medium and distribution channel are not market buffers but serve as an interaction carrier. both marketers and consumers can establish direct contact with each other. therefore, the capability of the communication medium and distribution channel does not limit the power of market participants. timely and accurate feedback can be delivered to manufacturers, and consumers can find information that fits their specific needs. changes in distribution channels the web empowers manufacturers. due to the communication ability of the web market, manufacturers can connect to large consumer bases without location limitations, which may allow them to vertically integrate retailing functions and eliminate distribution layers. avoiding traditional wholesale and retail channels may reduce the final consumer price and facilitate quicker service. customers may be able to interact with manufacturers during the entire marketing cycle, from product design to post-purchase service even to old product recycling. direct interaction benefits manufacturers by enhancing market understanding and building consumer relationships through pricing and personalization. dell computer corporation (www.det1.com) is an example of efficient online retailing through shortening the distance between manufacturers and consumers. 82 journal of business strategies vol. 19, no.1 however, with fewer distribution layers, there may exist a value gap (gallaugher 200 1). distribution layers add value, which may be lost through disintermediation. for example, retailers perform certain functions in distribution such as delivery, storage, and insurance. they have some advantages that manufacturers may lack, such as larger product profiles, retailing expertise and market knowledge. retailers are product collectors and market organizers in certain industries, such as the grocery sector, providing convenience to consumers that manufacturers could hardly substitute. customers may search and compare products more easily at a one-stop site without interacting with various individual manufacturers. the success of disintermediation will depend on appropriate adjustments of the generated value gap by decreased costs or providing additional services. in non-commodity industries that have few manufacturers and carry similar products, such as the pc industry, the benefits provided by retailers may have less value. new intermediaries are also appearing that may expand distribution channels. auto-by-tel and charles schwab's onesource mutual funds network are among many successful efforts that have created market makers by displacing an existing weak point in the distribution chain with a technology-driven value enhancement (gallaugher 1999). in these cases, online marketers can design products and services for customers' needs, which can not be effectively provided in traditional markets. a good example is garden.com (welles 1999), which is an e-tailer for garden supplies. this company distributes knowledge, takes orders online, and ships products directly from its suppliers to its customers. in this way, garden.com becomes a sole marketing and customer service company for its suppliers and targets a special group of customers who value time and product knowledge. the internet allows for the re-organization of distribution channels to better match consumers' needs. it may decrease distribution layers, possibly lowering costs and facilitating direct interaction. it may induce online and offline competition. and it may create additional distribution layers to provide service and value for consumers. response strategies the web has the power to fundamentally influence the retail market. facing this challenging and changing market phenomenon, retail businesses are adapting their strategies to take advantage of new opportunities. this section addresses the business response strategies shown in figure 1. retailers can consider the potential impact of the web from two perspectives. the first perspective considers the web as one of many tools available for marketers to communicate and sell their products to customers (peterson et a1. 1997; deighton 1997; burke 1997). the second view recognizes the potential power of the web to create a new marketplace (mahajan & wind 1989). we have spring 2002 wang, head & archer: e-taiting 83 developed a summary, shown in table 2, that outlines the main differences between these two views. to the best of our knowledge, such a comparison has not been adequately defined in previous work. it is important to note that although we separate these two perspectives, various combinations are also possible. however, it is of value to separate and clearly outline the two views in order to provide a basis for further investigation. separating the role of the web as a tool and as a marketplace is similar to the concept of separating sustaining and disruptive technologies (christensen 1997). we propose that by using the web as a marketing toot, businesses are actually adopting a sustaining approach to employ new technology. by viewing the web as a new marketplace, business strategies are more disruptive, and may thus lead to more dramatic changes in the organization. different views will generate different strategies, which will have different implementation implications. the web as a marketing tool peterson et al. (1997) argues that the web will have major effect on communication, will influence transactions, but will have no effect on distribution unless the good is based on digital assets. businesses, which view the web as a marketing tool, mainly employ it as a communication tool to take advantage of its benefits in lower costs, interactivity, personalization, digitization, automation, and constant communication. most traditional retailers who do not currently sell their products/services through their sites hold this view. many traditional retailers construct their site to foster better communication and public relations. consumers can obtain corporate information, and may be encouraged to subscribe to customized electronic flyers/newsletters. many businesses, which sell through both traditional and web channels, such as business depot (www.businessdepot.com). also follow this model. the website of business depot is simply another store front or interactive catalog. when viewing the web as a marketing tool, value proposition focuses on improving existing products and services by expanding their reach and range. the communication power of the web allows companies to effectively provide information to consumers without geographical or time limitations. from the consumer's point of view, their information access is dramatically expanded and decision making is facilitated. customers can easily evaluate competing offers through available tools or services. for example, realtor.com offers a webbased mortgage financial calculator (www.realtor.com/resourcecenter/ financecenter), which is not available through traditional channels. employing the web marketing tool will not tend to dramatically change the organization's customer groups or advertising criteria. companies can better serve the same group of customers. for example. office depot employs the web to improve its existing store and catalog services. without opening more stores 84 journal of business strategies table 2 different views of the web vol. 19, no.1 the role of the web characteristic a marketing tool a new marketplace value provided improve existing new definition of value product/service value main function communication tool a channel that facilitates a fun range of interaction competitive strategy expanding reach/range seeking new market nicheslboundaries and appropriate strategies/ business models effect on consumers more efficient and increased growth of complete information customer power access target customers existing, with same value new/existing group, with uj criteria different value criteria-0 strategic focus a technology tool that can new web-supportedqlc. uj facilitate existing strategic actions < 0 strategies c) business functions facilitate implementation facilitate existingql-a:l affected of existing marketing functions and seek new...functions value/opportunities(/) main relationship with complementary and co-existing and existing marketplace integrating, one of several competing, a new marketing tools marketplace with distinct characteristics and structure product selling potential limited unlimited marketing implication improved interaction, integrated interactive market microchannel, new marketing segmentation, possible campaign under new one-to-one marketing market strategy market structure effect not obvious fundamental strategic potential short-term long-term spring 2002 wang, head & archer: e-tailing table 2 continued different views of the web 85 the role of the web characteristic a marketing tool a new marketplace implementation realistic, based on the developing, based on feasibility major current market substantial analysis of capability future markets organizational effect structural or functional re-organization of the change in communicationentire organization 1il related departments-ucll major function of the web communication web sellingq. 1il webc( c:: marketing plan marketers both marketers and0 +: m participants consumer-c cll market researchl normal difficulte cll prediction q. .e uncertainty low high business process covered 82c b2c, 828, c2c, intra-8 complexity of web low to medium highly complicated and information systems complexity integrated used relationship between well researched trial-and-error. strategy and implementation strategies guide emphasis on feedback scheduled and adjustment implementation or printing more catalogs, customers can access updated and accurate information through the web and complete transactions online. the gap's (www.gap.com) target customers are not dramatically different online than offline. however, their online customers can be better served through more extensive information and product availability, and service integration between their online and traditional stores. as a new technology tool with strong communication power, the web can be used to support existing strategies by facilitating the implementation of existing marketing functions. the web serves as one of many marketing tools, such as television, and marketers try to benefit from the strengths provided by different media. the functions of these media are often complementary, and most marketers use them simultaneously to enhance results. the web is particularly powerful for consumer interaction. companies can acquire more consumer informa86 journal of business strategies vol. 19, no.1 tion and feedback through the web channel and deliver targeted messages more efficiently. businesses with this view do not expect the web to create dramatic structural changes in the market. major distribution chains remain relatively stable. the potential to use the web as a marketing tool to seek strategic advantage is often limited and short-termed, since competitors can quickly copy the strategy. necessary resources, such as technology and corresponding marketing expertise, may be easy to gain with existing strategies and consumer base. this sustaining approach to web utilization has minimal effects on strategy formulation, and thus implementation tends to be relatively easy and realistic. without major shifts in consumer characteristics and industry relationships, companies can adjust their practices gradually. it is not difficult to open a web site to provide company and product information or for catalog sellers to introduce an online catalog. since this view facilitates existing marketing strategy, structural or functional changes are mostly expected in communication-related departments. the suitability of the web for product selling depends to a large extent on the characteristics of the products and services (peterson et al. 1997) and is limited to certain product categories. generally, products that have a low outlay, are frequently purchased, have an intangible value proposition, and can be highly differentiated, are more likely to be purchased through the web (phau & poon 2000). as industry practice shows, products such as books and toys are among the best selling products online. thus, it is necessary to explicitly consider product characteristics when evaluating web strategies. marketers are major players in the implementation of communicationrelated changes. they help open the web channel, design available functions, collect market information, promote interaction, and offer more alternatives to consumers. without major market or consumer changes, existing business expertise may be readily applied to new media. with business expertise, financial stability, and existing branding, traditional retailers can implement online channels with relatively low risk. the major business process influenced by this implementation is b2c communication. other relationships, such as business procurement, may not be affected. the web information systems (wis) used to implement this marketing tool will be of low to medium complexity, depending on the level of web service provided. for the case of business depot, which had catalog selling experience and an existing infrastructure, less market research and organizational changes were needed to initiate its online business. with an existing market and customer base, the uncertainty and risk involved in this venture was relatively low. using the web as a marketing tool, companies can design a well-researched strategy through their understanding of the market, configuration of media effects, and cost allocation. such a strategy will help guide a scheduled implementation to ensure success. spring 2002 wang, head & archer: e-tailing 87 the web as a new marketplace mahajan and wind (1989) consider the web a "market discontinuity" businesses, which explore the web channel as an emerging new marketplace that facilitates a full range of interaction, may find that it co-exists and competes with traditional markets. online retailers must provide incentives for consumers to change their shopping patterns or explore new markets. new value must be defined and appreciated by consumers to compete with existing market channels. for example, customers must value the flexibility and convenience of web shopping. businesses need to explore market niches/ boundaries to fit the new value with customers' needs, and seek appropriate business models to achieve these needs. target customers will be new and existing groups with different value criteria, which may be difficult to achieve through traditional channels. for example, thepeachtree (www.thepeachtree.net). an online grocery-shopping provider, contracts with local grocery stores and provides shopping convenience to consumers. for consumers of thepeachtree, an additional distribution layer is added. thepeachtree, using the web communication advantage, seeks the market niche for customers who have time constraints or who will pay extra for the convenience of this service. in addition to using the web for information searching, consumers can increase their market power through high involvement in business processes and virtual communities. these are new web-centered strategies, which are restricted in traditional markets by fixed physical assets and slow transfer of information (werbach 2000). some researchers have noted the commercial effects of web groups (wotring et at. 1995; armstrong & hagel 1996; kozinets 1999). communication convenience allows consumers to form communities outside their traditional work or family groups. such communities accumulate information or knowledge by learning from the experiences of individual community members. information collection costs and times are often reduced for individuals within a community. opinions from other consumers are often more valued than messages from marketers, especially in a web market, where trust is critical and more difficult to build. not only do groups have a strong effect on purchasers' decision-making, but they may also affect market variables such as products and prices. for example, stocks that capture the attention of participants in chat rooms can move noticeably in price (bruce 1997). the web, as an interactive marketplace, also gives the consumer data selection and personalization power. customers can select information of interest and personalize presentation forms for their own use. personalized web pages, which can be constructed fairly easily, increase customer power (rousseau et al. 1999). customers on the web have greater control over what they view and examine. they can select their own path through the information network, process the data, or initiate communication with marketers. 88 journal of business strategies vol. 19, no.1 while businesses still need to consider product/service characteristics to design proper strategy, viewing the web as a new marketplace dramatically expands the possible product categories suitable to online selling. businesses are not limited by traditional models and strategies, but actively seek new value and strategies. many business functions are affected when trying to achieve value in the web marketplace. for example, some e-tailers may hold minimal or no inventory, and mainly handle information. the range of information goods can still be greatly expanded. marketers may also design new marketing campaigns that substantially differ from traditional ones. market structures may fundamentally change in the new marketplace. old intermediaries may disappear and new ones emerge. consumers may have different decision making patterns and market participation roles. major industry relationships may be redefined. since these e-tailers are realizing new value definitions and constructing new operational structures, strategic advantages may be longer lasting. most retailers with this view focus on web selling. consumer groups with new value criteria and shopping patterns are forming and expanding. they must actively play their new role in web shopping. on the other hand, industries will continue to evolve and companies will fe-organize to adopt new business models. werbach (2000) outlines many of these organizational changes, such as relationship structures and outsourcing roles. a focus of outsourcing in the traditional marketplace is to gain efficiency. in the electronic marketplace, outsourcing is facilitated by the domination of information manipulation, and a focus may be to assemble virtual corporations. organizations may need to reconfigure not only their business-to-consumer perspectives, but also their b2b and intra-business (intra-b) operations. facilitating and managing consumer-to-consumer (c2c) communication and knowledge sharing may become a major aspect of business intelligence. therefore, web information systems will be more complex due to integration and interaction requirements. information should be seamlessly transferred among the parties involved. these strategies are still developing and are mostly based on prediction and analysis of future markets. since the new market is still in its early formation stage, businesses and consumers need to learn and evolve with this new web marketplace. market prediction and analysis is difficult due to shifts in market forces (mahajan & wind 1989) and the speed at which internet-related changes are occurring (peterson et al. 1997). thus, the strategy formation and implementation processes are largely trial-and-error based. feedback from early implementation is needed and used for strategic adjustment. the success of each view depends on the current market situation, the maturity of technology and the readiness of consumers. even within the same market, either strategy may lead to success when targeted at different customers. spring 2002 wang. head & archer: e-tailing conclusions and future research 89 this paper presented a general web market framework to guide our discussion. we outlined three main web characteristics (technology infrastructure, channel integration, and information intensity) that impact the retail market. the effects of these impacts include an increased service perspective, a new market participation model, and changed distribution channels. retailers may respond to these impacts and effects by either viewing the web as a marketing tool or as a new marketplace. we have examined these two perspectives along several strategic and implementation dimensions. the success of these response strategies will depend on the types of products and services being marketed, corporate and market culture, technology maturity, and consumer readiness. the development of e-tailing accelerates competition. the online channel has to compete with offline stores and new entrants with innovative products, services or business designs. to survive, businesses must possess certain significant competitive factors. brand, economies of scale, and size seem to be important to e-tailers (gallaugher 1999). further research needs to systematically analyze competitive factors for e-tailers in order to provide effective guidelines. currently, with competitors being a click away, loyalty and trust are harder to build in the web environment. however, e-tailers need to build consumer loyalty to survive and thrive in this highly competitive landscape. guidelines to develop and build this loyalty and trust should be addressed in future research. further research is also needed in applying new technology development to business processes and strategies. as previously outlined, technology is essential to market development and marketers may gain substantial benefits from early adoption. web-based information systems serve as the storefront for consumers and must be easy to use. e-commerce usability is a new area in human computer interaction and critical to online business success. consumer information is viewed as an important asset to businesses. using this information, marketers may provide superior products and services at better prices. however, consumers are demanding more control on the use of such information. there is a delicate balance between perceived value and cost (wang et al 2001). further research may explore the factors, such as trust, which may serve as the threshold (long et al. 1999) of value for information and privacy concerns. e-tailing is a market practice that is still in its infancy. viewing the web as a marketing tool, marketers incorporate the web into their traditional strategies. viewing the web as a new marketplace, businesses emerge with new product! service designs, targeted customers, and strategies. traditional methods to evaluate the success of a business seem insufficient in the new economy. despite 90 journal of business strategies vol 19, no. 1 increasing sales, many e-businesses are not profiting. in this developing market, many businesses aim to build a brand name and customer base, while leaving profitability a long-term consideration. research needs to be conducted to categorize e-market assumptions and assess their validity. with further research and understanding, the web retuil market can prove to be a significant and profitable marketplace. references armstrong. a.. & hagellll, j. (1996). the real value of online communities. harvard business review, 74 (3),134-141. bakos, j. y. (1997). reducing buyer search costs: implications for electronic marketplaces. management science, 43 (12), 1676i 692. bellman, s., lohse, g.l., & johnson, ej. (1999). predictors of online buying behavior. communications of the acm, 42 (12), 32-38. berthon, p., pitt, l.f.. & watson, r.t. (1996). the world wide web as an advertising medium: toward an understanding of conversion efficiency. journal of advertising research, 36, 43-54. bruce, c. (1997). welcome to my parlor. marketing management. 5 (4), 11-24. burke, r.r. (1996). virtual shopping: breakthrough in marketing research. harvard business review, 74 (2), 120-131. burke, r.r. (1997). do you see what i see? the future of virtual shopping. journal of the academy of marketing science, 25 (4), 352-360. christensen, c.m. (1997). the innovator's dilemma: when new technologies cause great firms to fail. harvard business school press. cross, r .. & smith, j. (1995). customer-focused strategies and tactics: interactive marketing weighs in for customers. in e. forrest & r. mizerski (eds.) interactive marketing: the future present. (pp. 5-28). ntc publishing group. deighton. j. (1997). commentary on "exploring the implications of the internet for consumer marketing." journal of the academy of marketing science, 25 (4), 347351. gallaugher, j. (1999). challenging the new conventional wisdom of net commerce strategies. communications of the acm, 42 (7),27-29. spring 2002 wang, head & archer: e-tailing 91 gallaugher. j.m. (2001). e-commerce and the undulating distribution channel. communications of the acm (to appear), www2.bc.edu/-gallaugh/research/cacmudc/ undulating.html. graham, j.r. (2000). marketing strategies for businesses that are more "bricks" than "clicks". the american salesman, 45 (9),19-25. griffith, d.a., & krampf, r.f. (1998). an examination of the web-based strategies of the top 100 u.s. retailers. journal of marketing theory and practice, 6 (3), 12-23. gulati, r., & garino, 1. (2000). get the right mix of bricks & clicks. harvard business review, 78 (3), 107-114. head, m., & yuan, y. (200 i). privacy protection in electronic commerce a theoretical framework. human system management. 20, 149-160. head, m., archer, n,p., & yuan, y. (2000). world wide web navigation aid. international journal of human-computer studies. 53 (2), 301-330. hoffman, d.l., & novak, t.p. (1996). marketing in hypermedia computer-mediated environments: conceptual foundations. journal of marketing. 60, 50-68. isakowitz, t., bieber, m" & vitall, f. (1998). web information systems. communications of the acm, 41 (7), 78-80. jackson, r., & wang, p. (1995)_ the convergence of database marketing and interactive media networks. in e. forrest & r. mizerski (eds.) interactive marketing: the future present. (pp. 355-372). ntc publishing group, kolesar, m.b., & galbraith, r. w. (2000). a services marketing perspective on e-retailing: implications for e-retailers and directions for further research. internet research. 10 (5), 424-438. kozinets, r. v. (1999). e-tribalized marketing?: the strategic implications of virtual communities of consumption. european management journal, 17 (3), 252-264. long, g., hogg, m.k., hartley, m., & angold, sj. (1999). relationship marketing and privacy: exploring the thresholds. journal of marketing practice: applied marketing science. 5 (i), 4-20. mahajan, v., & wind, 1. (1989). market discontinuities and strategic planning: a research agenda. technological forecasting and social change. 36 (august), 185199. murphy, j., hofacker, c.f., & bennett, m. (2001). website-generated market-research data. hotel and restaurant administration quarterly, 42 (i), 82-91. 92 journal of business strategies vol. 19, no.1 pellet, j. (1996). the future of electronic retail. discount merchandiser. 36 (i), 36-46. peterson, r., balasubramanian, s., & bronnenberg, bj. (1997). exploring the implications of the internet for consumer marketing. journal of the academy of marketing science, 25 (4),329-346. phau, i., & poon, s.m. (2000). factors influencing the types of products and services purchased over the internet. internet research: electronic networkin~ applications and policy. 10 (2), 102-113. schlauch, aj., & laposa, s. (2001). e-tailing and internet-related real estate cost savings: a comparative analysis of e-tailers and retailers. journal of real estate research. 21 (i), 43-54, rousseau, e, macias, j.a.g., lima, j.y., & duda, a. (1999). user adaptable multimedia presentations for the world wide web. proceedings qf the 81b international world wide web conference, toronto, canada, may 1999, 195-213. turban, e., lee, j., king, d., & chung, h.m. (2000). electronic commerce: a managerial perspective, prentice hall. walters, e.g. (1977). marketing channels, goodyear publishing co., inc. wang, e, & head, m. (2001). designing web-based information systems for e-commerce. proceedings of the 200 world congress on the management of electronic commerce, january 2001, hamilton, canada, wang, f., yuan, y, & zhang, x. (2001), the use and protection of private information: a dynamic balance between businesses and consumers. proceedings of the 21111 world congress on the management of electronic commerce, january 2001, hamilton, canada. welles, e.o. (1999). the perfect internet business. inc. 21 (11), 71-78. werbach, k. (2000). syndication: the emerging model for business in the internet era. harvard business review. 78 (3), 85-93. williams, e, strover, s., & grant, a.e. (1994). social aspects of new media technologies. in j. bryand & d. zillman (eds.) media effects. advances in theqry and research. hillsdale, nj: lawrence erlbaum associates. wolfinbarger, m., & gilly, m.c. (2001). shopping online for freedom, control, and fun. california management review. 43 (2), 34-55. wotring, c.e., kayany, j.m., & ferrest, e.j. (1995). consuming technologies at home: new consumer research techniques. in e. forrest & r. mizerski (eds.) interactive marketing: the future present. (pp. 269-281). ntc publishing group. spring 2002 wang, head & archer: e-tailing 93 fang wang received her b.s. in economics at renmin university of china, in 1995, and mba at university of texas, san antonio, in 1998. she worked in hongkong and shanghai banking corp., beijing, in 1996. currently, she is a ph.d. student in the area of management information systems in the michael g. degroote school of business at mcmaster university. her research interests include electronic commerce, marketing and finance. milena head is an assistant professor of information systems in the michael g. degroote school of business at mcmaster university. her research interests are in topics that relate to electronic commerce and human-computer interac~ tion, including web-based agents, ec trust and privacy, e-tailing, and interface design. she has published in international journal of human-computer studies, interacting with computers, journal of internet research, human systems manat:ement, among others, and has presented at several international conferences. norm archer is the wayne c. fox chair in business innovation and professor of management science and information systems in the michael g. degroote school of business at mcmaster university, where he is also the director of the mcmaster e-commerce research centre. his research interests are in topics relating to electronic commerce, including business-ta-business implementa~ tions, intelligent agents, and the human-computer interface, and he has published over 45 refereed journal articles. e-tailing: an analysis of web impacts on the retail market 31664_19x13(4up)-6x9-cutstack.pdf 38 journal of business strategies differences in millennials in emerging markets and developed countries: the case of turkey and the united states timothy h. reisenwitz valdosta state univeristy • valdosta, ga iike kardes valdosta state univeristy • valdosta, ga asude yasemin zengin aksaray univeristy • aksaray, turkey abstract this study assesses the differences between millennials (generation y) in advanced and emerging countries, using the united states and turkey. the purpose is to give marketers more direction in better addressing the needs of millennial consumers in advanced and emerging countries. results showed that millennials in the united states are more satisfied with online purchases, have higher brand loyalty, and were more risk-averse compared to the millennials from turkey. there are no significant differences between the two countries in terms of social media usage. this study enriches the existing literature and provides directions for further research. keywords: gen y, millennials, consumer, emerging markets, developed markets introduction generational cohorts share cultural, political, and economic experiences as well as have similar outlooks and values (kotler & keller, 2006). today, millennials have been the main driver of markets both for emerging markets (ems) and advanced economies due to their considerable representation in the workforce and their high propensities of spending. millennial studies mainly stressed the characteristics of social media usage patterns. they typically focused on the high socioeconomic status consumers in advanced economies with a developed infrastructure of it (bolton et al., 2013). on the other hand, the population of the ems accounts for more and more of the world’s population day by day. as of october 2019, more than 6.56 billion of the world’s population lives in ems, and they account for almost 85 percent of the world’s total population (“imf”, 2019). thus, it is of importance to understand generation y’s (millennials’) consumer behavior and characteristics in emerging markets to execute proper marketing activities in ems. volume 38 number 1 39 marketers must adjust their marketing strategies to the dynamic needs of millennial consumers, as millennials continue to develop their careers and their disposable income increases. it is crucial for companies to get millennials satisfied and loyal to their brands so that they can achieve a sustainable competitive advantage in the global marketplace. however, firms should treat millennial consumers of advanced economies and ems differently. they need to execute country-specific marketing/marketing communications strategies mainly because of the differences in economic and cultural atmospheres in developed and emerging countries. generational cohorts generational cohort theory is a theory of social history that “describes and elaborates on differences and changes in generational and public attitudes over time” (van der walt et al., 2016, p. 53). a generational cohort consists of individuals who have shared the same external environment and events, which is thought to influence their behavior and thinking. the current generational cohorts in the united states consist of matures or traditionalists, baby boomers, generation x, generation y, and most recently, generation z. although there is much consensus on the birth years for matures (prior to 1946) and baby boomers (1946-64), there are variations for the birth years of generation x, generation y, and generation z. there is currently little consensus of when generation y ends, and generation z begins. much of the literature does not provide citations for the dates that were used to define these generational cohorts. therefore, the long-standing, reputable research organization, the pew research center, was chosen as the source for defining gen y by birth years. for purposes of this study, generation y is defined as those born during the years 1981-1996 (dimock, 2019). the term, generation y, was first coined in 1993 by advertising age as the last generation to be born entirely in the twentieth century (reed, 2007). generation y is also known as echo boomers, the millennium generation, millenniums or millennials, generation we, connect 24/7, leave no one behind (wiedmer, 2015), generation next (durkin, 2008), internet generation (wiedmer, 2015) or net generation (tyler, 2008), and generation why? (reed, 2007). there are about 60 million consumers in this group, over three times the size of their predecessors, generation x (montana & petit, 2008). 40 journal of business strategies purpose of the study the purpose of this study is to evaluate the differences between millennials in advanced and emerging countries, using the united states and turkey, and based upon hofstede’s cultural dimensions. the aim is to give marketers more direction in better addressing the needs of millennial consumers in advanced and emerging countries. internet shopping satisfaction, social media usage, brand loyalty, and risk aversion are the examined variables in this study. although there are a plethora of consumer variables that could be examined, the variables chosen are salient variables for youthful consumers (internet shopping satisfaction, social media usage) and important variables in the purchase decision process (brand loyalty, risk aversion). these variables are discussed in the literature review that follows and are measured using established scales. literature review hofstede’s cultural dimensions culture plays an important role in shaping attitudes, perceptions, and behaviors. in international marketing literature, many scholars attempt to explain differences among countries based on culture. the impact of culture is investigated in a variety of contexts including online customer experience (shobeiri et al., 2018), online product reviews (wang et al., 2019), global internet use (gong et al., 2007), online shopping behavior (stafford et al., 2004), perceived risk of online shopping (ko et al., 2004), and the usage of social networks (pookulangara & koesler, 2011). one of the popular theoretical foundations to be used in culture-related studies is hofstede’s cultural dimensions. there are six dimensions including individualism/ collectivism, masculinity/femininity, power distance, uncertainty avoidance, longterm versus short-term orientation, and indulgence/restraint (hofstede et al., 2010). individualism/collectivism and uncertainty avoidance are the major focus of this study. the reason why only those dimensions are considered in this study is explained in the section of hypothesis development. the original cultural framework by hofstede was based on a cross-cultural study among employees of ibm corporation and included four dimensions such as power distance, uncertainty avoidance, individualism/collectivism, and masculinity/feminity. later, hofstede added the fifth dimension as long-term versus short-term orientation in the framework (hofstede & mccrae, 2004). finally, in the 2000s, the sixth dimension, indulgence/restraint, was included in the cultural dimensions (hofstede, 2011). volume 38 number 1 41 power distance is related to the level of the inequality in a society. it explains how easy it is to reach the authorities, express opinions freely, and distribute rights evenly (hofstede, 2011). indidividualism/collectivism is the degree of the ties between individuals. in collectivistic cultures, people develop strong group memberships. personal decisions might be sacrified in favor of group conformity. in individualistic countries, “i”consciousness replaces “we”-consciousness. personal opinions are expected (hofstede, 2011). masculinity/femininity refers to whether competitive versus caring values dominate in a society. ambition, competition, success-orientation, and being strong are typical values of a masculine culture. on the other hand, sympathy for the weak, caring values, and balance between work and family are more important in feminine cultures (hofstede, 2011). uncertainty avoidance indicates the tolerance for uncertainties. in a society with high uncertainty avoidance, people experience high stress and anxiety in ambiguous situations. one might expect that such people may avoid taking risks to eliminate discomfort of an uncertain situation. societies with low uncertainty avoidance tolerate chaos or unusual situations and people (hofstede, 2011). one might expect that such societies may adapt changes in the environment faster, be open to innovations more, and establish new businesses with less hesitation. long-term versus short-term orientation explains whether the society leans towards future rewards versus tradition (hollebeek, 2018; hofstede, 2011). individuals from cultures with long-term orientation values put more importance on long-term strategies and objectives (khambata & liu, 2005). indulgence/restraint defines whether individuals allow themselves to show their desires and enjoy life versus whether their lives are shaped by strict social norms. freedom of speech, enjoying leisure time, and expressing positive emotions are typical characteristics of an indulgent culture. on the other hand, a tendency towards being pessimistic and feeling helpless as well as a focus on work life rather than leisure are observed in restrained cultures (hofstede, 2011). turkish and american cultures are considerably different, as seen in table 1. according to hofstede’s country comparison at https://www.hofstede-insights. com/country-comparison/turkey,the-usa/, turkey exhibits high on power distance and uncertainty avoidance, low on individualism and masculinity, as well as moderate long-term orientation and indulgence. on the other hand, the score of united states is high on individualisim, masculinity, and indulgence and low on power distance, uncertainty avoidance, and long-term orientation. 42 journal of business strategies table 1 hofstede’s cultural dimension scores in turkey vs. united states (as of 2020) millennials (generation y) in the united states and in turkey satisfaction with online shopping the united states started to use the internet in the early 1980s, and today internet penetration rate is about 87 percent (“we are social,” 2020). thus, the millennial grew up in a digital world, is technically literate, and has mastered the technology (pelet & lecat, 2014). the internet is a part of the daily routines and practices of millennials (issa & isaias, 2016). thanks to technological improvement policies, turkey started using the internet in 1993. as of january 2020, the internet penetration rate is about 54 percent (“we are social,” 2020). since the us millennials met and started to use the internet almost a decade earlier than their peers in turkey, millennials in the us grew up with a more mature internet infrastructure than their peers in turkey. several studies state the positive impact of habit on online shopping satisfaction and repurchase behavior (pappas et al., 2014; venkatesh et al., 2003). social interaction is an important factor that determines the choice of the retail shopping format. for some consumers, shopping is an experience beyond buying products and includes socialization through in-person discussions, such as consultations with salespersons or inconsequential conversations with other customers. therefore, individuals who seek the intimacy of human contact during shopping tend to shop at brick-and-mortar retailers (christodoulides & michaelidou, 2010). on the other hand, online shopping may be less satisfying for those consumers due to the lack of social interaction. from a culture-based viewpoint, collectivistic cultures put importance on group-based values and relationships (soares et al., 2007). these priorities in a collectivistic culture may decrease satisfaction with online shopping because the online environment limits the physical interaction between individuals. according to a recent study, more collectivist values lead to less frequent e-purchase behavior, and lower intention to spend online (e.g., korzeniowska, table 1 hofstede’s cultural dimension scores in turkey vs. the united states (as of 2020) power distance collectivism/ individualism masculinity uncertainty avoidance long term orientation indulgence turkey 66 37 45 85 46 49 united states 40 91 62 46 26 68 source: https://www.hofstede-insights.com/product/compare-countries/ table 2 sample demographics respondent profile % of respondents us turkey gender male 46.9 41.1 female 53.1 58.9 education ged 6.0 0 high school 20.0 1.9 undergraduate 54.0 62.0 graduate 17.0 36.1 professional degree 3.0 0 occupation student 51.0 13.1 homemaker/not employed 4.0 7.5 self-employed 4.0 16.8 educator 1.0 2.8 professional 38.0 53.3 other 2.0 6.5 marital married 18 39.3 single 68 60.7 living with another 12 0 divorced 2 0 volume 38 number 1 43 2015). turkish cultural values are more collectivist than that of the united states. therefore, the collectivistic nature of turkish culture influences consumer attitude towards online shopping in turkey. for instance, 35 percent of internet users in turkey and 69 percent of americans shopped online in 2018 (optinmonster, 2020). based on this discussion, the following hypothesis is proposed: h1: millennials in the us have higher overall satisfaction shopping with the internet than millennials in turkey. social media usage rising government investment in technology enhances internet penetration rates and social media usage rates in emerging markets. the turkish government’s expenditure on it was 913 million turkish lira (tl) in 2002. it reached tl 5,067 billion in 2018 (“t.c. kalkınma bakanlığı,” 2018). as of 2019, the top five social networks are youtube, instagram, whatsapp, facebook, and twitter based on the penetration rate (“statista,” 2020a). onurlubaş and öztürk (2018) examined the effects of social media marketing strategies on instagram on millennials in turkey. research results suggest that almost all the respondents use instagram every day, most of them one to two hours daily on average, and more than half of them comment on the contents posted on instagram. the respondents shop mainly for clothing and cosmetics products. effective instagram strategies include the use of visual images, having a high number of consumer likes and followers, as well as celebrity usage. arslan and baycan (2018) investigated the effect of social media on the purchasing behavior of millennials in turkey. the results reveal that media sharing sites, online communities, and social networks are the top platforms that influence purchasing behavior. millennials in the united states are well-versed in their use of the internet and social media. the pew research center reports that 92 percent of millennials own a smartphone, 53 percent own a tablet, 84 percent use facebook, and 86 percent use social media (vogels, 2019). the percentage of millennials who use social media has remained unchanged since 2012. as of 2019, the top five social networks apps are facebook, instagram, facebook messenger, twitter, and pinterest based on the number of monthly users (“statista,” 2020b). furthermore, millennials have influenced the development of social media via their employment in technology and social media companies (bauman et al., 2019). about 73 percent said that the internet has been good for society. 44 journal of business strategies studies show that social media usage behavior varies based upon whether a country is characterized by individualistic or collectivistic cultural values (e.g., kim et al., 2011; alhabash et al., 2012; fong & burton, 2008; bolton et al., 2013). as seen in table 1, turkish cultural values encourage collectivist behaviors in contrast to the american individualistic cultural patterns. due to collectivistic values, turkish people tend to prioritize face-to-face communication in brick-andmortar environments although they enjoy social media communication. based on the previous discussion, the following hypothesis is proposed: h2: millennials in the us have higher social media usage than millennials in turkey. brand loyalty recent studies imply that the millennial in the united states has less brand loyalty. nagy (2017) states that millennials tend to be less brand loyal than previous generations and are resistant toward marketing and advertising. kusek (2016) observed that cultural shifts in the united states have caused the demise of brand loyalty. major changes in marriage, religion, politics, and corporate america have shaped a theme that change is good and it should not be feared or avoided, i.e., “’new’ is better than ‘known’” (kusek, 2016, p. 3). similar to the us millennial consumers, turkish millennial consumers’ brand perception and brand satisfaction-related values are found to be lower than generation x (kahraman & dağlı, 2019). millennial consumers of turkey put great emphasis on the strong brand image (coşkun, 2019) and emotional bonds as brand love (kocakuş, 2019). price and the accessibility of the product at the pre-purchase stage are important determinants for brand loyalty or switching behavior. also, millennials in turkey reconsider their purchasing decision if there is a price increase (coşkun, 2019). moreover, turkey’s millennials are ready to switch brands due to ecological reasons (zengin & kumcu, 2018). as a result, it can be concluded that millennial consumers of turkey may not be keen on being brand loyal. as discussed earlier, millennials in both countries, the united states and turkey, are less loyal to brands compared to the previous generations. uncertainty avoidance of hofstede’s cultural dimensions may help to compare millennials in the us and turkey in terms of brand loyalty. as noted in table 1, the us has lower uncertainty avoidance compared to turkey. individuals from cultures with low uncertainty avoidance, such as the us, are more comfortable with uncertainties and open to changes. experimenting with volume 38 number 1 45 new brands and taking risks might be observed in such societies. on the other hand, cultures with high uncertainty avoidance, such as turkey, tend to maintain the current situation because individuals are less risk takers. they might be more open to loyalty, tradition, and the environment that decreases unpredictability (ndubisi et al., 2012). previous studies show that brand attachment reduces perceived risk in shopping behavior and increases brand trust. on the other hand, perceived risk decreases consumers’ willingness to try new brands/products (aboulnasr & tran, 2020). therefore, consumers stay loyal to their brands. according to some previous studies, consumers from individualistic cultures do not overlook quality defects (donthu & yoo, 1998; yoo, 2009) or inconvenient brand communications. however, consumers of collectivist cultures are more inclined to tolerate some failures in order to maintain the ongoing brand relationship (yoo, 2009). based on this discussion, the following hypothesis is proposed: h3: millennials in the united states are less loyal to brands than millennials in turkey. risk aversion the preponderance of the literature concludes that millennials in the united states are risk-averse. moskowitz (2019) states that millennials are the “most risk-averse generation since the great depression” (p. 1). a study by the brookings institution revealed that 52 percent of millennials have a majority of their money in cash compared to an average of 23 percent for other generations (moskowitz, 2019). similarly, another study revealed that 28 percent of millennials labelled themselves as risk takers versus 40 percent of gen x and 43 percent of baby boomers (chudgar, 2013). millennials are risk-averse due to their continual state of safety and security, if viewed from the perspective of maslow’s hierarchy of needs model (harrington, 2015). in contrast, millennials in turkey grew up with liberalization policies beginning in the early 1980s. political, economic, and cultural changes and developments in the country shaped millennials in turkey in terms of characteristics and socioeconomic behavior. millennials in turkey did not experience product scarcity, as it was the case for the generation that grew up before 1980. thus, millennials tend to consume anything rapidly (göksel & güneş, 2017). there is a change regarding the risk-taking behavior from earlier generations to millennials in both countries. while millennials have fewer risk takers compared to the previous generations in the united states, risk-taking behavior increased in turkey. to compare millennials between the two countries, hofstede’s cultural dimensions are utilized. 46 journal of business strategies two of hofstede’s six cultural dimensions, uncertainty avoidance and long term orientation, are evaluated as being related to risk aversion (khambata & liu, 2005). the intermediate score of 46 for long-term orientation in turkey is not enough to determine a characteristic for the country, according to the hofstede’s country comparison at https://www.hofstede-insights.com/country-comparison/turkey,the-usa/. thus, to make a cross-cultural comparison between two countries about risk aversion, uncertainty avoidance is considered as a theoretical base. according to the uncertainty avoidance dimension of hofstede insights (2020) in table 1, turkey scores 85 and is identified as a high uncertainty avoidance country. on the other hand, the united states scores 46, which is below average and relatively lower than turkey’s score. it means that americans are relatively less reluctant for taking risks and more tolerant to new ideas (hofstede insights, 2020). additionally, research findings suggest that countries with low uncertainty avoidance are the ones that are more stable socially, economically, and politically (khambata & liu, 2005). hence, a comparison between turkey and the us on risk aversion is possible relying on uncertainty avoidance. based on this discussion, the following hypothesis is proposed: h4: millennials in the united states are less risk-averse than millennials in turkey. research methodology sample and data preparation the target population of the study was millennials in turkey and the united states. a convenience sampling technique was used to select respondents for both the turkish and us samples. this convenience sample was deemed appropriate because the purpose of the study was not to provide point estimates of the variables but to test the relationships among them (calder et al., 1981). respondents from turkey were mainly the residents of ankara and aksaray cities. the respondents were volunteers and were not provided any incentives for their participation. respondents from the united states were undergraduate students at a medium-sized university in the southeastern united states. they were also not provided with any incentives for their participation. based on the definition of millennials by pew research (dimock, 2019), people who were born between 1981 and 1996 living in the united states and in turkey were administered a face-to-face questionnaire. the authors are bilingual. the questionnaire was translated from english to turkish. then, the turkish version volume 38 number 1 47 was back translated to evaluate differences in the two versions of the questionnaire. a total of 130 questionnaires in turkey and 163 in the united states were distributed. questionnaires were obtained from 101 respondents living in the united states and 111 living in turkey. one case from the us sample and five cases from the turkish sample were dropped due to a considerable amount of missing data. a total of 206 usable responses remained. if the value of only one variable among associated variables that form a construct is missing, that value was imputed with means of peer variables of that construct. therefore, missing values were imputed for two cases in the us sample for the construct of interaction in social media, one case in the us sample and one in the turkish sample for the construct use of social media in shopping, one case in the us sample and five cases in the turkish sample for the construct of brand loyalty, two cases in both the us and turkish samples for the construct of satisfaction, and two cases in the turkish sample. table 2 shows the demographics of the sample. table 2 sample demographics table 1 hofstede’s cultural dimension scores in turkey vs. the united states (as of 2020) power distance collectivism/ individualism masculinity uncertainty avoidance long term orientation indulgence turkey 66 37 45 85 46 49 united states 40 91 62 46 26 68 source: https://www.hofstede-insights.com/product/compare-countries/ table 2 sample demographics respondent profile % of respondents us turkey gender male 46.9 41.1 female 53.1 58.9 education ged 6.0 0 high school 20.0 1.9 undergraduate 54.0 62.0 graduate 17.0 36.1 professional degree 3.0 0 occupation student 51.0 13.1 homemaker/not employed 4.0 7.5 self-employed 4.0 16.8 educator 1.0 2.8 professional 38.0 53.3 other 2.0 6.5 marital married 18 39.3 single 68 60.7 living with another 12 0 divorced 2 0 48 journal of business strategies table 2 sample demographics (continued) table 2 sample demographics (continued) us turkey internet use reason in % stay in touch with friends and relatives 88% 82.1% stay current with news and events 82% 91.5% access the chat rooms 16% 9.4% access discussions/newsgroups 25% 19.8% shopping/gathering product information 81% 72.6% entertainment 92% 47.2% access health/medical information 50% 37.7% check stocks and information 24% 13.2% perform stock transactions 9% 4.7% research specific topics (other than health) 66% 59.4% internet access device my own computer (pc) 51% 21.3% by mobile phone 47% 75% my web tv 0% 0.9% a friend/relative’s computer 0% 0% a computer at the library/community center 0% 2.8% a computer at work/school 2% 0% internet usage weekly average 20 hours or more 40% 41.5% 10-19 hours 34% 21.7% 5-9 hours 20% 23.6% less than 5 hours 6% 13.2% online shopping frequency never 3% 0% once-twice a year 19% 25% once a month 35% 39.8% a few times a month 31% 29.6% once a week 8% 1.9% more than once a week 4% 3.7% volume 38 number 1 49 according to the frequency analysis, seen in table 2, the top five reasons of being involved with the internet are staying in touch with friends and relatives, following news and events, shopping or gathering product information, entertainment, and research specific topics (other than health). both consumer groups access the internet via either a personal computer or mobile phone, among others. mobile phone usage is higher in turkey than in the united states. in terms of the frequency of internet usage and its weekly consumption, 97 percent of both groups access the internet daily. among them, 40 percent of the american millennials compared to around 42 percent of the turkish millennials spend 20 hours or more weekly on the internet. in terms of shopping activities, 66 percent of the millennials from the united states and around 69 percent of the ones from turkey shop online at least once a month. constructs and measures the questionnaire includes three types of questions to measure demographics, characteristics in terms of internet usage behavior, and online shopping. the demographics of the sample are presented in table 2. all scales are well-established and have been used in previous research. satisfaction with internet shopping was assessed using a four-item scale used by rose et al. (2012), which is a modification of a scale developed by khalifa and liu (2007). rose et al. (2012) provided evidence in support of the scale’s convergent and discriminant validities. the social media usage scale was created by rapp et al. (2013). three of the ten statements that were context-specific, i.e., focused on a brand or store, were removed, with the remaining seven statements broadly covering social media usage. brand loyalty was measured using the four-item scale developed and used by lichtenstein et al. (1990) and raju (1980). the risk aversion scale was measured by a modified four-item scale used by donthu and gilliland (1996). all items were measured on a seven-point likert scale from 1 = strongly disagree to 7 = strongly agree, in which the rating, 4, was for respondents who felt neutral. the following section reports the results of independent samples t-tests, which tested the hypotheses of online shopping behavior. the reason for running a non-parametric test, such as an independent samples t-test, is that the constructs are not normally distributed according to the kolmogorov-smirnov test. in the absence of normality, non-parametric tests should be run (coussement et al., 2016). all analyses were conducted via spss. 50 journal of business strategies analysis and results reliability coefficients were computed for each of the scales. coefficient alphas were reported for the us group and the turkish group as well as the total sample. all alpha values were above the 0.70 value recommended by nunnally (1978). table 3 presents the reliability of the items. table 3 reliability coefficients a principal component analysis (pca) was run to identify whether the scale items build the expected constructs. the suitability of the scale items is determined by the kaiser-meyer-olkin (kmo) test and bartlett’s test of sphericity. the kmo test checks the sample adequacy to conduct pca. a high value of kmo is expected, and a value below 0.5 is not acceptable. the kmo value of the analysis is 0.807, as seen in table 4. barlett’s test checks scale items correlation. a high correlation among variables implies that the variables are suitable for structure detection. a table 3 reliability coefficients scale/statements coefficient alpha us tr combined internet shopping satisfaction 0.916 0.886 0.903 i am satisfied with my overall experiences of internet shopping. i am satisfied with the pre-purchase experience of internet shopping websites, for example, consumer education, product search, quality of information about products, and product comparison. i am satisfied with the purchase experience of internet shopping websites, for example, ordering, and payment procedure. i am satisfied with the post-purchase experience of internet shopping websites, for example, customer support and after-sales support, handling of returns/refunds, and delivery care. social media 0.913 0.884 0.900 i use social media to improve my relationship with different brands. i use social media to communicate with retailers. i use social media to improve my relationship with retailers. my relationship with my retail stores is enhanced by social media. brand loyalty 0.887 0.801 0.853 i generally buy the same brands that i have always bought. once i get used to a brand i hate to switch. if i like a brand, i rarely switch from it just to try something different. even though certain products/services are available in a different number of brands, i always tend to buy the same brand. risk aversion 0.822 0.720 0.781 i would rather be safe than sorry. i want to be sure before i purchase anything. i avoid risky things. i don’t like to take chances. volume 38 number 1 51 significance level < .05 indicates that pca is useful within the data. the significance value of the analysis is 0.000, as seen in table 4. the rotated component matrix, as seen in table 4, is useful to form constructs based on the factor loadings of the variables. loadings close to 1 indicate that the component (factor) strongly influences the variable and the highest loadings under a component constitute a construct. according to the results of the principal component analysis, there are five constructs as follows: satisfaction with online purchase, interactions in social media, social media use in shopping, brand loyalty, and risk aversion. table 4 principal component analysis hypotheses testing the independent samples t-test was conducted to determine whether there are significant mean differences between millennials in the united states and in turkey table 4 principal component analysis kmo and bartlett's test kaiser-meyer-olkin measure of sampling adequacy 0.807 bartlett's test of sphericity approx. chi-square 1853.759 df 120 sig. 0.000 rotated component matrixa constructs component 1 2 3 4 sat1 0.895 0.127 0.106 -0.029 satisfaction sat2 0.878 0.121 0.128 0.041 sat3 0.883 0.050 -0.007 -0.050 sat4 0.845 0.062 0.067 0.073 sm1 0.055 0.820 0.213 -0.086 social media use sm2 0.124 0.883 0.032 0.131 sm3 0.093 0.921 0.128 0.039 sm4 0.089 0.862 0.067 -0.041 bl1 0.084 0.165 0.703 0.154 brand loyalty bl2 0.006 0.058 0.872 0.113 bl3 0.150 0.078 0.813 0.051 bl4 0.042 0.114 0.860 0.139 risk1 0.115 0.017 0.147 0.775 risk aversion risk2 0.009 0.003 0.174 0.649 risk3 -0.013 -0.019 0.111 0.863 risk4 -0.072 0.030 -0.012 0.784 extraction method: principal component analysis. rotation method: varimax with kaiser normalization. a. rotation converged in 5 iterations. 52 journal of business strategies in terms of satisfaction with online purchase, interactions in social media, social media use in shopping, brand loyalty, and risk aversion. table 5 presents the results. table 5 independent samples t-test analysis as seen in table 5, there are significant differences in satisfaction with internet purchase, brand loyalty, and risk aversion between millennials from the united states and the ones from turkey at p <0.01. on the other hand, the difference in terms of social media (interaction and shopping) between the two groups is not statistically significant. therefore, the second hypothesis (h2: millennials in the us have higher social media usage than members of millennials in turkey.) is not supported. the means of satisfaction, loyalty, and risk are higher, and statistically significant, in the us sample than they are in the turkish sample. the interpretation of the analysis is that us millennials are more satisfied with online purchases, have higher brand loyalty, and are more risk-averse compared to the millennials from turkey. therefore, the results of the analysis support the first hypothesis (h1: millennials in the us have higher overall satisfaction shopping with the internet than millennials in turkey.). however, the third hypothesis (h3: millennials in the united states are less loyal to brands than millennials in turkey.) and the fourth hypothesis (h4: millennials in the united states are less risk-averse than members of millennials in turkey.) are not supported. table 6 summarizes the hypotheses testing. table 5 independent samples t-test analysis constructs df (equal variances assumed) country n mean std. dev. std. error mean t-value sig. satisfaction 206.00 us 100 5.42 1.27 0.13 0.13 turkey 108 4.89 1.28 0.12 0.12 0.003 social media 206.00 us 100 2.79 1.56 0.16 0.16 turkey 108 2.45 1.45 0.14 0.14 0.101 loyalty 206.00 us 100 4.83 1.49 0.15 0.15 turkey 108 4.01 1.34 0.13 0.13 0.000 risk 206.00 us 100 5.38 1.13 0.11 0.11 turkey 108 4.68 1.19 0.11 0.11 0.000 table 6 summary of hypotheses testing hypothesis significance means of the samples supported (√) vs. not supported (-) h1: millennials in the us have higher overall satisfaction shopping with the internet than millennials in turkey. 0.003 us: 5.42 tr: 4.89 √ h2: millennials in the us have higher social media usage than millennials in turkey. 0.101 us: 2.79 tr: 2.45 h3: millennials in the united states are less loyal to brands than millennials in turkey. 0.000 us: 4.83 tr: 4.01 h4: millennials in the united states are less riskaverse than millennials in turkey. 0.000 us: 5.38 tr: 4.68 volume 38 number 1 53 table 6 summary of hypotheses testing managerial implications millennials in the united states are more satisfied with online shopping than those in turkey. the low satisfaction level in turkey can be explained by the impact of collectivist values and habits of shopping. online shopping is less favorable for consumers who seek social interactions (christodoulides & michaelidou, 2010). cultures with collectivist values prioritize relationships and group conformity (soares et al., 2007). in terms of habits, turkish millennials met the internet at a later time in their lives compared to their counterparts in the united states. they already had a shopping routine shaped by brick-and-mortar stores. a lack of habit with online shopping may decrease satisfaction because habit has a moderator effect on online shopping satisfaction and repurchase behavior (pappas et al., 2014; venkatesh et al., 2003). satisfaction with online shopping can be increased with enhancing the cognitive and affective experience of the customer (rose et al., 2012; homburg et al., 2006). factors related to website navigation, such as website design and visual elements, influence cognitive experience (novak et al., 2000). retailer credibility and positive word-of-mouth toward the online retailer may improve the affective experience (bhattacharya et al., 2019). thus, marketers can be confident in taking advantage of us millennials’ satisfaction with online shopping by providing online shopping opportunities. whereas, marketing toward turkish millennials should take a more traditional retailing approach with online shopping more focused toward the information search stage of the purchase decision process. table 5 independent samples t-test analysis constructs df (equal variances assumed) country n mean std. dev. std. error mean t-value sig. satisfaction 206.00 us 100 5.42 1.27 0.13 0.13 turkey 108 4.89 1.28 0.12 0.12 0.003 social media 206.00 us 100 2.79 1.56 0.16 0.16 turkey 108 2.45 1.45 0.14 0.14 0.101 loyalty 206.00 us 100 4.83 1.49 0.15 0.15 turkey 108 4.01 1.34 0.13 0.13 0.000 risk 206.00 us 100 5.38 1.13 0.11 0.11 turkey 108 4.68 1.19 0.11 0.11 0.000 table 6 summary of hypotheses testing hypothesis significance means of the samples supported (√) vs. not supported (-) h1: millennials in the us have higher overall satisfaction shopping with the internet than millennials in turkey. 0.003 us: 5.42 tr: 4.89 √ h2: millennials in the us have higher social media usage than millennials in turkey. 0.101 us: 2.79 tr: 2.45 h3: millennials in the united states are less loyal to brands than millennials in turkey. 0.000 us: 4.83 tr: 4.01 h4: millennials in the united states are less riskaverse than millennials in turkey. 0.000 us: 5.38 tr: 4.68 54 journal of business strategies theoretical implications there are many studies about online shopping, social media usage, and comparing consumer behavior between emerging markets and developed countries. nevertheless, there is little research about the behavior and attitude of millennials. thus, this study enriches the existing literature and provides directions for further research. since particularly little is known about the differences in consumer behavior of millennials in terms of internet shopping satisfaction and social media use behavior, this study stands as a base for millennial consumer behavior and cross-cultural differences. it can be a starting point for the examination of internet shopping and social media usage in emerging markets and developed countries. according to some studies related to culture, countries with higher individualism, like the united states, exhibit more brand-switching behavior, less brand loyalty, and less risk avoidance compared to collectivist cultures like turkey (rajamma et al., 2010; lee & lim 2008; liu et al., 2001). however, the results of the study suggest that millennials in the united states are more brand loyal and risk-averse in comparison to millennials in turkey. a possible explanation might be found in socioeconomic factors, such as occupation, as well as political and economic conditions in the country (pitta & gurău, 2012). according to a study by pitta and gurău (2012), brand loyalty in millennial students is higher than it is in millennial professionals. from a socioeconomic perspective, the amount of disposable income may play a role on the relationship between a brand and a consumer. consumers in emerging markets, where the income level is lower, may search for branded products with discounted prices rather than establish brand loyalty (morgeson iii et al., 2015). therefore, socioeconomic factors have to be considered in studies related to millennials. millennials exhibit more brand-switching behavior and price consciousness in emerging markets than in developed countries. regarding risk aversion, the results show that turkish millennials are more prone to risk taking than us millennials. however, hofstede’s cultural dimensions suggest that individualistic cultures are more inclined to risk taking. the findings of this study may be best explained by the ongoing economic progress in turkey. particularly, the liberalization steps after 1983 resulted in growing gdp, employment and wealth. the millennials, who were born in early phases of the liberalization, had the chance of growing up in a politically and economically more stable, safe, and plentiful country. they did not even face the scarcity of convenience goods or poverty as their parents experienced. they wanted to achieve more than their parents due to their difficult economic and political conditions. hence, the improvements in volume 38 number 1 55 social, economic and political conditions make turkish millennials more confident about the future and eager to take the risk to get better opportunities. limitations and future research this cross-cultural study has some challenges. the main limitation of this research is the sample size. the sample size is not suitable enough to make generalizations regarding developed and emerging market consumers. it cannot also be treated as representative enough for the millennial populations of the two countries. sample characteristics is another limitation. while the us sample is comprised of mostly students, the turkish sample heavily consists of non-student consumers. due to the fact that the sample characteristics of this study are not homogeneous enough in terms of life stages of the consumers, future research may use samples from ems and developed countries that capture consumers from different educational, social, and economic backgrounds. another limitation of this research is only investigating the differences in consumer behavior of millennials. future research may focus on a comparison between millennials (gen y) and gen z consumers. the next limitation is the comparison between the united states and turkey. more than two countries could be compared in future research. this may provide a basis for better understanding the differences between the internet and/or social media usage, online buying, and post-purchase behavior of consumers of emerging markets and developed countries. it should be noted that millennials may not exhibit the cultural tendencies in the same way as reported by hofstede. furture research could be conducted to determine this possibility. if found, this could be an important contribution. also, future research may cover the underlying reasons for the variance in internet shopping behavior of consumers both in emerging economies and developed countries. in addition, future studies may focus on the effects of internet buying satisfaction and social media marketing on brand loyalty and contrast international differences. moreover, further research may investigate and compare the other aspects of postpurchase behavior as positive word-of-mouth or complaint behavior. 56 journal of business strategies references aboulnasr, k. & tran, g.a. (2020). is love really blind? the effect of emotional brand attachment on the perceived risk of really new products. journal of product & brand management, 29(1), 81-96. alhabash, s., hyojung, p., kononova, a., chian, y. & wise, k. (2012). exploring the motivation of facebook use in taiwan. cyberpsychology, behavior and social networking, 15(6), 304-311. arslan, i. k. & baycan, p. (2018). tüketici satınalma davranışları üzerinde sosyal medyanın etkisi: y kuşağı üzerine bir araştırma. i̇stanbul ticaret üniversitesi sosyal bilimler dergisi, 33, 269-286. bauman, m. j., velikova, n., dodd, t. & blankenship, t. (2019). generational differences in risk perception and situation uses of wine information sources. international journal of wine business research, 32(2), 247-265. bhattacharya, a., srivastava, m. & verma, s. (2019). customer experience in online shopping: a structural modeling approach. journal of global marketing, 32(1), 3-16. bolton, r., n., parasuraman, a., hoefnagels, a., migchels, n., kabadayi, s., gruber, t., komarova loureiro, y. & solent, d. (2013). understanding generation y and their use of social media: a review and research agenda. journal of service management, 24(3), 245-267. calder, b. j., phillips, l. w. & tybout, a. m. (1981). designing research for application. journal of consumer research, 8, 197-207. christodoulides, g. & michaelidou, n. (2010). shopping motives as antecedents of e-satisfaction and e-loyalty. journal of marketing management, 27(1-2), 181197. chudgar, s. (2013). forget gen y: baby boomers are the real entrepreneurial risk takers, inc. https://www.inc.com/sonya-chudgar/your-parents-may-be-betterentrepreneurs-than-you.html coşkun, m. (2019). marka bağlılığının tüketici satın alma davranışları üzerine etkisi: x ve y kuşaklarının cinsiyete göre karşılaştırmalı analizi. international journal of academic value studies, 5(2), 271-286. coussement, k., demoulin, n. & charry, k. (2016). marketing research with sas enterprise guide. routledge publishing. dimock, m. (2019). defining generations: where millennials end and generation z begins, pew research center, january 17, https://www.pewresearch.org/facttank/2019/01/17/where-millennials-end-and-generation-z-begins/. volume 38 number 1 57 donthu, n. & gilliland, d. (1996). observations: the infomercial shopper, journal of advertising research, 36, 69-77. donthu, n. & yoo, b. (1998). cultural influences on service quality expectations. journal of service research, 1, 178-185. durkin, d. (2008). youth movement. communication world, 25, 23-26. fong, j. & burton, s. (2008). a cross-cultural comparison of electronic word-ofmouth and country-of-origin effects. journal of business research, 61(3), 233242. gong, w., li, z.g. & stump, r.l. (2007). global internet use and access: cultural considerations. asia pacific journal of marketing and logistics,19(1), 57-74. göksel, a. & güneş, g. (2017). kuşaklar arası farklılaşma: x ve y kuşaklarının örgütsel sessizlik davranışı bağlamında analizi. gazi üniversitesi i̇ktisadi ve i̇dari bilimler fakültesi dergisi, 19(3), 807-828. harrington, m. (2015). millennials: the “risk-averse” generation? insights, june 8, https://www.td.org/insights/millennials-the-risk-averse-generation. hofstede insights (2020), https://www.hofstede-insights.com/country-comparison/ turkey,the-usa hofstede, g. (2011). dimensionalizing cultures: the hofstede model in context. online readings in psychology and culture, 2(1), 1-26. hofstede, g. & mccrae, r.r. (2004). personality and culture revisited: linking traits and dimensions of culture. cross-cultural research, 38(1), 52-88. hofstede, g., hofstede, g. j. & minkov, m. (2010). cultures and organizations: software of the mindm, 3rd edition. new york: mcgraw-hill. homburg, c., koschate, n. & hoyer, w. d. (2006). the role of cognition and affect in the formation of customer satisfaction: a dynamic perspective. journal of marketing, 70(3), 21-31. imf (2019). datamapper, world economic outlook, october, https://www.imf.org/ external/datamapper/lp@weo/oemdc/advec/weoworld. issa, t. & isaias, p. (2016). internet factors influencing generations y and z in australia and portugal: a practical study. information processing & management, 52(4), 592-617. kahraman, m. a. and dağlı, s. (2019), “marka algısı, müşteri memnuniyeti ve marka tercihi ilişkisinin x ve y kuşağına göre incelenmesi”, uluslararası ekonomi i̇şletme ve politika dergisi, 3(2), 381-398. khalifa, m. & liu, v. (2007). online consumer retention: contingent effects of online shopping habit and online shopping experience. european journal of information systems, 16(6), 780-792. 58 journal of business strategies khambata, d. & liu, w. w. (2005). cultural dimensions, risk aversion and corporate dividend policy. journal of asia-pacific business, 6(4), 31-43. kim, y., sohn, d. & choi, s. m. (2011). cultural differences in motivations for using social network sites: a comparative study of american and korean college students. computers in human , 27(1), 365-372. ko, h., jung, j., kim, j.y. & shim, s. w. (2004), cross-cultural differences in perceived risk of online shopping. journal of interactive advertising, 4(2), 2029. kocakuş, z. g. (2019). “kuşaklar bağlamında marka aşkının marka sadakatine etkisi: afyonkarahisar’da bir araştırma”, afyon kocatepe üniversitesi yayınlanmamış yüksek lisans tezi, https://acikerisim.aku.edu.tr/xmlui/ bitstream/handle/11630/7165/10271522.pdf korzeniowska, a. (2015). generation y on the e-commerce market: comparison between polish and south korean young consumers’ . journal of marketing and consumer behavior in emerging markets, 2(2), 33–48. kotler, p. & keller, k. l. (2006). marketing management, 12th edition. upper saddle river, new jersey: pearson prentice hall. kusek, k. (2016). the death of brand loyalty: cultural shifts mean it’s gone forever. forbes, july 25, https://www.forbes.com/sites/kathleenkusek/2016/07/25/thedeath-of-brand-loyalty-cultural-shifts-mean-its-gone-forever. lee, y. h. & lim, e. a. c. (2008). what’s funny and what’s not: the moderating role of cultural orientation in ad humor. journal of advertising, 37(2), 71-84. lichtenstein, d. r., netemeyer, r. d. & burton, s. (1990). distinguishing coupon proneness from value consciousness: an acquisition-transaction utility theory perspective. journal of marketing, 54(july), 54-67. liu, b. s., furrer, o. & sudharshan, d. (2001), “the relationships between culture and al intentions toward services. journal of service research, 4(2), 118-129. montana, p. j. & petit, f. (2008). motivating and managing generation x and y on the job while preparing for z: a market oriented approach. journal of business & economics research, 6(8), 35-40. morgeson iii, f. v., sharma, p. n. & hult, g. t. m. (2015). cross-national differences in consumer satisfaction: mobile services in emerging and developed markets. journal of international marketing, 23(2), 1-24. moskowitz, d. (2019). are millennials risk averse or risk takers? investopedia, june 25, https://www.investopedia.com/articles/investing/070815/are-millennialsrisk-averse-or-risk-takers.asp. volume 38 number 1 59 nagy, s. (2017). the impact of country of origin in mobile phone choice of generation y and z. journal of management and training for industries, 4(2), 16-28. novak, t. p., hoffman, d. l. & yung, y. (2000). measuring the customer experience in online environments: a structural modeling approach. marketing science, 19(1), 22–42. ndubisi, n.o., malhotra, n.k., ulas, d. & ndubisi, g.c. (2012). examining uncertainty avoidance, relationship quality, and customer loyalty in two cultures. journal of international consumer marketing, 24(5), 320-337. nunnally, j. c. (1978). psychometric theory. new york: mcgraw hill. onurlubaş, e. & öztürk, d. (2018). sosyal medya uygulamalarının y kuşağı satın alma davranışı üzerine etkisi: instagram örneği. opus international journal of society researches, 9(16), 984-1016. optinmonster (2020). online shopping statistics you need to know in 2020. https:// optinmonster.com/online-shopping-statistics/. pappas, i. o., pateli, a. g., giannakos, m. n. & chrissikopoulos, v. (2014). moderating effects of online shopping experience on customer satisfaction and repurchase intentions. international journal of retail & distribution management, 42(3), 187-204. pelet, j. & lecat, b. (2014). smartphones and wine consumers: a study of gen-y. international journal of wine business research, 26(3), 188-207. pitta, d. & gurău, c. (2012). a life-stage analysis of consumer loyalty profile: comparing generation x and millennial consumers. journal of consumer marketing, 29(2), 103-113. pookulangara, s. & koesler, k. (2011). cultural influence on consumers’ usage of social networks and its impact on online purchase intentions. journal of retailing and consumer services,18, 348-354. rajamma, r. k., pelton, l.e., hsu, m.k. & knight, d.k. (2010). the impact of consumers’ need for uniqueness and nationality on generation y’s retail patronage s: investigating american and taiwanese consumers. journal of global marketing, 23(5), 387-410. raju, p. s. (1980). optimum stimulation level: its relationship to personality, demographics, and exploratory . journal of consumer research, 7(december), 272-282. rapp, a., beitelspacher, l., grewal, d. & hughes, d. (2013). understanding social media effects across seller, retailer, and consumer interactions. journal of the academy of marketing science, 41(5), 547-566. 60 journal of business strategies reed, c. (2007). generation y research: what makes ‘y’ tick. brand strategy, february 5, 38. rose, s., clark, m., samouel, p. & hair, n. (2012). online customer experience in e-retailing: an empirical model of antecedents and outcomes. journal of retailing, 88(2), 308-322. shobeiri, s., mazaheri, e. & laroche, m. (2018). creating the right customer experience online: the influence of culture. journal of marketing communications, 24(3), 270-290. soares, a. m., farhangmehr, m. & shoham, a. (2007). hofstede’s dimensions of culture in international marketing studies. journal of business research, 60(3), 277-284. stafford, t. f., turan, a. & raisinghani, m. s. (2004). international and cross-cultural influences on online shopping. journal of global information technology management, 7(2), 70-87. statista (2020a). penetration of leading social networks in turkey as of 3rd quarter 2019, by platform. https://www.statista.com/statistics/284503/turkey-socialnetwork-penetration/. statista (2020b). most popular mobile social networking apps in the united states as of september 2019, by monthly users. https://www.statista.com/statistics/248074/ most-popular-us-social-networking-apps-ranked-by-audience/. t.c. kalkınma bakanlığı (2018). kamu bilgi ve iletişim teknolojileri yatırımları. http://www.bilgitoplumu.gov.tr/wp-content/uploads/2018/06/kamu_bit_ yatirimlari_2018.pdf. tyler, k. (2008). generation gaps. hr magazine, 53(1), 69-73. van der walt, f., jonck, p. & sobayeni, n. c. (2016). work ethics of different generational cohorts in south africa. african journal of business ethics, 10(1), 52-66. venkatesh, v., morris, m. g., davis, g. b. & davis, f. d. (2003). user acceptance of information technology: toward a unified view. mis quarterly, 27(3), 425-478. vogels, e. a. (2019). millennials stand out for their technology use, but older generations also embrace digital life. pew research center, september 9, https:// www.pewresearch.org/fact-tank/2019/09/09/us-generations-technology-use/. wang, y., wang, z., zhang, d. & zhang, r. (2019). discovering cultural differences in online consumer product reviews. journal of electronic commerce research, 20(3), 169-183. we are social (2020). digital in 2020. https://wearesocial.com/digital-2020. volume 38 number 1 61 wiedmer, t. (2015). generations do differ: best practices in leading traditionalists, boomers, and generations x, y, and z. the delta kappa gamma bulletin: international journal of professional educators, 82(1), 51-58. yoo, b. (2009). cross-national invariance of the effect of personal collectivistic orientation on brand loyalty and equity. the united states versus south korean consumers. asia pacific journal of marketing and logistics, 21(1), 41-57. zengin, a. y. & kumcu, e. h. (2018). green consciousness and intention to purchase green product: a comparison between generation y and z. conference paper, ibems-international congress of business economics and marketing, october 11-14, kiev. biographical sketch of authors timothy h. reisenwitz has a dba in marketing from cleveland state university, cleveland, ohio, usa, and is professor of marketing in the department of marketing & international business at valdosta state university, valdosta, georgia, usa. his work is published in several journals, including journal of consumer marketing, marketing management journal, journal of marketing education, marketing education review, and journal of business strategies. timothy h. reisenwitz is the corresponding author and can be contacted at treisenw@valdosta.edu. ilke kardes is currently an assistant professor of marketing & international business at valdosta state university. previously, dr. kardes taught classes in international business and served as research director at the center for international business and education research (ciber) at georgia state university. her academic career and abilities have been shaped in different cultures including united states, germany, and turkey during years. ilke is fluent in english, german, and turkish. asude yasemin zengin is an assistant professor in the health management department at aksaray university’s school of health sciences. she has publications on international marketing, social media marketing and consumer behavior also, has authored books on the export performance of emerging markets and integrated marketing communications. dr. zengin earned her master’s degree and doctorate from gazi university. she worked as a visiting scholar at georgia state university center for international business in the 2011-2012 academic calendar. mission statement content and firm diversification: a contingency approach rebecca j. morris university of nebraska at omaha omaha,ne introduction the starting point for most models of strategic management has been the creation of a mission statement (david, 1993; digman, 1990; hill & jones, 1992; thompson & strickland, 1992; etc.). the mission statement serves to set the organizational context within which strategic decisions will be made (hill & jones, 1992). as "an en· during statement of purpose that distinguishes one business from other similar firms" (pearce, 1982: 15), the mission statement is the "ultimate guiding force that governs where the firm's critical resources will be deployed" (boseman & phatak, 1989: 7). in its simplest form, the mission statement describes the nature and concept of the firm's future business. it establishes what the firm plans to do and for whom (below, morrisey & acomb, 1987). the mission statement answers the question "what is our business?" (drucker, 1973). in defining the business of the firm, its basic goals, characteristics and guiding philosophies, the mission statement provides the firm with strategic focus and direction (hill & jones, 1992). several models have been developed to suggest what elements should be contained in effective mission statements, but these models have typically failed to distinguish between elements necessary for single-business firms versus those for multi-business or diversified firms. should such a distinction exist? is the nature of the multi-business firm sufficiently distinct from that of a single business firm to warrant differences in the form of the mission statements? this paper addresses these questions through a review of the mission statement literature and an exploratory study of the missions of a random sample of fortune 500 firms. by contrasting the mission statements of single-product, dominant-product and diversified firms, this study was designed to provide guidelines for developing effective mission statements in a variety of strategic contexts. review of literature mission statement components although as steiner (1979) observed, the components and attributes of mission statements are among the least empirically understood issues in strategic management, previous theoretical and conceptual models of mission statements have been used to develop lists of desired components. for example, abell (1980) suggested that the question "what is our business?" could be answered in terms of three dimensions: (1) what customer groups are being satisfied; (2) what customer need is being satisfied; and (3) how are customer needs being satisfied. fall 1994 morris: content & firm diversification 159 want (1986) considered the primary components of the mission statement to be (1) purpose, (2) principle business aims, (3) corporate identity, (4) policies of the company, and (4) corporate values. kotler (1984) suggested that mission statements should be stated in terms of five key factors: (1) the firm's history, (2) current preferences of management and owners, (3) environmental considerations, (4) available resources, and (5) distinctive competencies. the scant empirical research regarding mission statements has utilized a list of eight key components of mission statements originally developed by pearce (1981). these components include: 1. the specification of target customers and markets. 2. the identification of principavproducts and services. 3. the specification of geographic domain. 4. the identification of core technologies. 5. the expression of commitment to survival, growth, and profitability. 6. the specification of key elements in the company philosophy. 7. the identification of the company self-concept. 8. the identification of the firm's desired public image. a ninth element, concern for employees, was later added to this list by david (1989). these nine elements appear to summarize many of the key concerns presented in alternative models of mission statement elements. empirical studies using these eight to nine elements have been conducted to examine the relationship of mission statement comprehensiveness (contains all elements) to firm performance (pearce & david, 1987), to contrast missions of consumer product firms with those of industrial product firms (david & cochran, 1987) and to study the communication effectiveness of mission statements (cochran & david, 1986). the assumption in these studies is that the "best" or most effective mission statement is one that contains all of the nine key elements (david, 1993, pg. 102). the results of the pearce and david (1987) study partially support this assumption. in their study of fortune 500 firms, they found that six of eight elements were more often associated with high performing firms (philosophy, self-concept, public image, geographic domain, technology and concern for survival). different strategic contexts while agreeing that mission statements may vary in length, content, format and specificity, most models of mission statement components do not discuss differences in mission statements for organizations in different strategic contexts. should the mission statement of a single-product firm contain the same elements as the mission for a highly diversified firm? campbell (1989: 7) asks the question "how diversified can a group of companies (businesses) be before it becomes impossible to have a shared sense of mission?" he further indicates that based on his consultations with many companies that it is possible to create a single mission statement for a multi-business company only so long as the level of diversity remains low. mission statements may not be appropriate when the company is a diversified conglomerate or holding company according to klemm, sanderson and luffman (1991).1 160 journal ofbusiness strategies vol. 11, no.2 in strategy formulation, differences in organizational context are thought to be significant enough to require the creation of a strategy hierarchy with separate levels of strategy to deal with corporate concerns versus those of the business level. some mission statement models have made this distinction as well. hill and jones (1992) provide a separate list of mission statement components for diversified companies. because the business of a diversified company is the management of a collection of businesses, the question "what is our business?" must be answered with a portfolio orientation. a portfolio approach to business definition in the mission statement should include: (1) the purpose of the company's portfolio of businesses, (2) the desired scope (diversity) of the portfolio, and (3) the balance desired between different businesses in the portfolio (hill & jones, 1992). the firm's corporate mission is then supplemented with the mission statements of each business unit. business unit missions follow the formats outlined in the previous section. wright, pringle and kroll (1992) distinguish between the mission at the corporate level and at the business unit level without providing much guidance as to what the mission should contain at each level. missions at the corporate level should be stated in fairly broad terms while still providing a sense of direction for the company. at the business level, the mission becomes more clearly defined and narrower in scope. similarly, david (1993) advocates a hierarchy of missions for the multidivisional organization with an overall corporate mission statement and a separate statement for each of its divisions. despite pearce and david's (1987) identification of this area as a "more intriguing question" for future research, previous empirical investigations have not considered the level of diversification in analysis of mission statements and their relationship to firm financial performance. if the differences in effective mission statements of diversified firms are as pronounced as suggested in the theoretical literature, failure to control for these differences in the research design may confound empirical research. the need for research in this area is apparent when considering the importance of an effective mission statement to the successful pursuit of a diversification strategy. ireland and hitt (1992) suggest that the lack of an effective mission statement may be a contributing factor in the high rate of divestitures occurring in large diversified firms especially when diversification is beyond the firm's original scope of operations. michael porter's (1987) study of the diversification record of 33 large u.s. firms, supports the notion that diversifications are more successful when firms have a clear concept of the strategic focus of their corporate strategy. because mission statements serve as a defining framework for evaluating both current and prospective activities (mcginnis, 1981) and provide strategic focus, an effective corporate mission statement serves a critical role in guiding the firm's choices of business units in pursuing diversification. as ramanujam and varadarajan (1989) point out in their comprehensive review of research on corporate diversification, the investigation of the relationship of firm diversification to performance and internal organizational processes has long been a mainstay of strategic management research. palia, hitt, ireland and godiwalla (1982) fall 1994 morris: content & firm diversification 161 identify diversification as one of six key contingency variables which explains differences in the way top managers prioritize strategic organizational functions. their findings indicate that managers of firms of differing levels of diversification consider different organizational functions to be strategically significant in the implementation of their grand corporate strategies. if there are differences in managers' perceptions of the strategic significance of functions such as marketing, production, finance, and public and government relations to the attainment of their chosen strategies, it follows that the mission statements should reflect these differences in prioritization. it is in this environment that an exploratory study was conducted to.compare the mission statements of firms at differing levels of corporate diversity. it was hypothesized that the mission statements of firms at differing levels of diversification would contain a different mix of the nine key elements of mission statements derived from the literature. although the mission statement literature has provided little guidance as to how the mix of elements in mission statements might differ, the work of palia et a1. (1982) suggests that differences might be expected in the emphasis on technology and public image components. in their study, managers of diversified firms placed different levels of importance on research and development and engineering functions which are encompassed in the technology mission element. the managers of more diversified firms considered technology factors to be of greater strategic importance than managers of less diversified firms, thus suggesting that diversified firms would be more likely to include a technology component in their mission statements than less diversified firms. managers of diversified firms also considered public and government relations to be more strategically important to their firm's success than managers of less diversified firms. this suggests that diversified firms may be more likely to address public image issues in their mission statements than less diversified firms. in the palia et a1. study (1982), no statistical difference was observed by level of corporate diversity in the managers perceptions of the strategic importance of organizational functions that correspond to mission elements such as products, customers, geographic domain, employees and corporate philosophy. the previously cited relationship of effective mission statements to the success of diversification strategies suggested a need to investigate the connection between firm financial performance and mission statement content. the current study was designed to examine the relationship between mission statement content and firm financial performance at different levels of firm diversification as part of the effort to provide empirical support for the linkage between strategic planning and corporate performance. in keeping with pearce and david's (1987) call for further research to determine the characteristic strategic contexts when specific mission components are most desirable, the present study addresses the following research questions: 1) does the mix of mission statement components differ in the mission statements of firms at differing levels of diversification? 2) how do the mission statements of diversified firms differ from less diversified firms? for example, are certain mission statement elements (such as technology and public image) more frequently found in the missions of more diversified firms than those of less diversified firms? 162 journal ofbusiness strategies vol 11, no.2 3) for firms pursuing different levels of corporate diversity, are there differences in the mix of mission statement components associated with superior corporate financial performance? methodology annual reports as noted in previous empirical studies of mission statements, many companies do not have formal mission statements. cochran and david (1986) found that 40.4% of the 218 fortune 500 firms responding to their request had no mission statement. lack of a formal mission statement document should not be interpreted as the firm's failure to consider its mission, purpose or reason for existence. individuals within the firm may have a clear idea of its mission without creating a formal mission document. a sense of a corporation's mission may be contained in the annual report (david, 1993; smith, arnold & bizell, 1991). in particular, the letter to shareholders section serves as a good indicator of the major topics attended to by organizational managers (watzlawick, beavin & jackson, 1967; bradley & baird, 1977) and may provide insight into the firm's values and beliefs (d'aveni & macmillan, 1990). if the firm included its mission statement in the letter to the shareholders as did 52 of the 141 firms (37%), the mission statement was included in the analysis for this study. sample a random sample of letters to shareholders for fortune 500 firms was extracted from the compustat corporate text cd-rom database for 1990. only those firms which are publicly held are included in the compustat database. the final sample included 144 firms representing a wide variety of industries. the sample firms represented approximately half of the fortune 500 firms available on the cd-rom for 1990. missing data further reduced the sample to 141 firms. the sample included firms with 37 two-digit sic classifications and 55 three-digit sic classifications, thus representing 37 of the 100 major sic industry classifications. average sales for the sample firms were $9.4 billion in 1988 with a standard deviation of $15.3 million, $10.0 billion (std. dev.=$18.6 million) in 1989, and $9.0 billion (std. dev.=$16.3 million) in 1990. firm size ranged from 771 employees to 1,211,900 employees. the average number of employees was 57,312 (std. dev.= 137,203). average return on equity for the sample firms was 12.61% in 1988 (std. dev.=.2548), 4.8% in 1989 (std. dev. =. 6670), and 6.27% in 1990 (std. dev.=.6751). the letters to the shareholders were supplemented with financial and sic information extracted from the disclosure cd-rom for the same time period. because the sample included a mixture of mission statements and letters to shareholders, analysis of variance (anova) was used to determine if there was any difference in the inclusion of the mission elements that could be attributed to differences in the type of document analyzed. no significant difference was detected in the inclusion of the mission elements due to the type of document analyzed. therefore, the remainder of the analysis does not make any distinction with regard to the original source of the mission information. fall 1994 morris: content & firm diversification 163 measurement of variables level of diversification. the extent of corporate diversity is defined according to guidelines proposed by rumelt (1974) as follows: 1. a single-product firm is defined as a firm whose primary commitment is to a single business (wrigley, 1970). more specifically, this is a firm that derives 95% or more of its revenues from a single product-market activity. 2. a dominant product firm has a primary commitment to a single business but has diversified to a small degree. firms are classified as dominant product firms if the revenues due to a single product-market activity are between 70%-94% of total revenues. 3. in diversified firms, less than 70% of the revenues are derived from anyone product-market activity. diversified firms are further classified as related or unrelated. a. a related diversified firm has diversified into new areas related to the primary end-product by market or technology. b. an unrelated diversified firm has diversified into new areas without regard to market or technology relationships to the primary product. the operationalization of these definitions is depicted in figure the first two steps of the classification of the level of diversification of each firm as depicted in figure 1 were accomplished by using sic codes as reported in the disclosure database. according to the manual accompanying disclosure, additional sic codes are not assigned to a firm unless the additional product/market activity accounts for a minimum of 10% of total revenues. the 10% figure is based on the requirements for industry segment reporting outlined in fasb-14.2 therefore, a firm that is assigned only one sic code has a specialization ratio of 90%, thus indicating that 90% or more of its revenues coming from that line of business. a firm with two sic codes derives at least 10% of its revenues from its secondary line of business and less than 90% from its primary line. firms with three or more sic codes derive less than 70% of their revenues from the primary line of business and are classified as diversified firms. use of the sic code in classifying single and dominant product firms resulted in a broadening of the single-product category to encompass all firms with revenues of 90% or more from a single product/market activity. normally, firms deriving between 5% and 10% of their revenues from a secondary product/market activity should be classified as dominant product firms (rumelt, 1974). however, the sic classification method does not permit this distinction and classifies these firms instead as single-product firms. it was thought that this problem would affect very few firms and would not distort the subsequent analysis. use of sic codes in classifying firm diversification closely approximates the method used by rumelt (1974) which was later validated in chatterjee and blocher (1992).3 164 journal ofbusiness strategies figure 1 classification process for level of diversification using sic codes and nature of diversification unclassified firms vol. 11, no.2 single-product business s1o=0.90* dominant product business sr>= 0.70 umelated product diversification business sr<0.70, rr<0.70 no is "" sic> 1? yes no is ii( sic> 31 yes no is related "" ratio> .70? related diversification business sr<0.70, rr>.70 *sr represents specialization ratio or the firm's revenue attributable to its largest product-market activity (rumelt, 1974) rr represents related ratio or the proportion of each firm's revenue coming from its largest group of related businesses. based on palia, hitt, ireland and godiwalla (1982) classification of the nature of diversification (either related or unrelated) was accomplished using the method outlined in rumelt (1974) and montgomery (1982). the related ratio, or the proportion of each firm's revenue coming from its largest group of related businesses was calculated using the line-of-business data reported in lo-k filings (chatterjee & blocher, 1992). as shown in figure 1, firms with related ratios of 70% or greater were considered related diversification firms (rumelt, 1974). firms with related ratios of less than 70% were classified as unrelated diversifications. fall 1994 morris: content & firm diversification 165 although there has been some criticism of the use of categorical measures of diversification such as the rumelt approach rather than continuous measures (see chatterjee & blocher, 1992), the rumelt approach has been shown to be more effective in investigations of the relationships between diversification and firm-specific managerial variables (montgomery; 1982). as this study attempts to detect differences in the rate of inclusion of various mission statement components for firms at different levels of diversification, the rumelt approach appears better suited to the research design than continuous measures. no statistical difference was observed in the size of the firms classified in each of the four diversification levels. analysis of variance of firm size as measured by sales for 1988, 1989, 1990 or the number of employees indicated that any differences observed in the later analysis was not due to differences in the firm size but due to the level of diversification. mission elements. computerized content analysis was used to evaluate each of the annual reports to determine whether the nine mission elements were included. content analysis is a qualitative research technique that uses a set of procedures to classify or categorize communications to permit valid inferences to be drawn (weber, 1990). the approach used in this study applies computer technology to replicate the research approaches used by cochran and david (1986), pearce and david (1987) and david (1989). the advantage of computerization of the content analysis process is that given a valid set of classification rules, the computer will classify the text quickly and reliably thus permitting an examination of larger volumes of qualitative data at lower cost (gephart & wolfe, 1989; weber, 1990). for each of the nine mission elements, a list of key words and phrases were developed from a review of the mission statement literature and many actual corporate mission statements (excluding those used in this study). the key words were then entered as search commands in the text management software chosen to perform the content analysis. the ability of the key words to represent the mission element was tested by requesting the computer to apply them to a sample of mission statements (again not those used in this study). the computer recorded a "hit" or a match each time a key word or phrase was found within the mission statement. a listing of all mission statements containing the key words was displayed for further analysis. each mission statement could be displayed with the key words highlighted in context. this capability proved important in refining the key word lists for each mission element by permitting the programmer/author to examine whether the key words were operating consistently with the conceptual definition of each element. an iterative process of defining the key words, testing them on sample mission statements and refining the key words was used to improve the content analysis capabilities. the content analysis approach via computer was validated by analyzing the mission statements contained in david (1991) and comparing the computerized results to those obtained by independent judges. the judges were six graduating mba students who had completed the capstone course in strategic management/business policy. the students were given the pearce and david article (1987) outlining the evaluation 166 journal ofbusiness strategies table 1 vol. 11, no.2 validation of computerized content analysis with compansion to coding by a panel of six mba students compariston of coefficient of concordance for mission computerized elements coded by mbs students analysis vs. mba student analysis pearson mission kendall'sw chi-square correlation element coeficients customer .5722 20.6000** .7303* products .5298 19.0714** .6455* geographic domain .7813 28.1250*** .7303* technology .4400 15.8400** .7500* survival, growth .5161 18.5806** .5477* & profitabiltiy company philosophy .3016 10.8570** -.0167 selfimage .5179 18.6429** .6455* public image .5402 19.4483** 1.0000*** * p<.lo ** p<.05 *** p<.ool criteria and a packet of the word-processed mission statements. they were instructed to read the article and to independently score each mission statement using the same criteria and procedures as in the article. the instructions further required students to read and complete their evaluation of each mission statement before proceeding to the next. they were also asked not to discuss their evaluations with any of the other students participating in the project. the mission statements were sorted randomly in the packets to avoid any biases due to the order in which they were evaluated. kendall's w (coefficient of concordance) was run to show the extent to which the six coders agreed on the evaluation of the mission statements. kendall's w for each mission element is shown in table 1. fall 1994 morris: content & firm diversification 167 the coefficients of concordance ranged from a low of w = .3016 for the company philosophy mission element to a high of w = .7813 for the geographic domain mission element. the chi-square statistic was statistically significant at the .01 level or better for six of the eight mission elements. the chi-square for the technology element was significant at the .05 level while the chi-square for the company philosophy element was moderately significant at the .10 level. statistically significant chi-squares indicate a high level of agreement between coders on the evaluation of each of the elements of the mission statements. for the remainder of the analysis, the evaluations of the student coders were aggregated according to a procedure used in d'aveni and macmillan (1990), david (1989b), david and cochran (1986) and pearce and david (1987). mission statements were coded as containing an element if at least four of the six coders indicated that the statement referred to that specific element. pearson correlation coefficients comparing the results of the computerized analysis of the mission statements with those obtained by the panel of six mba students are presented in the fourth column of table 1. as indicated by the significant and positive correlation coefficients, the two methods of content analysis reached substantially the same conclusions for the customer, products, geographic domain, technology, survival, self image and public image mission elements thus validating the computerized approach. only the score for the company philosophy element was not significantly related between the computerized and human coding methodologies. despite additional iterations of the development and testing process, development of a key word list which adequately represented the intent of the company philosophy element proved elusive. the company philosophy element was omitted from subsequent analyses due to the problems in the content analysis of this element.4 the computerized content analysis approach was utilized in all subsequent coding of company documents. performance measures. due to the desire to produce results which could be directly compared with those of pearce and david (1987), each firm's profit margin was used. in addition, financial performance measures such as return on assets (roa) and return on equity (roe) were included in the study. measures for profit margin, roa and roe for the years 1988, 1989 and 1990 were used to eliminate biases intro~ duced by temporary aberrations in fmancial performance. none of these variables were averaged in the subsequent analysis, but were treated as multiple dependent variables in the manova analysis. separate manova analyses were independently completed for each group of performance variables, thus permitting an examination of differences in the results due to differences in the performance variables themselves. the details of the manova analyses will be explained in a later section. summary of study variables. each firm in the sample was classified into one of the following four levels of diversification according to the method described earlier: single product firms, dominant product firms, related diversified firms, or unrelated diversified firms. the annual reports of the firms were examined via computerized content analysis for the presence or absence of eight attributes associated with mission statements. these attributes or elements included: customers, products, geotahlp 1· tntl"r_itl<'.m : "or ~ttrnv vartft'lu 1:'l;1 v.a ih a'iu f rust prod (teo tfc'h stir v sftf prtr emp mv pmrr pmrq pmqn roarr roarq roaqn rofrr rofrq roeqn mission variable: customer 1.0000 product .6864 1.0000 ••• geo. .5132 .6251 1.0000 ••• ••• technolgy .7271 .6225 .7317 1.0000 ••• ••• ••• survival, .5519 .3605 .3281 .4051 1.0000 igrowth ••• • •• ••• ••• self-image .5900 .6489 .6206 .7346 .5736 1.000< ••• ••• ••• ••• ••• public .2205 .2822 .1982 .0711 .4148 .4191 1.0000 imue • •• • ••• ••• employees .2766 .2073 .2510 .0735 .2651 .2743 .1653 1.0000 •• • • • • level of .0335 .0799 .1303 .3658 .1194 .2308 .0550 .2392 1.0000.. ••• ••• •• profit margin -.0203 -.0541 .0146 .2796 -.0549 -.0277 -.0443 .0120 -.0236 1.0000 1qrr •• profit margin -.0457 -.099..: .0007 .2511 -.0452 -.0508 -.0366 -.0008 -.ql05 .9333 ~.oooo 1qrq • ••• profit margin -.0148 -.0715 .0158 .2845 -.0270 -.0267 -.0194 .0011 -.0069 .9208 .9554 1.0000 1qqn ••• ••• ••• roa 1988 -.0868 -.0081 .0559 -.0829 .0257 0302 .1187 .0299 .0924 -.0683 -.0354 .0102 1.0000 roa 1989 -.1169 -.0743 -.0319 -.1371 -.0169 -.0630 .1189 .0083 .0181 -.0691 -.0354 -.0213 .8627 1.0000 ••• roa 1990 -.0625 -.0476 -.1309 -.1825 -.0542 -.0608 .0271 -.0318 .0015 -.1283 -.1439 -.1475 .4390 .5027 1.0000 • • ••• ••• roe 1988 .0813 .0928 -.0093 -.2800 .0172 -.1094 -.0235 -.0223 -.1469 -.0784 -.0606 -.0323 .0675 -.0226 .0945 1.0000 •• • roe 1989 -.0915 -.0446 -.0071 .1654 .0341 -.0176 .0902 .1166 -.0060 -.0337 -.0301 .0417 .2728 .1586 .1303 -.1311 1.0000 ••• • roe 1990 -.0379 .0209 .0008 -.0930 -.0343 .0192 -.0892 .1263 .0585 .0150 .0158 .0095 .3704 .1834 .3732 -.0721 .3800 1.0000 ••• •• ••• • •• • p< .10, .. p< .05, ••• p< .01 • for mission variables, a mean value of 1.00 indicates that all firms included this element in their mission statements. level of diversification was coded 8s l=single-product firm, 2=dominant product firm, 3=related diversification, 4-unrelated diversification. ~ 0\ 00 ~ ~ l:l~ b:l ~ ~. t'.i..... ~ ~ ~ ~. ~ r-,... r ~ tv fall 1994 morris: content & firm diversification 169 graphic domain, technology, concern for survival, self-concept, public image and employees. finally, to pennit the examination of the relationship of mission statement components to financial performance, profit margins, roas and roes for three years were included in the data set. the means, standard deviations and inter-correlation matrix are provided as table 2. discussion of findings analysis of variance was used to determine if there were differences in the mix of elements included in the mission statements of firms following different diversification strategies, thus addressing the issues presented in the first research question. means and standard deviations for each mission element are shown for the four levels of diversification (single, dominant, related and unrelated) in table 3. a series of one-way analyses of variances were run to determine if significant differences existed in the inclusion of each of the mission elements by level of diversification. significant differences (at the .05 level or better) between the four levels of diversification were found for the customer, technology, and self-image mission elements. the concern for employees mission element was marginally significant at the p < .10 level. no significant difference was observed in the other four mission elements. table 3 means, standard deviations and sample size for firm by level of diversification single dominant related unrelated product product diversified diversified mission element firms firms firms firms customers .8462' .7500 .6944 .7778 (.4249) (.4376) (.4672) (.4278) products .8974 .8333 .8889 .9444 (.3268) (.3766) (.3187) (.2357) geographic .8305 .8125 .8056 .9444 domain (.3888) (.3944) (.4014) (.2357) technology .3077 .2500 .4444 .6111 (.4676) (.4376) (.5040) (.5016) survival, growth .7692 .8333 .7500 .8889 & profitability (.4268) (.3766) (.4392) (.3234) self-image .9231 .8958 .9167 .9444 (.2700) (.3087) (.2803) (.2357) public image .6.154 .7083 .4722 .6667 (.4929) (.4593) (.5063) (.4851) employees .4615 .3958 .5278 .6667 (.5050) (.4942) (.5063) (.4851) n 39 48 36 18 • mean values and standard diviations in parenthesis. a mean of 1.000 indicates that all firms in the cell included this element in their mission statements 170 journal ofbusiness strategies vol. 11, no.2 when significant differences in the inclusion of the mission elements by level of diversification were indicated in the one-way analysis of variance, the scheffe multiple comparison test was run to pinpoint the differences between groups. of the multiple comparison tests, the scheffe method provides for the most conservative comparison of means (keppel, 1982). this analysis was performed to address the issues presented by the second research question which sought an explanation of how the mission statements of more diversified firms differed from those of less diversified firms. customers. for the customers mission element, the scheffe test indicated that the mean rate of inclusion for the related diversification firms was significantly different (at p < .05) from the means for the single-product and unrelated diversification firms. both the single-product and unrelated diversification turns were more likely to include a discussion of the firm's target customers than the firms following a related diversification strategy. the finding for single-product firms is not surprising. one would expect that because single product firms are obtaining the largest percentage of their revenues from a single product/market activity, specification of target customers would be an important part of defining the strategic focus for single-product firms. however, the fmding that unrelated diversified rums were more likely to include a discussion of target customers in their missions than firms following a related diversification strategy is somewhat counter-intuitive. one might expect that the more diversified a firm becomes and the more unrelated the diversification, the more difficult it would become to defme exactly who the customers of the firm are. for firms following an unrelated diversification strategy, specification of target customers may be a means for effectively elaborating the various business interests of the firms. rather than serving as a unifying element of the mission, unrelated diversified firms may use descriptions of the fums target customers to describe the diversity of its mission. products or services. no statistical difference was found in the rate of inclusion of a statement of products or services in the missions of firms at different levels of diversification. in fact, at least half of the firms in each diversification category included this component in their missions. the mean for the unrelated diversification firms was greater than the mean for any other level of diversification but not significantly so. these findings support pearce's claim that description of the company's basic products or services is an indispensable component of the mission statement (pearce, 1982: 17). the significance of the products element for all firms is also demonstrated by the importance of the products a fum makes to its corporate identity with outsiders such as investors and competitors. geographic domain. specification of a rum's geographic domain in the mission statement was also expected to differ at different levels of diversification, with unrelated diversification firms less likely to include a description of their target geographic markets. as the rum becomes more diversified, different geographic domains may apply to each of the firm's different product/market divisions. as the number of different geographic domains served by the various divisions of a firm increased, the expectation was that the firm would be less likely to include this element in its misfall 1994 morris: content & firm diversification 171 sion statement due to the complexities it posed. however, no significant difference was observed in the geographic domain means between diversification levels. in fact, firms at all levels of diversification were more likely to include a description of geographic domain in their mission statements than other mission elements such as technology, public image and employees. this may be due in part to the increased emphasis on international business in the 1990's. firms that were doing business internationally may have felt it beneficial to identify their geographic markets. technology. inclusion of the technology element was expected to vary with different levels of diversification. more diversified firms were expected to have difficulties in describing the various technologies utilized, especially as they began to diversify in unrelated areas. the scheffe results indicate just the opposite. no significant difference was observed in the mean rate of inclusion of the technology component for the single-product, dominant product or related diversification firms. the rate of inclusion of the technology element in unrelated diversification firms was significantly greater than for all other levels of diversification. as found in pearce and david (1987), the technology element was less frequently included in the mission statements than the other mission elements. however, the tendency of unrelated diversification firms in this sample to more frequently include the technology element than firms with lower levels of diversification contradicts the rationale given in pearce and david (1987). responses to their follow-up questions indicated that many firms did not incorporate the technology element in their missions due to the impossibility of describing the diverse technologies on which the firm's multiple products depended. a possible explanation may be that in seeking to provide a sense of unified purpose, firms following an unrelated diversification strategy are more likely to find the common thread through similarities in technology than through products or customers. thus, although classified as unrelated diversified firms using the more product-oriented definition based on specialization ratios and related ratios, the firms may have technological processes in common and emphasize them in their missions. this makes some sense especially in light of pearce's (1991) assertion that the products, geographic domain and technology components were indispensable in describing a firm's business activity. if unrelated diversified firms do not have commonalties in their products or primary markets, relationships (however slight) between the technologies of divisions may be the only way to provide a common focal point for future strategies. commitment to survival, growth & profitability. since survival, growth and profitability are mainstay goals of almost every business organization (pearce, 1991), the level and type of diversification were not expected to influence the inclusion or exclusion of this element from a firm's mission. no difference in commitment to survival, growth and profitability was predicted for firms at different levels of diversification. the results of the one-way analysis of variance supported this prediction. all rums were equally likely to include language expressing their commitment to the firm's continued survival, growth and profitability in the letters to the stockholders. although the mean rate of inclusion for this element appears greater for unrelated diversifications, the difference in means was not significant. 172 journal ofbusiness strategies vol. 11, no.2 self-image. a finn's self-image reflects a self-assessment of competitive strengths and weaknesses. the ability of a firm to perfonn a realistic self-diagnosis is crucial to finn success regardless of its complexity due to diversification. however, significant differences were observed between finns at different levels of diversification when referring to the self-image mission element. the scheffe test indicated a significant difference in the mean rate of inclusion of the element between the unrelated diversification finns and the dominant product or related diversification firms. the mean for the single-product finns was not significantly different from those of firms employing different diversification strategies. finns following an unrelated diversification strategy were more likely to include statements identifying their competitive strengths and weaknesses (their self-image) than finns following either related diversification or dominant-product strategies. one possible explanation for this seemingly contradictory finding may be that unrelated diversified finns may be trying to compensate for the supposed disadvantages of the "unrelatedness" of their businesses by explicitly stating and drawing attention to their competitive strengths. current trends toward related diversification as a superior strategy tend to support this explanation. public image. the public image mission element addresses the qualities which are attributed to the finn by customers, suppliers, creditors and other external entities. inclusion of a firm's desired public image in its mission provides outsiders with a statement of the firm's future intentions to remain true to those qualities the public has come to associate with the firm. it was expected that all finns would express their desired public image in their mission statements and that this expression would not differ with regard to the level of diversification. this prediction was supported by the one-way analysis of variance. no significant difference in the rate of inclusion of the public image element was observed for the different levels of diversification. although all firms were equally likely to include this element, concern for public image was included less frequently than many of the other mission elements. only 24% of the 141 finns in this study included this element in their mission statements while 87% of pearce and david's (1987) firms expressed their desired public image. the smaller percentage of firms including public image in this study may be due to differences in environmental stresses encountered by the firms at the time the samples were collected for this study and the pearce and david (1987) study. during times when corporate legitimacy and responsibility is challenged by outsiders, finns may be compelled to include more public image verbiage to reemphasize or stress the firm's beneficial aspects. concern for employees. the concern for employees mission element recognizes the employees of the finn as valuable assets instrumental to achievement of organizational goals. this recognition appears to be equally important to all firms whether they are single-product or diversified finns. this prediction was not supported by the results of the one-way analysis of variance or the scheff6 multiple comparisons procedure. finns that followed an unrelated diversification strategy were more likely to fall 1994 morris: content & firm diversification 173 include a discussion of the importance of employees than single-product firms. only 5% of the single-product firms included a discussion of employees while almost 28% of the unrelated diversification firms discussed the importance of employees to firm goal attainment. the inclusion percentages appear to be the reverse of what one would expect although unrelated diversification firms might view concern for employees as a potential rallying point for unifying their diverse interests. by emphasizing a commitment to value the employees and their contributions to the firm, the unrelated diversification firm may be trying to motivate and inspire employees to achieve corporate goals. in addressing the third research question, multivariate analysis of variance (manova) was used to examine the relationship of the mission statement elements to level of diversification and firm financial performance. manova is used to assess the statistical significance of differences between groups across multiple dependent variables simultaneously. manova provides better statistical control over the experiment-wide error rate than use of separate univariate anovas as well as a more powerful examination of differences in group means of the multiple dependent variables (hair, anderson, tatham & black, 1992). three separate dependent variables sets were evaluated in separate manovas: profit margins for 1988-1990, roas for 1988-1990 and roes for 1988-1990.5 a series of manovas were run using one of the performance variable sets as the dependent variables and each mission statement element and the four levels of diversification as the independent variables. this resulted in a 2 x 4 design for each mission element: the mission element was included or not included in the firm's letter to shareholders and the firm was either a single-product, dominant-product, related diversified or unrelated diversified firm. since a requirement of manova is that the dependent variables included in the analysis be correlated, the appropriateness of the multivariate technique was tested by bartlett's test of sphericity (cooley & lohnes, 1971). the test was significant at p < .001 for· all three performance variable sets thus indicating that manova is appropriate for analyzing the data. although all of the eight cells in the research design contained firms, the ns in the cells were unequal. as a result, a or approach was used in the manova model. the or approach is used in unbalanced manova designs to eliminate the confounding influence of other factors when testing each effect. the or approach in spss-x estimates parameters using householder transformations to effect an orthogonal decomposition of the design matrix. table 4 shows the results of the manovas of the three performance measure vectors by each of the eight mission elements and the level of diversification. significant interactions between the mission element (m) and level of diversification (d) (interaction represented by m x d), were observed for the customer, geographic domain, survival, self-image and public image mission elements. no significant interactions or main effects were observed for the products and employees mission elements. a significant overall main effect was found for the technology mission element. the presence of significant interaction terms indicate that for at least some of the mission table 4 f -ratio and level of significance for manova main effects and interaction terms (1) i-" ~ examination of differences in the relationship of mission element inclusion to financial performance source of variation customers products geographic technology survival, selfpublic employees performance variables domain growth & image image profitabiltiy mission element (m) profit margin 1988-1990 5.29221*** 1.14176 1.78432 2.26839* 1.55455 1.65435 .18609 1.49419 ~ roa 1988-1990 2.39621* .26915 .60946 .25399 1.32416 .05014 .54165 .16377 r::: roe 1988-1990 2.70647* .35680 .09198 1.98698 1.65725 .48705 1.60490 .40806 ~i:llevel of ~ diversification (d) b:l ~ profit margin 1.97751" .74927 1.83181* .90844 2.43930*** 2.29522" 1.09792 1.04507 s· roa 1988-1990 2.16938** .37145 .78105 .32322 1.98761** .70893 1.14157 .49104 ~ roe 1988-1990 1.62905* .84528 .44891 1.15559 .65576 .23299 1.34852 1.43201 t-.l t'=i.... m x d interaction ~.... profit margin 1988·1990 2.82035*" 1.19006 1.75882* .41453 2.10264" 3.25708"* 1.24155 .41319 ~-. roa 1988-1990 2.60669*" .46084 .66896 .74691 2.14997" .64045 1.96014" .89370 ~ roe 1988-1990 1.35020 .50447 .25336 .74340 .64144 .26752 1.32177 1.28594 df 3,128 3,128 3,128 3,128 3,128 3,128 3,128 3,128 ................................. significance levels denoted as: * p<.l0 .. p<.05 <: *.. p<.ol 12(1) each column of the table represents a separate manova analysis with dependent variables of three years of the performance variables. (profit margin, roa, i-"r roe). independent variables were the mission element (either present or absent) and the level of diversification (single-product, dominant product, related ~diversification, unrelated diversification). n fall 1994 morris: content & firm diversification 175 elements, the inclusion or exclusion of the element in the mission was contingent upon the firm's level of diversification and financial performance. this finding lends support to the argument against universal mission content regardless of strategic context. the nature of the interactions may be interpreted through multivariate tests of simple effects (bray & maxwell, 1990). a second set of manovas was conducted for the five mission elements with significant interaction terms. in these manovas, the dependent variables were again the three measures of profit margin 1988-1990, roa 1988-1990 or roe 1988-1990. the independent variable was the mission element to be analyzed (either included or excluded). an independent manova was conducted for each level of diversification. the univariate and multivariate results of these analyses are summarized in tables 5 through 7. by conducting an independent manova of each mission element by each level of diversification, the mission element effects can be analyzed and interpreted in the context of the interactive effects of the level of diversification factor. for the customer mission element, significant multivariate effects are observed for single-product and unrelated diversified firms when profit margin or roa was used as the dependent variables (table 5). no significant multivariate or univariate results were observed for dominant product. a significant univariate result was observed for related diversified firms when the roa for 1988 was the dependent variable. with this exception, for firms following a dominant product or related diversification strategy, the inclusion or exclusion of the customer element in the firm's mission did not have an effect on the firm's financial performance. an examination of the univariate f-ratios for single-product firms reveals that while the inclusion of the customer element has a significant effect on the multivariate profit margin measure, no significant difference is observed for the univariate profit margin measures. the profit margin means for each year are not significantly different between single-product firms that included or did not include the customer element in their mission. when roa is considered, single-product firms including the customer element in their missions earned a significantly higher roa in 1988 than firms who did not discuss customers in their mission. single-product firms that included the customer element in their missions earned an average roa of 3.7% in 1988 (sid dev=.069) as compared to an average roa of -8.5% (std dev=.320) for single-product firms that did not mention their customers. no statistical difference was observed in the roas for 1989 and 1990 of single-product firms regardless of whether the customer element was included. although focus on customers seems consistent with superior financial performance, it is difficult to determine a specific explanation for the 1988 results without additional information regarding economic and other environmental conditions of that time period. an increased customer orientation for single-product firms in this sample appears to have been favored by industry and general environmental conditions prevalent in 1988. for related diversified firms in 1988, a moderately significant f-ratio was observed for the relationship between inclusion of the customer element and firm performance tables summary of importance of customer mission element multivariate and univariate analysis of variance, means and standard deviations by level of diversification single dominant related unrelated product firms product firms diversified firms diversified firms f-ratio f-ratio f-ratio f-ratio & customers & customers & customer & customer performance signif. not custome signif. not customer signif. not custome signif. not customer variables levels included included levels included included levies included included levels inlcuded included multivariate 2.86067 1.08384 1.61867 1.28409 profit margin: p < .051 p<.366 p<.206 p< .011 profit margin .60051 .444" .382 1.13344 .409 .470 .26268 .407 .373 10.52398 .649 .320 1988: p< .443 (.141) (.187) p<.293 (.200) (.162) p<.612 (.125) (.200) p< .005 (.041) (.197) profit margin 1.46827 .478 .378 1.90963 .379 .457 .04912 .414 .398 10.18811 .631 .312 1989: p<.982 (.229) (.178) p<.174 (.165) (.168) p<.826 (.124) (.226) p<.006 (.069) (.192) .profit margm .uuuu"l .3l:su .3l:s2 1.42471 .385 .456 .uu146 .3~6 .3~~ 7.88715 .6u5 .313 1990: p<.982 (.178) (.192) p<.239 (.174) (.180) p<.970 (34) (.228) p<.013 (.099) (.197) n 6 32 12 35 11 23 4 13 multivariate 3.88500 1.66522 1.69950 2.53839 roa: ip< .017 p<.188 p< .193 p<.099 roa 1988: 4.21935 -.085 .037 .03628 .057 .049 3.60116 .029 .064 8.66912 .061 -.023 10<.047 (.320) (.069) p<.850 (.060) (.131) 0<.066 (.042) (.054) 0< .010 (.051) (.046) roa 1989: .79237 .012 .048 .51170 .040 .069 2.04994 .034 .063 5.10688 .060 -.033 p< .379 (.186) (.064) p< .478 (.067) (.135) p<.161 (.037) (.063) p<.038 (.054) (.010) roa 1990: .34599 .065 .047 .53424 .063 .048 .27409 .040 .051 4.17416 .064 .010 p< .560 (.057) (.057) p< .469 (.073) (.053) p<.604 (.040) (.065) p<.058 (.052) (.008) n 6 33 12 36 11 25 4 14 " mean for the performance variable. standard deviation given in parenthesis i-" ~ ~ ;:: 3 a ~ ttl f; s· ~ ~ l:"-l ::;l:l..... ~ ~. ~ i-" r ~ ~ table 6 summary of importance of geographic domain mission element, multivariate and univariate analysis of variance, means and standard deviations by level of diversification single dominant related unrelated product firms product firms diversified firms diversified firms f-ratio f-ratio f-ratio f-ratio & domain & domain & domair & domain performance signif. not domain signif. not domain signif. not domain signif. not domain variables levels included included levels included included levels include, included levels included included multivariate: 2.42461 .91227 .99300 2.32635 0<.083 0< .443 0< .409 0< .132 profit margin 2.06452 .479" .372 1.20388 .398 .468 .15814 .409 .378 1.81241 .682 .379 1988: p< .159 (.103) (.189) 0<.278 (.174) (.171) p<.694 (.135) (.189) ·p<.198 (.000) (.218) profit margin 5.09715 .531 .363 1.24144 .381 .450 1.17779 .475 .385 1.09731 .610 .374 1989: 0<.030 (.163) (.180) ·0< .271 (.189) (.164) 0<.286 (.189) (.198) 10< .311 (.000) (,218) profit margin 1.94788 .470 .362 1.90211 .364 .455 1.29766 .474 .378 .82968 .575 .370 1990: p< .171 (.100) (.198) p< .175 (.205) (.171) p< .263 (.193) (.200) p<.377 (.000) (.218) n 7 31 9 38 7 27 1 16 • mean for the performance variable. standard deviations given in parenthesis. ~ ....... ~ 3:a !ii' ~a ~ ~ t::1 <' ~ ei a g' ....... :j table 7 summary of importance of survival, growth & profitability mission element multivariate and univariate analysis of variance means and standard deviations by level of diversification smgle donunant related unrelated product firms product firms diversified firms diversified firms f-ratio f-ratio f-ratio f-ratio & survival & survival & survival & survival performance signif. not survival signif. not survival signif. not survival signif. not survival variables levels included included levels included included levels included included levels included included multivariate 2.11242 1.29282 2.21869 .05513 profit margin: p< .117 p<.289 p< .106 p<.982 profit margin .21006 .368" .399 .30281 .485 .448 .03431 .375 .388 .40143 .445 .371 1988: p<.649 (.202) (.176) p< .585 (.220) (.164) p<.854 (.163) (.186) p<.536 (.221) (.231) profit margin .26631 .422 .385 .01410 .443 .436 .80800 .454 .385 .16839 .418 .371 1989: p<.609 (.246) (.170) p<.960 (.182) (.169) p<.375 (.213) (.192) p< .687 (.201) (.236) profit margm .10298 .364 .387 .06151 .423 .441 .84349 .451 .379 .10661 .406 .369 1990: 0<.750 (.211) (.184) p< .805 (.176) (.182) p< .365 (.211) (.197) p< .749 (.196) (,236) n 9 29 8 39 9 25 6 11 multivariate 3.00218 2.41633 .17944 2.13474 roa: p<.043 p<.079 p< .910 p< .142 roa 1988: 4.36692 -.063 .043 7.42820 .147 .032 .25584 .061 .051 .00285 .045 .043 0<.044 (,247) (.078) 0<.009 (.226) (,071) p<.616 (.057) (.052) p<.958 (.049) (,063) roa 1989: 1.59028 .009 .052 4.84651 .145 .045 .24980 .062 .051 .00088 .045 .046 0<.215 (.129) (.076) 0<.033 (.271) (,054) 0<.620 (,059) (,057) 0<.977 (.049) (.056) roa 1990: 2.33962 .019 .059 .13305 .059 .051 .00420 .049 .047 .89048 .020 .056 p< .135 (.075) ,(.066) p< .717 (.082) (.053) p<.949 (.076) (.053) p<.359 (.028) (.052) n 9 30 8 40 9 27 6 11 "mean for the performance variable. standard deviation given in parenthesis. .... oj ~ t: ~ 5::l~ t::o ~ s· ~ ~ ~ ~ ~ ~. ~.... r ~ to-) fall 1994 morris: content & firm diversification 179 as measured by roa. the mean return on assets for related diversified firms including the customer element in their annual report was significantly higher than for firms who did not discuss customers. this mirrors the relationship that was found for single-product firms in 1988. once again it is difficult to provide an explanation for the importance of the customer element to firm performance in 1988 as opposed to other years. for unrelated diversified firms significant f-ratios are observed for the multivariate profit margin and roa measures as well as for each annual profit margin or roa. in each of the three years included in this analysis, the mean profit margin (or roa) for unrelated diversified firms including the customer element in their mission is significantly different from unrelated diversified firms that did not discuss customers in their mission. unrelated diversified firms that did not explicitly identify their customers in their missions had a higher average profit margin and roa than unrelated diversified firms that included a discussion of customers. these findings have an intuitive appeal due to the unrelatedness of the businesses of the firms in this segment of the sample. customers of a firm's unrelated divisions may be as unrelated as the divisions themselves, thus describing who the firm's customers are may not be effective in providing a unifying vision and strategic focus. dwelling on the firm's customers may distract the unrelated diversified firm from more important strategic issues. additional research incorporating a larger sample of unrelated diversified firms will be needed to further elaborate the relationship between firm performance and inclusion of the customer element in the mission. for the geographic domain mission element (table 6), no significant multivariate or univariate difference in financial performance was observed for firms following a dominant-product, related diversified or unrelated diversified strategy. discussion of the firm's geographic markets was unrelated to firm performance for firms following anything but a single-product diversification strategy. significant multivariate and univariate results were obtained for single-product firms. in 1989, single-product firms that included explicit references to the firm's markets in their mission experienced lower profit margins (on average) than firms following the single-product strategy that had omitted an elaboration of geographic markets. a focus on the firm's geographic markets may have come at the expense of more strategically important mission elements in identifying the firm's strategic direction. specification of the firm's primary markets in the mission may reflect recent market expansions which may result in negative pressures on the firm's profit margin, thus providing a possible explanation for the lower average profit margins for single-product firms including the geographic domain component in their missions. this effect may be more pronounced in single product firms than for any of the other three categories of firm diversification. because the content analysis procedure only measured whether the mission included or excluded the firm's target markets in the mission and not whether the market was appropriate given competitive conditions, another possible reason for the relative poor performance of single-product firms may be due to markets that are too restrictive or narrowly defined. 180 journal ofbusiness strategies vol. 11, no.2 although the omnibus f-test for the survival, growth and profitability element (table 7) indicated the relationship of this element with financial performance was contingent on the level of diversification, no significant multivariate or univariate results were obtained in the secondary manovas when profit margin was considered. only the multivariate f-ratio for firms following a related diversification strategy was marginally significant (p < .106). no further explanation or interpretation of the initial significant f-ratio is possible given the results of the secondary analysis. when roa is considered, significant multivariate and univariate f-ratios were observed for single-product and dominant product firms. single-product firms that included language regarding their concern for survival, growth and profitability earned a higher rate of return on assets in 1988 than single-product firms that did not include this element. the opposite was observed for dominant product firms. in 1988 and 1989, dominant product firms that did not include the survival, growth and profitability element in their annual reports earned a higher rate of return on assets than firms including this element. the results for dominant product firms may be explained in part by the prevailing assumption that economic goals guide the strategic direction of almost every viable business firm and therefore need not be explicitly stated (pearce, 1982). firms that were performing well may not have felt it necessary to address economic issues in their annual reports. on the other hand, firms that were performing poorly may have devoted more of their texts to provide a rationale for their performance or to set out goals for future improvement. the opposite relationships observed in single-product and dominant product firms may be partially due to the small cell sizes in the categories for firms that did not include this element in their annual reports. further research will be necessary to improve our understanding of this relationship. table 8 shows the results of the multivariate and univariate analyses for the self-image mission element. significant multivariate and univariate results were found for single-product and dominant product flrms. the inclusion or exclusion of the flrm's self-image in the missions of related and unrelated diversified firms did not influence financial performance as shown by the lack of significant univariate or multivariate f-ratios for firms following diversification strategies. in 1989, single-product firms that omitted the self-image element from their mission yielded higher profit margins (on average) than single-product firms that included the self-image element. since the self-image component addresses the firm's concept of its strengths and weaknesses, this finding appears to be contrary to expectations. because annual reports are publicly available, inclusion of a firm's competitive strengths may prove advantageous to competitors formulating preemptive or retaliatory competitive strategies. public disclosure of competitive strengths may be particularly harmful to firms following a single-product strategy. these findings should not be interpreted to suggest that single-product firms should not undergo strategic diagnosis to determine their competitive strengths, but to suggest that public disclosure of the results of such a diagnosis may have damaging effects on firm financial performance. for dominant product firms, significant multivariate and univariate f-ratios reveal an opposite relationship between firm performance and disclosure of firm self-image. for all three years (1988-1990), dominant product firms that included a discussion of table 8 summary of importance of self-image mission element multivariate and univariate analysis of variance means and standard deviations by level of diversification single dominant related unrelated product firms product firms diversified firms diversified firms f-ratio selff-ratio selff-ratio selff-ratio self& image self& image self& image self& image selfperformance signif. not image signif. not image signif. not image signif. not image variables levels included included levels included included levels included included levels included included multivariate 4.12897 3.07093 .63898 .48405 p<.013 p<.038 p<.596 p<.699 profit margin 1.14531 .498.383 8.90339 .254 .479 1.41912 .501 .373 1.43056 .653 .381 1988: p<.292 (.075) (.184) p<.005 (.074) (.165) p<.242 (.217) (.174) p<.250 (.000) (.221) profit margin 5.04078 .615 .375 9.41640 .235 .461 .79089 .500 .394 1.21400 .620 .373 1989: p<.031 ! (.194) (.177) p<.004 (.094) (.160) p< .380 (.206) (.197) p<.288 (.000) (.218) profit margin .94620 .483 .373 9.32067 .225 .463 .91203 .503 .388 1.20523 .612 .368 1990: p<.337 (.071) (.193) p<.004 (.088) (.171) p<.347 (.218) (.199) p< .290 (.000) (.216) n 3 35 5 42 3 31 1 16 -mean for the performance variable. standard deviation given in parenthesis. ~.... ~ f !ii' ~ a ~ it.l ~. tj =:1' ~ slg.... g .... 00.... 182 journal ofbusiness strategies vol. 11, no.2 the self-image component in their missions had higher (on average) profit margins than dominant product firms that did not include the self-image element. although this finding is more in tune with expectations, the conflict with the findings for single-product firms is indeed puzzling. dominant product firms that had explicitly discussed their competitive strengths in their missions earned higher profit margins than firms that did not. why is such a dramatic difference observed between dominant product and single-product firms? before becoming alarmed by these inconsistencies, additional research will be necessary to affirm that these differences truly exist. a significant interaction term was observed for the public image element when roa was used as the performance measure. as table 9 shows, the significant multivariate and univariate results for dominant product firms are the source of the significant interaction. although the difference is only marginally significant, firms following a dominant product strategy earned a higher rate of return on assets in 1988 when public image was not included in their annual reports than did firms that included this element. while firms are often concerned about their public image in the absence of expressed public concern, a negative public image often prompts firms to articulate their beneficial aspects in public communications such as annual reports (pearce, 1982). by this reasoning, firms that included public image in their mission statements may have been responding to negative public opinion which may have also negatively influenced their financial performance. a positive public image would be particularly important to dominant and single-product firms due to their concentration on a narrow business scope. no significant multivariate or univariate differences were observed in the roas of single-product, related diversified or unrelated diversified firms with regard to the inclusion of the public image element. since the interaction term for the technology mission element was insignificant, the significant main effect can be interpreted directly. thus, the results show that financial performance is influenced by the inclusion or exclusion of the technology component regardless of the level of diversification. profit margin means and standard deviations for firms that included the technology element in their missions versus those that did not include a discussion of technology are provided as table 10. contrasts comparing the profit margin means resulted in significant differences (p < .05) between the univariate means for all levels of the diversification factor. at all levels of diversification, firms that did not include the technology element in their missions enjoyed higher profit margins than firms that included a description of their core technologies in their missions. because company spokespersons attributed the omission of the technology component to difficulties in "succinctly describing the many technologies on which their multiple products depended," pearce and david concluded that the technology component was "far more relevant to smaller, more narrowly focused businesses" (pearce & david, 1987; p. 111). this rationale was not supported by the manova results. table 9 summary of importance of public image mission element multivariate and univariate analysis of variance, means and standard deviations by level of diversification single dominant related unrelated product firms product firms diversified firms diversified firms f-ratio public f-ratio public f-ratio public f-ratio public & image public & image public & image public & image public performance signif. not image signif. not image signif. not image signif. not image variables levels included included levels included included levels included included levels included included multivariate 1.18996 2.63989 1.43468 .17849 roa: p<.328 p<.061 p<.251 p<.909 roa 1988: 1.62690 -.017" .041 3.77858 .101 .031 .94201 .045 .062 .49674 .028 .050 p<.210 (.216) (.050) p<.058 (,176) (.176) p< .339 (.053) (.053) p<.617 (.052) (.065) roa 1989: .25615 .033 .048 1.54626 .096 .048 1.74799 .042 .067 .25988 .037 .051 p<.616 (.127) (.061) p<.220 (.209) (.057) p< .195 (.061) (.051) p<.617 (.059) (.054) roa 1990: .02273 .047 .051 2.36571 .032 .060 .01000 .047 .063 .37047 .042 .058 p<.881 (.094) (.051) p< .131 (.051) (.059) p<.921 (,063) .(.055) p<.551 (.060) (,048) n 6 32 12 35 11 23 4 13 "mean for the performance variable. standard deviation given in parenthesis. ~ ~ \0 'f f pi' ~ g... rc ~ ~. t:j.... <: ~ ~ ~........ g ~ 00 w 184 journal ofbusiness strategies table 10 profit margin means and standard deviations by inclusion or exclusion of technology and by level of diversification vol. 11, no.2 technology technology not included included level of standard standard diversification mean deviation n mean deviation n single-product .413" .183 .339 .169 .422 .188 27 .325 .175 11 .411 .189 .310 .172 dominant .473 .166 .402 .186 product .457 .162 35 .378 .183 12 .462 .174 .367 .185 related .436 .173 .320 .168 diversified .469 .190 19 .321 .179 15 .465 .192 .314 .182 unrelated .445 .221 .371 .231 diversified .418 .201 6 .371 .236 11 .406 .196 .369 .236 "profit margin means for 1988, 1989 and 1990. standard deviations for 1988, 1989 and 1990. all means are significantly different at the p< .05 level. rapidly changing technologies may provide an explanation for the lower average profit margins of firms that included the technology component in their missions. by not tying the firm's future strategies to a specific technology that may become obsolete, firms that did not emphasize the technology component may be more flexible in adapting to future changes. it would be interesting to study whether this finding is more pronounced in the latter 1980's and early 1990's than at other times in history when technology was not changing as rapidly. in summary, this exploratory study of 141 fortune 500 firms yields a different picture of the relationship of firm mission content to firm financial performance than shown in the pearce and david (1987) study. the results show that the firm's level of diversification does influence the magnitude and direction of the relationship between financial performance and mission content for some mission elements. significant mission element by level of diversification interactions were observed for the customer, geographic domain, self-image, public image and survival mission elements thus providing support for a new model of the "ideal" mission statement which stresses the importance of strategic context in determining which of the mission elements are essential for inclusion. differences in the findings of this study and those of earlier studies may be due to the use of a multiple measure of financial performance in the current study as opposed to the single measure used in pearce and david (1987). as fall 1994 morris: content & firm diversification 185 explained earlier, the differences could also be due to differences in the environmental pressures encountered by firms at different time periods of data collection. some of the cautions expressed by pearce and david (1987) bear repeating here. financial performance is affected by many variables besides those examined in these studies of mission statement components. their findings and the present findings are not meant to suggest that improvements in financial performance could be obtained by simply including or excluding certain elements from a firm's mission statement. as pearce and david (1987) pointed out, firms can have comprehensive mission statements and still experience poor sales and profits due to some other reasons. the findings of the current study and those of pearce and david are important in demonstrating the relationships between mission statement content and financial performance and the need for additional empirical research to further establish the strategic contexts in which certain mission elements are more desirable. summary the results of the current study demonstrate a need for a hierarchical model of mission statements much like the strategy hierarchy. the strategic needs of single-product, dominant product, related diversified and unrelated diversified firms are significantly different enough to warrant mission statement models which take these differences into account. intuitively, the model of corporate mission statements proposed by hill and jones (1992) and described in the literature review section of this paper has considerable appeal. their model parallels the defined role of corporate level strategy nicely, utilizing a portfolio approach to the firm's mission at the corporate level and supplementing it with more detailed business level mission statements. diversified firms might follow such a model in creating their own mission statements. the intended practical contribution of the present research was to suggest to practitioners that the most effective mission statement for their firm was one which was tailored to their unique strategic situation. there is no magic check-list of items that must be contained in the mission statement to ensure firm profitability. if the mission statement is to be effective in providing a strategic direction for the firm, it must address the unique aspects of a firm's strategic context rather than follow a "generic" mission statement format. pearce and david (1987) recognized this need in their original article, but unfortunately, their work has often been misinterpreted as providing a blueprint for creating the "ideal" mission statement. the exploratory results presented in this paper should provide a foundation for future research which seeks to determine the importance of certain mission components in a variety of different strategic contexts. although the current research demonstrates the need to consider the diversification strategies offirms in mission statement research, other contextual variables such as industry characteristics,6 and a host of external environmental variables such as economic conditions, international operations, intensity of competitive rivalry, and others may prove important in developing better models of mission statement content. 186 journal ofbusiness strategies endnotes vol. 11, no.2 1 the views of campbell (1989) and klemm et a1. (1991) may reflect a cultural difference with respect to the descriptive content, purpose, and audience of mission statements as both studies utilized samples of firms operating in the u.k. mission statements have not been as widely utilized in the u.k. as in the u.s. although this may be changing (klemm et a1.,1991) 2 under fasb-14, publicly held companies are required to report disaggregated financial information for segments considered significant to the enterprise as a whole. significance is determined by three 10% tests, the first of which states, that a segment is considered significant and therefore reportable if its revenue is at least 10% of the firm's revenues from all segments. the two other 10% tests examine percentage of operating profits and losses accounted for by each segment and percentage of identifiable assets attributed to each segment. the requirements of fasb-14, therefore, make it possible to use financial reports in the classification of the level of diversification in publicly held companies. see delancy, adler, epstein & foran (1994) for a further explanation of segment reporting requirements. 3 disclosure of this data is a further requirement of fasb-14. 4 for a more complete description of the development, operation and validation of the computerized content analysis program for evaluating mission statements, see morris (1994). 5 the performance variables were not averaged in the analysis, but were entered as a group of three dependent variables in each mangva analysis. there was no mixing of performance variables. profit margin measures were only analyzed with other profit margin measures and not with roa or roe. the manovas thus examine overall group differences that may not have been detected if each dependent variable had been used separately (hair et ai., 1992). 6 a recent study by subramanian & kumar (1993) demonstrated that hospital mission statements were more likely to include a different subset of mission elements components than firms in the pearce and david (1987) sample of firms in manufacturing industries. references abell, d.f. 1980. defining the business: the starting point of strategic planning. englewood cliffs, nj: prentice-hall. below, pj., morrisey, g.l. & acomb, b.l. 1987. the executive guide to strategic planning. san francisco: jossey-bass, inc. boseman, f.g. & phatak, a.v. 1989. strategic management. new york: john wiley & sons. fal11994 morris: content & firm diversification 187 bradley, p.h. & baird, j.e., jr. 1977. "management and communication style: a correlation analysis." central states speech journal, 28, 194-203. bray, j.h. & maxwell, s.e. 1990. multivariate analysis of variance. newbury park. ca: sage publications. campbell, a. 1989. "does your organisation need a mission?" leadership and organization development journal, 16(3),3-9. chatterjee, s. & blocher, j.d. 1992. "measurement of firm diversification: is it robust?" academy of management journal, 35(4), 874-888. cochran, d.s. & david, f.r 1986. "communication effectiveness of organizational mission statements." journal of applied communication research, 14(2), 108-118. cooley, w.w. & lohnes, p.r. 1971. multivariate data analysis. new york: john wiley & sons. d'aveni, ra. & macmillan, lc. 1990. "crisis and content of managerial communications: astudy of the focus of attention of top managers in surviving and failing firms." administrative science quarterly, 35, 634-657. david, f.r 1993. strategic management (fourth edition). new york: macmillan publishing. . 1989. "how companies defme their mission." long range planning, 22(1),90-97. david, f.r. & cochran, d.s. 1987. "a study of mission statements among large u.s. manufactur ers." journal of business strategies, 4(2), 59-67. delaney, p.r, adler, j.r, epstein, b.j. & foran, m.f. 1994. gam: interpretation and application ofgenerally accepted accounting principles (1994 edition). new york: johnwiley&sons. digman, l.a. 1990. strategic management: concepts, decisions, cases. homewood,il: richard d. irwin. drucker, p.f. 1973. management: tasks, responsibilities and practices. new york: harper & rowe. gephart, r.p. & wolfe, r.a. 1989. "qualitative data analysis: three microcomputer-supported approaches." in academy of management best paper proceedings ed. f. hoy ,(pp. 382-386). washington, d.c. hair, j.f., jr., anderson, r.e., tatham, r.l. & black, w.c. 1992. multivariate data analysis. new york: macmillan. hill, c.w.l. & jones, g.r. 1992. strategic management: an integrated approach. boston, ma: houghton mifflin. ireland, rd. & hitt, m.a. 1992. "mission statements: importance, challenge and recommendations for development." business horizons, may-june, 34-42. 188 jdumal ofbusiness strategies vol. 11, no.2 keppel, g. 1982. design and analysis: a researcher's handbook. englewood cliffs, nj: prentice-hall. klemm, m., sanderson, s. & luffman, g. 1993. "mission statements: selling corporate values to employees." long range planning, 24(3), 73-78. kotler, p. 1984. marketing management. englewood cliffs, nj: prentice-hall. mcginnis, v.j. 1981. "the mission statement: a key step in strategic planning," business, november-december, 39-43. montgomery, ca. 1982. "the measurement of firm diversification: some new empirical evidence." academy of management journal, 25(2), 299-307. morris, r.j. (1994). "computerized content analysis in management research: a demonstration of advantages and limitations." journal of management. 20 (4), 903-931 palia, k.a., hitt, ma., ireland, r.d. & godiwalla, y.h. 1982. grand corporate strategy and critical functions: interactive effects of organizational dimensions. new york: praeger publica tions. pearce, ja., n,1982. "the company mission as a strategic goal." sloan management review, 23(3), 15-24. . 1991. strategic management: formulation, implementation and control. homewood, il: richard d. irwin. pearce, ja., ii, & david, f. 1987. "corporate mission statements: the bottom line." academy of management executive, 1(2), 109-115. porter, m.e. 1987. "from competitive advantage to corporate strategy." harvard business review, may-june, 43-59. ramanujam, v. & varadarajan, p. 1989. "research on corporate diversification: a synthesis". strategic management journal, 10, 523-551. rumelt, r.p. 1974, strategy, structure, and economic performance. boston: division of research, graduate school of business administration, harvard university. smith, g.d., arnold, d.r. & bizzell, b.g. 1991. business strategy and policy. boston, ms: houghton mifflin. steiner, g. 1979. strategic planning: what every manager must know. new york: the free press. subramanian, r., & kumar, k. 1993. "mission statements of hospitals: an empirical analysis of their contents and their relationship to organizational factors." journal of business strategies, 10(1), 63-78. fall 1994 morris: content & firm diversification 189 thompson, aa., jr., & strickland, aj., iii, 1992. strategic management: concepts and cases. homewood, il: richard d. irwin. want, j.r. 1986. corporate mission. management review, 75(8), 46-50. watzlawick, p., beavin, j.h., & jackson, d.d. 1967. pragmatics of human communication: a study of interactional patterns, pathologies and paradoxes. new york: w.w. norton, weber, rp. 1990. basic content analysis. newbury park, ca: sage publications. wright, p., pringle, c.d. & kroll, m.j. 1992. strategic management: text and cases. boston, ms: allyn and bacon. wrigley, l. 1970. divisional autonomy and diversification. doctoral dissertation. harvard university. mission statement content and firm diversification: a contingency approach participative management's influence on effective strategic diffusion john a. parnell university of north carolina at pembroke pembroke, nc shawn carraher texas a&m university-commerce commerce, tx kenneth holt union university jackson, tn abstract recent research has highlighted the importance of middle and lower level managers in strategy formulation in ensuring that the strategy effectively "diffuses" throughout the organization. however, the question remains as to whether prevailing participative management styles in an organization can enhance this process. the present study suggests that the propensity of managers to employ participative management styles wasfound to positively influence the degree to which strategies were perceived as part of the organization. introduction strategic diffusion refers to the degree to which a strategy is effectively implemented and becomes an accepted part of the organization. whereas much of the current research is based on the notion that strategy should "fit" with a variety of organizational and environmental constructs in order to lead to superior performance (e.g., barney, 1986; brouthers & arens, 1999; hamilton & shergill, 1992; neilsen, 1992; zajac, kraatz, & bresser, 2000), researchers have not fully considered behavioral factors in the organization that influence strategic diffusion. this paper considers whether or not the prevailing participative management styles in an organization influence top management's ability to "diffuse" the strategy throughout the organization. strategic diffusion three dimensions of strategic diffusion involvement, understanding, and commitment have been elaborated in the literature (parnell & crandall, 1995). the first dimension involvement concerns the degree to which middle and lower level managers were involved in the strategy-making process. 162 journal of business strategies vol. 19, no.2 involvement can encompass numerous processes and techniques as long as it reflects top management's active consultation with other managers in the organization. researchers have consistently found that individuals tend to work harder at attaining a goal when they were involved in setting it (locke, latham & erez, 1988; roberson, moye, & locke, 1999). since strategy formulation encompasses some degree of implicit or explicit goal setting, greater involvement in formulation enhances efforts at implementation. although the concept of non-conceptual management involvement in strategy is not a recent phenomenon, the last decade has produced evidence to suggest that strategy formulation and implementation can reflect a diverse array oftop and middle management inputs (antonio, 1999; barney, 1986; burgelman, 1983; currie, 1999; thakur, 1998). mintzberg and waters' (1985) notion of deliberate and emergent strategies acknowledges the significant role of top and middle managers in the strategic management process. paralleling the work of burgelman (1983) and hiam (1993), nichol (1992) observed that top management simply cannot effectively develop a strategy and plan for its implementation without assistance from middle managers. wooldridge and floyd (1990) conducted the most comprehensi ve empirical analysis of middle management strategic involvement. not only did they find that middle management involvement in strategy formulation improved performance, they also noted that most organizations in the sample deliberately involved middle managers in the process. although their study reflects a culmination of thought acknowledging involvement beyond the top manager and even the top management team (for example, see barker & patterson, 1996; schilit, 1987), most published studies utilizing perceptual data continued to rely solely on the perceptions of the top manager (goll & johnson, 1996). wessel (1993) identified numerous individual barriers to effective implementation associated with management involvement, including conflicting managerial priorities, a top-down management approach (le., lack of non-conceptual manager involvement in strategy formulation), and poor communication. others have focused on the need for "selling" the strategy to non-conceptual managers (coulson-thomas, 1992; hambrick & cannella, 1989), but complete strategy permeation also may suggest non-conceptual manager involvement at the front end. the problem could be so acute that brache (1992) even suggested that organizations consider adopting a system-oriented organizational structure to improve cross-functional communication, teamwork across functions, and a focus on system-wide goals instead of functional ones. the second dimension understanding suggests that it is much easier to implement a strategy when middle and lower level managers thoroughly comprehend its component parts. recent research has emphasized the need for a clear understanding of the organization's strategy among all managers in constructing the superior performing organization (athanassiou & nigh, 2000; meyer, 2000; wright, kroll, pringle, & johnson, 1990). however, much of the strategy research in the 1970s and early 1980s followed ansoff (1965) and fall 2002 parnell, et at.: participative management 163 others (andrews (1971; schendel & hofer, 1979), relying on the understanding of the top manager for insight into an organization's strategic intentions. however, the belief that top management's clear understanding of strategy is all that matters is myopic. strategic management helps organizations cope with uncertainty by helping shape the competiti ve environment (das, handfield, calantone, & ghosh, 2000; guth, 1976; jauch & kraft, 1986; katz, zarzeski, & hall, 2000). the strategy selected by each organization determines the means by which it intends to successfully meet competitive challenges (porter, 1980). better information and certainty about the internal and external environmentsincluding competition tends to translate into superior performance (katz et a\., 2000). if the management of uncertainty is the primary challenge of top management (thompson, 1967), then effective implementation must reflect common perceptions of the strategy at all levels of management (engdahl, keating, & aupperle, 2000). understanding, however, is not sufficient. the third dimension commitment reflects the degree to which managers determine to see the strategy effectively implemented and become part of the organization. in the behavioral literature, commitment has been measured effectively through surveys. theory and empirical research suggest a relationship between commitment and implementation (locke et a\., 1988). whereas most of the emphasis on organizational commitment has been placed on gaining commitment to how things are done, little management emphasis has been focused on the issue of gaining commitment to what is done the strategic dimension of the organization (engdahl et ai., 2000). in sum, strategic diffusion is a function of management involvement in strategy development, management understanding of the strategy, and management's commitment to its effective implementation. the propensity for participative management research has suggested that the factors associated with strategic diffusion (i.e., involvement, understanding, commitment) tend to be enhanced through participative management styles (yuki, 1989). however, not all managers possess the same desire to utilize participative management processes (mudacumura, 2000). parnell, bell and taylor (1992) identified three dimensions organizational culture, organizational effectiveness, and power that comprise a manager's propensity for employing participative management techniques. the first two are further examined in this study. first, a manager's propensity for participative management is influenced by the prevailing culture ofthe organization. individuals, as members of an organization, are likely to share common values, attitudes, and behaviors (bennett, 1999; oliver, 1999; pettigrew, 1979). as such, managers in organizations where participation is prevalent are more likely to encourage their own subordinates to participate in decisions (parnell et a\., 1992). on the other hand, managers operating in organizations where decisions tend to be made autocratically are less likely to encourage their subordinates to participate. thus, one's propensity 164 journal of business strategies vol. 19, no.2 for participative management may be affected by the degree to which such behavior is encouraged or discouraged by the organization. second, if a manager believes that participative decision making (pom) enhances organizational effectiveness, he or she may be more likely to employ the technique. this belief may be reflected in the assertion that participation leads to higher quality decisions and greater productivity. further, there may be a greater tendency to promote participation as a means of obtaining higher quality decisions when it is believed that subordinates prefer the added involvement. this notion has received considerable support in the literature. in addition to quality, one's propensity for pom (ppdm) is also influenced by a second factor the perceived correlation between participation and productivity. in other words, a manager would likely employ ppdm if he or she believes that it will improve the productivity of the subordinates or the department as a whole. indeed, much of the literature suggests a positive correlation between pdm and productivity (dickson, 1982; hennestad, 2000; lovrich, 1985; oradat, 1998). for example, latham and steele (1983) concluded that an acute positive relationship exists when participation involves the setting of employee goals. likert and araki (1986) proposed a "system five" consensus approach, citing the relationship between pdm and productivity. lovrich (1985) investigated alleged participative management failures in the public sector and found little evidence to support the most typical managerial objections to participation. managers who expect that pom positively influences productivity are less likely to object to its utilization. likewise, managers who believe that participation is an ethical imperative that improves organizational effectiveness tend to promote pdm with subordinates. participative decision making has been found to increase organizational effectiveness, improve relationships between managers and subordinates, increase creativity and productivity, increase company loyalty, and reduce absenteeism and turnover (eoch & french, 1948; tannanbaum & allport, 1956). indeed, many have suggested that participation is the "right" or ethical approach to leadership (latham & steele, 1983; oradat, 1998; weiss, 1998). however, there is no consensus on the universal effectiveness of participation (kittrell & parnell, 1994). it appears to increase job performance and satisfaction in some situations but not in others. some top managers have adopted and then abandoned this practice for various reasons, concluding the participation is not for their organizations. research has examined possible reasons for the discontinuation of participative management: a lack of commitment or interest by management and employees, failure to properly implement the processes, and a lack of fit between the organization and the participative management processes. hypotheses the present study tests four hypotheses associated with the ppom components of organizational culture and decision effectiveness, and the strategic fall 2002 parnell, et al.: participative management 165 diffusion components of involvement and understanding. the hypothesized relationships are summarized in figure 1. figure 1 strategic understanding model h4 first, a positive linkage between a culture's participative nature and management beliefs that participation results in high quality decisions is expected. individuals tend to believe that their own organizational culture as they perceive it is the "right one" (d' andrade, 1984). hence, if participation is an integral part of the organizational culture, then managers are more likely to support the idea that participative management will improve decision quality. previous empirical research has demonstrated a positive relationship between these two dimensions of the ppm construct (latham & steele, 1983). hypothesis i: managers in organizations with more participative cultures will be more likely to believe that participation improves the quality of decisions. second, it is believed that organizations that promote participative management styles are more likely to include managers beyond the top level in strategy formulation. this hypothesis is intuitively appealing, as it simply proposes that organizations that foster participation in routine managerial decisions are also likely to encourage participation in the strategy process. hypothesis 2: managers in organizations with more participative cultures will tend to be more involved in strategy formulation. third, it is believed that managers who value participation the most are more likely to involve themselves in the decision of their superiors, including strategy formulation. in other words, if managers encourage their subordinates to participate in management decisions in part because they perceive a link 166 journal of business strategies vol. 19, no.2 between participation and effectiveness, one would expect these same managers to seek out opportunities to participate in the decisions that their managers make. hypothesis 3: managers who believe that participation enhances decision quality will tend to be more involved in strategy formulation. finally, it is suggested that those involved in formulating the organization's strategy will have the best understanding of it. research has suggested a strong correlation between these two dimensions of the strategic diffusion construct (schilit, 1987). hypothesis 4: managers who are more involved in strategy formulation are more likely to possess a greater understanding of the implemented strategy. development of the strategic diffusion scale (sds) item selection in the first stage, items believed to reflect one of the three dimensions of strategic diffusion were developed, utilizing a seven-point likert scale. a response of 7 denotes strong agreement (i.e., "strongly agree") with a given statement, while a response of 1 denotes strong disagreement (i.e., "strongly disagree"); responses of 2 through 6 were included to allow the participant to express moderate levels of agreement or disagreement with each item. a 90-item initial survey of 107 practicing lower and middle managers suggested that 47 of the items were vague or conceptually inadequate in wording; these items did not justify further consideration. the surviving 43 items were then further scrutinized by the author and an additional management researcher in order to assess content validity. twenty items were judged to be ambiguous, redundant, or not clearly reflective of the construct. these twenty items were eliminated; 23 remained for further testing. a second survey consisting of the remaining 23 items was administered to 113 practicing lower and middle managers. an exploratory factor analysis and a scree test was applied and factor loadings were generated at what appeared to be a "natural cutoff' in eigenvalues (7.40, 2.63, and 1.95). the resulting three factors accounted for 52.1 percent of the variance (bollen, 1989). eight items did not sufficiently load on one of the factors and were eliminated. a final theoretical scrutinization of the remaining items resulted in the elimination of two others in order to improve both parsimony and construct validity. the resulting instrument consisted of the strategic diffusion scale (sds) as well as questions concerning age, gender, and managerial level. the scale was then administered to 177 employees of eleven firms located in the southeastern united states. firms included both small entrepreneurial fall 2002 parnell, et al.: participative management 167 organizations and large multinational organizations with both the service sector and production sectors represented. the sample was 51 percent male and distributed almost evenly among lower [those managing workers] (47%) and middle [those managing managers] (53%) managerial levels. the ages of the respondents ranged from 22 to 68 with an average age of 37.1. the principal components (harman & jones, 1966) factor extraction technique resulted in each item loading significantly on only one of the three factors. the loadings supported the existence of three dimensions of the construct. eigenvalues were 6.26, 1.56, and 1.00, with the three factors accounting for 67.9 percent of the variance. hyperplane counts supported an oblique (oblimin) rotation method (gorsuch, 1983). while other methods of rotation are available in factor analysis, this type of oblique rotation is preferable because of its ability to "obtain theoretically meaningful dimensions" (kumar & beyerlein, 1991, p. 621). table 1 lists the loadings of the three factors, along with their corresponding eigenvalues and percentage explained by each factor. table 1 factor loadings for the sds corrected alpha factor item-total if item variable item wording loading correlation deleted com i i am committed to seeing that our organizational strategy is effectively implemented .836 .784 .894 com2 i don't worry about implementing strategy; i just do my job .753 .691 .899 com3 i don't concern myself with implementing strategies if they are not beneficial to my department .719 .643 .901 com4 departments in our company tend to be less concerned with working together and more concerned with competing for resources .715 .651 .901 com5 our organization is most successful when everyone works to implement a common strategy .781 .723 .897 com6 developing our company strategy is often a waste of time .771 .700 .898 unoi i fully understand the strategy my organization is attempting to implement .730 .667 .900 un02 [ know how our present strategy differs from that which was developed last year .610 .546 .905 un03 strategy is top management's problem i don't have time to understand all of the details .653 .590 .903 und4 [ know where our company intends to be in five years .671 .6d6 .902 [nyi my superiors frequently ask for my input concerning the direction of the company .487 .425 .909 iny2 when strategic or policy decisions are handed down to me, they often come as a surprise .523 .462 .908 iny3 our strategies would be more effective if i had a greater opportunity to contribute my opinions .686 .624 .902 168 journal of business strategies vol. 19, no.2 the first dimension (in the order of factor loadings) understanding is measured with four items. und 1 directly assesses the belief that the manager understands the organization's strategy. und2 measures the extent to which the respondent can differentiate between the present strategy and the previous one. und3 addresses the perception that understanding is not important at middle and lower management levels. und4 concerns knowledge about strategy in a specified time frame. the second dimension involvement is measured by three items. inv 1 directly assesses the degree to which superiors ask for inputs into the strategy making process. inv2 concerns the degree to which strategies appear to reflect the input. inv3 (reverse coded) assesses one's beliefs concerning the value of his or her involvement in strategy formulation. the third dimension commitment is measured with six items. com 1 directly assesses the commitment to effective implementation. com2 (reverse coded) concerns the perception that strategy implementation is not a primary concern of the respondent. com3 (reverse coded) addresses the perception that some strategies may benefit some departments or members of the organization more than others. com4 (reverse coded) addresses competitiveness among departments in the organization. com5 concerns the need for cohesion in the organization. com6 (reverse coded) addresses the perceived value of strategy formulation. the use of limited information factor analysis (sethi & carraher, 1993) supported the unidimensionality of each of the scales. reliability and validity were assessed to ensure the integrity of the strategic diffusion scale. coefficient alpha (cronbach, 1951) for the sds was.91, indi~ cating that the scale has a high level of internal consistency, an important indication of reliability (kuratko, montagno & hornsby, 1990; peter, 1979). coefficient alphas for each of the subscales were .91 for the com subscale, .84 for the und subscale, and .67 for the inv subscale. findings the ppm scale the principal components (harman & jones, 1966) factor extraction technique resulted in each item loading significantly on only one ofthe three factors. the loadings supported the existence of three dimensions of the construct. eigenvalues were 5.78, 1.34, and 0.78, with three factors accounting for 65.9 percent of the variance. as supported by hyperplane counts, the data were rotated using an oblique (oblimin) rotation method. table 2 provides factor loadings, coefficient alpha, and alphas following an item deletion routine. the first dimension of the scale culture encompasses six items that measure the influence of norms and behaviors on ppm. ppmculi and ppmcul2 reflect culture at the department level, whereas ppmcul3ppmcul6 reflect culture at the organizational level. the second dimension organizational effectiveness encompasses three items that consider one's fall 2002 parnell, et al.: participative management 169 beliefs concerning the relationship between participative management and the organizational variables of decision quality (ppmorg i and ppmorg2) and interpersonal relationships (ppmorg3). the third dimension power considers the perceived relationship between participation and the superior's power and control (ppmpwrl-ppmpwr3). reliability and validity were assessed to ensure the integrity of the ppm scale. coefficient alpha (cronbach, 1951) for the scale was .90, indicating that the scale has a high level of internal consistency, an important indication of reliability (kuratkoet ai., 1990; peter, 1979) and limited information factor analysis supported their unidimensionalities. hypotheses having established reliability of the two scales, it was necessary to develop measures for each of the elements in the model. to do so, each of the four subscales utilized in the study (i.e., two from the ppm scale and two from sds scale) were factor analyzed separately and factor scores (regression method) were computed to serve as composite measures of each dimension. table 3 provides the factor loadings and coefficient alphas for each analysis. table 4 provides correlations and significance levels among each of these factors. table 2 factor loadings for the ppm scale corrected alpha factor item-total if item variable item wording loading correlation deleted ppmculi my subordinates tend to possess the same organizational goals i have .746 .688 .887 ppmcul2 my subordinates are generally informed and experienced .762 .689 .888 ppmcul3 participative decision making is widely used in my organization .723 .649 .889 ppmcul4 i am free to make decisions as i wish in my organization .640 .557 .894 ppmcul5 participative decision making is promoted in my organization .681 .598 .892 ppmcul6 my boss frequently solicits my participation in his or her decisions .7ti .634 .890 ppmorgi many organizational problems disappear when everyone has a chance 10 participate in decision making .726 .656 .889 ppmorg2 participative decision making usually results in effective decisions .774 .713 .886 ppmorg3 participative decision making promotes positive relationships at all levels of the organization .762 .687 .887 ppmpwri participative decision making requires divulging too much confidential information .559 .502 .896 ppmpwr2 participative decision making gives too much power to subordinates .580 .523 .895 ppmpwr3 subordinates often cannot be trusted .593 .531 ,896 170 journal of business strategies vol. 19, no.2 correlational analysis lent support to each of the four hypotheses. first, the correlation between the ppm dimensions of organizational culture and decision effectiveness was .52. second, the correlation between the ppm dimension of organizational culture and the strategic diffusion dimension of involvement was .41. third, the correlation between the ppm dimension of decision effectiveness and the strategic diffusion dimension of involvement was .35. finaj)y, the correlation between the strategic diffusion dimensions of involvement and understanding was .56. structural equation model a structural equation model was developed to test the four hypotheses simultaneously (see figure 2). for the ppm factors (i.e., organizational culture and decision effectiveness), the best three measures were retained; for the strategic diffusion factors (i.e., involvement and understanding), the best two measures were retained. saturated models with all construct measures were tested but were rejected because of high covariances among measurement errors across constructs. table 3 factor loadings for single-factor solutions item factqr i.oading strategic diffusioninvolvement (alpha .67) invi inv2 inv3 strategic diffusion-understanding (alpha =.84) undl und2 und3 und4 strategic d,ffusion-commitment (alpha =.9!) comi com2 com3 com4 cams com6 ppm-organizational culture (alpha=.86) ppmculi ppmcul2 ppmcul3 ppmcul4 ppmcul5 ppmcul6 ppm-decision effectiveness (alpha =.s!) ppmorgi ppmorg2 ppmorg3 .685 .817 .832 .828 .814 .789 .842 .836 .789 .844 .774 .849 .860 .793 .816 .768 .682 .764 .753 .823 .863 .864 fall 2002 parnell, et al.: participative management 171 the chi-square statistic was 40.642 (df = 31), with a probability level of .115. the chi-square is the most widely accepted overall measure of fit for a structural equation model. however, three additional measures warrant consideration (arbuckle, 1997). first, the bentler-bonett (1980) normed fit index (nfl) compares the proposed model to a baseline model. bentler and bonett (1980) suggested that nfl statistics above. 90 suggest that the model cannot be improved substantially. the nfl for the proposed model was .989. table 4 correlations variable ppmorganiz. culture ppmorganiz. sdssdseffectiveness involvement understanding .74 1.00 p = .00 .4l .35 1.00 p = .00 p = .00 .62 .52 .56 1.00 p = .00 p = ,00 p = .00 propensity for participative management1.00 organizational culture propensity for participative managementorganizational effectiveness strategic diffusion-understanding strategic diffusion-involvement figure 2 structural equation model o. 0, 1 8 ppm org. culture o. 0, ppm decision effectiveness 0, o. o 0, 172 journal of business strategies vol. 19, no.2 second, the comparative fit index (cpi) also compares the proposed model to a baseline model (bentler, 1980). scores in the. 90 or .95 range or higher suggest that it would be difficult to substantially improve the model fit. the cpi for the proposed model was. 997. finally, the "root mean square error of approximation" (rmsea) statistic attempts to overcome the bias of chi-square by compensating for model complexity. browne and cudeck (1993) suggested that values of .08 or less represent reasonable errors or approximation, whereas values greater than .10 represent unreasonable errors. the rmsea for the proposed model was .042. path estimates appear in table 5. table 5 path estimates for structural equation model path path estimate standard error ppm decision effectiveness ppm organizational culture 0.674 0.081 str. diffusion involvement ppm organizational culture 0.306 0.129 str. diffusion involvement ppm dec. effectiveness 0.087 0.151 str. diffusion understanding str. diffusion involvement 1.562 0.340 ppmcul i ppm organizational culture 1.000 ppmcul2 ppm organizational culture 0.748 0.075 inv i str. diffusion involvement 1.000 inv2 str. diffusion involvement 1.131 0.252 ppmorg 1 ppm decision effecti veness 1.000 ppmorg3 ppm decision effectiveness 1.344 0.141 undi str. diffusion understanding 1.000 und3 str. diffusion understanding 1.190 0.161 ppmcul6 ppm organizational culture 0.844 0089 ppmorg2 ppm decision effectiveness 1.156 0.127 within the model, proposed linkages among the constructs were strong, with the exception of the link between ppm decision effectiveness and strategic diffusion involvement. the model was modified to remove the link, but comparisons between the two competing models were inconclusive. in sum, the structural equation model lends strong support for the first, second, and fourth hypotheses, and limited support for the third hypothesis. discussion, conclusions, and future research this paper considered factors in the organization that may influence strategic diffusion. it specifically explored the role that managers' propensity for fall 2002 parnell, et af.: participative management 173 participative management styles might play in the effective diffusion of strategy throughout the organization. the support found for the second and fourth hypotheses particularly indicate that a participative organizational culture breeds more involvement in the formulation of strategy and that managers who are more involved in strategy formulation have a greater understanding of the implemented strategy. the lack of support found for the third hypothesis in the structural equation model may be interpreted as implying that managers who believe that participation enhances decision quality will not tend to be more involved in strategy formulation. instead it may be that the stated hypothesis is true, except that the nature of the culture may modify the relationship. a manager may very well agree that participation enhances decision quality and may prefer more involvement in strategy formulation, but if that belief is not accompanied by a participative culture that affords the manager an opportunity to become involved, his or her involvement in strategy formulation may be limited. these findings represent an important first step in the process of examining the organizational factors that may influence the diffusion of strategy. they also create an important bridge between organizational theory, organizational behavior, and strategic management. despite great efforts of management to develop an effective strategy for the organization, without the means to share the strategy throughout the organization its potential successes may not be realized (engdahl et al., 2000). two future research directions have been identified. first, the sds does not take into account organization-specific factors that may affect strategic diffusion and ultimately be associated with ppm. research must inevitably probe more deeply into the impact of organizational culture on the strategy making process (athanassiou & nigh, 2000; harris & purdy, 1998). strategic change challenges the taken-for-granted beliefs of all organizational members and typically is not easy to accomplish (scholes, 1991). for instance, hennestad (2000) examined attempts for extrusion company to transform itselffrom a traditional style of management to a participative style of management and he reported that insufficient attention was paid to the change management process which led to a lack of momentum for the change process. earlier, lorenz (1988) demonstrated that general electric was not able to defend its market positions in many of eighteen businesses studied because sudden changes of any kind tended to be perceived as evidence of poor and inadequate planning rather than as an indication of the volatility of the real world. as a result, ge increased the involvement of line managers in the strategy process and was thus able to better defend its market positions. longitudinal research designs could be especially effective in answering questions such as whether an organizational culture that values ppm leads to greater strategic understanding, and then whether this understanding influences actual organizational performance (oliver, 1999) and it also may prove fruitful for future research to examine and compare the results across countries both within a single organization and across organizations. 174 journal of business strategies vol. 19, no.2 second, the results of this study implore researchers to more fully integrate behavioral theory into the equation by determining what may lead to strategic diffusion. specifically, an examination of the processes through which top managers involve subordinates in the strategy making process may provide insight into the genesis of strategic consensus. the intricacies surrounding one specific form of participative management participation in strategy making and its relationship to strategic consensus remain tenuous (crandall & parnell, 1994). in addition, factors such as personality, cognitive complexity, managerial diversity, experience, and functional background (carraher & buckley, 1996; carraher & whitely, 1998) may provide insight into why some strategies are more easily diffused than others (budd & carraher, 1998). indeed, this avenue holds the potential for increased dialogue among various managerial disciplines. in sum, this study has demonstrated a linkage between propensity for participative management and strategic diffusion. results suggest that perceptions of greater participation may result in more effective dissemination of the organization's strategy and greater decision effectiveness. references andrews, k. (1971). the concept of corporate strategy. homewood, ii.: dow jones. ansoff, h.i. (1965). corporate strategy: an analytical approach to business policy for growth and expansion. new york: mcgraw-hill. antonio, d. (1999), what motivates middle managers. industrial management, 41 (6), 27-30. arbuckle, j.l. (1997). amos user's guide version 3.6. chicago, il: smallwaters corporation. athanassiou, n., & nigh, d. (2000). internationalization, tacit knowledge and the top management teams ofmncs. journal of international business studies, 31 (3),471487. barker, v.l., & patterson, p.w., jr. (1996) top management team tenure and top manager causal attributions at declining firms attempting turnarounds. group and organization management, 21 (3), 304-336. barney, j.b. (1986). types of competition and the theory of strategy: toward an integrati ve framework. academy of management review, ii, 791-800. bennett, r.h., ill (1999), the relative effects of situational practices and culturally influenced values/beliefs on work attitudes. international journal of commerce and management, 9(1/2), 84-102. bentler. p.m. (\ 980). multivariate analysis with latent variables: causal modeling. annual review of psychology. 31, 419-456. fall 2002 parnell, et al.: participative management 175 bentler, p.m. & bonett, d.g. (1980). significance tests and goodness of fit in the analysis of covariance structures. psychological bulletin. 88, 588-606. bollen, k.a. (1989). structural equations with latent variables. new york: john wiley & sons. brache. a.p. (1992), process improvement and management: a tool for strategy implementation, planning review, 20, 5. 24-26. brouthers, k.d., & arens, p. (1999). privatization and strategic fit: evidence from rumania. business strategy review, 10(2), 53-59. browne, m.w., & cudeck, r. (1993). alternative ways of assessing model fit. in bollen, k.a. & long, j.s. (eds.) testing structual equation models. newbury park, ca: sage publications. pp. 136-162. budd, j, & carraher, s. (1998). validation of an inventory to measure attributes of strategic management. psychological reports, 82, 1220-1222. burgelman, r.a. (1983). a model of the interaction of strategic behavior, corporate context, and the concept of strategy. academy of management review, 8, 61-70. carraher, s. & buckley, m.r. (1996). the effect of cognitive complexity on the perceived dimensionality of the psq. journal of applied psychology. 81, 102-109. carraher, s. & whitely, w. (1998). motivations for work and their influence on pay across six countries. global business and finance review, 3, 49-56. coch, l., & french, j.r.p., jr. (1948). overcoming resistance to change. human relations, i, 512-532. coulsonthomas. c. (1992). leadership and corporate transformation. leadership and organization development journal, 13, 16-27. crandall, w.r., & parnell, i.a. (1994). on the relationship between propensity for participative management and intentions to leave: re-opening the case for participation. mid-atlantic journal of business, 30, 197-209. cronbach, lj. (1951). coefficient alpha and the internal structure of tests. psychometric a, 16. 297-334. currie. g. (1999). the influence of middle managers in the business planning process: a case study in the uk nhs. british journal of mana~ement, 10(2). 141-155. d' andrade, r. (1984). cultural meaning systems. in culture theory, r. shweder & r. levine (eds.), pp. 88-119. 176 journal of business strategies vol. 19, no.2 das, a., handfield, r.b., calantone, r.j., & ghosh, s. (2000). a contingent view of quality management the impact of international competition on quality. decision sciences. 31 (3), 649-690. dickson, j. w. (1982). top managers' beliefs and rationales for employee participation. human relations. 35(3), 203-217. engdahl, r.a., keating, rj., & aupperle, k.e. (2000). strategy and structure: chicken or egg'? (reconsideration of chandler's paradigm for economic success). organizational development journal, 18(4), 21-33. gall, i., & johnson, n.b., (1996). the role of top management demographic characteristics in employee participation programs. international journal of management, l3( 0, 76~83. gorsuch, r. (1983). factor analysis (2nd ed.) hillsdale, nj: lawrence erlbaum associates publishing. guth, w. (1976). toward a social system theory of corporate strategy. journal of business, 49, 374-388. hambrick, d.c., & cannella, a.a., jr. (1989). strategy implementation as substance and selling. academy of management executive, 3, 278-285. hamilton, r.t., & shergill, g.s. (1992). the relationship between strategy-structure fit and financial performance in new zealand: evidence of generality and validity with enhanced controls. journal of management studies, 29( 1), 95-113. harman, h.h., & jones, w.h. (1966). factor analysis by minimizing residuals. psychometrica, 31, 351-368. harris, c.r., & purdy, r.l. (1998). the role of participative management in the implementation of total quality management programs. international journal of techno1ogy management, 16(4-6),466-478. hennestad, b.w. (20(0). implementing participative management: transition issues from the field. journal of applied behavior science, 36(3). 314-335. hiam, a. (1993). strategic planning unbound. journal of business strategy, 14(2), 4652. jauch, l.r., & kraft, k.l. (1986). strategic management of uncertainty. academy of management review, ii, 777-790. katz, j.p., zarzeski, m.t., & hall. h.j. (2000) the impact of strategy, industry, and culture on forecasting the performance of global competitors: a strategic perspective. journal of business strategies, 17(2), 119-143. fall 2002 parnell, et at.: participative management 177 kittrell, l.m., & parnell, j.a. (1994). an analysis of the relationship between organizational character and propensity for participative management. proceedings of the annual meeting of the institute of behavioral and applied management, washington, dc. kumar, k., & beyerlein, m. (1991). construction and validation of an instrument for measuring ingratiatory behaviors in organizational settings. journal of applied psychology, 76, 619-627, kuratko, d.e, montagno, r.y, & hornsby, j.s. (1990). developing an intrapreneurial assessment instrument for an effective corporate entrepreneurial environment. strategic management journal, ii, 49-58. latham, g.p, & steele, tp. (1983). the motivational effects of participation versus goal setting on performance. academy of management journal, 26(3),406-17. likert, j.g., & araki, c.t. (1986). managing without a boss: system five. leadership and organization development journal, 7(3), 17-20 locke, e.a., latham, g.p., & erez, m. (1988). the determinants of goal commitment. academy of management review, 13, 23-39. lorenz, c. (1988, may 18). why strategy has been put in the hands of line managers. financial times, p, 20. lovrich, n.p. (1985). the dangers of participati ve management: a test of unexamined assumptions concerning employee involvement. review of public personnel administration, 5(3), 9-25. meyer, h. (2000). boards take on the heavy lifting. journal of business strategy, 21 (4), 18-23. mintzberg, h. & waters, j .a. (1985). of strategies, deliberate and emergent. strategic management journal, 6, 257-272. mudacumura, g.m. (200d). participative management in global transformational change. international journal of public administration, 23( 12), 2051-2083. neilsen, a. (1992). a new metaphor for strategic fit: all that jazz. leadership and organization development journal, 13(5),3-6. nichol, r.l. (1992). get middle managers involved in the planning process. journal of business strategy, 13(3), 26-32. oii ver, b. l. ( 1999). com pari ng corporate managers' personal values over three decades. journal of business ethics, 20(2),147-161. 178 journal of business strategies vol. 19, no.2 orad at, g.d. (1998). a supervisor's responsibility in a gainsharing and continuous improvement environment. supervision, 59(5). 3-4. parnell, j.a., bell, e.d., & taylor, r. (1992). the propensity for participative management: a conceptual and empirical analysis. mid-atlantic journal of business, 28(1), 31-42. parnell, j.a., & crandall, w.r. (1995). the strategic diffusion construct: measuring a strategy's dissemination throughout the organization. proceedinji:s of the 1995 southeast tlms meeting, myrtle beach, sc. peter, j.p. (1979). reliability: a review of psychometric basics and recent marketing practices. journal of marketing research, 16, 6-17. pettigrew, a.m. (1979). on studying organizational cultures. administrative science quarterly, 24, 570-581. porter, m.e. (1980). competitive strategy. new york: free press. roberson, q.m., moye, n.a., & locke, e.a. (1999). identifying a missing link between participation and satisfaction: the mediating role of procedural justice perceptions. journal of applied psychology, 84(4), 585-593. schendel, d., & hofer, c. (1979). strategic management. boston, ma: little, brown. schilit, w.k. (1987). an examination of the influence of middle-level managers in formulating and implementing strategic decisions. journal of management studies, 24,271-293. scholes, k. (1991). the way to manage strategic change. accountancy, 107(1170),9899. sethi, v. & carraher, s. (1993). developing measures for assessing the organizational impact of information technology: a comment on mahood and soon's paper. decision sciences, 24, 867-877. tannenbaum, a.s., & allport, fh. (1956). personality structure and group structure; an interpretive study of their relationship through an event structure hypothesis. journal of abnormal and social psychology, 53, 272-280. thakur, m. (1998). involving middle managers in strategy making. long range planni!:j.g, 31(5), 732-741. thompson, j.d. (1967). organizations in action. new york: mcgraw-hill weiss, w.h. (1998). improving employee performance: major supervisory responsibility. supervision, 59( 10), 6-8. fall 2002 parnell, et al.: participative management 179 wessel, j.r. (1993). the strategic human resource management process in practice. planning review, 21,5,37-38. wooldridge, b., & floyd, s.w. (1990). the strategy process, middle management involvement, and organizational performance. strategic management journal, 11, 231-241. wright, p., kroll, m., pringle, c, & johnson, j. (1990). organization types, conduct, profitability and risk in the semiconductor industry. journal of management systems, 2(2), 33-48. yuki, g. (1989). managerial leadership: a review of theory and research. journal of management, 15(2), 251-289. zajac, e.j., kraatz, m.s., & bresser, r.k.f. (2000). modeling the dynamics of strategic fit: a normative approach to strategic change. strategic management journal, 21 (4), 429-453. john a. parnell (john_parnell@tamu-commerce.edu) earned the doctor of philosophy degree in strategic management from the university of memphis. dr. parnell presently serves as the william henry belk distinguished professor of management at the university of north carolina at pembroke. he is the author of over 100 basic and applied research articles, published presentations, and cases. his present research is focused on business strategy and performance, subordinate participation, and management ethics. shawn carraher (shawn_carraher@tamu-commerce.edu) received his ph. d. in business administration from the university of oklahoma. he presently serves as professor of management & global entrepreneurship at texas a&m university-commerce. his primary research interests combine international business. strategic management, human resources, and entrepreneurship in order to examine cross-cultural differences in compensation. selection, and staffing within entrepreneurial organizations. m. kenneth holt (kholt@uu.edu) received the m.s. degree from louisiana state university and is presently a ph.d. candidate at the university of memphis. he also serves as an associate professor of economics and management and director of the center for business & economic development at union university. footnotes i this paper is not concerned with which means of involvement are more or less effective, but rather with the perception by middle and lower level managers of the degree to which they were involved in the strategy formulation process. participative management's influence on effective strategic diffusion 336 journal of business strategies optimal ceo incentive contracts: a prospect theory explanation joshua r. aaron middle tennessee state university • murfreesboro, tn michael l. harris east carolina university • greenville, nc william c. mcdowell middle tennessee state university • murfreesboro, tn brandon n. cline mississippi state university • starkville, ms abstract this study examines the relationship between ceo incentive-based compensation and firm performance, based on the role of prospect theory in executive compensation. our results indicate that moderate levels of performance-based ceo compensation are generally optimal. when an executive’s total compensation package is based more on firm performance there is often a level of higher returns, but to a point of diminishing return. our findings suggest that boards must clearly communicate with ceos to determine the most appropriate levels of incentive-based compensation. additional managerial and theoretical implications are offered, as well as avenues for future research. introduction the proper structuring of executive compensation contracts has been the subject of much debate in the finance (jensen & meckling, 1976; jensen & murphy, 1990) and management literatures (wright, ferris, sarin, & awasthi, 1996; sundaramurthy, rhoades, & rechner, 2005). this debate has largely been grounded in agency theory, which suggests that executives should be given equity stakes in their companies in order to properly align their interests with shareholders’ interests. thus, equity ownership is assumed to have a positive and direct effect on firm performance because aligning the risk preferences of executives and shareholders is the key to aligning their interests. the results, however, have been inconclusive. it is possible that the reliance on agency theory and the assumption of a positive linear relationship between ownership and performance has been the cause of confusion. prospect theory (kahneman & tversky, 1979), however, may provide a better explavolume 31, number 2 337 nation for how individuals actually make decisions regarding a bundle of financial resources. prospect theory is derived from offering individuals prospects (decision sets) with various payoffs and observing their decision making process and outcomes. prospect theory is presented as an alternative to utility theory assumptions that serve as the foundation for agency theory. we believe the application of prospect theory can help explain that the ownership-performance relationship is actually nonlinear (concave). the purpose of this study is to apply prospect theory to incentive-based ceo compensation in an attempt to clarify conflicting findings in this area. specifically, this study examines the relationship between ceo incentive-based compensation and subsequent firm performance in a sample containing 18,540 ceo observations from 1992-2004. literature review ownership – risk relationship by properly structuring an incentive contract, firms can motivate corporate insiders to engage in additional corporate risk taking while developing growth opportunities (jensen & meckling, 1976; jensen & murphy, 1990). in order to more closely merge the interests of corporate insiders and shareholders, and thus reduce the potential for agency conflict, insiders have often been provided with an equity interest in firms. typically, firms allow discounted stock purchase programs or grant stock options in an attempt to reduce agency conflict. the presumption underlying these programs has been that there is a positive relationship between insider equity ownership and corporate risk taking (wright et al., 1996). eisenmann (2002) does find that ceos given equity ownership are more risk-seeking while those with no ownership are risk-averse. however, other studies have shown that this increase in risk-taking behaviors will eventually diminish at higher levels of equity ownership. wright et al. (2007) find that at low to moderate values of managerial stock ownership, risk-increasing decisions predominate. however, at substantial executive equity values, risk-reducing decisions are motivated. similarly, wright et al. (1996) find a nonlinear (concave) relationship between insider equity ownership and firm risk-taking. despite shareholders preference for growth-oriented risk taking, there are instances where executives may desire to reduce risk-taking behavior. they suggest two explanations concerning why equity ownership programs do not give corporate insiders clear in338 journal of business strategies centives to enhance firm performance through growth-oriented risk taking. these include financial costs as well as personal costs for the executive (wright et al., 1996). first, regarding the financial costs, executives may not increase corporate risk taking as they obtain higher levels of equity ownership because of the potential for wealth “undiversification.” more specifically, if a substantial component of an executive’s wealth is concentrated in a single investment, the executive may not find it personally desirable to increase risk taking in regards to that investment (wright et al., 1996). high levels of equity ownership in the firm serve to decrease the executive’s portfolio diversification and may cause them to adopt a suboptimal conservative strategy due to the executive having so much “on the line”. second, regarding the personal costs for the executive, “they may reduce corporate risk taking in order to lower the personal costs of such decisions. included among these costs would be the potential loss of employment, the extra effort required to master new technologies or manage new ventures, and the anxieties inherent in higher-risk corporate undertakings” (wright et al. 1996 p. 443). corporate insiders may make decisions based upon an attempt to minimize personal stress generated by a particular firm strategy. this practice could result in the selection of a set of non-value-maximizing projects for a firm. wright et al. (1996) do not establish a relationship between ownership and firm performance although they suggest that future research should explore the issue. ownership – performance relationship wright et al. (1996) state the nature of a firm’s risk-taking behavior can significantly affect corporate performance, but they do not attempt to establish a link directly from insider equity ownership to firm performance. subsequently, several researchers have attempted to expand on this research area and establish this important link. mcguire and matta (2003), however, find that the exercise of stock options has no impact on the levels of ceo equity and no relationship with subsequent firm performance. thus, the decision to exercise stock options appears to reflect riskbalancing concerns rather than expectations for future performance. empirical evidence regarding the impact of executive and institutional ownership, however, is quite mixed. for example, tsetsekos and defusco (1990) found no significant relationship between executive ownership and firm performance while mehran (1995) and hambrick and jackson (2000) each found a direct, positive relationship, and others such as mcconnell and servaes (1990) found a non-linear relationship. in an attempt to reconcile these contradictory findings, sundaramurthy volume 31, number 2 339 et al. (2005) performed a meta-analysis, and their results indicated that there is no substantive relationship between ownership and firm performance. in an effort to explain these conflicting problems, it is proposed that overreliance on agency theory has been the cause for much confusion in literature. the application of agency theory leads to an assumption of a positive linear relationship between ownership and firm performance. the next section will explain the basic tenants of agency theory and outline the problems associated with attempting to utilize this theory to explain the ownership-performance relationship. the agency theory problem in an effort to examine the ownership-performance relationship through the lens of existing theory, agency theory should be examined. agency theory (eisenhardt, 1989) is directed at explaining agency relationships, where one party (principal) delegates work to another party (agent) who actually performs the work and addresses two main problems within the organization. the first is that of shirking which occurs because the goals or desires of the principal and agent often differ and it is difficult for the principal to monitor agent activity. the second is a problem of risk sharing and occurs when the principal and agent have different attitudes toward risk. in this case, the agent may favor a different course of action than the principal. agency theory is concerned with solving this problem by determining the best way to govern the principal-agent relationship given a different set of assumptions, attitudes, and goals (eisenhardt, 1989). the ceo-shareholder relationship is a very complex version of an agency problem. based on agency theory, firms may use their executive compensation plans to properly align the interests of corporate executives (agents) with those of the shareholders (mengistae & lixin, 2004). alignment of incentives is difficult due to uncertainty about the relationship between agent actions and desired outcomes. additionally, shareholders and ceos have varying amounts of information about the firm. it is costly for shareholders to monitor ceo behavior because so many of their actions are hard for shareholders to detect (chaudri, 2003). since actions are imperfectly observable, performance measures must accommodate relative weightings of managerial actions and exogenous factors that affect desired outcomes. firms need to decide the appropriate balance between rewarding individual performance and rewarding firm performance (chaudri, 2003). agency theory predicts that the optimal contracts depend not only on firm-specific factors but also on ceo-specific factors as well (kim, 2004). kim suggests that 340 journal of business strategies firm-specific factors such as riskiness, size, growth, and governance structure are important but not the only concern. firms should also consider ceo-specific factors, such as ceo ability and experience, and alter the pay-performance sensitivity when a ceo leaves and is replaced. the use of agency theory to explain the ownership-performance relationship has, however, been called into question (buck et al., 2003). dalton et al. (2003) conducted a meta-analysis of relevant ownership-performance studies and found little support for agency theory, calling for a new lens to be applied. despite this, the basic agency problem certainly exists and the alignment of interests is important. compensation should be, at least partially, tied to performance, but research is lacking a prescriptive suggestion in terms of how much compensation to tie to performance. is more necessarily better? is there such a thing as too much? why has the agency theory lens been so inconclusive? noorderhaven (1992) notes agency theory relies on an individual utility maximization assumption (utility theory). we believe that utility maximization assumptions are fundamentally flawed in terms of explaining the way people make decisions. in the following section, prospect theory is offered as an alternative explanation to individual decision making and distinguish it from utility theory assumptions. prospect theory and executive compensation prospect theory (kahneman & tversky, 1979) challenges the assumptions of utility theory in terms of the ways individuals make decisions in three primary ways. first, utility theory evaluates utility from the final states of wealth, including wealth from the prospect and other existing assets, whereas prospect theory evaluates the value of a prospect from a change in wealth due to a prospect (kahneman & tversky, 1979). second, utility theory uses stated probabilities to find the expected utility, where expected utility is the summation of utilities from each possible outcome, weighted by the probability of occurrence for each potential outcome. prospect theory, however, uses decision weights in its value function. the decision weighting function proposed by kahneman and tversky (1979) has the decision weights different from the states’ probabilities, except for extreme outcomes. extremely low probability events beyond a certain benchmark are assigned a zero probability of occurrence, whereas those with an extremely high probability of occurrence are treated with certainty. third, utility theory assumes that investors are risk averse, risk neutral or risk seeking, but the same person cannot simultaneously exhibit risk aversion, risk neutrality and risk-seeking characteristics. on the other hand, prospect theory volume 31, number 2 341 predicts that investors would be risk averse in gains and risk seeking in losses, regardless of their level of wealth. the value function of prospect theory follows an s-curve with a gentle slope for gains and a much steeper slope for losses suggesting that investors would suffer a much greater disutility in a loss than they would enjoy utility from a gain of the same absolute magnitude (ding et al. 2004). prospect theory offers an attractive alternative to the assumptions of utility theory in terms of individual decision making among several prospects. in this context, different compensation packages represent different prospects from which to choose. in the following section, we differentiate prospect theory from utility theory and apply prospect theory to the context of executive compensation. there are four primary ways that prospect theory informs the issue of executive compensation. first, prospect theory holds that people overweigh outcomes that are considered certain relative to outcomes that are merely probable. when an executive has a large amount of options relative to total compensation and those options are “in the money”, the executive may choose to “maintain the status quo” and try to hold on to that amount of money. an “in the money” option refers to an option where the underlying stock price is trading at a price above the strike price of the option. for example, if an option were struck at $50, a stock trading at $70 would be considered “in the money” while a stock trading at $30 would be considered “out of the money” or “underwater.” in essence, the executive will view the current level as a certain gain and any additional gains as merely probable. in this case, the executive will adopt a defensive strategy designed to maintain the current stock price until the vesting date of the options. the interests of the shareholders are clearly not aligned with those of the executives. second, the converse also results in incentives being misaligned. if the options are out of the money, there are two alternatives for executives that shareholders would not prefer. first, the executives may become “too risky” in terms of firm strategy in an attempt to rescue the option value before the vesting date. brunnermeir (2004) suggests that individuals exhibit a diminishing sensitivity to losses. a monetary loss at the breakeven point will lead to a far higher decrease in utility than an equal monetary loss from a deep loss position. people become more willing to take on risk after suffering a substantial loss. more specifically, they become less risk averse or even risk seeking over losses. this translates into a value function that is less concave or even convex in the loss region. brunnermeir also claims that individuals’ preferences exhibit loss aversion. therefore, they are much more responsive to losses than to gains. a decrease in income by $x results in a much higher utility loss than the utility gain associated with an increase in income by $x. 342 journal of business strategies in other words, the value function is steeper in the loss region than in the gain region. second, the executives may become disheartened and think that the option becoming “in the money” is hopeless. here, the executive may not continue the pursuit of better financial performance of the firm, as the shareholders would expect. third, prospect theory also holds that an individual’s reference point may shift (kahneman & tversky, 1979). risk preferences depend highly on the individual’s reference income level. the reference income plays an important role in determining whether a prospect will be accepted or not. the reference income level refers to the level to which an individual will compare future states. for example, a person that started a job making $50,000 per year and now makes $100,000 per year will see a drop to $90,000 as a $10,000 loss and not simply a reduction of a gain. therefore, it is useful to consider losses and gains with respect to this reference income level rather than to the absolute income level (brunnermeir, 2004). this further explains the desire to maintain status quo when options are “in the money.” executives who have options “in the money” may change their reference point to the current value of the stock and see even a small drop in stock price as a direct loss rather than a reduction in gain. we have already stated above that an individual’s utility functions are steeper for losses than gains. in this case, the executive will likely minimize the risk of the firm by adopting a defensive firm strategy because firm risk is exactly equivalent to the risk of the executive’s personal wealth. levy and levy (2004) claim that individuals make decisions based on change of wealth rather than the total wealth, which is in direct contradiction to expected utility theory. thus, risk aversion does not prevail globally. individuals become risk seeking regarding losses. additionally, individuals distort objective probabilities and subjectively transform them in a systematic way so that even a small probability for a loss will have a profound impact on executive decision-making. finally, prospect theory also helps to explain the threat of a top manager’s desire to manage earnings. shen and chih (2005) specifically applied prospect theory to the incentives of banks to manage earnings. the theory suggests that individuals derive values from gains and losses with respect to a reference point, rather than being from absolute levels of wealth. it also suggests that individuals’ value functions are concave in gains and convex in losses (s-shape). thus, for a given increase in wealth, the increase in value is greatest when the wealth of the individual increases from a loss to a gain relative to a reference point. if the preferences of the stakeholders are consistent with the prospect theory, then the manager has an incentive to report earnings that exceed the threshold, or the reference point, such as zero earnings levels or zero earnings changes, to obtain more rewards. the s-shape prospect volume 31, number 2 343 theory suggests that the decision maker will be risk averse above the reference point and risk seeking below it. here, executives have incentive to manage earnings in order to avoid earnings decreases. the same could certainly be true for an executive whose compensation is tied to the performance of the firm. hypothesis based on the findings of wright et al. (1996) of a nonlinear relationship between equity ownership and risk taking behaviors as well as the insights of prospect theory, it is expected that the relationship between ownership and firm performance will be nonlinear (concave). thus, this paper extends previous empirical research in hypothesizing that moderate levels of ceo pay for performance will result in the highest returns. h1: the relationship between the percentage of incentive-based ceo compensation and firm performance will be nonlinear (concave). methodology sample the dataset used in this study is drawn from standard and poor’s execucomp. execucomp is an executive compensation database consisting of executive compensation data reported beginning in 1992 to 2004. the dataset reports more than 100 financial variables from 24,170 executives at 2,540 firms from 1992-2004. the original dataset contained 19,167 ceo observations ranging from 19922004. we chose to examine ceos only to avoid confounding the results with multiple observations tied to the same performance item. we deleted the observations that were missing data on one of our focal variables and 19,029 remained. finally, we deleted the observations that had stock prices of less than one dollar because they tend to have highly abnormal returns. the final sample contains 18,540 observations. those observations were sorted by percentage of performance-based compensation and then divided into quintiles, each with 3,708 observations. the purpose of using quintiles was to observe the pattern of the data and subsequently test for mean differences among them. quintile 1 contains the lowest 3,708 observations in terms of percentage performance-based compensation while quintile 5 contains the highest 3,708 observations. each quintile had some missing performance data and thus we lost some observations. the number of observations ranges from 3,496 in quin344 journal of business strategies tile 1 to 3,574 in quintile 4. the cutoffs for the quintiles (in terms of percentage of incentive-based compensation) are as follows: q1 0%; q2 1%-34%; q3 35%-52%; q4 53%-71%; q5 72%-100%. measures, data and analysis we define the independent variable as the percentage of incentive-based compensation relative to the overall compensation for the ceo. previous literature has focused on the percentage of insider ownership (morck et al., 1988; wright et al., 1996) or amount of a rise in performance that should be shared with insiders (jensen & murphy, 1990). here, we choose to examine the percentage of incentive-based compensation to total compensation because we look at ceos only. ceos will likely make their choices in terms of risk-preference based on the actual dollar value they have “on the line” as a percentage of their overall pay rather than basing their preferences on the percentage of the firm they own. incentive-based compensation includes the black-scholes option value plus the value of the restricted stock grants. total compensation includes performance-based compensation plus salary and bonus. the dependent variable for the study is firm performance. we assessed firm performance as the crsp (center for research in security prices) equally weighted mean cumulative abnormal return. cumulative abnormal returns (car) are the returns for a specific firm for one year, two years, etc. following the fiscal year end as compared to the market as a whole. essentially, car are the returns the firm received net of the return they “should have” received simply from being a publicly traded firm operating in this particular industry during the time period examined. results to estimate abnormal performance, we conduct an event study employing a crsp market model. an event study uses the eventus software through wrds (wharton research data services) to determine the impact of a precipitating event (occurring on the “event date”) measured in terms of the market reaction to it. the use of the crsp market model (noted below) allows multiple and overlapping option grants for ceos to be aggregated to one date. thus, it was possible to examine the returns around the specific date. fiscal year end for a firm serves as the focal date because we do not have the date of the option grant and there would be some ceos with several grant dates in one year. mean cumulative abnormal returns were used to examine the performance around the focal date. the crsp market model is stated as: volume 31, number 2 345 rjt = α+βj rmt+ ɛjt, where rjt is the rate of return of the j th firm in month t; rmt is the rate of return on the market index in month t; and βj is a parameter that measures the sensitivity of rjt to the market index. bae and sami (2002) in their investigation of the impact of environmental liabilities on the reliability of accounting information control for market expectation, opportunities for growth, industry membership, firm size, and firm risk. the use of the crsp market model allows control for market expectation, industry membership, and firm risk as well as stock market fluctuations. market expectation and firm risk are controlled because the market model first calculates what a “normal” return should be in order to calculate the “abnormal” return. the normal return is itself the market expectation and takes the inherent risk of the firm into account. stock market fluctuations are controlled because the data runs from 1992-2004 and each year’s returns are given equal weight. therefore, to the extent that the time period 19922004 approximates an “average” of the stock market, our results will be free from a stock market bias. figure 1 displays the results of the association study. the mean abnormal return for each of the first five years was tested after the event date. figure 1 represents the market-adjusted mean cumulative abnormal return. cumulative abnormal return means that the return in year 2 includes the return over the 2-year period, not just year 2 alone. the pattern of the data displayed in figure 1 appears to suggest the underlying relationship is non-linear. the pattern for each of the first three years appear to follow a nonlinear concave curve with a rise from quintile 1 to quintile 2 and from quintile 2 to quintile 3 followed by a subsequent drop from quintile 3 to quintile 4 and from quintile 4 to quintile 5. the four and five year returns do not follow the same pattern exactly because of a drop from quintile 1 to quintile 2, but all data points from quintile 2 through quintile 5 are consistent with expectations and with the results from years 1-3. these results indicate that basing more of an executive’s total compensation on firm performance is linked with higher abnormal returns, but to a certain diminishing point. 346 journal of business strategies figure 1 market-adjusted cumulative abnormal returns figure 1 market-adjusted cumulative abnormal returns two-sample t-tests were used to examine the differences between quintile 1, quintile 3 and quintile 5. all means are significantly different from each other at the p<.001 level, providing evidence that there is a significant rise from quintile 1 to quintile 3 followed by a subsequent significant fall from quintile 3 to quintile 5 for each curve. we ran analyses for each year separately. each of the first two years has the exact same pattern as the curves in figure 1. years 3, 4 and 5 do not have as smooth of a curve, but each of those years shows a dramatic drop from quintile 3 to quintile 5, providing further evidence against a strictly positive relationship. regression results in order to test the curvilinear nature of the data, we ran listwise linear regressions on car measured in five different points in time. the dependent variable is cumulative abnormal return for 12 months, 24 months, 36 months, 48 months and 60 months. first, the controls in model 1 were entered: net sales, total compensation of the ceo and number of employees. in model 2, focal variable of percentage of volume 31, number 2 347 incentive-based compensation was entered to obtain an r-square assuming a linear relationship. in model 3, the squared term of percentage of incentive-based compensation was entered to see if the curvilinear assumption added any explanatory power. the results are remarkably consistent regardless of the number of months used as the dependent variable. in each case, the controls explain a very minimal amount of variance (.004 or less). all r-squares for the linear and curvilinear models are significant at the p<.001 level. in each year, the curvilinear model explains more than twice as much (average of .026 versus .012) variance in cumulative abnormal return than does the linear model. tables one through five display these results. table 1 1-year cumulative abnormal returns model (1) model (2) model (3) constant .007 .031 -.004 (.160) (.674) (-.094) control variables net sales .013 .015 .012 (1.101) (1.306) (1.064) number of employees .015 .016 .014 (1.296) (1.345) (1.186) total compensation -.090*** -.078*** -.059*** (-11.217) (-9.312) (-6.869) compensation variables percent incentive compensation -.042*** .169*** (-5.117) (6.485) percent incentive compensation ^ 2 -.229*** (-8.551) model significance r-squared .011*** .013*** .017*** adjusted r-squared .010*** .012*** .016*** change in r-squared .002*** .004*** * p <.05 level, ** p <.01 level, *** p <.001 level n=18,540 top line = standardized beta coefficients (constant is unstandardized) bottom line = t-statistics (in parentheses) 348 journal of business strategies table 2 2-year cumulative abnormal returns model (1) model (2) model (3) constant .018 .066 -.007 (.244) (.913) (-.092) control variables net sales .022 .025* .021 (1.855) (2.124) (1.810) number of employees .018 .019 .016 (1.549) (1.614) (1.408) total compensation -.116*** -.100*** -.076*** (-14.480) (-12.013) (-8.836) compensation variables percent incentive compensation -.055*** .221*** (-6.659) (8.512) percent incentive compensation ^ 2 -.298*** (-11.208) model significance r-squared .020*** .023*** .030*** adjusted r-squared .019*** .022*** .029*** change in r-squared .003*** .008*** * p <.05 level, ** p <.01 level, *** p <.001 level n=18,540 top line = standardized beta coefficients (constant is unstandardized) bottom line = t-statistics (in parentheses) volume 31, number 2 349 table 3 3-year cumulative abnormal returns model (1) model (2) model (3) constant .035 .111 .002 (.375) (1.182) (.020) control variables net sales .021 .025* .021 (1.809) (2.135) (1.773) number of employees .022 .023* .020 (1.907) (1.987) (1.752) total compensation -.126*** -.107*** -.079*** (-15.849) (-12.945) (-9.312) compensation variables percent incentive compensation -.066*** .252*** (-8.040) (9.745) percent incentive compensation ^ 2 -.343*** (-12.974) model significance r-squared .025*** .029*** .039*** adjusted r-squared .024*** .028*** .038*** change in r-squared .004*** .010*** * p <.05 level, ** p <.01 level, *** p <.001 level n=18,540 top line = standardized beta coefficients (constant is unstandardized) bottom line = t-statistics (in parentheses) 350 journal of business strategies table 4 4-year cumulative abnormal returns model (1) model (2) model (3) constant .030 .129 -.014 (.264) (1.148) (-.124) control variables net sales .018 .022 .017 (1.535) (1.892) (1.496) number of employees .023* .024* .021 (1.995) (2.083) (1.827) total compensation -.131*** -.110*** -.080*** (-16.460) (-13.325) (-9.382) compensation variables percent incentive compensation -.072*** .275*** (-8.794) (10.673) percent incentive compensation ^ 2 -.375*** (-14.210) model significance r-squared .027*** .032*** .044*** adjusted r-squared .027*** .031*** .043*** change in r-squared .005*** .012*** * p <.05 level, ** p <.01 level, *** p <.001 level n=18,540 top line = standardized beta coefficients (constant is unstandardized) bottom line = t-statistics (in parentheses) volume 31, number 2 351 table 5 5-year cumulative abnormal returns model (1) model (2) model (3) constant .008 .123 -.041 (.059) (.954) (-.319) control variables net sales .015 .019 .014 (1.284) (1.644) (1.246) number of employees .021 .022+ .019 (1.850) (1.939) (1.682) total compensation -.131*** -.111*** -.080*** (-16.522) (-13.354) (-9.408) compensation variables percent incentive compensation -.073*** .274*** (-8.901) (10.653) percent incentive compensation ^ 2 -.375*** (-14.224) model significance r-squared .028*** .033*** .045*** adjusted r-squared .028*** .032*** .044*** change in r-squared .005*** .012*** * p <.05 level, ** p <.01 level, *** p <.001 level n=18,540 top line = standardized beta coefficients (constant is unstandardized) bottom line = t-statistics (in parentheses) discussion and implications pierce and aguinis (2013) introduce a meta-theoretical principle called toomuch-of-a-good-thing effect (tmgt effect). they suggest antecedent variables widely accepted as leading to desirable consequences sometimes actually lead to negative outcomes. the authors posit that, due to the tmgt effect, seemingly monotonic positive relations reach context-specific inflection points after which relations turn asymptotic and often negative, resulting in an overall pattern of curvilinearity. the authors offer examples in key areas such as organization behavior (e.g. leader352 journal of business strategies ship, personality), human resource management (e.g. job design, personnel selection), entrepreneurship (e.g. new venture planning, firm growth rate), and strategic management (e.g. diversification, organizational slack). we believe our results fit well with the implications of the tmgt effect. specifically, the results indicate moderate levels of incentive-based compensation of ceos are optimal for overall firm performance. ceos in q3 (ceos receiving 35-52% incentive-based compensation) consistently outperform other ceos. most interestingly, the ceos in q3 significantly outperform those in q4 and q5, meaning incentive-based compensation is good to a point but there is a tmgt effect. this finding is robust across each of the first five years of financial performance after the announcement of stock option grants. the implication of our findings is that basing more of an executive’s total compensation package on firm performance is associated with higher abnormal returns to a point, but beyond that point diminishing returns occur. specifically, the peak car occurs for ceos given 42% incentive-based compensation. our results lead us to believe that agency theory does not tell the whole story. at some point, it becomes detrimental for a firm to give an executive more performance-based pay relative to total pay. this study provides useful insights for both future research and managerial practice. from a risk perspective, these results are consistent with those of wright et al. (1996). they found insider ownership to have a nonlinear (concave) relationship with firm risk-taking. we agree that aligning the risk propensities of ceos and shareholders is the key for increased performance, and our study provides evidence of the effect of compensation package on that performance. prospect theory helps explain the misalignment of incentives between the ceo and shareholders. executives possessing options in the money are more likely to adopt a strategy that is too defensive while those out of the money are likely to become too risky. executives also shift their reference points to the current stock price, meaning every rise or fall in the stock price feels like a real financial gain or loss to the executive. obviously, so much focus on the stock price gives the executive incentive to increase that value at all costs, maybe even engaging in unethical behavior in the process. another potential explanation not explored in this paper is the role of prior wealth of the ceo. if a ceo is very wealthy prior to his/her current employment, he/she may be more willing to assume risk because this income is expendable. these explanations in light of prospect theory certainly have face validity but need to be corroborated, perhaps through additional qualitative research. agency theory has long served as the basis for executive compensation research. the application of agency theory, however, has produced mixed results in volume 31, number 2 353 the literature. dalton et al. (2003) suggested agency theory alone is insufficient, stating that a new lens must be applied. we agree with their suggestion and provide convincing evidence that a positive linear relationship assumption does not tell the whole story in terms of proper structuring of executive compensation contracts. certainly, some amount of the ceos compensation should be tied to the performance of the firm in order to properly align his/her interests with those of the shareholders. however, past some point (around 42% for ceos in this study), more relative incentive-based compensation is associated with poorer firm performance. we have suggested the insufficiency of agency theory is due to its reliance on certain assumptions of utility theory. we offer prospect theory as an alternative to utility theory and apply it to the executive compensation context. prospect theory provides greater insight into the link between incentive-based compensation and ceo risk preference. this insight can also be useful in explaining the appropriate levels of incentives varies by ceo. our findings support the use of prospect theory to develop a stronger understanding of executive compensation, and help set the stage for future research in this arena. a potential managerial implication of our results is that boards of directors need better communication with their ceos. board members could simply inquire of the ceo’s preferences for incentive compensation rather than trying to assume their preferences. the purpose of an incentive-based compensation plan is to properly motivate the executive. our results suggest the amount of incentive-based compensation should be a sizable percentage (35-52%) of total compensation, but what properly motivates one ceo may not work for another. ceos and boards should work together to create a compensation package that provides the stability of guaranteed salary and the performance incentive of stock options. this can lead to a situation that promotes better performance at both the executive and firm level. limitations and future research our results suggest a moderate level of performance-based compensation package is most appropriate, particularly when based on the ceo’s specific risk preferences. future research in this arena should incorporate qualitative measures to support our empirical findings. this qualitative research could include and this could include detailed interviews with ceos. such interviews may offer more evidence as to the levels of risk seeking and risk aversion among executives. additional research should also examine contingency factors where this relationship may be stronger or weaker, such as firm size, firm age, and industry. our study examined only the 354 journal of business strategies overall sample of ceos, but future studies might examine mean differences between subsets of ceos. these studies should employ a variety of performance measures to determine if the nonlinear relationship is robust across accounting performance measures as well as market measures. a more thorough understanding of executive compensation can lead to better relationships between ceos and their boards. conclusion in conclusion, this paper demonstrates there is a relationship between incentive-based ceo compensation and the actual performance of the firm. while the variance explained may appear to be a rather small number, the results of this small number when examined on the scale of a large corporation are immense. executive compensation can be very complex and our results shed some additional light on this critically important topic. an appropriate compensation package is needed to attract the necessary executive talent to best deliver positive organizational outcomes. by utilizing prospect theory, this paper has demonstrated there is a non-linear (concave) relationship between incentive-based ceo compensation and firm performance. as margins continue to shrink and competition continues to increase, the optimal ceo compensation package, should be an area of increased concern. if firms, by properly structuring their ceo compensation plans, can increase performance then this research can support proper decision making in regards to that compensation package. therefore, we suggest that our findings provide value for both academic researchers and business practitioners, and add a new piece to our understanding of the executive compensation puzzle. references bae, b. & sami, h. (2005). the effect of potential environmental liabilities on earnings response coefficients. journal of accounting, auditing & finance, 20, 4370. brunnermeir, m. (2004). learning to reoptimize consumption at new income levels: a rationale for prospect theory. journal of the european economic association, 2, 98-114. buck, t., bruce, a., main, b., & udueni, h. (2003). long-term incentive plans, executive pay and uk company performance. the journal of management studies, 40, 1709-1727. chaudhri, v. (2003). executive compensation: understanding the issues. australian economic review, 36, 300-305. volume 31, number 2 355 dalton, d., daly, c., certo, t., & roengpitya, r. (2003). meta-analyses of financial performance and equity: fusion or confusion? academy of management journal, 46, 13-26. ding, d., charoenwong, c., & seetoh, r. (2004). prospect theory, analyst forecasts, and stock returns. journal of multinational financial management, 14, 425442. eisenhardt, k. (1989). agency theory: an assessment and review. academy of management review, 14, 57-74. eisenmann, t. (2002). the effects of ceo equity ownership and firm diversification on risk taking. strategic management journal, 23, 513-534. hambrick, d. & jackson, e. (2000). outside directors with a stake: the linchpin in improving governance. california management review, 42, 108-124. jensen, m. & meckling, w. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3, 305-360. jensen, m. & murphy, k. (1990). performance pay and top management incentives. journal of political economy, 98, 225-264. kahneman, d. & tversky, a. (1979). prospect theory: an analysis of decision under risk. econometrica, 47, 263-291. kim, j. (2004). executive compensation contracts: change in the pay-performance sensitivity within firms. journal of american academy of business, 4, 449-454. levy, h. & levy, m. (2004). experimental test of the prospect theory value function: a stochastic dominance approach. organizational behavior and human decision processes, 89, 1058–1081. mcconnell, j. & servaes, h. (1990). additional evidence on equity ownership and corporate value. journal of financial economics, 27, 595-612. mcguire, j. & matta, e. (2003). ceo stock options: the silent dimension of ownership. academy of management journal, 46, 255-265. mehran, h. (1995). executive compensation structure, ownership, and firm performance. journal of financial economics, 38, 163-184. mengistae, t. & lixin, c. (2004). agency theory and executive compensation: the case of chinese state-owned enterprises. journal of labor economics, 22, 615637. morck, r., shleifer, a., & vishny, r. (1988). management ownership and market valuation: an empirical analysis. journal of financial economics, 20, 293-315. noorderhaven, n.g. (1992). the problem of contract enforcement in economic organization theory. organization studies, 13(2), 229. 356 journal of business strategies pierce, j. & aguinis, h. (2013). the too-much-of-a-good-thing effect in management. journal of management, 39, 313-338. shen, c. & chih, h. (2005). investor protection, prospect theory, and earnings management: an international comparison of the banking industry. journal of banking & finance, 29, 2675-2697. sundaramurthy, c., rhoades, d., & rechner, p. (2005). a meta-analysis of the effects of executive and institutional ownership on firm performance. journal of managerial issues, 17, 494-510. tsetsekos, g. & defusco, r. (1990). portfolio performance, managerial ownership, and the size effect. journal of portfolio management, 16, 33-39. wright, p., ferris, s., sarin, a., & awasthi, v. (1996). impact of corporate insider, blockholder, and institutional equity ownership on firm risk-taking. academy of management journal, 39, 441-458. wright, p., kroll, m. & davis, p. (2007). the influences of the chief executive officer’s stock and option ownership on firm risk taking: an examination of resource allocation choices. academy of strategic management journal, 6, 47-68. biographical sketch of authors joshua r. aaron is an assistant professor in the management & marketing department in the jennings a. jones college of business at middle tennessee state university. he currently serves as the treasurer of the national small business institute®. dr. aaron’s research and expertise focuses on strategic management, strategic planning, corporate reputation and small business strategy. michael l. harris is an associate professor and chair of the department of management at east carolina university. he currently served as the vice-president of the national small business institute®. dr. harris’ research interests include small business strategy, entrepreneurial attitudes and intentions, and entrepreneurship education. william c. mcdowell is a full professor and the wright travel chair in entrepreneurship in the jennings a. jones college of business at middle tennessee state university. he currently serves as the president-elect of the national small business institute®. dr. mcdowell’s research and expertise focuses on small business and entrepreneurship. brandon n. cline is the bancorpsouth professor of finance in the department of finance and economics at mississippi state university. dr. cline’s research focuses on insider trading, executive compensation, equity offerings, and corporate governance. development of a generic knowledge strategy typology paul e. bierly iii james madison university harrisonburg, va abstract knowledge strategies are the set ofstrategic choices related to firms' knowledgebases that provide a guideline for strategic action. in this paper, we develop a variety ofpossible generic knowledge strategies and discuss how they can be internally consistent, mutually reinforcing, and lead to a sustainable competitive advantage. introduction over the last several years a knowledge-based view of the firm has blossomed and has provided a fresh, new perspective for the study and development of organizational design and strategic management (grant, 1996a, b; spender, 1996; nonaka, 1994; conner & prahalad, 1996). according to this view, the principal function of an organization is the creation, integration, and application of knowledge. sustainable competitive advantages and performance differences are the result of firms having unique knowledge-bases and their capability of managing their different knowledge areas. several authors have relied on the principles of the knowledge-based view to propose improvement in organizational design. for example, hedlund (1994) developed an n-form organizational structure to facilitate knowledge integration and sanchez and mahoney (1996) illustrated the importance of modularity with respect to product and organizational design to facilitate knowledge management. in addition, a number of scholars have illustrated the importance of a knowledge-based view to successfully manage strategic alliances (hamel, doz & prahalad, 1989; hamel, 1991; mowery, oxley & silverman, 1996). a knowledge-based view of the firm has also reshaped the field of strategic management. 1 some, such as spender (1996), go so far as to suggest the field is in the middle of a paradigm shift. today, when managers develop a strategy outlining how they will compete in their different industries, they are strongly advised to focus on their core competencies and capabilities (hamel & prahalad, 1994; prahalad & hamel, 1990; leonard-barton, 1995). the essence of strategy, the development of sustainable competitive advantages, can then be viewed as the development and application of these core competencies. however, to date this advice to become a learning (i.e., senge, 1990; garvin, 1993) or knowledgecreating company (i.e., nonaka, 1991; leonard-barton, 1995) has mostly guided organizations to try to maximize their learning and has not addressed the specific 2 journal of business strategies vol. 16, no.1 strategic choices that arise in this process. these sets of strategic choices are what we refer to as the firms' generic knowledge strategies and provide firms with a guideline for strategic action. other generic strategy typologies, such as porter's (1980) (low cost, differentiation, and focus), have emphasized that, for each type of generic strategy, there must be consistency of strategic actions, organizational design, control systems, human resource systems, and organizational culture. thus, each of the different generic strategies provide a fundamentally different approach to the strategic management of the firm. each of the different generic strategies seek to create and sustain competitive advantages using different internally consistent sets of resources, skills and systems. the purpose of this paper is to develop a variety of possible generic knowledge strategies and discuss when and how they can be internally consistent, mutually reinforcing, and lead to a sustainable competitive advantage. thus, the underlying basis of our generic knowledge strategies, the need for internal consistency in strategic decisions, is similar to the rationale for the development of other generic strategies such as porter's, except that ours is narrower in focus and based on a knowledge-based perspective. elsewhere, exploratory empirical studies have identified the existence of different approaches to knowledge management in specific settings (henderson & cockburn, 1994; pisano, 1994; bierly & chakrabarti, 1996a). our aim is to develop a broad-based typology of generic knowledge strategies and also explain why certain combinations of strategic knowledge decisions are unlikely to be successful in certain conditions. the nature of organizational knowledge knowledge is a highly contentious, abstract, and multifaceted concept that has chal1enged the greatest minds of the world. it is related, but clearly different, than concepts such as information, technology, science and truth. webster's (1981: 1252) defines knowledge as the "acquaintance with or theoretical or practical understanding of some branch of science, art, learning, or other area involving study, research, or practice and the acquisition of skills." key elements of the concept of knowledge are: (a) that knowledge can be created through experience (empiricism) or reason (theory), (b) the development or acquisition of some skills is critical to the enhancement of knowledge, (c) knowledge is a "broad" concept in the sense that it includes but is not limited to science, art, information and technology, and a "deep" concept in that it requires understanding of the area, and (d) there are different types of knowledge. knowledge and learning can be viewed as inextricably related concepts in the following manner: knowledge is a stock variable and learning is a flow variable. at a gi ven point of time, an indi vidual or group possesses a stock of knowledge and this stock is changed over time by a learning process (or unlearning in the case where the stock is depleted). spring 1999 bierly: generic knowledge strategy 3 concerning organizational knowledge, most of the research has focused on describing and categorizing different types of knowledge and explaining the differences between individual and social knowledge (spender, 1994). an important distinction of knowledge is between tacit and explicit knowledge. knowledge can be classified as explicit if it can be transferred from one individual to another using some type of formal communication system. thus, explicit knowledge must be articulable or codifiable. on the other hand, tacit knowledge is generally viewed as knowledge that cannot be fonnally communicated (polanyi, 1966). tacit knowledge is deeply rooted in one's experience and own "mental model." the distinction between explicit and tacit knowledge is important when we evaluate competitive differences between firms. tacit knowledge is more valuable and more likely to lead to a sustainable competitive advantage than explicit knowledge because it is much harder for competitors to imitate (winter, 1987; kogut & zander, 1992; zander & kogut, 1995). inimitability is further increased when the knowledge is complex and combined with other types of knowledge in an unclear fashion; that is, there is causal ambiguity (kogut & zander, 1992; lippman & rumelt, 1982). even though the importance of tacit knowledge is stressed in many theoretical discussions, the usefulness of the concept is limited due to the vagueness and complexity of the topic. specifically, the concept of tacit knowledge is vague because there is not an accurate and precise definition of what it is; instead the focus is on what it is not. it is knowledge that is not codifiable or explicit. due to the vagueness of the term, it is essentially impossible to conduct useful empirical research to detennine the different impact of tacit and explicit knowledge. in addition, almost no knowledge is fully tacit or explicit; most "complex" knowledge is difficult to transfer and often meaning is altered during the transfer. knowledge that may be easy to transfer between two specific individuals may be very difficult to transfer between two other individuals due to different training, language, and mental models. thus, instead of classifying knowledge as either tacit or explicit, it is probably more appropriate to discuss different degrees of tacitness for different situations. when discussing the concept of organizational knowledge it is also important to clarify the difference between individual, group and organizational learning. according to simon (1991), all knowledge is initially created or acquired by individuals. individual learning is a prerequisite for organizational learning. after an individual learns, knowledge is first passed on to other "close" individuals who share similar interpretation frameworks, or what brown and duguid (1991) refer to as a community-of-practice. this social context of knowledge transfer between individuals is an extremely important part of the process of organizational learning (march. 1991). besides having the ability to ueate or interpret new ideas from outside sources, "expert" individuals must also have the social skills to pass the knowledge to others. more explicit knowledge may be easily passed from one individual to another, but more tacit knowledge may require informal and difficult methods, such as the use of 4 journal of business strategies vol. 16, no.1 stories or metaphors (brown & duguid, 1991). however, the collective knowledge of the group often is much more than the sum of the individuals' knowledge. synergies exist between individuals as the knowledge is integrated and reinterpreted by others (spender, 1994). group norms can be used to store certain types of knowledge and pass them on to others. organizational knowledge can be viewed as the integration of group knowledge, mainly through middle level managers (nonaka, 1994). generally speaking, organizational knowledge is referred to that knowledge that has diffused throughout the entire organization. however, in reality this is rarely the case since not all individuals have the ability to interpret and understand the new knowledge. whereas it may be difficult to transfer knowledge to other work groups and there may be limited incentive to do so, it usually is critical to transfer knowledge up through an organization to the key strategic decision makers who allocate resources. once knowledge has reached the top of the organization, it then becomes institutionalized and forms the basis for new organizational rules, procedures and routines, which are the means that the knowledge is stored within the organization. then other individuals are socialized to the new organizational beliefs (march, 1991). this process of mutual individual and collective learning is never-ending. in addition, as the knowledge is transferred up and down the organization, the knowledge spirals and expands through different conversion modes, including the conversion of tacit knowledge to explicit knowledge, and vice-versa (nonaka, 1994). over time, the knowledge becomes embedded in routines (nelson & winter, 1982), and after employees come and go throughout the organization the organization's knowledge-base becomes distinct from the aggregate knowledge of individuals at a specific point of time. the processes of knowledge transfer within an organization and across organizations creates a dilemma for the strategic decision makers of an organization (kogut & zander, 1992). the transfer of knowledge within the firm is maximized if the knowledge is more codifiable and simple. members of the organization outside the community-of-practice can readily interpret, understand, and integrate the knowledge with their own knowledge-base. however, the more codifiable and simple the knowledge becomes, the easier it is for competitors to imitate. thus, actions by a firm to maximize the speed and quantity of knowledge transferred within the organization typically are inconsistent with actions to limit the flow of the knowledge outside the organization. the evolution of the knowledge-based view of the firm the current focus on the importance of knowledge, and the strategic implications of a firm's knowledge structure, has evolved from three different, but related, streams of research. first, organizational theorists have attempted to develop a general theory of organizational learning. even though there is widespread acceptance of the notion of organizational learning and its importance to spring 1999 bierly: generic knowledge strategy 5 organizational performance, no model of organizational learning is widely accepted (fiol & lyles, 1985). huber (1991) argues that the effort to develop a general theory of organizational learning has been mostly unsuccessful for the following reasons. (a) each theorist, or group of theorists, defines organizational learning quite differently. for example, fiol and lyles define organizational learning as "the process of improving actions through better knowledge and understanding" (1985, p. 803). this narrow definition requires a change in behavior of the organization to ensure learning has occurred. alternatively, according to huber "an entity learns if, through its processing of information, the range of its potential behaviors is changed" (1991; 89). this broader definition specifically does not require a change in behavior; he argues organizations can "learn" and decide not to act on their new knowledge. weick (1991) argues that in some cases, there is too much reliance on the traditional (stimulus-response) definition of learning, which most psychologists and experts in learning view as a very limiting case of learning and do not support as a general framework. (b) many researchers only attempt to analyze a specific type of organizational learning or a specific part of the learning process. for example, whereas some researchers focus on adaptive learning (e.g., hedberg, nystrom & starbuck, 1976; nystrom & starbuck, 1984), others focus on vicarious learning (e.g., gilad & gilad, 1988), and still others focus on experiential learning (e.g., argyris, 1982; argyris & schon, 1978). furthermore, whereas each of the above researchers is primarily focusing on information acquisition, others have focused on information distribution (e.g., huber, 1982; huber & daft, 1987), information interpretation (e.g., daft & weick, 1984), or organizational memory (e.g., nelson & winter's, 1984, discussion of routines and gioia & poole's, 1984, discussion of scripts). (c) there is little integration of these different views (huber, 1991; fiol & lyles, 1985) and support for the theoretical arguments is limited and is usually based on computer simulation models (e.g. eyert & march, 1963; levinthal & march, 1981; march, 1991; lant & mezias, 1992) or case studies (e.g. brown & duguid, 1991; bierly & spender, 1995). recent attempts to synthesize this literature and standardize terminology, such as miller (1996), have not yet been generally accepted. second, a group of strategic management theorists have focused on the importance of organizational capabilities (prahalad & hamel, 1990; teece, pisano & shuen, 1997; leonard-barton, 1992, 1995; stalk, evans & shulman, 1992). they view the central issue of strategy as the development of a set of core capabilities or competencies that will provide a competitive advantage. most of these theorists believe that the firm's knowledge structure and its ability to learn are the backbone of this approach to strategy and some have viewed learning as the meta-capability that is the principal driver of all other organizational capabilities (e.g., lei, hitt & bettis, 1996). prahalad and hamel define core competencies, which they claim are the roots to competitive advantage, as "the collective learning in the organization, especially how to coordi6 journal of business strategies vol. 16, no.1 nate diverse production skills and integrate multiple streams oftechnologies" (1990: 82). this "school" of strategy, which evolved from the resource-based view of the firm, has become very popular and has recently influenced the strategic thinking of many corporate executives. third, organizational theorists that study innovation and the management of technology have increasingly focused on the firm's knowledge structure and its reconfiguration (henderson & clark, 1990; cohen & levinthal, 1990; imai, nonaka & takeuchi, 1988; wheelwright & clark, 1992). the study of conditions for successful innovation (e.g., kanter, 1988) are inextricably related to the conditions required for organizational learning. technology can be viewed as one type of organizational knowledge and the study of technology transfer can be considered a specific type of knowledge acquisition and distribution. most of these researchers focus on the development of new products and processes, and specifically the explicit technologies associated with these innovations. only recently have researchers in this field shifted their attention to the tacit knowledge associated with innovations and realized how different knowledge environments affect the innovation process (e.g., cohen & levinthal, 1990; pisano, 1994). in a similar manner, earlier research on technology strategies (e.g., maidique & patch, 1983) has some similarities to what we are terming knowledge strategies. broadly speaking, the major thrust of each of these three streams of research is that the management of a firm's knowledge-base and its ability to learn are critical to its success. but each group is looking at the process of learning and its purpose from different perspectives. most of the researchers in the organizational learning group are addressing issues related to the adaptive behavior of firms in response to a change in the environment. many of them place narrow boundaries on the concept of learning in the sense that they only consider learning to occur if actions have visibly changed (i.e., argyris & schon, 1978; fiol & lyles, 1985; see huber, 1991, for a detailed discussion of the shortcomings of this narrow view). alternatively, the strategic management group outlined above takes the perspective that learning is a more creative and proactive process. their focus is on the development of new, inimitable capabilities that lead to a sustainable competitive advantage. the management oftechnology perspective oflearning is different than the other two views in that most of the work in this area is narrowly focused on the new product development process. the knowledge-based view of the firm essentially can be viewed as a holistic approach that includes and integrates these three different streams of research. elements of a knowledge strategy to date, the research discussed above has expanded our understanding of the descriptive process of knowledge generation and application within a firm. however, recommendations of how to best become a learning or knowledge-creating organization have been very broad and not too practical. the advice of most "exspring 1999 bierly: generic knowledge strategy 7 perts" (e.g. senge, 1990; nonaka, 1991) is that managers need to develop the proper climate to foster learning and creativity. essentially, managers are simply guided to maximize learning as best they can. however, we believe that there are several critical strategic choices managers make, either as part of an explicit or implicit strategy-making process, that provide the foundation for their knowledge strategy. these decisions mayor may not be explicitly declared by top management. often they are implied by top management's actions regarding the allocation of resources and the establishment of different customs, goals, procedures and incentive systems. nevertheless, these decisions shape and direct the organization's learning process and, subsequently, determine the firm's knowledge-base. our intention is not to imply that there is one best strategy that will maximize learning, but quite the contrary, we propose that there are several internally consistent generic knowledge strategies that may be successful in certain circumstances. we propose that there are four basic tradeoffs that require strategic decisions concerning knowledge management. (1) internally vs. externally sourced knowledge. (2) enhanced vs. new knowledge. (3) fast vs. slow speed of learning. (4) depth vs. breadth of knowledge-base. for each of these four areas, there are advantages and disadvantages of placing stronger emphasis in one or the other direction. ideally, organizations would prefer to achieve the best of both worlds concerning these tradeoffs, however this usually can not be accomplished due to limited resources, cultural conflict, and a need for internal consistency. we define a firm's generic knowledge strategy as the collective responses to these four strategic choices, whether each of the responses is a formally stated decision or a more emergent, culturally-driven reaction to a perceived environmental condition. internally vs. externally sourced learning internal learning is the generation and distribution of new knowledge within the boundaries of the firm. external learning can be defined as a two step process where, first, boundary spanners are exposed to knowledge from an outside source and, second, the knowledge is passed on throughout the organization. ideahy, firms want to excel at both internal and external learning, but this is rarely the case. due to limited resources, limited management attention, and the nature of the finn's culture, firms tend to focus more and excel at either internal or external learning. for example, firms that develop a strong sense of pride in being the leaders in knowledge development in a certain field may be skeptical and resistant to the ideas of outsiders. on the other hand, firms that are excehent at benchmarking may become experts at improving products and processes within a given frame of reference, but may lack the creativity and out-of-the-box thinking required to generate new ideas internally. 8 journal of business strategies vol. 16, no.1 from one point of view, internalleaming is most critical to the development of core competencies, competitive advantages and superior profits (bierly & hfunalliinen, 1995). if a competency is to be unique to a finn and inimitable to competitors, it must be internally developed and not obtained from an outside source that is also available to others. additionally, certain types of knowledge need to be internally sourced. specifically, systemic knowledge, which is defined as knowledge that is complexly integrated with other knowledge areas, should be internally sourced so that the finn can better understand and have more control over the development process (chesbrough & teece, 1996). the tacit nature of systemic knowledge essentially makes it nearly impossible to obtain from an outside source. from another point of view, a strong focus on external learning has several advantages to a firm. a firm can develop a broader knowledge-base and keep in touch with leading technologies by maintaining an external focus. this broader knowledge-base allows a firm to have more strategic flexibility and be more adaptive to changing environments (bierly & chakrabarti, 1996c; grant, 1996b). costs can be reduced since there is less "reinventing the wheel." however, excessive reliance on external learning may degrade a firm's internal learning skills to such an extent that it may be difficult to maintain core competencies and sustainable competitive advantages. for example, hitt, hoskisson, ireland and harrison (1991) illustrated that increased reliance on acquisitions as a source of new products often results in reductions in both r&d inputs and outputs. this study supports, in a limited case, our assertion that there exists tradeoffs between internal and external learning and it is very difficult for a firm to excel at both. this dimension of internal vs. external learning is further complicated in the sense that the two are mutually interdependent and complimentary processes. to be successful at external learning, members of the finn must already have enough knowledge in the area to understand, interpret and realize the benefits of the external knowledge source. this ability to internalize outside knowledge, which cohen and levinthal (1990) refer to as "absorptive capacity," can be enhanced by internal learning methods, such as internal r&d, production experience, and technical training. likewise, external learning can facilitate the internalleaming process by providing a source of new ideas and a different perspective for viewing both problems and opportunities. no company is so large that they have enough resources to excel at all areas and can not benefit from advice from others. in summary, it is hard to imagine a successful finn that is poor at either internal or external learning. both are important to the success of the finn, but usually a finn can not aggressively pursue both simultaneously due to limited resources and various tradeoffs. finns determine the balance of internal and external learning that is best for them based, in part, on the other dimensions of their knowledge strategy. enhanced vs. new knowledge another dimension of a firm's knowledge strategy is whether the firm focuses more on new, original knowledge or on enhancing knowledge domains they spring 1999 bierly: generic knowledge strategy 9 already understand. product innovations based on new knowledge are usually classified as radical, whereas innovations based on enhanced knowledge are incremental (see tushman & anderson, 1986). concerning the learning process, firms that focus on enhancing the current knowledge-base usually stay within a gi ven frame of reference, which argyris and schon (1978) refer to as single-loop learning. firms that focus on new knowledge areas typically must challenge basic assumptions, values and mental models, which is referred to as double-loop learning. similarly, march (1991) outlined the tradeoffs associated with the exploitation of current knowledge that maximizes profits in the short-run, and the exploration of new knowledge that maximizes long-term success. exploration is costly and risky, but is more likely to lead to a sustainable competitive advantage. too much focus on exploration does not allow firms to reap the benefits from its breakthroughs. on the other hand, march (1991) has illustrated how firms that focus too much on exploitation typically find themselves trapped in suboptimal stable equilibria. they may become experts in an area that has become obsolete. however, few firms are successful at developing both enhanced and new knowledge, primarily because there are usually limited resources within the firm (levinthal & march, 1993). however, other researchers (e.g., volberda, 1996; hedlund, 1994) have also pointed out that focusing on new knowledge and focusing on enhancing a current knowledge-base often require different types of organizational cultures and structures. learning speed in essence, this decision concerning speed of learning comes down to the practical decisions about how much resources should be allocated to further speeding up the learning process. in general, firms want to learn and develop new products as fast as possible. in many industries, such as the computer and computer software industries, time is an important source of competitive advantage (stalk, 1988; bower & hout, 1988). in such industries, first-mover advantages typically outweigh additional development costs and risk associated with being aggressive (see lieberman & montgomery, 1988). however, learning too fast and committing oneself to a specific knowledge trajectory may create major problems if one ends up on the "wrong branch of the tree" (levinthal & march, 1981). when environmental signals are ambiguous and make learning difficult, it is often better to learn at a slower rate to ensure reliability (herriott, levinthal & march, 1985; lounamaa & march, 1987). once a firm proceeds along a certain knowledge trajectory, it may be difficult to switch to a different trajectory because (a) the firm may be too far behind competitors in the other area and (b) it may be difficult to garner internal support to change, especially if the current learning path has experienced at least moderate success (march, 1991). additionally, slower learning may allow complementary knowledge streams to progress together, allowing for the better integration of different knowledge areas and, in the end, a superior collective knowledge-base. 10 journal of business strategies vol 16, no.1 this dimension of learning speed can also be influenced by the internal vs. externalleaming dimension outlined above. there is a debate whether more internal or external learning increases innovation speed. some research has indicated that more internal learning will decrease technology cycle time and increase learning speed (bierly & chakrabarti, 1996b). if a fmn generates new knowledge internally, such as in its r&d lab, it will have a much deeper understanding of the knowledge than outsiders and will probably face fewer internal organizational barriers to change. most likely, there will be a strong commitment toward the technology by the employees and a sense of ownership. also, it is much more likely to have a strong champion within the organization that will be able to overcome others' natural resistance to change and obtain necessary resources for further development (chakrabarti, 1974). external learning is often slower because a) there is no internal champion, b) it may be difficult to interpret and understand the external knowledge, and c) the "not in~ vented here" syndrome may be a substantial barrier. other researchers have argued the opposite: more reliance on externalleaming will increase learning speed (kessler & chakrabarti, 1996; gold, 1987; meyer, 1993). this counter argument stresses the importance of not "reinventing the wheel" and using partners to keep abreast of cutting-edge technologies. since no firm can efficiently develop a broad range of technologies, they should focus on the few that they can best develop and rely on others to provide supporting technologies. to summarize, there probably is not a simple linear relationship between technology sourcing and learning speed. both internal and external learning can support and hinder the speed of learning in different ways, depending on the situation. breadth of knowledge-base the final dimension of a firm's knowledge strategy is the decision of whether the firm should develop a narrow and hopefully deep knowledge-base or a broad and shallow knowledge-base. again, with limited resources firms cannot realistically pursue both a broad and deep base. according to hamel and prahalad (1994), most firms are better off if they focus on specific domains of knowledge (core competencies) so that they can become leaders in those areas. they illustrated the strategic importance of developing core products and a depth in a few critical knowledge areas in a wide range of cases. however, for some firms the opposite strategy may be more successful. if firms have a broader knowledge-base they are better able to combine related technologies in a more complex manner, which can create causal ambiguity and sustainable competitive advantages (reed & defillipi, 1990). additionally, if a firm's knowledge-base is too narrow, its core capabilities may evolve into core rigidities since the firm may lack the ability to monitor and adapt to advances in different but related knowledge areas (leonardbarton, 1992). in general, a broader knowledge-base results in increased strategic flexibility and allows firms to be more adaptive to external changes (grant, 1996a; volberda, 1996). spring 1999 bierly: generic knowledge strategy one best knowledge strategy in an industry? 11 spender (1989) illustrated that within an industry an 'industry recipe' develops that can be viewed as a shared set of ideas that become institutionalized and provide a guide to action. he defined strategy as "the intellectual response to the uncertainties present in the managers' ideas and data about the organization" (spender, 1989: 186). however one could, incorrectly, extend this framework to assume that since finns within an industry share a common industry recipe, then they would have common beliefs concerning uncertainty resolution and learning; similar rational intellectual responses would result in all finns following the one best knowledge strategy in the long run. this line of reasoning is faulty for several reasons. first, industry recipes are changing rapidly in many industries due to radical technological advances and the blurring of industry boundaries. finns adapt to these changes of industry recipes at different rates, thus creating groups of finns with each group following a different recipe at a given point of time. second, even if a dominant industry recipe exists, firms may choose different knowledge strategies because they have different histories, organizational cultures, resources and capabilities, and because they are at different evolutionary stages. even though in the long run these differences may tend to converge if the industry recipe remains constant and the environment remains stable 2 , this would not be the case if the industry recipe continually changes, especially if the recipe changes at a faster rate than the organizations can change their cultures, capabilities, etc. third, detennining industry boundaries is a difficult and somewhat arbitrary process. a different industry recipe may evolve for the different segments of an industry, each with different competitive environments, which could result in a dominant know ledge strategy for each segment. for example, pisano (1994), in studying manufacturing process development projects in phannaceuticals, concluded that finns in different environments had different approaches for learning. for the above reasons, we believe that within a given industry, groups offinns do exist with different knowledge strategies. from the above argument, it also follows that perfonnance will differ for finns following different knowledge strategies for the following three reasons. first, if the industry recipe is changing, the groups of firms that are able to adapt quicker, such that their current cognitive frames are closer to reality, will be more successful. second, there may be superior knowledge strategies for an industry, but only firms with the prerequisite rare resources and capabilities will be able to pursue these strategies. other finns would be forced to follow a knowledge strategy commensurate with their assets. third, industry segments may differ in their profitability due to the industry structure. it is our contention that there are similar knowledge strategies in many industries, particularly in industries with dynamic and complex (hypercompetitive) environments where organizational knowledge is clearly the finn's preeminent resource. for different knowledge strategies there are examples of finns in other 12 journal of business strategies vol. 16, no.1 industries that have been successful, and firms that have been unsuccessful. industry characteristics such as the rate of change, the nature of the key technologies, the importance of economies of scale and scope, and the degree of competition will influence the appropriabi1ity of profits from an innovation. also, for some firms the risk associated with failure may be very high suggesting a more conservative knowledge strategy may be appropriate. thus, whereas the knowledge strategies exist in other industries, the characteristics of the industry will determine which strategies can be successful. generic knowledge strategies above, we outlined the following four elements of a knowledge strategy, each requiring a focus in a direction and involving tradeoffs: (1) internally vs. externally sourced knowledge. (2) enhanced vs. new knowledge. (3) fast vs. slow speed of learning. (4) depth vs. breadth of knowledge-base. if we simplify each of the elements to two dimensions, there are 16 different combinations of the four strategic decisions. these combinations are displayed in the 4x4 matrix in table 1 and are referred to as generic knowledge strategies. we realize that this simplification comes at a cost of not accounting for firms that (a) are balanced between the two dimensions (which is possible even though we discussed above how this may be difficult) and (b) are at an unhealthy extreme of one ofthe dimensions, such that the company is neglectful in other areas. we will discuss these circumstances later. our intent in developing these generic knowledge strategies is not to try to determine a single strategy that is superior in all situations. on the contrary, there is no one specific strategy that can assure a sustainable competitive advantage and each of the strategies may be effective at different times. however, for a specific situation, some strategies will be more effective than others and some strategies will be inappropriate. the specific conditions that will determine the effectiveness of each of the generic knowledge strategies are industry characteristics, organizational resources and capabilities, and the nature of the knowledge associated with the development of products in the industry. the following are several examples of generic knowledge strategies and a discussion when they are and are not effective. these four generic knowledge strategies are discussed in detail because (a) they are clearly distinct from each other, and (b) they best illustrate the theoretical issues discussed above. explorer (strategy 2). strategy 2 is an aggressive, focused strategy typically followed by technological leaders in a certain area. the focus is on the rapid development of new knowledge, mostly in a specific area. since the focus is in a narrow field of study the firm will be able to primarily create the new knowledge internally. an advantage of internal learning in this situation is that it ensures a table 1 generic knowledge strategy typology more internal focus more external focus more enhanced more new more enhanced more new knowledge knowledge knowledge knowledge narrow breadth faster learning strategy 1 strategy 2 strategy 3 strategy 4 slower learning strategy 5 strategy 6 strategy 7 strategy 8 broad breadth faster learning strategy 9 strategy 10 strategy 11 strategy 12 slower learning strategy 13 strategy 14 strategy 15 strategy 16 en '0 ~. :::s 0ti \0 \0 \0 t1;:l ~. ? c) ~ ;:s ~ "'c;:;. ~ c ;:; e ~ v) ~ ~ ...... w 14 journal of business strategies vol. 16, no.1 deeper understanding and the knowledge will be able to be integrated with other knowledge areas more efficiently than external learning. in this situation, focusing on speed and new knowledge enables firms to maximize their competitive advantage and first-in advantages. if the firm proceeded more cautiously and focused primarily on enhancing its knowledge-base in only a narrow area (a strategy 1), the resultant competitive advantage would be minimal. additionally, if a firm used this aggressive strategy focusing on a broad area (a strategy 10), the firm may run the risk of not having a sense of direction and projects in critical knowledge areas may not get adequate funding due to limited resources and management attention. for example, at&t, which followed a strategy 10 during the late 1980's and early 1990's, recently reorganized and shifted to a strategy 2, citing these specific reasons. more likely, if a firm is to sustain a knowledge strategy of internally focusing on predominantly new knowledge in a broad area, it would need to slow down its learning process to maintain a sense of control and not become chaotic, which we identify as strategy 14. in summary, the four elements of strategy 2 appear to fit well together and are mutually reinforcing, creating a cohesive generic knowledge strategy. strategy 2 has some similarities to march's (1991) exploration type of organizationallearning, thus, to maintain consistency with the established literature we refer to this generic knowledge strategy as the explorer strategy. this strategy is most likely to be successful when (a) the firm has the established capabilities to generate and apply the new knowledge to a commercializable product, and (b) the firm is able prevent others from rapidly imitating its advances. it will probably be most successful in industries that are based more on tacit knowledge, have long lead times, and have an effective patent system. a disadvantage of this strategy is that it is costly. thus, it would not be appropriate to use this strategy in conditions where competitors could quickly imitate any new products, eliminating profits and the ability to repay development costs. examples of successful explorers are netscape, ben and jerry's, abbott, pfizer, and many biotechnology firms. exploiter (strategy 5). whereas strategy 2 has similarities to march's (1991) concept of exploration, strategy 5 has similarities to what he refers to as the exploitation type of organizational learning. this generic knowledge strategy, which we term exploiter, enhances and maximizes the returns from its current knowledge-base more than trying to generate new knowledge. the exploiter typically focuses on internal learning, a narrow breadth, and learns at a relatively slower rate. strategy 13 is similar to the exploiter strategy, except it focuses on a broader knowledge-base, which would require the vast resources of a larger company. following the exploiter strategy, the firm refines and becomes very efficient at its current practices. it maximizes its short-term profits by optimally using its current resources. however, this may be self-destructive in the long-term since there is no development of new knowledge, which is required for long-term success (march, 1991). the firm may become a leader and the most efficient in a knowledge area that no longer leads to a competitive advantage. spring 1999 bierly: generic knowledge strategy 15 this strategy is probably most successful in more mature industries where radical, new advances rarely occur. thus, the firms can develop a competitive advantage by fine-tuning current knowledge areas, without competitors making their area of expertise obsolete. conversely, the exploiter strategy is probably not appropriate in rapidly changing industries where competitors are frequently coming up with new creative ideas. examples of successful exploiters are honda, toyota, johnson & johnson and compaq. imitator (strategy 16). as the name implies, firms that follow this strategy are very good at imitating others, and they focus on new knowledge in a broad area. however, to excel at this type of extemallearning they would be required to have "absorptive capacity" in many diverse knowledge areas to be able to understand, interpret and implement these many new ideas (cohen & levinthal, 1990). to successfuljy implement different radical changes simultaneously across a broad knowledge-base would be very difficult. the firm would need to follow a slower learning rate to allow the different, and especially complementary, knowledge areas to evolve together and to aljow management to understand and manage the complexity of the situation. the competitive advantage of these firms would not necessarily be their ability to generate new knowledge, since their primary focus is on external learning, but would be their unique ability to integrate different, radically-changing knowledge areas, similar to what kogut and zander (1992) refer to as "combinative capability." following this strategy firms would avoid the high costs associated with discovering new knowledge and typically would offer customers high quality products at a lower price. a vulnerability of this strategy is that it may be very difficult to develop a unique combinative capability that others can not imitate. it would probably be most successful in industries that ate based more on explicit knowledge and where patents are difficult to enforce. it would be inappropriate in a scenario where patents are effective and it is difficult to imitate competitors because innovations are based on tacit knowledge and there is high causal ambiguity. examples of firms following an imitator strategy are cooper tire and rubber and generic drug companies. passive learner (strategy 7). passive learners, who follow strategy 7, do not follow an aggressive approach to expanding the firm's knowledgebase. following this strategy, firms focus on incremental improvements in a narrow knowledge area, externally source the new ideas, and proceed through the learning process relatively slowly. the obvious problem with this strategy is that there is no creation of a competitive advantage. other competitors have access to the same improvements and implementation should be relatively easy for many competitors since the advancements are only incremental and in a focused area. in addition, the learning process is followed relatively slow, such that otherfirms will probably be able to implement the relatively simple improvements more rapidly. probably the only situation where this strategy can be implemented over a long period of time is in a very stable industry when the company already has 16 journal of business strategies vol. 16, no.1 some other type of competitive advantage established, such as strong brand name or superior location. an example of this strategy is personal products company (a johnson and johnson company) with its stayfree feminine hygiene products. stayfree was the market leader throughout the 1960's, 70's and 80's and had very high brand loyalty. they rarely made improvements to their product or processes, and the minor improvements they made were only implemented after their competitors established them as reliable. little effort was spent attempting to generate new knowledge internally, as the product line was clearly viewed as a "cash cow." their brand image was so strong that they were able to maintain market leadership for several decades. but eventually their competitor, proctor and gamble who followed a more aggressive knowledge strategy, developed a far superior product, the always line, and became the new industry leader. personal products company is now mostly unprofitable and is faced with the difficult challenge of radically changing its knowledge strategy and corporate culture, a fate encountered by most passive learners. looking beyond a dichotomous approach in the above discussion, we simplified each of the four elements of a knowledge strategy into two dimensions to generate generic knowledge strategies. using such a configurational approach in studying the complexity associated with organizational phenomena can improve our understanding by identifying and analyzing distinct, internally consistent clusters of processes rather than by searching for consistent behavior among all organizations (meyer, tsui & hinings, 1993; mintzberg, 1990). however, by only looking at this simplified version of knowledge strategies we may neglect some key issues. specifically, the typology illustrated in table 1 does not address (a) extreme cases of one of the strategy elements, and (b) the combination of more than one generic knowledge strategy (in a similar manner that porter's strategies of low cost and differentiation may be combined in certain circumstances). each of the four elements of a firm's knowledge strategy involve tradeoffs. any of these areas could be pushed to an unhealthy extreme if other areas are neglected. for example, the explorer strategy (strategy 2) could overemphasize internal learning at the neglect of extemalleaming. bierly and chakrabarti (1996a), using patent analyses, identified that several firms in the pharmaceutical industry are essentially isolated from the rest of the research being done in the industry. even though these companies spend as much or more in r&d, their knowledgebases generally are not as deep as their competitors who also incorporate advancements from outside sources. the explorers tend to be more like loners and are not as successful as others. cray computer systems, carter wallace, and kodak are examples of firms that follow such a loner strategy. at the other extreme, firms focusing exclusively on external learning, and do not internally learn enough to achieve absorptive capacity are likely to fail (cohen & levinthal, 1990). in a similar manner, an extreme position in any of the other three elements of a knowlspring 1999 bierly: generic knowledge strategy 17 edge strategy (i.e. too fast or slow, too narrow or broad, too much focus on new or enhanced knowledge) is also problematic. a second key issue is whether or not these generic knowledge strategies can be combined. earlier we provided reasons why most companies tend to focus more on specific dimensions and have difficulty excelling at both directions of the elements of knowledge strategy simultaneously: lack of resources, cultural conflict, and a need for internal consistency. however, detailed case analyses of a few exceptional firms seems to indicate that it is possible to combine generic knowledge strategies. for example, leonard-barton (1995) illustrated how chaparral steel has been able to not only balance the tradeoffs between internal and external learning, but excel in both areas. merck could likewise be viewed as a firm that is outstanding at both internal and external learning. in a similar manner, march (1991) illustrated that most firms focus primarily on either exploration or exploitation, but there are a few exceptional firms that can do both. thus, our knowledge strategy typology may provide a general guideline for strategic action that ensures consistency, but in some cases a combination of strategies may be the appropriate benchmark for firms to strive to meet. but, as stated earlier, the problem with combination strategies is that the strategic direction of firms may become less clear. implications we believe the development of a generic knowledge strategy typology has major implications in two different, but related ways. first, such a typology has practical implications for managers in that it provides a guideline to assist in the formulation and implementation of a consistent, effective strategy. second, the typology provides organizational researchers who are concerned with theory development a tool to classify firms that allows for the better understanding of complex issues that are unique to specific types of firms. managerial implications the use of the above typology offers managers a new knowledge-based perspective of strategic issues. the typology can provide a guide for knowledgebased strategic decisions that will ensure internal consistency and the development of core competencies that will lead to sustainable competitive advantages. most managers are unfamiliar with the concept of knowledge management and have not directed their attention toward these strategic choices. figure 1 provides a simple circular framework to use for the identification and continuous development of a firm's knowledge strategy. the steps in this process, which are not necessarily sequential, are as follows. 1. identification of current knowledge-base and past generic knowledge strategy. it is imperative that a firm has an accurate picture of its own resources. an audit of its own knowledge-base would identify current core competencies and 18 journal of business strategies vol. 16, no. i figure 1 continuous development of a knowledge strategy 1. identification of current knowledge base and past generic knowledge and strategy 2. identification of key industry characteristics 4. detennination of future generic knowledge strategy 3. identification of competitor's current knowledge base and past generic knowledge strategies areas of weakness. it is also vital that a finn identifies how its current knowledgebase evolved or, in other words, what was its past knowledge strategy. the knowledge-base is path dependent to a degree and can be viewed as having momentum in a certain direction. without intervention by management, the future knowledge strategy will most likely be the same as the past knowledge strategy, since these methods of learning become institutionalized in the organization's culture. this mayor may not be problematic, based on the other factors discussed below, but either way it is important for managers to know the direction they are currently heading. 2. identification of key industry characteristics. in the above sections, we discussed under what conditions certain generic knowledge strategies are and are spring 1999 bierly: generic knowledge strategy 19 not appropriate. specifically, the dynamism of the industry, the tacitness of the knowledge associated with the products in the industry, the ability of competitors to imitate each other, the level of industry rivalry, and the relatedness of complementary knowledge areas are all factors that influence the success of different knowledge strategies. managers must identify these key industry characteristics and have an understanding how they are changing before determining their future knowledge strategies. 3. identification of competitors' current knowledge-base and past generic knowledge strategies. strategy and tactics can not be developed and implemented without appreciating the dynamic interactions among firms. an apparently ideal strategy for a given set of industry characteristics may be unsuccessful because (a) other powerful players are also pursuing that strategy, creating abnormally high rivalry among the group, and (b) competitors' retaliatory responses may change industry characteristics and the nature of competition. in other words, a firm's knowledge strategy should be dependent upon the actual and anticipated strategic decisions of competitors. thus, before a firm develops and implements its own knowledge strategy, it should identify its competitors' current knowledge-base, and their past and future knowledge strategies. 4. determination of future generic knowledge strategy. based on its current knowledge-based resources, key industry characteristics, and competitors' knowledge strategies, a firm can formulate its own knowledge strategy for the future. the nature of the competitive environment will determine what set of generic knowledge strategies are most appropriate for the specific industry. from these, the firm should choose a specific generic knowledge strategy that best utilizes its unique knowledge-base that has developed over time. the knowledge strategy will provide consistency throughout the organization concerning how and in what direction the organization learns and changes its knowledge-base. as figure 1 attempts to illustrate, this process is not a sequential, static process, but rather a dynamic, continuous process. each of the components in figure 1 are continually changing and are interactive with the other components. the components are placed in a wheel configuration to illustrate the circularity of the process and as a means of emphasizing that the process "rolls on" over time. research implications typologies and taxonomies assist researchers in understanding complex phenomena by promoting the study of similar types of firms. in the strategic management field, the following configurational approaches have greatly improved our understanding of the nature of competition within an industry: generic strategy typologies (e.g. miles & snow, 1978; porter, 1980), strategic archetypes (e.g. miller & friesen, 1978), and strategic groups (caves & porter, 1977; mcgee & thomas, 1986). each of these classifications have helped researchers better understand complex phenomena and these advances may not have occurred if only the entire industry was analyzed as a whole. 20 journal of business strategies vol. 16, no.1 in a similar manner, the generic knowledge strategy typology developed in this paper provides a means of classifying different types of firms to better understand their behavior and determinants of success. of course, the main difference between our typology and the classifications listed above is that ours is grouping firms based on knowledge and learning characteristics, while the others used different variables. clearly, the next step is to conduct empirical research to test the propositions developed throughout this paper. specifically, empirical research questions that follow from this paper are: do all of the generic knowledge strategies exist and which ones are most prevalent? are certain generic knowledge strategies more highly correlated with profitability in different industry settings? how frequently do firms change their generic knowledge strategies? are firms that are more flexible and change their knowledge strategies in response to a change in the environment more successful than firms that maintain a stable knowledge strategy? additionally, detailed case studies could be used to better understand how knowledge strategies evolve over time and identify barriers and facilitators to the implementation of different knowledge strategies. references argyris, c. (1982). reasoninfj. learninfj. and action: individual and orfjanizational. san francisco: jossey-bass. argyris, c., & schon, d. (1978). organizational learning: a theory of action perspective. reading, ma: addison-wesley publishing. barney, j. (1991). firm resources and sustained competitive advantage. journal of management. 17 (1),99-119. bierly, p., & chakrabarti, a. (1996a). generic knowledge strategies in the u.s. pharmaceutical industry. strategic management journal. 17 (winter special issue), 123135. bierly, p., & chakrabarti, a. (1996b). determinants of technology cycle time in the u.s. pharmaceutical industry. r&d manafjement. 26, 115-126. bierly, p., & chakrabarti, a. (1996c). technological learning, strategic flexibility, and new product development in the pharmaceutical industry. ieee transactions on engineering manafjement. 43, 368-380. bierly, p., & hfimiihiinen, t. (1995). organizational learning and strategy. scandinavian journal of management. ii, 209-224. bierly, p., & spender, j. c. (1995). culture and high reliability organizations: the case of the nuclear submarine. journal of management. 21, 639-656. spring 1999 bierly: generic knowledge strategy 21 bower, j. l., & hout, t. m. (1988). fast-cycle capability for competitive power. harvard business reyiew. 66 (6),110-118. brown, 1. s., & duguid, p. (1991). organizational learning and communities-of-practice: toward a unified view of working, learning, and innovation. qrganization science. 2,40-57. caves, r. e., & porter, m. e. (1977). from entry barriers to mobility barriers: conjectural decisions and contrived deterrence to new competition. quarterly journal of economics. 91, 241-262. chakrabarti. a. k. (1974). role of product champion in innovation. california manaaement review. 17 (2), 58-62. chesbrough, h. w., & teece, d. j. (1996). when is virtual virtuous? organizing for innovation. harvard business review, january-february, 65-73. cohen, w. m., & levinthal, d. a. (1990). absorptive capacity: a new perspective on learning and innovation. administrative science quarterly. 35, 128-152. conner. k. r., & prahalad, c. k. (1996). a resource-based theory of the firm: knowledge versus opportunism. oraanization science. 7, 477-501. cyert, r. m., & march, j. g. (1963). a behavioral theory of the firm. englewood cliffs, nj: prentice-hall. daft, r. l., & weick, k. e. (1984). toward a model of organizations as interpretation systems. academy of management review. 9. 284-295. fiol, c. m., & lyles, m. a. (1985). organizational learning. academy of management review. 10, 803-813. garvin. d. a. (1993). building a learning organization. harvard business review, julyaugust, 78-91. gilad, 8.. & gilad, t. (1988). the business intelligence system. new york: american management association. gioia, d. a.. & poole, p. p. (1984). scripts in organizational behavior. academy of management review. 9, 449-459. gold, b. (1987). approaches to accelerating product and process development. journal of product innovation management. 4,81-88. grant, r. m. (1996a). toward a knowledge-based theory of the firm. strategic management journal. 17 (winter special issue), 109-121. 22 journal of business strategies vol. 16, no.1 grant, r. m. (1996b). prospering in dynamically-competitive environments: organizational capability as knowledge integration. organization science. 7, 375-387. grant, r. m. (1991). the resource-based theory of competitive advantage. california management review. 33 (3),114-135. hamel, g. (1991). competition for competence and inter-partner learning within international strategic alliances. strategic management journal. 12 (summer special issue), 83-103. hamel, g., doz, y., & prahalad, c. k. (1989). collaborate with your competitors-and win. harvard business review. 67 (1), 133-139. hamel, g., & prahalad, c. k. (1994). competing for the future. boston: harvard business school press. hedberg, b., nystrom, p. c., & starbuck, w. h. (1976). camping on seesaws: prescriptions for a self-designing organization. administration science ouarterly. 2, 39-52. hedlund, g. (1994). a model of knowledge management and n-form corporation.~ gic management journal. 15 (summer special issue), 73-90. henderson, r., & clark, k. (1990). architectural innovation: the reconfiguration of existing product technologies and the failure of established firms. administrative science quarterly, 35,9-30. henderson, r., & cockburn, i. (1994). measuring competence? exploring firm effects in pharmaceutical research. strategic management journal. 15 (winter special issue), 63-84. herriot, s. r., levinthal, d., & march, j. g. (1985). learning from experience in organizations. american economic review. 75,298-302. hitt, m. a., hoskisson, r. e., ireland, r. d., & harrison, j. s. (1991). effects ofacquisitions on r&d inputs and outputs. academy of management journal. 34, 693-706. huber, g. p. (1991). organizational learning: the contributing processes and the literatures. organization science. 2, 88-115. huber, g. p. (1982). organizational information systems: determinants of their performance and behavior. management science. 28, 135-155. huber, g. p., & daft, r. l. (1987). the information environments of organizations. in f. jablin, l. putman, k. roberts and l. porter (eds.), handbook of organization communication. beverly hills, ca: sage. spring 1999 bierly: generic knowledge strategy 23 imai, k., nonaka, i., & takeuchi, h. (1988). managing the new product development process: how japanese companies learn and unlearn. in m. tushman and w. moore (eds.), readings of the management of innovation. cambridge, ma: ballinger. kanter, r. m. (1988). when a thousand flowers bloom; structural, collective, and social conditions for innovation in organization. in l. l. cummings and b. m. staw (eds.), research in organizational behavior: vol. 10, 169-211. kessler, e. h.• & chakrabarti, a. k. (1996). innovation speed: a conceptual model of context. antecedents. and outcomes. academy of management review. 21, 11431191. kogut, b., & zander, u. (1992), knowledge of the firm. combinative capabilities, and the replication of technology. organization science, 3, 383-397. lant, t. k., & mezias, sj. (1992). an organizational learning model of convergence and reorientation. organization science. 3, 47-71. lei, d .• hitt, m. a.. & bettis, r. (1996). dynamic core competencies through meta-learning and strategic context. journal of management, 22,549-569. leonard-barton, d. (1995). wellsprings of knowledge. boston: harvard business school press. leonard-barton, d. (1992). core capabilities and core rigidities: a paradox in managing new product development. strategic management journal. 13. 111-125. levinthal. d., & march. j. g. (1981). a model of adaptive organizational search.~ of economic behavior and organization. 2. 307-333. levinthal. d .• & march. j. g. (1993). the myopia of learning. strategic management journal. 14 (winter special issue), 95-112. levinthal, d .• & myatt, j. (1994). co-evolution of capabilities and industry: the evolution of mutual fund processing. strategic management journal. 15 (winter special issue). 45-62. lieberman. m. b., & montgomery, d. b. (1988). first-mover advantages. strategic management journal. 9, 41-58. lippman, s. a., & rumelt, r. p. (1982). uncertain imitability: an analysis of interfirm differences in efficiency under competition. bell journal of economics. 13,418-438. lounamaa, p. h., & march. 1. g. (1987). adaptive coordination of a learning team. m.@: a~ement science. 33. 107-123. 24 journal of business strategies vol. 16, no.1 maidique, m. a., & patch, p. (1983). corporate strategy and technological policy. in m. l. tushman and w. l. moore (eds.), readin~s in the mana~ement of innovation, boston: pitman, 273-285. march, j. g. (1991). exploration and exploitation in organizational learning. or~aniza­ tion science. 2, 71-87. mcgee, j., & thomas, h. (986). strategic groups: theory, research and taxonomy. strate~ic mana~ement journal. 7, 141-160. meyer, a. d., tsui, a. s., & hinings, c. r. (1993). configurational approaches to organizational analysis. academy of management journal. 36, 1175-1195. meyer, c. (1993). fast cycle time: how to align purpose. strategy. and structure for speed. new york: free press. miles, r. e., & snow, c. c. (1978). organizational strategy. structure and process. new york: mcgraw-hill. miller, d. (l996). a preliminary typology of organizational learning: synthesizing the literature. journal of management. 22,485-505. miller, d., & friesen, p. (1978). archetypes of strategy formulation. management science. 24, 921-933. mintzberg, h. (1990). strategy formation: schools of thought. in j. f. fredrickson (ed.), perspectives on strategic mana~ement. philadelphia: harper business. mowery, d. c., oxley, j. e., & silverman, b. s. (1996). strategic alliances and interfirm knowledge transfer. strategic management journal. 17 (winter special issue), 7792. nelson, r., & winter, s. (1982). an evolutionary theory of economic change. cambridge, ma: harvard university press. nonaka, i. (1991). the knowledge-creating company. harvard business review, november-december, 96-104. nonaka, i. (1994). a dynamic theory of organizational knowledge creation. organization science. 5, 14-37. nystrom, p. c., & starbuck, w. (1984). to avoid organizational crises, unlearn. organizational dynamics. 13,53-65. peteraf, m. a. (1993). the cornerstones of competitive advantage: a resource-based view. strategic management journal. 14, 179-191. spring 1999 bierly: generic knowledge strategy 25 pisano, g. p. (1994). knowledge. integration. and the locus of learning: an empirical analysis of process development. strategic mana/:~ment journal. 15 (winter special issue), 85-100. polanyi. m. (1966). the tacit dimension. london: routledge & kegan paul porter, m. (1980). competitive strategy. new york: free press. prahalad, c. k.• & hamel, g. (1990). the core competence of the corporation. harvard business review. 68 (3), 79-91. reed. r., & defillipi, r. j. (1990). casual ambiguity. barriers to imitation, and sustainable competitive advantage. academy of management review. 15, 88-102. sanchez, r.• & mahoney, j. t. (1996). modularity, flexibility. and knowledge management in product and organization design. stratel:ic management journal. 17 (winter special issue), 63-76. senge, p. m. (1990). the fifth discipline. new york: doubleday. simon, h.a. (1991). bounded rationality and organizational learning. organization sci~, 125-134. spender, j.-c. (1989). industry recipes: the nature and sources of managerial iudfl,ement. oxford: basil blackwell spender. l-c. (1994). organizational knowledge. collective practice and penrose rents. international business review. j, 353-367. spender. j.-c. (1996). making knowledge the basis of a dynamic theory of the firm. sill!.: tefl,ic management journal. 17 (winter special issue), 45-62. stalk, g. (1988). time the next source of competitive advantage. harvard business review. 66 (5), 41-51. stalk, g., evans, p., & shulman, l. (1992). competing on capabilities: the new rules of corporate strategy. harvard business review, march-april. 57-69. teece, d. j., pisano, g., & shuen, g. (1997). dynamic capabilities and strategic management. strategic mana/:ement journal. 18, 509-533. tushman, m., & anderson. p. (1986). technological discontinuities and organizational environments. administrative science quarterly. 31,439-465. volberda, h. w. (1996). toward the flexible form: how to remain vital in hypercompetitive environments. orfl,anizatjon scienc:;e. 7, 359-374. 26 journal of business strategies vol. 16, no.1 webster's third new international dictionary (1981). springfield, ma: merriam-webster. weick, k. e. (1991). the nontraditional quality of organizational learning. or~anization science. 2. 116-124. wheelwright, s. c., & clark, k. b. (1992). revolutionizin~ product development. new york: free press. winter, s. (1987). skill and knowledge as strategic assets. in d. teece (ed.), the competitive challen~e, 159-184. cambridge, ma: ballinger. zander, u., & kogut, b. (1995). knowledge and the speed of the transfer and imitation of organizational capabilities: an empirical test. organization science. 6, 76-92. endnotes j similar to conner and prahalad (1996), we view the knowledge-based view of the finn as a similar approach to, but narrower than the resource-based view of the finn. the resource-based view explains perfonnance differences by identifying unique, valuable and inimitable resources and capabilities; but, in most cases, the resource that ultimately leads to a sustainable competitive advantage is the finn's unique knowledge-base (grant, 1991; barney, 1991; peteraf, 1993). 2 levinthal and myatt (1994) discussed the co-evolution of finns' organizational capabilities within an industry. it is an interesting proposition that within a very stable environment with a dominant industry recipe, the knowledge strategies of all firms may converge. however, we believe this situation to be a very limited case. paul e. bierly iii (ph.d., rutgers university) is an assistant professor at james madison university. earlier, he was a submarine officer in the u.s. navy's nuclear power program and he worked in manufacturing for johnson and johnson, inc. his current research is in the areas of the management of technology, knowledge management and strategic alliances. his research has been recently published in strategic management journal, journal of management, ieee transactions on engineering management, r&d management, and several other management journals. development of a generic knowledge strategy typology volume 31, number 1 221 influences of unemployment rates and s&p 500 movements on eight selected individual us casino stock performances matiur rahman mcneese state university •lake charles, la muhammad mustafa south carolina state university • orangeburg, sc stephen caples mcneese state university •lake charles, la abstract this paper studies the causal effects of changes in unemployment rates and u.s. s&p 500 returns on changes in stock returns of selected eight u.s. casinos individually. monthly data from january, 1982 through july, 2012 are employed. the time series data in percentage changes are found stationary. as a result, multivariate var in first-difference is implemented since the objective is to investigate the effects of changes in causal variables on changes in individual selected casino stock returns. the estimates depict weakly positive and somewhat mixed causal influences of changes in unemployment rates on changes in casino stock returns. in the case of the changes in s&p 500, the results are uniformly positive and relatively strong. in other words, the latter unleash stronger influence than the former on changes in casino stock returns with mixed net short-run interactive feedback effects.1 introduction casino stocks, in general, are considered sin stocks like tobacco and alcohol stocks. socially responsible, ethical, and environment-friendly investors tend to avoid them in their portfolios. however, such investors seem to enjoy gaming, tobacco and alcohol regardless of economic conditions and political tensions (berman, 2002; ahrens, 2004; and waxler, 2004). sin stocks, as a whole, are defensive (β < 1) but casino gaming stocks seem to be more aggressive (β > 1).2 thus, these stocks individually outperform the stock market during bad times because of limited risk sharing. their excess returns, in general, are higher when the overall stock market is down than when the market is up. the casinos use more private debt than equity 1 keywords: casino stock returns, unemployment rates, s&p 500 returns, unit roots, and granger causality. 2 β is a measure of systematic risk as in capital asset pricing model (capm) by sharpe (1964). 222 journal of business strategies financing, and they have superior financial reporting quality than other stock issuing entities. in short, casino stocks add “sizzles” to securities portfolios of individuals. the casino gaming is a multi-billion dollar industry in the usa. in 2010, total casino gaming revenue was flat at $57.5 billion as compared to 2006. this is expected to grow to $73.3 billion in 2015 presenting a cumulative average growth rate of 5 percent during the forecast period of 2011-2015. actual amounts of us casino gaming revenue for 2006-2010 and the forecast amounts thereof for 2011-2015 are shown in appendix a-i. in conjunction with it, the trend is shown for the same sub-periods for global casino gaming revenue in appendix a-ii (www.casinoenterprisemanagement.com/january-2012/pwc). to examine the time series properties of each variable in percentage change form, the df-gls test for unit root and the kpss test for no-unit root are implemented. on the evidence of stationarity of each variable, the var model in first-difference is estimated for each selected casino stock returns for short-run causal flows and interactive feedback effects. usually, var is recommended to be estimated in levels for stationary variables. however, first-differencing or overdifferencing of stationary variables for var’s is also appropriate for robust estimates (marcet, 2005). the primary objective of this paper is to investigate the causal influences of changes in unemployment rates and those of the u.s. stock market (s&p 500) returns on the changes in returns of eight selected u.s. casino stocks, individually. this paper is motivated to study whether the stock prices of the selected casinos are countercyclical. the casino stock prices are considered individually to gain some micro-level insight. the remainder of this paper proceeds in sequence as follows: brief review of related literature, empirical methodology, results, and conclusions. brief review of related literature sin stock returns over various phases of business cycle are likely to be less sensitive to business conditions than other stocks. during bad economic times, they also tend to outperform other stocks. academic research by hong and kacperczyk (2009) documented that sin stocks are underpriced with positive alphas3, consistent with the portfolio theory. they study the performance of sin stocks in relation to the us stock market over the period of 1965-2003. based on an unconditional four-factor model which controls for market premium, size, book-to-market and past returns, they argue that sin stocks outperform the stock market because they are not 3 a positive alpha means outperformance and a negative alpha means underperformance of a stock against its benchmark index. volume 31, number 1 223 held by institutions subject to social norms. while gauging the relative importance of litigation risk versus this neglected-stock effect, the authors find that litigation risk cannot explain the abnormal returns on sin stocks. this neglect-effect implies risk-sharing with higher expected returns. further, hong and kacperczyk (2009) study the financing decisions of sin companies and find that they use more private debt financing than equity financing. kim and mohan (2006) examine whether this neglected effect is attributable to differential information risk for these firms. they show that sin firms’ financial reporting quality is superior to a control group of firms due to greater regulatory scrutiny. hong and kacperczyk (2009) form a sin-stock portfolio and compare its average return to an industry-comparable portfolio. the performance of sin stocks over the business cycle has not been examined from an industry point of view, except for gaming stocks. goodall (1994) studies gaming stock returns over a 20-year horizon, and find that they tend to be more volatile than the market as a whole. in addition, some special events can cause the gaming stocks to move in a direction opposite to the general stock market. the above results are driven by the relatively small capitalization of these stocks. in addition, this study shows that gaming stocks are more sensitive to stock market declines. chen and feng-shun (2001) study u.s. gaming stock returns over up and down markets, using capm regression with time-varying alphas and betas, in a garch estimation framework. they show that investors earned negative excess return at an above-market-average systematic risk for holding stocks of gaming companies over 1993-1997. after changes in market conditions were considered, however, the investors in gaming stocks gained a relatively normal return at an abnormal level of risk as compared to the market average systematic risk. but the excess return on sin stocks was higher during down markets than during up markets. they also investigate the effects of legislation events on gaming stock returns, and find that small casino operators are more reactive to deregulation/regulation actions in comparison with large casino gaming firms. fabozzi, et al., (2008) examine the issue of how social values affect economic values. based on a small subset of the stock universe that has been generally associated with sin-seeking activities, such as alcohol consumption, adult services, gaming, tobacco, weapons, and genetic engineering, the authors find that a sin-stock portfolio produced an annual return of 19% over the study period, unambiguously outperforming common benchmarks in terms of both magnitude and frequency. several likely reasons for the positive excess returns in sin stocks are identified. the 224 journal of business strategies authors argue that trustees or fiduciaries who develop institutional investment policy statements should fully understand the economic consequences of screening out stocks of companies that produce a product inconsistent with their value systems. in general, stock returns and unemployment rate reveal causality that runs from stock market to unemployment (geske and roll, 1983). causality between unemployment and small cap returns has also been investigated in moscarini and postel-vinay (2010). they find a distinctly similar cyclical pattern in both large cap and small cap stock performances. both papers thus underscore the importance of the inclusion of unemployment in this study relating to stock market returns. more recently, farsio and fazel (2013) investigate the relationship between unemployment rate and stock prices in usa, china and japan challenging the assertion that unemployment rate is a strong predictor of stock prices (little, 2010 and wojdylo, 2009). they conclude analyzing the data over the 1970-2011 period that it would be a mistake to rely on unemployment rate data to make investment decision in stock market. empirical methodology in general functional form, the estimating model is as follows: yt=f (ut , xt(+) (+)) (1) where, yt = individual casino’s monthly stock return, ut = monthly u.s. unemployment rate, and xt = monthly return on s&p 500. the expected sign of causal flow of each explanatory variable is indicated underneath. the time series properties of each variable are investigated by implementing the modified dickey-fuller test (df-gls) following elliot et al. (1996), and ng and perron (2001). the kpss test as its counterpart is also applied following kwaitkowski et al., (1992). the df-gls test is about data non-stationarity for the null hypothesis of unit root in each time series variable while the kpss test is about the null hypothesis of no-unit root in each time series variable. testing for nonstationarity of each time series variable is essential to ascertain the application of a correct estimating technique since the application of ols on nonstationary variables leads to the problem of spurious correlation inducing bias and inefficiency in the estimated parameters (granger and newbold, 1974). volume 31, number 1 225 on the evidence of stationarity in each time series variable, the following var model in first-difference is estimated in line with (granger, 1998) for individual stock return: ∆𝑌𝑡=𝛼+ n ∑ n=1 1𝜋2 ∆𝑌𝑡−𝑖+ k ∑ 𝑖=1 𝜃𝑖∆𝑈𝑡−𝑖+ m ∑ 𝑖=1 𝛽𝑖∆𝑋𝑡−𝑖+𝑒𝑡 (2) here, e = error term, t = time subscript, i = represents optimum number of lags and ∆ = first-difference operator. the estimated coefficients of the lagged explanatory variables and their statistical significance display short-term causal flows to the dependent variable with net interactive feedback effects. the optimum lag-lengths are determined by the final prediction error (fpe) criterion following akaike (1969) to overcome the problems of over-parameterization and under-parameterization that may also induce bias and inefficiency in the estimated parameters. time series data on macroeconomic variables can be nonstationary in levels with the first order of integration, but not cointegrated. in this case, a multivariate var with first-differencing of variables in a single equation captures short-run dynamic causal effects with interactive feedback (bahmani and payesteh, 1993). the var-family has several variants in levels or in first-difference of variables included in the estimating model(s). a multivariate var is natural extension of the standard univariate var. a shortcoming of the standard framework for granger causality is that it only allows for examination of dynamic interactions between single (univariate) variables within a system, perhaps conditioned on other variables. however, interactions do not necessarily take place between single variables but may occur among groups or “ensembles” of variables. this study thus establishes a framework for granger causality in the context of causal interactions among three variables (barrett et al., 2010). moreover, multivariate var often provides superior forecasts to those from univariate time series models requiring less a priori information (gujarati, 1995). the time profile causal impacts of unexpected shocks or innovations to specific variables on the variables in the model are usually summarized with impulse response functions within the var-frameworks for business-cycle analyses (greene, 2007 and watson, 1994). a historical variance decomposition of variables is also useful to assessing the driving forces of cyclical fluctuations in var-form (gali, 1999, and king et al., 1991). transfer function is an alternative to var that does not require either impulse response or variance decomposition analysis. this is used in intervention analysis, but it may be of a little practical value due to unduly high over parameterization (newbold and bos, 1990). monthly data on all variables are collected from january, 1982 through july, 2012. the data source includes ameristan casinos inc (asca: nasdaq gs). 226 journal of business strategies brief descriptions of the eight selected u.s. casinos are provided in appendix b. in addition to data availability, they have been selected for broader geographic network, market capitalization and significant sales volumes. results the simple correlation coefficients of 8 selected u.s. casino stock returns and causal variables (ut and xt) are reported as follows: as observed in table 1, the pair-wise simple correlation coefficients of casino stock returns are positive. the magnitudes are from moderate to high. however, they may change across sample periods due to changes in macro-economic conditions. furthermore, correlation does not imply causality. as observed above, the simple correlation coefficient between unemployment rates and s&p 500 returns is positive and very low at 0.1761 suggesting very marginal multi-colinearity for linear dependence of explanatory variables. both unemployment rates and s&p 500 returns are exogenous as they are generated outside the equation of interest (engle, hendry and richard, 1983). next, the time series properties of each variable are examined by implementing the df-gls and the kpss tests. the results are reported as follows: volume 31, number 1 227 table 1 correlation matrix sample: (january, 1982 july, 2012) c ou nt ry e c t p m ax ,t p re c, t p cu t,t ∆p m ax ,t ∆p pr ec ,t ∆p cu t,t ∆g d p t c on st an t u er (u ) s& p 50 0 (x ) lv s (y 1) w yn n (y 2) m g m (y 3) pe n n (y 4) m tn (y 5) c ak e (y 6) as c a (y 7) pn k (y 8) u er (u ) 1. 00 00 s& p 50 0 (x ) 0. 17 61 1. 00 00 lv s (y 1) 0. 19 60 0. 67 74 1. 00 00 w yn n (y 2) 0. 14 72 0. 64 31 0. 82 38 1. 00 00 m g m (y 3) 0. 11 33 0. 51 65 0. 80 62 0. 77 08 1. 00 00 pe n n (y 4) 0. 05 97 0. 59 50 0. 51 25 0. 46 41 0. 54 43 1. 00 00 m tn (y 5) 0. 08 47 0. 65 45 0. 66 98 0. 61 32 0. 65 36 0. 53 47 1. 00 00 c ak e (y 6) 0. 22 42 0. 63 92 0. 66 09 0. 53 24 0. 55 57 0. 57 61 0. 62 00 1. 00 00 as c a (y 7) 0. 08 05 0. 52 47 0. 62 57 0. 56 29 0. 60 85 0. 68 53 0. 58 35 0. 67 18 1. 00 00 pn k (y 8) 0. 14 54 0. 54 50 0. 61 88 0. 65 54 0. 67 71 0. 63 54 0. 57 20 0. 57 71 0. 63 05 1. 00 00 228 journal of business strategies table 2 unit root tests level series df-gls kpss uer (u) -11.61586* 0.30350** s&p 500 (x) -14.6874* 0.06925** lvs (y1) -3.8239* 0.09700** wynn (y2) -9.6807* 0.06920** mgm (y3) -16.8845* 0.02330** penn (y4) -14.4548* 0.04381** mtn (y5) -11.5055* 0.051941** cake (y6) -12.0066* 0.06118** asca (y7) -13.6191* 0.08659** pnk (y8) -19.5814* 0.03380** * significant at 1% level. ** less than the critical values of 0.739, 0.463, and 0.347 respectively at 1%, 5%, and 10% levels of significance failing to reject the null hypothesis of no unit root. table 2 reveals that the null hypothesis of unit root for df-gls test is clearly rejected at 1% level of significance (as indicated by *). for kpss test results, the null hypothesis of no unit root cannot be rejected at 1, 5 and 10 percent levels of significance (as indicated by **). thus, there are clear evidences of stationarity in all the variables, based on the aforementioned tests. to note, non-stochastic explanatory variables are strongly exogenous for all the parameters (greene, 2007). the impulse response analyses due to a given external shock by one standard deviation in s&p 500 returns and unemployment rates unleash short-lived effects on individual casino stock returns (appendix c). the historical variance decompositions of variables depict modest and decaying variability, as evidenced in appendix d. volume 31, number 1 229 finally, the var model, as outlined in equation (2), is estimated for changes in each individual selected casino stock returns. the results are reported in table 3. a close inspection shows that changes in each casino stock returns are influenced positively and more pronouncedly by changes in the overall us stock market returns than by those in us unemployment rates with two exceptions. they are revealed in coefficients and their associated t-values for individual casino stock returns. the respective sums of the contemporaneous and lagged coefficients of the changes in s&p 500 returns and unemployment rates indicate mixed net short-run interactive feedback effects. conclusions the selected eight u.s. individual casino stock returns are influenced positively by movements in the us stock market (s&p 500) returns. six stocks are positively and weakly influenced by the changes in unemployment rates with one-period lag, while two stocks are negatively and weakly influenced. in short, the evidences are somewhat mixed in this regard. comparatively, the u.s. stock market returns unleash positive influences on the selected eight casino stock returns with greater strength. the influences of changes in unemployment rates on these stock returns are weak and inconclusive to some extent. so, changes in unemployment rates appear not to be a good predictor of casino stock returns. in closing, the findings of this paper to draw any general and firm conclusion on the countercyclical behavior of casino stock returns should, therefore, be weighed with due caution. 230 journal of business strategies table 3 vector autoregression estimates* in de pe nd en t v ar ia bl es d ep en de nt v ar ia bl es δ lv s δ w y n n δ m g m δ p e n n δ m t n δ c a k e δ a sc a δ p n k 0. 16 31 57 -0 .0 03 25 8 0. 13 64 41 0. 04 32 25 0. 00 63 03 0. 06 11 92 0. 06 52 27 -0 .0 95 29 7 δ u er (t1) [1 .0 17 28 ] [-0 .0 33 54 ] [1 .6 95 58 ] [0 .6 32 72 ] [0 .1 25 14 ] [1 .1 30 34 ] [[0 .8 43 13 ] [-1 .5 85 07 ] -0 .2 02 36 4 0. 01 31 12 -0 .1 22 26 2 -0 .0 44 54 0. 00 02 72 -0 .0 68 11 3 -0 .0 56 87 9 0. 05 72 57 δ u er (t2) [-0 .8 08 01 ] [0 .1 32 68 ] [-1 .5 01 94 ] [-0 .6 41 24 ] [0 .0 05 31 ] [-0 .8 53 53 ] [-0 .5 08 58 ] [0 .6 32 41 ] 0. 05 49 01 0. 01 26 38 -0 .0 13 08 0. 05 02 53 δ u er (t3) [0 .3 30 73 ] [0 .2 27 51 ] [-0 .1 62 71 ] [0 .8 13 48 ] 1. 86 70 06 1. 64 76 34 1. 57 94 87 0. 25 34 47 0. 75 26 06 0. 54 73 92 0. 68 44 54 0. 20 91 91 δ sp 50 0( t1) [2 .1 76 75 ] [3 .2 79 56 ] [5 .0 56 66 ] [0 .9 77 77 ] [3 .9 80 35 ] [2 .4 71 94 ] [2 .4 56 42 ] [0 .9 14 34 ] -1 .2 80 73 6 -0 .4 20 04 8 -0 .0 31 90 9 -0 .5 97 79 6 -0 .3 61 59 2 -0 .1 86 81 9 -0 .5 14 56 6 -0 .4 19 32 2 δ sp 50 0( t2) [-1 .4 44 84 ] [-0 .8 26 90 ] [-0 .0 98 46 ] [-2 .3 01 87 ] [-1 .8 50 86 ] [-0 .8 40 44 ] [-1 .8 14 29 ] [-1 .8 55 82 ] -0 .2 13 32 9 -0 .2 38 71 4 -0 .3 44 70 8 -0 .0 55 74 8 δ sp 50 0( t3) [-0 .2 32 06 ] [-1 .0 76 61 ] [-1 .2 07 67 ] [-0 .2 44 59 ] 0. 25 94 37 δ lv s( t1) [1 .5 34 32 ] -0 .2 75 89 4 δ lv s( t2) [-1 .7 78 69 ] 0. 24 12 15 δ lv s( t3) [1 .5 33 50 ] volume 31, number 1 231 -0 .2 23 08 8 δ w yn n (t1) [-1 .7 48 42 ] -0 .3 33 83 δ w yn n (t2) [-0 .2 65 34 ] -0 .2 03 51 1 δ m g m (t1) [-3 .0 19 60 ] -0 .1 67 52 2 δ m g m (t2) [-2 .5 53 16 ] -0 .0 31 16 3 δ pe n n (t1) [-0 .4 06 31 ] -0 .0 07 79 5 δ pe n n (t2) [-0 .1 01 91 ] -0 .1 93 89 5 δ m tn (t1) [-2 .2 88 75 ] -0 .1 73 06 6 δ m tn (t2) [-2 .0 70 71 ] -0 .0 63 79 6 δ c ak e( t1) [-0 .8 13 41 ] -0 .1 22 09 9 232 journal of business strategies δ c ak e( t2) [-1 .5 98 67 ] -0 .0 86 03 8 δ c ak e( t3) [-1 .1 29 05 ] -0 .0 13 22 9 δ as c a( t1) [-0 .1 73 94 ] -0 .0 07 95 1 δ as c a( t2) [-0 .1 03 75 ] 0. 01 52 54 δ as c a( t3) [0 .2 03 65 ] 0. 04 92 97 δ pn k (t1) [0 .7 22 39 ] 0. 05 89 84 δ pn k (t2) [0 .8 75 73 ] -0 .0 44 21 8 δ pn k (t3) [-0 .6 53 76 ] -0 .0 81 52 4 -0 .0 18 11 49 -0 .0 66 20 4 0. 04 14 6 -0 .0 23 11 -0 .0 13 47 7 0. 04 44 55 -0 .0 55 65 8 c [-0 .8 78 07 ] [-0 .3 00 14 ] [-1 .2 87 92 ] [1 .0 13 14 ] [-0 .8 27 99 ] [-0 .4 12 64 ] [0 .9 62 23 ] [-1 .4 53 82 ] volume 31, number 1 233 references ahrens, d. (2004). investing in vice: the recessionproof portfolio of booze, bets, bombs, and butts. newyork, ny: st. martin press. akaike, h. (1969). fitting autoregression for prediction. annals of the institute of statistical mathematics, 21, 243-247. bahmani, o.m. & payesteh, s. (1993). budget deficits and the value of the dollar: an application of cointegration and error-correction modeling. journal of macroeconomics, 15, 661-677. barrett, a. b., bamett, l., & seth, a. k. (2010). multivariate granger causality and generalized variance. american physical society, 81(4), 041907. berman, d. (2002). why sin is good: tobacco, alcohol, and gaming stocks can add sizzle to your portfolio. money sense. november. chen, d.h., & feng-shun, b. (2001). effects of legislation events on u.s. gaming stock returns and market turnings. tourism management, 22, 539-549. elliot, g., rothenberg, t.j., & stock, j.h. (1996). efficient test for an autoregressive unit root. econometrica, 64, 813-836. engle, r.f., hendry, d.f., & richard, j.f. (1983). exogeneity, econometrica, 51, 277-304. fabozzi, f.j., ma, k.c., & oliphant, b.j. (2008). sin stock returns. journal of portfolio management, 35, 82-94. gali, j. (1999). technology, employment and the business cycle: do technology shocks explain aggregate fluctuations? american economic review, 89, 249271. geske, r., & roll, r. (1983). the fiscal and monetary linkage between stock returns and inflation. journal of finance, 38, 1-33. gujarati, d. (1995). basic econometrics, (3rd ed.). new york, ny: mcgraw-hill. farsio, f., & fazel, s. (2013). the stock market/unemployment relationship in usa, china and japan. international journal of economics and finance, 5, 24-29. goodall, l. (1994). market behavior of gaming stocks: an analysis of the first twenty years. journal of gambling studies, 10, 323-337. granger, c.w.j. (1998). some recent developments in a concept of causality. journal of ecoanometrics, 39, 199-211. greene, w. h. (2007). econometric analysis, (6th ed.). new jersey, ny: pearson. 234 journal of business strategies hong, h., & kacperczyk, m. (2009). the price of sin: the effects of social norms on markets. journal of financial economics, 93, 15-36. kim, i., & venkatachalam, m. (2006). are sin stocks paying the price for their accounting sins? working paper. king, r. g., plosser, c. i., stock, j. h., & watson, m.w. (1991). stochastic trends and economic fluctuations. american economic reivew, 81, 819-840. kwiatkowski, d., phillips, p.b., schmidt, p., & yongcheol, s. (1992). testing the null hypothesis of stationarity against the alternative of a unit root. journal of econometrics, 54, 159-178. little, k. (2010). rising unemployment hurts stocks, about.com: stocks, february 10. moscarini, g., & postel-vinay, f. (2010). unemployment and small cap returns. american economic review (papers and proceedings), 100, 333-337. marcet, a. (2005). overdifferencing var’s is o.k. working paper. newbold, p., & bos, t. (1990). introductory business forecasting. dallas, tx: south-western publishing co. ng, s., & perron, p. (2001). lag length selection and the construction of unit root tests with good size and power. econometrica, 69, 1519-1554. sharpe, w. (1964). capital asset prices: a theory of market equilibrium under conditions of risk. journal of finance, 19, 425-442. watson, m.w. (1994). vector autoregressions and cointegration. handbook of econometrics (eds. engle, r.f. and mcfadden, d.l.), iv, elsevier science b.v. wojdylo, j. (2009). best prediction of the stock market and economy-unemployment rate, subprime blogger, march 17. waxler, c. (2004). stocking up on sin: how to crush the market with vicebased investing. hoboken, n.j.: john wiley and sons. volume 31, number 1 235 appendix a-i trend in us casino gaming revenue and forecast for 2011-2015 (i n m ill io ns o f u .s . d ol la rs ) r eg io n 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 20 11 -1 5 c a g r n ev ad a 12 ,7 83 13 ,0 17 11 ,5 99 10 ,3 93 10 ,4 05 10 ,7 00 11 ,1 35 11 ,6 52 12 ,2 90 12 ,9 55 % c ha ng e 8. 4 1. 8 -1 0. 9 -1 0. 4 0. 1 2. 8 4. 1 4. 6 5. 5 5. 4 4. 5 at la nt ic c ity 5, 21 8 4, 92 0 4, 54 5 3, 94 3 3, 56 5 3, 30 0 3, 08 0 2, 94 5 2, 87 0 2, 81 5 % c ha ng e 4. 0 -5 .7 -7 .6 -1 3. 2 -9 .6 -7 .4 -6 .7 -4 .4 -2 .5 -1 .9 -4 .6 tr ib al c as ino s 24 ,8 89 26 ,1 43 26 ,7 39 26 ,4 82 26 ,5 03 27 ,5 00 28 ,8 00 30 ,2 00 31 ,7 50 33 ,3 50 % c ha ng e 10 .6 5. 0 2. 3 -1 .0 0. 1 3. 8 4. 7 4. 9 5. 1 5. 0 4. 7 r eg io na l c as in os 14 ,5 80 16 ,3 60 16 ,5 50 16 ,5 50 17 ,0 15 18 ,0 00 19 ,3 00 20 ,7 00 22 ,2 00 24 ,2 00 % c ha ng e 6. 4 12 .2 1. 2 0. 0 2. 8 5. 8 7. 2 7. 3 7. 2 9. 0 7. 3 to ta l 57 ,4 70 60 ,4 40 59 ,4 33 57 ,3 68 57 ,4 88 59 ,5 00 62 ,3 15 65 ,4 97 69 ,1 10 73 ,3 20 % c ha ng e 8. 4 5. 2 -1 .7 -3 .5 0. 2 3. 5 4. 7 5. 1 5. 5 6. 1 5. 0 236 journal of business strategies appendix a-ii trend in global casino gaming revenue and forecast for 2011-2015 (i n m ill io ns o f u .s . d ol la rs ) r eg io n 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 20 11 -1 5 c a g r u ni te d st at es 57 ,4 70 60 ,4 40 59 ,4 33 57 ,3 68 57 ,4 88 59 ,5 00 62 ,3 15 65 ,4 97 69 ,1 10 73 ,3 20 % c ha ng e 8. 4 5. 2 -1 .7 -3 .5 0. 2 3. 5 4. 7 5. 1 5. 5 6. 1 5. 0 em b a 20 ,7 83 20 ,8 94 19 ,9 59 17 ,5 67 16 ,3 07 16 ,1 75 16 ,2 50 16 ,7 51 17 ,3 50 18 ,3 43 % c ha ng e 2. 8 0. 5 -4 .5 -1 2. 0 -7 .2 -0 .8 0. 5 3. 1 3. 6 5. 7 2. 4 as ia p ae ifle 13 ,6 87 17 ,7 14 21 ,3 79 22 ,8 98 34 ,2 80 47 ,0 42 58 ,1 24 66 ,9 61 73 ,4 29 79 ,2 66 % c ha ng e 16 .3 29 .4 20 .7 7. 1 49 .7 37 .2 23 .6 15 .2 9. 7 7. 9 18 .3 la tin a m er ic a 2, 58 4 2, 95 9 3, 26 9 3, 60 1 3, 80 0 4, 09 6 4, 37 0 4, 75 7 5, 16 5 5, 61 4 % c ha ng e 25 .6 14 .5 10 .5 10 .2 5. 5 7. 8 6. 7 8. 9 8. 6 8. 7 8. 1 c an ad a 5, 35 4 5, 68 5 5, 69 4 5, 87 4 5, 70 4 5, 59 7 5, 62 1 5, 74 3 5, 98 6 6, 23 0 % c ha ng e 10 .7 6. 2 0. 2 3. 2 -2 .9 -1 .9 0. 4 2. 2 4. 2 4. 1 1. 8 to ta l 99 ,8 78 10 7, 69 2 10 9, 73 4 10 7, 30 8 11 7, 57 9 13 2, 41 0 14 9, 68 0 15 9, 70 9 17 1, 04 0 18 2, 77 3 % c ha ng e 8. 7 7. 8 1. 9 -2 .2 9. 6 12 .6 10 .8 8. 9 7. 1 6. 9 9. 2 so ur ce : p w c ’s g lo ba l g am in g o ut lo ok to 2 01 5 volume 31, number 1 237 appendix – c impulse response analyses (cholesky one s.d. innovations ± 2 s.e.) 238 journal of business strategies appendix – d* (variance decomposition) p er io d lv s sp 50 0 u e r t w y n n sp 50 0 u e r t m g m sp 50 0 u e r t 1 10 0. 00 00 54 .6 06 35 97 .0 92 81 10 0. 00 00 66 .7 61 88 98 .0 92 41 10 0. 00 00 87 .1 51 46 98 .8 59 82 2 90 .5 13 46 54 .3 26 15 91 .6 63 03 89 .5 90 59 66 .6 59 21 96 .9 04 24 90 .1 78 90 86 .9 46 24 98 .0 01 91 3 90 .4 05 8 54 .5 43 06 85 .8 44 13 89 .2 12 86 66 .6 25 80 95 .2 65 16 90 .0 88 70 86 .4 32 06 96 .3 65 60 4 87 .9 60 60 54 .5 21 54 83 .3 53 04 89 .1 28 28 66 .5 86 35 94 .5 14 89 89 .9 01 30 86 .4 34 45 95 .4 73 62 5 87 .8 01 11 54 .4 68 28 81 .6 26 95 89 .0 97 94 66 .5 51 45 94 .0 43 17 89 .8 78 07 86 .4 10 42 94 .8 74 47 p e n n sp 50 0 u e r t m t n sp 50 0 u e r t c a k e sp 50 0 u e r t 1 10 0. 00 00 84 .8 16 32 99 .2 41 52 10 0. 00 00 80 .2 85 90 98 .6 87 51 10 0. 00 00 77 .4 67 83 96 .6 23 51 2 99 .3 56 13 83 .8 98 58 97 .7 88 51 91 .1 46 89 78 .9 87 25 97 .8 84 98 96 .3 05 15 76 .6 96 35 95 .5 54 21 3 96 .7 57 77 83 .8 60 02 96 .4 57 39 88 .9 60 34 78 .4 45 22 96 .1 17 49 96 .0 13 68 75 .2 33 82 92 .6 93 65 4 96 .6 86 42 83 .8 21 49 95 .3 94 37 88 .7 57 13 78 .4 45 99 94 .6 61 15 95 .9 25 75 75 .1 85 18 91 .2 72 52 5 96 .6 79 09 83 .8 06 69 94 .8 85 21 88 .6 74 02 78 .4 01 80 93 .9 15 21 95 .9 22 63 75 .1 52 42 90 .3 07 16 a sc a sp 50 0 u e r t p n k sp 50 0 u e r t 1 10 0. 00 00 90 .9 33 04 97 .2 37 16 10 0. 00 00 90 .0 76 70 98 .3 87 69 2 96 .8 27 68 89 .8 23 26 91 .5 03 07 98 .2 24 75 89 .8 03 83 98 .3 04 54 3 95 .1 91 42 89 .6 88 03 87 .0 15 15 97 .1 78 18 89 .1 49 96 96 .6 55 22 4 95 .0 98 82 89 .6 67 34 84 .7 08 97 97 .1 65 22 89 .0 96 08 95 .7 12 33 5 95 .0 96 97 89 .6 56 77 83 .2 66 54 97 .1 38 34 89 .0 76 43 95 .0 06 17 *c ho le sk y o rd er in g volume 31, number 1 239 appendix – b* the cheesecake factory inc (cake) is traded on nasdaq and is headquartered in calabasas hills, california. its primary businesses include restaurant and bakery operations. the company has approximately 170 restaurants operating nationwide. the market capitalization was 2.01 billion dollars in 2012. sales and income are growing at close to a 3% rate. the sales have been 1.81 billion dollars in the last year. pinnacle entertainment inc. (pnk) is traded on the nyse and headquartered in las vegas, nevada. the company is an owner, operator and developer of casinos and related entertainment facilities. the company operates in several states as well as asia. their market capitalization was $852.37 million in 2012. sales were 1.2 billion dollars in the last year. income growth was negative for the period but the sales growth has been almost 5%. ameristar casinos inc. (asca) is traded on nasdaq and headquartered in las vegas. the company has 8 casinos in seven different markets in the us. in july of 2012 it purchased creative casinos of louisiana in its entirety. the market capitalization for ameristar was $864.51 million in 2012. sales have been 1.2 billion dollars in the last year. the growth rate in sales has been slightly negative but the income growth rate has been over 1,000% vail resort inc. (mtn) is traded on the nyse and headquartered in colorado. vail is a holding company consisting of operations in mountain (ski resorts), lodging and real estate. they acquired several new properties in 2012. their market capitalization was 2.22 billion dollars in 2012. sales were $1.07 billion in the last year. the growth rates in sales and income were negative for the last year. penn national gaming inc. (penn) is traded on nasdaq and is headquartered in pennsylvania. penn is the owner and manager of gaming properties and race tracks throughout the us and in canada. the market capitalization for the company was $4.24 billion in 2012. sales in the last year were $2.9 billion. the growth rate in sales was almost 6%, but the growth rate in income was negative. 240 journal of business strategies mgm resorts international (mgm) is traded on nyse and headquartered in las vegas. the company is engaged primarily in the gaming business with 15 resorts in the us and more in china under the name mgm macau. the market capitalization of the firm was $6.29 billion in 2012. the sales in the last year was $9.16 billion. the growth rate in sales was 17%, and the income growth rate was negative for the period. wynn resorts ltd (wynn) is traded on nasdaq and headquartered in las vegas. the company is a developer, and operator of casino properties. the company operates in las vegas and in macau. the market capitalization of the company was $12.48 billion last year. the last year’s sales were $5.15 billion. the growth in sales for the period was slightly negative and the growth in income was more negative (18.2%). las vegas sands corp (lvs) is traded on the nyse and is headquartered in las vegas. the company is a developer of destination properties in the us and china. the market capitalization of the company was $45.95 billion in 2012. the last year’s sales figures were $11.13 billion. the sales growth and income growth rates for lvs were around 20%. biographical sketch of authors dr. matiur rahman is a professor of finance and mba director at mcneese state university. he earned his ph.d. in economics from southern methodist university, dallas, texas. he is a prolific researcher and published numerous theoretical and empirical articles in refereed u.s. and foreign journals in economics, finance and international business. dr. muhammad mustafa is a professor of economics at south carolina state university. he teaches courses in economics, finance and agribusiness. he is an avid researcher and published empirical articles quite extensively in his fields of specialization in refereed journals in the usa and abroad. dr. stephen caples is a professor of finance at mcneese state university. he earned his ph.d. in finance from the university of texas at arlington. he has published a host of empirical articles in refereed finance and economic journals in the usa. *as abbreviated in table 1 are shown in parentheses. analysis of organizational culture: a critical step in mergers and acquisitions suresh gopalan j om e. dittrich west texas a&m university canyon,tx reed e. nelson southern illinois university at carbondale carbondale, il the importance of culture in mergers and acquisitions the 1980s witnessed an unprecedented wave of mergers and acquisitions. greenberg (1989) estimated that 3,500 to 7,500 mergers and acquisitions have taken place in the last few years. ironically, most of these mergers and acquisitions have ended with lowered financial performance and capital productivity, higher market-related risks, lower employee morale, high turnover, and a high degree of variance in performance. similar conclusions were reached by mckinsey and company in a study of 18 recent acquisitions (lefkoe 1987), and in knowles' (1988) analysis of mergers and acquisitions which concluded that seven out of ten acquisitions failed in the first ten years. the american management association's 1988 study ofl09 firms that were involved in either mergers or acquisitions found that "mergers and acquisitions ... enable companies to streamline business activities, but frequently they create many problems that result in lesser productivity, market share, and profits" (greenberg 1989). results from this investigation revealed that thirty-six percent ofthe firms experienced high employee turnover, twenty-four percent had decreased profitability, and twenty-four percent reported losses in worker productivity. in many cases these factors caused a divestment ofthe acquired organization(lev and mandelker 1972; rumelt 1974; shrivastava 1985; walter 1985). a cultural mismatch between the acquiring and acquired organizations offers one explanation for this pattern of unfortunate consequences (jemison and sitkin 1986). the management of acquiring organizations often focuses on achieving a strategic and financial fit or accomplishing product synergy while neglecting issues ofcultural compatibility (burke and jackson 1991; cartwright and cooper 1993; mirvis and marks 1992). nahavandi and malekzadeh (1988) comment: "with a few exceptions ... the role ofsociocultural factors and the processes involved in merging two organizations as cultural entities have not been studied thoroughly." schein (1992) concurs, observing that "rarely checked, however, are those aspects that might be considered cultural: the philosophy or style of the company; its technological origins, which might provide clues as to its basic assumptions; and its beliefs about its mission and its future." early efforts to integrate or change incompatible cultures after an acquisition or merger have met with employee conflict, resistance, frustration, and turnover often leading to eventual divestiture of the acquired organization (bastien 1987; porter 1987; sinetar 1981). fall 1994 gopalan, et. al.: analysis oforganizational culture 125 in the acquisition of intersil by general electric, for example, ge made only one change in intersil's operations. this change, however, was seen by employees as severely limiting the possibility for personal financial gain, and over one third ofintersil's managers and engineers left the firm (magnet 1984; trice and beyer 1993). it is extremely important, therefore, for top management to gain insights about the culture of a firm which is the target of an acquisition or merger, well before the merger is consummated (lefkoe 1987; schein 1992; shrivastava 1986). managers should note that while there is considerable consensus in the field that culture is important to organization effectiveness and success, there is much ambiguity and lack of precision regarding the operational definition of culture and consequently its measurement (kotter and heskett 1992; rousseau 1990). culture includes the behaviors, beliefs, attitudes, values, assumptions, shared by members of an organization and can be visualized as composed of many layers ranging from easy to observe artifacts, technology, and behaviors to hard to decipher assumptions. culture, therefore, should be considered as a multidimen~ sional, multilevel concept (nahavandi and malekzadeh 1988; rousseau 1990; schein 1992). depending on their defmition and methodology, scholars designate one or another ofseveral possible layers as "culture" and relegate others as by-products or artifacts of culture (cooke and rousseau 1988; kilmann et al 1986; schein 1984). despite multiple definitions associated with the culture construct, rousseau (1990) considers the layers of culture associated with values, beliefs, and expectations as the primary elements of culture. the need for unobtrusive pre-merger cultural diagnosis a pre~acquisition or pre~mergercultural diagnosis of the target company can provide management with valuable information to determine whether a proposed acquisition or merger should take place. additionally, such an analysis may also provide management with insights helpful in developing successful post~acquisition/mergercultural change strategies and thus reducing post-acquisition/merger acculturative stress and failure. it is logical, then, to consider cultural diagnosis of the target organization as a necessary and significant step before any acquisition or merger process. acquisition activities are usually characterized by secrecy, confidentiality, and urgency, especially where more than one organization is interested in an acquisition (bastien 1987; ivancevich et al1987; walter 1985). traditional methods of gathering information about organizational culture include ethnographic observation (morgan and smircich 1980), in-depth open~nded interviewing (becker and goor 1970), collecting and analyzing questionnaire responses from workers (cooke and rousseau 1988; hofstede 1990), interpreting rites (beyer and trice 1983), and understanding symbols, ceremonies, and myths (ouchi 1981). these methods are often quite time consuming, and compromise secrecy by requiring the cultural analyst to interact extensively with the organization to be acquired. important insights into an organization's culture, that is, its values, attitudes and beliefs, can be obtained from readily available data. corporate annual reports, company sales catalogs, advertisements and product literature, dun and bradstreet, standard and poors, moodys, popular business magazines such as business week, fortune, forbes, govemment reports, scholarly journals, and industry analysts are all potential sources of cultural 126 journal ofbusiness strategies vol. 11, no.2 information. given the need for secrecy, we believe that these public sources of information offer an invaluable source of data which should be used to conduct a first-level, feasibility analysis of the merger or acquisition from a cultural perspective. assessing culture strength and content of the target organization we believe that two aspects of a target organization's culture are critical to management analysis. the notion of culture strength, introduced by deal and kennedy (1982), refers to the pervasiveness of a given set of norms, beliefs, and values in an organization. kilmann, saxon, and serpa (1986) theorize that the strength of organizational cultures can range from very weak (diffused and non-pervasive) to very strong (widely held and shared). strong cultures exert considerable pressure on organizational personnel to conform to established norms and prescribed patterns of behavior. the hewlett packard organization, in its published "the hewlett packard way" philosophy, provides explicit guidelines for em~ ployee behavior. strong cultures can also contribute significantly to organizational success or failure (kotter and heskett 1992). again, hewlett-packard serves as an example ofcultural support for continued success, as might the strong culture developed and reinforced in the wal-mart organization. ibm's strong culture, established early and reinforced through years of successful performance, has,however, also contributed to ibm's slow response to changes in its industry, and to its recent declining fortunes. in contrast, weak cultures are less influential in their impact on employees' values, beliefs, and norms and are largely inconsequential in shaping organizational outcomes. cultural content refers to actual norms, beliefs, values, and assumptions that are present in the organization. a review of the organization culture literature shows that organizations vary considerably in the values they espouse. some have cultures emphasizing and encouraging creativity, flexibility, autonomy and adaptability (trice and beyer 1993). other organizations have cultures displaying preference for authority, resistance towards change, and emphasis on stability. still others stress excellence, competition, achievement, and winning (deal and kennedy 1982; peters and waterman 1982; schein 1992). measurement of culture strength from the work of wilkins and ouchi, several externally visible clues to the strength of an organization's culture are identified. they propose that a long history and stable membership, an absence of institutional alternatives, and interaction among members facilitate the emergence of strong cultures (wilkins and ouchi 1983). operationally, these broadly described factors can be assessed by the following six indicators: tenure of founder(s) the founder serves as the primary source of an organization's culture. according to schein (1984), "an organization's founder ... by the sheer force of his or her personality, begins to shape the group's culture." in addition, where founders have remained at the helm for many years, strong cultures are likely to have developed. lengthy tenure permits personal convictions, philosophies, and ideas of the founders to become deeply embedded in their respective organizations. thomas watson of ibm, harley proctor of proctor & gamble, and fall 1994 gopalan, et. al.: analysis of organizational culture 127 william kellogg of kellogg inc., were all founders with lengthy tenures who had lasting influences on their organization's culture. more recently, the late sam walton shaped an organizational culture which extends across hundreds of separate wal-mart retail stores (kotter and heskett 1992). conversely, strong cultures are unlikely to develop in organizations where the founder or the founding group remained in control for only a brief period. management by founder's family culture strength is also enhanced by the number of family members occupying key management positions and the length oftime that family hold such positions. founders often appoint relatives as successors, a practice which will tend to reinforce and strengthen the cultural legacy. tom watson, jr., for example, was outspoken in carrying forward and reinforcing the culture established by his father at ibm (kotter and heskett 1992). if the practice of appointing family members to key positions (as opposed to professional managers) is continued for an extended period, organizations will develop cultures that are strong, cohesive, and resistant to change. kotter and heskett (1992) mention the coors family, as anotherexample, which has continued through family management along-standing (if frequently criticized) organizational culture established by the company's founder. family ownership of stock from these examples of the effect of continued family domination (i.e.; watson, coors, busch, and others cited by kotter and heskett 1992), it seems reasonable to expect that an organization is more likely to possess a strong culture when a significant percentage of stock is held by the founder and hislher family (or by the founding group and their families). when ownership and management are vested with the same group, owner-managers are in a unique position to promote their own ideas, interests, and preferred mode of functioning with little or no opposition. in the brewing industry, the coors and busch families continue to provide direction to their respective organizations after many decades of operation. conversely, widely dispersed ownership and management by professionals makes it more difficult for any individual or group to make a strong impression on organizational culture. employee turnover low turnover enhances cultural strength by enabling members of one generation to pass on organizational values and beliefs to successive generations. this process affords a means for those cultural attributes to become institutionalized (berger and luckmann 1967). organizations with lifelong employment practices, such as lincoln electric company, tend to have low turnover rates and therefore a stable membership. the institutionalization of social knowledge does not occur in organizations with high turnover rates because brief employment periods do not lend themselves to internalization and transmission of the organizations' values and beliefs. age of the organization the older the organization, the stronger is its culture, as cultural elements such as values, attitudes, and beliefs have had a longer time to be ingrained in employees through shared 128 journal ofbusiness strategies vol. 11, no.2 experiences (schein 1984; wilkins and ouchi 1983). organizations with long histories and stable memberships are characterized by a higher degree of socially shared knowledge, and consequently have stronger cultures. single versus multiple locations the concentration of employees in one location facilitates extensive interaction and socialization and a process where shared values and beliefs (social knowledge) are "passed on" from one generation of employees to another. social knowledge becomes institutionalized as "culture" when extensive interaction takes place among employees (wilkins and ouchi 1983). thus, other things being equal, organizations that are located in a single geographic location are likely to have stronger cultures than those which are dispersed nationally or internationally (kotter and heskett 1992). the impact of the environment od organizational cultural content for many years, organizational theorists have affirmed that organizations tend to be structurally responsive to the demands of their environments (woodward 1965). while these studies did not examine organization-industry relationships from a cultural perspective per se, the results make it clear that organizations adapted to the needs of their environment by internalizing and displaying environmentally compatible characteristics (aldrich 1979; bums and stalker 1961; lawrence and uusch 1967). in the process of adapting to the environment, we would expect cultural elements from the environment to be assimilated by the organization (trice and beyer 1993). reynolds (1986) found empirical support for this idea in a study of 275 employees from five organizations on 14 aspects of organizational culture. these organizations were drawn from the computer services/software, franchised restaurants, and advanced technology industries. reynolds observed that different industries spawn different organizational cultural characteristics. for example, those in the computer service/software industry displayed the least social conformity and a high cooperative work atmosphere; franchise restaurants reported the greatest task focus, the least risk taking, the highest social conformity; and centralized decision making; advanced technology firms had moderate social conformity, complex systems, and the greatest use offormal procedures. reynolds (1986) concluded that (1) organizational cultures should be studied with reference to the industries from which they are drawn and (2) organizational cultures within the same industry will tend to display similar cultural characteristics. similarly, gordon (1985; 1991) drew upon the work of katz and kahn (1966), porter (1987), and other organizational theorists to suggest that organizations are affected by their industrial environment. the central premise of gordon's (1985; 1991) argument is that although organizational cultures are unique, industrial environments affect organizations causing their cultures to develop within certain parameters. such parameters are based on industry-wide assumptions about environment, customer requirements, and competition resulting in shared common cultural characteristics within firms in the same industry. these cultural characteristics comprise the core of a company's values concerning the "right thing to do." consistent with these values, management then develops strategies, structures, and fall 1994 gopalan, et. al.: analysis oforganizational culture 129 processes that are necessary to conduct the business of an organization. in the following sections, industry characteristics are described from the competitive and customer aspects that affect the content of organizational cultures. competitive environment while presented in a number ofdifferent frameworks, three major factors are seen to have a significant affect on the nature of the competitive environment (byars 1991; day 1975; mintzberg and quinn 1991). they are: a. the intensity of competition. b. the rate of environmental change. c. the extent to which the environment can sustain growth. competition and environmental change create uncertainty and volatility. consequently, organizations respond by encouraging values and behaviors which help them to adapt to environmental demands. organizations operating in dynamic environments with fierce competition (e.g., software companies) therefore, are likely to have highly responsive, adaptive, and aggressive cultures. companies in industries with a high growth potential (e.g., medical bio-tech companies) are characterized by risk taking and innovative behaviors. conversely, stable and predictable environments with little or no competition alloworganizations to foster values and behaviors that institutionalize and standardize ways of conducting business. these organizations are likely to have cultures that are stable, conservative, and slow-changing with centralized structures. for example, utility companies face no direct competition and are frequently embedded in markets with stable growth potential. consequently, the cultures within such companies are more likely to emphasize service, technical excellence, and efficiency over innovation and risk. customer requirements customer buying preferences are seen by gordon to determine the technology that organizations employ in dealing with their environments. these factors can be viewed as a single continuum ranging from a highly static marketplace with a demand for reliability to a highly dynamic marketplace with a demand for novelty. organizations operating in the former environment are more likely to employ routine technologies compared to organizations in the latter environment which use advanced technologies. organizations utilizing high level technologies encourage behavioral norms which emphasize achievement, encouragement of individual initiative, and action (gordon 1991). these organizations allow their employees the greatest degree of freedom and independence, factors which are instrumental in developing creative, flexible, and innovative behaviors. companies utilizing routine sequential technologies (paper and glass industries for instance), develop norms which promote interdependence ofpeople and organizational units, standardization of behaviors, deference to seniority, and deliberation when solving problems. in such organizations, speed and creativity are sacrificed for consistency and reliability. thus, by analyzing the industry environment with respect to the number of competitors, the rate of environmental change, the degree of growth potential in the environment, and the nature of customer requirements, managers of acquiring companies can gain insights about 130 journal ofbusiness strategies vol. 11, no.2 industry-driven assumptions and consequently about the target company's principal cultural content. are the two organizations culturally compatible? for a satisfactory analysis, the management of the acquiring firm should conduct a study of the strength and content of the culture of its own organization, as well as that of the target organization. understanding one's own values system can go a long way in preparing for the potential clashes and difficulties which may be encountered in carrying out the merger (lefkoe 1987). when the analysis is complete, the target organization's culture should be compared with that of the acquiring:firm for similarities and differences. the strength of the culture of the target company could either be strong or weak, and its cultural content similar or dissimilar to that of the acquiring organization. the results of the diagnosis can then be placed into one of the alternative configurations created by the combination of these two factors. from an acquirer's perspective we see four possibilities. figure 1: assessing cultural compatibility cultural similarity of the target organization similar dissimilar cultural strength of the target organization weak strong ideal problematic 1 2 3 4 desirable undesirable cultural fit, or compatibility, is considered to be ideal (cellt) when the culture of the target organization is diagnosed as weak in strength and similar in cultural content to the acquiring organization. for a variety of reasons (weak leadership, high turnover, geographic dispersion), organizations with weak cultures do not posses values, beliefs, and norms that are widely shared and strongly held. consequently, members of the target organization are not likely to display a strong desire to preserve their own culture following an acquisition or merger. resistance to change following an acquisition or merger, therefore, should be limited, sporadic, and basically inconsequential. we consider degree of cultural compatibility to be problematic (cell 2) when the target organization's culture is considered to be weak and dissimilar to that of the organization initiating the merger or acquisition attempt. the weakness ofthe target organization's culture fall 1994 gopalan, et. al: analysis of organizational culture 131 reflects the possibility that employees may not have strongly internalized the organization's values. thus, the assimilation of new values will not be strongly resisted. the lack of similarity between cultures, however, indicates that employees in the target organization have been socialized very differently, and may have a quite different view of their working world while the overall organization culture of the target organization may be "weak," subcultures may exist which are firmly embedded and not easily observed, especially by these unobtrusive measures. as mentioned earlier, cultures that are strong and dissimilar are hard to integrate. strong and dissimilar subcultures will be no easier. furthermore, if these subcultures are in areas operationally and strategically critical to the organizatidn's success, then the task of post acquisition/merger acculturation becomes extremely complex, and of crucial importance. a more obtrusive analysis which might involve ethnographic analysis, focus group discussions, and intensive qualitative interviews would be needed to reveal the identity and/or nature of subcultures present in the target organization (peters and waterman 1982). we recommend that the more intensive cultural audit should probably be deferred pending further discussion and preliminary decisions on the general viability of the merger or acquisition. for these reasons, we consider the degree of cultural compatibility in cell 2 as at best limited, and for practical reasons, problematic. when the target organization's culture is diagnosed as strong and similar to the acquiring organization (cell 3) we consider culture compatibility to be desirable (but not ideal) for the following reasons. organizations with strong cultures have enduring values reinforced by strongly held beliefs and proud traditions which are widely shared by a majority of the employees. employees in these organizations value their culture and are likely to demonstrate a strong desire to preserve these important aspects of their work life. similarity in cultures between two organizations does not necessarily imply sameness. each culture may possess subtle but unique patterns in the way relationships are conceptualized with customers, employees, and may have unspoken assumptions relating to performance, leadership practices, and ethics to guide everyday action. the acquiring organization can overcome resistance, build harmony and enhance cultural fit, however, by emphasizing common areas of cultural concordance between both organizations. in spite of the many challenges that are involved with the integration process under this scenario, success is possible with a suitable well developed acculturation strategy. we consider cultural relationship between the two organizations to be undesirable when the target organization's culture is diagnosed as strong and dissimilar to that of the acquiring organization (cell 4). as in cell 3, employees working in organizations with strong cultures possess durable and widely held values and are likely to have a strong desire to preserve them. employees in culturally dissimilar firms have different ideologies and value systems which are a consequence of differences in education, occupational habits, customers, suppliers, leadership, location and so on. given that the cultures of the two organizations are dissimilar in content, it is unlikely that common core cultural areas can be found. integrative measures which could be developed to enhance cultural fit, therefore, are not likely to be very effective (ivancevich et a11987). attempts to assimilate two strong, dissimilar organization cultures have almost always ended in failure (magnet 1984; shrivastava 1986). therefore, when a target organization is 132 journal ofbusiness strategies vol. 11, no.2 diagnosed as possessing a strong and dissimilar culture, we suggest that the management of an organization initiating the acquisition or merger seriously consider the possibility of looking for a more suitable target, even though financial and market factors may be attractive. cultural change strategies framing a cultural change strategy before the actual acquisition or merger allows management of both organizations to anticipate challenges and difficulties involved in bringing two cultural entities together. this approach reduces the likelihood of arbitrary imposition of the acquiring company's culture, or neglect of issues likely to result in cultural conflict, a path of action which has caused the failure of many acquisitions (sinetar 1981). based on earlier diagnosis of the target organization's cultural strength, content, and degree of compatibility with the acquiring company, four modes of cultural change suggest themselves: figure 2: cultural change strategies cultural similarity of the target organization similar dissimilar cultural strength of the target organization weak strong imposition assimilation andorg. development 1 2 3 4 combination isolation and loose coupling or liquidation assimilation assimilation is seen as an acceptable mode of cultural change when the degree of compatibility of the two organizations is diagnosed as "ideal." this situation exists when the target organization has a culture which is weak but similar to that of the acquiring firm (cell 1). assimilation involves a gradual replacement of the target organization's cultural components with the cultural values, beliefs, and organizational practices of the acquiring organization. assimilation theorizes that the members of the acquired firm would willingly adopt the cultural practices of the acquirer due to their similarity and their desire to be associated with a "stronger" organization (berry 1980; sales and mirvis 1984). at best, resistance to assimilation should be minimal, since employees in such organizations are not imbued with strong values or beliefs which they wish to preserve. fall 1994 gopalan, et. al: analysis o/organizational culture 133 the process of assimilation may also be facilitated by removing the entire top management of the acquired organization. william agee and alonzo mcdonald, for example, were the ceo and president of bendix corporation respectively and were immediately removed from their offices by edward hennessey, chairman of allied corporation soon after allied acquired bendix (walter 1985). trice and beyer (1993) note that the removal of top executives makes it much easier for the acquiring firm to "introduce" their brand of culture by removing the locus of an existing subculture that might interfere with assimilation. cross-firm orientation programs and planned cross-firm rotational assignments for technical and managerial personnel can also aid in reducing uncertainty and improving cultural interchanges. as one example, an extensive retreat was conducted to help in clarifying and harmonizing the cultural differences observed during the h-p and apollo merger (mirvis and marks 1992). events after the post-retreat period showed that a gradual process of assimilation and integration was taking place because (a) both h-p and apollo were in the same industry and their employees could relate to common technology, customers, and competitors, and (b) because each had faced similar problems such as competition from sun and dec (mirvis and marks 1992). imposition and organizational development imposition is the next mode of cultural change and is recommended when the object of acquisition is characterized by a weak and dissimilar culture (cell 2). imposition involves a comprehensive replacement of the acquired organization's culture especially when the culture contains elements that are considered as dysfunctional and unattractive from the acquirer's perspective. under imposition, the acquired organization has a limited role in shaping and or affecting cultural, strategic and or operational decisions during and after the acquisition. hewlett-packard's acquisition ofapollo computer involved imposition, since a number of h-p policies were established at apollo by directive (mirvis and marks 1992). hewlett-packard's planning and control systems, for example, were incorporated throughout apollo. in addition, the manufacturing and sales functions were completely absorbed into hewlett packard's organization and policy framework. resistance to cultural change should be anticipated but in most cases may be ineffectual due to overall weakness in the acquiree's culture. in some instances, however, the overall weakness in the target organization's culture, may be the result of strong and antagonistic subcultures which are potential sources of resistance to change. in this situation, cultural "match" may be problematic, especially if these subcultures are found in organizationally valued occupations or functions. where the differences are seen as overly significant, but where the commercial gains are considered to be very attractive, a more intensive cultural audit of the target organization's culture using intensive focus group interviews with employees may be needed to identify cultural sources of resistance which can then be suppressed, eliminated, or transformed as the merger or acquisition proceeds. if further analysis reveals that strong and antagonistic subcultures are located in areas of strategic interest to the acquiring organization, we recommend that intensive organizational development strategies involving cross-company orientation or training assignments and conflict resolution techniques be employed to help 134 journal o/business strategies vol. 11, no.2 in the cultural change process. while drastic, removal of subculture leaders can also be considered as one of several approaches to reducing the resistance of key subcultures. consequently, imposition as a cultural change strategy should be considered only when the commercial or strategic gains are so attractive as to outweigh the cultural problems which will be encountered. combination in cell 3, where the acquiring organization has diagnosed the culture of the target company as strong, but similar to itself (a degree of cultural compatibility considered desirable), the suggested mode of acculturation is combination. combination involves identifying and incorporating the core areas of common values into the value systems of the emerging organization so that resistance to change on the part of employees is minimized. the worst qualities of both cultures should be examined for ways to eliminate or reduce their negative impact on organizational performance. the best attributes of each should be retained and merged into a new culture which members ofeach organization can comfortably adopt. this cultural change strategy could be labeled a true acculturation strategy, since values from both organizations are adopted by the emerging organization (berry 1980). good examples of this process and its results include the smithkline-beecham merger (burke and jackson 1991) and the merger of the norfolk and southern railroads (napier 1989). in the smithkline-beecham case, the focus was on creating a new and different culture, one which combined the positive qualities of both organizations while eliminating the negative qualities from both. an executive committee comprised of senior management from both organizations identified five primary values and nine leadership practices which were to be the basis of the organization's new culture. traditional organizational development techniques were used to reduce intergroup conflict and the negativism in subcultures opposed to the merger. planned cross-company familiarization activities reduced resistance brought about by a lack of knowledge on the part of employees and managers in both organizations. other organizational development activities were tailored to meet the special needs of the two organizations involved. (for an extensive discussion of two merging organizations with strong, similar cultures, we suggest burke and jackson's (1991) account of the smithkline and beecham merger.) in the norfolk & southern railway merger, a new culture emerged as a result of combining names, locating the headquarters in a neutral city, cross-training key managers, and balancing representation on the board of directors (napier 1989). isolation and loose coupling !!i liquidation in situations where the target company's culture is strong but dissimilar to that of the acquiring company and cultural compatibility viewed as undesirable (cell 4), isolation should be the preferred means of accommodation, if the acquisition or merger target is considered operationally attractive from a commercial perspective. an isolation strategy involves creating a structural configuration which results in cultural isolation of the target company. under this "loose-coupling" strategy, some form of structural connection is made between the two organizations but with very little mutual cultural and behavioral exchange. fall 1994 gopalan, et. al.: analysis o/organizational culture 135 the target company's employees are allowed to participate in their own cultural practices without intervention from the acquiring organization. this form of cultural accommodation is seen in acquired or merged firms which exist as wholly-owned but independently operated subsidiaries. these organizations arrange financial and operating linkages with the parent organization, but retain their original cultures and often their intact management teams (magnet 1984). in mcgraw-hili's acquisition of standard & poors in 1966 and several other firms (four television firms, datapro research corporation, dri) in the 1970's and 1980's, where these firms were not in the same industry as mcgraw-hill, the strength of the acquired firms' cultures and their strong market position contrasted with a relatively weak organizational culture at mcgraw-hill. in the ensuing years, the acquired firms functioned relatively autonomously within the loosely-coupled corporate framework, and continued to perform well (kotter and heskett 1992). good results from this form of accommodation, but within the same industry, are reported in the bank of america acquisition of seattle first national. mer a short period of corrective action, seafirst operated with little change imposed by its acquirer, and became a strong contributor to bank of america (napier 1989). mergers that have ignored the vast cultural differences between the two firms (such as federal express and tiger international inc. merger) have experienced tremendous financial losses, lower stock price, the emergence of a 'we-they mentality' and poor morale among the employees (tu and sullivan 1994). when the cultural differences seem to be ~ pronounced, and where the principal strategic attractiveness of the acquired company lies in its resources, customers, federal and state tax benefits due to operating losses and assets, (rather than in its continued operation), the acquisition might ultimately call for a plan ofliquidation. the acquisition by hca of botany mills and the reorganization and liquidation of the operating textile company is one example of an acquisition undertaken wherein liquidation was deemed more strategically and financially attractive than a continuation of operations. a $15,500,000 tax loss carry-forward was also a factor in this liquidation of the textile company «tompkins 1957). botany subsequently was renamed botany industries, to reflect the broad range of its non-textile interests (new york times 1959). another example is the acquisition and subsequent liquidation of auto parts maker sheller-globe by colonial press, a printer of paperback books (magnet 1986). implications of cultural diagnosis and assessment performing cultural analysis not only has implications for suitable partner selection, but also embodies a proactive management approach in managing the human aspects of mergers and acquisitions, a factor that has been overlooked in most mergers and acquisitions (cartwright and cooper 1993). an initial assessment should attempt to compare the cultural strength (the intensity and concentration) and content (the substance) of both organizations to explore the degree of similarities and differences between them. this step is necessary because any decisions regarding cultural change are dependent on such an assessment. once such an evaluation is complete, a list of possible acculturation strategies emerge. two of the four cells (#1 and #3) appear to offer attractive opportunities where there is similarity in cultural content. in one of the two cells where cultural content is not similar and where strong 136 journal ofbusiness strategies vol. 11, no.2 subcultures may be present, (cell #2), acquisition or merger prospects are considered much less attractive. in this situation, continued operations will call for significant attention to organizational development to address problems of conflict resolution or minimization. in the second case, in which cultures are strong and dissimilar (cell #4), a formal separation of the two organizations is recommended to reduce or eliminate the opportunity for cultural dissonance. this line of thinking suggests that mergers and acquisitions are probably most successful within one's own industry, where the content of the cultures of the two organizations may reflect the same environmentally-induced responses (porter 1987; shrivastava 1986). where employees from two organizations, embedded in same or related businesses, share similar values and hold a common view ofthe world (markets, products, processes, technology), the degree of cultural compatibility is high. consequently, cultural fit and integration can be maximized in such organizations following a merger or acquisition. a similar contention is made in the organizational strategy literature regarding the success of intra-industry mergers on the one hand and the difficulties encountered by mergers which cross industry lines on the other (kusewitt 1985; shelton 1988; singh and montgomery 1987). industry commonality in mergers and acquisitions is associated with superior performance and economic return while unrelated acquisitions have demonstrated higher risks and sub-par performance. while scholars examining strategy have attnbuted better financial returns in related mergers or acquisitions to synergies obtained through product, process, and market fits, they have not adequately recognized the importance of"cultural fit" and "cultural compatibility" as crucial factors for ensuring a successful outcome in a merger or acquisition. acquisitions and mergers between firms with strong cultures which operate in dissimilar environments are likely to have sustaining value only so long as they are considered a part of a financial "portfolio" of companies, and are isolated as independently operated subsidiaries (magnet 1984). when the original management team departs (typically within 5 years) and is replaced by managers from the acquiring organization, the problems of cultural differences become quite evident (shrivastava 1986). this pattern has been seen in mergers which formed conglomerates, many of which have fallen on very difficult times, and have subsequently divested themselves ofthe least similar subsidiary companies. examples might include the merger ofwestinghouse and teleprompter (business week 1985) and exxon and vydec (shrivastava 1986). the divestiture ofsubsidiary companies following an udsuccessfulmerger and the loss ofthe key management team, has more than financial consequences for the acquiring firm and the target. the acquiring company typically suffers financially, and is burdened by management problems in the acquired unit which are unresponsive to the thinking of its management. for employees of the target company, their organization has been devastated by the loss of its long-standing leadership, by a lack ofunderstanding on the part ofthe new corporate leadership, and by inept decisions in day to day operations (bahn 1989; ivancevich et al1987). uncertainty, the potential loss of one's job, and the real possibility of the demise of the entire organization are factors faced by all of those associated with the target company (ivancevich et al 1987). consequently, the cost of an unsuccessful merger or acquisition is clearly quite high. with increasing demands for an organization to be "socially responsible," the liquidation approach (prescribed in cell #4) may be counter-productive, especially in the short-run. fall 1994 gopalan, et. al.: analysis oforganizational culture 137 negative media reports regarding the adverse economic impact of plant closures on local communities can result in organized opposition, and pose serious public relations problems. even where financial reasons may clearly justify liquidation or plant closure, organizations may face a high degree of political and social pressure to delay or to indefinitely postpone such decisions. one must ask whether the social costs of liquidation or a failed merger or acquisition are reasonable, given the consequences described above. a more responsible solution to dealing with mergers and acquisitions where cultural problems seem likely to seriously interfere with the operations of a merged or combined organization would seem to be to fmd more ways to form a meta-organizational form, or network of associations, which preserves the identity, leadership, and culture of organizations while offering their associates the commercial value of their hard-earned expertise in dissimilar environments. these networks are increasingly observed in the formation of multinational enterprises, organizations where the cultural problems are not only caused by differences in companies and industries, but also by religions, nations, and national movements (bartlett and ghoshai1991). references aldrich, h. e. 1979. organizations and environments. englewood cliffs, nj: prentice hall. bahn, charles. 1989. "surprise endings to takeovers." across the board (may): 39-44. bartlett, c. a and s. ghoshal. 1991. "global strategic management: impact on the new frontiers of strategy research." strategic management journal 12: 14. bastien, david t. 1987. "common patterns of behavior and communications in corporate mergers and acquisitions." human resource management 26: 17-33. becker h. s. and b. geer. 1970. qualitative methodology. chicago: rand mcnally. berger p. l and t. luckmann t. 1967. the social olnstruction of reality. garden city, new york: anchor books. berry j. w. 1980. "social and cultural change." in h. c. triandis & r .w. brislin (eds.), handbook of cross-cultural psychology 5: 211-279, boston: allyn and bacon. beyer, janice m. and harrison h. trice. 1983. "how an organization's rites reveal its culture." organizational dynamics (autumn): 5-24. burke, warner w. and peter jackson. 1991. "making the smithkline beecham merger work." human resource management 20,1: 69-87. bums, tom and george stalker. 1961. the management of innovation. london: tavistock. byars, l.l.1991. strategic management: formulation and implementation. third ed., new york: harper collins inc. 138 journal ofbusiness strategies vol. 11, no.2 cartwright, susan and cary l. cooper. 1993. "the role of culture compatibility in successful organizational marriages." academy of management executive 7, 2: 57-70. cooke, robert a and denise rousseau. 1988. "behavioral norms and expectations: a quantitative approach to the assessment of organizational culture." group and organizational studies 13: 245-273. day. g. s. 1975. "a strategic perspective on product planning." journal of contemporary business (spring): 27. deal, terrence and alan kennedy. 1982. corporate cultures: the rites and rituals of corporate life. reading, ma: addison wesley. "do mergers really work?" business week (june 3, 1985). gordon, george. 1985. ''the relationship of corporate culture to industry sector and corporate performance." in rh. kilmann. m.j. saxton, r. serpa & associates (eds.). gaining control of the corporate culture. san francisco: jossey-bass: 103-125. . 1991. ''the industry determinants of organizational culture." academy of management review 16,2: 396-415. greenberg, r e. 1989. "measuring the impact of mergers and acquisitions." management review (july): 54-56. hannan m. t. andj.h. freeman. 1977."thepopulation ecology of organizations." american joumal of sociology 28: 926-964. hofstede"geert. 1990. "measuring organizational cultures: a qualitative and quantitative study across twenty cases." administrative science quarterly 35: 286-316. ivancevich, john m., david m. schweiger and frank r power. 1987. "strategies for managing human resources during mergers and acquisition." human resource planning 10, 1: 19-36. jelinek, m., l. smircich and p. hirsch. 1983. "introduction: a code of many colors." administrative science quarterly 28: 331-338. jemison, david and sim sitkin. 1986. "corporate acquisitions: a process perspective," academy of management review 11,1:145-163. katz, d. and r.l. kahn. 1966. the social psychology of organizations. new york: wiley. kilmann, ralph, mary saxton and roy serpa. 1986. "issues in understanding and changing culture." california management review 28, 2: 87-94. knowles, robert. 1988. "most mergers fan in 10 years: study." national underwriter (april 25): 235-252. fall 1994 gopalan, et. al.: analysis oforganizational culture 139 kotter, john p. and james l. heskett. 1992. corporate culture and performance. new york: the free press. kusewitt, john b. 1985. "an exploratory study of strategic acquisition factors relating to perfor mance." strategic management journal 6: 151-169. lawrence, paul r. and jay w. lorsch. 1967. organization and environment. cambridge, mass.: harvard university press. lefkoe, morty.1987. "why so many mergers fail" fortune (july 20): 113-114. lev, b. and g. mandelkar. 1972. ''th.e microeconomic consequences of corporate merger." journal of business (january). magnet, m. 1984. "acquiring without smothering." fortune (february 3): 22-30. magnet, m. 1986. "what merger mania did to syracuse." fortune (february 3): 95-98. mintzberg, h. and j.b. quinn. 1991. the strategy process: concepts. contexts. cases. second ed., englewood cliffs, nj.: prentice hall. mirvis, p. h. and m.l marks. 1992. "the human side of merger planning: assessing and analyzing fit" human resources planning 15, 3: 69-92. morgan, gareth and linda smircich. 1980. "the case for qualitative research." academy of management review 5, 4: 491-500. nahavandi, msaneh and ali r. malekzadeh. 1988. "acculturation in mergers and acquisitions." academy of management review 13, 1: 79-90. napier, nancy k. 1989. "mergers and acquisitions, human resource issues and outcomes: a review and suggested typology." journal of management studies 26, 3 (may): 271-289. "botany asks new name." 1959. new york times (april 7). quchi, william. 1981. theory z: how american business can meet the japanese challenge. reading, massachusetts: addison wesley. peters, tom and r.h. waterman, jr. 1982. in search of excellence: lessons from america's best-run companies. new york: harper & row. porter, michael. 1987. "from competitive advantage to corporate strategy." harvard business review (may-june): 43-49. reynolds, paul d.1986. "organizational culture as related to industry, position and performance: a preliminary report." journal of management studies 23, 3: 33-345. 140 journal ofbusiness strategies vol. 11, no.2 rousseau, denise. 1990. "assessing organizational culture: the case for multiple methods" in benjamin schneider (ed.). organizational climate and culture. san francisco: jossey-bass: 153-192. rumelt, r. p. 1974. strategy, structure, and economic performance. harvard business school: division of research. sales, a. l. and p .h. mirvis. 1984. "when cultures collide: issues of acquisition.". in j.r. kimberly, & r. e. quinn (eds.). managing organizational transition. homewood ii., irwin: 107-133. schein, edgar h. 1984. "coming to a new awareness of organizational culture." sloan management review (winter) 3-15. schein, edgar h. 1992. organizational culture and leadership. second edition, san francisco: jossey bass. shelton, lois m. 1988. "strategic business fits and corporate acquisition: empirical evidence." strategic management journal 9: 279-287. shrivastava, paul. 1985. "integrating strategy formulation with organizational culture," journal of business strategy 5, 3: 103-111. shrivastava, paul. 1986. ''postmerger integration." journal of business strategy 7, 1: 65-76. sinetar, m. 1981. "mergers, morale and productivity." personnel journal 60: 863-867. singh, harbir and cynthia a. montgomery. 1987. "corporate acquisition strategies and economic performance." strategic management journal 8: 377-386. tompkins, john s. 1957. "trouble-dodging botany's 'secret'" new york times (october 13). tu, howard s. and sherry e. sullivan. 1994. "federal express: the road to globalization" in peter wright, charles d. pringle and markj. kroll, strategic management. 4th. edition. allyn-bacon: boston. trice, harrison m. and janice m. beyer. 1993. the cultures of work organizations. englewood cliffs, new jersey: prentice-hall. walter, gordon a. 1985. "culture collision in mergers and acquisitions" in p. j. frost, l. f. moore, m. r. louis, c. lundberg, & j. martin (eds.), organization cultures. beverly hills, ca: sage: 301-314. wilkins, alan l. and william g. ouchi.1983. "efficient cultures: exploring the relationship between culture and organizational performance." administrative science quarterly 28: 468-481. woodward, j.1965. industrial organization: theory and practice, london: oxford university press. analysis of organizational culture: a critical step in mergers and acquisitions 180 journal of business strategies boards as resource providers and monitors for research and development xuanli xie peking university • beijing, china hugh o’neill university of north carolina -chapel hill • chapel hill, north carolina abstract innovation is essential for every organization. yet the relationship between boards and innovation remains unclear. we argue that boards not only monitor, but also provide resources, and innovations require both proper levels of resources (skills) from the board, and appropriate forms of control. in this study, we integrate resource-dependence and agency perspectives to examine how a board’s knowledge and skills (board diversity) and a board’s preference for behavior based controls (board composition) influence the board’s ability to provide resources and design controls, which in turn affect the level of research and development intensity in the firm. hypotheses are tested using a panel data set of firms in research intensive industries. introduction “every organization needs one core competence, innovation” (drucker, 1995) certainly, most top managers would agree that innovation is essential for the survival of business, especially in these times of technological and global turbulence. despite this recognition, though, few firms are able to sustain innovation. each decade seems to bring renewed recognition that inertia drives out innovation in many established firms (christensen, 1997; cooper and schendel, 1976; miller, 1990). not surprisingly, ceos and their top management bear some blame for the problem. under the pressure of meeting quarterly forecasts, ceos claim to have little time to formulate and implement long-range growth initiatives. while there may be a natural excess of managerial myopia within the executive team, we suggest here that part of the cause for near-sighted management may lie with the board of directors. research has shown that boards can influence major corporate decisions such as strategic changes (goodstein and boeker, 1991; golden and zajac, 2001), diversification (amihud and lev, 1981; lane, cannella and lubatkin, 1998), shifts in r&d intensity (baysinger and hoskisson, 1989; hill and snell, 181 journal of business strategies 1988), restructuring (goodstein, gautam, and boeker, 1994; johnson, hoskisson, and hitt, 1993), and corporate entrepreneurship (zahra, 1996, 2000). clearly, boards can influence some major change episodes. yet to date, research has not provided consistent explanations on how boards affect varied aspects of firm innovativeness. for example, goodstein, gautam, and boeker (1994) found that board diversity may hinder the board’s ability to initiate strategic change, despite scholars’ arguments on how board diversity promotes a wider range of solutions and decision criteria for strategic decisions and encourages strategic change (eisenhardt & bourgeois, 1988; kosnik, 1990). another example of inconsistency occurs in investigations of the relationship between outside directors and innovation. arguments based on agency theory suggest that independent outsiders better align the strategic orientation to stockholders’ interest, encouraging more risk-taking and increases in r&d spending (kosnik, 1990). however, a number of studies found that the outside director ratio was negatively related to r&d investment (baysinger, kosnik & turk, 1991; hill and snell, 1988), suggesting that insiders better safeguard innovation. we believe that the inconsistencies in our understanding of the relationship between boards and innovation can be traced to three causes. first, the board’s role is not one dimensional. boards of directors play multiple roles, which include monitoring management and providing resources (zahra & pearce, 1989; adams, hermalin & weisbach, 2010). these two roles sometimes are complementary, but at other times may be conflicting. past research tended to look at each role using differing theoretical lenses. agency theory has mainly focused on the control role, while resource-dependence theory usually considers the resource role. however, controls and resources are each related to firm innovation. a study combining these two diverse perspectives will provide a clearer picture of how boards influence firm innovation. secondly, most investigations focus on the composition of boards. like all decision making groups, the board’s effectiveness depends on its knowledge and skills as well as the way in which the knowledge and skills are used (forbes & milliken, 1999). while board diversity increases the “stock” of board knowledge and skills, the board’s orientation towards controls and incentives determines how they transfer their knowledge into final task results. the board’s intellectual capital (that is, knowledge and skills) and the board’s form of control are two distinctive constructs, and each play a key role in influencing firm activity (hillman & dalziel, 2003). unfortunately, most research in the past studied these constructs separately. agency based perspectives over-emphasize controls and incentives at the expense of knowledge, while resource dependency perspectives do the reverse. there is a need 182 journal of business strategies to integrate these two perspectives as board capital and board approaches to control jointly determine board results. finally, the construct of innovation has not been well specified in past studies. innovation is composed of at least two distinct steps. innovation requires both search and launch (burgelman & sayles, 1986). boards affect each step by providing resources and designing controls. past research on r&d intensity (baysinger et. al, 1991; hill & snell, 1999) fails to fully probe the controls and incentives necessary to prompt the risky behavior that research efforts demand (hoskisson, hitt, johnson & crossman, 2002). to provide some insights on these issues, this study will explore the relationship between boards of directors and firm r&d intensity. specifically, we examine how the boards’ knowledge and skills (measured by board diversity) and the boards’ approach to control (measured by board composition) influence the level of research intensity in the firm. our study integrates agency and resource dependence perspectives. in the following section, we briefly discuss the two components of innovation (search and risk-taking), two roles of boards (providing resources and controlling), and how the components of innovation and the board roles are linked together. based on these concepts, we then generate our hypotheses relating variables that link board knowledge and the board’s choice of controls with innovation. after presenting our hypotheses, we describe our data and analyses. in the end, we discuss the results and conclusions of this study. literature review search and risk-taking in innovation past research generally treats innovation as a single construct, measured as an input variable such as r&d intensity, or output variables like new product introductions, the number of patents, etc. however, a more holistic approach to innovation suggests that innovative success requires attention to two stages: the development of ideas and the launching of innovative products (burgelman & sayles, 1986). in the development stage, firms acquire or build their knowledge base for innovation, through a form of organizational search (cyert & march, 1963). in the launching stage, firms overcome organizational inertia and take risks. risk is the “variation in the distribution of outcomes, their likelihoods, and their subjective values”(march and shapira, 1987). in innovations, taking risk means committing resources toward 183 journal of business strategies activities with a likelihood of loss (gomez-mejia et al, 2007). each component, search and risk-taking, is necessary for two reasons. first, organizational search can result in either innovative or imitative solutions, thus search itself cannot provide a sufficient condition for innovation. second, search can only provide a pool of potential solutions, and realization of that potential depends on the risk-taking in the final stages of decision-making. as a result, the rate of innovation is affected by both the search process and the managerial willingness to take risk (greve, 2003). we believe it is important to consider these two components of innovation as conceptually different because each component builds on a separate dimension of the board’s role in governance. organizational search is related to organizational learning, which is influenced by the board’s resource provision role, while the will to take risks is affected by the board’s control role. we will further explain these two roles in the following section. the two roles of the directors the resource role the resource dependency perspective argues that directors provide access to essential resources through linkages to the external environment (pfeffer & salancik, 1978; hillman, withers & collins, 2009). boards are a mechanism for managing and reducing transaction costs associated with external contingencies. boards are also boundary spanners that provide timely information to executives. recent research demonstrates that directors bring their knowledge and experience to the board room and affect a variety of firm consequences (kor & misangyi, 2008; kroll, walters & le, 2007; jones, makri & gomez-mejia, 2008). finally, board members’ prestige in their professions and communities can help firms extract resources for successful company operations. in sum, this perspective suggests that directors influence innovation by providing critical resources for the firm in its search for ideas and external support. r&d is one form of organization search (greve, 2003) and it is an important source of internal knowledge (cardinal & hatfield, 2000) and a contributor to the capacity to absorb external knowledge (cohen & levinthal, 1990). while it is a long-established practice that r&d expenditure is used as a proxy of innovativeness of the firm, r&d intensity only represents an input to innovation, but cannot measure the direction and amount of risk-taking in innovation. boards can provide two types of resources to facilitate organizational search through r&d. first, board 184 journal of business strategies members bring specific knowledge. directors provide advice and counsel to r&d projects. second, board members span boundaries and link the firm to a broader network. board members bring external research opportunities to the firm through these linkages. as the resources provide by board increases r&d intensity increases. the control role the directors’ control role is to ensure corporate growth and protect shareholder’s interest by evaluating company and ceo performance (zahra & pearce, 1989). agency theory argues that as firms grow large and management and ownership become specialized, conflicts of interest arise (jensen and meckling, 1976). one conflict emerges due to different risk preferences. shareholders prefer high average return on each stock they hold, even at the cost of higher risk, because their overall risk can be reduced by holding diversified portfolios of stocks (copeland and weston, 1979). however, management may not want to bear the extra risk because risky projects can trigger poor outcomes which will lead to career failure. boards of directors align the conflicting interests of owners and management through their choice of control tools and systems (oviatt, 1988; walsh and seward, 1990). one form of control is an incentive contract. the use of incentives based on specific behavior, as opposed to incentives based on outcomes, shifts the potential cost of risk-induced shortfalls in performance to the principal rather than the agent (eisenhardt, 1985). so boards can use behavior-based control to encourage managerial risk-taking in innovation. the board’s composition affects its preference for incentive schemes which, in turn, determines the form of contract used to reward the ceo. in the following section, we develop arguments on how specific board attributes affect their resource and control roles, which in turn impact innovation search and risk-taking. hypotheses our hypotheses investigate the effect of two aspects of board characteristics on firm innovation. first, we are interested in how board diversity affects organizational search and risk-taking. we argue that board diversity has mixed effects on the board’s ability to provide resources and design controls. second, we are interested on how board composition changes the propensity for the board to engage in providing resources or designing effective controls. 185 journal of business strategies board diversity and firm innovation here board diversity refers to the diversity of the board along functional backgrounds. functional background reflects an individual’s core skill set, which is gained through education and job roles and is not very changeable (tuggle, schnatterly, & johnson, 2010). functional background schemas shape and frame how managers view and approach issues (hambrick & mason, 1984). board diversity in background experience influences how the board provides resources, and how the board chooses incentives to monitor and control management. board diversity increases the boards’ ability to acquire critical resources for the organization (pfeffer, 1972, 1973; pfeffer & salancik, 1978). diverse boards can also provide a wider range of alternatives and criteria for choice (eisenhardt & bourgeois, 1988). previous research suggests board diversity increases the resource pool for the board and enhances overall board capability (hillman & dalziel, 2003). the broader the base of the board’s skill set, the wider the set of ideas and external sources the board can provide. board diversity, then, should have the potential to increase innovation. though diversity stimulates creativity and innovation it also reduces cohesion and communication (glick, miller and huber, 1993). board members with diverse functional backgrounds can bring different approaches to problem solving. this may increase the alternatives available to solve complex problems, but at the same time, also increase the difficulty in achieving cohesive decision making (michel & hambrick, 1992; waller, huber & glick, 1995). social categorization theory suggests that when an individual is specialized in a particular area, he/she will attribute positive characteristics to his/her own group and negative attributes to other groups (williams and o’reilly, 1998). functional background, which is a very observable and stable characteristic, is a demographic characteristic that individuals use for categorization, leading to in-group/out-group categorizations (webber & donahue, 2001). this social categorization process can lead to stereotyping and restricted communication. as a result, as board functional heterogeneity increases, board information sharing could decrease. this social categorization process could also prompt political behavior and conflict, thereby reducing cohesion. a potential outcome would be a decrease in the group’s decision making ability (knight, pearce, smith, olian, sims, smith, and flood, 1999; hambrick, cho, and chen, 1996). these negative effects can be pronounced in board settings because board member roles are part-time commitments, so board members have few opportunities to work together and smooth over differences. empirical studies have found that 186 journal of business strategies heterogeneous boards are less likely to initiate strategic change (goodstein et al., 1994). forbes and milliken (1999) proposed that job related diversity on the board increases the amount of cognitive conflict while decreasing the board’s cohesiveness. westphal and bednar (2005) describe the construct of “pluralistic ignorance,” where individual board members fail to share what might be commonly held insights due to a lack of common experiences with members of a diverse board. although functional diverse board members possess greater knowledge resources, they may not be able to transform their diverse functional knowledge into effective board discussion and decision-making. the negative impact of board functional heterogeneity on team process makes board members less effective in performing their resource roles, which will negatively affect firm r&d search. given the negative effects of functional diversity on board process effectiveness, we argue: hypothesis1a. as the functional diversity of the board increases, r&d intensity will decrease. functional heterogeneity will also have a specific effect on the board control function. organizational control theory describes two control strategies for executive level work. behavior-based control evaluates managerial performance based on the quality of the decision-making process, while outcome-based control evaluates managerial performance based on the measurable outcomes of the decision-making process (eisenhardt, 1985). diverse board members may find it difficult to concur on the best form of behavior based controls due to their varied experience bases. difficulties in communication will restrict their ability to define the information and gain the knowledge necessary to use behavior-based controls. when information constraints become severe, directors rely more exclusively on financially based, that is, outcome-based, measures (schaffer, 2002). thus, a diverse board will be more likely to use outcome-based control. outcome-based control will increase the attention of managerial effort towards maximizing short-run profits and direct that effort away from the high risk-return strategies shareholders prefer (cardinal, 2001; hambrick and snow, 1988). outcome-based incentives are usually based on profits and stock prices. since the link between r&d and profits is uncertain, managers under these outcome-based control systems will want to avoid the risk in r&d investments. as importantly, outcome-based incentives are usually based on outcomes measured in the short-term. innovation is an inherently long-term investment, and measures based on short-term outcomes may cause managers to be too responsive to the pressures for short-term 187 journal of business strategies profits, at the expense of important long-term investments (porter, 1992). functionally heterogeneous boards tend to use more outcome-based control, which will lead to less risk-taking in innovation. hypothesis 1b. as the functional diversity of board increases, use of behavior-based control will decrease. board composition and firm innovation board composition denotes the mix of inside and outside directors. outside directors are members of the board who lack current or past professional or personal associations with the firm (cochran, wood, & jones, 1985). while previous research has examined the impact of board composition on firm outcomes, the interactions between different board design characteristics has not been well explored. here we argue different aspects of board design might complement or reinforce each other. while board members bring different resources and skills to the task of governance, these necessary skills may not be sufficient to accomplish the tasks required. where board diversity captures capabilities and skills, board composition determines the tendencies of the board toward the choice of types of control (hillman & dalziel, 2003). so board composition interacts with board diversity to determine firm innovation. we propose the influence of board composition on innovation is indirect because an incentive preference cannot lead to better performance unless matched with adequate knowledge and skills. outsiders are more independent in the control and monitoring of management, in that they do not face conflicts induced by evaluating themselves or their work colleagues, as inside directors do. however, outsiders may possess less tacit knowledge about the firm and may be less willing to provide resources than inside directors (hillman & dalziel, 2003). so here we argue the effect of board composition on board resource provision role and monitoring role differ. because organizational innovation is a collective learning process, much of the new knowledge generated by research is firm-specific and tacit (penrose, 1995; teece, pisano & shuen, 1997; o’sullivan, 2000). among board members, the tacit knowledge of a firm’s innovation is retained by executive directors because they are the ones that directly shape the process of innovation. outside directors may not fully comprehend the content and significance of the innovation. some researchers propose that inside directors can better govern innovation (lazonick & o’sullivan, 1996; tylecote & conesa, 1999). 188 journal of business strategies moreover, outsiders may feel less obligated to provide resources than inside directors. westphal (1999) found that social ties between directors and ceos can increase their frequency of advice and counsel. we believe insiders have more social ties with their ceos than outsiders, and we expect that westphal’s findings about advice and counsel will extend to the provision of resources. because outside directors know less about firm innovation and they are not tied to the firm and management, they may have less incentive to contribute their resources to the firm. when diverse board members are dominated by outsiders, their lowered level of interest in the resource role (compared to insiders) will further reduce the effectiveness of a diverse board. hypothesis 2a. the outsider ratio on the board will negatively moderate the relationship between board diversity and r&d intensity. agency cost arguments support a contrasting hypothesis in suggesting that more outsiders strengthen the monitoring and control function since outsiders are better aligned with shareholder interests (cochran et al., 1985; coughlan & schmidt, 1985; kesner & johnson, 1990; weisbach, 1988) and are less likely to be dominated by the firm’s executives (conyon & peck, 1998). outsiders may help management avoid falling into a “competency trap” (ranft & o’neill, 2001). myopia in learning implies that organizations tend to engage in activities that they are more competent and familiar with, while overlooking the distant new opportunities (levinthal & march, 1993). executives, including inside directors, who are engaged in the management of the organization on a day-to-day basis, are more prone to fall into this trap (levinthal & march, 1993). management may put r&d spending into the projects that they familiar with or escalate past commitments (staw, 1981), which reduces overall risk-taking. outside directors, on the other hand, bring independent thinking and strategic advice to discourage management myopia. and when agency conflicts are suspected, outside directors are apt to become more vigilant to ensure owners’ interest (kroll, wright, toombs & leavell, 1997). several researchers have shown that the proportion of outsiders on the board is positively associated with director’s strategic involvement (johnson et al., 1993; judge & zeithaml, 1992). thus, from this line of reasoning, firms with high outsider ratios on the board will have better control and monitoring, which can to a certain degree overcome the negative effect of board diversity. outside directors will increase the vigilance of functionally diverse boards, reducing the negative effect of functional diversity, leading to more behavior-based control. 189 journal of business strategies hypothesis 2b. the outsider ratio on the board will positively moderate the relationship between board diversity and the use of behavior-based controls. our overall model is depicted in figure 1. we also summarize our key constructs in table 1. figure 1 integrated model of board attributes, board roles and innovation. 30 table 1: summary of constructs and measures constructs definition measures board capital/capability the knowledge and skills processed by the board members to provide resources and monitor board functional background heterogeneity board motivation/incentives the degree of effort board members put into providing resources and monitor. board composition (ratio of outside directors) innovation search the amount of resources committed to innovation. r&d intensity innovation risk-taking the commitment of resources to innovation activities with a likelihood of loss. ceo behavior-based control + + + board knowledge & skills: diversity control resource board motivation: outsider ratio org. search: r&d intensity innovation risk-taking: behavior-based control figure 1: integrated model of board attributes, board roles and innovation. table 1 summary of constructs and measures constructs definition measures board capital/capability the knowledge and skills processed by the board members to provide resources and monitor board functional background heterogeneity board motivation/incentives the degree of effort board members put into providing resources and monitor. board composition (ratio of outside directors) innovation search the amount of resources committed to innovation. r&d intensity innovation risk-taking the commitment of resources to innovation activities with a likelihood of loss. ceo behavior-based control 190 journal of business strategies methods sample and data hypotheses were tested using a sample of firms in research intensive industries. we selected research-intensive industries because innovations are of high importance in these industries. we expect the relationship between the board of directors and innovations will be more salient in these environments. previous work (hill and snell, 1988) was used to identify seven research intensive industries: chemical manufacturing (naics code first three digit 325 except for 3254), pharmaceutical and medicine manufacturing (3254), machinery manufacturing (333), computer and electronic product manufacturing (334), electrical equipment, appliance and component manufacturing (335), computer programming & data processing (514), and software publishers (511210). 20 firms were randomly selected in each industry. due to missing data, the final sample contains 108 firms. a panel dataset of the sampled firms was collected from 1998 to 2001. variables dependent variables r&d intensity is measured as the relative r&d spending per employee of the firm. r&d per employee is chosen because it is regarded as the best proxy for innovation and it is more stable than the other measures such as r&d spending per sales or number of patents granted (baysinger et al. 1991; hill & snell, 1988). r&d spending and number of employees are measured in million dollars and thousands respectively. behavior-based control is measured by the percentage of ceo compensation that is not tied to firm performance in the total compensation of ceo. ceo’s compensation primarily consists of two elements: the fixed salary that is not tied to performance, and a variable part that is depended on the firm performance, such as bonus and stock options. so here we use ceo salary divided by ceo total compensation to calculate behavioral control. total compensation is the sum of ceo salary, bonus, long-term incentives, other compensations, restricted stock awards, and value realized from stock options. these data elements are collected from standard and poor’s compustat executive compensation database, and supplemented by company proxy statement. all dependent variables are lagged by one year. 191 journal of business strategies independent variables board diversity: information on the directors serving in the sample firms was collected from the company proxy statement and company annual reports. diversity is measured by the dissimilarity in the functional backgrounds of members on the board. past researchers have studied the implication of group heterogeneity along a variety of dimensions, such as age, tenure and educational or occupational background. however, job related diversity is a better proxy of underlying cognitive diversity and more related to group strategy orientation (golden & zajac, 2001; wiersema & bantel, 1992). we developed six functional background groups (general management, marketing, r&d, finance and accounting, law, and operations), and calculated a gibbs-martin index: , where pi represents the proportion of a board accounted for by the i th group and n is the number of groups. board outsider ratio: outsiders are identified as those directors who are not on the top management team and do not have a past relationship with the firm. insiders are identified as those directors who are also top management team members. the outsider/total board member ratio is calculated by dividing the number of outsiders by number of total board members. control variables we utilized five control variables for r&d intensity: unrelated diversification, firm size, firm past performance, board tenure, and prior r&d intensity. and we utilized three control variables for behavior-based control: firm size, firm past performance and director stock ownership. diversification: diversification, especially unrelated diversification, is usually associated with outcome-based controls on division managers. under such controls, division managers will under invest in r&d to maximize short-term performance (baysinger & hoskisson, 1989). empirical studies have found that diversification is negatively related to r&d expenditure (baysinger & hoskisson, 1989; hill & snell, 1988). we measure unrelated diversification with an entropy measure (palepu, 1985). the entropy measure for a firm operating in n industry segments is defined as: , where pi is the dollar value of sales attributed to business segment i and ln(1/pi) is the natural logarithm of the inverse of its sales. unrelated diversification is calculated based on the industry segments operating in different two-digit naics codes. 192 journal of business strategies firm size: firm size is measured by the logarithm of firm revenue. several empirical studies have found larger firms tend to spend more on r&d (bayinger & hoskisson, 1989; baysinger et al., 1991). and firm size may influence ceo compensation structure because large firms have higher level pay. this data is gathered from standard and poor’s compustat industry annual database. past performance: there are two possible performance impacts on r&d spending. first, profitability may give the firm more disposable resources and more confidence in investing in r&d projects. second, poor performance may spur the organization to increase r&d in a search for new opportunities. performance also influences ceo compensation because a portion of the ceo’s pay is tied to firm performance. therefore, we also use performance as the control variable for behavior-based control. we measure performance by firm return on assets. this data is calculated from the compustat database. board tenure: tenure is the length of time the director has served on the board. longer tenured boards may have more time to work together, thus affecting their process effectiveness. board tenure is the average tenure of all the board of directors. prior r&d intensity: firm prior r&d intensity is controlled when testing the impact of boards on r&d intensity. because r&d investment is often path-dependent, firms may follow previous routines on r&d investment decisions. to control for this routinized part of r&d investment, and identify the unique impact of boards on r&d decisions, we use prior r&d intensity as a control variable. we also control for any potential environmental turbulence by using a dummy code for each year. analysis we employed panel data regression techniques to test the hypotheses. we used the hausman specification test to compare the fixed-effects and random-effects estimators and found that the fixed-effects model was appropriate. fixed effects coefficients are analogous to standard regression coefficients. results the means, standard deviations, and correlations among key variables are reported in table 1. 193 journal of business strategies table 2 means, standard deviations, and correlationsa,b mean s. d. 1 2 3 4 5 6 7 1 r&d intensity 46.61 86.29 2 behavior-based control 0.64 0.28 0.19* 3 board diversity 0.45 0.21 0.26* 0.16* 4 board outsider ratio 0.73 0.14 0.01 -0.24* -0.17* 5 diversification 0.09 0.20 -0.16* -0.12* -0.02 0.11* 6 board tenure 8.08 4.16 -0.22* -0.10* -0.09 -0.19* 0.03 7 firm size 5.33 2.67 -0.45* -0.60* -0.36* 0.30* 0.23* 0.21* 8 firm performance -0.05 0.39 -0.33* -0.24* -0.12* 0.05 0.07 0.24* 0.34* a there are 432 observations except for behavior-based control, which has 430 observations, and firm size, which has 426 observations. b * <.05 in our sample, firms spent an average of us$46.61 million per thousand employees on r&d. however, the standard deviation of us$86.29 million shows firms vary greatly on r&d spending. sampled firms also slightly favor behavior-based control, as suggested by the fact that, on average, 64% of ceo compensation is fixed and not tied to firm performance. the standard deviation of 28% suggests that not all firms use behavior-based control as a major control strategy. on further examination of the correlations, we found r&d intensity and behavior-based control were not very correlated with each other (0.17). we will present the results of the direct effects for board diversity and board composition on research intensity and on the use of behavioral controls. we will then follow with a discussion of the interaction effects for board functional diversity and board composition. 194 journal of business strategies table 3 results of linear regression analysis on r&d intensitye variable model 1 model 2 model 3 model 4 year dummies included included included included constant -46.81 -18.32 -11.72 -12.23 firm size 19.26*** 20.14*** 20.21*** 20.24*** prior performance -33.36** -37.94** -37.99** -37.80** diversification 3.25 1.89 .85 .80 board tenure -.49 -1.00 -1.05*** -1.03*** prior r&d intensity -.27*** -.29*** -.29*** -.29*** board diversity -63.17* -63.65* -62.88* outsider ratio -8.58 -9.10 board diversity × outsider ratio -31.39 r2 .17*** .20*** .20** .20** r2 change .03* .00 .00 * <.05, **<.01, ***<.001 table 3 presents details of the regression on r&d intensity. stepwise regression analysis was used to assess the effects of the independent variable and their interaction. model 1 examined the effects of control variables on r&d intensity. these variables explained about 17% of the total variance of r&d intensity of sample firms. specifically, prior firm performance and prior r&d intensity was negatively associated with current r&d intensity (p<.05, p<.01 respectively) and firm size was positively related to r&d intensity (p<.05). the overall model significantly explains the variance in r&d intensity (p<.01). in model 2, the variable, board diversity, was added. as can be seen in the change in r-square statistics at the bottom of table 2, board diversity added an additional (3%) and significant (p<.05) amount to the variance explained by the control variables. the effect of board diversity on r&d was negative and significant (p<.05). even when board outsider ratio is added (model 3), this effect remains sig195 journal of business strategies nificant. this finding is consistent with hypothesis 1a. board diversity is negatively related to r&d intensity. the conflict induced by the diverse backgrounds apparently overwhelms the variety in knowledge and/or connections potentially provided by diversity. table 4 results of fixed effect regression on behavior-based control variable model 1 model 2 model 3 model 4 year dummies included included included included constant .49** .57** .40 1.04* firm size .04* .04* .04* .04 firm performance -.025 -.04 -.03 -.04 board tenure -.21 -.01 -.01 -.01 diversification -.06 -.07 -.04 -.04 board diversity -.17 -.16 -1.55* outsider ratio .21 -.59 board diversity × outsider ratio 1.83* r2 .08* .08* .09* .11** r2 change .00 .01 .02** * <.05, **<.01, ***<.001 the results of tests for behavior-based control are shown in table 4. similar to the analysis for r&d intensity, stepwise regression was used to test the effects of the variables we are interested in. in model 1, control variables were entered, and this model explains about 8% of total variance of behavior-based control (p<.05). specifically, firm size was positively related to behavior-based control (p<.05). after adding board diversity in model 2, the model r-square increased insignificantly, as board diversity was not significant. in model 4, when the measure of composition and the interaction of diversity and composition were added, the model increased r-square by .02 (p<.01). in this model, board diversity was negatively related to behavior-based control (p<.05). so hypothesis 1b received support. 196 journal of business strategies with respect to interaction affects, as seen on table 3, the interaction effect of board diversity and board outsider ratio did not improve the total variance explained for r&d intensity. the coefficient of the interaction effect was negative as predicated, but not significant. thus hypothesis 2a was not supported. in contrast, as presented in table 4, the interaction between board diversity and board outsider ratio had a positive and significant (p<.01) effect on the use of behavior based controls. this finding supports hypothesis 2b, which predicted that composition would moderate the negative relationship between board diversity and the use of behavioral controls. we use a graph to visually present the interaction effect in figure 2. figure 2 specifically, we used standardized regression coefficients from the final regression equation to plot the relation between board diversity and behavior-based control at low (one standard deviation below the mean) and high (one standard deviation above the mean) levels of board outsider ratio. as shown in figure 2 and as expected, board diversity is negatively related to behavior-based control when the outsider ratio is low. yet, when outsider ratio is high, the negative relationship between board diversity and behavior-based control became less steep, indicating the negative relationship became weaker for high outsider ratio boards. 197 journal of business strategies discussion and conclusions in this study, we model the relationship between the board characteristics and r&d intensity. we expected that resources and the form of controls affect r&d intensity. board diversity and board composition jointly affect board resource and control roles. board diversity represents board knowledge and skills. we found functional diversity will negatively impact board resource and control roles, leading to lower r&d intensity and less behavior-based control. functional diverse boards face more communication challenges and this may reduce board effectiveness. several other studies also found that functional background diversity, compared to other types of diversity, may not create positive board dynamics as expected. westphal and bednar (2005) found board functional background diversity tended to exacerbate pluralistic ignorance at a greater extent than industry background diversity. tuggle et. al. (2010) examined board functional and industry diversity and found board functional diversity did not increase their discussion of entrepreneurial issues. these studies, combined with our findings, suggest board members should not be too diverse in their functional background, for those firms which depend on research and development. alternately, patterns of diversity may be more important than the absolute levels of diversity. we would expect that issues such as agenda setting and work climate affect whether diversity has a positive or negative impact, and these deserve direct attention. our research also suggests board composition, as indicated by the ratio of outside directors, will have an indirect impact on firm innovation. the board outsider/insider dichotomy mainly reflects the board’s dependence on its management, which determines director motivation to provide resources and exert control. because board independence may help the board meet its control more effectively, but reduce board willingness to provide resources, the moderating effect of board composition on the relationship between board diversity and r&d intensity introduces complexity in predicting the expected impact on r&d. our findings show a positive interaction effect of board composition and board diversity on behavior-based control. more diverse boards lead to a reduction in the use of behavior controls, but this reduction is less drastic in boards with a higher proportion of outsiders. therefore, hiring outside directors can improve the control effectiveness of functional diverse boards. although we also found a negative interaction between board composition and board diversity on r&d intensity, the effect is not statistically significant. this non-finding may reflect the fact that the effect of functional diversity on r&d in198 journal of business strategies tensity is very strong, so changes in outsider ratio will not generate much variance to that relationship. a larger sample in future research might provide more insight into the exact nature of this effect. the multi-faceted effects of board composition on board roles suggest putting more outside directors on boards can create a double edged sword, in that potentially positive and negative outcomes accrue. the multi-faceted effects may help explain why studies fail to find consistent effects of the board outsider ratio on firm performance. most importantly, the dominant reliance of past studies on archival data may indicate that researchers have over-emphasized structural aspects of board design (functional diversity and board composition) without recognizing how the constructs interact to influence forms of control. although there have been many studies on board of directors and varied aspects of firm innovation, knowledge on the relationship between boards and innovation remains limited. we believe the key to a better understanding of this relationship is to recognize the complex nature of the board’s roles and the complex nature of innovation. first, our research suggests that boards serve different roles. consistent with resource dependency theory, boards provide resources. consistent with agency theory, boards monitor management. by combining two theoretical perspectives, we provide a clearer view of the relationship between board characteristics (diversity and composition) and the resource provision and control roles. board knowledge and skills and effective design of controls by the board each contribute to innovation. our study also suggests that innovation taps two board roles. due to overreliance on a single dimension, previous research yielded inconsistent findings between board characteristics and firm innovation. we consider two board roles: providing resources and designing rewards. board composition has moderating effects on the board’s resource role and board’s control role. we found a higher outsider ratio may help boards to better perform its control role, but not its resource providing role. these distinctions should lead to future study on the varied roles of boards and their different contribution to the innovation process. the limitations of this study should also be noted. first, our measures of diversity and composition are only proxies for the underlying behavior. future studies could find more direct measures to capture board behavior. secondly, we use board functional background as an indicator of board knowledge and experiences. this may not be the only or best indicator. measures that go beyond demographic backgrounds may better capture board dynamics. in addition, new forms of communication technology may be changing the nature of board dynamics. finally, our data do not include the passage of sarbanes-oxley. how did this exogenous policy change 199 journal of business strategies the relationship between boards and firm innovation? the changed rules for board governance provide several interesting topics for future studies. innovation is long-term and difficult, yet critical to firm survival. our study suggests that boards of directors are an important component in providing both the means (via resources) and the will (via controls) to sustain innovation. the cure for myopia, then, has to involve the board. references amihud, y. and lev, b. (1981). risk reduction as a managerial motive for conglomerate mergers. bell journal of economics, 12, 99-110. baysinger, b. & hoskisson, r.e. (1989). the composition of boards of directors and strategic control: effects on corporate strategy. academy of management review, 15, 72-87. baysinger, b.d., kosnik, r.d. & turk, t. a. (1991). effects of board and ownership structure on corporate r&d strategy. academy of management journal, 34, 205-214. burgelman, r. a. & sayles, l.r. (1986). inside corporate innovation: strategy, structure, and managerial skills. new york: free press. cardinal, l.b. and d.e. hatfield (2000). internal knowledge generation: the research laboratory and innovative productivity in the pharmaceutical industry. journal of engineering and technology management, 17, 247-271. cardinal, l.b. (2001). technology innovation in the pharmaceutical industry. organization science, 12(1), 19-36. christensen, c.m. (1997). the innovator’s dilemma: when new technologies cause great firms to fail. boston, ma: harvard business press. cochran, p., wood, r. & jones, t. (1985). the composition of boards of directors and incidence of golden parachutes. academy of management journal, 28, 664671. cohen, w.m. & levinthal, d.a. (1990). absorptive capacity: a new perspective on learning and innovation. administrative science quarterly, special issue on technology, organizations, and innovation, 35, 128-152. cooper, a. & schendel, d. (1976). strategic responses to technological threats. business horizons, 19(1), 267-280. copeland, t., & weston, j.f. (1979). financial theory and corporate policy. reading, ma: addison-wesley. 200 journal of business strategies conyon, m. j. & peck, s.i. (1998). board control, remuneration committees, and top management compensation. academy of management journal, 41(2), 146-158. coughlan a.t., schmidt, r.m. (1985). executive compensation, management turnover and firm performance: an empirical investigation. journal of accounting and economics, 7, 43-66. cyert, r.m., & march, j.g. (1963). a behavioral theory of the firm. englewoof cliffs, nj: prentice-hall. drucker, p.f. (1995). the information executives truly need. harvard business review, jan.-feb, 54-62. eisenhardt, k.m. (1985). control: organizational and economic approaches. management science, 31(2), 134-150. eisenhardt, k. & bourgeois, l. (1988). politics of strategic decision making in high-velocity environments: toward a midrange theory. academy of management journal, 31, 737-770. forbes, d.p. & milliken, f.j. (1999). cognition and corporate governance: understanding boards of directors as strategic decision-making groups. academy of management review, 24, 485-505. glick, w. h., miller, c.c., & huber, g.p. (1993). the impact of upper-echelon diversity on organizational performance. in organizational change and redesign, glicks w. h., g. huber p. (eds). new york: oxford university press. golden, b.r. & zajac, e.j. (2001). when will boards influence strategy? inclination×power=strategic change. strategic management journal, 22, 1087-1111. gomez-mejia, l.r., haynes, k.t., nunez-nickerl, m., jacobson, k.j.l, & moyano fuentes, j. (2007). socioemotional wealth and business risks in family-controlled firms: evidence from spanish olive mills. administrative science quarterly. 52: 106-137. goodstein, j. & boeker, w. (1991). turbulence at the top: a new perspective on governance structure changes and strategic change. academy of management journal, 34(2), 306-330. goodstein, j., gautam, k. & boeker, w. (1994). the effects of board size and diversity on strategic change. strategic management journal, 15(3), 241-250. greve, h.r. (2003). a behavioral theory of r&d expenditures and innovations: evidence from shipbuilding. the academy of management journal, 46(6), 685. hambrick, d.c. & mason, p.a. (1984). upper echelons: the organization as a reflection of its top managers. academy of management review, 9(2), 193-206. 201 journal of business strategies hambrick, d.c. & snow, c.c. (1988). strategic reward systems. in c.c. snow (ed.), strategy, organization design, and human resource management. greenwich, ct: jai press. hambrick d.c., cho t., & chen m.(1996). the influence of top management team heterogeneity on firm’s competitive moves. administrative science quarterly, 41, 659-684. hill, c.w.l & snell. s.a. (1988). external control, corporate strategy, and firm performance in research-intensive industries. strategic management journal, 9(6), 577-590. hillman, a.j. & dalziel, t. (2003). board of directors and firm performance: integrating agency and resource dependence perspectives. the academy of management review, 28(3), 383. hillman, a.j., withers, m.c., & collins, b.j. 2009. resource dependence theory: a review. journal of management, 35(6): 404-427. hill, c.w. & snell, s.a. (1988). external control, corporate strategy, and firm performance in research-intensive industries. strategic management journal, 9(6), 577-590. hoskisson, r.e., hitt, m.a., johnson, r.a. & grossman, w. (2003). conflicting voices: the effects of institutional ownership heterogeneity and internal governance on corporate innovation strategies. the academy of management journal, 45(4), 697. jensen, m.c. & meckling, w.h. (1976). theory of the firm: managerial behavior agency costs and capital structure. journal of financial economics, oct, 305360. judge, w.q. & zeithaml, c.p. (1992). institutional and strategic choice perspectives on board involvement in the strategic decision process. academy of management journal, 35(4), 766-794. johnson, r.a., hoskisson, r.e. & hitt, m.a. (1993). board of director involvement in restructuring: the effects of board versus managerial controls and characteristics. strategic management journal, summer special issue, 14, pp. 33-50. jones, c.d., makri, m., & gomez-mejia, l.r. (2008). affiliate directors and perceived risk bearing in publicly traded, family-controlled firms: the case of diversification. entrepreneurship: theory and practice, 32: 1007-1026. kesner i.f., & johnson, r.b. (1990). an investigation of the relationship between board composition and stockholder suits. strategic management journal, 11(4), 327-337. 202 journal of business strategies kor, y.y. & misangyi, v.f. (2008). outside directors’ industry-specific experience and firms’ liability of newness. strategic management journal, 29: 1345-1355. knight d., pearce c.l., smith k.g., olian j.d., sims h.p., smith k.a., & flood p. (1999). top management team diversity, group process, and strategic consensus. strategic management journal, 20, 445-465. kosnik, r.d. (1990). effect of board demography and directors’ incentives on corporate greenmail decisions. academy of management journal, 33, 129-150. kroll, m., wright, p., toombs, l. & leavell, h. (1997). form of control: a critical determinant of acquisition performance and ceo rewards. strategic management journal, 18(2), 85-96. kroll, m., walters, b.a. & le, s. (2007). the impact of board composition and top management team ownership structure on post-ipo performance in young entrepreneurial firms. academy of management journal, 5: 1198-1216. lane, p.j., cannella, a.a. & lubatkin, m.h. (1998). agency problems as antecedents to unrelated mergers and diversification: amihud and lev reconsidered. strategic management journal, 19, 555-578. lazonick, w., & o’sullivan, m. (1996). organization, finance, and international competition. industrial and corporate change, 5(1), 1-49. levinthal d.a. & march, j.g. (1993). the myopia of learning. strategic management journal, 14, 95-112. march, j.g., & shapira. z. (1987). managerial perspectives on risk taking. management science, 33: 1404-1418. michel j.g., & hambrick, d.c. (1992). diversification posture and top management team characteristics. academy of management journal, 35: 9-37. miller, d. (1990). the icarus paradox: how exceptional companies bring about their downfall: new lessons in the dynamics of corporate success, decline and renewal. new york: harper business. oviatt, b.m. (1988). agency and transaction cost perspectives on the managershareholder relationship: incentives for congruent interests. academy of management review, 13(2), 214-226. o’sullivan, m. (2000). the innovative enterprise and corporate governance. cambridge journal of economics, 2000 (24), 393-416. palepu, k. (1985). diversification strategy, profit performance and the entropy measure. strategic management journal, 6, 239-255. pfeffer, j. (1972). size and composition of corporate boards of directors: the organization and its environment. administrative science quarterly, 17, pp. 218-229. 203 journal of business strategies pfeffer, j. (1973). size, composition, and function of hospital boards-of-directors: a study of organization-environment linkage. administrative science quarterly, 18(3), 349. peffer, j. & salancik, g.r. (1978). the external control of organizations: a resource dependence perspective. new york: harper & row. porter, m.e. (1992). capital disadvantage: america’s failing capital investment systems. harvard business review, sept./oct, 65-83. ranft a.l., & o’neill h.m. (2001). board composition and high-flying founders: hints of trouble to come? academy of management executive, 15(1), 126-138. schaffer, b.s. (2002). board assessment of managerial performance: an analysis of attribution processes. journal of managerial psychology, 17(2), 95-115. staw, b.m. (1981). the escalation of commitment to a course of action. academy of management review, 6, 577-587. teece, d., pisano, g. & shuen, a. (1997). dynamic capabilities and strategic management. strategic management journal, 18(7), 524. tuggle c.s., schnatterly k., & johnson r.a. (2010). attention patterns in the boardroom: how board composition and processes affect discussion of entrepreneurial issues. academy of management journal, 53(3), 550-571. tylecote, a., & conesa, e. (1999). corporate governance, innovation systems and industrial performance. industry and innovation, 6(1): 25. waller, m.j., huber, g.p. & glick, w.h. (1995). functional background as a determinant of executives’ selective perception. academy of management journal, 38, 943-974. webber, s.s. & donahue, l.m. (2001). impact of highly and less job-related diversity on work group cohesion and performance: a meta-analysis. journal of management, 27, 141-162. weisbach, m.s. (1988). outside directors and ceo turnover. journal of financial economics, 20, 431-460. westphal, j.d, & bednar, m.k. (2005). pluralistic ignorance in corporate boards and firms’ strategic persistence in response to low firm performance. administrative science quarterly, 49, 262-298. walsh, j.p. & seward, j.k. (1990). on the efficiency of internal and external corporate control mechanisms. academy of management review, 15(3), 421-458. westphal, j. (1999). collaboration in the boardroom: behavioral and performance consequences of ceo-board social ties. academy of management journal, 42, 7-25. 204 journal of business strategies wiersema, m.f. & k.a. bantel (1992). top management team demography and corporate strategic change. academy of management journal, 35, 91-121. williams k.y., & o’reilly c.a. 1998. demography and diversity in organizations: a review of 40 years of research. in research in organizational behavior, staw b.m., cummings l.l. (eds) (pp. 77-140). greenwich, ct: jai press. zahra, s.a. & pearce, j.a. (1989). boards of directors and corporate financial performance: a review and integrative model. journal of management, 15(2), 291334. zahra, s.a. (1996). governance, ownership, and corporate entrepreneurship: the moderating impact of industry technological opportunities. academy of management journal, 39(6), 1713-1735. zahra, s.a., neubaum, d.o. & huse, m. (2000). entrepreneurship in medium-size companies: exploring the effects of ownership and governance systems. journal of management, 26(5), 947-976. biographical sketch of authors xuanli xie is the assistant professor of strategic management at national school of development, peking university. she received her phd in strategic management from the university of north carolina at chapel hill. her research interests include corporate governance, innovation, entrepreneurship, and international business. hugh o’neill is edward m. o’herron, jr. distinguished scholar and professor of strategy and entrepreneurship at kenan-flalger business school, the university of north carolina at chapel hill. he received his phd from the university of massachusetts. his research interests include turnaround strategies, corporate governance, mergers, entrepreneurship in emerging and recovering economies and managerial decision making. pitfalls and paradoxes: coping with the capabilities-rigidities dilemma in whole networks1 william r. carter university of north texas • denton, texas phillip e. davis university of north texas • denton, texas julia l. herchen university of north texas • denton, texas vallari chandna university of north texas • denton, texas abstract emergent interorganizational forms intent on long-term competitive performance at the network level are affecting markets and gaining scholarly attention. whole networks are an example of such organizations. managerial paradoxes result from these informal, non-hierarchical structures when they seek long-term competitive advantage. applying paradox theory and research on ambidexterity, we conclude that, counter intuitively, formalized governance is necessary to sustain informal competitive entity success. contrary to traditional network theory, social capital mechanisms and trust are not solely adequate. we examine challenges facing whole networks and propose three governance strategies to address them: (1) formalized governance with adequate authority; (2) centralized leadership with decentralized decision-making; and (3) provisions for managing membership composition. we discuss implications for practitioners and scholars and suggest research paths for validating and extending this theory. introduction interfirm networks are altering the competitive landscape (parkhe, wasserman, & ralston, 2006). the benefits of networks for rapid technical innovation, for example, have led to widespread government involvement in creating science parks and incubators to foster economic development and growth of small, entrepreneurial firms (phan, siegel, & wright, 2005). networks can offer access to resources, 1the authors would like to thank dr. derrick d’souza for his assistance and contribution to the development of this manuscript, our anonymous reviewers for their valuable comments and suggestions, and bainan zhang for his involvement in an early version of the manuscript 98 journal of business strategies capabilities, and markets not easily available to individual firms. networks can thus achieve valuable competitive advantage for themselves and their members (meiseberg & ehrmann, 2012). though interfirm organizations have been a topic of study for several decades, there is a “growing set of pioneering organizational experiments” intent on leveraging the advantages of networked business models (miles, miles, snow, blomqvist, & rocha, 2009; p 61). advances in information and communication technology have allowed unique organizational forms such as virtual organizations to emerge for both short-term and going-concern motivations (pedersen & nagengast, 2008; riemer & klein, 2008). non-traditional network forms are becoming pervasive and increased competitive intensity is fueling further network form innovation (parkhe et al., 2006). it is thus not surprising that scholars are increasingly studying emergent organizational forms such as virtual organizations the v-form (riemer & klein, 2008), innovation networks – the i-form (miles et al., 2009), and whole networks (provan, fish, & sydow, 2007). the modern economy and much of the competition within it is knowledge-based. customization, flexibility, and the rapid creation, sharing, and value conversion of knowledge are often key success factors for firm success (contractor & lorange, 2002; miles et al., 2009. these competitive demands are resulting in the continued rise of networked organizations. as a secondary result, the increase in interfirm networks is leading to competition between networks and between networks and individual firms (gimeno, 2004; guidice, vasudevan, & duysters, 2003). as these emergent network forms flex their competitive muscle, many individual firms, especially small and medium sized firms (meiseberg & ehrmann, 2012), are likely to feel pressure to create or join rival networks in order to survive and compete with these new organizations. thus, the emergence of such competitive networks is likely to influence the creation of more and more such organizations. firms in affected markets that are not members of a network may find themselves with strategic disadvantages that are individually insurmountable. thus, an increasing number of managers may find themselves forming, joining, or considering joining such networks in order to access the unique advantages (or necessary survival benefits) they may afford. various descriptors distinguish types of networks that involve specific strategic intent. the literature has addressed dynamic networks (snow, miles, & coleman, 1992), strategic networks (jarillo, 1993; sydow & windelar, 1998) and the ‘network für such’ (network for itself) (raab & kenis, 2009) to distinguish networks with a unifying, common purpose from those designed for knowledge sharing, r&d co-development, supply-chain efficiencies, or collaborative equity investment in new volume 30, number 2 99 ventures. recently, researchers have conceptualized whole networks as those interorganizational networks involving a unified goal-orientation, substantial individual member autonomy, and a nonhierarchical structure (kilduff & tsai, 2003; provan et al., 2007). to help frame our analysis of these emergent forms, we ground this paper in the work of provan and colleagues to use whole networks as an example of an emergent interfirm organization possessing unique operational and competitive characteristics. network failure is usually attributable to weaknesses in network management (miles & snow, 1992) such as unclear procedures, poorly coordinated resource allocations, and imbalances of power and influence (meiseberg & ehrmann, 2012). much research has been conducted on governance within traditional network theory (jones, hesterly & borgatti, 1997). however, we find a deficient amount of research probing the challenges of management and governance systems in emergent forms such as whole networks. our point of departure from prior research is to focus on how the unique characteristics of whole networks bring about paradoxical challenges and fundamental agency problems. though whole networks organize to leverage the benefits of flexibility and informality, we argue that sustaining such an organization over time requires both informality in structure and formality in governance. as one anonymous reviewer commented, there is irony in the prospect that an organizational form of independent firms, dedicated to flexibility, informality, and non-hierarchical relationships may require some formality of centralized governance in order to sustain performance. indeed, this is the essential paradox of these emerging network forms. we argue that, left unattended, adaptation of the network and its independent members over time produces a high probability of fractures to the intuitively desirable mechanisms of trust and reciprocity. network theory informs that trust is a primary mechanism for managing transaction costs and opportunism (goerzen, 2007). over time, however, trust can become increasingly fragile (granovetter, 1985). ironically, the development and management of such informal social capital assets requires management process and structure in these loosely formed, emergent organizations (reimer & klein, 2008). further, meiseberg and ehrmann (2012) note that without proper governance, relational network communications may become biased, sub-group and individual member power positions and resource dependency effects may emerge, and untimely and inefficient resource coordination may inhibit the sustainability of competitive advantage. there are numerous paradoxes inherent in network theory (parkhe et al., 2006). addressing all of such challenges in whole network type organizations is beyond the limitations of one paper. therefore, we fo100 journal of business strategies cus attention on one core issue: the capabilities-rigidities dilemma (leonard-barton, 1992). to sustain performance, organizations must not only exploit and defend their current advantages, but they must also explore for new advantages and avoid inertial forces that can inhibit adaptation when conditions reduce or destroy the value of their current strengths. applying prior theory related to balancing exploitation and exploration and the achievement of ambidexterity in firms (o’reilly & tushman, 2008; raisch & birkinshaw, 2008), we posit that whole networks have access to several of the same coping strategies empirically supported for helping firms face the capabilities-rigidities dilemma. however, due to unique characteristics of whole networks, we emphasize that they face distinctive challenges that require governance mechanisms not relevant to the management of other organizational forms. such unique governance and management challenges involved in emerging network organizations have been generally overlooked by researchers (riemer & klein, 2008), and thus are important topics to be addressed. the propositions set forth in this paper not only offer a unique, network-level view of competitive intent and the implications of developing and exploiting capabilities, they also contribute to expanding network-level applications of firm-level performance theories. it is our hope that this analysis will aid managers who are founders or members of these emergent network forms as well as those who may at some point consider involvement in such a network. further, this work aims to provide value to researchers by helping to clarify and distinguish whole networks from other organizational forms and to spur curiosity toward the investigation of the unique paradoxical governance mechanism we posit as necessary for the long-term performance of these emergent organizations. a review of theoretical background emergent network organizations riemer and klein (2008) characterize virtual organizations (what they term the v-form) as those networks of firms connected through communication technology that allows them to span spatial and temporal boundaries. these organizations are composed of independent firms acting as a single entity toward customers and competitors (kasper-fuehrer & ashkanasy, 2001; riemer & klein, 2008). v-forms have minimal formal structures with hierarchical management being replaced with more social governance structures such as self-regulation and trust (kasper-fuehrer volume 30, number 2 101 & ashkanasy; pihkala, varamaki, & vesalainen, 1999). v-forms are born of opportunistic desires to take advantage of a short or medium range market opportunities and collaborative projects (kasper-fuehrer & ashkanasy; tuma, 1998). the i-form, or innovation-form (miles et al., 2009), is described as a new, modern form of interfirm network characterized by a focus on market exploration. members benefit by expansion into complementary product markets. the key assets involved are knowledge and collaborative processes. as originally defined by provan et al., (2007) a whole network is “…a group of three or more organizations connected in ways that facilitate achievement of a common goal…often formally established and governed and goal directed …relationships among network members are primarily nonhierarchical and participants often have substantial operating autonomy” (p. 482). applying this definition can lead to classifying several different types of networks as whole networks. prior literature provided examples that offered insight into whole network formation and evolution over time. whole networks in life sciences (powell, white, koput, & owen-smith, 2005), community economic development (safford, 2005), and biotechnology (owen-smith & powell, 2004) shed light on the long-term objectives and challenges of an evolving field of science, an economically challenged community, and an emerging field of commercialization, respectively. these accounts of whole networks lend credence to the distinct challenges of identifying and managing whole networks. for the purposes of this paper, we explicitly distinguish a unique type of interfirm organizations to which we apply the label ‘whole network’. whole networks, as we conceive them, differ from v-forms because they are going-concern organizations, not opportunistic project based entities. in many ways, the v-form represents a potential short-term representation of a whole network. indeed, riemer and klein (2008) propose that v-form organizations may evolve toward long-term network structures in order to enhance social capital and overcome some of the weaknesses inherent in virtual organizations. unlike i-forms whose focus is innovation, whole networks seek sustainable competitive advantage where both exploitation of advantages to compete and exploration to expand and develop new growth opportunities are required. to differentiate whole networks from other network forms we believe four dimensions highlight this phenomenon most clearly: (1) source of value creation; (2) level of value appropriation; (3) location of strategic decision-making; and (4) level of entity identification. prior theory (kilduff & tsai, 2003; provan et al., 2007) emphasizes that whole networks have a singular, common goal. the goal of whole networks aims to serve the needs of a market segment or client base external to the network. the 102 journal of business strategies collective resources of network members are transformed through whole network capabilities to produce a marketable output. unlike the goals of other networks that focus on development of either a new source of value that the individual firms can exploit or on a reduction in supply chain costs to benefit member firms’ operational efficiencies, whole networks create value through a unified value chain. buyer-supplier networks emphasize transaction cost and other supply chain benefits such as supply stability or inventory management tactics (parmigiani & rivera-santos, 2011).the benefits from the transaction system are appropriated at the firm level (dyer, 1996). r&d networks are generally initiated to apply joint efforts to the development of a new technology, product, or standard and outcomes are commercialized by each firm independently. conversely, in the whole network value production process, the conversion of value by an exchange with buyers occurs only at the end of the composite value chain. whole network members do not individually exchange inputs for payment and profit via intra-network transactions; they contribute inputs toward an allocation of appropriated profit of the composite production system when the outputs are sold in the market. because the commercialization of outputs is a network-level concern, it follows that the critical strategic decisions in whole networks are made by a centralized body representing and holding a degree of authority for the entire group of firms. this parallels a firm in which the dominant coalition guides the strategic direction and decision making for the entity. to summarize, whole networks are formed and managed as going concerns, competing in existing markets as a singular entity and striving to sustain their existence. this emergent form operates more akin to a single firm with members contributing to one, unified result from which all contributors draw their rewards. further, these characteristics of whole networks are manifested in the striving for sustainable competitive advantage and the need to balance the exploitation of advantages at hand and the exploration and development of new innovations that can contribute in the future. just as in individual firms, however, the quest for stability and the exploitation of key success factors can paradoxically lead to counter-productive tensions, inertia, and eventual loss of competitiveness. a host of issues can arise such as inefficient and isolated dyadic communications, resource coordination, and power asymmetries. a particularly salient issue involves the dilemma in managing exploitation and exploration activities.. volume 30, number 2 103 the capabilities-rigidities dilemma teece, pisano, & schuen (1997) noted that while developing capabilities to gain an advantage in the current environment is necessary, it is also important to consider what will happen to those capabilities when the environment changes. levinthal and march (1993) highlighted this challenge by explaining how core competencies of a firm tend to calcify as rigidities that institutionalize and lock in certain behavior patterns that inhibit adaptability. march (1991) explained that when knowledge is found to lead to successful outcomes, it is applied repeatedly to exploit the value it delivers. exploitation behaviors that have become institutionalized lead to barriers to change (hannan & freeman, 1984; leonard-barton, 1992; lieberman & montgomery, 1988). core rigidities hamper innovation and adaptive behaviors thus resulting in organizational dysfunction (o’driscoll, carson, & gilmore, 2001). as interfirm organizations develop to accentuate rapid innovation, flexibility, efficiency, and low barriers to relationship collaboration, contradictions arise that undermine and challenge those very advantages (miles et al., 2009). for instance, the typical actions of v-form organizations toward such idealized benefits actually impede the development of the social capital and complex relationships required to sustain the level of open collaboration necessary for success (riemer & klein, 2008). the consequences of organizational structures striving for these benefits often lead to fragmentation, failure, and dissolution (riemer & klein, 2008; ring & van de ven, 1994). yet the very structural characteristics that enable the achievement of these benefits can lead, if unchecked, to inabilities to react to shifts in value or competition in the market. the attention to key success factors of flexibility and speed and the exploitation of advantages gained in those areas can paradoxically result in rigidities and competency traps that lead to whole network decline and failure. whole networks, as we have argued, engage in competition in much the same manner as firms. thus, the challenge of effectively balancing exploration and exploitation is clearly an issue for whole networks as well. yet there is little if anything that is known about how whole networks can avoid the pitfalls of the capabilities-rigidities paradox and effectively balance exploitation and exploration. implications of the capabilities-rigidities dilemma for whole networks we expand on three important implications of the dilemma and discuss the appropriateness, or lack thereof, of firm-level theory for handling them. these implications involve challenges in: (1) allocating network assets with little or no direct 104 journal of business strategies control over those assets; (2) avoiding relational imbalances; and (3) maintaining operational stability while acknowledging the reality that member composition will evolve. in addition, we address the topic of trust as it is a critical component of effective network operations that weaves through all considerations of structure, governance, and relationship management. the challenge of limited authority and control in the single firm, the integration and coordination of tensions such as marketing and production, efficiency and growth, exploitation and exploration can be achieved to some degree through the formal control and authority aspects of hierarchical structures (scott & davis, 2007). however, the governance and leadership mechanisms available to whole networks do not have such direct authority. the resources and capabilities of the whole network lay within the boundaries of each component firm. there is no network owner to confer legitimate authority onto agents. member autonomy, network interdependence and the importance of trust inhibit (or prohibit) the development of hierarchical authority. yet network-level decisions must be made to effectively allocate activities toward exploitation and exploration. if coordination processes are too weak, the effective integration of member firm activities toward the production of competitive value may be inadequately efficient or may decline over time. capabilities may degrade into rigidities and strengths may drift toward weaknesses. even if efforts for both exploitation and exploration are simultaneously active, without strong central leadership, the opposing tensions between the two may disrupt trust, unity, and network identification. the challenge of relational imbalances the successful efforts to strengthen ties and build trust among whole network member organizations can lead to instability through asymmetries of power and influence. when certain dyadic relationships in a network grow tightly coupled and influential in the value-production system, proximately linked and more loosely coupled firms may begin to feel inferior, more excluded, or less powerful (anderson, hakansson, & johanson, 1994). the network may become highly influenced by the members who contribute the most valued resources and skills. depending on the network’s strategic orientation, these value imbalances may favor exploiters over explorers or vice versa. under conditions in which certain members achieve higher status and value than others, lower esteemed firms may experience declining network identification stemming from their sense of alienation, frustration, or lack of volume 30, number 2 105 network attention (huemer, 2004). hierarchies of power may develop and lead firms to withdraw from or seek alternatives to the existing relationships (emerson, 1962). granovetter (1985) remarked on this paradoxical situation by noting that conditions for opportunistic behavior are most ripe when trust is high. the challenge of managing membership composition powell (1990) argued that enduring patterns of repeated trading build barriers to network entry and thus restrict access to newcomers. building and reinforcing existing relationships often becomes the focus of networks (levinthal & march, 1993; ireland, hitt, & vaidyanath, 2002) and this can lead to poorer performance (goerzen, 2007). without being open to new exogenous parties and their potentially additive inputs and knowledge, whole networks accentuate exploitation and further build barriers to adaptation. granovetter (1973) addressed this paradox as the strength of weak ties, explaining that strong network ties repeat the same knowledge and ties beyond the primary relationships are the ones that allow valuable new information into the network. accepting that change is inevitable, that existing competitive advantages will erode, and that new configurations of resources and capabilities will be required to sustain the whole network, it must be accepted that the composition of member firms is likely to require adjustment. theory on dynamic capabilities (teece et al., 1997) emphasizes that to maintain competitive advantage and congruence with a changing environment, organizations must be able to reconfigure their existing resources to develop new capabilities. whole networks, too, must be cognizant that the strategic assets available from the current roster of member firms may not be adequate to compete in a changed environment. members may need to contribute different resources and capabilities to the value chain, new assets may need to be brought into the system, and some current assets or component firms may no longer have competitive value. due to factors such as changing strategic priorities, deficiencies in member performance, or voluntary network exit, firms will need to be removed from the network, others will voluntarily drop out, and new firms will need to be added to replace them and maintain the value chain. in summary, an element of risk in the interdependencies of the whole network is that a vital link of the production chain (i.e. an important member) may leave or not perform, thereby disrupting the network’s production system until a replacement link can be activated. with each such change, the relationships and social capital built up in the network are disrupted and made, at least temporarily, less certain and stable. 106 journal of business strategies trust: a contextual foundation of whole network operations in order to survive, interfirm networks must create and maintain stable relationships among member firms (madhavan, koka & prescott, 1998; simsek, lubatkin, & floyd, 2003). it is critical to recognize the importance of trust within the relations of the whole network. theory provides us a strong foundation here, and on that foundation rests every consideration of whole network operations. but as a review of research will show, establishing high levels of trust can paradoxically lead to weaknesses and failure for the whole network. trust between members is critical to the success of the network because it facilitates governance and fosters the cooperative nature of the network (inkpen, 2001; krishnan & martin, 2006; tiwana, 2008). trust builds a ‘band of tolerance’ within which firms can endure periods of partial goal conflict or inequities (madhok, 1995). trust is a key element in whole networks due to their lack of hierarchical or equity-based authority mechanisms and because the risks of goal conflict are likely high over the life of the network. ironically, the very work to build network identification, trust, and strong ties also lays the groundwork for network rigidity and the fragility of trust. dyer & nobeoka (2000) and granovetter (1973) showed how strong tie networks emphasizing trust and integration are at risk of developing an increasingly inward focus which can make them less able to respond to change. in sum, network success in building strong bonds of trust creates fertile ground for inertia and rigidity to grow. trust alone may be a sufficient governance mechanism for interfirm networks that do not aspire to long-term network competitive advantage. however, prior theory and research informs that over the long term, it is unlikely that trust alone can sustain a commercial enterprise’s competitive effectiveness. this is the essential challenge in whole network leadership and design: how to emphasize trust in the member relationships while also legitimizing a governance structure that protects long-term viability of the entire network. coping with the capabilities-rigidities dilemma one stream of research on how firms effectively deal with the dilemma inherent in capabilities exploitation is the stream addressing how firms can be ambidextrous. tushman and o’reilly (1996) described ambidexterity as the ability of a firm to simultaneously exploit and explore. this concept was refined as organizational ambidexterity by gibson and birkinshaw (2004). they distinguished structural mechanisms separating business units for exploitation and exploration from contextual mechanisms (e.g. overarching and compelling visions, decentralized planning, volume 30, number 2 107 and cross-unit communications) that integrate the tensions into a coherent organizational strategy that fosters ambidexterity at the individual level. ambidexterity theory emphasizes the particular skills, knowledge, and processes that enable leaders to stand above the forces driving exploitation on one hand and exploration on the other. ambidextrous leaders foster an integrating, ‘both/ and’ culture rather than an ‘either/or’ investment-analysis approach. top management that is cognizant of this duality and is capable of leading in such a manner is central to contending with the capabilities dilemma (lubatkin, simsek, ling, & veiga, 2006; jansen, tempelaar, van den bosch, & volberda, 2009). further, for ambidexterity to be effective, the internal context of the firm needs an appropriate mixing of centralization with decentralization (tushman, smith, wood, westerman, & o’reilly, 2010), top management control with empowered initiative (gibson & birkinshaw, 2004), and reliable standardization with autonomous experimentation (tushman & o’reilly, 1996). leadership must guide and control the course of the overall organization while simultaneously allowing it to function in a decentralized, segmented manner (tushman et al., 2010). it is clear that organizational leadership and governance mechanisms play vital roles in how firms cope with the capabilities-rigidities dilemma. for whole network organizations, however, these mechanisms must address the unique challenges stemming from the capabilities-rigidities dilemma that we have previously noted. the primary challenges we have described thus far, and the intuitive and necessary counter-intuitive mechanisms for addressing them, are summarized in figure 1. the following sections expand on the means of coping with these challenges. figure 1 challenges and management mechanisms for whole network governance 108 journal of business strategies coping with low authority compared to the formal authority of hierarchical structures, whole network leadership has little authority over the resources of network members. conflicts of agendas and debates about issues such as value production, rent appropriations, and network composition necessitate a strong governance structure and formal process for clear, decisive, and necessarily endorsed leadership roles. saz-carranza and ospina (2010) discuss the unique ‘unity-diversity tension’ (p.327) as an integral issue in whole network governance. tensions not only exist between the forces of exploitation and exploration, but also between the unified agenda of the network as a whole and the independent strategies and agendas of each individual member firm. to enable sustainable performance through change, organizational context and processes must simultaneously promote and manage the integration of exploitative and exploratory assets (lubtakin, et al., 2006; smith, binns, & tushman, 2010). as benefits of exploitation accrue to network members, leadership must have adequate authority to insure that appropriate investments pursue exploration. network leaders do not have the advantage of agency or hierarchical sources of authority like their firm-level counterparts nevertheless, critical decisions for whole network success, often involving issues that are ambiguous, uncertain, and contentious, must be made and acted upon. member participation and relational harmony is important, but authority mechanisms are as well. power, as pfeffer (1992) pointed out, is necessary to get things done in any organization. an appropriate leadership and authority structure, formal or informal, must be established, clearly communicated, and consensually agreed to at the onset of whole network operations. proposition 1: to cope with the capabilities-rigidities dilemma, whole networks require explicit and formalized governance processes imbued with enough authority and legitimacy to negotiate the tensions between exploitation and exploration. coping with risks of relational imbalances openness and transparency are critical in governance to avoid perceptions of power grabs, coalition building, or other political moves that could harm network trust. mechanisms that ensure decision-making transparency and provide for open flows of information among members support the development and maintenance of trust. when such systems are performed around consistent values and principles, the cycle of trust is enhanced (colquitt & rodell, 2011). transparent processes for decision authority and control must be balanced with involvement and shared purvolume 30, number 2 109 poses in order for trust and network identification to be supported. decentralized involvement and cross-unit integration (jensen et al., 2009; smith & tushman, 2005; tushman & o’reilly, 2006) supports that while maintaining centralized control, leaders of ambidextrous organizations involve their disparate component functions in planning activities to both draw knowledge from and diffuse knowledge to subunits. in the whole network context, involvement of the component firms in strategic planning likewise aids in knowledge transfer, improved coordination and decision-making, and overall network identification (kale, singh, & perlmutter, 2000). because members of a network-linked value chain are diverse operations and likely have different biases and backgrounds, social uncertainty exists (riemer & klein, 2008). mcevily and marcus (2005) showed that joint problem solving was the most important mechanism for building trust and increasing the strength of network relationships. prusak and cohen (2001) stated that social capital is best developed when members work face-to-face frequently, and simsek et al. (2003) inform that network member interaction builds cognitive similarity. while disproportionate input values from specific member assets likely emerge through exploitation and maximization of network value, balance of relational powers must also be maintained. unchecked, imbalances of power and influence on decisions may skew relationships away from a harmonized, network-sustaining direction. dhanaraj and parke (2006) described how real or perceived power and value imbalances can lead to member isolation, migration, or attrition. such outcomes can cause network instability. explicitly providing systems for all members to be involved in the decisions of the whole network is a productive mechanism for both limiting the formation of power imbalances and for establishing a climate that fosters trust, understanding, and network identification. such transparent and inclusive processes also assist in keeping tensions between members out in the open where they can be recognized and addressed. proposition 2: to cope with the capabilities-rigidities dilemma, whole network leadership must employ centralized guidance while promoting open, decentralized decision-making and problem solving involvement. coping with changes in membership composition the coordination of details such as work flows and resource commitments magnify the complexity of the whole network value chain. each member firm is essentially a component asset. when changes in the environment occur and the nature 110 journal of business strategies of network outputs must evolve to maintain congruence, one or more member firms may no longer be relevant toward network value creation. to adapt the production system may require dropping, replacing, or adding new component firms. such reconfigurations in membership composition may negatively impact stability, trust, and relationship capital. to avoid system shocks, whole network members should be aware of and acknowledge that such changes to composition are inevitable. clearly defined roles and performance standards must be set for each segment of the system and thus for each member. procedures for removing and replacing members who are unable or unwilling to perform as needed are critical to maintain network outputs. and because continuous production is generally a requirement for competitive success, the whole network must also have mechanisms for identifying and quickly integrating new or replacement members who can pick up when prior members leave or fail to perform. in some critical operations, it may be advisable that the whole network engage in contingent relationships that may or may not come to be required. critical elements for the ongoing survival of complex, whole network operations are managing the accumulation and aggregation of resource stocks within the whole network, ensuring that members perform as needed, and allowing for necessary reconfigurations of existing and new resources to adapt to change. proposition 3: to cope with the capabilities-rigidities dilemma, whole network governance systems must include provisions for managing membership composition and performance. specifically; 3a: whole network governance systems should include clear, explicit standards of performance for each member in order to maintain network membership. 3b: whole network governance systems should include explicit, clear, and transparent procedures for expelling and admitting firms. 3c: whole network governance systems should include clear, explicit, and transparent policies related to engaging alternative firms as members or sources of contingent supply for critical input components. discussion as organizational environments become more complex and dynamic, contradictory tensions within organizations become much more salient (smith & lewis, volume 30, number 2 111 2011). many managers are likely to apply traditional ‘either/or’ decision approaches in leading emergent network organizations. they may abandon a principal-agent notion of leaders and followers believing that the informal, trust-based nature of the network must be matched with an equally informal and parallel style of governance. paradox theory, however, counters that such ‘either/or’ thinking can be a recipe for failure (lewis, 2000; smith & lewis, 2011). understanding how paradoxical tensions arise, how they are manifested in behaviors, and how they can be managed is an increasingly important and timely field. by examining the paradox of how capabilities of social governance (e.g. trust) can become rigidities hindering whole network adaptation and change, we have brought attention to the paradoxical nature of emergent organizations such as whole networks. while these organizations have admirable ambitions of flexibility, informality, and social bonds, in the course of pursuing long-term sustainable performance, forces of environmental change can convert such positive qualities into survival-limiting anchors. organizational innovations such as whole networks are increasingly competing with established firms and other networks. they create new sources of value while simultaneously reducing the value of others through this creative destruction (schumpeter, 1950). it is therefore quite relevant for managers and scholars to begin to give attention to the how these organizations achieve and sustain competitive advantage. our examination of paradox and governance of whole networks makes several contributions to practice and theory. this research can assist executives who are leading, involved in, or considering joining such network organizations. even for those firms not organizing or joining a network, such emergent competitive entities will likely influence markets directly or indirectly. especially for small and medium sized firms constrained in their access to resources, capabilities, and markets, whole network type organizations may offer paths toward long-term success. managers leading whole networks, or those considering founding such organizations, will benefit by understanding the paradoxical and counter-intuitive steps that likely benefit long-term network performance. by understanding how network governance structures play a role in the long-term viability of a network, managers considering joining such a network can benefit in an enhanced ability to assess such opportunities. a trust-based, socially integrated, and “no rules; no structure; no contracts” type of alliance network may work for certain goals or for certain period of time, but environmental forces and the “dark side of close relationships” (anderson & jap, 2005; p. 75) can transform these informal governance mechanisms into inertial barriers that prohibit market-required change. managers will do well to recognize that the way they operate their own 112 journal of business strategies firms, however successful, is unlikely to work as a leadership and management style for the unique nature of a whole network structure. for leaders of member firms, too, an understanding of the realities of environmental change and its consequences for whole network governance can be beneficial in decisions about network relationships, including decisions to join or remain in a network. alternatives to a traditional principal-agent control system are available (granovetter, 2005). leveraging social capital to enable formal governance rules and standards is quite achievable. with an awareness of the paradoxical challenges we have noted, leaders who can apply their innovativeness toward governance practices that not only manage inherent tensions, but also leverage social assets toward creating strong governance are likely to create enduring organizational performance. for scholars, understanding that whole networks are subject to firm-type challenges such as the capabilities-rigidities dilemma highlights that other firm-based theory may also have relevant extensions to emergent network organizations. our research additionally sheds light on a boundary condition for social mechanisms. that is, how and when they may not operate as effective governance tools for all networks. reliance on trust and reciprocity has its place in network theory; however, it must be recognized that these positive factors can also fracture or become inhibitors to change (anderson et al., 1994; granovetter, 1973; 1985). we do not dispute or attack the role of such mechanisms in network governance (jones et al., 1997). we agree that building trust and social cohesion should remain an objective in all networks. however, dependence on social mechanisms to sustain the organization through the forces of time and change is risky. the emergent network forms we have addressed in this paper operate with a unique combination of motive and structure. that is, they are informally and non-hierarchically networked firms that have come together to produce a singular value-chain and compete as a singular entity as a going concern. to achieve this, considerations of firm-level theory on competition and sustainable competitive advantage (e.g. barney, 1991; leonard-barton, 1992; teece et al., 1997; tushman & o’reilly, 1996) become relevant. thus, more firm-like governance, we argue, becomes necessary and relevant as well. while the present study better informs the literature on network-level competitive theory, there are significant challenges going forward to validate and extend our conclusions. in particular, one challenge will be gaining access to whole networks to test the propositions put forth in this manuscript. since the subject involves a loosely formalized emerging form of an interorganizational relationship, it could prove difficult for researchers to identify, observe, and assess the early formations and ongoing management of a whole network. to address this challenge, a volume 30, number 2 113 mixed-method approach could be used to historically examine the formation aspects of the whole network, utilizing event history analysis. a longitudinal case study approach to study the ongoing management of the whole network could then be used to examine leadership and management. in such a new area, where existing theory may not hold and where the relative importance of elements and relationships are not clearly understood, a case study approach is a very appropriate methodology (eisenhardt, 1989). once researchers have better organized and refined the vital components, more targeted empirical research can follow. this path can extend this stream toward statistical validation, predictions of contingent conditions, and identification of configurations of governance mechanisms that will further help managers make appropriate choices to lead network-structured competitive entities. emergent organizational forms are, by definition, still evolving and thus subject to continued radical change. any conclusions and implications at this juncture must be viewed in that light. however, we are confident that based on prior theory and empirical research, network governance is, and will continue to be, a critical answer for how whole network organizations manage the implications of inherent challenges such as the capabilities-rigidities dilemma. references anderson, e., & jap, s. d. (2005). the dark side of close relationships. mit sloan management review, 46(3), 75-82. anderson, j.c., hakansson, h., & johanson, j. (1994). dyadic business relationships within a business network context. journal of marketing, 58(4), 1-15. barney, j. (1991). firm resources and sustained competitive advantage. journal of management, 17(1), 99-120. colquitt, j.a., & rodell, j.b. (2011). justice, trust, and trustworthiness: a longitudinal anlaysis integrating three theoretical perspectives. academy of management journal, 54(6), 1183-1206. contractor, f.j., & lorange, p. (2002). the growth of alliances in the knowledge-based economy. international business review, 11, 485-502. dhanaraj, c., & parke, a. (2006). orchestrating innovation networks. academy of management review, 31(3), 659-669. dyer, j.h. (1996). specialized supplier networks as a source of competitive advantage: evidence from the automotive industry. strategic management journal, 17, 271-291. 114 journal of business strategies dyer, j.h., & nobeoka, k. (2000). creating and managing a high-performance knowledge-sharing network: the toyota case. strategic management journal, 21, 345-367. eisenhardt, k. m. (1989). building theories from case study research. academy of management review, 14(4), 532-550. emerson, r. (1962). power-dependence relations. american sociological review, 27, 31-40. gibson, c. b., & birkinshaw, j. (2004). the antecedents, consequences, and mediating role of organizational ambidexterity. academy of management journal, 47(2), 209-226. gimeno, j. (2004). competition within and between networks: the contingent effect of competitive embeddedness on alliance formation. academy of management journal, 47(6), 820-842. goerzen, a. (2007). alliance networks and firm performance: the impact of repeated partnerships. strategic management journal, 28, 487-509. granovetter, m.s. (1973). the strength of weak ties. american journal of sociology, 78(6), 1360-1380. granovetter, m.s. (1985). economic action and social structure: the problem of embeddedness. american journal of sociology, 91(3), 481-510. granovetter, m. (2005). the impact of social structure on economic outcomes. journal of economic perspectives, 19(1), 33-50. guidice, r.m., vasudevan, a., & duysters, g. (2003). from ‘me against you’ to ‘us against them’: alliance formation based on inter-alliance rivalry. scandinavian journal of management, 19, 135-152. hannan, m.t., & freeman, j. (1984). structural inertia and organizational change. american sociological review, 49(2), 149-164. huemer, l. (2004). balancing between stability and variety: identity and trust tradeoffs in networks. industrial marketing management, 33, 251-259. inkpen, a. c. (2001). strategic alliances. in hitt, m. a., freeman, e., & harrison, j. s. (eds.), handbook of strategic management (pp. 409–432). oxford, uk: blackwell publishers. ireland, r.d., hitt, m.a., & vaidyanath, d. (2002). alliance management as a source of competitive advantage. journal of management, 28(3), 413-446. jansen, j. j. p., tempelaar, m. p., van de bosch. b., & volberda, h. w. (2009). structural differentiation and ambidexterity: the mediating role of integration mechanisms. organization science, 20(4), 797-811. volume 30, number 2 115 jarillo, j.c. (1993). strategic networks: creating the borderless organization. oxford: butterworth-heinemann. jones, c., hesterly, w.s., & borgotti, s.p. (1997). a general theory of network governance: exchange conditions and social mechanisms. academy of management review, 22(4), 911-945. kale, p., h. singh, & perlmutter, h. (2000). learning and protection of proprietary assets in strategic alliances: building relational capital. strategic management journal, 21, 217 – 223. kasper-fuehrer, e.c., & ashkanasy, n.m. (2001). communicating trustworthiness and building trust in interorganizational virtual organizations. journal of management, 27, 235-254. kilduff, m., & tsai, w. (2003). social networks and organizations. london. sage krishnan, r and martin, x. (2006). when does trust matter to alliance performance? academy of management journal, 49(5), 894–917. leonard-barton, d. (1992). core capabilities and core rigidities: a paradox in managing new product development. strategic management journal, 13, 111-125. lewis, m.w. (2000). exploring paradox: toward a more comprehensive guide. academy of management review, 25(4), 760-776. levinthal, d. a., & march, j.g. (1993). the myopia of learning. strategic management journal, 14, 95-112. lieberman, m. b., & montgomery, d. b. (1988). first mover (dis)advantages: retrospective and link with the resource-based view. strategic management journal, 19(12), 1111-1125. lubatkin, m. h., simsek, z., ling, y., & and veiga, j. f. (2006). ambidexterity and performance in small-to-medium-sized firms: the pivotal role of top management team behavioral integration. journal of management, 32(5), 646-672. madhavan, r., koka, b.r., & prescott, j.e. (1998). networks in transition: how industry events (re)shape interfirm relationships. strategic management journal, 19, 439-459. madhok, a. (1995). opportunism and trust in joint venture relationships: an exploratory study and a model. scandinavian journal of management, 11(1), 57-74. march, j.g. (1991). exploration and exploitation in organizational learning. organization science, 2(1), 71-87. mcevily, b., & marcus, a. (2005). embedded ties and the acquisition of competitive capabilities. strategic management journal, 26, 1033-1055. 116 journal of business strategies meiseberg, b., & ehrmann, t. (2012). tendency to network of small and medium-sized enterprises: combining organizational economics and resource-based perspectives. managerial and decision economics. retrieved from wiley online library. doi: 10.1002/mde.2590 miles, r.e., & snow, c.c. (1992). causes of failure in network organizations. california management review, summer, 53-72. miles, r.e., miles, g., snow, c.c., blomqvist, k., & rocha, h. (2009). the i-form organization. california management review, 51(4), 61-76. o’driscoll, a., carson, d., & gilmore, a. (2001). the competence trap: exploring issues in winning and sustaining core competence. irish journal of management, 22(1), 73-90. o’reilly, iii, c.a., & tushman, m.l. (2008). ambidexterity as a dynamic capability: resolving the innovator’s dilemma. research in organizational behavior, 28, 185-206. parkhe, a., wasserman, s., & ralston, d.a. (2006). new frontiers in network theory development. academy of management review, 31(3), 560-568. owen-smith, j., & powell, w.w. (2004). knowledge networks as channels and conduits: the effects of spillovers in the boston biotechnology community. organization science, 15(1): 5-21. parmigiani, a, & rivera-santos, m. (2011). clearing a path through the forest: a meta-review of interorganizational relationships. journal of management, 37(4), 1108-1136. pedersen, c., & nagengast, j. (2008). the virtues of the virtual organization. strategic hr review, 7(3), 19-25. pfeffer, j. (1992). understanding power in organizations. california management review, 34(2), 29-50. phan, p.h., siegel, d.s., & wright, m. (2005). science parks and incubators: observations, synthesis, and future research. journal of business venturing, 20, 165-182. pihkala, t., varamaki, e., & vesalainen, j. (1999). virtual organization and the smes: a review and model development. entrepreneurship & regional development, 11(4), 335-349. powell, w.w. (1990). neither market nor hierarchy: network forms of organization. research in organizational behavior, 12, 295–336. powell, w.w., white, d.r., koput, k.w., & owen-smith, j. (2005). network dynamics and field evolution: the growth of interorganizational collaboration in the life sciences. american journal of sociology, 110(4): 1132-1205. 117 journal of business strategies provan, k.g., fish, a., & sydow, j. (2007). interorganizational networks at the network level: a review of the empirical literature on whole networks. journal of management, 33(3), 479-516. prusak, l., & cohen, d. (2001). how to invest in social capital. harvard business review, 79(6), 86-93 raab, j., & kenis, p. (2009). heading toward a society of networks: empirical developments and theoretical challenges. journal of management inquiry, 18(3), 198-210. raisch, s., & birkinshaw, j. (2008). organizational ambidexterity: antecedents, outcomes, and moderators. journal of management, 34(3), 375-409. riemer, k., & klein, s. (2008). is the v-form the next generation organization? an analyisis of challenges, pitfalls and remedies of ict-enabled virtual organisations based on social capital theory. journal of information technology, 23, 147-162. ring, p.s., & van de ven, a.h. (1994). developmental processes of cooperative interorganizational relationships. academy of management review, 19(1), 90-118. safford, s. 2004. why the garden club couldn’t save youngstown: civic infrastructure and mobilization in economic crises. working paper, mit industrial performance center, cambridge, ma. saz-carranza, a., & ospina, s.a. (2010). the behavioral dimension of governing interorganizational goal-directed networks-managing the unity-diversity tension. journal of public administration research and theory, 21, 327-365. schumpeter, j.a. (1950). capitalism, socialism, and democracy, 3rd edition. new york: harper and brothers. scott, w.r., & davis, g.f. (2007). organizations and organizing: rational, natural, and open systems. upper saddle river, new jersey: pearson education simsek, z., lubatkin, m.h., & floyd, s.w. (2003). inter-firm networks and entrepreneurial behavior: a structural embeddedness perspective. journal of management, 29(3), 427-442. smith, w. k., binns, a., & tushman, m. l. (2010). complex business models: managing strategic paradoxes simultaneously. long range planning, 43(2-3), 448461. smith, w.k. & lewis, m.w. (2011). toward a theory of paradox: a dynamic equilibrium model for organizing. academy of management review, 36(2), 381-403. smith, w. k., & tushman, m. l. (2005). managing strategic contradictions: a top management model for managing innovation streams. organization science, 16(5), 522-536. 118 journal of business strategies snow, c.c., miles, r.e., & coleman, h.j. (1992). managing 21st century network organizations. organizational dynamics, 20, 5-20. sydow, j. & windeler, a. (1998). organizing and evaluating interfirm networks: a structurationist perspective on network processes and effectiveness. organization science, 9(3), 265-284. teece, d.j., pisano, g, & schuen, a. (1997). dynamic capabilities and strategic management. strategic management journal, 18(7), 509-534. tiwana, a. (2008). do bridging ties complement strong ties? an empirical examination of alliance ambidexterity. strategic management journal, 29(3), 251-272. tuma, a. (1998). configuration and coordination of virtual production networks. international journal of production economics, 56/57, 641-648. tushman, m. l., & o’reilly iii, c. a. (1996). ambidextrous organizations: managing evolutionary and revolutionary change. california management review, 38(4), 8-30. tushman, m., smith, w. k., wood, r. c., westerman, g., & o’reilly, c. (2010). organizational designs and innovations streams. industrial and corporate change, 19(5), 1331-1366. biographical sketch of authors william r. carter is a doctoral candidate in strategic management at the university of north texas. after receiving his mba from the cox school of business at southern methodist university, he spent over twenty-five years in industry as a marketing and strategic planning executive. his research interests are paradoxes in strategic leadership, top management team functioning in small and medium-sized enterprises, and sustainability entrepreneurship. phillip e. davis is a doctoral candidate at the university of north texas where his studies focus on strategic management and entrepreneurship. he received his mba and bs in industrial engineering from clemson university. his research interests include capability development, strategy process, and strategic entrepreneurship. prior to his doctoral studies, phillip held managerial and executive positions in manufacturing and banking. julia l. herchen is a doctoral candidate in organizational behavior at the university of north texas. she received her mba from baylor university and her bba from eastern new mexico university. prior to pursuing a phd, julia was a financial executive, primarily in the commercial mortgage sector. julia’s research 119 journal of business strategies interests include behavioral ethics, pro-social behavior, deviant workplace behavior, leadership, organizational misconduct and corporate social responsibility. vallari chandna is a doctoral candidate in the department of management at the university of north texas. she earned her mba from the same university in organizational behavior and a degree in law (ba.ll.b) from india. her current research interests in organizational theory and entrepreneurship including new organizational forms (temporary organizations), individual and organizational issues in start-ups, de-growth, inter-organizational relationships and identity issues. discount retail profitability: a harbinger for e-commerce? richard skolnik state university of new york at oswego oswego, ny abstract expansion of electronic commerce has the potential to increase retail productivity. however, these gains may not translate into enhanced retailer profitability. this study examines profitability of the discount retail industry from 19811998, a period during which the industry realized significant productivity gains. although productivity measures like inventory turnover and sales per employee increased during this period, industry profitability did not increase. instead, consumers benefited from the increased efficiency through paying lower markups. the experience of the discount retail industry may indicate that retailers face a product price treadmill: gains in efficiency result in lower prices rather than higher profits. the projected efficiencies of the internet and the expansion of electronic commerce may portend lower retail profitability but greater savings for consumers. introduction at the end of the twentieth century, the potential of electronic commerce fueled investor optimism and helped propel u.s. equity valuation to historic heights. investors believed that productivity gains of network technology would generate increased corporate profitability for companies involved in electronic commerce. although the bubble has burst on internet valuations, the question remains about whether innovations that lower production costs will result in increased profitability. in a competitive market, lower costs produce lower prices. innovative firms may be able to capture abnormal profits before other firms in the industry adopt the new technology or business mode but once the innovation is widely diffused, sustained profitability is possible only if significant barriers to entry exist. this paper examines discount retailers, a category that includes firms like wal-mart and kmart, to determine whether increased efficiency attributable to improvements in distribution and inventory management have resulted in abnormal profits for retailers or lower prices for consumers. the fortunes of discount retailers during a period of technological innovation may be a harbinger of the financial impact that electronic commerce will have upon retailers. 150 journal of business strategies the internet, retailers and the treadmill vol. 18, no.2 this work is motivated by the uncertainty regarding valuations ofinternetbased retailers. in 1998 and 1999, financial analysts were discarding traditional price-earnings (pie) valuation models for other methods in order to justify the high valuations of etailers (laderman & smith, 1998). although many internet companies lost the majority of their market valuation when the nasdaq corrected sharply in 2000, analysts continue to disagree about the proper valuation of companies utilizing a new technology (trueman, wong & zhang, 2000; schwartz & moon, 2000). one of the arguments advanced for high market valuations of internet retailers is the increased efficiency and the reduced costs that the internet brings to businesses (johnson, 1999; tully, 2000). however, the benefits of cost saving technology may not accrue to the firm. instead, consumers may enjoy lower prices or a factor of production, like labor or landowners, may realize increased compensation. the agricultural economics and resource economics literature documents the equivocal results that technological innovation can have on producers. cochrane (1958) introduced the concept that farmers are on a product price treadmill. profits that result from the adoption of new technologies evaporate as increased competition drives price down. farmers constantly strive to improve their incomes by adopting new technologies. lower costs ensure that early adopters of the technology enjoy above average profits for at least a brief period of time. however, as more farmers adopt the technology, production increases and prices decrease. the product price treadmill benefits consumers through lower food prices, but farm profitability remains relatively low. a similar product price treadmill can exist in the retailing industry. growth in the retail industry is constrained by growth in consumer spending. for a given amount of consumer spending, retailing is a zero sum game. one retailer's gain becomes another retailer's loss. technological innovation can benefit the initial innovators, but as more firms adopt the technology, prices, and therefore profits, can decline through increased competition. the internet has, and will continue to have, a significant impact upon retailing. retailers use the internet as an efficient marketing medium, and for digitized products like software, as a distribution channel. however, if a treadmill exists in retailing, the internet may not benefit the industry through sustained increased profitability. in fact, the internet, through greater price transparency, may increase the speed of the treadmill by fueling competition (sinha, 2000). the effect of the internet upon retail profitability can only be measured with hindsight. nevertheless, the effect of previous technological innovations on retailers can be measured by studying historical retail profitability. fall 2001 skolnik: discount retail profitability innovation and profitability 151 retail innovations can take various forms. walters and laffey (1996) identify four categories of retail innovations: new delivery systems, new products or services, improvements in existing products, and the development of superior product or service attributes. process innovations straddle several of these categories: they allow retailers to modify delivery systems, decrease costs and improve the shopping experience for consumers. the information revolution has generated numerous productivity enhancing processes. throughout the 1980s and 1990s, retailers have exploited information technology (it) to decrease costs and improve customer service. some of these initiatives include synchronized consumer response, quick response, vendor-managed inventories, and demand-chain management solution (fioritio, may & straughn, 1995; simbari, 1996). retailers have implemented improvements in the management of goods and services continuously over the past 20 years. ultimately, investors would like to see innovation affect the profitability of the firm, which can be measured by the return on equity (roe). using the extended dupont relationship, roe can be partitioned into contributing components (selling & stickley, 1990): roe = ebitm * asset turnover * (1 interest and tax load) * (equity multiplier) the first two terms are operating outcomes. the second two terms are financial structure outcomes. earnings before interest and taxes margin (ebitm = ebit/sales), also known as operating profit margin, represents the portion of each sales dollar that a firm converts into operating profit. asset turnover (sales/assets) represents the sales dollars produced by one dollar of assets. the interest and tax load depend upon a firm's capital structure and tax management policies. the equity multiplier (assets/equity) measures the firm's financial leverage. adopting it to improve processes affects roe through operating performance, either due to increased profit margins or increased turnover. first, improved inventory management should decrease inventory levels resulting in lower asset requirements and higher asset turnover. second, it can increase worker productivity, leading to lower labor requirements per dollar of sales. a reduction in workforce requirements results in lower payrolls and higher profit margins. third, itcan result in better stock management leading to less stockouts, less obsolete products, and increased customer satisfaction. greater product availability can lead to increased customer spending resulting in higher turnover. stock management can also increase profit margins by decreasing the amount of merchandise that must be sold at clearance. 152 journal of business strategies vol. 18, no.2 although it should have a positive impact upon financial ratios, previous research has indicated that improved production techniques may not translate into superior financial performance. just-in-time production (jit) is a case in point. the resources that are freed up by more efficient inventory management need to be utilized for the firm to realize improved profitability (mia, 2000). balakrishnan, linsmeier, and venkatachalam (1996) studied the cross-sectional results of firms that adopted jit production compared to a control group that did not adopt jit. their results showed that firms which adopted jit did not, on average, have a significant return on asset (roa) response to jit adoption. mia (2000) found that jit profitability depends upon the provision of information in a firm's management accounting system. in summary, adopting a process innovation will improve a firm's financial performance only if the innovation is properly implemented. discount retailers and innovation in contrast to the mia (2000) and balakrishnan et al. (1996) studies, i do not measure the impact of a specific technology on individual firms, but rather the effect of a series of technological innovations on the entire industry. discount retailers, formally classified as variety retailers with a sic number of 5331, provide an ideal segment to study the effects of technological innovation, and hence the potential impact of the internet, on the retail industry. during this period, the industry has invested aggressively in it and has had dynamic growth. during the 1990s annual sales growth in the discount retail industry averaged 5.8 percent exceeding the 5.5 percent growth of general retailers (sack, 2000). the innovativeness of the discount retail industry leader, wal-mart, has even had an effect upon other retail channels by forcing firms to adopt new innovations for their survival (kaufman, 2000). this study examines operating performance variables to determine whether the industry has had a significant increase in efficiency and profitability from 1981-1998. inventory turnover, total asset turnover, sales per employee, operating profit margin, basic earning power and cost of goods sold as a percentage of sales are each analyzed for significant changes. each of the series was tested for stationarity by regressing the variables against time, with the following model: y/ = f3() + f3,/ = e, the null hypothesis of b 1 =0 implies a stationary or trendless series. a significant b) results in a rejection of the null hypothesis. a positive b) indicates an increasing trend; a negative coefficient indicates a decreasing trend. a priori, the following results are expected for each of the variables: inventory turnover: positive trend coefficient. investment in it and improved distribution and inventory management procedures should translate into higher inventory turnover. fall 2001 skolnik: discount retail profitability 153 total asset turnover: positive trend coefficient. a reduction in inventory should result in higher total asset turnover. sales per employee: positive trend coefficient. increased productivity should result in higher sales per employee. operating profit margin. indeterminate trend coefficient. the change in operating profit margin depends upon the industry structure. in a price-competitive industry, return on investment will trend toward an equilibrium, or normal, level. competition would ensure that innovations leading to increased total asset turnover would not increase return on investment. an increase in total asset turnover would be accompanied by a decrease in operating margin. in a less competitive industry, operating profit margin could increase as costs decrease in response to improved productivity. firms capture the gains of cost decreases through higher investment returns. if retailing is competitive, and a product price treadmill exists, operating profit margin would be expected to fall if total asset turnover increased. basic earning power: non-negative trend coefficient. operating returns should remain constant if retailing is competitive and there are no economywide trends in operating returns. if retailing has barriers to entry or other non-competitive characteristics, productivity improvements can translate into enhanced bep. cost ofgoods sold as percentage of sales: non-negative trend coefficient. in a competitive industry, consumers should realize the gains in retail efficiency through decreased retail mark-ups. cost of goods sold as a percentage of sales should increase. if the industry is not competitive, firms can capture increases in productivity for themselves, in which case, cost of goods sold as percentage of sales would be unchanged. data and results data from 1981-1998 were obtained from compustat active and research files for firms identified by the sic code of 5331 (variety stores). data collected included sales, cost of goods sold, earnings before interest and taxes (ebit), inventory turnover, total asset turnover, ebit/total assets, and number of employees. table 1 summarizes the data. statistics for sales, cost of goods sold, and total employees were calculated by summing variables for the entire industry within the sample. inventory turnover, total asset turnover, operating profit margin, and basic earning power were found by using a sales weighted average. as a quality check, the compustat data were compared to data from an industry report (discount merchandiser, 1997) for consistency. inventory turnover, total asset turnover, sales per employee, ebit margin, basic earning power (ebitm/assets), and cost of goods sold as a percentage of sales were regressed against time to test for stationarity. table 2 reports the table 1 vi.j:::.. summary financial ratios for the variety store industry (sic 5331) number of inventory total asset ebit basic earning cog/ sales/ total sales year firms turnover turnover margin (%) power (%) sales employee x 1000 (millions) 1981 28 4.70 2.64 4.16 11.00 0.73 $ 63.12 $36,238 1982 27 4.71 2.56 4.73 12.09 0.72 $ 71.08 $37,908 1983 27 4.91 2.60 5.98 15.55 0.72 $ 73.51 $43,230 <...., 1984 27 4.87 2.60 5.77 14.99 0.72 $ 74.24 $47,074 0 ;:: '""c 1985 31 4.80 2.48 5.36 13.30 0.73 $ 68.28 $51,671 ;:: >.:l..... 1986 32 5.11 2.58 5.39 13.88 0.73 $ 77.00 $61,578 <q., 1987 31 5.19 2.70 4.82 12.99 0,74 $ 84.23 $70,781 ~;:: 2.49 $ 82.80 $92,014 '"1988 29 4.75 5.03 12.52 0.74 s· ~ 1989 29 5.39 2.78 4.71 13.09 0.75 $ 89.76 $104,990 '"'" 1990 31 5.34 2.75 4.48 12.31 0.75 $ 95.08 $118,924 v)... 1991 34 5.66 2.77 4.49 12.41 0.76 $ 109.44 $138,899 ~... ~ 1992 36 5.20 2.48 4.48 11.11 0.78 $ 126.15 $172,417 ~-. ~ '"1993 33 5.40 2.52 4.31 10.87 0.76 $ 122.74 $173,163 1994 34 5.52 2.57 4.00 10,26 0.77 $ 116.57 $193,018 1995 32 5.36 2.54 3.24 8.23 0.78 $ 125.75 $209,693 1996 32 5.75 2.66 3.73 9.93 0.78 s 142.34 $225,483 t1997 31 6.09 2.74 4.22 11,55 0.78 $ 145.91 $246,702 ~ ...... 1998 25 6.45 2.79 4.58 12.80 0.78 $ 136.06 $270,902 00 z 0 source: compustat active and research files. calculations based upon a sales weighted average. tv fall 2001 skolnik: discount retail profitability 155 parameter estimate for the time variable value, its corresponding t statistic, and its significance level. table 2 tests for stationarity variable inventory turnover total asset turnover sales per employee ebit margin ebit margin/assets cog/sales parameter estimate 0.080 0.006 5.029 -0.084 -0.190 0,004 t statistic 7.622 1.166 14.421 ·3.370 -2.746 12.610 probability> 0 0.0001 0.2608 0.0001 0.0039 0.0144 0,0001 inventory turnover has a positive and significant coefficient indicating that discount retailers managed their inventory more efficiently in the sample period. turnover of 4.7 times in 1981 corresponds to an inventory period of 77.7 days. turnover of 6.45 times in 1998 corresponds to an inventory period of 56 days. the inventory period decreased 28 percent from 1981 to 1998. the parameter estimate of 0.080 indicates that the inventory period decreases by approximately 1.5 days per year. the increase in inventory turnover does not seem to have translated into an increase in asset turnover. the total asset turnover coefficient was positive but insignificant. the result is surprising, although consistent with the findings of balakrishnan et al. (1996) and mia (2000), since inventory constitutes approximately one third of assets for variety retailers. a significant decrease in inventory requirements should correspond to a decrease in total asset requirements. further study is needed to determine which asset categories increased to offset the decrease in inventory. increased productivity is evident through the considerable increase in sales per employee. the positive and significant regression coefficient for sales per employee indicates that discount retailers increased labor productivity during the 1981-1998 sample period. the regression coefficient of 5.029 implies that sales per employee increased approximately $5,000 per year. salaries constitute a significant portion of retail operating expense. increases in labor productivity decrease a firm's labor requirements and reduce salary expense. both ebit margin and bep have negative and significant regression coefficients, indicating that profitability for discount retailers deteriorated during the sample period. however, both ratios reversed their steady decline with increases from 1996 through 1998. perhaps competitive pressures in the industry have abated or perhaps the industry has begun to move to higher margin merchandise. increased efficiency in the variety retail industry has translated into gains for consumers. the regression parameter for cog/sales was positive and signifi156 journal of business strategies vol. 18, no.2 cant, indicating that consumers paid a smaller markup over the time period. the increase of 5 percent from 1981 to 1998 may seem relatively small but it represents significant savings for consumers. the variety retail industry had total sales of $256.3 billion in 1998, representing a cost of goods sold of $199.9 billion. if the mark-up of 1981 were applied to the 1998 cost of goods sold figures, consumer expenditures would have been $273.9 billion in 1998. without considering the impact that the discount retailers have had on other retailers, consumers saved approximately $17.6 billion in 1998 due to increased discount retail efficiency. although increased productivity does not seem to have translated into increased profitability for industry, consumers have benefited through lower prices. other potential benefits for consumers, including convenience, merchandise availability, and merchandise selection are not measured in this study. implications for retailers and electronic commerce discount retailers experienced a tremendous increase in efficiency in the 1981-1998 period. inventory turnover increased 37 percent and sales per employee increased 115 percent. unfortunately for the retailers, these gains did not translate into higher operating profits. operating profit margins remained trendless; margins fluctuated between four and five percent during the period. likewise, basic earning power was relatively flat, fluctuating between 11 percent and 15.5 percent. productivity gains translated into lower prices for consumers. cost of goods sold as a percentage of price increased steadily throughout the period. the effects of the internet upon retailing may be similar to the process efficiencies realized by discount retailers; customers may benefit but at the expense of firm profitability. the internet increases price transparency, which results in more competition. as sinha (2000) states, "the internet represents the biggest threat thus far to a company's ability to brand its products, extract price premiums from buyers, and generate high profit margins." the extent to which the internet benefits firms or consumers depends upon the nature of the product and the existing market structure of the industry. efficiencies will be generated in product categories in which the internet can increase inventory turnover and reduce product management expense. the cost-saving benefits of the internet will accrue largely to consumers unless a non-competitive market structure or substantial barrier to entry exists. conclusion the discount retail industry achieved significant increases in productivity from 1981-1998. the productivity increases did not improve industry profitability. instead, consumers benefited through lower markups. like agriculture, the fall 2001 skolnik: discount retail profitability 157 retail industry may be on a product price treadmill. productivity gains due to innovation lead to lower costs and lower prices, but profitability remains un· changed. innovations raise the standards that firms must meet firms either adopt the new technology or are forced out of the market. the internet has the potential to increase retail efficiency but firms can capture the gains only if the market lacks price competition. although this study examined overall productivity changes in the discount retail industry, other factors besides technological innovation can be responsible for changes in costs and profitability. in this study, innovations due to it are commingled with other effects, such as changes in consumer demand and changes in product and input costs. future studies may seek to measure the efficiency changes due to the implementation of specific technologies. such studies would need firm-specific data, including capital expenditures on it. references balakrishnan, r., linsmeier, t. j, & venkatachalam, m. (1996). financial benefits from j1t adoption. the accounting review, 71, 183-205. cochrane, w, w. (1958). farm prices: myth and reality. s1. paul: university of minne· sota press. demsetz, h. (1973). industry structure, market rivalry, and public policy. journal of law and economics. xvi (1), 1-9. discount merchandiser (1997). the true look: 1997 state of the industry report. 37 (6), 29-54. fioritio, s., may, e. g. & straughn, k. (1995). quick response in retailing: components and implementation. international journal of retail and distribution management, 23 (5), 12-21. hayashi. a. m. (1997). squeezing profits from it. datamation, 43 (7), 42-47. heard, e. (1994). quick response: technology or knowledge? industrial engineering, 26 (8), 28-30. johnson. j. (1999). bubble.com or valuing an internet company. management today, august, 60-63. kaufman, l. (2000, october 22). as biggest business, walmart propels changes elsewhere. new york times, 1. laderman, j. m. & smith, g. (1998). internet stocks: what's their real worth? business week, 12 (14), 120-124, 158 journal of business strategies vol. 18, no.2 mia, l. (2000). just-in-time manufacturing, management accounting systems and profitability. accounting and business research. 30 (2),137-151. sack, k. 1. (2000). retailing: general. standard & poor's industry surveys. 168 (21), 130. schwartz, e. s. & moon, m. (2000). rational pricing of internet companies. financial analysts journal. 56 (3), 62-75. selling t. l. & stickney, c. p. (1980). disaggregating the rate of return on common shareholders' equity: a new approach." accounting horizons, 4 (4), 9-17. simbari, d. j. (1996). competitive advantages. manufacturing systems, 14 (9), 92-96. sinha, i. (2000). cost transparency: the net's real threat to prices and brands. harvard business review, 78 (2),43-49. trueman, b., wong, f. m. h. & zhang, z. j. (2000). the eyeballs have it: searching for the value in internet stocks. working paper. haas school of business, university of california berkeley. tully, s. (2000). has the market gone mad? fortune, 141 (2), 80-84. walters, d. & laffy, d. (1996). managing retail productivity and profitability, london: macmillan press, ltd. richard skolnik (ph.d., rensselaer polytechnic institute) is an assistant professor of finance at the state university of new york at oswego. a chartered financial analyst, his current research examines the impact that operational factors have upon profitability. before academe, he worked for at&t as a market analyst in the international telecommunication group. in addition to a ph.d. in managerial economics, he has a m.s, in operations research and statistics. discount retail profitability: a harbinger for e-commerce? characieristics of boards of direcrors and perceptions of corporate social responsibility: an examination of me for1unb survey joseph l¥. hoft union pacific railroad co. st. louis, missouri j. david hunger charles b. shrader iowa state university ames, iowa introduction is there any relation between the composition of a corporation's board of directors and the corporation's level of social responsibility? in a recent article, hambrick and mason [6] propose that top management has a strong impact on organizational outcomes. specifically, they argue in favor of an ''upper echelons perspective" which states that strategic choices and organizational performance can be partially predicted by background characteristics and the composition of the top management team. this perspective is based on march and simon's [8] view that each decision maker brings his or her own set of "givens" to an administrative situation. thus, a person's cognitive base and values affect strategic choices and organizational performance through their impact on managerial perceptions. o'neill, saunders, and mccarthy [11, p. 5] note that research offers support for the upper echelons perspective for both top management and the board of directors. it is well accepted that chief executives have a strong impact on the strategic direction of their firms [2, p. 315]. in a survey of top investment analysts and money managers, for example, almost half responded that their personal evaluation of top management is worth 60% of their total evaluation of a company [12, pp. 35-36]. although boards of directors are only supposed to exercise a general corporate leadership role and not to involve themselves in day-to-day operations, an evolving research stream suggests that there is an indirect link between the composition and structure of the board of directors and company performance [16]. the trend to add more "outsiders" (people not employed by the corporation) to a corporation's board of directors reveals an implicit acceptance of the upper echelons perspective that boards can indirectly affect organizational performance [16]. the american law institute, for example, proposes that all corporations be required to have outside directors form a majority of the membership of their boards of directors. the securities and exchange commission requires corporations whose stock is listed on the new york stock exchange to have at least two outside directors. these outside directors are expected to staff the board's audit committee. the addition of outsiders to a board is thought by many to make top management more accountable to key stakeholders in the company's 78 journal of business strategies vol. 8, no.2 task environment [7]. the presence of outsiders on the board has also been found to improve the organization's ability to secure scarce resources from the environment [13]. consequently, there is increasing support to broaden the perspective of the board through "the addition of individuals with different backgrounds and experience, who would bring fresh perspectives and values to board decision-making" [3, p. 41]. a major role of the board is to provide guidance and direction relative to the demands of society placed on the firm [16]. in his call for refonning corporate governance, nader [10, p. 130] states that "the display of ethical behavior at its heights reflects the guiding hand of the people at the top who set the tone and direction." research by zahra and stanton [17] of 100 large united states companies reveals that a company's commitment to social responstbility (as evidenced by statements in its annual report) is related to board size as well as to outsider and minority representation on the board. their conclusion is that larger boards that are dominated by outsiders are more conducive to corporate social responsibility than are smaller boards with less outsiders. a study by o'neill, saunders, and mccarthy [11] comparing the responses by board members to a social responsibility questionnaire to board member characteristics reveals that a board member's orientation toward corporate social responsibility is related positively to his/her age and educational level and negatively to bislber financial stake in the company. in agreement with the previously mentioned zahra and stanton study, o'neill et a1. find that outside directors have a greater orientation toward corporate social responsibility (as measured by the selfreport measure) than do inside directors. the key variable may be the insider-outsider distinction since outsiders in the o'neill et al. study tended to have a higher educational level and owned less stock in the company than did insiders. these and other studies support the contention that the background characteristics of board members are related in some fashion to corporate social responsibility. both the zahra and stanton and the o'neill, saunders, and mccarthy studies are flawed, however, by their use of self-report measures of corporate social responsibility. such measures are susceptible to personal bias. o'neill et ai. admit this limitation by stating that "orientation toward corporate social responsiveness does not guarantee that the corporation will behave in a manner consistent with the orientation of the outside board members" [11, p. 21]. variables of the study this study attempts to add to the knowledge regarding boards of directors and corporate social responsibility and to deal with some of the limitations of previous studies. in line with the upper echelon perspective proposed by hambrick and mason, the study assumes that the characteristics of a corporation's board of directors have a definite, although indirect, impact upon a company's activities and performance. the following variables describing the board of directors are correlated with a measure of corporate social responsibility: (1) percentage of insiders on the board, (2) percentage of major stockholders on the board, (3) ceo (chief executive officer) or cob (chairman of the board) remuneration, (4) mean age of directors, (5) standard deviation of directors' ages, and (6) size of the board. fall 1991 hoft, hunger, & shrader: characteristics 79 percentage of insiders on the board as previously mentioned, the upper echelons perspective suggests that the background, values and cognitive ability of the individual board members greatly affect the agenda and strategic policies of the corporation. it is, therefore, assumed that those members on the board who are not insiders will bring different cognitive backgrounds and values with them to the board room. therefore, a firm with fewer insiders as a percentage of the board as a whole is likely to be more respodslble towards society and to direct the corporation toward socially iespons1ble actions. this reasoning is in line with previous studies by zahra and stanton, and o'neill, saunders, and mccarthy. percentage of mauor stockholders on the board it is assumed that board members who are also major stockholders in the corporation (owning over 1000 shares) will have goals and values leaning toward the increasing of earnings of the stockholders. therefore, they will not have corporate social responsibility as a main goal, and the board will, consequently, devote less attention to corporate social responsibility as the percentage of major owners on the board increases. in agreement with the findings of o'neill et al., we assume a negative correlation between cor" porate responsibility and the percentage of owners on the board. ceo/cob remuneration commitment to employees is a socially responsible action because employees have a large stake in the corporation. however, we believe that major officers in the corporation can be paid too much or too little. when the remuneration of a ceo or cob exceeds a certain point, then the act of distnbuting the salary is socially irresponsible since the money that goes to top management could be better used in other areas. we assume that the closer the ceo's or cob's salary is to the mean ceo or cob salary, the more that corporation is likely to be viewed as being generally socially responsible. mean age of directors in agreement with the o'neill, saunders, and mccarthy study, it is hypothesized that age should be related positively to social responsibility. older board members will likely have a great deal of managerial experience, and will probably seek more infonnation in decision making processes and tend to go beyond purely utilitarian concerns when confronting complex problems. standard deviation of directorst ages beginning with the assumption that diversity in backgrounds will be reflected in a diversity of perspectives on a board of directors, it is hypothesized that there is a positive relationship between corporate social responsibility and the standard deviation of directors' ages. differences in ages should reflect differences in experiences and should, thus, encourage more diverse perspectives on a complex situation. more diverse perspectives should create a richer discussion of problems and alternatives one more likely to consider non-financial side effects. 80 journal of business strategies vol. 8, no.2 size of the board in agreement with zahra and stanton, it is hypothesized that more socially responsible corporations have larger boards (in terms of number of members) than do less socially responsible corporations. the reasoning is similar to that regarding the standard deviation of directors' ages. the larger the board, the greater the number of perspectives on any given issue, and thus, the greater likelihood that non-financial questions will be dealt with in board discussions. corporate social responsibility findings from the zahra and stanton, and o'neill, saunders, and mccarthy studies are limited because of their use of self-report measures of social responsibility. this study, in contrast, uses the opinions of outside observers, which hopefully act as a more objective measure. data on corporate social responsibility were obtained from fortune magazine's annual survey of corporate reputations. published in january 1989, the survey measured 305 united states corporations in 32 industries. over 8,000 senior executives, outside directors, and financial analysts rated the ten (in some cases less than ten) largest corporations in their own industry on eight key attributes of reputation, using a scale of 0 (poor) to 10 (excellent). the attributes were: quality of management; quality of products or services; innovativeness; long-term investment value; financial soundness; ability to attract, develop, and keep talented people; community and environmental responsibility; and wise use of corporate assets. used previously in studies of corporate social responsibility and financial performance, the fortune ratings correlated well ~th other social responsibility measures thus, providing evidence for validity as well as with previous fortune ratings thus, providing evidence of reliability [9, pp. 860-861]. as pointed out by spencer and taylor [14], the advantage of this survey is that all the ratings were made by outside experts about firms in their own industry which should help to ensure that respondents have some knowledge of the activities of the firm they are rating, without being overly biased. other advantages of this survey are that it provides comparable data over an extended period and that the number of respondents is comparable or superior to those of other ratings [9]. although fortune's "community and environmental responsibility" rating does not incorporate all the many aspects of social responsibility as defined by carroll [4] and others, we feel that it does capture a key segment of a corporation's overall social responsibility. methodology of the study the fortune community and environmental responsibility rating was correlated with the six variables of the board of directors: percentage of insiders on the board, percentage of major stockholders on the board, ceo's or cob's remuneration, mean age of directors, standard deviation of director's ages, and size of the board. the infolmation on these variables was taken from the disclosure database. since the fortune survey took place from september 13, 1988 to november 1, 1988, the lists of board members elected for fall 1991 haft, hunger, & shrader: characteristics 81 coming terms in early 1988 and late 1987 were obtained, as well as infonnation needed for each corporation. information on all the variables for each corporation was only available in the database for 255 of the 305 corporations listed in the fortune survey. to check whether there was evidence that the missing corporations were not random i.e., the missing corporations might be socially irresponsible concerns, we compared the mean value of the fortune rating for our data with the mean value of the 305 corporations in the fortune survey. the mean score for the responsibility to the community and environment rating for our data set of 255 companies was 6.208 as compared to 6.142 for all 305 companies. a t-test revealed that there was no significant difference between the two means. data were collected on the six variables. the number of insiders on each board was divided by the number of members on the board to obtain the percentage of insiders on the board. the number of major stockholders on each board (those with more than 1,000 shares of ownership as listed by disclosure) was divided in the same manner to arrive at the percentage of major stockholders on the board. the ages were collected on all the members of each board and the mean age for each board of directors was tabulated. the standard deviations of the ages of the board members were also collected and tabulated. the number of board members was used as the size of the board the ceo's or cob's remuneration was also collected depending on which was higher (in many cases the ceo and cob were the same person). since we proposed that the more socially responsible the firm, the closer the ceo/cob remuneration should be to the mean average, we subtracted the mean of the ceo'slcob's remuneration for the 255 organizations collected from each corporation's ceo or cob salary. the resulting variable was named "n." we then squared this variable and named it 0 to generate a variable manifesting the total difference from the mean salary regardless of sign. the variables are named as follows: k = fortune's responsibility to the community and environment rating l = percentage of insiders on the board m = percentage of major stockholders on the board h = mean age of directors i = standard deviation of directors' ages n = ceo/cob salary mean ceo/cob salary o = n squared d = size of the board results of the study the correlation matrix resulting from the application of the statistical package for the social sciences (spss) on the variables k, 1." m, h, i, n, 0, and d is shown in exhibit 1. the matrix suggests a significant positive relationship between (k) the responsibility rating and (0) the size of the board (.1836), and a significant negative relationship with (1) the standard deviation of directors' ages (-.1794). as hypothesized, the larger the size of the board (0), the higher the responsibility of the finn (k). however, we expected 82 journal of business strategies vol. 8, no.2 (i) the standard deviation of directors' ages to also be positively correlated with (k.) s0cial responsibility, which was not the case. the correlations of (k) the responsibility rating with (h) the mean age of directors, (l) percentage of insiders, (m) percentage of owners (major stockholders), (n) ceo/cob salary minus the mean, and (0) the n squared variable were not significant. a significant positive correlation was found between (d) the size of the board and (n) ceo/cob salary minus the mean salary (.2198). thus, firms with larger boards tend to pay higher than average salaries to their chief executives. significant negative correlations were found between (ii) the mean age of directors and both (l) the percentage of insiders (-.2736) and (0) ceo/cob salary minus the average salary squared (-.1476). the first of these indicates that the higher the mean age of the directors, the lower the number of insiders as a percentage of total board membership. thus, boards with older members tend to have a greater percentage of outsiders than do younger aged boards. the negative correlation of (ii) the mean age of directors and (0) ceo/cob salary minus the average salary squared indicates that boards with older members tend to pay their chief executives closer to the mean average salary than do younger boards. a significant positive correlation was found between (l) the percentage of insiders on the board and (m) the percentage of major stockholders (.2174). this suggests that either many insiders on the boards are also major stockholders or that major stockholders on the boards tend to keep the number of outsiders on the boards to a minimum. the high positive relation (.6204) between (n) ceo/cob salary minus the mean salary and (0) n squared is basically as expected. conclusion this study found a significant positive relationship between the fortune ratings of a company's community and environmental responsibility and the size of its board of directors as well as a negative relationship between the ratings and the standard deviation of the directors' ages. in agreement with the z8hra and stanton study, a company's reputation for corporate social responsibility is related to board size. corporations with large boards tend to be perceived by others in their industry as more socially responsible. in contrast to both the z8hra and stanton, and o'neill, saunders, and mccarthy studies, the fortune rating was not significantly related to the percentage of insiders on the board the failure of this study to find this relationship may be less a fault of the study and more a result of the trend toward an increasing percentage of outsiders on the boards of most 1ajge u.s. corporations [15, pp. 61-62]. the percentage of outside directors on the boards of the 255 companies in this study is 74%. the insider-outsider distinction per se may no longer be relevant as a distinguishing characteristic of the boards of directors of 1ajge u.s. corporations. although this study failed to find a significant positive relationship between a company's social respodslbility and directors' age, as was found by o'neill et ai, it did find that age homogeneity was significantly related to a firm's responsibility rating. it is possible that age heterogeneity may create conflict on the board, thus preventing the consensus needed for a board to influence the corporation's social agenda. the failure of this study to find fall 1991 hoft, hunger, & shrader: characteristics 83 any significant relationship between the responsibility rating and the percentage of major stockholders on the board as was found by o'neill et at., is harder to explain. the percentage of board members who are major stockholders in this study is 46%. perhaps major stockholders do not focus only on economic returns as suggested by o'neill et al., but also consider longer~term social issues as well. major stockholders may be more concerned with the long-term success of their company and less with short-tum economic gain than are those who own less stock in the company. as with most research effortst some of our assumptions and decisions with regard to the inclusion of variables can be questioned. for example, we included two "age" measures one based on the mean, and the other on the standard deviation. this is a rather rough attempt to get a sense of board heterogeneity. the standard deviation of age a~ pears to be the better measure and should be included as part of more sophisticated composite measures of heterogeneity in future research. additionally, there may be many other board composition variables which affect social responsibility. studies adopting different measures such as educational level or interlocks might produce more illuminating findings. finally, our use of the fortune survey can be criticized because even though it is a survey of top management, it includes only one element of social responsibility, namely, community and environmental responsibility. indeed, social responsibility is more complex than this. future studies addressing the affect of board composition on social responsibility should use instruments which are based on more comprehensive models and which have tested reliability and validity such as the one developed by aupperle, carroll, and hatfield [1l. in conclusion, this research should prove useful to top executives and board chairmen who are charged with overseeing the corporate social responsibility of their firms. the findings of this study clearly suggest that firms with larger board membership are perceived to be more socially responsible. thus, directors and managers should consider adding members to their boards as part of developing socially relevant strategies. as firms are beed with increasingly complex environments and conflicting demands from constituent groups, the necessity for firms to be proactive with respect to social responsibilities will probably increase as well. if this pattern holds true, managers and directors can use the results of this study to structure their boards to more adequately respond to community and environmental demands. nevertheless, more work needs to be done on this topic to resolve some of the disagreements between this research and previous studies. references 1. aupperle, k.e., carroll, ab., and hatfield, j.d. "an empirical examination of the relationship between corporate social responsibility and profitability." academy of management journal, vol. 28 (june 1985), pp. 446-463. 2. beatty, r.p. and zajac, ej. "ceo change and firm performance in large corporations: succession effects and manager effects." strateldc management journal, vol. 7 (july~ august 1987), pp. 3os~317. 84 journal ofbusiness strategies vol. 8, no.2 3. blumberg, p.i. "who belongs on corporate boards?" business and society review, (spring 1983), pp. 40-47. 4. carroll, ab. "a three-dimensional conceptual model of corporate performance." academy of management review. vol. 4 (october 1979), pp. 497-505. 5. davenport, d. "america's most admired corporations." fortune, (january 30, 1989), pp. 68-94. 6. hambrick, d.c. and mason, pa ''upper echelons: the organization as a reflection of its top managers." academy of management review, vol. 9 (april 1984), pp. 193-206. 7. kesner, i.p. and johnson, r.b. "board room crisis: fiction or fact." academy of management executive, vol. 4 (february 1990), pp. 23-35. 8. march, j.g. and simon, ha organizations. new york: wiley and sons (1958). 9. mcguire, j.p., sundgren, a, and schneeweis, t. "corporate social responsibility and firm financial performance." academy of management journal vol. 31 (december 1988), pp. 854-872. 10. nader, r. "reforming corporate governance." california management review. (summer 1982), pp. 126-132. 11. o'neill, h.m., saunders, c., and mccarthy, a "the background characteristics of board members and their orientation toward corporate social responsiveness: an investigation from the upper echelons perspective." unpublished working paper (1988). 12. pincus, t.h. "a crisis parachute: helping stock prices have a soft landing." journal of business strategy, vol. 6 (spring 1986), pp. 32-38. 13. shrader, c.b., hoffman, an., and steams, t.m. "agency directors and network centrality: an examination of resource dependencies." journal of managerial issues, vol. 3 (spring 1991), pp. 46-61. 14. spencer, ba and taylor, g.s. "a within and between analysis of the relationship between corporate social responsibility and financial performance." akron business and economic review, (fall 1987), pp. 7-18. 15. wheelen, t.l. and 1.0. hunger. strategic management and business policy. 3rd edition (1989). reading, massachusetts: addison-wesley publishing company. 16. zahra, sa and ja pearce ii. "boards of directors and corporate financial performance: a review and integrative model." journal of management. vol. 15 (june 1989), pp. 291334. fall 1991 haft, hunger, & shrader: characteristics 85 17. zahra, sa and w.w. stanton. ''the implications of board of directors' composition for corporate strategy and performance." international journal of management, vol. 5 (june 1988), pp. 229-236. exhibit 1 coaelation matrix coaelations k d h i (rating) (size) (age) (s.d. of age) k (rating) 1.0000 .1836* -.0508 -.1794* d (size) .1836* 1.0000 .1218 -.0628 h (age) -.0508 .1218 1.0000 -jl943 i (s.d. of age) -.1794* -.0628 -.()943 1.0000 l (% insiders) .1342 -.0446 -.2736** .1385 m (% owners) .1006 -.0638 -.0221 .1089 n (s-mean) .1260 .2198** -.0045 -.0354 o (s-mean)2 -.1042 -.0459 -.1476* .0731 coaelatiods l m n 0 (% insiders) (% owners) ($-mean) ($-mean)2 k (rating) .1342 .1006 .1260 -.1042 d (size) -.0446 -.0638 .2198** -.0459 h (age) .2736** -.0221 -.0045 -.1476* i (s.d. of age) .1385 .1089 -.0354 .0731 l (% insiders) 1.0000 .2174** .0141 .1009 m (% owners) .2174** 1.0000 .0854 -.0193 n (s-mean) .0141 .0854 1.0000 .6204** o (s-mean)2 .1009 -.0193 .6204** 1.0000 n of cases: 255 i-tailed significant *p less than .01 **p less than .001 characteristics of boards of directors and preceptions of corporate social responsibility: an examination of the fortune survey an exploratory study of the link between strategic types and quality implementation terry l. obert barbara a. spencer mississippi state university mississippi state, ms abstract this paper explores the relationship between strategy and quality. by drawing on contingency theory and the resource-based view of strategy. we demonstrate conceptual linkages among the two concepts. then, based on these views, we hypothesize that the use of recognized quality management practices will vary across strategy types. results of our empirical analysis show clear support for this hypothesis. in other words, there is no "one best way" to implement quality management in organizations. introduction the strategic implications of quality and quality management practices are gaining recognition. many organizations have found that quality management can enhance their ability to compete in the marketplace (anderson, rungtusanatham, and schroeder 1994). as a result, managers often include practices such as quality planning and continuous quality improvement as part of their strategy formulation process (pfau 1989). according to dean and bowen (1994), some quality advocates even suggest that quality management should replace strategy. the argument is that continuous quality improvement is all that is needed to create satisfied customers. dean and bowen are wary of this view, however, pointing out that high quality by itself may not insure competitive success. even if customer needs are accurately identified, and organizational processes enhanced, an advantage created in the marketplace will not be sustaina..ble unless the resulting product or service attributes are unique, valuable, and difficult to imitate (barney 1991). a sound strategy, therefore, both complements and directs quality efforts by ensuring that customer needs are served in ways that competitors cannot duplicate. hofer and schendel (1978) define strategy as the match an organization makes between its internal resources and skills and the opportunities and risks created by its external environment. based on this definition, it seems clear that quality management practices can support strategy by improving skills and 90 journal of business strategies vol. 13, no. 1 developing resources that allow the firm to take advantage of opportunities and avoid risks. moreover, as the quality of processes and outputs improves in the long run, new opportunities and eventually new strategies are likely to emerge. it follows that a link should exist between strategy and quality management practices in organizations. in other words, companies pursuing different strategies should emphasize different quality management practices. firms stressing innovation, for example, are likely to implement different quality practices than those emphasizing efficiency and low cost. moreover, some strategies may require greater attention to quality overall than do others. in other words, there is no reason to believe that quality management is appropriate for every organization, or that it will look the same for every organization. the purpose of this paper, therefore, is to investigate the relationship between strategy and quality management practices. it must be noted that this is a study of quality improvement processes, not quality output content. we define quality management practices as those specific activities and techniques that managers implement to improve the way things are done throughout the organization. examples range from training employees to building supplier relationships. specifically, we hypothesize that the use of specific quality management practices will vary across strategy types. because our data were collected at one point in time, we did not attempt to address causality issues here. we cannot say for sure whether strategy dictates selection of quality methods or whether quality practices influence selection of strategy. our aim in this study is only to link the two constructs. our underlying assumption, however, is that quality practices both support the implementation of a given strategy and help shape the choice of new strategy as follows: current strategy choice of qualitymanagement practices potential newstrategy the strategy-quality connection the "best practices report" prepared by the american quality foundation in cooperation with ernst & young noted that "part of the current skepticism about the quality movement stems from its underlying premise that the same set of management practices can be effective for all organizations" (1992: 7). according to this report, it is this reliance on supposedly "universally beneficial" practices which helps to explain the mixed results gained by many organizations in implementing total quality management. in other words, the "one best way" model does not work any better for quality than it has for other management concepts throughout history. spring 1996 obert & spencer: strategic types 91 laza and wheaton (1990) adopt this theme when they note that a common error in implementing quality programs is the failure to recognize that every company, and every environment, is different. they recommend that specific quality practices be matched to the "'organizational context, or more specifically, to strategy. chorn (1991) also suggests that quality management techniques, like other implementation procedures, are contingent on strategy. he contends that total quality management methods should be very useful for strategies emphasizing incremental or evolutionary refinements of organizational products and processes but less applicable to fast-moving organizations whose strategies require risk-taking, creativity, or quantum changes in short periods of time. similarly, krishnan, shani, grant, and baer (1993) state that quality management programs are likely to be most effective when a company in a stable strategic position wishes to enhance its competitive position through long tenn improvements in product perfonnance and customer satisfaction. they predict that quality programs will be less beneficial for companies whose strategies involve radical restructuring or competitive repositioning. in general, this work reflects a contingency view in which quality management techniques support the chosen strategy. a change in strategy calls for a change in the quality practices utilized and perhaps even in the degree of emphasis placed on quality management throughout the organization. a somewhat different view of the strategy/quality relationship can be drawn from the resource-based theory of competitive advantage. grant (1991) argues that an organization's resources and capabilities serve as the foundation for its strategy. resources are basic inputs to the production process ranging from employee skills to brand names. a capability is the capacity to perfonn some task or activity. capabilities are built from resources and yield competitive advantage. strategies, in turn, should be built around competitive advantage. belohlav (1993a, 1993b) explains how high quality influences competitive position which, in turn, opens a new range of strategic options to the company. by implementing quality practices, a finn may develop new skills or capabilities which lead to the development of new strategies. prahalad and hamel (1990) use the tenn "core competencies" to describe these central, strategic capabilities. by developing unique capabilities over time, a finn gains the capacity to adopt new and different strategies. spitzer (1993) also reflects this view when he describes tqm as the only source of competitive advantage. drawing on work by feeny and ives (1990), spitzer shows how quality management can help a company build generic lead time, leverage competitive asymmetries, and create preemption potential, all of which are crucial to sustainable competitive advantage. the implication is that quality management can create these sources of competitive advantage and that companies should build strategies around them (spitzer 1993: 61). in summary, both contingency theory and the resource-based view offer explanations for a linkage between strategy and quality in organizations. in the 92 journal of business strategies vol. 13, no. 1 former case, strategy dictates particular quality practices and in the latter, improved quality processes and outputs enable new strategic choices. combining the two approaches suggests that the relationship between strategy and quality management may be a reciprocal one. that is, at time a, the choice of appropriate quality management techniques may be influenced by company strategy. at time b, however, the improvement of products and processes may generate new capabilities that allow modification of the strategy in ways that yield greater performance results. whatever the causality, it seems clear that we can expect to find a link between strategy and quality management techniques. thus we hypothesize that at a given point in time, organizations following different competitive strategies will utilize different combinations of quality management methods. method operationalization of concepts strategy types; miles and snow's (1978) well-known strategic typology identifies four primary strategy types: prospectors, defenders, analyzers, and reactors. prospectors are entrepreneurial firms whose managers actively seek new opportunities in the marketplace, are willing to take risks and develop new innovative businesses, and who don't mind trading off efficiency for growth. defenders, in contrast, stress efficiency with tightly organized firms focused on a narrow market niche. they emphasize the engineering aspects of production and pay close attention to the bottom line. because defenders abhor risk, they tend to lag behind industry competitors in innovations seeking only proven opportunities in their area of expertise. analyzers blend elements of both prospector and defender strategies and so are able to focus on efficiency and productivity when the market is stable or on scanning and innovation when the market is turbulent. these organizations balance risks and returns by following other firms (usually prospectors) into new markets and improving on their technological advances. although they sometimes move from stable markets to dynamic ones, they do so with foresight. reactors, on the other hand, have no clear strategic orientation. as their name implies, they tend to react to environmental trends and as a result, often find themselves in crisis. their behaviors are unstable and their decisions are oriented toward the short versus the long term. our choice of this typology to operationalize the strategic context of organizations was based on its assumption that relatively enduring links exist among strategy, structure, and process variables. prior research (cf., conant, mokwa and varadarajan 1990; snow and hrebiniak 1980; smith, guthrie and chen 1986) has linked the first three strategy types with consistent responses to environmental challenges and hence good performance. reactors, however, respond uncertainly or inappropriately and are generally linked with poor performance. to measure strategic type, we followed procedures prescribed by conant, mokwa and varadarajan (1990). these authors developed a multi-item scale spring 1996 obert & spencer: strategic types 93 based on the strategic dimensions associated with the miles and snow (1978) typology. this instrument, which identifies respondents as prospectors, defenders, analyzers, or reactors, is contained in appendix a. these questions were developed using a panel of organization theory and strategy researchers. questions and response options were revised iteratively until the entire panel agreed that each question and response option accurately measured the intended strategic type. conant et al. (1990) field-tested the instrument along with snow and hrebiniak's (1980) paragraph approach to operationalizing the miles and snow (1978) strategic typology. this dual use allowed them to compare the classifications made by each instrument. they followed a test-retest procedure on 102 of their respondents and found that the percentage of organizations classified similarly during the initial test and then during the retest for the paragraph approach and the multi-item instrument was 0.75 and 0.74, respectively. the reliability coefficients for the multi-item scale ranged from 0.56 to 0.82, with a mean reliability of 0.69. although conant et al. (1990) acknowledged that their multi-item measure is still in need of additional refinement, the results of the initial field test of the instrument are deemed strong enough to warrant its use in this study. quality management practices: quality as an output is distinct from those processes used internally to create it. as noted earlier, this research emphasizes quality management practices such as employee training and relationships with suppliers. saraph, benson and schroeder (1989) identified eight critical factors of quality management at the business unit level. in this study, we used six of these dimensions to measure the degree of quality implementation within a company. these included: role of top management and quality policy, quality training, product/service designs, supplier quality management, quality data and reporting, and employee relations. the other two dimensions, role of the quality department and process management/operating procedures, were not used both to reduce the length of the questionnaire and to make it more applicable to service as well as manufacturing companies. for each question, respondents were asked to indicate the extent or degree of current practice within their organization using the scale: very low (1), low (2), medium (3), high (4), very high (5), and unable to judge .(6). appendix b provides a list of the questions asked and the dimensions those questions represented. eleven demo graphical questions were also asked, determined in part by the work of benson, saraph, and schroeder (1991) who found that the size of the company responding, the type of the company, and the position in the company held by the respondent all influence quality management. questions about downsizing, annual turnover, and whether or not the company had experienced any change in market share over the last two years were asked and are shown in appendix c. 94 journal of business strategies data collection and analysis vol. 13, no. i a five page, 73-item survey was sent to 2084 finns randomly selected from the compustat data base. selections were made from companies traded on the new york stock exchange, the american stock exchange, overthe-counter, the regional stock exchange, and the non-nasdaq using a randomization algorithm. no attempt was made to limit the sample by company size, type (le., service or manufacturing), or location. the sample contained at least one company from all fifty states except alaska and 165 companies located outside the u.s. self-reported measures of strategic type, quality management implementation, and company demographics were collected from each company representative. responses were first categorized by strategy type based on a majority-rule decision. following conant et al. (1990), ties between defender, prospector and/or analyzer responses were resolved by designating the respondent as an analyzer, which is considered a hybrid of the other two. ties with reactor responses resulted in the respondent being categorized as a reactor since they are typically inconsistent in their responses and could exhibit some tendencies of all four types. items from the quality management section were grouped into scales representing six of saraph et al.'s (1989) quality dimensions. cronbach's (1951) alpha was calculated for each dimension, and all values were .80 or higher indicating a high degree of internal consistency in this application of the instrument. mean scores generated for each dimension represented the extent of each separate quality management practice. in order to investigate the proposition that perceptions of the current practice of quality management in the company will differ by strategic type, analysis of variance and mean comparisons were perfonned on each quality dimension by strategic type, with and without controlling for company type, size, and position in the company held by the respondent. results responses were received from 64 companies, with an additional 27 questionnaires returned as nondeliverable. because the questionnaire was lengthy, the low response rate was not unexpected. we did not test for nonresponse bias, but we did note that the companies from which respondents returned surveys were small to mid-sized and were split between manufacturing and service. they represented almost every state and three foreign countries. finally, they had predominantly experienced an increase in market share and employed quality professionals as a consulting resource. when the responses were scored by strategic type, one questionnaire could not be used which reduced the sample size to 63. additionally, when the 51 questions on quality implementation were reviewed, one respondent answered spring 1996 obert & spencer: strategic types 95 too few of the questions for the survey to be used, resulting in a final sample size of 62. of these, 21 were categorized as prospectors, 20 were categorized as analyzers, 11 were categorized as reactors, and 10 were categorized as defenders. to get an initial view of the extent of quality management practiced by the sample firms, the 51 questions in the quality implementation survey were averaged for each respondent and then an overall average was calculated for each strategic type. these results are in table 1, from which it can be seen that analyzers perceive the current extent of quality implementation within their company to be moderate to high, prospectors and defenders perceive it to be moderate, and reactors perceive it as low to moderate. since reactors are generally linked with poor performance and an orientation for short-term, stopgap solutions, it is not surprising that these companies have less well-developed quality policies in place than the others. table 1 averages among strategic types for responses to all 51 questions on the quality implementation survey strategic type n mean standard deviation analyzer 20 3.49 .51 prospector 21 3.20 .47 defender 10 3.02 .53 reactor 11 2.82 .47 degree of implementation in your company: very low (1), low (2), medium (3), high (4), very high (5) to examine whether or not the four strategic types differed in their responses to each separate quality dimension, an analysis of variance was performed using a randomized block design where the questions comprising a dimension were the blocks. company size, type of company, and position held in the company by the respondent were not part of this model which only examined whether or not there were significant differences among strategic types for each dimension. the f and p-values for these analyses are given in table 2 and support the premise of significant differences among strategic types across all six critical dimensions of quality management. table 3 displays the f and p-values for the model with company size, type of company, and position of the respondent as well as strategic type. for this model, only strategic type and type of company had a significant effect on the average quality score which was obtained by averaging responses across all 51 questions without regard to the six separate quality dimensions. 96 journal of business strategies vol. 13, no.1 table 2 significance of differences among the strategic types for the six dimensions on the quality implementation survey quality dimension f value p-value 1. role of top management 16.71 .0001 2. training 29.94 .0001 3. product/service design 12.86 .0002 4. supplier quality management 10.81 .0002 5. quality data and reporting 12.89 .0001 6. employee relations 12.94 .0001 table 3 effects of strategic type, type of company, size of the company, and position held by respondent on average quality score source f value p-value strategic type type of company size of the company position of the respondent *significant at .10 or less 2.73 5.17 0.04 1.92 .0531 * .0090* .9899 .1713 the results in table 3 suggest that a model using strategic type as the independent variable and type of company as a covariate should be chosen to investigate differences in responses for the four strategic types for each of the six quality dimensions. subsequently, significant differences among strategic types were obtained and least squares means were used to conduct pairwise comparisons tests. these results are displayed in table 4. table 4 differences among strategic types controlling for type of company analyzer prospector defender reactor role of top management a b b b training abe b,e product/service design a b,e a,b e supplier quality management a a b b quality data and reporting a a a,b b employee relations a,b b e a strategic types with the same letter are not statistically significantly different at the .05 level spring 1996 obert & spencer: strategic types 97 for the dimensions of training and the role of top management, analyzers have a significantly different view than the others. the analyzers reported a higher level of acceptance of responsibility for quality and support for quality performance by the top management of their company. they also perceive the level of quality-related training as being higher in their company than the other respondents did. these results support the findings of miles and snow (1978) who characterized analyzers as prone to forming planning staffs, and making comprehensive plans. perhaps respondents from analyzer firms view quality-related training as the first step toward employee quality performance. all four strategic types had similar views on product/service design. in terms of supplier quality management, analyzers and prospectors are more likely to involve the supplier in their product development process and select a supplier on the basis of quality than reactors and defenders are. all four strategic types perceive the degree of the collection and analysis/use of quality data as a tool for managing product quality in their companies as moderate at best. this finding was consistent with views expressed by baldridge examiner george easton who noted that quality data is generally not well organized to support quality management in u.s. firms (easton, 1993). with regard to the role employees are expected to play in quality management, reactors show the most empowerment of employees while defenders seem the least inclined to pass the quality responsibility directly to the employees. this lack of delegation is quite consistent with the mechanistic, highly centralized management style typically associated with defender organizations. it seems from this data that our defenders still believe that quality can be "managed" into a product. conclusions the majority of the respondents (78%) were ceos, directors, presidents, or vice presidents of the company. it would seem a reasonable assumption that these respondents have a strong hand in the policies implemented by the company. therefore, based on the results presented here, companies guided by analyzers are most likely to implement quality policies and practices while reactors are the least likely to implement them. generally prospectors and defenders will fall somewhere in the middle, although they will more often resemble analyzers than reactors. these results were quite consistent with our understanding of activities and behaviors typically associated with miles and snow's (1978) strategic types. the analyzers in this sample, for example, reported the most emphasis on quality management overall. in an attempt to balance stability and change, this strategy type tends to emphasize planning, coordinating and learning: they move into new markets only after their viability has been demonstrated; they use mechanisms such as cross functional teams as a normal part of daily op98 journal of business strategies vol. 13, no. 1 erations. hence it makes sense that their managers are willing to support the up-front preparation and training necessary to put quality programs in place. as spitzer (1993) points out, it takes a long time to bring quality initiatives on line, and analyzers, with their emphasis on both effectiveness and efficiency, may have the foresight and capability to see it through. defenders, on the other hand, are motivated to keep costs down. training costs money-as a result, they invest in less training than any other strategy type. in addition, they are highly centralized. as a result, we saw little use of employee empowerment among the defenders in our sample. our finding that prospectors did not place a great deal of emphasis on quality practices also has support in the literature. both chorn (1991) and krishnan et al. (1993) posited that quality practices would be inconsistent with strategies based on rapid change and repositioning. as a whole, these results clearly support the central hypothesis of this research; that is, in our sample at least, there is a significant relationship between strategy type and quality management approach. this relationship manifested itself despite our small sample size and the low power of our statistical tests. certainly, we can make no comments concerning the generalizability of our findings, but they suggest intriguing possibilities for future study. the causal nature of this linkage remains open to interpretation. the typology we used here assumes organizations to be characterized by enduring patterns of adaptive behavior. the introduction of quality management processes could represent a reinforcement of the pattern, or could lead to the initiation of a new pattern. strategic contingency theory would suggest the former; the resource based approach appears to assume the opposite. both theories support the alignment between strategy and quality management processes at a given point in time. future research should use a longitudinal approach to examine whether quality management precedes or follows strategic change. in addition, the effects of other changes should be studied. for example, what happens to the alignment between strategy and quality when companies experience growth and decline? how does this relationship affect performance? dean and bowen (1994) suggest that both conceptual and empirical work is needed to sort out differences among the various total quality and management theory positions on the role of quality and strategy. this paper has attempted to make preliminary progress on both fronts, first by tracing the linkages between quality and strategy based on the strategy literature, and second, by examining data from a sample of diverse organizations. given our results, we suggest that the challenge to researchers is to continue this research stream in new contexts and with different methods. the challenge to practitioners is to ensure that their choice of quality management practices both supports current strategic efforts and enhances future strategic changes. at a minimum, practitioners should look at pre-packaged quality programs and standardized applications of quality techniques with skepticism. there is spring 1996 obert & spencer: strategic types 99 no "one best way" to implement quality management. we contend that a well thought out strategy must drive the development and application of quality practices throughout the organization. managers may want to begin by improving processes and implementing practices that enhance the firm's ability to satisfy customer needs, while also protecting it from imitation by competitors. over time, as new skills are learned and new capabilities developed, new opportunities may emerge and new strategies may be enabled. references anderson, lc., m. rungtusanatham, and rg. shroeder. "a theory of quality management underlying the deming management method." academy of mana~ement journal 19(3) (1994): 446-471. barney, j.b. "firm resources and sustained competitive advantage." journal of mana~ement 17(1) (1991): 99-120. belohlav, j.a. "developing the quality organization." quality press 26(10) (1993a): 119-122. belohlav, j.a. "quality, strategy and competitiveness." california mana~ement review 35(3) (1993b): 55-67. benson, g.p., ly. saraph, and rg. schroeder. ''the effects of organizational context on quality management: an empirical investigation." mana~ement science 37(9), (september 1991): 1107-1124. chorn, n.h. "total quality management: panacea or pitfa1l?" internatjonal journal of physical distribution and lo~istics mana2ement 21(8) (1991): 31-35. conant, j.s., m.p. mokwa, and r varadarajan. "strategic types, distinctive marketing competencies and organizational performance: a multiple measures-based study." strate~jc mana~ement journal 11 (5), (september 1990): 365-383. dean, j.w., jr. and d.e. bowen. "management theory and total quality: improving research and practice through theory development." academy of mana~ement journal 19(3) (1994): 392-418. easton, g.s. "the 1993 state of u.s. total quality management: a baldridge examiner's perspective." californja mana~ement revjew 34(3) (1993): 32-54. ernst & young and the american quality foundation. best practices report. new york: ernst & young, 1992. feeny, d.e and b. ives. "in search qf sustainability: reaping long-term advantage from investments in information technology." journal of mana2ement and information systems 7(1) (1990). 100 journal of business strategies vol. 13, no. 1 grant, r.m. "the resource-based theory of competitive advantage." california manajiement review (spring 1991): 114-135. hofer, c.w. and d. schendel. strate~y formulation:analytic concepts. s1. paul: west, 1978, pp. 12. krishnan, r., a.b. shani, rm. grant, and r baer. "in search of quality improvement: problems of design and implementation." academy of management executive 7(4) (1993): 720. laza, rw. and p.l. wheaton. "recognizing the pitfalls of total quality management." public utilities fortnightly (april 1990): 17-21. miles, rand c. snow. organizational strategy, structure and process. new york: mcgraw-hill, 1978. pfau, l.d. "total quality management gives companies a way to enhance position in global marketplace." industrial engineering 21 (4), (april 1989): 17-21. prahalad, c.k. and g. hamel. "the core competence of the corporation." the harvard business review (may-june 1990): 79-91. saraph, j.v., g.p. benson, and rg. schroeder. "an instrument for measuring the critical factors of quality management." decision sciences 20(4), (fall 1989): 810-829. smith, k.g., j.p. guthrie, and m. chen. "miles and snow's typology of strategy, organizational size and organizational performance." academy of management review 5(4), (october 1986): 527-538. snow, c.c. and l.g. hrebiniak. "strategy, distinctive competence, and organizational performance." administrative science ouarterly 25(2), (june 1980): 317-336. spitzer, r.d. "tqm: the only source of sustainable competitive advantage." ouality progress (june 1993): pp. 59-64. spring 1996 obert & spencer: strategic types appendix a strategic type instrument 101 directions: please read the following eleven questions carefully. for each one, select the answer that best describes your organization and circle the letter for that answer. 1. in comparison to our competitors, the products/services which we provide to our customers are best characterized as: a. products/services which are more innovative, continually changing and broader in nature throughout the organization and marketplace. (p) b. products/services which are fairly stable in certain units/departments and markets while innovative in other units/departments and markets. (a) c. products/services which are wen focused, relatively stable and consistently defined throughout the organization and marketplace. (d) d. products/services which are in a state of transition, and largely based on responding to opportunities or threats from the marketplace or environment. (r) 2. in contrast to our competitors, our organization has an image in the marketplace as a company which: a. offers fewer, selective products/services which are high in quality. (0) b. adopts new ideas and innovations, but only after careful analysis. (a) c. reacts to opportunities or threats in the marketplace to maintain or enhance our position. (r) d. has a reputation for being innovative and creative. (p) 3. the amount of time my company spends on monitoring changes and trends in the marketplace can best be described as: a. lengthy: we are continuously monitoring the marketplace. (p) b. minimal: we really don't spend much time monitoring the marketplace. (d) c. average: we spend a reasonable amount of time monitoring the marketplace. (a) d. sporadic: we sometimes spend a great deal of time and at other times spend little time monitoring the marketplace. (r) 4. in comparison to our competitors, the increases or losses in demand which we have experienced are due most probably to: a. our practice of concentrating on more fully developing those markets which we currently serve. (d) b. our practice of responding to the pressures of the marketplace by taking few risks. (r) c. our practice of aggressively entering into new markets with new types of product/service offerings. (p) d. our practice of assertively penetrating more deeply into markets we currently serve, while adopting new products/services only after a very careful review of their potential. (a) 102 journal of business strategies vol. 13, no. 1 5. one of the most important goals in my company, in comparison to our competitors, is our dedication and commitment to: a. keep costs under control. (0) b. analyze our costs and revenues carefully, to keep costs under control and to selectively generate new products/services or enter new markets. (a) c. insure that the people, resources and equipment required to develop new products/services and new markets are available and accessible. (p) d. make sure that we guard against critical threats by taking whatever action is necessary. (r) 6., in contrast to our competitors, the competencies (skills) which our managerial employees possess can best be characterized as: a. analytical: their skills enable them to both identify trends and then develop new product/service offerings or markets. (a) b. specialized: their skills are concentrated into one, or a few, specific areas. (0) c. broad and entrepreneurial: their skills are diverse, flexible, and enable change to be created. (p) d. fluid: their skills are related to the near-term demands of the marketplace. (r) 7. the one thing that protects our organization from our competitors is that we: a. are able to carefully analyze emerging trend and adopt only those which have proven potential. (a) b. are able to do a limited number of things exceptionally well. (0) c. are able to respond to trends even though they may possess only moderate potential as they arise. (r) d. are able to consistently develop new products/services and new markets. (p) 8. more so than many of our competitors, our management staff tends to concentrate on: a. maintaining a secure financial position through cost and quality control measures. (0) b. analyzing opportunities in the marketplace and selecting only those opportunities with proven potential, while protecting a secure financial position. (a) c. activities or business functions which most need attention given the opportunities or problems we currently confront. (r) d. developing new products/services and expanding into new markets or market segments. (p) 9. in contrast to many of our competitors, our organization prepares for the future by: a. identifying the best possible solutions to those problems or challenges which require immediate attention. (r) b. identifying trends and opportunities in the marketplace which can result in the creation of product/service offerings which are new to the industry or which reach new markets. (p) spring 1996 obert & spencer: strategic types 103 c. identifying those problems which, if solved, will maintain and then improve our current product/service offerings and market position. (d) d. identifying those trends in the industry which our competitors have proven possess long-term potential while also solving problems related to our current product/service offerings and our current customers' needs. (a) 10. in comparison to our competitors, the structure of our organization is: a. functional in nature (le., organized by department-marketing, accounting, personnel, etc.). (d) b. product/service or market oriented (le., individual units/departments have marketing or accounting responsibilities). (p) c. primarily functional (departmental) in nature; however, a product/service or market oriented structure does exist in newer or larger product/service offering areas. (a) d. continually changing to enable us to meet opportunities and solve problems as they arise. (r) 11. unlike many other similar companies, the procedures our organization uses to evaluate our performance are best described as: a. decentralized and participatory encouraging many organizational members to be involved. (p) b. heavily oriented toward those reporting requirements which demand immediate attention. (r) c. highly centralized and primarily the responsibility of senior management. (d) d. centralized in more established product/service areas and more participatory in newer product/service areas. (a) appendix b dimensions measured and questions asked by the quality implementation survey degree of implementation within your company: very low (1), low (2), medium (3), high (4), very high (5), unable to judge (6) dimension i: role of top management and quality policy i. extent to which the top executive assumes responsibility for quality performance. 2. acceptance of responsibility for quality by major department heads. 3. degree to which top management (top management executive and major department heads) is evaluated for quality performance. 4. extent to which the top management supports long-term quality improvement process. 5. degree of participation by major department heads in the quality improvement process. 6. extent to which the top management has objectives for quality performance. 7. specificity of quality goals within the company. 8. comprehensiveness of the goal-setting process for quality in the company. 9. extent to which quality goals and policy are understood within the company. 104 journal of business strategies vol. 13, no. 1 to. importance attached to quality by the top management in relation to cost and schedule objectives. ii. amount of review of quality issues in top management meetings. 12. degree to which the top management considers quality improvement as a way to increase profits. 13. degree of comprehensiveness of the quality plan within the company. dimension 2: training 14. specific work-skills training (technical and vocational) given to hourly employees throughout the company. 15. quality-related training given to hourly employees throughout the company. 16. quality-related training given to managers and supervisors throughout the company. 17. training in the "total quality concept" (le., philosophy of company-wide responsibility for quality) throughout the company. 18. training in the basic statistical techniques (such as histograms and control charts) in the company as a whole. 19. training in advanced statistical techniques (such as design of experiments and regression analysis) in the company as a whole. 20. commitment of the top management to employee training. 21. availability of resources for employee training in the company. dimension 3: product/service design 22. thoroughness of the new product/service reviews before the product/service is produced and marketed. 23. coordination among affected departments in the product/service development process. 24. quality of new products/services emphasized in relation to cost or schedule objectives. 25. clarity of product/service specifications and procedures. 26. extent to which implementationlproducibility is considered in the product/service design process. 27. quality emphasis by sales, customer service, marketing, and pr personnel. dimension 4: supplier quality management (supplier of goods and/or services) 28. extent to which suppliers are selected based on quality rather than price or schedule. 29. thoroughness of the supplier rating system. 30. reliance on reasonably few dependable suppliers. 31. amount of education of supplier by company. 32. technical assistance provided to the suppliers. 33. involvement of the supplier in the product development process. 34. extent to which longer-term relationships are offered to suppliers. 35. clarity of specifications provided to suppliers. dimension 5: quality data and reporting 36. availability of cost of quality data in the company. 37. availability of quality data (error rates, defect rates, scrap, etc.). spring 1996 obert & spencer: strategic types 105 38. timeliness of the quality data. 39. extent to which quality data are available to hourly employees. 40. extent to which quality data are available to managers and supervisors. 41. extent to which quality data are used to evaluate supervisor and managerial performance. 42. extent to which quality data, control charts, etc., are displayed at employee work stations. dimension 6: employee relations 43. extent to which quality circle or employee involvement type programs are implemented in the company. 44. effectiveness of quality circle or employee involvement type programs in the company. 45. extent to which employees are held responsible for error-free output. 46. amount of feedback provided to employees on their quality performance. 47. degree of participation in quality decisions by hourly/nonsupervisory employees. 48. extent to which quality awareness building among employees is ongoing. 49. extent to which employees are recognized for superior quality performance. 50. effectiveness of supervisors in solving problems/issues. appendix c demographics ouestion i. company size: under 1000 employees 1000-5000 employees 5000-10,000 employees more than 10,000 employees 2. company type: service manufacturing other 3. employees are unionized: yes no 4. utilized quality professionals as consultants: yes no 5. applied for a quality award: yes no 6. marketshare may 91-may 93: increased slight loss significant loss percent 42.2 28.1 1.6 28.1 29.7 53.1 17.2 68.7 73.4 68.7 29.7 14.8 85.2 70.3 18.8 4.7 106 journal of business strategies vol. 13, no. 1 7. reduction in force may 91-may 93: yes no 8. position held by respondent: ceo directors presidentivp others 9. average percentage annual thrnover: hourly 10. average percentage annual thrnover: salaried 34.4 65.6 23.0 25.0 30.0 22.0 6.2 6.0 11. states represented: ar, az, ca, co, ct, fl, ga, la, id, 10, il, in, ma, mi, mn, ms, nc, nh, nj, nv, ny, oh, or, pa, sc, so, tn, tx, wa, wi an exploratory study of the link between strategic types and quality implementation incorporating the natural environment in corporate strategy: a stakeholder approach michael jay polonsky university of newcastle newcastle, australia abstract developing corporate strategies dealing with the natural environment requires that the organisation take into consideration a number of internal and external stakeholders. whilst most firms understand this need, most do not have a process for examining the relevant stakeholders and including them in the environmental strategy development process. this paper discusses how firms can use the stakeholder management process to identify important environmental stakeholders. it also discusses how firms can use an expanded version of the stakeholder strategy matrix to incorporate stakeholders into the environmental strategy development process. utilising these tools would allow firms to develop more effective strategies to deal with the natural environment, thus reducing their vulnerability to external shocks caused by "unsatisfied" stakeholders. introduction the growing importance of the firm's interaction with the natural environment has received an increasing amount of interest in the academic and practitioner press. for example, one study of the top 50 uk organisations reported that 78% of chief executive officers (ceo) believed green issues were important to organisations' present activities, 82% indicated that green issues would be important in the future [peattie and ring 1993]. in attempting to develop strategies to address the firm-natural environment interface, firms need to realise they are responsible to numerous internal and external stakeholder groups [winter and legerwood 1994]. a broad range of groups' are pressuring firms to behave in a more environmentally "responsible" fashion, these include: consumers [ottman 1993, vandermere and oliff 1991, vaughan et. al. 1994]; governmental bodies [spearot 1991, davis 1992]; competitors [shearer 1990, taylor 1992, mcdaniel and rylander 1993]; environmental groups [anonymous 1991, westley and vredenburg 1991]; and shareholders [copulsky 1991, thomlison 1992]. given that stakeholder group's often have competing objectives, completely satisfying all stakeholders with one set of environmental strategies may be difficult, if not impossible [lerner and fryxell 1994]. in many cases achieving one group's objectives will result in another group being disappointed. therefore any strategic process that reduces conflict between the organisation and its stakeholders would be 152 journal of business strategies vol. 12, no.2 extremely beneficial, one such strategic process is the stakeholder management process. there is extensive management literature examining stakeholder theory [donaldson and preston 1995, lerner and fryxell 1994, the toronto conference 1994]. though the stakeholder management process can be used as a strategic planning tool to incorporate the concerns of stakeholders in relation to any strategic issue, there has been little examination as to how stakeholders can be or have been integrated into corporate environmental strategy development, or any strategy development process for that matter. there are some examples in the literature relating to strategies that can be used to include stakeholders in specific situations [aggarwal and chandra 1990, maranville 1989], though these papers fail to develop a generalisable stakeholder process. this paper will attempt to address the issue of how organisations can integrate stakeholders into corporate strategy dealing with the natural environmental (hereafter identified as corporate environmental strategy). while the same basic process can be applied to other strategic issues, it could be argued that few other issues involve the same degree of involvement from such a diverse range of stakeholders. therefore the stakeholder management process is especially relevant to corporate environmental strategy. the paper is divided into two sections: the first provides a brief overview of stakeholder theory and the stakeholder management process; the second examines the literature on how stakeholders can be integrated into the strategy development process, and the implications of using stakeholder management in designing corporate environmental strategy. further, the second section builds on the limited literature examining the stakeholder strategy matrix. this literature and the matrix are expanded by incorporating a broader range of "influencers" or "bridging" groups in the strategy process. examples of how environmental stakeholders have been integrated into firms' environmental strategy and the corporate environmental strategy formulation process are included throughout the paper. an overview of stakeholder theory according to freeman, in 1964 the stanford research institute defined stakeholders as "those groups without whose support the organisation would cease to exist". as more researchers have examined stakeholder theory the number of definitions have proliferated. no consistent definition appears in the literature, with many authors taking slightly different perspectives as to which groups can be identified as stakeholders [clarkson 1994a & b, donaldson and preston 1995, the toronto conference 1994]. the difference in perspectives is based on a difference of opinion as to which groups have a "stake" in organisational activities. one of the more widely accepted definitions of a stakeholder is based on the principle that "(t)he firm takes into account all of those groups and individuals that can affect, or are affected by, the accomplishment of organisational purpose" fall 1995 polonsky: natural environment in corp. strategy 153 [freeman 1984]. thus the firm is required to "take into account its relationship with specific stakeholder groups as it sets corporate direction and formulates its strategies" [roberts and king 1989]. using this view the stakeholder can be identified as almost any group remotely involved in organisational activities. an alternative perspective suggested by clarkson is that "all stakeholders bear some form of risk" [clarkson 1994b]. thus in clarkson's narrower definition some stakeholders, such as the media who do not bear "risk" in the firm-stakeholder interface, might be omitted. in this paper freeman's broader definition of a stakeholder will be used. given the experts inability to develop a comprehensive definition [clarkson 1994a] no attempt will be made to further examine this issue here, but it may be one area warranting further research. the stakeholder management process, as well documented by freeman and others, is one tool designed to allow the firm to modify strategy to reflect the concerns of their various stakeholders, and is applicable to corporate environmental strategy. as defined in the literature this process comprises four basic steps: 1) identify the relevant stakeholder groups in relation to the issue being addressed; 2) determine the stake and importance of each stakeholder group; 3) determine how effectively the "needs" or "expectations" of each group is presently being met; and 4) modify corporate objectives and priorities to take into consideration stakeholder interests [freeman 1984, carroll 1989, roberts and king 1990]. while the focus of this paper is examining how stakeholders can be integrated into the environmental policy development process,· it is important to understand this general four-step stakeholder management process. step one: stakeholder identification the first step in the stakeholder management process is to identify which organisations or individuals are environmental stakeholders. stakeholders may differ for each specific issue examined by the finn and may vary across firms [freeman 1984]. when evaluating green marketing strategies it has been suggested that activities such as product development, promotional mix, support services, manufacturing and production processes, r&d, material purchasing and waste disposal acti vities all need to be considered when determining stakeholders [vandennere and oliff 1990]. finns should attempt to include "any person or organisation with a vested interest in the outcome of a companies environmental effort" [thomlison 1992]. thus the finn must concern itself will all groups, internal and external, which are affected by the finns environmental behaviour or who can influence the finn's environmental behaviour. for example consumers may demand products have various environmental attributes, regulators may require corporate compliance with specific environmental standards, or unions may "protest" over questionable cor~ porate environmental practices. the identification of all stakeholders is essential for the remainder of the process to be effective. it is therefore necessary to utilise some type of systematic approach to detennine who the relevant stakeholders are. while no general 154 journal ofbusiness strategies vol. 12, no.2 process has been accepted in the literature, stakeholder audits are one process that firms can use to identify all appropriate stakeholders (see freeman 1984 for a more detailed discussion of this process.) once the firm identifies all of the appropriate stakeholders it can then develop a stakeholder map. this map visually identifies the relationships between the stakeholders and the firm, it also identifies the relationships among stakeholders. when identifying stakeholders it needs to be realised that individuals often have several different roles at anyone time. for example, employees may consume the firm's products, live in the local community, own shares in the firm, and be a member of a special interest group. this issue is extremely important, for each firm may face a different set of stakeholders in relation to a given issue. thus developing a "generalisable" stakeholder map in relation to all firms' environmental strategies, may be impossible. step two: determining the stakes the firm must determine each stakeholder's "stake" in respect of the issue being examined. each group's "stake" varies by issue and firm, thus one group might have a "high" stake in one firm's environmental policy and a low stake in another. for example, stakeholders "concerned" about deforestation may be more "influential" in relation to logging firms' activities, yet may have a negligible influence on the chemical industry. an individual's stake is hislher potential or ability to influence the firm's behaviour. it should be noted that stakeholders can have both a positive and/or a negative "influence" on organisational outcomes [freeman 1984, savage et al 1991]. firms have been traditionally more concerned about stakeholder's potential for harm, rather than his/her potential for cooperation. this point has significant implications in relation to environmental strategy development and is a focus of the strategy development matrix. a number of other ways can be used to categorize stakeholders: position [the toronto conference 1994], interest [freeman 1984], power [freeman 1984], risk [clarkson 1994b] and formality [savage et al 1991]. however, an in-depth discussion of these classifications will not be undertaken in this paper. stakeholders can also have a direct influence or indirect influence on firm's behaviour. in the case of a direct influence a given group's behaviour directly "modifies" organisational outcomes. for example, consumers boycotting producers of "environmentally harmful" products result in lower corporate profits. stakeholders' indirect influence on organisational behaviour occurs were there is a chain of events affecting the firm's behaviour. for example, local residents may be concerned about the environmental impact of a new manufacturing plant in their community and petition their local council not to grant the firm a building permit. if the council bows to community pressure, the firm will have to find an alternate location. the completion of step two (as well as step three discussed below) is very difficult without open communication channels between the organisation and the stakeholder group. unfortunately, in many situations organisations may not be on fall 1995 polonsky: natural environment in corp. strategy 155 favourable terms with all stakeholders. in these situations the firm will have to develop communication channels if stakes are to be accurately determined. (specific strategies to develop communication channels, such as bridging stakeholders, will be discussed later in the paper.) a less desirable alternative may be to "estimate" the stakes of the groups and how well they are met. even in situations where communication channels do exist, not all stakeholder groups have clearly established policy statements. indicating their expectations or needs in relation to a specific environmental issue. in addition, to say that every stakeholder group is made up of homogeneous individuals would be an exaggeration. for example, there are many regulatory bodies that license different aspects of a firm's environmental behaviour. therefore the firm needs to identify stakeholders in "identifiable units" that have a common set of objectives. step three: determine how well expectations are met determining if there is a gap between expectations and performance is an important step in the stakeholder management process. the expectations of stakeholders may be difficult to assess, for as was discussed in step two, the firm may not be able to freely communicate with stakeholders, stakeholder groups may not have clearly established objectives, or groups may be very heterogeneous. where the firm's environmental behaviour does not at le~st match stakeholders' expectations, a gap will exist. this gap results in stakeholders being dissatisfied with the firm's present environmental behaviour, with the size of the gap indicating the degree of stakeholder dissatisfaction. if there is no gap, stakeholders would be satisfied with firm's environmental behaviour. step four: adjusting strategy the last step of the stakeholder management process is the readjustment of corporate priorities to bring the firm in line with stakeholders interests" [roberts and king 1989]. this readjustment requires that the proceeding three steps have been undertaken appropriately, for if not, the firm's new strategy may not reduce the gap in stakeholders' expectations and corporate behaviour. modifying environmental strategy simply to address the needs of one "unsatisfied" stakeholder may result in the alienation of other stakeholders who are already "satisfied" with the firm's performance. for example, incorporating a new technologically advanced production process that reduces pollution may satisfy local community concerns, but the reduction in profits due to increased capital costs may be of concern to owners. in addition, if the new technology displaces workers, unions may also be concerned. as this example highlights, environmental activities can have complex implications for stakeholders. the firm needs to consider all implications of a shift in strategy, not simply the effect on a specific stakeholder group. a reduction in the gap between expectations and behaviour can occur for one of three reasons: 1) the firm's behaviour changes, such that it is closer to stakeholder expectations; 2) stakeholder expectations change and become more ac156 journal of business strategies vol. 12, no.2 cepting of existing corporate behaviour; or 3) both stakeholders' expectations and organisational behaviour change. in most situations a change will result due to a movement by both parties, with a "change" in stakeholder expectations possibly occurring due to a change in corporate behaviour. for example, if the firm develops more credible and accurate communication channels, stakeholders may modify their expectations of corporate activity. even after a change in strategy has occurred a gap may still exist, thus the potential for negative stakeholder behaviour may be reduced. in these cases the firm will be able to develop contingency programs to address the potential negative behaviour that may arise from dissatisfied stakeholders. thus the stakeholder management process allows the firm to address the environmental needs of stakeholders or develop strategies for problems should they arise. integrating stakeholders into environmental strategy development the objective of the four step process described above, is to enable the firm to modify corporate environmental strategy such that "all" stakeholders' objectives are considered. while this is an important objective, the stakeholder management process alone, does not give managers sufficient clues as to how stakeholders should be integrated into the strategy formulation process. furthermore it is unclear from the four step stakeholder management process, which stakeholders should be included in strategy development. is it simply appropriate to target stakeholders who are most affected by firms' activity or would it be better to focus on stakeholders who have the ability to affect firms' ultimate performance? an alternative strategy might be to integrate stakeholders who have the greatest influence on "other" stakeholder groups. the focus of this section of the paper is to examine the issue of incorporating stakeholders in the 'itrategic process in more detail. it should be recognised that it is highly unlikely that all stakeholder's expectations will be met. therefore, the firm must somehow ascertain which stakeholder's should be incorporated. since stakeholders have the ability to positively or negatively influence the firm [freeman 1984, savage et. al. 1991], integrating the right group is essential. specific organisational strategies to integrate stakeholders will differ, depending on the issue and the groups potential to cooperate or threaten the firm's performance. while freeman's [1986] text addresses the issue of including stakeholders in the strategic process, little other academic literature examines this issue. of this literature, most focuses on methods for evaluating stakeholders' importance [roberts and king 1989, ryan 1992] or methods of determining the rewards of adopting a stakeholder orientation [barton et. al. 1989, lerner and fryxell 1994, preston and sapienza 1990]. there is very little literature examining specific strategies that can be used to incorporate stakeholders into the strategic development process [freeman 1984, maranville 1989, savage et al 1992]. fall 1995 polonsky: natural environment in corp. strategy the stakeholder strategy matrix 157 a matrix approach has been suggested in the literature as one method that could be used by the firm to determine the appropriate strategy for addressing different types of stakeholders [freeman 1984, savage et. a1. 1991]. the stakeholders identified in step one of the stakeholder management process would be incorporated into the suggested matrix (see figure one). the underlying issue, as identified by freeman (1984) and savage et al (1991), is to identify stakeholders' ability to cooperate with the firm (i.e., assist it in achieving its objectives) or their ability to threaten the firm's performance (i.e., harm it in achieving its objectives). it might be suggested that cooperation and threatening behaviour are extremes of one continuum, but this is not necessarily the case. in developing strategy a firm needs to consider that each stakeholder has the ability both to threaten and to cooperate. the objective of corporate strategy is to reduce the threatening potential and increase the cooperative behaviour. thus the potential to cooperate and to threaten are the two characteristics placed on the two axes of the matrix. each stakeholder's position would have been partially determined in step two of the stakeholder management process. figure one the traditional stakeholder strategy matrix stakeholders potential to threaten the organisation stakeholders poltential to cooperate with the organisation high collaborate with the stakeholder (1) defend against stakeholders actions (3) low involve the stakeholder (2) monitor for changes (4) in earlier works both freeman (1984) and savage et. al .(1991), also put forward a generic set of strategies that the firm can use to address each type of stakeholder (see table one). freeman identified that stakeholders can have a positive or negative influence on firm activities, whereas savage et al concentrated on stakeholders potential to influence organisational behaviour negatively. it is important to realise that the stakeholders potential to act and their willingness to act are not directly related. an environmental group may have the ability to cooperate with an organisation, but they may not be willing to do so. therefore when looking at strategies it is important to examine not only strategies addressing 158 strategy developer journal of business strategies table one generic stakeholder strategies strategy vol. 12, no.2 strakeholder disposition f f,s f s,f f f f f f f f f f f s f,s f f o o o o collaborate use alliances with stakeholders to change the official rules governing firm behavior. work to involve different stakeholders in rule establishment process. refocus stakeholders, such that they address "different" issues. integrate more stakeholder input. involve modify stakeholder beliefs or expectations regarding firm behavior. modify organisational behavior. modify stakeholder objectives. adopt stakeholders objectives regarding the issue of concern. tie the issue of concern to broader stakeholder strategy in an attempt to show stakeholders that their support is consistent with other objectives. attempt to have more stakeholders input. defend re-enforce stakeholders' positive position. continue with existing organisational activities. tie organisational activities to other issues that stakeholders are pursuing. include stakeholder in the decision process. reduce stakeholders status, i.e. reduce their stake. monitor don't change organisational behavior, but monitor stakeholder for changes in behavior re-enforce stakeholders' existing belief about the firm. attempt to minimise the possibility that rules governing firm activity will change. bridging attempt to have more stakeholder communication. attempt to have stakeholder input. attempt to affect the perception of "other" stakeholder towards the bridging group. attempt to change "other" stakeholder expectations directly. positive positive negative positive negative both negative both negative both positive positive both both negative both positive both both both negative both f suggested by freeman (1984) s suggested by savage et al (1991) o suggested by other literature fall 1995 polonsky: natural environment in corp. strategy 159 stakeholders who are positively disposed towards an organisation but those who are negatively disposed towards an organisation as well. some strategies may only be appropriate for a stakeholder with a specific disposition towards the organisation, i.e., positive or negative. in other cases a given strategy may be appropriate for either type of stakeholder, i.e. both. while the classification of stakeholders using cooperation and threatening behaviour is useful, it only refers to the stakeholder-firm interface, omitting the important stakeholder-stakeholder relationship. as suggested earlier the interaction between stakeholders can have a significant indirect impact on corporate environmental behaviour. the importance of these interactions have been identified by several authors, who have recognised the importance of "boundary spanners" or "bridging" groups [brickner 1993, feyerherm 1994, mendleson and polonsky 1995, sharma et al 1994, westley and vredenburg 1991]. these groups act as influencers in the stakeholder process, indirectly affecting organisational activities. one definition of the term "bridging stakeholder" could be all "groups who forward their own ends as well as to serve as links" between other stakeholders [westley and vredenburg 1991]. bridging groups can also be classified as stakeholders in their own right under the broader definition of a stakeholder as "all of those groups and individuals that can affect, or are affected by, the accomplishment of organisational purpose" [freeman 1984]. the stakeholder matrix presented in figure one does not allow for these intluencers and needs· to be modified to take into consideration the role of bridging stakeholders. as these groups can fall within any of the four quadrants, in their own right, the bridging classification must overlap all four of the traditional quadrants established by earlier authors. figure two incorporates this additional "bridging" category into the traditional matrix (figure one) and additional generic strategies are incorporated at the bottom of table one. figure two modified stakeholder strategy matix stakeholders potential to threaten the organisation high low stakeholder type 1: stakeholder type 2: high mixed blessing supportive strategy: collaborate strategy: involve stakeholders stakeholder type 5: potential to bridging cooperate with strategy: mixed approach the organisation stakeholder type 3: stakeholder type 4: low non-supporti ve marginal strategy: defend strategy: monitor 160 journal of business strategies classifying stakeholders vol. 12, no.2 at first examination the classification of a stakeholder group into figure two may appear a simple matter. yet when classifying stakeholders, it is important for managers to consider all potential interactions between the organisation and their stakeholder, not simply the interactions as they exist today. for example, it is likely that most firms consider regulatory bodies as a non-supportive stakeholder and adopt a defensive strategy for dealing with them (see table one and figure two). yet using innovative strategies other firms may consider these stakeholders to be type i, mixed-blessing stakeholders and form collaborative relationships with them. this type of relationship occurred when regulatory bodies developed environmental marketing guidelines in the us and australia [kangun and polonsky 1995]. several businesses made submissions to their respective regulatory bodies, requesting that the regulators establish concise guidelines controlling environmental marketing activities. these firms went on to suggest specific issues that they believed needed to be addressed [ftc 1991, naag 1990, tpc 1990]. in this case the organisations collaborated with regulators to establish new environmental marketing guidelines, whereas other organisations might have perceived regulators as adversaries and adopted a confrontational strategy. thus organisations must not simply consider present probable strategies. they must also consider all potential strategies available before classifying stakeholders into a specific quadrant. as can be seen in table one there are several different strategies for stakeholders in each quadrant, these strategies have been suggested by freeman (1984) and savage et al (1991), as well as in the literature relating to bridging stakeholders. each strategy is not mutually exclusive, some are appropriate for more than one type of stakeholder group. implementation of each strategy may be extremely difficult as well, especially those designed to deal with bridging stakeholders. these general comments about classifying stakeholders and utilising strategies form the backdrop for an examination of the five stakeholder types. a discussion of these classifications and appropriate strategies follows. mixed blessing these stakeholders are extremely important, for they have the ability to cooperate with the organisation or threaten the achievement of organisational objectives. one such environmental stakeholder might be the firm's employees. it is this group that ultimately determines a firms' environmental performance by complying or not complying with specific operational or environmental procedures. when employees do not comply with environmental policies, "environmental breaches" may occur. these individual "errors" or "omissions" are ultimately the responsibility of the firm. for example, the exxon valdese disaster, partially caused by the operating breaches of the pilot on duty at the time, left exxon with a billion-dollar bill, extensive negative publicity, and a loss of consumer goodfall 1995 polonsky: natural environment in corp. strategy 161 will. in another example, a firm may wish to update a production process to reduce environmentally harmful emissions of some type. if this new process affects staffing requirements, the firm will need the support of workers and unions if the new process is to be successfully implemented. as suggested by figure two and table one, one appropriate strategy for mixed blessing stakeholders is to integrate them into the strategy development process. this action will ensure that the objectives of the stakeholders are included in strategy as it is formed and thus will not require a later "redevelopment" of strategy. one innovative example of a collaborative strategy occurred between the australian firm aci and the environmental group, the australian conservation foundation (acf) [mendleson 1994]. aci wanted to develop a food packaging that would allow them to use recycled plastic, which had not been previously permitted due to health concerns. to tackle this problem aci collaborated with the acf. the result was in a new multilayer pet plastic that allowed recycled plastic to be used for drink and food containers by placing a layer of virgin plastic between the food and the recycled plastic [mendleson 1994]. previously environmental groups had been "pressuring" producers to reduce pet use. thus aci turned a normally "hostile" environmental stakeholder, into an ally. a collaborative strategy minimised the potential for threatening behaviour from acf and increased its cooperative behaviour. supportive these stakeholders have the ability to cooperate with the firm, but have little ability to threaten organisational activities. one such environmental stakeholder might be a firm's suppliers. for example, when mcdonald's decided to reduce its impact on the natural environment, it instituted a number of recycling programs relating both to disposal of waste and to purchase of recycled materials. this strategy greatly assisted the suppliers of recycled plastics and polystyrene, as they now had a quality source of material to recycle, as well as a consumer for goods made from their recycled materials [hume 1991, gifford 1991]. freeman (1984) and savage et. al. (1991), disagree on appropriate involvement strategies for supportive stakeholders. this disagreement is due to savage et. al. (1991) not considering the possibility of negatively disposed groups' having little negative impact but high cooperative potential. these cases may require extremely innovative strategies to be developed in order to effectively diffuse negatively disposed stakeholders. for example, when the international olympic committee requested that all future olympic bids integrate environmental principles the sydney olympic committee established their environmental guidelines together with greenpeace [sydney 2000 1993a]. this involvement resulted in the sydney bid being the most environmentally responsible [sydney 2000 1993b, sydney 2000 1994] and may have assisted in sydney's winning the olympics for the year 2000. thus by involving greenpeace, the sydney bid committee adopted stakeholder's objectives, had more stakeholder input, modified organisational behaviour, and may have even modified stakeholders' beliefs about the organisation. 162 journal ofbusiness strategies vol. 12, no.2 non-supportive these stakeholders have the ability to threaten organisational activities, but have little ability to cooperate with the organisation. as mentioned earlier governmental bodies are often considered to be non-supportive stakeholders. they establish environmental regulations and guidelines that many firms believe are restrictive. this is not always the case, for there are numerous examples of where organisations have cooperated with regulatory bodies in establishing various environmental guidelines. as suggested earlier one such example, is the establishment of environmental marketing regulations, both in the us and australia [ftc 1991, kangun and polonsky 1995, naag 1990, tpc 1990]. in both these cases various organisations suggested that regulations were needed to allow consumers to make informed purchasing decisions and to protect competition. yet, none of the firms suggested that regulating environmental marketing claims would assist in protecting the environment. in this example, organisations tied their activities to stakeholders' (regulatory bodies) other objectives. marginal these stakeholders have little ability to threaten organisational activities or to cooperate with the organisation. this group may have little interest in the firm's environmental activities at a given point in time. but this interest may change over time and therefore the potential for cooperation or threat may change. for the purposes of an example, it is useful to examine how the relationship between financial institutions and organisations changed between the 1970s and the 1980s. in the 1970s when financial institutions loaned firms capital they were concerned with the return on their investment, few banks had any concern for the borrowing organisation's environmental activities. this relationship changed in the 1980's after various us court rulings on the superfund act of 1980 [hector, 1992]. the act held banks ultimately liable for their customer's pollution. this law shifted the burden of paying for environmental cleanups from the government to the owners, past and present, of polluted property [sarkin and schelkin 1991]. to address financial institutions new "interest" in their client's environmental activities, firms had to keep rigid environmental records and undertake regular environmental audits [quirke 1992]. those organisations monitoring financial stakeholders and the business environment would have observed the movement of these marginal stakeholders to the non-supportive category. if this were the case, they may have anticipated the change in stakeholder concern and adjusted their environmental strategy accordingly. those firms who did not anticipate the shift, may have had significant difficulty in obtaining financing until their environmental strategy changed. an unrevised strategy may also have put them at a competitive disadvantage to those firms who anticipated the change in stakeholder interest and acted accordingly. fall 1995 polonsky: natural environment in corp. strategy 163 bridging as suggested earlier, bridging stakeholders are not directly referred to in the stakeholder strategy matrix literature. as suggested in figure two bridging stakeholders fit into one of the four classifications identified earlier, and they also influence "other" stakeholder groups' expectations and behaviour towards the firm. the influencing or bridging role may be more important than the stakeholders direct affect on the firm. there may be many important bridging stakeholders that need to be carefully watched. for example, a financial institution's role as a marginal stakeholder was shifted to that of a non-supportive stakeholder. this shift was the result of "interference" from a bridging stakeholder, legislators, who initiated the superfund act. another example of a bridging stakeholder is the media. they may only influence organisational behaviour through their bridging role and have no direct influence on the organisation, i.e., they could be classified as a marginal stakeholder as well. the media influences other stakeholders through the"publicising" of a variety of activities, such as the forcible removal of environmental protesters from an organisations facilities, or the occurence of an environmental accident. while the media itself does not directly influence the firm's behaviour, they may impact a number of stakeholders who can, such as consumers, regulators, employees, and shareholders who can exeft influence. strategies designed to address bridging stakeholders are more complex than those of the other four groups. the firm must identify in which of the four quadrants the stakeholder falls, as well as identify which stakeholders can be affected by a bridging group and how important that bridging groups influence might be. one of the positive strategy approaches is to have open communication channels with the bridging stakeholders. this strategy allows organisations to "influence" the bridging group's actions and thereby indirectly to affect the "influenced" groups' expectations or behaviour towards the firm. for example, an organisation that has a good relationship with the media may be able to ensure that a balanced perspective is presented and that stories are not presented in a sensationalist fashion. this approach would reduce the negative influence of the media's bridging role on other stakeholders. a more aggressive strategy might be to target the influenced stakeholders directly and to seek to minimise the bridging groups' effect. to accomplish this, the firm could attempt to increase the validity of the firm-based information (i.e., change stakeholder expectations towards the firm) or it could attempt to minimise the credibility of the btidging stakeholder (i.e. change stakeholder expectations towards the bridging group). implications and conclusions through the use of the stakeholder management process and the associated stakeholder strategy matrix, the firm can include stakeholders into the environmental strategy development process. this inclusion should ensure that the firms 164 journal of business strategies vol. 12, no.2 environmental strategies address the needs and expectations of its various stakeholders. this process requires managers to consider stakeholders in an innovative light, for not only is the present relationship between the firm and stakeholders important, but so are future activities and interactions. thus shifting stakeholders between quadrants within the strategy matrix, or designing strategies that maximise organisational benefit, requires that managers think of potential methods of building "links" between the firm and their stakeholders. to some extent all strategies suggested require some degree of socialising stakeholders into the organisational decision making process. this socialisation can range from the extreme of collaborative activities, to a minimalist approach of developing simple "formal" communication that would feed into the organisation's management information system. one of the main strategies the firm must utilise is continual monitoring of stakeholders. this process should determine how their stakes "change" as well as to determine how effectively the "needs" or "expectations" of each group are being met. in other words firms may need to continually undertake step two and step three in the stakeholder management process to ensure that strategies are effective. developing good communication channels between the firm and its stakeholders, is one effective corporate strategy. however, if the information obtained is not incorporated into the firm's management information system and used when developing environmental strategy, the firm is not maximising the value of its communication with stakeholders. information is more than a simple monitoring device, it is also an important strategy tool. in those cases where stakeholders are not open to communication due to their negative disposition towards the firm, alternative strategies need to be developed. these strategies may attempt to change the stakeholder group's disposition, or minimise its negativity. strategies to undertake this "change" may require the use of bridging stakeholders to "communicate" on behalf of the firm with these negatively disposed stakeholders. in cases where stakeholders' expectations cannot be met or changed, the firm will be able to develop contingency programs to minimise any potential harm. bridging stakeholders may be one strategy tool that can be effectively utilised by organisations. numerous examples in this paper demonstrate how the inclusion of an independent stakeholder in environmental strategy has led other stakeholders to modify their behaviour and expectations. these changes can occur in either a positive or negative fashion. as a positive example, some firms have formed strategic alliances with environmental groups to develop new products, which are perceived by consumers to be more environmentally responsible. thus environmental groups have played an important bridging role as well as being a mixed blessing type of stakeholder however, bridging stakeholders have to be used carefully, for they 'may also send the "wrong" message to other stakeholders [mendleson and polonsky 1995]. as a negative example, involving "radical" environmental groups in firm activities may alienate a "conservative" general pubfall 1995 polonsky: natural environment in corp. strategy 165 lie, rather than put them more on side. in addition if bridging groups are perceived to lose their "objectivity" the benefits of their involvement may be lost [carson and fyfe 1992, westley and vredenburg 1991]. while innovative strategies appear to be a useful method of incorporating stakeholders into the environmental strategy development process, more research needs to be undertaken into the successfulness of the various strategies. the literature presented does provide some interesting case studies, but extensive opportunities exist for additional quantitative and qualitative research in this area. research needs to examine the effectiveness of the various generic strategies for each of the five different groups. more research could be undertaken with bridging stakeholders to determine how they can be motivated to become involved with the firm or to examine the potential loss of credibility caused by a "closer" bridging group-firm relationship. in addition more research might be done regarding the specific organisational structures required for socialising stakeholders, as a variety of approaches may be possible. the structures established might determine the effectiveness of the specific strategies, with some structures being more appropriate for a given strategy. references aggarwal, raj and chandra, gybe, "stakeholder management opportunities and challenges", business, vol 40 no i (1990): 48-51. anonymous, "spurts and starts: corporate role in '90s environmentalism hardly consistent" advertising age, vol. 62 n0 46 (oct. 28,1991): gri4-gri6. barton, sidney l., ned c. hill, and srinivasan sundaram, "an empirical test of stakeholder theory predictions of capital structure", journal of financial management, vol 18 no 1 (1989): 36-44. brickner, wm scott. "stakeholders versus constituents: what stakeholder theory tells us about the organization and reform of congress & what congressional reform tells us about stakeholder theory" proceedings 5th annual labs conference, (1993): 199-204. carroll, a. b., business and society ethics and stakeholder management, cincinnati ohio usa, south-western publishing company, 1989. carson, patrick aj;1d andrew fyfe, "a canadian retailers perspective: loblaw companies ltd." in martin charter (ed) greener marketing sheffield, england, greenleaf publishing, (1992): 307-310. clarkson. max "report of the definitions working group." proceedings of the second toronto conference on stakeholder theory. 1994a. clarkson, max "a risk based model of stakeholder theory" proceedings of the second toronto conference on stakeholder theqry~ 1994b. 166 journal of business strategies vol. 12, no.2 copulsky, william, "balancing the needs of consumers and shareholders" the journal of business strategy. vol 12 no 6 (1991): 44-47. davis, joel j., "ethics and environmental marketing." journal of business ethics, vol 11 no 2, (1992): 81-87. donaldson, thomas and lee e. preston, "the stakeholder theory of the corporation: concepts, evidence, implications." academy of management review, vol 20 no 1 (1995): 65-91. federal trade commission, hearings on environmental marketing issues, washington, dc usa: ftc, july 17 18, 1991. feyerherm, ann e. "the influence of dialogue on multiple stakeholders in interorganizational, collaborative networks." proceedings 5th annual labs conference. (1994): 517-528. freeman, r. edward, strategic management: a stakeholder approach, pitman publishing company, massachusettts, 1984. gifford b., (1991) "the greening of the golden archesmcdonalds teams with environmental group to cut waste". the san diego union, (august, 19, 1991): cl,c4. hector, gary., a new reason you can't get a loan. fortune, vol 126 no 6 (1992): 107-112. hume, scott, "mcdonald's: case study" advertising age, vol 62 no 5 (1991): 32. kangun, norman and michael polonsky, "regulation of environmental marketing claims: a comparative perspective" international journal of advertising, vol 14 no 1 (1995): 1-24. lerner, linda d. and gerald fryxell, "ceo stakeholder attitudes and corporate social activity in fortune 500." business and society, vol 33 no 1 (1994): 58-81. maranville, steven j., "you can't make steel without having some smoke: a case study in stakeholder analysis" journal of business ethics, vol 8 no i (1989): 57-63. mcdaniel, stephen w. and david h rylander, "strategic green marketing." journal of consumer marketing., vol 10 no 3 (1993): 4-10. mendleson, nicola, "environmental marketing business partnering at afcdeveloping strategic alliances." environmental marketing: critical success strategies for reaching the green consumer proceedings of the 1994 conference, (february, 1994): 87-103. mendleson, nicola and michael jay polonsky "using strategic alliances to develop credible green marketing" (with n. mendleson) journal of consumer marketing. vol 12 no 2 (1995): 4-18. fall 1995 polonsky: natural environment in corp. strategy 167 national association of attorneys-general, (naag) the green report: findings and preliminary recommendations for responsible advertising. usa: national association of attorneys-general, 1990. ottman, jacqueln, "brand 'stewards' will guide environmental planing" marketing news, vol 26 no 8 (1993): 15. peattie, ken and tony ring "greener strategies: the role of the strategic planner" greener management international issue 3 (1993): 51-64. preston, lee e. and sapienza, harry j., "stakeholder management and corporate performance", the journal of behavioral economics, vol 19 no 4 (1990): 361-375. quirke, brendan, "environmental auditing: what's it all about?," management accounting, vol: 70 no 3 (1992): 34-35. roberts, nancy c. and king paula j., "the stakeholder audit goes public" organizational dynamics, vol 17 no 3 (1989) 63-79. ryan, pratrick, "calculating the "stakes" for corporate stakeholders as part of business decision-making", rutgers law review, vol 44 no 3 (1992): 555-583. sarkin, d. and j. schelkin, "environmental concerns and the business of banking," the journal of commercial bank lending, vol 73 no 3 (1991): 7-19. savage, grant t; nix, timothy w.; whitehead, carlton j.; and blair, john d., "strategies for assessing and managing organisational stakeholders" academy of management executive, vol 5 no 2 (1991): 61-75. sharma, s., h. vredenburg and f. westley, "strategic bridging: a role for the multinational corporation in third world development", journal of applied behavioral science, vol 30 no 4 (1994): 458-476. shearer, j.w., business and the new environmental imperative. business quarterly, vol 55 no 3 (1990): 48-52. spearot, rebecca m., environmental liability: what you don't know can hurt you. ~ porate controller, vol 4 no 1 (1991): 20-23. sydney 2000, sydney 2000 environmental guidelines, sydney australia: sydney 2000., 1995a. sydney 2000, sydney's olympic village plan wins support from greenpeace, sydney australia: sydney 2000, 1995b. sydney 2000, environmental guidelines for the summer olympic games -summary. sydney australia: sydney 2000, 1994. 168 journal of business strategies vol. 12, no.2 taylor, stuart r., green management: the next competitive weapon. futures, vol 24 no 7 (1992): 669-680. tpc (trade practices commission), draft for discussion environmental claims in marketing, canberra, australia, trade practices commission, 1990. thornlison, bryan m., "environmental consumerism must meet needs of corporate stakeholders" marketing news, vol 26 no 9 (1992): 12. vandermere, s. and oliff, m.d., consumers drive corporations green. long range planning, vol 23 no 6 (1991): 10-16. vaughan, d.a.j., p. scott and craig mickle, "environment: what do europe's boardrooms think?" greener management international, issue 7, (1994): 28-35. westley, frances and harrie vredenburg, "strategic bridging: the collaboration between environmentalists and business in the marketing of green products" journal of applied behavioral science, vol 27 no 1 (1991): 65-90. winter, lynn and grant legerwood, "motivation and compliance in environmental performance for small and medium-sized business." greener management international, issue 7, (1994): 62-72. incorporating the natural environment in corporate strategy: a stakeholder approach transformation of strategic types: an examination of the internal antecedents to organizational change charles e. bamford texas christian university fort worth, tx patrick r. rogers north carolina a&t state university greensboro, nc alex miller university of tennessee knoxville, tn abstract a change in the strategic direction of an organization is usually regarded as a deliberate effort to impact firm performance. yet empirical examinations of the drivers of organizational transformations have been inconclusive. in this study of banks, results indicate that financial performance is inversely related to a transformation of strategic type while changes in the dominant coalition are significant predictors of subsequent change in the firm's strategic type. it appears that a firm's ability to change its strategic focus is highly dependent upon it changing the membership of its board of directors, ceo, and its top management team. "to dispose a soul to action we must upset its equilibrium" eric hofer, 1964 researchers have been able to identify a variety of strategic types and to document some aspects of the shift from one type of strategy to another (zajac & shortell, 1989). while such transformations may not be uncommon, a change from one type of strategy to another is surely one of the most significant events in the life of an organization (chakravarthy, 1982; ginsberg, 1988~ miller & friesen, 1980). the number of risky procedural and organizational adjustments necessitated by such a transformation makes the very process firm-threatening (cool & schendel, 1988; tushman & romanelli, 1986). yet, theory suggests that despite the risks involved, a change in the type of strategy an organization pursues often is an important means of avoiding the even greater disruptions incurred by an organization that is no longer aligned with its environment (andrews, 1971; miles & snow, 1978). 136 journal of business strategies vol. 16, no.2 given the risks involved in transforming an organization from one strategic type to another, the potentially greater risks of not making such a transformation if it is needed to maintain the finn's alignment with its environment, and the documented fact that transformation of type are not uncommon, it is clear that we need to understand how and why such transformations take place (chakravarthy, 1982; dutton & duncan, 1987; ginsberg, 1988; miller & friesen, 1980; zahra & pearce, 1990; zajac & shortell, 1989). such research would ideally address two deficiencies in the extant literature, first, few researchers have used a longitudinal framework to examine the pro· cess by which organizations change from one type of strategy to another (ginsberg, 1988; zahra & pearce, 1990). cross sectional designs, while helpful in understanding the current state of the adaptive process, or even the alignment of internal structures with a given strategy, are oflittle aid in understanding the antecedcnts to a strategic change which embody a temporal dimension (meyer, tsui & hinings, 1993). second, within the relevant literature there has been an overwhelming tendency to focus on environmental forces outside the finn as the primary stimulus to change (chakravarthy, 1982; ginsberg, 1988; goodstein & boeker, 1991; miller & friesen, 1980). much of this research has identified turbulent environments (jennings & seaman, 1994; virany, tushman & romanelli, 1992) or even specific environmental discontinuities (meyer, 1982; tushman & anderson, 1986) as the triggering device that pushes the organization toward a change in the strategy of the whole organization. while this stream of research has yielded some interesting findings, it is conceptually limiting as one of the fundamental strategic management prescripts depict strategic change as a deliberate managerial effort to align the company with its environment (andrews, 1971; child, 1972; jennings & seaman, 1994). firm specifk, internally-focused antecedents to changes in strategy type have not been examined with the same effort when compared to the examination of environmental antecedents, but, theory, research results, and anecdotal evidence can be pieced together to suggest important organizational antecedents to a transformation of type. as the following section will explain, these include changes in financial performance (dutton & duncan, 1987; ginsberg, 1988; tushman & romanelli, 1985), and changes in the dominant coalition (chandler, 1962; ginsberg, 1988; keck & tushman, 1993; tushman & romanelli, 1985; wiersema & bantel, 1992). this study reflects an effort to improve our understanding of strategic type changes with a direct examination of these antecedents through the longitudinal analysis of a single industry. antecedents to a change in strategic type much of the research into changes in strategic types has utilized a typology such as that presented by miles and snow's (1978) adaptive typology (james & fall 1999 bamford, et al: transformation of strategic types 137 hatten, 1994; jennings & seaman, 1994; zajac & shortell, 1989). the fouf types (prospector, defender, analyzer and reactor) represent not only a strategic posture, but a complete organizational configuration that is consistent with the firm's strategy. the miles & snow strategic types allow the researcher to directly access the realized strategy of the firm at various points in time (zajac & shortell, 1989). a change in strategic type is a fundamental process of reorganizing the structure, processes, procedures and power within an organization (tushman & romanelli, 1985). miles and snow explain that a transformation from one strategic 'type' to another is both difficult and rare. in general, most executives will express satisfaction with their current strategy. however, they suggest that a complete change in the processes of the organization may be required if a strategic change is initiated by a change in the dominant coalition, a change in the environment or by unintended outcomes of the current strategy. while never directly tested, an examination of the extant literature also suggests several primary organizational elements that may be important internal antecedents to 'strategic change. changes in the dominant coalition strategic decisions are the function of the apex of the organization, sometimes referred to as the dominant coalition (cyert & march, 1963). this dominant coalition is generally thought to be a function of the interactions among three groups: 1) the ceo or president; 2) the members of the board of directors and 3) the members of the top management team (finkelstein & hambrick, 1990). a substantial body of research suggests that changes in the makeup of the dominant coalition may be crucial for overcoming organizational inertia and the effects of strategic myopia (chandler, 1962; finkelstein & hambrick, 1990; goodstein & boeker, 1991; tushman & romanelli, 1985; virany, tushman & romanelli, 1992; wiersema & bantel, 1992). the dominant coalition's perception of the environment, the alignment of corporate strategy with the environment, as well as the assessment of their company's strengths and weaknesses, appear to be critical factors in the decision to change strategies (dutton & duncan, 1987; tushman & romanelli, 1985). in this light, it is important to note that miles and snow (1978) suggested that the management of an organization would be likely to express satisfaction with their current strategy unless the dominant coalition is relatively new or the environment has changed dramatically. both situations occurred in the banking industry during the early 1980's. the environment changed dramatically with the authorization of limited interstate banking. two relatively stable banks based in north carolina (nationsbank [recently merged with bank america] and first union) radically changed their management team and subsequently their approach to banking. changes in the management team disrupt the status quo and general inertia of the organization. as more members of this dominant coalition are replaced, we would expect the likelihood of a dramatic shift in the organization to take place. given this discussion, we hypothesize the following: 138 journal of business strategies vol. 16, no.2 hypothesis 1: change in the dominant coalition will be positively related to subsequent change in the strategic type of the firm. changes in financial performance financial performance variables are the primary indicators with which the dominant coalition measures the effectiveness of their current strategy (ginsberg, 1988). two of the most important measures of financial performance are profitability and growth (capon, farley & hoenig, 1990). these variables are used to monitor the health of the organization as well as to evaluate the dominant coalition (hannan & freeman, 1984). interestingly enough, the association between organizational performance and changes in the strategic type of the firm has yet to be established (ginsberg, 1988). tushman and romanelli suggested that a decline in performance would trigger "a shift in perceptions of key strategic contingencies" (1985, pp. 20 i) and goodstein and boeker (1991) found moderate support for the contention that poor prior performance might have an impact on changes in the strategy of the firm. however, wiersema and bantel (1992) found a positive relationship between firm performance and a change in the scope of the firm (defined as diversification change), while romanelli and tushman (1994) did not find a significant relationship between poor firm performance and revolutionary organizational transformations. this confusing set of findings leaves current researchers and practitioners with little empirical guidance. in spite of this, it is conceptually difficult to hypothesize that a change of strategic types would be undertaken during periods of high performance. high performing firms would, by explication, seem to have a good fit with their environment and therefore have little incentive to initiate a dramatic change within the firm (ginsberg, 1988). consider walt disney company, a firm that has enjoyed a track record of success rarely achieved by corporations. profitability and growth have been on a ten-year trend of improvement resulting from an aggressive, consistent strategy of total family entertainment. no change in disney's strategic type is anticipated by their management nor desired by the stock market (huey, 1995). miles and snow (1978) further suggested that unintended outcomes of a firms' strategy may independently push the firm toward a change in its strategic type. in keeping with this more intuitive and conceptually supportable approach, we hypothesize the following: hypothesis 2a: the profitability ofa firm is inversely related to a subsequent change in the strategic type ofthe firm. hypothesis 2b: the growth of a firm is inversely related to a subsequent change in the strategic type of the firm. fall 1999 bamford, et at: transformation of strategic types methodology 139 sample and data a study of organizational antecedents to changes in strategic types requires that we attempt to control for environmental effects by selecting a single industry as opposed to a large multi-industry approach (spender, 1983). we chose to analyze the banking industry for the period 1989-1993. this period (while a growth period in banking) was characterized by its absence of significant discontinuities as defined by prior studies (kelly & amburgey, 1991; romanelli & tushman, 1994; tushman & romanelli, 1985). data was collected from both primary and secondary sources. since transformations of type are expected to be relatively rare, a large sample was chosen. primary data was collected during the fall of 1993 in the form of a survey of 924 u.s. banks randomly selected from all fifty states as listed in the 1990 rand mcnally bank directory. bank size was controlled by selecting banks using an existing bank classification scheme. for this research, we chose banks in the medium-asset class ($50 million to $1 billion in assets) which are more likely to be engaged in the singular business of consumer banking (roussakis, 1984) . the large-asset class banks tend to be diversified (e.g. brokerage operations, insurance subsidiaries and credit card centers) giving rise to multiple business level strategies and making it more difficult to accurately determine the appropriate segmentation of perfomlance and the potential for the use of separate business unit strategies. the medium asset class banking organizations allowed us to evaluate the realized strategies of the entire organization (shortell & zajac, 1990). survey responses were received from 255 bank ceos or 27.6% of those initially surveyed. the respondents classified themselves utilizing the miles and snow (1978) typology as: prospectors 71 (27.8%), defenders 86 (33.7%), analyzers 80 (31.4%) and reactors 18 (7.1 %). each ceo was asked to classify their firm's current strategy as well as their strategy during the previous one to three year period (zajac & shortell, 1989) based on written descriptions of miles and snow strategy types developed by mcdaniel and kolari (1987) specifically for the banking industry (appendix a). due to missing archival data, the sample was reduced to 227 of which 65 banks or 28.6% reported a change in their strategic type between their current strategy and the one pursued during the previous one to three years. the data was analyzed for potential response bias. no differences were found with either regional disparities or size between firms that had changed their type and those that did not. furthermore, an analysis of response bias by size or performance between respondent and non-respondent firms found no significant differences. variables and measures transformation of types. in keeping with our research objectives, the miles and snow (1978) typology allowed us to directly assess the change in type from the perspective of the decision-maker. zajac and shortell (1989) used this typol140 journal of business strategies vol. 16, no.2 ogy to conceptualize firm strategy in a similar way. in their case, ceos were asked to categorize the strategy type that best described their firm (hospitals) currently as well as during the prior two years. this method of evaluating realized strategies has been shown to be both reliable and valid (shortell & zajac, 1990). by comparing current strategy to prior strategy, they were able to develop a change of strategic type variable. chan~e in strategic type. this was coded as a binary categorical dependent variable (1change, 0no change). the limited number of banks that reported a change in strategic type prevented an analysis of all the individual types of change, therefore, a binary variable seemed the most appropriate. however, changes from anyone to another of the miles and snow types represents a change in the processes, direction and internal mechanisms of the organization. the questionnaire was completed by ceos using descriptive paragraphs of each of the four miles and snow strategic types which were tailored for the banking industry (mcdaniel & kolari, 1987). furthermore, the use of the miles and snow typology in this manner has been shown to have high measurement validity (james & hatten, 1994; shortell & zajac, 1990). ceo's were used as the key individual for assessing the firm's overall strategy (shortell & zajac, 1990; snow & hrebiniak, 1980). to assess the reliability of the ceos classification of strategic type, state bank supervisors (or a recommended and qualified substitute within the supervisory office) were selected as an appropriate expert group to validate the strategy type chosen by ceos. forty-one state banks supervisory offices agreed to participate. these experts were asked to classify the strategic type of each identified bank in their state. the alpha coefficient between expert and ceo agreement was .84 adding to our confidence that we were tapping into realized strategy. change in the dominant coalition is comprised of changes in three groups within the firm. they are: 1) the ceo/president; 2) the members of the board of directors, and 3) the members of the top management team. archival measures of the changes in the membership of the dominant coalition as well as prior firm performance were gathered from the polk's bank directory (north america) spring edition for the period 1989-1993. change in ceo. ceo change was coded as a binary variable with i representing a change in ceo and a 0 representing no change in ceo (keck & tushman, 1993). none of the banks examined had more than one change in ceo during the period examined. change in bod. board of directors change was coded on an interval scale with each change in the bod being coded as a 1. all changes were summed for a total change in the board. we then calculated a proportional change in each board in order to adjust for various board sizes (goodstein & boeker, 1991). in order to minimize potential confounding effects in the data, we did not count a ceo change or top management team change as a bod change. change in tmt. it is widely understood that banks in general and small banks in particular reward employees with officer titles. these titles are often referred fall 1999 bamford, et al: transformation of strategic types 141 to as "dry promotions" as they include no additional remuneration. furthermore, they are often awarded for reasons other than holding a significant strategic position within the firm (e.g. long tenure, community visibility). this makes archival identification of the true members of the tmt difficult. in keeping with prior literature, top management team changes were defined as those members of the management team that held the title of senior vice president and above. the coding system mirrored that used for bod changes. change in dominant coalition. given the multi-faceted nature ofthe dominant coalition (ginsberg, 1988), we utilized a single measure (varimax-rotated factor analysis) for the dominant coalition which was composed of the change in ceo, change in bod and change in tmt. financial performance. we obtained four archival performance measures to analyze the separate effects of firm profitability and firm growth. they were: 1) return on assets (roa); 2) return on equity (roe); 3) average annual loan growth (lg) and 4) average annual deposit growth (dg). these were collected from the polk's bank directory (north america) spring edition for the period 1993-1995 (wiersema & bante!, 1992; zajac & shortell, 1989). these measures are the predominant measures of financial performance in the banking industry and are reported in a standard, well regulated manner (garcia, 1985; roussakis, 1984» results table i presents the means, standard deviations, and correlations for the variables used in this study. table 2 presents the rotated factor loadings for each of our variables. three factors are apparent: 1) dominant coalition; 2) profitability and 3) growth. table 3 presents the results of the three separate logistic regression models. hypothesis i predicts that change in the strategic type of a firm will be preceded by changes in the dominant coalition. model i utilizes our dominant coalition factor score and yields a positive and significant beta (p<.oo i). changes in the dominant coalition are strongly related to a subsequent transformation of type. thus, hypothesis i appears to be strongly supported. hypotheses 2a and 2b suggested that firm profitability and growth would be inversely related to a subsequent change in strategic type. these hypotheses are partially supported. using the factor loadings, model 2 of our logistic regression found a negative and somewhat significant (p<.lo) beta for firm profitability. model 3 included firm growth, which had a negative beta, but was not statistically significant. the negative betas suggest an inverse relationship between firm profitability and growth with a subsequent transformation of type and as this was hypothesized, we conclude that hypothesis 2a is supported and 2b is not supported. -table 1 ~n summary statistics and correlationsb variable mean s.d. 1 2 3 4 5 6 7 1. change in strategic type 0.2915 0.4555 2. ceo change 0.2063 oa055 .24*** 3. bod change 0.2679 0.3583 .21 *** .4 i**'" ~;:: ~ 4. tmt change 0.3172 0.5377 .21*** .76*** .49*** t:l5. average roa 0.0057 0.0031 -.20*** -.15** ~ -.14** -.10 ~ $: ""...6. average roe 0.0635 0.0407 -.12* -.05 -.13* -.04 .71*** :;::i'i:l ""r..., 7. loan growth 0.0523 0.1261 -.06 -.08 ,02 .01 .21*** .28*** v)... t1 8, deposit growth 0.0725 0.1175 -.07 -.17** -.13* -.14** . i 8** .21*** .51 *** ... i'i:l !xl... ii:> r..., an = 227 *p < .05 ** p < .01 *** p < .001 ~ .-. ~o\ z 0 n fall 1999 bamford, et al: transformation of strategic types table 2 factor analysis of antecedentsa 143 variable tmtchange ceo change bod change average roe average roa deposit growth loan growth faclor eigenvalues percent explained • factor loadings are in bold dominant coalition 0.9121 0.8546 0.7554 -0.0408 -0.0796 -0.1789 0.0305 2.3981 34.30% profitability -0.0241 0.0000 -0.1108 0.9072 0.9067 -0.0869 0.3150 1.7495 25.00% growth 0.0102 -0.0975 -0.0998 0.1437 0.0280 0.8452 0.7618 1.1268 16.10% table 3 results of logistic regression analysisa model i model 2 model 3 " dominant coalition .58*** .60**-* .60"*"" (.15) (.16) (.16) profi tabi ii ty -.271 -.271 (.15) (.15) sales growth -.03 (.15) constant -.94 -.95 -.95 (.15) (.16) (.16) model chi-square 16.02*"* 19.24*** 19.30*** percent classified 72.20% 73.54% 73.99% • standard errors are in parentheses ***p < .001 .... p < .01 *p < .05 < .10 discussion based on the results, it. is clear that it is. not unusual for organizations to change from one strategic type to another. zajac and shortell (1989) found that over half of the organizations they studied, 55% to be more precise, accomplished such a 144 journal of business strategies vol. 16, no.2 transfonnation during the two-year time period they studied. these results may not be too surprising given that zajac and shortell specifically targeted turbulent environments. however, even in the relatively stable banking industry, we found that almost three out of every ten banks underwent a change of strategic type during the three-year time period we studied. while it would be enlightening to have comparable data from additional industries and environments, it seems clear that changes in strategic types are a relatively common phenomenon. our results also provide some evidence regarding the antecedents to a transformation of strategic types. the strongest results relate to changes in the dominant coalition. this variable was a composite of changes in the top management team, changes in the ceo position, and changes among members of the board of directors. in our analysis, changes in the dominant coalition were clearly and consistently linked to transfonnation of types. for example, among firms in our sample that did not undergo a transfonnation of type, only 14% had experienced a change in their ceo. this is in sharp contrast to the subsample of firms that did undergo a transfonnation of type, where 35% of the finns had experienced a change in their ceo. to understand the predictive power of dominant coalition change in predicting a transformation of strategic type, compare model 1 from table 3 to any of the other models in that table. knowing whether or not there has been a change in the dominant coalition is sufficient to allow us to correctly classify 72% of all the finns in our sample. adding all the tenns in our most complex model only improves our classification rate by approximately two percentage points. having said this, we need to point out that profitability was also a statistically significant predictor of transformation of type. the size of the effect was generally smaller, and it added little to our classification ability, but the finding supports the original proposition of tushman and romanelli (1985), who suggested that poor prior performance might be associated with an organizational reorientation. interestingly enough, their most recent research, which studied the effects around environmental discontinuities, found an insignificant connection between poor prior perfonnance and a 'revolutionary transformation' within the finn (romanelli & tushman, 1994: 1158). our study did not have the fine grained detail of the romanelli and tushman study and as such our knowledge of the organizational impact on the complete adaptive cycle of a change in strategic direction is limited. the weight of these various observations seems to suggest that there may be fundamental differences in both the factor and response mechanisms between relatively stable and unstable environments when analyzing transformations of type. in environments not identified with an environmental discontinuity, detection of needed change in type may be more focused upon factors within the firm. examining profitability, replacing members of the dominant coalition and perhaps as goodstein and boeker (1991) suggest, changes in organization structural variables are attempted as a precursor to a change in strategy, however, when the environment has changed dramatifall 1999 bamford, et al: transformation of strategic types 145 cally, the need to change is more obvious and the change is initiated by removing various perceived impediments to the implementation of the new strategy (keck & tushman, 1993). while change in the dominant coalition was an important place to start looking for antecedents of strategic change, it is not difficult to identify other possibilities. for example, changes in organization structure, changes in reward systems, and changes in funding patterns would all be plausible candidates for study. however, as one moves beyond the most distinct antecedents and into other possibilities, it becomes less clear what constitutes an antecedent and what constitutes part of an implementation effort facilitating the transformation of type after a decision has already been made to bring about such a change. furthermore, this study was focused on a single, regulated industry. while we believe that there are significant advantages to be gained from such focused research, we do not wish to suggest that this pattern exists outside of the banking industry. that is the subject of future research efforts. another interesting set of questions raised by the present research deals with the generalizability of the results. the questions here deal with generalizability across industries, however, we find that a more interesting question concerns generalizability across different combinations of transformations of type. for example, are the antecedents relevant to a transformation from prospector to defender the same as those relevant to a transformation from defender to prospector? how about a change from reactor to analyzer or vice versa. using the relatively simple four-part miles and snow typology, there are 12 possible combinations of transformations. a lack of data prohibited our controlling for the specific form of transformation, which has the benefit of a set of results more likely to be generalizable across the twelve different possibilities. however, what we gain in generalizability, we lose in accuracy, and it would be useful to see how our results would differ from one form of transformation to another. the results from this study offer some interesting implications for managers and organizations. it is not unusual for top executives to implore their organizations to undertake major changes in strategic orientation and to bemoan the resistance to change their organizations display. our results show that one of the most important antecedents in a change of strategies is a change in the dominant coalition ofthe firm. this may hint at a fundamental difficulty in bringing about transformation in strategic types. how often will executive teams be willing to replace themselves in order to help bring about a needed strategic transformation? of course, there is also a sort of converse logic that applies to the link between changes in the dominant coalition and changes in strategic types. how often do changes in the executive ranks lead to changes in strategy that would not otherwise be needed or motivated? there is a commonly observed phenomenon in which an individual offered a seat will not simply sit down, but instead will reposition the chair before being seated. there was nothing wrong with the chair's original position and there is nothing inherently better about the chair's new position. could execu146 journal of business strategies vol. 16, no.2 tives be making similarly unnecessary adjustments when they are offered new "seats"? given the costs and risks associated with major strategic changes, this is a potentially important question. research into this aspect of firm alignment offers a unique perspective of dominant coalition actions. pressures to perform and an increasing trend to hold members of the dominant coalition responsible for firm outcomes (pettigrew, 1992) suggest that these events provide a needed window into the strategic decision making aspect of organizations and offer ample incentive for continued research into the antecedents of the transformation of strategic types. references andrews, k. r. (1971). the concept of corporate strate~y. irwin, homewood, il. capon, n., farley, j. u. & hoenig, s. (1990). determinants of financial performance: a meta-analysis. management science. 36 (0), j143-1159. chakravarthy, b. s. (1982). adaptation: a promising metaphor for strategic management. academy of management review. 1 (1), 35-44. chandler, jr., a. d. (1962). strategy and structure: chapters in the history of the american industrial enterprise. the mit press, cambridge, ma. child, j. (1972). organization structure, environment and performance: the role of strategic choice. sociology. 6, 1-22. cool, k. & schendel, d. e. (1988). performance differences among strategic group members. strategic management journill. 9, 207-223. cyert, r., & march, j. (1963). a behavioral theqry qfthe firm. prentice-hall, englewood cliffs, nj. dutton, j. e. & duncan, r. b. (1987). the creation of momentum for change through the process of strategic change diagnosis. strategic management journal, 8, 279-295. garcia, f. l. (1985). how to analyze a bank stiltement (7th ed). bankers publishing co., boston, ma. ginsberg, a. (1988), measuring and modeling changes in strategy: theoretical foundations and empirical directions, strategic manilgement journal. 9. 559-575. goodstein, j. & boeker, w. (1991). turbulence at the top: a new perspective on governance structure changes and strategic change. academy of management journal, 34 (2), 306-330. fall 1999 bamford, et al: transformation of strategic types 147 finkelstein, s. & hambrick, d. c. (1990). top-management-team tenure and organizational outcomes: the moderating role of managerial discretion. administrative science quarterly. 35,484-503. hannan, m. t. & freeman, j. (1984). structural inertia and organizational change. american sociological review. 49, 149-164. hofer, e. (1964). the ordeal of change. harper & row publishers, new york. huey, 1. (1995). eisner explains everything. fortune. 131 (7), 44-68. james, w. l. & hatten, k. j. (1994). evaluating the performance effects of miles' and snow's strategic archetypes in banking, 1983 to 1987: big or small? journal of business research, 31, 145-154. jennings, d. f. & seaman, s. l. (1994). high and low levels of organizational adaptation: an empirical analysis of strategy, structure, and performance. strategic management journal 15,459-475. keck, s. l. & tushman, m. l. (1993). environmental and organizational context and executive team structure. academy of management journal 36 (6), 1314-1344. kelly, d. & amburgey, t. l. (1991). organizational inertia and momentum: a dynamic model of strategic change. academy of management journal. 34 (3),591-612. mcdaniel, s. w. & kolari, j. w. (1987). marketing strategy implications of the miles and snow strategic typology. journal of marketing. 51 (4),19-30. meyer, a. d. (1982). adapting to environmental jolts. administrative science quarterly, 27,515-537. meyer, a. d., tsui, a. s. & hinings, c. r. (1993). configurational approaches to organizational analysis. academy of management journal. 36 (6), 1175-1195. miles, r. e. & snow, c. c. (1978). organizational strategy, structure, and process. mcgrawhill, new york. miller, d. & friesen, p. h. (1980). momentum and revolution in organizational adaptation. academy of management journal. 23 (4),591-614. pettigrew, a. m. (1992). qn studying managerial elites. strategic management journal. u,163-182. romanelli, e. & l'ushman, m. l. (1994). organizational transformations as punctuated equilibrium: an empirical test. academy of management journal. 37 (5), 11411166. 148 journal of business strategies vol. 16, no.2 roussakis, e. n. (1984). commercial banking in an era of deregulation. praeger publishers, new york. shortell, s. m. & zajac, e. j. (1990). perceptual and archival measures of miles and snow's strategic types: a comprehensive assessment of reliability and validity. academy of management journal. 33 (4), 817-832. snow, c. c. & hrebiniak, l. g. (1980). strategy, distinctive competence, and organizational performance. administrative science quarterly, 25, 317-336. spender, j. c. (1983). the business policy problem and industry recipes. in r. lamb (ed.) advancys in strate~ic management. 2, 211-229. jai press, greenwich, ct. tushman, m. l. & anderson, p. (1986). technological discontinuities and organizational environments. administrative science ouarterly. 31,439-465. tushman, m. l. & romanelli, e. (1985). organizational evolution: a metamorphosis model of convergence and reorientation. in l. l. cummings and barry m. straw (eds.). research in organizational behavior, 7, 171-222. jai press, greenwich, ct. virany, b., tushman, m. l. & romanelli, e. (1992). executive succession and organization in turbulent environments: an organization learning approach. organization science, 3 (1),72-91. wiersema, m. f. & bantel, k a. (1992). top management team demography and corporate strategic change. academy of management journal. 35 (1), 91-121. zahra, s. a. & pearce, j. a. iii (1990). research evidence on the miles-snow typology. journal qfmanajwment. 16 (4), 751-768. zajac, e. j. & shortell, s. m. (1989). changing generic strategies: likelihood, direction, and performance implications. strategic management journal. 10, 413-430, fall 1999 bamford. et al: transformation of strategic types appendix a 149 which one of the following descriptions most closely fits your bank compared to other banks in the industry? (please consider your bank as a whole and note that none of the types listed below are inherently "good" or ·'bad.") type i this bank attempts to locate and maintain a secure niche in a relatively stable product or service area. the bank tends to offer a more limited range of products or services than its competitors, and it tries to protect its domain by offering higher quality, superior service, lower prices, and so forth. often this bank is not at the forefront of developments in the industry it tends to ignore industry changes that have no direct influence on current areas of operation and concentrates instead on doing the best job possible in a limited area. type 2 this bank typically operates within a broad product-market domain that undergoes periodic redefinition. the bank values being "first in" in new product and market areas even if not all of these efforts prove to be highly profitable. the organization responds rapidly to early signals concerning areas of opportunity. and these responses often lead to a new round of competitive actions. however. this bank may not maintain market strength in all of the areas it enters. type 3 this bank attempts to maintain a stable. limited line of products or services. while at the same time moving out quickly to follow a carefully selected set of the more promising new developments in the industry. the bank is seldom "first in" with new products or services. however, by carefully monitoring the actions of major competitors in areas compatible with its stable product-market base, the bank can frequently be "second in" with more cost-efficient product or service. type 4 this bank does not appear to have a consistent product-market orientation. the bank is usually not aggressive in maintaining established products and markets as some of its competitors, nor is it willing to take as many risks as other competitors. rather, the bank responds in those areas where it is forced to by environmental pressures. 150 journal of business strategies vol. 16, no.2 charles e. bamford received his ph.d. in strategic management and entrepreneurship from the university of tennesseeknoxville. during a twelve-year career prior to joining the university of tennessee, dr. bamford was the head of the business analysis department (mergers & acquisitions, dispositions, and small business consulting) for a super-regional bank holding company. his research has been published in strategic management journal, journal of business venturing as well as the frontiers of entrepreneurship research. patrick r. rogers received his ph.d. in strategic management from the university of tennessee-knoxville. he is an assistant professor of management at north carolina a&t state university, greensboro, nc. professor rogers research interests include strategic planning, strategic information as competitive advantage, organizational learning styles and organizational learning disabilities. his research has been published in the strategic management journal. alex miller is the william b. stokely professor of management at the university of tennessee-knoxville. he earned an mba from amos tuck school of business at dartmouth college, where he was a tuck scholar and a ph.d. from the university of washington. his research has been published in such journals as the academy of management journal, journal of business research, journal of business venturing, strategic management journal, and journal of management studies. transformation of strategic types: an examination of the internal antecedents to organizational change service encounter mismatches: a conceptual framework integrating it and job design george mechling beverly little western carolina university cullowhee, nc abstract as the services sector becomes a larger component ofour national economy, it becomes increasingly critical that the management of service operations is addressed systematically. one concern is the interaction of service employees and the technology making up the job design. effectively matching job design and technology leads to effective service encounters, while mismatches cause shortrun or long run problems for the organization. organizational mismatches between job design and supporting infrastructure, specifically the info171ultion technology (it) selected, can give rise to the use and exercise ofjudgment and discretion by service encounter employees that from the viewpoint ofthe organization or the customer is extraordinary. conflicted or perverse. perverse judgments debilitate the organization and degrade the quality ofthe service encounter. conflicted and extraordinary judgments ultimately debilitate the organization and may degrade the quality ofthe service encounter ifsome customers should perceive others as having received preferential treatment. this paper explores dynamics in managing operations, technology, and human resources that give rise to the exercise of such judgments with the intent to construct a conceptual framework that will explain such judgments and the behaviors that issue from them. introduction the importance of the service encounter to a service organization is well documented in the operations management and marketing literature. this encounter is often the only point of contact the customer has with the organization. it is the context in which the organization provides the customer with what is presumably of value. the customer assesses the value of what the service organization provides on the basis of how adequately it provides explicit and implicit benefits that meet customer needs and expectations. it is thus incumbent upon a service organization to insure that its customer contact personnel are sufficiently supported through appropriate job design, training, and supporting infrastructure that can include an appropriate information technology (it). this better insures that the organization's customer contact personnel represent it in the best possible way to its customers. 66 journal of business strategies vol. 17, no.1 job design defines the ext~nt to which customer contact personnel must exercise judgment in meeting customer needs. ideally, the organization's infrastructure is sufficient to support the confonnance ofjob design to customer needs. this paper will explore dynamics in managing operations, technology, and human resources that give rise to the exercise of problematic judgments with the intent to construct a conceptual framework that will explain such judgments and the behaviors that issue from them. the authors have identified three types of problematic judgments that they label perverse, conflicted, and extraordinary judgments. perverse judgments debilitate the organization and degrade the quality of the service encounter. conflicted and extraordinary judgments ultimately debilitate the organization and may degrade the quality of the service encounter if some customers should perceive others as having received preferential treatment. a conceptual framework that provides an adequate understanding of the dynamics that prompt such judgments being made pennits more effective planning of the service encounter, the discovery and analysis of the nature of service quality gaps, and suggests actions that can be taken to close those gaps. in cases where these judgments occur, remedial actions can be taken that have both operational and strategic implications. such a framework can benefit both the organization and the customers it serves. this paper is divided into five parts. part one is a literature review. this review provides the motivation for critiquing the quality of service encounters as a technology management and subsequent organizational design issue. this part will touch on the increasingly important role of services in societal economies, the focus on the training of customer contact personnel at the expense of attending to the organizational infrastructure that supports those encounters, and how the introduction of it into a service organization impacts its infrastructure. part two outlines the relationship between business strategy and service package design. part three examines the interaction of customer contact personnel's job designs as a function of the design of the service package and the manner in which the service organization employs it. part four, using several cases, introduces an incipient typology of service organization mismatches based on the dynamic factors introduced in the previous parts. part five analyzes the cases provided in part four for the purpose of suggesting remedies to the problematic judgements those cases depicted. thus, part five demonstrates the usefulness of the incipient typology developed in part four as an analytic tool for systemically examining and defining service encounter problems in an environment impacted by the installation of it. the role of services in the economy the evolutionary course societal economies appear to follow involves a movement toward increasing organizational complexity. technological innovations result in increased productivity and diversity in the extractive (including agriculture) -and manufacturing sectors of an economy which result in shifts of spring 2000 mechling & little: service encounter mismatches 67 the labor force into other sectors'! this shift is made possible only because of a simultaneous accompanying increase and expanding diversity of business, trade, infrastructure, social/personal, and public administration services. without the direct and indirect linkages that exist between the material goods producing sectors and these service sub-sectors, increased productivity and diversity in the goods producing sectors would not be viable (reddle, 1986). adequately performing this increasingly complex function has resulted in the percentage of the u.s. workforce allocated to services steadily increasing at a modest exponential rate in this century. since the 1960's, services have accounted for more than half of that labor force with no indication that the continued growth in this proportion has passed an inflection point (fitzsimmons & fitzsimmons, 1997). by 1995, service industries accounted for 75% of gdp and 78% of employment (keltnwer & finegold, 1999). therefore, it becomes increasingly important that services be the focus of critical attention for the purpose of evaluating their functional effectiveness and efficiency. if not done, our understanding of services for this time and the future may prove inadequate. eventually, this inadequacy will lead to their practical mismanagement and the degradation of the effectiveness and efficiency required of services to contribute toward the realization of healthy activity of an evolving economy. focus on the service encounter addressing the concerns for service quality and effectiveness has been done in several different ways. the most basic way is to analyze the service encounter, the interaction between the customer and the service delivery or customer contact personnel. researcb on service encounters may focus onperceptions ofmepersons involved in the exchange. hartline and ferrell (1996) devised a model that addressed the management of service encounter employees based on the perceptions of the three groups that had previously been studied separately; managers, employees and customers. their literature review and the literature search this paper's authors conducted inductively suggest that the preponderance of studies exploring service quality and effectiveness have limited themselves to issues related to micromanaging service encounters. global views of service quality and effectiveness management, in addition to service encounter models, more global views of the management of service performance have been addressed. bowen and lawler (1992) stress that decisions concerning how to manage service employees should be based on five contingency factors. they state that an organization should consider its basic business strategy (high volume versus customized output), the nature of the relationship to the customer (transactional versus relational), technology (routine versus nonroutine), business environment (predictable versus turbulent), and types 68 journal of business strategies vol. 17, no.1 of managers and employees (theory x versus theory y). thus, management of services is based on a set of variables that constitute settings in which service encounter perceptions are formed. singh and deshmukh (1999) advocate the application of total quality management (tqm) principles to the management of services. they stress that tqm is a systems approach to organizations in which every element interacts with every other element. like bowen and lawler, they argue that service quality is not simply a function of what the manager wants the employee to do, or what the customer perceives, or how well trained the employee is. the success of a service organization is predicated more on the interaction of many its aspects. one systems approach to achieving service quality and effectiveness is found in hauser's and clausing's (1988) "house of quality." applying the "house of quality" to the service encounter, fitzsimmons and fitzsimmons (1997) show how marketing, design, engineering and manufacturing (delivery) must be coordinated in order to actually meet the customer's desires. information technology fit) and global views of service quality and effectiveness a global or systemic view is critical in managing an organization's adoption of a technology, particularly when that adoption directly involves the organization's operations. the manufacturing management literature of the 1980's and early 1990's, for example, is replete with discussions that advocate this perspective. this is so because its contributors found that the repercussions of introducing a new technology into a manufacturing concern ran through virtually every aspect of that concern's organizational structure. they further found that unless that concern accommodated the adoption of its new technology by reorganizing itself so as to effectively exploit its new technology's capabilities, the end result was far more likely to be counterproductive and deleterious than beneficial (festa, 1987; gerwin & kolodny, 1992; meredith, 1986). both sciulli (1986) and rodger and paper (1998) argue that what has been said about manufacturing organizations and their adoption of new technologies holds true for service organizations as wen, and their adoption of it, in particular in both the banking and healthcare industries. their argument is in part supported by the work of a committee of the national academy of sciences that identified a phenomenon that it labeled the "information technology paradox." this paradox refers to the lagging growth in service sector productivity when compared to the growth in investments in service sector it. the committee provided a list of several explanations for this paradox. at the top of its list was the mismanaged employment of information technology (heitoff, 1998). this paper pursues research of the sort anticipated in the efforts of those cited in the previous paragraph. it does not however, discount the importance of the service encounter, that is, the interaction between customers and customer contact spring 2000 mechling & little: service encounter mismatches 69 personnel. rather, it regards successful service encounters as resulting from a coordinated convergence of organizational factors; customer contact personnel training, job design, the reward/punishment system, empowerment, and the manner in which it is integrated with the rest of these factors forming an organizational infrastructure supporting those encounters. by rigorously analyzing service operations and the encounters they produce as a function of the effectiveness with which technology and its adoption are managed, it may be possible to discover a basis for identifying types of service failures resulting from infrastructure design flaws integrating it. business strategy organizational strategy begins with the organization's mission statement that identifies what service the organization provides. this implies an interaction between the target market segment and the service provided and an interaction between technology and personnel employed to produce and deliver the service and how the service package is designed (figure 1). figure 1 service package/job design and market interaction figure 1 illustrates an interaction between the job design/service package and its market via the service encounter. the design of a job consists of what customer encounter personnel are expected to do based upon their skills and qualifications and organizational constraints (±empowerment and other inputs). these expectations 70 journal ofbusiness strategies vol. 17, no.1 cannot, however, be divorced from the technology through which customer encounter personnel act. a service is produced as a response to an existing market that it can opportunistically enter, as an instrument that calls new kinds of markets into being, or as a combination of both. the internet auction company, ebay, is a recent example of such a combination. on-line auctioning existed prior to ebay 's appearance. however, ebay took on-line auctioning several steps beyond what already existed to an interactive environment and redefined customer expectations. as a result, ebay has virtually monopolized the on-line auctions industry and has dramatically expanded the industry's market in which it is the dominant player, attracting new customers while holding its old ones (dunkin, 1999). the nature of services is such that their production and consumption is simultaneous (mills & moberg, 1982; schmenner, 1986). consequently, the production and delivery of a service constitute its encounter with the customer whose expectations are standards against which the efficacy of the service is evaluated. how the production and delivery of the service are designed into the service package is therefore, critical. the technology selected for the service package plays a part in that design (fitzsimmons, 1983). on the one hand, the service package is first designed to which a suitable and available technology is then attached. such is the case, for example, with fast foods where it systems are employed to open transactions and communicate customer orders to the back room. it may be employed in the back room to monitor operations and bring the transactions to a close (mechling & little, 1997). on the other hand, technology may restrict how decision makers would like to design their service packages or it can open up the design of a package so as to include heretofore infeasible possibilities by which competitive advantages can be pursued. such is the case, for example, in teleradiology (dwyer, sayer, & honeyman, 1992; franken, 1998). recent developments in it (particularly compression and transmission technology) and standardization in the way imaging equipment generates its images has made it technologically possible to physically decouple radiologists from the images they must read. as a result, access to radiological services has become decidedly more timely and widespread for potential customers (especially those in remote locales) than heretofore thought possible. such developments have created opportunities to redesign the initial service package and revise customer expectations by reinforcing initial diagnoses with second and third opinions and exploiting subspecialization skills while at the same time, reducing the turn-around time to patient (customer) consultation (heitoff, 1998). service packae-e desie-n the widely accepted means of categorizing service organizations is through the use oftypologies (cook, gho, & chung, 1988; kellogg & nie, 1995). one of the most widely used typologies is lovelock's (1983) that strategically profiles a service package. of particular interest to the authors of this study is lovelock's typology that juxtaposes ± customization of services with ± exercise ofjudgement spring 2000 mechling & little: service encounter mismatches 71 and discretion by customer contact personnel in meeting individual customer needs.2 a barber, for example, is expected to provide the customer more customized services than a home pest extenninator who has a finite set of program modules from which to select and much less judgment to exercise. like the barber, an attorney also perfonns a customized service but the attorney must use and exercise judgement and discretion that exceeds the judgment and discretion a barber uses and exercises and certainly exceeds the judgment and discretion the home pest exterminator must use and exercise (figure 2). it is expected that similar services will position themselves similarly in lovelock's typologies. technological innovations in service production and delivery can, however, lead to typological repositionings of a service operation and a consequent revision and redesign of its profile and service package. one must assume that such redesign of the service package is done to derive some competitive advantage or at least prevent the service operation from being competitively disadvantaged. the various technologies an organization chooses to employ therefore interact with all the typologies that strategically profile it and contribute to the design of the organization's service package. the specific interaction between the employment ofit and the extent to which customer contact personnel are empowered or not empowered to use and exercise judgment and discretion to meet customer needs during the service encounter is this study's object of analysis. working down the main diagonal of lovelock's typology of customization and discretion, the more standardized the service, the less use and exercise of judgement and discretion by customer contact personnel is necessary. the more customized the service, the more use and exercise of judgement and discretion by customer contact personnel is necessary.3 figure 2 lovelock's typology ----increasing standardization -----.... decreasing need for the exercise and use of judgement and discretion by 1 professional services mass education surgery preventative health taxi service programs beautician plumber college food service telephone service public transportation hotel services routine appliance repair most retail banking movie theatre family restaurant spectator sports 72 journal of business strategies vol. 17, no.1 in most cases customer contact personnel are the sole points of contact customers have with an organization providing them the service they seek. their evaluations of it and decisions about future patronization of it are largely determined by how customer contact personnel manage to present the organization during service encounters. thus, how the judgment and discretion customer contact personnel are empowered or not empowered to use and exercise and the it they employ interact in the design of the service encounter can be decisive if the organization is to attract and hold its customers. the extent ofjudgment and discretion customer contact personnel are expected to use and exercise understandably varies from service to service. however, what about situations that do not precisely conform to a given service for which the technology has been designed? judgment and discretion used and exercised by customer contact personnel in such situations is important for at least two reasons. first, decisions including judgment and discretion or the lack of them may affirm or contradict organizational objective or policies. furthermore, unacceptable decisions issuing therefrom will result in positive or negative encounters from the customer's viewpoint. these decisions may be particularly important in achieving a service recovery when a service failure has occurred or is imminent. choice of it a service operation employs it in order to increase and improve service efficiency and effectiveness in a way that is consistent with its competitive strategy. fitzsimmons (1993) suggests that it accomplishes this by creating another entry barrier, generating revenue, creating a database upon which empirically based decisions can be made, and enhancing productivity. customer contact personnel draw on and contribute to such a resource when they access it to support their service encounter activity. their access to the it system can, however, vary. they may be restricted with respect to the range of information they can browse. they may also be restricted with the respect to the range of infonnation they can input. fast food customer contact personnel can browse virtually no range of infonnation and the range of information they input into the system is restricted to the orders they take. their job can be characterized as being almost completely circumscribed by the technology associated with their job.4 a customer wants, for example, a taco with allowable modifications. a predetermined closed set of intermediate steps is synchronic with the outcome. the employee merely selects predetermined and technologically constrained choices, as one would push a stop or start button on a machine. airline ticket counter personnel must, on the other hand, be able to browse routings, schedules, and ticket information for the entire industry in order to input the orders they take. the outcome of the order (a customer being at point b after having been at point a) is something separate from the subset of intermediate steps that achieve it (getting to point b from point a). airline ticket counter personnel must create that subset (construct a routing). they use it to expedite spring 2000 mechling & little: service encounter mismatches 73 the construction and creation of that subset. the it they employ does not therefore, so nearly circumscribe their jobs as with the fast food order taker. figure 3 lovelock's typology increasing standardization -----t..~ pc decreasing need for the exercise and use of judgement and discretion by 1 sional services rgery taxi vice beautic plumber telephone service hotel services most retail banking family restaurant mass education preventative health programs college food service increasing technological increasing technological circumscription ---1"~ tc tc total circumscription pc . partial circumscription job desil:d job design for service employees has been categorized as a "production line" approach or an "empowerment" approach (bowen & lawler, 1992). the production line approach, as its name implies, is based on a tayloristic view. it is based on four tenets simple tasks, clear division of labor, substitution of equipment and systems for employees, and little decision-making discretion of employees. this design seeks to gain customer satisfaction through efficiency, consistency, and low costs. the empowerment approach, on the other hand, allows employees to make decisions that in the production orientation would be reserved for higher-level management. in such settings, jobs are less simple and more broadly defined and employees are given more latitude. in order for employees in such a design to be effective, they must have access to needed information, knowledge about how to use the information, and sufficient power to meet customer requests during the service encounter. the production line approach gains its low costs through consistency, which can be translated into lack of personal service. this means that as the service 74 journal of business strategies vol 17, no.1 encounter is standardized, the choice of actions possible by the service provider is limited. attempts to provide personalized service in such a setting would drive up costs and violate the competitive advantage of the firm. in addition, while the customer receiving the personal service may be more satisfied, other customers who are receiving slower service because of it may be disgruntled. the empowerment design is slower, less efficient and more expensive to operate. it requires careful selection and extensive training of employees. this design could put a firm at a competitive disadvantage from a cost standpoint servicing encounters of a routine form. companies must clearly define their business strategy and know the environment and the customer base they pursue in making a decision concerning job design for their employees. interaction of job desi2n and information technolo2y it is imperative with the production line job design that it is installed as a part of that design so as to facilitate matching it to the service encounters anticipated. the number and nature of the options from which the employee chooses should then be limited to matching the constraints on their decisionmaking authority. any access to additional information would not only be of no use~ it would actually deter efficiency. for example, if all hamburgers are prepared to the same degree of doneness, giving a customer encounter person the option of asking a customer how he/she would like the meat cooked would slow down the process. in fast food, cash registers (which also communicate orders to the backroom) prompt order-takers through the decisions that are allowable. thus, the more standardized the service the more easily circumscribed technologically it can be 5 because the reality of the encounter is simple and presumed to be more easily captured than encounters in which provided services are customized and the outcome of anyone such encounter is variable. the more circumscribed technologically the service is, the more efficiently the service can be performed but the more dependent upon the circumscribing technology customer encounter service personnel become. in the case of the empowerment job design, use of judgment and exercise of discretion on the part of employees demands access to information. ifthe employee is to provide personalized service, the it system must provide access to information concerning options and their availability. thus, if the service can be customized and the service provider has discretion, the information must be provided to enable that discretion to be used. this means that the less standardized the service the less easily circumscribed technologically it can be because the reality of the encounter is too complex and varied in individual outcomes to be easily captured. this does not mean however, that these customer contact personnel are any less dependent upon the technology that less extensively circumscribes their job than their counterparts who provide standardized services. rather, their dependence is spring 2000 mechling & little: service encounter mismatches 75 different. they cannot effectively use and exercise judgment and discretion that, by definition, are parts of their job without it. a typology of service organizational mismatches one may assume that for any given range of actions provided to customer contact personnel, protocols exist that prohibit, obligate, and permit selections of alternatives that depend on the encounter circumstances. within this normative framework, the exercise and use ofjudgment and discretion can be extensive or limited to the point of being virtually nonexistent. where their use and exercise are extensive, it is to presumably match and conform the job to the needs and expectations of specific customers. where their use and exercise are virtually nonexistent, the job as it is designed and its supporting organizational infrastructure are presumably adequate to also match and conform the job to the needs and expectations of specific customers. organizational mismatches, therefore, arise between the job design and its supporting organizational infrastructure when customer contact personnel are confronted with a service demand that cannot be met without their being at odds with how they are to do their job and/or with the goals and objectives of the organization. this section provides a typology of such mismatches based on job design and it as the significant infrastructural component of interest providing the contexts in which judgement and discretion are used and exercised. violations of the job design can occur in a number of ways. first of all, do customer contact personnel follow courses of action that fall outside what the technology circumscribes for them? examples of such behavior are abundant. one can imagine an employee breaking open a cash register to make change for a customer because there is no sale with which to ring it open or no access to a key with which to unlock it. one can also imagine a situation where a hotel guest is permitted to take a free muffin from the breakfast line because the cash register is not programmed with a "muffin" key. as job violations go, breaking open a cash register to make change is certainly more extreme than giving away muffins. both cases, however, suggest that the customer contact job as it is technologically circumscribed may be inadequately designed to satisfactorily address every encounter for providing service that might come its way. such design inadequacies typify mismatches. such mismatches could lead to service failures that in some cases only the extraordinary use and exercise of judgment and discretion can repair. thus, the exercise of extraordinary judgment is a legitimate topic to examine. figure 4 illustrates the process by which the use and exercise of extraordinary judgement and discretion occurs. the job design/service package is totally circumscribed, consisting of other organizational inputs including customer encounter personnel who have no leeway whatsoever using or exercising judgement and discretion in their conduct of the service encounter. as long as these encounters are routine, i.e., match the job's design, encounters are successful 76 journal of business strategies vol. 17, no. i and customers are satisfied. non-routine encounters, on the other hand, do not match the job design. from the viewpoint of the organization, such an encounter is a non-event. it is certainly not a success but neither is it a failure, for the organization has not defined the customer's need as something the job was designed to satisfy. from the viewpoint of the customer seeking satisfaction, however, it is hard to argue that the encounter can be anything but a failure. the customer encounter personnel may, however, be able to satisfy a non-routine need and achieve a service encounter success attended by a mix of other results, but they must do so by abandoning altogether the use of the technology that is a fundamental functional part of their job's design. figure 4 extraordinary judgementsldiscretion routine satisfied organizational / encounter; customer ~ reputation -(jid) , / .... production line encounter .x job design \~ success .. envious ./' dissatisfied tc customer (dissatisfied) custom ~ \:encounter / ~customers encounter failure , . encounter orgaolzatlonal /' success debilitation extraordinary ± (jid):± use .and exercise of judgement jid ~a~~s::::~r and discretion u pc: partial circumscription tc: total circumscription violations can occur within the job as designed and technologically circumscribed. these violations involve judgments that disregard organizational protocols and lead to particular technologically-doable ends that the technology installed is not intended to support. such judgments may be conflicted or perverse. the exercise of judgments that are conflicted may result in a service encounter success in the view of the customer and probably the customer encounter service person as well. take for example, a customer who wishes to make a last minute change to hislher discount fare airline ticket at an airport airline ticket-counter. penalties for making such changes are part of the terms to which the customer agrees when he/she purchases such a ticket. yet, the customer encounter service personnel at airline counters in airports rarely assess such penalties. not only will they change flights for discounted tickets, they will even change airlines. they are perfectly capable of assessing such penalties, taking money, even making change. they have the it available to do it, but they rarely do despite the fact that airline management directs them to the contrary. apparently, such personnel are empowered to exercise a great deal of individual judgment and discretion in such matters as they weigh such issues as customer flow, acceptable aircraft load factors, spring 2000 mechling & little: service encounter mismatches 77 +(1id)~ pc/ and customer goodwill.6 the authors regard conflicted judgments as being made in situations where the customers can be better served even though providing such service could prove detrimental to the service organization. figure 5 illustrates the process by which the use and exercise of conflicted judgment and discretion occurs. the job design/service package consists of a partially circumscribing it and other organizational inputs including customer encounter personnel who have substantial leeway in terms of the judgement and discretion they can use and exercise in their conduct of the service encounter. given that non-routine!custo91 service encounters are within the realm of possibility, success certainly occurs when customer contact personnel use and exercise judgement and discretion only insofar as they choose to strictly adhere to organizational guidelines and policies. thus an airline customer contact person could change a customer's discount ticket and assess the prescribed penalty and neither party would have any reason to regard such an encounter as anything but successful, for the desired change was made and the customer was assessed only the agreed-upon change fee. such customer contact personnel can, however, use and exercise their judgement and discretion and not adhere to policies by choosing not to assess a customer a penalty for changing a discount ticket. this also results in a successful service encounter from the point of view of the customer. it is, however, one that is lavish compared to assessing the customer a penalty for making the change. furthermore, such a choice on the part of the customer contact person does not involve abandoning the technology that is a part of hislher job design but putting it to use. figure 5 conflicted judgementsldiscretion custom satisfied organizational / encounter; customer ~ reputation empow~red --iiiencounter i job deslgn success di' fied envious /' c~s~~~~r ~(dissatisfied) encounter customers failure la . h org . . al vis amzatlon 6 encounter debilitation conflicted ",. success i""±-(-jid-)-:±-u-s-e-an-d-e-x-er-c-ise-of-j-ud-g-e-m-en--'t lid satisfied and discretion customer pc: partial circumscription tc: total circumscription the exercise of perverse judgments and the behaviors that ensue are often motivated by a perceived need on the part of various employees to "beat the system" and almost invariably jeopardize the success of the service encounter and well being of the service organization as well. a study the authors did of a 78 journal of business strategies vol. 17, no.1 well-known fast-food service franchise, referred to as flex-mex, serves as an example (mechling & little, 1997). flex-mex's market qualifiers were a number of competitive priorities, "mass customization" of its product and speed of service. its employment of it contributed to a great extent in making this possible. flexmex's cash register(s) transmitted orders through a computer to display screens located in its back room where ingredients were assembled into menu items and orders filled. the assembly employee who completes the last step in filling the order removes it from the display screen. the screen then displays the next order in the queue. screens may hold many orders at a time and rarely do they become overloaded. this is due in part to screen capacity and in part due to the fact that an order can be "bumped" (erased from the screen) at anytime. assembly personnel, therefore, do not necessarily need to wait until a customer physically receives his/her order to remove that order from the screen. it, however, performed more than an order communication function for flexmex. it was used to monitor order delivery speed performance and foodstuffs wastage. crews were rewarded for above-standard performance with half-price menu items for their meals and were denied half-price menu items for their meals and/or penalized individually with demotions or dismissal for sub-standard performance. as a result of this additional set of functions it performed, assembly personnel would often "bump" an order before it was filled because that would stop the timer on that particular order. thus, assembly personnel were able to insure that no one order ever took an excessive amount of time quite independent of whether a customer had to wait an excessive amount of time for hislher order. such a practice also resulted in misfiiled orders since employees often carried as many as five different orders in their short-term memory. several other downside phenomena accompanied these service failures. first, the correct order had to be refilled. this took additional time but it was not timing this activity. second, the shelf life of these menu items is very short once prepared, less than five minutes in most cases. thus, a certain amount of foodstuffs had to be scrapped if no new customer came along shortly ordering the same item. the assembly crew could only compensate for this waste by shorting other orders by small amounts of the ingredients. figure 6 illustrates the process by which the use and exercise of perverse judgement and discretion occurs. the job design/service package consists of a partially circumscribing it and other organizational inputs including customer encounter personnel who have no leeway whatsoever in terms of the judgement and discretion they can use or exercise in the conduct of the service encounter. what is noteworthy is that it is not an encounter with a customer that elicits a perverse use of the technology of which the job design is in part constituted, but the encounter with limited measures of employee performance upon which a system of rewards and punishments is based. the encounter with the customer is irrelevant. spring 2000 mechling & little: service encounter mismatches figure 6 perverse judgementsldiscretion 79 ± (jid):± use and exercise of judgement and discretion pc: partial circumscription tc: total circumscription prospect of punishment -(jid)~ pc ",/' "fouled up" job design technologically driven i partial perfonnance ~ prospect of i failing to meetr/standards ~-(lid) "'.. perverse jid analysis organizational7,"on dissatisfied reward customers organization! debilitation encounter . failures satisfied / customer encounter success analysis of these cases can establish the utility of a conceptual framework to explain the use of judgment by customer contact service personnel when acting within the technology paired to their jobs. thus, what would otherwise be anecdotal information can be processed into knowledge about the management of operations, technology, and human resources. such knowledge will permit decisions to be made as to the extent to which customer contact service personnel should use judgment and exercise discretion to the benefit of both the customer and the servicing organization. the first case involves two examples in the use of extraordinary judgment. one is the example of breaking open the cash register to give a customer change. the other is the hostess who gives away breakfast muffins. both examples suggest that the involved customer contact personnel are committed to effectively serving the customer. both, however, constitute organizational mismatches that derail the organization's pursuit of its goals. the circumscribing technology has not adequately comprehended all the different kinds of service encounters involving customer needs. given that service operations management does not recognize needing change or wanting only a muffin as legitimate customer needs, the protocols in place are not adequately conceived. the ends of the organization and the ends of its customer contact personnel are at odds because the technology as employed by the organization is divisive. given the conceptual framework the authors have constructed several alternative courses of action that can be proposed. there may be very good reasons why customer contact service personnel are not allowed to make change. ifmanagement wishes to continue that restriction, the protocols must be very clear that customer contact service personnel are not so empowered. if the failure to make change 80 journal of business strategies vol. 17, no. i results in needless loss of goodwill, the most obvious alternative course of action would be to give the operator the cash register access key. such a change in policy would invariably require additional protocols as to whom change can be given and when it can be given, thus empowering the register operator to use hislher judgment and exercise discretion in applying those protocols. concerning the muffin give-away example, the most obvious failure is that the technology inadequately captured the range of service encounters. this failure should be easy to rectify by merely programming the register with alternatives to selling just the buffet. this would further circumscribe the register operator's job and remove the need for extraordinary judgments from time to time. given that part of the hotel's breakfast line consists so often of a breakfast buffet, there may be little incentive to go to that kind of trouble since little control would be exercised over breakfast buffet customers as to how many muffins they might take in the first place. be that as it may, over time, the practice of muffin give-away could prove costly and, while the cost of operating a breakfast buffet line is partially subsidized by hotel registrations, there is little reason to carelessly add to its cost. despite upper management level directives urging airline ticket counter personnel to assess penalties more frequently, they continue to use and exercise their judgment and discretion in this matter and assess them much less frequently than upper management would prefer. they do this without fear of sanctions. this is a case of conflicted judgments and could of course be resolved by technologically circumscribing the process by which those changes are made. it would be an easy matter to program for such changes so that the change could not be finalized until the penalty was assessed for the change. this would take the control of assessing such penalties out of the hands of the airline ticket counter personnel. such programming has not however, been done. the reasons for not doing such programming could be several, the most likely one being that airline ticket counter personnel have as a primary task facilitating the movement of traffic through the terminal. anything contributing to impeding that movement must be regarded as undesirable and costly. airline ticket counter personnel are, therefore, left to use judgment and exercise discretion in such matters since assessing penalties could prove time consuming. on the other hand, changing discounted tickets disrupts the yield management schemes designed to optimize flight revenues. changing discount tickets involves a cost for which airlines can make a compelling argument. penalties are assessed to offset this loss. this conflict between what is practiced and the protocols in place suggests that from the standpoint of the conceptual framework the airline ticket counter personnel have not been sufficiently empowered. they certainly have been sufficiently empowered in terms of their use and exercise of judgment and discretion. they have not, however, been sufficiently empowered to have a say in how the protocols are devised and applied (bowen & lawler, 1992). the higher levels of airline management would do well to so empower them. working together on equal footing, both parties might be able to agree on protocols that would garner more spring 2000 mechling & little: service encounter mismatches 81 revenue through penalties that would offset the organization's yield management shortfalls while keeping the traffic moving at an acceptable rate. the case of flex-mex provides a true-life example of the judgments service personnel (in the case, back room personnel) make that are perverse. unlike extraordinary and conflicted judgments that work for the most part to the benefit of the customer but are potentially debilitating to the service organization, perverse judgments are debilitating to the service organization including the quality of the customer service it provides. the conceptual framework the authors have constructed provides a basis for identifying the factors that contributed to the flex-mex mismatch and proposing alternative courses of action to remedy it. first, the extent to which technology circumscribed the jobs of the flex-mex employees, particularly those in the back room, was not extensive enough. this resulted in flex-mex's reward/punishment system and its performance measurement method that were intended to motivate high performance actually leading to the contrary (kerr, 1995). in addition, flex-mex's employees were not sufficiently empowered for management to be receptive to their observations concerning their dysfunctional work setting or suggestions they might submit as to how that work setting could be made more functional. thus alienated, they acted in a way to protect their individual interest that put them at odds with some of the organization's goals and objectives. the conceptual framework constructed suggests several alternative courses of action flex-mex could pursue to remedy this mismatch. first, it could extend the application of its it to more completely circumscribe the tasks of its employees. this could include timing an order from when it is placed with the order taker to when it is placed on the customer pick-up portion of the front counter and not electronically permit back room employees to "bump" orders from their screens. the it system could also be reengineered to account for redoing misfilled orders. such changes in it's application would certainly restrict the extent to which employees could make perverse judgments. it would also, however, undoubtedly further intensify the hostility of the work environment and could lead to other undesirable results. flex-mex could also consider empowering its employees in ways that could possibly even dispense with any need to reengineer its it system. revising the incentive and performance measurement systems would be a start. tying their rewards to the success of both their local operation and the organization at large might do better at gaining the loyalty and dedication of flex-mex's customer service personnel than providing them half-price menu items (mcnerney, 1996). this would be especially so if these personnel had some say as to what those rewards would be and how their performance should be measured. this does not necessarily mean that the use of judgment and the exercise of discretion in doing their jobs would be increased. these jobs require the use and exercise of little judgment and discretion. rather, it would mean that flex-mex's customer contact service personnel had a stake in how well flex-mex does. 82 journal of business strategies conclusion vol. 17, no.1 this paper has provided a conceptual framework for exploring the dynamics that arise in managing the integration of operations, technology (primarily it), and human resources. it has focused on how mismatched combinations of operations, technology, and human resources impact the use and exercise of judgment and discretion by customer contact service personnel and how these organizational anomalies can be eliminated. the few examples presented in this paper hardly provide sufficient data to empirically validate this framework and the kinds of organizational mismatches it identifies. furthermore, the off-diagonal categories have not been addressed. therefore, further work empirically validating and perfecting this framework or developing one to more accurately categorize types of service organizations in order to better isolate types of intra-organizational mismatches is in order. beyond that is the issue of determining from among a set of alternative courses of action the framework specifies which alternative is the most appropriate to pursue in eliminating organizational mismatches. thus, it will be necessary to identify, select, and develop measures as well as techniques to process these measures to rigorously determine the appropriate alternative course of action. the authors believe that this program of applied research is both fruitful and valuable inasmuch as it addresses potential service operations ineffectiveness and inefficiency resulting from failures integrating technology and human resources and could contribute to sorting out the factors that have resulted in the "information technology paradox." references bowen, d., & lawler iii, e. (1992). the empowerment of service workers: what, why, how, and when. sloan mana~ement review, spring, 31-39. clark, c. the conditions of economic progress 3rd ed. london: the macmillan co. cook, d.p., gho, c.h., & chung, c.h. (1988). service typologies: a state of the art survey. production and operations mana~ement. 8, 318-338. committee to study the impact of information technology on the performance of service activities. (1994). information technology in the service society. washington, dc: national academy press. dunkin, a. (1999). all the world's an auction. business week, feb. 8, 1999, 120-121. dwyer, s.b., sayre, s.j., & honeyman, j. (1992). wide area network strategies for teleradiology systems. radio~raphics. 12 (30), 567-576. spring 2000 mechling & little: service encounter mismatches 83 festa, f. (1987). methodology to evaluate cad/cae/cam systems. computer applications in production and en~ineerini, 893-912. fitzsimmons, j. (1993). strategic role of information in services. perspectives in operatjons management: essays in honor of elwood s. buffa. r. sarin (ed.). norwell, ma: kluwer academic. fitzsimmons, j., & fitzsimmons, m. (1997). service management: operations. strate~y. and information technology 2nd ed. boston: irwin/mcgraw-hill franken, e. (1998). teleradiology: moving into the mainstream. telemedicine today. 4 (1),6-7. gerwin, d., & kolodny, h. (1992). management of advanced manufacturing technology: strategy. organizatiqn. and innovation. new york: john wiley and sons, inc. hartline, m.d., & ferrell, o.e. (1996). the management of customer contact service employees: an empirical investigation. journal of marketing. 60, 52-71. hauser, j.r., & clausing, d., (1988). the house of quality. harvard business review, may-june, 63-73. heitoff, k. (1998), reinventing the wheel. decisions in imaging economics. 11 (2), 1216. kellogg, d.l., & nie, w. (1995). a framework for strategic service management.lqm:nal of operations management. 13, 323-337. keltner, 8" & finegold, d. (1999). market segmentation strategies and service sector productivity. california management review. 41 (4),84-103. kerr, s. (1995). on the folly of rewarding a, while hoping for b. academy of manaaement executive. 9 (1), 716. lovelock, c. (1993). classifying services to gain strategic marketing insights. journal of ma[}cytin~. 47, 9-20. mcnerney, d. (1996). creating a motivated workforce. hr focus. 73 (8), 1-4. mechling, g., & little, b. (1997). operations and hrm: can it merge the two in support of business strategy. journal obhy international academy for case studies. 3 (1), 811. meredith, j. (1986). automation strategy must give careful attention to the firm infrastructure. industrial eniineerin~. 18 (5), 783-792. 84 journal of business strategies vol. 17, no.1 mills, p., & moberg, d. (1982). perspectives on the technology of service operations. academy of manal:ement reyiew. 7, 467-478. riddle, d. (1986). service-led a:rowth. new york: praeger. rodger, j., & paper, d. (1998). an empirical study for measuring operating room quality performance attributes. journal qf hikh iecbnoloky mll.nakement research. 9 (1), 131-157. schmenner, r. (1986). how can service businesses survive and prosper? sloan manaiement review, sprink, 21-32. sciulli, l. (1998). how organizational structure influences success in various types of innovation. journal of retail bankina: services, 20 (l), 13-19. singh, s., & deshmukh, s.g. (1999). quality initiatives in the service sector: a case. iotal quality manaiement. 10. 5-18. 1 this empirical observation, the clark-fisher hypothesis, explains employment shifts toward sectors of lower productivity (clark, 1957). 2 according to cook, gho, and chung (1988), researchers have developed different typologies to answer specific questions a pragmatic consideration. therefore, the authors believe that they have sufficient warrant to employ one of lovelock's typologies because of its implicit usefulness to the question at hand. 3a competitive advantage can be achieved by providing a low-cost speedy standardized service to a large market segment with similar needs or by providing customized service to a segment whose needs are dissimilar. in the first case customizing services would be inefficient, strategically contradictory, and possibly annoy customers delayed by the preferential treatment they perceive others receiving. in the latter case, such customization would be strategically necessary because it would be what was expected. 4 a totally circumscribed job design is one in which every organizationally sanctioned course of action customer encounter personnel can take as a part of their job is executed through the it system. 5 the extent to which a particular service is technologically circumscribed, if at all, depends of course on factors other than the mere fact that it can be done. certainly the benefits gained and the costs incurred to so circumscribe a set of tasks are major onsiderations. spring 2000 mechling & little: service encounter mismatches 85 6 from conversations with delta, usair, and lwa airport ticket/check-in counter personnel. george w. mechling is an associate professor in management at western carolina university. dr. mechling's teaching and research interests include operations management, operations management, and the management of technology and innovation. beverly little is an associate professor in management at western carolina university. dr. little's teaching and research interests include human resource management and organizational behavior. service encounter mismatches: a conceptual framework integrating it and job design network intensity: assessing the strategic value of installed base david p. mcintyre providence college • providence, ri abstract the purpose of this research is to explore variation in the influence of network effects across competitive settings. specifically, this study tests for significant differences in the impact of a product’s installed base on its growth in an industry influenced by network effects, application software. variation in size-on-growth effects across industry segments is conjectured to be a function of the network intensity, or degree of consumer interdependence, of the segments. the results illustrate significant variation in the magnitude of size-on-growth effects across segments, consistent with the notion of network intensity. implications for strategy in hightechnology settings are discussed. introduction network effects broadly refer to conditions in which consumer demand is interdependent, i.e., where consumers prefer to use products or technologies that many other consumers also use (katz & shapiro, 1986; rohlfs, 1974). industries influenced by network effects offer a compelling context for the study of strategy and innovation management. in these “network industries,” a single firm can enjoy robust growth and industry dominance via forces of positive feedback that tend to push the market toward the adoption of a single product or product design (david, 1985; arthur, 1989). when consumers value a large cohort of fellow adopters for a given product, extant theory suggests that the firm with the largest installed base (i.e., current users of the product) should be optimally positioned to win the battle for market dominance. despite an increasing number of empirical advances regarding network effects (e.g. eisenmann, 2007; hill, 1997; majumdar & venkatraman 1998; schilling, 2002), studies of the direct impact of installed base size on firm growth are largely absent from the strategy literature, with few exceptions (chacko & mitchell, 1998; shankar and bayus, 2003). furthermore, while the existence of network effects has been well established, the extent to which they manifest heterogeneously across competitive contexts remains unclear. extant theory tends to focus on the presence, rather than the magnitude, of network effects in various high-technology settings. 178 journal of business strategies as a preliminary step toward understanding variation in the impact of network effects, this research examines the influence of installed base size on growth in the application software industry. specifically, variation in size-on-growth effects across segments of the industry is examined, and the concept of network intensity is described as a rationale for such variation. the impact of installed base size on growth is found to vary significantly across segments, consistent with the notion of network intensity and the characteristics of the individual segments. this finding has important implications for firm strategy and the management of innovation, as the strength of network intensity may significantly impact the optimal timing of market entry and generational product releases. theoretical background network industries: characteristics and prevalence network effects occur when consumers value a given product contingent upon the number of people who are already using it (katz & shapiro, 1986; farrell & saloner, 1986). network effects can be seen in basic technologies such as telephones and fax machines, which have very little value to a consumer in the absence of other users of the product. for such products, as well as more modern examples such as online auctions, consumers tend to value a network of other users, as this network is essential to derive value from the product. network effects are thought to be an important strategic aspect of many hightechnology industries (arthur, 1996; eisenmann, 2007; mcintyre & subramaniam, 2009; tanrivierdi & lee, 2008). in such settings, competitive outcomes are heavily influenced by positive feedback to leading products, whereby each new user of a product increases the likelihood of future users adopting the product. for example, as a social networking site such as facebook increases its user base, it becomes increasingly attractive to future users who could interact with a larger number of friends, family members, or other users of the site. when such positive feedback accrues to a leading firm and its technology, there is a tendency for the “strong to grow stronger and the weak to grow weaker” (shapiro, 1999). thus, firms with an early foothold in the market tend to increase their lead, while those who are unable to attract a critical mass of adopters tend to be competed out of the marketplace. once a leading product emerges, positive feedback tends to push a single product, and its sponsoring firm, toward dominance of the focal market (besen & farrell, 1994). volume 28, number 2 179 the influence of installed base size on growth while a broad literature in strategy and industrial organization has found mixed effects in the relationship between measures of organizational size and growth (e.g., penrose, 1955; hymer & pashigian, 1962; evans, 1987; hall, 1987), these studies focus primarily on manufacturing industries, in which the benefits of network effects are largely absent (arthur, 1996). conversely, in network industries, the size of a product’s installed base is thought to be a primary determinant of its growth. specifically, a large installed base confers at least three types of benefits to potential adopters: direct network benefits, reduced uncertainty, and indirect effects benefits via availability of complementary products. first, direct network benefits are present when the value of a product is largely a function of the number of other individuals or firms using it (chacko & mitchell, 1998). examples include telecommunications networks and certain types of computer software, wherein network participants interact frequently, and thus value compatibility with a large number of other participants. second, when product adoption requires some degree of learning investments by consumers, uncertainty about the returns to these investments can be problematic. a large installed base acts as a signal that a given product exhibits some degree of long-term viability, thereby reducing uncertainty and assuring adopters that investments in learning will be beneficial (brynjolffson & kemerer, 1996). third, a large installed base is thought to attract producers of complementary goods and services to the focal product (clements & ohashi, 2005; stremersch et al., 2007; venkatraman & lee, 2004). for example, software vendors must decide which operating system platforms to target when developing new applications. the platform with the larger installed base offers a larger potential pool of adopters for the application, over which the vendor may be able to exploit economies of scale in production (chacko & mitchell, 1998). variation in size-on-growth effects: the role of network intensity much of the empirical literature on network effects focuses on technologyoriented industries, such as software or internet commerce (e.g., brynjolfsson & kemerer, 1996; schilling, 1998; eisenmann, 2007; tanrivierdi & lee, 2008). yet from a strategy perspective, the presence or strength of network effects in these select industries may be less informative than the relative influence of network effects across the competitive landscape. for example, in social networking web sites, we expect that installed base size plays a very strong role in driving installed base 180 journal of business strategies growth, as such sites have almost no residual value in the absence of a network of fellow adopters.1 however, other products, such as video game consoles, have a great deal of value to individual users in the absence of network interaction. for both social networking and video games, consumers derive some value from interacting with a network, yet in the case of video games, the proportion of total value derived from network membership is likely lower than in online auctions. figure 1 presents a very basic illustration of this notion, with the light region representing the proportion of a product’s value that is dependent on network size, and the shaded region representing the proportion of network-independent value. if the total value of a product is conceptualized as the sum of its network value and network-independent value, then one might expect video game consoles to lie near point a, as consumers can derive value from simply using the console, but also from the ability to exchange or play online games with fellow users. in contrast, social networking sites would lie closer to point b, as the brunt of their value comes from the consumer’s ability to interact with the largest possible network of users. note that figure 1 makes a critical assumption underlying the nature of network effects, in that it portrays the total value of any product as normalized across a broad spectrum of products. in other words, a vast array of consumer goods, from those with very little network value (e.g., clothing, appliances) to those with very high network value (e.g., computer operating systems, online auctions), are assumed to have some overall value to an adopter of the product. this overall value is depicted on the vertical axis as a function of both network and network-independent value. theoretically, this standardization of product value allows for a more robust illustration of network intensity as a continuum, along which virtually any product could characterized by the relative influence of network membership for a product. thus, figure 1 presents a basic conceptual framework for network intensity; specific empirical techniques for applying such standardized measures across products are beyond the scope of this article. figure 1 basic illustration of network intensity • • 0% a b 100% proportion of value from network increasing network intensity total value of product volume 28, number 2 181 for this research, network intensity is conceptualized as the proportion of total value that consumers derive from network interaction for a given product, ceteris paribus.2 this notion, that network effects manifest heterogeneously for different products, is not an entirely novel one. for example, previous literature has noted the implications of asymmetric network effects at the industry (lin & kulatilaka, 2006) and firm level (shankar & bayus, 2003), as well as the drawbacks of using gross installed base size to approximate network value (suarez, 2005). however, empirical tests of this phenomenon are largely absent from the literature, and a comprehensive framework for assessing the competitive influence of network intensity remains elusive. observing significant variation in size-on-growth effects across segments of a network industry would provide preliminary evidence that network intensity is heterogeneous across these industry segments. thus: hypothesis 1: in a network industry, the effect of installed base size on growth will vary significantly across segments. a stronger form of this hypothesis is that size-on-growth effects will vary in accordance with the network intensity of the product, i.e., the greater the network intensity in a given setting, the stronger the influence of installed base size on growth. while no quantifiable measures of network intensity are evident in the literature, certain product characteristics are indicative of greater network intensity. for example, the word processing and spreadsheet segments of the application software industry have frequently been used in empirical tests of network effects, as compatibility with a broad base of other users is critical (e.g., gandal, 1995; brynjolfsson & kemerer, 1996; liebowitz & margolis, 1999). in contrast, applications such as desktop publishing and cad may be less network-intensive, as their outputs tend to have value largely to a single user, or to a relatively small cohort around that focal user (astebro, 2002). thus, the proportion of value that consumers derive from installed base size varies as consumers increasingly desire network interaction for a product, or as total network size is more important than interaction with smaller, more tightly connected groups of consumers (suarez, 2005). in sum, network intensity moderates the relationship between a product line’s installed base size and its growth in future periods — the stronger the network intensity, the more positive the effect of installed base size on growth. a stronger form of hypothesis 1, contextualized to the application software industry is proposed: 182 journal of business strategies hypothesis 2: the effect of installed base size on growth will be more positive in high network-intensity segments (i.e., word processing and spreadsheets) than in other segments. data and methods for this research, data were gathered on a sample of software releases in four segments of packaged application software (naics 51120) from 1986-1998 word processing, spreadsheet, desktop publishing, and computer-aided design (cad) segments. application software is thought to exhibit many of the characteristics of network dynamics (e.g., brynjolffsson & kemerer, 1996; chacko & mitchell, 1998; liebowitz & margolis, 1999), and this time frame represented a period of significant growth in the industry. because these four segments of application software exhibited focal products with unique attributes, as well as significantly different competitors, they were thought to be an ideal focus for the explorative study of network intensity dynamics. the raw sample for the study included 247 product-years in the word processing, spreadsheet, desktop publishing, and cad segments. these included both leading products, such as microsoft word and aldus pagemaker (in word processing and desktop publishing, respectively), and lesser-known products such as displaywrite and framemaker. as different operating systems may have influenced growth patterns, the sample was limited to software that was compatible with the dominant platforms, the dos/windows operating systems. this constraint, along with a lack of sufficient installed base data for some observations resulted in a final sample of 125 product-years encompassing 21 product lines. the time frame of the sample offered a chance to explore emerging products influenced by network effects, and a period of substantial growth in all four segments. for example, the total units shipped in the word processing segment doubled roughly every two years throughout this time period. yearly data on market share, sales, shipments, price and revenue were gathered from a dataset based on reports provided by idc (international data corporation) and dataquest, leading providers of market research in software and other information technologies. information on product release dates, corporate parents, and general background were gathered through archival searches of software trade journals and periodicals, including infoworld, pc world, pc magazine, pc week and byte. volume 28, number 2 183 measures dependent variable: change in installed base the dependent variable of interest is the change in a product line’s installed base over a one-year period. consistent with chacko and mitchell’s (1998) study of network dynamics, this study holds that lagged cumulative unit sales over a twoyear period provide a reasonable approximation of a product’s installed base. thus, change in installed base is measured as the difference between the natural logs of the product’s installed base at times t+1 and t0, i.e., the size of the base in the following year less the size of the current base. independent variables the first independent variable of interest is a product’s existing installed base in a given year. as noted previously, installed base size was measured as lagged cumulative unit sales over a two-year period. a quadratic term on installed base was incorporated to gauge curvilinear and critical mass effects of installed base. such effects tend to be indicative of “critical mass” in network industries, where firms are competed out of the market unless they achieve a certain level of installed base, after which they tend to enjoy stronger growth due to the benefits of network effects. the influence of network intensity was captured in two ways: first, interactive terms between segment dummy variables and installed base were developed, to gauge significant differences in each segment from the mean in size-on-growth effect across other segments. second, a network intensity dummy variable was coded, whereby high-network intensity (i.e., word-processing and spreadsheets) segments were coded “1” and other segments were coded “0.” this dummy was also interacted with installed base to test the stronger-form hypothesis that size-on-growth effects vary in a manner consistent with the network intensity of a segment. control variables segment characteristics concentration. the degree of segment concentration may have a significant influence on innovativeness, average profitability, and firm growth potential (stigler, 1964; porter 1980). one measure of concentration was included in the model, the herfindahl-hirschman index (hhi), which indicates the sum of the squared market shares of competitors, to control for concentration effects at the segment level. 184 journal of business strategies platform. a dummy variable was included indicating the operating system platform for which the software was designed — dos or windows. this variable was included to ensure that growth dynamics are not platform-dependent or unduly influenced by broader patterns of platform use. product characteristics price. the retail price of a network product has been described as an important factor in network competition (shapiro & varian, 1999). yet if price or product discounts fully account for installed base growth, then simple firm economies of scale may explain the brunt of growth patterns in these settings. thus, the price of the product in a given year was included in the model. generational innovation. a generational product innovation is a substantial advance in the technical performance of a product (lawless & anderson, 1996). conversely, incremental product innovation focuses on the reinforcement of existing product designs, leaving fundamental aspects of the product unchanged (henderson & clark, 1990). for each product-year, a variable indicating the generational nature of the product was included. a product was coded 1 if its primary version in a given year represented a whole number (2, 2.0 etc.), and 0 if the primary version contained one or more decimal points (5.1, 5.01, etc.) firm-level characteristic multi-segment firm. firms competing in multiple segments of an industry may have a dual advantage with regard to performance metrics such as growth. first, firms that compete in related segments are thought to possess certain managerial advantages because of their relatedness (rumelt, 1973; bettis 1981). second, these firms may have greater capabilities to leverage related competitive knowledge across multiple segments (henderson & cockburn, 1996 ; tanrivierdi and venkatraman, 2004). as such, firms which produced products in more than one segment of the sample (microsoft and ibm, for example) were assigned a “1,” others a “0” for this variable. summary model the baseline model used to test the effect of installed base size on growth, and significant variation in these effects due to network intensity, is as follows: volume 28, number 2 185 (lninstalled base t+1 – lninstalled base t) = b0 + b1 (lninstalled base t) + b2 (lninstalled base t) 2 + b3(pricet) + b4(multi-segment firm) + b5(concentration) + b6(platform) + b7(generational innovation) + b8(network intensity * lninstalled base t) results descriptive statistics and correlations for the sample are shown in table 1. note that installed base size has a negative correlation with growth (r = -0.16), which is consistent with previous empirical findings of a negative linear relationship but positive curvilinear relationship between size and growth in network industries. firms competing in multiple segments tend to be associated with larger installed bases in those segments (r = 0.38), but also lower prices (r = -0.07), which is somewhat surprising given the concerns over pricing and antitrust in network industries (liebowitz & margolis, 1999). recall that the hypotheses relate to variation in the influence of installed base size in driving growth in the application software industry. results of the regression analyses (product-line fixed effects models) are shown in table 2. several specific aspects of these analyses merit further discussion. first, the negative linear and positive quadratic terms on installed base in the nested models suggest that installed base size has a generally negative impact on growth, which becomes more positive as installed base size increases (the quadratic term is positive in all models, and significant at p < .05 in two of the models). this finding is again consistent with the notion of “critical mass” effects in network industries (chacko & mitchell, 1998). hypothesis 1 holds that significant variation will be observed among segments in the focal industry, packaged application software. consistent with this hypothesis, the interaction terms between segment dummies for spreadsheets, desktop publishing, and cad are significant (model 3), indicating that size-on growth effects are significantly different for each segment relative to the mean effect of the other segments. cad and desktop publishing appear to have lower baseline size-ongrowth effects relative to the other segments (β = -0.64, β = -0.44), while spreadsheets appear to be exhibit significantly stronger effects than other segments (β = 0.41). the word processing segment also appears to have significantly more positive size-on-growth effects (β = 0.06), though only marginally so (p < .10). thus, hypothesis 1 is generally supported, in that influence of installed base size on growth in each segment varies significantly from the mean effect of the other segments. 186 journal of business strategies table 1 descriptive statistics for key variables (n = 126) mean s.d. 1 2 3 4 5 6 1. growth 0.17 1.13 2. installed base 14.23 1.90 -0.16 3. price 146.59 98.39 -0.01 -0.32 4. generational 0.50 0.49 0.03 0.23 -0.08 innovation 5. platform 0.70 0.46 0.06 0.44 -0.12 -0.03 6. multi-segment firm 0.39 0.17 -0.03 0.38 -0.07 0.14 0.01 7. concentration 0.68 0.47 0.07 0.52 -0.18 0.09 0.61 0.10 hypothesis 2 tests whether the segments that were conjectured to exhibit higher network intensity do indeed exhibit stronger size-on-growth effects. the primary variable of interest for this hypothesis is the interaction term between the network intensity dummy variable and installed base (coefficient b8 in the model described previously, or “network intensity*installed base” in table 2). given the positive and significant interaction term, this hypothesis is supported in both the baseline model (model 2) and the full model with controls (model 4). thus, segments which have been hypothesized to exhibit stronger network effects — word processing and spreadsheets — do indeed appear to exhibit stronger size-on-growth effects than other segments. volume 28, number 2 187 table 2 regression results (dv = installed base growth) 1 2 3 4 concentration (hhi) -0.94* -0.16 (0.54) (0.63) price 0.58 0.17 (0.90) (0.99) multi-segment firm 0.77 0.22 (0.57) (0.54) generational product innovation 0.13 0.10 (0.15) (0.14) platform 0.18 0.02 (0.25) (0.14) (ln) installed base -3.14*** -1.34* -1.59** -1.45** (0.64) (0.72) (0.74) (0.68) (ln) installed base2 0.10*** 0.03 0.05** 0.03 (0.02) (0.03) (0.03) (0.03) word processing* installed base 0.06* (0.03) spreadsheet* installed base 0.41** (0.19) desktop publishing* installed base -0.44** (0.19) cad*installed base -0.64*** (0.18) network intensity*installed base 0.38** 0.47*** (0.16) (0.16) constant 23.67*** 8.89* 12.73** 8.43* (4.36) (5.24) (4.93) (5.00) n 125 125 125 125 model significance (f) 21.66*** 5.51*** 12.54*** 4.15*** statistically significant at *p <0 .10, **p < 0.05, ***p < 0.01. standard errors in parentheses. discussion the primary result of this study is that the influence of installed base size on growth is not homogeneous across competitive contexts, even in high-technology industries which are thought to be characterized by network effects. while there may 188 journal of business strategies be benefits to network membership for many products and technologies, the extent to which installed base size drives growth may vary significantly across industries and segments. this variation is hypothesized to be dependent upon on the network intensity of a given setting, or the extent to which consumers derive value from network membership for a given product. network intensity has several broad implications for innovation management and product diffusion. first, it may explain why we often see variation in the number of product standards across network industries (eisenmann, 2006). when network intensity is high, we would expect to see a higher prevalence of “winner-take-all” product markets, where an early leader comes to dominate the market. for a product market with lower network intensity, we would expect to see a higher incidence of multiple, evolving standards, as consumers place increased emphasis on product quality and features. second, network intensity may inform the firm’s optimal entry or generational product release strategy in a given market or segment. when network intensity is high, then extant theory suggests early releases at all costs, thereby quickly building an installed base. as network intensity decreases, competition becomes increasingly focused on quality differentiation between competing products, suggesting that firms should defer releases to improve the intrinsic quality of the product. finally, a greater understanding of network intensity may allow for the possibility that firms can manipulate certain aspects of their products to make them more or less network intensive.3 for example, an online auction company may try to increase the network-independent value of its product by adding a multi-service web portal interface. conversely, online video gaming can be viewed as an attempt to add direct network value to a stand-alone console. theoretical implications this research offers several implications for the literature on network effects and strategic management. first, the results are broadly consistent with the idea that first-mover status in a network industry may not always confer a competitive advantage via immediate positive feedback (lieberman & montgomery, 1988; schilling 2002). rather, positive feedback from network effects appears to manifest heterogeneously across different competitive settings. as such, effective innovation strategy in network competition appears to depend on the critical trade-off between the pre-emption advantages of early entry, and delays which may improve a product’s technical quality and positively impact the growth potential of the firm. volume 28, number 2 189 second, this work illustrates the complexity of network dynamics. though there are many direct and indirect benefits resulting from a large installed base, these results indicate that such benefits are not uniform. as such, characterizations of gross installed base size as a distinct competitive advantage by itself may oversimplify the complex nature of network competition in a given industry. third, while previous work has postulated asymmetric strength of network effects at the firm level (shankar & bayus, 2003), this is the first study that makes such a contention at the broader segment level. if the influence of network effects varies significantly across competitive contexts, then the ability to accurately gauge the network intensity of a given market or segment becomes a critical firm capability. inaccurate perceptions of network intensity can have a detrimental impact on performance, as firms may either rush to release low-quality products, or delay releases beyond the point of viability. managerial implications the prescriptive contributions of this work are closely aligned with the theoretical advances noted previously. if winning strategies in network industries are more complex than simply establishing an early lead, then the locus of innovative efforts should shift from early product releases to consideration of the trade-offs between releasing new or generational products either too early or too late to maintain a viable competitive position (e.g., schilling, 1998). furthermore, these results offer important implications for both incumbents and new entrants in high-technology markets. having established that not all network industries exhibit uniform size-on-growth dynamics, the notion of network intensity can facilitate managers in gauging the proportion of value derived from network membership for a given product. as web-based means of transaction become more prevalent, accurate judgments regarding the network intensity of a given industry or segment will become increasingly important for effective strategy formulation, particularly with regard to new market entry and generational product innovations. extensions and future research several avenues of potential research flow logically from the results of this work. first, the regression results are consistent with the notion that greatest benefits of network effects may take hold only after a sufficient installed base has been attained. however, this paper does not attempt to address the dynamics of competition in the early stages of a network industry, when leading firms and products have yet 190 journal of business strategies to be established. the technical quality of products in network industries is often thought to suffer as consumers rush to join the largest network regardless of quality (besen & farrell, 1994; schilling, 1998; shapiro & varian, 1999). however, if the full benefits of network membership are not evident below some critical mass, then the role of quality in network-based competition — particularly early in the life of network industry — merits further study. second, the concept of network intensity has been limited to multiple segments within a single network industry. the extent to which network intensity can be quantified and/or normalized across industries merits further investigation. the establishment of a priori metrics for gauging network intensity would offer a valuable strategic tool for managers in high-technology settings. finally, this research was developed under the assumption that network intensity is a largely exogenous aspect of a given market or segment. however, relaxing this assumption may provide valuable insights for strategic management. if firms can partially influence the network intensity of their products, then the manipulation of network intensity is itself a worthy avenue of future study. using a prior example, large video-game console producers have recently added online capabilities to their core products. future work in this domain might examine whether this represents a demand-driven evolution of the product-market, or a conscious effort by manufacturers to increase the network intensity of their products. limitations and conclusion several limitations are evident in the course of the study. first, the sample for this study was limited to a single network industry. while network intensity was tested via variation in multiple segments of the industry, a more representative cross-section of highand low-network intensity industries may prove fruitful for future empirical research. furthermore, though the time frame of the sample was consciously chosen for its high-growth nature, it would have been ideal to examine the industry from its inception. however, limitations in the availability of data earlier than 1986 made this approach less viable. second, the sample has been limited to a setting where one-sided network effects tend to accrue to end users of the product. while technology diffusion and the emergence of dominant designs are integral aspects of product life cycles in many industries (arthur, 1996; eisenmann, parket & van alstyne, 2006; schilling, 1998; suarez & utterback, 1995), this study consciously focuses on one particular type of industry, application software. in this setting, direct and indirect network effects are volume 28, number 2 191 thought to offer distinct value to consumers, and thus uniquely influence patterns of product diffusion. markets influenced by “two-sided” network effects, involving the interplay of two sets of participants in a given platform (eisenmann, parker & van alstyne, 2006) may present more complicated strategic scenarios than those addressed here. third, this study involves a trade-off between depth and breadth in the sample. while the sample size is smaller than some comparable longitudinal studies of growth, recent studies have made similar concessions with respect to sample size in order to gain a deeper understanding of network dynamics.4 furthermore, the availability of more recent data on network competition in emerging industries such as social media or online auctions, which serve as logical and contemporary examples of network dynamics, might have provided substantial insight into the focal relationships in this study. finally, this study is an exploratory step toward understanding the impact of heterogeneity in network effects across industries. as such, simple interaction terms were used to gauge differences in size-on-growth effects across segments of the application software industry. the development of more robust measures of network intensity, which can account for the a priori strength of network effects in a given industry, would benefit scholars and practitioners alike. in conclusion, this research explores the notion that the influence of network effects varies across competitive settings. the results indicate that the effect of installed base size on growth varies significantly across segments of the application software industry, and in a manner consistent with the network intensity of the segments. future research should further examine the concept of network effects as a continuum, and the moderating role of network intensity on the effectiveness of strategic actions and innovation initiatives. end notes 1. this residual value can also be conceptualized as the autarky value of the product, or the value of the product assuming no interaction among users (liebowitz & margolis, 1999). for consistency, this article will continue to refer to this as networkindependent value, though the terms are largely interchangeable. 2. lin and kulatilaka (2006) characterize asymmetric strength of network effects as the “intensity of network effects.” they conceptualize this intensity as the coefficient (β) in the equation v(q) = βq, where q represents the quantity demanded for the good. 192 journal of business strategies 3. note, however, that this paper characterizes network intensity as an exogenous aspect of the product/segment. 4. for example, shankar and bayus (2003) use a sample of only 64 product-months in estimating firm-level network effects. references arthur, w. b. (1989). competing technologies, increasing returns, and lock-in by historical events. economic journal, 99, 116-131. arthur, w. b. (1996). increasing returns and the new world of business. harvard business review, july-august, 100-109. astebro, t. (2002). noncapital investment costs and the adoption of cad and cnc in u.s. metalworking industries. rand journal of economics, 33(4), 672-688. besen, s., & farrell, j. (1994). choosing how to compete: strategies and tactics in standardization. journal of economic perspectives, 8(2), 117-131. bettis, r., & hitt, m. (1995). the new competitive landscape. strategic management journal, 16, 7-19. brynjolfsson, e. (1996). network externalities in microcomputer software: an econometric analysis of the spreadsheet market. management science, 42, 167182. brynjolffson, e., & kemerer, c. (1996). network externalities in microcomputer software: an econometric analysis of the spreadsheet market. management science, 42(12). chacko, m., & mitchell, w. (1998). growth incentives to invest in a network-externality environment. industrial and corporate change, 7(4), 731-744. clements, m., & ohashi, h. (2005). indirect network effects and the product cycle: video games in the u.s., 1994-2002. journal of industrial economics, 53(4), 515-542. cowan, r. (1990). nuclear power reactors: a study in technological lock-in. journal of economic history, 50(3), 541-567. david, p. (1985). clio and the economics of qwerty. american economic review, 75(2), 332-337. eisenmann, t. (2006). platform structure in networked markets. boston: hbs publishing. eisenmann, t. (2007). internet companies’ growth strategies: determinants of investment intensity and long-term performance. strategic management journal, 27(12), 1183-1204 volume 28, number 2 193 eisenmann, t., parker, g., & van alstyne, m. (2006). strategies for two-sided markets. harvard business review, 84(10), 92-101. evans, d. (1987). the relationship between firm growth, size, and age: estimates for 100 manufacturing industries. journal of industrial economics, 35(4), 567-581. farrell, j., & saloner, g. (1985). standardization, compatibility, and innovation. rand journal of economics, 16, 70-83. farrell, j., & saloner, g. (1986). installed base and compatibility: innovation, product preannouncements, and predation. american economic review, 76(5), 940955. fine, c. (1986). quality improvement and learning in productive systems. management science, 32(10), 1301-1315. gandal, n. (1994). hedonic price indexes for spreadsheets and an empirical test for network externalities. rand journal of economics, 25(1), 160-170. hall, b. (1987). the relationship between firm size and firm growth in the united states manufacturing sector. journal of industrial economics, 35(4), 583-606. hill, c. (1997). establishing a standard: competitive strategy and technological standards in winner-take-all industries. academy of management executive, 11(2), 7-18. hymer, s., & pashigian, p. (1962). firm size and rate of growth. journal of political economy, 70(6), 556-569. katz, m. l., & shapiro, c. (1986). technology adoption in the presence of network externalities. journal of political economy, 94, 822-841. katz, m. l., & shapiro, c. (1994). systems competition and network effects. journal of economic perspectives, 8(2), 93-115. lin, l., & kulatilaka, a. (2006). network effects and technology licensing with fixed fee, royalty, and hybrid contracts. journal of management information systems, 23(2), 91-118. lieberman, m., & montgomery, d. (1988). first-mover advantages. strategic management journal, 9, 41-58. liebowitz, s. & margolis, s. (1990). the fable of the keys. journal of law and economics, 33, 1-26. liebowitz, s., & margolis, s. (1999). winners, losers, and microsoft. oakland, ca: the independent institute. majumdar, s., & venkatraman, s. (1998). network effects and the adoption of new technology: evidence from the u.s. telecommunications industry. strategic management journal, 19(11), 1045-1062. 194 journal of business strategies mcintyre, d., & subramaniam, m. (2009). strategy in network industries: a review and research agenda. journal of management, 35(6), 1494-1517. parker, g., & van alstyne, m. (2005). two-sided networks: a theory of information product design. management science. penrose, e. (1955). limits to the growth and size of firms. american economic review, 45(2), 531-543. porter, m. (1980). competitive strategy. new york: the free press. rohlfs, j. (1974). a theory of interdependent demand for a communications service. bell journal of economics and management science, 16. saloner, g. & shepard, a. (1995). adoption of technologies with network effects: an empirical explanation of the adoption of automated teller machines. rand journal of economics, 26(3), 479-501. schilling, m. (1998). technological lockout: an integrative model of the economic and strategic factors driving technology success and failure. academy of management review, 23(2), 267-284. schilling, m. (2002). technology success and failure in winner-take-all markets: the impact of learning orientation, timing, and network externalities. academy of management journal, 45(2), 387-398. shankar, v., & bayus, b. (2002). network effects and competition: an empirical analysis of the home video game industry. strategic management journal, 24, 375-384. shapiro, c., & varian, h. (1999). information rules. boston: hbs press. stigler, g. (1964). a theory of oligopoly. journal of political economy, february. stremersch, s., tellis, g., franses, p., & binken, j. (2007). indirect network effects in new product growth. journal of marketing, 71(3), 52-74. suarez, f. (2005). network effects revisited: the role of strong ties in technology selection. academy of management journal, 48(4), 710-722. tanriverdi, h., & lee, c. (2008). within-industry diversification and firm performance in the presence of network externalities: evidence from the software industry. academy of management journal, 51(2), 381-397. venkatraman, n., & lee, c. (2004). preferential linkage and network evolution: a conceptual model and empirical test in the u.s. video game sector. academy of management journal, 47(6), 876-892. volume 28, number 2 195 biographical sketch of author dr. david p. mcintyre is an assistant professor of management at providence college. he received his ph.d. in business administration from the university of north carolina. his current work examines strategy and innovation management in high-technology industries. this research appears in the journal of management, the journal of product innovation management, and the journal of high technology management research, among other venues. 196 journal of business strategies network intensity: assessing the strategic value of installed base niche markets and small business strategies: shifi1ng the focus of international business education jack scarborough barry university miami shores, florida the purpose of this paper is to propose a shift in the emphasis of international business education, both teaching and research, in favor of small and mid-sized firms. two established, mutually reinforcing trends suggest the need for this shift; (a) the continuing role of small business as the engine of innovation, and growth in output, export and employment creation, and (b) the continuing reluctance of many small businesses to explore export opportunities. to the extent business education serves the nation, the economy as a whole, and our international competitiveness, and what promises to be an important avenue of growth in employment opportunities for our students, we should be doing more to help small and mid-sized businesses, and let the large, capital and job exporting multinational corporations (mncs) fend more for themselves. whatever store one might put into this argument now, it will become stronger as we approach the tum of the century because of a new trend which will amplify the impetus of the two trends already identified, thereby raising the incentive both for educators to emphasize smaller firms, especially international market penetration and risk reduction strategies, and for smaller firms to overcome their reluctance. this new trend is the proliferation of international niche markets as developing countries advance, creating opportunities well suited to the strategic advantages of smaller firms relative to the globalization and multicountry strategies employed by mncs. examination of international business textbooks and academic journals reveal a very strong emphasis on the fortune 500 kind of mnc. this literature addresses the problems of managing a big company trying very hard to be all things to all (very different) people, to act local while thinking global. is this the proper focus for our efforts? can we achieve anything more than marginal improvement? are these the companies which are creating most of the new jobs, wealth and exports? are we betting on "mudders" on a fast track? why do globalization advocates support what is essentially a low-cost-leadership strategy, product driven, managed centrally, in a very complex organizational setting, when we would not consider the same recommendation for a domestic firm unless it is in a commodity business? is the international environment so different that the concentrated, focused kind of company with a flat organization, capable of quick, flexible reaction to volatile market conditions we want to see at home irrelevant and ineffective internationally? international markets stand to become more like our own, specifically, the eventual emergence of a middle class in developing countries begun in the newly industrialized countries of east asia, now beginning in latin america, and inevitably to follow in eastern europe and perhaps elsewhere. with a middle class must emerge the kind of market niches which will make business conditions very difficult for the big company. before addressing these issues, it will be useful to examine typical mnc strategies. 138 journal ofbusiness strategies the globalization strategy vol. 10, no.2 the globalized firm typically exhibits the following characteristics: (a) it seeks economies and learning curve effects from highly standardized operations, rationalized worldwide, exploiting local comparative advantages; (b) its resources flow to any point on the globe where they can be employed most productively; (c) it obtains labor, capital and intermediate inputs and raw materials from whatever worldwide sources offer the best value; (d) in order to allocate global resources efficiently and optimize management of global operations and logistics networks, decision making tends to be centralized, even if the firm is highly dispersed geographically. only functions which must be adapted, typically marketing, are decentralized; (e) the sheer magnitude of operations may require regional management structures, which may result in organizational complexities in melding geographical and functional responsibilities; (1) as it strives to conduct its operations, invest, and source globally, the firm tries to ignore national boundaries whenever it can; it truly looks at the world as one market, for both inputs and outputs; (g) the basic parameter of global resource allocation is to capitalize on comparative advantages. the first rough cut is to perform labor intensive operations where labor is cheap and sophisticated operations where labor is highly skilled. the second is to optimize the trade-offs among production and logistics costs. an effective illustration of the concept is the global network of sourcing, assembly and distribution employed by automobile manufacturers which serve global requirements from regionalized production plants. the global firm operates in what is thought to be one world of rapidly converging needs and wants, and purchase decisions based more on price and less on unique product features (levitt 1983). other necessary conditions include the existence of scale economies and learning curve effects in the relevant technology, and free trade to accommodate both intracompany and extra-company trade, foreign investment, and access to low-cost sourcing (doz 1987). globalization strategy weaknesses the globalized firm strives to establish and improve a finely-tuned, highly-integrated, maximally-optimized system of input, conversion and output processes producing massmarket, or otherwise uniform, products or services which can be sold almost anywhere. it is product driven rather than market driven. it is concerned more with efficiency than effectiveness. its product must serve lowest-common-denominator needs, or sizable sets of such needs, i.e., "custom" mass production, such as the various versions of the ford escort, to generate sufficient market share to maintain cost advantages. therefore, any force which tends to generate differentiated demand, or to neutralize cost advantages, is a threat to the globalized firm or, at best, greatly complicates its operations. fall 1993 scarborough: niche markets and small business strategies the strategic risks of standardization 139 the globalization strategy, by virtue of its requirement for maximum standardization and the remoteness of decision-making authority from markets, clearly is vulnerable to companies which target segments or niches. it is at once a low-cost leadership strategy and a concentration strategy, both of which expose the firm to the risks of (a) falling out of touch with customers in some way, and (b) product and/or process innovation by competitors. a low-cost-ieadership strategy must be based on the assumption that buyers find price a more important purchase criterion than product or service quality or features. it seems that the number of products for which this assumption holds is diminishing (douglas and wind 1987). moreover, low cost leaders face the potentially adverse consequences of not being the low cost leader. if not, they face the threat of being underpriced by the low cost leader and being outflanked by segmenters or niche finders, depending on how they stand on the various dimensions of quality. while the validity of generic strategy theory remains arguable, firms can and do find themselves "stuck in the middle." sears, struggling for an identity, has watched low cost leader wal-mart become the world's leading retailer and has lost customers to more focused retailers on both ends of the market. holiday inns found itself under attack from both flanks and dropped out of the middle market entirely by spinning off the holiday chain and reconstituting itself as promus, positioned only on the flanks with embassy suites and hampton inns. compaq found itself squeezed between the industry leaders and the i.b.m. clones. general motors is still struggling to establish itself as a leader on either flank, with revitalized buick and cadillac on the quality end and the saturn on the low-price end. ohmae (1990) suggests that even japanese automakers are becoming stuck in the middle between korean competitors and high-status european cars (although mercedes is putting that proposition to a stiff test with the large price increases on its new s-class cars, in the face of lexus, infiniti and acura). the global firm will encounter the same threats in greater numbers. iffirms find themselves "stuck in the middle" in domestic markets, why should not the same thing happen to firms in international markets, where they face even more competitors? why should management practices and strategies appropriate for the domestic goose also not work for the global gander? in other words, why should not the more focused, more concentrated, more differentiated, more responsive, more market-driven strategies which work at home not work abroad? the multicountry variation mncs have responded to this challenge with the multidomestic or multicountry strategy, which entails decentralization of decision making and adapting any elements of the product/market strategy mix necessary to satisfy differentiated, local needs and wants. however, the multicountry organization tends to be even more complex than the global organization, with an array of product or market divisions, geographic divisions, functional subunits and matrix arrangements to coordinate its numerous, far-flung operations. this complex form is an attempt to reconcile the need for centralized control of the firm with the decentralized decision making necessary to respond to local market requirements. the 140 journal ofbusiness strategies vol. 10, no.2 advent of flexible manufacturing techniques allows mncs to capture some of the benefits of greater market segmentation, but these firms still remain remote from many of their markets. moreover, it is by no means clear that many mncs are taking a sufficiently long term view to make the necessary investment in flexible manufacturing equipment and the highly-skilled labor necessary to operate it. the effectiveness of globalization strategy depends on the validity of the assumptions on which it is based. scholars have challenged all of them. global products some notable studies (boddewyn et a1.1986; douglas and wind 1987; doz 1987; kotler 1986; ohmae 1990; porter 1985; quelch and hoff 1986; sheth 1986) are among the many which challenge the very notion ofglobal products beyond some industrial and luxury goods. there are many anecdotal reports of practitioners finding difficulty accepting the idea or making it work. in response to attacks on the globalization strategy by marketing firms, levitt said in 1988 that "even if some local tastes are different now ... you'll find that 1992 will make a big difference" referring to ongoing european unification. levitt added that " ... the specialized brands and small market niches proliferating now (will) show up everywhere" (lipman 1988). yet in 1992, firms still report difficulty finding, for example, the "elusive euroconsurner" (browning 1992). the preference of japanese consumers for specifically tailored products is well known (kang 1990 and ohmae 1992, for example). standardized operations and large scale drucker (1986) and doz (1987), among others, question whether modem, flexible, automated manufacturing technologies require large scale, suggesting that not all industries have much to gain from globalizing. manufacturing costs are becoming a less important component of total cost, negating some of the advantages of relocating, and scaling up, manufacturing for that purpose. moreover, large scale and long distances make it more difficult to employ techniques such as just-in-time inventory management. massed, globalscale plants require larger shipments over longer distance, putting upward pressure on logistics costs which rise with either increased shipment size or frequency, and with larger inventory volumes, whether enroute or on hand. douglas and wind (1987) suggest that variations in the relative price of alternative inputs (e.g., plastic vs. paper packaging) will vary over time, complicating efforts to standardize. manageability and bureaucracy globalized firms normally would prefer not to localize because to do so might break down scale advantages and weaken the centralized decision making needed to optimize global systems and networks. localization would compound the already difficult problem of managing mncs, already broken down into various, often complicated, combinations and layers of geographical, functional and product/market divisional subunits or matrices. even fall 1993 scarborough: niche markets and small business strategies 141 without locally decentralized subunits, it is not yet clear that any form of global corporate structure can be managed effectively, even if managed efficiently (doz 1987; doz and prahalad 1981; prahalad and doz 1981). the complicated mnc structure, together with its centralized decision making, appears even more risky in the face of a manifest need for speedy decisions engendered by accelerating evolution of markets and shorter product development cycles. global firms will become increasingly exposed to the threat of advancing product and process technologies. as a global firm becomes locked into an optimized high-volume, highefficiency mode, it becomes more vulnerable to technological advances. the u.s. as a nation suffered this fate at the hands of the japanese, who are now looking over their shoulders at the asian tigers and, in the long run, the peoples' republic of china. more recently, who could have imagined how fast personal computers would become a commodity-like product? the portability oftechnologies like cad-cam increases the number of potential innovators and hastens their rate of advance. if globalization is based on sound theory, then firms may indeed be able to optimize production of "world" products, and accept some isolation from their markets. but that has not been the case even in domestic markets. the imperative to "build a better mousetrap" may be inconsistent with the very idea of globalization. will a globalized firm be able to match the innovations of smaller, more agile competitors? will it recognize the need to do so? will it be able to react quickly enough if it does recognize the need? an optimized system is often an inflexible one in human terms as well as technologically. the investment of so much effort and capital in existing organizational configurations and relationships causes behavioral and financial resistance to change. highly centralized structures delay and dilute decision making, causing ineffective responses and lost opportunities. many firms are working hard to become more responsive, quicker to react, more sensitive to changing needs and wants. the importance of technology highlights the need for flexibility. even if one's customers do not change, one's competitors will continue to search out better ways to serve them. globalization itself serves to increase the number of competitors, all of whom are potential innovators trying to make one's business obsolete, while weakening the global firm's ability to match them. recall how badly japan's more rapid product development cycle hurt u.s. automobile makers. firms must be prepared to counter substitute products not yet conceived or brought to market. bureaucracy seems to grow like weeds; unwanted, unintended, but prolific nonetheless. is there any reason to presume that whatever dysfunctions afflict conventional firms will not afflict global ones, and on a global scale at that? free trade the global strategy is associated with a borderless world and the triad megamarkets (ohmae 1990; 1985), i.e., a strategy requiring a firm foundation in the three great markets to build sufficient scale to compete effectively in those markets as well as in other, smaller markets. the extent of free trade more or less accommodates that strategy today, but that may not remain so. the prognosis for global, as compared to regional or bilateral, free trade is 142 journal ofbusiness strategies vol. 10, no.2 mixed at best. even as the world tries to converge economically, there remains sometimes violent political divergence, which will be exacerbated by periodic declines in economic activity. already existing and reemerging nationalism, extremism and zealous religious factions are fractionating forces which sustain and even heighten cultural differences. the emergence of trading blocs may well make the situation worse. these blocs could shrink global horizons to hemispheric (enterprise for the americas), continental (european community) or even regional (e.g. east asian) dimensions. a reduced opportunity to move the factors of production across borders is a major threat to globalization and thus a strong incentive to localize. while regional integration threatens the global strategy, it still accommodates the regional and, obviously, the local strategy. the stronger international competitors the europeans are trying to create by unifying their market will intensify competition elsewhere, generating more pressure on firms to carve out defendable niches. if japan, perhaps because it might be excluded from, or inhibited in, europe or the western hemisphere, establishes a yen-based bloc in east and southeast asia, those markets will not be large enough to support japan's export requirements. thus, where local markets do remain open, and it will be very much in their interest to do so, the competition stands to become quite intense. the upside potential of the general agreement of tariffs and trade (gait) may well depend on its ability not only to break its present deadlock, but to forge a link among these emerging trading blocs. this kind of highly competitive environment, in markets with more differentiated requirements, should be highly susceptible to niche strategies. the vulnerabilities inherent in the assumptions on which the globalization construct is grounded have been masked by the large proportion of trade by globalized mncs among developed countries (dcs), which have markets large and diverse enough to absorb all kinds of products, even if undifferentiated, as long as they conform to levitt's prescriptions that such products offer both high quality and low price. moreover, despite the requirement that global products offer low price, it is probably more correct to say that successful global products are relatively high-priced or even luxury goods, produced at relatively low costs afforded by economies ofscale (boddewyn et a1. 1986; douglas and wind 1987). this would account for the success of the globals in ldcs, where there is almost always a market for high-end goods, now matter how poor the country. perfonnance the first major empirical study of the impact of global standardization in terms of financial performance, reported in the journal of marketing, does not support the superiority of the globalization strategy (saimee and roth 1992). this study of 147 business units in twelve industries, 85% of which manufacture industrial products (i.e., those usually deemed very susceptible to standardization), found no significant advantage in financial performance for firms employing global standardization strategies in the most recent three-year period. the authors concluded that any cost advantages associated with standardization are probably offset by the effects of price competition in global markets. this finding is consistent with the expectation that firms which target the mass market expose themselves to niche finders who can target more discriminating and hence more lucrative segments, leaving the larger, fall 1993 scarborough: niche markets and small business strategies 143 standardized firms with increasingly commodity-like products which must compete primarily on price. in essence, the strategic risk of globalization is that it is a low-cost-ieadership strategy, relying on cost advantages based on scale and bargaining power, and the threat of massive retaliation and cross subsidy to deter new entrants. this offers the downside potential of frontal-assault price wars as these large firms compete to cover their large overheads. if the study is correct in that standardization does not necessarily yield improved returns, then it seems difficult to justify pursuit of this strategy with its attendant limitations and risks. an upper limit on globilization? a basic premise of this paper is that improving business, economic, financial and political conditions in ldcs will accelerate development in those countries in the next decade, and that these improved conditions will generate opportunities for mid-size and small u.s. firms to export to those markets. these opportunities will manifest themselves in the form of greater market segmentation which will accompany rising standards of living, most likely to emerge first in latin america. should that prove to be the case, the demand for differentiated goods should grow faster than the market for standardized goods, shifting demand in favor of more focused, specialized firms and exacerbating the weaknesses of the globalized company and the less effective multicountry companies. given that this argument remains somewhat speculative at this point, it will be developed in a series of propositions which, if tested and found valid, will serve to support it. p1 the ongoing shift in manufacturing employment from dcs to ldcs eventually must begin to consume excess labor supplies and drive up wages, incomes and consumption in those ldcs. p2 this transfer will promote entrepreneurship and initiative manifested in the development of supporting industries and stimulate local competition, which in tum will amplify wealth creation. more manufacturing means not only higher disposable income, but development ofloeal human and capital infrastructure, expansion of intermediate product, service and distribution industries, and the foundation for industrialization. in effect, the developing countries will begin developing faster, and become, necessarily, more developed, exhibiting the more statistically normal income distribution characteristic of a developed country, in effect, the ldcs will develop a middle class. therefore, as an ldc more resembles a dc, the more effective product and market strategies employed in dcs, i.e., differentiation, should become more effective in ldcs. the mncs are transferring technology, skills and experience to ldcs and, perhaps most significantly, models for local entrepreneurship. p3 improved macroeconomic, financial and political conditions in ldcs will draw more foreign investment and induce the return of flight capital which will finance development of primary and secondary industries. 144 journal ofbusiness strategies vol. 10, no.2 the health of local capital markets and the competitiveness of local firms will be enhanced by the return of flight capital and increased foreign investment encouraged by improving financial and political stability in ldcs, especially in latin america. perceived risk is being reduced by a shift in policy from import substitution to export promotion and free trade. this shift is manifested in more democracy, privatization of state-owned enterprises, reduction of debt burdens and inflation, lowering of barriers to trade and investment, and growing equity markets. trade with latin america and trade within and among the newly invigorated trading blocs in south america is booming. mexico's recent actions and positive results are the most salient example. when mexico enters the north american free trade agreement, chile and much of the rest of latin america should follow, thereby accelerating this trend. p4 rising income levels will generate more market segments which will, in turn, generate demand for more differentiated products, especially consumer goods. the emergence of a middle class accommodates more income levels and concentrates more! wealth and purchasing power in what will become much larger lower-middle and middle-income groups. new consumers will generate more volume and diversity in the demand for goods and services than either the poor lower classes or very small wealthier classes which together formerly constituted the "two-humped" income distribution of the typical ldc. with greater wealth should come increased buyer sophistication and discrimination, and thus a taste for differentiated products. increasing travel and education levels will intensify this trend. if we do see significantly rising incomes in ldcs in the coming years, then we know what to expect. new market niches should proliferate not only among more and larger middle income groups, but across new lifestyles and ethnic groups (douglas and wind 1987). weakening social norms should develop segments across generations. newly emergent purchase criteria such as novelty and conspicuous consumption will encourage differentiation (sheth 1986). thus, an improved standard of living allows more choice, creating new, divergent needs and wants in societies formerly dominated by two segments, rich and poor. one-time subsistence workers will enjoy new opportunities to improve their individual standards of living, and in so doing exercise their individual tastes and preferences. more differentiated consumer demand should in turn generate more differentiated demand for intermediate products by local producers, thereby providing more opportunity for intermediate or industrial goods makers. anecdotal evidence suggests that this process has already begun in mexico, where rising incomes, shortages in some worker categories, and more discriminating consumer demand are being reported (perry, 1992). indeed, it now appears that latin america will be the next region to make the transition to industrialization (baker et a1.19913; 1992b; martinez et al. 1992). these trends will accelerate existing forces favoring unique products. perhaps 80% of international products require some adaptation while the average product requires substantial fa111993 scarborough: niche markets and small business strategies 145 adaptation. many international product failures are attributed to inadequate adaptation (kotler 1986). an overly standardized product/ market mix stifles innovation, inventiveness and responsiveness (kashani 1987). many global product buyers tend not to be price sensitive, and so-called world products tend to be luxury goods. research findings and pims data indicate that uniqueness is increasing in importance as an international marketing tool (douglas and wind 1987). strategic implications ps not only global mncs, but even multicountry mncs are vulnerable to niche finders. the prevailing wisdom holds that the large mncs, aided by their ability to crosssubsidize, will continue to dominate international markets. for all the reasons noted above, the utility of the pure global mnc strategy is limited. the more effective multicountry mncs are much better positioned and skilled in their ability to target newly emerging market segments. this competitive advantage should precipitate a shift in market share in their favor as ldc economies advance. but these finns have their weaknesses as well. even mncs which have sought to localize will suffer competitively relative to local niche players because of the mncs' larger overheads, slower response, and less thorough knowledge of local markets. p6 even if the mncs continue to dominate international markets, they cannot defend them all. if international market behavior replicates our domestic markets, the inevitability of successful niche finders is certain. increasing segmentation of markets puts large companies on the defensive, just as flanking or guerilla forces put superior armies on the defensive. with due respect to clausewitz, the great flaw of the defensive is that the larger one's territory, or market share, becomes, the more difficult it is to defend, because attackers can concentrate, or focus, their resources while the defender cannot. the defender must try to occupy and fill all gaps, stretching even superior resources too thinly, leaving itself exposed somewhere. the clever and determined niche finder will find and exploit those gaps. the challenge for america, and american business education, is to provide our potential niche finders the necessary wherewithal and the determination, even as our mncs improve the employment and trade balances of other nations. a new educational framework much of our research and pedagogical material deals with the structuring and operation of large mncs, with emphasis on how mncs need to localize while remaining basically global. this argument goes largely unquestioned, despite the increasing irrelevance of standardization in our own market. but evolving market conditions seem to suggest that we 146 journal ofbusiness strategies vol. 10, no.2 should devote less attention to fortune 500 mncs and more to our middle-market and smaller firms. this would be particularly so for schools which teach students employed not by the fortune 500, but that much more dynamic, larger, faster growing, employmentcreating, and perhaps even more interesting mass of smaller firms. except for our most elite schools, it would seem that most international business students are destined for these smaller firms. even if the hypothesis offered here proves totally unfounded, we still are remiss if we let any firm move toward greater rigidity, standardization and less responsiveness to customers, no matter how clever the techniques we devise to cope with the globalizationlocalization dichotomy, without raising caution flags. by not doing so, we would be letting businesses make the same mistakes internationally that they made at home, in a competitive environment much less forgiving than our own. the stakes of international competition are too high to risk such an error. conversely, the encouragement of smaller businesses to engage internationally would serve to focus the efforts of the most creative and energetic of american firms in a direction which can only improve our competitiveness. to focus only on global mncs and their problems may be too narrow an approach to international business education. moreover, it may be self-defeating; as our mncs continue to export jobs, where will our students find jobs? the answer lies with where we should refocus our efforts, with our smaller firms. entrepreneurship is our national comparative advantage; we must exploit it more effectively and completely. let us leave the dangerous, commodity-like markets to others and strive for the entrepreneurial markets which best suit our innovativeness, psychological orientation and business and cultural values. we should redirect our thoughts, our research, and our teaching to improving our support for, and the competitiveness of, smaller firms. we should be emphasizing practical skills, teaching our students how to do international market research, where and how to find assistance from governments, financial institutions, trade associations and trade centers, and middlemen. we should prepare them to help middlemarket and small firms build the skills and confidence they need to recognize and evaluate international opportunities, overcome risk, and to plan and commit themselves to the long term. the strategies small firms should employ are well established. happily, and a basic point of this paper, what will work best is what small firms do best, i.e., well-executed, focused strategies. this is how small firms competed successfully against large firms at home, and what they must do well to take on the mncs. we certainly can teach it and they clearly can do it. what is more difficult is generating the enthusiasm and commitment in risk-averse small firms and, what must go beforehand, shifting our own priorities as educators. international business educators should shift from efforts to improve mnc performance, which results in only marginal improvement of company performance and little benefit for our economy, to improving small business exports which can lead to much more significant improvements on both scores. this involves changing our dispositions from: (a) optimizing global systems to optimizing exports, (b) the theoretical to the practical, (c) thinking global to thinking local, fall 1993 scarborough: niche markets and small business strategies 147 (d) emphasis on corporate strategy to business-level strategy, (e) managing investments to managing companies, (f) east-west trade to north-south trade, (g) consulting with the fortun~ 500 to consulting with the agencies, institutions and organizations which promote the interests of small business, and, for smaller schools, with small companies directly, and (h) researching mnc behavior to researching ldc consumers and niche markets, and export channel behavior. research needs and expectations realization of the basic premise of this paper, that industrialization will lead to greater segmentation of markets, requires little more than continuation of similar processes which have already occurred in developed countries and are ongoing in newly industrialized countries such as taiwan and south korea, even though those countries have relatively homogenous cultures. nearby mexico may provide a real-time laboratory to test a hypothesis regarding the proliferation of segments with rising incomes. prior research suggests that the kinds of consumer goods used in the home should provide the most immediate results (quelch and hoff 1986). the greatest vulnerability in this entire argument may be the notion embodied in proposition one, that the shift in manufacturing employment from dcs to ldcs eventually must begin to consume excess labor supplies and drive up wages, incomes and consumption. the nature of the vulnerability lies in the word "eventually;" in that the poor, unemployed populations in ldcs are so large that it may be many years before incomes rise to the extent that a middle class and, with it, a proliferation of income-based segments, develops. in other words, the real issue here is not "if," but "how soon." hence, it is not the validity of this proposition that is in question as much as the timing. the same logic applies to proposition two, regarding development of entrepreneurship and supporting industries, and proposition four, regarding generation of more market segments and greater demand for more differentiated products. historical patterns of market segmentation in newly industrialized countries might shed some light on this issue. the flow of new and returning capital into ldcs which demonstrate the resolve and pursue the correct policies to reduce structural problems, such as mexico, chile and argentina, is underway. open questions include whether (a) the political changes attracting capital will continue and (b) capital markets function efficiently. if so, proposition three is valid. proposition five, which suggests that even multicountry mncs are vulnerable to niche finders, may understate the wiii or ability of multicountry mncs to target emerging niches sooner or more effectively than smaller exporters. the resolution of this issue depends on timing, just as does the basic premise of this paper. the longer it takes for new market segments to develop, the more time the mncs will have to make the necessary adjustments. this suggests an urgent need is to get our smaller firms moving as soon as possible to take advantage of what may be a limited window of opportunity. we can help our smaller 148 journal ofbusiness strategies vol. 10, no.2 exporters most in this regard with finely honed market research techniques which can detect early signals of emerging segments or lucrative product line voids. proposition six says that even large companies cannot defend all niches. our domestic experience bears this out in one industry after another. this proposition may well be the most important point in this entire argument. references baker, stephen, elizabeth weiner, geri smith, ann charters, and ken jacobson. 1992a. "latin america: the big move to free markets." business week (june 15): 50-55. baker, stephen, ken jacobson, elizabeth weiner, and geri smith. 1992b. "brave new financial world: investors in latin america are betting the region can only grow." business week (june 15): 60-62. boddewyn, j. j., robin soeh! and jacques picard. 1986. "standardization in international marketing: is ted levitt in fact right?" business horizons 29 (november-december): 69-75. browning, e. s. 1992. "in pursuit of the elusive euroconsumer." the wall street j oumal (april 23): bl,b8. douglas, s. p. and y. wind. 1987. "the myth of globalization." columbia journal ofworld business 22 (winter): 19-29. doz, y. 1987. "international industries: fragmentation versus globalization." in technology and global industry. eds. b. k. guile & h. brooks. washington: national academy press: 96-118. doz, y. and c. k. prahalad. 1981. "headquarters influence and strategic control in multinational companies." sloan management review 23 (fall): 15-29. drucker, p. f. 1986. "the changed world economy." foreign affairs 64 (winter): 768-791. kang, t. w. 1990. gaishi: the foreign company in japan. new york: basicbooks. kashani, kamran. 1989. "beware the pitfalls of global marketing." harvard business review 67 (september-october): 91-98. kotler, philip. 1986. "global standardization-courting danger." journal of consumer marketing 3 (spring): 13-15. levitt, t. 1983. "the globalization of markets." harvard business review 61 (may-june): 92-102. lipman, joanne. 1988. "marketers tum sour on global sales pitch harvard guru makes." the wall street journal (may 12): 1, 13. fail 1993 scarborough: niche markets and small business strategies 149 martinez, jon i., john a. quelch, and joseph ganitsky. 1992. "don't forget latin america." sloan management review 33 (winter): 78-92. ohmae, k 1990. the bordcrless world: strategy and power in the interlinked economy. new york: harperbusiness. ohmae, k 1985. triad power-the coming shape of global competition. new york: free press. perry, nancy j. 1992. "what's powering mexico's success?" fortune (february 10): 109-115. porter, m. e. 1985. competitive strategy: techniques for analyzing industries and competitors. new york: free press. prahalad, c. k and y. doz. 1981. "an approach to strategic control in multinational companies." sloan management review 22 (summer): 5-14. prahalad, c. k and y. doz. 1987. the multinationals' mission. new york: free press. quelch, john a. and edward j. hoff. 1986. "customizing global marketing." harvard business review 64 (may-june): 59-68. samiee, saeed and kendall roth. 1992. "the influence of global marketing standardization on performance." journal ofmarketing 56 (april): 1-17. sheth, jagdish. 1986. "global markets or global competition?" journal of consumer marketing 3 (spring): 9-11. niche markets and small business strategies: shifting the focus of international business education service quality perceptions in the banking industry: major dimensions minjoon jun new mexico state university las cruces, nm robin t. peterson new mexico state university las cruces, nm george a. zsidisin arizona state university tempe,az bonnie f. daily new mexico state university las cruces, nm abstract this article aimed to expand the body ofknowledge relating to the issues associated with customer-focused service quality and effective service delivery. a mail questionnaire inquired into the effectiveness ofthe marketing and operationsfunctions of commercial banks in delivering loan products. this study revealed that substantial differences existed between bankers and customers groups in the perceived importance of service quality dimensions. some suggestions and recommendations were provided to close the "gaps" and improve banking service quality. introduction during the past decade, the banking industry has witnessed a number of dramatic changes. the deregulation of the financial sector in 1982 has paved the way for free market entry and has enabled banks to pay what they want in interestbearing accounts and assess desired charges for the services. essentially, deregulation has intensified rivalry among banks in the u.s. and abroad and has led to increased competition from nontraditional institutions such as money management, securities, and insurance companies. in addition, new information technologies, such as check imaging, home banking, and electronic funds transfer, have sped and simplified financial activities and eroded geographic boundaries, producing further volatility in the industry. this unprecedented competitive market environment presents bankers with substantial marketing and operations challenges. many bankers have arrived at fall 1999 jun, et al: service quality perceptions 171 the conclusion that effective quality management practices can enhance their competitive advantage in this rival-driven marketplace, and have embraced total quality management (tqm) or tqm-type programs over the past decade (rivers, 1993; boaden & dale, 1993). if properly implemented, tqm can result in enhanced levels of service quality, reduced operating costs, the creation and retention of loyal customers through response to changing customer needs, and thus improved financial results (e.g., easton & jarrell, 1998; hendricks & singhal, 1997; and flynn et a1., 1995). one bank, for example, increased its profitability, directly due to a tqm initiative, by over two million dollars annually in a period of under two years (bird, 1993). however, tqm has resulted in a mixed success record, although banks have expended considerable time and effort, and have devoted substantial financial resources on quality tools and training and the launching of quality improvement teams (tucci, 1997; eskildson, 1995). many researchers (amsden et ai., 1996; hakserver, 1996; cowling & newman, 1995; and dotchin & oakland, 1994, to name a few) have attempted to identify the key elements of an effective tqm program and those identified can be summarized as: customer-driven quality, continuous improvement, top management leadership, teamwork, employee empowerment, and involvement of multiple personnel in decision making. customer-focused quality management is one of the most important tqm ingredients and is a point of departure for the implementation of such initiatives (amsden et ai., 1996; lengnick-hall, 1996; reed et ai., 1996; and dean & bowen, 1994). this is the case because the customer is the ultimate judge of product quality. if a company fails to identify precisely what customers want and to closely monitor their changing preferences, efforts to provide satisfaction are likely to be ineffective. this article aims to expand the body of knowledge relating to the issues associated with customer-focused service quality and effective service delivery by examining the following questions: (1) what do bank customers perceive to be the key attributes of quality?; (2) what do bank executives and loan officers perceive to be the key attributes of quality?; (3) are there substantial discrepancies between bankers and customers in the perceived importance of the determinants of service quality?; and (4) if any discrepancies exist between these two groups, what can be recommended to close the "gaps" and hence to permit improvements in service quality? such an examination is essentially pertinent, given governmental commitment and support to quality initiatives and the range of companies which are currently embarking on programs of product and process quality improvement. research objectives this study investigated the effectiveness of the marketing and the operations functions of commercial banks in delivering two loan products: commercial and installment loans. this was accomplished by searching for possible dissimilarities between customers and bankers in the perceived importance of service qual172 journal of business strategies vol. 16, no.2 ity dimensions. loan services were selected for this study since they are the most important profit generation source in community banking. specifically, the research first identified and prioritized the bank service quality attributes for the two types ofloan products, as perceived by the two groups: bankers (executives and loan officers) and customers. second, the study investigated discrepancies between the banker and customer groups with regard to the perceived importance of the quality attributes for the loan products. third, when significant differences between the two groups was observed, this research examined the perceived "gaps" in importance of each of the 19 service quality attributes. finally, this study provided various recommendations that may assist service providers in closing the "gaps" and improving the quality level of loan services. literature review strategic importance of customer focused service quality the managers of many service firms have concluded that quality is one of the major underlying contributors to their succe~s (mefford, 1993). according to shetty (1987), the attainment of quality can advance profitability by reducing costs and enhancing the firm's competitive position in the marketplace. consumers are increasingly becoming more quality conscious (moore & schlegelmilch, 1994). hence, it is imperative that service firms not only satisfy customers but also delight them (saunders, et ai., 1995). "delighted" customers are those whose expectations have not just been met, but have been exceeded (berry, parasuraman, & zeithaml, 1988). recent studies have shown that high levels of service quality can exert a positive influence on customer satisfaction (cronin & taylor, 1992; parasuraman, zeithaml, & berry, 1988). this force is so far-reaching that among the various criteria of the 1997 malcolm baldrige national quality award, three dimensions including customer and market knowledge, customer satisfaction and relationship enhancement, and customer satisfaction results accounted for 210 out of 1,000 total points. significantly, tqm programs focus on the importance of customer satisfaction through the provision of high quality products and services. identification and measurement of service quality unlike a manufactured product where quality can be readily assessed, based on product specifications, service quality has no direct and tangible criteria for measurement. that is, service quality is an elusive and abstract construct that poses definition and measurement obstacles. ross (1995) has proposed a customer-focused quality assessment effort. he has noted that services are not actions and behaviors in and of themselves, but are the means whereby customers perceive and interpret those actions. of course, the inherently subjective nature of service quality makes the measurement task complex. the banking industry is fall 1999 jun, et al: service quality perceptions 173 no exception in relation to the problems of complexity and efficacy in the conceptualization and measurement of service quality. the complexity of measuring banking service quality is evident through an examination of three well-documented features of services: intangibility, heterogeneity. and inseparability of production and consumption (parasuraman, zeithaml, & berry, 1985). first, services are intangible, as it is not possible to count. measure, inventory, test or verify them in advance of delivery. most banking services, such as loan processing, cannot be stored and their quality assessed in advance. customer experience, either directly or vicariously from outside sources, is frequently the only means of verifying whether bank services manifest high quality. second, service performance diverges from transaction to transaction. this heterogeneity can occur because the service is delivered at various times, by different employees to a variety of customers with varying needs. finally, in banking services, production and consumption are inseparable. the services are consumed when they are produced, which renders quality control difficult (desouza, 1989). this condition necessitates that marketing and operations functions occur simultaneously (mefford. 1993). in spite of these obstacles, customer perceptions of service quality should be assessed in all banks. this is the case since it is difficult to manage and improve that which is not carefully defined and measured. compared with other service industries such as healthcare, little literature has addressed in depth the issues of identifying bank service quality attributes and measuring customer satisfaction. most past studies have focused either (1) on anecdotal cases about banks' quality improvement efforts in which a few of key service quality dimensions were briefly discussed or (2) on a conceptual framework for tqm approaches and identifying causes of failures. customer satisfaction is an outcome of a range of quality attributes which include the quality of service core products (le., interest rate, fees) and of service delivery (i.e., error rate, process time, accessibility of service and equipment failures). more specifically, customer satisfaction occurs when customers feel that the overall quality of service products and delivery of service has met or exceeded their expectations relative to the competition and the cost they have paid. gronroos (1984, 1983) has noted that perceived service quality is influenced by both a technical and a functional dimension. technical quality is the material content of the buyer-seller interaction: what the customer receives. this dimension would include error rates, process times, accessibility of services, and equipment failures. on the other hand, the functional quality is the manner in which this technical quality is transferred: how the customer receives a service. this dimension would include the responsiveness, competence and courtesy displayed in the delivery of the service. these two dimensions of quality combine to form a perceptual map in the mind of the customer. parasuraman, zeithaml, and berry (1985) have attempted to identify those dimensions that customers employ when evaluating services, in terms of anticipated expectations. their objective was to discover those dimensions that were generic and relevant to services in general. parasuraman et al. (1985) initially 174 journal of business strategies vol. 16, no.2 identified ten determinants of service quality, based on a series of focus group sessions. these were tangibles, reliability, responsiveness, competency, courtesy, communication, credibility, security, access, and understanding. later parasuraman et al. (1988) developed servqual, an instrument created to measure five service quality dimensions induding tangibles, reliability, responsiveness, assurance, and empathy, which were distilled from ten original determinants using factor analysis. this method has been adopted by many banks to assess service quality (cowling & newman, 1995). for example, one bank used the five quality dimensions and found that the disparity between expectations and perceptions were the highest for reliability, responsiveness, and empathy, and the lowest on tangibles. however, these dimensions developed by parasuraman et al. (1988) have received some criticism, although they have been frequently used in the field of service quality management (johnston, 1995). for instance, cronin and taylor (1992), in their research into service quality in banks, pest control, dry cleaning, and fast food, found that the five-dimension structure for the servqual scale was not confirmed in any of their samples. armistead (1990) has suggested that the key determinants of service quality are categorized into two categories: firm and soft groups. the firm group includes time (i.e., availability, waiting time and responsiveness), fault freeness (i.e., physical items, information and advice), and flexibility (le., ability to recover from mistakes, to customize the service or add additional services). in return, the soft group comprises style (i.e., attitude of staff, accessibility of staff and ambience), steering (i.e., the degree to which customers feel in control of their own destiny), and safety (i.e., trust, security, and confidentiality). johnston (1995) has attempted to classify the determinants of service quality into those which are predominantly satisfiers and others that are predominantly dissatisfiers, using the critical incident technique. he selected a bank for his study because banks have identifiable customers, many of whom will have undertaken not just a single experience with that organization, but an ongoing relationship over a period of time, involving multiple transactions. johnson (1995) identified 18 individual determinants of service quality. they include access, aesthetics, attentivenesslhelpfulness, availability, care, cleanliness/tidiness, comfort, commitment, communication, competence, courtesy, flexibility, friendliness, functionality, integrity, reliability, responsiveness, and security. in assessing the intangible segment of bank branch operations, athanassopoulous (1997) employed three quality dimensions: physical, corporate, and interactive quality. the first, physical quality incorporates the physical aspects of the service (le., equipment, buildings, other tangibles). corporate quality includes dimensions related to the corporate image of bank branches' the parent organization. finally, interactive quality embraces the nature of the direct interaction between the customers and the bank service delivery mechanisms including personal involvement (i.e., credit/debit transactions) and mechanical involvement (i.e., atm transaction): fall 1999 jun, et al: service quality perceptions 175 in order to accomplish the research objectives of this study, the authors identified a total of 19 key quality attributes of loan services, rather than quality dimensions of general banking service, through a content analysis of the relevant literature discussed earlier and interviews with practitioners. these attributes are total cost of loan, interest rate, amount of security, choice of loan duration, points (front end fees), total number of payments, competence of loan officers, credibility, amount of required documentation, relationship banking, courteous service, location of loan approval authority, loan processing time, responsiveness to customers, reliable service, communications, appearances, high traffic and accessible location, and physical layout. the discussion that follows outlines the procedures which were included in the analysis. methodology a mail survey was employed to elicit information regarding the perceptions of bankers and loan customers. the survey questionnaires were initially developed by the researchers, based upon previous studies and then were reviewed by two practitioners from the banking industry. various alterations were undertaken, based on their inputs. in turn, survey questionnaires were forwarded to the bank executives and loan officers. in the cover letter, the bankers were requested to distribute the survey questionnaires to the customers of commercial and installment loans, who were either recent loan applicants or recipients. a total of 500 questionnaires were mailed to a sample of 25 banks located in the southwestern region of the u.s. and 124 usable returns were obtained, resulting in a response rate of 24.8%. table i summarizes the number of usable returns classified by loan types, and by banker and customer groupings. table 1 mail survey responses by loan types and by customer and banker groups bankers customers total installment loan 31 39 70 (56.5%) commercial loan 32 22 54 (43.5%) total 63 (50.8%) 61 (49.2%) 124 (100%) a total of 19 key quality attributes of loan services that were mentioned in the literature review section were identified by the authors. these attributes were categorized into two categories: loan product characteristics, and processing and delivery of loan service. the definitions of these attributes appear in table 2. 176 journal of business strategies table 2 service quality dimensions of loan products vol. 16, no.2 loan product characteristics: i. total cost of loan (principal, interest, fees). 2. interest rate (equivalent apr). 3. amount of security (deposits, assets, down payment). 4. choice of loan duration. 5. points, front end fees. 6. total number of payments. processing and delivery of loan service: 7. competence of loan officers, skilled and knowledgeable. 8. credibility, trustworthiness, honesty of bank personnel. 9. amount of required documentation (minimum paperwork) 10. relationship banking: non-intimidating, behavior towards customer, seeking long term banking relationships. ii. courteous service: polite, respect, friendly. 12. location of loan approval authority: centralized, decentralized, or other. 13. loan processing time: time needed to get approval. 14. responsiveness to customers: prompt problem solving and other customerrequested assistance. 15. reliable service: consistent error free service. 16. communications: informing customers clearly and completely free from loan application to end of loan. 17. appearances: grounds, furnishing, personnel. 18. high traffic and accessible location. 19. physical layout: access to parking, loan office privacy. in the questionnaire, the bankers were asked to rate each of the 19 service quality attributes in terms of their capability to attract and retain eligible loan customers. in turn, the customers were asked to rate each of the attributes in regard to their perceived importance in evaluating the quality of loan services. a likert-type seven-point scale ranging from 1 = no importance to 7 = extreme importance was utilized for these measurements. results and discussions perceived importance of each dimension tables 3 and 4 summarize the mean scores, standard deviations, and rankings of each of the 19 quality attributes, classified by customers and bankers groups, for installment and commercial loans respectively. as is indicated in table 3, for both respondent groups, all of the quality dimensions for installment loans have mean score of 4.4 or higher. this suggests that the members of both customer and fall 1999 jun, et al: service quality perceptions 177 banker groups perceive all of the dimensions listed to lie between "important" and "extremely important" as gauges of service quality for installment loans. in addition, both the customer and the banker groups produced an identical rank order of the top five attributes, including, in order of importance, credibility, courteous service, competence, responsive to customers, and reliable service. further all five dimensions have a mean score of 6.0 (= of great importance) or higher. however, in the case of the customer group, five additional dimensions yielded a mean score of 6.0 or higher: relationship banking, interest rate, communications, total cost of loan, and loan processing time. this suggests that customers for installment loans are expecting higher service quality levels on a wider range of quality attributes than are bankers. table 3 installment loans (customers group) quality attributes credibility courteous service competence of loan officers responsiveness to customers reliable service relationship banking interest rate communications total cost of loan loan processing time choice of loan duration points. front end fees amount of securities amount of required documentation # of payments location of loan approval authority high traffic and access location physical layout appearances mt 6.6* 6.6 6.5 6.5 6.5 6.4 6.3 6.3 6.3 6. t 5.9 5.7 5.5 5.4 5.4 5.2 5.1 5.1 5.0 sdtt 0.7 0.6 0.6 0.7 0.7 1.0 1.1 1.1 l.l 1.0 l.l 1.4 1.4 1.3 1.4 1.6 1.3 1.3 1.4 rank 1 1 3 3 3 6 7 7 7 10 11 12 13 14 14 16 17 17 19 note: t : mean tt: standard deviation '" : a likert-type seven-point scale (i:::: no importance; 4:::: moderate importance; 7:::: extreme importance) 178 journal of business strategies vol. 16, no.2 table 3 (continued) installment loans (bankers group) quality attributes mt sdtt rank credibility 6.4* 0.9 i courteous service 63 0.8 2 competence of loan officers 6.1 1.0 3 responsiveness to customers 6.1 1.0 3 reliable service 6.0 1.1 5 communications 5.8 1.2 6 loan processing time 5.5 0.9 7 relationship banking 5.5 1.2 7 total cost of loan 5.2 1.3 9 appearances 5.1 1.3 10 location of loan approval authority 5.0 1.5 ii amount of securities 5.0 1.2 ii high traffic and access location 5.0 1.2 ii interest rate 4.9 0.9 14 points, front end fees 4.8 l.l 15 choice of loan duration 4.7 1.0 16 # of payments 4.6 1.0 17 amount of required documentation 4.5 1.1 18 physical layout 4.4 1.3 19 note: t : mean tt: standard deviation * : a likert-type seven-point scale (1= no importance; 4= moderate importance; 7= extreme importance) as shown in table 4, for commercial loans, the dimensions of high traffic and access location, number of payments, and physical layout were positioned by both of the responding groups as between "not important" and "neutral," and the dimension of appearances was also specified as "not important" by the customer group. the remainder of the dimensions manifest a mean score of 4.1 or higher, for both of the two groups. the customer group ranked credibility, competence, relationship banking, reliable service, and total cost of loan as the top five dimensions, whereas bankers considered credibility, competence, responsiveness to customers, courteous service, and reliable service as the most important. further, all the mean scores of the top five dimensions for the customer group are higher than or equal to 6.0, while only one dimension, credibility, has a mean score of higher than 6.0 for the banker group. this configuration suggests that bankers should focus increased attention on such dimensions as relationship banking and total cost of loan. fall 1999 jun, et al: service quality perceptions 179 table 4 commercial loans quality attributes mt sdtt rank (customers group) credibility 6.7* 0.6 i competence of loan officers 6.6 0.8 2 relationship banking 6.0 1.2 3 reliable service 6.0 0.9 3 total cost of loan 6.0 1.5 3 responsiveness to customers 5.8 1.2 6 courteous service 5.8 1.2 6 points, front end fees 5.7 1.6 8 interest rate 5.6 1.3 9 loan processing time 5.6 1.0 9 location of loan approval authority 5.4 1.5 ii amount of securities 5.2 1.6 12 amount of required documentation 5.2 i.l 12 communications 5.2 1.5 12 choice of loan duration 5.1 1.2 15 high traffic and access location 3.9 1.6 16 # of payments 3.7 1.8 17 appearances 3.6 1.8 17 physical layout 3.5 1.7 18 (bankers group) credibility 6.1 * 1.2 i competence of loan officers 5.9 1.0 2 responsiveness to customers 5.8 1.2 3 courteous service 5.8 1.2 3 reliable service 5.7 0.9 5 relationship banking 5.7 1.2 5 communications 5.6 0.8 7 loan processing time 5.2 0.7 8 interest rate 5.1 1.0 9 total cost of loan 5.0 lo 10 amount of securities 4.9 0.9 ii choice of loan duration 4.6 1.0 12 points, front end fees 4.6 1.0 12 amount of required documentation 4.5 1.3 14 location of loan approval authority 4.5 1.2 14 appearances 4.1 1.4 16 # of payments 3.9 i.l 17 high traffic and access location 3.8 ll 18 physical layout 3.8 i.l 18 note: t: mean tt: standard deviation * ; a likert-type seven-point scale (1= no importance; 4= moderate importance; 7= extreme importance) 180 journal of business strategies vol. 16, no.2 in addition, for each of the product types, both the customer and the banker groups tend to focus on the dimensions in the processing and delivery category of loan service more than those in the product characteristics category. given that new products developed by a bank can be quickly and easily imitated by its competitors, using the definitions of gronroos (1984, 1983), functional quality (i.e., how the customer receives a service) may be a more useful source for gaining a sustainable competitive advantage over competitors than technical quality (i.e., what the customer receives). between group agreement the between group agreement for the two segments in the sample was assessed through multivariate analysis of variance (manova). as shown in table 5, both of the two manova tests reject the null hypothesis that the two groups have equal means on the 19 service quality dimensions (for installment loans, f=3.43177 with a p value of 0.000; for commercial loans, f=3.40902 with a p value of 0.001). in other words, for both types of loan products, there is a highly significant disagreement among the two groups in perceiving the relative importance of the quality dimensions. gap measurement between groups for each dimension in order to detect dissimilarities between the two groups with respect to each of the 19 service quality dimensions for the two loan product types, two-tailed ttests for equality of means were employed at the p<.05 level. this was undertaken to identify gaps between customers and bankers for the two loan products in their perceptions of the importance of each dimension. table 6 presents the mean scores and standard deviations for the customer and banker groups in the first two columns, and t-values and p-values in the last two columns. as indicated in the table, for installment loans, twelve dimensions were significantly different in the perceived importance by the two groups, whereas for commercial loans, only three attributes were perceived to be significantly different. table 5 between group agreement measured by multivariate analysis of variance loan types installment loans commercial loans wilks' lambda .39998 .30891 f value 3.43177 3.40902 p·value .000 .001 fall 1999 jun, et al: service quality perceptions 181 table 6 gap measurement between two groups measured by t-test customers bankers mt(sdtt) m(sd) t-value p-value installment loan competence of loan officers 6.5 (0.6) 6.1 (1.0) 2.06 .044* amount of required documentation 5.4 (1.3) 4.5 (1.1) 2.94 .005*** interest rate 6.3(1.1) 4.9 (0.9) 5.63 .000**** choice of loan duration 5.9 (1.1) 4.7 (1.0) 4.66 .000**** relationship banking 6.4 (1.0) 5.5 (1.2) 3.45 .001 **** courteous service 6.6 (0.6) 6.3 (0.8) 2.22 .030* loan processing time 6.1 (1.0) 5.5 (0.9) 2.85 .006** responsive to customers 6.5 (0.7) 6.1 (1.0) 2.31 .024* reliable service 6.5 (0.7) 6.0 (1.1) 2.47 .016* total # of payments 5.4 (1.4) 4.6 (1.0) 2.33 .023* total cost of loan 6.3(1.1) 5.2 (1.3) 3.79 .000**** physical layout 5.1(1.3) 4.4 (1.3) 2.12 .038* commercial loan competence of loan officers 6.6 (0.8) 5.9(1.0) 2.30 .025* location of loan approval authority 5.4 (1.5) 4.5 (1.2) 2.48 .017* points, front end fees 5.7 (1.6) 4.5 (1.0) 3.17 .003*** note: t: mean score tt: standard deviation * significant at .05 level ** significant at .0 i level *** significant at .005 level **** significant at .001 level conclusions and recommendations the implementation of quality initiatives should begin with defining customer needs and preferences, and the respective quality dimensions for multiple targets and market segments, since measuring service performance per se is not as meaningful as measuring performance relative to customers' expectations. measurement of customers' expectations of banking services provides a frame of reference for banks' assessment of their service quality. management's first step in planning quality enhancement programs, then, is to survey customer quality criteria. this research focused on two types of loan products, installment and commercial loans, and measured the perceived importance of customer and banker groups on 19 quality dimensions to investigate the consistency between the marketing and operations functions of community banks. 182 journal of business strategies vol. 16, no.2 with respect to the perceived importance of loan service quality attributes by customers and bankers groups, some major findings and recommendations are as follows: 1. for each of the types of loan products, both the customer and banker groups consider the five dimensions of credibility, courteous service, competence of loan officers, and reliable service as the most important. all of the five dimensions are related to functional quality (processing and delivery of loan service) rather than technical quality (loan product characteristics). this finding parallels with that of johnston (1995), in which he found that the top ten determinants, in terms of frequency of mention, are concerned primarily with the intangible aspects of staffcustomer interface (reliability, availability, responsiveness, and care). this finding can be particularly evident at a time when all competing banks have reached technological and pricing parity because they are searching for high quality through focusing on the interaction between customers and employees. it is essential that bank management produce strategic plans and tactics which take all five of these dimensions into account. 2. with respect to installment loans, both of the groups evaluated the 19 dimensions on a level between "important" and "extremely important." however, the mean scores for the customer group on all of the 19 attributes are higher than those for the banker group. this suggests that customers' expectations for installment loan services are more demanding than bankers' perceptions of the service. bankers are encouraged to conduct reviews of their operations which might allow their firms to be more competitive in responding to these dimensions. 3. as for commercial loans, fewer quality dimensions were perceived by the two groups as lying between "important" and "extremely important" than was the case for installment loans. specifically, both of the groups mentioned the attributes of the number of payments, high traffic and access location, and physical layout as "not important." it seems that business customers place their emphasis on fewer dimensions than do individual customers in evaluating loan service quality. this suggests that bankers should focus specifically on these dimensions in quality control efforts. the manova tests indicate substantial differences between the two groups on the ]9 loan service quality attributes. this suggests possible inefficiencies both in performing one of the important marketing functions in banks: listening to customer needs and preferences, and in linking the chosen marketing strategies to those of operations functions. by continually developing various intelligence gathering approaches such as service satisfaction surveys of customers following a service encounter, focus group interviews, and new, declining, and lost-customer surveys, banks can gain understanding on what customers demand and fall 1999 jun, et al: service quality perceptions 183 their changing preferences. particularly, when utilizing customer expectation and satisfaction surveys, it is recommended that survey questionnaires be developed internally and tailored to each market or product segment, rather than employing standard survey questionnaires generated by an independent research agency or consulting firm. this will permit effectively meeting or exceeding customers' unique needs for each market or product segment. customized measuring devices will permit unique assessments of the needs of each bank's clientele. once customer needs are identified, efforts should be undertaken to effectively meet those needs through well-coordinated operations functions. by employing the qfd (quality functions deployment) technique, which is a means of integrating customer needs into new product development and aiding in developing marketing and operations strategies, coordinated marketing and operations strategies are likely to be implemented (reed et al, 1996). further, banks can deliver appropriate services to their customers in an effective manner only through effective training programs. a growing trend is to require managers, by acting as coaches, to conduct one-on-one service quality training with their employees at the workplace (morrall, 1995). athanassopoulos (1997) has noted, in his empirical study, that branches with highly trained personnel who are capable of responding to service queries can exert a positive effect on the sales of loans. further, he contends that this indicates the importance given by the customers to those banking operations which require human judgments. hence, carefully conceived training programs should be created, closely supervised, and monitored for effectiveness. further, vertical teamwork between top management and low-level employees, and horizontal-cross-functional teams (i.e., teamwork between the front and back offices) playa pivotal role in satisfying customers without undue bureaucracy and communication barriers between levels in banks. forexample, although service quality is largely determined by the employees who directly interact with customers, their performance can be greatly influenced by cooperation from backroom workers and other support systems. integrated teamwork between the various levels in the organizational hierarchy and within multi-functional teams can be obtained through effective communications between the members of the organization and well-conceived training programs. these efforts will increase the probability of a well-coordinated program that focuses directly on customer needs. finally, two-tailed t-tests for each of the two product types revealed dissimilarities for individual service quality dimensions. these tests identify the attributes where the greatest between group disagreement took place. particularly, in the case of installment loans, there are highly significant gaps between customer and banker groups on particular dimensions, such as interest rate, choice of loan duration, relationship banking, and total cost ofloan. bank managers are well-advised to analyze these particular dimensions and attempt to determine why there is such substantial disagreement and how the views of the two groups can be brought 184 journal of business strategies vol. ] 6, no.2 into a degree of confonnity needed to forge a coordinated marketing and operations strategy. further understanding of customer preferences is important if the bank is to be in a position of competitive advantage. references amsden, r. t., ferratt, t. w., & amsden, d. m. (1996). tqm: core paradigm changes. business horizons (nov.ldec.l, 6-14. armistead, c. g. (1990). service operations strategy: framework for matching the service operations task and the service delivery system. international journal of service industry management. i (2),6-17. athanassopoulos, a. d. (1997). service quality and operating efficiency synergies for management control in the provision of financial services: evidence from greek bank branches. european journal of operational research. 98 (2), 300-313. berry, l l, parasuraman, a., & zeithaml,v. a. (1988). the service-quality puzzle. business horizons (sep.locll, 35-43. bird, a. (1993). one bank's approach to total quality management. the bankers magazine (may/june), 63-68. boaden, r. j. & dale, b. g. (1993). managing quality improvement in financial services: a framework and case study. the service industries journal. 13 (i), 17-39. cowling, a. & newman,. k. (1995). banking on people: tqm, service quality, and human resources. personnel review, 24 (7), 25-40. cronin, j. j. & taylor, s. a. (1992). measuring service quality: a reexamination and extension. jql,irnal of marketing. 56, 55-68. dean, j. w. & bowen, d. e. (1994). management theory and total quality: improving research and practice through theory development. academy of management review, 19 (3), 392-418. desouza, g. (1989). now service businesses must manage quality. the journal of business strategy (may/june), 21-25. dotchin, j, a. & oakland, j, s. (1994). total quality management in service part 2: service quality. international journal of quality & reliability management. ii (3), 24-42. easton, g. s, & jarrell, s. l. (] 998). the effects of total quality management on corporate performance: an empirical investigation. journal of busjness, 71 (2),253-307. fall 1999 jun, et a1: service quality perceptions 185 eskildson, l. (1995). tqm's role in corporate success: analyzing the evidence. national productivity review (autumn}, 25-38. flynn, b. b., schroeder, r. c., & sakakibara, s. (1995). the impact of quality management practices on performance and competitive advantage. decision scien<;es, 26 (5), 659-691. gronroos, c. (1983), innovative marketing strategies and organization structures for service firms. in l. l. berry, g. l. shostack, & g. d. upah (eds.). emerging persdectives on services marketing. (pp. 9-21). chicago: american marketing association. ---(1984). a service quality model and its marketing implications. european, 18, 36-44. hakserver, c. (1996). total quality management in the small business environment. business horizons (march-aprid, 33-40. hendricks, k. b. & singhal, v. r. (1997). does implementing an effective tqm program actually improve operating performance? empirical evidence from firms that have won quality awards. management science. 43 (9), 1258-1274. johnston, r. (1995). the determinants of service quality: satisfiers and dissatisfiers. international journal of service industry management. 6 (5), 53-71. lengnick-hall, c, a. (1996). customer contributions to quality: a different view of the customer-oriented firm. academy of management review. 21 (3),791-824. mefford, r. n. (1993). improving service quality; learning from manufacturing. international journal of production economics. 30, 399-413. moore, s. a. & schlegelmilch, b. b. (1994). improving service quality in an industrial setting. industrial marketin& mana~ement. 2, 83-92. morrall, k. (1995). building the bank on total quality management. bank marketing, 27 (3),64-68. parasuraman, a., zeithaml, v. a., & berry, l. l. (1985). a conceptual model of service quality and its implications for future research. journal of marketing. 49, 41-50. ---(1988). servqual: a multi-item scale for measuring consumer perception of service quality. journal of retahin!i:. 64, 12-40. reed, r, lemark, d. j., & montgomery, j. c. (1996). beyond process: tqm content and firm performance. academy of manallement review. 21,173-202. rivers, d. b. (1993). harnessing the poweroftqm. bank marketing, 25 (6), 35-39. 186 journal of business strategies vol. 16, no.2 ross, g. r. (1995). interpersonal stress reactions and service quality responses among hospitality industry employees. the service industries journal, 15,314-331. roth, a. v. & jackson, w. e. (1995). strategic determinants of service quality and performance: evidence from the banking industry. management science, 41 (11), 17201733. saunders,p. m,. scherer, r. e, & brown, h. e. (1995). delighting customers by managing expectations of service quality: an example from the optical industry. journal of applied business research. 1j, 101-109. shetty, y. k. (1987), product quality and competitive strategy. business horizons (sep.l !k!j., 4652. tucci, r. (1997). first chicago employees give retail banking a 'workout'. national productivity review. 17 (1),25-32. fall 1999 jun, et al: service quality perceptions appendix 187 both bankers and loan customers were asked to evaluate each of the 19 service quality attributes for commercial and installment loans. the 19 service criteria employed in the survey include: the total cost of the loan (principal, interest, fees); interest rate (equivalent apr); amount of security (deposits, assets, down payment); choice of loan duration; points (front end fees); total number of payments; competence of loan officers (skill and knowledge); credibility, trustworthiness, honesty of bank personnel; amount of required documentation (minimum paperwork); relationship banking conduct (non-intimidating, behavior towards customer, seeking long term banking relationships); courteous service (politeness, respect, friendliness); location of loan approval authority (centralized, decentralized, or other); loan processing time (time needed to get approval); responsiveness to customers (prompt problem solving and provision of other customer requested assistance); reliable service (consistent error free service); communications (infonning customers clearly and without change from loan application to end of loan); appearances (grounds, furnishing, personnel); high traffic and accessible location; and physical layout (access to parking, loan office privacy). a seven-point likert scale ranging from 1= no importance to 7= extreme importance was used for the measurements. for example, the survey request on commercial loans to which bankers responded was "please circle the response that best indicates how important each service quality criteria is to attracting and to keeping eligible commercial loan customers." the survey request on the same loan product directed to customers was "please circle the response that best indicates how important each criteria is in evaluating service quality for your commercialloan." dr. minjoon jun is an associate professor in the management department at new mexico state university. he holds a ph.d. in operations management from the georgia state university. his research interests include total quality management, service operations management, supply chain management, and operations strategy. dr. robin t. peterson is norwest distinguished professor at new mexico state university. he holds a ph.d. in business administration from the university of washington. he has written articles and books in the fields of marketing and management. mr. george a. zsidisin is a doctoral candidate in supply chain management at arizona state university. his research interests include supply risk, service quality, and environmental concerns that impact the supply chain. 188 journal of business strategies vol. 16, no.2 dr. bonnie f. daily is an associate professor in the management department at new mexico state university. she holds a ph.d. in engineering management from the university of missouri-rolla. her research interests include group decision support systems, quality management, and environmental management. service quality perceptions in the banking industry: major dimensions dividend policy: an empirical test using tile october. 1987 crash wold zemedkun william lewis randolph norfolk state university norfolk, virginia the finance literature has not yet reached a consensus on the relevance of dividend policy. the main consideration in the dividend policy debate is the impact of dividends on the value of the finn's stock. dividend policy issues have been investigated by many. miller and modigliani [9] analyzed the special case of perfect markets and concluded that dividend policy does not detennine or affect the value of the finn. others ([6], [8]) have argued· that investors prefer dividend to capital gains, and thus dividend policy affects the valuation of the company stock. most recent academic work leans toward the argument that dividend policy is relevant survey results reported by researchers ([1], [11]) indicate that corporate chief financial officel8 believe that dividend policy does affect stock prices. baskin [2] analyzed dividend policy and found an inverse correlation between dividend yield ~d stock price volatility. the purpose of this study is to examine the relationship between dividend policy and stock price volatility to detennine if dividend yield has an impact on either stock price behavior, the rate of growth, or stock beta.i we have chosen to observe dividend yield and stock price behavior in the period surrounding the crash of october 1987. such a period provides us with an excellent opportunity to examine factors that affect the adjustment of prices of individual stocks to major market changes. the primary hypothesis for this study is that stock prices of finds with high cash dividend yields are less sensitive to a market crash and exhibit lower market risk (beta) than stock prices of firms with low or no cash dividend yields. that is, the market does care about dividend policy. dividend policy is one important finn-specific factor that could modify the effect of a crash on a finn's stock price. this is important information for investors and has implications for portfolio strategies. the concept of duration2 is the theoretical basis for the explanation of an inverse 1the beta of a stock is a measure of its price variability compared to the variability of the stock market as indicated by an index such as the s&p 500 index. according to the capital asset pricing model (capm), beta is a measure of the stock's nondiversifiable risk. as a statistical measure beta is found by regressing a stock's price changes on the market index changes over time. a stock with a high beta, greater than i, would be more volatile than the average stock and therefore more risky. 2unlike maturity, which looks only at the time to the last payment from an investment, duration gives weight to the time at which each cash payment occurs. the weight assigned to each period is the present value of the cash flow for that period divided by the current price of the security. early payments are discounted less than those received later. thus, duration is the effective matmity of the investmenl 70 journal ofbusiness strategies vol. 9, no.1 relationship between dividend yield and stock price volatility. as reilly and sidhu [10] have shown, the stock with a high dividend yield will have a shorter duration than a stock that pays no dividends. duration considers the timing and pattern of payments to the investor and indicates stock price sensitivity to changes in yield. thus, duration plays a vital theoretical role in the risk assessment of common stocks. the important relationship between growth and dividend yield is also examined. firms that retain all of their earnings need to rely less on external sources of capital during periods of high growth. the theoretical reason for finns to retain all of their earnings is to finance growth. we expect to find that rums with low dividend or zero dividend yields have a higher growth rate than finns with high dividend yields. this is important because duration is a positive function of growth rate. data and methodology the data for this study is taken from the standard and poor's compustat data base. the pc plus version of the data base dated may 24, 1990, is used. the study period is oriented around the crash of october 1987 and the study group of stocks is drawn using three screening rules. the first screening rule is that the company's stock be listed on the new york stock exchange (nyse), the american stock exchange (ase), or trade in the over-the-counter market (otc). this rule excludes canadian stocks and companies listed only on regional exchanges. the second screening rule requires that enough data for the company be available to compute beta for september 1987. beta is computed by using a minimum of 24 months of stock prices. the third screening rule requires a stock price greater than three dollars in september 1987. this rule is used in order to screen out "penny stocks." the national association of security dealers uses a three dollar stock price minimum to qualify newer companies for inclusion in the national market system. the application of these three screening rules to the data base results in a sample of 3,039 companies available for the study. we divide the resulting group of stocks into three categories based upon fiscal 1987 dividend yield. companies with a dividend yield equal to or greater than three percent are placed in the high dividend category. companies that have a dividend yield of less than three percent but greater than zero are in the medium dividend yield category. companies which paid no dividend in 1987 are in the zero dividend category. the three percent boundary between the high and medium dividend categories divides the companies which paid dividends into equal groups. we fonn subsets of the overall study group by first separating the s&p 500 stocks into one subset and then using listing criteria to fonn two more subsets. the first subset consists of companies whose stock was part of the s&p 500 index on september 1987. the second subset is those companies whose stock was listed on the nyse or ase but are not in the s&p 500 index. the third subset is made up of otc companies who are not in the s&p 500. this breakdown fonns subsets of companies that are of different sizes. we also study the monthly stock returns of the group using the period surrounding the crash as the focal point following the earlier empirical example of fama, fisher, spring 1992 zemedkun &: randolph: dividend policy 71 jensen, and roll (ffjr) [5], we use the market model to investigate the effect of the crash on the stock prices of the various dividend groups. by adjusting for the market effect or systematic risk, we can focus on the pattern of excess returns or prediction errors surrounding the crash. while the ffjr methodology may have some theoretical weaknesses, it has proven to be remarkably robust in detecting abnormal stock price performance. in order to test the hypothesis, we will employ the test statistic described in dodd and warner [4]. to compute the statistic, the prediction error is standardized by its estimated standard deviation. the standardized prediction error is accumulated over the prediction intelval and divided by the square root of the number of time periods in this intelval. the test statistic is then derived by summing the accumulated standardized prediction error across finns and dividing by the square root of the number of finns. results we show various characteristics of the sample group and it's subsets by exchange listing in tables 1 through 4. these tables present the mean or median of a characteristic for the sample and by high, medium, and zero dividend yield we use the median for dividend yield and payout in order to avoid bias caused by outliers which are present in these data elements. for the other characteristics we use the mean. in table 1, we see that the average beta is low for the high dividend group and high for the zero dividend group. a test of the difference in the mean beta of the three dividend subgroups indicates that there is less than a one percent probability that the mean betas are equal.3 our primary hypotheses, that risk and dividend yield are inversely related, is supported by this evidence. the correlation between dividend yield . and beta is -0.24, and, is highly significant, further confmning the inverse relationship between beta and dividend yield. in tables 2 through 4, we can see that the relationship between beta and dividend yield is consistent across the different listing groups. we measure the growth rate by computing the rate of change in earnings per share (eps), sales, and assets over the period 1983 to 1987. a company that retains all its earnings can support a higher rate of growth without external financing. thus, all things being equal, we could expect an inverse relationship between growth and dividend yield. this inverse relationship holds for the total sample and the subsets in at least two of the growth factors measured. from table 1 we can see that the zero dividend group has the highest growth rate in sales and assets but not eps. we suspect this is because the zero dividend group contains a large proportion of relatively new companies that are at the critical point in the growth cycle and growth in earnings is taking a backseat to growth in sales and assets to support new sales. 3see iman and conover [7, p. 282] for the procedures for inferences about the difference in means. 72 journal ofbusiness strategies table 1: characteristics or total sample vol. 9, no. 1 number dividend yield ** dividend payout** beta*** growth rates*** bps sales assets market value (millions)*** total sample 3039 0.89% 4.8% 0.99 6.7% 12.0% 12.2% $1057 high dividend* 847 4.83% 54.0% 0.77 2.6% 6.2% 8.4% $1957 medium. dividend* 847 1.68% 22.2% 1.02 10.8% 10.8% 12.5% $1571 zero dividend* 1345 0.0% 0.0% 1.10 6.6% 16.6% 14.5% $179 *high dividend stocks yield greater than 3%, medium. dividend stocks yield between o and 3%, zero dividend stocks paid no dividend in 1987. **the statistic computed for this characteristic is the median. ***the statistic computed for this characteristic is the average. table 2: characteristics of s&p 500 stocks number dividend yield** dividend payout** beta*** growth rates*·· bps sales assets market value (millions)··* total sample 456 2.58% 32.6% 1.13 8.1% 7.2% 8.8% $4771 high dividend* 195 4.44% 50.2% 1.00 2.5% 4.2% 6.5% $6204 medium. dividend* 211 1.88% 25.4% 1.17 12.3% 9.3% 11.1% $4085 zero dividend* 50 0.0% 0.0% 1.46 14.2% 9.5% 7.9% $2168 *high dividend stocks yield greater than 3%, medium. dividend stocks yield between o and 3%, zero dividend stocks paid no dividend in 1987. **the statistic computed for this characteristic is the median. *·*the statistic computed for this characteristic is the average. spring 1992 zemedkun & randolph: dividend policy table 3: characteristics of non-s&p soo listed stocks 73 total sample number dividend yield** dividend payout"'* beta**'" growth rates*** bps sales assets market value (millions)*** high dividend* 1284 1.52% 13.8% 0.97 7.3% 10.6% 11.9% $602 medium dividend* 417 5.33% 58.8% 0.74 3.0% 6.9% 9.5% $889 zero dividend* 388 1.65% 21.3% 1.02 10.6% 10.2% 12.2% $861 479 0.0% 0.0% 1.13 8.4% 13.9% 13.3% $147 *high dividend stocks yield greater than 3%, medium dividend stocks yield between o and 3%, zero dividend stocks paid no dividend in 1987. **the statistic computed for this characteristic is th~ median. ***the statistic computed for this characteristic is the average. table 4: characteristics of otc stocks number dividend yield ** dividend payout** beta*** growth rates"'*'" bps sales assets market value (millions)*** total sample 1299 0.0% 0.0% 0.96 5.3% 15.3% 13.9% $210 high dividend'" 235 4.38% 47.1% 0.63 1.9% 6.9% 8.2% $323 medium dividend'" 248 1.48% 20.5% 0.90 9.9% 13.1% 14.0% $542 zero dividend* 816 0.0% 0.0% 1.06 4.7% 18.8% 15.7% $77 *high dividend stocks yield greater than 3%, medium dividend stocks yield between o and 3%, zero dividend stocks paid no dividend in 1987. *"'the statistic computed for this characteristic is the median. **"'the statistic computed for this characteristic is the average. another characteristic that we measure is company size. the market value of the common stock is the surrogate we use for size. when we examine the sample by listing subset, tables 2, 3, and 4, we see that there is a natural breakdown by size due to the various listing requirements. the s&p 500 companies are the largest with an average market value of $4,771 million. the other listed stocks are next in size 74 journal ofbusiness strategies vol. 9, no.1 with an average of $602 million. and, the otc companies are the smallest with an average size of $210 million. the size difference between the high and medium dividend groups in each subset is usually not significant, but the difference between the medium and zero dividend groups is more evident in each subset the smallest companies are the zero dividend companies, and the difference in size between the zero dividend and the medium dividend companies is statistically significant at the 1% level. the monthly stock returns of the study group, separated by dividend category and listing subset, are presented in table 5. the returns for august 1987 to january 1988 are listed. the first set of returns is for the whole sample group and its categories by dividend. in october 1987, the month of the stock market crash, the total sample went down 28.2% (-0.282). the high dividend category went down 21.3%, the medium dividend category down 27.4%, and the zero dividend category lost 33.1%. the difference between the mean returns of the different dividend categories for october 1987 is significant at the 1% level. this is more evidence confmning that high dividend yields are related to lower levels of risk. table 5: monthly stock returns: august 1987 january 1988 aug sep oct nov dec jan total sample 0.023 -0.012 -0.282 -0.053 0.051 0.058 hi div 0.021 -0.027 -0.213 -0.038 0.032 0.067 moo div 0.033 -0.011 -0.274 -0.043 0.082 0.035 zero div 0.018 -0.003 -0.331 -0.068 0.043 0.068 s&p 500 0.027 -0.021 -0.254 -0.067 0.090 0.044 hi div 0.027 -0.033 -0.224 -0.069 0.060 0.071 moo div 0.025 -0.017 -0.269 -0.065 0.115 0.028 zero div 0.037 0.003 -0.302 -0.065 0.103 0.006 listed stocks 0.022 -0.013 -0.281 -0.049 0.045 0.058 hi div 0.018 -0.025 -0.209 -0.035 0.025 0.068 med div 0.035 -0.007 -0.286 -0.041 0.077 0.035 zero div 0.015 -0.007 -0.338 -0.068 0.036 0.070 otc stocks 0.023 -0.008 -0.294 -0.052 0.044 0.064 hi div 0.023 -0.028 -0.212 -0.018 0.024 0.061 med div 0.036 -0.011 -0.261 -0.029 0.063 0.039 zero div 0.018 -0.001 -0.329 -0.069 0.044 0.071 the october returns of each of the listing subsets in table 5 follow the same pattern with high yield stocks suffering the smallest losses in the crash and zero yield stocks suffering the highest losses. the differences between the mean returns of the various dividend categories within each listing subset are also statistically significant at the 1% level. thus, the behavior of stock prices in the crash was consistent with their beta and the capital asset pricing model. this means that the prices of high beta stocks lost more value during the crash than the value of low beta stocks. spring 1992 zemedkun &: randolph: dividend policy conclusion 75 our analysis of companies with high, mediwn, and zero dividend yield in the period swtowlding the stock marlret crash in. october 1987 shows a very strong inverse relationship between risk and dividend yield. stocks with high dividend yield have lower betas and suffered the least in the crash. stocks that pay no dividends have significantly higher betas and suffered the greatest losses in the crash. stocks with dividend yields between zero and three percent, the mediwn dividend yield group, have betas between the zero and high dividend paying stocks. the differences in the betas of these three groups is statistically significant no significant excess returns were evident in the crash time frame. our examination of growth rates by dividend yield group found that the zero dividend group had the highest rate of growth in assets and sales. and the high dividend yield group had the lowest rate of growth. growth rates of the companies under study are consistent with the theoretical view that companies that pay no dividends can support higher levels of growth. the concept of duration is the theoretical basis for the explanation of an inverse relationship between dividend yield and stock price volatility. in general, stocks with high dividend yields have lower growth rates and therefore will have shorter durations than stocks that pay no dividends. thus, price volatility is a direct function of duration. the conclusion is that the market views companies that pay no dividends to be more risky and companies that pay high dividends to be less risky than companies in the mediwn dividend group. the market appears to be consistent (or perhaps efficient) since beta explains the post crash returns fairly well for each of the three dividend groups. references 1. baker, h. k., furely, g. e., and edelman, r. b. "a survey of management views on dividend policy." financial management (autmnn 1985), pp. 78-84. 2. baskin, j. "dividend policy and the volatility of common stocks." journal of portfolio mana~t (spring 1989), pp. 19-25. 3. boquist, j., racette, g., and schlarbaum, g. "duration and risk assessment for bonds and common stocks." journal of fmance, vol. 30 (1975) pp. 1360-1365. 4. dodd, p. and warner, j.b. "on corporate governance: a study of proxy contests." journal of financial economics, vol. 11 (1983), pp. 401-38. 5. fama, e., fisher, l., jensen, m., and roll, r. "'the adjustment of stock prices to new information," international economic review, vol. 10 (1969), pp. 1-21. 6. gordon, m. "optimal investment and financing policy," journal of fin!lllcft (1963), pp. 264-272. 76 journal ofbusiness strategies vol. 9, no. 1 7. iman, r. l. and conover, w. j. modem business statistics, (1983). 8. litzenberger, r. and ramaswamy, k. "the effects of dividends on common stock prices: tax effects or infonnation effects." journal of finance, vol. 37 (may 1982), pp. 429-443. 9. miller, m. and modigliani, f. "dividend policy, growth and the valuation of shares." journal of business, vol. 34 (1961), pp. 411-433. 10. reilly, f.k. and sidhu, r.s. '''the many uses of bond duration." financial analysts journal (july-august 1980), pp. 58-72. 11. sterk, w. and vandenberg, p. "the market valuation of cash dividends and tax differential theory of dividend policy: a case revisited." the financial review, vol. 25 (1990), pp. 441-455. dividen policy: an empirical test using the october 1987 crash journal of business strategies special issue on e-commerce and e-marketing strategies introduction by guest editors: e-commerce strategies for the future sanjay s. mehta sam houston state university huntsville, tx douglas m. kline university of north carolina wilmington, nc we present in this issue, five additional articles that were accepted from the call for papers in the fall of 2000 for a special issue of the journal of business strategies on ecommerce and e-marketing strategies. the papers in this special issue collectively focus on e-business strategies for both "brick-and-mortar" and "pure-play" firms to be successful in today's global environment. the first paper, "alternative measures of performance for e-companies: a comparison of approaches," by esmeralda garbi compares and contrasts traditional measures (e.g., accounting and profitability ratios) and e-commerce specific measures (e.g .• web presence growth) of performance. utilizing secondary data from a sample of thirty pureplays and thirty brick-and-mortar companies within the same industries, the author concludes that multiple indicators are necessary to measure variability and no single measure is a good predictor of future success. the second paper, "service quality offering strategies: from internet purchasers' and information searchers' perspective," by zhilin yang and minjoon lun focuses on two groups of e-commerce customers: internet purchasers and information searchers. the author identified six service quality dimensions for internet purchasers and seven service quality dimensions for internet purchasers. the reliability/responsiveness dimension was found to be most important for internet purchasers and the securityltrust dimension was found to be most important for information searchers. the third paper, "digital knowledge network: linking communities of practice with innovation," by patrice braun proposes a conceptual model that suggests that cooperation, collaboration, and connectivity among smes is necessary in today's digital economy. business models in the future need to include relationship management strategies (e.g., the exchange of knowledge and trust among business partners). the fourth paper, "a longitudinal price comparison for music cds in electronic and brick-and-mortar markets: pricing strategies in emergent electronic commerce," by zoonky lee and sanjay gosain compare price, price dispersion, and price dynami~s of music cds between pure-plays and brick-and-mortar firms. the authors found that pricing strategies vary across the retail format and that information technology can play an active role in strategy development. the fifth paper, "e-tailing: an analysis of web impacts on the retail market," by fang wang, milena head and norm archer recommends that firms, which develop ebusiness strategies, evaluate the web from two perspectives: as a marketing tool to be integrated into existing business strategies or as a new marketplace that requires new business models and strategies. the authors maintain that making this distinction aids the development, implementation, and evaluation of an effective strategy. the papers in this special issue recommend strategies that can be used by pure-plays and brick-and-mortar firms, large and small firms, and global and domestic firms. their focus on strategy is important since strategic planning is key to successfully competing in today's digital environment. in conclusion, the special issue editors would once again like to thank each of the reviewers (listed on the following page) for their comments and suggestions. given the importance of this topic, as demonstrated by the large number of submissions we received, we are very grateful to the journal editor, dr. jo ann duffy, for her willingness to publish a second special issue. douglas m. kline (ph.d., kent state university) is an associate professor of management information systems at the university of north carolina, wilmington, nc. dr. kline teaches courses in the areas of electronic commerce implementation and relational database management. he has published over 20 articles at various journals and international proceedings. he has worked as system architect and project manager, constructing a multi-million dollar system with an international is consulting firm. his current research areas include artificial neural networks, electronic commerce, and intelligent systems for text processing. sanjay s. mehta (ph.d., university of north texas) is an assistant professor of marketing at sam houston state university, huntsville, tx. dr. mehta is an award winning researcher and educator with 13 years of academic experience. dr. mehta has been a guest lecturer at several institutes in asia, australia, and n. america. he has presented and/or published over 100 articles in both trade and academic journals, national and international conferences. dr. mehta's current research interests include e-commerce, geographic information systems, and marketing strategies. journal 01 fljusiness 9trategies and the southwest academy of management have fonned a strategic alliance effective 2000-2003 with the aim of better serving the lbs subscribers and the southwest academy of management members. jo ann duffy, editor, irs stephanie newport, president, swam journal of business strategies special issue on e-commerce and e-marketing strategies ad hoc reviewers carl adams. university of ponsmoulh norm archer, mcmaster university j. thomas arias. university of coruna david bakuli, westfield state college anne banks pidduck, universityofwaterloo rua barkhi. virginia tech martin barnett, edith cowan univ",sity jon beard. university 0/ sourhern filinois edwardsville sleven bellman, univ. o/western australia andrew serai, wilfrid laurier university doug berg. sam hous/on state university prasad bingi, indiana-purdue university ed blackburne, sam housron stare unik jan bon. inform-it john branch, university of cambridge malin brannback, turku school of economics and business administration juergm brock, university ofstrathclyde ann brown, city university business school janice burn, edith cowan university donna carmichael, ibm consulting group casey cegielski, auburn university akhilesh chandra, north carolina a&t state university cristian chelariu. georgia state university shobha chengalur-smilh, state university o/new york rosann collins. univ. ofsouth florida rohert cosenza, christian brothers unlv. slephen dann, griffith university enrique dans. instifuto de empresa chrys de almeida, sheridan college s, k. dejveccbio. east carolina university pierre desmet, university oj paris ix dauphine and essec business school prakmh dheeriya. california state university domingo hills laurelk1e donahue wenyu 000. st. cloud state university marcia flicker, fordham university charles foltz. east carolina university k. dale fosler, memorial university oj newfoundland mohamed ghuloom, university ojbahrain janis gogan, bentley university willie golden, nul, galway ron goldsmith, florida state university sigi goode, australian national university ake gronlund. umea university richard halapin.lndiana university of pennsylvania susan hannon. middle tennesse state university chuck hermans, new mexico state univ. mark hill. lynchburg college charles hofacker. florida state unlv. kai jakobs, technical university of aachen ricjentzsch, university of canberra timothy johnston, university of tennessee at marrin stavros kajai'atis. kingston business school joseph kavanaugh, sam houston state university timothy kayworth. baylor university haim kilov,lona technologies jai-beom kim. myongji university tunga kiyak, michigan state university brad kleindl, missouri southern state college douglas kline, university ofnorth carolina at wilmington gerald kohen, sam houston state univ, andy koronios. university of southern queenskmd parag kosalge, indian institute a! management, bangalore marios kooraris, city univ. ojnew york sandeep krishnamurthy, university of washington jean.pierre kuilboer, university of massachuseus boston michael lane. university of southern queensland uloke lechner. university ofst. gallen zoonky lee, univ. ofnebraska lincoln jungwoo lee, univ. ojnevada las vegas shibo li, carnegie mellon university adam lindgreen, mark-lnstifut d'administration et ge.lfion mary long, po£/' university xueming luo, state university ofnew york. fredonia hank maddux, sam houston state univ. farrokh mamaghani. sr. john fisher college bala maniam. sam housron stale univ. donna maupin, university ofkenfucky mike mccardle, university of central florida chuck mcmejlon, hofstra university sanjay mehta, sam houston state university nirup menon, texas tech mohan menon. university ofsouth alabama catherine middleton. york university ronald milliman, western kentucky univ. hokey min, university oflouisviile luvai motiwalla, university of massachuserrs lowell susan mudamhi, temple university avinandan mukherjee, indian institute of management calcutta rudolf muller, university maastricht alhert muniz, depaul univer.li/)' jamie murphy, univ, of western australia martha myers, kennesaw state university mike o'dea, waikato polytechnic talai osmonhekov, georgia slate university jan owens. univ. of wi.lconsin parkside audhesh pll!iwan, university ofnorth texas keri pearlson, kp partners justin peart, florifkt international univ. richard platt, university oj west florida nava pjiskin, ben-gurian university ofthe negev edward pogossian. academy ofsciences ofarmenia madhavarao raghunathlm, bowling green stare university balaji rajagopalan. oakland university ashok ranchhod. southampton business school sally rao, unlv. ofsouthern queensland mohammed razzaque, national university of singapore william remington, emporia state university catherine ridings, lehigh university gail ridley, university ojtasmanla charlene riggle, unlv. ofsouth florida mark rosenbaum, ariwna state univ, jenny rowley, edge hill college of higher education ralfschejlhase, university ofapplied sciences. darmstadt gary schneider, university ofsan diego mareike schoop, aachen university of technology kevin shanahan. new mexico state univ, wai-sum siu, hong kong baptist university jill slater, university ofdenver craig slyke, university of central florida vic sower, sam houston state university sarah spencer-matthews, university of southern queensland thomas stirrel, university of st. gallen chuck stowe, sam houston state university fay sudweeks, murdoch university vamtha swaminathan, university of massachusetts david taylor, sam houston state universi/)' erraim turban, city univ. ofhong kong jan van bon. inform-it craig van slyke. univ. ofcentral florida jean walker, univ. ofhouston clear lake hong wang, wright state university victor wayhan, sam houston state univ. frank xie, georgia state universif)' kenneth yang, national univ. of singapore hurrem yilmu, univ. oftexlls at dallas aimao zhang, southern illinois uniursity a/ carbondale introduction by guest editors: e-commerce strategies for the future geo-demograpwc marker segmentation: an application in marketing management dan rutledge thomas callahan university of michigan-dearborn dearborn, michigan introduction segmentation has been a key tenant of marketing since its introduction by smith in 1956 ([2], [6]). this concept is based on the premise that differences in response behaviors exist among various groups of buyers comprising the market. for segmentation to be an effective analytical tool customers within a segment must display homogenous behavior while between segments customers must display heterogenous behaviors. the purpose of this paper is to illustrate the value and an application of geo-demographic market segmentation in practice. it can be shown that this method is easily implemented. has the potential for uncovering valuable information, and can be easily conducted for a minimal cost. more important, managers can then make decisions based upon concrete information rather the relying on assumptions based upon overall market 'averages'. within this context, a market research study was conducted for a small retailer of women's clothing. specifically, this sponsor wanted to know if there was a difference between the two cities that bordered the shopping center containing their store (these cities are referred to later as city a and city b). if differences were found this might explain why store sales were disappointingly low. in the process of analyzing the data, a third area (city c) emerged as important because its residents accounted for a large proportion of visitors to this center (a surprising fact previously unknown to the sponsor). thus, the analysis was extended to include city c in addition to the other two cities originally designated by the sponsor. the article is divided into six parts. segmentation theory and its practice in marketing is reviewed; the background of the sponsor's study is outlined; the purpose of the study and related hypotheses are discussed; research methodology and limitations are explained; results and hypotheses are analyzed; and lastly, conclusions and managerial implications are presented segmentation theory segmentation theory assumes that groups of customers in a market are different on some important dimension(s) that effects their buying behavior. the term 'different' means some unique characteristic that distinguishes one group's behavior from all other groups. segmentation is possible if significant customer differences are evident. this fall 1992 rutledge & callahan: geo-demographic market segmentation 125 idea contrasts with the assumption that customers are basically alike and can be depicted by some average numerical value. three advantages are realized from segmenting a market. the first is an enhanced ability to define the market resulting from discovering important differences among customer groups. second, these differences serve as a basis for selecting target customer segments. and third, strategies can be developed that should be more effective when competing in these segments. absent distinct market differences, a "mass" marketing strategy would be aimed at all customers. whereas this approach might be adequate for some situations, it is unlikely to produce optimal results. the reason for this is straightforward: those factors differentially significant to individual segments are not emphasized relative to their importance to those respective segments. deciding on a basis for segmentation is a central issue in marketing strategy. which dimension(s) to select depends mainly on management objectives and information requirements. no single segmentation schemata is preferred but several approaches might be appropriate for a given situation [11]. major segmentation categories most often cited by marketing writers are provided below ([4], [13], [lsd. within each category a variety of delineating dimensions are possible as the following examples show: geographic locations (e.g.) state, msa, mid-west demographic descriptors (e.g.) age, occupation, income, gender, education psychographic lifestyle (e.g.) upscale, health-conscious, interests in life behavioristic habits (e.g.) brand loyalty, heavy-user, benefits sought, occasion of purchase image how buyer see themselves in relation to the brands they buy (e.g.) extroverted, blue-collar, sophisticated one question that arises when deciding on segmentation base is whether to employ an fa priori' or clustering partitioning method. 'a priori' partitioning is a predetermined method that specifies in advance the basis for segmentation. as a judgmental method it assumes the dimension selected represents a clear and significant difference for defining segments [12]. a shortcoming of 'a priori' partitioning is this method may be too readily assumed a valid basis for segmenting groups. another is that often this method has not produced sufficiently distinct criteria for differentiating groups [11]. a second partitioning method is cluster analysis. segments are formed based upon information provided by the respondents themselves, requiring the data to be analyzed before describing the groups. clustering does not assume automatically significant differences exist or the best basis is already known. however, it is a more complicated and more expansive method to implement in practice. one basis for 'a priori' partitioning is geo-demographic segmentation, defined as the combination of "geographic units with respect to demographic characteristics 126 journal of business strategies vol. 9 no.2 (e.g., age, gender, income, occupation, etc.) they hold in common" [8]. there are several advantages to employing a geo-demographic approach: it is easy to use, cost effective, relatively inexpensive, and data is available from multiple sources [8]. geodemographics are widely recognized in practice and are relevant for planning advertising media [1]. they provide a common link among groups (e.g., data base marketing applications) by combining demographics with other household data, improving the marketer's ability to identify and reach target market segments ([11], [18], [19]). disadvantages of using geo-demographic dimensions are noted also. some studies have indicated weak associations between demographics and buying behavior ([3], [7). selection of the level of analysis (individual households versus groups of households) has produced different findings [2]. there is a tendency to unconsciously demographically stereotype people [25], the practice of attributing the same behavior to all members of the group (e.g., all women shoppers, age 18-34, rate low price their most important criteria). geo-demographic variables alone might not be sufficient for describing groups [1]. data may be aggregated into categories that are too broad [4]. lastly, the data may be far outdated, and thus, of limited value. on the other hand, research has been reported supporting the use of demographics for segmentation purposes. bass, tigert and lonsdale [2] found demographics predicted purchasing behavior of grocery products. this study attributed the improved results over previous studies to using household groups rather than the individual household as the unit of analysis. assael and roscoe [1] found income level predicted heavy versus light users of long distance calling as well as direct dial versus operator assisted calling behavior. blattberg, buesing, peacock, and sen [7] found demographic variables significant for identifying "deal prone" (bargain hunting) behavior among household units. warren, stevens, and mcconkey [22] combined lifestyle and demographic variables to identify investor segments. this combination explained both investment behavior and type of investment instruments held. cannon and rashid [9] examined the use of demographic selectivity (a proxy for heavy versus light users) for selecting magazines for placing advertising. this method, referred to as indirect matching, requires customers be defined in demographic terms, then matches these profiles with magazines having readers with similar descriptions. in one study of 25 randomly selected products and 50 randomly selected magazines, the authors found a correlation of 0.776, supporting a relationship between indirect matching efficiency and demographic selectivity. background of the sponsor's study the background for this paper was a market research study conducted for a women's clothing retail chain specializing in mid-priced apparel, appropriate for an office environment, and targeted at an "upscale" clientele. the sponsor had outlets in various suburban shopping centers,all located near a major midwestern city. the central focus of this study was a store located at an established strip-mall shopping center, well known to local residents because of the prominence of its major anchor fall 1992 rutledge & callahan: geo-demographic market segmentation 127 retailer. the trading area covered approximately a six mile radius and contained a population near 250,000 people. of the twenty-six businesses at this center, the sponsor's store, the major anchor retailer and four others sold women's clothing. the sponsor's target customers were upscale working women, defined as middle-aged (34-54), white-collar employed (teacher, manager, etc.), with above average incomes ($41,000). due to this fact only three stores at this center were considered serious competitors. initially, the sponsor assumed that because the two cities (a and b) that bordered the center indicated having demographic averages that matched their target customer profile, there would be an attractive customer base within a few miles of their store. they also believed these two cities (combined population 75,000) provided the large proportion of shoppers to this mall. what was overlooked were the differences between residents of the two cities that indicated distinct market segments. the data also revealed a number of shoppers attracted to the center coming from an area northeast of this location (referred to as city c, area population about 90,(00) that profiled a somewhat different type of resident. these facts were missed because the assumption was made that the area's overall geo-demographic averages were adequate for explaining this market. for the first three months sales exceeded expectations, but declined thereafter and remained at low levels for the next nine months. purpose of the sttjdy and hypotheses the impetus for this study was management's desire to know whether there was evidence of different geo-demographic segments in this trading area, in particular, between city a and city b. h differences were evident, then shopping behaviors might also differ, leading to varied expectations and evaluations of women's clothing stores as well as the sponsor's store. these factors combined might explain why this store was experiencing problems. the market research study was to answer four questions. the first question was to determine if city a residents were upscale (matching the sponsor's target customer profile) and different from city b or city c residents. h different, then city b and city c might not be providing a sufficient number of upscale customers. hypothesis 1 relates to the demographic compositions of the residents of the three cities: hi: the residents of city a have an "upscale" demographic profile compared to residents of city b or city c. the second question relates to customer search behavior, the motivated decision to seek new inputs [13], one step of their total buying process (e.g., looking for advertising information, visiting stores). h geo-demographic differences exist (vis-avis upscale versus downscale), then upscale residents might be more likely than downscale residents to display more active shopping behaviors. h the latter have less 128 journal of business strategies vol. 9 no.2 tendency to engage in active shopping behavior they would be less likely to patronize the sponsor's store. hypothesis 2 relates geo-demographics and buyer shopping behavior activity: h2: the residents of oty a display more active shopping behaviors than residents of oty b or oty c. question three focuses on shoppers' expectations of women's clothing stores. this issue concerns whether upscale shoppers have higher demands and expectations than downscale shoppers, a difference indicating upscale shoppers consider, for example, merchandise selection or ease of returns, important when deciding which stores to visit. hypothesis 3 looks at goo-demographics and shopper expectations: h3: residents of oty a have higher expectations of women's clothing stores than do residents of oty b or oty c. fourth, are shoppers' evaluations of the sponsor's store. high evaluations would be expected from upscale residents, given the type of store and merchandise presented. the implication is that because upscale residents seek a store like what the sponsor offers, they would give higher evaluations; downscale residents, making fewer visits, would give lower evaluations. hypothesis 4 relates geo-demographics and evaluations of the sponsor's store: h4: residents of oty a hold higher evaluations of the sponsor's store than do residents of oty b or oty c. overall, if the predicted differences exist between oty a and oty b (or oty a and oty c), then distinct market segments would be concluded to exist. finding this result might explain why sales had declined to low levels: there was not a sufficient target customer base to support this store. research methodology the sponsor requested several conditions be fulfilled when conducting this project. specifically, these were: 1) questions and response categories used in a previous study were to be followed as closely as possible. the sponsor was familiar with these questions which would allow for comparisons to be made between this study and the earlier study. 2) mall-intercept interviewing would ease the survey execution, save costs, and speed the timing for conducting the study. this convenience sampling method was utilized. fall 1992 rutledge & callahan: geo-tlemographic market segmentation 129 3) a total of 119 interviews were conducted. of this total, 22 were from city a (18%) and 23 from oty b (19%), cities specified by the sponsor as the main focus. a third area, oty c, provided 49 (41%) interviews. it was comprised of three small cities plus a portion of the major city and had a fairly homogenous resident base, which was the rationale for grouping them into one unit. the three cities accounted for 94 (79%) of the total interviews. 4) survey respondents included day, night and weekend shoppers. approximately onethird were sought from each period; the actual proportions were 29%, 29%, and 42%, respectively. participants were to be over age eighteen and not employed at this center. 5) interviewers selected participants by intercepting shoppers at three points along the outdoor causeway at this strip center. a total of 54 participants (45%) indicated sufficient familiarity with the sponsor's store to provide an evaluation. cities a, b, and c accounted for 12, 11, and 21, respectively (44 or 81 %), of the respondents evaluating the sponsor's store. survey questions covered four areas of inquiry: resident demographics, shopping behavior, evaluations of women's stores and evaluations of the sponsor's store. shopping behavior questions were asked first, expectations of women's stores next, followed by evaluations of the sponsor's store, with demographic information asked last. both demographic and shopping behavior questions primarily utilized closed-end responses, asking participants to indicate the choice which best reflected their background or shopping behavior. the eight questions asking expectations of women's clothing stores employed a five point scale (1=low to 5=high). these questions were used for evaluating the sponsor's store. a major problem using convenience sampling relates to its nonprobability method of selecting respondents. convenience samples may provide good estimates but there is no objective method to determine if the sample is representative of the underlying population; even increasing the sample size will not make it more representative ([10], [16]). selection bias occurs because of the limitations of the mall intercept technique. bias is due to: when and where in the mall the sample is selected; patronage habits (responding to special sales or weather conditions); frequency of visits to the center; and distance the respondent lives from the center which effects frequency of visitation ([17], [21n. when studying groups with particular characteristics. (i.e., older households), bias can become very large. weighting has been suggested as a method for correcting bias [21]. however, others have concluded weighting will not likely produce geographic representative data for adis, smsas or trade areas [17]. because this project was for comparison purposes only, the sponsor was willing to accept the results of a nonprobability sample despite these shortcomings. although trading-off cost and time savings for accuracy may be questioned by some, the sponsor believed the information gained for the cost incurred was worth the risk. 130 journal of business strategies evaluation of results and hypotheses vol. 9 no.2 convenience sample selection raises the question of the appropriateness of parametric methods for statistical analysis. parametric methods require two conditions to be satisfied: the population should be approximately normal and the observations be recorded on unambiguous measurement scales [5]. in this study it was suspected these conditions were not satisfied. nonparametric statistical methods overcome both problems. they are favored for distribution-free populations, i.e., for categorical or ordinal scale items, and are appropriate for small and moderate size samples [5] as found in this study. the demographic and shopping behavior profiles are found in table 1 and table 2, respectively. the similarity or difference for each city's profile is analyzed using a paired comparisons sign test, an easy to use method requiring only the sign of the differences be determined. the null hypothesis: ho: p[+] = .s = p[-] is formulated against the statistic s, the number of successes in n trials, based on the binomial distribution b(n,.5) [5]. rejection for large values of s would indicate the two groups are probably different. hypothesis 1 in table 1, the demographic profiles for cities a, b, and c are compared. the residents of city a exceed city b on all six factors; nearly the same result was found comparing city a with city c residents with city a higher on five of the six factors (p < 0.02). table 1 demographic profiles factor city a city b city c a-b sign a-c sign resident agel 44.9 39.2 33.8 + + household income2 46.2 32.5 31.9 + + education3 50% 39% 51% + occupation4 46 22 30 + + married5 68 61 42 + + no children at home5 59 57 47 + + n = 1 years 2 dollars in thousands 3 % attended some college 4 % white collar employed 5 % total 22 23 49 fall 1992 rutledge & callahan: geo-demographic market segmentation 131 we note age, income level, and occupation as items supporting hypothesis 1 that city a residents are upscale compared to city b or city c residents. hypothesis 2 proij1es of shopping behavior by city of residence are provided in table 2. comparing city a residents versus city b, residents indicates seven items positive for city a with two positive for city b; this same result was found between city a and city c. finding s = 7 successes in n = 9 items is significant at p < 0.05 [5]. table 2 shopping behavior promes + + + a-c sip + + + + + a-b sign + + + + + + city c 1.47 1.92 4.39 1.59 4.82 14% 24 4 734 cityb 1.52 2.74 5.17 1.43 3.30 17% 35 9 652 city a 1.68 3.68 5.85 1.68 3.50 55% 32 14 636 factor newspapers read1 credit cards held1 trips to center per month1 shop at other centers1 shop any women's stores1 shop at sponsor store2 search any oothing brands2 search sponsor's featured brand2 median spending oothingiyearj n = 22 23 49 1 average number 2 % total 3 dollars the majority of evidence offers support for hypothesis 2 that city a has more active shoppers than city b or city c. underlying this conclusion are several profile differences. first, there is the percent of city a versus city b or city c residents visiting the sponsor's store. second, we note three minor differences: shop at other centers, trips to this center per month, and number of newspapers read. for testing hypotheses 3 and 4 regarding shoppers' views of women's clothing stores, wilcoxson's signed-rank statistic is employed. this statistic calculates the value 1'+ by summing the ranks associated with the positive observations, then compares this value to the critical value x: prrt' ~ xl [5]. when 1'+ exceeds x, the two group are concluded to be significantly different 132 journal of business strategies vol. 9 no.2 hypothesis 3 the ratings attached to the eight items related to shoppers' expectations of the women's clothing stores are given in table 3. comparing city a to city b (one item was dropped because of a tie score) items rated higher for city a result in a total score of 25 (p < 0.04) [5]. however, comparing city a with city c, the latter has a higher ratings with a total score of 30 (p <0.06). table 3 expectations of women's stores a-b a-c factor city a city b city c dill rank diff rank attractive presentation 4.00 4.00 4.28 .00 -.28 7 convenient to location 4.55 4.22 4.53 +.33 6 +.02 2 ease of returns 4.68 4.09 4.67 +.59 7 +.01 1 fashion appeal 4.18 4.04 4.41 +.14 4 -.23 6 merchandise selection 4.50 4.22 4.36 +.28 5 +.14 3 personal service given 3.82 3.91 4.16 -.09 1 -.34 8 prices 4.18 4.30 4.38 -.12 2 +.20 4 speed at counter 4.09 3.96 4.31 +.13 3 -.22 5 n= 22 23 49 hypothesis 3 is supported, that is city a residents have higher expectations of women's stores than city b residents. this hypothesis is not supported for city a versus city c; just the opposite is observed. one explanation for this result might be that city c residents magnify the differences between stores at this center compared to the stores near their place of residence to justify traveling the further distance to this center. hypothesis 4 evaluations of the sponsor's store are presented in table 4. six of the eight items were rated higher by city a residents, two items rated higher by city b residents, producing a total score of 27 (p < 0.13) [5]. this same comparison for city a and city c produced a total score of 28 (p < 0.10). fall 1992 rutledge & callahan: geo-demographic market segmentation 133 table 4 ev~utiooors~nmrssron a-b a-c factor city a cityb city c diff rank diff ~ attractive presentation 4.33 3.91 4.06 +.42 7 +.27 7 convenient to location 4.67 4.18 4.33 +.49 8 +.34 8 ease of returns 4.25 3.91 4.00 +.34 6 +.25 6 fashion appeal 4.17 4.09 4.22 +.08 3 -.05 2 merchandise selection 3.67 3.63 3.88 +.04 2 -.21 5 personal service given 4.08 4.23 4.11 ~.15 4 -.03 1 prices 3.67 3.64 3.61 +.03 1 +.06 3.5 speed at counter 4.00 4.27 3.94 -.27 6 +.06 3.5 overall 4.00 3.91 4.17 n = 12 11 21 the results indicate marginal support for hypothesis 4 that city a residents have higher evaluations of the sponsor's store than city b. comparing oty a with oty c. slightly greater support is evident. overall comparisons can be made based on the overall number of differences between the three cities. based on the number of positive signs, city a had 24 of 30 items (p < 0.01) compared to oty b. compared to city c, the number of positive signs for city a number 21 of 31 items (p < 0.05). we conclude that city a represents a unique market segment in this trading area distinct from either city b or oty c. conclusions and manllgerial impucations we believe this study reemphasizes an important point for small business managers in the 199os. competitive pressures have increased the requirement for accurate and meaningful market information, making it an absolute prerequisite for survival and success. as shown in this study, a small retailer filling a market niche may require geo-demographic data about the trading area that is more than generalizations based on broad averages. in the case of this small retailer, geo-demographic averages were used for desaibing the population in the area surrounding this shopping center, becoming an important input in the decision to open a new store. the logical assumption was that the overall averages would reflect the demographics of customers coming to this mall; this assumption later proved incorrect. in reality, the market averages distorted the presence of distinct customer segments: a smaller number of attractive target customers and a 134 journal of business strategies vol. 9 no.2 larger number of customers below the profile considered the store's clientele. this post hoc information led to the decision to close this store. in our opinion, the challenge to "know your customer" has become an increasing and inescapable requirement, especially for small businesses. as observed from the above study, the need for detailed, accurate, and up-to-date information about customers is necessitated by the importance of the strategic decision being faced. a solution to this information dilemma is offered. cost can always be given as an objection to conducting any market research survey. we suggest, however, for the critical decisions that the dollars spent are relatively small and more efficiently used when compared to the costs of opening, operating, and closing an unprofitable store. if little or no up to date information about customers is readily available from the shopping center's management (the case in this study), agreeing to expand the study and share the costs between the center and retailer is a mutually beneficial alternative, one preferred to relying upon potentially outdated assumptions. additionally, some financial and/or time constraints can be circumvented by asking for a few, basic geodemographic fundamentals: age, income level, occupation, city of residence, household composition, and frequency of visits to the center. finally, the above recommendation identifies an area where market research can provide management with help understanding the relationship between geo-demographics and customer behavior. this type of research should provide small business with surveys designed and tailored for answering key questions about their specific markets and improve their decision making capability. references 1. assel, henry and roscoe, jr., a marvin. "approaches to market segmentation analysis," journal of marketine, vol. 76 (1976), pp. 67-76. 2. bass, frank m., tigert, douglas j. and lonsdale, ronald t. "market segmentation: group versus individual behavior," journal of marketine research, vol. 5 (1968), pp. 264-70. 3. beane, t.p. and ennis, d.m. "market segmentation: a review," e1j1vpean journal of marketine. vol. 21 (1987), pp. 20-42. 4. berman, barry and evans, joel r. retail management, 4th 00., new york, macmillan publishing co., (1989), p. 234. 5. bhattacharyya, gouri k. and johnson, richard a statistical concepts and methods, new york, john wiley & sons, (1977), pp. 505-38, 588-94, 615-16. 6. biggadike, e. ralph. "the contributions of marketing to strategic management,"~ emy of manaecment review, vol. 6 (1981), pp. 621-32. fall 1992 rutledge & callahan: geo-demographic market segmentation 135 7. blattberg, robert, buesing, thomas, peacock, peter and sen, subrata. "identifying the deal prone segment," journal of marketine research, vol. 15 (1978), pp. 369-77. 8. cannon, hugh m. and linda, gerald. "beyond media imperatives: geo-demographic media selection," journal of advertisins research, vol. 22 (1982), pp. 31-36. 9. cannon, hugh m. and rashid, amir. "when do demographics help in media planning?" journal of advertisins research, vol. 30 (1991), pp. 20-26. 10. churchill, gilbert a marketing research, 4th ed., new york, the dryden press (1987), pp. 217-18, 434-36. 11. cravens, david a strategic marketing. 3rd ed, homewood, il, rd. irwin. inc., (1991), pp. 162-95. 12. dillon, william r, madden, thomas j. and firtle, neil h. marketins research in a marketing environment 2nd ed., homewood, il, rd. irwin, inc., (1990), pp. 288-89, 618-20. 13. engel, james f., blackwell, roger d. and kollat, david t. consumer behavior, 3rd ed., hinsdale, il, the dryden press, (1978), p. 238. 14. kotler, philip and armstrong, gary. principles of marketina, 4th ed., englewood cliffs, nj, prentice-hall, inc., (1989), p. 226. 15. mason, j. barry and ezell, hazel f. marketing principles and strategy, plano, tx, business publications, inc., (1987), p. 159. 16. mccarthy, e. jerome and perreault jr., william d. basic marketins, 9th ed, homewood, il, r.d. irwin, inc., (1987), p. 81. 17. murry jr., john p., lastorvicka, john l., and bhalla, gaurav. "demographic and lifestyle selection error in mall-intercept data," journal of advertisine research, vol. 29 (1989), pp.46-52. 18. peterson, robert a marketins research, 2nd ed., plano, tx, business publications, inc., (1988), pp. 308-9. 19. riche, maratha f. "new frontiers for geo-demographics," american demowwhics, vol. 12 (1990), p. 20. 20. shelton, dwight j. "birds of a geo-demographic feather flock together," marketing news vol. 21 (1987), p. 13. 21. sudman, seymour. "improving the quality of shopping center sampling," journal of marketins research vol. 17 (1980), pp. 423-31. 136 journal of business strategies vol. 9 no.2 22. walsh, doris. "ouster demographics can target consumers but zip-code groupings may not be accurate," marketin& news. vol. 17 (1983), pp. 24-25. 23. warren, william e., stevens, robert e., and mcconkey, william. "using demographic and lifestyle analysis to segment individual investors," financial analyst journal. vol. 46 (1990), pp. 74-77. 24. wind, yoram. "issues and advances in segmentation research," journal of marketin& research, vol. 15 (1978), pp. 317-37. 25. winter, frederick w. "match target markets to media audiences," journal of advermine research. vol. 20 (1980), pp. 61-66. 25. zeithaml, valarie. "piecing together a fragmented market," marketine and media decisions, vol. 21 (1986), p. 160. geo-demographic market segmentation: an application in marketing management a strategic approach to polmcal risk assessment daniel sauers lincoln university canterbwy, new zealand recent events in the middle east. where the outbreak of hostilities has put foreign invesbnents in jeopardy, and the political volatility in eastern europe, asia. and latin america, once again point to the need for the systematic assessment and management of political risks associated with oversea investments. while a number of sophisticated techniques for assessing political risk are available, most multinational corporations (mncs) use subjective, sporadic analysis by overseas staff and independent consultants [21]. furthermore, the integration of political risk assessments into the strategic decision-making process of mncs tends to be informal and unsystematic [8]. political risk has long been identified as a prime factor to consider when making foreign invesbnent decisions. however, it has only been in the past decade that political risk assessment has emerged as an established managerial function in mncs. as with any new function, a number of problems have emerged. in an in-depth study of ten united states-based mncs, mascarenhas and atherton [9] found a general lack of satisfaction on the part of executives with regard to their existing system of assessing political risk. the need for a more formal assessment of political risk and its implications for strategic decision-making is apparent. in this article, a general framework for integrating political risk assessment into the strategic planning process of the mnc is developed. the political risk assessment approaches of american firms who first established joint ventures in china and the soviet union are then evaluated in light of this framework. political risk assessment and strategic management there is a basic linkage between political risk assessment and strategic management. higgins defines strategic management as "the process of managing the pursuit of organizational mission while managing the relationship of the organization to its environment" [5, p. 3]. the primary purpose of strategic management is to optimize the "fit" between the organization and its present and future environment. micallef, on the other hand, refers to political risk assessment as ''the systematic means of assessing and managing the political risks of foreign direct investment or international business" [10, p. 47]. while political risk assessment should play an integral part in a mnc's strategic planning process, in practice, its role is often limited to politic8j. forecasting [10]. as for the integration of political assessments into decision making, most authors confine themselves to the capital budgeting process where forecasts are used to adjust cash flows or the discount rate [6]. capital budgeting is but one function that can and should be affected by political risk judgements. a strategic approach to political risk assessment is required in order to fully integrate this function into the corporate planning process. spring 1992 sauers: political risk assessment 39 a strategic approach to political risk assessment involves four interrelated steps: 1. identification and analysis of key political issues and trends. 2. development of policy, strategy, and tactics for addressing key issues. 3. implementation and execution of the chosen strategic plan. 4. evaluation and adjustment of the strategic plan in light of actual experience andchanging political conditions. a model of the strategic approach to political risk assessment is presented in figure 1. phase i involves the application of environmental scanning and forecasting techniques to identify and analyze potential political risks. phase 2 involves the evaluation of feasible alternatives and the development of a strategic plan which takes into consideration political risk. factors. phase 3 embraces all the administrative actions associated with putting a strategic plan into action and making it work as well as political developments permit phase 4, evaluation and adjustment, is both the end and the beginning of the political .risk assessment process. the march of political change guarantees that the time will come for making revisions in strategy. most of the time, revisions will be of the fine-tuning variety, but occasions for major overhaul in strategy arise--sometimes because of significant political developments. figure 1: strategic political risk assessment phase 1 phase 2 phase 3 phase 4 identification strategy implementation evaluation & & analysis fonnulation & execution adjustment ----------..... ---------~ -----------. ----------environmental .... -evaluation of -organizing -monitoring scanning alternatives -resource -strategy -forecasting -strategy allocation refonnulation selection ~~ ~ ~ ~ ~ before examining each of the phases in the political risk assessment process in more detail, a word of caution: it is practically impossible to construct a model of political risk assessment which accurately portrays the dynamic, interactive nature of the process. while the model indicates four sequential phases, this is only partially realistic. the relationship between issue identification and analysis, and strategy fonnulation is particularly troublesome to portray realistically. in order to focus scanning efforts, for example, it is often advisable for management to start the process by tentatively defining the finn's strategy [9]. this scenario highlights the fact that the component phases of the political risk assessment process are interactive and can occur simultaneously. 40 journal ofbusiness strategies phase one issue identification and risk analysis vol. 9, no.1 schmidt [17] stresses the importance of understanding what constitutes a political risk. only after political risks have been defmed or identified can international managers posit relationships, gauge risk exposure, and recommend a course of action aimed at capitalizing, alleviating, or avoiding the various forms of this risk. although the term ''political risk" is used extensively in the international business literature, there is little agreement regarding the precise meaning of the tenn. in developing an operational definition of political risk suitable for integration into the strategic planning process of the mnc, it is helpful to consider the concept in an environmental context. robock [15], for example, suggests that political risk in international business exists when discontinuities, which are difficult to anticipate, occur in the business environment as a result of political change. these changes in the business environment constitute a risk if they have the potential for significantly affecting the profit or other goals of a particular enterprise. robock notes that fluctuations in the political environment that do not change the business environment of the firm significantly do not constitute a political risk. thus, what is a political risk fof one fnm may not be a political risk for another. it is also helpful to distinguish between uncertainty and risk in the political environment. political uncertainty describes an unmeasured, subjective doubt about a political environment. political risk, on the other hand, denotes a relatively objective measurement, usually resulting in a probability estimate of that doubt. root writes: "when the international manager makes a probability judgement of an uncertain p0litical event in a host country, he thereby converts a political uncertainty into a political risk" [16, p. 57]. political risk-assessment provides a means for the objective evaluation of foreign investment climates by converting uncertainties in the political environment into probability tends. finally, risk that is of a political nature encompasses governmental actions as well as any environmental forces which could change the government or its policies. thus, political risk generally refers to a full range of environmental factors that may affect a finn's performance in a particular country. normal business risks that emanate from pure market developments, however, are excluded from this definition. such a comprehensive view of political risk stresses the importance of environmental scanning in identifying potential sources of political risk. scanning activities should have as their focus the identification of the key political issues. such issues represent the major opportunities and threats which could critically affect the fjrnl' s performance in a particular country. a key political issue may be immediate or emerging, host country, home country, international or global in origin, that will directly or indirectly affect any facet of the firm's operations [21]. unfortunately, several problems plague political data collection efforts ([9], [18]). pertinent data is often not readily available. first-hand data collection of a political nature is not only difficult and time--consuming but also likely to be biased as the local people respond guardedly to sensitive questioning. data that are available tend to be biased and not in a readily usable fonnat. infonnation may be distorted due to internal spring 1992 sauers: political risk assessment 41 politics, and by communication problems arising from differences in personal orientation and from the peculiar nature of political data. finally, data that is collected for political risk assessment is often irrelevant. sethi and luther [18] place an emphasis on collecting data that are strategyspecific. this can be accomplished by tentatively defming the initial strategy so that relevant infonnation can be determined in the scanning process. several sources of data can also be employed to cross-check infonnation for biases [9]. incorporating these suggestions before initiating the scanning process should eliminate many of the problems noted above. once data on the environment has been collected, it must be analyzed and interpreted in an effort to forecast future issues and problems. there are a number of sophisticated qualitative and quantitatively oriented techniques available for this purpose. no one technique, however, is accurate for all political forecasting situations. political risk forecasting must be approached from the viewpoint of the individual ftrm. purchasing general reports from or utilizing the services of organizations such as the business environmental risk index (beri) or governmental agencies is useful, but such practices will be inadequate unless supported by detailed interpretation with respect to the individual fum. a fum would be well advised to follow rice and mahmoud's [14] seven step managerial procedure when selecting a political risk forecasting technique suitable for their needs and budget. steps included in the procedure are: problem definition; identiftcation of the lead time; identiftcation of the data pattern; accuracy of the method; cost analysis; subjective and environmental factors involved in the choice and implementation of a technique. phase two: strategy formulation once the key political issues have been identifted and the trends forecasted, the focus of the assessment shifts to developing strategies designed to mitigate or avoid the effects of negative factors as well as take advantage of positive ones. numerous risk management strategies have been espoused in the literature ([2], [10], [13], [15], [19]). political risk management strategies can be employed at both the pre-investment stage and in the course of operations. at the pre-investment stage, for example, shapiro [19] identiftes four separate, though not necessarily mutually exclusive, strategies that a mnc can follow: avoidance, political risk insurance, negotiating a concession agreement with the host government, and structuring the investment to minimize its exposure to political risk. at this stage, all feasible alternatives should be identifted and evaluated with regard to risk, cost, timing, etc. for example, political risk insurance can provide partial protection against such political risks as expropriation, civil or foreign war damage, and currency inconvertibility, but premiums can run high and coverage is usually limited to 90% of equity participation [2]. once a foreign investment is operationalized, a number of creative conflict-management strategies can be employed to cope with political risk [4]. poynter suggests that more effective strategies are aimed at increasing the finn's bargaining power relative 42 journal o/business strategies vol. 9, no.1 to the host government, which is "based on the scarce and significant resources the fum can make available to the host nation" [13, p. 267]. for example, a fmn may increase its bargaining power by up-grading product and process technology, developing new products, increasing exports and intrafirm trade, and providing better management. whatever strategy adopted, it should follow logically from previous analysis, addressing the key problems/issues identified and analyzed. phase three: implementation and execution once the course of action has been charted, attention then shifts to the task of converting the chosen, strategic plan into actions and positive results. it is often easier to develop a sound strategic plan than it is to "make it happen." mncs often devote a great deal of time to analyzing the environment and fonnulating strategies, but then fail to plan adequately for implementation. although the basic approach to successful strategy implementation is the same for both foreign and domestic operations, specific issues and their solutions are often different because of a different set of influencing environmental factors. there are a number of conflicts that can lead to implementation problems. phatak [12] notes that the basic cause of most problems encountered by international managers can often be traced to conflicts between the basic values held by two or more groups of people. for example, cultural differences with regard to individualism, infonnality, materialism, time orientation, and authority may influence a mnc's ability to implement a strategy successfully. to help alleviate strategy implementation problems an international expert, or, even better, a specialist on the specific country involved, is often needed. this person can often pinpoint likely implementation problems and suggest ways to reduce them. phase four: evaluation and adjustment tile last major step in the strategic political risk assessment process involves the evaluation and, if necessary, the adjustment of the finn's strategy in light of changing political, social, and economic conditions. after the strategic plan is implemented, management must recognize that periodic adjustments to the plan may be necessary. management must ensure that the strategies employed to control political risk factors are working. this requires that the mnc develop an intelligence system to monitor and evaluate political developments. according to micallef [10], the two primaty concerns here are: first, the development of reliable in-house expertise; second, insuring that the necessary infonnation is distributed to all relevant parties. simmon [20] provides guidelines for mncs interested in developing their own in-house monitoring capability, which he refers to as an "early warning system." feedback from those units monitoring the political environment is an integral part of the political risk assessment process, leading to revisions in political forecasts and, if necessary, corporate policy and strategy. spring 1992 sauers: political risk assessment organizational integration of the process 43 1be problems that plague the political risk assessment effort in mncs can be traced to the failure to fully integrate this function into the corporate planning and decisionmaking processes. the strategic approach to political risk assessment outlined above provides a general framework for the integration of this function into the strategic planning process. how the political risk assessment function is carried out, however, can and must vary from one institutional setting to another. the specific procedures used must suit the organization, fitting what has been called the "corporate culture," or risk being ineffective no matter how accurate the assessment. while each corporation will want to develop its own particular procedures, the chances for the successful implementation of the political assessment function may be enhanced by taking into consideration some of the factors discussed below. for optimal results, the political risk assessment function must be completely integrated into the organization's culture, structure, and strategic planning system. the process described in this paper can be operationalized through the setting up of a political risk assessment unit. kobrin [7] argues most convincingly for the institutionalization of political risk assessment. he sttesses that environmental scanning and communication flows can be improved through the introduction of a political risk assessment unit. the support of top management for the political risk assessment function is essential. their role is to encourage communication with respect to political developments between line managers and staff analysts. resistance by the corporate culture can be overcome by encouraging full participation in the political risk assessment process at all levels of the organization. line management involvement in the assessment process can be encouraged by having line managers perform some of the assessment activities. simmon [20] suggests a division of tasks between corporate headquarters and overseas affiliates, with the former responsible for macro risk analysis, and the latter perfonning micro risk assessments. line managers. however, will usually need training to develop their assessment skills. thus, the political specialists must also play an educational role within the firm. structure can be built into the system with the use of questionnaire survey reports to be completed by affiliates and assessed by headquarters [20]. a formal, systematic, uniform procedure incorporating the use of objective data should be developed. at the same time, however, ritualized, routinized, procedure-driven approaches that lead to a lack of flexibility must be avoided. in turbulent environmental conditions, going through the process is often more important than the final product. from a strategic standpoint, the political risk assessment process must be proactive, not reactive. the common reactive stance seems to occur because assessment resources are limited and therefore used sparingly [9]. one solution would be to marshall all the resources necessary for assessing initial investments, but make this first group of resources self-liquidating, leaving only a modest group to orchestrate updates and adjustments. furthermore, while political risk forecasters must obviously evaluate historical conditions and results, they must avoid merely extrapolating from the past. 44 journal ofbusiness strategies vol. 9, no.1 a forward looking perspective is particularly important when developing a strategic plan in complex and turbulent political environments. < finally, strategic decision makers should maintain a skeptical (but not cynical) attitude toward political risk forecasts, particularly when experience is limited. on the other hand. over-reliance on quantitative data and long-tenn forecasts by political analysts should be avoided. judgement should be used and forecasts limited to the time horizon dictated by the nature of the investment. political uncertainty makes forecasting for longer time horizons an exercise in futility. political risk assessment: theory versus practice in 1985. daniels. krug. and nigh [3] published a study of the political risk assessment approaches used by eleven american finns who were early entrants into joint ventures in china. this study and a more recent study by nigh and smith [11] of the assessment approaches used by nine american companies who were among the first to enter joint ventures in the soviet union provide an unusual opportunity to compare practice with theory. how do the political risk assessment approaches of these two groups of american finns compare to the strategic approach set forth above? below, some of the significant differences are addressed. the approach to political risk assessment used by these pioneering american firms can best be described as infonnal and unstructured. neither study found evidence of the application of an institutionalized assessment function utilizing stmctured, systematic analytical methcxls. rather the approach used in most of the companies surveyed involved intuitive judgements of the political risk, made by the ceo or another e:xecutive with country responsibility or, less frequently. by headquarters staff. in general, the finns surveyed did not report employing individuals whose primary responsibility was to analyze political conditions in foreign countries. two finns did report having a s1rategic analyst at headquarters for whom political risk assessment was a part-time responsibility ([3], [ii)). another finn employed one fun-time individual in the international division to collect infonnation on political factors [3]. in another finn, government affairs personnel were responsible for political risk assessment [11]. the political risk assessments concerning the joint ventures were seldom integrated in any formal way with economic and other considerations involved in the establishment of the joint ventures. in general~ they were integrated implicitly by an individual or considered in discussions among executives as they attempted to form subjective opinions on the extent of the political risk associated with their joint ventures. one finn did report that it used the assessment to shorten the payback pericxl and increase the return on investment criterion [11]. in setting up their joint ventures. each finn reported using some method to reduce their vulnerability to political risk. these included insuring through the overseas private inve8bnent corporation (opic). making small initial investments, and negotiating provisions in the joint venture agreement for the united states partner~s withdrawal under certain political conditions. fmns having larger investments tended to strocture their financing packages so as to shift the risk: to the lenders. once the joint ventures became spring 1992 sauers: political risk assessment 45 operational, however, few of the finns continued to monitor political risk. these findings concerning the political risk assessment approaches of american finns operating joint ventures in china' and the soviet union are consistent with the findings of an earlier conference board study which found that a fonnal political risk: assessment function is still very much in the beginning stages of development in the vast majority. of united states finns [4]. in general, a fonnal, systematic, and objective integration of assessments of political factors into the strategic decision-making process appears to be the exception rather than the rule. conclusion political risk assessment is still in its infancy. while there are numerous articles discussing sophisticated political risk assessment techniques, most of these techniques do not appear to be widely used. in addiction, integration of the assessment function into decision-making tends to .be informal and wlsystematic. the need for more formal assessment of political risk and its implication for corporate decision making is apparent the process described in this article provides a general framework which can help management better integrate the political risk assessment function into its strategic planning process. with more strategic assessment systems, there is less likelihood that a finn will be deterred from investing overseas by misperceptions of the actual political risk associated with its specific investment references 1. blank, s., basek, j., korbin. s.l, and lapalombara. j. assessine the political environment; an emereinj function in international companies. new york: the conference board, inc. (1980). 2. buckley. a. "taking account of political risk." accountancy, vol. 100. no. 1127 (july 1987). pp. 79-81. 3. daniels. j.d.• king. j. and nigh, d. "u.s. loint ventures in china: motivation and management of political risk..' california manaeement review. vol. xxvll. no.4 (summer 1985), pp. 26-58. 4. gladwin. t.n. and walter, i. multinationals under fire: lessons in the management of conflicts. new york: john wiley (1980). s. higgins. 1. organizational policy and strategic management: text and cases. second edition. chicago: the dryden press (1983). 6. kobrin. sj. "political risk: a review and reconsideiblion'" journal of international business swdies, vol. 10. no.1 (spring/summer 1979), pp. 67-80. 46 journal ofbusiness strategies vol. 9, no.1 7. kobrin. sj. managing political risk assessment: stratepc response to environmental challen&e. los angeles: university of california press (1982). 8. kobrin, sj., basek, j., blank, s. and la palombara, j. "the assessment and evaluation of non-economic environments by american finns: a preliminary report." journal of international business studies, vol. 11, no.1 (spring/summer 1980), pp. 32-47. 9. mascarenhas, b. and atherton, c. "problems in political risk assessment" management international review, vol. 23, no. 2 (1983), pp. 22-32. 10. micallef, j.v. "political risk assessment" columbia journal of world business, vol. 16, no. 2 (summer 1981), pp. 47-52. 11. nigh, d. and smith. kd. 'the new us joint ventures in the ussr: assessment and management of political risk." columbia journal of world business, vol. 24, no.2 (summer 1989), pp. 39-44. 12. phatak, a. international dimensions of management boston: kent (1983). 13. poynter, t.a. "strategic responses to government intervention in developing countries." in: t.l. brewer (00.), political risks in international business, new york: praeger (1985), pp. 259-274. 14. rice, g. and mahmoud, e. "a managerial procedure for political risk forecasting." management international review. vol. 26, no.4 (1986), pp. 12-21. 15. robock, s.m. ''political risk: identification and assessment" cohunbia joumal of world business, vol. 6, no.4 (july-august 1971), pp. 6-20. 16. root, f.r. "analyzing political risk in international business." in a. kappor and p.o. grub (eds.) the multinational entetprise in tdlp!ption: selected readings and essays. princeton: the darwin press (1972), pp. 354-365. 17. schmidt, d.a. "analyzing political risk." business horizons, vol. 29, no.4 (julyaugust 1986), pp. 43-50. 18. sethi, s.p. and luther, k.a.n. "political risk analysis and direct foreign invesbnent: some problems of defmition and measurement" california management review, vol. 28, no.2 (winter 1986), pp. 57-68. 19. shapiro, a.c. "managing political risk: a policy approach." columbia journal of world business, vol. 16. no.3 (fall 1981), pp. 63-69. 20. simmon, j.d. "political risk assessment: past trends and future prospects." columbia journal of world business, vol. 17, no.3 (fall 1982), pp. 62-71. 21. simmon, j.d. "a theoretical perspective on political risk." journal of international business studies, vol. 15, no.3 (winter 1984), pp. 123-143. a strategic approach to political risk assessment foreign-trade zones: opportunity for strategic development in the southwest james e. groff john p. mccray university of texas at san antonio san antonio, texas united states foreign trade has expanded dramatically throughout the decade of the 1980's. as shown in figure 1, total united states exports grew by 42.6% and imports grew by 80% from 1980 to 1988 [6]. however, finns in the southwestern united states have not participated in this growth. during the same period exports through southwestern ports' grew by only 5.4% and imports actually fell 9.1% [6]. figure 1: u.s. foreign-trade 1980-1988 v / / / / .)j ~~ / 1/.--' ..... .v·i·r-..............-....--.,.... 500 400 300 200 1978 1980 1982 i::j exports 1984 year 1986 • imports 1988 1990 iporpurposes of this paper, southwestern region involvement in foreign trade is measured by activity through these customs districts: dallasifl worth, ei paso, houston, laredo, new orleans, and port arthur. spring 1992 groff & mccray: foreign-trade zones 15 figure 2 shows how poorly the southwest region has fared relative to the rest of the nation. with the increasing globalization of markets there is no evidence of a reversal in the national trend. to be successful in the new global economy, businesses in the southwest must find ways to participate more fully in international markets. figure 2: southwest as percentage of all trade 24 22 20 i:: 14 12 ~~ """.~.~ ~. ""~ ii,\ ~ \ "-... \ "'" . . . " ............. "10 1978 1980 1982 gj exports 1984 year 1986 • imports 1988 1990 one tool which southwest business should consider as they work. to expand their international business is the united states foreign-trade zone (fiz).2 an fiz is an area which is physically located on united states. soil, but is not legally considered part of the united states commerce; it is considered to be outside united states customs territory. because of this unique status, goods brought into the ffz are not taxed or regulated until the owner decides to transfer them to another location which is within u.s. conunerce. because there is no limit on the amount of time a commodity can be held in an fiz, an owner gains a great deal of flexibility with regard to the timing of any duties or fees which are ultimately imposed on the goods. 2a valuable source of infonnation about free trade zones is the national association of foreign trade zones, international square, suite 400, 1825 eye street n.w., washington, d.c. 20006, (202) 429-2020. infonnation about a particular fiz in one of the cities listed in table 1 can be obtained through that city's chamber of conunerce or industrial development organization. 16 journal ofbusiness strategies vol. 9, no.1 which finns can use in a variety of ways to reduce costs associated with international trade. southwest region ftz's are shown in table 1. among firms already successfully using ftz's in the southwest are oil refmers coastal refining and marketing and valero refining co., aluminum producer reynolds metals company, and electronic manufacturers harvey industries inc. and zenith television. table 1: foreign-trade zones in the southwest region zone # 14 2 87 124 145 154 110 53 106 164 12 36 39 62 68 80 84 94 95 96 97 113 115 116 122 149 150 155 156 city little rock, ar new orleans, la clacasieu parish, la (lake charles) gramercy, la shreveport, la baton rouge, la albuquerque, nm rogers county, ok (tulsa) oklahoma city, ok muskogee, ok mcallen, tx galveston, tx dallas/ft. worth, tx brownsville, tx ei paso, tx san antonio, tx harris county, tx (houston) webb county, tx (laredo) star county, tx (rio grande city & roma) maverick county, tx (eagle pass) val verde county, tx (del rio) ellis county, tx (dallas/ft. worth) beaumont, tx port arthur, tx corpus christi, tx brazoria county, tx (freeport) ei paso, tx victoria & calhoun county, tx (port comfort) weslaco, tx number of subzones 1 o 2 1 o o 1 o 1 o o o i o o o 2 o o o o o 1 o 11 o o 2 2 spring 1992 groff & mccray: foreign-trade zones 17 the opportunities for using fiz's are far greater than many managers imagine. in this paper the strategic advantages of fiz's are explained. background foreign-trade zones are an underutilized resource which can offer strategic advantages to companies engaged in international commerce. the number and scope of fiz's in the united states have grown dramatically in the last decade. in 1980 there were only 59 general zones and nine subzones sheltering firms employing about 9,880 people and handling $5.1 billion dollars in merchandise. by april 1990 there were 158 general purpose zones and 168 subzones [3]. in 1987, the last year for which data are currently available, over 1,850 united states fmns were operating under ffz rules. these firms employed an estimated 165,000 people and processed over $104 billion in merchandise [2]. as figure 3 shows, the three major categories of goods that flow through ffz's -exports, foreign sourced imports, and domestically sourced reimports-all grew rapidly during the 1980's. figure 3: foreign-trade zone activity 40 30 ~ 20 o 3 l:q 10 j v / / / / v v / ...~ _......i ~ .~.-.... o 1976 1978 1960 1962 year 1984 1966 1968 el exports • foreign receipts a domestic receipts 18 journal ofbusiness strategies vol. 9, no.1 ironically, as one recent study indicates, despite this rapid growth, one of the biggest obstacles to further growth faced by fiz's is the failure of many potential users to recognize the benefits they can provide [4]. as united states finns, especially those in the southwest, increasingly fmd it necessary to become integrated into the global economy it is important that corporate decision makers recognize the opportunities provided by fiz's. what is a foreign-trade zone? a foreign-trade zone is an entity created under the foreign-trade zones act of 1934. fiz's are: "... secured areas approved by the [u.s.] foreign-trade zone board which for legal purposes are considered outside the customs territory. they are operated as public utilities by states, political subdivisions, or corporations chartered for the purpose. they are located in or near customs ports of entry" (reg.146.l)[5]. because fiz's are required to locate "in or adjacent to a port of entry" they often are associated with seaports. today, however, the most common location for an fi'z is an airport, although many of the largest are at coastal ports and some, such as zone no. 53 at rogers county, oklahoma are located at inland port facilities. while there are many potential benefits from locating in an frz, many companies are not able to locate in the area physically defmed as an frz. to accommodate these users subzones have been created. subzones are: ". . . special purpose facilities for companies unable to operate effectively at public zone sites and are located at the zone user's facility" (reg. 146.1) [5]. while an fiz is physically located within the boundaries of the united states it is, by law, outside united states commerce territory. this extraterritorial treatment for customs and some tax purposes and the wide range of activities which are pennitted within the zone make locating within an fiz attractive for many finns. how is a foreign-trade zone established? each ftz is operated by a grantee. the grantee is often a local public agency such as a city. however, private parties, such as industrial developers, may also apply to establish an fiz. an application to establish an ftz is made to the united states department of commerce's foreign-trade zone board which must review and approve it. the application process itself is costly and there is currently a substantial backlog of applications awaiting processing [1]. applying to establish a new ffz may take a year or more. once the application is approved the grantee may operate the frz itself or it may contract with another party to operate the facility. the operator attempts to attract clients/users who can benefit from the ftz's special customs and tax status to locate within its zone, and insures that the activities carried out within the zone comply with appropriate regulatory provisions. because of the significant costs and delays involved in establishing a new zone and the administrative burden imposed on the zone operator, the most attractive alternative for most fmns would be to locate within an existing frz. this may mean building a facility in the designated zone area; however, several alternatives exist h a fum has an existing facility such as a manufacturing plant which can not be physically relocated, or cannot identify a suitable plant site within an existing fiz, the plant owner can negotiate with an existing frz to develop a subzone which spring 1992 groff & mccray: foreign-trade zones 19 encompasses the area of the existing or proposed plant. the subzone is under the supervision of the existing fiz operator, but is physically removed from the fiz and is authorized to perfonn only certain activities. this arrangement is called a special purpose subzone. establishing such a subzone increases the physical space in the existing fiz by the area in the subzone. the approval process is generally less costly and more expedient than for a new zone. allocating portions of an already approved zone to physically separated facilities is a second alternative, which is increasingly popular. this process has occurred where a grantee has established a zone comprising a fixed area (for example, five acres of property adjacent to an airport) but has been unable to attract clients to the site. to allow f'nms to obtain the benefits of fiz status without increasing the total amount of duty free area, the grantee may apply to have the five acres at the airport site decreased by the same amount that is designated as an fiz at the new factory or warehouse site. unlike the subzone, this reallocation does not establish a new fiz entity since the physically remote area is considered part of the original ffz and does not increase the total area designated as an fiz. this approach is particularly attractive where the original grantee is a public body and the purpose of establishing an fiz in the first instance was to promote economic growth. in this case the grantee is less interested in promoting a particular site than in spurring investment through the use of the fiz. like the subzone, the application procedure is less involved, less costly and more expeditious than establishing a new zone. a variant on the last procedure involves establishing a new fiz which does not designate a specific site, but designates a specific maximum area which may be used as an fiz within a larger area. this approach allows a grantee, particularly a developer in an industrial park, greater flexibility than does the traditional ftz. within a development only those facilities which benefit from the ffz status need be so designated. this increases the number of potential sites an investor needing fiz status can choose from when investigating plant locations. a variety of potential benefits can be obtained from locating within an ffz. not all of these benefits will accrue to every finn but managers considering site locations for manufacturing. warehousing, shipping or exhibiting goods should pay careful attention to all the possible sources of savings. advantages of foreign trade zones duty and tax deferral or avoidance. the most obvious advantage of an fiz is that it can be used to delay the payment of duties and excise taxes on goods which are imported into u.s customs territory and avoid their payment entirely on imported goods (such as re-exports or broken units) which never enter u.s. commerce. this is illustrated in figure 4. import duties and excise taxes are not collected until goods are moved out of an ffz and into u.s. commelce. for finns which hold large amounts of inventory, the interest costs on these duties and taxes can be reduced by holding the inventory in an fiz until it is ready to be shipped to the buyer. this is particularly useful for finns that build inventories of highly seasonal inventories such 20 journal ofbusiness strategies figure 4 a foreign trade zone vol. 9. no. i items lost or destroyed in process u.s. commerce no duties, taxes or fees '\..-1...., duties, taxes an foreign trade zone are assessed a paid storage, processing & manufacturing when the fin product enters u.s. ommerce foreign manufactured goods no duties, taxes or fees re~export no duties, taxes or fees spring 1992 groff & mccray: foreign-trade zones 21 as chrisbnas items. tracking goods to final destination. ftz's facilitate tracking of imports from their source to their final destination. firms involved in international sourcing and trans-shipment find this to be a particularly attractive reason for locating in an ftz. when a united states based manufacturer located outside an fi'z imports raw materials for processing and re-export, it must first pay the appropriate duties, (or obtain a temporary import bond) then apply for a reimbursement (called a drawback) of 99% of the duties paid on that portion of the raw materials which are re-exported as finished goods. this is a costly and time consuming procedure. not only does the manufacturer have to pay the duties up-front but it must also track the raw materials through the manufacturing process to insure that the drawback is taken on goods which are reexported. when the processing is done in an ftz, duties are only paid on the goods which enter united states commerce. inverted duties. ftz's allow manufacturers to take advantage of inverted duty schedules which are part of united states customs laws. this is illustrated in figure 5. in many cases, united states customs laws impose significantly higher duties on manufactured component parts than they do on items which can be assembled from those parts. manufacturing operations in fiz's can use foreign sources for component parts of a product with a high tariff (for example 10% of the value), assemble the product in an fiz using united states labor, and export the finished product into united states commerce at a significantly lower tariff (for example 3% of the product value) than would be imposed on the individual foreign components. relabelling and fitting. ftz's can be used to avoid fines resulting from improper labelling or fitting. many foreign manufactured goods do not meet united states health, safety, pollution control or labelling requirements without significant modification. importation of these goods directly into united states customs territory without meeting all united states requirements can subject the importer to heavy fines or other penalties. these penalties can be avoided by moving the goods into an ftz fltst and performing the modifications or relabelling there before they enter united states commerce. ouota management. ftz's allow a more sensitive response to quota and antidumping requirements. some imports are subject to quotas or extraordinary duties because of anti-dumping laws. goods held in ftz's are not considered imported until they are moved into united states commerce; therefore, they are not counted against quotas or as part of dumped goods. firms can move goods into ftz's and hold them there until favorable windows of opportunity (for example, when quotas are not full) allow their further movement into the united states without penalties or fmes. if these opportunities do not develop, the goods can be re-exported without being assessed penalties for quota or dumping violations. reductions in inventoiy costs. ffz's may result in lower inventory costs. inventory costs may be reduced in several ways. first, inspection and testing can take place in the fiz. only useable goods need to be moved into united states commerce and are subject to tariffs. second, by storing inventory which is subject to shrinkage, such as grain or volatile liquids, in an ftz until they are sold, no tariff is paid on the shrinkage loss. third, insurance costs are reduced because the insured value of 22 journal ofbusiness strategies figure 5 tariff inversion foreign trade zone storage, processing & manufacturing facility within ftz processing produces new product with new form and/or content % foreign manufactured goods vol. 9, no.1 spring 1992 groff & mccray: foreign-trade zones 23 inventory is less by the amount of the duties which must be paid when goods enter united states commerce. finally, because, by law, an fi'z must be a secured area, loss due to theft may be reduced. avoidance of inventozy taxes. some state and local taxes may be avoided by locating in an fi'z. for example, many texas taxing entities have an inventory tax. if goods are held in an ffz in one of these texas jurisdictions, this tax is avoided. establishing a country of origin. goods assembled in an fiz from foreign made parts are classified as united states made products for re-export purposes. also, components from countries not eligible for "most favored nation status," which are subject to a higher tariff schedule can be included in products assembled in the fiz with the resulting product being subject to the more favorable tariff schedule when the ftnished product enters united states commerce. from this list it is clear that many avenues for cost savings are potentially available. two approaches to using foreign-trade zones which have contributed signiftcantly to their growth are, 1) foreign trade zone networks and 2) using foreign trade zones as part of a system of international production sharing, particularly with ftmls that participate in the maquiladora program along the mexico/united states border. foreign-trade zone networks a product imported into an fi'z can be stored indefmitely without being subject to u.s. customs charges and state and local taxes. however, once it is moved out of an fi'z and into united states commerce the importer becomes liable for all duties, fees and taxes that apply. while importing products into an ffz adjacent to a port of entry may initially delay these charges, eventually those products must be moved to another manufacturing plant, warehouse or distribution center. the movement away from the entry port would usually trigger the customs and duties liability even though there may be many months between this movement and the ultimate sale or distribution of the product an approach which allows the maximum deferral period is a foreigntrade zone network. one of these is illustrated in figure 6. in a foreign-trade zone network the importer obtains the maximum deferral of duties, taxes and fees by establishing every intermediate stopping point for the imported products in ffz's. in figure 6, the receiving warehouse at the original port of entry, the production plants that receive and process the imported goods and the distribution center which holds the goods until they are distributed to the purchaser are located in ffz's. once the goods enter any ffz in the network they travel between ffz's in the network "in bond" and remain outside united states commerce. the goods do not become liable for duties and taxes unless they are moved into united states commerce. additionally, activities such as changing the duty status (which are shown in figure 5) may take place at these intermediate points to gain further savings. 24 journal ofbusiness strategies figure 6: foreign~trade zone network foreign source vol. 9, no.1 u.s. domestic content plant 1 in fiz#2 warehouse m fiz#l "" ............. k'" '~uctstra~~l"""~ in bond u.s. domestic content plant 2 m fiz#3 distribution center in k" fiz#4 , ...... ' duty is deferred until product is placed into u.s. commerce ******************************** ******************************** products enter u.s. commerce foreign-trade zones and international production sharing international production sharing takes place when the production process takes place in more than one country. as it is generally used in the united states, it refers to a manufacturing arrangement where some initial, usually capital intensive, processing steps, such as cutting of fabric or fabrication of parts, are done in the united states. these partially completed products are shipped to a low labor cost country for completion, which usually means assembly. the completed product is then returned to the united states for sale. while production sharing has been done in many parts of the world including the far east, south america and the caribbean. it has experienced the greatest success and recent growth in the form of the mexican spring 1992 groff & mccray: foreign-trade zones 25 maquiladora program. this program, which now employs over 450,000 workers in mexico, almost all adjacent to the united states border, has expanded rapidly since the devaluation of the mexican peso in 1981 and 1982. a number of maquiladoras, particularly those serving the domestic auto industry are part of foreign-trade zone networks like those described above. united states produced components are shipped to maquiladora plants in mexico for assembly. the completed parts are then returned to a warehousing and distribution facility on the united states side of the border which is designated as an ffz. from this facility the parts are forwarded to production plants particularly in the northern united states. these plants are designated as ffz subzones. this process minimizes the duties and taxes associated with the work done in mexico. production sharing can also be used to alter the duty status of goods imported in the united states (as illustrated in figure 5). in its simplest form, components, which are subject to a high tariff, are imported into an ffz. they are then transferred to a maquiladora plant for assembly into lower duty status products. these are then moved back into an ffz or directly into united states commerce as the lower tariff assembled product. a version of this process involves importing high duty goods into an ffz such as light truck chassis. these goods are moved out of the ffz and into a maquiladora without paying any united states duties. in the maquiladora, the high duty imported items are fitted with components, such as bodies and interiors, which are manufactured in the united states and shipped to the maquiladora. this refitting increases the domestic (u.s.) content of the final products. when the completed products are finally moved into united states commerce they are subject to a more favorable tariff treatment. conclusion as world markets have become increasingly integrated, united states firms have been reorienting themselves toward international trade. one tool which has facilitated this trend is the foreign-trade zone. a lack of understanding in the business community in the southwestern united states of the advantages that can derive from an ffz has prevented an even wider use of this resource. this paper has detailed a number of the advantages which can accrue from locating in an fi'z. it has also explained two developing trends in ffzs, foreign-trade zone networks and international production sharing. there is not likely to be any decline in the internationalization of the united states economy. the growth in world trade will stimulate the growth of fi'zs and provide strategic development opportunities in the southwest. 26 journal ofbusiness strategies references vol. 9, no.1 1. curran. d.l. "foreign-trade zones expedite and encourage foreign commerce." global trade. vol. 108 (september 1988), pp. 10, 12. 2. "foreign-trade zones board." 49th annual report of the foreign trade zones board to the congress of the united states, washington, d.c.: foreign tmde zones board, (1987). 3. national association of foreign-trade zones, foreign-trade zones: a positive force in trade and economic development. washington, d.c.: national association of foreigntrade zones (1990). 4. tansuhaj, p.s. and gentry. l.w. "firm differences in perceptions of the facilitating role of foreign-trade zones in global marketing and logistics." journal of international business studies, vol. 18 (spring 1987). pp. 19-33. 5. u.s. customs service, customs regulations, washington, d.c.: department of treasury. u.s. customs service. 6. u.s. deparbnent of commerce, highlights of u.s. export and import trade. washington d.c.: u.s. deparbnent of commerce, various monthly reports. foreign-trade zones: opportunity for strategic development in the southwest the role of middle management in the knowledgefocused service organization rolf blumentritt australian centre for innovation and international competitiveness university of sydney sydney, australia neil hardie lona consulting sydney, australia abstract this paperproposes a new rolefor middle management. technology and the growth ofspecialization are altering the main role ofthe middle managerfrom supervision to the support of knowledge transfer. middle managers must identify knowledge gaps and communication problems between groups, and bridge them. this bridging activity creates a network organization, linked by the knowledge transfer between groups. this bridging role is particularly important in service organizations because the particular properties ofservices make knowledge transfer difficult. the cohesion and effectiveness ofthe service organization in the future will come from the circulation of knowledge. an example is given of how middle managers can facilitate knowledge transfer in a service organization. introduction the survival of middle manaeement when electronic communications became common in organizations, many observers predicted that the role of the middle manager would decline rapidly. naisbitt and aburdene (1985) claimed that: middle managers the people who collect, process and pass information up and down the hierarchy are losing out to smart technology in the race for productivity. ... what really enables us to shrink middle management is the computer, which gives top executives immediate access to the information previously obtained from middle managers. ... now with the computer to keep track of information and people, middle managers are seen as disposable. (pp. 12-13) h~wever, middle managers have not disappeared. the changes in technology, social structures, employee skills, customer preferences and the size of markets have altered the task of the middle manager; but they have not replaced it. middle manag38 journal of business strategies vol. 17, no.1 ers have always done more than merely transmit information: they have co~ordinated and directed staff, trained them and motivated them. however, changes in technology and workplace relations mean that the way middle managers operate is now very different. the middle manager is no longer the department expert, for activities are too complex and change too quickly. the middle manager is no longer the main source of data, for information technology has given staff direct access to data. the middle manager is no longer the unquestioned authority who directs work, because staff no longer need this, or accept it. the role of the middle manager has changed from an authoritarian one of getting tasks done, to a role of ensuring that the knowl~ edge necessary for effective operation is possessed by the staffthe knowledge of what they must do, how they should do it, and why it should be done. the new function of middle manaaement in this contemporary world of reduced management authority, greater task complexity, and intense competition, the key to survival and success is better knowledge; knowledge of customers, of processes, of competitors, of technology, of suppliers. there is a need to acquire and transfer knowledge across and through the organization; and the middle manager is a key player in this according to marshall, prusak, and shpilberg (1997). many firms are finding post-downsizing, post~reengineering­ that middle managers who had seemed to be simply pushing paper, are in fact playing a valuable role in the transfer, access and generation ofknowledge. (p. 226) knowledge is generally used and applied by the operational staff. the people who can facilitate the acquisition and transfer of this knowledge need to have a detailed understanding of the operational tasks, and have direct relationships with a wide range of operational staff. this implies that they should be middle managers. this paper discusses how this knowledge transfer role may be carned out by middle management. the manaeement of know1edee the development of a taxonomy of knowledge management processes and the linked description of operational steps is still in its infancy. various approaches have been proposed. for example, coombs and hull (1997) have emphasized "knowledge management practices". jordan and jones (1997) have developed a framework for assessing the knowledge management framework in an organization, in terms ofknowledge acquisition, problem solving, dissemination, ownership, and storage. these ideas have been developed further by johnston and blumentritt (1998). as a first step in the management of knowledge, a knowledge gap assessment is necessary. it has to be established what knowledge is needed to perform a certain task and if this knowledge is available for use. if a gap has been found, the next step is to spring 2000 blumentritt & hardie: role of middle management 39 determine how it can be closed. this can be done in two ways: external knowledge acquisition or internal knowledge creation. the following list summarizes the main steps in the management of knowledge. • knowledge identification: the processes of locating and recognizing knowledge, which is relevant to the organization. • knowledge acquisition: the process of obtaining knowledge previously not available to the organization, so that it can be used by the organization. • knowledge creation: the processes of creating new knowledge within an organization through traditional research and developments or the linking of previously separate information. much of this occurs on individual or team level. • knowledge validation: the process of determining the accuracy, the value, and the validity of the knowledge. • knowledge capture: the process by which the organization gains control over particular knowledge. • knowledge transfer: the process of transferring knowledge throughout an organization and to targets outside the organization. this process may take place in a relatively informal manner through conversations and discussions or through more explicit processes designed to insure that relevant staff and sections are informed about particular knowledge assets considered valuable for a particular objective. • knowledge utilization: the process of deliberately and intentionally using knowledge to pursue a specific objective. 'this model can be used to initiate the knowledge management process; but the steps have to be performed continually as knowledge has dynamic properties and is changing constantly. the rate with which knowledge is changing and the nature of the organization detennine the effort and the cycle-time of the knowledge management processes. there are greater demands on the management of knowledge in service organizations than in manufacturing organizations, which are generally more stable. because of the individual nature of most service encounters, it is difficult to control service organizations through standard procedures and specified criteria. knowledge transfer is more important, and more difficult, in service organizations, and places more demands on middle managers. as a result, our research has focused on service organizations. knowledge and the service industry properties of service orpnizations the problems of knowledge management in service organizations arise from the particular properties of service organizations identified by such researchers as zeithaml, parasuraman, and berry (1985), oakland (1993), and bateson (1995). knowledge management is made difficult by intangibility of the product, inseparability of pro40 journal of business strategies vol. 17, no.1 duction process and consumption of the product, heterogeneity of the product, and perishability of the product. these properties mean that the creation of knowledge in service organizations usually occurs in individuals (inseparability of production and consumption); that the transfer of knowledge is more difficult (due to intangibility of the product); that each transaction involves new knowledge (heterogeneity); and that knowledge must be transferred urgently due to the perishability. as an example, in a travel agency, the inseparability of production and consumption affects knowledge creation and transfer during consultation. the customer is receiving the service of being advised on his holidays and is actively participating in the process. slhe asks questions, has special plans and wants to combine different routes on the way to and from the holiday destination. during this process, the travel agent will encounter situations in which he has to find out the information himself and has to link these with already known characteristics of the travel business. in other words, the travel agent creates new knowledge from new and old information throughout the service delivery process. this new knowledge will help the individual travel agent to service the next customer with a similar agenda faster and more reliably. the knowledge of the individual travel agent is therefore growing with every service encounter. an area of knowledge has been created in this transaction; but it is not linked to the rest of the organization. it is, in a sense, a 'knowledge island'. the existence of 'knowledge islands' creates problems for the co-ordination of service organizations. 'knowledi:e islands' the development of knowledge islands has two consequences. on one hand, the creation of new knowledge by the employee is a positive development. it helps to enlarge the experience base of the employee and with this the possible enrichment of the service. on the other hand, the organization as a whole encounters problems. the newly created knowledge belongs at this time only to the individual employee. when s/he leaves the knowledge is lost. furthermore, unless the knowledge is diffused, the performance of the organization as a whole will vary from agent to agent. this diffusion must occur across all the different service agents to keep the barriers between the knowledge islands as small as possible and enable the organization as a whole to learn from the situation. this problem increases with the size of the operation. the probability of a build up of knowledge islands within a service organization is high. management needs to identify the location and size of the knowledge islands, and the barriers to the diffusion of the knowledge. this identification is an ideal task for middle management, who is close enough to recognize the individual islands in their area of business. connection of these islands through middle management would foster a better understanding and overcome some of the problems associated with the special properties of services. by establishing connections between areas of knowledge, the middle managercreates links to other parts of the organization. these links are lateral ones, between similar levels and across disciplines. as these links multiply, the organization changes spring 2000 blumentritt & hardie: role of middle management 41 from one directed from the top to a network where 'mutual adjustment' between groups (mintzberg, 1983) is the way operations are co-ordinated. there is strong support for the idea that networks are the way organizations will develop. the tasks of the knowledge manager the hierarchy of coordination with the growth of specialization and rapid changes occurring, modem managers ~ whether middle or senior often lack the expertise to supervise or direct the work of their staff. the hierarchy of authority, in which orders and directives pass down from higher levels of the organization to the lower levels, has been largely superseded in the most competitive organizations. the hierarchy of authority has been replaced by an hierarchy of coordination (ackoff, 1984; mintzberg, 1993); and coordination is achieved by the transfer and creation of knowledge. instead of a tree-structure with decisions flowing down the branches, an adaptive organization generally has a network structure. network structures are characterized by lateral or horizontal patterns ojexchange, interdependentflows ojresources, and reciprocal lines of communication (ibarra, 1992, p. 169). the concept of the modem organization as a network is emphasized by toffler (1985); kanter (1983, 1988); and white (1993). the contemporary middle manager must operate largely within these lateral exchanges between groups, rather than along vertical lines of communication. this accords with their new role as knowledge facilitators. little of the knowledge, which their staff requires, comes from senior management. much of it comes from other departments and groups within the organization; the remainder comes largely from groups or individuals outside the organization. the middle manager therefore becomes principally an intermediary between lateral groups, and not primarily a channel from senior management. facilitatin& knowled&e transfer the transfer or facilitation of knowledge is not simply a matter of providing data to the right person. it requires an understanding of the recipient's needs and ways of thinking; and a respect and trust by the recipient for the source of the information. these factors come only through prolonged personal interaction between the people involved. this kind of personal interaction occurs mainly between members of a group, and between group members and their direct manager. sometimes it occurs between members of one group and those of another at the same level. the middle manager is in a better position to facilitate knowledge transfer between operational groups than more senior personnel. the middle manager has day-to-day personal contact with operators, which develops the level of trust and understanding 42 journal of business strategies vol. 17, no.1 required to be an effective facilitator. the role of senior management is to facilitate knowledge transfer between the people with whom they interact regularly the other managers. it has been claimed by some writers that network structures will provide their own coordination through the informal communication paths, which make up the network. naisbitt and aburdene (1985) suggest: we are reinventing the corporationjrom a top-down bureaucracy into a network where everyone learns from everyone else (p. 78) advocates of the process view of organization claim that a focus on process will automatically generate cooperation between the participants (eg. ostroff & smith, 1992). supporters of cross-functional teams claim that these teams will provide the communication and coordination required. in reality, the organization where everyone interacts with everyone else does not occur unless the organization is very small. within larger organizations, the best way to get effective cooperation at the task level is to form coherent groups or teams. people work best in teams; and teams by their very nature are small and exclusive. teams and communication the small, dedicated group develops highly efficient communication, involving its own coding systems. katz and kahn (1996); sapir (1969); boisot (1987); and davenport and prusak (1998) have observed that effective knowledge transfer is far easier when participants speak the same or similar language (i.e. share the same terminology). thus, engineers in a team develop sets of acronyms, terms with special connotations, and shared inferences, which would make their discussions incomprehensible to eavesdropping accountants. internal communication becomes extremely efficient, but the ability to communicate with outside groups is often diminished. for tasks to be performed efficiently and effectively, teams are required. however, this efficiency comes at a cost. the more cohesive a team, the less it is likely to share knowledge with those outside the team (schein, 1969). there is therefore a trade-off between coordination at the micro levelthrough strong teams and coordination at the macro level through wide-ranging communication. it is to overcome this conflict that the middle manager must provide a 'knowledge bridge' between groups. the middle manager becomes a manager of knowledge, helping to direct learning within the organization. the knowledee facilitator in this learning environment, the middle manager can no longer be a guardian of traditional knowledge, which he or she provides to the workers with directions how it spring 2000 blumentritt & hardie: role of middle management 43 is to be used. the middle manager has become a key link in the learning process within organizations, a channel through which knowledge is transferred, and a catalyst for the creation of knowledge. nonaka and takeuchi (1995) claim that knowledge is created by middle managers . .. at the intersection of the vertical and horizontal flows of information within the company. (p. 125) the new role of the middle manager is that of the knowledge facilitator or coordinator of learning for organizational groups. many recent writers have advocated the role of the manager as coach. however, the role of a knowledge facilitator is different from that of a coach. a coach is still the source of expertise; the coach is the possessor of the skills that the team requires. a coach has authority from his or her knowledge. the modem organization is generally too complex nowadays for a single individual to coach a department. the middle manager brings people together to share knowledge, or provides the communication link to bring information to those who need it, in the form in which they can comprehend it. this task of coordinating knowledge is a difficult one, even when there are standard processes and teams working closely together. the problems are multiplied in the service environment, where each transaction is likely to be different, and occurs between individuals. however, these very features of the service organization make the management of knowledge a greater priority than in manufacturing organizations. the 'informal-network' administrator if the key task of a manager is to ensure that knowledge is transferred between groups, the problem is to detennine how they will do this. there are many problems in the transfer of knowledge between groups; it is a very different matter from the mere transmission of data between locations. knowledge is what people know; it is the structures and relationships within their minds. for people to acquire new knowledge, they must first have a motive for acquiring it; then they must be exposed to the information and/or analysis which can generate the new knowledge; they must be able to decode, interpret and process this information; and finally, they must possess an existing mental structure which can accept the new knowledge. the stages, which are necessary for knowledge acquisition, are: • recognition of the need for the knowledge • access to the sources from which the knowledge can be acquired • decoding and interpretation of the information from these sources • relating the new information to the existing mental structures there are generally major communication difficulties between the source of knowledge and the recipient. whenever an organization has been divided into groups or teams, these create cohesiveness and a culture of their own, which inhibits coopera44 journal of business strategies vol. 17, no.1 tion and communication with outsiders. sackman (1992) has shown how subcultures in an organization emerge around shared terminology and meanings rather than around practices, prescriptions or theories. these different groups have difficulty understanding and interpreting each other's ideas and information. within an organization there are problems of clear communication across subsystems, the messages emanating in one part ofthe organization need translation if they are to be fully effective in other parts (katz & kahn, 1996, p. 227). there is also a problem of lack of trust between the source and the recipient. trust is a strong element in working together and sharing knowledge (burt, 1992). when trust does notexist, there are problems on both sides ofthe communication; the source is reluctant to share its knowledge; the recipient is reluctant to rely on the information provided. each group begins to see other groups as the enemy . .. each group is likely to listen more closely to their own representative and not to listen to the representative ofthe other group, except to find fault with his presentation (schein, 1992, pp. 72-73). the knowledee aeent these conditions place requirements on the function of the middle manager as knowledge agent. first, the middle manager must work to earn the trust of both the groups which slhe is coordinating. secondly, the middle manager must be familiar with the technology, coding. interpretation and mental maps of the two groups of staff involved. thirdly, the middle manager must understand the operations of each group sufficiently to identify the knowledge needs of each group, and what knowledge exists in the other group which might be used to fill the gap. it is unlikely that a single manager will be able to master the expertise, gain the trust, and understand the coding systems of several different disciplines or groups. however, an intelligent manager should be able to achieve this for two separate groups. this leads to the concept of 'bi-skilling', where a manager acts as the knowledge transfer agent between two particular groups within an organization. each pair of groups in the organization needs such an agent if they are to be supplied effectively with the knowledge which they require, from the source which possesses it. in a form which they can comprehend, from a source which they trust. nahapiet and goshal (1998) state: the term 'social capital' {highlights] the central importance . .. of the networks of strong crosscutting personal relationships developed over time that provide the basis of trust, cooperation and collective action . ... (p. 243) this idea of a set ofbi-skilled knowledge transfer agents linking each pair ofgroups gives rise to the network-linked organization. the function of the chief executive becomes one offacihtating the knowledge transfer relating to organizational strategy, spring 2000 blumentritt & hardie: role of middle management 45 by linking customers (and, to an extent, competitors) to the strategy group. this strategic knowledge needs to be transferred to each department and to each group, in a way that the recipient group can understand and apply it. this understanding of organizational strategy serves to direct the efforts and goals of each group within the organization, and replaces the directives which an authoritarian hierarchy uses to coordinate groups. this knowledge of strategy is transferred through a knowledge agent a middle manager who understands the organizational strategy, and can relate it to the language and needs of the group which s1he relates to. in order to do this, the manager must be familiar with rpe knowledge and the competitive pressures which led to the strategy; and be able to guide a specific group into a set of goals which are within their capability and meet the strategic needs. the middle manager also provides knowledge in the reverse direction, from the operational groups to the strategic planners. this knowledge would include the capabilities of the group concerned, how they can contribute to the strategy, and any obstacles which may require the strategy to be modified. the communication enhancer the transfer of knowledge between groups with different cultures usually needs extended personal contact between members of the groups. this can be achieved by setting up cross-functional teams, or by 'mentoring'. it is often useful for the middle manager, who can communicate well with both groups to be involved in these contacts. in other circumstances, the knowledge agent can himjher self be the intermediary between the groups, obtaining the relevant knowledge from one group, and translating it and conveying it to the other group. conclusion puttina the concepts into practice initial work is being carried out on how these ideas can be put into practice in service organizations. one organization which has been analyzed is a project management organization dealing with a variety of technologies. in this company, there are various teams who contract to manage projects. there is a degree of overlap between the project customers and technologies, so there is an interest in the transfer of knowledge between project tearns. at present this is done by using a project director who manages a different tearn from the project manager. however, in many cases, the project director plays little part in the operation. this appears to be due to the lack of a suitable forum for the knowledge transfer. it is proposed to make the project review this forum. at present the project reviews are essentially policing exercises, where outside experts try to find fault with the project design and. implementation. if their focus can be changed to that of knowledge transfer, it is believed that this will benefit the organization. the 46 journal of business strategies vol. 17, no. i idea is that the project team will use the review to describe the innovative techniques and successful methodologies which they have used, which may be of interest to the reviewers. the project team will then define the various problem areas which they face, with the idea of gaining useful information from those in the review group, whose expertise and experience may be relevant. the project director is in a good position to be the knowledge agent who facilitates the transfer of this knowledge. in order to use the project review as a knowledge transfer forum, the middle manager must have an understanding of the project involved and its technology; have a clear aim of transferring knowledge; have the ability to organize the review sessions to minimize fear and conflict; have the capacity to act as an information link when the project team and reviewers fail to communicate; and have the skill and tact to guide the discussions along lines which will lead to the exchange of beneficial information. the middle manager has therefore to be an engineer, psychologist, manager, leader and interpreter! summaa large service organizations are facing enormous pressures in the modem, global environment. the difficulty of coordinating professional staff, the continuous evolution of technology, the erosion of profits by competition, are all forcing these organizations to adopt new structures, and assign new roles for its management. this paper proposes a new focus for the middle manager in such organizations that of the knowledge facilitator. it suggests that this role will be to arrange the transfer of knowledge between elements of a complex network of groups. the coordination of operations and strategy will be through the transfer of knowledge. as organizations recognize the importance of knowledge resources, this role of the middle manager as knowledge facilitator will be accepted as one of great value. as pressure grows on the acquisition and use of knowledge, new reporting lines and new knowledge links will have to be established so that the organizational knowledge is fully and effectively used. the middle managers, who are in the center of this web of communications, will need to have a clear idea of the strategic direction of the organization; for they guide and control the knowledge resources which are the key to the success of that strategy. unless knowledge is transferred efficiently, the effectiveness of the organization will suffer. this efficient transfer of knowledge between groups is a challenge for the new manager, and will require a range of new skills and functions. the middle man~ ager must possess an understanding of the needs of their staff, an ability to generate trust and respect, communication skills of a high order, and an ability to influence people. they must also have a clear idea of the organization's aims, and what information and knowledge will contribute to those aims. to be effective in these condi~ tions is a challenge that the contemporary middle manager must meet for service organizations to remain competitive. spring 2000 blumentritt & hardie: role of middle management references ackoff, rl. (1994). the democratic corporation. new york: oxford university press. bateson, j. (1995). manalpn~ services marketing 3rd ed. orlando, fl: the dryden press. 47 boisot, m. (1987). information and organizations: the manager as anthropologist london: fontana/collins. burt, rs. (1992). the social structure of competition. in nohria, n., & eccles, r. (eds.) networks and organizations: structure, form and action. boston: harvard business school press. coombs, r, & hull, r (1997). knowledge management practices and path-dependency in innovation cric discussion paper, june, no.2. davenport, t.h., & prusak, l. (1998). workin~ knowledge: how organizations manage what they know. boston: harvard business school press. ibarra, h. (1992), structural alignments, individual strategies, and managerial action: elements toward a network theory of getting things done. in nohria, n., & eccles, r (eds.) networks and organizations: structure. form and action. boston: harvard business school press, 165-188. johnston, r, & blumentritt, r. (1998). knowledge moves to center stage. science communication. 20 (1), 99-105. jordan, j., & jones, p. (1997). assessing your company's knowledge management style. i.&ng range planning. 30 (3), 392-398. kanter, rm. (1988). the middle manager as innovator. in katz, r (ed.) managing professionals in innovative or~anizations. (reprinted from harvard business review, juvaug 1982), 183-188. ----the change masters: corporate entrepreneurs at work. london: unwin. katz, d., & kahn, r.l. (1966). the social psychology of organizations. new york: wiley. marshall, c., prusak, l., & shpilberg, d. (1997). financial risk in the need for superior knowledge management in prusak, l. (ed.) knowledge in organizations. boston: butterworthheinemann, 227-251. mintzberg, h. (1983). structure in fives: desilming effective organizations. englewood cliffs, nj: prenticehall. nahapiet, 1., & goshal, s. (1998). social capital, intellectual capital and the organizational advantage. academy of management review. 23 (2), 242-266. 48 journal of business strategies vol. 17, no.1 naisbitt, j., & aburdene, p. (1985). re·inventing the corporation: transfonning your job and your company for the new infonnation society. london: futura. nonaka, i., & takeuchi, h. (1995). the knowledge-creating company. new york: oxford university press. oakland, j.s. (1993). total quality mamuiement 2nd ed. oxford: butterworth-heinemann. ostroff, e. & smith. d. (1992). the horizontal corporation. the m£kinsey quartt'<.rly. i. 148168. sackman, s.a. (1992). culture and subculture: an analysis of organizational knowledge, administrative science quarterly, 140-161. sapir, e. (1969), communication. in de cecco, l.p. (00.) the psychology of1anliua~, thought and instruction. london: holt, rinehart and winston, 75-78. schein, e. (1969). pr~ess £onsultation; its role in organizational develqvment. reading, ma: addison wesley. toffler, a. (1985). the adaptive corporation, london: pan. white, rc. (l992). agency as control in formal networks. in nohria, n., & eccles, r. (oos.) networks and organizations: strn£ture. form and action. boston: harvard business school press, 92-117. zeithaml, v.a, parasuraman, a., & berry. l.l. (1985). a conceptual model of service quality and its implications for future research. journal of marketing. autumn, 41-50. rolf blumentritt was born and educated in germany. after finishing a mechanical engineering degree and a quality management degree, he worked several years for bmw rolls royce gmbh (aerospace) in the area of supplier management and as consultant for organisational development. in 1996, he moved to australia to take up a ph.d. position at the university of sydney. his main research area is knowledge management and its impact on organisations. (contact details: rolf blumentriu,aciic, university ofsydney, nsw 2006, australia; e~mail: r.blumentritt@eng.usyd.edu.au) neil hardie worked in industry for over twenty years, mainly for multinational com~ panies in the electronics industry, managing research and development. these companies included krupp, marconi, plessey and de la rue. he has worked in various countries, including britain, australia, india, papua new guinea, libya and pakistan. he has masters degrees in both engineering and economics, and a ph.d. in management. he now offers advice to companies on strategic issues, and teaches management at australian universities. the role of middle management in the knowledge-focused service organization strategic management of human resources for global competitive advantage abagail me williams university of illinois at chicago chicago,il david d. van fleet arizona state university west phoenix,az patrick m. wright cornell university ithaca, ny abstract this article extends the literature on the role of human resources in global competitiveness by focusing on the ability of transnational firms to create a sustainable competitive advantage through the strategic management of their work force. we focus on the ability of managers to strategically draw from multiple human resource labor pools, creating a competitive advantage for transnational firms vis-a-vis domestic and multinational firms. a model, which extends the resource-based view of the firm, is developed. strategic management of human resources for global competitive advantage recent conceptual and empirical work has focused on how firms go about developing and maintaining a competitive advantage' (barney, 1991; lawler, 1992; lawler, 1996; peteraf, 1993; wernerfelt, 1984; wright, mcmahan & mcwilliams, 1994). this focus on competitive advantage requires additional consideration in light of the increasingly global nature of competition, as evidenced by surveys of u.s. business. twenty-six percent of u.s. managers surveyed indicated that their companies had recently expanded internationally. the percentage increased to 45 for firms with 1,000 or more employees (kanter, 1991). the rise in u.s. exports is additional evidence of the growing importance of global competition. exports currently account for ii percent of the gross domestic product of the u.s., and have been growing at a rate of 12 percent a year since 1987 (norton, 1993). one of the keys to successful competition in the global market is the effective deployment of human resources to achieve a competitive advantage (schuler, dowling & de cieri, 1993). much of the research on the role of human resources 2 journal of business strategies vol. 18, no.1 in global competitiveness has focused on management (adler & bartholomew, 1992a; adler & bartholomew, 1992b; bass & burger, 1979; doz & prahalad, 1988; ratiu, 1983). the effectiveness of management techniques across cultures and the difficulties of adjustment both in the work place and in the social environment have been extensively examined (black & porter, 1991; lee & larwood, 1983; mendenhall & oddou, 1985; tung, 1981). the role of the remainder of the firm's work force in achieving competitive advantage in the global marketplace has received much less attention. the purpose of this paper is to explore how human resources, defined as the entire pool of employees, constitute a potential source of sustainable competitive advantage for transnational firms. in order to achieve this aim, we first distinguish transnational firms from multinational and domestic firms. we then use the resource-based view of the firm to examine how human resources can form a source of sustainable competitive advantage for domestic firms (peteraf, 1993; barney, 1991; wernerfelt, 1984). building on this discussion, we explore the additional ways in which the human resources of a transnational firm can constitute a source of sustained competitive advantage. finally, we discuss the managerial implications of our analysis. levels of global competition firms differ in the extent to which they participate in global competition. adler (1991) categorizes firms as domestic, international, multinational, and transnational, depending on the level to which they participate in global competition. 2 understanding the differences across these categories is helpful to understanding the role of human resources in global competition and the need for human resource management (hrm) systems commensurate with the rigors of global competition. domestic. most companies begin by operating within a domestic marketplace. this entails having all of the firm's facilities, employees, and customers within the boundaries of one country. while employees may differ to some extent in terms of their regional or ethnic cultural orientations, the pool of employees is relatively homogeneous. thus, it is important to note that firms functioning at the domestic level of participation face an environment very similar with regard to culture, human capital, political/legal systems, and economic systems, although some variation might be observed across states and geographical areas. international. as domestic markets become saturated, firms often seek other markets for their products. these firms tend to regard their international markets as simple extensions of their domestic operations (bartlett & ghoshal, 1998). this usually requires entering international markets, initially by exporting products, but ultimately by building production facilities in other countries. an international firm spring 2001 mcwilliams et at.: strategic management 3 that is essentially a collection of relati vely independent operating subsidiaries is also termed a multidomestic firm (griffin & pustay, 1996). the decision to participate in international competition raises a host of human resource issues. one consideration is whether a particular location provides an environment where human resources can be successfully acquired and managed. multinational. whereas international firms build one or a few facilities in another country, firms become multinational when they build facilities in a number of different countries, attempting to capitalize on lower production and distribution costs associated with different locations. multinational firms are sometimes referred to as global (bartlett & ghoshal, 1998) because they tend to view the world as a single market and strive to provide standardized goods or services to meet the needs of all markets simultaneously (griffin & pustay, 1996). the lower production costs are gained by shifting production from highercost locations to the lower-cost locations. the hrm problems faced by multinational companies arc similar to those faced by international companies, only magnified. instead of having to consider only one or two countries' cultural, human capital, legal, and economic systems, the multinational company must address these differences for a large number of countries. transnational. many researchers now propose a fourth level of integration: transnational organizations. transnational organizations compete on state-ofthe-art, top-quality products and services and do so with the lowest costs possible. they try to combine the advantages of global-scale efficiencies (like a multinational firm) with those of local responsiveness (like an international firm) (griffin & pustay, 1996). whereas multinational companies focusing on economies of scale attempt to develop identical products distributed worldwide, transnational companies increasingly focus on economies of scope and emphasize flexibility and mass customization of products to meet the needs of particular clients. multinational firms are usually driven to locate facilities in a particular country as a means of reaching that country's market or as a means to achieving lower production costs, and then must "deal with" the differences across countries. transnational firms, on the other hand, choose to locate facilities based on the ability to effectively. efficiently, and flexibly produce a product or service, and to create synergies through the cultural differences. production and research and development that benefit from uniform standards and scale economies tend to be centralized, whereas marketing and hrm tend to be decentralized to take advantage of local cultural differences (griffin & pustay, 1996; hannon, huang & jaw, 1995). this creates the need for hrm systems that encourage flexible production, thus creating a host ofhrm issues. transnational firms proactively consider the cultures, human capital, politicalllegal and economic systems to determine locations where production facilities can be located to provide a competitive advantage. these firms have multiple headquarters spread across the globe, resulting in less hierarchically structured organizations that emphasize decen4 journal of business strategies vol. 18, no. 1 tralized decision-making. this results in the need for human resource systems that recruit, develop, retain, and utilize managers and executives who are not only competent transnationally but also are competent in decision-making in flattened, non-hierarchical organizations. in a transnational firm, the hrm issue is no longer where to find the work force but "'what strategic advantages do our labor resources give us?' and 'what operations should we be planning in order to apply them most effectively?'" (mead, 1998, 358). adler and bartholomew (1992a) point out that a transnational hr system should be characterized by three attributes, which they describe as transnational scope, transnational representation, and transnational process. the first attribute, transnational scope, refers to the fact that hr decisions must achieve a global, rather than a national or regional, scope. this creates the necessity to ensure that decisions reflect a balancing of the needs for uniformity (to ensure fair treatment of all employees) and flexibility (to meet the needs of employees in different countries). the second attribute, transnational representation, reflects the multinational composition of a firm's managers. to achieve transnational scope, each country should be represented in the managerial ranks of the firm. having transnational representation is also a prerequisite if the firm is to achieve the third attribute. the third attribute, transnational process, refers to the extent to which the firm's planning and decision-making processes include representatives and ideas from a variety of cultures. it is this attribute that allows for the diversity of viewpoints and knowledge, associated with different cultures, that increases the quality of decision-making. this is a process of negotiation whereby subsidiaries propose strategic initiati ves and the centralized unit "co-ordinates, criticises, approves and adds its own funds" (trompenaars, 1993, 174). in conclusion, the entry into international markets creates a host of hrm issues that must be addressed if the firm is to gain competitive advantage. moreover, these issues become more complex as the firm increases its level of international involvement. however, these issues also create an immense potential for a firm's human resources to provide a source of competitive advantage. in the next section, we use the resource-based view ofthe firm to examine the potential for firms to use human resources as a source of sustained competitive advantage, particularly in an international context. this discussion will provide the foundation for exploring this role in the special case of the transnational firm. the role of human resources in competitiveness recent research in the strategic management area has focused on the role of heterogeneous firm resources in achieving and sustaining competitive advantage (peteraf, 1993; barney, 1991; wernerfelt, 1984). this emerging paradigm is called the resource-based view of the firm and has become increasingly popular for explaining why firms differ in performance (wernerfelt, 1995). according to this view, the internal resources of the firm are responsible for spring 2001 mcwilliams et al.: strategic management 5 competitive advantage and are the source of sustained competitive advantage (amit & schoemaker, 1993). while it has been demonstrated that resources in and ofthemselves contribute positive returns to organizations (miller & shamsie, 1996; pennings, lee & van witteloostuijn, 1998), it is the interaction of resources and strategy that seem to form the basis of sustainable competitive advantage (schoenecker & cooper, 1998). barney (1991) developed a model that demonstrates that, for a resource to be the source of sustained competitive advantage, it must create value (v) for the firm; it must be rare (r); it must be inimitable (i); and it must be nonsubstitutable (s). applying barney's vris framework of sustained competitive advantage, wright, mcmahan, and mcwilliams (1994) demonstrate that human resources (defined as the total pool of human capital under the control ofthe firm) have the highest probability (among all resources) of being the source of sustained competitive advantage for the firm. this is because human resources are more likely than other resources to be inimitable and non-substitutable, as well as being valuable and rare (wright, mcmahan & mcwilliams, 1994). we use this argument to support our first point, that a firm should focus on its entire pool of human resources, as outlined below. human resources as a pool of human capital we distinguish between human resources as individuals (or an elite group of individuals such as top management teams) and human resources as the total pool of human capital. barney (1991) emphasized that human capital resources refer to the characteristics of both managers and workers in the firm, and speculated that the managerial team might constitute a source of competitive advantage. wright, mcmahan, and mcwilliams (1994), however, argue that the larger pool of human capital that constitutes the entire organization is more likely to be a source of sustained competitive advantage. therefore, consistent with wright, mcmahan, and mcwilliams, we focus on the larger pool of human capital. human resources as valuable according to the resource-based view, a resource must first be valuable in order to provide a source of sustainable competitive advantage. firm specific human capital theory provides an explanation of the conditions under which human capital can create value for the firm (hashimoto, 1981). according to this theory, when the demand for labor is heterogeneous (that is, when the jobs of firms differ and these jobs require different skills) and the supply of labor is heterogeneous (that is, individuals differ in both the types and levels of their skills), then human capital can create value for the firm. steffy and maurer (1988) provide evidence that, in fact, the demand for and supply oflabor are heterogeneous across most industries. 6 journal of business strategies vol. 18, no.1 the demand for labor is more heterogeneous across countries than it is within countries due to differences in capital availability, labor practices, and social and cultural norms relating to work. labor supply is also more heterogeneous across countries than within countries, due to differences in such things as nutrition, sanitation, health care, and training and educational opportunities. therefore, there is more opportunity for creating value through human resources as competition becomes more global. empirical evidence also supports the idea that the demand for and supply oflabar are heterogeneous, at least with regards to skill levels of individuals. for example, virtually all of the work with regard to personnel selection (guion, 1991), training (goldstein, 1991), and utility analysis (boudreau, 1991) has demonstrated that more highly skilled individuals outperform lower skilled individuals, and that these performance differences provide value to firms (hunter & hunter, 1984). lawler (1996) argues that human resources must have power, information, knowledge, and rewards (pikrs) to be a source of competitive advantage. clearly, more skilled individuals are more likely to possess these. human resources as rare a resource must also be rare if it is to be a source of sustained competitive advantage. because human skills are normally distributed in the population (jenson, 1980), human resources with high skill levels are, by definition, rare. that is, only a relatively small proportion of individuals in any human resource pool will have high skill levels. to the extent that jobs require skills, which allow for variance in individual contributions and human resources vary in quality, job-relevant skills will be rare. thus, to the extent that jobs require skills that allow for variance in individual contributions, firms with high average skill levels relative to their competitors possess a rare resource. in addition, firms that, because of their international operations, can draw from more than one labor pool have a greater potential for developing this valuable and rare resource. therefore, firms that, because of their international operations, can draw from more than one labor pool have a greater potential for developing a humanresource-based sustainable competitive advantage than do domestic firms that can draw from only one labor pool. transnational organizations by virtue of transnational representation and a transnational process are particularly able to draw upon the rare components of their multiple labor pools, and are, thus, more likely to develop sustainable competitive advantages. human resources as inimitable unless a resource is difficult to imitate, it cannot be the source of a sustainable competitive advantage. barney (1991) argues that resources will be more difficult to imitate in the presence of causal ambiguity and social complexity. causal ambiguity exists when the link between a firm's resources and its competitive spring 2001 mcwilliams et al.: strategic management 7 advantage is imperfectly understood (reed & defillippi, 1990). in the case of human resources, if competing firms cannot identify the human resources that are responsible for the competitive advantage, or the way in which human resources create the competitive advantage, they cannot imitate the advantage. human resources often lead to causal ambiguity because of team production. with team production, it is difficult to isolate and identify the particular human resources (individuals) that produce the superior performance of the team (alchian & demsetz, 1972). social complexity may arise from transaction-specific relationships, and the competitive advantage these relationships create may he due to transactionspecific human capital, i.e., human capital, such as knowledge, that is of value only in the focal transaction (becker, 1964). it is possible that relationships between key personnel such as sales represcntatives and buying agcnts will develop over time and become part of a nctwork that includes a larger group of personnel such as design and marketing staff, production and distribution workers, and management, as well as final consumers. a very complex social situation may result and this may constitute a competitive advantage for the firm. although the relationship may be too complex to dissect, it is reasonable to speculate that the value of the focal relationship may be due to transactionspecific human capital, that is, the knowledge and trust that are developed over time by the focal personnel and which have value only in the focal relationship. human resources and social complexity are intrinsically linked because social complexity, by definition, must result from human interactions. for firms involved in global markets, causal ambiguity and social complexity may be particularly important barriers to imitation. differences in customs and norms of behavior may make it impossible for outsiders to understand, and therefore imitate, a competitive advantage based on human resources. additionally, religious, cultural, and political alliances may create strong webs of social complexity that make imitation of an advantage virtually impossible. on the other hand, differences in religion, culture, and politics may prevent the creation of relationships that could, otherwise, lead to a competitive advantage. thus, causal ambiguity and social complexity strongly influence the inimitability of human resources, cspecially in a global marketplace. transnational organizations by emphasizing transnational representation and by developing transnational processes are better able to exploit these local phenomena in achieving sustainable competitive advantage. human resources as nonsubstitutable a resource must also pass the test of having no good substitutes if it is to be the source of a sustainable competitive advantage. this raises the question of whether or not other resources, such as technology, have the potential for offsetting any competitive advantages obtained from human resources. good substitutes are unlikely, because human resources are one of the few firm resources 8 journal of business strategies vol. 18, no.1 which have the potential to be transferable across a variety of technologies, products, and markets, and to not become obsolete. many human capital resources are quite generalizable. for example, general human capital resources such as learning capability are transferable across a wide variety of technologies, products, and markets (harrigan & dalmia, 1991). in addition, if a firm has obtained individuals with high levels of learning capability, then constant training in state-of-the-art technological skills ensures that the resource does not become obsolete. therefore, we argue that, while it might be possible to substitute other resources in the short term, it is highly unlikely that such substitution would eliminate the advantage of the human resources for long. this stems from the fact that, to the extent that the resource offsetting the advantage of human resources is not, in and of itself, rare, inimitable, and non-substitutable, then it will be imitated and human resources will once again constitute a competitive advantage. for example, consider a firm, firm a, which has high ability individuals who are highly committed to the organization, thus constituting a source of competitive advantage. what happens if a competitor, firm b, develops a new technology, which provides productivity increases greater than the productivity differences stemming from firm a's work force? if the technology is imitable, then firm a will also install the new technology and firm a's human resources will once again constitute a competitive advantage. it is worth noting here that technology is becoming increasingly internationalized. transnational firms are likely to have r&d facilities in more than one country, and technology advances by one company in one country are likely to increase the rate of technological advance and productivity of other firms in other countries, because of the globalization of competition (mansfield, 1984). technology may be easier to imitate (or substitute around) as competition becomes more global for a number of reasons. first, the number of companies with comparable r&d resources increases as an industry becomes global. second, the amount of knowledge available to build on increases as the number of firms increases. and, third, property rights to intellectual capital become increasingly hard to protect. this argues that, as competition becomes increasingly global, technology is increasingly imitable, which, in turn, argues for the increasing importance of human resources as a source of sustainable competitive advantage. human resources as a source of advantage in transnational firms in order to examine how human resources can provide a competitive advantage to transnational firms, we must first explore how this advantage takes place domesti~ally. two aspects of human resources work together to create a competitive advantage for the firm. first, there are the know ledges, skills, and abilities (ksas) inherent in the individuals who make up the organization spring 2001 mcwilliams et at.: strategic management 9 (flamholtz & lacey, 1981; mckelvey, 1983), or the power, information, knowledge, and rewards (pikrs) that can be developed for these individuals (lawler, 1996). second, there are the employee behaviors that are necessary for translating those into producti vity for the firm. wright and snell (1991) present an open system model of the hrm system, which explicitly notes the interrelationships between employee ksas/pikrs and employee behaviors. according to this model, ksas/pikrs are necessary, but not sufficient, for employee behavior to be in line with a firm's strategic goals. therefore, we explicitly recognize that, while employee behavior is the most direct way in which strategies are implemented, employees must have the competencies (ksas/pikrs) necessary to exhibit the appropriate behaviors. this can be seen in the model represented in figure 1. as depicted in figure 1, firm strategies and culture both separately and through interaction determine appropriate hr practices, which affect (through selection and retention) both the human capital pool (including ksas/pikrs) and exhibited behaviors. the human capital pool and behaviors, together, may create sustainable competitive advantage, and their effects may be enhanced by causal ambiguity and social complexity as explained in the previous discussion. figure 1 a model of human resources as a source of sustained competitive advantage firm strategies firm culture human resource practices human capital pools including ksasipikrs human resource behavior sustained competitive advantage source: adapted from wright, mcmahan, and mcwilliams, 1994 10 journal or business strategies vol. 18, no. i the sustainable competitive advantage depicted in figure stems from two mechanisms. first, higher level human capital enables a firm to have productivity advantages relative to its competitors. for example, given the strong linear relationship between human capital skills such as cognitive ahility and job performance (hunter & hunter, 19h4), one could assume that the firm with superior human capital resources in terms of cognitive ability should, ceteris paribus, achieve higher productivity levels. second, the firm with superior human capital should havc advantages in flexibility and adaptability. snow and snell (i (92) argue that the continuing globalization of markets will result in more rapid environmental changes, which will require flexibility and adaptability from the work force. as international barriers are dropped at an increasing rate, firms are faced with increasingly dynamic and competitive environments, which necessitate quick responses. these responses must be evidenced throughout the entire work force, and may require quickly learning and applying new skills, implementing new technologies, and/or reorganizing the way work gets done (snow & snell, 1992). a firm with higher levels of human capital relative to its competitors should have an advantage in the ability of its work force to be flexible and adaptable to new market demands and new technologies (harrigan & dalmia, 1(91). therefore, a firm with superior human resources has the potential for sustainable competitive advantage. gi ven this model of how human resources can provide a source of sustainable competitive advantage to a firm competing in a given market, it is now possible to broaden this discussion to the transnational firm. we argue that human resources can provide additional sources of sustainable competitive advantage for transnational firms in two ways: (i) by capitalizing on multiple labor pools including ksas/pikrs, and (2) by exploiting the cultural synergies inherent in a diverse work force. capitalizing on multiple labor pools transnational firms have the potential to develop superior human capital pools, because they can draw from many different labor pools. that is, being transnational adds a choice variable for the firm, as depicted in figure 2. there are two significant diffcrences betwecn figure i and figure 2. first, figure 2 includcs a box that represcnts the human resource decisions of top-icvelmanagers in transnational firms. second, figure 2 shows that transnational firms have multiple human capital pools from which to choose the most appropriate workers. the human resource decisions of transnational managers include both the choice of labor pools from which to draw workers and the appropriate practices for managing diverse labor pools. remembering that labor pools differ across countries, the transnational manager has the opportunity to not only draw from superior labor pools, but to draw from many of them and to match the attributes of different labor pools to the different needs of the firm (bartlett & ghoshal, spring 2001 mcwilliams et at.: strategic management 11 1998). for example, microsoft uses programmers in india, because of the highly educated, high quality labor pool available there. figure 2 a model of transnational human resource management for sustained competitive advantage firm strategies firm culture transnational managerial decisions human resource practices multiple human capital pools including ksas/pikrs human resource behavior sustained competitive advantage the heterogeneity of demand for, and supply of, labor creates the potential for a sustainable competitive advantage, because the transnational firm has an additional opportunity that is not open to other types of firms. the transnational manager can choose labor pools that offer superior talent for different links in the firm's value chain or for different firm/market demands. for example, some labor pools may have workers who, on average, have higher cognitive ability or have had greater access to education and training. (the quality of workers may also differ because of the available infrastructure, labor practices, and social and cultural norms relating to work.) the transnational firm would be able to draw from the highest quality labor pools for those functions that require high cognitive ability and education and training. this creates a potential advantage over 1) domestic firms, which can choose from only one labor pool; 2) multidomestic firms in which each international division chooses from its local labor pool; and 3) multinational firms, which emphasize economies of scale and are, therefore, strongly influenced by least-cost considerations. because of increasing global 12 journal of business strategies vol. 18, no.1 competitiveness, transnational firms must pay attention as much to quality, state-of-the-art design, and cultural appropriateness as to cost minimization (adler & ghadar, 1990; adler & bartholomew, i 992a). the additional requirements of quality, state-of-the-art design, and cultural appropriateness increase the pay-off for superior human resources. returning to our argument that many human capital resources are quite generalizable, choosing from the highest quality labor pools creates an additional advantage for the transnational firm. as stated earlier, general human capital resources such as learning capability are transferable across a wide variety of technologies, products, and markets (harrigan & dalmia, 1991). this may create an important competitive advantage, because many transnational firms have r&d facilities in more than one country and transfer technology (especially product technology) extensively across facilities and countries (mansfield, 1984). the transnational firm would, therefore, be able to benefit from the ability of its superior labor force to use technologies developed in all of the firm's facilities, regardless of the country of origin (hitt, dacin, levitas, arregl & borza, 2000). firms with superior human resources could expect their workers to adapt more quickly and more effectively to new technologies. therefore, those firms whose human capital resources are superior would be able to maximize the benefit of technology transfers. the rapid development of a tr.ansnational human capital pool may be a partial explanation for the increasing use of strategic alliances as an entry mechanism into international markets (osborn & hagedoorri, 1997). however, international strategic alliances have frequently not worked well (madhok & tallman, 1998). one reason for this has been lack of sufficient attention to selecting the correct partner (hitt, tyler, hardee & park, 1995). hitt, dacin, levitas, arregle and borza (2000) have demonstrated that partner selection is not only critical but also varies across emerging and developed market contexts. exploiting diversity and cultural synergy the use of multiple labor pools provides the potential for firms to increase the quality of global business decision-making. a firm, which employs culturally diverse labor pools, has a distinct pool from which to develop managers. this creates the potential for higher quality, flexible decisions. we recognize two ways in which having managers from different cultural backgrounds may increase decision quality. first, managers from specific countries bring to the process tacit knowledge of aspects of that country's political, cultural, legal, and economic situation. this knowledge might mitigate against faulty decision-making that has resulted in a plethora of business blunders (ricks, 1993). second, in addition to the tacit knowledge of specific customs and requirements, having managers from a variety of cultures increases the diversity of viewpoints in terms of values, problem definition, and problem solving. given the existing empirical evidence that such hetspring 2001 mcwilliams et al.: strategic management 13 erogeneity of viewpoints increases decision quality (watson, kumar & michaelson, 1993), diversity among decision-makers should ensure that higher quality decisions are made. that diversity also necessitates flexibility. managers in transnational organizations must be capable of applying their skills throughout the organization, not just in one location. a geocentric policy of managerial development and staffing is required to assure that transnationals are able to assure this flexibility among their managers (welch, 1994). however, the diversity inherent in multiple labor pools also presents a challenge that may result in an additional source of sustainable competitive advantage. managing multiple labor pools adds an additional area of responsibility for transnational managers. to maximize the potential benefit of drawing from the highest quality labor pools, the transnational manager must be able to elicit the appropriate behaviors. drawing from more than one labor pool means that the diversity of workers to be managed will be greater. as the work force becomes more diverse, aligning workers' behavior with the firm's goals becomes more difficult. adler and bartholomew (1992a) point out that many transnational firms are ill equipped to manage transnational labor forces. they do not have a multitude of executives "who can think, lead, and act from a global perspective" (kim, 1999, 228). they are ill equipped because their top managers' lack 1) international experience, 2) experience or training in cultural diversity, and 3) a global perspective about the worldwide business environment. because of these shortcomings, many firms are not establishing truly transnational human resource systems. therefore, the firms that can do so will surely have a competitive advantage, at least in the short run. in the long run, the sustain ability of this competitive advantage will depend on the superiority of the labor force assembled and the hr practices developed for managing it (wright, mcmahan & mcwilliams, 1994). stickiness a potential problem all of the above potential for utilizing multiple human capital pools as a source of sustainable competitive advantage relies on the capabilities within those pools being readily transferable. transferring capabilities is not easy, and, while studies of such transfers between organizations exist, little research has been done on internal transfers such as those required here (grant, 1991; prahalad & hamel, 1990). the difficulty of transferring capabilities within an organization is referred to as internal stickiness (szulanski, 1996). four sets of characteristics influence the degree of stickiness. they are characteristics of the knowledge itself, of the source, of the receiver, and of the circumstances within which the transfer is to take place. while anecdotal evidence, speculation, and conventional wisdom seem to suggest that the 14 journal of business strategies vol. 18, no. i major causes of internal stickiness are individual motivational factors, such as perceived threats to advocates of the old paradigm (zupan, 1991), research suggests otherwise (szulanski, 1996). the major causes of internal stickiness are "the lack of absorptive capacity of the recipient, causal ambiguity, and an arduous relationship between the source and the recipient" (szulanski, 1996, 36). absorpti ve capacity refers to the extent of know ledge the receiver has prior to the transfer. the more knowledge the receiver has, particularly knowledge relevant to the situation at hand, the easier or less sticky the transfer will be. causal ambiguity is related to tacitness (simonin, 1999) and refers to the receiver's understanding about cause-effect relationships involved in the capabilities to be transferred. again, the greater the receiver's understanding, the less sticky or easier the transfer will be. finally, the better the quality of the relationship between sender and receiver, the more likely the receiver will accept and internalize information involved in the transfer. this would suggest that if startup costs are shared so as to minimize free-rider problems (zupan, 1991), potential stickiness problems would be reduced. the differences in education levels, type of education, culture, language, and the like that are faced by transnational managers exacerbate these potential sources of stickiness. instead of trying to use incentive programs to overcome internal stickiness, firms should devote their time and resources to foster closer relationships among individuals and units within those firms and to develop the learning capacities of individuals (si & bruton, 1999; szulanski, 1996). as relationships and communication improve and learning develops, internal stickiness will become less of a problem and the potential for utilizing multiple human capital pools as a source of sustainable competitive advantage will increase. transnational firms are in excellent positions to focus their efforts on developing the learning capacities of their pools of human capital. this argues for an additional benefit derived from superior labor pools ~ the ability to overcome stickiness. one way to foster such closer relationships is to recognize that the type of knowledge to be shared is a strong moderating factor. it is much easier to share knowledge of the same type than mixtures. one method that has been suggested for easing the stickiness problem, then, is to organize subunits in a multiunit organization in terms of the type of knowledge involved ~ simple versus complex or by assuring that acquisitions all involve only one type of knowledge (hansen, 1999). another is the use of strategic communities such as the transition alliance teams used by xerox to facilitate necessary communication (storck & hill, 2000). this is further supported by research by bresman, birkinshaw, and nobel (1999) who show that knowledge transfer is facilitated by visits and meetings that improve the overall pattern of communication within organizations. spring 2001 mcwilliams et al.: strategic management summary and practice implications 15 the purpose of this paper is to extend the existing literature on the role of human resources in global competitiveness by examining the contribution of a firm's human resources in the attainment of sustainable competitive advantage in today's global marketplace. this examination gives rise to several implications for managers in the global marketplace. first, consistent with the resource-based view of the firm developed by wernerfelt (1984), barney (1991) and others, our analysis points out that human resources, defined as the entire pool of human capital under the control of the firm, are the most likely source of a sustainable competitive advantage, because human resources are more likely than other resources to be inimitable and nonsubstitutable, as well as valuable and rare. second, for transnational firms, causal ambiguity and social complexity may be particularly important barriers to imitation. causal ambiguity becomes an important barrier to imitation because differences in customs and norms of behavior may make it impossible for outsiders to understand, and therefore imitate, a competitive advantage based on human resources. similarly, social complexity becomes an important barrier because religious, cultural, and political alliances may create strong webs of social relationships that make imitation virtually impossible. thus, transnational firms must develop managers with experience in a variety of cultures, and those firms must provide those managers with training in cultural diversity. those managers also need training and experience in how to manage transnational teams and alliances in decentralized, flattened organizations. the importance and use of transnational teams as well as their impact on staffing, training, and reward systems is increasing (snell, snow & hambrick, 1998). experiential exercises may be needed to assist managers in those teams to develop skill in making decisions in the face of rapidly changing situations. third, for transnational firms, the non-substitutability of human resources becomes even more important. superior human resources can be expected to protect a firm from substitutability because the resources that are likely to be substituted for human resources are themselves not inimitable. we used technology as an example and showed that technology is likely to be imitable, especially as competition becomes more global. as technology is imitated, human resources can be expected to recapture the advantage. training and development of not only the managers of transnational firms but also of all employees ofthose firms is, then, clearly necessary to assure that superior human resources are available to the firms. such training should have both broad conceptual aspects and very practical advice don't use your left hand in moslem countries; don't ask personal questions in the middle east; and don't make direct eye contact in japan, for instance. fourth, consistent with the model developed in wright, mcmahan, and mcwilliams (1994), we demonstrated that, to achieve competitive advantage, 16 journal of business strategies vol. 18, no.1 managers must be able to identity individuals who possess higher quality human capital; to attract individuals who possess higher quality human capital; to retain individuals who possess higher quality human capital; and to encourage individuals to behave in a way that supports the organization's strategic goals. to focus on how the role of the manager changes as a firm globalizes, we examined the importance of international training, experience, and perspective for top managers in transnational firms (see also, mallampally, 1997). as adler and bartholomew (1992a) point out, many transnational firms are having difficulty implementing well-thought-out strategies because top management lacks international experience and an understanding of the worldwide business environment from a global perspective. therefore, these managers are not able to develop transnational human resource systems that take advantage of the recruiting and utilization opportunities that arise from having access to multiple human resource pools. further, they are not exploiting the potential advantage that would result from developing a company culture around the possible cultural synergies. finally, our analysis highlights the role of multiple labor pools in global competitiveness. the existence of multiple labor pools creates additional sources of potential sustainable competitive advantage for transnational firms. these include i) the ability to draw from more than one labor pool, 2) the opportunity to exploit cultural synergies, and 3) the ability to overcome stickiness. especially important to the first effect is the ability of superior human resources to adapt quickly and effectively to new technologies developed in facilities of the organization in different countries. especially important to the second effect is the ability of top managers to develop truly transnational human resource systems that are characterized by a global "frame of mind," transnational representation across top management teams, and multicultural decision making and planning processes (adler & bartholomew, 1992a). conclusions and research implications managers in transnational firms should recognize the critical importance of human resources rather than attempting to rely heavily upon capital and technology for success. they must truly be transnational, striving for global integration with local responsiveness (rothwell, prescott & taylor, 1999). managers in transnational firms should recognize the value of having access to multiple human resource pools. these expanded pools provide greater opportunity to locate qualified personnel capable of helping the firms achieve their objectives in a global environment. human resource professionals should help managers develop awareness of cultural diversity both through training and also through direct experience on international assignments. human resource professionals should also develop training programs for all employees on cultural diversity so that they are able to better deal with diversity and change. those individuals spring 2001 mcwilliams et al.: strategic management 17 should get involved in organizations in countries in which they operate chambers of commerce, policy-formulating governmental bodies, powerful civic organizations, and the like. performance assessments should be restructured to include evaluations of effectiveness in adapting to and performing within the country in which the manager operates. managers in transnational firms and human resource professionals should recognize that hrm strategies will have local variations depending upon the laws and customs of differing countries. the design and management of employee benefit and compensation programs, for instance, are highly likely to necessitate local variation as are programs dealing with safety and health. employee privacy and rights issues are also likely to vary from one country to another. the impact of the shadow work force and the use of temporary help may become even more complicated as personnel are able to cross national boundaries and become more mobile. the importance of a careful process for dealing with inpatriates is clear (harvey, speier & novicevic, 1999; harvey & buckley, 1997). there has been a void in knowledge and practice where global corporate strategy and human resource management intersect. hopefully, focusing on the model presented in this paper will enable both researchers and practitioners to fill that void (adler & bartholomew, 1992b). researchers might investigate, for instance, the specific impact of multiple human resource pools. are the benefits derived from having simply more than one pool or are numerous pools required? is involvement, as suggested by lawler (1996), necessary in every country in which a firm operates or only in those in which it is compatible with local cultures? these and other specific research questions can readily be derived from the model. the role of technological learning that takes place in transnational human capital pools is largely supported only through case studies and merits stronger empirical research (zahra, ireland & hitt, 2000). the answers to such questions would go a long way towards improving the practice of human resource management in transnational organizations. that research, however, will need to be different from that to which most management scholars are accustomed. rouse and daellenbach (1999) have shown very clearly that research methods dealing with the resource-based view will need to be crafted very carefully particularly when one is investigating the concept of sustainable competitive advantage. while much strategic management research relies on secondary sources of information from large sample, multi-industry, single time-period samples, those approaches are not applicable to studying sustainable competitive advantages. 3 because the sample is so critical, they propose a four-step selection process. step one is to select a single industry. step two is to "cluster firms by strategic type or group within the industry selected" (rouse & daellenbach, 1999,489), and to validate the clustering. step three involves comparisons of performance indicators within these strategic groupings. step four then involves careful internal analysis of simi18 journal of business strategies vol. 18, no.1 larities and differences between high and low performers within each group. research done using this framework will likely shed more light on the role of human resources in organizations. this paper, then, sheds light on the importance of a firm's human resources for achieving competitive advantage in a global marketplace. it points to the fact that human resources are a potential source of sustainable competitive advantage, and one over which managers have influence. further research and observation will refine and clarify the model presented here so that both the theory and practice of transnational human resource management will continue to develop and improve. references adler, n. (1991). international dimensions of organizational behavior. boston: pws kent. adler, n. & bartholomew, s. (l992a). managing globally competent people. academy of management executive. 6, 52-65. adler, n. & bartholomew, s. (1992b). academic and professional communities of discourse: generating knowledge on transnational human resource management. journal of international business studies, 23, 551-569. adler, n. j. & ghadar, f. (1990). international strategy from the perspective of people and culture: the north american context. research in global business management. 1, 183-184. alchian, a. & demsetz, h. (1972). production, information costs, and economic organization. american economic review, 62, 777-95. amit, r. & schoemaker, p. j. h. (1993). strategic assets and organizational rent. strategic management journal, 14,33-46. barney, j. (1991). firm resources and sustained competitive advantage. journal of management. 17,99-120. bartlett, c. a. & ghosha1, s. (1998). managing across borders. boston: harvard business school press. bass, b. m. & burger, p. c. (1979). assessment of managers: an international comparison. new york: free press. becker, g. (1964). human capital. new york: columbia u. press. besanko, d., dranove, d. & shanley, m. (2000): economics of strategy. (2nd ed.), new york: john wiley. spring 2001 mcwilliams et at.: strategic management ]9 black, j. s. & porter, l. w. (1991). managerial behaviors and job performance: a successful manager in los angeles may not succeed in hong kong. journal of international business studies, 22 (1), 99-113. boudreau, 1. w. (1991). utility analysis for decisions in human resource management. in m. d. dunnette and l. m. hough (eds.), handbook of industrial and organizational psychology. (2nd ed.), (vol. 2, pp. 621-745), palo alto, ca: consulting psychologists press. bresman, h., birkinshaw, j. & nobel, r. (1999). knowledge transfer in international acquisitions. journal of international business studies, 30 (3), 439-462. doz, y. & prahalad, c. k. (1988). quality of management: an emerging source of global competitive advantage," in n. hood and j. vahine (eds.), strategies in global competition. london: croom helm. flamholtz, e. & lacey, j. (1981). personnel management: human capital theory and human resource accounting. los angeles: institute of industrial relations, ucla. flint, g. d (2000). what is the meaning of competitive advantage? advances in competitiveness research. 8 (1), 121-129. goldstein, l (1991). training in organizations. in m. d. dunnette and l. m. hough (eds.), handbook of industrial and organizational psychology. (2nd ed.), (vol. 2, pp. 507-619), palo alto, ca: consulting psychologists press. grant, r. m. (1991). the resource-based theory of competitive advantage: implications for strategy formulation. california management review, 33, 114-135. griffin, r. w., & pustay, m. w. (1996). international business: a managerial perspective. reading, ma: addison-wesley publishing company. guion, r.m. (1991). personnel assessment, selection and placement. in m. d. dunnette and l. m. hough (ed:;.), handbook of industrial and organizational psychology. (2nd cd.), (vol. 2, pp. 327-397), palo alto, ca: consulting psychologists press. hannon, j. m., huang, i. & jaw, b. (1995). "international human resource strategy and its determinants: the case of subsidiaries in taiwan. journal of international business studies, 26, 531-554. hansen, m. t. (1999). the search-transfer problem: the role of weak ties in sharing knowledge across organizational subunit. administrative science quarterly. 44 (i), 82-11 l harrigan, k. & dalmia, g. (1991). knowledge workers: the last bastion of competitive advantage. planning review, nov-dec., 4-48. 20 journal of business strategies vol. 18, no.1 harvey, m. g. & buckley, m. r. (1997). managing inpatriates: building a global core competency. journal of world business. 32, 35-52. harvey, m. g " speier, c. & novicevic, m. m. (1999). the role of inpatriates in a globalization strategy and challenge associated with the inpatriation process. human resource planning. 22, 38-50. hashimoto, m. (1981). firm-specific human capital as a shared investment. american economic review. 71, 475-482. hitt, m. a., tyler, b. b., hardee, c. & park, d. (1995) understanding strategic intent in the global marketplace. academy of management executive. 9, 12-19. hitt, m. a., dacin, m. t., levitas, e., arregle, j. & borza, a. (2000). partner selection in emerging and developed market contexts: resource-based and organizational learning perspectives. academy of management journal, in press. hunter, j. & hunter, r. (1984). validity and utility of alternative predictors of job performance. psychological bulletin. 96. 72-98. jenson, a. r. (1980). bias in mental testing. new york: free press. kanter, r. m. (1991). transcending business boundaries: 12,000 world managers view change. harvard business review, may-june, 151-164. kim, p. s. (1999). globalization of human resource management: a cross-cultural perspective for the public sector. public personnel management. 28, 227-243. lawler, e. e., iii (1992). the ultimate advantage. san francisco: jossey-bass publishers. lawler, e. e., iii (1996). from the ground up. san francisco: jossey-bass publishers. lee, y. & larwood, l. (1983). the socialization of expatriate managers in multinational firms. academy of management journal. 26, 657-65. madhok, a. & tallman, s. d. (1998). resources, transactions and risks: managing value through interfirm collaborative relationships. qr~anizatiqn science. 9, 326-339. mallampally, p. (1997). transnational corporations and human resource development. prospects. 27, 55-78. mansfield, e. (1984). r&d and innovation: some empirical findings. in z. griliches (ed.), r&d patents and productivit~. chicago: university of chicago press. mead, r. (1998). international management; cross-cultural dimensions. (2nd ed.), oxford: blackwell publishers ltd. spring 2001 mcwilliams et al.: strategic management 21 mendenhall, m. & oddou, g. (1985). the dimensions of expatriate acculturation. academy of management review, 10,39-47. miller, d. & shamsie, j. (1996). the resource-based view of the firm in two environments: the hollywood film studios from 1936 to 1965. academy of management journal. 39, 519-543. norton, r. (1993). will a global slump hurt the u.s.? fortune, february 20, 1993,63-64, osborn, r. n. & hagedoorri, j. (1997). the institutionalization and evolutionary dynamics of interorganizational alliances and networks. academy of management journal. 40, 261-278. pennings, j. m., lee, k. & van witteloostuijn, a. (1998). human capital, social capital, and firm dissolution. academy of management journal. 41,425-440. peteraf, m. a. (1993). the cornerstones of competitive advantage: a resource-based view. strategic management journal. 14, 179-192. prahalad, c. k. & hamel, g. (1990). the core competence of the corporation. harvard business review. 68, 79-91. ratiu,1. (1983). thinking internationally: a comparison of how international executi ves learn. international studies of management and organization, 13, 139-150. reed, r. & defillippi, r. (1990). causal ambiguity, barriers to imitation, and sustainable competitive advantage. academy of management review, 15,88-102. ricks, d. (1993). blunders in international business. cambridge, ma: blackwell business. rothwell, w. j., prescott, r. k. & taylor, m. (1999). transforming hr into a global powerhouse. hr focus, march, 7-8. rouse, m. j. & daellenbach, u. s. (1999). rethinking research methods for the resource-based perspective: isolating sources of sustainable competitive advantage. strategic management journal. 20,487-494. schoenecker, t. s. & cooper, a. c. (1998). the role of firm resources and organizational attributes in determining entry timing: a cross-industry study. strategic management journal. 19, 1127-1143. schuler, r. s .• dowling, p. & de cieri, h. (1993). an integrative framework of strategic international human resource management. journal of management. 19,419-459. 22 journal of business strategies vol 18, no.1 si, s. x. & bruton, g. d. (1999). knowledge transfer in international joint ventures in transitional economies: the china experience. academy of management executive, 13 (i), 83-90. simonin. b. l. (1999). transfer of marketing know-how in international strategic alliances: an empirical investigation of the role and antecedents of knowledge ambiguity. journal of international business studies. 30 (3). 463-490. snell. s. a., snow, c. c. & hambrick, d. c. (1998). designing and supporting transnational teams: the human resource agenda. human resource management. 37, 147-158. snow, c., & snell, s. (1992). staffing as strategy. in n. schmitt and w. borman (eds.), personnel selection. (vol 4). san francisco: jossey-bass. steffy, b. & maurer, s. (1988). conceptualizing and measuring the economic effectiveness of human resource acti vities. academy of management review, 13, 27]-286. storck, j. & hill, p. a. (2000). knowledge diffusion through 'strategic communities.' sloan management review. 41 (2), 63-74. szulanski, g. (1996). exploring internal stickiness: impediments to the transfer of best practice within the firm. strategic management journal. 17, 27-43. trompenaars, f. (1993). riding the waves of culture. london: nicholas brealey. tung, r. (1981). selecting and training of personnel for overseas assignments. columbia journal of world business, 16,68-78. watson, w., kumar, k. & michaelson. l. (1993). cultural diversity's impact on interaction process and performance: comparing homogeneous and diverse task groups. academy of management journal 36, 590-602. welch, d. (1994). "hrm implications of globalization. journal of general management. 19, 52-66. wernerfelt, b. (1984). a resource based view of the firm. strategic management journal. ~, 171-180. we rn erfelt, b. (1995). the resource based view of the firm: ten years after. strategic management journal, 16, 171-174. wright, p. m. & snell, s. a. (1991). toward an integrative view of strategic human resource management. human resource manacement review, 1,203-225. spring 2001 mcwilliams et al.: strategic management 23 wright, p. m., mcmahan, g. & mcwilliams, a. (1994). human resources and sustained competitive advantage: a resource-based perspective. international journal of human resource management. 5 (2), 301-26. zahra, s. a., ireland, r. d. & hitt, m. a. (2000). international expansion by new venture firms: international diversity, mode of market entry, technological learning and performance. academy of management journal, in press. zupan, m. a. (1991). paradigms and cultures: some economic reasons for their stickiness. american journal of economics and sociology, 50 (i ), 99-104. endnotes i by competitive advantage, we mean that a firm or business unit has higher than average profits for firms in its market. while this is a commonly used definition (besanko, dranove & shanley, 2000, p. 389), the precise meaning of that and related terms is only now being clarified in the literature (see flint, 2000). 2 there are no generally accepted definitions of terms for organizations whose activities cut across national political boundaries. definitions vary depending in part on the emphasis placed on the location of operations (all production in one country, a few countries, or widely dispersed), markets (all sales in one country, a few countries, or widely dispersed), or ownership (all owners citizens of only one country, usually the country of incorporation; owners citizens of a limited number of countries; owners spread widely over the whole world). however, legal arrangements (country in which incorporated), the dominance of cultural or national groups in organizational activities. and strategies (worldwide uniformity, worldwide presence but with regional/local differences, and so on) are also frequently part of definitions. many of the general terms used (international, global, multi domestic, transnational, and multinational) have different meanings to different people, and some arc used almost interchangeably. therefore, it is extremely important that the reader uses the same set of definitions as do the authors. adler's (1991) set of definitions is used here because they are widely recognized by management scholars and practitioners alike. 3 while a thorough review of the rouse and daellenbach (1999) treatment is not presented here, they note that significantly different results arc obtained for business segment-specific effects relative to industry effects and that the very definition of competitive advantage restricts relevant analysis to only selected firms (those with "best practices") in particular industries. research using the resource-based view to study sustainable competitive advantages will, then, investigate the internal workings of carefully selected firms. 24 journal of business strategies vol. 18, no.1 abagail mcwilliams is head of the managerial studies department at the university of illinois at chicago. she received her bachelor's degree in business administration, and her master's and doctoral degrees in economics from the ohio state university. her research interests include strategic management, strategic human resourcc management, gender issues in labor mobility, and the link between firm performance and corporate social responsibility. david d. van fleet is professor of management at arizona state university west. he has 37 years of teaching experience, over 1go publications and presentations, and has consulted in the united states and abroad. he is a past president of the southwest academy of management and the southern management association. he served on the board of governors of the academy of management and is a fellow of the academy of management and the southern management association. patrick m. wright is professor of hr studies and chair of the hr studies department in the school ofindustrial and lahor relations, cornell university. he holds a ba in psychology from wheaton college, and an mba and a ph.d. in ob/hrm from michigan state university. he teaches and conducts research in the area of strategic human resource management, particularly focusing on how firms use people as a source of competitive advantage. strategic management of human resources for global competitive advantage environmental change and management staffing: an empirical examination of the electric utilities industry ram subramanian carol m. sanchez seidman school of business grand valley state university allendale, mi abstract this paper examines the relationship between environmental change, changes in competitive dynamics, and top management staffing in the electric utilities industry during the period surrounding the passage of the energy policy act of 1992 (epact 92). the findings suggest that following the passage of the epact 92, competition in the electric utilities industry intensified, placing greater emphasis on achieving internal, firm-level efficiencies. this external environmental change and the corresponding shift in the competitive context resulted in an adjustment in the composition of the top management coalition in these firms. the dominant coalition following the epact 92 consisted ofolde r manage rs with longer company and industry tenure who had efficiency-oriented backgrounds in operations, engineering, and accounting/finance. introduction the adaptation research within the organizational theory literature (e.g. katz & kahn, 1978; pfeffer & salancik, 1978) posits that changes in the external environment tend to encourage the selection of top-level managers whose backgrounds and skills are more appropriate for the new environment. using deregulation as a proxy for environmental change, prior studies have empirically examined this relationship in the railroad (guthrie, grimm & smith, 1991) and airline (thomas & ramaswamy, 1993) industries. the two studies yielded somewhat inconsistent findings. guthrie et al. (1991) found evidence to support their contention that following deregulation, railroad companies adopted new strategies that emphasized innovation, risk-taking, and an external, market-focused perspective. top railroad executives tended to have fewer years of industry and company tenure (i.e. more outsiders were employed at the top level), more years of formal education, be younger, and come with backgrounds in functional areas of marketing rather than engineering, operations, or accounting/finance. in contrast, thomas & ramaswamy (1993) concluded that 18 journal of business strategies vol. 15, no.1 following deregulation, airline companies emphasized efficiency and cost control. in turn, top airline executives were older, had longer tenures both in the company and in the industry (i.e. more insiders were employed at the top level), and came from functional backgrounds in engineering, operations, and accounting/finance, rather than marketing. thus, the same environmental change (i.e. deregulation) produced very different adaptive reactions in two different industries. to explain the inconsistency, thomas & ramaswamy (1993) argued that the nature of competitive change that results from the change in the external environment must first be identified prior to examining the adaptive response by companies in an industry. these authors used a finer grained analysis to test their hypotheses, by adding an extra methodological step to their study. they suggested that it is necessary to examine the type of competitive change brought about by a change in the external environment, and its relationship to changes in management staffing, to increase the generalizability of the findings of a study of any specific industry. this paper makes a contribution to the strategic management/organizational theory literature by examining the environmental change-management staffing relationship in yet another industry setting~ the electric utilities industry. using the finer-grained methodology pioneered by thomas & ramaswamy (1993), this study examines the effect of environmental change and the change in competitive dynamics it stimulates on management staffing of firms in the electric utilities industry during the period surrounding the passage of the energy policy act of 1992 (epact 92). the paper also makes a contribution to managerial practice by analyzing one of the effects of a significant environmental change ~ industry-level deregulation on the strategic responses of firms. given the significant impact of any type of regulatory change, firms must be aware that regulation, or the absence of it, can change the intensity and configuration of rivalry in an industry (porter, 1985). these changes in industry conditions can shift the balance of power among firms in an industry, depending on how firms respond strategically to the new industry conditions. by examining one set of firm level responses top management changes this sfudy may shed light on how firms may achieve and sustain competitive advantage under new competitive conditions. the next section of the paper discusses the framework that allows us to identify changes in competitive dynamics as a result of environmental change. we then examine the nature of the competitive change in the industry that was associated with the passage of the epact 92. next, we develop arguments and hypotheses that predict how top management teams will be affected by the changed competitive environment. finally, we test the hypotheses using a sample of u.s. electric utility firms. top management succession and turnover organizational theorists (e.g. aldrich & pfeffer, 1976; katz & kahn, 1978) suggest that top executive succession is a means of adapting the organization to spring 1998 subramanian & sanchez: environmental change 19 environmental alterations. pfeffer & salancik (1978) argue that environmental changes influence the distribution of power and control in organizations. through this influence, the environment affects the selection and removal of top executives. studies of executive or top management succession have generated great interest in recent years. perhaps the topic has become so important because organizations are often identified by their top managers and the decisions they make (hambrick & mason, 1984). after all, top managers are considered to be responsible for an organization's strategy, design, and performance (dalton & kesner, 1985). as a result, internal and external stakeholders of organizations often interpret top management changes as an indication of the future strategic direction of the firm (beatty & zajac, 1987). accordingly, one stream of top management succession research suggests that the most effective changes in top management involve a match between the characteristics of the successor and the strategic needs of the organization (gupta, 1984; hambrick & mason, 1984). these studies by strategic management scholars examined succession as one aspect by which organizations aligned themselves with a competitive environment (kesner & sebora, 1994). but competitive environments are not static. competitive environments often adjust themselves to conditions that emerge as a result of external environmental change. thus, environmental changes can influence changes in top management teams by pressuring the organization to select new managers that will better be able to strategically align the organization with its new competitive environment (pfeffer & salancik, 1978). for example, guthrie et al. (1991) argued that the deregulated railroad industry was "unstable and complex," which prompted railroad companies to adopt an innovative, market-focused approach in response. relative to the regulated industry environment, guthrie et al. (1991) found that railroad managers in the deregulated era had fewer years of company and industry tenure, were better educated, younger, and came from different functional backgrounds, compared with managers in the regulated era. similarly, thomas & ramaswamy (1993) studied deregulation as a surrogate for environmental change in their study of the airline industry. but their methodology included one important new step. they first determined the type of competitive orientation (a focus on efficiency versus a focus on market orientation) that was dominant among successful airline companies following deregulation, and then examined the environmental change top management staffing relationship. the authors reasoned that one could not assume that all deregulated environments in all industries are, as guthrie et al. (1991) put it, "unstable and complex." rather, only by establishing "the changes in critical contingencies" (thomas & ramaswamy, 1993: 877) following the environmental change can one predict specific, directional changes in top management characteristics. other research supports these authors' view. for example, reger, duhaime & stimpert (1992) found that the impact of environmental turbulence varies by industry con20 journal of business strategies vol. 15, no.1 text. adaptation appears to be contingent on industry-specific factors such as the threat and number of new entrants, market growth rate and capacity utilization (thomas & ramaswamy, 1993). therefore, any hypotheses that predict how firms will adapt to environmental change must be linked to the specific nature of the competitive changes driven by the external jolt. likewise, the generalizability of the findings of a study of the environmental change management staffing relationship in one industry context will be increased by examining the type of competitive change brought about by the external environment. this is the approach used in the current study. the two-step process used in the current study is portrayed in figure i. regulation as environmental change mahon & murray (1981) have argued that the transition from a regulated to a deregulated environment involves dramatic environmental changes for firms within an industry. regulation is the establishment of standards through formal legislation designed to control various aspects of industry activity including prices, entry, and exit (cohen, 1987). regulation in the u.s. electric utility industry allowed power companies to operate as natural monopolies with entry and prices determined by regulatory commissions. incumbent utility companies did not have to overly concern themselves with obtaining and sustaining a competitive advantage. but the epact 92 began the process of deregulation of the electric utility industry. deregulation, then, can be seen as a significant environmental change, that in the case of the electric utility industry significantly changed the rules of competition for power companies. the epact 92 in recent times, market forces have gradually pushed the electric utility industry toward competition. this process was greatly accelerated, however, by the passage of the epact 92. according to grant (1995:15), this legislation promotes competition in the electric generation market and mandates wholesale transmission access. under the act, the federal energy regulation commission is empowered to direct an electric utility to provide wholesale wheeling. wholesale wheeling refers to the transmission of electric power from any electric generating entity to another utility. the passage of the epact 92 created a new class of independent power producers that could either generate power of their own, or, alternatively, buy power from an electric utility and sell it to end users. the epact 92 also loosened the legal restrictions on ownership of generating facilities, and allowed a new breed of generators (e.g. equipment vendors, fuel suppliers, municipalities, universities, etc.) to compete with established utilities. analysts predicted that non-utility generation may capture up to 50 percent of the market for spring 1998 subramanian & sanchez: environmental change 21 figure 1 study methodology phase i examine the dimensions of change in the electric utilities industry step i competitive factors efficiency orientation market orientation statistical test multiple linear regression step 2 identify competitive factors related to performance prior to the epact 92 identify competitive factors related to performance after the epact 92 determine the nature of environmental change following the epact 92 time period: 1993-94time period: 1990-91 step 3 phase ii develop hypotheses predicting change in the dominant coalition consistent with changes in the environment. step 4 characteristics of dominant coalition: age company tenure industry tenure functional area orientation test hypotheses statistical test for age, company and industry step 5 age, company, and industry tenure functional area: } manova and univariate analysis of variance chi square step 6 explain findings 22 journal of business strategies vol. 15, no.1 new electricity capacity (rosemann & poirier, 1993). the entrance of new providers of electric power significantly altered the competitive landscape of the industry. electric utilities now have to contend with competitors in their hitherto protected marketplace, with the competition coming from buyers of their electric power that, through wholesale wheeling, have not invested in capital intensive power generation facilities. thus, the enactment and passage of the epact 92 changed the rules of engagement in the electric utilities industry, similar to the way deregulation changed competition in the railroad and airline industries. the dominant dimensions of competition important research in business-level strategic management has established that organizations adopt internally consistent strategic postures ranging from an efficiency orientation to a market orientation (miles & snow, 1978; porter, 1980). firms generally use one ofthese two strategies to position themselves in a competitively advantageous manner (porter, 1980). efficiency oriented strategies are characterized by extensive cost controls, a large volume of sales, and the ability to charge lower prices than the competition and still make a profit (huo & mckinley, 1992). market-oriented strategies are associated with the ability of firms to create unique, value-enhancing product or service attributes other than low price (porter, 1985). another stream of research has suggested that the skills and expertise of top managers reflect the dominant strategic orientations of their organizations. top managers of efficiency oriented firms are frequently older, have extensive industry and company-specific experience, and have backgrounds in efficiency-oriented functions such as finance and accounting. managers of market oriented firms are generally younger, have less industry and company tenure, and bring with them backgrounds in external functions such as advertising, sales, research, and product development (govindarajan, 1989; thomas & ramaswamy, 1993). these two literatures can be combined to create a framework for studying the changes in the competitive dynamics of an industry as a result of environmental change, and how subsequent changes in top management teams are related to such dynamics. this approach is consistent with the thomas & ramaswamy (1993) study. the current study ofthe electric utilities industry under conditions of regulation and deregulation allow us to characterize the competitive dynamics of the industry under both situations. then, by examining changes in the top managerial ranks from the first period to the second, we can determine whether or not these changes coincided with the new competitive requirements that resulted as the industry moved into an era of deregulation. the epact 92 and the changing dimensions of competition in accordance with the model outlined in figure 1 and with the work of thomas & ramaswamy (1993), we first examined the competitive factors that were related to the performance of the companies we studied both before spring 1998 subramanian & sanchez: environmental change 23 and after the passage of the epact 92. based on these findings, we then developed hypotheses that would relate management characteristics to changes in the external environment. consistent with the thomas & ramaswamy (1993) study, we used two contrasting competitive foci an efficiency orientation and a market orientation to categorize the competitive factors at play in the electric utilities industry. the two orientations indicated above are consistent with the dominant typologies in the business-level strategy literature, in that an efficiency orientation is akin to porter's (1980) "cost leaders" and miles & snow's (1978) "defenders", while a market orientation corresponds to porter's (1980) "differentiators" and miles & snow's (1978) "prospectors") we first identified factors specific to the electric utilities industry that indicate an efficiency focus, and then identified those that indicate a market orientation focus. power production and power distribution expenses were selected as efficiency indicators, and customer service and sales expenses were the market orientation indicators (huo & mckinley, 1992). all indicators were measured as a percentage of total revenues in order to control for the potentially confounding effect of firm size. return on investment (roi) was the measure of performance used. firm level data were obtained from financial statistics of major u.s. investor-owned electric utilities published by the u.s. department of energy. an efficiency orientation was identified by measuring total power production expenses and total distribution expenses. total power production expense (pwrpro) was the sum total of operating and maintenance expenses for the utility. total distribution expense (disexp) included all expenses relating to the transmission of power and maintenance of transmission facilities. in a capital intensive industry such as electric utilities, it is important to control expenses relating to both the production of power and its transmission. utilities focused on reducing these expenses by investing in new equipment and maintaining strict control over the deployment of resources to these activities. as surrogates of a market orientation, total customer service expense (cusser) and total sales expense (salexp) were used. customer service expense included expenses for providing assistance to customers and those related to producing and disseminating information and instructions to customers. a utility's sales expenses included salaries of sales supervisors and other sales personnel and advertising expenses. data on the above measures were collected for two periods. since the epact 92 was passed in 1992, the period 1990-1991, the two years immediately preceding the enactment and passage of the act, was selected as the base period, while period ii was 1993-1994, the two years immediately following the act. we expected significant differences in competitive conditions because of the act and consequent management changes when comparing 1990-1991 and 1993-1994. a multiple year period was used to smooth unique situations that an utility may encounter in a particular year. while a two-year time period may not be adequate 24 journal of business strategies vol. 15, no.1 to fully capture the reaction to an external change in the fonn of executive suc~ cession, two reasons were used to justify the selection of this time period. first, in the opinion of the researchers, the nature of the change brought about by the epact 92 was significant enough for electric utilities to warrant a quick reaction. second, a similar time period was used by thomas & ramaswamy (1993) in their study of the airline industry. investor-owned utilities were selected as the population for this study because they represent the largest percentage of electricity generated by all utilities and because of the availability of financial and top management demographic data. from the total of 148 investor-owned utilities for which data was available for both periods, a random sample (restricted be~ cause ofresearchers' resource constraints) of 50 utilities were selected. in order to ensure that the sample of 50 companies was representative of the population, we did a chi-square analysis to test the difference in annual revenue between the sample firms and those in the population. the analysis indicated that the difference between the two groups was not significant (x2 = 0.37; p>0.18). table 1 shows the profile of the target group in terms of average annual total revenue, average annual operating income, the standard deviation and the range. table 1 profile of target group average total revenue standard deviation average operating income standard deviation range of total revenue 1990 (in $ millions) 1512.30 791.80 211.66 118.70 334.0 to 3975.8 1994 (in $ millions) 1638.60 835.63 272.00 152.24 351.6 to 4002.1 data for periods i and ii were independently pooled prior to the multiple linear regression analysis. subsequently, independent regression models were de~ veloped for each period. such a procedure was used by thomas & ramaswamy (1993) who provide the rationale for the methodology. table 2 reports the results of this analysis. the results of the regression analysis indicated that in period i (immediately preceding the passage of the epact 92), superior performance (as measured by return on investment) was associated with lower levels of power production and power distribution expenses. enhanced efficiency and control of production and distribution costs were the key drivers of competition. market orientation indicators had a non-significant relationship to performance in this period. the dimension of competition did not change following the epact 92 (i.e. in period ii), in that efficiency once again drove competition and market factors were not signifispring 1998 subramanian & sanchez: environmental change 25 cantly related to performance. however, the increase in the proportion of variance in roi explained (i.e. the adjusted r2) which went from 39% before the epact 92 to 47% following the epact 92 underscores the greater emphasis on efficiency as a key dimension of competition fohowing the environmental change. in summary, following the enactment and passage of the epact 92, the competitive environment for electric utilities necessitated a greater focus on efficiency than prior to the regulation. table 2 results of multiple regression analysis of competitive variables on roi competitive variables period i (1990.91) period ii (1993·94) efficiency orientation pwrpro -2.125* -3.125* disexp -2.872* -2.921 * market orientation cusser 1.040 1.159 salexp 1.349 10417 adjusted r2 0.39 0.47 f value 6.378** 7.171** • p<o.05 .. p<o.oi environmental change and management staffing based on the results obtained in the first stage of the study, we developed hypotheses that relate the change in external environment to changes in the dominant coalition of electric utility companies. we note that guthrie et al. (1991) examined the demographic characteristics of unspecified "principal officers." consistent with the approach used by thomas & ramaswamy (1993), the current study examined executives who were in the position of senior vice president or above. this dominant coalition can be expected to have the greatest impact on organizational decisions. we predicted that three characteristics of members of top management teams would be associated with the intensified emphasis on efficiency that is being required by electric utility firms following deregulation, notably fohowing the passage of the epact 92: the years of company and industry tenure of managers, their age, and their functional background training. company and industry tenure studies (e.g., hambrick & mason 1984, guthrie et al. 1991) point out that managers recruited from outside of the organization and outside of the industry tend to bring with them fresh perspectives for handling new competitive conditions. on the other hand, managers with long company and industry tenure may 26 journal of business strategies vol. 15, no.1 have developed competencies relevant to their particular industry conditions. company insiders such as these are more likely to share the long-held traditional values of the firm, and they are more familiar with its organizational processes (helmich & brown, 1972). insiders have been associated with fewer organizational changes than outsiders (helmich, 1975; wiersema, 1992). pfeffer & leblebici (1973) found that as industries became more competitive, executives tended to come from inside their firms to a greater degree than in industries that were less competitive. the passage of the epact 92 did not result in a change in the direction of the competitive environment in the electric utility industry. rather, it increased the importance of efficiency as the primary driver of competition. accordingly, we pose the following hypothesis: hypothesis 1: following the epact 92 in the electric utilities industry, managers will on average have greater years of company and industry tenure than those managers employed prior to the epact 92. age researchers (e.g. hambrick & mason, 1984) have argued that a manager's age indicates that person's flexibility and propensity to take risks. younger managers are thought to be more flexible and risk seeking than their older colleagues, and younger top managers are more likely to pursue innovative growth strategies than their older counterparts (child, 1974; grimm & smith, 1987). on the other hand, older managers will tend to be more conservative, less risk-prone, and committed to managing the organization as it has been managed in the past (stevens, beyer & trice, 1978). rosen & jerdee (1976) found that older employees were more resistant to change in a study that examined the effects of age on selection evaluations. in the electric utility industry following the passage of the epact 92, firms continued competing by intensifying their efficiency measures. although this intensification of activities was significant, it did not represent a change in the mode of competition among utility companies. it has been noted that the propensity to adopt organizational innovations is negatively associated with a strict efficiency focus such as that which was observed after the passage of the epact 92 because innovation adoption requires a decision to invest scarce resources (kwon & zmud, 1987). it can be argued, then, that changes in the top management of electric utility companies after the epact 92 would favor older managers over younger managers, because older managers would be more likely to continue on a strategic path that was oriented towards traditional, efficiency measures. this leads to the following hypothesis: hypothesis 2: following the epact 92 managers in the electric utilities industry will on average be older than those managers employed prior to the epact 92. spring 1998 subramanian & sanchez: environmental change 27 functional background dearborn & simon (1958) found that a manager's orientation and behavior are influenced by experience in a functional area. subsequent research has supported the association between top management functional background and the strategic focus of the organization (e.g. chaganti & sambharya, 1987; pfeffer & salancik, 1978). further, it has been proposed that managers with different types of functional expertise will rise to become part of the dominant coalition of the organization when this expertise is considered critical to helping the organization achieve its strategic goals (miles & snow, 1978). for example, pfeffer & salancik (1978) found that top hospital administrators tended to have more training in hospital administration when the hospitals received more funding from insurance companies than from private donations. organizations with an external or a marketing orientation require strategic actions that include close monitoring of customer needs, increased sales, and new product design with added value and service components. to implement these strategies effectively, top managers of these organizations are likely to posses functional training and expertise in marketing and sales (gupta & govindarajan, 1984). on the other hand, organizations with an internal or an efficiency focus require strategic actions that emphasize cost reduction, engineering and operating efficiencies, and financial controls (guthrie et ai., 1991). thus, top managerial expertise in internally oriented functions such as operations, engineering, accounting, and finance would be a good match with electric utility companies' efficiency orientation following the passage of the bpact 92. we therefore posit the following hypothesis: hypothesis 3: following the epact 92 in the electric utilities industry, managers with backgrounds in operations, engineering, and accounting or finance will continue to be more dominant than managers with backgrounds in marketing. method data on the characteristics of the dominant management coalition for the two periods (1990-1991 and 1993-1994) studied were obtained from dun and bradstreet's reference book of corporate management. obtaining data from the same publication ensured consistency in data collection. for a randomly selected list of 10 companies, the dun and bradstreet demographic data were cross validated with the company's lo-k reports. for the 50 companies for which data were collected, period i resulted in 141 and period ii in 144 executives, all of whom held positions of vice-president or higher. since the study used a 3-year time difference between the two periods (1990-1991 and 1993-1994), a lack of turnover among these executives could confound the study's results. to safeguard against this, the names of executives in the base period (1990-1991) were com28 journal of business strategies vol. 15, no.1 pared with the names of executives in the second period (1993-1994). a total of 41 executives (29%) changed from the base period to the second period, in that the second period contained 41 executives who did not work in the utility in the base period. since the objective of the study was to test for differences across means while controlling for interrelations among dependent variables, a multivariate analysis of variance (manova) procedure was used. following a manova to test the overall significance of the differences in means, univariate f-tests and planned comparison tests were performed. to test hypothesis 3, a chi-square test was used. results since the manova was significant (approximate f= 7.71, p<.o 1), univariate and planned comparison tests were performed. table 3 displays these results. table 3 results of univariate f·tests and planned comparison tests variable period i (0= 141) period ii (0= 144) f-statistic t-value age 54.54 (8.16) 57.88 (5.89) 5.17** 4.19** company tenure 21.37 (13.22) 26.12 (11.35) 6.87** 3.87** industry tenure 25.24 (12.04) 28.30 (9.53) 6.56** 3.17** ** p<o.ol figures in parenthesis are standard deviations the first hypothesis related to the age of the dominant coalition. following the epact 92, the dominant coalition in the electric utilities industry were significantly older than their counterparts prior to the act (57.88 vs. 54.54, p<.o 1). these results support hypothesis 1. the dominant coalition also held longer tenures both within the company (26.12 vs. 21.37, p<.ol), and industry (28.30 vs. 25.24, p<.oi), thereby providing support for hypothesis 2. the third hypothesis posited that following the enactment of the epact 92, managers with backgrounds in operations, engineering, and accounting or finance (internally oriented functions) will continue to be more dominant than managers with backgrounds in marketing. as seen in table 4, the proportion of executives with backgrounds in internally oriented functions (operations, engineering, and accounting/finance) increased from 69.50 percent to 82.60 percent in period ii (x2 = 34.21, p<.oi), while executives from marketing declined in proportion from 13.60 percent to 10.70 percent (p<.oi), thus providing support for the hypothspring 1998 subramanian & sanchez: environmental change 29 esis. interestingly, the category "other" also showed a significant decrease in period ii. this category consisted of managers whose functional area could not be clearly classified as being either internally oriented or externally oriented. they included managers in the areas of law and human resources. since the executive succession literature is silent with regards to expected changes in these functions (following an environmental change), we did not examine this finding further. table 4 results of chi-square analysis l functional area internally oriented externally oriented other (law, etc.) period i (n= 141) 69.50 13.60 16.90 period ii (n= 144) 82.60 10.70 6.70 chi-square 34.21 ** 29.60** 37.85** ** p<o.oi i percent of dominant coalition discussion and implications the results of this study shed considerable light on the environmental changetop management succession nexus. following the occurrence of a significant environmental event, e.g., the enactment and passage of the epact 92, competition in the electric utilities industry intensified with increased emphasis on internal efficiencies. this change in the external environment resulted in a concomitant adjustment in the composition of the dominant coalition in these organizations. we predicted that the dominant coalition would have longer company and industry tenure, be older, and come from internally-focused functional areas. empirical results substantiated these predictions in both cases. following the passage of the epact 92, the executive teams of electric power companies consisted of older managers with longer company and industry tenure, predominantly from efficiency-oriented backgrounds in operations, engineering and accounting/finance. our findings are consistent with those of thomas & ramaswamy (1993), and they increase the generalizability of the notion that only by observing the unique impact of environmental shifts, such as deregulation, on the competitive dynamics of an industry can one accurately examine organizational adaptation. although previous research has suggested that market forces become more important following deregulation (guthrie et al., 1991), this may be the case in only one industry. the findings of our study and those of thomas & ramaswamy (1993) suggest that it is necessary to identify the nature of the com30 journal of business strategies vol. 15, no.1 petitive change in an industry following deregulation before cogent observations about the nature of managerial changes can be noted. since each industry may respond uniquely to the same environmental change (such as deregulation or the enactment of a new law), it becomes necessary to first delineate what the change is before attempting to relate it to the management staffing issue. this study adds to the body of research on executive succession and its relationship to strategic fit. it reinforces prior studies that have suggested that top management staffing changes may be more effective, or more appropriate, if the characteristics of the new leadership match the characteristics of the firm and its environment (gupta, 1984; hambrick & mason, 1984; leontiades, 1982). the observation that firms in the electric utility industry intensified their efforts to achieve internal efficiencies following the passage of the epact 92 , and the concomitant dominance of managers who possessed characteristics consistent with an internal focus, might suggest that firms carefully scan the various factors affecting the industry environment to determine how it will best be able to compete under the new conditions. alternatively, the results could suggest that firms pay close attention to the competitive actions of other firms in the industry following an external jolt, and imitate what they perceive to be successful adaptation strategies. this mimetic isomorphism is another type of attempt to achieve the appropriate "fit" between the environment and the firm, although it may be driven by institutional forces acting together with the rational processes that tend to characterize strategic decision making (mckinley, sanchez & schick, 1995). in either case, executive succession emerges as a way that organizations can align themselves within a competitive environment and reconfigure their internal resources to maximize competitive advantage (kesner & sebora, 1994). the notion of top management succession as an adaptation strategy involving a high degree of managerial selection is reinforced. in addition to its contribution to organizational theory, this study has implications for practicing managers. first of all, the study tests a framework that allows for precise prediction of changes in top management characteristics following environmental change. the results ofthe study suggests that managers would be well-advised to examine the specific bases of competition in their industry, and how environmental changes modify them, before they attempt to make strategic responses to what they perceive to be new competitive situations. second, the results of this study have specific implications for managers of u.s. electric power companies. the study may provide insight as to how utility managers might respond to ongoing attempts to restructure competition in the power industry. competition has put the electric utility industry in a transitional stage. many power companies are, for the first time, initiating strategic planning processes based on competitive market conditions, instead of simply reacting to state regulatory commissions and monopolistic conditions (murray, 1994; welshjohnson, 1994). the industry is consolidating (doughty & rode, 1995), witnessed by the merger of several utility companies since 1990 (sanchez, 1995). other spring 1998 subramanian & sanchez: environmental change 31 companies are unbundling generation, transmission, and distribution services, while others are divesting the generation business altogether (doughty & rode, 1995). how these and other competitive moves relate to top management staffing changes might reveal interesting outcomes for firms in this important industry. one limitation of this study could be that the results may be confounded by the differences between stable and dynamic industries (dess & beard, 1984). dynamism describes the degree of market instability in an industry and the turbulence caused by the interrelatedness between organizations (aldrich, 1979). mcarthur & nystrom (1991) found that the degree of dynamism significantly interacts with strategy to affect performance. low dynamism or stable industries, which are characterized by a high level of regulation, include the electric utility industry (mcarthur & nystrom, 1991). thus, it could be argued that the relatively stable environment of the electric utility industry might affect the nature of the strategy-performance relationship. nevertheless, we argue that even if the level of dynamism in the electric utility industry affects strategy and performance, the changes in strategic orientation and top management staffing observed as a result of this study would still be present. reflecting on the implications of this single-industry study for future research, we first note that more work is required to increase the generalizability of the notion that the specific nature of environmental change is important to organizational adaptation. we suggest that future studies include firms across multiple industries, to make an even greater contribution to the generalizability of the theory. for example, future studies might identify those environmental changes, including but not limited to regulatory jolts, that affect firms in several industries. researchers could observe the effects of those changes on the patterns of competition among firms in multiple industries, and then develop specific hypotheses that predict the effects of these competitive changes on top management staffing. this approach would be a significant departure from the ground originally broken by guthrie et al. (1991) and thomas & ramaswamy (1993), and it would begin to address inter-industry patterns of adaptation under conditions of environmental change. note according to the miles and snow (1978) classification, defenders emphasize a narrow domain by controlling secure (and often premium) niches in their industries. they engage in little or no product or market development and stress efficiency of operations. prospectors, on the other hand, constantly seek new opportunities and stress product development. the other two categories in the miles and snow classification are analyzers who exhibit characteristics of both defenders and prospectors and reactors who do not follow a conscious strategy and are viewed as a dysfunctional organizational type. 32 journal of business strategies references vol. 15, no.1 aldrich, h.e. (1979). on~anizations and environments. englewood cliffs, nj: prenticehall. aldrich, h.e., & pfeffer, j. (1976). environments of organizations. annual review of sociolo~y. 2,79-105. beatty, r.p., & zajac, ej. (1987). ceo change and firm performance in large corporations: succession effects and manager shifts. strate~ic mana~ement journal. 8, 305317. chaganti, r., & sambharya, r. (1987). strategic orientation and characteristics of upper management. strate~ic mana~ement journal. 8, 393-403. child, j. (1974). managerial and organizational factors associated with company performance. journal of mana~ementstudies. ii, 13-27. cohen, i. (1987). regulation and deregulation. california mana~ement review, 29 (4), 169-183. dalton, d., & kesner, i. (l983). inside/outside succession and organizational size: the pragmatics of executive succession. academy of mana~ementjournal. 26, 736-742. dearborn, d.c., & simon, h.a. 0958}. selective perceptions: a note on the departmental identification of executives. sociometry. 21, 140-144. dess, g., & beard, d. (1984). dimensions of organizational task environments. administrative science ouarterly. 29, 52-73. doughty, g.r., & rode, d.m. (1995). unlocking a potential paradise or competitive chaos? electrical world. 209 (3), 22-26. grant, cj. (1995). standard and poor's industry surveys electric utilities. new york: mcgraw-hill govindarajan, v. (l989). implementing competitive strategies at the business unit level: implications of matching managers to strategies. strategic mana~ement journal, 1q, 251-269 grimm, c.m., & smith, k.g. (1987). the organization as a reflection of its top managers: an empirical test. paper presented at the meeting of the academy of management, chicago. gupta, a.k. (1984). contingency linkages between strategy and general manager characteristics: a conceptual examination. academy of management review. 9, 399-412. spring 1998 subramanian & sanchez: environmental change 33 gupta, a.k., & govindarajan, v. (1984). business unit strategy, managerial characteristics, and business unit effectiveness at strategy implementation. academy of manaiement journal. 27, 25-41. guthrie, j.p., grimm, c.m., & smith, k.g.(199l). environmental change and management staffing: an empirical study. journal of management. 17 (4), 735-748. hambrick, d.c., & mason, p.a. (1984). upper echelons: the organization as a reflection of its top managers. academy of mana~ementreview, 9, 193-206. helmich, d.l., & brown, wb. (1972). successor type and organizational change in the corporate enterprise. administrative science ouarterly. 17,371-381. helmich, d.l. (1975). corporate succession: an examination. academy of management journal. 3,429-441. huo, yp., & mckinley, w. (1992). nation as a context for strategy: the effects of national characteristics on business-level strategies. management international review. .n, 103-113. katz, d., & kahn, r.l. (1978). the social "sycholoiy of organizations. 2nd ed. new york: john wiley and sons. kesner, i.f., & sebora, t.c. (1994). executive succession: past present & future. journal of management. 20 (2),327-372. kwon, t.h., & zmud, r.w (1987). unifying the fragmented models of information systems implementation. in r.j. boland, jr., & r.a. hirschheim (eds.), critical issues in information systems research: 227-251. new york: john wiley & sons. leontiades, m. (1982). choosing the right manager to fit the strategy. american sociological review. 37, 117-130. mahon, if., & murray, e.a. (1981). strategic planning for regulated companies. strategic manaiement journal. 2, 251-262. mcarthur, a., & nystrom, p. (1991). environmental dynamism, complexity, and munificence as moderators of strategy-performance relationships. journal of business research, 23, 349-361. mckinley, w, sanchez, c.m., & schick, a.g. (1995). organizational downsizing: constraining, cloning, learning. academy of manaiement executive. 9 (3), 32-44. miles, r.e., & snow, c.c. (1978). organizational strategy. structure and processes. new york: mcgraw-hill. murray, w.r. (1994). competitive positioning. fortnightly. 132 (13), 18-21. 34 journal of business strategies vol. 15, no.1 pfeffer, j., & leblebici, h. (1973). executive recruitment and the development of interfirm organizations. administrative science quarterly. 18, 449-461. pfeffer, j., & salancik, gr (1978). the external control of qrganizations: a resource gependency perspective. new york: harper and row. porter, m.e. (1980). competitive strate/:y. new york: the free press. porter, m.e. (1985). competitive agvantat:e. new york: the free press. reger, r.k., duhaime, lm. & stimpert, j.l. (1992). deregulation, choice, risk and performance. strate~ic mana,~ement journal. 13, 189-204. roseman, r.l., & poirier, j.k. (1993). crossing the threshold. electric perspectives, julyaugust. rosen, b., & jerdee, h.t. (1976). the influence of age stereotypes on managerial decisions. journal of applieg psycholol:y. 61,428-432. sanchez, c.m. (1995). environmental rei\llatory impact and firm-level innovation: astuay of electric utilities' responses to the clean air act amendments of 1990. unpublished doctoral dissertation. carbondale, il: southern illinois university. stevens, j.m., beyer, j.m., & trice, h.m. (1978). assessing personal, role, and organizational predictors of managerial commitment. academy of manaeement journal. 8, 363-376. thomas, a.s., & ramaswamy k. (1993). environmental change and management staffing: a comment. journal of manaiement.19 (4), 877-887. welsh-johnson, d. (1994). will the fittest survive? pqrtniibt!y. 132 (8), 18-22. wiersema, m.e (1992). strategic consequences of executive succession within diversified firms. journal of manaeement studies. 29, 73-94. dr. ram subramanian has a ph.d. in organization theory and policy from the university of north texas. he is an associate professor in grand valley state university's seidman school of business. his research, which centers on various facets of the organization-environment nexus, has been published in journal of manaeement, manaiement international review, and health care manaaement review, among others. dr. carol sanchez received her d.b.a. in strategic management and organization theory from southern illinois university at carbondale. she is an assistant professor of management at the seidman school of business, grand valley state university. her research interests include the effects of social pressures on managerial perceptions and actions, top management teams, innovation, and international management. environmental change and management staffing: an empirical examination of the electric utilities industry an evaluation of wholesaler accuracy in judging the legality of selected activities robin t. peterson new mexico state university las cruces, nm abstract wholesalers are subject to a wide variety of edicts at the federal, state, and local levels. this paper sets forth the results of an inquiry into the degree of knowledge held by a sample of wholesalers with regard to various major federal laws. a mail survey requested respondents to indicate their degrees of belief in the legality of a number of commercial practices. an analysis of the results, in total and by size offirm, resulted in various conclusions on perceptions oflegality in this sector. background the inquiry pursued in this paper assesses the degree to which wholesale managers are familiar with important federal laws. the paper addresses the importance of this topic and highlights some wholesale activities that are especially vulnerable to regulation. in addition, it discusses changes in the regulations and the status of small wholesalers as regards the law. in addition, it looks at the importance of the topic to manufacturers. finally, it presents an empirical analysis of managerial cognizance of the federal laws. wholesaler knowledge of federal law is a topic that deserves study. are these managers aware of the constraints which legislators place upon them? it is possible that many are not aware of the depth of their knowledge regarding this subject and mistakenly believe that they can judge which practices are compatible with the law and which are not. if this were the case, these managers are rendering themselves vulnerable to possible prosecution and a number of corollary consequences. it follows that wholesale managers could benefit by becoming aware of the state of their legal knowledge in relation to federal regulation. wholesalers are an essential component of many marketing channels. manufacturers, retailers, and industrial buyers have found that these entities are required because they perform a variety of necessary functions both effectively and efficiently. manufacturers who utilize wholesalers in the channel should be aware of legal problems that can materialize in the process of employing these intermediaries for distribution and related functions. if wholesale managers are violating the law, they may involve their suppliers in lawsuits and find that these activities must be altered, due to unexpected legal edicts. hence, it is in the interest of manufacturers that wholesale managers be familiar with the law. 164 journal of business strategies vol. 17, no.2 wholesalers are confronted with a robust and expanding volume of federal regulations which affect their activities. the regulations have an impact on an extensive number of the strategies and tactics which the enterprise might undertake. there are restrictions on advertising, personal selling, sales promotion, hiring and promoting employees, dealing with suppliers, collusion with rivals, pricing, and numerous other activities (wiesendanger, 1993; apaiwongse, 1993). an especially consequential area of the law relates to price fixing. a multi-state plumbing wholesale firm, for instance, was charged with engaging in a conspiracy to suppress and restrain competition by raising, fixing, and maintaining prices for the sale of wholesale plumbing supplies ("price fix in texas," 1995). legal expenses for the firm were almost a million dollars and the court ruled against the defendant company. alterations over time in the laws and in the ways they are implemented obfuscates the regulatory climate (department of justice, 1992; hunter, 1993). these changes require wholesalers to continuously moniter new regulations which federal authorities might adopt or have already brought into play (hollander & popper, 1994; siebert, 1992). some recent court rulings, for example, have illustrated that interpretations of what constitutes damages to a wholesaler under the robinson-patman act have been amended with the passage of time ("failure to show," 1995). managers who work for smaller wholesalers are confronted with an especially severe burden (heide, 1994). local and regional managers who are employed by larger concerns are not accountable for some activities that the federal government regulates such as buying and advertising, many of which are centered at the corporate or division level (bunn, 1993; robicheaux,1994). but executives in smaller concerns have a much more extensive range of responsibilities. in addition, large wholesaler managers often have recourse to specialized attorneys which the company retains (bellhouse & hutchison, 1993; "franchising currents," 1993). this condition is less common for smaller companies. the laws can influence numerous wholesaling functions, are sometimes unclear, and may impose severe consequences to the firm (plaisance, 1997; budden, jones & budden, 1996). hence, wholesalers are well-advised to remain informed on the nature of these constraints and how federal authorities implement them (himelstein, 1993). wholesalers require insights into legislation to avert possible damage awards, injunctions, fines, legal fees, out-of-court settlements, and even imprisonment (hukill, 1990; bowers, 1991; swift & kent, 1994). manufacturers who employ wholesalers may subject themselves to legal liabilities and loss of goodwill when the latter commit legal infractions (arreda & hovenkamp, 1989). in certain instances, courts may rule that the wholesaler was acting as the agent of the manufacturer, legally binding the manufacturer for the actions of the wholesaler (boyd, walker & larreche, 1998). hence, unwitting producers can subject themselves to vulnerability, even though they are not directly responsible for the actions that gave rise to the litigation. illegal actions by fall 2000 peterson: an evaluation of wholesaler accuracy 165 wholesalers also can result in unfavorable publicity for the manufacturer, especially when the details are heavily publicized in the media. wholesale managers cannot, of course, be expected to be conversant with all aspects ofre1evant legislation. rather, thorough comprehension of the law is better placed in the responsibilities of attorneys employed by or retained by the company (areeda & hovenkamp, 1989). on the other hand, wholesalers should have some comprehension of the more significant legislation and court rulings and be alert to situations where attorneys should be retained (bloom, milne, & adler, 1994; wisconsin music network, 1993; "commercial litigation," 1992). trade and professional organizations can have an impact on enhancing the knowledge of wholesalers regarding practices that are legally sensitive. these organizations can provide insights through publications and seminars that will be useful to wholesale managers. in some cases, such organizations can take on a proactive role and attempt to influence legislators to change the law, where such alteration appears to be needed. this inquiry explored the extent to which a sample of wholesalers could correctly differentiate between illegal and legal actions. it also scrutinized differences in perceptions of legality between managers employed by large and small wholesalers. a sample of wholesale managers received a list of written activities and were asked to examine the list and to specify the extent to which they believed each one to be illegal or legal. the analysis also examined the degree to which these perceptions were or were not correct. two hypotheses were subjected to test: hypothesis i: wholesalers will be able to correctly identify, as legal or illegal, fifty percent or more ofa list of actions that are potentially illegal. hypothesis 2: small wholesalers will be less accurate than large wholesalers in judging the legality of actions that are potentially illegal. the inquiry the researchers mailed cover letters and questionnaires to 500 randomly:"selected managers of wholesale firms. the sample frame was made up of telephone book yellow pages from 17 large and geographically-dispersed cities throughout the continental united states. the letters were addressed to the senior marketing officer at each wholesale unit. where a senior marketing manager did not exist, the letters were addressed to the general manager. approximately one week before obtaining the questionnaire, each manager received a postcard which requested participation in the inquiry and mentioned that a questionnaire would soon arrive in the mail. the instructions requested 166 journal of business strategies vol. 17, no.2 completion of the questionnaires and their return in postmarked preaddressed envelopes. one hundred-forty-one usable completed questionnaires were derived from this initial mailing. a follow-up postcard and a second questionnaire were forwarded to wholesalers that did not respond. this wave provided sixty-eight additional usable completed questionnaires. the final sample size was 209, producing a response rate of 41.8%. the questionnaire asked the respondents if their annual sales over the past two years had exceeded $2 million. those with revenues exceeding this figure were categorized as "large wholesalers" while those with $2 million or less were categorized as "small wholesalers" '. the sample resulted in 73 large and 136 small wholesaler respondents. the questionnaire described twenty actions that wholesale managers might take in the course of their daily work. the researchers carried out a content analysis of six chapters relating to laws, ethics, and social responsibility appearing in four top-selling channels of distribution books as a source of the actions2• these represented activities that were either illegal or potentially unethical, depending on the circumstances surrounding the actions. one-half of the actions are specifically in violation of federal laws or have been interpreted as such by the courts. the appendix describes each action. these descriptions were furnished to the members of the sample so that they might comprehend exactly what the listed actions meant. the other half of the actions were not in violation of the federal laws although some wholesale managers might see them as unethical. the respondents were asked to specify their opinion of the legality of the actions on a five-point scale that was anchored by the terms "obviously illegal," "probably illegal," "gray area," "probably legal," and "obviously legal" measured against federal laws. the respondents were only asked to respond to the legality question. they were not asked to judge the degree to which the actions were ethical or unethical. the hypothesis was that the wholesalers, as a group, would correctly identify the legal status of fifty-percent or more of the twenty actions. fifty-percent was chosen because it is the most neutral proportion available and, by default, marks the mid-point between what might be construed as "naive," on the one hand and "knowledgeable," on the other. this percentage has been employed in other studies of perceptions of the assessment of the legality of business practices (peterson, 1998). the tabulation process involved assigning quantitative values to the five elements in the scale. these values ranged from five (for "obviously illegal") to one (for "obviously legal"). the assigned values in each class were multiplied by their respective frequencies to derive arithmetic means for each of the twenty actions. hence, a mean value of two for a specific action would signal that the sample members felt that action was "probably legal." table i lists the mean values for each of the twenty actions. fall 2000 peterson: an evaluation of wholesaler accuracy 167 table 1 wholesaler perceptions of the legality of various actions action* mean scale actual legal std. value status dey. price collusion with competitors 3.6 illegal .27 charging higher prices than rivals 2.2 legal .14 hiring only experienced help 2.0 legal .15 predatory pricing 2.4** illegal .12 disparaging a competitor's integrity 3.1 illegal .21 charging the same price to similar buyers 1.9 legal .13 suggest that customers buy an item now 2.1 legal .12 agree to divide market with rivals 2.2** illegal .11 steal trade secrets 4.1 lliegal .25 ten customers they are getting a price break when this is untrue. 2.0** illegal .13 sen a low quality product 2.1 legal .10 aim the marketing effort only on larger customers 3.7** legal .28 sell products in throw-away non-degradable containers 1.7 legal .11 preempt potential competition with prices below costs 2.3** illegal .13 inducing price discrimination 2.0** illegal .15 selling unsafe products 4.4 illegal .21 having directors on the boards of directors of competitors 2.3** illegal .22 using comparative advertisements 3.8** legal .25 discriminating in price when this can be justified by cost differences 3.7** legal .26 ignoring a manufacturer's suggested price 1.4 legal .09 * the questionnaires described each action in detail. ** indicates that respondents' mean value on the legality of an activity was in error. significant differences between mean values and 3.0 were assessed by tukey k tests at the .05 level. according to the data in the table, the sample members incorrectly perceived the legality of nine actions. these were: 1. predatory pricing. 2. agree to divide market with rivals. 3. tel1 customers they are getting a price break when this is untrue. 4. aim the marketing effort only on larger customers. 5. prempt potential competition with prices below costs. 6. inducing price discrimination. 168 journal of business strategies vol. 17,no.2 7. having directors on the boards of directors of competitors. 8. using comparative advertisements. 9. discriminating in price when this can be justified by cost differences. six of the incorrectly judged actions are illegal but the respondents judged them to be legal. conversely, only three of them were legal but were judged to be illegal. the main bias, then, is in the direction of being unaware of federal laws instead of incorrectly interpreting that various actions are not in compliance. the wholesalers made correct judgments in eleven cases. thus, they correctly identified 55 percent of the legality associations, thereby providing support for the first hypothesis. however, the data shows that they have insights into only slightly better than half of the constraints which federal statutes impose. their collective response was wrong in 45 percent of the cases and these mistaken perceptions are in the domain of regulations which are associated with severe penalties, such as large fines, restrictive injunctions, and even possible imprisonment. interestingly, all of the incorrect judgments but one (using comparative advertisements) pertain to antitrust legislation, assuming that the federal trade commission act is included in that category. given the significant penalties that antitrust laws impose, misperceptions relating to these laws can be very costly to the company. five of the actions which the respondents judged incorrectly relate to the pricing function. it appears that there is considerable lack of insight on laws which pertain to this activity a very critical one in the marketing strategies of numerous wholesalers. another major portion of this study required analyzing the responses by size of company. it was hypothesized that managers from larger wholesalers would correctly identify the legal status of a larger number of actions. one reason for this is that large companies tend to be more highly scrutinized by federal authorities. management can be expected to be aware of this condition and to inform themselves about the regulations as a means of reducing the probability of prosecution or fines. another reason is that managers in larger companies are more likely than those in smaller companies to specialize in management functions per se and be familiar with laws relating to such duties. in smaller companies, managers are more likely to have nonmanagerial duties. to the extent that these duties consume time and effort, management is less able to have the resources necessary to become aware of legal requirements. finally, larger wholesalers are more likely than small wholesalers to have formal training programs in areas such as legal issues. table 2 sets forth data on perceptions of the legality of wholesaling actions, categorized by size of firm. the same test of significance as was employed in table 1 was applied to the data in table 2. in addition tukey k tests were made to assess the significance of the differences between scores for large and small firms. in order to directly address the hypotheses, only those differences which take place when large and small firms, as a group, differ on the legality ofthe practices fall 2000 peterson: an evaluation of wholesaler accuracy 169 are meaningful. where such differences occur, they reinforce the assessment of the hypotheses. table 2 wholesaler perceptions of the legality of various actions by size of retailer action* mean scale values large small actual legal std firms firms status dey price collusion with competitors 3.8 3.2# illegal .19 charging higher prices than rivals 2.0 2.6# legal .13 hiring only experienced help 2.0 2.0 legal .15 predatory pricing 2.8 2.2**# illegal .17 disparaging competitor's integrity 2.9 3.3 illegal .21 charge same price to similar buyers 1.5 2.7# legal .18 suggest customers buy item now 2.1 2.1 legal .14 agree to divide market with rivals 2.6 2.0**# illegal .12 steal trade secrets 4.3 3.7# illegal .24 tell customers they are getting a price break when this is untrue 2,4** 1.8**# illegal .08 sell a low quality product 2.0 2.2 legal .15 aim the marketing effort only on larger customers 3.6** 3.8** legal .21 sell products in throw-away non-degradable containers 1.6 1.7 legal .09 preempt potential competition with prices below costs 2.9 2.0**# illegal .14 inducing price discrimination 2.2** 1.9** illegal .16 selling unsafe products 4.4 4.4 illegal .24 having directors on the boards of directors of competitors 2.9 2.0 illegal .15 using comparative advertisements 3.0 4.2** legal .26 discriminating in price when this can be justified by cost differences 3.5 3.8** legal .20 ignoring a manufacturer's suggested price 1.3 1.6 legal .15 * the questionnaires described each action in detail. ** indicates that respondents' mean value on the legality of an action was in error. significant differences between mean values and 3.0 were assessed by tukey k tests, .05 level. # indicates action scores that are significantly different for small and large firms at the .05 level, according to a tukey k test. the mean scale values in table 2 confirm the hypothesis that wholesale managers of small companies are less accurate in their perceptions than those of large 170 journal of business strategies vol. 17, no.2 companies. in the large firm sample, only three of the mean scale values signify inaccurate perceptions by the respondents. the corresponding number of erroneous mean perceptions for small wholesalers is eight. fifteen percent of the practices evaluated by large wholesale managers and forty percent evaluated by small wholesaler personnel were in error. further, for activities where both large and small companies are in error, the mean scale values for the smaller companies were further away in magnitude from the correct response. it is apparent that the larger company managers possessed a superior knowledge of the federal laws and their application. summary and conclusions the goal of this inquiry was to measure the degree to which a sample of wholesale managers employed by large and small companies could correctly differentiate between illegal and legal actions, as prescribed by federal laws. in the full sample the wholesaler managers were able to correctly identify the legality of the actions in fifty five percent of the cases. a comparison between large and small wholesalers indicated that small wholesale managers were less accurate than large wholesale managers in identifying legal and illegal actions. the inquiry suggests that wholesale managers, particularly those employed by smaller firms, are in need of more supervision, training, and education in federal regulation of marketing actions. if firms do not attain this, they and their managers are subject to governmental prosecution and lawsuits levied by customers, rivals, and others. smaller wholesalers tend to be less familiar with the regulations, since they have limited staffs and are pressed for time. there are, however, several courses of action which they can pursue which will be neither costly nor time consuming. one is to subscribe to and read industry trade association bulletins and newsletters. many of these are useful in pointing out trends and new developments in the legal field. another approach is to retain an attorney on a contractual approach, where a nominal sum is given to the attorney each month, in return for legal advice, when needed. finally, many community colleges, colleges, and universities offer summary courses and seminars which cover aspects of the law that are relevant to business managers. many of these offerings provide valuable insights on matters such as practices which are likely to be in violation of the law and when to utilize an attorney_ this study focused only upon federal regulations. however, it is possible that wholesale managers are equally ill-informed on the legality of business practices in light of state and local regulations. further inquiries which analyze the state of knowledge regarding these constraints would be useful. managers in wholesale firms are well-advised to measure the degree to which they have knowledge of federal, state, and local regulations. other laws, in addition to those studied in this paper, could be covered by the measurement effort, fall 2000 peterson: an evaluation of wholesaler accuracy 171 depending on the specific legal environment confronting the firm. if the analysis reveals shortcomings in knowledge, remedial measures could be pursued to correct the shortcomings. these could include consulting with knowledgeable attorneys, reviewing business law texts and journals, and enrolling in classes and management development seminars. the result of well-conceived efforts could be actions that are more in congruence with the continually expanding depth and scope of regulation. beyond informing themselves about the relevant laws, wholesale managers are well-advised to take steps resulting in legal insights on the part of key employees. these individuals can easily pursue actions that violate the statutes, creating major problems for the company. key employees should have insights into the provisions of the laws and be aware that management is strongly motivated to avoid legal entanglements. manufacturers who use wholesalers should take steps to minimize the risk that the latter commit actions which legally bind or cause loss of goodwill for producers. this includes careful screening of potential wholesale channel members, monitoring of their activities which might violate laws, and careful supervision of their day-to-day actions (where this is practical). i large and small wholesalers are defined in different ways by different sources. the definitions used by the federal reserve, theu.s. employment service, the committee for economic development, and the small business adminstration all differ. this paper uses the $2 million annual sales figure as the criterion is relatively common (see peterson & koorisparian, 1997). 2 1. bowersox, donald & m. bixby cooper, stratq;ic marketin2 channel mana~ement new york: mcgraw-hill, 1992. 2. berman, barry, marketin~ channels. new york: wiley, 1996. 3. rosenbloom, bert, marketin~ channels: a mana~ement view. dryden press, 1995. 4. stern, louis w. & adel i el-ansary. marketing channels. englewood cliffs, nj: prentice-hall, 1992. appendix written description of the actions assessed 1. price collusion with competitors: making agreements with rival wholesalers which stipulate the prices each competitor would charge to its customers. 2. charging higher prices than rivals: assessing company customers higher prices than those assessed by competitors to their customers. 3. hiring only experienced help: hiring only those job applicants who have personal experience in wholesaling work. 172 journal of business strategies vol. 17, no.2 4. predatory pricing: setting company prices at low levels in order to drive competitors out of business. 5. disparaging a competitor's integrity: spreading false rumors that a competitor overcharges customers. 6. charging the same price to similar buyers: charging identical prices to different company customers when these customers are essentially alike in terms of the costs of serving them. 7. suggest that customers buy an item now: urging immediate purchase as prices may rise sometime in the future. 8. agree to divide market with rivals: reach an agreement whereby you will not compete for certain customers reserved for competitors and they will not compete for certain markets reserved for your firm. 9. steal trade secrets: acquire important confidential information possessed by rivals, without their knowledge or consent. 10. tell customers they are getting a price break when this is untrue: falsely informing customers that they are receiving a price that is lower than that charged to other customers. 11. sell a low quality product: sell a product that is inferior in performance, materials, or workmanship to products sold by competitors. 12. aim the marketing effort only on larger customers: concentrate your marketing personnel and activities on satisfying the needs of your larger customers. 13. sell products in throw-away non-degradable containers: sell goods in packages that will not break down into natural commodities in a reasonable period of time. 14. prempt potential competition with prices below costs: keep new firms from entering your market by pricing below costs, making it impossible for new firms to make a profit. 15. inducing price discrimination: persuading a supplier to sell goods to you at a lower price than that paid by a similarly situated competitor. 16. selling unsafe products: offering for sale goods that could damage the health or safety of users. 17. having directors on the boards of directors of competitors: using as direcfall 2000 peterson: an evaluation of wholesaler accuracy 173 tors, individuals who are also on the board of directors of one or more rivals. 18. using comparative advertisements: pointing out, in advertisements, that your products are superior to those carried by competing firms. 19. discriminating in price when this can be justified by cost differences: charging different prices to different customers when the costs of serving the customers is different. 20. ignoring a manufacturer's suggested price: selling above or below the price suggested by the supplier of the goods. references apaiwongse, t.s. (1993). market responses to epa policies. industrial marketing; mana~ement, 22, 319-330. areeda, p. e., & hovenkamp, h. (1989). antitrust law 1989 supplement. boston: little, brown, and company, 234-248. bellhouse, a. e., & hutchison, g. m. (1993). a model for the analysis of distribution channels. marketiok intelligence and planning journal. 11, 22-27. bloom, p. n., & milne, g. r., & adler, r. (1994). avoiding misuse of new information technologies: legal and societal considerations. journal of marketing, 58, 98-110. boyd, h. w, jr., walker, o. c., jr., & larreche, j. c. (1998). marketing mana"ment. boston: irwin mcgraw-hill, 62. bowers, d. k. (1991). the privacy challenge. marketinl{: research. 11,37-49. budden, m. c., jones, m. a., & budden, c. b. (1996). supplier relationships and the trade secrets dilemma. journal of purchasing and materials management. 32, 45-49. bunn, m. (1993). taxonomy of buying decision approaches.loumai of marketinll. 57, 38-56. commerciallitigatioo. (1992). law reporter, 35,254-259. department of justice adopts picot program for united states business review procedures. cch,150,095, (dec. 1992),4. failure to show lost sales prompts court to eject distributor's r·p damages. (1995). rna antitrust & trade reiu)atiqn report, 69(728), 275. 174 journal of business strategies vol. 17, no.2 franchising currents. (1993). franchise law journal. 13,49-55. heide, j. b. (1994). inter-organizational governance in marketing channels. journal of marketing. 58, 71-85. himelstein, l. (1993). should business be afraid of juries? businessweek. 3345, 100-101. hollander, s. c, & popper, k. m. (1994). balkanization of america: lessons from the interstate trade barrier experience. journal of macrqmarketin~.14(2), 62-72. hukill, c. (1990). significant decisions in labor-law. monthly labor review, 113,52-55. hunter, b.t. (1993). will beefed up inspection assure food safety? consumers' research. 73, 17-21. peterson, r. (1998), an assessment of the accuracy of independent retailer judgment of the legality of selected commercial practices. journal of business and economic perspectives, 14, 32-41. plaisance, s. (1997). where credit is due: study gives affirmative action hires their day of reckoning. the journal qf state government. 70, 2-6. price fix in texas. (1995). contractor, 42, 5-9. robicheaux, r. a. (1994). the structure of marketing channel relationships. journal of the academy of marketine science. 22, 38-51. siebert, b. (1992), downsizing: an overview of legal considerations. labor law journal. 43, 483-487. swift, co., & kent, r.l. (1994). sexual harassment: the issues and guidelines. lm!!:nal of marketing education. 16, 3-14. wiesendanger, b. (1993). last call. sales and marketing management. 145,62-67. wisconsin music network v. muzak ltd. (1993). 5 f. 3rd. 218 nth cir.) robin t. peterson is the norwest bank distinguished professor of marketing at new mexico state university. he received the ph.d. in marketing from the university of washington in seattle. he has produced a number of articles and books in the areas of marketing, retailing, wholesaling, business ethics, forecasting and small business. an evaluation of wholesaler accuracy in judging the legality of selected activities the customer as a productive resource: a pilot study and strategic implications cindy claycomb cynthia a. lengnick-hall wichita state university wichita, ks lawrence lv. inks honeywell abstract service delivery is an interactive process in which customers are often vital participants, with the level of participation varying among individual cc)flsumers. using a service setting (i.e., ymca), a pilot study examines differences in organizational socialization of customers and outcomes experienced by customers for three levels of customer participation. the findings indicate that there are significant differences in the (a) degree of organizational socialization across customers and (b) perceptions ofservice qualityfor the different levels of customer participation. specifically, organizational socialization and perceptions of service quality increase as customers become more active participants in service delivery. strategic implications are considered. introduction service delivery is an interactive and dynamic process, that from the consumer's point of view is much more than a passive exchange of money for a particular service. characteristics of services (e.g., intangibility, heterogeneity, simultaneity, and perishability) often require customers to be actively involved in helping to create the service value either by serving themselves (as in getting food in a buffet restaurant line or by pumping their own gas) or by cooperating and often working collaboratively with service personnel (as in settings such as hair salons, motels, universities, or lawyers' offices). in highcontact systems customers can influence the time of demand, the exact nature of the service, and the quality of service (chase, 1978; lovelock & young, 1979). if consumers somehow become better customers that is, more knowledgeable, participative, or productive the quality of the service experience will likely be enhanced for the customer and the organization (bowers, martin & luker, 1990). organizations that capitalize on customers' active participation in organizational activities can gain competitive advantage through greater sales 48 journal of business strategies vol. 18, no.1 volume, enhanced operating efficiencies, positive word-of-mouth publicity, reduced marketing expenses, and enhanced customer loyalty (lovelock & young, 1979; reichheld & sasser, 1990; vavra, 1992). customers who actively participate in organizational activities can directly increase their personal satisfaction and perceptions of service quality (bowers, martin & luker, 1990; czepiel, 1990; mills, chase & margulies, 1983; solomon et al., 1985). this view of customer participation requires organizations to broaden their perspectives of productive resources beyond their traditional boundaries to include customers as potential participants in, not merely recipients of, service delivery (bettencourt, 1997; lengnick-hall, 1996; prahalad & ramaswamy, 2000; schneider & bowen, 1995). however, customers have considerable discretion regarding the effort put forth and the range of actions towards which their efforts are applied during service delivery (bitner et al., 1997). for example, some customers decide to merely "show up," whereby their attendance is the extent of their participation. other customers become more actively involved by, for example, providing useful information to the organization or to other customers. this is a more moderate level of participation. finally, still other customers may decide to become co-producers of the service and actively help the firm do its work. in other words, some customers may become "partial employees" of the organization (mills, chase & margulies, 1983) and, in turn, derive additional benefits from service as an outcome of interactive experiences in which they participate (bateson, 1992). ultimately, the level of participation customers provide influences the service outcomes that are important to them and to the organization. customer participation, however, does not automatically materialize. the type of service, the environment in which the service is delivered, and individual differences among customers influence the level of customer participation (danaher, 1998). therefore, organizations should make it clear to customers what forms of participation are expected or might be beneficial to themselves or the firm. this suggests that customers should be trained, or socialized, by the organization if effective participation is to result. customer organizational socialization, then, is a key process for determining both the level and effectiveness of customer participation. based on this perspective of customer participation, our research focuses specifically on the relationships among customers' participation in service delivery, the socialization of customers into this process, and their subsequent satisfaction and perceptions of service quality. as pointed out by kellogg, youngdahl, and bowen (1997), each of these concepts has been researched separately and extensively; however, to date these concepts have not been integrated into a comprehensive research framework. the purpose of this paper is to show managers how increased customer participation in service delivery can improve organizational productivity and enhance customers' perceived outcomes. the results suggest specific managerial actions that can contribute to increasing customer participation. the research framework displayed in figure spring 2001 claycomb et al.: customer as a productive resource 49 i shows the model of customer participation we use in this study. fundamentally, the model depicts customer organizational socialization as a primary driver of customer participation in the service setting. when customers are properly socialized they are more likely to effectively participate in service delivery. effective participation, in turn, influences customer satisfaction and perceived service quality. following the theoretical development of this model, we report the results of a pilot study that is an exploratory tcst of the framework. we conclude by discussing the strategic implications of our research. figure 1 customer participation model levels of customer participation while some customer participation in service delivery is inevitable, the level of customer participation low, moderate, or high varies across service settings and across individuals. researchers have identified activities that correspond to three levels of participation: attendance, information provision, and coproduction (zeithaml & bitner, 1996). at a low level of participation, all that is required is the customer's physical presence or attendance, with the employees of the organization doing all of the service production and delivery work. an example would be a symphony concert, where symphony-goers must merely be present to receive the entertainment service. although symphony-goers may be 50 journal of business strategies vol. 18, no.1 more participatory, for example, by talking to other concert-goers about the concert or by applauding the performance, little more than their attendance is required once they are seated (bitner et al., 1997). at a moderate level, customer participation takes the form of providing information. the customer is a consultant and quality inspector to the organization and a reporter to others. this form of participation includes providing information to the organization about both good and bad service delivery, offering innovative ideas, and communicating with other potential and existing customers about the service or the organization (bettencourt, 1997; martin, 1992; mills, margulies & chase, 1983; plymire, 1991; schneider & bowen, 1995; wolstenholme, 1988). customers are uniquely situated to offer information to the organization. they may be familiar with the service through experience and they often have something to gain from their participation (wolstenholme, 1988). customers' complaints and suggestions may lead to fixing product and service delivery problems, expanding current service, or creating innovative goods and services (bettencourt, 1997; plymire, 1991). for example, federal express was able to discover and overcome a delivery process problem via information provided by a customer, boehringer mannheim biochemicals (bmb). after continually asking fedex employees for help in solving a problem with ruined shipments of bmb biochemicals, the fedex salesperson gathered 25 customer service and operations people from each company and convened a series of meetings. the group developed a simple solution that saved bmb an estimated $1.3 million a year by reducing spoiled deliveries and increasing customer goodwill. customer supplied information allowed fedex to solve a problem in two days that it had not been able to solve by itself in two years (dumaine, 1994). customers may also participate at a moderate level by communicating with other customers. for example, mcgrath and gtnes (1995) refer to overt interpersonal influences between unacquainted consumers in market settings. they found that consumers in retail settings will respond to others (i) when directly asked for information in the form of advice (e.g., when asked if they have ever tried a particular product) and evaluative comments (e.g., when asked how another looks in a new outfit) and (2) with unprompted or unsolicited advice, expertise, and complaints (e.g., when answering a question for a customer that a salesperson could not). in some cases the customer becomes an acti ve advocate, promoter, or defender of the organization (bettencourt, 1997; bowers, martin & luker, 1990; christopher, payne & ballantyne, 1991; harris, baron & davies, 1999; mcgrath & gtnes, 1995). in other cases, negative word-of-mouth is disseminated to voice dissatisfaction to others about a service experience (martin, 1992). customer participation at a high level is necessary to assist some organizations in creating the service. when service customers are actually involved in co-producing the service, the customer behaves as a partial employee who contributes effort, time, or other resources to either design the service or perspring 2001 claycomb et al.: customer as a productive resource 51 form some of the service deli very functions (bettencourt, 1997; lengnick-hall, 1996; lovelock & young, 1979; martin, 1992; mills & morris, 1986; schneider & bowen, 1995). fundamentally, this level of participation involves the customer in a partnership with the service organization to help assess the need for service, customize the design and delivery of the service, and produce a portion or all of the service him or herself. as a consequence of co-production, the nature of the service outcome can be negatively influenced for customers who choose to participate at a lower level. for example, citizens who attend but do not participate in a town hall meeting are likely to have their views overshadowed by more active co-producers who join committees and help draft policy. in other circumstances, co-production is a prerequisite for effective service delivery. for example, unless a health club member (who joined to lose weight) exercises and eats the right foods, the service provider cannot effectively deliver the service outcome. it should be recognized, however, that effective delivery of the service outcome also depends on the goal of the customer. if the health club member joined for social reasons, losing weight may be a side benefit with social interaction necessary for effective service delivery. participation by customers in service delivery varies considerably among service settings and among customers. even within the same service setting, different customers may show variations in their behaviors. some customers are prepared to playa purely physical role in the performance, for example, by sacking and carting their own groceries. others take on a verbal script, conversing with other customers or service employees (baron, harris & davies, 1996). by definition, customers who participate in co-production (i.e., at a high level of participation), must also be in attendance and provide information; customers who participate at a moderate level by providing information must be in attendance but would not be involved in co-production; customers who participate at a low level merely attend and do not provide information nor become invmved in co-production activities. for example, when a patient visits a physician, he decides which level of participation he is willing to adopt. he may choose to merely go to the appointment, but because of embarrassment or confusion, be non-communicative about symptoms and history; however, a patient who explains the symptoms and progression of an illness to the physician to help diagnose the illness is participating at a moderate level through both attendance and information provision. finally, a patient who, in addition to attendance and information provision, interacts with the physician to develop a workable treatment program, and then administers his own medication is actively engaging in co-production. customer organizational socialization to be effective participants, customers must possess the knowledge, skills, abilities, and attitudes that will enable them to perform effectively in service 52 journal of business strategies vol. 18, no. i encounters (bateson, 1992). socialization is the means through which people acquire the knowledge, skills, dispositions, and motivations that make it possible for them to effectively participate in a social structure. when properly socialized, a person has a greater ability to effectively participate in social interaction (biddle, 1979; sarbin & allen, 1968; stryker & statham, 1985). customer organizational socialization is the process used to prepare customers with behavioral guidelines that are organizationally specific; it allows customers to learn firm-specific values, develop the knowledge, skills, and abilities necessary to function within a specific organization, and acquire the knowledge necessary for interaction with employees and other customers (kelley, donnelly & skinner, 1990; kelley, skinner & donnelly, 1992). to the extent to which lack of effective participation can be attributed to the absence of appropriate experience or training, participation can be improved through the instruction and practice associated with socialization (biddle, 1979; sarbin & allen, 1968). specific examples of customer organizational socialization include formal programs, such as health spas that formally train customers to appropriately use their facilities; organizational literature, such as annual reports, used to advance organizational values; environmental cues, such as those used by airlines, hotels, and car rental agencies to provide customers with appropriate queuing behaviors; positive reinforcement and punishment, such as telephone companies charging to use directory assistance (i.e., punishment); and observation of other customers, such as new customers, upon going to a restaurant for the first time, watching experienced customers' behaviors (bowers, martin & luker, 1990; kelley, donnelly & skinner, 1990; kelley, skinner & donnelly, 1992). customer organizational socialization is the means by which a firm encourages customers to actively participate rather than remain passive recipients (bowers, martin & luker, 1990; goodwin, 1988). through this process, service customers gain an appreciation of organizational specific values, develop organiz.ational specific skills, gain an understanding of role expectations, and acquire the knowledge needed for social interaction with employees and other customers. as customers come to identify with organizational goals and values through the socialization process, they become more committed to the organization and engage in greater participation in organizational activities (kelley, donnelly & skinner, 1990). they become more productive when there is a match between the required service production-related skills, knowledge, and attitudes and the abilities and attitudes of the customer (bateson, 1992). consequently, customer organizational socialization and the level of customer participation are hypothesized to be associated, with more effective socialization being linked to higher levels of customer participation. hypothesis 1: customer participation levels increase as levels of organizational socialization increase. spring 2001 claycomb et al.: customer as a productive resource customer satisfaction and perceived service quality 53 participation in a relationship (e.g., the service delivery process) persists, in part, because of the consequences (i.e., the experienced rewards). the general principle is if a person's preferences and needs are met in a relationship, then higher levels of personal satisfaction with the relationship are likely to develop (biddle, 1979; stryker & statham, 1985). effective participation in the relationship facilitates this process because it increases the likelihood that a person's wants and needs are met and thereby increases the likelihood that satisfaction is experienced. effective participation by customers in the service delivery process is indispensable to the production activities of most service organizations and an essential requirement for any human service provider (bloom & wilson, 1979; lengnick-hall, 1996). different modes of interaction call for different types of customer participation, but despite these variations, consistent links have been demonstrated between increased customer involvement and increased customer loyalty and satisfaction (gutek, 1995; schneider & bowen, 1995; groth, gutek & douma, 2000). customers can directly influence organizational productivity (lovelock & young, 1979; mills & morris, 1986). however, while customers may care little about their contributions to increased organizational productivity, they are likely to care a great deal about whether their needs are met and other benefits are derived (e.g., lower prices) (bateson, 1992; bitner et ai., 1997). customers are typically present in the "service factory" (the place the service is produced or consumed, or both), interacting with employees and with other customers (chase & garvin, 1989). this suggests that effective participation on the part of customers can increase the likelihood that their needs are met and that the benefits they are seeking are actually attained (bitner et a\., 1997). however, not all participation by customers is beneficial to the service outcome. to ensure a positive relationship between participation and outcomes, customers must understand what they are expected to do, must have the skills and abilities to do the work correctly, and must receive some form of performance appraisal to correct any problems that occur (bowen, 1986; 2000). the outcomes of participation (i.e., fulfilled/unfilled wants and needs; personal satisfaction/dissatisfaction) are dependent on, at least partially, the level of the person's participation. findings from the employee participation literature lend theoretical justification to this idea. employee performance, productivity, and job satisfaction are influenced by the type and extent of decision making participation. in particular, when employees' participation in decision making regarding work, job issues, and informal situations increases, performance and satisfaction increase (cotton et al., 1988). this suggests that as a person's participation increases, perceived outcomes will be positively influenced. ulrich (1989) argues that involving customers in determining organizational policies is a powerful way to increase customer loyalty and commitment. 54 journal of business strategies vol. 18, no.1 likewise, bowen (1986) explains that as customers increase their level of involvement with a firm, the firm gains the opportunity to shape customer perceptions by making more direct evidence both about the service concept and the service delivery system available for customers to draw upon in making judgments about the firm. webber (2000) takes this a step further and uses stewardship theory to explain the relationship between co-production and increasing client trust and loyalty. the service literature lends further support to this claim as a positive and significant relationship has been found between customer participation and customer commitment (a potential outcome of participation) (bettencourt, 1997). it is a logical corollary, then, that the level of customer participation in the service production and delivery process will influence customers' total service experiences. ultimately, customers control or contribute to their own satisfaction through their participation (lovelock & young, 1979; mills & morris, 1986; solomon et ai., 1985; zeithaml & bitner, 1996). consequently, it is hypothesized that: hypothesis 2: customer satisfaction levels increase as the level of customer participation increases. similarly, customers' levels of participation will contribute to their perceptions of service quality (lovelock & young, 1979; mills & morris, 1986; solomon et ai., 1985; zeithaml & bitner, 1996). five dimensions of perceived service quality are recognized tangibles, reliability, responsiveness, assurance, and empathy (parasuraman, zeithaml & berry, 1988); however, only three of the dimensions are direct aspects of service encounter performance (czepiel, 1990). therefore, it is hypothesized that: hypothesis 3: levels of customer perceptions ofservice quality increase as customer participation levels increase. specifically, customer perceptions of the service firm's (a) responsiveness, (b) assurance, and (c) empathy increase as levels of customer participation increase. pilot study sample respondents were drawn from a random sample of member and non-member participants in organizational activities of a ymca having three branches in a mid-sized city in the midwest. ten-page surveys were mailed to participants' homes, accompanied by a letter from the executive director of the ymca encouraging their participation in the study. respondents were entered into a drawing for various prizes offered by the sponsoring organization. a total of 750 questionnaires were sent. of these, 127 completed surveys were received, givspring 2001 claycomb et al.: customer as a productive resource 55 ing a response rate of 17%. marketing mail surveys typically receive lower response rates than mail surveys in different disciplines (allen el ai., 1997). moreover, this is a reasonable response rate because there was no prenotification or followup with the sample (dillman, 2000; fox, crask & kim 1988; yammarino, skinner & chi iders 1991). there was a relatively even distribution of responses across the three branches of the metropolitan ymca (31 % east, 35% west, 34% central). slightly over half of the respondents (56%) were female. ymca customers include both members (i.e., individuals who have formally joined the organization and pay membership dues) and non-member participants (i.e., individuals who participate in ymca activities but are not members of the organization). nearly threequarters (72%) of the respondents were members. the remaining respondents were participating non-members of the ymca. while anonymity of the survey precluded comparison of respondents to non-respondents, these distributions are representative of the sample population, and no significant demographic differences were found between the respondents and the general customer base for this organization. measures all measures used in the present study were assessed on 5-point likert scales, with responses ranging from 1 (strongly disagree) to 5 (strongly agree), unless otherwise stated. the appendix contains a copy of the scales. levels of customer participation three dimensions of customer participation were assessed: attendance, information provision, and co-production. the three levels of customer participation were assessed by measures designed to identify attendance, information provision, and co-production on the part of customers. attendance was measured by the number of hours a customer spent in a typical week at the ymca. information provision was measured by an index offive items that assessed the extent to which customers provided information to the ymca (through focus groups and committees), made innovative suggestions to the ymca, and provided information to other customers of the ymca. co-production was measured by an index of three items used to assess the extent to which customers went beyond normal expectations to orient new members, provide service to the ymca, and put forth a great deal of effort to help the ymca in the service delivery process. scores on these three dimensions (i.e., attendance, information provision, coproduction) were used to classify respondents into one of four levels of participation. the levels of customer participation were determined as follows. the low level of customer participation (group 1 attendance) included those respondents who, in a typical week, spent time at the ymca, but exhibited low scores on information provision and co-production (i.e., in the bottom third of scores for information provision and co-production). these people were spend56 jourl/ol or business s'trategics vol. 18, no. i ing varying amounts or hours at the ymca hut were not providing information to the ymca nor actively participating with the ymca in the service delivery process. the moderate level of customer participation (group 2 inrormation provision) included those respondents who attended the ymca for three hours or more a week (top two-thirds) and scored in the top two-thirds of the respondents on the information provision index, hut exhibited low scores on coproduction (i.e., in the botlom third of scores). these people were spending relatively high amounts of time at the ymca and providing information to the ymca and other customers, but were not actively participating with the ymca in the service delivery process. the high level of customer participation was divided into moderate co-production (group 3) and high co-production (group 4). moderate co-production (group 3) included those respondents who attended the ymca for three hours or more a week (top two-thirds) and scored in the middle third of the respondents on the information provision and co-production indexes. to be classified in high co-production (group 4). rcspondents had to have scores in the top third on all participation measures (i.e., hours attended more than five hours per week and top third of information provision and co-production scores). a set of the respondents (n ::: 64) fit the definitions established for the customer participation levels. rather than arhitrarily identifying: additional levels (for which there is no theoretical support), we decided to analyze the subset of responses that fit the conceptual definition of customer participation. this method of identifying the four levels of customer participation and hence classifying respondents into the levels followed the definition of cumulative customer participation set forth earlier. this yielded the following numbers for this exploratory study: attendance n::: 14; information provision n::: i]; moderate co~ production n ::: 24; ,md high co-production n::: 15. other variables organizational socialization of customers measured the respondents' knowledge, skills, and attitudes regarding organizational norms and ymca policies and practices. twelve items drawn from kelley. skinner & donnelly (1992) were used to measure customer organizational socialization (0. ::: .80). the customer satisfaction scale utilized multiple indicators rather than the single-item measures that are often used (taylor & baker, 1(94). the two items used were general satisfaction measures developed for the study (0. = .85). these items were evaluated on five-point scales ranging from "very dissatisfied"' to "very satisfied," performanl:e items from parasuraman, zeithaml and berry's (1988) servqual scale were used to measure perceptions of service quality. this scale assesses the respondents' judgment of the overall superiority or excellence of service. support for using perceptions of actual performance measures rather than the difference scores between expectations and perceptions of actual perspring 200 i claycomb et at.: customer as a productive resource 57 formance has been found (cronin & taylor, 1992; olivcr, 1993). czepiel (1990) argues that three spccific dimensions mcasure servicc encounter performance: responsiveness (a:= .84), assurance (a:= .82), and empathy (a:= .87). therefore, thirteen items were used to measure these three dimensions orperceived quality of service encounter performance. results a series of anoya analyses was conducted to examinc the relationships among levels of customer participation, customer organizational socialization, and the outcomes customers experience from the service delivery process. anoyas were conducted for each set of hypothesized relationships. table i reports means, standard deviations, and alpha coefficients for each of the scales used in the analyses. correlations between these scales arc also presented in table i. table 1 correlations and descriptive statistics variable soc satis res assr mean sd alpha soc customer organizational socialization 3.73 ai) .80 satis customer satisfaction .39 4.09 .76 .85 res responsiveness .42 .32 3.73 .75 .84 assr assurance .56 .49 .51 3.79 .66 8". "emp empathy .57 .39 .67 .64 3.50 .78 .157 p $ .01 for all correlations hypothesis 1 predicted that significant differences in organizational socialization would be found across the levels of customer participation, with socialization levels and levels of participation increasing concurrently. the results, shown in table 2, provide support for this hypothesis. customer organizational socialization was significantly and positively related to customer participation (f =9.12; p ~ .0001). relatively high levels of customer organizational socialization were associated with high and moderate co-production (mean := 4.03; mean =3.88, respectively). relatively low levels of customer organizational socialization were associated with information provision and attendance levels of customer participation (mean =3.46; 58 journal of business strategies yol. 18, no. i mean = 3.37, respcctively). there was a statistically significant difference in the means for socialization betwccn co-production and the two lower levels of customer participation (i.e., information provision and attendance). there was not a statistically significant difference in the means for socialization between high and moderate co-production, nor the means between information provision and attendance. the means, however, were in the predicted direction (i.e., increasing from low icvels to high levels of customer participation). table 2 anova resultsgroup differences across levels of customer participation level of customer participation * dependent variable f df high comoderate coinformation p = production production provision attendance * customer organizational socialization 9.12 3;60 .0001 4.03" 3.8r' 3,46" 3.37" customer satisfaction 2.16 3;60 .102 4.47 4.10 3.91 3.82 perceived quality of service encounter performance responsiveness 2.37 3;60 .080 3.92 3.91 3.52 3.36 assurance 3.57 3;60 .019 3.90"" 4'() i" 3.73'" 3.34" empathy 5.64 3;60 .002 3.83" 3.76' 3.09"h 3.01" '.. significant differeni:es across customer role groups indicated by different lellers in superscripts post-hoi.' tests utilized bonferroni t-tesl with p<.05 significance level hypothesis 2 predicted that significant differences in customer satisfaction would be found across levels of customer participation, with satisfaction levels increasing as levels of participation increase. as shown in table 2, this hypothesis was not supported (f =2.16; p ~ .102). because the overall anoya model was not statistically significant, differences across the customer satisfaction means for different levels of customer participation were not evaluated. hypothesis 3 predicted that significant differences in customer perceptions of service quality would be found across levels of customer participation, with spring 2001 claycomb et at.: customer as a productive resource 59 higher levels of perceived quality of service encounter performance being linked to higher levels of customer participation. the results, shown in table 2, provide support for this hypothesis for two of three dimensions of service encounter performance. the means for responsiveness were not significantly different across the levels of customer participation (f =2.37; p ~ .080). hence h3a was not supported. h3b was supported, as assurance was significantly and positively related to customer participation (f =3.57; p ~ .019). relatively high levels of perceptions of assurance were associated with moderate co-production (mean = 4.01). relatively low levels of perceptions of assurance were associated with the attendance level of customer participation (mean =3.34). this was a statistically significant difference in the assurance means between moderate co-production and attendance. there were no statistically significant differences in the means for assurance between high co-production and the other levels of customer participation and between information provision and the other levels of customer participation. empathy was significantly and positively related to customer participation (f =5.64; p ~ .002), therefore providing support for h3c. relatively high levels of perceptions of empathy were associated with coproduction (high co-production mean = 3.83; moderate co-production mean = 3.76). relatively low levels of perceptions of empathy were associated with attendance (mean = 3.01). the empathy means were significantly different for co-production and attendance. there were not statistically significant differences in the means for empathy between co-production and information provision and between information provision and attendance. discussion summarizing, the level of customer participation at the ymca was found to be positively and significantly associated with customer organizational socialization and customers' perceptions of assurance and empathy (i.e., service encounter performance). as predicted, customers became more productive participants in the service delivery process when they received direction from the organizational socialization process at the ymca which enhanced their ability and motivation to participate in the production and delivery of the service. customers whose knowledge, skills, and attitudes more closely matched ymca norms, policies, and practices participated at higher levels in the service delivery process than customers with a weaker fit. these customers became involved in co-production as partial employees of the organization. in contrast, customers who perceived relatively less socialization by the organization did not participate as actively in the service delivery process. customers who participated at higher levels, in general, perceived that the ymca employees were knowledgeable and courteous and provided caring, individualized attention. moderate co-production was found to be related to increases in customers' perceptions of assurance, while mere attendance was 60 journal of business strategies vol. 18, no. 1 associated with less favorable perceptions of assurance. customers who participated in the service delivery process as co-producers (at least at a moderate level) found employees to be knowledgeable, courteous, and able to inspire trust and confidence. in contrast, those customers who operated at a low level of participation (i.e., attendance) were more likely to perceive employees as less knowledgeable, less courteous, and less able to inspire trust and confidence. similarly, customers who participated at higher levels believed the ymca provided caring and individualized attention to its customers. surprisingly, customer satisfaction and perceptions of responsiveness were not found to differ significantly across levels of customer participation. when customers participated in the service delivery process with the ymca, they were neither more satisfied nor dissatisfied. likewise, high levels of customer participation were not linked to customers' perceptions of the ymca's willingness to help customers and provide prompt service. the lack of a statistically significant effect may be attributable to the small cell sizes used in the study. strategic implications there are differing views on how much customers should be allowed to contribute to the service system process (bitner et a!., 1997). some experts advocate isolation of the service system to reduce the uncertainty that customers can introduce to the production and delivery process. this perspective argues that the less contact the customer has with the service system, the greater the potential for the system to operate at peak efficiency (e.g., chase, 1978). for example, the ymca could introduce automatic check-in and check-out as a way to reduce uncertainty in the deli very process associated with direct providercustomer contact. other experts believe that service can be delivered most efficiently by viewing customers as partial employees, designing their participation to maximize their contributions to the service system. this view reasons that organizational productivity can be enhanced if customers icarn to perform service related activities more effectively (e.g., mills, chase & margulies, 1983). the findings from the present study indicate that this latter view would result in more positive perceptions of the organization by the consumer. fundamentally, asking customers to participate as partial employees appears to increase the efficiency of the service delivery process and also appears to result in positive customer perceptions of service quality. this would suggest (at least for ymca organizations) that customers should be encouraged to participate in service related activities to the extent that they are able to make effective contributions. the findings of the pilot study indicate the following: (i) when customers are engaged at a high level of co-production, they perceive employees to be knowledgeable and courteous and able to inspire trust and confidence; and (2) when customers are engaged at a moderate level of co-production, they perceive spring 2001 claycomb et al.: customer as a productive resource 61 employees to be effective at providing caring, individualized attention. it may be that when customers participate with the organization as co-producers in service delivery, it is relatively easier for the organization to build relationships with them. relationships may develop because customers trust employees and believe that they are receiving individual and personal attention from the organization. therefore, these perceptions should be seen as part of a relationship building strategy. this can be profitable for organizations because the costs of maintaining existing customers are typically lower than those associated with acquiring new customers (berry, 1995). socialization is an important and valuable means for motivating customers to participate in the service delivery process. by identifying the level of customer participation desired, an organization determines what information, education, and training should be part of the organizational socialization of customers. in doing this, firms must recognize two factors. first, economic issues are not motivators for all customers. some customers may be motivated by other needs. for example, ymca patrons may be more interested in participating if it improves their fitness levels, helps them make new friends, or allows them to spend more time with their families. furthermore, the community outreach focus and the spiritual base may motivate customer participation at the ymca; however, other types of non-economic motivators need to be considered for an organization with a different mission or focus than the ymca. second, firms must make a highly visible connection for customers between participation and desirable outcomes. for organizations like the ymca, it may be important to promote the benefits that customers can obtain by greater participation (bowen & schneider, 1985). expanding the ymca example, it is important for the organization to develop a connection for customers between active participation in the service delivery process and fitness improvement, an atmosphere for making new friends, and a healthy environment for spending more time with family. it might also help to develop methods for rewarding customers for effective participation (bitner et ai., 1997). when considering the level of customer participation, organizations should recognize that they want customers to participate, but not to the extent that they decide to produce the service for themselves (lusch, brown & brunswick, 1992). for example, consumers could decide to bypass joining the ymca and set up gyms in their own homes. to avoid this, firms must emphasize their contribution to the service outcome. they must stress elements of their service delivery that customers cannot deliver or would find difficult to produce themselves (bitner et ai., 1997). the benefits of a collaborative and reciprocal relationship should be underscored. for example, the ymca may stress the empathetic, trusting, knowledgeable, and courteous employees or the esprit de corps created by working out with other customers. 62 journal of business strategies summary and conclusions vol. 18, no.1 the current pilot study investigated the influence of organizational socialization of customers on the level of customer participation and the subsequent influence of customer participation on perceptions of service quality and customer satisfaction. the study found that greater amounts of customer organizational socialization tend to be associated with higher levels of customer participation in the service delivery process. furthermore, higher levels of customer participation in the service delivery process tend to be associated with positive perceptions of service encounter performance. customers who actively participate in the service delivery process perceive employees to be knowledgeable and courteous, employees as having the ability to inspire trust and confidence, and the firm as providing caring, individualized attention to its customers. this research represents an important step toward explaining customer participation and its antecedents and outcomes. limitations and future research the current research opens up avenues for future research into customer participation. first, the measurement of levels of customer participation should be expanded. other researchers have identified specific levels of customer participation (e.g., bitner et ai., 1997); however, few, if any, have attempted to explicitly classify and measure customers' activities at the different levels. while our measures of the different levels of customer participation are theoretically sound, they may not tap the depth and intensity of customer participation. for example, the results indicate that the information provision index was not a clear differentiator of the moderate level of customer participation because it was not statistically different than other levels of participation. it may be that information provision is part of co-production, or there is more to a moderate level of participation than information provision (e.g., other inputs such as physical possessions or effort) (bitner et ai., 1997). future research should involve expanding the current measures to tap the depth and intensity of the different levels of customer participation. second, investigation into the link between customer participation and customer satisfaction should be continued. customer satisfaction and customer participation were not found to be associated in the present study. this could be a result of the global measure of customer satisfaction that was used in the current research. while our measure was similar to previous operationalizations in the service literature (e.g., kelley, skinner & donnelly, 1992; taylor & baker, 1994), recent research indicates that satisfaction may be of several types (spreng, mackenzie & olshavsky, 1996). for example, consumers may experience feelings of satisfaction or dissatisfaction with the attributes of a service as well as with the information provided about the service. in addition, these types of satisfaction may be distinct, though related, to overall satisfaction. future research should study the association between customer spring 2001 claycomb et at.: customer as a productive resource 63 participation and the types of customer satisfaction associated with various aspects of the service process. third, the setting for this study was one type of service organization (i.e., the ymca). a particularly useful extension of the study would be to examine customer participation in a variety of different service settings. in service firms such as the ymca, close and multidimensional interactions with customers are unavoidable because these firms concentrate on creating human change. furthermore, it is not known if the altruistic mission of the ymca influences customer participation. it may be that participation at the ymca is influenced by the spiritual base and community outreach focus. future research should take these elements into account. a better understanding of customer participation and the potential contributions it can make to individual and organizational outcomes in other types of organizations would enable managers to make more informed choices when customer participation is discretionary. as competition becomes increasingly knowledge-based, effective management of customerorganization relationships becomes an increasingly important competitive issue. finally, future research should strive for larger sample sizes. while 127 completed surveys were returned, only 64 were used in the current analysis. the resultant small sample size opens up opportunities for errors of inference. a larger sample size would help lessen these. furthermore, the sample size of the current pilot study was too small to conduct a test of a composite model of customer participation. a composite model would allow researchers to determine the interrelationships among customer organizational socialization, customer participation, perceptions of service quality, customer satisfaction, and various other antecedents (e.g., time poverty) and outcomes (e.g., loyalty) of customer participation. the results of this conceptual framework and pilot study build a foundation for the study of customer participation when looking for ways to achieve desirable performance objectives. this research examines important issues being explored in both management and marketing, and begins to integrate some of the findings from these literature streams. it is this type of integration that helps strategists overcome artificial boundaries around key questions related to customer orientation and performance. references allen, j., scott, j., roberts, m. & chiriac, o. (1997). a trend analysis of mail survey response rates for selected marketing journals, 1960-1995. in j. hair and e. wilson (eds.), developments in marketing science. (vol. 20, pp. 264-268). chicago: academy of marketing science. 64 journal of business strategies vol. 18, no.1 baron, s., harris, k. & davies, b. j. (1996). oral participation in retail service delivery: a comparison of the roles of contact personnel and customers. european journal of marketing, 30 (september), 75-90. bateson, j. e. g. (1992). managing services marketing. (2nd cd.), fort worth, tx: the dryden press. berry, l. l (1995). relationship marketing of services growing interest, emerging perspectives. journal of the academy of marketing science. 23 (4).236-245. bettencourt, l. a. (1997). customers voluntary performance: customers as partners in service delivery. journal of retailing. 73 (3),383-406. biddle, b, j, (1979). role theory. expectations, identities and behaviours. new york: academic press, inc. bitner, m. j., faranda, w. t., hubbert, a. r. & zeithaml, v. a. (1997). customer contributions and roles in service delivery. international journal of service industry management. 8 (3),193-205. bloom, s. w. & wilson, r. n. (1979). patient-practitioner relationships. in h. e. freeman, s. levine and l. g. reeder (eds.), handbook of medical sociology. (pp. 275296). englewood cliffs, nj: prentice hall. bowen, d. e. (1986). managing customers as human resources in service organizations. human resource management. 25 (3), 371-383. bowen, d. e. (2000). developing high-performance customers as a source of sustainable competitive advantage. symposium paper presented at the annual meeting of the academy of management, toronto, ontario, canada. august 16. bowen, d. e. & schneider, b. (1985). boundary-spanning-role employees and the service encounter: some guidelines for management and research. in j. a. czepiel, m. r. solomon and c f. surprenant (eds.), the service encounter. (pp. 127-148). lexington, ma: lexington books. bowers, m. r., martin, c l. & luker, a. (1990). trading places: employees as customers, customers as employees. journal of services marketing, 4 (spring), 55-69. chase, r. b, (1978). where docs a customer fit in a service operation? harvard business review, 56 (6),137-142. chase, r. b. & garvin, d. a. (1989). the service factory. harvard business review, 57 (4),61-69. christopher, m., payne, a. & ballantyne, d. (1991). relationship marketing. oxford, great britain: butterworth heinmann. spring 200 1 claycomb et al.: customer as a productive resource 65 colton, j. l., vollrath, d. a., froggatt, k. l., lcngnick-hall, m. l. & jennings, k. r, (1988). employee participation: diverse forms and different outcomes, academy of management review, 13 (1), 8-22, cronin, j, 1. & taylor, s, a. (1992), measuring service quality: a reexamination and extension. journal of marketing, 56 (july), 55-68. czepiel, j. a. (1990). service encounters and service relationships: implications for research. journal of business research, 20 (1), 13-21. danaher, p. j. (1998). customer heterogeneity in service management. journal of service research, i (november), 129-139. dillman, d. a. (2000). mail and internet surveys: the tailored design method. (2nd cd.), new york: john wiley & sons, inc. dumaine, b. (1994). mr. learning organization. fortune (october 17), 147-157. fox, r. 1.. crask, m, r. & kim, j. (1988). mail survey response rate: a meta-analysis of selected techniques for inducing response. public opinion quarterly. 52, 467-491. goodwin, c. (1988). "i can do it myself'; training the service consumer to contribute to service productivity. journal of services marketing. 2 (fall), 71-78. groth. m., gutek. b. a. & douma, b. (2000). effects of service delivery modes and mechanisms on customers' perceptions in coproduction. symposium paper presented at the annual meeting of the academy of management, toronto, ontario, canada. august 16. gutck, b. a. (1995). the dynamics of service: reflections on the changing nature of customer/provider interactions. san francisco: jossey-bass. harris, k., baron. s. & davies, b. (1999). "what sort of soil do rhododendrons like?" comparing customer and employee responses to requests for product related information, journal of services marketing. 13 (1),251-37. kelley, s. w.. donnelly, j. h., jr. & skinner, s. j. (1990). customer participation in service production and delivery. journal of retailing, 66 (fall), 315-335. kelley, s. w., skinner, s. j. & donnelly, j. h., jr. (1992). organizational socialization of service customers, journal of business research. 25 (november), 197-214. kellogg. d. l .. youngdahl, w. e. & bowen, d. e. (1997). on the relationship between customer participation and satisfaction: two frameworks. international journal of service industry management. 8 (3), 206-219. 66 journal of business strategies vol. 18, no.1 lengnick-hall, c. a. (1996). customer contributions to quality: a different view of the customer-oriented firm. academy of management journal, 21 (3),791-824. lovelock, c. h. & young, r. f. (1979). look to consumers to increase productivity. harvard business review, 57 (may-june), 168-178. lusch, r. e, brown, s. w. & brunswick, g. j. (1992). a general framework for explaining internal vs. external exchange. journal of academy of marketing science. 10 (2), 119-134. martin, c. l. (1992). perspective of service consumers: their multiple roles and challenges. journal of consumer studies and home economics. 16, 139-149. mcgrath, m. a. & otnes, c. (1995). unacquainted intluencers: when strangers interact in the retail setting. journal of business research, 3 (2), 261-272. mills, p. k., chase, r. b. & margulies, n. (1983). motivating the client/employee system as a service production strategy. academy of management review, 8 (2), 301-310. mills, p. k. & morris, j. h. (1986). clients as "partial" employees of service organizations: role development in client participation. academy of management review, 11 (4), 726-735. oliver, r. l. (1993). a conceptual model of service quality and service satisfaction: compatible goals, different concepts. in t. a. swartz, d. e. bowen & s. w. brown (eds.) advances in services marketing and management. (vol. 2, pp. 65-68), greenwich, ct: jai press. parasuraman, a., zeithaml, v. a, & berry, l. l. (1988). servqual: a multiple-item scale for measuring consumer perceptions of service quality. journal of retailing. 64 (spring), 12-40. plymire, j. (1991). complaints as opportunities. journal of services marketing, 5 (january),61-65. prahalad, c. k. & ramaswamy, v. (2000). co-opting customer competence. harvard business review, 78 (1), 79-90. reichheld, f. f. & sasser, w. e, jr. (1990). zero defections: quality comes to services. harvard business review, 68 (september-october), 105-111. sarbin, t. r. & allen, v. l. (1968). role theory. in g. lindzey and e. aronson (eds.) the handbook of social psychology. (2nd ed.), (vol. i, pp. 488-567), reading, ma: addison wesley. spring 2001 claycomb et at.: customer as a productive resource 67 schneider, b. & bowen, d. e. (1995). winning the service game. boston: harvard business school press. solomon, m., surprenant, c, czepiel, j. a. & gutman, e. g. (1985). a role theory perspective on dyadic interactions: the service encounter. journal of marketing. 49 (winter), 99-111. spreng, r. a., mackenzie, s. b. & olshavsky, r. w. (1996). a reexamination of the determinants of consumer satisfaction. journal of marketing. 60 (3), 15-32. stryker, s. & statham, a. (1985). symbolic interaction and role theory. in g. lindzey and e. aronson (eds.) handbook of social psychology. (3rd ed.), (pp. 311-378). new york: random house. taylor, s. a. & baker, t. l. (1994). an assessment of the relationship between service quality and customer satisfaction in the formation of consumers' purchase intention. journal of retailing, 70 (2), 163-178. ulrich, d. (1989). tie the corporate knot: gaining complete customer commitment. sloan management review. 3q (4), 19-27. vavra, t. g. (1992). aftermarketing. homewood, il: business one irwin. webber, s. s. (2000). project managers as client relationship managers: implications for client loyalty. presented at the national academy of management meetings, toronto, ontario, canada. august 16. wolstenholme, s. m. (1988). the consultant customer a new use for the customer in service operations. in r. johnston (ed.) the management of service operations: proceedings of the operations management association. (pp. 195-203). berlin: ips publications. yammarino, f. j., skinner, s. j. & childers, t. l. (1991). understanding mail survey response behavior: a meta-analysis. public qpinion quarterly. 55 (4),613-639. zeithaml, v. a. & bitner. m. j. (1996). services marketina. new york: mcgraw-hill. 68 journal of business strategies appendix measures of constructs vol. 18, no.1 attendance 1. in a typical week, how many hours do you spend at the ymca? information provision (applies to respondent's actions as a ymca participant) i. i am always ready to help or to lend a helping hand to those around me. 2. i am willing give of my time to help others. 3. i make innovative suggestions to improve the overall quality of the ymca's programs. 4. serve as a branch advisory board member (ongoing policy committee). 5. participate in various focus groups. co-production (applies to respondent's actions as a ymca participant) 1. i help orient new ymca participants even though it is not required. 2. the ymca really inspires me to help provide service in any way i can. 3. i am willing to put in a great deal of effort beyond that normally expected in order to help the ymca provide service to me. orl:anizationai socialization 1. the ymca is what i was looking for. 2. the ymca can depend on me as a participant. 3. i feel comfortable at the ymca. 4. i understand the values that are important to the ymca. 5. i understand the policies of the ymca. 6. i get along with the employees of the ymca. 7. i am similar to the other participants of the ymca. 8. i understand the responsibilities of the employees of the ymca. 9. since i first became a participant of the ymca, my expectations about the service i receive have changed. 10. since i first became a participant of the ymca, i have learned about its history. 11. since i first became a participant of the ymca, i see myself differently. 12. what the ymca stands for is important to me. customer satisfaction 1. overall experience with the ymca. 2. overall quality of the services offered by the ymca. spring 2001 claycomb et al.: customer as a productive resource 69 perceptions of service quality responsiveness (all items reverse-scored) 1. the ymca does not tell participants exactly when services will be performed. 2. i do not receive prompt service from the ymca's employees. 3. employees of the ymca are not always willing to help participants. 4. employees of the ymca are too busy to respond to participants' requests promptly. assurance i. i can trust employees of the ymca. 2. i feel safe in my transactions with the ymca's employees. 3. employees of the ymca are polite. 4. employees get adequate support from the ymca to do their jobs well. empathy (all items reverse-scored) 1. the ymca does not give me individual attention. 2. employees of the ymca do not give me personal attention. 3. employees of the ymca do not know what my needs are. 4. the ymca does not have my best interests at heart. 5. the ymca does not have operating hours convenient to all their participants. cindy claycomb (ph.d., oklahoma state university) is an associate professor of marketing and entrepreneurship at wichita state university. earlier in her career she worked for the boeing company and pepsico, inc. hercurrent research is in the areas of supply chain management, services marketing, relationship marketing, and knowledge management. her research has recently been published in journal of business research, european journal of marketing, industrial marketing management, and several other marketing and logistics journals. cynthia a. lengnick-hall is a professor of strategic management in the w. frank barton school of business at wichita state university. her articles have been published in such journals as the academy of management review, academy of management journal, strategic management journal, journal of management, and strategy and leadership. she has co-authored two books and contributed chapters to five other books. her current interests include: strategic analysis, competing in high-velocity environments, designing complex adaptive organizations, and strategic human resource management. larry w. inks is director of organization and leadership development for honeywell (formerly alliedsignal) polymers. prior to his position with honeywell, larry was assistant professor of management in the w. frank barton school of business at wichita state university. he has also held positions in organization and management development with pepsico. larry has a ba in psychology from purdue university, and a masters and ph.d. in industrial/organizational psychology from ohio state university. 70 journal of business strategies vol. 18, no.1 the customer as a productive resource: a pilot study and strategic implications volume 37, number 1 29 psychological contract violation and the escalating cycle of mistrust juliana d. lilly sam houston state university • huntsville, tx abstract psychological contract violations in the workplace can lead to disruptive behavior, but few studies have examined why the disruptive behavior may persist over time. this paper extends the current understanding of psychological contracts by proposing a model that illustrates an escalating cycle of mistrust resulting from a perceived contract violation. the model proposes that after a psychological contract violation has occurred, an escalating cycle of mistrust is created that feeds on itself through transactional cost behaviors of both the victim and the perpetrator of the violation. once the cycle of mistrust has begun, it can only be broken if one party exhibits specific behaviors that focus on resolving the issue rather than perpetuating the cycle. keywords: psychological contract, trust, procedural justice introduction when individuals experience disappointment or anger due to an unexpected occurrence, their reactions may vary from mild irritation that quickly dissipates to severe behavioral reactions that consume much time and effort. consider the difference in a work disagreement over a routine report which is quickly forgotten versus a work disagreement over a routine report which turns into a long-term feud between coworkers or departments. all employees have good days and bad days, but why do individuals sometimes continue a fight long after the initial disagreement? and why does the disagreement spill into other areas not impacted by the original report in question? this paper attempts to answer these questions by presenting the escalating cycle of mistrust, a cycle originating from an incident, or series of incidents, that create disappointment or anger due to an unexpected occurrence. management researchers have examined behavioral issues in the workplace for decades, and studies on trust, organizational justice, and leadership have provided some insight into the psychology of work behavior. this research is important since work is a social endeavor, managers and employees are required to interact with one another, and disagreements may lead to disruptive behavior that interferes with organizational effectiveness. as such, studies that examine work disagreements 30 journal of business strategies and the subsequent anger or disappointment could be beneficial in finding ways to alleviate some of the resulting detrimental behaviors. the literature on psychological contracts in the workplace often includes elements of trust, organizational justice, and leadership in empirical studies of psychological contract violations and this research may help explain the psychological impulse to prolong a workplace disagreement. a psychological contract is based on the concept of reciprocity between employees and organizations such that an employee who is loyal and productive expects the organization to reciprocate by treating the employee fairly in terms of pay and work conditions. articles on corporate layoffs have alluded to the psychological contract when reporting on companies that terminated thousands of loyal, productive employees while executives profited (brookman, chang & rennie, 2007; cramer, 1996; maremont, 2005), a clear violation of the expectation of reciprocity between employees and organizations. one study found that psychological contract violations experienced by layoff victims from a previous employer were negatively related to trust in their new employer (pugh, skarlicki passell, 2003), suggesting the emotional impact of the violation may be long-term and transferable to a neutral party. other findings suggest that violations of the psychological contract could result in increased turnover (arasli, et al., 2019; von stormbroek & blomme, 2017), increased absenteeism (deery, iverson & walsh, 2006), lowered trust (deery, iverson & walsh, 2006; kingshott & pecotich, 2007), and increased job neglect (lo & aryee, 2003). although the two parties in a traditional psychological contract are considered to be the “employee” and the “organization,” there are many individuals who could be perceived by the employee as representing the organization by proxy, such as supervisors, executives, and even coworkers. thus, these individual proxies could trigger psychological contract violations that result in negative outcomes to the overall organization such as turnover, increased absenteeism, and job neglect. the purpose of this paper is to extend the current understanding of psychological contract violations by proposing a model that illustrates an escalating cycle of mistrust that results from a perceived contract violation. the model is based on findings from the literature on psychological contracts, trust, and procedural justice. research on trust in organizations has shown a relationship between perceived trust and organizational outcomes such as turnover (zeffane & bani melhem, 2017), performance (verburg, et al., 2018)), and employee behavior (duffy & lilly, 2013). few studies, however, have considered trust in a longitudinal sense to study the long-term effect of mistrust on employee behaviors, and no studies to date have examined the potentially escalating cycle of mistrust in the workplace. this paper presents a model in which mistrust has already occurred due to a psychological volume 37, number 1 31 contract violation and then examines the behavioral reactions of the two parties involved in the psychological contract. the resulting model depicts an escalating cycle of mistrust that can only be broken by specific behaviors focused on breaking the cycle. literature review psychological contracts the term psychological contract typically refers to the expectations or beliefs held by employees concerning the reciprocal obligations between them and their organization (morrison & robinson, 1997), but can also apply to customer-provider relationships (rousseau, 1995; rousseau & wade-benzoni, 1994). in essence, a psychological contract is grounded upon expectations that one party has toward another. these expectations are not written or implied contracts; rather, they are perceptions of a socially constructed relationship (robinson, kraatz & rousseau, 1994). when these socially constructed relationships are not fully understood by both parties, misunderstandings may lead to a perceived contract violation. two types of psychological contracts identified in the literature are the transactional contract and the relational contract. a transactional contract is one in which an exchange of some sort takes place (rousseau & maclean-parks, 1993). for example, in a typical employee-employer relationship, the employer pays a fair wage to the employee in exchange for an appropriate level of productivity. a second form of contract, the relational contract, is characterized as a long-term contract that is not restricted to economic exchange (morrison & robinson, 1997). rather, the contract is somewhat broad and includes long-term emotional involvement as well as financial rewards. for example, one might assume long-term employee loyalty is a factor that could be exchanged for job security or job advancement in an organization. a study by boey & vantilborgh (2015) found that personality characteristics help predict perceptions of psychological contract type as either transactional or relational. two factors that often act as antecedents to a psychological contract violation are incongruence and reneging (morrison & robinson, 1997). incongruence refers to a situation when the parties in a relationship have different expectations, and a misunderstanding occurs. as a result, one party believes the other has not fulfilled their obligations, while the other party believes they have fulfilled their obligations. this could occur when an employee who demonstrates exceptional work performance 32 journal of business strategies expects to receive recognition or a reward beyond what is normally received, but the organization does nothing out of the ordinary to recognize the performance, perhaps believing the salary and job security are sufficient to expect exceptional performance from employees. reneging occurs when one party knowingly fails to fulfill their obligations, either because they do not want to or because they cannot. this type of violation could occur when an employee reaches a specified performance goal expecting a bonus, but the organization changes the bonus plan when too many employees successfully meet the goal. robinson and morrison (2000) studied the antecedents of psychological contract violations and found that when an organization’s performance had fallen short of what was expected, or when the employee’s job performance was low, perceived contract violations by employees were more likely to occur. concerning antecedents of incongruence, specifically, researchers found that psychological contract violations were less likely to occur when formal socialization and prehire interaction between employees and the employing organization had occurred (robinson & morrison, 2000; woodrow & guest, 2020). this seems likely since formal socialization and onboarding processes often clearly outline expectations of behavior and performance in the organization. a number of studies have examined the longitudinal aspects of psychological contracts (e.g., freese, schalk & croon, 2011; lester, kickul & bergmann, 2007; woodrow & guest, 2020), and the longitudinal study of psychological contracts is particularly interesting since the very nature of the contract in a work setting tends to be a long-term endeavor. however, to fully understand employee reactions in any work setting, individual characteristics and behaviors must also be considered. thus, this paper proposes to develop a long-term view of the psychological contract, but only after a contract violation has occurred. as with any disappointing experience, the individual experiencing the disappointment may engage in behaviors that are hurtful to themselves as well as others. this is no different in a workplace setting, such that disappointment due to a psychological contract violation may be very damaging or disruptive to the work environment. indeed, perceived injustice at work (a disappointing outcome) has been linked to deviant behavior in multiple studies (e.g., priesemuth, arnaud & schminke, 2013; zoghbi-manrique-de-lara , 2010). although the preferred course of action is to prevent a violation from ever occurring in the first place, inevitably, a violation will occur, and the focus should be on how to fix the situation. the model presented in this paper thus focuses on the aftermath of a violation and behaviors to ameliorate the negative impact. volume 37, number 1 33 trust trust is defined as employees’ willingness to be vulnerable to the actions of their employer based on positive expectations about its intentions or behavior (mayer, et al., 1995). the initial reaction to a psychological contract violation is often a decrease in trust (deery, iverson & walsh, 2006; robinson, 1996). trust has become a major topic of research in the social science literature because trust is recognized as an important aspect of maintaining cooperation in long-term relationships (tyler & kramer, 1996). violations of trust are similar to violations of psychological contracts in that expectations are unmet (anderson & narus, 1990; lewis & weigert, 1985) and values of the parties are incongruent (sitkin & roth, 1993). when trust in a relationship is low or nonexistent, the parties may insist on costly sanctioning mechanisms to protect themselves, a type of trust known as calculus-based trust (lewicki & bunker, 1996). in calculus-based trust, the threat of punishment is the mechanism by which cooperation is ensured, and the parties may spend enormous amounts of time and money monitoring each other to ensure each is adhering to their commitments. these monitoring behaviors are actually the transactional costs of maintaining the relationship, in that the two parties must spend time, effort, and money to ensure their interests are protected. calculus-based trust is the lowest level of trust and is often associated with new relationships or relationships that have never grown beyond the first stage of trust. two higher stages of trust, knowledge-based trust and identification-based trust, focus on regular communication plus an understanding and appreciation for the other party in a relationship (lewicki & bunker, 1996). at these levels of trust, the parties are often willing to forgive the other for transgressions in behavior because the two parties understand that they share common values and objectives. trust at these higher levels helps remove some of the costly compliance mechanisms present in calculus-based trust. thus, repairing the damage from a psychological contract violation requires both parties to recognize the importance of nurturing trust in the relationship. procedural justice procedural justice refers to the fairness of a decision-making procedures leading to a decision outcome (lilly, 2016). procedural justice research has focused primarily on the idea that individuals desire some amount of control over decisions that affect them (thibaut & walker, 1975), and many studies have researched the effects of procedural justice in organizations concerning issues such as layoff 34 journal of business strategies decisions and performance appraisals (see brockner & weisenfeld, 1996, for a review). when individuals believe they have some control over the process used to make decisions, they are more likely to say the final outcome is fair even if the outcome is unfavorable to them (thibaut & walker, 1975). some basic components of procedural justice include the ability to have input into the final decision, the ability to appeal a bad decision, consistency in implementing the decision process, and lack of bias on the part of the decision-maker (leventhal, 1980). the academic literature on procedural justice and trust is vast and very rich in examining the impact of these constructs in organizations. in the present paper, however, procedural justice and trust are considered somewhat basic in a relationship context since the two constructs are defined in a similar way to what one would see in a dictionary. for example, a performance evaluation system is perceived by employees to be either a fair process or an unfair process based on normative expectations of what an evaluation system should be. likewise, an organization is perceived by employees as either trustworthy or untrustworthy based on normative expectations of how an organization should treat employees and other stakeholders. psychological contracts, however, are a little more complicated. the relationship between the parties of interest in a psychological contract is often more complex since the expectations in a psychological contract are more likely to be unknown, ambiguous, or misinterpreted. misinterpretation of another party’s behavior or not knowing the cause of another party’s behavior often leads to a lack of trust between the two parties. thus, this study attempts to determine how psychological contract violations, trust, and procedural justice are related to one another, and how behaviors resulting from mistrust may increase the level of mistrust over time. perpetrators and victims in a psychological contract violation, the perpetrator is the party who violates the contract while the victim is the party who suffers from the violation. the perpetrator has some control over the victim’s response even if the perpetrator is initially unaware of the violation. for example, when the victim responds in anger to a psychological contract violation by engaging in disruptive work behavior, the perpetrator becomes fully aware at that time the victim is upset. at this point, how the perpetrator responds should influence the victim’s subsequent response, and research on workplace revenge suggests the victim may choose to forgive a perpetrator under certain situations (bies & tripp, 1996). for example, the victim may allow the perpetrator to redeem himself or herself if the victim believes the volume 37, number 1 35 perpetrator is empathetic to their situation or if the victim believes the perpetrator is willing to change their behavior to correct the violation (bies & tripp, 1996). in addition, the victim may forgive the perpetrator if the victim believes the perpetrator is focused on the situation and how to solve the problem rather than focused on the individual personalities involved in the situation (heider, 1958). the most preferable means of dealing with dissatisfaction in any relationship is to prevent it from ever occurring in the first place. unfortunately, in some situations, the violation has already occurred and both the perpetrator and victim are forced to deal with the effects of the violation. based on the idea that violations occur despite good efforts to prevent them, a model depicting the outcomes of psychological contract violation was developed as shown in figure 1. figure 1 the escalating cycle of mistrust the model and propositions the model presented in figure 1 identifies severity of psychological contract violation as the starting point of interest. after the psychological contract violation has occurred, the model depicts a continuous cycle of mistrust that feeds on itself through transactional cost behaviors of both the victim and the perpetrator. the cycle of mistrust can be reduced initially through the use of timely and fair procedures that correct unmet expectations. as the victim’s level of mistrust increases, however, perhaps because there are no procedures in place to resolve differences or because procedures in place are not used properly, the victim begins to engage in transactional cost behaviors to protect their interests in the relationship. if the 36 journal of business strategies perpetrator is perceived by the victim to also increase their transactional cost behaviors in response, the level of mistrust is again increased, causing the victim to once again increase their transactional cost behaviors, thus feeding the cycle of mistrust on a continuous basis. once the cycle of mistrust has begun, it can only be broken if one party exhibits specific behaviors that focus on resolving the issue rather than focusing on “beating” the other party. it has been empirically established that once a perceived violation has occurred, a reduction of trust in the other party leads to subsequent reactions that are detrimental to the organization (robinson, 1996). in an employment relationship these reactions may include a reduction in job performance (lo & aryee, 2003), organizational citizenship behavior (arshad & sparrow, 2010), and increased turnover (asrali, et al., 2019). a perceived psychological contract violation should also result in subsequent reactions that are detrimental to the ongoing relationship. such negative reactions may include harsh criticism of either or both parties, perhaps even public criticism, or resorting to legal procedures in settling the disagreement. as such, proposition 1 serves as a test of the relationship between severity of contract violation and mistrust in the customer-provider relationship, while proposition 2 serves as a test of the relationship between trust and victim transactional cost behaviors. proposition 1: there is a positive relationship between the severity of the psychological contract violation and mistrust. proposition 2: there is a positive relationship between mistrust and victim transactional cost behaviors. mistrust in this situation acts as a mediator between severity of violation and victim transactional cost behaviors. this premise is supported by theory on psychological contract violation that suggests a contract breach (i.e. a cognition that expectations are unmet) is followed by a contract violation (i.e. an emotional response to the breach) (morrison & robinson, 1997; robinson & morrison, 2000), which then results in behavioral responses to the violation (robinson, 1996). in support of this premise, agarwal (2014) found that trust positively mediated the relationship between psychological contract fulfilment and work engagement, with engagement significantly influencing employee innovative work behavior. therefore, proposition 3 outlines the mediating effect of mistrust on the relationship between severity of contract violation and negative behavioral outcomes. volume 37, number 1 37 proposition 3: there is a mediating effect of mistrust on the relationship between severity of psychological contract violation and victim transactional cost behaviors. procedural justice research has focused on whether or not fair procedures lead to greater acceptance of an unfavorable outcome (thibaut & walker, 1975). it is possible to have a process that is fair in theory, but not in practice; therefore, procedural justice issues should be carefully considered from all perspectives before making decisions on how the process is created and implemented. nevertheless, studies have shown that when procedures allow the individual to maintain some control over the final outcome, the process is considered to be more fair than if no control over the process and outcome are present (e.g., greenberg, 1986). therefore, the presence of procedural justice should lessen the negative effect of mistrust that occurs after a contract violation, leading to the following proposition: proposition 4: there is a negative moderating effect of procedural justice on the relationship between severity of violation and mistrust. american citizens are guaranteed by law the right to a fair and speedy trial when accused of wrongdoing under the general principle that justice delayed is justice denied. in fact, researchers have found that temporal urgency in disputes affects the disputants’ preferred method of conflict resolution (thibaut & walker, 1975). as such, the timing of a process used to solve a dispute becomes important, with longer time lapses between the start of a conflict to the resolution of the conflict most likely to create increased feelings of mistrust. proposition 5: there is a positive moderating effect of length of time elapsed to problem resolution on the relationship between severity of violation and mistrust. in one study of trust, subjects were asked to name the person who has made it the most difficult for them to carry out their job responsibilities. when asked to explain why they named that particular person, the explanations indicated that the person was uncooperative (burt & knez, 1996). if the victim of a psychological contract violation believes the perpetrator is uncooperative, he or she is likely to perceive the perpetrator as someone who will be uncooperative or retaliate when the victim acts to protect their interests using transactional cost behaviors. even if the perpetrator does not retaliate, the victim may perceive any neutral action as an attempt to hurt the victim’s ability to monitor the relationship due to an egocentric bias in 38 journal of business strategies the experience of pain by victims (bies & tripp, 1996). in fact, the fundamental attribution error (ross, 1977) suggests that individuals are more likely to blame the person for any undesirable behavior rather than the situation. thus, individuals who experience an unfavorable experience of any kind are more likely to blame the perpetrator for all actions connected to the experience than to blame factors external to the perpetrator. in addition, if the victim is likely to blame the perpetrator for all actions connected to the experience, the victim is also likely to increase the level of mistrust directed toward the perpetrator. propositions 6 and 7 depict these relationships. proposition 6: there is a positive relationship between victim transactional cost behavior and perpetrator transactional cost behavior as perceived by the victim. proposition 7: there is a positive relationship between perpetrator transactional cost behavior as perceived by the victim and mistrust. specific behaviors exhibited by the perpetrators may help reduce the victim’s perception of retaliation. for instance, bies & tripp (1996) found that when victims believed a trust violation was caused by factors beyond the perpetrator’s control, victims tended to forego revenge tactics. however, if the perpetrator offered no explanation or apology for their actions, victims were more motivated to take revenge. these findings are in line with attribution theory (heider, 1958) in which individuals make either dispositional or situational attributions for the behavior of others. specific perpetrator behaviors that indicate empathy and a focus on solving the problem rather than defending the decision, or a recognition that behavior changes need to be made should ameliorate the victim’s perception of retaliation by the perpetrator. proposition 8: perpetrator empathy will have a neutralizing moderating effect on the relationship between victim transactional cost behavior and transactional cost behavior of perpetrator as perceived by victim. proposition 9: perpetrator positive behavior will have a neutralizing moderating effect on the relationship between victim transactional cost behavior and transactional cost behavior of perpetrator as perceived by victim. it is clear from the model presented that the perpetrator has the primary volume 37, number 1 39 responsibility to break the cycle of mistrust once it starts, even if the perpetrator does not perceive himself or herself as having committed a psychological contract violation. although this may seem unfair, it is important to remember the model is developed from the victim’s perspective, and the victim believes a wrong has occurred. this situation is not unlike a scenario in which one employee unintentionally offends a coworker. once the offending employee knows how the coworker feels, the employee often apologizes even though the employee may believe he or she did nothing wrong. he apologizes nevertheless because the work relationship is more important than proving who was right. in essence, common courtesy and concern for another person’s feelings help resolve an issue that could escalate over time. the model serves to illustrate how this escalation could occur without specific actions to stop the escalating cycle. practical implications and future directions the model presented in the current paper is based on a workplace relationship typically considered when psychological contracts are discussed. however, the model, if supported, could be generalized to a number of different contexts, such as studying the relationships between business organizations and their customers, married couples, and even relationships between political parties or countries. the escalating cycle of mistrust may be too simplistic in its present form to fully explain the role of numerous personality traits, cultural styles, ethical values, and other individual characteristics inherent in relationships, but the basic model presents a starting point for understanding the need to break the cycle of mistrust before too much damage occurs. future research should consider introducing into the model some of the variables suggested above such as personality and culture, but another potentially interesting variable to include into the model is propensity to forgive. individuals who are more likely to forgive might be less likely to increase their mistrust of the perpetrator. in other words, the victim might never instigate the cycle of mistrust if the victim has a high level of propensity to forgive others. although the model is directed toward the victim’s perspective, the perceived power level of the perpetrator might also be a factor. for instance, if the perpetrator is perceived as having high levels of reward or coercive power, the victim might not engage in the cycle of mistrust out of fear of the perpetrator. 40 journal of business strategies conclusion many organizational behavior researchers focus on how to manage individual behavior in the workplace. to manage behavior, it is often necessary to understand why the behavior occurs in the first place; thus, the effort to explain why negative behavior may escalate over time in the workplace may help managers in their daily supervising activities. basic courtesy and consideration of others is prevalent in the proposed model, and these concepts are tested by variables such as procedural justice, perpetrator empathy, and perpetrator positive behaviors. if the model is supported in subsequent empirical research, it will potentially help individuals in the workplace recognize the escalating cycle and help them engage in specific actions to stop it. since workplace harmony and cooperation are often necessary to gain high levels of efficiency and productivity, any research that helps explain mistrust and negative workplace behaviors would be beneficial. references agarwal, u.a. (2014). linking justice trust and innovative work behaviour to work engagement. personnel review, 43(1): 41-73. anderson, j. c. & narus, j. a. (1990). a model of distributor firm and manufacturer firm working partnerships. journal of marketing, 54(1): 42-58. arasli, h., arici, h., cakmakoğlu arici, n. (2019). workplace favouritism, psychological contract violation and turnover intention: moderating roles of authentic leadership and job insecurity climate. german journal of human resource management, 33(3): 197-222. arshad, r. & sparrow, p. (2010). downsizing and survivor reactions in malaysia: modelling antecedents and outcomes of psychological contract violation. the international journal of human resource management, 21(11): 1793-1815. bies, r. j. & tripp, t.m. (1996). beyond distrust: “getting even” and the need for revenge. in r. m. kramer & t. r. tyler (eds.), trust in organizations, pp. 246260. thousand oaks, ca: sage. boey, l. & vantilborgh, t. (2015). a theoretical model relating the dark triad of personality to the content of employees’ psychological contracts. new zealand journal of employment relations, 40(3): 44-66. brockner, j. & weisenfeld, b. m. (1996). an integrative framework for explaining reactions to decisions: interactive effects of outcomes and procedures. psychological bulletin, 120: 189-208. volume 37, number 1 41 brookman, j. t., chang, s. & rennie, c. g. (2007). ceo equity portfolio incentives and layoff decisions. journal of financial research, 30(2): 259-281. burt, r. s. & knez, m. (1996). trust and third-party gossip. in r. m. kramer & t. r. tyler (eds.), trust in organizations, pp. 68-89. thousand oaks, ca: sage. cramer, j. (1996). let them eat stocks. new republic, 214(18): 24-25. deery, s. j., iverson, r. d. & walsh, j. t. (2006). toward a better understanding of psychological contract breach: a study of customer service employees. journal of applied psychology, 91(1): 166-175. duffy, j. & lilly, j. d. 2013. do individual needs moderate the relationship between ocb, organizational trust, and pos? journal of behavioral and applied management, 14(3): 185-197. freese, c., schalk, r. & croon, m. (2011). the impact of organizational changes on psychological contracts: a longitudinal study. personnel review, 40(4): 404422. greenberg, j. (1986). determinants of perceived fairness of performance evaluations. journal of applied psychology, 71: 340-342. heider, f. (1958). the psychology of interpersonal relations. new york: john wiley. kingshott, r. p. j. & pecotich, a. (2007). the impact of psychological contracts on trust and commitment in supplier-distributor relationships. european journal of marketing, 41(9/10): 1053-1072. lester, s. w., kickul, j. r. & bergmann, t. j. (2007). managing employee perceptions of the psychological contract over time: the role of employer social accounts and contract fulfillment. journal of organizational behavior, 28: 191-208. leventhal, g. s. (1980). what should be done with equity theory? new approaches to the study of fairness in social relationships. in k. gergen, m. greenberg & r. willis (eds.), social exchange: advances in theory and research, pp. 27-55. new york: plenum press. lewicki, r. j. & bunker, b. b. (1996). developing and maintaining trust in work relationships. in r. m. kramer & t. r. tyler (eds.), trust in organizations, pp. 114-139. thousand oaks, ca: sage. lewis, j. d. & weigert, a. (1985). trust as a social reality. social forces, 63(4): 967-985. lilly, j.d. 2016. organizational justice. in a. farazmand (ed.) global encyclopedia of public administration, public policy, and governance (pp. 1-7). switzerland: springer international publishing. http://link.springer.com/ referenceworkentry/10.1007/978-3-319-31816-5_2472-1 42 journal of business strategies lo, s. & aryee, s. (2003). psychological contract breach in a chinese context: an integrative approach. journal of management studies, 40(4): 1005-1020. maremont, m. (2005). no razor here: gillette chief to get a giant payday –about $153 million awaits kilts after p & g deal, his second merger score. the wall street journal (jan 31 2005). mayer, r.c., david, j. h. & schoorman, f. d. (1995). an integrative model of organizational trust. academy of management review, 20, 709-734. morrison, e. w. & robinson, s. l. (1997). when employees feel betrayed: a model of how psychological contract violation develops. academy of management review, 22(1): 226-256. priesemuth, m., arnaud, a. & schminke, m. (2013). bad behavior in groups: the impact of overall justice climate and functional dependence on counterproductive work behavior in work units. group & organization management, 38(2): 230257. pugh, s. d., skarlicki, d. p. & passell, b. s. (20030. after the fall: layoff victims’ trust and cynicism in re-employment. journal of occupational and organizational psychology, 76: 201-212. robinson, s. l. (1996). trust and breach of the psychological contract. administrative science quarterly, 41(4): 574-599. robinson, s. l., kraatz, m. s. & rousseau, d. m. (1994). changing obligations and the psychological contract: a longitudinal study. academy of management journal, 37: 137-152. robinson, s. l. & morrison, e. w. (2000). the development of psychological contract breach and violation: a longitudinal study. journal of organizational behavior, 21(5): 525-547. ross, l. (1977). the intuitive psychologist and his shortcomings: distortions in the attribution process. in l. berkowitz (ed.), advances in experimental social psychology. new york: academic press. rousseau, d. m. (1995). psychological contracts in organizations: understanding written and unwritten agreements. thousand oaks, ca: sage. rousseau, d. m. & mclean parks, j. (1993). the contracts of individuals and organizations. in l. l. cummings & b. m. staw (eds.), research in organizational behavior (vol. 15, pp. 1-43). greenwich, ct: jai press. rousseau, d. m. & wade-benzoni, k. a. (1994). linking strategy and human resource practices: how employee and customer contracts are created. human resource management, 33(3): 463-489. volume 37, number 1 43 sitkin, s. b. & roth, n. l. (1993). explaining the limited effectiveness of legalistic “remedies” for trust/distrust. organization science, 4: 367-392. thibaut, j. & walker, l. (1975). procedural justice: a psychological analysis. hillsdale, nh: lawrence erlbaum associates. tyler, t. r. & kramer, r. m. (1996). whither trust? in r. m. kramer & t. r. tyler (eds.), trust in organizations, pp. 1-15. thousand oaks, ca: sage. van stormbroek, r. & blomme, r. (2017). psychological contract as precursor for turnover and slef-employment. management research review, 40(2): 235-250. verburg, r. n., nienaber, a., searle, r. h., weibel, a., den hartog, d. n. & rupp, d. e. (2018). the role of organizational control systems in employees’ organizational trust and performance outcomes. group & organization management, 43(2): 179-206. woodrow, c. & guest, d. (2020). pathways through organizational socialization: a longitudinal qualitative study based on the psychological contract. journal of occupational and organizational psychology, 93(1): 110-133. zeffane, r. & bani melhem, s. j. (2017). trust, job satisfaction, perceived organizational performance and turnover intention. employee relations, 39(7): 1148-1167. zoghbi-manrique-de-lara, p. (2010). employee deviance as a response to injustice and task-related discontent. the psychologist-manager journal, 13(3): 131146. brief biographical sketch of author juliana d. lilly is a professor of management at sam houston state university. she holds degrees in hotel/restaurant management (b.s.), organizational management (m.b.a.), and organizational behavior (ph.d.). she has presented research at numerous international, national, and regional academic meetings. her publications appear in journals such as journal of organizational behavior, social justice research, and current psychology. accounting for environmental contingencies: the impact on small business strategies mark e. steadman thomas w. zimmerer ronald f. green east tennessee state university johnson city, tennessee introduction the past decade has witnessed a variety of developments which, in combination, have caused small manufacturers to significantly alter their methods of doing business. global competition, enriched information technology, micro marketing, just-in-time manufacturing philosophies, and the increased quality demands of customers are only a few of the forces which have altered the management strategies of small manufacturers in the past decade. an equally influential force which has grown in importance and which looms as a significant factor which will affect small business operations is the national concern with the environment. mandatory compliance with federal and state legislation has already forced numerous changes in how businesses operate, ranging from their use of natural resources such as water to their control of emissions released into the air. the burden of increasing regulatory costs has resulted in rising operating costs at a time in our economic history where many of our global competitors in developing economies are not experiencing comparable cost increases. these differences in cost represent a major difficulty for u.s. manufacturers in their efforts to remain cost competitive in world competition. . the brookings institute has estimated the total cost of federal air and water legislation in the united states in 1990 at $320 billion. these costs represent a reallocation of resources with a corresponding reduction in gross domestic product of 5.8% (fortune 1992). at the federal level, small manufacturers may be responsible for compliance with the clean air act, the clean water act, the resource conservation and recovery act, the toxic substance control act, the congressional comprehensive environmental response, compensation and liability act, and the superfund amendment and reauthorization act. in addition, most states have enacted their own versions of this federal legislation. small manufacturers are well aware of the direct costs they incur to comply with the various environmental laws. however, only a few may be aware that the single most significant liability they may face in the environmental area is the remedial cleanup of a hazardous waste site. the liability under federal legislation (especially the superfund act) is very broad and far-reaching and allows for any potentially responsible party (current owner, owner at time of disposal, waste generator, or waste transporter) to be held joint and severally liable for all costs associated with the cleanup. liability can arise from non-compliance, personal injury or damage, or remedial fall 1993 steadman, et al.: accounting for environmental contingencies 113 cleanup. currently, the environmental protection agency has now identified 1200 "priority" sites with the estimated cleanup cost per site of $20-40 million (review 1992). there are numerous well-known examples of large firms such as union carbide ($470 million fine for bhopal, india incident) and exxon ($2 billion cleanup cost for valdez oil spill) with multi-million dollar costs resulting from environmental accidents. for every union carbide and exxon, there are dozens of smaller companies operating in the chemical, petroleum, and other high risk industries that could potentially be exposed, on a smaller scale, to similar environmental costs. small manufacturers facing even a fraction of these cleanup costs would face financial ruin. the magnitude of the potential problems for smaller firms is difficult to determine because such firms are often privately held and not required to issue financial statements to the public. while the environmental problems with smaller firms may receive extensive local exposure, the lack of national coverage may lead the general public and small firm executives to perceive the problem as one associated primarily with large firms. bringing this issue quickly to the forefront and adding to the complexity of the problem is the increased awareness by the accounting profession of their responsibility to record or disclose environmental liabilities and contingencies. until recently, little emphasis was given to this area by members of the accounting profession. companies, with their auditors' concurrence, simply applied statement of financial accounting standards no.5 (sfas no.5), accounting for contingencies, and in most cases any future environmental liability was neither recorded nor disclosed. in recent years, the rule-making boards of the accounting profession have begun to recognize the magnitude of the possible effects of these contingencies on the financial well-being of firms of all sizes. the purpose of this paper is twofold. first, the recent and anticipated future rulings formulated by various accounting and auditing bodies to improve the accounting treatment of environmental costs and to strengthen the audit procedures in this area will be presented. second, the effect of these rulings on financial statement recognition and disclosure will be discussed, as well as the implications for valuation, divestiture and acquisition, and access to capital for small manufacturers. developments in environmental accounting the primary pronouncement used in accounting for environmental contingencies is sfas no.5. most authorities on environmental accounting agree that this statement, issued in 1975, was never intended to be used in this manner. however, the lack of additional guidelines by the financial accounting standards board (fasb) has necessitated its use. sfas no.5, along with fasb interpretation no. 14, requires the auditor and accountants for the firm to determine the likelihood of incurring a material loss. this likelihood is classified as either remote, reasonably possible, or probable. if the occurrence of the loss is determined to be remote, no accounting treatment is required. if the loss is deemed probable and the amount of the loss (or a range) 114 journal ofbusiness strategies vol. 10, no.2 can be reasonably estimated, the loss contingency must be recorded as a liability with a charge against current earnings. for a reasonably possible loss, disclosure in the financial statement footnotes is required. disclosure is also required by the statement if the likelihood of the loss occurrence is probable but the amount cannot be reasonably estimated. note that the present financial accounting treatment regarding contingencies is based upon two factors-probability of occurrence and measurability. in most situations concerning environmental liabilities, the probability of occurrence is usually certain; i.e., the firm is aware of the existence of prior actions which have resulted in the creation of a hazardous waste site. while these actions were possibly appropriate at the time, they may be in violation of present environmental regulations. thus, firms are judged for past actions based upon current standards and find themselves in violation of these standards. a primary concern in this area is that the measurement of the potential liability (the cleanup costs) is often very difficult to quantify. factors such as the cost of the preferred cleanup method (which can change with even newer epa regulations) the availability of insurance reimbursement, the financial viability and contributions of coparties, and the length of time for cleanup activities can make an accurate measurement of the future liability practically impossible. these difficulties become the major source of the problem for the accountant who must estimate, with some degree of accuracy, the amount of the potential liability. this computation is the key factor in determining the accounting treatment of the environmental liability. if the measurement (or a range) can be made, accrual of the loss is required by sfas no.5. if no estimate can be made, disclosure of the matter in the financial statement footnotes satisfies the requirements of current accounting standards. presently, firms can comply with generally accepted accounting principles with a brief disclosure of the potential loss in the footnotes. for example, as late as 1989, the financial statement footnote for occidental petroleum corporation contained only a brief disclosure of the liabilities associated with the love canal site in upper new york state. no real disclosure of the estimated loss or range of loss was made even though the hazardous waste site was identified in 1978 and litigation initiated in 1979. in 1990, occidental recorded a $620 million provision for anticipated future environmental costs for past chemical operations in disposal sites including love canal. therefore, for a ten year period, financial statement users were not fully informed of the magnitude of the potential costs (rubenstein 1992). the auditor as sherlock holmes the application of sfas no.5 requires a great deal of professional judgment on the part of the accountant or auditor. in most cases, information is gathered by contacting the client's attorney for his/her assessment of the contingency and by questioning management about the situation. while auditors are frequently required to use their judgment in applying professional standards and to maintain a sense of profesfall 1993 steadman, et al.: accounting for environmental contingencies 115 sional skepticism, one concern is that management may be somewhat hesitant to provide full information about past environmental actions. also, current management may not be aware of actions taken by their predecessors in this area. if information is provided by management or legal counsel, even the less stringent treatment of the contingency (disclosure) by the firm's accountant does not guarantee adequate treatment. freedman and stagliano (1991) found a broad range of diversity in environmental disclosures even within the same industry. the authors found the range of disclosures to vary between detailed discussions to little elaboration about the item. thus, the use of sfas no. 5 to account for environmental contingencies has led to inconsistent reporting practices and, in some cases, non-conformity. one of the main tenets of the accounting/auditing function in the united states is the comparability of financial statement presentation. the fasb has continually stated its desire to have similar transactions comparably recorded in relevant and reliable terms even though they may occur in different companies. only through consistent application of financial accounting standards can comparability and reliability of the reporting process be assured. to illustrate this point, consider the accounting treatment of the costs incurred after federal, state, and local laws were passed which required firms to remove or contain asbestos in buildings. before any action could be taken by a standards setting body, some firms expensed the costs as incurred, while others capitalized the expenditures. this represented inconsistent accounting treatment of similar costs, and accurate comparisons between firms with similar economic circumstances could not be made by the financial statement users. recent reforms the emerging issues task force, a group formed by the fasb to handle issues not deemed appropriate for full board action, resolved the problem by releasing two eitf abstracts. the first of these statements (issue no. 89-13) dealt specifically with asbestos cases, and stated that in most cases the costs should be capitalized. the second abstract (issue no 90-8) presented the accounting treatment for environmental expenditures for a broader spectrum of issues. these abstracts lack the standing of a statement of financial accounting standard which is issued after the fasb's due process procedure, but are considered to be generally accepted accounting principles which must be followed by accountants. the eitf abstracts addressed only the costs which have been incurred in a known environmental cleanup situation. no mention is made of the potential contamination and the associated costs. sfas no. 5 still applies to the latter area, and the deficiencies of the statement are recognized by members of the accounting profession. dennis beresford, chairman of the fasb, has indicated that sfas no.5 may not be adequate to allow for the proper financial statement presentation of environmental contingencies. according to beresford, "another issue that may receive greater attention is accounting for environmental matters" (securities regulation and law report 116 journal ofbusiness strategies vol. 10, no.2 1990). continuing, beresford adds that application of sfas no.5 "is not providing the right answer when it comes to environmental matters because the loss may not be absolutely probable or it is not possible to make a reasonable estimate." the underlying cause of this inadequacy can be traced to fasb action since its formation in the early 1970's. one of the first projects of the board was the development of a conceptual framework of accounting (statements of financial accounting concepts no. 1-6). this framework provided the fasb with justification for most of the pronouncements which have been issued. the framework relied on a balance sheet orientation-a premise that items on the balance sheet should be properly valued and that more items (especially liabilities) should be shown on the balance sheet. this orientation is evidenced by many of the major pronouncements of the fasb in recent years. these include spas no. 87 employers' accounting for pensions, sfas no. 106 employers' accounting for postretirement benefits other than pensions, and sfas no. 109 accounting for income taxes. each of these pronouncements focus on the balance sheet presentation of items in the respective area with special emphasis on the recording of liabilities. given the remarks of the chairman of the fasb, the desire for financial statement comparability, and the balance sheet orientation of recent pronouncements, future action by the board in this area is very likely and will inevitably lead to stricter financial accounting standards. these standards can be expected to focus on the balance sheet presentation of environmental liabilities. however, because of the lengthy process used by the fasb, the basic treatment of environmental contingencies may continue for some time to be based upon the requirements of sfas no.5. what the small manufacturer can expect at the next audit despite the fact that fasb action is not scheduled in the near future for environmental matters, the auditing sector of the accounting profession has taken steps to increase the awareness of auditors with regard to these contingencies. as the interest level of auditors is heightened, the impact of environmental accounting and reporting will be felt by small manufacturers. professional standards and practices will require auditors to investigate the potential liability with greater scrutiny and to either record or disclose in more detail the financial effect of the contingent loss. because of the negative impact of the savings and loan crisis on the accounting profession, the auditing sector is facing increased pressure to provide more stringent audits in accordance with generally accepted auditing standards. as a whole, the profession is very concerned with the image of independent, prudent, and objective auditors. thus, small manufacturers will be faced with audits which are more carefully planned and executed and which focus on areas with a high level of inherent risks such as environmental contingencies. the auditing standards division of the american institute of certified public accountants has issued two audit risk alerts in response to the growing concern about environmental matters and their potential impact on a firm's financial statements. the fall 1993 steadman, et al.: accounting for environmental contingencies 117 first of these alerts, issued in december 1990, directs the auditor to consider asking management if the company has ever been named as a potentially responsible party under the superfund act or otherwise has a high level of environmental exposure. if so, the auditor is directed to consider the need to accrue the estimated cleanup costs and to determine the need for disclosure under the requirements of sfas no.5. also, the auditor is instructed to consider environmental matters in the planning phase of the audit in order to properly examine the area for possible recording or disclosure. in november 1991, a second audit risk alert was issued which provides examples of environmental "red flags". these "red flags" are items which may indicate an increased risk of exposure to environmental liabilities. examples of these items include (the cpa letter 1991): 1) participation in a real estate transaction or corporate merger. 2) the purchase of land at a price significantly below local market prices (a possible bargain price due to environmental risk). 3) aborted transactions that involved the client as a seller of property. 4) piecemeal sale of assets. 5) the acquisition of new or increased insurance coverage against environmental liability. the auditor is advised to specifically look for any of these events and to be more professionally skeptical in their audit. also, the auditor is cautioned against the possibility of a client's inappropriate delay of recording an environmental loss until all information is known. fasb interpretation no. 14 requires the accrual of a loss contingency when the estimated loss is within a range of amounts, and auditors are advised by this alert to consider this possibility. other pronouncements also influence the auditor in this area. according to statement on auditing standards (sas) no. 47, an auditor must assess environmental risk as part of the overall audit risk of a client. sas no. 54 requires an auditor to plan the engagement to take into consideration the possibility that illegal acts (violations of laws or governmental regulations) could have occurred which may have a direct effect on the financial statements. if an auditor discovers an environmental matter that is an illegal act and has not been accounted for in accordance with generally accepted accounting principles, sas no. 58 requires the auditor to qualify his opinion or to issue an adverse opinion. sas 58 also requires an auditor to add an explanatory paragraph to his opinion which highlights the financial statement presentation of an environmental uncertainty in certain cases. another indication of the increased environmental awareness on the part of the auditing profession is the action taken by some of the big six accounting firms. arthur andersen has started an environmental management practice and has published a booklet on the subject. gary dominy, managing director of arthur andersen's environmental management service practice, believes that "firms will have to become more aware that their clients in almost every industry will need some kind of expertise in understanding the environmental risk they face" (public accounting report 1991). small 118 j oumal ofbusiness strategies vol. 10, no.2 manufacturers can be assured that all cpa firms, large or small, will soon start similar practices for two reasons: the cpa firms see the area as a chance for increased consulting fees, and the cpa firms seek to reduce their liability in the area. the possibility of litigation resulting from the issuance of a "clean" opinion to a firm with hidden environmental losses and the subsequent failure of the firm because of the cleanup costs does not appeal to cpa firms already facing significant liability in other areas. the impact of environmental concerns on the small manufacturer is apparent. compliance with the various federal and state laws can result in expenditures that could be better invested in firm-specific revenue enhancement or cost reduction strategies. this opportunity cost can negatively effect the firm's long-term potential for improving organizational effectiveness and increasing the economic value of the business. the requirement for the recognition of liabilities stemming from potential environmental problems may dramatically reduce the value of the business, inhibit its ability to raise additional capital, and restrict its options in term of corporate growth, diversification, or merger opportunities. strategic implications based on the current rules and anticipated developments in environmental accounting, three areas of critical importance emerge: 1. valuation of the business, 2. divestiture and acquisition, 3. access to capital. valuation of the business the immediate effects of changing environmental accounting practices on the firm's balance sheet is unclear. however, as additional environmental regulations specify the types of environmental liabilities that must be accounted for in an audit of the firm, the balance sheet will be required to recognize an appropriate, corresponding dollar liability. the liability would remain on the balance sheet until either the environmental issue in question ceases to be a physical liability or a full and complete cleanup has occurred. this may take decades to resolve and will depress the value of the firm in the long term. the processes normally used in determining the value of a business (balance sheet approach and income statement approach) will be impacted by the requirement of recognizing the estimated liability associated with the specific environmental problems. in the case of the balance sheet approach to valuing the business, the increase in recorded long-term liabilities will directly alter the firm's value in a negative fashion. although very crude and possibly simplistic, this "quick look" valuation method is widely used. the impact of an environmental contingency on the worth of the business is directly proportional to the magnitude of the liability recorded on the balance fall 1993 steadman, et al.: accounting for environmental contingencies 119 sheet. thus, more stringent accounting treatments regarding the measurement and disclosure of these contingencies will directly and, in most cases, adversely affect the value of the firm. the earnings approach to business valuation will naturally need to reflect the new long-term environmental liability that will increase the levels of risk of the business, and therefore affect the potential stream of expected earnings. each of the three most recognized techniques (excess earnings method, capitalized earnings method, and the discounted future earnings method) involve some objective evaluation of the risk of the firm's earnings. consider the amount of uncertainty introduced into these valuation techniques by the recognition on the balance sheet or in the financial statement footnotes of a long-term environmental liability whose actual amount can only be approximated. earnings in any future time period must be discounted by some probabilistic approximation of the future expense associated with the magnitude of the risk and the liability of the firm for its correction. the recognized environmental liability must be considered as a potential factor that may result in a severe reduction in future income streams. lower potential revenues convert directly into a lower value of the business. divestiture and acquisition from a corporate perspective, the divestiture of a firm that has been identified as having an environmental problem will be extremely complicated and potentially impossible. as discussed above, traditional methods of valuation will likely result in a dramatic decrease in the value of the business when the risk of the potential longterm expenses or liabilities are factored into the equation. this decline creates a condition where the owner cannot find a buyer willing to pay a price that allows the owner to divest the business in a reasonably profitable manner. in reality, the probabilistic nature of this potential environmental liability may make interested buyers avoid the firm entirely and search for an acquisition that is not burdened by an environmental problem. many small manufacturers view being acquired by larger firms as a preferred "exit strategy." acquisition of firms with an identified environmental problem may also create significant problems for the acquirer. the acquiring firm may find it impossible to justify to its stockholders the risk that they would be assuming by acquiring a firm already identified as "at risk." this may greatly restrict the options of small manufacturers who depend upon being acquired by larger firms with the resources to finance the growth necessary to achieve higher levels of performance. one documented example of a small, regional manufacturing firm facing large environmental fines and cleanup costs resulting from an acquisition is foamex. in 1990, this firm purchased recticel foam corporation, a belgium owned company operating in rural tennessee. according to court documents, employees of recticel allegedly disposed of hazardous waste on an employee's farmland between 1975 and 1986. foamex is now facing a $22.5 million civil lawsuit from adjoining landowners, as well 120 journal ofbusiness strategies vol. 10, no.2 as criminal charges in federal court. they have also incurred substantial costs associated with monitoring the site before cleanup. even though the current management of foamex did not participate in and had no knowledge of the waste disposal, the firm finds itself facing financial ruin from previous environmental action that was beyond their control (richey 1993). access to capital the third major area of concern is the access to external capital. traditional lending institutions evaluating the potential borrower's balance sheet will quickly discover that the environmental liability "land mine" produces financial ratios that may not be acceptable. also, the issue of a secured lender's potential liability for the environmental cleanup of collaterized property can reduce a bank's willingness to lend. lawsuits in these cases have resulted in inconsistent rulings concerning bank liability. because of the unsettled nature of the issue, many in the banking profession are still hesitant to make loans to certain types of firms (moses 1993). banks have always been conservative in their lending practices toward small businesses. in recent years, the lending practices of commercial banks have become increasingly constrictive and the noted "credit crunch" has created problems throughout our economy. consider the reaction of the commercial banking community to the potential risk represented by environmental liabilities. normal working capital may be difficult to obtain, not to mention the capital normally needed for expansion and growth. in a period of time when the economy needs the manufacturing sector to create permanent, high-paying jobs, bank lending could be further restricted due to the environmental risk. equity capital may be just as difficult to attract due to an unwillingness on the part of most investors to choose a firm "at risk" over one that is risk free on the environmental issue. investment will logically flow away from the more risk prone alternatives toward those which are considered safer. in either situation, bank or equity financing, management will be faced with increased difficulties in obtaining external capital. conclusions the business community should be made aware of the changing accounting practices concerning environmental issues and the impact on small manufacturing firms. future contingent liabilities can dramatically affect the long-term ability of the firm to grow and operate profitably. the financial accounting standards board is aware of the deficiencies of the present accounting treatment in the area, and additional fasb action is inevitable. this action may result in more stringent recognition and disclosure rules which must be applied to insure the firm's financial statements are in compliance with generally accepted accounting principles. according to the american institute of certified public accountants' code of professional conduct, a cpa can not fall 1993 steadman, et al.: accounting for environmental contingencies 121 issue an unqualified ("clean") opinion on financial statement unless they are prepared in accordance with these principles. this factor may increase the difficulties associated with all three areas previously discussed. external users of financial statements will be reluctant to lend, invest, or acquire a firm with anything less an unqualified audit opinion. as discussed, small businesses may be seriously limited in the areas of valuation, divestiture and acquisition, and access to capital because of the accounting and auditing treatments of environmental matters. also, the increased attention of the accounting and auditing professions will make the less stringent treatments of the past unacceptable. managers, faced with increased external pressure to record or disclose environmental contingencies, will be required to investigate prior actions, alter current decisions, and plan future activities with these issues in mind. informed planning and control for these factors will enable small manufacturers to survive and thrive in the future. references audit risk alert. 1990 (november). american institute of certified public accountants. auditing standards division. new york ny. audit risk alert. 1991 (december). american institute of certified public accountants. auditing standards division. new york ny. statement on auditing starujards no. 47: audit risk aruj materiality in corujucting an audit. 1983. american institute of certified public accountants. new york ny. statement on auditing standards no. 54: illegal acts by clients. 1980. american institute of certified public accountants. new york ny. statement on auditing standards no. 58: reports on audited financial statements. 1988. american institute of certified public accountants. new york ny. the cpa letter. 1991. 71:10 (november): 4b-4c. statement of financial accounting concepts nos. 1-6. 1978-85. financial accounting standards board. stamford cr. statement of financial accounting starujards no.5: accounting for contingencies. 1975. financial accounting standards board. stamford cr. statement of financial accounting starujards no. 87: employers' accounting for pensions. 1985. financial accounting standards board. stamford cr. statement of financial accounting starujards no. 106: employers' accounting for postretirement benefits other than pensions. 1990. financial accounting standards board. stamford cr. 122 journal ofbusiness strategies vol. 10, no.2 statement of financial accounting standards no. 109: accounting for income taxes. 1992. financial accounting standards board. stamford cr. fasb interpretation no. 14: reasonable estimate of the amount of a loss. 1976. financial accounting standards board. stamford cr. accounting for the cost of asbestos removal. 1989. financial accounting standards board. emerging issues task force. issue no. 89-13. stamford cr. capitalization of costs to treat environmental contamination. 1990. financial accounting standards board. emerging issues task force. issue no. 90-8. stamford cr. fortune. 1992. "how zealous greens hurt growth." (march 23): 26. freedman, m. and a. j. stagliano. 1991. "disclosure of environmental cleanup costs: the impact of the superfund act." the second annual critical perspectives symposium. (march). moses, jonathan m. 1993. "trustees may be liable for costs of pollution cleanup, judge say." the wall street journal. (march 9): b10. occidental petroleum corporation. 1993. 1992 annual report. los angeles ca. public accounting report. 1991. xv: 5 (march 15): 4. review. 1992. 36:2. price waterhouse. new york ny. richey, suzanne s. 1993. "cansler to cooperate fully in hazardous waste case." the greeneville sun. (may 25): al & a7. rubenstein, daniel b. 1992. "natural capital and invisible interest in natural resources." 62:3. the cpa journal. (march): 28-33. securities regulation and law report. 1990. "beresford says environment, copyrights, combinations may be future fasb issues," bna, inc. (september 14). accounting for environmental contingencies: the impact on small business strategies the journal of business strategies: the first fifteen years sanjay s. mehta balasundram maniam mark leipnik sam houston state university huntsville, tx abstract the historical publishing pattern of jrs is examined. authors from 171 institutions have written over 176 articles from spring 1984 to fall 1998. contributions to the journal were studied in terms of numbers ofschools represented, number of authors per article, diversity of articles, gender of authors, types of citations, and empirical orientation of the articles. findings indicate that publications in jbs represents a significant scholarly contribution to the field ofbusiness strategy. few differences were detected between jbs and other selected journals. recommendation to enhance jbs are based on quantitative analysis ofpast jbs articles and personal interviews with selected stakeholders. introduction the publication of this issue of the journal of business strategies (jbs) marks the end of the fifteenth year of publication. it is important for a journal, when it reaches a significant milestone, to look at where it has been, where it is, and where it could be in the future (malhotra, 1996; hyman & steiner, 1997; muncy,1991). summary articles of single journals have been written for many well-established business journals. for example, the journal of advertising (muncy, 1991), journal of accounting education (lehman & street, 1990), journal of 1nternational business studies (inkpen & beamish, 1994; chandy and williams, 1994), journal of the academy of marketing science (malhotra, 1996), journal of consumer affairs (geistfeld & key, 1986), journal of economic psychology (van raaij, 1986), journal ofmarketing education (clark & hanna, 1986), journal of business communication (koch, 1979; reinsch & lewis, 1993), journal of marketing (grether, 1976; marquardt & murdock, 1986), journal of finance (schweser, 1977; heck, cooley & hubbard, 1986; schroeder, langrehr & floyd, 1995), journal of macromarketing (finn & the editor thanks michael hyman for his thoughtful and constructive review of this paper. 90 journal of business strategies vol. 16, no.1 mcquitty, 1994), journal ofapplied business research (urbanek, 1994),journal of business and entrepreneurship (hyman & steiner, 1997), journal of purchasing and material management (williams & oumlil, 1987), and journal of personal selling and sales management (swan, powers & sobczak, 1991). because no article has ever looked at the past, present and future of jbs, its fifteen year anniversary seems an appropriate time for such an effort. the primary purpose of this paper is to trace the evolution of jbs from conception to its present state. more specifically, the article will provide a detailed look at specific aspects of the oldest business strategy journal based on both quantitative and qualitative research methodologies. history jbs was founded in 1982 at the center for business and economic research, sam houston state university. since its inception, jbs has been published semiannually (i.e., spring and fall). the first issue of jbs was published in spring 1984 under the editorship of william b. green. in a recent interview, william b. green indicated that the first issue mainly contained invited articles from reputable authors because he wanted to make sure "that the journal of business strategies started off with some quality articles." this was done to attract quality articles in the future and also to sell jbs to both practitioners and academicians. beginning with the second issue, all articles were double blind reviewed by selected members of the editorial board. he also indicated thatjbs established itself as a reputable journal with ever improving manuscripts. he added that he is pleased that the quality of the editorial board has been sustained and improved. susan a. simmons took over editorial duties in spring 1986. no significant changes were observed during simmons' tenures as the editor of jbs. most of the articles published during both green's and simmons' tenure as editor were in the area of management strategy. in spring 1987, george d. greenwade became the third editor of jbs. he immediately instituted three major changes. first, jbs took on a glossy look. second, the fa111987 issue contained a cumulative index of previously published articles. third, the fa111988 issue contained the only paid advertisement in jbs history. jo ann duffy became the fourth editor of jbs in fall 1990. with one exception, the status quo was maintained during duffy's tenure as the editor. beginning the fall of 1991, biographical sketches of the authors were published. in the fall of 1992, roger d. abshire became the fifth editor of jrs. during his short tenure as editor (i.e., two issues), the center for business and economic research was renamed the gibson d. lewis center for business and economic development. while this change had a significant impact on the institution, it had no impact on jbs. joann duffy was reappointed the editor for the fall 1993 issue and she has remained the editor until today. during duffy's second tenure as the editor, she implemented two spring 1999 mehta, maniam, & leipnik: the first fifteen years 91 changes. first, the cover of the journal was "modernized." second, a web site (http://coba.shsu.edu/jbs/) was created where researchers could order articles from past issues of the journal. as frs prepares for the next millennium, one of duffy's long-term goals is to attract more articles that are relevant to practitioners. according to duffy, "the upcoming special issues on services marketing and banking is one avenue of moving the journal to address the needs of practitioners." findings output during its first fifteen years, 176 articles have been published in frs. as shown in table 1, the average length of the article was 12.22 pages and the average articles per issue were 5.87. the average length of the article is consistent with others journals (12.22 pages versus 10.5 pages respectively), and the average number of articles published per issue is about the same as other journals (malhotra, 1996; hyman & steiner, 1997). likewise, it has other similar attributes consistent with other journals, such as number of issues per year and total number of pages per issue. however, it was observed that there is a trend for the number of pages per article to increase (le.• from 8.80 in 1984 to 19.70 in 1996). table 1 jbs output per year· 1984 • 1998 year number of articles* total number of pages* pages per article 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 total 5+5=10 5+4=9 5+5=10 5+5=10 6 + 8 =14 8 + 7 =15 7 + 8 =15 6 + 8 =14 9+8=17 6 + 7 =13 6 + 6 =12 6+4::010 5 + 5 = 10 5+4=9 4+4=8 176 41 + 47 =88 47 + 41 = 88 51+44=95 47 + 40 = 97 52+66=118 77 + 84 = 161 65+67=132 76 + 71 = 147 85 + 110= 195 78 + 89 =167 82+ 101 = 183 98+82=180 106 + 91 = 197 82+73=155 72 + 75 = 147 2150 8.80 9.80 9.50 9.70 8.40 10.73 8.80 10.50 11.50 12.80 15.25 18.00 19.70 17.20 18.38 12.22 (mean) * the first number and second number represent the first and second issues respectively. 92 journal of business strategies vol. 16, no.1 table 2 institution affiliation of authors unequal equal institution unweighted weights weights mississippi state university 10.00 4.65 4.84 sam houston state university 9.00 4.60 4.50 auburn university 9.00 3.85 3.84 university of texas at san antonio 9.00 3.40 3.50 louisiana state university baton rouge 8.00 3.25 3.00 texas a&m college station 7.00 2.60 2.50 lamar university 7.00 2.20 2.20 kansas state university 7.00 2.05 1.94 southeastern louisiana university 6.00 2,45 2.40 the university of tennessee at chattanooga 6.00 1.85 2.00 university of texas tyler 5.00 4.30 4.25 louisiana tech university 5.00 2.65 2.49 eastern lllinois university 5.00 2.40 2.17 georgia state universj~y 5.00 1.50 1.42 east carolina university 4.00 2.20 2.33 middle tennessee state university 4.00 2.10 1.97 jacksonville state university 4.00 2.05 1.50 university of oklahoma 4.00 2.00 2.00 university of north carolina at charlotte 4.00 2.00 2.00 sonoma state university 4.00 2.00 2.00 southwest missouri state university 4.00 1.80 1.56 iowa state university 4.00 1.75 1.99 mcneese state university 4.00 1.60 1.50 university of north texas 4.00 1.45 1.50 east tennessee state university 4.00 1.45 1.34 memphis state university 4.00 1.30 1.42 florida atlantic university 4.00 1.05 1.10 university of texas pan american 3.00 2.00 2.00 new mexico state university 3.00 2.00 2.00 university of missouri 3.00 1.80 1.67 purdue university 3.00 1.40 1.50 florida international university 3.00 1.40 1.17 marshall university 3.00 1.20 1.33 shippensburg university 3.00 1.20 1.17 grand valley state university 3.00 1.20 0.93 western carolina university 3.00 1.00 1.00 virginia commonwealth university 3.00 1.00 1.00 kent state university 3.00 1.00 1.00 university of maryland 3.00 1.00 1.00 spring 1999 mehta, maniam, & leipnik: the first fifteen years 93 table 2 institution affiliation of authors (continued) unequal equal institution unweighted weights weights idaho state university 3.00 1.00 1.00 florida state university 3.00 1.00 1.00 university of colorado at colorado springs 3.00 1.00 1.00 university of louisville 2.00 2.00 2.00 norfolk university 2.00 2.00 2.00 illinois state university 2.00 1.60 1.50 university of notre dame 2.00 1.60 1.50 john carroll university 2.00 1.20 1.00 university of houston clear lake 2.00 1.00 1.00 oregon state university 2.00 1.00 1.00 university of delaware 2.00 1.00 1.00 southern illinois university 2.00 1.00 1.00 florida a&m university 2.00 1.00 1.00 lona college 2.00 1.00 1.00 st. cloud university 2.00 1.00 1.00 university of michigan dear born 2.00 1.00 1.00 north carolina central university 2.00 1.00 1.00 barry university 2.00 0.90 0.75 oklahoma state university 2.00 0.80 1.00 indiana university 2.00 0.80 1.00 arizona state university 2.00 0.80 0.83 texas tech university 2.00 0.80 0.70 university of kentucky 2.00 0.80 0.67 university of newcastle 2.00 0.80 0.67 cameron university 2.00 0.75 0.70 suffolk university 2.00 0.70 0.59 university of south carolina 2.00 0.65 0.65 the university of tennessee 2.00 0.55 0.66 indiana university of pennsylvania 2.00 0.55 0.66 the university of georgia 2.00 0.55 0.66 nicholls state university 2.00 0.55 0.53 university of colorado at boulder 2.00 0.45 0.50 note: all cells in the second column (unweighted) with values less than 1 was deleted from this table to shorten the table. unweighted: all authors were given equal weights (each author was assigned a i) unequal weights: if two authors then 0.6 & 0.4; if three authors then 0.45, 0.35, & 0.20; if four authors then 0.30. 0.25, 0.25, 0.20; if five authors then 0.25, 0.20, 0.20, 0.20, 0.10 equal weights; if two authors then 0.5 & 0.5; if three authors then 0.34,0.33, & 0.33; if four authors then 0.25,0.25,0.25,0.25; if five authors then 0.20,0.20,0.20,0.20,0.20 94 journal of business strategies vol. 16, no. 1 authorship many studies use authorship with respect to institutional affiliation or the affiliation tally to gauge the diversity of authors andlor institutions that have published in a particular journal. it is an appropriate measure because institutions of higher education provide various resources and incentives to encourage high productivity among faculty. because authorship with respect to institutional affiliation can enhance image and reputation of an institution, many serial retrospectives list the most common institutional affiliations of authors (hyman & steiner, 1997; carnaghan, flower-gyepesi & gibbins, 1994; clark, hancock & kaminski, 1997; clark & hanna, 1986; fields & swayne, 1988; geistfeld & key, 1986; gentry, allen & vellenga, 1995; goldsmith, 1983; hoverstad, shipp & higgins, 1995; reinsch & lewis, 1993, swan, powers & sobczak, 1991; wheatley & wilson, 1987). table 2 lists the most common institutional affiliations of jbs authors weighted by three measures: unweighted, unequal weighted, and equal weighted authorship. the unweighted and equal weighted measurement techniques have been previously used by several authors of summary articles (hyman & steiner 1997). the unequal weighted technique is unique to this study. the order and weights assigned represents the contribution of each of the authors to the manuscript. the only exception to this technique is if the authors are listed in alphabetical order. to keep the list of institutions manageable, only institutions that have an unweighted scores greater than 1 are reported (unweighted score of 1 means that the institution's authors published one coauthored article in ibs). the top five universities, using either ofthe three weighting methods, are as follows: mississippi state university, sam houston state university, auburn university, university of texas at san antonio, louisiana state university baton rouge. and texas a&m college station. the inclusion of sam houston state university in that list may suggest that jbs has become an in-house publication outlet. further analysis shows that there is no such association. for example, no authors from sam houston state university have published an article in ibs from 1993 to the last issue in 1998, diversity given its nature, ibs attracts manuscripts from diverse disciplines. using hyman and steiner (1997) categories of academic areas, table 3 shows the most published disciplines in irs are management, finance, and marketing. specifically, 57.4% of the articles are about management and organizational behavior, 13.6% are about finance, and 11.4% are about marketing. one likely reason for the high percentage of management and organizational behavior articles in ibs is its title, which implies its orientation towards management and strategy issues. generally, authors tend to do research in their area of specialization or home disciplines (geitfeld & key, 1986). it is safe to conclude that most authors in spring 1999 mehta, maniam, & leipnik: the first fifteen years 95 jbs are from management, finance, and marketing related disciplines. unfortunately, because biographical sketches of the authors were not published prior to 1991, no further implication or conclusion can be drawn regarding the authors primary area of research and teaching. table 3 academic area of jbs articles academic area frequency percent management/organizational behavior marketing accounting finance insurance/small business entrepreneurship economics international business unknown and others total 101 20 9 24 8 5 1 8 176 57.39 11.36 5.11 13.64 4.55 2.84 0.57 4.55 100 gender of authors another criterion used to evaluate journals is the ratio of male to female authors. similar to other journals, where the ratio of male to female authors is about 4 to 1, the ratio for jbs is roughly the same. table 4 highlights the difference between jbs and three other selected serials. out of 375 authors, 317 (84.5%) are male. also, further analysis found that like other comparable journal authors, jbs authors also tend to choose coauthors of the same gender (mcdowell & smith, 1992). coauthorship a growing percentage of articles published in business journals have multiple authors. as noted by hyman and steiner (1997), an increasing percent of business and psychology articles published annually are coauthored (barnett, ault & kaserman, 1988; dufrene & nelson, 990; mcdowell & melvin, 1983; presser, 1980; schroeder, langrehr & floyd, 1995). urbancic (1992) also concluded that two thirds of accounting articles from 1978 to 1988 that were written by reputable and well-known accounting authors were coauthored. similarly, mcdowell and melvin (1983) found that in the area of economics, there is a positive correlation between experience and the probability of coauthorship. in other words, the greater the experience of an author, the higher the probability of coauthoring. we believe that this trend may partly be attributed to the increasing number of schools seeking greater research output from their faculty (i.e., "the publish or perish" mentality). many institutions, 96 journal of business strategies vol. 16, no. 1 especially smaller universities, do not or cannot provide the necessary tools for such productivity (e.g., databases, reduced teaching assignments, graduate research assistants). therefore, coauthors tend to be faculty members from different institutions. table 4 gender of authors in jbs and selected serials gender jbs freq. pet. jbe* pet. car* pet. jme* pet. male female 317 58 84.5 15.6 80.3 19.7 88.5 11.5 91.4 8.6 notes: jbe is journal of business and entrepreneurship car is contemporary accounting research jme is journal of marketing research * hyman and steiner (1997) in jbs, only 27.8% of the articles (49 out of 176) had one author, 39.2% (69 out of 176) had two authors, 27.8% (49 out of 176) had three authors, and only 5.1 % (9 out of 176) had four or more authors. the percentage of single-authored articles in jbs is significantly lower than in other selected business journals (see table 5). in fact, the closest journal to jbs is the journal ofpersonal selling and sales management (jpssm) with 49.6%; all others are above 50%. on the other hand, the percentage of two author articles in jbs is twice as much as all other journals (39.3%) except jpssm (25.2%). this indicates that authors in jbs contribute fewer single author articles and more two author articles than authors who contribute to other journals. the average number of authors per article is 2.10 (370/176). the highest average was in 1991, at 2.5, and the lowest average was in 1987, at 104. references the impact of other researchers and disciplines on research trends can be studied by citation analysis (hyman & steiner, 1997; chandy & williams, 1994; reinsch & lewis, 1993). the average number of references used in an article can reveal how much jbs authors draw from other researchers. the formal definitions of the various citations are given in table 6 above. table 7 shows thatjbs authors referenced 23.85 citations per article. while the mean number of citations for jbs is lower than journal of international business studies (35.8) and journal of business communication (32.3), it is spring 1999 mehta, maniam, & leipnik: the first fifteen years 97 higher than journal of business and entrepreneurship (20.6), journal of accounting education (11.2), and home economics research journal (16.9) (hyman & steiner, 1997). upon further examination, it is interesting to note that there is an upward trend in the number of references cited from 1984 to 1998 in jrs. at the very least it does indicate that jrs authors are using a greater number of references to support their studies, table 5 single and multiple authorship in jbs and selected serials author jbs jbe* jm* jm· jams· jcr· jmr· ms· jpssm*jme* eeon* freq. pet. pet. pet. pet. pet. pet. pet. pet. pet. pet. pet. one 49 27.8 77.6 77.5 77.7 76.6 67.2 70.1 64.0 49.6 90.0 57.7 two 69 39.2 15.4 14.1 14.3 15.4 18.8 15.8 19.0 25.2 9.0 16.4 three 49 27.8 3.7 5.4 5.1 4.2 6.4 7.8 9.0 11.1 1.0 7.1 four 7 4.0 1.4 1.3 1.3 1.9 3.9 2.7 4.7 7.9 0.0 4.4 five or more 2 l.l 2.0 1.7 1.6 1.9 3.7 3.6 3.3 6.2 0.0 14.4 number of different authors 370 299 955 447 520 563 526 300 405 199 13576 mean mentions per author 1.38 1.4 1.4 1.4 1.4 1.6 1.6 1.7 2.0 1.1 2.0 years published 198419891960198419841984198419841980197919631998 1996 1981 1993 1993 1993 1993 1993 1993 1985 1988 note: jbe is journal of business and entrepreneurship jm is journal of marketing jams is journal of the academy of marketing science jcr is journal of consumer marketing jmr is journal of marketing research ms is marketing science jpssm is journal of personal selling and sales management jme is journal of marketing education econ is percentages for top 20 economics journals * hyman and steiner (1997) 98 term journal of business strategies table 6 definitions of citations definition vol. 16, no.1 citation serial book trade press/ magazines/newspaper publication listed among references at the end of an article periodical published annually or more frequently that contains articles on various topics one-time publication devoted to one topic (including readings book (essay collection), and handbooks newspaper or specialty magazine devoted to narrow topic (the wall street journal, financial times, forbes, business week) proceedings/conference published conference proceedings or working paper or presentation presentations from academic conference other * hyman and steiner (1997) general interest magazine or other source comparing citation by outlet type for jbs and other selected serials, table 8 shows that jbs authors cite a larger percent of serials. serial citations in jbs is 71.8%, compared to 48.9% for journal of business and entrepreneurship, 55.7% for journal of international business studies, and 55.7% for journal of business communication. jbs authors cite a far smaller percentage of books/ monograph citations. books/monograph citations in jbs is 6.9%, compared to 22.4% for journal of business and entrepreneurship, 37.4% for journal of international business studies, and 36.0% for journal ofbusiness communication. the difference can be attributed to the fact that serial citations may be more valuable to business strategy issues, since scholarly books can become obsolete and outdated rather quickly. spring 1999 mehta, maniam, & leipnik: the first fifteen years table 7 references and number of articles in jbs 99 year number number average number of of references of articles references per article 1984 33 +71 = 104 5 + 5 = 10 loa 1985 76 +48 = 124 5+4=9 13.77 1986 59 + 60= 119 5 + 5 = 10 11.9 1987 90+77=167 5+5=10 16.7 1988 90+ 110= 200 6 + 8 = 14 14.28 1989 173 + 178 = 351 8 + 7 = 15 23,4 1990 134 + 140 = 274 7 + 8 = 15 18.26 1991 il2 + 103 = 215 6 + 8 = 14 15.35 1992 177 + 237 = 414 9 + 8 =17 24.35 1993 122 + 196 = 318 6+7= 13 24.46 1994 230 + 192 =422 6 + 6 = 12 35.16 1995 252 + 147 = 399 6+4=10 39.9 1996 215 + 227 = 442 5 + 5 = 10 44.2 1997 187 + 132 = 319 5+4=9 35.4 1998 183 +147 = 330 4+4=8 36.6 total 4.198 176 23.85 table 8 citations of jbs and other selected serials citations jds jde· jibs· jbc· jae· herj· freq. pct. pet. pet. pct. pet. pct. serials 2934 71.8 48.9 55.7 55.0 51.6 38.3 books/monographs 281 6.9 22.4 37.4 36.0 26,4 29.1 trade press/ magazineslnewspaper 239 5.8 14.6 na na na na proceedings/conference presentations papers 536 13.1 4.1 2.0 na 2.0 2.4 dissertations/theses i na na na na 1.0 8.3 other 95 2.3 10.0 4.9 9.0 18.1 10.8 total 4086 100 100.0 100.0 100.0 100.0 100.0 mean cites per article 23.85 na 20.6 35.8 32.3 11.2 16.9 number of articles 176 na 189 252 90 187 106 years published 1984-1998 198919841988198319741996 1993 1992 1989 1980 notes: jbe is journal of business and entrepreneurship jibs is journal of international business studies jbc is journal of business communication jae is journal of accounting education herj is home economics research journal na implies not available or neglible • hyman and steiner (1997) 100 journal of business strategies vol. 16, no. i the only other difference noted (see table 8) is that jbs articles have a higher percentage (13.1 %) of proceedings/conference presentations papers compared to 4.1 % for journal of business and entrepreneurship, 2.0% for journal of international business studies and almost no such citations for journal of business communication. jbs has a higher percentage of trade presslmagazines and newspapers (5.8%) compared to journal ofinternational business studies or journal ofbusiness communication, which has none. only journal ofbusiness and entrepreneurship has a higher percentage (14.6%) than jbs. this is in part due to the fact that jbs and journal of business and entrepreneurship are more practitioner oriented than other journals (e.g., journal of international business studies). similar to other journals, jbs cites very few dissertations or other miscellaneous publications. empirical articles about 43.75% (77 out of 176) of the articles in jbs are empirical. this percentage is somewhat lower than the other surveyed journals. for instance, the journal of business and entrepreneurship had about 63.5% empirical articles (hyman & steiner, 1997), journal ofaccounting education had 53% (lehman & street, 1990), and journal ofeconomic psychology had 66% (waheeduzzaman & krampf, 1992). only the journal of macromarketing had a somewhat lower percentage (37.5%) than jbs (finn & mcquitty, 1994). while the empirical articles use various methodologies, most ofthem are relatively easy to comprehend. this is consistent with the scope of jbs which is orientated to both academicians and practitioners. conclusions a survey of jbsfor a is-year period reveals that many authors are affiliated with regional institutions and that a relatively small number of the authors published more than one article. it also shows that co-authorship is getting increasingly common, a trend noticed by others who have written summary articles (schroeder, langrehr & floyd, 1995). also, authors are choosing to cite an increasing number and a larger variety of sources. the largest percentage of citations in jbs is serial publications. the diversity of the articles suggest that the articles are mainly about management, marketing, and finance. similar to other academic journals, jbs is dominated by male authors. the mean number of authors in jbs is 2.10 per article, which is consistent with other journals. when william b. green, the first editor, was asked about the future of jbs, he said "he is confident that the journal will continue to produce quality articles and that it will be successful in the long run." but he also emphasized that jbs must maintain its current focus of both theoretical and practical orientation in order to be of interest to academicians and practitioners. spring 1999 mehta, maniam, & leipnik: the first fifteen years recommendations 101 personal interviews were conducted with a convenient sample of several editorial board members of jbs. their recommendations and views have been aggregated and summarized below. the primary concern expressed consistently by many of the surveyed board members was the similarity in the name between jbs and another journal with an analogous name (i.e., journal of business strategy). in our view, either the editorial board must consider a name change or position jbs differently. further, the editorial board members felt that jbs must attempt to increase its circulation among both academics and practitioners. one possible solution to help boost circulation, would be to consider the publishing of more special issues, and/or increase the number of issues per year from two to three or four. by either indexing the abstract or the entire journal, most journals increase the readership and dissemination of knowledge. although jbs have been indexed by wilson business abstracts and carl uncover abstracting services, another recommendation is to persuade additional abstracting services (such as abiiinform). based on personal interviews with selected editorial board members and the analysis of both past issues of the jbs and other comparable journals, some additional recommendation warrant consideration. these include, but are not limited to, printing the title, author(s), and abstracts of the forthcoming articles in the current issue; printing the call for papers for special issues in the current issue; securing paid advertisement from large publishers in the business strategy area; and adding an editorial preface and introduction to each issue. to make jbs appeal to a wider audience, some new sections could be incorporated into the journal, such as book reviews and software reviews. considering the high cost of printing and circulating a journal, one possible solution to offset these expenditures, would be to increase the annual subscription fee (it is presently $12.50). similar to many other journals, an alternative could be to offer a three-tier subscription fee (le., individuals, institutions, and libraries). to generate additional revenues, another option would be to charge a submission fee for the review process and/or publication fee for all accepted articles. finally, an annual business strategies conference chaired by the editor would significantly help jbs in generating revenues as well as increasing the notoriety of the journal. some of these recommendations are easy to implement while others may require some additional resources. for instance, the call for papers for the special issue can either be published in the bi-annual issues or mailed out to various institutions, whereas hosting an annual conference or increasing the number of issues per year may require additional resources. to determine the feasibility of implementing some of the above mentioned recommendations, jbs could hold an annual meeting of the editorial board members at one of the conferences which a majority of the board members attend. 102 journal of business strategies vol. 16, no.1 limitations and future research this study has two key limitations. first, because jbs did not publish biosketches of the authors prior to 1991, several other summary and comparisons cannot be undertaken. for instance, the rank of the authors who published in jbs cannot be easily determined. also the area of specialization of the authors or area of expertise cannot be determined directly. second, the study did not attempt to assess how well jbs is received by its readers. a formal survey would have provided these insights. references barnett, a. h., ault, r. w., & kaserman, d. l. (1988). the rising incidence of coauthorship in economics: further evidence. review of economics and statistics 70 (august), 539-543. carnaghan, c., flower-gyepsi, j., & gibbins, m. (1994). a profile of contemporary accounting research: fall 1984-spring 1994. contemporary accountiol: research. ii (summer), 251-270. chandy, p. r., & williams, t. g. e. (1994). the impact of journals and authors m international business research: a citational analysis of jibs articles. journal of international business studies. 24 (4), 715-728. clark g. l., hancock, w., & kaminski, p. f. (1987). an analysis of leading contributors to the journal of marketing research: 1964-1985. in 1987 ama summer educators' conference p[qceedin~s (susan douglas, et. al. eds). chicago: american marketing association, 250-253. clark, g. l., & hanna, n. (1986). an analysis of the sources of articles in the journal of marketing education since its foundation in 1979. journal of marketin~education. ~ (summer), 71-74. dufrene, d. d., & nelson, b. h. (1990). effective co-authoring for business communication academicians. bulletin of the association for business communications. 53 (june), 68-71. fields, d.m., & swayne, l. e. (1988). publication in major marketing journals: 19601986. journal of marketin~ education. 10 (fall), 36-48. finn, a., & mcquitty, s. (1994). empirical research in macromarketing. journal of macromarketin~.14 (fall), 63-68. geistfeld, l.v., & key, r. (1986). a decade in perspective 1975-84: focus and trends in the journal of consumer affairs. journal of consumer affairs. 20 (summer), 65-76. spring 1999 mehta, maniam, & leipnik: the first fifteen years 103 gentry, j, j., allen, b. j., & vellenga, d. b. (l995). affiliation of authors in transportation and logistic academic journals-revisited. transportation journal. 34 (spring), 54-62. goldsmith, e. b. (1983), an empirical analysis of the home economics research journal. home economics research journal. 11 (march), 207-214, grether, e. t. (1976), the first forty years. journal of marketim~,40 (july), 63-69. heck, j. l., cooley, p" & hubbard, c. m, (1986). contributing authors and institutions to the journal of finance: 1946·1985. journal of finance. 41 (december), 11291140. hoverstad, r., shipp, s. h., & higgins, s. (1995). productivity, collaboration, and di versity in major marketing journals: 1984-1993. marketin~ education review. i (summer), 57-65. hyman, m" & steiner, s. (1997). the journal of business and entrepreneurship: the first eight years. journal of business & entrepreneurship. 9 (march), 1-31. inkpen, a., & beamish, p. (1994). an analysis of twenty-five years of research in the journal of international business studies. journal of international business stud~ (4), 703-714. koch, j. e. (1979). a citation analysis for business communication. journal of business communication. 16 (summer), 45-56. lehman, m. w., & street, d. l. (1990). a taxonomy of content and citations in the journal of accounting education (1983-1989). journal ofaccountin~education. 8 (spring), 63·75. malhotra, n. k. (1996). the impact of the academy of marketing science on marketing scholarship: an analysis of the research published in jams. journal of the academy of marketin~ science. 24 (fall), 291-298. marquardt, r. a., & murdock, g. w. (1983). analysis of authorship in the journal of marketing 1960-1981. journal of marketjn~education. 5 (fall), 53-57. mcdowell, j. m., & smith, k. l. (1992). the effect of gendenorting on propensity to coauthor: implication for academic promotion. economic inquiry. 30 (january), 68-62. mcdowell, j. m., & melvin, m. (1983). the determinants of coauthorship: an analysis of the economic literature. review ofecqnomics and statistics. 65 (february), 155160. 104 journal of business strategies vol 16, no.1 muncy, j. a. (1991). the journal of advertising: a twenty year appraisal. journal of advertising. 20 (december), 1-11. presser, s. (1980). collaboration and the quality of research. social studies of science, 10,95-101. reinsch, n. l. jr., & lewis, p. v. (1993). author and citation patterns for the journal of business communication: 1978-1992. journal of business communication. 30 (october),435-462. schroeder, d. m., langrehr, f. w., & floyd, s. m. (1995). marketingjournal coauthorship: is it a hit or a miss with coauthors? j!;mmal qfmarketing educatiqn, 17 (summer), 45-58. schweser, c. (1977). the doctoral origins of contributors to the journal of finance from 1964 through 1975. journal of finance. 32 (june), 908-910. swan, j. e., t.l. powers, t. l., & sobczak, p. m. (1991). utilization of sales management knowledge and identification of contributors: an analysis of jpssm 19801990. journal of personal selling & sales management 11 (winter), 5-16. urbancic, f. r. (1994/1995). an analysis of the institutional and individual authorship sources of articles in the journal of applied business research: 1985-1993.lqw:nal of applied business research. 11 (winter), 108-116. van raaij, w. f. (1986). the first five years of the journal of economic psychology. journal qf economic psychology. 7 (march), 1-15. wheatley, j. j., & wilson, l. c. (1987). the origins of published marketing research in the 1980's. in 1987 ama summer educators' cqnference proceedings (susan douglas, et. al. eds). chicago: american marketing association, 260-265. williams, aj. and b. oumlil (1987). a classification and analysis of ipmm articles. journal of purchasing and material management. 23 (fall), 24-28. spring 1999 mehta, maniam, & leipnik: the first fifteen years 105 sanjay s. mehta (m.s., ph.d., university of north texas) is currently an assistant professor of marketing at sam houston state university. he holds a b.s. in mathematics and an mba in management from angelo state university. he has presented over 45 papers at regional. national, and international conferences and served as track chair. session chair, discussant, and reviewer at many of these conferences. he has published over 40 articles in various proceedings and journals. balasundram maniam (ph.d.• university of mississippi) is currently an assistant professor of finance at sam houston state university. he holds an mba and a b.s. in computer science from arkansas state university. dr. maniam has presented over 50 papers at regional, national and international conferences. he has published over 40 articles in various proceedings and journals. mark r. leipnik (ph.d.• university of california at santa barbara) is an assistant professor in the geography department at sam houston state university and director of a gis research lab. he holds an mba from rice university and undergraduate degrees in business economics and environmental studies from the university of california. he has published in business application of geographic information system (gis), use of gis, and related technologies in environmental assessment. the journal of business strategies: the first fifteen years distinguishing between the capital tax view and the benefit view of the property tax at the local level russell r. evans oklahoma city university • oklahoma city, oklahoma mary n. gade oklahoma state university • oklahoma city, oklahoma abstract the great recession of 2008 exposed municipalities across the u.s. to the dangers of over-reliance on a volatile sales tax base for general revenue financing. a 2010 interim study convened by the oklahoma legislature examined the possibility of offering access to the property tax base as a source of municipal general revenue. the feasibility of such a move depends crucially on understanding the economic incidence of the local property tax. current research is divided on the issue, with one school proposing the property tax as a tax on capital generally (the capital tax view) and the other asserting the property tax as a user-fee for locally provided public services (the benefit view). we examine the incidence of the local property tax in oklahoma county recognizing explicitly that the tax levy is really an aggregate of independent levies — each tied to the provision of a specific subset of local services — and that incidence outcome may vary by jurisdiction. an analysis of the 19 independent school districts in oklahoma county over a 10-year period finds evidence that the incidence of the property tax varies both by levy and jurisdiction. introduction property taxes persist as a staple of local government finance. wallis (2001) notes that while the role of the property tax at the national and state level has diminished over time, it continues to be the most important source of local government revenue. in fiscal year 2007, local governments in the u.s collected $518.6 billion with just over 71%, or $370.4 billion collected via local property taxes.1 in the same period, local governments in oklahoma collected $3.6 billion, with property taxes accounting for roughly 52%, or $1.9 billion of total collections. in oklahoma, county governments rely heavily on the property tax as a source of local revenue while municipalities rely instead on a general sales tax; school districts employ the property tax exclusively as a source of local funding. a 2010 oklahoma legislative task force was convened to examine the feasibility of allowing municipalities access to the local property tax base as a source of general revenue funds. interest in the 2 journal of business strategies property tax as a source of general revenue funding underscores the importance of understanding the incidence and efficiency implications of the local property tax. the unfortunate reality of an absent consensus is discussed subsequently. almost as widespread as the reliance on the property tax as a local revenue source is the dislike for and confusion surrounding the levy. o’sullivan, sexton, and sheffrin (1995) document the fascinating passage of california’s proposition 13 and the subsequent spread of property tax reform. in fact, while wallis (2001) posits that the reliance of local governments on the property tax likely reflects the “ability to more closely match the beneficiaries of government investments, policies, and programs with the taxpayers who foot the bill,” economic development packages often center on local property tax abatement programs (dalehite, mikesell, & zorn, 2005). accompanying (and perhaps contributing to) a widespread distaste for the property tax, is a lack of agreement of its economic incidence.2 alternative views of property tax incidence the traditional view approaches the property tax as an excise tax levied on land and capital improvements. generally considered in a partial equilibrium, single jurisdiction framework, the traditional view concludes that a jurisdiction’s perfectly inelastic supply of land cannot escape its portion of the tax. the levy on land is borne by landowners and to the extent that land ownership increases with income, the property tax on land will be progressive. the excise tax on capital improvements begins with the assumption of perfectly elastic capital (between industries within a jurisdiction) and concludes that capital avoids the tax generally, leaving the burden with occupants (tenants) of the improvements. depending on the measure of income employed, the excise tax on improvements was thought to be regressive to proportional. carroll and yinger (1994) test the hypothesis that the excise tax on improvements is fully shifted to tenants by investigating the rental housing market and conclude that, even under conditions of relatively elastic supply, landlords bear on average $0.89 of every dollar of the tax, suggesting a much less regressive outcome than initially believed. adopting a harberger (1962) general equilibrium framework, mieszkowski (1972) proposes new view of the property tax. the new view positions the property tax as a general tax on capital (and is not so new anymore). the new view is now commonly referred to as the “capital tax view”. the capital tax view recognizes explicitly that property is taxed economy wide, albeit at different rates. therefore, regardless of the mobility of capital, it cannot escape the tax entirely. the portion of volume 30, number 1 3 capital subject to the average rate of property taxation is defined as a “profits tax”, falling on capital generally and progressively. capital mobility will lead to capital migration into (and out of) relatively low (high) jurisdictions. these individual “excise tax” effects tend to offset each other, leaving the property tax as a progressive tax on capital. it is important to stress not only the progressive nature of the capital tax view, but also the distortionary impacts of the property tax under this view. specifically, the property tax distorts capital use both between sectors and across jurisdictions, incentivizes governments to provide inefficiently low levels of public services, and gives rise to inter-jurisdictional redistribution of income. for a more exhaustive review of the historical development, extensions, and empirical studies of the capital tax view, see zodrow (2001). building on the seminal work of tiebout (1956), a model of the property tax as an efficient user fee for public services is articulated by hamilton (1975) and extended convincingly be fischel (1992, 2001). under the “benefit view”, individuals sort according to their demand for local services and then implement strict zoning requirements effectively limiting the ability of a low home value resident to consume public services at a discount. extensions admit jurisdictions of heterogeneous home values (but similar demand for public services), and find fiscal differentials capitalized into home values, restoring the user fee aspect of the tax.3 extending the argument to jurisdictions as municipal corporations and homeowners as rational maximizers of their share value, the “benefit view” envisions home owners rationally evaluating policy and zoning proposals, approving those that increase the value of their home and rejecting those that do not. under the benefit view, the local property tax is an efficient user fee for local services, with no distortionary effect on the allocation of capital or distribution of income. zodrow (2008) observes that the “effects of the property tax, including its economic incidence, efficiency properties and distributional implications have been the subject of a long and contentious debate.”4 while the debate is certainly entertaining, its resolution has significant applied implications. indeed, zodrow offers the comment above in the context of assessing the efficacy of shifts in the relative mix of state and local financing from local property taxes to alternatives administered at higher levels of governance. clearly, this type of inspection requires some conclusion be reached as to property tax incidence. 4 journal of business strategies distinguishing between incidence views: issues and considerations empirical work on property tax incidence has largely centered on estimates of home price capitalization of fiscal differentials. unfortunately, while fiscal capitalization is required to support the benefit view (given heterogeneous neighborhoods), its presence is not precluded by the “capital tax” view. other work has focused on the anecdotal evidence of increased reliance on zoning, household participation in the zoning and expenditure process, and determinants of household location, all of which coincide with the behavioral assumptions of the benefit view without providing empirically testable hypotheses. the first issue to arise is isolating an appropriate definition of the problem. nechyba (2001) offers perspective on this issue by noting that there may not be one right model. some jurisdictions may be characterized by the assumptions underlying the benefit view and others by those supporting the capital tax view. in other words, the problem defined as identifying the correct model universally may be misconstrued. rather, a more correct statement of the research task may be in identifying the better model for a particular jurisdiction. second, the jurisdiction must be defined. isolating effective tax rates for a large metropolitan area obscures the reality that the area is comprised of multiple counties, many cities, and dozens of school districts, all combined with special districts and parceled up into potentially hundreds of individual tax districts. we argue that it is at the individual tax district level where the assumptions of the opposing models will be most clearly delineated and offer the greatest success in empirically distinguishing benefit view jurisdictions from capital tax view jurisdictions. third, the property tax must be defined. the generically referenced property tax is really an aggregate levy: county rate, city rate, school district rate, higher education rate, fire district rate, etc. even within each levy we find multiple delineations. consider, for example, the adjacent jurisdictions with identical county and school district levies, but with different city and special district levies. it is possible that property tax incidence varies not only between jurisdictions, but between levies within a jurisdiction. fourth, an estimation procedure must be set forth that recognizes the expected population heterogeneity. recent advances in computing power now make mixed models and their non-parametric cousins, latent class models, readily available. of particular interest are models that estimate class membership, where class is defined according to property incidence. such models have traditionally been more common volume 30, number 1 5 in biostatistics; however, they are becoming more visible in the economic literature. sjoquist, walker, and wallace (2005) employ a mixture model analysis to estimate differential responses to local fiscal conditions. it is quite possible that the failure to model population heterogeneity explicitly explains much of the difficulty in establishing firm and broad empirical support. finally, one other issue merits consideration. the municipal corporation narrative is complicated by the reality that zoning decisions are made at a level of government above the individual tax jurisdictions. even if we retain the home price maximization objective, city and planning officials are functionally managers of a multi-product firm, overseeing home prices in many distinct tax jurisdictions. just as managers engage in global profit maximization, so to we might expect city leaders to engage in optimal decisions for the community at large, even if to the detriment of individual jurisdictions. in other words, even active use of zoning regulations need not imply the assumptions required to support the benefit view are present in all tax districts. analysis of oklahoma county independent school districts, 8 special districts, and had a total assessed valuation of $5.34 billion. in addition county collections, property tax levies serves as the primary source of funding for k-12 education as well as the state department of career and technology education. city governments primarily rely on sales tax revenue for funding, but a few do make use of a modest property tax levy. ideally, one would use the individual tax districts as the unit of observation, but estimation of taxable value of property per district is ongoing. however, using the school districts as the unit of observation and investigating property tax base responsiveness to differentials in the school levy is sufficient to highlight some of the considerations addressed previously. table 1 below summarizes some of the information available for each district. 6 journal of business strategies table 1 oklahoma county school districts: selected characteristics school district, total valuation % api, state 2008 total valuation of county total facilities total = 1279 okc $1,786,215,690 34.06% k-12 1074 edmond $1,247,113,876 22.81% k-12 1449 putnam city $885,707,748 16.81% k-12 1281 mid-del $438,591,008 8.49% k-12 1302 western heights $227,324,271 3.94% k-12 1090 choctaw $163,380,118 2.97% k-12 1312 deer creek $166,037,364 2.78% k-12 1488 luther $72,024,124 1.67% k-12 1230 moore $70,822,973 1.33% k-12 1385 harrah $62,468,979 1.19% k-12 1310 oakdale $58,983,612 0.94% k-8 1470 millwood $34,717,695 0.68% k-12 945 crooked oak $38,371,130 0.67% k-12 1018 jones $30,195,265 0.52% k-12 1259 piedmont $24,097,402 0.43% k-12 1416 bethany $12,745,824 0.24% k-12 1422 crutcho $10,667,830 0.22% k-8 641 mustang $7,327,802 0.12% k-12 1362 mcloud $6,365,510 0.12% k-12 1275 the school districts with the largest tax base are oklahoma city (okc), edmond, putnam city, and mid-del. it is interesting to note that edmond and mid-del are oklahoma city suburbs to the north and east of the city respectively. putnam city, by contrast, is well within the main development of the city. crutcho and oakdale are small districts serving kindergarten through eighth grade only, before feeding into adjacent high schools. the final column reports the academic performance index, a standardized accountability test required through the no child left behind legislation. in 2008, the state’s score was 1279, offering a comparison against the performance of the districts presented. volume 30, number 1 7 table 2 model variables, 2008 diff. diff. from avg. from avg. career school career school tech school district, county district tech district district 2008 net valuation rate rate rate rate rate okc $1,734,580,222 23.18 52.48 15.45 (9.48) 1.45 edmond $1,220,056,252 23.18 66.23 15.69 4.27 1.69 putnam city $858,874,911 23.18 60.72 15.69 (1.24) 1.69 mid-del $418,631,144 23.18 65.05 17.3 3.09 3.30 western heights $225,014,196 23.18 57.92 5.08 (4.04) (8.92) deer creek $163,046,388 23.18 76.08 15.69 14.12 1.69 choctaw $154,261,735 23.18 66.66 16.24 4.70 2.24 luther $70,886,600 23.18 56.19 16.24 (5.77) 2.24 moore $67,960,941 23.18 67.41 5.08 5.45 (8.92) harrah $60,024,314 23.18 57.6 16.24 (4.36) 2.24 oakdale $58,478,251 23.18 59.52 0 (2.44) (14.00) crooked oak $38,035,196 23.18 57.90 15.45 (4.06) 1.45 millwood $33,607,078 23.18 59.55 15.69 (2.41) 1.69 jones $28,637,254 23.18 64.3 16.24 2.34 2.24 piedmont $23,248,353 23.18 74.51 15.72 12.55 1.72 bethany $12,227,320 23.18 67.58 15.72 5.62 1.72 crutcho $10,420,521 23.18 48.18 17.3 (13.78) 3.30 mustang $7,024,802 23.18 68.42 15.72 6.46 1.72 mcloud $6,016,827 23.18 50.93 15.47 (11.03) 1.47 as data collection continues, we assess the need to treat individual districts as heterogeneous subjects by investigating the relationship between a district’s property tax base and its relative school district levy. our approach is similar in spirit, though more narrow and less complex, to that of wassmer (1993). we begin by collecting data on the 19 districts for the period 1981 to 2008. we use the net valuation of property as a measure of the property tax base within each jurisdiction. then, creating the average levy for both school district and careertech for every time period, we construct a local tax differential. an overview of the data for 2008 is provided in table 2. note that the data reflect a 2008 average school district levy of 61.96 mills and average careertech levy of 14.00 mills. similarly, table 2 indicates that the 8 journal of business strategies okc school district imposed a 2008 levy that was 9.48 mills below the average and a careertech levy 1.45 mills above the average. now consider the alternative positions. the capital tax view would have us believe that high tax jurisdictions will be characterized by capital outflow (ceteris paribus) as capital, (and people), move to neighboring jurisdictions offering similar levels of services with lower property tax collections. the benefit view counters with fischel (2001) saying, “voters are pleased that their home values rise if schools and bicycle paths are improved (even if they don’t have children or ride bicycles), but are displeased by the reduction in their home values from increased local taxes. if the appreciation effect exceeds the depreciation effect, they approve the decision…” note that it is only at the margin under the benefit view that increases in property tax rates yield no change in the property tax base. indeed, under the assumptions of the model and the logic of the municipal corporation, a jurisdiction might be expected to enjoy an extended period of asset appreciation as the municipal directors strategically pursue the most profitable proposals first. suffice it to say, we expect relatively high tax jurisdictions to have a negative effect on property tax base under the capital tax view and a zero to positive effect under the benefit view. the model the model is fitted using a simple semi-log specification, where coefficient estimates are interpreted as semielasticities. specifically, the model is, ln(netval) = β0 + β1*year + β2*dasdrt + β3*dactechrt + ε (1). we exclude oakdale and crutcho from the analysis, leaving the remaining 17 districts who serve k-12 needs. the results are presented as model 1 below. the results suggest that all variables are statistically significant, though dactechrt only marginally so. the year coefficient is interpreted as the expected percent change in netval over a one-year period. that is, holding all other influences constant, the property tax base in the city seems to be growing at an average annual rate of 5.6%. likewise, every one unit change in dasdrt and dactechrt are expected to exert a downward influence of 3.5% and 4.7% on property tax base respectively. volume 30, number 1 9 model 1 = all districts ln(netval) = 16.57093 + 0.056193year 0.035413dasdrt 0.047853dactechrt t = (95.544) (5.403) (-3.469) (-1.821) r2 = 0.091023 f statistic = 15.75505 while we are pleased generally with the reasonableness of the coefficients, our intent at this stage is only to look for evidence that not all jurisdictions within the county are similarly classified according to tax incidence. a more rigorous econometric specification will follow. to explore further, we divide the individual school districts into groups based on their location relative to the city center. these categories are simply city (school district encompassed by okc proper), suburb (school district shares a border with the city), and rural (school district does not share a border with the city). we reestimate the model for our city, suburb, and rural districts individually and present the results below. again, in all models all variables are statistically significant, with one only marginally significant and so indicated with an (*). all coefficients have an analogous interpretation to those presented in the original model. model 2 = city districts ln(netval) = 17.87536 + 0.032997year 0.114850dasdrt 0.062425dactechrt t = (78.616) (2.450) (-8.845) (2.000)* r2 = 0.377885 f statistic = 27.536 the results when looking at a subset of the panel consisting of districts located entirely within the city suggest the capital view is associated with the school district levy while the benefit view explains the career tech levy. this outcome is perhaps not surprising. school districts in the heart of the oklahoma city metro area are among those with the highest levies (and therefore above average school district rates, dasdrt > 0) but the product provided to homeowners apparently is not sufficient to increase home values enough to offset the discount created by the present value of future tax payments. in contrast, in the central city the career tech system can provide valuable vocational training, jobs assistance, small business guidance, eco_wbg sticky note the 2 on the r-square should be a smaller font size. 10 journal of business strategies and other programs that are expected to be of value to local residents. in this case, proximity to a well-funded and peak functioning career tech campus appears to be reflected in home values. model 3 = rural districts ln(netval) = 14.55768 + 0.075004year 0.030661dasdrt 0.339869dactechrt t = (66.478) (6.775) (2.819) (7.433) r2 = 0.412901 f statistic = 31.8825 when restricting the panel to look at the subset of rural school districts (districts within the county that do not share a border with the main section of the city), coefficients change signs and suggest a different reality. in rural districts, both the school district levy and the career tech levy seem to indicate a benefit view reality. while the influence of the school district levy is modest, it nonetheless suggests that capital flows into these districts in response to the value that is provided through local education funded through rates below the regional average. the stronger impact, however, is associated with the careertech levy. this is also not surprising as the career tech system is home to a vital collection of agricultural support programs including agricultural education, agricultural business management, and future farmers of america among others. proximity to this vital support system serves as a benefit to local residents with positive implications for local home values. model 5 = suburb districts ln(netval) = 15.83206 + 0.067263year 0.052584dasdrt 0.074372dactechrt t = (57.348) (3.983) (2.691) (-1.767)* r2 = 0.130938 f statistic = 9.642632 finally, the pooled sample is restricted to a subset of districts representing the oklahoma city suburb areas. these districts are all removed from the central city but share at least one border with the city. again, an interesting and somewhat intuitive pattern emerges from the estimated coefficients. the school district levy volume 30, number 1 11 supports a strong benefit view conclusion suggesting capital flows into suburban districts in response to the value provided by suburban school districts driving up home values. in contrast, while the career tech system offers a host of continuing education courses that might be of interest to suburban residents (photography, culinary, basics of investing, etc.) it appears these programs are not sufficient to counter the negative impact associated with the tax levy and exert negative pressures on home prices. the preceding discussion suggests two important contributions. first, there is evidence that the incidence of the property varies by jurisdiction, suggesting the presence of both capital view and benefit view jurisdictions. pooled samples result in misleading estimates as the sample likely includes observations of distinct subsets that may or may not be distinguished by observable characteristics. an extension of this paper would involve estimation of models that explicitly account for the underlying population heterogeneity. second, the property tax is really an aggregate levy with the individual levies each exhibiting distinct incidence implications. future research should recognize the complex structure of the levy explicitly in developing appropriate incidence models. discussion and conclusion while the magnitudes of the coefficients are reasonable enough, it is the switching of the signs of the coefficients that is of most interest. for example, in all models the trend growth of property tax base is positive and significant, with the greatest trend growth being experienced in rural districts at 7.5% per year, followed by suburb districts at 6.7%, and city center districts at 3.3%. all of these estimates are consistent with current development patterns in oklahoma county. looking and the differential impacts of school district tax rates, we find it to be strongly negative and significant in magnitude at the city level, but equally as strongly positive and significant in magnitude at the rural and suburb levels. the coefficients suggest a deeper look is merited into the possibility of capital tax view jurisdictions in the city and benefit view jurisdictions in the periphery. again, this is consistent with relocation patterns throughout the county as homeowners essentially shop for school value. this is perhaps the strongest evidence in favor of the argument to investigate property tax incidence at the local level and expect population heterogeneity. finally, the differential impacts of the careertech levy also indicate a benefit view to this service in the city and rural areas, but not in the suburbs. these findings are consistent with the vocational and agricultural objectives of the careertech system. 12 journal of business strategies the ongoing property tax incidence debate is not only interesting academically but also has significant policy implications. without a better understanding of the role the local property tax plays in regional efficiency and distribution outcomes, comparisons against alternative methods of local finance are near impossible. we have proposed some parameters to facilitate future empirical investigation, among them: an inherently local focus, a disaggregation of the property tax levy, and explicit incorporation of the possibility the incidence implications may vary across jurisdictions. we illustrate using easily accessible data and a straightforward model how significantly the interpretations can vary depending on the perspective taken. ultimately, we find reason to expect differing incidence outcomes in oklahoma county’s city, suburb, and rural areas. as tax reform discussions progress at the state and national level, the business community will be asked to lend their significant voice to the various alternatives. crucial to a region’s ability to foster economic development will be its success at designing efficient systems of local finance. the evidence we provide for oklahoma county suggests the need for local examination of the incidence of the property tax on case-by-case basis. notes 1 local government is given by county, municipality, township, special district, and school district 2 william fischel (2001) opens a recent article with the following sentence: “the local property tax is so widely criticized by scholars and reformers that its persistence demands some explanation.” 3 the fiscal differential is given by the difference in the present value of the benefits received and local property taxes paid. 4 for some additional perspective on the early contributions to the debate, see aaron (1974) and musgrave (1974). references aaron, h. (1974). a new view of property tax incidence, the american economic review, 64, 212-221. carroll, r. and yinger, j. (1994). is the property tax a benefit tax? the case of rental housing, national tax journal, 47, 295-316. volume 30, number 1 13 dalehite, e.g., mikesell, j.l., and zorn, c.k. (2005). variation in property tax abatement programs among states. economic development quarterly 19, 157. fischel, w.a. (1992). property taxation and the tiebout model: evidence for the benefit view from voting and zoning, journal of economic literature, 30, 171-177. fischel, w.a. (2001). municipal corporations, homeowners and the benefit view of the property tax, in property taxation and local government finance, ed. by w. e. oates, lincoln institute of land policy, cambridge, ma. hamilton, b. w. (1975). zoning and property taxation in a system of local governments, urban studies, 12, 205-211. harberger, a.c. (1962). the incidence of the corporate income tax, journal of political economy, 70, 215-240. mieszkowski, p. (1972). the property tax: an excise tax or a profits tax? journal of public economics, 1(1), 73-96. nechyba, t. j. (2001). the benefit view and the new view: where do we stand, twenty-five years into the debate? property taxation and local government finance, ed. by w. e. oates, lincoln institute of land policy, cambridge, ma. o’sullivan, a., sexton, t. a., and sheffrin, s.m. (1995). property taxes and tax revolts: the legacy of proposition 13, new york and cambridge, uk: cambridge university press. sjoquist, d.l., walker, m.b., and wallace, s. (2005). estimating differential responses to local fiscal conditions: a mixture model analysis, public finance review, 33, 36-61. tiebout, c. m., (1956) a pure theory of local expenditures, journal of political economy, 64, 416-424. wallis, j. j. (2001). a history of the property tax in america, in property taxation and local government finance, ed. by w. e. oates, lincoln institute of land policy, cambridge, ma. wassmer, r. (1993). property taxation, property base, and property value: an empirical test of the “new view”, national tax journal, 46, 135-160. zodrow, g. r. (2001). reflections on the new view and the benefit view of the property tax, in property taxation and local government finance, ed. by w. 14 journal of business strategies e. oates, lincoln institute of land policy, cambridge, ma. zodrow, g. r. (2008). the property tax incidence debate and the mix of state and local finance of local public expenditures, oxford university centre for business taxation, forthcoming, cesifo economic studies. biographical sketches of authors russell r. evans, ph.d. is the executive director of the steven c. agee economic research and policy institute in the meinders school of business at oklahoma city university. dr. evans currently teaches courses in applied business statistics and public finance, while working closely with local policymakers advising on such matters as revenue forecasts, economic development, and policy analysis. mary gade, ph.d. is an associate professor of economics and the graduate coordinator in the spears school of business at oklahoma state university. dr. gade teaches courses in public finance, game theory, and sports economics. her research interests are centered on property taxes, and state and local government finance. notes managing in the 1990s • freeing the entrepreneurial spirit stanley c. ross state university of new york brockport, new yark: integration of the united states into the world economy successful management is critical in tooay's business climate, because large organizations no longer can consider the united states as their private domain nor dominate individual markets with little to no competition. global interdependencies are accelerating the integration of the united states economy with the world economic community. the momentum means that turning back is not a realistic alternative without seriously impairing the domestic economy [1]. to remain competitive using a global strategy demands that products meet the needs of users, product quality achieves the performance standards expected by buyers, and costs are contained in order to offer competitive prices. to achieve these ends and to remain competitive requires a radical shift in the thinking about strategy (how to compete) and strategy implementation (organizing to enhance the firm's competitive position). the purpose of this paper is to address the management problems of large organizationsl and to suggest a resolution to the problems by recasting the large organization as a free market system. problems in managing large organizations like society, an organization is a collection of people interacting for the benefit of themselves and the collective whole. as the society within the organization expands. greater effort is expended to control the actions of its members with the objective of coordinating all activities. control gains in importance as the organization attempts to maximize economic returns through intensive coordination of effort, a natural response when mana~ a large enterprise. the result is that control activities begin to dominate organizational decisions, and control itself becomes problematic due to the enormity of the task: and resistance from members of the organization [2]. control is of less importance in the design and ongoing function of the management systems initially; but as the organization expands and adds employees. there. seems to be a gradu8i but undeniable tum away from a goal orientation. two explanations are suggested to account for the change in emphasis. first, to better manage large numbers of employees in an increasingly diverse operation, firms promote 1a large organization is defined as an organization with 2,000 or more employees. 78 journal ofbusiness strategies vol. 9, no.1 confonnance among employees in order to simplify management requirements. second, expansion activities lead to growth which only exacerbates the difficulty in controlling the "society" within the organization. initially the organization adds support personnel and develops more elaborate management systems to facilitate control. the failure to achieve the desired ends results in a shift away from growth opportunities because of the control problems associated with growth management. for large organizations, internal harmony and consistency have become the important goals. innovation strains management systems' capacity to control the behavior of individuals and ultimately the entire organization. harmony and innovation are seen as mutually exclusive; and though a finn might aspire to the appeal of being a known innovator, it cannot cope with a catalytic phenomenon that is destabilizing, no matter how great the appeal [3]. the paradox organizations advocating growth oriented goals and strategies will be encouraging change within the organization. according to general systems theory, change in one part of the organization affects all the other parts. goals promoting growth, dermed here as leading to economic gains, are necessary if the organization is to ward off atrophy by adapting to trends in the marketplace. promoting growth leads to a paradox; because change dismpts relationships and established nonns, leading to resistance. the emphasis on maintaining order concomitant with the inclination to resist change by individuals results in organizational resistance. the large organization faces two difficult and mutually exclusive choices. it can promote growth, which disrupts~ or stability can be emphasized, which gradually leads to declining growth patterns. unable and seemingly unwilling to accept this contradiction, the large organization's strategic agenda is to promote growth while maintaining stable operations. the goals and strategies may appear to emphasize growth, but the organization has no intention of following through (i.e., the hidden agenda). this inconsistency reflects an organization suffering from cognitive dissonance, exhibiting behavior consistent with its basic beliefs [4]. in this case, maintaining stability is the primary goal because change is too disruptive and unsettling. since growth and stability are incompatible, the large organization chooses stability because of the difficulty in creating management systems that can support both concurrently. the emphasis on stability as the central focus gives short shrift to innovative behavior, ultimately leading to the demise of growth strategies that promote innovation. resolving the paradox modeling the large organization as a free market system frees the entrepreneurial spirit of business units from the straightjacket imposed by the controlling corporate parent. the organization as a free market system should function like one, with the flow of resources moving to the most productive units offering the greatest rate of return ror. the impetus and commitment for change in strategy and strategy spring 1992 ross: managing in the 1990's 79 implementation is derived from the requirement that the competitive position must be improved. the corporate growth strategy, in effect, is an investment strategy. the goal is to maximize the (ror) on the investment. the business units comprising the holdings represent an investment portfolio. perfonnance of the organization is evaluated by the portfolio's ror. units would be added or dropped contingent on their actual contribution or potential to support the investment strategy. the allocation of resources would be based on unit perfonnance and future prospects for contributing to economic growth and ror. units should be able to operate in any industry and illal'ket because operational compatibility with the parent is no longer axiomatic other than to support the investment strategy. tensions between the parent and business units will exist over the allocation of resources which are influenced by the investment strategy of the finn. however, the parent's control over resources and business units' control over their operations will force each into mutually beneficial agreements. the corporate and business strategies will be linked because providing capital to business units willing to pay a higher price will enable the parent to achieve its ror goal. business units exercise a greater commitment to productivity and efficiency because of the need to demonstrate real economic gains. improved performance can lead to a higher ror, enabling the business units to gain greater access to capital and more control over the management of their operations. acquisition policies are derived from the investment strategy. divestiture occurs when a unit is unable to support the investment strategy according to specific performance criteria. the organization would be designed as a holding company. operating autonomously allows each business unit to develop an organizational design and operating policies to address the competitive conditions in the markets in which they compete. by maximizing the autonomy of business units and minimizing parental interference in day-to-day issues, business units' flexibility in making strategic and operating decisions will be strengthened [5]. elaborate management systems are no longer needed to facilitate control. performance control measures, derived from the parent's investment strategy and investment goals, will form the basis for assessing the performance of the rmn. business units will respond in kind by utilizing performance measures; because survival and growth are now linked to access to capital, which is tied to performance. a complication for many large organizations is business units which sell all or most of their outputs internally. too often transfer price agreements have not been established or are dictated by the parent the supplier's performance will often be under reported because the prices are below the market rates, while the buyer's performance may look too good due to a deflated cost structure. under the proposed model, the buyer and seller would be able to negotiate with any party which offers the optimal deal, to include market prices. both buyer and seller will have to adhere to market standards. each becomes performance driven. economies of scale have often been used to justify uniting many businesses under one corporate roof, and closely integrated. the focus on economies of scale shifts the emphasis towards efficiency, with goals dermed as cost-reducing targets. units 80 journal ofbusiness strategies vol. 9, no.1 are organized by competitive distinctiveness in order to provide a common frame of reference. the goals and strategy are derived from their respective strengths and environmental circumstances and competitive opportunities. organizing around a unique characteristic(s) tends to diseconomies of scale. however, higher cost, rather than a negative, are offset by the increased motivation to expand in order to reduce operating costs. reliance on efficiency measures over the long run are inadequate in generating satisfactory perfonnance or growth because of the diminishing returns associated with cost-reduction activities. summary in an organization modeled on the free market system, the corporate parent and the business units better their productivity and become more efficient to attract the resources needed to support a growth strategy. individual business units are able to identify their own goals and strategies as well as develop the operational plans for implementing the strategies. resistance to the changes is defused because the parent focuses on performance and seeks sustained economic growth instead of homogenizing the organization under the guise of promoting synergy [6]. references 1. keane, iohn. "focusing on the corporate future: not a trivial pursuit" business horizons {ianuary-february 1987), p. 31. 2. perror, charles. complex organizations. 3rd edition, new york: random house (1986), pp. 178-257. 3. watennan, ir., robert. the renewal factor: how the best get and kee.p the competitive edae. new york; bantam (1987), p. 112; y. allarie and m. fii'sirotu, "how to implement radical strategies in large organizations," sloan manaaement review (spring 1985). p. 19; h. igor ansofi. ··strategic management of technology," journal of business sttatea:y. vol. 7, no.3 (winter 1987), p. 38. 4. kimble, gregmy a. and gennezy. nonnan. principles of general psychology. 2nd edition, new york: the ronald press co. (1963), pp. 591-594. 5. prahalad. c.k. and hamel, gary. "the core competence of the corporation." harvard business review (may-iune 1990), pp. 79-91 6. fama, eugene f. "agency problems and the theory of the finn." iournal of political economy. vol 88 (1980), pp. 288-307. managing in the 1990s freeing the entrepreneurial spirit conglomerate restructuring in the 1980's: a study of performance/strategy linkages alan l. brumagim university of scranton scranton, pa richard klavans center for research planning philadelphia, pa introduction the 1980s appear to have been a period of decline and retrenchment for united states based conglomerates (williams, paez, and sanders 1988). several macro-level factors may have contributed to these trends. scherer and ross (1990) suggest that changes in anti-trust regulation and enforcement during the 1980s allowed companies to pursue strategies of increased related diversification. corporations once limited to growth through unrelated diversification were able to alter strategies and benefit from the potential synergies of operating more related business portfolios. conglomerates may have found it easier to focus on increasing the size of core businesses. competition faced by secondary business units might have increased (as industry leaders gained levels of market share once precluded by law), thus making these secondary businesses less desirable. or conglomerates may have found a better marketplace for the sale of secondary business units, as industry leaders looked for acquisitions in core areas. another possible explanation for these conglomerate trends comes from agency theory. this argument suggests that conglomerates originally formed, in part, due to the corporate manager's desire for growth and stability over profitability. however, recent innovations such as hostile takeovers and a more efficient market for corporate control have led to de-conglomeration (hoskisson and turk 1990). along these lines, davidson (1985) suggests that depressed stock prices, particularly during the early 19808, have made many conglom~ erates more valuable dead and broken into pieces than alive. these de-conglomeration trends are also consistent with a large body of diversification research which has hypothesized an inverse relationship between diversification and subsequent corporate performance (rumelt 1974; simon 1957). however, the presence of many highly successful foreign-based conglomerates, such as hanson from great britain and mitsubishi from japan, presents an interesting paradox. in fact, the conglomerate form may contain more benefits than commonly recognized. a greater understanding ofthese foreign-based conglomerates (as well as the few remaining u.s. based conglomerates) may be particularly helpful, given the increasingly global nature of competition in many industries. unfortunately, the possible confounding effects of differences in national culture, economic differences between countries, and differences in political environments makes such a comparative study somewhat problematic. instead this paper will examine the strategies ofsixty-five united states based conglomerates during the 1980s. are 142 j oumal ofbusiness strategies vol. 11, no.2 certain conglomerate strategies associated with high levels of corporate performance? are other strategies associated with lower levels of corporate performance? this study is particularly important given the strong prescriptions to avoid the conglomerate form which have emerged from diversification research. along these lines, diversification research generally assumes that strategy drives performance. that is, related diversification leads to higher performance than umelated diversification. the diversification research paradigm seems to acknowledge a feedback loop from performance back to subsequent strategy, but this feedback loop has clearly been of secondary importance. given the cross-sectional nature of many past research designs, the strength of this feedback loop has rarely been examined empirically. the purpose of this paper is to examine performance/strategy and strategy/performance relationships in conglomerates. to what degree does poor corporate performance lead to strategic restructuring? is this feedback loop strong enough to discourage conglomerates with adequate performance from restructuring? or have the hostile macro-level changes facing conglomerates been so strong that the general trend to de-conglomerate is an overwhelming influence? this paper will examine one type of restructuring, the divestiture of one or more major business segments. a business segment is a group of corporate businesses (business units) as defined by management for presentation in segment reporting within annual financial statements. despite the fact that these business segment definitions are based upon management perceptions of business activity (which may not be consistent across corporations), these measures have been commonly used in diversification research (grant, jammine and thomas 1988; lee and cooperman 1989). business segments are, by definition, very broad. therefore, the divestment of even a single business segment could suggest a major change in corporate strategic direction. this paper will use the term conglomerate "focusing" to describe this type of restructuring. other types of restructuring, not examined in this paper, include: 1) internal reorganizations, including the reshuffling ofbusiness units into other business segments, 2) repositioning of the corporate portfolio by divesting entire business segments, including acquiring completely new business segments, and 3) partial retrenchments within a business segment (by selling a few individual business units, but maintaining the core ofthe business segment). the period of conglomerate restructuring in the 1980s provides an ideal opportunity for examining these performance/strategy linkages because: 1) despite the pressures facing conglomerates in general, a fairly large number of conglomerates did not engage in focusing during this period, 2) performance varied significantly between conglomerates (dundas and richardson 1982), and 3) many of the conglomerates had focused so dramatically that the conglomerate form had been abandoned (lee and cooperman 1989). literature review diversification research draws upon the careful historical study of the rise of the diversified firm over the last sixty years (chandler 1962; rumelt 1974; wrigley 1970). rumelt (1974), in his seminal work, identified a link between corporate diversification fall 1994 brumagim & klavans: conglomerate restructuring 143 (strategy) and performance. he found that corporations which had diversified in a related (linked) manner outperformed corporations in other diversification categories. theoretically, the benefits of related diversification have been explained as emerging from the presence ofsynergies (ansoff 1957; chaterjee 1986), distinctive competencies (hitt and ireland 1985; hitt, ireland, and palia 1982) or the increased development of core skills (rumelt 1974; wemerfelt 1984). common to all these explanations is the basic assumption that diversification (strategy) drives performance. since rumelt's initial work, the prescription that related diversification is superior to unrelated diversification appears to have become very widely accepted (leontiades 1986; salter and weinhold 1979). however, the research results from this stream have not been unequivocal (grant, jammine and thomas, 1988; michel andshaked 1984). still others have challenged the basic diversity/performance relationship as being spurious (bettis 1981; christensen and montgomery 1981). for a review of this literature see ramanujam and varadarajan (1989). more recent diversification research has continued to assume the basic strategy to performance linkage suggested by earlier research. this recent research has tended to either look for diversification to performance linkages in more specific business contexts or has focused on exploring possible methodological and measurement improvements. for example, nayyar (1993) examined the role of related diversification as it relates specifically to service firms. he suggests that implementation difficulties related to achieving economies of scope may have resulted in less favorable stock market performance for many companies. he also suggests the benefit of a finer-grained measure ofrelated diversification. in order to identify the differing benefits of information asymmetry versus economies of scale. lubatkin and chatterjee (1991) examined how the strategy/shareholder value phenomenon varied across stages of the business cycle. they found that related diversifiers (diversification based upon common core technologies) had lower levels of systematic risk (on average) across the business cycle. the ability of these related diversifiers to earn higher risk-adjusted rates of return was particularly noticeable during periods of market decline. several recent studies have further explored the concept of risk (bettis and hall 1982) within the context of the strategy/performance relationship. hill and hansen (1991) found evidence that companies in the u.s. pharmaceutical industry diversified to reduce the risks associated with a technologically dynamic environment. similarly kim, hwang & burgers (1993) found evidence that global market diversification was a useful way of managing corporate risk and return. although they found evidence that these benefits accrue from either related or unrelated global diversification, they suggest that related diversification offers a more efficient risk-return tradeoff. research has also expanded more directly into the study of implementation issues. for example, gomez-mejia (1992) found that a "fit" between compensation strategies and corporate diversification posture contributes to higher corporate performance levels. hoskisson and johnson (1992) found a positive relationship between increased related diversification and r&d intensity. along these lines, recent studies have continued to suggest the limited benefits of unrelated diversification. markides (1992) concluded that firm diversification levels during 144 journal ofbusiness strategies vol. 11, no.2 the 1980s were higher than optimal. hoskisson, hitt and hill (1991) claim that excessive diversification has resulted in control loss and corporate misallocation of resources via managerial risk aversion. another characteristic of this research stream has also been the increased attention to methodological issues. lubatkin, merchant and srinivasan (1993) found evidence of acceptable construct validity for several diversification measures commonly used in research. on the other hand, nayyar (1992) based upon questionnaire data received from 80 large service firms found that internal conceptualizations of relatedness varied significantly from external measures. as can be seen, as diversification research has advanced, the primary assumption that strategy drives performance has remained intact. one study, grant, et.al. (1988) noted that performance seemed to drive strategy, although a line of reasoning for these results was not developed. the focus of diversification research has also been influenced by massive corporate restructuring that has taken place during the 1980s (bowman and singh 1993). in fact, the virtual disappearance of the conglomerate form by the early 1990s (in the u.s.) precludes continued study of conglomerate strategies. the development of the concept of a feedback loop between performance and strategy (where performance drives strategy) has come not from diversification research, but from the emerging research stream on organizational learning (senge 1990). this research stream has emerged from the works of eyert and march (1963) as well as simon (1957). recent work has been more conceptual than empirical (woodman, sawyer, and griffin 1993). for example, mezias and glynn (1993) have conducted computer simulation experiments to evaluate various renewal strategies within the context of a corporate learning model. some empirical investigation has been conducted in this area. grinyer and mckiernan (1990) proposed an extension of cyert and march's (1963) behavioral theory of the firm which could be used to explain the possible presence of a performance to strategy feedback loop. they suggest that corporations with satisfactory performance will not alter strategy. drawing upon the concept of "satisficing" (simon 1957), only corporations with less than satisfactory performance will alter strategy in an attempt to improve performance. furthermore, strategic change will only be attempted after less severe "operational" corrections have been attempted. grinyer and mckiernan model three separate phases in the corporate attempt to close performance gaps moving from operating level cost-controls to alteration of market or product strategies to divestiture ofbusinesses or business segments. they found empirical support for their model in a study of 25 united kingdom based corporations which had changed from positions of stagnation to positions of sustained performance. lant, milliken and batra (1992) found that poor past performance was associated with corporate reorientation, particularly in stable environments (where poor performance is more likely to be attributed to the firm rather than to the environment). although these two research streams (diversification research and organizational ieaming) have yet to merge, this study moves in this direction by examining the prior performance to strategy linkages as they relate to conglomerate activity. fall 1994 brumagim & klavans: conglomerate restructuring hypotheses 145 poor performance would be expected to be an antecedent to conglomerate restructuring. formally stated: hypothesis 1prior corporate performance will be inversely related to the number of conglomerate divestments of major business segments. this is a test of the grinyer/mckiernan model. they suggest that the performance-to· strategy linkages may be particularly strong during periods of general economic retrenchment. on the other hand, conglomerates facing particularly turbulent business environments (during the 1980s) may be inclined to abandon the conglomerate form, regardless of prior performance. thus, by considering non-turnaround situations, this study may provide additional evidence to support the grinyer/mckiernan model. following the prescriptions of diversification research, focusing upon core businesses would be expected to lead to improved corporate performance. formally stated: hypothesis 2 conglomerate divestment of major business segments will result in higher levels of corporate performance. by examining corporate performance two years after the completion of major restructuring efforts, this study avoids some of the limitations of cross-sectional designs. data and methodology sample a comprehensive sample of conglomerates was obtained by compiling a list from forbes annual industry surveys 1980-1988 (see williams, et.al. (1993) for a discussion of various conglomerate data sources). statistical power was a concern and additional conglomerates were identified from the varadarajan and ramanujam (1987) list ofthe 10 largest companies in each of25 united state industries. to insure that only conglomerates were added, the list was screened to include only companies which had at least four different business segments, where the largest segment accounted for less than 70% of corporate revenues. this set of screening criteria is consistent with past conglomerate research (rumelt 1974). only companies which were in existence for the entire 1980-1988 period were included. this resulted in a sample of 86 conglomerates. preliminary analysis of the restructuring activity suggested a taxonomy of four types of strategic behavior. twenty-eight (28) conglomerate "holders" maintained all existing business segments throughout the 1980-1988 period. furthermor,e these "holders" did not acquire any new business segments. thirty-seven (37) "focusers" divested major business segments without acquiring any new business segments. eighteen (18) "repositioners" 146 journal ofbusiness strategies vol. 11, no.2 divested major business segments and also acquired new business segments. finally, three (3) conglomerate "expanders" continued to acquire new business segments without making any major divestitures. although the "repositioners" as a group were empirically quite similar to the "focusers," conceptually, "repositioners" seemed to be engaged in a trading strategy rather than a focusing strategy. because ofthis, repositioners were excluded from this study. this resulted in a final conglomerate sample of 65 conglomerates, including 28 holders and 37 focusers. a list and classification of the corporations used in this study is shown in appendix a. model specification and variable definitions this study will test the following model: s= f(pp, at, dv, d1) where s is strategic behavior over time, i.e., the number of business segments divested, pp is prior corporate performance, atis an industry profitability composite measure used to control for industry performance effects (a control variable), dv is the initial level of diversity (a control variable), and dt is the initial debt-equity level (a control variable). the number of major business segment divestitures occurring during the 1980-1988 period was used as a measure of strategic behavior (the dependent variable). supplemental analysis, using the percentage of 1980 corporate revenue divested, produced similar results. average 1976-1980 return on capital (roc) was used as a measure ofprior performance. similar results were obtained when using return on equity (roe) and return on sales (ros) measures. industry performance (return on assets at the 3-digit sic level) was used to assess industry effects. the importance ofcontrolling for industry effects in diversification research has been established (christensen and montgomery 1981; rumelt 1982). a composite industry performance measure was created for each conglomerate following rumelt (1982). this measure is an unweighted average of industry performance (for all corporate 3-digit sic operations) and was calculated using data from irs source books. corporate sic codes were obtained from the directory of corporate affiliations. comparison of 1980 and 1985 irs data showed that relative industry performance was fairly stable over time. irs data from 1980 were used to test the model. a jacquemin-berry (june 1979) entropy measure was used to assess 1980 diversification levels (following palepu (1985». a second measure ofdiversification based upon sic codes, (using varadarajan and ramanujam's (1987) measures of broad spectrum and mean narrow spectrum diversity) revealed diversification levels consistent with the entropy measure. 1980 debt-equity levels were used to control for differences in initial financial leverage. early conglomerate research indicated that conglomerates may benefit from lower costs of capital via risk pooling, i.e., the greater use of financial leverage (lewellen 1971). more recently, lee and cooperman (1989), in studying 43 conglomerates for the time period 1980-1985, found that conglomerates were de-leveraging to a significant degree. they fall 1994 brumagim & klavans: conglomerate restructuring 147 suggest that changes in real (inflation-adjusted) interest rates may have limited the continued viability of financial leverage strategies. data were obtained from compustat, forbes annual industry surveys, corporate 10ks, the directory of corporate affiliations, and irs source books. results performance to strategy linkages multiple regression was used to test hypothesis 1, which proposed a strong perfo~ance/ strategy feedback effect. pearson correlations between all variables are shown in table 1. multicollinearity between debt-equity and prior performance (five year return on capital) appears to be an issue. the correlation coefficient was -.6533 (p=.001). as suggested by miller and wichern (1977), the inclusion of independent variables that are highly correlated with each other (generally correlation coefficients greater than .50) can lead to misleading results and inflated beta estimates. high correlations also existed between debt-equity levels and other performance measures (both return on sales and return on equity). table 1 means, standard deviations and intercorrelation matrix for all variables (n=61) mean s.d. (1) (2) (3) (4) divested segments 1.46 1.57 prior performance 11.81 4.96 -.51** diversification level 1.42 .36 .48 -.10 industry roa 6.24 1.32 -.28 .31 -.15 debt-equity level .45 .30 .69** -.65** .12 -.28 •• p=.ool in order to avoid these multicollinearity problems, two separate regression models were tested. the first regression model, shown in table 2, excludes the debt-equity control variable. in the second model (also shown in table 2), the measure of prior performance is excluded and the debt-equity variable is included. as the first model shows, both poor prior performance and high initial diversification levels were significant predictors of divestment activity. even though all conglomerates are (by definition) very diverse, some conglomerates had initial diversity levels which were significantly greater than others. these results are consistent with both diversification research prescriptions and the expectation of a strong performance/strategy feedback loop. 148 journal ofbusiness strategies table 2 multiple regression results vol. 11, no.2 (dependent variable = number of business segments divested) model model (1) (2) betas p betas p prior performance (1976-1980 roc) -.403 .001 1980 debt-equity level 0402 .001 diversification level .341 .004 .307 .009 industry roa -.213 .069 -.223 .055 f statistic 11.518 11.359 r-squared .266 .263 the industry performance (control) variable is significant at p=.07. low industry performance is associated with divestiture activity. to the degree that industry performance may be a proxy for future business attractiveness, managers may be more inclined to divest businesses in low performance industries. the overall results are fairly strong with an adjusted r·square value of .266. this test suggests support for hypothesis 1. model 2 results show that high debt-equity levels are also strongly related to divestment activity. initial diversification level and industry performance effects are similar to those shown in model 1. the results of the second model are also quite strong, with an adjusted r-square of .263. given the design of this study and the nature of the data, it was difficult to unravel the causal patterns between highly leveraged financial positions and poor performance. lee and cooperman (1989) suggest that the high cost of capital during the 1980s may have caused highly leveraged conglomerates to de-leverage. thus, high leverage may have induced poor performance by burdening some conglomerates with extremely high interest expenses. on the other hand, debt may have been used to fund growth despite poor earnings. in any event, it is less important to untangle the financial leverage/poor performance linkages than it is to examine the possibility that strategic redirection during the 1980s was based primarily upon financial considerations. under financially motivated redirection, receipts from divestitures would be used to reduce corporate debt. strategic redirection to achieve more manageable levels of diversity would be a secondary issue. fall 1994 brumagim & klavans: conglomerate restructuring 149 additional analysis, however, tended to refute a financial explanation. the average annual debt-equity levels offocusers (as a group) did not decrease from 1980 through 1988. in fact, debt-equity positions of the focusers tended to increase slightly over this time period. during this same time period, holders (as a group) maintained very stable, though much lower, debt-equity levels. although further examination of this phenomenon is needed, it appears as if focusers were investing more heavily in core businesses. there is no evidence that focusers, as a group, were divesting to reduce financial leverage. conglomerate groups logistic regression (not shown in the tables) was used to assess the degree to which the performance/strategy results applied to focusers as a group. the strategic categorical variable holder/focuser was used as the dependent variable in place of the number of segments divested. results were similar to those reported in table 1. this further supports the validity ofdiscussing strategic group characteristics (holders versus focusers), despite the fact that the number of divested segments varied among focusers. descriptive statistics of the foeuser group are shown as appendix b. stock market performance stock market performance measures were also modeled. because holders, by definition, did not have a strategic "event," standard capm event methodology could not be used. following the methodology outlined by lubatkin and rogers (1989), alpha and beta estimates were developed for each conglomerate, using month end stock market prices for five years (various five year time periods from 1980 to 1987 were examined). mean differences in alpha estimates (jensen's alpha is a measure of cumulative abnormal returns over the time period) between focusers and holders were calculated. no statistically significant performance differences were found between holders and focusers for any of the time periods examined. although limitations of the methodology used may have affected these findings, it does not appear that the stock market rewarded the holders, despite nearly a decade ofrelatively superior (accounting-based) performance. although some may not find this lack of stock market differentiation (between holders and focusers) surprising, it is interesting in light of the strategic directions taken by these conglomerates. (see rappaport (1986) for a discussion of the limitations of accounting-based measures). strategic action appeared to be triggered by poor accounting performance rather than by poor stock market performance. despite the potential of being undervalued by the market, the top management teams of conglomerate holders maintained portfolios of diverse businesses. performance implications of restructuring hypothesis 2 suggested that conglomerate focusing would result in improved corporate performance. this hypothesis was tested using paired t-tests for a subsample of 19 conglomerates which had completed major divestment programs by 1986. subsequent performance was measured by using corporate performance two years after the completion of conglomerate focusing programs. this was judged to be a sufficient period of elapsed time, since the post-divestiture adjustment period should be fairly short (unlike the adjustment period 150 journal ofbusiness strategies vol. 11, no.2 needed for some acquisitions). since performance data was available through 1988, only corporations which had completed restructuring by 1986 were included in the sub-sample. table 3 shows the results for both corporate return on equity and profit margins for these focusers. table 3 focuser perfonnance differences over time paired t-tests end of restructuring subsequent (2 years) p= return on capital mean s.d. 7.64 6.83 14.31 6.25 .007 return on sales mean s.d. 2.43 1.93 4.27 2.20 .030 as shown in table 3, significant improvements in corporate performance were evident two years after the completion of major business segment divestment programs. this was true, both in terms of return on capital and return on sales. to rule out the possibility that the significant improvements of focusers were a function ofgeneral business conditions rather than an effect ofrestructuring activity, changes in holder performance over the same time period were examined. assessing two year performance patterns in a similar manner, holders (from analysis not shown in the table) showed no significant improvements in either return on equity or profit margin. average holder performance remained relatively flat over the entire period of study (a return on capital mean over time of 14.57 and a return on sales mean over time of 4.48). this analysis suggests support for hypothesis 2. discussion this study has many of the limitations common to diversification research (venkatraman and grant 1986). internal validity, in particular, is a concern. although the trends reported here are consistent with theory, this study lacks an in-depth examination of specific strategic actions. for example, what internal or external events triggered divestitures of specific segments? despite these weaknesses, this study has found evidence of a strong performance to strategy feedback linkage. these findings suggest that the grinyer/mckiernan model can be generalized beyond turnaround situations. further research is needed to explore the relationship between diversification strategy and organizational learning. this study also found that some conglomerates benefited from becoming more focused. corporate performance (on average), both in terms of return on equity and profit margin, fall 1994 brumagim & klavans: conglomerate restructuring 151 nearly doubled within two years after the completion of conglomerate focusing actions. (because of the differences in duration and timing of restructuring activity, these performance differences do not emerge when examining the cross-sectional performance levels of focusers). however, performance improved primarily as a result ofdivesting low-performing units, which says very little about the benefits of related diversification. that is, divesting low-performing units (either units related or unrelated to core segments) will improve performance. the long-term performance trends of focusers and holders seem to be consistent with the "satisficing" predictions of the grinyer/mckiernan strategic behavior model. conglomerate focusers, on average, significantly improved performance, but only to levels approaching those maintained by the conglomerate holders. although additional research is needed in this area, it appears as if the top management teams of conglomerate focusers were unwilling to shrink corporate size to the degree needed to achieve "maximum" profitability. such findings would be consistent with agency theory arguments which suggest that managers maximize corporate size rather than profitability. this study also suggests the benefit of assessing strategic actions over time to develop a taxonomy of conglomerate groups. although conglomerate focusers divested anywhere from one to seven major business segments, the decision to focus, in itself, appears to be important. differences between holders and focusers appeared to be substantial. the emergence of these two groups leads to several interesting future research questions. what historical patterns led to the emergence of the highly leveraged, low-performing conglomerate focusers? did focusers (relative to holders) rely particularly heavily upon financial leverage strategies during the 1960s and 1970s? were the management teams of conglomerate focusers more prone to agency problems? did focusers expand rapidly via the use of debt, despite patterns of poor performance? finally, given the apparent divergence between accounting and stock-market performance measures, this conglomerate sample may be quite useful for examining performance issues, induding the degree to which top corporate managers consider the price of corporation stock and potential stock market reactions before making strategic decisions. corporate managers may find these diverging performance results interesting, particularly in light of the widespread criticism that u.s. corporations are overly focused on short-term (share-price driven) results. the conglomerate holders, in particular, appeared to be much more driven by long-term internal performance measures rather than external stock prices. on the other hand, stock market influences cannot be ignored forever. many holders subsequently focused (in the 1990s) and were often rewarded with higher stock prices (despite a lack of improvement in internal performance measures). this study also holds additional implications for top management and corporate boards of directors. this study has shown that there have been some conglomerates which have maintained high levels of corporate performance over long periods of time. understanding these patterns may be relevant not only to managers ofthe few remaining u.s. conglomerates, but to any manager facing global competition from foreign-based conglomerates. additionally, managers should (as they often do) take academic prescriptions with a grain of salt. rumelt (1974), in discussing the adoption of the m-form structure, found evidence that top 152 journal ofbusiness strategies vol. 11, no.2 managers can become susceptible to the latest management fad. given both the significant restructuring trends of the 1980s and the propensity for management scholars to provide strong warnings about unrelated diversification (leontiades 1986; porter 1990), managers may underestimate the ability of some corporations to achieve benefits from the unrelated diversification. this is not to suggestthatthe conglomerate form should re-emerge in the u.s. or that there are not real benefits to related diversification. however, prescriptions against unrelated diversification may be somewhat overstated. a balanced strategic view is particularly important during the 1990s as many companies shift from retrenchment strategies back to growth strategies. references ansoff, h.i. 1957."strategies for diversification." harvard business review (september-october): 113-124. bettis, ra. 1981. "performance differences in related and unrelated diversified firms." strategic ~anagementjournai2:379-393. bettis, ra. and hall. 1982. "diversification strategy, accounting determined risk, and accounting determined return." academy of ~anagementjournal 25: 254-264. bowman, e.h. and h. singh. 1993. "corporate restructuring: reconfiguring the firm." strategic ~anagement journal 14 (special issue summer): 5-14. chandler, jr., a.d. 1962. strategy and structure. cambridge, ma: ~it press. chaterjee, s. 1986. ''types of synergy and economic value: the impact of acquisitions on ~erging and rival firms." strategic ~anagement journal 7: 119-139. christensen, h.k. and ca. ~ontgomery.1981."corporate economic performance: diversification strategy versus ~arket structure." strategic ~anagement journal 2: 327-343. cyert, r.~. and j.g. ~arch. 1963. a behavioral theory of the firm. englewood cliffs, nj: prentice-hall. davidson, k.~. 1985. megamergers. cambridge,~: ballinger publishing. dundas, k.~. and p.r. richardson. 1982. "implementing the unrelated product strategy." strategic ~anagement journal 3: 287-301. gomez-~ejia, l.r. 1992. ''the structure and process of diversification, compensation strategy, and firm performance." strategic ~anagement journal 13: 381-397. grant, r., a. jammine and h. thomas. 1988. "diversity, diversification, and profitability among british ~anufacturing companies 1972-1984." academy of ~anagementjourna131: 771-801. fall 1994 brumagim & klavans: conglomerate restructuring 153 grinyer, p. and p. mckiernan. 1990. "generating major change in stagnating companies." strategic management journal 11: 131-146. hill, c.w.l and g.s. hansen. 1991. "alongitudinal study of the cause and consequences ofchanges in diversification in the u.s. pharmaceutical industry 1977-1986." strategic management journal 12: 187-199. hitt, ma. and rd. ireland. 1985. "corporate distinctive competence, strategy industry and performance."strategic management journal 6: 273-293. hitt, ma., rd. ireland and k.a. palia. 1982. "industrial firm's grand strategy and functional importance: moderating effects of technology and uncertainty." academy of management joumal25: 265-298. hoskisson, re., m.a. hitt, and c.w.l hill. 1991. "managerial risk taking in diversified firms: an evolutionary perspective." organization science 2: 296-313. hoskisson, re. and ra. johnson. 1992. "corporate restructuring and strategic change: the effect of diversification strategy and r&d intensity." strategic management journal 13: 625-634. hoskisson, r.e. and t.a. turk. 1990. "corporate restructuring: governance and control limits of the internal capital market." academy of management review 15: 459-477. jacquemin, a.p. and c.r. berry. 1979. "entropy measure of diversification and corporate growth." the journal of industrial economics 27(4) (june): 359-369. kim, w. c., p. hwang and w.p. burgers. 1993. "multinationals' diversification and the risk-return trade-off." strategic management journal 14: 275-286. lant, t.k., fj. milliken and b. batra. 1992. "the role of managerial learning and interpretation in strategic persistence and reorientation: an empirical exploration." strategic management journal 13:585-608. lee, w.b. and e.s. cooperman. 1989. "conglomerates in the 1980s: a performance appraisal." financial management (spring): 45-54. leontiades, m. 1986. managing the unmanageable: strategies for success within the conglomerate. reading, ma: addison-wesley publishing. lewellen, w. 1971. "a pure financial rationale for the conglomerate merger." journal of finance may: 521-537. lubatkin, m. and s. chatterjee. 1991. ''the strategy-shareholder value relationship: testing temporal stability across market cycles." strategic management journal 12: 251-270. lubatkin, m., h. merchant and n. srinivasan. 1993. "construct validity of some unweighted product-count diversification measures." strategic management journal 14: 433-449. 154 journal ofbusiness strategies vol. 11, no.2 lubatkin, m. and r.c. rogers. 1989. "diversification, systematic risk, and shareholder return: a capital market extension of rumelt's study." academy of mana&ement journal 32: 454-465. markides, c.c. 1992. "consequences of corporate refocusing: ex ante evidence." academy of management journal 35: 398-412. mezias, sj. and ma. glynn. 1993. "the three faces of corporate renewal: institution, revolution, and evolution." strategic management journal 14: 77-101. michel, a. and i. shaked. 1984. "does business diversification affect performance?" financial management 13(4): 18-25. miller, r. and d. wichern. 1977. intermediate business statistics. new york, ny: holt, rinehart and winston. nayyar, p.r. 1992. "on the measurement of corporate diversification strategy: evidence from large u.s. service firms." strategic management journal 13: 219-235. nayyar, p.r. 1993. "the stock market reactions to related diversification moves by service firms seeking benefits from information asymmetry and economies of scope." strategic management journal 14: 569-591. palepu, k. 1985. "diversification strategy, profit performance, and the entropy measure." strategic management journal 6: 239-255. porter, m.e. 1990. the competitive advantage of nations. new york, ny: the free press. ramanujam, v. and p. varadarajan. 1989. "research on corporate diversification: a synthesis." strategic management journal 10: 523-551. rappaport, a. 1986. creating shareholder value: new standards for business performance. new york, ny: the free press. rumelt, r.p. 1974. strategy structure and economic performance. boston, ma: harvard business school press. rumelt, r.p. 1982. "diversification strategy and profitability." strate&ic management journal 3: 359-369. salter, m.s. and w a. weinhold. 1979. diversification through acquisition. new york, ny: the free press. scherer, f.m. and a. ross. 1990. industrial market structure and economic performance. new york, ny: houghton mifflin. senge, p.m. 1990. the fifth discipline. new york, ny: doubleday/currency. simon, h. 1957. administrative behavior. new york, ny: collier/macmillan. fall 1994 brumagim & klavans: conglomerate restructuring 155 varadarajan, p.r. and v. ramanujam.1987. "diversification and performance: a reexamination using a new two-dimensional conceptualization of diversity in firms." academy of managementjournal30: 369-380. venkatraman. n. and i.h. grant. 1986. "construct measurement in organizational strategy research: a critique and proposal." academy of management review 11: 71-87. wemerfelt, b. 1984. "a resource based view ofthe firm." strategic management journals: 171-180. williams, j.r., rl. paez and l. sanders. 1988. "conglomerates revisited." strategic management journal 9: 403-414. woodman, r.w., j.e. sawyer, and r.w. griffm. 1993. "toward a theory of organizational creativity." academy of management review 18: 293-321. wrigley, l. 1970. "divisional autonomy and diversification." unpublished doctoral dissertation, harvard business school. 156 journal ofbusiness strategies vol. 11, no.2 appendix a: conglomerate sample by classification type focusers 1. alco standard 2. allegheny international 3. allis-chalmers 4. american express 5. armco 6. borg-warner 7. brunswick 8. curtiss-wright 9. easton 10. fuqua industries 11. gatx 12. general tire & rubber 13. gulf & western 14. household international 15. ic industries 16. itt 17. litton industries 18. ltv 19. manville 20. national distil. & chern. 21. nl industries 22. norton 23.nvf 24. occidental petroleum 25. ogden 26. olin 27. rollins 28. standex 29. tenneco 30. time 31. transamerica 32. trw 33. union carbide 34. vulcan materials 35. warner communications 36. whittaker 37. zapata holders 1. allied products 2.amax 3. american brands 4. american home products 5. consolidated food 6. coming glass works 7. dover 8. emerson electric 9. figgie international 10.gaf 11. general electric 12. general signal 13. halliburton 14. harsco 15. interco 16. minnesota mining & mfg. 17. national services ind. 18. northrop 19. pfizer 20.ppg 21. raytheon 22. rockwell international 23. sears robuck 24. southdown 25. teledyne 26. united technologies 27. walter (jim) 28. westinghouse fall 1994 brumagim & klavans: conglomerate restructuring 157 appendix b: descriptive statistics of focuser group number of percentage ofcorporate segments frequency 1980 corporate divested revenue divested (group mean) 1 8 25% 2 13 34% 3 6 52% 4 6 52% 5 2 75% >5 2 43% total 37 39% year in which m~or divestment activity was completed year 1981 1982 1983 1984 1985 1986 1987 1988 present total corporate connt 1 1 1 6 5 5 6 12 37 conglomerate restructuring in the 1980's: a study of performance/ strategy linkages intrafirm technical knowledge and competitive advantage: a framework and exploratory study morry ghingold bloomsburg university of pennsylvania bloomsburg, pa ernest h. hall, jr. university of southern indiana evansville, in bruce johnson xavier university cincinnati,oh abstract the ability of managers to monitor; acquire, and manage new technologies may be a critical resource in developing a sustainable competitive advantage (barney, j99j). expanding on recent work by day ( j994), this paper develops a conceptual framework that links intrafirm technical knowledge with the ability to develop and maintain a sustainable competitive advantage. focusing on a sample of production/operation managers, a key industrial buying constituency, an exploratory study was undertaken that examined the linkage between managers' technical knowledge and their decision making styles and outcomes. results of the present study suggest strong relationships among technical knowledge, decision making styles and outcomes. based on these findings, it is argued that firms with managers who possess greater technical knowledge will be better equipped to develop and maintain a competitive advantage. intrafirm technical knowledge and competitive advantage: a framework and exploratory study developing and sustaining a competitive advantage is the ultimate goal of strategic management (barney. 1991; perteraf, 1993). as the research on competitive advantage has progressed and become more focused, adding detail to its application. its usefulness and popularity have increased among both practitioners and academics (barney, 1991; day 1994; wernerfelt, 1984). based on the seminal work of porter (1980, 1985). several strategies have been identified for developing a sustainable competitive advantage: cost leadership, differentiation, and focus. the imperative of pursuing one or more of these broad strategies to fall 1998 ghingold, et al: intrafirm technical knowledge 109 establish a competitive advantage is well understood and widely accepted among academics and practitioners alike (day, 1994; hill, 1988). given the firm grounding upon which competitive advantage has been built, research interest has shifted to prerequisite conditions, skills, resources, and capabilities, which enable a firm to achieve and sustain competitive advantage (barney, 1991; bartness & cerny, 1993; day, 1994; peteraf, 1993; wernerfelt, 1984). through the judicious and effective allocation of critical resources, a firm is able to concentrate on building and exploiting distinctive competencies, which can result in sustainable competitive advantage (barney, 1991). however, such normative prescriptions are fairly broad and difficult for managers to apply. day (1994) has presented a synthesis of current research that integrates competitive advantage with the market-driven organization by providing a holistic perspective of competitive advantage and a conceptual framework that links internal resources, marketplace capabilities, and process factors as drivers of competitive advantage and superior firm performance. day (1994) and other scholars contend that positions of competitive advantage result from market-wide distinctive capabilities (amit & schoemaker, 1993; peteraf, 1993). these broadly defined capabilities are partly based on firm specific competencies (day 1994). according to barney (1991) a firm's resources can be divided into three categories: physical (williamson, 1975), human (becker, 1964), and organizational (tomer, 1987). of these three categories, the human resource will be singled out as a critical business resource and serve as the foundation for the present paper. first, the human component of an organization is the most unpredictable and unique, representing resources that are difficult to understand and replicate; two essential requirements for developing a sustainable competitive advantage (barney, 1991). second, due to the difficulties associated with measurement, the human resource issue has not been widely studied. third, due to their richness and complexity, human resources may be the ultimate source of competitive advantage (leonardbarton 1992; mahoney & pandian, 1992). human resources include such items as: training, experience, judgment, intelligence, and insight of a firm's managers. therefore, human resources at the business level can be understood as complex bundles of skills and knowledge that lead to superior asset utilization or customer service (teece, pisano & shuen, 1991). as mahoney & pandian (1992) suggest, unique capabilities arising from technical know-how and managerial ability "are important sources of heterogeneity that may result in sustained competitive advantage" (p. 365). combining the richness of the human resource with research conducted on business-level strategy (porter, 1980, 1985) and competitive advantage (barney, 1991; wernerfelt, 1984) provides a more complete picture of an organization's potential for success. regardless of the strategy pursued the ability of managers, employees and others to implement the chosen strategy is essential to future success and may determine the firm's fate. 110 journal of business strategies vol. 15, no.2 within this framework technical knowledge plays a major factor in driving business-level capabilities and competitive advantages (leonard-barton, 1992; mahoney & pandian, 1992). this knowledge encompasses employee technical knowledge, training, and experience (leonard-barton 1992; mahoney & pandian, 1992). citing penrose (1959), mahoney & pandian argue that "a firm may achieve rents not because it has better resources, but rather the firm's distinctive competence involves making use of its resources" (1992: 365). one source of distinctive competence is technical knowledge, where efficiencies result from the application of knowledge to the processes of an organization. technical knowledge has continued to play an increasing role in modern business. the importance of understanding innovations within the areas of operations research and technology are clearly evidenced by programs such as total quality management, process reengineering, and just-in-time management. technical knowledge is defined as the knowledge, information, and expertise in applying and managing technology that directly impacts the operations processes of the organization (ghingold & johnson, 1997). such a definition includes familiarity, understanding, and awareness of firm operations, including technologies used, product designs, equipment, production processes, operating facilities, and information systems (porter, 1980). any decision made with respect to business operations is defined as technical decision making. the interaction of technical knowledge and decision making with regard to technical aspects related to production processes is the primary focus of the current study. the present paper will develop and empirically test a theoretical framework that integrates technical knowledge, decision-making style, and outcomes. it is argued that these variables and their associated relationships have the capability to develop and maintain a competitive advantage based on intrafirm technical knowledge. the role of technology in competitive advantage day & wensley (1988) define competitive advantage using a marketplace perspective. in their model, a firm's superiority in technological resources allows it to develop a position of advantage over its competitors. this position is achieved by offering customers the lowest delivered cost or superior customer value, paralleling porter's (1985) business-level strategies of cost leadership, differentiation and focus. the firm's optimal use of current technologies relevant to its industry and markets has been noted by porter (1980, 1985). the importance of technology and technical knowledge for firm success is implicit in both the barney (1991) and day & wensley (1988) frameworks. however, the specific role of technology management in these models has not been critically examined. day (1994) argues that technology management plays a direct role in establishing a competitive advantage. day's classification of key capabilities distinguishes between capabilities that are externally and internally focused. exterfall 1998 ghingold, et al: intrafirm technical knowledge 111 nally focused capabilities are reflective of market-driven firms and are categorized by their outside-in activities (e.g., market sensing, developing linkages and relationships with customers, etc.). internally focused firms emphasize internal capabilities that are deployed from the inside-out and are activated by market requirements (e.g., technology development, manufacturing processes, etc.). within this framework technical knowledge enables a firm to respond to the market and thereby, create and sustain a competitive advantage. this elaboration on the role of technical knowledge in establishing a competitive advantage mirrors the findings in the operation management literature (schmenner, 1983), which has long heralded the strategic importance of technology and technical knowledge (hayes & wheelwright, 1984). effective utilization of technology has been linked to the development of competitive advantages based on several criteria: (1) reduced costs (henderson, 1982; schmenner, 1983), (2) better quality (hayes & wheelwright, 1984), (3) faster adoption of new process technologies (mcfarlan, mckenney & pyburn, 1983; raho, belohlav & fiedler, 1987), or (4) more successful competition, particularly against global competitors (nayak, 1984). thus, for both manufacturing and service organizations alike, effective utilization of technology should be a central part of competitive strategy. many of the principal benefits of effective technology utilization (e.g., cost reductions, quality improvements, improvement in speed of new product developments, etc.) relate directly to the positions of competitive advantage defined by porter (1985), and day & wensley (1988) (i.e., cost and value leadership) and the concept of business capabilities (day, 1994). the application of technical knowledge as a firm resource is also consistent with the resource-based view of the firm (barney, 1991; wernerfelt, 1984). it is upon this critical resource that the development of successful business-level strategies rests (porter, 1980, 1985). based on this discussion, we can conclude that the linkage between technical knowledge and competitive advantage is critical to a firm's future success. managing technical knowledge and competitive advantage the strategic importance of effective technology utilization and management is well understood and widely accepted as a means for creating a sustainable competitive advantage (barney, 1991; becker, 1964; mahoney & pandian, 1992; porter,1980, 1985). however, research efforts have begun to focus on understanding the conditions necessary for developing a competitive advantage (bartness & cerny, 1993; day & wensley, 1994; peteraf, 1993) . it has been argued by ghingold & johnson (1997) that technical knowledge is "an important strategic asset ofthe firm that is essential for achieving and sustaining competitive advantage." the result of obtaining and sustaining a technical knowledge base provides the firm with the ability to exploit technological advances to the fullest and serves as the basis for determining how technology and technological change can best be managed. 112 journal of business strategies vol. 15, no.2 figure 1 presents a general framework linking technical knowledge with competitive advantage at a macro level of analysis. as can be seen, the technical knowledge of management may serve as the foundation for developing a competitive advantage. it is suggested that the amount of technical knowledge possessed by management will influence decision style, decision outcome, technology-based competencies, and competitive advantage. all of these variables are contained within the organization, while external market-driven forces will interact in determining decision outcomes and the effectiveness of technology-based competencies. when incorporating technical knowledge and decision making in the context of manufacturing technology, the framework suggests the following relationships: 1. the level of technical knowledge among management will have an impact on the decision-making style(s) used. 2. the decision-making style(s) used by management will result in different outcomes. 3. technology-related decision outcomes will affect the firm's ability to achieve specific technology-based competencies. 4. a firm's ability to develop distinctive competencies and leadership positions will determine its ability to achieve and sustain a competitive advantage. figure 1 a macro framework linking technical knowledge and competitive advantage global constructs: market -driven influences external ------------------------internal management decisiondecision technologymarketplace technical f--+ making ----. outcomes 1----' based finn !----. competitiveknowledl!:e styles competencies advantage the linkages between effective technology management and competitive advantage (i.e., items 3 and 4 above) are discussed by day (1994), and therefore will not be explicitly discussed. (readers are referred to day (1994) for a detailed discussion of these relationships). since day (1994) has established their linkage, we will build on this by investigating the necessary prerequisites for developing technology-based competencies. the nature of the relationships among technical fall 1998 ghingold, et al: lntrafirm technical knowledge 113 knowledge, decision-making style, and decision outcomes will be discussed, identifying the underlying components of each construct in the model. it should be noted that although the same model is presented in figure 2, the critical difference is the level of analysis: figure 2 shows a detailed, micro analysis as opposed to the macro level of analysis of figure 1. for example, management technical knowledge in figure 1 has three core variables: application, effects, and state of the-art technical knowledge. figure 2 presents the variables used in the present study to operationalize the core constructs of management technical knowledge, decision making styles, and decision outcomes. figure 2 a micro framework linking technical knowledge and competitive advantage time horizon market factors influencing decision making market factors determining goals of technology management faster adoption of l'iew processe new products cost leadership value leadership technical knowledge, decision-making style and outcomes johnson (1990) argues that technical knowledge is a prerequisite for improving the quality of technical decision making and concluded that to be more effective, technical decision making requires management to do several things. first, management should increase information use, both in terms of how much is considered (quantity) and how rigorously it is analyzed (thoroughness of analysis). 114 journal of business strategies vol. 15, no.2 second, management must adopt a proactive approach to managing risk by learning how to deal with uncertainty. third, management needs to make use of longer time horizons by avoiding situations that call for immediate decisions. a planning process can minimize the need for immediate decisions. decision-making style can be broken down into four dimensions: information acquisition, information evaluation, risk avoidance (how risk is perceived), and time horizon (when decisions are made) (johnson, 1990). information acquisition style reflects the degree to which a person will seek out information pertinent to the decision being made. it may involve soliciting opinions from others, asking questions, seeking out relevant studies, or relying on one's own understanding and knowledge. we contend that the amount of technical knowledge one possesses will be correlated with the information acquisition style used in gathering information. managers with greater technical knowledge will be more likely to adopt an extensive search for information than managers with less technical knowledge. first, greater amounts of technical knowledge broaden a manager's mind to the complexity of technical decisions and the plethora of available solutions, while managers with less technical knowledge may oversimplify the problem or seek to "satisfice" by adopting a less than optimal solution. second, understanding breeds interest and excitement. such an interest will lead to a more detailed approach to information acquisition. third, the gathering of information is time consuming. managers with less technical knowledge will be unable to adopt a very detailed approach to information acquisition. managers with a greater amount of preexisting technical knowledge will be better able to assimilate and grasp the details of developing technologies than managers with less technical knowledge. hypothesis 1: the greater the technical knowledge of an operating manager, the more detailed his/her information acquisition style will be. information evaluation style may involve top down, bottom up, logical, intuitive, or systematic approaches, as well as what-if or scenario planning. it is believed that managers with a greater amount of technical knowledge will adopt a more systematic approach to decision making since a greater amount of information is available. only through such a detailed process can information be accurately evaluated. managers with less technical information must either adopt a detailed search to obtain the necessary information or rely on more intuitive methods of evaluation. hypothesis 2: the greater the technical knowledge ofan operating manager, the more systematic (versus intuitive) his/her information evaluation style will be. fall 1998 ghingold, et al: lntrafirm technical knowledge 115 the element of risk is an inherent condition of decision making. managers often perceive different levels of risk given the same situation, which can be explained by a manager's previous experience, knowledge, information, and familiarity with a particular decision. since risk is measured by the level of uncertainty, managers possessing greater expertise or knowledge tend to perceive lower levels of risk than less knowledgeable and less experienced managers in similar situations. knowledge of the details of technological processes decrease the amount of risk perceived by the decision maker and are likely to be less risk averse than less qualified managers. hypothesis 3: the greater the technical knowledge of an operating manager, the less averse he/she will be to making manufacturing decisions under risk or uncertainty. when making decisions, managers are confronted and influenced by time constraints. one such time constraint involves the lead time required to recoup the capital expenditures associated with a particular decision. for example, the decision to adopt new technology will likely require a large investment of capital. due to the nature of major technological changes, large capital expenditures may be required over a prolonged period of time before any positive effects are realized. making such a decision, although it may be in the best interest of the firm in the long term, may be financially devastating in the short term. we argue that such decisions will be affected by the amount of technical knowledge possessed by the decision maker and that higher levels of technical knowledge result in the confidence necessary to invest in such long term projects. managers with lower levels of technical knowledge will be more likely to adopt a short term perspective, since they lack the requisite knowledge to fully understand the new technology and opportunities for exploiting it. hypothesis 4: the greater the technical knowledge of an operating manager, the longer hislher time horizon will be in making manufacturing related decisions. we evaluate the outcomes of the decisions along two dimensions: quality and timeliness of the decision. the quality ofthe decision can be judged by whether or not it was successful in accomplishing its goals. greater levels of technical knowledge by management are expected to lead to better decision outcomes, assuming that the application of more effective decision-making styles will result in better decisions (i.e., higher quality decisions can be made in a more timely manner). effective decision-making styles include detailed information acquisition, systematic information evaluation, less risk aversion, and a long-term perspective. our reasoning is that managers with more relevant information will make better decisions than managers with less information, resulting in more 116 journal of business strategies vol. 15, no.2 successes. since more information is understood, evaluated, and utilized, the resulting decision should be more successful. hypothesis 5: the greater the technical knowledge of an operating manager, the higher the quality of his/her manufacturing related decisions. an age old maxim states that "more information is better than less." while this may be true, managers are bound by time in that there is an inherent trade-off between better quality decisions and time. technical knowledge assists the manager in making timely decisions for several reasons. first, when a manager is familiar with the technical information, there is less need to gather additional information, since the manager's expertise serves as a first screen in evaluating options. second, if additional information is necessary, he or she will be able to identify what type is needed. managers with less technical knowledge must undertake an initial search to familiarize themselves with the new information. this allows technically competent managers the added advantage of making decisions in a more timely manner. what might be a great decision at one point in time may not be nearly as attractive at another point in time. as less technically competent managers search for and study additional information, the opportunity to exploit a decision to its fullest may be missed, while technically competent managers already have the necessary information and can spend more time evaluating their options for the greatest probability for success. hypothesis 6: the greater the technical knowledge of an operating manager; the more timely (neither too early nor too late) his/her manufacturing related decisions. methodology sample in order to test the theoretical model and the associated hypotheses a mail survey methodology was deemed most appropriate. the target population was comprised oftwo groups: top level manufacturing executives and operations managers (with day-to-day responsibility) of manufacturing firms. both of these managers are of great interest to businesses since they play critical roles in determining manufacturing equipmentand services-related purchases. (see hutt & speh (1995) for a presentation of the buying center construct and a description of buying center roles.) operation managers are the primary users of manufacturing or process technologies and are therefore likely to exert major influence over the buying decision process for technological (and technologically-related) purchases. in many fall 1998 ghingold. et al: intrafirm technical knowledge 117 cases operations managers are given the authority to be the ultimate deciders, personally making the final decision. some operations managers also play gate-keeping roles if they have direct control over information used within the buying center. therefore, operations managers should be viewed as a key constituency when it comes to making technology purchase decisions. likewise, top level managers are likely to exert a great deal of influence over the buying decision process, due to in large part to their position as strategy setters. since technological purchases can have a dramatic impact on a firm's strategy, top-level mangers will want to insure that these purchases and the resulting technology "fit" with the organization's overall strategy. to insure adequate representation of both top executives and operations managers in the sample, two mailing lists were compiled to sample the target population. to reach the top executives of manufacturing firms the first list was compiled utilizing information provided by the leaders of the american production and inventory control society (apics) chapters from the midwest. the leaders provided a list of senior executives that belonged to four apics chapters. this list contained only names of high-level manufacturing executives from the midwestern united states. therefore, the population of senior managers of manufacturing firms in the midwest was surveyed. the second list, containing only operations managers, was obtained from the same four midwest chapters ofapics. each of the operations managers contained on this second list were included in the mail survey. a total of 1,248 managers, including both operations managers and senior managers, were mailed questionnaires. a single follow-up survey was used in an attempt to obtain the largest number of possible respondents. a total of 169 usable questionnaires were returned, yielding a response rate of 13.5 percent. the response rate is representative for mail surveys not offering compensation (hall, 1976; ryan, 1987). both operation managers and top management were represented in the final sample. approximately 60% of the respondents were operating managers and 40% were top managers. a group comparison test was performed to determine whether there was any significant difference between operating and top managers across the variables in question. no significant differences were reported between the two samples on any of the variables. therefore, the results of this study are equally comparable to operation managers and senior managers of manufacturing firms. measurement all variables were measured using multiple items from a questionnaire using a 5-point likert scale. the appendix contains a listing of the constructs used for all of the variables included in this study along with their associated reliability tests (cronbach's alpha). technical knowledge. technical knowledge has received a great deal of attention in the operations literature as a theoretical concept, but has yet to be rigor118 journal of business strategies vol. 15, no.2 qusly measured. this lack of attention may be attributable to the difficulty associated with operationalizing the concept of technical knowledge. technical knowledge is defined as knowledge, information, and expertise in applying and managing technology that directly impacts the operations and manufacturing processes of the organization (ghingold & johnson, 1997). drawing from the extant literature on the subject, three components or aspects of technical knowledge can be identified. (for a more detailed discussion please refer to johnson (1990». for the purposes of the present study, these components can be classified into the following three categories: 1. application: knowledge related to the application of equipment and process technologies by the manufacturing firm (weitzel, 1984; gregennan, 1981); 2. effect: knowledge related to the effect of equipment and process technology on the management of the manufacturing firm (skinner, 1985); 3. currency: knowledge of state-of-the-art techniques or technologies gaining acceptance in advanced manufacturing firms (thurow, 1987; hayes & wheelwright, 1984; henderson, 1982). in order to measure technical knowledge, a variety of items representing each of these components were drawn from the extant operations literature (using five point interval scales). results of reliability tests conducted on the questions used to measure each construct (cronbach's alpha) suggest that the questions, scales, and constructs were reliable measures of the concepts being investigated in the present study. the questions and scales used to measure technical knowledge demonstrated a high degree of inter-item reliability with cronbach alpha scores ranging from a low of .86 to a high of .94. technical knowledge was evaluated on the basis of knowledge scores for each of the three knowledge components independently. by treating the three components as different dimensions it was possible to determine if certain types of technical knowledge are more consequential than others. decision-making style. decision-making style is a multidimensional con~ struct that reflects a person's individual decision-making process. in particular, the four variables used are: information acquisition, information evaluation, risk (risk aversion), and time horizon (long-, short-term). inter-item reliability was good with cronbach alpha scores ranging from .54 to .66. decision outcomes. decision outcomes are evaluated by assessing the quality (success, failure) and timeliness (fast, slow) of the decision. although there is an inherent trade-off between these two variables it is necessary to strike a balance between the two. decisions that are evaluated as successful may have taken such a long time that the benefits were severely diminished, whereas a more timely, but less optimal decision may have resulted in a greater benefit to the organization. cronbach alphas for the two decision outcome variables were .53 and .59. fall 1998 ghingold, et al: intrafirm technical knowledge 119 statistical analysis to test the relationships between technical knowledge (application, effect, currency), and decision-making style (infonnation acquisition, infonnation evaluation, risk avoidance, time horizon), and decision outcome (quality and timeliness of decisions) a series of multiple regression analyses were performed to detennine how well respondents' technical knowledge scores could predict the decision style used and decision outcomes. since all ofthe variables were obtained using a likert 5-point scale, which approximated an interval scale, we used multiple regression analysis, making it possible to treat the data as continuous measures of technical knowledge, decision making, and outcomes. this allows for a more rigorous test of the hypotheses. therefore, each of the dimensions of decision-making style and outcomes was introduced as dependent variables, while the three dimensions oftechnical knowledge were used as independent variables. the general model used in the regression analysis can be represented as follows: decision-making style and outcomes = f (technical knowledge) the specific models tested included a total of six multiple regression models. information acquisition = 81 knowledge application + 82 knowledge effect + 8) knowledge currency information evaluation = 81 knowledge application + 82 knowledge effect + 8) knowledge currency risk aversion = 8) knowledge application + 82 knowledge effect + 8) knowledge currency time l-iorizon, = 81 knowledge application + 82 knowledge effect + 8) knowledge currency quality of outcome = 8) knowledge application + 82 knowledge effect + 8) knowledge currency timing of decision = 81 knowledge application + 82 knowledge effect + /3) knowledge currency the results of the regression analyses appear in table 1. 120 journal of business strategies vol. 15, no.2 table 1 regression analysis of decision making variables technical knowledge components application of effects of currency of technical technical technical decision-making knowledge knowledge knowledge variables r2 beta weight beta weight beta weight) (t) (t) (t) f information acquisition information evaluation risk handling time horizon quality timeliness .355 -.028 .181 (3.10)3 (0.32) (1.95)4 .13 6.92 2 .154 .081 .151 (1.61 ) (1.15) (1.98)4 .10 5.482 .337 .031 0.80 (3.84)2 (0.49) (1.14) .16 9.40 1 .533 .028 .211 (5.30)1 (0.38) (2.63)3 .30 20.49 1 .312 .009 .158 (3.50)2 (0.14) (2.25)4 .17 10.10 1 .393 .104 -.026 (3.47)" (1.26) (0.29) .13 7.46 1 i test statistic significant at <= 0.000 1 2 test statistic significant at <= 0.00 1 'test statistic significant at <= 0.01 4 test statistic significant at <= 0.05 results and discussion the results suggest that technical knowledge is a very strong predictor of the decision-making style and outcome variables investigated in the present study. all models reported high levels of statistical significance (p<.oo 1), with r2 s ranging from a low of .10 to a high of .30. such results support the argument that technical knowledge does in fact influence the decision-making styles of managers. findings also reflect that technical knowledge will have a positive influence on the quality and timeliness of decision making. of the three technical knowledge components studied, application and currency (or state-of-the-art technological innovations) were the strongest predictors of the fall 1998 ghingold, et al: lntrafirm technical knowledge 121 decision-making variables, thereby confirming hypothesis hi technical knowledge on how to apply equipment and process technologies was the strongest predictor of decision-making style, reaching significance in five of the six models tested. these findings suggest that the amount of technical knowledge possessed by managers will have a large effect on the decision-making style used and the success of subsequent outcomes. managers with higher levels of technical knowledge are more likely to be willing to assume greater levels of risk, adopt longer-term perspectives, and utilize more intensive information-gathering techniques. the outcomes of the decisions that are made by managers with higher levels of technical knowledge are also more likely to be successful in terms of the quality of the outcome and the timeliness in which the decision was made. these findings provide support for hypotheses hs and h6 . due to the larger amount of technical knowledge available to these managers, they are capable of determining what additional information is needed, where to get it, and are able to get it sooner than the managers with less knowledge. such a situation affords a firm the opportunity to move more quickly and decisively in capturing and exploiting a competitive advantage. the other dimension of technical knowledge that was important in predicting the decision-making style was currency. currency was significant (p < .05) in explaining decision making style and outcomes in four of the six models. managers that keep themselves up to date on the most recent technologies and techniques available tend to use extensive techniques in gathering and evaluating information, and make decisions with longer time horizons than managers with less knowledge of current developments, and make higher quality decisions. it should be noted that the third element of technical knowledge, effect of equipment and technology on management, was not significant in any of the models tested (rejecting hypothesis h2). it is possible that technical decisions do not currently consider the effects of technological decisions on management because they have been considered irrelevant in the past. the results may also be a function of the type of people making the technical decisions within the firm. being largely engineering or scientifically trained in their professions, managerially related issues associated with technical decisions may not be within their area of training. therefore, it is not that these effects are unimportant to the firm as a whole, but that the training and expertise of the managers making the decisions are incongruent with managerial implications. for a long time such "technical" decisions have been left to the technocrats of the organization, with little if any consideration for the effects on management. another explanation for the lack of significance is that application and effect may be inseparable within the decisionmaking process. this aside, the findings of the study are generally consistent with the proposed theoretical model and research hypotheses. the results offer preliminary empirical evidence establishing the value of technical knowledge as an important 122 journal of business strategies vol. 15, no.2 resource for manufacturing finns, particularly as a means for achieving and sustaining a competitive advantage (barney, 1991). however, it should be noted that the three components of technical knowledge were not equal predictors of the decision-making variables (see table 1). in particular, knowledge related to the application of technology was the strongest predictor, while knowledge related to the managerial effects of technology was the weakest predictor. knowledge of state-of-the-art techniques and technologies was a significant predictor for all of the decision-making variables except risk aversion and timeliness. overall, managers with higher levels of technical knowledge employ more advantageous decision-making styles, in tenns of the four dimensions studied, and have more favorable decision-making outcomes. these results hi~hlight the importance of technical knowledge to a finn that is striving to establish and maintain a competitive advantage. implications for management of technical knowledge viewing technical knowledge as a strategic asset upon which to build a competitive advantage used to be considered an unorthodox view for most management professionals. however, with the popularity of the resource-based view of the finn (wernerfelt, 1984; barney, 1991) and its implications for exploiting the use of infonnation in establishing a competitive advantage, the importance of having more knowledge cannot be ignored. the importance of knowledge as a resource may well be the next great development in the ever expanding search for competitive advantage. given the rapid pace oftechnological change occurring throughout the world, the demand for timely and accurate decisions simply cannot be postponed without dire consequences. decisions pertaining to when to adopt new technologies and how to fully exploit them become imperative if a finn is going to succeed. therefore, managers must take appropriate actions to insure the future viability of their organizations on technological grounds. several things are clear: (l) the technical component of the organization's resources is not a generic product, but one that must be actively managed to be successful, (2) the implementation of technical decisions can offer finns a competitive advantage that cannot be easily imitated by competitors, since the requisite knowledge, skills and training are imbedded in the human resources of the finn, and (3) greater amounts of technical knowledge will result in higher quality and more timely decisions. all too often, managers see themselves as repositories for endless infonnation and targets for incessant communications. this clutter and competition for the manager's time and attention has had a negative outcome. many 'managers are unreceptive to new infonnation whether from vendors or other sources. knowledge, and of particular importance to the present study, technical knowledge, is a fall 1998 ghingold, et al: lntrafirm technical knowledge 123 resource with major strategic ramifications that will impact a firm's level of competitiveness. the acquisition and development of technical knowledge will have longterm implications for business organizations, since managers with more technical knowledge tend to adopt a long-term perspective when it comes to making decisions. managers must be trained to view such information not as an intrusion into their "normal" role as manager, but as valuable information that can have a great impact on an organization's performance. in addition, it can be argued that such information should be actively sought out and viewed as opportunities, and not as threats to their time. managers who recognize the value of additional technical knowledge will be able to exploit opportunities that may otherwise have gone unnoticed. this change in the mind-set of many managers will be required before specific "knowledge strategies and tactics" can be implemented. the starting point in this process rests with top management. changing management values, orientations or cultures is difficult. organizational inertia, resistance, conservatism and fear all limit a firm's ability to change and adopt new and more effective methods of operation. a shift in the organizational culture to embrace technical knowledge as a vehicle for long-term competitive advantage must first be adopted by senior management. this top down approach is necessary to develop an organizational commitment to, and ultimately a written policy for, knowledge acquisition that reassures all levels of management that the time taken to gain technical knowledge is time well spent. the support of top management is the catalyst in establishing an atmosphere in which technical knowledge is valued and pursued. for procurement once the value of technical knowledge as a resource is accepted, purchasing and materials management professionals can play important roles for their organizations. burt (1984) has called for purchasing managers to accept their important role as a key contributor in the strategic management of the firm. purchasing managers must recognize the value of knowledge in today's competitive marketplace and take specific steps to acquire the necessary information, establish distinctive competencies, and build long lasting competitive positions. in order to develop a competitive advantage, purchasing managers can develop specific strategies for managing the process of knowledge procurement within their firms. one approach could involve what may be called "no dollar cost" sources of technical knowledge or proactive gate-keeping. these strategies involve basically no additional costs and may include such things as: 1. certifying or qualifying strategic vendors and developing strategic relationships with technological leaders. inclusion of vendors that provide strategically important materials in the decision-making process can increase the organization's amount of technical knowledge. 124 journal of business strategies vol. 15, no.2 2. welcoming or encouraging sales calls and presentations, particularly those of a technical nature. recognizing the importance of technically knowledgeable managers that are more willing to entertain new technological innovations by soliciting the assistance of firms with superior technical information. 3. increasing or maximizing technical inputs and information from all current and potential suppliers to benefit from their specialized knowledge and competencies. adopting an open door policy with regard to technical knowledge will allow for a relationship more conducive to learning. 4. encouraging technical personnel to interact with technical vendors and technical experts from vendors. staying abreast of technological trends will increase a firm's ability to identify potentially useful innovations before competitors. the additional lead time allows firms to develop first mover advantages that cannot be easily imitated. such proactive approaches to procuring and disseminating technical knowledge involve non-monetary costs and the desire to search out relevant information and integrate it into the organization. it should be noted that these strategies do require a new approach to managing knowledge as a resource. therefore, significant incremental effort and specific strategies are required to successfully utilize the technical knowledge gathered. purchasing efforts regarding the gathering of technical knowledge may also require the disbursement of additional capital these additional funds can be used for the proactive procurement of technical knowledge. although there are a variety of different sources that can provide technical knowledge to a firm and its managers, some of the more commonly used sources include workshops or seminars, consulting contracts with individuals or organizations possessing valuable expert knowledge that can benefit the firm and its operating personnel, subscriptions to relevant technical and professional journals and periodicals which can be passed on for reading by operations managers, trade show attendance (including multiple trade shows, not just the firm's industry show), and company support for the continuing education of operating personnel. it can be said that many firms currently "buy" one or more of these sources of technical knowledge. however, that does not insure that the firm will gain the technical knowledge required to be successful. although the information is available, the problem is the lack of coordination between the acquisition of knowledge and its implementation. all too often, firms buy such information without a long-term knowledge procurement strategy in place. clearly the impact of informed, cutting edge, long-term oriented decision making on firm competitiveness is great. it is imperative that all levels of management be valued for the important role they play in developing the kinds of policies and culture that encourage the transfer of technical knowledge among the managers of the firm. fall 1998 ghingold, et al: lntrafirm technical knowledge 125 for management competitive advantage lies at the heart of strategic management, so any discussion of competitive advantage will have implications for management. studying the linkage between customers, their needs and expectations, and the finn's actual product offering is the basis for developing a competitive advantage. in this paper we have discussed one potential source upon which a competitive advantage can be built technical knowledge. by increasing the quantity of technical knowledge within a finn, managers can expect to recognize improvements in the quality and timeliness of decision making in matters pertaining to technological processes within the firm. educating themselves and their employees on technical processes and infonnation opens the door to more productive decision making. although the present study focused on technical knowledge as a means of developing a competitive advantage, it should not be viewed in isolation from the rest of the organization's resources and activities. instead, technical knowledge should be viewed as an example of how infonnation resources can be utilized in establishing a competitive advantage. although there are a variety of infonnation resources available to finns, we chose technical knowledge to illustrate the point that infonnation and knowledge can be resources upon which a competitive advantage can be built. the development of a sustainable competitive advantage is a complicated undertaking and all of the components of an organization must work together to be successful. however, the availability of technical knowledge within an organization will affect the finn's perfonnance. the usage of this technical knowledge will assist managers in exploiting technological synergies and efficiencies. adequate amounts of technical knowledge will provide the foundation for the ultimate survival of the finn. as an example of the unavoidable interrelatedness among departments, wilson & ghingold (1987) noted that frequently there have been poor coordination and communication between r&d and marketing departments. the production side of many business organizations is not adequately linked to the needs of the marketplace. marketing may need to take a more active role in specifying technical advancements currently under development since they possess the requisite knowledge of consumer desires. in this way customers will ultimately be more satisfied with the products developed by the finn, thereby helping the finn establish a potential competitive advantage. in the context of this paper, management has again several roles to play. for example, management should be actively involved in technological issues affecting manufacturing to insure that any such investments do in fact contribute to making the organization more competitive (i.e., developing or sustaining a competitive advantage). manufacturing technology decisions that do not meet this basic threshold should be challenged. understanding the technical issues and how they will affect the organization is key to making the best decision possible. managers that stay abreast of the latest technological advancements will be in a better 126 journal of business strategies vol. 15, no.2 position to make these critical decisions in a timely and efficient manner. since the managers are current in technological matters they will more accurately assess the potential impact of any changes on the future performance of the firm. management also has the responsibility for guiding manufacturing technology by highlighting the areas most in need of attention. in order for managers to accurately assess such situations, it is important that they have the necessary technical knowledge to make educated decisions. for example, management should indicate whether cost leadership is the desired goal versus quality or feature enhancement (differentiation). the strategy chosen by management will indicate the path and pattern of resource allocations that will be most beneficial to achieving a sustainable competitive advantage. depending on the strategy chosen, manufacturing and engineering and all other functions will choose different paths in order to reach the goals that have been set. a solid understanding of the competitive advantage being sought is necessary to make strategic decisions that are consistent with the firm's overall strategy. a third management issue involves the marketing and communicating of technical skills and achievements. this problem can be looked at in several ways. if proper management of technology has yielded an advantage, management wi ii be responsible for exploiting it. thus, management must plan for the introduction of "new and improved" product offerings that will maximize the competitive advantage. this mandates target marketing to identify and reach appropriate prospects who will value the new offering. additionally, management may seek to exploit the firm's technical competence as a competitive tool, offering it as a value-added service to both current and prospective customers. the use of technical competence as a value-added service has its own set of management and programming requirements. conclusions this paper has promoted a new proposition for management's consideration. a theoretical model was developed based on the concept of knowledge, particularly technical knowledge, as it is related to manufacturing operations and processes, which highlights the importance of knowledge as a strategic resource. the foundation of the model is that a firm's technical knowledge can be a valuable resource in helping firms build or maintain a competitive advantage. results of an exploratory study examining the relationship between technical knowledge and operations decision making demonstrated a strong linkage between managers' technical knowledge and effectiveness of decision making. our results suggest that firms with managers that have more technical knowledge tend to make higher quality and more timely decisions. such results are consistent with the proposition that technical knowledge cannot be ignored. therefore, the extent to which technical knowledge is acquired, stored, disseminated and utilized will be an important determinant of a firm's long-term competitiveness. fall 1998 ghingold, et al: intrafirm technical knowledge 127 top management has the preeminent role to play in this process. it is through the actions of senior managers that an organization and its management can develop a new culture where technical knowledge is valued and pursued. only then will purchasing management have important responsibilities in this context. proactive strategic purchasing adds new priorities to its management: developing strategic knowledge sources and effectively managing knowledge procurement. similarly, managerial implications for management were developed. management's involvement here is to link technical decision making with the strategic goal of developing and sustaining competitive advantage, identifying the appropriate technical objectives, and developing effective strategic programs to exploit technically-based advantages. perhaps the most critical issue for all fields and levels of management, however, is to recognize the importance of technical knowledge and its impact as one of the crucial "inputs" needed for a firm's success in a dynamic and highly competitive global marketplace. specifically, organizations must be conscious of the effect of management's technical competency on future performance. by understanding the results of the present study management can focus their attention on increasing the quantity and quality of technical competence within its organization. the relationships discovered suggest that managers need to devote considerable time to the development of technical expertise. such expertise can have a dramatic influence on the decision-making style of managers. the impact of technical training programs becomes a prime avenue for enhancing a firm's effectiveness by altering the decision-making style of its managers. firms "that pursue technical training for its managers will benefit from increases in information acquisition and evaluation, risk handling, longer time horizons, better quality decisions, and decisiveness in decision making. references amit, r., & schoemaker, p.j.h. (1993). strategic assets and organizational rent. strategic management journal. 14,33-46. barney, j. (1991). firm resources and sustained competitive advantage. journal of management. 17, 99-120. bartness, a., & cerny, k. (1993). building competitive advantage through a global network of capabilities. california management review. 36(1), 78-103. becker, g.s. (1964). human capital. new york: national bureau of economic research. burt, d.n. (1984). proactive procurement. englewood cliffs, nj: prentice-hall. day, g.s. (1994). the capabilities of market driven organizations. journal of marketin~• ..l8., 37 -52. 128 journal of business strategies vol. 15, no.2 day, g.s., & wensley, r. (1988). assessing advantage: a framework for diagnosing competitive superiority. journal of marketing. 52, 1-20. ghingold, m., & johnson, b. (1997). technical knowledge as value added in business markets: implications for procurement and marketing, industrial marketing management. 26(3), 271-280. gregerman, i.b. (1981). knowledge worker productivity. american management association, ama briefing. hall, j.l. (1976). organizational technology and executive succession. california management review. 19(1),35-39. hayes, r.h., & wheelwright, s.c. (1984). restoring our competitive edge: competing through manufacturing. new york: john wiley & sons. henderson, r.p. (1982). the high technology industry is taking off. but there may be one hitch: the serious shortage of engineers. how did it happen and what should be done? enterprise, march. hill, c.w. (1988). differentiation versus low cost or differentiation and low cost: a contingency framework. academy of management review. 13,401-412. hutt, m.d., & speh, t.w. (1995). business marketing management.(5th ed.). dryden. johnson, b. (1990). the interaction of equipment and process technology knowledge and decision making methodology. unpublished doctoral dissertation, university ofcincinnati, cincinnati. leonard-barton, d. (1992). core capabilities and core rigidities: a paradox in managing new product development. strategic management journal. 13 (summer), 111-125. mahoney, j.t., & pandian, j.r. (1992). the resource-based view within the conversation of strategic management. strategic management journal. 13,363-380. mcfarlan, f.w., mckenney, j.l., & pyburn, p.p. (1983). information archipelago-plotting a course. harvard business review, 16 (january-february), 145-156. nayak, p.r. (1984). too many u.s. technologists are managerially illiterate. high technology, september, p. 10. penrose, e.t. (1959). the theory of the growth of firms. new york: john wiley & sons. peteraf, m.a. (1993). the cornerstones of competitive advantage: a resource-based view. strategic management journal. 14, 179-191. porter, m.e. (1980). competitive strategy. new york: the free press. fall 1998 ghingold, et al: intrafirm technical knowledge 129 porter, m.e. (1985). competitive advantage: creating and sustaining superior performance. new york: the free press. raho, l.e., belohlav, j.a., & fiedler, k.d. (1987). assimilating new technology into the organization: an assessment of mcfarlan & mckenney's model. management information systems quarterly, 11,47-57. ryan, m. (1987). the influence of technologists on corporate decision-making in the united kingdom. international journal of qderations management. 7(3), 14-25. schmenner, r.w. (1983). every factory has a life cycle. harvard business review, 16, (march-april), 121-129. skinner, w. (1985). manufacturing: the formidable competitive weadon. new york: john wiley & sons. teece, oj., pisano, g., & shuen, a. (1991). dynamic capabilities and strategic management. working paper, university of california, berkeley. thurow, l.c. (1987). the task at hand: after decades of excuses, it's time for american managers to learn technology. the wall street journal, (june 12), 46d. tomer, j.e (1987). organizational capital: the path to higher productivity and well-being. new york: praeger. weitzel, j.r. (1984). managing the implementation of information systems: a multiple industl)' investigation of process. information systems-user relationships. and project outcomes. unpublished doctoral dissertation, university of cincinnati, cincinnati. wernerfelt, b. (1984). a resource-based view of the firm. strategic management journal. ~, 171-180. williamson, o.e. (1975). markets and hierarchies: analysis and antitrust implications. new york: free press. wilson, d.t., & ghingold, m. (1987). linking r&d to market needs. industrial marketing management. 16(3),207-214. 130 journal of business strategies appendix vol. 15, no.2 reliability tests (cronbach alphas) for all constructs used in the study. technical knowledge application of technical knowledge effects of technical knowledge state-of-the-art technology knowledge decision-making styles information acquisition information evaluation risk avoidance time horizon decision outcomes quality of decisions timeliness of decisions .94 .94 .86 .58 .61 .54 .66 .53 .59 intrafirm technical knowledge and competitive advantage: a framework and exploratory study keys to improving economic performance at the business unit level: business strategy, funcnonal skills and key success facfors james j. chrisman louisiana state university baton rouge, louisiana william r. boulton auburn university auburn, alabama strategy is generally described in terms of the fit between an organization and its environment [3]. strategy evaluation typically includes the analysis of this fit in terms of the firm's internal strengths and weaknesses and the opportunities and threats of its external environment [46]. the quality of the resulting strategic fit is argued to affect a firm's economic performance ([27], [38], [33], [48]). leading theorists further argue that at the business level, a firm's skills and distinctive oompetences are the key building blocks of strategy ([27], [36]) and that strengths in different types of skills are needed to effectively pursue different types of strategies ([32], [33], [35]). even though both the levels and types of competitive skills are considered important to the economic success of a strategy [28], few studies have oonsidered them simultaneously in support of this oontention. researchers have studied strategy-performance relationships in terms of oompetilive environments ([23], [42], [15], [11], [16], [2], [49]), competitive positions ([39], [14], [50], [13]), and key functional policy decisions ([18], [9], [12], [29]). these studies concentrated on how such variables affect the scope component of competitive strategies, the investment component of business strategies, and the firm's economic performance. while verifying the importance of the environment in formulating effective business strategies and supporting the notion that sustainable competitive advantages are related to superior performance, these studies have not identified how internal functional skills affect business-level performance. studies investigating the relationships among strengths and weaknesses, strategies, and firm. performance ([to], [19], [20], [21], [22]), have generally supported the work of earlier theorists ([40], [3], [27]). they have, however, almost without exception, concentrated on corporate-level strategy issues. the only business-level studies conducted to date have investigated the relationships between functional strengths and strategies, strengths and performance, and strategies and performance ([6], [41], [43]). there have been no business level studies though that have investigated how a firm's functional skills moderate strategy-performance relationships. because corporate performance depends on the performance of individual business units [24], studies investigating the relationships between strategies, functional skills, and performance at the business-level are clearly needed. such a study must also account for the external factors already found to have relationships with strategy and performance. 170 journal ofbusiness strategies vol. 9, no.2 to fill this gap, this article explores the relationships between competitive strategy, functional skills, key success factors, and economic performance at the business unit level. the study analyzes 27 fmns from six industries using what harrigan [17] called a medium-grained research methodology. it is an attempt to build theory and test the broad premise of strategic management that economic success is related to the fit between a business strategy and the competitive skills used to meet the key success factors of an industry. the research questions central to this study are: 1. is a business unit's overall competences in its functional skills related to its economic performance? 2. is the fit between a business unit's competitive strategy, its dominant functional skills, and its industry's key success factor related to its economic performance? the lack of research and mid-level theories concerning the relationships between competitive business strategies, functional skills, and economic performance make hypothesis testing impractical for this study. there are classification systems for business strategy [5], skills [35], and key success factors [31], but few, if any, adequate propositions concerning the combinations of skills and key success factors required for a particular strategy to achieve superior economic performance. it is the intent of this study to generate such propositions. conceptual framework & language the conceptual framework used in this study (figure 1) can be described as follows. since strategy represents the fit between an organization's functional skills and the key success factors in its competitive environment ([24], [27], [38], [32]), a business unit's choice of strategy should be influenced by the nature of its functional skills vis-a-vis those skills that are critical to success in its chosen domain of operations. the competitive strength of such skills should further determine the effectiveness of this strategy in achieving an advantageous competitive position and superior economic performance ([3], [24], [27], [1], [32]). functional-area skills this study identified the skills that form the basis for competitive strategy, and may provide an organization with its competitive advantages. functional skills include the tasks a firm performs in creating, producing, distributing, and marketing its products or services. thus, four types of functional skills are used in this study: research and development (r&d), manufacturing, distribution, and marketing ([4], [44], [27]). a business unit's dominant skill is defmed as the functional skill that it performs better than any of its other functional skills. we use the concept of dominant skill to supplement the concept of distinctive competence [40] because not every firm has a competence so distinctive that it provides it with a competitive advantage ([3], [27], [41]). by contrast, a dominant skill is the key functional skill upon which the business unit falll992 chrisl1ul1l & boulton: keys to improving performance 171 has based its strategy. by definitio~ every fum has a dominant skill whether or not it provides a basis for competitive advantage. figure 1: conceptual framework key success facrors in competitive environment business unit's dominanf functional area skills business unit's compei'ltlve strategy business unit's competitive posmon business unit's economic performance the competitive environment how does an industry's environmental context determine if a firm's functional skills and strategy provide it with sustainable competitive advantages? most authois would suggest that strategy evaluation must compare the business unit's dominant skills or distinctive competences with its industry's key success factols to determine whether it can develop competitive advantages ([46], [4], [3], [24], [27], [36], [32], [31]). the term "key success factor" denotes the functional skill that is considered critical to success in an industry [31] even though other skills might be more important in certain segments of an industry. research has sliown that business performance is related to a firm's ability to develop strengths in areas that are key to success in its industry [43]. for the purpose of this study, the four functional skills used to classify and identify the key success factor in each industry are research and development, manufacturing, marketing, and distnbution. competitive strategies business strategies determine the fit between an organization's dominant functional skills and competences (i.e., corresponding strengths and weaknesses) and the key 172 joumal ofbusiness strategies vol. 9, no.2 success factors in its competitive environment (i.e., corresponding opportunities and threats) as it pursues its objectives [27]. realized strategies are, of course, the fit that actually is achieved [30]. business strategies consist of three substrategies (investment, competitive, and political) which describe the nature of the strategic fit with the industry ([24], [27]). competitive strategies describe how resources are committed to functional skills and used to attain competitive advantages in the industry. competitive strategies consist of three primary components: scope, segment differentiation, and competitive weapons ([1], [33]). consistent with the work of chrisman, hofer, and boulton [5], this study integrates the generic strategy classification schemes developed by abell (differentiated, undifferentiated, and focus) and porter (cost leadership, differentiation, and focus) to account for all three components of strategy. both abell's and porter·s schemes are described below. according to abell [1], a business can be defined by the scope of its offerings and the extent to which its offerings are differentiated across market segments. business definition, therefore, consists of both the scope and segment differentiation components of strategy. at the business level scope can be described by the number and breadth of the total product-market segments a company serves in an industry. segment differentiation describes the extent to which an organization tailors its products, services, or operating methods (competitive weapons) to meet the unique needs of the various segments its serves. using the terminology of chrisman, hofer, and boulton [5], abell's three types of business definition strategies have been adapted for this study as follows: mass-market businesses have broad scopes and use the same competitive weapons in all product-market segments they serve; segmented businesses also have broad scopes, but use different competitive weapons to serve different product-market segments; focused or niche-oriented businesses target only one or a few of the product-market segments in an industry. competitive weapons refer to the way in which a business unit's functional skills are used to meet customer needs and combat rivals. porter's [32] differentiation strategy is based on the use of benefit-oriented weapons appealing primarily to the noneconomic needs of buyers. in this study, this strategy will be referred to as a benefit strategy. porter's cost leadership strategy is based on the use of cost-oriented weapods appealing primarily to the economic (price) needs of customers. utility-oriented weapons refer to the balanced use of both costs and benefits, thereby meeting both economic and non-economic needs of the marketplace. in this study we refer to simultaneous use of cost and benefit weapons as a utility strategy. although porter suggests that the majority of firms that attempt to develop a utility strategy based on the use of both cost and benefit weapons end up "stuck-in-the-middle" with no lasting competitive advantage, research has shown that such an attempt can lead to superior economic performance ([11], [7], [47]). the combination of abell's business definitions with these three types of competitive weapons yields nine possible generic strategies: (1) focused cost; (2) focused utility; (3) focused benefit; (4) segmented cost; (5) segmented utility; (6) segmented benefit; (7) mass-market cost; (8) mass-market utility; and, (9) mass-market benefit fall 1992 chrisman & boulton: keys to improving performance 173 competitive position a business unit's competitive position will be determined by its ability to develop distinctive competences in its functional skills that fit its industry's key success factors, and the degree to which its strategy effectively exploits and enhances this fit ([3], [27). thus, the types of functional skills a business possesses and its level of capability in them should be assessed relative to both its major competitors in the same businesses and its industry's key success factors ([44], [6], [10], [41], [19], [21], [22]). in this study, the level of competitive skill of a business unit in any functional area will be classified as strong, average, or weak, relative to its major competitors. a business unit's overall level of competitive capability is assessed in terms of its combined capability in its functional skills relative to its major competitors. in the world motorcycle industry, for example, the british competitor, norton villiers triumph (nvf), was competitively weak in all major functional areas. however, nvt's dominant skill was in research and development. even though r&d was nvt's dominant skill, japanese competitors had much greater r&d strengths. nvt, therefore, had no significant competitive strengths; in other words, it possessed no distinctive competences. business unit performance a business unit's competitive position results from its ability to develop and exploit competences that fit its industry's key success factors through the application of its competitive strategy. the resulting competitive position will determine its economic (financial and market) performance relative to its competitors. business unit imancial performance has been measured in a variety of different ways such as by return on assets (roa), return on equity (roe), return on sales (ros), and return on value added (rova), to name but a few [25]. objective measures were used to determine relative performance where data were available. however, it was also necessary to use subjective measures because business level performance data are much more difficult to obtain than corporate level performance data. therefore, to compensate for this problem, a business unit's performance was ranked as superior, average, or inferior relative to competition, based on both objective measures and subjective assessments, as discussed below. methodology to understand the nature of the relationship between competitive strategy, skills and competences, key success factors, and performance, a longitudinal analysis of 27 business units from six different industries was conducted. both qualitative and quantitative data were collected and analyzed. research design & s8idple selection hofer [24] argued that the stage of industry evolution is the most fundamental variable for determining an appropriate business-level strategy. he also suggested that 174 jout1idi ofbusiness strategies vol. 9, no.2 the introduction, shake-out, and decline might be most strategically important to a business in developing its competitive strategy. because past studies have supported hofer's contention on the importance of the stage of an industry's evolution in determining business unit performance ([2], [45]), this criterion was used as the primary basis for sample selection. iii selecting the sample for this study, businesses competing in industries in the shake-out, maturity (usually the longest and most prevalent stage observable in an industry's life cycle), and decline stages of evolution were selected. industries in the introductory stage were excluded after initial analysis showed a lack of sufficient data. for each stage of industry evolution studied, two consumer manufacturing industries were selected: one where buyer needs were considered to be primarily benefit-oriented and one where buyer needs were considered to be primarily cost-oriented [24}. in total, 27 businesses from six industries were studied. market growth rates and the assessments of industry observers were used to identify each industry's stage of evolution. to ensure an adequate mix of functional competences amongst the sample, industries were selected that included at least one firm with a dominant skill in r&d, manufacturing, and marketing or distribution. descriptions of 24 industries and more than 100 companies, found in a total of 46 casebooks, industry analyses, and research monographs, were thoroughly reviewed to ensure that the industries selected met the research design criteria. table 1 lists the six industries and 27 businesses included in this study as well as the time periods over which they were analyzed. table 1: industries & businesses selected for the study shake out maturity decline personal computers motorcycles receivin~ tubes 1980-1985 1967-1975 1967-1978 apple bmw general electric commodore harley-davidson gte sylvania mm honda rca osborne norton villiers tandy texas instruments fall 1992 chrisman & boulton: keys to improving performance table 1: industries & businesses (continued) 175 shake out maturity decline writing instruments watches cigars 1968-1973 1968-1973 1964-1978 bic pen bulova american cigar gillette hamilton watch bayuk cigar scripto seiko consolidated cigar the swiss culbro timex havatampa jno. h. swisher data gathering methods a total of 119 secondary sources of information, including previously published case studies, articles in business periodicals and books, company documents, and reference books were content analyzed to obtain data for the study. general information about each industry and company was collected, as well as published statements from industry analysts concerning industry key success factors, functional skills, and business strategies ([17], [34], [37]). data covering periods ranging from ten to twenty years for each business and industry were initially collected. however, strategies, skills, and industry key success factors can change over time. therefore, each industry and company was analyzed over time periods of five to fifteen years during which key success factors, dominant skills, and strategies remained relatively stable. if more than one time period was usable, the time period with the best quality data was selected. initial analysis aid not suggest that differences in time periods or economic cycles influenced the results of this study. a subsequent test using different time periods for a subsample of eight business units from two industries further supported this assumption. measurement issues & techniques detailed case descriptions of each industry and its competing business units were developed. the cases included data on the key success factors of each industry, as well as the functional skills, strategies, and performance of each business unit. the cases averaged over 40 pages in length. published reports by industry analysts were critical for identifying industry key success factors, business strategies, functional skills and competences, and performance. comparative variables, including performance, were determined by ranking the competitors. performance evaluations were made independently after all other variables were measured to minimize the possibility of rating bias. to ensure the measurement reliability of key success factors, dominant skills and distinctive competences, and competitive strategies, a two stage procedure was followed. 176 journal ofbusiness strategies vol. 9, no.2 first, the two researchers independently evaluated the cases and classified the variables of interest. their interrater agreement was 88.9 percent. additional research resolved the few discrepencies that occurred. second, a panel of seven doctoral students independently reviewed the detailed cases and completed data evaluation forms. while one member of the panel evaluated all six industries, the remaining six panelists evaluated three industries each. therefore, a total of four judges independently identified each industry's key success factor, and the strategies, functional skills, and performance of each business unit overall agreement between raters on all these evaluations was 75.9 percent, as shown in table 2. further discussion helped to attain final consensus in cases where raters disagreed. table 2: degree of agreement of the evaluations of the panel with tile evaluadons of the researchers on the variables of interest by industry key suredominant business economic ess factor skill strategy performance total interrater agreement personal computers (6 firms) writing instruments (3 firms) motorcycles (4 firms) watches (5 firms) receiving tubes (3 firms) cigars (6 firms) total interrater agreement (27 firms in six industries) 3 of 4 23 of 24 17 of 24 19 of 24 62 of 76 (75.0%) (95.8%) (70.8%) (79.2%) (81.6%) 3 of 4 11 of 12 10 of 12 12 of 12 36 of 40 (75.0%) (91.7%) (83.3%) (100.0%) (90.0%) 2 of 4 11 of 16 14 of 16 10 of 16 37 of 52 (50.0%) (68.8%) (87.5%) (62.5%) (71.2%) 3 of 4 14 of 20 17 of 20 16 of 20 50 of 64 (75.0%) (70.0%) (85.0%) (80.0%) (78.1%) . 3 of 4 12 of 12 4 of 12 8 of 12 27 of 40 (75.0%) (100.0%) (33.3%) (66.7%) (67.5%) 4 of 4 18 of 24 15 of 24 15 of 24 52 of 76 (100.0%) (75.0%) (62.5%) (62.5%) (68.4%) 18 of 24 89 of 108 77 of 108 80 of 108 264 of 348 (75.0%) (82.4%) (71.3%) (74.1%) (75.9%) falll992 chrisnum & boulton: keys to improving performance 177 functional skills the functional skill that the organization performed better than any other was considered its dominant skill and was rated as strong, average, or weak. interrater agreement on the dominant skills of the 27 businesses analyzed was 82.4 percent each business unit's overall competence in the four functional areas studied were then analyzed relative to major competitors and rated as strong, average or, weak. all functional areas were weighted equally to obtain the business unit's level of overall functional competences. rater assessments yielded consistent results in 82.4 percent of the cases. additional research was conducted to resolve the discrepancies in the cases where the evaluations did not agree. k.ey success factors the key success factor for each industry was determined from published reports of recognized industry analysts. their reviews described the importance of the various functional skills for an industry as a wnole and for particular product-market segments of the industry. the observations of industry experts were generally consistent. overall interrater agreement between the panel and researchers on the key success factors in the six industries included in this study was 75 percent competitive strategies competitive strategies were evaluated in terms of scope, segment differentiation, and competitive weapons. scope measures the extent of a business unit's productmarket coverage and segment differentiation measures the number and type of competitive weapons used across served product-market segments. for example, a business unit with broad scope that competed in the same way across all major segments served was considered to follow a mass-market strategy. a business unit with broad scope that varied its approaches across segments served was considered to follow a segmented strategy. a business unit that served only one or a few small segments of the market, had a narrow scope, and, thus, was considered to follow a focused strategy. competitive weapons were distinguished using porter's [32] criteria for classifying cost leadership and differentiation (benefit) strategies. the relative costs, prices, and benefits of the competing products and services offered by each business unit were examined. for example, a business with lower-priced products of average quality followed a cost strategy, a business with higher-priced products of high quality followed a benefit strategy, and a business with lower-priced products of high quality followed a utility strategy. the proportions of each business unit's activity in low, medium, and high priced segments were also considered. h, for instance, the business unit's major source of sales revenues came from lower priced products, it was considered to follow a cost strategy. where possible, both methods of assessment were used and tended to yield consistent results. in all, the panel agreed 71 percent of the time with the researchers' identification of the competitive strategies of the sample. 178 journal ojbusiness strategies vol. 9, no.2 economic performance a business unit's economic performance was rated as superior, average, or inferior in relation to its major competitors. to the extent possible, evaluations were based on the actual fmancial (roe, ros, roa) and market share data. however, for slightly more than half of the business units studied, the performance data used were qualitative. in these instances, performance data were determined from reports and observations of industry analysts and executives. dess and robinson [8] showed that such subjective measurements, although less desirable than objective measures, are reasonably accurate. in fact, the quantitative and qualitative performance evaluations were consistent in almost 80 percent of the cases where both types of data were available. the performance evaluations of the panel were consistent in almost 75% of the cases with the researchers' assessments. data analysis techniques nominal and ordinal business unit data were cross-tabulated and analyzed in a variety of ways. patterns of successful strategies and functional skills, key success factors, and performance were identified. the strongest pattems were statistically tested using the chi-square, kmskal-wallis, and wilcoxon rank-sum nonparametric tests. small sample sizes, the ordinal nature of the data, and non-normal distributions prevented the use of parametric statistics. tests were used to investigate the research questions descnbed earlier as well as to generate specific propositions on strategy-skillperformance relationships. analysis & results is a business unit's overall competences in its functional skills related to its economic performance? the first research question compared a business unit's level of overall functional competences, relative to competitors, with its economic performance. not unexpectedly, the level of a business unit's overall competences was found to be positively related to its performance (table 3). the performance of almost 80 percent of the business units in the sample was consistent with their overall competences, a result significantly different from chance (p < .001). falll992 chrisman & boulton: keys to improving performance 179 table 3: relationships between the overall strengths of a business unit and its economic performance economic performance superior average inferior relative overall strengtiis strong average weak 8* 3 0 0 6* 3 0 0 7* ·correct predictions: 21 of 27 (78%) chance predictions: 9 of 27 (33%) chi-square goodness-of-fit test (dj. = 1) = 24.0 (p < .001) a kruskal-wallis test provided additional support for this conclusion. significant differences were found in the performance of businesses with strong, average, and weak overall competences in their functional skills (p < .001). multiple comparisons of the three groups using the wilcoxon rank-sum test revealed significant performance differences between businesses with strong and weak (p < .01), strong and average (p < .01), and average and weak (p < .05), overall competences. is the fit between a business unit's competitive strategy, its dominant functional skills, and its industry's key success factor related to its economic performance? the matrix shown in figure 2 shows the competitive strategies, dominant functional skills, industry key success factors, and relative economic performance of the business units included in this study. each business unit is positioned in the matrix according to its industry's key success factor and the type of dominant functional skill it possessed. its strategy (e.g., sb=segment benefit) and economic performance (e.g., o=average performance) are also denoted. strategies and economic performance of the business units were then analyzed according to their positions in the matrix. 180 jou17ul1 ofbusiness strategies vol. 9, no.2 figure 2: competitive strategies, key success factors, dominant skills, and economic performance of consumer products manufacturers· key success facrors product-related r&d mfg market-related dst mkt r&d product-related mfg dominant skill dst market-related mkt su (+) i su (0) sc (0) i sb (0)i ifb (-) i sb (-) i sb (0) i sb (-) i 1---1 -----~----r---fb (0) i mu(+) fu (+) i mc(o) i sc (+) sc (-) i i fb (-) fc (-) i i sc (-) i i i. i i fb (-) i mc(+) fc (0) i sc (0) i fu (0) i i-----.j-----i-----l----l sb (+) sb (+) l mu(-) mc(+) i sc (-) i i i *economic performance: (+) = superior, (0) = average, (-) = inferior competitive strategy: s = segmented, f = focused, m = mass-market, b = benefit, u = utility. c = cost dominant skills: r&d = research & development, mfg = manufacturing. mkt = marketing, dst = distribution the 16 cell matrix created small cell counts and made it difficult to find meaningful relationships. however, patterns within the matrix suggested that successful business units with dominant skills in product-related functions (i.e., r&d or manufacturing) used different competitive strategies from than less successful firms, and from the successful firms with dominant skills in market-related functions (i.e., marketing or distribution). likewise, successful firms with dominant skills in market-related functions used somewhat different strategies than their less successful counterparts. the same held tme when analyzing strategies and performance according to industry key success factors. these observations suggested that the matrix might be collapsed into product-related and market-related cells for further analysis. this simplified matrix falll992 chrisman & boulton: keys to improving perfotl7ulnce 181 allowed the analysis of larger sample sizes per cell. the simplified matrix is composed of four cells distinguished by the solid lines in figure 2. relationships between strategies and key success factors no strategies were found to be superior or inferior to other strategies in all situations. analysis of the simplified matrix indicated, however, that a strategy's success was related to the key success factor in an industry. the wilcoxon rank-sum test indicated that in industries where the key success factor was product-related, benefit strategies were significantly less successful than utility and cost strategies (p < .05). in fact, out of the six firms following benefit strategies, five (83%) experienced inferior performance vis-a-vis their major competitors. by contrast, all four firms employing utility strategies achieved at least average performance (50% achieved superior performance) and both of the firms following cost strategies attained superior performance. the inferior performance of the benefit strategies was particularly apparent when the businesses following those strategies had a product-related dominant skill. benefit strategies were significantly more successful in industries where the industry key success factor was market-related rather than product-related (p < .05). benefit strategies also appeared more successful than cost strategies in industries with market-related key success factors, although the differences in performance were not statistically significant. out of the nine business units following cost strategies in such industries, four (44%) experienced inferior performance, four (44%) were average performers, and only one (11%) achieved superior performance. by contrast, two of the four businesses (50%) following benefit strategies in those industries achieved superior performance and two (50%) experienced average performance. relationships between strategies and dojdinant skills analysis of the simplified four-cell matrix also suggested that a strategy's success was related to the dominant skill of the business (figure 2). the wilcoxon rank-sum test indicated that business units following utility strategies significantly outperformed those that followed cost or benefit strategies when the dominant skill was productrelated (p < .05). thus, three of the four businesses (75%) following utility strategies achieved superior performance while only one of the six businesses (17%) followina cost strategies, and none of the seven (0%) following benefit strategies were able to do so. in fact, over half of the businesses following cost or benefit strategies experienced inferior performance relative to their major competitors. cost strategies, however, did seem to lead to slightly more favorable performance than benefit strategies for businesses with dominant skills in product-related functions, but this finding was not statistically significant. no strategies were found to be statistically superior for businesses with dominant skills in market-related functions. the utility strategies of the two businesses with dominant skills in market-related functions yielded average and inferior performance. on the other hand, two of the three businesses (67%) that followed benefit strategies achieved superior performance. cost strategies also appeared to provide prospects for 182 journal ofbusiness strategies vol. 9, no.2 at least average performance. among the five firms following cost strategies, two were superior performers (40%), two were average performers (40%), and one (20%) was an inferior performer. competitive strategy propositions results indicate that successful strategies are related to both the dominant functional skill of a business unit and the key success factor of its 'industry. to further test such relationships, the propositions shown in figure 3 were developed from the findings shown in figure 2 and descnbed above. these propositions suggest what should be the best, next best, and worst strategies for a business depending on its dominant skill and the key success factor in its industry. the rationale for these propositions is summarized as follows: figure 3: competitive strategy propositions· key success facrors product-related r&d mfg market-related dst micr r&d product-related mfg dominant skill dst market-related mkt secror 1 secror 2 best strategy: utility best strategy: utility next best: cost next best: benefit worst strategy: benefit worst strategy: cost secror 3 secror 4 best strategy: cost best strategy: benefit next best: utility next best: cost worst strategy: benefit worst strategy: utility *economic performance predici10n: best strategy =superior performance next best = average performance worst strategy = inferior performance (1) business units following the best strategy will usually achieve superior performance, (2) business units following the next best strategy will usually achieve average performance, and, (3) business units following the worst strategy will usually achieve inferior performance. fall 1992 chrisman & boulton: keys to improving performance 183 for example, according to the propositions in sector 1 of figure 3, a business with a dominant skill in a product-related function (r&d or manufacturing rows) that competes in an industry where product-related skills are key to success should be most successful using a utility strategy and least successful using a benefit strategy. in the same vein, a cost strategy should result in average pedormance. as shown in table 4, a chi-square goodness-of-fit test indicated that in almost 75% (20 of 27) of the cases, performance predictions derived from the propositions shown in figure 3 proved correct, a result significantly different from chance (p < .001). table 4: competitive strategies as predictors of business unit economic performance economic performance superior average inferior appropriateness best of strategy selected given dominant skill next best and key success facfor worst 6* 1 0 2 5* 1 0 3 9* ·correct predictions: 20 of 27 (74%) chance predictions: 9 of 27 (33%) chi-square goodness-of-fit test (d.f. = 1) = 20.16 (p < .(01) propositions about competitive strategy, dominant skills, and performance propositions provided in figure 3 explain the variations in the sample's performance almost 75% of the time. however, since a business unit's relative economic performance will also be influenced by its relative overall competences (table 3), following the correct strategy will not necessarily generate superior pedormance if the business unit's skills are weaker than its major competitors' skills. on the other hand, as figure 3 presumes, an inappropriate strategy can reduce the economic effectiveness of even the strongest firms. a business with superior overall competences that develops an appropriate strategy should be virtually guaranteed superior pedormance, and one with inferior overall competences and an inappropriate strategy should almost always experience inferior performance. 184 journal ofbusiness strategies vol. 9, no.2 to account for both the appropriateness of a business unit's strategy and its overall competences relative to its competitors, the results regarding overall functional competences (fable 3) and business strategy (fable 4) were combined to develop the propositions shown in figure 4. the actual performance of each business unit was then compared against the performance predicted by the propositions (fable 5). this approach allowed us to test the overall validity of the framework despite the fact that sample sizes were insufficient to individually test each proposition that made up the framework [26]. as table 5 indicates, the combined framework helped explain the relative economic performance of the entire sample. while there is an obvious bias in using the same data to both develop and test a framework, the strong fit suggests that the propositions have high potential for explaining performance variations among consumer goods manufacturers. figure 4: strategy-sldlls-perlormance propositiods* relative overall competence of the business·· strategy*** strong average weak best next best worst superior superior or average average or inferior superior or average average average or inferior average average or inferior inferior *given the way the propositions illustrated in this matrix were formulated, performance could be correctly predicted by chance 51.9% of the tinie. "see table 3 ·**see figure 3 and table 4 fall 1992 chrisman & boulton: keys to improving per/o17lul1jce 185 table s: actual versus predicted economic performance of the sample of busidess units· relative business actual predicted company ds ksf skills strategy performance performance mm mid mkt strong seg-ben (+) (+) bic mkt mkt strong mm-cost (+) (+)/(0) honda r&d r&d strong seg-util (+) (+) timex dst mig strong mm-cost (+) (+) seiko mig mig strong mm-util (+) (+) gte sylvania mig mig strong seg-cost (+) (+)/(0) consol. cigar mid dst strong seg-ben (+) (+) swisher mig ost strong foc-util (+) (+) apple r&d mkt average seg-ben (0) (0) commodore mig mkt average mm-cost (0) (0)/(-) tandy dst mkt average seg-cost (0) (0) gillette r&d mkt strong seg-ben (0) (0)/(+) bmw mfg r&d average foe-ben (0) (0)/(-) bulova r&d mig average seg-util (0) (0)/(+) general electr. dst mig strong foe-util (0) (0)/(+) culbro r&d o8t strong seg-cost (0) (0) havatampa ost o8t average foe-cost (0) (0) texas instr. mfg mkt weak seg-cost (-) (-) osborne mfg mkt weak foe-cost (-) (-) scripto mig mkt weak seg-cost (-) (-) harley-dav. ost r&d average foe-ben (-) (-)/(0) nvf r&d r&d weak foe-ben (-) (-) hamilton(hmw) r&d mig weak seg-ben (-) (-) the swiss mfg mfg weak foe-ben (-) (-) rca r&d mig average seg-ben (-) (-)/(0) american cigar mkt o8t average mm-util (-) (-)/(0) bayuk cigar mkt ost weak seg-cost (-) (-)/(0) ·correcr predlcnons: 27 of 27 (100%), chance predicnons: 14 of 27 (51.9%). economic performance superior =(+), average =(0), inferior =(-) competmve slrategies foe =focused, mm = mass-marke4 scg = segmented, ben = benefi4 util =utility, cost =cost. dominant skii.j.jkey success facror r&d = researeh & developmen4 mfg = manufacturing, mkt = marketing, dst =distribution 186 journal ofbusiness strategies vol. 9, no.2 in sum, the effectiveness of the framework of propositions to predict the economic performance of the sample appears to support the theory of the field. the explanatory power of the propositions shown in the figure 4 framework was greater than those that considered either a business unit's overall functional competences (fable 3) or strategy (figure 3 and table 4) separately. summary '" coadusions the results of this study further support the conceptual arguments and research of the field of strategic management. thus this study found that no generic strategy was inherently superior or inferior to other generic strategies. this study also found that successful business units had greater levels of competences in their functional skills than their less successful competitors, as well as strategies that better fit their dominant skills and the key success factors of their industries. this strongly suggests that superior performance depends upon both a business unit's ability to develop distinctive competences in its functional skills, and the strategy used to achieve fit between its dominant skills and the key success factors of its industry. neither distinctive competence nor strategy alone was as effective as both combined in predicting the relative economic performance of this sample. thus, as strategic management theory argues, relative strengths or weaknesses in specific functional skills are important only in the context of the industry environment. it is the way in which a business utilizes these skills to support its strategy that ultimately determines its competitive position and performance. it is also interesting to note that the effective use of functional skills seems more important than either scope or degree of segment differentiation, since all the significant findings and propositions reported in this study related to the competitive weapons employed. thus, within a given industry, how a business competes appears to be more important to its relative economic performance than where it competes. in short, this study confirms the usefulness of the concept of strategy for examining business unit performance, and the primary importance of identifying and developing distinctive competences that may lead to competitive advantage. directioas for futul'e researdl the findings of this study suggest a line of inquiry that may be generalizable to manufacturers of consumer products. first, the propositions generated from this study should be tested and refined through future research with larger samples. replications of this study in industrial manufacturing, retail, wholesale, and service businesses are clearly needed as are replications in consumer products industries in other stages of development. such studies sh~uld strive to improve upon the methods of sample selection, data collection, and variable measurements as these areas represent the primary limitations of this exploratoty study. the development of competitive functional skills proved to be critical to attaining superior economic performance. therefore, future studies might investigate a number fall1992 chrisman & boulton: keys to improving performance 187 of questions related to the nature of strategies needed to utilize, develop, and maintain such competitive capabilities. is it possible, for example, for a business to effectively change its dominant skill over time, or do initial choices determine, for all practical purposes, its future in any specific industry? if it is possible, how long does it usually take for such changes to payoff! it would also be useful to investigate whether a business, can, or should, change either its strategy, dominant skills, or both when it finds that they do not match the key success factors of its industry. similar studies to identify corporate-level competences and strategies that may either influence, or be transferrable to, the business level are also needed, as are studies that relate corporate-level competences and strategies to diversification or innovation options. however, researchers should keep in mind that corporate-level competences are not simply aggregations of business-level competences [44]. besides these replications and extensions, additional work is needed in improving the systems used for classifying and identifying organizational strategies, functional skills and competences, and various environmental characteristics such as key success factors. the extensive amount of time and attention paid to these areas are believed to have contributed to the generally high level of statistical significance of this study's findings despite its small sample size [36]. implications for mluulgement practice the findings of this study suggest that the most important challenges for businesslevel managers are (1) to develop distinctive competence in functional skills key to success in their industries, and (2) to formulate strategies that effectively utilize these functional competences. thus, managers must appreciate the business unit's dominant skills and key success factors in its industry, and deploy the resources necessary to sustain and improve its capabilities in those areas. this suggests that a business will do better with a strategy built on its strengths than a strategy designed to compensate for its weaknesses. in short, managers who understand what their business can do better than its competitors and what skills are most highly valued in the marketplace are much more likely to formulate a strategy which will achieve superior performance than those that do not. references 1. abell, d.f. definin& the business; the startin& point of stratemc planninlo prenticehall; englewood cliffs. nj (1980). 2. anderson, c.r., & zeithaml, c.p. stages of the product ufe cycle, business strategy, and business performance. academy of mana,mnent journal, vol. 27 (1984), pp. 5-24. 3. andrews, k.r. the concept of comorate stratep, irwin: homewood, il (1971). 4. ansoff, h.i. cor.porate stratep; an analytical f\wroach to business policy for growth and im>ansion, mcgraw-hill: new york, ny (1965). 188 journal ofbusiness strategies vol. 9, no.2 5. chrisman, jj., hofer, c.w., & boulton, w.r "toward a system for oassifying business strategies." academy of manaeement review, vol. 13 (1988), pp. 413-428. 6. comte, t.e. "a study of the process of appraisal of internal strengths and weaknesses as a strategic activity in selected industries." unpublished doctoral dissertation, university of missouri-columbia (1978). 7. dess, g.g., & davis, p.s. "porter's (1980) generic strategies as determinants of strategic group membership and organizational performance." academy of management journal. vol. 27 (1984), pp. 467-488. 8. dess, g.g., & robinson, rb. jr. "measuring organizational performance in the absence of objective measures: the case of the privately-held firm and conglomerate business unit." strate&ic manaiement journal, vol. 5 (1984), pp. 265-273. 9. galbraith, c., & schendel, d. "an empirical analysis of strategic types." strategic manaiement journal, vol. 4 (1983), pp. 153-173. 10. godiwalla, y.m., meinhart, w a, & warde, w.d. comorate strategy and functional manaeemenl praeger: new york, ny (1979). 11. hall, w.k. "survival strategies in a hostile environment." harvard business review. vol. 58 (5), (1980), pp. 75-85. 12. hambrick, d.c., macmillan, i., & barbosa, r.r "business unit strategy and changes in the product r&d budget." management science, vol. 29 (1983), pp. 757-769. 13. hambrick, d.c., & schecter, s.m. "turnaround strategies for mature industrial-product business units." academy of management journal. vol. 26 (1983), pp. 231-248. 14. hamermesh, r.g., anderson, mj. jr., & harris, j.e. "strategies for low market share businesses." harvard business review. vol. 56 (3). (1978), pp. 95-102. 15. hamermesh, r.o., & silk, s. "how to compete in stagnant industries." in hamermesh, r.g. (ed.), strate&ic manaeement. wiley & sons: new york: ny (1983), pp. 139-150. 16. harrigan, k.r strateipes for declining businesses. lexington books: lexington, ma (1980). 17. harrigan, k.r "reseaich methodologies for contingency approaches to business strategy." academy of management review, vol. 8, (1983), pp. 398-405. 18. hatten, kj. "strategic models in the brewing industry." unpublished doctoral dissertation, purdue university (1974). fall1992 chrisman & boulton: keys to improving performance 189 19. hitt, m.a, ireland, r.d., & palla. k..a "industrial firms' grand strategy and functional importance: moderating effects of technology and uncertainty." academy of management journal, vol. 25 (1982), pp. 265-298. 20. hitt, m.a., ireland, r.d., & stadter, g. "functional importance and company performance: moderating effects of grand strategy and industry type." strategic management journal. vol. 3 (1982), pp. 315-330. 21. hitt, m.a., & ireland, r.d. "corporate distinctive competence and performance: effects of perceived environmental uncertainty (peu), size, and technology." decision sciences, vol. 15 (1984), pp. 324-349. 22. hill, m.a, & ireland, r.d. "corporate distinctive competence, strategy, industry, and performance." strategic mamu~ement journal. vol. 6 (1985), pp. 273-293. 23. hofer, c.w. "some preliminary research on patterns of strategic behavior." academy of management proceedin&s (1973), pp. 46-54. 24. hofer, c.w. "toward a contingency theory of business strategy." academy of management journal, vol. 18 (1975), pp. 784-810. 25. hofer, c.w. "rova: a new measure for assessing organizational performance." in lamb, r. (ed.), advances in strate&ic manasement, vol. 2 (1983), pp. 43-55. 26. hofer, c.w., & charan, r. "the transition to professional management: mission impossible?" american journal of small business. vol. 9 (1), (1984), pp. 1-11. 27. hofer, c.w., & schendel, d.e. strateq formulation: analytical conce.pts. west: st. paul, mn (1978). 28. lenz, r.t. "strategic capability: a concept and framework for analysis." academy of management review, vol. 5 (1980), pp. 225-234. 29. miller, r. "strategic pathways to growth in retailing." journal of business strateq, vol. 1 (3) (1981), pp. 16-29. 30. mintzberg, h. ''patterns in strategy formulation." management science, vol. 24 (1978), pp. 934-948. 31. ohmae, k. the mind of the strategist, penguin: new york, ny (1982). 32. porter, m.e. competitive strate;u: techniques for analyzing industries and competi~ free press: new york, ny (1980). 33. porter, m.e. competitiye ady!ultljle: creatins and sustainins superior performance, free press: new york, ny (1985). 190 journal ofbusiness strategies vol. 9. no.2 34. quinn, j.b. sttateaies for oianae: loiical incrementalism, 1jwin: homewood, il (1980). 35. rothschild, w.e. how to gain (and maintain) the competitive advantaae. mcgrawhill: new york, ny (1984). 36. rumelt, rp. "evaluation of strategy: theory and models." in schendel. d.e.• & hofer. c.w. (eds.). strateaic manaeement: a new view of business policy and planning. little, brown: boston, ma (1979). 37. sandberg, w.r. new venture performance: the role of sb'ateu and indushy structure. lexington books: lexington, ma (1986). 38. schendel, d.e.. & hofer. c.w. strateeic manyement: a new view of business policy and planning. little. brown: boston, ma (1979). 39. schendel. d.e., patton, g.r., & riggs, j. "corporate turnaround strategies: a study of profit decline and recovery." journal of general manlliement. vol. 3 (1976), pp. 3-11. 40. selznick, p. leadership in administration: a sociolqaical interpretatiqd. harper & row: new york, ny (1957). 41. snow. c.c., & hrebiniak, l.g. "strategy, distinctive competence, and organizational performance." administrative science quarterly. vol. 25 (1980), pp. 317-336. 42. soukup, w. "sb'ategic responses to technological threats." unpublished doctoral dissertation, purdue university (1979). 43. sousa de vasconcellos e sa, ja., & hambrick, d.c. "key success factors: test of a general theory in the mature industrial products sector." strate&ic manaeement jourjml vol. 10 (1989). pp. 367-382. 44. stevenson, h.h. "defining corporate strengths and weaknesses: an exploratory study." unpublished doctoral dissertation, harvard business school (1968). 45. thietart, ra, & vivas, r. "an empirical investigation of success sb'ategies for businesses along the product life cycle." manaaement science, vol. 30 (1984). pp. 1405-1423. 46. tilles, s. "how to evaluate corporate sb'ategy." harvard business review, vol. 41 (4). (1963). pp. 111-121. 47. white. r.e. 1986. "generic business sb'ategies, organizational context and performance: an empirical investigation." strateldc manaaement jqumal vol. 7 (1986). pp. 217-231. 48. white, r.e., & hamermesh, r.g. toward a model of business unit economic performance. academy qf manafment review, vol. 6 (1981). pp. 213-223. 49. willard, g.e., & cooper. ac. "survivors of industry shakeouts: the case of the u.s. color television set industry. strateldc manapnent journal. vol. 6 (1985), pp. 299-318. so. woo, c., & cooper, ac. "the surprising case for low market share." harvard business review, vol. 60 (6). (1982). pp. 106-113. keys to improving economic performance at the business unit level: business strategy, functional skills and key success factors volume 31, number 2 357 social networking as a strategy for improving food safety: a pilot study chao-shih (jake) wang arizona state university • mesa, arizona david d. van fleet arizona state university • mesa, arizona ella w. van fleet professional business associates • scottsdale, arizona abstract the fda [food and drug administration], america’s consumer watchdog for food safety, needs a more effective means of communicating with all participants from food sources to consumers. this paper presents a pilot study using responses from an online survey to explore the feasibility of using social media to enhance the current food safety system in the u.s. while more research is needed, the results suggest that, although the primary users of social media are young and well-educated adults, social media networking can play an important role in the rapid dissemination of food recall notices and other preventive information in a message form that is more likely to be read or heard. thus, the fda should consider social media as an important tool in increasing the effectiveness of its overall strategy. key words: social network; social media; food safety; food recall introduction the purpose of this pilot study was to determine whether food regulatory agencies such as the u. s. food and drug administration (fda) and the food safety and inspection service (fsis) should adopt a strategy of using social networks to enhance the current food safety system. research into organizational use of social networks is emerging (carpenter, li, & jiang, 2012; gulati, nohria, & zaheer, 2000; rangan, 2000), but its strategic use by public organizations has not yet been studied (mahon, heugens, & lamertz, 2004). background food safety and public policy “the fda is supposed to be a watchdog for consumers, and for too long, 358 journal of business strategies this agency has been coming up short,” said jean halloran, director of food policy initiatives at consumers union (consumers union, 2013). corporations supplying processed foods in the united states are unable to guarantee the safety of their ingredients. many do not even know who is supplying their ingredients, let alone if those suppliers are screening for microbes and other potential dangers (moss, 2009). currently, the strategic focus of public policy regarding food safety is “control” (e. g., preventive control standards and science-based measures). that control is accomplished in a variety of ways, including product recalls. food recalls occur for many reasons, including biological or physical contamination or other quality issues. recalls may be initiated by the manufacturer, distributor, the fda, or the department of agriculture. for the recall process to function effectively, it is important to have rapid dissemination of information and traceability so any affected product can be identified and withdrawn from the market as quickly as possible. but the food safety modernization act is changing that as it has shifted the direction of food safety management from reaction to prevention. the u. s. president’s food safety working group (fswg) has advocated a new direction for the u.s. food safety system — a public health-focused approach. the fswg is committed to modernizing food safety through partnerships with consumers, industry and regulatory agencies (food safety working group, 2009). the fswg suggests a route toward a freedom-from-fear food safety environment through its charge: “to have safe food that does not cause us harm and to enhance our food safety systems” (food safety working group, 2009). based on three principles set by the fswg -prioritizing prevention, strengthening surveillance and enforcement, and improving response and recovery -fda and fsis are taking action on two initiatives: the fda food safety modernization act (fsma) and the fsis haccp-based inspection models project (himp). food safety and social media although “…the systematic study of effective [food] recall communications is in its infancy” (freberg, 2013; hallman & cuite, 2009), freberg (2013) has shown that both attitudes and subjective norms influence consumers in their intention to comply with a food recall with attitudes having the greater impact. both attitudes and subjective norms exist in social networks. thus, social networks are “of central importance” (granovetter, 1973), and the role of social media in those networks has important implications for public policy (leyden, link, & siegel, 2014; benkler, 2006 and 2011). in particular, this suggests that regulatory agencies should adopt volume 31, number 2 359 strategies that emphasize exploiting social media (rutsaert, pieniak, regan, mcconnon, kuttschreuter, lores, lozano, guzzon, santare, & verbeke, 2014). using social media involves bringing together heterogeneous groups to form social networks and facilitating their coordination for the purpose of identifying food hazards and spreading the word about recalls (burt, 2005; peters & golden, 2013; inkpen & tsang, 2005; jackson & watts, 2002). announcements about recalls are available on the fda web site (http://www. fda.gov/), and consumers can request to receive e-mail alerts on recalls. consumers can also report problems at that site, and fda district offices have consumer complaint coordinators who take complaints on foods they regulate. in addition, traditional news outlets distribute recall information. however, with the increase in popularity of social media, regulatory agencies and news media can use social networks to reach more people in a shorter amount of time. instead of hearing a broadcast on radio or television or reading a story in a newspaper about a recall sometimes long after it was issued, consumers may hear about a recall almost immediately through social media such as facebook or twitter. plum organics voluntary use of social media to spread the word of a recall is a good example of how it can be used (crum, 2009). earlier research has shown that people hearing about a negative event such as a recall that directly impacts them will seek information from informal networks (vihalemm, kiisel, & harro-loit, 2012). also, individuals are most likely to become involved when the recall or negative event applies to them and when they believe that the consequences are serious enough to warrant action (hallmak, 2013). these highly involved consumers are more likely to be involved in spreading the word about negative events (choi & lin, 2008). consumers who spread the word about negative events through blogs, tweets, and the use of other social media are known as social media influencers (smis) (freberg, graham, mcgaughey, & freberg, 2011). their role may create noise in the system (gorry & westbrook, 2009) and their credibility sometimes questioned due to distortions or misinformation (wright & hinson, 2012; carlson & peake, 2013), but social media could be used to improve the overall performance of the system (freberg, graham, mcgaughey, & freberg, 2011; golub & jackson, 2010). perhaps even more importantly, the adoption of a strategy to exploit social networks through the use of social media could not only expand the agencies’ reactive role of disseminating information to the public but also enable their new preventive role by tapping into previously unused external resources (consumers and suppliers) regarding food hazard problems. the advance of information and communication technologies en360 journal of business strategies ables a creative avenue for the public agency to learn about potential food hazards more quickly than in the past. coordination by the public agency is still required to maintain the integrity of the system, but the strategic use of these new technologies permits coordination with more efficient regulatory interventions. social networks are extensively used, especially in times of negative events (liu, austin, & jin, 2011). should these new communication technologies be used as an integral part of the system by all participants in the food chain to exchange information about food safety? or has little effort been made formally to involve consumers as participants in food safety (williams & hammitt, 2001)? research into organizational use of social networks is emerging (carpenter, li, &jiang, 2012; gulati, nohria, & zaheer, 2000; rangan, 2000), but its strategic use by public organizations has not yet been studied (mahon, heugens, & lamertz, 2004). a caveat in all of this is that at present social media can involve distortions or misinformation and can be manipulated to a degree. this could lead to “naïve learning” (golub & jackson, 2010). because of the asymmetry of information (siegel, 2009), organizations and individuals could potentially attempt to insert false information into social networks (lauretti, 2013; skelton, 2012; ramsey, 2010; grant, 2009) to raise their rival’s costs (barjolle, jeanneaux, & meyer, 2012; mcwilliams, van fleet, & cory, 2002). in addition, smis might have an incentive to manipulate information to increase their “popularity” in the social network. while efforts are being made to expose those who attempt to distort information on social media, it does exist. so any strategic efforts to utilize the benefits of social media must take into account and guard against such attempts. what is the current situation? how does the general public use social media in response to food recalls and bad food experiences? materials and methods to more specifically investigate the current situation in the united states, during december of 2013 and january of 2014, a survey was conducted. to focus the thinking of those responding to the survey, we began by focusing their attention: “”the purpose of this study is to examine aspects of responses to food recalls. a food recall is a request to return to the maker (or seller) a batch or an entire production run of a food product usually due to the discovery of safety issues or a product defect.” since the use of social media was the predominant issue in this survey, we first examined that with the question: which of the following (smartphone, tablet, volume 31, number 2 361 laptop computer, other computer) do you own or regularly have access to? two questions were then asked about product recall experiences in general -have you ever heard of a food recall, and how did you hear about it? -followed by seven demographic items. if a respondent indicated that he or she had not heard of a recall, they were automatically jumped to another section of the survey. to focus more closely on personal experiences, the respondents were presented with four scenarios. the first two scenarios dealt with the respondents’ personal experiences with food problems; the last two, with recall announcements (see table 1). again, if a respondent indicated that he or she had not experienced a particular scenario, they were automatically jumped to another section of the survey. table 1 scenarios used in the survey scenario 1 experienced major issue “ you ate lunch in a restaurant and during the afternoon you developed severe intestinal cramping and diarrhea causing you to seek assistance from the medical community (physician, urgent care or emergency room) for treatment.” scenario 2 experienced minor issue “ you ate lunch in a restaurant and during the afternoon you developed an upset stomach and mild diarrhea.” scenario 3 recall of product you use “ you heard (television, radio, online, newspaper, etc.) that a recall of packaged lettuce is being made and that it involves a brand/label that you generally use.” scenario 4 recall of product you do not use “ you heard (television, radio, online, newspaper, etc.) that a recall of packaged lettuce is being made but it involves a brand/label that you generally do not use.” the survey was conducted using surveymonkey.com® and ended with three open-ended questions. “think of a time when you heard about a food recall. tell us about that incident—what was your reaction, how did you feel, did you talk to anyone about it, did it change your food buying or eating pattern?” “think of a time when you experienced a problem with something you ate at home or at an eating establishment. tell us about that incident—what was your reaction, how did you feel, did you talk to anyone about it, did you seek medical help, did it change your food buying or eating pattern?” “would you like to add any comments?” 362 journal of business strategies results and discussion a convenience sample of 214 people responded to the survey (212 complete and usable responses; see table 2) from 22 states, the district of columbia, and canada. in terms of gender, the total sample consisted of slightly more females (58.5%) than males (41.5%). respondent age groupings were 18-29 (26.4%), 30-49 (27.8%), 50-64 (22.6%), and 65 or older (23.1%). they were overwhelmingly white/caucasian (83.5%) and well educated: 41.5% had advanced degrees, an additional 16.0% were college graduates, and 35.4% had some college. only 7.1% had not at least graduated from high school. most importantly, the use of social media by these respondents is quite similar to national usage rates as found by the pew research center (duggan & smith, 2013). table 2 sample demographics characteristic number in sample age 56 18-29 59 30-49 48 50-64 49 65 and older gender 89 males 124 females race 177 white 5 black 12 asian 18 other education 15 high school 75 some college 34 college graduate 88 advanced degree use of social media by survey respondents the respondents indicated that they have shared recall information or bad food experiences primarily with family, friends, and coworkers, with the use of social media. sharing tended to be under particular circumstances, such as relevancy to the person contacted and seriousness of the problem. the pew research center had found that the use of social media was greatest in the 18-29 and 30-49 age groups and lowest in the 65 or older group (duggan & smith, 2013). our results show rates similar to theirs, as shown in table 3. “smart phone” access decreases with age whereas “other computer” (generally desktop or all-in-one computers) increases with age. as shown in table 4, in this study the same overall pattern of decreases with age occurs. but usage varies with the specific form of social media. specifically, “facebook” and “youtube” are fairly similar across age groups while “google+” increases across the age groups and both “instagram” volume 31, number 2 363 and “twitter” decrease across the age groups. table 3 respondents’ access to communication technology technology owned or used regularly sample age 18-29 age 30-49 age 50-64 age 65 or older smartphone 153 (29.4%) 51 (36.4%) 49 (32.2%) 34 (26.8%) 19 (18.8%) tablet 90 (17.3%) 22 (15.7%) 28 (18.4%) 21 (16.5%) 19 (18.8%) laptop computer 160 (30.8%) 50 (35.7%) 46 (30.3%) 37 (29.1%) 27 (26.7%) other computer 117 (22.5%) 17 (12.1%) 29 (19.1%) 35 (27.6%) 36 (35.6%) total* 520 (100%) 140 (26.9%) 152 (29.2%) 127 (24.4%) 101 (19.4%) table 4 social media used by respondents which of the following do you use? sample age 18-29 age 30-49 age 50-64 age 65 or older facebook 157 (26.9%) 51 (27.0%) 51 (26.6%) 35 (26.9%) 20 (27.4%) google+ 86 (14.7%) 16 ( 8.5%) 25 (13.0%) 21 (16.2%) 24 (32.9%) linkedin 93 (15.9%) 20 (10.6%) 40 (20.8%) 25 (19.2%) 8 (11.0%) myspace 2 ( 0.3%) 1 ( 0.5%) 0 ( 0.0%) 1 ( 0.8%) 0 ( 0.0%) instagram 35 ( 6.0%) 21 (11.1%) 10 ( 5.2%) 4 ( 3.1%) 0 ( 0.0%) printerest 36 ( 6.2%) 15 ( 7.9% 9 ( 4.7%) 6 ( 4.6%) 6 ( 8.2%) twitter 48 ( 8.2%) 20 (10.6%) 17 ( 8.9%) 10 ( 7.7%) 1 ( 1.4%) badoo 1 ( 0.2%) 0 ( 0.0%) 0 ( 0.0%) 1 ( 0.8%) 0 ( 0.0%) tumblr 10 ( 1.7%) 4 ( 2.1%) 4 ( 2.1%) 2 ( 1.5%) 0 ( 0.0%) viadeo 0 ( 0.0%) 0 ( 0.0%) 0 ( 0.0%) 0 ( 0.0%) 0 ( 0.0%) youtube 116 (21.7%) 41 (21.7%) 36 (18.8%) 25 (19.2%) 14 (19.2%) total* 584 (100%) 189 (32.4%) 192 (32.9%) 130 (22.3%) 73 (12.5%) 364 journal of business strategies table 5 familiarity with food recalls have you ever heard of a food recall? sample age 18-29 age 30-49 agee 50-64 age 65 or older no 11 ( 5.2%) 6 (10.7%) 3 ( 5.1%) 1 ( 2.1%) 1 ( 2.0%) yes 201 (94.8%) 50 (89.3%) 56 (94.9%) 47 (97.9%) 48 (97.9%) total 212 56 59 48 49 table 6 how respondents heard of food recalls if yes, how did you hear about it? sample age 18-29 age 30-49 age 50-64 age 65 or older newspaper or other print media 112 (19.3%) 22 (20.6%) 28 (23.1%) 34 (31.5%) 28 (33.3%) television or radio 163 (28.2%) 37 (34.6%) 44 (36.4%) 42 (38.9%) 40 (47.6%) face-to-face 29 ( 5.0%) 16 (15.0%) 6 ( 5.0%) 6 ( 5.6%) 1 ( 1.2%) phone call 11 ( 1.9%) 2 ( 1.9%) 4 ( 3.3%) 4 ( 3.7%) 1 ( 1.2%) email 33 ( 5.7%) 5 ( 4.7%) 13 (10.7%) 7 ( 6.5%) 8 ( 9.5%) online social media (twitter, facebook, etc.) 55 ( 9.5%) 17 (15.9%) 21 (17.4%) 13 (12.0%) 4 ( 4.8%) other 17 ( 2.9%) 8 ( 7.5%) 5 ( 4.1%) 2 ( 1.9%) 2 ( 2.4%) total 420 107 121 108 84 as shown in table 5, almost all (94.8%) of the respondents had heard of a food recall. all age groups except the youngest were 95% or more “yes,” but even it was almost 90%. not surprisingly, most respondents heard about food recalls by print or broadcast media (table 6). the younger age groups received the news this way just over half the time (55.2% for ages 18-29 and 59.5% for ages 30-49) while the older groups heard the news this way much more frequently (70.4% for ages volume 31, number 2 365 50-64 and 80.9% for 65 or older). social media was a more prevalent source in younger groups (15.9% for ages 18-29 and 17.4% for ages 30-49) compared with older groups (12.0% for ages 50-64 and only 4.8% for 65 or older). that same pattern exists when email is combined with social media (20.6% for ages 18-29; 28.1% for ages 30-49; 18.5% for ages 50-64 and 14.3% for 65 or older). logistic regression analysis using the outcome variable “social media,” logistic regression was used to more systematically measure whether social media are involved when respondents receive food recall information. the model assumes that the logit (the log of odds) of the social media using behavior has a linear relationship with four predictor variables – age, gender, race, and education. to accomplish this, the data were coded as shown in table 7. table 7 data coding variable coding social media (y) 1 = use social media age (x1) 1 = 18-29 2 = 30-49 3 = 50-64 4 = 65+ gender (x2) 1 = male 2 = female race (x3) 1 = white 2 = black 3 = asian 4 = other education (x4) 1 = high school 2 = college 3 = college graduate 4 = advanced degree using this coding, then, “y” is the binary outcome variable indicating social media using behaviors where “1” indicates the use of social media and “0” indicates that social media are not used. “p” represents the probability that “y” equals 1. x1, x2, x3, x4 are then a set of predictor variables (age, gender, race, and education, respectively). the logistic regression of y on x1, x2, x3, and x4 estimates parameter values for β0, β1, β2, β3, and β4 through maximum likelihood method of the equation: logit (p) = log (p / (1-p)) = β0 + β1*x1 + β2*x2 + β3*x3 + β4*x4. the likelihood ratio chi-square test examines whether all four predictor variables are simultaneously equal to zero, a sign indicating the model has no explanatory power. the null hypothesis is that all of the regression coefficients are zero. the test result shows the likelihood chi square of 25.46 with a p-value 0.0045. under the chosen level of significance, the willingness to accept a type i error, 0.05, 366 journal of business strategies the smaller p-value supports the conclusion that at least one of the regression coefficients in the model is not equal to zero. therefore, the individual variables were tested. the coefficient for age is statistically significant under the level of significance 0.05, with p-value 0.006 < 0.05. the coefficient for gender is statistically significant under the level of significance 0.1, with p-value 0.067 < 0.1. the coefficients for race and education are not statistically significant, with p-values 0.3316 and 0.1938, respectively. within the age groups, a comparison of group 1 (ages18-29) and group 4 (65+), that of group 2 (ages 30-49) and group 4 (65+), and that of group 3 (ages 5064) and group 4 (65+) are all statistically significant, with p-values 0.0034 (<0.01), 0.0008 (<0.01), and 0.0519 (<0.1) respectively. the coefficients are in the form of the log of odds [logit (p) = log (p / (1-p))]. the exponential coefficient is the ratio of two odds, which indicates the change in odds in the multiplicative scale for a unit increase in a predictor variable when holding other variables constant. p/(1-p) = exp (β0 + β1*x1 + β2*x2 + β3*x3 + β4*x4). as shown in table 8, the odds ratios can be further transformed into probabilities: p = exp (β0 + β1*x1 + β2*x2 + β3*x3 + β4*x4) / [1 + exp (β0 + β1*x1 + β2*x2 + β3*x3 + β4*x4)] logit group comparisons holding gender, race, and education constant, the probability for a social media user to be in the age group 18-29 is 86.81%, while the probability for a social media user to be in the age group 65+ is 13.19%. thus, the odds for people age 18-29 are 6.58 times higher than the odds for people above age 65. so the 18-29-year-old respondents, compared to those age 65+, are more likely to use social media. in like manner, holding gender, race, and education constant, the probability for a social media user to be in the age group 30-49 is 88.72%, while the probability for a social media user to be in the age group 65+ is 11.28%. so comparing these two groups, the odds for people age 30-49 are 7.86 times higher than the odds for people above 65 years. compared to age 65+ respondents, those in the age 30-49 group are more likely to use social media. holding gender, race, and education constant, the probability for a social media user to be in the age group 50-64 is 77.35%, while the probability for a social media user to be in the age group 65+ is 22.65%. this, then, indicates that the odds for people age 50-64 are 3.41 times higher than the odds for people above 65 years. volume 31, number 2 367 so those in the age 50-64 group are more likely to use social media than those 65 or older. table 8 logit results model result: estimate p-value significance 1 age (18-29) vs. (65+) 1.8846 0.0340 yes(<0.05) age (30-49) vs. (65+) 2.0620 0.0008 yes (<0.01) age (50-64) vs. (65+) 1.2281 0.0519 yes(<0.10) 2 gender (male vs. female) -0.6500 0.0670 yes (<0.10) transformed probabilities: log of odds odds ratio probability 1 age (18-29) vs. (65+) 1.8846 6.5837 86.81% 2 age (30-49) vs. (65+) 2.0620 7.8617 88.72% 3 age (50-64) vs. (65+) 1.2281 3.4147 77.35% 4 gender (male vs. female) -0.6500 0.5220 34.30% 95% wald confidence interval: probability lower limit upper limit 1 age (18-29) vs. (65+) 86.81% 65.13% 95.87% 2 age (30-49) vs. (65+) 88.72% 70.16% 96.34% 3 age (50-64) vs. (65+) 77.35% 49.75% 92.17% 4 gender (male vs. female) 34.30% 20.70% 51.12% finally, holding age, race, and education constant, the negative value of the log of odds -0.65 indicates that being male decreases the log odds of using social media. the probability for a social media user to be a male is 34.3%, while the probability for a social media user to be a female is 65.7%. males are less likely than females to use social media. respondents’ concern and experience with food problems many respondents indicated a growing concern about food safety, particularly the ability of companies and the government to successfully monitor what goes 368 journal of business strategies into the products we consume. in commenting on whether informal communication helps or hinders the food safety system, respondents generally were positive but noted that caution would be needed. they appreciate hearing from someone about food recalls but recognize that a person reporting the bad food may have been self-diagnosing inaccurately. they usually do mention recalls to family and friends but feel there is a need to make the public aware of how to notify the correct authorities when experiencing a food related illness. table 9 experiences with and responses to food problem scenarios (percentages) scenario 1 medical help needed % scenario 2 medical help not needed % scenario 3 do use product % scenario 4 don’t use product % all respondents have experienced 20.6 65.1 66.4 75.0 have told others 86.0 73.6 69.0 39.1 would tell others 83.7 57.1 68.2 50.0 18-29 age group have experienced 17.9 80.3 44.6 73.2 have told others 70.0 75.6 64.0 36.6 would tell others 84.8 90.9 74.2 46.7 30-49 age group have experienced 26.3 75.4 43.9 77.2 have told others 80.0 62.8 68.0 31.8 would tell others 76.2 64.9 59.4 53.8 50-64 age group have experienced 25.0 58.3 88.0 76.6 have told others 100.0 89.3 63.6 38.9 would tell others 80.6 35.0 52.0 63.6 65 or older age group have experienced 12.5 41.7 30.6 72.9 have told others 100.0 70.0 86.7 51.4 would tell others 92.9 46.4 73.5 38.5 note: only those who experienced a scenario were asked to respond to each scenario. volume 31, number 2 369 as shown in table 9, respondents had experienced scenario 2 more than scenario 1 and, except for the 50-64 age group, they had also experienced scenario 4 more than scenario 3. except for the youngest age group, respondents indicated that they had told or would tell others about the experience if scenario 1 than they would if it were scenario 2. those who had told others were greater for scenario 3 than scenario 4 and that pattern holds for those who would tell except for the 50-64 age group. consistent with previous research (vihalemm, kiisel, & harro-loit, 2012; hallman, 2013), these results suggest that individuals are more likely to tell others if the event was severe and they are also more likely to tell others about a recall if that recall was for a product that they used. symphony© (http://www.activejava.com/) software was used to analyze these comments to see if patterns occurred. while no distinct pattern existed, nearly 40 different foods were mentioned in the comments (see table 10). table 10 specific foods mentioned bacon beef berry brownie butter cabbage cantaloupe cereal cheese chicken chili corn fruit hamburger lettuce meat peanuts peanut butter pizza pork poultry rice salad salmon sausage seafood shell shellfish shrimp soup spinach steak strawberry sushi tomato tuna turkey vegetables yogurt the basic question raised through this is: what are the characteristics of those who inform others about experiences/recalls through the use of social media? to answer that question, all respondents who used social media for one or more of the scenarios were grouped together. the results of that are shown in table 11. this would suggest, then, that if an agency wants to spread the word of a food recall, it needs to make sure that young, well-educated adults are informed. 370 journal of business strategies table 11 characteristics of those who inform others through social media gender: age: education: female 38 18-29 21 no high school diploma 0 male 26 30-49 28 high school graduate 4 50-64 10 college graduate (bachelor’s degree) 24 65 or older 5 advanced degree (master’s, doctor’s) 23 to further examine the scenario results, generalized estimating equations (gee) were used. gee is a quasi-likelihood approach to model changes and marginal effects particularly useful for initial explorations. first scenarios 1 and 2 were examined to see how or if the use of social media changed between a major issue and a minor one. the response variable was set as 0= social media was not used and 1= social media was used. the predictor variables, then, were experience, age, and gender. experience was coded as 0= the individual did not personally have the experience and 1= the individual did personally have the experience. age was coded into four groups (1, 2, 3, 4 in ascending order), and gender as 0= male and 1= female. as shown in the first part of table 12, all the predictors except one (age 3049 vs. age 65+) were significant. the second part of the table shows the probabilities associated with the significant predictors. perhaps counterintuitively, these results suggest that when a health issue becomes more severe the use of social media in general decreases, younger groups tend to not use it, but males do tend to use it. it may well be that a reluctance to share a very personal, possibly even embarrassing, event or the level of concern leads to this decrease in the use of social media so that the information is more likely shared only through more direct means (face-to-face, phone calls, or the like). using the same coding, scenarios 3 and 4 were examined to see how or if the use of social media changed between a relevant recall and one that was not particularly relevant. the predictor variables were as before except that experience was coded as 0= the individual is not personally impacted by the recall and 1= the individual is personally impacted. volume 31, number 2 371 table 12 gee results: use of social media for major vs minor issue predictor variable estimate p-value significance experience (no vs. yes) 0.8203 0.0768 yes (<0.10) age (18-29) vs. (65+) -0.5828 <0.0010 yes (<0.01) age (30-49) vs. (65+) -0.1992 0.4526 no age (50-64) vs. (65+) -0.2229 <0.0010 yes (<0.01) gender (male vs. female) 0.2148 0.0001 yes (<0.01) log of odds odds ratio probability experience (no vs. yes) 0.8203 2.2712 69.43% age (18-29) vs. (65+) -0.5828 0.5583 35.83% age (50-64) vs. (65+) -0.2229 0.8002 44.45% gender (male vs. female) 0.2148 1.2396 55.35% table 13 gee results: use of social media for relevant vs non-relevant issue predictor variable estimate p-value significance experience (no vs. yes) 0.0493 0.0251 yes (<0.05) age (18-29) vs. (65+) -0.8806 <0.0001 yes (<0.01) age (30-49) vs. (65+) -0.2640 0.2063 no age (50-64) vs. (65+) -0.3671 0.2249 no gender (male vs. female) -0.1400 0.0103 yes (<0.05) log of odds odds ratio probability experience (no vs. yes) 0.0493 1.0505 51.23% age (18-29) vs. (65+) -0.8806 0.4145 29.31% gender (male vs. female) -0.1400 0.8694 46.51% again, the first part of table 13 shows that all the predictors except two (age 30-49 vs. age 65+ and age 50-64 vs. age 65+) were significant. the second part of the table shows the probabilities associated with the significant predictors. these results, then, suggest that when a food recall involves a more familiar product people tend not to use social media (however the difference is small) and, again, that 372 journal of business strategies younger age group tend not to use social media, but contrary to the previous results, females tend to use social media. taken together, the scenario results suggest that there is a situational effect on the use of social media when dealing with negative food experiences and food recall announcements. indeed, these results imply that at present people use social media mainly for socializing and spreading the word primarily when they are not personally involved or impacted. limitations as with most survey research, this pilot study is limited but suggests future research. we used a convenience sample and, although the respondent characteristics were similar to some national data, this was not a representative sample. in addition, we did not gather information about income or employment. clearly a representative sample covering an extensive list of demographics would be especially useful in examining this topic more fully. conclusions in the food safety process, hazard communication is the exchange of food hazard knowledge and information. given the characteristics of the food safety system, this paper has argued that a key to an efficient and effective food safety process is the adoption of a strategy by regulatory agencies to exploit social networks through the use of social media. this might be achieved by facilitating the creation of collections of individuals and organizations representing heterogeneous backgrounds (what might be referred to as competitive cohorts; flint & van fleet, 2011). an important implication of this pilot study is that due to the dynamics of networking through social media, food safety agencies need more than good ideas, sufficient resources, and intelligence. they need to have a strategy that provides a particular alertness in terms of information on social media, the formation of their social media groupings/cohorts, and how they manage that network (kirzner, 1985). developing trust so as to be perceived positively by participants in the food safety social network is then an important aspect of the agencies’ strategic ability to effectively manage that social network (san martin & camarero, 2008; chen, chien, wu, & tsai, 2010; sparrowe, liden, wayne, & kraimer, 2001). the use of hashtags associated with recalls would greatly facilitate searching and grouping messages to spread the word quickly. voluntary posting of recall information on the websites and facebook pages of manufacturers, suppliers, distributors, grocers, restaurants, and volume 31, number 2 373 the like could go a long way to help establish that trust. in that event, being required to do so by a regulatory agency would not be necessary. while more research is clearly needed particularly about specific strategic applications of the use of social media for health and safety (chang & hsiao, 2013; kaplan & haenlein, 2010; kietzmann, hermkens, mccarthy, & silvestre, 2011; coulson & knibb, 2007), the results of this pilot survey suggest that the use of social media to spread the word regarding negative events (experiences or recalls) would not only help people to cope with that event both emotionally and cognitively, but also would increase the effectiveness of the food safety system (vihalemm, kiisel, & harro-loit, 2012). that increase will occur because of the rapid dissemination of information through social media and because information sent by a friend, relative, or contact may be more likely to be read than a message being circulated via public news media such as a newspaper. the results of this pilot study suggest that, in general, the primary users of social media are young, well-educated adults but optimal targets for spreading the word may not be just those with the most friends (campbell, 2013). there are clear situational effects on its use when dealing with negative food experiences and food recall announcements. when gender, race, and education are held constant, (1) younger age groups are more likely to use social media than are older age groups, and (2) males are less likely than females to use social media. further, at present people appear to use social media mainly for socializing and for spreading the word primarily when they are not personally involved or impacted. upon hearing about a recall, then, individuals, especially females, are more likely to tell others about that recall if it was for a product that is familiar to them or that they use. after personally experiencing a food problem, individuals are more likely to tell others (1) if the event was severe and (2) if that recall was for a product that they used, although they are less likely to do so through the use of social media. this suggests, then, that agencies wanting to spread the word of a food recall need to adopt strategies and formulate policies to make sure that young, well-educated females are involved. effective hazard communication among diverse stakeholders in a complex environment requires an information structure. clearly, social media will be part of that structure whether formally or informally. references barjolle, d., jeanneaux, p., & meyer, d. (2012). raising rivals’ costs strategy and localized agro-food systems in europe. international journal on food system dynamics, 3(1), 11-21. 374 journal of business strategies benkler, y. (2006). the wealth of networks: how social production transforms markets and freedom. new haven, ct: yale university press. benkler, y. (2011). the penguin and the leviathan: how cooperation triumphs over self-interest. ny: crown business. burt, r. s. (2005). brokerage and closure: an introduction to social capital. oxford: oxford university press. campbell, a. (2013). word-of-mouth communication and percolation in social networks. american economic review, 103(6), 2466-98. carlson, c. c., & peake, w. o. (2013). rethinking food recall communications for consumers. iridescent: icograda journal of design research, 3(3), 11-23. carpenter, m. a., li, m., & jiang, h. 2012. social network research in organizational contexts: a systematic review of methodological issues and choices. journal of management, 38(4), 1328-1361. chang, t. s., & hsiao, w. h. (2013). factors influencing intentions to use social recommender systems: a social exchange perspective. cyberpsychology, behavior, and social networking, 16(5), 357-363. chen, y. h., chien, s. h., wu, j. j., & tsai, p. y. (2010). impact of signals and experience on trust and trusting behavior. cyberpsychology, behavior, and social networking, 13(5), 539-546. choi, y., & lin, y. h. (2008). consumer response to crisis: exploring the concept of involvement in mattel product recalls. public relations review, 35(1), 18–22. consumers union. (2013). call for fda review “good news” for consumers. consumers union 2013. consumersunion.org/news/call-for-fda-review-good-newsfor-consumers/ (accessed feb. 22, 2014). coulson, n. s., & knibb, r. c. (2007). coping with food allergy: exploring the role of the online support group. cyberpsychology & behavior; 10(1), 145-148. crum, c. 2009. baby food recall shows social media done right. available at http://www.webpronews.com/baby-food-recall-shows-social-media-doneright-2009-10 [accessed 1 october 2014]. duggan, m., & smith, a. (2013). social media update 2013. pew research internet project 2013. www.pewinternet.org/2013/12/30/social-media-update-2013/ (accessed feb. 22, 2014). flint, g. d., & van fleet, d. d. (2011). the competitive cohort: an extension of strategic understanding. journal of business strategies, 28(2), 97-122. food safety working group. (2009). food safety working group 2009. www.foodsafetyworkinggroup.gov/home.htm (accessed mar. 14, 2014). volume 31, number 2 375 freberg, k. (2013). using the theory of planned behavior to predict intention to comply with a food recall message. health communication, 28(4), 359-365. freberg, k., graham, k., mcgaughey, k., & freberg, l. (2011). who are the social media influencers? a study of public perceptions of personality. public relations review, 37( ), 90-92. golub, b., & jackson, m. o. (2010). naïve learning in social networks and the wisdom of crowds. american economic journal: microeconomics, 2(1), 112-49. gorry, g. a., & westbrook, r. a. (2009). winning the internet confidence game. corporate reputation review, 12(3), 195–203. granovetter, m. s. (1973). the strength of weak ties. the american journal of sociology, 78, 1360-1380. grant, b. (2009). elsevier published six fake journals. the scientist 2009. www.thescientist.com/?articles.view/articleno/27383/title/elsevier-published-6-fakejournals/ (accessed mar. 22, 2014). gulati, r., nohria, n. and zaheer, a. (2000). strategic networks. strategic management journal, 21(3), 203–215 hallman, w. k. (2013). addressing the potential for food recall fatigue. rutgers, nj: food policy institute, new jersey agricultural experiment station. hallman, w. k., & cuite, c. l. (2009). food recalls and the american public: improving communications. rutgers, nj: food policy institute, rutgers university. fpi publication number rr-0310-020. hathi, s. (2009). communicators remain unclear on business case for social media. strategic communication management, 14(1), 9. inkpen, a. c., & tsang, e. w. (2005). social capital, networks, and knowledge transfer. academy of management review, 30(1), 146-165. jackson, m. o., & watts, a. (2002). the evolution of social and economic networks. journal of economic theory, 106(2), 265-295. kaplan, a. m., & haenlein, m. (2010). users of the world, unite! the challenges and opportunities of social media. business horizons, 53(1), 59-68. kietzmann, j. h., hermkens, k., mccarthy, i. p., & silvestre, b. s. (2011). social media? get serious! understanding the functional building blocks of social media. business horizons, 54(3), 241-251. kirzner, i. m. (1985). discovery and the capitalist process. chicago: university of chicago press. lauretti, d. (2013). 19 seo companies fined for creating fake reviews. 2013: examiner.com, http://www.examiner.com/article/19-seo-companies-fined-for-creating-fake-reviews 376 journal of business strategies leyden, d., link, a.n., & siegel, d. s. (2014). a theoretical analysis of the role of social networks in entrepreneurship. research policy, forthcoming. liu, b. f., austin, l., & jin, y. (2011). how publics respond to crisis communication strategies: the interplay of information form and source. public relations review, 37: 345–353. mahon, j. f., heugens, p. p., & lamertz, k. (2004). social networks and non-market strategy. journal of public affairs, 4(2), 170-189. mcwilliams, a., van fleet, d. d., & cory, k. d. (2002). raising rivals’ costs through political strategy: an extension of resource-based theory. journal of management studies, 39(5), 707-723. moss, m. (2009). food companies are placing the onus for safety on consumers. ny times 2009. www.nytimes.com/2009/05/15/business/15ingredients. html?ref=michaelmoss&_r=0 (accessed feb 22, 2014). peters, r., & golden, p. (2013). stakeholder networks and strategy: the influence of network consistency and network diversity on firm performance. journal of business strategies, 30(2), 120-144. ramsey, l. p. (2010). brandjacking on social networks: trademark infringement by impersonation of markholders. buffalo law review, 58(4), 851-929. rangan, s. (2000). the problem of search and deliberation in economic action: when social networks really matter. academy of management review, 25(4), 813-828. rutsaert, p., pieniak, z., regan, a., mcconnon, a., kuttschreuter, m., lores, m., lozano, n. guzzon, a., santare, d., & verbeke, w. (2014). social media as a useful tool in food risk and benefit communication? a strategic orientation approach. food policy, 46: 84-93. san martín, s., & camarero, c. (2008). consumer trust to a web site: moderating effect of attitudes toward online shopping. cyberpsychology & behavior; 11(5), 549-554. siegel, d.s. (2009). green management matters only if it yields more green: an economic/strategic perspective. academy of management perspectives, 23(3), 5-16. skelton, v. (2012). “best blog post ever” – the rise of fake reviews and why it matters. information today europe 2012. www.infotodayeurope.com/2012/09/20/ best-blog-post-ever-the-rise-of-fake-reviews-and-why-it-matters/ (accessed mar. 22, 2014). volume 31, number 2 377 sparrowe, r. t., liden, r. c., wayne, s. j., & kraimer, m. l. (2001). social networks and the performance of individuals and groups. academy of management journal, 44(2), 316-325. vihalemm, t., kiisel, m., & harro-loit, h. (2012). citizens’ response patterns to warning messages. journal of contingencies and crisis management, 20(1), 13–25. williams, p. r. d., & hammitt, j. k. (2001). perceived risks of conventional and organic produce: pesticides, pathogens, and natural toxins. risk analysis, 21(2), 319–330. wright, d. k., & hinson, m.d. (2012). examining how social and emerging media have been used in public relations between 2006 and 2012: a longitudinal analysis. public relations journal, 6(4), 1-42. biographical sketch of authors chao-shih (jake) wang is a doctoral candidate in agribusiness at arizona state university. he received a master of international management from the thunderbird school of global management and a b.a. in business administration from soochow university in taipei, taiwan. his experience is in the construction and electronics industries. his research interests include food safety management, hazard communication, reverse logistics, transaction cost economics, social networks, and agent-based modeling dr. david d. van fleet is a professor of management in the morrison school of agribusiness, w. p. carey school of business, arizona state university. he has numerous publications and officer roles in professional associations. he is a past editor of both the journal of management and the journal of behavioral and applied management. he is or has been a member of the board of governors, academy of management, southwest federation of academic disciplines, and the southern management association; and was national chair of the management history division of the academy of management. he is a fellow of the academy of management and a fellow of the southern management association. dr. ella w. van fleet, founder and president of professional business associates, has more than 35 years of experience in teaching, training, managing, and consulting. she spent sixteen years as a practicing and teaching entrepreneur in texas, for which the texas house of representatives passed h.r. no. 746 honoring her for outstanding professional contributions to the state of texas. she was also associate director of the texas institute for ventures in new technology, a founding 378 journal of business strategies member of the board of governors of the houston enterprise alliance, a member of the international council of small businesses, and a member of the sba advisory council for region iv. officer and direcfor stock ownership and firm performance in the pubucly traded small corporation catherine m. daily ohio state university columbus, ohio dan r. dalton indiana university bloomington, indiana introduction questions concerning the financial interests held by chief executive officers (ceos) and boards of directors in the firms they serve has been a continuing topic of discussion and debate in the corporate governance literature (e.g., [26], [27]). it has been suggested, for example, that in order to ameliorate the costs associated with self-interested behavior on the part of management and board members, which is not necessarily isomorphic with that of shareholders, these individuals should be required to own substantial portions of the firm's stock ([3], [8], [25]). when these individuals possess significant personal financial interests in the firm, they are less prone to act opportunistically or behave apathetically with respect to firm performance, and are more prone to take an active interest in the financial well-being of the firm. moreover, such equity interests may act to more closely align the objectives of corporate officers, board members, and shareholders. agency theory, for example, would suggest that the level of equity interest which individuals hold will directly influence the degree to which they are subject to selfinterested behavior, as opposed to firm-interested behavior [24]. the owner-entreprenem, for example, will strive for profit maximization since firm profits accrue directly to this individual [30]. when organizational agents hold only a minor equity position in the firm, however, this incentive may be lacking, necessitating an increase in the monitoring of managerial actions [3]. without monitoring mechanisms, the financial impact of poor decisions is borne by shareholders who are unable to directly sanction those making organizational decisions. presumably, when the fmancial impact of organizational actions directly affects the financial status of those making the decisions, less monitoring will be necessary as organizational decision makers seek to improve firm performance to their direct fmancial benefit legally, the board of directors is mandated to perform this monitoring function with respect to :firm management, including the ceo [31]. as a governance body, the board has a fiduciary duty to protect shareholder interests. moreover, the board is created to safeguard shareholders' interests from being exposed to excessive amounts of risk [52]. unfortunately, boards are often negligent in this function. many aities 102 journal of business strategies vol. 9, no.2 of boards of directors charge tha~ despite their legal responsibility to attend to the interests of the owners of the corporation (shareholders), directors seem unwilling or unable to challenge or constrain inappropriate managerial action ([16], [21], [37], [48]). in response to the lack of careful monitoring, kesner and johnson [28] have recommended that directors become increasingly more active in corporate affairs. in theory, director ownership of the firm's stock should be accompanied by an increased incentive to closely monitor managers [50]. while the monitoring function of managers may be the most critical task of board members [51], it is often neglected. calls for increased monitoring of management by the board of directors are grounded, in part, in the need to monitor ceo behavior in particular. t. boone pickens, jr., for example, has claimed that the biggest problem facing corporate america today is the lack of ceo ownership in the firms they serve [8]. without ownership interest in the firm, ceos are subject to self-interested behavior, often at the expense of shareholder interest. pickens further argued that this "absence of financial risk is inconsistent with the free-enterprise system" [8]. as a result, both ceos and board members should be required to maintain a financial interest in the firms they serve, in order to attenuate self-interested behavior and apathy. such self-interest may manifest itself in the form of increased managerial salaries, extra staff, managerial shirking, and perquisites ([13], [35]). the ownership-performance linkage agency theory assumes that managers (agents) are often motivated to maximize their own utility, which often does not converge with that of the firm's owners ([17], [23], [24], [29]). in the corporate form of organization, executives are those managers with the power to direct the firm. and the owners are the body of shareholders. when the agency problem exists, it is the owners of the firm who suffer the actions of the agents who may overlook the maximization of the shareholders' wealth [32]. the most obvious disadvantage of diffuse ownership, then, is the increased opportunity for managerial opportunism, at the cost of firm performance [17]. while extant research has generated conflicting results concerning the impact of ownership structure on firm performance, some support has been found for the proposition that stronger links between organizational agents and firm ownership result in improved firm performance. krause [29], for example, found that among fortune 500 firms, owner-controlled firms utilized their assets more efficiently, tended to grow at faster rates, and achieved significantly higher raw and excess returns than those firms under managerial control. additionally, rumelt [46] found that in firms where ceos perceive a strong connection between their personal financial stake in the firm and the wealth of the organization, the :firm tends to be more profitable than when this linkage is absent. ceos and board members, however, generally own relatively small portions of outstanding shares in the :firms they serve ([20], [22]). absent this linkage, it is the shareholder who endures the decline in equity value, not the managers responsible for the decisions. fall 1992 daily & dalton: stock ownership & firm performance 103 as ownership in the inm increases, managers are less likely to behave in a manner which detracts from firm value maximization [24]. this necessarily occurs because managers, then, bear the costs they incur when behaving in a manner which detracts from the augmentation of corporate wealth [35]. while ownership in the firm does not guarantee value maximization on the part of managers, it is certainly the more likely and rational outcome. such arguments are predicated on a convergence-of-interests hypothesis [35]. board members, in particular, may demonstrate a lack of concern regarding management decisions because "they run virtually no personal risk for any amount of complacency, cronyism, or outright neglect of their duties" [21]. in small firms this problem is further intensified by the small retainers paid to directors. compensation paid for board service is so minimal as to provide little, if any, incentive to perform directoral functions effectively. directors serving on small firm boards receive, on average, between $6,000 and $8,000 annually for their board service [38]. this situation may be further complicated in the small firm where control is a critical issue for ceos. founder ceos in particular are more apt to exert control over firm operations, especially when personal financial interests are at issue ([6], [12], [45]). these ceos, then, are resentful when directors presume to question their ability to effectively operate the firm. they prefer that the board not actively intervene [38]. this insistence for overarching control, however, may be a primary contributor to the ineffectiveness of founder-run companies [44]. in order to avoid the scrutiny of careful monitoring and evaluation of managerial actions, ceos in small corporations may select board members who are sympathetic to the ceos' opinions [6]. the implication is that only those who are wiiling.to "rubber stamp" decisions will be invited for board service. such directors are likely to be disinterested parties both unwilling and unable to serve as a necessary system of checks and balances to ensure effective management of the firm [49] and the protection of shareholder interests [52]. as a means for creating an incentive for directors to perform their monitoring function, board reform critics have suggested directors maintain a financial interest in the firms they serve. when directors own substantial portions of the firm's stock they are personally affected by the decisions and actions of top management ([26], [28]). it may, therefore, be particularly important for these individuals to possess large financial interests in the small corporation to effectively align personal and firm interests. owner/directors may be willing to challenge and constrain management when it directly affects their financial situation [21]. proponents of this theory include muckley [36], patton and baker [40] and pickens ([42], [43]). their arguments include (1) the provision of strong leadership from someone who owns large amounts of stock [40], (2) dignifying the positions these individuals occupy through stock ownership [36]), and (3) the ability to relate to and act more like stockholders ([42], [43]). the outcome of these positions is increased shareholder value. the theory, however, has failed to receive widespread empirical support. 104 joumal of business strategies hypotheses vol. 9, no.2 despite calls for increased ownership in firms, the extant research suggests a lack of consensus for the proposition that increased ownership by organizational agents improves corporate performance by reducing agency costs [50]. while theory would suggest that if officers and directors own substantial amounts of stock in the companies they serve the firms will perform better, the empirical evidence is equivocal. kesner [26], for example, examined this financial dependence perspective among a sample of fortune 500 companies. she found the amount of equity held by board members to be significantly related to several measures of financial performance, when controlling for industry growth. in low growth industries, board stockholdings were unrelated to firm performance; however, in high growth industries firms performed better when directors maintained a financial stake in the firm. alternatively, chacko [8], in an examination of fortune 500 firms, found "an utter lack of interdependence between company performance and the level of stock holdings by top management:' using net income and price/earnings ratio as dependent variables, and controlling for company size, he found no systematic relationship between management stock ownership and firm performance. these mixed results may be attributable to the level of impact organizational agents may exert in large, complex firms. both examinations relied on samples of large firms. as evidence of the need to examine smaller firms as well, several organizational scholars have suggested that in larger organizations the ability of ceos to impact firm processes and outcomes may be constrained (e.g., [1], [14], [39]). it is in the smaller firm where organizational agents may be less constrained in their ability to directly impact firm actions. this study, then, examines the linkage between ceo and board of directors equity ownership (and effective control of the corporation) and financial performance in the context of the small corporation. much of the prescriptions aimed at improving the governance of corporations have been directed at board of directors composition (le., the inside/outside distinction). vance [49], however, suggested that financial commitment to the firm in the form of stock ownership may have a greater influence on corporate performance than the inside/outside director issue. as a result, the financial impact of stock ownership by firm officers and directors is of interest to this study. maintaining control of the firm is a critical issue for ceos of small firms. typically, the owner-manager uses the business as a means for satisfying both professional and personal needs [38]. one means for exerting control is by holding the position of ceo and board chairperson concurrently (ceo duality). to do otherwise invites some risk of divided authority. to further entrench one's authority position, then, the ceo would elect to hold substantial portions of the firm's stock, particularly in the case of a founder-ceo. hi: there will be a positive association between the incidence of ceo duality and ceo stock holdings. fall 1992 daily & dalton: stock ownership & firm performance 105 h2: there will be a positive association between founder-ceos and ceo stock holdings. presumably, officers and directors in the firm would have some faith in the leadership of the organizations which they serve. as a consequence, these individuals would view ceo holdings in the firm as a sign of the ceo's confidence in his/her ability to effectively manage the firm and in the viability of the frrm. almost certainly the ceo would not maintain a large financial stake in a failing flrid. this same rationale may be more salient when the ceo elects to hold the position of board chairperson as well. h3: there will be a positive association between ceo stock holdings and officer and director stock holdings. h4: there will be a positive association between ceo duality and officer and director stock holdings. as previously suggested, ceo and officer and director stock ownership in the frrm should serve to ameliorate self-interested behavior and align personal and frrm interests to the direct fmandal benefit of the owners of the frrm (shareholders). in line with the convergence-of-interests proposition [35], it is expected that as ownership stakes increase, firm performance will increase. this association will be particularly salient in the small corporation where organizational agents are more able to impact firm processes and outcomes. morek, et al. [35], in particular, have called for research which specifically considers this ownership/firm performance linkage in the small frrm. h5: ceo stock ownership will be positively related to firm performance. h6: officer and director stock ownership will be positively related to flrid performance. given the support presented in prior literature, all hypotheses have been presented in the alternative form. past works have provided sufficient guidance to suggest the anticipated direction of the associations hypothesized. methods sample a variety of defmitions of what constitutes a small business have been offered (e.g., [1], [41]); however, d'amboise and muldowney [15] have suggested that the most commonly accepted definition of the small business for research and reporting purposes is that the business employs no more than 500 and does not have sales which exceed $20 million per year. this defmition, then, guided the selection of flrids for 106 journal of business strategies vol. 9, no. 2 the purposes of this study. indeed, the 186 firms included in this study constitute all of the firms which meet this profile. the publicly traded small corporations were selected from standard & poor's reports: over-the-counter & re&ional exchan&es and standard & poor's reports: american stock exchan&e. these sources were chosen based upon their comprehensiveness in reporting all corporations which fit the criteria for selection. corporations are required to file documents with the securities and exchange commission, and the data required to test the six hypotheses were available in these volumes. variables ceo duality: ceo duality is a binary variable; either the ceo concurrently holds the position of board chairperson or an independent individual holds this position. this information was obtained from the standard and poor's re&ister of corporations. directors. and executives (1990). founder-ceo: information concerning whether the ceo was also the founder of the corporation was determined through telephone interviews with representatives of the sample firms. typically, the secretary/receptionist was able to provide this information. in some cases, however, the call was transferred to other parties (e.g., personnel office, public relations, office of the ceo) who were able to provide this information. all firms contacted provided the requested information. stock holdings: the level of common stock holdings was also provided in the standard & poor's sources. common stock holdings for both ceos and officers and directors of the firm were listed. because the variable for officer and director holdings includes those holdings by the ceo, ceo common stock holdings were subtracted from this figure to obtain the aggregate common stock holdings of officers and directors of the firm, excluding the ceo. performance indicators: chakravarthy [9] has suggested that there currently is no agreement regarding the choice of an appropriate set of dependent variables to define corporate performance. furthermore, bourgeois [5] has noted that the selection of any given performance indicator creates a multiplicity of problems for the researcher, including quantification, dimensionality, validity, and universal acceptance. selection of anyone indicator, however, is likely to be deficient in capturing corporate performance for any given sample of firms. accordingly,othere have been several calls for the use of multiple indicators of performance (e.g., [7], [11], [33], [47]). when relying on performance as an outcome variable in examinations of small firms in particular, it is critical to use multiple measures of performance [4]. reliance upon any single performance indicator will likely result in ,a biased view given that small business ownerl managers may operate based upon divergent goals. cochran and wood [11] have noted that while any number of financial measures of firm performance are available, such measures can be classified into two broad categories: market measures and accounting measures. both categories should be included in performance studies. consequently, three commonly relied indices of fifall 1992 daily & dalton: stock ownership & firm performance 107 nancial performance, capturing both categories, were used in this study: return on assets (roa), return on equity (roe), and price/earnings ratio (pie ratio). these data were collected from standard & poor's reports: over-the-counter and recional exchance and american stock exchance. analyses pearson product-moment correlation coefficients were relied on to test hypotheses one through four. these hypotheses suggest variables which are positively associated. correlation coefficients measure the degree to which variables move in association with each other [10]; therefore, this statistical procedure provided an appropriate means to test the first four hypotheses. for hypotheses five and six we rely on canonical correlation. these hypotheses each have three interrelated dependent variables (roa, roe, price/earnings ratio). accordingly, the relationship between the independent variable and the three independent variables must be simultaneously assessed. given that all variables for hypotheses five and six are interval, canonical correlation is the appropriate analytical technique. because canonical correlation results can be subject to different interpretations we will provide both simultaneous and separate analyses for the dependent variables of hypotheses five and six. results the six hypotheses consider the relationships between ceo duality, founder·ce~ ceo and officer and director stock ownership, and flod performance. hypothesis one posits an association between ceo duality and amount of common stock holdings. a pearson correlation provides support for this view (r=.18, p<.oi). hypothesis two suggests a similar relationship between the founder-ceo corporate structure and equity holdings. the results indicate that this, too, is a viable hypothesis (r=.26, p<.ool). hypothesis three suggests an association between ceo stock holdings and officer and director stock holdings. curiously, this association is not as hypothesized. the results indicate an inverse relationship (r=-.25, p<.05). interestingly, large blocks of ceo equity are associated with lesser holdings by officers and directors. hypothesis four is opposite as well. it seems that ceo duality/independence structures are inversely related to officer and director equity holdings (r=-.31, p<.01). the fifth hypothesis suggests that the levei of ceo stock ownership will be positively related to firm performance. given that we rely on three dependent variables to capture firm performance, we report here the results of a canonical correlation. based on this analysis, there is no support for this hypothesis while considering the dependent variables simultaneously (f=2.01, os), or separately (roa, f=3.82, os; rob, f=.81, os; pie ratio, f=3.02, os). the final hypothesis posits a relationship between levels of equity held by 0fficers and directors and the financial performance of the firm. once again in this case we rely on three dependent variables. a canonical correlation analysis indicates do 108 journal of business strategies vol. 9, no. 2 support for this hypothesis either considering the dependent variables simultaneously (f=.22, ns) or separately (roa, f=.07, ns; roe, f=.52, ns; pie ratio, f=.36, ns). discussion the results are supportive of the tendency of ceos, founder-ceos in particular, to maintain control positions in the firms they serve. among the firms sampled, ceos holding the position of board chairperson and founder-ceos both held higher levels of stock in the firm. by maintaining both an authoritative and equity position in the firm, ceos decrease the likelihood of being challenged by the firm's officers and directors. the results of hypotheses three and four may not be inconsistent with this view. from a control perspective (e.g., a ceo with large equity holdings or a dual ceo), that other officers or directors hold substantial equity positions in the firm may be interpreted as a threat given this, one would not be surprised, for example, if a ceo was not supportive of granting stock options to officers or directors. failing this, a ceo may be influential in keeping such options at a modest level. the results are also supportive of chacko's [8] findings that there exists no significant relationship between top management's stock holdings and corporate performance. additionally, the results did not distinguish between accounting returns or the market measure relied on in this study. one explanation may be that these measures are arguably short-term in their orientation. perhaps expanding the variety of performance dependent measures to include those that capture more of a long-term orientation on the part of officers and directors of the firm would provide alternative results. expenditures for research and development or advertising, for example, are suggestive of a long-term focus, as opposed to short-term indicators such as return on assets or return on equity. the inability to link financial dependence and fmn performance, based on agency theory arguments, may be the result of "gaping holes in the theory from the beginning" [8]. the belief that increased stock holdings by organizational agents would result in more careful management of the firm was based largely on conjecture and speculation [8]. perhaps, such prescriptions are ill-informed. drucker [18], for example, has noted the benefits of having professional managers, as opposed to firm owners or family members, lead the corporation. he rejects the notion that large-scale stock ownership is a necessary condition for proper management of the firm. chacko [8], in agreement with drucker's observations, has noted that: a corollary to the theory is that the stockholder with the largest holding should be seriously considered for the ceo's job. the qualities needed to lead the business organization of the future have little to do with the talent to amass and manage a huge personal fortune. fall 1992 daily & dalton: stock ownership & firm performance 109 perhaps critics of professional management in the modem corporation have been too harsh in their judgment of the quality of leadership a firm receives when someone other than the owner is guiding the corporation. from the results of this study, it would seem that those individuals hired to oversee firm operations do so equally well regardless of the extent to which these individuals are financially tied to the firm. given the impact that organizational agents may exert on the small firm in particular, these findings provide little promise for the dictate that the means for improving the performance of the firm is through financial dependence. rather, the issue appears to be one of control. given that there are no financial gains which accrue when officers and directors hold stock in their firms, such holdings may be representative of the desire of these individuals to exert some control over firm operations. in the small firm in particular, ceos have demonstrated a tendency to maintain tight controls over firm operations (e.g., [6], [13], [45]). small firm owners have been less than enthusiastic when firm outsiders presume to advise them on the management of their firms [38]. the unwillingness to accept advice includes the board of directors as well. ceos tend to prefer an inactive board of directors who is less likely to monitor managerial actions ([2], [51]). unfortunately, directors are often all too willing to accommodate this managerial preference. outside directors, in particular, often lack the incentive or commitment to carefully monitor firm operations, especially ceo performance [19]. additionally, a certain irony should be noted with respect to the board reform critics calling for increased stock ownership on the part of board members. if, in fact, board members did have an increased financial interest in the firm, it might be reasonably expected that their interests and those of the shareholders-the group they presumably represent-might converge. at the same time, however, the notion of "outside" direction would be lost. in general, one could hardly expect a director with a large equity stake in the firm to be a dispassionate observer. it might also be difficult to anticipate that a director would be independent of the very management which provided this largess. future research in this area, then, may benefit from an increased emphasis on the control dimension of stock ownership. it might be interesting, for example, to examine the relationships among ceo equity holdings and commonly operationalized factors in corporate control, e.g., ceo duality, board composition (proportion of outside directors), and number of outside directors. some interdependence among such factorsin absence of systematic relationships with financial performance-might be interpreted as evidence of corporate control strategies. references 1. alcorn. p. success and survival in the family-owned business. new york: mcorawhill (1982). 2. andrews, k.r. "directors' responsibility for corporate strategy." harvard business review, vol. 58(6) (1980), pp. 30-42. 110 journal of business strategies vol. 9, no. 2 3. beatty, r.p. & zajac, ej. "top management incentives, monitoring, and risk-bearing: a study of executive compensation, ownership, and board structure in initial public offerings." academy of manaeement best pa,pers proceedinp. (1990), pp. 7-11. 4. begley, t.m. & boyd, d.p. "executive and corporate correlates of financial performance in smaller firms." journal of smajl business management. vol. 24(2) (1986), 8-15. 5. bourgeois, lj. "performance and consensus." strateeic management journal. vol. 1 (1980), pp. 227-248. 6. brady, g.f. & helmich, d.l executive succession: toward excellence in corporate leadership. englewood a.iffs, nj: prentice-hall. inc., (1984). 7. capon, n., hulbert. j.m., farley, j.u., & martin, le. "corporate diversity and ec0nomic performance: the impact of market specialization." strategic manaeement jourmll vol. 9 (1988), pp. 61-74. 8. chacko, c. "management's stock: ownership: irrelevant?" business horizons, vol. 33(3) (1990), pp. 75-78. 9. chakravarthy, b.s. "measuring strategic performance." strategic management journal. vol. 7 (1986), pp. 437-458. 10. aover, v. & balsey, h. business research methods. columbus, oh: grid, inc., (1974). 11. cochran, r.l. & wood, r.a. "corporate social responst"bility and financial performance." academy of ma.naaement journal. vol. 27 (1984), pp. 42-56. 12. daily, c.m. & dalton, d.r. in press. "founder versus non-founder professional management in the small corporation and financial performance." journal of small business ma.naaement. (in press). 13. daily, c.m. & dol1inger, mj. in press. "an empirical examination of ownership structure in family and nonfamily managed firms." family business review. (in press). 14. dalton, d.r. & kesner, i.f. "inside/outside succession and organizational size: the pragmatics of executive replacement." academy of manafment journal. vol. 26 (1983), pp. 736--742. 15. d'amboise, g. & muldowney, m. "management theory for small business: attempts and requirements." academy of manaaement review, vol. 13 (1988), pp. 226-240. 16. dayton, k.n. "corporate governance: the other side of the coin." harvard business review, vol. 62(1) (1984), pp. 34-37. fall 1992 daily & dalton: stock ownership & firm performance 111 17. demsetz, h. & lehn, ie. wote sbucture of corporate ownership: causes and consequences." journal of political economy. vol. 93 (1985), pp. 1155-1184. 18. drucker, p.f. "the coming of the new organization." harvard business review, (january-february) (1988), pp. 45-53. 19. fleischer, a., hazard, a.c., & klipper, m.z. board games: the chaneing sh;me of cofjxjrate power. boston, ma: little, brown, (1988). 20. fosberg, r.h. "outside directors and managerial monitoring." akron business and economic review, vol. 20(2) (1989), pp. 24-32. 21. geneen, h. managing. new york: doubleday & co., inc., (1984). 22. herman, e.s. cofjxjrate control. cofjxjrate power. cambridge, uk: cambridge university press (1981). 23. hill, c.w.l. & snell, sa. "effects of ownership structure and control on corporate productivity." academy of management journal. vol. 32 (1989), pp. 25-46. 24. jensen, m.c. & meckling, w.h. "theory of the firm: managerial behavior, agency costs and ownership sbucture." journal of financial economics. vol. 3 (1976), pp. 305-360. 25. johnson, e.w. "an insider's call for outside direction." harvard business review, (marcbjapril) (1990), pp. 46-55. 26. kesner,i.f. "directois' stock ownership and organizational pedormance: an investigation of fortune 500 companies." journal of manalement. vol. 13 (1987), pp. 499507. 27. kesner, lf. & dalton, d.r. "boards of directors and the checb and (im)balances of corporate governance." business horizons. (september/october) (1986), pp. 17-23. 28. kesner, i.f. & johnson, r.b. "crisis in the boardroom: fact and fiction." academy of management executive, vol. 4(1) (1990), pp. 23-35. 29. krause, d.s. "corporate contral." journal of political economy. vol. 73(2) (1988), pp. 110-120. 30. lamer, rj. matla£ement control and the lar&e cowomtiod. new york: dunnebeu publishing company (1970). 31. louden, i.k. the director: a professional's guide to effective board work. new york: amacom (1982). 112 journal of business strategies vol. 9, no.2 32. masson, r.t. "executive motivations, earnings and consequent equity performance." journal of political economy, vol. 79 (1971), pp. 1278-1292. 33. maupin, r.j. "financial and stock market variables as predictors of management buyouts." strategic manaaement journal, vol. 8 (1987), pp. 319-327. 34. mcgivern, c. "the dynamics of management succession: a model of chief executive succession in the small family firm." family business review, vol. 2 (1989), pp.401-4h. 35. morek, r., shleifer, a., & visbny, r w. "management ownership and market valuation." journal of financial economics. vol. 20 (1988), pp. 293-315. 36. muckley, j.e. "dear fellow shareowner." harvard business review. (march-april) (1984), pp. 46-64. 37. nader, r, green, m., & seligman, j. tamina the giant cor,poration. new york: w.w. norton & company, (1976). 38. nash, j.m. "boards of privately held companies: their responsibilities and structure." family business review. vol. 1 (1988), pp. 263-269. 39. norbum, d. & birley, s. "the top management team and corporate performance." strate&ie manaaement journal. vol. 9 (1988), pp. 225-237. 40. patton, a & baker, j.e. "why don't directors rock the boat?" harvard business review. (november-december) (1987), pp. 10-18. 41. peterson, ra, albaum, g., & kozmetsky, g. "the public's definition of small business." journal of small business managemenl (july) (1986), pp. 63-68. 42. pickens, t.b. ~. boston: houghton mifflin co., (1987). 43. pickens, t.b. "takeovers: a purge of poor managements. man~ement review. (january) (1988), pp. 53-55. 44. poe, r. "the sobs." across the board-the conference board maaazine. vol. 17(5) (1980), pp. 23-33. 45. pondy, l.r. "effects of size, complexity, and ownership on administrative intensity." administrative science ouarterly. vol. 14 (1969), pp. 47-60. 46. rumelt, r.p. "theory, strategy, and entrepreneurship." in d.j. teece (ed.), the competitive challenae: strateaies for industrial innovation and renewal cambridge, ma: bollinger (1987), pp. 137-158. fall 1992 daily & dalton: stock ownership & firm performance 113 47. shortell, s.m. & zajac, ej. "internal corporate joint ventures: development processes and performance outcomes." strate&ic management journal, vol. 9 (1988), pp. 527542. 48. townsend, r. "up the board of directors." across the board, vol. 21(7) (1984), pp. 48-50. 49. vance, s.c. cor.porate leadership: boards, directors. and stratec. new york: mcgraw-hill (1983). 50. walsh. j.p. & seward, j.k. "on the efficiency of internal and external corporate control mechanisms." academy of manakcment review, vol. 15 (1990), pp. 421-458. 51. wheelen, t.l. & hunger, j.d. stratepc manascmenl reading. ma: addison-wesley publishing company (1990). 52. williamson, o.e. the economic institutions of capitalism: firms. markets. and relational contraetinj, new york: macmillan (1985). officer and director stock ownership and firm performance in the publicly traded small corporation financial slack: a strategic control decision michael n. baur karen a. smith arizona state university tempe, az omar m. benkato ball state university muncie, in abstract financial slack or debt capacity adds to the discretion of managers. for strategic reasons, this discretion is valuable in the event of unforeseen future investment opportunities. this paper investigates how this strategic allocation of control within the firm influences the choice among short-term debt, long-term debt, and equity. this analysis suggests that equity or long-term debt produces efficient investment decisions when relationship-specific assets exist and are unequally distributed. otherwise, non-integration via short-term debt is preferred. introduction under certain conditions, it can be shown that corporate financing decisions do not affect the value of the finn.] this implies that finn managers should select capital budgeting projects independent of considerations about how the projects will be financed. although this financing irrelevance theorem has become standard theory in capital budgeting and capital structure problems, we present it in our classrooms as a starting point in discussing corporate value maximization through financing decisions. by. expanding the theoretical structure to include the uncertainty and transaction costs, financing issues such as financial slack or debt capacity become important strategic decisions that impact corporate value. this paper examines one perspective on how financial slack can affect corporate investment decisions, and hence corporate value. specifically, we investigate the roles of debt and equity in allocating control within the finn. the optimal allocation of control among the various parties within a firm is the primary problem of corporate governance. coase's (1937) contribution to this problem is to see vertical integration as a governance mechanism, that is, an important function of backward or forward integration is to allocate or fe-allocate 2 control. largely because of this view, many internal and external contractual arrangements have been described as vertical integration situations. coase suggests 170 journal of business strategies vol. 12, no.2 that transactions will be vertically integrated inside the finn whenever the costs are lower than the costs of market-oriented, non-integrated external transactions. williamson (1988) recognizes that since financial contracts are used to allocate control, the vertical integration framework can apply equally to financial contracting issues, including the debt/equity decision. based on this perspective, forward and backward integration are competing governance structures for assets. some assets are better controlled by the customer (i.e., managers). this is called backward integration and corresponds with equity financing since it allows managers enhanced control over investors (le., suppliers). similarly, other assets are better controlled by the supplier. this is called forward integration and corresponds with debt financing since it allows debt holders enhanced control over managers. in this control framework, there are two types of investors: debt holders and equity holders. each type of investor acquires a different set of control rights over the firm's managers. debt financing removes control rights from managers since they are forced to return capital to investors after a project's life span according to tenns specified in loan and bond covenants. unlike equity holders, debt holders stipulate to managers: 1) the timing and amount of cash flows (interest payments); 2) the maintenance of liquidity and other solvency tests; 3) and that certain creditors stand behind those debt holders in the event of bankruptcy. the debt holder not the manager retains control of how to spend the firm's cash flows in the future. williamson (1988) argues that this important veto over future investment decisions gives debt holders a different and larger set of control rights than equity holders. 3 the allocation of control within the firm the specific rights given up by managers are made explicit with the rulesbased governance structures established in debt contracts. unlike equity, debt is unforgiving if the fii1ll perfonns poorly. if a finn goes bankrupt, debt holders have the right to repossess funds and exercise their residual control rights about how the funds will be spent. thus, under debt financing, investors possess a larger set of control rights than managers. however, the cost of giving control to debt holders is a loss of control by managers. this loss of control may cause inefficient investment allocation decisions within the firin. in many circumstances, it is optimal to give managers control rights over future investment decisions. 4 equity financing perfonns this role. unlike debt holders, who dictate that part of cash flows are used to pay bond coupons, equity investors agree to give managers wide latitude about spending present and future cash flows. internal and extetnai corporate governance varies from firm to firm depending on the control needs of assets within the firm. control is rarely absolute, either for the manager at the investor (debt holder or equity holder). however, to understand the potential control aspects of debt or equity, it is useful to view debt financing as a control·allocating mechanism giving all control to debt holders and fall 1995 baur, smith, & benkato: financial slack 171 equity finance as a control-allocating mechanism giving all control to managers. this framework simplifies reality but highlights the implications of the control allocation of debt versus equity. in the framework of this simplified view, exhibit 1 summarizes the vertical integration perspective as it applies to the financial contracting issue of debt versus equity financing. exhibit 1 vertical integration summary forward integration • suppliers of capital (i.e., investors) control future investment decisions. debt removes corporate cash flows from the manager's discretion. • long-term debt financing is a forward integration solution that allows investor control. • because the firm will make more efficient investment decisions, and investors have relationship-specific assets at risk, investors have an incentive to control future investment decisions. backward integration • users of capital (i.e., managers) control future investment decisions. equity allows managers to decide whether to keep or return corporate cash flows to investors. • equity financing is a backward integration solution that allows managerial control. • because the firm will make more efficient investment decisions, and managers have relationship-specific assets at risk, managers have an incentive to control future investment decisions. non-inteiration • neither suppliers nor users are given control over future investment decisions. • short-term debt financing is a non-integration solution that allows joint control. • if managers and investors have relationship-specific investments at risk, both have an incentive to retain control. an incentive for non-integratiun also arises if managers and investors have no relationship-specific investments at risk. 172 journal of business strategies why investors want control vol. 12, no.2 investors want control of the firm to protect their investments. the suppliers of capital bear a unique relationship to the firm (williamson, 1988, p. 304307). suppliers of labor, raw materials and products typically retain possession of their investment. if a firm attempts to consume the products of suppliers without satisfactory reimbursement, these suppliers have the option of retaking possession of their investments and redeploying them. s suppliers of capital have no such option, and are thus placed in a vulnerable position. capital is a generalpurpose purchasing power that can be quickly depleted or misappropriated. 11 the purchase of relationship-specific assets is one use of funds. if the finn fails to properly reimburse its suppliers of capital for their investments, these capital suppliers can retake possession of these relationship-specific assets. however, capital suppliers will be unable to sell these relationship-specific assets without a loss in value. these unique hazards faced by suppliers of capital may cause the large and varied set of contracts we observe in capital markets. contracts with other input suppliers arc less complicated because the contractual hazards are less serious. thus, we should observe fewer and a less varied set of contracts in markets for products other than capital. protection for debt and equity holders comes in several forms. a board of directors exercising their fiduciary responsibility to the equity holders, covenants in debt contracts, and corporate charters are a few of the protection mechanisms for debt and equity holders. equity investors are further protected from managerial abuse by the market for corporate control, which can be used to remove bad managers. however, this investor protection device is a last resort, to be used only after a complete breakdown of the internal protection mechanisms provided by debt and equity. because equity gives significant rights of discretion to ma~agers, equity holders are the least-well protected suppliers of capital and receive a higher rate of return than debt investors. because of these risks to equity holders, managers are willing to construct protective mechanisms to benefit equity holders. managers are willing to do this because it lowers the required rate of return equity holders will charge for their funds. one important protective mechanism for equity holders is the board of directors. managers organizing an enterprise can fonn a board of directors and give control of the board to equity holders. without control of the board of directors, investors are reluctant to invest or require a higher rate of return for their investments. even with a board of directors to protect the -interests of equity holders, the managers control much of the finn since they continue to control most decisions. why managers want control managers want control of the firm to protect their human capital investments. like investors or other suppliers to the firm, managers have their own set of fall 1995 baur, smith, & benkato: financial slack 173 unique hazards when contracting with the firm. if managers develop marketable skills in their jobs, managers can look to the competitive managerial marketplace to protect them from exploitation by the firm. however, if managers develop relationship-specific skills that are valuable in one firm only, they cannot expect to be equally productive outside their current firm. if wages reflect marginal product, their wages will be highest in their current firm. without an external managerial labor market, managers with relationship-specific skills are placed in a poor negotiating position when recontracting with the firm. however, such hazards facing managers are often overlooked. since managers are the central contractual agent, they are thought to operate the firm at the expense of others. unusual financial contracts (e.g., golden parachutes) crafted by managers are viewed as attempts to add to management's all-powerful positions rather than for efficiency purposes. as the central contractual agent of the firm, managers are the natural candidates to control allocation decisions within the firm. other participants in the finn including investors do not have access to as complete a set of information and would thus be inclined to make less efficient investment allocation decisions. since equity grants the largest amount of managerial discretion, managers favor equity for maximum flexibility. control rights are not costless, however. in exchange for the enhanced managerial discretion and the associated risks, equity holders require a higher return than debt holders. the control decision: a flow chart suppose, for example, that a manager (or investor) devises a business opportunity in which several suppliers are needed. s some suppliers provide assets that are redeployable, and other suppliers provide relationship-specific assets. managers will be able to contract for redeployable assets easily and without contractual hazards. for relationship-specific assets including funds from capital suppliers, contracts must be carefully written to protect these suppliers. the manager can either issue long-term debt, short-term debt or equity. if the manager issues long-term debt, he pays a moderate cost of capital but gives away some future decision rights. if he issues equity, he keeps future decision rights but must pay a higher cost of capital. short-term debt has the lowest cost of capital and is neutral with respect to future control rights. to decide between these alternatives, the manager values future decision rights and determines whether the added cost of long-term debt or equity is justified. exhibit 2 presents the flow chart describing the manager's problem. we assume that relationship-specific assets are important in the production process. thus, profits are assumed to depend on the amount and distribution of relationship-specific investments between managers and investors. since production efficiency depends on relationship-specific assets, profits are assumed to increase as relationship-specific investments increase. according to the exhibit 2, the debt/equity decision depends critically on the payoffs associated with each set of (relationship-specific) investment decisions. 174 journal of business strategies vol. 12, no.2 exhibit 2 the managers's decision: the optimal allocation of control manager pays moderate price for capital but loses control of future investment decisions. manager makes less relationship-specific investments. manager ~ manager pays high price for capital but gains control of future investment decisions. manager makes more relationshi p-specific investments. i short-term ... debt manager pays low price for capital. relationship-specific investments are not important in the production process. nete: a similar flow chart would describe the parallel decision by an investor whether to acquire control of the firm's investment decisions. to maximize firm profits, the financing decision that generates the most profitable set of investments will be selected. if investors secure future control rights with long-tenn debt financing, investors are willing to make larger relationshipspecific investments. they are willing to do this because their control rights guarantee that others cannot confiscate the economic rents arising from their relationship-specific investments. alternatively, if managers secure future control rights with equity financing, they are willing to make large relationship-specific investments since their control rights guarantee that no one will b~ able to confiscate their rents. to maximize profits, the financial contracts of the firm will be written to encourage the manager or investor who adds the most value to the finn from relationship-specific investments to make the most relationship-specific investments. the manager or investor making the largest relationship-specific investment has the largest incentive to acquire control. since the manager or investor does not want others to make decisions that make his relationship-specific investments worthless, he places himself in an increasingly vulnerable position if he does not acquire control. if he does not have control, the confiscation of etonomic rents by investors or others is a credible threat. the larger the investments in relationship-specific assets, the more he will pay to acquire control rights. this willingness to pay larger and larger sums to acquire control rights lessens the desire of the other party to retain control rights. the size of these sums, however, will be limited by the productivity associated with the relationship-specific investments. the investor or manager able to extract the greatest productivity from the acquisition of control rights will pay the highest sums to acquire control. fall 1995 baur, smith, & benkato: financial slack 175 if the manager or investor is unwilling to pay a sufficiently high price to acquire control over future investment decisions, he has two choices. first, he can sell his control rights and reduce his relationship-specific investments. this limits his exposure to the confiscation of his economic rents. second, he can sell his control rights but continue to make the technologically-efficient amount of relationship-specific investments and rely on alternative mechanisms to prevent confiscation of his rents. to the degree that alternative mechanisms are inadequate, he will make the first choice and continue to underinvest in the otherwise optimal amount of relationship-specific investments. 9 finally, if technology dictates that no relationship-specific investments are needed in the production process, the manager and investor are indifferent to acquiring control. if no relationship-specific investments are needed, there is no risk of confiscation. the confiscation of rents is implausible without relationship-specific assets. if threatened, either side can costlessly redeploy their assets in a competitive market that pays a wage equal to their marginal product. the manager and investor are indifferent about control. neither the manager nor investor will pay for complex vertically integrated financing contracts like long-term debt or equity. less expensive non-integrated solutions similar to short-term debt financing will be observed. like spot markets, short-term debt does not require costly relationships. spot markets lower transaction costs because they specialize in standardized contracts that require no relationship between the supplier and the customer. the conventional treatment of financial slack and the strategic allocation of control within the firm ross, westerfield and jaffe (1993), brealey and myers (1991) and jensen (1986) recognize that debt financing reduces the discretion of managers either through increased financial distress or the loss of financial slack. for example, ross, westerfield and jaffe (1993, p. 475-479) list taxes, risk, asset type, and financial slack as real world influences of a firm's capital structure. brealey and myers (1991) list taxes, financial distress costs, pecking order, and financial slack. according to brealey and myers (1991, pp. 447-448), financial slack is important because "in the long run, a company's value rests more on its capital investment and operating decisions than on financing. therefore, you want to make sure your firm has sufficient financial slack, so that financing is quickly accessible when good investment opportunities arise. financial slack is most valuable to firms that have ample positive-npv growth opportunities. that is another reason why growth companies usually aspire to conservative capital structures." also, jensen (1986, p. 324) concludes that "debt reduces the agency costs of free cash flow by reducing the cash flow available for spending at the discretion of managers. these control effects of debt are a potential determinant of capital structure." 176 journal ofbusiness strategies vol. 12, no.2 as mentioned above by ross, westerfield and jaffe (1993), another factor thought to influence capital structure is the asset type. more specifically, williamson (1988) suggests that the existence of relationship-specific assets impacts the choice between debt contracts and equity. relationship-specific assets are assets that have value when used in a specific relationship. for example, bankers must decide whether to develop expertise about a specific firm. this expertise is valuable if a long-term relationship develops between the firm and the bank. however, if the banking relationship fails, the value of this expertise about a specific firm is reduced. when relationship-specific assets are redeployed, owners of relationship-specific assets incur a transaction cost or 10ss.1o a transaction that includes substantial relationship-specific assets ties two contracting parties together in a bilateral monopoly relationship.ll before the rela~ tionship-specific assets are sunk, each side can deal with many traders in a competitive market. once the relationship-specific investments are sunk, one or both sides have assets at risk that become worthless if the bilateral relationship fails. relationship-specific assets discourage or prohibit frequent recontracting. neither can walk away without incurring losses. williamson calls this the "fundamental transformation" of contracting. what is initially a market-based contracting problem becomes a bilateral monopoly problem after relationship~specific investments are sunk. 12 if assets are not relationship-specific, capital market-based contracting modes (e.g., auctions) will be more efficient. however, if relationship-specific assets are significant, governance-based contracting modes (e.g., internal organizations) will be efficient. using slightly different language, brealey and myers (1991) and masulis (1988) also recognize that relationship-specific assets influence financial contracting choices such as the debt/equity decision. these authors suggest that relationship-specific assets increase the cost of financial distress, which influences the debt/equity decision. "the costs of distress are likely to be greater for firms whose value depends on growth opportunities or intangible assets. these firms are more likely to forgo profitable investment opportunities and, if default occurs, their assets may erode rapidly. hence firms whose assets are weighted toward intangible assets should borrow significantly less, on average, than firms holding assets you can kick" (brealey and myers, 1991, p. 448). "the size of particular debt instruments outstanding and the characteristics of the debt contract appear to be related to the firm's level of tangible assets, the extent of specialization of these assets.... in short, the theory and evidence on optimal capital structures seems to be uncovering significant interdependencies between firm investment and financing decisions. . . . many questions remain unanswered. . . . how do various features of a firm's securities and other contracts affect managerial incentives and firm operating efficiency?" (masulis, 1988, p. 90). fall 1995 baur, smith, & benkato: financial slack conclusions 177 vertical integration is a mechanism suggested by coase and williamson to allocate control within the firm. if one investigates the consequences of investments in relationship-specific assets, and views debt and equity within a vertical integration framework, a control rationale for debt and equity emerges. relationship-specific investments create hazards for managers and investors when they contract with each other. since debt and equity contracts outline the boundaries of control between managers and investors, debt and equity contracts can be used to reallocate control. this reallocation of control mitigates some of the problems caused by relationship-specific assets. using this control framework, two results emerge. first, the manager or investor making the largest investments in relationship-specific investments has the largest incentive to acquire control. equity for the manager and long-term debt for the investor are avenues to acquire this control. secondly, if technology dictates that no relationship-specific investments are needed in the production process, the manager and investor will be indifferent to acquiring control. in this case, short-term debt will be the least-costly financing choice, and thus the most appropriate source to use. because of reduced financial slack or debt capacity, textbooks frequently recognize that debt financing reduces the discretion of managers. this strategic decision of how to allocate control within the firm has potentially serious consequences. the loss of control by managers (or investors) can lead to sub-optimal investment decisions. our findings have practical implications that can be summarized as follows: • under debt financing, investors (debt holders) possess a larger set of control rights than under equity financing. consequently, the manager's decision rights are limited which may cause inefficient investment decisions within the firm. • debt financing allows debt holders to dictate that cash flows are used to pay bond coupons instead of reinvested in new projects. • equity investors, unlike debt holders, agree to give managers more latitude about spending present and future cash flows. • in exchange for giving up control, equity holders expect and demand to receive higher rates of return than debt holders because of the higher risk they are facing. • managers want control in order to protect their relationship-specific human assets. the more specialized they become, the less marketable they will be and the higher degree of control they will demand. • as a manager's talents become specific to a single firm, the manager will prefel' the use of equity. • if technology dictates that no relationship-specific investments are needed in the production process, managers and investors will be indifferent to acquiring control because there is no risk of confiscation. 178 journal ofbusiness strategies endnotes vol. 12, no.2 ithese conditions include: certainty, competitive markets, costless transactions, and no taxes. see martin, cox, and macminn (1988, p. 67-85) for a formal proof and discussion of this irrelevance theroem. 2control is the set of rights to purchase, direct, and sell assets within the firm. the set of control rights is divided among the participants in the firm, specifically managers and investors. corporate governance suggests that control rights are allocated differently between managers and investors across firms. vertical integration includes backward and forward vertical integration. 3it is certainly debatable whether a debt holder or equity holder has a larger set of control rights. it is difficult to compare whether the debt holder's power to cdncretely stipulate future cash flows with interest and principal repayment schedules is greater than the equity holder's power to hire and fire managers. in addition, a large equity block holder can have significant control rights over a wide range of managerial actions. 4legally and operationally, control often defines ownership. for equity financed firms, one could say that managers "own" the firm because managers control important future investment decisions. likewise, for heavily debt-financed firms, the debt holders could be said to "own" the firm since they implicitly control how future cash flows will be spent. although this definition of ownership sounds unconventional, it is generally consistent with standard usage. tax rulings, for example, have traditionally held that ownership is essentially a question of control. despite the existence of a long-term lease, the internal revenue service considers a building to be "owned" by the tenant whenever the tenant exercises control over a much larger set of decisions than the titleholder, who has given up effective control in exchange for a cash payment. 5for labor suppliers, this is true to varying degrees. it has been pointed out to me that some faculty members are paid for past efforts and therefore these faculty members cannot repossess their efforts. 6this same idea is expressed by shleifer and vishny (1989) in their management entrenchment hypothesis. 70ther suppliers also extract protection mechanisms such as a seat for labor on the board of directors, mandatory arbitration of disputes, or specialized contract covenants. for example, coal suppliers for steel mills require steel company managers to sign complicated and detailed long-term contracts when they have relationship-specific assets at stake (joskow, 1987 and 1985). if relationship-specific assets are at risk, other suppliers will attempt to align incentives to protect themselves from specific risks. for a discussion of how conflicts of interest can be mitigated by contractual innovations within the corporation, see jensen and meckling (1976). 8the control problem is also a problem for an investor, who must also determine whether to acquire control of the firm. 9conventional financial thought has long recognized the importance of eliminating poor investment decisions. for example, myers (1977) emphasizes the importance of future investment decisions to firm value, and the costly effects of managerial underinvestment caused by debt financing. myers also stresses the importance of relationship-specific investments and suggests that a large portion of firm value arises from intangible assets and the future investment opportunities made possible by these intangible assets. myers, however, described a different cause for underinvestment. he suggested that since debt financing allows much of the potential benefit from these projects to accrue fall 1995 baur, smith, & benkato: financial slack 179 to bondholders, managers of debt-financed firms will underinvest relative to equity-financed firms. 10 other works in this area include joskow (1987, 1985), brickley and dark (1987), monteverde and teece (1982), and klein, crawford and alchian (1978). ii with bilateral monopoly, there are quasi-rents that must be divided through a bargaining process. when quasi-rents exist, the potential for opportunism is greater since competition and market discipline is removed. these quasi-rents are generated by the relationship-specific assets. 12in joskow's (1985, p. 105) words, "anonymous spot markets fail because the sinking of relationship-specific investments transforms a large-numbers bargaining situation ex ante into a small-numbers bargaining situation ex post in which one or both parties have an opportunity to extract a portion of the quasi-rent stream associated with specific investments. to induce the parties to make optimal investments ex ante, some method must be found to constrain the ex-post hold-up and haggling problems that would emerge if the parties relied on repeated bargaining over the terms of trade ex post. in principle this can be accomplished if the parties can costlessly contract on the specific investments that they agree to make, the quantities they agree to deliver, and the prices that they agree to pay when various contingencies arise as the contractual relationship plays out over time. they are likely to be able to do so only imperfectly, however. furthermore, long-term contracts themselves may introduce costs and performance problems of their own. internal organizations or vertical integration is viewed as a method for overcoming some of the problems associated with long-term contracts,' although vertical integration may intorduce costs of its own as well. the ultimate choice of governance structure requires balancing the costs and benefits of these alternative governance systems." references brealey, richard a. and stewart c. myers. principles of corporate finance. fourth edition. new york: mcgraw-hill, 1991. brickley, james and federick h. dark. 'the choice of organizational form: the case of franchising." journal of financial economics 18 (1987): 401-420. coase, ronald h. "the nature of the firm." economica 4 (november 1937): 386-405. fama, eugene and michael c. jensen. "separation of ownership and control." journal of law and economics 26 (june 1983): 301-26. grossman, sanford 1. and oliver d. hart. "the costs and benefits of ownership: a theory of vertical and lateral integration." journal of political economy 4 (1986): 691-719. jensen, michael c. "agency costs of free cash flow, corporate finance and takeovers." american economic review (may 1986): 323-329. jensen, michael c. and william h. meckling. "theory of the firm: managerial behavior, agency costs and ownership structure." journal of financial economics 4 (1976): 305360. 180 journal f)f business strategies vol. 12, no.2 joskow, paul l. "contract duration and relationship-specific investments: empirical evidence from coal markets." american economic review 77 (march 1987): 168-185. joskow, paul l. "vertical integration and long-term contracts: the case of coal burning electric generating plants." journal of law. economics and organization i (fall 1985); 33-80. klein, benjamin, r. a. crawford, and a. a. alchian. "vertical integration, appropriable rents, and the competitive contracting process." journal of law and economics 21 (october 1978): 297-326. martin, john d., samuel h. cox jr., and richard d. macminn. the theory of finance evidence and applications. new york: dryden press, 1988. masulis, ronald w. the debtleg,uity choice. new york: ballinger, 1988. monteverde, kirk and david teece. "supplier switching costs and vertical integration in the automobile industry." bell journal of economics 13 (spring 1982): 206-13. myers, stewart c. "determinants of corporate financing." journal of financial economics (november 1977): 147-176. ross, stephen a., randolph w. westerfield, and jeffrey f. jaffe. corporate finance. third edition. homewood. il.: irwin, 1993. shleifer, andrei and robert w. vishny. "management entrenchment: the case of managerspecific investments." journal of financial economics 25 (november 1989): 123-139. titman, sheridan and roberto wessels. "the determinants of capital structure choice." the journal of finance 43 (march 1988): 1-19. williamson, oliver e. "corporate finance and corporate governance." journal of finance 3 (july 1988): 567-591. williamson, oliver. the economic institutions of capitalism. new york: free press, 1985. financial slack: a strategic control decision 28 journal of business strategies a model relating ceo social intelligence and strategic engagement: a study in small business organizations m. afzalur rahim western kentucky university • bowling green ky jeffrey p. katz western kentucky university • bowling green ky shane spiller western kentucky university • bowling green ky abstract answering the call for additional investigation into microfoundations recently raised by organizational theorists and researchers, this study empirically investigates the relationship between social intelligence (si) and strategic engagement (se) among u.s. small business chief executive officers (ceos). si is being aware of key social contexts, effectively addressing challenges occurring in those contexts, understanding the concerns of others and their related personal situations/emotional states, and building/maintaining positive relationships in social situations thereby behaving appropriately. se refers to actively participating in the process of formulation, implementation, and review of strategies for the purpose of improving the competitive position of the organization. opinions of observers (top managers) regarding their respective ceos’ si and se were assessed with questionnaires to explore the relationship between si and se. data analysis using lisrel 9.2 suggests that social intelligence is positively associated with strategic engagement behaviors among successful top executives. implications for the selection of new ceos and the training of existing ceos are offered. keywords: social intelligence, leadership, strategic engagement, top management teams, ceo. introduction recent work by organizational theorists has concluded that organizational analysis should be concerned with how individual factors can be studied, and perhaps aggregated, to better understand the success of organizations at the collective level (gavetti, 2012). the overall conclusion is the assertion that management and strategy researchers should seek to better understand the links between micro–macro strategy relationships (barney & felin, 2013; gavetti, volume 36, number 2 29 2005). they suggest that microfoundations have been generally neglected in the literature of strategic management. one of the encouraging signs in connection with this notion is that scholars are realizing that “we need to build microfoundations rooted in individual action and interaction” (felin & foss, 2009, p. 162; see also hodgson, 2012; nadkarni & herrmann, 2010). the editors of a special issue of strategic management journal on psychological foundations of strategic management suggested that “strategic management theory lacks adequate psychological groundings . . . until strategy theory builds stronger foundations in psychology, it will struggle to explain the facts of firm performance” (powell, lovallo, & fox, 2011, p. 1370). in other words, individual organizational members have different ways of thinking, feeling, and behaving that can significantly influence strategic issues. according to klein, tosi, and cannella (1999) “multi-level theories may illuminate the steps organizational actors may take, individually and collectively, to yield organizational benefits” (p. 243). over the past 10 years this discussion has resulted in studies reporting that psychological attributes of ceos significantly influence the strategic orientation of the firm (hiller & hambrick, 2005; nadkarni & narayanan, 2007). a recent study by nadkarni and herrmann (2010) reports that strategic flexibility mediates the relationship between ceo personality and firm performance. in this article, we take the lead from these findings and design a study to explore the relationship between ceos’ social intelligence and their strategic engagement of the firm. social intelligence is one of the constructs that was not only neglected in the strategic management literature, but also in the literature of organizational behavior and management (rahim, 2018, 2014; rahim, civelek, & liang, 2018). the present study presents a structural equations model and provides empirical evidence that the si competence of ceo’s can significantly influence their contributions to strategic engagement. this study was designed to make a value-added contribution to the microfoundations of strategic management literature by showing the link between ceos’ social intelligence and their strategic engagement, that is, their active participation in the strategic engagement processes of the firm. humankind generally associates intelligence with cognitive, academic, or mathematical–logical competence. scholastic aptitude tests, gpa, act, gmat, gre, and other admission tests are surrogates of cognitive intelligence. although academic institutions offer programs that are associated with this 30 journal of business strategies intelligence, the relevant literature on management generally acknowledges the inadequacy of cognitive intelligence as a predictor of one’s success in life or effective leadership (see the meta-analysis by judge, colbert, & ilies, 2004). that is, the management literature generally has ignored the contribution of other types of intelligence that are necessary for successful leadership at the top management level. gardner (1983), goleman (2005), mayer, salovey, and caruso (2008), sternberg (1985), and ang, van dyne, koh, ng, templer, and tay (2007) suggest that there are other components of intelligence—emotional, social, and cultural—that may influence one’s success in life or business. people with these types of intelligence are described by scholars as having “street smarts”— which indicate that an individual is not constrained simply because he or she may have below average academic intelligence or iq (e.g. bass, 2002; rahim, civelek, & liang, 2016). the value-added contribution of the present study is the successful evaluation of a micro–macro model specifying the relationships between si components and the ceo’s engagement with the strategic functions of the firm. strategic engagement intelligence is associated with one’s ability to interact effectively with the internal and external environments to be successful in life or as a leader in organizations. however, most published discussions regarding leadership and strategic engagement are focused at the national level rather than at the firmlevel. for example, wright (2010) suggests that the concept of engagement “is an amorphous and vague . . . its purpose, parameters, and promise remain unclear” (p. 35). however, it seems that wright’s comment on the concept of engagement in the area of international politics is also applicable to a significant extent on the strategic engagement construct in organizations. unfortunately, there is no consensus on the meaning of this construct in the area of management and organizational behavior. in the private sector, some management consultants have suggested that strategic engagement involves achieving changes in organizational culture and structure designed to improve performance (e.g., guttman & hawkes, 2004; smythe, 2007). others advocate employee engagement which emphasizes enhancing employees’ commitment and loyalty to work for improving overall performance (federman, 2009; macey, schneider, barbara, & young, 2009). there are many websites that advocate various types of change for improving performance. volume 36, number 2 31 unfortunately, there is no evidence that these changes improved learning and effectiveness in organizations. thus, strategic engagement is associated with a top manager’s active involvement in the strategy formulation, implementation, and review of processes to attain the goals of an organization. this involves changes in the process and structure at the macro-level so that top managers are actively involved in the continuous review and refinement of strategies for improving the competitive position of an organization. for the purpose of this study, ceo strategic engagement includes articulating a compelling vision, formulating, implementing and refining strategies, and moving those key factors from the drawing board to desirable organizational outcomes. drawing from previous research and recommendations in the strategic management literature (gavetti, 2012; guttman & hawkes, 2004; wright, 2010), strategic engagement is the process used by the leader of the firm to facilitate the interaction between the external environment of the firm, the key stakeholders of the firm, and the internal activities that align the goals of the firm with the expenditures of resources (baron & markham, 2000). social intelligence sternberg (2009) provides evidence that there are three types of intelligence― creative, analytical, and practical―that are needed for one’s success. his concept of practical intelligence is very similar to the commonly-used notion of social intelligence. several scholars suggest similar concepts―intrapersonal or emotional and interpersonal or social intelligence (gardner, 1999; goleman, 2005; mayer, salovey, & caruso, 2008). finally, cultural intelligence is another type of “intelligence” that has been suggested by ang et al. (2007). it is generally agreed that si is different from cognitive intelligence. although there is no agreement on the definition of the construct, many conclude that si is associated with understanding the thinking, feelings and behaviors of others, interacting with them properly, and acting effectively in various situations (ford & tisak, 1983; kihlstrom & cantor, 2000; sternberg, 2002). thus, social intelligence is defined as being aware of relevant social situational contexts, effectively addressing challenges, understanding the concerns, feelings and emotional states of others, communicating by knowing what to say, when to say it and how to say it, and building and maintaining positive relationships with others (rahim, 2014). this definition consists of four categories of abilities—situational awareness, situational response, cognitive empathy, and social skills. situational awareness is associated with one’s ability to collect data 32 journal of business strategies and information for the diagnosis and formulation of problem(s). whereas situational response is associated with one’s ability to use this information to make effective decisions to attain desired results. these two basic abilities, or competencies, are needed for one’s success in life or effective leadership (rahim, civelek, & liang, 2015a, 2015b). cognitive empathy and social skills are needed to better understand the feelings and needs of people, communicate with them effectively, and build and maintain relationships. these two abilities can help ceos remain aware of various social situational contexts, which in turn, help them improve their situational response competence. it is possible that these two abilities mediate or moderate the relationship between situational awareness and situational response. the theoretical basis of the four-category nomenclature of the si construct is described as follows. situational awareness bennis and thomas (2002) have categorized this ability as contextual intelligence. this is associated with one’s competence or ability to comprehend or assess relevant social situational contexts. ceos must be very strong in this ability, as it is needed to collect relevant information from the internal and external environments and make an appropriate diagnosis of the firm’s strengths, opportunities, weaknesses, and threats in a timely manner. this ability enables ceos to formulate a problem correctly. if they feel that they do not have adequate information on a problem or a potential business opportunity, they are likely to engage in environmental scanning behavior. if they do not understand a particular situation involving a technical problem, they may seek help from experts so that they have an overall understanding of the problem. for example, experts may bring different and even contradictory assessments of a problem, but it is the ceo who decides which problem formulation reflects social reality and is to be accepted. one can infer that ceos who have high situational awareness ability are better able to formulate their organization’s problems or challenges correctly. a study by o’brien and o’hare (2007) reported that participants in training programs who had higher situational awareness performed well irrespective of the training conditions. situational awareness competence is important at all levels of management, but it is particularly important at the top management level. if a problem is wrongly formulated, one would follow a wrong solution to the problem. this would lead to type iii error, which is defined as the probability of solving the wrong problem when one should be solving the right problem (mitroff, 1998; mitroff & silvers, volume 36, number 2 33 2010). ceos who possess this ability are able to collect necessary information and formulate a problem correctly, thereby avoiding type iii errors. situational awareness competence has been generally neglected in the theories of leadership, which implicitly assume that leaders can effectively diagnose the relevant situational variables and are able to formulate their problems correctly. however, leaders who are deficient on this competence may not be able to fully comprehend important situational issues. situational response this micro-factor is associated with one’s competence or ability to deal with any social situation effectively. this is essentially the decision making competence of leaders that is positively influenced by their prior problem formulation. although bennis and thomas (2002) describe this as adaptive capacity, situational response is a broader concept than that. in the present study, a distinction is made between the two abilities—situational awareness and situational response. it is possible for leaders to recognize or diagnose a situation or problem correctly, but they may not be able to make a decision due to political and other reasons that is likely to lead to desirable outcomes. in the present study, an attempt was made to integrate the diverse literatures relating to the fields of organizational behavior and strategic management for the application of social intelligence. in connection with organizational learning, argyris and schon (1996) carefully examine the detection and correction of error involved in organizational learning. in connection with the management or organizational conflict, rahim and bonoma (1979) present a model of diagnosis of and intervention in conflict, and schmidt and tannenbaum (1960) describe these as abilities as “to diagnose an issue and its causes” and “to decide on the best course of action” (p. 107). the two processes, diagnosis or detection of error and intervention or correction of error, correspond well with the two components of si—assessment of and responses to situational contexts. these two components are conceptually independent. thus, it is possible for a leader to have high or low abilities associated with these two components. a high–high leader is more effective than a high–low, low–high, or low–low leader. in other words, these two abilities are essential for effective leadership. the literature on leadership has generally done a better job of prescribing how to match leadership styles with situational variables for improving job performance and satisfaction of followers. unfortunately, scholars have been unable to capture 34 journal of business strategies the unique situations for which creative responses (leadership styles) would be needed for improving outcomes. contingency theories of leadership generally suggest that certain situational variables should be adequately matched with appropriate leadership styles in order to enhance job performance and satisfaction of subordinates. unfortunately, leadership theories did not discuss the need for leaders to possess situational awareness and response competencies to define the situational variables and respond to them with appropriate styles. even if a leader can diagnose a situation correctly, he or she may not possess the competence needed to make an effective decision to deal with it. the preceding discussion made clear that situational awareness and situational response are two essential abilities that are needed for effective leadership. however, there are other abilities, such as cognitive empathy and social skills that can help leaders to improve their effectiveness. the following is a discussion of each ability as measurable variables. cognitive empathy another component of si that has been discussed by scholars is empathy (e.g. goleman, 2005; albrecht, 2007; see also ang & goh, 2010). empathy refers to understanding others and taking active interest in them, recognizing and responding to changes in their emotional states, and understanding their feelings. several components of empathy are cognitive, intellectual, affective, and behavioral. cognitive empathy is associated with one’s ability to recognize the thinking, feelings, intentions, moods, and impulses of people inside and outside the organization and is a component of si. kaukiainen et al. (1999) suggest that “the cognitive component of empathy forms an essential part of social intelligence” (p. 83). cognitive empathy should help to improve a leader’s awareness of the feelings and needs of supervisors, subordinates, and coworkers as well as people from outside the organization. this ability to connect with people should help to improve a leader’s social skills. in other words, cognitive empathy should be positively associated with social skills. volume 36, number 2 35 social skills most of the definitions of social intelligence include social skills which are one’s ability or competence to speak in a clear and convincing manner that involves knowing what to say, when to say it, and how to say it. social skills also involve building and maintaining positive relationships, acting properly in human relations, dealing with problems without demeaning those who work with him or her, and negotiating and managing conflict with tact and diplomacy. social skills competence enables a ceo to continuously collect relevant information from internal and external environments, which enhance their situational awareness. social skills help leaders explain and justify their decisions to followers and motivate them so that the leaders’ decisions are effectively implemented. studies by baron and markham (2000) and baron and tang (2009) suggest that entrepreneurs’ social skills—specific competencies that help them to interact effectively with others—may also play a role in their success. in the previous section, it was argued that cognitive empathy directly influences social skills but indirectly influences situational awareness. therefore, it is likely that social skills will mediate the relationship between cognitive empathy and situational awareness (baron & kenny, 1986). as previously discussed, situational awareness positively influences situational response, but social skills indirectly influence situational response. thus, it is likely that situational awareness will mediate the social skills–situational response relationship. on the basis of this literature review, the we present the following research hypotheses. hypothesis 1: social skills will mediate the relationship between cognitive empathy and situational awareness. hypothesis 2: situational awareness will mediate the relationship between social skills and situational response. hypothesis 3: situational response will mediate the relationship between situational awareness and strategic engagement. the hypotheses investigated in the present study are presented in the model identified in figure 1. the solid lines indicate significant positive relationships. dotted lines indicate indirect and non-significant relationships. 36 journal of business strategies figure 1 a model of ceos’ social intelligence and strategic engagement cognitive empathy situational response social skills situational awareness strategic engagement method sample and procedure four hundred members of the chamber of commerce in a southern state in the u.s. were invited to participate in the study. after two reminders 150 usable responses were received, i.e. a response rate of about 37.5 percent. as respondents were asked to estimate their ceos’ social intelligence and strategic engagement, a decision was made that each respondent must have at least five years of work experience with his/her ceo. as a result, 74 respondents were selected and their responses were used for further analysis. chronological age and working experience with the present ceo were 46.48 (sd = 10.15) and 13.42 (sd = 7.79) years, respectively. their total job experience was 23.43 years (sd = 9.74). forty-eight percent of the respondents were female. table 1 reports the relevant demographical statistics. volume 36, number 2 37 table 1 demographical information of respondents item mean sd age 46.48 10.15 education 14.59 2.19 experience 23.43 9.74 exp. w/ceo 13.42 7.79 ceo’s educ. 15.30 2.69 employees 132.29 121.64 gender 52% male 48% female measurement social intelligence the four components of ceos’ si were measured with 28 items adapted from a new instrument—rahim social intelligence test (rsit)—developed by rahim (2014). the items adapted from the rsit were designed to measure observers’ (top managers) perceptions of their respective ceos’ si. the rsit was designed on the basis of repeated feedback from respondents and faculty and an iterative process of exploratory factor analyses of various sets of items in multiple samples. the final set of items was selected on the basis of a confirmatory factor analysis. the rsit uses a 5–point likert scale (5 = strongly agree . . . 1 = strongly disagree) for ranking each of the items, and a higher score indicates a greater si of a ceo. the subscales were created by averaging responses to their respective items. sample items are: “the ceo of our company can size up a situation, he/ she finds himself/herself in, rather quickly” (situational awareness); “the ceo of our company usually adapts appropriately to different situations” (situational response); “the ceo of our company understands people’s feelings transmitted through nonverbal messages” (cognitive empathy); and “the ceo of our company interacts appropriately with a variety of people” (social skills). rahim (2014) provided evidence of internal consistency and indicator reliabilities and convergent, discriminant, and criterion validities of the instrument and that it was free from social desirability response bias. 38 journal of business strategies strategic engagement this was measured with nine items particularly designed for this study. the instrument uses a 5–point likert scale (5 = strongly agree . . . 1 = strongly disagree) for ranking each item and a higher score indicates greater se of a ceo. these items were completed by the ceo’s direct subordinates of the firm and directly assess the ceo’s level of strategic engagement. sample items for this scale are, my supervisor (the ceo): “…participates in the strategy formulation process” and “participates in strategy implementation.” the items were factor analyzed to determine they form a single index measuring the level of ceo strategic engagement as observed by the ceo’s closest direct-reporting employees. analysis and results the first part of the analysis was designed to test the psychometric properties of the measures of si and se. the second part of the analysis was designed to test the three study hypotheses. data analyses were performed with spss 24 and lisrel 9.2 (jöreskog & sörbom, 1996a, 1996b) statistical packages. validity assessment (measurement model) confirmatory factor analysis of the 28 si and nine se items was computed. results show excellent fit indexes for the five components of the two instruments (see table 2). table 2 fit indexes for the measurement and structural equations models fit index measurement model structural equations model χ2/df 1.00 1.04 rmsea .00 .00 rmsr .06 .07 nfi .97 .95 cfi 1.00 1.00 ifi 1.00 1.00 note: rmsea = root mean square error of approximation, rmsr = root mean square residual, nfi = normed fit index, cfi = comparative fit index, and ifi = incremental fit index volume 36, number 2 39 the values for the χ2/df should be less than 4, root mean square error of approximation (rmsea) and root mean square residual (rmsr) should be low and generally ≤ .07. the values for other fit indexes, such as normed fit index, comparative fit index, incremental fit index, and goodness of fit index should be ≥ .90. the fit indexes for the measurement model satisfied these requirements (χ2/df = 1.00, rmsea = .00, rmsr = .06, nfi = .97, cfi = 1.00, and ifi = 1.00). overall, these indexes indicate that the rsit is a 4–dimensional measure of social intelligence and the criterion measure is a one-dimensional measure of se. the two questionnaires were completed by the same subjects at the same time, which could lead to common method variance. the extent of common method variance present in the measures was tested with one of the procedures suggested by podsakoff, mackenzie, lee, and podsakoff (2003). if common method variance was present, then all the observed variables (items) measuring si and se will load on a single factor. if a single-factor solution fits the data well, one can conclude that common method variance is mainly responsible for explaining the relationships among the variables (mossholder, bennett, kemery, & wesolowski, 1998). a onefactor measurement model was computed and the results show that all the six fit indexes (χ2/df = 6.43, rmsea = 21, rmsr = .13, nfi = .80, cfi = .86, and ifi = .78) were unsatisfactory. in other words, the single-factor model did not fit the data and, as a result, the absence of five components of the two measures or the presence of common method variance in the measures should not be assumed. convergent validity the average variance extracted by all the observed variables loading on a given factor measures convergent validity and should exceed .50 (carr, 2002). in the present study, these values were averaged for factors and all of the average r2 exceeded .50, the threshold for supporting convergent validity. this validity for the five latent variables (situational awareness, situational response, cognitive empathy, social skills, and strategic engagement) was judged by examining whether each observed variable had a statistically significant factor loading on its specified factor (netemeyer, johnston, & burton, 1990). factor loadings were highly significant, with a minimum t–ratio of 4.04 (p < .01). these results provided support for the convergent validity of the latent variables. 40 journal of business strategies discriminant validity one of the tests for discriminant validity requires squared correlations between factors to be less than the average variance extracted for each factor (carr, 2002). results provide support for the discriminant validity between si and se. another test for discriminant validity involves pair-wise comparisons of latent variables using a chi-square difference test (anderson & gerbing, 1988). for each pair of latent variables two models are developed. in one model the two latent variables are defined by their respective observed variables. in the second model, the correlation between the latent variables is constrained to 1.00. the chisquare difference test can be used to determine if the appropriately defined twofactor model provides statistically better fit than the constrained model. in each pairwise comparison of latent variables, the constrained model resulted in a significantly higher χ2 value supporting discriminant validity. overall, there is adequate support for discriminant validity. univariate normality the samples exhibited a high degree of univariate normality with skewness and kurtosis statistics well within the acceptable levels of 1 and 7 for all items. descriptive statistics and reliability coefficients table 3 reports the means, standard deviations, indicator and cronbach α internal consistency reliabilities, and inter-correlations of the five variables. the inter-correlations of the five variables ranged between .42 and .68. all the correlations were positive and significant at .001 level. the variance inflation factor (vif), which ranged 2.10 and 2.55 was < 10.00 which indicate that multicollinearity was not a problem. volume 36, number 2 41 table 3 means, standard deviations, cronbach α and indicator reliabilities, correlations, and variance inflation factor variable m sd α ir 1 2 3 4 vif 1. situational awareness 3.84 .84 .77 .50 2.10 2. situational response 3.96 .66 .72 .54 .67 2.50 3. cognitive empathy 3.48 .75 .86 .60 .65 .66 2.55 4. social skills 3.99 .71 .81 .62 .54 .68 .43 2.34 5. strategic engagement 3.79 .90 .93 .69 .51 .45 .52 .42 note. n = 75. ir = indicator reliability, vif = variance inflation factor. all the correlations are significant at p < .001 (two-tailed). indicator reliability each item has a reported r2 that measures the item’s variance explained by the factor. this measure of indicator reliability should be greater than or equal to .50 for each of the indicators. the r2s for all the variables ranged between .50 and .69. these reliabilities were judged sufficient. internal consistency reliability the internal consistency reliability coefficients of the five scales/subscales, as assessed with cronbach α, ranged between .72 and .93. overall, these coefficients are satisfactory. structural equations model the three mediation models presented in figure 1 were tested with a sem suggested by james and brett (1984) that differs from the widely used incremental approach of baron and kenny (1986). in the sem, mediation is indicated when the paths between the independent and mediator, and the path between the mediator variable and the outcome variable are significant and the overall model shows acceptable goodness of fit (see james, mulaik, & brett, 2006 for details). the fit indices, which are portrayed in table 2 suggest an excellent fit for the hypothesized 42 journal of business strategies model (χ2/df = 1.04, rmsea = .00, rmsr = .07, nfi = .95, cfi = 1.00, ifi = 1.00). the path coefficients for the sem are presented in table 4. table 4 statistics for structural equations model relationship β t ce -----> ss .90 6.69 *** ss -----> sa .91 5.72 *** sa -----> sr .99 5.94 *** sr -----> se .49 3.75 ** ** p < .01. *** p < .001. note: ce = cognitive empathy, sa = situational awareness, ss = social skills, sr = situational response, se = strategic engagement. • hypothesis 1 is concerned with the mediation effect of social skills on the relationship between cognitive empathy and situational awareness. the path from cognitive empathy to social skills (β = .90, p < .001) and the path from social skills to situational awareness (β = .91, p < .001) were significant which provide full support for hypothesis 1. this finding implies that cognitive empathy can influence situational awareness only indirectly through social skills. a mediation hypothesis suggests that the independent variable (i.e., cognitive empathy) causes the mediator variable (i.e., social skills), which in turn, causes the dependent variable (i.e., situational awareness). the mediator variable, then, serves to clarify the nature of the relationship between the independent and dependent variables. • a similar procedure was used to test hypothesis 2, which is concerned with the mediation effect of situational awareness on the relationship between social skills and situational response. the path from social skills to situational awareness (β = .91, p < .001) and the path from situational awareness to situational response (β = .99, p < .001) were significant which provide full support for hypothesis 2. this finding implies that social skills can influence situational response only indirectly through situational awareness. this mediation hypothesis suggests that the independent variable (i.e., social skills) influences the mediator variable (i.e., situational awareness), which in turn, influences the dependent variable (i.e., situational response). • hypothesis 3 is concerned with the mediation effect of situational response on the relationship between situational awareness and strategic engagement. the volume 36, number 2 43 path coefficients from situational awareness to situational response (β = .99, p < .001) and from situational response to strategic engagement (β = .49, p < .01) provided support for this hypothesis. discussion this was an exploratory investigation to test a model of ceos’ leadership as measured by strategic engagement based on their social intelligence. our results provide compelling support for the model presented in figure 1. previous studies did not test the relationships of top managers’ perception of ceos’ si components to each other and to se. the present study contributes to our understanding of the microfoundational linkages between situational awareness and situational response and between situational response and strategic engagement. it also contributes to our understanding of the relationships between cognitive empathy, social skills, and situational awareness as they relate to situational response. the results provide acceptable evidence of convergent and discriminant validities as well as internal consistency and indicator reliabilities of the measure of si and se. evidence from the present study and the studies by rahim (2014) and rahim et al. (2015a) provided support for construct validity of the measure of si. the present study provided some new evidence for the construct validity for ceo strategic engagement. however, since the measure of se is relatively new, we recommend additional assessment of the se instrument in other contexts, such as larger organizations and not-for-profit firms. in addition, it was assumed the se respondents were the closest subordinate managers to the ceo with full knowledge of the ceo’s activities. future research should include hierarchy information regarding the relationship between the two. implications for management there are several key implications of our study. first, it is clear that cognitive empathy, social skills, situational awareness, and situational response are important for the success of top managers. those social intelligence factors have direct and indirect impacts on the strategic engagement displayed by top organizational leaders. this study supports the contention that microfoundations are complex yet critical to better understanding the interaction between individual behaviors and the strategic focus of the firm (klein, tosi, & cannella, 1999). clearly, behavioral interviews for top managers need to include assessments of the four components of si along with the assessment of ceo strategic engagement. for those seeking higher level 44 journal of business strategies leadership roles within their own organizations, appropriate employee development plans may be needed to strengthen their si competencies. such activities may include additional education and role-playing training (cherniss & adler, 2000; goleman, 2005). second, ceos and managers should be encouraged to enhance their abilities through continuous self-learning and through mentorship programs. organizations should provide positive reinforcements for learning and improving ceos’ essential si competencies needed for their specific jobs. finally, even though education and training are useful for improving the si of supervisors and leaders, there are limitations on enhancing the appropriate workplace behaviors in each of the si components. to address this issue, the board of directors should clarify the position description of ceos to specifically acknowledge the importance of si factors and se behaviors as necessary for job success. strengths and limitations one of the strengths of this study is that the measures of independent and dependent variables were collected from observers, which should reduce the problems of method variance (podsakoff, mackenzie, lee, & podsakoff, 2003). also, confirmatory factor analyses of the items indicated the absence of common method variance. if common method variance was present, the items of the independent and criterion measures will not significantly load on the five a priori factors. limitations of this field study should be noted. data were collected from a convenience sample and might limit generalizability of the results. also, a small sample size of 74 cases may be an issue that should be investigated in future studies. references albrecht, k. (2007). social intelligence: the new science of success. san francisco: jossey-bass. anderson, j. c., & gerbing, d. w. (1988). structural equation modeling in practice: a review and recommended two-step approach. psychological bulletin, 103, 411–423. ang, s., van dyne, l., koh, c. k. s., ng, k. y., templer, k. j., tay, c. (2007). cultural intelligence: its measurement and effects on cultural judgment and decision making, cultural adaptation, and task performance. management and organization review, 3, 335–371. volume 36, number 2 45 ang, r. p., & goh, d. h. (2010). cyberbullying among adolescents: the role of affective and cognitive empathy, and gender. child psychiatry: human development, 41, 387–397. argyris, c., & schon, d. (1996). organizational learning–ii. reading ma: addisonwesley. barney, j., & felin, t. (2013). what are microfoundations? the academy of management perspectives, 27, 138-155. baron, r. a., & markham, g. d. (2000). beyond social capital: how social skills can enhance entrepreneurs’ success. academy of management executive, 14, 106–116. baron, r. a., & tang, j. (2009). entrepreneurs’ social skills and new venture performance: mediating mechanisms and cultural generality. journal of management, 35, 282–306. baron, r. m., & kenny, d. a. (1986). the moderator‒mediator variable distinction in social psychological research: conceptual, strategic, and statistical considerations. journal of personality and social psychology, 51, 1173‒1182. bass, b. m. (2002). cognitive, social, and emotional intelligence. in r. e. riggio, s. e. murphy, & f. j. pirozzolo (eds.), multiple intelligences and leadership (pp. 105–118). mahwah, nj: erlbaum. bennis, w. g., & thomas, r. j. (2002). geeks and geezers. cambridge, ma: harvard business school press. carr, c. l. (2002). a psychometric evaluation of the expectations, perceptions, and difference-scores generated by the is–adapted servqual instrument. decision sciences, 33, 281–296. cherniss, c., & adler, m. (2000). promoting emotional intelligence in organizations: making training in emotional intelligence effective. alexandria, va: astd federman, b. (2009). employee engagement: a roadmap for creating profits, optimizing performance, and increasing loyalty. san francisco: jossey-bass. felin, t., & foss, n. j. (2009). organizational routines and capabilities: historical drift and a course-correction toward microfoundations. scandinavian journal of management, 25, 157−167. ford, m. e., & tisak, m. s. (1983). a further search for social intelligence. journal of educational psychology, 75, 197–206. gardner, h. (1983). frames of mind: the theory of multiple intelligences. new york: basic books. gardner, h. (1999). intelligence reframed. new york: basic books. 46 journal of business strategies gavetti, g. (2005). cognition and hierarchy: rethinking the microfoundations of capabilities’ development. organization science, 16, 599-617. gavetti, g. (2012). toward a behavioral theory of strategy. organization science, 23, 267-285. goleman, d. (2005). social intelligence: the new science of human relationships. new york: bantum books. guttman, h. m., & hawkes, r. s. (2004). new rules for strategic engagement. journal of business strategy, 25, 34–38. hiller, n. j., & hambrick, d. c. (2005). conceptualizing executive hubris: the role of (hyper-) core self-evaluations in strategic decision-making. strategic management journal, 26, 297–319. hodgson, g. m. (2012). the mirage of microfoundations. journal of management studies, 49, 1389−1394. james, l. r., & brett, j. m. (1984). mediators, moderators, and tests of for mediation. journal of applied psychology, 69, 307–321. james, l. r., mulaik, s. a., & brett, j. m. (2006). a tale of two methods. organizational research methods, 9, 233–244. jöreskog, k. g., & sörbom, d. (1996a). lisrel 8: user’s reference guide. chicago: scientific software international. jöreskog, k. g., & sörbom, d. (1996b). prelis 2: user’s reference guide. chicago: scientific software international. judge, t. a., colbert, a. e., & ilies, r. (2004). intelligence and leadership: a quantitative review and test of theoretical propositions. journal of applied psychology, 89, 542–552. kaukiainen, a., bjorkqvist, k., lagerspetz, k., osterman, k, salmivalli, c., rothberg, s., & ahlbom, a. (1999). the relationships between social intelligence, empathy, and three types of aggression. aggressive behavior, 25, 81–89. kihlstrom, j. f., & cantor, n. (2000). social intelligence. in r. j. sternberg (ed.), handbook of intelligence (2nd ed., pp. 359–379). cambridge, uk: cambridge university press. klein, k., tosi, h., & cannella, a. (1999). multilevel theory building: benefits, barriers, and new developments. academy of management review, 24, 243-248. macey, w. h., schneider, b., barbara, k. m., & young, s. a. (2009). employee engagement: tools for analysis, practice, and competitive advantage. west sussex, uk: wiley-blackwell. mayer, j. d., salovey, p., & caruso, d. r. (2008). emotional intelligence: new ability or eclectic traits? american psychologist, 63, 503–517. volume 36, number 2 47 mitroff, i. i. (1998). smart thinking for crazy times: the art of solving the right problems. san francisco: berrett-koehler. mitroff, i. i., & silvers, a. (2010). dirty rotten strategies: how we trick ourselves and others into solving the wrong problems precisely. stanford, ca: stanford university press. mossholder, k. w., bennett, n., kemery, e. r., & wesolowski, m. a. (1998). relationships between bases of power and work reactions: the meditational role of procedural justice. journal of management, 24, 533–552. nadkarni, s., & herrmann, p. (2010). ceo personality, strategic flexibility, and firm performance: the case of the indian business process outsourcing industry. academy of management journal, 53, 1050–1073. nadkarni s., herrmann p., & pérez p. 2011. domestic mindsets and early international performance: the moderating effect of global industry conditions, strategic management journal, 32, 510531. nadkarni, s., & narayanan, v. k (2007). strategic schemas, strategic flexibility, and firm performance: the moderating role of industry clock speed. strategic management journal, 28, 243–270. netemeyer, r. g., johnston, m. w., & burton, s. (1990). analysis of role conflict and role ambiguity in a structural equations framework. journal of applied psychology, 75, 148–157. nunnally, j. c. (1978). psychometric theory (2nd ed.). new york: mcgraw-hill. o’brien, k. s., & o’hare, d. (2007). situational awareness ability and cognitive skills training in a complex real-world task. ergonomics, 50, 1064–1091. podsakoff, p. m., mackenzie, s. b., lee, j. y., & podsakoff, n. p. (2003). common method biases in behavioral research: a critical review of the literature and recommended remedies. journal of applied psychology, 88, 879–903. powell, t. c., lovallo, d., & fox, c. (2011). behavioral strategy. strategic management journal, 33, 1369−1386. rahim, m. a. (2014). a structural equations model of leaders’ social intelligence and creative performance. creativity and innovation management, 23 (1), 44– 56. rahim, m. a. (2018). a structural equations model of social intelligence and job performance, applied management journal, 19, 92─108. rahim, m. a., & bonoma, t. v. (1979). managing organizational conflict: a model for diagnosis and intervention. psychological reports, 44, 1323–1344. 48 journal of business strategies rahim, m. a., civelek, i., & liang, h. (2018). a process model of social intelligence and problem solving style for conflict management, international journal of conflict management. rahim, m. a., civelek, i., & liang, h. (2016). a model of leaders’ social intelligence and followers’ satisfaction with annual evaluation. current topics in management, 18. 1−16. rahim, m. a., civelek, i., & liang, h. (2015a). a model of department chairs’ social intelligence and faculty members’ turnover intention. intelligence, 53, 65−71. rahim, m. a., civelek, i., & liang, h. (2015b). department chairs as leaders: a model of social intelligence and creative performance in a state university. business creativity & the creative economy, 1 (1), 53−60. schmidt, w. h., & tannenbaum, r. (1990, november–december). management of differences. harvard business review, pp. 107−115. smythe, j. (2007). the ceo: chief engagement officer: turning hierarchy upside down to drive performance. hampshire: uk: grower. sternberg, r. j. (1985). the triarchic mind: a new theory of human intelligence. new york: viking. sternberg, r. j. (2002). successful intelligence: a new approach to leadership. in r. e. riggio, s. e. murphy, & f. j. pirozzolo (eds.), multiple intelligenecs and leadership (pp. 9–28). mahwah, nj: erlbaum. sternberg, r. j. (2009, fall). wisdom, intelligence, and creativity synthesized: a new model for liberal education. liberal education, pp. 10–15. wright, t. (2010). strategic engagement’s track record. washington quarterly, 33 (3), 35–60. brief biographical sketch of authors m. afzalur rahim (ph.d. university of pittsburgh) is a university distinguished professor of management at western kentucky university. he specializes in the management of organizational conflict, emotional and social intelligence, creativity, and organizational learning. jeff katz (ph.d. university of florida) is the oppitz endowed professor of business and professor of management at western kentucky university. his research focuses on global competitors, strategic decision-making, and corporate governance. shane spiller (ph.d. university of alabama) is a professor of management and hays watkins teaching fellow at western kentucky university. his research interests include decision-making, leadership, and ethics. a survey on accounting for derivatives and other financial instruments alan reinstein, dba, cpa wayne state university detroit, mi gerald h. lander, dba, cpa, cca university of south florida st. petersburg, fl abstract in response to the recent growth in the use of derivative financial instruments, the financial accounting standards board (fasb) recently required all companies to make certain classifications and disclosures for such "complex" financial instruments. yet, the securities and exchange commission (sec) and the fasb now demand even further reporting requirements including requiring companies to recognize the "fair value" (and resultant gains and losses) of their financial derivatives as well as make other "qualitative disclosures" of the potential risk of holding such financial securities. the provisions of the current and proposed standards will affect significantly virtually all types of companies, especially those using derivative instruments. hence, those preparing and evaluating financial statements under this emerging set ofstandards must comprehend these new provisions. the paper first discusses the current standards relating to financial derivatives and other financial instruments; it then provides examples of "leading" disclosures of such financial instruments. then, based upon the responses to a mail questionnaire, the paper discusses how key groups view potential sec changes in accounting for derivatives. all four of the groups generally agree with the provisions of sfas no. jj9 and most favor the recently passed, increased reporting standards. a survey on accounting for derivatives and other financial instruments the 1990s witnessed a large growth in the issuance and use of new types of financial instruments. prompted by such forces as the deregulation, internationalization and increased competition of financial markets, new financial instruments have emerged that contain debt, equity or hedging features. briefly, companies can use such instruments as floating rate mortgages, stripped mortgage-backed securities and interest rate swap contracts to invest excess funds to "create" earnings or to hedge their portfolios from unexpected market activities. with the increased popularity of derivatives, the financial press also has reported significant losses by corporate and municipal end-users and dealers from the use of deriva132 journal of business strategies vol. 15, no.2 tives. meanwhile, the financial accounting standards board (fasb) and the securities and exchange commission (sec) continue to grapple with the accounting and disclosure issues associated with derivatives. the purposes of this paper are to discuss current and proposed standards relating to derivatives and to present the results of a study that ascertain how key groups view sec changes in accounting for derivatives. derivatives represent an interesting and important type of financial instrument, normally used to provide hedges against unexpected business risks, to lower borrowing costs or to increase income over that of other more conventional investments. specifically, a derivative financial instrument's value is derived, at least in part, from the value and characteristics of one or more underlying assets, including commodities, securities or interest rates. for example, a company expecting the price of gold to reach $500 an ounce within six months (when its current price is $450 an ounce) may purchase a call option at, say, $40 per ounce. if the price of gold reaches $500, the company would exercise its call; otherwise, it loses only its $40 call payment. (note: the entity "betting" that the price of gold will not reach $500 issues a put option, and such entities as the chicago mercantile exchange bring the parties together.) many insurance companies, manufacturers, banks, not-for-profit organizations and other large and small companies such as coca cola and mcdonald's have made large investments in derivative financial instruments. per sec release nos. 33-7250 and 34-36643 (1995), the worldwide notional/contract amounts for derivative financial and commodity instruments increased from $7.1 trillion in 1989 to $62.1 trillion in 1994. forbes magazine (1994) states that derivative transactions could have exacerbated many recent swings in stock prices, including the 1987 stock market crash. furthermore, many losses in making such investments have occurred, reaching nearly $6 billion in 1994 (business week, october 31, 1994). many publicly held companies and governmental entities have suffered financial losses and embarrassment within the financial community from investing in derivatives causing major fasb and sec interest in the topic. the following sections provide an overview of current and proposed accounting and disclosure rules for derivative transactions. current rules for derivative financial instruments until 1995, only two fasb statements provided specific guidance for accounting for derivatives and hedging transactions. fasb statement no. 52, foreign currency translation, addresses forward foreign exchange contracts, and fasb statement no. 80, accounting for future contracts, addresses exchangetraded future contracts. recognizing, however, that these two standards only address a few of the many different types of derivative financial instruments used today, the fasb placed this issue on its active agenda. fall 1998 reinstein & lander: accounting for derivatives 133 in 1996 the fasb's statement (sfas) no. 119, disclosures about derivative financial instruments and fair value of financial instruments. began requiring entities to separately disclose (a) information about derivative financial instruments held for trading and non-trading purposes and (b) categories of financial instruments, including classes of financial instruments, business activities, risks or any other categories that are consistent with the management of those instruments. in 1998, the fasb issued a new standard fasb no. 133, accounting of derivative instruments and hedging activities, requiring entities to recognize derivatives as either assets or liabilities in their balance sheets and measure such instruments at their fair market values. entities now recognize gains and losses resulting from changes in fair values depending upon the intended uses of the derivatives and whether they are designated and qualified for a hedging accounting relationship (i.e., that are "highly effective" to achieve offsetting changes in values or cash flows). moreover, in 1997 the sec issued frn no. 48 requiring publicly traded entities to disclose additional information about the potential market risk associated with such derivatives. similar to the provisions of sfas no. 105, 107 and 115, sfas no. 119 (which require entities to recognize and disclose the risks of certain financial instruments e.g., those declining in value in the financial statements themselves or in the footnotes) defines a financial instrument as evidence of ownership interest in an entity or a contract that both: (1) imposes on one entity a contractual obligation to a. deliver cash or another financial instrument to a second entity, or b. exchange financial instruments on potentially unfavorable terms with the second entity, and (2) conveys to that second entity a contractual right to a. receive cash or another financial instrument from the first entity, or b. exchange other financial instruments on potentially unfavorable terms with the first entity. thus, one party to the transaction has a contractual right (e.g., to receive a security at a specific date), and the other has a contractual obligation (e.g., to deliver that security at that date). such instruments include debt and equity securities. sfas no. 119's provisions do not apply to investments in on-balance-sheet receivables and pay ables, including those deriving their values or contractually required cash flows from the price of some other security or index, including interestand principal-only obligations, mortgage-backed securities and indexed debt instruments, as well as optional features embedded within on-balance-sheet receivables or payables, such as conversion and call features found in some convertible bonds. 134 journal of business strategies vol. 15, no.2 types of derivatives many types of derivatives can help manage risk in financial markets: options are securities transaction agreements tied to stocks, commodities or stock indices involving the right to buy or sell those instruments for agreed-upon sums. collateralized mortgage obligations pay a fixed interest rate at regular intervals, include mortgage-backed bonds that separate mortgage pools into short-, medium and long-term portions to provide flexibility in the repayment of investor capital. floating rate notes, including those relatively insensitive to interest rate changes, are debt instruments with a variable rate generally tied to prevailing short-term interest rates. futures contracts (which are usually publicly traded) represent promises to buy or sell specific numbers of commodities, financial instruments or interest payments at a set price on a stipulated future date. indexed securities (also called structured notes) are highly customized shortterm debt instruments that allow investors to create and capitalize on short-term investment opportunities without liquidating or restructuring sound long-term investment positions. these "customized bonds" instruments are designed with yield features, with interest rates or principal amounts indexed to an unrelated indicator. interest-only strips (los) consist of the interest part of a mortgage security that was stripped into two parts; the other part is a principal-only strip. los receive cash flow from interest payments and offer an attractive yield as long as mortgage rates are stable or rising. principal-only strips (pos). as discussed above, pos receive cash flow from principal payments. inverse floaters consist of debt instruments whose yields rise as short-term rates fall, and vice versa. inverse floaters act like very long-term bonds. some rationales for issuing sfas no. 119 and other future authoritative pronouncements on this issue given the importance of accounting properly for derivatives, financial analysts, the business press, the sec and others mandate that entities, their auditors and financial statement users and preparers monitor such transactions and their financial controls most carefully by focusing on such issues as: • off-balance-sheet nature. since derivatives contracts often occur with little or no cash changing hands, reported amounts may not indicate the full extent of an entity's involvement. moreover, without necessary controls to record changes in value, significant unrecorded gains and losses can go undetected. • complexity. an entity may misunderstand the actual terms and effects of a particular derivative contract, including how it uses a particular financial instrument, how to value and account for it and whether it achieves its desired economic objectives. fall 1998 reinstein & lander: accounting for derivatives 135 • leverage. derivatives create new opportunities to increase significantly financial leverage. for example, leveraged interest rate swaps that require interest payments of multiples of changes in a specified market rate sharply expose an entity to potential losses disproportionate to interest rate changes. • non-liquidity. since derivatives markets may not be liquid (i.e., "easily" marketable), problems exist in valuing current instruments and their exit (e.g., fair market) values. • unclear accounting and tax rules. designers of complex financial instruments often try to utilize perceived market anomalies, since current tax and accounting rules generally have not kept pace with the rapid development of new derivatives products and uses. • legal risk. some entities have been unable to enforce the terms of derivatives contracts against counterparties such as government agencies or companies in a regulated industry that do not have the authority to enter into the transaction or lack adequate or clear documentation of contract terms. enforceability risks are heightened with foreign counterparties and may not come to light until the counterparties' credit deteriorates or bankruptcy or insolvency occurs. • operational and control risk. a company's treasury department often originates derivatives transactions, sometimes without coordinating them with those responsible for recording the transaction and the financial and tax reporting. sfas no. 119 in response to the above-named objectives, sfas no. 119's provisions require disclosing a financial instrument's face or contract amount, the instrument's nature and terms (incorporating a discussion of its credit and market risks), cash requirements of such instruments and related accounting policies. derivatives classified as held or issued for trading purposes should disclose the average and related end-of-period fair value, any net gains or losses from the trading activities, and the location in the financial statements of the gains or losses. derivatives classified as held or issued for purposes other than trading require a description of the entity's objectives for holding or issuing such derivatives and a description of how the derivative and related gains or losses are reported, in addition to their location in the financial statements. based upon a reading of many annual reports, exhibit i presents two examples of "model" footnote disclosure taken from 1995 annual reports. however, sfas no. 119 recommended but did not require making quantitative disclosures concerning interest rate, foreign exchange, commodity price or other market risks, causing major concern at the sec as discussed below. for example, wooley (1997) notes that sears' 1996 financial statement discloses a $382 million loss from derivative holdings in its footnotes but does not indicate the source or disposition of this major item. 136 journal of business strategies exhibit 1 disclosure examples of financial instruments vol. 15, no.2 mcdonald's corporation financial instruments the company utilizes derivatives in managing risk, but not for trading purposes. nonu.s. dollar financing transactions generaily are effective as hedges of either long-tenn investments in or intercompany loans to foreign subsidiaries and affiliates. foreign currency gains and losses on the hedges of long-tenn investments are recorded as foreign currency translation adjustment included in shareholders' equity. gains and losses related to hedges of intercompany loans offset the gains and losses on intercompany loans and are recorded in nonoperating income (expense). interest-rate exchange agreements are designated and effective to modify the colljpany's interest-rate exposures. net interest is accrued as eitherinterest receivable or payable with the offset recorded in interest expense. gains or losses from the early termination of interest rate swaps are amortized as an adjustment to interest expense over the shorter of the remaining life of the swap or the underlying debt being hedged. the company also purchases foreign currency options (with little or no intrinsic value) to hedge future foreign currency-denominated royalty and other payments received in the u.s. the premiums paid for these options are amortized over the option life and are recorded in nonoperating expense. any realized gains on exercised options are deferred and amortized over the period being hedged. short-tenn forward foreign exchange contracts are also used to mitigate exposure on foreign currency-denominated cash flows received from affiliates and subsidiaries. these contracts are marked to market with the resulting gains or losses recorded in nonoperating income (expense). gains and losses associated with these forward contracts have not been material. if a hedged item matures or is extinguished. the associated derivative is marked to market with the resulting gain or loss recognized immediately. the derivative then is redesignated as a hedge of some other item or tenninated. the carrying amounts for cash and equivalents and notes receivable approximated fair value. no fair value was provided for noninterest-bearing security deposits by franchisees as these deposits are an integral part of the overall franchise arrangements. general motors note 11. fair value of financial instruments in accordance with the requirements of sfas no. 107, disclosures about fair value of financial instruments. and sfas no. 119, disclosures about derivative financial instruments and fair value of financial instruments, general motors has provided the following fair value estimates and infonnation about valuation methodologies. the estimated fair value amounts have been determined using available market infonnation or other appropriate valuation methodologies. however, considerable judgment is required in interpreting market data to develop estimates of fair value; therefore, the estimates are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange. the effect of using different market assumptions and/or estimation methodologies may be material to the estimated fair value amounts. fair value infonnation presented herein is based on infonnation available at december 31, 1995 and 1994. although management is not aware of any factors that would signififall 1998 reinstein & lander: accounting for derivatives exhibit 1 disclosure examples of financial instruments cont'd 137 cantly affect the estimated fair value amounts, such amounts have not been updated since those dates and, therefore, the current estimates of fair value at dates subsequent to december 31, 1995 and 1994 may differ significantly from these amounts. the estimated fair value of financial instruments held by general motors, for which it is practicable to estimate that value, are set forth below: december 31 $16,642.9 $16,642.9 $16,075.6 $16,075.6 58,714.8 59,095.9 54,048.4 53,869.8 9,946.2 9,946.2 8,742.5 8,742.5 (dollars in millions) assets cash and marketable securities finance receivables net accounts and notes receivable net book value 1995 fair value book value 1994 fair value sec's new disclosure requirements while many financial statement users consider the fasb's new disclosure provisions regarding derivative financial instruments more than adequate, the sec requires publicly traded companies to make even further disclosures. spurred by the recommendations of the american institute of cpa's special committee on financial reporting, the federal reserve bank of new york and a task force of the financial executives institute, the sec staff reviewed over five-hundred 1994 and 1995 annual reports which showed that many entities inadequately reported how derivatives affected such reported items as commodity positions, firm commitments and other anticipated transactions. these omissions could impair financial statement users from effectively predicting expected future cash flow streams of such items as how financial derivatives impact the repricing characteristics of certain debt obligations. thus, the sec's new requirements clarify and expand existing footnote disclosures regarding derivative financial instruments by requiring disclosures outside the financial statements about market risk inherent in derivative and related financial instruments. the sec allows companies some flexibility in disclosing quantitative information by choosing from three disclosure alternatives, thereby allowing registrants to disclose the information to best reflect the degree of market risk inherent in their activities. 138 journal of business strategies vol. 15, no.2 additional disclosures to supplement the requirements of sfas no. 119, the sec required that publicly traded companies with material amounts of derivatives should disclose in their footnotes: 1. all methods used to account for derivative financial instruments; 2. types of derivatives (e.g., interest rate floors) accounted for under each method; 3. criteria required to be met for each accounting method (e.g., the company will recognize revenues if such stated criteria are met); 4. the accounting method used if the specified criteria are not met; 5. accounting for the tennination of derivatives designated as hedges or otherwise used to affect other financial instruments (e.g., to balance out expected cash flows); 6. accounting for derivatives if the designated item matures, is sold, terminated or the related, anticipated transaction is no longer likely to occur; and 7. where and when derivatives and their related gains and losses are reported in the balance sheet, income statement and statement of cash flows. furthermore, registrants should distinguish between accounting policies adopted for derivatives used for trading and other (e.g., speculative) purposes. disclosures of quantitative and qualitative information about market risk registrants with material amounts of market risk sensitive financial instruments or who face potentially material losses from reasonably possible market movements, would prepare a new disclosure section outside the basic financial statements that discusses certain quantitative and qualitative aspects of market risk. small business issuers must also consider making such disclosures in the management discussion & analysis (md&a) requirements in their sec filings to the extent that market risk represents a materially known trend, event or uncertainty. specifically as shown in exhibit 2, registrants would select one of three quantitative disclosure methods (i.e., tabular presentation of expected cash flows, sensitivity analysis or value at risk) and highlight qualitative disclosures of market risk, focusing on how the entity manages those exposures (e.g., describing the general objectives of holding such financial instruments and strategies used to manage these risks). fall 1998 reinstein & lander: accounting for derivatives exhibit 2 proposed additional sec disclosure requirements 139 type of disclosure (1) quantitative disclosure (2) qualitative (3) accounting policy summary requirements outside the basic financial statements, chose one of three alternatives: • tabular presentation show instruments' fair values, expected cash flows and weighted average effective rates or prices. summarize by used exposure category (e.g., interest rate used, foreign currency exchange rate used, commodity price risk or equity price risk). group instruments by common characteristics. • sensitivity analysis disclose potential losses in future earnings, fair values or cash flows of market risk sensitive instruments. • value at risk show potential entity-wide loss in flow values, cash or earnings of market risk sensitive instruments. disclosure required outside basic financial statements show by category primary market risk exposure and any changes in market risk exposure. disclose how exposures to market risk are managed. disclosure required in financial statement footnotes. disclose each method used to account for derivatives and criteria required to use each method. show types of derivatives used under each method. first, the tabular presentation would require quantitative information containing common inputs to market risk measurements and, thus, provide additional information of the registrant's exposure to market risk. registrants would summarize this tabular information by risk exposure category (e.g., interest rate, foreign currency and commodity price risk), and the foreign exchange rate risk category should be further subdivided by functional currency (e.g., japanese yen or 140 journal of business strategies vol. 15, no.2 u.s. dollar). entities should also group such instruments by common risk exposure characteristics. thus, a registrant would disclose in the interest rate exposure category such items as fixed rate mexican peso investments, variable rate french franc debt obligations or long u.s. treasury futures. they would report for each instrument in the table, separate expected principal or cash flow information for each of the next five years, with any remaining, expected cash flows presented separately as an aggregate amount. next, registrants disclosing hypothetical losses in future earnings, cash flows or fair values of market risk sensitive instruments using sensitivity analysis would make separate disclosures for interest rate, currency exchange rate, certain commodity price and other types of sensitive instruments. to provide further information about the sensitivity ofthe instruments' assumptions and parameters, registrants also should disclose (a) how they define such losses (e.g., lost earnings or cash flows), (b) the general modeling technique (e.g., changes in net present values arising from parallel shifts in market rates), (c) the general types of instruments covered by this model (e.g., derivative commodity instruments) and (d) other relevant information on the model's parameters (e.g., prices used for each category of market risk exposure and how discount rates are determined). entities selecting the third alternative would show adverse market conditions by disclosing separately interest rate, currency exchange rate, certain commodity price and other types of sensitive instruments. they would also show for the current period either the (a) average or range in value at risk amounts, (b) average or range in actual changes in fair values or (c) percentage of actual changes in fair values, earnings or cash flows from market sensitive instruments that exceed the reported value at risk amounts. to provide additional qualitative disclosures, entities would describe how they evaluate material changes in their primary risk exposures and material changes in managing material risks to those exposures. they should also compare changes in these items from prior periods and discuss expected effects in future periods. these provisions would apply both to derivative financial instruments and to other related items including derivative commodity instruments, commodity positions and expected cash flows from anticipated transactions. to encourage companies to disclose this forward-looking information, the sec grants them safe harbors from many unwarranted legal actions (as provided by the recently passed private securities litigation reform act of 1995). the sec contends further that qualitative disclosures complement quantitative disclosures by placing risk management activities in perspective. since sfas no. 119 qualitative disclosures apply only to certain derivatives held or issued for purposes other than trading, the sec requires expanded disclosure by creating a new item 305 (b) of regulation s-k. here an entity would present narrative disclosures that would occur outside the basic financial statements and include primary market risk exposures and how these exposures are managed by the entity. registrants would disclose their primary market risk exposure at the end of the fall 1998 reinstein & lander: accounting for derivatives 141 reporting period and how they manage those risks, as well as discuss material changes in how those risks are managed when compared to the most recent reporting period. such qualitative disclosures would be presented separately for instruments entered into for trading and nontrading purposes. entities must also disclose "material" market risk based upon two key factors: (l) the materiality of the fair values of the disclosed instruments outstanding at the end of the current reporting period, and (2) the materiality of any potential loss predicted for any reasonably possible market movements. if either is material, they must disclose both qualitative and quantitative information concerning market risk. entities should also place such disclosures outside the financial statements; they therefore would not be covered by the independent auditor's opinion. finally, entities should consider the potential duplication of disclosures required by the current md&a requirements and the proposed rules in the new item 305. the sec concludes that registrants currently disclosing the impact of known uncertainties in its md&a or in other financial statement footnotes, need not report such duplicate information in its sec filings. fasb accounting requirements for hedging and derivatives to blunt some sec criticism and to provide additional information to financial statement users, in june 1996 the fasb issued an exposure draft to help "improve" how entities account for derivatives (cheney, 1997) which ultimately became sfas no. 133. now, derivatives are valued at current market prices, but also encompass changes in the values of the underlying financial instruments thereby minimizing fluctuations in the values of these financial instruments. basically, the new statement requires that all derivatives be carried on an entity's balance sheet as either assets or liabilities at fair or market value. gains or losses in the fair values of derivatives are accounted for based on the derivatives' designation. entities designating derivatives as hedges of cash flow exposure of a forecasted transaction defer changes in fair value as a component of comprehensive income and recognized in earnings when the transaction is projected to occur. for all other derivatives, the change in fair value is recognized as a gain or foss in the current income statement. the fasb found that derivatives are either assets or liabilities and, thus, should be recorded and reported in the financial statements. such financial instruments should be measured at fair value, which the board determined is the only relevant measure for derivatives since fair value is useful and understandable to financial statement users. during the discussion period, however, 13 chief executives of major banks and other large corporations (cheney, 1997) informed the fasb, the sec and federal reserve chair greenspan that the fasb's then proposed additional qualitative disclosures could cause "incorrect valuations" of equity investments. similarly, the institute of management accountants (ima) (rogero, 1996) also protested these new qualitative disclosures and asked that the relevance of management be allowed to disclose its market risk in any way it sees fit. 142 journal of business strategies vol. 15, no.2 several empirical studies have found inefficiencies in the pricing of financial derivatives and their associated, underlying financial securities. jordan and kuipers (1997) derived direct evidence that derivative assets can significantly distort efficient pricing in the primary asset market; and sim and thurston (1996) found some market inefficiencies in the relation between the yield-to-maturity and timeto-maturity of default-free pure discount bonds, and the price and hedge interest rates of derivative financial instruments. such market inefficiencies suggest that the relevance of viewpoints of users and preparers of financial instruments should playa key role in developing new rules to account for such financial instruments. empirical study methodology to explore how key constituencies view derivative financial instruments, we surveyed four major groups who must implement any new standards: cpas who specialize in auditing publicly-traded financial institutions; bank accounting executives (ae) of financial institutions selected from faulkner & gray's bank accounting & auditing executives data base; management accountants (ma) working for financial institutions, selected from the ima's membership list; and financial analysts (fa) selected from 1995 membership directory published by the association for investment management and research. the 400 questionnaires were sent to 100 members from each group. after reviewing current and proposed standards for derivatives and mahoney, and kawamura's (1995) study of derivative disclosures for the fasb, we developed a preliminary survey instrument, which was then pretested and revised based upon the comments of five academicians, six cpas, five financial officers and four management accountants. the questionnaire addressed three main areas relating to accounting for derivatives: 1. questions relating to financial reporting and economic reality; 2. questions relating to entities' decision making capabilities; and 3. questions relating to potentially "manipulating" financial information or statements. the final questionnaire appears as exhibit 3. to garner a high response rate, we hand-signed all correspondence, used four waves of response requests, including pre-notification letters, and applied postage stamps on envelopes both to and from the respondents. we received 176 usable responses (responses from 40 cpas, 44 aes, 47 mas and 45 fas), an overall 44% response rate. even with a relatively high response rate, tests were made for non-response bias using (1) the early-late hypothesis (oppenheim, 1966), and (2) a comparison of known characteristics of respondents and non-respondents (ferber, 1948). the results indicate no significance (p.<.05) differences between early and late respondents, suggesting strongly that no significant non-response bias occurred. fall 1998 reinstein & lander: accounting for derivatives exhibit 3 summary of questionnaire used in survey 143 please indicate the extent to which you agree or disagree to the following statements. strongly agree neither strongly agree nor disagree strongly disagree < 1··-···--2--------3--------4--------5--------6--------7> i. do disclosures required by spas no. 119 disclose adequately current derivative activities? 2. do the provisions of spas no. 119 cause companies to report financial derivatives to "manipulate income rather than report economic reality?" 3. the sec has proposed increasing the disclosure requirements of accounting for certain derivative instruments. should the scope of such new disclosures primarily be limited to publicly traded companies? 4. will such additional sec disclosures for derivatives add "critical information" for investment purposes? 5. will such additional sec disclosures for derivatives add "critical information" for lending/credit purposes? 6. should the sec require entities to disclose "material" changes in the fair values of derivative activities measured both at the end and during each reporting period? 7, should entities be allowed to choose one of three ways to present quantitative information about market risk: tabular presentation of expected future cash flows and terms, sensitivity analysis or value at risk? 8. the sec proposes that entities disclose quantitative information about general market risk to help indicate the level of market risk from normal market movements. should it also require estimating market risk inherent in unusual markets reflecting worst-case scenarios? 9. the sec recognizes that the proposed disclosures may be complex, especially in requiring the describing of the model and key assumptions used to prepare quantitative disclosures about market risk. given this complexity, should the proposed information disclose market risk in reports and statements filed with the sec that are not required to be delivered to all shareholders and investors? 10. should small business issuers be excluded from part of proposed quantitative and qualitative disclosures of market risk? 144 journal of business strategies vol. 15, no.2 a seven-point likert scale (1 indicating agreement and 7 disagreement) was used by the respondents to indicate their degree of agreement or disagreement to questions addressing the key issues. while the question form ordinarily suggests a "yes" or "no" answer, the likert scale allows a continuum of strongly agree to strongly disagree responses. results and observations sample mean responses are summarized and shown in table i, with paired comparison tests, anova and scheffe's test results shown in table 2. where the anova indicated significant differences (p.<.05) among mean responses of the various treatment groups, scheffe's multiple comparison test was used to determine which groups had statistically significant differences. the results show that all four groups generally agree with the provisions of sfas no. 119 (question no.1), and most favor the increased reporting standards (questions 4-9). mas were mostly indifferent (3.75) to the sec proposal of using only three qualitative methods to disclose market risk (question no.7) despite the ima's "strong" letter to the contrary [rogero, 1996]. however, only two sets of significant differences among the four groups of respondents arose. regarding question nos. 4 and 5, fats with mean responses of 3.41 and 3.21 generally considered the sec proposals to add "critical information" for investment and lending purposes more cost-beneficial than did the other three groups (cpas: 1.95 and 1.87; fes: 2.16 and 2.07; and mas: 2.05 and 1.95, respectively). thus, the groups are nearly unanimous in their evaluations of the three areas of questions, indicating that they generally believe that the sec statement will enhance economic reality and increase the reliability and relevance of financial reporting. these results also indicate support of the main provision of sfas no. 133. while the survey instrument gave many details of the new standards on derivatives, some respondents may have been unfamiliar with the relevant details of the pronouncements. this limitation could weaken the generalizability of the findings. furthermore, as the respondent groups gain experience from using financial derivatives, their viewpoints may change. conclusions the fasb 's and sec's current standards seek to improve financial reporting for derivatives and other financial instruments, thereby increasing the visibility, comparability and understandability of risks associated with such instruments. given the magnitude of this issue, corporate controllers and financial executives should plan now to understand and implement these new accounting requirements and, thus, provide fuller disclosure to their financial statement users. fall 1998 reinstein & lander: accounting for derivatives 145 table 1 mean responses of groups surveyed* questions group response certified bank public financial management financial accountant executive accountant analyst total (40) (44) (47) (45) (176) [group 1] [group 2] [group 3] [group 4] ql 2.02 2.35 2.37 2.65 2.36 q2 2.47 2.17 2.61 2.71 2.51 q3 3.41 3.97 3.65 4.12 3.76 q4 1.95 2.16 2.05 3.41 2.37 q5 1.87 2.07 1.95 3.21 2.26 q6 1.21 1.35 1.27 1.31 1.27 q7 2.82 3.15 3.75 3.15 3.20 q8 2.03 1.83 2.15 2.14 2.02 q9 1.51 1.62 1.82 1.75 1.68 qio 6.21 6.35 6.51 6.17 6.33 * scaling and other notes 1. values represent a 7-point scale (1= strong agreement through 7= strong disagreement with the statement). 2. a summary of the questions is found in exhibit i. 3. if significant differences using one-way analysis of variance (p.<.05) in the response patterns between at least two groups were noted, scheffe's multiple comparison test was used to determine which groups had statistically significant weaknesses. 4. the responses to questions 4, 5 and 7 indicated such significant differences, with the results appearing in table 2. 146 journal of business strategies vol. 15, no.2 table 2 scheffe pairwise comparison test results question group group number groups means differences 4 3.41 * q4 2 2.16 i. 2 and 3 > 4 3 2.05 i 1.95 4 3.21* q5 2 2.07 1,2 and 3> 4 3 1.95 i 1.87 3 3.75 q7 2 3.15 no differences 4 3.15 among groups i 2.82 notes 1. abbreviations for groups presented in the above table: (i) certified public accountants; (2) bank financial officers; (3) management accountants; and (4) financial analysts 2. (*) denotes pairs of groups significantly different at the 0.05 level of significance. 3. scheffe's lest performed on questions which exhibited significant differences in means between groups in the anoya tests. references barrett, a. & zweig, p.l. (1994). managing risk, business week, (october 31),86-104. cheney, g. (1997). bankers battle tenaciously to block fasb on derivatives, accountin~ today. (october 3), 4, 61. ferber, r. (1948). the problem of bias in mail returns; a solution, public opinion quarterly, 669-676. financial accounting standards board (1981). statement of accounting standards (sfas) no. 52. foreign currency translation, stanford, ct: fasb. ____, spas no. 80, (1980). accounting for futures contracts. ____, sfas no. 105 (1990). disclosure of information about financial instruments with off-balance sheet risk and financial instruments with concentrations of credit risk. fall 1998 reinstein & lander: accounting for derivatives 147 ____, seas no. 107 (1991). disclosures about fair values of financial instruments. ____, sfas no. 115 (1993). accounting for certain investments in debt and equity securities. ____, sfas no. 119 (1994). disclosure about derivative financial instruments and fair value of financial instruments. ____, sfas no. 133 (1998). accounting of derivative instruments and hedging activities. mahoney, j.p. & kawamura, y. (1995). review of 1994 disclosures about derivative financial instruments. norwalk. ct: fasb special report no. 156-a. oppenheim. a.n. (1966). ouestionnaire design and attitude measurement, new york: basic books. rogero, l.h. (1996) (chair, financial reporting committee. institute of management accountants). letter to the securities and exchange commission, (may 13). securities and exchange commission (1995). proposed amendments to require disclosure of accounting policies and qualitative market risk information inherent in financial instruments" file #s7-35-95, washington, dc: sec (december 28). ____• securities and exchange commission (1977). general report release (frr) ~, disclosure of financial policies, washington, dc: sec (january). sim, a.b. & thurston, d.c. (1996). an empirical study of a new class of no-arbitragebased discrete models of the term structure, journal of financial research, (winter), 493-513. wooley, s. (1997). night baseball... without iights,~, (august 11), 42-43. a survey on accounting for derivatives and other financial instruments a process for defining what the supervisor really wants mark kroll university of texas at tyler tyler, tx barbara d. davis ashaydesai peter wright university of memphis memphis, tn intoduction when a man does not know what harbor he is making for, no wind is the right wind. -seneca as our citation suggests, people must be provided accurate direction from those they follow, if they are to be productive. in an organizational context, there is a need to communicate to subordinates what the key performance criteria are and how important the various criteria are to the supervisor. supervisors typically feel they know which criteria are important and what values they might assign to each (carroll and schneier 1982). we suggest an objective method for more accurately assessing supervisors' weightings of the performance criteria used to evaluate their subordinates. we will demonstrate how this approach can define the gaps between supervisors' actual weights, what they thought the weights were they were applying, and the weights the organization feels are appropriate. the problem today, virtually every organization of any size attempts to appraise performance. the majority of the appraisal systems in use today focus on broad, trait oriented aspects of employees (llgen, barnes-farrell, and mckellin 1993). typically, these systems have gone through numerous revisions and refinements. unfortunately, research in this area shows that dissatisfaction with the processes in place is the norm rather than the exception (landy and farr 1980). however, it could be that oftentimes the problem is not the system used, but rather the managers' inability of coming to terms with what really matters to them in terms of subordinate performance. therefore, we will first examine the nature of the problem and what others have said concerning its consequences. we then offer a workable, practical solution: conjoint analysis. fall 1994 kroll, et. al.: defining what the supervisor really wants 99 while the appraiser, as well as the appraisal systems in use have received a great deal of attention, little has been offered to help supervisors get in touch with their own feelings as to which job performance characteristics they most emphasize in subordinate behavior (ostroff 1993; pearce and porter 1986). this is a critically important issue since many of the appraisal systems observed by the authors merely define the dimensions to be evaluated. frequently, there is little continuity among supervisors or raters as to how to "weight" the various performance dimensions in arriving at a relative ranking of their subordinates (borman 1987). raters have definitions of "performance as a whole" which go beyond an employee's performance ofhislher stated job duties. past research on performance appfjlisals suggest that the managers go through a complex multiattribute decision process by trading off among a relatively large number of attributes (budman and rice 1994; ilgen, barnesfarrell, and mckellin 1993). when performance of an employee is appraised using rating scales, it is done so along certain identified dimensions. the raters judge the value of the identified criteria and usually trade off unfair conditions of some attributes for favofable conditions of others. managers' or raters' perceptions play an important role in the complex considerations of alternatives that fall along more than a set of dimensions. research has provided evidence that varied cognitive processes engaged in, by raters, influence rating accuracy (ostroff 1993). refinements in performance appraisals, such as behaviorally anchored rating scales (bars), have sought to provide more reliable appraisals, less subject to rater bias, though the success ofthese efforts is an open question (bernardin and smith 1981; decotiis 1977). however, when promotion, demotion, or layoff decisions are made and supervisors are asked to make recommendations, they are likely to base them on individual priorities as to which criteria are more or less important (bernardin and smith 1981; decotiis 1977). such decisions are usually made by supervisors after considering the simultaneous and joint effect of ratings along all attribute dimensions. while alternatives have been offered as to how the organization might establish criteria weights, these alternatives offer appraisers little help in coming to understand their own priorities, which may be different from those suggested by the organization. in fact, quite often supervisors are unaware of what their priorities actually are. the organizational method used to establish criteria weights needs to be flexible enough to capture this multiattribute choice problem, which may cause deviations from the criteria weights assigned by the organization. our focus in this paper is on the raters process of assigning priorities and not on the organizational rating scale used. some evidence of potential harm juxtaposed with the supervisors' criteria valuation is the problem experienced by the subordinates of deciding where to concentrate their efforts. most subordinates neither have the time, talent, or ability to excel in every dimension in which they are evaluated. they must therefore make trade-offs that they anticipate will gamer the greatest value in the eyes of their supervisor. obviously, if it were possible for subordinates to accurately gauge their supervisors' priorities, their choices would be far more efficient. 100 journal ofbusiness strategies vol. 11, no.2 an important question therefore is whether or not subordinates truly know what their supervisors' priorities are in terms of various performance dimensions. in case they do not, then another question would seem to be whether or not real harm accrues if such misunderstandings do exist. the research to date suggests that the lack of congruence between subordinates and their supervisors, as to the relative importance of various performance dimensions, is a common problem. in addition, this incongruence helps explain a significant portion of the difference between subordinates' assessments of their performance and the ratings they receive from their supervisors (oberg 1972). more important to the organization, such incongruence has been linked to lower subordinate job satisfaction, performance, and personal and organizational goal attainment. the link between low superior-subordinate goal congruence, job satisfaction and performance has been demonstrated in a number of studies (ostroff 1993; pearce and porter 1986). for instance, ngen, fisher and taylor (1979), found a significant gap in job satisfaction levels with those who reported fewer differences between role perceptions and their job descriptions and those who had significant incongruence. these findings were similar to bernardin (1979), who found a significant, negative relationship between police officer performance and resultant job satisfaction and the level of goal non-congruence. hobson, mendel, and gibson (1981), found the same type of relationship in a later study. from a motivational theory point of view, these findings are quite reasonable (vroom 1964). for some time, it has been recognized that significant incongruence between superior and subordinate performance expectations will likely diminish the subordinate's belief that effort leads to performance, and consequently, job performance and satisfaction suffers. more accurately, defining what superiors most value in subordinate performance and then communicatingthat information would seem a likely path toward enhancing the subordinate's beliefs that effort invested correctly will lead to performance, goal attainment, and job satisfaction. related to the problems of lower job satisfaction and performance is the issue of employee development. one of the purposes of appraising performance is to define subordinate training needs. if goal incongruence is a problem, it is possible that what a supervisor may diagnose as a lack of ability may simply be a lack of emphasis based on what the subordinate perceives as a low priority activity (hobson, mendel, and gibson 1981). as mentioned earlier, beyond the problems which might occur for the individual employee, there are also possible negative consequences for the organization. as just mentioned, performance appraisals should tie individual efforts to the goals of the organization, yet if the priorities of the supervisor are not those of the organization, the appraisal process could be counter-productive (u.s. government 1978). it might be argued that higherups could set weights, thus insming congruence between appraisal outcomes and organizational needs. however, this view fails to consider the inevitable intervention of the appraisers' own values when decisions are made regarding employees' futures (e.g., promotion, demotion or transfer decisions). fall 1994 kroll, et. al.: defining what the supervisor really wants 101 the research gap it is of critical importance to the organization that supervisors exhibit high inter-rater consistency in assigning weights to the same job. additionally, it is imperative that the weights supervisors assign to job performance criteria correlate with the goals of the organization. the success an organk:ation has in utilizing and developing its talent depends, at least in part, on the congruence between organizational and individual priorities. insuring such congruence should be one of the goals of performance appraisals. while a great deal of attention has been given to aiding organizations in achieving inter-rater reliability for a given performance profile, organizations have been provided little help in assessing and evaluating raters' weightings of the performance criteria included in the evaluation processes used. research has provided evidence that varied cognitive processes engaged in by raters influence rating accuracy. as mentioned earlier, various methods are available to aid organizations establish criteria weights. methods such as allowing a panel of judges to set the weights, measuring the correlation of criteria with "performance," or simply weighting each criteria equally. the problem with each of these is that they do not explore the appraiser's own values and priorities. appraisers quite simply may be unaware of how heavily they weight one criteria in relation to others. it is important to recognize that all the criteria included in an appraisal will carry a positive value (le., few supervisors will likely not want subordinates to do well on a given criterion). yet, inevitably, supervisors will see some as more important than others. consequently, there is a need to apply a technique to uncover the latent bias, sometimes unknown to the raters themselves. given the potential benefits, a practical, objective means for assessing supervisors' performance priorities would seem very desirable. such measurements would allow supervisors to come to know themselves and communicate their priorities to their subordinates. additionally, the organization could determine whether their supervisors' priorities are in line with its own. while attempts have been made to define weights using techniques such as multiple regression analysis (hobson, mendel, and gibson 1981), conjoint analysis offers an alternative prospective to defining criteria weights incorporating supervisors' performance priorities. a possible solution: conjoint analysis we wish to accomplish four tasks in this section. first, conjoint analysis is briefly described and illustrated. second, adaptive conjoint analysis is introduced. third, an illustration of the use of adaptive conjoint analysis in defining supervisor performance criteria weights in an actual organization is presented. finally, the results are evaluated in terms of how they vary across departments and organizational levels, and what the consequences of such variances might be. conjoint analysis though not previously applied to the area of performance appraisal, conjoint analysis has been used in marketing research for quite some time (green and rao 1971). however, in the last decade, increased availability of software packages has made it easier for the application of conjoint methodology to areas such as corporate strategy and human resource 102 journal ofbusiness strategies vol.u, no.2 issues pertaining to compensation analysis, litigation and determining employee benefit preferences (green, krieger, and agarwal 1991; riquelme and rickards 1992). "conjoint" refers to a process of measuring the relative values people assign to attributes or features (typically product features when used in market research) when they consider them together rather than individually. this allows the researcher to determine the relative importance of various product features as they are considered within the context of a set of features (or as a whole product package) by the person being asked to make the evaluation. this technique has traditionally been used in product development or positioning. in an attempt to determine the optimal combination of product features, potential buyers are presented with different versions of the product, with varying feature combinations. by analyzing consumer rankings of the various product offerings from most to least desirable, conjoint analysis defines how valued the various features are by the potential buyer or how much ......eight each feature carries in the decision process (green and yoran 1975). it is perhaps obvious that the same approach in defining product feature weights could also be used to define weights for subordinate performance criteria. what follows is a brief (and somewhat simplistic) illustration of the use of conjoint analysis in performance appraisal, a more extensive illustration will be presented later. assume that a firm wishes to understand how heavily its supervisors weight each of three performance criteria: delegating skills, communication skills, and decision-making skills. rather than simply asking each supervisor to rate the criteria individually, (e.g., "which of the three criteria is most important to you?") they are asked to rank order from least to most preferred, all of the possible combinations ofthe three criteria, with four performance levels each (e.g., excellent, good, fair, poor), for a total of 64 possible combinations. table 1 lists the possible choices, and the hypothetical selections made by a supervisor. as there are three criteria involved, each ranking presented represents a combination of all three. for instance, the value -13 circled in table 1 indicates that the supervisor has ranked as 13th from the bottom the combination of: poor communication, fair decision making and excellent delegating skills. conjoint analysis attempts to identify consistencies in the supervisor's judgment of the relative desirability of the various criteria and the importance placed on the various levels of performance (e.g., "excellentvs. "good). in effect, conjoint analysis determines the influence of each criterion on the supervisor's ranking of the performance profiles. the technique permits determination ofwhich criterion the supervisor feels is of greatest importance, which is second, etc. additionally, the importance of one level of performance versus another is ascertained (e.g., how much more valued is "excellent" versus "good"). each criterion level is assigned a numerical weight, or measure of relative significance, so that when the weights of each criterion for each performance profile are summed, the result represents a score for that performance profile which should closely parallel the supervisor's original ordering of the performance profiles. fal11994 kroll, et. al.: defining what the supervisor really wants table 1 supervisor's rankings of performance profiles communication skids 103 e g f p d e em i a s k i i on ng e g f p e g f p e g f p e g f p e 64* 58 40 16 61 56 37 14 59 49 34 11 47 44 31 8 g 63 57 39 15 60 53 36 12 52 48 33 9 46 42 30 6 f 62 55 38@ 54 51 35 10 50 45 32 7 43 41 29 2 p 28 26 20 5 27 25 19 4 24 22 18 3 23 '2.1 17 1*· e g f p *•• delegating skills indicates the most preferred alternative indicates the least preferred alternative performance levels: eexcellent f-fair g-good p poor this table presents an illustrative ranking of au 64 possible performance profiles made by a supervisor. the 64th profile represents the one which the supervisor most favored while the lst represents the one the supervisor least favored. table 2 part weights performance factors delegating skills communication skills decision making skills excellent 47.0 excellent 89.0 excellent 52.0 good 19.0 good 47.0 good 21.0 fair 7.0 fair 16.0 fair 2.0 poor 0.0 poor 0.0 poor 0.0 this table presents the "part weights" or measures of relative importance the supervisor holds for the various criteria levels, based on the choices presented in table 1. 104 journal ofbusiness strategies vol. ii, no.2 using the supervisor rankings provided in table 1, table 2 provides the conjoint analysis generated weights for each level of the three performance criteria. it is quite easy to identify which of the three criteria is of greatest consequence in influencing this supervisor's ratings of subordinates, in this case--communication skills. in fact, this particular supervisor values "good" communication skills (worth 47 points), as highly as "excellent" communicatioon skills, while delegating skills (worth 47 points) is the criterion the supervisor least values. a subordinate who did well in terms of hislher communication skills rating but poorly on delegating skills would be considered a much better performer by this supervisor than had the subordinate done best on delegating skills and worst on communication skills. in addition to allowing us to assess the relative importance to a supervisor of each criterion, as is apparent from table 2, conjoint analysis permits assessment ofhow important one level ofperformance is versus another (e.g. "excellent" performance for a criterion versus "good" performance). simply put, given that numerical weights are defined at every level of each criterion, it is possible to measure the gap between levels of the criterion. we can tell how important a supervisor feels one level of performance is in relation to another. additionally, since the various weights of each criterion can be added for any possible performance combination, the overall difference between one performance profile and another can be fairly and precisely quantified. for instance, using the data in table 2, assume we wished to know how this particular supervisor would rate a subordinate with poor delegating skills, fair communication skills, and good decision-making skills versus a subordinate with good delegating skills, fair communication skills and poor decision-making skills. by adding the appropriate weights for each of the criterion, we arrive at total profile scores. the first subordinate would be ranked slightly higher (0 + 16 + 21 = 37) than the second subordinate (19 + 16 + 0 = 35). the basic idea behind the conjoint analysis is to decompose a set of overall responses to multiattribute alternatives, which can then be stratified. this stratification makes it easier to understand the intricate decision processes a supervisor goes through during performance ratings. afirm using either rating scales, bars, or behavioral expectations scales could very easily apply conjoint analysis, using the already established criteria weights. applying conjoint analysis in organizations using management by objectives or some other approach would obviously not be so simple, as shared criteria would first have to be identifled. both the earlier illustration, as well as the one that follows are based upon a rating scale approach. this is simply because rating scales are a very widely used evaluation technique. innovations in conjoint analysis the obvious problem with using traditional conjoint analysis (as just illustrated) to measure supervisor performance preferences is the number of profiles which would have to be ranked based on the typical evaluation instrument. for instance, a rating instrument consisting of five criteria with four possible levels of performance would result in 625 (5 x 5 x 5 x 5) combinations. no supervisor could be expected to rank so many performance profiles. fortunately, recent interactive software developments now make it possible to accurately assess a supervisor's preferences by asking him/her to make less than 25 evaluations, taking about 10 minutes. such software was used in the following illustration fall 1994 kroll, et. al.: defining what the supervisor really wants 105 and is now readily available (here, the "adaptive conjoint analysis program" developed by sawtooth software was used). while a detailed discussion of the algorithms employed is beyond the scope of this paper, very simply put, weights are assigned as a result of a two-step process. first, supervisors are simply asked to indicate how important each criterion is on a likert-type scale (e.g., 1 to 10, with 10 being assigned to very important criteria). incorporating this information, the software presents the supervisor with a series of performance profile contrasts (see exhibit 1). exhibit 1 example of questions asked in the adaptive conjoint analysis interview instructions: please indicate which of the two performance profiles presented below you prefer most by typing one of the values on the left hand side of the screen. strong prefer top 1 2 3 4 5 6 7 8 9 strong prefer bottom unacceptable planning/organizing skins (unable to plan and implement) below average interpersonal skills (occasionally underperforms) below average technical skills (needs improvement in technical skills) above average technical skills (exceeds requirements) below average supervisory skids (needs improvement) or below average planning/organizing skills (needs improvement) above average interpersonal skills (frequently displays above expected interpersonal skills level) unacceptable technical skills (doesn't meet minimum requirements) below average personal skills (needs improvement in dependability, creativity and adaptability) unacceptable supervisory skills (cannot supervise the work of others) 106 journal ofbusiness strategies vol. 11, no.2 by favoring one profile over another, or expressing indifference to the two profiles, the supervisor provides indications of which performance criteria are favored, and how much those criteria influence his/her preferences. the software continues to present profile contrasts until a clear picture of criteria weights is developed. exploring criteria weights in the organization in order to illustrate the potential benefits of using interactive conjoint analysis in conjunction with the performance appraisal process, the technique is applied in a fairly large, regional bank ($500 million in total assets). the purpose is threefold: to illustrate what the results of such analysis are like for an individual supervisor, to illustrate how the results can be compared and contrasted among supervisory ranks, and to assess how upper-level management views the criteria weights their subordinate managers are applying vis-a-vis organizational priorities and goals. . the organization studied was, as mentioned, a relatively large bank which is a component of a very large holding company. the bank has developed three performance appraisal instruments. one is used by first-line supervisors to evaluate operative level employees (mostly non-exempt). a second is used by mid-level managers to evaluate firstline supervisors (these are all exempt employees). the third is used by the ceo to evaluate middle management (who typically carry the title vice president or senior vice president). for the sake of brevity, this study will focus only on criteria weights middle managers apply in evaluating first line supervisors and criteria weights the ceo applies in evaluating middle management. middle managers middle managers of the bank are asked to evaluate their first line supervisors using an evaluation instrument consisting of five attributes or criteria. what follows is a listing of the criteria, as well as their descriptions taken from the performance appraisal documents used by the bank. 1. planning and organizing this criterion refers to the subordinate supervisor's ability to define objectives, monitor progress toward objectives, prioritize tasks, set schedules and adequately document departmental progress (ie. securing authorization, making appropriate filings). 2. technical skills this criterion refers to the supervisor's ability to keep up-to-date technically with regard to banking practices, analyzing information and evaluating findings critically, and using the information and expertise he/she should possess to make sound decisions. 3. interpersonal skills this criterion refers to the supervisor's ability to communicate effectively, coordinate the work of the department, and represent his/her employees to others within the. bank and the bank to the community. 4. personal skills this criterion refers to the supervisor's dependability, innovativeness, and adaptability to change (willingness to try new approaches to problems/situations). 5. supervisory skillthis criterion refers to the development of human resources in his/ her department through coaching and delegating, as well as the supervisor's ability to fa111994 kroll, et. al.: defining what the supervisor really wants 107 motivate the employees in hislher unit toward the accomplishment of departmental objectives. middle managers can assign one of four possible scores to their supervisors for each of the criteria just listed: superior, above average, below average, and unsatisfactory. they are required to also write out brief statements justifying their scoring for each ofthe four criteria. it should be pointed out that it is not the purpose of the paper here to render judgment on the relative validity or appropriateness of the criteria used by the institution. the purpose is simply to illustrate how conjoint analysis can be adapted to an appraisal scheme. table 3 presents criteria weight profiles for four of the bank's mid-level managers. the weights for all five factors total five hundred points (averaging 100 points for each criteria). table 3 criteria weights for middle managers manager a managerb managerc managerd planning/organizing superior 60.0 61.0 70.0 51.0 above average 18.0 50.0 47.0 26.0 below average 9.0 27.0 11.0 16.0 unacceptable 0.0 0.0 0.0 0.0 interpersonal superior 40.0 37.0 33.0 55.0 above average 37.0 20.0 32.0 41.0 below average 31.0 7.0 16.0 23.0 unacceptable 0.0 0.0 0.0 0.0 technical superior 93.0 45.0 27.0 89.0 above average 60.0 41.0 27.0 59.0 below average 12.0 18.0 16.0 17.0 unacceptable 0.0 0.0 0.0 0.0 personal superior 53.0 30.0 24.0 61.0 above average 34.0 30.0 34.0 32.0 below average 14.0 9.0 21.0 16.0 unacceptable 0.0 0.0 0.0 0.0 supervisory superior 34.0 50.0 66.0 8.0 above average 5.0 58.0 53.0 6.0 below average 0.0 27.0 23.0 0.0 unacceptable 0.0 0.0 0.0 0.0 total 500.0 500.0 500.0 500.0 108 journal ofbusiness strategies vol. 11, no.2 as is apparent from a review of table 3, there are some significant differences in the weights assigned by the supervisors. most notable are the differences in importance placed on technical skills (ranging from 93 for manager a, to 27 for manager c) and supervisory skills (manager c places fairly great significance on this criteria, while manager d sees it as largely irrelevant). it is also worth noting that, in many instances, the managers consider "above average" performance on certain criteria as being just as good as "superior" performance. for instance, manager c weights above average interpersonal skills almost as heavily as "superior" interpersonal skills. the same is true of manager b's weighting of personal skills performance. in terms of the manager's reaction to the findings, there was a combination of confirmation of expectations and genuine surprise. manager d was most surprised at having given such little weight to supervisory skills, while manger a expressed concern at how heavily he was weighting technical skills at the expem:e of personal and supervisory skills. the chief executive officer the ceo of the bank does all the evaluations of the middle level managers. he uses an instrument that differs somewhat from that used by his subordinates to evaluate supervisors; it consists of only four criteria: planning and organizing, interpersonal, personal, and supervisory skills. the results of the conjoint analysis of these four criteria are presented in table 4 below. table 4 criteria weights for the ceo planning/organizing 64.0 44.0 23.0 0.0 superior above average below average unacceptable interpersonal superior 39.0 above average 33.0 below average 7.0 unacceptable 0.0 personal superior 41.0 above average 33.0 below average 12.0 unacceptable 0.0 supervisory superior 46.0 above average 36.0 below average 23.0 unacceptable 0.0 total 400.0 fall 1994 krol~ et. al.: defining what the supervisor really wants 109 one of the more interesting observations concerning the ceo's weightings is the relative balance. the ceo displays much greater uniformity ofweights when contrasted with his subordinates' weights. when asked what possible cause might explain this, he responded that he expects his subordinate managers to be fairly balanced, generalists managers. he also mentioned that, at the middle management level, planning and organizing are quite important to him. in fact, a review of table 4 reveals that planning was the most heavily weighted criteria. overall, the ceo was only surprised by the relatively heavy weight assigned to superior supervisory skills in relation to other criteria. discussion after completing conjoint analyses for all of the managers in the bank and sharing the results with them, a discussion was held with the ceo and the middle level managers. the purpose was to allow the ceo and his immediate subordinates to explore both the weights he received, as well as those received by each of his top executives on the specified performance dimensions. what follows is an excerpted summary of the observations resulting from the discussions. manager a is the chief lending officer of the bank. as a review of table 3 reveals, he tended to be the most concerned with technical skills as well as planning and organization. the discussion resulted in the conclusion that this might be due to the difficult banking climate that existed in this particular market, with many defaults and problem loans. this officer's emphasis came as a surprise to others who thought the ability to represent the bank to the business community, which would be measured as "interpersonal skills" on the bank's instrument, would be most critical. however, manager a later explained how much the last few years of banking difficulty had changed his view of the business, and obviously his view of subordinate behavior. manager b, who heads operations, had perhaps the most balanced criteria weight profile of the four managers. he also is responsible for more supervisors and more diverse activities--ranging from maintenance to safety deposit box operations. as a consequence, he felt that his weightings reflect the balance required to lead such a diverse unit. however, it was also recognized that manager b was probably not as concerned as he should have been about technical skills, as his unit consisted ofsuch technical activities as data processing and automatic teller machines. manager c, who heads the trust operations was at a loss to explain why he placed such little emphasis on technical skills and yet weighted planning and organizing so heavily. this was of special concern given the fiduciary responsibilities of the unit. after some deliberation, it was suggested that the strong emphasis on planning and organizing reflected manager c's efforts to get his department heads to "act more like managers and less like clerks" (manager c had held his position for only a year at the time ofthis study). manager d heads the credit administration department. this department is responsible for such functions as credit analysis, note and loan document processing, collateral inspection and valuation, and handling loans in foreclosure. according to manager d, the technical skills of the people who handle these various functions determines success or failure. as a result, he was not disappointed at the very minor concern he has for supervisory skills or personal skills. 110 journal ofbusiness strategies vol. 11, no.2 there was a comment concerning his failure to develop his subordinates' supervisory skills, with an eye toward their promotion. overall the results contained both some surprises and some confrrmations of what was anticipated before the analysis. mterreviewing the results with his vice-presidents, the ceo did express a desire for managers a and b to place greater emphasis on developing their subordinate managers' supervisory skills. there was also some discussion of the fact that managers band c oftentimes weighted "above average" performance as heavily as "superior." for instance, manager b weighted the two levels equally on the personal criteria, while manager c weighted "above average" more heavily than "superior" on the personal criteria. after reviewing the appraisal instrument, they concluded that a subordinate who was above average in dependability and adaptability was fulf'illing the position adequately, that the marginal difference between "superior" and "above average" levels on this criteria was not of real importance to them. conclusion our purpose here has been to present an innovative method for measuring supervisors' weights of the different criteria used in evaluating their subordinates. traditionally, rating scales or other techniques have been used for appraisal without much thought given to how evaluators view the criteria which make up the instrument. heretofore, those organizations which did seek to determine how their supervisors value the criteria being used had to either resort to regression analysis techniques or simply ask the supervisors to rank their priorities from first to last. while the rust approach is likely to be too complex for most organizations to attempt, the latter really does not get at the issue of how much one performance dimension a supervisor will trade for another. it is quite possible that some organizations may have more elaborate performance appraisal systems than the above example. however, there are meaningful differences within managerial perceptions, which can affect the ratee's performance appraisal. periodic checks need to be introduced in the organization to detect any deviations which have crept into the performance appraisal system. conjoint analysis offers both an efficient and effective means for exploring supervisors' values and ascertaining what it is they truly prize in their subordinates' performance. with the introduction ofcommercial conjoint computer packages such as bretton-clark's conjoint design, con analyzer, simgraf, and adaptive conjoint analysis (green, krieger, and agarwal 1991), it is easier to implement such periodic checks within the performance appraisal system without much difficulty. in fact, software innovations ofthe past few years permits this analysis to be done in a matter of minutes and provides easily interpreted results. this information can be beneficial for the supervisor, hislhersubordinates, and the organization. the supervisor may, for the first time, come to understand not only which criteria they value the most, but how much so. subordinates benefit (if the results are shared with them) by having a clearer picture of just what the supervisor really wants. the organization, also for the rust time, can determine whether or not what its supervisors are looking for in subordinate behavior matches its own needs. after years of attempting to fix the performance appraisal process, maybe it is time to understand and agree upon just what it is we are looking for and value in subordinate behavior. conjoint analysis may offer a workable means for doing just that. fa111994 kroll, et. al.: defining what the supervisor really wants references 111 bernardin, h. j. 1979. "the predictability of discrepancy measures of role constructs," personnel psychology 32 (spring): 139-153. bernardin, h. and p. smith. 1981. "a clarification of some issues regarding the development and use of behaviorally anchored rating scales," journal of applied psychology 66 (august): 45-46. borman, w. 1987. "personnel constructs, personnel schemata, and 'folk theories' of subordinate effectiveness: explorations in the army officer sample," organizational behavior and human decision processes 40 (december): 307-322. budman, m. and b. rice. 1994. "the rating game," across the board 31 (february): 3438. carroll, s. j. and c. schneier. 1982. performance appraisal and review systems. glenview, il: scott, foresman. decotiis, t. 1977. "an analysis of external validity and applied relevance of three rating formats," organizational behavior and human performance 19 (august): 247266. green, p., a. krieger, and m. agarwal. 1991. "adaptive conjoint analysis: some cavaets and suggestions," journal of marketing research 28 (may): 215-225. green, p., and v. rao. 1971. "conjoint measurement for quantifying judgmental data," journal of marketing research 8 (august): 355-363. green, p. and w. yoran. 1975. "new way to measure consumer judgements," harvard business review 53 (july-august): 107-119. hobson, c., r. mendel, and f. gibson. 1981. "oarifying performance appraisal criteria," organizational behavior and human performance 28 (october): 164-188. llgen, d. r., j. bames-farrell., and d. mckellin. 1993. "performance appraisal process research in the 1980s: what has it contributed to appraisals in use?" organizational behavior and human decision processes 54 (april): 321-368. llgen, d. r., c. d. fisher, and m. s. taylor. 1979. "consequences ofindividual feedback on behavior in organizations," journal of applied psychology 64 (august): 349-371. 112 journal ofbusiness strategies vol. 11, no.2 landy, f. and j. farr. 1980. "performance ratings," psychological bulletin 87 (january): 72-107. oberg, w. 1972. "make performance appraisal relevant," harvard business review 50 (january-february): 61-67. ostroff, c. 1993. "rater perceptions, satisfaction and performance ratings," journal of occupational & organizational psychology 66 (december): 345-356. pearce, j. and l. porter. 1986. "employee responses to formal performance appraisal feedback," journal of applied psychology: 71 (may): 182-211. riquelme, h. and t. rickards. 1992. "hybrid conjoint analysis: an estimation probe in new venture decisions," journal of business venturing 7 (november): 505518. seneca, epistulae ad lucilium. uniform guidelines on employee selection procedures. 1978. washington, dc: u.s. government printing office. vroom, v. 1964. work and motivation. new york: wiley. a process for defining what the supervisor really wants reclaiming the environment-organization fit: matching turnaround strategies to environmental exigencies ananda mukherji texas a&m international university laredo, tx ashay desai university of wisconsin oshkosh oshkosh, wi john francis mississippi college jackson, ms abstract this paper discusses the relationship afirm has with its total environment in the context ofdecline. we dimensionalize the total environment to exist at the (j) organization, (2) industry, and (3) macro levels. these levels impact the firm directly, and indirectly through interactions of the different levels. each level of the environment or combination of levels has forces acting in similar or in different directions which results in uniquely different and complex conditions for firms facing decline. we suggest that the firm has to assess its environment carefully, establish the nature of environmental impact, and develop turnaround strategies to match the pressures of its multilayered environment in order to become competitive. introduction one of the most pressing challenges finns face during their lifetime is understanding causes of decline, and managing the turnaround process. many researchers have been studying the consequences of decline, and the process of turnaround (cameron, whetten & kim, 1987; hofer, 1980; robbins & pearce, 1992). although research originally centered on the operational aspects of turnaround, namely retrenchment of expenses and reduction of assets, the scope has expanded to other issues, such as management of human resources, capital restructuring, market choice, and selective product divestiture (bibeault, 1982; pearce & robbins, 1993; starbuck, greve, & hedburg, 1978). currently there is a developing stream of literature which studies the impact of environment, environmental changes on finns (castrogiovanni, 1991; hannan & freeman, 1977; starbuck, 1976), and responses of finns to such changes (covin & slevin, 1990; hambrick & schectar, 28 journal of business strategies vol. 16, no.1 1983). research in the environment-organization relationship exhorts the importance of the alignment of a firm's strategies and resources with environmental requirements to be one of the critical steps in achieving desirable performance (child, 1971; dill, 1958; venkatraman & camillus, 1984). this paper considers the firm-environment fit as an important ingredient in the quest for reclaiming lost competitive advantage, and develops some suggestions for researchers and managers. in order to ground behavior of firms to changes in the environment, we believe the very definition of the environment has to be made much more explicit. there have been many varying definitions of what constitutes the environment (aldrich, 1979; castrogiovanni, 1991; dess & beard, 1984). while researchers have been identifying components of the environment along several dimensions, most of them have essentially treated it as a unilevel construct. the emphasis regarding firm environment in this paper is not so much with its varying definitions, but with how different aspects of the environment are interrelated to each other, and how these interrelated parts differentially impact organizations. we discuss the topic of developing appropriate turnaround strategies by addressing three substantial issues. the first issue is that of defining a more structured, tier-oriented denotation of the environment. for example, one level of the environment should include aspects beyond the industry, another level may be at an intra-industry level, and so on. the stand we take in this paper is that different levels of the environment could impact firms differently, especially if they move in different directions. the second concern is the importance of assessing causality of decline, i.e., to understand how and why firms are being impacted. the third is to look at a range of strategic and tactical options available to the firm, and to understand the relationship between a particular set of environmental conditions and the organization's options. the underlying theme of the paper is that a clear description of the different levels of the environment, and the effect of each level on declining firms would help identify appropriate responses to achieve turnaround. most strategy literature and research treats the environment as a single construct that can be categorized as being adverse and hostile on the one hand, as opposed to be being munificent and liberal on the other. the contribution of this paper is that such an omnibus classification is misleading, if not inappropriate. as this paper will attempt to show, different levels of the environment may pull in different directions (one level being hostile and the another munificent), and firms may have to exhibit different and unique responses. these responses would depend upon understanding and mapping the total environment and its many levels. turnaround: situations and strategies organizations eventually suffer a decline in performance sometime during their lifetime; some of them manage to recover while others do not. hambrick and d'aveni (1988) highlight the growing importance of turnaround processes spring 1999 mukherji, et al: environment-organization fit 29 by citing business week statistics which report the annual failure rate per 10,000 large firms growing from 100 during 1967 through 1982 to over 300 since 1985. this problem is further escalated, by the number of new business fonnations not offsetting the increase in business failures (cameron, sutton & whetten, 1988). cameron, kim and whetten (1987) define decline as a condition in which a substantial, absolute decrease in an organization's resource base occurs over a period of time. krueger and willard (1991) suggest that a firm is said to face a situation requiring turnaround when it has experienced an absolute decline in earnings in two consecutive years. this is a useful a priori condition as it controls for any cyclical or seasonal pattern of decline faced by the organization. this in turn, indicates that turnaround is a result of management actions taken in situations which are continually adverse. many researchers suggest that turnaround involves an organizational metamorphosis consisting of alterations in the finn's ideology, strategy and structure (barker & duhaime, 1994). turnaround is said to have been achieved when the firm has been transformed from a position of decline to a position of strength and competitiveness (stopford & baden-fuller, 1990). thus, attempted turnaround is not an event and is certainly not achieved overnight. we look at turnaround as a process which requires meticulous planning in order to achieve the fit between components of the organization and their corresponding sub-environments with which they share a reciprocal relationship. research in this area originally centered on operational aspects of turnaround, namely retrenchment of expenses and reduction of assets. turnaround theorists thus prescribed cost cutting, tighter controls, and laying off personnel as the solution to a successful return to profitability (starbuck, greve & hedburg, 1978). recently, the perspective has shifted towards strategic turnarounds that involves much more than efficiency increasing processes. hofer (1980) provides a distinction between operational and strategic endeavors, which is either improving efficiency or changing the finn's basic strategy in order to achieve a fit with environmental conditions. in addition, he broadly divided research in the turnaround area into two streams: the content of the turnaround, and the process of turnaround (hofer, 1980). harrigan's (1980) seminal work on declining organizations has added theoretical robustness to this stream of literature. concentrating on strategies for firms in declining industries and the variables that affect the choice of strategies, she suggests that several strategic options could be available to the finn depending on the environmental situation and the internal capabilities of the finn. this paper suggests that a lot of the research related to firm decline, both conceptual and empirical, addresses a limited part of the overall issue. based on hofer's (1980) work, a number ofresearchers have undertaken empirical studies to better understand this relationship. on close examination, hofer's (1980) paper does not specifically address the external environment and its impact on the organization. rather, it is a method of assessing firm performance over various functions like its market position, technological strengths, and overall health. based 30 journal of business strategies vol. 16, no.1 on this assessment of the internal environment, he prescribes certain ways to redeem the situation. hambrick and schectar (1983), in studying the behavior of finns, have used cluster analysis to assess the possible relationship betwet:n hofer's conceptual assessment, and actual finn behavior. although their results were mixed, they were generally supportive of hofer's overall contentions. on closer look, strategic moves were essentially tactical or operational in nature such as pricing, capacity utilization, and production. hambrick and schectar mention, "one of the weaknesses ofthe research design was a lack of data on the origin of the business's trouble, or how long the business had been in trouble" (1983: 240). correctly identifying and assessing the source of the problem and subsequent finn action, one of the underlying issues of research in studying environment and declining finn behavior, has been largely ignored. rather, debate has been in assessing the efficacy of a few strategic and numerous operational actions that finns undertake to overcome adverse perfonnance. we propose the need for a larger framework that helps identify and assess the source of the problem, and relate it to subsequent efforts made by the finn. we also suggest that the distinctions made by pearce and robbins (1993) in dichotomizing a limited set of organizational actions into strategic and operational responses to counter problems of decline and turnaround may be somewhat artificial, unless such categorizations can be thoroughly explained as we attempt to do in this paper. in doing so, we also enlarge the scope of what can be considered strategic under the rubric of organizational response. conceptualizing the environment while the debate on the environment, its varying components and definitions, and its impact on organizations has continued in the management literature for a long time, there has been some disagreement on what precisely constitutes the environment (castrogiovanni, 1991; dess & beard, 1984; gerloff, muir & bodensteiner, 1991; sharfman & dean, 1991). specifically, there are considerable differences among scholars over conceptualizing the environment, and defining the components of the environment, and its measures (dess & beard, 1984; sharfman & dean, 1991). the treatment of the environment as an objective reality as opposed to a perceptual phenomenon further complicates this debate. substantial discussion exists on whether the 'objective' environment differs substantially from the 'perceived' environment, and if so, what are the implications of these differences (bourgeois, 1985). sharfman and dean (1984) submit that research has been unable to build a comprehensive conceptualization of the .environment or its measurement, and the precise impact the environment has on the finn. nevertheless, aldrich's (1979) typology of environmental dimensions, and dess and beard's (1984) measurements have become the basis for much of contemporary research that has been examining the relationship between the finn spring 1999 mukherji, et al: environment-organization fit 31 and its environment (keats & hitt, 1988). in this paper, we take the stand that there are three levels of the environment, each impacting the firm in a different manner, and the subsequent section explicates these three levels. three levels of the environment in order to clarify the various conceptualizations of the environment, castrogiovanni (1991) suggested a multilevel model which explains different aspects of the environment. rather than look at the environment as a single variable, he segmented it into different levels and suggested that each of the levels affects firms in different ways. we find castrogiovanni's (1991) five level model somewhat complex and cumbersome, as three of the five levels are within the organization itself. hence we propose that the total environment can be more effectively conceived as consisting of three distinct parts or levels. the first two levels are consistent with castrogiovanni's (1991) model, but the third, the organization level, is created by collapsing three of castrogiovanni 's (1991) levelsresources, sub-environment, and organizations into one aggregate level. figure 1 forces at three levels impacting firms in summary, the three levels of the environment we present and discuss next are: (1) organization; (2) industry; and (3) macro levels, respectively. 32 journal of business strategies vol. 16, no. 1 organization level the first level, the internal environment of the finn, consists of its overall set of resources, its functional sub-environments, and its internal competencies (selznick, 1957; barney, 1991). the firm can determine its own performance by way of its capabilities and unique competencies independent, to the extent possible, of the external environment (barney, 1991; selznick, 1957). this level of the environment impacts the firm's survival and performance directly. moreover, the firm also has the most influence on this level of the environment, and can be at its most proactive in being able to manage its environment. among the functional parameters that a firm has to consider at this level, both in an absolute and in a relative sense, are its sales level, sales growth rate, cash flow, return on equity, gross margin, net profits from operations, profits to sales ratio, and the ability to fund business through internal accruals (covin & slevin, 1989; hofer, 1980). hambrick and schectar (1983) mention that there are other organizational and managerial variables, like decision making, product quality, attitude, culture, and morale, that are critical at the firm level issues. thus, the internal environment of an organization is multi-faceted in terms of performance parameters and organizational variables. industry level at this level, the impact of the environment on the finn is both direct if the industry is faring poorly and interactional if the firm is performing poorly at the same time. the proactive influence of the firm is more limited at this level, and the firm has to accept much of the industry structure and characteristics as given. it needs to change what it can, and adapt where it must. the work of dess and beard (1984) provides an excellent framework for measuring characteristics at this level. their measures, at the industry level, include: (1) growth of sales, gross margin, employment, value added, number of establishments; (2) industry sales concentration; (3) concentration of inputs and outputs; (4) diversity of products; (5) instability in key parameters like sales, profits, and employment. macro level at this level, the firm operates at what can be described as inter-industry, or the macro environment level. this is the milieu of distal variables that influence the firm more than being influenced by the firm. logically, the level of determinism (hannan & freeman, 1977) would be at its highest at the macro level compared to the other two levels. the elements of this level of the environment are the overall performance of the economy measured by key economic indicators such as gnp growth, unemployment rate, consumption patterns, among others, and how a particular industry is performing in relation to other industries. the macro environment is, in fact, composed of a number of dimensions that include the technological, political, international, and economic components. we, however, restrict our view of the macro environment to the economic dimension for two important reasons. one restriction is the need to maintain parsimony in spring 1999 mukherji, et al: environment-organization fit 33 order that the scope of the paper remains within limits, as a more complete explanation covering the forces in the macro environment would be prohibitively long. two, and more important, is to keep our analysis more in line with other management researchers in this area who primarily focus on a select set of economic variables (dill, 1958; staw & szwajkowski, 1975). it is also important to note that economic forces in the environment are generally easier to operationalize both in theory development and in empirical research. we also believe that our restricted approach in conceptualizing the macro environment will allow for easier comparison across different studies. while acknowledging the importance of other dimensions, we focus primarily on the economic aspect for reasons of parsimony, operationalization, and comparability. assessment of the firm's environment and fit assessing environment and performance measures assessment of the environment has been described as an important process of strategic management and is posited to be the first link in the chain of perceptions and actions that permit the organization to adapt to its environment (hambrick, 1981). hrebiniak and joyce (1985) consider environmental scanning to be a preliminary activity before organizations commit themselves to a particular strategy. the relationship between a firm's strategy and its focus on certain aspects of the external environment has been a subject of both conceptual enquiry (aquilar, 1967; hrebiniak and joyce, 1985; and porter, 1980) and empirical research (hambrick, 1982; jennings & lumpkins, 1992; miller, 1989). researchers maintain that beliefs and expectations of managers are formalized based on their definition of what phenomena (in their environment) are considered to be relevant, important, and desirable (jennings & lumpkins, 1992). subsequently, managers then develop strategies based on their perceptions on how to deal with specific situations (goleman, 1985; starbuck, 1983). in a study of 56 firms from the texas savings and loans (s&l) industry, jennings and lumpkins (1992) found that firms tend to emphasize certain areas within the environment during the process of assessment depending on the strategic needs and postures of the firm. specifically, they found that those s&ls with a differentiation strategy place more importance on "evaluation of opportunities" and "evaluation of customers' attitudes." those s&ls with a cost leadership strategy place more importance on "evaluation of threats from competitors and regulators" and "tracking policies and tactics of competitors." they conclude, "thus there appears to be a rather distinct difference in orientation with respect to environmental scanning based on generic strategy" (jennings & lumpkins, 1992: 799). miller has also discussed the association between strategy and scanning activity by investigating the relationship between information processing and porter's (1980) generic strategies. this relationship, which is extended by tushman and nadler (1978), suggests that effective organizational performance is a function 34 journal of business strategies vol. 16, no.1 between information processing demand and the organization's information processing capacity. consequently, awareness of the three levels and their impact on the organization is an integral part of the demand for and capacity to process information. underestimating the impact, importance, or the interrelationships of any of the levels would imply inadequate information that is being processed to assess the firm's overall environment. the firm's mechanisms to process information from the environment should be optimally designed such that it does not capture and overprocess trivial information, or fail to obtain and underprocess critical information. thus, the ability to look at the total environment in the form of the three levels becomes increasingly important. our suggestions are in line with emery and trist's concept of the "causal texture of the environment which include the processes through which parts of the environment become related to each other the area of interdependencies that belongs to the environment itself' (1965: 22). organization level performance measures at the organization level provide information on how the firm is performing in an absolute sense based on a purely internal assessment. these absolute measures establish how close the firm is in achieving its internally defined goals. among the functional parameters that a firm has to consider at this level include its sales level, sales growth rate, cash flow, return on equity, gross margin, net profits from operations, profits to sales ratio, and the ability to fund business through internal accruals (hofer, 1980). industry level performance measures at the industry level provide information on how the industry is performing in the absolute sense, and the how the firm is performing in comparison to other firms in the same industry. the work of dess and beard (1984) provides an excellent framework for measuring parameters of how the industry is performing. their measures, as mentioned earlier, include: (1) growth of sales, gross margin, employment, value added, number of establishments; (2) industry sales concentration; (3) concentration of inputs and outputs; (4) diversity of products; (5) instability in key parameters like sales, profits, employment, and population. in order to assess the firm's performance in relation to that of other firms in the same industry a number of financial criteria should be used such as sales growth rates, returns on equity, returns on assets, gross margins, and profits to sales ratios (covin & slevin, 1989). these are useful relative measures which the firm can assess its performance in relation to referent other firms. macro level performance measures of the macro level provide information on how the industry is performing in a relative sense when compared to other industries. staw and szwajkowski (1975) have suggested a measure of the macro environspring 1999 mukherji, et at: environment-organization fit 35 ment by assessing the performance of the firm's industry, in relation to the financial performance of all firms and all industries in the fortune 500 list. four financial criteria, taken over a given period of time. have been suggested. these are: (1) mean return on equity; (2) mean return on sales; (3) percentage change in sales; and (4) percentage change in profits. these measures provide an indication of how a firm is performing in relation to all other firms. both within and outside the industry. this set of performance measures provides key information to the firm and helps it assess its overall performance position and its relationship with its environment. thus. a firm may find itself in a declining macro environment and a growing industry environment. or vice versa. assessing fit the firm's response can be viewed as a process of realigning the organization to the environment in order to attain a desired level of competitive advantage. research has discussed the need to achieve a fit between the firm and its external and internal environments (jemison, 1981; miles & snow, 1980). organizational adaptation, as seen by contingency theorists (aldrich, 1984; lawrence & lorsh. 1967) or as seen by population ecologists (hannan & freeman, 1977), is a function of congruence with the environment. thus, improving the congruency between the environment and the organization is posited to lead to improved performance. figure 2 the environment-performance-response linkage macro environment industry environment ----------... assessment _..-response how can firms assess their environments to make sure that, given the circumstances, they have the best fit possible? this perhaps is the essence of the 36 journal of business strategies vol. 16, no. 1 discipline of strategy a search for a fit between an organization and its environment. the concept of fit is central in distinguishing the field of strategic management (summer et. ai, 1990) from its brethren: finance, managerial controls, human resources, marketing, and organizational behavior. having suggested that the environment can be best understood in three levels, all of which impact the finn in direct as well as in indirect ways, the question of assessing the environment from the point of view of fit now becomes more complicated. various fit models have been developed and tested. for example, naman and slevin (1993) have developed a fit model consisting of entrepreneurial style, organizational structure, and mission strategy, and empirically tested this profile against certain measures of financial perfonnance. venkatraman and camillus (1984) consider the concept of fit to be fundamental to strategic management. this follows from the notion that organizational resources should be aligned to match the environmental contingencies faced by the organization (andrews, 1971). we see the issue differently based on the multilevel model of the environment that we have suggested. literature and research discussing strategic fit between an organization and its environment in many cases does not explicitly state what level of the environment it is addressing, consequently it is left to the reader to assume the appropriate environmental level fit, therefore, is not just with the immediate environment, but it also needs to relate to the three levels mentioned earlier. an organization may be exhibiting appropriate fit for one or two levels, but not all three, and this is likely to make its performance suboptimal. we suggest that environmental assessment should encompass an appraisal of the variations in all three levels and the repercussions this has on the organization (figure 2). there exists an interaction among the three levels of the environment which in turn determines firm's performance. a firm's long-term viability, survival, and prosperity depends upon the overall competitive environment it operates in. here, its task environment (dill, 1958) at the industry level, and the forces within this level determine competition. porter's (1980) five forces model most elegantly explains the degree of competition and rivalry a firm faces. certainly a poor fit with the many elements of a firm's environment will heighten competition to the extent that the survival of the firm is at stake. on the other hand, the ability to optimally organize its internal resources and sub-environments will allow a firm to manage its competitive conditions better, and prevent excessive rivalry from overwhelming the firm. some firms are able to contain and manage competition on account of its well-organized and well-deployed internal resources. other firms are able to extend this in optimizing the forces (from suppliers, buyers, new entrants, etc.,) at the industry level. certainly an inability to manage competition and rivalry is indicative of a poor fit at the organization or the industry level or both. it is important to conceptualize fit in terms of managing internal resources and industry level forces to not get overwhelmed by competition and rivalry. spring 1999 mukherji, et al: environment-organization fit organizational responses 37 an important aspect of the organization-environment relationship is the ability of an organization to correctly understand and respond to the signals emanating from this interface. while the signals are difficult to measure, it is obviously important to evaluate these indicators as there is a considerable time lag between the first weak signals and the ultimate decline in measurable business performance (lorange & nelson, 1987). the issues that have been raised in this paper are primarily concerned with the organization's abilities to properly assess the causes of decline, and to follow this with the most appropriate responses. with the environment operating at three levels, decline sources can be from the macro level, the industry level, or the organization level. specific environmental levels will have different effects on organizations. we present two tables. table 1 presents a framework where the macro environment itself is a source of decline. other rows and columns indicate whether other levels of the environment, the industry and organization levels, are or are not sources of decline. the table also suggests that a label for each type of decline, the 10ngand short-term prospects for the industry and the organization, examples of industries, and finally the type of strategy the firm or organization may choose to undertake. table 1 macro environment as primary source of decline and organizational responses environment level environmental conditions as causes hostile macro level yes yes yes yes declining industry level yes yes no no poorly performing organization level yes no yes no prospects industry ... poor poor poor poor organization short term ... poor good poor poor long term ... poor poor good good examples railroads, isolated industries countertobacco businesses, that do well, cyclical catering to especially industries special niches during or tastes recessions strategy type collective collective/ collective/ collective/ organizational operational operational 38 journal of business strategies vol. 16, no.1 a second table is also presented. this table is structurally similar to table i, however, the difference is that the cause of decline is no longer from the macro environment (which have been covered in table 1), but are either from the industry level or from the organization. what table 2 presents is that, given the macro environment is not the source of the decline, the source of decline is from one of the two more proximal levels. table 2 industry and organization levels as sources of decline and organizational responses environment level environmental conditions as causes hostile macro level no no no declining industry level yes yes no poorly performing organization level yes no yes prospects industry ... poor poor poor organization short-term . .. poor good poor long term ... poor poor good examples sunset industries individual firms individual firms like steel, doing well in a doing poorly in a extraction, black declining industry bountiful and white tvs environment typically, if the source of decline can be traced to the macro level, which in tum has negative consequences at the industry level, then firms within that industry should follow collective strategies (astley & fombrun, 1983). on the other hand, if a firm is in decline due to strategic reasons at the industry level, it should develop responses that are aimed at strategic reorientation. finally, if a firm is in decline due to internal causes related to either issues of efficiency or due to organizational reasons, it should undertake operational or tactical responses. for example, an unstable marketing environment would affect all firms in the industry while a specific firm's unstable labor union relationship could affect just the specific firm. in other words, the response pattern of the firm will have to be a combination of actions taken in correspondence to the causes of decline emanating from a multi-level environment. collective strategies one major area of the environment that may be affecting firms and causing decline is the macro level. while deterioration in the macro environment may affect the spring 1999 mukherji, et al: environment-organization fit 39 finn directly, it is more than likely that the finn's industry is also negatively affected. thus an adverse macro environment is usually related to a declining industry. in this situation, finns usually have to adopt some fonns of collective strategies (astley & fombron, 1983; astley, 1984; benson, 1975; oliver, 1988; dollinger, 1990; dollinger & golden, 1992) in conjunction with other finns. these collective strategies can take the fonn of federations (provan, 1983) or consortiums (provan, 1984) or some other type of interorganizational cooperation. collective strategy has been defined as "a systematic response by a set of organizations that collaborate in order to absorb the variation present in the environment" (astley & fombron, 1983: 580). bresser defines the objective of collective strategy to "managing mutual independence and the system dynamics of their interorganizational environment" (1988: 375). earlier collective strategies were posited to be an option for concentrated and oligopolistic industries (bresser, 1988; hamel, doz and prahalad, 1989). the ability of a single finn in such an environment to unilaterally influence conditions for itself or the industry would be limited. oliver (1988) exhorts the use of collective and cooperative efforts among finns as a concerted response to ubiquitous (inter-industry) environmental changes. collective strategies would be more applicable in complex environments with the added threat of increasing dynamism. moreover, finns lacking the ability to secure critical resources (hambrick, 1983), access and procure infonnation (williamson, 1975) and coupled with the absence of slack resources to absorb this hostility, would largely benefit from collective strategies. aldrich (1979) suggests that some finns do have the power to influence the environment on their own. in the absence of such power, collective strategies can be used as alternatives. for example, organizations facing changes in governmental agencies, social and technological subsystems, customers, and internal organizational environment would not only need operational and strategic turnaround strategies but would be required to resort to a collective response in the fonn of associations, lobbying, and collaboration. we take the view that organizations, when faced with decline or possible decline, can and indeed do make strategic choices on how the effects of the environment can be handled collectively. under such conditions, organizations fonn collectives like coordinating agencies, coalitions, networks, and federations. federations, for example, are often fonned when interdependent organizations find themselves engaged in activities for which they are ill-suited (provan, 1983). interorganizational cooperation is a major strategy used by organizations to enhance their capacity to serve clients or to acquire resources through the formation of ties with other organizations (provan, 1984). interorganizational fonnations can be internally driven, or may fonn due to pressures from regulatory commissions (mcdaniel, 1978). either way, our contention is that some fonn of collective strategy is an appropriate response for an organization if it assesses that the source of decline is from the macro environment. under extreme conditions, when the macro environment is considered to be unsupportive, staw and szwajkowski (1975) have found empirical evidence of illegal collective strategies being under40 journal of business strategies vol. 16, no.1 taken such as collusion, price fixing, refusal to deal, monopoly, tying arrangements, price discrimination, foreclosure, and conspiracy. firm strategies when firms find that the cause of decline is not due to the macro environment, but is within the context of the industry it operates in, it has to assess its own strategic posture to determine whether it has an appropriate fit with its industry environment. in this situation, the suggestions made by hofer (1980) to assess the organization's strategic position in the industry would be most useful. he suggested that the organization's current operating and strategic health be mapped so as to determine appropriate responses to improve its current position. strategic turnaround is associated with declines which are primarily due to misalignment of the firm with the environment. the thrust of strategic turnaround is one of innovation, application of new ideas, and doing new things, while operational turnaround dictates maintaining the variety of the current strategy with more efficiency (hofer, 1980). in other words, strategic turnarounds can be associated with doing the right things, while operational turnarounds can be associated with doing the things right. a strategic turnaround would mean that the focus of the organization needs to be shifted from one area of competency to another. strategies at this level include divestiture, repositioning, and handling of exit barriers (harrigan, 1985). other strategic options are usually at a corporate level and include those of diversification, joint ventures, mergers, acquisitions, and vertical integration. the industry environment is concerned with ends, and the objectives of a firm are a part of this level of the environment. astley and fombrun (1983) have • suggested that corporate and business strategies are appropriate for this level of the environment. it is usually at this level that matters pertaining to what is called corporate strategy are followed. strategic choice operates at three levels (dill, 1957). one is the choice of industry, the second is choice of market, and the third is choice of product and price. thus, key decisions of reconsidering ends is a part of corporate strategy which generally covers decisions of whether to enter or exit a particular industry. furthermore, strategic issues at the industry environment are also matters of business strategies, which are primarily concerned with means to achieve particular ends. decisions of this kind have less to do with whether or not to enter an industry, but are issues of what best to do within the industry in order to overcome decline. product diversification, pricing policies, emphasis on r&d, capital investment, technological innovation, and the like are different means to achieve given, ends. operational responses another level that a finn may recognize as the fundamental source of decline may be at the organization level itself. under these circumstances, the finn has to spring 1999 mukherji, et al: environment-organization fit 41 undertake operational and tactical actions like better management of plant and equipment and related efficiency-oriented activities. such a concerted response by the organization to decline due to temporary or cyclical industry contractions based on efficiency-related postures is termed as operational turnaround (hofer, 1980). actions that include pricing, plant and equipment, marketing, receivables, inventories, capacity utilization, productivity, quality, and material management should really be considered operational issues. (hambrick & schectar, 1983; hofer, 1980). operational responses include intra-organizational and managerial variables (hambrick & schectar, 1983) like structure, decision-making processes, delegation, centralization, and other similar variables. lorange and nelson (1987) have pointed out other internal causes that are responsible for firm decline like top management self-deception, hierarchy orientation, cultural rigidity, conformity, and a dysfunctional need for consensus and compromise. responses to address decline from within the organization itself have to first recognize that the organization is the source of decline. this is a key step in making an appropriate decision that specifically confronts problems from within. lorange and nelson (1987) suggest a number of steps that include explicitly defining goals, subgoals, and benchmarks, identify and address key competitors and customers, link job with responsibility, and address issues of structure and processes. discussion and conclusions this paper considers firm-environment fit as an important ingredient towards achieving competitive advantage. we extend the logic to the attempted turnaround process. in other words, we look at this process as a mechanism for realigning the organization with the exigencies of the environment in order to reclaim the lost position of competitiveness. this argument indicates that there exists a great need to be more precise in studying the effects of environmental conditions on declining organizations. a lot of research looks at the environment as a univariate construct, and perhaps this is justified from the context of the research question. we have suggested a more elaborate view so that actions or responses that firms take can be understood based on the impact different levels of the environment have on the firm (see figures i and 2). given the suggested three level structure of the environment macro, industry and organization we propose that there are a number of different possibilities in the way the overall environment acts. leaving out the impact, importance, or the interrelationship of any of the levels would imply either that inadequate information is being processed to assess a firm's overall environment, or redundant information is being processed. ferris, schellenberg and zammuto (1984) have suggested that environmental conditions of organizations differ, hence firm-level responses for dealing with decline should consequently be different. we recommend that the strategy and tactics the firm plans to adopt need to be consistent with the magnitude and source of change taking place in the environment. a range of environmental conditions 42 journal of business strategies vol. 16, no.1 are possible based on our framework (table 1). at the one end is when the three levels of the environment are positive. under this condition, decline is not likely to occur and is not addressed in our paper. at the other end is when the macroenvironment is in decline, indicating an economy in recession, without there being a specific negative impact on the industry or finn. our framework addresses conditions that occur between these two extremes. an important question arises as to the true meaning of "fit" between an organization and the different levels of its environment. does fit automatically assure the firm of success, or is success a higher order set of activities, and perhaps "fit" is only a means to prevent failure? this is a difficult question to answer, and is a theoretical and research issue that is yet to be fully explored. an important strategic issue may have been overlooked in management research is the appropriateness of classifying strategies into two factors in tenns of failure-preventors and success-providers (varadarajan, 1985). most strategy researchers have not seriously considered this two-factor classification when undertaking research in strategic management (mckee, conant, varadarajan & mokwa, 1992 are among the few exceptions). we take the position that alignment of a finn with its environment is more like a failure prevention strategy (varadarajan, 1985; mckee, conant, varadarajan & mokwa, 1992) and is akin to necessary conditions. however, the process of alignment while distinct, are closely related to strategies that have to be implemented to obtain success. strategy scholars have suggested that failurepreventor variables (the necessary conditions) are distinct from the success-provider variables (the sufficient conditions), and go on to suggest that failurepreventor skills are necessary but not sufficient for superior organizational perfonnance. while we suggest that the process of aligning the finn with its environment is a failure-preventor (necessary condition) and subsequent strategies are success providers (sufficient conditions), enough theoretical and empirical work has not been done in any conclusive manner in this area. we recommend the use of collective strategies to overcome decline resulting from environmental changes beyond the scope of anyone individual firm, the use of firm strategies to manage firm deterioration arising out of industry-level environmental difficulties, and the use of operational strategies to readjust any deviation attributable to within-firm disturbances. (while it appears that our discussion suggests that there is a set of responses for each level of the environment causing the decline, the reality is that one, two, or all three levels of the environment can contribute to decline.) consequently, multiple responses based on our suggestions would be appropriate. it is possible that particular internal corporate strengths of an organization would make certain strategic options more appropriate for specific organizations and their environments. even when external environmental factors are held constant, several business strategies, depending on the internal environment, may be applicable to bring about a successful turnaround. our intention behind this paper is to emphasize that the environment is a multilevel interrelated construct. decline conditions can be caused by one or more of spring 1999 mukherji, et al: environment-organization fit 43 these levels, and these levels themselves may be moving in different directions. finally, turnaround strategies have to be related and linked to the appropriate environment level or levels. references aldrich, h. (1979). organization and environments. englewood cliffs, nj: prenticehall. andrews, k. (1971). the conceut of como rate strategy. homewood, il: irwin. aquilar, f. j. (1967). scanning: the business environment. new york: macmillan. astley, w. g., & fombrun, c. j. (1983). collective strategy: social ecology of organizational environments. academy of manag:ement review. 8 (4), 576-587. astley, w. g. (1984). an appreciation of collective strategy. academy of management review. 9 (3), 526-535. barker, v. (1992). corporate turnarounds as strategic reorientations: a field study of turnaround attempts from firm-based decline. unpublished doctoral dissertation, university of illinois at urbana-champaign. barker, v., & duhaime, 1. (in press). toward a thorough understanding of strategic change in turnaround companies: theory and evidence. strategic management journal. barney, j. (1991). firm resources and sustained competitive advantage. journal of management. 17 (1), 99-120. benson, j. k. (1975). the interorganizational network as a political economy. administrative science quarterly. 20, 229-249. bibeault, d. (1982). corporate turnaround. new york: mcgraw-hill. bourgeois, l. j. (1985). strategic goals, perceived uncertainty, and economic performance in volatile environments. academy of management journal. 28 (3),548-573. beard, d. w., & dess, g. g. (1981). corporate-level strategy, business-level strategy, and firm performance. academy of management journal. 24, 663-688. bresser, r. (1988). matching collective and competitive strategies. strateg:ic management journal. 9, 375-385. cameron, k., whetten, d., & kim, m. (1987). organizational dysfunctions of decline. academy of management journal. 30 (1), 126-138. 44 journal of business strategies vol. 16, no.1 cameron, k., sutton, r, & whetten, d. (1988). issues in organizational decline. in k. cameron, r sutton, and d. whetten (eds.), readin~s in organizational decline: frameworks. research and prescriptions, 3-19. boston: ballinger. castrogiovanni, g. j. (1991). environmental munificence: a theoretical assessment. academy of mana~ementreview. 16 (3), 542-565. castrogiovanni, g. j. (1995). business turnaround processes: reconsidering the role of retrenchment. proceedings of the southwest academy of management's 37th annual meeting, 14-18. child, j. (1972). organizational structure, environment and performance: the role of strategic choice. sociology. 6, 1-21. covin, j., & slevin, d. (1989). strategic management of small firms in hostile and benign environments. strategic management journal. 10, 75-87. dess, g., & beard, d. (1984). dimensions of organizational task environments. adminjstrative science quarterly. 29, 52-73. dill, w. r (1958). environment as an influence of managerial autonomy. administrative science quarterly. 2 (4), 409-443. dess, g., ireland, r, & hitt, m. (1988). industry effects and strategic management research. paper presented at the academy of management meeting, anaheim, ca. dollinger, m. (1990). the evolution of collective strategies in fragmented industries. academy of management review. 15 (2), 288-265. dollinger, m., & golden p. (1992). interorganizational and collective strategies in small firms: environmental effects and performance. journal of management. 18 (4),695715. d' aveni, r. (1989). the aftermath of organizational decline: a longitudinal study of the strategic and managerial characteristics of declining firms. academy of mana~e­ ment journal 32 (3), 577605. emery, f. e., & trist, e. l. (1965). the causal texture of organizational environments. human relations. 18 (l), 21-32. gerloff, e. a., muir, n. k., & bodensteiner, w. d. (1991). three components of environmental uncertainty: an exploratory analysis of the effects of aggregation. journal of management. 17 (4),749-768. goleman, d. (1985). vital lies. sim[jle truths: the psychology of self-deception. new york: simon and schuster. spring 1999 mukherji, et at: environment-organization fit 45 hambrick, d. (1981). specialization of environmental scanning activities among upper level executives. journal of management studies. 18, 213·220. hambrick, d. (982). environment scanning and organization strategy. strategic management journal. 3, 159-174. hambrick, d., & d' aveni, r. (1988). large corporate failures as downward spirals. administrative science quarterly. 33, 1-23. hambrick, d., & schectar, s. (1983). turnaround strategies for mature industrial-product business units. academy of management journal. 26 (2), 231-248. hambrick, d. (1985). turnaround strategies. in handbook of business strategy, 10.110.32. boston: warren, gorham, and lamont. hannan, m., & freeman, 1. (l977). the population ecology of organizations. american journal of sociology. 78 (2), 929-964. hannan, m., & freeman, j. (1984). structural inertia and qrganizational change. a.mrn.: can sociological review, 49,149-164. harrigan, k. (1980). strategies for declining businesses. lexington, ma: lexington books, 1980. harrigan, k. (1985). strategic flexibility; a management guide for changing times. lexington, ma: lexington books. hrebiniak, l., & joyce, w. (1985). organizational adaptation: strategic choice and environmental determinism. administrative science quarterly. 30,336-349. hofer, c. (1980). turnaround strategies. journal of business strategy. i, 19-31. jemison, d. (1981). the importance of an integrated approach to strategic management. academy of management review. 6,601-608. jennings d., & lumpkin, p. (1992). insights between environmental scanning activities and porter's generic strategies: an empirical analysis. journal of management. 18 (4),791-803. levine c. h. (1978). organizational decline and cutback management. public administration review. 38. 316-325. lorange, p., & nelson, r. t. (1987). how to recognize and avoid organizational decline. sloan management review, spring, 41-48. mcdaniel, 1. p. (1978). maryland health care system, inc.: a creative response to change." health care manat:ement review. 3 (4), 29-50. 46 journal of business strategies vol. 16, no.1 mckee, d.o., conant, j. s., varadarajan, p. r., & mokwa, m. p. (1992). success-producer and failure-preventor marketing skills: a social learning theory interpretation. journal of the academy of marketing science, 20 (1),17-26. miles r, & snow c. (1978). organizational strategy. structure and processes. new york: mcgraw hill. miller, d. (1989). matching strategies and strategy making: process, content, and performance, human relations, 42, 241-260. naman, j. l., & slevin, d. p. (1993). entrepreneurship and the concept of fit: a model and empirical tests. strategy management journal. 14, 137-153. oliver, c. (1988). the collective strategy framework: an application to competing prediction of isomorphism." administrative science ouarterly. 33, 543-561. pearce, j., & robbins, d. (1994). retrenchment remains the foundation of business turnaround. strategic management journal. 15 (5), 407-417. pearce j., & robbins, d. k. (1993). toward improved theory and research on business turnaround. journal of management. 19,613-636. porter, m. e. (1990). competitive strategy. new york: free press. provan, k. g. (983). the federation as an interorganizationallinkage. academy of management review. 8 0), 79-89. provan, k. g. (1984). interorganizational cooperation and decision making autonomy in a consortium multihospital system. academy of management review. 9 (3), 494504. robbins, d. k., & pearce, j. (1992). turnaround: retrenchment and recovery. strategic management journal. 13 (4), 287-309. selznick, p. (957). leadership in administration, new york: harper and row. sharfman, m. p., & dean, j. w. (991). conceptualizing and measuring the organizational environment: a multidimensional approach. journal of management. 17 (4), 681-700. starbuck, w. h. (1976). organizations and their environments. in m.d. dunnetle's (ed.), handbook of industrial and organizational psychology, 1069-1123. chicago: rand mcnally college publishing co. starbuck, w. h. (1983). organizations as action generators. american sociological review. 43, 91102. spring 1999 mukherji, et al: environment-organization fit 47 starbuck, w., greve. a., & hedburg, b. (1978). responding to crisis. journal of business administratiqn,9.111-137. staw. b. m.• & szwajkowski, e. (1975). the scarcity-munificence component of organizational environments and the commission of illegal acts. administrative science quarterly. 20. 345354. stopford j. m.• & baden-fuller c. (1990). corporate rejuvenation. journal qf mana~e­ ment studies. 27, 399-415. thomas, p. (1980). environmental scanning the state of the art. long ran~e plannjne, 11.20-28. tushman. m. l., & nadler, d. a. (1978). information processing as an integrating concept in organization design. academy qf mana~ement review, 3,613-624. varadarajan, p. r. (1985). the two-factor classification of competitive strategy variables. strategic management journal. 6, 357-375. venkatraman, n" & camillus, 1. (1988). exploring the concept of "fit" in strategic management. academy qfmanagement review. 9 (3), 513-525. whetten, d. (1987). organizational growth and decline processes. annual review of sqrullw. 13,335-358. williamson, o. e. (1975). markets and hierarchies: analysis and anti-trust implications, new york: free press. ananda mukherji is working as an assi stant professor at texas a&m internatiqnal university in laredo, texas. he received his ph.d. from the university of memphis and his masters from the xavier labour relations institute in india. he worked as a systems and management consultant for a number of years, and ran his own business subsequently. his research interests include competitive strategies. inter-firm relations, international business strategy, and agency issues. ashay desai is currently working as an assistant professor at the university ofwisconsin oshkosh. he received his ph,d. from the university of memphis, and his mba from the university of wyqming. he previously worked for the indian hotels company in the human resources department. dr. desai's research interests have focused on decline and turnaround, issues of international competitiveness. strategic planning and corporate gover· nance. john francis is as an instructor at mississippi college in jackson. he received his mba from samford university and is completing his ph.d. degree in strategic manage· ment at the university of memphis. he has worked for a few years with an engineering firm in the construction industry. his research interests include strategic and international management, with particular emphasis on institutional theory and born global firms. reclaiming the environment-organization fit: matching turnaround strategies to environmental exigencies consumer attitudes towards multi-channel retailers' web sites: the role of involvement, brand attitude, internet knowledge and visit duration. george balabanis city university business school london, england nina l. reynolds university of wales swansea swansea, wales abstract the study examines how different consumers evaluate online shopping sites set up by bricks-and·mortar retailers. in particular, it examines how differences in consumers' information processing abilities and motivation as well as in their predispositions towards a site s material affect their attitudes towards that site and the amount oftime they spend at the site. the postulated relationships are depicted in the form of a path diagram. the sites assessed were two electronic shopping sites belonging to well established casual wear multi-channel retailers. findings suggested that attitudes towards a retailers brand (predisposition) transfers to attitudes towards the retailer's shopping site. the characteristics of the web site were found to moderate the impact of involvement, internet knowledge and internet experience, on both attitudes towards a site and the visit duration. introduction the revenue generated from internet shopping is increasingly rapidly in terms of both its share of all retail sales and its overall value (economist 2/26/00; 6/2/ 00). sales from multi-channel retailers (catalogue and/or physical stores that also sell on-line) dominate this outlet, and they are expected to increase their dominance as the internet matures (economist 8121/99). businesses recognized, however, that use of the internet should not be restricted to sales functions such as "building brand awareness" and" providing marketing information" are also relevant (www.yankeegroup.com). these trends and issues, alongside the changing nature of consumers' online shopping habits, reduce the importance of traditional distribution channels to retailers (e.g., quelch & klein, 1996; hoffman, novak & catterjee, 1995; hamill & gregory, 1997). the role of the internet, in particular, of electronic commerce web sites, has been recognized as a marketing tool for attracting and maintaining customers (dreze & zufryden, 1997; vrolijk, huizingh & hoekstra, 1998; mcmurdo, 1998; dholakia & rego, 1998; hofacher & murphy, 1998; o'keefe, o'connor 106 journal of business strategies vol. 18, no.2 & kung, 1998). settles (1995) has claimed that one of the most important elements of a web site's value to customers is the provision of pre-purchase sales information. web site technology can allow consumers to view different product features, assess possible product attribute combinations and/or compare competitive offerings. however, the attractiveness and appeal of a web site is not the same to all customers (settles, 1995). nevertheless, despite the emphasis placed on the marketing potential of the internet and the need for well-designed web sites, very little is known of consumer differences regarding their attitudes towards a web site. specifically, there is very little academic research on the impact of consumer behavior on online shopping at web sites set up by bricksand-mortar retailers (katros, 2000). based on the above, the main objective of this study is to examine consumers' attitudes towards a multi-channel retailer's web site. drawing from research in psychology (petty & cacioppo, 1986; chaiken, liberman & eagly, 1989) and advertising (macinnis & jaworski, 1989), the study concentrates mainly on the differences between individuals in terms of motivation, ability to process information and attitudes towards the brand. literature review and model development while consumer internet research has considered the virtues of the medium and its potential uses (berthon, pitt & watson, 1996), innovation diffusion and consumer internet adoption (gupta & rabikar, 1997; keeling & mcgoldrick, 1997; keeling, fowler & mcgoldrick, 1998; white, abels & murnane, 1998), and how, with certain product categories, consumer buying can be modeled (liang & huang, 1998), it is still limited in scope. a popular internet research topic is web site effectiveness, where researchers have focussed on web site design features and content (dreze & zufryden, 1997; vrolijk et ai., 1998), profiles of effective web sites (johnson, cleland, williamson, carmichael, gleason, cuneo, mandese, waltner, donaton, zbar, haran & fawcett, 1995), and the features that make a 'good' web site (mcmurdo, 1998; dholakia & rego, 1998; hofacher & murphy, 1998). nevertheless, little attention has been given to how consumers' differences affect their use and evaluation of web sites. how consumers' use web sites is highly dependent on how they processes information, as such this study draws from the information processing evaluation literature (e.g., petty & cacioppo, 1986; chaiken et ai., 1989). in addition, work on advertising evaluation, in particular the role of attention and preexisting brand attitudes on information processing/evaluation, is also drawn upon (macinnis & jaworski, 1989). according to these authors, the processing and evaluation of information depends primarily on three factors; the individual's (i) motivation, (ii) ability, and (iii) opportunity to process information. the importance of these factors to the internet, particularly internet navigation behavior, has been recognized by hoffman et al. (1996). fall 2001 balabanis & reynolds: consumer attitudes 107 how relevant the information presented is to the consumer, that is the consumer's level of involvement, impacts on their motivation to process that information (macinnis & jaworski, 1989). involvement can also have an impact on the way information is processed (see johnson & eagly, 1989; 1990). it can influence both the direction and intensity of an individual's attention. attention itself refers to the allotment of an individual's mental activity to the task of concern (macinnis & jaworski, 1989). increased duration on a web site is a manifestation of increased attention, which, in turn, is an indication of increased motivation (i.e., higher level of involvement). the second factor, ability to process information, refers to the consumer's skill or proficiency in interpreting information. factors such as intelligence or education, product knowledge or experience, and message difficulty, influence an individual's information processing ability (macinnis & jaworski, 1989). web sites, which provide information through a complex nexus of hypertext links, may restrict the information processing ability of those consumer's that are inexperienced with and/or not knowledgeable about the internet l . as such, consumer's that are experienced of and knowledgeable about the internet, will have greater ability to process and evaluate the information found on a web site. the third factor considered in this study, situational and information-related effects, can obstruct the interpretation process and the time spent processing information and, as such, have an impact on the consumers' opportunity to process information (macinnis & jaworski, 1989). the opportunity to process information can be influenced by features that distract consumers' attention from the message evaluation (e.g., background music, source, etc.) or factors such as the level of information condensation and the pace of the deli very of the message. ceteris paribus, individuals with different levels of opportunity to process a piece of information will form different views about that information. ideally, individuals would process any information presented to them free of bias or preconceptions. however, individuals often have a' pre-formed set of attitudes about the brands marketed on web sites or about the owners of the sites. consumers' attitudes towards a brand (or a b ), for example, are likely to affect the way they process the information presented on that brand's web site and the formation of attitudes towards that web site (a wcb )' corresponding research in advertising, for example, has found that attitudes towards an advertisement (a ad ) are highly correlated to a b (mackenzie, lutz & belch, 1986). this may be because consumers do not devote enough attention to the advertisement to distinguish it from the brand, or it may be that exposure to the advertisement helps consumers to retrieve brand associations (macinnis & jaworski, 1989). although there are certain differences between the way information is presented in an advertisement and on a web site, the rationale advocating a relationship between brand attitudes and attitudes towards the associated web site remain pertinent. 108 journal of business strategies vol. 18, no.2 consequently, this study focuses on the impact of these areas when considering consumers' attitudes towards web sites: (i) consumer involvement with the product category (motivation factors); (ii) internet/knowledge experience (ability factors); (iii) pre-existing attitudes towards a brand (opportunity factors). their relationships with (a) attitudes towards an electronic shopping web site (a web ) (b) duration of a visit to that site, as well as (c) their inter-relationships, are depicted in figure i. figure 1 the relationship between involvement, brand attitude, internet knowledge and experience, visit duration and attitudes towards a web site attitudes towards the retailer's brand involvement with product category knowledge of the internet t experience with the internet attitudes towards the retailer's web site time spent browsing the retailer's web site involvement with a product category consumers will process information presented to them in detail and make complex evaluations only if they are motivated (petty & cacioppo, 1986); an individual's motivation to process information about an issue is his/her level of involvement with that issue (see johnson & eagly, 1989; 1990 for review). in the case of commercial web sites, the "issue" is usually a set of products or services. the level of involvement a consumer has with a product is based on the relevance of that product to the consumer's inherent needs, values and interests (zaichkowsky, 1985). in turn, involvement influences the amount of mental and physical effort a consumer puts into the buying process (laaksonen, 1994). highly-involved consumers will: (i) search for more information before they fall 2001 balabanis & reynolds: consumer attitudes 109 buy; (ii) process relevant information in greater detail; and (iii) use more criteria in their buying decisions than other consumers (maheswaren & meyers-levy, 1990; leong, 1993; laaksonen, 1994). involvement also affects consumers' levels of attention, information processing, comprehension, decision-making and responses to advertising (celsi & olson, 1988; maheswaren & meyerslevy, 1990). for example, highly involved consumers will pay greater attention to relevant web sites than less involved ones (hoffman & novak, 1996). highly involved individuals also appear to process relevant information more conscientiously than less involved ones. petty and cacioppo (1986), for instance, have shown that cogent information is more effective for highlyinvolved individuals than for less involved ones, while specious information is less effective for highly involved individuals than for less involved ones. thus, involved consumers are likely to react differently to a web site and provide different evaluations of that site than less involved consumers. aspects of the web site related to the object of involvement (i.e., the product) are more likely to attract the interest of involved consumers, whereas, uninvolved consumers are likely to focus more on the peripheral stimuli of the site (visuals, sounds, frames, etc.) or the site's design characteristics. thus, the relationship between involvement and attitudes toward the web site is partially dependent on the characteristics of the site. in addition, highly involved individuals are expected to spend more time at a web site gaining information about a product. thus, hypothesis 1a: the length of time a consumer spends on a web site is positively related to his/her level of involvement with the product category featured on that web site. hypothesis 1b: a consumer's attitude towards a web site is positively related to his/her level ofinvolvement with the product category featured on that web site. experience with and knowledge of the internefl consumers' attention and reaction to received information depends on their information processing ability. the ability to comprehend and interpret information is influenced by education, intelligence, product experience, relevant knowledge, and message difficulty (macinnis & jaworski, 1989; petty & cacioppo, 1986). knowledgeable consumers can, however, lack the excitement of a novice when processing a piece of information (motivational factors). nevertheless, experience and knowledge provide the background to recognize strong or weak points in a piece of information. moreover, knowledge can influence a consumer's information processing by prompting or enabling individuals to argue for or against a piece of information (rather than passively accept it). 110 journal of business strategies vol. 18, no.2 in relation to the internet, experienced and knowledgeable users may lack motivation and adopt a "we've seen it before attitude" to web site features. these users have a large comparison base of web sites and are able to spot technical flaws more easily than less knowledgeable/experienced users. such experienced users are attracted to, and spend more time at, technically advanced sites, or sites with novel features that present more challenges to them (hoffman & novak, 1996). they are also more likely to appreciate technical web site design features that are not easily discernible to less knowledgeable/experienced internet users. the above factors will have an impact on the way these users process the information presented in a site and the attitudes they form towards a site. consequently, while experienced users are prone to get bored with under-challenging web sites, novice users are likely to experience anxiety from over-challenging (hoffman & novak, 1996). thus, both experience and knowledge will be related to the individual's attitudes towards the site. however, the direction of that relationship will vary according to the characteristics of the site. additionally, knowledgeable and experienced internet users are more efficient at navigation and web site browsing than those without experience or knowledge. consequently, consumers with internet experience and/or knowledge will spend less time browsing web sites than users without; less experienced! knowledgeable users need more time to read and understand web site instructions and to identify navigational shortcuts (e.g., buttons). from the above discussion the following hypotheses emerge: hypothesis 2a: internet experience is negatively related to the length of time an individual spends at a web site. hypothesis 2b: internet experience is related to an individual's attitudes towards a web site. hypothesis 2c: internet knowledge is negatively related to the length of time an individual spends at a web site. hypothesis 2d: inte met knowledge is related to an individual's attitude towards a web site. internet knowledge, that is the level of understanding of the medium, can be gained via online experience or from other sources (e.g., technical manuals). continuous use of the internet is, however, likely to result in internet knowledge if the user intentional, or unintentional, experiments and observes the results of those experiments. as such, one would expect that use of the internet would increase an individual's knowledge of the internet. that is: hypothesis 2e: internet experience is positively related to internet knowledge. fall 2001 balabanis & reynolds: consumer attitudes iii prior attitudes towards a brand consumers' attitudes towards a web site (or advertisement) are likely to be conditioned by any prior attitudes towards the brand associated with that web site. although there is some debate over which of these attitudes (web site/advertisement or brand) the consumer forms first (brown & stayman, 1992; mackenzie et al, 1986), there is no debate of the presence of a relationship. according to the brand attitude and advertising literature (brown & stayman, 1992; mackenzie et al., 1986), a positive attitude towards an organization's brand predisposes a positive attitude towards the organization's advertisements and other communications. by the same token, it can be assumed that consumers will spend more time on web sites owned by favored organizations than on those of un favored organizations. based on the above the following hypotheses are formulated: hypothesis 3a: an individual's brand attitude is positively related to his/her attitude towards that brand's web site. hypothesis 3b: an individual's brand attitude is positively related to the length of time that he/she will spend at that brand's web site. attitudes towards a web site and visit duration3 the last area to be considered concerns the relationship between attitude toward the web site and visit duration. similar to advertisements, the characteristics of the internet are likely to influence both the amount and pace of a visitor's exposure to information (thorson, chi & leavitt, 1992). literature suggests that both amount of information and speed of processing would be related to an individual's attitude towards a web site (cf. olney, holbrook & batra, 1991). given the same speed of processing, an individual that devotes more time to a web site will process more information and notice more details than an individual that only visits the site briefly. it is also likely that longer visits will allow the visitor the time to reflect on the information more carefully. thus, visiting time increases the possibility of an individual's attention to, processing of, and reflection on a larger amount of information that, in turn, is likely to lead to better comprehension of the information (cf. olney, holbrook & batra, 1991). however, it appears that there is a bi-directional (non-recursive) relationship between visit duration and attitudes towards a web site (cf. thorson, chi & leavitt, 1992). on the one hand, individuals will spend more time at a web site that is to their liking; if they do not like the web site then they will move onto another more pleasing site. conversely, if an individual is se,arching for something specific on a web site and cannot find it, then slhe will have to spend more time on that web site. however, s/he is likely to become increasingly frustrated with it than if the information was easily found. consequently, it is important to determine whether increasing visit duration corresponds with increasingly posi112 journal of business strategies vol. 18, no.2 tive attitudes towards the web site; if it does not, then improvements to the web site may be required. if the relationship between favorable attitudes towards the site and visit duration is positive, then falling duration would indicate that improvements were needed on that web site. thus, the following two hypotheses can be put forward: hypothesis 4a: an individual's attitudes towards a web site are positively related to the length of time he/she spends at that site. hypothesis 4b: the length of time an individual spends at a web site is related to his/her attitudes towards the site. research methodology as part of the research process involved the browsing and evaluation of two web sites this study required subjects that could, and were able to, access the internet. sample selection was restricted as (i) the evaluation process was relatively time-consuming, and (ii) control over the order in which some of the measures were presented was required (e.g., prior attitudes towards the brand needed to be measured before the formation of attitudes towards the brand's web site). in addition, to help ensure a narrow range of information processing ability, subjects with similar levels of education were needed. these restrictions led to the use of an undergraduate student sample. students working in a university's computer labs were approached and asked if they knew how to use an internet browser and whether they would like to participate in the study. care was taken with the sample selection to ensure a gender balance, and participants were screened to check that they had not visited the selected web sites previously. respondents qualified to take part in the study filled-in the initial sections of a questionnaire and then browsed two bookmarked electronic shopping web sites. no time restriction was placed on their visit duration. when they finished browsing, respondents' attitudes towards each web site (a wcb ) were measured. the web sites used for the study belonged to two store-based retailers, "gap" and "principles", with relatively high brand recognition. these retailers were selected because both: (i) sell casual clothes, a product category relevant to the sample selected. (moreover, clothes are a popular product category for traditional home-shoppers, that is, print catalogue shopping, with 41 % of all home-shopping coming from clothingft 3/13/98.); (ii) were new to electronic-shopping with recently established web sites (i.e., www.gap.com/onlinestore/storefront.asp and www.prindples.co.uklpromoinvocation; and, fall 2001 balabanis & reynolds: consumer attitudes 113 (iii) sell products that carry only their own brand names (i.e., "gap" and "principles" respectively). this prevents the emergence of effects originating from attitudes towards other brands stocked by the retailers. in total 102 students participated in the study (56% males; 44% females) with ages ranging from 18 to 32 years. the research instrument, a questionnaire, was pre-tested on five subjects using the debriefing approach (hunt, sparkman & wilcox, 1982). measures involvement. zaichowsky's (1985) personal involvement inventory, a sevenpoint bipolar semantic differential scale, with items such as important/unimportant, irrelevant/relevant, boring/interesting, was used to measure involvement in buying casual clothes. lisrel 8 (joreskog & sorbom, 1993) showed an unacceptable initial fit for the one factor model. a model modification procedure was undertaken (gerbing & anderson, 1988; kaplan, 1990). the final scale consisted of eleven items (appendix 1) and had acceptable levels offit on all indices (joreskog & sorbom, 1993) and coefficient alpha of 0.938, well above nunnally and bernstein (1994) recommended level of 0.70. the scale construct validity statistic was equal to 0.938 (acceptable minimum. 70) and the extracted variance equal to 0.641 (acceptable minimum .50). both statistics were well above the recommended cut-off points (hair, anderson, tatham & black, 1995). prior attitudes towards a brand. aaker's (1996) inventory measured attitudes towards the two brands considered. following his advice, only the seven items that closely matched the objective of the study were used good value for money, trustworthy, innovative, admirable, high quality, consistent quality and interesting. respondents indicated how well each described both the "gap" and "principles" brands using a seven-point scale (not at all to very much so). confirmatory factor analysis using kaplan's (1990) modification procedure resulted in the removal of two items (i.e., trustworthy and consistent quality of the brand). the remaining items had acceptable levels of fit for both "gap" and "principles" (see appendix 2). the values of the respective construct validities (0.846 and 0.871) and extracted variances (0.530 and 0.594) were above their acceptance thresholds. cronbach's alpha on the remaining items was .863 and .853 respectively. attitudes towards a web site. items were drawn from measures of attitudes towards advertisements (hill & mazis, 1986; gardner, mitchell & russo, 1985). for each web site a seven-point bipolar scale with nine items was used very bad/very good, uninterestingl interesting, dislikablellikeable, unfavorable/favorable, poor quality/good quality, disagreeablel agreeable, confusing/clear, uninformative/informative, low/high attention grabbing ability. the scales were applied after the web sites had been browsed, nevertheless, confirmatory factor 114 journal of business strategies vol. 18, no.2 analysis using lisrel 8 required the removal of three items (very bad/very good, dislikable/likeable, uninformativelinformative) to achieve an acceptable level of fit for both the "gap" and "principles" scales (see appendix 3). with the remaining six items cronbach's alpha for the "gap" scale was .838, .851 for the "principles" scale. the reported construct validities (0.858 and 0.853) and extracted variances (0.517 and 0.506) of both scales were at acceptable levels. experience with and knowledge of the internet. experience refers to the length of time an individual has used the internet for, as such, respondents were asked to indicate approximately how long they had used the internet for and, on average, how many hours a week they spent on it. the product of these two indices (converted into weeks) was used as a measure ofinternet experience. in this sample respondents had, on average, been using the internet for 19.516 months (standard deviation 13.448) with an average frequency of 7.196 hours a week (standard deviation: 6.549). following park, mothersbaugh and feick's (1994) suggestion to use objective rather than perceived knowledge measurement, respondents' knowledge of the internet was assessed using five questions on a multiple-choice test (see appendix 4). the average score in that test was 2.951 with a standard deviation 1.423. results before testing the specific hypothesis, overall ratings are required for the a priori attitudes of respondents to the two brands. overall, the "gap" brand is stronger than the "principles" brand with this sample (arithmetic means 23.614 and 19.783, standard deviations 5.254 and 4.889 respectively)4. this difference is significant at a = 0.00 i. in line with brand attitudes, the evaluations of the two web sites also showed significant differences when a = 0.001 (gap mean = 28.928, standard deviation =6.346, principles mean::: 25.990, standard deviation ::: 6.602)5. while these results are not surprising given the age of respondents and the nature of the web sites, the purpose of this study is not to compare the two web sites per se, but to use the differences in respondent's ratings to empirically test the hypothesis in two contexts (i.e. the two web sites). however, while differences existed in the evaluations of the web sites, there was no significant difference in the length of time spent browsing each site (t value ::: .456, p = .650; "gap" mean = 15.218 minutes, standard deviation::: 20.252; principles mean::: 15.807, standard deviation = 19.840). model testing to test the model, the path analysis procedure of the lisrel viii software program (joreskog & sorbom, 1993) was used. due to sample size limitations, the use of single indicators for each variable was preferred to latent variable modelling. the figure 1 model was tested for the "principles" and "gap" web sites, respectively. results showed that the initial fit of the model (applied to fall 2001 balabanis & reynolds: consumer attitudes 115 both sites) was not satisfactory for either site and some modifications were necessary. in particular, the initial chi square for both "principles" and "gap" were significant and more importantly the rmsea indices offit were unacceptably high (principles fit statistics: x2(1) = 4.650, p = 0.0311, rmsea = 0.188; gfi = 0.986; and agfi = 0.704; gap fit statistics: x2(1) = 8.530, p = 0.003, rmsea =0.270; gfi = 0.975 and agfi = 0.472). as a result, a model modification procedure was undertaken based on gerbing and anderson's (1988) and kaplan's (1990) recommendations. during the model modification process, care was taken to ensure that the modifications undertaken were based on modification indices that were simultaneously high for both sites on which the model was applied (i.e., gap and principles) and that the indicated changes were theoretically meaningful (gerbing & anderson, 1988; kaplan, 1990). at the end of the process, two models with satisfactory goodness of fit emerged (see figure 2 and figure 3). the resulting chi-square (x2( 4) = 5.166) for "principles" was insignificant (p-value =0.271) and all the other indices of fit followed suit (see fitted model and other fit statistics in figure 2). the fit of same model in the case of the "gap" web site was also acceptable (see fitted model and fit statistics in figure 3). hypotheses involvement hypotheses la predicts that consumer involvement with a product category will be positively related to the length of time a consumer spends on the web site related to that product category. our analysis (figure 2 and 3) does not support hypotheses 1a for either "gap" or "principles". no difference in the duration of visit was observed between high and low involvement respondents with regard to the "gap" web site. in contrast, with "principles" involved consumers were found to spend less time at the web site than less involved consumers. hypothesis ib predicts a positive relationship between involvement and respondents' attitudes towards a web site. results failed to support hypotheses lb. in the modified models (depicted in figure 2 and figure 3), this path had to be removed as involvement was found to have no effect on respondents' attitudes towards either web site (a b)' we internet experience and knowledge hypothesis 2a postulates that internet experience is negatively related to the length of time an individual spends at a web site. this hypotheses is partially supported; that is, the relationship holds on the "principles" web site, but not on the "gap" web site. as can be seen in figure 2, experience is significantly and negatively related to the time respondents spend at the "principles" web site, however, figure 3 ("gap" model), does not show a significant relationship between internet experience and visit duration. 116 journal of business strategies vol. 18, no.2 figure 2 the relationship between involvement, attitudes towards principles, internet knowledge and experience, visit duration and attitudes towards principle's web site time spent browsing the principle's web site r' = 0.368** 0.681* -0.738** 0.446** -0.274* involvement t 0.472** knowledge of the internet r' = 0.233** experience with the internet attitudes towards the l..-__p_ri_n_ci_p_'e_'s_b_r_a_nd__--' ------------. .-------------, attitudes towards the principle's web site i r'=0.147** '----fit statistics chi-square with 4 degrees of freedom = 5.166 (p = 0.271); root mean square error of approximation (rmsea) =0.0546; goodness of fit index (gfi) =0.984; adjusted goodness of fit index (agfi) =0.914; normed fit index (nfl) =0.930; comparative fit index (cfi) =0.980; incremental fit index (ifi) = 0.983 where: ** significant at (x = 0.01; • significant at (x = 0.05; + significant at (x = 0.1 hypothesis 2e, that internet knowledge is negatively related to visit duration, is not supported with either web site. this relationship was excluded from the modified model; it was insignificant and detrimental to the model's fit (figures 2 and 3). hypothesis 2b assumes that internet experience will affect the way individuals assess different web sites. this hypothesis is supported in the "principles" case but only at a confidence interval of 90% (figure 2); experienced respondents gave lower ratings to the "principles" web site than inexperienced ones. however, the same is not true in the "gap" case (figure 3) where experience was found to be unrelated to attitudes towards the "gap" web site. fall 2001 balabanis & reynolds: consumer attitudes 117 figure 3 the relationship between involvement, attitudes towards gap, internet knowledge and experience, visit duration and attitudes towards gap's web site time spent browsing the principle's web site r 2 =0.368** 0.109 -0.163 0.550** -0.170+ involvement t 0.449** knowledge of the internet r 2 =0.201** experience with the internet attitudes towards the l...-__g_a_p_'s_b_r_an_d__---l r-------------. attitudes towards the principle's web site i r2 = 0.147** '------fit statistics chi-square with 4 degrees of freedom = 9.623 (p = 0.0473); root mean square error of approximation (rmsea) =0.117; goodness of fit index (gfi) =0.972; adjusted goodness of fit index (agfi) =0.852; normed fit index (nfl) = 0.900; comparative fit index (cft) = 0.931; incremental fit index (ifi) =0.939 where: •• significant at a = 0.01; • significant at a = 0.05; + significant at a = 0.1 hypothesis 20 postulates that individuals with knowledge of the internet will evaluate web sites in a different manner to less knowledgeable individuals. results in figure 2 seem to support this view as knowledgeable respondents gave higher ratings to the "principles" web site than less knowledgeable ones. however, the impact of knowledge of the internet on respondents' attitudes towards the "gap" web site (figure 3) was statistically insignificant. hypothesis 2e assumes that internet experience is positively related to internet knowledge. it is supported by the data. 118 journal of business strategies vol. 18, no.2 attitudes towards the brand hypothesis 3a predicts that individuals with positive attitudes towards a brand will also have positive attitudes towards that brand's web site. findings in both cases (figures 2 and 3) support this hypothesis. in contrast, hypotheses 3b (an individual's brand attitude is positively related to the length of time that he/ she will spend at that brand's web site) is not supported. the postulated path had to be removed from both the "gap" and the "principles" models as it was statistically insignificant and adversely affected the models' fit. visit duration hypothesis 4a claims that individuals will spend more time at web sites towards which they have positive attitudes. the results for the "principles" model (figure 2) support this hypothesis, however, no significant relationship is observed on the "gap" web site. hypothesis 4b postulates that the time an individual spends at a site will affect his/her attitudes towards the site. again, hypotheses 4b is true for the "principles" web site where a negative effect is observed (figure 2) but not for the "gap" web site (figure 3). consequently, hypotheses 4b can only be partially supported. discussion the main finding of this study is that prior attitudes of consumers towards a brand transfer into attitudes towards the web site associated with that brand. consumers are biased in their assessment of web sites and brand owners need to consider the likely predispositions of consumers when designing, evaluating and implementing their web strategy. as images or attitudes external to the web site transfer to the consumers' assessment of the web site, traditional retailers and other organizations planning to introduce web sites should exploit their existing brand online. the complementary nature of the relationship between onand off-line branding is encouraging to established brand owners in the face of the recent threats coming from the emergence of intelligent search engines that facilitate the online comparison of price and other product attribute (mitchell, 2000). while the internet has seen some strong e-brands surfacing as technology matures. it is nevertheless "consumer behavior that drives the market and redefines your brand" (thompson, 2000, p. 90). this study confirms the influence of existing brand attitudes on the attitude formation of online shoppers. harvin (2000) suggest consumers are more comfortable with organizations that have strong off-line brands that they already know and trust. as such, this study provides reassurance to multichannel retailers who compete with an ever increasing number of e-brands (dignam, 2000); a strong offline brand will help them compete effectively in the online envir0nment (auton, 2000; karas. 2000; mcwilliam, 2000). moreover, as traditional retailers are perceived as loosing ground to manufacturers on the internet battlefield, strong brand names provide fall 2001 balahanis & reynolds: consumer attitudes 119 an important advantage to the retailers (mcelnea, 2000). a complication, however, exists for web sites that carry multiple brands (e.g., e-malls). the success of these web sites is likely to depend on attracting the right combination of complimentary brands to be able to build a successful internet brand. another important finding of this study concerns visit duration (one aspect of the "stickiness" ~ of a web site), a highly regarded attribute that is used for the ranking of different sites (see rankings at adweek, 4/5/00, p. 45) and as an indicator of web site effectiveness? (hoffman & novak, 1996; raman & leckenby, 1998). unfortunately our results show that the duration of a visit to an electronic shopping site does not ensure positive attitudes towards that site; longer visits can actually result in less (even un-) favorable attitudes towards the web site in question. thus, from a practical point of view, visit duration, if used in isolation as a measure of effectiveness may result in an inaccurate reading of a web site's appeal to visitors. internet retailers must move away from interpreting lengthy visits as an indication of positive attitudes towards the site. moreover, the observed inconsistency on the impact of visit duration on the two sites researched suggests that a web site's features and content moderate the relationship between visit duration and attitude towards the web site. involvement with the product category was also considered in this study. involvement is known to be an important element ofinternet purchasing behavior (bulter & peppard, 1998), however, it is not sufficient, in isolation, to drive a consumer to spend more time at a web site. indeed, our results suggest highly involved consumers may spend less time on a web site than uninvolved consumers. this may be because the involved consumer is already aware of the alternatives available. nevertheless, if involvement is not enough to hold the consumer, then in-site motivation (i.e., features/content) may be required. however, the web site manager should not forget that extending the stay of the consumer is only necessary if it has an impact on the objectives of the web site (e.g., do longer visit durations result in increased revenues from the visitor in question). finch (1999) showed how important the internet can be when building consumer involvement for a product category, however, he did not examine how increased involvement affected consumers' online shopping behavior. the findings of this study suggest that individuals with increased involvement may be more demanding of a web site. web site features and content can either maintain or quickly vaporize the elevated interest of involved visitors (as appeared to happen with the "principles" site). from a practical point of view online retailers should design web sites that sustain the interest of highly involved consumers; a very influential and sought after category of consumers that tend to be opinion leaders in that category of products (mowen & minor, 1998, p. 494). nevertheless, despite the evidence that suggests involved consumers are more demanding of web sites, involvement was not found to have a direct effect on consumers' attitudes towards the web sites in this study. 120 journal of business strategies vol. 18, no.2 the final part of this study that needs to be discussed is the relationship between internet experience and internet knowledge with both attitudes toward the web site and visit duration. the findings from this study do not give clear-cut answers to these relationships; the characteristics of the web site concerned appear to have an impact on the relationships considered. internet experience, in the context of the "principles" web site, did impact upon visit duration. this negative relationship may be explained by inexperienced users being less competent on the internet and loosing time finding their way through a web site, as such, experienced users spend less time on a site that inexperienced ones. however, as experienced users gave lower ratings to the "principles" site than less experienced ones, it would appear that the web site did not hold the interest ofthe more experienced internet users. in contrast, on the "gap" web site, which used more visuals and had a greater number of technically advances features, there was no difference in visit duration between experienced and inexperienced users. the design ofthis web site provided more challenges to experienced users and consequently maintained their interest (hoffman & novak, 1996). nonetheless, this seems contrary to the findings reported by hammond, mcwilliam and narholz (1998) who found that, for experienced users, the hedonic aspects of the web site are less important than the utilitarian ones. however, as this study did not attempt to discern the contribution of the different aspects of attitude formation, advice on how to maintain the interest of knowledgeable users is contradictory. however, as hammond et al. 's (1998) study suggested that users' appreciation of a web site is not linearly related to their experience with the medium and the present study is based on a linear model, this study may not have captured possible non-linearities in the relationship between experience and web site rating. turning to the effect of internet knowledge on visit duration and attitude towards the web site shows no relationship between knowledge and visit duration, however, more knowledgeable respondents are more positive about the "principles" web site than less knowledgeable ones (no relationship on the "gap" web site). knowledgeable respondents are more aware of the technical difficulties and the 'cost' of different web site features in terms of web site functionality (e.g., download time). so, while internet knowledge is unlikely to have a direct impact on visit duration, knowledge may lead to an appreciation of why novel features are not included on a site, and as such, lead to more positive attitudes towards relatively simply web sites. in addition, the operationalization of internet knowledge in this study measured theoretical knowledge, but not the navigational ability of the respondent, and this may have had an impact on the results. nevertheless, the inconsistencies between the effects of internet knowledge and internet experience strongly suggest that they need to be treated differently by marketers. it appears that different web site features are appreciated by knowledgeable users and experienced users. consequently, online retailers aiming to appeal fall 2001 balabanis & reynolds: consumer attitudes 121 to consumers of different levels of internet knowledge or internet experience need to adapt their web sites in the appropriate manner. conclusions and topics for future research this study throws light onto a little researched area, consumers' attitudes towards multi-channel retailers' web sites, and identifies the impact product involvement, brand attitude, internet knowledge/experience and visit duration on consumer attitudes. although the study focused on one type of web site, that is, electronic shopping sites owned by multi-channel retailers, the application of the findings may also be extended to the other types of sites (hoffman and novak, 1996). the impact of brand attitude on attitude towards websites is, for instance, unlikely to be restricted to retailers. attitudes towards informational sites, such as www.yell.com. are also likely to be affected by the users' attitude towards their offline brand. in addition, the impact ofthe differences in behavior based on the users' level of internet experience, and their level of internet knowledge, measures sometimes considered interchangeable, are likely to apply to all types of web sites. nevertheless, the conclusions that can be drawn from this study alone are limited to the specific research questions explored and, as such, several areas for future research remain. these include those given below. (i) different retailers seem to follow different brand transfer strategies (from the physical store brand to the online brand) (morrison, 2000); future research should examine which elements of the physical brand transfer successfully to the associated web site. (ii) future research also needs to consider the extent to which consumer attitudes towards specific brands influences their attitudes towards web sites that are associated with multiple brands. (iii) the observed inconsistency in the relationship between visit duration and attitude towards the web site suggest that factors other than those examined in this study moderate the relationship. future research should examine this effect on a larger number of sites and should try to isolate the site features that generated these deviations. (iv) from the results of this study product involvement is not, in itself, sufficient to encourage consumers to spend time on a web site, however, it may be that features and functions on the web site could be used to involve the consumer more with the product category online. future research could investigate the role of involvement and motivation emanating from the web site on attitude towards the web site as well as visit duration. 122 journal of business strategies vol. 18, no.2 (v) in relation to the previous area for future research, the relationship between product involvement and visit duration needs to be expanded to include more types of sites. it may be that the relationship hinted at in this study was context specific. future research could, for instance, allow respondents a less restricted choice of web sites, or investigate different types of web sites (e.g., information sites). (vi) in this study, an overall measure of attitude towards web sites was used, however, the findings using this measure were unclear. research considering the consumers attitude towards different aspects of the web site (e.g., hedonic/utilitarian value) could provide more insight into the relationships hypothesized in this study. (vii) although only tentatively, this study shows that consumers with different levels ofinternet experience and different levels of internet knowledge react differently to the same web site. future research should isolate the source ofthese differences as they may provide useful segmentation variables for e-stores. notes i experience with the internet refers to the length of time and frequency with which somebody has used the internet. knowledge of the internet refers to an individual's technical understanding of the new medium that can be acquired by other means except experience (studying of manuals, training, etc.). 2 more specific factors, such as, web-interface knowledge and experience may also have an impact on the duration of users' visits to web sites, and their attitudes towards web sites, however, practical limitations restricted this study to measures of broader internet knowledge and experience. 3 the user friendliness of the web site (i.e., logical and consistent screen layout and linkage structure; easily recognizable metaphors; appropriate organization of data, functions, features and tasks; efficient navigation schemes; and high quality appearance characteristics) is also an important factor with regard to web site usage duration and frequency. 4 arithmetic mean and standard deviation of the (5-item, 7-point) aggregate scale in appendix 2 (range = 5-35) j arithmetic mean and standard deviation of the (7-item, 7-point) aggregate scale in appendix 3 (range =6-42) i> stickiness, also considers the visit frequencies of users, and their typical usage patterns. 7 effectiveness might, for example, be measured by how quickly a user is able to find information on a web site (informational sites), or the extent to which the web site enhances the brand (branding sites). fall 2001 balabanis & reynolds: consumer attitudes references 123 aaker, d. a. (1996). measuring brand equity across products and markets. california management review 38 (3),102-120. auton, f. (2000). brands still stay centre stage in the dotcom era. marketing, apr 27,202l berthon, p., pitt, l. & watson, r. (1996). marketing communication and the world wide web. business horizons, september-october, 24-32. brown, s. p. & stayman, d. m. (1992). antecedents and consequences of attitudes towards the ad: a meta-analysis. journal of consumer research, 19 (june), 34-51. butler, p. & peppard, j. (1998), consumer purchasing on the internet: processes and prospects, european management journal. 16 (5), 600-610. celsi, r. & olson, j. c. (1988). the role of involvement in attention and comprehension process. journal of consumer research. 15 (2),210-224. chaiken, s., liberman, a. & eagly a. h. (1989). heuristic and systematic processing within and beyond the persuasion context. in uleman, j. s. & bargh, j. a. (eds.) unintended thought. (212-252). new york: guilford. dholakia, u. m. & rego, l. l. (1998). what makes commercial web pages popular? an empirical investigation of web page effectiveness. european journal of marketing. 32 (7-8), 724-737. dignam. c. (2000). old brands face a battle for survival in the dotcom age. marketing. mar 16, 17. dreze, x. & zufryden, f. (1997). testing web site design and promotional content. journal of advertising research. march/april, 77-91. finch, b. j. (1999). internet discussions as a source for consumer product customer involvement and quality information: an exploratory study. journal of operations management. 17 (5), 535-556. gardner, m. p., mitchell, a. a. & russo, j. e. (1985). low involvement strategies for processing advertisements. journal of advertising. 14 (2), 4-13. gerbing, d. w. & anderson, j. c. (1988). an updated paradigm for scale development incorporating unidimensionality and its assessment. journal of marketing research, 25 (may), 186-192. 124 journal of business strategies vol. 18, no.2 gupta, s. & chatterjee, r. (1997). consumer and corporate adoption of the worldwide web as a commercial medium. in peterson, robert (ed.) electronic marketing and the consumer. thousand oaks, ca: sage. hair, j. f., anderson, r. e., tatham, r. l. & black w. c. (1995). multivariate data analysis (2nd ed.). new jersey: prentice hall. hamill, j. & gregory k. (1997). internet marketing in the internationalisation of uk smes. journal of marketing management. 13, 9-28. hammond, k., mcwilliam, g. & narholz, d. a. (1998). fun and work on the web: difference in attitudes between novices and experienced users. advances in consumer research. 25, 372-378. hammond, k., emmanouilides, c., turner, p. & barwise, p. (1998). consumer adoption of electronic commerce: initial results. proceedings of the 27th emac conference. stockholm. sweden. 6, 575-583. harvin, r. (2000). in internet branding, the off-lines have it. brandweek. jan 24. 41 (4), 30-3 i. hill r. p. & mazis m. b. (1986). measuring emotional responses to advertising. advances in consumer research, 164-169. hofacker, c. f. & murphy, j. (1998). world wide web banner advertisement copy testing. eurodean journal of marketing. 32 (7-8), 703-713. hoffman d., novak t. & chatterjee, p. (1995). commercial scenarios for the web: opportunities and challenges. journal of computer mediated communications, 1 (3), (http//jcmc.mscc.huji.ac.illindex) hoffman, d. l. & novak, t. p. (1996). marketing in hypermedia computer-mediated environments: conceptual foundations. journal of marketing. 60 (3), 50-69. johnson, b., cleland, k., williamson, d. a., carmichael, m., gleason, m., cuneo, a. z., mandese, j., waltner, c., donaton, s., zbar, j. d., haran, l. & fawcett, a. w. (1995). adage's cybermarketing leaders. advertising age. sedt 18.66 (37),15 (5). johnson, b. t. & eagly, a. h. (1989). effects of involvement on persuasion: a metaanalysis. psychological bulletin. 106,290-314. johnson, b. t. & eagly, a. h. (1990). involvement and persuasion: types, traditions, and the evidence. psychological bulletin. 107,375-384. joreskog, k. g. & sorbom, d. (1993). lisrel 8: user's reference guide, scientific software international fall 2001 balabanis & reynolds: consumer attitudes 125 kaplan, d. (1990). evaluating and modifying covariance structure models: a review and recommendations. multivariate behavioral research, 25 (2), 137-155. karas, j. (2000). domain names emerge as key tools for on-line retail marketing. stores, 82 (5), 94. katros, v. (2000). a note on internet technologies and retail industry trends. technology in society. 22 (i), 75-81. keeling, k. a., fowler, d. & mcgoldrick, p. j. (1998). electronic banking customers: determinants of adoption and retention. proceedings of the 27th emac conference. stockholm. sweden, 6, 535·554. keeling, k. a. & mcgoldrick, p. j. (1997). the acceptance of electronic shopping: a question of control? proceedings of the 26th emac conference. warwick, uk. 2, 669-688. laaksonen p. (1994). consumer involvement: concepts and research. london: routledge leong s. m. (1993). consumer decision making for common, repeat-purchase products: a dual replication. journal of consumer psychology. 2 (2), 193-208. liang, t. & huang, j. (1998). an empirical study on consumer acceptance of products in electronic markets: a transaction cost model. decision support systems. 24 (1),2943. macinnis, d. j. & jaworski, b. j. (1989). information processing from advertisements: toward an integrative framework. journal of marketing, 53 (4), 1-24. mackenzie, s. b., lutz, r. j. & belch, g. e. (1986). the role of attitude toward the ad as a mediator of advertising effectiveness: a test of competing explanations. journal of marketin~ research, 23 (2), 130-] 44. maheswaren, d. & meyers-levy, j. (1990). the influence of message framing and involvement. journal of marketinl: research. 27 (august), 361-367. mcelnea, j. k. (2000). who will own the consumer of the 21st century? brandweek. mar ~ (i 1),32-37. mcmurdo, g. (1998). evaluating web information and design. journal of information science, 24 (3), 192-205. mcwilliam, g. (2000). building stronger brand through online communities. sloan management review. 41 (3),43-54. mitchell, a. (2000). web presents acid test for brand robustness. marketing week. mar 2.23 (4), 44. 126 journal of business strategies vol. 18, no.2 morrison, g. (2000). getting the web site to click with the brand within the bricks. brandweek, apr 10,41 (15),50-52. mowen, c. j. & minor, m. (1998). consumer behaviour. new york: prentice hall. nunnally, j. c & bernstein, i. h. (1994). psychometric them:)'. new york: mcgraw hill inc. 0' keefe r. m., o'connor, g. & kung, h. (1998). early adopters of the web as a retail medium: small company winners and losers. european journal of marketing, 32 (78), 629-644. olney, t. j., holbrook, m. b. & batra, r. (1991). consumer responses to advertising: the effects of ad content, emotions, and attitude toward the ad on viewing time, journal of consumer research, 17, 440-453. park, c. w" mothersbaugh, d. l. & feick l. (1994). consumer knowledge assessment. journal of consumer research 21 (l), 71-82, petty, r. e (1994), two routes to persuasion: state of the art. in d'ydewalle, g., eelen, p., & bertelson, p. (eds.) international perspectives on psychological science, 2, (229-247). hillsdale, nj: erlbaum petty, r. e. & cacioppo j. t . (1986), the elaboration likelihood model of persuasion. in berkowitz, l. (ed.) advances in experimental social psychology. 023-205). orlando: academic press. quelch j, & klein l. (1996). the internet and international marketing. sloan management review, spring, 60-75. raman, n. v, & leckenby, j. d. (1998), factors affecting consumers' "webad" visits. european journal of marketing. 32 (7-8), 737-749, settles, c. (1995). cybermarketing: essentials for success. new york: ziff-davis press, thompson, d. (2000), branding hasn't changed much. mc technology marketing intelligence, 20 (4), 90-95. thorson, e., chi, a. & leavitt, c. (1992). attention, memory, attitude, and conation: a test of the advertising hierarchy. advances in consumer research, 19,366-379. vrolijk, h., huizingh, c. j" eelko. k. r. e.; & hoekstra, j. c. (1998). experimental research on the effectiveness of web sites. proceedings of the 27th emac conference, stockholm, sweden. 4, 299-311. fall 2001 balabanis & reynolds: consumer attitudes 127 white, m. d., abels, e. g. & murnane. l. (1998). what constitutes adoption of the web: a methodological problem in assessing adoption of the world wide web for electronic commerce. proceedings of the asis annual meeting. 35, 217-226. zaichkowsky, j. l. (1985). measuring the involvement construct. journal of consumer research. 12 (december), 341-352. appendix 1 involvement with casual clothes items important/unimportant (r) of no concern to me/of concern to me means a lot to mel means nothing to me (r) valuable/worthless (r) tri vial/fundamental beneficial/not beneficial (r) matters to mel does not matter to me (r) uninterested/interested essential/nonessential (r) undesirable/desirable wanted/unwanted (r) (r) :: reversed item reliability/validity statistics construct validity extracted variance cronbach's alpha fit statistics x2(44) p-value root mean square error of approximation (rmsea) goodness of fit index (gfi) adjusted goodness of fit index (agfl) normed fit index (nfl) comparative fit index (cfi) incremental fit index (lfi) standardized factor loadings 0.) 0.801 0.731 0.863 0.733 0.719 0.622 0.874 0.696 0.789 0.800 0.733 0.938 0.641 0.938 53.411 0.156 0.051 0.898 0.848 0.914 0.983 0.984 128 journal of business strategies appendix 2 attitudes towards retailer's brand vol. 18, no.2 principles gap standardized factor standardized factor items loadings (a) loadings (a) good value for money 0.620 0.619 innovative 0.720 0.890 admirable 0.866 0.844 high quality 0.607 0.522 interesting 0.791 0.872 reliability/validity statistics construct validity 0.846 0.871 extracted variance 0.530 0.594 cronbach's alpha 0.853 0.863 fit statistics x1(5) 7.409 2.676 p.value 0.192 0.750 root mean square error of approximation (rmsea) 0.074 0.001 goodness of fit index (ofi) 0.971 0.988 adjusted goodness of fit index (agfd 0.912 0.954 normed fit index (nfl) 0.958 0.967 comparative fit index (cfi) 0.986 0.997 incremental fit index (ifi) 0.986 0.998 fall 2001 balabanis & reynolds: consumer attitudes appendix 3 attitudes towards retailer's web site principles 129 gap items un interesti ng/] nteresting unfavorable/favorable poor quality/good quality disagreeab]elagreeable confusing/clear low/high attention grabbing ability reliability/validity statistics construct validity extracted variance cronbach's alpha fit statistics x2(9) p-value root mean square error of approximation (rmsea) goodness of fit index cgfl) adjusted goodness of fit index (agfi) normed fit index (nfl) comparative fit index (cfi) incremental fit index (lfl) standardized factor loadings 0.) 0.730 0.822 0.586 0.570 0.747 0.781 0.858 0.517 0.851 12.764 0.174 0.069 0.956 0.897 0.94] 0.981 0.982 standardized factor loadings (i..) 0.694 0.880 0.726 0.682 0560 0.644 0.853 0.496 0.838 13.840 0.128 0.071 0.956 0.898 0.934 0.975 0.976 130 i) yahoo is: [ j c [.j ii) a url is: journal of business strategies appendix 4 multiple-choice test used to assess respondent's knowledge of the internet kid's web page. web searching engine. an internet communication service a tele-shopping organization in the network. a web browser. vol. 18, no.2 [j a programming language in the internet. o another word for internet site address. u a web searching engine. n a web browser. u a body regulating internet traffic. iii) a cookie is: [] another word for net-surfing. [] is a small piece of information that a web server sends to your browser to collect information about you. el a computer virus. [j a net-nerd or a net-junkie. n a web security protocol. iv) hypertext is: [j the connection that brings various bits together to make the web pages. u a spell checker. l: a word-processor. foj a programming language to design web pages. :j a special font. v) java is: [j a web browser. [j a computer language. [j an internet service provider. o a chat services in the internet. o a computer virus. fall 2001 balabanis & reynolds: consumer attitudes 131 george balabanis is a senior lecturer in marketing at city university business school. george obtained a b.a. (hons) in business administration from the university of pireaus and a ph.d. in international marketing from the university of strathclyde. his current projects include country of origin effects on consumer evaluations, internet marketing and relationship marketing. his research has appeared in the journal of international business studies, european journal of marketing, journal of global marketing, and journal of marketing management. nina reynolds is a lecturer in marketing at the european business management school. she obtained a b.sc. (hans) in american management studies from the university of wales and then completed a ph.d. in international marketing research. her current projects are in the areas of international marketing research methodology, the sales negotiation process, and internet marketing. her work has appeared in the journal of the market research society, european journal of marketing, journal of marketing, and benchmarking: an international journal. 132 journal of business strategies vol. 18, no.2 consumer attitudes towards multi-channel retailers' web sites: the role of involvement, brand attitude, internet knowledge and visit duration intangible strategic assets and firm performance: a multi-industry study of the resource-based view michael d. michalisin southern illinois university at carbondale carbondale, il douglas m. kline sam houston state university huntsville, tx robert d. smith kent state university kent,oh abstract according to the resource-based view (rbv), firms achieve a sustainable competitive advantage and earn superior profits by owning or controlling strategic assets. the rbv literature, hall's empirical findings (1992, 1993), and other corroborating literature indicate that certain intangible resources, such as reputation, knowhow, and organizational culture, possess the characteristics of strategic assets. this study empirically tests the relationship between these intangible strategic assets and relative return on shareholders' equity using 100 randomly selected fortune 500 and service 500 firms. the results are statistically significant and strongly support rbv. introduction the resource-based view of the firm (rbv) has become an important stream of literature in strategic management. yet, while the conceptual development of rbv is impressive, empirical testing of it is still in its infancy. some rbv studies focus on the linkage between finn resources and diversification (chatterjee and wernerfelt, 1991; farjoun, 1994; markides & williamson, 1994,1996; robins & wiersema, 1995). other studies focus on the linkage between certain resources and perfonnance but are industry specific, such as the pharmaceutical industry (henderson & cockburn, 1994), the dutch audit industry (maijoor & van witteloostuijn, 1996), the hollywood film industry (miller & shamsie, 1996) and the canadian oil and gas industry (sharma & vredenburg, 1998). unfortunately, single-industry studies suffer from a lack of generalizabi1ity. rbv's main prescription is that owning or controlling strategic assets leads to a sustainable competitive advantage and superior finn perfonnance. recently, rbv scholars have begun recognizing that only intangible resources appear capable 92 journal of business strategies vol. 17, no.2 of simultaneously possessing all of the characteristics of strategic assets (barney, 1991; bates & flynn, 1995; godfrey & hill, 1995; mcgrath, macmillan, & venkatraman, 1995). further, micha1isin, smith and kline (1997) note that many intangible resources are not strategic assets and that the ones most capable of being strategic assets are reputation, knowhow and organizational culture. this study empirically tests the relationship between these three intangible strategic assets and relative return on shareholders' equity using 100 randomly-selected fortune 500 and service 500 firms. the results strongly support rbv the paper is divided into five sections. the first section (a) discusses rbv; (b) describes why strategic assets are intangible in nature, why not all intangible resources are strategic assets, and why reputation, employee knowhow, and organizational culture appear capable of possessing the characteristics of strategic assets; and (c) presents the hypotheses. the second section describes the methodology used in the study. the third section presents and interprets the statistical results. the fourth section draws overall conclusions about the results, discusses the contributions, implications and limitations ofthe study, and presents possible avenues for future research. the fifth section, the appendix, describes the content analysis methodology. resource-based view of the firm according to rbv, firm resources are the main determinant of competitive advantage and firm performance (amit & schoemaker, 1993; mahoney & pandian, 1992; peteraf, 1993; wernerfelt, 1984). barney (1991) defines resources as "all assets, capabilities, organizational processes, firm attributes, information, knowledge, etc. controlled by a firm that enable a firm to conceive of and implement strategies that improve its efficiency and effectiveness" (p. 101). as such, rbv recommends that managers mainly concern themselves with selecting, acquiring, and managing resources superior to their competitors (rumelt, 1984). strategic assets and intangibles not all resources are sources of competitive advantage. some resources are necessary to conduct business but are not sources of superior profits (e.g., desks for the employees). resources that are sources of sustainable competitive advantage and superior profits are called strategic assets. strategic assets are resources that are simultaneously valuable, rare, imperfectly imitable, and nonsubstitutable (barney, 1991). recently, rbv scholars have begun to recognize that strategic assets are generally not tangible in nature (barney, 1991; bates & flynn, 1995; godfrey & hill, 1995; mcgrath, macmillan, & venkatraman, 1995). tangible resources are resources with physical properties, such as property, plant, equipment, and other physical technologies. they are often not rare because they can often be purchased in the open market. as a result, tangible-resource-based advantages are susceptible to imitation. fall 2000 michalisin, et al.: intangible strategic assets 93 conventional thinking suggests that internally-developed technologies may be important to firm success. yet, in today's rapidly changing competitive environment, physical technologies can quickly become obsolete or re-engineered by competitors. the inability of such resources to provide a sustainable competitive advantage is inconsistent with the definition of strategic assets. of course, internally-developed physical technologies can be afforded legal protection against imitation via intellectual property rights. intellectual property rights, such as patents, trademarks, and copyrights, are intangible resources representing and protecting an inventive idea, name of an idea, or embodiment of an idea (hall, 1992, 1993). yet, it is the idea and knowledge behind the idea, represented and protected by the intangible resource, that constitutes the strategic asset, not the physical form. moreover, the resource-based advantage is only sustainable due the legal protection afforded by the intangible resource. this points to an important difference between tangible and intangible resources their imitabijity, or lack thereof. imitability is in large part a function of observability (godfrey & hill, 1995). specifically, the extent to which resourcebased advantages are imitable is a function of the observability of the resources underlying them. thus, the more unobservable the resources driving competitive advantage, the more insurmountable the barriers to imitation, and the more sustainable the advantage. unlike tangible resources with physical properties, intangible resources are state unobservable and difficult to imitate. yet, not all intangible resources are strategic assets. supplier knowhow and distributor knowhow are not strategic assets because the knowledge is not proprietary to the firm and thus not rare. contracts and licenses can lose their value if contexts change. for instance, a contract to purchase a specific quantity of computer chips, over an extended period of time, at a specific price, could become a liability to the firm if another supplier later develops a superior chip at a lower price. in short, it appears that only certain types of intangible resources are capable of being strategic assets. han performed two studies (1992 & 1993) to detennine the relative importance of intangible resources on business success. in the first study, hall (1992) surveyed chief executive officers in the united kingdom to determine the relative importance of intangible resources on firm success. his findings indicate that only four intangible resources are more important than tangible resources in terms of business success: reputation, employee knowhow, organizational culture and networks. if tangible resources do not possess the characteristics of strategic assets and thus are not sources of sustainable competitive advantage, then any intangible resource deemed less important than tangible resources, by rbv definition, cannot be a strategic asset. of these four intangibles, reputation, employee knowhow and organizational culture were ranked as the three most important resources to the firms' competitive advantage. in the second study, hall (1993) performed six case studies of british firms to detennine which intangible resources were most important to their success. the results of the case studies were strikingly similar 94 journal of business strategies vol. 17, no.2 to hall's (1992) survey results. reputation, employee knowhow, and organizational culture were again deemed the most important firm resources. in sum, hall's findings (1992 & 1993) indicate that reputation, employee knowhow and organizational culture contribute most to firm success. by rbv definition, resources contributing most to firm success are strategic assets. these three intangibles are also cited in rbv's conceptual literature as resources most capable of being strategic assets (e.g., barney, 1986, 1991; collis & montgomery, 1995; garud & nayyar, 1994; henderson & cockburn, 1994; lado & wilson, 1994; michalisin, smith & kline, 1997, miller & shampsie, 1996; oliver, 1997). unfortunately, hall (1) does not test the relationship between these intangible resources and firm performance, (2) does not mention the resource-based view or the concept "strategic assets", and (3) does not demonstrate that reputation, employee knowhow and organizational culture are capable of simultaneously being valuable, rare, imperfectly imitable, and nonsubstitutable. in the next section, we draw on rbv's conceptual literature and the logic embodied in other literature streams to demonstrate that reputation, employee knowhow and organizational culture possess the characteristics of strategic assets. reputation reputation is the perception of customers, competitors, potential recruits, and other stakeholders about a firm's quality of management; quality of products and services; innovativeness; long-term investment value; financial soundness; ability to attract, develop, and keep talented people; community and environmental responsibility; and use of corporate assets (davenport, 1989; stewart, 1998). a favorable reputation is valuable because it helps the firm win customers, charge premium prices, attract superior human resources, improve access to capital markets and thwart competitors (fombrun & shanley, 1990; fombrun, 1996; porter, 1980, 1985; rao, 1994; turban & greening, 1996; weigelt & camerer, 1988). it can also increase the success rate of new product and service offerings and make the firm an attractive partner for cooperative arrangements (dollinger, golden & saxton, 1997). a valuable reputation is also typically rare and imperfectly imitable. first, reputation develops through a process of legitimation (rao, 1994). legitimation is the outcome of certification contests (e.g., moody's rating of insurance companies and j.d. powers rating of automobile performance) which act as yardsticks of social standing among organizations. and second, reputation is rare and imperfectly imitable because it (1) takes long periods oftime to develop, (2) "depends upon specific, difficult-to-duplicate historical settings" (barney, 1991, p. 115), and (3) evolves through unique, socially complex relationships between the firm and its multiple stakeholders. reputation also appears to lack strategically equivalent substitutes. one might argue that contracts and guarantees to stakeholders are substitutes for reputation. however, socially-complex relationships with large numbers of stakeholders make fall 2000 michalisin, et al.: intangible strategic assets 95 contracts and guarantees imperfect substitutes at best. in summary, (l) the value of a firm's reputation is a function of its favorableness, and (2) by nature, reputation is rare, imperfectly imitable and nonsubstitutable. hypothesis 1: a favorable reputation will be positively associated with future peiformance. knowhow knowhow is the knowledge, insight, experience, skill, and judgement of the firm's managers and non-managers. it resides in individuals (knowing corporate tax laws), groups (quality circle analysis of performance), organizations (organizational charts, systems and processes), and across organizations (shared understanding of processes and practices in just-in-time arrangements) and can be articulable (training subordinates in corporate taxation) or tacit (team coordination in complex work) (dyer & singh, 1998; hedlund, 1994; inkpen & dinur, 1998). knowhow is valuable because it is the main driver of firm capabilities. it determines how resources are deployed to perform activities that result in new products and services (amit & schoemaker, 1993; itami & roehl, 1987). it also drives the selection, creation, and management of other firm resources such as new physical technologies (rumelt, 1984; wernerfelt, 1984) and affects the ability to reconfigure resources in strategically valuable ways (galunic & rodan, 1998). knowhow is also often rare and imperfectly imitable because: (1) it accumulates over time and is function of rare experiences, choices, personalities, and contexts (coff, 1997; tyre & hippel, 1998), (2) the absorption and assimilation of knowledge is constrained by existing knowhow (levinthal & myatt, 1994), and (3) shared knowledge is socially complex and not entirely understood by employees and competitors (barney, 1991; henderson & cockburn, 1994; peteraf, 1993). knowhow that is valuable, rare, and imperfectly imitable has been referred to as distinctive competence in the management literature (e.g., lei, hitt & bettis, 1996; mcgrath, macmillan & venkatraman, 1995; prahalad & hamel, 1990). distinctive competencies are generally nonsubstitutable. expert systems, programs that run production equipment and other processes, attempt to replicate human decision making; however, they are merely embodiments of past articulated knowledge. in today's turbulent environment, competency-based advantages are only sustainable through learning and the advancement of knowledge (d' aveni, 1994; davidow & malone, 1992; von krogh, roos & slocum, 1994; prahalad & hamel, 1990). otherwise, superior skills and technologies will evolve and substitute for existing ones. as such, firms are constantly challenged to upgrade and leverage their distinctive competencies in new ways to better meet the demands of a changing competitive landscape (henderson & mitchell, 1997; lei, hitt & bettis, 1996). 96 journal of business strategies vol. 17, no.2 hypothesis 2: distinctive competencies will be positively associated with future firm performance. organizational culture organizational culture is a set ofvalues, beliefs, assumptions, and ideologies defining the way a firm does business (deal & kennedy, 1982; denison, 1984, 1990, 1996; peters & waterman, 1982). organizational culture can be a valuable resource when it possesses attributes important to sustainable competitive advantage (barney, 1986; fortune, 1998). hall (1992, 1993) identifies six cultural attributes frequently cited in the management literature as being important to strategic competitiveness: perceptions ofquality, perceptions ofcustomer service, ability to manage change, ability to innovate, team-working ability and participative management style. if these attributes are important to strategic competitiveness, then firm performance should be enhanced to the extent they are embodied in the firm's culture. organizational culture is also typically rare and difficult to imitate because (l) it is shaped by the unique personalities of the firm's members and the finn's unique history (e.g., founding father influences, rare experiences), (2) values, beliefs, and assumptions underlying organizational culture are difficult to describe, yet alone understand, and (3) even if understood, its effect on firm performance is often causally ambiguous (barney, 1986; reed & defillippi, 1990; oliver, 1997). organizational culture also appears to lack strategically equivalent substitutes. hypothesis 3: organizational culture rich in attributes important to strategic competitiveness, such as perceptions of quality, perceptions of customer service. ability to manage change, ability to innovate, team-working ability, and participative management style, will be positively associated withfuturefirm performance. methods as discussed earlier, strategic assets are state unobservable. the problem is that unobservable resources resist empirical testing. godfrey and hill (1995) note that the solution to this empirical problem is to examine observable traces left by the unobservables and then correlate the traces with firm perfonnance. in this study, we identify and analyze trace evidence of reputation, employee knowhow and organizational culture so that we can make inferences about the presence of these intangibles in our sample firms, and then correlate the traces with relative return on shareholders' equity to determine whether these intangibles are sources of superior profits. identifying and measuring trace evidence of intangible resources is challenging. godfrey and hill (1995) suggest using qualitative methods to gather trace evidence of unobservable resources for purposes of testing rbv. in this study, we use a fa112000 michalisin, et al.: intangible strategic assets 97 qualitative research method, called content analysis, to analyze the textual data in annual reports to determine whether or not important cultural attributes existence in our sample firms. additionally, it is worth noting that while intangibles are invisible to the naked eye, they can be perceived, discerned and sensed (itami, 1987). for example, reputation is the perception of stakeholders about a firm's quality of management, quality of products and services, innovativeness, and so on (rao, 1994). yet, despite their inability to see the intangible resource, industry analysts have translated their perceptions about the reputations of hundreds of firms into numerical ratings and rankings for fortune magazine each year since 1983 (stewart, 1998). in this section, we detail the methodology used in this study, including sampling procedures and operationalization of the dependent, independent and control variables. sample in this study, fortune's january 30, 1989 list of "america's most admired corporations" (davenport, 1989) constitutes the population frame; mainly because fortune's survey data is used in this study to measure the variable "reputation." it comprises 305 firms spanning 32 industries. these american firms are the ten largest in each industry based on the fortune 500 and the service 500 directories. we randomly selected 100 firms from the population frame, except for firms in the life insurance industry. the financial structure of life insurance companies is not conducive to measuring relative return on equity, the dependent variable used in this study. dependent variable relative return on shareholders' equity (rroe). performance lies at the core of strategic management (venkatraman & ramanujan, 1986; robinson & mcdougall, 1998), yet scholars disagree over the appropriateness of various performance measures (chakravarthy, 1986). the choice of performance measures should be a function of one's research. rbv describes how resources can be sources of sustainable competitive advantage and above average industry profits (amit & schoemaker, 1993; mahoney & pandian, 1992; peteraf, 1993). thus, in this study, performance is measured in terms of firm profitability relative to industry competitors. firm profitability, or financial performance, is the most dominant measure of firm performance in strategy research (venkatraman & ramanujan, 1986). woo and willard (1983) factor analyzed fourteen quantitative financial and operational measures of performance and found that the profitability factor had the highest factor magnitude and that roi (return on investment) loaded highly on that factor. roi has a number of variants. this study measures firm performance using return on stockholders' equity (roe), a popular variant of roi (chakravarthy, 1986; hopkins & hopkins, 1997; robinson & mcdougall, 1998). rbv tells us that strategic assets are sources of sustainable competitive advantage and superior profits (mahoney & pandian, 1992). how many years 98 journal of business strategies vol. 17, no.2 can a strategic asset provide superior profits? unfortunately, the rbv literature does not answer that question. we take the position that operating, tactical and strategic time horizons are approximately one year, three years and five or more years, respectively. the notion that an asset is "strategic" indicates that it should provide superior profits for at least as long as the shortest strategic time horizon five years. as such, to test rbv's prescription that strategic assets are sustainable sources of superior profits, we measured the observable traces of reputation, employee knowhow, and organizational culture in one year (1988) and then measured finn performance over the subsequent five-year period (1989-93) using relative return on shareholders' equity (rroe). rroe (1989-93) represents the difference between the sample firm's five-year average roe (1989-93) and the median five-year average roe for the industry (1989-93). thus, rroe (19891993) indicates whether the firm earned above-industry-median returns (superior returns), at-industry-median returns (median-level returns), or below-industrymedian returns (poor returns). according to rbv, high levels of strategic assets in 1988 should be associated with high levels of returns (superior returns) in 19891993. the data comes from the fortune 500, the service 500 and compustat. independent variables reputation. reputation was defined as stakeholder perception about a firm's quality of management; quality of products and services; innovativeness; longterm investment value; financial soundness; ability to attract, develop, and keep talented people; community and environmental responsibility; and use of corporate assets. each year, since 1983, fortune has published the results of an annual survey on corporate reputation, entitled "america's most admired corporations" (stewart, 1998). fortune surveys thousands of senior executives, outside directors, and financial analysts to determine how american companies rate in terms of the attributes of reputation noted above. firms are rated in each reputation attribute using a 0 (poor) to 10 (excellent) scale. firms in multiple industries are assigned to the industry contributing most to overall sales. for each firm, the category scores are averaged to compute an overall reputation score. in this study, the overall reputation score from the 1988 fortune survey (appearing in the january 30, 1989 issue of fortune) is used to measure the favorableness of each firm's reputation (davenport, 1989). knowhow. measuring the individual, group, organizational, and interorganizational tacit and articulable knowledge underlying a firm's distinctive competencies is difficult, if not impossible. yet, as discussed, an organization's products and services are manifestations of its distinctive competencies. furthermore, the ability to create new products and services to meet changing customer needs tells of the organization's ability to learn and convert new knowledge into customer value, which is essential in sustaining a competitive advantage (d' aveni, 1994; davidow & malone, 1992; von krogh, roos & slocum, 1994; prahalad & hamel, 1990). fall 2000 michalisin. et at.: intangible strategic assets 99 trademarks are legally-protected devices, names, signatures and other visual marks that are attached to products and services (hall, 1992). in this study, we counted the number of applications for trademark protection for each sample firm and its competitors in fortune's january 30, 1989 list of "america's most admired corporations" for the ten-year period ending december 31, 1988. we then computed the difference between the sample firm's total trademarks and the median number of trademarks for fortune's industry group. fortune's reputation survey does not include all firms in an industry, however, it does include firms that are similar in product and service offerings and in size. firms sharing similar organizational and strategic attributes are often considered direct competitors comprising a strategic group (porter 1980). as such, using a relative measure of trademarks controls for differences in the number of trademarks across industries and indicates whether a firm has more or less trademarks than the median number for the strategic group. trademarks represent many different types of new products and services developed over a long period of time, which is important given the diversity of the firms comprising our sample. the data comes from lexis-nexis and includes all u.s. federal trademarks and all state trademarks. organizational culture. organizations leave distinct traces of their values, beliefs and ideologies in documents, such as annual reports, and these traces can be observed and measured (kabanoff, waldersee & cohen, 1995). analysis of the values, beliefs and ideologies contained in annual reports can provide valuable information about an organization's culture (howard, 1991). content analysis is a research technique used to analyze textual information. it is the objective, systematic and quantitative description of attributes of communication occurring earlier in time (holsti, 1968) and is a proven research technique for studying individual communication at a distance, as opposed to face-to-face interview, questionnaire, or observation (morris, 1994; rogers & grant, 1997). in this study, we content analyzed each sample firm's 1988 annual report for emphasis on perceptions of quality, perceptions of customer service, ability to manage change, ability to innovate, team-working ability, and participative management style. the textual information in annual reports (art), which includes the letter to the shareholders, company report and management discussion and analysis, is also useful for this type of empirical study because (l) it provides a comparable data set across a broad sample of corporations, and (2) it represents evidence of past articulations of firm leaders, useful in measuring past organizational values, beliefs, ideologies and strategic postures (bettman & weitz, 1983). for these reasons and because senior management, particularly the ceo, is the main crafter of organizational culture and the only one who can give a complete account as to its attributes, (peters & waterman, 1982; deal & kennedy, 1982; kotter & heskett, 1992), artis a rich data source for studying senior management's intended culture. arts are sometimes written with the assistance of outside consultants, however, ceos are ultimately responsible for what is said in them and thus have final say as to their contents (bowman, 1984; d'aveni & macmillan, 1990). given that 100 journal of business strategies vol. 17, no.2 control, ceos, particularly those of poorly performing firms, have used arts to manage the perceptions of stakeholders. empirical and anecdotal evidence indicates that ceos of unsuccessful firms tend more than ceos of successful firms to hide organizational outcomes and give the appearance of stronger performance and organizational strengths in arts than truly exist (e.g., abrahamson & park, 1994; frazier, ingram & tennyson, 1984; givoli & palmon, 1982; ingram & frazier, 1980; meyer, 1979; stauffer, 1997). for example, ingram and frazier (1980) found that firms with poor social performance disclosed more information about their environmental activities in arts than did firms with better social performance, creating an exaggerated image of social responsiveness. such exaggerations are often meant to strategically manipulate causal attributions to give the impression that the ceo has control over the organization and that they are taking steps to be more competitive (chandler, 1987; salancik & meindl, 1984). consistent with that logic, ingram and frazier's (1983) study of metal companies shows a negative relationship between return on investment and art discussion about changes in operations to strengthen the company. two concerns of the ceo drive this behavior. one is that the board of directors will make changes to their compensation package or dismissed them (abrahamson & park, 1994). the second coneern is that market participants will lose confidence in their managerial abilities and sell their shares, causing the firm's stock price to fall (fama, 1980; fama & jensen, 1983). falling stock prices could then make the firm a potential takeover target whereupon the firm's existing managers would be replaced. for these reasons, ceos of poorly performing firms tend to use less of their art discussing results (failures) and more of it exaggerating organizational strengths and/or telling stakeholders about the steps they are taking to be more competitive, such as re-crafting organizational culture to be stronger in attributes important in gaining a competitive advantage. in either case, the more an important organizational attribute is discussed in the art, the less it probably exists, and the poorer the firm's performance. this pattern in art data is useful for assessing the extent to which cultural attributes exist or do not exist in an organization. specifically, based on this art pattern, a statistically-significant negative relationship between an art emphasis on the six cultural attributes and firm performance will provide support for hypothesis 3. the letter to the shareholders, company report, and management discussion and analysis sections of each firm's 1988 annual report were content analyzed for emphasis on the attributes of organizational culture noted above. we computed the total number of times key words and key word combinations relating to the six attributes appeared in the art and then divided that total by the number of bytes in the file (on diskette) containing the textual data. dividing by the number of bytes controls for differences in the size of annual reports. the content analysis was performed via computer, which has important advantages over manual analysis. manual searches are expensive, time consuming, and subject to error due to fatigue, boredom, and frustration (wolfe, gephart & fall 2000 michalisin, et at.: intangible strategic assets 101 johnson, 1993). these problems are accentuated when samples become large (this study involves use of 42,826 sentences). thus, an important advantage of computerized content analysis is that the researcher can focus more on interpretation and explanation. also, computer-driven content analysis can produce perfectly reliable results, is fast, requires rigor and discipline in formulating the research, and is amenable to reanalysis (holsti, 1968; krippendorff, 1980; weber, 1990; wolfe, gephart, & johnson, 1993). yet, as noted by wolfe, gephart, and johnson (1993), "very little concerning this burgeoning approach to research has appeared in the management literature, however, despite its potential to contribute much to management research" (p. 637). one potential disadvantage of computerized content analysis is that it may be unable to interpret the multiple meanings of words (weber, 1990). ambiguity of word meanings might then lead to validity problems. the computerized content analysis methodology used in this study considers context, thus improving validity. the computerized content methodology is described in the appendix. control variables we controlled for the effects of the following variables: relative prior years' performance, debt structure, organizational type and size. given our sample size and the number of variables in the statistical models, we limited the control variables to those most frequently used in performance-type studies in the strategy literature. inclusion of other extraneous control variables would weaken the power of our statistical tests. relative prior years' performance, debt structure and size are frequently cited in the strategy literature as influencing firm performance (e.g., jensen, 1991; hoskisson, johnson & moesel, 1994; robins & weisema, 1995). in addition, because our sample includes both manufacturing and service type firms, we controlled for organizational type to determine the extent to which it explains variability in the dependent variable. firm type is measured via dummy variable, where manufacturing firms are coded as zero and service firms are coded as one. relative prior years' performance is measured using relative return on shareholders' equity (rroe) for the five-year period ending 1988. rroe 1984-1988 represents the difference between the sample firm's roe and the median roe for the industry for the period 1984-1988. using a relative performance measure is an efficient way to adjust firm performance for the effects of industry performance. moreover, because rroe 1984-1988 (control variable) and rroe 1989-1993 (dependent variable) use the same performance measure (roe) and adjust for industry performance the same way, we gained some precision in controlling for the effect of relative prior years' performance on relative future years' performance. debt structure is the extent to which a firm's assets are funded with debt. finns with high levels of debt use significant amounts of cash flow to service debt obligations, thereby reducing free cash flow (jansen, 1986). the reduction in free cash flow disciplines managers to invest wisely and to closely monitor firm 102 journal of business strategies vol. 17, no.2 activities. this can improve firm performance unless the firm becomes overleveraged and unable to meet its debt obligations (hitt & smart, 1994). in this study, debt structure is measured as total debt to total assets as of 1988. firm size can impact performance through economies of scale, monopoly power and bargaining power (chandler, 1990; porter, 1980). in this study, firm size is measured as both total assets and total employees as of 1988 to capture size effects across both organizational types. the data used to measure these control variables comes from the fortune 500, the service 500 and compustat. results the statistical model used in this study is multiple regression (least squares method). the statistical and graphical analysis does not indicate any violation of the regression assumptions. the descriptive statistics and correlations are shown in table i and indicate that the correlations between reputation, knowhow, and organizational culture and rroe for the period 1989 to 1993 are statistically significant at p < 0.01, p < 0.05, and p < 0.05, respectively. also, based on the data sources, the signs of the correlations between the independent variables and rroe 1989-93 support all the hypotheses. the variance inflation factors (vif), shown in table 2, do not indicate any multicollinearity among the control and independent variables. regression models the regression models are shown below in standardized form. modell regresses rroe 1989-1993 against only the control variables, while model 2 includes both control and independent variables. model i: model 2: rroe 1989-93 = 60 + 6(rroe 1984-88) + 62(assets) + b](employees) + 64(debt:assets) + bs(manufacturing/service) rroe 1989-93 =60 +b1(rroe 1984-88) + 62(assets) + 63(employees) + b4(debt:assets) + bs(manufacturing/service) + b6(reputation) + 67(knowhow) + 6g(culture) the results of the regression analysis are shown in table 2. in model i, the control variables collectively explain 10 percent of variation in relative future firm performance, as indicated by r2, however the relationship is not highly significant (p < 0.10). rroe 1984-88 (p < 0.05) and total employees (p < 0.05) have statistically-significant relationships with rroe (1989-1993). in model 2, the control variables and independent variables collectively explain 24 percent of the variation in relative future performance, as indicated by r2, which is statistically significant at p < 0.001. also, the incremental change in r2 of 14 percent (as a result of adding the independent variables) is statistically 104 journal of business strategies vol. 17, no.2 table 2 results of multiple regression analysis modell model 2 beta" t beta" t vif control variables: rroe 1984-88 0.21 2.09* 0.07 0.62 1.32 assets 0.07 0.52 0.02 0.19 1.92 employees -0.24 -2.11 * -0.30 -2.62** 1.58 debtassets -0.06 -0.54 0.01 0.08 1.68 mfg i svc -0.03 -0.30 -0.06 -0.52 1.45 independent variables: reputation 0.25 2.21 * 1.52 knowhow 0.27 2.77** 1.10 culture -0.20 -2.02* 1.15 multiple r 0.32 0.49 r square 0.10 0.24 adjusted r square 0.05 0.17 fvalue 2.13t 3.49*** incremental r square 0.14 incremental f value 3.92*** standardized regression coefficients p < 0.10 * p < 0.05 ** p < 0.01 *** p < 0.001 vif = variance inflation factor significant at p < 0.001. reputation (p < 0.05) and knowhow (p < 0.01) have positive, statistically-significant relationships with future performance, supporting hypotheses 1 and 2. the statistically-significant, negative relationship between the emphasis on key attributes of organizational culture (p < 0.05) and firm performance is consistent with prior empirical and anecdotal evidence which indicates that the more a key organizational attribute is discussed in annual reports, the less it probably exists, and fall 2000 michalisin, et at.: intangible strategic assets 105 the poorer the finn's perfonnance. sentences used in the key word in context (kwic) analysis (see appendix) were reviewed to gain insight into this phenomenon. interestingly, many of the sentences referred to an attribute as something the finn was striving to possess. to illustrate, a sample of sentences used in the kwic analysis is shown in table 3, along with their associated cultural attribute. table 3 a sample of sentences used in the kwic analysis sentence in reaching this goal, we will be fulfilling scott's vision of creating substantial wealth and value for our customers, employees, shareholders and other key stakeholders. while he actively pursues instilling innovation and teamwork in every function of the organization, his emphasis is on making lederle's approach to marketing unique. as the production and delivery problems continued into 1989, mdc restructured this segment under a management team dedicated to bringing about fundamental change and improvement in the production process. located in st. louis, the motor technology center will be one of the worlds largest and most advanced electric motor and electronic control engineering and development centers. james river's strategy is to prevail with superior product performance emphasizing the unique physical and aesthetic properties increasingly required in packaging and selling these consumer products. meanwhile, through such vehicles as a systemwide video report and several employee publications, we are attempting to open new lines of communication with our employees. to be the leader, i am convinced we have to be the best: the best is providing outstanding value to customers, value that will generate a high level of customer satisfaction. to strengthen customer support, we are organizing glass and fiber glass sales, manufacturing and technical teams to serve specific automakers. among notable modernizations was a multi-million dollar upgrade underway at the main v-belt and hose plant in lincoln, nebraska. in 1989, the division's priority will be to introduce new products, capitalizing on the well-established airkem name and reputation. cultural attribute perception of customer service team working ability ability to manage change ability to innovate quality participative management style perception of customer service team working ability ability to manage change ability to innovate 106 journal of business strategies vol. 17, no.2 the sentences in table 3 tend to emphasize future action more than present or past results, indicating that ceos use their annual report's text to tell stakeholders about the steps they are taking to be more competitive. in short, our research findings provide support for hypothesis 3. the next section draws overall conclusions about the results of the study, discusses the limitations of the study and presents avenues of future research. discussion and conclusions the results ofthis study strongly support rby. collectively and individually, these strategic intangible assets impact future perfonnance beyond that explained by industry perfonnance or the other control variables. furthennore, consistent with rbv logic and the definition of strategic assets, these strategic intangible assets are associated with above-median industry returns. the standardized regression coefficients of reputation, knowhow, and organizational culture also show that a one unit change in these intangibles has a relatively sizable impact on finn perfonnance. this has important implications for both practitioners and academics. for practitioners, this study identifies resources capable of being strategic assets and empirically shows their association with superior firm performance. senior managers are the guardians ofthe firm's resources (collis & montgomery, 1997). as such, they are responsible for identifying those resources which constitute the firm's strategic assets and making certain that they are maintained, upgraded and leveraged throughout the corporation. this paper helps managers in that effort by demonstrating that strategic assets are generally intangible in nature, that not all intangible resources are strategic assets, and that reputation, employee knowhow and organizational culture are capable of possessing the characteristics of strategic assets. in our analysis of these three intangibles, we also demonstrate how managers can systematically evaluate the value, rareness, imitability and substitutability of any resource. with practice, that type of systematic resource-oriented thinking can result in more profitable ways of selecting, developing and managing firm resources. furthermore, through training and development, strategic resourceoriented thinking can permeate throughout the firm demonstrating yet another way managers can cultivate and leverage an important strategic intangible (resource-oriented knowhow) in the firm. for academics, this paper has important implications for both the resourcebased view of the finn (rbv) and for the industrial organizational model (i/o) of competitive advantage. since wernerfelt (1984) coined the phrase "resourcebased view of the firm," the rbv literature has made significant strides in conceptually crafting an alternative view of sustainable competitive advantage. unfortunately, empirical testing of rbv is still in the embryonic stages. this paper provides empirical evidence supporting rbv's main prescription that resources possessing the characteristics of strategic assets are sustainable sources of superior profits. fall 2000 michalisin, et al.: intangible strategic assets 107 the i/o model tells us that industry profitability is the key determinant of firm profitability and is a function of five industry forces: the bargaining power of suppliers, the bargaining power of buyers, the threat of substitutes, the threat of potential entrants, and existing rivalry among competitors (porter, 1980). this means that firm managers should mainly concern themselves with selecting attractive industries to compete and with attempting to manipulate the five industry forces in the firm's favor. this external view of strategy is based on the two key assumptions: (1) that firms possess the same strategically-relevant resources and (2) that resources are relatively mobile (porter, 1980, 1985; hitt, ireland & hoskisson, 1999). based on these assumptions, resource-based advantages do not exist, or if they do exist, they are very short lived. yet, this study shows that three intangible strategic assets, measured in 1988, can explain to a statisticallysignificant degree why firms are either above or below industry median roe for the subsequent five years (1989-1993). in other words, we demonstrate that resource-based advantages exist and are important in explaining future performance relative to one's competitors. this also supports rbv's assumption that firms are unique bundles of resources, while contradicting the i/o assumption that firms possess the same strategically-relevant resources. in the next section, we discuss limitations of this study and propose possible avenues for future research. limitations and future research there are limitations inherent in this study. first, the population frame (and thus the sample) only includes american firms. second, the firms in the population frame are relatively large. in any study, one can only generalize to the population from which the sample was drawn. third, the organizational culture findings are subject to some interpretation and could provide opportunities for future research. for instance, one could replicate the content analysis using documents written by independent parties (e.g., reports written by industry analysts). using documents written by individuals outside the firm may provide additional evidence as to the existence and strength of key organizational attributes. however, individuals inside the firm may be the only ones who can give an accurate account of an organization's culture. computerized content analysis is a useful research technique when information about a variable is in the form of text. it provides a means of translating textual data into measurable units, making it amenable to statistical analysis. this tool is particularly useful for management research where many variables are qualitative. specifically, researchers might be able to test theory in situations where other research tools cannot get at the data. surprisingly, the use of computerized content analysis is still fairly uncommon in management research (morris, 1994; wolfe, gephart, & johnson, 1994), particularly in strategic management. perhaps this study will generate additional interest in the use of computerized content analysis in strategic management research. another possible avenue for future research would be to replicate the study using other types of intangible resources that possess the characteristics of strategic 108 journal of business strategies vol. 17, no.2 assets. of course, as with this study, measuring intangible resources requires considerable creativity. appendix content analysis methodology this section describes, in five parts, the content analysis methodology used in this study. the first part describes the population of words used in the analysis, called the "word population frame." the second part describes how management textbook concepts were used in selecting key words and key word combinations. the third part describes the process of selecting key words and key word combinations. the fourth part describes the key word in context analysis. the fifth part presents the key words and key word combinations used for measuring organizational culture. word population frame all words appearing in the letters to shareholders', company report, and management discussion and analysis sections of the 1988 annual report of all sample firms were compiled, along with their frequency, into a single alphabetic list called the "word population frame" (wpf). as will be discussed, single key words and key word combinations were selected from the wpf to measure organizational culture via computerized content analysis. consistent with the content analysis literature, irrelevant words (e.g., a, an, the, then) and low frequency words were excluded from the wpf. eliminating these words reduces the wpf from 21,172 words to 1,681 words. management textbook key concepts management textbooks discuss key concepts related to various topics in management. among those topics are the cultural attributes of interest in this study. key concepts about the six cultural attributes were gathered and summarized from popular management textbooks. this list served as a reference tool in selecting key words and key word combinations from the wpf. selecting key words and key word combinations three experts in management selected key words and key word combinations relating to the six cultural attributes from the wpf. each individual used the summary of management textbook key concepts and their knowledge about the cultural attributes in selecting key words and key word combinations. kwic analysis key word in context analysis (kwic) is about examining a word, or combination of words, in its surrounding context to see how it is being used (krippendorff, 1980; weber, 1990). for each of the key words and key word combinations, ten sentences were randomly selected from the 100 annual reports fall 2000 michalisin, et at.: intangible strategic assets 109 and independently read by the three experts. key words and key word combinations were included in the final content analysis only if two of the three experts agreed that at least nine out of the ten randomly selected sentences clearly related to the relevant cultural attribute. each expert also had the option of requesting another random sample of sentences based on new specifications. for instance, the key word "control" may have failed to meet the nine-out-of-ten sentences rule. however, during the kwic analysis, the reviewer may have noticed that sentences containing both "statistical" and "control" clearly related to the cultural attribute "perception of quality." furthermore, the relationship was strongest when "statistical" and "control" appeared within four words of each other. in such instances, the kwic analysis was repeated using the new specifications. these procedures improve the validity of the content analysis. first, reviewing the entire population of frequently occurring words (wpf) promotes completeness in the selection of key words and key word combinations. further, all key words and key word combinations chosen by the three experts were included in the kwic analysis. that, coupled with the opportunity to request new specifications for kwic analysis, promotes completeness in the selection of key words and key word combinations for the final content analysis. second, systematizing the content analysis procedures enhances consistency. moreover, once content rules are established, the computer program provides perfect reliability. third, documenting the procedures supports the possibility of replicating the study. fourth, the tight selection criteria of key words and key word combinations enhances the accuracy of the findings. and fifth, content analyzing annual reports (a regulated document) across thirty industries (both manufacturing and service) strengthens external validity. final list of key words and key word combinations the final list of key words and key word combinations appear in table 4. proximity requirements for key words in key word combinations are identified via asterisk and described at the bottom of the table. the program computed the number of times the key words and key word combinations appear in the letter to the shareholders, company report, and management discussion and analysis sections of each firm's 1988 annual report and then divided that amount by the total number of bytes in the file (on diskette) containing that textual data. dividing by the total number of bytes controls for differences in the size of annual reports. 110 journal of business strategies table 4 key words and key word combinations customer service vol. 17, no.2 customer relationships * serving customers* customers value consumers satisfaction help customers response customers consumer service* innovation advanced technology advanced technologies dramatic improvements modernization changing goals innovations creative restructuring planned changes strategic change strategic changes team teams team decision employee communication employees communication employee involvement involvement teams quality continuous improvement* improve continuously statistical process customer satisfaction* serving clients* customer involvement* customer customers help customer customer services* customer driven* ability to innovate creativity innovator innovators innovative product development process development new processes ability to manage change managing change managing changes management flexibility manage change team working ability teamwork working together** participative management style development teams employee decision employee ownership employees ownership quality excellence product improvements** better products** superior products customer service* customer value consumer satisfaction customer support customer focus customer focused * new process automate automated cycle time* new products* new services** significant progress flexibility change agents organizational changes* expanded capacity work together*** employee participate participation employee employee contribution group process* superior services just in time* best industry** * the key words must appear together in the sentence, in the order listed. ** the key words must appear within four words of each other in a sentence. *** the key words must appear within five words of each other in a sentence. no asterisk indicates that the key words can appear anywhere in a sentence. fall 2000 michalisin, et al.: intangible strategic assets references 111 abrahamson, e., & park, c. (1994). concealment of negative organizational outcomes: an agency theory perspecti ve. academy of manal;ement journal. 37 (5), 1302-13 34. amit, r., & schoemaker, p. 1. h. (1993). strategic assets and organizational rent. stratel;ic manal;ement journal. 140), 33-46. arogyaswamy, b., & byles, c. m. (1987). organizational culture: internal and external fits. journal of management. 13(4),647-659. barney, j. b. (1986). organizational culture: can it be a source of sustainable competitive advantage? academy of management review. 11(3), 656-665. barney, j. b. (1991). firm resources and sustainable competitive advantage. journal of management. 17(1),99-120. bates, k. a., & flynn, e. 1. (1995). innovation history and competitive advantage: a resource-based analysis of manufacturing technology innovations. 1995 academy of management best paper proceedings, 235-239. bettman, j. r., & weitz, b. a. (1983). attributions in the board room: causal reasoning in corporate annual reports. administrative science ouarterly. 28(2), 165-183. bowman, e. h. (1984). content analysis of annual reports for corporate strategy and risk. interfaces. 140),61-71. chakravarthy, b.s. (1986). measuring strategic performance. strategic management journal. 7(5), 437457. chandler, a. d. (1990). scale and scope. cambridge, ma: harvard university press. chandler, r. c. (1987). organizational communication to corporate constitutuents: the role of the company annual report. unpublished dissertation, university of kansas. chatterjee, s., & wernerfelt, b. (1991). the link between resources and type of diversification: theory and evidence. strategic management journal. 12,33-48. coff, r. w. (1997). human assets and management dilemma: coping with hazards on the road to resource-based theory. academy of management review. 22(4),374-402. collis, d .1., & montgomery, c. a. (1995). competing on resources: strategy in the 1990s. harvard business review, july-august. 118-128. collis, d. j., & montgomery, c. a. (1997). corporate strategy: resources and the scope of the firm. chicago: irwin. 112 journal of business strategies vol. 17, no.2 d' aveni, r. a. (1994). hypercompetition: mana~in~ the dynamics of strate~ic maneuvering. new york: free press. d' aveni, r. a., & macmillan, i. c. (1990). crisis and the content of managerial communications: a study of the focus of attention of top managers in surviving and failing firms. administrative science ouarterly. 35(41, 634-657. davenport, c. (1989). america's most admired corporations. fortune. 119(3), january 30, 68-94. davidow, w. h., & malone, m. s. (1992). the virtual corporation. new york: harpercollins. deal, t., & kennedy, a. e. (1982). corporate culture. reading, ma: addison-wesley. denison, d. r. (1984). bringing corporate culture to the bottom line. organizational dynamics. autumn, 4-22. denison, d. r. (1990). corporate culture and organizational effectiveness. new york: wiley. denison, d. r. (1996). what is the difference between organizational culture and organizational climate? a native's point of view on a decade of paradigm wars. academy of manae;ement review. 21(3), 619-654. dollinger, m. c., golden, p. a., & saxton, t. (1997). the effect of reputation on the decision to joint venture. stratee:ic manae;ement journal. 18(2), 127-140. dyer, 1. h., & singh, h. (1998). the relational view: cooperative strategy and sources of interorganizational competitive advantage. academy of management review, 23(4), 660-679. fama, e. (1980). agency problems and the theory of the firm. journal of political economy. .8..8.,288-307. fama, e., & jensen, m. (1983). separation of ownership and control. journal of law and economics. 26, 301-325. farjoun, m. (1994). beyond industry boundaries: human expertise, diversification and resource-related industry groups. ore:anization science, 5(2), 185-199. fombrun, c., & shanley, m. (1990). what's in a name?: reputation building and corporate strategy. academy of management journal. 33(2), 233-258. fombrun, c. (1996). reputation: realizing value from the corporate image. boston: harvard business school press. fall 2000 michalisin, et at.: intangible strategic assets ]13 fortune (1998). what makes a company great? .llli([l, october 26, ] 28. frazier, k. b., ingram, r. w., & tennyson, b. m. (1984). a methodology for the analysis of narrative accounting disclosures. journal of accountini research. 22( 0, 318331. galunic, d. c., & rodan, s. (1998). resource recombinations in the firm: knowledge structures and the potential for schumpeterian innovation. strategic management journal. 19, 1193-]201. garud, r., & nayyar, p. r. (1994). transformative capacity: continual structuring by intcrtcmporal technology transfer. strategic management journal. 15(5), 365-385. givoli, d., & palmon, d. (1982). timeliness of annual earnings announcements: some empirical evidence. the accounting review. 57(3), 486-508. godfrey, p. c., & hill, c. w. l. (1995). the problem with unobservables in strategic management research. stratellic management journal. 16(7), 519-533. hall, r. (1992). the strategic analysis of intangible resources. strategic management journal. 13(2), 135-144. hall, r. (1993). a framework linking intangible resources and capabilities to sustainable competiti ve advantage. stratee.ic management journal. 14(8), 607-618. hedlund, g. (1994). a model of knowledge management and the n-form corporation. strategic manallement journal. 15, 73-90. henderson, r., & cockburn, i. (1994). measuring competence? exploring firm effects in pharmaceutical research. strategic management journal. 15 (special winter issue), 63-84. henderson, r., & mitchell, w. (1997). the interactions of organizational and competitive influences on strategy and performance. strategic management journal. 18 (summer special issue), 5-14. hitt, m. a., ireland, r. d., & hoskisson, r. e. (l999). strategic management: competitiveness and globalization (third edition). cincinnati, oh: south-western college publishing. hitt, m. a., & smart, d. l. (1994). debt adisciplining force for managers or a debilitating force for organizations? journal of management inguiry, j: 144-152. holsti, o. r. (1968). content analysis. in gardner lindzey & elliot aronson (eds.), the handbook of social psychology (2nd ed.), 596-692. reading, ma: addison-wesley. 114 journal of business strategies vol. 17, no.2 hoskisson, r. e., johnson, r. a. & moesel, d. d. (1994). corporate divestment intensity in restructuring firms: effects of governance, strategy and performance. strategic mana~ement journal. 37(5),1207-1251. hopkins, w. e., & hopkins, s. a. (1997). strategic planning-financial performance relationships in banks: a causal examination. strategic management journal. 18(8), 635-652. howard, e. (1991). preparing annual reports in the 1990s. public relations journal. 47(5), 26-27. inkpen, a. c., & dinur, a. (1998). knowledge management processes and international joint ventures. organization science. 9(4), 454-468. ingram, r. w., & frazier, k. b. (1980). environmental performance and corporate disclosure. journal of accounting research. 18(2), 614-622. ingram, r. w., & frazier, k. b. (1983). narrative disclosures in annual reports. journal of business research. 11 (l), 49-60. hami, h., & roehl, t. w. (1987). mobilizing invisible assets. cambridge, ma: harvard univ. press. jensen, m. c. (1991). corporate control and the politics of finance. journal of applied colllorate finance. 4, 13-33. kabanoff, b., waldersee, r., & cohen, m. espoused values and organizational change themes. academy of mana~ementjournal. 38(4), 1075-1104. kotter, j. p., & heskett, j. l. (1992). co'l'orate culture and performance. new york: free press. kri ppendorff, k. (1980). content analysis: an introduction to its methodology. newbury park, ca: sage publications, inc. lado, a. a., & wilson, m. c. (1994). human resource systems and sustained competitive advantage: a competency-based perspective. academy of management review, 19c4), 699-727. levinthal, d., & myatt, j. (1994). co-evolution of capabilities and industry: the evolution of mutual fund processing. strategic management journal. 15 (special winter issue), 45-62. lei, d., hitt, m. a., & bettis, r. (1996). dynamic core competencies through meta-learning and strategic context. journal of management. 22(4), 549-569. fall 2000 michalisin, et at.: intangible strategic assets 115 mahoney, 1. t., & pandian, j. r. (1992). the resource-based view within the conversation of strategic management strateaic manaaement journal. 13(5), 363-380. maijoor, s., & van witteloostuijn, a. (1996). an empirical test of the resource-based theory: strategic regulation in the dutch audit industry. strategic management journal. 11, 549-569. markides, c. c., & williamson, p. 1. (1994). related diversification, core competences and corporate diversification. strategic manat:ernent journal. 15 (special winter issue), 149-165. markides, c. c., & williamson, p. j. (1996). corporate diversification and organizational structure: a resource-based view. academy of manaaement journal. 39(2),340-367. mcgrath, r. g., macmillan, i. c., & venkatraman, s. (1995). defining and developing competence: a strategic process paradigm. strategic manaaement journal. 16(3), 251-275. meyer, h. e. (1979). annual reports get an editor in washington. forlui1' (may 7), 210222. michalisin, m. dt. smith, r. d., & kline, d. m. (1997). in search of strategic assets. th international journal of organizational analysis. 5(4),360-387. miller, d., & shamsie, j. (1996). the resource-based view of the firm in two environments: the hollywood film studios from 1936 to 1965. academy of management journal. :2.2ul,519-543. morris, r. (1994). computerized content analysis in management research: a demonstration of advantages and disadvantages. journal of manaaement, 20(4), 903·931. oliver, c. (1997). sustainable competitive advantage: combining institutional and resourcebased views. strateiic manaiement journal. 1iu9),697-713. peteraf, m. (1993). the cornerstones of competitive advantage: a resource-based view. slrategic manuetneot journal. 14(3), 179-192. peters, t. 1., & waterman, r. h. (1982). in search of excellence lessons from america's best run companies. new york: harper and row. porter, m. e. (1980). compelitive slrate&y: iechniguel for analyzjni industries and competitors. new york: free press. porter, m. e. (1985). compelitiye advantq:c; creatine and sustainjne superiqr performance. new york: free press. 116 journal of business strategies vol. 17, no.2 prahalad, c. k., & hamel, g. (1990). the core competence of the corporation. harvard business review. 68 (may-june), 79-91. rao, h. (1994). the social construction of reputation: certification contests, legitimation, and the survival of organizations in the american automobile industry: 1895-1912. strategic management journal. 15 (special winter issue), 29-44. reed, r, & defillippi, r 1. (1990). causal ambiguity, barriers to imitation, and sustainable competitive advantage. academy of management review, iso}, 88-102. robins, j., & wiersema, m. f. (1995). a resource-based approach to the multibusiness firm: empirical analysis of portfolio interrelationships and corporate financial performance. strategic management journal. 16,277-299. robinson, k. c., mcdougall, p. p. (1998). the impact of alternative operationalizations of industry structural elements on measures of performance for entrepreneurial manufacturing ventures. strategic management journal. 19, 1079-1100. rogers, r. k., & grant, j. (1997). content analysis of information cited in reports of sellside financial analysts. journal of financial statement analysis, 3( i ), 17-30. rumelt, r p. (1984). towards a strategic theory of the firm. in b. lamb (ed.), competitive strategic manaljement (pp. 557-558). englewood cliffs, nj: prentice hall. salancik, g. r, & meindl, j. r. (1984). corporate attributions as strategic illusions of management control. administrative sciences quarterly, 29, 238-254. sharma, s., & vredenburg, h. (1998). proactive corporate environmental strategy and the development of competitively valuable organizational capabilities. strategic management journal. 19, 729-753. stauffer, d. (1997). what annual reports won't say. the wall street journal, april 14. stewart, t. a. (1998). america's most admired companies. fortune. 137 (4), march 2, 70-73. turban, d. b., & greening, d. w. (1996). corporate social performance and organizational attractiveness to prospective employees. academy of management journal. 40(3}, 658-672. tyre, m. j., & von hippel, e. (1997). the situated nature of adaptive learning in organizations. organization science. 8c]), 71-83. venkatraman. n., & ramanujan, v. (1986). measurement of business performance in strategy research: a comparison of approaches. academy of management review, .l.lill. 801-814. fall 2000 michalisin, et at.: intangible strategic assets 117 von krogh, g., roos, 1., & slocum, k. (1994). an essay on corporate epistemology. stratef:ic manaf:ement journal. 15 (special summer issue), 53-71. weber, r. p. (1990). basic content analysis (2nd ed.). newbury park, ca: sage publications, inc. weigelt, k., & camerer, c. (1988). reputation and corporate strategy: a review of recent theory and applications. strate&ic mana&ement journal. 9(5),443-454. wernerfelt, b. (1984). a resource-based view of the firm. strategic management journal. ~, 171-180. wolfe, r. a., gephart, r. p., & johnson, t. e. (1993). computer-facilitated qualitative data analysis: potential contributions to management research. journal of management. 19(3),637-660. woo, c. y, & willard, g. (1983). performance representation in business policy research: discussion and recommendation. paper presented at the 23rd annual national meetings of the academy of management, dal1as. michael d. michalisin is an assistant professor of management at southern illinois university at carbondale. he earned his ph.d. from kent state university, his mba from duquesne university, his undergraduate degree from the pennsylvania state university and is a cpa. in addition to his academic background, he has worked for ernst & whinney (now ernst & young). westinghouse and finalco group incorporated. his journal publications focus on resource-based strategies, strategic flexibility, new organizational forms and textbased research methodologies. douglas m. kline is an assistant professor of management information systems at sam houston state university in huntsville. texas. he received his ph.d. from kent state university. his main research interests focus on artificial intelligence, artificial neural networks and intelligent text-based systems. robert d. smith is professor of management and leadership at kent state university, college of business administration. he earned his ph.d. from the pennsylvania state university. he has co-authored several books in human resource management and published in such journals as management science, journal of applied psychology, academy of management journal and communications of the acm. his major research interests are in the fields of strategy, leadership and information management systems. intangible strategic assets and firm performance: a multi-industry study of the resource-based view 120 journal of business strategies stakeholder networks and strategy: the influence of network consistency and network diversity on firm performance richard peters xavier university of louisiana • new orleans, louisiana peggy golden florida atlantic university • boca raton, florida abstract as academic and practitioners continue to demand greater stakeholder acknowledgement and engagement, firms must seek ways to move beyond dyadic interactions and treat internal and external stakeholders as components of a holistic network. this paper introduces two new constructs, network diversity and network consistency, proposing that both the variety of stakeholder partners (network diversity) as well as the uniformity of social performance across multiple stakeholder constituencies (network consistency), will influence corporate reputation (cr) and ultimately, firm financial performance. using a sample of 158 firms, across a five year time span,we find that while network diversity has no significant relationship to cr, network consistency is in fact related to corporate reputation. further, high levels of network diversity may actually detract from, rather than enhance financial performance, via increased cost and relationship management complexity. introduction the concept of corporate reputation, and its relationship to firm performance, is not novel to business literature. academics have written extensively and even previously tested this link, indicating that there is both theoretical and empirical evidence supporting the strategic benefit of a superior cr. yet, despite this previous work, less emphasis has been placed upon identifying the antecedents of cr and how they can best be used to enhance financial outcomes. to address this deficiency, we address two specific questions: (1) how can the firm’s cr, or what we will soon refer to as its reputational stock, be increased, and (2) how can the firm’s approach to stakeholder management attenuate the relationship between its reputation and financial performance. exploration of these two issues requires richer understanding of the underpinnings of corporate reputations. generally, most authors agree that corporate reputa121 journal of business strategies tions emerge from the evaluations stakeholders (both internal and external), ascribe to the firm (barnett, 2007). two important characteristics of these evaluations may help illuminate the nature and antecedents of firm reputations. first, these evaluations are based upon the firm’s behavior, both intentional and unintentional, towards its various stakeholder constituents (fombrun & shanley, 1990; fombrun, 1996). thus the firm’s ability to effectively manage and meets its stakeholder obligations is likely to positively influence evaluations (russo & fouts, 1997; hillman & keim, 2001) and enhance the firm’s cr (fombrun, 1996; fombrun et al. 2000). second, while individual stakeholders provide separate evaluations; “sub-reputations” (neville, bell & mengue, 2005: 1189), the firm’s overall corporate reputation is essentially a collection and/or integration of these individualized assessments (fombrun, 1996; weiss, anderson & macinnis, 1999; hutton, goodman, alexander & genest, 2001; neville et al. 2005, barnett, 2007). thus, it is clear that a firm’s cr is a function of both its individual and collective stakeholder performance and that a network approach to stakeholder management is essential to explaining the firm’s reputational ‘drivers’. a stakeholder network approach, unlike a dyadic treatment of firm-stakeholder interaction, simultaneously accounts for both individual as well as structural ties. it acknowledges that while specific firm-stakeholder ties provide firms with opportunities and constraints, the assimilation and integration of these ties create an holistic network structure, that can impact, if or how the firm derives and/or benefits meet cr (granovetter, 1992; gulati & gargiulo, 1999; borgatti & foster, 2003). consistent with this stakeholder network approach, two concepts, network diversity and network consistency, are introduced. network diversity refers to the number of distinct stakeholder relationships the firm adopts and implements. network consistency, on the other hand, considers the uniformity of social performance across multiple stakeholder relationships. we propose that these constructs will have both a direct relationship to cr as well as a moderating effect on the relationship between cr and firm financial performance. the former effect is premised on the ability of these constructs to foster greater and more positive flows of reputational equity from firm stakeholders. positive and continuous flows lead to an accumulated stock of intangible, but valuable corporate reputation.1 the latter effect suggests that crs, built on high network 1this treatment of flows and stock is synonymous with dierick & cool (1989) which state that accumulated assets, like cr, are non-appropriable, non-fungible, idiosyncratic resources that the firm internally creates. the stock, or overall level of these assets, is determined by the specific flows of resources from which they are cumulatively and collectively derived. 122 journal of business strategies diversity and consistency, are inherently complex and thus difficult to imitate. complex resources are difficult to imitate since they not only require identification of the specific resource elements, but also the successful replication and management of the interdependencies among these elements (black & boal, 1994). this makes these types of crs more valuable and rare (barney, 1991); therefore more likely to contribute to positive financial outcomes. the rest of our paper is dedicated to theoretically and empirically examining these two general effects (direct and moderating). the following sections provide our hypothesis development. we then present our findings and lastly discuss their implications to our research and possible future study. theoretical framework figures 1 and 2 illustrate our proposed models and their underlying effects. as argued above, network diversity and network consistency, affect corporate reputation in two distinct ways. first, as illustrated in figure 1, we propose that they help firms increase their overall stock of cr, and are thus direct antecedents. second, as shown in figure 2, because of their proposed ability to promote cr complexity, rareness and inimitability, both constructs are hypothesized to moderate the relationship between cr and firm financial performance. figure 1 direct model 123 journal of business strategies figure 2 moderator model hypothesis development network diversity-corporate reputation the concept of network diversity is similar, but not equivalent, to conventional network constructs such as size and density. as with network size and density, network diversity is dependent on the number of actors and relationships present throughout the entire system. unlike size and density, however, network diversity is also contingent upon the level of diversity among network members. while a firm can increase its stakeholder network size by engaging in additional individual stakeholder relationships, it can only improve its network diversity by adopting additional stakeholder group relationships. therefore a firm that maintains relationships with customers, employees and environmental activists is argued to demonstrate more network diversity than one that has a strong relationship with only its customer base. fiji water working with environmental groups or wal-mart engaging with community agencies indicate tangible examples of firms increasing their network diversity by adding new stakeholder ‘types’ instead of stakeholder ‘numbers’. h5+ 124 journal of business strategies network diversity is argued to positively affect cr by increasing its overall stock of firm reputation capital. similar to fombrun and shanley (1990) and bromley (2000), we argue that each new stakeholder group represents a potentially unique contributor to cr, and thus an additional and distinct flow towards overall cr stock. as network diversity increases, the firm’s number of potential avenues from which to ‘draw’ positive cr increases. therefore a firm is able to decisively leverage its reputation for strategic gain. today, for example, we might expect network diversity to extend itself to suppliers or vendors such as recycling agencies with waste management. while it is arguable that the firm can create a similar effect, (i.e. increase its reputation stock), by simply increasing the numbers of relationships within existing stakeholder constituencies (for example working with more community groups or environmental ngos), we suggest that the incremental contribution to cr of a new stakeholder from a previously unaffiliated stakeholder constituency is greater than that of a new partner in an already affiliated constituency. thus, we propose that scope is better than size, a position consistent with granovetter’s weak ties argument. granovetter (1973) proposes that individuals were more likely to get valuable job leads through persons outside their ‘social inner circles’, since the information garnered from these immediate social circles was often myopic, subjectively biased, and relatively common. thus, by increasing their network diversity, an individual could access, not only greater, but also more unique sources of information, which proved advantageous to their employment searches. similarly, firms, which extend their stakeholder networks to include new stakeholder constituencies, are expected to mitigate the redundancy that comes from network homogeneity, and capitalize on the unique contribution each new constituency provides to cr stock. therefore, network diversity is expected to positively impact the corporate social reputation the firm achieves through its csr initiatives. h1: network diversity is positively related to corporate reputation network consistency-corporate reputation another stakeholder network attribute that is argued to influence the magnitude of cr stock is network consistency. network consistency is a measure of uniformity, or conversely variance, in the firm’s social performance across its multiple stakeholder constituencies. high network consistency occurs when there is minimal discrepancy in the firm’s positive treatment of its stakeholder constituencies across the entire stakeholder network. conversely, low network consistency, occurs when the firm excessively discriminates among its stakeholder constituents, 125 journal of business strategies treating some significantly better or worse than others. an example might be deference to union negotiations at a high cost in an austere financial climate. while stakeholder groups (constituencies) are expected to concentrate mainly on their own expectation and needs when evaluating firms, they may also consider firm treatment of other stakeholders when determining firm reputation. for example, brown and dacin (1997) show that customers may consider employee well-being when making purchasing decisions. further, turban and greening (1997) propose that firm csr, in some cases, matter to prospective employees. employee well-being is generally translated into satisfied customers. as stakeholders become aware and interested in the welfare of others outside their primary stakeholder constituency, a firm’s holistic performance across its stakeholder network becomes significantly important to its cr stock. certain factors within the stakeholder network and general environment, such as role multiplicity and media intervention, increase the propensity of stakeholders within one constituency to consider those in another. with respect to role multiplicity, almost everyone in society performs multiple roles in order to fulfill diverse personal, professional and social needs (beggs, haines & hurlbert, 1996). as no single social institution can fulfill all human need, individuals must often subscribe to multiple social groups. role multiplicity presumes that individuals, by virtue of their different social roles, can potentially hold dual or multiple stakeholder constituent membership. customers can simultaneously be environmental activists, while employees might act as community leaders. these simultaneous roles allow these stakeholders to observe the firm’s actions in different contexts, and thereby evaluate the firm’s consistency across multiple stakeholder domains. additionally, stakeholders belonging to more than one stakeholder constituency may act as boundary spanners. boundary spanners are internal sources of external information (kostova & roth, 2003). they introduce ‘in-group’ members to the attitudes, experiences and needs of ‘outsiders’. because of their primary knowledge about firm behavior and their ties to multiple stakeholder constituents, these boundary spanners increase awareness of firm inconsistency across large sections and in some instances, the entire stakeholder network. the external media also provides an avenue through which stakeholders can acquire information about network consistency. because of the recent ethical fiascos, such as nike’s sweat-shop labor problems in asia, enron’s fraudulent accounting, and worldcom’s mismanagement issues, the social responsiveness has been subjected to the popular press as well as academia. the information reported in academic journals, daily periodicals, business publications and television, provide 126 journal of business strategies stakeholders with a clearer image of the firm’s overall character, which then allows them (stakeholders) to evaluate the firm’s network consistency. by acting inconsistently across their stakeholder networks, firms risk eroding their established stock of cr. stakeholders that are both aware of and concerned with the firm’s performance across multiple stakeholder constituencies are likely to react less favorably to low network consistency. for example, an employee who is treated well by his/her respective organization is likely to have a favorable impression of the firm. this impression, however, might be severely tainted if this employee lived in the community in which the firm operated in, and experienced the firm’s pollution first-hand. similarly, a customer who is appreciative of the company’s provision of highly innovative products may become less enamored with the firm upon learning that these products are manufactured using sweat-shop labor. even for stakeholders that are not unduly concerned with the welfare of others outside their immediate stakeholder constituency, network consistency can still be a factor in determining cr. individuals utilize information about the firm’s behavior from multiple stakeholder sources, including themselves, to assess the organization’s credibility (whetten & mackey, 2002; neville et al., 2005). if these multiple sources are incongruent, stakeholders become less willing to trust the organization and ascribe to it a positive cr (lewis, 2003). h2: network consistency is positively related to corporate reputation corporate reputation and financial performance the instrumental value of cr to the firm is demonstrated in its effect on both organizational efficiency and product differentiation (roberts & dowling, 2002). these two advantages help the firm to reduce its organizational costs (via organizational efficiency) and distinguish itself in the marketplace (via differentiation). these can separately, and in tandem, lead to positive financial outcomes. positive and superior crs are often built upon constructive and dedicated stakeholder-firm relationships. these relationships are characterized by increased levels of dedication, personalization and trust (hillman & keim, 2001). the firm, by actively and consistently addressing the needs of its stakeholder, engenders not only positive stakeholder perceptions but also a distinct atmosphere of reciprocity, wherein stakeholders feel socially and personally obligated to tangibly reward the firm. the reward results in a willingness on the part of stakeholders, such as employees (turban & greening, 1997), investors (srivastava, mcinish, wood & capraro, 127 journal of business strategies 1997), suppliers and governments (fombrun, 1996; fombrun et al., 2000) to grant the firm greater access to the resources they own (knowledge, capital, raw materials, legitimacy etc.). the increased investments in socially responsible funds are arguably a testament of this ‘efficiency’ effect (c.f. us sif report 2012). firms are in competition for these resources and, easier and/or greater access can significantly help promote organizational efficiency, and financial performance (hart, 1995; nelson &winter, 1982, eisenhardt & martin, 2000; helfat & peteraf, 2003). differentiation, much like organizational efficiency, allows the firm to improve its financial performance as well as achieve a competitive advantage over its existing industry rivals (barney, 1991; porter, 1985 & 1996). the instrumentality of differentiation stems from the value customers place on unique firm and product attributes which increases their propensity to purchase as well as their willingness to pay higher prices for products they deem to be differentiated. previous researchers have argued, and in some cases demonstrated a positive link between cr and customer-related performance indicators (sanchez & sotorrio, 2007). for example, carmeli and tishler (2005), using a sample of 300 kibbutz enterprises, found a positive relationship between reputation and amount of customer orders. walsh, dinnie and weidmann, (2006) demonstrate that cr and customer satisfaction are positively correlated, from their sample of 422 customers of a german utility firm. with respect to buying intention, yoon, guffie and kijewski (1993) show that customers were more willing to purchase business services from companies deemed to be reputable. and in terms of pricing, shapiro (1983) empirically demonstrates that customers are motivated to pay more for products from firms that have reputations for high quality manufacturing. these findings suggest that along with improved efficiency, a superior cr can help firms differentiate themselves and their product/services in the marketplace. h3: corporate reputation is positively related to firm financial performance moderating effect on cr-firm financial performance network diversity our underlying argument for a moderating effect, by both network diversity and network consistency, on the relationship between cr and firm financial performance, rests on the proposed ability of these two network constructs to increase 128 journal of business strategies cr complexity and inimitability. as others have suggested (roberts & dowling, 2002; bronn & bronn, 2005), cr, because of its intangible nature, is complex and often multifaceted, and thus difficult to imitate. this ambiguity and inimitability are reasons it can serve as a firm distinctive competency (roberts & dowling, 2002). congruently, we propose that any effect that can either increase or decrease this complexity and inimitability will likely alter the financial benefit of the firm’s cr, and will thus act to moderate this direct relationship. as argued previously, by increasing network diversity, the firm gains reputational flows from multiple and importantly, unique sources. these unique sources are not just simply ‘more tributaries in the river of cr stock’, but potential inhibitors to cr imitation. since each firm-stakeholder constituent network tie represents a substantial investment of time, resources, capital and human acumen (stanwick & stanwick, 1998), increasing network diversity may make cr imitation financially prohibitive for competitors. further, because of heterogeneity present in diverse stakeholder networks, potential imitators must invest in multiple, differentiated skills, technology and knowledge to be successful at complete cr imitation. neville et al. (2005) suggest that each stakeholder group is idiosyncratic with respect to their needs and demands on the firm. to simultaneously maintain stakeholder group relationships, firms must effectively fulfill these differentiated needs and demand, which often requires diverse sets of resources and skills. this then represents an additional obstacle or to potential imitators and thus further protects the strategic value of firm’s cr. h4: network diversity moderates the relationship between corporate reputation and firm financial performance network consistency network consistency also provides implications for cr complexity and inimitability. firms, which behave consistently across their stakeholder networks (high network consistency), it can be argued, demonstrate an understanding of the dynamic interdependencies across their multiple stakeholder constituencies. using a river analogy, while it is relatively easy to identify each tributary before it meets the river, once entry occurs, it is practically impossible to isolate its individual contribution. similarly, as stakeholder groups and their interests coalesce and become interconnected, the ability of potential imitators to discern the sources of cr, as well as their effect on firm profitability is severely precluded. thus, firms familiar with stakeholder independencies, and the ability to successfully leverage them, are 129 journal of business strategies advantageously positioned relative to their present and would-be competitors, and are likely to reap the financial benefits of positive and superior crs. h5: network consistency moderates the relationship between corporate reputation and firm financial performance methodology sample data for one hundred and fifty eight companies, across multiple industries, over a five-year period were collected, pooled and analyzed. this resulted in seven hundred and ninety observations (790) for each construct. the companies chosen are u.s. firms, which cover a variety of industries including travel, retailing, telecommunications, energy and health care. while all constructs were measured over five years, the specific five -year period differed across constructs. for firm financial performance, the construct was measured from 1995 to 1999, for corporate reputation from 1994 to 1998, and for network diversity and network consistency from 1993 to 1997. this variation in five-year period was a consequence of lagging independent variables one year, relative to their respective dependent variable. the time period, 1995-1999, was selected based on the matched availability and completeness of construct information across the three main sources of secondary data: the kinder, lindenberg & domini (kld) ratings, the fortune most admired companies annual rankings and the compustat database. it should be noted that companies for which there was missing data from the reputation or compustat databes were kept only if there was available data for at least three years on each measure. the missing data was imputed based on the average of the known data for that firm, for that particular construct. importantly, the number of firms for which there was any missing data for any construct was always small relative to the overall sample, never exceeding more than eighteen firms. measures corporate reputation (cr) with the recent surge in research dedicated to corporate social reputation, issues related to conceptualizing and measuring this complex construct have emerged at the forefront of this niche area of business study (money & hillenbrand, 2006). numerous measures including the reputation quotient (rq) (fombrun, 1996), corporate personality scale (davies et al., 2003), and 130 journal of business strategies the spirit instrument (mcmillan et al., 2004) have been created and used to operationalize corporate social reputation. while these measures individually offer great conceptual and empirical insight into both the antecedents and consequences of corporate reputations, their newness, data unavailability and lack of widespread use make them relatively inappropriate for this type of longitudinal, strategic study. one instrument that has a historical legacy, widespread application, and considerable acceptance in the academic arena is the fortune most admired company rankings (luo & bhattacharya, 2006; roberts & dowling, 2002). since 1983, the fortune periodical has published a list of the most admired companies in the united states. in order to develop and publish these lists, fortune surveys multiple managers, across various industries, as well as strategic and financial analysts possessing intimate industry and firm knowledge. variables within the fortune instrument evaluate firm behavior, ability, and performance on eight dimensions including innovation, financial well-being, product quality, trust, community involvement, sustainability, consumerism and employee management (luo & bhattacharya, 2006). overall reputation scores are the average of the scores on all eight dimensions, which are each scaled from 1-10, (one being the least reputable and ten the most). while reputation data for the majority of firms in the final sample was complete (i.e. scores were retrieved for all five years between 1994 and 1998), eighteen firms had missing reputation scores for at least one year but not more than two years. in order for these firms to be accepted into the final sample they must have had a recorded reputation score for the first year (1994) and also demonstrate reputation scores for three consecutive years. to impute the missing values, a moving average (prior or post) was calculated, based on the available reputation scores and substituted for the missing data point. this method seemed suitable considering the fact that reputation scores across a moderate period of time are relatively stable and consistent (luo & bhattacharya, 2006); thus, previous or even future reputation scores could be credibly used to impute missing data. also, as this imputation was done for only a small portion of the sample (eighteen firms) any potential negative effects on empirical validity were relatively minimized in a total sample of 158. network diversity (nd) was calculated using data from the kinder, lydenburg and domini (kld) database. the kld measures firms on multiple stakeholder dimensions, which essentially equate to stakeholder constituencies. while traditionally these scores have been used to operationalize corporate social responsibility/ performance (waddock & graves, 1997; berman, wicks, kotha & jones, 1999; orlitzky, schmidt & rynes, 2003), in this paper we utilize them as measures of the 131 journal of business strategies level of firm’s stakeholder engagement (i.e. the firm’s ability to respond effectively to each stakeholder groups’ demands). since network diversity prioritizes scope over size activity, we borrow a formula that is common in natural science research, the shannon index (shannon, 1948). while the application of the formula has normally been limited to estimating animal specie diversity, its precepts are valid for our specific purposes. the specific measure is as follows s network diversity = σ p*ln p i =1 where p = kld dimension score/ total kld score we focus on six kld dimensions or stakeholder constituencies (community development, workplace diversity, employee relations, product safety/quality and stockholder/other). in the kld database, each dimension is separated in two categories, strengths and weakness. for example on the community involvement dimension there are six variables which attempt to measure the effectiveness of firm community involvement, as well as four variables that evaluate the firm’s efforts at not addressing the concerns related to the community stakeholders. conventionally, to calculate a kld dimension score, the weaknesses of each dimension was subtracted from its corresponding strengths and these values were then aggregated. in this study a novel approach was implemented which treated the weakness variables on the kld instruments as negatively worded items. instead of subtracting the weaknesses from the strengths, the weaknesses items were reverse scored (since each item was binary scored 0s become 1s and vice versa) and then added to their corresponding strengths. the decision to use this calculation was prompted by a need to eliminate negative numbers (because of the use of the shannon index) and to salvage variance across the construct. considering the kld items used in this study were already binary scored, using the residual scores between strengths and weaknesses may further impinge upon the variance across the sample for this construct, and potentially deflate any significant relationships it may have with other constructs. total kld score was the aggregate of each individual dimension score. network consistency (nc) the measure of network consistency (nc) uses the scores on the strengths and weakness on each kld stakeholder dimension. importantly, the emphasis of network consistency is to determine the level of variance in the firm’s responsiveness/behavior across its stakeholder group relationships 132 journal of business strategies (i.e. stakeholder network). in order to derive this measure, the standard deviation among the firms score on the six stakeholder dimensions incorporated in the kld was computed. as per the csr measure, the weaknesses items were reverse scored and aggregated and then added to the corresponding strength for each dimension. the standard deviation across these six scores was then inverted to ensure that firms with higher consistency (i.e. lower standard deviations) were rewarded with higher network consistency. this inverted standard deviation score, by itself, is insufficient since it does not discriminate between positive and negative consistency. positive consistency occurs when firms treat each stakeholder group partner well and similarly. negative consistency, alternatively, describes a situation where the firm treats its stakeholder partners similarly, but poorly. since the influence of network consistency on corporate social reputation is hypothesized to be positive, one does not expect negative network consistency to be instrumental to corporate reputation enhancement. in fact, negative network consistency is argued to detract from the level of reputational capital since it is likely to stir ill-will and negative stakeholder dispositions towards the firms. therefore, the valence of the firm’s stakeholder relationships (positive or negative) must be accounted for in order to empirically reward firms that demonstrate high positive network consistency, and punish those that show high negative consistency. in order to incorporate valence directly into the measure of network consistency, a maximum possible score was calculated based on the number of kld items for which data was available. there was data for fifty-six items (56) across these six dimensions, and since binary scoring was used, the maximum score for any firm was fifty-six (56). the average score for each firm was therefore twenty-eight (28). this average score was used to assign a valence sign (positive or negative) to the inverted standard deviation scores of the firms in the sample. firms, for which the sum of their kld stakeholder dimension scores (strengths + reverse scored weaknesses) was less than the 28, were assigned a negative sign. those with scores of twenty-eight and above remained positive. utilizing this approach, both the consistency of scores across stakeholder dimensions, as well as the magnitude of the firm’s performance with respect to stakeholder treatment is explicitly considered and included in the measurement of the network consistency construct. 133 journal of business strategies firm financial performance (fp) in this study two base measures of firm financial performance were used: return on assets (roa) (measured as income before extraordinary items/total assets) and tobin’s q (market value of the firm at end of fiscal year (mkvalf)/book value of total assets). the former represents a conventional ‘accounting’ or internal measure of firm performance, while the latter is market oriented, and has been used as a valid measure of a firm’s market value (lee & grewal, 2004; rao, manoj & dahlhoff, 2004). the firm’s score on these principle measures was standardized based on industry average and standard deviation to derive the actual firm financial performance score. there are two reasons why we employed two measures for this construct. first, we acknowledge the debate pervading previous stakeholder research regarding the merits of both accounting and market-based measures of firm performance (mcguire, sundgren & schneeweis, 1988). second, because of the cognitive, intangible and ‘environmentally-determined’ nature of corporate reputation, we expect its relationship with tobin’s q to be stronger than that with roa (wood & jones, 1995; orlitzky et al., 2003). therefore using these two measures should allow for some meaningful comparison. finally, we controlled for firm size because of its established relationship and influence on financial performance (wiggins & ruefli, 2002). this control variable was operationalized as the logarithm of number of employees. results tables 1 and 2 illustrate, respectively, the descriptive statistics and correlation matrix for our measures. with respect to table 1, the measures of skewness and kurtosis are a test of the normality of the data. for skewness, values < -1 or > 1 indicate high skewness (bulmer, 1979) while values < -3 or larger than 3 indicate high levels of kurtosis (since skewness for a normal distribution is 0 and kurtosis is 3). with respect to our constructs, network diversity, network consistency and corporate reputation were all within the range for both skewness and kurtosis. however, both our measures of financial performance, tobin’s q and roa, are both substantially outside the desired limits (roa in regards to kurtosis and tobin’s q for both skewness and kurtosis). this was relatively expected considering the volatile and sporadic nature of financial measures (corrado & su, 1996). while transformations of data through logarithms or exponential manipulations (conventionally squaring values or taking their squared roots) can often effectively deal with non-normality, 134 journal of business strategies the nature of the data for both these constructs made these transformations impractical and/or impossible. both roa and tobin’s q included negative values in their data distribution, which eliminates the use of logarithm or square root transformation. although the data could have been squared, because these values were measured relative to industry average, using absolute values would have compromised the ability to discern between high and low performers. finally, while inversion transformation was attempted it did little to normalize the data and so the data for these constructs were left in their present state. while recognizing the problematic nature of violating the non-normality assumption, especially for tobin’s q, we accepted these measures into the model based on the argument, that as sample size increases, the difference in power, (i.e. the model’s ability to detect a ‘true effect’), between a normal and non-normal distribution decreases (jahan & kahn, 2012). thus, because of our sample size, we do not expect significant underestimation, overestimation or misspecification of our results. also, since outliers here are extreme actual values found in the tail of the distribution, and not from non-normal measurement error, then, the robustness of the regression is less compromised. further, since both roa and tobin’s q were standardized relative to the industry average, the influence of outliers is expected to less pronounced and troublesome. table 1 descriptive statistics n mean skewness (range) kurtosis (range) corporate reputation 790 6.50 (0.44) 0.77 network diversity 790 0.18 0.80 0.63 network consistency 790 (0.51) 0.94 0.17 financial performance (roa) 790 0.21 0.06 14.62 financial performance (tobin’s q) 790 0.14 18.16 417.83 firm size 790 1.57 0.03 0.56 the correlations in table 2 indicate that there are some significant correlations between constructs, which provide preliminary support for our hypothetical relationships. 135 journal of business strategies a multiple regression approach was employed to test our model. in the first equation (regression 1) the two network constructs, diversity and consistency, were added as independent variables, regressed on the dependent variable corporate reputation. for the second equation, (regression 2), firm financial performance (roa or tobin q) becomes the dependent variable regressed against corporate reputation. table 2 correlation matrix 1 2 3 4 5 6 1) corporate reputation 1 2) network diversity 0.10 1 3) network consistency 0.11** 0.12** 1 4) roa 0.21** (0.01) 0.00 1 5) tobin's q 0.15** 0.05 0.004 0.45** 1 6) firm size 0.07* 0.12** (0.08)* 0.00 (0.01) 1 * significant at p= 0.10, ** significant at p= 0.05 table 3 provides these results, including regression coefficients and f values for the regression equations. based on the results we do not find support for hypothesis 1, that network diversity is positively related to corporate reputation. the coefficient is almost 0 (-0.002) and not statistically significant. however the standardized beta coefficient for network consistency is both positive and significant (0.11, p<0.05) thus supporting hypothesis 2. hypothesis 3, which purports that corporate reputation is positively related to firm financial performance, is supported for both roa (0.211, p<0.05) and tobin’s q (0.153, p<0.05). this provides evidence that corporate reputation is a valuable resource to enhancing firm success. 136 journal of business strategies table 3 regression for model 1 dependent variable = corporate reputation standardized beta coefficient (only for independent variables) network diversity (0.002) network consistency 0.111** r 0.111 adjusted r sq 0.01 f 4.90** * significant at p= 0.10, ** significant at p= 0.05 to test hypothesis 4 and 5 which argue that network diversity and network consistency positively moderate the relationship between corporate reputation and firm financial performance, we create interaction terms by finding the product between the predictor (corporate reputation) and moderator (network diversity or network consistency) and through regression, identify the significance of the change in f scores as well as the strength and statistical significance of the interaction term in the hierarchical regression equation (frazier et al. 2004; baron & kenny, 1986). table 4 provides these results for both roa and tobin’s q. in the case of roa, the change in the f statistic after introducing the two interaction terms (netdivint and netconint) is not significant (f change = 1.46, p>0.05). also, while both interaction terms are negative (netdivint substantially so), neither is statistically significant. so both h4 and h5 are not supported for roa. using tobin’s q however provides us with some interesting, albeit unexpected results. the change in f value here is significant (f change = 4.33, p<0.05) but this significance is driven primarily by the moderating effect of network diversity (netdivint) which is significant, but highly negative (-0.752, p<0.05). thus, as with roa, the tobin’s q model does not lend support for h4 or h5, but potentially proposes a reverse moderating effect for network diversity. 137 journal of business strategies table 4 regression for model 2 dependent variable roa tobin’s q corporate reputation 0.630** 0.901** network diversity*reputation (0.419) (0.0752)** network consistency*reputation (0.026) (0.038) firm size (0.032) (0.037) ∆f 1.46 4.33** * significant at p= 0.10, ** significant at p= 0.05 discussion this study is an attempt to identify the effect of stakeholder management on both corporate reputation and firm financial performance and by so doing contributes to multiple streams of business literature. some examples of these are: (a) corporate reputation with respect to cr research, our model introduces two network antecedents that are proposed to help to increase reputation stock, as well as protect this stock from competitor imitation. much of the work on cr has focused on one or few stakeholder dimensions; customers (carmeli & tishler, 2005), community (mcguire et al., 1988), financial investors (srivastava et al., 1997), employees (turban & greening, 1997) or the natural environment (russo & fouts, 1997). this myopic treatment, while simple and appealing, often ignores the complexity of cr. a network approach however, while acknowledging the independence of stakeholder relationships, also accounts for possible interdependencies between and among stakeholder constituencies, and the implications of these interdependencies to cr. thus it does not sacrifice the macro for the micro or vice versa, but incorporates these levels simultaneously and complementarily. while our findings suggest that network consistency enhances cr, the value of network diversity to cr is not clearly evident. one explanation for this result is that stakeholder multiplicity, identified earlier as a driver of network diversity, may ironically erode the benefits associated with diverse stakeholder engagement. as suggested previously, the benefit of increased network diversity is derived from the uniqueness of the reputational flow each new stakeholder constituency provides to the firm. however in an age of increased role multiplicity and information sharing, the potential uniqueness from enhanced network diversity might be more of 138 journal of business strategies a perception than a reality; therefore, the benefit of network diversity might be exaggerated. (b) social network theory social network theory has a rich legacy in business literature (borgatti & foster, 2003; brass et al., 2004). however, as provan, fish and sydow (2007) note, much of the network research, especially in the organizational studies arena, actually ignore the network level of analysis in favor of the inter-organizational or intra-organizational level. to remedy this, they recommend greater utility of network level constructs such as network density, centrality, and multiplicity in contemporary network studies (provan, fish & sydow, 2007). consistent with their recommendations, both network constructs discussed here, exist at the network level of analysis, suggesting that their existence and magnitude are dependent upon the state of the overall network rather than the properties of its individual parts. (c) resource based view (rbv) finally, the study does offer some insight to rbv researchers, especially with respect to inimitability. while many drivers of inimitability, both internal and external, have been previously identified (rumelt, 1984; dierickx & cool, 1989; barney, 1986; barney, 1991; mahoney & pandian, 1992), researchers still struggle to conceptualize and measure these drivers. our stakeholder network approach might prove helpful to these endeavors by first arguing that networks themselves can be effective tools for resource inimitability and by further proposing that network properties, such as network diversity and network consistency, can be used as ‘proxy’ measures of inimitability. both network diversity and network consistency are expected to promote resource complexity, which in turn positively affects resource inimitability and ultimately firm financial performance. however, our results show that neither actually positively moderates the link between cr and firm financial performance. while the effect of network consistency is negligible, the moderating effect of network diversity is highly negative. although the latter finding is unexpected and initially counterintuitive, considered simultaneously with the lack of a relationship between network diversity and cr, this negative finding seems relatively understandable. because there is little tangible reputational advantage from network diversity, there is little financial reward to offset the additional financial, informational and managerial resources expended on acquiring and sustaining these diverse relationships. further, while the complexity of a diverse stakeholder network might be an obstacle to competitor imitation, in the short-term it may also impede the firm’s ability to 139 journal of business strategies effectively manage its existing reputation. thus the perceived pay-off isn’t worth the potential pain we conclude our discussion with a brief description of our empirical limitations. in an effort to be both transparent and balanced we identify some key issues that challenged our methodology and restricted our empirical analysis and ultimately, our findings. limitations: firstly, because of the longitudinal nature of the study, and its dependence on secondary data, there was a need to compromise between optimality and availability. both the kld and fortune databases have been previously criticized for subjectivity, selectivity, content invalidity and financial bias (mattingly & berman, 2006; brown & perry, 1994; luo & bhattcharya, 2006). these shortcomings notwithstanding, the databases offer large sample sizes and multiple years of data. nevertheless, future efforts could be made to either minimize the biases within these measures, or create new instruments to more accurately measure the constructs used. secondly, because the sample is exclusively comprised of large u.s. public firms, questions about the generalizability of our results are warranted. while a more cosmopolitan and inclusive sample would have been preferred, the unavailability of data for either small and/or non-us firms made this unattainable. thirdly, much like the sample selection and measurement choices, the selected time period was somewhat determined by the availability of data. the chosen period, 1995-1999 is associated with general growth and prosperity in the us economy. ironically, this economic health might affect the generalizability of the results, since critics may suggest that the financial welfare of us firms during this period fuelled cr, rather than the other way around. increasing the tenure of years analyzed, as well as using more contemporary data, might assist in overcoming this limitation. conclusion as scholars, we have accepted that the issues related to corporate reputation are vast and often complex. we have also acknowledged that in order for reputation research to be taken seriously as in the realm of strategy and management study, it must submit itself to the rigors of scientific inquiry. this study, while in no means exhaustive, attempts to contribute to the evolution of this scientific inquiry by adopting a novel approach to cr management and empirically testing the benefits of this network treatment to both corporate reputation and firm financial performance. although, we do not find evidence here to 140 journal of business strategies equivocally support or denounce our model, or the strategic stakeholder benefits of the network approach, we strongly suggest that our findings motivate further and richer investigation. finally, while it may possibly raise more questions than its answers, the study hopes to motivate research aimed at investigating the strategic implications and benefits of a network stakeholder approach. references barnett, m. (2007). stakeholder influence capacity and the variability of financial returns to corporate social responsibility. academy of management review, 32, 794-816. barney, j. b. (1991). firm resources and sustained competitive advantage. journal of management, 17, 99-120. baron, r. m., & kenny, d. a. (1986). the moderator-mediator variable distinction in social psychological research: conceptual, strategic and statistical considerations. journal of personality and social psychology, 51, 1173-1182. beggs, j.j., haines, v.a. & hurlbert, j.s. (1996). revisiting the rural-urban contrast: personal networks in non-metropolitan and metropolitan settings. rural sociology, 2, 306-325. berman, s.l., wicks, a.c., kotha, s & jones, t.m. (1999). does stakeholder orientation matter? the relationship between stakeholder management models and firm financial performance. academy of management journal, 42, 488-506. black, j. a. & boal, k. (1994). strategic resources: traits, configurations and paths to sustainable competitive advantage. strategic management journal, 15, 131148. borgatti, s.p. & foster, p.c. (2003). the network paradigm in organizational research: a review and typology. journal of management, 29, 991-1013. brass, d.j., galaskiewicz, j., greve, h.r. & tsai, w. (2004). taking stock of networks and organizations: a multilevel perspective. academy of management journal, 47, 795-817. bromley, d. (2000). psychological aspects of corporate identity, image and reputation. corporate reputation review, 3, 240-252. bronn, c. & bronn, p.s. (2005). reputation and organizational efficiency: a data envelopment analysis study. corporate reputation review, 8, 45-58. brown, b. & perry, s. (1995). halo-removed residuals of fortune’s responsibility to the community and environment: a decade of data. business & society, 34, 199–215. 141 journal of business strategies brown, t.j. & dacin, p.a. (1997). the company and the product: corporate associations and consumer product responses. journal of marketing, 61, 68-84. bulmer, m. (1979). principle of statistics. dover, new york carmeli, a. & tishler, a. (2005). perceived organizational reputation and organizational performance: an empirical investigation of industrial enterprises. corporate reputation review, 8, 13-30. corrado, c.j., & su, t. (1996). skewness and kurtosis in s&p 500 index returns implied by option prices. journal of financial research, 19, 175–92. davies, g., chun, r., da silva, r.v. & roper, s. (2003). corporate reputation and competitiveness. london and new york: routledge. dierickx, i. & cool, k. (1989). asset stock accumulation and sustainability of competitive advantage. management science, 35, 1504-1511. eisenhardt, k. m. & martin, j. a. (2000). dynamic capabilities: what are they? strategic management journal, 21, 1105-1121. fombrun, c. & shanley, m. (1990). what’s in a name? reputation building and corporate strategy. academy of management journal, 33, 233-258. fombrun, c., gardberg, n. & barnett, m. (2000). opportunity platforms and safety nets: corporate citizenship and reputational risk. business and society review, 105, 85-106. fombrun, c.j. (1996). reputation: realizing value from the corporate image. harvard business school press, boston, ma. frazier, p. a., tix, a. p. & barron, k. e. (2004). testing moderator and mediator effects in counseling psychology research. journal of counseling psychology, 51, 115–134. granovetter, m. (1973). the strength of weak ties. american journal of sociology, 78, 1360-1380. granovetter, m. (1992). problems of explanation in economic sociology. in nohria, n., eccles, r.g. (eds.), networks and organization: structure, form, and action, 22-56. hbs press: boston. gulati, r. & gargiulo, m., (1999). where do inter-organizational networks come from? american journal of sociology, march, 177-231. hart, s.l. (1995). a natural-resource-basedview of the firm. academy of management review, 20, 986-1014. helfat, c. e. & peteraf, m. a. (2003). the dynamic resource-based view: capability lifecycles. strategic management journal, 24, 997-1010. 142 journal of business strategies hillman, a. j. & keim, g. d. (2001). shareholder value, stockholder management and social issues: what’s the bottom line? strategic management journal, 22, 125-139. hutton, j.g., goodman, m.b., alexander, j.b. & genest, c.m. (2001). reputation management: the new face of corporate public relations? public relations review, 27, 247-261. jahan, s. & khan, a. (2012). power of t-test for simple linear regression model with non-normal error distribution. journal of scientific research, 4, 609-622. kostova, t. & roth, k. (2003). social capital in multinational corporations and a micro-macro model of its formation. academy of management review, 28, 297317. lee, r. & grewal, r. (2004). strategic responses to new technologies and their impact on firm performance. journal of marketing, 68, 157–171. lewis, s. (2003). reputation and corporate social responsibility. journal of communication management, 7, 356-365. luo, x. & bhattacharya, c.b. (2006). corporate social responsibility, customer satisfaction, and market value. journal of marketing, 70, 1-18. macmillan, k., money, k., downing, s. & hillenbrand, c. (2004). reputation in relationships: measuring experiences, emotions and behaviors. corporate reputation review, 8, 214-233. mahoney, j.t. & pandian, j.r. (1992). the resource-based view within the conversation of strategic management. strategic management journal, 13, 363-380. mattingly, j.e. & berman, s. (2006). measurement of corporate social action: discovering taxonomy in the kinder, lydenburg, domini (kld) ratings data. business and society review, 45, 1-27. mcguire, j. b., sundgren, a. & schneeweis, t. (1988). corporate social responsibility and firm financial performance. academy of management journal, 31, 854-872. money, k. & hillenbrand, c. (2006). beyond reputation measurement: placing reputation within a model of value creation by integrating existing measures into a theoretical framework. working paper presented at the 10th annual conference on corporate reputation, image and competitiveness nelson, r. r. & winter, s. g. (1982). an evolutionary theory of economic change. cambridge, ma: harvard university press. neville, b.a., bell, s.j. & menguc, b. (2005). corporate reputation, stakeholders and the social performance-financial performance relationship. european journal of marketing, 39, 1184-1198. 143 journal of business strategies orlitzky, m., schmidt, f. & rynes, s. (2003). corporate social and financial performance: a meta analysis. organization studies, 24, 403-441. porter, m.e. (1985). comparative advantage. new york: the free press. porter, m.e. (1996). what is strategy? harvard business review, boston, ma. provan k.g., fish a. & sydow j. (2007). inter-organizational networks at the network level: a review of the empirical literature on whole networks. journal of management, 33, 479-516. rao, v., manoj, k.a. & dahlhoff, d. (2004). how is manifest branding strategy related to the intangible value of a corporation? journal of marketing, 68, 126– 141. roberts, p.w. & dowling, g.r. (2002). corporate reputation and sustained superior financial performance. strategic management journal, 23, 1077-1093. rumelt, r. (1984). towards a strategic theory of the firm. in r. lamb (ed.), competitive strategic management, 556-570, englewood cliffs, nj: prentice hall. russo m.v. & fouts p.a. (1997). a resource-based perspective on corporate environmental performance and profitability. academy of management journal, 40, 534–559. sanchez, j. l., & sotorrio, l. (2007.) the creation of value through corporate reputation. journal of business ethics, 76, 335–346. shannon, c.e. (1948). a mathematical theory of communication. bell system technical journal, 27, 379-423 and 623-656. shapiro, c. (1983). premiums for high quality products as returns to reputations. quarterly journal of economics, 98, 659-679. srivastava, r., mcinish, t., wood, r. & capraro, a. (1997). the value of corporate reputation: evidence from equity markets. corporate reputation review, 1, 6267. stanwick, p. a. & stanwick, s.d. (1998). the relationship between corporate social performance and organizational size, financial performance, and environmental performance: an empirical examination. journal of business ethics, 17, 195204. turban, d. b. & greening, d. w. (1997). corporate social performance and organizational attractiveness to prospective employees. academy of management journal, 40, 658-672. us sif report (2012). http://www.ussif.org/files/publications/12_trends_exec_ summary.pdf waddock, s.a. & graves, s. (1997). the corporate social performance-financial performance link. strategic management journal, 18, 303-317. 144 journal of business strategies walsh, g., dinnie, k.j. and weidmann, k.p. (2006). how do corporate reputation and customer satisfaction impact customer defection? a study of private energy customers in germany. journal of services marketing, 20, 412-420. weiss, a.m., anderson, e. & macinnis, d.j. (1999). reputation management as a motivation for sales structure decisions. journal of marketing, 63, 74-89. whetten, d.a. & mackey, a. (2002). a social actor conception of organizational identity and its implications for the study of organizational reputation. business & society, 41, 393-414. wood, d. j., & jones, r. e. (1995). stakeholder mismatching: a theoretical problem in empirical research on corporate social performance. international journal of organizational analysis, 3, 229-267. yoon, e., guffey, h. & kijewski, v. (1993). the effects of information and company reputation on intentions to buy a business service. journal of business research, 27, 215-228. biographical sketch of authors dr. richard peters is an assistant professor of management at xavier university of louisiana. he currently teaches at the undergraduate level in the division of business. his research interests are in corporate social responsibility and sustainability (csrs) and international csrs pedagogy, with a recent emphasis on emerging markets. he has published articles in the international journal of management and enterprise development and journal of management and organization (forthcoming) and has presented at numerous national and regional conferences. he holds a ph.d. from florida atlantic university dr. peggy golden is a professor of management and chair of the management department at florida atlantic university. she has been published in many leading journals including european management journal, strategic management journal and journal of international marketing. her present work is related to knowledge, capabilities and corporate social responsibility. she holds a ph.d. in strategic management, from the university of kentucky. improving bank market performance cheryl j. frohlich university of north florida jacksonville, fl c. bruce kavan university of north florida jacksonville, fl a. coskun samli university of north florida jacksonville, fl abstract the primary assertion of this paper is that banks need to redirect and balance the focus of their business strategy from that of an internal (efficiency oriented) to an external (effectiveness oriented) marketing research program in order to achieve full profit potential. the return on assets (roa) ofbanks has only fluctuatedfrom 0.93% in 1992 to 1.24% in 1997. as one alternative to the flat roa, the industry has engaged in a merger mania and invested in internal, transactionoriented information systems in order to reduce costs and increase the current net income (efficiency driven). however, this,business strategy results in short-run profits to the exclusion of opportunities that may result in long-run profits. 1t is obvious from this flat roa that banks have not been effective. therefore, in order to avoid the danger of banks becoming atrophied, the organizational effectiveness component must be brought into the overall architecture of the bank's information system rather than the simple current emphasis on processing efficiency. this change in business strategy requires a fundamental paradigm shift in the manner in which banking executives view their industry. the business strategy must change from the narrow "provider offinancial service" orientation to the broader "fulfiller of financial needs" orientation. a marketing information research system facilitating such a major shift in orientation is presented. introduction during the last decade, the banking industry has been characterized as one of increasing mergers and acquisitions accompanied by a large amount of technological change. the number of banking institutions decreased from approximately 14,451 in 1982 to 8,774 in 1998, representing a 39 percent decline nationally (fdic statistics on banking, 1998). the higher level of merger and acquisition activity seen in recent times has been in response to a changing regulatory envi~ 108 journal of business strategies vol 16, no.2 ronment including the liberalization of state branching laws (christopher & craig, 1996; helfer, 1997). much of this merger and acquisition activity has been driven by the industry's focus on the bottom line (net income). with the decline of the average money center and regional banks net interest income from 1986 through 1997, an economy of scale (efficiency) merger mania has occurred in order to maintain or improve that bottom line. industry profits are at historic highs; however, it is becoming painfully obvious that these historic profits are a result of the customer absorbing an increasing share of bank cost through increased bank fees. thus, these historic industry profits are not being gen~r­ ated from net interest income of the larger banks that control the majority of deposits. industry profit is being generated from smaller institutions net interest income coupled with the additional "fee for service" income generation and transaction efficiency in larger institutions. industry profits could be even greater if the larger banks were able to increase their net interest spread. could a more effective information technology strategy be an appropriate method for larger banks to increase their profitability through a more favorable net interest spread? literature the excessive bottom-line orientation of the banking industry (deutsch, 1990) has been maintained over the decade by the industry's continued cost-cutting behavior (nelson & owen, 1996). this cost-cutting behavior has been reflected in the industry's development and use of its information technology (it) (mccormick, mcmahon, & kuenne, 1996). a study by the bank administration institute, furash & co, and the wharton financial institutions center (anonymous, 1999 p.18) found that "... in most banks ... visited, it acts as a spending control .... there was surprisingly little analysis of competitive response, performance measurements were simple and there typically has been no decision-review process." thus, information systems have been used to gather and use internal information and increase the efficiency of the bank without a review process involving the external environment (the measure of effectiveness). as pressures on margin and efficiencies from increasing competition has occurred, the response of the banking industry has been "... to look to technology to offer new revenue sources, streamline operations and enhance efficiencies (hilj, 1998, p, 30)." much of the technological development has focused on the gathering of detailed customer information for sales purposes (cline, 1999). in addition, information has been gathered concerning the best branch and atm sites based on data such as population demographics, streets, zip codes, county lines and competitor locations (amato-mccoy, 1999). technology has also been used to reduce internal costs through the automation of transaction intensive applications such as the loan underwriting process (caner, 1999). fall 1999 frohlich, et at: bank market performance 109 research findings reveal banks with a stable customer base show substantial profit increases. the development of long-term relationships with bank customers can be achieved by creating and delivering products desired by those customers. finally, banks have gathered feedback on customer satisfaction to ensure customer satisfaction (licata, weber, & reed, 1998). this later idea addresses the effectiveness of the marketing strategy. few articles (kavan, frohlich, & samli, 1994) have been written on the use of a complete information system that marries the historical efficiency-driven use of technology to reduce costs with the longrun effectiveness of customer satisfaction. according to fornell et al (1996) banks do not rate high on customer satisfaction. thus, there appears a need for the industry to develop an effective information technology strategy that will address this customer satisfaction issue. the need for an effective information technology strategy it has been said that the only constant in the life of an executive is change itself. it should be obvious that yesterday's standards and results are not acceptable in today's operating environment. as markets become more global, opportunities are greater, expectations are higher, and the challenges facing banking executives are more significant than ever. the organizational foundations that are laid today become the basis upon which to build for the future. the primary responsibility of a bank's executive management is to build for the future and insure the perpetuation of the organization through the creation of new value. for the senior information technology (it) executive, value creation must begin with the specification of the information infrastructure that underlies the entire organization. this infrastructure is at the core of a bank's competency, and it manifests itself to the it executive in the form of an architecture. therefore, one of the primary roles of the bank's senior management team is the creation of infrastructure or architecture (kavan, 1998). the infrastructure or system architecture provides a shared vision of the information systems environment required to meet the needs of an organization. thus, for a bank, the architecture represents the technological structure for conducting business. the degree to which such architecture is implemented represents the bank's coordinated response to the market place (i.e., the strategic direction). thus, the technology linkage between a bank business strategy (and vision) and its architecture is a very critical one. the senior management team must actively participate and orchestrate the development of such an actionable business strategy for the bank. this articulation of an organizational strategic response through the successful translation of the strategy into an appropriate and enduring architecture is critical for the perpetuation of the bank. the architecture is achieved by acquiring and directing the technology and organizational resources to support the bank's strategic direction. the degree to which the architecture reflects and is able to support the bank's strategic 110 journal oj business strategies vol. 16, no.2 objectives is reflected in the ability to generate the information necessary to make appropriate market decisions. these market decisions are of the same type (price, product, channels, etc.), and therefore the information needed to drive these decisions is consistent between all types and sizes of institutions. although the information requirements are common, the bank's response to this information may vary based upon individual market characteristics and competitive business strategy. just as smaller banks outsource transaction-processing capabilities to larger correspondent banks, these infrastructure considerations might also be outsourced. all organizations are systems, and banks are no exception. bank organizational systems may be depicted as the bank acquiring resources and transforming these resources (inputs) into products or services (outputs) that are sold in a marketplace. the servomechanism for control of the organizational system is the bank's management team. it is up to this team to ensure that the bank is operationally efficient and effective. efficiency is defined as the ratio of output to input (a necessary condition) whereas effectiveness is associated with the rate of absorption of outputs (products and services) to the environment or marketplace. an organization that utilizes only internal information for strategic decision purposes (efficiency driven) will lose its connection with the "outside world" or environment. this will result in a failure to adapt to undetected change in the environment because internal information is insufficient to detect external change. any system that is not open to its environment will atrophy and die (schoderbek, schoderbek, & kefalas, 1985). thus, the organizational infrastructure or architecture developed for a bank must provide for input (feedback) from the environment or marketplace to insure its perpetuation. the authors contend that many bank information systems or architectures are inherently closed (kavan, frowich, & samli, 1994). in most bank information systems, information for new value creation (product and service) is inherently flawed since the information is acquired only from the bank's existing customer base. this type of data gathering assumes the current customer base is representative of the marketplace as a whole and ignores opportunities not represented within the bank's current customer base. with the prevailing record high levels of bank profits and with no major bank threatened with failure, the incentive to change banking behavior may be lacking. this paper establishes a banking information structure that would avoid the negative effects of the current efficiency driven merger mania. in an effort to construct an architecture that is both efficient and effective, three basic propositions are put forth. first, banks already have certain critical information· regarding their customers. this information, if used properly, provides a solid basis upon which to build an internal bank information management system that is efficiency oriented. second, a comprehensive bank marketing research activity is presented as a critical component missing from most current bank systems. finally, this article presents a strategic information framework that combines current bank internal information systems with externally oriented information required for truly effective marketing oriented decision making. fall 1999 frohlich. et al: bank market performance the efficiency focus 111 financial institutions have failed to adequately respond to a changing environment as evidenced by the inadequate creation of new value demonstrated by their flat return on assets (roa). roa has only fluctuated from 0.93% in 1992 to 1.24% in 1997 (fdic third quarterly report 1997). given current high market returns and the industry's flat roa, the only way to increase return on equity is through leverage, but this increases risk. as one alternative to the flat roa, the industry merger mania continues. in 1995, some 389 mergers worth $57 billion took place (pare, 1995). realizing the problem of the flat roa, financial institutions have invested in internal transaction-oriented systems in order to reduce costs and increase the current net income. however, because of excessive bottom-line orientation (deutsch, 1990), these systems have focused primarily on internal efficiency, which results in short-run profits to the exclusion of opportunities that may result in long-run profits. efficiency, as previously defined, is the ratio of output to input. improved efficiency, therefore, reduces the cost of operation and has an immediate effect on profitability. however, emphasis on internal efficiency does not provide a bank with information concerning some critical issues relative to basic survival. it is extremely important to ask the pertinent questions: what are the benefits for the consumer? what is the consumer looking for? what are the customer's needs (lovelock, 1991)? even though a bank's business is to fulfill the customer's financial needs, most banks still see themselves as providers of financial services. that is, the bank provides a financial service or produces a financial product without first fully assessing the customer's financial need. as a result, as with most service industries, banks do not rate high on customer satisfaction (fornell, et ai, 1996). pare (1995) indicates that the basic business of banking taking deposits and making loans is collapsing (thus the declining net interest spread of the larger banks) and expansion into fee-based business is not happening quickly enough to offset the losses. therefore, banks have been putting emphasis only on efficiency rather than the effectiveness that a good service organization should emphasize. this behavior is contrary to the practice of profitable service organizations. thus, the banking industry has a wrong focus in its business strategy. the paradox of efficiency perhaps the most critical point here is that in the banking industry, more than most other industries, there is a new type of competition in the making. this new type of competition is based upon information. however, this information has been primarily internally oriented. therefore, it cannot be used to establish a competitive advantage and improve market position (lengnick-hall, 1996). organizations operating in today's competitive environment require the adoption of defined strategies as well as the ability to adopt these 112 journal of business strategies vol. 16, no.2 quickly and effectively. while an organization may well have superior products or services today it can quickly lose this leadership position if it does not develop a clear decision-making process and the ability to implement decisions (takac & singh, 1992, p. 32). indeed, the information technology (it) is already developed to provide the bank with a new consumer/market dimension. one aspect of this recent development is "buyer-value" analysis. this methodology enables the bank to identify whom among their prospects will buy what and when. they may even determine why customers select one provider of financial services over another (elliott, swan, & whitmyer, 1995). but none of these opportunities can take place if the banking industry insists on taking the narrow "provider of financial service" orientation rather than the broader "fulfiller of financial needs" orientation. in fact, if the banking industry continues to take the narrow rather than the broader focus in their business strategy, they will continue to lose market share in total consumer assets. in 1980, banks and thrifts had accounted for 54 percent of the financial institutions in the u.s. by december 1994, that share had dropped to 33 percent and by june 1995, it had slipped to 32 percent. fifteen years ago, consumers left about 34 percent of their assets in checking and savings accounts and cds; in 1995 consumers banked only 17 percent in savings (pare, 1995). it is obvious from these statistics that banks have not been effective. in order to avoid the danger of banks becoming atrophied, the organizational effectiveness component must be brought into the overall architecture of the bank's information system rather than the simple current emphasis on processing efficiency. effectiveness organizational effectiveness may be defined as providing financial services for a consumer. typically, such action is rewarded by profits. these profits may not be immediate but may occur over the long-run. this customer oriented focus requires a strategic shift towards more emphasis on the individual needs and less emphasis on the accounting function. from a marketing viewpoint, these two perspectives represent the difference between a production and marketing orientation (deutsch, 1990). in order to prevent the bank from atrophy, it must become open to the environment in a marketing sense. banks still see themselves as providing a product that should be produced efficiently; whereas, the modern marketing concept implies that the product must be first and foremost consumer oriented, in other words, market effective (deutsch, 1990; kavan, frohlich, & samli, 1994). this dichotomy must be accepted and fully explored by bankers in their effort to develop an effective infonnation infrastructure. the banks that consider themselves financial services providers (which the authors maintain most banks do) are likely to develop an efficient information system dealing with primarily the fall 1999 frohlich, et al: bank market peiformance 113 input/output relationship and utilizing the bottom-line (i.e., current year's net income) as the servomechanism for feedback. all of these, input, output, and feedback are internally data dependent. as a result, bankers are attempting to change their environment to fit their products, which again, in marketing terminology is a production orientation (kavan, frohlich, & samli, 1994). market effectiveness requires that product service organizations provide a product and service mix appropriate for a particular group of consumers. banks are no exception to this rule. in other words, banks should adjust themselves to the environment, which is not only a less risky strategy but is also more plausible than trying to adjust the environment to their products. if a bank narrowly defines its business strategy as a financial services provider to consumers rather than the broader business strategy of a consumer-financial service solutions provider, it is likely to look only at efficient ways to make resources available. however, if this broader interpretation of the business strategy is accepted, then it becomes crucial for the bank to understand what kind of satisfaction (market-effectiveness) it is providing, for whom, and how this consumer satisfaction could be enhanced by the bank's services. in other words, banks must think of themselves not as financial service providers, but as consumer financial problem solvers. this broader strategy interpretation will also result in greater long-term profits for the bank. thus, this broader strategy interpretation implies the balancing of internal and external information along with the development of an optimal information infrastructure. the business strategy must change for banks. the information system to facilitate an understanding of the concepts to be enumerated, consider figure 1 (information framework). the organization is depicted with input, process, and output components within the context of an environment or market place. there are many exogenous variables to the organizational system. these exogenous variables include such areas as economy, government, public attitude, competitors, technology, etc. the organizational system exists within an environment that it contributes to, while at the same time the environment affects the system's organizational effectiveness. current banking systems are primarily driven by internal information and are bottom-line oriented. a servomechanism to control feedback governs the organization. this feedback loop interacts with a bank's management decision process and, for the most part with today's banks, relies heavily upon internal information in the input and output relationship rather than these external exogenous variables. in the proper information or infrastructure development, direct feedback from the environment or marketplace must be included. 114 journal of business strategies figure 1 information framework (adapted from schoderbek, et al) efficiency and systemic controls introduce effectiveness r--to adjust for :-products! plan externalities services i feedbkk controls i result of efficiency strategy vol. 16, no.2 if a bank only uses this internal information, there will be an inappropriate emphasis on attempting to control the environment due to banks driving emphasis on minimizing the cost of banking. such bank systems are strictly efficiency oriented (as defined by the ratio of output to input) and do not consider the bank's ability to develop an effective competitive edge by adjusting its information gathering processes to more closely monitor consumer desires. this type of organizational system does not provide for nor integrate the external information required for marketing research. externally based marketing information provides an opportunity for the bank to adapt itself to its environment. without such a component within the bank's information system, the internal system will not be able to adjust to changing externalities. the basic orientation of a bank should be towards controllable systemic variables versus environmentally uncontrollable conditions. however, the current trend toward improved efficiency is, in essence, a veiled attempt by the bank to control variables that, by definition, are uncontrollable environmental conditions. thus, it should be of little surprise that these attempts to fall 1999 frohlich, et al: bank market performance 115 manipulate the environment have had little effect on improving the bank's position within the industry. proposed system framework banks should follow the "accepted" information framework that includes both internal and external information. as figure 1 demonstrates, the critical point is that the bank must adjust to the externalities of the environment. in so doing, the proposed system is an open system. it collects information from without as well as from within. hence, it draws richer information because it is extracted directly from the market and consumer rather than the inadequate internal proxy for those entities. such an open organizational model emphasizes a balance between efficiency and effectiveness. in other words, the entire system is geared toward identifying critical external parameters and internal factors that may be utilized to develop marketing strategies which, in turn, enhance the bank's ability to survive through adjustment to the externally changing environment. additionally, organizational adjustment based upon early consumer reaction is a more superior regulator than waiting for the lagging indicator of short-term profit. such a feedback mechanism must be composed of two generic groups of information psychometrics (economic, demographics, and behavioral) and marketing mix information inputs. bank image research an important aspect ofconsumer analysis involving psychometrics is in the area of bank image and location. although much work has been done in retailing regarding the store image, in bank marketing this is still a neglected area. it has been posited that if the consumer's perception of the retail store's image matches the consumer's self perception, a congruity is developed. such congruity enhances the customer's loyalty towards the store (samli, 1989). it is proposed that such a relationship already exists in banking. however, this implies that bank marketers can successfully measure their bank's image and make it congruent with the self-image of their core customers. this proposition requires quite sophisticated consumer and bank image analyses. location relates to local geographic dimension within which the bank has communication capabilities with current and prospective customers. again, this is a very critical external marketing research activity. this is a particularly germane question in the emerging era of "virtual banks." just as retail establishments have a trading area, banks also have a trading area that needs to be identified, measured and evaluated (samli, 1989) even in cyberspace. marketing mix research marketing mix information inputs deal with the target market customers' behavior regarding the bank and its services, associated price of the services and the customers' mass media exposure. this particular portion of the information sys116 journal of business strategies vol. 16, no.2 tem provides data not only about the target customers' psyche and their perceptions of the bank, as mentioned above, but also how the bank can communicate with that segment and deliver its services (kotler, 1997). cognitive dissonance research the last component of the bank consumer research is related to cognitive dissonance. it is very critical for a bank to realize that cognitive dissonance is very real. in simple terms, cognitive dissonance is defined as having "second thoughts." it implies that after patronizing the bank, the customer may have second thoughts about the rationality of their choice. if cognitive dissonance exists, it might even be stronger in banking than in other types of businesses. because banking is as personal to a consumer as medicine or a relationship with an attorney (samli & frohlich, 1992), consumer satisfaction is unique for each consumer. since most of the bank's activities are dependent upon repeat business, the customer's dissatisfaction with a bank is likely to be exacerbated even more than a typical product or service group's customer dissatisfaction. thus, the bank not only must have proper information to identify its target markets but also must have the proper information about how to develop and deliver its products and establish an effective communication base with its targets to satisfy customer needs. in order to eliminate or reduce this potential cognitive dissonance, both internal and external information must be used jointly to create an information system which facilitates the developing of a marketing strategy that enables the bank to adjust to external conditions and be efficient in this adjustment process. managing the proposed system it must be recognized that such a proposed infrastructure is not a one-point-intime activity, but rather an ongoing or continuous strategic planning process (kavan, 1998). managing such a system is extremely critical. figure 1 provides a general management concept of the organizational system. as illustrated by this figure, the whole process is related to identifying and using internal controllable variables (a bank's resources or strengths) in order to adjust to the externalities which are not controllable. typically, the controllable aspects of internal variables are much more dominant than external variables. it must be emphasized that adjusting to externalities can be achieved more effectively than trying to manipulate the externalities through efficiency. only a mature functional development of a current infonnation system will enable the bank to think in terms of its external information requirements as the missing linkage to the external environment (i.e., customer satisfaction). these external infonnation requirements will identify the type of additional marketing research that should be undertaken and dictate details of the external information gathering process. fall 1999 frohlich, et al: bank market performance 117 continuous performance monitoring (internal) of the proposed information system is critical. feedback (external) should provide insight into a number of vital questions: are the bank's product offerings adequate? does the bank know its target markets? can the bank distinguish the risk factor among its market segments? are there other untapped target markets? is the bank successfully communicating with the consumers who are likely to be in its target markets? are the pricing policies of the bank acceptable to its customers? do recent customers of the bank exhibit the target market's customer features? is there any cognitive dissonance? although performance monitoring and feedback are commonly construed to be one and the same, their functions are conceptually different. this distinction is the difference between short-run marketing research dealing with the bank's performance (monitoring) and the long-run marketing research dealing with the feedback. feedback is used within the context of a bank establishing a certain image in such a manner that it would create a long-term loyalty on the part of its target market's customers. customer loyalty, therefore, is the key feedback factor that should be emphasized in bank marketing (samli, 1989). if the consumers are not quite loyal (feedback), the bank must explore the ways to make them happier and loyal (control). if a bank can project an image that is not only acceptable but also desirable to its customers, it will be able to consider its marketing efforts successful. desirability to the customer is the feedback or control mechanism. a program of ongoing market research generally provides this feedback. therefore, it (feedback) modifies the entire process under conditions of the external environmental (customer) dissatisfaction as illustrated in figure 1. conclusions in the current world, the missed opportunities in market performance are due primarily to an ineffective or totally inapplicable information system. effective decisions require appropriate information one can profit through knowledge. in most cases, banks are currently dealing with internal information systems that emphasize efficiency rather than market effectiveness. as a result, banks are experiencing difficulty in adjusting to their changing market environment. unless change is made, these behaviors will result in atrophy of the individual banking organization. it has been posited in this paper that consumer banks must migrate in the direction of balancing external and internal information requirements to be simulta118 journal of business strategies vol. 16, no.2 neously efficient and effective. efficiency without effectiveness as experienced by many banks is deadly. effectiveness alone is not likely to be very profitable. the framework proposed in this paper implies a need for a heavy commitment to marketing research. consumer banking will have to perceive itself as not just a financial service provider but as a consumer financial problem solver. such a paradigm shift in the bank's strategy will elevate marketing research to an ongoing research activity that provides information for determining appropriate marketing strategies or market focused management. this change in the bank's strategy, coupled with the appropriate use ofthe proposed information system, is likely to be the key for survival under turbulent and adverse market conditions. references amato-mccoy, d. (1999). summit employs mapping system to pinpoint best branch, atm sites. bank systems and technology. 36 (4), 54. anonymous, (1999). bank it decisioning needs tuning up. bank systems and technology. jq..(2), 18. caner, j. (1999). soaring performance. mortgage banking, 59 (6), 58-64. christopher, b. b., & craig, v. v. (1996). recent developments affecting depository institutions. federal depository insurance corporation: fall 1996 banking review (electronic edition). cline. k. (1999). harnessing customer information. banking strategies, 75 (2), 48-54. deutsch, b. i. (1990). a conversation with philip kotler. bank marketing, december, 1420. elliott, m., swan, a.. & whitmyer. l (1995). pursuing profits in retail markets: focus on consumers' hot buttons. bank management, september-october, 70-73. federal deposit insurance company (fdic) third quarterly banking profile (1997) (electronic edition). federal deposit insurance company (fdic) statistics on banking (1998) (electronic edition accessed 6/21/99). fornell, c., johnson, m. d., anerson, e. w., cha, j., & bryant, b. e. (1996). the american customer satisfaction index: nature. purpose, and findings. journal of marketina. 60 (4), october, 7-18. helfer, r. (1997). history of the eighties: lessons for the future. published remarks at fmc symposium. arlington, va, january 16, 1997 (electronic edition). fall 1999 frohlich, et al: bank market performance 119 hill, m. (1998). technology investment in business banking. journal of lending and credit risk, 81 (6), 30-35. kavan, c. b. (1998). profit through knowledge: the application of academic research to information technology organizations. information resources management journal, lui),17-22. kavan, c. b., frohlich, c. j., & samli, a. c. (1994). developing a balanced information system. the journal of services marketing, 8 (1), 4-13. kotler, p. (1997). marketing management, englewood cliffs: prentice hall. lengnick-hall, c. a. (1996). customer contributions to quality: a different view of the customer-oriented firm. academy qfmanagement review. 21 (3),791-824. licata, j. w., weber, j. m., & reed, p. f. (1998). satisfaction surveys: staying on the right side of the tracking. bank marketing, 30 (12), 26-32. lovelock, c. h. (1991). why marketing management needs to be different for services. marketing of services, j. h. donnelly and w. r. george, cds., chicago: american marketing association, 5-9. mccormick, 1. m., mcmahon, s. p., & kuenne, c. b. (1996). scaling the ladder to marketing excellence. banking strategies. 72(5),46-52. nelson, w. l., & owen, a. l. (1996). profits and balance sheet deveiopments:commercial banks in 1996. federal reserve bulletin. 83 (6),465-489. pare, t. p. (1995). clueless bankers. fortune, november 27, 151-158. samli, a. c. (1989). retail marketing strategies, new york: quorum books. samli, a. c., & frohlich, c. 1. (1992). service: the competitive edge in banking. the; journal of services marketing, winter, 15-22. schoderbek, p. p., schoderbek, c. g., & kefalas, a. g. (1985), management systems. (3rd ed). homewood, il: bpi/irwin, 22. takac, p. & singh, c. p. (1992). strategic alliances in banking. mana&ement decision, 30 (1),32. 120 journal of business strategies vol. 16, no.2 cheryl j. frohlich is an associate professor of finance at the university of north florida. she received her ph.d. in finance from the university of illinois. dr. frohlich has taught in numerous management development seminars and has served as a consultant for local banking organizations. the majority of her research has been conducted in the banking industry both on performance and management issues. in addition, she has done substantial research in the mutual fund performance area. c. bruce kavan is the nationsbank professor of information technology at the university of north florida. prior to completing his doctorate at the university of georgia in 1991, he held several positions with dun & bradstreet including vice president of information services for their receivable management services division. dr. kavan is an extremely active consultant in the strategic use of technology, system architecture, and client/server technologies. his main areas of research interest are in interorganizational systems, the delivery of it services, and technology adoption/diffusion. his research has appeared in such publications as mis quarterly, information strateljty: the executive's journal, journal of strategic performance measurement, journal of end user computinljt, information resources management journal, auerback's handbook of is management, and journal of service marketing. a. coskun samli is research professor of marketing and international business at the university of north florida. he received his doctorate from michigan state university where he was a ford foundation fellow with postdoctoral work at ucla, the university of chicago and new york university. dr. samli is a distinguished fellow in the academy of marketing science and a past chairman of its board of governors. he is a frequent international speaker and has served on the fulbright commission. dr. samli is a prolific author with numerous journal articles, books and monographs. improving bank market performance volume 31, number 1 241 a new state-level panel of annual inequality measures over the period 1916 – 2005 mark w. frank sam houston state university • huntsville, tx abstract this paper introduces a new panel of annual state-level income inequality measures over the ninety year period 1916-2005. among many of the states inequality followed a u-shaped pattern over the past century, peaking both before the great depression and again at the time of the new millennium. the new panel reveals significant state-level variations, both before the year 1945, and regionally. while northeastern states are strongly correlated with aggregate u.s. trends, we find many of the western states have little overall correlation over the past century. the availability of this new panel may prove useful to empirical researchers interested in all aspects of income inequality, particularly given the panel’s unusually large number of both time-series and cross-sectional observations introduction as the threat of war loomed, the 16th amendment to the u.s. constitution was ratified on february 3rd 1913, giving the u.s. congress the authority to levy a federal income tax.1 congress followed by adopting a 1% tax on incomes of more than $3,000, with a surtax of 6% on incomes of more than $500,000. since 1916, the internal revenue service (irs) has published income and tax statistics based on information reported on the federal tax returns filed by u.s. individual taxpayers. these annual irs publications provide unique and comprehensive access to the incomes of americans over the past century. the primary innovation of this paper is to use irs income tax filing data to construct a comprehensive state-level panel of annual income inequality measures (the panel may be obtained online at www.shsu.edu/eco_mwf/inequality.html). although irs income data has several important limitations, including the censoring of individuals below a threshold level of income, it has the unique feature of being 1 the 16th amendment states in full: “the congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.” 242 journal of business strategies available annually for each state since the year 1916. current empirical research on income inequality has benefited primarily from the construction of two prior income inequality data sets: the international panel of deininger and squire (1996), and the u.s time-series data of piketty and saez (2003). deininger and squire (1996) offer inequality measures for a wide panel of nations with several time-series observations for each nation beginning in the year 1960. these time-series observations are spaced over multiple decades, with an average of six observations per nation in their high-quality subset of the panel.2 piketty and saez (2003), on the other hand, construct a high-frequency u.s. time-series data set. unlike the large-n small-t panel of deininger and squire, the piketty and saez data contains up to 85 annual observations for the u.s. covering the period 1913-1998. this paper seeks to contribute to the literature on income inequality by providing a third data alternative: a panel which covers an under-exploited unit of observation, u.s. states, and that is large in both cross-sections and time-series observations. while a panel of u.s. states is more homogenous than most cross-national panels, it still retains a useful degree of heterogeneity derived from each state’s unique political/institutional history, and regional heritage. moreover, a moderate amount of cross-sectional heterogeneity would appear to be a useful econometric feature, as the overwhelming cross-sectional heterogeneity in the international panel of deininger and squire (see li, squire, and zou, 1998) has led to some econometric misuse, a point of emphasis in quah (2001) and partridge (2005). our new state-level panel shows that many states followed a distinctive u-shaped pattern over the past century, with inequality peaking both before the great depression and again at the time of the new millennium. this trend is consistent with overall u.s. trends (see piketty and saez, 2003), though we do uncover sizable state-level variability over time. this variability is particularly large before the year 1945, and appears to reemerge during recent years. we also find considerable regional variation, with northeastern states being most closely associated with aggregate u.s. trends, and western states being the least associated. a distinctive feature of our data is its unusually large panel dimensions (n = 51, t = 90). as econometric attention has recently shifted towards the asymptotics of large-n large-t macro panels (see for example, pesaran and smith, 1995; pesaran, shin and smith, 1999; phillips and moon, 1999, 2000), the dimensions of our panel are large enough to exploit these developments. alternatively, given the large number of time-series observations available for each state, traditional time-series 2 u.s. state-level inequality panels of similar dimensions can be constructed from decennial u.s. census data (see for example, partridge 1997, 2005). volume 31, number 1 243 analysis could be performed on each state individually, as one would with the u.s. time-series data of piketty and saez (2003). likewise, the number of cross-sections is large enough for one to sub-sample the time-series observations (e.g. at five, ten, or twenty year intervals) and pursue the use of traditional large-n small-t panel data econometrics, as one would with the international panel of deininger and squire (1996). the structure of the paper is as follows. section 2 introduces our new panel and offers a brief overview of the trends in state-level income inequality. section 3 continues this overview by presenting a comparison of the state-level inequality trends to aggregate u.s. inequality trends. section 4 provides an important discussion of the key limitations inherent with irs income data. section 5 presents several alternative measures of income inequality, and compares these with the top income share measures presented in sections 3 and 4. finally, section 6 offers a brief set of conclusions. trends in state-level income inequality this paper provides a new panel annual state-level income inequality measures. the panel includes the 50 states and the district of columbia, with 90 annual observations for each state except alaska. for alaska, the panel includes annual observations only for the period of statehood (1959 2005). this brings the total number of observations to 4,547. the inequality measures are constructed using data published in the irs’s statistics of income on the number of returns and adjusted gross income (before taxes) by state and by size of the adjusted gross income.3 the pre-tax adjusted gross income reported by the irs is a broad measure of income. in addition to wages and salaries, it also includes capital income (dividends, interest, rents, and royalties) and entrepreneurial income (self-employment, small businesses, and partnerships).4 notable income exclusions include interest on state and local bonds, and transfer income from federal and state governments. further details on the construction of the inequality measures are provided in the appendix. 3 for the years 1916 to 1973, and 1975 to 1981, the data are available in the statistics of income, individual income tax returns annual series. the 1974 volume of this series was never published, but the data are available from the 1974 edition of statistics of income: small area data. data for the years 1982 to 1987 were tabulated by the irs, but never included in any of the publicly available irs publications. upon our request, however, charles hicks with the irs graciously provided the data. for the years 1988 to 2005, the data are available in the statistics of income bulletin quarterly series. 4 the irs does not provide a meaningful separation of these income sources for each income group at the statelevel, however. hence, unlike piketty and saez (2003), we will be unable to assess the relative impact from changes in each income source (wages and salaries, capital, or entrepreneurial) on income inequality. 244 journal of business strategies table 1 descriptive statistics of the top income shares variable mean standard deviation min. annual mean (year) max. annual mean (year) variance decomposition across state over time top 1% income share 11.3% 4.3 7.5 (1978) 20.3 (2005) 27.8% 72.0% top 10% income share 34.5% 5.9 28.2 (1953) 45.5 (1916) 23.0% 77.1% one must be cautious when using irs income data, however, given the truncation of individuals at the low-end of the income distribution. for this reason, we will follow piketty and saez (2003) in focusing our attention on top income shares as primary indicators of inequality trends. descriptive statistics for the top 1% and top 10% income shares are presented in table 1. figure 1 presents the annual trends in these two income shares averaged over the states. shaded areas show periods of recession as defined by the national bureau of economic research (nber). both measures of inequality display a distinct u-shaped pattern over the sample period. in the early part of the century, the state-averaged top decile peaked at 45.5% in 1916, and again at 44.1% in 1928. thereafter, the top decile began a substantial decline, particularly during the great depression and world war ii (see also goldin and margo 1992). the income share of the top 10% fell to a sample-low of 28.2% in 1953. after decades of post-world war ii stability, large increases in inequality began in the 1980s, with a significant part of this increase occurring after the tax reform act of 1986 (see also levy and murnane 1992, gottschalk 1997, and krueger 2003). by the final year of the sample, the top decile share reached 43.8%, a level just below the 1916 peak, and the second highest value in the ninety year sample. the state-averaged top 1% share of income followed a similar pattern. after early peaks in 1916 and 1928 (17.2% and 17.8%, respectively), the top 1% declined substantially in the 1930s. following a prolonged four-decade period of gradual decay, the top 1% attained a sample minimum of 7.5% in 1978. substantial increases followed in the 1980s, with the top 1% reaching a ninety-year sample-peak of 20.3% in 2005. volume 31, number 1 245 figure 1 trends in average state-level income inequalityfigure 1 trends in average state-level income inequality 25 % 30 % 35 % 40 % 45 % 50 % 0% 5% 10 % 15 % 20 % 25 % 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 year... top 1% (left scale) top 10% (right scale) nber recession table 1 also presents an analysis of variance for the two top income shares. approximately three-fourths of the variation in inequality is due to variation through time, while one-quarter is due to variation across states. this decomposition contrasts with the international inequality panel of deininger and squire (1996), where approximately 90% of the variation is cross-sectional, while only 10% is through time (see li, squire, and zou 1998, and quah 2001). two implications arise from these differences: first, the state-level panel is more balanced in its variation, and second, unlike the international panel, the state-level panel varies predominately through time, rather than across sections. the second feature is noteworthy given the econometric problems that arise with the common use of fixed-effect or first-difference estimators when a substantial proportion of the variation occurs through the cross-sections (see barro 2000, quah 2001, and partridge 2005). 246 journal of business strategies table 2 top decile income shares by state and decade a ll ye ar s l at e 19 10 s 19 20 s 19 30 s 19 40 s 19 50 s 19 60 s 19 70 s 19 80 s 19 90 s e ar ly 20 00 s al l s ta te s 34 .5 39 .5 37 .1 35 .8 31 .2 29 .9 30 .9 31 .3 33 .9 39 .3 41 .9 al ab am a 33 .6 34 .5 35 .9 33 .5 31 .5 29 .8 30 .5 31 .2 33 .2 38 .7 40 .8 al as ka 33 .2 27 .7 28 .8 33 .7 40 .0 38 .7 ar iz on a 32 .8 36 .6 30 .6 29 .2 29 .0 30 .0 30 .7 31 .7 34 .2 39 .7 42 .2 ar ka ns as 33 .9 32 .9 33 .5 31 .7 33 .5 31 .9 32 .6 32 .7 33 .6 38 .3 40 .5 c al ifo rn ia 36 .0 40 .7 40 .0 36 .5 30 .4 29 .8 30 .7 31 .8 36 .0 43 .6 47 .7 c ol or ad o 35 .0 38 .1 36 .8 37 .4 32 .8 30 .4 30 .3 31 .4 34 .2 40 .2 43 .5 c on ne ct ic ut 38 .5 45 .4 44 .2 43 .6 32 .5 31 .0 32 .2 32 .6 36 .4 45 .4 50 .6 d el aw ar e 43 .2 63 .5 52 .8 61 .6 42 .7 39 .8 37 .7 32 .2 33 .5 37 .9 41 .3 d is tri ct o f c ol um bi a 38 .1 42 .7 39 .9 33 .6 32 .1 32 .3 35 .6 36 .1 40 .1 45 .8 51 .0 fl or id a 38 .7 37 .2 41 .3 42 .0 36 .5 33 .2 33 .7 34 .2 38 .5 44 .9 48 .5 g eo rg ia 35 .0 36 .3 36 .1 35 .2 33 .7 30 .9 32 .0 32 .0 34 .6 40 .2 43 .3 h aw ai i 35 .7 50 .2 43 .1 41 .5 30 .2 29 .4 31 .4 31 .2 33 .6 37 .1 39 .3 id ah o 30 .6 32 .4 25 .0 25 .3 27 .2 28 .6 29 .6 31 .2 32 .6 38 .1 40 .6 illi no is 36 .2 44 .1 42 .6 39 .6 31 .9 29 .8 30 .5 30 .4 34 .5 41 .6 44 .6 in di an a 32 .4 36 .0 37 .0 36 .1 28 .5 27 .0 28 .4 29 .3 31 .7 36 .7 38 .1 io w a 32 .0 29 .2 33 .6 32 .7 30 .3 29 .1 29 .9 30 .3 32 .2 35 .9 36 .9 k an sa s 33 .1 33 .3 32 .3 32 .9 31 .5 29 .5 30 .6 31 .6 34 .0 38 .0 39 .8 k en tu ck y 33 .9 37 .1 38 .0 35 .7 30 .2 30 .1 31 .0 31 .2 33 .3 37 .7 39 .1 lo ui si an a 34 .7 43 .0 35 .3 33 .1 31 .7 31 .2 31 .9 32 .2 35 .3 39 .9 41 .4 m ai ne 34 .2 39 .9 40 .5 40 .0 30 .2 29 .4 29 .6 30 .8 31 .7 36 .3 38 .8 m ar yl an d 35 .0 43 .1 42 .2 37 .9 31 .5 29 .1 30 .7 30 .4 33 .2 38 .2 41 .2 m as sa ch us et ts 37 .1 49 .8 45 .7 40 .3 31 .4 29 .9 31 .3 31 .2 34 .4 41 .9 46 .3 m ic hi ga n 34 .2 43 .9 42 .7 38 .3 28 .9 28 .4 29 .1 29 .2 32 .1 37 .7 39 .4 volume 31, number 1 247 m in ne so ta 34 .6 40 .5 38 .9 37 .3 30 .7 29 .5 30 .7 30 .9 33 .4 38 .7 41 .1 m is si ss ip pi 34 .2 37 .2 33 .4 32 .2 34 .4 31 .9 32 .1 32 .3 33 .9 38 .4 40 .0 m is so ur i 35 .5 41 .8 41 .1 39 .1 32 .6 30 .8 31 .3 31 .1 33 .7 38 .7 40 .5 m on ta na 31 .7 32 .5 28 .8 28 .4 29 .4 28 .5 30 .0 31 .3 33 .4 37 .8 40 .8 n eb ra sk a 33 .3 30 .8 31 .9 32 .8 31 .7 30 .8 31 .7 31 .8 33 .8 38 .4 40 .5 n ev ad a 34 .8 28 .9 29 .0 37 .2 31 .4 30 .5 31 .3 32 .5 36 .9 44 .2 48 .2 n ew h am ps hi re 33 .9 40 .6 37 .7 37 .5 29 .5 28 .2 29 .2 30 .2 32 .9 38 .7 41 .3 n ew j er se y 35 .8 44 .5 41 .8 38 .1 30 .4 28 .8 30 .5 31 .2 35 .0 42 .0 45 .1 n ew m ex ic o 32 .2 33 .8 28 .4 28 .8 29 .9 29 .4 31 .0 32 .4 33 .9 38 .2 40 .3 n ew y or k 40 .6 56 .2 50 .2 44 .4 35 .1 33 .2 34 .0 32 .4 37 .4 45 .6 50 .7 n or th c ar ol in a 35 .6 41 .5 39 .5 40 .4 33 .3 31 .2 31 .8 31 .1 33 .4 38 .3 40 .8 n or th d ak ot a 31 .1 27 .3 27 .0 27 .0 30 .1 30 .7 30 .6 32 .1 32 .9 36 .1 37 .8 o hi o 34 .0 44 .9 41 .4 38 .1 30 .0 28 .0 29 .0 29 .3 32 .3 37 .1 38 .7 o kl ah om a 35 .1 44 .6 38 .6 35 .4 30 .8 31 .0 31 .9 32 .4 35 .3 38 .4 41 .1 o re go n 32 .9 37 .8 33 .9 32 .0 30 .5 28 .7 29 .5 30 .6 32 .8 38 .4 40 .4 pe nn sy lv an ia 35 .6 47 .6 44 .1 40 .1 30 .6 28 .9 29 .9 29 .9 33 .4 39 .1 41 .7 r ho de is la nd 36 .7 52 .4 46 .3 43 .1 31 .8 30 .1 30 .6 31 .0 33 .5 38 .2 41 .0 so ut h c ar ol in a 32 .5 32 .4 33 .2 32 .4 30 .8 29 .0 30 .1 30 .3 32 .2 37 .7 40 .1 so ut h d ak ot a 32 .3 25 .8 27 .6 29 .4 30 .1 30 .6 31 .3 32 .4 34 .3 39 .7 41 .1 te nn es se e 35 .0 37 .7 38 .0 35 .0 32 .5 30 .9 32 .4 32 .1 34 .2 39 .9 42 .0 te xa s 35 .9 39 .7 34 .1 34 .6 32 .3 31 .9 32 .8 33 .8 37 .3 42 .7 45 .4 u ta h 31 .8 34 .9 33 .0 32 .6 27 .6 26 .9 28 .4 29 .8 31 .7 38 .4 40 .3 ve rm on t 33 .7 44 .8 37 .1 33 .2 30 .2 29 .9 31 .2 30 .6 32 .5 36 .9 39 .5 vi rg in ia 34 .0 38 .0 36 .1 34 .9 31 .0 30 .0 31 .3 31 .2 33 .1 38 .5 41 .4 w as hi ng to n 31 .6 36 .1 30 .5 29 .4 27 .3 27 .7 28 .3 29 .9 32 .2 39 .4 42 .6 w es t v irg in ia 31 .6 39 .0 35 .6 33 .4 27 .2 27 .4 28 .9 29 .0 30 .7 35 .0 36 .5 w is co ns in 33 .0 39 .1 38 .0 35 .8 29 .3 27 .9 29 .1 29 .3 31 .9 36 .8 38 .6 w yo m in g 32 .8 36 .2 28 .6 30 .6 29 .7 28 .0 30 .1 31 .0 33 .0 41 .4 46 .9 248 journal of business strategies the distinguishing feature of our panel is the construction of annual inequality measures for each of the states. table 2 shows the income shares of the top decile for each state averaged over the decades. figure 2 shows the individual state-level trends in the top 1% and 10% income shares.5 the lowest level of income inequality over the ninety year period occurred in north dakota (with an average top decile share of 30.6%), while the highest level occurred in delaware and new york (43.2% and 40.6%, respectively). table 2 shows that the highest level of inequality over the sample period occurred most frequently in the early 2000s (33 of the states), or in the late 1910s (17 of the states). for a majority of the states, the minimum level of inequality occurred during the 1950s (33 states). comparing the state-level trends in the top decile presented in figure 2 with the average-state trend presented in figure 1, the average pearson’s correlation is 0.85. the four lowest pearson’s correlations occurred in north dakota, south dakota, delaware, and idaho (0.39, 0.48, 0.51, and 0.57 respectively). the remaining states vary between a correlation of 0.67 and 0.99 (virginia and new mexico, respectively), with an average correlation of 0.89. twenty-three of the states in fact have a very strong correlation (over 0.90) with the average-state. perhaps the most salient feature of income inequality trends over the past century is the distinct u-shaped pattern noted in figure 1. to further evaluate this pattern, in table 3 we estimate the quadratic equation top10% = β0 + β1 year + β2 year2 for the average-state and each individual state. from this estimation, β2 > 0 indicates a u-shaped parabola, while β2 < 0 indicates an upside down u-shaped parabola. in all cases except alaska, β2 is both positive and statistically significant at the 1% level, indicating a u-shaped function that opens upward. moreover, we can estimate the minimum year of the parabola as -β1 / (2 β2). most states have this estimated vertex in the 1940s, 1950s, or 1960s (45 of the states plus d.c.). the remaining five states, however, are outliers with an estimated minimum that is either before this period (alaska, north dakota, south dakota, and idaho), or after (delaware). hence, with the possible exception of these five states, the fit of a u-shaped pattern appears reasonable and consistent. comparison of state-level inequality to u.s. inequality aggregate u.s. trends in income inequality from irs income data have been explored before, most notably by piketty and saez (2003), who construct several 5 each state’s trends may also be viewed online at: www.shsu.edu/eco_mwf/inequality.html. volume 31, number 1 249 figure 2 individual state-level trends in income inequality 250 journal of business strategies table 3 top decile income shares by state and decade β0 β1 β2 ( x10,000) r2 minimum all states 226.3 -0.231 0.589 69.3 1958.1 alabama 182.0 -0.186 0.475 65.7 1955.6 alaska 28.1* -0.032* 0.089* 77.7 1778.1* arizona 172.8 -0.177 0.455 67.4 1947.8 arkansas 96.6 -0.099 0.254 58.6 1947.2 california 326.3 -0.333 0.851 79.2 1956.7 colorado 227.1 -0.232 0.592 60.8 1957.5 connecticut 380.1 -0.388 0.989 69.2 1959.6 delaware 262.2 -0.264 0.667 51.3 1982.0 district of columbia 278.2 -0.285 0.729 79.3 1952.3 florida 234.5 -0.239 0.612 51.4 1956.2 georgia 185.2 -0.189 0.484 68.0 1955.0 hawaii 310.3 -0.315 0.802 74.9 1965.9 idaho 122.8 -0.127 0.327 75.5 1936.4 illinois 334.9 -0.341 0.870 72.7 1961.1 indiana 227.8 -0.232 0.592 54.1 1960.3 iowa 106.6 -0.109 0.279 38.1 1952.7 kansas 137.6 -0.141 0.361 63.1 1950.8 kentucky 190.3 -0.194 0.495 58.7 1959.6 louisiana 206.2 -0.211 0.538 74.4 1956.2 maine 232.9 -0.237 0.603 53.5 1964.5 maryland 287.5 -0.293 0.745 74.2 1963.0 massachusetts 393.6 -0.401 1.021 78.0 1962.3 michigan 313.0 -0.319 0.811 66.2 1963.8 minnesota 245.9 -0.251 0.639 62.6 1960.5 mississippi 118.1 -0.121 0.309 57.1 1952.3 missouri 240.8 -0.245 0.624 66.6 1963.0 montana 132.8 -0.136 0.351 70.4 1943.4 nebraska 108.5 -0.111 0.286 66.5 1946.2 nevada 166.1 -0.171 0.440 62.7 1941.2 new hampshire 269.2 -0.274 0.700 66.2 1960.1 new jersey 347.2 -0.354 0.903 77.0 1959.9 new mexico 112.4 -0.116 0.298 70.5 1940.6 6 recent years in these series are available from the web page of emmanuel saez. volume 31, number 1 251 new york 447.1 -0.455 1.159 79.3 1962.9 north carolina 220.4 -0.224 0.571 59.5 1963.3 north dakota 27.2 -0.029 0.076 78.9 1879.5 ohio 299.3 -0.305 0.775 68.5 1964.1 oklahoma 235.0 -0.239 0.611 43.5 1960.1 oregon 206.8 -0.211 0.540 77.8 1955.7 pennsylvania 351.7 -0.358 0.911 74.5 1963.8 rhode island 359.0 -0.365 0.928 79.6 1966.4 south carolina 159.1 -0.163 0.416 69.9 1953.2 south dakota 65.5 -0.068 0.178 81.9 1916.6 tennessee 197.8 -0.202 0.516 67.7 1957.2 texas 199.8 -0.204 0.524 75.8 1951.0 utah 220.1 -0.225 0.575 65.9 1954.8 vermont 238.4 -0.243 0.619 68.7 1960.9 virginia 199.7 -0.204 0.521 65.8 1957.4 washington 231.8 -0.237 0.608 78.5 1951.5 west virginia 215.0 -0.219 0.558 61.3 1960.9 wisconsin 244.8 -0.249 0.636 65.3 1961.4 wyoming 227.3 -0.233 0.598 77.3 1948.4 note: estimated fit based on the quadratic equation: top10% = β0 + β1 year + β2 year 2, where β2 > 0 indicates a u-shaped parabola, with the minimum year estimated by: -β1 / (2 β2). *: indicates estimated coefficients are not statistically significant at the 10% level. all other coefficients are statistically significant at the 1% level. annual time-series measures of u.s. top income shares beginning in the year 1913. figures 3 presents a comparison of our new state-level inequality panel with the aggregate u.s. time-series data of piketty and saez. the solid line shows the trend in the (unweighted) state average of the top decile income share from our new state-level panel. the dashed line is the aggregate u.s. top decile income share from piketty and saez (2003).6 individual points are the state-level observations from our new panel. 7 piketty and saez (2003) omit the year 1916 in their construction of the top 10% share of income. 252 journal of business strategies figure 3 comparison of top 10% income share from the new state-level inequality panel to the u.s. time-series data of piketty and saez (2003)figure 3. comparison of top 10% income share from the new state-level inequality panel to the u.s. time-series data of piketty and saez (2003) though one would not expect an exact match, our unweighted state-average follows closely the aggregate u.s. inequality trend reported by piketty and saez, particularly after world war ii. the mean top 10% share of income averaged across the states from our panel is 34.5%. in the u.s. time-series data of piketty and saez, the mean top decile share of income is 37.3% for the sample period. the minimum annual share of income is 28.2% in the state-level panel sample, and 31.4% in piketty and saez (both occurring in 1953), while the maximum annual share is 45.5% in our panel, and 46.3% in piketty and saez (1916 and 1932, respectively).7 overall, the pearson’s correlation coefficient between the two series is 0.77. for the period after world war ii, however, the pearson’s correlation increases to 0.99. the tighter fit after 1945 is in part due to the greater degree of state-level variability before world war ii. in the period 1916 to 1941, for example, the standard deviation of the top decile is 0.074. after world war ii the standard deviation decreases by about one-third, to 0.049. it is noteworthy that the higher variability reemerges at the end of the sample period: if one considers only the five decade period 1945 to 1995, the standard deviation of the top decile is only 0.034, less than half the pre-world war ii value. figure 4 provides a time-series comparison of each state’s top decile to the 8 not shown in figure 4 are the states of alaska and hawaii. the correlation values for these states are 0.91 and 0.81, respectively. volume 31, number 1 253 u.s. top decile income share from the piketty and saez (2003) data. while the average pearson’s correlation among the states is 0.63, there is notable regional variation. the northeastern states most closely fit the overall u.s. trend, with correlation values above 0.83 for many of these states (connecticut, maine, massachusetts, maryland, new hampshire, new york, ohio, pennsylvania, and rhode island). many of the western states, however, have a low correlation to the u.s. trend. several in fact have correlation values of less than 0.10 (arizona, idaho, montana, new mexico, north dakota, and south dakota).8 figure 4 state-level correlations of the top 10% income shares to the u.s. time-series data of piketty and saez (2003) figure 4 state-level correlations of the top 10% income shares to the u.s. time-series data of piketty and saez (2003) al az ar ca co ct dedc fl ga id il in ia ks ky la me md ma mi mn ms mo mt ne nv nh nj nm ny nc nd oh ok or pa ri sc sd tn tx ut vt va wa wv wi wy [-0.14,0.46] (0.46,0.69] (0.69,0.83] (0.83,0.89] correlation values to the extent that our new panel will be used in future empirical research, it is noteworthy that the moderate state-level heterogeneity evident in figure 4 offers several potentially important econometric advantages over the use of aggregate u.s. time-series data. the larger number of observations increases the degrees of freedom, and along with the enhanced variability, helps alleviate the multicollinearity problems which often plague time-series studies. it has been noted extensively elsewhere that panel data are also likely to improve the efficiency of the econometric estimates, reduce aggregation bias, and allow for the construction of more complicated econometric models (see for example, baltagi 2005, p.4-9; hsiao 2003, p.1-8). 254 journal of business strategies 9 the appendix explains the construction of these measures. for a formal treatment of their properties, see cowell (1995) chapters 2 and 3. limitations of irs tax data a significant limitation of irs income data is the omission of some individuals earning less than a threshold level of gross income. this threshold varies by age and marital status, as well as the tax filing year. for this reason, we have followed piketty and saez (2003) in focusing on measures of top-income shares as our primary indicators of inequality. other non-irs data sources have the clear advantage of not omitting these low-income individuals, but these sources are either not available annually, such as the decennial census, or, in the case of the march current population survey (cps), are only available annually for more recent years. akhand and liu (2002), moreover, provide evidence that these survey-based alternatives suffer additional bias resulting from an “over-reporting of earnings by individuals in the lower tail of the income distribution and under-reporting by individuals in the upper tail of the income distribution” (p. 258). the irs, unlike the march cps or census bureau, will penalize respondents for income reporting errors. the omission of low-end income earners in irs data is most problematic before the 1940s, when the number of tax returns filed each year was relatively small. figure 5 displays the overall trends in the number of tax returns filed each year (see hollenbeck and kahr 2008), as well as trends in the size of the u.s. population. in the first few years after passage of the 16th amendment in 1913, the number of tax returns ranged from only 330 thousand to 440 thousand per year. as a result of significant tax law changes in 1916 and 1917, the number of tax returns rose to over 7.2 million in 1920. over the following two decades, the number of returns grew little, climbing only to 7.7 million in 1939. the introduction of lower income filing requirements in 1940 caused the number of returns to increase rapidly in the early 1940s, surpassing 55 million in 1947. as figure 5 shows, the yearly increases in the number of tax returns filed after 1947 follow closely the changes in the u.s. population. additional measures of income inequality figure 6 presents the annual trends in four additional measures of income inequality: the relative mean deviation, gini coefficient, atkinson index, and theil’s entropy index. the figure shows changes in each measure based on their 1916 values. unlike the two top income shares, these four additional measures focus on assessing inequality over the entirety of the income distribution. while analytically more apvolume 31, number 1 255 pealing, this feature comes with a drawback in the context of irs income data, given the truncation of some individuals at the low-end of the income distribution. each of these four additional measures represents a different class of inequality measures (based on transfer principles and decomposability), with the relative mean deviation being the least analytically attractive, and the theil entropy index being the most.9 figure 5 comparison of the number of individual income tax return filed to the u.s. population figure 5. comparison of the number of individual income tax return filed to the u.s. population figure 6 comparison of additional income inequality measures (1916 = 100) figure 6. comparison of additional income inequality measures (1916 = 100) 256 journal of business strategies 10 the source of income (wages and salaries, capital, or entrepreneurial) might also be a contributing factor in this estimated relationship. piketty and saez (2003) show, for example, that those in the upper-end of the distribution derive their income disproportionately from capital. however, since the irs does not separate these income sources for each income group at the state-level, we are unable to assess this further. the relative mean deviation can be defined as representing the average absolute distance between each person’s income and the mean income of the population. it varies between zero and two, with larger values indicating higher inequality. unlike the other three measures, the relative mean deviation fails to satisfy even the weak principle of transfers, meaning it is possible to have a reallocation of income without an associated change in inequality. over our sample period, the relative mean deviation has a mean and standard deviation of 0.66 and 0.11, with a range of annual averages between 0.49 and 0.84 (occurring in 1941 and 2005, respectively). table 4 shows that the evolution of the relative mean deviation over the sample is closely correlated with both the atkinson index and gini coefficient. the gini coefficient can be defined as representing the average distance between all pairs of proportional income in the population. it varies between zero and one, with higher values indicating greater inequality, and is known for being sensitive to transfers in the middle of the income distribution (cowell 1995, p.23). the gini coefficient satisfies the weak principle of transfers, meaning any reallocation of income will be associated with a change in overall inequality. like the relative mean deviation, however, the gini coefficient has the unattractive property of being non-decomposable. hence, it is possible for each subgroup in the population to experience an increase in inequality, while overall inequality shows a decrease. this property makes it difficult to disaggregate changes in overall inequality into changes among specific subgroups of the population. over our sample period, the gini coefficient has a mean value of 0.47, with a standard deviation of 0.07. as table 4 shows, it is most closely correlated with the relative mean deviation. the atkinson index of inequality is a social welfare function based measured of inequality bound between zero and one, with higher values indicating greater inequality. it is analytically appealing since it is both decomposable and satisfies the weak principle of transfers. the atkinson measure we employ uses an inequality aversion parameter (ε) of 0.5, meaning the index is more sensitive to changes in the upper-end of the income distribution. the mean and standard deviation for the atkinson index over our sample period is 0.19 and 0.05, with a range of annual averages between 0.13 and 0.28 (occurring in 1920 and 2000, respectively). volume 31, number 1 257 table 4 correlations of the inequality measures atkinson index gini coefficient relative mean deviation theil entropy index top 10% income share top 1% income share atkinson index 1.000 gini coefficient 0.875 1.000 relative mean deviation 0.915 0.975 1.000 theil entropy index 0.905 0.798 0.829 1.000 top 10% income share 0.838 0.741 0.794 0.924 1.000 top 1% income share 0.729 0.604 0.642 0.886 0.926 1.000 it is apparent from figure 6 that the gini coefficient, and to a lesser extent the relative mean deviation and atkinson index, portray two pronounced differences over the last ninety years when compared with the two top income shares. first, the decrease in inequality after the great depression and world war ii is not as precipitous. second, the gini coefficient surpasses its pre-great depression high in 1985, more than a decade before either of the two top income share measures. one possible explanation for these relative differences is that inequality in the upper-end of the income distribution fell considerably more at mid-century. hence, the smaller decline in the atkinson index, gini coefficient, and relative mean deviation are meaningful differences driven by the broad nature of inequality captured by these three measures. the top 1% and 10% income shares, by contrast, are not broad distributional measures, and thus portray meaningful distinctions. alternatively, it is plausible that the additional measures are simply inefficient measures of inequality in the context of irs income data, since irs data is truncated below a threshold level of income, as discussed in the previous section.10 258 journal of business strategies 11 the number of state-level income groups reported by the irs varies by year. (over our ninety year sample period, the irs used an average of 23 income groups per state per year.) following the concerns raised by morgan (1962, p.281), for years with fewer than seven income groups we scaled the inequality measures for that year based on the difference between the group-restricted and unrestricted measures of u.s. inequality. table 4 shows that the top 10% income share is most closely correlated with the fourth and final additional measure, theil’s entropy index. the theil index is an unbound derivative of statistical information theory where larger values indicate greater income inequality. it is both decomposable and, unlike the other inequality measures, satisfies the strong principle of transfers. the latter is exclusive to generalized entropy indexes, and implies that changes in inequality from reallocations of income depend only on the relative distances between individuals, not their locations within the overall distribution. in figure 6, the theil index appears to closely follow the trend of the top 1% share of income, with high levels of income inequality at the beginning and end of the sample, and low levels of inequality between 1940 and 1980. over the sample period, the mean and standard deviation for the theil index are 0.49 and 0.21, with an annual average range of 0.34 to 0.86 (in 1974 and 2005, respectively). conclusions for many u.s. states the income share of top income earners has experienced a distinct u-shaped pattern over the last century. following early-century peaks in measures of income inequality, inequality declined substantially during the great depression and world war ii. the lowest level of income inequality for many states occurred during the 1950s. after decades of post-world war ii stability, however, large increases in income inequality began again in the 1980s, with a significant part of this increase occurring after the tax reform act of 1986, and continuing throughout the 1990s. there appears to be significant state-level variations, however, both before the year 1945, and regionally. while northeastern states appear most closely associated with overall u.s. trends, western states show the least amount of association. the dual peak in income inequality before the great depression and again during the new millennium raises important economic, political, and sociological questions. this paper seeks to contribute to these discussions by providing a comprehensive state-level panel of annual income inequality measures covering the ninety year period 1916 to 2005. recent empirical research on income inequality has usually relied on the aggregate u.s. time-series data of piketty and saez (2003), or the low-frequency cross-national panel of deininger and squire (1996). state-levvolume 31, number 1 259 el panels, though underutilized relative to international panels, can be constructed in low-frequency form using data from the decennial census (e.g., partridge 1997, 2005), or for more recent years using the march current population survey (e.g., doyle, ahmed, and horn 1999). important caveats arise with our new panel, however, since our measures of inequality are constructed from individual tax filing data available from the internal revenue service. although irs income data is the only informational source available annually for each state since 1916, it does not include income on some individuals at the low-end of the income distribution. the censoring threshold varies by age, marital status, and most notably, tax filing year. as a consequence, our data appears best suited for assessing changes in the upper-end of the income distribution. used in conjunction with other existing data, it is hoped that the availability of our ninety year annual state-level panel can further illuminate both the causes and consequences of the income inequality changes over the last century. for example, an early version of this data set covering the period 1945-2004 was used to explore the association of income inequality on economic growth during the post-war period (see frank 2009a and 2009b). clearly the large and balanced size of our new panel offers several potential advantages in the furthering empirical research surrounding income inequality. by combining variation across states with the variation over time, a state-level panel offers less-collinearity, a greater ability to control for unobserved heterogeneity, and improvements the efficiency of the econometric estimates over strictly time-series data. the greater number of observations in the panel increases the degrees of freedom, and allows for the testing of more complicated econometric models. moreover, following of the same states over time permits one to control for both state-invariant and time-invariant variables, and better enables the study of dynamics and speed of adjustment than either purely time-series or cross-sectional data. finally, following the same states over a long period permits exogenous variation in policies and institutions, and facilitates the identification of parameters of interest. appendix – construction of the inequality measures since irs income data is reported in income groups, the percentile ranking measures are based on the split histogram interpolation method proposed by cowell (1995), whereby the proportion of the sample population with income less than or 12 the sample population includes only tax-filers; those not filing taxes are not included in the reported irs income data. section iv discusses the important limitations associated with of this exclusion. 260 journal of business strategies equal to income y is defined as f(y)=fi+ y ∫ a i φi(x)dx, (1) where ai is the lower bound of group i, and fiis the cumulative frequency of the number of individuals before group i.11 the proportion of the total income received by those with income less than or equal to is given by ϕ(y)=ϕi+ 1—μ y ∫ a i xφi(x)dx, (2) where μ is mean income. the density within each interval i is defined by the split histogram density: (3) φi= fi(ai+1-μi) (ai+1-ai)(μi-ai) , for ai ≤ x ≤ μi fi(ui-ai) (ai+1-ai)(ai+1-μi) , for μi ≤ x ≤ ai+1 where fi is the relative frequency of ni within group i, and ai+1 is the upper bound of group i.12 the gini coefficient we construct is the compromise gini coefficient proposed by cowell and mehta (1982) and cowell (1995). accordingly, the lower limit of the gini can be derived based on the assumption that all individuals in a group receive exactly the mean income of the group: (4)gl = 1—2 k ∑ i=1 k ∑ j=1 ninj nμ | μi -μj |, where n is the number of individuals, and subscripts i and j denote within group values. the upper limit gini can be constructed based on the assumption that individuals within the group receive income equal to either the lower or upper bound of the group interval: (5)gu = gl + k ∑ i=1 n2i (ai+1-μi)(μi-ai). n2i μ(ai+1-ai) given equations (4) and (5), the compromise gini coefficient proposed by cowell and mehta (1982) is simply: gu 2/3+gl 1/3. volume 31, number 1 261 the remaining three measures can be derived using the general form: j = k ∑ i=1 a i +1 ∫ a i h(y)φi (y)dy, (6) where φi .is the split histogram density, and h(y)is an evaluation function. to construct the atkinson index, the evaluation function is defined as: h(y) = ( y—μ )1-ε (7) where 1-j1/1-ε. note that ε is the atkinson inequality aversion parameter. the evaluation function for the relative mean deviation is defined as: h(y) = | y=y -1| (8) to construct the theil entropy index, the evaluation function is defined as: h(y) = y—μ ln( y—μ ) (9) unlike the percentile rankings, gini coefficient, or relative mean deviation, the atkinson index and theil index are undefined for negative incomes. hence, to construct the atkinson and theil inequality measures, negative irs income data must be truncated, meaning the lowest possible income, a1, is $0. biographical sketch of author mark frank is a professor of economics and international business at sam houston state university. he received his ph.d. from the university of texas at dallas. his research interests include telecommunications regulation, the economics of advertising in the liquor industry, and income inequality in the united states. references akhand, h., & liu, h. (2002). income inequality in the united states: what the individual tax files say. applied economics letters, 9(4), 255-259. baltagi, b.h. (2005). econometric analysis of panel data/ badi h. baltagi. new york, n.y.: john wiley & sons. barro, r.j. (2000). inequality and growth in a panel of countries. journal of economic growth, 5(1), 5-32. cowell, f.a. (1995). measuring inequality, (2nd ed.). new york and toronto, n.y.: 262 journal of business strategies simon and schuster international, harvester wheatsheaf/prentice hall, london cowell, f.a., & mehta, f. (1982). the estimation and interpolation of inequality measures. review of economic studies, 49(2), 273-290. deininger, k., & squire, l. (1996). a new data set measuring income inequality. world bank economic review, 10(3), 565-591. doyle, j.m., ahmed, e. & horn, r.n. (1999). the effects of labor markets and income inequality on crime: evidence from panel data. southern economic journal, 65(4), 717-738. frank, m. w. (2009). inequality and growth in the united states: evidence from a new state-level panel of income inequality measures. economic inquiry, 27(1), 55-68. frank, m. w. (2009). income inequality, human capital, and income growth: evidence from a state-level var analysis. atlantic economic journal, 37(2), 173-185. goldin, c., & margo, r.a. (1992). the great compression: the wage structure in the united states at mid-century. quarterly journal of economics, 107(1), 1-34. gottschalk, p. (1997). inequality, income growth, and mobility: the basic facts. journal of economic perspectives, 11(2), 21-40. hollenbeck, s., & kahr, m.k. (2008). ninety years of individual income tax statistics, 1916-2005. statistics of income bulletin, 27(3), 136-147. hsiao, c. (2003). analysis of panel data. (2nd ed.). cambridge university press. krueger, a.b. (2003). inequality, too much of a good thing. inequality in america: what role for human capital policies?, eds. j.j. heckman & a.b. krueger, mit press, cambridge, 1-75. levy, f., & murnane, r.j. (1992). u.s. earnings levels and earnings inequality: a review of recent trends and proposed explanations. journal of economic literature, 30(3), 1333-1381. li, h., squire, l., & zou, h. (1998). explaining international and intertemporal variations in income inequality. economic journal, 108(446), 26-43. morgan, j. (1962). the anatomy of income distribution. the review of economics and statistics, 44(3), 270-283. partridge, m.d. (2005). does income distribution affect u.s. state economic growth?. journal of regional science, 45(2), 363-394. partridge, m.d. (1997). is inequality harmful for growth? comment. american economic review, 87(5), 1019-1032. volume 31, number 1 263 pesaran, m.h., shin, y. & smith, r.p. (1999). pooled mean group estimation of dynamic heterogeneous panels. journal of the american statistical association, 94(446), 621-634. pesaran, m.h. & smith, r. (1995). estimating long-run relationships from dynamic heterogeneous panels. journal of econometrics, 68(1), 79-113. phillips, p.c.b. & moon, h.r. (2000). nonstationary panel data analysis: an overview of some recent developments. econometric reviews, 19(3), 263-286. phillips, p.c.b. & moon, h.r. (1999). linear regression limit theory for nonstationary panel data. econometrica, 67(5), 1057-1111. piketty, t. & saez, e. (2003). income inequality in the united states, 1913-1998. quarterly journal of economics, 118(1), 1-39. quah, d. (2001). some simple arithmetic on how income inequality and economic growth matter, working paper edition, london school of economics. 22 journal of business strategies the enduring importance of entrepreneurial motivation for growth abayomi k. akinboye university of canterbury • christchurch, new zealand jamie d. collins university of canterbury • christchurch, new zealand sussie c. morrish university of canterbury • christchurch, new zealand abstract for decades entrepreneurship scholars have advanced the frontier of knowledge in venture growth. more recently the desire to understand the motivation for different phases of business development (e.g., initiation, growth, and exit) has necessitated a review of literature on venture growth and the motive for entrepreneurial actions at these stages. we have conducted a comprehensive and critical review of empirical contributions on venture growth and entrepreneurial motivation. interestingly, we identified a lack of unity in the meaning and measures of growth as the reason for the fragmentation in theory development. we highlight that the motives for engaging in entrepreneurial actions may differ based on the stage of entrepreneurial development. we also highlight the importance of keeping entrepreneurial motivations as a major focus area for scholars in this domain particularly as an enabler of growth intention. introduction entrepreneurship is a foundational component required for economic and societal achievement. the creative prowess entrepreneurs bring to the task of solving the needs of others in society can spark a virtuous cycle of improved market efficiencies, economic growth, enhanced standards of living, and higher levels of health, as well as providing accompanying improved educational and societal outcomes. given these benefits from entrepreneurial activity, it is therefore in the interest of all economies that enterprise grows. the numerous potential benefits of entrepreneurship and increasing motivation for societal impact have contributed to the flourishing of entrepreneurship research over the past several decades. volume 37, number 2 23 entrepreneurial growth intention entrepreneurial intention beyond start-up is gaining momentum in entrepreneurship research, and growth intention is increasingly a focus of interest. while there are many drivers of entrepreneurial growth, scholars seem to be nearly unanimous in the view that growth intention precedes actual growth (knockaert et al., 2015; puente et al., 2017; rasmussen et al., 2016). entrepreneurs’ growth intention has been found to evolve as entrepreneurs interact with the environment, which presents opportunities and constraints. intention to growing ventures in such an environment is motivated by perceived opportunities, achievement needs and perceived ability to navigate such environment (davidsson, 1989, 1991). the motivation for start-up usually determines the venture types, and that commonly influence the growth intention of entrepreneurial firms (edelman et al., 2010; jayawarna et al., 2013; morris et al., 2016). internationalising entrepreneurial firms with their export propensity are also found to have growth intention (moen et al., 2016). for example, spence et al. (2011) noted that owners of firms that internationalise early expressed their intention to pursue growth, and this was notably lacking in their counterparts owning domestic new ventures. equally seen as important is entrepreneurial passion. some scholars believe that motivation has more to do with start-up while passion has been attributed to strength to continue the entrepreneurial process despite challenges along the way; therefore entrepreneurial passion and persistence are strongly linked (cardon & kirk, 2015). entrepreneurial passion has been anchored on the entrepreneur’s self-identity (baker et al., 2017; morris et al., 2016) with the role salient to the self-identity of the entrepreneur such as inventing, founding and developing used to describe the passion of entrepreneurs (cardon et al., 2013). generally speaking, these identities are linked to intention (biraglia & kadile, 2017; dalborg & wincent, 2015) while identity such as passion for developing is positively related to growthoriented entrepreneurs (cardon et al., 2013; mueller et al., 2017). the importance of cognition in the evolution of growth intention has also attracted much attention from scholars. entrepreneurial cognition observes the complex interaction between the entrepreneur and the environment (armstrong et al., 2012; baldacchino et al., 2015). in a very recent study, akinboye, morrish and collins (2019) found the dominance of emotion over cognition in the formation of growth decisions and acknowledges the hostile and limiting role of the context in which they operate, hence dwindling motivation to pursue entrepreneurial opportunities that could lead to growth. entrepreneurs’ decision and intention for 24 journal of business strategies growth-oriented ventures have been linked to their cognitive styles and logics (dutta & thornhill, 2008; wright & stigliani, 2013), thus worthy of further investigation. defining growth entrepreneurship scholars have discussed venture growth for decades with limited progress in pinpointing precise cause-effect relationships. leitch et al. (2013) argue that for almost 50 years, researchers have shown substantial interest in this entrepreneurial phenomenon. however, the journey has been stagnated by the complexity and confusion surrounding it. the inconsistencies in the way growth have been measured (weinzimmer et al., 1998) in extant literature alluded to the fact that it has a different meaning to stakeholders. gibb (2000) noted that the four main stakeholders (policymakers, business owners, academics, and others, e.g., customers, funders, and suppliers) attached a different meaning to this phenomenon. to some, growth means more jobs created while others see growth as the generation of greater revenues. this is also evident in academic research as different scholars use a range of different measures to assess business growth. policymakers’ interest in employment creation means they favour using “number of employees” as a measure of growth, while business owners with a desire for profitability prefer sales-related indicators. these two measures dominate the entrepreneurship literature. for example, weinzimmer et al. (1998), analysed 193 firms in 48 industries using comparative regression analysis and found that the significance of relationships between growth and the explanatory variables, as well as the amount of explained variance, is subject to the particular concept of growth utilised. furthermore, they noted that sales growth (42.8%) was better explained with a set of commonly used explanatory variables from literature than were either employee growth (29.2%) or asset growth (28.3%) using various formulas. interestingly, this view was supported by others accepting that “for most purposes, sales is the more relevant growth indicator” (davidsson et al., 2009, p.395). some scholars advocated for an inclusive measure (delmar et al., 2003; havnes & senneseth, 2001; o’gorman, 2001), stressing that using integrated measures will provide a comprehensive examination of any empirical relationships and allow testing for the robustness of any theoretical model (dobbs & hamilton, 2007). however, mckelvie & wiklund (2010) maintain that the advancement of knowledge stalled in venture growth research due to the focus on “how much” rather than on the “how”. volume 37, number 2 25 mode of growth for the advancement of knowledge in venture growth research, there needs to be a shift in focus from growth rate to growth mode. scholars have suggested that more attention should be given to “how” growth occurs before answering the “how much” question (mckelvie & wiklund, 2010; wright & stigliani, 2013). in a review of 82 empirical studies from 11 top management journals ranging from 1992 to 2006 (shepherd & wiklund, 2009), several attempts were made by scholars to explain differences in growth but totally ignoring the process or path of growth. as a result, the literature on venture growth has been highly fragmented making it difficult to compare studies (shepherd & wiklund, 2009) which according to davidsson & wiklund (2008) has hindered theoretical advancement. in order to unravel the complexity surrounding firm growth as an entrepreneurship phenomenon as well as “keep up with changes in how contemporary firms choose to grow”, it is expedient that there is practical clarification of growth mode (nason & wiklund, 2018, p. 54). in the same vein, gilbert et al. (2006) in their extensive review of literature on new venture growth note that without a proper understanding of growth mode, it will be difficult to explain growth outcomes and how their underlying mechanisms (either internal or external) produce different impact. mckelvie and wiklund (2010) support this view and arguing that prioritising research on modes of growth is imperative for a better understanding of the causal mechanisms that explain growth. entrepreneurship scholars have classified the process by which growth can occur into three modes: organic, acquisitive, or hybrid ( koryak et al., 2015; lockett et al., 2011). organic growth (also referred to as internal growth mode) relied on product development and internal research and development (chen, zou, & wang, 2009) and firms that focus on organic growth invest in r&d for possible new product opportunities in order to enhance their product portfolio (zahra, 1996). consequently, firm’s innovation ability is enriched, leading to strong technological capability with frequent product upgrades, patents as well as valuable technology sources which spur organic growth (zahra et al., 2006). organic growth brings about genuine job creation, but employment growth in an acquisition is usually a form of movement of jobs from one firm to another (chen et al., 2009). growth through acquisitions is a mode whereby a business acquires an existing firm or business in the same or other business areas. this strategy provides the fastest trajectory for strategy implementation and growth such as market expansion, however, firms that follow this path are often faced with the challenge of integration which is absent in organic growth (agnihotri, 2014). although growth 26 journal of business strategies through acquisition does not provide any net increase to the economy but afford firms opportunities to reach and explore new markets without developing (davidsson et al., 2010; gilbert et al., 2006). this is worth noting because a study of a dataset comprising a 10-year panel (1987–96) of more than eleven thousand commercially active swedish enterprises in the private (non-government) sector with 20 or more employees by lockett et al. (2011) discovered something interesting. they found that firms that have organically grown in the past might find it difficult to experience another organic growth, whereas past acquisitive growth is found to lead firms into future organic growth. therefore, a combination of growth strategies (hybrid) becomes necessary to overcome “traditional limits to firm growth” resulting from environmental dynamism of business landscape (dagnino et al., 2017, p. 427). entrepreneurial growth intention and actual growth studies have found evidence that firm personal growth objectives are themselves predictive of subsequent growth (delmar & wiklund, 2008; wiklund & shepherd, 2003). in a longitudinal study of swedish entrepreneurs, delmar & wiklund (2008) found small business owners’ growth motivation have a positive impact on subsequent venture growth regarding employment growth, but in term of sales growth, the evidence is limited. establishing this kind of relationship requires longitudinal data: collecting data at the intentional stage and after that as well. another study conducted in finland (stenholm, 2011) examined longitudinal data from 232 small and medium-sized businesses. the results show the existence of a positive relationship between growth intention and firm growth, but innovative behaviour weakens this relationship. previous studies that confirmed this relationship have also shown that the relationship between growth intention and realised growth is mediated or moderated by other factors such as resources and opportunities (delmar & wiklund, 2008; wiklund & shepherd, 2003). the evidence reviewed here seems to suggest a pertinent role for growth intention as predictor of growth. with the perceived benefits to the economy, venture growth research has enjoyed attention for decades (mason & brown, 2013). douglas (2013) suggests that entrepreneurial intention should extend beyond start-up intention in order to identify firms with growth tendency. integrating heterogeneous opportunities and ‘individual-opportunity nexus’ in the entrepreneurial intentions model, douglas found that entrepreneurs at the intentional stage show different growth intention, which eventually impacts their choice between independence and growth-oriented new ventures. volume 37, number 2 27 determinants of small business growth in an attempt to classify growing firms, entrepreneurship scholars have investigated factors seen as determinants of growth. these factors are broadly categorised as external and internal. however, various scholars approach these classifications differently. in particular, some studies focused on the entrepreneurs and the context (environment) (hitt et al., 2000). others looked at the entrepreneur, the firm and the strategy of the firm. moreover, baum, locke, & smith’s (2001) large us study (with a sample of 307 companies in the same industry) found that entrepreneur’s motivation have a direct impact on venture growth while the environment has indirect effects. the motivation result from self-efficacy, growth goals and vision with other factors such as general and specific competencies of the chief executive officers as well as competitive strategies. in a later longitudinal study, baum & locke (2004) examined entrepreneur’s motivation (comprising goals, selfefficacy, and vision) finding that all three have direct effects on venture growth. growth occurs at the intersection of three spheres: entrepreneur, firm and strategy. all these components must connect properly for rapid growth. the entrepreneur makes decisions, and the firm chooses the right strategy for the execution. non-growing or failing firms are often deficient in at least one area. the ultimate challenge is the appropriate combination of these components. the presence and proper combination of these characteristics can be a predictor of growth, while the absence or neglect of one or more could be a barrier to growth. for instance, the willingness of the entrepreneur to share equity with external entities such as banks and angel investors could accelerate growth while their reluctance could be a barrier or constraint on growth. interestingly, wiklund et al. (2003) found that firms that experience little or no growth are primarily due to their unwillingness to grow. thus, the most strategic decision lies with the entrepreneur (shepherd et al., 2015; vermeulen & curşeu, 2010) and decisions on “how much to grow” is often made in the early years of the firm which “have profound, long-lasting implications for performance” (gilbert et al., 2006, p.929). understanding the decision-making process of the entrepreneur is imperative. as research in the field of entrepreneurship advances, scholars have turned their attention to cognitive variables to understand the growth-related decision of the entrepreneurs (armstrong et al., 2012; baldacchino et al., 2015). according to wright & stigliani (2013), an attentive perusal of entrepreneurs’ growth decisions as well as the knowledge structures and cognitive styles used in the process will advance knowledge in the field of entrepreneurship. indeed, entrepreneurial decision-making 28 journal of business strategies can not be overemphasised as founders decisions on which activities to delegate or engage in themselves determine a venture’s survival and growth (haeussler, hennicke, & mueller, 2019). in a longitudinal qualitative study of 30 entrepreneurs in western canada over a five-year span, dutta & thornhill (2008) found that entrepreneurs’ cognitive styles determine their approaches toward framing and reviewing growth intention. their study further revealed that their cognitive style shapes entrepreneurs’ growth intention resulting from their environmental perceptions. knockaert et al. (2015) also maintain that the formation and promotion of growth intention among academic entrepreneurs are contingent upon cognitive style. evidence suggests that cognitive style plays a vital role in the formation of growth intention, however, little is known about this in other contexts. for example, some regions offer a unique characteristic from the rest of the developed world. a significant number of the empirical works done on entrepreneurial growth were conducted in sweden and the united states. however, entrepreneurship scholars have stressed the importance of the context in which the entrepreneur operates. there is substantial evidence that contextual factors like location, industry, market, environmental hostility and institutional environment affect entrepreneurial behaviour (puente et al., 2017; wiklund, patzelt, & shepherd, 2009). barriers to small business growth small and medium enterprises (smes) are a catalyst that spurs economic growth. their growth means more jobs and revenue for the economy, however, their pursuit of growth is not without challenges (collins & reutzel, 2017, collins, mcmullen & reutzel, 2016). there is a considerable volume of literature on barriers to smes growth involving studies conducted in developed and developing economies as well as transition economies. the findings show that some of these barriers are peculiar to economic status. in a survey of 219 smes in western canada, gill & biger (2012) found that a number of issues could hinder smes growth. some of the issues identified are market challenges, lack of financing and regulatory issues. this view is supported by lee (2014), who investigated obstacles to high-growth firms’ performance in the united kingdom using quantitative data from 4,858 smes. the results suggest that firms in periods of high growth face challenges such as cash flow, securing finance, shortages of skilled labour and finding suitable premises but are less likely to see regulation as a major challenge. in addition, romero-jordán et al. (2019) studied the impact of corporation tax on productivity growth in spain and found that smes growth in the area of productivities is hampered by corporation tax volume 37, number 2 29 more than the bigger firms. in new zealand, hansen & hamilton (2011) identified “controlled ambition of the owner-manager to grow” as a major obstacle to growth. while documenting the evolution of small business policy in australia and new zealand in the last 46 years, mazzarol & clark (2016) claimed that access to financing and credit is a pertinent issue. exploring investor readiness in australia, douglas & shepherd (2002) suggest that the venture capital industry in australia is less mature compared to the us. in another set of studies carried out in former centrally planned economies that have transited or are transiting to a market economy, researchers found that entrepreneurs in this type of environment face something unique. for example, hashi (2001) surveyed smes in albania and reported that the primary barriers to smes growth are those caused directly or indirectly by the state. the study noted that financial constraints resulting from fiscal policy (mainly high rate of taxes and contributions coupled with the poor institutional environment) hinders entrepreneurs. similarly, krasniqi (2007: 71) studied 178 smes in kosovo and concluded that “legal environment, administrative burden, external financing, tax burden and unfair competition” hinder the growth of smes. additionally, other factors associated with the institutional environment, such as external financial constraints as a result of the high cost of capital and bureaucracy, were also identified (bartlett & bukvič, 2001). attempting to sort out the most significant obstacles facing smes in developing countries, wang (2016) analysed data from 119 developing nations and noted that access to finance is perceived as the most significant obstacle by owner-managers. although there are other issues such as political instability, lack of electricity and corruption, barriers to external financing (because of the high costs of borrowing) ranked the highest. almost every study conducted in various developing countries on growth supported these findings. for instance, across india, researchers discovered that small business growth is hindered by a variety of challenges which include the shortage of working capital, power shortage, market challenges, regulatory issues and management problems (coad & tamvada, 2012; gill & mand, 2013). robson & obeng (2008) surveyed 500 entrepreneurs from all six regions in ghana and reported the three greatest problems highlighted by these entrepreneurs comprising of the high rate of inflation, high-interest rate and currency depreciation. another study from south africa noted that “difficulty in securing loans, lack of training opportunities, and shortage of entrepreneurial skills” adversely influenced small, micro and medium-sized business enterprises (worku, 2016, p. 134). although some of these factors are unique (depending on the circumstances surrounding the 30 journal of business strategies economies), collectively, evidence reviewed here outline a critical role of finance in entrepreneurial growth as financial issues resonated across all economic status. similarly, beck & demirguc-kunt (2006: 2942) in their review of literature on access to funding by small and medium-size enterprises concluded: “that access to finance is an important growth constraint for smes”. acknowledging the role of resource constraints in the entrepreneurial process, scholars in the field of entrepreneurship have paid close attention to effectuation logic for over a decade which emphasises available resources as a “source of entrepreneurial opportunity” and “resource constraints as a source of creativity” (fisher, 2012, p. 1039). effectuation has promoted the means (what i am, what i know and whom i know) of the entrepreneur as a way of dealing with constraint posed by lack of resources. moreover, as entrepreneurs strive to deal with the challenges of growth, effectual principles offer them a lifeline in a dynamic environment. growth and smes’ internationalisation growth through internationalisation has been identified as another alternative through which smes overcome barriers to growth (omer et al., 2015; veronica et al., 2019). internationalisation is seen as the expansion of target market from domestic to international markets by new ventures, and this is considered a vital performance driver that can increase firm feasibility (zahra et al., 2000). smes are often faced with stiff challenges which limit their ability to grow domestically (hessels & parker, 2013). scholars have examined the internationalisation process of smes, and this is not without challenges (collins & reutzel, 2016). contractor et al. (2007) acknowledge the impact of internationally expanding companies on the financial performance of firms as the process produces high costs and uncertainties. however, a quantitative study conducted by pinho & prange (2016) in portugal with 107 sme exporters, found that social network relationships of firms will positively affect their international performance. they further noted that obstacles in the internationalisation process could be minimised with the help of dynamic internationalisation capabilities through exploitative and explorative dynamic capabilities. this concept of network relationships has attracted scholarly attention because it is fundamental to internationalisation strategies (kampouri et al., 2017). it has been noted that networks play a crucial role in smes’ effort to reduce information asymmetry with the provision of access to information that is relevant to their international survival and growth (zhou et al., 2007). in most cases, firms’ volume 37, number 2 31 decision to establish network relationship is a thoughtful strategic choice which is based on the resources they lack and the assets or resources that another actor in the network can offer (hessels & parker, 2013). in particular, networks are necessary for small and medium-sized firms (smes) in foreign markets because of the challenges posed by lack of knowledge and resource constraints needed for internationalisation (gilmore et al., 2006). for optimal export performance, brouthers et al. (2009) suggested that small firms from small countries should concentrate on a few overseas markets. conversely, casey & hamilton (2014: 254) examined a sample of 249 small new zealand exporters reported that exporters should not just focus on one or a few foreign markets, however, they acknowledged that to be successful these small firms will spend more on r&d and embrace “multi-market exporting through company-owned channels in distant markets”. interestingly, galkina & chetty (2015) discovered that by utilising effectual logic entrepreneurs network with interested parties rather than making careful selection from numerous international partners and they do this by entering markets wherever an opportunity occurs establishing commitment with network relations that can increase their means. the network approach to smes’ internationalisation is gaining recognition and helping international new ventures to overcome and navigate foreign markets with the associated challenges. considering the size and the distance of australia and new zealand to the rest of the developed world, taking the growth path of internationalisation leaves smes with daunting obstacles that could be managed through effectual principles. there are three significant modes of entry into international market, e.g. “foreign technology licensing, imports of intermediate production inputs and exporting”(abubakar et al., 2019, p. 60). from empirical evidence, smes prefer an incremental approach such as exporting, presenting them the advantage of learning effects (dominguez & mayrhofer, 2017). “in the process of exporting, smes gain exposure to various foreign markets and gradually build networks with local clients” (lu & beamish, 2006, p.31). exploiting a foreign market via exporting activities allow firms to launch out from their existing domestic base choosing to locate production plants and/or sales and marketing offices in other countries to boost their market development strategy (abubakar et al., 2019). researchers have also linked exporting with innovation (filippetti, frenz, & ietto-gillies, 2012). meeting foreign customer expectations and the required standards in the host nations, firms innovate new products or processes. examining exporting firms’ data from a region in chile between 2006 to 2011, geldres-weiss et al. (2016) found that strategic activities such as export market innovation and 32 journal of business strategies export product innovation enhance experiential knowledge which reduces risk and uncertainty associated with internationalisation. concerning the decision-making process relating to foreign markets selection and entry, chetty et al. (2015) noted that entrepreneurs use effectuation and causation logics, alternating the two in their decision-making. however, those with existing partners in foreign markets relied mostly on effectuation to select and enter international markets. entrepreneurial motivation entrepreneurial cognition is central in the entrepreneurial process (baron, 2004; mitchell et al., 2007). understanding how entrepreneurs think can make understanding their actions more achievable. entrepreneurship researchers have promoted the importance of entrepreneurial thinking because this plays a central role in entrepreneurial decision-making (shepherd et al., 2015; oyson & whittaker, 2015). these questions cut across vital entrepreneurial phenomena such as opportunity identification (baldacchino et al., 2015) and growth: “why are some entrepreneurs more motivated than others to grow their firms?” (wright & stigliani, 2013, p.15). gaglio (2004) proposes counterfactual thinking as one of the mechanisms through which entrepreneurs recognise and nurture innovative opportunities. in an experimental study frederiks et al. (2019) found that the type of cognitive thinking employed by entrepreneurs impacts the quality of new venture ideas. they found that the use of future-oriented thinking such as prospective thinking, which could be enhanced by prior knowledge would lead to new venture ideas of higher quality compared to counterfactual thinking. however, arora et al. (2013) suggest that the amplifying effects of experience could be hampered by the dispositional attributes of the entrepreneur resulting from their individual differences. the heterogeneity of the entrepreneurs’ metacognitive thinking influences entrepreneurial growth decision making (shepherd et al., 2015). ginn & sexton (1990) found that the difference between owners of slower growth firms and rapid growth firms originates from their cognitive profile. sadler-smith (2004) also observed that cognitive styles positively impact sales growth, quality of products and services as well as the efficiency of operations. this shift of attention from traits of the entrepreneur to entrepreneurial cognition offers hope of understanding the entrepreneurial processes with deeper insights into how entrepreneurs think and the effects on entrepreneurial decision making (armstrong et al., 2012). for a more in-depth and better understanding of entrepreneurial cognition, scholars in the field of entrepreneurship have recommended that entrepreneurial volume 37, number 2 33 motivation be revisited (carsrud & brännback, 2011). decision making in different stages of the entrepreneurial process has been heavily linked with motives of entrepreneurs (jayawarna et al., 2013; murnieks et al., 2019). consequently, human motivation should not be overlooked in the entrepreneurial process because the dominant player is the entrepreneur. entrepreneurs make decisions to commence the entrepreneurial process and are regularly called to make decisions all through the entrepreneurial process (shepherd et al., 2015). entrepreneurship scholars have investigated the motives for these entrepreneurial decisions. initially, scholars believed that the primary motivation for entrepreneurial decision is economic gain (carsrud & brännback, 2011) but social entrepreneurship is becoming prominent as some entrepreneurs are now devoted to societal benefit. entrepreneurial motivation for venture start-up there is a considerable amount of research on entrepreneurs’ start-up motivations. these studies have identified factors that drive entrepreneurial motivation. for example, in a quantitative study of 401 nascent entrepreneurs in the united states, edelman et al. (2010) found that desire for recognition and independence as well as financial success motivate entrepreneurs into new venture initiation. studying a sample of 465 university students from cross-sectional data, farhangmehr et al. (2016) established that competencies which are the bedrock of entrepreneurial self-efficacy, significantly predict entrepreneurial motivation. in the same vein, in their quantitative study of 237 samples from eastern poland’s podlasie region, tyszka et al. (2011) suggest that entrepreneurs high in self-efficacy are more motivated to exploit opportunities; however, this is only true with opportunitydriven entrepreneurs (not necessity-driven). to determine the effects of socioeconomic variables, hessels et al. (2008) compared motives across and found that economies with gdp growth will have more entrepreneurs whose motivation for a start-up is to increase wealth while independence and necessity motive is prevalent with economies without gdp growth. they found that social security encourages necessity motive but discourages independence motive and shows no significant relationship with increase-wealth motivation. entrepreneurial motivation for survival the world of business is very complex, and the battle for survival becomes real immediately after venture initiation. however, there is only a relatively small body of literature relating to entrepreneurs’ motivation to survive. an exception is detienne 34 journal of business strategies et al. (2008), that examined factors that motivate entrepreneurs to persist when their firms are underperforming. they propose that their personal investment, previous venture success and perceived efficacy contribute significantly to their persistence, although entrepreneurs with other alternatives apart from underperforming firms are less likely to persist. in a qualitative study of 35 women-led service firms from valencia in spain, rey-martí et al. (2015), suggest that those with risk-taking motive are more likely to survive than those seeking better work-life balance. morris et al. (2012: 12) point out that by the “occurrence of salient events and the manner in which they are processed” profoundly influence risk-taking. hence, entrepreneurs with positive feelings and peak experiences might embrace risk-taking actions while those with low arousal resulting from negative emotions might be riskaverse. stenholm & renko (2016) argue that entrepreneurs with an intense positive feeling associated with an entrepreneurial role such as inventing and developing are likely to engage in “make-do” practices that could promote the survival of their firms. while striving to survive, new ventures try to increase their market presence motivating them to grow in areas that are vital to their survival. entrepreneurial motivation for growth although scholars study entrepreneurial growth extensively, understanding entrepreneurial motivations for growth continues to be an area that requires further investigation. motivation for growth captures the attention of both practitioners and scholars but not as much as motivation for venture start-up (achtenhagen et al., 2010; murnieks et al., 2019). to date, several studies have investigated the impact of motivation on firm growth (baum & locke, 2004; delmar & wiklund, 2008; wiklund et al., 2003) and a relationship has been established between growth motivation and firm growth. questions such as “why are some entrepreneurs more motivated than others to grow their firms?” is suggested for scholarly probing (wright & stigliani, 2013, p.15). moen et al. (2016) analysed the quantitative data from 247 firms over 11 years. they concluded that motivation for growth was highly and frequently associated with international orientation, which greatly influences growth in revenue and exports. a recent study by gielnik et al. (2017) involving a sample of 201 small business managers with over 5 years of their firm performance data (which resulted in 836 observations) found a strong positive impact on venture performance over time for owner-managers who focused on entrepreneurial opportunities. in a multiple case study to characterise high-growth firms in new zealand, (hinton & hamilton, 2013) one of the four dimensions that describe their essential features is opportunity volume 37, number 2 35 exploitation. this again stresses the importance of entrepreneurial opportunity in the growth of firms. furthermore, baum et al. (2001) suggest that vision, growth goals and self-efficacy impact entrepreneurs’ motivation for growth. baron et al. (2016) found that entrepreneurial self-efficacy positively impact venture growth and this relationship is mediated by goal difficulty. tumasjan & braun (2012: 626) argue that “promising business ideas result from forward-looking visions”. they propose that visions build promotion-focused individuals who are open-minded, embracing a variety of ideas to enhance venture performance. in their review of the literature on entrepreneurial growth, wright & stigliani (2013) concluded that there is a need for more empirical studies on factors that influence entrepreneurs’ motivation. a quantitative study of 122 high technology firms in the united states, drnovsek et al. (2016) found that entrepreneurs who enjoy activities associated with the entrepreneurial role identity of a developer are motivated to grow their firms because of their commitment to growth goals. this view is supported by mueller et al. (2017) who argue that passion for developing positively influences grit which positively relates to venture performance. conclusion decades of international entrepreneurship research clearly points to the conclusion that entrepreneurial growth requires sufficient motivation on behalf of entrepreneurs as well as ample economic opportunities. many factors were identified as having the potential to motivate entrepreneurs for growth. a continued systematic effort to understand the nuances of entrepreneurial motivation for growth could be quite fruitful. for example, perceived entrepreneurial opportunity could trigger growth motivation in entrepreneur, which might eventually lead to actual growth. however, it is almost taken as a given that entrepreneurs have a desire to achieve substantial growth. entrepreneurs can have a wide range of motivations (some economic, many non-economic) and automatically assuming an inherent bias towards firm growth does not align with the reality of entrepreneurs around the globe. firm growth frequently requires a willingness to make internal processes more standardized, an ongoing of scan the market for opportunities, the accumulation needed resources, and an increasing complexity in the operations of the firm. the research reviewed herein suggests that entrepreneurs throughout the world have varied motivations that influence the choices made on behalf of their firms. thus, understanding the motivations of entrepreneurs might well be fertile research territory for the next several decades. 36 journal of business strategies references abubakar, y. a., hand, c., smallbone, d., & saridakis, g. (2019). what specific modes of internationalization influence sme innovation in sub-saharan least developed countries (ldcs)? technovation, 7956–70. achtenhagen, l., naldi, l., & melin, l. (2010). “business growth” do practitioners and scholars really talk about the same thing? entrepreneurship: theory and practice, 34(2), 289–316. agnihotri, a. (2014). corporate reputation based theory of choice between organic, hybrid and inorganic growth strategies. corporate communications, 19(3), 247–259. akinboye, a., morrish s., & collins j. (2019), “entrepreneurial motivation and growth intention: an australasian study”, global research symposium in marketing and entrepreneurship, regents university, london, 27-39 june. armstrong, s. j., cools, e., & sadler-smith, e. (2012). role of cognitive styles in business and management: reviewing 40 years of research. international journal of management reviews, 14(3), 238–262. arora, p., haynie, j. m., & laurence, g. a. (2013). counterfactual thinking and entrepreneurial self-efficacy: the moderating role of self-esteem and dispositional affect. entrepreneurship theory and practice, 37(2), 359–385. arregle, j. l., batjargal, b., hitt, m. a., webb, j. w., miller, t., & tsui, a. s. (2015). family ties in entrepreneurs’ social networks and new venture growth. entrepreneurship: theory and practice, 39(2), 313–344. baker, t., grimes, m., hamann, r., hmieleski, k., kim, p., kim, s., pollock, t. (2017). in the beginning: identity processes and organizing in multi-founder nascent ventures. academy of management journal, 60(6), 2381–2414. baldacchino, l., ucbasaran, d., cabantous, l., & lockett, a. (2015). entrepreneurship research on intuition: a critical analysis and research agenda. international journal of management reviews, 17(2), 212–231. barbera, f., & hasso, t. (2013). do we need to use an accountant? the sales growth and survival benefits to family smes. family business review, 26(3), 271–292. baron, r. a., mueller, b. a., & wolfe, m. t. (2016). self-efficacy and entrepreneurs’ adoption of unattainable goals: the restraining effects of self-control. journal of business venturing, 31(1), 55–71. bartlett, w., & bukvič, v. (2001). barriers to sme growth in slovenia. economic policy in transitional economies, 11(2), 177–195. volume 37, number 2 37 bartz, w., & winkler, a. (2016). flexible or fragile? the growth performance of small and young businesses during the global financial crisis evidence from germany. journal of business venturing, 31(2), 196–215. baù, m., chirico, f., pittino, d., backman, m., & klaesson, j. (2019). roots to grow: family firms and local embeddedness in rural and urban contexts. entrepreneurship: theory and practice, 43(2 special issue), 360–385. baum, j. r., & locke, e. a. (2004). the relationship of entrepreneurial traits, skill, and motivation to subsequent venture growth. journal of applied psychology, 89(4), 587–598. baum, j. r., locke, e. a., & smith, k. e. n. g. (2001). a multidimensional model of venture growth. academy of management journal, 44(2), 292–303. beck, t., & demirguc-kunt, a. (2006). small and medium-size enterprises: access to finance as a growth constraint. journal of banking and finance, 30(11), 2931–2943. biraglia, a., & kadile, v. (2017). the role of entrepreneurial passion and creativity in developing entrepreneurial intentions: insights from american homebrewers. journal of small business management, 55(1), 170–188. bradley, s. w., wiklund, j., & shepherd, d. a. (2011). swinging a double-edged sword: the effect of slack on entrepreneurial management and growth. journal of business venturing, 26(5), 537–554. brouthers, l. e., nakos, g., hadjimarcou, j., & brouthers, k. d. (2009). key factors for successful export performance for small firms. journal of international marketing, 17(3), 21–38. cardon, m. s., glauser, m., & murnieks, c. y. (2017). passion for what? expanding the domains of entrepreneurial passion. journal of business venturing insights, 8, 24–32. cardon, m. s., gregoire, d. a., stevens, c. e., & patel, p. c. (2013). measuring entrepreneurial passion: conceptual foundations and scale validation. journal of business venturing, 28(3), 373–396. cardon, m. s., & kirk, c. p. (2015). entrepreneurial passion as mediator of the self-efficacy to persistence relationship. entrepreneurship: theory and practice, 39(5), 1027–1050. casey, s. r., & hamilton, r. t. (2014). export performance of small firms from small countries: the case of new zealand. journal of international entrepreneurship, 12(3), 254–269. carsrud, a., & brännback, m. (2011). entrepreneurial motivations: what do we still need to know? journal of small business management, 49(1), 9–26. 38 journal of business strategies chandler, g. n., mckelvie, a., & davidsson, p. (2009). asset specificity and behavioral uncertainty as moderators of the sales growth employment growth relationship in emerging ventures. journal of business venturing, 24(4), 373–387. chen, x.-p., yao, x., & kotha, s. (2009). entrepreneur passion and preparedness in business plan presentations: a persuasion analysis of venture capitalists’ funding decisions. academy of management journal, 52(1), 199–214. chen, x., zou, h., & wang, d. t. (2009). how do new ventures grow? firm capabilities, growth strategies and performance. international journal of research in marketing, 26(4), 294–303. chetty, s., ojala, a., & leppäaho, t. (2015). effectuation and foreign market entry of entrepreneurial firms. european journal of marketing, 49(9–10), 1436–1459. collins, j. d., & reutzel, c. r. (2017). the role of top managers in determining investment in innovation: the case of small & medium enterprises in india. international small business journal, 35, 1-21. collins, j. d., mcmullen, j. s., & reutzel, c. r. (2016). distributive justice, corruption, and entrepreneurial behavior. small business economics, 47(4), 981-1006. collins, j. d., & reutzel, c. r. (2016). entrepreneurial strategies for emerging markets. journal of business strategies. 33(1). dagnino, g. b., king, d. r., & tienari, j. (2017). strategic management of dynamic growth. long range planning, 50(4), 427–430. daily, c. m., & thompson, s. s. (1994). ownership structure, strategic posture, and firm growth: an empirical examination. family business review, 7(3), 237–249. dalborg, c., & wincent, j. (2015). the idea is not enough: the role of self-efficacy in mediating the relationship between pull entrepreneurship and founder passion a research note. international small business journal, 33(8), 974–984. davidsson, p. (1991). continued entrepreneurship: ability, need, and opportunity as determinants of small firm growth. journal of business venturing, 6(6), 405–429. davidsson, p., achtenhagen, l., & naldi, l. (2010). small firm growth. foundations and trends in entrepreneurship, 69–166. davidsson, p., steffens, p., & fitzsimmons, j. (2009). growing profitable or growing from profits: putting the horse in front of the cart? journal of business venturing, 24(4), 388–406. davidsson, p., & wiklund, j. (2006). conceptual and empirical challenges in the study of firm growth. entrepreneurship and the growth of firms, 1(1), 39-61. volume 37, number 2 39 delmar, f., davidsson, p., & gartner, w. b. (2003). arriving at the high-growth firm. journal of business venturing, 18(2), 189–216. delmar, f., & wiklund, j. (2008). the effect of small business managers’ growth motivation on firm growth: a longitudinal study. entrepreneurship: theory and practice, 32(3), 437–457. detienne, d. r., shepherd, d. a., & de castro, j. o. (2008). the fallacy of “only the strong survive”: the effects of extrinsic motivation on the persistence decisions for under-performing firms. journal of business venturing, 23(5), 528–546. dobbs, m., & hamilton, r. t. (2007). small business growth: recent evidence and new directions. in international journal of entrepreneurial behaviour and research, (13(5), 296-322. dominguez, n., & mayrhofer, u. (2017). internationalization stages of traditional smes: increasing, decreasing and re-increasing commitment to foreign markets. international business review, 26(6), 1051–1063. douglas, e. j. (2013). reconstructing entrepreneurial intentions to identify predisposition for growth. journal of business venturing, 28(5), 633–651. douglas, e. j., & shepherd, d. (2002). exploring investor readiness: assessments by entrepreneurs and investors in australia. venture capital, 4(3), 219–236. drnovsek, m., cardon, m. s., & patel, p. c. (2016). direct and indirect effects of passion on growing technology ventures. strategic entrepreneurship journal, 10(2), 194–213. dutta, d. k., & thornhill, s. (2008). the evolution of growth intentions: toward a cognition-based model. journal of business venturing, 23(3), 307–332. dutta, d. k., & thornhill, s. (2014). venture cognitive logics, entrepreneurial cognitive style, and growth intentions: a conceptual model and an exploratory field study. entrepreneurship research journal, 4(2), 147–166. edelman, l. f., brush, c. g., manolova, t. s., & greene, p. g. (2010). start-up motivations and growth intentions of minority nascent entrepreneurs. journal of small business management, 48(2), 174–196. farhangmehr, m., gonçalves, p., & sarmento, m. (2016). predicting entrepreneurial motivation among university students. education + training, 58(7), 861–881. filippetti, a., frenz, m., & ietto-gillies, g. (2012). the role of internationalization as a determinant of innovation performance: an analysis of 42 countries. cimr research working paper series no. 10 51 (6): 1006–1022 fisher, g. (2012). effectuation, causation, and bricolage: a behavioral comparison of emerging theories in entrepreneurship research. entrepreneurship: theory and practice, 36(5), 1019–1051. 40 journal of business strategies frederiks, a. j., englis, b. g., ehrenhard, m. l., & groen, a. j. (2019). entrepreneurial cognition and the quality of new venture ideas: an experimental approach to comparing future-oriented cognitive processes. journal of business venturing, 34(2), 327–347. gagliardi, f. (2009). financial development and the growth of cooperative firms. small business economics, 32(4), 439–464. gaglio, c. m. (2004). the role of mental simulations and counterfactual thinking in the opportunity identification process. entrepreneurship: theory and practice, 28(6), 533–552. galkina, t., & chetty, s. (2015). effectuation and networking of internationalizing smes. management international review, 55(5), 647–676. geldres-weiss, v. v., uribe-bórquez, c. t., coudounaris, d. n., & monreal-pérez, j. (2016). innovation and experiential knowledge in firm exports: applying the initial u-model. journal of business research, 69(11), 5076–5081. gibb, a. a. (2000). sme policy, academic research and the growth of ignorance, mythical concepts, myths, assumptions, ritual and confusions. international small business journal, 18(3), 13–35. gibb, a., & davies, l. (1990). in pursuit of frameworks for the development of growth models of the small business. international small business journal, 9(1), 15–31. gilbert, b. a., mcdougall, p. p., & audretsch, d. b. (2006). new venture growth: a review and extension. journal of management, 32(6), 926–950. gill, a., & biger, n. (2012). barriers to small business growth in canada. journal of small business and enterprise development, 19(4), 656–668. gill, a., & mand, h. s. (2013). barriers to the growth of small business firms in india. international journal of business and globalisation, 10(1), 1–13. gilmore, a., carson, d., & rocks, s. (2006). networking in smes: evaluating its contribution to marketing activity. international business review, 15(3), 278– 293. haeussler, c., hennicke, m., & mueller, e. (2019). founder–inventors and their investors: spurring firm survival and growth. strategic entrepreneurship journal, 13(3), 288-325. hansen, b., & hamilton, r. t. (2011). factors distinguishing small firm growers and non-growers. international small business journal, 29(3), 278–294. hashi, i. (2001). financial and institutional barriers to sme growth in albania: results of an enterprise survey. economic policy in transitional economies, 11(3), 221–238. volume 37, number 2 41 havnes, p. a., & senneseth, k. (2001). a panel study of firm growth among smes in networks. small business economics, 16(4), 293–302. heshmati, a. (2001). on the growth of micro and small firms: evidence from sweden. small business economics, 17(3), 213–228. hessels, j., & parker, s. c. (2013). constraints, internationalization and growth: a cross-country analysis of european smes. journal of world business, 48(1), 137–148. hessels, j., van gelderen, m., & thurik, r. (2008). entrepreneurial aspirations, motivations, and their drivers. small business economics, 31(3), 323–339. hitt, m. a., ireland, r. d., & lee, h. (2000). technological learning, knowledge management, firm growth and performance: an introductory essay. journal of engineering and technology management, 17(3–4), 231–246. jayawarna, d., rouse, j., & kitching, j. (2013). entrepreneur motivations and life course. international small business journal, 31(1), 34–56. kampouri, k., plakoyiannaki, e., & leppäaho, t. (2017). family business internationalisation and networks: emerging pathways. journal of business and industrial marketing, 32(3), 357–370. knockaert, m., foo, m. der, erikson, t., & cools, e. (2015). growth intentions among research scientists: a cognitive style perspective. technovation, 38, 64–74. koryak, o., mole, k. f., lockett, a., hayton, j. c., ucbasaran, d., & hodgkinson, g. p. (2015). entrepreneurial leadership, capabilities and firm growth. international small business journal: researching entrepreneurship, 33(1), 89–105. krasniqi, b. a. (2007). barriers to entrepreneurship and sme growth in transition: the case of kosova. journal of developmental entrepreneurship, 12(01), 71–94. lee, n. (2014). what holds back high-growth firms? evidence from uk smes. small business economics, 43(1), 183–195. leitch, c., hill, f., & neergaard, h. (2013). entrepreneurial and business growth and the quest for a “comprehensive theory”: tilting at windmills? entrepreneurship theory and practice, 34(2), 249–260. lockett, a., wiklund, j., davidsson, p., & girma, s. (2011). organic and acquisitive growth: re-examining, testing and extending penrose’s growth theory. journal of management studies, 48(1), 48–74. lu, j. w., & beamish, p. w. (2006). sme internationalization and performance: growth vs. profitability. journal of international entrepreneurship, 4(1), 27–48. markman, g. d., & gartner, w. b. (2002). is extraordinary growth profitable? a study of inc. 500 high–growth companies. entrepreneurship theory and practice, 27(1), 65–75. 42 journal of business strategies mason, c., & brown, r. (2013). creating good public policy to support high-growth firms. small business economics, 40(2), 211–225. mazzarol, t., & clark, d. (2016). the evolution of small business policy in australia and new zealand. small enterprise research, 23(3), 239–261. mckelvie, a., & wiklund, j. (2010). advancing firm growth research: a focus on of growth rate. entrepreneurship theory and practice, (315), 261–289. mitchell, r. k., busenitz, l. w., morse, e. a, & smith, j. b. (2007). the central question in entrepreneurial cognition research. entrepreneurship: theory and practice, (806), 1–27. moen, o., heggeseth, a. g., & lome, o. (2016). the positive effect of motivation and international orientation on sme growth. journal of small business management, 54(2), 659–678. moreno, a. m., & casillas, j. c. (2008). entrepreneurial orientation and growth of smes: a causal model. entrepreneurship: theory and practice, 32(3), 507–528. morris, m. h., kuratko, d. f., schindehutte, m., & spivack, a. j. (2012). framing the entrepreneurial experience. entrepreneurship theory and practice, 36(1), 11–40. morris, m. h., neumeyer, x., jang, y., & kuratko, d. f. (2016). distinguishing types of entrepreneurial ventures: an identity-based perspective. journal of small business management, pp. 1–22. mueller, b. a., wolfe, m. t., & syed, i. (2017). passion and grit: an exploration of the pathways leading to venture success. journal of business venturing, 32(3), 260–279. murnieks, c. y., klotz, a. c., & shepherd, d. a. (2019). entrepreneurial motivation: a review of the literature and an agenda for future research. journal of organizational behavior, 1–29. naldi, l., & davidsson, p. (2014). entrepreneurial growth: the role of international knowledge acquisition as moderated by firm age. journal of business venturing, 29(5), 687–703. nason, r. s., & wiklund, j. (2018). an assessment of resource-based theorizing on firm growth and suggestions for the future. journal of management, 44(1), 32–60. nuscheler, d., engelen, a., & zahra, s. a. (2019). the role of top management teams in transforming technology-based new ventures’ product introductions into growth. journal of business venturing, 34(1), 122–140. volume 37, number 2 43 o’gorman, c. (2001). the sustainability of growth in smalland medium-sized enterprises. international journal of entrepreneurial behaviour & research, 7(2): 60-75. omer, n., burg, e. van, peters, r. m., & visser, k. (2015). internationalization as a “work-around” strategy: how going abroad can help smes overcome local constraints. journal of developmental entrepreneurship, 20(02), 1550011. pinho, j. c., & prange, c. (2016). the effect of social networks and dynamic internationalization capabilities on international performance. journal of world business, 51(3), 391–403. puente, r., cervilla, m. a., gonzález, c. g., & auletta, n. (2017). determinants of the growth aspiration: a quantitative study of venezuelan entrepreneurs. small business economics, 48(3), 699–726. rasmussen, c. c., ladegard, g., & korhonen-sande, s. (2016). growth intentions and board composition in high-growth firms. journal of small business management, 00(00), 1–17. rey-martí, a., tur porcar, a., & mas-tur, a. (2015). linking female entrepreneurs’ motivation to business survival. journal of business research, 68(4), 810–814. robson, p. j. a., & obeng, b. a. (2008). the barriers to growth in ghana. small business economics, 30(4), 385–403. romero-jordán, d., sanz-labrador, i., & sanz-sanz, j. f. (2019). is the corporation tax a barrier to productivity growth? small business economics, 1-16. sadler-smith, e. (2004). cognitive style and the management of small and mediumsized enterprises. organization studies, 25(2), 155–181. shepherd, d. a., & wiklund, j. (2009). are we comparing apples with apples or apples with oranges? appropriateness of knowledge accumulation across growth studies. entrepreneurship theory and practice, 33(1), 105–123. shepherd, d. a., williams, t. a., & patzelt, h. (2015). thinking about entrepreneurial decision making: review and research agenda. journal of management, 41(1), 11–46. spence, m., orser, b., & riding, a. (2011). a comparative study of international and domestic new ventures. management international review, 51(1), 3–21. steffens, p., & omarova, a. (2019). global entrepreneurship monitor (gem) 201718 australian national report. stenholm, p. (2011). innovative behavior as a moderator of growth intentions. journal of small business management, 49(2), 233–251. 44 journal of business strategies tumasjan, a., & braun, r. (2012). in the eye of the beholder: how regulatory focus and self-efficacy interact in influencing opportunity recognition. journal of business venturing, 27(6), 622–636. vermeulen, p. a m., & curşeu, p. l. (2010). entrepreneurial strategic decisionmaking: a cognitive perspective. in international journal of entrepreneurial behaviour research (15). veronica, s., shlomo, t., antonio, m. p., & victor, c. (2019). international social smes in emerging countries: do governments support their international growth? journal of world business. wang, y. (2016). what are the biggest obstacles to growth of smes in developing countries? – an empirical evidence from an enterprise survey. borsa istanbul review, 16(3), 167–176. weinzimmer, l. g., nystrom, p. c., & freeman, s. j. (1998). measuring organizational growth: issues, consequences and guidelines. journal of management, 24(2), 235–262. wennberg, k., delmar, f., & mckelvie, a. (2016). variable risk preferences in new firm growth and survival. journal of business venturing, 31(4), 408–427. wiklund, j., davidsson, p., & delmar, f. (2003). what do they think and feel about growth? an expectancy-value approach to small business managers’ attitudes toward growth. entrepreneurship: theory and practice, 27(3), 247–270. wiklund, j., patzelt, h., & shepherd, d. a. (2009). building an integrative model of small business growth. small business economics, 32(4), 351–374. wiklund, j., & shepherd, d. (2003). aspiring for and achieving growth: the moderating role of resources and opportunities. journal of management studies, 40(8), 1919–1941. worku, z. (2016). barriers to the growth of small, micro and medium-sized business enterprises in the vaal triangle region of south africa. african journal of science, technology, innovation and development, 8(2), 134–141. wright, m., & stigliani, i. (2013). entrepreneurship and growth. international small business journal, 31(1), 3–22. yang, c. h., & tsou, m. w. (2019). globalization and firm growth: does ownership matter? small business economics, (2013). zahra, s. a. (1996). technology strategy and new venture performance: a study of corporate-sponsored and independent biotechnology ventures. journal of business venturing, 11(4), 289–321. volume 37, number 2 45 zahra, s. a., ireland, r. d., & hitt, m. a. (2000). international expansion by new venture firms: international diversity, mode of market entry, technological learning, and performance. academy of management journal, 43(5), 925–950. zahra, s. a., sapienza, h. j., & davidsson, p. (2006). entrepreneurship and dynamic capabilities: a review, model and research agenda. journal of management studies, 43(4), 917–955. zhou, l., wu, w. p., & luo, x. (2007). internationalization and the performance of bornglobal smes: the mediating role of social networks. journal of international business studies, 38(4), 673–690. biographical sketch of authors abayomi k. akinboye earned his ph.d. in the department of management, marketing and entrepreneurship at the university of canterbury. his doctoral thesis investigates entrepreneurial growth intention and effectual logic. jamie d. collins is professor and university chair of strategy, innovation & entrepreneurship at university of canterbury where he teaches post-graduate courses. he also holds professorial fellow status at clemson university. he earned his ph.d. from texas a&m university. jamie’s research examines the influence that perceptions of entrepreneurs and strategic leaders exert on their deliberate choices to invest organizational resources in the pursuit of innovation opportunities, in various institutional contexts. sussie c. morrish is associate professor of marketing at the university of canterbury where she teaches strategic marketing and social entrepreneurship. she gained her phd from the university of canterbury while simultaneously teaching at the university of auckland business school. her main research interests revolve around the marketing and entrepreneurship interface including various strategic approaches to post-disaster business recovery, internationalisation, sustainability and entrepreneurial ecosystems. a longitudinal price comparison for music cds in electronic and brick-and-mortar markets: pricing strategies in emergent electronic commerce zoonky lee university of nebraska-lincoln lincoln, ne sanjay gosain university of maryland college park, maryland abstract the internet has great potential as a medium to reach consumers but we still need to improve our understanding of the impact of it on information asymmetries governing buyer and seller positions. in this study we are primarily interested in exploring differences in pricing strategies between physical and electronic markets, across product categories and over time, and to understand the reasonsfor these differences. choosing a homogenous product music compact disks, we compare prices. price dispersion and price dynamics on the internet with brick-and-mortar retailers. we collected price information for 21 currenthits and 23 old-hits albums from top five nationally-known brick-and-mortar cd retailers and nine on-line stores, and repeated the data collection one year later. overall, 905 data points, 572 from the internet and 333 from brick-andmortar retail shops were collected. we find that: 1) the internet market continues to show price dispersion despite the apparently near zero search costs for consumers and the growth of market size; 2) brick-and-mortar markets execute more consistent and dominant short-term discount strategies for current-hit albums, and as a result, cd prices for old-hit albums are cheaper in the internet market as was found in other studies. but cd prices for current-hit albums in the physical markets are comparable to prices in the internet market, and; 3) price dynamics alter over time with internet retailers offering cheaper prices for albums and apparently employing more frequent and finer price changes. the results suggest that it is important to look at dynamic price behavior and product portfolio issues when trying to characterize pricing strategy in this media. we propose that it's role in segmenting customers to extract greater consumer surplus, as well as differences in consumer base and preferences and seller cost structures and differentiation strategies, need to be carefully examined to explain price dispersion and dynamic price behavior. 56 journal of business strategies introduction vol. 19, no. i the growing population of internet users provides a large consumer base for businesses to target. businesses have responded by increasing their visibility on this medium, and some have tried to move parts oftheir value chains onto the internet. clearly, the internet has a great potential as a medium to reach consumers. however, our understanding about the internet as market is still in infancy (bakos 1998). we need to examine the effectiveness of this medium in effectively disseminating price information to produce efficient markets. we are also interested in investigating how internet pricing strategy has been set up in a way that is different from the brick-andmortar market. above all, we are interested in seeing how pricing strategies of sellers in internet markets will impact market efficiency. using the music compact disk (cd) market, we empirically test how the expected efficient pricing is borne out in practice and how the pricing strategies of on-line retail shops are different from traditional markets as they adjust to the new environment. two categories of albums current hits and old hits based on the expectation that they have distinctive pricing patterns due to differences in volumes, price sensitivity and customer segment appeal are collected at two different points in time, in the expectation that we would observe the dynamic pricing strategies in the two markets. through this effort we hope to acquire a better understanding of the difference in strategies utilized by conventional stores and on-line sites. theoretical underpinnings one theme consistently discussed in the electronic markets literature is that, with the advent of electronic markets, the buyer will be better off in extracting a share of the sellers' profit (benjamin & wigand 1995). it is expected that a reduction of consumer search costs would occur through information technology (bakos 1997). the hypothesis, therefore, predicts that electronic markets will reduce searching costs resulting in efficiency gains, and also reduce information asymmetries for buyers by helping them to be better informed about prices, leading to price convergence. neoclassical economic theory suggests that in the absence of transaction costs there should be pure price-based competition for homogeneous goods. the central implication of costly information-gathering is that the equilibrium will not occur at the perfectly competitive price. economic models (salop 1979) have argued that positive consumer search costs can lead to prices above marginal cost in equilibrium, even for otherwise homogeneous products. electronic markets, however, reduce transaction costs resulting in efficiency gains, and also reduce information asymmetries for buyers by helping them be better informed about prices. in competitive market conditions the classical economic model suggests that market price will converge to marginal cost of sellers (i.e. bertrand model). the bertrand model, named after a 19th century french economist, is a model of price-taking firms facing perfectly elastic demand curves. even with just two firms, if the firms spring 2002 lee & gosain: longitudinal price comparison 57 compete on price, the outcome is the same as perfect competition thus as search costs converge to zero, price dispersion is expected to diminish. when we compare the electronic marketplace with traditional shopping, the former offers a huge search space coupled with low search and transaction cost. since, in the electronic market, search costs are typically smaller than the brick-and-mortar market, it is proposed that hypothesis 1: price dispersion on the internet will be lower than the price dispersion in the brick-and-mortar market. improvement in retailer cost structures may also contribute to lower price levels in electronic marketplaces (smith, bailey & brynjolfsson 1999). improved cost structures may lead to more efficient pricing as low market entry costs may limit the price premiums sustainable by existing market participants by increasing actual or potential competition (milgrom & roberts 1982). also, favorable cost structures can lead to lower price levels in the long run by decreasing the underlying costs on which any price premiums are based. thus it is hypothesized that hypothesis 2: prices in electronic markets will be lower than prices in physical markets. reduced menu costs, the cost related to changing prices, for retailers in electronic markets allow retailers to adjust their prices with ease. sheshinski and weiss (1993) describe how menu costs affect the setting of prices and often explain the non-optimal prices in an economy. in electronic markets, price changes are supported through flexible information systems that will significantly reduce the effort required to change prices needed in physical markets. menu costs are important from the standpoint of buyer welfare and market efficiency because high menu costs can lead to stickiness in prices as retailers will not be able to adjust prices in response to supply or demand changes. in addition to considerations of menu costs, price dynamics is also influenced by changes in the competitive structure ofthe industry. bailey (1998), for example proposed that immaturity of the market may be a contributing factor based on the observation that during the 3 months following barnes and noble's internet entry on march 19, 1997, amazon.com dropped its prices by nearly 10 percent to match the prices charged by their new competitor. differences in cost structure or business models of industry participants might also lead to differences in pricing over time. for instance, firms may periodically offer price breaks to reduce inventory holding costs or the risk of obsolescence. in non-pure business models, firms may be able to reduce prices to build traffic to generate revenues through advertising or sales through other induced or non-planned purchases. based on the hypothesized reduction in menu costs and changing competitive structure of electronic markets it is hypothesized that 58 journal of business strategies vol. 19, no.1 hypothesis 3: the rate of change of prices in electronic markets would be greater than in physical markets. market prices are the result of deliberate supply-side pricing strategies of sellers as well as conditions impacting the demand side. while the previous three hypotheses are based on economic analysis of the demand-side factors in electronic commerce, we also expect that sellers will vary their pricing strategies based on the types of products they sell, and these strategies will intervene with demand conditions. in this study, we expect that current-popular and niche products have fundamental differences in their product volumes, price sensitivity and customer segment appeal. we also expect that these differences are recognized by sellers and taken into account in their pricing strategies. hence, we expect that pricing patterns will be different for the different categories of products. hypothesis i a: differences in price dispersion between online and physical markets will depend on the type of products (popular or niche). hypothesis 2a: differences in prices between online and physical markets will depend on the type of products (popular or niche). hypothesis 3a: differences in the rate of change of prices between online and physical markets will depend on the type of products (popular or niche). research direction recent studies have begun to empirically investigate whether prices and price dispersion in electronic markets are lower than prices and price dispersion in physical markets for homogeneous products. studies of online travel agent offerings have found that ticket prices vary by as much as 20% across travel agents even after controlling for observable product heterogeneity (clemons, hann & hitt 1998). bailey (1998) found that price dispersion for books, cds and software is no smaller online than in conventional markets. a more recent study by brynjolfsson and smith (2000) examined prices for books and cds sold through internet and conventional channels in 1998 and 1999. they find that prices are 9-16% lower on the internet than in conventional outlets even after accounting for costs from shipping and handling, delivery, and local sales taxes. they found that prices for identical books and cds at different online retailers differ by as much as 50%, and on average by 25% for cds. consumer behavior online is also expected to be different from conventional markets. spring 2002 lee & gosain: longitudinal price comparison 59 whether the internet will lead us to more efficient markets is a subject for further empirical tests as it is still a relatively new phenomenon (bakos 1998). our study goes beyond the previous studies to investigate the following (a) first, we look attwo categories ofthe same product mainstream products that are expected to have current mass-market appeal, and niche products that are expected to appeal to narrower segments. we empirically explore differences in market characteristics for product categories, and derive insights about internet retailers' pricing strategy. this is important because we hypothesize that different marketing channels may require distinct strategies depending on product attributes. (b) second, we compared prices in two distinct time periods to enable a longitudinal analysis to be done. earlier studies such as brynjolfsson and smith (2000) reported only cross-sectional analyses. however, there is speculation that the early internet companies were operating with evolving business models, this may have led to initial lower prices in a bid to attract "eyeballs" rather than profits. the results from the longitudinal analysis will provide us with a better understanding of retailer pricing for different product categories over a period of time. (c) lastly, but most importantly. while earlier studies have focused on consumer-side analysis of electronic markets. we explicitly consider both the consumer and seller side impact of it. a recent study by grover and ramanlal (1999) suggests that sellers can employ information-based strategies enabled by it to improve their margins. impeding market efficiency. by customizing products, discriminating consumer demands and locking in customers using proprietary networks, the seller may extract more ofthe consumer surplus than they would at the competitive equilibrium. accordingly, we discuss both the supply and demand sides of the nascent markets. research method we believe that important issues related to the structure of internet-based electronic markets vis-a-vis their physical counterparts still remain unsettled. understanding and resolving issues should begin from the basics. for this reason. we have investigated a mass-produced commodity-like product in this study. the choice of music compact disks as a product in our study is driven by their commodity-like nature, their popularity in the electronic marketplace and our intention to repeat the previous studies based on a different framework. we first listed music stores that have the largest collection of cds on the internet by using internet search engines. stores that carry special types of music (e.g. latin music, foreign music. etc.) were excluded, and only those that provided product and price information through a searching mechanism were selected. as a result, we identified nine on-line stores. brick-and-mortar retailers were selected based on size. limiting ourselves to a single market area. we 60 journal of business strategies vol. 19, no. i identified five nationally-recognized cd stores in a major us metropolitan area (sec appendix a for the list of shops included in this study). since we expected that the pricing strategy for mainstream high volume products could be different for specialized niche products, we collected prices for two kinds of albums current-hits and old-hits. this was done because temporal currency is an important attribute that impacts pricing and marketing decisions because it drives distinct patterns of customer behavior. prices were collected for one week's (current-hits) billboard chart and for the same period ten years ago (old-hits) of the billboard chart. as a result, we have 21 current-hit albums and 22 old-hit albums. approximately one year after the first data collection, cd prices were collected for the same albums from the same brick-and-mortar and on-line stores. overall, a total of905 cd prices, 572 from the internet and 333 from brick-and-mortar stores were collected over 43 different albums. results price dispersion first, we investigated the issue of price dispersion in electronic markets. although hypothesis i suggests a comparison between online and physical markets, we first wanted to test whether there were systematic price differences among online retailers since price convergence is expected with zero search costs. an ols regression model that relates the prices of albums to the identity of nine different internet retailers was used. the independent variables in the model were coded as dummy variables that have value 1 for the corresponding internet retailer and 0 otherwise. the dependent variable was the percentage deviation of a specific album price (i-th album) at one retailer (j-th shop) from the average price of that album across the internet retailers (pdij). while we could use price differences instead of the percentage of deviation, the percentage price dispersion led to a normal distribution of the errors, allowing for homoscedasticity assumptions to be met. the dependent variable is, pd., = (price of i-th album at the j-th retailer average price of i-th album across different retailers) average price of i-th album across different retailers then the model becomes for i = i to 43 (albums), and j = 1 to 9 (internet retailers) spring 2002 lee & gamin: longitudinal price comparison 61 where p is dummy variable with j p = 1 if prices in pd .. are for the j-th retailer ) ij = 0 otherwise. since the average price is reflected in the model, the intercept term was excluded from the model. the b coefficients, then, indicated the average percentage deviation in price of albums between the i-th internet shop and the overall average internet price. table 1 shows the results of the regression analysis. table 1 modeling price differences across internet retailers data collected in feb. 1999 the same data after one year(1 anuary 2000) for all for for old-hit for all for for albums current-hit albums albums (used to be) (used to be) albums current·hit old·hit albums albums ~i -0.021 * 0.033** -0.06*** 0.0002 0.197* -0.015 (0.011 ) (0.012) (0.013) (0.009) (0.011) (0.009) ~2 -0.057 *** -0.0063 -0.084*** -0.113*** -0.092 *** -0.131*** (0.014) (0.17) (0.014) (0.008) (0.010) (0.009) ~j -0.0018 0.032* -0.qi8 n/a n/a n/a (0.013) (0.017) (0.014) ~4 0.102 *** 0.044*** 0.171*** -0.0004 0.033 *** -0.038*** (0.011) (0.011 ) (0.014) (0.008) (0.010) (0.009) ~5 -0.021 -0.036** 0.049* 0.053*** 0.017 * 0.092*** (0.014) (0.011 ) (0.030) (0.008) (0.010) (0.009) ~(' -0.037 ** -0.024 -0.057** n/a n/a n/a (0.017) (0.016) (0.024) ~7 -0.0014 0.047*** -0.048*** 0.017* 0.0376*** 0.0032 (0.011 ) (0.011 ) (0.013) (0.009) (0.011) (0.009) ~g 0.039 ***-0.012 0.092*** 0.0073 0.00358 0.012 (0.011) (0.011) (0.013) (0.009) (0.010) (0.010) ~y -0.044 *** -0.067*** -0.021* 0.035*** -0.025** 0.095*** (0.011 ) (0.011) (0.013) (0.008) (0.010) (0.009) n 296 147 149 276 131 145 f 15.431 *** 10.785*** 30.326*** 34.921*** 17.067*** 61.93*** r2 32.6% 41.3% 66.1% 47.6% 49.1% 75.9% *** p < 0.01, ** p < .05, * p < 0.1, testing h,,: {3i = a ( ) standard error 62 journal of business strategies vol. 19, no.1 based on the results shown in table 1 (column 2), we reject the hypothesis that there is no price dispersion in the internet market (overall model is significant; f 9287 =15.431, p < 0.001). the deviation of the price from the average album price ranges from -5.7% to 10.2%. next we investigate whether the price dispersion is the same for the different product categories old hits albums and the current hits albums. the regression models were run separately for each group and analyzed. the results (the third and the fourth column of table 1) indicate that the price dispersion exists regardless of the product type. the f-values are 10.785 and 30.326 for the current and old albums respectively, rejecting the equal price hypothesis at the 99% level of confidence in both cases. the price dispersion was higher for the old albums: the price dispersion ranges from -8.4% to 17%, indicating a price dispersion range of over 25% for the old album while it was relatively lower for the current albums, ranging from -6.7% to 4.7%. an important issue in examining price dispersion is to overlay that with market share information. if one retailer is significantly higher in price and likely to be pricing itself out of the market, it may not be appropriate to include it in the analysis of market price dispersion. since the market share data were not available for all internet retailers (especially small retailers which have not been publicly listed), we decided to compare prices for the two leading internet music stores (stores 5 and 9) that combined account for more than 80% of current internet music cd sales. in order to test whether they have similar pricing we propose the null hypothesis, ho: ~5 =~9, and test it using f-value changes in the full and reduced model. since the multiple r2 for the reduced equations yield 0.391 and 0.644 for old and current albums respectively, the f-tests applying the equation results are f(}, 137) = 5.31 and fo, 139) =6.9, respectively. both are significant at the 95% level. therefore, we reject the hypothesis that the two leading internet music cd retailers have the same price. how do we compare the price dispersion in brick-and-mortar and internet markets? although an f-test can be used for testing for equal variance from two samples, the percentage of price difference between the highest-priced and lowest-priced stores for each album is used because each different album should be treated independently. since the number of stores in the brick-and-mortar is only 5 compared with 9 in the internet, caution is necessary in interpreting the result; it is likely that the dispersion will be higher for the internet just because of the larger number of retailers. among the twenty-one current-hit albums, the average percentage price difference is 18%, which was very similar to 19% for the brick-and-mortar markets. for old-hit albums, the price dispersion among internet stores is much higher than among brick-and-mortar stores. for twentytwo old-hit albums, the average percentage price difference was 31 % in the internet market ranging from 8% to 51 %, while it was only 11 % in the brickand-mortar market. spring 2002 lee & gosain: longitudinal price comparison 63 figure 1 average price dispersion for brick-and-mortar and internet retailers average price dispersion 35 30 25 20 is 10 5 o o brick-and-mortar • electronic current hits old hits figure i provides evidence of the dispersion independent of the regression model. the regression model looks at systematic retailer effects and would miss dispersion effects that were not consistent for a retailer. a retailer, for example, may discount some titles and inflate prices for others. the average price dispersion provides, therefore, a coarse summary measure that supports the findings of the systematic effects model. to summarize, hi was not supported as price differences among online retailers were persistent, and there is no evidence that price dispersion is lower in the online market. besides, the price dispersion is even bigger in the internet market for old-hit albums. h i a is supported as two different product types show very different patterns of price dispersion between two markets. price difference between brick-and-mortar and internet retailers next we investigate the difference in price levels between the two markets (h2). comparing prices requires the adjustment of prices; a shipping and handling (s&h) cost for the internet market and a tax charge for the physical market. currently internet retailers charge $2.95 to $4.95 for a single cd or usually $2.99+$0.96 per item, and each brick-and-mortar shop has a different tax rate depending on the state. taxes on internet sales are based on whether the buyer resides in the state where the retailer has a nexus. we adjusted the shipping and handling cost for each on-line shop based on three cd purchases following brynjolfsson and smith (2000) and a uniform 6% tax rate was added for the brick-and-mortar market. later, a sensitivity analysis was conducted for various ranges of tax rates (e.g. 4% to 8%) and various s&h costs (e.g. buying one cd to buying 3 cds). we wih report later but it is worth noting that the cd prices are very sensitive to s&h cost. for example, we have to add on $3.95 for a single cd purchase, but it comes to $1.96 per album for a three cd purchase on amazon.com, more than the 12% price difference for an average cd. as a result, the direct price comparison between the physical and internet 64 journal of business strategies vol. 19, no.1 markets are very sensitive to assumptions on how many cds consumers purchase at one time. a non-parametric test, the wilcoxon signed rank test was selected for the comparison since the data are differences in price from two related samples (brick-and-mortar and internet stores), where each album may have a different price depending on retailer strategy. we could have used paired t-tests instead, but the small sample size and the assumptions of normality were a concern. while the sign test considers only the direction of signs, the wilcoxon signed rank test is more powerful as it considers not only the signs but the magnitude of the signs (siegel & castellan 1988). so, it can take into consideration price differences that may result from a chance error. prices are compared for both average differences and the cheapest available prices in the two markets. after the differences of prices (i.e. brick-and-mortar price internet store price) are calculated for each album, its sign direction along with absolute values of differences was ranked for the wilcoxon signed rank test. then, r, the positive ranks are summed. for the large sample size (i.e. typically over 15), r, is approximately normally distributed with mean = n (n+l)/ 4, variance;::: n (n+ 1) (2n + 1) 124, therefore, r n (n+ 1)/4 z= .j--;'n=(=n=+:;::l=):::;(2;::n=+:::;l::;:)::;:;;/2;::;4::-n (0,1) table 2 shows the result of wilcoxon ranked sign test for price comparison between the brick-and-mortar market and on-line stores across old and currenthit albums. table 2 shows that the internet market of old-hit albums is cheaper for 19 out of 19 albums in terms of both average and cheapest price available comparison, yielding z-value -3.8 and -3.85 respectively (p < 0.01, based on 6% tax and 3 cds purchase). the price comparison for the current-hit albums showed similar but slightly different results. a comparison based on both average and cheapest available prices also shows the similar result with z ;::: -3.49 and -3.17, respectively (p < 0.01), suggesting that physical markets are more expensive for current-hit albums, too. the result, however, was very sensitive to s&h cost charges (it was insensitive to the tax rate from 4% to 8%). when we assumed one cd purchase in this case adjusted cd prices for the internet market became more expensive current-hit albums are cheaper in the physical market while old-hit albums are still cheaper in the internet market (i.e. the result for the current-hit albums reversed from the case when we spring 2002 lee & gosain: longitudinal price comparison 65 assumed three purchases per visit). a simple mean difference between two markets confinned that the price differences for the current-album was only $0.67, (it was $1.83 for the old-hit albums) when three cd purchases are assumed. table 2 the z-values of the wilcoxon signed rank test (price comparison for internet and brick-and-mortar retailers) data collected in feb. 1999 average price cheapest price current-hit albums -3.49** -3.17** old-hit albums -3.8** -3.85** all albums -5.3** -5.2* +: internet price> brick-and-mortar price -: internet price < brick-and-mortar price **p < 0.01 testing ho: # of cheaper albums are the same for both markets we could not compare the prices of the two markets controlling for market share information since exact market share information was difficult to acquire. but, in order to explore the impact of market share, we did the same analysis with the two leading online shops that combined account for more than 80% of the market share. the results indicated that, similar to the previous analysis, current-hit albums do not have any difference in price (z =-0,47) and the old-hit albums are cheaper in the internet market (z =-3.67, p < 0.01). therefore, combing two analyses, we conclude that there is not much price difference between physical and on-line shops for current-hit albums, but prices for old-hit albums are cheaper in the internet market. so, h 2 is supported as, on average, prices are cheaper in the internet market. h 2a is also supported as the two product types show different patterns of price differences. price changes over time one year after the first data collection, we again collected price data for the same albums. since one of the internet retailer web-sites was being remodeled and another one was extinct, analyses are conducted based on seven internet retailers. the regression analysis indicates that price dispersion among internet stores remained high (see the fifth, sixth and seventh col umns of table 1). we can still reject the hypothesis that the prices are equal across the internet market (f 7 ,276 = 34.92, p < 0.0l). the deviation of prices from the average album price ranges from -11 % to 5%. furthermore, price dispersion seems to increase as the variance explained increased for all current-hit (r2 increases to 0,49 from 0,4l) and old-hit albums (r" increases to 0.76 from 0.66) despite the fact that the number of retailers included in the model decreased. 66 journal of business strategies vol. 19, no.1 price comparison between brick-and-mortar and internet retailers show results that are similar to the earlier period. it shows that brick-and-mortar prices are dominantly higher than prices from internet retailers in old-hit albums, and comparable for the current-hit albums. however, it is of interest to observe how prices have changed in the two different marketplaces. the following crosstable (table 3) shows the price difference (i.e. old price current price) by the market and by the product. the negative number represents that the stores increased prices for the albums. table 3 changes in prices over time for current-hits for old·hits total change in price %of %of price % of % of prices over change albums albums change albums albums 1 year with price with price small unchanged small unchanged «]0%) «]0%) price price change change brick-and-0.18*** -0.004 -0.12** mortar (0.12) 4.9% 16% (0.11 ) 6.4% 85% (0.14) (81) (47) (125) internet -0.04*** 0.07** 0.02*** (0.009) 36% 19% (0.16) 23% 5.1% (0.14) (115) (118) (233) total -0.10*** 0.048*** -0.03*** (0.12) (0.15) (0.154) (196) (165) (361) standard deviation in the first parenthesis; number of albums in the second paremhesis; ***p < 0.01. **p < .05, *p < 0.1. testing ho: no price difference the numbers in table 3 show that brick-and-mortar stores have a clearly distinct pricing strategy for the two different types of albums. they sharply increased the prices ofcurrent-hit albums of one year ago; price increases average 18%. however, they left the prices of old-hit albums unchanged (more than 85% of old-hit albums have not had price changes). the on-line stores also increased prices for their current-hit albums, but the increase has a wide dispersion depending on albums, and the increase is much smaller, only 4% on average. for the old-hit albums, the on-line stores decreased the price slightly, but again show a wide dispersion within the same product category. the online stores exhibit a finer granularity of change: the change in prices was within 10% of the earlier price for 36% of current-hit albums and 23% of old-hit albums. the corresponding proportion was 5% and 6% respectively for spring 2002 lee & gosain: longitudinal price comparison 67 brick-and-mortar retailers. the analysis indicated that online shops executed much finer granularity of changes compared with physical markets. since the data were collected at only two time periods, and we can observe the price change once, we cannot conclude that the rate of change is greater in electronic markets. but the fact that most physical stores do not change their old-hit album prices indicates that h 3 is partially supported. h 3a is supported as both markets showed very distinct pricing strategies for old-hit and current-hit albums. discussion our results suggest that on-line retailers have a very different pricing strategy from the conventional retailers. physical shops offer significant price breaks on the more popular products and increase prices once the products do not have sustained mainstream market appeal. they increased prices averaging 18% compared to a 4% price increase for the on-line stores. for more niche products, the brick-and-mortar did not change prices but on-line stores decreased prices by about 7%. on-line stores, on the other hand, have much more dynamic pricing strategies. while conventional stores leave their prices for old-hit albums unchanged (more than 85% of their album prices were unchanged), on-line stores changed prices of 95% of their old-hit albums. additionally, internet retailers show much finer price adjustments, indicating that they employ a relatively more dynamic pricing strategy. overall, the larger increase in brick-and-mortar store prices for current albums after their popularity has gone combined with the decrease in prices for the internet stores explained why old-hit albums are more expensive in the physical shops, and internet prices become dominantly cheaper. our results, combined with previous studies of the music cd market, provide a number of important insights. since our study is based on one type of product and regional physical markets, generalization of the results beyond the cd market might be difficult. the study does provide a basis for building our knowledge in the area, and should be augmented with different research designs and theoretical grounding. first, unlike previous studies that empirically demonstrated price dispersion and cheaper prices in the internet market, our study shows how sellers in the new internet market may react to the trend of "near-zero" search costs. grover and ramanlal (1999) argue that while we usually possess a congenital view that it will benefit the buyer by decreasing the price, the supplier also will exert alternative strategies to extract consumer surplus, making the trend more interacting and complex. our results show that internet retailers are able to exert finer-grained control over prices based on their lower menu cost. they are also able to experiment with new pricing strategies as opposed to the conventional shops that only change prices once the cd moves into less popular vintage, and they tend to adjust prices by a larger amount. second, we show that the price structures and dynamics for the two different product categories (i.e. popular products vs. niche products) are very distinct, 68 journal of business strategies vol. 19, no.1 and that the distinction strongly reflects the deliberate pricing strategies of retailers. in comparing conventional brick-and-mortar and on-line stores, these two categories are different in terms of both price differences and price dispersion. larger price dispersion is observed for old-hit albums, and price differences of current-hit albums between the physical and the internet markets are much smaller than those of old-hit albums. understanding these results requires us to think of the electronic markets as a totally new market with different cost structures and possibly a different consumer basis. studies have found that differences in cost structure such as inventory cost and selling cost result in different pricing strategies. eppen and liebermann (1984), for instance, show that sellers with higher inventory costs will offer periodic price deals as a mechanism for minimizing inventory holding costs. then, the higher inventory cost of the brick-and-mortar stores might lead to price breaks for the current-hit albums as was observed in the study. another reason for price breaks may be sellers adopting more "inducing strategies." one way in which price breaks for popular products work is that sellers induce customers with notable products and induce them to purchase other products. the assumption here is that customers commit the resources to purchase a product (i.e. going to the shop) and that by purchasing other products they will save on the average purchasing cost. then, "inducing customers" by lowering the prices for the most popular products may be more effective in the brick-and-mortar shops than in the electronic market. it is expected, then, that sellers tend to "sale" their prices in brick-andmortar markets (in response to seasonal and other factors) to a greater extent than electronic markets. our results also show that the brick-and-mortar markets have more price breaks for popular cds. these price breaks make the brick-andmortar markets comparable in internet market prices for the currently popular products. the strategy further entails increasing the prices once the "popularity" declines. finally, differences in the two product categories suggest that the dynamic nature of pricing strategies needs to be understood and captured in the new models of electronic commerce. current developments in the electronic market have witnessed new purchasing methods, settlement method and marketing technologies in the internet market, and these changes lead to different consumer segmentation, pricing strategies and consumer behaviors (rayport & jaworski 2000). at the retailer end, segmentation may be based on information-use profiling of consumers, for example, to determine their price sensitivity and employ discriminatory pricing. this information processing makes narrower segmentation strategies viable and also enables finer-grained price changes. at the consumer end there may be natural segmentation due to differences in price sensitivity, familiarity/awareness of search tools, product/service preferences and risk profiles. from a consumer behavior perspective, a study by clemons, hann and hitt (1998) argues that even a commodity-like product can have differentiation. on-line cd stores can differentiate the product through spring 2002 lee & gosain: longitudinal price comparison 69 shop credibility, promised delivery time, an easier searching mechanism, a refund guarantee, suggested products and product evaluation. another study by bailey, yao and faraj (1999) shows that price dispersion is partly explained by firm strategy. further, evaluating products online may lead to "missing information" regarding the characteristics ofthe product (degeratu, rangaswamy & wu 1998) and may lead consumers to rely more heavily on other signals of quality, such as brand. these new observations and opportunities all suggest that it is not that the internet market simply provides the cheaper prices, therefore the more benefit to the consumers due to search cost reduction. we, then, need to understand this new market and the new marketing and pricing strategy that suit this new market structure. by empirically investigating pricing in brick-and-mortar and internet markets, and comparing price differences for two different types of products, this exploratory study showed that price dispersions and prices differences depend on product structures, and suggested that the structural differences between two markets might contribute to price dispersion and higher than expected average prices for internet retailers. conclusion consistent with previous studies, our study confirms that price variance exists on the internet even for the simplest commodity-type products. direct price comparison also confirmed the previous results that prices in the internet are generally cheaper than in the physical market (brynjolfsson & smith 2000). when we look at product categories, "popular" and "niche," however, we find differences in prices and price dispersion patterns. lower price dispersion was reported for the current-hit albums: there are consistent 15% to 20% price differences for the current-hit and 25% to 35% differences for the old hits. direct price comparison also revealed that cd prices for current-hit albums in the physical markets are comparable to prices in the internet market and the old-hit albums are consistently cheaper in the internet market. the longitudinal data of our study suggest that the price variance on the internet is not getting smaller, and may actually be increasing. for both old and current hit albums, the variances explained due to price dispersion increased. since the first data collection, we have witnessed an enormous increase in ecommerce volumes and emergence of a number of price comparison sites (e.g. mysimon.com, cnet.com, pricescan.com, bottomdollar.com), driving searching costs down. the results, however, indicate that the price dispersion is persistent. besides, the two leading on-line shops that account for more than 80% of the total market share are not the dominant price leaders. this study paves the way for a better understanding and crafting of pricing strategies by illuminating variation in prices over time and across product categories with different customer bases and cost structures. 70 journal of business strategies references vol. 19, no. i bailey, j. (1998). intermediation and electrqnic markets: aggregation and pricing in internet cqmmerce, ph.d. dissertation. technology, management and policy, massachusetts institute of technology, cambridge, ma. bailey, j., yao, y. & faraj, s. (1999). price djspersion among internet retailers. workshop on information systems and economics. bakos, y. (1991). a strategic analysis of electronic marketplaces. mis qullrterly, 15 (3), september, 295-3 i o. bakos, y. (1997). reducing buyer search costs: implications for electronic marketplaces. management science, 43 (12), december, 1676i 692. bakos, y. (1998). the emerging role of electronic marketplaces on the internet. communications of acm, 4 i (8), 35-42. benjamin, r. & wigand, r. (1995). electronic markets and virtual value chains on the information superhighway. sloan management review, winter, 62-72. brynjolfsson, e. & smith, m. d. (2000). frictionless commerce? a comparison of internet and conventional retailers. management science, 46 (4), 563-585, clemons, e., hann, i. & hitt, l. (1998). the nature of competition in electronic markets: an empirical investigation of online travel agent offerings. department of operations and information management working paper, the wharton school. degeratu, a., rangaswamy, a., & wu, j. (1998). consumer choice behavior in online and regular stores: the effects of brand name, price, and other search attributes. presented at marketing science and the internet, inform college on marketing mini-conference.cambridge, ma. 6-8 march. eppen, g. d. & liebermann, y. (1984). why do retailers deal? an inventory explanation. journal of business, 57. october, 519-530. grover, v. & ramaniai. p. (1999). six myths of information and markets: information technology networks, electronic commerce, and the battle for consumer surplus. mis quarterly. 2j (4), 455-485. milgrom. p. & roberts, j. (1982). limit pricing and entry under incomplete information. econometrica. 50, 443-460. rayport, j. & jaworski, b. j. (2000). e-commerce. new york: mcgraw-hill/irwin. salop, s. (1979). monopolistic competition with outside goods. bell jqurnal ofeconomki...j.q.141-156. spring 2002 lee & gosain: longitudinal price comparison 71 sheshinski, e., & weiss, y. (eds.) (1993). optimal l)ricing. inflation. and the cost of price adjustment. cambridge, ma: mit press. siegel, s., & castellan, jr., j. (1998). non-parametric statistics for the behavioral sciences. new york: mcgraw-hill. inc. smith, m. d., bailey, j.• & brynjolfsson, e. (1999). understanding digital markets: review and assessment. mit working paper, massachusetts institute of technology, cambridge. ma. appendix a list of stores included in this study internet stores abbyroad: www.abbyroad.com all direct: st5.yahoo.com/cgi-bin/ addback?acct=adirect amazon: www.amazon.com borders: www.borders.com cd connection: www.cdconnection.com cdnow: www.cdnow.com cd world: www.cdworld.com spree: www.spree.com tower records: www.towerrecords.com brick-and-mortar stores barnes & noble borders sam goody tower records virgin zoonky lee is assistanat professor ofinformation systems at the university of nebraska lincoln. he holds a ph.d. degree from the university of southern california. his current research interests include designing it infrastructures for organizational learning and e-business. he has published in information and management, journal of organizational computing and electronic com~, journal of information technology and electronic markets. sanjay gosain is assistant professor of information systems at the robert h. smith school of business at the university of maryland. his research is focused on the design and analysis of information systems, particularly to support interorganizational coordination as well as issues related to electtonic business. 72 journal of business strategies vol. 19, no.1 a longitudinal price comparison for music cds in electronic and brick-and-mortar markets: pricing strategies in emergent electronic commerce beautifully broken benches: a typology of strategic bankruptcies and the opportunities for positive shareholder returns jerry paul sheppard* simon fraser university burnaby, british columbia abstract merchants in medieval venice who failed to pay their debts were closed by banca roua the breaking of the bench from which they did their business. in some cases today, bankruptcy is seen as a beautiful strategic maneuver. while there are currently some positive aspects which can be attributed to filing for bankruptcy, there is still debate as to its merits as a strategy. to allow for a more detailed understanding of the strategic bankruptcy concept, the author defines, identifies and categorizes types of bankruptcies. to address the issue of whether bankruptcy is a worthwhile strategy the author also presents a study of the effectiveness of bankruptcy in advancing long-run shareholder wealth. a sample of 155 bankruptcies was employed to study the impact of various strategies on returns to shareholders. some types of strategies were found to result in significantly greater returns than average. introduction if merchants in medieval venice failed to pay their debts, creditors closed their operation by breaking the bench from which they did all their business. italian for "broken bench", banca rotta, is the word from which bankrupt is derived (cifelli, 1983). while the bankrupt party in medieval venice saw their place of business go from commerce to kindling in moments, the situation in the united states today is different. a business' "broken bench" is not seen as a stack of splintered. wood, but as a beautiful work of art. bankruptcy, or, to be more accurate, chapter 11 reorganization, has been viewed as a business strategy that can help turn around an ailing company. like opera, if well performed, the chapter 11 strategy can be a beautiful thing to behold: the corporation, assaulted by its creditors, is rescued from certain death and brought back to health by the wise ministrations of the court (sheppard, 1992). like opera in italy, chapter 11 is certainly popular in the u.s. over 60,000 filings and a total of $82.7 billion in assets wound up in the u.s. bankruptcy '" special thanks to sharon sheppard, rocky and rose sheppard, elaine fairly, maharnad dhanani, mark wexler, jean last, ann winton and two anonymous reviewers for their assistance in this research. the author, however, assumes responsibility for all errors, omissions, etc. 100 journal of business strategies vol. 12, no.2 courts in 1990 (duncan, 1991; sherman, 1991). while there are potentially many desirable aspects one can attribute to filing for chapter 11 (e.g. see sheppard, 1992), there is disagreement as to the merits of strategically filing for bankruptcy (flynn and faird, 1991; moulton and thomas, 1993; sirower, 1991). furthermore, there is disagreement as to how strategic bankruptcy should be defined (delaney, 1992; flynn & faird, 1991; moulton and thomas, 1993). for an intelligent discourse, a clear definition and conceptualization of strategic bankruptcy as differentiated from non-strategic bankruptcy are needed. it would also help to have some parameters within this conceptualization that help identify various types of strategic bankruptcies. this approach would allow one the weighing of possible merits and problems involved with each type of strategy. thus, in this paper four questions will be addressed. one, what is strategic bankruptcy? a clearer definition and conceptualization of strategic bankruptcy will be introduced in the sections to follow. two, how can one identify and categorize strategic bankruptcies? by being able to identify and categorize strategic bankruptcies, an improved understanding of the phenomenon can developed. three, are certain types of bankruptcies effective in advancing the long run wealth of a company's shareholders? there may be situations where filing for bankruptcy might aid investor returns. this leads to the final question. what other conditions aid investor returns in situations where the firm files chapter ii? some understanding of circumstances which might make strategic bankruptcy a viable alternative can be achieved by answering this final question. sirower (1991) demonstrated that firms that were about to go bankrupt steadily lost value for shareholders in the year prior to the firm's filing date, and such firms steadily gained value for shareholders in the year after the chapter 11 filing. therefore, the strategic goal of optimizing long-run shareholder value (hax and majluf, 1984) could support a bankruptcy filing. on the other hand, moulton and thomas (1993) found little evidence to support the idea that a strategic bankruptcy was useful in optimizing long-run shareholder wealth. this idea that a bankruptcy filing could promote shareholder wealth gave rise to the phrase strategic bankruptcy (e.g. see cifelli, 1983). however, if the only requirement defining a strategic bankruptcy is that shareholders might benefit, then all bankruptcies can be viewed as strategic. this definition would render the phrase redundant, and therefore useless. thus, if the phrase is to have any real meaning one needs to ask "what is strategic bankruptcy?" what is strategic bankruptcy? according to moulton and thomas (1993) and delaney (1992), strategic bankruptcy implies two things. first, a petition under chapter 11 of the u.s. bankruptcy code is initiated by one stakeholder at the expense of others. second, strategic bankruptcies are invoked to deal with a single problem (e.g. a lawsuit or class of lawsuits). by this logic, all bankruptcies are strategic (moulton and thomas, 1993), and there is some validity to this perspective. the competifall 1995 sheppard: strategic bankrupties 101 tive nature of the asset recovery game for creditors may create a situation where some stakeholders are favored at the expense of others. also, the law gives some stakeholders priority over others in all bankruptcy proceedings (brown, 1989). finally, the need to file for bankruptcy, in the end, often appears to result from a single problem (e.g. cash flow problems, equity insolvency, creditor petitions). however, the "all bankruptcies are strategic" perspective is not a very useful one. if all bankruptcies are strategic, then why would authors like delaney (1992) focus only on specific filings (e.g. texaco)? this perspective also does not tell us much about any variation which might occur within the realm of strategic bankruptcy. given the wide variation in stakeholder groups that may be concerned with one bankruptcy as opposed to those that gre concerned with another there should be different types of strategic bankruptcies. why are some bankruptcies labeled "strategic" and others not? a more straightforward definition of strategy may help distinguish between the two types of bankruptcy. mintzberg (1991) gives five definitions of strategy: a plan, a ploy, a pattern, a position, and a perspective. regarding these definitions, sheppard (1992) has noted, chapter 11 does not qualify as a strategy in most respects. bankruptcy, however, may fit two of mintzberg's definitions of strategy: a plan and a ploy. as a plan, the strategic bankruptcy must be a "consciously intended course of action, a guideline (or set of guidelines) to deal with a situation" (mintzberg, 1991: 12). in the case of strategic bankruptcy, the plan must deal with a specific stakeholder threat. as a ploy, the strategic bankruptcy must be a "specific 'maneuver' intended to outwit an opponent or competitor l (mintzberg, 1991: 13)." daily (1994: 269), referring to earlier work by delaney (1992) and flynn & faird (1991), states that the strategic bankruptcy can be defined as "a proactive attempt by firm's management to contend with some threat posed by a stakeholder group." delaney (1992), also notes that, in cases of strategic bankruptcy, there is an intention to promote some group of stakeholders at the expense of others. to identify the strategic bankruptcy, one needs to go beyond the items moulton & thomas (1993) and delaney (1992) mention: that a petition is initiated by one stakeholder at the expense of others and the filing is invoked to deal with a single problem. a strategic bankruptcy must also be one in which the firm is attempting to use chapter 11 as a illm:: or a plan (mintzberg, 1991) in a proactive fashion (daily, 1994) to deal with some threat posed by an identifiable stakeholder group. what is a non-strategic bankruptcy? if one can identify strategic bankruptcies, then one must surely be able to spot non-strategic bankruptcies. non-strategic bankruptcies may possess some of the attributes of strategic bankruptcies. thus, differentiating one from the other may be difficult. for example, both strategic and non-strategic bankruptcies greatly impact a single identifiable stakeholder. however, with non-strategic fail102 journal of business strategies vol. 12, no.2 ures the impacted parties are usually commercial or financial creditors (e.g. suppliers or lenders, respectively). in these non-strategic cases, the debtor company seeks to obtain a straight-forward stay against the action of creditors. as shall be seen, strategic failures typically, although not always, impact groups other than creditors. this means is that one can file a strategic chapter 11 which targets creditors, but the objective of the filing must appear to go beyond a simple stay. in other words, to be defined as a strategic bankruptcy which targets creditors, there must be some evidence that the filing was part of a plan that the firm's managers were unable to execute pre-petition, and that the filing, was being used as a ploy to force the support of creditors". table 1: strategic vs. non-strategic bankrupties attributes non-strategic strategic bankruptcies bankruptcies filing impacts one identifiable usuaily commercial i usuaily stakeholders other stakeholder group financial creditors than commercial/financial greatly creditors (e.g. customers). filing is at the impacted identifiable impacted identifiable expense of others stakeholders usuaily stakeholders usuaily assume, and accept. do not intend to accept some level of risk a level of risk in their in their relationship relationship with the with the bankrupt bankrupt corp. (e.g. dalkon corp. (e.g. lenders shield i. u.d. customers). risk loan default). filing deals with creditors are attempting interference with normal a single problem to seize assets used as operations (e.g. press loan collateral exposure affecting govt. (e.g. foreclosure). contracts). filing may be debtor is employing debtor employs ch. ii seen as a plqy chapter 11 to stay the to re-negotiate some or plan creditor's actions (e.g. agreement (e.g. lease stop foreclosure). agreements). filing may be a debtor is faced with debtor faces eventual loss proacti ve measure immediate loss due to to stakeholder actions (e.g. stakeholder actions lawsuits overload). (again, foreclosure). fall 1995 sheppard: strategic bankrupties 103 given the definition for strategic bankruptcy included in the above section, several subtle differences between the strategic and non-strategic filings can be noted. these differences are summarized in table 1. in general, non-strategic bankruptcy deals with debts incurred in the normal course of business e.g. debts owed to suppliers and lenders and the chapter 11 filing simply seeks to stay the creditor's actions until the firm can develop a plan for reorganization. for example, when pettibone corp. found itself overburdened with debt from a downturn in the construction industry, it went into chapter 11 in order to devise a plan that would raise equity and return the company to solvency. this action is different from strategic bankruptcies, which attempt to address obligations or problems that either: (l) do not deal with these traditional creditors, or (2) deal with these creditors in ways that were not previously contemplated 3 • a simple typology of bankruptcies to uncover distinctions between types of chapter 11 filings, a typology of bankruptcies is developed and presented here. typologies are typically employed to provide guidance in early exploratory work (harrigan, 1983). early strategy research provides numerous examples of such exploratory typologies (miles and snow, 1978; miller and friesen, 1980; rumelt, 1974). since one of the purposes of the present study is to explore the concept of strategic bankruptcy, the usc of a typology is warranted. for a bankruptcy to be strategic, it must be targeted at a stakeholder, and be for a specific purpose. thus, to identify strategic bankruptcies one would need to identify which stakeholders the firm was attempting to "outwit" and what specific action the firm was attempting to "thwart." take the example of a. h. robins. in that case, the firm intended to outwit plaintiffs of the dalkon shield lawsuits in order to thwart their legal claims against the company. again, strategic bankruptcy was not the simple avoidance of general creditors but something very specific. the sample and operationalization to create a bankruptcy typology, a sample of 155 companies that entered chapter ii between october, 1979 (when the current bankruptcy law took effect) and december, 1987 was employed. the list of failed firms was gathered by scanning commerce clearinghouse's capital changes reporter for companies which declared bankruptcy during the period. because the rationale behind the chapter 11, filings for start-ups and heavily regulated or recently deregulated firms could with high probability be attributed to non-strategic reasons, these firms were eliminated from the sample. moody s manuals were used to identify start-up firms (those with less than 100 employees and in existence less than five years) to be eliminated. such firms are particularly susceptible to the ills of autocratic leadership that argenti (1976) finds critical to firm survival. these start-up firms 104 journal of business strategies vol. 12, no.2 are also impacted by the liability of newness (singh and lumsden, 1990). heavy industry regulation or a change in the level of industry regulation would be an added factor affecting the likelihood of firm failure (owen and brautigam, 1980). thus, firms in heavily regulated or recently deregulated industries were not considered. these firms were primarily involved in the industries of transportation, telecommunications, utilities, banking, insurance, medical practice, and legal practice (sic code groups 40-42, 44, 48, 49, 60, 63-64 and 80-81). for the remaining firms, business press reports about the bankruptcy filing (from the wall street journal, business week, barrons, fortune, and regional business newspapers) were analyzed in order to determine the company's reason for filing. filings classified as strategic bankruptcies had to meet four criteria: 1. there must be one identifiable stakeholder group against which the firm could be employing chapter 11 (e.g. product users). 2. there must be a single identifiable action the stakeholder group was taking that the firm sought to thwart via its filing of chapter 11 (e.g. collecting on lawsuits). 3. there must be a specific goal which a chapter 11 filing could aid the firm in accomplishing (such as a reduction in lawsuit awards). 4. the filing must go beyond simply staying the actions of general creditors to collect debts. the first two criteria address the notion of bankruptcy strategy as a ploy, the last two ensure that the bankruptcy indicates some kind of plan. all other filings were classified as non-strategic bankruptcies. classifications fifty-five of the 155 bankrupt companies in the developed list of companies possessed strategic elements. these were categorized into nine stakeholder groups. these stakeholder groups were then divided into a total of 16 subgroups based on the firm's apparent rationale for filing. these categories and subgroups are described in table 2. fall 1995 sheppard: strategic bankrupties 105 table 2: typological categories of strategic bankruptices described ploy aimed at with the intent to comments & examples creditors force lenders to allow prompt lenders to approve prefor proposed~ bankruptcy proposals to change c structure changes. a finn's capital structure. this a was howmgf hoped to force p debt holders into an equity i swap proposed prior to filing. t a allow finns to complete the finn attempts to use ch. ii l negotiation for sale of to reduce debt to make it more all/part of the firm. attractive to a waiting buyer. whippany paperboard used ch. ii to complete negotiations for sale of the firm to new investors. p allow a finn to f.i.niill force lenders to allow comr restructuring efforts pletion of corporate strategy 0 begun prior to filing. change. cook united tried v using ch. ii to get additional i funds to complete store red modeling. eastmet tried using e ch. ii to reduce debts involved r in exiting an industry. s force lender to~ magic circle energy tried assets needed by finn. using ch. ii to attempt to force its bank to release real estate collateral to allow oil drilling. force lender to provide to get credit to meet seasonal for seasonal borrowing. demand wicks used ch. ii. suppliers who shipped after filing gained first priority to assets. shareholders stop takeovers /~ heck's ch. ii aided in thwarting h2!.qg actions / cleara potential takeover. up ownership disputes. schaak used ch. 11 to support owner ship claims by its ceo. altec used ch. ii to avoid required payments to preferred shareholders. 106 journal ofbusiness strategies vol. 12, no.2 table 2: typological categories of strategic bankruptcies described (cont'd) ploy aimed at with intent to comments & examples government pass unfunded pension significant unfunded pension g costs to government liabilities can be shed in this 0 backed insurance agent. manner. for wheeling corp. v the amount of debt shed e was $475 million-more than r 30% of their total debt. n use legally allowed tax large losses mean future tax loss carryforward as an free income. mlx had $10 asset to get investors. million in assets / $150 million in debts after selling everything. by convincing lenders to provide equity and back acquisitions the firm put to use $300 million in loss carryforward tax credits. the press remove industy scandal ch. 11 gets firm out of the news from~ attention & back to business. mobile p home firms did so after bad r press on the bill padding of e fha loans. s s remove company firm gets back to business once ~ from public out of the press. wedtech did attention this once it left its government procurement scandal behind. remove mgmt. scandal ch. 11 quiets news about its from public attention exec.s so the firm can operate. as worked with saxon ind. after news of being looted by their ceo. fall 1995 sheppard: strategic bankrupties 107 table 2: typological categories of strategic bankruptcies described (cont'd) ploy aimed at with intent to comments & examples buyers & esca~e unprofitable revere copper & brass was m suppliers contracts arranged with able to escape over-priced i buyers or suppliers. contracts with its electric sups pliers and under-cost contracts c with its aluminum buyers via its use of ch. ii. i competitors avoid damage claims re-negotiate damage awards in single lawsuit brought from a civil suit. texaco used l by a competitor. ch. 11 to avoid billions in dame ages awarded to pennzoil. smith g international used ch. ii to a avoid paying on patent infringel ment. i customers i avoid damange claims the firm used ch. ii to solve s prod. users in mass tort lawsuit many damage claims. manville s filed by past product used it to handle thousands of u users. asbestos related personal ine jury claims. a.h. robins used s it to deal with dalkon shield claims. employees esca~e unprofitable this is the well known ploy of contracts with union using ch. ii to void union conemployees. tracts. among firms in the present sample tobin packing could have benefited from this use of ch. ii. lessors escave unprofitable renters can get out of unlong term leases. profitable leases. flannigan's enterprises was able to renegotiate over priced leases via ch. ii. by using ch. 11, hrt industries was able to shut down 55 of its 192 retail outlets and regain profitability. 108 journal of business strategies vol. 12, no.2 to create a more parsimonious set of categories, the nine stakeholder groups in table 2 have been sorted into four clusters based on common themes (see sheppard, 1994a for further details). the capital providers cluster addressed cases where the bankruptcy strategy thwarted the actions of shareholders or impacted the actions of creditors in ways that are not straightforward stays. the government cluster dealt with those cases where the bankruptcy strategy involved the firm receiving some benefit from the government which made the firm's continued existence more likely. the press cluster involved cases where a firm was connected to a scandal, and the bankruptcy filing removed the firm from public scrutiny and allowed it to get back to business. finally, the miscellaneous i legal issues cluster concerned those firms employing the bankruptcy strategy to resolve some legal issue involving a contractual obligation (contracts, leases, union agreements) or an implied contractual obligation (fair trade, implied warranties of product merchantability). the remaining sample consisted of 100 non-strategic bankrupt companies. a detailed list of the non-strategic bankrupt companies is included in appendix 1. all companies involved in strategic bankruptcies, and the groups to which they belong, are included in table 3. table 3: list of strategic bankrupt firms by type ploy aimed at intended action companies and filing year: creditors allow cap. global mgf salant '85 change marine '86 oil '84 complete american roberts & vector the sale of advent. '86 porter '83 graphic '85 capital the company crompton transcon. whippany '84 energy '84 paper '80 finish a cook mesta sambos providers restructuring united '84 machine '83 resturant previously eastmet '86 newbery '87 '81 begun jamco richton white ltd. '87 inteml. '80 motor '80 release computer magic assets depot '86 circle '85 seasonal new sam borrowings england soloman fish '80 '80 steiger wickes tractor '86 co.s '82 fall 1995 sheppard: strategic bankrupties table 3: list of strategic bankrupt firms by type (cont'd) 109 ploy aimed at intended action companies and filing year: sharestop inaltec '83 heck's '87 schaak holder vestor act electric. '85 govemgovempension ltv '86 phoenix wheeling ment ment costs steel '83 pitts. '85 tax loss allismclouth carrychalmers steel '81 forwards '87 northwest itel corp. eng. '83 '81 press press industry commodore mobile scandal corp. '85 home ind. conner '84 homes '87 tidwell ind.s '85 company coleman national wedtech scandal american paragon '86 '80 '85 mega swanton intematnl. '85 '82 mgmt. rusco '81 saxon scandal industries '84 buyl avoid revere mise.! supply contracts copper '82 legal comavoid one smith texaco petitors lawsuit interntnl. '87 issues '86 110 journal of business strategies vol. 12, no.2 table 3: list of strategic bankrupt firms by type (cont'd) ploy aimed at intended action companies and filing year: prod. avoid manville robins unr users mass torts '82 (a.h.) '85 ind.s '82 employunion tobin ees agreements packing '81 lessors void flannigan's hrt ind.s lafaytte leases ent. '85 '82 radio '80 returns to shareholders the next step of the research involved a determination of how well the company performed from the shareholders' point of view. the reason shareholders were selected was as follows. since common shareholders are the last in line to receive anything after a bankruptcy, one would assume that if shareholders received anything, creditors as well as a wide variety of other stakeholders would also have obtained something. thus, the needs of a great many stakeholders would likely have been addressed if common shareholders received some net benefit from the filing. of concern here, however, are the shareholders. since managers and directors in theory have a responsibility toward shareholders, one would assume that entering into chapter 11 (particularly, the "strategy" of entering chapter 11) would be in the shareholders' best interest. to determine what happened to these chapter 11 firms, computer searches of several databases were run. in addition, the commerce clearinghouse's capital changes reporter and financial information's directory of obsolete securities were employed to trace securities. capital changes reporter, moody's manuals and press reports were searched to ascertain what stock conversions (i.e. pre-bankruptcy shares traded in for new shares) and dividends had been issued since the firm's chapter 11 filing. finally, standard & poors' directory of corporate officers & directors indexes were cross checked in order to trace firm names since, in an effort to 'start over', firms will sometimes change their name. appendix 2 presents the list of the firms that changed their names. returns to shareholders were calculated to address the question, "did the move into chapter 11 improve the long-run financial well-being of the shareholders?" to calculate returns to shareholders, the share price on the day prior to filing was compared to the share price at the end of 1992. annual returns to shareholders were calculated as follows: fall 1995 ar = asr sheppard: strategic bankrupties amr 111 where ar = annual returns asr = amr = and where asr = amr = such that me = = average shareholder returns average market returns t/y market value of pre-bankruptcy shares (adjusted for dividends, splits, and payments) at the end of the study period (12-31-92). market value of common shares on the day prior to filing. y t = = years since the bankruptcy until 12-31-92. three month t-bill rate 4 compounded from date of filingto 12-31-92 sirower (1991) observed that the price immediately prior to filing is the lowest price a stock will possess. both sirower (1991) and hambrick and d' aveni (1988) note that this is the point at which the organization's downward spiral halts, that it is possible for conditions to improve from there onward, and that the value of the company to shareholders should also improve. over half the firms in the sample had a -100% return to shareholders; i.e. their stock was worthless. about 40% of the strategic bankruptcies and about 65% of the non-strategic bankruptcies were worthless. as shown in table 4, this difference in worthless rates is significant (p <.01). only 14 of the 155 bankruptcies in the sample (about 9%) resulted in a return to shareholders that was positive relative to the market rate. the majority of these 14 companies utilized strategic bankruptcy. ten of the positive return companies (72%) were strategic bankruptcies, four were non-strate¥ic (28%). this difference in positive return rates is significant (cross-tabs chi of 7.05, p <.01) as shown in table 4. 112 journal ofbusiness strategies vol. 12, no.2 table 4: worthless vs. non-worthless shares / positive vs. non-positive returns bankruptcies bankruptcies strategic nonstrategic nonstrategic strategic s r h worth23 65 e positive 10 4 a less (41.9%) (65.0%) t (18.2%) (4.0%) r u e non32 35 r non45 96 s worthless (58.1%) (35.0%) n positive (81.8%) (96.0%) s ch/ = 685 sig. @ .01 chi 2 = 7.05 sig. @ .01, annual returns 5 for the 100 non-strategic bankruptcies in the sample averaged -3.923 (with a standard deviation of 1.94). the 55 strategic bankruptcies averaged an annual return of -1.175 rate (with a standard deviation of 7.94). the returns for the two groups were compared via a test of means at-test (not an uncommon test for bankruptcy data; see sheppard, 1994b). strategic bankruptcies, on average, had a significantly higher return to shareholders than the non-strategic group (t = 2.53, p <.05). however, neither type of bankruptcy produced an above market rate of return since the returns for both groups are negative. while both strategic and non-strategic bankruptcies result in negative returns, there may be some subgroups of strategic failures which create positive returns. in order to investigate this possibility the one way analysis of variance (anova) shown in table 5 was performed. fall 1995 sheppard: strategic bankrupties 113 table 5: anova results using four clusters of strategic bankruptcies strategic shareholder returns bankruptcy types n mean std.dev. anova results capital providers 26 -0.921 0.968 f statistic= 3.242 (p < .05) government 7 -1.221 0.201 scheffe procedure press 12 -0.918 1.256 contrasts (p < .05) misc.llegal issues 10 0.731 1.547 misc.llegal #capital provider the results of the scheffe procedure shown in table 5 demonstrate that the firms which filed for a strategic bankruptcy when dealing with a miscellaneous / legal issue had significantly different returns from those firms dealing with capital providers (p <.01). while the miscellaneous / legal issues group was the only one in which there were positive returns to shareholders, the anova does not tell us whether the rate of return was significantly better than what could have been achieved in the market over the same time frame. to investigate whether this group of strategic bankrupts performed at better than the market rate, a pairwise t-test comparing average shareholder returns to average market returns was performed. although firms in this group, on average, out-performed the market rate of return, the difference was not significant (pairwise t of 1.36 was not significant at .1). within the miscellaneous / legal cluster, only firms fending off a single lawsuit had returns significantly higher than market (p < .01 via pairwise t-test comparing average shareholder returns to average market returns). very few strategic bankruptcies had higher than market rates of return. many categories within the set of strategic bankruptcies had lower than market rates of return 6 . thus, one is tempted to discard the idea of chapter 11 filing as a useful strategic ploy. however, it is possible that effective use of bankruptcy as a strategy may be contingent upon some other factors. to address this possibility, a final test was run. other possible conditions that may impact investor returns to investigate the possible impact of other factors related to returns from bankruptcy, two variables were studied: (1) the firm's size at filing, and (2) the 114 journal ofbusiness strategies vol. 12, no.2 company's equity at filing. while this list is not exhaustive, given the exploratory nature of the present research, it should be a sufficient starting point from which to evaluate some contingencies which might suggest that the use of strategic bankruptcy can lead to positive shareholder returns. corporate size firm size has been identified as one of the most important variables that impact the relationship between strategy and performance (hoffer, 1975; smith, guthrie and chen, 1989). moulton and thomas (1993) found that firm size was the most important variable in determining whether companies successfully reorganized. firm size has long been recognized as an important determinant for organizational survival in the population ecology literature (for a review see singh and lumsden, 1990). as well, finance literature has long been concerned with attempting to control for firm size effects in failure studies due to the impact firm size may have on survival likelihood (e.g. see altman, 1968). while it is thus important to include size as potential factor in determining the outcome of a chapter 11 filing, the direction of the relationship between firm size and survival is debatable. large firms are typically viewed as more likely to be successful. moulton and thomas' (1993) research showed that large firms are more likely than small firms to survive chapter 11 reorganization intact. the likelihood of failure among small firms is well known in the population ecology literature as "the liability smallness" (singh and lumsden, 1990). however, smallness may not always be a liability. a small firm may have the advantage of quicker response to environmental change, because smaller firms may be organized in a less mechanistic manner and their response to external threats may thus be quicker than that of a larger organization (staw, sandelands and dutton, 1981; sutton and d'aunno, 1989). in order to be consistent with moulton and thomas' (1993) study, the measure of size employed here was firm asset size. the list of 155 sample firms was divided into small versus large firms. small firms had less than the median $49 million in assets; large firms had more than the median $49 million in assets. company equity company equity may also impact a company's response to threats. equity can be considered a form of "organizational slack" (sheppard, 1994b). firms lacking slack resources may be more likely to encounter managerial paralysis or rigidity (smart and vertinsky, 1977; staw, et. ai., 1981) when the need for change is critical as it is in reorganization. if such rigidity occurs, shareholder value will be dissipated since it is unlikely that management will make timely decisions that could halt the company's downward spiral in its earlier stages (hambrick and d' aveni, 1988). in addition, part of the logic behind the enactment of the fall 1995 sheppard: strategic bankrupties 115 1978 bankruptcy law was to encourage companies to file earlier, while they still had some equity from which to rebuild the firm (cifelli, 1983). if congress was correct in its estimation that early filing companies are the ones with sufficient equity bases to survive bankruptcy, then equity would be an important variable in determining reorganization success likelihood. the ratio of equity over total assets was used as the measure of a firm's resource base. for financial institutions, net worth over total assets is also a general indication of solvency (mun and garcia, 1983). pinches and mingo (1973) and chen and shimerda (1981) also mention this ratio as an important, useful one. therefore, the list of 155 firms was divided into low versus high equity firms. low equity firms had less than a median equity to asset ratio of 9.1 %; high equity firms had more than a median equity to asset ratio of 9.1 %. test of the impact of size and equity base to evaluate how the two factors of size and equity base along with strategy impacted the returns provided to shareholders, an anava was performed. results of the anava are shown in table 6. table 6 also notes the group which had the highest returns within each category. these high return groups would most obviously be preferred by shareholders (detailed returns for all groups are included in appendix 3). table 6: anava results by type of bankruptcy, size, equity and corporate purchase anova annual f -statistic highest return group results shareholder returns f sig. group n mean main effects 8.22 .001 strategy 9.29 .010 strategic 55 -1.17 bankruptcies size .03 large 77 -2.62 companies equity 5.91 .020 high equity 77 -2.18 companies 116 journal ofbusiness strategies vol. 12, no.2 table 6: avova results by type of bankruptcy, size, equity and corporate purchase (cont'd) anova annual f -statistic highest return group results shareholder returns f sig. group n mean two-way interactions 1.26 strategy and size 0.03 strategic i small 19 -0.88 strategy and equity 3.62 .060 strategic i high 28 0.53 equity size and equity 0.07 large i high 37 -1.70 equity three-way interactions 0.57 strategy, size and equit strategic / small 11 1.07 high equity the anova results show that the main effects were significant (p <.001). in particular, there was a statistically significant relationship between annual shareholder returns, strategy and equity base (p <.05). corporate size was the only factor not significantly related to returns. although strategic bankruptcies, large companies and high equity companies all fared well, none of these groups, on average, had returns that exceeded the market rate of return (as shown by their negative return figures), the two-way interaction between strategy and equity in the anova was of minor significance (f = 3.62, p <.1). each two-way interaction creates four possible sub-groups. thus, strategy and equity create: (l) low equity, non-strategic bankruptcies, (2) low equity, strategic bankruptcies, (3) high equity, non-strategic bankruptcies and (4) high equity, strategic bankruptcies. thus, table 6 also shows which sub-group had the highest returns for each interaction. as shown in table 6, strategic i high equity companies had positive above market returns to shareholders. however, a pairwise t-test comparing average shareholder returns to average market returns showed that the returns these for these sub-groups of bankrupt companies were not significantly greater than the market rate of return over the same period (p <. i). three way interactions in the anova were not significant (p <. i ). fall 1995 sheppard: strategic bankrupties. results summary 117 generally, the results of the present study show that strategic bankruptcies out-perfonn their non-strategic counterparts. impacts from other factors are shown in table 7. table 7: summary of results ! shareholder return for results comments all strategic bankruptcies did finns filing for strayes t-test shows a significant diftegie bankruptcy have ference between the two a higher rates of return groups (p < .05). than non-strategic finns? l did finns filing for strano the mean fqr strategic bankl tegie bankruptcy have ruptcies wa·s below the higher than the market market rate of return. rate of return? shareholder return by strategic bankruptcy type did any types of strayes anova scheffe procedure t tegic bankruptcies have contrast rate misc. i legal :t: higher rates of return capital provider (p < .05). y than other types? p did any types of straone misc. i legal had positive tegic bankruptcies have returns, but not significant e higher than market rates (pairwise t: p < .1) of return (one small misc. i legal issues finns group) trying to avoid 1 lawsuit had significantly higher than market returns (pairwise t: p < .01). 118 journal of business strategies table 7: summary of results (cont'd) vol. 12, no.2 other impacts on results comments shareholder returns was there a firm size / no not significant return relationship? (anova f: p < .1). a were there significant none not significant interactions with size? (anova f: p < .1). t was there a tirm equity / yes positive significant h return relationship? (anova f: p < .05). e were there significant strategic / high equity strat. filers out interactions with equity? high equity performed others significant r (anova f: p < .05). did any sub-groups none no group mean had a sigbased on strategy, size nificant improvement over and equity out-perform market (pairwise t: p < .1). the market rate of return? (high equity most significant improvement misc. / legal) over market for sub-group, pairwise t == 1.87: p < .12. in general, table 7 shows that a larger firm equity base can help shareholders realize more of their investment. size does not significantly impact these other factors. in any case, only very rarely did shareholders of bankrupt firms realize returns that were greater than the market rate. this result was generally true for both strategic and non-strategic bankruptcies. discussion shareholders can make high rates of return in the year following a chapter 11 filing according to sirower (1991). the present study looked at the longer run return to shareholders more than five years. in theory, management shotlld be managing the company for the long run benefit of the shareholders (hax and majluf, 1984). did chapter 11 bankruptcy particularly strategic bankruptcy aid shareholder returns? were there other conditions that may have helped shareholders earn higher long run returns? fall 1995 sheppard: strategic bankrupties synopsis of the results 119 generally, chapter 11 filers are poor long run investments. if one invested equal amounts in each of the 155 companies studied here in the month they went bankrupt, the return on investment would average substantially below what one could have obtained by investing in long tenn risk-free investments during the same time period. given the risk involved in investing in these types of firms, the long-run return is very low. strategic bankruptcies, in general, had below market returns. only single lawsuit cases had significantly higher returns than market. in the single lawsuit cases, investors may have simply over-estimated the ability of the main creditor to press its claims against the debtor where the debtor was about to file for chapter 11 reorganization. possibly, the fact that the solution to the finn's problems was simple and obvious (re-negotiate the amount of the claim down to an amount the company could afford to pay) that it could be dealt with in a far more easy and legally inexpensive way than investors would have predicted. size and reorganization success were found to be strongly related to one another in moulton and thomas' (1993) work. they defined successful reorganizations as those where the firm maintained its identity, continued to be publicly traded on a national exchange and kept at least half its pre-bankruptcy assets. the firms with the highest returns in the, present study lafaytte radio and sam soloman would not have qualified as even partially successful companies for moulton and thomas. both finns were sold: lafaytte to circuit city and sam soloman to service merchandise. the difference in results between moulton and thomas' study and the present one may be the result of the differences in how one defines success. in other words, size may be important in allowing a firm to keep its identity, but it has no effect with regard to maximizing shareholders' returns. there is another way this difference between survival and returns may impact the results. large size may cause higher numbers of firms with low average returns to survive. small firms may be less likely to survive but those that do could have higher average returns. this is in fact the case with the present study. while shares in 69% of small'firms became worthless, only 44% of shares in large firms became worthless (as shown in appendix 4, cross-tabs ch/ of 8.93 is significant at .01). among the non-worthless firms, large firms had a somewhat lower annual return to shareholders than smaller firms (though not significantly so). small firms had an annual return of .3 and large firms had an annual return of -1.03. why might this happen? large companies may have the reputational capital to insure proper funding support (d' aveni 1989) but their relatively more mechanistic structures (staw, et al., 1981) may cause great delay in their developing of plans that could stop the downward spiral of decline soon after their filing (hambrick and d' aveni, 1988). these firms thus have substantial organizational inertia which better insures their existence but inhibits their ability to change (hannan and freeman, 1984). this 120 journal of business strategies vol. 12, no.2 would be so even when they are under extreme pressure to change (zajac and kraatz, 1993) as is the case in a bankruptcy filing. thus, these firms produce relatively poor average returns. conversely, small firms may lack reputational capital to insure proper funding (d'aveni, 1989) but they may be able to change more quickly due to more organic structures (sutton and d' aunno, 1989) and lower organizational inertia (hannan & freeman, 1984). also, small firms may be able to attract new investors who can purchase sufficient equity in the company so that old management can be forced out. this situation would not only provide new capital for a fresh start but also allows the company to bring in people better able to develop new strategies (slatter, 1984) to break the firm free of its downward spiral (hotchkiss, 1995). so, it is evident that fewer small firms survive, but the ones that do have higher returns. the net effect is that the average return among these firms will be poor due to the significant number of worthless ones. thus, the inertial forces which aid the large firm's survival (e.g. reputational capital) are balanced out by those which hinder change (e.g. mechanistic structures). likewise, inertial forces which defeat the small firm's survival (e.g. lack of reputational capital) are balanced out by those which promote change (e.g. organic structures). equity was found to be far more important than size in aiding positive shareholder returns. the impact of equity on returns likely stems from two sources. one is the simple point that a stronger equity base is a foundation upon which a restructured company can be built (sheppard, 1994a). two, equity allows shareholders some ability to pursue their claims against the company. if there is little to no equity in the company, shareholders fail to be "real parties in interest" at filing (sabin, neporent and weiner, 1991). without equity, courts could, in theory, block the rights stockholders may have in the bankruptcy proceedings including the rights to any claims on the firm or its assets (sabin, et. al., 1991). thus, higher levels of equity may simply serve to allow shareholders to better maintain their claims against the compan/. the interaction of equity and strategy was found to be significant in aiding positive shareholder returns. flynn and faird (1991) argued that there are circumstances under which early bankruptcy filing may be the best way to maximize shareholder wealth. the present study found that shareholders of strategic early filers i.e. firms with high equity, filing a strategic bankruptcy achieved positive returns. however, since the returns were not significantly above the market rate, there is relatively weak support for early filing. this result leads to two questions. one, why was there any effect from the equity i strategy interaction on returns? two, why were these effects not more significant? there are two points to remember. one, a strategic bankruptcy is invoked to proactively deal with a single threat from an identifiable stakeholder group (daily, 1994). by nature, the strategic bankruptcy is an expedient device to deal with a relatively simple problem (e.g. the threat posed by one lawsuit). two, the presence or absence of organizational slack (cyert and march, 1963) in the fall 1995 sheppard: strategic bankrupties 121 form of equity base (sheppard, 1994b) alters the organizations' response to threats. bozeman and slusher (1979, 346) note that "scarcity-induced stress causes organizations to behave as if complex, dynamic and interrelated environments are in fact simple, static and unrelated." so, the forces at work are: (1) the simplicity of the problem and (2) the resource base available to deal with the problem. high equity strategic filers would therefore be under less stress due to higher levels of resources (staw, et. al., 1981). yet, like many firms in crisis, they would respond by restricting information gathering and alternatives (smart and vertinsky, 1977). by doing so, they quickly focus on the simple and obvious solutions to what may be simple and obvious problems 8 • this appropriate response is in contrast to low equity non-strategic filers. these firms would be under more stress due both to a scarcity of resources and a set of problems and solution alternatives that taxes their information processing capabilities (staw, et. al., 1981). by restricting information gathering and alternatives, such companies would be less likely to be come to decisions which would allow them to properly allocate resources and break free of their downward spiral (argenti, 1986a and 1986b; hambrick and d' aveni, 1988) why would equity and strategy not result in returns to shareholders significantly above market? it is possible that either (1) investors could not correctly estimate the corporation's likelihood of chapter ii filing or (2) they could not correctly estimate the effects that the filing would have upon their investment. in the first case, the filing might have taken investors by surprise and any possible impacts (positive or negative) from filing may not have been factored into the price. this is unlikely since there are many early warning signs of failure that investors could have identifed (e.g. see argenti, 1986a and 1986b). it is more likely that the investors incorrectly estimated the outcome of the bankruptcy process for firms in this category. being uncertain of how the courts would interpret the new bankruptcy statutes, investors could not have correctly estimated the value of the stock. implications for practice what do these results mean for investors of companies facing a chapter ii filing? first, investors should, in general, avoid these stocks as long term investments. the average return on investment here was substantially below the risk-free rate. second, the presence of a high return category of strategic bankruptcy indicates some limited opportunity for significant returns above the risk free rate. miscellaneous i legal strategic bankruptcies may provide investors with a positive return particularly in cases where the company is attempting to use chapter ii to defend itself against the impacts from a single lawsuit. however, the positive returns found here may be fleeting. when the bankruptcy law was new there may have been uncertainties regarding how the law would impact some types of filings. the price may have been distorted as to allow for some posi122 journal of business strategies vol. 12, no.2 tive returns. with investors having better knowledge of how the bankruptcy process works, the price distortion, along with possibilities for positive returns, may be gone. finally, company size does not matter for the investor seeking high returns but for managers seeking corporate survival. managers should be aware that early filing is advantageous. thus, as soon as managers realize that filing is inevitable, it is in the best interest of shareholders that it is done expeditiously. this outcome holds particularly for companies with a high equity base and problems that chapter 11 can easily address (i.e. early filing strategic bankrupt companies). these companies may be best at achieving some sort of positive outcome from the bankruptcy process for their investors. the high returns for such filings may also suggest that there are circumstances where the threat-rigidity response may work in favor of an organization in crisis (as suggested by staw, et. ai., 1981). as previously suggested, such a response would serve to simplify the set of alternative problem solutions under circumstances where such simplification is most appropriate and resources for implementation still exist. finally, managers of smaller firms going into chapter 11 should not be totally disheartened provided their company was a strategic early filer. though not significantly better than the market, small companies with early filing of strategic bankruptcies had the best rate of return. limitations as in all studies, there are some limitations to the present research which must be discussed. these include factors regarding definition, sample composition and time period studied, alternatives that may have served chapter 11 filers better, and learning by investors or courts after the period of study. the definition for strategic bankruptcy used here is a broad one and a narrowly-defined one may give different success results. however, a narrower definition may not cover as many possibilities open to managers who wish to pursue strategic bankruptcy. also, given the sample size available, a narrow definition would not lend itself well to testing. also, different interpretations of the available data might have resulted in different firm classifications. the exploratory nature of the present study did not allow for a more complete search of all possible data sources. sample composition may have also had an impact on the results. the minimum size and age limits set for sample firms could mean that younger or smaller firms may be at greater risk than the present analysis indicates. hambrick and d' aveni (1988) note this possibility as well. there are two important items of note about the time period selected. first, in an effort to ensure firms made it through their chapter 11 proceedings, no firms which initially filed after 1987 were included in the study. since prepackaged bankruptcies, or "pre-packs" are a new twist to chapter 11 in the last five years there are no pre-packs in the sample. the success likelihood of this particular category of strategic bankruptcies will thus require further study. second, some fa111995 sheppard: strategic bankrupties 123 firms re-entered bankruptcy after 1987 but have not yet come out of chapter 11. such firms were considered to be worthless since there was likely little that would be left for shareholders after a second round of chapter 11 proceedings though the full impact of the second filing is unknown. less than 5% of the firms in the sample were second filings after 1987. 9 alternatives that may serve shareholders better than chapter 11 may exist. returns to investors in companies that managed turnarounds or arranged workouts with their creditors versus returns to shareholders of companies that filed were not studied. for this reason, early or strategic filing cannot be wholeheartedly supported. for example, it is unknown how well a company could have done with a debt-for-equity swap as opposed to a chapter 11 reorganization. learning by investors may change opportunities for future profitable shareholder returns. the results of the present study may simply demonstrate the failure of the market to price the stock correctly at filing. this failure may have occurred since investors had to deal with a new law (the 1978 bankruptcy act) that had yet to be interpreted. as bankruptcy case law has built up over the years, investors should have improved their ability to evaluate good strategic bankruptcies. the opportunity for excess returns may have been a fleeting one brought on by a change in the law. in the future, investors may have to look for some new revisions to find future positive returns. also, the courts may interpret the law more narrowly in the future. for example, if the bankruptcy courts begin to lean toward the plaintiffs side in mass tort or single lawsuit cases, the parts of the broken bench which seemed beautiful may instead provide investors with some painful splinters. directions for future research several avenues for future research present themselves as a result of the present study. these inquiries would deal with returns regarding specific types of bankruptcies, alternatives to bankruptcy, organizational response to the chapter 11 filing, and learning by investors. the present study found the value of strategically filing for bankruptcy in general to be questionable. however, research into the category of miscellaneous / legal strategic bankruptcies, high equity strategic bankruptcies, or pre-packaged bankruptcies may be fruitful avenues for looking into circumstances where chapter 11 could enrich shareholders. of particular interest may be the returns to shareholders when the firm is merged into another after chapter 11. the firms with the highest shareholder returns in the present study fell into this category while it was beyond the scope of the present study, investigation into the returns to shareholders of declining corporations that sought to move away from ruin by other methods may prove an interesting area of study. for example, a financial restructuring or workout arrangement with creditors may have provided better returns for shareholders. 124 journal ofbusiness strategies vol. 12, no.2 the organizati<mal responses that cause some chapter 11 filers to become worthless and others to have returns above the market need to be studied. how the combination of organizational inerita and managerial paralysis or rigidity work within the organization that has filed for chapter 11 reorganization may have great impact upon returns to shareholders. finally, the ability of investors to learn from prior court decisions could be studied to see if returns on these type of investments decline as the market learns how to interpret the impact of the law. as the law in this area becomes clearer returns should begin to approach zero relative to the market. investors should become better at pricing the stock at filing. extraordinary returns would thus be less likely to occur in the future since investors have learned which types of strategic filings are likely to be successful and now price the pre-bankruptcy investment accordingly. conclusion there are some types of strategic bankruptcies which can result in positive returns to shareholders. however, the number of high return types is low and the extent to which these types provide shareholders with returns that are significantly above market is limited. returns to shareholders of companies that either merged after chapter 11 filing, or sought alternatives to bankruptcy could be fruitful avenues for future research. finally, what the present research shows is the importance of having some useful guide in this case a typology to find a way around the confusing landscape of strategic bankruptcies. like the streets of venice, it is easy to get lost without a map, and hopefully the present research provides one. endnotes in a sense, stakeholders become competitors for the company's assets. 2 on the surface, some strategic bankruptcies against creditors often appear to be filings for straightforward stays 'as well. however, the difference between the strategic and nonstrategic bankruptcies in these cases is that the non-strategic ones are using the stay to develop a plan to reorganize and the strategic ones have already developed a plan whose implementation the creditors were unwilling to support. the strategic filing is thus a way to force that support and allow for the full implementation of the plan. as will become clearer, in-depth analysis of the press reports of these types of strategic filers reveals a complex underlying strategy, or ploy. analysis of press reports on non-strategic filers does not reveal the same machinations. 3 an example of using chapter 11 against a non-traditional creditor would be the use of bankruptcy by manville corp. (successor to johns manville) to sort out thousands of asbestos claims which could have been potentially filed against the company. an example of a strategic use of chapter 11 against a traditional creditor would be magic circle energy's attempt to use bankruptcy to force its bank to release real estate collateral to allow oil drilling. fall 1995 sheppard: strategic bankrupties 125 4 the simple annual percentage returns to shareholders used here represent excess returns over the risk free rate. analysis was also performed to evaluate excess returns relative to investments with a somewhat higher degree of risk, le. change in the dow industrial average from the time of chapter 11 filing until the end of 1992. when the dow figures were substituted for the average market the results did not differ significantly from the results of the study shown here. s the numbers employed were the transformed returns. the transformations were designed to reduce the impact of outliers. the numbers were transformed using the square root of the absolute value of their percentage returns. in order to maintain the variables' signs these values were multiplied by the untransformed value over the absolute value of the untransformed value. 6 on average, the shareholder returns for firms filing for strategic bankruptcies dealing with capital providers or the government had significantly lower rates of return than the market (p<.ooi via pairwise t-test comparing average shareholder returns to average market returns). 7 however, due to the legal wrangling likely to occur, courts do not typically try to exclude stockholders from the bankruptcy proceedings when there is little to no equity. 8 this would explain the high returns for firms entering chapter 11 to settle single lawsuit cases. 9 these firms were cs group in 1989; salant in 1990; lionel in 1991; combustion equipment in 1992; and tacoma boat in 1993. references altman, e. i. "financial ratios, discriminant analysis and the prediction of corporate bankruptcy." journal of finance 23 (dec. 1968): 589-609. argenti, j. corporate collapse: the causes and symptoms. new york: john-wiley, 1976. "predicting corporate failure." accountancy (april 1986a): 157-8. "spot danger signs before it's too late." accountancy (july t 986b): t 012. agresti. a. and b. f. agresti. statistical methods for the social sciences. san francisco: dellen publishing, 1979. bozeman, b. and e. a. slusher. "scaricity and environmental stress in public organizations: a conjectural essay." administration and society 2 (1979): 335-55. brown, d. t. "claimholder incentive conflicts in reorganization: the role of bankruptcy law." the review of financial studies 2 (1989): 109-23. cifelli, a. "management by bankruptcy." fortune (october 31, 1983): 69-72. chen, k. u. and t. a. shimerda. "an empirical analysis of useful ratios." financial management 10 (spring 1981): 51-60. 126 journal of business strategies vol. 12, no.2 cyert, r. and j. g. march. a behavioral theory of the firm. englewood cliffs, nj: prentice hall, 1963. daily, c. m. "bankruptcy in strategic studies: past and promise." journal of management 20 (summer 1994): 263-95. d' aveni, r. "dependability and organizational bankruptcy: an application of agency and prospect theory." management science 59 (sept. 1989): 1120-38. delaney, k. j. strategic bankruptcy: how corporations and creditors use chapter 11 to their advantage. berkeley, ca: university of california press, 1992. duncan, j. w. "business failures post sharpest increase since 1983." d and b reports (may-june, 1991): si-s3. flynn, d. m. and m. faird. "the intentional use of chapter xi: lingering versus immediate filing." strategic management journal 12 (feb, 1991): 63-74. hambrick, d. c. and r. a. d' aveni. "large corporate failures as downward spirals." administrative science ouarterly 33 (spring 1988): 1-23. harrigan, k. r. "research methodologies for contingency approaches to business strategy." academy of management review 8 (may 1983): 398-405. hannan, m. t. and j. freeman. "structural inertia and organizational change." american sociologal review 49 (april 1984): 149-64. hax, a. c. and n. s. majluf. strategic management. an integrated approach. englewood cliffs, nj: prentice-hall, 1984. hoffer, c. w.. "toward a contingency theory of business strategy." academy of management journal 18 (oct. 1975): 784-810. hotchkiss e. s. "postbankruptcy performance and management turnover." journal of finance 50 (jan. 1995): 3-21. miles, r. e. and c. c. snow. organizational strategy. structure and process. new york: mcgraw-hill, 1978. miller, d. and p. friesen. "archetypes of organizational transition." administrative science ouarterly 25 (fall 1980): 591-614. mintzberg, h. "five ps for strategy." in the strategy process concepts. contexts. cases 2nd ed. eds. h. mintzberg and j. b. quinn. englewood cliffs, nj: prentice hall, 1991. _____. "patterns in strategy formulation." management science 24 (jan. 1978): 47-72. fall 1995 sheppard: strategic bankrupties 127 moulton w. n. and h. thomas. "bankruptcy as a deliberate strategy: theoretical considerations and empirical evidence." strategic management journal 14 (feb. 1993): 12535. mun, g. g. and f. l. garcia. encyclopedia of banking and finance 8th edition. boston: bankers book co., 1983. norusis, m. j. spss/pc+ advanced statistics. chicago: spss inc., 1988. owen, b. and r. brautigam. the regulation game: strategic use of the administrative process. cambridge, mass: ballinger publications, 1980. pinches, g. e. and k. a. mingo. "a multivariate analysis of industrial bond ratings." journal of finance 38 (jan. 1973): 1-18. porter, m. e. comdetive strategy. technigues for analyzing industries and comdetitors. new york: free press, 1980. rumelt, r. p. strategy. structure and economic performance. cambridge, mass.: division of research, harvard business school, 1974. sabin, j., m. neporent and c. weiner. "legal considerations of purchasing securities." workouts & turnarounds: the handbook of restructuring & investing in distressed comdanies. eds. d. dinapoli, s. sigoloff and r. cushman homewood il: business 1 irwin, 1991. sheppard, j. p. "when the going gets tough, the tough go bankrupt: the questionable use of chapter 11 as a strategy." journal of management inguiry 1 (fall, 1992): 183-92. _____,. strategic bankruptcy: lypology and success likelihood discussion paper, simon fraser university, 1994a. _____. "strategy and bankruptcy: an exploration into organizational death." journal of management 20 (winter 1994b): 795-833. sherman, s. p. "bankruptcy's spreading blight." fortune (june 3 1991): 123 132. singh, j. v. and c. j. lumsden. ''theory and research in organizational ecology." in the annual review of sociology eds. w. r. scott & j. blake, palo alto, ca: annual reviews, 1990. sirower, m.. "bankruptcy as a strategic planning tool." in academy of management best papers proceedings eds. j. l. wall and l. r. jauch, ada, oh: academy of management, 1991. slatter, s. corporate recovery: successful turnaround strategies and their implementafum. harmondsworth, middlesex, england: penguin books, 1984. 128 journal of business strategies vol. 12, no.2 smart, c. and i. vertinsky. "designs for crisis decision units." administrative science ouarterly 22 (fall 1977): 640-57. smith, k. g., j. p. guthrie and m. j. chen. "strategy size and performance." organization studies 10 (jan 1989): 63-81. staw, b. m., l. e. sandelands and j. e. dutton. "threat-rigidity effects in organizational behavior: a multilevel analysis." administrative science quarterly 32 (spring 1981): 542569. sutton r. i. and t. d' aunno. "decreasing organizational size: untangling the effects of money and people." academy of management review 14 (summer 1989): 194-212 zajac, e. j. and m. s. kraatz. "a diametric forces model of strategic change: assessing the antecedents and concequences of restructuring in the higher education industry." strategic management journal 14 (spring 1993): 83-102. fall 1995 sheppard: strategic bankrupties appendix 1: list of non-strategic bankrupt finns 129 filing filing filing filing filing filing company year company year company year name name name aic photo 1985 general 1986 polaron 1981 exploration products am 1982 geophysical 1983 pubco 1982 international systems ati 1984 gilman services 1982 rps products 1982 advent 1981 gilpin 1980 reading 1981 (henry b.) industries allied 1980 glover 1980 richmond 1983 technology tank car american 1985 goldblatt bros. 1981 robintech 1983 monitor amfesco 1985 good (1.s.) 1980 roblin 1985 industries &co. industries argo 1985 hardwicke 1983 ronco 1984 petroleum companies teleproducts barclay 1981 imperial 1986 sal 1985 industries industries communications beker 1985 inflight 1986 seiscom delta 1986 industries services berry 1984 john f. 1981 servamatic 1986 industries lawhon systems berven 1982 koss 1984 shelter 1982 carpets resources birdview 1986 k-tel 1984 spencer 1986 satellite international companies bobbie 1982 leisure 1983 spiral metal 1983 brooks dynamics 130 journal of business strategies vol. 12, no.2 appendix 1: list of non-strategic bankrupt finns (cont"d) filing filing filing filing filing filing company year company year company year name name name brody (b.) 1980 lionel 1982 standard 1984 seating metals buttes gas 1985 lynnwear 1981 steelmet 1983 &oil cs group 1982 macrodyne 1986 stevcoknit 1981 industries charter 1984 magic 1980 storage 1984 corp. marker technology combustion 1980 magnuson 1983 sykes 1985 equipment computer datatronics consolidated 1984 marion 1983 tacoma 1985 package corp. boatbuilding consolidated 1984 maxon 1981 tenna corp. 1979 petrol. industries crutcher 1986 mays, l.w. 1982 texscan 1985 resources crystal oil 1986 michigan 1987 todd 1987 general shipyards daleo 1983 monolith 1986 towle mfg. 1986 petroleum portland dant & 1982 morton 1982 towner 1984 russell shoe petroleum data access 1983 national 1980 travel 1980 systems shoes equipment eagle 1986 nexus 1985 una corp. 1986 computer industries fall 1995 sheppard: strategic bankrupties appendix 1: list of non-strategic bankrupt firms (cont"d) 131 filing filing filing filing filing filing company year company year company year name name name edmos 1983 nicklos oil 1985 unimet 1985 & gas evans 1985 nucorp 1982 upson 1980 products first 1981 oxoco 1986 van wyke 1980 hartford internat!. flame 1983 opelika mfg. 1985 victoria 1986 industries station garland 1980 penn-dixie 1980 winn 1986 industries enterprises gateway 1981 pettibone 1986 xonics 1984 sporting corp. pizza time 1984 theater 132 journal of business strategies vol. 12, no.2 appendix 2: post chapter 11 filing company name changes pre-ch. 11 filing name post-ch. 11 filing name aic photo aic international american monitor am diagnostics ati inc. ati pharmaceutical allied technology technological sciences amfesco industries new american shoe argo petroleum fortune petroleum berry industries strata search inc. combustion equip. assoc. carter day industries data access system authorized distribution edmos corp. bangor america evans products grossman lumber gateway sporting goods gateway gathering sys. goldblatt brothers jg industries heck's inc. hallwood holdings john f. lawhon furniture w & j sloane co. magic circle energy mceinc. mclouth steel mlx industries mego international mego corp. mesta machine mestek mobile home industries mhi group fa111995 sheppard: strategic bankrupties 133 appendix 2: post chapter 11 filing company name changes (cont'd) pre-ch. 11 filing name post-ch. 11 filing name morton shoe morton co.s transport northwest engineering terex oxoco ironstone group penn-dixie continental steel sambos restaurants sri holdings transcontinental energy regency affiliates van wyke international robeson industries wheeling-pittsburgh steel wheeling pittsburgh co. white motor envirosource inc. 134 journal of business strategies appendix 3: post chapter 11 returns vol. 12, no.2 all bankruptcies strategic non-strategic shareholder bankruptcies bankruptcies returns n mean n mean n mean total bankruptcies 155 -2.95 55 -1.17 100 -3.92 small bankruptcies 78 -3.27 19 -0.88 59 -4.04 large bankruptcies 77 -2.62 41 -3.76 36 -1.33 low equity 78 -3.71 27 -2.95 51 -4.11 bankruptcies small bankruptcies 38 -3.95 8 -3.67 30 -4.05 large bankruptcies 40 -3.48 19 -2.68 21 -4.19 high equity 77 -2.18 28 0.53 49 -3.73 bankruptcies small bankruptcies 40 -2.62 11 1.07 29 -4.02 large bankruptcies 37 -1.70 17 0.19 20 -3.30 appendix 4: worthless/non-worthless shares by finn asset size asset size large small s h worthless 34 (44.2%) 54 (69.2%) a r n00-worthless 43 (55.8%) 24 (30.8%) e s chf = 8.93 sig. @.oi beautifully broken benches: a typology of strategic bankruptcies and the opportunities for positive shareholder returns service classification and management challenges rohit verma kenneth k. boyer depaul university chicago,il abstract coincident with the increasing importance of services as a primary component ofthe economies in developed countries, a number oftheoretically derived service typologies have been developed, yet there has been virtually no empirical validation ofthe proposed ideas. we conducted a survey of273 managers in four service industries (fast food, auto repair, retail sales, legal services) to test how management challenges differ across different sendee industries. we also empirically tested a widely accepted service typology developed by schmenner (1986) within the context of management challenges. discriminant analysis was utilized to test the degree to which companies can be classified into groupings similar to the schmenner's service process matrix according to empirical data rather than anecdotal observations. our findings indicate that the while the service process matrix can be partially validated using empirical data, the distinctions between various industries are much ''fuzzier'' in practice. different service industries can be classified according to empirical data, but misclassifications do occur. in particular, misclassifications are most prevalent where two service industries share a common characteristic as described by the service process matrix. introduction as the post-industrial economy evolves, the service sector continues to in~ crease in importance, both in terms of its contribution to the gross domestic product (gdp) of all advanced economies and in terms of the percentage of workforce employed in services. for example, it has been predicted that the service sector will account for more than 88% of the workforce in the united states by the year 2001 (fitzsimmons & fitzsimmons, 1994). accordingly, the last decade has witnessed an increased emphasis on teaching and research of service management issues by business schools and professional organizations. in response to the increased importance of services, numerous articles on issues related to the effective management of service operations have appeared in hoth academic and practitioner based publications (for example, chase & hayes; 1991, karmarker & pitbladdo, 1995; kellogg & nie, 1995; lovelock, 1992; roth & van der velde, 1991). several of these articles present typologies 6 journal of business strategies vol. 17, no.1 of services and provide directions for improving quality, productivity and operating efficiency, however relatively little has been done to empirically test the proposed ideas. this article presents an empirical assessment of the management challenges proposed by one of the widely accepted service typologies the service process matrix (spm) developed by schmenner (1986). we gathered data relating to management challenges experienced by managers of four different types of service industries (fast food, auto repair, retail sales and legal services). these services were chosen because they differ in terms of various attributes of service delivery systems as suggested by the spm. based on empirical data collected from 273 managers, we show how management challenges differ across four types of services. in addition, we provide an empirical test of how well the four types of industries described by schemnner (1986) can be classified using empirical data. the remainder of the article is divided into four sections. first, we present a review of various service typologies; next we describe the research methods used in the study; third, we present the results of our analysis; and finally, we present a discussion of the implications of the findings from this research. service typologies this section offers a review of various service classifications schemes that have been developed, as well as a discussion of their relative strengths and weaknesses (table 1). this review is provided in order to illustrate that while a variety of insightful conceptual typologies have been developed, there is a need to provide empirical validation in order to identify whether these typologies accurately model reality, as well as identify any shortcomings. the diversity of the service sector makes it difficult to come up with useful generalizations concerning the management of service organizations. therefore, a considerable of amount of research has been focused on developing service classification schemes. for example, judd (1964) classified services according to three categories: rented goods, owned goods and non-goods services. similarly, rathmell (1974) categorized services according to: type of buyer, buyer moti ves, buying practices, type of seller, and degree of regulation. even though these classifications show how some services are different from the others, they do not provide much useful insight into the design and management of service processes from an operational perspective. more recent classification schemes have explored the complex nature of service delivery systems with the goal of identifying differentiating characteristics, which affect quality and process improvement, as well as service design. for example, shostack (1977) and sasser, olsen and wyckoff (1978) developed the concept of "product-service package" based on the tangible versus intangible nature of services. based on similar ideas, levitt (1972, 1976) suggested spring 2000 verma & boyer: service classification 7 that services are commonly thought of in humanistic terms and manufacturing is thought of in technocratic terms. accordingly, manufacturing is seen as efficient and forward~looking, whereas services are viewed as primitive and inefficient. table 1 service typologies author(s) judd, r.c. (1964) rathmell, j.m. (1974) shostack, g.l. (1977) sasser, w.e. jr., olsen, r.p., & wyckoff, d.d. (1978) hill, t.p. (1977) chase, r.b. (1978, 1981) kotler, p. (1980) lovelock, c.r (1980) schmenner, r.w. (1986) mersha, t. (1990) chase, r.b. & hayes (1991) kellogg & nie (1995) categories/groups • rented goods services • owned goods services • non~goods services • types of seller • types of buyer • buying motives • buying practice • degree of regulation proportion of physical goods and intangible services contained in each "product~service package." • services affecting people vs. those affecting goods • permanent vs. temporary effects of service • reversibility vs. non reversibility of service • physical vs. mental effects of service • individual vs. collective services degree of customer contact • people vs. equipment based • extent of customers' presence • public ~ private vs. for~profit ~ non~profit five two-by-two classification matrices based on the following ideas: • nature of service act • relationship between service provider and customer • customization • demand and supply • service delivery service process matrix based on two dimensions: • customer contact and customization • labor intensity degree of customer contact. definition of customer contact expanded to include active and passive contact based on competitive stage service product service process matrix 8 journal of business strategies vol. 17, no.1 more recent researchers however believe in an integrated approach to service management. for example, thomas (1978) argues that a large part of manufacturing experience is irrelevant to the management of service operations because services are very different from manufacturing. sullivan (1981) and bowen and cummings (1990) also advocate an integrated approach to service management and suggest that operations management researchers must include organizational behavior and marketing constructs and techniques to address service operations problems adequately. in addition to the above-cited studies, a number of articles and books emphasize the multi-functional nature of services. therefore, recent service typologies build on managerially useful service delivery system attributes. for example, lovelock (1992) classifies services in five different two-by-two matrices and examines how the specific nature of services in a particular class affects operations and marketing. lovelock's (1992) framework addresses the following questions: (1) what is the nature of the service act? (2) what type of relationship does the service organization have with its customers? (3) how much room is there for customization and judgment on the part of the service provider? (4) what is the nature of demand and supply for the service? and (5) how is the service delivered? lovelock (1992) proposed that his classification scheme addressing the above five questions can help managers develop a better understanding of their business. chase (1978, 1981) proposed that if there is less direct customer contact in the service system, then the service system is more likely to operate at its peak efficiency. conversely, the system is less likely to operate at its peak potential with high direct customer contact. mersha (1990) proposed a broadened definition of customer contact and differentiated between active and passive contact. based on these distinctions, mersha (1990) extended the customer contact model and addressed several earlier concerns about this classification scheme. building on the customer contact approach to services, schmenner (1986) proposed the service process matrix (spm), based on three characteristics of service delivery systems. the spm expands the customer-contact model and categorizes services on two dimensions: (1) labor intensity, and (2) customer contact and service customization. labor intensity is defined as the ratio of the labor cost incurred to the value of the plant and equipment. a high labor intensity business involves relatively small plant and equipment investment relative to a considerable amount of worker time, effort, and cost. the second dimension in the classification scheme combines two distinct concepts: customer interaction and customization. a service with a high level of interaction is one in which the customer can actively intervene in the service process. a service with high customization will work to satisfy an individual's particular preferences. the joint measure has a high value when a service exhibits both a high level of interaction and a high level of customization for the customers. schmenner (1986) proposed a two-by-two service process matrix that classifies services as spring 2000 verma & boyer: service classification 9 service factory, service shop, mass service, and professional service. figure i shows the service process matrix and the corresponding management challenges associated with each type of service. a brief description of each of the four service types is provided below. figure 1 service process matrix (schmenner, 1986) capital decisions technological advances managing demand scheduling service delivery i i customer contactlcustomization fighting cost increases• maintaining quality marketing t+-i r---reacting to customer making service "warm" il service i service intervention attention to physical factory i shop managing career surroundings advancements managing fairly rigid ------+-----managing aat hierarchy i+-mass i professional r---hierarchy i gaining employee service i service loyalty 1 1 hiring training methods development & control employee welfare scheduling workforce control of far-flung operations startup of new operations managing growth service factory. services with both low customer contactlcustomization and a low degree of labor intensity are classified as service factories. similar to line type processes in manufacturing, the facilities and equipment account for a large fraction of costs. much of the transportation industry (airlines, trucking companies), hotels and fast-food establishments can be classified as service factories because of low customer contact, customization and low labor intensity. service shop. services with low labor intensity but high customer contact! customization are classified as service shops. similar to a job-shop type of operation in manufacturing industry, service shops can provide various types of customized services for their customers. hospitals, auto and other repair services are excellent examples of service shops. 10 journal of business strategies vol. 17, no.1 mass service. mass services have low customer contact!customization in combination with high labor intensity. retail companies, wholesaling and schools are examples of mass service. professional service. these services have both high customer contact! customization and a high degree of labor intensity. services provided by doctors, lawyers, accountant and architect all have a very high labor costs due to the large amount of education associated with these professions. in addition, these services tend to be highly customized according to the particular situation/need of each customer. the single common characteristic of all the cited studies is that they are primarily conceptual or theoretical in nature. each of the cited studies presents a typology of either ideal service management or theoretically derived differences between services. as a result, each of the studies provides important insights into important characteristics of services. yet, although many of these studies are based on anecdotal or actual experience with a representative sample of companies. none have been empirically validated using a broad sample of quantitative data rather than subjective inferences. for example, even though the customer contact model was first proposed over fifteen years ago and is widely cited in business management literature, only recently has an empirically derived measure for customer contact been developed (kellogg & chase, 1995). the development of empirical models or taxonomies to quantitatively measure differentiating characteristics of services is an area sorely deprived of adequate study. empirical studies are needed not only to validate largely conceptual models, but also to highlight areas where such models fall short of providing a perfect explanation of important relationships in a service environment. in particular, empirical studies provide an opportunity to identify companies or industries, which are a little bit off the beaten path and don't fit the assumptions of the conceptual model well. these companies often are trendsetters that develop new techniques for providing a product that are then copied by competitors as an industry evolves. for example, amazon.com (http://www.amazon.com) is changing the nature of book retailing through its use of the internet to minimize customer contact while cutting costs and increasing choices. competitors such as barnes and noble are also implementing online sales services in an effort to remain competitive. empirical studies thus present an opportunity to develop or validate models that classify services. with much of the value in these models lying in their ability to identify outliers such as amazon.com. this study presents an empirical assessment of one of the more widely accepted service typologies. as described earlier, we use the service process matrix because it not only expands the customer contact model but also suggests how management challenges differ across different types of services (see figure 1). we also seek to test the predictive accuracy of the service process matrix by means of discriminant analysis. spring 2000 verma & boyer: service classification research methods 11 the data for this study was collected from service managers in four different types of industries: fast food, automobile repair, retail sales and legal services. a random sample of 70 firms from each of these industries was selected from the yellow pages phone directory of a large metropolitan area in the western united states. each service firm that was contacted received a cover letter from the lead researcher, a forwarding letter from the chairperson of the management department of the sponsoring university and a two-page questionnaire. the questionnaire asked the managers to rate twenty-two management challenges (identified by schmenner, 1986) on a five point likert scale (1 = not a challenge; 3 = average challenge; 5 = big challenge). the items addressing management challenges included in the questionnaire are shown in table 3 and figure 1. in addition, the instrument contained four demographic questions regarding the gender, age, work experience and education level of the respondent. the length of the questionnaire was intentionally kept to less than two pages so that the total time needed to respond to survey was less than 15 minutes. in order to increase the response rate, we offered to send a summary of the results to the managers. the respondents also had an opportunity to participate in a raffle and win a $200 cash prize. each of these techniques has been shown to encourage participation in the data collection effort (linsky, 1972). the survey instrument was hand delivered to the managers of each of the 280 service firms sampled. the managers were asked to complete the questionnaire immediately (if possible) and told that it would take less than 15 minutes of their time. almost 75% of the managers completed it immediately. the rest of the managers agreed to complete the survey within a week. a return visit was made to these companies after 4-8 days with another copy of the survey instrument. after the completion of data collection, only six firms chose not to participate in the study. one questionnaire was not complete and was therefore excluded from further analysis, the resulting final sample size was 273, or an effective response rate of 97.5%. results and discussion table 2 provides demographic information for the sample. several differences in education levels of the respondents can be readily identified. the legal service managers are most highly educated (91 % have college degrees). managers in retail sales also are highly educated, with 40% holding a college degree. in contrast, less than 20% of the managers in the fast food and auto repair industries have college degrees. another interesting demographic pattern was observed with respect to the gender of the respondents. there were no female respondents from the auto repair industry and only 7.25% of the managers in legal service are female. by 12 journal of business strategies vol. 17, no.1 comparison, 39% of the retail sales managers and 29% of the fast food managers were female. table 2 also shows the average ages, average work experience and the sample sizes for the four industries. it is interesting to note that managers in auto repair and legal service tend to be older and more experienced than managers in either fast food or retail sales. table 2 sample demographics fast auto retail legal food repair sales service (n =66) (n =69) (n =69) (n =69) education (%) high school 48.5 39.4 26.1 0.0 associate degree/some college 36.4 40.9 34.8 4.4 four year college degree 13.6 19.7 29.0 4.4 masters 1.5 0.0 10.1 31.9 doctorate/jd 0.0 0.0 0.0 59.4 total 100.0 100.00 100.0 100.0 female respondents (%) 28.8 0.0 39.1 73 average age (years) 28.2 38.7 31.3 44.5 average work experience (years) 6.8 18.5 9.8 17.8 scale development the service process matrix proposes that management challenges differ across different types of services (see figure 1). these management challenges have not been empirically assessed in prior research. instead, they are based on anecdotal evidence derived from limited samples. we therefore seek to develop scales to assess management challenges, which are more readily generalizable in a variety of situations. therefore, we examine the twenty-two management challenges shown in appendix i with the objective of developing reliable and valid scales. many of the individual management challenges appear to be components of a larger, underlying construct. for example, employee hiring, training and welfare could be considered as individual management challenges which comprise a larger construct (employee management). in order to identify the underlying factors within the 22 management challenges, as well as reduce the size of the data set to facilitate further analysis, we conduct an exploratory factor analysis. an exploratory factor analysis of the twenty-two management challenges was conducted and the results are summarized in table 3. seven eigenvalues exceeded the generally accepted cutoff value of 1.0 (kim & mueller, 1978) and are therefore retained in the analysis. the seven factors explain a total of 60.6% of spring 2000 verma & boyer: service classification 13 the variance in the data. in order to increase the interpretability, a varimax rotation was performed on the principal components. items were then assigned to the factor on which they had the highest loadings. only items which had loadings of at least 0.40 on at least one factor were retained in the analysis. as a result of this cutoff, one item (qio. managing growth) did not load on any factor and was therefore removed from further analysis. table 3 shows the results of the varimax factor rotation. table 3 factor analysis of service management challenges factor i 2 3 4 5 6 7 eigenvalue 5.20 1.93 1.52 1.42 1.13 1.08 1.05 cumulative percentage of variance 23.6% 32.4% 39.3% 45.8% 50.9% 55.9% 60.6% employee a:::: 0.77 q5. employee hiring 0.77 0.21 -0.04 0.03 -0.q7 0.07 0.12 q6. employee training 0.80 0.13 0.q7 -0.03 0.19 0.02 0.08 q7. employee welfare 0.70 0.04 0.15 0.10 0.09 0.23 -0.12 q9. gaining employee loyalty 0.59 0.29 0.q2 0.08 0.17 0.15 -0.03 service quality a:::: 0.70 q i. physical surroundings 0.06 0.71 0.02 0.09 -0.04 0.05 0.04 q 16. quality of service 0.33 0.63 0.18 0.14 0.15 o.ll -0.13 q17. making service warm 0.29 0.77 -0.q2 0.16 0.14 0,11 -0.03 operations a:::: 0.62 q3. capital decisions 0.00 0.02 0.83 -0.03 0.00 -0.13 0.14 q4. developing work and control methods 0.26 0.25 0.59 -0.06 0.20 -0.09 0.08 q8. fighting cost increases 0.26 -0.12 0.44 0.20 0.32 0.03 -0.q7 qil technological advances -0.15 -0.02 0.68 0.24 0.02 0.28 -0.14 market q12. managing demand 0.03 0.19 0.15 0.56 0.04 0.29 -0.06 q 18. marketing 0.02 0.11 -0.02 0.79 0.15 -0.19 0.10 scheduling a=0.65 q19. reacting to customer intervention 0.13 0.34 0.02 0,45 0.49 0.15 0.12 q20. scheduling service delivery 0.02 0.00 0.22 0.05 0.81 0.12 -0.04 q21. scheduling workforce 0.41 0.23 -0.05 0.12 0.61 0.11 0.09 organization a= 0.57 q13. managing career advancements 0.37 -0.15 0.09 0.38 -0.11 0.51 0.15 q14. managing flat hierarchy 0.18 0.09 -0.07 0.07 0.1l 0.74 0.07 q15. managing rigid hierarchy 0.10 0.32 0.04 -0.09 0.28 0.62 0.14 control q2. controlling work for far locations -0.11 0.06 0.01 0.08 -0.10 0.19 0.80 q22. startup of new operations 0.20 -0.13 0.08 0.26 0.17 0.01 0.70 note: the highest loading for each item is indicated in bold. 14 journal of business strategies vol. 17, no. i we have labeled each of the seven factors shown in table 3 according to the items which loaded on that factor. the employee factor is comprised of items relating to the hiring and training of employees, as wen as employee welfare and gaining employee loyalty. the items loading on the service quality factor pertain to the challenges associated with physical surroundings, quality of service and making service warm. the third factor, operations, includes questions regarding capital decisions, work and control methods, cost increases and technological advances. the market factor includes two items: managing demand and marketing. scheduling is comprised of challenges relating to scheduling both the workforce and service delivery, as well as reacting to customer intervention. the organization factor includes items relating to managing career advancements, managing a flat hierarchy and managing rigid hierarchy. the final factor, control, is comprised of items regarding controlling work in far locations and the startup of new operations. scale reliability assessment since the scales developed via factor analysis are new, we must take care to assess the inter-item reliability of the questions comprising each scale (flynn et al, 1990). cronbach's coefficient alpha is used to assess inter-item reliability, with alpha values of 0.70 or higher considered to indicate acceptable reliability for established scales and 0.60 being acceptable for new scales (churchill, 1979; nunnally, 1978). as shown in table 3, four of the seven scales possess alphas which exceed the 0.60 threshold and are therefore considered to exhibit acceptable reliability. two of the remaining three scales have only two items, while the final scale (organization) does not meet the minimum threshold or reliability (ct. = 0.57). based on these results, we therefore discard these three scales and remove them from further analysis. scores for the remaining scales are developed by taking the average of the items, which had their highest loading on that scale in the factor analysis shown in table 3. industry comparison dess, ireland, and hitt (1990) suggest that the variables of interest in a particular study should be examined in order to ascertain their sensitivity to industry conditions. similarly, ward et al. (1995) find between industry differences in manufacturing strategies with regard to a sample of singapore-based manufacturing firms. we therefore test for industry level differences in the four remaining management challenges scales across the four service industries studied. table 4 contains the means for the four management challenges scales for both the entire sample and for each of the four service industries. the four scales are ranked in order of decreasing importance based upon the average response for the entire sample. service quality is considered to be the most imporspring 2000 verma & boyer: service classification 15 tant challenge (mean = 3.64), while scheduling is considered to be the least important (mean = 3.07). table 4 also provides a more intriguing analysis by breaking the sample down based on industry membership. if we examine the two industries with low customer contact (fast food and retail sales) separately from the two industries with high customer contactlcustomization (auto repair and legal services), several interesting differences appear. first, the low customer contact industries consider service quality and employee challenges to be most important. in contrast. auto repair shops consider operations to be their primary challenge. table 4 group means and one-way anova results industry 2 3 4 entire fast auto retail legal sample food repair sales service f= 2.58 service quality 3.64 3.74 3.48 3.83 3.52 p =0.05 (4) (4) (1.3) f= 6.09 employee 3.56 3.78 3.49 3.74 3.23 p < 0.01 (2) (1,3,4) (2) (2) f= 17.36 operations 3.25 2.98 3.79 3.06 3.18 p < 0.01 (4) (4) (2,3) f = 4.44 scheduling 3.07 3.10 3.23 3.22 2.73 p < 0.01 note:numbers in parentheses indicate the group numbers from which this group was significantly different at the p < 0.05 level according to the scheffe pairwise comparison procedure. f statistics and associated p-values are derived from one-way anovas. the industry with the highest mean value for each management challenge scale is shown in bold. next, a series of one-way anovas was conducted to test ifthe four management challenge scales differ across the four types of services identified by the service process matrix. the overall f-test indicates that there are significant differences across the fouf industries for each of the four management challenge scales (used as the dependent variable). in addition, a scheffe pairwise comparison was conducted to test for differences between individual pairs of industries. no significant pairwise differences were found for service quality. but the other three management challenge scales did exhibit dramatic differences. first, employee issues were much more important for the fast food and retail sales industries (means of3.78 and 3.74) than they were for legal service (mean of 3.23). in addition. the importance of operations was dramatically higher for auto repair (mean of 3.79) than for any of the other three industries. 16 journal of business strategies vol. 17, no.1 finally, scheduling was of relatively little importance (mean of 2.73) for the legal services industries, but was of significantly greater importance for the auto repair and retail sales industries (means of 3.23 and 3.22, respectively). manaeement challenees and service process matrix one of the primary objectives of this empirical study is to detennine whether the service process matrix typology developed by schmenner (1986) can be validated and confinned using empirical data. we therefore employ the four management challenge scales developed in section 4.1 in a discriminant analysis to test whether these scales can be used to differentiate and classify the four service types posited by spm. discriminant analysis is used because it pennits examination of the differences between two or more groups with respect to multiple discriminating variables simultaneously (klecka, 1980). the management challenges scales are used as the discriminating variables to predict the actual industries of the respondents. the data are randomly divided into two samples, a calibration sample (n=180) and a validation sample (n=90). it is a common practice to use a calibration or training sample to derive the discriminant functions which best classify the data into groups. the coefficients derived from the calibration sample are then applied to the validation sample to test how well the discriminant functions actually classify a set of independent data into groups (johnson & wichern, 1988). if the discriminant functions derived from the calibration sample perfonn well in predicting the industry of companies in the independent validation sample, then the predictive ability is not merely an artifact of the set of companies contained in the calibration sample, thus demonstrating a base level of generalizability. calibration sample. the discriminant model is developed by applying a stepwise procedure in spss to the 180 companies included in the calibration sample. the independent variables are the four management challenge scales with high inter-item reliability which were retained in section 4.2 (employee, service quality, operations and scheduling) and the dependent variable is the industry of the company (fast food, auto repair, retail sales or legal services). the stepwise procedure is analogous to the stepwise procedure for multiple regression, i.e. variables which explain a significant amount of variance (p < 0.05) are selected to enter the model in order of decreasing effect and variables can be removed at later stages if they are no longer significant due to the addition of other variables at earlier stages. the stepwise procedure selected two of the four management challenge scales, employee and operations, for inclusion in the model. table sa shows the coefficients for each of the two discriminant functions, as well as wilk's lambda and the industry means for each of the two functions for each of the four service industries. spring 2000 verma & boyer: service classification table 5 discriminant analysis results 17 a. standardized canonical discriminant function coefficients and industry means scale industry means for discriminant functions function 1 function 2 employee -0.78 0.73 operations 0.96 0.47 wilks' lambda 0.75 0.94 p < 0.01 p < 0.01 fast food -0.59 0.02 auto repair 0.65 0.28 retail sales -0.37 0.09 legal service 0.32 -0.39 b. classification results for calibration sample predicted group membership fast auto retail legal food repair sales service total fast food 21 2 14 7 44 47.7% 4.5% 31.8% 15.9% 100.0% auto repair 4 26 5 9 44 actual 9.1% 59.1% 11.4% 20.5% 100.0% group retail sales 16 9 13 8 46 34.8% 19.6% 28.3% 17.4% 100.0% legal service 6 16 2 22 46 13.0% 34.8% 4.3% 47.8% 100.0% total 47 53 34 46 180 as shown in table 5a, both of the functions are statistically significant based upon wilk's lambda (p < 0.01). in addition, the group centroids (industry means) for each of the four industries differ substantially. discriminant function scores are standardized so that the entire sample has a mean of 0.00 with a standard deviation of 1.00. this allows easy comparisons between the groups being classified. for example, the mean for the fast food industry on function 1 is -0.59, while the mean for auto repair is 0.65, or a difference of 1.24. this substantial difference (more than one standard deviation) indicates that auto repair places a much greater premium on operations than on employee concerns relative to fast food companies 18 journal of business strategies vol. 17, no.1 (based on the negative coefficient for employee and the positive coefficient for operations for function 1). although it is important to have statistically significant functions, it is at least equally important that the discriminant functions perform well in classifying companies into groups. therefore, table sb presents the classification results for the calibration sample based on the two functions shown in table sa. the rows of table 5b show the actual group/industry of which a company was a member, while the columns show the predicted group based on the discriminant functions. the companies in the diagonal have correct predictions (shown in bold), while companies off the diagonal have incorrect predictions. without prior information, we could expect to guess group membership correctly in approximately 25% of the cases by guessing that all of the companies were in the auto repair industry (we simply pick the group with the most members and guess that each company will be a member of this group). lacking prior information, this is the best guess we can make. in comparison, the discriminant model accurately predicts 45.56% (82/180) of the company's industry membership accurately. table 5b indicates that our discriminant model accurately classifies a substantially higher percentage of companies (45.6% versus 25%) than we could expect based on random guessing. the model works particularly well for the auto repair industry (59.1%), but not so well for retail sales (28.3%). the model clearly provides an increase in predictive power over random guessing and does provide support for the conceptually derived service process matrix. validation sample. table 6 shows the classification results when the disciminant model shown in table 5 is applied to the independent validation or holdout sample of 90 companies. the classification accuracy for the validation sample is consistent (41.1 % or 37/90) with that of the calibration sample. once again, the auto repair industry has the highest percentage of correct classifications (68.2%). in summary, the fact that the discriminant model works well on the validation sample in addition to the calibration sample indicates that the classification power of the model is not dependent on the data used to estimate and develop the model. conclusions and future research directions the objective of this research was to empirically assess the differences in management challenges experienced by managers in different industries using service process matrix (spm) as the framework. data collected from the managers of four different industries from separate cells of the spm provide several interesting insights about the management of service operations. the results also serve to partially validate spm while simultaneously illustrating the "fuzzy nature" of services. spring 2000 verma & boyer: service classification 19 table 6 classification results for validation sample predicted group membership fast auto retail legal food repair sales service total fast food 8 5 4 5 22 36.4% 22.7% 18.2% 22.7% 100.0% auto repair 1 15 2 4 22 actual 4.5% 68.2% 9.1% 18.2% 100.0% group retail sales 7 4 6 6 23 30.4% 17.4% 26.1% 26.1% 100.0% legal service 6 6 3 8 23 26.1% 26.1% 13.0% 34.8% 100.0% total 22 30 15 23 90 the exploratory factor analysis of the management challenge questions revealed seven underlying factors. these factors were than compared across the four distinct service industries, and the results yielded important insights. for example, it is interesting to note that service quality was identified as the top management challenge for all the respondents. this result reaffirms the importance of quality in service businesses as proposed by a number of researches (for example. parasuraman, zeithaml, & berry, 1985). the importance attributed to service quality was relatively consistent across the four industries studied. employee issues were the second ranked concern for the entire sample, and were of the greatest importance to the fast food industry. it is interesting to note that employee issues were of significantly less importance in legal services than for either fast food or retail sales. another intriguing difference concerned the importance of operations issues. these were the foremost concern of auto repair shops, but were of significantly less concern to the other three industries. this result is consistent with the service process matrix, since auto repair is considered to be high customer contactlcustomization, yet the fact that operations issues were relatively unimportant to legal services (the other high customer contactlcustomization industry studied) underscores the difficulties inherent in clearly differentiating service types. perhaps operations issues are less important for legal services that for auto repair because of the higher level of education and professionalism. lawyers are known for working long hours to make partner as a result, short term fluctuations in demand may be more easily handled by simply encouraging young associate attorneys to work long hours. in contrast, extensive overtime in auto repair is more likely to be very expensive because workers are paid on an hourly basis rather than a fixed salary. the results of the discriminant analysis of management challenges serve to validate the descriptive power of the service process matrix, yet also demonstrate 20 journal of business strategies vol. 17, no.1 that services are inherently "fuzzier" than manufacturing and more difficult to differentiate cleanly. the results show partial support for the spm classification scheme but also reveal the limitations of theoretical classification schemes. while theoretical typologies provide an important intuitive model of the basic differences among disparate groups, there are distinct limitations to their ability to capture all (or most) differences among service firms. theoretical service typologies are to an extent similar to classifying individuals based on demographic characteristics. such classifications do have intuitive appeal and can broadly provide general guidelines for the groups, yet do not take into the account the individual differences among the group members. this is not to suggest that conceptual models and typologies are not valued. instead, such typologies serve to focus our thoughts and provide an easily understood description of complex relationships. a primary cause of many misclassifications is likely to be the relati ve similarity of different industry groups along one dimension of the service process matrix. for example, according to the service process matrix (figure 1), both fast food and retail sales are characterized as low customer contact/ customization, yet they differ in terms of labor intensity. similarly, fast food and auto repair are both characterized by low labor intensity, but differ in terms of customer contact. in contrast, there is in no commonality between fast food and legal services, or between retail sales and auto repair. these two pairs of services exist in opposite corners of the service process matrix. it is not entirely unreasonable to assume that service industries in adjoining cells of the service process matrix might be misclassified as a member of the adjacent industry. on the other hand, we would expect it to be relatively rare that service industries in non-adjoining cells be mis-classified. in order to test this proposition, we break the classifications shown in tables 5b and 6 into three groups: (l) correct classifications [1191270 =44.1 %], (2) mis-classifications along adjoining cells ofthe service process matrix [1071270 = 39.6%], and (3) complete mis-classifications of cells in non-adjoining cells [16.3%]. table 7 presents the details. this analysis provides further support for the discriminant validity of the service process matrix. the discriminant model not only predicts a greater percentage of industries than could be expected due to random guessing (44.1 % versus 25%), but the mis-classifications which do occur are more likely to be along adjoining cells in the service process matrix than in non-adjoining cells. the role of empirical analysis is to test the extent to which such typologies fully represent reality and to suggest shortcomings, which lead to further research and refinement. toward that end, further research should seek to add to the current findings by examining additional quantitative measures in an effort to develop a more accurate classification model. in particular, further analysis should seek to better differentiate fast food and retail sales, since these two groups were misclassified disproportionately by the discriminant model. spring 2000 verma & boyer: service classification table 7 classification accuracy a. calibration sample 21 sample correct partially correct incorrect actual industry size classification classification (.) classification (*) i. fast food 44 21 16 7 47.7% 36.7% 15.9% 2. auto repair 44 26 13 5 59.1% 29.5% 11.4% 3. retail sales 46 13 24 9 28.3% 52.2% 19.6% 4. legal service 46 22 18 6 47.8% 39.1% 13.0% total 180 82 71 27 45.6% 39.4% 15% b. validation sample sample correct partially correct incorrect actual industry size classification classification (.) classification (*) 1. fast food 22 8 9 5 36.4% 40.9% 22.7% 2. auto repair 22 15 5 2 68.2% 22.7% 9.1% 3. retail sales 23 6 13 4 26.1% 56.5% 17.4% 4. legal service 23 8 9 6 34.8% 39.1% 26.1% total 90 37 18 17 41.1% 20.0% 18.9% • represents the following misclassification: 1 classified as 2 or 3 3 classified as i or 4 2 c1assi fled as 1or 4 4 classified as 2 or 3 '" represents the following misclassification: i classified as 4 3 classified as 2 2 c1assi tied as 3 4 classified as 1 22 journal of business strategies references vol. 17, no.1 bowen, d,e., & cummings, t.g. (1990). suppose we took service seriously. in~ manafi.ement effectiveness, new york: jossey-bass publishers, 1-4. chase, r.b. (1978). where does the customer fit in a service operation. harvard business review. 56 (6), 137-142. chase r.b. (1981). the customer contact approach to services: theoretical bases and practical extensions. operations research. 29 (4),698-700. chase, r.b., & hayes, rh. (1991). beefing-up operations in service firms . .sj.q.im management review. 33 (l), 15-26. churchill, g.a. (1979). a paradigm for developing better measures of marketing constructs. journal of marketinfi. research. 16 (2), 64-73. dess, g.g., ireland, rd., & hitt, m.a. (1990). industry effects and strategic management research. journal of management. 16 (1), 7-27. fitzsimmons, j.a., & fitzsimmons, m.j. (1994). service manafi,ement (or competitive advanta&e, new york: mcgraw-hill. flynn, b.b., sakakibara, s., schroeder, rg., bates, k.a., & flynn, e.j. (1990). empirical research methods in operations management. journal of operations management. 9 (2), 250-284. hill, t.p. (1977). on goods and services. review ofincome and wealth. 23, 12. johnson, ra., & wichern, d.w. (1988). applied multivariate statistical analysis, 2nd ed. englewood cliffs, nj: prentice hall. judd, r.c' (1964). the case for redefining services. journal of marketin&. 28, 1. karmarkar, u.s., & pitbladdo, r. (1995). service markets and competition.1qurnal of operations mana&ement. 12 (4), 397-411. kellogg, d.l., & chase, rb. (1995). constructing an empirically derived measure for customer contact. management science. 41 (ii), 1734-1749. kellogg, d .l. & nie, w. (1995). a framework for strategic service management. .lmll:niu of operations manafi,ement. 13, 323-337. kotler, p. (1980). principles of marketing. englewood cliffs. nj: prentice hall. kim, j .• & mueller, c.w. (1978). factor analysis: statistical methods and practical ~, newbury park, ca: sage publications. spring 2000 verma & boyer: service classification 23 klecka, w.r. (1980). discriminant analysis. newbury park, ca: sage publications. levitt, t. (1972). production·line approach to service. harvard business review. 50 (4), 41-52. levitt. t. (1976). the industrialization of service. harvard business review. 54 (5), 6374. linsky, a.s. (1972). stimulating responses to mailed questionnaires: a review. fl!j2!k opinion ouarterly. 39. 82·101. lovelock, c.h. (1983). classifying services to gain strategic marketing insights. journal of marketini. 41 (3), 9·20. lovelock. c.h. (1992). a basic toolkit for service management. in mana~in!: services: marketing. operations. and human resources 2nd ed. englewood cliffs. nj: prentice hall. meredith. j.r., raturi, a., amoako·gyampah. k., & kaplan, b. (1989). alternative research paradigms in operations. journal of operations management. 8 (4). 297· 326. mersha. t. (1990). enhancing the customer contact model. journal of operations manaument. ..2 (3),391·405. nunnally, j. (1978). psychometric theory, new york: mcgraw·hill. parasuraman, a., zeithaml, v., & berry. l.l. (1988). servqual: a multiple-stem scale for measuring consumer perceptions of service quality, journal of retailin!:, 39-48. rathmell. j.m. (1974). marketing in the service sector, cambridge, ma: winthrop. roth. a. v., & van der velde, m. (1991). operations as marketing: a competitive service strategy. journal of operations management. 10 (3), 303-328. sasser, w.e., jr., olsen, r.p.• & wyckoff. d.d. (1978). manaiement of service opera· tions: text and cases, boston: allyn and bacon. schmenner. r.w. (1986). how can service businesses survive and prosper. sloan management review. 27 (3), 21·32. shostack. g.l. (1977). breaking free from product marketing. journal qfmarketini. 41 (4). sullivan, r.s. (l98l). the service sector: challenges and imperatives for research in operations management. journal of operations manat;ement, 2(4),211-214. 24 journal of business strategies vol. 17, no.1 thomas, d.r.e (1978). strategy is different in service businesses. haryard business review. 56 (4), 158-165. ward, p, duray, r., leong, g.k., & sum, c. (1995). business environment, operations strategy, and performance: an empirical study of singapore manufacturers. journal of operations management. 13, 99-115. robit verma is assistant professor of operations management in the department of management at the depaul university. he holds a ph.d. in operations management from the david eccles school of business, university of utah, an m.s. from the university of utah and a b. tech. from the indian institute oftechnology, kanpur, india. his research interests include operations strategy, product/service design, operations-marketing interdisciplinary issues, and business education. his research is published in international journal of service industry management, international journal of operations and production management, journal ofoperations management, journal ofproduct innovation management, omega, production and operations management, journal ofservice research and other journals. his current and research has been funded by first chicagolnbd corporation, apics education & research foundation, marketing science institute, ncr knowledge laboratory, united states forest service and other organizations. kenneth k. boyer is assistant professor of operations management in the department of management at the depaul university. he earned a b.s. in mechanical engineering from brown university, and an m.a. and ph.d. in business administration from the ohio state university. dr. boyer worked as a project engineer with general dynamics electric boat division in groton, connecticut. dr. boyer's research interests focus on the strategic management of operations and technology management, including e-commerce. he has published articles in management science, business horizons, production and operations management, decision sciences, journal of operations management, omega and the international journal of operations and production management. ken is an associate editor for the journal of operations management and is a member of the acad~ emy of management, decision sciences institute and the society of manufacturing engineers. service classification and management challenges yoyo theory: a strategy for escalation situations richard c. hicks the university of nevada at las vegas las vegas, nevada a frog dropped into a pot of cold water will remain there calmly while the water is gradlullly heated to a boil, but a frog dropped into hot water will leap out instantaneously." attributed to gregory bateson [24]. descn"be the decision-making characteristics of managers in relationship to their past record, present organizational resources, and perceived view of the future. specify possible situations where a rational manager may make decisions dangerous to the company and himself. offer recommendations to keep the company out of boiling water. 2. 3. like the frog, businesses must analyze changing situations and make decisions about them in order to survive. decisions evolve incrementally as businesses are exposed to a bewildering flood of bits and pieces of information which, by action or the lack of it, is eventually translated into a business strategy. the intent of this paper is to: 1. introduction the most critical aspect of a manager's job is making strategic decisions that involve risk and uncertainty. current research indicates that decisions are made incrementally [9] as many small decisions combine to make the larger decisions, and each decision (and its outcome) impact on the succeeding ones. however, three independent bodies of literature have emerged, each with it's own proponents and opponents, and a single vision of the influences impacting on decision-making processes has not been persuasively proposed. prospect theory is focused on the decision frame: by interpreting the way superiors frame the decision, one is given expectations for the future [13]. organizational slack looks at the present situation by examining that company resources are obtainable for the decision [6]. escalation of commitment considers the past by focusing on the previous decisions in this sequence [27]. bateman and ziethaml ([2], [3]) performed a number of experiments on the relationships between these three elements of the decision process; i propose that an initial step toward a unified theory of escalating situations may be suggested by these experiments. i further propose that decision behavior can be predicted by examining the relationship between a decision-maker's perceived track record (his opinion of the success of previous decisions) and his perceived goal. the perceived goal may this research is supported in part by a research grant from first interstate bank. 48 journal ofbusiness strategies vol. 9. no.1 be thought of as the position the decision-maker feels that he deserves based on past perfonnance (i.e.• where i should be). or the minimum acceptable position (i.e.• what is necessary to keep my job). four categories of managers may be identified by their track record. the first category, the gogo, has a good track record. the second. the yoyo, has some success and some failure. the third. the oodo. has a poor record. for completeness, i add the zero, who does not impact on decisions. of these four categories. the oodo and the zero can be eliminated because they are not key players in decision making. the gooo is (usually) successful. therefore. we will concern ourselves primarily with the yoyo. yoyo theory is an initial step toward a unifying model appropriate for strategic decision-making. it considers bodies of literature relevant to the past (escalation to commitment), present (organizational slack). and future (prospect theory) aspects of a decision to predict the behavior of a rational decision-maker in tenns of the decisionmaker's position and goals, as suggested in [25]. its focus is on identifying danger zone situations in which a rational decision-maker may not act in the organization's best interest, and proposing solutions. section one of this paper is a brief overview of the three bodies of literature and notable opponents. the focus is on escalation of commitment situations. section two describes yoyo theory, the danger zone for decisions, and recommendations for upper management. finally, directions for further research are discussed. literature review the first part of this section is an overview of three major bodies of literature: escalation of commitment [25], organizational slack [6], and prospect theory [13], with an emphasis on potentially dangerous situations. escalation of commitment. staw and ross describe an escalation situation as "predicaments where costs are suffered in a course of action and subsequent activities have the potential either to reverse or compound one's original losses" [29]. many variables impact on a course of action and the business' level of commitment, and most projects contain several variables which may cause problems. 1bese variables must have initially indicated that the decision would have positive utility or it would have not been made. however, decisions do not always turn out as expected; it is the unsuccessful decisions and the commitment to them that i focus on here. four major determinants of commitment are psychological detenninants. social detenninants, long-range detenninants, and structural determinants. commitment is strongly influenced by psychological variables; reinforcement, self-justification, selfinference and information processing biases may all lead to a belief that the project will turn around ([20], [26], [15], [30]). social detenninants are another strong source of commitment. face-saving. external binding, competition, modeling. and norms all may be powerful forces that impact on a decision ([8], [12], [22], [28]). commitment to a course of action may be increased by long-range commitments, salvage value, and spring 1992 hicks: yoyo theory 49 closing costs [29]. structural determinants such as economic and technical side-bets, political support, administrative inertia, and institutionalization may also increase commitment. for example, lockheed proceeded with the l-io11 program in spite of a low potential for profit because the aircraft was seen as lockheed's entry into the commercial aircraft market. the institution of lockheed required that it build commercial aircraft and not become (in the minds of the company) ''just another defense contractor" [29]. considering these detenninants, staw and ross proceed to identify an escalation prototype. in each phase the determinants of commitment are identified. it is significant to note that in phases n through iv, the dominant detenninant is psychological. in phase i, we have the promise of good future outcomes. commitment is based on project determinants, which must appear positive or the project would not be funded. in phase n, questionable outcomes are perceived. psychological detenninants become active, becoming dominant over project detenninants. in phase ill, negative outcomes are perceived. now, psychological detenninants, social determinants and project detenninants are factors enhancing commitment the decision-maker feels anxiety about the decision. in phase iv, highly negative outcomes are perceived. now, structural determinants are added to the equation, but below psychological and social determinants in influence. lockheed and the frog both ended up in escalation situations. to minimize these situations, staw and ross [29] offer the following techniques: (1) administrative turnover, (2) bifurcated decision procedures, (3) excuses, debinding and scapegoating, (4) support for failure, (5) unambiguous negative feedback, (6) bringing phase-out costs forward, and (7) deinstitutionalism. the seven solutions proposed by staw and ross may be difficult to implement administrative turnover, bifurcated decision procedures, bringing sunk costs forward and deinstitutionalism are difficult tasks that focus on avoiding escalation situations; administrative turnover and bifurcated decision procedures add additional time, manpower, and cost pressures to a decision while reducing accountability, phase-out costs cannot be manipulated on many projects, and institutionalism is often a powerful force necessary for difficult projects. solutions 3, 4, and 5 offer some solutions to an escalation situation in progress. excuses allow the decision-maker to retain face while distancing himself from the project and it's outcome. support for failure reduces anxiety in the manager, lowering the potential for escalation. unambiguous negative feedback is a powerful tool because it allows the manager to recognize the true situation instead of believing the promise of the original project throughout the escalation process, the dominant factor is psychological and social detenninants. therefore, solutions 3,4, and 5 offer the most powerful solutions to the escalation process. i shall return to this theme when i consider the implications of yoyo theory. escalation of commitment is focussed on the implications of past decisions on current ones. other factors to be considered are the present resources of the finn as discussed by cyert and march in organizational slack, and the influence of perceptions of the future described by kahneman and tversky in prospect theory. 50 journal ofbusiness strategies vol. 9, no.1 organizational slack. cyert and march emphasized the role of organizational slack in decision-making [6]. as defmed by bourgeois [5], organizational slack is "that cushion of actual or potential resources which allow an organization to adapt successfully to internal pressures for change in policy, as well as to initiate changes in strategy with respect to the external environment" in the book a behavioral theory of the firm, cyert and march conclude that "organizational slack absorbs a substantial share of the potential variability in the finn's environment. as a result. it plays both a stabilizing and adaptive role" [6]. in this light, slack is seen as a buffer against unforseen circwnstances. additionally, successful companies tend to generate more slack than unsuccessful ones, not only protecting against unforseen difficulties but allowing more creative and innovative activities to take place. bourgeois provides additional insight into other uses of slack, listing the following: inducement, conflict resolution, technical buffer, facilator of strategic behavior, facilator of creative behavior, facilator of sub-optimal behavior, and as a promoter of political behavior [5]. successful managers are seen to be less active in investing slack than unsuccessful ones [3]. perhaps unsuccessful managers appear to be seeking buffers against variability, using slack as protection against unforseen difficulties. another possibility is that successful managers have slack stockpiles besides the traditional storehouses. as sitkin [23] points out, another school of thought is that organizational slack enables strategic and creative behavior in an organization. high slack conditions indicate prosperity, and allow the development of new strategies and experimentation. low slack indicates a tight ship, allowing little deviation from the plotted course. this school of thought indicates that high organizational slack should be positively associated with strategic risk-taking [1]. the direct contradiction between the two schools of thought is not one to be reconciled in this paper. however, as the focus on this paper is on escalation situations, i will base yoyo theory on the results of empirical experiments focussed on escalation of commitment situations. prospect theory. kahneman and tversky first proposed prospect theory in their 1979 article "prospect theory: an analysis of decisions under risk" [13]. in later work, prospect theory evolved to consider the importance of the decision frame ([14]. [18], [31]). (i will consider label and decision frame to be synonymous.) decision framing considers the positive or negative implications in the way the problem is presented. in experiments where all figures remained the same, managers presented with a positive decision frame invested at a higher rate than the same managers faced with a negative decision frame. prospect theory indicates that managers will invest not solely on the projected outcome of a project, but on the relationship between the outcome and the manager's goals. in other words, successful managers will usually be risk-adverse, while unsuccessful managers will usually be riskprone. a successful manager invests moderately because he has established himself as a success. the present decision will impact on his position; a successful decision will spring 1992 hicks: yoyo theory 51 raise it and an unsuccessful decision will lower it. the successful manager sees his position as an investment and wishes to protect it; the perceived rise in position (from success to success+) is not as significant a change as the perceived fall (from success to success-), because as a pop singer is perceived as being only as good as his last record, a manager is only as good as his last decision. to protect his position, the successful manager invests more moderately in order to limit losses. the unsuccessful manager, on the other hand, has little to lose. unsuccessful managers are filled with anxiety about decisions because, unlike a successful manager, a bad decision often leads to unemployment. his motivation is not to retain his position (unsuccessful), but to improve it; his focus is on the upside, not the downside of the decision. by this focus on the upside of the decision, the unsuccessful manager sees only the potential to raise his position and underestimates the possibility of failure. a positive decision frame reinforces the focus on the upside of the decision because it is seen as a company prediction of success. with all of these factors, the unsuccessful decision-maker _s found to reinvest heavily when faced with a positive decision frame [3]. other bodies of literature contradict the ideas presented earlier. march and shipira propose that a positive decision frame accentuates the potential for gain in a decision while lessening the potential for loss, therefore encouraging higher investment. the negative decision frame is thought to encourage threat-rigidity and low investment by emphasizing the loss potential of the decision ([17], [11]). bateman and zeithaml experiments. prospect theory and organizational slack have each developed contradictory bodies of literature. however, an illuminating series of experiments testing all three theories may remove some of the noise present in the literature and allow the development of a consistent theory. in a series of experiments ([2], [3]) bateman and zeithaml tested both students and practicing managers to reveal a decision-maker's characteristics in order to test all three theories. most significantly, two studies revealed inter-relationships between the three factors in ways consistent with the original theories, but in greater detail. the following hypothesis were proposed and supported in [2]: hi. failure feedback from a past investment decision will lead to significantly higher levels of reinvestment than success feedback (ec).l h2. low perceived organizational slack will lead to significantly higher levels of reinvestment than high perceived slack (os). h3. a positive, gain-oriented decision frame will lead to significantly higher reinvestment levels than a negative, loss-oriented decision frame (pt). h4. decision frame will have a greater impact on reinvestment, with positive frame leading to the highest reinvestment levels, after failure feedback than after success feedback (ee, pf). rs. decision frame will have a greater impact on reinvestment, with positive itheories associated with a hypothesis (by this author) are listed after it. pl'is prospect theory, os is organizational slack. and ec is escalation of commitment 52 journal ofbusiness strategies vol. 9, no. i hs. decision frame will have a greater impact on reinvestment, with positive frame leading to the highest reinvestment levels, when perceived organizational slack is low than when perceived organizational slack is high (pi', os). h6. decision frame will have a greater impact on reinvestment in a context of failure feedback and lower perceived organizational slack than in a context of success feedback and high perceived slack (pt, os, be). in study 2, results of the f:lrst study are validated with a group of practitioners, but the decisions were framed differently. in study i, organizational slack and success/ failure feedback demonstrated virtually identical behavior. therefore, study 2 used the decision frame as one variable and the combination of organizational slack and successlfailure feedback as the other. the results of study 2 are especially significant. decision frame is shown to be the dominant factor in decision-making. positive decision frame led to higher levels of reinvestment than negative decision frame in both high slack/success-feedback and low slack/failure feedback situations. the interesting result is that highest levels of investment are reached with positive decision frame and low slack/failure feedback. these findings are consistent with prospect theory. escalation of commitment and organizational slack; however, they further define the situations under which dangerous reinvestment may occur. the predictions and results of study 2 are shown in table 1. table 1: bateman and zeithaml predictions and findings $12m $llm $lom $9m $8m $1m $6m positive frame $5m $4m success/high slack predictions'-------negative framefailure/low slack results _ spring 1992 hicks: yoyo theory 53 as the hypothesis suggested, highest reinvestment occurred with conditions of positive decision frame. note, however, the relationship between success/high slack and failure/low slack and decision frame. when failure/low slack situations are combined with a positive decision frame, reinvestment is dramatically higher ($1o.83m) than with success/high slack ($7.42m). this series of experiments provides a basis for yoyo theory. the relationships between the three bodies of literature are depicted in terms of all three, allowing a subsuming theory to be derived and submitted for validation. yoyo theory this section is an integration of escalation of commitment, organizational slack, and prospect theory. yoyo traits. first, the cast of managers will be categorized because it is his perception of his tiack record (successlfailure of past decisions) that must be considered. since it is difficult to judge, the categories will be: good, average, and poor. the yoyo with which we will be most concerned with is much closer to dodo than gogo since it is highly unlikely that his negative outeomes have escaped his superior's attention. first comes the gogo (good). he is the successful manager. his decisions are rated as being well above average by his superiors. he is rarely associated with failure. as side-effects of his track record, he is calm, relaxed and happy about his job. a typical gogo perfonnance rating (from hiring) is shown in table 2. table 2: gogo track record second is the yoyo (average). the yoyo usually, but not always. makes good decisions. his track record shown in table 3 moves up and down, reflecting successful and unsuccessful decisions. he is nervous about his position and perfonnance. yoyos aspire to be gogos; it is the yoyo and his relationship to his (gogo) goal that i examine in yoyo theory. i will def"me a yoyo as one whose goal is to raise his effective position in the company. if the goal is to avoid failure or to minimize variance, escalation situations are not probable. 54 journal ofbusiness strategies table 3: yoyo track record vol. 9. no.1 the third category is the dodo (poor). this manager does not have a good track record (table 4). it is unlikely that he will remain with the finn, and more unlikely that he will be involved in strategic decision-making. table 4: dodo track record the final category is the zero (table 5). unlike the others, the zero does not have a track record. a zero may be a staff person who contributes data or information to the decision-makers, or a surrogate to another decision-maker. for example, a young decision-maker being groomed may duplicate the decisions of his mentor. a zero is not someone who has major impact on decisions, although he may in time. table 5: zero track record (none) spring 1992 hicks: yoyo theory 55 now, the behavior of the yoyo and gogo in different decision situations will be examined. experiments show that most rational decision-makers have a preference curve that is decreasingly risk averse in the positive quadrant and increasingly riskprone in the negative quadrant [7]. in the case of success, the gogo is near his goal, and acts cautiously to protect his gains [3]. on the other hand, the yoyo's track record is lower than his goal. to reach it, he will therefore try to achieve a success larger than his previous failure, discounting the possible losses. this escalation of commitment can be destructive to both the decision-maker and the company. the decision frame is considered to be the most significant factor in the equation [2]. in essence, the decision frame is the official company prediction of the success of the decision. the decision-maker who is presented with an opportunity to be successful will make larger investments than one presented with an opportunity to fail, even though the opportunities have the same value. again, the gogo will invest moderately. the most extreme case is when a yoyo is presented with a positive decision frame. here, the yoyo sees an opportunity to move much closer to his goal (because management has predicted success) and invests heavily. scarce resources are another important part of any business decision. experiments show that decision-makers are fairly consistent investors when presented with a negative decision frame, but raise their investments when presented with a positive decision frame and either previous failure or low slack. a gogo is near his goal position and will take his fair share of the slack, where a previous failure (and distance from his goal) encourages a yoyo to invest more heavily and request a larger percentage of the slack resources. in the previous section a manager's reaction to a single variable was considered. following, the effects of all three simaltaniously on a yoyo as they would occur in a decision simation are examined. first, consider the two negative decision frame siblations. in both, survival becomes more important than success. in smdy 2, negative decision frames resulted in the lowest reinvestment ($6.08m with high slack/success, $5.33m with low slack/failure) of the four situations.2. in both simations, the yoyo treats a negative decision frame as a threat that the company is not convinced of future success and therefore lowers his reinvestment. in essence, he is lowering his personal commitment to the decision. a negative decision frame discourages investment in both cases, a negative decision frame leads to low reinvestment this is consistent with the threat-rigidity opponents of prospect theory and with the original theory. consideration of the actions of a yoyo majdng a decision with a positive decision frame and success/high slack follows. his track record is successful, so he is near his goal position. high slack is available, so there is little need to lay in stockpiles of slack for protection against unavailability. 1be decision frame is positive, indicating that the company has a favorable vision of the decision and will support it as he is near his goal position, he invests moderately ($7.42m vs. $6.08m with negative frame) to protect his position. 2j>ollar figures are from bateman [3] tests of practitioners. all figmes in $ million. 56 journal ofbusiness strategies vol. 9, no. 1 a positive decision frame will lead to moderate investment if high slack or success feedback are present. moderate investment occurs when the situation is optimum; good past record, good decision frame, and high slack. this finding is consistent with the tendency to protect gains described in prospect theory and escalation of commitment, as well as the school of thought which considers high slack as a means to develop new strategies. next, the situation where a decision-maker is presented with a positive decision frame and failurellow slack will be considered. the positive decision frame is the dominant force in this situation. the yoyo interprets the positive decision frame as an endorsement of the project or decision. he takes aggressive steps to ensure adequate organizational slack so that his project will not lack for materials. his previous failures places his track record as low, so he may see this project as the one to return him to his goal position. to achieve his goal, he invests heavily ($10.8m). in an extreme situation, a moral hazard develops where the manager reinvests everything he can because a failure will result in dismissal; he has nothing to lose. a positive decision frame coupled with failure feedback or low slack will result in high levels of investment. this combination encourages high levels of commitment to a decision. this finding is consistent with prospect theory, escalation of commitment and organizational slack. finally, consider the relationship between a yoyo and his goal. in negatively framed decisions, avoidance of failure predominates because the probability of improving his position is low. in positively framed decisions, the yoyo sees an opportunity to raise his position and invests heavily in order to get closer to his goal, and that failure feedback and low slack encourage higher levels of investment a greater gap between position and goal leads to a higher level of investment. if coupled with a positive decision frame, failure feedback and low slack, a dangerous situation occurs where excessive investment takes place. this hypothesis offers a more refined view of escalation of commitment, prospect theory, and organizational slack. danker zone. the description of yoyo behavior presented above defines a danger situation in which the yoyo is presented with a positive decision frame, low slack, and/or failure feedback, causing him to reinvest heavily to raise his track record closer to his goal. remember that a similar behavior does not occur when a negative decision frame occurs, even when a low slack/failure feedback condition is present this situation corresponds to those described in escalation of commitment, but is further refined by the interaction of slack and decision frame. in most situations, the decision-maker makes reasonable decisions. it is only when a positive decision frame is combined with either failure feedback or low slack that a dangerous situation occurs. the danger zone can then be defined as situations where: 1. the decision-maker's perceived track record is average or below. 2. the decision-maker receives a positive decision frame. 3. the decision-maker has received failure feedback about this project. it is also hypothesized that a greater gap between track record and goal leads to spring 1992 higher investment. hica: yoyo theory table 6: yoyo danger zones goal 57 track record table 6 shows the danger zone in tenns of the yoyo's track record and goals. a yoyo is defined as a manager who wishes to raise his perceived track record. the closer he is to his goal, the more protective he becomes of his track record. when track record and goal are not close together, the yoyo becomes more risk prone in an attempt to raise his track record. when failure feedback is combined with low organizational slack and a positive decision frame, a danger zone situation is possible. implications for tqp management. special care is demanded when a positive decision frame is used if the decision-maker has failure feedback from his earlier decision or perceives low organizational slack because the situation is ripe for a dangerous decision. it is important for management to both recognize and utilize the decision frame to control managers and their decisions. consider a yoyo who has received failure feedback. if management tells him that the new project/decision is expected to do well, this is seen as an endorsement of the impending success of the project. with this endorsement, the yoyo will display the dangerous behavior illustrated by both escalation of commitment and bateman and zeithaml, investing heavily. in situations such ~ this, management should temper enthusiasm for the yoyo and the decision while considering psychological and social characteristics. a current analysis should be done with current data to see if the decision is, after all, a good one or not~ managers faced with unambiguous negative data will withdraw instead of escalate [29]. several techniques may be applied to lower the possibility of an escalation situation. 58 journal ofbusiness strategies vol. 9, no.1 1. make decisions more team-oriented, lowering individual commitment, gathering more input, and sharing blame for bad results. 2. use analysis of current data to fmd realistic levels of reinvestment 3. be wary of behavioral determinants of commitment such as self-justification, selfinferencing and information processing biases, as well as the social determinants of face-saving, external binding, competition, and nonns. excuses may be used to· lessen the commitment of the decision-maker. 4. support failure (especially fast failures [21]) to lessen the anxiety and commitment of the decision-maker as well as reducing costs to the company. 5. use unambiguous failure feedback gracefully, as it may lower the decision-maker's perceived position and encourage escalation. 6. be especially wary of large requests from yoyos. i hypothesize in this paper that a greater gap between perceived position and goal leads to higher reinvestment levels. by lowering expectations and penalties for failure, the decision-maker's tendency to escalate his commitment is also lowered. by placing a neutral or negative decision frame on the decision, the situation is managed so that the yoyo's decisions are basically rational. summary yoyo theory is derived from escalation to commitment, organizational slack, and prospect theory. it is consistent with all three, as well as with the series of experiments perfonned by bateman and zeithaml. in yoyo theory, special care is used in framing a decision where the decisionmaker has received failure feedback or perceives low organizational slack. these situations, combined with a positive decision frame, may result in the dangers of escalation of commitment. however, yoyo theory refines escalation of commitment by further explanation of the causes in tenns of decision frame and organizational slack. the importance of decision framing in prospect theory is validated. decision framing is consistently the most significant element of the decision environment. yoyo theory refines prospect theory by considering the effects of decision feedback and organizational slack. finally, organizational slack theory is supported by recognizing the importance of slack and refming the situations in which it is critical. organizational slack is the least significant of the three detenninants. to lower the commitment to a decision, yoyo theory recommends making decisions grouih>riented, using current analysis to determine reasonable reinvestment levels, considering psychological and social detenninants of commitment, supporting fast failures, and using graceful failure feedback to infonn the decision-maker of the situation without causing further escalation. spring 1992 hicks: yoyo theory further research 59 yoyo theory is an attempt to explicate and understand the intersection of prospect theory, escalation of commitment, and organizational slack. as such, it is a first step toward a more unified theory for decision-making. empirical testing to both confirm yoyo theory and to validate the findings of bateman and zeithaml is the next step toward this more unified theory. yoyo theory extensions should be considered to include other elements of the decision. note that we have only discussed psychological and social aspects of the decision-making environment. as suggested by staw and ross, the decision environment also includes program and structural detenninants. for an all-encompassing theory to be developed, these other determinants must be integrated into it additional research is also needed into the decision frame and it's impact on decision-making. as the decision frame exerts powerful (and possibly dangerous) influence on the decision-maker, considerable research should be expended to detennine the correct decision frame for a given situation to extend the primitive guidance given here. strategic decision-making is an important area for organizational research. it is hoped that this paper will make a contribution to further understanding the interrelationships between the three established bodies of theory, predicting decision situations when a decision-maker may make dangerous decisions, and by guiding management in these situations. like the frog in the story, businesses must be aware of the environment in which they operate and react to changes. they must understand the decision-making situation and the characteristics of managers in making decisions. if not, they, like the frog in the boiling water, may not survive. references 1. baird, j. s. and thomas, h. "toward a contingency model of strategic risk-taking." academy of management review, vol. 10 (1985). 2. bateman, thomas s. and zeithaml, carl p. "the psychological context of strategic decisions: a model and convergent experimental findings." strategic management journal, vol. 10 (1989), pp. 59-74. 3. bateman, thomas s. and zeithaml, carl p. "the psychological context of strategic decisions: a test of relevance to practitioners." strategic management journal. vol. 10 (1989), pp. 587-592. 4. bazennan, m. "the relevance of kahneman and tversky's concept of framing to organizational behavior." journal of management vol. 10 (1984), pp. 333-343. 60 journal ofbusiness strategies vol. 9, no.1 5. bourgeois, l.j. "on the measurement of organizational slack." academy of management review, vol. 6 (1984), pp. 29-39. 6. cyert, rm. and march, j.g. a behavioral theory of the finn. englewood cliffs: prentise-hall (1963). 7. fishburn, peter c. nonlinear preference and utility theory. balitmore: john hopkins university press (1988). 8. fox, f.v. and staw, b.m. "the trapped administrator: effects of job insecurity and policy resistance upon commitment to a course of action." administrative science quarterly. vol. 27 (1979), pp. 449471. 9. fredrickson, j.w. "strategic process research: questions and recommendations." academy of management review, vol. 8 (1985), pp. 565-575. 10. fredrickson, james w. ''the strategic decision process and organizational structure." academy of management review, vol. 11 (1986), pp. 280-297. 11. janis, ll. and mann, l. decision makin~. new york: free press (1977). 12. jones, e.e. and davis, k.e. "from acts to dispositions: the attribution process in person perception." advances in experimental social psychoiq~, vol. 2, no. 38 (1986). 13. kahnemenn, daniel and tversky, amos. "prospect theory: an analysis of decision under risk." econometric!!, vol. 47, no.2 (march 1979), pp. 263-291. 14. kahnemenn, daniel and tversky, amos. "choices, values and frames." american psychologist, vol. 39 (1983), pp. 341-350 15. kiesler, c.a. the psychology of commitment, new york: academic press (1971). 16. knight, p.a. and nadel, j. l "humility revisited: self-esteem, information search, and policy consistency." organizational perfonnance and human decision processes. vol. 38 (1986). 17. march, j.g. and shipira, z. "managerial perspectives on risk and risk-taking." management science, vol. 33, no 11 (1987). 18. mcneil, b., pauker, s., sox, h. jr. and tversky' a. "on the elicitation of preferences for alternative therapies." new england journal of medicine, vol. 306 (1982), pp. 1259-1262. 19. norbum, david and birley, sue. "the top management team and corporate perfonnance." strategic management journal, vol. 9 (1988). 20. platt, j. "social traps." american psychologist, vol. 28 (1973). spring 1992 hicks: yoyo theory 21. peters, tom. 1brivin& on chaos. new yolk: random house (1987). 61 22. ruben, j.z, brockner, j., small-well, s., and nathanson, s. "factors affecting entry into psychological traps." joumal of conflict resolution. vol. 24 (1980). 23. sitkin, sim b. and pablo, amy l. "reconceptualizing the detenninants of risk. behavior." department of management, working paper 89/90-4-14, the university of texas. 24. starbuck, william h. and milliken, frances j. "challenger: fine tuning the odds until something breaks." journal of management studies, vol. 25, no.4 (july 1988). 25. simon, herb a. administrative behavior. new york: free press (1976). 26. staw, b.m. "knee deep in the big muddy: a study of escalating commitment to a course of action." organizational behavior and human perfonnance. vol. 16 (1976), pp. 27-44. 27. slaw, b.m. and ross, j. "escalation to a policy decision: a multi-theoretical perspective." administrative science ouarterly. vol. 23 (1978), pp. 577-587. 28. staw, h.m., and ross, j. "commiunent in an experimenting society: an experiment on the attribution of leadership from administrative scenarios." joumal of applied psychololy, vol. 65 (1980). 29. staw, barry m. and ross, j. "behavior in escalation situations: antecedents, prototypes, and solutions." research in organizational behavior, vol. 9 (1987). 30. thomas, james b. and mcdaniel, ruben r. jr. "interpreting strategic issues: effects of strategy and top management team information processing structure." academy of management journal. to appear (1992). 31. teger, a. too much invested to quit. new york: pergamon press (1980). yoyo theory: a strategy for escalation situations 44 journal of business strategies the u.s. long-haul trucking industry through the lens of frei’s service model andrew s. griffith iona college • new rochelle, ny abstract this paper examines the irregular route, long-haul segment of the u.s. trucking industry through the lens of frei’s (2008) service model. firms in this industry often offer too many services. frei’s model predicts firms that do not focus on the market niches that are best met by their core expertise are at risk of losing their profitable niches to competitors. to address two key industry problems identified through the lens of this service model, a modification to the industry’s billing model and a minimum guaranteed daily wage for drivers are proposed. introduction frei (2008) describes a service model that firms need to follow in order to survive on a long-term basis. the elements of this service model are the offering, the funding process, and managing the employee and customer systems. failing in any one of these four areas can lead to the demise of a firm. the purpose of this paper is to apply frei’s (2008) service model to the irregular route, long-haul segment of the united states trucking industry. this segment was selected due to its volatility and normally disorganized, fragmented condition (jin, swanson, waller, & ozment, 2017; page, 2017) whereas the regular route component of this industry appears to be better organized than its counterpart (belzer, 1995). a discussion of the irregular route, long-haul us trucking industry through the lens of frei’s (2008) service model follows. the u.s. interstate trucking industry firm turnover manatayev (2004) observed that third party logistics services were experiencing commoditization since deregulation. commoditization of an industry is accomplished by transforming the industry into a buyer’s market, which includes reduced margins, additional services, and increased competition in the form of many firms. more than 1000 firms in the u.s. third-party logistics industry as of 2003 is sufficient evidence of this industry’s fragmented state. volume 37, number 1 45 similar to the third-party logistics industry, the interstate trucking industry in the u.s. is also fragmented. the federal motor carrier safety administration (fmcsa) (2016) reported on october 28, 2016 that 512,145 firms were registered with interstate carrier authority. on september 27, 2019, the fmcsa (2019) disclosed that 569,946 registered firms had interstate carrier authority. further analysis of these fmcsa disclosures reveals that at least 118,641 firms (23.17% of october 2016’s disclosure) ceased operations and more than 183,128 firms (32.13% of september 2019’s disclosure) began operations during the 35 months between disclosures. part of the increase in interstate firms during this time can be explained by a movement within the industry to require contractors to possess their own operating authority if they want to lease to certain established interstate trucking firms (for example, see https://www.drive4freymiller.com/own-authority/). nevertheless, the large quantity of firms within this industry indicates that the industry is flooded with capacity and the buyers can dictate the terms. the failure rate within the industry is an indicator of margins being low and the large quantity of new entrants to the industry suggests that barriers to entry (human capital, financial capital, etc.) are low. the offering according to frei’s (2008) service model, a firm’s offering of a service requires that the service must meet the customer’s needs, be excellent, convenient, and friendly for the customer. firms often encounter challenges created by flaws in the execution of the delivery of the offered service. frei compares the service design process with the design phase of a product. as a result, the design phase for both categories should be conceptually the same and incorporate strategic planning. a key flaw found in many firms’ service offerings involves attempting to offer too many services to their customers with the idealistic and often naïve approach of attempting to be a customer’s sole service provider (frei, 2008). stone (2009) argues that the services offered by a firm should depend on that firm’s priorities and not its desire to meet all customers’ needs or resolve all of their problems. in other words, firms should specialize in their offerings. harrison-walker (2009, p. 107) points out the “confused perception [of a firm] in consumers’ minds” is often a direct result of firms attempting to offer a broad array of services to its customers. she advocates for firms to concentrate on what they do well to effectively position themselves within the marketplace. this allows each firm to create a perception of uniqueness within its market niche. firms that “attempt to be all things to all people begin to struggle when upstart 46 journal of business strategies competitors… start picking off profitable niches” (frei, 2008, p. 78). some firms elect to selectively cover profitable market niches and ignore the rest of the market. broadly focused firms that experience poaching of their profitable niches often do not realize or react to the activity until it is too late because they are unable to focus on their primary market. the trucking industry has historically been tightly regulated. pettus and munoz (2007) concluded that firms within this industry were unable to reach any level of optimal resource utilization during its period of regulation. when the industry was deregulated in the 1980s, the industry became more fragmented and disorganized but still remains heavily burdened with regulations (belzer, 1995; winebrake et al., 2015). the modern period of deregulation permitted the industry’s customers to exploit its many weaknesses (guo, lim, rodrigues, & zhu, 2006) while simultaneously eliminating trucking firms that were inefficient or irresponsible with their resources (pettus & munoz, 2007). trucking firms that tend to do well within their markets usually focus on the services that they execute best (jin, et al., 2017). as a result, they normally do not offer a wide array of services to their customers. in other words, they specialize instead of attempting to be the supermarket of the trucking industry. those that attempt to offer a wide array of services frequently compromise their brand positioning efforts. in an effort to counteract this kind of negative effect on their brands and still offer many services to their customers, some firms in this industry formed strategic alliances (pettus & munoz, 2007). strategic alliances allow firms to pool their freight and maximize the utilization of their resources (nowak, ergun, & white, 2008; pettus & munoz, 2007; prabhu, d, surekha, holla, & patel, 2008). another advantage to these alliances it is allows their customers to have access to a supermarket of sorts for their trucking needs (nowak, et al., 2008). this technique also allows the industry an opportunity to create an image of cooperation and present itself as being less disorganized and fragmented. the funding mechanism the funding mechanism involves more than the simple collection of funds from customers. frei (2008) identifies four areas that could improve funding: quality collections from customers, balancing operational savings with value-added services, strategic spending, and shifting work to the customer. it entails providing quality service to the customer so that a discount is not needed to entice the customer to do business with the firm. volume 37, number 1 47 because people tend to focus primarily on the short-term results instead of the long-term benefits (boles, barksdale, & johnson, 1997), decision-makers in trucking firms will often take any load that will keep their equipment occupied instead of locating loads that are in the best long-term interests of their firms (min & lambert, 2002). when this situation arises, customers can and do exploit the apparent weaknesses of the short-term focused trucking firms. if a customer is capable of routinely exploiting this scenario, that customer may not conduct any business with a firm unless an opportunity to exploit such a weakness exists (e.g. discounted rates in exchange for keeping the equipment busy). such scenarios produce a power imbalance in the customer-vendor relationship (essabbar, zrikem, & zolghadri, 2016; nyaga, lynch, marshall, & ambrose, 2013). such an imbalance can lead to a vendor becoming inappropriately dependent on a customer (essabbar, et al., 2016). for example, a common but adverse practice within the trucking industry involves the efforts of some customers to lengthen the payment cycle to the trucking firms. this practice further strengthens a customer’s power imbalance over a trucking firm and permits that customer to dictate the payment terms and rates and even the utilization of the trucking firm’s equipment. in an effort to minimize a customer’s ability to exploit the trucking firms’ need for cash, france requires its trucking firms to be paid within 30 days (barrot, 2016). the united states government requires its agencies to pay small businesses “within 15 days instead of 30 days” and the eu prohibits payment terms beyond 60 days without a formal written agreement (barrot, 2016, p. 1977). another example of an adverse customer dependent relationship is when the trucking firm is or has become cash poor and starts to factor its receivables (barrot, 2016). firms that need cash quickly to address short-term funding issues will often sell their receivables under recourse conditions or negotiate even lower rates with the debtor customer that is delaying payment in exchange for an immediate cash inflow. some firms will offer a version of factoring by agreeing to pay a reduced rate in exchange for making the contractual payment within a shorter period of time (such as 20 days within invoice date) instead of the contracted rate with a customerimposed longer payment period (such as 60 or more days). cash hungry organizations will often elect to defer maintenance and training expenditures now to use these funds elsewhere (calderon, wang, & conrad, 2012; kaganova, 2010). a consequence of this practice is a shorter life span of the equipment, which requires more funds to repair or replace the equipment later (vanier, 2001). operational savings is created by extending the lifespan of existing equipment and not by replacing that equipment more frequently. properly 48 journal of business strategies planned maintenance activities and regular training of the equipment operators and maintenance personnel to maintain their skills extends the lifespan of equipment and translates to operational savings in the long run (kolman, 2011). this segment of the trucking industry routinely fails to hold the customer responsible for its work. truck drivers are routinely required to load and unload the customer’s freight and they often wait extended amounts of time for their customers to take delivery (belzer & sedo, 2017). the time spent waiting and loading or unloading often results in little or no compensation for the drivers and, in some cases, the drivers are required to pay a third party or the customer to do it (belzer & sedo, 2017; min & lambert, 2002). the carrier is often forced to provide low cost freight storage for the customer. in this situation, the customer succeeds in transferring its work to the carrier. collectively, this segment could eliminate some of its inefficiencies if the customer was required to load and unload its freight. more importantly, carriers need to do a better job of holding the customer financially responsible for the excessive time spent under a load. carriers should not be a cheap alternative to traditional freight storage but a more expensive alternative. the employee management system a proper employment management system enables employees to perform to the best of their abilities (frei, 2008). this system covers all aspects of the employee experience at a firm: from appropriate and reasonable compensation packages to proper training, job/employee matching, as well as hiring and retention practices. a key aspect of this is ensuring that the employee is sufficiently challenged and that the employee’s skills are properly utilized to meet both the needs of the firm and the employee. failure to do so makes it difficult to meet the commitments to customers. the trucking industry has a traditional emphasis of focusing on building capacity and staffing its capacity to the maximum without focusing on maximizing the utilization of its resources before adding more capacity. evidence of this is born by frequent claims of an industry-wide or firm-specific driver shortage (min & lambert, 2002). additional evidence of the industry’s lack of utilization of its resources is found in the high turnover rates among its drivers (lemay, taylor, & turner, 1993; nyaga, et al., 2013). drivers in the irregular route, long-haul trucking industry are often paid on a per mile basis (belzer & sedo, 2017). if they are not receiving a sufficient quantity of regular paid miles or overall compensation to meet their own financial needs, they will move to an employer that promises them better financial volume 37, number 1 49 results (lemay, et al., 1993; min & lambert, 2002). variances in the paid mileage and overall compensation of the drivers often are a direct function of the scheduling practices of the firm (belzer & sedo, 2017). customers that insist on scheduling pickup and delivery times with excessive days built into these loads are using a trucking company’s equipment as free or low rent storage facilities. for example, a normal three-day trip might be scheduled in a way that requires the driver to spend six days with the load. this hurts the utilization of the equipment and the driver’s compensation. trucking firms can minimize some of the financial consequences of this practice if they schedule the pickup and delivery times in a manner that minimizes the driver’s and equipment’s idle time. from the driver’s perspective, he has little control over when a customer decides to load the truck and when it is willing to take delivery of the product. the time that the driver spends waiting on the load often results in minimal compensation that amounts to nothing more than a token, after-tax, value that might cover most of the cost of his meals (belzer & sedo, 2017). this practice contributes unnecessarily to high turnover rates in the industry (lemay, et al., 1993; min & lambert, 2002). a properly managed firm will maximize the utilization of its employees without suppressing the compensation packages of its employees. in other words, a productive trucking firm will keep its drivers from sitting idle without earning a reasonable daily wage. a poorly managed firm will either schedule its drivers with excessive travel time or will allow the customer to utilize the equipment and driver without proper compensation for the time, resources, and risk involved. ultimately, inefficient utilization of a firm’s resources (including its employees) results in less revenues, less contribution margin (to cover fixed costs and profits), and reduced profits or increased losses (katz & shapiro, 1994). the customer management system frei (2008) considers the customer management system to be the focal point of the business activity that simultaneously meets the needs of the customers and the firm. to accomplish this, firms often establish different priority levels for their customers. those who represent a significant volume of business or a critical area of a firm’s business activity would take priority over those who represent a minor or insignificant portion of the firm’s business. some firms attempt to train their customers and employees by invoking a system of rewards and punishments for the customers’ behavior (frei, 2008). these rewards encourage specific behaviors that benefit the firm and the punishments 50 journal of business strategies discourage behaviors that are contrary to the firm’s mission. one motivation for such a system is a quest to reduce customer variability (frei, 2006). during the age of regulation, trucking firms were permitted to operate in very inefficient manners. in fact, firms were unable to operate at optimal efficiency because of the regulatory environment (pettus & munoz, 2007). deregulation removed the safeguards that ensured the survival of many inefficient firms and allowed customers to disregard the needs of the trucking industry to be more efficient with its resources. after deregulation, many firms in the trucking industry attempted to cater to every customer’s desires by taking any and all loads that fit their short-term focus of equipment utilization regardless of profitability. some of this is clearly a function of economic agency issues—meaning that a firm’s agents were operating in their own best interests instead of the best interests of their employers (jensen & meckling, 1976; mitnick, 1973). as a result, these firms were often obligated to transport product at rates significantly below the actual costs to move these loads. obviously, this arrangement was not in the best long-term interests of firms but keeping the equipment occupied was in the short-term interests of the firm’s agents. large customers have exploited the deregulated and fragmented trucking industry to obtain lower rates and extended low-cost use of its equipment. much of this was accomplished through the use of carrier assignment models. this allowed customers to efficiently identify the carriers that would provide the desired service at the lowest possible rates (guo, et al., 2006). as fuel costs rose significantly after 2001, trucking firms began to react and take a stand against hauling product for inadequate rates and inefficient use of their resources. this translated to an industry-wide renegotiation of freight transportation terms including expanding the practice of a cost sharing provision, called a fuel surcharge, based on the market rate of fuel (winebrake, et al., 2015). additional provisions negotiated during this effort included additional rates for occupying the equipment for extended timeframes (such as excessive loading or unloading time and layover charges), providing additional services (such as expedited delivery), and customer error (failure to comply with the shipping terms or errors in loading trucks). trucking firms should extend this process by billing their customers not just on a per-mile or agreed rate-per-load basis (with a fuel surcharge hedging variable) but to include a per-day rate that covers the trucking firm’s cost per day for the equipment (and the normal daily wages of the assigned drivers) while under that load. along with this improvement of the equipment utilization, the industry made some adjustments to its compensation package to acquire and retain the better drivers (min & lambert, 2002). this resulted in significant improvements to the rates in volume 37, number 1 51 the industry’s compensation model but these changes remain inadequate as drivers still are not compensated adequately for the time they work (belzer & sedo, 2017). drivers should be compensated in a way that ensures the needs of the trucking firms and the customers are better met. one approach to this is to provide the driver with a guaranteed minimum daily wage for every day spent away from home. this minimum guaranteed daily wage would have to be set high enough to ensure that the driver can pay for his meals and continue to meet reasonable financial obligations. this may be accomplished by setting this minimum guaranteed daily wage rate at 300% of the irs recognized per diem rate for those subject to dot hours of service. the 300% multiplier is intended to ensure that each driver has some funds available after paying for their daily expenses away from home and taxes to meet non-driving financial obligations while keeping the calculation simple and easy for firms to implement and manage. conclusion frei’s (2008) service model is a compelling argument for firms to specialize in their industries instead of “[attempting] to be all things to all people” (p. 78). she advocates that firms should focus on the market segment(s) that match their core expertise and ignore the other areas of their industry. firms that attempt to offer too many services tend to be distracted from the areas of their core expertise and that creates opportunity for their competitors. because of the fragmented condition of the u.s. irregular route, longhaul trucking industry, firms in this industry that offer a wide range of services to customers will be prone to having their profitable market niches exploited by competitors who are willing to focus on these niches and ignore the other market segments. underlying this condition is an industry that has great difficulty with employee management, customer management, and its funding and service offering processes. this highlights that the traditional ways of conducting business in this industry are inefficient, insufficient, and economically harmful to the firms and those working within the industry. the firms that excel in this industry manage frei’s (2008) service model better than their competition. 52 journal of business strategies references barrot, j. n. (2016). trade credit and industry dynamics: evidence from trucking firms. the journal of finance, 71(5), pp. 1975-2016. doi:10.1111/jofi.12371 belzer, m. h. (1995). collective bargaining after deregulation: do the teamsters still count? industrial and labor relations review, 48(4), pp. 636-655. doi:10.2307/2524348 belzer, m. h., & sedo, s. a. (2017). why do long distance truck drivers work extremely long hours? the economic and labour relations review, pp. 1-21. doi:10.1177/1035304617728440 boles, j. s., barksdale, h. c., & johnson, j. t. (1997). business relationships: an examination of the effects of buyer-salesperson relationships on customer retention and willingness to refer and recommend. the journal of business & industrial marketing, 12(3/4), pp. 253-264. calderon, t. g., wang, l., & conrad, e. j. (2012). material internal control weakness reporting since the sarbanes-oxley act. the cpa journal, 82(8), pp. 20-25. essabbar, d., zrikem, m., & zolghadri, m. (2016). power imbalance in collaboration relationships. international journal of supply and operations management, 2(4), pp. 1021-1034. federal motor carrier safety administration. (2016). motor carrier census information. u.s. department of transportation. retrieved from https:// ai.fmcsa.dot.gov/sms/tools/downloads.aspx. federal motor carrier safety administration. (2019). motor carrier census information. u.s. department of transportation retrieved from https://ai.fmcsa. dot.gov/sms/tools/downloads.aspx. frei, f. x. (2006). breaking the trade-off between efficiency and service. harvard business review, 84(11), pp. 92-101. retrieved from https://hbr.org/2006/11/ breaking-the-trade-off-between-efficiency-and-service. frei, f. x. (2008). the four things a service business must get right. harvard business review, 86(4), pp. 70-80. retrieved from https://hbr.org/2008/04/thefour-things-a-service-business-must-get-right guo, y., lim, a., rodrigues, b., & zhu, y. (2006). carrier assignment models in transportation procurement. the journal of the operational research society, 57(12), pp. 1472-1481. doi:10.1057/palgrave.jors.2602131 harrison-walker, l. j. (2009). strategic positioning in higher education. academy of educational leadership journal, 13(1), pp. 103-111. volume 37, number 1 53 jensen, m. c., & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3(4), pp. 305-360. doi:10.1016/0304-405x(76)90026-x jin, y. h., swanson, d., waller, m., & ozment, j. (2017). to survive and thrive under hypercompetition: an exploratory analysis of the influence of strategic purity on truckload motor-carrier financial performance. transportation journal, 56(1), pp. 1-34. kaganova, o. (2010). government property assets in the wake of the dual crisis in public finance and real estate: an opportunity to do better going forward? real estate issues, 35(3), pp. 31-41. katz, m. l., & shapiro, c. (1994). systems competition and network effects. the journal of economic perspectives (1986-1998), 8(2), p 93. doi:10.1257/ jep.8.2.93 kolman, d. a. (2011). maintenance outlook report. fleet maintenance, 15(10), pp. 8-10,12-14,16-22,24-25. lemay, s. a., taylor, g. s., & turner, g. b. (1993). driver turnover and management policy: a survey of truckload irregular route motor carriers. transportation journal, 33(2), p 15-21. manatayev, y. y. (2004). commoditization of the third party logistics industry (master of engineering in logistics). massachusetts institute of technology, cambridge, ma. min, h., & lambert, t. (2002). truck driver shortage revisited. transportation journal, 42(2), pp. 5-16. mitnick, b. m. (1973) fiduciary rationality and public policy: the theory of agency and some consequences. paper presented at the 1973 annual meeting of the american political science association, new orleans, la. https://papers.ssrn. com/sol3/papers.cfm?abstract_id=1020859 nowak, m., ergun, o., & white, c. c., iii. (2008). pickup and delivery with split loads. transportation science, 42(1), pp. 32-43. doi:10.1287/trsc.1070.0207 nyaga, g. n., lynch, d. f., marshall, d., & ambrose, e. (2013). power asymmetry, adaptation and collaboration in dyadic relationships involving a powerful partner. journal of supply chain management, 49(3), pp. 42-65. page, p. (2017, apr 10). business news: truckers knight and swift to merge. wall street journal. pettus, m. l., & munoz, j. m. (2007). resource-based value creation: experiences from the u. s. deregulated trucking industry. competition forum, 5(1), pp. 253259. 54 journal of business strategies prabhu, b. v., d, r., surekha, a., holla, a. j., & patel, k. m. (2008). value stream mapping of truck operations: a case study. south asian journal of management, 15(2), pp. 107-115. stone, r. d. (2009). achieving results with a performance-centered design framework. performance improvement, 48(5), pp. 37-44. doi:10.1002/pfi.20077 vanier, d. j. (2001). why industry needs asset management tools. journal of computing in civil engineering, 15(1), 35-43. doi:10.1061/(asce)08873801(2001)15:1(35) winebrake, j. j., green, e. h., comer, b., li, c., froman, s., & shelby, m. (2015). fuel price elasticities in the u.s. combination trucking sector. transportation research part d: transport and environment, 38(supplement c), pp. 166-177. doi:10.1016/j.trd.2015.04.006 biographical sketch of author andrew s. griffith, dba, ea, cpa, cma, cia, cfe, crma, is an associate professor of accounting at iona college (usa), where he teaches undergraduate thesis research courses in the honors program and graduate accounting courses. he is a former assistant director of the honors program and a former chair of the human subjects/institutional review board at iona college. his research doctorate in accounting is from nova southeastern university. slowing the revolving door: looking for new keys to retain entry-level retail workers d. michael fields southwest missowi state university springfieldt missouri stella m. nkomo university of north carolina at charlotte charlotte, north carolina introduction retailers entered the 19908 struggling with a problem most had not previously faced-the availability of entry-level labor. during the 1980st retailers became increas~ ingly dependent on the young worker to staff the ever-growing number of part-time, entry-level positions-unaware that trends that demographers had spotted 20 years before were about to have a severe impact on their ability to service their customers. beginning in 1979, and continuing almost unintenupted into the 19908, there were fewer potential workers in the 16-24 age group than there had been in each succeeding year. the result of this reoccurring reduction was first felt in the fast food industry in the mid-1980s. by the end of the decadet the problem plagued the entire retail sector. retailers have been scrambling to survive what has become a serious labor shortage. although some efforts have been expended to recruit nontraditional workers (e.g., handicapped and elderly)t a bidding war for the typical worker has ensued. workers have responded to the escalating wage rate and increasing benefits by moving from job to job at previously unrecorded rates. many retailers have become a virtual revolving door for personnel. this skyrocketing turnover has caused retailers to spend substantially more time and money recruiting and training new employees as well as to question the level of service that these personnel are providing their customers. for retailers to succeed in this sellerts labor marke~ they must find ways other than the increase of wages and benefits in order to retain new employees. a possible option is to better understand the job expectations of potential employees. the ideal situation would be for a retailer to be able to isolate differences in job expectations between identifiable groups. by knowing these differing expectatio~ the retailels could tailor their internal environment to better match the expectations of targeted employees and/or hire employees from the groups that have more realistic employment expectations. the primary purpose of the present study is to identify the relative importance of several job and company characteristics to newly hired retail employees. a secondary objective is to determine if corresponding generalizations regarding these characteristics might be supported across retailers. information was gathered from employees from a department store, a specialty storet and a supermarket early in tlie individualts first week of employment. the newly hired employees were asked a series 138 journal ofbusiness strategies vol. 9. no.2 of questions regarding the degree of importance for certain characteristics in their selection of a job and the likelihood that their new employer would be able to provide each of these characteristics. differences between employee groups among the three companies as well as differences between the employees of the three differing retailers were examined. backgroudd in the 1960s. when retailers had an entry-level sales opening. selection could be as simple as pulling an application from a large stack that was almost certainly on hand. as increasing numbers of baby boomers (those born between 1946-1964) reached working age. the supply of workers increased. this abundant supply afforded employers several advantages. first, the wages for hourly personnel were suppressed, often being defined by the prevalling minimum wage. second, corresponding benefits offered employees were very limited. third, turnover was low because of the difficulty in finding replacement jobs. fourth. employers could exercise more selectivity in filling these job openings when they did occur. fifth. management could utilize an authoritarian style to emphasize the attainment of company oriented goals. finally. many retailers were able to increase their percentage of part-time workers. several benefits were associated with this increased use of part-timers. the primary advantage was the opportunity to reduce both direct (lower wage rates) and indirect (less benefits) labor costs. an additional benefit was that a large contingent of part-time workers allowed the retailer greater scheduling flexibility. workers could be scheduled to better match demand peaks and to meet the increased demands of longer hours as retailers continued their suburban development. finally, the use of part-time employees made it easier to specialize among job tasks [10]. during the 1970s, although retailers continued to need additional numbers of workers. the uninterrupted increase in the supply of young workers ended (see figure 1). however, there were sufficient numbers seeking jobs to fill both the existing positions and these new jobs that a growing retail sector developed. retailers, which bad become increasingly dependent on the young worker (16-24) to staff their stores, continued to utilize a larger percentage of part-time workers. this trend can be seen by examining the average hours per week for the non-supervisory retail worker (see figure 2). for some sectors of retailing. declining productivity has further worsened the pr0blem. for those areas of retailing for which data are available, both eating and drinking places and food stores suffered average annual productivity declines. as a result of this situation, these retailers are increasingly reliant upon labor to meet the higher output requirements [4]. as retailers entered the 19808, researchers began to isolate differences between the full-time worker and the part-time employee that could be potential sources of concern for the employers. the research has shown that part-time personnel will not only leave their jobs more often than will full~timers, but they will leave because of external reasons while full-timers tend to separate because of job related reasons [6]. also, fall 1992 fields & nkomo: slowing the revolving door figure 1: supply of young workers vs. dellwld for non-supervisory retail employees employees (millions) 139 30.,....--------------------......., 25 20 15 10 5 19901985 0 .....----..,.---.......---..._--_---..-----1 1960 1965 1970 1915 1980 m non-supervisor years • 1 6-24 workers source: u.s. bureau of labor statistics findings have indicated that the motives that part-time employees have to work may be different from those of their full-time counterparts [10]. the personnel environment changed dramatically in the 1980s. the supply of young workers continued to decline throughout most of the decade. as the "baby boom" generation matured. and cycled out of the young worker category, they were replaced by a much smaller number of youth from the "baby buse' genemtion (see figure 3). at the same time, there was continued growth in the total retail sector which developed a need for additional jobs (see figure 1). an examination of figure 1 suggests that the two horizontal lines are converging. indeed, projections are that the demand for nonsupervisory retail workers will exceed the number of 16-24 year old workers before the turn of the century. the result of this decreased supply and increased demand places retailed in a new competition. not only will they continue to compete for customers, but re1a.ilers will also be faced with competition for personnd. unfortunately, the labor environment will continue to women through out the 1990s. as can be noted by examining figure 3, the pool of young workers will continue to decline through 1995. although the group of available young worked will have increased slightly in the last half of the decade, this increase will be more than offset by the previously noted continuing demand for entry-level workers. 140 journal ofbusiness strategies vol. 9, no.2 figure 2: avenge hoursiweek for non-supervisory workers in retail trade, 1960-1989 hours/week 40 -r---------------------....., 38 36 34 3z 30 z8 -f---.....----,..--..........--,.-------r----r--___.......---1 1950 1955 1960 1965 1970 1975 1980 1985 1990 years iii hours/week source: u.s. bureau of labor statistics competing for employees the competition for employees has several ramifications for retailers. not unexpectedly, labor costs have risen dramatically in areas where the shortage is being felt most severely. specifically, these areas include locales in which the percentage of young people is particularly low (e.g., retirement areas) and/or the overall unemployment rate is low. the latter point is true because retail has typically been used for nonpermanent employment by individuals who temporarily cannot find employment in their chosen industry. retailers in these areas are faced with increases in both direct and indirect labor costs. the direct costs are higher because the supply/demand labor imbalance is causing the starting rates for even the inexperienced employee to be substantially over the minimum wage rate. indirect costs have risen as well because the benefit packages being offered-particularly for the part-time worker-have been increased dramatically. another result is the marked increase in employee turnover. although turnover is typically higher for all types of retailers, the greatest impact bas been felt by fast food retailers. once again, the rate for part-timers bas been particularly high, with some companies facing annual turnover rates in excess of 300 percent [9]. for other industries such as the grocery industry, rates in excess of 100 percent are not uncommon. the problem has taken an increasing amount of the retail manager's time-not just in looking for solutions, but in order to simply maintain day-to-day operations. facing these staggering turnover rates, management must spend valuable time recruiting and fall 1992 fields & nicoma: slowing the revolving door figure 3: u. s. births 1950-1985 141 ~umber of bin ~«()()() ~. ,/ \ i \ i \ / \ / ....... /'-'. \ .v \ i \ / \ / \ / source: u.s. bureau of census 4400 4200 4000 3800 3600 3400 3200 3000 1940 1950 1960 years 1970 1980 1990 training new employees. some retailers have gone so far as to pull out of entire areas because of the difficulties associated with staffing their stores. but perhaps the retailer's greatest fear associated with this staffing problem is the unacceptable level of service that an untrained or marginally trained employee will provide to a firm's customers. in many maturing retail industries, such as department stores, supermarkets, and many specialty stores, the greatest opportunity to differentiate from competition lies in the level of service that accompanies the sale of similar products. however, before carefully constructed strategies to gain a differential advantage by out-servicing competition can be put into place, the personnel turnover problem must be controlled. in fac~ if competing firms can do a better job of retaining their personnel-and as a result service their customers with more knowledgeable employees-then a firm may actually find itself at a competitive disadvantage. there are two ways to approach this turnover problem. the first is to reduce the reliance on personnel. the second is to improve the retention of the new employees that are hired. although moving customers toward greater levels of self-service does not appear to be a widespread option, it is one toward which some retailers are moving. for example, several supermarket firms have tested "checkerless" check stands [2]. in what could be described as the ultimate self-service setting, customers not only select the items they wish to purchase, but also scan (i.e., register) their purchases, bag their order, and transport their purchases to their vehicles. thus customers can complete their entire 142 journal ofbusiness strategies vol. 9, no.2 shopping visit, never interacting with an employee except to pay for their groceries. this is an option that will not likely appeal to a large segment of the market. most retailers will seek ways to retain a higher percentage of the new employees that they hire. to this point, retailers have pursued a series of options, including increasing the level of compensation, offering more flexible scheduling, increasing educational assistance (e.g., tuition waivers), and offering other assistance such as improved transportation arrangements in order to bus workers into areas where the shortage is particularly severe. unfortunately, each one of these options can be readily observed and easily duplicated by a inm's competition. if a retailer instituted one of these options and it was well received by potential employees, then the inm would likely soon find the option widely offered in the market. thus, changes in the options noted above serve to do little more than to up the bidding war (and employer costs) for available entry-level employees. more successful strategies for the retailer will be those which are effective, but less transparent. the result will be programs that will be harder to emulate. a key here is a better understanding of expectations that a new employee brings to the job. further, retailers need to understand what, if any, differences may exist in the expectations between the different demographic groups of potential employees. if differences can be isolated, internal strategies can be initiated that will result in the perceived environment more closely matching the expectations that an employee brings to the job. this should lead to personnel who are happier with their employment setting and are thus less likely to leave the organization. the study early in the first week of employment, newly hired personnel were asked to complete a questionnaire designed to: (1) prioritize a list of 24 job characteristics by importance to the new employee and (2) record the new hire's initial expectations regarding their employer's ability to provide these characteristics. these characteristics essentially covered three major aspects of work: the job itself (e.g., challenging/interesting work), company environment (e.g., pleasant work environment), and compensation/job security (e.g., good salary). the 24 characteristics of importance were measured on a seven point likert scale, with the range going from "very important" to "very unimportant." the employee's perception of the company's ability to provide "these same 24 characteristics was also measured on a seven point likert scale, with options ranging from "very likely" to "very unlikely." (see table 4 for a list of the 24 characteristics.) in addition, both the respondent and the employer (at a later date) provided information useful in classifying the respondents into groups. job attn"bute and corresponding company characteristic questions were largely derived from scales and questions that had previously been validated ([5], [7], [8]). in addition, previous tests indicated the measurement scales to have relatively high levels (alpha scores of from .74 to .87) of internally consistent reliability [8]. fall 1992 fields & nkomo: slowing the revolving door 143 newly hired employees from each of the three retailers were given identical questionnaires. each of the three retailers was chain operations and responses were gathered from multiple stores at each site. in each case, surveys were administered by company personnel at the individual store site. respondents were unmonitored and were given time "on the clock" to fill out the questionnaires. following completion of the survey, respondents sealed the questionnaires in a return envelope addressed to the researchers and sent them to the company mail room where the researchers later picked them up. a total of 796 questionnaires were collected from the three sites; 140 from the department store, 356 from the specialty store, and 300 from the supermarket. because of the method of data collection, fewer than five percent of potential respondents did not fill out the surveys or filled out so little of it as to render it useless. approximately eight weeks following the end of data collection, the researchers obtained employee rosters from each of the companies. the list of new hire respondents was checked against the rosters to determine which of the new personnel had quit and which were still employed. for the department store, 64 of the 119 respondents (54.6%) had left the company. in the case of the specialty store, 218 of the 356 respondents (61.2%) were no longer employed. finally, 179 of 300 supermarket new hires (59.7%) were no longer with the firm after eight weeks. looking at the three samples together, 461 of the 775 (59.5%) bad left their respective company before they had been on the job eight weeks. the filldidgs demograpltks the demographic profde of the new employees is significantly different among the three retailers (fable 1). compared to the specialty store and the supermarket, the department store employed a much higher percentage of full-time workers. in addition, their new hires were older (one third were over 24) and had a higher level of education. in contrast, the supermarket was the most dependent of the three retailers on the young (16-24) worker. correspondingly, their new hires had lower levels of education and were most often single. additionally, the supermarket operation hired a higher percentage of males. the profile of the specialty store new hire fell between the contrasts established by the department store and the supermarket for certain characteristics. however, the specialty store new hires seemed to more closely paraliel the new supermarket employees. for example, the specialty store was dominated by part-time workers and relied on a higher percentage of younger workers. a breakdown of the demographic cbaracteristics among the three retailejs for those employees who have left their job versus those who remained. employed revealed some interesting fmdings. in six instances there were significant differences between the new hire leavers and the stayers for the individual retailers among the demographic variables studied (see table 2). these differences supported a general lack of consistency across the three samples of new hires. 144 journal ofbusiness strategies vol. 9, no.2 table 1: demographic comparison of new hires for three diff'erent types of retailers variables department store specialty store supermarket (119) (356) (300) employee typel part-time 54.6% 94.4% 98.3% full-time 45.4% 5.6% 1.7% sex1 male 20.2% 8.2% 45.8% female 79.8% 91.8% 54.2% marital status single 70.6% 73.9% 78.3% married 22.7% 18.3% 16.7% other 6.8% 7.6% 5.0% education1 grade school 0% 0.6% 0.3% some high school 0% 9.7% 6.8% attending high school 10.9% 32.7% 48.6% high school graduate 12.6% 27.0% 22.0% some college 27.7% 12.8% 9.5% attending college 23.5% 15.1% 10.1% college degree 21.0% 1.1% 2.7% some graduate school 2.5% 1.1% 0% graduate degree 1.7% 0% 0% agel 18 and under 20.2% 47.5% 62.4% 19-24 45.3% 30.5% 21.5% 25-35 23.6% 14.1% 8.7% 36-50 8.4% 5.6% 4.7% 51 and over 2.5% 2.3% 2.7% average age 24.6 yrs. 22.1 yrs. 20.9 yrs. race white 78.8% 73.6% 79.9% black 16.9% 24.2% 18.7% others 4.2% 2.3% 1.3% 1significant differences between the three samples exists at the 0.10 level in the case of part-time versus full-time employees, for example, little apparent difference existed between the two categories for the specialty store and the supermarket for the department store, however, a significantly higher percentage of parttimers left than did full-timers. although the differences were not significant, a higher percentage of males both in the department store and the specialty store left the orgafall 1992 fields & nkomo: slowing the revolving door 145 table 2: demographic comparison of new hire leavers and stayers in three different types of retailers variables department store specialty store supermarket leave stay leave stay leave stay (64) (55) (219) (137) (175) (125) employee type part-time 56.9 31.58 94.5 94.2 98.9 97.5 full-time 43.1 68.58 5.5 5.8 1.1 2.5 sex male 21.5 18.5 8.7 7.3 41.9 51.7b female 78.5 81.5 91.3 92.7 58.1 48.3b marital status single 80.0 59.3c 71.6 78.1 77.7 79.2 married 16.9 29.6c 18.8 17.5 16.8 16.7 other 3.1 1l.2c 9.6 4.4 5.6 4.2 education grade school 0.0 o.od 0.9 0.0 0.6 o.od some high school 0.0 o.od 11.5 6.7 8.5 4.2d attending high school 12.3 9.3d 27.6 40.7 46.6 51.7d high school graduate 10.8 14.8d 29.0 23.7 23.9 19.2d some college 23.1 33.3d 13.4 11.9 10.2 8.3d attending college 32.3 13.od 14.3 16.3 6.3 15.8d college degree 21.5 2o.4d 1.8 0.0 4.0 0.8d some graduate school 0.0 5.6d 1.4 0.7 0.0 o.od graduate degree 0.0 3.?d 0.0 0.0 0.0 o.od age 18 and under 27.7 1l.lc 44.5 52.2 58.7 68.1 19-24 46.1 42.6c 22.6 27.2 26.2 14.3 25-35 21.6 27.se 15.6 11.8 8.4 9.2 36-50 4.6 12.9c 4.1 8.1 4.5 5.0 51 and over 0.0 5.6c 3.2 0.7 2.2 3.4 average age (years) 22.2 27.6 22.4 21.6 20.8 21.1 race white 76.9 81.1 72.0 75.9 81.6 77.5 black 16.9 17.0 25.7 21.9 16.8 21.7 others 6.2 1.9 2.3 2.2 1.7 0.8 bsignificant differences (p < .01) between leavers and stayers for employee type bsignificant differences (p < .10) between leavers and stayers for sex <:significant differences (p < .05) between leavers and stayers for marital status dsignificant differences (p < .05) between leavers and stayers for education csignificant differences (p < .01) between leavers and stayers for age 146 journal ofbusiness strategies vol. 9, no.2 nizations. for the supermarke~ significantly higher percentages of females left the company. similar conflicts were apparent for the balance of the variables. a significantly higher percentage of single employees left the department store while the find· ings were in the opposite direction for the new hires of the other two retailers. the department store had a significantly higher percentage of new hires attending college leave the company, while a significantly higher percentage of college students stayed with the supermarket conversely, though both the specialty store and the supermar· ket had higher percentages of young workers (under 24) stay with the organizations, the department store had a significantly higher percentage of this group leave the company. finally, in the case of race, although none of the differences were significan~ there were different directions in the findings. characteristics of importance table 3 indicates characteristics of importance for which there were significant differences between the leavers and the stayers for each of the three retail organizations. as can be noted, there was much diversity in the results across the three retail samples. for the supermarket respondents, no differences between the leavers and the stayers could be found. in the specialty store, the two groups differed only in their rating of the importance of showing effective performance and medical benefits. however, in the department store, the leavers and the stayers recorded significant diftable 3: characteristics of importance significant differences between leavers and stayers by retaller mean value ranking characteristic leave stay leave stay department store good co-workers 1.50 1.872 4 19 challengingllnteresting work 1.63 1.353 9 1 good salary 1.83 1.3~ 14 2 training programs available 2.17 1.832 17 17 chance to advance rapidly 2.25 1.783 19 16 good career path 2.26 1.002 20 10 medical benefits 2.54 1.681 21 12 specialty store show effective performance 1.50 1.673 5 10 medical benefits 2.13 2.4~ 20 21 supermarket no significant differences i significant differences between leavers and stayers were found at the p < .01 level 2significant differences between leavers and stayers were found at the p < .05 level 3significant differences between leavers and stayers were found at the p < .10 level fall 1992 fields & nkomo: slowing the revolving door 147 ferences on seven of the 24 characteristics. the stayers viewed six of the seven characteristics as having significantly more importance. however, the good co-workers characteristic was considered by the leavers to have more importance. the relative ranking of the characteristics (with 1 having the highest rating) is also included in table 3. substantial differences in the order in which leavers and stayers rated the importance of the characteristics can be seen on a majority of the entries. consistency in the rating and relative ranking of the characteristics for the leavers across the three retailers was considered in table 4. respondents from each of the three retailers indicated similar ratings for characteristics that had both highest and lowest relative rankings. characteristics that leavers rated as having the greatest level of importance (boss i can work with, enjoyable type of work, and pleasant work environment) were consistent across the three samples. similarly, leavers from each table 4: characteristics of importance for leavers mean score and ranking by retaner characteristic boss i can work with enjoyable type work pleasant work environment good co-workers company's good reputation opportunity to learn desirable store location show effective performance challengingllnteresting work opportunity to use abilities job fits my lifestyle flexible work schedule job security good salary variety of activities good fringe benefits training programs available appropriate sized company chance to advance rapidly good career path medical benefits individual work freedom prestigious job title tuition waiver opportunity department store mean rank 1.43 1 1.45 2 1.46 3 1.50 4 1.55 5 1.57 6 1.57 7 1.62 8 1.63 9 1.65 10 1.74 11 1.75 12 1.80 13 1.83 14 1.89 15 1.92 16 2.17 17 2.17 18 2.25 19 2.26 20 2.54 21 2.63 22 2.81 23 3.05 24 specialty store mean rank 1.19 1 1.47 4 1.43 2 1.55 7 1.67 10 1.44 3 1.65 9 1.50 5 1.63 8 1.69 11 1.86 14 1.53 6 1.75 13 1.73 12 2.01 15 203 16 2.32 21 2.12 19 2.06 17 2.07 18 2.13 20 2.96 24 2.55 22 2.84 23 supermarket mean rank 1.46 1 1.73 4 1.61 2 1.81 10 1.74 5 1.77 7 1.66 3 1.81 9 1.88 12 1.97 13 2.27 19 1.77 8 1.85 11 1.75 6 2.28 20 2.09 17 2.39 21 2.03 14 2.05 15 2.09 16 2.27 18 2.86 24 2.72 22 2.85 23 note: there were no significant differences between the three samples. mean value ranking leave stay leave stay 2.09 1.691 11 5 2.65 2.151 17 16 2.91 2.261 19 17 3.05 2.431 20 18 1.71 1.491 4 2 2.88 3.182 15 18 148 journal ofbusiness strategies vol. 9, no.2 sample ranked individual work freedom, prestigious job title, and tuition waiver opportunity as having the least importance. although there was generally more variation among the three samples in the ''midrange" variables, some merit additional discussion. the rating for the good salary variable was remarkably consistent-with scores ranging from 1.73 to 1.80 for the three samples. the rating for flexible work scheduling was similar although the range was wider because respondents who ultimately left the specialty store indicated a slightly higher level of importance for the variable. other variables which exhibited a narrow range were desirable store location and job security. company characteristics differences between the leavers' and the stayers' perceptions of the particular retailer's ability to provide the characteristic were examined for each of the 24 variables. significant differences for each of the three samples (if any) are reported in table 5. although responses should be expected to differ from retailer to retailer, at issue is whether a relationship between the perceptions of incoming employees and the decision to leave the company after a short time might be suggested. the results follow a pattern similar to that found for the characteristics of importance. once again, there were no significant differences between the leavers and stayers for the supermarket respondents. two differences were found for the specialty store sample. i..eavers indicated a lower expectation that the specialty store would be able to provide flexible scheduling. unexpectedly, the leavers also indicated a higher level of expectation that training programs would be available. table 5: company characteristics significant difi'erences between stayers and leaven characteristic department store training programs available good fringe benefits medical benefits good career path spedalty store flexible work schedule training program available supermarket no significant differences 1significant differences at the p < .05 level 2significant differences at the p < .10 level fall 1992 fields & niromo: slowing the revolving door 149 more differences were observed between the leavers and the stayers in the department store sample. significant differences for training programs available, good fringe benefits, medical benefits, and good career path were found. in each case, leavers were more pessimistic that the particular characteristic would be provided by the company. conduslods in the research at hand, the demographic characteristics of the newly hired employees who remained on the job after eight weeks were not consistent among the three retailers studied. while some of the differences may be explained by the fact that the three retailers are hiring employees, as a group, who have slightly differing characteristics, this retention inconsistency develops more questions than it answers. for example, in the case of employee type, clearly the department store placed more emphasis on the hiring of full-time employees than did the other two retailers. this effort is consistent with actions of other department store operations [1]. however, explanations for the numerous other differences are not as apparent. in the case of the opposite findings in the retention of student new hires for the department store versus the other retailers, no clear reason surfaces. none of the three retailers provided any special incentive (e.g., tuition waiver) to this group. a possible explanation, unsubstantiated by any data in the present study, as to why both the specialty store and the supermarket do a better job retaining student new hires than does the department store may lie in the companies' approach to work scheduling. if, for example, the department store is very rigid in their scheduling, students may find after a short period of employment that this is not consistent with their needs. given the present labor market, other employers with more flexible scheduling practices will be sought out this, and other similar expladations for conflicting characteristics, can be offered to explain the differences. however, the analysis of differing demographic characteristics was not the focus of this research. indeed, the degree and the number of differences found were unexpected. as a result, the research was not directed at determining why newly hired employees were reacting differently in different retail environments. this should be the objective of future research. the value of this research is: (1) the development of knowledge of characteristics that are important to the employee at the time of hire which may be utilized to improve new hire retention and (2) the realization that while many differences do exist across retailers, some possible generalizations are suggested for all retail new hires. identifying and incorporating the employee's characteristics of importance into employment policy may help retailers retain a higher percentage of their new hires. for example, individuals who left each of the three retailers after a short period of time apparently came to that organization driven by characteristics about their jobs that were oriented around the present working environment. these workers do not apparently place a great deal of importance on future considerations. rather, they are most interested in doing work that they enjoy, in a nice environment, and for a supervisor with whom they are compatible. 150 journal ofbusiness strategies vol. 9, no.2 characteristics that retail management have traditionally considered as keys to retaining entry-level new hires-a good salary and flexible work scheduling-do not appear near the top of the characteristics of importance of any of the three groups of new hire leavers. relative to the other characteristics, the new hire ieavers apparently do not view these two factors as critical to continued employment. retailels will likely find this result surprising, since these are areas which most often receive attention when companies attempt to improve their new hire retention rate. the relative importance of characteristics may differ between new hire leavels and stayers for a particular retailer. in the case of the department store, the new hire stayers cited several factors which indicated an interest with the level of personal development in their job. the top characteristics selected by the new hire leavers, as was discussed above, centered around their present work environment. examining the new hire's perception of the retailers' provision of the characteristics of importance could be of value in two ways. first, any differences in the perceptions between the new hire leavers and the new hire stayers could be identified. the newly hired personnel who ultimately left the department store entered the job with a higher level of pessimism regarding the finn's ability to provide their characteristics of importance. apparently, the formal training by the department store was not able to overcome the higher concerns on the part of this group of new hires. it seems logical that this impacted on the individual's decision to leave the company. a second possible benefit for the retailer is the determination of the degree that the new employees perceive that the company will provide the various characteristics of importance. this knowledge would be particularly beneficial for the highly ranked characteristics. when new employees enter a job feeling that there is little likelihood that the organization will provide certain key characteristics, their retention may be difficult. if these new hires later discover other employment opportunities that they perceive better provide their key characteristics, then it is likely that job change will result. a labor seller's market magnifies this problem. managerial implications the results of this study of newly hired entry-level retail employees suggest that while it might be beneficial for the department store, or the specialty store, or the supermarket to profile their retained new hires to identify characteristics that contribute to their retention, these characteristics apparently do not uniformly hold across retail classifications. thus, there is no single profile for an entry-level worker applicable to all retail industries. further, whether or not profiles within a particular industry are valid is not known and should be the subject of future research. this emphasizes the importance of retailers understanding their employees. if simple demographic characteristics for employees who typically stay in their jobs longer can be identified, then these retailers can improve retention by utilizing improved hiring practices. several traditional assumptions about employee retention are negated by this study. as a group, entry-level new hires apparently do not view their jobs in retailing from fall 1992 fields & nlwmo: slowing the revolving door 151 a career perspective. this employee group places little relative importance on those characteristics that are critical for career development. thus, retailers who go to the expense of developing and maintaining intermediate job levels for their salespeople may not be appealing to as many entry-level personnel as may have previously assumed. the traditional methods of increasing salary do not hold a high relative position of importanee-particu1arly for the younger worker. as a result, many retailers who increase the wage rate to this level of worker expecting to significantly improve their retention may be disappointed. similarly, offering a flexible work schedule appears to have a low relative level of importance to these workers. factors other than simply bumping up their wage rate and scheduling these people to work when they want to work appear more critical in the retention decision. an analysis of the characteristics of importance for the new hire leavers suggests that training may hold the key for all retailers to realize increased retention for this group. the training is not for the workers; however, it is for their immediate supervisors. the uniform importance that the leavers placed on having a boss they could work with stresses the importance of the presence of "people skills" in these first-level managers. while the objectives of the organization cannot be sacrificed, neither can the needs of the employees. thus, these supervisors must be able to blend the expectations of the employee with the expectations of the retailer. unfortunately, this management talent does not necessarily come with the job title. since this supervisory level is often used by retailers as an entry-level management position, these managers typically have little or no previous management experience. as a result, retailers may be setting themselves up for high levels of turnover among entry-level salespeople. in the present job market, retailers may no longer be able to accept the results of "on-the-job" management training as newly appointed managers hone their personnel skills. immediate and thorough training must quickly convert autocratic managers to "team managers" before their previous style has had a chance to impact the entry-level salespeople. in some retail situations, isolating differences between the characteristics that are important to new hire stayers versus new hire leavers can lead to the development of programs that may reduce the percentage of new hire leavers. where clear differences are found to exist, retailers have the opportunity to develop and implement additional programs aimed at the characteristics that are most important to the group that had previously been leaving the organization. as long as these programs supplement and do not replace existing efforts, then retailers should be more effective in meeting the needs of this group. implicit in this program development is the importance of not misleading the employee. employees who feel they have received accurate information are more likely to remain with the organization than those who perceived that they have received inaccurate information about their job (3). a comparison of new employees' characteristics of importance with their impression of how a company will provide these characteristics can be extremely helpful in directing training emphasis for future employees. when viewing new employees' perceptions relative to their characteristics of importance, decisions can be made as to whether to address the significant differences through new programs (when the differ152 joul7iqi 01business strategies vol. 9, no.2 ence is valid) and/or through emphasis on employee training (when the difference is the result of a misconception) or to ignore the difference (when either the cost of the program is too great or the characteristic is judged to have insignificant importance). regardless of the decision, the important issue is recognizing the difference that exists. to help determine if differences in the perceptions of new hires are present, it may be helpful to query applicants about what they know about the company and its characteristics during the job interview. misperceptions can be corrected at this stage of the employment process with little or no direct costs. perceptions regarding the provision of characteristics of importance may be found to differ significantly between the new hire stayers and the new hire leavers. when this is noted, it's an indication that not only are leavers entering employment with a more pessimistic view of the company, but this view is not being corrected in the course of the retailer's formal training of its new employees. improving the retention of new employees in retailing has been, and remains, a complex issue. retailers can puisue simple actions, however, that should yield a better retention rate for their new employees. first, the retailer should develop a demographic profile of the employees who have maintained employment over a certain period of time versus a profile of those who have left the company. significant differences should be incorporated into future hiring strategies. second, it may be valuable to identify the job characteristics which are most important to the two groups of new hires. . h differences exist between the two groups, then programs may be developed in order to better address the important characteristics of the individuals who have been leaving the company. finally, it should be beneficial for the retailer to identify how incoming employees perceive the company's ability to provide the characteristics which are important to the new employees. when significant differences are found on key characteristics, then the retailer must decide (1) if action is warranted and (2) when needed, the action that would be most appropriate. the result will be a higher level of retention of new employees, corresponding lower training costs, and greater profitability. the key is whether or not employers undemtand the newest additions to their most valuable resource. the need to better undemtand the entry-level retail worker is moving from a managerial luxury to a managerial necessity. firms that undemtand and develop corresponding programs that are consistent with the expectations of their new employees will enjoy a higher retention rate. the result will be a more knowledgeable group of personnel who are most often the ones who interact with the firm's customers. retailem who do not recognize this need will find their revolving door of personnel cycling through their organization to be turning even faster in the future. refered~ 1. bergman. joan. "who's selling the merchandise in your store?" stmg, (january), vol. 28 (1984), p. 113. fa111992 fields & nkomo: slowing the revolving door 153 2. blumenthal. robin goldwyn. "self-service goes to the checkout counter as supermarkets test automated system." wall street journal. (november 13. 1986). p. a70. 3. caldwed, david f. and o'reilly m. charles a "the impact of information on job choices and turnover." academy of manaaement journal. (1985). no.4, p. 940. 4. haugen, steven e. "the employment expansion in retail trade, 1973-1985." monthly labor review. (august 1986). pp. 9-15. 5. harris. michael m. and fink, laurence s. "a field study of applicant reactions to employment opportunities: does the recruiter make a difference?" personnel psycholo8y. vol. 40 (1987), pp. 765-784. 6. jackofsky. eden f.• salter, james and peters, lawrence h. "reducing turnover among part-tldle employees." personnel (may 1986). pp. 41-42. 7. posner, barry z. "comparing recruiter, student, and facii1ty perceptions of important applicant and job characteristics." personnel psychoiq8y. vol. 34 (1981), pp. 329-339. 8. pawed, gary n. "effects of job attributes and recruiting practices on applicant decisions: a comparison." personnel psycbqiq8y. vol. 37 (1984), pp. 721-732. 9. serlen, bruce. "the qlanging face of the franchise worker." franchise, (may-june 1986), pp. 12-16. 10. thurik, roy and van der wijst, nico. "part-tldle labor in retailing." journal qf retailioa. vol. 60. no.3. (fall 1983), pp. 62-80. slowing the revolving door: looking for new keys to retain entry-level retail workers competitive strategies and financial performance: tim impacf of scope and competitive weapons julio o. decastro university of colorado boulder, colorado james j. chrisman university of calgary calgary, alberta canada david m schweiger william r. sandberg university of south carolina columbia, south carolina introduction a business's competitive strategy defines the match it makes between its environment and resources in pursuit of its objectives (hofer and schendel 1978). in keeping with this definition, two primary components, scope and competitive weapons, have been used to describe competitive strategies (chrisman, hofer, and boulton 1988; porter 1980). scope describes the environment a firm serves and can be classified as broad or narrow (abell 1980; chrisman, et ai. 1988; porter 1980). competitive weapons descnbe the ways a firm uses its resources to create a competitive advantage (chrisman, et at. 1988; hofer and schendel 1978). achieving a low delivered cost position or product differentiation are the two primary competitive weapons from which firms may chose (porter 1980). when a firm achieves both low cost and differentiation it is said to utilize "utility" weapons (chrisman, et ai. 1988). however, not all firms are able to develop low cost and/or differentiated positions. porter (1980) has labeled these unfortunate firms "stuck-in-the-middle" because they lack a basis for competitive advantage. despite much attention in the literature to the impact of strategy on firm perfonnance, the effects of a firm's scope and competitive weapons are notably unclear in the cases of strategies characterized by narrow scope or utility weapons (chrisman, et al. 1988). to help resolve this ambiguity, this study investigates the impact of competitive strategy, measured in tenns of scope and competitive weapons, on the perfonnance of a sample of business units competing in mature, concentrated, manufacturing industries producing heterogeneous products for domestic markets. conceptual model the conceptual model for this study is based on the notion that among businesses in similar environments, perfonnance will be a function of competitive strategy. in tum, a 2 journal of business strategies vol. 11, no.1 business's competitive strategy can be descnbed in terms of its scope and competitive weapons. this basic conceptual model is depicted in the functional relationship shown below. business performance = f(scope, competitive weapons) (1) in the following pages we elaborate on the concepts of scope and competitive weapons and also discuss how the interaction of strategic decisions in these two areas influences the financial performance of a business. the concept of scope at the business level, scope is defined as the extent of a firm's product-market domain in one specific industry (abell 1980; hofer and schendel 1978; porter 1980). operationalizations of scope have typically distinguished between firms that choose to compete in most or all of the major product-market segments in an industry (broad scope) and those which restrict their domain to one or a few smaller segments (abell 1980; chrisman, et al. 1988; porter 1980). however, our understanding of scope is limited. thus, white (1986) chose not to include focused strategies in his study of generic strategies, organizational characteristics, and performance because of a lack of previous conceptualizations of the organizational characteristics associated with narrow scope. furthermore, while broad and narrow scope firms appear to be different in their fundamental characteristics (murray 1988), the limited research comparing their performance has been inconclusive. for example, miller (1991) argued that scope may be a source of competitive advantage but found no significant relationships between scope and performance. firms with broad scopes may enjoy, among others, two primary advantages that are less readily available to firms with narrow scopes: economies of scale and economies of scope. economies of scale occur when the unit costs of a product decline as the volume produced and sold increases (porter 1980). such economies enable a firm to supply a product at a lower cost than several smaller firms producing and selling the same cumulative volume (carroll 1984). in the main, firms competing in a broad array of market segments should be better positioned to exploit scale economies than firms competing in a more limited domain. a larger base of customers usually leads to higher sales volumes, more efficient capital-intensive production techniques, and lower research and development expenditures per unit. since economies of scale are positively related to firm performance (capon, farley, and hoeing 1990), broad scope should be related to performance in a similar fashion. economies of scope occur when resources, fixed expenses, and learning can be shared among a broad array of products (hill 1988). scope economies at the business-level are possible when products are highly similar, such as men's and women's jeans (oster 1990: 163-165). a broad product scope should increase the possibility of economies in production, distribution, marketing, and research and development (murray 1988) even though some of the economies accruing from scale may be sacrificed (oster 1990). research has shown that in industrial markets breadth of product line had a small but favorable impact on costs and profits (kekre and srinivasan 1990). spring 1994 decastro, et af.: competitive strategies 3 a firm with a broad scope may also achieve advantages from greater product availability and customer choice, especially if products are tailored to the tastes of different customers (abell 1980; chrisman, et al. 1988). caves and ghemawat (1992) have shown that product breadth increases a firm's ability to create mobility barriers from differentiation as well as improve its performance. by contrast, the performance of narrow-scope firms centers on the benefits of specialization (hannan and freeman 1989). by limiting the number of product-market segments in which it competes, a firm should be able to gain superior knowledge and therefore derive competitive advantages as a consequence of an improved ability to tailor its offerings to the needs of consumers (porter 1980). researchers and theorists in strategic management have struggled with the viability of narrow-scope strategies. scholars have traditionally believed that narrow scope firms should compete only in market niches that broad-scope firms find unattractive or infeasible to enter (buchele 1967). however, declining prospects in traditional markets may prompt large, scale-dependent firms to tum to market niches they formerly considered too small or specialized to be of interest (penrose 1959). as large firms invade, asymmetrical mobility barriers may prevent narrow-scope firms from counter attacking the segments occupied by broad-scope rivals (hatten and hatten 1987). on the other hand, some dispute the marginality of narrow-scope firms and maintain that they are capable of effective head-on competition against large, dominant rivals without the protection of market niches (cooper, willard, and woo 1986). indeed, according to carroll (1984), the success of broad-scope firms creates conditions under which those of narrow scope may thrive. scope hypothesis. despite the advantages of specialization, the greater market power, cost advantages, and potential for market segmentation of broad scope firms suggest that, on average, they should outperform narrow-scope firms. hl. there is a positive relationship between a firm's breadth of scope and its financial performance. the concept of competitive weapons a firm gains competitive advantages by aligning its resources in ways that are valued by customers, and difficult for competitors to duplicate (barney 1991). these alignments are referred to as its competitive weapons (chrisman, et al. 1988). porter (1980) suggested that there are two primary weapons firms can use to obtain sustainable competitive advantages: cost leadership and differentiation. he also argues that these weapons are generally incompatible and therefore the pursuit of both avenues to competitive advantage is usually unsustainable, leaving the firm "stuck-in-the-middle." despite porter's reservations, the possibility of a firm deriving competitive advantages from both a low cost position and differentiation remains theoretically appealing (chrisman, et al. 1988; hill 1988; murray 1988). differentiation to create a low cost position may be possible if products are not perfectly substitutable, buyer switching costs are low, and the potential for cost reductions exist (murray 1988). attempts to compete with both 4 journal of business strategies vol. 11, no. 1 weapons may not only be possible but necessary if efficiency is sustainable but imitable and differentiation opens new avenues for competitive advantages as well as further cost savings (murray 1988). limited empirical evidence suggests the viability of such a strategy during pronounced periods of disequilibrium (sandberg 1986), and for rmns with distinctive competence in r&d or manufacturing (chrisman and boulton 1992). by acknowledging these possibilities it becomes clear that karnani's (1984) description of low cost and differentiation as continuums with multiplicative effects is more appropriate. his multiplicative argument suggests four distinct possibilities based on a firm's cost and differentiation positions, and clearly outlines, theoretically, the possibility of an effective combination of these weapons (chrisman, et al. 1988). thus, low cost firms derive competitive advantage from their low cost (and usually price) position and acceptable levels of benefits. differentiated flnns, in turn, derive competitive advantage from high levels of uniqueness offered to customers combined with acceptable cost levels. firms with utility weapons achieve competitive advantages from both a high level of differentiation and a low delivered cost position. finally, stuck-in-the-middle rmns, being only average or below average in terms of both costs and benefits, are unable to obtain any advantages other than just ''being there" (chrisman, et al. 1988: 423). researchers and theorists agree that failure to develop either a low cost or differentiated position leads to inferior performance (dess and davis 1984; porter 1980; white 1986). murray (1988) suggests that because of this it stands to reason that firms using both weapons simultaneously should be able to out compete rivals using only one or the other. he also contends that because in most markets customers will base purchasing decisions on attributes other than price, and because opportunities to exploit cost economies exist at some point of the value chain of most industries, the combination should usually be feasible. miller (1991) asserts that utility weapons should be effective when there is no conflict between quality and low price, and when industries are relatively mature and the possibility to be distinctive in a meaningful way by either differentiation or cost leadership alone are limited. he explains that since the best ideas are imitated by competitors, a single source of competitive advantage becomes more difficult to sustain as an industry ages. similarly, kamani (1984) argues that the relative effectiveness of low cost and differentiation depends upon the importance of efficiency and cross elasticity of demand. for example, in mature, concentrated industries selling heterogeneous products, low cost and differentiation should be of roughly equal importance. product life cycle theory indicates the importance of efficiency as markets mature and demand growth slows to the level of the overall economy (hofer and schendel 1978; porter 1980). on the other hand, the oligopolistic structure of a concentrated industry implies strong non-price competition, while product heterogeneity suggests the potential for differentiation based on real and perceived product and service attributes (scherer 1970). competitive weapons hypothesis. based on the studies discussed above, we propose that a strategy based on the use of both low cost and differentiation weapons is both a feasible and superior strategic option to the choice of one weapon alone regardless which weapon that may be. furthermore, it has been well established that firms which fail to spring 1994 decastro, et al.: competitive strategies 5 develop either a low cost or differentiation position will achieve inferior performance visa-vis firms with one of the two weapons or both. therefore: h2. there is a positive relationship between the number of competitive weapons a frrm uses and its financial performance. in other words, we predict that firms with utility weapons will outperform firms with either low cost or differentiation weapons alone. similarly, firms with either cost or differentiation weapons will achieve performance that is statistically equivalent, but superior performance to those firms that are stuck-in-the-middle. the relationship between competitive weapons and scope up to this jx>int we have discussed the concepts of scope and competitive weajx>ns and speculated on their individual relationships to performance in mature, concentrated industries with heterogeneous products. however, it should be clear that these decisions cannot be made in isolation. in fact, it is the combination of decisions concerning product-market opportunities to pursue and the ways in which resources should be aligned to exploit those opportunities that constitutes a firm's business level competitive strategy (hofer and schendel 1978). furthermore, it is the choices in both areas combined that determine a flrm's performance, even though it is possible to investigate those choices separately in empirical research. from the discussion provided above it should be clear that a choice of scope can reinforce or dilute the competitive advantage a firm hopes to achieve through the deployment of its resources. for example, a firm pursuing a cost advantage may be better able to achieve it by targeting a broad domain of products and markets, owing to the economies that broad scope allows. on the other hand, narrow scope might allow similar advantages, although in a more limited setting, if the firm targets highly price-sensitive customers and concentrates on products that offer cost economies independent of scale, such as those accruing from location, proprietary technologies, access to raw materials, and so on (porter 1980). furthermore, as companies such as general motors have discovered, bureaucracy, excess unproductive resources, and sluggish decision making may eliminate any cost advantages accruing from size and scope. nevertheless, while one might identify examples of successful firms pursuing any of the combinations of scope and competitive weapons we have discussed, the purpose of this study is to investigate more general patterns of the relationship between competitive strategy and performance. hypothesis on the interaction of scope and competitive weapons. firms with broad scopes and utility weapons are expected to outperform firms using other strategies because a broad scope should afford greater opportunities for exploiting these weapons through economies of scale and scope, and because the dual advantages of using low cost and differentiation should provide a stronger, more enduring position vis-a-vis major competitors. on the other hand, stuck-in-the-middle firms with narrow scopes should be the lowest performers since they cannot derive either economies of scale or scope, and lack the competitive weapons necessary to build a position of specialization. thus: 6 journal of business strategies vol. 11, no.1 h3. there is a positive relationship between the interaction of scope and competitive weapons and financial performance, i.e., the broader a imn's scope and the greater the number of competitive weapons used, the higher its financial performance. it is not entirely clear, however, whether choices of scope or competitive weapons will have the greater impact on an organization's economic performance. the work of porter (1979) implies that scope is key, whereas hamermesh, anderson, and harris's research (1983) suggests the opposite. probably closer to the truth was sousa and hambrick's (1989) demonstration of the importance and interactive nature of both a company's skills and an industry's key success factors, implying the importance of choices of both competitive weapons and scope at the business level. unfortunately, sousa and hambrick's criteria for selecting environments were so narrow that they actually captured key success factors in industry segments rather than industries, making it difficult to draw conclusions concerning the relative importance of key success factors and skills in whole industries. therefore, the relative importance of the environment in which firms choose to operate versus their chosen method of competing cannot be thoroughly conceived or predicted. nevertheless, this research should provide preliminary evidence toward resolving this issue. methodology our sample included 599 business units. data were collected and averaged for the years 1981 to 1984, the most recent period for which data were available at the time the study was conducted. the sample was drawn from the profit impact of market strategy (pims) spi4 database. the pims database includes self-reported data on approximately 3000 business units of large u.s. corporations. participating companies provide more than 100 data items describing the business, its competitive environment, and its performance. the sample was composed of fmns competing in concentrated, mature industries that manufacture heterogeneous (noncommodity) products for domestic markets. the industries represented a wide variety of four-digit manufacturing industries that possessed these characteristics. table 1 lists the industries represented in the sample. table 1: manufacturing industries represented in the study industry consumer durables consumer non-durables capital goods raw or semi-finished materials components supplies totals number 51 156 112 83 101 96 599 percentage 8.5% 26.0% 18.8% 13.9% 16.8% 16.0% 100.0% spring 1994 decastro, et at.: competitive strategies 7 theoretical relevance governed our choice of industry settings. the competitive strategies and performance of firms have long been linked to industry structural variables (hofer and schendel 1978; porter 1980). as a consequence, dess, ireland, and hitt (1990) have argued for the need to control for industry effects in strategy research when studying multiple industries. following hambrick and lei (1985), we selected industry control variables which seemed most likely to moderate the link between strategy and firm performance. furthermore, concentration, maturity, and product heterogeneity are common in u.s. manufacturing industries (scherer 1970). therefore, our results are likely to be widely generalizable. concentrated industries were selected to ensure adequate numbers of both broadand narrow-scope firms, and because detection of high performing narrow-scope firms in such industries would help fill theoretical and empirical gaps in the literature (white 1986). dess, ireland and hitt (1990) and hambrick and lei (1985) agree on the importance of concentration as an industry control variable. mature industries were selected because most industries exist in their mature stage, the stage that generally endures for the longest period of time (hambrick 1983). more importantly, industry maturity ensures reasonably stable relationships among the strategic and performance variables (hofer and schendel 1978). industry maturity also brings strengthened relationships among operating efficiency, market share, product quality, and profitability (anderson and zeithaml 1984), suggesting an environment less tolerant of competitive weakness than those in early stages of industry evolution. heterogeneous industries were chosen because coupled with industry concentration and maturity, product heterogeneity suggests that a variety of competitive strategies might be associated with acceptable performance. the first two conditions admit the possibility of broad-scope firms using competitive weapons based on cost advantages; product heterogeneity admits the possibilities of narrow-scope and differentiation (hill 1988). finally, we confined our study to domestic industries in order to minimize the effects of international competition, cross-subsidization, and variable market growth rates across countries (sousa and· hambrick 1989). variable measurements three sets of variables were used in the analysis to identify the scope, competitive weapons, and performance of the firms in our sample (table 2). 8 journal of business strategies table 2: descriptive statistics and intercorrelations vol. 11. no. 1 financial variabie roi return on investment in1ercorrelations mean s.d. roi ps ms rs is 22.74 23.71 scope variables ps relative product breadth ms relative market breadth 2.01 .79 .22 2.02 .59 .14 .43 competitive weapons variables rs receivables/sales 14.75 7.97 .08 -.01 -.08 is inventory/sales 19.99 11.32 .34 -.07 -.05 .26 rc relative compensation 100.95 6.48 .14 .15 .16 -.14 -.04 roc relative direct cost 101.95 6.77 .28 -.17 -.07 .02 .19 mes manufacturing expenses/sales 26.64 11.20 .24 -.17 -.00 .06 .15 rpq relative product quality 0.61 21.26 .35 .35 .17 .05 -.11 rp relative price 103.35 7.58 .10 .16 .08 -.03 .01 rds r&d/sales 1.76 1.96 .05 .00 .06 .09 .22 as advertising/sales 9.49 7.85 .03 -.04 -.03 -.03 -.03 pcg price cost gap -1.14 4.38 .08 .02 -.04 -.02 -.00 ii investment intensity 0.27 1.15 .40 -.05 -.06 .27 .39 cu capacity utilization 75.51 15.80 .14 .10 .08 .07 -.06 ep employee productivity 41.13 30.36 .17 .03 .04 -.24 -.14 infercorrelations rc rdc mes rpq rp rds as pcg ii cu ep rc rdc .09 mes .04 .12 rpq .14 -.15 -.06 rp .19 .24 -.04 .39 rds .10 .02 .15 -.02 -.01 as .05 .06 -.28 -.04 .14 .02 pcg .10 -.01 -.07 -.01 .03 -.07 .07 ii -.19 .03 -.02 -.11 -.17 .00 -.35 -.07 cu .06 -.21 .06 .12 -.08 -.03 -.24 -.05 .10 ep .09 .04 -.22 .02 .09 -.03 .25 .07 -.08 -.06 scope variables. scope was operationalized in terms of firms' self reports of the product and market segments in which they competed as compared to industry leaders. we classified as narrow scope the 209 firms that reported their product or market scope or spring 1994 decastro, et af.: competitive strategies 9 both to be narrower than their leading competitors' and classified as broad the 390 firms that reported that their scope was equal to or broader than leading competitors on both dimensions. competitive weapons variables. thirteen variables were used to operationalize competitive weapons. the variables used are consistent with those used in prior research on competitive strategies (dess and davis 1984; hambrick 1983; hatten 1974; kekre and srinivasan 1990). strategy scholars have warned against taxonomic classifications developed without theoretical backing (chrisman, et al. 1988; mckelvey 1982). to avoid this problem we used prior research and theoretical arguments to predict what the characteristics of firms using different competitive weapons should be. this procedure is consistent with that of hambrick (1983) and sousa and hambrick (1989), and provides a theory-based rationale to identify different types of competitive weapons. the appendix presents the expected characteristics of each competitive weapon taxon. the link between the theoretical groupings suggested by prior research, and the actual data was accomplished through the use of cluster analysis. auster analysis has been frequently used in strategy content research (dess and davis 1984; hambrick 1983; hatten 1974; miller 1992). harrigan (1985: 60) has stated that "cluster technk 'ire a preferable means of sorting competitors into strategic groups because additiolldj interpretation of competitive dynamics is possible." the minimum squared error grouping process (hambrick 1983; harrigan 1985; miller 1992) was utilized to identify the competitive weapons of the firms. auster solutions were chosen so that between-group cluster distances were maximized and so that the error sum of squares increased when changing to a less optimal solution. the best solution consisted of four clusters: cost strategies, differentiation strategies, utility strategies, and stuck-in-the-middle strategies (table 3). the results of the four cluster solution were consistent with the classification proposed by chrisman, et al (1988), as well as with our a priori criteria for classification. 10 journal of business strategies vol. 11, no.1 table 3: competitive weapon variables and cluster means variables competitive weapons clusters stuck-in~ differentiation cost utility the-middle receivables/sales 17.2* 11.2* 7.4* 14.5* inventory/sales 22.6* 19.0* 11.0* 19.4* relative compensation 102.4* 100.8* 102.8 100.3 relative direct cost 100.9 102.0* 104.4 102.3* manufacturing expenses/sales 26.7* 21.0* 16.2* 27.7* relative product quality 24.1* -8.4* 20.6* -8.9* relative price 106.5* 101.3* 113.4 101.8 r&d/sales 1.8* 1.7* 0.6 1.8 advertising/sales 9.0 14.2 15.9* 8.9* price-cost gap -1.2 0.4 -0.3* -1.3* investment intensity 0.3 0.4* -0.7 0.2* capacity utilization 82.5 70.9 71.5 73.3 employee productivity 35.5* 105.8* 144.0* 31.7* number of firms 158 44 16 381 * denotes relationships between variables and competitive weapons that correspond to expectations listed in appendix. over 65 percent (34 of 52) of these predictions were substantiated, a result which was significantly different from 50-50 chance (p < .05). discriminant analysis was performed on a random sample of 75 percent of the firms to determine the reliability of the cluster solutions. the resulting discriminant function was able to classify over 90 percent of the holdout sample correctly. performance variables. for the pims sample, performance was measured via return on investment (roi). we did not use market-related measures of performance such as overall sales or market share because their obvious correlation with scope would have made comparisons of broad and narrow scope firms tautological. results and discussion a two-way analysis of variance (anoya) with an interaction term was used to test the hypotheses. assuming a large effect size, directional hypotheses, and an alpha level of .05, the power of the statistical analysis exceeded the traditionally accepted level of .80 (magin, mazen, hemmasi, and lewis 1987). table 4 presents the financial performance data for the firms in the sample by scope and competitive weapons. table 5 provides the results of the two-way anoya and interaction. spring 1994 decastro, et al.: competitive strategies 11 table 4: finn perfonnance by scope and competitive weapons return on investment mean s.d. n scope broad scope 26.48 23.74 390 narrow scope 15.92 21.14 209 competitive weapons differentiation weapons 30.06 22.86 158 cost weapons 28.61 29.73 44 utility weapons(cost + differentiation) 39.69 34.90 16 stuck-in-the-middle (no weapons) 18.40 21.02 381 table 5: anova results source of variation ssq df msq f p main effects 32187.1 4 8046.8 16.4 .000 scope 10448.8 1 10448.8 21.3 .000 competitive weapons 17024.2 3 5674.7 11.6 .000 two-way interaction 5280.2 3 1760.1 3.6 .014 explained 37467.3 7 5352.5 10.9 .000 residual 289889.4 591 490.5 total 327356.4 598 547.4 hypothesis one hypothesis one stated that there is a positive relationship between a firm's breadth of scope and its financial performance. this hypothesis was supported (p < .001). although there may be benefits from focusing on a product-market niche, the general rule appears to be that a broad scope is preferable to a narrow scope. hypothesis two the second hypothesis stated that there is a positive relationship between the number of competitive weapons a fum uses and its financial performance. thus, fums using a combination of low cost and differentiation weapons, the utility strategy, should outperform firms using only one competitive weapon. likewise, :firms that find themselves stuckin-the-middle without any clear competitive weapons should be the worst performers. this hypothesis was supported (p < .001). despite the relative scarcity of firms following a utility strategy, there was a significant, positive relationship between the number of competitive weapons utilized by the fums and their fmancial performance. 12 journal of business strategies vol. 11, no. 1 hypothesis three the third hypothesis stated that there is a positive relationship between the interaction of scope and competitive weapons and financial performance. in other words, we expected that firms with broad scopes using utility weapons would achieve the highest performance and stuck-in-the-middle firms with narrow scopes would achieve the lowest performance. this hypothesis was supported; our analysis detected a significant interaction effect between scope and competitive weapons (p < .02). apparently, a firm's choices of scope and competitive weapons both matter and can be either mutually reinforcing or defeating depending upon which choices are made. discussion scope. we had expected broad-scope firms to outperform narrow-scope firms in the concentrated, mature industries under study. this hypothesis was confirmed. the strength of the results indicate that the market power and economies afforded by broad scope usually outweigh the benefits of specialization in such settings. although not all firms can or should pursue a broad scope strategy, our analysis suggests the attractiveness of this option. competitive weapons. also important is the evidence of the superior performance of firms using utility weapons. while the possibility of firms competing through a combination of low cost and differentiation has been suggested (hill 1988; murray 1988), our results go further by demonstrating the desirability of such a strategy. the reasons behind the success of utility strategies may be related to our decision to study mature, concentrated, manufacturing industries producing heterogeneous products. survivors of industry shakeouts may be peculiarly suited to compete with both differentiation and low cost, or industry maturity may open new opportunities to do so (hill 1988). furthermore, in heterogeneous industries, perceived sources of differentiation such a..'i advertising, or real sources of differentiation such as proprietary product features, may be necessary to obtain the sales volume required to enjoy cost economies. likewise, concentration may provide dominant firms with both the market power and the time to develop a utility strategy, or may require narrow scope firms to seek both advantages in order to stave off threats from larger rivals. in spite of their high performance, and consistent with previous studies (hall 1980; white 1986), our results suggest that only a few firms are able to successfully develop utility strategies. this could be an indication that porter (1980) was correct in assuming that the risks of attempting to achieve advantages in both cost and differentiation are higher than for attempting to develop advantages in only one area. in fact, in some industries, such as candy and perfume, there may be significant tradeoffs between low cost and differentiation that leave even a finn with a utility strategy without a clear identity amongst consumers. the paucity of adherents to the highest performing option may partially be a consequence of our use of realized rather than intended strategies, a possibility that future studies should investigate. it seems possible, for instance, that many of the stuck-in-the-middle firms had intended to achieve both low cost and differentiation but failed on both counts. spring 1994 decastro, et al.: competitive strategies 13 the imbalance found between the users of utility and stuck-in-the-middle weapons (16 versus 381) may again reflect the difficulty of attaining both low cost and differentiation, as porter (1980) asserted. thus, while utility weapons offer very high returns, such returns seem to come only with a substantial risk suggested, but not captured, in our methodology. the higher number of stuck-in-the-middle :firms may have also been a result of our choice of mature industries. it is possible that some firms may have lost their advantages in cost because, as experience curve effects are exhausted, a number of firms are able to reach low cost positions. other firms may have lost advantages of differentiation because of imitation, shared knowledge, or technological development on the part of competitors. these speculations aside, other factors not accounted for in our study may hold the explanation for the relative numbers of stuck-in-the-middle firms. this is a possibility only future research can answer. appendix: expected relationships between pims variables and competitive strategies stuck-invariables differentiation cost utility the-middle receivables/sales high low low high inventory/sales high low low high relative compensation high low low high relative direct costs high low low high manufacturing expenses/sales high low low high relative product quality high low high low relative price high low low high r&d/sales high low high low advertising/sales high low high low price-cost gap high low high low investment intensity low high high low capacity utilization low high high low employee productivity low high high low receivables/sales. a high value for this ratio implies that either the manufacturer is providing fmancing to its customers to differentiate its offering from competitors, or its customers have buyer power because the firm is stuck-in-the-middle (hatten 1974; porter 1980). hambrick and schecter (1983) suggest that fums emphasizing cost cutting strategies will attempt to minimize the amounts of receivables held. firms with utility strategies are also expected to be low on this dimension, reflecting their emphasis on costs and their strong bargaining position. 14 journal of business strategies vol. 11, no. 1 inventory/sales. firms following cost strategies are expected to minimize this ratio because there is usually a cost associated with holding inventory (hambrick and schecter 1983). on the other hand, differentiated firms are more likely to keep high levels of inventory to provide better customer service. utility firms are expected to resemble cost firms on this dimension for the reasons noted above. firms stuck-in-the-middle should have a high ratio because of inefficiencies or an inability to meet sales quotas. relative compensation. because of their importance to cost structures, firms with cost or utility strategies are expected to minimize compensation expenses vis-a-vis firms with differentiation or stuck-in-the-middle strategies. relative direct costs. a cost strategy suggests low direct costs. differentiation, on the other hand, is usually costly, as is being stuck-in-the-middle (porter 1980). utility frrms are expected to resemble cost firms on this dimension as providing differentiation at a low cost is the essence of this strategy (chrisman et al. 1988). manufacturing expenses/sales. such expenses represent a substantial portion of a manufacturer's costs. therefore, their relationship with competitive strategy should be the same as discussed above for relative direct costs (dess and davis 1984). relative product quality. quality is more important to firms following differentiation and utility strategies than firms following cost strategies (hambrick 1983). as porter (1980) notes, firms with cost strategies will be more concerned with ensuring that the quality gap between their products and those of differentiators does not grow too large. firms that are stuck-in-the-middle should also have lower quality, but is expected to be a consequence of ineffectiveness rather than design. relative price. because differentiation is usually costly, differentiators will usually fmd it necessary, if not advantageous to keep prices high. on the other hand, because firms with cost strategies have lower costs, they are more likely to compete on price (dess and davis 1984). firms with utility strategies should charge lower prices for their high quality products than differentiated frrms owing to their lower cost structure. their differentiated position, however, may allow them to command price premiums vis-a-vis firms with cost strategies. due to their high cost structures, firms stuck-in-the-middle will usually have higher prices even though they lack differentiation. r&d/sales. firms with differentiation or utility strategies are expected to spend substantially on r&d to maintain a position of uniqueness (porter 1980). because changes in existing products or the development of new ones is often inconsistent with a low cost position, firms using cost strategies are expected to spend less on r&d (dess and davis 1984; hambrick and schecter 1983). stuck-in-the-middle firms will refrain from heavy r&d investment due to a lack of resources and the long term nature of such investments. spring 1994 decastro, et 01.: competitive strategies 15 advertising/sales. advertising is a method of achieving product differentiation (porter 1980; scherer 1970). thus, firms with differentiation or utility strategies should outspend firms with cost strategies. stuck-in-the-middle firms are expected to refrain from heavy spending on advertising for reasons similar to those listed above with respect to r&d. price-cost gap. firms that have achieved differentiation should be able to command a larger differential between their prices and costs than firms that compete on costs and prices (caves and ghemawat 1992). utility firms should also have large differentials and stuck-in-the middle firms should have small differentials. investment intensity. high investments in plant and equipment are often necessary to obtain low costs through economies of scale (hatten 1974). differentiation, on the other hand, should be more closely allied with the production of specialty and custom-designed products (dess and davis 1984). we expect firms with utility strategies to resemble those with a cost strategy on this dimension and stuck-in-the-middle firms to resemble differentiated firms because low cost is an essential component of the utility strategy and resource limitations or myopia inhibit large investments by firms stuck-inthe-middle. capacity utilization. high capacity utilization is necessary to exploit scale economies (hambrick 1983; hatten 1974). thus, cu should be higher among £inns with cost or utility strategies than firms with differentiation strategies. stuck-in-the-middle firms should also have lower capacity utilization due to a lack of a basis for sustainable advantage. employee productivity. high productivity reduces labor costs per unit; thus, firms with cost or utility strategies should have higher productivity than differentiated firms (hambrick 1983). the inefficiency and ineffectiveness of finns stuck-in-the-middle mitigates against high levels of productivity. references abell, d.f. 1980. definin& the business: the starting point of strategic planning. englewood qiffs, nj: prentice-hall. anderson, c.r. and c.p. zeithaml. 1984. "stages of the product life cycle, business strategy, and business perfonnance." academy of management journal 27: 5-24. barney, j. 1991. "finn resources and sustained competitive advantages." journal of management 17: 99-121. buchele, r.b. 1967. business policy in growing firms. san francisco, ca: chandler publishing. carroll, g. 1984. "the specialist strategy." california management review 25: 126-137. 16 journal of business strategies vol. 11, no. 1 capon, n., j.u. farley, and s. hoeing. 1990. "determinants of financial performance: a metaanalysis." management science 36: 1143-1159. caves, r. and p. ghemawat. 1992. "identifying mobility barriers." strategic management journal 13: 1-13. ouisman, i.i. and w.r. boulton. 1992. "keys to improving economic performance at the business unit level: business strategy, functional skills, and key success factors." journal of business strategies 9: 169-190. chrisman, j.j., c.w. hofer, and w.r. boulton. 1988. "toward a system for classifying business strategies." academy of management review 13: 413-428. cooper, a, g. willard, and c. woo. 1986. "strategies for high performing new and small firms." journal of business venturing 1: 247-261. dess, g.g. and p. davis. 1984. "porter's (1980) generic strategies as determinants of strategic group membership and organizational performance:' academy of management journal 27: 467~ 488. dess, g.g., d. ireland, and m. hitt. 1990. "industry effects and strategic management research." journal of management 16: 7-27. hall, w. 1980. "survival strategies in a hostile environment." harvard business review 58 (5): 75-85. hambrick, d.c. 1983. "high profit strategies in mature capital goods industries: a contingency approach." academy of management journal 26: 687-707. hambrick, d.c. and d. lei. 1985. ''toward an empirical prioritization of contingency variables for strategy research." academy of management journal 28: 763-788. hambrick, d.c. and s.m. schecter. 1983. "turnaround strategies for mature industrial-product business units." academy of management journal 26: 231-248. hamermesh, r.g., m.j. anderson, jr., and j.e. harris. 1983. "strategies for low market-share businesses." in strategic manal:ement. ed. r.g. hamermesh. new york, ny: wiley, 126-138. hannan, m.t. and j. freeman. 1989. organizational ecology. cambridge, ma: harvard univer~ sity press. harrigan, k. 1985. "an application of clustering for strategic group analysis." strategic management journal 6: 55-73. hatten, k.j. 1974. "strategic models in the brewing industry." unpublished doctoral dissertation, purdue university. spring 1994 decastro, et al.: competitive strategies 17 hatten, k.j. and m.l. hatten. 1987. "strategic groups, asymmetrical mobility barriers, and contestability." strategic management journal 8: 329-342. hill, c. 1988. "differentiation versus low cost or differentiation and low cost: a contingency framework." academy of management review 13: 401-412. hofer, c.w. and d. schendel. 1978. strategy formulation: analytical concepts. s1. paul, mn: west publishing company. karnani, a 1984. "generic competitive strategies: an analytical approach." strategic management journal 5: 367-380. kekre, s. and k. srinivasan. 1990. "broader product line: a necessity to achieve success." management science 36: 1217-1231. magid, a, m. mazen, m. hemmasi, and m.f. lewis. 1987. "assessment of statistical power in contemporary strategy research." strategic management journal 8: 403410. mckelvey, b. 1982. organizational systematics: taxonomy. evolution, classification. berkeley, ca: university of california press. miller, d. 1991. "generalists and specialists: two business strategies and their context." in advances in strategic management. eds. p. shrivastava, a huff, and j. dutton. greenwich, cf: jai press, 3-41. miller, d. 1992. "the generic strategy trap." journal of business strategy 12: 37-41. murray, a 1988. "a contingency view of porter's generic strategies." academy of management review 13: 390-401. oster, s. 1990. modern competitive analysis. new york, ny: oxford university press. penrose, r. 1959. the theol~ of the growth of the firm. new york, ny: wiley. porter, m.e. 1979. "the structure within industries and company performance." review of economics and statistics 61: 214-227. porter, m.e. 1980. competitive strategy. new york, ny: free press. sandberg, w.r. 1986. new venture performance: the role of strategy and industry structure. lexington, ma: lexington books. scherer, f.m. 1970. industrial market structure and economic performance. chicago, il: rand mcnally. 18 journal of business strategies vol. 11, no. 1 sousa de vasconcellos e sa, i.a and d.c. hambrick. 1989. "key success factors: test of a general theory in the mature industrial products sector." strategic malulgement journal 10: 367382. white, r.e. 1986. "generic business strategies, organizational context and performance: an empirical investigation." strategic malulgement journal 7: 217-231. competitive strategies and financial performance: the impact of scope and competitive weapons understanding quasi-integration abagail me williams * arizona state university west phoenix, az samuel r. gray university of richmond richmond, va abstract cooperative strategies and interorganizational linkages, or quasi-integration. in vertical relationships are important concerns to strategy researchers and practitioners. in this paper, we present a model that integrates insights from transaction cost theory (an economic construct), environmental uncertainty (an organization theory construct), and resource-based theory (a strategic management construct) to explain the determinants of quasi-integration. this extends prior work which relied exclusively on transaction cost economics and organization theory to explain and predict optimal organizational form. introduction one of the most compelling areas of research in strategic management deals with cooperative strategies and the resulting inter-organizational linkages through which such strategies are implemented. cooperative strategies enable the participating firms to pool or exchange resources for their mutual benefit, diminish competitive attacks, and collectively manage the environment facing the firms (astley 1984; bresser and harl 1986; gupta and lad 1983; harrigan 1985; nielsen 1988). the literature on cooperative strategy stands in stark contrast to the notion of the firm as an autonomous profit maximizer waging a solitary struggle for survival within the limits of a hostile, deterministic environment (astley 1984). recent work by mahoney (1991) and contractor (1990) suggests that inter-firm cooperative arrangements may, under certain conditions, be employed as viable substitutes for vertical integration. following blois (1972), we refer to these cooperative arrangements as quasi-integration. much of the traditional management research on vertical integration followed the transaction cost tradition and frequently employed the "make or buy" analogy (c.f. balakrishnan and wernerfelt 1986; harrigan 1985; walker and weber 1984). cooperative quasi-integration alternatives, however, involve neither a pure "make" nor a pure "buy" arrange* the authors thank bert cannella, mike hilt, bob hoskisson, don siegel, dick woodman, and two anonymous reviewers for their help in developing this paper. 70 journal of business strategies vol. 12, no. 1 ment, therefore the motives for choosing them have remained less clear. organization theory has shed some light on the issue by providing valuable insights into the factors that determine organizational form in vertical relationships (emery and trist 1965; thompson 1967; williamson 1975). the transaction costs approach, as articulated by williamson (1975) focuses on the importance of behavioral uncertainty in choosing an organizational form. work by emery and trist (emery and trist 1965) and thompson (1967) recognizes the role of environmental uncertainty in the choice of organizational form. taken together, the concepts of transaction costs and environmental uncertainty have expanded our understanding of quasi-integration choices. these two approaches, however, suffer from a common fundamental shortcoming. both models assume (either explicitly or implicitly) homogeneity of firms in a given industry. that is, they assume that the firms have similar resources and technologies. if we assume that the firms in an industry are homogeneous and that their decision makers behave rationally, we would expect individual firms in an industry to choose identical or very similar organizational forms. in the 'real' world, however, we observe very different organizational forms for firms in the same industry. these observations may best be explained by developing a model that integrates the insights from transaction cost economics, organization theory, and the emerging resource-based view from strategic management (barney 1991). the resource-based view has much to offer in explaining quasi-integration, because it is based on the assumption that firms are heterogeneous. therefore, firms in the same industry would not be expected to have the same organizational form. the purpose of this paper is to extend our understanding of quasi-integration by developing an integrative model of the choice of organizational form in vertical relationships. the remainder of the paper is organized as follows. first, a brief account is given of the different options for vertical combinations. this discussion is followed by a review of the transaction cost and organization theory explanations of the determinants of these combinations. next, insights from the resource based view are introduced and an integrative model is presented. in conclusion, we discuss implications of our integrative model for researchers and practitioners. alternative vertical strategies the organizational choices aimed at managing vertical relationships may be conceptualized as falling over a range between pure market exchange and full internalization (i.e., merger). this is depicted in figure 1. moving from pure market exchange to internalization, one finds intermediate arrangements such as relational contracting, strategic alliances, and equity joint ventures. a short discussion of each of these alternative arrangements follows. relational contracting involves jointly managed relationships based on trust and goal congruence (jarilla 1988). located conceptually near a pure market arrangement, relational contracting typically does not involve joint ownership. spring 1995 mcwilliams & gray: quasi-integration figure 1 71 flexibility control pure market exchange relational contracting strategic alliance equity joint venture full internalization a contemporary example can be found in just-in-time inventory supply agreements in which a high degree of coordination and cooperation between firms is a critical success factor. an example of a just-in-time inventory arrangement is the materials as needed (man) system employed by harley-davidson. this program virtually eliminated inventories by requiring vendors to deliver inputs (from raw materials to finished components) on the same day as needed in the assembly process. this system was initially resisted by the vendors, because it required a high degree of reorganization within the vendors' operations and coordination with harley-davidson's operations. however, it has proved to be highly successful. strategic alliance, as used in this paper, is defined as a cooperative arrangement engaged in by two or more firms that does not involve the creation of a separate organization, but which mayor may not involve a minority investment by one or more of the participating firms. the strategic alliance lies conceptually between relational contracting and integration. this form of organizational arrangement differs from relational contracting in that it mutually benefits the downstream and upstream firms and may involve a minority equity stake by one or both firms in the other. an example of this type of arrangement is the recently announced alliance between ibm and geographic systems corporation in which ibm became a minority owner in geographic systems. this allowed ibm to enter the geographic information systems market and gave geographic systems access to ibm marketing and financial resources. equity joint ventures are arrangements in which two or more firms pool resources to establish a separate legal entity which is jointly owned by the sponsoring firms (kogut 1988; pfeffer and nowak 1976). activity is organized between firms but is hierarchically controlled within the joint venture itself. although equity joint ventures may be employed for a wide range of strategic purposes (harrigan 1985), this paper will consider only joint ventures which involve a vertical relationship with one or more of the parent firms. an example of this type of arrangement is the ponderay newsprint company, a joint venture designed to produce and supply the newsprint needs of five newspaper publishers (wall street journal 1987). the number of alternative strategies for implementing quasi-mtegration is indicative of the complexity of the problems firms face in vertical relation72 journal of business strategies vol. 12, no. 1 ships. pure market exchange, or arms length bargaining, affords a firm maximum flexibility because the firm is tied to a supplier or buyer for one transaction only. vertical integration affords a firm maximum control. once vertically integrated, the firm can control (and monitor) all aspects of its supplier or buyer relationship. pure market exchange and vertical integration represent the familiar make or buy options. they also represent the extremes of arms length dealing versus internalization and flexibility versus control. intermediate arrangements, or quasi-integration, could reflect the necessity, in a world of uncertainty, to make trade-offs between flexibility and control. we postulate that there is an optimal degree of quasi-integration that corresponds to the controllflexibility trade-off where the degree of quasi-integration refers to the number of, and degree to which, activities are internalized in an exchange relationship. this extends the transaction cost explanation of vertical integration by allowing for options that are intermediate between make or buy decisions. transaction cost approach to vertical relationships coase (1937) developed a theory of the firm based on transaction costs. transaction costs are the costs associated with using the market to exchange goods and services and include such costs as negotiating, writing, and enforcing contracts, as well as costs associated with gathering information about relevant prices (coase 1937). according to coase's theory, the number of activities that a finn engp,ges in (the level of vertical integration) is determined by the relative costs of using the market or employing resources within the firm. when it costs less to internalize a transaction, the transaction will be internalized. when it costs less to use the market, the market will be used. the primary insight from coase was that the choice between market exchanges and internalization turns on the existence of transaction costs that can be eliminated by internalization. building on this insight, transaction cost theory has been used to explain the strategy/structure choice (jones and hill 1988), the multiproduct firm (teece 1982), and vertical integration (mahoney 1991). further, williamson (1975) extended coase's transaction cost theory by examining the relationship between behavioral uncertainty and transaction costs. simply put, williamson demonstrated that uncertainty about the behavior of a trading partner increases transaction costs because it makes the writing and enforcing of contracts much more costly. therefore, the level of transaction costs will be positively related to the level of uncertainty in an exchange relationship. because of the positive relationship between behavioral uncertainty and transaction costs, transaction cost theory postulates that integration is more likely when ~here is high uncertainty about the behavior of a trading partner. williamson'sl(1975) extension of coase's theory identified opportunism as an important factor that increases behavioral uncertainty, and hence transaction costs. opportunism refers to either the buyer or the seller attempting to change the terms of a contract after the fact. behavioral uncertainty increases spring 1995 mcwilliams & gray: quasi-integration 73 the cost of enforcing contracts and, therefore, increases the cost of writing contracts because care must be taken to lessen the threat of opportunism. opportunism may be possible because of asymmetric bargaining power due to a small numbers bargaining problem or because of asset specificity. opportunism can arise if the number of suppliers (or buyers) is small, resulting in what williamson (1975) refers to as a "small numbers bargaining" problem. the small numbers bargaining problem is conceptually similar to porter's (1980) "bargaining power of customers" and "bargaining power of suppliers." as an example, suppose a firm has only one supplier. if demand for the final product increases suddenly, the supplier may act opportunistically, that is, try to extract a side payment from the buyer because the buyer can not produce more of the final good without the supplier's input. the supplier can exert asymmetric power because the buying firm has no alternative source of supply in the short run, an example of this occurred between general motors and fisher body company in the early 1920s. fisher body was originally an autonomous company that supplied car bodies to gm under a contractual agreement signed in 1919. when the demand for gm cars exceeded predicted levels, the absence of additional suppliers gave fisher body asymmetric power in re-negotiating which allowed it to charge gm considerably higher prices. in reaction to this, gm began acquiring fisher stock and eventually acquired the entire firm, a buyer can also act opportunistically. suppose the supplier has only one buyer for an input and demand suddenly decreases for the final product. the buyer may then try to renege on the terms of the contract and the supplier has no alternative outlet for the input. opportunistic behavior on the part of buyers led to the creation of the ocean spray cranberry company in the 1930s, prior to the formation of ocean spray, national food distribution companies often encouraged cranberry growers to extend their crops by forecasting high demand and high market prices. once the cranberries were ready to harvest, the food distributors offered much lower prices. because the growers had no alternative outlets, they were forced to accept the lower prices. frustrated by such treatment, the growers formed ocean spray cranberry, inc. to represent the growers and, thereby, reduce the asymmetry in bargaining power (nielsen 1988). full integration, such as that between gm and fisher body, provides one mechanism for dealing with opportunism arising from small numbers bargaining, but there are other solutions. in fact, the extent of the problem that arises from small number bargaining may be conceptualized as a variable which depends upon the relative distribution of bargaining power in a vertical relationship. in other words, there are varying levels of transaction costs which correspond to variations in customer and supplier concentration. in the case of upstream vertical relationships. the level of transaction costs will be negatively related to the number of potential supp.liers. in the case of downstream vertical relationships, the level of transaction costs will be negatively related to the number of poten~ tial buyers. 74 journal of business strategies vol 12, no.1 williamson (1975) also linked opportunism to asset specificity, which is just a special case of the small numbers bargaining problem. asset specificity refers to a situation in which a physical or human resource becomes specific to the transaction and thus has a lower value in its alternative uses. asset specificity lowers the number of potential users of the resource and therefore will increase the possibility of opportunism. this results in higher transaction costs (williamson 1975). one way in which asset specificity can arise is if a vertical arrangement requires the building of new industrial capacity. since the new capacity is built specifically to service the supply needs of the buying firm, the buying firm might try to appropriate some of the profits of the supplying firm after the capacity is on line if the exchange is organized by means of a pure market relationship (klein, crawford, and alchian 1978). equity ownership by participating firms may be used to partially offset the risks of such opportunistic behavior. an example of this is oil wells built to serve a pipeline. the wells represent a substantial fixed cost that is incurred solely to service the pipeline. once the wells are built, the pipeline company might try to extract the profits of the wells. to alleviate this problem, well owners might acquire an equity stake in the pipeline (klein, crawford, and alchian 1978). in line with the argument of opportunism arising from small number bargaining above, the relative amount of assets specific to an exchange relationship is a variable rather than an either-or condition. therefore, because it increases the probability of opportunistic behavior, the level of transaction costs will be positively related to the value of new industrial capacity added in a vertical exchange relationship. the degree of opportunism will also be affected by the sensitivity of the downstream firm to the cost of the input it buys from the upstream firm. if the input cos~ from the upstream firm is a large percentage of the cost of the final product, the downstream firm will be more vulnerable to opportunistic behavior (layard and walters 1978). hence, the downstream firm will desire more control over the behavior of the upstream firm to lessen the threat of opportunism. therefore, in the case of upstream vertical relationships, the level of transaction costs will be positively related to the ratio of the input cost to the final product cost opportunism is also affected by demand uncertainty, an element of environmental uncertainty discussed later in this paper. demand uncertainty may provide the impetus for firms to act opportunistically. sudden, unpredicted increases in demand for the final product may lead to opportunistic behavior on the part of the upstream supplier, while sudden, unpredicted decreases in demand may lead to opportunistic behavior on the part of the downstream buyer. when demand is uncertain, the downstream firm runs a risk of inadequate supplies during periods of peak demand and the upstream firm runs a risk of overproduction and the resulting inventory costs during periods of low demand. these risks can be lowered by integration (carlton 1979; mahoney 1991) or by quasi-integration. therefore, because it increases the probability of opportunistic behavspring 1995 mcwilliams & gray: quasi-integration 75 ior, the level of demand uncertainty facing the downstream firm will be positively related to the level of transaction costs. alternatively, it should be recognized that cooperative arrangements may be used by one or both parties to increase the possibility of opportunistic behavior. according to harrigan (1985), joint ventures may be used to gain access to proprietary information of another firm, with pernicious intent. while this motivation should be taken into account, it may be less likely in a joint venture that involves vertically, as opposed to horizontally, related firms, because the firms are less likely to be able to benefit from the gained information. from the arguments above, it is clear that behavioral uncertainty increases the level of transaction costs. therefore, behavioral uncertainty indirectly affects the choice of interorganizational form through its effects on transaction costs, that is, behavioral uncertainty is positively, but indirectly, related to the degree of quasi-integration. it has already been established that there is a wide range of alternative organizational forms that also solve the transaction costs and behavioral uncertainty dilemmas, but which do not involve the full internalization of the focal activity. examples of this are relational contracting (jarillo 1988), licensing (hill and kim 1988), joint ventures (hennart 1988; kogut 1988), joint r&d (teece 1983), and strategic networks (jarillo 1988). because integration is postulated to be positively related to the level of transaction costs (coase 1937) and there are intermediate forms of organization that solve the same transaction cost problem, it is reasonable to postulate that quasi-integration is also positively related to the level of transaction costs. further, because there are many alternative organizational forms that facilitate economic exchange by minimizing transaction costs, transaction costs alone can not explain all of the variance in the choice of organizational form. in fact, according to contractor (1990), .... .transaction cost minimization alone cannot describe completely the optimum mode of inter-organizational linkage." therefore, although the insights from transaction cost theory have expanded our understanding of vertical relationships, it is important to keep in mind that there are other determinants of the degree of quasi-integration. coase predicted only a make or buy decision when, in fact, there are many forms of quasiintegration that lie between these two extremes. therefore it is reasonable not only to view transaction costs as a continuum along which firms make different choices, but also to examine the determinants of the level of transactions costs and other determinants of the degree of quasi-integration. in the following section we examine how environmental uncertainty affects the form of vertical interorganizational arrangements both directly and also indirectly through its effect on transaction costs. environmental uncertainty coase's transaction cost theory, like much of traditional industrial organization economics, is limited in its explanatory power because it is based on 76 journal of business strategies vol. 12, no. 1 static analysis (mcwilliams and smart 1993). industry structure, demand, and technology are assumed to be known and constant. therefore, there is little uncertainty about aspects of the firm or its environment other than behavioral uncertainty inherent in interorganizational exchanges. the transaction costs theory of vertical integration can be represented by a two-by-one matrix (figure 2, panel a), where high transaction costs would result in full integration and low transaction costs would result in market exchange. uncertainty is viewed only in terms of behavioral uncertainty on the part of trading partners (williamson 1975) and effects only the level of transaction costs. figure 2 coasian economics transaction costs high full high integration behavioral incertainty low pure low market a strategic management environmental uncertainty high low quasifull integration integration pure quasimarket integration b uncertainty can also come from the environment. the organization theory literature has long recognized the importance of environmental uncertainty in shaping the strategy and structure of firms (dess and beard 1984; emery and trist 1965; milliken 1987). thompson (1967), for example, identified uncertainty as the fundamental problem facing executives within an organization. examples of environmental uncertainty are changes in technology, demand, legal liability, and government regulation. the probability of technological obsolescence has been recognized as an element of environmental uncertainty (balakrishnan and wernerfelt 1986). if technology is changing rapidly, the rational manager will want to externalize transactions involving the use of such technology to reduce the risk of incurring sunk costs in obsolete plant and equipment that could put the firm at a disadvantage with respect to competitors. high levels of quasi-integration (and of course full integration) could effectively lock in a firm's commitment to yesterday's technology (hayes and abernathy 1980). therefore the degree of quasi-integration will be negatively related to the rate of technological change in the upstream industry. demand uncertainty was identified earlier as a variable which affects behavioral uncertainty in vertical exchanges. demand uncertainty is also an elspring 1995 mcwilliams & gray: quasi-integration 77 ement of environmental uncertainty and has implications beyond its influence upon transaction costs. sudden changes in demand can also saddle a firm with obsolete plant and equipment if it is highly integrated. therefore, uncertain demand has an impact similar to rapidly changing technology. this implies that the degree of quasi-integration will be negatively related to the instability of demand. changes in government regulation and legal liability are also an element of environmental uncertainty. where changes in regulation may increase the cost of production or increase the liability of the firm at one level of the production/ distribution channel, there is an incentive to separate that stage from the rest of the firm, so as to limit the liability of the larger organization (barney, edwards and ringleb 1992). this implies that the degree of quasi-integration will be negatively related to the amount of legislative and judicial activity related to the firm's product. environmental uncertainty differs fundamentally from behavioral uncertainty. behavioral uncertainty can be eliminated or mitigated by changing the number of activities controlled by the firm. therefore, where behavioral uncertainty is high, firms choose more control in their vertical relationships. contrarily, environmental uncertainty cannot be eliminated or mitigated by the firm changing the number of activities it controls, because the uncertainty is external to the exchange. therefore, controlling more vertically-related activities will not improve the position of the firm. under conditions where uncertainty cannot be eliminated, flexibility in reacting to the uncertainty becomes a viable option. the higher the uncertainty, the more important is flexibility. therefore, where environmental uncertainty is high, firms choose organizational forms that provide more flexibility. that is, environmental uncertainty is negatively and directly related to the degree of quasi-integration. behavioral uncertainty, as discussed in the preceding section, refers to uncertainty involving the actions of the parties of an exchange relationship, while environmental uncertainty refers to uncertainty that is external to the exchange relationship, such as demand uncertainty and technology innovation. as we developed above, these two types of uncertainty have very different implications for the choice of organizational form. we believe that the choice of inter-organizational form is more accurately represented by the two-by-two matrix in figure 2 (b), than by the two-by-one matrix of figure 2 (a), as implied by transaction costs. panel (b) shows that where behavioral uncertainty is high and environmental uncertainty is low, full integration would be the optimal inter-organizational form (coase 1937; williamson 1975). where environmental uncertainty is high and behavioral uncertainty is low, pure market exchange would be optimal. but, where there are appreciable levels of both types of uncertainty, quasi-integration would be used to balance the trade-off between control and flexibility. the twin concepts of transaction costs and environmental uncertainty have provided valuable insights for understanding quasi-integration. these two approaches, however, do not adequately explain why firms within a given industry 78 journal of business strategies vol. 12, no.1 choose different degrees of vertical integration. we believe this shortcoming may be due to an inadequate attention to the resource endowments of the individual firms. traditional economic theory explicitly assumes homogeneity of firms in an industry. organization theory's treatment of environmental uncertainty implicitly makes the same assumption. these approaches, therefore, allow us to understand the determinants of quasi-integration at the industry level, but not at the firm level. in the next section, we turn out attention to the additional insights that arise when the assumption of homogeneity of firm resources is relaxed. firm resources the resource-based view of the firm (barney 1991; conner 1991; wernerfelt 1984) argues that a firm gains a sustainable competitive advantage as a result of its strategic exploitation of unique resources internal to the firm. this theory makes it clear that sustained competitive advantage depends on the resources controlled by the firm (barney 1991). in much the same manner that transaction costs and environmental uncertainty are important external determinants of optimal organizational form, the resource endowments of firms are important internal determinants. strategists making organizational form decisions must consider both the availability and nature of resources within their own firm and within the trading partner firm when assessing the opportunities for enhancing performance through cooperative strategies. strategists must also take into consideration the presence or absence of resources essential to implement alternative strategies. in this sense, firm resources may represent both strengths and weaknesses of the firm. as an example, consider a small high technology firm that has the resources to develop and produce new products, but lacks the resources to effectively market and d:stribute the products. one alternative open to the firm is to vertically integrate, that is, to acquire a firm that has skills in marketing and distribution. but, what if the high technology firm lacks the financial resources to acquire another firm, or the organizational skills to integrate another firm? the managers of such a firm may find an attractive alternative in a strategic alliance, joint venture, or relational contract. a quasi-integration arrangement will be particularly attractive if the firms entering the arrangement have both a resource strength and a resource weakness. for example, one firm may have a strength in r&d, but weaknesses in marketing and distribution as well as in financial resources. the other firm may have a strength in marketing and distribution, but weaknesses in r&d and in financial resources. by circumventing the acquisitions market, the firms can overcome their mutual lack of financial resources, but still take advantage of each other's strengths through the quasi-integration relationship. an optimal arrangement would exploit the complementarity between the firms (harrison, hitt, hoskison, and ireland 1991). it would, therefore, likely involve a situation in which participating firms have quite different resource bases. for example, a firm which has a distinctive competency in r&d might benefit spring 1995 mcwilliams & gray: quasi-integration 79 from a cooperative arrangement with a firm which has skills in marketing, and vice versa. therefore, the degree of quasi-integration will be positively related to a measure of the differences in the internal resources (strengths) of the participating firms. a contemporary example is the quasi-integration relationship between johnson & johnson and merck, formed to enable both firms to enter the nonprescription drug market. according to a merck executive, "we have the products and the development know-how ... but lack the marketing and distribution capabilities to tap the highly competitive over-the-counter market" (brady 1989). johnson & johnson, by contrast, had excellent marketing capabilities but a weak portfolio of drugs for this market. by combining forces in a cooperative alliance, both companies were able to simultaneously exploit their strengths and overcome their weaknesses. as alluded to above, a firm's financial resources may represent a major obstacle to the implementation of its market strategies. vertical quasi-integration, as developed in this paper, represents a way to overcome problems that result from a lack of capital by allowing a firm to pursue value-increasing strategies that otherwise would be beyond its reach. however, firms with limited financial resources may find an arrangement closer to pure market exchange is their only viable option. therefore, all else equal, the degree of quasi-integration will be positively related to the firm's financial resources. for example, in the case of gm and fisher body mentioned earlier, gm had the requisite financial resources to fully integrate fisher body. two small firms who faced the same situation might not be able to carry out a full integration because of the lack of financial resources and would, therefore, have to choose a form of quasi-integration. in this context, a firm's resources may act as constraints that favor quasi-integration over full integration even when the latter course of action affords lower transaction costs. there is an even more compelling reason for believing that firm resources enter heavily into a vertical integration or quasi-integration decision. porter (1980) developed the concept of the value chain as a tool to analyze both cost and differentiation advantages. under this approach, the individual components in a value chain are analyzed in isolation and as a complete system to gauge an activity's influence upon the firm's competitive advantage. in order to understand the contribution of value chain analysis to strategic decisions involving vertical integration, it is helpful to draw upon barney's (1991) framework for analyzing the sustainability of competitive advantage. barney suggests that a firm's resources and strategies can be conceptualized in terms of their value, rarity, imitability, and substitutability. valuable resources and strategies enable the firm to increase revenues or lower costs compared to their rivals. rarity implies that the resource is not diffused across firms in the industry. valuable and rare resources or strategies provide a competitive advantage to the firm. furthermore, competitive advantage is sustainable over time if, and only if, the resources in question are inimitable (by the firm's ri80 journal of business strategies vol. 12, no. 1 vals) and rivals do not possess resources that, while different from the resources of the focal firm, provide a substitute effect in the marketplace. resources that can be cloned or worked around (through substitutability) by rivals can only provide a temporary competitive advantage. once imitation (or substitution) occurs, the resource can no longer be considered a source of competitive advantage. by using the value chain analysis in tandem with barney's framework, it becomes obvious that some vertical integration or quasi-integration decisions are independent of both transaction costs and environmental uncertainty considerations. activities that represent a source of competitive advantage to the firm will never be externalized even in the presence of high environmental uncertainty or low transaction costs. there are two reasons why this must hold. first, if the activity can be outsourced to another firm, it must be imitable. the implication, following barney's logic, is that it was never a source of sustainable competitive advantage to the firm in the first place. second, even if this problem can be resolved (perhaps by spinning off a division), the firm would be surrendering its value added as well as its competitive advantage over its rivals. competitive advantage is the coin of the realm in the resource-based view and would not be willingly compromised via outsourcing. while these arguments hold for most resources, there are different implications associated with human resources. economic rent (profit) is a return to resources over and above costs, including the cost of capital. economic rent accrues to the owner of the resource. but, because, human resources are not owned by the firm, an individuals' separable and unique contributions (i.e., the contributions of the person rather than the contributions attributable to teamwork) to the firm provide a source of competitive advantage and economic rent to the individual rather than the firm (grant 1992). that is, the firm can not capture the economic rents generated by an individual to the extent that the individual's contribution can be identified. the insights from the resource-based view, when applied to human resources, may explain why many contemporary corporations are eager to seek the services of external consultants and specialist firms. externalizing activities that rely on individual human resources, either through a pure market exchange or one of the quasi-integration surrogates, can provide benefits to the firm that could not represent a source of competitive advantage to the firm. because the firm could not capture the benefits from the human resource by integration, it is reasonable to use market exchange or quasi-integration to obtain the resources. finally, the resource-based view of the firm helps us understand why quasi-integration is many times preferred to full integration when the firm is attempting to overcome a resource weakness. again we will draw upon the experience of the merck and johnson & johnson alliance discussed earlier. merck and johnson & johnson are both giants in the pharmaceutical industry. since merck desperately sought marketing expertise, why didn't merck simply acquire johnson & johnson? financial resources, as discussed earlier, may of course play spring 1995 mcwilliams & gray: quasi-integration 81 a role, however, even if we assume that financing is adequate, a strategy of full internalization may still be problematic. we identify two reasons why this may be true. first, even though merck is well managed and possesses a resource base that yields a competitive advantage, there is no reason to believe that the firm possesses the resources necessary to make the merger successful. the cultures of merged firms are likely to be quite different (grant 1992), leading to tremendous assimilation problems. organizational routines (grant 1992) are highly specialized by organization and would likely be disrupted as the merged firms adjust to one another. these management issues make the successful combination of two large and unique firms unlikely. second, resources that can lead to a sustained competitive advantage cannot be purchased in efficient resource markets (barney 1991). this is true because the price paid for a resource traded in 'a factor market will reflect the value of the resource to the acquiring firm, leaving no excess returns. any future financial advantages of the acquired expertise will be capitalized in the purchase price and hence be dissipated at the time of the merger. this insight from the resource-based view helps explain the large premiums historically paid by acquiring firms. in the merck-johnson & johnson example, this implies that, had merck purchased johnson & johnson, it would have paid as much as johnson & johnson was worth in future benefits, leaving no margin for excess profit. therefore, there would have been no additional gain to integration over and above what merck gained through the strategic alliance. from the above arguments, it is clear that, while transaction costs and uncertainty act as stimuli for quasi-integration, firm resources provide additional incentives which influence the extent of integration. in addition, firm resources affect the ability of the firm to engage in the optimal degree of quasi-integration, independent of transaction costs and environmental uncertainty considerations. taken together, these insights inform us that internal firm resources can act as both incentives and constraints. as such, firm resources directly affect the degree of quasi-integration independent of transaction costs and environmental uncertainty considerations. summary and conclusions one of the most important and challenging areas of research in strategic management deals with cooperative strategies and interorganizational linkages. properly chosen and implemented these strategies enable the participating firms to engage in value increasing strategies by pooling or exchanging resources with other firms in order to maximize their response to behavioral and environmental uncertainty. in this paper we examined cooperative strategies between vertically related firms. the organizational choices available for managing vertical relationships wer; conceptualized as falling between pure market exchange and full internalization and include arrangements such as relational contracting, strategic alliances, and equity joint ventures. 82 journal of business strategies vol. 12, no. 1 figure 3 i behavioraluncertainty i form of verticaltransaction costs i~~i1............1 t i environmental 1----.......... 1uncertainty organization (degree of quasi-integration) i finn i---+-~iresources '--------_....... figure 3 presents an integrated model of the choice of organizational form which includes insights from the emerging resource-based view. the model holds that the organizational arrangements chosen to facilitate inter-firm cooperative strategies between vertically related firms are contingent upon the level of transaction cost, the level and type of uncertainty faced by the firms, and the firms' resource endowments, that is: degree of integration = f (transaction costs, behavioral uncertainty, environmental uncertainty, firm resources) the model presented in this paper and displayed graphically in figure 3 allows us to extend earlier research which relies exclusively on transaction cost economics and organizational theory to explain and predict optimal organizational forms. this is important because, while traditional explanations of organizational form provide valuable insights, they cannot account for the wide variety of alternative organizational arrangements that are observed across firms in the same industry. careful attention to the resource bases of the individual firms represent the beginning of a more productive approach. the present research extends our understanding of the determinants of the optimal level of quasi-integration by drawing upon the insights of the resource-based view of the firm. this is an important step toward developing more comprehensive prescriptions concerning optimal interorganizational form. some important implications for researchers follow from the present research. first, midrange theories are inherently limited in their ability to explain complex organizational phenomena. the present research has integrated the concepts from three such midrange theories, each from a different research tradition transaction costs theory from economics, environmental uncertainty from orspring 1995 mcwilliams & gray: quasi-integration 83 ganization theory, and the resource-based view from strategic management. future advances in business policy and strategy will be enhanced by such integrative efforts. second, we believe that tremendous opportunities exist in further developments and applications of the resource-based view. still in its infancy, this perspective may represent an embryonic form of a unifying theory of strategic management. that is, it may provide the mechanism for understanding the firm in a holistic, rather than a reductionist, sense through its emphasis on the uniqueness of individual organizations. there are also some relevant suggestions for practitioners implied by this research. a firm's primary long-term strategic thrust should be to build unique resources and capabilities that can provide the basis of future competitive advantage. acquiring these resources in a marketplace is less likely to produce the desired results than the careful attention to the organization's internal development. on the other hand, resources that do not represent the firm's source of competitive advantage can be efficiently acquired through the use of cooperative arrangements, or quasi-integration, with other firms. thus, an analysis of the firm's resources and competencies should be conducted prior to the implementation of a vertical integration or quasi-integration strategy. references astley, w. g. ''toward an appreciation of collective strategy." academy of mana~ement review 9, no.3 (1984): 526-535. balakrishnan, s. & wernerfelt, b. "technical change, competition and vertical integration." strategic management journal, 7 (1986): 347-359. barney, j. b. "firm resources and sustained competitive advantage." journal of management, 17, no. 1 (i991): 99-120. barney, j. b., edwards, f. & ringleb, a. "organizational responses to legal liability: employee exposure to hazardous materials, vertical integration, and small firm production." academy of management journal 35, no. 2 (1992): 328-349. blois, k. j. "vertical quasi-integration." journal of industrial economics, 20 (1972): 25372. brady, c. "powerful duo at the counter." chemical week (aprils, 1989): 16. bresser, r. k. & harl, j. e. "collective strategy: vice or virtue?" academy of management review 11, no. 2 (1986): 408-427. carlton, d. w. "vertical integration in competitive markets under uncertainty." journal of industrial economics, 27 (1979): 189-209. coase, r. h. "the nature of the firm." econqmica, 8 (1937) : 386-405. 84 journal of business strategies vol. 12, no.1 conner, k. r "a historical comparison of resource based theory and five schools of thought within industrial organization economics: do we have a new theory of the firm?" journal of management 17, no. i (1991): 121-154. contractor, f. j. "contractual and cooperative forms of international business: towards a unified theory of modal choice." management international review, 30 (1990): 3154. dess, g., & beard, d. w. "dimensions of organizational task environments." adminis: trative science ouarterly, 29 (1984); 52-73. emery, f. e. & trist, e. l. "the causal texture of organizational environments." human relations, 18 (1965): 21-32. grant, r m. contemporary strategy analysis. cambridge, ma: blackwell publishers, 1992. gupta, a. k. & lad, l. 1. "industry self-regulation: an economic, organizational, and political analysis." academy of management review, 8 (1983): 416-425. harrigan, k. r "vertical integration and corporate strategy." academy of management journal, 28 (1985): 397-425. harrison, j. s., hitt, m.a., hoskisson, r.e., & ireland, rd. "synergies and post-acquisition performance: differences versus similarities in resource allocations." journal of management, 17 no. i (1991): 173-190 hayes, r. h. & abernathy, w.j. "managing our way to economic decline." harvard business review, (july-august, 1980): 67-77. hennart, j. r. "a transaction costs theory of equity joint ventures." strategic management journal, 9 (1988): 361-374. hill, c. w l. & kim, wc. "searching for a dynamic theory of the multinational enterprise: a transaction cost model." strategic management journal, 9 (1988): 93-104. jarillo, j. c. "on strategic networks." strategic management journal, 9 (1988): 31-41. jones, g. r. & hill, c. w l. "transaction cost analysis of strategy-structure choice." strategic management journal, 9 (1988): 159-172. klein, b., crawford, r g. & alchian, a.a. "vertical integration, appropriable rents, and the competitive contracting process." journal of law and economics, 21 (1978): 297325. kogut, b. "joint ventures: theoretical and empirical perspectives." strategic management journal, 9 (1988): 319-332. spring 1995 mcwilliams & gray: quasi-integration 85 layard, p. r. g. & walters, a.a. microeconomic theory. new york: mcgraw-hill, 1978. mahoney, j. t. "the choice of organizational form: vertical integration versus other methods of vertical control." working paper #89-1622, university of illinois, 1991. mcwilliams, a. & smart, d. "efficiency v. structure-conduct-performance: implications for strategy research and practice." journal of management, 19, no. i (1993): 63-78. milliken, f. j. "three types of perceived uncertainty about the environment: state, effect, and response uncertainty." academy of management review. 12, no. i (1987): 133-143. nielsen, r. p. "cooperative strategy." strategic management journal, 9 (1988): 475-492. pfeffer, j. & nowak, p. "joint ventures and inter-organizational interdependence." administrative science ouarterly, 21 (1976): 398-418. porter, m.e. "competitive strategy." new york, ny: free press, 1980. teece, d.j. "towards an economic theory of the multiproduct firm." journal of economic behaviour and organization, 3 (1982): 39-63. teece, d.j. "multinational enterprise, internal governance, and industrial organization." american economic review, 75 (1983): 233-238. thompson, j. d. "organizations in action." new york: mcgraw-hill, 1967. walker, g. & weber, d. "a transaction cost approach to make-or-buy decisions." administrative science quarterly, 29 (1984): 373-391. wall street journal."great lakes forest plans newsprint mill with five publishers." (july 8 1987): 16. wernerfelt, b. "a resource based view of the firm." strategic management journal, 5 (1984): 171-80. williamson, o.e. markets and hierarchies. new york: free press, 1975. understanding quasi-integration logistics leverage donald j. bowersox michigan state university east lansing, mi john t mentzer the university of tennessee knoxville, tn thomas w speh miami university oxford, oh abstract it is the purpose of this paper to position marketing and logistics relationships in a strategic context. the strategic position of both areas is used to draw conclusions for the future relationships of marketing and logistics and to suggest the need to focus on creating "logistics leverage." logistics leverage the ability to achieve marketing advantage through logistics superiority is accomplished through the resolution of nine key issues. once resolved, logistics can be exploited to obtain and maintain significant competitive advantage. introduction much recent attention in both business and research has been devoted to the importance of interfunctional coordination (crittenden 1992; deshpande and webster 1989; kahn and mentzer 1994; lichtenthal and wilson 1992; o'reilly 1991; ruekert and walker 1987; st. john 1991; st. john and hall). two areas that have received particular scrutiny have been marketing and logistics (granzin 1980; granzin and bahn 1989; mentzer 1993; rinehart, cooper, and wagenheim 1989; voorhees and coppett 1986; voorhees, et. al. 1988). the objective of this paper is to examine the relationship between marketing and logistics within a strategic context. this examination is developed in four parts. in the first part, two catalysts to further integration of marketing and logistics are discussed. in the next part, the integration of marketing and logistics is projected into a strategic context. the third part introduces the concept of logistics leverage and the nine issues that must be resolved to accomplish it. finally, conclusions for marketing and logistics managers and researchers are presented. spring 1995 mentzer, et. al.: logistics leverage 37 marketing/logistics integration catalysts although marketing and logistics often receive some degree of integration, two catalysts existing in the business environment are working to make logistics superiority, and its strategic integration with marketing, a necessity for many companies. understanding these catalysts better positions how logistics can be deployed as a key strategic resource. time and quality based competition time and quality based competition focus on eliminating waste in the form of time, effort, defective units, and inventory in manufacturing-distribution systems (larsen and lusch 1990; schonberger and ei ansary 1984; schultz 1985). the most popular time and quality based concepts are just-in-time (jit) and quick response (qr). jit has many facets and touches almost all aspects of a business enterprise (bartholomew 1984; daugherty and spencer 1990; frazier, spekman, and oh 1987; jackson 1983; rosenberg and campbell 1985). as a result, purchasing, transportation, inventory, and manufacturing personnel all consider jit to be indigenous to their performance (yanacek 1987). in reality, all these activities, plus marketing, are impacted by the adoption of a jit system within which logistics becomes the focal point of implementation. one of the effects of jit is to direct logistics attention toward an overall procurement, manufacturing, operating, and marketing orientation of the business. importantly, there are significant marketing benefits that can result from establishing jit competency for example, higher customer satisfaction from better quality products with zero defects, more consistent availability, and faster product delivery. typically, such benefits are fully exploited only if logistics managers are more attuned to internal, supply-side systems and cost control, while integrating with marketing programs and customer requirements. quick response (qr) systems are similar to jit programs (i.e., the required integration of marketing, purchasing, transportation, inventory, and manufacturing), but differ by the fact that they deal with the distribution of finished products from manufacturers to wholesalers and retailers (larsen and lusch 1990). many of the principles of successful qr are similar to the logic that drives jit. because qr typically deals with finished product distribution, performance is an integral part of total customer service (dumaine 1989). however, the drivers that make most existing qr programs successful are inventory velocity and total cost reduction. only a limited number of firms have begun to manage qr programs toward the goal of achieving competitive advantage (daugherty and spencer 1990). the competitive impetus for such coordination of inventory velocity and cost control with customer satisfaction serves as a catalyst for marketing/logistics integration in finished goods channels. more advanced forms of qr, however, focus primarily on customer satisfaction. recently coined "service response logistics" (davis and manrodt 1991 and 1993; manrodt and davis 1992), these programs tend to position logistical 38 journal of business strategies vol. 12, no.2 competency as the core activity aimed at achieving customer satisfaction through inventory availability, timely delivery, less product failure, and, thus, less lost sales or returns/complaints (stalk, evans, and shulman 1992). the achievement of such customer satisfaction requires significant integration of logistical competency and marketing performance. the combined effect of time and quality based systems has been to emphasize the need for marketing/logistics integration as a competitive advantage. while both jit and qr thrive on interorganizational and interfunctional coordination, such arrangements must be driven by a desire to reduce cost, improve asset utilization, and more effectively service customers. attention to service response logistics suggests that some significant break-throughs that capitalize on the strategic impact of marketing/logistics integration are developing. efficiency and effectiveness logistics, by its nature, is quantitative in the measurement of efficiency delivery time, the number of short orders, inventory, and similar operational activities can be readily measured. as a result, logistics practice and research has been more operationally oriented and tended to focus more on economic or efficiency measures of performance. the absolute magnitude of logistics cost has directed many firms to control the expense side of logistics; that is, to manage the process to achieve a level of efficiency. although there has been considerable research in the logistics area concerning how logistics impacts customer service (for a review, see mentzer, gomes, and krapfel 1989), no accepted protocol for measuring customer responsiveness to logistics service levels exists. further, the traditional focus of logistics research on economic (efficiency) issues rather than behavioral issues has not brought the attention of behaviorr.l researchers in marketing to bear on this problem. although much research in marketing has been devoted to the behavioral implications of service quality and customer satisfaction/dissatisfaction (for a review, see zeithaml, berry, and parasuraman 1993), little such research has addressed the behavioral implications of changes in logistics service quality as part of overall marketing strategy (mentzer, bienstock, and kahn 1993). however, cost control (efficiency) without recognition of customer service requirements (effectiveness) will doom any aspect of a marketing effort to failure. logistics is no exception. the need for a clearly defined linkage between logistics performance, marketing strategy, and their behavioral consequences provides the second, and perhaps most important, catalyst for the implementation of logistics as a strategic marketing tool. summary current developments in the business environment and the marketing literature suggest these catalysts are having an impact. there are increasing examples of firms such as wal-mart, target, and k-mart establishing alliances with manufacturers to jointly reduce costs and leverage performance. further, the spring 1995 mentzer, et. al.: logistics leverage 39 recent interest in the marketing literature with relationship marketing (anderson and weitz 1992; anderson and narus 1990; dant and schul 1992; dwyer, schurr, and oh 1987; frazier, spekman, and o'neal 1988; heide and john 1992; larsen and lusch 1990) suggests progress in examining the strategic management of logistics issues in building relationships with customers. results of such alliances and research scrutiny suggest that issues of efficiency and effectiveness measurement can be jointly resolved and that logistical performance can be integrated into mainstream marketing strategy and research. the reality of such catalysts and the potential to be gained from them argue strongly for in-depth examination of logistical effectiveness in overall marketing strategy and a searching consideration of the key role that logistics plays in creating customer satisfaction. the marketing/logistics strategic linkage in porter's (1985) value chain, one of the four support activities (procurement) involves logistics and all of the five primary activities involve logistics (inbound logistics, operations, and outbound logistics), marketing (marketing activities), or both (service). it is interesting to note how these functions are so important and inextricably linked in the value chain and suggests that increased focus be placed on effectively coordinating their interaction. the foundation of future marketing and logistics integration is strategic. with this goal in mind, figure 1 utilizes the competitive advantage framework of day and wensley (1988) to develop the dimensions of the relationship and position the strategic importance of integrated marketingllogistics. the focus of logistics has been and will primarily continue to be upon cost drivers, i.e. skills and resources that generate efficiency. the integration of marketing and logistics is necessary to bring the logistics sources of advantage into the realm of effectiveness, or drivers of differentiation. this will only occur and result in positional advantages if the leverage logistics can bring to marketing is realized. this leverage can only be realized by recognizing and exploring, both within the practitioner and academic communities, the strategic linkage between marketing and logistics wherein logistics skills and resources are translated into effective drivers of differentiation. where this integration is accomplished, strategic positioning of the marketingllogistics integrated firm as cost efficient and customer effective will result. it will be incumbent upon marketing to emphasize these superior performance outcomes to achieve sustainable competitive advantage. firms that have successfully implemented such coordination are now building corporate strategies that exploit logistics competency (bowersox, el. al. 1991). by focusing on logistics competency (e.g., one call for complete order status information, total flexibility in ordering to support either store direct or warehouse delivery, no order minimums), the leading logistics performers are providing tangible and significant benefits to customers. the net result is the creation of a meaningful competitive advantage. 40 journal of business strategies figure 1 integrated strategic planning vol. 12, no.2 marketing focus effectiveness superior skills superior resources logistics focus efficiency superior skills superior resources i catalysts to integration i integration for superior customer value and lower relative costs + strategic positioning logistics leverage + performance outcomes t competitive advantage selected finns are beginning to realize that logistics excellence is a significant differential advantage that can be exploited in the marketplace (bowersox et. al. 1991). logistics service is an effective tool for building closer relationships with key customers. although the expression "being easy to do business with" is over used, the fact remains that some finns are very difficult to buy products from and have poor response systems for providing infonnation concerning such facts as order status and invoice discrepancy. other finns have stateof-the-art logistics infonnation systems that enable maximum control (shapiro, spring 1995 mentzer, et. al.: logistics leverage 41 rangan, and sviokla 1992; stalk, evans, and shulman 1992) a source of advantage which can be translated through integration with marketing into a positional advantage (day and wensley 1988). the result is the performance outcome of significant customer impact. the final outcome of these superior logistics systems is an added positional advantage of preferred status for selected suppliers and such status draws directly from the logistics competency (even in situations where price, product, and promotion are undifferentiated or marginally higher in comparison to selected competitors). as day and wensley (1988) observed, "the sustainability of this positional advantage requires that the business set up barriers that make imitation difficult." the true positional advantage of logistics competency is that a chief executive officer cannot, by the whisk of a pen, mandate such competency and automatically obtain the facilities, systems, human resources, and information control necessary to produce a consistent level ci' logistical performance. as marketing strategies evolve toward greater market segmentation sophistication, the ability to provide customized logistics service to unique segments will become increasingly demanding. firms with high levels of logistical competence are better positioned to exploit such opportunities. logistics leverage the critical question is how to leverage the strategic benefits inherent in an effective logistics system for maximum competitive advantage. logistics leverage is the ability to effectively influence market demand through the application of excellent logistics systems, techniques, and programs. the term leverage indicates relatively high market returns may be gained from relatively small investments. significant sales, market share, and consumer satisfaction gains can be achieved if the firm consciously positions itself to leverage its logistics capabilities. it is not enough to have created the human resources, technical tools, and operational systems for effective logistics, the firm must be able to market and use its logistics expertise to achieve marketing goals. thus, logistics leverage is based upon successfully resolving nine issues. creation of value-added services the exploitation of logistics competence offers a meaningful way to create value-added services not achievable in other ways (cooke 1990; mentzer 1993; wittersdorf 1991). such positioning requires defining critical business processes from a logistics perspective. such value-added processes have spawned the development of new channel institutions. logistics facilitation companies are one of the most rapidly growing marketing institutions. such facilitators do not view themselves as traditional wholesalers, retailers, warehousers, or transportation companies. their mission vision is one of being a service organization which satisfies a specific niche requirement. they provide logistics economies of scale, essential services, and time and quality based delivery. 42 journal of business strategies vol. 12, no.2 the combination of more effective delivery at a lower cost translates to increased value. thus, what have traditionally been logistics cost drivers are becoming drivers of differentiation (day and wensley 1988; porter 1985). again, the shift from cost driving logistics activities to logistics drivers of differentiation requires the integration of marketing and logistics activities and strategic plans. management vision top management must fully understand the real and significant market impact that results from logistics superiority. recent history has demonstrated that many of the successes achieved by large consumer goods firms with mass merchandisers resulted from the manufacturer's ability to lower iogistics costs while increasing logistics service, resulting in increased final consumer satisfaction combined with reduced retailer inventory. these drivers of differentiation were accomplished through management's vision of the potential of logistics and a commitment to leveraging their logistics system for their customers. management vision will achieve logistics leverage only if (1) top management applies resources to bring logistics expertise to their customers on a customer-by-customer basis (davis and mandrodt 1991), (2) the attitude of marketing customer satisfaction as a corporate core competency is nurtured by top management throughout the entire organization, not just in marketing, and (3) the logistics benefits of the manufacturer are communicated directly from the supplier ceo to the customer ceo. this latter point is an essential ingredient in the establishment of strategic alliances and partnerships. strategic alliances and partnerships the marketing value of exploiting logistics competency is demonstrated by the positional advantage available as a result of linking firms and their customers into strategic alliances and partnerships. the last decade has witnessed the growth of vertically-integrated marketing systems in a behavioral or relational sense (dwyer, shurr, and oh 1987; frazier, spekman, and o'neal 1988; narus and anderson 1986). the strategic alliances that have evolved are broader in scope than simple out-sourcing because they include risk and reward sharing. a significant aspect of these newly created alliances is the central role typically played by logistics (bowersox 1990). inventory management, directstore delivery, warehousing, and transportation consolidation are typical logistics functions that are at the core of many partnerships. the efficient performance of these activities by specialists produces benefits shared by both partners. as frazier, spekman, and o'neal (1988, p. 53) stated, the emphasis in such relationships is on "the notion of 'total cost of ownership' and the array of valueadded services provided." strategic interfunctional teams logistics superiority as a driver of differentiation can be achieved only when all parties in the marketing organization are integrated in terms of the baspring 1995 mentzer, et. al.: logistics leverage 43 sic concept of customer satisfaction, the potential of logistics leverage to aid in obtaining customer satisfaction, how the message of logistics customer value needs to be communicated, and to whom this message should be delivered. team marketing approaches, typically composed of marketing, sales, logistics, finance, and production representatives, are common place and the norm in some industries, with significant resultant advantages (hun and speh 1984). to achieve logistics leverage, marketing must recognize the role logistics plays in achieving customer satisfaction. without this recognition, the related promotional, pricing, and "service package" strategies to market logistics expertise to the customer will not be achieved. it falls to logistics to develop and deliver the logistics excellence that marketing has identified as important to customers. orientation of marketing for many firms, particularly in the consumer goods industries, the overriding emphasis in marketing personnel training is given to the product and promotional dimensions of marketing strategy. many factors reinforce this orientation: brand manager organizations; college marketing curricula with an emphasis on advertising, promotion, and product development; and corporate training programs where marketing personnel are given little exposure to logistics. to achieve logistics leverage, colleges and corporations need to rethink the manner in which marketing managers are developed. one step that can be taken by colleges in this leadership role is to make logistics courses required for all business students. organizational issues a major premise of this work is that logistics competency can be created, but unless the firm is positioned to exploit it, little strategic significance will result. one way to leverage logistics excellence is to establish hierarchies and reporting relationships that maximize the integrated potential. when marketing, sales, and logistics each report to a separate vice president, each with their own organization, more effort will be required to break down the inherent organizational barriers so that integration is achieved. customer teams and matrix management are commonly used to overcome organizational inflexibility (clark and wheelwright 1992; gibson, ivancevich, and donnelly 1988; lawrence, kolodny, and davis 1977). however, since logistics is a customer satisfaction impacting function and its significance as a competitive marketing tool has been demonstrated, logistics should logically be more closely aligned organizationally with marketing. rather than a team approach, if logistics reports directly to marketing, the potential for maximum market impact of logistics leverage is increased. market intelligence to achieve logistics leverage, information systems need to be restructured so that new and different types of information are routinely gathered and sup44 journal of business strategies vol. 12, no. 2 plied to the marketingllogistics function. information on customer logistics problems and opportunities are required so the firm can quickly adapt their logistics expertise to meet these challenges. market research needs to expand from the traditional study of needs, attitudes, and behavior related to product, price, and promotional offerings to include the study of customer logistics needs that customers may not even be aware exist. in addition, environmental assessment studies to benchmark the efforts of those firms deemed to be leaders in logistics excellence will supply strategic information relative to the firm's existing logistics offering. channel member programs to effectively exploit logistics competence, significant efforts may be required to upgrade the logistics systems of other channel members. all channel members must share the vision of the potential market impact of logistics excellence. without that vision, there will be little hope of developing a marketing program with a logistical focus. further, logistics leverage can only be achieved in market segments served by channel members when those members possess the level of logistics excellence required by those customers. this excellence can be developed by careful selection of channel members by market segment, by transferring logistics excellence through strategic alliances, or out-sourcing certain traditional channel functions to third party providers. sole-source relationships finally, the last several years have witnessed increasing efforts by firms to reduce their supplier base and move into sole-source relationships with key suppliers (bertrand 1986; frazier, spekman, and oh 1988; purchasing 1989). this trend underscores t,e need to refocus strategic thinking on the role logistics can play in establishing sole-source relationships. because of the impact of a vendor's logistics competence on the buyer's costs and operations (just-in-time delivery to production sites, damage-free products, error-free orders, and real-time information are all cost drivers that are potentially also drivers of differentiation for the firm), the vendor's logistics system may be the most effective way to create and support a sole-source relationship. conclusions the relationship between the related, but often independently managed, functions of marketing and logistics has been examined. the strength and longevity of the positional advantage from logistics excellence is impressive because of the difficulty of duplicating outstanding logistics systems and the significant benefits they provide to customers from a cost and quality standpoint. logistics leverage has to be consciously created through the actions of marketing and logistics managers within the firm. key issues to be resolved include the creation of value-added services, top management vision, strategic allispring 1995 mentzer, et. al.: logistics leverage 45 ances and partnerships, interfunctional teams, the orientation of marketing, organization structure, marketing intelligence, channel member programs, and the nurturing of sole-source relationships. once these issues are resolved, the firm will be positioned to effectively integrate logistics competence into marketing strategy to create sustainable differential advantage. future research and management issues are very much related to the effort to create logistics leverage. managers and researchers alike need to become more concerned with the buyer behavior implications of changes in the marketingllogistics customer service package. buyer attitudes and behavior can be expected to change with integrated marketing/logistics efforts (mentzer, bienstock, and kahn 1993). whether this altered behavior will be for the good or detriment of the company, and in what degree, lies within the realm of buyer behavior and service quality research both applied and academic. measurement issues should continue to occupy the attention of researchers. without valid models and predictions of logistics impact on sales, costs, and profits, it is difficult to successfully plot the most meaningful role for logistics in the strategic thrust of a firm. more effective models are needed at two levels: within the channel and at the point of sales to the consumer. logistics service (in-stock levels, order cycle time, etc.) interacts with a variety of other marketing variables (price, boundary person relationships, location, brand name, advertising claims, etc.) to determine the customer's satisfaction. it will be necessary to expand research efforts to measure these interactions and isolate the specific effect of each variable. once these effects are better understood, marketing decision-making will be better positioned to make more effective decisions regarding the strategic positioning of logistics services within the overall marketing offering. the arenas of logistics and channels have long followed separate predominant paradigms economic for logistics and socio-psychological for channels. however, both areas of marketing address the same marketing phenomena distribution of products. the channels area typically addresses negotiation between channel members, whereas the logistics area addresses the operational interaction between these channel members. these two areas are not separate and cannot be meaningfully managed or researched without recognition of their interaction. the effect of negotiation upon operational reality and vice versa would seem a topic with rich potential for research and managerial creativity. in particular, the application of the transaction cost analysis paradigm (mcneil 1980; williamson 1975 and 1985) to the effect of logistics transaction specific investments upon negotiation behavior would seem to be a research area immediately ripe for investigation. also within the tea paradigm, an area of increasing importance is the role of third-party logistics suppliers. effective logistics competency may be enhanced through the utilization of independent suppliers of a wide array of valueadded logistics services. research, grounded in the transaction cost analysis paradigm, to evaluate the efficiency and effectiveness of out-sourcing logistics func46 journal of business strategies vol. 12, no.2 tions would help develop the dimensions of how logistics can contribute to maximum strategic impact. by out-sourcing some logistics functions (e.g. warehousing), a firm may gain cost and service advantages not available from internal performance, but incur additional transaction specific investments. as a result, the enhanced level of performance may create a differential advantage that otherwise would not have existed, but come at the cost of increased dependence upon a third party. being aware that an enhanced performance level is possible at the cost of increased risk permits decision-makers to more effectively assess the contributions of logistics to overall marketing success. references anderson, erin and barton weitz. "the use of pledges to build and sustain commitment in distribution channels." journal of marketing research 29 (february, 1992): 1834. anderson, james c. and james a. narus. "a model of distributor firm and manufacturer firm working partnerships." journal of marketing 54 (january, 1990): 42-58. bartholomew, d. "the vendor-customer relationship today." production and inventory management 25, no.2 (1984): 106-21. bertrand, kate. "crafting 'win-win situations' in buyer-seller relationships." business marketing 71 (june, 1986): 42-50. bowersox, donald j. "the strategic benefits of logistics alliances." harvard business rev.iew 68 (july-august, 1990): 36-45. ____, patricia j. daugherty, cornelia l. droge, richard n. germain, and dale s. rogers. logistical excellence: its not business as usual. new york: digital press, 1990. clark, kim b. and steven c. wheelwright. "organizing and leading 'heavyweight' development teams." california management review 34 (spring, 1992): 9-28. cooke, peter n. c. "value-added strat~gies in marketing:' international journal of physical distribution and logistics management (1990) 20, no.5: 20-24. crittenden, victoria l. "close the marketinglmanufacturing gap." sloan management review 33 (spring, 1992): 41-52. dant, rajiv p. and patrick l. schul. "conflict resolution processes in contractual channels of distribution." journal of marketing 56 (january, 1992): 38-54. daugherty, patricia j. and michael s. spencer. "just-in-time concepts, applicability to logisticsrrransportation." international journal of physical distribution & logistics mana~ment 20, no. 7 (1990). spring 1995 mentzer, et. al.: logistics leverage 47 davis, frank w. jr. and karl b. manrodt. 1991. "principles of service response logistics." proceedings. chicago: council of logistics management: 339-55. ____ and karl b. manrodt. "the evolution to service response logistics." international journal of physical distribution and logistics management 22, no. 9 (1991): 310. day, george s. and robin wensley. "assessing advantage: a framework for diagnosing competitive superiority." journal of marketing 52 (april, 1988): 1-20. deshpande, rohit and webster, frederick e., jr. "organizational culture and marketing: defining the research agenda." journal of marketing 53 (january, 1989): 3-15. dumaine, brian. "p&g rewrites the marketing rules." fortune (november, 1989): 3448. dwyer, f. robert, paul h. schurr, and sejo oh. "developing buyer-seller relationships." journal of marketing 51 (april, 1987): 11-27. frazier, gary l., robert e. spekman, and charles r. o'neal. "just-in-time exchange relationships in industrial markets." journal of marketing 52 (october, 1988): 52-67. gibson, james l., john m. ivancevich, and james h. donnelly, jr. organizations: behavior. structure. and processes. 6th ed. plano, tx: business publications inc., 1988. granzin, kent l. "physical distribution: a description of its structure by means of second-order factor analysis." journal of business research 8, no.2 (1980): 213-223. ____ and kenneth d. bahn. "consumer logistics: conceptualization, pertinent issues and a proposed program for research." journal of the academy of marketing science 17 (winter, 1989): 91-102. heide, jan b. and george john. "do norms really matter?" journal of marketing 56 (april, 1992): 32-44. hutt, michael d. and thomas w. speh. "the marketing strategy center: diagnosing the industrial marketers interdisciplinary role." journal of marketing 48 (fall, 1984): 5361. jackson, g. c. "just-in-time production: implications for logistics managers." journal of business logistics 4, no.2 (1983): 1-19. kahn, kenneth b. and john t. mentzer. "norms that distinguish between marketing and manufacturing." journal of business research 30 (1994): 111-118. larsen, paul d. and robert f. lusch. "quick response retail technology: integration and performance measurement." the international review of retail, distribution and consumer research (october, 1990): 17-34. 48 journal of business strategies vol. 12, no.2 lawrence, paul r, harvey f. kolodny, and stanley m. davis. "the human side of the matrix." organizational dynamics 6 (summer, 1977): 47-62. lichtenthal, david 1. and wilson, david t. "becoming market-oriented." journal of business research 24, no.3 (1992): 191-207. mandrodt, karl b. and frank w. davis, jr. "the evolution of service response logistics." international journal of physical distribution and logistics management 22, no. 9 (1992): 3-10. mcneil, ian r. the new social contract: an inquiry into modern contractual relations. new haven, ct: yale university press, 1980. mentzer, john t. "managing channels in the 21st century." journal of business lol:is!i£§. 14, no.1 (1993): 27-42. ____, carol c. bienstock, and kenneth kahn. "customer satisfaction/service quality research: the defense logistics agency." journal of consumer satisfaction, dissatisfaction and complaining behavior 6 (1993): 43-49. ____, roger gomes, robert e. krapfel. "physical distribution service: a fundamental marketing concept?" journal of the academy of marketing science, 17 (winter, 1989): 53-62. narus, james a. and james c. anderson. "turn your distributors into partners," harvard business review 64 (march-april, 1986): 66-71. o'reilly, charles. corporations. culture, and commitment: motivation and social control in organizations, in motivation and work behavior. eds. richard m. steers and lyman w. porter. new york: mcgraw-hill, inc., 1991. porter, michael e. competitive advantal:e: creating and sustaining superior performance. new york: the free press, 1985. purchasinl:. "buyers keep trimming supplier base despite tight supplies." 104 (february 23, 1989): 18. rinehart, lloyd m., m. bixby cooper, and george d. wagenheim. "furthering the integration of marketing and logistics through customer service in the channel." journal of the academy of marketing science 17 (winter, 1989): 63-71. rosenberg, l. j. and d. p. campbell. "just-in-time inventory control: a subset of channel management." journal of the academy of marketing science 13 (summer, 1985): 124133. spring 1995 mentzer, et. al.: logistics leverage 49 ruekert, robert w. and walker, orville c, jr. "marketing's interaction with other functional units: a conceptual framework and empirical evidence." journal of marketini 51 (january, 1987): 1-19. schonberger, richard j. and a. e1 ansary. "just-in-time purchasing can improve quality." journal of purchasing and materials management 20 (spring, 1984): 1-7. schultz, david p. "just-in-time systems." stores (april, 1985): 28-31. shapiro, benson p., v. kasturi rangan, and john 1. sviokla."staple yourself to an order." harvard business review 70 (july-august, 1992): 113-122. stalk, george, philip evans, and lawrence e. shulman. "competing on capabilities: the new rules of corporate strategy." harvard business review 70 (march-april, 1992):5769. st. john, caron h. "marketing and manufacturing agreement on goals and planned actions." human relations 44, no.3 (1991): 211-229. st. john, caron h. and ernest h. hall, jr. "the interdependency between marketing and manufacturing." industrial marketing management, 20 (1991): 223-229. voorhees, roy dale and john i. coppett. "marketing-logistics opportunities for the 1990's." journal of business strategy 7 (fall, 1986): 33-38. ____, r. kenneth teas, benjamin j. allen, and earl t. dinkier. "changes in the marketing-logistics relationship." journal of business logistics 9, no.1 (1988): 34-48. williamson, oliver e. markets and hierarchies, analysis and antitrust implications. new york: the free press, 1975. ____. the economic institutions of capitalism. new york: the free press, 1985. wittersdorf, r. graeme. "adding value through logistics management." international journal of physical distribution and logistics management 21, no.4 (1991): 6-8. yanacek, frank. "one more just-in-time." handling and shipping management 28 (may, 1987): 47. zeithaml, valatie a., leonard l. berry, and a. parasuraman. "the nature and determinants of customer expectations of service." journal of the academy of marketing science 21 (winter, 1993): 1-12. logistics leverage volume 36, number 2 1 board gender diversity, social performance, and ceo compensation k. matthew gilley, ph.d. st. mary’s university • san antonio, tx kelly pledger weeks, ph.d. rhodes college • memphis, tn joseph e. coombs, ph.d. virginia commonwealth university • richmond, va myrtle p. bell, ph.d. university of texas at arlington • arlington, tx donald h. kluemper, ph.d. university of illinois at chicago • chicago, il abstract this study examines the extent to which board gender diversity and corporate social performance influence ceo compensation. the sample includes 1,829 observations from 262 fortune 500 companies over multiple years. findings indicate that board gender diversity and corporate social performance interact to predict ceo compensation. the data show that boards comprised of a higher percentage of women place increasing emphasis on certain kinds of corporate social performance when setting ceo pay, and decreasing emphasis on other types of social performance. our findings highlight the complex interrelationships between executive compensation, board composition, and corporate social performance. keywords: executive compensation, boards of directors, corporate social responsibility, diversity introduction according to main and colleagues (1995: 299), corporate governance scholars suggest that there are four key duties of a company’s board of directors. they include: “(i) overseeing of management to include the selection, monitoring, evaluation, compensation and replacement of the ceo, (ii) the management of the board to include the selection and replacement of board members, (iii) reviewing the firm’s financial performance and approving the allocation of funds, and (iv) insuring compliance with the law and corporate social responsibility (e.g., lorsch, 1989; walsh and seward, 1990; jacobs, 1991).” 2 journal of business strategies there is debate, however, about whether certain characteristics of a board can detract from the board’s ability to perform these tasks to the satisfaction of shareholders (zahra & pearce, 1989). anecdotal evidence suggests that maledominated boardrooms oftentimes have a “clubby” atmosphere in which executives’ rewards spiral upward without legitimate reason (e.g., burke, 1993; ezzamel & watson, 2002). ineffective board governance mechanisms provide ceos with opportunities to implement self-interested strategic initiatives that increase their job security and compensation at the expense of long-term organizational effectiveness. diversifying the board may have a significant effect on board decisions (e.g., hambrick & mason, 1984; pfeffer, 1972; post & byron, 2015). as such, larger boards, the presence of outsiders, and the inclusion of members of different groups (e.g. women) are presumed to be more conducive to debate and discussion of the firm’s mission, strategies, and performance. such debates may force management to consider a wider range of options, and they may clarify constraints within which strategy implementation should proceed. over the past two decades, scholars have focused on whether more diverse boards affect firm performance, and the results have been mixed (e.g., campbell & minguez-vera, 2010; nguyen & faff, 2012; shrader, blackburn & isles, 1997). scholars have recently called for more research to assess the effect of board diversity on outcomes other than financial performance (johnson, schnatterly, & hill, 2013), and it is our assertion that one reason for the mixed results is that diverse boards may focus on different areas of firm performance (such as social performance) than homogenous boards. in addition, one area in which the board of directors uses its resources to exert influence is on executive compensation, and the question of whether women on corporate boards are influential in determining ceo compensation is important. therefore, this study fills two gaps in the literature on diversity of corporate boards. for one, we will examine the effects of board composition on ceo pay, focusing specifically on board gender diversity. in addition, we will examine the effects of board gender diversity on the relationship between firm performance and ceo pay; however, our primary firm performance measure is social performance instead of the more traditional financial performance orientation. our work adds to the body of knowledge on ceo compensation, corporate governance, and organizational performance. we begin by discussing executive compensation and the need for more governance. then we will examine the statistics and literature about gender diversity on boards. finally, we will apply upper echelon theory to explain why more gender diverse boards may take a stakeholder view of firm governance as opposed to a purely agency-related view. volume 36, number 2 3 executive compensation corporate boards have been criticized for allowing excessive compensation for ceos. one explanation about why ceo pay continues to grow is that ceos have power in the selection of board members, and they often select other ceos to serve who are more amenable to the idea of escalation of compensation (burke, 1993). debate continues in both academic literature and the popular press about the most effective ways to control ceo behavior (devers et al., 2007; o’connor et al., 2006). many argue that ceo compensation is still exorbitant, compared to what most people consider fair, and it is not connected to firm performance (e.g., delacroix & sandagaran, 1991). board members are often influenced by managerial power (mcconvill, 2016), cronyism, and interlocking boards (bilimoria, 1997; oxelheim & clarkson, 2015). attempts to control increasing ceo compensation that is not clearly associated with increasing firm performance have not been successful (bilimoria, 1997; ogden & watson, 2008). bilimoria (1997) examined the mechanisms that boards use to control executive rewards and determined that each mechanism contributed to excessive compensation, but in differing ways. even though researchers have long argued for more outside directors on boards (e.g., bilimoria, 1997) as a means to control escalation of pay, and there have been calls specifically for more women on corporate boards (e.g., burke, 1993), there still is not a gender balance at the board level that reflects the larger society, which may be partly responsible for growing extremes in executive wages. gender diversity in boards of directors in the more than 50 years since passage of title vii of the civil rights act prohibiting sex discrimination in employment, women’s presence in u.s. corporations has significantly increased. women now comprise about half of the u.s. workforce, including increasing representation in high wage, high status, and influential positions. although women comprise just four percent of s&p 500 ceos, women’s representation on s&p 500 boards is considerably higher, reaching over 19% in 2014, up from approximately eight percent in 1993 (catalyst, 2014). in comparison to jobs that most women hold, women on corporate boards occupy some of the most powerful positions, with the opportunity to influence organizational decision making. despite these recent advances, women directors remain poorly represented. most boards have nine to 12 members (konrad et al., 2008), but usually only one or two women. as of 2015, nearly 5% of fortune 500 companies still had no women on the board, while nearly 30% listed one woman director (fairchild, 4 journal of business strategies 2015). women board members are also underrepresented in australia, canada, hong kong, india, japan, and across europe (adams & ferreira, 2009; catalyst, 2014), although pressures are continuing to grow in some countries for more women on their boards (sheridan, ross-smith, & lord, 2014). in fact, the european commission is proposing legislation that aims to have 40% of non-executive directors be women at public companies. women directors, often viewed as “outsiders”, take their responsibility as board members seriously, consider the company’s wide range of stakeholders (mcinerney-lacombe et al., 2009), and monitor and evaluate differently than men (adams & ferreira, 2009). hillman and colleagues (2000) categorized boards as having insiders, business experts, community influentials, and support specialists, each providing different resources to enhance board effectiveness. hillman et al. (2002) showed that women and minorities serving on fortune 1000 company boards have higher education levels and tend to be from non-business careers (support specialists and community influentials) more than the white, male board members, demonstrating that they likely provide novel resources to the board. a growing literature indicates that women influence multiple aspects of board behavior and decision-making. mcinerney-lacombe and colleagues (2009) argue that by taking on tough issues, women directors help boards make better decisions. evidence indicates that gender diversity on the board is related to more effective governance (buse, bernstein, & bilimoria, 2016), has a positive relationship with employee productivity (ali, ng, & kulik, 2014), and improves financial performance (hoobler et al., 2016; post & byron, 2015). other effects of women board members include changes in leadership styles and decision making in organizations (mcinerney-lacombe et al., 2009), increased diversity of opinions, and a greater range of intellectual capital (daily, certo, & dalton, 1999), all of which may lead to more effective governance practices (buse et al., 2016). it is still not clear, however, whether strategic changes described above are also accompanied by changes in ceo compensation or whether gender diverse boards reward ceos differently than do more homogenous boards. theoretical explanations to explain why gender diverse boards may approach ceo compensation differently than homogenous boards, we will examine common theories of board governance. specifically, we argue that upper echelon theory will explain why more gender diverse boards may take a stakeholder view of firm governance as opposed volume 36, number 2 5 to a purely agency-related view. when studying corporate boards, scholars often debate the virtues of agency theory versus stakeholder theory. agency theory (see jensen & meckling, 1976) suggests an inherent conflict between the interests of the shareholders (maximize profits) and the interests of the management (maximize their own rewards). it is assumed that top managers will choose to maximize their own interests at the expense of the company’s interests. these are known as agency costs. one role of the board of directors, then, is to mitigate this conflict. they do this through incentive compensation and governance structures. however, boards often fail at this key task. according to stakeholder theory, there are multiple stakeholders that either make contributions to the firm (normative) or constrain the corporation (derivative), and all stakeholders should be considered in board decisions (freeman, 1984). within stakeholder theory, there is a differentiation between a corporate egoist model and a moral stakeholder model (jones, felps, w. & bigley, 2007). the corporate egoist model considers the interests of those stakeholders who will help the firm achieve its profit goals, whereas the moral stakeholder model assumes the necessity of considering all stakeholders because it is the right thing to do. the former view can be integrated with agency theory and continues to be focused mainly on economic prosperity. the latter perspective has a more ethical nature and is often argued to be at odds with agency theory (shankman, 1999). therefore, the debate continues between the focus on self-interested economic profit and other-focused ethical consideration (jones et al., 2007). if the board is focused on all stakeholders simultaneously, they may reward ceos through higher compensation for what is typically considered social performance of the company (such as helping the environment or the community), rather than the more traditional financial performance alone. more recently, upper echelon theory has emerged as another compelling explanation as to how women may change the monitoring behavior of boards. most research on upper echelons theory to date has focused on how the individual characteristics of top level managers in a corporation will make a difference in the daily decisions that are made in that organization (hambrick & mason, 1984). specifically, individuals have different values, experiences, and “cognitive frames” about each decision in which they participate. therefore, more diverse top management teams should receive the benefit of varying perspectives (hambrick & mason, 1984). research has accepted that upper echelon theory can apply to groups that “occupy formally defined positions of authority” in an organization (pettigrew, 1992, p. 162), including corporate boards. in this manner, diverse cognitive frames can enhance information seeking and information processing behaviors on the 6 journal of business strategies board (hambrick, 2007). accordingly, female and male directors may influence the strategic choices of the board differently because of their different cognitive frames (post & byron, 2015). specifically, because women directors tend to have more education, be from less traditional functional backgrounds, and are more likely to value cooperative decision making styles, and they are most often considered the “external” board member, they may have significant influence on critical board decisions (post & byron, 2015). in fact, post and byron (2015) found that more gender-diverse boards were more engaged in strategic decisions and with ceo monitoring, especially in certain contexts (i.e., countries with higher shareholder protections). our contention is that the higher levels of board monitoring that result from increasing gender diversity will also influence the level of ceo compensation and those factors that are used by boards to determine it. the presence of a minority in a group (in this case women) can prompt divergent thinking (van knippenberg, de dreu, & homan, 2004), not only about the primary topic of conversation, but also on related topics (crano & chen, 1998) by offering unique perspectives that change the assumptions that have implicitly guided the group’s reasoning (nameth, 1986). demographically diverse groups have been described as being more innovative, having a wider range of perspectives, and having greater task-relevant knowledge (pelled, eisenhardt, & xin, 1999; watson, kumar, & michaelson, 1993). diverse groups may, however, have greater conflict (pelled et al., 1999), which may influence various group outcomes, including productivity (gladstein, 1984), performance (pelled et al., 1999), group decision quality (pearson, ensley, & amason, 2002), and strategic decision making (amason & mooney, 1999). therefore, through infusion of different ideas and skills, the introduction of conflict into decision-making processes, and championing tough issues, upper echelon theory would indicate that women can stimulate boards to consider a wider range of problems and potential solutions, including decisions regarding ceo compensation, and they may move the board from an agency to model toward a stakeholder model of governance (e.g., post & byron, 2015). strategic changes such as more corporate philanthropy (williams, 2003), lower levels of risk taking (hutchinson, mack, & plastow, 2015), and more corporate social responsibility (harjoto, laksmana, & lee, 2015) have also been shown to be influenced by board gender diversity. gender diversity is also positively related to more diversity policies and inclusive behaviors by board members (buse et al., 2016). research demonstrates that women are more likely than men to focus stakeholder concerns in several ways. for example, women on boards have greater concern for others and for interpersonal relationships (andrews, 1992). women directors volume 36, number 2 7 are also more likely to be concerned with recruitment, retention, development, and advancement of women (konrad et al., 2008). women directors also support more philanthropic causes than their male counterparts (williams, 2003). further, women directors are more likely to contribute to corporate social responsibility (csr) tasks as compared to operational, financial, and behavioral control tasks (huse, 2009), and diversity in gender, tenure, and expertise on boards may lead to more csr activities (harjoto et al., 2015). because of their divergent focus and past experiences, women are likely to also base their decisions about ceo compensation upon social and community factors (ellwood & carcia-lacalle, 2015), and they will likely attempt to influence the boards to consider these criteria when setting ceo pay. in sum, agency theory promotes primarily financial motives for ceo and board decisions, and, therefore, boards use ceo pay to bring the financial interests of principals and agents into alignment. this is likely the case in less gender diverse boards. upper echelon theory, on the other hand, suggests that board gender diversity will lead to a more robust discussion around executive compensation, resulting in a ceo’s rewards being more closely linked to the outcomes of multiple stakeholders. we argue that adding gender diversity to the board of directors may move the board’s compensation focus from an agency model toward a stakeholder model because of the differing cognitive frames that women on the board contribute. their often-nontraditional background and unique perspectives they bring to the board should drive significantly different approaches to executive compensation, especially with regard to rewarding social responsibility performance. a stakeholder-focused board would, research suggests, tie ceo compensation to the needs of a variety of stakeholders, resulting in increasing compensation for ceos who lead their organizations to higher levels of social performance. in other words, we anticipate an interaction effect between board gender diversity and corporate social performance to predict executive compensation. specifically, we anticipate that ceos will have higher compensation when their board is comprised of more women and the firm has higher levels of social performance, a set of relationships that has not been studied previously. hypothesis: board gender diversity and corporate social performance interact to predict ceo pay, such that boards with greater percentages of women will reward ceos more when their firms have higher levels of social performance. 8 journal of business strategies method sample and data collection our sample is derived from the msci (formerly kld) database and the directorship organization, which includes all firms included in standard and poor’s 500 and is considered the most comprehensive social performance database available for u.s. corporations. the msci/kld database is a primary data source for stakeholder-based research (berman et al.,1999; coombs & gilley, 2005; hillman & keim, 2001; kacperczyk, 2009; turban & greening, 1997; waddock & graves, 1997). consistent with its extensive use, sharfman (1996) established the construct validity of the kld measures while waddock (2003) refers to the kld measures as the “de facto” standard for research in stakeholder management. ceo compensation data were collected from the execucomp database. firmlevel financial and control variables and industry control variables were collected from the compustat database. governance data were collected from directorship’s annual publication and from securities and exchange commission (sec) filings. our final sample yielded an unbalanced panel data set of 1,829 observations across 262 firms for which all variables were available for at least two consecutive years. these firms represented a total of 52 two-digit sic code industries. dependent variables. our primary dependent variables represent three forms of ceo compensation: salary, bonus, and the value of stock options granted during a given year. stock options value was calculated using the black-scholes options pricing model. values for each compensation variable are reported in thousands of dollars (see table 1). the black-scholes methodology is a widely used and validated measure of stock option value (e.g., coombs & gilley, 2005; o’connor et al., 2006), allowing our results to be generalizable to other executive compensation studies (bettis et al., 2016; o’connor et al., 2006). the average ceo in our study had a salary of $740,000, a bonus of $986,000, and received stock options valued at $4.73 million. predictor variables. our predictor variables are board gender diversity and corporate social performance. board gender diversity was measured as the percentage of women on the board. these data were collected from directorship’s annual publications and from sec filings.the boards of directors in our sample averaged 11% women board members, which is consistent with previous research (daily et al., 1999). the average board of directors in our sample was just over 11 individuals, with a range from 0-3 women on each board. . volume 36, number 2 9 we used five corporate social performance measures best reflecting a multiple stakeholder view of the organization (agle, et al., 1999). the five measures include: community relations, diversity, employee treatment, environmental impact, and product-related performance. community relations includes matters related to charitable contributions, support for education, volunteer programs, and so on. diversity addresses issues related to the promotion of women and minorities, women and minority contracting, employment of the disabled, and gay and lesbian policies. with regard to employee treatment, the msci/kld data cover items such as health and safety, benefits, profit sharing, union relations, and so forth. environmental impact includes such issues as recycling, use of clean energy, pollution prevention, and related matters. finally, product-related performance deals with quality, innovativeness, marketing integrity, and providing services/products helping the disadvantaged. these measures have been widely used and described in the literature as valid measures of corporate social performance (agle et al., 1999; coombs & gilley, 2005; hillman & keim, 2001; kacperczyk, 2009; waddock & graves, 1997). consistent with aiken and west (1991), we mean centered our independent variables prior to creating interaction terms. control variables. six control variables were used in the analyses: firm size, ceo ownership, ceo tenure, board size, return on equity, and shareholder returns. prior research has hypothesized or reported a significant relationship between firm size and ceo compensation (belliveau et al., 1996; sanders, 2001). we therefore include a commonly used measure of size, the natural logarithm of sales, to control for this potential relationship. firm size data were collected from compustat. research also suggests higher levels of ceo ownership may influence ceo compensation by making ceos more risk averse (finkelstein, 1992; sanders, 2001). ceo ownership was measured as the percentage of common stock owned by the ceo and was collected from execucomp. ceo tenure may also influence ceo compensation, as ceos tend to be more risk averse as their tenure increases (hambrick & finkelstein, 1995). ceo tenure was measured as the number of days a ceo has held their position at the firm, and these were also collected from execucomp. board size is measured as the total number of board of director members and is expected to be negatively associated with ceo compensation as larger boards are thought to be less effective and more easily influenced by the ceo (jensen, 1993; yermack, 1996). ceo compensation is also believed to be influenced by financial performance (jensen & murphy, 1990). we include two financial performance control variables, return on equity and shareholder return, both of which are measured as percentages. financial performance data were collected from compustat. industry control variables were 10 journal of business strategies also included in our study to increase confidence in our findings. consistent with hillman and keim (2001), industry dummy variables were created at the two-digit sic code level to control for the previously identified relationship between industry affiliation and stakeholder focus (hillman and keim, 2001; waddock and graves, 1997), as well as industry affiliation and ceo compensation (coombs & gilley, 2005). industry data were collected from compustat. endogeneity and reverse causality kacperczyk (2009) noted that prior research testing the relationship between effective governance and corporate attention to stakeholders has been “plagued by concerns about endogeneity” (p. 267). more specifically, the central concern is reverse causality, where significant relationships between governance and corporate attention to stakeholders may result not only from governance’s influence on attention to stakeholders, but also because firms’ stakeholder relationships shape the firm’s governance mechanisms (kacperczyk, 2009). hillman and keim (2001) also highlighted their concern regarding reverse causality between stakeholder management and firm performance. kacperczyk (2009) emphasized that, if not addressed, endogeneity resulting from reverse causality may bias regression coefficients affecting researchers’ ability to properly interpret both significant and non-significant relationships. although a one-year lag, in addition to use of unbalanced panel data provides some assurance that reverse causality is not significantly affecting our results (benner & tushman, 2002), we incorporated hillman and keim’s (2001) suggested process whereby we estimated a 1-year lagged model using return on equity and shareholder return as dependent variables and our five social performance measures as independent variables. our results provided no evidence of a recursive relationship between social performance and ceo compensation. estimation methods given the likelihood that our data contain both firm-specific and time-specific effects, we use a panel estimation procedure (chamberlain, 1982) including a white (1980) heteroskedasticity-consistent variance-covariance matrix. because industry control variables are invariant over time, fixed-effects specifications are improper to use (greene, 1995); therefore, we use a random-effects model with the firm as the primary stratification variable. our panel data set includes a total of 1,829 observations. to eliminate year-specific heterogeneity, we followed bergh’s (1993) suggestion and included year dummy variables in our models. volume 36, number 2 11 table 1 d escriptive statistics and correlations m ean s.d . 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 salary 739.49 382.67 2 b onus 986.05 1745.35 0.35 3 o ptions 4729.04 17536.04 0.11 0.16 4 firm size 8.79 1.27 0.47 0.33 0.15 5 c eo stock o w nership 0.02 0.05 0.01 0.01 0.01 -0.08 6 c eo tenure 2914.66 2665.45 0.01 0.01 0.00 -0.08 0.36 7 b oard size 11.35 3.11 0.22 0.13 -0.01 0.47 -0.14 -0.12 8 r eturn on equity 17.19 73.57 -0.03 0.02 0.00 0.01 0.01 -0.02 0.01 9 shareholder r eturn 19.37 49.43 -0.05 0.07 0.08 -0.03 0.03 0.07 -0.04 0.02 10 b oard g ender d iversity 0.11 0.08 0.14 0.07 0.00 0.21 -0.03 -0.02 0.06 0.01 -0.01 11 c om m unity r elations 0.32 0.76 0.08 0.11 0.02 0.16 0.04 0.04 0.17 0.04 0.04 0.15 12 d iversity 0.70 1.32 0.20 0.17 0.07 0.37 -0.03 -0.03 0.25 0.02 -0.01 0.49 0.28 13 em ployee treatm ent 0.30 0.93 -0.07 0.03 -0.01 0.04 -0.03 -0.04 0.05 0.03 0.01 0.03 0.05 0.16 14 environm ental im pact -0.18 0.97 -0.21 -0.05 0.01 -0.28 0.06 0.09 -0.12 0.01 0.07 0.04 0.19 0.01 0.05 15 product-r elated perform ance -0.20 0.80 -0.31 -0.16 -0.03 -0.36 0.14 0.13 -0.18 -0.02 0.05 -0.07 -0.02 -0.11 0.10 0.28 n ote: c orrelations greater than or equal to 0.05 or less than or equal to -0.05 are significant at p < 0.05 12 journal of business strategies table 2 moderated multiple regression results for board gender diversity and social performance on ceo salary model 1 model 2 model 3 firm size 101.09*** 100.29*** 104.27*** ceo ownership -212.30 -217.13 -201.72 ceo tenure -0.02*** -0.02*** -0.02*** board size -4.18 -4.18 -4.70 return on equity -0.09 -0.09 -0.09 shareholder return 0.09 0.09 0.10 community relations -8.01 -8.15 -3.80 diversity -3.41 -3.45 -2.94 employee treatment -5.79 -5.66 -4.27 environmental impact -20.65** -20.60** -20.44** product-related performance -13.75 -13.56 -8.20 board gender diversity -3.94 -149.07 community x board gender diversity -177.45* diversity x board gender diversity 106.39** employee x board gender diversity -194.79** environment x board gender diversity 42.18 product x board gender diversity -461.88*** f 29.53*** 29.01*** 27.11*** partial f 1.09 2.23* adj.r2 0.45 0.45 0.46 n 1829 1829 1829 unstandardized regression coefficients * p < .05 ** p< .01 *** p< .001 volume 36, number 2 13 table 3 moderated multiple regression results for board gender diversity and social performance on ceo bonus model 1 model 2 model 3 firm size 451.85*** 452.91*** 469.88*** ceo ownership -681.84 -681.00 -779.51 ceo tenure -0.00 -0.00 -0.00 board size -21.43 -21.84 -22.03 return on equity 0.18 0.18 0.20 shareholder return 2.23*** 2.24*** 2.33*** community relations 31.58 31.60 45.48 diversity -4.74 -1.40 -1.16 employee treatment 148.42** 148.21* 148.06** environmental impact -114.28* -113.98* -124.11* product-related performance -5.49 -5.33 -4.32 board gender diversity -150.44 -426.21 community x board gender diversity -558.30 diversity x board gender diversity 866.05** employee x board gender diversity 164.27 environment x board gender diversity -1569.27* product x board gender diversity -1997.36** f 11.42*** 11.23*** 11.02*** partial f 1.04 4.04*** adj.r2 0.23 0.23 0.24 n 1829 1829 1829 unstandardized regression coefficients * p < .05 ** p< .01 *** p< .001 14 journal of business strategies table 4 moderated multiple regression results for board gender diversity and social performance on ceo stock option value model 1 model 2 model 3 firm size 2307.19*** 2351.52*** 2336.16*** ceo ownership -6395.37 -6494.75 -5890.11 ceo tenure 0.02 0.02 0.07 board size -330.26 -353.23 -368.34* return on equity 0.29 0.28 0.39 shareholder return 14.83* 15.08* 16.27* community relations 48.12 45.13 -208.66 diversity -90.90 81.34 121.36 employee treatment -367.13 -381.45 -397.83 environmental impact 450.96 462.22 351.21 product-related performance 324.42 340.47 497.03 board gender diversity -6480.54 -4290.76 community x board gender diversity 7121.90 diversity x board gender diversity 2245.13 employee x board gender diversity 15349.79** environment x board gender diversity -3145.07 product x board gender diversity f 3.11*** 3.11*** 3.25*** partial f 2.47 2.73** adj.r2 0.06 0.06 0.07 n 1829 1829 1829 unstandardized regression coefficients * p < .05 ** p< .01 *** p< .001 volume 36, number 2 15 results descriptive statistics and correlations are presented in table 1. results for our hypothesis tests using each form of ceo compensation as the dependent variable are shown in tables 2-4. because prior research has shown varying relationships between different types of social performance and various forms of ceo compensation (miles & miles, 2013) we report results for ceo salary in table 2, bonuses in table 3, and stock options in table 4. each of our models has variance inflation factors below 4.0, supporting the conclusion that multicollinearity is not a problem in our data set (hair et al., 1995). in tables 2, 3, and 4, each model 1 presents regression results that include the control variables and the various forms of social performance. each model 2 in tables 2 through 4 adds board gender diversity, showing no main effect of board gender diversity on any of the three forms of ceo pay. each model 3 in tables 2, 3, and 4 provides results for tests of our hypothesis, namely, that board gender diversity and corporate social performance interact to predict ceo compensation. to test our hypothesis, we created interaction terms between each of the five types of social performance and the percentage of women on the board. we then tested for the influence of those interaction terms on our three forms of ceo compensation (salary, bonus, and stock options). our results for these tests provide mixed results. as shown in model 3 of table 2, community relations ×board gender diversity, employee treatment × board gender diversity, product performance × board gender diversity are negatively and significantly associated with ceo salary. diversity × board gender diversity is positively and significantly associated with ceo salary. regarding ceo bonus (model 3 of table 3), environmental impact × board gender diversity and product performance × board gender diversity are negatively and significantly associated with ceo bonus, while diversity × board gender diversity has a positive and significant relationship. lastly, employee treatment × board gender diversity is significantly and positively associated with ceo stock options while product performance × board gender diversity is significantly and negatively associated with ceo stock options. plotting the interactions1 sheds additional light on these relationships and provides mixed support for our hypothesis. consistent with our hypothesis, more gender-diverse boards reward ceos with higher salaries when diversity performance is higher. the same holds true with ceo bonuses; boards with greater representation by women reward ceos with higher bonuses when their organization performs 16 journal of business strategies better with regard to diversity. similarly, boards with greater representation of women reward ceos with significantly higher stock options when their organization is more successful in terms of employee-related social performance metrics. given that stock options represent by far the greatest percentage of a ceo’s compensation package in our sample (approximately 73%), this finding is especially important. contrary to our hypothesis, boards with higher percentages of women appear to compensate the ceo less in salary when community performance, employee treatment, and product-related social performance are higher. we also find lower bonuses for ceos in companies with greater board gender diversity when both environmental impact and product-related performance are higher. as noted, in our sample of publicly traded firms, ceo stock options were by far the largest component of executive compensation, comprising nearly threequarters of total pay. moreover, it is clear from our analyses that women on the board exert significant influence when the board is deliberating matters related to the setting of those stock options. specifically, when determining this most important ceo compensation component, boards comprised of more women clearly consider the extent to which the ceo is leading his/her organization to treat its employees well. in contrast, product performance indices produce lower ceo options when there is a greater percentage of women on the board. our results indicate an important influence of women directors on the ceo compensation-setting process, particularly with broader measures of organizational effectiveness and for the single largest component of ceo pay. discussion the purpose of this study was to examine the extent to which ceo compensation is determined by the simultaneous influences of corporate social performance and board gender diversity. despite being one of the most highly researched areas in the field of management, empirical investigations of ceo compensation have neglected the potential effects of board gender diversity, especially with regard to the extent to which diversity may interact with social performance. using upper echelons theory, we argued that, because of the differing cognitive frames that women bring to the board, firms with more gender diverse boards will structure executive compensation consistent with a stakeholder model. more specifically, firms with more gender diverse boards will tie ceo compensation more closely to social performance. our results partially support this contention, and particularly with what is by far the most important component of ceo pay, stock options. volume 36, number 2 17 generally, our results suggest that more gender-diverse boards pay ceos more for higher performance with respect to internal forms of social performance (employees and diversity, for instance), while they pay them less when focused on external social performance measures (such as community relations, environmental impact, and product performance). specifically, for salary and bonus, more gender diverse boards appear to place greater emphasis on the firm’s diversity performance when setting the ceo’s compensation. and, when determining stock options, more gender diverse boards clearly place significant weight on employee treatment by the firm. implications for researchers and practitioners our results provide support for van knippenberg and colleagues’ (2004) assertion that the presence of minority members can spur divergent thinking when making important decisions, as well as harjoto and colleagues’ (2015) finding that diversity on boards leads top management to consider many stakeholders in decision making. gender diverse boards seem to be considering a wider range of inputs to the ceo pay-setting process, which is important to researchers and practitioners alike. women on the board are offering different perspectives, changing conventional wisdom about how to reward chief executives in public companies, and challenging the board’s assumptions (nameth, 1986). our results suggest that, to the extent that women on the board are causing the board to consider a wider range of performance metrics when setting ceo compensation, they have significant contributions to make with regard to reducing agency costs by helping the organization create shared value (porter & kramer, 2011) for multiple stakeholders (harjoto et al., 2015). clearly, this is important to the practice of effective governance. the necessity of inclusive hr practices and climate indicators could explain why more gender-diverse boards value employee treatment when setting stock options for ceos. diversity initiatives and employee treatment are clearly related. essentially, if a company has more women on the board, the company will compensate the ceo more for paying attention to the importance of a culture that truly values diversity at all levels. when ceos are attentive to matters of diversity, they will likely see higher employee satisfaction and morale, more innovativeness and creativity, and higher firm performance (pelled et al., 1999). therefore, our results suggest that, to more fully understand the complex relationships between firm financial performance, social performance, and ceo compensation, researchers must examine board composition variables such as 18 journal of business strategies gender diversity in more detail. in addition, if researchers are to fully understand ceo compensation’s antecedents and consequences, firm performance measurement in governance research needs to move beyond purely financial measures to include measures incorporating dimensions of social performance and matters of concern to other key stakeholders (see hoobler et al., 2016). it is clear that an exclusive focus on the relationship between financial performance and ceo compensation limits our understanding of this important aspect of corporate governance. our results also suggest that ceos with more diverse boards are given different signals than ceos whose boards are more homogenous with regard to making investments in certain aspects of social performance, another important finding for practitioners. at the outset, we suspected that the interaction between various social performance measures and board gender diversity would be consistent across types of social performance and compensation categories. our findings contradict this assumption. the findings indicate that, as boards consider inputs to ceo compensation decisions, women board members are influencing the boards to reward social investments by senior executives targeted toward key stakeholders, which include diverse employees, possibly at the expense of the broader community, the environment, and products. limitations and future research an important limitation of our research is that it does not actually examine the complex interpersonal relationships among board members, or the specifics of how women on boards actually influence the discussions and help change the outcomes, which is a common limitation in board research (hoobler et al., 2016). rather, we have taken a more coarse-grained approach by using ceo compensation as a proxy for those behaviors that boards are rewarding. researchers could extend this line of inquiry by collecting primary data from directors, especially those serving on compensation committees, dealing with the extent to which they value corporate social performance, as well as the extent to which they take measures to reward a ceo for such performance. this may shed light onto why women appear to reward “internal” social responsibility and not “external” social responsibility, which is itself an opportunity for future research. hoobler and colleagues (2016, p. 15) called for more research measuring the “deep-level gender diversity in leadership” by assessing the power differences between men and women in organizations and how these affect communication, decisions, and even perceived position in the organization. this type of focus on specific mechanisms that drive board decisions on important volume 36, number 2 19 factors such as ceo compensation would be invaluable in future research. another area for future research would be to specifically study how the climate for diversity and the “psychological climate of gender inequity (pcgi)” affects board decisions (bernstein & billimoria, 2015; king et al., 2010). king and colleagues (2010) measured how tokenism affects several organizational outcomes, showing that tokenism experienced by women on boards can hurt their psychological ability to perform well. hoobler and colleagues (2016) note that this is a good example of a way for future researchers to study the specific ways that women influence decisions of boards, as well as thinking about how the power differences on the board affect the women who are a part of the system. in addition, we argue that future researchers should use more mixed method studies to examine whether rewarding ceos for firm-level diversity initiatives and employee treatment are related to the subjective experiences of employees from diverse backgrounds throughout the company. another limitation of our study is that the generalizability of our findings is somewhat limited. given that our sample consisted only of the largest publicly held companies in the united states, it remains uncertain whether our results are generalizable to smaller public firms, private firms, non-profit and government agency executives, and firms outside the united states. thus, future research might attempt to collect additional data and develop theory on the dynamic relationships among board gender diversity, social performance, and ceo compensation. conclusion this paper has extended research into the antecedents of ceo compensation by examining the extent to which top executives’ compensation is affected by board gender diversity and its interactions with corporate social performance. our results suggest that board gender diversity plays an important role in the determination of ceo compensation, especially when measures of corporate social performance are considered. specifically, ceos are rewarded for considering diversity initiatives and employee treatment when the board is more gender-diverse. however, ceo pay is reduced when their board has higher levels of gender diversity and they pursue strategies focusing on more external types of social performance. women on the board appear to generate meaningful dialog on the most appropriate ways in which to reward ceos, resulting in boards that consider a much broader variety of performance criteria when setting ceo salaries, bonuses, and stock options. 1 interaction plots are available from the author 20 journal of business strategies references adams, r.b. & ferreira, d. (2009). women in the boardroom and their impact on governance and performance. journal of financial economics, 94(2), 291-309. agle, b.r., mitchell, r.k. & sonnenfeld, j.a. (1999). who matters to ceo’s? an investigation of stakeholder attributes and salience, corporate performance, and ceo values. academy of management journal, 42(5), 507-527. aiken, l.s. & west, s.g. (1991). multiple regression: testing and interpreting interactions. sage publications, newbury park, ca. ali, m., ng, y.l., & kulik, c. (2014). board age and gender diversity: a test of competing linear and curvilinear predictions. journal of business ethics, 125(3), 497-512. amason, a.c., & mooney, a.c. (1999). the effects of past performance on top management team conflict in strategic decision making. international journal of conflict management, 10(4), 340-359. andrews, p.h. (1992). sex and gender differences in group communication: impact on the facilitation process. small group research, 23(1), 74-94. belliveau, m.a., o’reilly, c.a., & wade, j.b. (1996). social capital at the top: effects of social similarity and status on ceo compensation. academy of management journal, 39(6), 1568-1593. benner, m.j., & tushman, m. (2002). process management and technological innovation: a longitudinal study of the photography and paint industries. administrative science quarterly, 47(4), 676-706. bergh, d.d. (1993). don’t ‘waste’ your time! the effects of time series errors in management research: the case of ownership concentration and research and development spending. journal of management, 19(4), 897-914. berman, s.l., wicks, a.c., kotha, s., & jones, t.m. (1999). does stakeholder orientation matter? the relationship between stakeholder management models and firm financial performance. academy of management journal, 42(5), 488506. bernstein, r.s., & bilimoria, d. (2012). diversity perspectives and minority nonprofit board member inclusion. equality, diversity and inclusion: an international journal, 32(7), 636-653. bettis, r.a., ethiraj, s., gambardella, a., helfat, c., & mitchell, w. (2016). creating repeatable cumulative knowledge in strategic management: a call for a broad and deep conversation among authors, referees, and editors. strategic management journal, 37(2), 257-261. volume 36, number 2 21 bilimoria, d. (1997). perspectives on corporate control: implications for ceo compensation. human relations, 50(7), 829-858. burke, r.j. (1993). women on corporate boards of directors. equal opportunities international, 12(6), 5-13. buse, k., bernstein, r.s., & bilimoria, d. (2016). the influence of board diversity, board diversity policies and practices, and board inclusion behaviors on nonprofit governance practices. journal of business ethics, 133(2), 179-191. campbell, k., & minguez-vera, a. (2010). female board appointments and firm valuation: short and long-term effects. journal of management & governance, 14, 37-59. catalyst (2014). women ceos of the s&p 500, catalyst, new york [online], available at: http://www.catalyst.org/knowledge/women-sp-500-companies. chamberlain, g. (1982). multivariate regression models for panel data. journal of econometrics, 18(1), 5-46. chrobot-mason, d., & aramovich, n.p. (2013). the psychological benefits of creating an affirming climate for workplace diversity. group & organization management, 38(6), 659-89. cook, a. & glass, c. (2016). do women advance equity? the effect of gender leadership composition on lgbt-friendly policies in american firms. human relations, 69(7), 1431-1456. cook, a., & glass, c. (2014). women and top leadership positions: toward an institutional analysis. gender, work, and organization, 21(1), 91-103. coombs, j.e., & gilley, k.m. (2005). corporate social performance as a predictor of ceo compensation: direct effects and interactions with financial performance. strategic management journal, 26(9), 827-840. crano, w.d., & chen, x. (1998). the leniency contract and persistence of majority and minority influence. journal of personality and social psychology, 74(6), 1437-1450. daily, c.m., certo, s.t., & dalton, d.r. (1999). a decade of corporate women: some progress in the boardroom. strategic management journal, 20(1), 93-99. day, n.e., & schoenrade, p. (2000). the relationship among reported disclosure of sexual orientation, anti-discrimination policies, top management support and work attitudes of gay and lesbian employees. personnel review, 29(3), 346-365. delacroix, j., & saudagaran, s.m. (1991). munificent compensation as disincentives: the case of american ceos. human relations, 44(7). 665-678. 22 journal of business strategies devers, c.e., cannella, a.a., reilly, g.p., & yoder, m.e. (2007). executive compensation: a multidisciplinary review of recent developments. journal of management, 33(6), 1016-1072. ellwood, s., & garcia-lacalle, j. (2015). the influence of presence and position of women on the boards of directors: the case of nhs foundation trusts. journal of business ethics, 130(1), 69-84. ezzamel, m., & watson, r. (2002). pay comparability across and within uk boards: an empirical analysis of the cash pay awards to ceos and other board members. journal of management studies, 39, 207-232. fairchild, c. (2015). the 23 fortune 500 companies with all-male boards. fortune [online], available at: http://fortune.com/2015/01/16/fortune-500-companieswith-all-male-boards/ finkelstein, s. (1992). power in top management: dimensions, measurement, and validation”, academy of management journal, 35(3), 505-538. freeman, r.e. (1984). strategic management: a stakeholder approach, pittman, marshfield, ma. gladstein, d.l. (1984). groups in context: a model of task group effectiveness. administrative science quarterly, 29(4), 499-518. gleckman, h. (2002), the imperfect science of valuing options: there’s no one way to figure how they affect earnings. businessweek, 28 october 2002: 122. greene, w. (1995). limdep version 7.0 user’s manual, econometric software, plainview, ny. hair, j., anderson, r., tatham, r., & black, w. (1995). multivariate data analysis, prentice-hall, upper saddle river, nj. hambrick, d.c. (2007). upper echelons theory: an update. the academy of management review, 32(2), 334-343. hambrick, d.c., & finkelstein, s. (1995). the effects of ownership structure on conditions at the top: the case of ceo pay raises, strategic management journal, 16(3), 175-193. hambrick, d.c., & mason, p.a. (1984). upper echelons: the organization as a reflection of its top managers. the academy of management review, 9(2), 193206. harjoto, m., laksmana, i., & lee, r. (2015). board diversity and corporate social responsibility. journal of business ethics, 132(4), 641-660. hillman, a.j., cannella, a.a., & paetzold, r.l. (2000). the resource-dependent role of corporate directors: strategic adaptation of board composition in response to environmental change. journal of management studies, 37(2), 235-255. volume 36, number 2 23 hillman, a.j., & keim, g.d. (2001). shareholder value, stakeholder management, and social issues: what’s the bottom line? strategic management journal, 22(2), 125-139. hoobler, j.m., masterson, c.r., nkomo, s.m., & michel, e.j. (2016). the business case for women leaders: meta-analysis, research critique, and path forward. journal of management [first published , 2 march 2016], available at: doi: 10.1177/0149206316628643 huse, m. (2009). “women directors and the ‘black box’ of board behavior,” in vinnicomb, s., singh, v., burke, r., bilimoria, d. and huse, m. (eds), women on corporate boards of directors: international research and practice, edward elgar publishing, northampton, ma, pp.140-151. hutchinson, m., mack, j., & plastow, k. (2015). who selects the ‘right’ directors? an examination of the association between board selection, gender diversity and outcomes. accounting and finance, 55(4), 1071-1103. jacobs, m.t. (1991, cited in main, b.g.m. et al., 1995), short-term america: the causes and cures of our business myopia, harvard business school press, boston, ma. jensen, m. (1993). the modern industrial revolution, exit, and the failure of internal control systems. journal of finance, 48(3), 831-880. jensen, m.c., & meckling, w.h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3(4), 305-360. jensen, m.c., & murphy, k.j. (1990). performance pay and top-management incentives. journal of political economy, 98(2), 225-263. johnson, s.g., schnatterly, k., & hill, a.d. (2013). board composition beyond independence: social capital, human capital, and demographics. journal of management, 39(1), 232-262. jones, t.m., felps, w., & bigley, g.a. (2007). ethical theory and stakeholderrelated decisions: the role of stakeholder culture. academy of management review, 32(1), 137-155. kacperczyk, a. (2009). with greater power comes greater responsibility? takeover protection and corporate attention to stakeholders. strategic management journal, 30(3), 261-285. king, e.b., hebl, m.r., george, j.m., & matusik, s.f. (2010). understanding tokenism: antecedents and consequences of a psychological climate of gender inequity. journal of management, 36(2), 482-510. 24 journal of business strategies konrad, a.m., & goldberg, c.b. (2010). asymmetrical demography effects on psychological climate for gender diversity: differential effects of leader gender and work unit gender composition among swedish doctors. human relations, 63(11), 1661-1685. konrad, a.m., kramer, v., & erkut, s. (2008). critical mass: the impact of three or more women on corporate boards. organizational dynamics, 37(2), 145-164. lorsch, j. (1989, cited in main, bgm et al., 1995), pawns or potentates: the reality of america’s boards, harvard business school press, boston, ma. main, b.g., o’reilly, c.a., & wade, j. (1995). the ceo, the board of directors, and executive compensation: economic and psychological perspectives. individual and corporate change, 4(2), 293-332. mcconvill, j. (2006). executive compensation and corporate governance: rising above the ‘pay-for-performance’ principle. american business law journal, 43(2), 413-438. mcinerney-lacombe, n., bilimoria, d., & salipante, p.f. (2009). “championing tough issues: how women corporate directors contribute to board deliberations”, in vinnicombe, s., singh, v., burke, r., bilimoria, d. and huse, m. (eds), women on corporate boards of directors: international research and practice, edward elgar publishing, northampton, ma, pp. 123-139. miles, p.c., & miles, g. (2013). corporate social responsibility and executive compensation: exploring the link. social responsibility journal, 9(1), 76-90. nameth, c.j. (1986). differential contributions of majority and minority influence. psychological review, 93(1), 23-32. nguyen, h., & faff, r. (2012). impact of board size and board diversity on firm value: australian evidence. corporate ownership and control, 4, 24-32. o’connor, j.p., priem, r.l., coombs, j.e., & gilley, k.m. (2006). do ceo stock options prevent or promote corporate accounting irregularities? academy of management journal, 49(3), 483-500. ogden, s., & watson, r. (2008). executive pay and the search for legitimacy: an investigation into how uk remuneration committees use corporate performance comparisons in long-term incentive pay decisions. human relations, 61(5), 711-739. oxelheim, l., & clarkson, k. (2015). cronyism and the determinants of chairman compensation. journal of business ethics, 131(1), 69-87. pearson, a.w., ensley, m.d., & amason, a.c. (2002). an assessment and refinement of jehn’s intragroup conflict scale. international journal of conflict management, 13(2), 110-126. volume 36, number 2 25 pelled, l.h., eisenhardt, k.m., & xin, k.r. (1999). exploring the black box: an analysis of work group diversity, conflict, and performance. administrative science quarterly, 44(1), 1-28. pepper, a., gosling, t. & gore, j. (2015). fairness, envy, guilt and greed: building equity considerations into agency theory. human relations, 68(8), 1291-1314. pettigrew, a. (1992). on studying managerial elites. strategic management journal, 13, 163-182. pfeffer, j. (1972). size and composition of corporate boards of directors: the organization and its environment. administrative science quarterly, 17(2), 218229. pichler, s., ruggs, e., & trau, r. (2017). worker outcomes of lgbt-supportive policies: a cross-level model. equality, diversity and inclusion: an international journal, 36(1), 17-32. porter, m.e., & kramer, m.r. (2011). creating shared value. harvard business review, 89(1/2), 62-77. post, c., & byron, k. (2015). women on boards and firm financial performance: a meta-analysis. academy of management journal, 58(5), 1546-1571. richard, o.c., & miller, c.d. (2013). “considering diversity as a source of competitive advantage in organizations”, in roberson, q.m. (ed.), the oxford handbook of diversity and work, oxford university press, new york, ny, pp. 239-251. sanders, w.g. (2001). behavioral responses of ceos to stock ownership and stock option pay. academy of management journal, 44(3), 477-492. shankman, n.a. (1999). reframing the debate between agency and stakeholder theories of the firm. journal of business ethics, 19(4), 319-334. sharfman, m. (1996). the construct validity of the kinder, lydenberg & domini social performance ratings data. journal of business ethics, 15(3), 287-296. shrader, c., blackburn, v., & iles, p. (1997). women in management and firm financial performance: an exploratory study. journal of managerial issues, 9, 355-372. sheridan, a., ross-smith, a., & lord, l. (2014). institutional influences on women’s representation on corporate boards: an australian case study. equality, diversity, and inclusion: an international journal, 33(2), 140-159. turban, d.b., & greening, d.w. (1997). corporate social performance and organizational attractiveness to prospective employees. academy of management journal, 40(3), 658-672. 26 journal of business strategies van knippenberg, d., de dreu, c.k.w., & homan, a.c. (2004). work group diversity and group performance: an integrative model and research agenda. journal of applied psychology, 89(6), 1008-1022. waddock, s. (2003). myths and realities of social investing. organization & environment, 16(3), 369-380. waddock, s., & graves, s. (1997). the corporate social performance-financial performance link. strategic management journal, 18(4), 303-319. walsh, j.&, seward, j.k. (1990, cited in main et al., 1995). on the efficiency of internal and external corporate control mechanisms. academy of management review, 15(3), 421-458. watson, w., kumar, k., & michaelson, l. (1993). cultural diversity’s impact on interaction process and performance: comparing homogeneous and diverse task groups. academy of management journal, 36(3), 590-602. white, h. (1980). a heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticy. econometrica, 48(4), 817-838. williams, r.j. (2003). women on corporate boards of directors and their influence on corporate philanthropy. journal of business ethics, 42(1), 1-10. yermack, d. (1996). higher market valuation for firms with a small board of directors, journal of financial economics, 40(2), 185-211. zahra, s.a., & pearce, j.a. (1989). boards of directors and corporate financial performance: a review and integrative model. journal of management, 15(2), 291-334. brief biographical sketch of authors k. matthew gilley, ph.d., holds the bill greehey chair in ethics and corporate social responsibility in the greehey school of business at st. mary’s university. his research has been published in academy of management journal, strategic management journal, journal of international business studies, journal of management, journal of business ethics, and many other outlets. kelly pledger weeks, ph.d., is assistant professor of management at rhodes college in memphis, tennessee. her research focuses on various aspects of diversity and inclusion in the workplace, including issues of race/ethnicity, lgbtq issues, and generational differences. her work has been published in harvard business review, journal of applied psychology, journal of business ethics, and equality, diversity, and inclusion, among others. volume 36, number 2 27 joseph e. coombs, ph.d., is associate professor of management and academic director for entrepreneurship programs in the school of business at virginia commonwealth university where he teaches courses in entrepreneurship and strategic management. his research has been published in premier academic journals including academy of management journal, entrepreneurship theory and practice, journal of business venturing, journal of engineering and technology management, strategic entrepreneurship journal, and strategic management journal. myrtle p. bell, ph.d., is professor of management at the university of texas at arlington. her research considers a wide range of diversity and social issues and appears in such outlets as equality, diversity and inclusion, human resource management, journal of organizational behavior, and academy of management journal. her book diversity in organizations, a comprehensive, research-based book for teaching and learning about diversity, is in its third edition. don kluemper, ph.d., is associate professor of management and director of the institute for leadership excellence and development (ilead) at the university of illinois at chicago. don’s research has been published in outlets such as journal of applied psychology, journal of management, personnel psychology, organizational behavior and human decision processes, journal of organizational behavior, and leadership quarterly, and his research has been featured in media outlets including the wall street journal and national public radio. gwbal strfjegifs for 1he f\rrure: large vs. small business joel corman sulfolk university boston, massachusetts robert n. lussier springfield college springfield, massachusetts robert lv. baeder university of new haven new haven, connecticut introduction most of the scholarly articles on global strategies are relevant to the large corporation, but not to the small business. in this article the authors take a new approach by contrasting global strategies for the large vs. small business, with practical strategies for the small business person interested in taking his or her firm global. why businesses must go global peter drucker [4, p.50] was asked, "apart from the heads of big multinationals, how much should the average ceo worry about the global company?" isn't the domestic market still most companies' bread and butter?" his response was ''the other day, i read a nice quote by a distinguished economist who said that in five years there will be only two kinds of economists those who think in terms of a world economy and those who are unemployed. the same is true of ceos, even of small companies. if you don't think globally, you deserve to be unemployed and you will be." up until the mid-'30s there were practically no national companies except very large ones. but suddenly, an adhesive manufacturer in new england found that he had competition from an adhesive manufacturer in california. the same was true in many industries. a good many companies that did not understand what was happening went under. even the small ones had to learn to think nationally. small, midsize, and large companies must all go global. however, it is actually easier for midsize and small companies to operate without much regard for national boundaries than large firms. most large multinationals do not have global cultures; it is generally easier for the young midsize and small companies to change cultures. and small companies can usually change faster than large companies. small companies are barely visible politically. according to drucker [4] the most successful global companies are small specialists; they are niche players with one product or product line. a good example is service master, a chicago company specializing in maintenance and consumer service products. it is fall 1991 corman, lussier & baeder: global strategies 87 increasing its number of contracts in japan and the united kingdom, as well as the united states. service master and many other midsize and small companies in manufacturing, banking, insurance and building contractors are expanding throughout the globe. domestic companies even companies that are purely domestic must at least think globally and act locally. managers must realize that what happens in other countries affects their business either directly or indirectly. managers must understand how world events, like foreign-exchange rates, affect their businesses and know how to deal with these changes. all companies must keep the global competitors from gaining advantage in their home country to keep from being forced out of business. large vs. smau global business strategies in this section six critical areas for global success are presented, contrasting the large vs. small business applications. there are six critical areas for success: global management team, global strategy, global operations, global technology and r&d, global financing and global marketing. global management thain large successful global corporations strive to have top-level executives from around the world provide a world view. multinational companies realize that it is important to have managers from the home country who are familiar with its business practices, customs, and etiquette. trying to impose american ideas abroad, without modification, can ultimately lead to failure. however, the small firms often do not have, and cannot afford to hire, foreign managers. in place of foreign managers small businesses can use the services of consultants and agents. consultants can be american or foreign. a united states consulting firm with offices in the soviet union has encouraged a number of mid-hudson valley companies in new york state to export products to the soviet union. the help of a consultant is needed by these small firms who are not familiar with the complicated language, tariffs, and exchange barriers of the soviet union. according to lee [12], who has sold to different cultures for over 15 years without specialized staff, effective decisions can be made from the domestic office with only the aid of agents. lee states that it is not difficult to find sic codes, regulations, specifications, and overall cultural acceptance for one's products through reliable agents. picking the correct agent is crucial for global relations. lee makes decisions based on foreign agents' information from environmental scanning to market trends. successful globalization begins at the top. the ceo must be strongly committed to taking the firm global. part of this commitment involves learning about foreign business diplomacy. to operate globally a company must understand its foreign customers. to this end, there are available various publications, seminars and agencies. a few sources of informations on training include the business council for international understanding at the american university; the david kennedy center for international studies at brigham 88 journal ofb~iness strategies vol. 8, no.2 young university; going international inc. of san francisco, the american management association of new york, and the international society for intercultural education training and research in washington, d.c. many successful multinationals believe that top managers cannot understand other cultures unless they spend some time in those countries on a regular basis. an american will have limited ability in designing products, such as furniture, that will be sold in europe and japan if s/he has never been in japanese homes. the cost of extensive travel may be a negligible part of what is spent on advertising and other expenses. global strategy there are three major strategies for going global: • direct investment • contractual agreement • exporting direct investment is often the choice of large global multinational corporations. multinationals establish their own businesses or may buy existing foreign companies through acquisitions and mergers. however, most small businesses find it difficult to finance such deals through direct investment. exporting and contractual agreement are often more appropriate for the small business. contractual agreements include a variety of business deals, a few of which include licensing, contracting, swapping of new products and models, supply agreements, cooperative r&d, and joint ventures. many large multinational corporations have also developed many of these contract agreements, particularly joint ventures. the joint venture is a viable alternative to wholly-owned subsidiaries in foreign countries for the small business. joint ventures usually require a direct investment, and result in a loss of control. however, they are less risky in determining the ability to penetrate unfamiliar markets. joint ventures help reduce the difficulties resulting from differences in taste, shopping habits, and business conditions. joint ventures also enable the american firm to work with a company overseas which is already familiar with the language and culture, and has an established clientele. ejq>orting comprises a major part of how small businesses obtain global stature. exporting is considered the minimum financial risk approach. the firm finds one or more buyers in one or more foreign countries for its product or service. mockler [14] recommends exporting when the sales potential for the target market is high, the estimated production costs are lower at home, product adaptability requirements are not needed or are simple, import and export restrictions are favorable, raw materials are less costly, the political climate abroad is relatively unstable, and the firm has limited financial resources. the small firm can use a combination of strategies. for example, overseas corporation of birmingham, alabama, specializes in solid waste handling systems. overseas offers its customers and partners three choices: 1. it will act as a true exporter by selling a complete solid-waste unit. 2. overseas will sell technical components that can be assembled and integrated locally. 3. it offers licensing agreements, and it will supervise the construction of the waste system. fall 1991 corman, lussier & baeder: global strategies 89 global operations and products many of the major multinational corporations have operating facilities in all the major cowltries with which they do business, or are moving in that direction. for the small firm this is not possible. however, the small firm could work to develop joint ventures in more cowltries as part of its global strategy. major multinationals strive to develop global operations in order to be viewed as "good citizens" who provide jobs to local workeis. local production offeis protection from import quotas and tariffs. small companies are not at such a large risk because they are barely visible politically. they can also create market niches to deflate a certain amount of protectionism. major multinational corporations are also striving to develop global products that rew quire little adaptation to local markets. small firms can also standardize their products. standardized global products can be an area that becomes a differential advantage for the small business niche player. small companies can usually change faster than large companies. while the multinational wants to view the customers from different countries as being the same, the small frrm can cater to cultural differences such as aesthetic sensibilities, languages, electrical currents, and weights and measures. the small firm can capitalize on flexibility to meet unique needs that the large firms overlook. products that offer reliability and quality, delivered promptly, are of paramount importance to foreign customers. the small firm can also work towards standardization of unique products. for exw ample, econocorp, was founded by dick lee as a manufacturer of packaging machines to fit special production needs. when econocorp went global, lee turned from an engineering service to a product oriented company, with greater concern for marketing of the product. econocorp is currently producing all new machine designs with metric measurements and converting all old designs to metric as well. lee is targeting a centralized product design for special production needs, in preparation for europe 1992. lee's top concern with his overseas products are quality and delivery dates. he attributes expansion of sales and networking to product quality. global technology and r&d less than 50 percent of the world's technological innovations can legitimately lay claim to the "made in american" slogan, down from 80 percent mthe 1950's. large multinationals search the world for the latest and best technology. they do not adhere to the not-invented-here mentality. multinationals tend to have large budgets for technology and r&d. they search the globe for low-cost sites for r&d. some countries including israel, ireland, and canada offer attractive government r&d subsidies and ample, well trained english-speaking researchers. other cowltries offer more attractive wage-rates. india is making a concerted effort to market its software-developed capabilities to firms worldwide. these types of sites may be fowld by contacting the foreign commerce departments. the small firms tend to have small, or no, budgets for r&d. with limited research capability it is important to scan the globe for the latest technology, and to be able to operationalize it quickly. small american firms can choose to copy the latest technology, rather than develop it. 90 journal ofbusiness strategies vol. 8, no.2 global finance large multinationals search the world markets to get the best rates and terms for longterm financing. generally, small firms will not be able to borrow from one foreign country and invest it in another. american businesses looking for united states loans to go global should consider the export-import bank of the united states eximbank is the government agency responsible for aiding the export of united states goods and services through a variety of loan guarantees and insurance programs. to encourage small businesses to sell overseas, eximbank maintains a special office to provide information on the availability and use of export credit, insurance, guarantees, direct and intermediary loans extended to finance the sale of united states goods and services abroad. the bank offers briefing programs available to the small business community. the program includes group briefing and individual discussions held both within the bank and around the country. however, before selecting a foreign country to do business in, financing should be considered. small firms may be able to get loans in taiwan and japan at about one half the united states rates. with the tight money situation in america, it may be easier to get a loan in foreign countries. global marketing the 1aige multinational corporations have the resources to perform all marketing functions on a global basis. for the small business this is not always possible. there are several sources the small business firm can tum to for help to find market niches for the same products and services it offers in the united states: ey>ort-management companies (emcs) are united states based companies that specialize by product group or country. for the american firm which does not have the time to do international marketing, the emc will do just about everything from locating markets and distributors to getting products through foreign government approval processes. agents provide various services including: • market investigation and strategic location recommendations. • technology support. • operations development. • strategic alliances. • administration from employee travel to interviewing. • sales and marketing forces. • product or service representatives. • business planning. • sales consulting and identification of appropriate trade shows. agentldistributor services (ads) are currently used by small multinational companies [6]. ads was established by the department of commerce to aid united states firms in locating overseas sales representatives. this agency will locate, screen, and help evaluate agents, distnbutors, representatives and other foreign partners for american businesses. this service has advantages for the company with limited financial and manpower resources. in addition, business people in other countries are more comfortable dealing with a company introduced to them by the government. fall 1991 corman, lussier & baeder: global strategies 91 once a group of candidates has been found, companies using this service are required to travel to the foreign nation to review and interview these applicants and make selections. after the selection has been made, training begins. the agents learn about the company products and support services. before the company representatives leave the country, a reception is held by ads to announce the selections. the announcement will be a form of publicity that may start inquiries about the product and company. although ads does not guarantee finding successful agents in other countries, it does provide indirect advertising. foreign business becomes aware of the product or service and may contact the company at a future date. the use of ads has been complimented as the most useful mechanism to screen out the best qualified agents, it saves a company time, money, and effort. pan-data systems used ads as a primary step in going global and found it advantageous. it plans to use ads to expand to three other countries. clifton and leon brown, export agents, used ads. subsequently they discovered that three companies in italy are interested in their products. trade shows are also an effective way of networking. these trade shows contain top product offerings within an industry from around the world. potential buyers come to see the products. sales transactions and future sales meetings take place at these trade shows. networking is important in foreign sales. one method of networking is to become a member of a local trade center. the world trade center network is a computerized trading and communications data base linked to more than 100 trade centers and their subscribing companies worldwide. advertising in industry publications may also lead to global business transactions. developing the global strategy becoming a successful small global business depends upon the determination and commitment of the entire organization. management must be committed to devoting time for planning and implementation. preparation often takes six to eight months. after the commitment to expand globally has been made, top management should develop a master strategy. the strategies should be reviewed in the six critical areas for success. the starting place is the analysis of the firm's capabilities. does the firm have the products and/or services with the potential to go global? if yes, which foreign market(s) will be targeted for penetration? which global strategy (direct investment, contractual agreements, exporting, or a combination) is most appropriate for the firm? next, the market entry strategy should be developed along with appropriate export and transaction procedures. sources of assistance when a small business developes a global strategy, export-management companies and/ or agent/distnbutor services can be very helpful sources of assistance. another souicc is the small business administration, which provides free export counseling via the service 92 journal of business strategies vol. 8, no.2 corps of retired executives of active corps of executives. obstacles small businesses face many obstacles in developing a global strategy. a small business subcommittee on export, tax policy and special problems held an oversight hearing last year. different small business people and federal agency representatives testified by identifying several major barriers to the house subcommittee. some of the most common obstacles were: lack of information available for small businesses capable of exporting, a shortage of marketing export information, a high "hassle-factor" that discourages exports, insufficient financing options, and intense foreign competition. additional problems identified were lack of tax incentives and the language barriers. assistance is available to help overcome these obstacles. there are an estimated 2000 export services available to small business owners. additionally, a nationwide support network has sprung up to offer assistance to u.s. exporters. it supplements the activities of the international trade administration (ita) of the u.s. department of commerce and other federal agencies. state governments have also moved decisively into export promotion, so have local chambers of commerce, port authorities, universities, district export councils, world trade clubs, and various other organizations. to reiterate, the most successful global companies are small specialists the niche players with one product, or product line. effective decisions can be made domestically if the critical success strategies are implemented. the authors have presented the strategies employed by successful global companies; however, the firm must tailor strategies to its specific needs and timing. blind imitation and wholesale adoption of other company methods may end in failure. smad business must learn from others, but build their own program for success. references 1. baty, g.b. entrepreneurship for the nineties. englewood cliffs, nj: prentice hall (1990). 2. bidlake, s. "reaching across the seas." marketing uk (october 5, 1989), pp. 31-32. 3. ''fifty firms share export techniques." business america, vol 109 (september 12, 1988), p.16. 4. drucker, p. "''the new world according to drucker." business month vol. 133, no.5 (may 1989), pp. 50-56. 5. eckerson, w. "big finns should aspire to small company flexibility." network world, vol. 6, no. 8 (february 27, 1989), pp. 27-28. 6. glover, k. "linking u.s. exporters with overseas buyers: agentidistributor service." business america, vol. 110, no. 22 (november 1989), pp. 2-5. fal11991 corman, lussier & baeder: global strategies 93 7. glover, k "oo's and taboos." business america vol. m, no. 15 (august 13, 1989), pp.2-8. 8. hampton, w. '''the long ann of small business." business week vol. n3040 (febru~ ary 29, 1988), pp. 63-66. 9. hyatt, j. "exporting the risk." inc., vol. 12, no. 11 (november 1990), pp. 163-64. 10. kainen, b. and roha, r. ''taking your small business global." oianging times (december 1989), pp. 103-10. 11. keefe, g.l. "helping qients prepare for global markets." journal of accountancy, vol. 168, no. 1 (july 1989), pp. 54-64. 12. lee, r. founder and president of econocorp, personallnterview, "how to take the small firm global," (october 1990). 13. lussier, r.n., baeder, r.w. and connan, j. "how global is your company?" paper not published. 14. mockler, rj. "strategic planning for multinationally operations: the decision making process involved." business research institute (august, 1990), no. wp9os-4. 15. poorsoltan, k "stay home, plunge, or take the middle path: a global strategy for small business," advanced management journal, vol. 53, no.1 (winter 1990), pp. 4247. 16. sisisky, n. "small business: obstacles to exporting," business america, vol. 110, no. 9 (may 8, 1989), pp.5-7. 17. sloan, p. and graham, j. "retail marketing: international intriguing: buddy system makes sence." advertising age, vol. 61, no.5 (january 29, 1990), pp. sl-2. 18. u.s. small business administration, federal register, 13 cpr part 121. 19. u.s. small business administration, "market overseas with u.s. government help business development publication," pp. 1-12. global strategies for the future: large vs. small business expressing organizational dissent: the role of ethical ideology and corporate ethical values sean valentine university of wyoming laramie, wy kimberly young citation-mabry company beaumont, tx lorissa bailey life resource community mental health center beaumont, tx naser barhoum lamar university beaumont, tx stacy labure roche labs, inc. beaumont, tx natasha glover federal prison industries beaumont, tx peter isaac east texas pathology laboratory beaumont, tx abstract using a sample of 101 employees from a community-based health care agency in the southern u.s., we empirically examined the relationships between organizational dissent and idealism, relativism, and corporate ethical values. the results indicated that idealism and dissent were negatively related, relativism and dissent were unrelated, and corporate ethical values and dissent were positively associated. the findings suggest that both individual and organizational factors should be noted when assessing dissent. individual judgments concerning the ethics or morality of specific actions are typically the focus of ethical decision-making studies. models produced 72 journal of business strategies vol. 18, no.1 in these studies generally propose a causal linkage between ethical judgments regarding an action and an individual's behavioral intentions (barnett, bass & brown, 1994; dubinsky & loken, 1989; hunt & vitell, 1986; jones, 1991) or an individual's actual behavior with regard to ethical issues (barnett et ai., 1994; trevino, 1986). forsyth (1992) states that judgments are influenced by personal moral philosophies such as idealism, which relates to the concern for others, and relativism, which refers to the rejection of common moral rules. in addition to personal moral philosophies, contextual factors such as rewards, rules, and codes also influence ethical decisions (trevino, butterfield & mccabe, 1998). corporate ethical values, which are comprised of many contextual factors, estahlish ethical standards that influence individual choices (conner & becker, 1975; hunt, wood & chonko, 1989; jansen & von gilnow, 1985), and they have been theorized to influence individual actions in organizations as well (hunt et ai., 1989; yankelovich, 1971 ). dissent, which is a form of indi vidual behavior, has also received considerable attention by hoth practitioners and scholars in the past two decades (ncar, baucus & miceli, 1993). dissent is an individual's expression of disagreement with an organization's practices, policies and operations (kassing, 1998), and serves as a form of corrective employee feedback (hegstrom, 1995), which is necessary for organizational success (kassing, 1998; thompkins, 1977). since personal moral philosophies and organizational ethical values are theoretically linked to ethical judgments, the purpose of this study is to investigate the role of dissent in ethical issues by examining how idealism, relativism, and corporate ethical values influence the expression of dissent. figure i outlines the study's framework and intent. organizational dissent kassing (1998) defines dissent as a multi-step process that involves feeling apart from one's organization and is driven by (1) the recognition of wrongdoing, (2) the need for intervention, (3) perceived responsihility, and (4) the screening of alternatives. dissent is essentially an individual's expression of disagreement with an organization's practices, policies, and operations (kassing, 1998). the majority of the research on dissent has failed to consider the entire range of dissenting hehavior, with most studies focusing on whistle-blowing (dozier & miceli, 1985), which is an extreme case of dissent (kassing, 1998). whistle-hlowing involves the disclosure of unethical practices to people both inside and outside of the organization who possess the ability to initiate change (miceli & ncar, 1985; redding, 1985; stewart, 1980). although such actions may present a threat to the formal chain-of-command (stone, 1975), whistleblowing can improve long-term organizational effectiveness (brief & motowidlow, 1986). spring 2001 valentine et at.: expressing organizational dissent figure 1 an ethics framework of organizational dissent ethical ideologies 73 idealism relativism ethical context corporate ethical values organizational dissent dissent is broader than whistle-blowing in terms of the audiences to whom disagreements are expressed (kassing, 1998). it is considered to be an antecedent to whistle-blowing because whistle-blowers tend to express their disagreements within the organizations initially and only turn to public, external sources when organizations are unresponsive to their concerns (stewart, 1980). kassing (1998) argues that many employees assess available strategies for expressing dissent in response to individual, relational and organizational influences, and that they actually express dissent after considering whether they will be perceived as adversarial or constructive and the likelihood that they will be retaliated against for expressing dissent. kassing (1998) also suggests that individuals use articulated, latent, and displaced methods for expressing dissent. articulated dissent involves expressing concerns directly and openly with management, supervisors, and corporate officers who can effectively adjust the wrongdoing within organizations and occurs when employees believe that they will be perceived as constructive and that their dissent will not lead to retaliation. latent dissent involves expressing dissent about personal-advantage issues to people who are captive or influential, 74 journal of business strategies vol. 18, no.1 and occurs when employees believe that they will be perceived as adversarial but also feel they have some safeguard against retaliation. and finally, displaced dissent involves expressing dissent to external audiences (like spouses/partners, family members, and non-work friends) and/or to ineffectual internal audience (like fellow coworkers who have no ability to address the dissent concern directly). displaced dissenters believe that their behavior is pcrccived as adversarial and will he answered with retaliation (kassing, 1998). ethical ideology personal moral philosophies have heen linkcd to ethical decisions (barnett, bass & brown, 1996, 1994; forsyth, 1992, 1980; hunt & vasquez-parraga, 1993; hunt & vitcll 1993, 1986; schlenker & forsyth, 1977). a personal moral philosophy is defined as a sct of beliefs, altitudes, and values that provide a framework for considering ethical dilemmas (barnett ct ai., 1994), and they offcr guidance to individuals as they make ethical judgments (forsyth & nyc, 1990). more specifically, forsyth (1992) concluded that moral philosophies might influence judgments of certain business practices and decisions to engage in those practices. there are many individual personal philosophies (forsyth, 1992), hut the ethics literature focuses particularly on relativism and idealism. a highly relativistic individual espouses a personal moral philosophy based on skepticism, which assumes "that it is impossible to develop or follow universal principles" when making decisions (barnett et ai., 1994, p. 471). highly relativistic individuals feel that moral actions depend on the nature of the situation and the individuals involved so that when judging others, they weigh the circumstances more than the ethical principle that was violated. thus, individuals scoring high in relativism tend to reject the notion of an overriding moral code (barnett et ai., 1994; vitcll, rallapalli & singhapakdi, 1993), and individuals scoring low in relativism support only those moral actions that are founded in moral principle, norms, or law (forsyth, 1992). idealism describes a concern for others, and highly idealistic individuals believe that morally "right" behavior leads to good or positive consequences (vitell et ai., 1993). a highly idealistic individual feels that harming others is always avoidable and will not act in a manner that leads to negative consequences. a low idealistic individual believes that harm will sometimes be necessary to produce good (forsyth, 1992, 1980; schlenker & forsyth, 1977). consequently, forsyth (1980) describes a model of personal moral philosophy that focus on both principles and consequences. empirical studies generally suggest that individuals who subscribe to different ethical ideologies vary in their judgments of ethical issues (barnett, bass & brown, 1998; barnett et ai., 1994; forsyth, 1981; forsyth & pope, 1984). forsyth (1980) concluded that students scoring high in idealism and low in relativism tended to judge ethical issues harsher than other students. barnett et al. (1994) examined how business students' ethical ideologies affected their spring 2001 valentine et al.: expressing organizational dissent 75 ethical judgments in various business situations. results indicated that highly idealistic individuals' judgments were harsher compared to those from others, while individuals classified as low idealists and high relativists were the most lenient in their ethical judgments. and finally, barnett et al. (1998) concluded that individuals classified as highly idealistic and non-relativistic judged ethical issues more harshly than other individuals using a national sample of marketing professionals (barnett et al., 1998). the relationship between ethical ideology and intention to report a peer's wrongdoing has been explored (barnett et al., 1996). peer reporting involves telling an authority figure about a person's unethical actions and is considered a specific type of whistle-blowing (trevino & victor, 1992). barnett et al. (1996) found that individuals who were classified as highly idealistic and low relativistic were more likely to consider reporting a peer's cheating as ethical. individuals who believed reporting a peer's cheating was ethical were more likely to say they would report a peer's cheating. since the theory of reasoned action suggests that individuals' attitudes or judgments influence their behavioral intentions, and that behavioral intentions are predictive of behavior (ajzen & fishbein, 1980), there is reason to believe that ethical ideology may also influence dissent. highly idealistic individuals are generally concerned with the welfare of others. trevino and victor (1992) found that these individuals are more likely to perceive peer reporting as ethical when the wrongdoing has the potential to harm the group as a whole. forsyth and nye (1990) found that low relativistic individuals were less likely than high relativists to violate a social norm for personal gain. similarly, barnett et al. (1996) suggested that individuals scoring high in relativism may be more likely to excuse unethical behavior if it is self-beneficial, and therefore, be less likely to be a whistleblower than a low relativist. based on the above discussion, the following hypotheses are presented: hypothesis 1: idealism will be positively related to organizational dissent. hypothesis 2: relativism will be negatively related to organizational dissent. corporate ethical values liedtka (1991) indicated that people rather than organizations make decisions. however, organizations do have core values that represent the corporate principles and beliefs, and these values play an important role in individual decisions (hunt et al., 1989; liedtka, 1991; schein, 1985; selznick, 1957). corporate values are a major facet of corporate culture (hunt et al., 1989), which tends to define what is and is not appropriate behavior within an organization (akaah, 1993; akaah & riordan, 1990; trevino 1986). corporate ethical values are a 76 journal of business strategies vol. 18, no. i composite of managers' ethical values and the formal and informal ethics policies of an organization, and they establish and maintain ethical standards by which individual choices are influenced (conner & becker, 1975; hunt et ai., 1989; jansen & von glinow, 1985). according to trevino and youngblood (1990), such an ethical culture encourages ethical behavior through various formal and informal social networks. weaver, trevino, and cochran (1999) state that organizational ethical values can be defined through control theory and managerial choice theory. control theory outlines the scope of the ethics program and its compliance structure, while managerial choice theory suggests that various environmental factors and the level of managerial commitment to ethics programs influence the characteristics of the program. weaver et al. (1999) conclude that while control theory is instrumental in the formation of ethical programs, management and environmental factors influence the program's dimensions. trevino, weaver, gibson and toffler (1999) emphasize that although control theory is important, a values-based approach for ethics programs ensures a stronger commitment to ethical behavior. although it is important for employees to recognize ethical issues, it is even more imperative for them to act ethically. in addition, employees need to be comfortable enough with their supervisors to discuss ethical issues without the fear of punishment. with supervisory support, trevino et al. (1999) note that companies can develop and successfully implement ethics programs. several u.s. corporations have implemented formal ethics programs, many of which have varying characteristics. ethics programs typically include ethics codes, ethics committees, communications systems, ethics officers, training programs, and various disciplinary procedures. although the amount of control over these programs varies by organization, they are generally developed to monitor ethical conduct and to punish those who do not abide by set standards. weaver et al. (1999) refers to such programs as compliance+oriented. alternatively, values-oriented ethics programs focus on the development of shared values that encourage ethical conduct. empirical efforts have generally highlighted a consistent relationship between organizational ethical values and ethical behavior. gaertner (1991) found that a number of ethical climate dimensions influenced ethical decision-making indirectly. trevino et al. (1998) concluded that various measures of ethical context were strongly associated with both individual behavior and commitment. sims and keenan (1998) concluded that external whistleblowing was influenced by both organization and individual characteristics. and finally, a number of studies (conner & becker 1975; haberstroh & gerwin, 1972; hunt et ai., 1989; jansen & von glinow, 1985; trevino et ai., 1998) have also indicated that there is a relationship between various types of corporate ethical programs and employee behavior. based on previous empirical efforts, the following hypothesis is presented. spring 2001 valentine et al.: expressing organizational dissent hypothesis 3: corporate ethical values will be positively related to organizational dissent. methods 77 data were obtained by means of a self-administered questionnaire distributed to approximately 250 employees employed at a community-based health care agency in the southern united states, and a sample of 101 respondents was obtained. the total survey count yielded an approximate response rate of 40%. the questionnaire included the ethical position questionnaire (epq), the corporate ethical values scale (cev), the organizational dissent scale (ods), and various items that measured demographic and professional characteristics. examples of scale items are provided in appendix a. forsyth (1980) developed the epq to evaluate an individual's personal moral philosophy and to tap the degree to which an individual is relativistic, or regards universal moral principles, and the degree to which an individual is idealistic, or regards the consequences of actions. the epq is a 20-item, 9-point likert-type scale ranging from 1 (strongly disagree) to 9 (strongly agree), and ten items measure relativism and ten items measure idealism (barnett et ai., 1994; forsyth, 1980). the cev scale developed by hunt et al. (1989) is a five-item, seven-point likert-type scale ranging from 1 (strongly disagree) to 7 (strongly agree). the scale measures individual perceptions of managerial behavior, concerns for ethical standards, and the extent to which ethical behavior is rewarded. the ods was developed by kassing (1998) and measures how employees express their concerns at work. the scale utilizes a five-point likert-type scale ranging from 1 (strongly disagree) to 5 (strongly agree), and contains 20 items that measure various dimensions of dissent. reliability analysis was conducted, and acceptable coefficient alphas for organizational dissent (a. = .79), idealism (a. = .77), relativism (a =.81), and corporate ethical values (a = .88) were obtained. results a summary of the sample characteristics is presented in table 1. approximately 77% of the respondents were female, and nearly 69% of the sample was comprised of anglo-americans. over half of the respondents (60%) were married, and 61 % of the respondents had a bachelor's degree or some college. the majority of the respondents (73%) earned less than $30,000 per year, and the total household income was less than $50,000 for 61 %, between $50,000-80,000 for 21 % and over $80,000 for 18%. thirty-seven percent of the respondents were professionals within the company, 21 % were clerical, 17% were in management, and 14% were technical. 78 journal of business strategies vol. 18, no.1 table 1 characteristics of the sample variable frequency valid % cumulative % female 71 77.2 77.2 sex male 21 22.8 100.0 total 92 100.0 single 23 24.5 24.5 marital married 56 59.6 84.0 status divorced 15 16.0 100.0 widowed 0 .0 total 94 100.0 minority anglo american 60 68.2 68.2 status minority 28 31.8 100.0 total 88 100.0 some h.s 2 2.2 2.2 h.s. grad 30 17.2 19.4 some college 15 32.3 51.7 education bachelors 16 29.0 80.7 masters 27 16.1 96.8 doctorate 3 3.2 100.0 total 93 100.0 management 15 16.9 16.9 professional 33 37.1 54.0 level at clerical 19 21.3 75.3 company technical 12 13.5 88.8 other 10 11.2 100.0 total 89 100.0 < 20,000 15 16.7 16.7 20-29,999 12 13.3 30.0 30-39,999 15 16.7 46.7 40-49,999 13 14.4 61.1 household 50-59,999 4 4.4 65.5 income 60-69,999 6 6.7 72.2 70-79,999 9 10.0 82.2 80-89,999 3 3.3 85.5 90-99.999 5 5.6 91.1 > 100,000 8 8.9 100.0 total 90 100.0 spring 2001 valentine et af.: expressing organizational dissent 79 table 1 characteristics of the sample (cont'd) variable frequency valid % cumulative % < 20,000 33 36.7 36.7 20-29,999 33 36.7 73.4 30-39,999 12 13.3 86.7 personal 40-49,999 5 5.6 92.3 annual 50-59,999 2 2.2 94.5 income 60-69,999 2 2.2 96.7 70-79,999 1 .0 96.7 80-89,999 0 1.1 97.8 90-99,999 1 2.2 100.0 > 100,000 2 .0 100.0 total 91 100.0 descriptive statistics and the results of the correlation analysis are presented in table 2. respondents' average age in years was 40, and average tenure with the company was 4.5 years. the mean score for organizational dissent was 60.97 (maximum = 100), which indicated that the respondents as a whole were slightly inclined toward dissent. the mean score for idealism was 7.37, and the mean score for relativism was 4.80 (maximum for both = 9), which implied that sample members were moderately idealistic. the mean score for corporate ethical values was 4.65 (maximum = 7), and this value indicates that the environment was perceived as just slightly ethical. overall, dissent exhibited a statistically significant negative relationship with idealism (r =-.23, p < .05) and a statistically significant positive relationship with corporate ethical values (r = .22, p < .05). with reference to the demographic variables, gender (being male) was negatively related to idealism (r = -.24, p < .05), while minority status (being a non-white) was positively related to relativism (r =.33, p < .01). hierarchical regression was employed to test the hypotheses of the study, and the results of the analysis are presented in table 3. since various demographic factors have been found to influence ethics-related constructs (see ford & richardson, 1994, for detailed summary of previous research), these factors were entered into the regression equation first as control variables. upon entry, the demographic variables caused a marginally significant change in the model r2 of .15 (p < .10). standardized regression coefficients indicated that education level and organizational dissent were marginally related (~= .23, p < .10), while organizational tenure and dissent were positively related (~ = .28, p < .05). these findings support previous research that has determined that both experience and education tend to increase ethical judgments (dawson, 1997; glover, 80 journal of business strategies vol. 18, no. 1 bumpus, logan & ciesla, 1997; ford & richardson, 1994). the two ethical ideologies and corporate ethical values were then added to the model, which resulted in a significant change in the model r2 of .14 (p < .05) and a significant overall model f of2.88 (p < .01). standardized regression coefficients revealed a negative relationship between dissent and idealism (p =-.24, p < .05) and a positive relationship between corporate ethical values and dissent (p = .35, p < .01). table 2 correlation analysis variable mean sd 1 2 3 4 5 6 7 8 9 i. organizational dissent 60.97 9.41 2. idealism 7.37 1.12 -.233. relativism 4.80 1.56 -.12 .084. corporate ethical values 4.65 1.59 .22 .08 -.15 5. age 39.88 11.15 -.05 -.06 -.08 .146. gender 1.23 .42 -.10 -.24 -.06 .12 .167. minority status 1.32 .47 ~.16 .09 .33 -.01 .00 .138. education 3.48 1.35 .19 -.06 -.19 .07 .11 -.02 -.15 9. organizational tenure 4.50 4.17 .10 -.05 .02 -.21 .36 -.07 .04 .04notes: correlations greater in magnitude than .21 are significant at the 0.05 level correlations greater in magnitude than .32 are significant at the 0.01 level. spring 2001 valentine et al.: expressing organizational dissent table 3 hierarchical regression analysis 81 independent variable age gender minority status education level organizational tenure ideaiism relativism corporate ethical values change in r2 change in f overall r! overall adjusted r! overall model f **p<.oi * p < .05 "p<.1d step 1 standardized coefficients -.13 -.02 -.16 .23 1\ .28 * .i5 2.02 1\ .i5 .07 2.02 1\ s..tw.1 standardized coefficients -.21 1\ -.10 -.i3 .15 .36 ** -.24 * -.0 i .35 ** .14 3.82 * .29 .19 2.88 ** discussion of findings and conclusions we hypothesized that organizational dissent would more likely be exhibited by individuals whose responses were consistent with having idealistic views. the results indicated that the opposite was true among the individuals in the sample, with idealism sharing a negative association with organizational dissent. also, the hypothesis that relativism was negatively related to organizational dissent was not supported by the regression results. the hypothesis that corporate ethical values would positively influence organizational dissent was supported by the data. our results implied that personal moral philosophies marginally influence organizational dissent. specifically, the findings indicated that idealistic views might limit the exhibition of dissent to superiors and to fellow employees, while relativistic views were not related to dissent. these results were unexpected given previous work in this area, but they may be accounted for in several ways. 82 journal of business strategies vol 18, no.1 since "individuals who are highly idealistic have an overriding concern for the welfare of others" (barnett et ai., 1996, p. 1163), idealists may avoid dissent because they have compassion for those involved in a questionably activity. essentially, they may exercise tacit approval to protect the people or companies involved in the ethical dilemmas. the social practices within the organization, the quality of the supervisor-subordinate relationships, and other situational conditions present in the organization may also have caused this negative association (kassing & avtgis, 1999). for example, respondents may have believed that morally questionable acts in the company did not directly harm organizational members. high scores in idealism would therefore cause individuals to accept such acts since they do not adversely affect the welfare of others. the organization's culture may have also prompted the negative relationship between idealism and dissent. organizational culture defines generally preferred practices, and a culture that treats dissent as a behavior that adversely affects the well being of others might discourage dissent among highly idealistic individuals. relativism and dissent were unrelated in this study, and the variables' conceptual distinctions can be used to explain this finding. while relativism involves the degree to which individuals reject universal moral codes, dissent involves an individual's expression of disagreement about organizational practices, which would make any relationship that exists between these two variables complex and inconsistent. both individuals who score high in relativism and individuals who score low in relativism could essentially express dissent about an unethical situation or act, but they would have different reasons for doing so. highly relativistic employees would express dissent because they feel the circumstances of a morally questionable situation are inherently deleterious, while employees scoring low in relativism employees would express dissent because they accept the notion of universal moral principles. clearly, additional research is needed to clarify this seemingly complicated relationship. corporate ethical values were found to positively influence organizational dissent in this company. the relationship between corporate ethical values and the exhibition of organizational dissent was expected and provides further support for the link between organizational culture and individual conduct. unlike many of the personal factors that are typically beyond an organization's control, corporate cultures and ethical values can be cultivated and managed by company leaders. consequently, managers need to support corporate ethics programs and promote their integration throughout all levels of the organization, as well as ensure "open door" policies that facilitate the expression of dissent. a relatively useful business strategy would include developing formal codes of conduct or corporate codes of ethics that provide guidance about standards of behavior. by outwardly promoting a culture of ethical sensitivity and awareness, companies may be able to systematically improve ethical decisions. spring 2001 valentine et al.: expressing organizational dissent 83 the correlation analysis indicated that males tended to be less idealistic compared to women, and several post hoc inferences can be made. some research illustrates that women tend to think and behave more ethically compared to men (see ford & richardson, 1994), which may suggest that women are more idealistic. for instance, women have strong intentions to whistle-blow when faced with a morally questionable situation (wise, barnett & brown, 1997), and this may be caused by their concern for the well being of others. some research also indicates that women favor relationship building, egalitarianism, and nurturing more than do men (see valentine & godkin, 2000). the correlation analysis also implied that members of minority groups tended to be more relativistic compared to anglos. while race has not been extensively explored in the ethics literature, some differences across various racial groups have been noted. for instance, tsalikis and nwachukwu (1988) found black students and white students held different ethical views about price discrimination. similarly, mccuddy and perry (1996) found that individual perceptions of ethical standards varied across different racial groups. relativism may indeed influence these relationships since high relativism tends to negatively influence ethical decisions. even though the results of this study are promising, the study had several key limitations that must be highlighted. most notably, the sample size was relatively small, and the sample was taken from just one health care organization, which reduces the ability to externalize results and increases the probability of sample bias. for instance, there may be reason to believe that health care professionals score relatively high in idealism since many of the organizations for which they work uniquely prescribe highly constructive cultures (peterson, cooper & scherer, 2000; seago, 2000), and these sample characteristics could have influenced the findings. sample homogeneity may have also influenced the results of the study since women, who scored high in idealism, composed over three-quarters of the sample, and well over half of the participants were anglos, who scored low relativism. furthermore, the fact that the corporate ethical values construct was measured through individual perceptions must be emphasized. if these values had been measured as a singular corporate-level construct, the analysis may have provided quite different results. overall, the results of this study imply that dissent is influenced by both individual and organizational principles. future studies should further clarify these relationships by obtaining much larger cross-sectional samples from a variety of organizations. future research should also examine how both gender and race influence ethical judgments through both idealism and relativism. such research would provide further insight into the complex nature of ethical decisions. 84 journal of business strategies references vol. 18, no.1 akaah, i. p. (1993). organizational culture and ethical research behavior. journal of the academy of marketing science. 21 (1), 59-64. akaah, i. p. & riordan, e. a. (1990). the incidence of unethical practices in marketing research: an empirical investigation. journal of the academy of marketing science, 18, 143-152. ajzen, i. & fishbein m. (1980). understanding attitudes and predicting social behavior. englewood cliffs, nj: prentice hall, inc. barnett, t, bass, k. & brown, g. (1994). ethical ideology and ethical judgment regarding ethical issues in business. journal of business ethics. 13,469-480. barnett, t, bass, k. & brown, g. (1996). religiosity, ethical ideology, and intentions to report a peer's wrong doing. journal of business ethics. 15, 1161-1174. barnett, t, bass, k., brown, g. & herbert, f. j. (1998). ethical ideology and the ethical judgments of marketing professionals. journal of business ethics, 17, 715-723. brief, a. p. & motowidlo, s. (1986). prosocial organizational behaviors. academy of management review. 11,710-725. conner, p. e. & becker, b. w. (1975). values and the organization: suggestions for research. academy of management journal. 18 (3),550-561. dawson, l. m. (1997). ethical differences between men and women in the sales profession. journal of business ethics. 16, 1143-1152. dozier, j. b. & miceli, m. p. (1985). potential predictors of whistle-blowing: a prasocial behavior perspective. academy of management review. 10, 823-836. dubinsky, a. j. & loken, b. (1989). analyzing ethical decision making in marketing. journal of business research. 19,83-107. ford, r. c. & richardson, w. d. (1994). ethical decision making: a review of the empirical literature. journal of business ethics. 13, 205-221. forsyth, d. r. (980). a taxonomy of ethical ideologies. journal of social psychology. 39,175-184. forsyth, d. r. (1981). moral judgment: the influence of ethical ideology. personality and social psychology bulletin. 7, 218-223. forsyth, d. r. (1992). judging the morality of business practices: the influence of personal moral philosophies. journal of business ethics. 11,461-470. spring 2001 valentine et ai.: expressing organizational dissent 85 forsyth, d. r. & nyc, l. (1990). personal moral philosophies and moral choice. journal of research in personality. 24, 398-414. forsyth, d. r. & pope, w. r. (1984). ethical ideology and judgments of social psychological research: a multidimensional analysis. journal of personality and social psychology. 6 (6), 1365-1375. gaertner, k. (1991). the effect of ethical climate on managers' decisions. in r. m. coughlin (ed.), morality. rationality, and efficiency: new perspectives on socioeconomics. (pp. 211-223), armonk, ny: m. e. sharpe. glover, s. h., bumpus, m. a., logan, j. e. & ciesla, j. r. (1997). re-examining the influences of individuals on ethical decision making. journal of business ethics, lq,1319-1329. haberstroh, c. & gerwin, d. (1972). climate factors and the decision process. general systems. 17, 129-141. hegstrom. t. g. (1995). focus on organizational dissent. in critical perspectives on communication research and pedagogy. (pp. 83-94), st. inghert, germany: rohrig university press. hunt, s. d. & vasquez-parraga, a. z. (1993). organization consequences, marketing ethics, and salesforce supervision. journal of marketing research. 30, 78-90. hunt, s. d. & vitell, s. (1986). a general theory of marketing ethics. journal of macromarketing. 6. 5-16. hunt, s. d. & vitell, s. (1993). the general theory of marketing ethics: a retrospective and revision. in n. c. smith and j. a. quelch (eds.), ethics in marketing. (pp. 775784), homewood, il: irwin. hunt, s. d., wood. v. r. & chonko, l. b. (1989). corporate ethical values and organizational commitment in marketing. journal of marketing. 53, 79-90. jansen, e. & von glinow, m. a. (1985). ethical ambience and organizational reward systems. academy of management review, 10 (4), 814-822. jones, t. m. (991). ethical decision making by individuals in organizations: an issuecontingent model. academy of management review. 16 (2),366-395. kassing, j. w. (1998). development and validation of the organizational dissent scale. management communication quarterly. 12 (2), 183. kassing, j. w. & avtgis, t. a. (1999). examining the relationship between organizational dissent and aggressive communication. manaiement communication quarterly. 13 (1), 100-116. 86 journal of business strategies vol. 18, no.1 liedtka, j. (1991). organizational value contention and managerial mindsets. journal of business ethics. 10, 543-557. mccuddy, m. k. & perry, b. l. (1996). individual differences and ethical beliefs. journal of business ethics. 15,261-273. miceli, m. p. & near, j. p. (1985). organizational dissidence: the case of whistleblowing. journal of business ethics, 4, 1-16. near, j. p., baucus, m. s. & miceli, m. p. (1993). the relationship between values and practice: organizational climates for wrongdoing. administration & society. 25 (2), 204-226. peterson, f. l., cooper, r. f. & scherer, r. f. (2000). organizational change: initial results in a health care setting. psycholo~ical reports. 86, 608-610. redding, w. c. (1985). rocking boats, blowing whistles, and teaching speech communication. communication education, 34, 245-258. schein, e. (1985). or~anizational culture and leadership. san francisco: jossey-bass. schlenker, b. r. & forsyth, d. r. (1977). on the ethics of psychological research. journal of experimental social psycholo~y. 13, 369-396. seago, j. a. (2000). registered nurses, unlicensed assistive personnel, and organizational culture in hospitals. journal of nursing administration. 30, 278-286. selznick, p. (1957). leadership in administration. evanston, il: row & peterson. sims, r. l. & keenan, j. p. (1998). predictors of external whistleblowing: organizational and intrapersonal variables. journal of business ethics. 17, 411-421. stewart, l. p. (1980). whistle blowing: implications for organizational communication. journal of communication. 30 (4), 90-101. stone, c. d. (1975). the culture of the corporation: where the law ends. new york: harper & row. tompkins, p. k. (1977). management communication in rocket research and development. communication monographs. 44, 1-26. trevino, l. k. (1986). ethical decision making in organizations: a person-situation interactionist model. academy of mana~ementreview. 11 (3).601-617. trevino, l. k., butterfield, k. d. & mccabe, d. l. (1998). the ethical context in organizations: influences on employee attitudes and behaviors. business ethics ouarterly. 8 (3), 447-476. spring 200 i valentine et al expressinj? organizational dissent 87 trevino, l. k. & victor, b. (1992). peer reporting of unethical hehavior: a social context perspective. academy of management journal. 35 (1 ), 38-64. trevino, l. k., weaver, g. r" gibson, d. g. & toltler, b. l. (1999). managing ethics and legal compliance: what works and what hurts. california management review, ±l(2),131-151. trevino, l. k. & youngblood, s. a. (1990). bad apples in bad barrels: a causal analysis of ethical decision-making behavior. journal of applied psychology, 75,378-385. tsalikis, j. & nwachukwu, o. (1988). cross-cultural business ethics: ethical beliefs difference between blacks and whites. journal of business ethics, 7, 745-754. valentine, s. & godkin, l. (2000). supervisor gender, leadership style, and perceived job design. women in management review, j 5, 117-129. vitell, s. j., rallapalli, k. & singhapakdi, a. (1993). marketing norms: the influence of personal moral philosophies and organizational ethical culture. journal of the academy of marketing science. 21, 331-337, weaver, g. r .• trevino. l. k. & cochran, p. l. (1999), corporate ethics programs as control systems: influences of executive commitment and environmental factors, academy of management journal. 42 (i), 41-57, wise, t, barnett, t. & brown, g. (1997). consequence seriousness, gender, and intentions to blow the whistle on an unethical act. journal of business strategies, 14,3246. yankelovich, d. (1971), what new life styles mean to market planners. marketing communication. 299, 38-45. 88 journal of business strategies appendix a scale item examples vol. 18, no. i organizational dissent scale kassing (1998) i am hesitant to raise questions or contradictory opinions in my organization. i refuse to discuss work concerns at home. 1 criticize inctticiency in this organization in front of everyone. ethical position questionnaire forsyth (1980) idealism a person should make certain that their actions never intentionally harm another even to a small degree. risks to another should never be tolerated. irrespective of how small the risks might be. the existence of potential harm to others is always wrong. irrespective of the benefits to be gained. relativism there arc no ethical principles that are so important that they should be part of any ethics codes. what is ethical varies from one situation to another. different types of moralities cannot be compared as to "rightness". corporate ethical values scale hunt, wood & chonko (1989) managers in my company often engage in hehaviors that i consider to be unethical. in order to succeed in my company. it is often necessary to compromise one's ethics. top management in my company has let it he known in no uncertain terms that unethical behaviors will not be tolerated. spring 200 i valentine et al.: expressing organizational dissent 89 sean valentine is assistant professor of management at the university of wyoming and has a d.b.a. from louisiana tech university. his research has appeared injournals such as women in management review, journal ofapplied social psychology, psychological reports, hispanic journal ofbehavioral sciences, international journal ofmanagement, health care management review, and journal of education for business. kimberly young is an accounting manager at citation-mabry company and m.b.a. student at lamar university. lorissa bailey is a client rights officer at life resource community mental health center and an m.b.a. student at lamar university. naser barhoum is an m.b.a. student at lamar university. stacy labure is a sales representative at roche labs, inc. and an m.b.a. student at lamar university. natasha glover is an accountant at federal prison industries and an m.b.a. student at lamar university. peter isaac is owner and director of east texas pathology laboratory. he has a medical degree from the university of michigan and an m.b.a. from lamar university. expressing organizational dissent: the role of ethical ideology and corporate ethical values moderating effect of hofstede’s cultural values on the locus of control/job performance relationship of managers in usa, mexico, south korea and hong kong maria a. leach-lópez auburn university montgomery • montgomery, alabama abstract this study evaluates relationships between job performance, locus of control, and cultural values. survey data was collected from 265 managers working for us controlled firms located in the us, hong kong, south korea and mexico. findings indicate that there is a stronger relationship between reported job performance and a manager’s personality versus the manager’s culture. these results should help multinational firms better understand a significant influence on the job performance of mid-level managers working in different countries. us controlled, manufacturing multinational firms can feel confident when designing management control systems at the individual level regardless of the country in which they operate. introduction today’s global economy poses many challenges for multinational corporations (mncs). cross-national human resource management is one of many logistic challenges that mncs must address. human resource management requires a significant investment in time and money and it is important for international companies to identify and attract high performance managers. another challenge for mncs is whether to design management control systems for each country in which they operate at a macro level for the whole company (where a human resource management policy is developed for the whole organization and is directed from headquarters) or at a micro level for individual employees in the company within a specific country (where each subsidiary and plant would develop its own hrm policy without a centralized model). in other words, should the management control systems be directed from the multinational’s headquarters, or should management control systems be designed for each country considering that country’s culture? it is useful to know what is more significant when attempting to maximize job performance: a manager’s personality or a manager’s culture. barrick and mount (2005) concluded that personality is an effective predictor of job performance and emphasized that managers should care about the personality of employees. but mncs have employ16 journal of business strategies ees located in various and diverse cultures. competitive success in a global environment requires an awareness of how personality and culture may affect employees’ job performance. there are practical implications to finding whether mncs must consider the personality or the cultural values of the manager when job performance is to be maximized. in a meta-analysis study, ng, sorensen and eby (2006) examined the relationship of the personality variable locus of control (loc) and various work outcomes and found that internal locus of control was positively associated with favorable work outcomes. spector (1982) found that internals have higher job performance than do externals. the role of personality at work has received increased attention (barrick & mount, 2005) because all managers have a personality and personality helps predict and explain behavior at work (goldberg, 1993). in addition to managers’ personalities, mncs must remember that national culture must be considered when managerial practices are implemented. there are various management control systems (mcss). a universally used mcs is budgeting. according to leach-lópez et al. (2007) the managerial practice of budget participation works to help job performance of managers in various countries. but is job performance affected by the personality or by the culture of the manager? should a different mcs be designed for each country? national culture is an important field of study in various business disciplines: leach-lópez, stammerjohan, and mcnair (2007) and lagrosen (2002), among many others, found that culture matters. flynn and saladin (2006) believe that the role of national culture has not been systematically investigated in an organizational context. kirkman, lowe and gibson (2006) also believe that there are still many gaps in cultural studies and suggest various research ideas that still need to be explored. this study tries to narrow this gap as a first line of research. it is hoped that other researchers will replicate and expand the results obtained and presented below. the research presented in this paper investigates the moderating effect of cultural values on the job performance/locus of control relationship. the results obtained should help mncs understand job performance in an international setting. model variables job performance personality as a predictor of job performance has been widely studied in the past decades. as far back as 1965, guion and gottier (1965) concluded that personality was not a valid predictor of job performance. since then, many researchers volume 30, number 1 17 have challenged this conclusion. hogan (2005) published a historical review of this line of research which continues to this day. following this line of inquiry led penney, david and witt (2011) to conclude that “personality is an important determinant of individual behavior in the workplace (p.297).” campbell, mccloy, oppler, and sager (1993) describe job performance as actions that are under an individual’s control, and which help reach the organization’s goals. campbell, mchenry, and wise (1990) and campbell et al. (1993) have introduced various models that attempt to increase our understanding of job performance. these models have served as an impetus for further theoretical and empirical development of this construct. leach-lópez, stammerjohan, and rigsby (2008) studied the moderating effect of personality and culture in the relationship between budget participation and job performance. they tested this relationship using a separate model for each sample used: us managers and mexican managers. they detected a significant relationship between budget participation and job performance for each of the samples used in their study. they did not find that personality moderated these relationships. thus they conclude that culture does matter in the budget participation-job performance relationship and suggested that mncs should be cautious when using and transferring mcss from the us to mexico. leach-lópez et al. (2008) reached their conclusion without testing the cultural values of the respondents. locus of control locus of control (loc) is a personality construct denoting an individual’s generalized expectancies for control of reinforcements. rotter (1966) described loc as distributing individuals according to the degree to which they accept personal responsibility for what happens to them. under loc, individuals are classified as being either more internal or more external oriented. responses to rotter’s (1966) questionnaire provides a loc value for each respondent where higher loc calculated values indicate a more external orientation and lower loc calculated values indicate a more internal orientation. individuals who believe they can control reinforcements in their lives are considered to be more internal. those who believe that fate, luck, or other people control reinforcements in their lives are considered to be more external (spector, 2005). rotter (1966) found that personalities that tend to be external are generally more susceptible and submissive to direct influence by others. personalities that tend to be more internal are not as susceptible and submissive to others’ influence. 18 journal of business strategies according to bruk-lee, khoury, nixon, goh and spector (2009), locus of control is one of the most studied personality traits and its effect on work outcomes has been reported widely (e.g., judge & bono, 2001; ng et al., 2006; spector, 1982). broad dimensions of personality, such as the big five are not good predictors of job performance (murphy & dzieweczynski, 2005). barrick, mount & judge (2001) found that measures of the big five factors have little to do with performance so that “correlations between measures of the big five personality dimensions and measures of job performance are generally quite close to zero” (murphy & dzieweczynski, 2005, p. 345). given the reliable relationship between locus of control and job performance and the problems associated with the big five factors, a broad measure of personality, rotter’s (1966) locus of control measurement was used in this study. hofstede’s cultural values culture is an important construct in that it indicates how, in general, a person should behave in a particular role or status in a given society (harrison, 1993). the concept of culture used by most researchers is based on the work of hofstede (1980), who developed a commonly acceptable, well-defined, and empirically-based terminology to identify and describe cultural values. hofstede (1980) and hofstede and bond (1988) identified five dimensions of culture: large versus small power distance, individualism versus collectivism, masculinity versus femininity, strong versus weak uncertainty avoidance, and long-term orientation versus short-term orientation. power distance. power distance (pdi) refers to the way in which individuals handle the problem of human inequality. a large pdi classification would be characterized by the acceptance of inequality; individuals would tend to accept a hierarchical order in which everybody has a place which needs no further justification (perera & mathews, 1990). a small pdi would require justification of power inequalities that do exist; thus, individuals with small pdi require that inequality in relationships between supervisors and subordinates should be minimized. small pdi values indicate that subordinates and supervisors regard each other as equivalent people who should have equal rights (hofstede, 1980, 2001). individualism. individualism (idv) measures how individuals look after their own self-interests and the interests of their immediate family only. at the other extreme of this dimension is collectivism where everyone is expected to look after the interest of their relatives or other members of their own in-group (hofstede, 1983b). volume 30, number 1 19 a high individualism score indicates that people focus on themselves as individuals rather than on the groups to which they may belong. under this perspective, an individual is seen as having an identity not dependent upon a group affiliation (hofstede, 1980, 2001). uncertainty avoidance. uncertainty avoidance (uai) relates to the degree to which individuals feel uncomfortable with uncertainty and ambiguity. with strong uai there is low tolerance for ambiguity and uncertainty and an aversion towards risk taking (hofstede, 1980, 2001), which means that people prefer group decisions, consultative management, and believe that subordinates should not be able to influence superiors’ decisions. according to perera and mathews (1990), the fundamental issue involved in this dimension is how individuals react to the fact that the future is not known. strong uncertainty avoidance individuals would like to beat an unpredictable future which creates a higher level of anxiety. masculinity. masculinity (mas) represents a societal preference for showing off, achievement, heroism, assertiveness, making money or enjoying material success. at the other extreme is femininity which represents a preference for putting relationships with people before money, helping others, caring for the weaker, the quality of life, preserving the environment. the mas value describes the extent to which aggressiveness and success are valued instead of concern for relationships (hofstede, 1980, 2001). this dimension draws attention to the existence of competitiveness as opposed to solidarity, equity as opposed to equality, and achievement motivation as opposed to relationship motivation. long-term orientation. long-term orientation (lto) refers to a cultural value fostering virtues oriented towards future rewards. short-term orientation stands for a cultural value fostering virtues related to the past and the present, in particular respect for tradition, preservation of “face,” and fulfilling social obligations (hofstede, 1980, 2001). with a long term orientation there is a tendency towards valuing order in relationships by status and observing this order. with a short term orientation there is a tendency towards valuing personal steadiness and stability, thus discouraging change or risk. this cultural dimension was originally labeled confucianism, but it was renamed since both opposing poles of the dimension contain confucian values (hofstede, 2001, p. 355). expected results according to ozer (2008), people who are more internal oriented take more assertive actions to change the work environment or to change jobs when they are 20 journal of business strategies not satisfied, thus will likely perform better (blau, 1987; judge & bono, 2001; ng et al., 2006). for this study, loc was measured so that the larger the value, the more external is the manager. the lower loc values indicate a more internal personality. job performance is measured so that the higher values indicate higher job performance. the findings should indicate an inverse relationship between loc and performance, i.e. internals should report higher performance. loc and cultural values hofstede (2001) explains that culture and personality interact so that “cultural traits can sometimes be measured through personality tests” (p. 10). thus, correlations between loc and hofstede’s cultural values would be expected. the more internal managers would feel in control of their destiny and have lower loc values. they would be expected to exhibit high individualism (idv), high masculinity (mas), low power distance (pdi), low uncertainty avoidance (uai), and to have a short term orientation. lower pdi managers would be more assured of their position in the firm, and those with lower uai can tolerate uncertainty and are able to make decisions, thus feel more in control. managers with lower loc would have a short term orientation (low lto) since a mid-level manager makes more operational decisions as opposed to long term, strategic decisions. performance and cultural values given that there is a relationship between personality and job performance, and since culture and personality interact (hofstede, 2001), it can be speculated that relationships between hofstede’s cultural values and job performance could be detected. in a high power distance (pdi) society the superiors make the decisions, there is a less consultative work environment, so that the power is not distributed equally (hofstede, 1980, 2001) and subordinates expect an autocratic management style (hofstede, 1980, 1984). in an international study of mid-level manufacturing managers, leach-lópez et al. (2007) found that mid-level managers prefer a more consultative decision making process. thus, an inverse relationship between pdi and job performance (per) is expected, i.e. respondents with low pdi will report higher per. uncertainty avoidance is related to the acceptance of an unknown future. managers with low uncertainty avoidance (uai) dislike formal rules and are willing to live day to day (hofstede, 1980, 2001) while high uai managers would tolerate behaviors and opinions that are different from their own (flynn & saladin, 2006). volume 30, number 1 21 managers in a high uai culture are less reactive, less flexible (wacker & sprague, 1998). managers must be reactive in order to respond to the every day challenges, thus we expect an inverse relationship between uai and per so that respondents with low uai will report higher per. an individualistic manager would score high in the individualism (idv) construct. respondents high in the idv construct would tend to act according to their own interests (hofstede, 1983a, 1983b) and would value individual success (flynn & saladin, 2006). collectivism, by contrast, takes satisfaction in a job well recognized. these managers would have more pressure to conform to their in-group and strive to preserve face and avoid shame (hofstede, 1980, 2001). a direct relationship between idv and per is expected so that respondents high in idv should report higher per. respondents high in the masculinity (mas) construct (versus a feminism slant) would value high earnings, advancement and challenging work. with a high mas outlook, an ideal job provides opportunities for recognition, advancement and challenge (hofstede, 1980, 2001) so that a direct relationship between mas and per can be expected, that is, the higher mas managers should report higher per. the labels in this cultural classification are used as presented by hofstede (1980, 2001) and are not meant to be disparaging in any way, nor are they meant to represent the gender of the respondent. the long-term to short-term orientation dimension is based on teachings similar to those of confucius. the concepts advocated by confucius can be found at both ends of this dimension. this cultural value opposes long-term to short-term aspects of confucian thinking: persistence and thrift compared to personal stability and respect for tradition. given the duality of this cultural value, it is difficult to determine a priori an expected relationship between lto and per. moderating effect of culture given that there are expected relationships between personality and cultural values and between cultural values and job performance, one would expect to detect a moderating effect of culture on the personality/performance (loc-per) relationship. the analysis described below was undertaken to determine which, if any, of the five cultural values moderates, or does not moderate, this relationship. 22 journal of business strategies methodology variables and measures job performance (per) was measured with an eight-dimension scale developed by mahoney, jerdee and carroll (1963). the mahoney et al. scale measures eight performance dimensions: planning, investigating, coordinating, evaluating, supervising, staffing, negotiating, and representing. this scale has been widely used in participative budgeting research (e.g., brownell, 1982, 1983; brownell & hirst, 1986; brownell & mcinnes, 1986; frucot & shearon, 1991; leach-lópez et al., 2007, 2008; tsui, 2001). budgets and budget participation are commonly used as management control systems, as well as other accounting measurements such as variance analysis. job performance was operationalized with the mahoney et al. scale because it incorporates questions related to accounting measurements and to budgets and variance analysis. self-reported performance has also been used in other recent studies. nouri and parker (1998) employ a self-reported measure of performance adapted from govindarajan and gupta (1985) and shields, deng and kato (2000) developed their own self-reported measure of performance. please see bommer, johnson, rich, podsakoff and mackenzie (1995) for a complete discussion of the implications of self-reported performance measures. more recently, avey, reichard, luthans and mhatre (2011) found no major differences between self reported performance measures and other types of performance measures. the locus of control personality variable (loc) was measured with a refined version of the additive scale developed by rotter (1966). the refined scale includes filler items to disguise the purpose of the test. the cultural dimensions scores for power distance (pdi), uncertainty avoidance (uai), individualism (idv), masculinity (mas), and long term orientation (lto) were calculated using hofstede’s vsm 94 (hofstede, 1994). the respondents were also asked to indicate their gender, age, education, and length of employment in the firm and in their current position. data sample. a survey instrument was used to collect the data for this study. the questionnaire was prepared in english and translated to chinese, korean, and spanish. each mid-level manager completed the survey written in their native language: chinese, korean, spanish, or english. the questionnaires were translated using the method suggested by hui and triandis (1985) and by hui and yee (1999). first, two individuals highly proficient in english and one of the other languages translated volume 30, number 1 23 from the english version of the questionnaire into chinese, korean, or spanish. the translations were compared and a third bilingual person reviewed the translations. minor adjustments were made at each step as needed. different methods of data collection were employed due to logistical differences within the four countries included in the sample. all of the surveys were completed in a written format. the us sample included emailing the survey instruments to the hr managers. the hr managers forwarded the email to functional managers. the managers who received the forwarded email were instructed to return their completed surveys as email attachments directly to the author. the mexican samples were all hand delivered to the hr manager and hand collected directly from the managers who decided to complete the survey. the process had to be face to face due to the unreliability of the mexican postal system. the hr manager of each south korean firm sampled was contacted and surveys were delivered and returned by mail. the chinese surveys were answered at one plant located in hong kong with the hr manager’s permission; they were also hand delivered and hand collected. the firms in the us were selected by geographic location. they were all located in the southeast us. a directory search yielded the names of manufacturing firms. the firms used were the ones with helpful hr managers. the mexican firms contacted were registered as maquiladoras in the interior department website. the south korean firms met the criteria of being a us controlled firm. again, as in the us, the south korean firms included in this study had helpful managers. only one chinese firm was contacted due to limited available contacts in that country. the full sample consists of mid-level functional managers working in manufacturing firms. the us sample consists of us managers working for us firms in the us. the other subsamples (mexican, korean, and chinese) include foreign managers working for us controlled companies located in mexico, south korea, and hong kong respectively. the mexican managers are employed by us controlled maquiladoras located in mexico. each of the korean managers is employed by a different us controlled joint venture firm, while the chinese managers all work for a single us controlled joint venture firm. for the us sample, 30 firms located in southeast united states were contacted and responses were received from 16 firms for a response rate of 53%. for the mexican sample, 88 maquiladoras were contacted and 49 firms participated for a response rate of 56%. for the korean sample, a manager in each of 55 firms was contacted to obtain an oral agreement to participate in this study, 52 responses were obtained for a 94% response rate. for the chinese sample, our intent was to obtain a minimum of 50 responses to allow for the minimum sample size of 20 suggested by 24 journal of business strategies hofstede (1994). the sample used in this study includes 265 responses: 54 from the us, 90 from mexico, 71 from south korea, and 50 from china. the data gathering had to be conducted according to the limitations placed by the various managerial styles in the four countries and by accessibility to willing respondents. all of the responses were obtained within a two to three week time period. analyses of the data were conducted to examine whether any non-response biases were present. tests were conducted to rule-out any potential non-response bias by comparing early to late responders on all study variables and demographics. no significant differences were found between early and late respondents across the study variables. common method variance. this study addressed common method variance (cmv) using both ex ante design and ex post analysis. please see chang, witteloostuijn, and eden (2009) for an excellent explanation of this problem and suggestions to test and handle this concern. the variables used measure the survey respondent’s perceptions; therefore, a second source to measure the dependent variable (job performance) was not possible. however, several procedural remedies were incorporated in the questionnaire design. following standard survey practice, the respondents were assured of anonymity and confidentiality. respondents were also told that the survey’s main purpose was to obtain their honest opinions and perceptions. the survey also used different scale endpoints and formats to “reduce method biases caused by commonalities in scale endpoints and anchor effects” (chang et al., 2009, p. 3). the instrument for each variable varied as follows. loc had 29 questions with possible answers of a/b per question, with 5 filler questions included. per consisted of 8 questions with ranked answers from 1 to 9 anchored on below average to above average performance. the vsm 94 (hofstede, 1994) was composed of 20 questions with a likert type scale ranging from 1 to 5 and anchored on stronglyagree and strongly-disagree. given this variations and the length of the questionnaire, it would be difficult for the respondents to “cognitively ‘create’ the correlations needed to produce a cmv-biased pattern of responses” (murray, kotabe, & zhou, 2005, as reported by chang et al., 2009, p. 3). to further confirm absence of cmv, the marker-variable technique first proposed by lindell and whitney (2001) as discussed by malhotra, patil, & kim (2007) was used. the cmv discounted correlations and the observed correlations were not statistically different which confirms the finding using harman’s single factor test. hence, it can be reported that there is no significant evidence of cmv in this study. volume 30, number 1 25 data analysis and results table 1 shows the means and possible range of the variables under study of the captured demographics. it also includes a correlation matrix using pearson bivariate correlation coefficients for two-tailed relationships of key variables included in this study. a comparison of the means with the possible ranges provides a profile of the average respondent. the average manager reports a job performance that falls slightly above the third quartile in the possible range. on average, the respondents have an internal personality with low power distance (pdi), high individualism (idv) and high masculinity (mas) and rank in the middle for uncertainty avoidance (uai) and long term orientation (lto). the average respondent has been with the same firm 10 years and in their current position for 5 years. he or she has attended college and is between 35 and 39 years old. no significant difference in the education level of the respondents in the four countries was detected (school). the significant relationships found in table 1 show the expected relationship between job performance (per) and locus of control (loc) at a high significance level (p < 0.000) and with the expected sign. this result mirrors prior research in that internals report higher job performance. uncertainty avoidance (uai) and individualism (idv) were found to be correlated with job performance (p < 0.05). an inverse relationship with uai was detected, as expected, which indicates that the respondents are able to make decisions and take risks which improves performance. unexpectedly, a direct relationship between per and idv was found. this last result seems to indicate that group effort might generate better performance as opposed to individual efforts. masculinity was the lone significant relationship detected with locus of control and with the expected inverse relationship. this finding indicates that success is valued by those with internal personalities. 26 journal of business strategies table 1 descriptive statistics and correlations correlations possible expected expected n mean range per sign loc sign job performance (per) 265 51 8-72 1 locus of control (loc) 264 8 0-23 -.223** – 1 power distance (pdi) 265 27 0-100 -.019 – .109 + uncertain avoidance (uai) 265 50 0-100 -.125* – .063 + individualism (idv) 264 74 0-100 -.127* + .045 masculinity (mas) 265 64 0-100 .033 + -.270** long term orientation (lto) 265 49 0-100 .019 ? -.051 + firm tenure 250 10 job tenure 248 5 school 253 16 age 251 5 gender 201 males and 49 females ** correlation is significant at the 0.01 level (2-tailed). * correlation is significant at the 0.05 level (2-tailed). the moderating effect of culture on the job performance-locus of control relationship was examined using moderated hierarchical regression as suggested by aiken and west (1991) and by barrick, parks and mount (2005). in step 1, the main effect of locus of control and each of the cultural values were controlled by entering them in the initial step of a series of five regressions. per = loc + cultural value [step 1] in step 2, the interaction term of locus of control and each culture value was added. the interaction terms were calculated using centered scores of the independent variables. the variables were centered by subtracting the mean from each score. the results are presented in table 2. per = loc + cultural value + (loc*cultural value) [step 2] volume 30, number 1 27 table 2 results of hierarchical regression analysis of moderating effect of culture on the job perfomance-locus of control relationship step 1 step 2 variables β std. error β std. error constant 55.86** 1.47 55.83** 1.48 locus of control (loc) -0.59** .16 -0.58** .16 power distance (pdi) 0.01 .01 0.00 .01 loc x pdi 0.00 .00 model r2 0.050 0.050 step change in r2 0.000 constant 56.69** 1.50 56.83** 1.49 locus of control (loc) -0.56** .16 -0.57** .15 uncertainty avoidance (uai) -0.02+ .01 -0.02+ .01 loc x uai -0.01 .00 model r2 0.062 0.082 step change in r2 0.020* constant 57.72** 1.69 57.62** 1.69 locus of control (loc) -0.57** .15 -0.55** .15 individualism (idv) -0.02+ .01 -0.02+ .01 loc x idv 0.00 .00 model r2 0.063 0.072 step change in r2 0.009 constant 56.26** 1.68 56.09** 1.69 locus of control (loc) -0.59** .16 -0.60** .16 masculinity (mas) 0.00 .01 0.00 .01 loc x mas 0.00 .00 model r2 0.050 0.054 step change in r2 0.004 constant 55.68** 2.07 55.71** 2.09 locus of control (loc) -0.58** .16 -0.58** .16 long term orientation (lto) 0.00 .03 0.00 .03 loc x lto 0.00 .01 model r2 0.050 0.050 step change in r2 0.000 significance level: **p < .01 *p < .05 +p< .10 28 journal of business strategies as reported in table 2, locus of control (loc) has a significant effect on job performance (per). the cultural variables uncertainty avoidance (uai) and individualism (idv) have a marginal effect (both at p < .10) on job performance. uai is the lone cultural value with a moderating effect on the loc-per relationship (p < .05). this moderating effect is very small (β = -0.01). no moderating effect of the remaining cultural values was detected on the loc-per relationship. the hierarchical regression model presented in table 2 was replicated for each country. the results obtained for each country were the same as those obtained for the full model. this indicates that the results are not driven by a particular country due to a larger sample size. ng et al. (2006) concluded that there are five major employees’ characteristics that must be modeled when analyzing job outcomes. these characteristics are job level (managers vs. non-managers), job types (manufacturing vs. non-manufacturing), age, job tenure, and gender. in this study, job level and job type were controlled by including only mid-level managers in manufacturing multinational firms. job tenure and gender were tested and neither was found to be a significant characteristic. age was found to be significant so that older, more internal, managers report higher job performance. the results of this study appear very straightforward: culture does not appear to moderate the relationship between the personality variable locus of control and self reported job performance. the results indicate that the personality of the manager is what drives the manager’s job performance. having high performance employees is critical to the longevity of a firm. the findings indicate that, in order to facilitate job performance across countries, manufacturing multinational corporations can have a level of certainty that they can focus the international human resource function on the individual regardless of the country in which they are operating. conclusion, limitations and future research the findings indicate that the personality of the manager has a significant relationship with job performance. the cultural values of uncertainty avoidance and individualism have a marginal relationship with job performance. the lone cultural value found to moderate the loc and job performance relationship was uncertainty avoidance. the effect was very small and not highly significant (β = -.01 and p < .05). the results indicate that us controlled manufacturing mncs can confidently address international human resources and design management control systems at the individual level; that is, the personality of the manager is what appears to volume 30, number 1 29 drive the job performance of the manager as opposed to the cultural contingencies. this global integration should increase efficiency to us controlled manufacturing multinational corporations. this study suffers from some common limitations to this type of research. despite valiant efforts, the sample size could always be larger. the minimum sample size of 20 recommended by hofstede (2001) was obtained for each country, though. the unequal sample size from each country might also affect the results. to address this possible limitation, the model was tested using each country’s sample and no significantly different results from the overall model were detected. all of the respondents work in firms associated with, or controlled by us firms. future research is needed to determine whether the respondents have been ‘americanized’ and whether the findings reported here will hold for foreign firms that are not associated with, or controlled by us multinationals. another common limitation usually found in this type of research is the use of self reported variables. established scales were used but each of the scales contains a level of measurement error and it was expected that the respondents would to be truthful and accurate. despite these acknowledged limitations, the findings reported contribute to an overlooked area of research as a first line of inquiry. the findings suggest that us controlled manufacturing mncs should feel free to institute policies addressed to the individual manager’s personality without regard to within country or between country cultural differences. future research should investigate various management control systems to determine whether the results reported in this study hold. in order to triangulate the results, multinational firms in other countries should be included in the model tested. in addition, non us controlled mncs and non-manufacturing firms need to be studied. by using non us controlled firms, future research will be able to determine whether an “americanization” process of managers exists in the us controlled firms, or, is there a self selection process that occurs in multinational corporations? are certain personalities attracted to us controlled international firms? or are managers with certain cultural values attracted to international firms? answers to these questions will help evaluate the generalizability of the findings reported in this study. 30 journal of business strategies references aiken l. s., & west, s. g. (1991). multiple regression: testing and interpreting interactions, new york: sage publications, inc. avey, j. b., reichard, r. j., luthans, f., & mhatre, k. h. (2011). meta-analysis of the impact of positive psychological capital on employee attitudes, behaviors, and performance, human resource development quarterly, 22(2), 127-152. barrick, m. r., & mount, m. k. (2005). yes, personality matters: moving on to more important matters, human performance, 18(4), 359-372. barrick, m. r., mount, m. k., & judge, t. (2001). personality and performance as the beginning of the new millennium: what do we know and where do we go next?, international journal of selection and assessment, 9, 9-30. barrick, m. r., parks, l., & mount, m. k. (2005). self-monitoring as a moderator of the relationships between personality traits and performance, personnel psychology, 58, 745-767. blau, g. (1987). locus of control as a potential moderator of the turnover process, journal of occupational psychology, 60, 21-29. bommer, w. h., johnson, j. l., rich, g. a., podsakoff, p. m., & mackenzie, s. b. (1995). on the interchangeability of objective and subjective measures of employee performance: a meta-analysis. personnel psychology, 48, 587-605. brownell, p. (1982). a field study examination of budgetary participation and locus of control. the accounting review, 57(october), 766-777. brownell, p. (1983). leadership style, budgetary participation and managerial behavior. accounting, organizations and society, 8(4), 307-321. brownell, p., & hirst, m. k. (1986). reliance on accounting information, budgetary participation, and task uncertainty: tests of a three-way interaction. journal of accounting research (autumn), 241-249. brownell, p., & mcinnes, m. (1986). budgetary participation, motivation, and managerial performance. the accounting review 61 (october), 587-600. bruk-lee, v., khoury, h. a., nixon, a. e., goh, a., & spector, p. e. 2009. replicating and extending past personality/job satisfaction meta-analyses. human performance, 22. 156-189. volume 30, number 1 31 campbell, j. p., mchenry, j. j., & wise, l. l. (1990). modeling job performance in a population of jobs. personnel psychology, 43, 313-333. campbell, j. p., mccloy, r. a., oppler, s. h., & sager, c. e. (1993). a theory of performance. in n. schmitt & w. c. borman (eds.), personnel selection in organizations. san francisco: jossey-bass, 35-70. chang, s., witteloostuijn, a. v., & eden, l. (2009). from the editors: common method variance in international business research. journal of international business studies, 41(2), 1-7. flynn, b. b., & saladin, b. (2006). relevance of baldrige constructs in an international context: a study of national culture. journal of operations management, 24, 583-603. frucot, v., & w. t. shearon. (1991). budgetary participation, locus of control, and mexican managerial performance and job satisfaction. the accounting review, 66 (january), 80-98. goldberg, l. r. (1993). the structure of phenotypic personality traits. american psychologist, 48, 26-34. govindarajan, v., & gupta, a. k. (1985). linking control systems to business unit strategy: impact on performance. accounting, organizations and society, 10, 51-66. guion, r. m., & gottier, r. f. (1965). validity of personality measures in personnel selection. personnel psychology, 18, 135-164. harrison, g. l. (1993). reliance on accounting performance measures in superior evaluative style – the influence of national culture and personality. accounting, organizations and society, 18(4), 319-339. hofstede, g. h. (1980). culture’s consequences: international differences in workrelated values. beverly hills, ca: sage publications. hofstede, g. h. (1983a). dimensions of national cultures in fifty countries and three regions. in j. b. deregowski, d. dzuirawiec, & r. c. annis, (eds.), explications in cross-cultural psychology, swets and zeitlinger. hofstede, g. h. (1983b). the cultural relativity of organizational practices and theories. journal of international business studies, fall, 75-89. 32 journal of business strategies hofstede, g. h. (1984). the cultural relativity of the quality of life concept. academy of management review, 9(3), 389-398. hofstede, g. h. (1994). vsm94: value survey module 1994. retrieved from stuwww.uvt.nl/~csmeets/~1st-vsm.html, 9 november 2011. hofstede, g. h. (2001). culture’s consequences: comparing values, behaviors, institutions, and organizations across nations. 2nd edition. thousand oaks, ca: sage publications, inc. hofstede, g. h., & bond, m. h. (1988). the confucius connection: from cultural roots to economic growth. organizational dynamics, 5-21. hogan, r. (2005). in defense of personality measurement: new wine for old whiners. human performance, 18, 331-341. hui, c. h., & triandis, h.c. (1985). measurement in cross-cultural psychology: a review and comparison of strategies. journal of cross-cultural psychology, 16 (june), 131-152. hui, c. h., & yee, c. (1999). the impact of psychological collectivism and workgroup atmosphere on chinese employees’ job satisfaction. applied psychology: an international review, 48(2), 175-185. judge, t. a., & bono, j. e. (2001). relationship of core self-evaluations traits-self esteem, generalized self-efficacy, locus of control, and emotional stability-with job satisfaction and job performance: a meta-analysis. journal of applied psychology, 86, 80-92. kirkman, b. l., lowe, k. b., & gibson, c. b. (2006). a quarter century of culture’s consequences: a review of empirical research incorporating hofstede’s cultural values framework. journal of international business studies, 37, 285-320. lagrosen, s. (2002). quality management in europe: a cultural perspective. the tqm magazine, 14(5), 275-283. leach-lópez, m. a., stammerjohan, w. w., & mcnair, f. m. (2007). differences in the role of job relevant information in the budget participation-performance relationship among us and mexican managers: a question of culture or communication? journal of management accounting research, 19, 105-136. http://stuwww.uvt.nl/~csmeets/~1st-vsm.html http://stuwww.uvt.nl/~csmeets/~1st-vsm.html volume 30, number 1 33 leach-lópez, m. a., stammerjohan, w. w., & rigsby, j. t. (2008). an update on budgetary participation, locus of control, and the effects on mexican managerial performance and job satisfaction. journal of applied business research, 24(3), 121-134. lindell, m. k., & whitney, d. j. (2001). accounting for common method variance in cross-sectional research designs. journal of applied psychology, 86(1), 114121. mahoney, t. a., jerdee, t. h., & carroll, s. j. (1963). development of managerial performance: a research approach. cincinnati, oh: south-western publishing, co. malhotra, n. k., patil, a., & kim, s. s. (2007). bias breakdown. marketing research, 19(1), 24-29. murphy, k. r., & dzieweczynski, j. l. (2005). why don’t measures of broad dimensions of personality perform better as predictors of job performance? human performance, 18(4), 343-357. murray, j. y., kotabe, m., & zhou, j. n. (2005). strategic alliance-based sourcing and market performance: evidence from foreign firms operating in china. journal of international business studies, 36(2), 187-208. ng, t. w. h., sorensen, k. l., & eby, l. t. (2006). locus of control at work: a metaanalysis. journal of organization behavior, 27, 1057-1087. nouri, h., & parker, r. j. (1998). the relationship between budget participation and job performance: the roles of budget adequacy and organizational commitment. accounting, organizations and society, 23, 467-483. ozer, m. (2008). personal and task-related moderators of leader-member exchange among software developers. journal of applied psychology, 93(5), 1174-1182. penney, l. m., david, e., & witt, l. a. (2011). a review of personality and performance: identifying boundaries, contingencies, and future research directions. human resource management review, 21, 297-310. perera, m. h. b., & mathews, m. r. (1990). the cultural relativity of accounting and international patterns of social accounting. advances in international accounting, 3, 215-251. 34 journal of business strategies rotter, j. b. (1966). generalized expectancies for internal versus external control of reinforcement. psychological monographs, 80(1), whole no. 609. shields, m. d., deng, f. j., & kato, y. (2000). the design and effects of control systems: tests of directand indirect-effects models. accounting, organizations and society, 25, 185-202. spector, p. e. (1982). behavior in organizations as a function of employees’ locus of control. psychological bulletin, 91, 482-497. spector, p. e. (2005). locus of control. blackwell encyclopedic dictionary of organizational behavior, 1. tsui, j. s. l. (2001). the impact of culture on the relationship between budgetary participation, management accounting systems, and managerial performance: an analysis of chinese and western managers. accounting, organizations and society, 36, 125-146. wacker, j. g., & sprague, l. g. (1998). forecasting accuracy: comparing the relative effectiveness of practices between seven developed countries. journal of operations management, 16, 271-290. biographical sketch of author dr. maria a. leach-lópez — before joining academia, dr. leach-lópez and her husband owned a construction business and had two daughters. she earned a b.a. in accounting from mississippi university for women (1987), earned a master of professional accountancy (1988) and a doctor of business administration degree (2002) from mississippi state university. she is a certified public accountant and a certified management accountant and has taught at mississippi state university, jackson state university, and auburn montgomery. volume 37, number 2 1 corporate social responsibility engagement, economic policy uncertainty, and firm financial performance sammy g. muriithi university of central oklahoma • edmond, ok bruce a. walters louisiana tech university • ruston, la otis w. gilley louisiana tech university • ruston, la abstract the link between corporate social responsibility (csr) engagement and firm financial performance has been examined in a variety of contexts. we extend this link to an understudied but important context for strategic decisions: environmental uncertainty. we draw on stakeholder theory to investigate the potential moderating influence of an increasingly important measure of environmental uncertainty – economic policy uncertainty (epu), on the csr-performance relationship. panel data analysis of 484 firms using kld data and the compustat/capital iq database reveal that epu appears to moderate the relationship between csr and financial performance. moreover, supplemental analysis reveals that this moderated relationship varies when considering individual components of csr. implications for both research and practice are suggested regarding managers’ emphases among various csr initiatives in times of high policy uncertainty. keywords: corporate social responsibility; uncertainty; policy uncertainty; firm performance; stakeholder theory. introduction corporate social responsibility (csr) has been defined as “actions that appear to further some social good, beyond the interest of the firm and that which is required by law” (mcwilliams & siegel 2001: 117). the benefits firms derive from engagement in csr initiatives have been debated. some question whether such actions are an overinvestment of investors’ contributions (barnea & rubin, 2010), or perhaps the result of entrenched managers’ empire-building efforts (e.g., gul, krishnamurti, shams, & chowdhury, 2020). an opposing view is that csr engagement is required by managers on a variety of fronts, implying that the interests of multiple stakeholders, including shareholders, are somehow balanced 2 journal of business strategies (e.g., freeman, 1984; wood, 1991). in their investigation of corporate governance structures’ impact on csr and financial performance, harjoto and jo (2011) pitted agency theory’s overinvestment hypothesis against stakeholder theory’s conflict resolution hypothesis, concluding that the conflict resolution hypothesis was supported whereas the overinvestment argument was not. they argued that not only is csr engagement influenced by firm governance, but after taking into account various endogeneity issues, csr also enhances firm financial performance. evidence continues to accumulate pointing to reputational benefits accruing to csr firms and the impact of csr on financial performance (e.g., cespa & cestone, 2007; george, dahlander, graffin, & sim, 2016; wang, dou, & jia, 2016). we aim to advance our understanding of the csr-firm performance link in a context that is critically germane to strategic decision-making, and yet has received surprisingly little research attention – the context of environmental uncertainty. a substantial body of research supports the moderating effect of uncertainty on the performance impact of strategy (song, augustine, & yang, 2016; srećković, 2018), structure (leifer & huber, 1977; sine, mitsuhashi & kirsch, 2006), and strategic decision processes (brouthers, brouthers, & werner, 2000), to name just a few examples. yet the only widely-known study to our knowledge that investigates environment’s effect on the csr-firm performance relationship is that of goll and rasheed (2004). these authors investigated the moderating influence of environment on the impact of discretionary social responsibility on financial performance. they reported that environmental dynamism and munificence exert a moderating influence on the link between discretionary social responsibility and financial performance. in that study, environmental dynamism and munificence were measured as variability and growth rate in the value of shipments. their proxy for executives’ perceptions of their firms’ discretionary csr was a three-item survey measure adapted from aupperle (1984). the authors concluded that discretionary social responsibility contributed more strongly to performance when environmental munificence and dynamism were higher. our study extends and builds upon the work of these authors both theoretically and methodologically. our assessment of firms’ csr engagement is obtained from the kinder, lydenberg, and domini (kld) database because of its comprehensive assessment of a range of csr initiatives, its broad support in csr studies, and its construct validity (hillman & keim, 2001; mattingly & berman, 2006; sharfman, 1996). the range of issues examined allows us initially to assess csr as a global construct, and subsequently disaggregate csr into individual components to explore differences among their effects. our measure of uncertainty—economic volume 37, number 2 3 policy uncertainty (epu) (baker, bloom, & davis, 2016)—is a pervasive objective measure that has been widely used in recent studies and is shown to affect investment decisions (gulen & ion, 2015). in contrast to environmental uncertainty concerning the variability in growth rate and the value of shipments (measures of environmental dynamism and munificence), the present focus is more specifically uncertainty about economic policy; government regulations; future federal tax code changes; and economic forecasts of government spending and the consumer price index, which represent fiscal and monetary policy uncertainty. we find that csr is positively associated with firm financial performance. additionally, epu is negatively related both to csr and firm financial performance. as epu increases, the positive association of csr on financial performance appears to diminish. in subsequent analysis, interesting differences emerge regarding the relationship between individual csr components and financial performance in the face of high policy uncertainty. the following sections present theoretical arguments and hypotheses concerning csr and financial performance, as well as the potential moderating influence of epu on performance. then we present our sample and methodology, along with results using csr in the aggregate. subsequent analysis demonstrates that some individual csr initiatives appear to be associated with higher performance under conditions of high epu whereas others do not. we conclude with discussion and implications for research and practice. ___________________________ theory and hypotheses firm reputation and stakeholder welfare derived from csr engagement are important components of long-term stockholder wealth maximization and survival (becchetti, ciciretti, hasan, & kobeissi, 2012). investments in csr are different from other forms of expenditures in tangible or intangible assets because the benefits are indirect, stemming from the reputational capital the firm garners from the visibility of its socially responsible endeavors (udayasankar, 2008). in addition, these investments are largely at the discretion of the top managers and will depend on, for example, the managers’ values and power in the organization (le et al., 2015) as well as the economic environment, competition, and the legal environment (campbell, 2007). the conflict resolution hypothesis (harjoto & jo, 2011) appears to have gained substantial credence. firms renowned for their csr initiatives often enjoy higher financial performance (barnett & salomon, 2012), in part because of positive evaluations on the part of numerous stakeholders (george et al., 2016). a csr 4 journal of business strategies reputation may lower the cost of capital (sharfman & fernando, 2008) as well as capital constraints (cheng et al., 2014). the investment community has been shown to react favorably to csr initiatives (coffey & fryxell, 1991; flammer, 2013), frequently resulting in lower market risk (bansal & clelland, 2004). security analysts often follow such firms with interest, and their assessments tend to be positive (ioannou & serafeim, 2015; luo, wang, raithel, & zheng, 2015). csr has been touted as providing “insurance-like” benefits against negative environmental events that threaten firm value (godfrey, merrill, & hansen, 2009; mcguire, sundgren, & schneeweis, 1988) as well as litigation risk (koh, qian, & wang, 2014). firms in which management genuinely commits to csr engagement have also been shown to benefit from a culture in which employees exhibit great efforts for the good of the firm. such firms tend to have increased employee creativity, innovation, and engagement (caligiuri et al., 2013; glavas & piderit, 2009), as well as higher employee retention (jones, 2010) and commitment (maignan et al., 1999). they often are at an advantage in attracting job applicants (lin et al., 2010). their enhanced image and reputation broadens their choice set among a greater number of highly qualified potential employees as compared to low-csr firms (fombrun & shanley, 1990). turnover is reduced as committed employees experience intrinsic job satisfaction and identification with the organization and its goals (brammer et al., 2007; peterson, 2004). corporate leaders with a stakeholder orientation have been shown to be perceived as visionary leaders that spur employees to make personal sacrifices for the firm (sully de luque et al., 2008). the accompanying organizational citizenship behaviors stimulate working relationships and enhance job performance (kim et al., 2010; lin et al., 2010). the foregoing characteristics attributed to csr firms set the stage for increased financial performance. such firms are endowed with a degree of moral capital that engages various stakeholders in a positive way (godfrey, 2005), and constituents respond in part because of signals csr evokes, such as customers’ evaluations (arora & henderson, 2007; maignan et al., 1999). employee commitment, engagement, creativity, and innovation are likely to enhance financial performance from within, while key external stakeholders can be expected to provide needed resources. these arguments lead to the following hypothesis: volume 37, number 2 5 hypothesis 1: csr is positively related to firm financial performance. figure 1 conceptual model policy uncertainty effects recent studies have begun to investigate the effect of contextual factors on firms’ investment in csr. for example, wang et al. (2016) and julian and ofori-dankwa (2013) conclude that institutional differences between advanced economies and developing economies are likely to result in different csr implications. goll & rasheed (2004) investigated the moderating influence of environmental dynamism and munificence on the relationship between discretionary social responsibility and firm financial performance. these studies reinforce the importance of environmental characteristics as a key driver of csr, hence the need for further inquiry into their influence. national domains harbor different contextual factors such as the political, social, and economic institutions that ultimately affect firms’ growth and profitability (khanna & rivkin, 2001; north, 1990). the government plays an important role in influencing the performance of firms (porter, 1990) within these domains given its impact on the policy environment. policy uncertainty becomes especially important due to its profound power over the performance of the economy, the markets, the industry, and ultimately the firm. the policy environment has been defined as the set of laws, regulations, and administrative procedures formally sanctioned by the government that impact a firm’s profitability by altering its costs or revenues (delios & henisz, 2003). policy uncertainty may increase as the number of veto players within their political institutions declines or as they become more homogeneous (henisz & delios, 2004). therefore, where sufficient checks and balances exist, for example, within the executive, legislative, and judicial branches, the political elite are limited in the breadth of action they can take by other political actors who must approve any proposed changes in policy (henisz, 2000; north, 1990). 20 figure 1 conceptual model csr engagement economic policy uncertainty firm performance 6 journal of business strategies the policy environment may be characterized by varying levels of uncertainty. policy uncertainty is unlike other types of risk (e.g., contracting or input-price uncertainty) because it is beyond the firm’s control and cannot be hedged (bonaime et al., 2018). while firms within a given national institutional context rationally pursue their interests and make strategic choices (lee, peng, & barney, 2007), policy uncertainty serves to cloud management’s judgment of various strategic options at their disposal. policy uncertainty has been found to adversely affect asset returns, firm-level investment, firm acquisitiveness, and innovation activity (bhattacharya et al., 2017; brogaard & detzel, 2015; chen et al., 2019; gulen & ion, 2015; kang et al., 2014; nguyen & phan, 2017). adverse effects associated with high epu include increases in the cost of external financing (gilchrist et al., 2014) and firm cash holdings (phan et al., 2019). as epu cannot be hedged through firm actions (bonaime et al., 2018), organizational researchers have traditionally viewed uncertainty as a threat to the organization (kogut & kulatilaka, 2001). indeed, studies have found that policy uncertainty not only raises the costs of new equity and debt (gungoraydinoglu, çolak, & öztekin, 2017), but also negatively affects investments in tangible assets (alesina & perotti, 1996; bloom, bond, and van reenen, 2007; gulen & ion, 2015; julio & yook, 2012), lowers firm engagement in mergers and acquisitions (nguyen & phan, 2017), and negatively impacts innovation (bhattacharya et al., 2017). given these outcomes, the real options perspective would suggest that during times of high policy uncertainty the option to postpone current investment would have a higher value for the firm. managers would likely adopt a more cautious approach to investment, putting off investments to a future they anticipate will be more stable and predictable, potentially leading to a decrease in the level of organizational performance. conversely, during times of low uncertainty, the external environment would be more predictable and the future outcomes of current investments would be more feasible to forecast. managers would be more likely to increase investments due to their confidence in making them. given their discretionary nature, csr investments might be among those to be eliminated or postponed during times of high policy uncertainty. it follows that, with lower csr engagement, the potential positive outcomes from these csr investments will be diminished, leading to lower overall financial performance. however, during times of low policy uncertainty, managers would be more confident making investments in csr, implying that the organization would reap greater benefits from engaging in csr. we therefore propose that policy uncertainty will negatively moderate the relationship between csr and cfp. volume 37, number 2 7 hypothesis 2: policy uncertainty negatively moderates the relationship between csr and firm financial performance. methodology our data were obtained from the msci kld database (henceforth kld), the baker et al. (2016) policy uncertainty index (hereafter, bbdi), and compustat/ capital iq. sample collection began with all us firms that consistently appear in the kld database from 2001-2010. for these firms, financial measures were obtained from the compustat/capital iq database, while the annual policy uncertainty measure was obtained from bbdi. after excluding firms with missing data, our final dataset consisted of 484 firms. variables our measure for csr, our independent variable, is derived for the years 20012010 from the kld database. the database objectively analyzes firm csr along 13 dimensions and assigns scores ranging from +1 (strength) to −1 (weakness), with 0 being a neutral score. five of these dimensions are directly attributable to stakeholders and are frequently used in research (community, diversity, employee relations, environment, and product). following convention, we obtained each firm’s overall csr score by summing its strengths and weaknesses along the five dimensions (e.g., johnson & greening, 1999). this study assesses the relationship between csr and firm financial performance as well as the potential moderating influence of policy uncertainty on the csr-performance relationship. financial performance was obtained as the roa (net income/total assets) for the focal year. for our moderating variable, economic policy uncertainty (epu), we utilized the baker et al. (2016) policy uncertainty index (bbdi). this index has been widely used in recent literature as a credible measure of policy uncertainty (e.g., gulen & ion, 2015; hadani et al., 2016). epu is constructed as a weighted average measure of (i) the frequency of newspaper articles related to policy uncertainty; (ii) uncertainty about future federal tax code changes; and (iii) dispersion in economic forecasts of government spending and the consumer price index, which represent fiscal and monetary policy uncertainty. for purposes of this study, the bbdi is advantageous in that it objectively quantifies environmental uncertainty dimensions, decreasing concerns of bias and validity inherent in perceptual measures of uncertainty (buchko, 1994). 8 journal of business strategies control variables firm size: larger firms are likely better endowed with resources, which may raise the availability of resources to spend on csr initiatives. in addition, they are likely to invest more in csr initiatives because of the greater public scrutiny over their behavior (christmann & taylor, 2001). debt ratio: extant research indicates that debt encourages restraint on managers, thereby limiting the exploration of new business and lowering profit potential, and motivates managers to make decisions that are in line with the interests of the firm (barnett & salomon, 2012). debt ratio is obtained by dividing the firm’s long-term debt by total assets. year effects: specific trends occurring in some years may affect firm financial performance (banalieva & santoro, 2009). to control for this possibility, dummy variables were created for each of our sampling years. advertising intensity: marketing efforts can be used to enhance competitive positioning and profitability (mcwilliams & siegel, 2000). advertising intensity is measured as the ratio of advertising expenditures to sales (barnett & salomon, 2012). industry effects: extant research suggests that industry characteristics can affect changes in customer tastes, competitor behavior, technology, and sources of supply (lawrence & lorsch, 1967), which may ultimately affect profitability of firms within them. dummy variables were created using the first two digits of the sic of each focal firm. prior performance: prior performance affects subsequent performance through its influence on managerial strategic decision-making processes (hambrick & schecter, 1983; tushman & romanelli, 1985; wiersema & bantel, 1992). this was operationalized as the average roa for the three years prior to the focal year. organizational slack: slack represents “a cushion of actual or potential resources which allow an organization to adapt successfully to internal pressures for adjustment or to external pressures for change in policy, as well as to initiate changes in strategy with respect to the external environment” (bourgeois, 1981: 30). slack resources can be used as a safeguard against the negative effects of uncertainty (reuer & leiblein, 2000) and can therefore have a substantial impact on firm performance (iyer & miller, 2008). slack also makes the firm less resistant to volume 37, number 2 9 stakeholder demands (tang & tang, 2012), potentially affecting firm investments in csr. slack was operationalized as the average cash and cash equivalents over the three year period prior to the focal year (le, park & kroll, 2014) empirical results a majority of studies of the effects of corporate social responsibility on firm performance have relied on cross-sectional datasets in investigating this relationship. a key distinction in the present study is that we make use of a panel dataset. this offers several important advantages over previous investigations. first, our panel of data consists of observations on 484 firms over a span of 10 years. second, since firms and their shareholders are by nature idiosyncratic, panel analysis allows us to overcome coefficient bias resulting from unobserved heterogeneity and omitted variables. third, panel data are better suited than cross-sectional data for studying the dynamics of change. fourth, panel data can minimize the effects of aggregation bias that might arise from aggregating firms into broad groups such as by industry. descriptive statistics and correlations are presented in table 1. we estimated a standard fixed effects panel model that regresses changes in the dependent variable against changes in the explanatory variables, thereby differencing out any unobserved heterogeneity. results of the firm fixed effects model utilizing robust clustered standard errors appears in table 2. table1 descriptive statistics and correlation 21 table 1 descriptive statistics and correlations variables mean sd 1 2 3 4 5 6 7 8 9 10 11 12 1. overall csr 0.58 2.92 1.00 2. product csr -0.39 0.86 0.25 1.00 3. environment csr -0.04 1.13 0.59 0.14 1.00 4. employee csr -0.08 1.10 0.52 0.12 0.06 1.00 5. community csr 0.18 0.76 0.55 -0.12 0.26 0.08 1.00 6. diversity csr 0.91 1.56 0.67 -0.21 0.14 0.12 0.37 1.00 7. policy uncertainty 105.07 35.55 0.07 0.01 0.17 0.03 0.04 -0.03 1.00 8. organizational slack 2.64 0.81 0.22 -0.36 0.01 0.11 0.27 0.40 0.02 1.00 9. prior performance 0.05 0.07 0.13 0.06 0.05 0.11 0.04 0.08 -0.01 -0.05 1.00 10. advertising intensity 1.03 10.29 0.01 0.02 0.01 0.07 -0.03 -0.02 0.00 -0.02 0.04 1.00 11. debt ratio 0.20 0.16 -0.15 -0.05 -0.07 -0.15 -0.09 -0.05 0.07 -0.22 -0.21 -0.07 1.00 12. firm size 3.85 0.66 0.10 -0.45 -0.13 0.02 0.21 0.42 0.01 0.71 -0.11 -0.06 0.02 1.00 n=484. 10 journal of business strategies table2 results of panel fixed-effects model dv: financial performance 22 table 2 results of panel fixed-effects model dv: financial performance. model 1 model 2 model 3 a b a b a b firm size 0.00097 0.00316 0.00202 (0.07) (0.22) (0.14) debt ratio -0.14779*** -0.14877*** -0.14868*** (-3.99) (-3.96) (-3.96) advertising intensity -0.00036*** -0.00038*** -0.00038*** (-3.83) (-4.43) (-4.28) prior performance -0.02074 -0.01242 -0.01113 (-0.37) (-0.22) (-0.20) organizational slack 0.00722 0.00727 0.0072 (1.65) (1.65) (1.64) epu -0.00029*** -0.00029*** -0.00027*** -0.00030*** -0.00027*** -0.00028*** (-8.18) (-8.42) (-8.03) (-8.23) (-8.03) (-8.15) overall csr 0.00352*** 0.00261 (4.03) (1.77) overall csr x epu 0.00001 (0.96) diversity csr -0.00082 -0.00449* (-0.53) (-2.06) diversity csr x epu 0.00003* (2.31) community csr 0.00254 -0.00554 (1.30) (-1.30) community csr x epu 0.00008* (2.12) constant 0.08541 0.08039 0.08169 (1.78) (1.65) (1.68) f 20.32642 20.49354 20.07202 a marginal effects (dy/dx); b model coefficients; t statistics in parentheses * p<0.05 ** p<0.01 *** p<0.001 volume 37, number 2 11 table 2 continued results of panel fixed-effects model dv: financial performance 23 table 2 continued results of panel fixed-effects model dv: financial performance. model 4 model 5 model 6 a b a b a b firm size 0.0051 -0.00165 0.00482 (0.35) (-0.12) (0.33) debt ratio -0.14746*** -0.14936*** -0.14770*** (-3.95) (-4.05) (-3.93) advertising intensity -0.00039*** -0.00038*** -0.00038*** (-4.09) (-4.27) (-4.28) prior performance -0.0267 -0.00895 -0.01478 (-0.48) (-0.16) (-0.26) organizational slack 0.00891* 0.00645 0.00727 (2.01) (1.48) (1.64) epu -0.00027*** -0.00027*** -0.00030*** -0.00030*** -0.00027*** -0.00030*** (-8.01) (-7.99) (-8.25) (-8.17) (-8.04) (-7.77) employee csr 0.00734*** 0.00629* (4.00) (2.34) employee csrx epu 0.00001 (0.45) environment csr 0.00681*** 0.00371 (3.53) (0.92) environment csr x epu 0.00003 (1.14) product csr 0.00589* 0.01569*** (2.38) (3.51) product csr x epu -0.00009** (-2.97) constant 0.06587 0.10056* 0.07592 (1.32) (2.08) (1.52) f 20.02673 20.54209 20.07172 a marginal effects (dy/dx); b model coefficients; t statistics in parentheses * p<0.05 ** p<0.01 *** p<0.001 12 journal of business strategies the dependent variable is the change in return on assets and the model includes an interaction between policy uncertainty and corporate social responsibility to capture the possible mitigating effects. the main question of importance is if and how corporate social responsibility might mitigate the potential negative effects of policy uncertainty if such effects exist. to answer this question, we report the average marginal effects from the fixed effects model (model 1a). these marginal effects isolate the effect of a change in each variable holding all else constant and account for the potential interaction of the variables. from these results we see that policy uncertainty, in line with our expectations, is negatively and significantly related to the change in return on assets (-0.00029, p<0.001). we also see that the marginal effect of corporate social responsibility is positive and significant (0.00352, p<0.001), which is in line with prior research supporting the beneficial outcomes of csr engagement for firms, providing support for hypothesis h1. these results suggest that csr may have the potential to offset the negative effects of policy uncertainty. to test this proposition, we include policy uncertainty as a moderator in the csr-performance relationship in model 1b. the coefficient of the interaction is found to be insignificant (0.00001), suggesting no moderation when considering overall csr as an aggregate measure. the possibility that effects of individual components were masked by such aggregation is quite conceivable, motivating us to de-compartmentalize csr in subsequent analysis. thus far, our analysis has relied on the aggregate csr measure composed of community, diversity, employee relations, environment, and product dimensions as reflected in the kld scores. prior research suggests that various csr dimensions may affect profitability in unique ways. to increase understanding of the relationship between epu and the csr-profitability link, supplemental analyses were performed (model 2 through model 6). model 2 tests the effect of the diversity dimension on performance. model 2a reports the marginal effects of the diversity dimension on performance, which are found to be insignificant (-0.00082). however, the interaction depicted in model 2b is positive and significant (0.00003, p<0.05), suggesting that, when policy uncertainty is high, engagement in diversity-related csr may be beneficial to the bottom line for firms. model 3 tests the effect of community csr on performance. similar to the diversity dimension, the marginal effect is insignificant. however, the interaction term is significant (0.00008, p<0.05), implying that engagement in communityrelated csr may mitigate the negative effects of high policy uncertainty. model 4 tests the effect of employee csr on performance. the marginal effect (model 4a) is highly significant (0.00734, p<0.001), meaning that employee csr is highly volume 37, number 2 13 related to organizational performance. however, the employee csr-policy uncertainty interaction term (model 4b) is insignificant (0.00001), so regardless of the uncertainty level, performance is not significantly affected by the level of policy uncertainty. model 5 tests the effect of environment csr on performance, and the moderating effect of policy uncertainty on that relationship. the marginal effect in model 5a is positive and significant (0.00681, p<0.001), suggesting that engagement in environment csr is beneficial for financial performance. however, the interaction effect of epu on the csr-fp relationship in model 5b is not supported. model 6 tests the effect of product csr on the csr-fp relationship. results of the marginal analysis in model 6a are positive and significant (0.00589, p<0.05), suggesting that engagement in product-related csr is beneficial for financial performance. however, the interaction effect in model 6b is negative and significant (-0.00009, p<0.01), suggesting that policy uncertainty reverses the positive outcomes of engagement in product-related csr activities. these results suggest that economic policy uncertainty has a negative and significant effect on the change in return on assets. additionally, the marginal effect of corporate social responsibility is positive and significant, potentially offsetting the effects of policy uncertainty. contrary to our expectations, economic policy uncertainty does not appear to moderate the relationship between csr and performance when considering csr as an aggregate measure. importantly, individual components of csr demonstrate unique effects regarding the observed relationships. thus, disaggregating the csr construct can bring to light potential relationships among csr, performance, and context that may otherwise be masked. discussion this study explores the relationship between socially responsible activities and firm financial performance and the potential moderation effects of an increasingly important and pervasive type of environmental uncertainty—economic policy uncertainty. a substantial body of research has been conducted on the effect of csr on financial performance, and we had the opportunity to confirm this relationship in another setting as well as extend the pioneering work of goll and rasheed (2004), both theoretically and methodologically. these authors found environmental characteristics to moderate the csr-performance relationship. our extensions include the use of kld data to assess the relationship overall as well as separate csr dimensions, and inclusion of an important dimension of environmental uncertainty—economic policy uncertainty. methodologically, we assessed these 14 journal of business strategies relationships using marginal analysis of panel data, along with objective measures of csr and epu. results indicate that the relationship between csr and financial performance is generally positive and significant in our sample, lending further credence to the positive outcomes that accompany csr engagement. csr engagement continues to gain prominence among stakeholders as a salient performance dimension. contemporaneously, environmental uncertainty is on the rise globally. these conditions set the stage for research that illuminates how specific aspects of uncertainty may affect the csr-financial performance relationship. after investigating this relationship initially in terms of overall csr using aggregated kld data, we then disaggregate csr into five unique dimensions in subsequent analysis. the results help to uncover differences in the apparent salience of each dimension, both in terms of main effects and as moderated by economic policy uncertainty. our supplemental analysis indicates that individual categories of csr engagement may demonstrate unique effects at given levels of policy uncertainty even as, in some cases, the main effects may not be apparent. for instance, although the diversity dimension of csr is not demonstrated to be related to performance, when epu is high, engagement in diversity-related csr may boost the bottom line. community-related csr similarly seems to mitigate the negative link between high policy uncertainty and performance. on the other hand, environmentand employeerelated csr appear important for financial performance whether policy uncertainty is high or low. and while product-related csr benefits financial performance, the negative interaction suggests high epu reverses such positive benefits. in other words, product csr appears to pay off more when epu is low. in addition, these have varying effect sizes, implying that payoffs from different dimensions of csr may differ depending on the level of economic policy uncertainty facing the firm. obviously these findings should be taken with caution. but they do imply that researchers may extend our knowledge by considering specific categories of csr engagement in different environmental contexts. for example, investigation of whether some types of csr are more beneficial in particular institutional settings, in line with wang and colleagues (2016) and julian and ofori-dankwa (2013), would be warranted. various stakeholder groups stand to benefit from csr engagement. this study indeed finds that, while this is true, the benefits accruing to the firm may vary with the level of environmental uncertainty. we thus contribute to the literature exploring the degree to which serving stakeholders might enhance firm performance, and also to csr literature by exploring the influence of csr dimensions as disaggregated from an overall construct. volume 37, number 2 15 this study is not without limitations. first, the reliance on kld data, an objective measure of csr, may not adequately capture actual stakeholder sentiment of a firm’s social engagement. in a similar fashion, although baker and colleagues’ (2016) economic policy uncertainty index is arguably a prominent objective measure of epu and has been used in numerous studies, it may not always accurately capture executives’ perceptions of the current level of uncertainty in the environment. future empirical studies may add value by employing survey methods in assessing stakeholders’ perceptions of firms’ csr initiatives as well as executives’ perceptions of economic policy uncertainty and its ramifications for success. references alesina, a., & perotti, r. (1996). income distribution, political instability, and investment. european economic review, 406, 1203-1228. arora, n., & henderson, t. (2007). embedded premium promotion: why it works and how to make it more effective. marketing science, 26, 514-531. aupperle, k. e. (1984). an empirical measure of corporate social orientation. in l. e. preston (ed.), research in corporate social performance and policy, 6, 27-54. greenwich, ct: jai press. baker, s. r., bloom, n., & davis, s. j. (2016). measuring economic policy uncertainty. the quarterly journal of economics, 131, 1593-1636. banalieva, e. r., & santoro, m. d. (2009). local, regional, or global? geographic orientation and relative financial performance of emerging market multinational enterprises. european management journal, 27, 344-355. bansal, p., & clelland, i. (2004). talking trash: legitimacy, impression management, and unsystematic risk in the context of the natural environment. academy of management journal, 47, 93-103. barnea, a., & rubin, a. (2010). corporate social responsibility as a conflict between shareholders. journal of business ethics, 97, 71-86. barnett, m. l., & salomon, r. m. (2012). does it pay to be really good? addressing the shape of the relationship between social and financial performance. strategic management journal, 33, 1304-1320. becchetti, l., ciciretti, r., hasan, i., & kobeissi, n. (2012). corporate social responsibility and shareholder’s value. journal of business research, 65, 1628-1635. bhattacharya, u., hsu, p., tian, x., & xu, y. (2017). what affects innovation more: policy or policy uncertainty? journal of financial and quantitative analysis, 52, 1869-1901. 16 journal of business strategies bloom, n., bond, s., & van reenen, j. (2007). uncertainty and investment dynamics. the review of economic studies, 74, 391-415. bonaime, a., gulen, h., & ion, m. (2018). does policy uncertainty affect mergers and acquisitions? journal of financial economics, 129, 531-558. bourgeois iii, l. j. (1981). on the measurement of organizational slack. academy of management review, 6, 29-39. brammer, s., millington, a., & rayton, b. (2007). the contribution of corporate social responsibility to organizational commitment. international journal of human resource management, 18, 1701-1719. brogaard, j., & detzel, a. (2015). the asset-pricing implications of government economic policy uncertainty. management science, 61, 3-18. brouthers, k. d., brouthers, l. e., & werner, s. (2000). influences on strategic decision-making in the dutch financial services industry. journal of management, 26, 863-883. buchko, a. a. (1994). conceptualization and measurement of environmental uncertainty: an assessment of the miles and snow perceived environmental uncertainty scale. academy of management journal, 37, 410-425. caligiuri, p., mencin, a., & jiang, k. (2013). win–win–win: the influence of company‐sponsored volunteerism programs on employees, ngos, and business units. personnel psychology, 66, 825-860. campbell, j. l. (2007). why would corporations behave in socially responsible ways? an institutional theory of corporate social responsibility. academy of management review, 32, 946-967. cespa, g., & cestone, g. (2007). corporate social responsibility and managerial entrenchment. journal of economics & management strategy, 16, 741-771. chen, p. f., lee, c. c., & zeng. j. h. (2019). economic policy uncertainty and firm investment: evidence from the us market. applied economics, 51, 3423-3435. cheng, b., i. ioannou., & serafeim, g. (2014). corporate social responsibility and access to finance. strategic management journal, 35, 1-23. christmann, p., & taylor, g. (2001). globalization and the environment: determinants of firm self-regulation in china. journal of international business studies, 32, 439-458. coffey, b. s., & fryxell, g. e. (1991). institutional ownership of stock and dimensions of corporate social performance: an empirical examination. journal of business ethics, 10, 437-444. delios, a., & henisz, w. j. (2003). political hazards, experience, and sequential entry strategies: the international expansion of japanese firms, 1980-1998. strategic management journal, 24, 1153-1164. volume 37, number 2 17 flammer, c. (2013). corporate social responsibility and shareholder reaction: the environmental awareness of investors. academy of management journal, 56, 758-781. fombrun, c., & shanley, m. (1990). what’s in a name? reputation building and corporate strategy. academy of management journal, 33, 233-258 freeman r. e. (1984). strategic management: a stakeholder approach. pitman: boston, ma. gilchrist, s., sim, j. w., & zakrajšek, e. (2014). uncertainty, financial frictions, and investment dynamics. national bureau of economic research, inc. nber working papers: 20038. glavas a., & piderit, s. (2009). how does doing good matter? effects of corporate citizenship on employees. journal of organizational citizenship, 36, 51-70. george, g., dahlander, l., graffin, s., & sim, s. (2016). reputation and status: expanding the role of social evaluation in management research. academy of management journal, 59, 1-13. godfrey, p. c. (2005). the relationship between corporate philanthropy and shareholder wealth: a risk management perspective. academy of management review, 30, 777-798. godfrey, p. c., merrill, c. b., & hansen, j. m. (2009). the relationship between corporate social responsibility and shareholder value: an empirical test of the risk management hypothesis. strategic management journal, 30, 425-445. goll, i., & rasheed, a. a. (2004). the moderating effect of environmental munificence and dynamism on the relationship between discretionary social responsibility and firm performance. journal of business ethics, 49, 41-54. gul, f. a., krishnamurti, c., shams, s., & chowdhury, h. (2020). corporate social responsibility, overconfident ceos and empire building: agency and stakeholder theoretic perspectives. journal of business research, 111, 52-68. gulen, h., & ion, m. (2015). policy uncertainty and corporate investment. the review of financial studies, 29, 523-564. gungoraydinoglu, a., çolak, g., & öztekin, ö. (2017). political environment, financial intermediation costs, and financing patterns. journal of corporate finance, 44, 167-192. hadani, m., bonardi, j. p., & dahan. n. m. (2016). corporate political activity, public policy uncertainty, and firm outcomes: a meta-analysis. strategic organization, 15, 338-366. hambrick, d. c., & schecter, s. m. (1983). turnaround strategies for mature industrialproduct business units. academy of management journal, 26, 231-248. 18 journal of business strategies harjoto, m. a., & jo, h. (2011). corporate governance and csr nexus. journal of business ethics, 100, 45-67. henisz, w. j. (2000). the institutional environment for multinational investment. the journal of law, economics, and organization, 16, 334-364. henisz, w. j., & delios. a. (2004). information or influence? the benefits of experience for managing political uncertainty. strategic organization, 2, 389-421. hillman, a. j., & keim, g. d. (2001). shareholder value, stakeholder management, and social issues: what’s the bottom line? strategic management journal, 22, 125-139. ioannou, i., & serafeim, g. (2015). the impact of corporate social responsibility on investment recommendations: analysts’ perceptions and shifting institutional logics. strategic management journal, 36, 1053-1081. iyer, d. n., & miller, k. d. (2008). performance feedback, slack, and the timing of acquisitions. academy of management journal, 51, 808-822. johnson, r. a., & greening, d. w. (1999). the effects of corporate governance and institutional ownership types on corporate social performance. academy of management journal, 42, 564-576. jones, d. a. (2010). does serving the community also serve the company? using organizational identification and social exchange theories to understand employee responses to a volunteerism programme. journal of occupational and organizational psychology, 83, 857-878. julian, s. d., & ofori‐dankwa, j. c. (2013). financial resource availability and corporate social responsibility expenditures in a sub-saharan economy: the institutional difference hypothesis. strategic management journal, 34, 13141330. julio, b., & yook, y. (2012). political uncertainty and corporate investment cycles. the journal of finance, 67, 45-83. kang, w., lee, k., & ratti, r. a. (2014). economic policy uncertainty and firmlevel investment. journal of macroeconomics, 39, 42-53. khanna, t., & rivkin, j. (2001). estimating the performance of business groups in emerging markets. strategic management journal, 22, 45-74. kim, h. r., lee, m., lee, h. t., & kim, n. m. (2010). corporate social responsibility and employee–company identification. journal of business ethics, 95, 557-569. kogut, b., & kulatilaka, n. (2001). capabilities as real options. organization science, 12, 744-758. koh, p. s., qian, c., & wang, h. (2014). firm litigation risk and the insurance value of corporate social performance. strategic management journal, 35, 1464-1482. volume 37, number 2 19 lawrence, p. r., & lorsch, j. w. (1967). organization and environment: managing differentiation and integration. boston, ma: harvard business school press. le, s., fuller, b., muriithi, s., walters, b., & kroll, m. j. (2015). the influence of top managers’ values on corporate social performance: a meta-analysis. journal of managerial issues, 27, 9-27. le, s. a., park, j. c., & kroll, m. (2014). differential effects of pre and postacquisition r&d expenditures on post-acquisition performance. journal of business research, 67, 92-99. lee, s. h., peng, m. w., & barney, j. b. (2007). bankruptcy law and entrepreneurship development: a real options perspective. academy of management review, 32, 257-272. leifer, r., & huber, g. p. (1977). relations among perceived environmental uncertainty, organization structure, and boundary-spanning behavior. administrative science quarterly, 22, 235-247. lin, c. p., lyau, n. m., tsai, y. h., chen, w. y., & chiu, c. k. (2010). modeling corporate citizenship and its relationship with organizational citizenship behaviors. journal of business ethics, 95, 357-372. luo, x., wang, h., raithel, s., & zheng, q. (2015). corporate social performance, analyst stock recommendations, and firm future returns. strategic management journal, 36, 123-136. maignan, i., ferrell, o. c., & hult, g. t. (1999). corporate citizenship: cultural antecedents and business benefits. journal of the academy of marketing science, 27, 455-469. mattingly, j. e., & berman, s. l. (2006). measurement of corporate social action: discovering taxonomy in the kinder lydenburg domini ratings data. business & society, 45, 20-46. mcguire, j. b., sundgren, a., & schneeweis, t. (1988). corporate social responsibility and firm financial performance. academy of management journal, 31, 854-872. mcwilliams, a., & siegel, d. (2000). corporate social responsibility and financial performance: correlation or misspecification? strategic management journal, 21, 603-609. mcwilliams, a., & siegel, d. (2001). corporate social responsibility: a theory of the firm perspective. academy of management review, 26, 117-127. nguyen, n. h., & phan, h. v. (2017). policy uncertainty and mergers and acquisitions. journal of financial and quantitative analysis, 52, 613-644. north. (1990). institutions, institutional change and economic performance. cambridge, uk: cambridge university press. 20 journal of business strategies peterson, d. k. (2004). the relationship between perceptions of corporate citizenship and organizational commitment. business & society, 43, 296-319. phan, h. v., nguyen, n. h., nguyen, h. t., & hegde, s. (2019). policy uncertainty and firm cash holdings. journal of business research, 95, 71-82. porter, m. e. (1990). the competitive advantage of nations. harvard business review, 68, 73-93. reuer, j. j., & leiblein, m. j. (2000). downside risk implications of multinationality and international joint ventures. academy of management journal, 43, 203-214. sharfman, m. (1996). the construct validity of the kinder, lydenberg & domini social performance ratings data. journal of business ethics, 15, 287-296. sharfman, m. p., & fernando, c. s. (2008). environmental risk management and the cost of capital. strategic management journal, 29, 569-592. sine, w. d., mitsuhashi, h., & kirsch, d. a. (2006). revisiting burns and stalker: formal structure and new venture performance in emerging economic sectors. academy of management journal, 49, 121-132. song, l., augustine, d., & yang, j. y. (2016). environmental uncertainty, prospector strategy, and new venture performance: the moderating role of network capabilities. international entrepreneurship and management journal, 12, 1103-1126. srećković, m. (2018). the performance effect of network and managerial capabilities of entrepreneurial firms. small business economics, 50, 807-824. sully de luque, m. s., washburn, n. t., waldman, d. a., & house, r. j. (2008). unrequited profit: how stakeholder and economic values relate to subordinates’ perceptions of leadership and firm performance. administrative science quarterly, 53, 626-654. tang, z., & tang, j. (2012). stakeholder-firm power difference, stakeholders’ csr orientation, and smes’ environmental performance in china. journal of business venturing, 27, 436-455. tushman, m. l., & romanelli, e. (1985). organizational evolution: a metamorphosis model of convergence and reorientation. in l. l. cummings & b. m. staw (eds.), research in organizational behavior, vol. 7. greenwich, ct: jai press, inc. udayasankar, k. (2008). corporate social responsibility and firm size. journal of business ethics, 83, 167-175. wang, q., dou, j., & jia, s. (2016). a meta-analytic review of corporate social responsibility and corporate financial performance: the moderating effect of contextual factors. business & society, 55, 1083-1121. volume 37, number 2 21 wiersema, m. f., & bantel, k. a. (1992). top management team demography and corporate strategic change. academy of management journal, 35, 91-121. wood, d. j. (1991). corporate social performance revisited. academy of management review, 16, 691-718. biographical sketch of authors sammy g. muriithi, dba, is an assistant professor of management in the college of business at the university of central oklahoma. his primary areas of research interest include corporate social responsibility and sustainability, corporate governance, mergers and acquisitions, and family business. bruce a. walters is the edward l. moyers endowed professor in the department of management in the college of business at louisiana tech university. his teaching, research, and consulting interests include corporate governance, acquisitions, strategic decision processes, top executive characteristics, and corporate social responsibility. his research has appeared in several journals, including academy of management journal, strategic management journal, journal of management, strategic organization, journal of business ethics, and journal of business research. otis w. gilley is the clarke williams/centurylink endowed professor and head, department of economics and finance at louisiana tech university. his teaching and research include microeconomics and econometrics. his research has appeared in several journals, including american economic review, management science, review of economics and statistics, southern economic journal, journal of business and economic statistics, and economic inquiry. the role of business similarity in joint venture performance louise hatfield shippensburg university shippensburg, pa john a. pearce ii villanova university villanova, pa abstract business similarity between partners was found to be positively related to joint venture performance. this finding complements two past studies that also found a positive relationship between business similarity and performance. the strength of these findings is amplified by the fact that each of the three studies used a different method of measuring business similarity and employed a different performance measure. the positive relationship between business similarity and performance was strong enough and consistent enough that all three mea· surement schemes captured the phenomena. this research illustrates that (1) self-assessment by partner firms allows the degree of business similarity to be captured and (2) that self-assessment is more reflective ofreality than are traditional, coarse, categorical classification schemes. business similarity varies in degree, a phenomenon not captured in traditional research which emphasizes a dichotomous choice of similarity (i.e., related or unrelated). this study found key dimensions of business similarity in the joint venture environment to be geographic areas served, supplier base, distribution channels, and forms ofadvertising and promotion. these dimensions contrast with the tra· ditional business domain items that have been tried in past research, of product technology, manufacturing process, and product purpose. introduction joint ventures are discrete entities created, owned, and influenced by two or more firms (parents/partners) that provide inputs to and share in the outcomes of the created entity. joint ventures are one type of strategic alliance. whereas joint ventures are equity-based, most other strategic alliances are non-equity arrangements, such as licensing agreements, research and development contracts, codevelopment agreements, customer-supplier partnerships, and technology sharing (hennart & reddy, 1997; inkpen & beamish, 1997; mowery, oxley & silverman, 1996; park & russo, 1996; pearce, 1997). 36 journal of business strategies vol. 15, no.1 the surge in appeal of joint ventures comes as a result of the globalization of industries and the increasingly complex and competitive nature of the rapidly changing business environment. more and more firms find it necessary or advantageous to cooperate with other firms in order to be competitive. joint venturing is an important alternative entry mode to internal start-up and acquisition (kogut, 1988). in a fast-paced, highly competitive environment, the internal start-up option is exceptionally costly in terms of resources and time, as are acquisitions which include an obligation to manage all that comes with an acquired firm (kanter, 1989). joint venturing is faster, more flexible, less risky, and less costly than internal start-ups and acquisitions, while increasing access to critical resources such as marketing, technology, raw materials and components, financial assets, managerial expertise, and political influence (schillaci, 1987). the increasing use and strategic importance of joint venturing, as well as its unfamiliar complexity, suggest the need to know more about how to effectively utilize this cooperative strategy option. the purpose of this research is to contribute to the knowledge on conditions prevailing at the initiation of a joint venture strategy. this study explores how business similarity between partners and business similarity between a partner and its joint venture contribute to partner goal achievement. literature review and hypotheses joint venture performance althoughjoint venture duration, survival, liquidation, and partner stock price have also been utilized, managerial assessment (i.e., partner satisfaction or partner goal achievement) remains the most frequently used measure of joint venture performance. most joint venture performance studies have used managerial assessments as perceptual measures of performance (beamish, 1987; blumenthal, 1988; habib & burnett, 1989; harrigan, 1988; hatfield & pearce, 1994; killing, 1983; schaan, 1983). while duration and survival offer insight into joint ventures, they do not measure performance. although duration, survival and stability have been found to significantly correlate with overall partner satisfaction and joint venture performance (based on projections), the range of correlations (.29 to .60) suggest that these variables measure different phenomena (geringer & hebert, 1991). further, gomes-casseres (1987) identified several "adaptive" reasons for joint venture termination that are frequently overlooked in duration and survival studies: (1) dissolution due to partner's acquisition of new capabilities, (2) growth in a partner firm's network that leads to a change in the optimal ownership structure to exploit economies of scope, and (3) government policy changes. thus, duration, survival, and stability appear to be unacceptable measures of performance because termination of a joint venture may be the result of success, failure, or environmental change. spring 1998 hatfield & pearce: business similarity 37 liquidation or major reorganization, if due to poor performance, as used by killing (1983), may be a better objective performance measure. however, the qualifier "if due to poor performance," in the case of a takeover or reorganization has referred to perception-based explanations. liquidation appears to be an objective measure of failure because it indicates that the joint venture has insufficient value as an entity. in addition, divesture and shutdown have been used as indicators of failure in evaluating diversification strategies, including joint ventures (porter, 1987). however, liquidation measures alone capture only a portion of the corporate failures and poor performers. recognizing these deficiencies, joint venture researchers have relied heavily on the broad, but vague, measure of partner satisfaction. neither the objective performance measures duration, survival, liquidation or reorganization nor the managerial assessment measure of partner satisfaction explicitly consider the objectives or goals of the partners. further, one partner's success criteria is often different from that of the other partner (schaan, 1983). partner goal achievement offers a means to address this diversity in success criteria in a more precise fashion than is possible with partner satisfaction, while maintaining breadth of coverage. self-reported, perceptual measures permit the assessment of specific and disparate goals (blumenthal, 1988; harrigan, 1987; hatfield & pearce, 1994). in summary, non-financial performance criteria are widely used to measure joint venture performance. these measures correlate with more objective measures of performance, such as financial indicators, and liquidation or reorganization (dess & robinson, 1984; killing, 1983). many objective financial measures are fraught with problems of data availability and lack of comparability due to different accounting methods, and may be confounded due to varying goals and priorities. we, therefore, join other researchers in the belief that managerial assessment is the most appropriate measure of joint venture performance (blumenthal, 1988). results of prior research suggest that the benefits of perceptual measures outweigh potential respondent bias. partner goal achievement is the primary dependent variable in this study. the measurement of partner goal achievement is an expansion on traditional, simple, and often assumed goals. it allows for nonfinancial performance assessment, the need for which has been noted in the joint venture (anderson, 1990; gomescasseres, 1989; habib & burnett, 1989), strategic management (fahey & christensen, 1986) and organizational effectiveness literature (lewin & minton, 1986). focusing on partner goals offers a way to deal with the performance evaluation problem when a partner firm has a broader base of interests than does the joint venture (kanter, richardson, north & morgan, 1991). in a study on joint venture partner goals, hatfield & pearce (1994) illustrated that partner goal achievement provides an enriched understanding of joint venture performance. partner goal achievement overcomes the narrow focus of traditional financial measures, and the vagueness of the frequently used measure of partner satis38 journal of business strategies vol. 15, no. i faction. goal achievement offers more precision than partner satisfaction while maintaining breadth of coverage, by providing the ability to address partner goal diversity and divergent partner interests. partner satisfaction is added as a supplemental dependent variable because of its usage in past joint venture research. this combination of dependent variables provides a bridge to past research and a basis of comparison for the preferred dependent variable in this study of partner goal achievement. business similarity to expand operations or profits faster and/or less expensively, businesses often seek to acquire a competing firm that displays business similarity. the strategy of buying market share may improve the performance of corporate assets through operational economies or reduced costs. enhanced management capabilities and better utilization of capacity may follow the acquisition of a similar business. there also may be gains in efficiency due to the complementary capabilities of the joined forces that could not easily be accomplished through internal expansion (weston & chung, 1983; shepherd, 1985; rock, 1987; moose & richard, 1988). kusewitt (1985) examined the relationship between industry commonality and long term financial performance as measured by roa and market returns in a study of 135 acquiring firms. he found that the two variables were positively and significantly related. he concluded that acquisitions should be of related business to enhance synergy and management effectiveness. similarly, singh & montgomery (1987) examined business similarity as an acquisition strategy in a study of 105 acquisitions of value greater than $100 million each. they found that acquired firms involved in mergers of similar businesses have higher returns than acquired firms in unrelated acquisitions. production synergy is perhaps the most cited contributor to value maximization for a firm considering the acquisition of a similar business (fisher & lande, 1981). proponents of this argument emphasize both scale and scope economies. where these economies can be achieved, cost reductions ensue and true synergies exist (carlton, 1980; mueller, 1980; shepherd, 1985; singh & montgomery, 1987). the acquisition of a similar business also promotes the achievement of production dbjectives when a firm wishes to supplement an already established distinctive competence in a product technology or manufacturing process (hopkins, 1987). technology transfer through the acquisition of a similar business allows firms to respond quickly to industry changes and increase its ability to innovate. when the competitiveness of a firm is highly dependent of its geographic scope, it is usually more profitable to acquire an existing firm in another geographic location than to expand geographically through internal growth (allen, oliver & schwallie, 1981). since distribution costs are generally proportional to distance shipped, marketing synergies often result in economies in transporting spring 1998 hatfield & pearce: business similarity 39 bulky materials. thus, merged firms from different geographic locations shorten the average distance from one of their operations to customers. marketing synergy is likely to occur in the merging of similar firms when at least one product or service fortifies the sales of one or more others (hopkins, 1987). this synergy enhances a firm's competence in distribution channels. geographic location, promotion, and product lines. marketing synergy is also enjoyed by companies involved in a the acquisition of a similar business if their products or services can be sold through the same or similar channels, in the same or similar manner, or use the same or similar forms of advertising and promotion. bradley & korn (1981) found that when a firm acquires another with an established national sales force, warehouse system, and promotion program, it can quickly move from a regional to a national focus. an increase in purchasing power can be another consequence of the acquisition of a similar business. the increased purchasing power of the merged firm increases its leverage such that per unit costs should decrease below what either firm could have achieved individually. advertising is yet another source of synergy. if sales networks and other promotional devices are transferable, then synergy can result, thereby providing a source of pecuniary gains (shepherd, 1985). carlton (1980) even argued that management specialization might dictate the acquisition of firms in industries with similar advertising intensities. the business relatedness theme and accompanying synergy arguments in the merger and acquisition research also apply to joint ventures. business similarity between the partners and between the partners and their joint venture have been shown to relate to performance (balakrishnan & koza, 1993; harrigan, 1988; koh & venkatraman, 1991). although the findings of these studies are not directly comparable, due to different approaches in how business relatedness was operationalized, two found a positive relationship (harrigan, 1988; koh & venkatraman, 1991) and one found a negative relationship (balakrishnan & koza, 1993). that is. two studies found that business similarity between partners was positively related to performance, and business similarity between partners and their joint ventures was positively related to performance. the third study found that partner stock returns were higher for parents in dissimilar businesses (balakrishnan & koza, 1993). these contradictory findings can be reconciled in part by the differences in dependent variables and research methods. in their study onjoint ventures, koh & venkatraman (1991) found that when partners were related, and when partners were related to their joint ventures, the ventures had higher gains in abnormal stock returns than did partners involved in unrelated ventures. using compustat tapes and lo-k reports, partners were classified as related if they had at least one of the following characteristics: (l) similar products, markets, or both, (2) similar production technologies, (3) similar science-based research. sic codes and information from published announcements of joint venture activities were used to classify the partner-joint venture 40 journal of business strategies vol. 15, no. i relationship. although the authors reported the relatedness criteria, they did not report the degree of measurement nor detailed decision rules. thus, it is not known exactly what constituted a related classification. however, koh & venkatraman's (1991) report is consistent with duncan's (1982) finding that related joint ventures positively and significantly impact average rates of returns. in a study of strategic alliances, harrigan (1988) examined business similarity in products, markets, technologies, and competitive activities. she found that relatedness between partners and between partners and their ventures were both positively correlated with success. because strategic alliances include all types of cooperative ventures, not just joint ventures, it is not known if this finding held for the joint venture subset. harrigan's (1988) research did not indicate what items were included as competitive activities, nor how relatedness was measured. however, other research suggests that the following items may be important factors in business similarity: geographic areas served, distribution channels, and forms of advertising and promotion (hopkins, 1987; thorelli, 1986). using three-digit sics, balakrishnan & koza (1993) measured the distance between the primary businesses of the partner firms. the abnormal stock return for each partner firm was regressed on the distance measure, which yielded positive coefficients at a significance level of .10 or better. the authors concluded that the investors reacted more favorably to joint venture announcements between partners that were in dissimilar businesses. the actual standardized betas were not reported in the article. using transaction cost theory the authors argue that this favorable response is because joint venture is the most efficient mechanism for coordinating synergistic assets. thus, investors reward partner firms for choosing the joint venture structure over acquisition. the authors note that the dissimilarity of the partners' businesses may reduce synergy, which, in concert with the coarse dissimilarity measure of 3-digit sics, may account for the low significance level. further, the counter influences of distance between partners' businesses suggest that abnormal stock returns may not be an appropriate performance measure when examining similarity in partners' businesses. that is, dissimilarity may be critical in entry mode decisions (e.g., joint venture or acquisition), whereas similarity is critical to performance of the joint venture. in summary, business similarity appears to be associated with partner motivation and performance. however, there is little consensus on which dimensions of business similarity are important or on which performance measures and research methods are appropriate. hypotheses theory suggests that, for the sake of effectiveness, the overlap in business domains should be much less than complete (thorelli, 1986). however, empirical researchers, arguing from the merger and acquisition literature, suggest that the more related the partners, and the more related the partner and joint venture, the more opportunities there are for strategic compatibility and sharing oftechnispring 1998 hatfield & pearce: business similarity 41 cal and managerial skills (harrigan, 1988; koh & venkatraman, 1991). such relatedness exploits core competencies, leading to economies of scale and scope and efficiency in resource allocation (rumelt, 1982). related empirical findings from the merger and acquisition literature support this premise (bettis, 1981; montgomery & singh, 1984). similarly, mcconnell & nantell (1985) argue that joint venture partners are motivated by synergies, and that there must be some common activities or relatedness for synergy to be possible. as in the merger and acquisition literature (chatterjee, 1986; eckbo, 1983; lubatkin, 1987; walsh & seward, 1990), the overall effect of business similarity on performance is somewhat unclear. one joint venture study found that shareholders responded more favorably to joint ventures between partners in dissimilar businesses (balakrishnan & koza, 1993). the authors of this study argue that dissimilarity positively affects shareholder response (at the time of announcement) because joint ventures are more efficient than acquisitions when it is difficult to appraise the value of another firm's technology and assets. however, the authors also note the importance of synergy in joint ventures. it may be that business similarity has contradictory influences on joint venture performance. on the one hand, initial market costs resulting from firm dissimilarity may be minimized by choosing a joint venture over an acquisition. thus, shareholders may initially respond favorably to joint ventures between partner firms in dissimilar businesses. however, in the long run joint venture performance depends on synergy and similarity is necessary for synergy to occur. thus: hypothesis 1: the greater the similarity between the joint venture partners' businesses, the higher the achievement of each partner's goals. hypothesis 2: the greater the similarity between a partner's business and the joint venture's business, the higher the achievement of the partner's goals. research methods joint venture performance was measured as partner goal achievement. a list of 12 goals was assembled by consolidating the findings and propositions of previous researchers (berg, duncan & friedman, 1982; blumenthal, 1988; contractor & lorange, 1988; harrigan, 1987). the goals used in this study were generated in the following way: 1. each distinct goal that appeared at least twice in previous research was included. 2. although the goals of revenues and profits were included in only one previous study on joint ventures, they were included here due to the importance of such goals in any business endeavor. 42 journal of business strategies vol. 15, no.1 3. space was provided on the survey instrument for write-in goals, to ensure completeness of the goal list. business similarity was measured in terms of product and market factors, including technology and manufacturing process. joint venture theory provided four relevant business similarity dimensions: clientele served, functions performed, territory, and product or service (thorelli, 1986). guidance was also drawn from past empirical research on joint and cooperative ventures (harrigan, 1988; koh & venkatrarnan, 1991). because business relatedness is a major issue in the merger and acquisition literature, the approach used in that research was also reviewed (shelton, 1988). in his article on acquisition strategy, hopkins (1987) identified key technology and marketing competitive activities product technology, manufacturing process, distribution channels, and advertising and promotion. these competitive activities are used in this study. in categorizing these dimensions in terms of the input-transformation-output model of organizations, it was noted that although transformation and output were covered in hopkins' (1987) list, input was not. therefore, supplier base was included in this study as a competitive activity to address the input stage. seven business aspects (geographic areas served, product technology, manufacturing process, product purpose, distribution channels, forms of advertising and promotion, and supplier base) were assessed using five-point likert scales ranging from (1) no similarity to (5) completely the same. each partner assessed the similarity between their business and their partner's business, and their business and the joint venture's business, along the seven dimensions. sample and procedures data were collected from executive officers of u.s. firms and subsidiaries directly involved in manufacturing joint ventures. these individuals were identified through telephone conversations with corporate officers at the partner firms as "the most knowledgeable" about particular joint ventures. identifying joint ventures in the sampling frame was complicated by the fact that firms are not required by law to report their joint venture activity. therefore, such activity may or may not be reported in a firm's financial statements or by the business press. the yearbook on comorate meq~ers and joint ventures and corporate policy was found to be the most comprehensive source of joint venture formation information, since it contains a compilation of all the joint ventures that have been reported in the business press. in order to reduce non-relevant variance and, thus, make the phenomena under study easier to capture only manufacturing joint ventures created by two u.s. firms or subsidiaries were included in the sampling frame. also only joint ventures formed between january 1, 1981 and december 31, 1988 were included in the sampling frame. this time frame was chosen in order to create a sufficiently large population from which to draw a sample that would allow for statistical spring 1998 hatfield & pearce: business similarity 43 analysis. the year of 1988 was used as a cutoff point in order to allow sufficient time for meaningful progress to be made toward goals and to avoid complications of the 1990-91 recession which showed evidence of emerging in late 1989. the process yielded a sample of 72 joint ventures. executive officers ofthe joint venture partners provided consensus responses. that is, participants were asked by telephone and in the survey cover letter to provide information based on the views of the individuals most familiar with the joint venture. as indicated by the respondents, in answer to a direct question in the survey instructions, each response represented the consensus view of two or more of the executi ve officers most familiar with the joint venture. this response method was used to minimize the potential bias in single responses and to better capture the diversity and complexity inherent in the joint venture structure. ninety (90) partner companies, representing 54 joint ventures, were identified as the sampling frame. ninety-two percent of these companies' executives responded to the survey. the 83 responses provided representation for 50 of the joint ventures. responses from both partners were received for 33 joint ventures. the sample consisted of joint ventures in sics 28-38, with the largest number (30 percent) in sic 36 (electrical and electronic), followed by 24 percent in sic 28 (chemicals and pharmaceuticals). the sample included thirteen ongoing and 37 dissolved joint ventures, reflecting a dissolution rate of 74 percent among responding firms. the opportunity to assess the descriptive differences between response and non-response firms was limited because firms are not required to report information onjoint ventures separate from their consolidated financial statements. however, response and non-response firms were compared on the basis of the joint venture industry, year of joint venture formation, and percent of ongoing versus dissolved joint ventures. no significant differences were found. variables and measures to test the hypotheses, the two independent variables and the partner-goalachievement dependent variable had to be calculated. respondents rated the importance and achievement of twelve goals pursued through participation in specific joint ventures, using five-point likert scales. the likert scale for goal importance was labeled as follows: i-none, 2-minor, 3-moderate, 4-high, 5-critical. goals rated as i (none) on importance were deleted from further analysis. thus, accommodation was made for the fact that firms pursue a varying number and mix of goals. the likert scale for goal achievement was labelled as follows: i-far short of plan, 2-short of plan, 3-about at plan, 4-exceeds plan, 5-far exceeds plan. the partner-goal-achievement dependent variable is a composite measure, developed by averaging the achievement ratings of all goals rated to be of minor to critical importance. goals rated as not important were excluded. the achievement rating of each goal included in the composite measure was weighted by the importance rating. thus, the higher the importance rating the more weight the 44 journal of business strategies vol. 15, no.1 goal carried in the composite measure. the reliability coefficient alpha for the composite partner goal achievement scale was 0.88. to provide comparability with prior research, partner satisfaction was measured using a likert scale ranging from 1, extremely dissatisfied, to 5, extremely satisfied (beamish, 1987; blumenthal, 1988; habib & burnett, 1989; killing, 1983; schaan, 1983). respondents rated the degree of similarity between their business and their partner's business and between their business and their joint venture's business in seven areas. a five-point likert scale was provided for each measure, with the following labels: i-no similarity, 2-slightly similar, 3-moderately similar, 4-very similar, 5-completely the same. the business-similarity independent variables are composite measures, developed by averaging the similarity ratings of the individual business domain items. correlation matrices indicated that similarities in the seven business areas were significantly correlated, suggesting that the individual items could be averaged to produce composite scales. further, there were several correlations that were .70 or greater, which suggest some items represent much of the same information as other items. as shown in tables 1 and 2, manufacturing process and product purpose were highly correlated (.70 or greater) with product technology for both the partner-to-partner and partner-to-joint venture comparisons. therefore, product technology was dropped from the analysis. it may be that the concepts overlap to such an extent that they are indistinguishable. further, product technology is a more ambiguous concept than are the other business areas, which may have led to difficulty in assessing the item. in the partner-to-joint venture correlation matrix shown in table 2, 'forms of advertising and promotion' and 'distribution channels' were highly correlated (.80). therefore, 'forms of advertising and promotion' was dropped from further analysis of business similarity between partners and their joint ventures. most of the items retained in the business similarity measures represent concrete customer and supplier base dimensions of a firm's business domain. further, these items cover all three stages of the input-transformation-output model of organizations: input (supplier base), transformation (manufacturing process), and output (geographic areas served, distribution channels, forms of advertising and promotion, and product purpose). the independent variable used in hypothesis 1, business similarity between partners, was computed by averaging respondent ratings on the six business areas of manufacturing process, product purpose, supplier base, geographic area served, distribution channels, and forms of advertising and promotion. the reliability coefficient alpha for this composite measure was .82. similarly, the independent variable used in hypothesis 2, business similarity between the partner's and joint venture's businesses, was computed by averaging respondent ratings on the five business areas of manufacturing process, product purpose, supplier base, geographic area served, and distribution channels. the reliability coefficient alpha for this composite measure was .84. vl "'0 ::1. ::s (jq i-' \0 \0 6 7 00 5432 .40** .29* •74*** .39*** .48*** .43** .35* .46*** .38** .61 *** .21 .64*** .74*** .37** .36** .22 .49*** .47*** .31* .58*** .59*** .24* .09 .02 .27** .29** .05 .38*** .19* .04 .05 .04 .25** .28** .31 ** table 1 means, standard deviations, and correlations for business similarity between partnersa variables means s.d. 1. geographic area served 3.20 1.24 2. product purpose 2.50 1.41 3. product technology 2.26 1.15 4. distribution channels 2.12 1.26 5. forms of advertising and promotion 2.09 1.12 6. manufacturing process 1.94 1.18 7. supplier base 1.90 1.17 partner goal achievement 2.59 .90 partner satisfaction 2.72 1.34 ~ s, ~. ~ r-> ~ l:l ~ ~ ~ $::: ""5' "'""""v:l "n=82 partner respondents for the means and standard deviations; n=50 joint ventures for the inter-correlations (sample restricted to jvs in order to balance §. representation, due to the fact that for some jvs both partners responded and for other jvs only one partner responded). correlations .70 and above are ~ underlined. ~. *p<.05 **p<.ol ***p<.ool .f:>. u1 table 2 means, standard deviations, and correlations for business similarity between partners and their joint venturesa .j::o. 0\ variables means s.d. 1 2 3 4 5 6 7 1. geographic area served 3.51 1.34 2. product purpose 2.90 1.46 .53*** ...... cl 3. product technology 2.79 1.34 .44*** .73*** 0:: ~ 4. distribution channels c 2.74 1.50 .52*** .68*** .60*** "5. forms of advertising and promotion 2.51 1.38 .45*** .63*** .55*** .80*** ~ i::tl ;:: 6. manufacturing process 2.51 1.43 .27* .56*** .70*** .49*** .38*** '";;. t'l> 7. supplier base 2.49 1.36 .37*** .65*** .66*** .57*** .57*** .64*** '"'" partner goal achievement 2.59 .90 .05 .16 .06 v1 .23* .13 .10 .23* .... ~ partner satisfaction 2.72 1.34 .13 -.01 -.06 -.06 .04 .06 .05 .... t'l> oq-.t'l> 'n=78-80; correlations .70 and above are underlined. '" *p<.05 **p<.oi ***p<.ool ~ ~ ....... vi z ? spring 1998 hatfield & pearce: business similarity analysis 47 the literature suggests that self-reported data collected at one point in time is subject to common method variance bias. a frequently used procedure to test for common method variance bias is harman's one-factor test (podsakoff, todor, grover & huber, 1984). this technique suggests that if a substantial amount of common method variance is present, either (1) a single factor will emerge from a factor analysis, or (2) one general factor will account for the majority of the covariance (podsakoff & organ, 1986). the variables in this study were entered into a factor analysis, which yielded two clearly distinct factors and no general factor. the results of this analysis is reported in table 3. while this analysis does not rule out the possibility of samesource, self-report biases, it does suggest that common method variance does not explain the findings of this study. table 3 harman's one-factor test for common method variance bias· variables partner goal achievement partner satisfaction business similarity between partners business similarity between partners and jv eigenvalues percentage of variance explained '0=75 factor 1 .91764 .94134 .25128 -.03151 1.98263 49.6 factor 2 .17322 .05227 .72392 .85624 1.09963 27.5 descriptive statistics for goal importance and goal achievement indicate that partners pursue a variety of goals (see table 4). further, when examining the goals which were of critical importance (rating=5) it was found that partners still pursued a variety of goals, contrary to having one primary purpose (such as market access or technology transfer) as the theoretical literature on joint venture formation suggests. the goals most frequently pursued as "critically important" were 'product or technology development' at 38 percent, followed by 'acquisition of technical knowledge/skills' at 30 percent, 'market or product expansion' at 22 percent, and 'market entry' at 22 percent. frequencies of the two composite measures of business similarity between partners and business similarity between partners and their joint ventures are presented in table 5. based on the composite scale, 60 percent of the respondents reported that their business was at least moderately similar to their joint venture's business, and 40 percent reported that their business was at least moderately similar to their partner's business. ~ z 9 -vi ... 00 mean goal n achievement 77 2.91 77 2.79 77 2.76 64 2.73 78 2.69 ~68 2.69 l:: 73 2.67 3 72 2.65 l::l-75 2.60 ..s;, 76 2,42 l::tl 74 2.42 l::....... 75 2.27 :=~...... !j'.l.... 13.... ~ o'l).... ~... 38 30 22 22 15 13 10 9 9 8 5 i percent 30 24 17 17 12 10 8 7 7 6 4 i acquisition of technical knowledge/skills product or technology development/acquisition vertical integration overcome government barriers spread financial risk increase available capital economies of scale or production efficiency manage competition market entry market or product expansion revenues profits 4.04 3.99 3.96 3.89 3.88 3.64 3.54 3,48 3.33 3.22 3.00 2.70 critically important goals (rating=5) number n 75 72 71 73 76 70 63 69 66 51 53 30 table 4 descriptive statistics for goal importance and achievement mean goal importance goal product or technology development acquisition of technical knowledge/skills market or product expansion market entry profits economies of scale or production efficiency revenues spread financial risk vertical integration manage competition increase available capital overcome government barriers goal goal product or technology development/acquisition market or product expansion market entry profits acquisition of technical knowledge/skills revenues economies of scale or production efficiency spread financial risk manage competition increase available capital vertical integration overcome government barriers spring 1998 hatfield & pearce: business similarity 49 table 5 descriptive statistics for calculated business similarity independent variables frequencies degree of business similarity 5-completely the same 4very similar 3-moderately similar 2-slightly similar i-no similarity partner-to-partner' percent cum. percent 2 2 12 14 20 40 43 83 17 100 partner-to-jaint ventureb percent cum. percent 5 5 26 31 29 60 26 86 14 100 means, standard deviations, and correlations variables means s.d. 2 partner goal ach. 1. partner-to-partner 2.40 2. partner-to-iv 2.83 partner goal achievement 2.59 satisfaction 2.65 *p<.05 **p<.ol ***p<.ool .99 1.10 .90 1.30 .32** .24* .20* .13 .04 .77*** descriptive statistics for the business similarity independent variables are also presented in table 5. regression analysis was used to test the hypotheses. the regression models for partner goal achievement using the business similarity independent variables are presented in table 6. each hypothesis is tested independently of each other in regression models 1 and 2. in model 3, the business similarity independent variables, along with an interaction term, are combined into a single multiple regression model to more fully examine the business similarity concept in explaining performance. hypothesis 1, the greater the similarity between the partners' businesses the higher the average achievement on the set of partner goals, was supported by the regression analysis in table 6. that is, the standardized beta was positive and the f statistic for model 1 was significant at the .05 level. hypothesis 2, the greater the similarity between the partner's and the joint venture's businesses the higher the average achievement on the set of partner goals, was not supported by the regression analysis. that is, the standardized beta was positive as predicted, however, the f statistic for model 2 was not significant at the .05 level. 50 journal of business strategies vol. 15, no.1 table 6 results of regression analysis for partner goal achievement using business similarity variables· variables modell model 2 model 3 i. partner-to-partner 2. partner-to-joint venture 3. partner-to partner by partner-to-joint venture (interaction term) r2 adjusted r2 f .23* .05 .04 4.52* .13 .02 .00 1.36 -.29 .52** .12 .09 5.29** 'n=83 *p<.05 **p<.01 after testing each business similarity hypothesis an interaction term was computed and combined with the business similarity independent variables into a single multiple regression model for partner goal achievement. this analysis yielded a model that explained 12 percent of the variance in partner goal achievement, with the interaction term being the only significant variable in the model. thus, suggesting that business similarity between partners and business similarity between a partner and its joint venture have a multiplicative and positive effect on partner goal achievement. the same regression analysis (table 7) was performed with the supplemental dependent variable of partner satisfaction as with partner goal achievement. the pattern of influence was the same as with the partner goal achievement performance variable. however, the f statistics were not significant at the .05 level. table 7 results of regression analysis for partner satisfaction using business similarity variables· variables modell model 2 model 3 .04 -.30 .42* .00 .07 -.01 .04 .10 2.89t .04 .03 3.42t r2 adjusted r2 f 1. partner-to-partner .20 2. partner-to-joint venture 3. partner-to partner by partner-to-joint venture (interaction term) 'n=83 tp<.10 *p<.05 **p<.ol spring 1998 hatfield & pearce: business similarity discussion 51 business similarity between partners was found to positively relate to partner goal achievement. this research, therefore, provides support for the applicability of the business relatedness concept in the joint venture environment. in addition, this study offers a partial reconceptualization of the business relatedness concept in the joint venture environment by identifying key aspects of business similarity: geographic areas served, supplier base, distribution channels, and forms of advertising and promotion. further, the traditional business relatedness areas in the merger and acquisition literature of product technology, manufacturing process, and product purpose were not found to significantly relate to joint venture performance. finally, this study suggests that business similarity between partners and business similarity between a partner and its joint venture have positive multiplicative effects on performance. joint ventures are motivated by synergies, and relatedness is a necessary condition for synergy to be possible (mcconnell & nantell, 1985). such relatedness affords the ability to exploit core competencies, leading to economies of scale and scope and efficiency in resource allocation (rumeit, 1982). the findings of our research complement two past studies (harrigan, 1988; koh & venkatraman, 1991) that also found a positive relationship between business similarity and performance. our confidence in these findings is amplified by the fact that each study used a different method of measuring business similarity and employed a different performance measure. the positive relationship between business similarity and performance was strong enough and consistent enough that all three measuring schemes captured the phenomena. in a comparative analysis it was found that business similarity between partners explained only five percent of the variance in partner goal achievement, and business similarity between a partner and their joint venture did not significantly affect partner goal achievement. however, when combined into a single multiple regression model with the inclusion of an interaction term, the r2 increased to 12 percent, with the interaction term being the only significant variable in the model. for executives in search of joint venture partners the implication is clear: seek a partner similar to yourself. seek a partner whose operational and competitive situations you understand and to which you can relate. merger and acquisition researchers have measured business relatedness by relying on secondary data. using a variety of decision rules, they classified mergers into categories of relatedness. this study suggests that self-assessment by partner firms is also possible, and it is better, because it allows for the incorporation of situation specific nuances that researcher assessment cannot adequately capture. this is especially important given the existence of two organizational levels (le., corporate and business) at which a joint venture can be created and managed, which makes the relevant business domain difficult for researchers to identify and assess. self-assessment allows the degree of business similarity to be 52 journal of business strategies vol. 15, no.1 captured, which is more reflective of reality than are traditional categorical classification schemes. business similarity varies in degree and is not captured in the traditional research dichotomous choice of related or unrelated. prospective joint venture partners should, therefore, consider assessing mutual similarities that include intangible as well as objective factors. executives' aspirations for their own finn as well as for the contemplated joint venture may provide critical clues to the enduring compatibility of superficially enamored partner candidates. finally, in comparing the regression analyses using the perfonnance variable of partner goal achievement with the supplemental dependent variable of partner satisfaction, the non-significant relationship between similarity and partner satisfaction offers further evidence that partner goal achievement is a better performance measure than is partner satisfaction. the non-significance for partner satisfaction could be explained by the fact that satisfaction is affected by many more factors than perfonnance alone, such as iv duration and survival, and environmental factors (hatfield & pearce, 1994). this study addressed two-partner, for-profit, u.s. domestic joint ventures in the manufacturing sector. thus, generalizability to international joint ventures, service joint ventures, or joint ventures with more than two partners or non-profit partner(s) must be done with caution. the limited research on joint venture perfonnance necessitated extensive measure and scale development. although an attempt was made to base measures on previous research, there was little consensus in the literature on key dimensions. this was a cross-sectional study utilizing managerial assessments. thus, the possibility of recollection biases exits, despite the precaution of soliciting perceptions from multiple individuals at each partner finn and the negative results of the common method bias test. the support for the hypotheses that the research produced, and the compatibility of the findings when viewed as a group of related ideas, have a useful implication for practicing managers. executives searching for joint venture partners should look for compatibility not only in tenns of needs that both prospective partners hope to satisfy through the success of the venture but also in tenns of the prospective partners' business domains. our research results suggest that when partners' business similarity is at an initially high level, the probability of the success of the joint venture is improved. similarities between partners in their supplier base, their forms of advertising and promotion, their distribution channels, and the geographic areas that they serve appear to be important. a logical extension ofthis finding is the notion that partners should also seek opportunities to create overlaps between the joint venture's business domain with their own, particularly in the areas of supplier base and geographic area served. these common activities can provide a basis from which to create synergies in operations, such as the fuller utilization of shared warehouse and distribution facilities, the benefits from quantity discounts by combining orders for suppliers, and the exchange of technical and managerial skills that produce economies of scope and the exploitation of core competencies. spring 1998 hatfield & pearce: business similarity 53 the findings ofthis study, in concert with subsequent refinements and extensions, will contribute to the further development of a practitioner-worthy theory of joint ventures. this theory will need to accommodate: (1) the areas of business similarity that are critical in joint venturing, (2) the interaction effect on performance of business similarity between partners and business similarity between a partner and its joint venture, (3) the diverse goals partner firms pursue simultaneously, and (4) the need for joint venture performance measures, such as partner goal achievement, that are precise yet broad enough to include partners' nonfinancial objectives for joint venturing references allen, m.g., oliver, a.r., & schwallie, e.h. (1981). the key to successful acquisitions. the journal of business strate2v. 2 (2), fall: 14-24. anderson, e. (1990). two firms, one frontier: on assessing joint venture performance. sloan mana2ement review. 31 (2): 19-30. balakrishnan, s.• & koza, m.p. 1993. information asymmetry, adverse selection andjointventures. journal of economic behavior and or2anization. 20: 99-117. beamish, p.w. (1987). joint ventures in ldcs: partner selection and performance. man:: aiement international review. 27 (1): 23-37. berg, s.v., duncan, j., & friedman, p. (1982). joint venture and corporate innovation. cambridge, ma: oelgeschlager, gunn and hain publishers, inc. bettis, r.a. (1981). performance differences in related and unrelated diversified firms. strate2ic mana2ement journal. 2 (4): 379-392. blumenthal, j.e (1988). strategic and organizational conditions for joint venture formation and success. dissertation: university of southern california. bradley, j.w., & korn, d.h. (1981). acquisition and cco[porate development. lexington, ma: lexington books: 17-27. carlton, h.s. (1980). an empirical study of merger motives. e i.c, study, 1-97. chatterjee, s. (1986). types of synergies and economic value: the impact of acquisitions on merging and rival firms. strate2ic management journal. 7: 119-139. contractor, fj., & lorange, p. (1988). why should firms cooperate: the strategy and economics basis for cooperative ventures. in fj. contractor & p. lorange (eds.), cooperative strateiies in international busi~. lexington, ma: lexington books, 3-30. 54 journal of business strategies vol. 15, no.1 dess, g.g., & robinson, jr., rb. (1984). measuring organizational performance in the absence of objective measures; the case of the privately-held firm and conglomerate business unit. strateiic mana~ementjournal. 5 (3): 265-273. duncan, j.l. (1982). impacts of new entry and horizontal joint ventures on industrial rates of return. review of economics and statistics. 64 (2): 339-342. eckbo, b. (1983). horizontal mergers, collusion and stockholder wealth. journal of fi· nancial economics, 11 (1-4): 241-273. fahey. l., & christensen, h.k. (1986). evaluating the research on strategy content. .l.2b2 yearly review of the journal of manaument. 12 (2): 167-183. fisher, em. (1987). horizontal mergers: triage and treatment. journal of economic perspectives, fall: 23-40. geringer, j.m., & hebert, l. (1991). measuring performance of international joint ventures. journal of international business studies. 22 (2): 249-263. gomes-casseres, b. (1987). joint venture instability: is it a problem? columbia journal of world business. xxii (2): 97-104. gomes-casseres, b. (1989). joint ventures in the face of global competition. sloan manaaement reyiew. 30 (3): 17-26. gulati. r (1995). does familiarity breed trust? the implications of repeated ties for contractual choice in alliances. academy of mana~ementjournal. 38: 85-112. habib, g.m., & burnett, j.j. (1989). an assessment of channel behavior in an alternative structural arrangement: the international joiot venture. international marketini re~(3):7-21. harrigan, k.r (1987). managing joint ventures-part i. manaaement review. 76 (2): 24-42. harrigan, k.r. (1988). strategic alliances and partner asymmetries. manaaement international reyiew. 28: 53-72. hatfield, l. t & pearce ii, j.a. (1994). goal achievement and satisfaction of joint venture partners. journal of business venturing, 9 (5): 423-449. hennart, j.e. & reddy, s. (1997). the choice between mergers/acquisitions and joint ventures: the case of japanese investors in the united states. strategic management journal. 18 (1): 1-12. hopkins, h.d. (1987). acquisition strategy and the market position of acquiring firms. strateaic management journal. 8 (6): 535-547. spring 1998 hatfield & pearce: business similarity 55 inkpen, a.c., & beamish, p.w. (1997). knowledge, bargaining power, and the instability of international joint ventures. academy of manaiement review. 22 (1): 177-202. kanter, rm. (1989). becoming pals; pooling, allying, and linking across companies. academy of manatwment executive, 3 (3): 183-193. kanter, r.m., richardson, l., north, 1., & morgan, e. (1991). engines of progress: designing and running entrepreneurial vehicles in established companies; the new venture process at eastman kodak, 1983-1989. journal of business venturing. 6 (1): 63-82. killing, j. (1983). strate~es for joint venture success. cbs educational and professional publishing a division of cbs inc.: praeger publishers. kogut, b. (1988). joint ventures: theoretical and empirical perspectives. strategic management journal. 9 (4): 319-332. koh, j., & venkatraman, n. (1991). joint venture formations and stock market reactions: an assessment in the information technology sector. academy qfmanagement journal....3a (4): 869-892. kusewitt, jr., lb. (1985). an exploratory study of strategic acquisition factors relating to performance. strategic management journal. 6: 151-169. levine, j.b., & bryne, i.a. (1986). corporate odd couples. business ws;~k, luly 21: 100105. lewin, a.y., & minton, j.w. (1986). determining organizational effectiveness: another look, and an agenda for research. management sciencs;. 32 (5): 514-538. lubatkin, m. (1987). merger strategies and stockholder value. strategic manaii-ement jour~ (1): 39-53. madhavan. r, & prescott, j.e. (1995 ). market value impact of joint ventures: the effect of industry information-processing load. academy of management journal. 38 (3): 900-915. mcconnell, u., & nantell, tj. (1985). corporate combinations and common stock returns: the case of joint ventures. the journal of finance, 40 (2): 519-536. montgomery, c.a., & singh. h. (1984), diversification strategy and systemic risk. s1l::a: tegic management journal. 5 (2): 181-191. moose, s., & richard, j.d. (1988). roundtable managing the trade-offs in corporate development. meriers and acquisitjons. 23: 3, november: 18-31. mowery, d.c., oxley, j.e., & silverman, b.s. (1996). strategic alliances and interfirm knowl· edge transfer. strateiic manajwment journal. 17 (winter special issue): 77-91. 56 journal of business strategies vol. 15, no.1 mueller, d.c. (ed.). (1980). the determinants and effects of mergers an international comparison. cambridge, ma: oe1geschlager, gunn and hain publishers. park, s.h., & russo, m.v. (1996). when competition eclipses cooperation: an event history analysis of joint venture failure. management science. 42 (6): 875-890. pearce. rj. (1997). toward understanding joint venture performance and survival: a bargaining and influence approach to transaction cost theory. academy of management review. 22 (1): 203-225. podsakoff, p.m., todor, w.o., grover, r.a., & huber, v.l. (1984). situational moderators of leader reward and punishment behaviors: fact or fiction? organizational behavior and human performance, 34: 21-63. podsakoff, p.m., & organ, d.w. (1986). self-reports in organizational research: problems and prospects. journal of management. 12 (4): 531-544. porter, m.e. (1987). from competitive advantage to corporate strategy. harvard business review. 65 (3): 43-59. rock, m.l. (ed.). (1987). the mergers and acquisitions handbook, new york: mcgrawhill. rosenthal, r (1991). replication in behavioral research. in j.w. neuliep (ed.). replication research in the social sciences. newbury park, ca: sage publications, pp. 130. rume1t, rp. (1982). diversification strategy and profitability. strategic management journal.....1 (4): 359-369. schaan, j. (1983). parent control and joint venture success: the case of mexico. unpublished doctoral dissertation. ontario. canada: university of western ontario. schillaci, c.e. (1987). designing successful joint ventures. the journal of business steat~ (2): 59-63. shelton, l.m. (l988). strategic business fits and corporate acquisition: empirical evidence. strategic management journal. 9 (3): 279-287. shepherd, w.g. (1985). the economics of industrial organization. nj: prentice hall. singh, h.• & montgomery, c.a •. (1987). corporate acquisition strategies and economic performance. strategic management journal. 8: 377-386. thorelli, h.b. (1986). networks: between markets and hierarchies. strategic management journal. 7 (i): 37-51. spring 1998 hatfield & pearce: business similarity 57 walsh, j.p., & seward, j.k. (1990). on the efficiency of internal and external corporate control mechanisms. academy of management review. 15 (3): 421-458. weston, j.e, & chung, k.s. (1983). do mergers make money? mer"rs and acqj.lisitions, ~: (3): 40-48. jack pearce is the endowed chair in strategic management and entrepreneurship at villanova university. he has authored 70 articles, 120 refereed professional papers, and 25 books, including fonnulation and implementation of competitive stratel:y, irwin, 1997. he was the first chairman of the academy of management's entrepreneurship division and a past president of the southern management association. his executive development programs and business consulting emphasize mission statement development, industry analysis, strategy formulation, business turnaround, and process reengineering. louise hatfield is an associate professor of strategic management at the john l. grove college of business, shipppensburg university. she has thirteen years of business management experience. she was awarded her ph.d. in 1993 and has published 12 papers on joint ventures. the role of business similarity in joint venture performance plant location a case sruoy: the value of non-quaniilfled variables for site selecilon myron 1. peskin david halpern lona college new rochelle, new york introduction it has long been considered by management that the three most important considerations in plant location decisions are the delivered cost of materials and supplies, the cost of production and the cost of outbound finished goods transportation. the primary objective of management is to increase the wealth of the stockholders through improvement in the corporate bottom line. the principal method used by production management to accomplish this objective is to minimize the total delivered cost of the product to the final destination [1] and to most management this total delivered cost is merely the sum of the factory door cost for producing the product and the transportation cost for delivering the product from the point of manufacture to the customer. quite often those responsible for plant location decisions use the classical linear programming "transportation problem" model to determine the most cost effective area of all those under consideration [2] and then this "most cost effective area" is the one selected for further superficial study. but is cost the one overriding factor [3]1 and how does management know that cost, by itself, will really provide the optimal area? the authors of this paper have been intimately involved with several plant location studies performed by a fortune 100 corporation. it is our opinion that microanalysis, using the transportation model method with or without the additional superficial site selection studies generally considered necessary for selecting the optimal facility location, ignores a multitude of important factors. these additional meaningful, but generally non--quantifiable, factors must be fully investigated and evaluated, along with traditional site selection quantitative analyses, in order to determine as accurately as possible the probability of success or failure of a specific area toward reaching the corporate objective of being in a "quality" location. costs can be and generally are accurately measured and optimized, but it is our opinion that many intangible and not easily quantifiable factors must also be quantified and considered by the organization in order to predict success. 1\venty-two of these additional, generally non-quantifiable, variables are descn"bed in detail in this paper. the purpose of this paper is to describe a "total" area location and site selection study performed by a major corporation. as part of the overall study, this corporation went far beyond the usual economic analysis in order to identify locations totally satisfactory for both the near and long term. the "total" study did accomplish the organization's objective of avoiding a disastrous location and this corporation's management truly believes this objective is far more important than merely finding the location which is just the ''most cost effective." fall 1991 peskin & halpern: plant location 107 frequently other organizations identify what they deem to be suitable areas for new facilities through use of the traditional economic approach they first determine breakeven volume points for the various locations under consideration and then select the location which will generate the lowest total costs for the volumes selected. the break:even chart below is an example of this approach. figurel break-even analysis of facility-location decisions 500100 200 300 400o 9.------------.".....--.."....----. 8 7 6 5 4 3 2 1 66.7 333.3 annual units of output (thousands) results of break-even analysis when output is less than 66.667 units/year. location a is best. when output is between 66.667 and 333.333 units/year. location b is best when output is greater than 333.333 units/year. location c is best. this break~ven chart merely adds the fixed costs to the variable costs in order to obtain total costs at various volumes for each of the locations under consideration. the breakeven approach is a variation of the classical linear programming transportation model in that it analyzes costs from a different perspective it also considers labor and fixed costs while the transportation model considers only transportation costs. the break-even model, in addition, provides sensitivity of a particular site to changes in production volumes. the site selection technique which is reviewed in this paper is used by several major corporations. in order to properly employ this technique, the organization must first select the three or four (or more) most cost effective locations from all those under consideration through use of traditional site selection methodology be it break-even, transportation model, or some other cost comparison method. it must then compare each of these pre-selected locations one against the others on a checklist of various non108 journal of business strategies vol. 8, no.2 quantified intangible but identifiable variables such as labor and business climate, living conditions, ecology, educational opportunities, political and financial stability, police and fire protection, etc. each factor is then mted on a scale of 1 to 10, with each variable bearing its exclusive subjective weighting in comparison to the other variables. each evaluated location, then, is milked against each other and the location with the most favomble moking is recommended. using this approach, hewlett-packard recently selected boise, idaho as a new plant location based upon such subjective factors as: an attmctive place to live. a graduate engineering school nearby. two hours by air to san francisco. an adequate supply of available labor. good freight service. an enlightened community leadership. a community that wants hewlett-packard. using this same "logistics chain" approach, kraft-general foods selected both mason city, iowa in 1986 as a site for production of its new family of shelf stable ready-to-eat prepared food products and jonesboro, arkansas in 1988 as a new site for production of breakfast cereals; fuji-isuzu chose lafayette, indiana in 1986 for isuzu automobile production; chrysler-mitsubishi located its new automobile plant in bloomington, minois in 1986; and lockheed decided to build a new automated as/rs warehouse adjacent to its existing california facility mther than locate the warehouse at an alternate site. these are six specific examples of successful companies that have employed the method we will describe in detail for successful plant location selections. with the new united european economic community concept, many american corpomtions are now actively considering the establishment of european facilities so that they might be in a position to take advantage of the benefits of this united european community. when evaluating foreign locations however, many of these organizations have found that additional factors also require careful study. for example, language and cultural differences immediately become apparent, and these differences can present opemting and control difficulties overseas. all existing policies, procedures, and instructions which will be used in these foreign facilities must be tmnslated into the language of the land, and local customs must be recognized and observed. "cheap foreign labor" is generally no longer a major factor to american industry since many foreign industrialized countries now. enjoy wage and benefit mtes equal to, and in some cases greater than, those in the united states. in those foreign societies where these mtes are substantially below those in america, such as in many of the third world countries, the productivity of the worker is also substantially lower. governmental stability is also of great concern when it comes to guaranteeing the safety of overseas industrial investment. we have all recently been made aware of the importance of the relationship between overseas industrial investment and government stability by the august 1990 invasion of kuwait by iraq, the june 1989 events in china and the fall 1991 peskin & halpern: plant location 109 august 1991 events in russia. this is especially true. as reported in tune. business week and newsweek for those organmttions such as texaro which lost millions of dollars worth of petroleum in kuwait, and by occidental petroleum. chrysler. and wmdmere which had invested in excess of $2 billion in mainland china prior to the violence and massacre in beijing's tiailanmen square and subsequent political clampdown throughout china. plant location: a case study this paper discusses the procedure used by a consumer products manufacturer that is a member of the fortune 100 to select a site for a new manufacturing facility. to conceal the name of this client company. we will refer to it in this paper as "a" corporation a fictitious name. our purpose in preparing this paper is to present and discuss those non-quantifiable and intangible factors which this corporation considered important enough to use as a basis for the selection of a specific location for a new multimillion dollar facility. "a" corporation operated multiple manufacturing facilities in the northeastern section of the united states. all producing the same family of products. all of these facilities, although recently modernized, were relatively old and inefficient, but each was still producing an acceptable quality product with relatively few consumer romplaints. management recognized that this geographical concentration of old and inefficient facilities with multiple overheads was not cost effective. after a thorough study and evaluation, they concluded that a single new state-of-the-art facility should be established with the capability of producing twice the volume of the combined existing facilities. based upon distribution logistics. it was concluded in the evaluation that this new facility should be located within 350 miles of the principal market, new york city. a major plant location oonsulting organization was retained to identify. using traditional area location and site selection methodology. the most cost effective area for the company's new plant. various parameters and delimitations were provided to aid the consultants in the selection of a suitable location. among these. in addition to the marketing oriented objective that the facility should be within 350 miles of new york aty, was the sourcing oriented objective that the facility should be near an ocean port since much of the raw material used would come from overseas. these consultants evaluated many areas in the ten eastern states which satisfied the parameters and delimitations of the study. the consultants' study indicated that the new state-of-the-art consolidated facility should be located somewhere within the geographic triangle formed by wtlmingtod; philadelphia and baltimore. this area location study identified a general area for the new facility based upon the parameters supplied by "a" corporation and specific cost information which the oonsultants obtained, such as inbound transportation rosts for materials, costs of productiod; outbound transportation costs for finished product, state and local taxes. utility oosts. and other oosts which are generally associated with identifying the most cost effective site for a plant relocation. the study did not, however. identify any specific sites within the "triangle.» nor did it evaluate non-quantified variable factors which the oompany felt were necessary to insure a successful transition. "n' corporation then did two very important things first, it 110 journal of business strategies vol. 8, no.2 enlarged the consultants' assignment to include these non-quantified intangible variable factors. secondly, it assigned knowledgeable corporate production supervisory employees full-time to the consultants to provide user input and to work with the consultants in the identification and evaluation of specific alternate sites for the new facility. the consultants and production supervisors together developed and used the following checklist of 22 objective and subjective characteristics for detailed investigation of each potential site within the specified triangle. this list and analysis is presented as suggestive, rather than definitive. the specific factors relevant to any particular site location should be carefully considered to insure completeness. it should also be noted that the weighting of the factors are not equal, and any such weighting should be reserved until all information is gathered on each site. it is possible that one site could have a unique advantage that would dominate the decision, but which would have never been considered until this uniqueness is revealed from the investigation. 1. labor history 13. local and state business climate 2. labor availability 14. community employer 3. influence of labor on 15. police, security and fire protection local industry 16. physical climate 4. maturity of citizens 17. roads and highways 5. residential housing and general 19. trash, garbage and sewage disposal community aspects 19. utilities 6. management potential electricity, 7. educational facilities natural gas, 8. health care fuel oil, and 9. culture and recreation coal 10. industrial planning and zoning 20. water supply 11. community financial picture 21. transportation 12. lax structure 22. material availability the task force developed specific relevant questions for each of the categories on the check list. these questions were designed to complement "a" corporation's mission and to satisfy the requirements of the new facility. examples of the type of questions asked and evaluated for each of the categories follows: 1. labor history a. does a significant portion of the labor force have deep community roots as expressed by family orientation, long term residency, home ownership, and community involvement? b. what is the degree of area unionization? c. are one or two unions dominant in the area? d what has been the area history of work stoppages and the willingness of local labor to accept both work methods improvements and automation? the responses to this category of questions would provide an indication as to the relafall 1991 peskin & halpern: plant location 111 tive stability of the area's potential work force. "a" corporation was proud to have had a long-term history of labor peace and good labor-management relations at all of its locations, and it was considered important by management that this history be maintained at the new location. 2 labor availability a. what is the labor population within a 30 mile radius? what percent are employed in manufacturing? b. what is the area labor distribution between skilled, semi-skilled, and unskilled labor? c. what is the willingness within the area for shift work? d. what is the average area family income? does a need exist for supplemental income? the responses received to this grouping of questions would provide management with information about the availability of sufficiently skilled workers within the area willing to work each of the three shifts for wages considered "normal" for the industry. 3. influence of labor on local industry a. what are the area median wage rates and benefits, by skills. b. what is the area degree of unionization? how mature are the area union leaders? c. what has been the labor strife record in the area? d. how much will we have to compete with the area's larger industrial manufacturers for competent labor? e. have the labor or industry leaders in the area developed any special area contract provisions, such as for seniority, bidding, layoffs, grievances, etc.? what are these provisions? as previously stated, this company has had a long-term history of "good" relations with its workers at all locations. the responses to this series of questions would either resolve or heighten any fears that management might have about the probable relations between labor and management at this new location. 4. maturity of citizens a. have civic leaders, local officials, and religious leaders demonstrated a positive and progressive attitude toward industry? do they enthusiastically encourage new industry? b. are the area residents generally labor-oriented, business-oriented, or well balanced? c. what is the community attitude toward industrial development? d. do the area residents actively vote in municipal, state and national elections? are the residents active in community activities? e. is the area standard of living at or above average? as a "good" neighbor, "n' corporation has always encouraged its local management to become actively involved in local civic and community activities. the answers to this 112 journal of business strategies vol. 8, no.2 series of questions will indicate to corporate management the degree to which local company management might be accepted by the community and by local leaders. this series of questions will also forecast the probable degree of future "n' corporation involvement in the community and in community activities, as well as whether the community will accept "a" corporation as a "good" neighbor. 5. residential housing and general community aspects a. is there adequate rental and ownership housing available that will appeal to both new employees and corporate personnel being transferred into the area? is it reasonably priced? b. does the community have adequate residential zoning? c. are the residential areas attractive? is the appearance of the center of town attractive? does this indicate community pride? d. are there good motels and restaurants in the area? e. are there adequate banking, commercial, shopping and other community services and facilities available for area residents? f. does the community have an excessive amount of slum or sub-marginal areas? this group of questions will allow management to evaluate the community as a respectable and responsible living community for all its employees new hires currently in the area, new employees moving into the area, and seasoned corporate employees being transferred into the area. it has been an unwritten "n' corporation policy to encourage and provide "incentives" to management employees to live in the community where they work and to take an active part in community activities. the answers to this series of questions should provide the company with a sixth sense as to the degree of resistance it might expect when asking both new and existing employees to accept a position at the new facility and to move into the new community. 6. management potential a. what is the possibility of attracting supervisors and managers from the local area? b. what is the possibility of attracting scientists and technicians from the local area? c. can prospective local hourly workers be expected to grow into added supervisory responsibilities? d. are any vocational, technical, trade and/or scientific schools located nearby? are they accredited? by which associations? the answers to this series of questions would provide management with information concerning the degree of difficulty the company might expect if and when it attempts to recruit management, technical and/or scientific personnel from the community rather than import these necessary employees from outside the community. in previous area relocation situations, "n' corporation found that it is considerably less expensive to recruit locally than to import personnel into an area with the attendant relocation costs. fall 1991 peskin & halpern: plant location 113 7. educational facilities a. are there a sufficient number of «good" public elementary and high schools in the community to accommodate the families of new and transferred employees? b. is the public school system keeping pace with expected community growth? c. are the local vocational, trade, technical, and scientific schools oriented toward our requirements? if not, will they be willing to modify their orientation? will they be willing to implement specific training courses to meet our requirements? d. are higher educational facilities sufficiently near to help attract management and other key personnel? e. are there quality local adult and continuing education programs in the community? the responses to this group of questions will provide an indication of the community's attitude toward education and whether the community might help train potential employees and participate in the continuing education of existing employees. 8. health care a. are there adequate medical, dental and health services such as emergency services, doctors, general practitioners, specialists, hospitals, dentists, nursing services, etc.? b. is there an adequate public health program? c. has the community enacted and is it enforcing adequate sanitary and environmental health legislation? the answers to this group of questions will tell the company what the community's attitude is toward the health of its citizens, and will indicate the degree of difficulty that the company might expect when requesting employees to relocate there. 9. culture and recreation a. are there well maintained public parks and playgrounds, well equipped and adequately staffed public hbraries, and a sufficient number of cultural centers such as museums and theaters to attract and retain management and other key employees? b. do the local colleges and universities have cultural outreach programs for the community? c. does the area have a variety of local outdoor attractions such as boating, swimming, golf, tennis, fishing, hunting, ice skating, skiing, etc.? d. are there resort and other recreational areas located within a one hour drive? e. are there sufficient houses of worship of varying creeds and denominations? cultural and recreational activities located within a reasonable commuting distance have been found by "a" corporation to be very important to corporate employees transferring to rural locations from urban areas. the responses to this group of questions will help the company determine the degree of difficulty it might expect when recruiting manage114 journal of business strategies vol. 8, no.2 ment, technical and scientific personnel from outside the area, and when transferring employees into the community. 10. industrial planning and zoning a. does the community have an active and forward looking planning and zoning commission? b. are the industrial areas as well protected by planning and zoning as are the residential and commercial areas? c. have building codes been revised and updated for modem methods, materials, and technologies? d. will municipal authorities provide written assurances protecting against future unfavorable planning and zoning changes? e. if the specific site selected is outside the community zoning district, will the community annex the site to provide the necessary zoning for the plant's needs? management recognizes that it is extremely important to protect corporate assets. the answers received to this series of questions will provide "n' corporation with information concerning the community's attitude toward zoning, and the degree of planning and zoning protection the company might expect in the future from the community leaders. 11. community financial picture a. does the local tax structure allow the community to adequately service its existing indebtedness? b. is the community tax structure well balanced between residential, industrial and commercial sources? are the tax assessments in line with services received? c. will the municipal authorities provide written assurances concerning future d. do unusually low taxes indicate inferior schools, streets, health, safety and other services? the answers to this series of questions will indicate the community's degree of financial stability and the protection that "~' corporation might expect from unexpected community taxation. 12. tax structure a. what and how much are the state and local taxes • property, inventory, income, sales, franchise, other? b. which taxes increase or dectease the number of new and transfer employees? c. which taxes increase or decrease the number of new or expanded industry? d. are there any state or local "special" or unusual taxes? which taxes are these? e. will the state or local government offer any incentives for location into their area? what are these incentives? this group of questions will provide the company with an indication of the community's attitude toward industry and the existing tax relationship between personal and corporate taxation. fall 1991 peskin & halpern: plant location 115 13. local and state business oimate a. do the local community and the state both have a "good" record toward industry? are they "fair" and "cooperative" to industry? b. are local and state laws concerning industry fairly written and fairly administered? are these laws conducive to good management-labor-government relations? c. has the local community and the state each enacted legislation that will restrict unreasonable union acts? do the local and state courts have a "good" record against illegal strikes and picketing? d. will new industry strain municipal facilities? which facilities? e. does the community have any business-sponsored civic organizations? the answers to this series of questions will provide the company with an indication as to whether the community is or is not industry~riented. although "a" corporation is recognized as a "good" employer, it would be hesitant to enter an area which has an anti-management history. 14. community employer evaluation a. are there any branch plants representing national corporations in the area? which ones? b. do most area employers demonstrate enlightened management policies? c. does any singular area industry have a poor labor strife record? d. will local industry participate in surveys regarding wages, union contracts, personnel policies, etc.? "a" corporation has always cooperated with, participated in, and been a leader of areaindustry associations. the responses to this group of questions will indicate the degree of cooperation and association the company might expect from other industries in the area. 15. police, security and fire protection a. is the local fire department a paid department? b. do the local and state police and fire departments each have high standards for personnel, equipment, training, and morale? c. is a public police patrol provided for industrial properties? are private security agencies available? d. is there a cooperative disaster aid plan with other communities in the area? e. is community and area crime under control? f. does the area have a large number of bars and taverns? g. is local industry satisfied with the police and fire departments? security for both corporate assets and for corporate employees is paramount for the organizaoon and absolutely necessary for "a" corporation's continued presence in an area. responses to this group of questions will tell the company just how "secure" the area is for both the corporation and its employees. 116 journal ofbusiness strategies vol. 8, no.2 16. physical climate a. is the area climate satisfactory for both living and manufacturing? b. what has been the monthly average and ranges of temperature, humidity, rainfall, and snowfall? c. what has been the incidence of industrial disruption due to snow, heat, flood, wind, cold, prolonged dry spell, or prolonged wet spell? d. what is the average velocity and direction of prevailing winds? e. how deep is the area frost line? the ability to satisfy customer demand by maintaining scheduled production as planned without unanticipated interruptions is believed by management to be one of the key factors in the continuing success of the company. to insure uninterrupted production, "n' corporation needs to know that the climatic conditions of the area are such that continuing production is assured. 17. roads and highways a. are public roads and highways well maintained? b. are public highways quickly cleared of snow and ice? c. are local highways adequately interconnected with federal interstate highways? well maintained highways are essential for continued production support. employees require well maintained roads for access to and egress from the facility. incoming materials and outgoing finished product also require well maintained highways to assure adequate materials for production purposes and adequate finished goods for timely delivery to customers. without the ability for employees to have continuous access and egress to and from the facility in all types of weather, production will falter; without the ability to receive raw materials for production and to ship finished product in all types of weather, customer requirements will not be satisfied. in a competitive consumer product environment, if one manufacturer cannot guarantee a continuous supply of product to the customer, the customer will go to a competitor for the product. "n' corporation wants to assure itself that it will be able to guarantee the continuous supply of product to its customers. 18. trash, garbage and sewage disposal a. does the community have a pollution control board? are pollution regulations rigorously enforced? b. are incinerators permitted? c. are private contractors available for trash and garbage removal? d. is the municipal sewage system sufficiently sized to accommodate the plant's anticipated waste? e. does the community require industry to pretreat sewage? environmental concerns today are paramount in selecting a facility location. recognizing that solid waste landfills are becoming over utilized and are being closed by the various environmental protection agencies, that air and water pollution are becoming fall 1991 peskin & halpern: plant location 117 concerns of the local environmentalists, and that every industrial facility creates both garbage and exhaust, "1\:' corporation knows through its own experience that ineffective municipal control of the environment can, does, and will result in severe and unacceptable state and federal restrictions. the answer to this series of questions will provide management with a good knowledge of present and a reasonable knowledge of future environmental requirements within the community in advance of selecting it as a location for the new facility. 19. utilities electricity, natural gas, fuel oil, and coal a. is there sufficient economic electric power available for our present and future needs? b. is co-generation permitted and acceptable? c. what is the history of area electric power outages? d. are low sulphur oil, natural gas and low sulphur coal competitive fuels in the area? e. can oil and coal delivery be depended upon in all weather? f. is there any problem with disposal of coal ash? the cost for utilities is a major cost factor for this company. the responses to this series of questions will provide "a" cqrporation with the information it needs to know about the present status of utility supplies. management believes it must know if it can rely on the continuous availability of sufficient cost competitive utilities to maintain production, and if not, whether it will be permitted by legislation to generate its own power? 20. water supply a. is the quantity of water publicly available adequate for the plant's current and future needs? is it pure enough for the proposed manufacturing process? b. are private water wells permitted? c. what is the chemical analysis of the public water supply and of the well water? is this satisfactory for the plant's needs? d what is the history of uninterrupted public water service and well water supply? "a" corporation is a large consumer of water for processing purposes. the answers to this series of questions will tell management if it can be reasonably certain that sufficient water of acceptable quality will be continuously available to insure adequate product quality and uninterrupted production operations. 21. 'fransportation a. is there adequate rail, truck, ship, and air freight service available locally? b. will the railroad provide switching services as needed? c. do major truckers have terminals in the area? d. are any state or local laws restrictive to trucking? which ones? e. are freight forwarders available locally? 118 journal ofbusiness strategies vol. 8, no.2 f. is adequate air passenger service available within a one hour drive? as mentioned previously, good transportation facilities are essential for continued plant operations for continued receipt of those raw materials and supplies needed for production and for continuous shipments to customers with the product they require when they require it. this is especially important in the just-in-time environment "a" corporation is planning to implement at the new facility. 22. material availability a. what are the logistics of raw and packing material supply? b. will raw and packing material costs be competitive with other sites? c. can we be assured of multiple sources of supply? d. will there be strong area competition for our needed supplies? e. what is the anticipated quality of locally supplied materials? it goes without saying that the economical availability of raw and packaging materials are vital to the continued success of the operation the enlarged area location task force, consisting of the consultants and the assigned corporate supervisory employees, evaluated a total of six specific locations in detail, each against the others, based upon the preceding 22-category checklist. each of the twentytwo factors was independently weighted by the task force in consultation with corporate management based upon presumed importance of the individual factor. as was indicated previously, the weighting of the factors were not equal, and the assignment of relative weighting did not occur until all information was gathered on all sites. the weighting were developed using this procedure because it was felt by both management and the consultants that one site could conceivable have a unique advantage over the others that might dominate the decision making process but which would have never been considered until the uniqueness was revealed from the investigation. one of the six locations ranked very high and appeared to be superior to the others for the needs of the corporation. further detailed investigation indicated that this one location was indeed superior to the others, and the "n' corporation finalized on this one area as the most suitable for the new facility based upon a combination of both tangible cost factors and the important intangible non-quantifiable cost variables as descnbed in this paper. the facility was constructed as planned and the prognosis by corporation top management is that a very successful, accurate, and valid area location and site selection study was conducted. the consultants agree and believe that time will prove them to be correct. fall 1991 peskin & halpern: plant location references 119 1. anderson, j. "logistics management: an asset or a liability in the 198o&?" transportation review (winter 1983). 2. reed, r. plant location and layout: factors. principles. and techniques. homewood, il: richard d. irwin (1961). 3. schmenner, r makine business location decisions. englewood oiffs, nj: prenticehall (1982). related readings anderson, j. "logistics management: an asset or a liability in the 198o&?" transportation review (winter 1983). atkins, r and shriver, r "new approach to facilities location." harvard business review (may-june 1968). carlson,~. "some manufacturers sour on areas." wall street journal (may 4, 1988), p. 25. cooney, j. "expand or move: some intangible factors in making the choice." industrial development (may-june 1980). francis, r and white, j. facility layout and location: an analytical approach. englewood cliffs, nj: prentice-hall (1974). freed, s. and best, w. "future challenges to the site selection expert." industrial development (july-august 1981). geoffrion, a and powers, r "facility location analysis is just the beginning." interfaces (april 1980). hicks, p. and kumtha, a "one way to tighten up plant location decisions." industrial eneineerine (april 1971). schmenner, r "look beyond the obvious in plant location." harvard business review (january-february 1979). schmenner, r makin& business location decisions. englewood cliffs, nj: prentice-hall (1982). spohrev, g. and kmak, t. "qualitative analysis used in evaluating alternate plant location scenarios." journal of industrial eneineering (august 1984). "what management needs to know before picking a plant site." duns review (october 1979). plant location a case study: the value of non-quantified variables for site selection entrepreneurial exporting strategies: contractual considerations andrew l. zacharakis babson college babson park, ma abstract the best opportunity for growth is often overseas, even for smaller entrepreneurialfirms. however, resource constrained smaller firms do not have as many available entry strategies as do larger multinational corporations (mncs). smaller firms frequently must ally themselves with partners in order to make international expansion feasible. the alliance of two distinct parties central to these entry strategies lends itself to an agency theory (at) perspective. at illuminates the underpinnings of these relationships; in particular, highlighting problems and risks that the respective parties face when entering into the partnership. the paper develops these problems within the entrepreneur/export agent realm and suggests contractual methods for overcoming these problems. introduction betsy seabert, international manager of spyder active sports inc., recently observed ... "[our norway distributor] is only selling the racing pants, sweaters, and a couple of jackets. we have this great line for which the agent does not even purchase samples. we know that there has to be people in norway that would be interested in [our entire line]." "[we] receive reports on what they have ordered, but i do not have copies of orders or to whom they have sold. i could go over there and research each shop if i wanted to, but i do not have the time...also a company our size has to really watch [expenses]." "there have been problems in the past with collecting money long distance. we were not reimbursed for products shipped... .!t is not usually worth the expense [to enforce our contracts]." the above observations exemplify the difficulty of international operations, especially for small entrepreneurial firms. the small firm often worries about whether its foreign agents are acting in the firm's best interest. small firms are 74 journal of business strategies vol. 15, no.2 likely to suffer some broken contracts and they do not have the resources to either do more of the work themselves or keep tabs on their foreign operations. nevertheless, the potential opportunities of international expansion may outweigh the risks, even for small businesses. in fact, international expansion by small entrepreneurial organizations, or what oviatt & mcdougall (1994) call international new ventures (invs), is increasing (brokaw, 1990) which suggests that these firms perceive international opportunities. the number of smaller firms exporting goods has increased by over 22 percent since 1987 150 percent increase in the dollar value of those goods (brown, 1995) to the point where 96 percent of all u.s. exporters are firms with less than 500 employees (prosak, 1993). although entrepreneurs are exploring opportunities overseas more frequently, the research related to this topic has been somewhat ignored (oviatt & mcdougall, 1994). this paper explores the potential difficulties that smaller entrepreneurial organizations face when entering the international environment; particularly focusing on the partnerships that entrepreneurs often use for entry. since entrepreneurial firms are typically resource constrained, they must leverage their resources in order to successfully enter an international market. utilizing a partner with some knowledge of the target market, or what oviatt & mcdougall (1994) call hybrid entry strategies (le. export agent, licensing, joint ventures, strategic alliances see appendix for definitions of these terms), can help leverage the entrepreneur's resources. the real issue for the entrepreneur is picking the right party with which to ally. does the party possess the necessary skills to facilitate successful expansion? will the party perform as promised? how can the entrepreneur ensure that performance? in sum, the entrepreneur may be susceptible to informed partners who mayor may not share the entrepreneur's goals. recognizing and managing the information discrepancy (i.e. the entrepreneur does not know enough about the potential partner to ensure that they have the same goals and work ethic), or information asymmetry, is a cornerstone of agency theory (rumelt, schendel, & teece, 1991). the primary objective of the principal-agent branch of agency theory is to highlight the discrepancies in knowledge between the two parties and derive a proper governance structure to minimize problems (eisenhardt, 1989). agency theory highlights the diverse goals between entrepreneurs and their partners; it also suggests how such diversity can be managed. moreover, depending upon which country the entrepreneur is interested in expanding, agency theory can illustrate how the relationship might be structured. agency theory agency theory is closely related to transaction cost economics (mahoney, 1992a; williamson, 1988). transaction cost economics has been widely used in studying international business (e.g. contractor, 1990; hennart, 1988, 1990; fall 1998 zacharakis: entrepreneural exporting strategies 75 rugman & verbeke, 1992; shane, 1992, 1993), both theories address governance in the face of opportunism (i.e. one party seeks self interested gains "with guile" at the expense of the other [williamson, 1988]). each theory posits that opportunism can be controlled via contracting. whereas agency theory focuses on ex ante alignment of incentives, transaction cost economics is concerned with ex post governance issues such as dispute resolution (mahoney, i 992b). although there are many subtle differences between the two theories, the difference of central importance to the current paper is that of information asymmetry (rumelt, schendel & teece, 1991). agency theory focuses on the individuals involved in the partnership (versus the transaction) and how different knowledge (asymmetric information) may allow one party to take advantage of the other party. asymmetric information is especially problematic when the two parties have conflicting goals or desires (eisenhardt, 1989). agency theory as a framework for international entrepreneurial expansion agency theory provides insight and guidance for entrepreneurs considering international expansion. given the relatively small size of most entrepreneurial firms (versus larger mncs) and the subsequent scarcity of excess resources possessed by these firms, the entrepreneurial firm may need to leverage its available resources in order to make international expansion plausible. thus, entrepreneurial firms (or invs) typically resort to one of the hybrid entry strategies (mcdougall, shane & oviatt, 1994) mentioned earlier. i the unifying denominator between each of these entry strategies is that entrepreneur's (principal) ally themselves with a partner (export agent) in order to leverage their resources and make international expansion more affordable, as well as increasing the likelihood of successful entry. information asymmetry in order for both parties to benefit from the relationship, each must contribute some specialized knowledge that the other is lacking; or as lawless & price (1992) assert, each party must possess asymmetric information. for example, spyder the ski clothing manufacturer introduced at the beginning of the paper possesses the knowledge and skill of designing and producing highly desirable ski accessories. the export agent contributes an in-depth knowledge of the target market. each party possesses valuable information that the other party can utilize; the export agent wants a good product to sell and the entrepreneur wants i agency theory can apply to any relationship where the principal delegates responsibility to an agent. within the international context described in this paper, agency theory could apply to any of the hybrid entry strategies (licensing, joint ventures, strategic alliances, etc.) described by oviatt and mcdougall (1994). in an effort to simplify and focus the discussion, the current paper focuses on an entrepreneur/export agent scenario. 76 journal of business strategies vol. 15, no.2 a knowledgeable and skilled salesperson. thus, as lawless & price (1992) point out, asymmetric information can have positive implications. if each party possesses the requisite skill and each party's asymmetric knowledge complements that of the other party, entry success is apt to be greater. proposition i a: all else equal, each party's special knowledge (information asymmetry) increases the overall chances of entry success. however, asymmetric knowledge (as the majority of agency theory literature highlights) also provides the basis for opportunistic activity that may be detrimental to the other party. opportunistic behavior may so damage the partnership, that it is dissolved. even if the relationship remains intact, the lost "trust" may impede the two parties from effectively working together to the point where entry success is diminished. thus, each party prefers that the relationship be structured in a manner such that opportunistic behavior is dissuaded. proposition 1b: all else equal, opportunistic behavior on the part of either party will decrease the chances for successful entry. conflict of interest eisenhardt (1989) highlights two major problems associated with the agency relationship. first, the principal and agent generally have conflicting goals. moreover, it is often difficult and expensive for principals to verify that agents are complying with the entrepreneur's goal. for example, spyder wants its full line sold in norway while the export agent prefers only to sell the popular (and higher margin) ski pants. the verification problem is exemplified by two behaviors discussed in agency theory adverse selection and moral hazard. adverse selection occurs when one party misrepresents their abilities to the other (bergen, dutta & walker, 1987; eisenhardt, 1989). moral hazard occurs when one party does not put forth the level of effort agreed upon (bergen, dutta & walker, 1987; eisenhardt, 1989). the potential threat of these behaviors leads each party to a differing structure preference for the partnership. a second major problem generated by principal/agent structures is that the principal and agent are quite likely to have different attitudes towards risk. traditional agency theory suggests that agents are more risk averse than principals because they cannot diversify their employment (eisenhardt, 1989). principals, by extension, are risk neutral (eisenhardt, 1989). within the international scenario, the traditional interpretation of risk differences may not be applicable. for instance, entrepreneurs (principal) may offer their agents an "exclusive" for any particular target market which precludes entrepreneurs from diversifying their risk (i.e. using other agents in the target country). the agents, on the other hand, fall 1998 zacharakis: entrepreneural exporting strategies 77 may be able to represent several organizations (thereby becoming risk neutral). regardless of each participant's risk attitude, the agency relationship is one of dependency where each party can be adversely affected by the actions of the other. therefore, each party wants to structure the relationship in such a way as to limit their risk exposure. divergent goals and different risk preferences increase the cost of the relationship between the principals and agents because each respective party wants to structure the relationship in a manner that best meets their needs while reducing risks to an acceptable level. agency theory suggests that these problems are handled via a "nexus of contracts" (which jensen & meckling define "as a multitude of complex relationships ... between [the firm] and ... labor... " 1976, p. 311). 2 further, the theory suggests a continuum of contract types, ranging from behavior-oriented to outcome-oriented (eisenhardt, 1989). outcome-oriented contracts focus on the principal's (entrepreneur's) desired outcome. for example, the entrepreneur (principal) may contract for the sale of 200 ski jackets in europe. the outcome-oriented contract is based on the end result and not the method of selling the jackets. since the end result is the same for both parties (sell 200 jackets), outcome-oriented contracts align the principal's and the agent's interest. aligning interests reduces the threat that agents will misrepresent themselves (adverse selection) or shirk (moral hazard) because doing so exposes agents to losses (i.e. they eat the cost of the 200 ski jackets). outcome contracts are favored by entrepreneurs because these contracts shift the risk and uncertainty of meeting a certain outcome to the export agent. behavior-oriented contracts focus on the "means" of achieving the entrepreneur's goal. thus, a behavior-oriented contract might emphasize the number of outlets, price level, or some other factors affecting the method of selling jackets. to ensure that the agent puts forth the effort agreed upon, the entrepreneur must monitor the agent's behavior. if the agent does not sell the targeted level of jackets, the agent is not liable as long as (s)he conformed to the behaviors outlined in the agreement (e.g. met with 50 retail outlets during the year). agents prefer behavior based contracts because they are not exposed to risk from outside factors that might impede their efforts (e.g., downturn in the economy, below average snow fall, etc.). unfortunately, from a managerial perspective, the principal generally incurs the cost of verifying the agent's actions in this type of contract. however, monitoring costs may be offset to the extent that agents wish to protect their reputation (donaldson, 1990; larson, 1992). the reputation effect assumes either that the principal and agent will conduct business in the future or 2the term "contract" should be thought of as a metaphor; contracts describe relationships in which one party delegates responsibility to another (rugman & verbeke, 1992). the contract is not necessarily a formal, written contract, but may be a set of expectations between the parties that are not necessarily verbalized, let alone documented (brown, 1995). 78 journal of business strategies vol. 15, no.2 that the principal can diminish the agent's reputation to other potential principals. in order to reduce monitoring costs, principals also may attempt to bond the agent via guarantees, third party auditing, contractual limits on the agent's authority, and compensation agreements if the agent does take certain liberties (jensen & meckling, 1976). the next section further explores the issues and why they are particularly relevant for an entrepreneur considering international expansion. the agency costs to entrepreneurs of international expansion the agency issues raised by this relationship stem directly from the risks inherent in the expansion decision, and from the likelihood of divergent goals between the entrepreneur and the international agent. differing goals and desires as outlined above frequently cause problems between entrepreneurs and agents; in particular, the aforementioned adverse selection and moral hazard. adverse selection adverse selection is problematic because agents have asymmetric information regarding their own abilities. conlon & parks (1988) find that the principal's typically strong information network (or capability to verify an agent's ability) favors a behavioral based contract. however, conlon & parks' (1988) research focuses on large organizations (retailers) and their ability to gain information about their salespeople (agents). unlike principals in the majority of agency theory research, relatively resource constrained entrepreneurs may find it difficult to obtain good information about their agents. therefore, entrepreneurs may be more likely to favor outcome based contracts. several factors make adverse selection especially troublesome for entrepreneurs. first, entrepreneurs are relatively resource constrained (stinchcombe, 1965, vesper, 1990) compared with larger mncs that operate internationally. thus, the entrepreneur may be less able to verify the agent's credibility. the small organization often relies on the agent's resume, referrals, and the "grapevine" (i.e., talk at international trade shows) to judge the agent's ability and trustworthiness. however, these sources of information may not be nearly as reliable as those possessed by larger mncs. mncs, for example, are more likely familiar with the agent's reputation, because the mnc is tuned into the industry's "gossip circle that tells who is honorable, tough, sleazy and so on" (pratt & zeckhauser, 1985, p. 13). the entrepreneur in the current paper's scenario, on the other hand, is likely new to the international arena and, by extension, less connected to the industry's "gossip circle." second, the distance between the home market and the target market also impedes verification because it increases the cost of communication and travel. differences in language and culture further affect understanding about goals, risks and the development of adequate contracts. the principal and agent may not be able to achieve or maintain a "meeting of the minds." again, the principal fall 1998 zacharakis: entrepreneural exporting strategies 79 bears the risk of incurring extra costs to overcome any potential misunderstandings. these extra costs can be especially burdensome to smaller entrepreneurial organizations. finally, entrepreneurs, as relatively small players, can rely much less on the reputation effect (donaldson, 1990; larson, 1992) than larger firms, because their power over agents is limited. therefore, "trust" relationships (lawless & price, 1992), while the ideal, may subject the entrepreneurial firm to a heightened level of risk. for example, the agent may enter into a contract for a quick profit, realizing that the entrepreneur will not be able to adequately monitor or enforce the contract. thus, entrepreneurs are likely to favor an outcome based contract because of the protection it provides. moral hazard agency theory posits that agents shirk, or do not live up to their contracts where possible. moral hazard relates to information asymmetry in that the entrepreneur cannot easily obtain information about the export agent's performance. eisenhardt (1985) and others (e.g., brickley & dark, 1987) find that the more difficult it is to monitor the agent's behavior, the more likely the principal will use an outcome contract. several of the issues raised with respect to adverse selection apply to moral hazard as well. since entrepreneurs are resource constrained, the costs involved of adequately monitoring the agent's behavior may be overwhelming, especially considering the distance between the two parties. in addition, different cultural norms may lead entrepreneurs to believe that agents are shirking, but in reality, the agents are performing within the expected norms of their culture. for example, completing deals in japan can be time consuming since japanese business people value relationships. thus, the amount of time that japanese export agents spend making small talk might surprise american entrepreneurs. to impatient americans, the small talk and dinner appointments that can literally take days during the initial contact between two new business partners can seem like a huge waste of time and money. an american entrepreneur unfamiliar with japanese cultural norms might assume her/his japanese agent is shirking. yet, the development of a personal relationship is crucial to long term success in japan. therefore, american entrepreneurs would likely prefer to contract on an outcome basis versus a behavior basis because such contracts focus on the end result rather than how business is conducted. moreover, outcome-oriented contracts reduce the need for monitoring and align the interests of principals and agents (jensen & meckling, 1976). thus, entrepreneurs are apt to prefer outcome-oriented contracts. risk aversion each party anticipates benefits from a joint relationship, but recognizes that there is risk in the endeavor. thus, each would like the other to shoulder as much of the risk as possible (i.e., the entrepreneur wants the export agent to shoulder 80 journal of business strategies vol. 15, no.2 most of the risk and vice versa). eisenhardt (1985) finds that agents prefer behavioral based contracts because such contracts reduce their risk. likewise, entrepreneurs likely favor outcome based contracts. as mentioned earlier, principals (entrepreneurs) are more risk averse because it may be difficult to diversify their use of agents in anyone market. additionally, brickley & dark (1987) find that franchising (using an agent) is preferable when environmental uncertainty is high (just as it might be in the international area). a franchise can be viewed as an outcome contract, because the franchisee's interests are aligned with the franchiser's ("sell as many units as possible"). it is likely that international expansion causes entrepreneurs additional concern due to their unfamiliarity of the target market and their added reliance on others for s1a:cess. entrepreneurs entering foreign markets may tend to be risk averse for several reasons. first, entrepreneurs are entering an unfamiliar market. it is far more difficult for the entrepreneur to derive accurate estimates of future outcomes in the new international market than in the entrepreneur's existing areas of operation. thus, the "uncertainty" of future events (ring & van de ven, 1994) is compounded by unfamiliarity of the target market. the foreign market's preferences are likely to vary dramatically from the entrepreneur's home market due to culture, language, political, and environmental differences. this unfamiliar market raises the entrepreneur's uncertainty. the agent, on the other hand, is highly familiar with the target market. therefore, the export agent does not perceive the same level of risk in relation to the market as does the entrepreneur. another reason that the entrepreneur may be risk averse is that entrepreneurs are typically relatively smaller in comparison to other international players; which implies relatively limited resources. thus, they tend to be cautious when exploring different uses for their resources. limited resources in conjunction with geographical distance makes the control and monitoring of any international relationship more tenuous. since the entrepreneurial firm may be risk averse and susceptible to adverse selection and moral hazard, the entrepreneur prefers an outcome-oriented contract. the outcome-oriented contract shifts risk to the agent (eisenhardt, 1989). the preceding discussion leads to the following proposition: proposition 2: all else being equal, the added uncertainty of operating inforeign markets, in combination with the threat of adverse selection and moral hazard involving an export agent, encourages entrepreneurial firms to negotiate for outcomebased contracts (versus behavior-based contracts) in order to shift risk to the agent. export agent preference the export agent faces many of the same issues as the entrepreneur adverse selection, moral hazard and risk aversion. in order to secure the agent's fall 1998 zacharakis: entrepreneural exporting strategies 81 services, the entrepreneur may misrepresent the product's true potential (a case of adverse selection). just as the entrepreneur lacks complete knowledge about the agent, the agent lacks complete knowledge about the entrepreneur, especially since it is often difficult to get good secondary information about relatively new entrepreneurial organizations (versus larger more established mncs). thus, agents are assuming substantially more risk in aligning themselves with relatively smaller entrepreneurial organizations than if they aligned themselves with larger mncs. once the relationship has been established, the entrepreneur may fail to execute. for example, the entrepreneurial firm may not meet the agent's orders in a timely fashion which could adversely affect the agent's reputation (a case of moral hazard). the foreign agents that entrepreneurs are likely to deal with may also tend to be risk averse. just like the entrepreneur, the agent may also face the problems of geographical distance, and a different language and culture from the entrepreneur. in addition, the agent is likely to be relatively small. the smaller the principal organization is, the smaller the volume of business conducted between the principal and agent, which suggests small scale agents will dominate. since the agent is likely to be relatively small, the agent also tends to be resource constrained and relatively cautious. these circumstances raise the agent's uncertainty. the risk averse agent likely prefers a behavior-oriented contract, because the agent is not obligated to reach a certain outcome. instead, the agent is only required to perform in a certain manner (e.g., meet with thirty perspective clients in a month, etc.) versus achieving some end specified in an outcome contract (e.g. sell 3000 ski gloves a month). thus, risk is shifted to the entrepreneur. the above discussion leads to the following proposition: proposition 3: all else being equal, the added uncertainty ofdealing with a foreign entrepreneur, in combination with the threat of adverse selection and moral hazard encourages the agent to negotiate for a behavior-based contract (versus an outcome-based contract) in order to shift risk to the entrepreneur. the difference in contract desires means that it costs entrepreneurs more to shift the risk to the agent, especially since entrepreneurs lack power to enforce their will. therefore, the entrepreneur has to weigh the added monitoring costs associated with a behavior-oriented contract against the added cost to shift the risk to the agent associated with an outcome-oriented contract. a common method of solving this contract dichotomy is bonding. bonding bonding (the use of appropriate incentives to dissuade agents from acting opportunistically) makes behavior-oriented contracts more closely represent out82 journal of business strategies vol. 15, no.2 come-oriented contracts, because it shifts monitoring costs to the agent (jensen & meckling, 1976). as the quotations from the example cited at the beginning of this paper illustrate, entrepreneurs may have difficulty enforcing international contracts. bonding empowers the entrepreneurial firm by enabling it to more easily and efficiently enforce its contracts. there are several possible bonding avenues available for international transactions, including forum selection clauses, arbitration agreements, letters of credit, and escrow accounts. forum selection clauses enable the entrepreneur to specify where any disputes should be settled. thus, if the entrepreneur is au.s. firm, it might stipulate that all disputes be settled in the united states. similarly, an arbitration agreement specifies that any dispute be heard by an arbitrator instead of a court. arbitration ideally saves both parties considerable legal expenses. the entrepreneur can also demand a letter of credit through a bank in its home country; if the agent organization balks on fulfilling its obligations, the entrepreneur can enforce the letter of credit. since the letter of credit is through a home-country bank, the entrepreneur can avoid any uncertainty or misunderstanding that might result from different legal standards in the international country. again, such an arrangement reduces the entrepreneur's costs. another alternative might be an agent escrow account. an escrow account accomplishes similar objectives as the letter of credit, but increases the agent's bonding costs. thus, an escrow account will probably be used only if the agent is unable to obtain a letter of credit. since the entrepreneur lacks the power to dictate a purely outcome-oriented contract, bonding helps reconcile the entrepreneur's desire for an outcome-oriented contract and the agent's desire for a behavior oriented contract. bonding effectively moves a behavior based contract towards an outcome based contract. regardless of the method, bonding can reduce the entrepreneur's monitoring costs. the bonding discussion leads to the following proposition: proposition 4: since entrepreneurs and agents have different contract desires, most contracts will include bonding stipulations which reconcile a behavior-oriented contract with an outcome-oriented contract. cultural differences among target markets while the simplified agency theory framework provides direction to the entrepreneur considering international expansion, it may not provide the best basis for establishing a long-term, efficient, equitable and productive relationship. the basic agency framework assumes that the relationship is one of opportunism as a function of information asymmetry. in other words, the parties to the relationship (especially the agent) take advantage of their position to the detriment of the other party. while this most certainly does happen, it is not cast in stone. trust mitigates opportunism (ouchi, 1980). moreover, if both parties enter the relationship assuming the worst, it may have negative effects on the overall fa111998 zacharakis: entrepreneural exporting strategies 83 performance ofthe relationship (bazerman & carroll, 1987; neale & northcraft, 1991). the entry is more likely to succeed if the entrepreneur and export agent trust each other and, by extension, demonstrate that trust during the establishment of the relationship. unfortunately, the entrepreneur cannot blindly demonstrate trust in all target markets by automatically using behavior based contracting; such a move would be dangerous. thus, the basic agency theory framework should be modified to account for potential differences in the threat of opportunistic activity. possibly a good place to start might be to adjust the basic framework based upon the target country's culture or aptitude to be more opportunistic or altruistic. if an export agent is from a culture which dissuades opportunistic behavior, then the entrepreneur can negotiate a behavior based contract without greatly increasing the risk. in essence, people from trusting cultures automatically align their own interests with that of the entrepreneur because agent's from these cultures are less apt to misrepresent themselves (adverse selection) or shirk (moral hazard). therefore, behavior based contracts may approximate outcome based contracts. in essence, entrepreneurs may adjust their contract desires based upon the target market's trustworthiness. the more trustworthy the target country, the more likely the entrepreneur will prefer a behavior contract and vice versa. the question is how do resource-constrained entrepreneurs identify which countries are more trustworthy? shane (1992, 1993) uses hofstede's (1980) power distance index as a gauge of cultural trustworthiness. the power distance index represents the degree that members of a particular society expect power to be equally distributed in organizations (hofstede, 1980). stated differently, power distance is the degree to which inequality exists in a society (hofstede, 1980). hofstede notes that inequality exists on a number of different dimensions, such as prestige, wealth and power. for example, if a society has a large disparity between the wealthiest and poorest citizens, it has a high power distance. subordinates naturally try to reduce the power distance (or inequality) between them and their superiors. likewise, superiors try to increase the power distance. the societal average is the point of equilibrium where subordinates and superiors are comfortable with the power distance. hofstede (1980) directly links the index to trust. countries with high power distance "exhibit less interpersonal trust and a greater need for organizational controls on the behavior of individuals" (shane, 1992, p. 299). moreover, shane asserts that countries with more per capita lawyers are less trustworthy, because these countries need to write contingent claim contracts (shane, 1993). indeed, the power distance index significantly correlates with per capita lawyers (r=:.51, p<o.025 [shane, 1993]). although this relationship is significant, it is not perfectly correlated. for example, india has relatively few lawyers per capita (~ economist, 1992) in spite of its high power distance. other factors come into play such as the huge population, the relatively lower level of economic activity per 84 journal of business strategies vol. 15, no.2 capita, other types of activities that lawyers might partake (e.g., politics), etc. on the other hand, the united states has relatively high number of lawyers per capita (the economist, 1992), yet a relatively low power distance (ranks 11 see table 1). nonetheless, the relationship between lawyers and the power index is significant. the concept of equality and power distance has implications for the entrepreneur/export agent relationship. high power distance countries may be less stable. subordinates may try to enact changes in the power distance via violent means. thus, high power distance countries more frequently suffer sudden changes in form of government (i.e., revolutions [hofstede, 1980]). similarly, agents from these cultures may act covertly to equalize the entrepreneur/agent relationship; they are likely to act opportunistically. thus, entrepreneurs should seek strong outcome based relationships in these countries to limit their risk exposure. on the other hand, "a smaller power distance leads to the feasibility of control systems based on trust in subordinates; in larger power distance countries such trust is missing" (hofstede, 1980, p. 384). therefore, entrepreneurs entering low power distance countries can risk behavior oriented contracts because there is less danger of opportunistic behavior by the agent. shane (1992) adeptly demonstrates that the power distance index correlates highly with trust attributes. basically, shane finds that mncs are apt to engage in foreign direct investment versus licensing when entering countries which are less trustworthy. it is more effective to internalize (even if it increases initial expenses) than rely on opportunistic licensers. conversely, licensing is more effective if the culture is trustworthy, because the mnc does not have to worry about opportunistic behavior and licensing reduces the initial expenses of establishing a presence in the target country (shane, 1992). table 1 ranks a number of countries on hofstede's (1980) power distance index. if a country is ranked towards the bottom of the list (high power distance), its culture breeds opportunistic behavior. thus, when negotiating with an export agent from the philippines (ranked number 31 on hofstede's list), entrepreneurs should negotiate for strong outcome based contracts (if they decide to enter the country at all). however, entrepreneurs can feel pretty confident in behavior based contracts with agents from austria (ranked number 1), because members of this culture are apt to be more trustworthy. unlike the large mnc, the smaller entrepreneurial firm typically does not possess the resources to internalize into the target market. smaller organizations must leverage their relatively constrained resources by reducing up-front expenditures. the export agent strategy can greatly reduce the entrepreneur's initial expenses. the implications of hofstede's (1980) and shane's (1992, 1993) work is that the entrepreneur should (1) structure the agency relationship with the target country's trustworthiness in mind and (2) possibly avoid those countries with the lowest trustworthiness. if entrepreneurs fail to acknowledge a country's propensity for trustworthiness, they may inappropriately structure the relationfall 1998 zacharakis: entrepreneural exporting strategies table 1 ranking of countries on the power distance index (the higher the rank, the lower the power distance) country rank 85 argentina australia austria belgium brazil canada chile colombia denmark france germany great britain greece hong kong indonesia india italy japan korea malaysia netherlands norway new zealand philippines portugal south africa singapore spain sweden switzerland taiwan thailand united states venezuela 12 9 1 23 27 11 20 24 2 25 7 7 18 25 29 28 14 15 18 31 10 4 3 31 20 12 27 16 4 6 17 22 11 30 adaptedfrom hofstede (1980) ship such that they bear too much risk. likewise, it may be wise for entrepreneurs to avoid entering countries with the lowest trustworthiness because it would require a tight outcome oriented contract. although such a contract may bring the 86 journal of business strategies vol. 15, no.2 risk to acceptable levels, a contract entered with such negative stipulations often results in poor performance (bazerman & carroll, 1987; neale & northcraft, 1991). the above discussion leads to the final propositions: proposition 5a: all else being equal, entrepreneurs should negotiate for a behavior-oriented contract in countries with a high power index ranking (high trustworthiness) and for an outcome-based contract in countries with a low power index ranking (low trustworthiness). proposition 5b: all else being equal, entrepreneurs should target countries with a high power index ranking (high trustworthiness) for entry. discussion as the above dialogue demonstrates, there are a variety of factors that influence the entrepreneur/agent relationship. optimally, the entrepreneur prefers an outcome-based contract, because it aligns the entrepreneur's and agent's interests (jensen & meckling, 1976). the agent organization is less likely to misrepresent itself (adverse selection), because it is obligated to reach some specified outcome. furthermore, entrepreneurs are not subjected to the costs of moral hazard since agents are only rewarded for outcomes of their performance. large geographical separation favors outcome contracts to the extent that outcome-based contracts avoid monitoring costs. however, the entrepreneur may have difficulty finding an agent who will accept an outcome-based contract. moreover, the negative tone that such a contract conveys may lessen the chance for entry success. therefore, the entrepreneur needs to assess cultural values in determining the best contracting method. if the culture is one of trust, the entrepreneur can confidently employ a behavior based contract without incurring additional risk. when entrepreneurs negotiate for a behavior-based contract, they should be aware of possible bonding methods. adeptly bonding the agent via a letter of credit or some other mechanism may reduce the entrepreneur's monitoring costs associated with a behavior-oriented contract. in fact, adroit bonding mechanisms may reduce the entrepreneur's monitoring costs to the point where it would offset any concessions that the entrepreneur would have to make for the agent to accept an outcome-based contract. under such a scenario, the behavior-based contract might be more cost effective than an outcome-based contract, especially since it may enhance the trust within the relationship thereby improving the chances for success. while the pitfalls for a small company seeking international outlets are many, as the u.s. domestic market continues to mature, the best growth opportufall 1998 zacharakis: entrepreneural exporting strategies 87 nities may reside internationally. if an expansion opportunity arises, the entrepreneur should be cognizant of the agency issue; failure to recognize the agency problem might even affect the entrepreneur's survival. the agency model presented in the current paper illustrates ideal contract desires, the conflict in contract desires between entrepreneurs and export agents, and how these conflicts might be reduced via bonding. additionally, the concept that behavior oriented contracts lead to greater entry success and, as a result, entrepreneurs should first consider "trustworthy" countries (all else equal) provides powerful suggestions to entrepreneurs about "how to" and "what" countries to enter. although agency theory provides an excellent basis for evaluating international expansion, an important weaknesses of this perspective needs to be recognized. agency theory assumes that the two parties act in a rational, opportunistic way. thus, agents are assumed to shirk unless they are properly monitored, or obligated under an outcome-oriented contract, or fear reputation repercussions. other factors currently exogenous to this theory may, however, come into play. for instance, people generally refrain from shirking, because of social norms. while doz & prahalad (1991) rightfully stress the importance of including psychological and social factors into the agency model, it is especially difficult for an entrepreneur investigating a potential international relationship to gauge the agent's psychological or social biases, except at the broadest levels (i.e.. cultural biases). thus, agency prescriptions may still provide a realistic basis for structuring the relationship to maximize survival in a different context. this paper guides entrepreneurs in contract structuring. the paper applies agency theory to a specific application, the entrepreneur's entry into foreign markets. practitioners may find the paper illuminating when structuring their international relationships. the agency perspective clarifies the pluses and minuses of different contract options, which might help entrepreneurs decide if foreign expansion is advisable. and ensure that they negotiate for the most effec~ tive contract possible. in conclusion, the agency perspective provides a sound theoretical basis for exploring entrepreneurial international entry strategies and their consequences. references bazerman, m.h., & carroll, j.s. (1987). negotiator cognition. in b. staw & l. cummings (eds.) research in or~anizational behavior. vol. 9. (pp. 247-288). greenwich. ct: jai press. bergen, m., dutta, s., & walker, o.c. (1987). agency relationships in marketing; a review of the implications and applications of agency and related theories. journal of marketjn~, 56 (july), 1-24. brickley, l.a., & dark, f. (1987). the choice of organizational form: the case of franchising. journal of financial economics, 18 (june), 401-420. 88 journal of business strategies vol. 15, no.2 brokaw, l. (1990). foreign affairs. inc., november, 92-104. brown, r.h. (1995). the national exv0rt strate~y. third annual revort to the united states congress. conlon, e., & parks, j. (1988). the effects of monitoring and tradition on compensation arrangements: an experiment on principal/agent dyads. in f. hoy (ed.) best paper proceedings. (pp. 191-195). anaheim, ca: academy of management. contractor, f.j. (1990). contractual and cooperative forms of international business: towards a unified theory of modal choice. management international review, 30(1), 31-54. donaldson, l. (1990). the ethereal hand: organizational economics and manoagement theory. academy of management review, 15(3), 369-381. doz, yl., & prahalad, c.k. (1991). managing dmnc's: a search for a new paradigm. strategic management journal, 12, 145-164. a survey of the legal profession. (1992). the economist, july 18, 55. eisenhardt, k.m. (1989). agency theory: an assessment and review. academy of management review, 14(1),57-75. eisenhardt, k.m. (1985). control: organizational and economic approaches. management science, 31, 134-149. hennart, j-f. (1990). the transaction cost theory of the multinational enterprise. in c. pitelis and r. sugden (eds.) the nature of the transnational firm, london: routledge. hennart, j-f. (1988). a transaction cost theory of equity joint ventures. strategic management journal, 9(4),361-374. hofstede, g. (1980). culture's consequences: international differences in work related values, beverly hills: sage. jensen, m., & meckling w. (1976). theory of the firm: managerial behavior, agency costs, and ownership structure. journal of financial economics, 11,5-50. larson, a. (1992). network dyads in entrepreneurial settings: a study of the governance of exchange relationships. administration science ouarterly, 37, 76-104. lawless, m.w., & price, l.l. (1992). an agency perspective on new technology champions. organization science, 3(3), 342-355. mahoney, j .t. (i 992a). organizational economics within the conversation of strategic management. advances in strategic management, 8, 103-155. jai press. fall 1998 zacharakis: entrepreneural exporting strategies 89 mahoney, j.t. (1992b). the choice of organizational form: vertical financial ownership versus other methods of vertical integration. strategic management journal, 13,559584. mcdougall, p.p., shane, s., & oviatt, b.m. (1994). explaining the formation of international new ventures: the limits of theories from international business research. journal of business venturing, 9(6), 469-487. neale, m.a., & northcraft, g.b. (1991). behavioral negotiation theory: a framework for conceptualizing dyadic bargaining. in l. cummings & b. staw (eds.) research in organizatjonal behavior, 13, pp. 147-190. greenwich, ct: jai press. ouchi, w. (1980). markets, bureaucracies and clans. administrative science quarterly, 25, 129-142. oviatt, b.m., & mcdougall, p.p. (1994). toward a theory of international new ventures. journal of international business studies, 25(1), 45-64. pratt, j.w., & zeckhauser, r.j. (1985). principals and agents: the structure of business. boston: harvard business school press. prosak, s.l. (] 993). small businesses are exporting. business america, ] 14(24),2. ring, r.s., & van de ven, a.h. (]994). developmental processes of cooperative interorganizational relationships. the academy of management review, 19(]), 90118. rugman, a.m., & verbeke, a. (1992). a note on the transmitional solution and the transaction cost theory of multinational strategic management. journal of international business, 23(4), 761-771. rumelt, r.p., schendel, d., & teece, dj. (1991). strategic management and economics. strategic management journal, 12,5-29. shane, s.a. (1993). the effect of cultural differences in perception of transaction costs on national differences in the preference for international joint ventures. asia pacific journal of management, 10(1),57-69. shane, s.a. (1992). the effect of cultural differences in perception of transaction costs on national differences in the preference of licensing. management international review, 32(4), 295-3]1. stinchcombe, a.l. (1965). social structure and organizations. in j. march (ed.) handbook of qr~anizations,(pp. ]42-193). chicago: rand mcnally. vesper, k.h. (1990). new venture strategies, revised edition. englewood cliffs, nj: prentice hall. 90 journal of business strategies vol. 15, no.2 williamson, a.e. (1988). corporate finance and corporate governance. the journal of finance, 18(3),567-591. appendix definitions of international entry modes export firm maintains its home production facilities and sells same good! service that firm sells in domestic market through a contractual agent that gains access to foreign distribution channel. licensing arrangement that allows a foreign firm to purchase the right to manufacture and sell the firm's product within a host country or set of countries. franchising is a form of licensing. joint venture/strategic alliance entrepreneur joins with another firm to share the risks and resources required to enter international markets; usually with a firm from the host country. foreign direct investment direct acquisition and ownership of facilities within host country. entrepreneurial exporting strategies: contractual considerations note how to cope wrm a plant closing semoon chang university of south alabama mobile, alabama the reality of business closing is complex. one extreme is the way the baltimore colts closed their operations in baltimore. they loaded in moving vans all the colts' records and equipment and left baltimore toward indianapolis in the darkness of the early morning hours of march 29, 1984. they did not let anyone know in baltimore [7]. the other extreme is the december 18, 1991 announcement by the general motors of its plan to close six assembly plants and 15 component operations by 1995, thereby reducing its work force by 74,000 in the process. the 19908 is also experiencing the closing of many military bases owing to the demise of the soviet union. the closing of plants and military bases is only the beginning of problems for communities that have to cope with the loss of jobs and revenue. the term, plant closing, in this paper is used in a loose way to encompass closings of plants, businesses, and military bases that lead to the layoff of a large number of workers. discussed in this paper are approaches through which a community may be able to ease the adverse impact of a plant closing. these approaches include an active negotiation with the company in such a way to make the transfer process of displaced workers less painful, as well as a utilization of the closed plant for other productive uses. there is no easy or quick way of replacing the closing plant. this paper is intended to provide information that can assist communities in adapting to the closed plant. successful company programs many companies that have closed a plant in the past provided their displaced employees with a variety of assistance. communities may learn from these successful programs and use them as the basis for negotiation with the firm closing the plant. employee assistance programs are of four types: severance pay, extension of health care benefits, outplacement assistance, and counseling services. severance pay is a payment that a company makes to its employees who no longer work for the company. companies may continue to pay workers their regular wages for a certain period of time beyond termination of their employment. alternatively, one-time payment based on a certain formula may be made upon termination of employment. extension of health care benefits is probably the most important issue with most displaced workers. a desirable program for displaced workers would be that the extension of health care benefits covers dependents as well as workers and lasts until displaced workers can make alternative arrangements. outplacement assistance includes 192 journal qi business strategies vol 9, no.2 relocation of workers to other locations of the same company, job-search assistance outside the company, resume preparation, and letters to other companies. a successful outplacement assistance requires an advance notification of plant closing. counseling services are not as important as the three major types of assistance described in the above. studies have found that workers are not interested in counseling because economic conditions leading to a plant closing tend to cause employees to become reconciled to their fate long before they lose their jobs [2]. in 1986, the conference board published a research report in which six cases of plant closings were investigated in depth. the six cases are armoco steelworks (houston, texas), ford motor company (san jose, california), gte-lenkurt (san carlos, california), international harvester, corporate headquarters (chicago, dlinois), and levi strauss & company (denison, texas) [2]. all these six cases represented successful programs in which companies went an extra mile to help their displaced workers. according to the report by the conference board, successful plant closing programs had the following six characteristics [2]. first, a large percentage of displaced workers was offered a transfer to another location of the same company. second, outplacement was provided for those who were not offered or did not accept another job. third, the relation between displaced employees and the company was harmonious. fourth, workers did not file lawsuits. fifth, severance benefits were h'beral and health insurance coverage was extended beyond the plant closing date. finally, good community relations were maintained during the closing process. an exemplary case wapakoneta is a community of 8,500, located on 1-75 between toledo and dayton, ohio. fisher cheese, located in wapakoneta, was owned by amfac, inc. of san francisco. when 367 employees of fisher cheese made their way to the november 1986 meetings held at several locations throughout the community, they were wondering what the future held for the company and for themselves. at these meetings, the employees were told that fisher cheese was bought by borden as of november 18, 1986. borden subsequently closed the plant, and all 367 employees lost their jobs. plant closing was not announced in advance because of the alleged sensitivity of the negotiations and vulnerability of food products [10]. fisher cheese is a classic example of how a good company handles a plant closing. what amfac did as the owner of fisher cheese for its former employees was praised highly by many including the then ohio's u. governor paul leonard, who said, "they are truly setting a tone of leadership." the company continued to pay for six weeks; made severance pay of a week for each year's work; continued life and medical insurance benefits for 3 months; gave an option to extend the insurance up to 18 months; provided career counseling; provided a job placement center with 7 people, which found jobs for 332 people when it finally closed in may, 1987; donated $30,000 to church-sponsored emergency food services; and contributed $200,000 to the city for economic development. fall 1992 chang: how to cope with a plant closing use of displaced physical resources 193 displaced resources are of two types; the abandoned plant facility that may be called displaced physical resources, and the laid-off workers referred to as displaced human resources. displaced physical resources are discussed in this section using the case of the closed goodyear plant in windsor, vermont. on may 3, 1987, the goodyear tire and rubber company plant closed its soyear-old windsor plant and laid off 350 people. for a town of only about 4,100 people, the closing of the goodyear plant left windsor with a "gaping hole" [8]. as is often the case with the closing of a major plant, goodyear donated the old plant and the site to the town. windsor developed the surrounding area into an industrial park, taking advantage of its proximity to an interstate highway and wages that were slightly lower than those in nearby boston. in less than two years, a trucking company and a marble company had settled into the industrial park, while several small employers moved into the old goodyear plant. the long-term impact of a plant closing varies with the community. if a community is a company town and the company closes its doors, the impact would be devastating. in most cases, however, the long-term impact of plant closing has not been found to be disastrous. detailed case studies on the long-term impact of plant closing on the community are limited mostly to the closing of military bases, although conclusions are similar in limited studies of nonmilitary plant closing [8]. many old military bases are transformed into industrial parks and the long-term impact of the base closing has been encouraging. gazzano reached this conclusion after the review of base closings in quonset point (rhode island), chippewa county (michigan), selma (alabama), fort holabard in baltimore, and the boston naval annex [5]. a study by mackinnon reached a more positive conclusion by stating that after a brief lull, local economies bounced back with renewed vigor and there was no long term adverse impact on local economies [9]. mackinnon's study is based on the 19608' closings of air force bases in bangor (maine), uncoin (nebraska), reno (nevada), roswell (new mexico), harrisburg (pennsylvania), greenville (south carolina), and amarillo (texas). use of displaced h1iijwi resources although there are exceptions, many displaced workers eventually find jobs but at a lower wage. sixteen months after the closing of the goodyear plant, the unemployment rate in windsor returned to the pre-closing level. numerous adjustments had to be made by the former goodyear employees, however. mr. gary buealmont, who was 30 years old, spent 10 months looking for a job before becoming a computer consultant sherman carter, who was goodyear's plant manager, started a construction company with his sod. bruce curtis, who had been at the plant for 35 years, later managed the windsor country qub at a considerable salary reduction. joe dart, who had worked at the plant for 18 years, became a teacher. 194 journal of business strategies vol. 9, no.2 the community experiencing a plant closing may seek financial assistance from the job training partnership act in order to help displaced workers find jobs. title ill of the job training partnership act specifically addresses the issue of assisting displaced workers from plant closing or mass layoff. section 302-(a) authorized each state to establish procedures to identify eligtble individuals who have been terminated or have received a notice of termination as a result of any permanent closure of a plant or facility. in many local areas, the identification process and the actual assistance are handled through the private industry council (pic) and the state employment agency. the types of assistance authorized under this act are spelled out in section 303. financial assistance provided to states under this act may be used to assist eligible individuals to obtain unsubsidized employment through training and related employment services, which include but are not limited to: (1) job search assistance, including job clubs; (2) job development; (3) training in job skills for which demand exceeds supply; (4) supportive services, including commuting assistance and financial and personal counseling; (5) pre-layoff assistance; (6) relocation assistance; and (7) programs conducted in cooperation with employers or labor organizations to provide early intervention in the event of closures of plants or facilities. plant closing notification act although direct assistance is not likely, communities need to be aware of the worker adjustment and retraining notification act of 1988, popularly known as the plant oosing notification act according to the act, an employer cannot order a plant closing or mass layoff until the end of a 6o-day period after the employer serves written notice of such an order. the law applies to businesses that employ 100 or more workers excluding part-time workers. before the passage of the act, the percentage of no advance notice was high, ranging from 47 percent to 64 percent, depending on the period of study. the period of advance notice, when provided, was also short, averaging between 18 days if specific dates of lay-off were given, to 46 days if the notice was given without specifying the exact date of termination [3]. the legislative process, which required a compromise between businesses that opposed the law and labor unions that favored it, led to many exceptions thus weakening the law considerably. for example, an employer can close operations before the conclusion of the 6o-day period under two circumstances. the first is that the employer was actively seeking capital or business, which, if obtained, would have enabled the employer to avoid or postpone the shutdown. in this case the employer should have believed "reasonably and in good faith" that giving the required advance notice would have precluded the employer from obtaining the needed capital or business. the second is that the closing or mass layoff is caused by business circumstances that were not reasonably foreseeable as of the time the notice would have been required. another example of exceptions relates to temporary layoffs made to be permanent suppose that a business lays off employees by announcing that the layoff would fall 1992 chang: how to cope with a plant closing 195 last less than 6 months but extends it beyond 6 months. in this case, the employer would not violate the notification act if the extension beyond 6 months is caused by unforeseen business circumstances, including changes in price or cost that were not reasonably foreseeable at the time of the initial layoff. this exception is potentially a powerful excuse for an employer to bend the 6-month layoff rule. consider that businesses often reduce, or are forced to reduce, the number of employees long before plant closing becomes the reality ([8], [2]). when goodyear plant in windsor, vermont, closed its operations on may 3, 1987, its work force was down to 350 from its peak 800. when international harvester plant in louisville, kentucky, was closed on august 3, 1984, its work force was reduced to 727 from its peak 6,500. when amoco steelworks in houston closed its doors on january 27, 1984, the number of employees was 1,100 down from its peak 4,500. it can easily be claimed that the gradual decrease in the number of employees at these plants was caused by business circumstances that were not reasonably foreseeable. the central issue in the congressional discussion of the notification act was whether advantages of such requirement outweigh disadvantages. major economic advantages of the bill, supporters claimed, were (1) shortening the duration of unemployment after layoff or plant closing, and (2) saving of the unemployment benefit payments. major disadvantages, opponents of the bill claimed, were (1) the posstbility of shirking behavior by employees between notification and termination, and (2) the exit of highly qualified workers prior to the closing or layoff date. empirical findings are virtually unanimous in that advance notice significantly reduces the duration of unemployment of those notified workers ([4], [1], [11]). these studies also conclude that the shirking behavior of notified workers is not significant, although the loss of productivity owing to the early exit of qualified workers can be significant. summary communities may cope with a plant closing or mass layoff (1) by negotiating with the company for maximum assistance to displaced workers and the community itself, and (2) by developing plans to utilize displaced physical and human resources. in negotiating with the company, community leaders should pursue, at least, the following four types of employee assistance; severance pay, extension of health care benefits, outplacement assistance, and counseling services. communities may seek financial assistance for displaced workers through the job training partnership act. title ill of the job training partnership act specifica1ly addresses the issue of assisting displaced workers from a plant closing or mass layoff. the displaced plant site usually has locational advantages such as a proximity to good transportation infrastructure. the site therefore may be a candidate for development as an industrial park. although the short-term impact of a plant closing can be devastating, its long-term impact has been found to be encouraging. according to the worker adjustment and retraining notification act of 1988, an employer with 100 or more full-time workers has to provide a 6o-day advance notice before 196 journal of business strategies vol. 9, no.2 closing a plant. studies indicate that advance notice significantly reduces the duration of unemployment of those notified workers, and that the loss of productivity owing to the early exit of qualified workers can be significant. references 1. addison, john t. and portugal, pedro. "the effect of advance notification of plant oasings on unemployment," industrial labor relations review. vol. 41 (october 1987), pp. 3-16. 2. berenbeim, ronald e. company pr0ju81ds to ease the impact of shutdowns, new york: the conference board (1986). 3. brown, sharon p. "how often do workers receive advance notice of layoffs?" monthly labor review. vol. 110 (june 1987), pp. 13-17. 4. folbre, nancy r., leighton, julia 1..., and roderick, melissa r. ''plant oosings and their regulation in maine, 1971-1982," industrial labor relations review. vol. 37 (january 1984), pp. 185-96. 5. gazzano, louis a "old military bases never die: they become industrial parks," barron's. november 3, (1986), p. 57. 6. general accounting office, plant oosinas: information on advance notice and assistance to displaced workers. gao-hrd87-86br, april 17 (1987). 7. harris, david. the leaaue: the rise and decline of the nfl toronto, canada: bantam books, (1986). 8. johnson, sally. "town survives without a company," the new york times, september 18 (sunday), (1988), p. 52. 9. mackinnon, david a. "military base oosures: long range economic effects and the imphcations for industrial development," aioc journal vol. 13 (july 1978), pp. 7-41. 10. matte, harry. "cheese plant closing opens new doors," persopnel administrator, vol. 33 (january 1988), pp. 52-56. 11. mishe~ lawrence r. "advance notice of plant closings: benefits outweigh the costs," ql311egaevol 31 (july/august 1988), pp. 58-61. 12 united stales code congressional and administrative news, 97th congress-second session, vol i, "job training partnership act." pubhc law 97-300 (s. 2(36), october 13, 1982, %stat. (1982), pp. 1322-1399. 13. u.s. department of labor, bureau of labor statistics, pmj'nent mjp la. and plant clgsjnp (1987), washington, d.c.: u.s. government printing office, july 1988. how to cope with a plant closing effecr of firm size and inrernational stralegy on performana: patricia feltes southwest missouri state university springfield, missouri l. a. digman university of nebraska lincoln, nebraska entry into the international marketplace is a. frequently recommended strategy for small to medium size businesses. not only are they faced with the patriotic fervor of government agency representatives suggesting that their market participation would benefit the overall national economic situation [12], but they view with alarm or envy the professed improved growth and profitability of large muln lationals. only 10% of u. s. export sales are made by small businesses even though the general accounting office projects a potential export sale market for companies with less than 250 employees to be $4.2 billion annually [17]. this means that firms with less than a thousand employees could account for 51% of u. s. exports as opposed to the 16% they currently sell [14]. international trade benefits many studies have examined the reasons companies choose to engage in foreign trade [20]. a firm may be pushed into international trading because there is a lack of opportunity in the domestic market it can be pulled into international trade because someone perceives an opportunity abroad. foreign opportunities include: 1) sales growth in a product/market which is in an earlier stage of the life cycle abroad than it is in domestically [21, 16 p. 193]; 2) a way to distract foreign competitors from entering or expanding in the domestic firm's home market [21, 22]; and 3) expansion of operations leading to the advantages of economies of scale, including the ability to spread research and development expenses over a greater number of units [1,2]. foreign trade also provides a way to: meet actions of domestic competitors who are involved in international trading [22]; access foreign product innovation [1]; spread cyclical risk over additional and asynchronous markets [14]; and hedge· against domestic business fluctuations [1]. managements of small to medium sized firms are aware of these potential benefits. however, the threat of bottom line shortfalls is seen as imminently dangerous to those same organizations since smaller companies seldom have slack resources to absorb error. at the least, the ability to borrow funds in the future could be compromised by an ill conceived experiment in international trading. mistakes in the development of foreign operations, therefore, can be fatal to the entire organization. smaller companies are concerned about the additional cost of doing business abroad. they have limited financial resources and question whether the investment in developing knowledge of the foreign market, the complex paperwork, as well as various trade 106 journal ofbusiness strategies vo1.7,no.2 regulations and barriers would be worth the effort. they are faced with potentially expensive and risky decisions. should they market directly to foreign buyers through their own overseas sales staff, rely on foreign nationals, or contract services with an export management firm? would foreign direct investment be more effective or efficient? should they adapt their products for the new market? the answers to those questions are influenced by the manager's interpretation of the profit potential for the firm. ultimately, small, medium, and large companies want their strategic choices to be profitable. the basic objective of profit making firms which venture into the international trading arena is the maximization of profits [8, 14]. if smaller firms could have some assurance that other companies had entered the foreign marketplace without damaging their profitability they would find the entry questions easier to answer. the purpose of this study was to provide information regarding the effect of international practices on other firms to those small and medium size companies considering international expansion. the research question was: does the size of the company interact with its international trading strategy to penalize the relative profitability of the firm in comparison with other industry members? firm size and international strategy there is a conceptual connection between the size of an organization, its choice of international strategy, and its ability to benefit from that choice [19]. delacroix suggests there may be a size threshold which must be crossed before any international strategy can become successful for a firm. terpstra [23] theorizes that a minimal size is essential for product development and market research. a minimal sales volume may be required for each product before international activity is feasible [15]. while theorizing that export sales were an important route to growth for the small to medium sized firm, cooper and kleinschmidt [9] found no relationship between international strategy chosen and size of firm. furthermore, they did not find a significant relationship between size and export performance. it is possible that the choice of strategy and size of firm interact and that this interaction helps to explain a differential rate of performance. what is an appropriate strategy at one end of a size continuum may be inappropriate at the other end. few studies have looked at the relationship of international trading and financial effects [1, 19, 22, 26, 32]. performance is often defined, in fact, as the ability of a firm to sell more internationally rather than as a measure of economic benefit. this study attempts to provide some empirical information for both managers and academics who are interested in the competitive effect of the international decision. it concentrated on the financial success of domestic versus international traders. methodology there was no attempt in this study to suggest that international trading was the singular reason for a company's financial success or failure. this study was limited to an infall 1990 feltes & digman: firm size 107 vestigation of a single strategic choice variable, a single structural factor, the interaction of the two variables, and their effect on the dependent variable of financial performance. however, research into the effect of one of a few key variables can provide useful insights [4, 5]. sample data was gathered from secondary sources including loks and annual reports. in order to constrain the effect of the environment, the analysis was done with data pooled from two related industries (telephone and telegraph apparatus industry sic 3661 and radio and television broadcasting and communication equipment industry sic 3663) rather than from a random selection across industries. this choice followed the recommendations of benvignati [1] and sarathy [22] who found that the inclusion of multiple industries confused the effect of the environment on research results. both industries were categorized as industrial goods manufacturers producing high technology products. although consumer goods and services are also sold and produced abroad for foreign sale, they face more complex cultural and social issues in their businesses [9]. in addition, to maximize the likelihood of a significant relationship, the industries should possess products which lend themselves to international trading. according to industrial organization literature, the presence of intangible proprietary assets similar to the unique technical information generally associated with high technology products is a key reason that firms become involved in international trading [3 p.5]. the research period spanned the years 1981 through 1986. this series of years allowed an examination of the interaction of size and foreign trading strategy during a variety of international conditions including; both high and low relative dollar value; recession and recovery at differing domestic and international rates; the elimination of the tax incentives in the domestic international sales corporations (discs); and the 1984 deregulation of the u. s. telephone industry. in summary, firms included in the study were required to be: 1) publicly held; 2) single or dominant product line firms; and, 3) viable during the entire period of the study. using these criteria for selection resulted in a sample of 88 firms drawn from the two industries. table 1 contains a categorical breakdown of size/strategy of sample members. variables performance was defined as the financial results of the firm as expressed in the corporate return on assets, return on sales, and return on stockholders equity. although performance can be defined in terms of the identity and goals of a variety of stakeholders, financial measures are commonly used and widely accepted in the strategy/policy literature [16]. each of the dependent variable measures resulted in data which was continuous and proportionate. the use of ratios acted to normalize the data and facilitated comparability among firms. the continuous scale also provided the appropriate form of data required by the statistical procedure: multiple regression. 108 journal ofbusiness strategies voi.7,no.2 the size of the firm was measured using annual net sales as reported in the 10k or annual report. the use of a firm's annual sales figure as a surrogate for size is a commonly accepted research approach to size measurement [2, 7, 18]. the measure provided appropriate interval, continuous data for use in the statistical analysis. 1981 1982 1983 1984 1985 1986 table 1 sample membership size strategy foreign direct domestic export investment small 8 5 0 medium 17 29 8 large 0 8 11 small 5 3 0 medium 17 26 9 large 2 14 12 small 4 4 2 medium 15 25 7 large 2 15 14 small 6 2 1 medium 15 24 7 large 2 15 16 small 5 0 2 medium 17 24 6 large 4 14 16 small 4 2 0 medium 19 21 9 large 4 14 15 small = sales less than $5m medium = sales between $5m and $50m large = sales more than $50m sales sizes classified for information only. data was used as continuous intervals in statistical procedure. size classifications based on czinkota and johnston (10]. three international strategies were identified for the purposes of this study: 1) domestic strategy companies following this strategy are actively engaged in domestic marketing only. if they sell internationally it is a passive, occasional sale below the ten percent reporting level established by the financial accounting standards. they have no foreign investment either in marketing or manufacturing. fall1990 feltes & digman: firm size 109 2) exporting strategy companies classified as exporters only are essentially acting as international marketeers. they do not produce their product abroad for sale to unaffiliated foreign buyers. 3) foreign direct investment strategy companies are the majority owners of manufacturing companies'which produce and sell their products abroad to unaffiliated foreign buyers. an alternative measure of international trading involvement (percentage unaffiliated foreign sales) consists of the total reported export sales plus the total reported foreign subsidiary sales made to unaffiliated or noncompany related buyers as a percentage of the total sales made by the firm that year. this measure was found to correlate with the strategy classifications system described earlier in the range of pearson's r = .82 to .87. although not a true substitute for the concept of a finn's strategy, the expectation was that firms using the strategy requiring the most commitment would also be the firms, overail, experiencing the greatest relative percentage of sales from that involvement. analysis the data was analyzed using hierarchical multiple regression correlation. the statistical procedure and model is described in appendix a discussion the analysis of the data indicated no significant difference in financial performance due to the interaction of finn size and the type of strategy used by the firm. the results of this study suggest that a response to national calls for international trading should be based on company needs and constraints which were not included in this study. the findings indicate that participation in the international marketplace does not affect the financial returns of small or medium size firms differently than large firms. however, international trading may provide less direct or obvious benefits than increased financial returns. for example, factory capacity can be maintained if products can be exported. this can result in the retention of a skilled workforce and continued operations during domestic recessions. overseas subsidiaries may tap into research and development projects not easily accessed by foreigners. internationally based manufacturing plants may produce not only for the foreign market but also provide a source of component parts for the domestic company as a captive supplier. none of these benefits necessarily results in increases in short term profitability. for small and medium-size firms, this study implies that there is no greater financial risk associated with choosing an international trading strategy rather than a domestic strategy. they were not systematically singled negatively on the basis of size. firm size appears as neither a handicap nor an advantage in detennining the financial effect received from pursuing a particular international strategy. since financial performance does not appear to be influenced by the interaction of size and strategy, the advisability 110 journal ofbusiness strategies vo1.7,no.2 of employing international trading strategies should be evaluated using criteria other than size and should not automatically be ignored because a finn is small or medium size. references 1. benvignati, m. "domestic profit advantages of multinational firms." journal of business, vol. 60, no.3 (1987), pp 449-461. 2. brasch, j. j. "deciding on an organizational structure for entry into export marketing." journal of small business management, vol. 19, no.2 (1981), pp. 7-15. 3. caves, r. e. american industry: structure, conduct and performance. englewood cliffs: nj: prentice-hall inc. (1977). 4. child, j. "managerial and organizational factors associated with company performance-part i." the journal of management studies, vol. 11, no.3 (1974), pp. 175-189. 5. child, j. "managerial and organizational factors associated with company performanre-part ii." the journal of management studies, vol 12, no.1 (1975), pp. 12-27. 6. cohen, 1. & cohen, p. applied multiple regression/correlation analysis for the behavioral sciences. hillsdale: n.j.: lawrence erlbaum associates (1983). 7. contractor, f. j. "technology licensing practice in us companies: corporate and public policy implications." columbia journal of world business, vol. 15, no.3 (1983), pp. so88. 8. contractor, f. j. "choosing between direct investment and licensing: theoretical considerations and empirical test." journal of international business studies, vol. 15 (1984~ pp. 167188. 9. cooper, g. & kleinschmidt, e. j. "the impact of export strategy on export sales performance." journal of international business studies, vol. 16, no.1 (1985), pp. 37-55. 10. czinkota, m. r. & w. j. johnston. "exporting: does sales volume make a difference?" journal of international business studies, vol. 14, no.1, (1983) pp. 147-153. 11. delacroix, j. "export strategies for small american firms." california management review, vol. 26, no.3 (1984), pp. 138-153. 12. denoble, a. f., castaldi, r. m. & mouver, d. m. "export intermediaries: small business perceptions of services and performance." journal of small business management, vol. 27, no.2 (1989), pp. 33-41. 13. digman, l. a. strategic management. plano, texas: business publications inc, (1986). fall 1990 feltes & digman: firm size 111 14. edmunds, s. e. & khoury, s. j. "exports: a necessary ingredient in the growth of small business firms." journal of small business management, vol. 24, no.4 (1986), pp. 54-65. 15. hirsch, s. & bijaoui, i. "r&d intensity and export performance: a micro view." weltwirtschaftliches archiv, vol. 121, (1985), pp. 238-251. 16. hofer, c. w. " rova: a new measure for assessing organizational performance." advances in strategic management, in r. lamb, ed. new york: jai press. vol. 2, (1983), pp. 43-55. 17. kathawala, y. j., monipalli, m. & m. wienrich. "exporting practices and problems of illinois firms." journal of small business management, vol. 27, no.1 (1989), pp. 53-59. 18. kirpalani, v. r., and macintosh, n. b. "international marketing effectiveness of technology oriented small firms." journal of international business studies, vol. 11, no.3 (1980), pp. 81-90. 19. miller, j. c. and pras, b. "the effects of multinational and export diversification on the profit stability of u. s. corporations." southern economic journal, vol 46, (1980), pp. 7m805. 20. namiki, n. "export strategy for small business." journal of small business management, vol. 26, no.2 (1988), pp. 32-37. 21. rapp, w. v. "strategy formulation and international competition." columbia journal of world business, vol. 23 (1983), pp. 98-112. 22. sarathy, r. & 1. edmunds. "the international marketing strategies of new england hightechnology firms." journal of the academy of marketing science, vol. 11, no.3 (1983), pp. 226-239. 23. terpstra, v. "critical mass and international marketing strategy." journal of the academy of marketingscience, vol. 11, no.3 (1983), pp. 269-282. appendix a statistical procedure the data was analyzed using hierarchical multiple regression analysis. the following form of the equation was used: ,., y ::= a + blxi + b2x2 + b3x3 where: y::= dependent variable performance a ::= intercept b ::= partial regression coefficient xl ::= size of firm x2 = international strategy (dummy coded) x3 = interaction size x international strategy 112 jaurnal afbusiness strategies vol. 7, no. 2 statistical procedures included a regression of the current research year's size and strategy against the same year's performance. since the effect of a strategy may require the passage of a period of time to take effect, one year and two year lagged equations were run. one of the assumptions made in the use of multiple regression correlation is that the underlying relationship is linear. this is particularly of interest in this study since the relationship between fmancial performance and strategy may vary at differing levels of size. to test whether a curvilinear relationship is a more appropriate description of the true state between variables, a regression was run for each year using power polynomials. these variables are created by multiplying and existing research variable by itself and entering the computed variable into the regression equation as an additional independent variable [6, p. 226]. effect of firm size and international strategy on performance journal of business strategies special issue on services in the next millennium introduction by guest editors james a. fitzsimmons mona j. fitzsimmons university of texas at austin austin, tx services playa central role in the economies of nations and world commerce. no economy can function without the infrastructure that services provide in the form of education, health care, transportation, and communications. most of the world's economies have followed similar patterns of development; they have evolved through stages characterized first by subsistence living, then by agrarian activities, and by industrialization. evolution through these three stages could be measured in hundreds and thousands of years. in the 1970s and 1980s, however, evolution could be measured in decades as most industrialized economies moved into a postindustrial period. during this time, the majority of the populations in postindustrial economies became employed in service activities. the decade of the 1990s saw such rapid development of the information age in most nations that, at the birth of the 21st century, we are already anticipating another new economic paradigm an "experience" economy. we have recognized for a long time that the economic activity of a society determines the nature of how people live and how the standard of living is measured. as table 1 shows, the service sector today accounts for more than 80 percent of total employment in the united states, and continues a trend that began more than one century ago. the importance of the service sector is undisputed when viewed as a source of employment for other industrialized nations, also. table 1 contains some surprises, such as finding that canada, which is known for its mining industry, is high on the list and that china's economy is becoming much more sophisticated. we see that even in modem industrial economies, the majority of jobs are in the service sector. just as farming jobs migrated to manufacturing in the nineteenth century under the driving force of labor-saving technology, manufacturing jobs in due time migrated to services. global economic development, however, is progressing in unanticipated directions and successful industrial economies are built on a strong service sector. as we begin the new millennium of the 21st century, the emerging experience economy raises expectations for services. services are undergoing a transformation from the traditional concept of a service transaction to one of an experience. 2 journal of business strategies vol. 17, no.1 experiences create added value by engaging and connecting with the customer in a personal and memorable way. characteristics of a service experience include "staging" the service instead of just delivering it, treating the customer as a guest, and connecting with the customer in a memorable way. since about 1998 the internet has provided a channel for service delivery that offers a completely different way of doing business, but it is much too early to judge the impact of online services on traditional services. many people fear that internet services will drive traditional retailers out of business, for example, but forecasters doubt this will happen. table 2 examines the differences between the virtual services offered on the internet and the experiences offered by traditional services. table 1 percent employment in service jobs for selected nations, 1980-1999 country united states canada japan france israel italy china 1980 67.1 67.2 54.5 56.9 63.3 48.7 13.1 1987 71.0 70.8 58.1 63.6 66.0 57.7 17.8 1993 74.3 74.8 59.9 66.4 68.0 60.2 21.2 1999 80.4 73.9 72.4 70.8 70.7 61.1 26.4 source: 1999 statistical yearbook, department of international economic and social affairs statistical office, united nations, new york, 1999. table 2 virtual and experience service comparison features service encounter availability access market area ambiance competitive differentiation privacy virtual service screen-to-face anytime from home worldwide market electronic interface convenience anonymity experience service face-to-face normal working hours physically visit location local market physical environment personalization social interaction virtual services delivered over the world wide web are truly global in their reach. table 2 illustrates the dichotomy in service design represented by the physicalversus-electronic presence of the customer in the system. technology in both cases has been the driving force for change. advances in our understanding of the physical world contributed to the transition from preindustrial to industrial economies. today spring 2000 introduction 3 we find information technology is central to the development of our new experience economy. virtual services also differ from experiential services in the extent to which customer contact, customization, interaction, and technology can be used to deliver the service effectively. virtual-service offerings are composed of online interactive service dimensions and offline noninteractive service dimensions. the online service dimensions involve the customer's actual contact with the service system, and offline elements involve knowledge workers and the logistics operations of the system. customization of virtual services can take place both during online customer interactions, and through offline back-office processes that are separated from the customer. online customization might use technologies, such as video-conferencing systems and other technologies that connect directly to online operations. labor and technology are both used for offline custornization. the authors in this special issue addressed some of the issues facing those who manage services in this new century. james a. fitzsimmons is the william h. seay centennial professor of business in the university of texas graduate school of business. he received his ph.d. with distinction in operations management from the university of california, los angeles, and joined the university of texas at austin in 1971. he coauthored service management: operations, strategy and infonnation technology. he has published numerous articles in academic and professional journals and is active in his profession, serving as area editor of production and operations management and associate editor of journal of operations management. he also serves on the editorial boards of the international journal of service industry management and journal of service research. he is secretary of the production and operations management society, former at-large vice president of the decisions sciences institute, and former treasurer of the operations management association. mona j. fitzsimmons holds an undergraduate degree in journalism from the university of michigan and has done graduate work in geology at california state university, northridge, and the university of texas at austin. she has worked as a news reporter and as a writer and editor for encyclopedia britannica education corporation. she has also written and edited for business and professional journals and coauthored two editions of a service management textbook. editor's note: two reviewers deserve special recognition for their contribution to this special issue ofjbs: mousumi bhattacharya (syracuse university) and david p. paul iii (old dominion universitylmonmouth university). their thoughtful critiques of the manuscripts submitted for consideration enhanced the selection and editing of the articles that appear in this special issue on services. introduction the theoretical price-earnings ratio model: empirical evidence dean r. longmore idaho state university pocatello, idaho charles r. idol texas credit union league arlington, texas gary r. wells' idaho state university pocatello, idaho in an earlier article, the fundamental factors aff~cting common stocks' price-earnings (pe) ratios were theoretically investigated [3]. the proposed "theoretical model" established that the determinants of pe ratios are operating return on assets (positive), systematic business risk (negative), and an ambiguous relationship with the dividend payout ratio, financial leverage, and the firm's tax rate. functionally, the "theoretical model" follows: + ??? pe = 0 (r, ~u, b, l, 1) where (1) r = ~u = b = l = t = the firm's operating profitability ratio (the ratio of ebit to total assets), the systematic business risk of an unlevered firm, the expected dividend payout ratio, the firm's f'mancialleverage factor, calculated as the book-value ratio of total debt to common equity, the flrm's marginal income tax rate) 1 the symbol 0 implies that the dependent variable on the lhs of the equation is influenced bytbe causal variables enclosed in the parenthesis on the rhs of the equation. the directional (i.e., first partial derivative) effects of these separate influences are denoted by the sign ("+" for positive and "-" negative) above each causal variable. a "1" above a causal variable suggests that its influence on the dependent variable is conditional. fall 1991 longmore, idol & wells: theoretical pie ratio model 95 traditional theory ("traditional model") suggests that the pe ratio is positively influenced by earnings' growth and dividend payout, but negatively by risk [1,2,4,5]. + + pe = 0 (g, b, r) where (2) g r = = growth in earnings per share, risk measurement of earnings variability. the purpose of this paper is to compare the pe explanatory powers of the "theoretical model" and the "traditional model." it is hypothesized that the explanatory powers of the "theoretical model" will exceed those of the "traditional model" empirical tests to empirically test the "theoretical model" [equation (1)] and the "traditional model" [equation(2)], a sample of 259 industrial firms having sufficient historical data on the compustat tapes over the ten years 1969-1978 was selected.2 average values over the ten-year span for each firm's price-earnings ratio (pe), operating profitability ratio (r), dividend payout ratio (b), financial leverage factor (l), and marginal tax rate (i) were calculated. to estimate a firm's systematic business risk (pu), a "market" operating profitability ratio for the 259 firms was constructed during each of the ten years. the regression coefficient obtained by regressing a firm's annual operating profitability ratios against the market's operating profitability ratios over the ten years was used as a proxy measure of each firm's pu. the variance, denoted var(r), of each firm's ten annual operating profitability ratios was calculated to reflect total business risk during the ten-year span. each firm's compound growth (g) in earnings per share between 1969 and 1978 was also calculated. measurements of both the firm's total business risk and its earnings' growth (var(r) and g, respectively) were necessary so that empirical results obtained from both the "theoretical model" and the "traditional model" could be compared. with the average pe ratio being the dependent variable, two stepw:ise multivariate regressions were run on the sample of 259 firms. in the first run, the five casual variables (r, pd, b, l, 1) from the "theoretical model" were included as independent variables. in the second run, causal variables [g, b, l, var(r)] associated with the "traditional model" were included as independent variables; the risk dimension should be captured by inclusion of 2 the 1969-78 time span was chosen to reduce the impact of interest rate volatility on the sample firms' pe ratios. over this ten-year span, interest rates were both relatively low and stable, whereas rates were generally rising between 1979-81 and falling between 1982-86. 96 journal of business strategies vol. 8, no.2 measurements for both the firm's overall business risk and its financial leverage factor. the results of these two runs are presented in table 1. table 1 rearession results for all firms <n=2s9} run model regression equation adj. regression no. tested (refer to notes) r2 f stat. 1 theoretical equation (1) pe=16.8 + 24.9r .5llu 1.2l 18.ot .20 16.83** (6.01)** (3.05)** (2.08)* (3.93)** 2 traditional equation (2) pe=12.2 + 2.9g 1.8l + 2.0b .03 3.67* (.71) (2.78)** (.91) notes: 1) .. indicates statistical significance at the 1% level. 2) * indicates statistical significance at the 5% level. 3) the number beneath each regression coefficient is the coefficient's t statistic. 4) in run #1, the dividend payout ratio (b) failed to enter into the regression equation due to its lack of meaningful statistical significance with the pe ratio in a multivariate context. 5) in run #2, the total business risk measure [var(r)] didn't enter into the regression equation due to its lack of statistical significance with the pe ratio. the outcome of the first regression run provides empirical support for the "theoretical model." the regression's r2 (.20) was significant at the 1% level (f.0l =3.41). both the operating profitability ratio (r) and systematic business risk (flu) had expected directional effects on the pe ratio; further, from their t statistics, both variables were statistically significant at the 1% level additionally, both the marginal tax rate (1) and the financial leverage factor (l) had statistically significant influences on the pe ratio. the dividend payout ratio's (b) statistical association with the pe ratio was so weak that it failed to enter into the regression equation. when the "traditional model" was tested with the second regression run, the regression's modest r2 (.03) was statistically significant at the 5% level (p.os = 2.65). however, the only variable to have a statistical significance (at least at the 5% level) with the pe ratio was the financial leverage factor (l). as in the first regression run, us coefficient had a negative sign. thus, for the study's 259 firms, the "traditional model" performed very poorly compared to the "theoretical model" to examine whether the regression's r2s could be improved using a more homogeneous sample of firms, the two regressions were rerun on the firms in the sample which comprised the chemical process industry. as the regression run results shown in table 2 clearly indicate, the "theoretical moder' outperformed the "traditional model." in both cases, the r2s were much higher for the industry group (.51 for the "theoretical model" and .15 for the fal11991 longmore, idol & wells: theoretical pie ratio model 97 "traditional model") than for the general population of firms. 3 however, even though the r2s improved with the more homogeneous group of firms, the structural characteristics of the regression equations remained unchanged from those reported in table 1. table 2 regression results for firms in the chemical process industry (sic 20xxl run model regression equation adj. regression no. tested (refer to notes) r2 f stat. 1 2 theoretical equation (1) traditional equation (2) pe=15.3 + 35.4r .9~ 2.1l 16.7f (6.34)** (3.32)** (1.83) (2.30)** pe=11.0 + 14.5g 4.2l + 8.0b (1.75) (2.74)** (1.84) .51 .15 20.81** notes: 1) •• indicates statistical significance at the 1% level. 2) • indicates statistical significance at the 5% level. 3) the number beneath each regression coefficient is the coefficient's t statistics. 4) due to the lack of statistical significance with the pe ratio, the dividend payout ratio (b) did not enter into the regression equation. 5) due to the lack of statistical significance with the pe ratio, the total business risk measurement [var(r)] did not enter into the regression equation. conclusion the empirical results established the superiority of the "theoretical model" over the "traditional model" in explaining price-earnings ratios. as suggested in the earlier article, decisions to unconditionally enhance a firm's price-earnings ratio should strive either to increase operating profitability or to lower systematic business risk. on the other hand, decisions affecting a firm's financial structure, dividend policy, and tax strategy are less definitive on a firm's price-earnings ratio. 3by forming an even more homogeneous industry grouping from the chemical industry, the r2s could be increased further to .62 for the "theorectical mode1." 98 journal ofbusiness strategies references vol. 8, no.2 1. beaver, w. and morse, d. "what determines price-earnings ratios?" financial man· agement (summer 1975), pp. 53-64 2. bell, f. "the relationship of the structure of common stock prices to historical expectations and industrial variables." journal of finance (march 1974), pp. 187·197. 3. idol, charles r., longmore, dean r. and wells, gary r. "financial theory and the factors affecting common stocks' price-earnings ratios." journal of financial and strategic l.>ecisions (fall 1988). pp. 29-42. 4. malkiel, b. and cragg. j. "expectations and the structure of share prices." american economic review (september 1970). pp. 601-617. 5. whitbeck, v. and kisor, m. "a new tool in investment decision-making." financial analysts journal (may-june 1963), pp. 55-62. the theoretical price-earnings ratio model: empirical evidence strategic planning for financial service providers: a family life cycle profile of competitive marker segments paula j. haynes the university of tennessee at chattanooga chattanooga, tennessee neil riley francis marion college florence, south carolina marilyn m. helms the university of tennessee at chattanooga chattanooga, tennessee financial services providers face a marketplace redefined by a myriad of changes including deregulation, tax reform and heightened competition. questions that must be answered if a provider is to recognize competitive threats in a timely manner include: "what business are we in?", "who is our competition?" [6]. the differences in customer needs, combined with competitive pressures to segment the financial services market make strategic planning critical for profitable operations. because financial planning services are typically viewed as commodies by consumers, financial planning providers tend to take a commodity marketing approach. the commodity marketing approach focuses attention on short-term profitability which can lead to a less profitable long-term position and a lost competitive edge. this study uses family life cycle stages combined with consumers' self reports of willingness to accept risk and invest monetary assets to study ways financial providers can develop both short-term and long-term focuses on profitability. defining financial planning markets criteria used to defme the financial planning market should reflect not only the current profitability of the segment, but also the future profitability and competitive advantages offered by the financial planners should not rely solely on household income as a good indicator of segment potential because income alone is not a reliable predictor of the longterm strategic profitability of a customer segment. for example, younger households represent segments with a strong future benefit, but will have lower current household incomes than other segments. age and marital status also create different financial planning needs. the presence of children in a household can create different financial requirements than households of the same age, income and marital status without children present. these demographic factors can be combines to meaningfully divide the marker for financial products and services based on near and long term profitability by utilizing family life cycle stages [6]. family life cycle stages involve a combination of factors including age, income, marital status and the presence of children in the household [10, 16]. combinations of these factors defme tight family life cycle stages (table 1). fall 1990 haynes, riley & helms: strategicplanning table 1 typical stages in a family life cycle head of household less than 45: stage 1 not married, no children stage 2. married, no children stage 3. married or unmarried, children under 18 at home head of household between 45 and 65: stage 4. married or unmarried, children under 18 at home stage 5. married, no children under 18 at home stage 6. unmarried, no children under 18 at home head of household over 65: stage 7. married, no children under 18 at home stage 8. unmarried, no children under 18 at home 77 by clustering households according to these factors, the life stages reveal differences in financial decisions due in part to marital status or the presence of young children [7, 8, 16]. life experiences, household circumstances and personality factors affect attitudes toward risk and liquidity, and the choices of financial planning services. client needs and the financial planner since different needs motivate households, financial services providers must be responsive to the impact of these needs on the [mandal services purchases of each segment. client objective/constraint profiles that reflect investment goals should be formulated for the individual household segment and market limitations. such a profile has the benefit of providing a basis for evaluating the needs and risk/return options for the consumer client. such a profile should reflect: (1) the clien'ts need for current income; (2) their inflation protection needs; (3) their ability to tolerate a loss of principle; (4) their ability to tolerate volatility in income; (5) their liquidity requirements; (6) their particular tax bracket and situation; (7) any legal constraints; (8) the length of the planning time or horizon; and (9) any other unique needs of the client. orchestrating a system of financial product/service offerings around these needs as reflected in life stages would give an organization a competitive advantage. by following a household through the various stages, this approach moves a provider into a "financial consultant" role. strategy in the financial planning industry from a strategic standpoint, no single segment will continue to offer the same profitability over time. though in the near term younger households may be less profitable than older households, access to the segment can be gained by establishing an early financial planning relationship. this may be the most cost effective way to ensure future 78 journal of business strategies vol. 7, no.2 profitability for the company. while profitable markets can be won away from competitors, stealing market share may be less cost effective than nuturing share. current customers can be reached at lower costs, and their needs, as determined by their life cycle groups, are also more readily known. thus, "growing" a "future benefits" segment is clearly a strategic move in a competitive marketplace. since these "future benefits" segments may not be highly profitable today, financial planning firms must attract business from segments that can bridge the present and future profitability. all segments may not offer the same potential, but competitive advantage lies in the fit between segment needs and a financial services provider's offerings. methodology evaluation of market segment potential to assess the strategic possibilities of segmenting the client market for financial service providers, the authors evaluated household data included in the most recent "survey of consumer finances" [4]. conducted jointly by the survey research center of the university of michigan and the federal reserve board, this data was collected from 3,824 households and included extensive information on the financial assets households owned, risk and liquidity attitudes and use of financial service providers. responses to questions relating to the composition and ages of household members were used to classify households into the eight stages identified in table 1. using these stages, it was possible to define market segments according to the societal pressures prevalent to particular consuer groupings. table 2 summarizes the key characteristics of each stage. the value of total assets was greatest for consumers in stage five (married households, with the head of the household between 45 and 65 years old, with no children living at home). this segment also owned the greatest proportion of financial assets. stage three households, either married or not with children, represented the largest group of the eight segments, followed next by stage five households. while not as willing to accept financial risk as some segments, stage five households were willing to invest their money for longer periods of time. these characteristics suggest that the stage five life cycle segment represents the short-term to intermediate-term profitability target for financial service providers. when ranked by value of financial assets held, stages three and four (household heads under 45 and between 45 and 65 years old with children under 18 at home) fall next in potential. the younger of these two stages (stage 3) may be of greater potential benefit since this stage includes nearly one third of all represented households. while desiring some liquidity, they are willing to take more financial risks than other segments. also, the proportion of this group owning financial assets, as well as the dollar amount of those assets, is projected to grow in the future. this group may offer greater intermediate and future benefit flows for financial planners. of the married households, many were dual career/dual earner household~. stages composed soley of unmarried households, which included surviving spouses, divoreced fall 1990 haynes, riley & helms: strategic planning 79 and never married person, consistently owned lower proportions of financial assets. in the unmarried household stages, the absence of an additional wage earner had a negative impact on the accumulation of financial assets. table 2 financial asset holding by family life cycle stages %of %of total segment median value houseowning of financial acceptance of: lifecycle stage holds assets assets owned1 risk2 liquidity3 household head <45: stage 1. unmarried, no children 11.8 81 2,898 m m stage 2. married, no children 7.6 90 20,350 a m stage 3. married or unmarried, children 31.4 84 23,750 m a household head 45-65: stage 4. married or unmarried, children 8.9 86 31,850 l a stage 5. married, no children 13.9 94 37,100 a m stage 6. unmarried, no children 8.3 75 12,850 l a household head >65: stag~ 7. married, no children 8.0 82 31,625 l a stage 8. unmarried, no children 9.3 73 8,713 l l 1 2 3 financial assets used were: equity in the home, real estate, checking accounts, money market accounts, mutual funds, savings accounts, brokerage accounts, certificates of deposit, lras, keogh accounts, cash value of life insurance, all saver certificates, u.s. savings bonds, treasury bills and bonds, state and corporate bonds, publicly traded stock, trust accounts and investments in precious metals and collectibles. m, a, l = more, average or less willing to take financial risks. m, a, l = more, average or less willing to invest money. financial planners should not automatically assume, however, that consumers within each group are homegeneous units. in married households, for example, husbands and wives have been shown to have very different patterns of responses to the household's financial behavior (4). other studies suggest there is little agreement between husbands and wives on savings practices and priorities (4, 5). 80 journal of business strategies vol. 7, no.2 family structure has also been shown to affect a household's financial behavior. a 1986 study found that households containing young children were more likely to own fmancial assets such as ira accounts and college funds than those households without young children. older households were more focused on fmancial assets that would generate retirement income. this study confirmed that the ownership of financial assets reflects not only the individual needs of the households, but also the needs resulting from societal pressures (15). consumer usage patterns of financial planning services these differing financial and life cycle stages needs were also found to influence a household's choice of financial planning service. as shown in table 3, the "survey of consumer finances" provided data on the use of five financial planning services: accountants, bankers, brokers, lawyers and tax advisers. differences were apparent in the choice of financial service provider preferred by the various life stages. table 3 use of financial planning sources by family life cycle stages l financial planning service used lifecyc1e stage acct. banker broker lawyer tax advisor household head <45: stage 1. unmarried, no children 2172 97 167 90 73 stage 2. married, no children 283 92 114 120 82 stage 3. married or unmarried, children 117 111 124 160 173 household head 45-65: stage 4. married or unmarried, children 92 122 143 195 118 stage 5. married, no children 142 130 133 125 173 stage 6. unmarried, no children 67 124 114 100 118 household head >65: stage 7. married, no children 42 173 110 80 73 stage 8. unmarried, no children 67 168 90 115 64 1 index numbers were based on the percent of households in a stage using a source compared to the percent of all households using that source. 2 this index number means stage 1 households were more than twice as likely as all households to use accountants for financial planning fall 1990 haynes, riley & helms: strategicplanning 81 a pattern in use of financial planning sources by life cycle stage was evident. to test whether these differences were statistically significant, the authors performed the sas procedure catmod. this categorical modeling program derived a model that would indicate the probability of a particular consumer stage selecting a specific fmancial planning service (11). the ability of the eight life cycle stages to predict the use of the five sources of financial advice over another source of advice was supported. therefore by knowing the life cycle stage of a consumer, it is possible to predict the choice of fmancial planning advice the consumer in this stage would prefer to use. the impact of the stage was significant with a chi2 of = 81.12, with 28 degrees of freedom where p < 0.0001. the index numbers reported in table 3 allow financial planners to identify major user segments. index numbers over 100 indicate a greater than average use of service provider. heavier overall usage of planning service is evident in stages three and five. the level of financial asset ownership by households in stage five (table 2) suggests this is likely to be a highly sought after segment. heavy use of planning advice may reflect not only the financial motivations of the segment, but also the efforts of providers to attract these customers. younger households (stages one and two) were more than twice as likely to use accountants for financial planning. older households (stages seven and eight) were more likely to consult bankers for fmancial advice, as were stage six households. brokers were preferred by young, unmarried households (stage one). lawyers were more preferred for fmancial planning purposes by households with children (in stages three and four). tax advisors were more used by households with young children (stage three) or no children (stage five). although overall use of accountants for financial planning advice was relatively low, all households using accountants did not report the use of any other advice source. also, less than five percent of the consumers using bankers for financial planning purposes reported using additional sources. in contrast, nearly a quarter of those using brokers as financial planners also used other professional advisors; for tax advisors and lawyers this proportion was almost fifty percent. households with children (stages three and four) and middle aged married households (stage five) were most likely to use several sources of professional financial planning advice. older households (stages six, seven, and eight) were least likely to use more than one source of financial advice. in terms of absolute usage, bankers were more likely to be the source of fmancial planning advice for any life cycle stage. this indicates that bankers who establish an early contact with consumers can more than likely sustain this relationship over time. strategic planning for financial services providers figure 1 indicates the relationship of risk and liquidity attitudes to the choices of financial service provider by the eight life cycle stages. life stages are positioned on figure 1 by the risk and liquidity attitudes of the households while [manciai service providers are positioned according to the risk and liquidity attitudes of their clients. three com82 journal of business strategies vol. 7, no.2 petitive groupings, as represented by the circled areas, were defined by the position of the five sources of financial advice relative to the risk and liquidity attitudes of their customers segments. figurel the three competitive groupings in the financial service provider marketplacel broker tax advisor banker more willing to tolerate liquidity lawyer \ stage 8 stage 6 stage 7 ) stage 3 stage 4 ~ esswilling to tolerate liquidity stage 5 less willing to tolerate liquidity stage 1 accountant more willing to accept risk life stages are positioned by the risk and liquidity attitudes of those households; financial service providers are positioned according to the risk and liquidity attitudes of their clients. the three circles enclose the groupings most likely to use that grouping's financial service provider. strategic planning for bankers and lawyers risk averse consumers who desire liquidity characterized the banker/lawyers grouping. the use of bankers as financial planners depended more on avoiding risk than on customer's attitudes toward investing money for long periods of time. the use of lawyers as financial planners, in contrast, depended more of the preferences for liquidity than the desire of the consumer to avoid financial risk. this banker/lawyer grouping attracted two types of customers: those with the fewest and lowest value financial assets (stages six and seven); and those with the highest value of asset ownership (stages four and seven). the banker/lawyer group would have both present and intermediate-term markets well covered. future profitabiltiy is a strategic concern for this group. tax advisors offer the greatest peripheral competitive challenge, while accountants and brokers auract a different customer base and are not a major threat to the banker/lawyer planning group. fall 1990 haynes, riley & helms: strategic planning 83 strategic planning for brokers and accountants a willingness to take fmancial risks and invest money for longer time periods characterizes this competitive group. use of brokers and accountants, was greater among younger segments (in stages one and two). these segments represents a unique competitive situation, since these households selecting accountants usually use accounting services for all their financial planning needs. broker users demonstrate a different pattern as the households using broker services also use several other service providers. this broker/ accountant niche has growth potential with consumers in stages one and two. near and intermediate-term profitability depends on the degree to which stage five households use these service providers. because stage five households use multiple fmancial service providers, brokers and accountants face intense competition for these unfocused customers, particularly from tax advisors. strategic planning for tax advisors the third grouping represented consumers who were somewhat willing to accept risk but less willing to invest assets. this group relied on tax advisors for their planning needs. while tax advisors face no direct competition within the segment, they attracted a smaller customer base. future profitability for this segment can be attained by attracting and retaining the stage three customer base. near and intermediate term profitability is primarily from households in stages five and six. summary competitive consideration are suggested by the three grouping of financial service providers (as shown in figure 1). although there are other factors which can influence the choice of an advisor, risklliquidity attitudes are dominant motivations. bankers and lawyers tended to attract, within a certain range (stage 8), clients with similar risklliquidity attitudes. within this stage, the two providers tended to be in greater direct competition. while tax advisors, brokers and accountants each attracted consumers willing to accept risk, the clients of tax advisors preferred a more liquid position. though their customers are likely to use multiple sources for fmancial services. tax advisors have a customer base most capable of delivering near, intermediate and future profitability. brokers and accountants appeared to be in more direct competition for clients. however, households selecting accountants as advisors tended to use no other source of planning advice. broker users, in contrast, were much more likely to use multiple sources for planning advice. managerial implications this study has numeroud implications for the strategies of financial service providers. in broad terms the implications concern both the competitive marketing of fmancial planning services and products and the strategy for building near, intermediate, and longterm profitability. 84 journal of business strategies vol. 7, no.2 since the future, intermediate, and current benefits groups have distinctly different risk! liquidity profiles, it may be not be cost effective for fmancial planners to target their services to all households in all three groupings. instead, establishing a firm relationship with households within their particular strategic niche and offering some products and services to key households in neighboring groupings offers a better opportunity for longterm growth and profitability. after first establishing a strong base in the grouping it dominates, a financial services provider can develop a secondary strength among customers outside its major competitive area. areas for possible future research the fmancial planning market continues to be affected by numerous changes in both the economic and the financial environment. further research into the household life cycle profiles (that would identify even more demographic and attitudinal variables) would help to further refme market segments for fmancial planners. additional clarification of the competitive differences facing financial service providers would greatly improve the successful strategic planning of service providers competing in this complex industry. references 1. blume, m e. and i. friend. "allocation of wealth to risky assets." journal of finance, vol. 30 (may, 1975), pp. 585-603. 2. dickinson, j. r. and e. kirzner. "priority patterns of acquisition of financial assets." journal of the academy of marketing science, vol. 14 (summer, 1986), pp. 43-49. 3. dominguez, l and a. l. page. "formulating a strategic portfolio of profitable retail market segments for commercial banks." journal of economics and business, vol. 36 (1984), pp. 189-206. 4. ferber, r. and n. francesco. "newly married couples and their asset accumulation decisions," in stumples, morgan and zahn (eds.), human behavior in economic affairs. san francisco: josey-bass (1972), pp. 161-187. 5. ferber, r. and l. c. lee. "husband-wife influence in family purchasing behavior." journal of consumer research, vol. 1 (june, 1974), pp. 43-50. 6. hass, r. w. and l. l. berry. "systems selling of retail services." bank marketing (july, 1972), pp. 23-27. 7. lansing, 1. b. and j. n. morgan. "consumer finances over the life cycle." in clark ed., the life cycle and consumer behavior new york: new york university press (1955). 8. lansing, j. b. and l. kish. "family life cycle as an independent variable." american sociological review, vol. 22 (october, 1957), pp. 512-519. fall 1990 haynes, riley & helms: strategic planning 85 9. leavitt, t. "marketing myopie." harvard business review (july-august 1960). retrospective commentary published in harvard business review (september-october 1975). 10. murphy, p. e. and w. a staples. "a modernized family life cycle." journal of consumer research, vol. 6 (june, 1972), pp. 12-22. 11. sas institute inc. sas users guide: statistics. version 5 edition. cary, n.c.: sas institure inc. (1985), pp. 171-253. 12. stafford, e. f., kasulis j. j. and r. f. lusch. "consumer behavior in accumulating household financial assets." journal of business research, vol. 10 (1982), pp. 397-417. 13. stanley, t., moschis, g., and w. danko. "financial service segments: the seven roles of the affluent market." journal of advertising research, vol. 27, (august/september, 1987), pp. 52-67. 14. "survey of consumer finances." board of governors of the federal reserve system, washington, d.c. see also avery, elliehausen and canner, "survey of consumer finances, 1983." federal reserve bulletin (september, 1984), pp. 679-692. 15. townsend, b., and m. f. riche. "two paychecks and seven lifestyles." american demographics (august 1987), pp. 24-29. 16. wells, w. d. and g. gubar. "life cycle concept in marketing research." journal of marketing research, vol. 3 (november, 1966), pp. 355-363. 17. "who consumers look to for financial advice." journal of accountancy (january, 1988), p.24. 18. youman, n. "main street teaches wall street a lesson." adweek's marketing week, vol. 17 (may 30, 1988), pp. 20-21; 24. strategic planning for financial service providers: a family life cycle profile of competitive market segments multiple business goals and multfille business !nslruments: the application of tile theory of macroeconomic policy to business decisions beheruz n. sethna larry allen dee wellan lamar university beaumont. texas introduction a manager is often called upon to make decisions regarding the allocation of scarce resources between two or more business, management, or marketing instruments in order to be able to achieve a certain goal. the analysis of such a problem is not new to business. however, when there is more than one goal to be achieved, each of which is dependent upon a set of business, management, or marketing instruments, the problem is much more complex. the purposes of this paper are to: • analyze the situation of multiple business instruments being used to achieve multiple business goals, using selected principles of macroeconomics, • to present recommendations for the use of such instruments that suggest that instruments with comparative advantage should be selected to achieve each goal, and • to illustrate how violation of the principles presented in the paper might lead to undesirable results. the theory of economic policy may effectively be used to understand and help resolve such problems without restricting the form of the function as multivariate statistical methods usually require. an additional advantage is that it provides a dynamic analysis rather than a comparative-static one. the present work is essentially an application to business or management, of the theory of macroeconomic policy in a multiple goal, multiple instrument setting. tmbergen [7], a pioneer of economic policy in a multiple goal and instrument context, developed the tinbergen principle, which states that the number of policy instruments must be equal to the number of goals if all the goals are to be achieved. this applies in the context of a fixed target value for each goal, as is common in business the first author wishes to acknowledge the assistance of dr. sonmez atesoglu, professor of economics at oarkson univesrity, in the early stages of the paper. spring 1991 sethna, allen & wellan: multiple business goals 53 practice. if the decision-maker can make a trade"-off between goals. then the instruments are only required to be less than or equal to the number of goals. this is the case of variable targets. as discussed by tinbergen [6] and by theil [5]. the variable targets approach requires the policy maker to be able to specify a continuous trade-off function qike the utility function) between the two goals. although some trade-off is possible between goals, such a "utility function" is difficult (at best) to specify in management practice. it is much more probable that a manager is required to meet specific fixed target values in particular target or goal areas, such as profit ($x per unit), market share (y%), etc. consequently, the fixed targets approach is more applied even in actual economic policy issues. for the above reasons, it is the fixed targets situation that is analyzed in this paper. a major application of the fixed targets approach was presented by mundell [3, pp. 70-77]. mundell's principle of effective market classification states that policy instruments should be aimed at the goals on which they have the greatest influence, or in other words, the greatest comparative advantage. in his review of mundell's analysis of this principle in the context of the use of monetary and fiscal policy (two instruments) to achieve internal and external economic equilibrium (two goals), makin has observed that, while mundell's basic principle seems reasonable enough, "it is not immediately obvious that its violation can lead to rather disastrous results [2, pp. 460-461]." the current work makes use of the fact that there are different effects on goals of the various business instruments controlled by a manager. such effects were found by stowsand and wenzel [4, pp. 243-257] in eight different product groups. also, cronin and skinner [1, pp. 9-22] found that several business instruments (roa, liquidity, leverage, etc.) had different effects on business outcomes (profitability, [mancial structure, and marketing outcomes). in this paper, the above analysis of macroeconomic policy will be applied in a business context to assist in dynamic analysis of the problem of multiple business goals and multiple business instruments. the conclusions of the analysis will be shown to be consistent with good business practice. it will also be demonstrated how failure to conform to the derived guidelines may lead to "disastrous" results. analysis consider the case of a brand for which the manager must determine the appropriate business strategy. there are many instruments of strategy available to the manager, and any or all of the elements of the marketing mix may be used to achieve a particular target or goal. in deciding the business plan for the brand, the manager may allocate resources between the instruments he or she controls, depending upon their relative effect on the brand. such an analysis of effects, whether intuitively done or based on multivariate analysis, is not new to the field of business. however, when two or more (sometimes conoicting) targets have to be met, the problem is much more complex. it is this problem that is analyzed here. 54 journal of business strategies for the purpose of this analysis, consider two instruments: 1. unit price (p) of the brand, 2. advertising expenditure (a) per sales period. vol. 8, no.1 only two business instruments have been chosen for convenience of illustration. the mathematical analysis is generalizable and may be extended to any number of instruments. any or all of the instruments that a manager controls, including the elements of the marketing mix, may be used. in this paper, the analysis is concerned with the meeting of two goals: 1. per unit profit (c), 2. share of market (at the end of the sales period) (m). these two target areas have been chosen because of their importance and the frequency of their occurrence in business practice; and because they often require conflicting inputs, which makes the problem more interesting. as in the case of the instruments, the analysis is generalizable and may be extended to any number of targets. note that the design is consistent with the tinbergen principle which states that where there are fixed target values for policy goals, the number of policy instruments must be equal to the number of goals if all the goals are to be obtained. suppose that a target profit per unit for the brand is set at c* (dollars) and that the desired market share is targeted at m*. these targets may be determined at any level of the company. for example, the target profit, c* may be $1 per unit for a relatively low-price, high-frequency consumer purchase item; and the target market share m* may be 10%. these figures are only illustrations and would be vastly different for industrial goods or other products. each of the two target areas are affected by the two business instruments mentioned above. these may be expressed in a completely general form as: c = f(p,a) (1) or, in other words, per unit profit is some qinear or non-linear) function of unit price and advertising expenditure and m = f(p,a) (2) or, in other words, market share is some (linear or non-linear) function of unit price and advertising expenditure. spring 1991 where: sethna, allen & wellan: multiple business goals c = per unit profit m = market share p = unit price a = advertising expenditure 55 further, it appears reasonable to assume that, for many products; as price increases, with other variables being held constant (ceteris paribus): • per unit profit increases, at least in the short term, because more money is available for the bottom line. (3) • market share decreases, since customers buy less of that brand and more of competing brands or products. this is the case of the classic downward-sloping demand curve, often (though not always) found in practice. (4) as advertising expenditure increases with other variables being held constant: • per unit profit decreases, since less money is available for the bottom line (5) • market share increases (assuming that the advertising is any good) because more people are made aware of the brand, acquire more knowledge of the brand, and perhaps are persuaded to buy the brand. (6) expressions (1) through (6) are quite acceptable intuitively and have been found to be substantiated by numerous academic and corporate findings. they are working assumptions only; violation of these will not invalidate the procedure (although the results will be modified accordingly). we use the notation ma to denote the incremental change in market share (m) resulting from a unitary change in advertising, with all other variables remaining constant. graphically, it may be thought of as the slope of the market share (m) line with respect to advertising expenditure (a). (for those readers more comfortable with calculus, ma is the partial derivative of m with respect to a, 6m/fia) similarly, we use the notation mp to denote the incremental change in market share (m) resulting from a unitary change in price, with all other variables remaining constant). graphically, it may be thought of as the slope of the market share (m) line with respect to price (p). (mp is the partial derivative of m with respect to p, 6m/6p.) in business practice, the usual way of determining the incremental effect of one variable upon another is to do an empirically-based analysis. for example, a regression analysis may be done with market share (m) as the dependent variable, and advertising expenditure (a) and price (p) as the independent variables. then, the regression coefficients for a and p represent ma and m~ respectively, because they represent the incremental change in m resulting from incremental changes in a and p respectively, with the other variable being held constant. 56 journal of business strategies vol. 8, no.1 we can then rephrase expressions (3) through (6), using the above notation for the sake of brevity: as price increases, profit increa~s, so as price increases, market share decreases, so as advertising increases, profit decreases, so as advertising increases, market share increases, so (7) (8) (9) (10) given that both business instruments (price, p, and advertising, a) affect goals (per unit profit, c, and market share, m), we can find various combinations of p and a that can achieve together levels of c and m. for example, if our targeted market share is m* or 10%, it may be that a price of $5 per unit and advertising expenditure of $40,000 per year may achieve this target now if we increase the price to $6, market share may be in danger of dropping below the desired 10% level. however, by increasing the advertising level to say, $45,000 per year, (perhaps singing the praises of an upscale brand) the manager may be able to avert any decline of market share, leaving m at the desired 10% level. so, we now have two combinations of p and a that lead to the desired market share, m* or 10%: these are (p=$5 and a=$40,ooo) and (p=$6 and a=$45,ooo). similarly, several other combinations of p and a may be found; for example (p=$6.50 and a=$55,ooo), (p=$4 and a=$30,ooo), etc. may also result ia a market share of 10%. note that, as we increase price, we must increase advertising (and vice versa) to remain at the desired level of market share. this is a result of the basic relationships discussed in expressions (3) (6); the numbers, however, are for illustrative purposes only. the verbal arguments in the preceding paragraph lead to the generalizable result that several combinations of p and a may be found, that lead to the targeted value, m*, of market share. these combinations of p and a may be found experimentally or mathematically (by use of the calculus) once expressions (1) and (2) are empirically determined. for example, regression analysis on corporate data with market share as the dependent variable and price and advertising expenditure as independent variables is one way of empirically determining expression (2): m = f(p,a). in a similar vein, different combinations or trade-offs between p and a can lead to the desired per unit profit, c*. for example, if a price of $4.50 and advertising of $38,000 per year achieve the desired per unit profit of $1, we may be able to retain that $1 profit per unit by simultaneously increasing the price to $5.00 and increasing the advertising to $40,000. note that, as in the analysis of market share, an increase of price must be combined with an increase in advertising (and vice versa) to preserve the targeted per unit profit c*. figure 1 shows two lines: c=c* and represents the combination of p and a that lead to the targeted per unit profit of c*, and m=m* represent the combinations of p and a that yield the targeted market share of m*. note that both lines slope upwards; this is consistent with the conclusions of the precffiidg paragraphs that showed that, to preserve the targeted levels of c* and m*, if we increase p we must increase a, and vice versa. spring 1991 sethna, allen & welian: multiple business goals figure 1 57 case 1: assumes comparative advantage for advertising in affecting market share and for price in affecting profit m=m* region ill c<c* m>m* t price c>c* m<m* region iv region i c>c* m>m* region n advertising --..,. figure 1 is drawn such that the slope of the m=m* line is greater than the slope of the c=c· line. this is a representation of comparative advantage for advertising in affecting market share and for price in affecting profit. that is, market share is more sensitive to advertising expenditure changes than to price changes. the justification for the preceding statement is not immediately obvious and may be provided by a mathematical justification using differential calculus or by using graphical and verbal arguments. the latter approach is favored here and is described in the following paragraphs. if advertising expenditure has a relatively large effect on market share (m) and price has a small effect on m, we might expect the following to occur. as an example, let us start with one of the points of the m=m* line: let us say that the targeted market share of 10% is achieved when price (p) = $5 per unit and advertising (a) = $40,000 per year. now, if we increase the price to $6 (a 20% increase), that would, ceteris paribus, lead to a loss of customers because of the downward-sloping demand curve. to prevent this from occurring, we increase advertising. if advertising has a large 58 journal of business strategies vol. 8, no.1 relative effect on market share, we may need to increase advertising only by, say, $1,000 (a 2.5% increase; this high impact of advertising is exaggerated for illustration). so to move from one point on the m=m* line to another point, we have a relatively large movement on the p (price) dimension for a relatively small movement on the a (advertising) dimension. this corresponds to the relatively steep slope of the m=m* line in figure 1. further, if price has a relatively large effect on per unit profit (c) and advertising a relatively small effect or c, we might expect the following scenario. as an illustration, we consider one of the points on the c:c* line: price (p) = $4.50 and advertising (a) = $35,000 per year. now, if price has a relatively large effect on profit (because of the product's cost structure), and we increase price to $5 (approximately an 11% increase), we may be able to remain at our desired profit level even in spite of a relatively large increase in advertising, say, by $7,000 (a 20% increase). so, to move from one point on the c:c* line to another, we have a small increase in p accompanied by a large increase in a this shows up as a low slope for the c:c* line in figure l. figure 1, then, represents a case where advertising has a high effect (relative to price) on market share, and price has a high effect (relative to advertising) on per unit profit. this is the case of comparative advantage for advertising in affecting market share and for price in affecting per unit profit. the reverse case will be discussed later (figure 2). figure 1 may be divided into four regions formed by the intersection of the m=m* and c:c* lines. these are labeled regions i, ii, iii, and n. for any value of advertising, a point above the c:c* line represents a higher price than the one that achieves the desired per unit profit; it therefore represents a profit higher than c* (since, as price increases, ceteris paribus, so does per unit profit). so all points above the line c:c* represent values of c which are greater than c*. hence, regions i and ii are labelled as c>c*. correspondingly, points below the line c:c* (regions ill and iv) are labelled as c<c*. in a similar manner, for any value of price, note that points to the right of the line m=m* represent values of advertising which is greater than the value necessary to achieve targeted market share, m*. since, ceteris paribus, as advertising increases, market share increases, values of market share to the right of the line m=m* represent market share values greater than m*. so, regions ii and ill are labelled as m>m*. correspondingly, regions i and iv are labelled as m<m*. each of the four regions bounded by the lines c:c* and m=m* may be classified as c>c* or c<c*, and m>m* or m<m*. three of these regions (i, ill, and iv) represent a strategy problem for the manager, because one or both of the target areas falls short of the target. for example, in region i, though profit is greater than the target (c>c*), market share is less than the target (m<m*). an attempt to bring the "deficient" area on target may cause the other one to fall short of the target, because of the nature of the business problem chosen for study, since what is good for market share may be bad for per unit profit and vice versa. spring 1991 sethna, allen & wellan: multiple business goals 59 according to the ymbergen principle, since the manager has two targets, c* and m*, and two business instruments, p and a, under his or her control, it is possible to achieve both targets simultaneously (assuming reasonable targets). however, according to mundell's principle of effective market classification, this simultaneous achievement (overall equilibrium), though possible, need not necessarily be achieved unless his principle is followed. mundell's principle, repeated here for convenience, states that instruments should be aimed at target areas on which they have the maximum influence or comparative advantage. though this principle seems intuitively quite obvious, it is not as obvious that violation of the principle may lead to disastrous results. these points are illustrated below in the context of figure 1, using a dynamic business analysis. if, for example, the manager faces a situation where both, per unit profit and market share, fall below the targeted values (region iv, indicated by c < c*, m<m*), a dilemma exists. the need for higher (per unit) profit implies cutting back on business inputs (decrease advertising and increase price), whereas the need for higher market share implies allocating more funds into business inputs (increase advertising and decrease price). according to ymbergen's principle (according to business understanding as well), a judicious combination of pricing and advertising policies can be found so that both targets may be achieved (assuming realistic targets), i.e. the combination of p and a corresponding to point q in figure 1. a comparative-static analysis would be content to state that the use of the two instruments can move the brand from any other point to q. such an analysis tells the manager where to go (to q). a regression analysis, or other quantitative tools in an empirical study, may show the "correcf' slopes or signs on the coefficients (cp > 0, ca < 0, mp < 0, ma > 0, as described expressions (7) (10», which implies that either instrument may be used to achieve either goal. however, this approach may lead to potentially disastrous results, as the following analysis will show. as mentioned earlier, ca is the notation used to denote the incremental change in profit from a unitary change in advertising, with all other variables remaining constant. it may be thought of as the slope of the per unit profit (c) line with respect to advertising expenditure (a). alternatively, it is the partial derivative of c with respect to a let us assume that, as stated in expression (9), we find that ca < °based on an empirical study. this coefficient implies that, ceteris paribus, we expect a decrease in c if a increases, and vice versa. in figure 1, consider point w where c < c* and m < m*. if the principle of effective market classification is violated or ignored, very undesirable results may result. in order to increase per unit profit, advertising is cut back to a level corresponding to v which, in fact, decreases market share. in order to increase market share, price is decreased (since the empirical study showed the commonly-found result of mp < 0), moving the brand further away from the desired target. here, it does not matter which comes first the advertising cut-back or the price decrease; the result is not an expected or desirable one, in spite of the above (intrinsically sound) business strategies. 60 journal ofbusiness strategies vol. 8, no.1 let us now consider using mundell's principle, which is concerned with the dynamic analysis-the method to be followed to achieve the targets. since price has the comparative advantage in affecting ~ mundell's principle would suggest increasing price to that corresponding to x where c=c*. since advertising has the comparative advantage in influencing m, the principle would suggest that advertising be increased to that corresponding to y (m=m*) so that the brand may be moved from x to y in a similar fashion, by price and advertising increases, the brand can move towards q and so achieve both targets. there is no theoretical significance to starting with a price increase. in a given business situation, it may be more appropriate to start with an increase in advertising input. it must be emphasized that these results occur because of the relative comparative advantages of price and advertising in affecting the two target areas (profit and market share) represented by the relative slopes of the two lines, c=c* and m=m*, in figure 1. the opposite case would arise if the comparative advantages were reversed. this is discussed in case 2, which follows. fjgure 2 case 2: assumes comparative advantage for advertising in affecting profit and for price in affecting market share c=c* t pri c>c*m<m* region iv region i c>c* m>m* advertising --~ region n region ill figure 2 is divided into four regions, bounded by the lines c=c* and m=m*, respectively. each one of these regions (except for region ~ in which c > c*, m > m*) spring 1991 sethna, allen & wellan: multiple business goals 61 represents a strategy problem because at least one target is not met. consider, for example, the dilemma faced by the manager in region it represented by c<c*, m<m* (case 1). figure 2 is similar to figure 1, except for the relative slopes of the c=c* and m=m* lines. figure 2 assumes a comparative advantage for price in affecting market share and for advertising in affecting profit. this is the opposite case to case 1 (and figure 1). as in case 1, mundell's principle of comparative advantage is used to suggest a dynamic analysis to achieve both targets simultaneously. since price has the comparative advantage in influencing market share, and advertising in affecting profit, the principle would suggest using appropriate price decreases (to increase m) combined with appropriate advertising cuts (to increase q so as to move the brand along the path w x y z, and so on until the targets are met (approached) at point q. (as in case 1, an advertising cut-back may precede the price decrease.) if, however, mundell's principle is violated, the result will be disastrous. if, at the starting point, w, the manager only looks for the "correct" signs on the coefficients of price (cp > 0) and advertising (ma > 0), without considering comparative advantage, the advertising input may be increased (in an attempt to increase market share) to a level corresponding to \l, then price may be increased (in an attempt to increase profit), moving the brand further and further away from the targets. business implications and potential applications 1\vo cases were considered in the above analysis: one case in which advertising has the comparative advantage in affecting market share, and the other case in which its comparative advantage is in affecting profit. in fact, they may be taken as being instances of an entire spectrum of cases ranging from an extreme situation where the market share is inelastic to price, and dominated by advertising and other marketing inputs; to the other extreme in which price is the all important instrument in affecting market share. case 1 assumed that market share was "dominated': (to a greater or lesser extent) by advertising effects and price was the less dominant influence. such cases are very common in business practice. this is the case of the premium product (as seen from a product portfolio viewpoint), or the case of a quality product in a price-insensitive market (viewed as segmentation analysis), or the case of the image building task (at initial stage(s) in the product life=eycle), etc. the above examples (in parentheses) are intended only as instances of potential marketing applications. the theoretical analysis showed that the appropriate business strategy, if profit and market share targets are not met, is to increase advertising and price in the indicated manner. this is consistent with business judgment. case 2 is representative of the situation in which price has the dominant effect on market share and advertising has relatively little influence. the business applications 62 journal of business strategies vol. 8, no.1 of this case are opposite to the ones mentioned above: the standardized product or market, or a product in the later stage(s) of the life-cycle. the theoretical analysis indicated that the appropriate strategy, if targets were not met, would be decrease price and advertising as shown in figure 2. this, too, is consistent with business judgment. the analysis provides a rigorous theoretical base to some commonly held business beliefs. although the analysis is a general one, it is not any less pragmatic for that reason. the only parameters required for analysis of a specific brand in a particular market are the partial derivatives, (cp, ca, mp, and m,j in the cases discussed above. these parameters may be empirically obtained in a given situation. one method for obtaining them is to use the regression coefficients of a regression analysis with market share as the dependent variable, for example, and price and advertising (lagged, if appropriate) as the independent variables. as shown by stowsand and wenzel [5, p. 254] in their study of eight different product groups, and cronin and skinner [1, pp. 14-17] in their study of the different effects of several business instruments (roa, liquidity, leverage, etc.) on business outcomes (profitability, financial structure, and marketing outcomes), different instrument coefficients are obtained that show differing effects on business goals. the current paper provides a normative case for the appropriate use of such analyses. some conclusions of the analysis which would not have been immediately obvious without the benefit of this theory are described below: (a) the fact that the slopes or regression coefficients, cp, ca, mp, and ma , are found to be of the appropriate sign in an empirical study (cp > 0, ca < 0, mp < 0, ma > 0) is !lq indication that either instrument should be used to achieve a particular target. for instance, the analysis indicates that, even if price increases have a positive effect on profit and a negative effect on market share, as expected, it should not be used as a business instrument to affect market share unless it has the comparative advantage. (b) violation of the principle of effective market classification leads to disastrous consequences. to continue with the example mentioned in (a) above, if price is used as an instrument to change market share, the brand will move further away from its targets, unless it has the comparative advantage. based on the findings of this paper, it is recommended that a manager develop an understanding of the relative strength or comparative advantage of the instruments at his or her command. one method for doing this is through regression analysis, where the regression coefficients are indicators of the relative strength. other quantitative or accounting data may also help determine such relationships and effects. it no historical data is available, the manager may consider a judgemental analysis based on other similar products inside or outside the company. it is further recommended that the manager use the instrument that has the comparative advantage to achieve each of the goals. spring 1991 sethna, allen & wellan: multiple business goals summary and conclusions 63 the approach in this paper analyzes the problem of multiple goals and: multiple instruments in the business context and provides a rigorous theoretical base for some business strategies; it presents recommendations for the use of such instruments that suggest that instruments with comparative advantage should be selected to achieve each goal; and it illustrates how violation of the principles presented in the paper might lead to undesirable results. the conclusions of the theoretical analysis are shown to be consistent with business judgment. also shown are some conclusions of the theory which are not immediately obvious, and dangers of violation of the theoretical principles. the analysis presented in this paper uses a dynamic approach rather than a comparative-static one. in this respect, it adds an additional dimension to the solution of such business problems. this analysis is made possible by incorporating theories of macroeconomic policy into business framework. the resulting expansion of the boundaries of knowledge and integration of two fields (macroeconomics applied to the strategy of the firm) may well be contributions of this paper. the procedure described in this paper is a general one and may be applied to a number of corporate or social goals. references 1. cronin, u., jr. and skinner, sj. "marketing outcomes, financial conditions, and retail profit performance." journal of retailing. vol. 60, no.4 (1984) pp. 9-22. 2. makin, j.h. macroeconomics. hinsdale, il.: the dryden press (1975), pp. 460-461. 3. mundell, r.a. "the appropriate use of monetary and fiscal policy for internal and external stability." international monetary fund, staff papers, vol. 55, no. 3 (march 1962), pp. 401-415. 4. stowsand, h. and wenzel, w. "market mechanics: a study to measure the effect of marketing instruments on the market position of fast-moving consumer goods." journal of business research, vol. 7, no.3 (1979), pp. 243-257. 5. theil, h. optimal decision rules for government and industry. amsterdam: north holland (1964). 6. tinbergen, j. centralization and decentralization in economic policy. amsterdam: north holland (1954). 7. tinbergen, j. on the theory of economic policy. amsterdam: north holland (1951). multiple business goals and multiple business instruments: the application of the theory of macroeconomic policy to business decisions the new math for productivity: opportunity cost, revisited donald shadoan robert sharp eastern kentucky university richmond, kentucky economists frequently state that opportunity costs are the only relevant costs one should use when making resource allocation decisions. however, a significant neglect or, at the minimum, an incomplete application of the opportunity cost concept to decision making is frequently observed. the basic thesis of this paper is that the efficiency of allocating resources could be significantly improved if somehow decision makers could be made more aware of the relevance of this concept. economic historians generally give friedrich von wieser, a professor of economics at the university of prague, credit for initially developing the economic cost concept in his 1889 work, natural value [4]. professor von wieser pointed out that production not only creates value, but also destroys value in the process by using resources that could have been used to produce other goods. professor von wieser concluded that the potential value of all "cognate" products must, therefore be included as a cost of production when allocating economic factors of production ([4], p. 6). current day economists generally define opportunity cost as the value of the resource in its next best use. joel dean emphasized the distinction between opportunity costs and the accountants' outlay costs. dean stated, "in business problems the message of opportunity costs is that it is dangerous to confine cost knowledge to what the firm is doing. what the firm is not doing but could do is frequently the critical cost consideration which it is perilous but easy to ignore" ([1], p. 260). unfortunately, too many decision makers have been ignoring the risk implied by dean by failing to consider what the firm could do. failure to use opportunity cost ira magaziner and robert reich identify current accounting systems as one of the underlying causes of failing to properly use the opportunity cost concept ([2], p. 191). they imply that accounting systems are more concerned with maintaining cost control and keeping financial records for tax purposes rather than developing information for efficient decision making. it is also likely that efforts to objectively quantify costs have distracted decision makers from considering the relevant costs. in effect, there are no precise sets of objective costs that are germane to business firms or other decision makers. therefore, to assist in making efficient decisions, managers must become more familiar with the subjective processes associated with the opportunity cost journal of business strategies, volume 6, number 1 (spring 1989) 75 76 journal of business strategies vol. 6, no.1 concept and accept the responsibility for making informed determinations. failure to do this is tantamount to denying the existence of implicit costs. a special report in the june 6, 1988, issue of business week magazine, entitled the productivity paradox, dealt with many of the competitive and productivity problems existing in u. s. industry. the articles pointed out many paradoxes. while the text suggested a need to have the managerial skills to deal with these problems, not once did it explicitly refer to the opportunity cost concept. the failure of a major business publication to explicitly recognize the relevance of opportunity cost suggests that there is a dire need for resurrecting this concept. the new math? port, et ai., suggests that answers to many of the paradoxes of productivity may have been found by a "handful of companies that have developed a new math for productivity" ([3], p. 101). a careful examination of the "new math" reflects dean's message: what the firm is not doing, but could do, is frequently the critical cost. a review of the entire special issue of business week convincingly suggests the need for decision makers to become more accustomed to using the opportunity cost concept. decision makers can be trained to artfully use this concept by constantly asking, "what do i give up to employ a resource in this manner?," or conversely, "what must be foregone by not taking a particular course of action?" many of the so-called indices of efficiency or control used by business firms ignore these questions and therefore frequently lead to decisions based on irrelevant costs.! fortuitous use of opportunity cost the following two examples of decision making reported in the business week issue under, "how the new math of productivity adds up," correctly, although unknowingly, apply the opportunity cost concept. they also exemplify dean's message to consider the costs of not taking a particular action in addition to what the firm gives up to take a particular course of action [1]. cone drive operations, inc. was experiencing eroding profits, increasing inventory costs and late deliveries of gears. it was reported that switching to a computer integrated management system costing $2 million could not be justified for a company with sales of $26 million. it was later determined that the company made the correct decision of switching when viewed with respect to the cost of not taking the action. with the switch came an increase in business (partially brought about be on-time deliveries), a sixty percent reduction in required inventories, and a sizable reduction in the time required to handle special orders and new products ([3], p. 103). when cone management looked at the opportunity cost of not modernizing they had to subjectively evaluate such intangibles as better quality, greater flexibility, faster time 1 an ironic twist may be pointed out at this juncture: managers are often evaluated on their conformance to these irrelevant cost structuresj they continue to perform in this inconsistent manner only because the opportunity cost of not complying to these standards is high. spring 1989 shadoan (3 sharp: opportunity cost 77 to market, and greater customer satisfaction. apparently management correctly concluded that the opportunity cost of not modernizing was too high. in reality, failure to consider modernization would have reduced the efficiency of the firm. the correct application of the opportunity cost concept must consider the business gaim from an investment as well as any savings associated with the investment decision. in the second example, the financial staff of rockwell turned down an investment proposal in 1982, involved with spending $80,000 to buy a laser to etch contract numbers on communications systems sold to the pentagon. the rejection decision was based on the estimate that savings in direct labor costs would amount to only $4,000 per year. three years later, the project was approved when it was pointed out that an additional $200,000 per year could be saved in inventory hoi ding costs ([31, p. 104). it is obvious that those initially presenting the project did not ask the critical question of what the cost would be of not making the investment. traditionally, many firms have concentrated their evaluation of investment projects with respect to savings in labor cost. instead, they possibly should have been concerned with the evaluation of all costs encountered if the investment was not made. conclusions if resources are to be allocated efficiently, decision makers must be cognizant of the opportunity cost concept and be willing and able to develop estimates of this cost. this is tantamount to saying that a greater effort must be made to develop data for the sole purpose of decision making, rather than trying to use the traditional accounting data usually associated with the financial history of the firm. it appears that our management training programs, as well as our business publications, have been remiss in teaching decision makers a concept that is approximately 100 years old the "new math" is simply the neglected concept of opportunity cost. the need to develop objective data for control and tax purposes may serve as an impediment to the analysis of data necessary to estimate the opportunity costs of various decisions. the development of quantitatively-accurate computer applications may have been partially responsible for mangers attempting to make decisions based on objective data. however, although estimates of opportunity costs may be imprecise or non-objective, managers cannot be excused for ignoring applications of the concept the costs are too high! references 1. dean, joel. managerial economics. englewood cliffs, nj: prentice-hall (1965), pp. 258-260. 2. magaziner, ira c. and robert b. reich. minding america's business. new york, ny: harcourt, brace, and jovanovich (1982). 3. port, otis, resa king, and william j. hamptom. "the productivity paradox." business week, june 6, 1988, pp. 100-112. 4. von wieser, friedrich. natural value. new york, ny: kelly and millman (1956). the new math for productivity: opportunity cost, revisited budgeting: a str.ategic manager.ial tool elizabeth m. king wayne norvell dan deines college of business administration kansas state university manhattan, kansas the industrial revolution in the united states greatly accelerated the need for human influence over future economic activity. lndustrial development resulted in heavy industry accompanied by division of labor tasks and assembly line production. this complex development in our industrial society made budgetary procedures necessary for fadory planning. the first business budgets were adopted for the purpose of limiting expenditures (113], p. 44). many business managers began by budgeting expenses they considered discretionary, such as advertising, research, and capital expenditures. recognizing that production scheduling and control also depended on detailed preparation, frederick taylor attempted to adapt current industrial operations by applying scientific management methods to questions of "task management" ([2], p. 195). taylor believed that budgeting a1forded a means of placing responsibility and measuring performance, rather than simply limiting expenditures. the budgeting task involved balancing needs and resources in order to reach specified objectives with a minimum expenditure. eventually, business budgeting went further in asserting that this was done best wben annual and long-term plans were coordinated, and when goal-setting and program analysis were based on an ordered sequence of analytical steps. budgeting, today, implies a two-step approach to events (1) the planning process and (2) the control function. this paper examines the role of budgeting in the planning and control process and its importance as a strategic managerial tool. it extends the current literature by introducing the concept of a budget support schedule into the budgeting process. the planning and control process strategic planning and control is a process of deciding on corporate objectives, on the resources to be used, on the policies to control the procurement and use of those resources, and on the means (strategies) of attaining those objectives ([.'i], p. 11). as illustrated in figure 1, a planning and control system consists of (1) formulating the journal of busines.• strategic .•, volume 5, number 2 (fall 1988) 69 70 journal of business strategies vol. 5, no.2 corporate objectives from which the (2) master plans (overall plans for implementing the corporate strategy) are developed. the business organizat,ion's strategic information system then provides (3) feedback on whether the strategy is being implemented as planned, and whether the strategy is yielding the desired results. after (4) comparing actual conditions with planned conditions, the controlling process (5) analyzes the differences and makes necessary changes. figure 1 model of planning and control process i corporate objecti~ej()rmul~tiofl-1 1) l m;;::'~~fl-beveiopment 1)_~;:---:-:-.l __irnpie~~pt~1.i()"n and results i 1) l_~ontrol!ing and evaluation -'i in making the strategic decisions that are foremost for str~tegic management and planning activities, three types of analysis are necessary: 1. values analysis a!l assessment of the values, interests, desires, and expectations of the groups most affected by organizational plans. 2. environmental analysisan evaluation of the current and future state of the general environment (economic, technological, societal, legal, and political) with the industrial environment (competition, market structure and concentration). 3. resource analysis an analysis of the level and quality of the personnel, technological, physical, and financial resources the organization can commit to the implementation of a strategy. the role of budgeting, as a strategic managerial tool, lies with resource analysis. it is crucial for management to know what resources must be committed to corporate objectives. the importance of budgeting to planning and control a budget is a formalized, financial plan setting forth management's intended actions and the anticipated effects those actions will have on key business variables such as sales, production, expenses, and cash flows ([6), p. 926). the two major functions of a budget are planning and control. first, budgeting requires the formulation of a thorough plan of operations for the budget period hence its name, "profit planning." in constructing the budget, management must obtain and analyze data relating to sueh aspects of future operations as full 1988 king, not'veil, and deines: budgeting 71 the prices, quantities, types, and availability of sources of financing [8j. the planning process begins with the establishment of the organization's goals, and budget planning must be in harmony with the long-run goals of the company as well as the short-run objectives such as target amounts of costs and income. organizational goals state the desired position of the firm in the future. since they are directional and motivational in nature, goals involve a continual process of change throughout time [ij. without planning, most complex organizational ventures could be prone to crisis. however, budget planning provides management with a view of the future that serves as an early warning system for those contemplated actions that might lead to unacceptable results. a comprehensively prepared budget that shows how planned activities can lead to an acceptable net income indicates that management has done what it should to plan, successful operations within its personnel, technological, physical, and financial frameworks. second, a budget may serve as a control. it contains criteria of cost performance which can be compared with actual data on operations, thus facilitating evaluations and enforcing some measure of efficiency. frequent comparisons of budgeted and actual operating data are believed to be sound operating procedures, and give cause for the application of "management by exception" principles which suggest that as long as operations conform with the budget, the activity is in control and no intervention is required [ioj. how are comprehensive budget planning and control related to the strategic functions of management'! the response requires consideration of the basic functions of lilanagement and the nature of the management process. fayol, a scholar and observer of the management process, stated that all activities of an industrial undertaking could be divided into six groups: 1. technical (production) 2. colilmercial (buying, selling, and exchange) 3. financial (search ior, and use of capital) 4. security (protenion of property and persons) 5. accounimg (including statistics) 6. managerial (planning, organization, command, control, and coordination) [7]. budget planning and control rests upon the conviction that management can plan and control the long-range destiny of the organization by making a continual stream of well-conceived decisions. the managerial decisions must be both purposive and futuristic [14]. by "purposive," it is meant that the stream of important managerial decisions must be primarily concerned with developing purpose in goals, and with devising realistic strategies to attain those goals. by "futuristic," it is meant that the important managerial decisions be fundamentally concerned with the long-range 72 journal of business strategies vol. 5, no.2 future as opposed to "spur-of-the-moment" decisions. the need for continuous interchange of plans, policies, and ideas, as well as for changes affecting them, is essential for demonstrating the implicit managerial self-confidence the firm must possess to achieve its goals. a budget, since it emphasizes goal congruence through realistic planning, dynamic control, and effective communication, establishes the basis for the harmony and unity needed for achieving managerial goals ([6], p. 926). budget preparation even though specific budgeting procedures vary widely among organizations, all business enterprises which are engaged in comprehensive budgeting efforts must consider the organization's budget committee and the master budget. an organization's budget committee generally consists of representatives from all major areas of the organization, such as sales, production, marketing, and finance, and is headed by the organization's controller. the committee is responsible for coordinating the preparation of the budget, initiating budget procedures, collecting and integrating data from various organizational units, supervising the review and modification of original estimates, and directing the implementation of the budget. when all organizational departments participate in formulating the budget, it is more likely to be accepted as a reasonable standard of performance [9]. the master budget is a comprebensive planning document that integrates all of the details for the various specialized activities of the firm [4j. it outlines the organization's plans for its operations and resources during a given period of time. it contains the data necessary to formulate projected financial statements for the budget period. the master budget is usually prepared in four parts: (1) the profit plan for operations, (2) the cash budget, (3) the projected statement of financial position, and (4) the capital expenditures budget ([3kp. 487). supporting schedules for operational and resource budgeting are highly recommended, and should present cost data in great detail, taking into account all dimensions of an organization's plan. budget support schedules are most effective if prepared by functional area: marketing, finance, production, etc. preparation in this manner will provide qualitative and quantitative support for a comprehensive planning document. figure 2 presents a model of a budget support schedule for the marketing function. note how the operations section identifies the overall goals of the division using both written descriptions of the goals and the dollar amounts expected to accomplish these goals. the resources section is a breakdown of the overall cost projections with written justification for each expenditure. importance as a strategic managerial tool the use of budgets for cost control and the evaluation of performance entails the preparation of periodic performance reports to measure effectiveness. such reports compare budgeted and actual data and show any existing variances. it is critical in today's highly competitive market to not only discover variances, but also to make adjustments that reduce waste and improve competitive ability. fall 1988 king, norvell, and deines: budgeting figure 2 model of budget support schedule support schedule for marketing budget 73 budget for: 19__ to 19__ description of budgeting activity: 1. operations a. marketing objectives --b. gross revenue objectives -------.-.-~--_:_;---.--~:_______c:___:_;______:_;~----___1 c. cost projections (quantitative response) 11. promotion 2. distribution 13. product ii. resources classification -expensespurposeof":exijendltllre 1. promotion --.---media advert. per. sell. 2. distribution warehouse transport. inv. control 3. ·······_·_--_·_·····1---product development packaging pricing .j. ---"----.j 74 journal of business strategies vol. 5, no.2 activity or workload measures are very commonly found in current program and performance budgets. an example would be 'number of sales calls made' or 'number of employees in a training program.' gnd result measures attempt to estimate outcomes that are as ultimate as possible. these measures can be expressed in any units that are appropriate. in order for the effectiveness of an activity level, workload level, or end result to be measured, a means of setting and assessing the appropriate criteria must be set. in the development and use of appropriate effectiveness measures the accounting function is of major significance. at the center of the goal process is the commitment of resources; at the center of the resource allocation process is the budget; and at the center of the budget is the accounting activity. goal development, resource allocation, budgeting, effectiveness measurement, and review of actual performance are all interdependent processes, each interacting with the other within the organizational environment ([11]' p. 316). summary and conclusions budgeting is a strategic managerial tool. as an integral component of the management process, budgeting offers an approach for managing future performance consistent with specified management responsibilities. the budget imposes a self-discipline on management to specify plans, to evaluate precisely their probable effects on the resource flows of the firm, and to measure and evaluate performance critically on a continuing basis. from an organizational viewpoint, the budget affords a means through which management can agree on a planned allocation of resources that will facilitate the achievement of organizational goals. in today's highly competitive market, effective budgeting is more critical than ever before as a strategic managerial tool. this is true for firms of all sizes, from the smallest to the largest. often, small entrepreneurs lack budgeting capabilities or awareness. this unfortunately has contributed to far too many companies failing to reach their potential or failing completely. for example, a company with a weak budgeting process may not anticipate a working capital shortfall and be faced with a liquidity crisis that could end its existence. there is certainly a need for the diffusion of the latest budgeting technology throughout the business world. references 1. caplan, edwin h. "behavioral assumptions of management accounting." the accounting review, vol. 41 (july, 1966), pp. 496-509. 2. chatfield, michael. a history of accounting thought. huntington, ny: robert e. krieger publishing co. (1977). 3. decoster, don t. and eldon l. schafer. management accounting: a decision emphasis. new york, ny: john wiley & sons, inc. (1982). fall 1988 king, norvell, and deines: budgeting 75 4. deverall, c. s. management planning and control. london: gee & co. (publishers) limited. (1967). 5. digman, lester. strategic management. plano, tx: business publication, inc. (1986). 6. dittrich, norman e., ernest i. hanson, and paul h. walgenbach. principles of accounting, second edition. new york, ny: harcourt brace jovanovich, inc. (1980). 7. fayol, h. general and industrial administration. london: sir issac pitman & sons, ltd. (1949). 8. finch, gerald l. "improving the bottom line." management accounting, vol. 69 (october, 1987), pp. 42-47. 9. jones, john w. and michael a. wright. "material burdening." management accounting, vol. 69 (august, 1987), pp. 27-31. 10. lewin, arie y. and michael schiff. "where traditional budgeting fails." financial executive, pp. 51-58 (may 1968). 11. livingstone, j. leslie. "organization goals and the budget process." abacus, vol. 11 (june, 1975), pp. 306-17. 12. novick, david. origin and history of business budgeting. santa monica, ca: rand publishing (1966). 13. theiss, edwin l. "the beginnings of budgeting." the accounting review, vol. 12 (january, 1937), p. 44. 14. welsch, glenn a. budgeting: profit planning and control. englewood cliffs, n.j.: prentice-hall, inc. (1976). budgeting: a strategic managerial tool 62 journal of business strategies reconfiguring dependencies through acquisitions: a resource dependency perspective rama krishna reddy indiana university south bend • south bend, indiana sung-jin park indiana university south bend • south bend, indiana abstract organizations are embedded within ecosystems and develop varying degrees of dependence based on the actors within their environment. in this study, we investigate the effects dependency has on firms that rely heavily on a few major customers for their revenue streams. we posit that an increase in dependence on a small number of consumers will have an adverse effect on firm performance (roa). furthermore, we assert that firms acquiring other firms in order to counteract these negative repercussions actually demonstrate an improvement in their performance. to test this hypothesis, we conducted an empirical analysis using 12,038 firm-year observations and our empirical results lend support to our predictions. keywords: mergers & acquisitions, performance, resource dependency introduction mergers and acquisitions (m&as) are one of the most popular forms of corporate expansion in the twenty-first century. despite the empirical evidence suggesting that m&as seldom create value for the buying firms’ (joshi, sanchez, & mudde, 2018; king, dalton, daily, & covin, 2004), m&as remain popular. academic research is yet to explain the driving force resulting in firms choosing m&as in spite of poor performance record. in this study, we explore the context of a buying firm’s resource dependency under which m&as are implemented and ask whether m&as indeed resolve the dependency, and thereby, improve the operating performance of the buying firm. specifically, this study focuses on a firm’s revenue dependency on a few significant customers and examine whether m&as can mitigate the dependence and eventually lead to a higher return on assets (roa) for the buying firm. to maintain a coherent perspective in the exploration, this study relies on the resource dependence theory (rdt) as a theoretical lens explaining m&a activity (hillman, withers, & collins, 2009). rdt argues that “to understand the behavior of an organization, you must understand the context of that behavior –that is, the volume 36, number 2 63 ecology of the organization.” (pfeffer & salancik, 1978:1). one such context is the supplier-customer relationship. this research posits that the heavy reliance for revenue generation on a few customers erodes the bargaining power of a supplier, which becomes a resource constraint affecting the organizational ability to function and survive (pfeffer & salancik, 1978). one generic strategic response to overcome the constraint is diversification of the market dependence through an acquisition. therefore, this study focuses on the buyer firm’s customer-base concentration and examines the temporal changes in its profitability during the periods before and after the m&as. to the extent that m&as can relax the revenue dependency to a concentrated customer-base, we predict the buyer firm’s operating performance will improve after the completion of m&as. in the empirical test, this study employs a sample of domestically conducted m&as by u.s. firms in high-tech industries between 2000 and 2013. using a sample of 12,038 u.s. firm-year observations, this research adopts a difference-indifference research design and examines the relationship between customer-base concentration and firm profitability and incremental changes of the association after the expansion of the buyer firm’s customer-base through m&as. the results first find that the customer-base concentration has a negative association with roa, suggesting that the revenue dependency disempower the supplier during the trade bargaining process, thereby leading to a lower roa. this finding is consistent with our prediction. also, the results find that the relationship between customer-base concentration and roa changes post-acquisition, suggesting that acquisitions can help relieve reconfigure the constraints of concentrated customer-base. we acknowledge that the documented temporal change in the relationship between customer concentration and roa surrounding m&a activities falls short of articulating the causal mechanism regarding the effect of customer concentration on roa (ellsaesser, tsang, and runde 2013). nevertheless, we explore the implication of revenue dependency on a firm’s operating performance and the change in the relationship between customer concentration and roa following m&as to offer an additional venue to apply rdt on m&a activities. with these findings, this study contributes to the understanding of the drivers of m&a activity and the resulting m&a performance. also, these results provide empirical support to some of the key propositions of rdt theory. 64 journal of business strategies literature review and hypothesis customer concentration and performance organizations are subjects of their external environments, which influences organizational behaviors (pfeffer & salancik, 1978) where entities within the organizational ecosystems establish a network of interdependencies among organizations and constrain them (hillman et al., 2009). specifically, the entities within the eco-system that control critical resources and have power over the focal organization and are of significant consequences for the dependent organization (ulrich & barney, 1984). typically, significant customers are the transacting partners that have an enduring impact on an organization’s ability to profit (reddy et al., 2018). given that twenty percent of customers contribute to eighty percent of revenues for most firms (luo & kumar, 2013; zeithaml, rust, & lemon, 2001), we can infer that buyers who contribute large portions of firm’s revenues may exhibit significant influence and constrain a firm’s ability to profit. such reliance on one or a few major customers for the bulk of revenues is known as customer concentration or customer-base concentration (patatoukas, 2012). existing evidence suggests that an increase in customer-base concentration can have an adverse impact on organizations in areas such as equity cost of capital (dhaliwal, judd, serfling, & shaikh, 2016) and contracting costs with lenders (campell & gao, 2017). saboo and colleagues (2017) report findings that corroborate with the evidence of adverse impact of an increase in customer-base concentration. they argue that with an increase in customer-base concentration, the bargaining power of buyers will increase while lowering the ability of the seller to negotiate, and thus effecting a selling firm’s profitability. demand for an extended credit period for payments and irregular purchases can further impact profitability when the buyers have the bargaining power (fee & thomas, 2004; kelly, lustig, & van nieuwerburgh, 2013). though research provides evidence in support of the claims that customerbase concentration will have an adverse impact on the selling firm’s profitability, some evidence does exist to support that increase in customer-base concentration will create efficiencies and will assist in lowering transaction costs, thereby resulting in an increase in productivity (ak & patatoukas, 2016). for instance, the concentrated customer-base of a supplier firm allows the supplier to hold less inventory and experience fewer inventory write-downs (ak & patatoukas, 2016). when a few customers generate the bulk of revenues, the supplier firm can afford volume 36, number 2 65 significant customer-specific investments that enhance its operational efficiency. the operational efficiency gained through inventory management could eventually promote a firm’s profitability (patatoukas, 2012). despite the efficiencies and the cost savings, the associated power the buyer gets from the increased dependence of the seller shifts bargaining power away from the selling firm (and more towards the buying firm). the coercive and exploitative behavior of buying firms when the buyer contributes to a significant portion of sellers’ revenues casts doubts on the use of the positive outcomes of customerbase concentration. based on the evidence, it is reasonable to argue that, despite an increase in the possibility to create efficiencies and cost savings, the shift in bargaining power due to the increase in the dependence for substantial revenues reduces the performance outcomes of the selling firm. hypothesis 1: a supplier firm’s customer-base concentration is inversely related to its operating performance absent from m&as. customer concentration and m&a activity organizations that are dependent on their environment often attempt to reduce or minimize their dependence on the external environment (pfeffer & salancik, 1978). organizations engage in m&as to reduce their interdependence with their suppliers or buyers (pfeffer, 1972), where reducing organizational dependencies is the central goal of managers in pursuing m&as (walter & barney, 1990; hillman et al., 2009). specifically, firms that are dependent on a few customers for a significant portion of revenues (customer concentration) resulting in constraints, subsequent risks, and poor performance, initiate m&a to overcome limitations originating from customer-base concentration. organizations that conduct m&as can recalibrate their dependencies and through the recalibration of dependences, organizations can overcome constraints which provides supplying organizations with an avenue to improve performance. therefore, the performance of organizations with concentrated-customerbase is dependent on the firm’s ability to initiate m&as to overcome constraints and recalibrate their dependencies. thus, we argue that m&a activity by a focal firm will moderate the relationship between customer-base concentration and the performance of the firm. hypothesis 2: m&a activity will moderate the relationship between a firm’s customer-base concentration and operating performance 66 journal of business strategies methodology & results sample and variable measurement a sample of high-tech industry firms from compustat between 2000 and 2013 was collected. while using francis and shipper (1999)’s method and defining high-tech industries based on three-digit sic codes, the acquisition data was obtained from thomson reuters’ sdc platinum dataset. to be included in the acquisition sample, it is required that (i) the acquirer is a u.s. public firm listed on the nyse, amex, or nasdaq; (ii) the acquisition is a significant event (at least 5% of the acquirer’s total market value); and (iii) the acquisition is not a crossborder transaction. in addition, serial acquirers (i.e., multiple acquisitions during our sample period) were removed to avoid confounding effects of prior acquisitions in our differences-in-differences test. after eliminating observations with missing information for the calculation of control variables, a sample of 12,038 observations were obtained for the test of acquisition likelihood. fasb accounting standard codification topic 280 (asc 280-10-50-42) requires a firm to disclose all major customers that account for 10 percent or more of its revenue. to estimate the measure of customer-base concentration, following prior studies (e.g., patatoukas 2012; dhaliwal et al. 2016) and calculating the herfindahlhirschman index of customer-specific sales revenue disclosed under asc 280: by construction, this concentration measure is influenced by the number of major customers and the relative importance of each major customer reflecting a firm’s diversification strategy related to its customer base. for example, an acquisition of new major customers would lower the concentration measure by increasing the denominator and reducing the revenue reliance on existing customers. notably, cohen and li (2016) find that supplier firms having the united states government as a major customer experience a more transparent information environment and lower demand uncertainty. since these benefits may offset the threat of highly concentrated customer-base, we also measured our customer concentration measure after removing the u.s. government from the list of major customers. the definitions of the variables included in the analysis are provided in table 1. volume 36, number 2 67 table 1 variables description variable description roa a ratio of operating income to total assets cust_hh the measure of customer base concentration defined as the herfindahl-hirschman index of a firm's sales revenue. calculated as the sum of the squares of the sales shares to each major customer. post_acq an indicator variable equals 1 if a firm engages in a merger & acquisition and 0 otherwise firmsize log of total assets liquidity the ratio of operating cash flows to total assets leverage the ratio of the book value of short-term and long-term debts to total assets growth percentage of annual sales growth age age of the acquiring firm data analysis and results a preliminary analysis was conducted to examine the descriptive statistics (provided in table 2) of the variables under consideration. in addition, a correlation matrix was constructed (provided in table 3), that demonstrates the correlations among the independent and control variables range between 0.00 and 0.51 that is well below the cut-off limit of 0.7, indicating that there are no multicollinearity issues. 68 journal of business strategies table 2 descriptive of the sample variables n mean sd q1 median q3 roa 12,038 -0.3528 0.9865 -0.3771 -0.0857 0.0518 cust_hh 12,038 0.1894 0.2333 0.0325 0.1007 0.2481 post_acq 12,038 0.1095 0.3123 0.0000 0.0000 0.0000 firmsize 12,038 4.1971 2.2442 2.7317 4.1980 5.6110 liquidity 12,038 -0.1672 0.5231 -0.2241 -0.0035 0.0997 leverage 12,038 0.2761 0.6170 0.0000 0.0690 0.2907 growth 12,038 0.3239 1.1546 -0.1236 0.0778 0.3456 age 12,038 2.3332 0.7280 1.7918 2.3026 2.8332 table 3 correlation matrix variables 1 2 3 4 5 6 7 1. roa 1.00* 2. cust_hh -0.20* 1.00* 3. post_acq 0.07* -0.05* 1.00* 4. firm size 0.41* -0.21* 0.07* 1.00* 5. liquidity 0.64* -0.24* 0.04* 0.51* 1.00* 6. leverage -0.45* 0.11* -0.03* -0.29* -0.48* 1.00 7. growth -0.15* 0.12* -0.07* -0.00* -0.03* -0.02** 1.00* 8. age 0.15* -0.08* 0.11* 0.08* 0.12* 0.03* -0.21* ** p < .01. *** p < .001. to test the hypothesized relationship on the high-tech firm’s operating performance changes after the completion of an acquisition attributable to its customer-base concentration, a differences-in-differences method (bertrand & mullainathan 2003; low 2009) was used. specifically, this study estimates the following regression model: volume 36, number 2 69 as a summary measure of the acquirer’s operating performance, this research uses the return on assets. the variable of interest is the interaction between customer concentration and the post-acquisition indicator, cust_hh* post_acq, which represents the incremental effect of customer concentration on roa after the completion of an acquisition. since an acquirer’s operational profile can change significantly after the completion of an acquisition, industry fixed effects –were included, instead of firm fixed effects − in the differences-in-differences model to control for time-invariant unobservable factors affecting roa. furthermore, the use of firm fixed-effects is ruled out because our treatment variable, post_acq, is a linear combination of firm fixed effects. these results are presented in table 4. as a validity check of the model, this study first tests whether the average effect of customer-base concentration is positively related to roa. the results find that the joint coefficient of cust_hh + cust_hh*post_acq is positive and statistically significant at 5% level. this is consistent with patatoukas (2012), confirming the efficiency benefits of customer-base concentration, on average. a test of our first prediction on the relationship between customer-base concentration and firm performance without m&as is captured by the negative and statistically significant coefficient of cust_hh (b= – 0.1608) when all customers are considered; – 0.1678 for only non-government customers, showing that the suppliers having concentrated customer-base have lower roas without engaging in m&as. the second prediction on the moderating role of m&as ameliorating the negative influence of customer-base concentration on the firm performance is tested with the coefficient of cust_hh*post_acq. the positive and significant coefficients (b= +0.399) of cust_hh*post_acq suggest that the negative influence of customer concentration on roa is changed into positive after the acquisition. with respect to its economic significance, this is equivalent to 68% lower level of roa, on average, with one standard deviation lower customer concentration before the acquisition whereas 9.45% higher roa level with one standard deviation higher customer concentration after the acquisition. the findings were consistent when only non-government customers were considered (b= +0.398). these findings support the theoretical conjecture of rdt hinting that a supplier firm experiencing revenue dependency to a few significant customers can use m&as as a strategic tool to mitigate the resource dependency. 70 journal of business strategies ta bl e 4 c us to m er c on ce nt ra ti on a nd p os ta cq ui si ti on r et ur n on a ss et s d ep en de nt = r o a al l c us to m er s n on -g ov er nm en ta l c us to m er s r ob us t r ob us t va ria bl e c oe f. (b ) s td . e rr or pva lu e c oe f. (b ) s td . e rr or pva lu e c u st _h h -0 .1 60 8 (0 .0 61 7) [0 .0 09 ] -0 .1 67 8 (0 .0 64 1) [0 .0 09 ] po st _a c q -0 .0 08 1 (0 .0 18 9) [0 .6 68 ] -0 .0 04 0 (0 .0 19 0) [0 .8 32 ] c u st _h h *p o st _a c q 0. 39 98 (0 .1 13 7) [0 .0 00 ] 0. 39 82 (0 .1 21 2) [0 .0 01 ] fi r m si ze 0. 04 30 (0 .0 04 8) [0 .0 00 ] 0. 04 29 (0 .0 04 8) [0 .0 00 ] li q u id it y 0. 90 49 (0 .0 38 3) [0 .0 00 ] 0. 90 46 (0 .0 38 3) [0 .0 00 ] le ve r ag e -0 .3 18 0 (0 .0 34 6) [0 .0 00 ] -0 .3 18 3 (0 .0 34 5) [0 .0 00 ] g r o w th -0 .0 98 9 (0 .0 12 0) [0 .0 00 ] -0 .0 98 8 (0 .0 12 0) [0 .0 00 ] ag e 0. 07 39 (0 .0 12 0) [0 .0 00 ] 0. 07 32 (0 .0 12 1) [0 .0 00 ] c on st an t -0 .4 81 5 (0 .0 45 9) [0 .0 00 ] -0 .4 79 5 (0 .0 46 2) [0 .0 00 ] n 12 ,0 38 12 ,0 38 ad j. r 2 0. 47 24 0. 47 24 jo in t t es t: c u st _h h + c u st _h h *p o st _a c q 0. 23 89 [0 .0 18 ] 0. 23 04 [0 .0 34 ] te st s ta tis tic s ar e ca lc ul at ed u si ng h et er os ce da st ic ity -r ob us t s ta nd ar d er ro rs c lu st er ed b y fir m . volume 36, number 2 71 general discussion and conclusion this study has analyzed the impact of customer concentration on a firm’s profitability. through the lens of resource dependence theory, the study argues that as customer concentration increases, firms become more dependent on their significant customers. such an increase in dependence will increase a customer’s ability to constrain a dependent firm and thereby siphon away any joint benefits created by customer concentration. furthermore, the firms that attempt to initiate m&as in the presence of high customer concentration benefit by improving profitability as opposed to firms that maintain a high dependence. earlier research on customer concentration maintained that there is value created by a strong customer base (ak & patatoukas, 2016; patatoukas, 2012). this study reasons that such created value may be siphoned away by the more powerful firm in a buyer-supplier relationship when there is a high level of dependence. findings in this study revealed that increasing dependence on one or a few significant customers is associated with lower profitability of the firm. this is true to such an extent that the overall increase in customer-base concentration has decreased the profitability of the selling firm. these findings are consistent with much of the earlier research on customer concentration (fee & thomas, 2004; kelly, lustig, & van nieuwerburgh, 2013; saboo et al., 2017) and expand upon their observations. furthermore, these findings support the fundamental tenets of resource dependency theory, which states that the dependence on an external entity in the firm’s ecosystem constrains the firm and affects the performance of the firm (pfeffer & salancik, 1978; hillman et al., 2009). although these findings imply that increasing customer concentration is associated with lower profitability of the supplier, our study does not refute the findings in earlier studies that claim an increase in customer concentration can increase operational efficiencies and can create joint benefits (ak & patatoukas, 2016; patatoukas, 2012). the findings of this study are limited to highlighting the realized value for the supplier firm. the lower profitability associated with higher customer concentration indicates that increased dependence is likely to create unfavorable conditions to the supplier firm. the findings of this study also imply that organizations that attempt to overcome the constraints of a concentrated customerbase through acquisitions tend to improve their performance in contrast to those who do not reconfigure dependencies. this study contributes by expanding upon research on customer concentration, providing empirical support to the key tents of resource dependence 72 journal of business strategies theory, and clarifying some of the earlier findings in m&a research. the most important theoretical findings of this study are the demonstration of the relevance of resource dependence theory (rdt) to understand customer base concentration and the consequences of increased customer base concentration. the findings of this study provide empirical support to rdt’s assertion that the more dependent a firm is on its transactional partners, the more constrained the firm tends to be, which is demonstrated by lower profitability associated with higher dependence. furthermore, the findings also support the fundamental rdt assertion that when firms are constrained by dependence, firms tend to attempt to overcome the constraints through mergers and acquisitions. moreover, these findings clarify an earlier position that a majority of m&as fail to create value for the acquiring firm (cartwright & schoenberg, 2006; king et al., 2004) and guide our understanding of the popularity of mergers and acquisitions as a form of corporate growth strategy. this research is not free from limitations. first, we focus on customer concentration and dependence, and we do not differentiate between dependence and interdependence because of data limitations. second, the acquisitions that are taken into account in the analysis do not distinguish between acquisitions initiated to circumvent the constraint or directed to absorb the constraint. both these limitations were difficult to eliminate due to the limited availability of information via secondary data. future research should attempt to both differentiate between dependence and interdependence and to identify the nature of acquisitions while differentiating between acquisitions directed at the constraining organization and those bypassing the constraint by acquiring a non-participant organization. references ak, k., and patatoukas, p. 2016. customer concentration and inventory efficiency: evidence from the manufacturing sector. production and operations management, 25(2): 258-272. bertrand, m. and mullainathan, s. 2003. enjoying the quiet life? corporate governance and managerial preferences. journal of political economy, 111(5):1043-1075. campello, m. and gao, j. 2017. customer concentration and loan contract terms.” journal of financial economics, 123: 108-136. cartwright, s. and schoenberg, r. 2006. thirty years of mergers and acquisitions research: recent advances and future opportunities. british journal of management, 17(s1): s1-s5. volume 36, number 2 73 cohen, d. and li, b. 2016. customer concentration, profitability, and the information environment: the u.s. government as a major customer. working paper: the university of texas at dallas. dhaliwal, d., judd, j.s., serfling, m. and shaikh, s. 2016. customer concentration risk and the cost of equity capital. journal of accounting and economics, 61: 23-48. ellsaesser, f., tsang, e.w.k., and runde, j. 2014. models of causal inference: imperfect but applicable is better than perfect but inapplicable. strategic management journal, 35: 1541-1551. fee, c. e., and thomas, s. 2004. sources of gains in horizontal mergers: evidence from customer, supplier, and rival firms. journal of financial economics, 74(3): 423-460. francis, j. and schipper, k. 1999. have financial statements lost their relevance? journal of accounting research, 37(20): 319-352. hillman, a. j., withers, m. c., and collins, b. j. 2009. resource dependence theory: a review. journal of management, 35(6): 1404-1427. joshi, m., sanchez, c., and mudde, p. 2018. improving the m&a success rate: identity may be the key, journal of business strategy, https://doi.org/10.1108/ jbs-08-2017-0115 kelly, b., lustig, h., and van nieuwerburgh, s. 2013. firm volatility in granular networks (no. w19466). national bureau of economic research. king, d.r., dalton, d.r., daily, c.m. and covin, j.g., 2004. metaanalyses of postacquisition performance: indications of unidentified moderators. strategic management journal, 25(2): 187-200. low, a., 2009. managerial risk-taking behavior and equity-based compensation. journal of financial economics, 92(3): 470-490. luo, a, and kumar, v. 2013. recovering hidden buyer-seller relationship states to measure the return on marketing investment in business-to-business markets. journal of marketing research, 50 (1): 143–60. patatoukas, p. 2012. customer concentration: implications for firm performance and capital markets. the accounting review, 87(2): 363-392. pekar., p. 1985. mergers and acquisitions: a strategic approach to diversification, journal of business strategy, 5 (4): 99-104 pfeffer, j., and salancik, g. r. 1978. the external control of organizations: a resource dependence approach. ny: harper and row publishers. pfeffer, j. 1972. merger as a response to organizational interdependence. administrative science quarterly, 17: 382-394 74 journal of business strategies reddy, r.k., park, s.j., and fabian, f.h. 2018. “buying the buyers”: examining the effects of customer-base concentration on acquisitions. academy of management proceedings, 2018 (1), 16986. doi: https://journals.aom.org/doi/ abs/10.5465/ambpp.2018.16986abstract (last accessed: 20th june, 2019) saboo, a. r., kumar, v., and anand, a. 2017. assessing the impact of customer concentration on initial public offering and balance sheet–based outcomes. journal of marketing, 81(6): 42-61. ulrich, d., and barney, j. b. 1984. perspectives in organizations: resource dependence, efficiency, and population. academy of management review, 9(3): 471-481. walter, g. a., & barney, j. b. 1990. management objectives in mergers and acquisitions. strategic management journal, 11: 79-86. zeithaml, v. a., rust, r.t and lemon, k.n. 2001. “the customer pyramid: creating and serving profitable customers,” california management review, 43 (4): 118–42. short biographical sketch of authors rama krishna reddy is an assistant professor of management at indiana university south bend. he received his ph.d. from the university of memphis. dr. reddy’s research interests include foreign direct investment, mergers & acquisitions, institutional theory, and resource dependency theory. dr. sung-jin park is an assistant professor in accounting at indiana university south bend. he received his ph.d. from the university of texas at san antonio. prior to joining iusb, he taught at the university of texas at san antonio and he worked as a tax accountant for bgbc partners, llp, and the assistant director of the asian culture center at indiana university, bloomington. dr. park is a certified public accountant and a member of the american accounting association and beta gamma sigma. volume 31, number 1 205 cash position forecasts pre and post the 2008 market crash richard l. alltizer university of central oklahoma • edmond, ok zane l. swanson university of central oklahoma • edmond, ok abstract our study focuses on the important issue of cash forecasting. the wall street journal (wsj) published articles (1995, 2009) dealing with the record levels of cash held by large publicly traded companies, asserting that cash positions may be excessive. the articles discuss, at points in time, a trend over three decades of increasing cash holdings which doubled from 1980 through 2006. the ability to forecast cash holdings is an important element in deciding where to invest consistent with one’s predilection, and may therefore become more important as cash holdings increase. in contrast to prior research, our study demonstrates a forecasting model with firm-specific variables. the results indicate a strong model in spite of changing economic conditions; however, with significant turbulence (i.e. the 2008 market failure), we find that certain coefficients are impacted. data availability data used in this study are available from public sources identified in the study. introduction while it is generally agreed that there is not a “right answer” as to how much cash a firm should carry (opler et al., 1999), it is also generally agreed that practitioners find both the amount of cash a firm is carrying and the ability to accurately forecast cash holdings information that matters. basic financial theory holds that sitting on cash has a significant opportunity cost that may indicate either a lack of opportunity in an industry or the inability of management to find productive investment choices (grinblatt and titman, 2001). however, there is some fairly strong empirical evidence that, as a general rule, a firm’s investment behavior is a function of cash availability (fazzari, hubbard, and petersen, 1988). an obvious corollary is 206 journal of business strategies that a firm with large amounts of cash that does not invest sees no opportunity and consequently growth cannot be reasonably anticipated by an investor. basic agency theory would also suggest that management in firms sitting on large amounts of cash are far less incentivized to turn in optimal performance, and that large amounts of debt, that must be serviced, does tend to generate the best performance from management. it is also arguable that the financial crisis of 2008 produced an intercept shift in the corporate world’s faith in financial markets and thus attitudes changed towards holding large amounts of cash. irrespective of which of the above views is correct, in light of the financial crisis and the demonstrated importance of cash flow concerns to investors, the issue is worth revisiting. in addition, prior research (bates et al., 2009) demonstrates that firm value is positively associated with firm cash positions. in summary, the ability to accurately forecast cash impacts both investors and management. analyst and other information services (e.g. value line) provide cash flow forecasts for large and medium sized firms which are used in the valuation process. anecdotal information indicates firm cash positions have been increasing which may complicate an assessment of the appropriate holding of cash. our figure 1 illustrates an increasing trend in the ratio of cash holdings to total assets. from 1980, the ratio of cash to total assets has increased dramatically before trending back down in the mid-2000s (the ratio was 12.59 percent in 1980 and averaged 18.58 percent in the period 2000 to 2006). figure 1 thirty year summary of cash to total assets 0 0.05 0.1 0.15 0.2 0.25 8081828384858687888990919293949596979899 0 1 2 3 4 5 6 7 8 9 cash/asset time cash holdings history volume 31, number 1 207 certainly, if companies are hoarding cash, the economic uncertainty of the last decade may have a further adverse effect on forecasting. in their study, kim et al. (1998) offer two possible explanations as justification for increased holdings of liquid assets. they contend that when companies are faced with volatile earnings reports and/or relatively lower returns on assets the ratio of cash holdings increases. the decade of the 2000s was a period of economic turmoil which may contribute to the increase in cash ratios. this study utilizes a model that is historically effective in forecasting a firm’s cash position from 1980 through 2006. we posit that during periods of extreme economic uncertainty, the model and/or the independent variables may shift in importance as conditions change. thus, investors may have difficulty using cash forecasting data in their investment decisions during periods of uncertainty in the financial markets. given the importance of cash forecasting, the present study extends prior research by analyzing the ability to forecast cash during periods of economic uncertainty. to investigate this proposition, we study the 2008 market crisis. the remainder of the paper is organized as follows: the next section reviews the relevant literature. the methodology section follows and includes a description of the sample. next we present the empirical results, and the final section contains our conclusions. prior literature firm accumulation of cash is not a new phenomenon. reinhardt (1997) noted there were increasing amounts of cash accumulation. again, in 2009, the wsj (zwieg) reported that corporate cash umbrellas were quite large and perhaps too large. while the wsj articles discuss points in time and our study investigates a period of time, we reference their articles to note the perceived importance of cash holdings. bates et al. (2009) reported a 100 percent increase in the cash to total asset ratio for a sample of industrial firms between 1980 and 2006. bates concluded that firms tend to increase the ratio of their cash holdings as their cash flows become riskier. corporate cash holding is the subject of a considerable body of literature, and while most of the literature deals with levels of cash (e.g. reinhardt, 1997) some have dealt with cash forecasting (ozkan and ozkan, 2004). both lines of research employ variables relevant to cash forecasting. we draw from both types of studies in developing our cash forecasting model. morris (1983) developed a theoretical basis for the use of cash holdings to explain firm value. thus, forecasting cash positions is an important element in pre208 journal of business strategies dicting firm value. bates et al. (2009) examined data from the 1980s to 2006 and employed a predictive model based on four self-selected motives: transactions, precautionary, tax and agency. the transaction motive is based on utilizing economies of scale where noncash financial assets are converted into cash to support operating expenses. to mitigate risk, firms will tend to hold greater amounts of cash as a precaution against adverse events. the tax motive involves primarily multinational firms and the repatriation of foreign earnings. their actions suggest that companies minimize repatriation to maximize cash holdings by avoiding taxation on foreign earnings. the agency motive (jensen, 1986) predicts that firms with entrenched management will tend to hold more cash when faced with poor investment choices in lieu of payments to investors. our study utilizes data from the periods 1980-1989, 1990-1999 and 20002006 to establish the validity of our model, we then extend the analysis through 20072009. the primary focus of our study, after establishing a base case by period, is the period around the 2008 market crash (2007, 2008 and 2009). in contrast to bates et al. (2009) and others, our structured model is based on a cash flow statement approach developed by vickrey and swanson (1996). the cash flow statement describes the change in cash holdings from period t-1 to period t; therefore, we have a theoretically sound basis for the selection of our variables. in keeping with a cash flow statement approach, the present study includes firm specific variables representing the operating cycle of cash flows, long-term asset affects and a leverage variable. bates et al. (2009) asserted that firms hold increasing amounts of cash during market stresses as a precautionary motive; accordingly they included a market-tobook ratio to test that motive. bates found a positive association between his cash ratio (cash divided by total assets) and a market-to-book variable. ozkan and ozkan (2004) also found significance with a market-to-book variable in their cash forecasting study of uk firms. therefore, based on the prior literature, we include a marketto-book variable in our forecasting model. ozkan and ozkan (2004), in their forecasting study, found no linear relationship with respect to management ownership and cash projections. the present study utilizes a linear model, thus we are not including management ownership as a predictive variable. opler et al. (1999) developed a descriptive model for cash holding that is based on economic circumstances in the context of risk and management utility functions. their economic reasons (note similarities to bates et al., 2009) included: (1) a responsibility to pay obligations, (2) holdings to invest in business opportunivolume 31, number 1 209 ties and (3) reserves for contingencies1. alternatively, we develop a predictive model based on firm specific variables. for the above reasons, the present study includes firm variables representing a company’s operating cycle. we examine and extend the cash forecasting line of research by testing the reliability of variables affecting cash forecasting during a period of uncertainty in the financial markets. a complete description of our independent variables follows in the research methodology section. research methodology hypothesis development the present study investigates cash forecasting by developing a prediction model which is based on prior research (bates et al., 2009); (ozkan and ozkan, 2004); and (vickrey and swanson, 1996). we test the model over three periods (1980s, 1990s and 2000-2006) to establish robustness. after establishing the validity of the model, we then investigate the ability to forecast cash holdings during a period of significant uncertainty in the economy. specifically, did the 2008 market crisis impact the ability to forecast cash holdings? the formal statement of the null hypothesis is: h0: cash forecasting is unaffected by changing economic circumstances. regression model our study utilizes a regression model forecasting the ratio of cash to total assets at time t which employs the cash flow statement approach and includes a market-to-book variable. a basic premise of our regression equation is an autoregressive model where the forecasted dependent variable is equal to the prior period’s cash position (i.e. cashratiot = a0cashratiot-1). opler et al. (1999) tested the autoregressive theory that cash holding is mean reverting and found a significant association. the following equation utilizes an autoregressive model and incorporates firm fundamentals based on the cash flow statement approach as explained below. cashratiot = a0cashratiot-1 + b1δrect-1 + b2δinvt-1 + b3δapt-1 + b4δcflt-1 + b5ltat-1 + b6mktbkat-1 + b7drt-1 + et (1) 1 also see john, t. (1993), harford, j. (1999), kim et al. (1998), and mikkelson & partch (2003). 210 journal of business strategies where: cashratiot = cash at time t divided by total assets (tat) at time t, δrect-1 = scaled change in receivables in year t-1 (i.e., (-rect-1 + rect-2/tat-1)), δinvt-1 = scaled change in inventories in year t-1 (i.e., (-invt-1 + invt-2/tat-1)), δapt-1 = scaled change in accounts payable and accrued liabilities in year t-1 (i.e., (apt-1 apt-2/tat-1)), δcflt-1 = cash change in year t-1 less rect-1, invt-1, and apt-1 which is then scaled by tat-1, ltat-1 = log (tat-1 cat-1 rect-1 invt-1), mktbkt-1 = the stock market value in year t-1/book value in year t-1, drt-1 = the long term debt in year t-1/tat-1, and et = error in period t. the regression variables are explained as follows: 1) cashratiot-1 is included per the prior explanation of the autoregressive odel (opler et al., 1999), 2) we then add a set of operating cycle variables as follows: (δrect-1), inventory (δinvt-1) and payables (δapt-1) (vickrey and swanson, 1996), 3) δcflt-1 is included as per vickrey and swanson (1996). this variable represents changes in cash due to other than operating cycle changes, 4) ltat-1 is included per the cash flow statement approach (vickrey and swanson, 1996). theoretically, as the long-term asset holdings increase more cash is required for sustainability. a log of this variable is employed to scale it consistent with the other variables, 5) the market-to-book ratio is representative of the cash necessary to take advantage of investment opportunities (bates et al., 2009 and ozkan and ozkan, 2004) and 6) debt may be a constraining factor as firms may be required to use cash to reduce their leverage (bates et al., 2009 and opler et al., 1999). in summary, a company’s cash position is a function of firm fundamentals. our model employs the cash flow statement approach (vickrey and swanson, 1996) including operating, financing and investing activities. based on the prior work of bates et al. (2009) and ozkan and ozkan (2004), we also include a market-to-book variable. volume 31, number 1 211 sample description all research insight (compustat) firms were initially eligible for the period 1980 through 2008. the financial data for 2009 was obtained from extensible business reporting language (xbrl) filings located in the security and exchange commission’s (sec) edgar database. we restricted our sample in several respects. regulated firms in standard industrial classifications (sic) codes 4800 to 4899 and financial firms from sic codes 6000 through 6999 are excluded. the reasoning is that these firms have external regulators influencing the balance sheet accounts. furthermore, financial firms were removed because of regulatory constraints which may differentiate their investors from the rest of the market. we eliminate firms with sic codes 9000 or greater because they are generally nonbusiness entities (e.g. public administration) with operating characteristics different from for-profit firms. sic codes of 1000 or below are excluded because they are primarily agriculturally related firms which are influenced by commodity markets. elimination of these firms may also reduce an element of heterogeneity which could distort our results. only firms with positive cash balances are included in the study because firms with negative cash balances are suspected of being in financial distress. lastly, only firms with values for all applicable variables are included in the analyses. the industry membership of our sample is shown in table 1, and is representative of the general distribution of the firms in the stock market. thus, our results should be generalizable. table 1 industry membership (1980 through 1999) industry sic codes percent description 1 10-19 5.98 mining 2 20-39 59.61 industrial 3 40-48 5.38 transportation 4 50-51 5.65 wholesale 5 52-59 9.26 retail 6 70-89 14.12 service 212 journal of business strategies empirical findings we conduct an event study over the 2008 market crisis by focusing on cash forecasting over 2007, 2008 and 2009. as part of our analysis, we investigate for multicollinearity and provide a correlation table for the 2007, 2008 and 2009 data. only one pair of correlations is greater than .5 (see table 2). in the regressions, all variance inflation factors (vifs) are less than 10 suggesting that multicollinearity is not present in the model. table 2 pearson correlation coefficients, n = 4229 for the years 2007, 2008 and 2009 (variable definitions follow equation (1) in the text) v ar ia bl e c r at io t c r at io t1 δ r e c t1 δ in v t1 δ a p t1 δ c f l t1 lt a t1 m b k t1 c r at io t1 0. 87 * δ r ec t1 -0 .0 1 -0 .0 1 δ in v t -1 0. 07 * 0. 11 * 0. 21 * δ ap t1 -0 .0 6* 0. 01 -0 .3 2* -0 .1 3* δ c fl t1 0. 20 * -0 .0 3& 0. 30 * 0. 16 * -0 .8 5* lt a t -1 -0 .4 0* -0 .4 0* 0. 13 * 0. 08 * 0. 06 * -0 .0 5* m b k t1 -0 .0 0 -0 .0 0 -0 .0 2 -0 .0 1 0. 01 -0 .0 1 -0 .0 3# d r t1 -0 .2 7* -0 .2 8 0. 09 * 0. 01 -0 .0 2 0. 06 * 0. 27 * 0. 03 # si gn ifi ca nc e le ve ls a re * = .0 1, # = .0 5, & = .1 0 o ne p ai r o f i nd ep en de nt v ar ia bl es h as a n ab so lu te c or re la tio n gr ea te r t ha n .5 . v if s ar e le ss th an 1 0 su gg es tin g th at m ul tic ol lin ea ri ty is n ot a p ro bl em (k en ne dy 2 00 3) . volume 31, number 1 213 we also report regression results from 1980 through 2006 to demonstrate the validity of the model. an empirical analysis of the data reveals that cash holdings have indeed been on the rise. in 1980, the ratio of cash to total assets was approximately 10 percent, and rose to 15 percent in 1999, a 50 percent increase. by the mid1980s the ratio was approximately 13 percent and fluctuated around that amount for the balance of the 1980s and 1990s. the mean of the cash ratio for each decade was 12.59 percent to 13.91 percent respectively (see table 3, panels a and b). however, the 2000s saw increases in the ratios that ranged from approximately 15 percent to 21 percent except for 2009 when the ratio dipped to approximately 13 percent. the mean ratio of cash to total assets was approaching 19 percent for the period 20002006 (table 3, panel c). data for the mean value of each variable in equation 1 is provided in table 3 for each period. table 3 descriptive data for the periods 1980 to 1989, 1990 to1999 and 2000-2006 (variable definitions follow equation (1) in the text) panel a (the 1980s; n = 2253 avg.) variable mean standard deviation minimum maximum cashratiot 0.1259 0.1399 0.0000 0.9521 cashratiot-1 0.1259 0.1399 0.0000 0.09418 δrect-1 0.1279 0.1420 0.0001 0.9418 δinvt-1 -0.0242 0.0793 -0.5837 1.1602 δapt-1 -0.0196 0.0765 -0.5247 1.1403 δcflt-1 0.0380 0.7358 -22.0486 0.9760 ltat-1 0.0523 0.2354 -1.5507 4.9707 mktbkt-1 3.6131 2.3106 -3.2815 11.3218 drt-1 2.4835 12.3571 -145.7708 441.6951 214 journal of business strategies panel b (the 1990s; n = 2549 avg.) variable mean standard deviation minimum maximum cashratiot 0.1391 0.1656 0.0000 0.9818 cashratiot-1 0.1421 0.1678 0.0000 0.9799 δrect-1 -0.0217 0.0847 -0.6243 1.3263 δinvt-1 -0.0138 0.0724 -0.4633 1.3770 δapt-1 0.0167 1.3072 -50.1438 0.9908 δcflt-1 0.0669 0.5750 -4.3942 21.2730 ltat-1 4.1753 2.3964 -4.3635 11.4492 mktbkt-1 2.9639 19.4108 -498.4981 538.2716 drt-1 0.1657 0.2020 0.0000 3.8145 panel c (2000-2006; n = 2724 avg.) variable mean standard deviation minimum maximum cashratiot 0.1858 0.1994 0.0000 0.9785 cashratiot-1 0.1889 0.2058 0.0000 0.9658 δrect-1 -0.0013 0.2690 -0.5954 12.9568 δinvt-1 -0.0023 0.1637 -0.4521 7.1733 δapt-1 0.0176 2.1043 -61.5795 71.8166 δcflt-1 0.0410 2.8816 -63.7795 111.1420 ltat-1 5.1961 2.5609 -7.7573 12.2286 mktbkt-1 2.9189 65.6904 -1526.3992 2338.4568 drt-1 0.1875 0.3471 0.0000 10.6921 consistent with the findings of bates et al. (2009) of increasing cash holdings, we find evidence that companies progressively held more cash relative to their total assets. bates reports a doubling of the cash to assets ratio from 1980 to 2006. our findings are very similar. thus, the ability to accurately forecast cash holdings may become more significant as the ratio of cash holdings increases. we begin our analysis by testing the forecasting model over the periods of the 1980s, 1990s and 2000 to 2006 (table 4). a regression is run for each year and then averaged for the period; accordingly, the results for each period are expressed as a mean for that period. the results are generally consistent over the periods with the volume 31, number 1 215 firm operating variables remaining relatively static in terms of their predictability (α = .01). one financing variable (market-to-book) is not significant, while long-term debt to total assets is significant (α = .10) for the 1980s, but is not significant for the remaining periods. the overall results are relatively constant in spite of fluctuations in business cycles over the 26 year period. further, the adjusted r2 for each regression, and the periods, is relatively constant (adjusted r2 is between .87032 and .9010) for the three periods reported. from these results, we conclude that our cash forecasting model presents a successful cause and effect relation. table 4 summary of regression coefficients for equation (1) for the periods 1980 to 1989, 1990 to1999 and 2000-2006 1980-1989 (n=2263 avg.) 1990-1999 (n=2549 avg.) 2000-2006 (n=2724 avg.) variable coefficient coefficient coefficient cashratiot-1 0.83212* 0.84003* 0.8614* δrect-1 0.18499* 0.09243* -0.2027* δinvt-1 0.23392* 0.14983* -0.2369* δapt-1 0.03585* 0.02075* 0.2198* δcflt-1 0.30325* 0.16627* 0.2249* ltat-1 0.00314* 0.00245* 0.0024* mktbkt-1 -0.00026 0.00022 0.0000 drt-1 -0.01587& -0.00536 -0.0056 adj. r2 0.88888 0.87032 0.9010 significance levels are * = .01, & = .10 cashratiot = a0cashratiot-1 + b1δrect-1 + b2δinvt-1 + b3δapt-1 + b4δcflt-1 + b5ltat-1 + b6mktbkat-1 + b7drt-1 + et where: cashratiot = cash at time t divided by total assets (tat) at time t, δrect-1 = scaled change in receivables in year t-1 (i.e., (-rect-1 + rect-2/tat-1), δinvt-1 = scaled change in inventories in year t-1 (i.e., (-invt-1 + invt-2/tat-1)), 216 journal of business strategies δapt-1 = scaled change in accounts payable and accrued liabilities in year t-1 (i.e., (apt-1 apt-2/tat-1)), δcflt-1 = cash change in year t-1 less rect-1, invt-1, and apt-1 which is then scaled by tat-1, ltat-1 = log (tat-1 cat-1 rect-1 invt-1), mktbkt-1 = the stock market value in year t-1/book value in year t-1, drt-1 = the long term debt in year t-1/tat-1, and et = error in period t. note: regressions were run for each year of data and we then computed averages for each decade. we present the averages for ease of exposition. the next step in our analysis focuses on the ability to forecast the ratio of cash to total assets immediately before, during and after the market collapse of 2008. annual results for 2007, 2008 and 2009 are presented in table 5. for the period 2000 to 2006 (see table 4) and the specific years under review (see table 5), we find the model still performs well with high adjusted r2’s, albeit with a couple of minor exceptions. consistent with our prior findings, the operating variables are generally significant (α = .01) for 2007 and 2008. the only exception is the long-term asset (ltat-1) measure which is significant at α = .10 for 2008. the financing variable (market-to-book) generally does not have predictive value at a statistically significant level. however, the debt variable is significant for 2007 and 2009 (α = .01). the most interesting result for both 2007 and 2008 concerns the adjusted r2. the adjusted r2 for each year is approximately .97, an increase of about 10 percent over our previous results. this result may be attributed to precautionary control of cash balances by firms during a period of turbulent economic circumstances. after the market collapse in 2008, the predictive ability of the model for 2009 shifts with respect to the explanatory power of the operating and financing variables (see table 5). the lagged cash coefficient (cashratiot-1) drops from 2008 to 2009 (.90 to .69) while remaining significant (α = .01). however, the operating cycle variables of receivables and inventory are no longer significant at conventional levels. further, the debt variable is now significant and is negatively associated with the dependent variable (this occurs for both 2007 and 2009, α = .01). this result suggests that debt issues became more important with the general decline in overall business activities. the other interesting occurrence for 2009 is the adjusted r2. following the sharp increase in 2007 and 2008, this statistic drops back to the general level found volume 31, number 1 217 over the three base periods. thus, it appears that the crisis of 2008 disrupted firms’ operating cycle activities, and the normal patterns were altered, at least temporarily. with respect to the research hypothesis, our findings reflect only weak evidence to reject the null. specifically, we find that the coefficients on operating characteristics are potentially sensitive to serious changes in economic circumstances. however, the general explanatory power of the model is maintained relative to the historical norm. table 5 summary of regression coefficients for equation (1) for the years 2007, 2008 and 2009 2007(n=1982) 2008 (n=1639) 2009 (n=608) variable coefficient coefficient coefficient cashratiot-1 0.84851* 0.90152* 0.68858* δrect-1 0.14709* -0.63241* 0.04083 δinvt-1 0.19398* -0.64777* 0.05899 δapt-1 0.49313* 0.59121* 0.02904& δcflt-1 0.52737* 0.61728* 0.39384* ltat-1 0.00141* 0.00040& 0.00604* mktbkt-1 -0.00005 -0.00002 -0.00038 drt-1 -0.02957* 0.00458 -0.06989* adj. r2 0.9677 0.96850 0.8861 significance levels are * = .01, & = .10 cashratiot = a0cashratiot-1 + b1δrect-1 + b2δinvt-1 + b3δapt-1 + b4δcflt-1 + b5ltat-1 + b6mktbkat-1 + b7drt-1 + et where: cashratiot = cash at time t divided by total assets (tat) at time t, δrect-1 = scaled change in receivables in year t-1 (i.e., (-rect-1 + rect-2/tat-1), δinvt-1 = scaled change in inventories in year t-1 (i.e., (-invt-1 + invt-2/tat-1)), δapt-1 = scaled change in accounts payable and accrued liabilities in year t-1 (i.e., (apt-1 apt-2/tat-1)), δcflt-1 = cash change in year t-1 less rect-1, invt-1, and apt-1 which is then scaled by tat-1, 218 journal of business strategies ltat-1 = log (tat-1 cat-1 rect-1 invt-1), mktbkt-1 = the stock market value in year t-1/book value in year t-1, drt-1 = the long term debt in year t-1/tat-1, and et = error in period t. note: variance inflation statistics (vif) were computed on the individual 2007, 2008 and 2009 regressions as a multicollinearity check. conclusions this study examines the ability to forecast cash holdings pre and post the 2008 market crash. the main conclusions are two-fold: (1) we find that firm specific variables provide a model with enhanced forecasting qualities, and (2) cash forecasting is potentially sensitive to changing economic circumstances. first, in contrast to bates et al. (2009) and ozkan and ozkan (2004), who used independent variables that were general in nature, we use firm specific variables based on a cash flow statement model. we report an adjusted r2 at .88 (or higher) over the three decades analyzed. ozkan reports an adjusted r2 at .25, and bates reports an adjusted r2 that ranged from .199 to .459. these results suggest that firm specific variables based on the cash flow statement approach are more effective than a mix of both firm and general economic variables. unlike harford (1999) or bates et al. (2009), we find no support for the market-to-book variable in any of the sampled periods. second, our model is robust before the 2008 crisis, and remains robust after the event. however, the operating variables in the model declined in significance following the market problems, while the financing variables took on added importance. thus, investors wishing to rely on cash forecasting as a tool for decision making are advised to use a comprehensive firm specific model. future research could isolate industry effects, other significant events, international effects and investor behavior. corporate governance issues as they relate to cash forecasting is also an important issue which we do not address. our research demonstrates a successful cash forecasting model which is stable across time periods. thus, with the growing emphasis of cash as firms increase their cash holdings, our model demonstrates an effective tool in the firm valuation process. this finding is consistent with the autoregressive theory reported by opler et al. (1999). volume 31, number 1 219 references bates, t. w., kahle, k. m., & stulz, r. m. (2009). why do u.s. firms hold so much more cash than they used to?. the journal of finance, 64(5), 19852021. bleakley, f. (1995). awash in cash. the wall street journal (october 16) a1 & a9. fazzari, s. m., hubbard, r., petersen, b. c., blinder, a. s., & poterba, j. m. (1988). financing constraints and corporate investment. brookings papers on economic activity, 1998(1), 141-195. grinblatt, m. & s. titman (2001). financial markets and corporate strategy. (2ed.). new york, ny: mcgraw hill. harford, j. (1999). corporate cash reserves and acquisitions. journal of finance, 54(6), 1969-1997. jensen, m. c. (1986). agency costs of free cash flow, corporate finance, and takeovers. the american economic review, 76(2), 323-329. john, t. a. (1993). accounting measures of corporate liquidity, leverage, and costs of financial distress. financial management, 22(3), 91-100. kennedy, p. (2003). a guide to econometrics. cambridge, mass: mit press, 2003. kim, c., mauer, d. c., & sherman, a. e. (1998). the determinants of corporate liquidity: theory and evidence. the journal of financial and quantitative analysis, 33(3), 335-359. mikkelson, w. h., & partch, m. (2003). do persistent large cash reserves hinder performance? journal of financial and quantitative analysis, 38(2), 275-294. morris, j. r. (1983). the role of cash balances in firm valuation. journal of financial and quantitative analysis, 18(4), 533-545. opler, t., pinkowitz, l., stulz, r., & williamson, r. (1999). determinants and implications of corporate cash holdings. journal of financial economics, 52(1), 3-46. ozkan, a. & ozkan, n. (2004). corporate cash holdings: an empirical investigation of uk companies. journal of banking & finance, 28(9), 2103-2134. reinhardt, a., himelstein, l., weber, j. (1997). ‘an enormous temptation to waste’. business week, 42-43. vickrey. d. & z. swanson (1996). forecasting small firm cash positions: an assessment of the predictive ability of fasb 95 disclosures. journal of accounting and finance research, 1(8). zwieg, j. (2009 march 14). corporate-cash umbrellas: too big for this storm? the wall street journaleastern edition. p. b1. 220 journal of business strategies biographical sketch of authors dr. richard alltizer is a certified public accountant with more than 14 years of public accounting experience. dr. alltizer is active in several professional organizations including the aicpa, the aaa, as well as state and local organizations. in 1994, he earned a ph.d. in business administration from the university of oklahoma. dr. alltizer is published in numerous professional and academic journals. dr. swanson cpa, abv is an accounting professor at university of central oklahoma college of business where he teaches financial and international accounting courses. his research focuses on capital markets and he has published more than 30 journal articles, numerous textbook supplements and a book. he is also active in ais/xbrl studies. previous to his academic career, he was an analyst in nonprofit and financial institutions. he received his ph.d. from the university of oklahoma in accounting with a supporting field of finance. stralegy implementation: a conceyiual review of practical appllcations james f. van houten mutual service insurance s1. paul, minnesota v.k unni indiana university of pennsylvania indiana, pennsylvania introduction when systematic strategic planning was first introduced, the initial focus was on diversification of the firm. but as firms increasingly faced strategic challenges from technological turbulence, changing competition, saturation of growth, and socia-political pressures, it became evident that the problems posed by these challenges could not be resolved simply by adding new areas to the firm [1]. as a result, attention was turned to optimizing the firm's competitive strategies. corporate executives have continuously sought ever since to achieve such competitive advantage. most significant business decisions involve substantial commitments with attendant uncertainties. prominent writings on business strategy for practitioners, such as michael porter ([14], [15]), identify certain strategic options for a firm seeking advantage over its competitors. porter's strategy proposals have been well received in the field of strategic management where they have been analyzed empirically and theoretically. porter's model any business strategy, to be capable of sustained success, must be grounded in competitive advantage. competitive advantage is gained when a company moves into a position where it has an edge in coping with competitive forces. according to porter the intensity of competition is based on the economic structure of an industry and the state of competition in an industry depends on five basic competitive forces: (i) the threat of new entrants, (2) the threat of substitute products or services, (3) the bargaining power of suppliers, (4) the bargaining power of buyers, and (5) the rivalry among existing firms. the goal of competitive analysis is to find a position in the industry where the company can best defend itself against these competitive forces or can influence them in its favor. in coping with the five competitive forces, porter has identified three generic strategic approaches: (i) overall cost leadership, (2) differentiation, and (3) focus. cost leadership emphasizes producing a standardized product at very low per-unit costs for many buyers who are price-sensitive. the impetus for striving to be the industry's low-cost producer can stem from sizable economies of scale and strong learning curve effects. differentiation refers to outputs which are considered unique industry-wide and are addressed to many buyers who are relatively price-insensitive. success differentiation creates lines of despring 1991 van houten and unni: strategy implementation 37 fense for dealing with competitive forces. focus strategy adverts to products which fulfill the needs of particular buyers who are fewer in number in an industry. in this paper an attempt is made to operationalize porter's model by reviewing the relationship of situational factors to competitive strategy, and by identifying the actions taken to implement the various competitive strategies in the real world. data and methodology the data used for analysis were collected from articles in three business periodicals (business week forbes, and fortune) published during march 1988-89 ([2-13], [16-28]). a convenient sample of twenty-five firms was selected from eighteen different industry categories, with no more than three firms from anyone category. industry categories were also balanced between ''manufacturing'' and "service-retailing" classification. since competitive strategy deals with long range sustainable advantages [14], it was important to separate long-term strategic from short-term tactical actions. the fundamental basis of above-average performance in the long run is defined as sustainable competitive advantage. this sorting of the sample size was accomplished by relying on the authors comments, and by selecting only those firms identified in the literature as in "turn-around" or "problem solving" modes. these firms seemed most likely to be taking significant long-term actions as opposed to making tactical adjustments. table 1 lists the firms and industries selected as sample for the study. table 1 firms and industries selected for analysis madufaduring: autos: general motols, peugeot motor of america chemicals: cabot drugs: miles labslag. pharamaceuticals food processing: general mills, kellog general mfg: hillenbrand shoes: kedslstride rite special machinery: caterpillar tires: bridgestooe writing instruments: parker services add retailing: airlines: british airways discount and fashion retailing: goldblatt's, sears financial seivices: equimark, jeffries, solomon jeweliy retailing: tiffany marine transportation: sea container on and gas: dresser, mobil, occidental publishing: knight-ridder 38 journal ofbusiness strategies vol. 8, no. 1 each of the twenty-five firms were analyzed, and then classified on the basis of their environmental factors and competitive strategy selection. the environmental factors considered were the five identified by porter as those which drive industry competition, and therefore, determine the environment in which the competitive strategy will be implemented. since each of these factors is present to some degree for each firm in every industry, one challenge was to identify those which seemed to be the dominant strategic choice factors. when the journal author expressed an opinion, the opinion was accepted as correct and this may be considered as a limitation to the study. in most cases, however, it was necessary to evaluate each author's comments against porter's mtionale, and subjectively establish the environmental factors which seemed most critical. using this method it was possible to identify a single environmental factor as dominant for nine firms, and two factors for fifteen firms. all firms were classified on the basis of past competitive strategies using porter's three categories (differentiation, cost, and focus) whenever possible. this was possible in every case for current competitive strategies. however, the past strategies for eight of the twenty-five firms resisted any classification, and were identified as ''unclear''. four additional firms seemed to be moving from unsuccessful strategies best descn"bed as conglomerate diversification. the past strategies for these four firms were identified as "conglomerate". the fact that twelve of these twenty-five "turn-around" firms were moving from competitive strategies that could not be clearly classified in the porter model to strategies that could, seems to lend support to porter's argument that, "the firm failing to develop its strategy in at least one of the three basic directions, is in an extremely poor strategic situation" [14]. analysis of environmental factors and strategic selection table 2, lists the firms and a classification based on environmental factors and strategy selection. the environmental forces, in terms of the five factors in the porter model, are noted in column two, along with a narmtive about the specific internal and external situational choice factors which created the environmental forces. the third column indicates the past and current competitive strategy pursued by each firm. a narrative of the specific implementation actions taken by the firm to deal with the internal and external situational choice factors is also included in this column. spring 1991 van houten and unni: strategy implementation table 2 39 analysis and classification of firms based on environment factors and competitive strategy selection finn environmental forces strategic choice industry sitnational choice implementation factors actions 1. bridgestone boyers, rivalry from industry differentiated to (tires) (internal: mfg. industry cost leadership facilities inefficient, (internal: decentralized poor union and decision making, changing distributor relations. culture to get wider input, external: slow industry cost = reduced mgml levels. growth, competitors external: investing in new using new technology.) technology to upgrade mfg. 2. british airways new entrants, rivalry from unclear to segment focus (airlines) (internal: low employee (internal: new ceo, reduced productivity and poor mgml levels, new board, sold union relations, slow unprofitable assets, cut decision making. employees, changing culture external: outdated to emphasize service. route structure, new external: new advertising entrants in most agency, revised routes, profitable routes, invested in concorde, acquired service and price british caledovia ai.., joint based competition.) venture with ul) 3. cabot new entrants no oumge: industry cost ladenbip (chemicals) (internal: (internal: invest in new diversified into technology, centralizing some natural gas and functions to reduce cost, open alloys, core bus. new plants in pacific rim to mfg. is outdated. reduce transportation costs. external: new external: expand demand for technology in core core product by joint ventures bus., slow growth with tire cos, investment in in core bus. demand, r&d to find new uses.) depressed natural gas prices.) 4. cal fed substitntes, suppuers from unclear to segment focus (savings (internal: (internal: reduce cost by and loan) diversified into closing unprofitable branches 40 journal ofbusiness strategies vol. b,no.! s. caterpillar (special machinery) 6. dresser industries (petroleum services) 7. equimark (banking) additional bus. where had low share and limited expertise. external: new competition for same need with new products, new competitors in core business, high interest return demanded by suppliers of funds.) new entrants, rivalry (internal: outdated mfg. plants, poor union relations, high wage costs and restrictive work rules. external: slow down in world wide codsiruciion equip. demand, shift in market toward smaller construction firms, dollar value fluctuations vs. other currency, new mfg. technology, new rompetition competition with lower cast.) rivalry (internal: diversified broadly into unrelated businesses. external: oil exploration core business demand declined, low shares in new businesses.) buyers, rivalry (internal: poor quality loans decreased earnings, inefficient operations, many unprofitable locations. external: market demand becoming more segmented sold assets not related to core bus., opened branches in profitable markets. external: product-adjustable rate mortgages to reduce risk of rising interest rates.) from industry durei'edtiated to industry cost leadership (internal: cut number employees, renegotiated wages and work rules, installed computer inventory control, invested to modernize all plants. external: introduced new products for small codstruction firms, expanded into u.s. farm machinery and international markets.) from coogiomerate to segment focus (internal: new ceo, sold all businesses not related to core industry, pared capacity of core business to align with decreased demand, purchased m.w. kel108& inc. to strengthen core bus. external: joint ventures to reduce drilling costs.) from industry durei'edtiated to segment focus (internal: new ceo, cut staff 23%, closed unprofitable locations, upgraded collection staff quality, sold low performing assets. external: focus marketing effort on spring 1991 van houten and unni: strategy implementation 41 8. general mills (food processing) 9. general motors (automobiles and trucks) 10. goldblatt's dept. stores (discount and fashion retailing) and less homogeneous, power of large borrowers to negotiate rates.) rivalry, substitutes (internal: diversified into large number of related businesses. external: new products introduced by competitors in core business, changing customer preferences, slow industry growth.) new entrants, rivalry (internal: production costs higher than competitors, complex structure slowed decision making, culture resisted change. external: slower industry growth, changing customer design and style preferences, new mfg. technology, tluctuating value dollar vs. other currencies.) new entrants, suppliers (internal: expanded into unfamiliar upscale markets, many locations unprofitable. external: new low cost general competitors, many new entrants into upscale markets.) smaller firms, acquiring other banks and thrifts with strengths in small business lending.) from conglomerate to industry differentiated (internal: sold non-food businesses, expanded olive garden restaurants, retired 22% stock. external: introduced 260 new products in last 5 years.) no change industry differentiated (internal: acquired hitechnology firms, changed culture to emphasize quality, sold terex and frigidaire divisions, upgrading mfg. plant technology, closed inefficient plants. external: purchased lotus to take advantage of styling and design skills, moved more mfg. outside u.s.) from unclear to segment focus (internal: new ceo, closed stores in upscale markets, added 2 new stores in traditional inner city markets, more aggressive negotiating for low cost merchandise. external: advertising shifted to hand delivered circulars in adjacent target neighborhoods.) 42 journal ofbusiness strategies vol. 8, no.1 11. lliilenbnnd industries (general manufacturing) 12. jelrries and company (investment banking) 13. keels division stride rite corp. (shoes) rivalry (external: extended life expectancy and excess hospital capacity resulted in non-growth core businesses.) new entrants, rivalry (internal: firm prosecuted for insider trading, many top employees left. external: more financial services firms moving into investment banking, new methods of business financing introduced, traditional large customers market avoid firm because of scandal.) new entrants, substitutes (internal: previous parent-uniroyal-treated bus. as cash cow, competing on basis of price only, no focused distribution, identity and share declining. external: lifestyle changes created from segment focus to industry cost leadership (internal: used eainings from core bus. to purchase additional firms in related bus., invested in technology to reduce mfg. costs, cut core bus. expenses, created 59 warehouse distr. system to improve service. external: introduced new products in core and related bus., increased core bus. advt. to hold share, purchased medeco locks and american tourlster to take advantage of new low cost mfg. technology and expertise.) from segment focus to industry ditfereutiated (internal: new ceo, rebuild culture, more decentralized decision making. external: advertise to rebuild firm image, more emphasis on small as well as large customers, and broader services to all size customers.) from industry cost leadership to segment focus (internal: uniroyal sold division to stride rite in 1982. external: introduced new products and colors for women's and children's "canvas shoe" segment, heavy advertising support, distribution strategy spring 1991 van houten and unni: strategy implementation 43 numerous new segments, concentrate on dept. stores segments, each targeted and fashion retailers.) by new competitors, generic type product no growth.) 14. kellogg rivalry, substitutes from unclear to industry dijfa'entiated (food processing) (internal: mgmt lost (internal: increased r&d touch with markets, spending, invested in new culture resistant to mfg. technology. external: change, outdated. mfg. increased advertising of facilities. external: brand, introduced new products demographic and lifeemphasizing nutritional value, style changes reduced attacked niches controlled by demand for sweet competitors with me-too tasting children's products, expanded into cereal, new mfg. foreign markets, launched technology.) twice as many new products as competitors.) 15. knight-ridder new entrants, rivalry from unclear to segment focus (publishing) (internal: diversified (internal: new ceo, new into tv stations, poor publishers at 1/3 of papers, relations with unions, sold unprofitable-unfocused poor printing plant tv stations, acquired specific efficiency. external: market cable stations. changing population in external: seeking newspaper key markets-hispanics, acquisitions, introduced suburbs-new printing spanish language supplements, technology, new cut ad rates, introduced zone competitors in latin editions for larger papers.) language papers and stations.) 16. miles laboratory rivalry no change: industry diii'erentiated division, ag (external: lifestyle (internal: reorganized 178 pharmaceuticals change toward over person sales force into (drugs) eating and drinking separate divisions for reduced industry doctors, food stores, and rx. demand for stomach external: new advt. agency, upset and hangover increase advl expenditures, remedies including product line extensions, atka-seltzer key joint advl with h&r block.) product, many new 44 journal ofbusiness strategies vol. 8,no.l products for same purpose introduced.) 17. mobil corp. rivalry from conglomerate to (oil and gas) (internal: expanded industry cost leadership into unrelated (internal: sold non-oil and industries, expanded gas businesses, sold stations service stations into too distant from refineries new regional markets, for low cost distribution, many unprofitable, shut down least efficient refinery technology refineries, purchased high outdated, unsuccessful tech. refinery from tenneco, at finding new oil renovated service stations, reserves. external: reduced corp. staff by 33%, gas use decline, new acquired superior oil to refinery technology.) increase reserves, investing in new exploration. external: opening new type of service station with fast food facilities in selected regional markets, marketing higher profit margin refinery products more aggressively.) 18. occidental rivalry from conglomerate to petroleum (internal: heavy debt industry differentiated (oil and gas) incurred to expand into (internal new coo taking unrelated businesses, over more of leadership from heavy demand for cash ceo, changing culture to flow, autocratic encourage broader mgmt. leadership of 90 year participation in decision old ceo and founder. making, sold non-eore external: gas use industry assets to pay down decline, new refinery debt, increase investment in tedmology.) oil exploration, forward integration into distribution, acquired chemical businesses.) 19. parker pen rivalry from unclear to segment focus (writing (internal: diversified (internal: ibo of pen instruments) into temporary division from parent in 1985, employment business with new ceo, cut production manpower acquisition. capacity. external: new external: slow growth advt. to emphasize premium pen of premium pen market, markets, increased advt. aggressive competition expenditures 60%, introduced spring 1991 vanhouten and unni: strategy implementation 45 new entrants, substitutes, from segment focus to 20. peugeot motors of america, di'risiou of peugeot corp. (automobiles) 21. salomon, inc. (financial services) 22. sea coutainer corp. (ferry and marine freight transport) among top 3 firms for low price pen market. new technology in mfg. low price pens.) new entrants, rivalry (internal: low parent understanding of u.s. market. poor dealer relations, limited dealer representation and service facilities in some locations. external: slower industry growth, changing customer design and style preferences, new mfg. technology, fluctuation in value of dollar vs. other currencies.) rivalry (internal: autocratic ceo, culture resisted change. external: rely heavily on largest aistomers, needs of larger customers becoming more diverse, new business financing methods and services being introduced by both old and new competitors.) substitutes (internal: expanded to mfg. and supply all types of oontainers, acquired numerous ferries-many new luxury pens, raised prices.) from unclear to segment focus (internal: new ceo, improved parts delivery, closer relations with dealers, and more participation by them in decisions. external: parent won "car of the year" award in europe, introduced it with inaeased advt.in u.s., narrow target mkt. advertising~ mail to ajstomers near dealer locations, cash awards for test drives. seeking new dealer outlets in target markets.) industry differentiated (internal: reshuffled top mgmt., provided incentives and internal partnership to reduce turnover, reauited experienced mgrs to run new institutional investment and banking depts, alt employees 10% to reduce costs, purchased a s & l. external: reposition firm as provider of broad services with larger customers, i.naease advt. of broader services to all, expand stock trading to asia.) from industry differm.tiated to segment focus (internal: alt payroll, closed unprofitable ferries, sold hq bldg and excess container capacity, shifted 46 journal ofbusiness strategies vol. 8, no.1 23. sears, roebuck and co. (discount and fashion retailing) 24. tiffany and co. (jewelry) 25. union pacific (railroad) unprofitable, excess mfg. and transport capacity. external: shipping industry losing share to other transporters. overall no growth. helicopters and airlines competing with ferries.) new entrants, suppliers (internal: culture resistant to change, many unprofitable locations, productivity per square foot and employee is low. external: homogeneous market splitting into price and specialty store segments, many new competitors for each, customers less willing to buy store brands.) new entrants, rivalry (internal: purchased by avon in 1979 and changed emphasis to midprice premium items from unique-exclusive items, name recognition is primary asset-but losing awareness. external: gold price fluctuations, style changes, dept. stores and other entrants into premium jewelry, slow growth in market.) substitutes (internal: 74 year old ceo unwilling to change, poor union relations, mig to specialty containers. external: acquired hoverspeed, acquired additional european ferries with strong mkt positions, refurbished remaining ferries.) from industry differentiated to industry cost leadership (internal: selling hq bldg, closing unprofitable stores, reducing number models carried to control inv. costs, cut promotional expenses. external: redesign stores, discount all items, discontinue annual sales promotions, opening new specialty children's stores, testing superstore concept.) from industry differentiated to segment focus (internal: leveraged buyout from avon in 1984, sold existing merchandise and replaced with unique-high priced items. external: new advt agency and ads, increased advt budget, started prestige catalogue business. added luxury fragrances, purses and silk scarves to branded category, made stores avail for high prestige charity events.) from unclear to industry cost leadership (internal: new ceo, sold hq in ny and moved to bethlehem, spring 1991 van houten and unni: strategy implementation 47 high wage costs and restrictive work rules. external: deregulation increased price competition for traditional r.r. dominated commodity transport, airline fares declined, market demanding more comfort and more dependable service. new scheduling and communications technology.) pa, reduced layers of mgmt., cut jobs, closed outdated repair yards, tied sr. mgmt. compensation to performance, created customer service culture. external: est. a new natl. account sales staff for large customers, replaced distr. system of freight forwarding agents with national service center using computer technology.) discussion and conclusions the relationships between the specific environmental forces and selected competitive strategy are shown in table 3. table 3 environment f!!m no. firms alj'ectecj selected competitive strategy cost j pdership differentiation sejpnent focus buyers new entrants rivalry substitutes suppliers 2 12 18 7 3 1 3 4 i i o 3 7 3 o i 6 7 3 2 the data does not suggest any dominance of certain environment forces, in-and-of themselves that may lead to specific competitive strategy choice. this is not in conflict with the porter model, which states, "the best strategy for a given firm is ultimately a unique construction" [14]. the common requirements to effectively implement each strategy, as described by porter, and the number of firms in this study that possess each of these requirements are summarized in table 4. 48 journal ofbusiness strategies table 4 portion of firms in study that possess the most common requirements for the selected strategy vol. 8,no.1 strat.e2y skills or resources common qmnization regpirmen1s cost leadership (total: 7) access to capital (7) engineering skills (4) i.abor supervision (2) easy to mfg. prods (4) tight cost control detailed reports structured organization special mgmt. incentives (7) (0) (5) (1) at least one of above at least two of above three or more of above 7 7 4 7 5 1 industry differentiation (total: 7) marketing skill (5) engineering skill (3) creative (4) skilled employees (4) unique skill (7) strong internal coord. (5) subjective perf. measure (2) amenities to attract strong r&d (4) reputation (4) channel cooper (4) at least one of above at least two of above at least three of above four or more of above 7 7 5 5 6 3 2 na segment focus (total: 11) some combination of the above cost or differentiation strengths aimed at a particular segment at least one of above at least two of above at least three of above four or more of above 11 11 8 3 it should be noted that the data in table 4 are the minimum number of satisfied criteria, because not all of the criteria could be verified for each firm from the articles reviewed. for example, the common requirement for ''detailed reports" for the "cost leadership strategy" was mentioned in none of the articles, but seems likely to exist in at least some of the firms. only five of the twenty-five firms reviewed seemed to have situational factors that were in opposition to the selected strategy. despite these five possible conflicts, the model seems to do a good job reflecting the real world in the overall. all firms have at least some of the strengths needed to implement their selected competitive strategies. and the majority of the firms have all but one or two. spring 1991 van houten and unni: strategy implementation 49 table 5 summarizes the percentage of firms in each competitive strategy category taking each of the general actions identified in the literature review. table 5 portions of firms taking each management action competitive strategy cate&oa nurerentiatjon cost leadership eggg organization decentralize dec. making 29% 14% 9% change culture 57 29 18 replace ceo 14 14 64 redesign mgml incentives 14 14 0 cost/expense reduce mgml 14 71 9 sell unprofitable assets 29 57 18 oit /i employees 14 43 27 cose unprofit locations 14 29 18 sell non-core businesses 14 14 36 renegotiate wages/rules 0 29 0 marketing change advt. agency 14 0 18 change advt. strategy 43 0 36 increase advt. $ 57 14 36 change distr. system 43 29 18 r&d/product dev. invest in r&d 29 29 0 add new products 71 43 45 cut no. products 0 14 18 core business expansion acquisition 29 43 54 joint venture 14 14 27 invest new tech. 29 86 9 add facilities 14 14 27 new geog. mkts. 43 29 18 udrlated bus. expansion acquisition 43 0 0 core and unrelated bus. acquisition 72 43 54 50 joumalofbusiness strategies' vol. 8, no.1 firms implementing a product differentiation strategy were most likely to take actions to acquire additional businesses and add new products. they were least likely to cut their product portfolios or make it a high priority to renegotiate wage rates or work rules. firms implementing a cost leadership strategy were most likely to take actions to invest in new technology, reduce management levels, and sell unprofitable assets. th((y were least likely to acquire businesses unrelated to their core industry or to change advertising. firms implementing a segment focus strategy were most likely to take actions to replace their ceo and acquire additional businesses related to their core industry. all the above action patterns are similar to the strategic choice options indicated in the porter's model, and seem to relate logically to the general direction implied by each strategy. the conceptual nature of this study makes it impossible to quantitatively conclude that the porter model is supported by the actions taken by :firms in the real world. the lack of conflict between the model and paper indicate that the model fits the actions taken by at least some :firms in the real world. however, in some firm comparisons, the results did not support the validity of porter's model and suggest further study in these few specific areas. references 1. ansoff, lh. and mcdonnell, e.j. implanting strategic management. new york: prentice hall (1990). 2. dobrzynski, judith. "is john gutfreund dreaming an impossible dream?" business week (february, 1989), pp. 98-103. 3. hannon, k. ''fast, fast relief for sour sales." forbes (december, 1988), pp. 252-254. 4. heins, j. "back on course." forbes (october, 1988), pp. 66-68. 5. heins, j. "unhealthy growth." forbes (february, 1989), p. 56. 6. henkoff, r "this cat is acting uke a tiger." fortune (december, 1988), pp. 70-76 7. jereski, l "back in the game." forbes (october, 1988), pp.i48-150. 8. kitchen, s. "riding the crest of the raves." forbes (october, 1988), pp. 140-142. 9. labich, k. "the big comeback at british airways." fortune (december, 1988), pp. 70-76. 10. lappen, a "no jokes please." forbes (november, 1988), pp. 117-120. 11. mack, t. "integrated-and determined to stay that way." forbes (december, 1988), pp. 78-85. 12. mack, t. "murphy's law." foibes (march, 1988), pp. 174-176. spring 1991 van houten and unni: strategy implementation 51 13. mavcom, j. jr. "penmanship with a flourish." forbes (april, 1989), pp.152-154. 14. porter, m.e. competitive strategy; techniques for analyzing industries and competitors. the free press division, new york: mcmillan publishing co., inc. (1980). 15. porter, m.e. competitive advantage. the free press division, new york: mcmillan publishing co., inc. (1985). 16. ramirez, a.. "hammer hits 9o! oxy grown up too." fortune (november, 1988), pp. 59-64. 17. schillev, z. "can bridgestone make the climb?" business week (february, 1989), pp. 78-79. 18. schine, e., and freidman, j. "life after boyd? and how." business week (march, 1989), pp.143. 19. schroeder,m. "allan fellheimer wears combat boots." business week (march, 1989),pp.119120. 20. sellers, p. ''how king kellogg beat the blahs." fortune (august, 1988), pp. 54-55. 21. sherman, s. ''the smutty story of cabot corp." fortune (december, 1988), pp. 130-138. 22. taylor, j. "knight-ridder shifts into high gear." forbes (august, 1988), pp. 62-64. 23. trachtenberg, j. "cocktails at tiffany." forbes (february, 1989), pp. 128-130. 24. weiner, s. "calling betty crocker." forbes (august, 1988), pp. 88-89. 25. weiner, s. "don't write sears off." forbes (november, 1988), pp. 196-200. 26. weiner, s. "poor customers, rich profits." forbes (march, 1989), pp. 145-146. 27. willoughby, j. "the rebuilding ofunele pete." forbes (november, 1988), pp. 182-190. 28. woods, w. '7he u.s. must do what g.m. has done." fortune (february, 1989), pp. 70-73. strategy implementation: a conceptual review of practical applications note a note on the measurement of service quality-a (frmnnlv) critique of stank kelly c. strong steven a. taylor illinois state university normal, dlinois introduction theodore stank's (1993) recent article in the journal of business strategies offers a timely discussion of the importance of quality as a strategic tool within service industries. we emphatically agree with his argument that improving service quality is an effective way to gain competitive advantage through differentiation. we also applaud his suggestion that quality must be consistently and effectively measured from the customer's perspective. stank should also be commended for suggesting that service firms should consider service quality feedback prior to making resource allocation decisions within the context of strategic planning. in short, we are delighted to see that the special needs of service firms are receiving attention within the strategy literature and that quality of service is being discussed in strategic terms instead of being narrowly treated as a marketing construct. because we believe there to be a chronic shortage of illuminating discussions of strategies for service firms, (including quality assessment), we are reluctant to criticize one of the few service quality/service strategy articles published in a strategy journal. therefore, we wish to emphasize the adjective "friendly" in the title to this note. we do not wish to detract from the importance of service quality in developing strategies for service firms. however, we feel management educators, strategy researchers, and strategic decision makers should be aware of the rapidly evolving literature and research on service quality assessment which calls into question the foundations of the servqual (parasuraman, zeitharnl, and berry 1985; 1988; 1991) scale which forms the basis of stank's recommended method. the servqual scale (parasuraman, zeitharnl, and berry 1985; 1988; 1991; hereafter referred to as pzb) was devised and promoted as a generalizable instrument for measuring service quality across a variety of service industries. the logistics service quality measurement tool proposed by stank (1993) is based largely on the servqual scale, with minor adaptations tailored to the nuances of the logistics setting. thus, it would appear that many of the criticlsms being leveled at the servqual scale in the emerging literature apply equally to the logistics service quality instrument offered by stank. in the following section, we will attempt to present a summary of those criticisms, and will then offer some suggestions for future directions in service quality assessment. spring 1994 strong & taylor: measurement ofservice summary of findings regarding the servqual scale 77 the theory upon which the servqual scale is based was developed through exploratory focus--group research conducted by pzb (1985, 1988). from these focus--group interviews with consumers and managers, pzb concluded that customers bring some prior expectation of firm performance to a service encounter, and then compare their perceptions of the firm's actual performance with this preconceived expectation. this comparison of expected performance to perceived performance, termed expectancy disconfumation, forms the basis of service quality within the servqual methodology advocated by pzb. expectancy disconfirmation and its relationship to service quality are depicted in equation 1. service quality = f(perceptionsperformance expectationsperformance) [1] the crux of equation [1] is that service quality is a function of the gap between perceptions of performance and expectations of performance. when perceptions of performance meet or exceed expectations, positive service quality is perceived. when perceptions of performance are less than or equal to expectations, poor quality service is perceived. therefore, in order to measure service quality using equation [1], both perceptions of performance and expectations of performance must be captured. some strategy scholars (e.g. quinn 1992; stank 1993) have recently recommended the servqual scale (c.f., pzb 1988) as a survey instrument that purports to serve this purpose with broad generalizability and reliability across alternative service settings. in other words, consistent with pzb (1988), these strategists would argue that the servqual scale can and should be generalizable to alternative service settings such as logistics service quality. however, a number of emerging studies are questioning the use of the servqual scale as a basis for measuring service quality. criticisms of the conceptual arguments underlying the servqual model the first major criticism of the servqual scale was reported by cronin and taylor (1992). cronin and taylor present an empirical analysis demonstrating that the perceptionsperfolillllllcc measures alone in equation [1] explain more of the variance in overall service quality perceptions than does the entire expectancy disconfirmation equation. since a single variable from the servqual formula explains more variance in service quality perception than does the derivative of that formula, one can only conclude that the theoretical foundations of the servqual scale appear flawed. (at the risk of oversimplifying the argument, if one assumes that k is a function of i+j, but i explains more of k's variance than does i+j, then one must assume that i+j has no theoretical based relationship to k). specifically, cronin and taylor (1992) argue that the expectancy disconfirmation model was inappropriately generalized by pzb from the consumer satisfaction literature (c.f. oliver 1980) to explain service quality perceptions and suggest the simplified relationship described in equation 2 as a more appropriate model of service quality. 78 journal ofbusiness strategies service quality = f(perceptionperformance) vol. 11, no.1 [2] subsequent research appears to support this argument, although readers should be aware that the debate in the literature is ongoing. oliver (1993a), who developed the original expectancy disconfirmation model in 1980, recently reviewed the service quality and consumer satisfaction literature and concluded that service quality perceptions are sepa· rate from consumer satisfaction judgments along at least three dimensions (also see patterson and johnson (1993) for a similar discussion reaching similar conclusions, 1) the domains of service quality and consumer satisfaction are different (i.e., they are conceptually different things). service quality is best considered a long-term attitude reflecting service superiority or excellence while consumer satisfaction is a transitory judgment reflecting fulfillment. 2) service quality perceptions can develop in the absence of personal experience whereas consumer satisfaction requires personal experience. 3) service quality perceptions appear to be antecedents to consumer satisfaction judgments (i.e., quality satisfaction). taylor (1993) extends these arguments by developing a model of consumer decision making that reconciles the emerging evidence concerning the conceptual domains of the relevant constructs. taylor suggests that prior to personally experiencing a service provider, initial service quality perceptions can be based on communication influences and vicarious experiences through friends, relatives, and coworkers. however, once a person has a personal experience, service quality becomes an aggregate representation of the summed influences of their previous service quality attitudes and their most recent satisfaction judgment from a service encounter (see equation 3). service qualityl+l = f (service qualityt_l' satisfaction) [3] these models are at odds with the most recent servqual conceptualization. that is, the original authors of the servqual scale have maintained their support for the expectancy disconfumation model of service quality in spite of the growing arguments against the model. zeithaml, berry, and parasuraman (1993) recently present a response to the growing criticisms of the conceptual underpinnings of the servqual scale. here the authors modify their original position by suggesting that both consumer satis· faction judgments and service quality can form from the expectancy disconfumation process. importantly, there is no empirical evidence to date supporting this attenuated position. however, there is empirical evidence to support other models that do not appear reconcilable with the gap model. for example, teas (1993) recently assesses the servqual scale and concludes from a comprehensive empirical analysis that the gap formulation recommended by pzb appears to exhibit questionable validity. indeed, in a recent article on service quality by one of the original authors of the servqual scale report results that they themselves suggest appear inconsistent with the gap model (boulding, kalta, staelin and zeitharnl 1993). spring 1994 strong & taylor: measurement ofservice 79 the satisfaction literature similarly appears to support the argument that expectancy disconfinnation should not be used in service quality measurement. oliver (1993b) presents a compelling empirical analysis of consumer satisfaction which demonstrates that consumer satisfaction judgments result from the influences of both expectancy disconfinnation and (positive and negative) affect. we suggest that the weight of the evidence supports the position that expectancy disconfinnation belongs in models of consumer satisfaction and not service quality. equation [4] presents the model of consumer satisfaction empirically validated by oliver (1993b). consumer satisfactiont+l = f(affect., disconfirmationt> qualityt_l) [4] thus, the emerging literature and empirical evidence do not support the gap model advocated by parasuraman, zeithaml, and berry for service quality measurement (i.e., servqual). rather, the evidence supports the position that service quality should be measured by perceptions of service-firm performance only (see [2]), while satisfaction is unique from service quality and best modeled as equation [4]. this may lead one to wonder whether expectationsperformance are at all useful from a managerial or research perspective. we suggest that they are, however, only as a unique construct. boulding et al (1993) have recently presented evidence that consumers' expectations of what service firms should and will provide exerts a positive influence on subsequent service quality judgments. this suggests that while the gap measures advocated by pzb, and by extension stanks, may not be useful, expectations and perceptions of performance evaluations can contribute to a better understanding of consumer decision-making processes when treated as unique constructs. empirical criticisms of the servqual scale the psychometric properties of the servqual survey instrument have also recently been criticized by a number of authors. cronin and taylor (1992) were the first to point out that the generalizability of the servqual scale appears suspect. specifically, cronin and taylor (1992) found that the factor structure underlying data collected using the servqual scale varies across service settings. this led cronin and taylor (1992) to suggest that the individual scales for expectations and performance perceptions be treated as unidimensional scales and summed-and-averaged in analysis. 1 babalrus and boller (1992) empirically assessed the psychometric properties of the servqual scale and report findings that support the conclusions of cronin and taylor (1992). specifically, these authors also found that the dimensionality of service quality data captured using the servqual instrument appears to depend on the type of services under investigation. babakus and boller additionally found that the practices of using mixed-word item wording and the general use of gap measures should be approached with caution. brown, churchill, and peter (1993) recently report an additional assessment of the psychometric properties of the servqual scale and also report serious problems from their analyses. first, higher reliabilities are found with the performance-based measures 80 journal ofbusiness strategies vol. 11, no.1 of service quality than the gap-based measures advocated in servqual (c.f., cronin and taylor 1992). second, the servqual items failed to achieve discriminant validity from its component parts. third, the servqual scale items tend to exhibit variance restriction. finally, the distribution of servqual scores are reported as nonnormal in their study. readers interested in further exploring these issues are directed to a recent debate in print concerning the relative merits of these models (c.f., cronin and taylor 1994; parasuraman, zeithaml, and berry 1994; teas 1994). a final note concerns the use of importance weights in models of service quality. stank argues that the addition of importance weights is important for measuring logistics service quality. however, we ask that strategic decision makers take care to ensure that the data support this call in their own specific setting. cronin and taylor (1992) present evidence that not only do importance weights fail to contribute to the explained variance in many service settings, they can actually reduce one's ability to explain variations in service quality perceptions. recommendations for future research a number of recommendations are apparent for consideration by strategists. first, researchers should identify as a high priority the identification of reliable and valid sets of scale items that can serve as measures of service quality and satisfaction in models of organizational strategy. a fundamental challenge in achieving this end will be achieving discriminant validity between the measures. second, research investigating the antecedents and outcomes of service quality from a strategic perspective appears warranted. third, ascertaining if there are perceived differences between the internal and external constituencies of the organization's service quality should be investigated. the impact of these differences, if any, can then be assessed relative to such important constructs as leadership, organizational culture, and firm performance. summary the preceding discussion attempts to inform strategic managers and researchers of the rapidly evolving literature concerning the service quality and consumer satisfaction constructs. we take the position that dialogue and interdisciplinary efforts enhance our understanding of shared problems in the social sciences. we support stank's (1993) call for using consumer service quality judgments in strategic decision-making processes and hope that this discussion enhances these actions. clearly, strategic management must be approached from a quality enhancement framework (quinn 1992; drucker 1992) for all firms, including service organizations (nayyar 1992). this suggests the need for quality assessment tools designed for use within the service setting. the servqual scale as recommended by stank (1993) represents a noble start in the right direction, but strategists should be aware that the weight of the evidence suggests that it is not adequate in its current form and method. we caution both researchers interested in service quality and service finn executives to be fully aware spring 1994 strong & taylor: measurement ofservice 81 of what they are (and are not) getting when they use the servqual method of service quality assessment. endnote 1 cronin and taylor (1992) in effect suggest using these two set of items as indices rather than as factor-based scales. the difference is that an index is an exact linear combination of observed items. the dimensionality of the items of an index used as an observed variable is not relevant. references babakus, e. and g.w. boller (1992). "an empirical assessment of the servqual scale." journal of business research 24: 253-268. brown, t.j., ga churchill, and j.p. peter (1993). "improving the measurement of service quality." journal of retailing 69 (1): 127-39. boulding, william, ajay kalra, richard staelin, and valeri~ zeithaml (1993). "a dynamic pro-cess model of service quality: from expectations to behavioral intentions." journal of marketing research xxx: 2-27. carman, j.h. 1990. "consumer perceptions of service quality: an assessment of the servqual dimensions." journal of retailing 66 (1): 33-55. cronin, j., and s.a taylor (1992). "measuring service quality: a reexamination and extension." journal of marketing 56 (july): 55--68. cronin, j., and s.a taylor (1994). "servperf versus servqual: reconciling performance-based and perceptions-minus-expectations measurement of service quality." journal of marketing 58 (1), 125-3 1. drucker, p. (1992). managing for the future: the 19908 and beyond. new york: truman talley books/dutton. nayyar, p.r. (1992). "performance effects of information asymmetry and economies of scope in diversified service firms." academy of management journal 36 (1): 2b-57. oliver, richard l. (1980), "a cognitive model of the antecedents and consequences of satisfaction decisions." journal of marketing research xvii (november 1980): 460-469. oliver, richard l. (1993a), "a conceptual model of service quality and service satisfaction: compatible goals, different concepts." in advances in services marketing and management 2: 65-85. 82 journal ofbusiness strategies vol. 11, no.1 oliver, richard l. (1993b). "cognitive, affective, and attribute bases of the satisfaction response." journal of consumer research 20 (december): 418-30. parasuraman, a, v.a zeithaml, and l.l. berry (1985), "a conceptual model of service quality and its implications for future research." journal of marketing 49 (fall): 41-50. parasuraman, a, v.a zeithaml, and l.l. berry (1988), "servqual: a multiple-item scale for measuring consumer perceptions of service quality," journal of retailing 64 (1) 1240. parasuraman, a, v a zeithaml, and l.l. berry (1991), "refmement and reassessment of the servqual scale." journal of retailing 67 (4): 420-450. parasuraman, a, va zeithaml, and l.l. berry (1994). "reassessment of expectations as a comparison standard in measuring service quality: implications for future research," journal of marketing 58 (1), 111-24. patterson, paul g. and lester w. johnson (1993). "disconfirmation of expectations and the gap model of service quality: an integrated paradigm." journal of consumer satisfaction, dissatisfaction, and complaining behavior volume 6, 90-9. quinn, j.b. (1992), intelligent entemrise. new york: the free press. stank, t. (l993), "measuring logistics service quality." journal of business strategies 10 (spring): 51-62. taylor, steven a (1993). "the roles of service quality, consumer satisfaction, and value in quinn's (1992) paradigm of services." the journal of marketing theory and practice volume 2, number 1, (fall 1993): 14-26. teas, r. kenneth (1993). "expectations, performance evaluation, and consumers' perceptions of quality." journal of marketing 57 (4): 18-34. teas, r. kenneth (1994). ''expectations as a comparison standard in measuring service quality: an assessment of a reassessment," journal of marketing 58 (1), 132-9. zeitharnl, valerie a, leonard l. berry, and a parasuraman (1993). "the nature and detenninants of customer expectations of service." journal of the academy of marketing science 21 (1): 1-12. a note on the measurement of service quality-a (friendly) critique of stank corporate disclosure quality and social performance ahmed riahi-belkaoui university of illinois at chicago chicago,il abstract corporate audiences rate the social performance of firms by interpreting information signals about the firms from various monitors. of importance to these parties are signals about corporate disclosure quality. the results of an empirical study of large u.s. firms supported the general hypothesis that corporate audiences rate the social performance offirms on the basis of information about firms' corporate disclosure quality in addition to market and accounting signals indicating the size ofthe assets, market assessment of the value assets in place and rate of return on assets. introduction this paper investigates the link between a firm's overall disclosure quality and its social performance. this study adds to the growing literature on the detenninants of social performance by suggesting that corporate audiences rate the social performance of firms by interpreting information signals about the firm's corporate disclosure quality. what results is that firms that consistently make timely and informative disclosures are more likely to avoid withholding value-relevant unfavorable economic and social information. consequently these firms are given a high social performance rating. the resu its of this study conform to the above argument. a firm's social performance is measured by executives' evaluation of corporate practices, available annually from fortune magazine. a firm's disclosure policy is measured by financial analysts' evaluation and corporate disclosures policy available from the annual volume of the report of the financial analysts federation corporate information committee. results show that the measure of social performance is positively related to the disclosure measure, after controlling for market and accounting signals indicating the size of the assets, market assessment of the value of assets in place and rate of return on assets. the study extends the investigation of both the determinants of social performance and the consequences of disclosure quality by showing evidence of a link between disclosure quality and social performance of large u.s. firms. 92 journal of business strategies hypothesis development vol. 18, no.1 corporate social responsibility or social performance involves a continuance of social responsive activities that goes from profit-making only (friedman, 1962); going beyond profit-making (backman, 1975; davis, 1960); going beyond economic/legal requirements (mcguire, 1963); voluntary activities (manne & wallich, 1972); economic, legal, and voluntary activities (steinen, 1972); concentric, everwidening circles of influence (committee for economic development, 1971; davis & b1oomstrom, 1975); concern for the broader social system (elles & walton, 1961); responsibility in a number of social problem areas (hay, gray & gates, 1976); giving way to social responsiveness (ackerman & bauer, 1976; riahibelkaoui, 1999a, 1999b, 1984; sethi, 1975); and doing what society and the customer pay us for (drucker, 1977). however, given that business receives its legitimation from society, social performance is best defined as the accomplishment or the perception of accomplishment of the desired ends of society in terms of moral, economic, legal, ethical, and discretionary expectations (murray & montani, 1986). management may seek the accomplishment by looking at corporate social responsibility as a "product" offered to key publics. this marketing philosophy of social responsibility management, as proposed by murray and montani (1986), involves both a production and selling aspect. the production function involves the implementation of socially beneficial activities. the selling aspect of social performance is viewed as the public indoctrination by means of corporate disclosure. as a result corporate audiences will likely assess the social performance of a firm based on the firm's disclosure practices. they may be inclined to examine the adequacy of disclosure in annual and quarterly reports, the frequency of press releases and the availability of timely information to financial analysts. if a firm sores high on these actions, it may be perceived as having achieved quality in its corporate disclosures. it may follow that corporate audiences will attach a lower probability that the firm has withheld adverse private information and assign to it a high social performance ranking. this leads to the main hypothesis of the study: hypothesis 1: a firm 's social performance is positively related to the quality of its disclosures. methodology the impact of corporate disclosures in a firm's social performance is examined using the following model: sop l +1=f ( disci' control variables) (1) where sopi+1 is the social performance ranking issued in year t+ 1 and disci is a measure of disclosure quality over a period of years ending in year t. equation spring 2001 riahi-belkaoui: corporate disclosure quality 93 (l) shows social performance as a function of disclosure quality and a set of control variables. all the variables are discussed below. measure of social performance (sop) the social performance measure was derived from the annual survey of corporate reputation by fortune magazine. the survey, covering thirty-three industry groupings, asked executives, directors and analysts in particular industries to rate companies in the following eight key attributes ofreputations: (i) quality of management, (2) quality of products/ service offered, (3) innovativeness, (4) value as a long term investment, (5) soundness of financial position, (6) ability to attract/ develop/ keep talented people, (7) responsibility to the community, environment, and (8) wise use of corporate assets. ratings are on a scale of 0 (poor) to 10 (excellent). social performance of each company is measured by the score obtained in item 7 of the organizational effectiveness instrument. namely, responsibility to the community/ environment. the control variables the control variables were selected on the basis of a survey of prior research on the determinants of social performance (ullman, 1985). they were identified in these studies as being positively related to social performance. these studies typically explain social performance building for large u.s. firms in terms of market and accounting signals of performance. based on these studies, the following control variables were included. roa: rate of return on assets. a firm's efficient use of its assets is best reflected by its rate of return in assets. corporate audiences will assign better social performance ratings to firms with greater roas. lr: logarithm of total revenues as a measure of size. corporate audiences better appreciate the information quality of larger firms and assign them a better social performance ranking. qv: the market value relative to the accounting value, denoted "q-value," is computed as the ratio of the market value of the firm to the book value of its assets. as both a measure of managerial performance and a measure of agency costs, qv can also be interpreted as a signal of asset management performance. corporate audiences will assign a better social performance to firms with greater qv. (the "q-value" also used in smith and watts (1991) is found to be highly correlated with tobin's q). the disclosure quality measurement (disc) to measure disclosure quality, this study uses data from the annual volumes of the report of the financial analysts federation corporate information committee (faf 1986-1990). it is generally considered as a comprehensi ve measure of the informativeness of a firm's disclosure policy (lang & lundholm, 1993, 1996; farragher et.al., 1984; welker, 1995; sengupta, 1998; botosan, 1997). 94 journal of business strategies vol. 18, no. 1 sopit = disc = 11 the data measures the firm's effectiveness in communicating with investors and the extent to which the firm provides information so that investors have the information necessary to make informed judgments across all types of disclosures. the disclosures provided through annual reports, quarterly reports, proxy statements, published information in the form of press releases and fact books, and direct disclosures to and communications with analysts are used for the evaluation of the firm's disclosure practices. in the faf report, analysts evaluate the complete range of a firm's disclosures, summarize their evaluations by a score (out of 100 possible points) on the firm's total disclosure efforts and separate scores for the different disclosure categories. although these scores are based on analysts' perceptions of corporate disclosures practices any potential biases or errors are minimized by a procedure that a) requires the reporting of average scores (across industry analysts), and b) rests on the use of detailed guidelines and a comprehensive checklists of criteria that allow a standardization of the rating process both within and across industries. because corporate audiences may be expected to consider both past and present disclosures in their social performance assessments, the disclosure metric, disc, to be used in this study is the average of the total disclosure score of a firm over three consecutive years (years t, t-l, and t-2). the model the main hypothesis may be expressed by the following model: sop il = a lll + a lt disc it + a 2t lr i \ + a 3t roa jt + a 4t qv il + e it (2) where score on responsibility to the community/ environment average of total faf disclosure score over the years t, t-l, and t-2. lr jt = logarithm of total revenues at the end of year t. roa = rate of return on assets in year 1. it qv it = qvalue computed as total market value in year over total assets of year t. a j = regression coefficient. e. = residual term. it the model states that the score assigned to responsibility to the communityl environment, as a measure of social performance, is a function of the level of corporate disclosure quality after controlling for the size, profitability and market to accounting value of the firm. the regression coefficients measure the relative impact of each of the independent variables of disclosure quality, size, profitability and market to accounting value on the social performance score assigned to the firm. basically, a knowledge of the level of disclosure quality, size, profitability and market value to accounting value can be used to determine and lor explain the level of social performance assigned to a firm by external corporate audiences. the model was run for the 1986-1990 period. spring 2001 riahi-belkaoui: corporate disclosure quality sample 95 to secure the greatest sample of firms for which data would be available for all variables the initial sample chosen was for all firms included in both fortune's 1986 to 1990 studies of corporate reputation and in the annual volumes of the report of the financial analysts federation corporate information committee (faf 1986-1990). the disclosure scores of each firm were averaged over three consecutive years (years t, t-l, and t-2) to obtain the disclosure metric (disc) capturing a firm's current and past corporate disclosure performance. accounting data for these firms' control variables were obtained from standard and poor's compustat industrial and business segment tapes. the final sample was 347 firm-year observations. results descriptive statistics and correlation analysis table 1 presents the descriptive statistics for all the variables used for the study. the median disclosure score is 56.31. a wide dispersion of the score is present with a minimum of 47.31, a maximum of76.73, and a standard deviation of 6.89. the median of logarithm of revenues of 9.027 indicates a sample of large u.s. firms, with a wide variation as indicated by the minimum and maximum values. the social performance score also varies across firms with a minimum of 3.90 and a maximum of 8.51. table 2 presents the intercorrelations among the variables used in the study. the low intercorrelation among the predictor variables used in the model indicates no reasons to suspect multicollinearity, and various diagnostic tests run on the derived regression model confirmed that it was not a problem. effect of disclosure quality on social performance the test of hi is performed by running regression (2). table 3 presents the results of the regression coefficients for all the independent variables, using the social performance score as the dependent variable. the breusch and pagan (1979) test for heteroscedasticity yielded an x2 of a minimum of 132.16 and a maximum of 152.13 for the regression, indicating that heterosccdasticity could be a problem. accordingly, the reported t-statistics are based on white's (1980) heteroscedasticity corrected covariance matrix. hypothesis i predicts that corporate disclosure quality will positively affect social performance. the results appear to support the hypothesis that corporate audiences tend to assign higher (better) social performance ranking to firms with better corporate disclosure. the control variables were all significant and have the expected signs, supporting the results of previous research on the determinants of social performance. 96 journal of business strategies table 1 summary statistics and variable definitions. vol 18, no.1 panel a: summary statistics standard median variables number mean deviation (6.621) minimum maximum sop 374 6.47 0.607 6.45 3.98 8.51 disc 374 57.86 6.89 56.31 47.31 76.7 roa 374 0.057 0.05 0.057 0.08 0.2 lr 374 9.195 0.896 9.027 7.74 11.75 qv 374 0.8949 0.79 0.665 0.01 5.00 panel b: variable definitions sop : social performance score disc : faf disclosure score roa : rate of return on assets lr : logarithm of total revenues qv : qvalue computed table 2 correlations among selected variables* sop disc roa lr qv sop disc roa lr qv l.000 -0.00053 0.460 0.108 0.4495 0.00 (0.304) (0.0001) (0.036) (0.0001) l.000 -0.285 0.499 -0.457 0.00 (0.0001) (0.000l) (0.0001) load -0.136 0.459 0.00 (0.0004) (0.0001) 1.000 -0.320 0.00 (0.0001) 1.000 0.00 '" p-values for two-tailed tests are provided in parentheses. variables are defined in panel b of table l spring 2001 riahi-belkaoui: corporate disclosure quality table 3 explaining social performance 97 dependent adjusted variable intercept disc lr roa qv f r2 responsibility 3.412 0.006 0.315 2.042 0.472 46.323 32.65 to communityl (8.105)* (1.769)** (4.494)* (2.083)* (6.679)* environment variables are defined in panel b of table i. *absolute value of t-statistics in parenthesis, significant at a=o.oi **significant at 5=0.05. conclusion the paper has hypothesized that corporate audiences will assign social performance ranking on the basis of a firm's overall disclosure quality. more significantly, the results of an empirical study of large u.s. firms supported the general hypothesis that interested corporate audiences assign social performance ranking on the basis of information about a firm's overall disclosure policy in addition to market and accounting signals indicating the size of the firm, the market assessment of the value of assets and the rate of return on assets. firms appear to "sell" the social performance as a product to key publics through their disclosure policies in a way indoctrinating them and securing a societal support as a result of a blind conditioning process (murray & montanani, 1986). they may be assuming that the publics are cynical in their views of a firm's social responsibility but can be induced to alter their opinions and attitudes toward the firm after exposure to a firm's overall disclosures. references ackerman, r. w. & bauer, r. a. (1975). corqorate social responsiveness. reston, va: reston publishing. backman, j. (1975). social responsibility and accountability. new york: university press. botosan, c. (1997). disclosure level of the cost of equity capital. the accounting review. 72, july, 323-349. breusch, t. & pagan, a. (1979). a simple test for the heteroscedaticity and random coefficient variation. econometrica. 47, 1287-1294. 98 journal of business strategies vol. 18, no.1 committee for economic development. (1971). social responsibilities of business corporations. new york: committee for economic development. davis, k. (1960). can business afford to ignore social responsibilities? california management review, 2 (3), 70-76. drucker, p. f. (1977). people and performance. new york: harper & row. eelles, r. & walton, c. (1961). conceptual foundations of business. homewood, il: irwin. farragher, e., kleiman, r. & baza, m. (1994). do investor's relations make a difference? quarterly review of economics and finance, 34, winter, 403-412. financial analysts federation (faf). (1986-1990). report of the financial analysts federation corporate information committee. new york: faf. friedman, m. (1962). capitalism and freedom. chicago: university of chicago press. hay, r. d., gray, e. r. & gates, j. e. (1976). business and society. cincinatti: southwestern. lang, m. & lundholm, r. (1993). cross-sectional determinants of analyst ratings of corporate disclosure. journal of accounting research, 31, autumn, 246-271. -----, and . (1996). corporate disclosure policy and analyst behavior. the accounting review, 71, october, 467-492. manne, h. & wallich, h.c. (1972). the modern corporation and social responsibility. washington, dc: american enterprise institute for public policy research. mcguire, j.w. (1963). business and society. new york: mcgraw-hili. murray, h. b. & montanani, j. r. (1986). strategic management of the socially responsible firm: integrative management and marketing theory. academy of management review, 11, 815-827. riahi-belkaoui, a. (1999a). corporate social awareness and financial outcomes. westport, ct: greenwood publishing. -----( 1999b). social responsibility, internalization and market valuation. journal of global business. 10: 65-72. ----(1984). socia-economic accounting. westport, ct: greenwood publishing. spring 2001 riahi-belkaoui: corporate disclosure quality 99 sengupta, p. (1998). corporate disclosure quality and the cost of debt. the accounting review, 4, october, 459-474. steiner, g. a. (1972). social policies for business. california management review, 15 (2), 17-24. smith, c. w. & watts, r. (1992). the investment opportunity set and corporate financing, dividend, and compensation policies. journal of financial economics, 263-92. ullman, ariel a. (1985). data in search of a theory: a critical examination of the relationship among social performance, social disclosure and economic performance of u,s. firms. the academy of management review. 10,540-557. welker, m. (1995). disclosure policy, information asymmetry and liquidity in equity markets. contemporary accounting research, 11, spring, 801-827. white, h (1980). a heteroscedasticity-consistent covariance matrix estimator and a direct test for heteroscedasticity. econometrica. 48, 817-838. ahmed riahi-relkaoui is a era distinguished professor of accounting at the university of illinois at chicago. he received his ph.d in accounting from syracuse university in 1972. professor riahi-belkaoui has also taught at the university of chicago, the university of ottawa and sherbrooke university. he has published 66 books and in many journals. his research interests focus on the empirical analysis of the effectiveness of internal and external communications and international accounting issues. corporate disclosure quality and social performance the audit committee's role regarding the provisions of the foreign corrupt practices act alan reinstein albert d. spalding ir. wayne state university detroit, mi abstract the foreign corrupt practices act (fcpa) of 1977, as amended in 1988, prohibits individuals and corporations from using bribes and kickbacks to enhance foreign commerce. imposing stiff penalties for noncompliance, the fcpa includes internal control and accounting and recordkeeping provisions. several studies show that corporate codes of conduct and other formal ethical policies help assure compliance with ethical policies, including the provision of the fcpa. congress, the securities and exchange commission (sec), the courts, the american institute of certified public accountants (a/cpa), and many other financial statement users and preparers have endorsed the audit committee concept as a means to oversee the audit function and otherwise strengthen the financial reporting process. as such, audit committees should ascertain the effectiveness of the entity's internal control structure and compliance with the provisions of the fcpa. after highlighting the provisions of the fcpa, this study examines the extent of the audit committees' involvement in corporate compliance with the fcpa-focussing on corporate codes of conduct-based on a study of 152 audit committees whose securities are traded on the new york stock exchange (nyse). recommendations for strengthening the committees' and companies' roles in this area are also presented. introduction many provisions of the foreign corrupt practices act (fcpa), an antibribery law enacted in 1977 and amended in 1988, depend upon effective corporate internal control structures. the audit committee of the corporate board of directors is the most logical group to develop, implement, and ascertain observance of corporate codes of ethics. the monitoring of compliance with such codes is critical to firms' compliance with the fcpa, because the codes establish corporate policy regarding bribes, grease payments, and inappropriate disbursements. basee upon an analysis of audit committee operations, this study examines their oversight role regarding the fcpa. 24 journal of business strategies vol. 12, no. 1 background: history and importance of the fcpa in 1976, such publicly traded companies as bendix, it&t and lockheed admitted to making millions of dollars in "questionable payments" to japanese and european high officials-with or without their companies' top executives knowledge. these events and the post-watergate environment (under the leadership of then-president carter) helped enact the fcpa of 1977. adopted as an amendment to the securities act of 1934, the law makes it a criminal offense for publicly traded companies to bribe foreign officials, foreign political parties, or candidates for foreign public office to obtain "favorable" business decisions. the 1988 fcpa amendments allowed companies to give "token" or other "minor" gifts to clerical or "low-level employees to facilitate such administrative functions as expediting shipments through customs or securing required permits." congress enacted the fcpa after ascertaining that many u.s. corporations bribed foreign officials and performed other forms of unsavory conduct to secure business abroad. i so widespread was the appearance of corruption, that securities and exchange commission (sec) investigations found over 300 american companies making such questionable payments to foreign officials. 2 despite accusations of attempting to export american puritanical values to different types of cultures, congress enacted the 1977 fcpa to stress that corporate bribery was per se unethical and detrimental to american business. 3 the fcpa allowed many foreign companies, based in countries that view bribery simply as a way to do business, with little concern about corporate ethicswho often received local export incentives-an opportunity to edge out american companies. 4 as indicated at hearings on the original fcpa, congress believed that bribery (a) tainted the credibility of american business operations and the principles of free enterprise in general; (b) caused embarrassment with allies and foes alike; (c) created foreign policy difficulties; and (d) tarnished our nation's worldwide image. s anti-bribery provisions. the fcpa bans bribery, with prohibitions inserted both as an amendment to the securities and exchange act, as applied to publicly held companies considered "issuers" of securities, and as an identical stand-alone provision directed at all other american businesses. 6 while the 1977 fcpa prohibited companies from offering compensation to foreign officials to obtain or retain business, the 1988 fcpa allows them to make "grease payments" to essentially clerical or lowlevel employees that facilitate performance of routine administrative functions such as clerical processing or procurement of licenses. 7 accounting provisions. the fcpa's record-keeping requirements mandate u.s. corporations to keep books, records, and accounts in reasonable detail-to reflect fairly their transactions and dispositions of assets-and to develop and maintain adequate systems of internal control. s congress intended that these accounting standards would spring 1995 reinstein & spalding: foreign corrupt practices act 25 strengthen the credibility of corporate records, making the concealment of bribes less likely.9 the fcpa's accounting requirements require affected companies to maintain an internal control structure to assure that (1) transactions are executed per management's authorization, (2) records sufficiently permit preparing appropriate financial statements, (3) access to assets are limited to appropriate personnel, and (4) periodic checks are made to verify the existence of recorded assets and to resolve any differences thereto. lo penalties for noncompliance with the fcpa fcpa statutory penalties. both the fcpa's anti-bribery and the accounting provisions are enforced via civil liabilities and criminal sanctions. ii the sec has jurisdiction to investigate potential violators and bring civil injunction actions against them to the department of justice for prosecution. 12 the department of justice can investigate u.s. companies other than issuers, and handles all criminal prosecutions,13 and its criminal division responds to written requests for an advance indication of its position in light of specific circumstances under its "review procedures.',14 under the 1988 fcpa, corporate violators face fines up to $2 million, and individuals face fines up to $100,000 for willfully bribing foreign officials. companies may not pay their employees' fines, and violators face up to five years imprisonment; corporations are "vicariously" liable for their employees' acts, and such employees ma~ be convicted even if their employer was found not to have violated the fcpa. 5 in fact, general electric corporation was recently fined $9.5 million and agreed to pay an additional $59.5 million civil penalty, largely for failing to keep accurate books and records per the fcpa's requirements. 16 sentencing guidelines. penalties imposed under the fcpa are subject to the u.s. sentencing commission's guidelines,17 which require federal judges to examine the extent to which corporate defendants have established policies and procedures designed to ensure compliance with the fcpa. corporations proving that violations of fcpa provisions occurred despite the establishment of an effective compliance program face significantly reduced sentences. is ancillary litigation corporations violating the fcpa risk having claims ansmg from laws other than the fcpa. for example, companies suffering damages from lost business caused by a competitor's illegal bribe of foreign officials can seek relief under the racketeer influenced and corrupt organizations statute. 19 companies victimized by such violations can also bring traditional state causes of action for damages incurred as a result of fcpa violations, such as claims of tortious interference with contractual relations. 20 26 journal of business strategies vol. 12, no.1 the audit committee's role in achieving compliance with the fcpa background of audit committees many entities use audit committees to protect themselves from fraud, mismanagement and financial liability. generally comprised of outside directors, the committee serves as an intermediary between the external and internal auditors and the full board of directors in their oversight role of the financial reporting process. they are primarily responsible for selecting the entity's auditor, discussing the audit scope with both types of auditors, inviting direct auditor communications on major problems that arose during the audit, negotiating audit fees, reviewing the financial statements and related external audit report for the full board of directors' ultimate approval and otherwise overseeing the audit process to enhance the independence of both types of auditors. wagner, o'keefe and bostwick (1988) found that effective audit committees (1) communicate better with internal and external auditors, (2) provide enhanced external auditor independence, (3) more likely implement the auditors' suggestions relating to internal controls, and (4) bring added advisory personnel relating to the financial reporting process. many authoritative bodies and accounting organizations strongly support the audit committee concept. the importance and number of audit committees have grown significantly since they became mandatory for all new york stock exchange (nyse) listed companies in 1978. the aicpa's commission on auditors' responsibilities (1978), the national commission on fraudulent financial reporting (treadway commission), the federal courts and the united states congress 22 regard the audit committee as the most logical, cohesive body to insure the prevention of illegal or questionable acts. the sec also expects the committee to monitor corporate conduct and indicated that " ... in all but one instance, companies found to have rendered illegal payments did not have a fulltime audit committee.,,23 establishment & implementation of written ethics codes serving as financial overseers, audit committees represent an important step towards achieving effective internal controls and compliance with government regulations. several large cpa firms stress (ernst & whinney 1989), that a major committee responsibility includes ascertaining if their companies have in place adequate controls (i.e. to meet the fcpa's requirements) and, if not, determine what additional controls are necessary. shaun o'malley (1990), managing partner of price waterhouse, states that the last decade has brought "dramatic" changes in the public's expectations from the board of directors, management and both internal and external auditors. management is primarily responsible for establishing adequate internal accounting controls and avoiding "sensitive payments" whenever possible, and for disclosing them should they occur. spring 1995 reinstein & spalding: foreign corrupt practices act 27 audit committees and external auditors in 1947, the aicpa infonnally endorsed the audit committee concept in a journal of accountancy editorial (carey). in 1967 and 1977, it fonnally endorsed the audit committee concept as a means to strengthen the auditor's independence and competence (couel and rankin 1989). in 1988, the aicpa's auditing standards board issued four statements on auditing standards (sass) dealing with audit committees to help narrow the "expectations gap" between what cpas perform and what the public expects from them. sas nos. 53 and 54, the auditor's responsibility to detect and report errors and irregularities and illegal acts by clients, require auditors to notify audit committees (or equivalent authority, such as the finance or budget committee) of suspected fraud or illegal acts; sas no. 60, communication of internal control structure related matters noted in an audit, expanded the set of internal control deficiencies that auditors should report to audit committees or their equivalent; and sas no. 61, communications with audit committees, requires auditors to disclose certain potential and resolved matters pertaining to the audit to audit committees or their equivalent. cpas auditing publicly traded entities, thus, must be especially careful to discuss potential internal control weaknesses with their audit committees (roussey, ten eyck, and blanco-best 1988). audit committees and internal auditors audit committees should ascertain that their internal auditors examine the prescribed and actual internal control structure by (1) examining appropriate documentation of compliance with the all regulatory policies and provisions (e.g., flowcharts and organizational charts), (2) preparing internal control questionnaires and other documents that test actual compliance, and (3) focussing on potential inherent risk areas of potential weaknesses in the control structure (e.g., areas where much cash is spent without strong controls). schiff and balog (1988) note that by updating, monitoring and enforcing these codes (e.g., by protecting whistleblowers), internal auditors can assume such new duties as resolving ethical conflicts. many audit committees now use internal auditors to help assure compliance with the provisions of regulatory acts and corporate ethical policies by focussing more on operational audits and using more sophisticated infonnation technology and communications and computer skills. the treadway commission also concluded that internal auditors monitoring compliance with corporate codes of conduct benefit from exposure to the audit committee and other high levels of the corporation. audit committees and management accountants as corporate employees, management accountants are more directly responsible for assuring compliance with regulations and policies than are their independent auditors. thus, they should help perform such tasks as providing detailed analytical operating reports and other data regarding the company's adherence to the rules (i.e. the provisions of the fcpa). and ascertaining that 28 journal of business strategies vol. 12, no. 1 the company considers all suggestions to strengthen the internal control structure. the audit committee can also ask management accountants to identify and monitor transactions between management and supervisory personnel to comprehend better how the company delegates decision-making authority between these two parties. the committee should check that such transactions are documented properly, that management continuously improves its internal control structure, and that it follows its prescribed procedures. in their interactions between management, internal and external auditors and management accountants, audit committees can help assure adherence with the provisions of the fcpa. they should ascertain that (a) internal control mechanisms are functioning that can detect questionable behavior and that (b) financial reporting and other audit processes are operating as prescribed. continuous monitoring, reinforcing, and strengthening internal control mechanisms will help prevent abuses and provide compliance with the fcpa provisions. a survey of audit committees impetus the above discussion shows the audit committee's key role in helping their companies comply with the provisions with the fepa, including the monitoring of corporate codes of conduct. a survey of present practices was taken to determine how audit committees help monitor their companies' ethical and related policies. methodology after reviewing the fcpa and related literature, a survey instrument was pretested and revised based upon the comments of six academicians, five audit committee members, and seven other corporate directors. the data were obtained from a mail survey of one randomly selected committee member from 152 randomly selected companies whose securities are traded on the nyse. a total of 109 usable responses were obtained, and 22 committee members did not respond for reasons beyond their control (e.g., they were undergoing major surgery, were retired, or no longer with the company). moser and kalton (1972) found that such addressees who are "outside" the original survey population should be subtracted from the original survey population before calculating the response rate. thus, the adjusted 83.3% response rate {i.e., (109)/(152-22)} exceeds kerlinger's (1973) 80 percent criterion for a satisfactory response rate, where no further testing for non-response bias appears necessary. results the survey first ascertained if audit committees follow detailed work programs for their activities. including reviewing the internal control structure-an indispensable component of ascertaining compliance with the provisions of the spring 1995 reinstein & spalding: foreign corrupt practices act 29 fcpa. a total of 75 percent of the respondents followed such work programs, and, as several respondents indicated, that number that will undoubtedly rise as the audit committee process matures. the survey next examined aspects of the respondents' codes of ethics with these results appearing in table one, below. the vast majority (93 percent) of sampled companies use codes of conduct barring questionable or illegal payments, and 66 percent of them require employees to provide written assurances that corporate funds were not used for illegal purposes. table 1 characteristics of corporate codes of ethics percent code of ethics established at corporation 93.4 code of ethics publicized throughout the corporation 67.1 code of ethics includes anti-bribery provisions 35.9 code of ethics defines "grease payment" provisions 14.0 code administered via internal control functions 8.7 code compliance included in internal control functions 58.6 key managers annually certify code compliance 35.6 code compliance monitored annually in other ways 20.2 fcpa compliance report provided to the audit committee 10.7 fcpa compliance is audited by the independent auditors 25.8 upgrading compliance with written anti-bribery policies increased involvement of the audit committee to comply with the fcpa, management must establish and monitor a written code of ethics prescribing appropriate behavior, identifying penalties for noncompliance, and developing effectuate programs to insure adherence to these procedures. as shown in figure a, the audit committee must work with such parties as internal and external auditors, management accountants and top management to assure that fcpa requirements are met. marsh and powell (1989) stress that effective audit committees use charters to emphasize that they receive adequate information from management and both types of auditors. some elements of the charter include authorizing adequate resources to discharge its responsibilities, methods to enhance both types of auditors' independence, means to strengthen the internal control structure and otherwise assure compliance with the fcpa's provisions. 30 journal of business strategies figure a audit committee involvement with fcpa compliance vol. 12, no. 1 /1 audit committee l~i coordinates.. internal external auditors management auditors (cpas) accountants ~i i . 1/to accomphsh"fcpa compliance strengthening of internal controls i ~frolroint~ development of fcpa compliance reporting procedures implementation and improvement of adherance to code of ethics certification of compliance by key personnel while management is responsible for establishing internal accounting controls, most violations of the fcpa occur when management overrides these controls (neumann 1981). just as independent auditors obtain management's representations to confirm oral or implicit representations and to remind management of its primary responsibilities for the financial statements, audit committees should obtain management's written assurances that they have met the fcpa's requirements. as shown in table two, several survey respondents also indicated that rather than the committee, receives such written assurances, and two stated that they receive these reports "via their independent auditors." table 2 corporate personnel providing written assurance of compliance percent presidents 88.6 vice presidents 81.4 other corporate officers 78.6 directors 58.6 other corporate employees 32.8 spring 1995 reinstein & spalding: foreign corrupt practices act 31 the category "other corporate employees" includes certain marketing, manufacturing, and financial managers. the above table suggests that, while over half of the directors provide these assurances, a much larger majority of presidents, vice-presidents, and other corporate officers must also comply, since nondirector officials make many more day-to-day decisions than do directors and have more exposure to potentially illegal acts. audit committee review of management compliance procedures written assurances alone do not relieve audit committees of the responsibility of overseeing compliance with the fcpa. to properly monitor internal accounting controls and to ascertain that compliance with the fcpa is based upon objective and competent evidence, audit committees should review management's evaluation of the adequacy of corporate internal control procedures and request that both types of auditors corroborate these conclusions. management should also respond fonnally to pertinent comments found in the independent auditor's management letter and in internal audit reports. these responses should detail management's agreement or disagreement with the auditors' findings and resolve the problem or deficiency. recommendations of the treadway commission the treadway commission (1987, pp. 32-33), comprised of leaders from the aicpa, national association of accountants (now institute of management accountants), financial executives institute, american accounting association, and institute of internal auditors found that the most influential factor in deterring fraud (including, implicitly, violations of the fcpa) was the tone or atmosphere set by top management, the board of directors, and the audit committee. the commission also recommended that all public companies maintain internal controls to provide reasonable assurance to prevent fraudulent financial reporting or subject it to early detection. companies should also develop written codes of conduct. all publicly traded companies should also create internal audit departments whose directors have unrestricted and direct access to both the audit committee and the chief executive officer. audit committees should also ascertain that the internal and external auditors coordinate their efforts. the commission (1987, pp. 179-181) stated that top management overseen by the board of directors is primarily responsible for the company's financial reporting, and all public companies should establish effective audit committees to achieve this goal these committees should (1) be infonned and vigilant, (2) set forth its responsibilities in a written charter, (3) receive adequate resources to perfonn its duties, and (4) discuss with management and the auditors areas of potential internal control weakness, contingencies, claims and assessments-all areas directly relating to compliance with the provisions of the fcpa. the commission encouraged all finns to adopt, publicize and enforce written codes of conduct that contain a conflict-of-interest and corporate policies of compliance with domestic and foreign laws, including those related to proprietary 32 journal of business strategies vol. 12, no. 1 information, and also protect whistleblowers. the commission emphasized that the audit committee should review compliance with the corporate code and report its findings to the entire board of directors. these developments suggest that the fcpa will buttress the cpas' study and evaluation of internal control structure. cpas currently evaluate those controls and ascertain the reliability of accounting data to determine the nature, timing and extent of other audit tests, not to form an opinion on management's representations of the adequacy of the entire accounting control system. yet audit committees will undoubtedly request cpas to expand their scope to help the committee measure compliance with the fcpa. approximately 92 percent of the surveyed audit committees not only reviewed the cpa's audit scopes, but several respondents noted that the audit scope had been expanded to enable the committee to determine adherence to the fcpa. cpas assisting audit committees in judging the overall adequacy of internal control should help ascertain if employees adhere to management's formal code of conduct. if such codes do not exist, cpas can help prepare them and monitor adherence to them (ecton and schroeder 1978), by (a) determining that all employees read and sign it, (b) evaluating the level of management's compliance monitoring and the adequacy of reporting deviations from policy, and (c) scrutinizing the most susceptible areas of risk (considering the nature of the industry and the company's scope of operations). these findings can become part of the cpa's management letter, which audit committees should view as a partial indication of compliance to the fcpa. audit committee review of internal controls: fcpa implications since internal auditors focus on improving the efficiency of corporate operations and strengthening the internal control structure, they should be primarily and directly responsible for adherence to this aspect of the fcpa. audit committees should monitor internal auditors' operations and provide them with direct access to the committee. the survey found that 95 percent of the sampled firms' chief internal auditors had direct access to the audit committee. the remaining five percent observed that since the chief internal auditor reported directly to the chief executive officer and has direct access to the committee should the need arise, no reason existed to formally report to them. in monitoring compliance to the fcpa, audit committees should coordinate the efforts of internal and independent auditors to minimize any duplication of efforts. about 85 percent of the sampled audit committees reported that they plan to use both types of auditors as their "independent financial staff' in gaining assurance of compliance with the fcpa. the surveyed audit committees overwhelmingly (93 percent) reviewed the internal auditors' reports and suggestions for improving internal accounting controls and compared them with similar reports received from the cpas-a process that helps audit committees ascertain if management rectifies all reported, material weaknesses in internal accounting control spring 1995 reinstein & spalding: foreign corrupt practices act conclusion 33 compliance with the fcpa is still a challenge for many corporations. the survey results indicate that while most firms have codes of ethics, they often do not audit compliance with them, including adhering to the provisions of the fcpa. although many internal and external auditors have given this area increased attention, the importance of this issue suggests that audit committees should monitor their progress and otherwise help them achieve full compliance with the fcpa's provisions. as a result of the fcpa, financial statement users and governmental authorities expect greater audit committee involvement in the monitoring of corporate conduct. in turn, the committees must rely heavily on management and internal and independent auditors to assure compliance with the fcpa. audit committees should initiate a "top down" approach to the problem, including reviewing compliance with corporate codes of conduct. endnotes 1 u.s. senate report. no. 114, 95th congress, 1st sess. 1-2, reprinted in 1977 u.s. code congress & administrative news 4098, 4099. 2 u.s. senate report no. 114, 95th congress, 1st sess. 3, reprinted in 1977 u.s. code congress & administrative news 4098, 4101. 3 u.s. h.ouse of representatives report no. 640, 95th congress, 1st sess. 4-5 (1977), and u.s. house of representatives report no.114, 95th congress, 1st sess. 3-4, reprinted in 1977 u.s. code congress & administrative news 4098, 4101. 4 bribery is, in fact, a normal part of doing business in many countries. see "big profits in big bribery," time, mar. 19, 1981, at 58-67; "bribery: a shocker in u.s., but a tradition overseas," u.s. news & world report, apr. 12, 1976, at 33-34; "coping with the new rules of conduct," business week, oct. 10, 1977, at 76; "why americans pay bribes to do business abroad," u.s. news & world report, june 2, 1975, at 57-58. 5 see u.s. house of representatives report no. 640, 95th congress, 1st sess. 5 (1977); u.s. senate report no. 114, 95th congress, 1st sess. 3-4, reprinted in 1977 u.s. code congress & administrative news 4098, 4101; and u.s. senate report no. 1031, 94th congress, 2d sess. 3 (1976). 6 15 u.s. code § 78dd-1, as applied to issuers, and 15 u.s. code § 78dd-2, as applied to all other domestic concerns. 7 15 u.s. code §§ 78dd-l(b), 78dd-2(b), 78dd-l(f)(3), and 78dd-~(h)(4). 8 15 u.s. code § 78m (b)(l)-(3). 9 u.s. senate report no. 114, 95th congress, 1st sess. 7, reprinted in 1977 u.s. code congress & administrative news 4098, 4105. 10 note: congress took these provisions directly from the verbiage of sas no.1. 11 15 u.s. code §§ 78 m (b)(6), 78dd-l(a), 78dd-2(a)-(c), 78ff. 12 15 u.s. code § 78u(d). 13 15 u.s. code § 78dd-2(c). 14 28 code of federal regulations 50.18. 15 15 u.s. code § 78dd-2(g) (1994). 34 journal of business strategies vol. 12, no. 1 16 " fraud, ge pleads guilty in israel anus sale, settles qui tam case; govt. recovers $69m," 1992 federal contracts report, 58 (july 27): d19. 17 18 u.s. code §§ 3551·3559, and 28 u.s. code §§ 991-998 (1994). 18 united states sentencing commission, sentencing guidelines for organizational defendants, § 8di.4(a), 49 criminal law reorter (bna) 2059, 2086 (may 8, 1991). 19 see e.g., environmental tectonics v. ws. kirkpatrick & co., 847 f2d 1052 (3d. cir.), mc..!1 110 s. ct. 701 (1990) (rico claim for damages suffered as a result of competitor's alleged bribe of nigerian officials to obtain defense contract). 20 citkorp international trading co. v. western oil & refining co., 771 f. supp. 600 (s.d.n.y. 1991). ~ lawrence w newman and michael burrows, "private claims under the foreign corrupt practices act," new york law journal, international litigation (february 20): p.3. 21 see, for example, discussion of penn central and phillips petroleum cases, coopers & lybrand. 1992 audit committee guide. new york: coopers & lybrand: 809. 22 staff of the subcommittee on reports, accounting and management of the senate committee on government operations, "the accounting establishment: a staff study." 1977. journal of accountancy 143 (march): 108-lii. 25 u.s. senate banking, housing & urban affairs committee. 1976. report to the sec: ouestionable and illegal payments and practices washington, d.c.: u.s. government printing office, (may): 68-69. references carey, j. l."editorial." journal of accountancy 86 (october, 1947): 267. the commission on auditors' responsibilities report. conclusion and recommendations. new'york: aicpa, (1978): 41-44. couei, p.g. and l. j. rankin. "do audit committees bias auditor selection?" akron business and economic review 20 (fall, 1989): 33-37. ecton, w w. and r. g. schroeder. "auditing sensitive payment transactions." the ohio cpa journal 58 (spring, 1978): 53-57 ernst & whinney. the audit committee: functioning in a changing environment. cleveland, ohio: ernst & whinney, 1989. kerlinger, f. n. foundations of behavioral research 2nd, ed., new york: holt, reinhart & winston, inc., 1973. marsh, h. l. and t. e. powell. "the audit committee charter: rx for fraud prevention," journal of accountancy 167 (february, 1989): 55-57 moser, c.a. and kahon, g. survey methods in social investigation. 2nd. ed. new york: basic books, inc., 1972. spring 1995 reinstein & spalding: foreign corrupt practices act 35 neumann, f. f. "corporate audit committees and the foreign corrupt practices act." journal of accountancy 152 (march, 1981): 79. o'malley, s. f. "auditing, directors and management: promoting accountability." the internal auditor, 47 (winter, 1990): 3-9. roussey, r. s., ernest l. ten eyck and mimi blanco-best. ''three new sass: closing the communications gap." journal of accountancy. 166 (december, 1988): 44-52. schiff, j. b., and r. balog. "changing scope of internal audit," internal auditing, 16 (spring, 1988): 76-79. treadway, j. report of the national commission on fraudulent financial reporting. 1987. washington, d.c.: national commission on fraudulent financial reporting. wagner, n.a., h. o'keefe and w.j. bostwick. "audit committee functions for municipalities, hospitials and banks." the cpa journal, 58 (june, 1988): 46-53. the audit committee's role regarding the provisions of the foreign corrupt practices act a generalized mernooology to estabush a value of 11ie inmal franollse costs graham r. mitenko university of nebraska omaha omaha, nebraska introduction the strategic decision whether to operate an enterprise as a sole proprietor or with a partner has plagued entrepreneurs for many years. a partnership is usually advantageous over a sole proprietorship if, with the inclusion of a partner, some type of synergy is achieved. in the generic sense, this synergy is what franchising attempts to produce. one type of synergy which franchising provides is knowledge, more specifically, strategic operational experience. the franchisors provide operational experience to blend with the sole proprietor's capital in an attempt to make a business more successful. sole proprietors, therefore, attempt to reposition themselves and their establishment on the industry's learning curve by joining forces with a franchisor. the purpose of this research is to establish the value of this repositioning by presenting a model using a quantitative approach for assessing the benefits of the franchising contract. background and literature review an appropriate description of the literature in the franchising area is best descnbed in a quote by caves and murphy [6], franchised businesses account for over 38% of all retail sales in the united states and originate 12% of the gross national product, yet the franchise element has largely escaped economic analysis. the published articles in franchising generally follow two broad based sub-areas of franchising. the first sub-area of the literature focuses on organizational economics. in a classic article, coase [7] stated that economic organizations follow one or two general forms. the first form an organization will follow is that of the market organization. that is, the market that a firm is competing in helps develop and conform the firm to the market demands. the second form an organization will follow is that of the firm's organization. a firm's organization is a pre-ordained market structure, not influenced as much by the market forces, as it is by head office dictum. organizational and managerial topics are explored in a number of articles ([2], [6], [23], [18], [21]). the second sub-area compares the operations of franchisees with that of the franchisors. research in this area compares the performance of franchisees with that of franchisors ([3], [16], [11], [22]) and also explores the trade-offs between franchise fees and agency problems ([4], [5], [21]). 16 journal ofbusiness strategies vol. b,no. 1 many articles provide purely qualitative criteria by which franchises can be evaluated. these articles are usually found in publications such as venture, money, inc, and business week. the finance area is replete with articles dealing with valuation, however, empirical studies in the area of franchise valuation have not been as plentiful in the management and operations area. the equations used in this research were primarily derived and developed by the author. statement of the problem franchising comprises a significant portion of american business. the international trade administration states "... that franchise 'business accounted for $591 billion in annual sales in 1987. retail franchising amount to $515 billion which is 33% of total u.s. retail sales" [17]. the purported benefit of buying into a franchise is the reduction of risk gained by the repositioning of the sole proprietorship on the individual business' learning curve. however, since the same business also can be a non-franchised independent sole proprietorship, an evaluation should be made to determine whether joining a franchise provides risk reduction equal to or greater than the purchase price of the franchise. the purpose of this study is to present and test a model for determining the value of joining a franchised organization. the test will determine if becoming a franchisee is a prudent investment research design the prospective income from business assets gives them value [25]. in the case of a franchise, value accrues from the help and additional operational knowledge provided by the franchisor to the franchisee. the transference of entrepreneurial expertise repositions the franchisee on that industry's learning curve. the benefit of this repositioning may be measured by the decrease in entrepreneurial failure rates of new franchises versus new non-franchised firms. the success rates may also be calculated for both the new franchises versus new non-franchised firms (note: 1.0 the failure rates = the success rates). the value of the franchising license can be calculated using the difference in the success rates between franchised and non-franchised firms. this research looks at comparable investments of both franchised and non-franchised businesses. this is not to suggest that the same type of business could not be entered into on a non-comparable basis, but non-franchised operations are usually smaller and do not have the capital resources to consider franchising as an option. for example, a sole proprietor could open a small hamburger shack for considerably less than a mcdonalds outlet, however, the businesses would not compare in types of operations. this rese~h is interested in comparing franchised and non-franchised businesses for like operations in which the initial investment for establishing the businesses are essentially the same. assuming identical businesses (ie., identical assets and products), the cost of opening a business to a non-franchisee (independent sole proprietor) is equal to that of a franchispring 1991 mitenko: generalized methodology 17 see less the licensing costs. almost all basic business expenses remain the same regardless of whether the business is independent or franchised [14]. for example, one could open a hamburger stand identical to mcdonalds, serve the same generic food and in every way duplicate a mcdonalds-type atmosphere without infringing on mcdonalds' trademarks. the cost (construction and operation) of this independent proprietorship should approximate that of mcdonalds, without the licensing cost for the mcdonald's trademark usage. this leads to the development of the first equation: (1) where: ks =cost of an independent proprietorship kr = cost of a franchise* let = licensing costs ** • assuming identical businesses, the cost of a franchise includes all the same cost incurred by an independent proprietorship plus the cost of the franchise license. **the licensing costs take into account the franchising, advertising, and miscellaneous on-going fees. the benefits of franchising should therefore, at minimum, cover the licensing cost of franchising in order to make franchising a prudent investment. the licensing cost, sometimes referred to as the franchise fee, is usually an initial commitment fee (due prior to opening) and very often can be a major cost component of franchising. the franchises in this research charge a franchise fee which ranges from .03% to 937% of the estimated start-up cost of an independent proprietorship. the average franchise fee was 97% of the estimated start-up cost of an independent proprietorship. the benefits of franchising can be measured by the increased probability of success due to membership in a franchise. the increased probability of success due to membership in a franchise can be obtained by subtracting the percentage of the success rates of the franchised form of business from the non-franchised form of business. once again, this point can be illustrated by using the previous hamburger stand example. in order to determine the success differential that franchising makes, the prospective franchisor would have to compare the success rates of independent proprietorships with those of franchised outlets. assuming that franchising leads to a more successful venture, the difference between the two rates would be the increased probability of success due to inclusion in a franchise. this leads to the derivation of the second equation: (2) where: pi = increased probability of success due to membership in a franchise. pf = the percentage success rates of the franchised form of business. pn = the percentage success rates of the non-franchised form of business. 18 journal ofbusiness strategies vol. 8, no. 1 loss exposure is generically defined as that dollar value of an asset or investment which is exposed as a possible loss. the reduction in loss exposure to an individual investor may therefore be defined as the amount of the investment that is shielded from possible loss. one way of reducing loss exposure would be to increase the probability of success. the amount of reduced loss exposure may be defined as the increased probability of success multiplied by the cost of a business to an independent proprietor. this leads to the third equation: lx = pickj where: lx = the reduced loss exposure (3) once again, this idea can be demonstrated by using the hamburger stand example. assume that the cost of a non-franchised mcdonalds clone required an investment of $300,000. given that a non-franchised hamburger stand has an 80% probability of failure and a franchised hamburger stand has a 30% probability of failure, the realizable loss exposures can be calculated. the realizable loss exposure concerning failure of a nonfranchised burger stand would be $240,000 (80% x $300,000). the realizable loss exposure concerning failure of a franchised burger stand would be $90,000 (30% x $300,000). the probability of failure due to the inclusion in a mcdonalds' franchise is 50% (80% 30%) less. therefore, by joining the mcdonalds' franchise, the probability of realizable loss exposure has dropped $150,000 ($240,000 $90,(00). this reduction in loss exposure is due to the diminished probability of failure. this reduction in loss exposure represents the added value of belonging to a franchise. the added value of belonging to a franchise should be greater than or equal to the licensing cost of the franchise. an investment in a franchise would not be considered prudent if the projected monetary gains of belonging to a franchise were not greater than, or equal to, the cost of the franchise license. in other words, an entrepreneur should not consider purchasing a franchise license whose cost would exceed the protection offered by the reduction in loss exposure. this leads to the derivation of the fourth equation, the cost of the franchise license should be less than, or equal to, the value received through the reduction in loss exposure: (4) continuing with the previous example, if the entrepreneur could obtain a mcdonalds' franchise for less than $150,000, it would be considered a prudent investment, because the reduction in loss exposure by joining the franchise was calculated to be $150,000. if the costs of the franchise license were greater than $150,000, the cost would exceed the protection offered, and therefore should not be considered a prudent investment. as previously stated, the added value of a franchising license should be greater than or equal to the reduction in loss exposure [loss exposure was derived in eq. 3, pj(kj]. this is shown by the fifth equation: spring 1991 mitenko: generalizedmethodology avf > pj(kj where: avf = is the added value of a franchise license. 19 (5) the sixth equation then shows that the added value of a franchising license should be greater than, or equal to, the cost of that same license: (6) in summary, the cost of joining a franchise is the cost of a franchising license to a sole proprietor. the added value of joining a franchise to that sole proprietor is thus defined as the value obtained by the differentials in probability of success between a nonfranchised and a franchised business multiplied by the cost of establishing an independent proprietorship. this value also represents the reduction in loss exposure. the data used in this study came from many sources. the success rates of the two types of businesses (franchise and sole proprietorship) were not available, however, the failure rates of the two types of businesses were available. the minimum start-up costs for an independent proprietorship and the licensing costs (franchise fee), the business success rates and other data was obtained through information published in venture, entrepreneur, the department of commerce business failure rates, the franchises' individual 1d-k's and the franchises' individual uniform franchise offering circulars. method atkinson [3] provides success factors for both franchise and independent businesses. these factors indicate the probability that a business will still be operating in a given year. the difference between the success factors was defined as pi (eq. 2) which is the increased probability of success due to membership in a franchise. the success factors are listed in table 1. table 1 calculation of the increased probability of success of a franchise years of operation success factors ffancluse independent increased probability of success 1 2 3 4 5 6-10 93% 94% 93% 93% 92% 90% 62% 43% 33% 27% 23% 16% 35% 51% 60% 66% 69% 74% 20 journal ofbusiness strategies vol. 8, no. 1 the increased probability of success being associated with a franchise is the converse of the increased probability of failure for not being associated with a franchise. taking the present value of the decreased probability of failure and applying a 9% discount rate, provides the present value of the maximum amount of risk reduction provided by a franchise license in anyone given year. the 9% discount rate was taken from the ibbotson and sinquefield study [13] and represents the return of the market in a diversified portfolio (the discount rate of a comparative alternative investment). the results are given in table 2. table 2 calculation of the present value of the loss factor for a franchise years of qperadon 1 2 3 4 5 6-10 increased probability of failure 35% 51% 60% 66% 69% 74% present value of the probability of failure 32.1% 42.9% 46.3% 46.8% 44.8% 31.3% a comparison of the present value of the loss factors indicates that the maximum amount of risk reduction provided by purchasing a franchise is 46.8% of the invested capital. therefore, 46.8% multiplied by the cost of an independent proprietorship (.kj will give the overall value of risk reduction obtained through franchising. the value of the invested capital in an independent business was obtained through data provided by the franchisors as reported in venture. the value of an independent business was previously defined to be the start-up cost of a franchise business less the licensing costs (ig in eq. 1) a franchise benefit index was developed by the author to aid the reader in determining which franchises should be considered as a prudent investment based on the loss exposure criteria. the franchise benefit index commonsizes the investments in both the franchise license and the initial start-up costs and indicates the franchise benefit as a percentage of invested capital. invested capital in this case is the cost of an independent business to a sole proprietor. the larger the franchise benefit index, the better the investment as a greater percentage of capital is exposed to less risk. vi = <ki ljiks where: vi = the franchise benefit index (7) the franchise benefit was obtained by subtracting the reduction in loss exposure from the franchise licensing cost (or franchise fee, as it is more commonly referred to in some spring 1991 mitenko: generalized methodology 21 of the literature). the franchise benefit is the excess or deficit coverage of the loss exposure divided by the franchise fee. using the previous hamburger stand example, given that a company's loss exposure had been calculated to be $150,000 and the franchise fee was $75,000, the franchise benefit is $75,000 ($150,000 $75,000). the reduction in loss exposure was obtained by multiplying the cost of an independent proprietorship by the increased probability of success due to membership in a franchise ($300,000 x 50%: (eq.3». the franchise benefit index was then calculated by dividing the franchise benefit by the invested capital. any franchise which has a franchise benefit index in excess of zero. may be considered a prudent investment based on the previously discussed loss exposure criteria (the franchise benefit is positive which meets the criteria put forth in equation 5). the higher the franchise value index, the better the investment the reason for this is that the higher the index, the higher the coverage of the franchise benefit on the invested capital. for example, consider two franchises with an identical franchise benefit of $75,000. investment a requires an initial capital outlay of $400,000. investment a would be considered the better investment because the franchise benefit (i.e., that amount of benefit which is greater than the franchise licensing costs) indicates a greater amount of coverage on the initial capital outlay. an independent proprietorship would be a more prudent investment than a franchise if the franchise benefit index was less than one. results and conclusions appendix a provides an evaluation of various franchises sorted by the franchise value index. in some cases the franchise value index is undefined. this is due to the fact that some franchises have a franchise fee, but have no invested capital requirements (i.e., they sell the franchisee the franchise, however any goods or services are sold on a passthrough or consignment basis requiring no initial investment by the franchisee). analyzing the 1989-1990 data from one hundred and forty-nine franchises using the loss exposure method descnbed in this paper revealed some interesting findings. first, all of the franchises that were judged to be a non-prudent investment (from the franchisee's point of view) did not have a tangible product associated with their franchise's main line of business (i.e. hamburgers, pizzas etc.) a tangible product, however, was not a guarantee that a franchise would have a positive value index. most of the franchises that had a negative franchise benefit index were service related industries. the worst categories of business according to the franchise value index were: the health and fitness business (87% of those tested had a negative franchise benefit index), the packing and shipping and the maintenance and cleaning businesses (83% of both industries had a negative franchise benefit index), and real estate franchises (57% of those tested had a negative franchise benefit index). there does not appear to be any relationship between a company's franchise value index ranking and its franchise fee (r = .0098). there appears, however, to be somewhat of a relationship between a company's franchise value index ranking and the company's invested capital (r = .1736). this relationship may be explained in two ways. first, 22 journal ofbusiness strategies vol. 8, no.1 the more money that one has invested, the more determined that that person will work to make their franchise a success and; second, the more money that one has invested, the more one needs that extra protection of the capital that is offered by joining a franchise. this is also shown by looking at the relationship between the franchise value index rank and the franchise fee as a percent of invested capital (r2 ::: .2349). in general, the smaller the franchisee fee is, as a percent of invested capital, the better the company's franchise value index ranking. the research indicated a number of franchise offerings which have positive franchise value index. if there were more than four individual franchises in a business type, the business types were organized into categories in order to determine which business types should be considered for investment. the franchise category of hotevmotcl and fast food were the business types which had the highest overall average franchise value index. furthermore, none of the franchises in the hotevmotel or fast food categories had a negative franchise value index. this paper developed a generalized method to determine whether investing in a franchise is prudent. the success rates of both the franchised and the independent entrepreneurs in this model were obtained from aggregate data. the success rates for specific ventures may depend on individual factors which could affect the outcome. these factors may include such diverse items as: number of years in business, start-up costs, pending legal action and exclusivity. although this is not an inclusive list, it does represent some of the variables that may alter the success rate, and therefore affect the outcome. future research in this area of franchising is necessary. franchising is playing an increasingly important role in american business and qualitative measures alone may not be the best method of benefit analysis. the quantitative methods developed in this paper should provide an additional tool in evaluating a franchise to determine if an investment should be made. references 1. anderson, e.e. "the growth and perfonnance of franchise systems: company versus franchisee ownership." journal of economics and business, vol. 36 (1984), pp. 421-431. 2. alchian, aa. and demsetz, h. "production. information costs and economic organization." american economic review, vol. 62 (december, 1972), pp. 777-950. 3. atkinson, j.f. "franchising, the odds on favorite." international franchising association handbook (1968). 4. blair, r.d. and kaserman, d.l. "optimal franchising." southern economic journal, vol. 48 (october, 1982), pp. 494-505. 5. brickley, ja. and dark, f. "the choice of organizational form: the case of franchising." journal of financial economics, vol. 18 (june, 1987), pp. 401-20. spring 1991 mitenko: generalized methodology 23 6. caves, p.e. and murphy w.f. ii. ''franchising: firms markets and intangible assets." southern economic journal, vo1. 42 (april, 1976), pp. 572-86. 7. coase, rh. i'the nature of the finn." economild!, vol. 4 (november, 1927), pp. 386-405. 8. croft, n.l. "getting past the hassles." nation's business (may, 1988), pp. 49-50. 8. -. "the great american dream machine." nation's business (may, 1988) pp. 39-46. 10. fama, e.f. "agency problems and the theory of the firm." journal of political economy. vol. 88 (april, 1980), pp. 288-307. 11. garrett, e.m. ''franchises on a roll." venture (march, 1988), pp. 39-47. 12. "great expectations." venture (december, 1988), pp. 48-49. 13. ibbotson, rg. and sinquefield, ra stock. bonds. bills and {mation: historical returns (1926-1981). charlottsville, va: financial analysis research foundation, (1982). 14. justis, r.t. and judd, r franchising. cincinatti, ohio: southwest publishing co. (1989), p. 52. 15. justis, r.t. and judd, r "master franchising: a new look." journal of small business (july, 1986)pp. 16-21. 16. jones, c. the best 200 franchises to buy: the source book for evaluating the best franchise ojmortunities. toronto canada: bantam books (1987). 17. kostecka, a. franchise ojmortunities handbook. united states department of commerce, 21st edition (january 1988), p. xxviii. 18. knight, rm. ''franchising from the franchisor and franchisee points of view." journal of small business (july, 1986), pp. 16-21. 19. mathewson, g.f. and winter, rh. '''the economics of franchised contracts." journal of law and economics. vol. 28 (october 1985), pp. 503-526. 20. lee, l.w. ''franchising and interbrand competition." southern economic journal, vol. 51 (july, 1984), pp. 219-234. 21. mcnulty, p. "on the nature and theory of economic organization." histoty of political economy. vol. 16, no.2 (1988), pp. 233-253. 22. norton s. "an empirical look at franchising as an organizational form." journal of small business vol. 61, no.2 (1988), pp. 197-218. 24 journal ofbusiness strategies vol. 8, no. 1 23. o'hara. mj.. musgrave, f.w. and wade, t.l. '''the effects of ownership and investment upon the performance of franchised systems." american economists: to be published in a future edition. 24. rubin, p. "'the theory of the firm and the structure of the franchise contract." journal of law and economics, vol. 21 (april 1978), pp. 223-233. 25. weston, fj. and copeland, t.p. managerial finance. eighth edition, chicago, n: dryden press (1986), p. 689. appendix a fraachise adalysis sorted by bosidess type idvested franchise loss franchise value falchl. rgalpcp type !:uulil em "evjosgr .yaw iiuk.i da:iiiml 1 nows windshield repair auto maintenance 6,250 2,900 2,925 25 0.4 franc. 2jitiylube auto maintenance 116,000 35,000 54,288 19,288 16.6 franc. 3 f1yidg cololll auto maintenance 22,400 15,000 10,483 (4,517) (20.2) 1ddep. 4 laser lube auto maintenance 35,850 19,500 16,778 (2,722) (7.6) 1ddcp. 5eaglcspecd auto maintenance 49,600 17,500 23,213 5,713 11.5 franc. 6 ameri-mobile car care auto maintenance 61,900 20,000 28,969 8,969 14.5 franc. 7 meineke mufilers auto maintenance 74,250 22,500 34,749 12,249 16.5 franc. 811dycar auto maintenance 43,450 12,500 20,335 7,835 18.0 franc. 9 autospa auto maintenance 117,000 25,000 53,352 33,352 29.3 franc. 10 sparks thnc-up auto maintenance 114,000 20,000 53,352 33,352 29.3 franc. 11 precision thne auto maintenance 224,350 20,000 104,996 84,996 37.9 franc. 12 midas mulder auto maintenance 317,900 10,000 148,777 138,777 43.7 franc. 13 u.s.ve auto redta1 auto rental 42,200 17,000 19,750 2,750 6.5 franc. 14 ugly duck1idg rent·a·car autoredta1 323,300 52,00 151,304 99,304 30.7 franc. 15 cindy's cumamon rolls bakery 55,250 25,000 25/357 857 1.6 franc. 16 mom's cimiamon rolls bakery 72,750 20,000 34,047 14,047 19.3 franc. 17 ciddamon sam's bakery 86,950 20,000 40,693 20,693 23.8 franc. 18 t. j. cimiamons bakery 165,100 15,000 77,267 62,267 37.7 franc. 19 stork news birth am10uncements 2,000 12,250 936 (11,314) (565.7) 1ddcp. 20 ylid cards birth am10uncements 14,750 1,000 6,903 5,903 40.0 franc. 21 management reports &. serv. busidcss services 61,750 27,500 28,899 1,399 2.3 franc. 22 mail boji:es etc. busidess services 53,750 12,2s0 25,155 12,905 24.0 franc. 23 <lleck-x-01ange <lleck cashidg 87,000 19,700 40,716 21,016 24.2 franc. 2400scttec c10set orglulizc:lll 57,500 19,500 26,910 7,410 12.9 franc. 25 service coffee coffee sales 1,750 12,000 819 (11,181) (638.9) 1ddcp. 26 compact dibc warehouse compact disai 261,400 10,000 122,335 112,335 43.0 franc. 27 timbermill storage barns construction 6,700 12,000 3,136 (8,864) (1323) indep. 28 four seasons greenhouses construction 45,250 12,500 21,177 8,677 19.2 franc. 29 ameristar construction 521,650 15,000 244,132 229,132 43.9 franc. 30 jr. food mart convenience stores 360,000 10,000 168,480 158,480 44.0 franc. 31 cosmetic design center cosmetics 14,600 7,500 6,833 (667) (4.6) indep. 32 money mailer direct mail marketing 7,000 15,000 3,276 (11,724) (167.5) indep. 33 dollar discount stores discount stores 77,000 15,000 36,036 21,036 27.3 franc. 34 dryclean u.s.a. dryoeaning 187,500 40,000 87,750 47,750 25.5 franc. 35 oean 'n' press for less dry cleaning 201,100 25,000 94,115 69,115 34.4 franc. 36 auto mechanic training education 8,100 10,000 3,791 (6,209) (16.7) 1ddep. 37 gymboree education 16,200 16,000 7,582 (8,418) (520) indcp. spring 1991 mitenko: generalized methodology 25 38 sylvan learning centers education 53,300 24,750 24,944 194 0.4 franc. 39 huntington learning center education 78,900 ti,500 36,925 9,425 11.9 franc. 40 dunkin' donuts fast food 134,400 35,000 62,899 ti,899 20.8 franc. 41blimpie fast food 92,300 16,500 43,196 26,696 28.9 franc. 42 taco bell fast food 206,150 35,000 96,478 61,478 29.8 franc. 43 subway sandwiches fast food 53,900 7,500 25,225 17,725 32.9 franc. 44 arby's fast food 324,000 37,500 151,632 114,132 35.2 franc. 45 gourmet pizza fast food 73,000 7,500 34,164 26,664 365 franc. 46 fajita junction fast food 194,000 17,500 90,792 73,292 37.8 franc. 47 dairy queen fast food 362,300 30,000 169,556 139,556 38.5 franc. 48 taco john's fast food 213,600 16,500 99,695 83,465 39.1 franc. 49 domino's pizza fast food 103,100 6,500 48,251 41,751 405 franc. 50 mcdonald's fast food 393,000 22,500 183,924 161,424 41.1 franc. 51 wendy's hamburgers fast food 562,250 30,000 263,133 233,133 415 franc. 52 rny rodgers fast food 614,150 30,000 287,422 257,422 41.9 franc. 53 church's fried chicken fast food 310,250 15,000 145,197 130,197 42.0 franc. 54 popeyes fried chicken fast food 310,750 15,000 145,431 130,431 42.0 franc. 55 jack in the box fast food 518,700 25,000 242,752 217,752 42.0 franc. 58 kentucky fried chicken fast food 903,000 20,000 422,604 402,604 44.6 franc. 59 hardee's fast food 'nl,450 15,000 337,639 322,639 44.7 franc. 60 a night with the stars fund raising 15,100 16,650 7,067 (9,583) (635) indep. 61 basquettes gifts 75,250 12,500 35,217 22,717 30.2 franc. 62 fantastic sams hair cutting 64,600 25,000 30,233 5,233 8.1 franc. 63 easy hair hair cutting 64,000 20,000 29,952 9,952 15.6 franc. 64 cost cutters hair care hair cutting 53,500 12,500 25,038 12,538 23.4 franc. 65 diet center healtblfitness 0 18,000 0 (18,000) ••••• 1ddep. 66 total lifestyle healthlfitness 11,650 15,875 5,452 (10,423) (895) indep. 67 num-bolie weigth reduction healtblfitness 15,950 17,900 7,465 (10,435) (65.4) indep. 68 woman at large healtb/fitness 20,500 17,000 9,594 (7,406) (36.1) indep. 69 physicians weight loss healtbifitness 46,250 32,500 21,645 (10,855) (235) indep. 70 nat. health enhancement healtblfitness 26,450 16,250 12,379 (3,871) (14.6) indep. 71 nutri/system weight loss healthlfitness 66,150 34,500 30,598 (3,542) (5.4) indep. 72 jazzercise healtblfitness 1,550 500 725 225 145 franc. 73 decorating den home decorating 17,500 12,900 8,190 (4,720) (26.9) lndep. 74 deck the walls home decorating 159,500 35,000 74,646 39,646 24.9 franc. 75 super 8 motels hotevmotel 1,400,000 20,000 655,200 635,200 45.4 franc. 76 hampton inn hotevmotel 3,092,000 35,000 1,447,056 1,412,056 45.7 franc. 77 quallty/comfort inns hotevmotel 3,783,500 40,000 1,770,678 1,730,678 45.7 franc. 78 days inns of america hotevmotel 3,625,000 29,000 1,696,500 1,667,500 46.0 franc. 79 park inn international hotevmotel 3,5t1,050 13,500 1,650,659 1,637,159 46.4 franc. 80 compri hotel hotevmotel 8,955,250 30,000 4,191,057 4,161,057 465 franc. 817.ack's ice aeamiyogurt 103,800 20,000 48,578 28,578 tl5 franc. 82 i can't believe it's yogurt ice aeam/yogurt 124,650 20,000 58,336 38,336 30.8 franc. 83 penguin's place frozen yogurt ice aeam/yogurt 166,900 25,000 78,109 53,109 31.8 franc. 84 j. higby's yogurt ice aeam/yogurt 134,000 20,000 67,712 42,712 31.9 franc. 85 california yogurt ice aeam/yogurt 155,000 20,000 72,540 52,540 33.9 franc. 86tcby ice aeam/yogurt 168,750 17,000 78,975 61,975 36.9 franc. 87 perkits yogurt ice aeamiyogud 84,400 2,000 39,499 37,499 44.4 franc. 88 duraclean maintenance!cleaning 400 18,350 187 (18,163) (4,540.7) indep. 89 coverall maintenance/cleaning 950 8,900 445 (8,455) 890.0) indep. 90 coustic glo maintenance!cleaning 3,300 17,375 1,544 (15,831) (479.7) indep. 91 servpro maintenance/cleaning 6,950 32,500 3,253 (29,247) (420.8) indep. 92 rainbow international maintenancetcieaning 5,600 15,000 2,621 (12,379) (221.1) indep. 93 merry maids maintenance/cleaning 8,300 17,500 3,884 (13,616) (164.0) indep. 94 tgif maintenance!cleaning 4,700 8,500 2,200 (6,300) (134.1) indep. 95 jani-king maintenancetcieaning 6,400 10,250 2,995 (7,255) (113.4) indep. 96 master works maintenance/cleaning 10,950 14,248 5,125 (9,123) (833) indep. 97 service master maintenance/cleaning 15,900 13,600 7,441 (6,159) (38.7) indep. 26 journal ofbusiness strategies vol. 8, no.1 98 amer. mobile power wash maintenance/oeaning 22,900 15,000 10,717 (4,283) (18.7) lndep. 99 cbem-dry maintenance/oeaning 9,800 4,550 4,586 36 0.4 franc. 100 compufund mortgage services 4,000 1,795 2,153 358 7.8 franc. 101 pady the shipper paclmging/shipping 0 1,145 0 (1,145) ••••• indep. 102 package plus packaginglshipping 0 30,000 0 (30,000) ••••• indep. 103 united package packaging/shipping 21,600 15,000 10,109 (4,891) (22.6) lndep. 104 handle with care packaginglshipping 11,900 6,750 5,569 (1,181) (9.9) indep. 105 pat mail centers packaging/shipping 28,850 15,500 13,502 (1,998) (6.9) indep. 106 packaging plus service packaginglshipping 43,250 15,500 20,241 4,741 11.0 franc. 107 waynepaging paging systems 12,350 22,500 5,780 (1607z0) (135.4) indep. 108 voice-tel paging systems 95,100 20,000 44,507 24,507 25.8 franc. 109 ceilu.iand paging systems 162,500 25,00 76,050 51,050 31.4 franc. 110 management re>cruiters lnt'ipersonnel placement 24,650 25,00 11,536 (13,464) (54.6) lndep. 111 express services personnel placement 35,200 10,500 16,474 5,974 17.0 franc. 112 snellid,g temporaries personnel placement 95,000 6,000 44,460 38,460 40.5 franc. 113 pets are lnn pet care 3,500 5,300 1,638 (3,662) (104.6) indep. 114 pet nanny pet care 7,200 5,200 3,370 (1,830) (25.4) indep. 115 american speedy printing printing/copying 65,250 39,500 30,537 (8,963) (13.7) lndep. 116 minuteman press printing/copying 48,300 24,500 22,604(1,896) (3.9) lndep. 1171nsty-prints printing/copying 85,500 40,000 40,014 14 0.0 franc. 118 print shack printing/copying 47,450 17,500 'zl;107 4,707 9.9 franc. 119 pip printing printing/copying 119,500 40,000 55,926 15,926 13.3 franc. 120 transamcrica printing printing/copying 53,000 14,900 24,804 9,904 18.7 franc. 121 sir speedy printing printing/copying 74,300 17,500 34,m 17;272 23.2 franc. 122 belter homes read fstate real fstate 0 24,150 0 (24,750) ••••• indep. 123era real estate 4,630 14,400 2,176 (12,224) (2629) indcp. 124 reatly world real estate 15,600 10,400 7,301 (3,099 (19.9) indep. 125ambus realfstate 39,900 25,000 18,673 (6,3z7) (15.9) indep. 126rpjmax realfstate 39,200 13,750 18,346 4,596 11.7 franc. 127 partners realfstate 86,400 12,000 40,435 28,435 32.9 franc. 128 help-u-sell realfstate 45,000 4,500 21,060 16,560 36.8 franc. 129 o>lortyme redial services 82,900 6,000 38,797 32,7!j7 39.6 franc. 130 sizzler restaurants 800,000 30,000 374,400 344,400 43.1 franc. 131 ponderosa restaurants 747,650 25,000 349,900 324,900 43.5 franc. 132 shoney's restaurants 499,300 12,500 233,672 'zl1,172 44.3 franc. 133 miracle-bar retail hearing adis 31,500 6,250 14,742 8,492 27.0 franc. 134 mooograms today retaulntimate apparel 49,450 12,500 23,143 10,643 21.5 franc. 135 medicine shoppe retail pharmacy 65,000 18,000 30420 12,420 19.1 franc. 136 caddy shack golf shops retail sporting goods 130,000 30,000 60,840 30,840 '1.3.7 franc. 137 sports fantasy retail sporting goods 138,400 15,000 64,771 49,771 36.0 franc. 138 the elephant's trunk retail toys 65,100 8,000 30,467 22,467 345 franc. 1391be pro image retail-5porting goods 88,500 16,500 41,418 24,918 28.2 franc. 140 sign up signs 48,300 24,000 'zl,604 (1,396) (29) indep. 141 fastsign centers signs 65,000 17,500 30,420 12,920 19.9 franc. 142 sign shop signs 580,050 15,000 271,463 256,463 44.2 franc. 143 the signery signs 29,700 14,900 13,900 (1,000) (3.4) indep. 144 travd agents int'l travel agencies 63,900 39,500 29,905 (9,595) (15.0) lndep. 145 west cost video video 167,300 32,500 78,296 45,796 27.4 franc. 146 bloekbuster video video 527,500 100,000 246,870 146,870 27.8 franc. 147 blockbuster video video 549,800 35,000 257,306 222,306 40.4 franc. 148 steuarvision video services 22,500 15,000 10,530 (4,470) (19.9) lndep. 149 video data services videotaping services 2,500 13,950 1,170 (12,780) (511.2) indep. a generalized methodology to establish a value of the initial franchise costs corporate governance reform: influence on shareholder wealth richard w: pouder r. stephen cantrell clemson university clemson, sc abstract many corporations have adopted governance practices advocated by shareholder activists. to date, the net effect of such practices is largely unknown. both practitioners and academics agree that additional research is required to determine whether governance practices have actually improved corporate performance. this paper attempts to resolve some of the uncertainties surrounding changes in governance practice. we consider four governance practices widely advocated by shareholder activists and test whether their net and individual effects have an impact on shareholder returns following layoff announcements. introduction over the past two decades, shareholders have become an increasingly vocal and influential force in the governance reform movement. as advocates of governance reform, shareholder activists anticipate that certain changes in governance practice will better align their economic interests with those of management. the conceptual platform for the governance reform movement is agency theory. from this perspective, governance changes would be expected to make the board of directors more effective monitors of managements' strategies. as a consequence of improved monitoring, strategies ratified by the board should more closely reflect shareholder interests and thus increase shareholder wealth. in a recent special issue on governance, business week reported that governance changes have been observed in most major corporations over the past two decades with further changes expected (byrne, 1997). four governance changes receiving much attention are: (l) substantially increasing the proportion of unaffiliated outside directors, (2) separating the positions of ceo and board chairperson, (3) increasing stock incentives offered to board members, and (4) increasing the proportion of common shares held by institutional investors. although the proportion of firms separating their ceo and board chairperson has essentially remained constant (baliga, moyer, & rao, 1996), activists have successfully pressured corporations to adopt each of the other three changes sought. spring 1999 pouder & cantrell: corporate governance reform 49 while significant changes in corporate governance have been adopted as a result ofthe shareholder activist movement, it is not known whether the net effect of these changes actually improves performance. as business week asks, "how much is good governance worth? these days, corporate chieftains, shareholder activists, and academics are hotly debating that question" (byrne, 1997, p. 116). much of this debate stems from inconsistent research findings concerning the performance implications of governance practices. these inconsistencies are made clear in a recent meta-analysis of board composition, leadership structure, and financial performance by dalton, daily, ellstrand, & johnson (1998). their results show little systematic support for relationships between governance elements and financial performance. most of the arguments noted above are from the point of view of investors and owners. managers, however, have an interest in good governance as well. from their point of view, if good governance practices are employed, will owners and investors recognize that they are in place and put more faith in managers' decisions? the purpose of this research is to test empirically whether managerial decisions made under conditions of acceptable governance practice are more likely to increase shareholder wealth than managerial decisions that are not. in this study we consider a strategic decision that is inherently controversial: layoffs. layoffs can be part of a long-range repositioning or downsizing that has strategic merit and will likely result in improved investor wealth. such is the case in several recent layoffs at procter and gamble that were part of a decision to exit certain markets, while repositioning in others. layoffs can also be part of a myopic decision to improve short range operating income that likely decreases shareholder wealth, as evidenced in recent waves oflayoffs made by eastman kodak. 1 assuming that the decision to layoff a portion of the workforce will likely be weighed for strategic value by the stock market, we ask the question: are firms that employ good governance practices more likely to experience a positive market reaction to their layoff plans than firms that do not employ good governance practice? to answer this question, we organize the remainder of the paper as follows. first, we discuss governance problems perceived from an agency theory perspective. second, we use the agency perspective to explain the relationship between governance practices and layoffs. third, we give a brief account of research findings on governance elements, develop hypotheses, and describe our empirical approach. finally, we present the results and conclude by discussing their implications and limitations. the role of governance an agency theory perspective the governance concerns of investors and owners follow from agency theory. agency theory focuses on the relationship between principals and agents: that is, those who delegate work (principals) and those who perform work for the princi50 journal of business strategies vol. 16, no.1 pals (agents) (jensen & meckling, 1976). casting this relationship as a contract (jensen & meckling, 1976), agency theorists examine the problems that can arise between different forms of principal-agent relationships. in the agency theory framework, shareholders in large corporations (principals) hire managers (agents) to initiate and implement important decisions (fama & jensen, 1983). however, the risk preferences and interests of shareholders may differ from those of managers. driven by self-interest, managers may choose strategies that increase their compensation over strategies that respond to shareholders' wishes to increase the market value of the firm (fama & jensen, 1983). shareholders will thus seek governance practices that monitor managers' decision making activities. an agency view of governance and layoffs according to agency theory, the board of directors monitors and ratifies strategies formulated by management (fama & jensen, 1983; jensen & meckling, 1976). although the board rarely formulates strategy (harrison, 1987; hoskisson, johnson, & moesel, 1994), it reviews strategies to mitigate managerial inefficiencies (zahra & pearce, 1989) that misalign strategies with shareholder interests. earlier research findings suggest that the extent of board involvement and control in strategic issues varies substantially among firms (johnson, hoskisson, & hitt, 1993; judge & zeithaml, 1992). more recent evidence from the specialized governance and academic literatures, suggests that, over the past decade, shareholder activists have influenced many boards to augment their involvement by evaluating a broader range of strategies (clyde, 1997; lear, 1997; lear & yavitz, 1997; lorsch, 1996; witte, 1997), and in improving the quality of their evaluations (dobrzynski, 1993b; gordon, 1994). some earlier evidence suggests boards may not seriously consider layoff strategies or their consequences (horton, 1991). unlike strategies such as mergers and anti-takeover provisions, layoffs do not legally require board intervention and approval. in accordance with governance changes instigated by activists, we contend that boards have played a greater role in monitoring managements' layoff strategies over the past decade. although limited, the business literature provides anecdotal support for this contention (e.g., collins, 1993; heenan, 1993; morrissey, 1994; queenan, 1996). furthermore, layoffs are often part of an internal corporate restructuring or downsizing (freeman & cameron, 1993). over the past decade governance reform activists have successfully pressured boards to become more active monitors of internal corporate restructuring and re-engineering strategies (nelson, 1995). for example, the boards of general mills, ibm, ford motor company and l.a. gear were all active in internal restructuring that involved significant job cuts. major shareholders such as calpers have also become increasingly concerned with "corporate responsibility" and discourage boards from supporting employment policies that seek short term gains ("corporate responsibility," 1996). spring 1999 pouder & cantrell: corporate governance reform governance elements 51 given that boards are becoming more vigilant and better informed monitors of managements' layoff strategies, we next consider specific changes sought by shareholder activists in individual governance elements. board composition shareholder activists maintain that boards should be comprised of a majority of outside directors. boards dominated by inside director-managers are more likely to seek policies aligned with management rather than shareholder interests. this results in agency problems as discussed above. activists also argue that even outside directors may be favorably biased toward management. as a consequence of the governance reform movement, the securities exchange commission has established guidelines for defining outside directors in regulation 14a, item 6(b). affiliations that negate outsider status are based on past employment in the corporation, rel3:tionship by blood or marriage, and certain business transactions conducted with the corporation. it is also widely believed by the business press and academics that boards are more effective in protecting shareholder interests when there are greater proportions of unaffiliated directors (see zahra & pearce, 1989 for discussion; mclaughlin, 1994; mizruchi, 1983; schellhardt, 1991). empirical research findings show that higher proportions of outside directors are significantly associated with protecting shareholder interest in the following strategic contexts: removal of incompetent ceos (weisbach, 1988); stock market reaction to announcements of poison pills (brickley, coles, & terry, 1994); stock market reaction to acquisition announcements (brickley & james, 1987); and, boards sued for failing to meet their responsibilities to shareholders (kesner & johnson, 1990). other studies fail to show significant associations in the following settings: failed retail firms (chaganti, mahajan, & sharma, 1985); entrepreneurial firms (daily & dalton, 1992); stock market reaction to anti takeover provisions (sundaramurthy, mahoney, & mahoney, 1997); and level of ceo power (daily & johnson, 1997). board leadership agency problems may develop when the chairperson also serves as ceo. dual ceo/chairperson positions are likely to be viewed as more prominent and influential by board members. this confers an image of power that may hinder the board's ability to monitor independently (beatty & zajac, 1994) and introduces a pro-management board orientation (lorsch, 1989). alternately, separation of chairperson and ceo promotes the interest of shareholders through independent evaluation of the ceo and management and by introducing issues that directly affect shareholders (sundaramurthy & rechner, 1997). as in research on director independence, empirical findings that explore the link between dual chair52 journal of business strategies vol 16, no.1 person/ceo are mixed (cf., baliga, moyer, & rao, 1996; beatty & zajac, 1994; chaganti, mahajan, & sharma, 1985; daily & dalton, 1997; rechner & dalton, 1991). director stock incentives perfonnance-based incentives for directors is another important governance element in the shareholder activist movement. agency theorists argue that stock ownership by directors provides an incentive to improve their effectiveness in monitoring managers' decisions because they have a greater personal stake in the wealth effects of those decisions (jensen & meckling, 1976). in line with this prediction, governance refonners have influenced corporations to increase director stock ownership as an attempt to better align shareholder and managerial interests (mclaughlin, 1994). equity ownership encourages inside and outside directors to protect the interests of shareholders because these directors benefit from higher finn perfonnance (westphal & zajac, 1995). in addition, directors increase their voting rights in proportion to their equity ownership, thereby bringing their interests into even closer alignment with shareholders (zald, 1969). some empirical studies on equity ownership by directors find that such incentives act to increase the board's monitoring of management, resulting in the choice of strategies that increase shareholder wealth (e.g., hoskisson, lohnson, & moesel, 1994; mallette & fowler, 1992; rediker & seth, 1995; westphal & zajac, 1995). other empirical research fails to support the views espoused by agency theory and shareholder activists (e.g. byrd & hickman, 1992; kosnik, 1987; sundaramurthy et ai., 1997). stock ownership by institutional investors individual investors owning few shares exercise low control over potential agency problems because they have limited voting power and cannot economically obtain infonnation about managements' activities. the consolidation of external ownership. mainly by institutional investors, has both increased voting power and facilitated cost-effective collection of infonnation on board activities. large shareholders are better able to pressure boards to ratify strategies that serve their interests. unsurprisingly, as ownership of stock by institutions has grown from about 9% in 1970 to over 50% in 1996 (chaganti & damanpour, 1991; sundaramurthy & rechner, 1997), institutions have become a dominant force in the governance refonn movement (byrne, 1997; pound, 1992). because institutional investors often hold a large number of shares, they cannot easily shift their investments to other companies; they therefore will seek a more active role in the choice of a finn's strategies (changanti & damanpour, 1991; davis & thompson, 1994). this suggests that when finns announcing a layoff have a high proportion of institutional ownership, there is a greater likelihood that their boards have considered shareholder interests in ratifying management's layoff strategy. although there is some research and anecdotal spring 1999 pouder & cantrell: corporate governance reform 53 evidence linking greater institutional ownership to improved monitoring, most research studies show insignificant findings (cf., chaganti & damanpour, 1991; dobrzynski, 1997a; graves, 1988; mallette & fowler, 1992; sundaramurthy, 1996; sundaramurthy et ai., 1997). governance practice and stock market response is governance reform related to the choice of layoff strategies that improve performance? activists would contend that layoff strategies in firms whose boards are involved and effective monitors of management are more likely to improve performance than layoff strategies in firms whose boards are not involved and effective monitors of management. to test this idea, we measure performance using abnormal returns associated with the stock market's reaction to a layoff announcement. in announced stock market events performance is measured by stock market anticipation of value rather than post hoc accounting data. (lubatkin & shrieves, 1986). this implies that the stock market is aware of a firm's governance and its performance implications when the firm announces a layoff. for the following reasons, we assume that stock returns associated with a layoff announcement would be expected to incorporate the future costs or benefits ascribed to a firm's governance practices. first, a central tenet of financial economics is that efficient markets capture all publicly available information (fama, 1976). if investors consider a firm's governance practices in assessing its layoff announcement, then the abnormal returns associated with the layoff should be related to the firm's governance practices. second, a steady stream of evidence from the business press, including regularly published rankings of firms' governance practices, tend to make governance practices and issues highly visible (byrne, 1997; heenan, 1993). third, institutional shareholders are majority shareholders in many corporations. these shareholders have much at stake, making them highly visible to the stock market (brickley, lease, & smith, 1994). finally, the following event studies show that the market can view, and is influenced by each governance element: board composition (brickley, coles, & terry, 1994; hermalin & weisbach, 1988; lubatkin, chung, rogers, & owers, 1989; rosenstein & wyatt, 1990); director stock ownership (brickley, lease, & smith, 1988; mcwilliams, 1990; stulz, 1988); and dual versus separate ceo and chair positions (sundaramurthy, et ai., 1997). the foregoing suggests that the stock market should perceive good governance practices in firms. accordingly, layoff announcements in such firms would be valued higher than layoff announcements in firms that do not subscribe to good governance practices. from a managers' perspective, positive or negative stock market reactions to the firm's layoff strategy should signal that a good or poor governance practice is in place, respectively. this leads to the following hypothesis: 54 journal of business strategies vol. 16, no.1 hypothesis 1: corporate governance practices are significantly related to positive and negative changes in shareholder value following a layoff announcement. besides the overall effect of governance practices on shareholder value, managers would be interested to know the impact of individual governance elements on firm performance. as previously discussed, research findings in support of an agency theory approach to corporate governance are ambivalent. we therefore set up the following null hypotheses to test the effects of each governance element on performance: hypothesis 2: announcement effects of board composition on shareholder value will be zero. hypothesis 3: announcement effects of dual ceo and chairman positions versus separate ceo and chairman positions on shareholder value will be zero. hypothesis 4: announcement effects of director stock ownership on shareholder value will be zero. hypothesis 5: announcement effects of institutional stock ownership on shareholder value will be zero. method sample an event study methodology provides measures of abnormal stock market returns (see brown & warner, 1985, for a comprehensive explanation of event study methodology). as a first step, we reviewed the wall street journal index for announcements of layoffs during the 1989-1993 time period. we eliminated announcements of layoffs in the auto, airline, and defense contractor industries. layoffs in these industries tend to follow a regular and somewhat predictable pattern, which could dampen market reaction to the announcement (mcwilliams & siegel, 1997). we also eliminated announcements of layoffs that may have been confounded by other significant events such as changes in key executives, plant closings, changes in dividend policy, announcements of mergers, and changes in earnings. we dropped firms that had filed for bankruptcy protection. in all, we eliminated 91 announcements from an original total of 222 announcements, resulting in a final sample size of 131 announcements for 102 firms. the appendix lists firms in the sample and their corresponding layoff announcement dates. spring 1999 pouder & cantrell: corporate governance reform 55 measures an event study uses the "market model," which proposes a relation between the return on a stock, over a given period of time, and the return on the market portfolio over the same time period (brown & warner, 1985). this infonnation and all other stock information used in our study was obtained from the center for research in security prices university of chicago (crsp) tapes. we estimated the market model using one trading year of daily returns (from 331 to 91 days before the announcement). the two-day time period of the announcement date and previous day (t-l, t=o) showed the greatest cumulative abnormal returns (cars). for this reason, and because short time periods are more likely to exclude confounding events than long windows (mcwilliams & siegel, 1997), this two day period serves as the event window from which we compute our dependent variable. this research tests if governance practice can accurately predict a positive or negative market return in response to a layoff announcement. the dependent variable is therefore dichotomous, coded as a "1" for positive cars and "0" for negative cars (no car had a value of zero). four independent variables used in the analysis are proportion of outside directors, separation of ceo and chairperson, proportion of common shares held by all directors, and proportion of common shares held by institutional investors. information on the first three variables comes from proxy statements for the year prior to the layoff announcement. we define outside directors consistent with sec regulation 14a, item 6(b). shares held by institutional investors comes from the value line investment survey for the reporting date that most closely precedes the layoff announcement. we include three control variables. the stock market reaction to a layoff announcement may be influenced by the size of the layoff (worrell, davidson, & sharma, 1991), which we measure as the percentage ofthe work force targeted for a layoff. we also suspect that the finn's size and profitability influence the market reaction to a layoff announcement. larger and more profitable finns are more visible, and therefore likely to be subject to greater scrutiny. we use the finn's sales for the year before the layoff to measure size. to control for a firm's profitability, we use return on equity for the year prior to the layoff announcement. statistical model one of our interests is to see if overall governance practice can predict positive and negative abnormal returns. a second interest is to see if individual governance elements are significantly related to positive and negative abnonnal returns. because the dependent variable is dichotomous and our hypotheses require testing the signs of individual variables, we use logistic regression to analyze the data. a logistic regression model also has the following advantages: its regression coefficients are easy to interpret; it can compensate for the distorting effects of 56 journal of business strategies vol. 16, no.1 unequal proportions of dependent variables by allowing specification of the proportion of firms having positive and negative abnormal returns; it estimates the proportion of dependent variables correctly classified, and it can accommodate dichotomous independent variables (e.g., separate and dual ceo/chairperson). results table 1 presents means, standard deviations and intercorrelations. there are no excessively high correlations (r> .70), indicating that multicollinearity is not likely to be a problem. consistent with previous research, the average proportion of institutional ownership is 53.0% and 78.0% of ceos also serve as chairperson of the board. the average percentage of employees that a firm expected to layoff was 6.5%. the average percentage of outside directors on boards was 61.0% and directors held 3.0% of outstanding common shares. table 1 means, standard deviations, and intercorrelations of variables variables mean s.d. 2 3 4 5 6 7 1. cumulative abnormal returns (t::·i, t=o) 0.44 0.50 2. ceo/chairperson separation 0.78 0.42 .06 3. proportion of outside directors 0.61 0.17 .15 .15 4. proportion of institutional ownership 0.53 0.16 .27** -.02 .18* 5. proportion of shares held by directorsa 75.73 221.00 -.17 -.19* -,37* -,11 6. percentage layoff announced 6.48 5.70 -.01 .03 ,08 -.17 .12 7. return on equity 0.03 0.32 .10 .13 .23** .30** -.30* -.16 8. salesb 11.10 1698 .27** .19* .18* .18* -.57**-.36··.17 n=131 a porportion of shares held by directors transformed to its natural logarithm. b expressed in millions of dollars. transformed to natural logarithm in the logistic regression. "'p < .05 up < .01 table 2 presents the proportion of negative and positive cars, and the proportion of correctly classified cars for the logistic regression model (adjusted for the probability of observed outcomes). the model correctly classifies 69.5% of the 13 i abnormal returns associated with a layoff announcement (67.6% of negative cars and 7 1.9% of positive cars are classified correctly, respectively). spring 1999 pouder & cantrell: corporate governance reform table 2 classification results for logistic regression modelab 57 observed abnormal predicted negative returns abnormal returns predicted positive abnormal returns total count percent negative positive negative positive 50 16 67.6 28.1 24 41 32.4 71.9 74 57 100.0 100.0 a percentage correctly classified 69.5% b adjusted for proportion of positive and negative abnonnal returns (44.0% and 56.0%, respectively) table 3 reports the logistic regression analysis, which addresses the relation· ship between governance elements and change in shareholder value following a layoff announcement. as indicated by the value of chi·square, the model has a high goodness of fit (p < .01), suggesting that corporate governance practices are significantly related to positive and negative changes in shareholder value following a layoff announcement as proposed in hypothesis 1. table 3 also reveals that institutional investor stock ownership is a significant, positive predictor of changes in market returns (p slightly greater than .01) following a layoff announcement. however, no other governance element is significantly related to market returns following a layoff announcement. sales, used as a measure of firm size, is a highly significant and positive predictor of changes in shareholder value. conclusion and implications academic and practitioner support for governance reform has grown steadily over the past two decades. despite research and anecdotal evidence that some governance practices are associated with improved firm performance, an unanswered question is whether positive or negative performance effects can be predicted from attempts to improve governance. our findings suggest that four gov· ernance practices collectively can accurately predict positive or negative abnormal stock returns for about 70% of the cases in this study. whether the net effect of governance practices advocated by activists actually improves governance or is just perceived as protecting shareholder interests, the logistic regression shows that, overall, the market reaction is significantly related to governance practice. 58 journal of business strategies vol. 16, no.1 table 3 logistic regression analysis market reaction to layoff announcements, governance and control variables standard wald variable coefficient error statistic p-value ceo/chairperson separation -.0197 .4873 .0016 .9678 proportion of outside directors .8375 1.2724 .4332 .5104 proportion of institutional ownership 3.5693 1.3874 6.6181 .0101 proportion of shares held by directorsa .0311 .1234 .0637 .8007 percentage layoff announced .0537 .0395 1.8501 .1738 return on equity .0812 .7654 .oil3 .9155 salesa .4310 .1694 6.4741 .0109 constant -6.7218 2.0628 10.6179 .0011 n=131, -2 log likelihood =158.871, chi square =20.571, 7 df. p =.0045. a transfonned to natural logarithm value. the logistic regression also shows that the model's significance stems largely from the positive effect of institutional shareholdings on stock market reaction. this empirical finding supports expectations of agency theory and shareholder activists. however, none of the other three governance practices is significantly associated with market reaction to layoff announcements. this pattern of results suggests that the market perceives greater proportions of institutional investment to be most closely associated with good governance practice. at the same time, internal governance elements (i.e., greater proportions of outside directors, separation of ceo and chairperson, and higher levels of director stock ownership) appear to have little effect on determining whether the market reacts negatively or positively to layoff announcements. the following may explain this pattern of results. institutional investors represent a large proportion of shareholder activists and own a majority of shares in most large corporations. accordingly, when institutions own a greater proportion of shares in a corporation they may signal to the market a stronger likelihood that their influence will improve internal monitoring and choice oflayoff strategies, regardless of whether recommended internal governance practices have been adopted. as pfeffer (1981) suggests, the board may be symbolically signaling its governance role. these results have several implications. first, there is overall support for the idea that firms having better governance tend to be better performers. better governance can be largely attributed to concentration of ownership by institutional investors. consequently, managers contemplating layoffs should look at the level of institutional shareholdings in their firms to help make more informed decisions concerning whether layoffs will increase or decrease shareholder value. second, in the context of layoffs, it appears that other acceptable governance practices have less influence on performance than agency theory and activists spring 1999 pouder & cantrell: corporate governance reform 59 would predict. this is consistent with research findings in other contexts and implies that multiple conceptual approaches are needed to better explain corporate governance (for example, see daily et ai., 1998). these results should be interpreted with caution. findings of insignificant perfonnance effects associated with internal governance elements may indicate that the market does not perceive the board to playa key role in monitoring and ratifying layoff strategies. future research in corporate governance needs to investigate the extent of board involvement in layoff strategies. research methods in this area could include interviews and surveys targeted for directors and ceos. finally, the event study methodology implicitly assumes that the market can evaluate the full benefits of governance practices. a timely and useful follow-up to this study would test the long tenn implications of governance on layoffs using accounting-based perfonnance measures. references baliga, b. r., moyer, r. c., & rao, r. s. (1996). ceo duality and firm performance: what's the fuss? strategic management journal. 17, 1-43. beatty, r., & zajac, e. (1994). managerial incentives, monitoring, and risk bearing: a study of executive compensation, ownership, and board structure in initial public offerings administrative science ouarterly. 39, 313-335. brickley, j. a., & james, c. m. (1987). the takeover market, corporate board composition, and ownership structure: the case of banking. journal of law and economics. ~, 161-180. brickley, j. a., coles, j. l., & terry, r. l. (1994). outside directors and the adoption of poison pills. journal of financial economics. 35, 371-390. brickley, j. a., lease, r. c., & smith, c. w. (1988). ownership structure and voting on antitakeover amendments. journal of corporate finance. 1, 5-31. brown, s., & warner, j. (1985). using daily stock returns: the case of event studies. journal of financial economics. 14, 3-31. byrd, j. w., & hickman, j. a. (1992). do outside directors monitor managers? journal of fjnancial economics. 32, 195-221. byrne, j. a., (1997, september 15). the ceo and the board. business week, 106-116. chaganti, r. s., mahajan, y., & sharma, s. (1985). corporate board size, composition and corporate failures in retailing industry. journal of management studies. 22, 400417. 60 journal of business strategies vol. 16, no.1 chaganti, r. s., & damanpour, f. (1991). institutional ownership, capital structure, and firm performance. strategic manai:ement journai..j2, 479-491. clyde, p. (1997). do institutional shareholders police management? managerial aug decision economics, 18, 1-10. collins, t. (1993, april 29). stetson group to keep norwich group intact. computer weekly. i. daily, c. m., & dalton, d. r. (l992). the relationship between governance structure and corporate performance in entrepreneurial firms journal of business venturing.,.], 375-386. daily, c. m., & dalton, d. r. (1997). ceo and board chair roles held jointly or separately: much ado about nothing? academy of management executive. 11 (3), 11-20. daily, c. m., & johnson, j. l. (1997). sources of ceo power and firm financial performance: a longitudinal assessment. journal of manai:ement. 23, 97-117. dalton, d. r., daily, c. m., ellstrand, a. e., & johnson j. l. (998). meta-analytic reviews of board composition, leadership structure, and financial performance. strate2ic management journal. 19, 269-290. davis, g. e, & thompson, t. (1994). a social movement perspective on corporate control administrative science ouarterly. 39, 141-173. dobrzynski, 1. h. (1997a, february 11). a top-ten few companies care to be on. new york times, c3: 3. dobrzynski, j. h. (1997b, march 7). big investors train their fire on nonperforming directors. new york times, c6: 1. fama, e. f. (1976). foundations of finance. new york: basic books. fama, e. e, & jensen, m. c. (1983). separation of ownership and control. journal of law and economics. 26, 327-349. freeman, s. j., & cameron, k. (1993). organizational downsizing: a convergence and reorientation framework. organization science, 4, 10-29. gordon, j. n. (1994). institutions as relations investors: a new look at cumulative voting. columbia law review. 94, 124-192. graves, s. b. (1988). institutional ownership and corporate r&d in the computer industry. academy of management journal, 31, 417-428. harrison, j. r. (1987). the strategic use of corporate board committees. california management review, 30 (l), 109-125. spring 1999 pouder & cantrell: corporate governance reform heenan, d. a. (1993, october). reformation redux. chief executive (u.s.l, 50-53. 61 hermalin, b., & weisbach, m. s. (1988). the determinants of board composition. rillld journal of economics, 19, 589-606. horton, t. r. (1991). human resources in the boardroom. management review, 80 (3), 1-3. hoskisson, r. e., johnson, r. a., & moesel, d. d. (1994). corporate divestiture intensity in restructuring firms: effects of governance, strategy, and performance. academy of management journal. 37, 1207-1251. jensen, m. c, & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics. 3, 305-360. johnson, r. a., hoskisson, r. e., & hitt, m. a. (1993). board of director involvement in restructuring: the effects of board versus management controls and characteristics. strategic management journal. 14, 33-50. judge, w. q., & zeithaml, c p. (1992). institutional and strategic choice perspectives on board involvement in the strategic decision process. academy of management journal. 35, 766-794. kesner, i. f.,& johnson, r. b. (1990). an investigation of the relationship between board composition and stockholder suits. strategic management journal. 11,327-345. kosnik, r. (1987). greenmail: a study of board performance in corporate governance. administrative science ouarterly. 32, 163-185. lear, r. w (1997, august). twenty years of corporate governance. chief executive, 16-19. lear, r. w, & yavitz, b. (1997, october). hanging by a thread. chief executive, 46-51. lee, p. w. (1997). a comparative analysis of layoff announcements and stock price reactions in the united states and japan. strategic management journal. 18, 879-894. lorsch, j. w. (1989). pawns or potentates: the reality of america's comorate boards. boston: harvard business school press. lorsch,1. w (1996 july-august). the board as a change agent. comorate board, 1-6. lubatkin, m. h., & shrieves, r. e. (1986). towards reconciliation of market performance measures to strategic management research. academy of management review. ii, 497-512. lubatkin, m. h., chung, k. h., rogers, r. c, & owers, j. e. (1989). stockholder reactions to ceo changes in large corporations. academy of management journal. 32, 47-68. 62 journal of business strategies vol. 16, no.1 mallette, p., & fowler, k. l. (1992). effects of board composition and stock ownership on the adoption of "poison pills." academy ofmana~ementjournal. 35,1010-1035. mclaughlin, d. 1. (1994). the director's stake in the enterprise. directors & boards. 18 (2),53-60. mcwilliams, a., & siegel, d. (1997). event studies in management research: theoretical and empirical issues. academy of mana2ement journal. 40, 626-657. mcwilliams, v. b. (1990). managerial share ownership and the stock price effects of anti takeover amendment proposals. journal of finance. 45, 1627-1640. mizruchi, m. (1983). who controls whom? an examination of the relations between management and the board of directors in large american corporations. academy of mana~ement review. 8, 426-435. morrissey, j. (1994). quarterdeck ceo resigns over drastic cost-cutting. pc week. ii (34),109-110. nelson, c. a. (1995, may-june). the challenge of restructuring. corporate board, 20-23. pfeffer, j. (1981). management as symbolic action: the creation and maintenance of organizational paradigms. in l .l. cummings and b. m. staw (eds.), research in orianizational behavior (vol. 3), greenwich, ct: jai press, i-52. pound, j. (1992). beyond takeovers: politics comes to corporate control. harvard business review. 70, 83-93. queenan, j. (1996, november). getting (virtually) real. chief executive, 70. rechner, p. l., & dalton, d. r. (1991). ceo duality and organizational performance: a longitudinal analysis. strate~ic mana~ement journal. 12, 155-160. rediker, k. 1., & seth, a. (1995). boards of directors and substitution effects of alternative governance mechanisms. strate~ic manaiement journal. 16,85-99. corporate responsibility and the board. (1996, september-october). coujorate board, 1-3. rosenstein, s., & wyatt, j. (1990). outside directors, board independence, and shareholder wealth. journal of financial economics. 26, 175-192. schellhardt, t. d. (1991, march 20). more directors are recruited from outside. wall street .lid.!rlli!l, b 1. stulz, r. (1988). managerial control of voting rights: financing policies and the market for corporate control. journal of financial economics. 20, 25-54. spring 1999 pouder & cantrell: corporate governance reform 63 sundaramurthy, c. (l996). corporate governance within the context of anti takeover provisions. stratee;ic mana~ment journal. 15,377-394. sundaramurthy, c., & rechner, p. l. (1997). conflicting shareholder interest: an empirical analysis of fair price provisions. business and society. 36, 73-88. sundaramurthy, c., mahoney, j. m., & mahoney, j. t. (1997). board structure, anti takeover provisions, and stockholder wealth. strate&ic mana~ement journal. 18, 231-245. weisbach, m. s. (1988). outside directors and ceo turnover. journal of financial economics. 20, 431-460. westphal, j. d., & zajac, e. (1995). who shall govern? ceo/board power, demographic similarity, and new director selection. administrative science quarterly. 40. 60-83. witte, d. l. (1997, may-june). the board as a strategy-setting force. corporate board. 10-15. worrell, d. l., davidson, w. n., & sharma, v. m. (1991). layoff announcements and stockholder wealth. academy of management journal. 34, 662-678. zahra, s. a., & pearce, j. a. (1989). boards of directors and corporate financial performance: a review and integrative model. journal of management, 15, 291-334. zald, m. (1969). the power and function of boards of directors; a theoretical synthesis. american journal of sociology. 73, 261-272. endnotes recent studies show that both positive and negative abnormal stock market returns occur in response to layoff announcements (lee, 1997; worrell, davidson, & sharma, 1991). 64 journal of business strategies appendix sample firms and layoff announcement dates vol. 16, no.1 company name acuson corp advanced micro devices inc aetna life & casualty co alex brown inc amaxcorp amdahl corp amdahl corp american express co american telephone & teleg co apple computer inc applied magnetics corp applied materials inc atlantic richfield co avon products inc baxter international inc baxter international inc beckman instruments inc new bell atlantic corp bell atlantic corp bellsouth corp blount inc borden co borden co borland international inc brunswick corp brunswick corp burr brown corp businessland inc cr s s inc carolina power & light co centerior energy corp cincinnati & subn bell tel cincinnati gas & elec co commonwealth edison co commonwealth edison co compaq computer corp conner peripherals inc cray research inc cyprus minerals co cyprus minerals co cytogen corp d s c communications corp data general corp data general corp announcement date 06/03/93 11116190 06/30/92 11/28/90 06121190 10/13/92 04123/93 03/01/90 03/04/92 01116190 07119193 11116/90 08126191 04/17192 04/05/90 1lj 17/93 10119193 09115/89 07/10/92 ilj09/92 01/17/89 09129189 01113/92 12/10/92 07120/89 07/09/90 03119/92 01111/90 08/20/92 08/29/89 03/24/93 12/09/92 07123192 01123/89 07/23/92 10/08/92 10122/93 10/03/89 03/12192 07/08/93 09/20193 08/05/91 10/11189 04/02/92 spring 1999 pouder & cantrell: corporate governance reform 65 dayton hudson corp dayton hudson corp dennison manufacturing co digital equipment corp dun & bradstreet inc dun & bradstreet inc first fidelity bancorp fleet nor star financial grp inc florida power & light general electric co general electric co gerber products co goodyear tire & rubber co harley davidson inc harris corp hasbro industries inc illinova corp holding co intel corp international business machs cor international business machs cor international business machs cor international business machs cor international business machs cor iomega corp key tronics corp lotus development corp louisville gas & elec co m a i systems corp macdermid inc magma copper co new mcgraw hill publishing inc mead corp merck & co inc midlantic corp mobil oil corp monsanto chemical co monsanto chemical co national semiconductor corp niagara mohawk power corp niagara mohawk power corp nynexcorp nynexcorp occidental petroleum corp oryx energy co penney j c inc pepsico inc pfizer chas & co inc philip morris & co ltd philip morris & co ltd 06126/90 03/10/92 12/15/89 04/27/92 12/01192 11/01193 03/06/90 12/07/90 10125193 01/25/90 02/26/92 01114192 03114/91 09/24/90 04/06/92 05/30/91 04/04/89 04/27/90 12/05/89 12/07/90 03/28/91 07/29/92 02111/93 02117/93 08/30/91 08/06/90 11/07/89 04111191 06/27/91 10111193 12/06/89 07/03/92 03124193 05/01/92 03119/92 07/01/91 11123192 01117/89 09120/90 02/03/93 09117191 12/02/93 02114191 10115/91 0911 1/92 02104/92 10120193 05/06/92 11/26193 66 journal of business strategies vol. 16, no. 1 phillips petroleum co pitney bowes inc portland general electric co raytheon manufacturing co scott paper co sears roebuck & co sears roebuck & co sequent computer systems inc shawmut national corp tambrands inc tektronix inc tenneco inc tenneco inc texas instruments inc texas instruments inc texas instruments inc texas utilities co travelers corp trinova corp u sf & g corp u sf&gcorp union carbide & carbon corp unisys corp united states shoe corp united states shoe corp united technologies corp unocalcorp varian assoc wal mart stores inc wang laboratories inc wang laboratories inc wang laboratories inc wang laboratories inc wang laboratories inc warner lambert co xerox corp xerox corp xerox corp 02/19/92 12113/89 08/12/91 1li01l93 01124/92 09/17190 01l26/93 07/03/91 01124/91 12/14/89 05/30/90 10123/91 12/05/91 11i21189 07/19/91 02102/93 06/02/92 01125/89 10119/89 01/17/91 04/06/91 09126/91 02/21189 01129/91 01129/92 08/03/90 04128/92 05/15/90 10122191 04117189 11i03/89 04/27/90 01117/91 07/01191 11124/93 02/01/89 12112/91 12/09/93 richard w. pouder is assistant professor of management at clemson university. he received his ph.d. at the university of connecticut. his research applies different conceptual perspectives to areas in strategic management such as technology. innovation, and restructuring. r. stephen cantrell is professor of management and economics at clemson university. he received his ph.d. in economics and statistics from north carolina state university. his research interests include applied statistics, econometric aspects of business management, applied financial economics and strategic management issues in capital markets. corporate governance reform: influence on shareholder wealth 46 journal of business strategies the hanson brothers effect: is rough play a winning strategy in the nhl? kenneth m. york oakland university • rochester, mi cynthia e. miree oakland university • rochester, mi abstract the effectiveness of “rough play” as an on-ice operational strategy in the national hockey league (nhl) was examined for the effect on season outcomes (e.g., stanley cup playoffs, winning the stanley cup), and on-ice performance (e.g., points, wins). four measures of rough play were analyzed (penalties in minutes (pim), number of major penalties, number of minor penalties, pim differential). there were no significant differences between eventual stanley cup winners or playoff teams and other teams in the regular season, but stanley cup finalists had significantly fewer pim. rough play was not found to be an effective strategy for nhl teams. keywords: strategic management, national hockey league, firm performance, violence introduction strategic management, as a field, is concerned with understanding and enhancing firm performance. to this end, the vast majority of its sub-disciplines are focused on understanding the contribution of various resources (barney, 2001), processes (peng, quan, zhang, & dubinsky, 2016), activities (mithas, ramasubbu, & sambamurthy, 2011) or contextual elements (e.g., the macro or industry environment (tho, 2018; mukerjee, 2016; pelham, 1999)) on performance. given the importance of performance as a key dependent variable, identifying or developing appropriate measures continues to be an important organizational pursuit. measuring performance in “for profit” organizations typically involves assessing financial and/or market results (parnell, o’regan & ghobadian, 2006; aupperle & sarhan, 1995; chakravarthy, 1986; venkatraman & ramanujam, 1986) such as revenue, market share or return on investment. within the context of sports leagues, indicators of successful performance may be more than winning the championship, it may also include fan attendance, merchandise and ticket sales, competitive balance, advertising or cable contracts (e.g., laurell & soderman, 2018). volume 37, number 2 47 like many sports leagues, performance within the national hockey league (nhl) is best understood using a diverse set of player-focused, team-based, and overall league measures. examples of player-focused measures include statistics such as games played, assists, goals, shots on goal, penalties, etc. team-based measures include metrics such as fan attendance, ticket sales, wins or losses, team support, and fan satisfaction (e.g., kennett, sneath, & henson, 2001). at the same time, it should be noted that these intuitive indicators of successful performance such as fan attendance are often influenced by other factors such as violence, typically measured as fights (e.g., paul, weinbach, & robbins, 2013). the relationship between game violence and fan attendance has been established in the literature (rockerbie, 2016). indeed, the presence and role of different types of specialty players known as enforcers (burdekin & morton, 2015) and the value placed on these players (i.e., those who exhibit skills in executing aggressive behaviors) signals a type of acceptance of said roles as an often-necessary aspect of the games based on the positive relationship between violence and revenue (as measured by fan attendance). what remains under-explored however is the relationship between violence and other important measures of performance, such as points or wins. again, given that the literature has already demonstrated a positive relationship between fan attendance (as a measure of successful performance) and violence, one might likewise predict a positive relationship between violence and other measures of performance given the persistence of said phenomenon within the nhl. in other words, is the use of violence an effective on-ice operational strategy (i.e., does violence produces wins and championships?), as well as an effective marketing strategy (i.e., is fan attendance related to violence?). the purpose of the current paper is to explore this relationship within a performance measurement framework known as the balanced scorecard (kaplan and norton, 2005; 1992). this paper will compare in two related relationships: 1. the impact of violence on participation in the playoffs or winning the championship, 2. the impact of violence on on-ice performance as measured by points or wins. the remaining sections of the paper are arranged as follows. we will briefly explore the purpose of the balanced scorecard as a performance measurement system. we will then empirically explore the relationship between violence and performance measures. 48 journal of business strategies using the balanced scorecard to understand performance in the nhl the balanced scorecard (kaplan & norton, 2005; 1992) is an analytical framework designed to identify an appropriate set of critical success factors that when implemented lead to successful performance across a range of “balanced” performance measures. the balanced scorecard itself is divided into four categories of measures: financial, customer, internal business process, and learning and growth. in keeping with kaplan and norton (2005), a well-designed balanced scorecard would allow management to look at performance from four important perspectives while simultaneously answering the following questions within the nhl: 1. how do customers (e.g., fans) see us? [customer perspective] 2. what must we excel at to be successful (e.g., points or wins)? [internal business perspective] 3. can we continue to improve and create value? [innovation and learning perspective] 4. how do we look to shareholders (e.g., owners and the league as a whole) [financial perspective]. from a financial perspective, based on revenues the nhl is one of the four major professional sports played in the u.s., the others being football (nfl), baseball (mlb), and basketball (nba). to maintain positive revenue streams, different teams choose different styles of play. further, some styles of play may be more successful than others in drawing fans or winning games or winning the championship. for example, from an “on-ice operational” perspective, some nhl teams may focus on defense, some on offense, some on a balance between offense and defense. one notable example of this type of choice occurs in the movie “slap shot,” directed by george roy hill. in the movie, a small town’s minor league hockey team acquires the hanson brothers, who play in an especially rough style, which both brings in big crowds of fans and leads to the team winning the championship (imdb, 2019). while hollywood’s depiction of the dual and positive impact of rough play on performance may simply represent engaging storytelling, the effectiveness of this type of technical/operational strategy certainly merits further investigation. fortunately, the nhl keeps multiple statistics on games thereby enabling an empirical test using multiple measures of rough play and multiple measures of outcomes and on-ice performance. if, indeed, teams employ “rough play” because this type of play is seen as an important aspect of the value-creating process (from both a fan and management volume 37, number 2 49 perspective), the question of the use of enforcers or “rough play” as an effective onice operational strategy still remains. in other words, does a team that has a rough style of play have more on-ice success because of this strategic choice? to explore this question, we have developed four hypotheses, using multiple measures of performance and both regular season and playoff data. if rough play gives a team a strategic advantage1 (on the ice) we predict the following relationships for the nhl regular season: hypothesis 1a: stanley cup winners (the championship trophy in the nhl) will have more rough play than the other teams, in the nhl regular season. hypothesis 1b: stanley cup finals teams will have more rough play than the other non-finals teams, in the nhl regular season. hypothesis 1c: stanley cup playoff teams will have more rough play than the other non-playoff teams, in the nhl regular season. hypothesis 2a: rough play will predict whether teams made the stanley cup playoffs or played in the championship series or won the championship, in the nhl regular season. hypothesis 2b: rough play will predict on-ice performance, in the nhl regular season. if rough play gives teams a strategic advantage (on the ice), we predict the following relationships for the stanley cup playoffs: hypothesis 3a: stanley cup winners will have more rough play than the other teams, in the stanley cup playoffs. hypothesis 3b: stanley cup finals teams will have more rough play than the other teams, in the stanley cup playoffs. hypothesis4a: rough play will predict whether teams played in the championship series or won the championship, in the stanley cup playoffs. hypothesis 4b: rough play will predict on-ice performance, in the stanley cup playoffs. method the data were obtained from the nhl web page (www.nhl.com), the hockey reference web page (https://www.hockey-reference.com/), and the espn nhl team major penalties statistics web page (http://www.espn.com/nhl/statistics/team/_/stat/ major-penalties/sort/avgpim), for the eleven seasons 2008-2009 to 2018-2019. the hockey reference web page includes data on games played, points, wins, losses, 1http://www.baldrige21.com/baldrige_glossary.html 50 journal of business strategies and winners of the stanley cup, for the nhl teams, for each regular season and the playoffs. the espn major penalties web page includes data on penalties in minutes (pim), major penalties, minor penalties, and power play goals, for each nhl team, for each regular season and the playoffs. in the 2017-2018 season the nhl expanded from 30 to 31 teams. there were 11 seasons of data for 30 teams, and 2 seasons of data for 1 team, making a total of 332 observations. direct and indirect measures we tested whether rough play as measured by penalties, provides a team with a strategic advantage over other teams in terms of season outcomes and on-ice performance. the most important and direct measure of team success is winning the stanley cup, the championship for the nhl. we also tested two other direct measures, whether a team played in the stanley cup finals, and whether a team was in the stanley cup playoffs; these are both indicators of success, but less so than winning the championship. we also tested multiple indirect measures of on-ice performance such as points, (for the regular season), wins, and goals. these are indirect measures of success because a team may score more goals than other teams but not win many games if they allow even more goals, and a team can win more games than any other teams (president’s trophy is awarded to the team with the best overall regular season record) and even play in the stanley cup playoffs, but not win the championship. across the eleven nhl seasons examined here, the correlation between wins and goals was .81, and between wins and goals against was .05. rough play in the nhl teams make a strategic decision about their style of play. teams can try to avoid being penalized and playing “short-handed” or risk a rougher style of play and having more “power plays” against them. rough play may give an advantage that is not balanced by the penalties for rough play, and not every violation of the rules results in a penalty being assessed. another effect is that rough play may have an adverse effect on the play of the opposing team, i.e., the opposing team plays more tentatively, and wins fewer “puck battles,” so that rough play may result in more goals scored or fewer goals against them despite having more penalties. across the eleven nhl seasons examined here, the correlation between wins and power play goals against was .04, and between wins and power play goals .54, which indicates that the greater the number of power play goals scored, the more wins. for less serious infractions of the rules such as offside or icing there is not a volume 37, number 2 51 penalty; there is a stoppage in play and a re-start with a face off. for more serious infractions of the rules such as tripping or fighting the penalized team must play with fewer skaters for 2 minutes (for a minor penalty such as tripping) or 5 minutes (for a major penalty such as fighting), or play the remainder of the game without that player (e.g., game misconduct). the nhl records penalties in two ways: 1) the number of penalties in a game (i.e., the number of each major penalties and the number of each minor penalty), and 2) penalties in minutes (i.e., 3 minor penalties at 2 minutes each, plus 1 major penalty at 5 minutes, equals 11 pim). penalties can be coincidental; both teams are penalized at the same time (4-on-4, “even strength”), and the number of penalties and the pim are counted. if a penalty is given to only one team, the penalized team plays “short-handed” (e.g., 5-on-4), and it is called a power play opportunity for the team that is not penalized. if a team plays “short-handed,” they are more likely to have a goal scored against them than they are to score a goal. penalties and power play goals are a significant part of the game. in the eleven seasons analyzed here, there were an average of 48.7 power play goals per team each season, and 21.9% (16,158 of 73,741) of the goals scored were power play goals, scored while the other team was playing “short-handed” because of a penalty. operational definitions of variables we measured rough play by using nhl penalty data. pim (penalties in minutes) refers to the penalty minutes assessed. pim is the sum of the minutes assessed for both major penalties and minor penalties. the number of major penalties and minor penalties can also be used as measures of “rough play.” pim is the minutes assessed, not the minutes actually served; if a team is playing “shorthanded” because of a minor penalty and the opposing team scores, the penalized team returns to “full strength” and the penalized player does not stay in the penalty box for the full time assessed. for a major penalty, a player remains in the penalty box for the entire 5 minutes, no matter how many goals the opposing team scores. also, a team could have multiple, concurrent penalties, which means the team plays “short-handed” by two players. if a player is given a major misconduct penalty, the penalized team plays at “full strength” but the penalized player stays in the penalty box for the full time of the penalty (i.e., pim but not “short-handed”). or both teams could be given a penalty at the same time and neither team plays “short-handed.” so, pim is not equivalent to “short-handed” time. we used three outcome measures: 1) whether the team won the stanley cup (the championship for the nhl), 2) whether the team played in the final series of 52 journal of business strategies the stanley cup playoffs, 2 teams each season, and 3) whether the team played in the stanley cup playoffs, 16 teams each season. there were also seven on-ice performance measures: 1) points (2 points for a win, 1 point for a loss in overtime; points are not used in the stanley cup playoffs, so this was not used for the analyses using the stanley cup playoff data), 2) wins, 3) goal differential (goals for minus goals against), 4) goals, 5) goals against, 6) power play goals, and 7) power play goals against. we also calculated another measure of rough play: pim differential (e.g., the pim for each team minus the pim for all their opponents in a season). a team that had more pim than their opponents would have a positive pim differential. for these analyses, we calculated each these measures per game to have a common set of measures for the regular season of 82 games and the variable number of games each team plays in the stanley cup playoffs, which are four rounds of best-of-seven series (therefore the number of playoff games played by a team in the stanley cup playoffs varies from as few as 4 to as many as 28). analyses the strategic question for nhl teams is whether rough play is, despite the penalties, associated with more wins and points in a season, and the team is more likely to be in the stanley cup playoffs, in the finals, and win the championship. to answer the questions, we tested four hypotheses using two different datasets. for the first two hypotheses we used nhl regular season data, and for the second two hypotheses we used stanley cup playoff data. we tested the hypotheses using two different types of measures, direct and indirect. the direct measures were seasonal outcome measures: being in the playoffs, being in the final series of the playoffs, and winning the championship. the indirect measures were on-ice performance measures such as points, wins, and goals. results nhl regular season to test hypothesis 1a, four anovas were calculated using whether or not a team won the stanley cup as the classification variable, and four different measures of rough play per game: 1) penalties in minutes (pim), 2) major penalties, 3) minor penalties, and 4) pim differential. across the eleven nhl seasons analyzed here, pim was highly correlated with both major penalties (.90) and minor penalties volume 37, number 2 53 (.88), because the greater the number of major penalties and minor penalties, the greater the pim. however, pim differential was not highly correlated with pim (.16), major penalties (.09), nor minor penalties (.17). there was no statistically significant difference between stanley cup winners and non-winners in penalties in minutes, major penalties, minor penalties, nor pim differential. although not statistically significant, stanley cup winners had fewer pim (stanley cup winners = 9.96 and non-winners = 10.76), fewer major penalties (stanley cup winners = 0.32 and non-winners = 0.41), fewer minor penalties (stanley cup winners = 3.59 and non-winners = 3.68), and smaller pim differential (stanley cup winners = -0.29 and non-winners = 0.01). the results of the analyses are shown in table 1. table 1 descriptive statistics of the sample table 1 descriptive statistics of the sample measures of rough play mean (standard deviation) team seasons pim/game major penalties/game minor penalties/ game pim differential/ game anaheim 11 12.3 (2.6) 0.6 (0.3) 4.0 (0.6) 1.0 (1.0) arizona 11 10.1 (1.8) 0.3 (0.2) 3.7 (0.4) 0.7 (1.0) boston 11 11.3 (1.5) 0.5 (0.2) 3.6 (0.3) 0.1 (0.7) buffalo 11 10.5 (2.0) 0.4 (0.1) 3.6 (0.6) -0.05 (0.8) calgary 11 10.9 (2.3) 0.5 (0.2) 3.6 (0.6) -0.8 (1.2) carolina 11 8.5 (2.1) 0.2 (0.1) 3.3 (0.6) -0.9 (0.5) chicago 11 9.0 (2.2) 0.3 (0.2) 3.2 (0.5) -0.2 (1.8) colorado 11 10.9 (1.6) 0.4 (0.2) 3.7 (0.4) 0.0 (0.6) columbus 11 11.3 (2.8) 0.5 (0.2) 3.7 (0.7) -0.0 (0.9) dallas 11 11.0 (2.0) 0.4 (0.2) 3.8 (0.5) -0.6 (0.9) detroit 11 8.9 (0.6) 0.2 (0.1) 3.6 (0.4) 0.1 (0.6) edmonton 11 11.3 (2.6) 0.5 (0.2) 3.7 (0.6) -0.1 (0.9) florida 11 10.1 (1.1) 0.4 (0.1) 3.5 (0.3) -0.05 (0.6) los angeles 11 10.6 (1.8) 0.4 (0.1) 3.7 (0.6) 0.0 (0.6) minnesota 11 9.7 (1.9) 0.3 (0.1) 3.5 (0.5) -0.5 (0.8) montreal 11 11.2 (2.2) 0.4 (0.1) 4.0 (0.6) 0.1 (0.9) nashville 11 9.6 (1.3) 0.3 (0.1) 3.4 (0.4) -0.2 (0.8) new jersey 11 10.0 (1.4) 0.4 (0.2) 3.5 (0.4) 0.6 (0.9) ny islanders 11 10.7 (3.4) 0.4 (0.2) 3.5 (0.6) -0.5 (0.8) ny rangers 11 10.6 (2.6) 0.4 (0.2) 3.6 (0.5) 0.6 (1.2) ottawa 11 11.8 (2.3) 0.5 (0.1) 3.9 (0.6) 0.3 (1.0) philadelphia 11 13.0 (3.3) 0.5 (0.3) 4.1 (0.8) -0.0 (0.7) pittsburgh 11 11.5 (2.9) 0.4 (0.2) 4.0 (0.6) -0.1 (0.8) san jose 11 10.0 (2.0) 0.4 (0.2) 3.4 (0.6) -0.8 (1.0) st. louis 11 11.9 (3.0) 0.5 (0.3) 3.9 (0.6) 0.1 (0.6) tampa bay 11 11.4 (2.6) 0.4 (0.2) 4.0 (0.6) -0.1 (1.0) toronto 11 10.9 (3.0) 0.5 (0.3) 36 (0.5) -0.2 (0.7) vancouver 11 11.7 (2.8) 0.4 (0.2) 3.9 (0.7) 0.4 (0.6) vegas 2 7.0 (0.2) 0.1 (0.0) 3.0 (0.0) 0.3 (0.5) washington 11 10.4 (1.2) 0.3 (0.1) 3.8 (0.4) 0.3 (0.6) winnipeg/atlanta 11 11.4 (1.9) 0.4 (0.2) 4.0 (0.6) 0.6 (0.6) mean 10.6 (2.1) 0.4 (0.2) 3.7 (0.5) 0.0 (0.8) note. analysis includes 11 seasons, 2008-2009 to 2018-2019. vegas began play as the 31st team in the 2017-2018 season, and there was data on only two seasons. the total number of observations is 332. 54 journal of business strategies to test hypothesis 1b, four anovas were calculated using whether or not a team was in the stanley cup finals in a season as the classification variable, and the same four measures of rough play used above. there was no significant difference between stanley cup finalists and non-finalists in penalties in minutes, major penalties, minor penalties, nor pim differential. although not statistically significant, stanley cup finalists had fewer pim (stanley cup finalists = 10.26 and non-finalists = 10.77), fewer major penalties (stanley cup finalists = 0.35 and non-finalists = 0.41), fewer minor penalties (stanley cup finalists = 3.65 and nonfinalists = 3.68), and smaller pim differential (stanley cup winners = -0.18 and non-winners = 0.01). the results of the analyses are shown in table 2. table 2 anova of stanley cup winners and non-winners, with four measures of rough play, regular season to test hypothesis 1c, four anovas were calculated using whether or not a team was in the stanley cup playoffs in a season as the classification variable, and the same four measures of rough play used above. there was no significant difference between stanley cup playoff teams and non-stanley cup playoff teams in penalties in minutes, major penalties, minor penalties, nor pim differential. although not statistically significant, stanley cup playoff teams had fewer pim (stanley cup playoff teams = 10.72 and non-stanley cup playoff teams = 10.75), fewer major penalties (stanley cup playoff teams = 0.39 and non-playoff teams = 0.42), but more minor penalties (stanley cup playoff teams = 3.71 and non-stanley cup playoff teams = table 2 anova of stanley cup winners and non-winners, with four measures of rough play, regular season comparison measure of rough play f p means stanley cup winners vs. others penalties in minutes/game 1.19 .275 9.96 10.76 major penalties/game 1.97 .161 0.32 0.41 minor penalties/game 0.27 .607 3.59 3.68 pim differential/game 1.07 .302 -0.29 0.01 stanley cup finalists vs. others penalties in minutes/game 0.94 .334 10.26 10.77 major penalties/game 1.53 .217 0.35 0.41 minor penalties/game 0.08 .776 3.65 3.68 pim differential/game 0.82 .367 -0.18 0.01 stanley cup playoffs vs. others penalties in minutes/game 0.01 .929 10.72 10.75 major penalties/game 1.53 .217 0.39 0.42 minor penalties/game 0.92 .338 3.71 3.65 pim differential/game 3.47 .063 -0.09 0.10 note. pim differential/game = pim/game – opponents pim/game. bolded values indicate a greater number of penalties in minutes, number of major penalties/game, number of minor penalties, pim differential. * = p < .05. analysis includes 11 seasons, 2008-2009 to 20182019. in the seasons 2008-2017 there were 30 nhl teams, and starting in 2017-2018 there were 31. volume 37, number 2 55 3.65), and smaller pim differential (stanley cup playoff teams = -.09 and non-stanley cup playoff teams = 0.10. the results of the analyses are shown in table 1. penalties in minutes was not stable across the seasons analyzed here. pim declined in the nhl from the 2008-2009 to 2018-2019 season (13.9 to 8.3 per game for all nhl teams, 13.6 to 7.6 per game for the stanley cup winners), and the eventual stanley cup winner had a lower pim per game than the non-playoff teams in every season except 2017-2018. repeated measures anova on pim per game over the 11 seasons for all nhl teams showed there was a statistically significant within effect (f(10, 290) = 47.70, p = .000), and the polynomial test of order was statistically significant for linear, f(1, 29) = 180.10, p = .001. statistically significant within effects and linear polynomial test were also found for major penalties and minor penalties, but not for pim differential. the values for pim per game by season for all nhl teams are shown in figure 1. the values of pim per game for stanley cup winners, stanley cup finalists, and non-playoff teams for each regular season from 2008-2009 to 2018-2019 are shown in figure 2. figure 1 pim per game, all nhl teams, regular season 56 journal of business strategies figure 2 pim per game, stanley cup winners, playoff teams, and non-playoff teams, by season, regular season to test hypothesis 2a and 2b, ten sets of regression analyses were done. the regressions used the penalties in minutes and pim differential as the set of independent variables to predict winning the stanley cup, stanley cup finalist, and stanley cup playoffs (these were logistic regressions because the dependent variable was binary), points, wins, goal differential, goals, goals against, power play goals, or power play goals against (these were linear regressions because the dependent variable was continuous). although number of major penalties and number of minor penalties are different measures of rough play than pim and pim differential, the intercorrelations of the four measures (ranging from ranging from .09 to .90) were high enough to cause multicollinearity, so only pim and pim differential (which were correlated .16, and tolerance was acceptably low at .976) were used in the regression analyses. being in the stanley cup playoffs or the finals or winning the championship was not predicted from rough play. the set of two measures of rough play predicted goal differential, goals against, power play goals, and power play goals against, with variance accounted for ranging from 2% to 14%. the results of these analyses are shown in table 3. volume 37, number 2 57 table 3 logistic and linear regression analyses predicting stanley cup playoff outcomes and on-ice performance from penalties in minutes and pim differential, regular season table 3 logistic and linear regression analyses predicting stanley cup playoff outcomes and onice performance from penalties in minutes and pim differential, regular season direct measures of season outcomes – logistic regression model fit measure of rough playparameter estimate (standard error) chi square p mcfadd en's rho squared pim per game p pim differen tial per game p constant p win stanley cup 2.01 .367 .02 .133 (.143) .352 .283 (.332) .394 2.04 (1.48) .170 stanley cup finalist 1.54 .463 .01 .080 (.099) .831 .180 (.239) .752 1.80 (1.05) .086 stanley cup playoffs 3.52 .172 .01 -.010 (.047) .838 .223 (.120) .063 -0.02 (0.517) .971 indirect measures of on-ice performance – linear regression measure of rough play – standardized regression coefficient (standard error) f p rsq adjrsq pim per game p pim differen tial per game p constant p points per game 2.86 .059 .02 .01 .051 (.004) .359 -.129* (.010) .021 .000* (.044) .000 wins per game 2.39 .093 .01 .01 .039 (.002) .704 -.119* (.005) .032 .000* (.023) .000 goal differenti al per game 4.54* .011 .03 .02 .039 (.011) .481 -.165* (.027) .003 .000 (.117) .490 goals per game 2.06 .130 .01 .01 -.014 (.007) .800 -.108 (.018) .052 .000* (.078) .000 goals against per game 3.62* .028 .02 .02 -.072 (.007) .196 .140* (.018) .012 .000* (.079) .000 power play goals 23.98* .000 .13 .12 .340 (.003) .000 -.172* (.007) .001 .000* (.031) .000 power play goals against 28.52* .000 .15 .14 .314 (.003) .000 .178* (.007) .001 .000* (.030) .000 note. * = p < .05. analysis includes 11 seasons, 2008-2009 to 2018-2019. * = p < .05. for the regression analyses, the tolerances were .976. 58 journal of business strategies in summary, for multiple tests of the two hypotheses there was no support for the hypotheses that teams that had more rough style of play were more successful in terms of making the stanley cup playoffs, making it to the finals, or winning the championship, across 11 nhl regular seasons. there was weak support for rough play predicting the indirect measures of on-ice performance, such as goals and power play goals. these results indicate that rough play does not give teams a strategic advantage in getting to the stanley cup playoffs, getting to the stanley cup playoffs, or in winning the stanley cup, but there was a relationship between rough play and indirect measures of on-ice performance. however, whatever advantage the teams may have gained from rough play in the regular season, did not translate into winning the championship. stanley cup playoffs hypotheses 3a and 3b were tested and the results were similar to the regular season data. there was one significant difference between stanley cup finalists and other teams in the playoffs: stanley cup finalists had significantly fewer pim per game than the other teams in the playoffs (10.41 versus 12.58). there were no other statistically significant differences between stanley cup winners or finalists and other playoff teams in penalties in minutes, major penalties, minor penalties, nor pim differential. the results of these analyses are shown in table 4. table 4 nova of stanley cup winners and non-winners, with four measures of rough play, stanley cup playoffs table 4 anova of stanley cup winners and non-winners, with four measures of rough play, stanley cup playoffs comparison measure of rough play f p means stanley cup winners vs. others winner others penalties in minutes/game 2.09 .150 10.28 12.44 major penalties/game 0.67 .414 0.11 0.17 minor penalties/game 1.11 .293 3.88 4.20 pim differential/game 2.12 .147 -0.85 0.52 stanley cup finalists vs. others finalist others penalties in minutes/game 3.97* .048 10.41 12.58 major penalties/game 1.07 .303 0.12 0.17 minor penalties/game 2.37 .126 3.88 4.22 pim differential/game 3.62 .059 -0.71 0.60 note. * = p < .05. analysis includes 11 seasons, 2008-2009 to 2018-2019. volume 37, number 2 59 as in the regular season, pim per game also declined in the stanley cup playoffs from the 2008-2009 to 2018-2019 season (15.4 to 9.8 per game for all playoff teams, 11.8 to 7.2 per game for the stanley cup winners), and the eventual stanley cup winner had a lower pim than the other the playoff teams in every season except 2010-2011 and 2016-2017. because only 16 teams are in the stanley cup playoffs and different teams each season, a repeated measures anova on pim cannot be done here as was done for the regular season data on all the teams. the values for pim per game by season for stanley cup winners, stanley finalists, and all playoff teams for each season 2008-2009 to 2018-2019 are shown in figure 3. figure 3 pim per game, stanley cup winners, finalist, and other playoff teams, by season, stanley cup playoffs to test hypothesis 4a and 4b, ten sets of regression analyses were done, the same analyses as was done on nhl regular season data. the regressions used penalties in minutes and pim differential as the set of independent variables to predict winning the stanley cup, playing in the stanley cup finals (these were logistic regressions because the dependent variable was binary), points, wins, goal differential, goals, goals against, power play goals, or power play goals against (these were linear regressions because the dependent variable was continuous). as with the regular season data, the intercorrelations among the four measures of rough play (ranging from .06 to .70) were high enough to cause multicollinearity, so only 60 journal of business strategies pim and pim differential (which were correlated .32, tolerance was acceptably low at .898) were used in the regression analyses. the two measures of rough play did not predict winning the stanley cup or being in finals, but did predict most of the indirect measures of on ice-performance (but not power play goals). the results of these analyses are shown in table 5. table 5 logistic and linear regression analyses predicting stanley cup playoff outcomes and on-ice performance from penalties in minutes and pim differential, stanley cup playoffs table 5 logistic and linear regression analyses predicting stanley cup playoff outcomes and onice performance from penalties in minutes and pim differential, stanley cup playoffs direct measures of season outcomes – logistic regression measure of rough playparameter estimate (standard error) chisquare p mcfad den's rhosquare d pim per game p pim different ial per game p constant p win stanley cup 3.81 .149 .05 .112 (.094) .236 .124 (.112) .269 1.478 (1.046) .158 stanley cup finalist 6.73* .035 .05 .109 (.068) .109 .116 (.084) .168 0.717 (.767) .350 indirect measures of on-ice performance – linear regression measure of rough play – standardized regression weights f p rsq adjrsq pim per game p pim different ial per game p constant p wins per game 12.95* .000 .13 .12 -.097 (.003) .198 -.318* (.003) .000 .000* (.036) .000 goal different ial per game 21.67* .000 .20 .19 -.157* (.013) .030 -.372* (.020) .000 .000* (.165) .694 goals per game 7.06* .001 .08 .07 .096 (.010) .214 -.290* (.016) .000 .000* (.128) .000 goals against per game 18.36* .000 .18 .17 .297* (.010) .000 .214* (.016) .004 .000* (.127) .000 power play goals 1.67 .314 .01 .00 -.084 (.013) .292 -.056 (.021) .481 .000* (.171) .000 power play goal against 25.65* .000 .22 .23 .399* (.005) .000 .165* (.008) .020 .000* (.065) .000 note. * = p < .05. analysis includes 11 seasons, 2008-2009 to 2018-2019. * = p < .05. for the regression analyses, the tolerances were .898. volume 37, number 2 61 the results of these analyses of stanley cup playoff data showed that rough play did not give stanley cup playoff teams a strategic advantage in making it to the stanley cup finals, or in winning the stanley cup. there was mixed evidence that rough play gave teams a strategic advantage in indirect measures of on-ice performance, but whatever advantage the teams may have gained in playoff games, it did affect winning the championship. discussion and limitations we tested whether rough play gives nhl teams a strategic advantage across 11 regular seasons and the stanley cup playoffs (2008-2009 to 2018-2019) using four different measures of rough play: penalties in minutes, number of major penalties, number of minor penalties, and pim differential. we used multiple direct and indirect measures of on-ice performance: participation in the stanley cup playoffs, participation in the championship series, and winning the stanley cup, as well as points, wins, goal differential, goals, goals against, power play goals, and power play goals against. while there was some support for a strategic advantage for rough play for indirect measures of on-ice performance, we found no support for the idea that rough play gives team a strategic advantage in getting in the stanley cup playoffs, being one of the two teams in the stanley cup finals, nor winning the stanley cup. although hockey is best described as a “rough sport,” in contrast to the “hanson brothers effect” depicted by hollywood, our results indicate that there is no significant strategic advantage to rough play. in fact, and by sharp contrast, looking at penalties minutes over the 11 seasons examined here, pim in both the nhl regular season games and the stanley cup playoff games decreased over time. rather than some teams choosing a rougher style of play than other teams and being more successful in terms of being in the playoffs, in the finals, or winning the championship, there was a decrease in pim for nhl teams over the 11 seasons analyzed here, in both the regular season and the stanley cup playoffs. this may indicate that nhl teams are collectively choosing a less rough style of play, perhaps with the goal of reducing the number of power play goals scored against them. a change in referee enforcement policy or rule changes are possible alternative explanations for the downward trend in pim (i.e., a history effect), but we know of no announced change in enforcement policy or rule changes during the 11 seasons analyzed here. in fact, the downward trend in pim seen in our data is consistent with a long-term trend in the nhl. in the 1987-1988 season (a decade after the movie “slapshot” and the oldest data available on hockey-reference), the league average 62 journal of business strategies pim per game was 26.4 and 30.0% of goals were power play goals against, compared to the 2018-2019 season of 8.3 pim per game and 19.3% of goals were power play goals against. a question for future research is to determine whether the trend of decreasing pim over the eleven nhl seasons analyzed in this study is of recent origin. there are several limitations to the current study which merit more discussion. first and foremost, is the way that pim is counted by the nhl. a team is assessed two minutes (pim) for a minor penalty and 5 minutes for a major penalty whether the penalty gives the team a power play (and they are more likely to score than when they are “even-strength”) or is a coincidental penalty where the opposing team is also given a penalty and there is no power play. a greater pim indicates more rough play, but not every pim is a power play. this study examined pim differential over the games played in the regular season and in the playoffs, future research might examine individual game data, to test whether in games in which one team had significantly more penalties (i.e., more rough play) than their opponent was less likely to win the game. also, nhl data was analyzed here, future research may be directed at investigating whether these results generalize to minor hockey leagues (e.g., american hockey league), where a greater share of team revenues come from ticket sales than tv contracts. another limitation to this study is that teams vary not only in their playing style, but in the quality of the teams. the strength of schedule (a rating of the difficulty or ease of a team’s opponents as compared to other teams) and simple rating system (a team rating that takes into account average goal differential and strength of schedule) reported by hockey refererence are ways to measure the quality of a team. a “better” team may have a high pim and more wins, because the quality of the team can overcome having more penalties against them for rough play. a third limitation of the study is that an experiment cannot be done here; researchers can only examine penalties as an indicator of the rough play of different teams and their outcomes such as goals, wins, playoffs, and championships. teams cannot be randomly assigned to “normal play” and “rough play” conditions and then the two groups compared on their on-ice performance. conclusion sports teams, including the teams of the nhl, have more than one objective, some may focus more on trying to win the championship (the stanley cup for the nhl), and some may focus more on money (gate receipts, concessions, merchandise, volume 37, number 2 63 tv contracts, etc.). indeed, there are some teams which focus on both. in the movie “slap shot,” rough play supported a compelling hollywood ending wherein rough play helped the charlestown chiefs win the championship. while the current findings do not support a significant role for rough play in winning the stanley cup, future research may test whether rough play gives an advantage beyond gate receipts in attracting fans and examine revenues generated by selling more luxury boxes, more concessions, more merchandise, etc. an alternative explanation for the weak support that rough play gives teams an on-ice advantage over other teams is that there is might not be sufficient variability in the level of rough play across teams. the direct effect of playing “short-handed,” plus the indirect effect of rough play when playing “even-strength,” may not be great enough to have an effect on wins, even in the stanley cup playoffs. either way, given how violence within the nhl is increasingly being perceived as negative and inappropriate (wsj, 2011; gatehouse, 2011), and ineffective in terms of successful on-ice performance (leard and doyle, 2011; engelhardt, 1995), the current results add to the body of work that questions the true contribution of violence to successful performance within the nhl. references barney, j. b. (2001). resource-based theories of competitive advantage: a ten-year retrospective on the resource-based view. journal of management, 27(6), 643-650. burdekin, r. c. k., & morton, m. g. (2015). blood money: violence for hire in the national hockey league. international journal of sport finance, 10(4), 328-356. engelhardt, g. (1995). fighting behavior and winning national hockey league games: a paradox. perceptual and motor skills, 80, 416-418. espn.com (2020). nhl team major penalties statistics. http://www.espn.com/ nhl/statistics/team/_/stat/major-penalties/sort/avgpim gatehouse, j. (2011, mar 28). hockey violence: ‘it’s time to draw the line’: the nhl may finally be getting the message, but fans don’t think it’s enough, reports jonathon gatehouse. maclean’s, 124, 22. retrieved from https://search. proquest.com/docview/858329236? hockey-reference.com (2020). seasons. https://www.hockey-reference.com/. kaplan, r. s., & norton, d. p. (2005, jul). the balanced scorecard: measures that drive performance. harvard business review, 83, 172-180. kaplan, r. s., & norton, d. p. (1992, january). the balanced scorecard measures that drive performance. harvard business review, 70, 71-79. 64 journal of business strategies kennett, p. a., sneath, j. z., & henson, s. (2001). fan satisfaction and segmentation: a case study of minor league hockey spectators. journal of targeting, measurement and analysis for marketing, 10(2), 132-142. laurell, c., & soderman, s. (2018). sport in business studies: a state-of-the-art literature review. sport, business and management, 8(5), 529-546. leard, b., & doyle, j. m. (2011). the effect of home advantage, momentum, and fighting on winning in the national hockey league. journal of sports economics, 12(5), 538-560. mithas, s., ramasubbu, n., & sambamurthy, v. (2011). how information management capability influences firm performance. mis quarterly, 35(1), 237-256. mukerjee, k. (2016). factors that contribute towards competitive advantage: a conceptual analysis. iup journal of business strategy, 13(1), 26-39. national hockey league. (2020). stats. http://www.nhl.com. parnell, j. a., o’regan, n., & ghobadian, a. (2006). measuring performance in competitive strategy research. international journal of management & decision making, 7(4), 408-417. paul, r. j., weinbach, a. p., & robbins, d. (2013). american hockey league attendance: a study of fan preferences for fighting, team performance, and promotions. international journal of sport finance, 8(1), 21-38. peng, j., quan, j., zhang, g., & dubinsky, a. j. (2016). mediation effect of business process and supply chain management capabilities on the impact of it on firm performance: evidence from chinese firms: ssis. international journal of information management, 36(1), 89-96. pelham, a. m. (1999). influence of environment, strategy, and market orientation on performance in small manufacturing firms. journal of business research, 45(1), 33-46. rockerbie, d. w. (2016). fighting as a profit maximizing strategy in the national hockey league: more evidence. applied economics, 48(4), 292-299. slap shot. (2020). internet movie database. retrieved april 20, 2020, from https://www.imdb.com/title/tt0076723/. tho, n. d. (2018). firm capabilities and performance: a necessary condition analysis. the journal of management development, 37(4), 322-332 wsj: air canada threatens to end nhl sponsorship over violence. (2011, mar 10). dow jones institutional news. retrieved from https://search.proquest.com/ docview/2156712674/. volume 37, number 2 65 biographical sketch of authors kenneth m. york is a professor of management in the school of business administration at oakland university. he earned his ph.d. in industrial/ organizational psychology at bowling green state university, and his research interests are in applied problems in human resources management. cynthia e. miree is a professor of management in the school of business administration at oakland university. she earned her ph.d. in strategic management at the university of pittsburgh, and her research interests are focused in the area of strategic management. emerging value propositions for m-commerce irvine clarke iii, ph.d. james madison university harrisonburg, va abstract the proliferation of mobile internet devices is creating an unparalleled opportunity for e-commerce to leverage the benefits of mobility. mobile e-commerce, commonly referred to as m-commerce, is the ability to purchase goods anywhere through a wireless internet-enabled device. current e-commerce providers, engaged through mobile devices, will find advantage in developing unique m-commerce value propositions founded upon the specific dimensions of" ubiquity, convenience, localization, and personalization. a consumer orientation that provides value-for-time functions to create a new value curve may achieve a competitive advantage over traditional e-commerce models replicatedfor mobile business. therefore, this paper investigates the value propositions, that engender a productive mobile e-commerce strategy to provide recommendations for managerial decision-making in this emerging wireless environment. introduction in the new decade, the call for information technology will be information, any time, any place and on any device. accordingly, e-commerce is poised to witness an unprecedented explosion of mobility, creating a new domain of mobile commerce. mobile commerce, or m-commerce, is the ability to purchase goods anywhere through a wireless internet-enabled device. mobile commerce refers to any transaction with monetary value that is conducted via a mobile network. it will allow users to purchase products over the internet without the use of a pc. "within five years, individual e-commerce services will be primarily delivered by wireless and the wireless terminal will become the window of choice to the transactional e-world," says neil montefiore, executive of singapore mobile operator m i (hoffman, 2000, p.20). this proliferation of wireless capability has created an emerging opportunity for e-commerce businesses to expand beyond the traditional limitations of the fixed-line personal computer. the magnitude of the mobile internet revolution will pressure current ecommerce business models, create apertures for new mobile internet compathe authors gratefully acknowledge the commonwealth information security center at james madison university for support of their research. 134 journal of business strategies vol. 18, no.2 nies, engender a stream of change among established e-commerce paradigms, and lead to a reconfiguration of value propositions in many industries (evans & wurster, 1997). however, m-commerce is still not without its limitations. the problems it must overcome include: uniform standards, ease of operation, security for transactions, minimum screen size, display type and bandwidth, billing services, and the relati vely impoverished web sites. due to current technological limitations, limited service availability, and varying mobile consumer behavior patterns, business strategies developed for m-commerce applications will find it necessary to emphasize differing characteristics than traditional ecommerce strategies (barnett, hodges & wilshire, 2000; datamonitor, 2000). successful m-commerce providers will understand that consumers are unwilling to spend long periods "surfing' on these inherently less user-friendly wireless devices (albright, 2000). wireless users demand packets of hyper-personalized information, not scaled-down versions of generic information. therefore, technology-focused wireless internet business models will be replaced by models which best integrate the unique characteristics of wireless m-commerce. as such, the long-term success of e-commerce may be partially dependent upon the successful development of effective consumer-oriented m-commerce business strategies. "mobile commerce is per se not included in the traditional e-commerce market models. m-commerce will be able to increase the overall market for e-commerce, because of its unique value proposition of providing easily personalized, local goods and services anytime and anywhere" (durlacher, 2000, p. 12). despite tremendous interest in the melioration of m-commerce there is little, if any, research that examines how to develop a comprehensive consumer-oriented mobile e-commerce strategy. therefore, the primary purpose of this paper is to explore the factors which compose an effective m-commerce strategy. first, this paper investigates the nonpareil benefits of mobile applications. then, this paper explores how managers can incorporate potential m-commerce value propositions into their overall e-commerce strategies through creating new market space (kim & mauborgne, 1999). given the potential assemblage of wireless internet devices, an enhanced understanding of m-commerce could acutely improve a company's overall ability in e-business strategy formulation. background mobile devices have been the fastest adopted consumer products of all time with, last year, more mobile phones shipped than automobiles and pcs combined (chen, 2000; de haan, 2000). by 2003, there will be 1.4 billion mobile phones worldwide and half will be internet-enabled (zabala, 2000). nokia estimates that by 2002 a greater number of people will be linked to the internet via wireless connections than through traditional fixed lines (daitch et ai., fall 2001 clarke: emerging value propositions 135 2000).1 fueled by such enabling technologies as 3g broadband capability, extensible markup language (xml), compact html (chtml), wireless markup language (wml), wireless application protocol (wap), general packet radio services (gprs) and internet ready mobile terminals, e-commerce is now poised to take advantage of the current growth of mobile devices. "the wireless world is a parallel universe almost as large as the net, and the two are beginning a fascinating convergence," said swapnil shah, director of inktomi europe, a search engine and caching solutions company (rao 2000). however, u.s. providers have lagged in m-commerce development since the u.s. market has been pc oriented for internet technology. the u.s. leads the world in almost every e-commerce metric, while europe and japan have taken early leads in m-commerce. in fact some countries in europe, like spain and italy, may completely leap pc-oriented e-commerce, based on their veneration of mobile phones, directly to m-commerce. as many as 100 new m-commerce companies launch in europe each month (brandt, 2000). telefonica italy is already selling all cellular phones with a pre configuration for internet access. in japan, mobile phones penetrate about 50% of the market with ntt docomo's internet enabled i-mode service already connecting more than 5 million wireless users to the web. these markets continue to grow in appeal as docomo's i-mode is attracting about 12,600 new users per day, each generating about $26/month in additional revenue per user (schenker, 2000). commerce transpires as organizations introduce new methods to employ mobile devices to communicate, inform, transact and entertain using text and data via connection to public and private networks. this emergence of mobile commerce will happen even faster than the development of e-commerce in roughly the time between the invention of the first web browser and now (schenker, 2000). "if you look five to 10 years out, almost all of e-commerce will be on wireless devices" says jeff bezos chief executive and founder of amazon.com (mcginity, 2000). consequently, within the next 5-years, onequarter of all electronic commerce will take place through wireless devices (zabala, 2000). forecasts estimate the wireless web to be as large as the wired web of today and worldwide mobile commerce exceeding $200 billion by 2004 (m-commerce times, 2000; shaffer, 2000). the potential of m-commerce is considerable for those willing to develop mobile-specific business strategies. as m-commerce matures, current mobile operators will rely less upon usage fees and increasingly derive revenues from content and services (datamonitor, 2000; kpmg, 2000). additionally, m-commerce is going to bring about a massive change in the way users consume products and services. "it is key that commerce companies recognize m-commerce as a completely unique service. cell phone users are more impatient than internet users. the paradigm here is not surfing; all services for the mass market have to be pitched at users in such 136 journal of business strategies vol. 18, no.2 a seamless way that they need not even be aware that they are accessing the net," cindy dahm, european director for phone.com (rao, 2000, p.2 ). those best able to provide value-added user experiences, through content aggregation and portal development, will achieve long-term success. merely extending the current internet presence will not be enough. "mobile internet customers will be more demanding. they will want personalized service to meet their individual wants and needs and will no longer be satisfied with being a mass market" (kpmg, 2000, p. 2). providers must take advantage of the characteristics which make m-commerce distinct from e-commerce to develop truly unique and compelling services rather than replicating current e-commerce models. current e-commerce strategy is based on a traditional paradigm of consumers as passive receivers of communication efforts with the service provider holding control of the "when" and "where" of information (mahadevan, 2000). with wireless internet enabled devices, consumers now have more discretion of "when" and "where" the information that is available, creating new market space and demand for a specialized mobile business offering. value propositions for m-commerce value propositions define the relationship between supplier offerings and consumer purchases by identifying how the supplier fulfills the customer's needs across different consumer roles (band, 2000; porter, 1998). specifically, it specifies the interdependence between the performance attributes of a product or service and the fulfillment of needs. the value proposition furthermore solidifies the relationship between the customer and various dimensions of product value. thus, customer satisfaction is merely a response to the value proposition offered by a specific product/service bundle. for e-commerce, the establishment of a value proposition is rudimentary to any consumer-oriented strategy creation (timmers, 1998). the mobility afforded wireless devices shapes m-commerce into a disparate entity from conventional e-commerce. consequently, value propositions are likely to be new, different and novel for mobile e-commerce. the primary advantage of mobile devices is to provide a superior offering of value-for-time 2 to users. that is, by accessing the internet through mobile devices, users will be able to realize additional value allowances for any specified period of time, which fixed-line users will not be able to achieve. information may now truly become available anytime, anyplace and on any wireless device. as such, value propositions of e-commerce will be forced to change to reflect the underlying dimensions of value-for-time for users (figure 1). specifically, m-commerce differs from e-commerce on the following value proposition attributes: fall 2001 clarke: emerging value propositions figure 1 value propositions of mobile commerce 137 ubiquity what value offerings will be provided everywhere at the same time? personalization what individualbased target marketing can be employed? localization what locationbased marketing strategies can be offered? convenience what factors create time and place utility? 1. ubiquity: mobile devices offer users the ability to receive information and perform transactions from virtually any location on a real-time basis. m-commerce users will have a presence everywhere, or in many places simultaneously, with a similar level of access available through fixed-line technology. communication can take place independent of the users location. the advantages presented from the omnipresence of information and continual access to commerce will be exceptionally important to time-critical applications. mobile commerce businesses, for example, can leverage this value proposition by providing alert notifications, such as for auctions, betting, and stock price changes, which are specified by the user as an important part of relevant personal content. as such, the real-time, everywhere presence of m-commerce will offer capabilities uniquely beneficial to users. industries that are time and location sensitive, such as financial services and travel, are likely to benefit from businesses exploiting this value-added feature of mobile commerce. 2. convenience: the agility and accessibility provided from wireless devices will further allow m-commerce to differentiate its abilities from e-commerce. people will no longer be constrained by time or place in accessing e-commerce activities. rather, m-commerce could be accessed in a manner which may eliminate some of the labor oflife's activities. for example, consumers waiting in line or stuck in traffic will be able to pursue favorite internet based activities or handle daily transactions through m-commerce applications. consumers may recognize a special comfort which could translate into an improved quality of life. 138 journal of business strategies vol. 18, no.2 one opportunity to increase value lies in m-commerce capabilities that allow consumers to shop where they are not located. this ability to obtain information and conduct transactions from any location is inherently valuable to consumers. as such, m-commerce offers tremendous opportunities to expand a client-base by providing value-added services to customers heretofore difficult to reach. by making services more convenient the customer may actually become more loyal. consequently, communication facilities within m-commerce are key applications for the delivery of convenience. consumers will be looking for m-commerce applications which can deliver functions like: sending and receiving e-mail, voice mail forwarding, conference calling, faxing, document sharing, instant messaging; as well as transactional based activities. 3. localization: knowing the location of the internet user creates a significant advantage for m-commerce over wired e-commerce. location-based marketing, via global positioning technol ogy 3, will soon be available in all mobile devices. through gps technology, service providers can accurately identify the location of the user. utilizing this technology, m-commerce providers will be better able to receive and send information relative to a specific location. since mobile devices like cell phones are almost always on, vendors will know the location of their customers and can deli ver promotions based upon the likely consumer demands for that location. 4 location-specific information leverages the key value proposition of mcommerce over traditional e-commerce by supplying information relevant to the current geographic position of the user. m-commerce providers will be able to both push and access information relevant to the users specific location. mobile web-sites may serve as points of consolidation of consumer information and disseminate the relevant information for a particular location based on profile data built on the user's past behavior, situation, profile and location. as such, real time discounting may become the "killer application" for m-commerce. for example, each time you visit your local grocery store, procter & gamble can send directly to your wireless device, through the designated mobile device, tailored promotional information on their products. advertising will also be profoundly influenced by the expansion of these wireless services. mobile phones provide another effective medium for advertising products and services with the second highest potential reach, after television (zabala, 2000). durlacher predicts that by the year 2003, advertising will be the leading mobile commerce application (reed, 2000). craig owensby, coo of spotcast says: "mobile phone technologies are changing with incredible speed. within two years, mobile phones will evolve into multimedia devices for m-commerce to offer personal video communications, receive customized information, access the internet on-line [24 hours a day] to order and shop, as well as for games, entertainment and chatting. soon advertising through a mobile phone will be as normal as advertising in newspaper or tv" (zabala, fall 2001 clarke: emerging value propositions 139 2000, p. 35). applications based on this value proposition will expand the overall value frontier for mobile e-commerce as consumers recognize benefits from information relevant to the current geographic position. 4. personalization: mobile devices are typically used by a sole individual, making them ideal for individual-based target marketing. mobile offers the opportunity to personalize messages to various segments, based upon time and location, by altering both sight and sound. new developments in information technology and data-mining make tailoring messages to individual consumers practical and cost-effective. for example, upon employing your mobile internet device, advertising messages tailored to your individual preferences can be provided. relevance of material, and the "de-massing" of marketing becomes possible through the personal ownership of mobile devices. "a wireless device is a very personal device. so it becomes increasingly important that the ads you deploy are value added" says vic vasan, beyond interactive director of new technology (mack, 2000). additionally, personalized content is paramount in operating mobile devices because of the limitation of the user interface. relevant information must always be only a single "click" away, since web access with any existing wireless device is not comparable to a pc screen either by size, resolution or "surfability". therefore, subscriber profile ownerships is a key element in m-commerce success, as it will allow selectively targeted mcommerce and advertising. as such, the mobile database becomes a primary factor of m-commerce success by compiling personalized data bases and providing personalized services. one example, is the sim (subscriber identification module 0) smartcards which serve as a mobile database allowing the user to run applications and operate secure transactions. such personalized information and transaction feeds, via mobile devices, offer the greatest potential for the customization necessary for long-term success. a value proposition is developed as superior consumer value is created through an increasingly targeted internet experience for mobile users. for m-commerce, the technological limitations magnify these value-far-time propositions. it has been estimated that every additional click-through, which a user needs to make in navigating through a commercial online environment with a mobile device, reduces the possibility of a transaction by 50% (durlacher research, 2000). providing the user with the desired, most relevant information without forcing a complex click-through sequence will significantly improve the effectiveness of any mobile e-commerce strategy. value-for time propositions become maximized for those business strategies best able to implement m-commerce's distinguishing capabilities. m-commerce businesses will become differentiated from traditional e-commerce based upon 140 journal of business strategies vol. 18, no.2 their abilities to integrate and actuate the advantages germane to mobile devices. various applications may provide differing value for mobile internet users (figure 2). figure 2 m-commerce applications value proposition ubiquity convenience localization personalization application • news • sports scores • stock prices • travel information • weather • banking • communication • entertainment • gaming • mobile payment systems • retailing • videoconferencing • coupons • customer service • dispatch/scheduling • discounting • emergency services • supply chain management • advertising • database development • knowledge management systems figure 2 illustrates some possible m-commerce applications which manifest the specified value propositions. each application provides the user with value that cannot be found through traditional e-commerce. for example, a person who is waiting to check-out at the local grocery, and therefore is unable to access conventional e-commerce, may exercise this time to use their wireless pda to: move monies between personal bank accounts (convenience), receive an e-mail reminder to pick-up their dry-cleaning (ubiquity), and watch a tailored promotion (personalization) for a product available at a nearby point-of-purchase display (localization). in the past, the time of queuing has eluded e-commerce providers, but now, mobile devices offer this same person greater access to valuable services. fall 2001 clarke: emerging value propositions 141 creating a new value curve e-commerce is becoming an increasingly competitive environment where value streams become the basis for business models and strategy development. e-commerce strategies focusing on customer value not on competition may provide market opportunities in this hyper-competitive marketplace (mahadevan, 2000). yet, creating new market opportunities will require looking outside the accepted e-industry boundaries to unoccupied territory where breakthroughs in value can be discovered. this newly discovered market space can be represented by the value curve a tool which visually represents a range of value propositions. all industries can be viewed as a collection of value offerings; the value curve is a tool used to differentiate the bundle of benefits offered to each market segment (kim & mauborgne, 1997; porter, 1998). the value curve is particularly useful to business managers, in that it creates a graphic depiction of the wayan industry configures its offerings to customers (kim & mauborgne, 1999). m-commerce expands the horizons of value offerings to internet users through its unique value propositions. however, the technological limitations of wireless devices also alters the overall value package provided to customers. overall, wireless capabilities present the potential to advance the value curve creating new strategic opportunities for m-commerce organizations. figure 3 offers a comparison of the plausible value curves for both e-commerce and m-commerce 7• by integrating the value propositions into a new value curve, the area of market opportunity becomes apparent. the value curve shows the relative value of m-commerce applications compared to more traditional e-commerce offerings. the dissimilarity of the curves illustrates the fundamental differences in overall value propositions. clear advantages can be found for e-commerce in cost and speed. m-commerce provides for significant new value areas in ubiquity, localization and convenience. innovative companies can breach the ecommerce competitive environment by claiming the fundamentally new market space developed by the value propositions of mobility. real value innovations are found in applications which emphasize the characteristics of the new mcommerce territory. the m-commerce value curve depicts the relative advantages along key success factors. the broadened goal for m-commerce companies is to offer more value to clients and end-user customers along the~dimensions most relevant to each market segment. ideally, m-commerce providers will take advantage of the opportunities germane to wireless devices to create product/service specific value curves which look preferable to traditional fixed-line pc-oriented ecommerce competition. by operating in this expanded frontier of value, fixedline e-commerce competition will fail in attempts to replicate m-commerce value curves. 142 journal of business strategies vol. 18, no.2 figure 3 value curves for m-commerce and e-commerce offerings • •••• m-commerce e-commerce wireless value area •••• ••••. -. .. ..• flo. ••••. -. .. -.. -... -... .... .... -.." .-.. •••••••fixed linevalue area •••••••••••••••••.. •••• low l-,--,-----,--_,-----_-,----:--' speed price ubiquity convenience localization personalization key value offerings high implications the emergence of m-commerce specific value propositions has major implications in two different, but related ways. first, m-commerce will expose managers to a new consumer paradigm for decision making. value-far-time will be derived from the factors of mobility. as such, managers who can expand the value frontier offered through leveraging the advantages of mobility will be able to provide superior value propositions, and potentially receive greater satisfaction from mobile consumers. the m-commerce value frontier inherently expands the maximum performance currently feasible through ubiquity, convenience, localization, and personalization. innovative market space is developed as managers devise applications to exploit this new area under the value curve. second, the division of m-commerce strategies based upon consumer-orientation value propositions provides e-commerce researchers a tool for modeling the complex issues that are unparalleled in the mobile internet. business implications since the success of m-commerce applications is dependent on the ease of use and the delivery ofthe appropriate information at the correct moment, value-fortime propositions will be a key dynamic in determining the success of any mcommerce business. consumers utilizing wireless devices for internet access will come to expect improved value from their wireless experience. value-fortime will be accredited to those businesses which leverage the unique advantages of mobility. increased value-for-time propositions will enhance the success factors of mobile e-commerce businesses, with rewards to providers in increased user acquisition and retention. the implications for managers failing fall 2001 clarke: emerging value propositions 143 to develop effective consumer-oriented m-commerce strategies may include: wasting company resources chasing the ever changing technological environment, consumer alienation, and erosion of e-commerce market share. therefore, prudent managers may select to ask the following questions prior to offering an m-commerce application. 1. what is the value proposition provided from this wireless technology? managers must identify the industry value frontier and define the key value propositions. in this instance, the value offered to consumers must be germane to the mobility advantages of m-commerce. if the same application can be provided through fixed lines, and provide the same utility to consumers, the long-term success prospects would be limited. this does not mean that a comparable service cannot be provided through competing platforms, rather that the mobile application should offer additional value over the fixed line applications. 2. what market segments are best able to monetize this value proposition? managers must select and define the most attractive value proposition for each consumer segment. simple messages, based on the most relevant value offering, are likely to achieve greater success than broad-based, general appeals employing every possible value proposition. accurate identification of the markets which could best utilize the benefits provided from a m-commerce strategy will improve the time frame for success. for example, consumers may use m-commerce based on lifestyle. segment application or professional use (kpmg 2000). astute managers will leverage m-commerce capabilities to develop specific mobile strategies which appeal to these likely user groups. 3. does this application have potential to become a "killer apph? managers must always be aware that one application is likely to drive their segment of the m-commerce industry. the "killer app," or application which drives the development of that mcommerce sector, will likely vary across industries8 • managers must utilize these specific functionalities as consumers will expect such service as norm in wireless internet devices. 144 journal of business strategies vol. 18, no.2 4. is this value proposition congruent with other wireless applications currently provided? managers must find ways to organize and innovate to deliver the value proposition to consumers. thus, it becomes ever important to recognize that applications do not exist in isolation. 9 in the wireless world, users have less control over the aggregation of the services provided than in the pc world. as such, it becomes imperative that managers are able to best identify the benefit provided and only offer new applications which fit the growing consumer-orientation. research implications the unprecedented growth in e-cornmerce has underscored the need for a better understanding of the successful mechanisms and business models. as new devices become available for internet-based business, the development of new frameworks, specific to the mode of commerce will help researchers to better understand the complex environment of the digital world. the generic typology discussed in this paper will allow for a better understanding of the consumer benefits derived from making e-commerce mobile. clearly the next step is to empirically test the relative value of these benefits to the overall success of the e-commerce business. specific research questions are: which value propositions are most highly related to profitability? are there interactions amongst these value propositions? which bundles of values are most attractive to various consumer segments? are these value propositions relevant to all industries? additionally, as m-commerce develops into a distinct discipline, detailed case studies can be developed to enhance our understanding and facilitate the implementation of successful m-commerce strategies. conclusion "the wireless web is truly the next major wave of internet computing . .. its potential for bringing people together and expanding commerce is even greater than that of the wired internet. " edward kozel, board member and former cta of cisco systems (alterego, 2000, p.12) e-businesses are currently being presented new mobile technologies forexercising the advantages of m-commerce. e-commerce applications that succeed on the desktop pc win not necessarily meet with a similar accomplishment in a wireless commerce. success will depend on the ability to integrate e-competencies of current business models with the unique features of m-commerce. longfall 2001 clarke: emerging value propositions 145 term m-commerce business success is likely to come from consumer-oriented, rather than technology-based strategies. current e-commerce providers, engaged through mobile devices, will find advantage in developing unique mcommerce value propositions founded upon the specific dimensions of: ubiquity, convenience, localization, and personalization. a consumer-orientation that provides value-jor-time functions can gain a competitive advantage over traditional e-commerce models replicated for mobile business. new and even more innovative applications, than those discussed here, will arise as more people connect to the web through wireless devices and additional content becomes available. as other functionalities such as file attachments, faster network speeds, bluetooth lo , speech recognition and e-commerce security features are added, more users will be attracted to this intriguing mobile marketplace. in the short-term, e-business managers must be mindful to operate within evolving technological constraints. in the end, these problems, much like the initial problems associated with e-commerce, will also be overcome. utilization of the appropriate value propositions will be fundamental to the success of mobile e-commerce. for m-commerce to reach its full potential of information available, anytime, anyplace and on any device, business models and strategies must offer the user maximum effectiveness and value through leveraging the unmatched advantages of wireless technology. if this is accomplished, and e-commerce business models are adapted for wireless internet technology, expect to see a second e-business revolution take place based on the mobility of commerce. notes i historically, most innovations suffer turbulence before the innovation prospers. technological, social and cultural considerations may impact the rate of diffusion (rogers 1995). m-commerce will experience similar challenges as society adapts to these changes. therefore, m-commerce will not be the appropriate tool for all e-commerce operations. this paper indicates that m-commerce will best serve the organizations which can utilizes the benefits of mobility. 2 bellman, lohse and johnson (1999) provide an overview of the time critical applications for online behavior. 3 global positioning system (gps), time of arrival (toa), cell of origin (coo), enhanced observed time difference (e-otd), and location fixing schemes (lfs) are just some of the completing mobile location technologies which have capabilities of providing geographic specific value-added information. 4 issues of privacy may become a concern. intrusive messages could alienate consumers to product/service offerings. 5 services such as mobile aol explore consumer profile databases to find underlying characteristics which can be used for customer service. as database marketing matures, for mobile devices, expect greater use of such utilities. 146 journal of business strategies vol. 18, no.2 6 sim, or subscriber identification module, refers to a smart card holding the user's identity and telephone directory. short messaging service applications may reside within these sims. 7 industry and product/service m-commerce value curves may require modification of the universal curve presented. 8 certainly "killer apps" are rare which make them such a precious commodity. downes and mui (1998) explain that a "killer app" is any convergence of technologies, products and services in a way which reshapes an industry and leads to market dominance. as such, managers must scan their particular industry to find the mobile functionality which industry associates demand. 9 managers would be wise to consider the broad range of organizational issues which may be a significant impediment to implementation. 10 bluetooth is a chip technology that enables seamless voice and data connections between a wide range of devices through short-range digital two-way radio. references alterego (2000). building the intelligent internet: making the case for adaptive network services. [www.alterego.com]. albright, b. (2000). mobilize this!. frontline solutions, may, 28-32. band, w. (2000). creating value for your customer. sales and marketing management in canada. 31 (2),4-6. barnett, n., hodges, s. & wilshire, m. (2000). m-commerce: an operator's manual. mckinsey quarterly, 3,162-171. bellman, s., lohse, g. l. & johnson, e. j. (1999), predictors of online buying behavior. communications of the acm, 42 (12), 32-38. brandt, j. r. (2000). dail 'm' for 'mobile'. industry week, may 1,4. chen, p. (2000). broadvision delivers new frontier for e-commerce. m-commerce, october, 25, daitch, j., kamath, r., kapoor, r., nemiccolo, a., sahni, j. & varma, s. (2000), wireless applications for business: business anytime, anywhere. kellogg tech venture 2000 anthology, 88-120. datamonitor (2000). the race for m-commerce: shifting paradigms in the world of mobile commerce strategy. [datamonitor.com]. downes, l. & mui, c. (1998). unleashing the killer app: digital strategies for market dominance, boston: harvard business school press. fall 2001 clarke: emerging value propositions 147 de haan, a. (2000). the internet goes wireless. eai journal, april, 62-63. durlacher research ltd (2000). mobile commerce report. [www.durlacher.com] evans, p. b. & wurster, t. s. (1997). strategy and the new economics of information. harvard business review. 75 (5), 70-82. hoffman, g. (2000). start game. communications international. april, 18-22. kim, w. c. & mauborgne, r. (1999). creating new market space. harvard business review. 77 (i), 83-93. ______ (1997). value innovation: the strategic logic of high growth. harvard business review. 75 (i), 103-112. kpmg (2000). creating the new wireless operator. [www.kpmg.com]. m-commerce times (2000). m-commerce vital statistics. (16), [www.mcommercetimes.com]. mack, a. m. (2000). beyond interactive to deploy wap-enabled ads. adweek, june 12, 59. mahadevan, b. (2000). business models for internet-based e-commerce. california management review, 42 (4),55-69. mcginity, m. (2000). the net/wireless meeting of the minds.1nter@ctiveweek. march 2, 2. porter, m. e. (1998). competitive advantage: techniques for analyzing industries and competitors. the free press: new york. rao, m. (2000). em-wire: e-commerce, m-commerce poised for rapid take-off in europe. electronic markets: the international journal of electronic commerce & business media, april 6, [www.electronicmarkets.org/electronicmarkets/ electronicmarkets. nsflpages/emw_0004_cell. html]. reed, m. (2000). why the future will be wireless. marketing, february 3, 22-23. rogers, e. m. (1995). diffusions of innovations. (4th ed.). new york: free press. schenker. j. (2000). europes' high-tech start-ups have stolen a march on silicon valley by launching new mobile services. time europe, february 7, 1. shaffer, r. a. (2000). m-commerce: on-line selling's wireless future. fortune, july 10, 262. 148 journal of business strategies vol. 18, no.2 timmers, p. (1998). business models for electronic markets. electronic markets, 8 (2), 3-8. zabala, h. (2000). m-commerce, the next big thing? asian business, june, 34-35. irvine clarke is currently an associate professor of marketing at james madison university and is a research fellow at the commonwealth information security center. he earned a ph.d. from old dominion university in business administration with a major concentration in marketing. he has recently published in the journal of international marketing, international marketing review, industrial marketing management, and the journal of international consumer marketing. in the past five years he has taught at locations in canada, england, france, germany, malaysia, mexico, singapore and the peoples republic of china. he currently serves on the board-of-advisors for assorted wireless e-commerce companies and has 15 years private sector organizational experience in technology marketing. emerging value propositions for m-commerce just noticeable difference: the marketplace experience of general motors thomas l. powers graduate school of management the university of alabama at birmingham birmingham, alabama in mature markets, consumer perceptions of products are vitally important for the firm involved. products are typically similar, and care must be taken to maintain enough differences between them to insure that the marketplace will see them as discrete offerings. recently, general motors encountered problems in differentiating its products between market segments [23], a situation which resulted in lost market share, much to the concern of gm shareholders and management [6]. many of these problems have been attributed to gm's management, which has been viewed as carrying out an ill-conceived strategy differing from past practices [8]. this paper examines general motor's problem with similarly appearing products through the use of the "just noticeable difference" concept q.n.d.) ([1], p. 140), which can be used to explain the requisite level of perceived difference between products. several factors can affect this required level of difference, including consumers' previous product perceptions, changing demographics, and the number of products in the market. for a firm such as general motors, the level of product differences could remain relatively constant from year to year. however, due to the factors noted above, consumers' level of perceived difference may be reduced. additional competing products in the market can also result in limiting the number of distinct product positions [21j. by understanding these relationships, which are discussed in this paper, managers can anticipate and act on market developments that require a change in the level of differentiation between products. the general motors experience general motors represents a very real and current example of the problem of differentiating products. the impact of products that are seen as similar by the marketplace has been dramatic. in 1987, gm's market share dropped to 37% of the market nationwide, and to less than 25% in the bellweather state of california [13j. the 37% share contrasts sharply with a market share of more than 50% that prevailed for most of the post-world war ii period. a brief discussion of the history of general motors' product line helps explain how gm's problem came about and journ.al of business strategies, volume 5, number 2 (fall 1988) 93 94 journal of business strategies vol. 5, no.2 provides some insight into how other firms can anticipate and measure the actual and required perceived differences between products. structuring the general motors' product line 1897-1919 general motors began not as a monolithic manufacturer of automobiles as it is seen today, but as a collection of different automobile companies. oldsmobile, the oldest firm to become a part of general motors, was established in 1897 and by 1904 had produced 12,500 cars ([12], p. 16). the cadillac automobile company and the buick manufacturing company both were organized in 1902 with buick providing the base for the modern general motors. by 1907 buick had become the second largest manufacturer of automobiles in the country, and in 1908 william c. durant incorporated general motors, which was to include buick, oldsmobile, oakland, and cadillac by 1909. chevrolet was added in 1918, and by 1920 more than 30 companies became a part of the general motors holding company. with the multiple product lines, durant created a high level of market segmentation, i.e., the viewing of a heterogeneous market as a combination of a number of smaller homogeneous markets in response to differing product preferences among market segments [20]. he believed that the future would belong to the automobile company that produced a line of motorcars ranging from light, inexpensive cars to large, expensive vehicles which would appeal to several market segments ([9], p. 235). in addition, gm utilized product differentiation, a process which creates distinct images for a firm's products vis-a-vis their competition [20]. for example, the chevrolet automobile and marketing effort were designed to appeal to a cost-conscious market segment, and at the same time the automobile was differentiated from its competition by its distinct image and product features ([12], p. 32). the combination of the dual strategies of market segmentation and product differentiation resulted in several gm product lines which clearly appealed to distinct customer groups, and which in many cases were seen as superior to their competitors. during this time period, these products were different by definition since they were brought into gm as products of several different manufacturers. independent production processes typically were maintained for several years after the acquired firms became part of general motors. this led logically to a segmentation strategy which was developed fully a short time later. market segmentation 1920-1940 during this period general motors undertook a strategy which was one of the first examples of market segmentation on a large scale. its goal was to find "the best car for every purse and purpose" ([12], p. 36). chevrolet continued to be positioned as an "economy" or "entry level" automobile and was marketed with emphasis on its attributes of price, economy and value. its many competitors within the "economy" segment included ford and plymouth, which today, in the context of american manufacturers, still represent the lower-priced models. plymouth's advertising of the period encouraged buyers to examine all three "economy cars" ([22], pp. 108-09); recent fall 1988 powers: just noticeable difference 95 chrysler corporation advertising also has followed this theme. recently, chevrolet has tried to re-emphasize the youthful and value image with the "heartbeat of america" campaign that features models typically sought by entry-level buyers [18j. pontiac was developed as a spinoff of the oakland automobile line to fill the market gap between the chevrolet and the premium lines. it was positioned as an economical, low-priced car, though it was "sporty" and somewhat more upscale than a chevrolet of the time. pontiac today is the only one of the gm lines that has maintained its historic market position. not surprisingly, the pontiac strategy has met with a high level of success, with pontiac's relative sales out-performing the other gm divisions [7]. oldsmobile was positioned as a car for the successful person, although it was more conservative than other models; it was to serve as a restrained display of one's success in the world. this was a major repositioning of this product line, since olds originally was famous as the first mass-produced, low priced car ([91, p. 52). this division currently is suffering from the positioning problem that also has affected gm in general [15j. products of the buick motor division were targeted towards those who had achieved success and were interested in making a public statement to that effect. ironically, buick, on which gm was founded, today has lost its market identity perhaps more than any other gm line and has been considered for elimination [5]. the cadillac motor division represented the pinnacle of the gm line and was a worthy statement of the success of the individual owning one of these automobiles. today, cadillac has not been successful in competing with european automobiles for this segment of the market [16]. general motors was very aggressive during this period (1920-1940), attempting to develop new products from existing lines for every market niche. new products added included the lasalle, which was a spinoff of cadillac. oldsmobile developed the viking, and buick had the marquette automobile ([12], p. 46). many of these products did not survive; however, their development provides firm evidence of general motors' desire to seek out every possible market segment. promotion also reinforced general motors' segmentation strategy. chevrolet developed the american soap box derby to identify their product with young boys who soon would become entry-level buyers. even components such as engines were developed to reinforce the images of the various product lines during this period. cadillac offered v-16 engines which epitomized power and status, thus strengthening their appeal to the prestige segment of the market. cbevrolet had a "blue flame six" that emphasized performance within a simple, economical design, making an appeal to the economy or value-conscious segment. pontiac offered an "economy straight eight" which fell between the two ends of the market spectrum and appealed to this middle segment ([12], pp. 58-63). one must be aware that gm's products during this period were indeed different. they consisted of different components, many times were built in different plants, and were of varying lengths, weights, and designs. each product line also offered a 96 journal of business strategies vol. 5, no.2 number of different models to appeal to submarkets. for example, in 1941 buick had 26 body styles in five different series ([12], p. 102). fewer product differences 1946-1969 after world war ii general motors increasingly created economies of scale with common components across division lines; this was the fruition of the original concept of durant, who had envisioned a coast-to-coast system of component and assembly plants ([9j, p. 235). differences in sheetmetal, front and rear treatments, and minor trim items were used to differentiate the various lines. eventually the gm product lines included common engines, transmissions, and other major components. this commonality was partially due to the maturation of designs, with some components, such as overhead valve v-8 engines and automatic transmissions, reaching a near state-of-the-art for the period. body designs, although sharing common componentry, emphasized differing themes. the previously developed brand images and the limited number of radically different products undoubtedly reinforced differences between their lines. the success and dominance of gm in the marketplace at the time was unquestioned. although the gm products were similar (actually just as much as they are today), the marketplace viewed those products in the context of the brand images that had been developed earlier. new markets and new competition 1970-present during this period, general motors saw many environmental changes that impacted its operations. in the mid to late 1960's, market emphasis had been placed on performance. however, this emphasis was short-lived the 1970's saw two energy crises, a corresponding increase in consumer interest in economy, increased insurance premiums for owners of high performance models, and new regulations on safety and emission controls. these factors in combination caused the company to reduce costs by emphasizing more common designs and components, while maintaining its efforts to differentiate product lines by style and image. the 1970's also saw a major market development that changed general motors' ability to differentiate its product lines. import sales comprised five percent of the total market in 1958 ([17j, p. 33); during this period, however, they became a major force in the marketplace. by 1968 import sales had reached 10% of the total market ([17j, p. 84). despite this, general motors continued to vigorously pursue its basic segmentation strategy unchanged. this included a reluctance to pursue vigorously the small-car market, which represented not only a large market segment, but also many first-time buyers who were building brand allegiances that would remain for many years. by 1975 imports held 18% of the market, and by 1980, 27% ([17j, pp. 34-35). fall 1988 powers: just noticeable difference the new market and the old strategy 97 why doesn't the brand perception strategy that worked so well in the past work today? three factors have caused the relative differences between gm products and the market position of each of them to become diminished. increases in the number of total product offerings first, the total number of products in the marketplace has caused a decrease in the relative perceived differences in general motors cars. while general motors has continued to differentiate its products as it did in the 1960's, the total number of products in the marketplace has increased, making the relative differences between gm products seem smaller to the average consumer. prior to the influx of imports, general motors had almost 50% of the products on the market. general motors had five car lines, ford had three (excluding the short-lived edsel), and chrysler had three (after the demise of the desoto). after the decade of the 1970's, strong sales and brand images had been developed by toyota, nissan, honda, volkswagen, mercedes-benz, audi, volvo, saab, and several other firms. many of the new competing products were targeted towards the market segments that gm had identified in the 1920's. first the japanese, and more recently the koreans, have targeted the chevrolet economy segment. european imports are strongly appealing to the cadillac status segment. with the addition of new product offerings to the total market, perceived differences in gm lines become smaller. reduction in the available market positions second, the influx of competitors, primarily at the high and low ends of the market, has caused a decrease in the relative market space of gm products. the impact of more products on the market is compounded when one examines the markets that have been segmented effectively by imports. the low-end economy market has been dominated by the japanese, and more recently by korean a.nd eastern europea.n manufacturers. the higher end of the ma.rket ha.s been dominated by the european imports, and japa.nese firms increasingly are targeting this market segment. such competition ha.s made it necessary for general motors a.nd other american manufacturers to compete in a more limited area of the market. they have concentra.ted on the middle of the market because of the similarity among their product lines, and this emphasis may be considered to be one of the ma.jor strategic errors in this episode. it is well documented that general motors has exhibited a high degree of reluctance to enter the small-car economy end of the ma.rket. concomita.ntly, due to gm's standardized manufacturing methods, it ha.s been unable to produce distinctive vehicles for the higher end of the market. most recently this fa.ilure has been demonstrated by the poor showing of the cadillac allante which was designed to compete with mercedes-benz automobiles in the $50,000 price range [11]. 98 journal of business strate.qies vol. 5, no.2 changing demographics finally, changing demographics have heightened the problem of product similarity because those individuals with the greatest brand-perception differences are buying a smaller share of all products as they grow older. demographics also have reinforced perceptions of product differences. consider the following scenario, which concerns a buyer of an oldsmobile in 1965 who was 55 years old. that customer's brand perception probably was based on events which had occurred when that person was 20-25 years old. this would have been in the time period of 1930 to 1935, just at the time that gm's products were differentiated at their greatest level. studies have shown that individuals form brand preferences at relatively early ages ([11, pp. 46266), some even in childhood [2]. in this case it would be relatively easy 30 years later, in 1965, to convey substantially different product images with only slight differences in product design cues. an examination of that hypothetical buyer today reveals a different solution. if that person were alive, he or she would be 77 years old. this person would be retired and normally would be purchasing automobiles much less frequently. the percentage of gm buyers who are retired is growing at a rapid rate; of even greater concern is the number of buyers who are deceased. the old sales joke about the funeral industry, "the market is dead," unfortunately applies all too well in this instance. product proliferation while its market space was being reduced and its perceived product differences were being diminished, gm exacerbated the problem by putting more products within this limited market space. its strategy was designed to a.ppeal to all possible markets; however, it resulted in all company divisions trying to cover every segment with products shared by most gm divisions. at the same time, gm reduced somewhat the discern able differences between its products. one must keep in mind that this strategy probably would have worked very well in the 1950's, under the vastly different market conditions of that period. other factors several other factors compounded the problem for general motors. energy concerns created an increased demand for smaller, more fuel-efficient automobiles. gm moved very slowly in reacting to this trend and did not offer viable products for this market segment. foreign products, in addition to being seen as more economical, also were perceived as having higher quality and overall value. this in turn caused resale prices of foreign cars to be higher, adding to their appeal. the european and japanese car makers aggressively instituted major advertising and promotion programs which pointed this out to the consumer. the "just noticeable difference" concept the problem of gm products that appear to consumers to be similar can be understood further through the concept of "just noticeable difference" ([1], pp 14142). just noticeable difference, or j.n.d., is based on weber's law which was developed fall 1988 powers: just noticeable difference 99 by two german physiologists in the nineteenth century [3]. this concept. states that the stronger the initial stimulus, the greater the change must be in another stimulus to be perceived as different. the basic premise of this concept is that an additional level of stimuli is necessary for most people to see a difference between the new stimulus and the previous one [4j. the degree of stimuli required for a difference to be noticed is a constant ratio of the new stimulus to the initial one. one example of this concept is a price change. let's assume a small item, priced at $3.00 has a price increase of 22 cents. this amount might fall below the j.n.d. and thus not be noticed by the consumer. an increase of 27 cents might be noticed and cause a decrease in demand. the firm involved would be wise to increase price by the lower amount. the j.n.d. concept holds that the relationship between the differences in stimuli is a constant ratio. therefore, based on consumer perception in the previous example, an item that had a price of $30.00 could be increased by $2.20 without a difference in perception by the consumer, yet an increase of $2.70 would be noticed. the just noticeable difference notion is expressed as m--= k i (1) where: 6,.[ i k the just noticeable difference required to produce a change in perception; the initial stimulus; the constant amount for the stimulus to be noticed. in practice, this concept is valuable to determine price levels, product differences, package sizes, and other elements of marketing strategy. the level of change, or k, can be determined through market research using the constant stimuli method until the j.n.d. is reached [4]. in some cases, such as pricing, the object is to find the highest level attainable just below the j.n.d. in other actions such as differentiating products, the object is to determine the level at which a change will be noticeable. this point at which change is noted is referred to as the differential threshold ([10], p. 283). the change in product perceptions can be seen more dearly by using this concept. the type of product differences required in the past to make products appear different from each other and the competition can be seen as m = k(i) (2) where: i a positive function of n, c, and lip; n the number of products in the market; c the differences perceived between competing products; p the differences perceived between our prod uets both c and p are a function of external stimuli and previously internalized brand perceptions. 100 journal of business strategies vol. 5, no.2 in this case, 6.1 is the degree of product difference required to differentiate gm products from one another and from competitors. 1 is the initial stimulus, or the consumer's overall perception of products in the marketplace which a new product must be substantially different from. this is a function of the number of products in the marketplace, nj the perceived differences between competing products, cj and the perceived difference the subject fum's products, p. since 1 is inversely related to p, the function is negative and is expressed lip. both sets of product perceptions, c and p, are based on external stimuli such as observation of the product, advertising, and word-of-mouth communications. they also are related to previously learned brand identities that reinforce product differences. what can happen? as the number of products, n, increase in the market, the base level of initial stimuli increases, which in turn causes 6.1, the amount required for the new stimulus to be noticed to be increased to maintain the constant change or threshold level, k. the differences in product perceptions, c and p, likewise impact 1. as competing product differences within the consumer's base of experience increase, the level of i increases which again in turn requires 6.1 to be greater to maintain a constant k. increases in product differences for the subject firm's products reduce the level of 1. expressed another way, this relationship can be seen as k(i) or m k(n+c+l/p), (3) through the use of this framework, the general motors experience can be seen as follows. first, the level of product differences, tli, that was historically implemented was at or above the level necessary considering the base of experience, i, to produce a perception of different products. this was at the historical levels of n, c, and p. as has been discussed, several changes occurred in the market. the level of n, or the number of products in the marketplace, increased with the great increase in the number of foreign competitors. the perceived differences between competing products, c, became larger as these products established strong brand identities. finally, the perceived differences between gm's products, p, decreased on average as the population has moved further from the time period where major differences existed between the products. based on equation (3) all of these factors would result in an increase in tll, or the perceived differences that would have to be created between the general motors products in order to maintain the constant relationship, k, between their products and competing ones. did this occur? as seen in the previous discussion it did not, and most critics believe that those product differences were actually decreased in recent years. fall 1988 powers: just noticeable difference what can be learned? 101 several lessons can be learned from the om experience. first, brand perceptions are based on product positioning and image strategies that take place over a number of years. this product image can disappear quickly if new customers are not developed with similar brand perceptions. the result of such a change can impact even the largest and seemingly most secure firms in the marketplace [14]. this process happened in reverse with coca-cola whcn it attempted to pull from the market a product with long-standing brand identity. second, the degree of difference between brand images can change based on new product entrants and the relative product space in which a firm competes. the number of entrants alone can change the differences that may have to be emphasized in order that the desired level of perceptual difference between products can be maintained. the position that products occupy in the marketplace also plays apart in this process; this position can be compressed to a point where perceived product differences are extremely difficult to maintain. firms which can accurately measure and implement the just noticeable difference strategy can create a proper degree of difference in their products to make them recognizable and successful in the marketplace. for example, ford motor company's recent success with the taurus/sable line is du,e in large part to the products' distinctive styling which makes them clearly different from their competition and from one another. a degree of risk is associated with this strategy, of course. products which' are seen as being too different or distinct might fail for that reason alone. although the automobile industry was used to illustrate the just noticeable difference strategy in this paper, this concept can be applied to virtually any product or service area. it also can be applied to product differentiation as well as market segmentation strategies. for example, the hotel and airline industries are plagued with the problem of consumers not perceiving differences between competitors. in this case, j.n.d. could be applied to the problem of product differentiation, enabling these firms to identify the key dimensions and levels of stimuli to make their products or services appear substantially different than the competition. the process of implementing j.n.d. is not a particularly difficult one. the correct levels of differences between a firm's products can be readily determined using relatively routine market research procedures. first, a firm would need to ascertain, through a focus group process, the factors and attributes that consumers use to differentiate products. the factors that influence consumers usually span the marketing mix and are not limited to product content alone. for example, customers might inform the moderator that location and atmosphere of stores selling different products are factors that have a major impact on their perceptions. positive attributes associated with these factors might be comfort, soft textures, and earth-tone colors. the second step in this procedure is to test, using a concept test of an advertisement pre-test format, increasingly greater levels of differences in the attributes that were seen to be important by consumers. questionnaires then can measure levels of perceptions of attributes associated with that factor, including direct references to a 102 journal of business stmtegies vol. 5, no.2 prior stimulus. once the differential threshold is determined, it can then be utilized in the constant ratio format to define differential thresholds in related areas. complicating this procedurc ,umewhat are the number of ta.rget markets tested, and the number uf factors and attributes examined. this process can be a proactive one where the correct decisions can be made before the product is introduced to the marketplace. otherwise, corrective actions must be made after the problem is fully developed. gm, which provided the backgruund lor the illustration of this concept, has started to take actiuns to reorganize the cumpany in accordance with the original segmcntatiun strategy of the 1920's. unfortunately, this reorganization has been a slow process [19]. gm also is working on establishing a higher level of product differentiation. both of these tasks will take years to complete fully and will cost hundreds of millions of dollars. hopefully the lessom of thi, experience will not be lost on firms that have currently high sales and orand preferences based on past marketing efforts. references 1. assael, h. consumer behavior and marketing action, third editiun. boston, ma: kent publishing co. (1987). 2. bahn, k. d. "how and when do brand perceptions and preferences first form? a cognitive developmental investigation." journal of consumer research, vol. 13 (december 1986), pp. 382-93. 3. britt, s. "how weber's law can be applied to marketing." busmess horizons (february 1975), pp. 21-29. 4. britt, s. "the marketing importance of just noticeable difference." business horizons (august 1976), pp. 38-40. 5. bush, j. w. "buick: charting a comeback tied to its roots." ward's auto world, vol. 23 (february 1987), p. 28. 6. callahan, j. "cost cutting, confusion plagues gm." automobile industroy, vol. 166 (august 1986), p. 27. 7. callahan, j. m. "losh guides pontiac to new heights." automotive industry, vol. 166 (august 1986), p. 22. 8. "can gm solve its identity crisis?" business week (january 23, 1984), pp. 3233. 9. crabb, r. birth of a giant. philidelphia, pa: chilton book co. (1969). 10. engel, j. f. and r. d. blackwell. consumer behavior. hinsdale, il: dryden press (1982), p. 56. fall 1988 powers: just noticeable difference 103 11. flint, j. "allante: slow off the mark." forbes (november 30, 1987), p. 204. 12. gm: the first 75 years of transportation products. princeton, nj: princeton institute for historic research, 1983 general motors corporation, p. 16. 13. jeriski, l. "fiddling with figures while sales drop." forbes (august 24, 1987), pp. 32-35. 14. krebs, m. "gm products to die it they can't compete." automotive news (march 30, 1987), p. 56. 15. lapham, e. "olds places a new emphasis on quality to push its duds: delta 88 and toronado." automotive news (september 22, 1986), p. 30. 16. lowell, j. "cadillac: selling a balance between status, performance." ward's auto world, vol. 23 (february 1987), pp. 45-46. 17. rae, j. b. nissan/datsun, a history of nissan motor corporation in the u.s.a. new york, ny: mcgraw-hill (1982). 18. serafin, r. "heartbeat: new ads pump life into chevy's american image." advertising age, vol. 28 (january 12, 1987), p. 3. 19. serafin, r. and p. strnad. "gm gets competitive, will drop 39 models." advertising age, vol. 57 (august 4, 1986), p. 10. 20. smith, w. r. "product differentiation and market segmentation as alternative marketing strategies." journal of marketing (july 1956), pp. 3-8. 21. strnad, p. "new chevies lead gm deproliferation." advertising age, vol. 58 (january 12, 1987), p. 60. 22. watkins, j. a. the 100 greatest advertisements. new york, ny: dover publications, inc. (1959). 23. zois, d. "gm strives for variety in styling." automotive news (july 21, 1986), p. 1. just noticeable difference: the marketplace experience of general motors narrow-scope strategies and firm performance: an empirical investigation julio o. de castro university of colorado boulder, co james j. chrisman university of calgary calgary, canada abstract this study examines the peifonnance oftwo samples ofnarrow-scope manufacturingfirms competing in concentrated. mature industries. the conceptualization and measurement of scope is discussed, and hypotheses regarding broadand narrowscope are tested. results indicate broad-scope firms outpeiform narrow-scope firms, but also showed that cel1ain types ofnarrow-scope strategies can be effective. narrow-scope strategies and firm performance: an empirical investigation scope, defined by hofer & schendel (1978, p.25) as the extent of firms' present and planned interactions with the environment, has been recognized as one of the main components of competitive strategies. recent research has begun to explore the performance implications of scope both from the context of mainstream strategy research (prescott, 1983; woo & cooper, 1981), and from the perspecti ve of population ecology (carroll, 1984). following porter (1980), there has been renewed interest in the examination of focused (narrow-scope) strategies. focused (narrow-scope) strategies are strategies in which a firm decides to limit its operations to one or a few segments of customers or product types (e.g. dess & davis, 1984). there is recognition that those strategies may be valid strategic alternatives for firms. theoretical examinations have also explored the characteristics needed by narrow-scope firms in order to be successful (chrisman, hofer & boulton, 1988; wright, 1987; murray, 1988). research in this area, however, is lacking. even though authors such as prescott (1983) and dess & davis (1984) have examined the characteristics of competitive strategies and scope in particular industry environments, there is a lack of research that compares the relative performance of different types of scope in a contingency framework. if, as hofer (1975) argued, particular strategies may not be optimal in all situations, then it is important to determine the conditions under which narrow-scope strategies can be effective, and whether they are viable alternatives in less than favorable environments. in 2 journal of business strategies vol. 15, no.1 the context of new ventures, an examination of scope becomes important because different types of scope utilized by firms can have an impact on firm performance and survi val. although there is a body of work that has examined economies of scope at the corporate level (teece, 1980), the same cannot be said for the examination of scope at the business level. murray (1988) and oster (1990) have started work on the conceptualization of economies of scope at the business level, but little empirical research has investigated its performance implications. furthermore, the link between conceptualization and measurement of scope in previous research, especially of narrow-scope, is tenuous at best. the use of concepts similar or related to narrow-scope such as focus (porter, 1980; dess & davis, 1984), specialists (carroll, 1984), low market share firms (woo & cooper, 1981; cooper, willard & woo, 1986), and niche strategies (garda, 1981), have failed to lead to a consensus on the appropriate conceptualizations, prescriptions, or measurements of narrow-scope strategies. to fill this gap, this research first reexamines the concepts of scope and narrow-scope in light of previous definitions and conceptualizations, and secondly, investigates empirically the relationship between scope and finn performance at the business level. a key argument regarding narrow-scope is whether such strategies can be effective. to test the resilience of narrow-scope strategies, this study compares the performance of broadand narrow-scope firms in concentrated, mature industries. effective narrow-scope firms have been found in growth or fragmented environments (dess & davis, 1984). however, since the competitive challenges in concentrated, mature industries are usually greater, the presence of high performing, narrow-scope firms in these environments would make a more convincing case for their potential effectiveness in other environments. concentration presents a special challenge to narrow-scope firms because the dominant firms in the industry possess enormous market power. likewise, industry maturity, where firm growth must often corne at the expense of rivals and larger competitors invade previously ignored market niches. also provides an environment that is not altogether conducive to narrow-scope firms. characteristics and performance of narrow-scope firms the conceptualization and measurement of scope and narrow scope the examination of scope in the literature has been done in the context of economies of scope. chandler (1990) has argued that economies of scope exist when firms manufacture a number of products from the same production unit, from the same raw or semi-finished materials, or by the same intermediate processes. panzar and willig (1975) contend that economies of scope exist for two outputs when the cost of joint production is less than the cost of producing each output separately. both definitions examine economies of scope from the context of a family of products. teece (1980), however, has argued that economies of spring 1998 de castro & chrisman: narrow-scope strategies 3 scope exist in multi-product diversification and serve as an efficiency rationale for corporate diversification. in the context of business level research, analysis of scope is imbedded in the generic strategies literature. both porter (1980) and abell (1980) include scope as one of the main dimensions for their generic strategies frameworks. although these discussions set the tone for research on scope, they do not clearly explain the organizational characteristics that narrow-scope firms should have or how to measure them. an example of this problem is given by white (1986), whose study of organizational characteristics and generic strategies used porter's framework, yet specifically excluded focus firms for this reason. one of the main problems researchers face is a lack of clarity as to what constitutes narrow-scope. for example, as a result of the pims studies linking market share and profitability (buzzell, gale & sultan, 1975), high market share was, by implication, equated with a broad presence in the market. as a consequence, low market share firms were assumed to need the protection of market niches and, thus, a niche strategy (clifford & cavanaugh, 1984; garda, 1981). this argument, however, confuses strategic choice with strategic result; scope and market share are different phenomena. a firm's market share is a function of its ability to penetrate the productmarket segments in which it chooses to compete; an effective narrow-scope firm may obtain a larger market share than an ineffective firm with a broad scope. scope, by contrast, results from a firm's choice of domain. a firm can decide to compete in all, most, or a limited number of product-market segments in its industry; if it selects the latter, it is following a narrow-scope strategy. conceptualization of scope should rely on the examination of a firm's decision along two dimensions: products and markets. although a number of variables have been suggested as indicators of a firm's scope (e.g., geographic segments, customer groups, customer functions, technology), all are related to a firm's choice of products or services and markets. the appropriate specific variables to use in evaluating scope will then depend upon the nature of the industry examined. for example, miller (1981) used geographic areas and product segments to determine the scope of a sample of retail businesses. while useful for his study geographic areas are probably not sufficient to represent the markets served by manufacturing businesses. others, such as sandberg (1986), used expert panels to distinguish generic strategies, whereas prescott (1983) used a comparison measure to determine the scope of firms included in the pims database. researchers from the population ecology school such as freeman & hannan (1983) and carroll (1984) have also examined scope in their discussions of generalist and specialist firms. generalist firms, much like broad-scope firms, were identified by their attempt to compete in the large segments of the market. specialists, on the other hand, were those that competed for specific groups of customers. others have used cluster analysis to identify strategic types and scope. for example, gailbreath & schendel (1983), using factor and cluster analysis, found 4 journal of business strategies vol. 15, no.1 a "niche" strategy among both industrial and consumer goods manufacturers. interestingly, their results appeared to be based primarily on the source of strategic advantage employed by those firms since only one of the factors used in the cluster analysis represented scope, and neither group of "niche" businesses was particularly narrow in that dimension vis-a-vis the other groups identified. the clustering of microcomputer firms conducted by chrisman & bauerschmidt (1990) went to the other extreme; their clusters were based solely on product scope decisions. their approach made no allowances for market scope and, therefore, one of the key distinctions between broadand narrow-scope firms was lost. the effectiveness of narrow-scope firms in addition to the problems regarding the conceptualization of scope, questions regarding the viability of narrow-scope strategies remain unresolved. first, scholars disagree with respect to the viability of narrow-scope strategies. on the other hand, it is argued that few firms can succeed in the long run with a focused strategy (garda, 1981; hatten & hatten, 1987), or that narrow-scope firms should seek out market niches that are unattractive or unfeasible for their larger rivals (buchele, 1967; cohn & lindberg, 1972). on the other hand, the need for narrow-scope firms to seek protected niches has been challenged by the results of several studies (hamermesh, anderson & harris, 1983; woo & cooper, 1981; cooper, willard & woo, 1986). second, there is disagreement regarding the types of environments that will support narrow-scope firms. dess & davis (1984) provide support for the presence of narrow-scope firms in fragmented industries, a finding with intuitive appeal. carroll's (1984) analysis offour firms in highly concentrated industries suggests, however, that narrow-scope strategies may be viable alternatives in industry conditions other than fragmentation. he argues that the success of the broad scope firms creates the conditions necessary for narrow-scope firms to compete effectively. since broad-scope firms compete by means of universal appeal to all customers, they leave market segments with specialized appeal open for narrowscope firms. according to that argument, both types of firms should theoretically appear in all industry conditions. consistent with this viewpoint, prescott (1983) and sandberg (1986) found narrow-scope firms in a variety of environments. however, their findings provide contrasting conclusions regarding the relative effectiveness of narrow-scope strategies under different environmental conditions. prescott found 'focus' firms to be better performers in declining and stable non-fragmented industries, but relatively inferior performers in industry maturity. sandberg, by contrast, suggested that focused strategies appeared to be more appropriate than broad-scope strategies for new ventures entering industries in later stages of evolution, although his small sample made him unable to support this conclusion statistically. finally, from a theoretical point-of-view, researchers have argued that differences between broadand narrow-scope firms should translate into differences in spring 1998 de castro & chrisman: narrow-scope strategies 5 performance (murray, 1988). while a complete explanation as to why this occurs has yet to be developed; the few limited attempts have been instructive. for example, the concept of economies of scope may explain above normal returns for broad-scope firms (teece, 1980). oster (1990) has argued that multiple product lines can create economies of scope that cut across functions and panzar & willig (1981) assert that this can provide cost advantages. in the case of narrow-scope firms, in-depth knowledge of the characteristics and nuances of particular product/market segments can translate into above normal returns for firms. in heterogeneous industries, a narrow-scope firm can exploit differences in customer preferences to stake a preeminent position within a customer segment (murray, 1988). in spite of these insights more work is needed, a task to which we turn below. hypotheses which firms should perform better in an environment that is concentrated and mature: firms that are able to derive economies of scope, or firms that are able to exploit differences in customer preferences? given the effects of industry concentration and unequal degrees of market power in concentrated, mature industries and the possibility of deriving economies of scope, it is expected that benefits of competing with a broad scope should outweigh the benefits of specialization in such environments. however, because scope can be measured in terms of both products and markets, it is possible for a firm to be broad on one dimension while narrowly focused on the other. it is expected that the benefits of either economies of scope or specialization should be more acute for firms that are either broad or narrow on both dimensions. firms with a broad product scope should enjoy greater economies from their broad range of products when they sell them to a broad, rather than a narrow, set of markets. in the case of narrow-scope firms, the same argument should hold. that is, a narrow scope in both products and markets should permit a higher degree of specialization in production and the opportunity to more effectively tailor marketing programs for the targeted customers. indeed, carroll (1984) has argued that extreme specialism concentrating on a specific number of product-market segments may be the best strategy for most firms. hypothesis 1: firms with a broad scope in both products and markets will outperform: hypothesis ja. firms with a narrow scope in both products and markets; hypothesis jb. firms with a narrow product scope and a broad market-scope: and hypothesis jc. firms with a narrow market scope and a broad product scope. 6 journal of business strategies vol. 15, no.1 hypothesis 2: firms with narrow scope in both products and markets will outpeiform: hypothesis 2a. firms with a narrow product scope and a broad market scope; and hypothesis 2b. firms with a narrow market scope and a broad product-scope. finally, finns with a narrow-scope in products but not markets are expected to be better perfonners than finns with a narrow scope in markets but not products because advantages accruing from patents, production systems, and technology may be more easily defensible than advantages accruing from customer preferences, marketing methods, or auxiliary services in concentrated, mature industries. hypothesis 3: firms with narrow product scope and broad market scope will outpeiformfirms with narrow market scope and broad product scope. methodology two samples of manufacturing finns were drawn from a series of case studies and the pims database to test the above hypotheses in mature, concentrated, heterogeneous, domestic environments. the pims database was useful in that it provided a large sample of finns that cut across many industries. the case studies provided a smaller sample that allowed a more intensive understanding of the characteristics of specific industries. the result is a combination of both coarseand fine-grained research into the medium grained research championed by harrigan (1980). the use of two samples also allowed cross-validation of the research results, thus satisfying the concerns of authors such as ramanujan & venkantraman (1984) who have expressed concerns that most pims research has been validated only by other studies using the pims database. given the differences in the makeup of the two databases, if results can be confinned for both, or differences between the two databases can be explained adequately, the explanatory power gf the study would be greatly increased. the characteristics of industries were selected to allow a reasonable degree of generalizability to other industry settings and to ensure an adequate amount of variance and stability in both strategies and perfonnance. thus, mature industries were selected because of the likelihood of stable relations between the variables of interest because most industries exist in their mature stage which is the one that generally endures for the longest period of time (hambrick, 1983) and because they should provide the strongest test for narrow-scope strategies. concentrated industries were selected to ensure the presence of adequate numbers of broad-scope finns and because it still is not clear if narrow-scope strategies can spring 1998 de castro & chrisman: narrow-scope strategies 7 be superior perfonners in such an environment. heterogeneous industries were chosen to ensure the presence of imperfectly substitutable products and a variety of market segments containing customers with different needs. finally, domestic industries were chosen to minimize the effects of international competition, crosssubsidization, and variable market growth rates across countries (sousa & hambrick, 1989). the criteria used to select the industries from which the two samples were drawn are provided below. concentration maturity heterogeneity domestic pims sample 4 firm concentration ratio> .60 firms responded that they competed in mature industries advertising to sales ratio> 1.5% value of exports+ imports ~ 30% of industry sales case studies sample 4 firm concentration ratio> .60 average 5-year growth of industry less than 1% over gnp and industry at least 10 years old advertising to sales ratio> 1.5% value of exports + imports ~ 30% of industry sales business units of diversified firms in four industries breakfast cereals, aircraft, tires, and household appliances were chosen for the case studies sample. published information, annual reports, 10-k filings, and compustat tapes were used to gather data on 62 finns for the period from 1982 to 1986. analysis of variance showed that there were no significant differences across industries for the scope or performance variables used, suggesting the validity of aggregating the data from the four industries. from the pims inventory we selected the spi4 database, which possesses information on over 2718 strategic business units over four years, ending in 1984. in all, 599 sbu's were identified that met our research design criteria. variables scope. scope was measured in terms of the product and market segments in which the sampled firms competed. two measurement methods were utilized. in the case studies sample, each of the four industries was divided in terms of product and market segments. the size of each segment as a percentage of industry sales was determined. each firm was then assigned to the product and market segments in which it competed. multiple coders were used to assign firms to the segments. disagreements between coders were discussed until a consensus was 8 journal of business strategies vol. 15, no.1 reached. this procedure is similar to that utilized by montgomery, thomas & kamath (1984) in determining different categories for divestitures. once this procedure was completed, we calculated, as a percentage of industry sales, each firm's product and market coverage. firms that competed in product or market segments that, in total, accounted for 60 percent or more of industry sales were considered broad on that dimension. firms that competed in product or market segments that, in total, accounted for 40 percent or less of industry sales were considered narrow on that dimension. these cutoff points were based on natural breaks in the data (only one firm out of 62 fell between these cutoff points and was not included in the analysis), and were consistent with the responses to a survey we conducted of 12 leading researchers in strategy concerning what adequate cutoff points would be for broad and narrow scopes. this procedure provided four groups of firms: those with broad scopes on both dimensions, those with narrow-scopes on both dimensions, those with broad scopes in products and narrow scopes in markets, and those with broad scopes in markets and narrow scopes in products. table 1 presents frequencies for product and market scope for the case studies data. following these criteria, we classified 26 firms as broad on both dimensions and 35 firms as narrow on one or both dimensions. table 1 product and market scope classification of case market scope product scope 020% 020% ofirms 21 40% 41 60% 61 80% 81 100% 18 firms 1 firm* 0 firms 0 firms 21 -40% 41·60% 61 ·80% 81 100% narrow scope = 26 product focus= 5 2 firms 6 firms o firms 2 firms 3 firms ofirms ofirms o firms ofirms ofirms ofirms 2 firms ofirms 9 firms 3 firms market focus= 2 broad scope: 28 ofirms ofirms ofirms 6 firms 10 firms * not included in the analysis. spring 1998 de castro & chrisman: narrow-scope strategies 9 in the pims sample, scope was operationalized in terms of separate assessments of the product and market segments in which the firms competed. we based our assessments on the reported responses in the pims questionnaire as to how the firm's product or market coverage compared with that of the leading competitors in each industry. 209 firms were classified as narrow scope since they responded that their scope of operations on products or markets or both was narrower than that of the leading competitors in their industries. 390 firms were classified as broad since they reported their scope of operations to be the same or broader on both dimensions. in industries that are concentrated and mature, a comparison with the leading competitors should be an adequate measure of scope because leading competitors under those circumstances are expected to compete in most of the industry segments. peiformance. since a number of the businesses in the case studies sample were divisions oflarge corporations, it was not possible to obtain relevant data on roi for them. instead, we used the return on identifiable assets (roa) to measure the performance of the business unit or division of the company that competed in the industry under study. for the pims data, performance was measured via return on investment (roi). roi has been used in prior pims research on strategy content (woo & cooper, 1981; prescott, 1983), and has been acknowledged as an adequate performance measure (reece & cool, 1978). although the use of different measures of performance is a problem in terms of possible consistency of results, we believe that they capture similar aspects of firm performance and that their use is appropriate in exploratory research. data analysis for both samples, the hypotheses were tested using analysis of variance. to specify significant differences among the groups, the study utilized schefre posthoc comparisons. the schefre method was used because it provides the most stringent test of differences between groups. it should be noted, however, that the four case studies covered almost the entire population of participants in those industries, thus tests of significance were used only as a means of guarding against measurement error, to emphasize the magnitude of the results, and to suggest generalizability to other industries with similar structural characteristics. results table 2 presents group means, analysis of variance and schefre comparisons for the two databases. the pims results show significant main effects for product and market scope and a significant interaction between product and market scope. as predicted, hypothesis 1 was strongly supported. firms that compete with a broad scope on both product and market dimensions did significantly better than firms that com10 journal of business strategies vol. 15, no.1 table 2 group means, anovas, and schette comparisons for pims and case studies data group means for scope variables pims sample case studies sample market scope market scope narrow .b..rllill! narrow broad narrow 18.89 16.54 10.34 30.88 product (n=67) (n=110) (n=26) (0=6) scope broad 7.60 26.48 2.03 15.03 (n=32) (n=390) (n=6) (n=26) analysis of variance: pims data squrce of variation ~ j2e msq f-statistic sign. main effects 10218.4 2 5109.2 9.82 .000 product scope 3443.5 i 3443.5 6.62 .010 market scope 2979.8 i 2979.8 5.73 .017 2 way interactions 7793.1 i 7793.1 14.86 .000 explained 18011.7 3 6003.2 11.54 .000 residual 309344.9 595 520.0 total 327356.4 598 547.2 analysis of variance: case studies data source of variation ~ df msq f-stati stic sign. main effects 2409.4 2 1204.7 5.30 .008 product scope 1314.9 1 1314.9 5.71 .019 market scope 2405.0 1 2405.0 10.59 .005 two way interactions 97.2 1 97.1 0.43 .515 explained 2506.0 3 835.6 3.68 .017 residual 12936.3 57 227.0 total 15443.1 60 257.4 post hoc comparisons: scheffe tests significant differences between groups pims data ncp) ncm) ncp&m) case studies data r ncp) llim2 ncp&m)r broad narrow (p) * narrow (m) * narrow (p&m) * * ns * * os ns ns * os ns significant difference at .05 level difference not significant spring 1998 de castro & chrisman: narrow-scope strategies 11 pete with a narrow scope on at least one dimension. scheffe tests showed that there were significant differences between broad-scope firms and all types of narrow-scope firms. thus, hypotheses la, ib, and lc were all supported. hypothesis 2 was partially confirmed by the pims data. hypothesis 2a was supported: firms with a narrow scope in both products and markets did indeed significantly outperform those with a narrow scope in markets only. hypothesis 2b, however, could not be supported; there were no significant differences between firms with a narrow scope in both products and markets, and firms with a narrow scope in products only. hypothesis 3 was also confirmed: firms with a narrow scope in products significantly outperformed those with a narrow scope in markets. the results of the case studies show significant main effects for both product and market scope, but the interaction between them was not significant. the main effects indicate that in terms of market scope, firms with a broad scope outperformed narrow-scope firms. in terms of product scope, however, firms with narrow scope outperformed broad-scope firms. given the exploratory nature of the study, and the results from the comparison pims sample, scheffe tests were also conducted for the case studies sample. in contrast to the pims analysis, the results of the case studies analysis were not as consistent with expectations, even though significant differences between broadand narrow-scope firms in the sample were revealed. hypothesis 1 was not supported since, overall, narrow-scope firms outperfonned broad-scope firms and, more specifically, finns with narrow product scopes and broad market scopes achieved the best perfonnance. the schefte tests did not support hypothesis ia or ic at the .05 level of significance. the results were in the expected direction, however, with broad-scope firms outperfonning firms with narrow scope in both products and markets and firms with narrow scope only in markets. on the other hand, not only was hypothesis 1b not supported, firms with narrow product scopes and broad market scopes significantly outperfonned firms with broad scopes on both product and market dimensions. likewise, neither hypothesis 2 nor 3 could be confirmed. firms with narrow scopes in both products and markets outperformed those with narrow scopes in markets only, albeit at levels insufficient to support hypothesis 2b. but again, contrary to the expectations of hypothesis 2a, firms with narrow product scopes and broad market scopes significantly outperformed firms with narrow scopes on both dimensions. the findings with respect to hypothesis 3 were in the expected direction as firms with narrow scopes in products only outperformed those with narrow scopes in markets only. however, the number of firms in both groups was so small that hypothesis 3 could not be confirmed statistically. discussion in the pims sample, firms with a broad scope .outperformed firms with a narrow scope. in concentrated, mature industries the economies provided by a broad scope 12 journal of business strategies vol. 15, no.1 appear to have a greater impact on performance than the possible effectiveness benefits of specialization (carroll, 1984). however, it is also clear from the results that narrow-scope firms can compete effectively even under less than hospitable environmental conditions. these results are consistent with carroll's (1984) argument that "specialist" firms should appear in all environments because their strategies complement the strategies of the generalist firms with broad scopes. the pims results also show that firms that are broad or narrow in both products and markets outperform firms that are broad in one dimension and narrow in the other. these results are consistent with woo's (1980) notion that focused firms must be selective and discriminating, and with the population ecology argument that the specialists and generalists in an industry will be better performers over time than firms with scopes falling between the two extremes (carroll, 1984). this conclusion is reinforced by the lack of intermediate-scope firms in the case studies sample; such firms must have either previously adopted a broador narrow-scope strategy or left the industry via divestment, merger, or failure. the results of both samples indicated that in concentrated, mature industries, firms with a narrow scope in products and markets or a narrow scope in products alone will significantly outperform those firms with a narrow scope in markets only. firms with a narrow scope in both products and markets may be better performers because their degree of specialization allows them to meet the needs of targeted customers more effectively. conversely, firms with a narrow scope in products might do better than firms with a narrow scope in markets because product-related advantages (e.g., specialized production systems, patents) may be easier to sustain than marketrelated advantages (e.g., marketing programs, customer relations). the results regarding types of narrow-scope strategies are particularly enlightening in the context of new ventures. given the resource constraints and the learning process that needs to take place with most new ventures, it may be difficult for new ventures to compete in most of the market segments in the industry. thus, it is important to investigate how new ventures can use narrow-scope strategies to their advantage, and what types of strategies should be more appropriate for different industry types. the results indicate that to the extent that new ventures are able to compete with a narrow scope in both products and markets, or just in products, they would fare significantly better. product-specific attributes may be more defensible than characteristics of the markets, and for a new venture it may be easier to acquire and defend those attributes through patents, or specialized product or process technology. though the results of the case studies sample failed to corroborate the pims results, the differences in findings illustrated the advantages of utilizing multiple databases and multiple data gathering methods. in the case studies sample, firms with a narrow scope in products outperformed broad-scope firms. in the absence of other ways to test the hypotheses, this result could have been taken to mean that firms that compete with a narrow-scope in products would be the best performers in mature, concentrated environments. however, the pims results suggest that this finding is an spring 1998 de castro & chrisman: narrow-scope strategies 13 exception to the rules in most industries. nevertheless it is an interesting exception, and it shows that the general rules one may discover through large sample statistical analysis should not be taken as a universal condition. in business research both the generalities and the exceptions are interesting and important. directions for research future research should study the relationship between scope and performance in other types of industries and competitive environments. more work is also needed on the interactive nature of choices of scope and competitive weapons (chrisman, et ai., 1988), as well as scope and organization structure. for new ventures these new research avenues are of paramount importance. a narrowscope strategy with an emphasis in products or products and markets in industries with the conditions of the ones in this study may be the best alternative for new ventures given their constraints; the same may not be true for other types of industries or other environments. for example, new ventures in service, growth, or fragmented industries might fare better using other types of strategies. the progress made in clarifying the conceptualization and measurement of narrow-scope strategies was one of the major contributions of this research to the literature. future research should attempt to utilize and refine our approach to defining and operationalizing narrow scope. further research is also needed to examine the apparent lack of firms in the case sample that competed in an intermediate number of product-market segments. all except one of the firms in the sample competed in segments that represented more than 60 percent of sales in the industry, or in segments that represented less than 40 percent of industry sales. this tends to confirm the appropriateness of classifying firms as either broad or narrow scope, and addresses chrisman et ai. 's (1988) concerns about whether it is necessary to add a medium-scope taxonomy to the strategy classification scheme. our results suggest that an intermediate taxonomy may not be necessary in mature industries. nevertheless, bauerschmidt & chrisman (1990) found a number of medium-scope firms in their study of the shakeout in the microcomputer industry. given these differences, longitudinal research investigating the long term viability of various strategies of scope could be of great theoretical and practical significance. references abell, d.f. (1980). definin~ the business: the startin~ point of strategic plannin~. englewood cliffs, nj: prentice-hall. anderson, c., & paine, f. (1984). stage of product life cycle, business strategy, and business performance. academy of manat~ement review. 3, 602-611. 14 journal of business strategies vol. 15, no.1 anderson, c.r, & zeithaml, c.p. (1984). stages of the product life cycle, business strategy, and business performance. academy of mana~ementjournal. 27, 5-24. andrews, k.r (1971). the concept of coworate strate~y. homewood, il: irwin. buchele, rb. (1967). business policy in ~rowin~ firms, san francisco: chandler publishing. buzzel, rd., gale, r., & sutton, v. (1975). market share: a key to profitability. harvard business review. 53 (1), 97 -106. carroll, g. (1984). the specialist strategy. california manae;ement review. 25 (3), 126137. chandler, a. d. (1990). scales and scope: the dynamics of industrial capitalism. cambridge, ma: the belknap press. chrisman, j.j., & bauerschmidt, a. (1990). strategies for survival in the microcomputer industry: 1985-1989. 50th annual meeting of the academy of managment. chrisman, j.j., hofer, c.w., & boulton, w.r (1988). toward a system for classifying business strategies. academy of manae;ement review. 13,413-428. clifford, d.k., & cavanaugh, re. (1984). the winning performance of midsize growth companies. plannine; review. 18-24 cohn, t., & lindberg, ra. (1972). how manal:ement is different in small companies. new york: american management association. cooper, a., willard, g., & woo, c. (1986). strategies for high performing new and small firms. journal of business venturin~. 1, 247-261. dess, g.g., & davis, p. (1984). porter's (1980) generic strategies as determinants of strategic group membership and organizational performance. academy of manae;ement journal. 27, 467-488. freeman, j., & hannan, m. (1983). niche width and the dynamics of organizational populations. american journal of sociolo~y. 88 (6), 1117-1144. gailbraith, c., & schendel, d. (1983). an empirical analysis of strategic types. stratee;ic manae;ement journal. 4,153-173. garda, r (1981). a strategic approach to market segmentation. the mckinsey quarterly, autumn, 16-29. hambrick, d.c. (1983). high profit strategies in mature capital goods industries: a contingency approach. academy of manae;ement journal. 26, 687-707. spring 1998 de castro & chrisman: narrow-scope strategies 15 hamermesh, rg., anderson, jr., m.j., & harris, j.e. (1983). strategies for low marketshare businesses. in rg. hamermesh (ed.), strate~ic mana~ement (pp. 126-138). new york: wiley. harrigan, k. (1980). strate~ies fqr declinin~ businesses. lexingtqn, ma: lexington bqoks. hatten, kj. & hatten, m.l. (1987). strategic groups, asymmetrical mobility barriers, and contestability. strate~ic mana~ement journal. 8, 329-342. hill, c. (1988). differentiation versus low cost or differentiation and low cost: a contingency framework. academy of mana~ementrevjew. 13,401-412. hofer, c.w. (1975). toward a contingency theory of business strategy. academy of mana~ement journal. 18, 784-810. hofer, c.w., & schendel, d. (1978). strate~y fqnnulation: analytical concepts. st. paul, mn: west publishing. miller, r (1981). strategic pathways to growth in retailing. journal of business strate~y. 1 (3), 16-29. montgomery, c., thomas, a.r., & kamath, r. (1984). divestiture, market valuation, and strategy. academy of mana~ementjournal. 27, 830-840. murray, a. (1988). a contingency view of porter's generic strategies. academy of mana~ement reyiew. 13,390-401. oster, s. (1990). modern competitjve analysjs. yale press. oxford university. panzar, r, & willig, j. (1981). economies of scope. a.e.a. papers and proceedin~s. 71, 268-272. prescott, j.e. (1983). a contingency test of porter's (1980) generic industries, strategies, and performance. unpublished doctoral dissertation, university of pittsburgh. porter, m.e. (1979). the structure within industries and company performance. review of economics and statistics. 61, 214-227. porter, m.e. (1980). competitjve strate~y. new york: the free press. ramanujan, v., & venkantranan, n. (1984). an inventory and critique of strategy research using the pims database. academy of mana~ementreview. 9 (1), 138-151. reece, j., & cool, w. (1978). measuring investment center performance. haryard busjness review, may-june, 28-46. 16 journal of business strategies vol. 15, no.1 sandberg, w.r. (1986). new venture performance: the role of strategy and industry struc~. lexington, ma: lexington books. sousa de vasconcellos e sa, j.a., & hambrick, d.c. (1989). key success factors: test of a general theory in the mature industrial products sector. strategic management journal. 10,367-382. teece, d. (1980). economies of scope and the scope of the enterprise. journal of economic behavior and organization. i, 233-241. white, r.e. (1986). generic business strategies, organizational context and performance: an empirical investigation. strategic management journal. 7, 217231. wright, p. (1987). a refinement of porter's strategies. strategic management journal. 8, 93-107. woo, c. (1980). strategies for effective low share businesses. unpublished doctoral dissertation, purdue university. woo, c, & cooper, a.c (1981). strategies of effective low share businesses. strategic management journal. 2,301-318. julio o. de castro is an associate professor of strategy and organization management and the ruth w. van kempen entrepreneurship scholar at the university of colorado at boulder. professor de castro's research examines entrepreneurial and cross cultural aspects of firm management and strategy. in particular, his research examines the characteristics of the process of entrepreneurship, the nature of entrepreneurship among women and hispanics, and the nature of the entrepreneurial process in micro-enterprises. his research also examines the process of privatization of state-owned enterprises and the nature of technology transfer and its effect on new venture creation, from the perspective of the firm and its strategy, and with a particular interest in less-developed and formerly communist countries. james j. chrisman (ph.d., university of georgia) is the associate dean and professor of venture development in the faculty of management at the university of calgary. dr. chrisman's research interests include entrepreneurship and economic development, business strategy, new venture strategy, international business, social issues in management, small business management, strategy classification systems, management of medical technology, and family business. he has published over 60 articles on these topics in journals such as academy of management review, academy of management executive, entrepreneurship theory and practice, and the journal of business venturing. narrow-scope strategies and firm performance: an empirical investigation strategic use of countertrade in multinational business refik culpan the penlluylvania state university at harrisburg middletown, pennsylvania countertrade, a generic name for various types of non-cash or partial cash trading, has increased in volume in the world trade. this article deals with recent countertrade developments and offers a new conceptual framework which denotes how multinational managers can use countertrade as a strategic tool. the trend toward countertrade has stimulated considerable interest among both managers and academics. in practice, countertrade may take various forms, including barter, bilateral agreements, switch, counterpurchase, offset, and compensation. table 1 provides definitions for each of these terms. from the standpoint of international firm~, counterpurchase, offset, and compensation trading are considered the most vital transactions. traditionally, countertrade has been associated with east-west trade ([7),[12],[16]). however, recent world economic developments have augmented its use by third world countries as well ([5],[9],[11]). the major characteristics of present countertrade practices, which are summarized below, include the volume of countertrade, government intervention ill international trade, the involvement of multinational corporations in countertrade, and the permanence of countertrade. characteristics of countertrade volume of countertrade even though estimates vary, countertrade today represents a significant portion of the overall world trade. the u.s. department of commerce estimates that between 20 and 30 percent of world trade involves some form of counterpurchase, offset, or compensation, and it has been suggested that this share of the market could reach 50 percent in the next 15 years ([1],[6]). survey results of the national foreign trade council foundation indicate that countertrade transaction have increased 50, 64, and 117 percent in the years of 1982, 1983, and 1984 respectively ([4],[6]). thus, in the last decade, the volume of countertrade has surged from negligible to a considerable portion of world trade [10]. governmental intervention in international trade governments have been interfering increasingly with international free trade to the point of mandating countertrade. recently, the number of governments mandating countertrade has risen substantially. in 1982, indonesia adopted a counterpurchase journal 0/ business strategies, volume 6, number 1 (spring 1989) 22 spring 1989 culpan: strategic countertrade 23 policy affec.ting all governmental procurement in excess of $500,000. additionally, iraq prevailed upon foreign suppliers to accept payments in crude oil at official prices, while a 1984 governmental decree in colombia requires counterpurchase or barter of colombian goods in trade transactions involving private sector firms. table 1 forms of countertrade barter bilateral clearing agreements switch agreements counterpurchase offset compensation direct exchange of goods or commodities between two parties without cash payments. exchanging goods or commodities over a period of time by two governments. types of products to be exchanged, prices, total values, and contract durations are specified. conversion of a bilateral clearing agreement into a mul· tilateral one by permitting the country with a surplus in bilateral trade to make available to a third party a portion or all of its clearing account. acceptance of payments in counterdeliveries of goods that are not derived from or related to the original delivery. for example, pepsico supplied equipment and concentrates to soviet union and, in return, payment was made in vodka. a special version of counterpurchase in which connterdelivery can be used in the business of supplier. for example, a western company sold aircraft to ghana and agreed to receive manganese and bauxite to offset the sale. buying back "resultant/related product" for the sale of plant, equipment, or technology. for example, international harvester licensed poland to produce earthmoving equipment and agreed to market one third of the output in the west. multinational oorporation involvement traditionally, countertrade in the form of bilateral clearing agreements have occurred between governments. recently, multinational corporations (mncs) and international trading companies (itcs) have also knowingly engaged in counterpurcha.se, offset, and compensation trades. for example, occidental petroleum arranged for the delivery of fertilizer plants and pipelines to the soviet union in exchange for ammonia. douglas aircraft sold its dc-9s to yugoslavia. in return for an agreement by douglas to assist in marketing yugoslavian goods. such giant international trading 24 journal of business strategies vol. 6, no.1 companies as mitsubishi, c. itoh, and sumitomo of japan are expanding their countertrade operations, and some american companies, including general electric, bank of america, and first chicago, have established their own export trading companies. permanence of countertrade countertrade has emerged as a result of economic difficulties experienced in third world and socialist countries. as long as economic problems prevail in these countries, such as mounting foreign debt, balance of payment deficits, trade deficits, and hard currency shortages, countertrade will probably be used as an alternative trade pattern. in the past, third world and socialist countries have entered into counterpurchase, offset, and compensation arrangements to temporarily relieve the pressure of convertible currency shortages. today's increasing balance of payment and foreign debt problems in these countries suggest countertrade will continue to be a trade policy in the near future. brazil and indonesia, for example, have adopted trade policies requiring counterpurchase, offset, and compensation trade in international transactions. given the increasing role of countertrade in international marketplace, a conceptual framework is needed to display the process of countertrade strategy formulation and implementation. figure 1 presents such a framework. motives of multinational corporations although many motivating factors could exist for a mnc to be involved in countertrade, there are a few identifiable principal forces which appear to underlie their involvement in this activity. while not exhaustive, the enumerated list below provides an illustrative outline of motives which impact on their participation in countertrade. a) market penetration and expansion is a significant incentive for mncs to engage in countertrade. mncs practice countertrade to gain a competitive advantage against other international marketers. yoffie [19] has suggested that countertrade is a profitable instrument for international firms. for example, goodyear uses countertrade as a sales tool, trading its tires for minerals, textiles, and agricultural products. general electric has reached $4 billion in sales agreements through transactions involving countertrade. coca-cola, likewise, benefits from countertrade through its exploitation of two distinct market advantages it is one of the pioneers in these kinds of operations, and it has an extensive worldwide marketing network. in order to sell coca-cola concentrate, the company has been involved in numerous countertrade arrangements, including the construction of a whey-protein plant in the soviet union, the planting of thousands of acres of orange trees in egypt, and the exporting of soft-drink bottles from hungary to western europe. supporting the development of countertrade, mirus and yeung [13j regard countertrade as a different mode of foreign market entry by multinational firms, in addition to conventional entry modes such as exporting, licensing, and direct foreign investment. spring 1989 culpan: strategic countertrade 25 in this respect, huszagh and barksdale point out that "countertrade transactions support companies in implementing marketing strategies" ([8]' p. 26). figure 1 countertrade strategy i benefits mnc' 'iv suceess no failure costs i mul tinational company 2 coumertrade 3 international trading company 4 subsidiary 26 journal of business strategies vol. 6, no.1 b) luultinationa1 firms can use counterpurchase, offset, and compensation arrangements as tools for global "sourcing". global sourcing refers to procurement of raw materials and components, by international firms, in any part of the world for use in their production. walsh [18] argues that firms source globally in order to ensure a stable supply of essential imports or to obtain the most competitive inputs for their operations. in different ways, brazil, algeria, egypt, and india all encourage global marketers to engage in such arrangements. commodities such as oil, coal, phosphate rock, metal ores, coffee, cocoa, jute, timber, rubber, wool, and beef are among the most frequently countertraded goods [15]. c) multinational firms may seek diversified expansion through countertrade. met allgellschaft, the giant west german mining, engineering, metals, and trading company, engages in countertrade which now totais approximately $250 million annually. similarly, louis dreyfus & cie, a french grain trader which has sales of $10 billion, moved into countertrade to bolster its agriculturai commodities trade ([17], p. 32). the japanese consortium of showa aluminum co. ltd., kobe steel co., sumitomo industries limited, and mitsubishi metal industries has engaged in a major compensation agreement with venezuela. under the agreement, the consortium acquired a 20 percent equity stake in a venezuelan aluminum joint venture and agreed to buy back 170,000 metric tons of the aluminum produced. d) competitive advantage in international bids is a specific, common reason for mnc involvement in countertrade. although it could be considered a factor in any of the previous motives, it is important to emphasize the role of competitive advantage because it can provide significant strategic advantage for a mnc. for example, "(generai electric) won a bidding war for $150 million electric generator project in rumania against hitachi and siemens, among others, not because of a major technological or cost advantage but because it agreed to market $150 million worth of that country's products" ([19], p. 8). since public agencies in uruguay prefer foreign procurement bids with countertrade option, international firms try to include such offers in their packages. again, due to the saudi government's persistent emphasis on compensation, a u.s. company won the contract to build a petrochemical plant only after accepting provisions involving buy-back and international marketing of some of the resulting products. the strategic use of countertrade to become involved in countertrade, a multinational firm must first evaluate the potential benefits against potential drawbacks of this special form of internationai trade. the benefits expected from countertrade usually include a competitive edge for the company, effective global sourcing, optimal capacity utilization, growth in sales, enabling penetration to semi-closed markets (e.g. chinese market), control of control and exchange problems, and disposal of declining products [14]. in contrast, countertrade is not problem-free as there can be major pitfalls. it can be riskier than cash trade, the transactions can be quite complex and costly, spring 1989 culpan: strategic countertrade 27 the process is time consuming, the customer gains leverage, management exposes itself to a potential lack of knowledge about certain traits of both the customers and the markets with which it is dealing, and there may be difficulties in reselling counterdeliveries. a mnc should be aware of these pitfalls and assess the company's resources against them. if the benefits outweigh the costs and if the company's strengths seem to overcome those limitations, the company can pursue countertrade. if the firm determines to become involved in countertrade, it must subsequently develop operational policy components of its strategy. these operational components include selection of country, export product, counter delivery policies, and terms of countertrade agreement. country selection policies will determine which countries will be targeted for countertrading. these countries may range from socialist and third world countries to developed ones. "an evaluation of the country's economic and social conditions, political stability, legal systems, government regulations, and past performance in international trade and countertrade needs to be done to measure the suitability of the country as a potential countertrade partner" [3]. the country selection policy should also elaborate the company's position with respect to credit difficulties of countries under consideration. in this respect, it may focus on indebted latin american countries. it should decide whether the company will pursue an active strategy of countertrade (offering countertrade packages) or a passive one (accepting countertrade proposals initiated by the counterpart). product policies should specify what products or services will be offered through countertrade. a company which enjoys a strong bargaining position on c.ertain products can exclude those products from countertrade deals while it develops a list of other products subject to countertrade. counterdelivery policies must focus on acceptable counterdeliveries for trade purposes, considering types, amounts, and uses. the company may exclude certain type of products (for example, finished goods of poor quality) while accepting intermediate goods and raw materials as payment, or limit the acceptance of certain products (for example, oil in a glutted market). terms of countertrade agreement policies will, of course, refer to specifications on export products and counterdeliveries. however, they should also include such important information as 'contract duration, negotiation procedures, fines, delivery schedule, and dispute settlement. to implement the countertrade strategy, the firm should also decide on an organizational arrangement. in this respect, it has simply two options. one is to conduct countertrade through an in-house department or subsidiary. carter and gagne point out the advantages and disadvantages of this option as follows: managing countertrade in-house provides the company with lower costs, greater control, increased flexibility in deal making, and direct contact with the partner. the in-house route has disadvantages as well: it requires closely coordinating several functional departments, training inexperienced personnel, and using scarce managerial resources. ([2], p. 35) 28 journal of business strategies vol. 6, no.1 to use this alternative, the firm's potential countertrade volume should justify such an arrangement. in doing so, the firm can establish a special department, responsible for countertrade activities, or it can handle countertrade through a regular department. a special countertrade department should consist of staff knowledgeable in finance, marketing, purchasing, and legal functions. it would require extensive training of existing staff or recruitment of new specialists. for example, coca-cola has a special unit to handle countertrade functions. another version of an in-house arrangement is the creation of a subsidiary trade company. some companies, like general motors and general electric, employ trading subsidiaries which handle their own as well as others' countertrade activities worldwide. a regular department handling countertrade provides a standardization in operations, but this imposes an additional burden on the unit in terms of learning the intricacies of countertrade. despite the necessity of concerted efforts by various departments, one unit should be charged with the responsibilities of coordinating countertrade, such as the marketing or material management department. another option is to manage countertrade through brokers, agents, or an international trading company. this option relieves the company from the burden of dealing with the complexities of countertrade. however, this option could be a costly alternative since an outside intermediary might overlook the long-range interests of the company. countertrade agreements involving complex and long-lasting negotiations require an experienced staff to construct the components as well as define details of contracts. therefore, the negotiators should be selected carefully and be delegated with the authority to make instantaneous decisions. the company staff should be especially prepared for tough and experienced negotiators representing socialist bloc countries. clearly, the countertrading firm should train its staff carefully in the complexities of countertrade so that these negotiators can handle countertrade effectively. after successful negotiations to reach an agreement, the firm meets its commitment by exporting the designated product or by building a facility in the host country. in return, it receives counterdeliveries. however, the company should be aware that delays in scheduled deliveries or products of inferior quality are not uncommon, given the conditions in socialist and third world countries. it might be necessary for the firm to provide some initial means of product improvement for its partner to avoid poor quality of counterdeliveries later. for example, in order to improve the quality of yugoslavian wine, coca-cola made special arrangements to advance the yugoslavian technology through the assistance of a third party. of course, such an attempt entail additional costs which should be incorporated in the initial strategy development and, ultimately, in the countertrade agreement. the outcomes of countertrade deals, as well as their impact on the firm, should be provided as feedback in the strategic management process. a continual re-evaluation of the situation should assist in determining whether to continue, to modify, or to discontinue the firm's present countertrade strategy. one consideration which must be addresses at this level is the distribution of unusable counterdeliveries, which may spring 1989 culpan: strategic countertrade 29 be resold in domestic or global markets. for unfamiliar counterdeliveries products not in the usual business of the firm the firm must find buyers. strategic implications after introducing countertrade strategy components and process, the strategic implications of this special trading pattern require attention. if the present global and national economic conditions prevail, third world and socialist countries will continue to demand countertrade as a way of exchanging goods and services in the global market. from the standpoint of multinational firms, a sound strategy calls for timely responses to environmental opportunities. consequently, multinational firms should consider countertrade strategies to take advantage of those opportunities. therefore, it will be useful for international business managers to learn the dynamics of countertrade. in this respect, the following recommendations are made: 1. learn motives of the parties. as described above, third world and socialist countries and mncs have different motives. thus, a party should evaluate the motives and interests of other parties at the early stages of negotiations. the framework provided here can be used to identify and assess motives and the willingness of parties to engage in countertrade accords. this should assist the multinational strategist in determining under what conditions to use countertrade as an alternative technique. 2. gain competitive advantages. the developments with respect to counterpurchase, offset and compensation· trading suggest that these patterns will be one of the major international marketing forms in the near future. third world and socialist countries are willing to buy goods and services from multinational firms but cannot pay for them in hard currency. under such circumstances, multinational firms can use countertrade as a feasihle functional strategy. the firm extending a countertrade option to its third world and socialist customers will have a competitive advantage over firms not offering such deals. in addition to their conventional marketing techniques, multinational firms should employ counterpurchase, offset, and compensation trading techniques t.o be more competitive in the global market. 3. find an alliance. unlike convent.ional export. sales, typical countertrade agreements obligate exporting firms to buy or market counterdeliveries. the exporter may need to market those counterdeliveries through another firm. such situations require countertrading firms to seek partners, especially when count.erdeliveries lie beyond traditional area of expertise. it is not always easy to find a third party readily available for such arrangements. therefore, the firm should make a determined effort to locate domestic or foreign firms to jointly conduct its countertrade operations successfully and to build expertise in managing the intricacies of countertrade. as an example of this point, pepsico inc. receives vodka in exchange for the beverage concentrates it sells to the soviet union. as 30 journal of business strategies vol. 6, no.1 pepsico prefers to not sell the vodka itself, it has transferred the import rights to another company, monsieur henri wines, ltd. 4. be able to cope with problems. countertrading is a cumbersome process which requires the skillful handling of a variety of problems. major problems experienced with countertrading include late or inferior quality counterdeliveries and lack of sales. also, rapidly changing global and national economic conditions could force one of the parties to break its contractual obligations. it is not easy to predict the behavior of counterpart in a long-time countertrade accord. there will be uncertainties involved as the contractual time period lengthens. managers of international firms should be aware of these problems, they must formulate contracts clearly aware of these problems and develop contingency plans to deal with problems as they arise. a special effort must be made to maintain communication between trading counterparts. 5. offer countertrade in order to market grand packages. some goods and projects, such as aircraft sales or building petrochemical complexes, are very expensive and they are more subject to countertrade deals than others. multinational firms marketing such grand packages should be aware that third world and socialist countries will demand countertrade for such purchases. to make their proposals attractive, international firms can incorporate elements of counterpurchase, offset, or compensation in their offers. overall, developments in counterpurchase, offset, and compensation trading call for the attention of international business managers. the strategic process proposed in figure 1 helps those managers to develop countertrade strategies. conclusions strategic responses of mncs to environmental changes determine their level of success. during formulation and implementation of multinational strategies, managers are expected to scan global and national economic conditions, identify feasible alternatives, and make sound choices. countertrade appears to be an effective strategic alternative. to use this particular option efficiently, international managers should learn the motives of parties involved, actively seek competitive advantages, form alliances when needed, re-equip or re-organize structures to cope with countertrade problems, and be able to market grand packages through countertrade. recent worldwide developments indicate the number of countertrade arrangements in the form of counterpurchase, offset, and compensation will continue to increase. policymakers and international marketers should know wben and why these transactions occur, and how to deal with them. nevertheless, countertrade is a timeconsuming process and requires a specialized knowledge and experience. to gain the necessary specialized knowledge and experience, business organizations must make strategic commitments to the concept of countertrade. the countertrade model and strategy development framework provided herein should be useful in understanding spring 1989 culpan: strategic countertrade 31 this form of exchange and in constructing business strategies to exploit the possibilities arising from this emerging trend in world trade. references 1. alderkin, k. w. and w. e. norquist. creative counter trade: a guide to doing business worldwide. cambridge, ma: ballinger (1987). 2. carter, r. j. and j. gagne. "the dos and don'ts of international countertrade." sloan management review, vol. 29, no.3 (1988), pp. 31-37. 3. cho, k. r. "using countertrade as a competitive management tool." management international review, vol. 27, no.1 (1987), p. 55. 4. cohen, s. s. and j. zysman. "countertrade, offset, barter, and buybacks." california management review, vol. 28, no.2 (1986), pp. 41-56. 5. culpan, r. "re-emerging countertrade: the case of brazil" issues in international business, vol. 3 (winter/spring, 1986), pp. 37-41. 6. forbes. (march 12, 1984), p. 41. 7. hertzfeld, j. m." new directions in east-west trade." harvard business review, vol. 55 (may/june, 1977), pp. 28, 93-99. 8. huszagh, s. m. and h. c. barksdale. "international barter and countertrade: an exploratory study." journal of the academy of marketing science, vol. 14, no.1 (spring, 1986), pp. 21-28. 9. kaikati, j. g. "marketing without exchange of money." harvard business review, vol. 60 (november/december, 1982), pp. 72-74. 10. kaikati, j. g. "international barter boom: perspectives and challenges." journal of international marketing, vol. 1 (1981), pp. 29-38. 11. kim, c. "multinational banks and the third world's debt: are they in the same boat?" issues in international business, vol. 2 (1985), pp. 13-20. 12. mandato, j., t. skola, and k. 1. wyse. "counterpurchase sales in the german democratic republic." columbia journal of world business (spring, 1978), pp. 82-89. 13. mirus, r. and b. yeung. "economic incentives for countertrade." journal of international business studies, vol. 14, no.3 (fall, 1986), pp. 27-39. 14. shipley, d. and b. neal. "countertrade: reactive or proactive?" journal of business research, vol. 16 (1988), pp. 327-35. 32 journal of business strategies vol. 6, no.1 15. u. s. international trade commission. analysis of recent trends in u.s. countertrade, 1982. washington, dc: usitc publication 1237. 16. verzariu, p. countertrade practices in east europe, the soviet union and china. u.s.doc, ita (april, 1980). 17. ti,e wall street journal. (february 24, 1983), p. 32. 18. walsh, j. i. "mandated countertrade: hnplications for global marketing and global sourcing." issues in international business, vol. 2 (summer/fall, 1985), pp. 25-30. 19. yoffie, d. b. "profiting from countertrade." harvard business review. vol. 63 (may/june, 1984), pp. 8-11,16. strategic use of countertrade in multinational business value of shareholders in the turnaround process: a signaling theory perspective clay dibrell john francis the university of memphis memphis j tn robert van ness marshall university huntington, wv abstract this paper provides an exploratory examination of market reaction to announcements of turnaround strategies from firms involved in the turnaround process. the findings of this paper suggest the market reacts positively to announced turnaround strategies. interestingly, nonturnaroundfirms posted higher positive abnormal returns than firms that eventually were able to successfully complete a turnaround. value of shareholders in the thrnaround process: a signaling theory perspective with increased competition from both domestic and global competitors, more firms are falling into continual states of decline. once a firm recognizes it is in a prolonged cycle of decline, a turnaround process must be initiated. as managers start the turnaround process, they are faced with several difficult turnaround decisions, such as consideration of the firm's turnaround strategy on a firm's share price and stockholders. this element is a critical deliberation as shareholders contribute necessary resources to a firm (blair, 1995), and their commitment to the turnaround strategy is vital to its ultimate success. while previous turnaround research has focused on industry characteristics, types of decline, and differing types of turnaround strategy (hambrick & schecter, 1983; schendel & patton, 1976), the relationship between a firm's turnaround strategy and its shareholders has not been examined. the significance of shareholders lies not only in contributing financial resources to the declining firm but in providing signals to managers regarding the appropriateness of an announced turnaround strategy. signaling theory suggests that shareholders, through the market, provide signals to management concerning the impact of an announced strategy upon the future value of the firm (agrawal & kamakura, 1995; gilson, 1990; lane & jacobson, 1995; rappaport, 1987; sutton & callahan, 1987). for example, if the market reacts with an abnorspring 1998 dibrell, et al: value of shareholders 59 mally high return to an announced strategy, then the market sends a positive signal of the announced strategy to the manager (agrawal & kamakura, 1995; lane & jacobson, 1995; rappaport, 1987). this feedback is even more critical for firms in a prolonged decline which are attempting to regain creditability with employees, shareholders, creditors, and customers. with the paucity of empirical research concerning the significance of the shareholder in the turnaround process, the primary purpose of this paper is to examine how the market responds to an announcement of a turnaround strategy. the secondary purpose is to study whether the market signals nonturnaround firms more positively than turnaround firms. this paper attempts to answerthese questions through an event study of publicly traded firms that have undergone decline and have announced a turnaround strategy. the sample includes firms that were eventually able to turnaround (le., turnaround firms) during the sample period and those that either failed or continued to perform poorly (i.e., non turnaround firms) during the sample period. the first section of this paper consists of a brief, relevant literature review of the turnaround literature and application of signaling theory to the turnaround literature. then, the paper formulates hypotheses that reflect shareholder perceptions of a declining firm's turnaround strategy. the testing of these hypotheses is then provided through an event study of the relationship between a firm's announced turnaround strategy and the market. lastly, the paper concludes with a discussion and summary of the results. literature review in order to examine the market's response to turnaround actions, it is necessary to identify types of turnaround strategies that firms undertake in order to reverse decline. one method of organizing the numerous types of strategies is by classifying them as either operational or strategic (hofer, 1980). operational turnaround strategies involve increasing revenues, decreasing costs, decreasing assets, or a mixture of these actions. strategic turnaround strategies includes such actions as acquisitions, vertical integration, diversification, divestment, and top management changes, the distinguishing difference between these two types of turnaround strategies is that operational turnaround strategies are more tactical in nature (hofer, 1980), whereas strategic actions take place at the corporate level and alter a firm's structure and possibly its core competencies (arogyaswamy, barker & yasai-ardekani, 1995; barker & duhaime, 1997; hofer, 1980). operational turnaround strategies focus upon a firm becoming more efficient through asset and cost reduction (pearce & robbins, 1993, 1994; robbins & pearce, 1992; slater, 1984) where by performance targets are the key to operational strategies (barker, 1992; hofer, 1980), there is a variety of cost-cutting methods in this set of turnaround strategies that includes plant closings, reduction of overhead, dropping of product lines, and layoffs (bibeault, 1982; finkin, 1987; pearce & robbins, 1993, 1994; robbins & pearce, 1992). 60 journal of business strategies vol. 15, no.1 a strategic turnaround differs from an operational reorientation as it implies a change of a firm's strategy (arogyaswamy, barker & yasai-ardekani, 1995; barker & duhaime, 1997; hofer, 1980). a strategic turnaround is built on core competencies or key skills of functional areas (barker, 1992; hofer, 1980). a change of a firm's strategy can come in the form of either acquisition, divestiture, or ceo replacement (barker & duhaime, 1997; hofer, 1980). in keeping with these arguments, a coarse-grained approach is needed for this exploratory inquiry. this paper takes a perspective that both operational and turnaround strategies should be grouped together to allow for an exploratory understanding of how the market reacts to all turnaround strategies. another consistent finding of the turnaround literature is the need for slack resources to implement a turnaround strategy (hofer, 1980; d' aveni, 1989; robbins & pearce, 1992; arogyaswamy, barker & yasai-ardekani, 1995). if a firm has a scarcity of slack resources, it will further constrain a manager's efforts to successfully implement a turnaround strategy (hofer, 1980; d' aveni, 1989; robbins & pearce, 1992). argogyaswamy, barker & yasai-ardekani (1995) postulate that a firm's probability for a turnaround is correlated with the amount of slack that a firm possesses. if a firm does not have adequate slack resources to implement a turnaround strategy, then a firm is forced to generate slack in order to effectively implement a turnaround strategy. arogyaswamy, barker & yasai-ardekani (1995) suggest that the demand for the generation of slack resources is related to the perception of shareholders. positive signals from management during the turnaround process are essential to maintain and to generate shareholder support (castrogiovanni, balig & kidwell, 1992). therefore, managers must understand the significance of implementing strategies that shareholders believe will create a positive future value for a firm. if shareholders do not believe that the management of a declining firm is implementing an appropriate turnaround strategy, then shareholders will signal the firm's management with an abnormally negative market reaction (agrawal & kamakura, 1995; lane & jacobson, 1995; rappaport, 1987). the basis of signaling theory is a product of the research examining how the market reacts to announcements surrounding a firm's dividends (michaely & shaw, 1994; miller & rock, 1985; rock, 1986). this literature suggests that a firm which announces that it will either be increasing or reducing dividends sends a signal to the market. if a firm is increasing its dividends, this signals the market that a firm believes that it will be able to justify the increased dividends through immediate future positive growth. if the market believes the dividends justify an increase in the future value of a firm, then the market will react positively. this same argument has been extended in the work of rappaport (1987) to include non-dividend stock announcements. market expectations of a firm can be reflected in a firm's stock price (rappaport, 1987). rappaport postulates that managers can receive immediate feedback from the market concerning a firm's strategy. moreover, managers have the opportunity to determine if their strategies spring 1998 dibrell, et al: value of shareholders 61 will be appropriate through the response of the market. if the market provides a negative response to a proposed activity, then managers should reevaluate their strategy. conversely, if a firm's stock price has a positive abnormal return, then the market expects the immediate future value of a firm will increase. in effect, the market's reaction to a firm's announced strategy acts as a proxy of the market's expectations to the firm's announced strategy. therefore, managers must understand the significance of implementing turnaround strategies that shareholders believe will create an immediate positive future value for a firm. from a signaling theory perspective, it can be argued that nonturnaround firms could have a higher abnormal return than turnaround firms. the basis for this assessment is that the potential for growth for a nonturnaround firm that is continually in a state of decline is greater than for a firm that is completing a turnaround. for example, one nonturnaround firm has had increasing decline but makes a drastic reduction in net losses, while a turnaround firm is slowly and steadily growing toward profitability. the nonturnaround firm stems decline from a 200% annual loss to a 50% annual loss for the next time period through implementation of a turnaround strategy with a net positive gain of 150%. compare this scenario to the turnaround firm that continues to grow from a 7% annual loss to a 3% positive annual growth after implementing a turnaround strategy for the next time period with a net gain of 10%. where is the greatest net growth for the second time period? the greatest net growth for the second time period comes from the nonturnaround firm whose net gain is 150%, as compared to a 10% net gain for the turnaround firm. in this case, the market could provide an immediate higher abnormal return to the non turnaround firm. this argument is further supported by the belief that an action taken by management which increases the immediate value of the firm should result in positive signals from the market (agrawal & kamakura, 1995; lane & jacobson, 1995; rappaport, 1987). hypotheses arogyaswamy, barker & yasai-ardekani (1995) suggest that renewed shareholder support should be a primary consideration of management involved in the turnaround process. renewed shareholder support comes in several forms, including generating slack and access to capital needed for the implementation of a turnaround strategy. one possible way to generate these resources is through announcing a turnaround strategy that shareholders believe will increase the future value of a firm (davidson, worrell & el-jelly, 1995). a turnaround strategy implies that a firm implements some form of a strategy in order to regain a state of profitability (barker, 1992). in essence, a turnaround strategy attempts to create a future value for a firm. the market is based upon future values of firms (hoskisson, johnson & moesel, 1994; hoskisson, hitt & hill, 1993; jacobson, 1987); and 62 journal of business strategies vol. 15, no.1 shareholders will reward finns for attempting to generate greater immediate future value. based on this discussion, the following hypothesis is offered: hypothesis 1: the market provides immediate abnonnal positive returns for firms that announce a turnaround strategy. signaling theory suggests that the market provides feedback to a manager's strategy through positive or negative reactions to an announcement (agrawal & kamakura, 1995; gilson, 1990; lane & jacobson, 1995; rappaport, 1987). a positive reaction by the market will suggest that a finn is implementing an appropriate turnaround strategy (chatterjee, dhillon & ramirez, 1996; davidson, worrell & ei-jelly, 1995). furthennore, nonturnaround finns will exhibit immediate higher abnonnal returns than finns that eventually turnaround. for example, a continually failing finn announces to the market that it will be implementing a turnaround strategy that involves divesting an unprofitable strategic business unit. the market should react positively to the announcement and the possibility of a higher return once the unprofitable strategic business unit is unloaded. however, a turnaround finn that announces a turnaround strategy could possibly not have as a great return, as compared to the nonturnaround finn, since the potential for future short-tenn growth may be limited as the turnaround firm approaches profitability. this scenario, though, does not consider the long-term value of the announced turnaround strategy, only the immediate reaction of the market to the announced turnaround strategy. moreover, the market could be signaling the nonturnaround finn to continue to implement turnaround strategies. thus, the following hypothesis is offered: hypothesis 2: the market reacts more positively to an announcement of a turnaround strategy by a nontu rna round firm than a firm that eventually completes a turnaround on the day of the announcement of a turnaround strategy. methodology sample for a sampling of firms involved in the turnaround process, there has been a great deal of discussion regarding the most appropriate way to measure decline (arogyaswamy, barker & yasai-ardekani, 1995; barker, 1992; barker & duhaime, 1997; robbins & pearce, 1992). in order for this sample to reflect finns involved in a turnaround situation, several different conservative criteria were employed. the following perfonnance criteria were utilized in order to detennine declining finns: 1. initially a finn had to have at least two consecutive years of roi above the risk-free rate of return (barker & mone, 1994; robbins & spring 1998 dibrell, et al: value of shareholders 63 pearce, 1992). the return rate for six month us treasury notes at auction, reported in the economic report for the president, is used as a proxy for the risk-free rate. this criterion is included because it eliminates firms from the sample that continue to fail which limits the study to firms that face a turnaround process. the risk-free rate of return was used as a criterion based on porter's (1980) argument that a firm is failing in economic terms if it does not earn a return greater than the risk-free rate. furthermore, this measure provides a rigorous technique of examining financial performance of a cross section of firms (hansen & wernerfelt, 1989). 2. each firm had to have at least 3 consecutive years of decline below the risk-free rate of return. also, at least one year within three years of decline had to be characterized by a negative net income (barker & duhaime, 1997). 3. lastly, turnaround was characterized by two consecutive years of roi above the risk-free rate (robbins & pearce, 1992). nonturnaround firms will not achieve this performance recovery; however, data for these firms are gathered for this time-frame based on the three to four year average time for a successful turnaround (robbins & pearce, 1992). thus, turnaround performance is measured in terms of whether a firm is or is not able to recover within the time span of the data collection period. researchers have been critical of the small sample sizes that previous researchers have utilized when employing event studies (mcwilliams & siegel, 1997). to guard against a small sample, the sample was selected from manufacturing firms operating within the two digit sic groups (20-39) for two reasons. first, a sample taken within an industry that meets the turnaround criteria set forth would be too small, while going across industries provides for a larger sample size. secondly, the generalizability of the findings from this study will be enhanced with the sample being taken across manufacturing industries. the time frame of the sample covers the fiscal years 1980 through 1992, allowing sample firms a suitable amount of time for performance declines and strategic responses. lastly, the financial data was gathered through the compustat ii data repository. due to the exploratory nature of the study, both operational and strategic orientation turnaround strategies are grouped together. for a strategy to be identified as a turnaround strategy, an announcement must consist of one of the four turnaround strategies: 1) asset reduction; 2) acquisition; 3) change of ceo; and 4) divestiture. the asset reduction category includes announcements of layoffs, plant closings, and reduction of costs as suggested in the literature (hofer, 1980; pearce & robbins, 1993, 1994; robbins & pearce, 1992; slater, 1984). the ceo replacement category includes all ceo changes during the period of decline to 64 journal of business strategies vol. 15, no.1 account for officers that are forced to resign. furthermore, the following criteria are used in conjunction with the turnaround sample criteria. 1. since the daily stock data came from the center for research in security prices (crsp), firms must be traded on either the new york stock exchange or the american stock exchange. 2. no two turnaround events can overlap within 175 days before the event and 50 days after the event. 3. if turnaround events did crossover, then the events are eliminated from the study. 4. multiple turnaround event announcements eliminate all turnaround event announcements for that time period regardless of categorization. 5. all turnaround event dates are from the wall street journal. for the event study analyses, precise identification of the actual date of each turnaround announcement is a strong consideration. since an event announcement can be leaked to the public through a variety of sources before the event date appears in the wall street journal, we employed a 2-day event window to correctly identify when the market reacted to the announcement. the wall street journal index identifies the date of the announcement, but the market may have reacted to the announcement prior to the posting. for example, the announcement is given to the wall street journal the day before it goes to press. thus, it is possible that the announcement could be leaked. in order to capture these announcement effects, we used both the day that the wall street journal index provides and the prior day to ensure that the 2-day event window adequately captures the reaction to the announcement (mcwilliams & siegel, 1997; szewczyk, tsetsekos & zantout, 1996; tsetsekos & gombola, 1992). from the criteria, 137 firms were selected. of these firms, 58 successfully completed the turnaround process, while 79 continued to fail. method an event study methodology was chosen to measure the market's reaction to a firm-specific announcement. this methodology has been suggested to be an appropriate statistical technique to measure the reaction of the market to an announcement of a firm-specific event (brown and warner, 1980, 1985). to control for the potential for nonsynchronous trading problems of firms of differing liquidity to influence the empirical results, the scholeswilliams (1977) market model is employed to estimate the intercept and slope coefficients used in the generation of the expected daily returns for each firm in the absence of a turnaround announcement. specifically, intercept and slope coefficients used in the generation of the expected daily returns for each firm j, (xj and ~j, respectively, are estimated for the 150 day spring 1998 dibrell, et al: value of shareholders 65 period (event days t = -175 ... -26) prior to the event window period (event days t = -25... +50) and are defined as -26 -26 (1) llj =1/98 l rjt 1198 f)j l rmt 1"·174 1= -174 where rjt is the actual equity return on firm j for event day t, rmt is the actual return on the value-weighted crsp index for day t, and o + (2) j3j =(j3j + j3j + f)j)l(l + 2pm). in equation (2), pm is the estimated first order autocorrelation coefficient of the crsp index over the period t =-175...-26, and the individual beta terms are ordinary least squares regression coefficients estimated from the following three equations: (3) (4) (5) rjt = aj + j3jrmt-1 + ujt, o 0 rj t =aj + f)jrmt-l + vjt + + rj t = llj + j3jrmt-l + wjt, t =-174, ... ,-26, t = -175, ... ,-26, t =-175, ... ,-27. to detect abnormal firm returns in response to a turnaround announcement, a standard market-model event-time methodology is employed. thus, the abnormal return for firmj for event day t (t = -25 ...+50), arjt, is defined as in equation 6: (6) arjt =rjt (aj + j3j rmt), where llj and, f)j are the scholes-williams (1977) market-model parameters, and rjt and rmt are as previously defined above. lastly, to test for abnormal returns a t-test is employed between the expected daily returns and the actual returns for the event days examined. the critical value is derived from the student's t distribution tables for a two-tailed test at the (p < .05) level of significance. 66 journal of business strategies results vol. 15, no.1 the results of the analyses are presented in two tables. table 1 contains turnaround finns, and table 2 contains the sample of non turnaround finns. for the total sample of firms contained in both tables, hypothesis 1 is supported. finns that announced turnaround strategies enjoyed positive abnonnal returns on the day of the announcement. for example, in table 1, turnaround finns are significantly abnonnal through the standardized t-test statistic (t). at the (p < .05) level of significance with the critical t-value of 1.960, the market reacts positively (~ =.0176; t =3.0795) for finns announcing a turnaround strategy during the two-day event window. table 1 mean daily abnormal return results and test statistics for thrnaround firms (n = 58). event day -25 -15 -5 -4 -3 -2 -1 0 2 3 4 5 15 25 50 * p < .05 mean daily abnormal return -0.0010 -0.0012 0.0013 0.0073 -0.0004 -0.0042 -0.0096 0.0176 0.0050 0.0067 0.0066 0.0086 0.0032 0.0008 0.0018 test statistic -0.1812 -0.2120 0.2339 1.2907 -0.0726 -0.7370 -1.6821 3.0795* 0.8832 1.1754 1.1531 1.5026 0.5732 0.1463 0.3265 spring 1998 dibrell, et al: value of shareholders 67 for continually failing finns in table 2, the stock market reacts positively to announcements of turnaround strategies. there is a strong positive abnonnal return for failing finns (/l = .0172; t =3.3086) announcing a turnaround strategy at the (p < .05) level of significance. table 2 mean daily abnormal return results and test statistic for nonturnaround firms (n = 79). event day -25 -15 -5 -4 -3 -2 -1 0 2 3 4 5 15 25 50 * p < .05 mean daily abnormal return -0.0049 -0.0077 0.0013 0.0006 -0.0028 0.0055 -0.0025 0.0172 0.0072 -0.0048 0.0066 -0.0031 -0.0036 0.0046 0.0037 test statistic -0.9349 -1.4807 0.2394 0.1134 -0.5287 1.0642 -0.4841 3.3086* 1.3759 -0.9181 1.2587 -0.5869 -0.6860 0.8850 0.7083 comparison between turnaround and non turnaround firms demonstrates that the stock market reacts statistically more favorably to nonturnaround firms than to turnaround finns. overall, the market's reaction to the future value of both classifications of firms is abnormally positive. these results support hypothesis 2, which suggested that the market would react more favorably to the announcements of a turnaround strategy for non turnaround firms than for turnaround firms. 68 journal of business strategies discussion and conclusion vol. 15, no. 1 this paper attempted to explore the relationship between turnaround and nonturnaround firms and how the market reacts to a turnaround strategy. the paper tested the applicability of signaling theory to the turnaround process. interestingly, the findings of this paper suggest any announcement of a turnaround strategy provides a firm with an abnormal positive return on the day of the announcement, regardless of whether a firm successfully completes a turnaround or continues to fail. hypothesis 1 proposed that firms implementing any type of turnaround strategy should gain positive abnormal returns from the market and was supported. moreover, this finding could infer that firms which continued to fail were limiting shareholder losses through turnaround strategies. in addition, findings suggest that the market provides a stronger immediate positive return for firms that are failing. the support for hypothesis 2 suggests that managers of a firm in a turnaround process can look to the market for feedback regarding turnaround strategies. these announcements could generate immediate abnormal positive returns as the market reacts positively to firms that are stemming losses and creating wealth for the shareholders. this finding is consistent with signaling theory as the market reacts positively to firms that are creating shareholder wealth or potentially limiting shareholder losses by creating greater value for nonturnaround firms through turnaround strategies. from the findings, it can be argued that the market could consider the amount of risk involved and determine that more opportunities exist for short-term returns from adjustments as nonturnaround firms take actions to halt decline. the most interesting finding is that the market reacted more positively to nonturnaround firms than to turnaround firms. from this finding it can be inferred that on the day of the announcement, firms that are continually failing provide greater future value to shareholders than firms that are eventually able to turnaround. however, these findings do have limitations. one limitation of this paper is the original nature ofthis research. the lack of other studies to guide the research of market reactions to turnaround announcements limits the examination to a more exploratory nature. furthermore, the different types of turnaround strategies are not compared within the different strategic turnaround categories (e.g., operational versus strategic orientation); they are compared only at an aggregate level between firms that successfully completed a turnaround and those that continued to fail. the type of a turnaround strategy could have an effect upon the reaction of the market. another limitation of this study is that there is no differentiation between the types of shareholders (e.g., institutional and blockholders) which could influence the impact ofthe announcement (wright, ferris, sarin & awasthi, 1996). the objective of this paper was to provide an exploratory examination of the turnaround process from a market perspective. from this research, the findings provide fertile ground for future research. the different types of turnaround stratspring 1998 dibrell, et al: value of shareholders 69 egies can be examined individually between the different classifications (e.g., operational versus strategic oriented turnaround strategies) to indicate if the market consistently rewards one type of turnaround strategy over another. also. an agency theory perspective may further illuminate the relationship between the actions of shareholders and management. a practical implication for managers is that the market reacts positively to an announcement of a turnaround strategy. thus, managers should be more willing to attempt and to announce a turnaround strategy. the market's positive reaction to turnaround strategies should signal managers that attempting and implementing turnaround strategies is one potential way to generate increased slack resources. in addition. it provides an opportunity to gain creditability with shareholders through increased shareholder wealth. in conclusion, this paper attempted to examine the relationship between the market and firms involved in the turnaround process. the results of the study suggest that the market positively encourages a firm for implementing a turnaround strategy and rewards non turnaround firms more positively than turnaround firms on the day of the announcement. finally. this paper examined the turnaround process from an alternative perspective, from the viewpoint ofthe market. this perspective contributes to a richer understanding of the turnaround process. references agrawal, j., & kamakura, w.a. (1995). the economic worth of celebrity endorsers: an event study analysis. journal of marketing. 59. 56-62. arogyaswamy. k.. barker, v.l., iii, & yasai-ardekani, m. (1995). finn turnarounds: an integrative two-stage model journal of mana~ementstudies. 32. 493-525. barker, v.l, iii. (1992). coworate turnarounds as strate~ic reorientations: a field study of turnaround attempts from firm-based decline. unpublished doctoral dissertation, university of illinois at urbana-champaign. barker, v.l., iii., & duhaime, lm. (1997). strategic change in the turnaround process: theory and empirical evidence. strategic management journal. 18, 13-38. barker. v,l., iii., & mone, m.a. (1994). retrenchment: cause of turnaround or consequence of decline. strategic management journal. 15.395-405. bibeault, d. (1982). cqworate turnaround. new york: mcgraw-hill. blair, m,m. (1995) ownership and control: rethinkin~ coworate ~overnance for the twenty-first century. the brooking institute. brown. s.j., & warner, j.b. (1980). measuring security price performance. journal of financial economics. 8, 205-258. 70 journal of business strategies vol. 15, no.1 brown, s.j., & warner, j.b. (1985). using daily stock returns: the case of event studies. journal of financial economics. 14, 3-31. castrogiovanni, g.j., baliga, b.r, & kidwell, re., jr. (1992). curing sick businesses: changing ceos in turnaround efforts. academy of management executive. 6, 2641. chatterjee, s., dhillon, u.s., & ramirez, g.g. (1996). resolution of financial distress: debt restructuring via chapter ii, prepackaged bankruptcies, and workouts.~ cial management. 25, 5-18. d' aveni, r. (1989). the aftermath of organizational decline: a longitudinal study of the strategic and managerial characteristics of declining firms. academy of management journal. 32, 577-605. davidson, wn., iii, worrell, d.l., & ei-jelly, a. (1995). influencing managers to change unpopular corporate behavior through boycotts and divestitures: a stock market test. business and society. 34, 2: 171-196. finkin, e.f. (1987). successful coll'orate turnarounds: a guide for board members. financial managers. financial institutions. and other creditors. new york: quorum books. gilson, s.c. (1990). bankruptcy, boards, banks, and blockholders: evidence on changes in corporate ownership and control when firms default. journal of financial economics. 25, 355-387. hambrick, d.c., & schecter, s.m. (1983). turnaround strategies for mature industrialproduct business units. academy of management journal. 26, 231-248. hansen, g.s., & wernerfelt, b. (1989). determinants of firm performance: the relative importance of economic and organizational factors. strategic management journal. lq, 399-411. hofer, c.w (1980). turnaround strategies. journal of business strategy. 1, 1: 19-31. hoskisson, re., johnson, ra., & moesel, d.o. (1994). corporate divestiture intensity in restructuring firms: effects of governance, strategy, and performance. academy of management journal. 37, 1207-1251. hoskisson, re., hitt, m.a., & hill, c.w. (1993). managerial incentives and investment in r&d in large multi-product firms. organization science. 4, 325-341. jacobson, r. (1987). the validity of roi as a measure of business performance. american economic review. 77,470-478. lane, y., & jacobson, r (1995). stock market reactions to brand extension announcements: the effects of brand attitude and familiarity. journal of marketing. 59,63-77. spring 1998 dibrell, et al: value of shareholders 71 mcwilliams, a.. & siegel, d. (997). event studies in management research: theoretical and empirical issues. academy of mana~ementjournal. 40, 626-657. michaely, r, & shaw, wh. (994). the pricing of initial public offerings: tests of the adverse selection and signaling theories. reyiew of financial studies. 7, 279-320. miller. m.h .• & rock, k. (1985). dividend policy under asymmetric information. journal of finance. 40, 1031-1051. pearce. la., ii., & robbins, d.k. (1993). toward improved theory and research on business turnaround. journal of management. 19, 613-636. pearce j.a., ii., & robbins, d.k. (1994). retrenchment remains the foundation of business turnaround. strate~c management journal. 15,407-417. porter. m. (1980). competitive strategy. new york: the free press. rappaport, a. (1987). stock market signals to managers. harvard business review. 65, 6: 57-62. robbins, d.k., & pearce, j.a., ii. (1992). turnaround: retrenchment and recovery. strategic management journal, 13,287-309. rock. k. (1986). why new issues are underprices. journal of financial economics. 15. 187-212. scholes, m.s. & williams, j.t. (1977). estimating betas from nonsynchronoys data.1mr:: nal of fjnancial economics. 5. 309-327. schendel. d.e., & patton, g.r. (1976). corporate stagnation and turnaround. journal of economics and business. 28, 236-241. slater. s. (1984). coworate recovery: successful turnaround strategies and their implementation. singapore: penguin books. sutton, r.i., & callahan, a.l. (1987). the stigma of bankruptcy: spoiled organizational image and its management. academy of mana~mentjqurnal. 30. 405-436. szewczyk, s.h., tsetsekos, g.p, & zantout, z. (1996). the valuation of corporate r&d expenditures: evidence from investment opportunities and free cash flow. financial manaaement. 25, 105-ll0. tsetsekos, g.p., & gombola, mj. (1992). foreign and domestic divestments: evidence on valuation effects of plant closings. journal of international business studies. 23, 203-223. 72 journal of business strategies vol. 15, no.1 wright, p., ferris, s.p., sarin, a., & awasthi, v. (1996). impact of corporate insider, blockholder, and institutional equity ownership on firm risk taking. academy of mana~ementjournal. 39. 441-463. clay dibrell is currently completing his ph.d. degree in strategic management at the university of memphis. his current research interests include corporate diversification, influence of information technology upon firm competitiveness, and international strategy. john francis is an instructor of management in the fogelman college of business and economics at the university of memphis. he received an m.b.a. from samford university and is currently working on his dissertation at the university of memphis. his research interests include strategic and international management, with particular emphasis on international entrepreneurship and born global firms. robert a. van ness is an assistant professor of finance at marshall university. he received his ph.d. in finance from the university of memphis. his current research interests include investments and market microstructure. value of shareholders in the turnaround process: a signaling theory perspective the theory of re:ool marker strucrure: appucations 10 specific merchandise lines william c. rodgers kenneth c. schneider st. cloud state university 8t. cloud, minnesota introduction in what has become a classic article in the retailing literature, pierre martineau defined the personality or image of a retail store as "the way in which the store is defined in the shopper's mind, partly by its functional qualities and partly by an aura of psychological attributes" [14, p. 47]. spurred by martineau's conceptualizations, research into store image has continued virtually unabated ever since. one stream of research has investigated the use of various methods and procedures for measuring the image of particular stores. at least two such measurement techniques have achieved widespread acceptance; semantic differential and multidimensional scaling. a second stream of research has investigated the extent to which competing retail outlets in any market are defined by shoppers as similar to or different from one another. the primary goal of that research has been to better understand the overall structure of a retail market. managers can then use that understanding to propose positioning strategies for one store (or store type) vis-a-vis competing stores (or store types). several interesting and useful theories of the structure of retail markets have resulted from this research. for example, malcolm mcnair ([16], [17]) devised a theory explaining how new competitors in a market can gain entry by eliminating most or all ancillary services, thereby undercutting prevailing price levels. known as the "wheel of retailing," this theory has proved useful in studying the dynamics of retail positioning strategies over time. also, elizabeth hirschman [8] devised a theory explaining how retail competitors tend to cluster at one of relatively few points along a price-quality continuum. this theory again provides useful insight into appropriate positioning strategies for any given store. the purpose of this study was to apply the hirschman theory of retail market structure to the purchase process for a single product line greeting cards. the study was undertaken to examine whether that theory, largely developed from the perspective of general merchandise retailing, could be applied on a micro level to one specific product line. greeting cards were targeted in this research for several reasons. first, as part of a general trend toward scrambled merchandising, greeting cards are now available in a variety of retail outlets. second, greeting cards are somewhat unique in posing a purchase situation involving minimal economic risk but substantial social risk (i.e., the risk that the consumer's choice will affect the way others think of himlher). third, most consumers likely have at least some recent experience purchasing greeting cards because of their applicability in so many interpersonal relationships and social settings. fall 1991 rodgers & schneider: retail market structure background, hypotheses and research design 121 hirschman [8], in a seminal discussion of the structure of competing retail institutions, postulated that consumers differentiate between types of general merchandise retailers on the basis of perceived quality and perceived price. according to hirschman, discount department stores are seen by consumers as low price, low quality stores. hence, they primarily appeal to price sensitive shoppers. at the other end of the price-quality continuum, traditional department stores are seen by consumers as high price, high quality stores. hence, they primarily appeal to quality conscious shoppers. national chain department stores are seen as roughly mid-way between discount department stores and traditional department stores on both dimensions. these relationships are depicted graphically in exhibit 1. hirschman further postulated that specialty stores in any given market can be similarly differentiated on the basis of price and quality; in essence, clustering around one or another of the three types of department stores. thus, she concludes, "the three types of department stores form the essential core of a market's retail structure with the specialty stores serving as adjuncts to their functioning" [8, p. 33]. despite the compelling logical appeal of hirschman's theory (or maybe because of that appeal), there have been few attempts to empirically verify it. specifically, it would be interesting to examine the extent to which the ideas depicted in exhibit 1 transfer to specific lines of merchandise. intuitively, it seems that consumers would rank sources of specific products such as greeting cards in much the same way that they do general merchandise. (indeed, it is even plausible that general merchandise stores might be ranked at different points along the price-quality continuum for different products when the theory is applied to individual product lines. for example, sears might be classified as a midprice, mid-quality source of clothing but a high-price, high-quality source of tools.) unfortunately, such extensions of the hirschman theory have not yet been adequately addressed accordingly, as applied to greeting card outlets, the first hypothesis is: h1: consumers classify retail sources of greeting cards along a price-quality continuum, with concentrations of sources at a low price, low quality extreme, a high price, high quality extreme, and a mid-range point. dawson [4] enhanced hirschman's theory of the structure of retail markets by proposing and empirically verifying that the continuum from the upper-right to lower-left extremes in exlnbit 1 can be viewed as a store prestige hierarchy. a sample of consumers was asked to compare the "social standing or level of prestige" of fifteen clothing stores representing a cross-section of hirschman's store types (ie., local and national department stores, chain or mass merchandise stores, discount stores and specialty stores) (exhibit 1). the resultant rankings were roughly as anticipated by hirschman's price-quality continuum. department stores were perceived as having higher prestige than mass merchandise stores which, in turn, were perceived as having higher prestige than discount stores. interestingly, national department stores were seen as having higher prestige than local department stores, with specialty clothing stores interspersed among these traditional 122 journal ofbusiness strategies vol. 8, no.2 department stores. on the basis of these findings, dawson concluded that "a prestige hierarchy does exist and that it closely approximates the price-quality dimension underlying hirschman's [8] store typology" [4, pp. 142-143]. thus, there is substantial conceptual rationale and growing empirical support for the contention that consumers classify retail stores on the basis of their prestige or social standing which, in turn, maps directly onto a price-quality continuum. indeed, retailers are often advised to use such a continuum in selecting a positioning strategy. in one insightful discussion, lucas and gresham [13], after renaming the continuum as priceservice rather than price-quality, warn retailers that positioning strategies off the pricequality/service diagonal in exhibit 1 are doomed to failure in the long-run. low price, high service positions trap many new specialty stores because they seem to offer a means of building a customer base. the problem, of course, is that such positions generally lead to bottom-line financial disasters. the converse strategy employing high price, low service positions would nicely solve the bottom-line problem. but, those positions typically result in so small a customer base that top-line revenues are insufficient to cover operating expenses. q>nsequently, lucas and gresham argue that the best chance for long-run survival and growth lies along the price-service continuum. indeed, they are not even much enamored with the mid-range strategy typified by mass merchandisers, preferring instead either the low price, low service position of the price appeal discounter, or the equally clearcut high price, high quality prestige position of the traditional department store. the problem with a mid price, mid quality position is that it entails straddling two well-defined positions. unfortunately, adopting such a ''be all things to all shoppers" strategy runs the risk of leaving the store with an unclear, muddled image that appeals to nobody and results in too small a customer base. the national chains' management teams evidently concur with this assessment; at least it appears so given j. c. penney's repositioning as a national department store (i.e., repositioning up the diagonal and more directly against traditional department stores) and sears' recent stressing of its low everyday prices (le., repositioning down the diagonal and more directly against discounters). applying these arguments to greeting card purchases, one would expect to see more consumers patronizing outlets representing the extremes of the price-quality continuum in exhibit 1 than outlets representing the mid-range of the continuum. accordingly, the associated hypothesis is: hz: more greeting card customers will be attracted to low price, low quality sources and to high price, high quality sources than to sources located at the mid-range along the price-quality continuum. the notion that consumers evaluate the prestige of various retail outlets based on price/ quality comparisons can be linked to several important issues in consumer behavior. for example, such prestige ratings are likely to be related to consumer strategies for reducing perceived risk in shopping situations. most behaviorists believe that consumers purchase "well-known" brands (i.e., brands of known quality, reputation or prestige) when facing what are thought to be risky purchase situations (see, for example, [19], [7]). h fall 1991 rodgers & schneider: retail market structure 123 purchasing high price, high quality brands represents a means of reducing perceived risk, so also would patronizing high price, high quality stores. indeed, hirschman [9] relied heavily on risk concepts in explaining why her three types of department stores tended to dominate certain lines of merchandise: traditional department stores will dominate fashion goods and luxury items where the prestige of the store and the product's social conspicuousness are of integral importance (le., there is high social risk).... national chain department stores, in contrast, will dominate staple hard and soft goods ... (that) are non-conspicuous, have low social risk, and possess moderate to high economic risk. ... discount department stores will dominate branded hard goods (such as automotive supplies and small electrics) where economic risk is reduced by low prices, and social risk is overcome by brand name. [9, pp. 402-3] several empirical studies confirm just such a link between store patronage and perceived risk. for example, granzin and schjeldrup [5] found that consumers make different decisions about automobile repair services when in a situation of high risk (e.g., stranded 150 miles from home) than when in a situation of low risk (e.g., at home). similarly, hawes and lumpkin [6] found that consumers tend to rate discount stores as riskier than department or specialty stores when shopping for apparel, a purchase decision involving considerable social risk. they also found that price/quality perceptions are used heavily by consumers as risk reducing strategies in store patronage decisions for apparel. these findings suggest that consumers are relatively more likely to patronize higher prestige than lower prestige stores for purchases involving significant risk. greeting cards pose relatively little economic risk. they have gotten somewhat more expensive in recent years, with most now priced at $1.00 and up. this, of course, can add up to substantial expense over the course of a year, especially for the frequent giver. still, on a per unit basis, greeting cards are among the least expensive purchases made by consumers. however, greeting cards pose substantial social risk, as do other gift purchases. that greeting cards are gifts has been well-established in the literature. belk [1] referred to greeting cards as gifts several times while discussing the four functions served by gift~ giving; communication, social exchange, economic exchange and socialization. the com~ munication function would appear especially well-served by greeting cards. levi-strauss [12] suggested that recipients understand well the importance of greeting cards as gifts when, for example, a person publicly displays christmas cards on a fireplace mantel. davis [3] argued that some objects, including greeting cards, are perceived solely as gifts, being of no inherent utilitarian value to the recipient warshaw [22], in an empirical investigation into the determinants of purchase intentions regarding gifts, used valentine's day cards to operationalize an inexpensive gift condition. thus, there is substantial agreement that greeting cards often serve one or another gift function. that gift-giving entails considerable social risk is also well-established. vmcent and zikmond [21] found that purchasing a kitchen knife entailed much more social risk when 124 journal ofbusiness strategies vol. 8, no.2 bought as a gift than when bought for use at home. this suggests that behaviors such as buying a more expensive item, buying a well-known brand or shopping at a higher prestige store might be employed as risk reducing strategies intended to alleviate the perceived social risk implicit in selecting gifts. indeed, ryans [20j found that consumers are more likely to purchase small electric appliances in department stores (i.e., higher prestige outlets) when the purchase is for a gift than when it is for personal use. mattson [15] found the same was true for gift versus personal use purchases of apparel. finally, warshaw [22] found that subjective social norms (i.e., an individual's perception of what others feel is appropriate behavior) are closely linked to purchase intentions regarding inexpensive gifts such as valentine's day cards and boxed chocolates. these various findings imply that the selection of gifts, including greeting cards, is fraught with social risk. h so, one would expect to see higher patronage of higher prestige than lower prestige sources of greeting cards. accordingly, the appropriate hypothesis is: h3: more consumers will be attracted to high price, high quality sources than to low price, low quality sources of greeting cards. finally, a prestige ordering of retail store types also can be conceptually linked to the social status of shoppers. that consumers tend to patronize stores whose images they feel most closely match their own self-images has long been known (see, for example, [23]). burstiner [2], in discussing the results of a comparative image study of new york department stores, concludes: "human nature being what it is, it seems reasonable to assume that store shopping preferences tend to be functions, more or less, of the degree of congruency or "match" between the shopper's perceptions of each store's ''personality'' and his own self-perceptions." [2, pp. 33-34] when applied to individuals in society, prestige refers to the degree of social rank, respect or esteem bestowed on various people. while prestige derives from various sources, in advanced industrial and information based societies it is most often a function of one's occupation, income, wealth, education, or other measure of social status [4]. thus, it is reasonable to anticipate that consumers will tend to patronize retail outlets that most closely match their own level of prestige. for example, prasad [18] found a relationship between social status and attitudes toward shopping at discount department stores, but only for higher social risk products. to wit: "for products that may be generally categorized as of high social risk, on the other hand, consumers in the upper socioeconomic strata appear to hold significantly different and relatively less favorable patronage attitudes toward discount stores as compared to those consumers in the lower socioeconomic strata" [18, pp. 46-47]. as applied to greeting card purchases, the associated hypothesis is: h4: the social status of shoppers will be directly related to patronage of greeting card stores by prestige ordering. that is, higher social status shoppers will patronize higher prestige stores, lower social status shoppers will patronize fall 1991 rodgers & schneider: retail market structure 125 lower prestige stores. methodology the research was conducted as part of a larger study of gift giving behavior. specifically, telephone interviews were conducted with a sample of 440 householders randomly selected from a mid-sized, upper midwest metropolitan area. all relevant information concerning 1) perceptions of differences in price and quality levels across various retail sources of greeting cards, 2) patronage rates across these outlets, and 3) shoppers' social status, was obtained through these interviews. greeting cards are generally available in five types of outlets in the retail trade area covered by this study, including card/gift stores, department stores, discount stores, drug stores and supermarkets. respondents were asked to rate these types of greeting card outlets as to perceived price and quality level using selected five-point likert scale items, as shown in exhibit 2(a). the first of these items, "greeting cards sold at [store type] are expensive," was designed to measure perceived price level. perceived quality was measured with two items, "the selection of greeting cards available at [store type] is excellent" and "[store type] greeting cards look nicer than those in other stores." lwo items were used to measure quality because there was some concern that perceived quality might entail not only the physical product but also the breadth of selection at a store type. the results of a preliminary factor analysis (see exlnbit 2(b» confirm that these three likert scale items comprise two separate factors. a quality/selection factor with high loadings from the second and third statements was obtained, and a separate price factor with high loading from just the first statement was obtained. consequently, responses from these three statements were used to classify the five store types on perceived price and perceived quality/selection, with the latter measure consisting of a simple average of the responses to the second and third iikert scale statements. elsewhere in the telephone interview, respondents were asked approximately how many birthday, anniversary, wedding and general cards expressing friendship or love had been purchased within the past thirty days. they were then asked whether most of these greeting cards had been purchased at a supermarket, department store, and so on. responses to this question were used as a measure of store patronage. finally, as part of a standard battery of demographic questions, respondents were asked their education level, household income and occupation. responses to these questions were used to construct three separate measures of social status; education (college degree, some college, no college), income ($35,000 and above, $20,000 to $34,999, under $20,(00) and occupation status (higher level, mid-range, lower level). the last of these measures was derived by condensing into three categories the occupation scale developed by august hollingshead [10] as part of his "index of social position," which is now widely accepted as a measure of social class. 126 journal ofbusiness strategies m=gor findings and discussion vol. 8, no.2 using the results concerning perceived quality/selection and perceived price, the five store types can be plotted in two-dimensional space, as in exbiljit 3(a). the relative placement of the store types in this exhibit conforms extremely well to that expected from the hirschman model of retail structure. thus, h1 is strongly supported by these findings. consumers do classify retail sources of greeting cards along a price-quality continuum, though perhaps not a strictly linear one. more precisely, cardlgift stores are perceived alone as a relatively high quality, high price retail source of greeting cards. relative to cardlgift stores, supermarkets and discount stores are perceived as low price, low quality types of outlets. finally, drug stores and department stores are seen as occupying what could be called a mid-range point: exactly mid-range in terms of perceived price, with perceived quality/selection higher than but nearer to discount stores and supermarkets than to card/gift stores. if the five store types are reclassified as quality appeal stores (le., card/gift stores), price appeal stores (le., discount stores and supermarkets) and mixed appeal stores (i.e., drug stores and department stores), (exhibit 3) the patronage results appear as follows: 'jype of store quality appeal mixed appeal price appeal total percent of customers 51.8% 18.3% 29.9% 100.0% these results, shown graphically in exhibit 3(b), can be used to examine both h2 and h3. h2 implies that both quality appeal and price appeal stores should enjoy greater patronage than mixed appeal stores because of the enhanced clarity of their respective positions. the graphical results in exhibit 3(b) tend to confirm such an implication. indeed, using 95 percent lower confidence limits for the ratio of multinomial probabilities it can be shown that the patronage ratio to mixed appeal stores is not less than 2.25:1. similarly, the partronage ratio of price appeal to mixed appeal stores is not less than 127:1. thus, it is inferred that for every 100 consumers who patronize mixed appeal stores there are at least 127 who patronize price appeal stores and 225 who patronize quality appeal stores. hence, h2 is supported by these findings; a mid-range position on the pricei quality or prestige continuum is not a particularly effective one in terms of generating patronage. using a similarly derived patronage ratio, it can also be inferred that for every 100 consumers who patronize price appeal stores there are at least 143 who patronize a quality appeal store. thus, h3, which suggests that quality appeal stores will attract more consumers than price appeal stores because of the perceived social risk inherent in giving greeting cards, is also supported by these results. together, of course, h2 and h3 lead to a striking hierarchy among these three types of outlets for greeting cards. owing both to its clarity of position and the security offa111991 rodgers & schneider: retail market structure 127 fered in the purchase of a socially risky product, quality appeal stores are able to garner a relatively large share of the greeting card market. offering similar clarity but much less security against perceived risk, price appeal stores attract the next largest share of the market. finally, lacking even a well defined position, mixed appeal stores struggle with the lowest market share. finally, exhibit 4 presents findings appropriate to h4, linking the status or prestige of shoppers to the prestige ordering of types of outlets for greeting cards. as can be seen in exhibit 4, h4 is only partly supported by these findings. a significant relationship was found between education level and patronage across these types of stores. specifically, patronage of quality appeal stores increases with increasing education, while the converse occurs in mixed appeal stores. a similar but weaker relationship occurs with respect to occupation status. while not statistically significant, patronage of quality appeal stores shows a tendency to increase with increasing occupation status while, again, the converse occurs in both price and mixed appeal stores. findings relative to income are both statistically insignificant and directionally inconsistent with h4. this inconsistency, especially the v-shaped patronage of quality appeal stores across income, is at least partly explained by an associated result. in particular, it was found that relatively young, unmarried consumers show a disproportionate tendency to patronize quality appeal stores (details not shown). while speculative, it is probable that this consumer segment patronizes quality appeal stores despite their generally lower incomes because of the especially intense social risk involved in greeting card exchange in a dating or courtship relationship. (exlnbit 4) this, coupled with the status expectations from h4, could explain why quality appeal stores tend to draw disproportionately from both the "under $20,000" and the "$35,000 and above" income groups. finally, it is also plausible that because greeting cards pose minimal economic risk, any link between the prestige of stores patronized and income would be much less strong than for more expensive lines of merchandise. on balance, then, support for h4 is weak. the most appropriate conclusion is that there may be a mild patronage relationship between greeting card store prestige and consumer social status. but, even if there is such a link, it depends on other characteristics of the consumer and/or purchase situation, including possible intervening links to consumer life stage characteristics and related variables. concluding observations perhaps the most important conclusion to be gleaned from this study is that the general theory of retail structure, originally developed by hirschman ([8], [9]) in the context of general merchandise retailing, does indeed apply to at least some individual merchandise lines as well. this is a significant finding in these days of unbridled scrambling of merchandise lines across types of retail outlets. consumers still manage to simplify their thinking about outlets for products like greeting cards by categorizing stores into one or another of hirschman's three groups based on perceived quality and price; quality appeal stores versus price appeal stores versus those in the middle. it would, of course, be most instructive to examine the extent to which these findings 128 journal ofbusiness strategies vol. 8, no.2 hold in still other product lines, especially those which have been subjected to intense scrambling during the past decade or so. among others, grocery products have special appeal as a topic for such research. packaged foods and related grocery items are now available in a dizzying array of outlets, from traditional supermarkets to wave after wave of food discounters, and from established convenience stores to a host of other outlets capitalizing on the place utility inherent in food retailing (e.g., drug stores, service stations, car washes and video rental stores). it would be most interesting to see if these and other emerging grocery outlets are similarly classified into the same three price/quality categories. second, this study adds further empirical support to the contention that success in retailing tends to go to those stores and/or store types with a distinctive personality. while this has been said many times before, its importance cannot be overstressed. retail outlets that attempt to operate from a "middle of the road" position designed to appeal to wide segments of the consuming public generally end up with indistinct and undistinguished images that appeal to no one. how much better it is to set the store apart as one that attempts to accomplish something for someone; whether it be differential advantage on the quality side or on the price side. finally, the results of the study suggest that a quality appeal might be somewhat more effective than a price appeal if the purchase decision is one that entails sizable social risk. lbis, too, carries important strategic implications. consumer behaviorists have don~ considerable work in identifying and studying the phenomenon of perceived risk. retail managers, however, have been slow to make use of that knowledge. here, though, is an area of direct application. it seems that, when faced with a purchase decision carrying significant social risk, many consumers gravitate toward the security of the quality appeal store more so than the thrift of the price appeal store. this study, of course, was concerned only with social risk. it would be equally instructive to see whether or not choosing a quality appeal store becomes increasingly more likely as other types of purchase risk increase. for example, jacoby and kaplan [11] postulated the existence of at least four other risks besides social risk that consumers might face in any given purchase situation. these include financial risk (i.e., the purchase price), performance risk (ie., whether the product works as it's supposed to), physical risk (i.e., risk of harm or injury in using the product), and psychological risk (ie., how the purchase affects the consumer's self-image). each of these mayor may not be related to store choice in the same sense that social risk appears to be so related. finally, interesting issues pertaining to consumer behavior have been raised, especially in the finding that, while many consumers turn to quality appeal sources of greeting cards to reduce perceived risk, not all consumers do so. in addition, the selection of greeting card sources cannot be adequately explained just by the social status of consumers. thus, there are likely other demographic or psychological underpinnings to this choice. do some consumers perceive relatively less social risk in card and gift giving situations than others? are some consumers relatively more driven than others by different store choice criteria, possibly including shopping convenience or store proxirnity?is perceived risk in purchasing greeting cards highly situational for some consumers, increasing and decreasing by oocasion and recipient? each of these would be an interesting avenue for fa111991 rodgers & schneider: retail market structure 129 further research into perceived risk and retail store choice. references 1. belk, r. "gift-giving behavior." research marketing. sheth, j. (ed.) greenwich. cf: jai press (1979) pp. 94-126. 2. burstiner, i. "a three-way mirror: comparative images of the clienteles of macy's, bloomingdale's, and korvettes." journal of retailing. vol. 50 (spring 1974), pp. 24-36. 3. davis, j. "gifts and the v.k. economy." ~ vol. 7, no.3 (1972), pp. 408429. 4. dawson, s. "an exploration of the store prestige hierarchy: reification, power, and perceptions." journal of retailing. vol. 64 (summer 1988), pp. 133-152. 5. granzin, k.l. and schjelderup, lui. "situationally-determined risk as an influence on buyer behavior." evolving marketing thought for 1980. summey, jr. and taylor, r.d. (eds.) carbondale, il: southern marketing association (1980), pp. 127-131. 6. hawes, j.m. and lumpkin, j.r. "perceived risk and the selection of a retail patronage mode." journal of the academy of marketing science, vol. 14 (winter 1986), 3742. 7. hawkins, d.i., best, rj., and coney, k.a. consumer behavior: implications for marketing strategy. fourth edition, plano, tx: business publications, inc. (1989). 8. hirschman, e.c. "a descriptive theory of retail market structure." journal of retailing. vol. 54 (winter 1978), pp. 2948. 9. . "retail competitive structure: present and potential." 1979 educators conference proceedings. n. beckwith et al. (eds.) chicago, il: american marketing association (1979), pp. 401405. 10. hollingshead, a.b. and redlich, f.c. social oass and mental lliness. new york, ny: john wiley & sons, inc. (1958). 11. jacoby, j. and kaplan, l. ''the components of perceived risk." proceedings of the third annual conference of the association for consumer research. venkatesan, m. (ed.) chicago, il: association for consumer research (1972), pp. 382-393. 12. levi-strauss, c. "the principle of reciprocity." sociological theory. coser, l.a. and rosenberg, b. (eds) new york, ny: macmillan company (1965). 13. lucas, g.h. jr. and gresham, l.g. "how to position for retail success." business. vol. xx (april-june 1988), pp. 3-13. 14. martineau, p. "the personality of the retail store." harvard business review. vol. 36 (january-february 1958), pp. 47-55. 130 journal ofbusiness strategies vol. 8, no.2 15. mattson, b.e. "situational influences on store choice." journal of retailing. vol. 58 (fall 1982), pp. 46-58. 16. mcnair, m.p. "significant trends in the postwar period" competitive distribution in a free high leyel economy and its implications for the university. smith, a.b. (ed.) pittsburgh, pa: university of pittsburgh press (1958), pp. 17-18. 17. and may, e.g. "next revolution of the wheel of retailing." harvard business review, vol. 56 (september-october 1978), pp. 81-90. 18. prasad, v.k. "socioeconomic product risk and patronage preferences of retail shoppers." journal of marketing. vol. 39 (july 1975), pp. 42-47. 19. roselius, t. "consumer rankings of risk reduction methods:' journal of marketing. vol. 35 (janwuy 1971), pp. 56-61. 20. ryans, a "consumer gift buying behavior: an exploratory analysis:' contemporary marketing thought. beuenger, d. and greenberg, b. (eds.), chicago, 1l: american marketing association (1977), pp. 99-104. 21. vincent, m. and zikmond, w. "an experimental investigation of situational effects on risk perception." advans;es in consumer behavior. scblinger, mj. (00.), chicago, 1l: association for consumer research (1975). 22. warshaw, p.r. "buying a gift: product price moderation of social normative influences on gift purchase intentions." personality and social psychology bulletin. vol. 6 (march 1980), pp. 143-147. 23. weale, w.b. "measuring the customer's image of a department store:' journal of retailing. vol. 37 (summer 1961), pp. 40-48. fall 1991 rodgers & schneider: retail market structure 131 exhibitl retail market stnjctdre highest quality traditional ~ department stores ,~ ,,,,,,,,,,,,,,,, lowest quality ,,,,,,,,,,,,,, @discount department stores lowest price highest price -------ooo{.~----:::--national chain department store source: redrawn from hirschman, elizabeth c. (1978), ita descriptive theory of retail market structure," journal of retailing, 54 (winter), p. 32. exhibit 2 measurement of store prestige a. perceptions of store types index items item verbal description 1 greeting cards sold at [store type] are expensive 2 the selection of greeting cards available at [store type] is excellent 3 [store type] greeting cards look nicer than those in other stores item b. factor analysis results quality/selection (factor 1) price (factor 2) 1 2 3 -0.006 0.780 0.785 0.992 -0.106 0.096 eigenvalue pet of variance 1.225 40.8% 1.004 335% 132 journal ofbusiness strategies exhibit 3 a two~dimensional plot of greeting card outlets vol. 8, no.2 highest selection/quality lowest card/gift store 0 r l,....j d d drugstore discount store department store d supermarket lowest price highest b. market share by type of greeting card outlet highest quality appeal stores selection/quality lowest o~ appeal stores lowest price mixed appeal stores highest fall 1991 rodgers & schneider: retail market structure 133 exhibit 4 relationship between greeting card store patronage and socioeconomic characteristics store type choice by socioeconomic price mixed quality chi-square characteristics appeal appeal appeal total p-value totals, all respondents 29.9% 18.3% 51.8% 100.0% by education level college degree 30.8% 9.6% 59.6% 100.0% <.05 some college 30.9% 16.3% 52.8% 100.0% no college 27.6% 25.5% 46.9% 100.0% by occupation status higher level 28.1% 14.9% 57.0% 100.0% n.s. mid range 26.5% 21.7% 51.8% 100.0% lower level 34.3% 19.0% 46.7% 100.0% by income $35,000 and up 28.1% 16.5% 55.4% 100.0% n.s. $20,000-$34,999 30.9% 23.6% 45.5% 100.0% under $20,000 29.1% 15.1% 55.8% 100.0% the theory of retail market structure: applications to specific merchandise lines 28 journal of business strategies real estate investment decisions ii: commercial office property leasing jonathan breazeale sam houston state university • huntsville, tx abstract you are an asset manager of city view office, a publicly traded real estate investment trust (reit) with a portfolio of commercial office properties. your leasing agent has just brought you a request for proposal (rfp) from a potential creditworthy tenant who wants to lease office space in your class a property. your task is to determine whether or not your firm – the landlord – should enter into the lease. real estate investment trusts (reits) to avoid corporate income taxes, reits pay out at least 90% of their otherwise taxable earnings to their shareholders. historically, and due to these high dividend payouts, reits have been considered an investment vehicle of “widows and orphans,” but they really are designed to provide a way for small “retail” investors to access a very capital intensive sector of the economy in which they would otherwise be prohibited from participating. note that the main requirement for reit status (the 90% payout rule) is an accounting requirement – as are most of the requirements for reit status. as long as reits meet these accounting requirements, their earnings are not taxed at the corporate level. instead, reit profits are taxed only at the personal level via taxes on dividends and capital gains. investors get to “have their cake and eat it too.” they receive both the limited liability offered by corporations and single (or pass-through) taxation. the operation of a reit, however, is very much the same as any other real estate firm. investment decisions are made in much the same way. financing decisions, however, can be a bit different because debt no longer offers a tax shield from interest payments. office reits – like other non-reit office property owners purchase single and multi-tenant office properties. like all real estate owners, they generate a return for their shareholders by purchasing a property and selling it in the future at a higher price. not only do reits recognize the capital gain from the purchase and sale, they also receive the cash flows generated by the operation of the property. in other words, the success or failure of the leasing effort has an impact on all three types of cash flows – purchase price, sales price, and operating cash flows during ownership. if the building is purchased at 100% occupancy with high rental rates, the purchase volume 36, number 1 29 price will be high. if the building is sold at 50% occupancy with low rates, the seller will not receive what they otherwise could. the cash flows received during the years of ownership are similarly influenced by leasing. commercial office property owners are subject to the same old adage – maximize revenues and minimize costs. leasing leasing is to landlords as sales are to industrial firms. it is their life’s blood – their revenue stream. the typical office lease involves a variety of marginal cash flows to consider in determining whether of not the proposed deal is a good one for the landlord. of course, every detail of an office lease is negotiable but the basics are relatively uniform. first, the landlord agrees to incur some capital expenditures (cap ex) in order to pay the brokers (both the tenant’s and the landlord’s) and create the office space that suits the tenant’s needs. brokers’ commissions are always negotiable but local market rates do tend to prevail. in other words, the commissions that landlords pay in atlanta will not be the same as the commissions landlords expect to pay in houston. the amount needed to configure the space for the tenant is called tenant improvements (ti) or the work letter. the cost of the work letter depends on two things: (1) the condition of the existing space relative to the layout that fits the tenant’s needs, and (2) the tenant’s “taste” for upgraded finishes – plush carpet, granite countertops, stained base boards and moldings, etc. the layout of walls, doors, electrical outlets, etc., is a relatively easy thing to change in an office building, but it can be quite expensive. as a general rule, the more capital required to reconfigure the space to suit the tenant’s needs, the higher the rent. in some instances (in tenant-friendly markets), the landlord might also offer a moving allowance or some other cap ex incentive to move into the property. for long-term leases, landlords may also have to offer the tenant a refresher allowance of some type in the middle of the term to paint and/or freshen up the space due to the long lease term. as with all aspects of a lease, supply and demand for office space will dictate how much of an allowance the landlord must provide and how much of the construction the tenant must pay for themselves. next, the tenant most often agrees (especially on a new deal) to produce a security deposit to reduce the probability that they will default on the terms of the lease. the landlord has put money at risk to pay the brokers and configure the space, so the security deposit reduces the tenant’s incentive to pay rent late or move out of the space in the middle of the night and default on their obligations. alternative security exists in either a letter of credit or a personal guarantee. a letter of credit 30 journal of business strategies is a letter from a bank stating that in the event that the tenant fails to pay rent or otherwise defaults on the lease, the landlord can present the letter of credit to the bank for payment in the amount listed in the letter. effectively, the bank is insuring all – or a portion of – the rent. a personal guarantee is a document that makes an individual personally liable for the rent in the event of corporate default. in the case of a personal guarantee, landlords analyze the credit worthiness of both the corporate entity signing the lease and the individual net worth of the guarantor in the form of personal financial statements and income tax returns. lastly, it is not uncommon for landlords to check credit by checking public records and interviewing previous landlords. typically the office of the comptroller of the currency (occ) will release whether a company is delinquent in the payment of their franchise taxes. if the company is delinquent on taxes due in the state in which they are incorporated, then it’s more likely that they’ll be delinquent on their rent as well. a conversation with previous landlord(s) will also reveal whether the tenant has been habitually late on their rent payments or was otherwise a difficult occupant in a multi-tenant environment. if a tenant passes muster on each of these security measures and still defaults on its rent, then the final remedy available to landlords is to lock the space and exercise its lien on the assets therein. remember, a lease is a liability on the tenant’s balance sheet and landlords have a claim on the tenants’ assets just as a bank or bondholder would. the tenant pays rent on a monthly basis. rent is due by the 1st of the month, and it is usually considered late if not received by the 5th. a late fee of 5% of the overdue amount plus interest is customary if rent is not received on time. while these late charges are substantial and often collected, they are not typically modeled in the lease valuation process. landlords do not expect late fees. failure to pay rent usually results in a relatively aggressive collections effort on the part of the landlord. a phone call or meeting with the tenant happens on the 6th of the month as this is a pretty large red flag. landlords provide electricity to the space, janitorial services, elevator maintenance, heating and cooling, and pay ad valorem taxes on time, and they expect tenants to pay rent on time as well. office rent in most markets is referred to as gross rent. this means that the operating expenses of the property are to be paid by the landlord. landlord operating expenses include contracted services (such as janitorial and security), repairs and maintenance, utilities, personnel expenses, management fees, office and administrative, insurance, ad valorem taxes, and other non-pass through items such as advertising and legal fees. after the first calendar year (specified within the lease as the “base year”), tenants pay for any proportional increases in the allowable passvolume 36, number 1 31 through expenses. this protects the landlord from the costs of inflation; however, landlords of multitenant office buildings always have an incentive to keep costs down since a percentage of their property will be expiring each year. here’s an example of how operating expenses on a gross lease work: suppose a tenant commences a 10,000 square foot (sf) new lease on october 1, 2018, in a 100,000 square foot building. most likely, the base year established within the lease document will be 2019. for the period october 1, 2018 to december 31, 2019, the tenant will simply pay base rent on a monthly basis. if the actual reimbursable (pass-through) operating expenses for the property for the calendar year 2019 are $10.00 per sf, then the tenant will be responsible for their pro-rata share of any increases in operating expenses over and above $10.00 per sf for the duration of their lease. so if pass-through expenses in 2020 are projected to be $10.50 per sf, then beginning january 1, 2020, the tenant will also pay 10% (their pro-rata share: 10,000 sf / 100,000 sf) of the expected increase in operating expenses. for a 100,000 sf property, the $0.50 increase in expenses per foot for the 10,000 sf suite is $50,000, and 10% of that amount is $5,000. on a monthly basis, that is $416.67 in additional rent that is due the landlord beginning january 1, 2020. by around march of 2021, the landlord will have completed an actual accounting of the building’s operating expenses for 2011 and will reconcile the estimated $5,000 additional rent with the actual expenses and either bill the tenant for any 2020 overage or refund any 2020 overpayment. alternatively, in lieu of establishing a base year, some leases establish a base stop whereby the level of operating expenses that are the landlord’s responsibilities are expressly established. in the previous example, the lease may already establish the landlord’s responsibility at $10.00 per sf without regard to the calendar year in which it occurs. in this case, the tenant will always be responsible for any pro-rata increases in operating expenses of the property in excess of $10.00 per sf. as if this arrangement for operating expenses wasn’t complex enough already, two more items are sometimes included in the pass-through discussion of an office lease. first, tenants will often negotiate an annual cap on percentage increases in operating expenses each year. in other words, they will not pay any increases in excess of 4% of last year’s actual expenses. this protects the tenant from unseen increases in property taxes, utilities, insurance, etc. and further incentivizes the landlord to do everything in their power to keep costs low. second, the operating expense discussion will allow for a gross up of operating expenses to a specified level of occupancy. for example, the lease will state that if in any year of the lease that the property does not have an average occupancy of, say, 90%, then the operating expenses for that year will be adjusted to the level of operating expenses that would have occurred had the property been at 90% occupancy. sound crazy? well, it is. office reits and non-reit office owners typically employ many accountants! 32 journal of business strategies the tenant senior sta-home, inc. (ssh) has been in business in the houston area for over 15 years. they provide home health care and rehabilitation for geriatric patients throughout the city. they’ve been leasing space since the company’s inception in the greenway plaza submarket in a class b building, and they’d like to take advantage of the depressed office market to upgrade to nicer space for less money. any press that you’ve seen on ssh has been positive albeit very spotty. their existing landlord refuses to talk to you about their history because they want ssh to stay where they are and renew their existing lease. as a result, you don’t really know if ssh is serious about their search or if their broker is just trying to provide a few more data points for his client as ammunition to renew their existing lease at a much more favorable rate. they aren’t asking for any more space than they already lease, but you don’t know how well the layout of the existing space meets their operational needs. perhaps they just need a new floor plan. regardless of how serious ssh is about their search for office space, times are tough. you want to turn your non-income earning vacancy into rent producing square footage. your ceo has been on a tear to increase occupancy in this tough leasing environment by making more competitive offers than comparable properties. ssh has provided you with their unaudited financial statements (exhibit 1). the deal the deal you’ve just been brought is for a property located in the westchase corridor of houston, texas. your broker, to whom you pay a 2% commission on the day the tenant moves into the space, has presented a deal with ssh who is looking to relocate its 6,500 to 7,000 square foot office to the west side of town. the tenant’s broker is asking for a 4% commission to put his client into your building. the last three leases that you signed at the property were at rental rates of $16, $16.50 and $16.25 per square foot per year, but they are asking for a much lower rate than that. annual operating expenses at the property are $10.00 per square foot, and $4.00 of that are fixed costs. the tenant is asking for a turnkey work letter (where you agree to pay whatever cost needed to construct the space per mutually agreeable construction documents (cds)), but you are hesitant to grant such a liberal request. your architect figures that you can meet their needs with an improvement allowance of about $10 per sf, which is expected to take two months to complete. volume 36, number 1 33 you would certainly like to try to push rates to $16.75 per sf although it’s a very tough market. city view’s cost of capital is currently 9.0%. your largest concern is that the tenant wants nine months of free rent on the front end of the lease on a five-year deal! this is way beyond what you believe the market for free rent to be (about one month of free rent for each year of the lease). the tenant does not require any signage or roof access for an antenna, so you don’t expect any additional revenue other than rent. the current market will not allow you to charge for parking. you will base security deposit requirements on your review of their financials and underwriting. the actual request for proposal (rfp) is provided in exhibit 2. in essence, ssh has asked for the moon. you’re not sure that you can accommodate every one of their requests. the only thing that you know for sure is that you are sick of the weak office market. when will you stop seeing such unfavorable conditions for landlords? exhibit 1. tenant’s submitted financial statements senior sta-home, inc. consolidated balance sheet as of december 31, 2017 unaudited – internally prepared modified cash basis assets current assets checking / savings-cash in bank $ 1,000,073 accounts receivable associated practices (net of allow. for uncollectable) $ 10,350 therapy fees (net of allow. for uncollectable) 1,654,285 total accounts receivable $ 1,664,635 other current assets employee load $ 4,249 petty cash 8,627 total other current assets $ 12,877 total current assets $ 2,677,585 fixed assets office equipment and furniture $ 4,515 other assets 34 journal of business strategies investment in affiliate $ 340 organization cost & amortization 423 prepaid expenses & security deposits 7,203 total other assets $ 7,966 total assets $ 2,690,066 liabilities & equity current liabilities accounts payable $ 167,288 other current liabilities 401k er contribution $ 67,190 other payables $ 247,500 total other current liabilities $ 314,690 total current liabilities $ 481,977 other liability: overpayment reserve equity common stock class a&b $ 4,000 retained earnings 1,812,303 treasury stock (250,000) total equity $ 1,566,303 total liabilities & equity $ 2,690,066 volume 36, number 1 35 senior sta-home, inc. consolidated profit and loss for the period ending december 31, 2017 unaudited – internally prepared modified cash basis jan-dec 2017 ordinary income/expense income associate fees $ 779,768 therapy fees 12,757,118 total income $ 13,536,886 expense advertising $ 4,069 amortization expense 594 bank fees 6,049 billing cost 686,871 business meals & entertainment 14,538 computer expenses 27,208 consulting 75,042 contributions 1,600 depreciation 2,464 dues and subscriptions 7,133 employee benefits 23,863 equipment rental 6,000 facility expense 104,881 insurance 425,123 legal and accounting 16,949 licenses 235 marketing 19,146 office expense 99,352 postage/delivery 22,477 professional development 13,324 recruiting expense 51,095 rent 105,183 36 journal of business strategies repairs and maintenance 13,504 research & development 38,905 salaries and wages 5,652,007 payroll expense 494,701 tax-property & franchise 2,029 telephone 52,716 training 2,776 travel 121,902 uncollectable accounts 36,063 total expense $ 8,127,802 net ordinary income $ 5,409,084 other income / expenses other income 17,986 other expenses agent fees 160,000 er 401k contributions 67,190 federal income tax 3,000 managed unit compensation 1,606,646 management base compensation 650,316 total other expense $ 2,487,152 net other income (expense) $ (2,469,166) net income before management bonus $ 2,939,918 management bonus 3,117,593 net income (loss) $ (117,675) volume 36, number 1 37 exhibit 2. tenant’s request for proposal (rfp) tenant brokerage services 780 north avenue houston, tx 77098 october 22, 2018 via email: leasing.agent@landlord.com mrs. leasing agent landlord realty services 123 main street houston, tx 77098 re: proposal for senior sta-home, inc. / 358 west street dear mrs. agent: as exclusive agent for senior sta-home, inc. (“tenant”), we are forwarding this proposal for their potential office lease at the 358 west street office building (“building”). premises: approximately 6,500 to 7,000 square feet on the 5th floor term: 69 months lease commencement: january 1, 2019 expiration date: september 30, 2022 base rental rate: months 1-9: months 10-44: $0.00 per sf/year $14.25 per sf/year operating expenses: tenant will be responsible for all increases above and beyond the actual operating expenses for the calendar year 2019 (“base year 2019”), with such expenses being grossed up to reflect a 100% occupancy for the building. operating expense escalations will be capped at an annual increase of no more than five percent (5%). tenant improvements: landlord will provide a “turn-key” improvement allowance, based on architectural plans to be mutually agreed to by landlord and tenant with building standard finishes. 38 journal of business strategies option to renew: the lease shall contain one (1) five (5) year option to renew the lease for the demised premises, upon providing the landlord with six (6) months prior written notice. the base rental rate shall be ninety-five percent (95%) of the fair market rental rate at the time tenant exercises this option. landlord will have twenty (20) days to provide tenant with their interpretation of prevailing market rate terms. in the event that tenant does not agree to landlord’s proposal, then during the thirty (30) days following the delivery of landlord’s proposal, tenant and landlord will both use reasonable and diligent efforts to arrive at mutually agreeable terms. in the event that agreeable terms are not reached, then tenant may rescind its notice to exercise its renewal option, and the renewal option will then become void. right of first refusal: tenant shall have an ongoing right of first refusal (rofr) for adjacent vacant space at the fair market rental rate, with such right to be based upon bona fide offers and include a 5 business day notice period and subject to any existing tenant’s rights currently in place, to be defined specifically in the lease. parking: landlord will provide tenant 33 covered parking spaces (5 of which will be reserved) at no charge throughout the lease term. broker: landlord agrees to pay tenant’s designated broker, tenant realty, a commission equal to four percent (4%) of the total gross base rental received of the lease term, payable upon lease signature per a separate agreement. this proposal is submitted subject to the review and mutual acceptance of the final terms and conditions to be contained in the lease amendment. nothing contained herein shall be binding upon either party unless and until such documents have been fully executed and exchanged by both parties. thank you for your prompt response and if you have any questions, please give us a call at your earliest convenience. regards, tenant broker volume 36, number 1 39 instructors’ notes case description the primary subject matter of this case concerns a landlord’s financial analysis of an office lease. secondary issues include the quintessential aspects of office reits. students are not usually familiar with reits – especially those at the undergraduate level. the case has a difficulty level of three, appropriate for undergraduate juniors or seniors, and the case can be taught in a single 80 minute class period. alternatively, the case can be used as a problem in a course on spreadsheet modeling. case synopsis you are an asset manager for a commercial office real estate investment trust (reit). your leasing agent has just brought a request for proposal (rfp) from a local business needing space better suited to their operations and their recent growth. it is the fourth quarter of 2018, and the new tenant wants to move in as soon as construction is complete on the space – as quickly as possible. you want to lease the space at a rental rate that increases the value of the property, but you don’t want to run the prospective tenant off to a competitor. real estate concepts this case covers issues related to leasing decisions by real estate investment trusts (reits). this conceptual information is not necessarily pertinent to the calculations required to make decisions about the lease in question, but rather to expose students to an industry they might not otherwise be exposed to in a typical course in financial decision-making. reits (both public and private) are a driving force in the market for commercial real estate, and they own many of the properties that other types of businesses lease space from to conduct their operations. in other words, students stand a good chance of a reit being their commercial landlord. a sister paper to this case is breazeale (2017) titled “real estate investment decisions i: commercial office property acquisitions.” that paper leads students through the much more difficult decisions associated with property acquisitions by reits (and other real estate owners). this case completes the total picture associated with how real estate firms add value for their shareholders through real estate investment decisions. 40 journal of business strategies the prospective tenant is fictitious and not intended to reflect any particular actual firm. any resemblance to an actual firm is purely incidental – although the tenant in question is typical of a private firm in the market for office space. of particular importance in the case are (1) identifying the pertinent marginal cash flows relevant to value creation for the real estate owner, (2) determining the credit worthiness of the tenant and required security (if any) – despite unaudited and tenantprovided financial statements, and (3) determining an appropriate offer in response to the request for proposal (rfp). suggested questions for students the following questions are provided to aid in discussion and help determine a solution. the list is not exhaustive, and students may bring forth points not listed here. 1. should you respond to the rfp? does their request add any value for the landlord? answer: the following table provides an npv calculation for the tenant’s rfp. while the npv is positive and adds value for the landlord, the tenant’s request for a turnkey work letter poses the greatest financial risk to the proposal. the proposed solution incorporates $10.00 per square foot to reconfigure the space, but the term “turnkey” effectively means that the landlord is agreeing to pay whatever it takes to provide the space the tenant wants. this is never a good idea for the landlord. if the work totals $11.00 per square foot, the deal no longer creates value. a good proposal should cap the landlords financial responsibility for the initial construction to a specified amount to avoid the risk of destroying value. while the tenant broker has asked for a 4.0% commission, it will take 2.0% more to pay your leasing representative. total leasing commissions are therefore assumed to be 6.0% of the total rent generated by the lease. notice that the time value of money associated with a security deposit is also included. if students require a letter of credit or personal guarantee, those measures of security would not be included since they are not cash items. the applicable operating expenses for financial evaluation are the variable portion of the operating expenses. fixed operating expenses for the leased space are incurred by the landlord regardless of whether or not the space is leased. since the balance of the floor is probably leased, heating and cooling costs aren’t marginal. repairs and maintenance to elevators, lobbies and common areas would not be included either. janitorial costs to clean the space nightly would certainly be included as marginal. ad valorem taxes also volume 36, number 1 41 increase with the earnings of the property. $6.00 per square foot is a good approximation of the variable costs for the space ($6.00 per foot * 6,500 feet / 12 months = $3,250 per month). finally, the following analysis assumes a 9.0% weighted-average cost of capital (wacc). students may very well assume something different. nine-percent may be a bit high, but whatever number they use should be substantiated by returns offered on similar properties in the same submarket. senior sta-home, inc. $14.25 gross rental rate on a per square foot per year basis 6,500 square footage of the office suite 6.00% leasing commissions as a percentage of total gross rent (lcs) $10.00 tenant improvements per square foot of space (ti) $10.00 total operating expenses per square foot of space (opex) $4.00 fixed operating expenses per square foot of space 9.00% wacc month date ti lcs deposit rent op ex net cfs 0 1/1/13 (65,000) (16,673) 15,437.50 (3,250) (69,485) 1 2/1/13 (3,250) (3,250) 2 3/1/13 (3,250) (3,250) 3 4/1/13 (3,250) (3,250) 4 5/1/13 (3,250) (3,250) 5 6/1/13 (3,250) (3,250) 6 7/1/13 (3,250) (3,250) 7 8/1/13 (3,250) (3,250) 8 9/1/13 (3,250) (3,250) 9 10/1/13 7,718.75 (3,250) 4,468.75 10 11/1/13 7,718.75 (3,250) 4,468.75 11 12/1/13 7,718.75 (3,250) 4,468.75 12 1/1/14 7,718.75 (3,250) 4,468.75 13 2/1/14 7,718.75 (3,250) 4,468.75 14 3/1/14 7,718.75 (3,250) 4,468.75 42 journal of business strategies 15 4/1/14 7,718.75 (3,250) 4,468.75 16 5/1/14 7,718.75 (3,250) 4,468.75 17 6/1/14 7,718.75 (3,250) 4,468.75 18 7/1/14 7,718.75 (3,250) 4,468.75 19 8/1/14 7,718.75 (3,250) 4,468.75 20 9/1/14 7,718.75 (3,250) 4,468.75 21 10/1/14 7,718.75 (3,250) 4,468.75 22 11/1/14 7,718.75 (3,250) 4,468.75 23 12/1/14 7,718.75 (3,250) 4,468.75 24 1/1/15 7,718.75 (3,250) 4,468.75 25 2/1/15 7,718.75 (3,250) 4,468.75 26 3/1/15 7,718.75 (3,250) 4,468.75 27 4/1/15 7,718.75 (3,250) 4,468.75 28 5/1/15 7,718.75 (3,250) 4,468.75 29 6/1/15 7,718.75 (3,250) 4,468.75 30 7/1/15 7,718.75 (3,250) 4,468.75 31 8/1/15 7,718.75 (3,250) 4,468.75 32 9/1/15 7,718.75 (3,250) 4,468.75 33 10/1/15 7,718.75 (3,250) 4,468.75 34 11/1/15 7,718.75 (3,250) 4,468.75 35 12/1/15 7,718.75 (3,250) 4,468.75 36 1/1/16 7,718.75 (3,250) 4,468.75 37 2/1/16 7,718.75 (3,250) 4,468.75 38 3/1/16 7,718.75 (3,250) 4,468.75 39 4/1/16 7,718.75 (3,250) 4,468.75 40 5/1/16 7,718.75 (3,250) 4,468.75 41 6/1/16 7,718.75 (3,250) 4,468.75 42 7/1/16 7,718.75 (3,250) 4,468.75 43 8/1/16 7,718.75 (3,250) 4,468.75 44 9/1/16 (15,437.50) 7,718.75 (3,250) (10,968.75) total 227,875 npv 26,434.52 volume 36, number 1 43 2. is the tenant’s request comparable to market terms? should your offer be different from their request? answer: brokers always ask for the moon in an rfp. the case specifically states that the last deals signed at the building have been for $16.00, $16.50 and $16.25. $14.25 is off by $2.00. if you want the final lease signed at $16.50, then your first offer needs to ask for something north of $16.50. students should model the lease at higher rental rates as well. 3. do you believe that your offer will be accepted, rejected, or countered by the tenant? does this alter your answer to question 2 above? answer: a counteroffer to your initial proposal will almost assuredly follow. the learning point here is that the final lease will not look anything like your first offer. to convince the tenant that they are creating value for them, the broker will stick to their guns as long as they can with the $14.25 rental rate – or at least something substantially lower than the current market rate of $16.50. it is ok to say “no” in a negotiation. your job is to create value for the landlord – not the tenant. recall that the deal above is not a standalone deal – nor is it mutually exclusive. another tenant may want the space three months from now. as such, some real estate firms (but not many) use real options to value leases rather than traditional net present value. if your course includes real options, this case can be very easily extended to use that capital budgeting method as well. 4. examine the tenant’s financial information in exhibit 1. what gives you pause with regard to their creditworthiness? what gives you a sense of security? answer: pause: the tenant’s broker has only provided you with internally prepared and unaudited financial statements. unfortunately, this is usually what a tenant will provide you. audited financial statements are very costly, and tenants’ will be reluctant to conduct an audit for purposes of a lease. occasionally, a tenant will have recently received a bank loan or some other financing that required an audit, and they will make those financial statements and auditor’s opinion available to you. you’ll have to determine whether or not you think you can trust them. on the surface, the business appears to operate at a loss – mainly due to management compensation. sense of security: senior sta-home has positive retained earnings. this means that they have positive historical profits that have been reinvested into the company. their current income statement also shows that their last year’s rent was $105,183. at a rental rate of $16.50 for their requested 6,500 44 journal of business strategies square feet of space, their annual rent payment to you would be $107,250 – not a large increase at all. if they’ve paid their previous landlord on time, they’ll most likely pay you on time. 5. based on your answer to question 4, what type of security would you require for the deal (security deposit, letter of credit, personal guarantee?) answer: to partially cover the upfront tenant improvements, students should initially require two month’s rent as a security deposit. if the tenant does not slow pay over the three year term of the lease, the security deposit could be refunded if the tenant were to execute a renewal in 2022. works cited breazeale, j. (2017) real estate investment decisions i: commercial office property acquisitions. journal of business strategies 34 (2), 111-124. biographical sketch of author dr. jonathan breazeale is associate professor of finance at sam houston state university – where he teaches business finance, financial markets and institutions, and security analysis and portfolio management. his research interests include real estate, financial education, and working with students interested in publishing research – at both the undergraduate and graduate levels. prior to becoming a professor, dr. breazeale was vice president of parkway properties, inc. (nyse: pky), a public real estate investment trust (reit) invested in office properties. improving quality and organizational effectiveness go hand in hand through deming's management system dean elmuti eastern illinois university charleston, il taisier f. aidiab cameron university lawton, ok abstract this study was undertaken to investigate the perceived effects of deming's management system on employee job satisfaction, productivity, quality and overall organizational effectiveness. three published. validated instruments on organizational characteristics were used to gather data, and extensive, open-ended interviews were conducted with production and operation managers for each of the eight firms in the study. survey and interview results bolster the claims of proponents of deming's quality improvement ideas that these ideas improve employee perceptions of their own job satisfaction and organizational quality. furthermore, the results show a positive impact of deming's management system on employee perceptions of their own productivity and overall organizational effectiveness and industrial competitiveness. introduction w. edwards deming, who has been affectionately called the "messiah of management," has been highly critical of american corporations for their shortsightedness and for a lack of quality in their products and services. he believes that it is quality that has a major influence on market share and the ability to compete domestically and abroad. foreign competitors have moved in and capitalized on the united states' quality weaknesses. deming is credited with institutionalizing a system of strategic manfacturing which is responsible for the formidable japanese presence in the world market (yoshida 1989). his advice to japan made mr. deming the leader of a generation of specialists on product durability and reliability. after the application of his methods brought enormous commercial success to some japanese companies, the japanese created a deming prize, for companies that made striking advances in quality. dr. deming's principles were based on the premise that most product defects resulted from management shortcomings rather than careless workers, and the inspection after the fact was inferior to designing processes that would prospring 1995 elmuti & aldiab: improve quality 87 duce better quality (yates 1992). he argued that enlisting the efforts of willing workers to do things properly the first time and giving them the right tools were the real secrets of improving quality not teams of inspectors (holusha 1993). in spite of deming's success in japan, he claims that most american firms still don't really understand the concepts of improving quality through better control of the production system. he insists that american managers are still content to hang on to the "destructive" notions of "management by objectives" and "results-oriented management" (yates 1992). deming denounced management procedures like production quotas, performances ratings and individual bonuses, saying they were inherently unfair and detrimental to quality. he said customers would get better products and services when workers were encouraged to use their minds as well as their hands on the job (persico 1990). the prevailing sentiment in american industry during the 1960's and the 1970"s was that more quality meant more cost and that consumers did not want to pay for higher-quality products. that attitude began to change when japanese products with brand name sony and panasonic drove the american consumer electronics industries almost out of business while reliable, fuel efficient toyotas and hondas gnawed away at the domestic auto industry (holusha 1993). the united states is now engaged in an all out quality awareness alert. xerox corporation is but one organization that has been strongly influenced by the deming philosophy. xerox sees customer satisfaction and commitments to quality as their main goals. through a total quality drive, xerox reduced their manufacturing costs while developing equipment much faster and improving the reliability of products (norman 1991). ford motor company was also among the first to invite deming to help transform its operations. in 1992 the media celebrated the fact that ford taurus outsold the honda accord to become the leader in domestic sales. former ceo donald peterson stated: the work of dr. deming has definitely helped change ford's corporate leadership ... dr. deming has influenced my thinking in a variety of ways. what stands out is that he helped me crystalize my ideas concerning the value of teamwork, process improvement and the pervasive power of the concept of continuous improvement (dean and evans 1994). as ford's success became obvious, demand for mr. deming's services grew. among the companies that turned to mr. deming and his disciples were dow chemical, proctor & gamble, american telephone & telegraph and the new york times (holusha 1993). there are several individuals who are also regarded as quality gurus. each has developed a set of guidelines, principles, or philosophical statements to describe or explain the beliefs they advocate. some of these giants in the field of total quality management/control are joseph m. juran, armand v. feigenbau, kaoru ishikawa, and philip b. crosby. the works of deming are perhaps the most highly regarded of the total quality management systems (brocka 1992). 88 journal ofbusiness strategies vol. 12, no.1 as indicated earlier a wide range of quality implementation strategies exist, many of which have serious pitfalls. for example, at florida power and light, john l. hudiburg drove hard to win the deming prize in japan, but created a large bureaucracy in which morale fell as workers and managers had to compile hundreds of pages of analysis. the new ceo reduced the scope of the quality effort. alcoa's ceo scrapped the company's decade-long continuous improvement strategy, calling it a "major mistake" and focused instead on "quantum" improvements (dean and evans 1994). patten (1992), believes that total quality management systems require a new set of skills and learning, including interpersonal awareness and competence, team building, empowerment and continuous improvement as a way of life, the process must begin by creating a set of feelings and attitudes that lead to lasting values. deming's management system has been credited with helping to improve morale, reduce costs, improve quality, increase productivity, and improve organizational effectiveness and competitiveness (moen 1989; munroe 1991; walton 1990; whitlen 1989; yates 1992). the claims by proponents of deming's management system and total quality management principles suggest the following research questions that might be very useful to pursue in these early stages of investigation of the relationships between deming's management system and organizational effectiveness satisfaction, productivity and quality: 1. does deming's management system achieve its stated objectives of influencing and enhancing employees' of job satisfaction? 2. does deming's management system seem to contribute in any measurable extent to perceptions of higher levels of organizational productivity? 3. does deming's management system achieve its stated objectives of improving quality of products and services? this study investigates these three research questions and evaluates the impact of implementing deming's management system on organizational effectiveness. research methodology a survey was used, with open-ended interviews, to examine the relationships between deming's management system and organizational effectiveness. survey respondents were general managers (operations), production, middle managers and lower level r6anagers employed by large and mediumsized organizations presently operating in the mid-western united states. the sample consisted of eight corporations presently engaged in manufacturing and production of consumer products. the sample of finns were chospring 1995 elmuti & aldiab: improve quality 89 sen from the united states chamber of commerce, the u.s. department of commerce, and the department of commerce and community affairs in illinois. most of the selected firms were large and medium-sized corporations with 500 or more employees which had been in business for at least four years. all eight firms in this study had been adopting deming's quality improvement ideas for at least three years. the total number of general managers, production, middle level managers, and lower level managers in the eight selected organizations was 720. a representative sample of twenty percent was chosen, based upon recognized tables (krajcie and morgan 1970) for a total of 144 managers. due to cost limitations, and being an exploratory study in nature, only 144 managers were chosen among the total population in this study. ninety-two managers returned questionnaires, resulting in a 64 percent response rate. twenty-two questionnaires were not acceptably completed, thus reducing the response rate to 49 percent (70 managers). demographic characteristics of the respondent, and surveyed organizations are shown in table i. interviews were also conducted with at least one general manager and production manager in each of the eight organizations in the study to obtain a deeper understanding the company executives perceptions of deming's management system effectiveness. during the interviews, the questionnaires were used initially as a guide. three instruments used for this study were likert's (1967), profile of organizational characteristics, mott's (1972), characteristics of effective organizations, and a third instrument designed to tap a wide range of deming's management system facets with measures derived from deming's 14 points (deming 1986). likert's questionnaire was used because it emphasized the relationship between management systems and organizational effectiveness. mott's questionnaire was used to assess overall productivity and as a reinforcement for the data gathered from likert's instrument. response scales ranged from one (to a very little extent) to five (to a very great extent) for all measures. although likert's indices of management systems and organizational effectiveness have been tested for validity and reliability by taylor and blowers (1972), a reliability test was conducted for these indices to enhance their credibility. cronbach's alpha (1951), was calculated for each index in these instruments. the results of this test indicated that all indices were above 0.78 (alpha) criterion for adequate scale reliability. several variables were identified as being significant for the purpose of this study. first, there were the elements used to measure the independent variable deming's management system which include deming's quality improvement dimensions; second, there were the elements used to measure the dependent variable organizational effectiveness which include job satisfaction, productivity, and quality. the definition of the variables used in this study are explained in the appendix. 90 journal of business strategies vol. 12, no.1 table 1 demographic characteristics of the respondents and their organizations* demo&raphic characteristics percent respondent sample sex m~e m ~m~ w a&e under 30 40 31 40 38 41 50 16 over 50 6 education high schoool or less 8 two years college 30 baccalaureate degree 46 graduate degree 16 job status general manager (operations) 6 production manager 24 finance manager 12 marketing manager 14 human resource manager 8 training and development manager 16 lower level managers & supervisors 20 years experience at firm 1004 8 5007 ~ 8 to 10 38 over 10 5 number of employees at firm 500 to less than 1,000 employees 48 1,000 to less than 1,500 employees 36 over 1,500 employees 16 ~ $10 to less than $20 million 25 $20 to less than $30 million 12 $30 to less .than $40 million 14.. $40 to less than $50 million 20 $50 to less than $100 million 18 over $100 million 11 * number of respondents 70 managers at 8 firms spring 1995 elmuti & aidiab: improve quality 91 this study employs likert's (1967) model of human organizational dimension known as system four as its major conceptual framework. likert's, conceptualization of the management system and his advocacy of the participative management approach are based on his research efforts over many years. likert believes in the importance of the interaction influence process, work group communication participation in decision making and the team approach to management. likert's thinking is easily recognized in many articles ( persico 1990; wren 1987) dealing with deming's management philosophy and japanese management techniques such as quality circles and participative management. hypothesis the following major hypothesis guided the study: a positive relationship exists between deming s management system and organizational effectiveness in some of the firms investigated. this hypothesis was stated to reflect the claims made by deming's management system proponents. it was also stated in a way that seeks to determine linear relationships. results data analysis one major objective of this study was to examine the relationships between deming's management system and organizational effectiveness as perceived by respondents in the firms studied. the pearson product-moment correlation (r) was calculated for deming's management system dimensions and effectiveness dimensions job satisfaction, productivity and quality to measure the strength, direction and statistical significance of relationship between the independent and dependent variables with groups, each company represented a group in this study as a unit of analysis. table 2, presents the result of this analysis, which clearly indicates a positive relationship between all measures. it is therefore, appropriate to accept the main hypothesis, and to state, with more than 95 percent confidence that a positive relationship was found between deming's management system and organizational effectiveness. the results of this analysis also indicate that the highest relationships are found between measures of organizational effectiveness and employee participation in problem solving and decision making, extensive communication among management and lower level employees, extensive education and training, and support from leadership in that order. further analysis and evaluation of the relationship between deming's management system and organizational effectiveness were done with the use of multiple regression analysis. this analysis determine the proportion of variance in organizational effectiveness scores explained by the scores of the deming's management system. 92 journal ofbusiness strategies vol. 12, no.1 table 2: pearson correlation coefficients for demings mangements system dimensions and effectiveness dimensions effectiveness dimensions deming's management satisfaction productivity quality effectiveness dimensions* (a) (b) (c) (a+b+c) corporate strategy point i create constancy of purpose for the organization "clear mission" 0.45 0.42 0.38 0.43 point 2 adopt the new philosophy the never-ending improvement 0.50 0.52 0.40 0.58 point 14 involve everybody in the organization "employee participation" 0.62 0.45 0.45 0.68 human resource management point 8 drive out fear among employee "motivation" 0.46 0.39 0.57 0.48 point 9 break down organizational barriers "communication" 0.57 0.69 0.49 0.66 point 12 facilitate and promote pride of workmanship "promote excellence"0.69 0.44 0.69 0.58 measurement of results point 10 eliminate arbitrary numerical =goals "quality vs. quantity" 0.54 0.39 0.32 0.46 point 11 use statistical methods for improvement"spc..." 0.43 0.24 0.56 0.44 training and supervision point 6 institute modem methods of training "on the job training" 0.48 0.39 0.50 0.43 point 7 focus more on supervision "supportive leadership" 0.58 0.69 0.57 0.64 point 13 institute extensive education and training for all 0.59 0.54 0.62 0.65 quality assurance point 3 replace mass inspection with statistical monitoring at all phases 0.46 0.47 0.42 0.50 point 5 constant improvement through "team building" 0.36 0.54 0.59 0.55 purchasing policies point 4 stop awarding business on basis of price quality vs. price 0.47 0.35 0.43 0.56 *all p<.05 some of these statements and design of the company quality profile based upon deming's fourteen points and were adapted from motwani, sower and rosenfeldt (1989). 'operationalizing the process of quality improvement: an exploratory field study of a company quality profile," southern management association proceedings, pp. 385. spring 1995 elmuti & aldiab: improve quality 93 table 3 presents the results of the multiple regression analysis which indicates a positive relation ship exists between the measures of deming's management system and organizational effectiveness. the results indicate that 44 percent of the variation in job satisfaction, 60 percent of the variation in productivity and 62 percent of the variation in quality were explained by linear regression on deming's management system dimensions. the f-ratios of 8.50, 5.25, 6.45, and 12.25 for satisfaction, productivity, quality and effectiveness respectively indicate that these linear relationships are statistically significant at the .05 level. table 3 multiple regression analysis for evaluating the dependence of measures of effectiveness on deming's management system dimensions dependent variable multiple regression (effecti veness) regression square r2 f-ratio satisfaction (a) 0.68 0.44 8.50 productivity (b) 0.74 0.60 5.25 quality (c) 0.78 0.62 6.45 effectiveness (a+b+c) 0.76 0.72 12.25 findings from interviews the purpose of this section is to obtain a deeper understanding of deming's management system effectiveness as perceived by general managers and other management representatives in the eight selected firms, and report the interview findings. corporate strategy. ten out of the sixteen general and production managers interviewed in this study expressed strong support for deming's management system, and they claimed that the deming's quality improvement ideas were making a great contribution to their organizational effectiveness. they also indicated that the dollar savings and indirect benefits generated by the deming's quality improvement ideas were greater than the costs of implementing these ideas. deming's management principles were believed to help enhance morale and job satisfaction; to contribute to organizational goals of increased productivity, reduced costs; and to improve the quality of the operation and the products. the interviews and discussion with operation managers within the eight firms indicated a sincere desire to improve the quality of their operations and the products. they also stressed the point of creating constancy of purpose for improvement of product and service with the aim to become competitive. the remaining six general and production managers indicated that deming's management system failed to achieve its stated objectives of improving quality and productivity in their organizations. they also indicated that failure was due to the fact that little real empowerment was given and what was given was not supported in actions. another reason for failure was that senior 94 journal ofbusiness strategies vol. 12, no.1 management were not personally and visibly committed and were not actively participating. human resource management. exchange of information and openness to employee suggestions seemed to be the dominant characteristics of the majority of the eight firms in this study. most of the managers interviewed (eleven managers) expressed strong support for participatory activities such as employee participation in problem solving. in five of the eight firms, participatory programs such as quality circles, autonomous work groups, and employee-management forums had already been formed and very active in solving organizational problems. by breaking down organizational barriers between management and lower level, employees fear of informing superiors of any problems in their organizations was eliminated according to a majority of interview respondents. concurrently, participatory activities and communication contribute to the organizational goals of increased productivity and improved quality. measurement of results. twelve of the sixteen interviewed managers considered control charts, statistical methods, progress reports and encouragement programs superior to setting numerical goals and using posters and slogans in an effort to motivate workers to increase productivity and improve quality. one production manager remarked that his company was able to save $1.5 million in reject-related costs in one year alone due largely to the statical process control program that it had implemented. additionally, he stated that his company had reduced its reject rate from 24 percent to less than 12 percent by implementing deming's quality improvement ideas. training and supervision. eleven of the interviewed managers indicated that almost all training within their organizations was on-the-job. they also indicated all employees from top management to lower level employees were trained in the same manner, and continuing education is always a means of improvement. this education should consist of new skills, the corporation's goals and methods of achieving these goals. training in statistical methods and problem-solving techniques was provided to both top management as well as lower level employees according to twelve managers interviewed in this study. only five of the interviewed managers indicated that no training in statistical methods was provided to top managers and line managers. engineering and quality control staff were relied upon to handle most of quality problems in their organizations. most of the interviewed respondents (sixteen managers) indicated that effective and supportive leadership would help eliminate many of the barriers between management and lower level employees. quality assurance. catch phrases like "total quality management," "quality is job one," "smarter, not harder," "quality means jobs," "quality is way of life," are being implemented by most of the eight firms in this study. ten out of the sixteen managers interviewed also reported that quality of products and services had improved dramatically since their organizations incorporated deming's quality control methods. they also indicated that their suppliers and vendors used the same processes and controls. at the same time eight managspring 1995 elmuti & aldiab: improve quality 95 ersindicated that some statistical control techniques were used to monitor the production processes. however, most of the interviewed respondents (twelve) indicated that more emphasis should be placed on improving the process and manufacturing products correctly the first time. purchasing policies. eleven managers also indicated that quality of raw materials was the foremost criteria for selecting suppliers. most of these respondents also reported that standards were set when selecting a vendor. these standards were based on the quality of raw materials and not solely on price. furthermore, they indicated that only a small number of suppliers were selected to provide raw materials in order to have good relationships with their suppliers and vendors. conclusions the findings of this study support the conclusion that deming's quality improvement principles such as team-building, employee participation in problem-solving and decision making, sharing information, providing extensive education and training at every level in the· organization and supportive leadership often increase job satisfaction, productivity, quality, and over all organizational effectiveness. the attitudinal results presented here provide support for the claims of deming's management system proponents that the system improves, participates' morale, job satisfaction, productivity as well as the quality of their operations and the products they produce. furthermore, the results document a positive impact of deming's quality improvement ideas on overall organizational effectiveness. statistical analysis of the sample data also indicates that a positive association exists between deming's management system and organizational effectiveness in most of the firms investigated in this study. a majority of operation and production managers who were interviewed in this study expressed strong support for deming's management system, and they believed that the deming's quality improvement ideas in their firms were making a great contribution to their organizational effectiveness. they also indicated that the dollar savings and indirect benefits generated by the deming's ideas in their firms were greater than the costs of implementing these ideas. however, almost one-third of operation and production managers indicated that deming's management system failed to achieve its stated objectives of improving quality and productivity in their organizations. a major reason for such a failure was due to implementation of deming's management system without a full grasp of its nature. certain mistakes were made during the implementation of deming's management system in some of the firms investigated, such as the processes were not driven by a focus on the customer, strategic business issues, and senior management. 96 journal of business strategies implications vol. 12, no.1 one major implication of this study is that, to show positive results, productivity and quality improvement have to be planned, structured and carefully monitored. lasting producl:ivity and quality gains will be realized only through effective utilization of people and the system within which they operate. deming's concept of "hands on management," extends to many areas of production. included in a company's quality overhaul involves not only top management, but all level employees, customers, suppliers and investors. it must be understood that quality is a never-ending process of continuous improvement. in the past decade, a great emphasis have been put on quality. american man'ufacturers have finally taken notice and have begun implementation of total quality control. this process is long and tedious because quality needs to be not only taught, but absorbed, tested, and refined. a second implication of this study is that the deming's principles must be perceived and applied in their entirety, as a whole new way of thinking. his philosophy does not consist of separate techniques, but an organized way of life. in order to strengthen america's competitive position, education and training concerning quality must be evident not only in corporate america but also in schools. deming puts a share of the blame on american business schools (yates 1992). the united states has been forced to reassess the procedures of management. it is necessary therefore, for business schools to see that the students are armed with the necessary knowledge and communication skills in order regain industrial competitiveness. japan has been very successful in implementing deming's philosophy. this should inspire u.s. corporations to concentrate on a national movement to promote total quality management to improve this country's global competitive position. although many more issues remain to be investigated, this study consolidates much of the previous work into a base from which additional studies can spring. this study represents a beginning rather than an end of more research on the impact of deming's management principles. broader measurement of the quality of work life facets and performance outcomes claimed to be influenced by the deming's management doctrine is needed. references brocka, bruce and susanne brocka. quality management implementing the best idea of the masters. chicago, il: richard d. irwin publishing co., 1992. cronbach, lj. "coefficient alpha and the internal struc-ture of test." psychometroka 6, no.3 (1951): 297334. crosby, philip. quality is free: the art of making quality contain. new york: mcgraw-hill, 1979. spring 1995 elmuti & aidiab: improve quality 97 dean, james and james evans. total quality. management. organizations and strategy. st. paul, mn: west publishing co., 1994. deming, w. edwards. out of the crisis. cambridge, ma: mit center for advanced engineering study, 1986. holusha, john. "w. edwards deming, expert on business management, dies at 93." the new york times (december 21, 1993): al3. krajcie, ry. and d.w. morgan. "determining sample size for research activities." educational and psychological measurement 30, no.7 (may, 1979): 607-610. likert, r the human organization. new york: mcgraw-hill, 1967. likert, r. "human resource accounting buildings, and assessing productive organizations." personnel 2, no. 8 (may/june. 1973): 8-24. moen, ronald d. "the performance appraisal system: deming's deadly disease." ouality process 22 (november, 1989): 62-66. mott, p.e. the characteristics of effective organizations. new york: harper and row, 1972. motwani, j., y. sower and m. rosenfeldt. "operationalizing the process of quality improvement: an exploratory, field study of a company quality profile." proceedings of the southern management association, (1989) 384-386. munroe, tim. deming's canon booms for printers." printing impressions (june, 1991): c-l. norman, james r "xerox on the move." forbes (june 10, 1991): 70-71. patten, thomas. "beyond systems the politics of managing in a tqm environment." national productivity review 12, no.6 (1992): 68-82. persico, john jr. "employee motivation: beliefs vs. reality." ouality (march, 1990): 51-53. taylor, j.e. and david g. bowers. survey of organizations. ann arbor: institute for social research, university of michigan, (1972): 166-168. walton, mary. "the deming management method: a bedrock philosophy come home." small business reports 15 (june, 1990): 53-56. whitlen, shirley k. "award winning total quality at the naval publications and forms center." national productivity review 8 (3 summer, 1989): 14-18. 98 journal ofbusiness strategies vol. 12, no.1 wren, daniel a. the evolution of mana~ement thou~ht. new york, ny: john wiley and sons, 1987. yates, ronald. "game plan." chica~o tribune ma~azine (february 16, 1992): 14-22. yoshida, kosaku. well as in japan." 17. "deming management philosophy: does it work in the u.s. as columbia journal of world business 8, no. 5 (fall, 1989): pp 10appendix operational definitions of terms and variables in the study terms definitions deming's management system refers to certain types of practices, behaviors and beliefs, as perceived by the respondents where subordinates and superiors exhibit mutual confidence and trust. communication is extensive, decision making is widely dispersed throughout the organization. team work is encouraged in this atmosphere. extensive education and training provided at every level in the organization. this system mandates that a firm incorporate statistical process control and that its suppliers and vendors use the same processes and controls in order to achieve never-ending quality improvement to meet customer satisfaction (deming 1986). satisfaction employees' satisfaction with fellow workers, jobs, superiors, their organization compared with others, pay, progress in the organization so far and chances for advancement in the future (lickert 1973). productivity employees' perception of the quantity and quality of work done in their divisions or departments as well as the efficiency with which the work is done (mott 1972). quality employees' perception of work done in their organization according to the requriements set to meet customer needs, and satisfaction. quality as conformance to specifications (crosby 1979). effectiveness effective organizations are those that produce more and higher quality products and adapt more effectively to environmental changes, at the same time maintaining a high level of satisfaction of individual members (likert 1973). improving quality and organizational effectiveness go hand in hand through deming's management system an entrepreneur's guide to deciphering the former u.s.s.r. and eastern european markets michael g. harvey university of oklahoma norman, ok kiril kovatchky pimex trading co., ltd. bulgaria abstract when the berlin wall came down in 1989, most western businesspersons recognized the market potential of the eastern european bloc of countries and later the former u.s.s.r. both the consumer and industrial markets were in need, as they are today, of large quantities of updated products and technology. the process of segmenting the demands of consumers in various markets becomes the key to success for entrepreneurial firms. this paper describes a means to develop a dynamic segmentation strategy and entry modes that are most appropriate for each of the market segments of the former u.s.s.r. and eastern european countries. introduction the fall of the berlin wall opened the way for western businesses to reach an untapped market of 400 million consumers (collins & rodrik, 1992). the initial euphoria with such headlines as "gold rush: your small business can ma~e millions in the u.s.s.r. and the east bloc" (poe, 1990), however, soon gave way to pessimism. exaltations such as "it's the frontier, or the wild west" (haslach, 1992) quickly turned into frustration as hopes for rapid expansion and profits did not come to fruition. lack of information and knowledge about the local people, their culture and postcommunist conditions made businessowners conclude that their efforts would not be successful in the near-lerm (wood, 1992; manakkalathil & chelminski, 1993). although the region has been called "the eastern bloc," it consists of vastly different countries with unique cultural and historical backgrounds. this diversity makes it difficult for westerners to successfully sell their products there. perhaps the most important lesson since 1989 has been that rebuilding eastern europe's economies and the former u.s.s.r. will be a long-term task that will do nothing to boost western companies' earnings per share in the near future (wood, 1992). successful western companies will have specific market objectives and recognize the differences among the countries. in addition, to have an 2 journal of business strategies vol. 12, no.1 opportunity to succeed, they must also gain insight into the differences among the countries of the eastern bloc and the many republics that now constitute the commonwealth of independent states (cis), formerly the u.s.s.r. longterm commitment, global perspective, up-to-date information about local market conditions, and the rapidly evolving regulatory environment of those countries will be crucial to succeeding in the eastern european marketplaces. this paper examines and compares entry modes available to entrepreneurs interested in international expansion to eastern european countries and addresses the strengths and weaknesses of alternative strategies related to clusters of countries in the eastern bloc. by following a segmentation strategy and not assuming the eastern bloc or former u.s.s.r. are homogeneous, entrepreneurial organizations will be able to effectively compete in niches in eastern european markets. to be truly effective in these markets, small entrepreneurial companies must develop acompetitiveadvantage unique to their companies in the emerging free enterprise countries in which they are conducting business at the time (bamberger, 1989). segmentation/clustering eastern european markets traditional political segmentation most of the entrepreneur's knowledge of eastern europe and the former u.s.s.r. is based on the history/politics and, to some degree, the cultures of this geopolitical area. traditionally, most of the political and economic experts in the wes.t have tended to group the eastern european countries in the following clusters (congressional, 1990; quelch, 10achimsthaler & nueno, 1991; collins & rodrik, 1991; wood, 1992): (1) poland, hungary, czech, slovak (central europe); (2) bulgaria, romania, albania (the balkans); (3) commonwealth of independent states (the former u.s.s.r.); (4) estonia, lithuania and latvia (the baltic republics) and (5) the former yugoslavia (consisting of serbia, montenegro, croatia, slovenia, bosnia and herzegovina, and macedonia). this market clustering is based primarily on the timing and pace of the economic and political reforms, as well as, on their geographic locations. the countries of the first cluster started economic and political reform earlier and, therefore, have been more visible to the western experts. these countries experienced major economic declines of about 16 percent in gdp in 1990 (poland and hungary) and 1991 (czechoslovakia). after that, the economies of poland (1991) declined by only seven percent and five percent for czechoslovakia (1992) while hungary's economy was flat in 1992. many economists are ready to consider these declines in gdp as an indicator for relative recovery in these countries. (kopits, 1992; rosenberg, 1992). in contrast, romania's industrial production plummeted by 17 percent in 1991. the decline has continued in 1992 and 1993. following a 12 percent decline in 1990, bulgaria's economy declined by a shocking 22 percent in 1991. recently, payment delays common in rumania were eased through the liberalization of the foreign exchange market and investment opportunities (flint, 1994). this is exspring 1995 harvey & kovatchky: entrepreneur's guide 3 plained by the fact that bulgaria's economy was the most dependent on the former u.s.s.r. and was hit severely by the breakup of the regulated trading requirements of the former u.s.s.r. the economy of albania, by far the poorest country in europe, is in economic free-fall (rosenberg, 1992). the largest unresolved question appears to be the future of the former soviet union, where the enormity of potential markets is matched only by the economic and political confusion generated by the country's dissolution (ring, 1993). however, the 12 republics are starting their own unique strategies for economic reform/ development. because they are so different in their culture, religion, history, and ethnic make-up, they will require a special dynamic cluster analysis in the future. entrepreneurs will have to deal with a wide variety of issues in segmenting the macro-market in the former u.s.s.r. the traditional analysis of the former soviet union would suggest the following clusters: (1) russia, ukraine, and belarus being slavic, christian orthodox and with common historical, linguistic, cultural and economic relations; (2) armenia, georgia, and azerbaijan the caucuses republics clustered together mainly on considerations of their location, size, and richness of mineral resources ("can," 1992); (3) the republics of central asia uzbekistan, tadj iki stan, kirgizia and turkmenistan a dangerous mixture of islamic fundamentalism and autocratic communism. moldovia will probably continue to integrate with romania on the basis of their common origin and geographic proximity. a problematic country in this analysis is kazakhstan, where more than 30 percent of the population is of russian origin. kazakhstan can either move toward the first cluster or revert to its islamic neighbors of the third cluster. although the above clustering scheme is convenient, it hides many problematic areas which are now impossible to predict. for instance, what wi11 happen in the future with the multiple "autonomous republics" and "autonomous provinces" (shevardnadze, 1993)? many of them are located in the old russian federation, some of which, like dagestan, have claimed independence and sole authority over their national resources. one of the bright spots in the political unrest in russia between boris yeltsin and the supreme soviet legislators was bringing yegar goider back as first deputy prime minister. it is contemplated by observers that among goider's programs will be to liberalize foreign trade because there are too many restrictions (galuszka, stead & miller, 1993). the political climate in russia appears to be stabilizing and economic progress has been accomplished but not without costs (thorniley, 1994). a traditional cluster analysis of eastern europe is a static one, based on studying the current characteristics of the separate elements without looking at the dynamics of the region as a whole. a more accurate means of reflecting the context of european integration, where certain rearrangements are likely to take place in the near future, is needed. "assessment [of the region] is very often made more on the basis of historic political events and coalitions than sound economic analysis, ... very often we take poland, hungary and czechoslovakia together. we can doubt whether that's correct in terms of economics. quite often we put bulgaria 4 journal of business strategies vol. 12, no.1 and romania together. again, that can be questioned" (andriessen, 1992, p. 14). some of the developments worth watching are: (i) the closer integration of the czech republic to germany, especially after czechoslovakia split into two separate countries (kuchan, 1992); (2) the formation of the austrian-hungarian axis which might also attract italy (if ec divides into two circles of integration) and the former yugoslav republics of slovenia, croatia and what will be left of bosnia (kaikati, 1992); (3) the formation of the baltic trading area consisting of germany, poland, the baltic republics, some regions of russia, and the scandinavian countries; and (4) the development of the turbulent balkans where bulgaria is moving quickly forward in its economic and political reforms, while romania and serbia are still ruled by their former communists. a major impact, as a whole, could be exercised by the situation in the former soviet union where the democratic process has not become irreversible yet and the threat of possible dictatorship still hangs in the air (kaikati, 1992; galuszka, stead & miller, 1993; zlenko, 1993). but one very encouraging sign has appeared in russia, the emergence of a well educated, energetic under-40 generation which is quickly adapting to a "free" marketplace and showing energy unheard of in the days of the soviet command economy (kranz, 1994). dynamic, entrepreneurial segmentation a more dynamic segmentation process is needed to help insure accurate economic/political/cultural data for the entrepreneurial organization. a static, historic segmentation orientation provides little assurance to the "rifle shot" strategies of most entrepreneurial organizations. conducting a customized, dynamic segmentation strategy entails four related steps: (l) "average" country analysis; (2) relevant industry characteristic analysis; (3) progressive cross-cultural analysis; and (4) evaluation of governmental "externalities," i.e., exogenous factors/incentives given by each country. each of these stages of the segmentation strategy will be briefly discussed to highlight the data generated by that phase of the segmentation analysis (see exhibit one). "average" country analysis to provide the entrepreneurial organization's management with an objective gauge of the market potential in the eastern european/post u.s.s.r., an "average" country needs to be constructed. a listing of significant demographic variables, such as those given in exhibit two, may be used to indicate what the characteristics in the "average" market are in eastern europe/former u.s.s.r. this step helps the entrepreneur construct an "artificial" frame-of-reference to be used in assessing market potential relative to the "average" country in these regions. at the same time, this analysis reduces the tendency to compare data to the home country of the entrepreneur. the data for all the countries are summed and then divided by the number of countries, in this case five. this technique can also be used for regions within each country if the data are available. spring 1995 harvey & kovatchky: entrepreneur's guide 5 exhibit 1: dynamic entrepreneurial segmentation .. 1 ....... ..... ... -@regs 1 1 1 6 journal of business strategies exhibit 2 average country analysis variables (i) population (2) national income per capita, # per household (3) gross domestic product (4) manufacturing as a percentage of gross domestic product (5) average hourly earnings in manufacturing (6) total exports and export market (7) total imports and import partners (8) import/exports to and/or from eastern i western countries (9) private consumption expenditures vol. 12, no. 1 (10) personal consumption expenditures (11) passenger autos, trucks in use (12) telephones, tvs, radios in use (13) electricity production demographic variables are examined for trends of last 5/1 0 years and projections. relevant industry characteristics analysis to help customize the segmentation process, the entrepreneurial organization must select key market indicators/predictors that significantly influence its industry. these variables will be particular to each industry but should include economic factors that are used in the domestic market for planning and forecasting growth of sales in the industry. for example, in the housing industry and related suppliers' industry, growth is influenced by mortgage rates, the rate of inflation, the number of marriages, the demographic age breakdown of the population, and the number of unabsorbed houses (for detailed discussion see porter, 1980; 1985; 1990). every industry has a set of variables that comprise signals of the present/future levels of demand. most trade associations can provide the entrepreneur with relevant indicators of demand that could be used to enhance the segmentation process for their product even for eastern europe. spring 1995 harvey & kovatchky: entrepreneur's guide 7 progressive cross-cultural analysis to better understand the cultural, social, and economic development variations between the united states and the potential host eastern european market, the entrepreneurial organization must conduct a cross-cultural analysis. the process investigates: (a) the material aspects of the culture such as the level of technological and economic development in the country; (b) social institutions the influence of political, educational, and religious institutions in the market; (c) language official language, business language, and language taboos in the culture; and, (d) the aesthetic values of art, folklore, and music that are present in the country. this type of analysis is conducted on secondary sources of information. the analysis can assist in determining relevant motivation in a culture, characteristic forms of decision-making, "broad" cultural values associated with product categories. in addition, this analysis can be used to ascertain the appropriate marketing institutions, advertisin'g and pricing necessary to reach the entrepreneurial organization's target market in the host country. a great deal of this information can be obtained from the united states department of commerce. one such source, resource guide to doing business in central and eastern europe, provides an array of beneficial data illustrating economic and cultural similarities/differences in conducting business in eastern europe/former u.s.s.r. in addition, this source reviews united states government initiatives, strategy tips on how to approach these markets and a reference section on trade development industry exports and foreign commercial services district officers. this detailed listing includes trade support contacts including current telephone numbers. the similarities/dissimilarities between the cultures of the united states and the selected eastern european country aid in the development of the "rifle shot" strategy of many entrepreneurs. evaluation of governmental "externalities" to attract foreign investment and encourage privatization (reforming, 1992) of industry, each sovereign state can compile an array of inducements for western businesses that will conduct business with/within its country. for example in slovania, where 2,500 public sector enterprises will be privatized in 1994 (crisp, 1994). government incentives may strongly influence the entrepreneurial organization's selection of countries in the eastern european market, as well as their mode of operation. frequently, the following benefits may be provided by eastern european governments: • reduction in effective local tax liability • permit accelerated depreciation for high risk situations • exemption for fees for registration, financial transactions and local purchase of fixed assets • reduction of duties/tariffs on imported raw materials, semi-finished products and equipment to improve production efficiency • government subsidy to foreign business to encourage development in certain geographic areas (development loans) 8 journal of business strategies vol. 12, no. 1 • government involvement/ownership of plants and/or favorable leases to foreign producers • government protection against foreign and local competition • offers to train indigenous laborers • assurance of safety of corporate property and employees and • adequate compensation if property is expropriated by government officials the key to effectively employing the dynamic segmentation strategy is tapping information sources for that data needed in the analysis. there are three accessible sources of data to the entrepreneur: (l) federal government data sources; (2) universities; and (3) private data sources. each of these data sources will be briefly discussed to assist in directing the entrepreneur interested in dynamic market segmentation. federal government data sources knowing which agency can assist and what that agency has in the way of data are the keys to accessing government data (see exhibit three). the agency most likely to be able to generate the data needed to ascertain market characteristics is the commerce department's international trade administration (ita), which is responsible for promoting exports from the united states. there are 47 district offices and 21 branches of ita throughout the united states. each office has access to: • trade and investment opportunities abroad • foreign markets (requesting) united states products/services • service to locate and evaluate overseas buyers and sales representatives • financing aid for exporters • list and evaluation of international trade exhibitions • export documentation requirements • foreign economic statistics • united states export licensing and foreign national import requirements • export seminars and references for a listing of services and data available from ita most of the information about economic trends and consumers are gathered on-site by the commercial offices of the foreign embassies. an additional source of data is the country desk officer in ita's international economic policy unit. every country in the world has a country desk officer assigned to it. desk officers keep up-to-date data on economic and commercial conditions in their assigned country. they constantly update trade regulations, tariffs, economic and political developments, market size and trends and, most important, make assessments of market potential by domestic standard industrial classification codes (sic). an invaluable service they provide is information on foreign standards and certifications for each product category. spring 1995 harvey & kovatchky: entrepreneur's guide exhibit 3 export services of international trade association 9 export counseling. trade specialists are available at ita district and branch offices for individualized export counseling. agentidistributor service. a customized search for interested and qualified foreign representatives will identify up to six foreign prospects who have examined the u.s. firm's literature and expressed interest in representing it. commercial news usa. a monthly magazine that promotes the products or services of u.s. firms to more than 110,000 overseas agents, distributors, government officials, and purchasers. exporters may submit a black and white photo and a brief description of their product or service. comparison shopping. a custom-tailored service that provides firms with key marketing and foreign representation information about their specific products. commerce department staff conduct on-the-spot interviews to determine nine key marketing facts about the product, such as sales potential in the market, comparable products, distribution channels, going prices, competitive factors, and qualified purchasers. foreign buyer program. exporters can meet qualified foreign purchasers for their product or service at trade shows in the united states. the commerce department promotes the shows worldwide to attract foreign buyer delegations, manages international business centers, counsels participating firms, and brings together buyers and sellers. gold key service. a custom-tailored service for u.s. firms planning to visit a country. offered by many overseas posts, it combines several services, such as market orientation briefings, market research, introductions to potential partners, an interpreter for meetings, and assistance in developing a sound market strategy and an effective follow-up plan. trade opportunities program. provides companies with current sales leads from overseas firms seeking to buy or represent their product or service. these leads are available electronically from the commerce department and are redistributed by the private sector in printed or electronic form. world traders data report. custom reports that evaluate potential trading partners. includes background information, standing in the local business community, creditworthiness, and overall reliability and suitability. overseas catalog and video-catalog shows. companies can gain market exposure for their product or service without the cost of traveling overseas by participating in a catalog or video-catalog show sponsored by the commerce department. provided with the firm's product literature or promotional video, an industry will display the material to select foreign audiences in several countries. overseas trade missions. officials of u.s. firms can participate in a trade mission which will give them an opportunity to confer with influential foreign business and 10 journal of business strategies vol. 12, no.1 government representatives. commerce department staff will identify and arrange a full schedule of appointments in each country. overseas trade fairs. u.s. exporters may participate in overseas trade fairs which will enable them to meet customers face-to-face and also to assess the competition. the commerce department creates a u.s. presence at international trade fairs, making it easier for u.s. firms to exhibit and gain international recognition. the department selects international trade fairs for special endorsement. called certification. the cooperation with the private show organizers enables u.s. exhibitors to receive special services designed to enhance their market promotion efforts. there is a service charge. matchmaker events. matchmaker trade delegations offer introductions to new markets through short, inexpensive overseas visits with a limited objective; to match the u.s. firm with a representative or prospective joint-venturellicensee partner who shares a common product or service interest. firms learn key aspects of doing business in the new country and meet in one-on-one interviews with the people who can help them be successful there. public universities data sources the keys to unlocking the wealth of information in university libraries is finding a research librarian who can orient the small businessperson or a student andlor a faculty member who is knowledgeable of their library. these individuals can be hired to access data and to provide information to the entrepreneurial firm very inexpensively. the data that are in libraries can provide significant insight into the market demand for the company's product (see exhibit four). for example, if the target group of countries was europe, a library that have been designated a european community depository library will have an inordinate amount of free data in them. exhibit 4 designated libraries: european community collection european economy. four times a year. periodic report presenting ec commission analyses of economic conditions and policies within the ec. features and articles have substantial statistical content. european economy, supplement a: recent economic trends. monthly. monthly report presenting recent trends in basic economic indicators for the ec, total and by country, with comparisons for us and japan. covers unemployment rate; trade balance; short-and long-term interest rates; value of ecu in national currency and sdrs; and percent change over preceding period in industrial production; cpi, money supply, and effective exchange rate (export aspect). european economy, supplement b: business and consumer snrvey results. monthly report on opinions of business executives regarding current and expected performance of manufacturing, construction, and retail trade; and consumer opinions regarding general economic conditions; for ec countries. spring 1995 harvey & kovatchky: entrepreneur's guide 11 external trade: monthly statistics. monthly. monthly report presenting detailed external trade data for 12 ec countries, by sitc 1to 2-digit commodity and country, world region; and/or economic grouping. includes data on total ec trade with rest of world; and trade of individual member countries with ec and non-ec trading partners. eurostatistics: data for short-term economic analysis. monthly. monthly compilation of economic indicator indexes for 12 ec countries, with selected data for us and japan. indicators include production by industry group, industry expectations for production and orders, retail and foreign trade, prices, wages, financial transactions, and balance of payments. bulletin of the european communities. monthly. report on activities of ec institutions. includes data on financing operations, draft and final budget appropriations and resources, development assistance projects, food assistance, and emergency aid; and information on economic, foreign, and administrative policy actions, and court of justice cases and decisions. agricultural markets: prices. quarterly. report on prices of major agricultural commodities in 12 ec countries. includes market and fixed prices; ec target, intervention, and threshold prices; and trade levies as applicable for each commodity. crop production: quarterly statistics. quarterly. report presenting detailed data on production and supply of approximately 150 agricultural commodities. includes data on agricultural land use; and area, yield, production, stocks, trade, and consumption of major field crops, vegetable~, and fruits (including nuts and otl)er permanent crops). animal production: quarterly statistics. quarterly. report presenting detailed data on production, stocks, and trade of livestock, poultry, and dairy products by commodity for 10 ec member countries. covers livestock slaughtering and live animal trade; eggs incubated, poultry hatchings, and chick trade; and milk, butter, and other dairy products. energy: monthly statistics. monthly. report presenting data on production, consumption or inland deliveries, and trade of coal, oil, oil products, natural gas, and electric power. energy in europe: energy policies and trends in the european community. three times per year. periodic report on topics related to ec energy supply, demand, and policies. a regular feature examines energy market outlook which includes data on trends and short-term forecasts for production, consumption, trade balance, and stock changes, by energy type; hard coal and coke deliveries, by end user sector; deliveries of selected oil products; electric power plant fuel consumption; and nuclear power generating capacity. source; "a directory of export services," business america, may 7, 1990, pp. 14-18. 12 journal of business strategies vol. 12, no.1 private data sources there are over 400 private companies that conduct research to be sold to individual businesses. the key is to determine which companies conduct research on productslindustries/countries of interest to the entrepreneurial organization. where are all of these sources indexed for the entrepreneur? there is one source of this data compiled annually, findex: the directory of market research reports. studies and surveys. it profiles thousands of reports on the demand for products throughout the world in such categories as: industry reports, company reports, reports on companies that publish reports, publisher/distributor directories (how to contact), and a geographic index to pinpoint the area that may be of interest to the entrepreneur. unfortunately, findex is seldom found in university libraries. the index may be purchased ($275) and it provides an entrepreneur with a library of private research conducted by firms throughout the world. these three sources of information will provide the enterprising entrepreneurial organization with ample information on which to base a market assessment for the international market. however, large volumes of information may create difficulty in sorting and organizing the data into actionable information. the data are available; the entrepreneurial organization must invest the time and effort to gain access to these information sources. modes of entry and operation in the eastern european market for entrepreneurs international market entry mode is an institutional arrangement that makes possible the entry of a company's products, technology, human skills management or other resources into a foreign country. generally, entry modes can be classified into three majnr categories: (1) exportlimport entry modes; (2) contractual entry modes (licensing, franchising, turnkey contracts, technical agreements, service contracts and others) and (3) investment entry modes (joint venture, foreign subsidiary), (root, 1982). each of these modes of entry have unique characteristics that can be utilized by the entrepreneur when entering eastern european/ former u.s.s.r. countries. matching the relative advantage of an entry mode and the market "attractiveness" is critical due to the limited resources that many entrepreneurial organizations face when expanding into the international marketplace. exhibit five depicts the matching of country cluster "attractiveness" and mode of entry that supports an entrepreneurial organization's strategy. it is important to note that the "average" country analysis is based on a common set of economic characteristics (see exhibit four) in combination with key industry indicators selected by the entrepreneurial organization. to illustrate the value of each entry mode the following selections briefly describes pros and cons of each mode. spring 1995 harvey & kovatchky: entrepreneur's guide exhibit 5 country clusters and mode of entry entry mode 13 eastern european country export! foreign joint joint foreign clusters import licensing licensing venture subsidiary primary secondary "'above mode of mode of "average" entry (rapid (preempt country market entry of penetration) other foreign competition) primary secondary mode of entry mode "average" building (gain country brand production awareness relative advantage primary secondary below entry mode entry mode "average" (est. contact (contextual country for future) expansion.. limited risk) '" determination of "average" country based upon country variables e.g., deomgraphic as well as specific industry related issues selected by the organization undertaking the analysis. importlexport mode of entry the first level of involvement in international markets companies must overcome are their anxieties about the organizations ability to compete in foreign markets (root, 1994). this feeling of uncertainty is excentuated for entrepreneurial organizations contemplating eastern european markets. the level of organizational insecurity can be off-set to a degree by selecting an entry mode that reduces the risks by limiting the direct level of involvement in eastern european markets. the entry modes that fulfills the objective of containment of risk are exporting or importing from eastern european markets. the entrepreneurial organization can select between direct or indirect exporting and importing. direct exporting/importing requires the organization to commit to managing the export/importing activities through their own company. whereas, the indirect exporting/importing shifts the responsibility for entering the eastern european market to a specialist in the export/importation business. there 14 journal of business strategies vol. 12, no.1 is a variety of these experts: (1) export management companies (emcs) serve as the international marketing specialist for several manufacturers in noncompetitive lines by adapting their services to each client's products, markets and their own resources; (2) agents, brokers and commission houses represent manufacturers in the international marketplace much as manufacturers representatives do in the united states; and (3) complementary exporters contract for private labeled products from a variety of manufacturers to be so,ld in the international marketplace as a unique product line (root, 1994). small entrepreneurial companies may find these entry modes appealing when entering "exotic" markets to reduce the risks associated with selling their products (mcdermott, 1993). as is illustrated in exhibit five, the exporting/importing entry strategy may be employed when the market does not warrant a full scale commitment to the market cluster. the timing for high potential, low risk may not be right and the export/import entry mechanism allows for an introductive to the marketplace to be strategically positioned for future growth opportunities. this entry mode also permits the entrepreneurial organization the time to further assess the potential of the eastern european markets. the export/import mode of entry increases the knowledge and experience of the entrepreneurial organization before attempting a more aggressive, involved mode of entry. foreign licensing (fl) mode of entry the reasoning behind foreign. licensing, primarily used by western companies is to: (1) transfer existing technology to these countries; (2) sell licensed products to counteract counterfeiters; (3) avoid the high involvement and risk of joint ventures and foreign owned subsidiaries; and (4) rampart the product back in the home country (root, 1982; garland, farmer & taylor, 1990). important factors, however, make this mode-of-operation less preferred in eastern europe. the first one is the lack of management skills which will negatively affect the operation of the licensee (or the franchisee), and ultimately, the reputation and the brand name of the licenser (judy, 1992). another serious problem, is the existence of grey markets where licenser's products are sold by other unlicensed merchants without permission and without paying the appropriate royalties and fees. sony experienced such negative results in poland in 1991 despite increased shipments of sony products to pewex, the local company licensed to distribute them in poland, demand exceeded by far the official supply. private dealers began selling sony products on the grey market supplied by "parallel" imports independent of pewex. sony considered a number of options to deal with the situation but concluded that opening its own subsidiary would be the best solution because this would give the company control over sales and service, enhance its local image, and fit the corporate philosophy of "global localization" (wood, 1992). the third problem, especially for the software industry, is the potential for piracy. by one estimate, more than 90 percent of all software used in eastern europe has been illegally copied (hotopf, 1992). obviously, pure licensing withspring 1995 harvey & kovatchky: entrepreneur's guide 15 out strict control will only add to the headache. the situation, however, is improving with most of the countries enforcing laws that defend private intellectual property. still, foreign licensing can be used carefully in certain areas, such as retailing and soft drink bottling, e.g., coca cola's and pepsico's current agreements with a number of local partners. the austrian food retailer, with czech and slovak subsidiaries, has also four franchises in poland, two in hungary, and six in yugoslavia and plans to open a store in st. petersburg, as well (haslach, 1992). one opportunity for joint ventures for small and medium firms in the united states is to obtain technology rights from companies in eastern european countries. x-ray optical systems, inc. a small albany, new york startup in 1990 has obtained rights to a breakthrough technology that allows x-rays to be highly magnified (kruytbosch, silverman & pechter, 1992). the technology was developed by a small romanian company and marketed in the united states by xray optical systems, inc. joint ventures (jv) mode of entry joint ventures as a traditional instrument of entering foreign markets, allow more rapid market access than exports and have lower costs than joint investments. in addition, this mode of entry allows western companies access to sources of raw materials at below market prices (pfohl & lagrde, 1993). however, the legal contract which binds firms with different cultural, economic and political backgrounds can be more perilous than foreign license subcontracting or foreign investment where, in each case, one firm maintains managerial and financial control (stevens, 1990). the preferred investment has been joint ventures. in spite of the impressive number of such joint ventures, many of the ventures have yet to function. of the 5,000 or so joint ventures registered in the former soviet union in 1991, only 250 were operational at the end of 1992. ("economic," 1992). there has been a steady stream of headline-making mnc joint ventures such as fiat's plans to invest $2 billion in poland and phillip morris' agreement to pay almost $400 million for ownership in the czech cigarette maker tabak. it is the small service-oriented businesses that dominate the scene. in hungary, the average joint venture receives $130,000 in foreign capital, and fewer than a quarter of such ventures are in manufacturing (wood, 1992). even small entrepreneurial organizations like ben and jerry's homemade, inc. established a joint venture which has grown to four ice cream shops, employing 100 people in russia (doeff, 1994). other inherent disadvantages of a joint venture could include: (1) lack of full control over the company which is further worsened when one of the partners lacks basic management skills; (2) serious problems in dispute resolution, especially when the local panner has a completely different attitude to managementworkers relations; and (3) possibility of corruption, particularly when the local directors are government employees in a quickly changing environment in which 16 journal of business strategies vol. 12, no. 1 old controlling and supervising institutions are destroyed faster than new, marm ket-based ones are being built (root, 1982). joint ventures will probably continue to be preferred in countries averse to foreign private property, e.g., russia and the fonner soviet republics. this is particularly true in industries which will tend to remain under state control for a 10:lger period of time. this trend will also continue where the riskmsharing incentives are high, e.g., extraction, energy, telecommunications, and other specific large-scale infrastructure projects. such a project is the international telecommunications union consortium that is helping to rebuild eastern europe's outdated telecommunications infrastructure for over $94 billion between 1994-2000 (laplante, 1994). such a mode is particularly useful for oil and gas extraction in russia and the republics, where "there is still a tendency to regard foreign investors as nasty capitalist robbers and where many of the oil barons of siberia have a less positive attitude" (fraser, 1992a, p. 7). one such joint venture, white nights, is a threemway partnership between phibro energy of connecticut, anglo-swiss of texas, and varyegannyeftegas (a siberian oil association). white nights drills for new oil in leased fields. so far, the oil goes to the russian government and the revenues are split (fraser, 1992b). wholly owned subsidiaries (was) mode of entry some entrepreneurial organizations could progress from export lead expan m sion to establishing international production and assembly facilities in eastern europe countries, but this would be a significant organizational step for most entrepreneurs (stevens, 1990). while most firms that are directly investing in eastern europe are attracted by the si~e of the domestic markets, companies from certain industries (such as electrical goods and auto manufacturing) consider this region as an extension of western europe, and are establishing production facilities there as elements of their core networks with a view to supplying the entire european market. western companies can play a major role in the economic transformation of eastern european economies (feulner, 1994). such companies strongly prefer full management control over their eastern plants in order to ensure world standards of quality and proper management. although benefits to such investments may not materialize in the short-run, possible firstmmover advantages and long-term prospects have induced many to invest there. the eastern european scene is dominated by serious players with clear longtenn investment strategies such as: gm, ford, vw, daimlermbenz, suzuki (automobiles), samsung, daewoo, matsushita, siemens (electronics), ge and electrolux (lighting), ericsson and at&t (telecommunications), nestle and unilever (food), procter and gamble (consumer goods). such investments lead to modernization of technology, plant equipment and even infrastructure. improved road transportation feeds into more efficient distribution "of food and other retail goods. westm ern-style supermarkets and convenience stores have already come to eastern spring 1995 harvey & kovatchky: entrepreneur's guide 17 europe. the conglomerate austrian food retailer, julius meinl, formed czech and slovak subsidiaries with food stores in prague and bratislava and plans for twenty more. bsn, the french food giant which signed deals in czechoslovakia and poland to produce its danon brand yogurt, plans to run its own trucks and warehouses to ensure fresh delivery (wood, 1992). the german retail chain, adler, took over bulgaria's denitsa and immediately started op(;r~ltions in sofia. a heightened cultural sensitivity, however, is needed in order to gain a high profile and to not be viewed as "buying up the home country" (rosenberg, 1992). an example in this respect is the appointment of a local man as the chairman of skoda by vw's management. officially, the german manager is merely a vice chairman although he actually oversees all operations. in addition, local employees are also being schooled to take over the reins from expatriates, benefiting from language training and regular visits to wolfsburg, vw's headquarters in germany, for management seminars (studemann, 1992). on the other hand, parent companies should be ready for a long adjusting and modernization process in their east european subsidiaries before profits accrue to the company (laplante, 1994). a case in point is ge's purchase of the tungsram lighting company, considered one of hungary's most prominent companies. despite cutting staff by 28 percent and increasing volume by 30 percent since taking control in 1989, the u.s. company says tungsram still lost $14 million in 1991. further staff cuts and more training outlays are expected (wood, 1992). on a smaller scale, coinmach industries, company of roslyn new york is typical of non-mncs conducting business in eastern european countries. the self-serve laundromat to serve hungary's demand for consumer services will take twice as long to be implemented and become profitable than initial estimates (steinberg, 1991). the government's state property agency's inability to determine which properties will become privatized could result in failure of the entire project. another stimulus for opening foreign subsidiaries is to improve prospects for other foreign trade and investment and to follow major customers abroad. this is the case with first ukrainian international bank, the largest shareholder of which is a $1 billion new york international trading group. the new bank aims to facilitate trade among foreign republics and to begin providing a financial infrastructure for foreign investors in the ukraine. this is specifically targeted for american companies which showed in a recent survey that the chaotic state of the ex-soviet financial system with its lack of convertible currency is a major stumbling block to increased trade and investment (kruytbosch, 1992). several foreign banks have set-up subsidiaries in eastern europe, including citibank (the first to set up a subsidiary in budapest back in 1986); austria's creditaustalt and girozeutral; italy's san paolo di torino and banca commerziale italiana; france's societgnrale, crdit lyonnais and crdit agricole; and germany's dresdner and deutsche banks. it is estimated by united states banking regulators that there are now about 20 foreign banks with subsidiaries in the region and 80 representative offices. more are expected to open subsidiaries in the next year or two, 18 journal of business strategies vol. 12, no. 1 particularly german and austrian banks. this is due to the historic links with these countries and the eastern bloc, and to a lesser extent, french and italian banks ("can," 1992). home government support to large-scale infrastructure projects and other risky investments may turn out to be a serious competitive advantage. at the present time western firms are coming up against the regions' out-dated telecommunications infrastructure, which many observers cite as the biggest hurdle to achieving success (laplante, 1994). as the german, danish, and korean examples indicate, joint private and public sector actions, in the form of consortia for instance, are more successful in certain east european countries. this may be due to home country government participation, which seems more dependable to host country decision makers used to dealing, in the past, exclusively with state officials rather than with private companies and individuals. summary and conclusions the eastern european market represents a $400 million ultimate consumer market and an industrial sector that is antiquated, depressed and in need of revitalization (quelch, 10achimsthaler & nueno, 1991). creating a healthy enterprise sector is a key to improving productivity and growth for the eastern european/ former u.s.s.r. economies over the long term. close observers of the economic transformation in these countries are almost unanimous in that privatization is the larg~st and most important systemic issue that these economies face ("reforming," 1992; crisp, 1994; feulner, 1994). this movement must encourage emerging private sector business units (entrepreneurs), as well as promote restructuring and 'privatization of state-owned assets and enterprises. this type of fluid economic environment is ideal for western entrepreneurs to flourish. presently, large mncs and government agencies are leading the way into these unfolding markets, creating "piggyback" opportunities for the astute western entrepreneur. there are several keys to competing successfully in eastern european/former u.s.s.r. for entrepreneurial organization: • research sources of information that are available in the united states monitoring the very fluid condition of most of the eastern european/ russian markets and • analyze the basic economic determinants of their business and how these elements are going to be affected in the markets of eastern europe and russia • segment the aggregate market into logical country segments and do not assume that there is a homogeneous eastern bloc spring 1995 harvey & kovatchky: entrepreneur's guide 19 • develop a hypothetical frame-of-references by constructing an "average" country to serve as a point of comparison to each country in eastern europe and the former ussr • once countries have been arrayed according to their potential market, a progress across-cultural analysis should be conducted to better understand differences among the countries beyond their economic variation • examine government incentives being offered to induce western entrepreneurs to do business within each country • finally, select a mode of entry to reduce risk of conducting business in the east and at the same time provide the flexibility and latitude to expand their business in the future. this action plan should provide the necessary steps to help insure success when competing in the eastern bloc. references andriessen. f. interview. europe, (1992, march): 14-15. bamberger, i. "developing competitives advantage in small and medium size firms," loni: ran~e planning 22, no.5 (1989): 80-89. blinderman, m. "one company's success story," global trade and transportation 113, no. 11 (november, 1993): 24. "can the banks fly?" the banker, (september, 1992): 20-44. collingwood, h. "russian industry goes on the block." business week, (january 25, 1993): 48. collins, s. & rodrik, d. eastern europe and the soviet union in the world economy. institute for international economics, washington d.c., 1991. congressional budget office, "how the economic transformation in europe will affect the united states," congressional budget office, washington d.c., december, 1990. crisp, w. "smooth sailing." business eastern europe 23, no. 29 (july, 1997): 8. doeff, g. "russian revelation." dairy foods 95, no. i (january, 1994): 24. dowling, p. "hot issues overseas," personnel administrator (january, 1989): 66-72. 20 journal of business strategies vol. 12, no.1 economic trends. business week (december 7, 1992): 24, 104. feulner, e.j. "journey to the east: investment opportunities in eastern europe." chief executive 26 (july-august, 1994): 18-20. flint, a. "on the mend: business environment in romania," business eastern europe 23, no. 29 (july, 1994): 7. fraser, h. "under cover." international management (february, 1992): 45-47. fraser, h. "save the new kuwait." international management, (may, 1992): 79-81. galuszka, r., stead, d. & miller, l. "yeltsin pushes all his chips into the pot." business week, (october 4, 1993): 54. garland, j., farmer, r. & taylor, m. international dimensions of business volicy and strategy, 2nd, boston: pws-kent, pub. co., 1990. "grabbing new world orders," business week, (october, 1992): 110-118. haslach, r. "the bright lights of eastern europe." europe (march, 1992): 8-9. hotopf, m. "the east hungers for megabites." international management, (february, 1992): 48-49. judy, r. "prospects for economic and political freedom in poland." hudson count!)' re~, no.2 (december, 1992): 1-20. kaikati, j. "models of success and failure ..." east eurovean quarterly. xxv/(3), (september, 1992): 291-305. khalili, s. "emigre advantage: you can go home again," international business 4, no. 7, (august, 1992); 30-35. kopits, g. "fiscal reform in european economics in transition" in transitions to a market economy in central and eastern europe, cceet, gecd, paris, 1992. kranz, p. 'the young the ambitious," business week: 21st centu!)' capitalism, special issue, (1994): 128. kruytbosch, c. "capitalism's converts." international business, (july, 1992): 23-24. kruytbosch, c., silverman, s. & pechter, k. "global go-getters," international business 5, no.2 (february, 1992): 14-15. kuchan, d. "altered states." international management, (august, 1992): 58-65. spring 1995 harvey & kovatchky: entrepreneur's guide 21 laplante, a. "eastern europe's virtual curtain." computerworld, 28, no. 37 (september, 1994): 73-76. lo bello, n. "why not? yanks start english-language weekly in prague," editor & publisher 125, no. 35, (august 29, 1992): 28-29. manakkalathil, j.c. & chelminski, p. "the central european three: opportunities and challenges." sam advanced management journal 58, no.3 (summer, 1993): 28-36. mcdermott, k. "trailblazing in emerging markets: the rewards outweigh the sometime quirky risks of selling to developing nations." d&b reports 42, no. 3 (may-june, 1993):16-19. miller, w. "europe 1992: regionalism and globalism." the international executive. (october, 1991):28-35. nakarmi, l. "can korea unite and conquer?" business week, (november 16, 1992): 52-55. okoroafo, s. "modes of entering foreign markets." industrial marketing management, 20, (1990): 341-345. poe, r. "gold rush": your small business can make millions in the u.s.s.r. and the eastern bloc," success 37, no.7 (september, 1990): 33-42. pfohl, h.c. & lagrde, r. "sourcing from central and eastern europe: conditions and implementation." international journal of physical distribution and logistics management 23, no.8 (october, 1993): 5-16. porter, m. competitive strategy, free press: new york, 1980. competitive advantage. free press: new york, 1985. the competitive advantage of nations. free press: new york, 1990. puchev, p. "the bulgarian executive." the international executive, (october, 1991): 2324. quelch, j., joachimsthaler, e & nueno, j. "after the wall: marketing guidelines for eastern europe." sloan management review (winter, 1991): 42-51. quelch, j., brizzell, r. & salama, e. this marketing challenge of europe 1992, reading ma: addision-wesley publishing co, 1991. reforming the economics of central and eastern europe. organization of economic cooperation and development, paris, france, 1992. 22 journal of business strategies vol. 12, no.1 ring, m. "countertrade business opportunities in russia." business america 114, no. i (july, 1993): 15-17. root, f. "entry strategies for international markets." lexington, ma: lexington books, 1982. root, f. entry strategies for international markets. 2nd edition, lexington, ma: lexington books, 1994. rose, b. "the scramble for oils last frontier." business week (january 11, 1993): 4243. rosenberg, l. "economic transition in eastern europe... " east european quarterly, xxvi 3, (september, 1992): 361-277. savona, d. "crude caviar and capitalism." international business, (february, 1992): 7274. shevardnadze, e. 10. "georgia's security outlook." natq review, 41, no. 4(1993): 7simurda, s. "the rush for russian experts." international business (august, 1992): 8283. sokoloff, s. "beating the rush to russia," new england business 13, no.2 (february, 1991): 58-59. steinberg, c. "spin cycle," world trade 4, no.7, (november, 1991): 40-44. stevens, c. "technoglobalism v technonationalism." columbia journal of world business. (fall, 1990): 42-49. studemann, f. "baltic renaissance." international management, (february, 1992): 42-43. studemann, f. skoda. international management, (march, 1992); 47-49. thorniley, d. "russia: no new is good news." business eastern europe 23, no. 29 (july, 1994): 2. united nations world investment report 1992... department of economics and social development, 1992. wood, barry. "the eastern bloc two years later." europe (march, 1992): 12-13. zlenko, a. "ukrainian security and the nuclear dilemma." nata review 41, no. 4 (1993): 11-15. an entrepreneur's guide to deciphering the former u.s.s.r. and eastern european markets integrating employee benefits and competitive strategy margaret a. lucero* university of wyoming laramie, wy marion m. white james madison university harrisonburg, va abstract as the costs of employee benefits have escalated, labor cost control to enhance product market competitiveness has become a more critical organizational concern. however, benefits which are an element of compensation have remained a relatively neglected topic in the area of strategic human resource management. this paper explores the role of employee benefits in effective strategy implemen· tation. three core characteristics of employee benefits practices: timing, benefit level and employee-employer relationship, are described on continuum of choices. examples of various employee benefits practices are linked to low-cost leadership and differentiation strategies. introduction as global market pressures increased during the 1980s and 1990s, labor costs have become an important concern in many organizations. as part of efforts to enhance product market competitiveness, a growing number of organizations have taken steps to control compensation costs. accordingly, benefits have been closely scrutinized in recent years as employee benefits have increased to approximately # 39 percent of total labor costs (u.s. chamber of commerce, 1992). as a result of cost control efforts, some organizations have eliminated benefits while others have shifted a portion of the employer's costs of benefits to the employees receiving them. it appears,' however, that these efforts to control the cost of benefits have been as unsystematic as was the growth in supplemental compensation packages. over the years, employers added new benefits in response to factors such as government mandates, union pressures, tax incentives and employee initiatives (milkovich & newman, 1993). while responding to the various stakeholder pres* the authors would like to thank martin m. greller, robert e. allen. charles d. pringle. and two anonymous reviewers for their valuable comments on this paper. 136 journal of business strategies vol. 12, no.2 sures to add new benefits and improve old ones, employer concern for the return received on employee benefits expenditures appear to have obtained a lower priority. additionally, benefits are an element of the reward structure that have remained a relatively neglected topic by behavioral researchers. "at this point, benefits decisions are being primarily made based on beliefs and experience behavioral research simply does not exist to help inform such decisions" (gerhart & milkovich, 1992, p. 541). the escalating costs and the critical importance of benefits for employees provides a new impetus for linking benefits to compensation strategy, as well as to overall corporate strategy. organizations can realize positive results by thinking strategically with respect to their employee benefits practices. for example, at gte "benefits are those that help rightsize the work force either up or down, or motivate people to join us as a workplace of choice" (carswell, 1993, p.12). gte's view of benefits is indicative of the potential outcomes that can be realized by linking employee benefits to organizational strategy. at the same time, poorly conceived and executed attempts to cut the costs of benefits can interfere with the realization of important organizational goals. the purpose of this paper is to examine the contribution that employee benefits can make to an organization's ability to achieve overall strategic objectives. an organization's reward system is one of the most powerful tools in effective strategy implementation. as a result, the reward system must be clearly and tightly linked to strategic performance. many organizations have modified their reward systems to fit the objectives they are trying to achieve. for example, ibm changed its emphasis from sales objectives to financial objectives, and in order to make this change, has switched to pay for profits for its sales-force. now 60 percent of commissions are tied directly to sales-force generated profits, as compared to 20 percent in the previous year (sager, mcwilliams, & hof, 1994). similarly, the employee benefits portion of compensation can enhance strategy implementation when benefits and strategy are effectively linked. integrating employee benefits into strategy implementation in an area such as employee benefits, where theory-driven empirical research is sparse, the application of strategic human resource management theories can provide a valuable focus for future research and organizational decision-making. the choice of strategy has important implications for human resource management practices, because successful strategy implementation ultimately depends on the behavior of individual organizational members. future competitive success will be increasingly reliant on a concerted managerial effort to create strategysupportive "fits" (thompson & strickland, 1992). all organizational systems and goals should be supportive of the unit strategy and human resource practices are no exception. a number of alternative theoretical frameworks are useful when linking human resource practices to strategy, and thereby providing a view of human refall 1995 lucero & white: integrating benefits 137 source management activities "as being determined by proactive, strategically, intended decisions" (wright & mcmahan, 1992, p. 300). these four strategic theories of human resource management are, the resource-based view of the firm (barney, 1991), the behavioral perspective (jackson, schuler, & rivero, 1989; schuler & jackson, 1987), cybernetic systems (boulding, 1956) and agency/transaction cost theory (jones, 1984). the current paper is based on the behavioral perspective, following schuler and jackson's (1987) model linking human resource practices with the competitive strategies described by porter (1980). the behavioral perspective provides strong connections between employer practices and the appropriate employee role behaviors required by the implementation of the chosen competitive strategy. the schuler and jackson (1987) model illustrates how different employee role behaviors can be elicited through the human resource practices used by the organization, while at the same time emphasizing the need for congruence among these practices. accordingly, the strengths of the behavioral perspective provide a beneficial foundation for examining employee role behaviors that can result from employer-sponsored employee benefits programs. figure 1 presents a framework for integrating employee benefits practices into corporate strategy implementation. the following discussion describes the linkages between the competitive strategies described by porter (1980) and three core characteristics of employee benefits. consistent with the behavioral perspective, the appropriate fit between choice of strategy and benefit practices is theorized to encourage the types of employee behaviors needed for effective strategy implementation. figure 1 integrating employee benefits into strategy implementation strategy • desired behavior timing fit ,control • benefits costs relationship ~ --.. type of actual behavior hr system vl commitment _ timingbenefits costs relationship 138 journal of business strategies vol. 12, no.2 according to porter (1985), management must select a strategy that will allow it to develop and sustain a competitive advantage in order for that organization to perform at an above-average level. competitive strategy concerns the identification of organizational activities which provide an edge over the competition thereby allowing the organization to achieve a competitive advantage. porter (1980) describes three approaches to competitive strategy. these are: (1) a lowcost leadership strategy, (2) a differentiation strategy, and (3) a focus or niche strategy. the characteristics of the low-cost leadership strategy include a continuous emphasis on cost reduction (while maintaining acceptable levels of quality), tight controls and attaining economies of scale. alternatively, an organization following a differentiation strategy will seek ways to make its product or service unique. a differentiation strategy is exemplified by an emphasis on technical superiority, quality or high service. this generally requires an emphasis on quality rather than cost. an organization following a focus or niche strategy, can use either a low-cost leadership strategy or a differentiation strategy but will focus on a narrow portion of the market rather than the whole market. schuler and jackson (1987) argue that successfully linking strategy and human resource practices requires an understanding of the specific role behaviors needed for successful strategy implementation. some examples of key employee role behaviors include concern for quality, concern for quantity, risk taking, job involvement, and innovativeness. each of these role behaviors can be conceptualized on a continuum from low to high. the specific attitudes and behaviors that will be most effective for a particular organization will depend on the type of strategy the organization is trying to implement (wright & mcmahan, 1992). the behavioral perspective links human resources management practices with successful strategy implementation (schuler & jackson, 1987), thereby providing direction for achieving the critical "fit" between employee benefits practices and needed role behaviors. as with other human resource practices, employee benefits programs and practices can be instrumental in effective strategy implementation. a recent study (jackson, schuler, & rivero, 1989) indicated that differences in personnel practices vary with organizational characteristics such as industry sector, competitive strategy, and organizational structure. additionally, systematic differences in human resource systems have been identified and described (arthur 1992, 1994). this research has resulted in the labeling of two very different human resource systems : control and commitment. the control human resource system is aimed at reducing direct labor costs or improving efficiency, with a focus on employee compliance with specified rules and procedures. alternatively, the commitment human resource system attempts to forge psychological links between organizational and employee goals, while developing organizationally committed employees. in a study looking at steel minimills, arthur (1992) found that minimills following the low-cost business strategy were more likely to have control human resource systems, while minimills following differentiation strategies were more likely to have commitment human resource systems. fall 1995 lucero & white: integrating benefits 139 the behavioral perspective provides a basis for identifying appropriate employee benefits practices as they relate to the employee role behaviors needed for effective strategy implementation. the control and commitment human resource systems identified by arthur (1992, 1994) provide additional guidance for establishing employee benefits programs that fit the organization's strategic objectives. the major concern for organizations following a low-cost leadership strategy is on cutting costs and being efficient, while maintaining organizational quality and performance standards. emphasis on a control human resource system would be consistent with this strategy (arthur, 1992, 1994). similarly, an organization pursuing a niche strategy with a low-cost focus should also find the control system to be compatible with their strategic implementation. schuler and jackson (1987) describe the employee role behaviors required to support a low-cost leadership strategy as consisting of repetitive and predictable behaviors, a short-term focus, autonomous activity, modest concern for quality, high concern for quantity of output, low risk-taking activities, and a relatively high degree of comfort with stability (p. 211). successful strategy implementation requires high levels of productivity while maintaining low labor costs. accordingly, achieving congruence with a low-cost leadership strategy requires benefits ,practices that emphasize control over labor costs, while maintaining employee compliance in key performance areas. a differentiation strategy features innovation or high quality. a commitment human resource system is needed to encourage important employee role behaviors such as a high level of creative behavior, a long-term focus, and a relatively high level of cooperative behavior. high employee concern for quality is needed for organizations trying to differentiate products or services through high quality. a high degree of risk taking behavior is particularly important for organizations differentiating through innovative products and services. these critical role behaviors require flexible employees who are highly committed to the organization. the niche strategy with a differentiation approach requires comparable role behaviors consistent with a commitment human resource system. although control of benefits costs remains important, the shifting of costs to employees and reductions in benefits should be approached more cautiously if a differentiation strategy is followed rather than a cost control strategy. successful implementation of a differentiation strategy requires benefits practices that are capable of forging the links between organizational and employee goals (as described by arthur 1992, 1994). broadly speaking, this requires maintaining a balance between cost control and providing the benefits needed to support a committed workforce with an organization-centered, future orientation. in an effort to operate with minimal overhead, while maintaining quality human resource services to employees, ibm created an outsourcing company called workforce solutions (tarre, 1993). workforce solutions sells human resource services internally to other ibm units and is also available to provide these services externally. this change enabled ibm to save $45 million in the first year of opera140 journal of business strategies vol. 12, no.2 tion. new efficiencies due to outsourcing included an 80 percent reduction in the number of staff required to provide benefits services supporting employees and retirees. effective employee benefits practices similar to the control and commitment human resource systems, core characteristics of employee benefits practices can be conceptualized as diverse choices represented as endpoints on a series of continuum. such a range of benefits practices is presented in table 1, consistent with the need for diverse types of human resource systems to support a low cost or differentiation strategy. the representation of these two "ideal" forms is not intended to preclude the possibility of an organization that successfully combines aspects of both. table 1 employee benefits practices displayed by strategic choice and core characteristic strategic choice core characteristic timing benefits costs employee-employer relationship low-cost low percentage of deferred compensation minimal benefits relatively stable over time meets or follows competition low percentage of labor cost emphasis on basic needs low percentage of full-time benefitted workers low participation in decision-making cost orientation simple one-way communications differentiation high percentage of deferred compensation progressive benefits adapts with worker age leads competition high percentage of labor cost emphasis on flexibility or comprehensiveness high percentage of fulltime benefitted workers high participation in decision-making need orientation complex interacti ve communication fall 1995 lucero & white: integrating benefits 141 a number of core characteristics seem to exemplify the systematic differences needed to support a diverse set of employee role behaviors. while the follow~ ing characteristics of employee benefits practices should not be considered exhaustive, it is representative of the key issues for strategic implementation. each of three core characteristics will be described in the following sections with examples of possible benefits practices that can be used to encourage the needed employee attitudes and behaviors. timing one of the critical differences between the low cost and differentiation strat~ egies is the future orientation. a short-term focus is generally characteristic of a low-cost strategy. alternatively, differentiation through quality-enhancement requires an intermediate to long-term focus (schuler & jackson, 1987). accordingly, these variations in future orientation should be reflected in employee benefit practices that emphasize the delivery of rewards to employees at the appropriate time. a short-term perspective requires that the timing of rewards emphasize the present. rewards that are timed to be experienced in the future, rather than the present, support a longer-term focus. in general, "companies that want people to stay for a long time need benefits that bind the individual to the corporation" (greller & nee, 1989, p. 191). deferred compensation provides a good example of a practice that can be timed to support an organization's choice of strategy. a high percentage of deferred compensation favors the employee longevity needed for a longer~term focus. pension plans are an important form of deferred compensation. vesting requirements and related practices can penalize the employee for leaving the organization before retirement age. these practices increase the cost of leaving the organization, thereby, serving to bind employees to the organization for longer periods of time. this has been the choice of dow chemical company, which has maintained a retirement benefit based on years of service, to encourage a stable workforce. alternatively, wendy's international restructured retirement benefits to improve portability for employees, while supporting the company needs for flexible staffing and quality managers (murray, 1993). research supports the view that deferred compensation practices can act as deterrents to leaving the organization (mitchell, 1982, 1983). additional evidence indicates that the extraordinarily low quit rates associated with federal employees is due to the large portion of pay given as pensions and the large reductions in pension pay-outs incurred by workers who leave before retirement (ippolito, 1987). also consistent with a longer-term focus is the use of progressive benefits. progressive benefits, which increase in value as employee tenure increases, can be used to retain employees (gomez-mejia & balkin, 1992). retirement benefits would be included in this category as would forms of paid time-off. since benefits such as vacation time and sick leave increase with length of employee tenure, so do the costs associated with leaving the organization. these efforts at 142 journal of business strategies vol. 12, no.2 workforce retention are more critical to the longer-term focus of the differentiation strategy. another issue of timing can be reflected in the types of benefits included in the benefits package. as people age, the benefits they are most interested in change. for example, the issues involving retirement and medical benefits are likely to increase in importance as the workforce ages (greller & nee, 1989). some large employers such as general motors corporation and american express company have been attempting to meet the needs of their aging workforce by adding long term care insurance to benefits packages (sears, 1992). providing long term care insurance, generally entirely paid by employees, enables participants to better plan for future needs during retirement years. by providing long term care insurance the employer shows concern for employee retirement concerns, while emphasizing employee responsibility for personal planning. for organizations that are emphasizing retention and longer tenure, the availability of the right benefits at the right time is a critical concern. binding workers to the organization, therefore, requires benefits that can adapt to the changing needs of an aging workforce. where cost control is more critical than adaptability, providing a minimal benefits package maintained over time can better serve a fluctuating, short-tenured workforce. basic benefits such as health insurance emphasize the current needs of a wide range of workers, rather than the needs of more specific demographic groups. benefits' costs when determining the appropriate costs of benefits, both the overall compensation and the percentage of benefits relative to pay are key considerations. the compensation policy determines the total number of dollars available for pay and benefits. the traditional policy choices regarding compensation level are to lead, meet, or follow the competition (milkovich & newman, 1993). the decision to lead, meet, or follow the competition is an important factor for stimulating the inflow and outflow of human resources (gomez-mejia & balkin, 1992). an organization adopting a lead policy provides compensation at a level above that provided by organizations competing for the same workers. accordingly, "a lead policy maximizes the ability to attract and retain quality employees" (milkovich & newman, 1993, p. 213). a lead policy is more consistent with a differentiation strategy which requires a workforce committed to organizational goals. the longer-term focus of a differentiation strategy, as well as the development of employee commitment and flexibility, require longer-term worker retention and employment stability. alternatively, an organization can adopt a meet or follow policy. an organization pursuing a meet policy attempts to set the compensation rate at a level similar to its market competitors. a policy that meets or matches the competition prevents the organization from being placed at a competitive disadvantage, making this a popular choice (gomez-mejia & balkin, 1992). an organization fall 1995 lucero & white: integrating benefits 143 choosing to pay at a rate lower than its competition typifies the follow the market decision to achieve broader compensation objectives. the lead, meet, or follow policy influences the total number of dollars available for compensation, and therefore, affects benefit costs. since employee benefits are only a portion of compensation costs, the proportion of labor costs dedicated to the benefits portion of the compensation package is an important issue. choices regarding the mix of various forms of compensation (e.g., pay and benefits) can directly affect management's ability to meet strategic performance goals (milkovich & broderick, 1991). dreher, ash, and bretz (1988) found a negative relationship between pay and benefits levels, in a study of the uniformed members of seven law enforcement agencies. this finding suggests that a high pay level may not be matched with high benefits, but instead is more likely to be offset by lower benefits levels. factors such as tax advantages and group discounts encourage employees to trade-off pay in return for more benefits, as can be represented by a compensatory model (gerhart & milkovich, 1992). however, it should be noted that as benefits costs have risen for even basic benefits such as health insurance, many organizations have found effective ways to control these benefits costs, and accordingly labor costs. this implies that effective strategic planning for employee benefits involves a two-step process. first, a decision determining total compensation is made. then, the portion of compensation devoted to benefits is established. dramatic changes have occurred in the labor force over the past two decades. trends such as the increasing participation of women, dual-earner families, and a shift from manufacturing to service industries, have resulted in significant shifts in the benefits workers need (meisenheimer & wiatrowski, 1989). during this same period, factors including pressures from unions and tax advantages have stimulated expansion of the benefits portion of compensation (milkovich & newman, 1993) as reflected in higher benefits levels and the introduction of many new benefits. for organizations pursuing a low-cost strategy, offering basic benefits such as life and health insurance in place of pay, can be cost effective due to the associated tax advantages. limiting the employee benefits plan so that it emphasizes only the basic needs common to virtually all workers can provide cost effective compensation. providing too large a benefits plan, however, might unnecessarily bind workers to the organization because of their inability to secure comparable arrangements elsewhere. in support of a low-cost strategy, the organization should maintain low labor costs. walker manufacturing, a supplier of mufflers to the automotive industry, provides an illustration of a compensation program supporting a low-cost strategy. in order to lower overall labor costs, at walker manufacturing, employees do not become permanent, benefitted workers until they complete one year of service. additionally, permanent employees are required to make a small monetary contribution for health insurance coverage. although, attracting workers requires a meet the competition policy for wage and benefit levels, the heavy 144 journal of business strategies vol. 12, no.2 reliance on non-benefitted temporary workers is intended to keep down overall labor costs. controlling the number of employees eligible for benefits through the use of part-time and temporary workers is a practical method for reducing overall benefit costs, particularly when competitive pressures or union agreements prevent limiting or reducing benefits packages. in other cases, a low-cost strategy can require more extensive efforts to contain labor costs. in order to meet the demand for boxed beef products at low costs, litvak packing company evolved into the champion boxed beef company. a comparison of union-management contracts from litvak packing company in the 1970s and champion boxed beef company in the 1990s provides an illustration of efforts to contain compensation and achieve a low-cost strategy, as both wages and benefits for workers declined over an extended period of time. according to the 1976 contract, full-time employees were entitled to a week of paid vacation after one year with an additional week added after three, eight, fifteen and twenty-five years of service. in 1994, employees were entitled to a week after one year and an added week after three and ten years of service, with no mention of the supplemental weeks for longer service as was contained in the 1970s contract. similarly, pension plans changed over time. current employees are eligible for profit sharing with payouts based on company financial performance. these payout funds, although not guaranteed, can be used for retirement purposes. however, litvak packing company employees received an employerpaid pension upon retirement. a higher reliance on benefits, particularly those that help to attract and retain a stable workforce, can result in a higher percentage of labor cost being reflected in the benefits portion of compensation, thereby supporting implementation of a differentiation strategy. the proliferation of benefits can assist employers in binding workers to the organization not only financially, but also emotionally. milkovich and newman (1993) conclude, "many employer-initiated benefits were designed to create a climate in which employees perceived that management was genuinely concerned for their welfare" (p. 398). increasing the comprehensiveness of the benefits package, therefore, is consistent with the requirements of a differentiation strategy. in order to support quality products and quality of life for employees, stride rite corporation introduced a number of family friendly benefits that enable workers to better balance work and family concerns. stride rite's commitment to employees is reflected in benefits such as extensive childand elder-care assistance, educational scholarships to dependents of workers, and a paid family leave policy (laabs, 1993). the use of flexible benefits plans has increased as an alternative to large comprehensive plans (meisenheimer & wiatrowski, 1989). reasons for adopting a flexible benefits approach typically include the ability to contain costs while at the same time covering a wide range of employee needs (mccaffery, 1988). flexible benefits or cafeteria plans allow employees to allocate benefits dollars to the benefits that best meet their personal needs, enabling them to experience the greatest possible value for their compensation dollars. while the use of flexible benfall 1995 lucero & white: integrating benefits 145 efits is not solely beneficial for organizations with many types of benefits, the increased cost of administering a flexible plan is a key consideration in strategic implementation. more important than this issue of benefits program administration is the specific types of benefits included by the employer. employee-employer relationship as global competition has increased, many organizations have tried to cut overhead costs by downsizing. this is just one indication that important changes are occurring in the employee-employer relationship. from the individual's perspective, organizational life will never be the same, with the likely outcomes being shorter organizational tenure, as well as decreased loyalty and commitment. while virtually all organizations have been affected by skyrocketing costs of health care and other benefits, the manner in which the organization controls these costs can also send a strong message to employees. for example, the adolph coors company opened a well ness center for employees with projected savings based on the avoidance of future health care costs (bunch, 1992). alternatively, the retail grocery industry has come under recent attack by union groups for their practice of utilizing part-time un benefitted workers to hold down labor costs. these dramatically different types of response to the need to hold down benefits costs have major implications for the employee-employer relationship. the reduction in full-time positions generally decreases the benefits portion of the compensation budget, by reducing the number of workers included in the organization's benefits program. approximately 25 percent of the u.s. civilian work force is composed of what are termed "contingent workers" (mathis & jackson, 1994, p. 38), who regularly work only part-time or on a temporary basis since contingent workers are not part of the organization's full-time work force, they frequently do not receive benefits, thereby lowering overall labor costs. in an organization that does not need a long-term committed work force, such as when a low-cost strategy is employed, the replacement of full-time workers with contingent workers and outside consultants can be an effective way to reduce the benefits portion of labor costs. prudent· use of part-time workers can increase staffing flexibility, while reducing labor costs. however, it should be remembered that frequently full-time positions cut during lay-offs are later replaced by more expensive consultants. the replacement of full-time. benefitted workers by consultants can often result in an overall increase, rather than decrease in actual costs (cascio, 1993). as with any human resource practice a careful cost/benefit analysis is required to determine congruity with organizational objectives. allowing employees to participate in decision-making can assure that compensation dollars are spent in ways that maximize benefits for workers. this approach is supported by research which has identified an increase in satisfaction occurring after a change from a standard benefits package to a flexible benefits package (barber. dunham, & formisano, 1992). lawler (1991) suggests that an organization adopting a high employee involvement approach can allow employ146 journal ofbusiness strategies vol. 12, no.2 ees a great deal of flexibility in the decisions regarding their own rewards package. allowing employee participation, as in the case of flexible benefits, conveys the important message that the employer values employees and has confidence in their ability to make decisions (lawler 1990). a high participation approach is consistent with the type of employee-employer relationship needed to support a differentiation strategy. although the current trend is toward more flexibility in compensation and benefits programs (mccaffery, 1988), the costs of flexibility can increase communication and administrative costs. these increased costs are likely to continue to act as a deterrent to increasing employee participation in organizations choosing a low-cost strategy. as new types of benefits have been added to employer-sponsored packages, a resulting side effect has been the increased employer involvement in the nonwork lives of employees. as employees become more reliant on employers in nonwork areas such as childcare assistance "the bond between employee and employer can be profoundly affected" (guzzo, nelson, & noonan, 1992, p. 245). the historical evolution of benefits has not only increased employer involvement in employees' nonwork lives, but has encouraged the expectation that the employer will take care of employee needs. as argued by lucero and allen (1994), this gradual change in the employee-employer relationship, has resulted in an adversarial relationship between employees and employers with respect to benefits. while employers are increasingly concerned with benefit costs, employees are increasingly concerned about their ability to meet their own financial and security needs. employers who wish to maintain a stable, long-term work force should consider ways to continue to cover employee needs, thereby preventing the disruption of the important employee-employer relationship. manor healthcare corporation found the emphasis on employee needs to be an important value for their high service industry. the benefits package was designed to reward length of service while improving health insurance and pension contributions for lower paid employees (gunsch, 1993). where cost and efficiency are the primary values, communication with employees should emphasize the cost of benefits as a portion of employee total compensation. this emphasis on dollar value can deliver the message that the employer's responsibility is to fairly compensate, rather than provide for many personal needs. not only is the content of communication defined by the strategic objectives, but the form of communication is also variable. the content of communication is important, since it provides information about how the employer views the nature of the employee-employer relationship. additionally, past research (wilson, northcraft, & neale, 1985), indicates that many employees are unaware of some of the benefits provided, as well as the financial value. this suggests the need for employers to adequately inform employees of the cost and coverage of the benefits package. the form of communication, therefore, must also be adapted to employee requirements for information. where the employee benefits package contains only basic coverage, one-way communications are probably appropriate. however, complex, interactive communication forms are a crufall 1995 lucero & white: integrating benefits 147 cial aspect of an effective program when the employee benefits provided are more comprehensive. conclusions factors such as escalating employee benefit costs and increasing global competitive pressures indicate the need to manage employee benefit practices more efficiently. the core characteristics of employee benefits can be matched to the organization's choice of strategy. this linking of employee benefit practices to strategy can provide significant ways to improve organizational effectiveness and efficiency. control and commitment human resource systems can be viewed as opposite ends of a continuum of human resource systems (arthur, 1994), providing a useful typology by which to examine the range of possible employee benefits practices. this, of course, suggests that many organizations will contain a mix of control and commitment characteristics, thereby including a combination of employee benefits practices, rather than the ideal types described in this paper. similarly the core characteristics of employee benefits can be conceptualized as a continuum with opposite ends in the control versus commitment human resource systems. creating "fit" between the core characteristics and the choice of strategy can help secure employee behaviors and attitudes necessary for successful strategy implementation. this strategic approach can provide direction in the planning and management of human resources, thereby promoting organizational effectiveness and efficiency with respect to labor costs. for researchers, this approach provides the basis for examining an important issue that has been generally neglected. the strategic approach outlined in this paper describes the relationships between the organization's choice of strategy and employee benefits practices, as well as associated employee role behaviors needed for effective strategy implementation. future empirical research is needed to examine the impact that such a "fit" can have on organizational performance. linking benefits to strategy also has important practical implications for managers. the proposed framework provides a method for examining the contribution that benefits can make towards eliciting and reinforcing the workplace attitudes and behaviors required for effective strategy implementation. awareness of these linkages is especially important as managers engage in efforts to control the costs of benefits. two underlying assumptions of this view should be highlighted. first, today's competitive environment requires that employee benefits practices be examined as an integral part of human resource and corporate strategic planning. effective and efficient organizations should focus on accomplishing congruence across all organizational functions. second, all cost containment techniques are not created equal. the control and commitment systems highlighted in this paper provide some of the linkages between the needed employee out148 journal ofbusiness strategies vol. 12, no.2 comes and the organization's strategic choice. thinking about employee benefits practices strategically can enable organizations to realize cost savings while enhancing the appropriate employee attitudes and behaviors. references arthur, j. b. "effects of human resource systems on manufacturing performance and turnover." academy of mana~ement journal 37 (june 1994): 670-687. arthur, j. b. "the link between business strategy and industrial relations systems in american steel minimills." industrial and labor relations review 45 (april 1992): 488506. barber, a. e., dunham, r. 8., and formisano, r. a. "the impact of flexible benefits on employee benefit satisfaction: a field study." personnel psychology 45 (spring 1992): 55-75. barney, j. "firm resources and sustained competitive advantage." journal of management 17 (march 1991): 99-120. boulding, k. the image. ann arbor, mi: university of michigan press, 1956. bunch, d. k. "coors wellness center-helping the bottom line." employee benefits journal 17 (march 1992): 14-18. carswell, b. "how rightsizing affects benefits." in p. lacey (ed.), new strategies for employee benefits. 11-12. new york: the conference board, 1986. cascio, w. e "downsizing: what do we know? what have we learned?" academy of management executive 7 (feb. 1993): 95-104. dreher, g. e, ash, r. a., and bretz, r. d. "benefit coverage and employee cost: critical factors in explaining compensation satisfaction." personnel psychology 41 (1988): 237254. gerhart, b. and milkovich, g. "employee compensation: research and practice." in m. d. dunnette & l. m. hugh (eds.), handbook of industrial and organizational psycholqgy. 2nd edition, 481-569, palo alto, ca: consulting psychologists press, inc., 1992. gomez-mejia, l. r. and balkin, d. b. compensation. organizational strategy. and firm performance. cincinnati, oh: south-western pub. co. 1992. greller, m. m. and nee, d. m. from baby boom to baby bust: how business can meet the demographic challenge. reading, ma: addison-wesley pub. co. 1989. gunsch, d. "benefits program helps retain frontline workers." personnel journal 72 (february 1993): 88-94. fall 1995 lucero & white: integrating benefits 149 guzzo, r., nelson, g., and noonan, k. "commitment and employer involvement in employees' nonwork lives." in s. zedeck (ed.), work. families and organizations. san francisco: jossey-bass, 1992. ippolito, r. a. "why federal workers don't quit." journal of human resources 22 no. 2 (1987): 281-299. jackson, s. e., schuler, r. s., and rivero, 1. c. "organizational characteristics as predictors of personnel practices." personnel psychology 42 (winter 1989): 727-786. jones, g. "task visibility, free riding, and shirking: explaining the effect of structure and technology on employee behaviors." academy of management review 9 (october 1984): 684-695. laabs, j. j. "family issues are a priority at stride rite." personnel journal 72 {july 1993):48-56. lawler, e. e. strategic pay. san francisco: jossey-bass, 1990. lawler, e. e. "employee involvement and pay system design." in m. l. rock & l. a. berger, the compensation handbook: a state-of-the-art guide to compensation strategy and design. 3rd edition, 592-603. new york: mcgraw-hill inc., 1991. lucero, m. a. and allen, r. e. "employee benefits: a growing source of psychological contract violations." human resource management journal 33 (fall 1994): 425-446. mathis, r. l. and jackson, j. h. human resource management. minneapolis, s1. paul: west publ. corp., 1994. mccaffery, r. m. employee benefit programs: a total compensation perspective. boston: pws-kent publishing co., 1998. meisenheimer, j. r. and wiatrowski, w. j., "flexible benefits plans: employees who have a choice." monthly labor review 112 (december 1989): 158-164. milkovich, g. t. and broderick, r. f. "developing a compensation strategy." in m. l. rock & l. a. berger, the compensation handbook: a state-ofothe-art guide to compensation strategy and design. 3rd edition, 24-29. new york: mcgraw-hill, inc., 1991. milkovich, g. t. and newman, j. m. compensation., 4th edition, homewood, il: irwin, 1993. mitchell, o. s. "fringe benefits and labor mobility." journal of human resources 17 (1982): 286-298. mitchell, o. s. "fringe benefits and the cost of changing jobs." industrial and labor relations review 37 (1983): 70-78. 150 journal of business strategies vol. 12, no.2 murray, k. a. "how hr is making pensions portable." personnel journal 72 (july 1993): 36-45. porter, m. e. competitive strategy: techniques for analyzing industries and competi!qrs. new york: free press 1980. porter, m. e. competitive advantage. new york: free press, 1985. sager, i., mcwilliams, g. and hof, r. d. "ibm leans on its sales force." business week (february 7, 1994): 110. schuler, r. s. and jackson, s. e. "linking competitive strategies with human resource management practices." academy of management executive i (august 1987): 207-219. sears, r. w. "why offer long term insurance?" in t. brothers (ed.), controlling the costs of employee benefits. 30, new york: the conference board, 1992. tarre, m. "wfs workforce solutions: outsourcing the benefit function." in p. lacey (ed.), new strategies for employee benefits, 11-12, new york: the conference board, 1993. thompson, a. a. jr. and strickland, a. 1. iii. strategic management. homewood: irwin, 1992. u. s. chamber of commerce employee benefits. 1992 edition, washington, dc.,1992. wilson, m., northcraft, g, b., and neale, m. a. "the perceived value of fringe benefits." personnel psychology, 38 (1985): 309-320. wright, p. m. and mcmahan, g. c. . "theoretical perspectives for strategic human resource management." journal of management, 18 (june 1992): 295-320. integrating employee benefits and competitive strategy an empirical examination of the relationship between ceos and directors catherine m. daily the ohio state university columbus, oh abstract this study exammes the relationship between ceo characteristics and board composition. as well as the relationship between board composition and board roles. canonical correlation analysis demonstrates strong support for the relationship between ceo characteristics and board composition. no support was found, however, for the relationship between board composition and board roles. while ceos are associated with the composition of the board, this relationship does not appear to be associated with the board's ability to discharge their service, resource, and control roles. introduction the past several years have witnessed a renewed interest in firms' strategic leaders (hambrick 1989). sutton and callahan, for example, have noted that "images of organizations and their leaders are intertwined" (1987, p. 405). both ceos and members of corporate boards are recognized as influential organizational leaders (e.g., boeker 1992; hambrick 1981; pettigrew 1992). given their importance in influencing firm processes and outcomes, the nature of the relationship between ceos and directors continues to be of interest. one of the critical issues in strategic leadership research is the extent to which ceos influence the directors to whom they report (e.g., mace 1971; vancil 1987; see also pettigrew 1992). for example, ceos are widely regarded as influencing the director nomination process by selecting directors with whom they would be most comfortable working (e.g., fredrickson, hambrick and baumrin 1988). one of the chief criteria employed by ceos during the director nomination process is that the director nominee be "compatible" with the ceo (wheelen and hunger 1990). in tum, directors appointed by ceos often accommodate them by rubber-stamping executive decisions (e.g., patton and baker 1987). the process described enables ceos to influence the composition of the board. ceos desiring strong control positions, for example, may elect to invite a preponderance of inside (management) directors to serve on the board. even outside directors who feel no particular obligation to the ceo may be limited in their capacity to challenge ceo actions, as they are largely dependent upon the ceo for firm specific information (aram and cowan 1983; zald 1969). while the proportion of outside to total directors has been the most extensively respring 1995 daily: empirical examination 51 searched board composition measure (e.g., zahra and pearce 1989), the total numbers of directors, as well as minority and women director representation, have been found to be important components of the composition of the board of directors (e.g., chaganti, mahajan and sharma 1985; kesner 1988; patton and baker 1987; pearce and zahra 1991). the director nomination process, and its potential implications for board composition, is just one example of the importance of the relationship between ceos and directors (e.g., pfeffer and salancik 1978). these relationships may be particularly salient for those ceos who achieved their positions at relatively early ages. ceos of major corporations typically do not ascend to their positions until sometime in their early to mid-50s (vancil 1987). moreover, this ascent typically follows many years of working through the ranks of the firm (vancil 1987). consequently, those ceos who are appointed at a relatively young age may have very different experiences and face different challenges than their older counterparts, especially in their relationships with the board of directors. to date, however, no one has addressed the associations between young ceos and the boards of directors of the firms they serve. the purpose of this research is to enhance our understanding of the relationship between firms' ceos and boards of directors. specifically, we examine the extent to which enduring ceo traits are associated with the composition of the board and, consequently, with the board's ability to fulfill its service, resource, and control roles. the model depicted in figure 1 will be developed and tested, focusing on the association between ceo characteristics and board composition and the association between board composition and board roles. we rely on a specialized sample of young, successful ceos. we are aware of no research that addresses the relationship between ceos and board composition and roles for young executives. we also focus on modestly sized firms. while examples of young, powerful ceos are found among the largest of u.s. firms (e.g., business week 1991), they are more typically found in modestly sized firms and those that are privately held (e.g., eisenhardt and schoonhoven 1988; whisler 1988). it has been suggested that perhaps the most logical place to find ceo effects is in the smaller firm where the ceo is less constrained and monitored (e.g., dalton and kesner 1983; norburn and birley 1988). in the modestly sized firm, where it may be easier to advance to the position of ceo at an early age, leadership is generally concentrated and decision making is typically centralized around the ceo (begley and boyd 1986; whisler 1988). should ceo/board effects be found, then, they are likely to emerge in smaller firms where the ceo may have a more "hands on" relationship with the board (e.g., daily and dalton 1993). 52 journal of business strategies figure 1 the relationship between ceo characteristics and board composition and roles ceo characteristics • age • tenure • education • firm ownership board of directors composition • outside director proportion • total numbers of directors • minority directors • women directors board of directors roles • service • resource • control ceos and board composition vol. 12, no.1 ceo characteristics despite a considerable amount of attention to board composition, scant attention has been paid to the relationship between ceos and alternative board configurations. one means for addressing this relationship is the consideration of demographic variables in examinations of strategic leaders (finkelstein and hambrick 1990; hambrick and mason 1984; michel and hambrick 1992; wiersema 1992). reliance upon demographic measures provide several advantages in organizational research, including "objectivity, parsimony, and possible replication" (michel and hambrick 1992, p. 16). in addition, researchers are increasingly finding support for the importance of executive traits in organizational research (e.g., wiersema and bantel 1992). inclusion of demographic variables may be particularly important in strategic leadership research because investigations of executives' background, experiences and values inform the choices they make (finkelstein and hambrick 1990), including elected governance structures. spring 1995 daily: empirical examination 53 board composition as previously mentioned, ceos may play a significant role in determining the composition of the board, in part, to assemble a board that is unlikely to challenge their power and authority (rosenstein 1987). when the board is comprised predominately of outsiders, for example, ceos may have to work harder to convince directors to adopt their point of view. alternatively, a board composed of insiders may be more easily controlled by the ceo (brady and helmich 1984). should the ceo be more interested in strengthening his or her power base than in constructing a representative board, he or she might elect to have a small board with low proportions of outside directors and little minority or female representation. by considering ceos' age, tenure, educational level, and level of firm ownership we can begin to assess the relationship between executive characteristics and the composition of the board of directors. executive characteristics may be especially important in examinations of young ceos. for example, there may be degrees of "youth" that can be captured by examining the extent to which age, within a constrained sample, is related to board composition. also, factors such as tenure as ceo, educational level, and equity stake in the firm may prove equally as important. ceo age an executives' age has long been found to affect organizational decision processes and outcomes (e.g., finkelstein and hambrick 1990). younger executives, for example, have consistently been found to be associated with innovativeness and risk (carlsson and karlsson 1970). older executives tend to be more conservative and less likely to initiate strategic change (stevens, beyer and trice 1978; wiersema and bantel 1992). associations between executive youth and company growth have been posited, as well (child 1974; hambrick and mason 1984). if youth is positively associated with executives' propensity to initiate change and foster firm growth, we might expect younger ceos to invite greater numbers of outside directors for board service to enhance the number of alternative perspectives available. we might also anticipate the total size of the board, as well as representation from external stakeholder groups represented by minority and women directors, to increase. their older, more conservative, colleagues might elect opposite strategies as a less risky approach. hi: ceo age will be negatively associated with outside director proportion and total numbers of directors, as well as representation of women and minorities on the board. ceo tenure long tenure may be an indication of ceo's entrenchment (fredrickson et al. 1988; mallette and fowler 1992). as the ceo's tenure is extended, the board's allegiance and values will more closely approximate those of the ceo 54 journal ofbusiness strategies vol. 12, no.1 (fredrickson et a1. 1988). as tenure within the organization increases, one's knowledge base may become increasingly limited (cyert and march 1963) so insiders may be more reluctant to take on strategies involving new terrain (hambrick and mason 1984). additionally, over time firms' executives become embedded in organizational inertia, making it difficult for them to carry out major changes in organizational direction (wiersema 1992). finkelstein and hambrick (1990), for example, found that longer tenured executive teams followed more persistent strategies that conformed to industry standards. here, too, we might expect that ceos with shorter tenures would be more likely to invite outside directors, who could presumably offer alternative perspectives and perhaps help initiate change, and increase the total resource base with greater numbers of directors and women and minority director representation. ceos who have been with the organization for longer periods of time, however, may be more reticent to change and see this form of board as a threat to the status quo. h2: ceo tenure will be negatively associated with outside director proportion and total numbers of directors, as well as representation of women and minorities on the board. ceo education executives' education level, too, may be an important factor, as it serves as an indicator of a person's knowledge and skill base (hambrick and mason 1984). associations between educational level and openness to changes have also been found. kimberly and evanisko (1981), for example, demonstrated that more highly educated executives are more receptive to new ideas. in addition, linkages between educational level and firms' strategic posture have been shown. thomas, litschert, and ramaswamy (1991), for example, found that executives in prospector firms were younger, had shorter tenures, and had more education than executives in defender firms. these studies indicate that more highly educated executives may be more willing to pursue more innovative strategies. the inclusion of outside directors, greater overall board size, and the inclusion of minority and women directors on the board would serve as one mechanism for garnering the external support and expertise necessary to initiate and implement these strategies. h3: ceo educational level will be positively associated with outside director proportion and total numbers of directors, as well as representation of women and minorities on the board. ceo firm ownership ceos' financial stake in the firm may also impact board composition. firm ownership furthers a ceo's ability to influence the selection of directors (fredrickson et a1. 1988). allen (1981) and allen and panian (1982) have found that significant levels of firm ownership serve as a measure of ceo power. some discussion of the level of firm ownership needed to exercise control has been spring 1995 daily: empirical examination 55 advanced. jensen and warner (1988), however, have found that executives with as little as five percent ownership stake have considerable organizational power. if control is the preeminent concern of ceos, it would be unlikely that they would invite directors who are apt to challenge or constrain their actions. consequently, outside directors and minority and women directors who may bring alternative perspectives and agendas may be excluded from board service. additionally, smaller boards which are more manageable are likely to be associated with greater levels of ceo firm ownership. h4: ceo equity ownership will be negatively associated with outside director proportion and total numbers of directors, as well as representation by women and minorities on the board. board composition and roles much of the discussion regarding directors' roles focuses on the composition of the board, particularly the proportion of outside directors. board composition is believed to be an important factor with regard to the service. resource, and control roles of the board (pearce and zahra 1992). the following sections outline the importance of these roles, as well as the relationship between board composition and board roles. these relationships are important because the ability of directors to perform their roles may be largely dependent on the composition of the board (pearce and zahra 1992). service role directors fulfill the service role primarily through the quality of counsel and advice provided to ceos. outside directors, by virtue of their independence from the management of the firm, are believed to best fill this role. the importance of the service role was demonstrated by chitayat (1984), who found that board chairpersons believed consulting with and coaching the ceo were the most critical aspects of their jobs. additionally, stewart (1991) has found that ceos appreciate a board chairperson on whom they can rely for advice and counsel. the service role may be particularly valuable for the young ceo who, while arguably a powerful organizational force, may not possess the level of industry experience needed to make optimal choices for the firm. additionally, the external perception that a young ceo lacks the necessary experience and credentials to effectively run the organization may negatively impact the firm. a notable example of this occurred when bill gates, ceo of microsoft, began interacting with external firm constituents (wallace and erickson 1992). here, carefully selected outside directors may help the firm overcome this perception by enhancing the firm's general reputation and credibility. resource role the second role provided by boards of directors is resource acquisition. this role is related to the service role and advocates appointing representatives 56 journal of business strategies vol. 12, no. 1 of significant external constituencies as outside board members (e.g., pfeffer and salancik 1978; selznik 1949). such appointments can be viewed as a strategy for managing organizations' environmental relationships. in this role, directors serve as boundary spanning agents who coopt critical external constituencies with which they are interdependent (pfeffer and salancik 1978). cooptation of these individuals represents a means of effectively managing organizational dependence (e.g., mintzberg 1983; zald 1969). outside directors provide access to valued resources and information, facilitate interfirm commitments, and aid in establishing legitimacy (e.g., bazerman and schoorman 1983; pfeffer and salancik 1978; provan 1980). also, outside directors may be better able to protect the organization from environmental adversity (pearce and zahra 1992). this role may also be especially critical for the firm with a relatively young ceo. with less exposure to the external community than a more senior ceo, the firm may significantly benefit from the access to external resources that outside directors can provide. control role the final role involves the board's monitoring function (anderson and anthony 1986; mintzberg 1983; vance 1983; waldo 1985). this may be the most critical of the board functions, as it is this role that has received the most attention from board reform critics. outside directors are believed to be most effective in discharging this role. inside directors, due to their subordinate position in the organization, are unlikely to aggressively monitor and evaluate ceo actions (dalton and rechner 1989; fleischer, hazzard and klippel' 1988; harrison, torres and kukalis 1988; patton and baker 1987; rosenstein 1987). the issue is the extent to which inside directors can avoid conflicts likely to arise in attempting to maintain loyalty to the ceo while evaluating his or her actions (e.g., baysinger and hoskisson 1990; kesner and dalton 1986; lorsch and maciver 1989; geneen 1984). these concerns are particularly valid for inside directors reporting to an influential ceo. beyond the influence typical of a ceo in a modest sized firm, ceos who have ascended to their positions at relatively young ages may possess substantially more organizational influence. bill gates and steve jobs provide two notable examples of young, influential ceos (wallace and erikson 1992). the probability of active oversight on the part of inside directors, then, is significantly lessened. based on the preceding arguments, it may be that outsiders are more able to responsibly fulfill their directoral roles. the inclusion of minority and women directors may also be consistent with the resource acquisition role (see e.g., k~sner 1988; pearce and zahra 1991). these individuals may have linkages to the external environment thit provide the finn with a competitive advantage. kesner (1988), for example, found that women directors were typically outside directors, suggesting that perhaps they represented significant external constituencies. the overall size of the board may also be positively related to fulfilling the three board spring 1995 daily: empirical examination 57 roles. it is sensible that greater numbers of directors increase the available expertise and resource pool. h5: greater board representation by outside, minority, and women directors, as well as total numbers of directors, will be associated with greater board involvement in the service, resource acquisition, and control roles of the board. method sample the participation of a mid·western chapter of the young presidents organization (ypo) was solicited for this study. this group was primarily chosen due to the accessibility of the ceo. in addition, these ceos are typically young, successful ceos with operating responsibility for relatively modestly sized firms. the ypo is comprised of individuals who achieved the title of president/ceo prior to their 40th birthdays. members may join at anytime prior to their 40th birthday, however. additionally, members' firms must maintain gross annual revenues of at least four million dollars and employ at least 50 people. financial corporations must retain an average of 80 million dollars in assets. ypo members must retire from the organization the year following their 50th birthday. these members, therefore, are young, high profile, influential executives. the survey instrument was sent to the total membership of the ypo chapter (n=82) via the chapter president. the mailing was coordinated through the chapter president due to members' concerns about confidentiality. the care in protecting the identities of respondents provides some confidence that the ceos were candid in their responses to survey items. forty usable surveys were returned, for a response rate of 48.78 percent. this response rate is well within the acceptable range for this type of research (alpar and spitzer 1989). variables ceo characteristics: respondents identified their age, tenure in the position of ceo, education level (secondary, undergraduate, or graduate degree), and percentage of firm ownership. board composition is operationalized in four ways. the first is simply the proportion of outside directors. the definition of outside directors as it appeared on the survey instrument was adapted from pearce and zahra (1991) and read as follows: "outside directors have been defined as directors who are not members of the top management team, their associates, or families; are not employees of the firm or its subsidiaries; and are not members of the immediate past top management group." total numbers of directors, total number of minority directors, and total number of women directors were also included. board roles were assessed with a nine item, seven-point likert scale. these items were developed based on previous research (e.g., ford 1988). factor analysis (see tables la and lb) revealed three factors meeting the service, 58 journal of business strategies vol. 12, no.1 resource and control roles. due to the low sample size we also conducted a confirmatory factor analysis. these results supported the three distinct factors, with factor loadings similar to those reported in table 1a. factor reliabilities are provided in table ie. table la factor analysis of board activities item 1 2 3 active in strategic planning .78 provides financial expertise .73 provides ceo advice and counsel .71 contacts to external community .80 enhance firm reputation and credibility .80 provides technological expertise .78 top management succession plans .77 monitors ceo performance .61 reviews management proposals .54 table ib factor eigenvalues and names explained factor name eigenvalue variance factor i service 3.53 39.3 factor 2 resource 1.44 16.0 factor 3 control 1.14 12.6 total explained variance 67.9% table ie scale reliabilities scale no. of mean std. alpha name items value dev. coeff. service 3 14.76 4.18 .75 resource 3 12.00 5.05 .76 control 3 12.18 4.22 .64 spring 1995 daily: empirical examination 59 two control variables were included in the analyses: firm size and finn age. these variables have been found to be important in strategic leadership research (e.g., fredrickson et al. 1988; michel and hambrick 1992; wiersema and bantel 1992). the inclusion of these variables is based on the work of freeman, carroll, and hannan (1983) who found that organizations typically suffer from two major liabilities: newness and smallness. numerous studies, for example. have shown that an organization's age affects organizational processes (e.g., boeker 1989; eisenhardt 1988; tolbert and zucker 1983). firm size is operationalized as the number of full-time employees. past research has found that sales, assets, and number of employees are equally appropriate indicators of a finn's size (e.g., harrison et al. 1988). firm age was calculated based on the year the firm was founded. analysis we rely on canonical correlation analysis for hypothesis testing. these hypotheses are characterized by interrelated, interval level dependent variables. also, the independent variables are interval level. accordingly, the relationship between the independent variables and the dependent variables must be simultaneously assessed. therefore, canonical correlation is the appropriate analytical technique. in order to clarify interpretation of these results, we report both simultaneous and separate analyses for the dependent variables. results table 2 presents the means, standard deviations, and inter-item correlations for all variables included in the study. respondents' average age was 44.75 years and they had been in their current positions as ceolpresident for an average of 8.83 years. consistent with the membership criteria for ypo, these individuals were just under 36 years old when they assumed their roles as ceolpresident. ceos' age and tenure for this sample can be compared to what might be expected for ceos of large finns. the average age of ceos in the largest u.s. finns is in the mid 50s; these ceos have served in their current positions for approximately 14 years (business week 1991; vancil 1987). seven and one-half percent of the respondents had obtained high school degrees, 47.5 percent of respondents held undergraduate degrees, and 45 percent held graduate degrees as their highest level of educational achievement. these findings are quite similar to that of large finn ceos, 47 percent of whom hold graduate degrees (business week 1991). the level of firm ownership ranges from zero to 100 percent, with an average of 34.8 percent. this level of ownership is substantially more than might be found among large firm ceos (business week 1990). the first four research questions address the relationship between ceo characteristics and board composition. given the interval level nature of both the independent and dependent variables, and the interrelationships between the dependent variables, these hypotheses can be assessed simultaneously with canonitable 2 means, standard deviations, and inter-item correlations· variable mean sd 1 2 3 4 5 6 7 8 9 10 ii 12 1. ceo age 44.75 6,43 2. ceo tenure 8.83 5.92 27 3. ceo educational level 2.38 .63 34 -22 4. ceo firm ownership 34.80 35.97 00 45** 01 5. outside director proportion ,41 .30 33 -07 13 06 6. total number of directors 6.80 4.83 32 -06 41 * -45** 00 7. minority directors .08 .27 44* 14 01 -26 -22 41** 8. women directors .50 .88 -02 10 07 -31 -17 56*** 27 9. services 14.76 4.18 03 44* -24 28 09 -04 08 17 10. resources 12.00 5.05 18 17 13 -10 04 30 07 06 47** 11. control 12.18 4.22 49** 19 08 14 19 16 26 04 49** 25 12. firm size 694,48 1441.00 51** -13 31 ·35* -21 64*** 67*** 24 -06 10 24 13. firm age 47.75 28.45 -39* 02 -16 15 -28 -56*** -16 -25 05 -14 -14 -40* •=decimal points omitted * = p < .05 ** = p < .01 gj ~.. 3 1:)~ ttl.. ""s' <'ii """"v:l.... ~ ~ ~. "§--~ ~spring 1995 daily: empirical examination 61 cal correlation analysis. the results indicate a significant multivariate test of significance (see table 3), indicating that ceo characteristics are important indicators of the composition of the board of directors. canonical correlation analysis was also used to assess the relationship between board composition and board roles. these results did not support the existence of a relationship since neither the multivariate test nor the univariate tests were significant (see table 4). table 3 canonical correlation analysis ceo characteristics and board composition multivariate test of significance dependent error variable test f df df sig. multivariate wilks 2.5111 24 128 .001 univariate tests of significance error dependent variable test f df df sig. outside director proportion reg. 2.4692 6 32 .045 total number of outside directors reg. 5.5029 6 32 .001 minority directors reg. 2.5543 6 32 .039 women directors reg. 1.0440 6 32 .416 table 4 canonical correlation analysis board composition and board roles multivariate test of significance dependent error variable test f df df sig. multivariate wilks .6629 18 90.0 .837 univariate tests of significance dependent error variable test f df df sig. service reg. .3635 6 30 .896 resource reg. .5734 6 30 .748 control reg. .4545 6 30 .836 62 journal of business strategies discussion vol. 12, no .. 1 these results highlight the continuing importance of demographic traits in strategic management research (e.g., michel and hambrick 1992; wiersema and bantel 1992). ceo characteristics were found to impact three aspects of board composition. univariate tests indicated effects for the proportion of outside directors, total number of outside directors and the presence of minority directors on the board. these effects were not significant for female directors. it is instructive to examine the univariate tests to ascertain which demographic variables contribute most to the multivariate function. the demographic variables that were significantly associated with outside director proportion included ceo age (t=2.57, p<.05), firm ownership (t=2.32, p<.05), and firm size (t=-2.58, p<.05). presence of minority directors is most affected by the size of the firm (t=2.43, p<.05). the overall size of the board is associated with ceos' educational level (t=2.13, p<.05), firm size (t=2.48, p<.05), and firm age (t=-3.10, p< .01). based on large firm research, we know that the ability to influence the director nomination process increases as ceos extend their years of service with their organizations (e.g., pfeffer and salancik 1978). this study suggests that associations between ceos and directors may not be markedly different for young ceos. this, coupled with a smaller sized firm, may enable the ceo to impact important organizational processes such as the selection of directors. contrary to critics who suggest ceos' first concern is further entrenching their positions in their firms, these results suggest that as ceos aged the potential benefits to including outside and minority directors became more apparent. the mature ceo may be less likely to feel threatened by the inclusion of "outside" directors and may, therefore, be plore likely to include these individuals on the board as conditions warrant. a similar rationale might hold for ceos' ownership levels. a ceo with significant ownership in the firm (an average of over 34 percent for this sample) may be unlikely to feel threatened by directors of any particular character or persuasion. a related finding is that of the positive relationship found between a ceo's educational level and overall board size. the enhanced confidence with which more highly educated ceos approach their business environment may enable them to invite greater numbers of directors to assist in the strategic positioning of the firm. these results also suggest the importance of including firm size and firm age as control variables in strategic leadership research. these results provide preliminary evidence that young ceos do carefully select directors for board service. compatibility seems to be only one criteria for such selection, however (wheelen and hunger 1990). these findings may also suggest that building a board most capable of providing external resources (i.e., expertise and external firm contacts) is more important to ceos than entrenching themselves in the organizations they lead. perhaps achieving success at a relatively young age increases the confidence of ceos. with this enhanced confispring 1995 daily: empirical examination 63 dence, they may feel free to invite the diversity of opinion which is likely to accompany greater proportions of outside directors, larger boards, and board representation from historically under-represented groups. board composition was not found to be related to the board's ability to fulfill the service, resource, and control functions. despite consistent admonitions from board reform critics (e.g., dayton 1984; geneen 1984) to increase the proportion of outside, minority, and women directors, no support was found for this position when relying on board roles as outcome variables. there was no systematic relationship between the four measures of board composition and the level of activity for board roles. limitations the results of this study should be interpreted cautiously. several limitations affect these findings. the lack of significance when considering the relationship between board composition and roles is likely influenced by (1) the preliminary nature of this examination and (2) the reliance upon only the ceo's perceptions of board roles. while the board role factors of service, resource acquisition, and control achieved acceptable reliability coefficients (alpha = .75, .76, .64 respectively), it is necessary to further investigate the strength and applicability of these scales. additionally, replications of this study are needed due to the limited sample size. this study focused exclusively on the ceo; however, assessing directors' perceptions of their involvement in service, resource, and control activities is necessary, as well. ford (1988), for example, in a survey of directors of the inc. 500 found that outside directors were less influential than their insider counterparts in traditional areas of the board's domain. an additional limitation is that these analyses do not include comparisons of ceo and board characteristics with firm performance. consistent with past survey research, respondents were reluctant to provide financial data. this reluctance was complicated by the high rate of private firm ownership (72.5 percent) as compared to publicly-held corporations (27.5 percent). of the forty surveys returned, as few as 21 (47.5 percent) contained the requested financial information. comparison tests were performed on all variables included in this study, however, and no significant differences were found between those respondents providing financial data and those who did not. lastly, reliance on only young ceos limits generalizability. future research would be well directed at further examining the potential uniqueness of ceos who attain their positions early in life. direct comparisons between young ceos and those who are older also carry much potential. conclusion critics often charge that ceos exert far too strong an influence on firm processes and outcomes. while ceos who are relatively young and operating in 64 journal ofbusiness strategies vol. 12, no.1 modestly sized firms are strongly associated with the composition of the board, the resultant board make up does not appear to be related to the ability of directors to perform their service, resource acquisition, and control roles. the findings reported here suggest that further attention to the ceo characteristics and the extent to which these characteristics are associated with firm processes and outcomes is warranted. the results of this study lead us to conclude that organizational observers still have much to learn about the interactions between boards of directors and the ceos who serve them. references allen, m. p. "managerial power and tenure in the large corporation." social forces 60 (1981); 484-494. allen, m. p, and s. k. panian. "power, performance, and succession in the large corporation." administrative science quarterly 27 (1982): 538-547. a1par, p, and d. spitzer. "response behavior of entrepreneurs in a mail survey." entrepreneurship: theory and practice 14, no. 20 (1989) :31-44. anderson, c. a., and r. n. anthony. the new co[porate directors. new york: john wiley, 1986. aram, j. d. and, s. a. cowan. information for co[porate directors: the role of the board in the mana~ement process. new york: n. a. a. press, 1983. baysinger, b. d., and r. e. hoskisson. "the composition of boards of directors and strategic control." academy of management review 15 (1990): 72-87. bazerman, m. h., and f. d. schoorman. "a limited rationality model of interlocking directorates." academy of management review 8 (1983): 206-217. begley, t. m., and d. p. boyd. "executive and corporate correlates of financial performance in smaller firms." journal of small business management 24, no. 2 (1986): 815. boeker, w. "strategic change: the effects of founding and history." academy of mana~ement journal 32 (1989): 489-515. boeker, w. "power and managerial dismissal: scapegoating at the top." administrative science quarterly 37 (1992): 400-421. brady, g. e, and d. l. helmich. executive succession: toward excellence in corporate leadership. englewood cliffs, nj: prentice-hall, 1984. business week. "the corporate elite." (qctober 19, 1990): 8-14. spring 1995 daily: empirical examination 65 business week. "the corporate elite." (november 25, 1991): 180-184. carlsson, g., and k. karlsson. "succession and performance among school super intendents." american sociological review 35 (1970): 267-304. chaganti, r., v. mahajan, and s. sharma. "corporate board size, composition and corporate failures in retailing industry." journal of management studies 22 (1985): 400416. child, j. "managerial and organizational factors associated with company performance." journal of management studies 11 (1974): 13-27. chitayat, g. 1984. "working relationships between the chairman of the board of directors and the ceo." management international review 24, no. 1 (1984): 65-70. cyert, r., and j. march .. a behavioral theory of the firm. new jersey: prentice-hall, 1963. daily, c. m., and d. r. dalton. "board of directors leadership and structure: control and performance implications." entrepreneurship: theory and practice 17 (1993): 65-81. dalton, d. r., and i. f. kesner. "inside/outside succession and organizational size: the pragmatics of executive replacement." academy of management journal 26 (1983): 736742. dalton, d. r., and p. l. rechner. 1989. "on the antecedents of corporate severance agreements: an empirical assessment." journal of business ethics 8 (1989): 455-462. dayton, k. n. "corporate governance: the other side of the coin." harvard business review 62 (184): 34-37. eisenhardt, k. m. "agencyand institutional-theory explanations: the case of retail sales compensation." academy of management journal 31 (1988): 488-511. eisenhardt, k. m., and c. b. schoonhoven. "organizational growth: linking founding team, strategy, environment, and growth among u.s. semiconductor ventures, 19781988." administrative science ouarterly 35 (1988): 504-529. finkelstein, s., and d. c. hambrick. "top-management-team tenure and organizational outcomes: the moderating role of managerial discretion." administrative science ouar~ 35 (1990): 484-503. fleischer, a., g. c. hazzard, and m. z. klipper. board games: the changing shape of corporate power. boston, ma: little, brown, 1988. ford, r. h. "outside directors and the privately-owned firm: are they necessary?" entrepreneurship theory and practice 13 (1988): 49-57. 66 journal of business strategies vol. 12, no.1 fredrickson, j. w, d. c. hambrick. and s. baumrin. "a model of ceo dismissal." academy of manag:ement review 13 (1988); 255-270. freeman, j., g. carroll, and m. hannan. "the liability of newness and age dependence in organizational death rates. american sociological review 48 (1983): 692-710. geneen, h. "why directors can't protect shareholders." fortune (september 17, 1984): 28-32. hambrick, d. c. "strategic awareness within top management team." strategic management journal 2 (1981): 263-279. hambrick, d. c. "putting top managers back in the strategy picture." strategic management journal 10 (1989): 5-15. hambrick, d. c., and p. a. mason. "upper echelons: the organization as a reflection of its top managers." academy of management review 9 (1984): 193-206. harrison, j. r., d. l. torres, and s. kukalis. "the changing of the guard: turnover and structural change in the top-management positions." administrative science quarterly 33 (1988): 211-232. jensen, m. c., and j. b. warner. "the distribution of power among corporate managers, shareholders, and directors." journal of financial economics 20 (1988): 3-24. kesner, i. e "directors' characteristics and committee membership: an investigation of type, occupation, tenure, and gender." academy of management journal 31 (1988): 6684. kesner, i. e, and d. r. dalton. "boards of directors and the checks and (im)balances of corporate governance." business horizons 29 (1986): 17-23. kimberly, j. r., and m. j. evanisko. "organizational innovation: the influence of individual, organizational and contextual factors on hospital adoption of technological and administrative innovations." academy of management journal 24 (1981): 689-713 lorsch, j. w, and e. maciver. pawns or potentates: the reality of america's coeporate ~. boston, ma: harvard business school press, 1989. mace, m. l. directors: myth and reality. boston, ma: harvard university, 1971. mallette, e, and k. l. fowler. "effects of board composition and stock ownership on the adoption of 'poison pills'." academy of management journal 35 (1992): 10101035. michel, j. g., and d. c. hambrick. "diversification posture and top management teamcharacteristics." academy of management journal 35 (1992): 9-37. spring 1995 daily: empirical examination 67 mintzberg, h. power in and around or~anizations. englewood cliffs, nj: prentice hall, 1983. norburn, d., and s. birley. ''the top management team and corporate performance." strategic management journal 9 (1988): 225~238. patton, a, and j. c. baker. "why do directors not rock the boat?" harvard business review 65 (1987): 10-18. pearce, j. a., and s. a zahra. "the relative power of ceos and boards of directtors: associations with corporate performance." strate~ic management journal 12 (1991): 135153. pearce, j. a., and s. a. zahra. "board composition from a strategic contingency perspective." journal of management studies 29 (1992): 411-438. pettigrew, a m. "on studying managerial elites." strategic mana~ement journal 13 (1992): 163-182. pfeffer, j., and g. r. salancik. the external control of organizations: a resource dependence perspective. new york: harper & row, 1978. provan, k. g. "board power and organizational effectiveness among human service agencies." academy of management journal 23 (1980): 221~236. rosenstein, j. "why don't u.s. boards get more involved in strategy?" long range planning 20 (1987): 20-34. selznik, p. tva and the grass roots: a study in the sociology of formal q...l:. ganization. new york: harper & row, 1949. stevens, j. m., j. m. beyer, and h. m. trice. "assessing personal role, and organizational predictors of managerial commitment." academy of management journal 18 (1978): 74-81. stewart, r. "chairmen and chief executives: an exploration of their relationship." journal of management studies 28 (1991): 511-527. sutton, r. i., and a. l. callahan. "the stigma of bankruptcy: spoiled organizational image and its management." academy of management journal 30 (1987): 405-436. thomas, as., r. j. litschert, and k. ramaswamy. "the performance impact of strategy-manager coalignment: an empirical examination." strategic management journal 12 (1991): 509-522. tolbert, p. s., and l. g. zucker. "institutional sources of change in the formal structure of organizations: the diffusion of civil service reforms, 1880-1935." administrative science ouarterly 23 (1983): 22-39. 68 journal of business strategies vol. 12, no. .1 vance, s. c. corporate leadership: boards. directors. strategy. new york: mcgraw hill, 1983. vancil, r. passing the baton: managing the process of ceo succession. boston, ma: harvard business school press, 1987. waldo, c. n. boards of directors: their changing roles. structure. and information needs. westport, ct: quorum books, 1985. wallace, j., and j. erickson. hard drive. new york: harperbusiness, 1992. wheelen, t. l., and j. d. hunger. strategic management. reading, ma: addison-wesley publishing company, 1990. whisler, t. l. "the role of the board in the threshold firm." family business review 1 (1988): 309-321. wiersema, m. f. "strategic consequences of executive succession within diversified firms." journal of management studies 29 (1992): 73-94. wiersema, m. f., and k. a. bantel. "top management team demography and corporate strategic change." academy of management journal 35 (1992): 91-121. zahra, s. a., and j. a. pearce. "boards of directors and corporate financial performance: a review and integrative model." journal of management 15 (1989): 291-334. zald, m. "the power and functions of boards of directors: a theoretical synthesis." american journal of sociology 75 (1969): 97-111. an empirical examination of the relationship between ceos and directors strategic response hmrarcides as reaction m environmental 1'hreat marshall schminke creighton university omaha, nebraska to perform effectively, an organization must match its capabilities to its constantly changing environment. however, little research focuses on the dynamic processes by which organizations make these adaptive decisions. this research develops and tests a hierarchical model of organizational response to environmental threat. it suggests that organizations invoke preexisting sets of response programs to deal with familiar threats, and that these programs emerge in a predictable, hierarchical order. response programs when an air-raid siren sounds, the members of a military installation initiate a set of complex activities. the unit members need not discuss and plot a unique set of strategies in each instance, but rather draw on a well-learned set of programs designed to fit the situation in which they find themselves. in fact, under air raid conditions, the lost time involved in attempting to plot a unique, optimal reaction could well lead to tragic results. in many cases firms respond and react similarly to cues from their environment. often these events consist of situations the organization has experienced in the past. the prudent organization develops a repertoire of strategic response programs-prepackaged sets of actions to be implemented upon detection of particular, recurring, environmental cuesto deal with such shocks. these response programs can take on many forms. for example, staw, sandelands and dutton (1981) model a number of internal organizational responses to threat, one of which reflects the organization's attempts to increase operating efficiencies. consistent with other research (koberg 1987; miller and friesen 1980; tushman and romanelli 1985) the present paper suggests that firms do not execute these reactions randomly but rather in a predictable, hierarchical fashion. for example, in the case of a manufacturing firm, the hierarchy of responses to threat might appear as follows: (1) do nothing. (2) decrease labor costs through short term workforce layoffs. (3) increase short term financial liquidity through more aggressive collections. (4) decrease inventory levels. (5) decrease plant and equipment levels. a manufacturing firm might cut back on overtime nearly by fiat, more quickly and easily than it could collect overdue receivables and marginal accounts. in times of decline, especially during severe industry-wide shocks, excess inventory could be very difficult to dispose of, and the sale of plant and equipment would likely be the most difficult response of all. the precise ordering of the responses would not be the same in all 20 journal ofbusiness strategies vol. no. 11 no.1 firms or industries, of course (e.g., steel mills and candy manufacturers), but the hierarchy reflects a range of relative difficulty and expense involved in each action. further, within each category of responses-employment cutbacks vs. fixed asset reduction, for example-predictable sub-hierarchies also exist. the next section outlines the means by which these hierarchies may be mapped and tested. mapping response hierarchies to determine whether response programs exist and the extent to which firms employ them, two factors are necessary. the first is an observable set of responses for which a hierarchical order can be predicted and traced over time. in this study those responses are changes in employment levels. the second necessary factor is an environmental shock, familiar to and identifiable by the firms, for which standard response routines could exist. in this study that shock is recession. many organizational responses such as the commission of illegal acts are not readily observable (staw and szwajkowski 1975). however, tracing firms' response hierarchies requires that we focus on those that are. firms' adjustment of employment levels provides one such measure. this study examines the degree to which firms cut back in four distinct employment categories in response to recession: (1) overtime hours of production workers (2) average weekly hours of production workers (3) total number of production workers (4) total number of supervisory workers a predictable hierarchy of responses exists among these variables; it appears as follows: (1) decrease overtime hours of production workers. for a manufacturing organization, decreasing overtime hours should be the easiest, quickest, and most cost-effective method of decreasing employment expenses, as the overload of labor hours implemented during prosperous times is pared back. as long as some workers still earn overtime wages-typically at least fifty percent higher than base wages-an incentive exits to cut back on these relatively expensive overtime hours rather than cutting into other workers' regular hours. (2) decrease average regular weekly hours of production workers. however, as the recession develops, merely cutting back overtime hours may not provide sufficient savings. suppose a firm determines that an additional forty hours per week of labor cutbacks are required. it may respond by laying off one worker entirely or by cutting back each of forty workers to thirty-nine hours per week. the latter is a common practice, at least in the early stages of cutbacks. the company may achieve similar results by invoking mandatory vacation periods, leaves, and so on. either approach avoids actual layoffs, which may be costly in terms of unemployment benefits and union grievances. even more significant may be the demonstrated effects of layoffs on the survivors of those layoff~ those who retain their jobs. research shows that commitment, morale and productivity of the surviving workers may decline after layoffs (brockner 1992; brockner, et al. 1987) generating an additional cluster of indirect expenses related to the layoffs. other dysfunctional effects of declining organizational size-as indicated by employment levels (freespring 1994 schminke: strategic response hierarchies 21 man and hannan 1975)-include increased conflict, reduced flexibility, increased scapegoating, loss of leader credibility, as well as declining innovativeness, participation, and long-term planning (cameron, whetten and kim 1987; cameron, kim and whetten 1987). the astute firm will consider the entire package of costs-direct and indireet-of a particular employment policy. the net effect is that decreasing the average weekly hours across employees is likely to be a less costly way to reduce labor expense than complete worker layoffs. (3) decrease total number of production workers. as the recession develops more fully, and extra shifts or entire plants are idled, full layoffs must be invoked and the total number of production workers on the payroll will decrease. this is a difficult and costly process for the organization, especially in situations where labor unions are strong and job security has been a major concern in contract negotiations. further, the dysfunctional effects of decline cited above have been shown to be strongest under conditions of large layoffs (cameron, whetten and kim 1987). facing this, firms will resort to wholesale layoffs only after other reasonable alternatives have been exhausted. (4) decrease total number of supervisory workers. supervisory workers represent the final fatalities of the firm's search for increased labor efficiencies in response to the recession. research demonstrates that administrators added during times of prosperity are among the final victims of layoffs in times of decline (freeman and hannan 1975; miller and friesen 1980). the shock to which ftrrns are responding in this study is recession, a shock that is both familiar and identifiable. from 1945 to 1980, the u.s. economy suffered six separate recessions, the first five of which were of similar duration, lasting from eight to twelve months. these five provided firms with repeated opportunities to develop sets of employment programs to deal effectively with cyclical, short-term, recessionary decline. the sixth recession (1973-1974) was far more intense than the previous five, lasting eighteen months, and is the focus of this study. it has been described as a "prolonged agony" (egan and weiner 1990) as contrasted with the earlier "three quarter blips" (egan and weiner 1990) like the recession of 1970. (of the two more recent recessions-19801982 and 1990-1991-neither provides a clean contrast between a string of similar shocks followed by an aberrant, severe shock.) upon detecting the threat of decline, firms should employ the response programs developed in the five previous recessions, since at its outset they have no reason to believe this threat will differ significantly from earlier threats. however, these established programs would be inadequate to cope with the severity and duration of the harsh 19731974 recession. as a result, we expect that the initial responses will eventually be abandoned and a new set enacted. each of these responses and changes in responses should occur in a predictable fashion. this sixth recession provides a view of whether (1) response programs developed during the first five recessions were implemented, (2) whether they were enacted in the predicted order, and (3) whether firms came to recognize the recession as atypical and as a result, implemented a new, more severe, set of response strategies. in most cases, this updated response will reflect many of the characteristics of the first as firms facing 22 journal ofbusiness strategies vol. no. 11 no.1 novel problems engage in what cyert and march (1963) referred to as a problemistic search. under these conditions, most firms demonstrate tendencies to search in the neighborhood of current problems for potential solutions to new problems. that is, before engaging in zero-based solution generation-a costly and time consuming process--organizations explore their surroundings and histories for clues about prior problems whose successful solutions might provide for the basis of new solutions. in this case, reactions that worked well in typical recessions might be expected to work well in severe recession, if ratcheted up in intensity to match the intensity of the environmental shock. the following hypotheses formalize these assertions: hypothesis 1: in response to the threat of recession, firms will implement strategic response programs to decrease labor costs. hypothesis 2: these response programs will be implemented in the following hierarchical order: decrease overtime hours, decrease average weekly hours, decrease production workers, decrease supervisory workers. hypothesis 3: at a point at which the organizational decline is recognized as atypically severe, initial original response programs will be abandoned in favor of new, more extreme, measures. hypothesis 4: this second set of response programs will follow the same hierarchical order as the first: decrease overtime hours, decrease average weekly hours, decrease production workers, decrease supervisory workers. methods sample a sample of twenty-five industrial manufacturing and retailing groups was randomly selected from the u.s. bureau of labor statistics' (bls) monthly publication employment and earnings. appendix 1 lists the industry groups and their sic codes. (note: the bls does not release employment data for individual organizations but aggregates data at the 2-digit or 3-digit sic code level. however, this creates a level-of-analysis concern in that our thinking about responses to environmental threat was carried out at the firm leve~ while the analyses below are executed at the industry level. the reader is cautioned to keep this in mind during each set of analyses that follows.) measures environmental threat. examining firms' response to environmental threat requires an indication of the onset, duration, and the intensity of the shock. of course, different industries track different indices to determine the short and long term outlook for their markets. a variety of economic factors like money supply and housing starts as well as industryspecific measures like inventories and orders might be tracked by firms attempting to catch a glimpse of the future. however, for this analysis we cannot hope to track all indices employed by all firms across several industries. what is needed is a single index that captures a wide range of information about business conditions across a number of industries. spring 1994 schminke: strategic response hierarchies 23 for american corporate organizations whose common stock is publicly traded, such a measure is the market price of common stock or market indices derived from individual stock prices.1 these stock indices provide a useful measure of anticipated environmental shock to a firm. a decline in the price of a firm's stock indicates that analysts and investors in the financial markets have perceived some actual or potential negative shock to the com~any such as increased interest rates, international unrest, impending recession, and so on. the stock market traditionally acts as a leading indicator, providing finns with advance notice of impending economic decline. therefore, it provides a better indicator of the point at which firms, analysts, and investors first detect the threat of decline than do the gross domestic product (gop) (then, gnp) figures that determine the technical beginning and end of recessionary periods themselves. in this case, the standard & poor's 500 index began its grand decline in january 1973, ten months prior to the onset of the actual recession. likewise, it began to recover in december 1974, months before the technical end of the recession.3 organizational response. four categories of monthly employment data were gathered for each of the 25 industry groups from unpublished, seasonally-adjusted u.s. bureau of labor statistics employment data for the period 1972-1977.4 both the severity and the duration of the responses were calculated for each of the following: (1) average overtime hours (01) per production worker. (2) average weekly hours (ah) (non-overtime) per production worker. (3) total production workers (pw) employed. (4) total supervisory workers (sw) employed. a smoothing program was applied to the data to depict better the underlying patterns.5 the smoothed series-the response curves-were plotted and several critical points (a,b,c,d,r) were identified, as shown in figure 1. for illustrative purposes, consider the response curve for average overtime hours in industry x. it shows the pattern of increases and decreases in ot hours in industry x before, during, and after the recessionary period. point r represents january, 1973, the onset of the detected recession as indicated by the s&p 500 index. as would be expected, employment levels were typically rising during the pre-recession period. figure 1: sample "response curve" for overtime hours employment level a b d c 1972 r 1973 1974 1975 24 journal ofbusiness strategies vol. no. 11 no. i overtime hours peaked at point a, some months after the onset of the shock this point represents the industris initial reaction to the shock, the point at which ot hours began to decline. plotting point a generates two values: the month at which the response occurred (montha) and the number of ot hours per employee during that month (valuea). point d, the point six months prior to the initial industry reaction, likewise yields monthd and valued. point c indicates the point at which the response curve reached a minimum value. it denotes the end of the industry cutback responses, as overtime hours again began to rise. point c also yields two critical values, monthc and valuec. point b indicates the onset of the second, more severe, response program. it is the point at which the smoothed response curve made its most pronounced inflection-without turning upward-between points a and c. in situations where no inflection point was identifiable, the midpoint between points a and c was selected. point b also represents two values, monthb and valuer once the four key points were identified, the following values were calculated for each of the four employment variables. preslope: the average change per month in the employment variable during the six months prior to point a «valuea valued) / 6). lagi: the time (in months) from the onset of the shock to the beginning of the industry's initial response (montha monthr). duri: the duration of the first response program (monthb montha). magi: the magnitude of the first response program «valueb valuea) / valuea). this was the percentage change in the level of the employment variable during the first response program. slope1: the average change per month in the employment variable during the first response program «valueb valuea) / ouri). lag2: the time from the onset of the recession to the beginning of the second response program (monthb monthr). mag2: the magnitude of the second response «valuec valueb) / valueb). slope2: the average change per month in the employment variable during the second response period «(valuec valueb) / dur2). analysis and results hypothesis 1 states that firms will react to the recession by implementing labor cutbacks in each of the four employment categories. table 1 shows means and standard deviations for preslope and slopel for each employment variable across the 25 industries, with results of the pooled t-test comparisons of these means. preslope denotes the trend in employment levels prior to the initial reaction to the recession. slope1 denotes the trend in employment levels after the initial reaction to the recession. this comparison reveals that the average ot hours during the first response program were significantly lower than those in the pre-response period. the same is true across the other three employment variables, indicating that the firms in these industries did react to the spring 1994 schminke: strategic response hierarchies 25 impending decline with responses across all employment categories. these results support hypothesis 1. table 1: test of hypothesis 1 preslope slope1 t-value (d.f.) overtime hours weekly hours prod. workers super. workers mean (s.d.) .125 (.127) .198 (.300) .819 (.690) 1.04 (1.780) men (s.d.) -.057 (.072) -.046 (.067) -.331 (.586) -.729 (2.28) 5.46 (48) **** 3.97 (48) *** 6.23 (48) ** ** 3.06 (48) ** note: ** = p<.ol, *** = p<.ooi, **** = p<.oool hypothesis 2 states that the response programs will be implemented in a particular hierarchical order; cutbacks should be implemented first in overtime hours (ot), followed by average weekly hours (wh), total production workers (pw), and finally, total supervisory workers (sw). this suggests that the time lag from point r to the onset of the response program (lag1) will be shortest for ot, followed by wh, pw, and sw, respectively. table 2 shows results of a rank ordering of the industries' mean lag1 for each of the employment categories. table 2: test of hypothesis 2 test of lagl: months to 1st reactio av. overtime hrs. (ot) 6.16 av. weekly hrs. (ali) 6.76 tot. prod. workers (pw) 12.20 tot. super. workers (sw) 14.72 ot sw pw sig. of differences befween means: ah pw sw ** ** ** * ** note: * = p<.05, ** = p<.01, = not significant results in table 2 support hypothesis 2. lag times for each employment variable emerge in the predicted order. cuts in overtime hours occurred slightly more than six months after point r. cuts in average weekly hours began after nearly seven months. over twelve months passed before total number of production workers began to fall, and nearly fifteen months before total number of supervisory workers began to decline. table 3 also shows results of a simultaneous paired comparison procedure that tests whether the differences between these mean lag times were significant.6 with the exception of the ot-ah pairing, each response was instituted at a significantly later time than its predecessor. these results provide stronger support for hypothesis 2. 26 journal ofbusiness strategies vol. no. 11 no.1 hypothesis 3 suggests that upon discovering that the environmental shock is more severe than the current set of response programs can accommodate, organizations will invoke a second, more severe set of response programs. to test whether more severe changes were employed, two sets of comparisons were performed for each employment variable. first, slopei and slope2 were compared. slopei values show employment trends during the first response period, and slope2 values show employment trends after implementation of the second set of response programs. second, magi and mag2 were compared, assessing the difference in relative magnitude of the cutbacks in each period. table 3a shows means and standard deviations for slopei, slope2, magi, and mag2 values as well as results of pooled t-tests of differences between the means. table 3: test of hypothesis 3 table 3a: overtime hours weekly hours prod. workers super. workers overtime hours weekly hours prod. workers super. workers slopei mean (s.d.) -.057 (.072) -.046 (.067) -.331 (.586) -.729 (2.28) magi -.157 (.149) -.017 (.022) -.030 (.064) -.021 (.057) slope2 mean (s.d.) -.159 (.105) -.214 (.151) -1.52 (1.20) -1.02 (2.88) mag2 -.409 (.171) -.045 (.029) -.115 (.085) -.050 (.071) t-value (d.p.) 3.49 (48) ** 5.07 (48) **** 4.37 (48) *** n.s. 4.84 (48) **** 3.97 (48) *** 3.92 (48) *** n.s. note: * = p<.05, ** = p<.01, *** = p<.ooi, **** = p<.oooi, = not significant table 3b: test of durl: ean our. of 1st reactio av. overtime hrs. (01) 13.11 av. weekly hrs. (ar) 13.20 tot. prod. workers (pw) 13.00 tot. super. workers (sw) sig. of differences between means: ar pw ot pw note: * = p<.05, ** = p<.ol, *** = p<.ooi, **** = p<.oooi, = not significant spring 1994 schminke: strategic response hierarchies 27 results in table 3a indicate a marked change in employment policies between the two periods, both in trends (slopes) of employment and in the magnitude of change in employment levels. the decreases in each of the employment categories that began declining the initial response period continued, but at an accelerated rate, during the second period. all differences are significant except for the decreases in sw, which had not stopped declining during this period, but the rate of decrease had not accelerated rapidly enough to create significant differences. these results support hypothesis 3. however, since the results do not demonstrate a clear two-stage response in supervisory personnel the rest of the analysis will consider it to be a single-stage response. a further implication of hypothesis 3 is that if these responses are truly established programs rather than week-by-week updates reflecting companies' reactions to decline, their duration should reflect the average length of the event that they were designed to deal with. in the two-stage response demonstrated here, the duration of the first stage should correspond to the duration of the typical postwar recession. the lengths of the 1949, 1953, 1957, 1960, and 1970 recessions were 11, 10, 8, 10, and 11 months, respectively. those programs in the initial stage would reflect that time frame and were expected to run at least that long. however, they were not expected to stay in place much longer, as they were not developed to deal with severe recessions of over one year. on or about the twelfth month, firms would recognize that this shock was something out of the ordinary, abandon their initial response programs, and implement the second stage. results in table 3b demonstrate that the average duration of each employment response was approximately thirteen months. none differed significantly from the others, further supporting hypothesis 3. hypothesis 4 states that the second set of response programs will be implemented in the same hierarchical order as the first. testing this hypothesis followed the same format as testing hypothesis 2 with one exception. since a clear second-stage response for sw did not appear, it was not included in the analysis. table 4 shows results of the rankordering of iag2 for each of the other employment variables. table 4: test of hypothesis 4 test of iag2: mean months to 2nd reactio sig. of differences between means: ** av. overtime hrs. (ot) 19.26 av. weekly hrs. (ah) 19.96 tot. prod. workers (pw) 25.20 tot. super. workers (sw) ah pw ot pw ** note: * = p<.05, ** = p<.01, = not significant results indicated that the mean values for iag2 occurred in the predicted order. slightly more than nineteen months passed from point r to the beginning of the second, 28 journal ofbusiness strategies vol. no. 11 no.1 more severe, response in ot cutbacks. nearly twenty months passed before more severe cutbacks in wh began, and over twenty-five months passed before the second response in cutting back pw began. results indicated that with the exception of the pairing between wh and qt, these differences were significant. discussion and conclusions this paper examined the processes by which firms deal with environmental threats. it tested whether firms respond with sets of preprogrammed routines-response programswhen facing these threats. it investigated whether companies across 25 industries invoked predictable sets of strategic responses in a particular hierarchical fashion. further, it tested whether one set of routines was abandoned in favor of another upon discovery of the inappropriateness of the original package. all hypotheses were supported. the results are significant, both theoretically and practically. we know relatively little about the way organizations manage environmental shocks, and even less about the ways in which they should. this paper sheds some light on the processes employed, suggesting that under threatening conditions, mangers employ a problemistic search. that is, for solutions to new problems, managers seek out existing programs that worked in the past on similar problems. a repertoire of response programs simplifies this search. we commonly hear about the pitfalls of "managing by putting out fires"; managers often have all they can handle simply attending to the problem of the minute. less immediately-pressing issues like strategic planning are pushed to the background as managers employ a twine-and-bailing-wire approach to holding the firm together. diligent environmental scanning, monitoring, assessment, and forecasting fall by the wayside as readymade response programs are pulled from the shelf, put in place, and allowed to run (a fire is doused) until it is clear they are no longer appropriate (a new fire begins). these results suggest that may be the process firms use to cope with threat. ironically, the declining organization may be the least able to absorb the mistakes inherent in a system devoid of strategic management. further study is needed to develop programs aimed at culling out ineffective response programs, retaining the adaptive ones, and developing systems that would aid managers in determining which are which in a particular situation. knowing more about how firms are likely to respond to various shocks may be useful for the strategically adept organization. it has been shown that strategic planning can provide a source of competitive advantage (powell 1992) and a critical goal of planning is to be able to anticipate competitive responses to various market changes. these results suggest that under conditions of familiar shock, a firm might be able to predict accurately the likely responses of its competitors, buyers, and suppliers. with that ability will come first-mover advantages like increased market share (mascarenhas 1992). the larger issue of strategic scanning should also be noted. the present results regarding firms' use of response programs relate to a firm's scanning processes in two ways. first, an important component of the scanning process is for organizational boundary spanners to have some notion of the events to which they ought to be attending. recogspring 1994 schminke: strategic response hierarchies 29 nizing patterns in competitor responses would be key to formulating and executing appropriate responses. if, as these results suggest, firms tend to utilize existing routines of responses, those should be relatively easily recognized by skilled scanners. knowing that response routines are regularly repeated should allow scarce scanning resources to be concentrated on a set of "most likely" patterns of behavior. second, it has been shown that effective environmental scanning and interpretation is related to better performance ('thomas, et al. 1993). the other side of this coin is that poorer scanning leads to poorer performance, which has been linked to even less attention being paid to strategic planning. thus, a dangerous cycle has begun. to the extent that a firm is skillful in its scanning-and thus better able to detect and predict the responses of othersthe risk of further decline and the dysfunctions associated with it is minimized. however, several caveats remain. much of the discussion of the issues at the heart of this research was at the firm level, but analysis proceeded at the industry level. while industry-level data reflect the aggregation of individual firms' responses, and strong crossindustry results boost confidence in their generalizability, industry data miss much of the potential richness of firm-level data. in addition, industry-level data do not allow for the sort of between-industry analyses that would tell us about the specific differences that might be expected from one industry to the next. responses in recession-vulnerable industries like building materials may be quite different from those that are more recession-resistant like food products. however, it should be noted that these employment responses were strong and stable enough across disparate industries to yield significant results even at this macro-level of analysis. therefore, it is likely that the more homogeneous within-industry responses would be even more pronounced and traceable. second, this paper examined only a small subset of possible responses to a single type of environmental change. it would be interesting and useful to examine additional types of response hierarchies, to determine the extent of their predictability and stability. in addition, this paper shed little light on what additional types of responses exist in these and other organizations and whether the programs are common across alternative forms of environmental shocks. a third set of questions concerns the conditions under which these response programs might differ. for example, the degree to which a firm is buffered from environmental shock may affect the type, magnitude, and speed of response programs it invokes. specifically, those organizations or industries that are relatively well buffered from the environment may respond to market-wide shock much more slowly and to a much lesser degree than organizations or industries whose businesses are more volatile. for example, well-buffered firms may be able to make more effective use of response programs as reactions to decline in that implementing the ''wrong'' program would carry less severe results. less-buffered firms may need to decrease their dependence on prepackaged programs, in that they are especially vulnerable to these same potential mistakes. it may also be the case that new employment alternatives have emerged that would alter the nature of the particular employment hierarchy tested here. corporate restructuring has altered the face of many organizations in the past decade, especially in middle management, as increased outsourcing, subcontracting, and use of temporary workers has 30 journal ofbusiness strategies vol. no. 11 no.1 pushed the risk of carrying employees during economic downturns out to satellite firms. it is possible that a revised set of programs would include cutbacks in these areas as well at the traditional employee pools. finally, the role of organizational and managerial learning (lant and milliken 1992) in these response processes needs to be examined. the present research assumes that organizational response programs grow from previous organizational experience, either that of the firm or that of the individuals the firm might hire from experienced firms. the "liability of newness" effect (bruder! and schussler 1990) that relatively young firms are generally more vulnerable-may have to do with their inability to make good decisions regarding appropriate responses to what they view as novel events. their more experienced counterparts are able to implement established response programs more quickly, freeing up scarce resources for other needs and addressing the impending problem in a more timely fashion. the process by which well-learned response programs are updated or disposed of should also be addressed. the severe shock that was the focus of this study followed a series of mild, relatively similar, recessions that allowed firms to develop programs to deal with a ''typical'' recession. we do not know much about the process by which organizations cope with a series of atypical shocks or a change in what is believed to be typical. for example, since the 1973-1975 recession the u.s. has experienced two longer recessionary periods than were typical in the post-war era. the effect that the severe 1973-1975 recession and the later double-dip shocks have had on the established response routines provides an interesting avenue for future research. guidelines for managers several important lessons for managers may be drawn from this study. they involve the strategic benefits of recognizing and utilizing the response patterns of one's own firm as well as those of one's competitors. first mover advantages go to firms whose responses are both timely and accurate. this final section outlines the process by which managers might adopt some of these ideas for their own strategic benefit. (1) identify the critical success factors (csfs) for your industry. experts in most industries are able to identify a small set of numbers that conveys an accurate picture of the health of firms in that industry. typically, these are underlying operational figures rather than pure financial (outcome) statistics. for example, every carrier in the airline industry tracks and attends to passenger load factor, the percentage of available seats that are actually sold. keeping planes full (or as nearly so as possible) is key to success in this industry. retailers track inventory turnover, restaurants track food cost as a percentage of sales, and large brewers track market share. the specific categories differ across industries, but once identified, five or six csfs provide a great deal of information about the firms in that industry. they also provide the basis for tracking the response hierarchies in that industry. (2) identify threats and shocks common to the industry. this paper examined recession, and for some industries that constitutes a---<)r even the-major threat. for other busispring 1994 schminke: strategic response hierarchies 31 nesses, fuel prices, interest rates, international instability, or even the weather might be more salient threats. to identify the most pronounced response programs, these threats should include only recurring events for which firms would have well-developed, prepackaged responses. (3) gather historical data. once csfs and recurring threats have been identified, a history must be drawn. csf information for each competitor is gathered over a span of time in which industry threats emerged and subsided several times. part of this process includes identifying points analogous to those in figure 1: onset of the shock, inflection points, and so on. as the history is drawn, care should be taken to collect relevant control factors like firm size, severity of shock, and so on, to be used in the analysis. (4) include your firm in this process. like individuals, many firms may be more aware of others' habits than their own. throughout the process, self-analysis and self-evaluation are vital. (5) evaluate the effectiveness of the response programs. even within a single industry, firms will differ in terms of their responses to threats. some may implement layoffs while others cut back on research and development spending. by assembling a lengthy industry history we may learn not only what competitors did, but what worked. grossly inappropriate strategic moves are often self-correcting (firm death) but in most industries a range of strategic responses might be supported. the point is to determine which are most effective. (6) assess your firm's vulnerability to the shocks. not all organizations are equally vulnerable to a given threat. within-industry differences in strategic posture might soften or enhance the effect of a particular shock. in addition, something of a compensatory effect exists between resources devoted to buffering your firm from shock (e.g., outsourcing components even at slightly higher cost) and those devoted to managing the threat (e.g., scanning, analysis, and corrective action expenses). by prioritizing the threats to which a firm is most vulnerable, managers might make better use of limited resources. (7) adjust or create response programs accordingly. steps one through six are not the firm's solution. rather, they put the firm in a position to create solutions. carefully executed, steps one through six will provide a manager with a clear picture of patterns of responses to common environmental shocks, by his or her own firm as well as competitors, over time. at this point, a manager should understand the nature of the responses, as well as their predictability and effectiveness. once those three pictures emerge, it is relatively simple to evaluate one's own existing set of programs. it would not be unusual to expose overor under-allocation of resources across these programs. that is, the 80/20 rule (that 80% of the action comes from 20% of the cases) may be in effect here. if so, it would serve the strategic manager well to know of it and to reallocate adaptation resources accordingly. (8) explore related industries. a great deal can be learned from examining one's own industry, but additional insights may emerge from taking a close look at similar or related industries. much as technology transfers between industries or economies, strategies also find their way to arenas outside those in which they were born. sometimes those moves happen accidently; other times they are managed. the prudent strategic manager 32 j oumal ofbusiness strategies vol. no. 11 no.1 will look beyond his or her own industry in search of ideas that might lead to competitive advantage. in the art of war, sun tzu tells us "what enables the wise sovereign and the good general to strike and conquer, and achieve things beyond the reach of ordinary men, is foreknowledge" (sun tzu 1983). a great deal of knowledge can be gained from studying the history of one's firm, one's industry, and related industries. that study is made more efficient by knowing what information to gather and what sort of patterns to look for after gathering it. this approach to environmental scanning, information gathering, response mapping and strategic sense-making may yield significant strategic benefits. endnotes 1. reasonable theoretical basis exists for using a market index as a leading economic indicator. the efficient market hypothesis (emil) of finance theory suggests that the current market price of a stock reflects all publicly available and relevant information regarding the value of the firm {brigham and gapenski 1991). this information includes company earnings records and announcements, economic conditions, world news, and any other conditions that the buyers and sellers in the stock market feel will affect its present or future performance. according to the emh, stock prices reflect new information very quickly-just how rapidly is a point of some debate-but most evidence suggests these markets are quite efficient (arrow 1982). 2. it is not necessary to monitor all environmental events in order to identify impending environmental shock, since the financial markets perform the task for us. (it is estimated that each major stock is tracked by approximately 1000 industry analysts at banks, insurance companies, investment firms, and brokerage houses across the country and around the world {brigham and gapenski 1991).) in fact, it is not necessary even to agree upon or fully understand what the shock is or what caused it; we need only observe the change in the index to detect negative news. we may measure the intensity of the shock without fully understanding its cause in much the same way that we may measure temperature without an understanding of molecular theory. this holds for industry-level and market-level indices as well as individual stocks. the standard and poor's 500 composite index, for example, identifies market-wide shocks to american corporations and industries it represents. 3. it is not the position of this paper that a single market index like the s&p 500 is what firms are actually tracking, or that it will do a better job of predicting impending shocks to a firm or industry than the numerous indices they do follow. however, it does provide a useful proxy for the many individual indices firms and industries do, in fact, track. 4. this "unpublished" raw data is available from the bls, but does not appear in any periodical hls publication like employment and earnings. 5. this resistant smoothing program replaces each data value with the median of data values immediately before and after it. resistant smoothers were built up by successive applications of simple smoothers (running medians of 4, then 2, then 5, then 3) followed spring 1994 schminke: strategic response hierarchies 33 by a hanning process (a running average computed as z(t) = .25y(t-1) + .5y(t) + .25y(t+1». the smoothing program executed this sequence twice. see also velleman (1980). 6. tukey's paired comparison procedure tests for differences between multiple means, a procedure not possible with simple paired t-tests. references arrow, k.j. 1982. "risk perception in psychology and economics." ecolwmic inquiry 20: 1-9. brigham, e.f. and l.c. gapenski. 1991. financial management. chicago: the dryden press. brockner, j. 1992. "managing the effects of layoffs on survivors." california management review 34: 9-28. brockner, j., s. grover, t. reed, r. dewitt, and m. o'malley. 1987. "survivors' reactions to layoffs: we get by with a little help for our friends." administrative science quarterly 32: 526-541. broded, j. and r. schussler. 1990. "organizational mortality: the liability of newness and adolescence." administrative science quarterly 35: 530-547. cameron, ks., m.u. kim, and d.a. whetten. 1987. "organizational effects of decline and turbulence." administrative science quarterly 32: 222-240. cameron, k.s., d.a. whetten, and m.u. kim. 1987. "organizational dysfunctions of decline." academy of management journal 30: 126-138. cyert, r. and j. march. 1963. a behavioral theory of the firm. englewood giffs, nj: prenticehall. egan, j. and d.p. wiener. 1990. "fishing for good deals." u.s. news and world report sept. 24: 82-90. fama, e.f. 1976. foundations of finance. new york: basic books, inc. freeman, 1. 1979. "going to the well: school district administrative intensity and environmental constraint." administrative science quarterly 24: 119-133. freeman, j. and m.t. hannan. 1975. "growth and decline processes in organizations." american sociological review 40: 215-228. koberg, c.s. 1987. "resource scarcity, environmental uncertainty, and adaptive organizational behavior." academy of management journal 30: 798-807. 34 journal ofbusiness strategies vol. no. 11 no.1 lan!, t.k. and fj. milliken. 1992. ''the role of managerial learning and interpretation in strategic persistence and reorientation: an empirical exploration." strategic management journal 13: 585-608. mascarenhas, b. 1992. "first-mover effects in multiple dynamic markets." strategic management journal 13: 237-243. mckinley, w. 1987. "complexity and administrative intensity: the case of declining organizations." administrative science quarterly 32: 87-105. miller, d. and p.h. friesen. 1980. "momentum and revolution in organizational adaptation." academy of management journal 23: 591-614. powell, t.e. 1992. "strategic planning as competitive advantage." strategic management journal 13: 551-558. staw, rm., l.e. sandelartds, and j.e. dutton. 1981. "threat-rigidity effects in organizational behavior: a multilevel analysis." administrative science quarterly 26: 501-524. staw, b.m. and e. szwajkowski. 1975. "the scarcity-munificence component of organizational environments and the commission of illegal acts." administrative science quarterly 20: 345-354. sun tzu. 1983. the art of war. ed. j. oavell. new york: dell publishing. thomas, j.r, s.m. qark, and d.a gioia. 1993. "strategic sensemaking and organizational per~ formance: unkages among scanning, interpretation, action, and outcomes." academy of management journal 36: 239-270. tushman, m.l. and e. romanelli. 1985. "organizational evolution: a metamorphosis model of convergence and reorientation." research in organizational behavior. eds. l.l. cummings & rm. staw. greenwich, cf: jai press. velleman, p.f. 1980. "definition and comparison of robust nonlinear data smoothing algorithms." journal of the american statistical association 75: 609-615. spring 1994 sic industry schminke: strategic response hierarchies appendix 1: inventory of industrial groups 35 120 bituminous coal 130 oil and gas extraction 150 general building contractors 160 heavy construction contractors 207 confectionery and related products 208 beverages 211 cigarettes 220 textile mill products 230 apparel and other textile products 251 household furniture 260 paper and allied products 283 drugs 301 tires and inner tubes 331 blast furnace / basic steel products 352 farm machinery 353 construction and related machinery 354 metalworking machinery 363 household appliances 367 electronic components and accessories 372 aircraft and parts 374 railroad equipment 394 toys and sporting goods 530 retail variety stores 540 retail food stores strategic response hierarchies as reaction to environmental threat the impact of strategy, industry and culture on forecasting the performance of global competitors: a strategic perspective jeffrey p. katz kansas state university manhattan, ks marilyn t. zarzeski university of mississippi university, ms h. john hall university of florida gainesville, fl abstract this study examines how business strategy, industry competitive environment and national culture affect the accuracy and level of agreement among financial analysts who predict the future earnings of international competitors. recent research has reported the increasing importance played by financial analysts regarding the stock price and market value of firms. analysts' forecasts of peiformance have been found to significantly affect the cost ofcapital. valuation and stock price changes offirms. as the incidence of cross-national mergers and acquisitions continues to escalate, understanding factors that systematically affect peiformance predictions becomes increasingly important, especially for firms employing cross-national merger or acquisition strategies. we find that business strategies affect the accuracy of analysts' peiformance estimates while national culture plays an important role in determining the level of agreement among analysts' predictions. implications and plans of action for international management practitioners and researchers are discussed. background strategic management seeks to integrate the traditional functionally-related business fields, such as economics, finance, marketing and accounting, by focusing on top management decisions having long-term impact on the future success of the firm (andrews, 1987; porter, 1985). the most commonly cited factor linking strategic management with these fields is the financial outcome of the firm. describing how "strategic" factors focus on the external environment of the firm and affect the performance of the firm was the starting point for early models in strategic management (hofer, 1975). for example, porter's (1980) well-known 120 journal of business strategies vol. 17, no.2 model of competition serves as a basis for assessing the relative impact that key external factors, such as buyers, suppliers and rivals, have on competition within a particular industry. thus, strategic management historically sought to address how contingent factors from the firm's external environment, and resulting decisions made within the firm, systematically affected financial performance of head-to-head competitors (jauch, osborn & glueck, 1980). more recently, research in strategic management (venkatraman & ramanujam, 1986), behavioral finance (olsen, 1998) and financial accounting (das, levine & sivaramakrishnan, 1998; shipper, 1991; and dreman & berry, 1995) has attempted to expand our understanding of the factors affecting the prediction of future firm performance, with particular emphasis on the accuracy of indicators predicting future firm performance. this interest is increasing in importance as a strategic focus because understanding the factors affecting the accuracy of the firm's future earnings is key to understanding the firm's future valuation, cost of capital and the relationship between earnings and stock prices (brown & rozeff, 1978). that is, factors affecting the accuracy of performance predictors have a direct impact on the strategic alternatives available to firm managers. market valuation, stock price and cost of capital affect management's ability to implement broad competitive strategies, such as expanding the firm through mergers or acquisitions (barton & gordon, 1988). successful mergers and acquisitions are based on securing cost-effective capital through debt or equity markets (abolafia, 1996; shefrin & statman, 1993). the potential implication for effective management of the firm is significant. by understanding factors affecting financial analysts' predictions of future firm performance, related changes in stock prices can be anticipated by managers and investors thus limiting the potentially negative impact of unexpected changes in firm valuation (rivera, 1991). for example, mann (1998) recently reported the single-day 24 percent market value decline of one company attributable to differences between financial analysts' estimates of the firm's earnings and the announcement by management of actual earnings. despite the company's announcement that earnings would be equal to or slightly less than prior period earnings, financial analysts had incorrectly predicted substantial earnings increases. since capital markets value the information content of analysts' earnings estimates (brown & rozeff, 1978), determining the factors that systematically affect analysts' earnings estimates is increasingly important to investors and creditors (cheng, chan & liao, 1997). in previous research, imputed accuracy of earnings estimates was found to significantly explain investors' beliefs about the future performance in the value of both a company and its stock price (patell, 1976). recent attention on the importance of performance estimates has resulted in the popular business press investigating the role of financial analysts and their estimation accuracy (bartlett, 1998). thus, the impact of firm performance estimates has become linked to the strategic decisions of top company managers. fa112000 katz, et al.: forecasting performance 121 extending firm performance estimation to the global marketplace, recent studies have begun examining factors contributing to the accuracy of performance estimates across global competitors. for example, speidell and ramos (1998) recently questioned whether international estimates of global competitor performance are useful in making strategic decisions. they suggest that performance projections by analysts may be less accurate for global competitors than for domestic firms, despite the assertion that approximately one-third of "quantitative" investors rely on performance estimates for international competitors. while noting that differences exist between performance forecasts for firms based in different countries, spidell and ramos offer no systematic explanation why such differences exist. in addition, several recent high-profile cross-national mergers, such as chrysler and daimler-benz, have been the focus of analysts' earnings forecasts (vlasic, kerwin, woodruff, peterson & spiro, 1998). in this study, we seek to gain a better understanding of the factors affecting performance predictions of global firms. specifically, we investigate factors associated with "errors" in the estimates of earnings across global competitors relative to: 1.) the accuracy of financial analysts' estimates, and 2.) the causes of dispersion (systematic disagreement) among financial analysts' estimates. we develop and test a model predicting accuracy and agreement among analysts' estimates of future earnings that assesses the impact of factors stemming from three important information sources: 1.) national cultures, 2.) industry competitive environments, and 3.) business strategies. first, we examine estimated future firm performance based on the model tested by katz, zarzeski and hall (1997) who examined the effect of business strategies, industry environments and national culture on actual firm performance. second, we seek to extend rivera's (1991) work by decomposing the industry competitive environment into specific task environments and assessing their impact on the accuracy and level of agreement of earnings predictions across global competitors. by considering the effects of national culture, industry factors and business strategies on analysts' predictions of firm performance, we find that business strategies are an important factor in determining the accuracy of analysts' earnings predictions while national culture plays an important role in the level of agreement among analysts' earnings predictions. the next section presents the literature relating to forecast accuracy (analysts' forecast error) and level of agreement (forecast dispersion), national culture, industry environment and business strategy. the third section presents the methodology developed to operationalize and test the research hypotheses. section four presents the results of our empirical tests while the final section discusses our results and offers action plans for international management practitioners and researchers. 122 journal of business strategies literature vol. 17, no.2 prediction of performance financial researchers and professionals agree that earnings are a major determinant of stock prices (calderon, 1993; conroy & harris, 1987). a significant portion of the research budget of investment bankers and brokerage houses is spent on compensating top financial analysts claiming the ability to accurately estimate the future earnings of firms. professional analysis services, such as institutional broker's estimate system (lbes), track financial analysts' earnings estimates for over 17,000 firms worldwide. modern security analysis is the attempt by analysts to predict stock price movements by accurately estimating near-term firm performance (dreman & berry, 1995). because earnings forecasts have information content of importance to the marketplace, the more accurate the earnings prediction, the more information content the forecast carries (elton, gruber & gultekin, 1981; 1984). although the related literature since the late 1960's clearly suggests that analysts consistently mis-forecast earnings, there is little empirical evidence explaining the bases for the errors, especially across countries. for example, brown, richardson and schwager (1987) examined the general concepts that underpin analysts' forecasts but did not examine the specific nature of firm, industry or decision settings (business strategies) that inherently impact financial analysts' decisions (schipper, 1991). understanding the causes of errors in analysts' earnings forecasts is important to the corporate strategies available to the firm. since the mid-1970's numerous authors have identified the multinational corporation (mnc) as a target for corporate strategy through portfolio diversification because mnc's, particularly those headquartered in foreign countries, are affected by different market risks than purely u.s. domestic firms (see for example, solnik, 1974 and fatemi, 1984). domestic firms wishing to diversify their risk may seek to acquire firms in other countries but have relatively limited information about the future earnings of such firms. therefore, the search for systematic "bias" in earnings predictions continues with limited investigation into prediction accuracy of mncs (rivera, 1991). schipper (1991) suggested that examining the types (financial as well as strategic) of information available to analysts, and the context (environment) in which the firm being assessed competes, will potentially provide useful information about the accuracy of earnings estimates. thus, by understanding the sources of estimation bias, managers are able to weigh the impact of such factors on the future earnings estimations and the likely financial market reaction. the level of agreement, or dispersion, among analysts' estimates of earnings is an area of related interest. forecast dispersion also carries important information to the marketplace (elton et ai., 1981). if analysts have access to the same information, and interpret the information in the same manner, then their estimates of earnings will tend to be similar. however, if analysts with access to the same information make different interpretations, their level of disagreement (forecast fall 2000 katz, et al.: forecasting performance 123 dispersion) of estimates will be higher (lang & lundholm, 1996). it has been suggested that higher levels of disagreement indicate higher levels of systematic risk (conroy & harris, 1987; elton et at., 1984). thus, investigating the forces impacting analysts' forecast accuracy and dispersion will potentially provide important information to investors and managers about systematic differences in firm earnings and risk. the industry competitive environment early strategic management literature focused attention on industry factors affecting the firm's potential for sustaining market share and sales growth (hofer, 1975). the firm's competitive environment, defined by the industry in which it chooses to compete, was initially characterized by the level of munificence a concept meant to reflect the growth rates of specific industries over time. that is, an industry with a high level of munificence would be one in which firms are able to enter and maintain competitive positions with relative ease. in 1979 aldrich expanded the description of competitive environments by adding two more industry dimensions complexity and dynamism. environmental complexity describes the level of uniformitylheterogeneity of firms within an industry while environmental dynamism reflects the variability of industry growth, that is, relative market instability. the three industry dimensions form the context in which competitive strategies of the firm are developed and implemented (hambrick & lei, 1985; lee, lee & ulgado, 1993). in an effort to quantify and test the usefulness of the three conceptual industry factors, dess and beard (1984) developed and empirically tested industry competitive environments using standard industrial classifications (sic) for measuring the three industry factors. using the three measures of industry competition, dess and beard found systematic differences in the relationship between a firm's allocation of resources (business strategies) and its competitive environment. for 52 industries, dess and beard developed factor scores and ranks on munificence, complexity, and dynamism scales, thereby developing objective measures of the three dimensions comprising the firm's competi ti ve en vironment. more recently, rasheed and prescott (l992) replicated and cross-validated the three industry dimensions reported by dess and beard (1984) finding considerable measurement stability for the three factors. in the current study we employ munificence, dynamism and complexity measures to control for differences in industry competitive environments as a means to help us compare factors influencing analysts' estimations across different industries and competitive conditions. thus, because industry effects across global competitors are difficult to predict, we control for the effects of different industry competitive environments (prescott, 1986). the result is that all industries in our study are placed on a level playing-field relative to any special factors that might make certain industries easier, or more difficult, to track by financial analysts (porter, 1990; rivera, 1991). 124 journal of business strategies vol. 17, no.2 the role of firm strategy within the constraints imposed by the industry's competitive environment, firms use their resources to develop strategies for competition in their marketplace which, in turn, affects the firm's financial performance (andrews, 1987; hambrick & lei, 1985; porter, 1985). a strategy framework receiving considerable theoretical and empirical attention is the structure-strategy-performance model (caves, gale & porter, 1974; porter, 1980; scherer, 1970). this framework proposes that the performance of a company depends on the strategies undertaken within a particular industry's competitive structure. managers able to effectively match the business strategies of the firm with the competitive environment will be rewarded by enhanced firm performance. extending the work of porter (1980), mcarthur and nystrom (1991) examined the direct and moderating effects of the industry competitive on the strategyperformance relationship. they selected their sample of industries from dess and beard's (1984) study and found evidence that the competitive environment significantly interacts with strategies to affect performance. mcarthur and nystrom argued that the business environment modifies the form of the strategy-performance relationship. they recommended the use of all three industry competitive environment dimensions in future studies of strategy-performance. more recently, katz et al. (1997) sought to extend the work of mcarthur and nystrom (1991) by assessing the effects of strategy, industry and national culture on the actual financial performance of global competitors. they found financial performance is affected by the business strategies of the firm while holding industry and national culture constant across firms. cheng, etheridge and noland (1994) and franke, hofstede and bond (1991) have suggested that performance indicators of international firms possess a higher degree of informational complexity than domestic firms. therefore, examining the role that business strategies play on the estimation of earnings will help increase the information content of performance predictions for global competitors and, hopefully, decrease the level of perceived risk associated with investments in international ventures (shaked, 1986). the current study seeks to examine business strategies in relation to financial analysts' predictions of firm performance. because business strategies directly, or indirectly, affect firm performance (hambrick, 1983; hofer, 1975; porter, 1985), we believe that firm strategies will be systematically related to financial analysts' earnings forecasts. business strategies included in the current study are: 1.) inventory turnover, a measure of operational efficiency and a proxy for lowcost leadership; 2.) capital intensity, a measure of financial leverage; 3.) financial slack, a measure of management's decision to maintain uncommitted financial resources for future market opportunities; 4.) research intensity, a measure of investment in research and development as a basis for future competitive advantage; and 5.) sales growth, a measure of industry market share (katz et ai., 1997; mcarthur & nystrom, 1991). we chose these business strategies because they have been shown to reflect management's allocation of resources to the firm's fall 2000 katz, et al.: forecasting performance 125 competitive posture toward other firms in the same industry and the measures are accounting-based thus available world-wide to financial analysts tracking the performance of the firm. the role of national culture in the global marketplace the strategy~performance link has been shown to be affected by national culture, which stems from a country's values, norms and beliefs (franke et al., 1991; katz et al., 1997; katz, werner & brouthers, 1999). twenty years ago, hofstede (1980) conceptually and empirically defined culture as the collective mental programming of a nation's people. hofstede developed a classification scheme for national cultures by identifying four bi-polar dimensions of national culture: individualism-collectivism, masculinity-femininity, high-low power distance and high-low uncertainty avoidance. each of the four dimensions of national culture are scored on a continuous numeric scale, generally ranging from zero to 100, allowing for the relative comparisons of worker attitudes between nations. the first dimension, individualism, refers to the tendency of people to look after themselves and reflects the level of self-motivation and reward a culture encourages in its workforce. nations having high levels of individualism will tend to encourage and reward workers for their individual efforts. at the other extreme is collectivism, the belief in the importance of group decision-making and group-oriented goals. for example, the united states is ranked high in individualism reflecting the value placed on individual achievement while japan is ranked high in collectivism reflecting the group-oriented focus of workers in japan. the second dimension of national culture is masculinity, the degree of traditional masculine values, such as assertiveness and materiality, dominant in the nation. on the other~hand, femininity emphasizes concern for others and for the quality of work~life. countries scoring high on the masculinity scale will encourage economic performance and rewards related to corporate growth while countries scoring high on the femininity scale will place greater emphasis on the quality of work-life. for example, japan scores high on the masculinity scale reflecting a society valuing corporate growth while denmark scores high on the femininity scale reflecting a society valuing a high quality of work life. the third dimension of national culture is power distance, the level of acceptance by a society for the unequal distribution of power in organizations. high levels of power distance imply that workers expect to be given directions by a supervisor and expect highly bureaucratic organizational structures. on the other-hand, nations scoring low on the power distance scale will have workers approaching the workplace in a more egalitarian manner expecting flatter organizational structures and seeking worker input from the lowest levels ofthe organization. for example, countries such as france score relatively high, while the united states scores relatively low, on the power distance scale. 126 journal of business strategies vol. 17, no.2 finally, uncertainty avoidance is the extent to which people feel threatened by ambiguity in the workplace. high levels of uncertainty avoidance suggest workers in a nation will not easily make decisions on their own but will instead seek written procedures. conversely, nations scoring low on the uncertainty scale will have workers willing to make decision under risky conditions. for example, germany scores relatively high on the uncertainty avoidance scale reflecting workers who are more comfortable with rules and written procedures while the united states scores relatively low on the uncertainty avoidance scale reflecting workers more likely to make decisions under conditions with greater uncertainty. hofstede (1983) and franke et al. (1991) suggest that national culture influences the development and implementation of strategies used to accomplish the firm's competition goals. in this context, hofstede's theory of national culture predicts that culture will significantly affect business strategies as vehicles to achieve organizational success. recent research supports this contention. for example, katz et al. (1999) empirically tested a model predicting the importance of culture on business goals. they demonstrated that national culture, particularly individualism/collectivism, affects growth strategies and performance of firms in the international banking industry. thus, since national culture affects the strategies and performance of the firm (osland & cavusgil, 1996), it is likely that national culture will affect the ability to predict the future performance of the firm. numerous studies have shown that financial reporting practices of firms differ across cultures (choi, 1973; barrett, 1976; adhikari & tondkar, 1992). prior research indicates that firms develop practices to solve problems arising from their deriving value from business transactions (rockart, 1979). financial reporting results from practical solutions developed at the firm (micro) level and institutionalized through disclosure practices at the industry and national (macro) levels (leblebici & salancik, 1982). zarzeski (1996) found that national cultural impacts the level of financial reporting in firms across seven developed countries. she implied there is reason to believe that a greater level of financial reporting, and related company information, will be positively associated with the number of financial analysts tracking and estimating the future performance of a company. in summary, there is evidence to suggest that national culture, industry competitive factors and business strategies will affect how financial analysts interpret the future performance of global competitors. however, no study has examined the relationship between national culture, company strategy and the accuracy or, or agreement between, financial analysts' estimates of future firm performance in a single predictive model. therefore, the current study seeks to examine whether national culture affects analysts' earnings forecasts by assuming cultural differences are related to financial reporting differences as well as business, political, and economic differences across countries (das & saudagaran, 1998; das et al., 1998). fall 2000 katz, et al.: forecasting performance 127 figure 1 conceptual factors affecting the financial performance forecasting national cultural industry strategy past performance factors-> factors-> factors-> factors-> perf.-> estimation economic values growth efficiency profit accuracy systems rate stability legal norms firm effectiveness depth of variability systems homogeneity knowledge (level of agreement) political beliefs market systems instability technology adapted from: katz et al., 1997 figure 1 depicts the proposed relationships between national level (culture), industry level (competitive environment) and firm level (strategies) factors potentially affecting analysts' forecasting of company performance (accuracy and dispersion). it is in this context that global competitors attempt to use the resources at their disposal to develop sustainable competitive advantage and in which financial analysts predict the results of business strategies on the performance of the firm. therefore, based on the previous discussion, we propose the following research hypotheses: hypothesis 1: holding differences in national culture and industry competitive environment constant, firm strategies will significantly affect the accuracy offinancial analysts' estimates offuture firm earnings. hypothesis 2: holding differences in industry competitive environment andfirm strategies constant, national culture will significantly affect the dispersion offinancial analysts' estimates offuture firm earnings. methodology in order to test our hypotheses, we identified previously validated measures of national culture, industry and strategy. we proposed two regression models related to financial analysts' earnings forecasting behavior: forecast error and forecast dispersion. in the earnings forecast error model, we tested the effects that firm 128 journal of business strategies vol. 17, no.2 strategies have on analysts' ability to predict future firm performance, while controlling for national culture and industry factors. in the earnings forecast dispersion model, we tested the effects of national culture on analysts' ability of predict future firm performance, while controlling for business strategy and industry competitive conditions. data was collected from four sources. financial data used to assess actual firm performance and business strategies was collected from standard and poor's global vantage data base for five years covering 1988-1992. we controlled for the diversity of industry competitive environments by collecting data on companies doing business in 30 specific industries at the four digit sic level identified by dess and beard (1984) as being in the highest and lowest ranges of the three industry environmental dimensions. we collected data on the four dimensions of national culture for each global competitor by using the numeric scores for more than 20 horne countries as published in hofstede (1980). finally, i/b/e/s international provided earnings forecast and dispersion data for each finn. our goal was to develop and test two models replicating the information generally available to financial analysts for their prediction of future company performance. we chose the 1988-1992 period for collection of historical financial performance information for three reasons. first, we were interested in assessing the accuracy and dispersion of analysts' estimating behavior during a period of relati ve economic stability to ensure the most consistent results possible. since the historical financial data was after the 1986 u.s. tax act that radically changed the treatment of investment depreciation, we felt the impact of the change in the u.s. tax code would take a year or so to be fully understood by financial analysts. second, the data for 1988-1992 was prior to the effective dates of changes in accounting standards that modified the handling of deferred income taxes which we believed would make international comparisons difficult. finally, the data collected was prior to the increased mergerlipo activity that began around 1994. thus, we felt comparing analysts' estimates of future company performance versus the companies' actual performance, along with financial data from 1988-1992, was conducted during one of the most stable reporting periods for international firms over the last 15 years. the measures employed are summarized in figure 2 comparing the concepts discussed in the literature review to the operational measures. for both models, the control factors consist of the three measures of the industry competitive environment munificence, complexity and dynamism. the earnings forecast error model's independent variables of primary interest are five measures of firm strategies (inventory turnover, capital intensity, financial slack, research intensity and sales growth). the earnings forecast dispersion model's independent variables of primary interest are the four dimensions of national cultural individuality/collectivism, power distance, ambiguity avoidance and masculinity/ femininity. fall 2000 katz. et al.: forecasting performance 129 figure 2 operationalized factors affecting the financial performance forecasting national task firm past financial expected future culture-> environment-> strategies-> performance-> performance individuality munificence inventory earnings estimation error turnover stability masculinity complexlty capital intensity power distance dynamism financial slack number of agreement among estimate~ estimates (dispersion) uncertainty avoidance adapted from: katz et al., 1997 research intensity sales growth control factors task environment. to control for competitive differences in industries, data was collected for all firms in 30 industries nested into the five highest and five lowest ranked industries on the munificence, dynamism, and complexity factors developed by dess and beard (1984). to find the relative five highest and five lowest industries, the standardized factor scores in the dess and beard study were rank ordered. ouf total sample contained 421 firms representing 30 industries (five industries for each of the three high and low conditions). a validation of the dess and beard (1984) study was conducted by rasheed and prescott (1992), providing assurance regarding the accuracy of the rankings used in the present study. for example, in the environmental dimension, "complexity," which is used to define the relative level of protection an industry has due to the complex nature of the processes employed, data for all firms in the "high" condition in sic 2820, plastics and synthetic rubber manufacturing was collected, while data for firms in the "low" condition were chosen from sic 2080, beverage bottling. considering the relative differences in complexity of manufacturing processes between plastics and beverage bottling, particularly the impact of patents, it is highly likely that competition in the two industries would be significantly different table i displays examples of the industry dimensions, sample sics and definitions of firms in each the six control groups. 130 journal of business strategies vol. 17, no.2 table 1 measures and examples of industry environment dimensions environment industry example dimension condition industry sic company descriptions munificence high 3570 computer and office equipment low 3670 computer circuits and chips dynamism high 3330 metal smelting and refining low 3640 electric bulb and lamp manufacturing complexity high 2820 plastics and synthetic rubber manufacturing low 2080 beverage bottling size and variability. two additional variables are included in the model to control for company size: the natural log of total firm assets and the total number of estimates for each firm. typically, large companies provide more information to investors and are followed by more analysts because of the amount of information provided to make predictions (shipper, 1991). a third variable, earnings stability, is included to control for the variability of earnings of each firm as suggested by das et ai., (1998). the five-year earnings variation calculated by iib/e/s is the measure used for firm earnings stability. strategy measures five measures of business strategies were used as predictors of firm performance. since we are interested in assessing the impact of resource use (strategies) on performance prediction, three business strategies used by mcarthur and nystrom (1991) for which international data was available were replicated: inventory turnover, capital intensity, and financial slack. in addition, research intensity and sales growth were also employed to capture technology and market dominance as potentially related to earnings predictions (hambrick, 1983; shane, 1993). while these measures do not generally constitute a complete set of organizational strategies, they tend to provide a good sample of the strategies employed by firms in order to compete within industries and are based on information available to financial analysts through financial statements (hiu & ireland, 1987). in order to eliminate effects related to firm size, financial ratios were used for all firm-level predictors. specifically, inventory turnover is the ratio of sales to inventory; capital intensity is the ratio of assets to sales; financial slack is stockholders' equity as a percentage of total debt; research intensity is the ratio of sales to research and development expenses; and sales growth is the annual change in gross sales. all ratios were averaged over the five-year period to eliminate any potential effects attributed to cyclical variations due to macro-economic factors such as exchange rates or national recessions. fall 2000 katz, et at.: forecasting performance 131 cultural measures in order to assess the impact of national culture on business strategies and earnings forecasts, scores for the four dimensions of national culture (individuality, power distance, uncertainty avoidance and masculinity) as reported in hofstede (1980) were used. scores for the four cultural dimensions for each country are on a continuous scale ranging from 6 to 112. for example, the individualism score for the united states is 91 while the individualism score for japan is 46. the uncertainty avoidance score for the united states is 46 while the uncertainty avoidance score for mexico is 82. thus, firms headquartered in the united states, relative to those headquartered in japan, would be considered to have higher levels of individualism guiding the decisions of managers concerning business strategies of the firm. dependent variables we measured the dependent variables of the two forecast models as follows: earnings forecast error = in (actual mean eps forecast mean eps)/actual mean eps. earnings forecast dispersion = in (standard deviation of eps forecast). a logarithmic transformation of each measure was employed to ensure a normal distribution. results table 2 reports the means, standard deviations and bivariate correlations for the measures employed. the negative average forecast error (-2.23) reflects the systematic underestimation of earnings by financial analysts and is consistent with results reported in prior research (see for example, lang & lundholm, 1996). on a bivariate basis, forecast error was found to be significantly correlated with the level of industry dynamism, national culture measured by individualism and business strategies measured by inventory turnover, capital intensity, financial slack and research intensity. specifically, the incidence of forecast error was positively associated (r = .11, p < .05) with industries having a high level of dynamism and a negative association (r = -.09, p < .10) with industries having a low level of dynamism. this makes sense since it would be more difficult for financial analysts to accurately forecast earnings in a dynamically changing industry compared to an industry that is relatively stable. as expected, the relationships between forecast accuracy and firm size, earnings stability and number of estimates were found to be negative indicating that more information about the company results in more accurate estimations of future performance. table 2 v.jn means, standard deviations and correlations mean std 1 2 3 4 5 6 7 8 9 10 1 forecast error -2.23 1.58 1.00 2 forecast dispersion -1.23 2.57 .22*** 1.00 3 munificence high 0.31 0.46 .01 -.16*** 1.00 4 munificence low 0.22 0.41 .01 -.00 -.35*** 1.00 5 dynamism high 0.13 0.34 .11 ** .03 -.26*** -.20*** 1.00 ......c 6 dynamism low 0.10 0.31 -.09* -.09* -.23*** -.18*** -.13*** 1.00 :0::..., 7 complexity high 0.15 0.36 .02 .15*** -.28*** . -.22*** -.16*** -.14*** ;:s 1.00 l:l..... 8 complexity low 0.09 0.29 -.09* .11 ** -.21 *** -.17*** -.13*** -.11 ** -.13*** 1.00 ~ 9 uncertainty avoidance 58.25 23.50 .07 .61*** -.17*** .01 -.04 -.03 .14*** .16*** 1.00 tl::i 10 power distance 44.54 .17*** :0:: 12.27 -.03 .05 .00 -.12** -.04 .06 .06 .37*** 1.00 '"-. 11 masculinity 65.38 20.46 .02 .18*** -.07 .02 -.08 .00 .03 .03 .66*** .27*** ;:s ~ 12 individualism '"71.18 22.46 -.10* -.48*** .08 .05 .06 .05 -.15*** -.15*** -.45*** -.65*** '" 13 company size 11.34 -.20*** -.52*** .17*** .02 -.07 .00 -.09* -.11 * -.35*** c" 1.97 -.19*** .... ~ 14 earnings stability 34.82 32.42 -.27*** -.01 -.01 .03 .16*** -.16*** -.02 -.06 -.04 -.06 .... ~ 15 number of estimates 9.35 7.95 -.17*** -.18*** .12** .00 .05 -.12** -.03 -.08 -.20*** .06 00-. 16 inventory turnover -.02 ~ 7.92 7.95 -.13** .14*** .09* -.08 -.07 .00 .09* .05 .05 '" 17 capital intensity .47 .39 .09* .07 -.17*** -.06 .23*** -.06 .01 .13** -.06 .02 18 financial slack .46 .20 -.18*** -.33*** .12** .09 -.10** .01 -.09 -.10** -.29*** -.02 19 research intensity .07 .17 .17** -.13* .19** .00 -.10 -.08 -.10 -.05 -.06 -.05 20 sales growth 15.12 26.76 .03 -.09* .15*** .01 -.10* -.06 -.02 -.04 -.os .07 't-two-tailed test p-values: * p ~ .10, ** p ~ .05, *** p ~ .01 -.l z 0 n table 2 continued 'tl ~-means, standard deviations and correlations n 0 0 0 mean std 1 2 3 4 5 6 7 8 9 10 1 forecast error -2.23 1.58 2 forecast dispersion -1.23 2.57 3 munificence high 0.31 0.46 4 munificence low 0.22 0.41 ~ 5 dynamism high 0.13 0.34 .... !" 6 dynamism low 0.10 0.31 (1:>.... 7 complexity high 0.15 0.36 l::l :8 complexity low 0.09 '. 0.29 6l 9 uncertainty avoidance 57.65 23.50 ;;: 10 power distance 44.56 12.27 "l::l 11 masculinity 65.07 20.46 1.00 ""....s· 12 individualism 70.93 22.46 -.31 *** 1.00 oq 13 company size 11.34 1.97 -.03 .59*** 1.00 ""t::i(1:> 14 earnings stability 7.92 7.95 -.05 .09 -.06 1.00 ~ 15 number of estimates 9.35 0.90 -.17*** .13*** .42*** -.12** 1.00 ~ 16 inventory turnover 7.92 7.95 .05 -.11** -.03 -.09 .05 1.00 l::l ;:: 17 capital intensity .47 .39 "-.08 -.12** -.10** .02 -.04 -.01 1.00 (1:> 18 financial slack .46 .20 -.08 .18*** .03 -.12* -.01 .08 -.01 1.00 19 research intensity .07 .17 -.02 .09 -.07 .02 -.08 .00 .08 .13* 1.00 20 sales growth 15.12 26.76 -.02 -.01 .00 -.07 .07 -.oj -.oj .13** .82*** 1.00 two-tailed test p-values: * p ~ .10, ** p ~ .05, *** p ~ .01 -w w 134 journal of business strategies vol. 17, no.2 in regard to forecast dispersion, significant bivariate relationships are evident in industry competitive environments which have higher levels of munificence (r;::; . i6, p < .01), higher levels of complexity (r =.15, p < .01) and lower levels of complexity (r ;::; . i i, p < .05). analysts' forecasts of earnings were found to be marginally less dispersed in industries with lower levels of dynamism (r ::;: -.09, p < .10). forecast dispersion was found to be significantly associated (p < .01) with all four measures of national cultural consistent with franke et al. (1991). in addition, the size of the company and the number of analysts following the company resulted in lower variance among the analysts' estimates of earnings as predicted. table 3 reports the results of the earnings forecast error model. the results generally support hypothesis 1. that is, controlling for the effects of industry factors, the level of forecast error is significantly related to management decisions to allocate resources that result in changes to the rate of inventory turnover (a measure of relative operational efficiency), financial slack (a measure of management's decision to use cash as a competitive weapon), and research intensity (management's decision to use investment in research and development as a basis for firm growth). these results are consistent with mitroff and mohrman (1987) and nakata and sivakumar (j 996). the results of the model also indicate that national culture, specifically' individuality (b = -.15, p = .02), results in lower forecast error. overall, the results of the earnings forecast error model make sense. prior research has indicated that business strategies are significant determinants of firm performance, controlling for industry and national cultural factors (katz er al., 1997). overall, the model explains 12 percent (p < .0001) of the variance in earnings forecast errors made by financial analysts. table 4 reports the results of the earnings forecast dispersion model. the results support hypothesis 2. that is, controlling for industry competitive factors and business strategies, national culture has a significant impact on the level of agreement among financial analysts with regard to future earnings of the firm. interestingly, all of the measures of culture are negatively associated with forecast dispersion (lower dispersion) except uncertainty avoidance (b :;;; .75, p :;;; .001). perhaps this occurs because in countries having lower levels of uncertainty avoidance, such as the united states, it is more difficult for analysts to agree on the future earnings of the firm (gray, shaw & mcsweeney, 1981; peterson etal., 1995). conversely, in cultures where workers actively avoid uncertainty, such as japan, financial analysts are less able to gain consensus on earnings forecasts because workers are unwilling to disclose operational vagaries resulting from the finn's competitive environment or strategies employed by the firm. in the earnings forecast dispersion model, the only significant business strategy found to affect the level of forecast dispersion is inventory turnover (b = .09, p = .008). neither the size of the firm nor the variability of earnings appears to significantly impact estimate dispersion. overall, the model explains 54 percent (p < .000 i) of the variation in financial analysts' earnings forecast dispersion. fall 2000 katz, et al.: forecasting performance table 3 earnings forecast error model: regression of strategy, environment, and national culture on forecast error 135 variables b se beta beta p-value inventory turnover .03 .009 -.137 .003 capital intensity .30 .194 .076 .119 financial slack -1.05 .377 -.141 .005 research intensity 2.04 .830 .158 .014 sales growth -.003 .004 -.055 .392 earnings stability .01 .003 -.149 .002 number of estimates -.03 .009 -.132 .008 uncertainty .001 .004 .022 .751 power distance -.01 .008 -.018 .091 masculinity .03 .005 -.007 .917 indi viduality -.01 .004 -.151 .023 constant -.45 .677 adjusted r2 .12 f 4.55 p-value .0001 table 4 earnings forecast dispersion model: regression of strategy, environment, and national culture on forecast dispersion variables b se beta beta p-vaiue inventory turnover .03 .011 .090 .008 capital intensity .27 .232 .040 .251 financial slack -.67 .449 -.054 .135 research intensity 1.14 .988 .053 .251 sales growth -.003 .004 -.036 .445 earnings stability .001 .003 .014 .682 number of estimates -.002 .001 -.005 .882 uncertainty .08 .005 .754 .001 power distance -.06 .009 -.280 .001 masculinity -.05 .005 -.376 .001 individuality -.04 .005 -.398 .001 constant 2.65 .807 adjusted r2 .54 f 32.30 p-value .0001 136 journal of business strategies discussion vol. 17, no.2 we began this study by seeking to better understand the relationship between business strategies and analysts' earnings forecasts of global competitors while taking into account culture and industry factors previously suggested to affect the structure-strategy-performance relationship. prior research has documented the importance of psychological processes used by financial analysts in making market predictions. specifically, hunter and coggin (1988) reported that human judgement is more important in determining the accuracy of earnings forecasts than the efficient market hypothesis which assumes all available information is viewed uniformly by financial analysts. we believe that our results extend the work of hunter and coggin (1988) by examining the broad array of information used by financial analysts in a more fine-grained cross-sectional model than previous approaches. by hypothesizing that business strategies would influence earnings forecasts, we sought to control for the effects of national culture and industry on the estimation of future performance by financial analysts experts employed to predict future success, or failure, of international competitors. our study provides evidence that business strategies are a major influence on the accuracy of financial analysts' earnings forecasts of international competitors. our study also provides evidence that national culture is a dominant influence affecting the level of agreement among financial analysts' with regard to future earnings forecasts. it is, therefore, not surprising that previous exploratory research has shown understanding the factors affecting consensus earnings estimates in world financial markets is important in assisting firms in their diversification strategies (erickson & cunniff, 1995). thus, by examining the effects of four dimensions of national culture, we extended the existing research beyond the domestic/multinational dichotomy typically employed in recent research (cheng, chan & liao, 1997), and sought to assess the relative impact of specific cultural factors on the level of agreement among financial analysts. we believe these findings have significant implications for global managers, investors/financial analysts and academic researchers. implications for global managers our results provide evidence that global managers employing fast-paced strategies such as high levels of research and development investment, indicative of a differentiation strategy, and high levels of inventory turnover, indicative of a low-cost leadership strategy, may be providing an environment of prediction uncertainty for financial analysts. therefore, managers choosing these strategies should provide management earnings estimates and other data for use by financial analysts in order to lessen the financial market impact resulting from a more complex set of strategies. for example, gonsalves and eiler (1996) suggest it is important for managers to understand the impact of complexity on the operations ofthe firm and report in ways that will help stockholders and investors understand fall 2000 katz, et al.: forecasting performance 137 complexity faced by the firm. it is clear that stable earnings help financial analysts to more accurately predict future earnings. across countries, there is evidence that firms in countries having higher levels of power distance systematically have lower analysts' forecast errors. in addition, firms in countries having higher levels of individuality result in systematically higher levels of forecast accuracy. based on suggestions by hofstede (1983) it is possible the first relationship occurs because management does not willingly disclose firm strategies to outsiders. the second relationship may occur because management of firms in countries having high levels of individuality, such as the united states, disclose more extensive information to financial analysts (zarzeski, 1996). in regard to the dispersion of analysts' earnings forecasts, global managers should be aware that national culture dramatically influences how analysts predict earnings. culture is the overwhelming predictor of the variability of analysts' forecasts. because both culture and analysis of future earnings performance are complex, there are many potential reasons for disagreement about a firm's future earnings. for example, some cultures more readily disclose financial information and have a larger financial analyst community. in such cases, it has been reported that more financial analysts following a firm's activities will result in reduced cost of capital (botosan, 1997). however, even though there may be larger analyst communities, the analysts face the daunting task of predicting earnings for firms with different strategies, different industry environments, and different company cultures. for global financial managers interested in reducing the level of forecast error and dispersion for their firms, we offer the following actions plans: 1. in external communications to shareholders and the financial community, carefully disclose how the accounting standards of the home country maybe different than u.s. generally accepted accounting standards. 2. discuss the cultural context of the home country in terms that relate to how the company makes critical decisions affecting the long-term approaches the business uses in developing competitive advantage. 3. discuss the nature of the industry in which the firm competes with particular emphasis on driving forces of change in the industry. 4. discuss the strategies employed by the firm at the present time and a forward-looking discussion of the likely business strategies to be implemented in the near-term. implications for financial analysts/global investors the results of our study suggest that financial analysts who estimate earnings, and global investors who use earnings predictions, are impacted by "layers" of contingent factors affecting the accuracy and dispersion of earnings predictions in the global marketplace. for global investors using earnings predictions for capital market decisions, this study should increase the awareness that, in addition 138 journal of business strategies vol. 17, no.2 to industry environment, the business strategies and the national culture of a firm are important considerations. since numerous studies have shown that the change in earnings from one period to another correlates positively with the change in stock price at earnings announcement, global investors should now include a greater understanding of these factors affecting the accuracy of earnings predictions. implications for academic researchers there are a number of issues for future research. our findings provide a useful departure for future inquiry into the interaction of culture, environment, strategy and performance predictions. we have shown that company financial reporting and investment community environments can be analyzed in more detail to determine more specifically the factors affecting earnings predictions. if more recent models of culture having additional cultural dimensions can be employed, further insight into the nation/structure/strategy/performance relationship will be gained. for example, future research should examine the information strategy, the product diversification strategy and the geographic diversification strategy of firms across different cultures. the global marketplace appears to be encouraging researchers from several disciplines to collaborate on studies that explain these global business relationships. references abolafia, m. (1996). makinj; markets: opportunism and restraint on wall street. cambridge, ma: harvard press. adhikari, a & tondkar, r. h. (1992). environmental factors influencing accounting disclosure requirements of global stock exchanges. journal of international financial mana~ement and accountjn~. 4, 75-105. aldrich, h. (1979). qr&anizations and envjronments, englewood cliffs, nj: prenticehall. andrews, k. (1987). the concept of cqrporate strate&y, homewood, il: irwin publishing. bartlett, s. (}998). who can you trust? busjnessweek. october 5: 133-156. barrett. m. e. (1976). financial reporting practices: disclosure and comprehensiveness in an international setting, journal of accounting research, 14m, 10-26. barton, s. & gordon, p. (1988). corporate strategy and capital structure. strateiic manaj;ement journal. 9, 623-632. botosan, c. (997). disclosure level and the cost of equity capital. the accountinj; review. 72(3), 323-349. fall 2000 katz, et al.: forecasting performance 139 brown, l., richardson, g. & schwager, s. (1987). an information interpretation of financial analyst superiority in forecasting earnings. journal of accounting research. 250), 49-67. brown, l. & rozeff, m. (1978). the superiority of analyst forecasts as a measure of expectations: evidence from earnings. the journal of finance. 33(1), 1-17. caves, r., gale, b., & porter, m. (1974). interfirm probability differences, journal of economic literature. 88, 181-192. calderon, t. (1993). predictive properties of analysts' forecasts of corporate earnings. mid-atlantic journal of business. 290), 41-58. cheng, a., chan, k. & liao, w. (1997). an investigation of market response to earnings announcements: multinational firms versus domestic firms. the international journal of accounting. 32(2), 125-138. cheng. c., etheridge, h. & noland, t. (1994). information complexity and the earnings response coefficient: a comparison of multinational and domestic firms. advances in international accounting. 7, 89-120. choi, f. (1973). financial disclosure and entry to the european capital market. journal of accounting research. 11, 159-175. conroy, r. & harris, r. (1987). consensus forecasts of corporate earnings: analysts' forecasts and time series methods. management science. 33(6), 725-39. das, s., levine. c. & sivaramakrishnan. k. (1998). earnings predictability and bias in analysts' earnings forecasts. the accounting review. 73(2), 277-294. das, s. & saudagaran. s. (1998). accuracy, bias and dispersion in analysts' earnings forecasts: the case of cross-listed foreign firms. journal of international financial management & accounting. 90 ), 16-33. dess, g. & beard. d. (1984). dimensions of organizational task environments. administrative science quarterly. 29.52-73. dreman, d. & berry, m. (1995). analyst forecasting errors and their implications for security analysis. financial analysts journal. 51 (3), 30-41. elton. e .• gruber, m. & gultekin. m. (1981). expectations and share prices, management science. 27,975-987. elton, e., gruber. m. & gultekin, m. (1984). professional expectations: accuracy and diagnosis of errors, journal of financial and quantitative analysis. 19. 351-363. 140 journal of business strategies vol. 17, no.2 erickson, h. & cunniff, j. (1995). a comparative look at consensus earnings in world markets. journal of investing, spring, 19-28. fatemi, a. (1984). shareholder benefits from corporate international diversification. :rw. journal of finance. december, 1325-34. franke, r., hofstede, g & bond, m. (1991). cultural roots of economic performance: a research note. strategic management journal. 12, 165-173. gonsalves, f. & eiler, g. (1996). managing complexity through performance measurement. mana~ement accountin~, august, 34-39. gray, s., j. shaw, & l. mcsweeney. (1981). accounting standards and multinational corporations. journal ofinternational business studies. 12, 121-136. hambrick. d. (1983). high profit strategies in mature capital goods industries: a contingency approach. academy of mana~ementjournal. 26, 687-707. hambrick, d. & lei, d. (1985). toward an empirical prioritization of contingency variables for business strategy. academy of mana~ementjournal. 28, 763-788. hitt, m. & ireland, r. (1987). building competitive strength in international markets. lon~ ranie plannin~. 20(1), 115-122. hofer, c. (1975). toward a contingency theory of business strategy. academy of management journal. 18,784-810. hofstede, g. (1983). the cultural relativity of organizational practices and theories. imu:rnll of international business studies, fall, 75-89. hofstede, g, (1980). culture's consequences: international differences in work-related ~. beverly hills, ca: sage publications. hunter, j. & coggin, t. (1998). analyst judgement: the efficient market hypothesis versus a psychological theory of human judgement. organizational behavior and human decision processes. 42, 284-302. jauch, l., osborn, r. & glueck, w. (1980). short term financial success in large business organizations: the environment-strategy connection. strate2ic mana2ement journal. 1, 4963. katz, j" werner, s. & brouthers, l. (1999). country goal orientation differences of global competitors: an empirical assessment of u.s., japanese, and ec banks. journal of business research. 44(2),117-126. fall 2000 katz. et af.: forecasting performance 141 katz, j., zarzeski, m. & hall, j. (1997). the importance of strategy to global competitors: the strategy-performance relationship across cultures. journal of business strategies. 14(2), 126140. lang, m. & lundholm, r. (1996). corporate disclosure policy and analyst behavior. ~ accounting review 71{41,467-92. leblebici, h. & salancik, g. (1982). stability in interorganizational exchanges: rulemaking processes of the chicago board of trade. administrative science ouarterly. 27,227242. lee, m., lee, i., & ulgado, f. (1993). marketing strategies for mature products in a rapidly developing country: a contingency approach. international marketing review. 10(5), 56-72. mann, j. 1998. earnings forecast bruises stock: interstate bakeries says it doubts it will meet analysts' predictions. the kansas city star, october 31: b 1. mcarthur,a. & nystrom, p. (1991). environmental dynamism, complexity and munificence as moderators of strategy-performance relationships. journal of business research. 23, 349361. mitroff, i. & mohrman, s. (1987). the slack is gone: how the united states lost its competitive edge in the world economy. academy of management executive. lcd, 65-70. nakata, c. & sivakumar, k. (1996). national culture and new product development: an integrative review. journal of marketing. 60, 61-72. olsen, r. (1998). behavioral finance and its implications for stock-price volatility. financial analysts journal. 54(2), 10-18. osland, g, & cavusgil, s. (1996). performance issues in u.s.-china joint ventures. california management review. 38(2), 106-130. patell, j. (1976). corporate forecasts of earnings per share and stock price behavior: empirical tests. journal of accounting research, autumn, 246-76. peterson, m. et af. (1995). role conflict, ambiguity, and overload: a 21 nation study. academy of management journal. 38(2), 429-452. porter, m. (1990). the competitjve advantage of nations. new york: free press. porter, m. (1985). competitive advantage. new york: free press porter, m. (1980). competitive strategy. new york: free press. 142 journal of business strategies vol. 17, no.2 prescott, j. (1986). environments as moderators of the relationship between strategy and performance. academy of mana~mentjournal 29, 329-346. rasheed, a. & prescott, j. (1992). toward an objective classification scheme for organizational task environments. british journal ofmana~ement. 3(4),197-206. rivera, j. (1991). prediction performance of earnings forecasts: the case of u.s. multinationals. journal oflnternatjonal business studies. second quarter, 265-288. rockart, j. (1979). chief executives define their own data needs. harvard busjness review. 57, 8198. scherer, f. (1970). industrial market structure and economic performance. chicago: rand mcnally college publishing. shaked. i. (1986). are multinational corporations safer? journal of international busjness ~, spring, 83-106. shane, s. (1993). cultural influences on national rates of innovation. journal of bysiness yenturin~. 8(]), 59-73. shefrin, h. & statman, m. (1993). behavioral aspects of the design and marketing of financial products. financial management. 22(2), 123-134. shipper, c. (1991). commentary on analysts' forecasts. accounting horizons, december, 105-121. solnik, b. (1974). the international pricing of risk: an empirical investigation of the world capital market structure. the journal of finance, may, 48-54. speidell, l. & ramos, e. (1998). do earnings estimates matter? journal ofinvesting, 7(2), 23-31. venkatraman, n. & ramanujam, v. (986). measurement of business performance in strategy research: a comparison of approaches. academy of mana~!ilrnl;dt review. 1 j(4), 801-814. vlasic, b., kerwin, k., woodruff, d., peterson, t., & spiro, l. (1998). the first global car colossus. businl;ssweek, may 18,40-43. zarzeski, m. (1996). spontaneous harmonization effects of culture and market forces on accounting disclosure practices. accounting horizons. loci), 18-37. fall 2000 katz, et al.: forecasting performance 143 jeffrey p. katz is an associate professor in the department of management and the payless shoesource professor of business at kansas state university where he conducts research and teaches strategic management and international management. he received his doctor of philosophy in strategic management from the university of florida's graduate school of business administration. his research examines the role that national programs play in the international competitiveness of global firms. his work has appeared in the academy of management journal, academy of management executive, business horizons, human resource planning journal, international journal ofmanagement, journal of business strategies, long range planning, and the journal of business research. he is a former fulbright senior scholar at the university of giessen, germany. marilyn t. zarzeski is croft associate professor of accounting at the university of mississippi and has earned three research awards. prior academic assignments include the university of central florida and barry university. she earned her ph.d. at the university of florida in 1994. she received her cpa license in 1978, after earning her mba at youngstown state university. prior to academe, marilyn did auditing and accounting for american express, cigna, flagship bank, and keller industries. h. john hall is the director ofthe master ofarts in international business program in the warrington college of business administration at the university of florida. he received his ph.d. at the university of georgia. his research interests include strategic decision making and entrepreneurship. he is a heiser award recipient for outstanding research in entrepreneurship by the academy of management. he has presented executive workshops in the u.s. and numerous other countries. the authors gratefully acknowledge i/bie/s international, inc. for providing financial forecast data through the institutional brokers' estimate system and the helpful comments provided by the jbs' reviewers and editors. the impact of strategy, industry and culture on forecasting the performance of global competitors: a strategic perspective on the perils, pitfalls, and opportunities of global diversification: a high-stakes gamble? darryl g. waldron department of business administration trinity university san antonio, texas a company that recognizes its business as potentially global in nature must be willing to risk the heavy investment that global diversification can bring. to succeed, a firm must clearly understand what kind and level of resources--qver how long a period-will be required to establish a presence in overseas markets. there is considerable evidence that too many companies have undertaken diversification efforts without thoroughly understanding the complexities of the process. biggadike [4] made this clear in his study of over 200 firms that had attempted diversification, and others have reported similar findings ([i),[2],[3],[4],[5],[6],[7],[8],[9],[10],[l1j, [12]'[13]'[14],[15],[161,[17]). from his study, biggadike [4] concluded that companies contemplating diversification should be aware that: • large scale market entry will substantially improve the probability of success; • an emphasis on very rapid early gains in relative market share is the best way to reduce the length of time over which losses must be incurred; • even in narrowly defined market segments small-scale entry significantly reduces the probability of success; • one should back a diversification effort as long as it continues to build market share; and • resources should be withdrawn from a profitable venture if profits have been gained at the cost of market share (i.e., a profitable diversification effort based on low or declining market share is destined to be tomorrow's dog). the objective of this study was to apply biggadike's [4] analytical approach to a sample of international diversification efforts in order to identify any parallels that might exist, and to operationalize these findings in terms of a prescriptive model of practical value to decision makers. as in biggadike's study, no attempt was made to develop statistical inferences from the results because even though the data were journal of business strategies, volume 5, number 2 (fall 1988) 111 112 journal of business strategies vol. 5, no.2 collected in a standardized fashion, some diversifications were related, others were conglomerate in nature, and some did not fit neatly in a category. for example, does exxon's hong kong electric utility constitute a related or conglomerate diversification? they say related, while a strict academic interpretation might suggest otherwise. in addition, significant scale differences were present, and, where some questions were concerned, respondents were free to exercise considerable discretion in answering. as an example, while "later phase of market and share development" was defined, it was left to the respondent to interpret "relative market share" given that fum's definition of its market{ s). and, with respect to what constituted a "small," "medium," or "large" scale entry, respondents were given a description of each but were then left to decide where their diversification effort belonged. these insights are offered to assist the reader in judging the limitations of the study and its conclusions. the sample data for this study were drawn from a sample of 97 companies that have undertaken significant international product-market diversification efforts during the past 20 years. a significant international product market diversification effort was defined as: a product or market diversification involving the creation of at least a profit center in one or more foreign markets selling a distinct set of products or services to an identifiable target market where meaningful competition exists and where capital has been put at risk. under this definition, gaining entry to a foreign market by simply selling through a broker or manufacturer's representative would not constitute a "significant" productmarket diversification because no direct foreign investment has taken place. correspondingly, a fum that creates an offshore production facility, the output from which it imports for use in manufacturing a finished good, would not satisfy the "profit center" or "meaningful competition" criteria. corporate acquisitions were included only if the venture represented a significant international product-market diversification for the acquiring firm. as an example, unilever's acquisition of national starch was included because it represented both product and market diversification for unilever, direct foreign investment was involved, a profit center was created, a distinct set of products was being sold to identifiable target markets, and meaningful competition was present. on the other hand, 3m's acquisition of ferrania was not included because it was undertaken to acquire technology to improve its own film products which it was already marketing worldwide. firms receiving questionnaires were identified through a review of the trade literature (the national review of oorporate acquisitions, wall street journal, business week, the financial times, the european edition of the wall street journal, forbes, the asian edition of the wall street journal, and others) as having undertaken foreign diversification. in some instances these turned out to be fairly recent diversification fall 1988 waldron: global diversification 113 efforts but others represented investments extending back nearly 20 years. a wide range of experience was represented with respect to time of operation, financial performance, stage of market development, market versus financial performance, market shares, scale of operation, and scale of market entry. because this was a convenience sample, no attempt was made to extrapolate the results to a broader population. furthermore, no effort was made to correlate performance with geographical markets or to identify what might constitute a successful diversification. financial performance as a group, sample firms experienced significant losses for at least the first four to five years, some even longer. selected measures of financial performance are presented in table 1. clearly, the first six years was a period of marginal performance for most of the sample firms. table 1 median financial performance during the first six years years financial ratios 1-2 3-4 5-6 --------------gross margin 21 30 33 operating margin -31 -13 ~3 roi -36 -17 5 dncf /tnvestment a -48 -26 -14 adncf (discretionary net cash f1ow)= net income plus all non-cash expenditures minus capital expenditures necessary to maintain the investment and required debt retirement. not all diversification efforts resulted in losses. in fact, 27 of the sample firms recorded profits during the first two years of operation. however, eight of these later lost money, suggesting that early success is no guarantee of ongoing profitability. holding market share appeared to be an important determinant of longer term success. in general, sample firms found that "going international" is apt to result in prolonged negative cash flows. none of the diversification efforts generated a positive discretionary net cash flow during the first six years. gross profit was the most encouraging area of financial performance. even here, however, marginal gains in gross returns during years five and six remained quite modest. this was also true of operating expenses. most operating expenses declined as a percent of sales over the first six years, but at a diminishing rate. and these gains came not as a consequence of reduced spending, but from rapid growth in sales. the median rate of growth in sales for the period was 37 percent. once again, being able to grow market share, as opposed to simply increasing revenue through higher prices, appeared to be of critical importance for sample firms 114 journal of business strategies vol. 5, no.2 achieving long-term success. and any firm that undertakes an international diversification effort anticipating significant gains once "start-up" capital and operating outlays are covered may be surprised. results obtained here would suggest the possibility of significant losses for an extended period. for the firm that is unable to quickly achieve a major improvement in sales, high operating expenses and capital requirements as a percent of sales are apt to lead to a permanently weakened competitive position. taking losses for a period of time in association with any new venture is not unusual. consequently, knowing for how long and being able to anticipate the rate of improvement in performance are certainly important considerations. in exploring these issues the sample was arrayed on a time series basis and examined during the "early," "intermediate," and "later" phases of market development. more recent diversification efforts were categorized based on years of experience and unsuccessful efforts were tracked until they failed. table 2 presents these results. table 2 median performance in early, intermediate, and late phases of market development intermediate financial ratios early phase phase later phase yea~~years.-year~-year-s---y~~s--1-2 3-4 5-6 7-8 9-10 gross margin 21 30 33 34 43 operating margin -31 -13 -3 2 13 roi -36 -17 -5 7 21 dncf iinvestment -48 -26 -14 1 7 the message conveyed here is that, for the firms in the sample, significant international product market diversification efforts required an average of seven to eight years to achieve profitability. given this result, it would appear that international diversification may not be for the impatient or for those lacking "deep pockets." under such circumstances a firm with extraordinary patience and a long term strategic orientation, unencumbered by concerns about annual returns to stockholders, and with a surplus of low cost capital would seem to have a distinct competitive advantage. it is probably not coincidence that these qualities characterize many japanese multin ationals. there is considerable "real world" evidence that, over time a strong positive correlation exists between relative market share, roi and cash flow from operations (i.e., the pims study). and while building market share may compromise financial performance, long term returns to growth through expanded relative market share appear to make such compromises worthwhile. to examine the impact of market share on financial performance the sample was divided into three groups arbitrarily defined as "low," "medium," and "high" relative fall 1988 waldron: global diversification 115 market share diversification efforts. table 3 presents the results of a comparison of such efforts for the first two years and for second two years of the diversification. -----------------.'._-----rms years 1 and 2 rms years 3 and 4 financial ratios (below (over (below -~._--~.,-_.(o~er 10%) (10%-50%) 50%) 10%) (10%-50%) 50%) gross margin 19 23 28 18 25 36 operating margin -56 -29 -19 --41 -21 -15 roi -68 -30 -22 -39 -15 -8 dncf /investment -81 --47 -31 -60 -25 -12 ~------,......__ ..• "-------table 3 a comparison of relative market share and financial performance sample firms experienced a positive relationship between market share and financial performance both initially and over time. overall, these results seem to support the contention that market share is worth spending for given that management is strategically inclined and willing to live for some time with significant negative cash flows. here an important distinction must be made between having market share and growing market share. in general, having market share seemed to constitute a competitive advantage but having to grow market share from a low market share position appeared to compromise financial performance. table 4 looks at the financial consequences of having to grow market share over the first four years of an international diversification effort. financial ratios table 4 the fin8nc!ttl~~_()lgrowi!1g~relative market_share growth in relative market share &pl~~de~;;t-e--slow gross margin operating margin roi _d~cdirt,,-e~l~ent 20 31 38 -37 -13 -3 -41 -20 -7 -63 -33 -23 these results indicate that management, intent on rapidly building market share, may have to pay a handsome premium in terms of financial performance. in particular, the impact on discretionary cash flow is apt to be especially burdensome. this would seem to auger well for those firms able to readily draw cash from other sbus within their corporate portfolios. it appears that the scramble for market share during the early years of an international diversification effort can have a deleterious impact on financial performance. what is less clear are the relative benefits that might obtain for those competitors that, if necessary, are willing and able to sustain significant losses to capture and hold 116 journal of business strategies vol. 5, no.2 market share on a long term basis. table 5 looks at financial performance among low, medium, and high market share companies in years nine and ten, defined here as the "later phase" in terms of market and share development. table 5 relative market share and financial performance in the "later phase" of market and share development . ----rel~;:;ema,rk~t share' financial ratios low mediumiiigh_. gross margin 37 42 51 operating margin 12 15 21 roi 17 23 31 dncf /investment 5 11 20 i<or sample firms, high relative market share, while costly to achieve, was well worth the sacrifice. if this is true, the implication is clear: capturing market share is important and the earlier the better. growing market share can be a very costly proposition, especially when trying to work up from a low market share position against entrenched competition. in order to further explore the importance of scale of entry, the financial performance of small, medium, and large scale entrants was examined. the sample was grouped according to entry level strategies which were defined as follows: (1) sma.ll scale entry: limited investment, limited financial risk, grow over time, (2) medium scale entry: moderate investment, moderate financial risk, grow over time, (3) large scale entry: required level of investment, required financial risk, quickly capture and hold dominant market share. table 6 correlates financial performance with entry level strategies for the first two years. scale of entry table 6 and financial performance scale of entry financial ratios gross margin operating margin roi dnc~/investment small scale 20 -51 -61 -73 medium scale 21 -35 -33 -51 large scale 37 -17 -19 -30 a strategy based on a small scale of entry would appear to be suboptimal. furthermore, when one reflects on the "financial cost" of growing market share, an aggressive entry strategy would seem to represent the best alternative, at least in most instances. strategic implications for a company committed to undertaking a successful international productmarket diversification effort, the experience of firms in this study may be of interest. fall 1988 waldron: global diversification 117 while some firms experience immediate profits, most incurred significant losses for up to six or seven years. also, large negative cash flows obtained and firms unable to draw on other sources of financing to grow market share were at a distinct competitive disadvantage. with respect to market share, clear advantages in financial performance generally resulted for those oompanies able to capture and hold high relative market shares. while there were exceptions, the high relative market share rompanies in this study generally outperformed low share companies in each phase of market development. however, high relative market share did not assure profitability. rather, it was one means to that end. in terms of market entry, the probability of a successful international product market diversification effort would appear to be substantially enhanced by following a large scale market entry strategy. sample firms that took a less aggressive approach experienced compromised financial performance and faced the costly process of growing market share. in short, much of what biggadike [4j suggested as characteristic of domestic di· versification efforts would seem to characterize the international diversification efforts examined in this study. based on these results, the firm interested in formulating and implementing an optimal international diversification strategy should be prepared to sustain losses for up to eight years, focus on achieving a dominant relative market share as early as possible, and avoid having to grow market share over time by putting resources "up front" to achieve a large scale market entry. furthermore, today's profitable diversification effort with a low or declining market share has the potential to become tomorrow's dog. global diversification is indeed a high-stakes gamble but one that many companies have taken with considerable success. what this study has attempted to offer is anecdotal evidence to demonstrate that there may be a right way to go about diversifying internationally. the limitations of this study are clear, however, and this is an area of research with great potential for further investigation of a more rigorous nature. also, it is an area of real interest to practitioners and one where scholars can have a meaningful impact. references 1. aharoni, yair. the foreign investment decision process. boston, ma: graduate school of business administration, harvard university (1966). 2. ansoff, igor. corporate strategy. new york, ny: mcgraw-hill book co. (1965). 3. biggadike, ralph e. corporate diversification: entry, strategy, and performance. cambridge, ma: harvard university press (1976). 4. biggadike, ralph e. "the risky business of diversification." harvard business review (may-june, 1979). 118 journal of business strategies vol. 5, no.2 5. brown, paull "diversifying successfully." business horizons (august, 1976). 6. breen, timothy and stephen c. coley. "adding value through diversification." tbe mckinsey quarterly (winter 1984). 7. conner, f. and r. miller. "the performance of multinational corporations." international journal of business (summer, 1977). 8. conrad, gordon r. "unexplored assets for diversification." harvard business review (september-october, 1963). 9. davidson, william. "the location of foreign direct investment activity: country characteristics and experience affects." journal of international business studies (fall 1980). 10. harrell, gilbert d. and richard o. kiefer. "multinational strategic market portfolios." msu business topics (winter, 1981). 11. lecraw, donald j. "performance of transnational corporations in less developed countries." journal of international business (spring/summer, 1983). 12. pekar, peter p. and darryl j. ellis. "acquisitions: let's do them properly." managerial planning (january, 1980). 13. philippatos, george c. and kelly e.e. wickes. "comparative analysis of the foreign investment practices by u.s. based manufacturing multinational companies." journal of international business studies (winter 1982). 14. roberts, edward and charles berry. "entering new businesses: selecting strategies for success." sloan ma.na.gement review (spring, 1985). 15. rumelt, richard p. strategy, structure, and economic performance. boston, ma: division of research graduate school of business administration, howard university (1974). 16. salter, malcolm s. and wold a. weinhold. diversification tbrougb acquisition. new york, ny: free press (1979). 17. yip, george s. "diversification entry: internal development versus acquisition." strategic management journal (october-december, 1982). on the perils, pitfalls, and opportunities of global diversification: a high-stakes gamble? selected tax issues concerning the sale of a principal residence kathleen e. bauer, cpa division of business administration midwestern state university wichita falls, texas many times taxpayers change their personal residence as a result of job changes, job transfers, or a desire to move io another location. problems often arise when the taxpayer attempts to sell his old home and finds that he is unable to sell it because of a soft real estate market in the area or the unavailability of mortgage financing or high interest rates. the purpose of this article is to examine the feasibility of renting a personal residence during these periods of economic depression while at the same time retaining the nonrecognition of gain treatment for federal income tax purposes upon the eventual sale of the residence. to alleviate the cash flow problems of making two house payments, many taxpayers decide to rent their principal residence until it can be sold. for federal income tax purposes, this series of events creates two questions/problems from the standpoint of the taxpayer (seller-renter): 1. will the former personal residence be considered abandoned by vacating it before its sale? do rental activities from the time the former residence is vacated until its sale convert such property into "property held for the production of income"? depending upon the answers to these two questions, the former residence could be deemed as property held for investment rather than as a persona! residence the effect of which would preclude the nonrecognition of any gain on its sale (code section 1034 treatment ). 2. to what extent may the related rental expenses be deducted from the rental income collected during this interim period? are the deductibility of rental expenses and code section 1034 nonrecognition of gain treatment on the sale of a principal residence mutually exclusive? code section 1034 and code section 121, in general when a taxpayer sells his home, a loss (if realized on the sale) is generally not deductible because the property is personal use property and a gain (if journal of bu$iness strategies, volume 4, number 2 (fall 1987) 68 realized on the sale) is generally taxable as a capital gain. however, code section 1034 provides for the nonrecognition of any gain realized on the sale of a taxpayer's principal residence, if within a certain time period he invests (by purchasing or building) in a new principal residence an amount at least as large as the adjusted sales price of the old residence. for this section to be applicable, "the home sold and the home acquired must be the 'principal residence' " ([3], p. a-3) of the taxpayer. "principal residence" is ordinarily defined as the home you actually live in. the new residence must be acquired no earlier than two years before or no later than two years after the sale of the old residence [4]. in addition to the relief provided by code section 1034, code section i21 allows a taxpayer to exclude from gross income up to $125,000 ($62,500 for a married person filing separately) of the gain on the sale of a personal residence if he or she has reached age 55 on or before the date of sale. for this code section to be applicable, the residence must have been owned and used by the taxpayer as his principal residence for at least three years out of the last five years ending with the date of sale. this exclusion must be elected by the taxpayer and may be used only once by a taxpayer. it should be noted that the tax reform act of 1986 [6], while categorized as the most extensive overhaul of our tax system in history, did not affect the basic tax structure in regards to a sale of a principal residence. consequently, the tax law in this area remains unchanged. code section 1034 and the "actual physical occupancy" rule because the old prindpal residence must be sold either two years before or after the acquisition of the new principal residence in order to take advantage of code section 1034, certain tax problems aricse when the old home cannot be sold. such a home is often rented or left vacant between the time the taxpayer occupied it and the date of its eventual sale. does this preclude the taxpayer from the tax savings offered by code section 1034 because the taxpayer did not physically occupy the premises as his principal residence on the date of the sale? the legislative history of the statute indicates that the taxpayer does not have to physically occupy his old residence within two years of the date of its sale and purchase of a new principal residence. the requirement of "actual physical occupancy" of the old residence within two years of the date of its sale does not require the taxpayer to occupy his former home until the date he sells it. however, it does require the taxpayer to purchase and occupy his new principal residence within two years of the date that he vacated his former principal residence. failure to sell one's home within two years before or after the acquisition and physical occupancy of a new principal residence would preclude the taxpayer from applying code section 1034 resulting in the recognition and taxing of any gain on the eventual sale of the former principal residence [7]. 69 there are two exceptions to this "physical occupancy" rule. one exception to this rule involves the taxpayer who vacates his residence with the intention of returning but later changes his plans and sells the residence. in trisko v. commissioner [8], the taxpayer vacated his home because of a temporary work assignment abroad. while abroad, he leased the house. when he returned to the states, he attempted to occupy his home as his principal residence but could not due to rent controls and a lease obligation. the taxpayer then purchased a new home and sold his old home subject to the lease. the tax court permitted nonrecognition of the gain resulting from the sale of the former home under code section 1034 even though the taxpayer had not physically occupied the premises in several years. internal revenue ruling 59-72 states that the taxpayer will be entitled to apply code section 1034, even though the former residence was rented prior to its sale, if the facts and circumstances indicate that the property sold by taxpayer was his principal residence. the second exception to the "physical occupancy" rule involves a delay in selling the vacated premises due to a soft real estate market. there is still some uncertainty in the law in this area. however, in clapham v. commissioner [2], the tax court allowed code section 1034 treatment on the sale of a former residence although the taxpayer did not physically occupy the residence within the statutory period as of the date of the sale and had no intention of reoccupying this home as his principal residence. in this case, the taxpayer's job location was changed and he had no intention of returning to occupy this home. the taxpayer had vacated his former residence for a period of nearly three years. because of the real estate market, he was unable to sell his home and, therefore, agreed to lease it (with an option to purchase) for one year. when the lease term was up, the tenants vacated the home without exercising the option to purchase. the house was again listed for sale, but with no success, and the house was leased again for several months. within approximately a year from the date the former residence was sold, the taxpayer purchased a new home at his new job location. the court held that the sale qualified for code section 1034 treatment and ... viewed the rentals as necessitated by the exigencies of the real estate market and merely ancillary to the sales effort. the tax court, citing the ways and means committee report under the revenue act of 1951 regarded the situation of a change in residence due to change of employment as a type of involuntary conversion to which congress intended to extend relief, and stated that interpreting the statute as inapplicable when a poor real estate market or unavailability of mortgage funds required leasing 'for a temporary period concurrent with and ancillary to sales efforts' would be inconsistent with the statute's remedial purpose ([3], pp. a-6 a-7). 70 in clapham v. commissioner [1], "the court rejected the commissioner's [the internal revenue service's] argument, stating that rather than establishing a rule of law that a taxpayer must actually be occupying or intending to return to his old residence, ... [the question of] 'whether or not property is the principal residence of the taxpayer depends on all the facts and circumstances in each individual case.' " deductibility of rental expenses related to former residence if a taxpayer vacates his old residence and leases it until the date of its sale, he is faced with taxable rent income which he collects from the tenant. will rental expenses be permi.tted to offset this taxable rental income for federal income tax purposes? in bolaris v. commissioner [1], the internal revenue service and the tax court both held that a "personal residence" could not also be "property held for the production of income" (i.e., rental property) which, in essence, prohibited the deductibility of rental expenses in these situations. they view these designations of property as being mutually exclusive. in the bolaris case, the bolarises attempted to sell their old home from july, 1977 until they sold it in august, 1978. in october, 1977, they vacated their old home and moved into their new principal residence. after first unsuccessfully listing their home for sale for 90 days, they rented it on a month-to-month basis at a fair rental value. because the bolarises thought the old home would show better if it were vacant, they asked the tenants to move after eight months. six weeks later, the bolarises received their first offer to buy their old home which they accepted. due to financing difficulties, the bolarises agreed to rent the home to the buyers until they obtained financing. about one month later, the buyers purchased the home. the bolarises appealed the rulings of both the internal revenue service and the tax court to the ninth circuit court of appeals. after analyzing the legislative history of the appropriate statutes and applying their interpretation of such to the facts of the bolaris case, the ninth circuit court found several key factors in favor of the bolarises which they felt were essential in order for them to deduct rental expenses for federal income tax purposes. 1. there were both offers to rent and offers to sell and the home was actually rented at its fair market value; 2. the home had been abandoned permanently by the bolarises when they moved to their new residence; and 3. the home was not used for personal recreation. "the (c)ourt stated that '(i)t is completely understandable that petitioners (the bolarises) desired to turn this potential expense eater (the old residence) into an income-producing asset during (the) waiting period (prior to sale)' "[1]. 71 as a result, it reversed the tax court's decision and in summary, the bolarises were allowed to defer recognition of the gain on the sale of their old residence and were also entitled to deduct all expenses which were applicable to the rental activities of the old residence. although this decision is binding in the ninth circuit, the irs may attempt to challenge this interpretation of legislative history. if the irs refuses to acquiesce to the ninth circuit's decision, they probably will continue to challenge those situations in which a taxpayer claims a residence as qualifying as a principal residence within the context of code section 1034 while at the same time holding it for the production of income. summary in attempting to maximize the tax position upon the sale of a former principal residence, taxpayers strive to defer any gain that is realized on such a sale. if a home is sold within the two-year statutory period from the date the taxpayer vacates the premises and it continues to qualify as his principal residence on the date of sale, code section 1034 will be applied to defer recognition of any gain on the sale. if a loss is realized, such loss will be disallowed. if the residence were converted into income-producing property prior to its sale, then the loss may become deductible for federal income tax purposes [5]. profits or losses from rental activities that were incurred during the interim period will not prohibit code section 1034 treatment on a qualifying sale of the former residence. if a former residence is sold after the two-year statutory period, then section 1034 treatment of the gain realized will be disallowed and the gain, therefore, will be recognized for federal income tax purposes unless the taxpayer meets one of the following exceptions: 1. premises vacated with intent to return 2. exigencies in the real estate market if a loss is realized and if the taxpayer meets either of the two exceptions noted above, then the loss will not be recognized for federal income tax purposes. because this area of taxation is very complex, it is imperative that individuals who are considering the sale or rental of their principal residence be aware of the ramifications in order to achieve the desired result. references 1. bolaris v. commissioner, 81 t.c. 840 (1983). 2. clapham v. commissioner, 63 t.c. 505 (1975). 3. handler, r. arnold. sale or exchange of residence. 179-3rd t.m., washington, dc: bureau of national affairs, inc. (1985). 72 4. internal revenue code, section 1034(a). 5. rechnitzer v. commissioner, 26 t.c.m. (cch) 298 (1967). 6. tax reform act of 1986, pub. l. no. 99-514, 100 stat. 2085 (1986). 7. treasury regulations, section 1.1034-1(c)(l) (1960). 8. trisko v. commissioner, 29 t.c. 515 (1957), acq. 1959-1 c.b. 5. 73 selected tax issues concerning the sale of a principal residence development and interpretation of a credit risk evaluation instrument t. hillman willi, college of business administration louisiana tech university ruston, louisiana banks and other commercial lending institutions frequently use a credit "score card" instrument to evaluate the credit worthiness of potential borrowers. regulation b of the code of federal regulations (12 cfr 202), effective 1977, stipulates the requirements pertaining to the credit opportunity law. in essence, the regulation prohibits the denial of credit on the basis of age, marital status, location of residence, race, or sex. further, the regulation requires that every oommercial credit lending institution develop an objective credit scoring system on a statistically derived set of criteria stemming from empirical data pertaining to the credit history of loan applicants of that particular institution. therefore, the end product of a credit scoring system is a score card instrument that furnishes a numerical evaluation of the criteria for assessing credit worthiness. the purpose of this paper is to explain a statistical procedure for developing a score card and how the use of a score card can improve the loan approval decision. the improvement is demonstrated using a bayesian approach. the use of a point allocation system to measure the risk of a loan applicant has been used for several years and has been much discussed ([2], [7], [9], [10], [12]). a point score system can lend a certain amount of objectivity to what would otherwise be a personal judgment decision. many businesses use a point system that is simply an assignment of quantitative values for various personal data traits that are based on the subjective assessment of a "credit expert." these point systems oould be considered to be based on empirical data since the "expert" is using his or her experience with the credit history of borrowers. however, the development of a credit scoring system using statistical analysis and validation as required by regulation b, is not very oommon in the lending industry. durand [5] wrote the first significant and oomprehensive work on credit scoring. bis system was based on a univariate test for significance which is now outdated because of the availability of the oomputer to perform more sophisticated analyses. management decision systems, inc. of georgia [4] presents a more current procedure for developing a credit scoring system, but crucial details are left to the reader's imagination. this paper attempts to shed some journa.l of bu$ine63 stmtegiea, volume 5, number 1 (spring 1988) 21 light on the gray areas that are ubua.lly glossed over by the industry due to their confidential nature. credit risk variables the first step involves the selection of the variables included on the score card. a typical credit score card would contain several variables with a certain number of points allocated for each separate classification for each variable. such variables typically include years at present address, years at present job, occupation classification, annual salary, monthly housing payment, number of people in household, housing classification (own, rent, other), etc.. for example, the variable, time at present address, may be a.llocated 12 points for six months or less, 16 points for over six months to one year, 23 points for over one year to two years, etc. the points allocated to each category are not arbitrary values. they are computed from the discriminant function lis explained in the next section. a higher total score reflects a better credit risk. therefore, the points computed for each characteristic represent the relative importance of a particular categorical response to account for a good credit risk. for example, if living at the present address for over ten years is worth 32 points as compared to only 16 points for one year residence, a person with the longer time at the same residence is deemed the better risk by a factor of 2 to 1. a typical loan application normally includes an extensive list of variables. on the basis of the responses provided on the loan application, certain variables are scored and totaled. h the total exceeds a statistically derived cutoff value the loan would qualify for approval; otherwise, it would not. an alternative procedure would be to include another category, one for which a minimum and a maximum score is established. any score between these limits would be sent to the loan supervisor for further deliberation. an example of a credit score card developed for a medium-sized bank located in the midsouth is shown in appendix a. suppose an applicant has the following characteristics: (1) located at the present address for 2 years; (2) buying the residence; (3) monthly payment is $600; (4) four people in the household; (5) working at the present job for 5 yearsj (6) office worker; (7) no savings account; (8) paid out a bank loan; and (9) monthly income of $1,800. using the score card in appendix a, the point total is 240, which means that the applicant would automatically qualify for approval if the suggested cutoff guide is used. the process of selecting the particular variables to be used and allocating the point values to the various intervals is the critical part of the process. first, an appropriate data base must be established. a sufficient history of loan activity must be available to establish a block of "good" and "bad" loans. it is desirable to have several hundred loans of both types and preferably on computer tape or disk for processing convenience. 22 the size sample of "good" and "bad" loans that is sufficient for statistical analysis depends upon the number of credit characteristics evaluated. however, a sample of 100 loans of each type would be sufficient in most cases. actually, two samples are needed. an analysis sample is needed to construct the score card. a second sample, called the "holdout" or "validation" sample, is used to validate both the discriminant function and the score card. this process is discussed later. of course, the larger the sample the better. the lending institution illustrated in this paper had a loan population of sufficient size to permit a random sample of 500 good and 500 bad loans. half of these were used for analysis and half for validation. to get a sample this large requires that the loan application be standardized and used for a substantial period of time. in fact, the loan application should be used long enough for the loans to be either paid out (or a certain history of good credit to be built up) or defaulted (or excessive late payments to be recorded to result in a "bad" loan). the definition of a "bad" loan may vary among loan institutions, but it is up to the lender to make that determination. in most instances a loan default is not all that is required to result in a "bad" loan. a record of one payment over 90 days late, or two occasions of over 60 days late, or three or more occasions of being over 30 days late may be considered "bad." there appears to be no standard definition. the next step is to determine which variables are potential predictors of credit worthiness. this can be done with various procedures, the most popular of which is the chi-square test. the chi-square distribution is used to perform a contingency table test. the table consists of the number of loans that were found to be good or bad and classified according to an appropriate variable scale. an example of a chi-square contingency table is shown in table 1. table 1 contingency table for housing classification variable (number of loads) housing classification good loan bad loan buying or own 351 286 rent 92 121 other 57 93 r~-~~,----total 500 500 x: = 19.22 with 2 degrees of freedom p-value < 0.005 table 1 shows that more of the good loan applicants are buying or own their residence. on the other hand, more of the bad loan applicants either rent or fit some other classification, such as live with relatives. the p-value less than 23 0.005 indicates that this particular variable is very useful in predicting whether the applicant is a good credit risk. h the variable is dichotomous, such as the presence of a current checking account or savings account, or discrete, such as the housing classification as shown in table 1, the classes are obvious. but if the variable is continuous, the classes are not as obvious. for example, annual income, monthly housing payment, time at present job, and time at present address are variables that require class intervals to be specified. to determine the appropriate intervals, a sorted listing of the data for each variable is helpful. from this, the range and any natural groupings of the data can be identified. then it is a matter of testing various group intervals to determine the particular classifications that give the largest chi-square value. or course this extra effort is only justified after the variable has been identified as significant in distinguishing between good and bad loans. it is also possible to use a series of discriminan\ analyses to locate the most discriminating interval breaks, but it is recommended only when computer time is not a constraint. those variables that have significant relationships are selected for further consideration. a significance level should be selected for this decision. although significance levels of 0.01 or 0:05 are common, the researcher used a cutoff of a p-value of 0.10 or less. this figure would allow elimination of those variables showing no significant relationship and those being marginal would be tried because they could prove useful in combination with other variables. linear discriminant analysis those variables that have statistically significant relationships to credit worthiness are submitted to a multiple linear discriminant analysis program. this procedure is well documented ([11, [3], [6], [8]) 8jl.d is available on several computer packages. the most common packages are sas 8jl.d spss. a loan application may have thirty or forty data values that could be useful in predicting credit worthiness. after employing chi-square tests, as many as twenty variables may appear to be significant. the discriminant analysis program is then run on these variables to determine which variables should be included on the score card. as evidenced in appendix a, the typical score card usually contains ten or fewer evaluation criteria. a discriminant 8jl.alysis is appropriate when the population of interest consists of two distinct groups-good 8jl.d bad credit risks. an f-ratio is calculated from the analysis sample to measure whether the two loan type groups have been significantly separated on the basis of the sample loans. the necessary assumptions for the multiple linear discriminant function are equal dispersion matrices for each group and a multivariate normal distribution of the population. determining the best set of explanatory variables is a decision based on the results of the discriminant analysis. this is accomplished by evaluating 24 the f statistic, the standard error of estimate, the multiple coefficient of determination, &lld the partial correlation coefficients. the discriminant analysis accomplishes two things. first, it identifies those variables having the greatest explanatory value and, second, it provides discriminant linear coefficients which are used to calculate the points for the score card. the procedure for determining the actual points uses the ratio of good-tobad loans for each class interval for each variable. each variable will have an interval either established statistically for the data (e.g. monthly income-$o499, 500-999, 1000-1499, etc.) or the interval will be natural (e.g. housing classification-renting, buying, or other). the discriminant analysis coefficients for each variable are then multiplied by the ratio of good-to-bad loans that applies to each interval. the resulting values are the scores for each category. validation of the discriminant function is accomplished using the holdout sample to construct a confusion (cross-classification) matrix and computing the f statistic level and wilk's lambda to determine the significance of these characteristics. the confusion matrix gives the percentage of good and bad loans that are correctly or incorrectly classified and provides insight regarding the performance of the discriminant equation. score card validation another important use of the "holdout" sample is to use those loans to test the effectiveness of the score card iijld validate the score card. this is done by mst computing a total score for each loan known to be good or bad. when these total scores are ranked, it is' possible to estimate the percentage of good and bad loans that would be accepted at various cutoff scores. this allows the lending institution to predict the effect of selecting a particular cutoff score. a typical validation sample prediction table is given in table 2. to illustrate what the percentages in table 2 represent, suppose a credit score of 110 is considered. the table shows that no loans (good or bad) scored below this value. for those loans scoring 170 or lower, 89 percent were good loft-ns and 58 were bad. in fact, none of the loans that turned out to be bad scored higher than 270 whereas the good loans scored as high 8.8 310. thus, as the score gets higher, the percentage of bad loans drops faster than the percentage of good loans. as shown in table 2, the cutoff score resulting in the greatest differentiation between a good and bad loan is 210. in other words, if a loan scoring below 210 is rejected as too risky iijld one scoring 210 or above is accepted, then the result is to accept two-thirds of the potentially good loans and only one-fourth of the potentially bad loans. in actual practice, a minimum and a maximum cutoff are usually established. for example, a loan scoring below 170 is automatically rejected and one scoring 240 or li.bove is li.utomatically approved. h a loan scores between these two limits, then the loan supervisor can make the final decision. 25 one of the difficulties in developing a credit scoring system is that the sample should be representative of the entire population which includes accepted and rejected applicants. there are several ways to deal with the problem of including rejected applicants. one is to simply ignore them and this is often the case. another is to assume that the loan officer made the correct decision and, therefore, consider a rejected applicant a bad loan and include them in the "bad" population. a more valid approach is to score each rejected loan as either a good or a bad loan and use them to augment the population. in that case it will be necessary to take a new sample from this adjusted population and rerun the discriminant analysis and recompute the points for the score card. experience has shown that including the rejected loans only slightly affects the results. table 2 validation sample prediction table --_.,,--~~ ~-~.--,_.-percentage percentage cutoff of "good" of "bad" percentage score loans accepted loans accepted difference 110 100 100 0 130 99 94 6 150 97 82 15 170 89 58 31 190 80 39 41 210 67 25 42230 52 15 37 250 32 6 26 270 15 1 14 290 6 0 6 310 2 0 2 330 0 0 0 * = largest percentage difference ill sample bayesian interpretation the next step is to determine the effectiveness of the credit scoring instrument. a bayesian procedure can be used to predict the performance of the score card. assume that the minimum cutoff score of 170 is set. as shown in table 2, this score means that 89 percent of the good loans and 58 percent of the bad loans are accepted. next, suppose that the loan history for this particular institution prior to the use of a score card is as follows: % of total applicants granted and good 49% % of total applicants granted and bad = 9% % of total applicants rejected 42% 100% 26 notice that the population should also include the rejected loans. fiftyeight percent were approved and 42 percent were rejected. of the granted loans in the past, 84 percent (0.49/0.58 = 0.84) were good and 16 percent (0.09/0.58 = 0.16) were bad. multiplying the historical percentages by the probabilities that would apply when using the credit scoring model with a cutoff of 170, gives the following joint probability table. accepted by the model turned down by the model good .44 .05 .49 bad .05 .04 .09 reject .24 .18 .42 total .73 .27 1.00 the table shows the breakdown of how each type of loan would be treated by the scoring system. for example, of the 49 percent "good" loans, 44 percent (0.49 x 0.89 = 0.44) would be accepted by the model and 5 percent (0.49 0.44 = 0.05) would be turned down. of the 9 percent "bad" loans, 5 percent (0.09 x 0.58 = 0.05) would be accepted by the model and of the 42 percent rejected loans, 24 percent (0.42 x 0.58 = 0.24) would be accepted by the model. overall, the credit scoring model would accept 73 percent of the loan applicants and turn down 27 percent. the bayes formula used to revise the probability of a good loan is: p(aiia.c.) = p(a.a·iad x p(ad (1) p(a.a.iad x p(ad + p(a.a.ia2 ) x p(a2 ) where a.c. = "above cutoff," al = good loan, and a2 = bad loan. the bayes revision of the prior probabilities using the score card gives the following projection of the percentages of good and bad accounts that would be accepted by the model. percentage of accepted that are good = 90% (0.44/(0.44 + 0.05)) percentage of accepted that are bad = 10% (0.05/(0.05 + 0.44)) these probabilities can be summarized as follows: p(a.c. p(ai ) x p(a.c·iai ) and ~) p(aiia.c.) al "good" .49 x .89 .44 .44/.49 = .90 a2 "bad" .09 x .58 .05 .05/.49 = .10 .49 1.00 based on these figures, the forecasted percentages for a cutoff score of 170 can be calculated. percent above cutoff and " good" = .90 x .73 = .66 percent above cutoff and "bad" = .10 x .73 = .07 27 the performance of the credit scoring instrument can be illustrated by contrasting the probabilities associated with using a score card with those associated with not using a score card. this is shown in table 3. the result is that the scoring system is estimated to increase the percentage of good loans that are accepted from 49 to 66 percent which is a 17 percent improvement. the percentage of bad loans that are accepted is decreased by two percent. in addition, the percentage of loans that need to be rejected is reduced by 15 percent. table 3 performance comparison using 8 credit scoring instrument score card (cutoff = 170) no score card % of total applicants accepted and "good" 66% 49% -----% of total applicants accepted and "bad" 7% 9% % of total applicants "rejected" 27% 42% 100% 100% remember that this example is intended to merely illustrate the performance of the scoring instrument. experience has been that greater improvements in decision making are possible depending on the particular loan history of the lending institution. conclusions the use of an empirically derived credit scoring system has two advantages. one of these is that it enables the lending institution to be in compliance with federal regulations and furnishes a valid defense in case of litigation. second, when the score card is based on sound statistical practices, its use can often improve the lending decisions of the institution as compared with strictly subjective assessments. a credit scoring instrument can play an important role in the overall lending strategy of financial institutions. references 1. berenson, m. 1., d. m. levine, and m. goldstein. intermediate statistical method" and applications: a computer package approach. englewood cliffs, nj: prentice hall, inc. (1983). 28 2. bierman, h. jr. and hausman, w. h. "the credit granting decision." management science, vol. 16 (april 1970), pp. b519-b532. 3. cooley, w. w. and lohnes, p. r. multivariate data analysis, new york, ny: john wiley and sonll, inc. (1971) 4. credit scoring systems: a detailed analysis. atlanta, ga: management decision systems, inc. (1977). 5. durand, d. risk elements in. consumer installment f\nancing. new york, ny: national bureau of economic research (1941). 6. goldstein, m. and dillon, w. r. discrete discriminant analysis. new york, ny: john wiley and sons, inc. (1978). 7. johnson, n. "how point scoring can do more than help make loan decisions." banking, vol. 62 (august 1971), pp. 36-42. 8. morrison, d. g. "on the interpretation of discriminant analysis." journal of marketing research, vol. 6 (may 1969), pp. 156-163. 9. myers, j. h. "predicting credit risk with a numerical scoring system." journal of applied psychology, vol. 47 (october 1963), pp. 348-352. 10. orgler, y. e. "evaluation of bank consumer loans with credit scoring models." journal of bank research, vol. 2 (spring 1971), pp. 31-37. 11. rock, a. "sure ways to score with lenders." money, september 1984, pp. 121-126. 12. roy, h. j. h. and lewis, e. m. "credit scoring as a management tool" consumer credit leader, vol. 1 (november 1971), pp. 10-13. 29 col -a 8 li:i >< <~ ><"'0... "'""'0 li:i =0 col q. col q. "'"-< 8 tf.l ~ :.a col u 'is 1 ~ °~ ;.:;-lll.!::-5 . u:l iii"... = .$ l = -° =.""'" .....°e p.. :.::: f.) p....d p..='id =-= °° -=lll lll .;:.;: 'is'''c = 5 .9 ~ °il.l_"p....oe ... 8 .~-"'" ii) il.l ·c .:: il.l <"'d.,.. "'" 1'"'1 = q.-£ col lll ... ..d til_ ~~8iu8tion qualities characteristics point values time at 6 mos. 7 mos. 1 yr. 1 mo. 2 yrs. 1 mo. 6 yrs. 1 mo. over 10 present or less to 1 yr. to 2 yrs. to 6 yrs. to 10 yrs. years address 12 16 23 28 38 32 buys housing rents or owns other classification 10 32 14 monthly $401 owns free rent or so $1 200 $201 300 $301 400 and over and clear payment 5 6 8 14 19 10 number in 1 2 3 4 5 or more household 38 52 41 36 26 1-------time at 6 mos. 7 mos. 2 yrs 1 mo. 4 yrs. 1 mo. over 6 yrs. present or less to 2 yrs. to 4 yrs. to 6 yrs. and retired job 4 6 8 9 13 prof./exec. semi-prof. lab.jservice occupation mgr./ret. sales office/staff prod./driver other ----38-35 25 14 16savings none yes account 22 43 paid out none yes bank loan 14 60 total monthly --$3001 application $0 750 $751 1000 $1001 1500 $1501 2000 $2001 3000 and over income 7 9 10 14 21 22 i.i ""tl 'g, tid -.= !l! ~ ~° . p..== p..p.. ~ b c ii) "'" ~ .... ~~lll u:l b() • = il.l=.... ~.... ij 0:.::l ... " =='-~ ° ='idl:l:ioa.... °-lll .;: "'"lll ~<lic)..dc <ii bel=..!l ~ :.s 'id""'oo"",:> _ ° ~c)oo •• (ct--.:t< rq--c"l q. col ;i ~ development and interpretation of a credit risk evaluation instrument marketing warfare s1rategies: a model ronald d. taylor mississippi state university mississippi state, mississippi ronald l. coulter mary k coulter southwest missouri state university springfield, missouri while most economists do not agree about the short run outlook for the u.s. economy, most do agree that the most optimistic economic outlook for the next fifteen or twenty years is one of slow growth. this prediction of slow growth chronicles a new age for american business, in that the old policy of "business as usual" will not be applicable. no longer will firms take for granted their operations under the assumption that sales will grow because the economy is growing. in the coming years, any sales growth will potentially have to be at the expense of a competitor. this means that past marketing strategy formulations which ignored competitive considerations cannot be used. firms will be forced to consider the probable reactions of the competition to their strategies. during this period of intense competitive rivalry most american firms will essentially be involved in marketing warfare, since marketing is the tool that most firms use to combat their competition. the idea of marketing warfare and the application of warfare strategies is relatively new. kotler and singh [3] discussed some of the warfare strategies that seem to be applicable to marketing. ries and trout [8] went beyond kotler and singh in the discussion of marketing warfare strategies by advising how those strategies should best be used. cook calibrated "strategic ambition" and attempted to supply a framework as to when a few warfare strategies could be applied to marketing [1]. cook's framework has been criticized as being limited since "it apparently ignores the possible impact of contingency variables such as environmental, industry structure, market behavior, and organization variables on strategy formulation" [6, pp.l24]. the purpose of this article is to provide a model for the application of warfare strategies to marketing that overcomes some of the recognized shortcomings of cook's work. proposed model for application of warfare strategies to marketing the model used in this article is based on a two by two by three matrix with relative industry attractiveness identifying one axis, relative competitive strengths, the second axis, and relative market position, the third axis. figure 1 depicts the proposed model. 114 journal ofbusiness strategies figure 1 marketing warfare model l4~~ '-----''-----1.__ 'to,>r;,'to...4<;. s>·~ relative llaricet position 'jj$~ cilallellger uadeil follo\ieil vol. 7, no.2 the use of industry attractiveness and competitive strengths in the model is based on logic associated with the directional planning matrix developed by general electric in conjunction with the consulting firm of mckinsey and company. the directional planning matrix has three possible positions on both industry attractiveness and competitive strengths. it has been the basis of strategy determination in many different settings [2]. the model presented in this paper limits the number of positions of both industry attractiveness and competitive strengths to two in an effort to simplify the model. it is highly likely that many of the warfare strategy options from cell to cell would be identical if a 27 cell (3x3x3) model were employed instead of a 12 cell (2x2x3) model. relative market position can be classified into one of three positions: market leader, market challenger, and market follower [4]. in order to calculate a product's position in the proposed model, companies assign numerical values to each of the variables considered in the determination of both industry attractiveness and competitive strengths [7]. the dividing line between market leaders and market challengers in terms of relative market share is 1.0, meaning that the product with the highest market share in the industry would be the only product to fall into the market leader classification [4]. the dividing line between market challengers and market followers would be a relative market share of .5 (when compared to the market leader). thus, any product whose market share was less than the market leader's share but greater than one-half of the market leader's share would be considered to be a market challenger. in contrast,any product whose share was less than one-half of the market leader's share would be classified as a market follower [4]. the following discussion incorporates two ideas relevant to the application of warfare strategies to marketing [8]. first, only market leaders should defend. second, about 90% of all firms should be using guerrilla tactics instead of some other attacking procedure. strategies for market leaders figure 2 displays the warfare strategies that were deemed appropriate for market leaders in the four combination of industry attractiveness and competitive strengths. fall 1990 taylor, coulter & coulter: marketing warfare figure 2 market leaders industry attractiveness competitive strengths high low 115 high low frontal attack flank attack bypass attack position defense counteroffensive preemptive defense positional defense counteroffensive preemptive defense guerrilla attack position defense guerrilla attack preeemptive defense hedgehog defense guerrilla attack cell 1. high competitive strengths/high industry attractiveness firms in this position occupy an enviable spot because they can use a variety of both attacking and defensive warfare strategies. since these firms are the industry leaders, they are always going to be able to attack firms that have smaller market shares. the question that the industry leader needs to answer is whether he wants to attack a market challenger or a market follower. one obvious alternative is to attack the firm that has the second largest market share. in this situation, the attacker needs to be aware of the danger inherent in this choice. while a company's product may have the largest market share, as a company it may be smaller than the finn that owns the product with the second largest market share. a smaller firm attacking a larger firm is likely to fail if it employs a frontal attack. however, excluding the scenario in which a smaller firm attacks a larger firm, a frontal attack is a viable strategy for the market leader. a frontal attack is an expensive strategy, often requiring that the attacker out-advertise and outpromote its competitors at nearly a three to one ratio in order to be successful [3]. a second strategy that the market leader could employ is a flank attack. blind spots that exist on the flanks are often the prime points for attack. companies can direct a flanking attack against competitors by trying to uncover market needs that are being undeserved by the competitors or by concentrating on the geographic weaknesses of the competitors [3]. an alternative to attacking the firm second in terms of market share is to direct efforts at a much smaller foe in hopes of either taking away a significant share of the smaller firm's market, or weakening the smaller firm so that a buy our or merger can be achieved. this attack. strategy is referred to as a bypass attack. the decision to go after a smaller firm is called a guppy strategy (3). frequently 116 journal ofbusiness strategies vol. 7, no.2 big £inns choose a guppy strategy. by placing themselves in a position to take over a smaller firm they may inherit products and technologies that might otherwise cost them significant amounts of money and time to develop. of course, companies in this position may decide to defend rather than to attack. the three defensive strategies that make the most sense for market leaders operating in favorable situations are the position defense, the counteroffensive and the preemptive defense. taken literally, the decision to use a position defense. taken literally, the decision to use a position defense (also called the fortified front line) amid be a disaster for a firm. one does not have to go too far back in terms of military history to find an example of the position defense being the wtong decision. in world ii, the german armies successfully went around the french armies who were fortified in the static maginot line. from a business perspective smaller £inns trying to outdo the market leader which is in a fortified position defense, could come up with new technologies that could make the market leader's position obsolete. thus, market leaders that are trying to successfully employ a position defense must constantly be on the lookout for new technologies related to their existing product lines or for technologies in product lines that are related to the firm's existing product lines (but not yet part of the firm's product mix). firms practicing a position defense must be aware of /i marketing myopia" [5]. the second defensive strategy for market leaders in this position is the counteroffensive. with this strategy, the market leader waits until the competitor commits to an attack strategy and then counterattacks. this can be a very effective strategy on the part of the market leader because attacking competitors often overextend themselves to the point that they become vulnerable. two popular counterattacks are the frontal (or head-on) attack and the flanking attack mcdonalds used a frontal counterattack when burger king started their comparative advertising campaign [8]. the cadillac seville used a flanking counterattack aimed at mercedes by offering a luxury car with a smoother ride and more comforts (i.e. they found a segment of the market that was being undeserved), under the assumption that there was a large group of luxury car buyers wanting comforts and a smoother ride [3]. in order to be successful with a counterattack, the market leader must have the patience to wait until the attacking competitor has committed all of his /lforces" to the "battle" because it is at this time that the competitor will be most vulnerable. the preemptive defense is the third defensive strategy that can be employed by market leaders in this position of the model. market leaders using a preemptive defense try to anticipate the attacks of the competitors and then the market leader beats the competitor to the punch. the preemptive defense can be based around any type of attack strategy and is based on the premise that the best defense is a good attack. cell 2. high industry attractiveness/low competitive strengths due to their relatively weak competitive position, market leaders in this situation should be limited to some form of defense as any form of attack may be too fall 1990 taylor, coulter& coulter: marketing warfare 117 expensive in terms of possible strategic over-extension. one type of defense that could be used by market leaders in this position is the position defense. as previously stated, the position defense involves the fortification of existing positions held by the company. the best type of position defense would be a defense based around the maintenance of a strong customer franchise through consistent advertising and other marketing activities, while at the same time devoting efforts toward the development of new technologies both in the current product line and in related product lines. a second type of defense is the preemptive defense. the preemptive defense is actually a fonn of offense in that the market leader would try to anticipate the thrusts of the competition by attacking before the competitor attack. the preemptive defense can be based around any type of offensive maneuver. however, it is unlikely that a company in a relatively weak competitive position could successfully employ a frontal assault because the company would be prone to overextending itself by amassing the necessary numerical superiority (le., more advertising expenditures, a larger, more aggressive sales force, lower prices, etc.). the third defensive strategy is guerrilla attacks. market leaders in this cell of the model that elect to use guerrilla attacks could aim the guerrilla attacks at a variety of competitors with a larger concentration of the attacks being aimed at the major competitors(s). the objective of these guerrilla attacks is to keep the competition off balance by making the competition expect that a full scale offensive will soon be directed at position that is presently unknown. companies employing guerrilla tactics should consider that a key objective of these tactics is to delay the inevitable assault by a major competitor. finns attempting to delay the competitive assault do so in hopes of developing enough competitive strengths, through marketing and product development, to be able to successfully defend themselves when the competition mounts an attack cell 3. low market attractiveness/high competitive strengths the best advice to firms falling in this cell is that they should plan to defend rather than to attack finns in this cell of the model probably could survive sponsoring an attack since they have strong competitive advantages. however, attacking is not advisable because the cost of attacking is high and the comparative gains are few since the industry is not overly attractive. certainly if the industry is in decline, an attack strategy could be very costly from a financial point of view [2]. a position defense, for this cell is similar to much as described above could be used, earlier with one exception: a firm should not spend the time and effort trying to develop new products for the product line. instead, the company should look to the market for guidance in the development of related technologies. levitt [5] provided the example of buggy whip manufacturers and suggested that these manufacturers should have tried to develop technologies related to automobiles (the transportation industry) rather than spending money trying to develop a better whip. 118 journal ofbusiness strategies vol. 7, no.2 both the preemptive defense and a counteroffense could be used by firms in this cell of the model. however, the high financial costs associated with the launching of an attack and the low financial rewards associated with dealing in an unattractive market lessens the appeal of these strategies. perhaps the strategy that makes the most sense is the launching of guerrilla attacks. the use of frequent guerrilla attacks will likely discourage the competition. especially when the overall outlook for the industry is not attractive. competition in an unattractive less inclined to mount any type of campaign aimed at gaining market share. cell 4. low industry attractiveness/low competitive strengths for firms in this cell of the model an attack strategy would be particularly unappealing for two reasons. first, attack carries considerable opportunity for failure since these firms do not hold strong competitive positions. second, attacks cost money. since the industry is not overly attractive, an attack may not pay for itself in terms of added long run sales. thus, firms in this cell of the model should expect to be on the defensive. on the surface, it may seem that a position defense makes a lot of sense. however, a position defense only makes sense if the competition can be easily scared off. there is little doubt that competitors could be scared .by a company that appears to be solidly entrenched in an industry that is not overly attractive. however, if the competiti<;m is not scared away, the use of a position defense could be an error. this is particularly true if one of the competitors has already developed a technology for the product line (or a related product line) that outdated the technology being used by the company occupying this cell of the model. since a position defense requires some investment in advertising and other marketing expenses as well as investments in technologies in the product line or in relate product lines, firms should be apprehensive about using a preemptive defense under the best of conditions. when faced with competitors who have technology that outdated the technology of the product in question, the company should avoid the position defense at all costs. all in all, the position defense is not a strategy to be recommended for firms in this cell of the model. one defense that firms may opt to use is a series of guerrilla attacks. in many cases these guerrilla tactics should amount to little more than a bluff in hoped of convincing the competitor that the firm is much stronger that it actually is, and that the firm would not hesitate to launch a counterattack against any competitor that becomes overly aggressive. at their very worst, guerrilla attacks could become a delaying tactic that could keep competitors from launching a full-scale battle, at least until the firm has had time to strengthen its competitive position (if it so desires). another defensive strategy that could be successfully employed in this cell of the model is the so-called hedgehog defense or strategic withdrawal [3]. using this strategy a firm would basically maintain the status quo until it was faced with a major attack from one of the competitors. once the firm realized that it was under attack, it could withdraw to a more defensible terrain: one or more of its fall 1990 taylor, coulter & coulter: marketing warfare 119 most lucrative market segments. the withdrawal process prunes the product line of the firm to fit the needs of the segment(s) it targets. in a similar vein the firm could streamline advertising and other marketing efforts to better fir the needs of the market segments on which the firm has chosen to focus. the hedgehog defense is particularly appealing for two major reasons. first, the firm is not spending money trying to improve its competitive position in circumstances where the rewards are not likely to be great. second, through retrenching to one or more of the more lucrative market segments, the firm could actually make more money than the competitor who is attacking. this prediction of greater profits is based on the belief that the company should be able to depend on its reputation as a market leader to provide it with sales, while it would spend less on advertising in its now reduced area of market coverage. strategies for market challengers figure 3 displays the four cells associated with market challengers and the recommended strategies for each of these cells. figure 3 market challengers industry attractiveness competitve strengths high low high low frontal attack flank attack bypass attack guerrilla attack bypass attack guerrilla attack hedgehog defense counteroffensive bypass attack guerrilla attack preemptive defense hedgehog defense guerrilla attack cell 5. high industry attractiveness/high competitive attractiveness firms in this situation could launch a formal assault aimed at the market leader. as was previously stated, it normally takes about a three to one advantage before an attacker using a frontal assault will be successful in subduing the 9.efender. the bottom line is that many firms simply do not have the resources to launch a frontal attack, particularly one aimed at the market leader. a basic tenet of offensive warfare is that the attack should be aimed at the defender's weakest point [8]. unfortunately, it is likely that a frontal attack will end up being aimed at one of the strengths of the competitors rather than at one of the competitor's 120 journal ofbusiness strategies vol. 7, no.2 weaknesses. thus even though the frontal assault remains an offensive strategy to consider, it is not a particularly appealing strategy for most firms in this cell. a second strategy that can be used by firms in this cell is a flanking attack. companies can outflank their competitors by entering geographical areas that have been ignored by the competition, or by trying to attract market segments that have been undeserved by the competition. wal-mart outflanked k-mart and other discounters by using the strategy of opening stores in small towns that were ignored by other discounters. wal-mart was always the largest retailer in the small towns that it entered and it faced little competition from other major discounters. often wal-mart has encircled larger towns with stores in all of the smaller towns surrounding the larger town. after a sufficient number of the smaller towns have been dominated, wal-mart has established a sufficient flow of merchandise to the area to make it economical to build stores in the now encircled large town. the strategy has thereby effectively allowed wal-mart to compete with the other discounters on their "home turf." miller beer was able to successfully outflank anheuser-busch by appealing to an undeserved market segment with its meister brau beer. miller claimed that meister brau tasted like budweiser (anheuser-busch's product) but ca:>t less. thus, miller tried to appeal to those people who wanted a good tasting beer at a lower price. a third strategy that could be employed is a series of guerrilla attacks. chances are the object of these attacks would be the market leader; however, any strong competitor within the industry could be the object of the attacks. firms using this strategy would conduct a series of mini-skirmishes based on one or more of the marketing mix variables in isolated spots throughout the market. firms using guerrilla tactics in this situations should probably have either one of two objectives in mind. the first objective would be to keep the market leader somewhat offbalance in hopes that the leader would start to take the guerrilla tactics rather nonchalantly. market leaders that begin to relax when encountering guerrilla tactics from their competitors are likely targets for full-scale marketing battles. the second possible objective that firms may use for guerrilla attacks is the buying of time. by launching a series of guerrilla attacks the finn may be able to maintain the status quo relative to its market position while obtaining additional time to build on its competitive strengths. the building of competitive strengths will increase its chances of success when a full-scale battle is finally waged. the fourth and final attack strategy that could be employed by firms in this cell of the model is the bypass attack. firms using the bypass attack choose not to attack the market leader and instead either attack a firm of comparable size to themselves, or attack a firm smaller than they are. one possible reason for the refusal to attack the market leader is the fear of failure, however there are other reasons. some firms attack firms of equal or smaller size so that they may gain market share in these battles. the gaining of market share in this fashion is likely to be easier than gaining of market share from the market leader, while at the same time preparing the attacker for eventual battle with the market leader (gaining market share should translate to gains in competitive strengths ie expefall 1990 taylor, coulter & coulter: marketing warfare 121 rience curve cost reductions). some firms attack firms of equal or smaller size in hopes of weakening the defender sufficiently in order to take over the defender's operation. trying to take over the defender's operations particularly makes sense if the defender has the rights to technologies not possessed by the attacker, technologies that could be useful in waging a battle with the market leader. cell 6. high industry attractiveness/low competitive strengths firms occupying this cell of the model basically have three strategies that they can employ: bypass attacks, guerrilla attacks, and preemptive defense. a bypass attack is used in one of two ways: by avoiding confrontation with the market leader and attacking a firm of smaller or equal size, or by limiting their operations in one or more niches of the most lucrative market segments. regardless of which way the £inn elects to use the bypass attack the objective of the attack is to gain competitive strengths either through the building of market share or the acquisition of new technologies (from the smaller firm via takeover). a second strategy applicable to firms in this cell is the guerrilla attack. firms opting to use guerrilla tactics will probably do so either to buy time in an attempt to increase their competitive strengths or to worry the market leader and make the leader think that the guerrilla is stronger than they actually are. a third strategy is the preemptive defense. a company feeling that an attack is eminent from major competitor could beat them to the draw with their own offensive strike. companies in this cell of the model need to be careful in launching a preemptive strike against the market leader because it takes more resources to attack than to defend. since the market leader probably has more resources the leader could be unbeatable and could overpower the firm attempting a preemptive strike. cell 7. low market attractiveness/high competitive strengths firms in this cell of the model have several feasible strategies: at their disposal: bypass attack,. counteroffensive guerrilla attacks, and hedgehog defense. as stated previously the bypass attack can be employed in one of two ways. a bypass can be used to develop a market niche strategy by concentrating all of the efforts for the product in the most lucrative segments of the market or by attacking firms that are smaller while avoiding the market leader and £inns of equal size. the counteroffensive strategy can be used as well. however, companies should protect against overextension because the cost of the counteroffensive could easily outstrip the gains due to the unattractive industry conditions. guerrilla attacks can also be used by firms in this cell of the model. guerrilla attacks could and should be aimed at all other competitors including the market leader. the goal of the guerrilla attacker can be to inspire the market leader into a full-scale attack in hopes that the guerrilla with their strong competitive position would win. the last strategy that could be employed for firms in this cell of the model is the hedgehog defense. with the hedgehog the company would basically try to 122 journal ofbusiness strategies vol. 7, no.2 maintain the status quo for their product until faced with a strong attack. at that time the company would make a strategic withdrawal to one or more of the most lucrative segments in the market. cell 8. low industry attractiveness/low competitive strengths firms in this position have essentially two strategies that they can use: a series of guerrilla attacks or hedgehog defense. first, they can develop a series of guerrilla attacks probably with the objective of simply biding time and making sure that the competitors know that their product is still a threat. being much more ambitious than a guerrilla attack is probably going to cost the company much more money than it is worth due to their poor competitive position and the unattractiveness of the industry. the second strategy that should be considered is a hedgehog defense. this defense was described in an earlier section. strategies for market followers figure 4 displays the various warfare strategies that are appropriate for market followers based on their placement in terms of competitive strengths and industry attractiveness. figure 4 market followers industry attractiveness competitive strengths high low high low flanking attack bypass attack guerrilla attack bypass attack guerrilla attack guerrilla attack bypass attack preemptive defense guerrilla attack cell 9. high industry attractiveness/high competitive strengths while products in this cell of the model are blessed with very favorable conditions in terms of both competitive strengths and industry attractiveness, firms owning these products need to be careful in pitting these products against the industry leader simply because the industry leader is probably going to gain more simply because the industry leader is probably going to gain more from the confrontation than did the product with the small market share. for similar reasons, £inns having products with small market shares have long been advised to not use comparative advertising claims that pit them against the industry leader because the industry leader would get more publicity from the ad than would fall 1990 taylor, coulter& coulter: marketing warfare 123 the advertiser simply because more consumers were familiar with the industry leader. one strategy that should be successfully employed in this cell is the use of flanking attacks. flank attacks avoid direct confrontations and could be directed toward the market leader or one of the market challengers. the use of a flank attack in this manner means that the attacker would try to appeal to an underserved need of the customers or to take advantage of geographic lapses in the strategies of competitors. a second strategy that could be employed in this cell is the use of a bypass attack as a means of developing a market niche strategy. using the bypass attack in this manner means that the company tries to use their competitive strengths to develop a concentrated target marketing strategy with one or more of the most lucrative market segments. the third and final strategy that is useful in this cell is the use of a guerrilla attack which has been discussed previously. cell 10. high industry attractiveness/low competitive strengths only two strategies make sense in this cell of the model. first, the use of guerrilla tactics probably used solely with the hope of biding time with the feeling that things (the economy, the competitive situation, etc.) will get better in the future. second, a bypass attack with the purpose being the development of a market niche strategy. regardless of the strategy used, firms in this cell have to hope that some miracle (technological or otherwise) will occur that will make them more competitive. cell 11. low industry attractiveness/high competitive strengths again only two strategies seem to make sense for products falling into this cell. the two strategies, bypass attacks and guerrilla attacks, have both been discussed previously. cell 12. low industry attractiveness/low competitive strengths the best advice to firms falling in this cell of the model is to get out of the business[2]. under the assumption that some firms in this position elect to remain in the business, the only strategy that makes much sense is to conduct a series of guerrilla attacks. the employment of guerrilla tactics should be done simply as a stalling technique, hoping that conditions will change. this strategy is useful if conditions change: e.g. a number of competitors decide to call it quits, market conditions change increasing demand for the product. conclusion any marketing plan should have as two of its objectives the satisfaction of customers and the proposed interaction with the competition. marketing executives have at least given lipservice to the satisfaction of customers. however, it seems that these executives have frequently ignored the implications of competition when developing marketing strategies. one way that marketing decisions can be closely 124 journal ofbusiness strategies vol 7,no. 2 tied to the potential effects on competition is to use warfare tactics when considering the development of marketing strategies. for some time, managers have spoken the language of the battlefield when discussing the application of marketing. terms such as "invading" markets, ii offensive" advertising, and "fighting fire with fire" are common terms in co1porate board rooms[3]. despite the use of battlefield terminology, it seems that many corporate executives have yet to use warfare strategies in the development of marketing plans. these executives need to understand not only what the tactics are, but also when to apply them. the model described in this article provides a guide for identifying military tactics useful in marketing and for determining when to use the various military strategies. references 1. cook, j. jr. "marketing strategy and differential advantage." tournai of marketing, vol 47 (spring, 1983), pp. 68-75. 2. harrigan, kr. "strategies for declining industries." journal of business strategy, vol 1 (fall, 1980). 3. kotler, p. and singh, r. "marketing warfare in the 1980's." tournai of business strategy:, vol. 1 (fall, 1980). 4. kotler, p. marketing management: analysis, planning, implementation, and control. 5th edition. englewood cliffs, new jersey: prentice hall (1984). 5. levitt, t. "marketing myopia." harvard business review, vol. 60 auly-august, 1960). 6. parasuraman, a. and varadarajan, p. "more on 'marketing strategy and differential advantage'." journal of marketing, vol. 49 (spring, 1985) pp. 124-128. 7. robinson, s.j.q., himens, r.e., and wade, d.p. "the directional policy matrix-tool for strategic planning." long range planning, vol 11 oune, 1978). 8. ries, a. and trout, j. marketing warfare. new york: mcgraw-hill (1986). marketing warfare strategies: a model deierminants of muitlna1l0nal agfncy cosrs richard h fosberg sam houston state university huntsville, texas jeff madura florida atlantic university boca raton, florida introduction agency problems arise when a principal hires an agent to perform a task for the benefit of the principal. in many instances, the agent may have the opportunity to take actions which benefit the agent, but are detrimental to the principal. in the typical corporation, the primary agency relationship is between the shareholders (principals) and the firm's management (agents). usually, management has the opportunity to take certain actions which may benefit themselves while reducing shareholder wealth (e.g. inflate their salaries, deter takeovers by other firms, etc.). agency costs are the reductions in shareholder wealth that result from management's malfeasance and the cost of monitoring and bonding activities engaged in by the shareholders to prevent management misbehavior. the agency problems facing u.s. firms have been discussed extensively by jensen and meckling [8], fama [4] and others. empirical research has shown that these costs are significant and affect the ownership structure and capital structure of domestic firms ([3], [5]). agency theory, however, has not been extended to encompass direct foreign investment by multinational corporations (mncs) or investment in foreign companies. mncs which invest in productive assets in foreign countries (engage in direct foreign investment) or purchase shares of foreign companies encounter many agency-related difficulties as a result of these investments. problems related to monitoring, adverse incentives and pressures, and compensation arise which are not normally encountered in the domestic operations of the firm. in this study we identify and discuss some of the factors that are expected to affect the agency costs associated with overseas investing. agency problems of direct foreign investment myopia of foreign managers for firms engaging in direct foreign investment, there is a risk that the managers of the foreign operations will make decisions without fully considering the impact of these decisions on the parent firm. for example, foreign subsidiary managers often ignore exchange rate fluctuations, withholding taxes on earnings remitted to the parent, and additional taxes imposed in the parent's country (on the cash flows generated by foreign subsidiaries) in making investment decisions. failure to consider these factors can lead overseas managers to make investment decisions that are not in the best interests of the parent firm's shareholders. 100 journal ofbusiness strategies vol. 8, no.2 for example, the cost of ignoring exchange rate movements can be pronounced in countries that experience high rates of inflation. while the foreign currency cash flows a foreign project generates are generally enhanced by high inflation, the local currency's depreciation (against the dollar), caused by the inflation, may cause a reduction in the dollar cash flows from the project received by the parent further, decisions made by subsidiary management are more likely to conflict with shareholder goals if the host country does not have tax treaties with the parent's home country, because, additional taxesare likely to be imposed on income received by the parent from a subsidiary if there are no tax treaties between the two countries. this will cause a larger divergence between the after-tax cash flows the foreign manager believes a project will generate and the actual cash flows that the parent will receive. languages and customs in foreign markets foreign languages and customs may also make it more difficult to monitor the performance of an overseas operation. communication problems are more likely in host countries whose native language is not english. language translation problems and the interpretation of local idioms and jargon may make it more difficult to determine exactly what the overseas management is attempting to do and thus, make it harder to ascertain if they are performing as desired. foreign customs which relate to working conditions, fringe benefits, and vacations may make it harder to determine if foreign employees are diligently pursuing their responsibilities. accounting rules in foreign markets differences in foreign accounting rules may complicate the monitoring of the performance of foreign operations and personnel. at a minimum, different accounting rules will cause the managers of the overseas operation to incur additional time and expense in preparing one set of financial statements for the parent mnc and one for the local authorities. more importantly, the foreign accounting rules may make it possible for overseas managers to more easily hide their malfeasance from parent management and escape senior management discipline. detecting this type of activity requires a detailed knowledge of foreign accounting regulations that senior mnc management may not possess. this contention is supported by research by morsicato [10] which suggests that top-level management is often unable to properly interpret foreign subsidiary performance. distance and location monitoring the performance of overseas operations and personnel will, in general, be more difficult than for similar domestic operations. the distance of the overseas facilities from senior management and the board of directors is a major contributing factor. the farther a foreign operation is from the people responsible for monitoring that operation, the more expensive and time consuming it is for managers to travel to the overseas facilities to assess their performance. these considerations may cause managers to travel less to their overseas facilities than to domestic ones and result in less monitoring of their overseas operations. fall 1991 fosberg & madura: determinants ofmultinational costs 101 foreign operations may also enhance the ability of managers to engage in excessive perk consumption. excessive travel to overseas facilities may result if those facilities are located in desirable locations. the existence of these overseas operations may also make it easier for managers to hide excessive perk consumption by transferring part of these expenses (e.g., through overhead) to the books of the foreign operations. also, decisions on where to establish foreign subsidiaries may be influenced by managerial preferences to travel or to live in particular countries. incentive mechanisms incentive pay mechanisms such as bonuses and performance based salaries will generally be less effective in motivating managers of foreign operations, especially if those mechanisms are based on dollar performance measures. by converting the cash flows of the overseas operation into dollars for evaluation purposes, the bonuses and performance pay of overseas managers becomes dependent on exchange rate movements. thus, the variability (risk) in those incentive payments will be magnified by exchange rate variability. risk averse managers will require a larger average recompense to compensate them for this increased variability. further, as compensation becomes less dependent on their performance and more dependent on factors beyond their control, such as exchange rates, incentive mechanisms will become less effective in motivating the desired managerial behavior as the relationship between actions and rewards is weakened. foreign managers of united states based mncs whose performance evaluations and recompense are dependent on the dollar cash flows their operations generate may seek to reduce the variability in those dollar cash flows by hedging in the forward markets. while the variability of the dollar cash flows generated by the foreign operation will be reduced, hedging may not be in the best interests of the parent. giving stock and stock options as incentives may also not be as effective a motivational tool as it is in the united states. for american managers who are serving overseas for limited periods of time, stock options and share ownership are still viable incentive tools. as these managers serve overseas for only a short period of time it is likely that when they liquidate their holdings they will have returned to united states. and consume or invest the proceeds in dollar denominated items. if the managers are on long term overseas duty or are foreign nationals, the value of their stock options and shares (to the manager) will be dependent on the foreign currency value of those options and shares. here again, the value of the cash flows will be dependent on exchange rates and, consequently, will be less valuable for risk-averse managers and less effective motivators. diversification motives of managers the operation of overseas facilities by a mnc creates additional agency problems not encountered by firms with purely domestic operations, as well as exacerbating some agency problems faced by domestic firms. for example, it is well known that management tends to have a large proportion of their total wealth invested in the stock of their employer. this causes the portfolios of these managers to be are poorly diversified. portfolio theory implies that risk-averse managers will not like this circumstance and will be interested in diversifying away the risk of their portfolios. one way to accomplish this is to use the 102 journal ofbusiness strategies vol. 8, no.2 investment policy of the firm to diversify firm cash flows.! this will cause shareholder wealth to decline if good investments are foregone in favor of less valuable investments with greater diversification benefits. as foreign stock returns are not highly correlated with the returns of united states stocks, this implies overseas investments may offer better opportunities for managers to diversify the firm's cash flows (at the expense of the firm's shareholders) than domestic investments. dirctor monitoring overseas operations will also tend to make monitoring of senior mnc management (in the united states) by the board of directors more difficult. mnc management may be able to hide some of their nonoptimal actions through the intracompany shifting of ace:ounting revenues and expenses, and/or cash flows between the domestic and overseas operations of the firm. uncovering such stratagems would require expertise in international operations and accounting and a significant investment of time by the board of directors. the board members may not possess these skills or may be unwilling to spend the time necessary to adequately monitor mnc management. host government pressure host governments of underdeveloped countries and those of a leftist nature may pressure mncs that operate in their countries to spend money for "socially desirable" purposes [2]. this type of expenditure may come at the expense of the mnc's shareholders. however, tavis and crum [12] suggest that a subsidiary may sometimes be able to simultaneously satisfy the local government pressures and shareholder goals. for example, an employee training program may enhance productivity while it improves working skills of the host country's labor force. nevertheless, some host government expenditure demands may not be as companble with the goal of shareholder wealth maximization. if these expenditures are anticipated by mnc management, the costs can be viewed as costs of doing business in the country and incorporated into the investment decision making of the firm. if these costs are not fully anticipated, an agency cost is incurred and shareholder wealth is reduced. foreign financing many mncs seek to reduce the exchange risk of the cash flows of foreign operations by borrowing in the currency of the country in which the foreign operation is located. in doing so, the mnc has invited monitoring from a new source, the foreign lender. this additional monitoring of the mnc borrower by the foreign lender serves to reduce the agency cost of debt for the mnc. this may be detrimental to the shareholders if the foreign lenders are able, through restrictive covenants, etc., to circumscribe the wealth maximizing behavior of the shareholders or management. mncs that list their stock on foreign stock exchanges provide liquidity to foreign investors who own their shares. this additional liquidity makes the mnc's shares more lahmihud and lev [1] found evidence which tends to support the contention that managers use the investments of the firm to diversify away some of the risk of the firm. fall 1991 fosberg & madura: determinants of multinational costs 103 desirable investments for foreigners and allows the mnc to better exploit foreign pools of capital when they raise new equity funds. it may also lower the cost of equity funds for the mnc. the foreign shareholders of the firm may, however, have different incentives than the united states shareholders of the firm. foreign shareholders may be more sympathetic to the desires of their governments for the mnc to make 'socially desirable' investments in the foreign country. for example, a foreign subsidiary's decision to invest in pollution control equipment benefits the foreign shareholders directly (their air quality is improved) while most of the costs of the equipment are born by the united states shareholders who own the bulk of the mncs shares. this is an agency cost of foreign equity ownership for united states stockholders.2 firm decentralization when a firm expands overseas, a number of factors cause the operations of the firm to tend to become more decentralized. aesthetic and technical requirements of products vary from country to country. delegating authority for certain aspects of product design and production to the managers of foreign operations may facilitate adapting the product to local market conditions [6]. this decentralization will tend to increase as overseas production and sales increase [7]. mncs which have operations in countries where the typical firm is more decentralized than in the united states (e.g., japan) may be forced to adjust to local business practices by decentralizing the foreign operations of the firm [11]. decentralization will also tend to occur when the mnc provides relatively little financing of the overseas operations and few intracompany transactions take place between the mnc and the foreign subsidiaries. as decentralization occurs, operating and financial decisions are increasingly made by managers of the overseas operations. this may enhance the profitability of the mnc by allowing the foreign managers of the firm to adjust their operations to the demands of the foreign market in which they operate. this diffusion of decision making authority may also create additional agency problems for the mnc. as decision making authority is spread among the foreign operations of the mnc more people have the opportunity to use the resources of the firm for their own benefit. further, as decision making authority is spread among more managers it becomes more difficult and costly for senior mnc management and the board of directors to monitor the performance of the firm and its managers. the increased opportunity for malfeasance and the difficulty in monitoring will probably cause the agency costs of the firm to increase as decentralization increases. agency problems of investing in foreign stocks if a mnc decides against acquiring or establishing a wholly owned subsidiary or division overseas, it may still invest overseas by purchasing the shares in a publicly traded 2 a counter-argument is that foreign shareholders would prefer the direct benefits of a maximized share price over indirect benefits that could occur if managers satisfied local societal preferences. moreover. the foreign shareholders (especially institutional investors) may be able to prevent the host government from pressuring the subsidiary management to satisfy foreign societal needs. 104 journal ofbusiness strategies vol. 8, no.2 foreign:firm. the agency problems inherent in these foreign stocks are somewhat different from those found in united states stocks. the market for corporate control exerts pressure on managers to perform properly since substandard firm performance or malfeasance by management may trigger a takeover by outsiders and result in management's dismissal. the less active the market for corporate control, the less pressure there is on management to perform properly and the greater the agency costs incurred by the firm. in countries with a less active market for corporate control, the mnc will receive less help in monitoring the performance of the foreign firm from outsiders than it would if it purchased shares in a united states firm. foreign firms may, in some circumstances, be more heavily monitored than united states firms. in countries such as japan, banks are allowed to both lend to and invest in the shares of corporations. the banks that lend to and own stock in the same firm are in a position to be an effective monitor of firm and manager performance. as lenders, these banks come into possession of highly confidential information about the firm not generally available to the public. as shareholders, these banks have an incentive to protect the values of their shares by using this information to monitor the firm's management. potentially, these banks represent a valuable monitoring resource which benefits all the firm's shareholders. this monitoring may be especially valuable for shareholders in foreign firms as there is generally less publicly available information about foreign firms (even in their home countries) and, therefore, monitoring by non-inside shareholders is likely to be less effective. the holding of the debt and equity of foreign firms by foreign banks may also reduce the agency costs of debt for foreign firms. because these banks are shareholders in the firm, they are less likely to approve of stockholder appropriation of lender wealth (by asset substitution, etc.) as this will lower the value of the firm's debt held by the banks. as a consequence, the banks reduce the agency costs of debt for lenders to the foreign firm. the reduction in the agency costs of debt may at least partially explain why foreign firms in countries such as japan have more debt in their capital structures [9]. summary mncs which engage in direct foreign investment may find that their agency costs will increase. among the contributing factors are the difficulty in monitoring overseas operations, the existence of different foreign accounting rules, the reduction in the effectiveness of widely used incentive and performance evaluation mechanisms, and the emergence of new opportunities for managerial malfeasance. foreign stock investments also necessitate the reevaluation of the agency problems associated with share ownership because of the less active market for corporate control overseas and additional firm monitoring by foreign banks. fall 1991 fosberg & madura: determinants of multinational costs references 105 1. amihud, y. and lev, b. "risk reduction as a managerial motive for conglomerate mergers." the bell journal of economics, vol. 12 (1981), pp. 605-617. 2. baliga, b. ''world-views and multinational corporations' investments in the less developed countries." columbia journal of world business, vol. 19 (1984), pp. 80-84. 3. demsetz, h. and lehn, k. "the structure of corporate ownership: causes and consequences." journal of political economy, vol. 93 (1985), pp. 1155-1177. 4. fama, e. "agency problems and the theory of the firm." journal of political economy, vol. 88 (1980), pp. 288-307. 5. friend, i. and lang, l. "an empirical test of the impact of managerial self-interest on corporate capital structure." journal of finance, vol. 43 (1988), pp. 271-281. 6. gamier, g.. "context and decision making autonomy in the foreign affiliates of u.s. multinational corporations." academy of management journal, vol. 25 (1982), pp. 893908. 7. gates, s. r. and egelhoff, w.g. "centralization in headquarters-subsidiary relationships." journal of international business studies, vol. 18 (1986), pp. 71-92. 8. jensen, m and meckling, w. "theory of the firm: managerial behavior, agency costs and ownership structure." journal of financial economics, vol. 3 (1976), pp. 305-360. 9. kester, w. c. "capital and ownership structure: a comparison of united states and japanese manufacturing corporations." financial management, vol. 15 (1986), pp. 5-16. 10. morsicato, h. g. "the effect of translation on multinational corporations' internal performance evaluation." journal of international business studies, vol. 15 (1983), pp. 103112. 11. ouchi, w. and jaeger, a "type z organization: stability in the midst of mobility." academy of management review, vol. 3 (1978), pp. 305-314. 12. tavis, l. a and crum, r.l. strategies for mnc portfolio balancing." columbia journal of world business, vol. 19 (1984), pp. 85-94. determinants of multinational agency costs exclusive dealing in general business practice timothy j. brennan graduate school of arts and sciences george washington university washington, dc exclusive dealing is where a firm or individual deals with a worker, supplier, purchaser, or retailer on the condition that the latter works only for the firm or individual in question. examples illustrate the breadth of this practice. most companies expect their managerial and professional workers not to work for other firms, certainly not for other firms in the same business or in the same capacity for another employer. one would be very surprised to find a firm permitting its, say, vice president for sales to do the same work for another firm, even for one not a competitor. even blue collar or line employees are usually hired with the implicit if not explicit expectation that they will work solely for the employer. the decision to hire a worker to do a job or to have the job done by an independent contractor could be viewed as little more than a decision as to whether the firm wants its workers to "exclusively deal" their labor. these arrangements are hardly limited to labor settings. a partnership frequently will establish contractual expectations that the partners not engage in related business outside the partnership. firms may often expect their suppliers not to supply similar products to other firms. a pen manufacturer, for example, might buy from an ink manufacturer, under the condition that this ink manufacturer not sell similar ink to another pen company. the very idea of "vertical integration" presupposes the idea that the production stages within the firm work exclusively for the firm. one would regard exceptional that, say, an automobile plant was used to produce cars for another car company. a "firm," in fact, could usefully be defined as that set of production facilities and workers committed to work exclusively with each other. an important special case in which exclusive dealing may be applied is in the manufacturer/retailer relationship. in one direction, a manufacturer may grant a retailer the exclusive right to sell a product in a particular geographic area. a case in point is a franchise arrangement, where a firm like mcdonald's grants a franchise to a firm along with an agreement not to permit another mcdonald's not to deal with another food outlet within the marketing area. in the other direction, a manufacturer may employ a retailer on the condition that it sell only the manufacturer's products. looking at the mcdonald's example in this direction, mcdonald's \\~ll t,ypically expect its franchisee not to sell burger king products, pizzas, or other non-mcdonald's food items. journal of business strategies, volume 5, number 2 (fall 1988) 53 54 journal of business strategies literature review vol. 5, no.2 one would think that the study of "exclusive dealing" would have been motivated by this ubiquity, and that it would be understood by economists and students of industrial organization in that light. unfortunately, this has not been the case. since exclusive dealing predated sophisticated economic analysis of contractual practices, it was assumed that exclusive dealing must have been an indicator or manifestation of some kind of antitrust-like anticompetitive activity. it seemed that a fum only sacrifices profits by restricting the abilit.y of its employees, retailers, or input suppliers to engage in other business opportunities, since these parties need to be compensated for agreeing to face the restriction. therefore, it seemed that a firm would impose exclusivc dealing requirements on another only if it could do so without added compensation, i.e., by "foreclosing" its competitors from access to the individual or firm now "t.ied up" under the exclusive dealing requirement. because of its association with antitrust law, the emphasis of the exclusive dealing literature ([3], [7], [13], [14], [16], [21]) has been on whether exclusive dealing can enhance or protect a firm's market power. fortunately, however, exclusive dealing is among a number of non-price "vertical restraints" that have become the subject of considerable scrutiny and ret.hinking, both in the courts and in the academic literature ([1]' [8], [10], [17]). antitrust courts and legal commentators over the past ten years ([1], [4], [15], [17], [18], [20]) have come to view non-price vertical restraints more benignly than in the past. as we have seen, exclusive dealing is far more widespread than can credibly be attributed to antitrust considerations. even if the courts now view exclusive dealing in a more generous light, a firm still may wonder whether to institute exclusive dealing. not only may the costs and benefits of doing so be subtle, but the decision may be controversial among the affected parties. in the conventional "exclusive dealing" case, retailers may not want a major supplier to cut them off if they continue to sell another manufacturer's product, and will likely demand to be compensated for their lost business opportunities. our purpose here is to illuminate the tradeoffs inherent in the general exclusive dealing situation, where antitrust -related concerns are not relevant. we note that an obvious cost to the firm who wants an employee, retailer, or supplier to deal exclusively oil its behalf is that this firm will have t.o compensate these "agents" for the lost business opportunities sacrificed in the exclusivity. the gains, on the other hand, follow when we consider the relationship between a fum and these "agents" in terms of "conflict of interest." "conflict of interest" is a t.erm more familiar in politics, philosophy, or law rather than economics. as we discuss below, however, exclusive dealing or limitations on outside activities to mitigate conflicts of interest can enhance the operating efficiency of a vertical relationship. "principal!agent" analysis a useful way to identify and understand the costs and benefits involved in exclusive dealing is to look at what is called a "principal/ agent" setting. the "principal" is fall 1988 brennan: exclusive dealing 55 the party employing an "agent" to perform a service or supply a product. our question is when is it in a principal's (manufacturer's, wholesaler's, manager's) interest to have its agents (suppliers, retailers, workers) work exclusively on its behalf, assuming it must keep each agent as well off as it would be if it retained the freedom to engage in unrelated "outside" activities. the following table lists some "principal/agent" relationships in which exclusive dealing may become significant, along with an explanation as to why there may be need for additional compensation for the agent and why the principal might be willing to pay the price. table 1 exclusive dealing settings motive for exclusivity keep trade secrets from competitors nature of need for exclusion compensation -----c:cc------;--"supply output lost business only to from sales manufacturer to other firms principal/ agent manufacturer /supplier wholesaler /retailer sell only the wholesaler's product deprived of other sales opportunities devote sales effort solely toward wholesaler's product manager/worker work exclusively for the employer lost outside mcome eliminate distractions, shirking opportunities these examples have a number of properties in common. first is the conflict of interest between the agent and the principal. the principal wants the agent to do something the agent finds unprofitable or undesirable. the supplier wants to sell to other manufacturers; the manufacturer doesn't want the supplier who learns about the downstream production process to use the knowledge to benefit the manufacturer's competitors. the retail dealer wants to sell other products; the wholesaler wants the dealer to promote and service his products exclusively. the employee wants to make money moonlighting; the manager wants the worker to reserve her energies for the company's exclusive use. second, it is difficult for the principal to monitor the agent's behavior to see that these conflicts are not important. a manager often has no way of knowing how good a job the worker is doing; poor results could reflect either outside circumstances beyond the worker's control or lack of effort due to the pursuit of other employment. the wholesaler cannot easily attribute lost market share to improvements in the image of a competitor's product or laxity in the sales efforts of its dealers. the manufacturer has no way of knowing whether a competitor discovered a trade secret on its own or learned it from a common supplier. 56 journal of business strategies vol. 5, no.2 both the conflict and the inability to monitor are critically important in rationalizing exclusive dealing. obviously, if the agent's desires coincided with the principal's, the principal would have no reason to impose restrictions on the agent's actions. but even where there is a conflict of interest, a principal could in theory monitor the agent's effort and compensate him or her on the basis of the observed behavior. the ability to base rewards on monitored behavior can give the agent incentives to act as the principal prefers. if the worker knew, for example, that her payment would be based upon how quickly she responded to the company's needs, there would be no inherent problem in letting her moonlight. one could simply base her reward on her performance. exclusive dealing settings in an earlier paper [2], i constructed models of this principal! agent relationship to investigate further these benefits of exclusive dealing. unlike prior analyses of exclusive dealing ([6], 191, [101, [11], [12], [19]) we will not analyze effects beyond the principal and agent, e.g., whether exclusive dealing is inefficient because it promotes monopoly or excessive product differentiation. however, the discussion here may shed some light on antitrust issues by helping to understand when and why exclusive dealing would be instituted. simple conflict settings consider first a setting in which outside activities would discourage the agent form acting in the interests of the principal. this is a characteristic common to all the scenarios set out in table 1. one would expect that it would always be in the interest of the principal to have the agent deal exclusively on its behalf. principals, though, confront a tradeoff common to all these situations. the very fact of a conflict of interest means that the agent would rather be doing something other than what the principal wants it to do. it follows that the principal is going to have to compensate an agent for the opportunities it gives up when it makes an exclusive commitment on the principal's behalf. this introduces two complications into the question of when exclusive dealing benefits the principal. the first is that the principal v\~11 have to decide whether the improved performance of the agent is worth the increase in compensation necessary to get the agent to act on its behalf. to take an example, suppose a high technology firm can hire engineers for $10,000 less in annual salary if it permits them to take on outside consulting jobs or conduct independent research. it then has to decide whether it will get improvements in firm-specific effort worth the extra $10,000 per engineer to get exclusive performance. it may not if, for example, the opportunity to do outside work complements the engineers' efforts on behalf of the firm, rather than diverting attention from them. this might lead one to conclude that exclusive dealing is profitable only where the outside activity conflicts with the principal's desired activity. conversely, one might also conclude that where the outside activity complements the principal's interests, fall 1988 brennan: exclusive dealing 57 exclusive dealing would never be instituted. unfortunately, this need not be the case. situations can be identified in which it may be in the principal's interest to either (1) institute exclusive dealing even where the outside activities complement those in which the principal is most interested, and (2) permit conflicting activities even when they discourage performance of desired activities. the reason these unintuitive findings may hold is subtle, having to do with the relationship between an agent's income and its incentive to work on the principal's behalf. consider the engineer again. suppose the more income an engineer has, the more the professor is willing to undertake new research opportunities that benefit the high technology firm. note that this is not the same thing as paying the engineer more to work harder. rather, the engineer's own willingness to undertake this effort is correlated with income, in that an engineer who is wealthy will put more time into research of his own volition, reducing the need for the high technology firm to monitor his behavior or limit his opportunities. if this positive "income effect" is strong, it may be in the high technology firm's interest to permit some outside activity to increase the engineer's income, even if the outside activity itself has a negative effect on firm-specific effort. the benefits to the high technology firm in getting more highly motivated engineers, by allowing them to earn outside income, would exceed the costs of the "distraction." a similar line of argument shows that exclusive dealing may be imposed even where the outside activity is itself complementary if the "wealth effect" is strong but negative, i.e., more income makes acting in the principal's interest less attractive. these arguments can be generalized to all of the exclusive dealing situations displayed in table 1 or discussed above. provision of support services a more complex situation is one in which the principal can "invest" in the agent, e.g., when a manufacturer trains a dealer in the repair of his products. exclusive dealing here can serve as a way in which the principal can capture the "return" oil this investment; otherwise, it may not be provided. consider a bicycle maker, for example, who would find its bicycles in greater demand if trained repairpersons were easily available. however, repair expertise need not be specialized to the manufacturer's own brand. trained bicycle repairpersons could make it easier to get bicycles of any brand repaired, not just those of the manufacturer who provided the training. if the services provided by the bicycle maker cannot be linked to his brand, the benefits of those services will be diffused over the market as a whole. other manufacturers need not provide training; they can just "free ride" off the training already provided. if the training does not provide a competitive advantage to the bicycle maker, it will have little or no incentive to provide this training. here, exclusive dealing can provide the restriction necessary to generate the advantage. a bicycle retailer would receive instruction on how to fix brand x bicycles only if he or she refused to carry any other brand for which this training would apply. in that way, 58 journal of business strategies vol. 5, no.2 other manufacturers cannot "free ride" off the repair training provided by brand x's manufacturer. prevention of free riding has been the beneficial effect of exclusive dealing most discussed in the economic literature ([8], [10j, [17]). according to this story, increased outside activity by an agent discourages the provision of support services. if a bicycle dealer can sell other makes of bicycles, a manufacturer providing the training may "capture" less of the benefits of the training. the "income effect" discussed above comes in here in an interesting way, though. the more outside activity, the more income the agent can make in using that training, and the less the principal need pay to the agent. to rcturn to our example, the bicycle maker can reduce its compensation to its retailers if those retailers can make money by using training in the repair of other makes of bicycles. because of this "income effect," the principal's incentive to provide support services to its agent may actually be enhanced if its agent is able to profit from these services in the provision of outside activities. concluding remarks to summarize, we have found that exclusive dealing is far from being an aberration present only in alltitrust~related contexts. rather, it is a commop. device used to mitigate conflicts of interest between principals and their agents who cannot otherwise be monitored or controlled. an important special case is when an agent would have the incentive to use special training or support services on behalf of other "principals." when the effect of outside activity on an agent's income is recognized, though, a number of counterintuitive possibilities could occur. exclusive dealing may make sense even where outside activities complement work for the principal. it may not make sense even where there is a conflict of interest, and some outside activity may make it more profitable to provide support services that might benefit other principals. before leaving the topic, we should consider the possibility that exclusive dealing might be a device to exploit an agent. for example, once someone has decided to work at a particular firm, personal and financial commitments may reduce his mobility to the point where the firm may not need to maintain his welfare at the originally "promised" level. one way would be to cut salaries, but salary is often set over time by exclusive contract. a more feasible opportunistic strategy would be to impose exclusive dealing rules after the worker is already committed to the firm. such a change may get the worker to work harder for the firm without the need to compensate for lost earnings from foregone alternate employment opportunities. the theory of this kind of opportunism is set out by klein, crawford, and aichian [5j. while it may be in the principal's interest to take advantage of its agents' commitments, this will typically offer only short-run benefits, with potential long-run costs. a firm or wholesaler will not be able to continue to exploit its employees or retailers in this manner if it wants to recruit new agents or to retain those agents who are more mobile. it will have to promise salaries and compensation ex ante contingent upon the possibility of ex post exploitation, eliminating much of the gain and leaving only a mutually undesirable inefficiency. if the firm expects to be growing, it will find fall 1988 brennan: exclusive dealing 59 this kind of behavior detrimental to its long-run interests. tightening anti-conflict rules in midstream may be inconsistent with plans for growth. references 1. bork, r. the antitrust paradox. new york: basic books (1978). 2. brennan, t. "exclusive dealing and conflict of interest." economic analysis group discussion paper 87-10. u. s. department of justice: antitrust division (1987). 3. comanor, w. and h. e. frech. "the competitive effects of vertical agreements." american economic review, vol. 75 (1985), pp. 539-46. 4. continental t. v. inc., d. al. v. gte sylvania inc., 433 u.s. 36 (1977). 5. klein, b., r. crawford, and a. alchian. "vertical integration, appropriable rents, and the competitive contracting process." journal of law and economics, vol. 21 (1978), pp. 297-326. 6. klein, b. and l. f. saft. "the law and economics of franchise tying contracts." journal of law and economics, vol. 28 (1985), pp. 345-61. 7. krattenmaker, t. and s. salop. "anticompetitive exclusion: raising rivals' costs to achieve power over price." yale law journal, vol. 96 (1986), pp. 20993. 8. marvel, h. "exclusive dealing." journal of law and economics, vol. 25 (1982), pp. 1-25. 9. marvel, h. and s. mccafferty. "the welfare effects of resale price maintenance." journal of law and economics, vol. 28 (1985), pp. 363-79. 10. mathewson, g. f. "incentives and exclusive dealing." mimeo, university of toronto department of economics (1986). 11. mathewson, g. f. and r. a. winter. "an economic theory of vertical restraints." rand journal of economics, vol. 15 (1984), pp. 27-38. 12. mathewson, g. f. and r. a. winter. "the economics of vertical restraints in distribution." in j. stiglitz and g. f. mathewson (eds.), new developments in the analysis of market structure. cambridge, ma: the mit press (1986). 13. mathewson, g. f. and r. a. winter. "is exclusive dealing anti-competitive?" american economic review, vol. 77 (1987), pp. 1057-62. 14. pittman, r. "tying without exclusive dealing." antitrust bulletin, vol. 30 (1985), pp. 279-97. 60 journal of business strategies vol. 5, no.2 15. posner, r. "the next step in the antitrust treatment of restricted distribution: per se legality." university of chicago law review, vol. 48 (1981), pp.6-26. 16. schwartz, m. "exclusive dealing and product differentiation: what do comanor and frech really show." american economic review, vol. 77 (1987), pp. 1063-68. 17. schwartz, m. and d. eisenstadt. "vertical restraints." economic analysis group discussion paper 82-8. u. s. department of justice: antitrust division (1982). 18. standard oil co. of california v. united states, 337 u.s. 293 (1949). 19. teiser, 1. "why should manufacturers want fair trade?" journal of law and economics, vol. 3 (1960), pp. 86-105. 20. u. s. department of justice: antitrust division. vertical restraints guides (1985). 21. warren-boulton, f. r. vertical control of markets. cambridge, ma: ballinger (1978). exclusive dealing in general business practive an integrative planning model of mergers and acquismons garry d. bruton louisiana state university baton rouge, louisiana roger alexander management consultant margaret a. white oklahoma state university stillwater, oklahoma mergers and acquisitions (m&as) are methods frequently used for corporate growth and diversification. in 1988 alone, over $226 billion of mergers and acquisitions occurred in the united states [26]. while the volume of m&as is impressive, their effect on performance is often less than what was expected. the merger of dart industries with kraft food, people's express purchase of frontier airlines, and mobile corporation's purchase of montgomery ward & co. are just a few of the well publicized cases of m&as which were unsuccessful in meeting financial goal expectations. in addition to these case studies there is strong evidence from empirical investigations which raises questions about their financial benefits. for example, lubatkins's review of a number of merger and acquisition studies found that mergers do not benefit the acquiring firm with a return greater than it would receive from other investment opportunities with similar levels of risk [15]. other researchers have found that "mergers have not increased profitability, have not improved efficiency, have not expanded sales and in fact, do not seem to yield sufficient benefit to anyoneconsumer and companies alike" [17]. a potential reason for the lack of m&a success is the absence of adequate acquisition planning [2]. in particular, acquisition planners may not be considering process factors in their planning activities [13]. adequate considerations of process factors would include the organizational and behavioral relationships which occur throughout a m&a to date, planners and researchers have largely ignored these relationships in their effort to improve m&a performance. this paper develops a model that integrates process factors into m&a planning. the model builds on the previous research and prescriptive analyses of successful and unsuccessful approaches to m&a in addition, this model of m&a planning should be more effective than the previous models because it recognizes and integrates process factors from an acquisition planner's viewpoint. acquisition planners are the people centrally involved in any of the stages of a m&a the proposed model shown in figure 1 recognizes that a&m's have three stages: planning, acquiring, and integrating. fall1990 bruton,alexander& w'hite: integrativeplanning figure 1 acquisition planning model success integrating acquiring planning planning stage 87 the planning stage of the model focuses on building strategic readiness for the acquisition. this stage of the model has three central elements: 1) generating top level commitment; 2) formulating the firm's objectives, and 3) preparing to move opportunistically. these three elements are shown in figure 2. figure 2 planning stage generating top level commitment formulating firms acquisition objectives preparing to move opportunistically generating top level commitment an acquiring company must develop a commitment among top level management to support the firm's acquisition program. without the involvement of all top management personnel, implementation and involvement of lower level managers may be lacking. according to drucker, these supporting actions during the m&a are necessary for its success [9]. the harmful effect of the lack of commitment by top management was demonstrated in the baker international corporation and hughes tool company merger which occurred in 1987. the extreme conflict of opinions of a former ceo and sitting board members with the presiding ceo at the time of merger almost nullified the merger before it happened [10]. there were supporters for each man's viewpoint of the merger among the management of baker. the resulting merger has provided fewer benefits than originally expected. lack of agreement about the strategic worth of the merger created problems for the combined organization, baker-hughes, inc. 88 journal ofbusiness strategies vol. 7, no.2 formulating the firm's acquisition objectives once top management has developed a commitment to an acquisition program, a set of objectives for that program should be developed by top level management and should fit the firm's strategy. firms with successful acquisition programs formulate, as part of their objectives, a set of acquisition criteria to identify candidate f~s [8]. the criteria must involve more than financial calculations. instead, the use of acquisition criteria should ensure a strategic fit between the two firms. the need for this strategic fit is illustrated in the 1971 acquisition by general host corporation of cudahy company. general host stated that "acquisition represents a significant step toward our goal of acquiring businesses with proven earnings." general host divested cudahy 10 years later stating "the divestiture of cudahy will minimize our vulnerability to this cyclical commodity market" [1]. the focus by general host corporation strictly on financial concerns had blinded the corporation to whether a strategic fit would be present between the two firms. the importance of such acquisition criteria to insure the strategic fit of the firms has been readily recognized by acquisition practitioners [19, 23, 24,]. the acquisition criteria may be categorized as industry growth rate, degree of regulation, ease of entry, and capital versus labor intensity. firm specific criteria may include quality of management in the acquired firm, size of market share, and capital structure. while financial concerns should not dominate the objectives of the planner they must be considered. financial criteria such as expected cash flow, asset value desired, and tax benefits expected from the acquisition should all be specified. the pursuit of synergy is one of the most common objectives of an m&a. in fact, financial objectives of an m&a are often based on the presence of possible synergy between the acquired and acquiring firms. the evidence concerning the presence of synergies in m&as has been mixed. chesebrough-ponds bought stauffer chemical company expecting synergy between the two firms' r&d and marketing abilities. none was found; so when unilever bought chesebrough-ponds in 1986 it soon began to divest the elements which has been part of stauffer chemical. empirical investigations found little evidence of synergistic effects. haugen and langetieg found no evidence of any synergy in the mergers they examined [11]. however, chatterjee found that some financial synergies do exist in m&as [5]. financial synergies are derived from combining financial aspects of the two firms; the benefits of such synergies include obtaining lower cost of capital for the newly combined fmn. however, little support was found for technical synergies which result from combining operations. the absence of synergy, particularly operating synergy, may be due to the difficulty in combining the personnel of two firms. differences in operating procedures, culture, and employee competency introduce inefficiencies that eliminate any potential synergies. therefore, the planner must be careful to insure that the financial objectives, which are based on potential synergies, are actually possible. preparing to move opportunistically the final element in building the strategic readiness stage of the model is preparing to move opportunistically. organizational and fiscal resources must be available for the fall 1990 bruton, ale.xander& white: integrativeplanning 89 m&a. a common problem in acquisition is an underestimation of the requirements for the capital funds and management resources. such underestimation of resource requirements for an m&a can be serious. occidental petroleum purchased cities service in 1982. the $4 billion purchase price combined with a lack of management depth and a downturn in the oil industry resulted in significant financial pressure being placed on occidental. occidental was forced to sell not only significant portions of the old cities service but also other assets to recover [25]. this third element is driven by the prior two elements. the financial and management resources and their sources must be consistent with the firm's acquisition objectives. similarly, the ability to move opportunistically may be compromised without the support and commitment of top management. the speed and thoroughness required to be successful may not be possible if top management has not already corrunitted to a plan of action. in summary, the three elements of stage one of the model are driven by one another as seen in figure 2. it is critical that the firm recognize the importance of these factors and insure they are in place to support the acquisition program. acquiring stage the acquiring stage of the model deals with the actual identification of the merger or acquisition candidate and the negotiations to purchase that firm. there are three key elements in this stage of the model (figure 3). these are: 1) searching for acquisition candidates that meet acquisition criteria; 2) investigating organizational fit, and 3) negotiating the merger or acquisition. figure 3 acquiring stage searching for acquisition candidates assessing organizational fit negotiating purchase searching for acquisition candidate the initial task in stage 2 of the acquisition planning process is to conduct a search for acceptable acquisition candidates. this is a proactive element of the m&a process; the acceptable candidates are actively sought out. the basis of the analysis are the objectives and criteria that have been established in stage 1 of the model. industries are first screened to identify those that meet the acquisition criteria. next, acquisition candi90 journal ofbusiness strategies voi.7,no.2 dates are identified within the selected industries through an in-depth analysis of the industry participants. the acquisition candidates are those firms which most nearly match the acquisition criteria. those firms that then match the criteria may be approached concerning a possible merger and acquisition. as brian saffer, first vice president bache halsey stuart shield, stated "everybody's for sale until proven otherwise" [20]. assessing organizational fit once the acquisition candidate has been identified a more in-depth analysis is required to determine the degree of organizational fit. organizational fit between the administrative, cultural and personnel characteristics of the two firms is critical to reduce potential postmerger problems [7]. the impact of these problems may range from being a "serious nuisance" for a large firm acquiring a small firm to "life threatening" for a small firm acquiring an equal size or larger firm. therefore, prior to entering the negotiation process the acquiring firm should determine if a reasonable systematic fit can be expected [4]. one potential organizational fit issue is the difference in the administrative character~ istics of two firms. for example, the differences in administrative characteristics between a small entrepreneurial firm and a larger more bureaucratic firm can be substantial. these differences impacted their potential success of raythion's purchase of lexitron corporation in 1978. lexitron had been a leader in word processing technology and raytheon hoped to combine that knowledge with its computer terminal production to become a leader in the integrated office systems market. however, the marriage between the large established defence contractor and the high-tech entrepreneurial firm failed. by 1984 raytheon sold its divisions of which lexitron was a part, taking a $95 million write-off. the bureaucratic administrative structure of raytheon suffocated the entrepreneurial spirit of lexitron [6]. other large firms have had similar experiences with their purchase of entrepreneurial firms; schlumberger's acquisition of fairchild camera and instrument, and exxon's purchase of reliance electric failed as the larger firm smothered the innovative climate of the smaller firm. the administrative difference between two firms does not necessarily have to lead to failure. kraft's purchase of celestial seasonings involved similar bureaucratic and entrepreneurial firms [3]. however, kraft was clearly aware of these administrative differences and sought to deal with them during and after the acquisition. culture is another critical part of organizational fit. overall, culture can be defined as the assumptions, values, and perceptions of company practices in each firm. the culture of an organization shapes the behavior of the participants in that organization. the clash between two cultures can seriously inhibit postmerger performance as employees become unclear what values and actions are expected of them. for example, the acquisition of st. joe minerals corporation in 1981 by its "white knight" fluor corporation resulted in such a clash of cultures. both organizations' management were highly respected. however, each firm had a distinct culture. st. joe allowed managers considerable autonomy in their decision making and encouraged a structure more characteristic of a partnership than typical of a publicly traded corporation. fluor, on-the-other-hand, had a very centralized structure with fall1990 bruton, a lexander & white: integrativeplllnning 91 clear lines of democracy between various levels of the organization and a central corporate staff to make most critical decisions. the two cultures clashed and impeded the postmerger performance of the corporation. managers must be aware of the culture and administrative structure of a proposed merger or acquisition and how those factors may impact organizational fit. negotiation process the majority of cancellations that occur in the negotiation phase are due to inadequate bids or the inability to obtain sufficient financing to meet the candidates's terms [16]. however, beyond these two difficulties there are additional issues that may cause a combination's failure; these issues center on through communication being provided to, and received from, the acquisition candidate. in 1980, seagram's initially made an acquisition attempt for st. joe minerals. however, rather than contact the management of the firm directly, their announcement of intent to acquire was made through the press. as a result s1. joe began looking for a white knight, with fluor purchasing the firm in 1981. s1. joe's president later said, "if edgar bronfman had talked to us first, it might have worked. we might have reached an agreement, maybe for $52 a share" (fluor paid $60 a share) [12]. while seagram's might not want to lose its strategic advantage by giving prior notice, some prior communication, or communication during the process, may have prevented losing the m&a opportunity. finally, the negotiation process must communicate clearly what the acquiring firm is receiving for its purchase. the ford motor company, in its 1987 acquisition of 75% of aston martin, thought it bought a 50% stake in the italian design firm of zagato. it had not, and ford was left with a less attractive acquisition than it had originally envisioned. therefore, it is critical that sufficient information be exchanged and clarified for a successful m&a. integrating stage the planner's work is not fmished once the acquisition occurs. the negotiation process to purchase a firm often results in an "agreement in principle." the resulting structure of the firm, personnel issues and other relevant items are left to be settled after the acquisition is completed. if the potential firm rejects the acquisition offer, a hostile takeover may follow. issues of structure and personnel are again left unsettled. therefore, whether the takeover is hostile or friendly substantial amounts of work remain for the planner. too frequently, acquiring firms fail to plan how such issues will be addressed [8]. the third stage of the model examines integrating the acquired business with the acquiring company. this stage of the model has three elements (figure 4): 1) establishing a transition team, 2) integrating the acquired finn, and 3) gaining equilibrium. assigning the executive transition team the first element of this stage is assigning the executive team to aid in the transition. when making acquisitions a firm should have a plan of action to assist in the transition 92 journal ofbusiness strategies vol. 7, no.2 [22]. the transition team should consist of key managers from each organization and should represent critical functions or major product lines in both frrms. the transition team should develop a plan for integration of the firms and then help manage the integration of the two firms. the ultimate goal of the team should be to facilitate the integration of both individuals and operations of the previously independent entities. figure 4 integrating stage assigning transition team integrating the acquired firm gaining equilibrium the transition team can also help to deal with the key concerns of the employees immediately following the announced m&a. the transition of ownership is a highly stressful occurrence for employees [21j. accurate communication, both up and down the acquired organization, is critical to limit such stress [16]. the transition team can help to provide this steady flow of information from the acquiring firm to the employees of the acquired firm to ease their anxieties. the acquisition planners should recognize the potential for stress and uncertainty among organizational constituents. they must deal quickly and effectively to eliminate potentially destructive actions, such as the loss of key personnel, customers, and supplies. the successful allied-bendix merger illustrates the critical role a transition team can play in an m&a. to facilitate the merger, a transition team was established representing senior managers from both allied and bendix. this team was drawn from the areas of [mance, human resources, operations, law, tax, planning, public affairs, and technology. sub-transition teams were then formed to deal with specific problems in each of these areas. the transition team had five months to arrive at total integration plan for the two firms. the transition teams and ail senior managers sought to answer questions of employees as quickly as possible. clear time lines were established as to when key information needed to be communicated to the employees. major issues, such as key appointments as well as who was staying or leaving, were all answered in that first five months. the result was a highly successful combination of the two firms. integrating the acquired firm once an integration plan is established the acquiring firm should move quickly to structurally integrate the new firm into the company. reporting relationships should be fall1990 bruton, alexander& white: integrative planning 93 defined in a clear, precise manner. kitching argued that "the setting up of unclear reporting relationships and the temptation to change them often; such action was present in 81 percent of (acquisition) failures" [14]. the actual integration, therefore, should be carried out in a timely manner with the resulting organizational structure having some stability for a period of time following the merger or acquisition. the nature of the structure to be established after an m&a must also be examined carefully. the easiest structure for the acquiring firm to formulate is to make the acquired firm a separate operating unit. however, the m&a planner should establish organizational structure based on what is appropriate, not what is easy. baxter international acquired american hospital supply corporation in 1985. the organizational structure that resulted from this combination was substantially different than either firm's pre-m&a structure. baxter recognized that neither the control over personnel nor the potential economies of scale they desired could be provided by the structure either firm possessed. the new structure that was established allowed both of these issues to be addressed and helped provide baxter a successful m&a. gaining equilibrium after the firm's personnel and structures are integrated the focus of the planner is the return of the newly combined firm to a state of equilibrium. the planner's equilibrium is established by obtaining stability in the culture and key personnel attitudes of the acquired ftrm. they identified these attitude and the firm's culture in the analysis of organizational fit. however, the trauma of the m&a and turnover in key personnel may cause a change in these items. planners need to continue to communicate to the employees about the m&a and receive information about their feelings. surveys or structured interviews are an excellent way to receive feedback from the employees. these feedback mechanisms will allow the firm's culture and key attitudes to be monitored. particular problems that arise can then be identified and addressed. dupont's acquisition of conoco and general motors' acquisition of hughes aircraft are examples of firms which successfully sought to monitor and maintain key attitudes and culture in the firms they acquired. they did this by ensuring the retention of certain key individuals who reflected those values and making other specific efforts, such as through compensation, to reinforce certain values. acquiring firms should monitor their newly combined organization closely. if particular values appear to be diminishing, both symbolic and substantive actions should be taken to reenforce the desired values. summary in summary, acquisition planners need to include process factors in their planning activities. the incremental model for incorporation of process factors into the m&a planning process (with each element driving the other elements) should help managers adapt 94 joumal ofbusiness strategies vol. 7, no.2 as new information becomes available [18]. too often a m&a is viewed as a single event. by recognizing that a m&a is a process which begins before the consummation of the legal purchase and then continues after the purchase, the planner can develop a more thorough understanding of the m&a. this understanding can help the planner smooth the transition between the two organizations and reach a new equilibrium state faster than might normally be experienced. bibliography 1. achtmeyer, w.p. and danniell, m.h. "how advanced planning widens acquisition rewards." mergers & acquisitios, vol. 23 (july/august, 1988), pp. 37-42. 2. ansoff, i. h., avner, j., brandenberg, r. g., portner, p. e., and radosevich, r. "does planning pay? the effect of planning on success of acquisitions in american firms." long range planning, vol. 3. no. 12 (1970) pp. 2-7. 3. atchison, s. d. "kraft is celestial seasonings' cup of tea." business week (july 28, 1986), p.73. 4. callahan, j. p. "chemistry: how mismatched managements can kill a deal." mergers & acquisitions. vol. 21 (march/april 1986), pp. 47-53. 5. chatterjee, d. "types of synergy and economic value: the impact of acquisitions on merging and rival firms." strategic management journal, vol. 7 (1986), pp. 119-139. 6. cohen, l. p. "failed marriages: raytheon is among companies regretting high-tech mergers." wall street journal (september, 1984), p. 1. 7. davis, r.d. "compatibility in corporate marriages." harvard business review, vol. 46 (1968), pp. 86-93. 8. denoble, af., gustafson, l.t., and hergert, m. "planning for post-merger integrationeight lessons for merger success." long range planning, vol. 21 (1988), pp. 82-85. 9. drucker, p.p. ''the five rules of successful acquisition." the wall street journal (october 15, 1981). 10. eklung, c.s. and vogel, t. "why the baker-hughes merger almost didn't happen." business week, (may 11, 1987), pp. 110-111. 11. haugen, r.a. and langetieg, t. c. "an empirical test for synergism in merger." journal of finance, vol. 30 (1975), pp. 1003-1014. 12. hughes, k.a "in mergers, manners can matter a lot." wall street journal (october 4, 1982), p. 35. fall 1990 bruton, alexander& white: integrativeplanning 95 13. jemison, d.b. and sitkin, s.b. "corporate acquisitions: a process prospective." academy of management review vol. 11 (1986). 14. kitching, 1. "why do mergers miscarry?" _harvard business review, vol. 45 nol 6 (1967), pp. 84-101. 15. lubatkin, m. "mergers and performance of the acquiring firm." academy of management review, vol. 8 (1983), pp. 218-225. 16. mccann, j.e. and gilkey, r joining forces: creating and managing successful mergers and acquisitions. prentice-hall: new jersey (1988). 17. pekar, p. "a strategic approach to diversification," journal of business strategy, vol. 5. no.4 (1985) pp. 99-104. 18. quinn, j.b. "strategic change: logical incrementalism." sloan management review, vol. 27 (1978), pp. 47-57. 19. rockwell, jr. w.p. "how to acquire a company." harvard business review, vol. 46, no. 5 (1968), pp. 121-132. 20. "roundtable: searching for the 'right' company." mergers & acquisitions, vol. 17 (summer, 1982), pp. 23-30. 21. shirley, rc. "the human side of merger planning." long range planning, vol. 10 (1977), pp.35-39. 22. sinetar, m. "mergers, morale and productivity." personnel journal, vol. 60 (1981), pp. 863867. 23. temple, j.e. , veal, jr., t.g., and smith, w.k "strategic growth through merger and acquisition." financial executive, vol. 49, no.5 (1981), pp. 13-16. 24. terry, rj. "ten suggestions for acquisition success." managerial planning, vol 31, no. s (1982), pp. 13-16. 25. wayne, l. "executives will defend its $4 billion purchase of cities service, though analysts say debts from the deal are choking the company." new york times, (january 23, 1983). 26. "1988 profile." mergers & acquisitions, vol. 23, no.6 (1989), p. 53. an integrative planning model of mergers and acquisitions the impact of formal planning on the financial performance of real estate firmsl d. robley wood, jr. russell a. johnston guy j. degenaro school of business virginia commonwealth university richmond, virginia the body of academic literature on the relationship between formal planning drorts and financial performance contains mixed results (see [2], [11]). the effectiveness of formal planning has also been debated in the popular business literature. nevertheless, the idea that a structured format for processing information and evaluating alternatives should result in superior decisions is both logical and intuitively appealing. this research investigates the relationship between the formal planning efforts and financial performance for a sample of real estate firms located in the state of virginia, u.s.a. it was hypothesized that virginia real estate firms that were more formal in their planning would financially outperform those that were less formal. the guttman scaling method was used to develop a formal planning scale for the real estate firms. the group of real estate firms which scored high on the formal planning scale were compared with those that scored low. literature review during the past twenty years various researchers have conducted empirical studies into the relationship between formal planning efforts and organizational performance (for reviews, see [2], [11]). typically, the researchers have divided their sample into groups such as "planners vs. non-planners" (e.g., [6], [12]) and then compared the financial performance of the two groups over a. specific period of time. the results of these studies have not been consistent ([2], [11]). kudla [5] stated that one reason for the inconsistent results could be the method that was used to divide the sample into planners and non-planners. to reduce the chance of improper classification, wood and laforge ([14], [15]) ~~~--------lthis research was made possible by funding from the virginia real estate research center. journal of bu,l/iness strategies, volume 5, number 1 (spring 1988) 44 suggested that the guttman scaling method be used to categorize organizations when conducting empirical research on the relationship between planning and performance. venkatraman, ramanujam and camillus [13] studied data from 202 strategic planning units and concluded that the use of guttman scales in planning studies is feasible and desirable. therefore, in this study a guttman planning scale was developed and used to classify the real estate firms into those with more formal planning and ones with less formal planning. guttman scaling guttman scaling is a method of determining whether a series of questions are related to each other in such a way that one who replies affirmatively to the second question should also reply affirmatively to the fitst question; one who replies affirmatively to the third question should reply affirmatively to questions one and two, and so forth. this means that all real estate firms for which any particular question was answered affirmatively should have a higher score on the total scale than those firms for which that question was not answered affirmatively. the score for each firm is computed by counting the number of questions that were answered affirmatively. with cumulative scaling1 a given score for a series of questions always has the same meaning. that is, respondents in every real estate firm that have a total score of two will have replied affirmatively to the first two questions and not affirmatively to the remaining questions. since a perfect cumulative scale is very difficult to develop, 10 percent discrepancies are considered acceptable. a discrepancy would result if a firm's representative responded affirmatively to questions one and three while not responding affirmatively to question two. the premise of the guttman method is that if a series of questions on a subject, such as planning, can be developed where the responses deviate only slightly from the ideal scale pattern, then these questions form a scale which is ordinal. in addition, guttman maintains that if a series of questions are related in such a way that they form a cumulative sgale, then the subject being studied involves only a single dimension and therefore the scale is unidimensional. for more information about guttman scales, please see [4], [7], or [15]. method the research for the present study was initiated in march 1984, when personal, in-depth interviews were held with executives in seven real estate firms, a staff specialist with the virginia association of realtors and the director of the virginia real estate research center. the purpose of the interviews was to gain insights into the management practices of the real estate industry so a quick-answer questionnaire could be constructed. the resulting quick-answer questionnaire contained eighteen questions, and covered such topics 88 legal form of ownership, year firm was established, use of outside consultants, planning practices and financial data for 1982 and 1983. allor part of eight questions 45 were used to collect data on the planning practices of the real estate firms. the questions were designed to collect information on real estate firms which had little formal planning as well as those which were more comprehensive in their planning practices. one six-part question was used to collect information on the financial characteristics of the real estate firms. the questionnaire was mailed to all virginia association of realtors (var) principal broker members that were on the association's computerized mailing list. each real estate firm has only one principal broker and 2,050 were on the association's 1984 mailing list. the mailing of the questionnaire was conducted during july 1984. the mailing packet contained an explanatory cover letter, the questionnaire and a post card. to ensure the confidentiality of the replies, the respondents were asked not to sign the questionnaire. for purposes of providing to the respondents copies of the study, each was asked to sign a post card and mail it separately from the mailing of the completed questionnaire. of the 305 returned questionnaires, 126 contained all planning and financial data and were used as the sample for this paper. the low response rate of 305 out of 2,050 may be attributable to several factors. since specific financial information was solicited, many brokers may have been reluctant to divulge confidential data to the extent requested. additionally, the questionnaires were mailed bulk-rate. thus, the number not forwarded to new addresses was lost to the study. it is also not known how many organization's were no longer in business when the questionnaires were m8.iled. the sample used in this study, 126 real estate firms in virginia, was tested for representativeness using national data reported by the national association of realtors (nar) in their profile of rea.l esta.te firms, 1989 [8]. in terms of activity (brokerage versus non-brokerage), our sample of virginia firms tends to be comparable to the national distribution record in the nar study. the responses to the planning-related questions were arranged in a logical order starting with a total absence of formal pla.nning and going through strategic long-range corporate pla.nning. the responses were checked to see that they formed the proper cumulative pattern necessary for a guttman scale. it was found that the responses did form the triangular pattern, but more than 10 percent of the responses deviated from a perfect scale. however, through an iterative procedure it was possible to identify a set of nine questions that met the guttman criteria of less than 10 percent discrepancies. the actul!-l discrepancy rate was 7.84 percent for the scale that is presented in figure 1. the nine questions that scaled are in the order they appear in the scale from "more of the real estate firms agreed with" to ''fewer of the real estate firms agreed with." for purposes of analysis, it was decided to collapse the responses into two categories: "less formal planners" and "more formal planners." real estate firms placed in the category of less formal planners scored between zero and four on the lower five scale positions (the score of zero being one of the five 46 positions). real estate firms that were placed in the category of more formal planners were ones that scored on the upper five scale positions. figure 1 the applied scale more of the real estate firms agreed with it is more likely that things just happen than that the firm plans it that way! your firm makes use of written total revenue projections for one year or less. your firm makes use of written goals/objectives for one year or less. most of the firm's plans exist only in the mind of the top person in the organization.· there is an integrating of the long range strategic planning and budgeting processes. your various planning activities are consolidated into a written company plan. fewer of the real estate firms agreed with your firm makes use of a written analysis of the firm's internal strengths and weaknesses; e.g., staffing, training, financial, and facilities. detailed action plans are used to support each major strategy. your firm makes use of a detailed, written analysis of its market area. t------=--~--:c--____=----.~~~--.~-.. . , "" '.---------.--.---,-..---------• actual scoring was reversed on these items since agreement would indicate less, not more, formality in the planning process. findings the performance of the two groups were compared using average dollar changes in both gross income and net income. the averages were computed by individually calculating the dollar increase or decrease for each real estate firm in a group and then simply averaging them together. table 1 represents the average dollar changes in net income for 1982-1983. beneath the headings more formal planners and less formal planners is indicated the number of real estate firms in the sample group (n), the average dollar increase in the net income for that group over the one year x period and the standard deviation of the average dollar changes in net income (8). the information in table 1 shows that there were 34 firms in the sample classified as more formal planners. the average of this group's dollar changes 47 in net income was a positive $35,200 with a standard deviation of $76,000. there were 92 firms which were classified as less formal planners. the average of the less formal planners' dollar changes in net income was a positive $24,000 with a standard deviation of $37,260. the difference in the performance of the two groups is also presented in table 1. the information in table 1 shows that the more formal planners in the sample had an average dollar increase in net income for 1982-1983 that was $11,200 greater than the average dollar increase for the less formal planners. table 1 differences in performance (1982-1983) average dollar change in net income group characteristics difference in :z: (in $1,ooos) more formal planners (n = 34) iv = $35.20 s = $76.00 $11.20· less formal planners (n = 92) x = $24.00 s = $37.26 • p < .07 using the mann-whitney-wilcoxon test according to the research hypothesis of this study, the more formal planners would be expected to outperform the less formal planners. examination of the data in table 1 shows that the difference in net income growth was in the hypothesized direction. statistical significance was determined by use of the mann-whitney-wilcoxon test. the mann-whitney-wilcoxon test was used to test the hypothesis that the population means for any combination of groups of real estate firms is the same, and that the difference recorded in table 1 indicates that with regard to average dollar growth in net income over the 19821983 period, the 34 more formal planners as a group significantly outperformed (at the .07 level) the group of 92 less formal planners. the information in table 2 shows a comparison of the more formal planners with the less formal planners when the performance measure is average dollar change in gross income. the more formal planners had an average dollar increase in gross income for 1982-1983 of $218,210 while the increase for the less formal planners was $93,950. the difference in the average dollar increase in gross income between the two groups was $124,260 and it was in the hypothesized direction. the results in table 2 indicate that with respect to average dollar growth in gross income over the 1982-1983 period, the 34 more formal planners as a group significantly outperformed (at the .01 level) the group of 92 less formal planners. the financial performances of the two groups were also compared using average percentage changes in both gross income and net income. by using percentage changes, the problem of "size of firm" affecting the results was taken 48 into consideration. however, it is certainly not a perfect measure since it is much easier for smaller firms to show dra.matic percentage increases or decreases than for larger firms. table 2 differences in performance (1982-1983) average dollar change in gross income r-----------------,----------,----::--:--c:=------,---. group characteristics difference in a: f-~_----=_-----=---=c:-____'(_in___;_$ _1 !~~o__sc)-:-----------l more formal planners (n = 34) z = $218.21 8 = $277.62 $124.26· less formal planners (n = 92) z = $93.95 8 = $346.12 ----~----__,____----l • p < .01 using the mann-whitney-wilcoxon test for 1982-83, the average percentage increase in net income jar the group of 92 less formal planners was 49.41 percent. during the same period, the average percentage increase in net income for the group of 34 more formal pla.nners was 54.75 percent. the difference between the two groups was 5.34 percent and it was in the expected direction. however, because of the amount of variability in the data, the 5.34 percent difference between groups was not statistically significant. during 1982-83, the average percentage increase in gross income for the group of 93 less formal planners was 33.57 percent. for the same period, the average percentage increase in gross income for the group of 34 more formal planners was 39.70 percent. the difference between the two groups was 6.13 percent and it was in the hypothesized direction. however, consistent with the findings for percentage change in net income, the amount of variability in the data for the percentage change in gross income was so large that the 6.13 percent difference between groups was not statistically significant. other financial measures were also utilized in this study. data on dollar investment in the business were collected and determined to be useless in any meaningful analysis. in the real estate business it is possible to rent or lease almost everything one needs to operate. also, owners do not typically leave large amounts of money in the business. therefore, investment in the business tends to be a low figure and return on investment ratios are often extremely high. information on dollars paid to the owners was also collected for this study. the typical ways the owners receive dollar compensation are salaries, commissions and distributions or dividends. the above categories and percentage increases between 1982-1983 for the less formal planners were as follows: salaries (31.6%), commission (40.0%) and distributions or dividends (87.4%). similar data for the more formal planners is: salaries (53.8%), commissions (105.6%), 49 a.nd distributions or dividends (294.3%). the importance of this finding is twofold. first, the more formal planners outperformed the less formal planners in all categories of growth in dollar compensation for the owners during the survey period. second, the differences in growth rates of all forms of compensation to owners were large between groups. in summary, the financial performance measures were all in the direction of support for the research hypothesis. specifically, the findings presented below in table 3 suggest that real estate firms which are more formal in their planning have a competitive advantage over similar firms which make less use of written documents and specific procedures. table 3 average performance of firms in sample (1982-1983) performance less formal more formal indicator planners planners number of firms 92 34 average dollar change in net income 824,000 $35,200 gross income 393,950 $218,210 average percentage increase in net income 49.41% 54.75% gross income 33.57% 39.70% salaries 31.60% 53.80% commissions 40.00% 105.60% distributions and/or dividends 87.40% 294.30% discussion in this study a group of real estate firms that engaged in formal planning financially outperformed a group of real estate firms that were less formal in their planning efforts. previous research of this type produced results that were evenly split for service industry firms. fulmer a.nd rue [3] a.nd robinson a.nd pearce [9j compared groups of firms in the service industry according to their planning activities a.nd did not find that the firms differed in financial performance. the research results of this study are consistent with the previous finding of wood and laforge [15] and sapp &ild seiler [10]. the real estate industry in the united states had a much better year in 1983 than it did in 1982. because industry performance improved, some of the sample firms had dramatic increases in their sales and income. the dramatic increases experienced by these firms contributed to the large standard deviations for the groups. the differences in size of the individual firms also contributed to the large standard deviations. small, medium and large real estate firms were in the 50 groups of more formal planners and less formal planners. the smallest fum in the group of more formal planners had only $40,000 in gross income for 1983 while the largest reported $562,000 in gross income. large standard deviations are not unusual in this type of research. examples of other research reporting similar results include ansoff, avner, brandenburg, porter, and radosevich {i} and fulmer and rue [3}. conclusion the superior financial performance of any firm is attributable to many different factors which are typically referred to as better management practices. the findings of this research suggest that a source of these superior management practices, at least in the area. of real estate firms, is comprehensive formal planning by the firm. references 1. ansoff, h. i., j. avner, r. c. brandenburg, f. e. portner, and r. radosevich. "does planning pay? the effect of planning on success of acquisitions in american firms." long range planning, vol. 3, no. 2 (1970), pp. 2-7. 2. armstrong, j. s. "the value of formal planning for strategic decision: review of empirical research." strategic management journal, vol. 3 (1982), pp. 197-211. 3. fulmer, r. m. and rue, l. w. "the practice and profitability of long range planning." managerial planning, vol. 22 (1974), pp. 1-7. 4. guttman, l. "a basis for scaling qualitative data." american sociological review (1944), pp. 139-150. 5. kudla, r. j. "the effects of strategic planning on common stock returns." academy of management journal, vol. 23 (1980), pp. 5-20. 6. malik, z. a. and karger, d. w. "does long-range planning improve company performance?" management review, vol. 64 (1975), pp. 26-31. 7. oppenheim, a. n. questionnaire design and attitude measurement, new york, ny: basic books, inc. (1966), pp. 143-155. 8. profile of real estate firms, 1983. washington, dc: national association of realtors (1983). 9. robinson, r. b. and pearce, j. s. "the impact of formalized strategic planning on financial performance in small organizations." strategic management journal, vol. 29 (1983), pp. 32-36. 51 10. sapp, r. w. and seiler, r. e. "the relationship between long-range planning and financial performance of u. s. commercial banks." management planning, vol. 29 (1981), pp. 32-36. 11. shrader, c. r, l. taylor, and d. r. da.lton. "strategic planning and organizational performance: a critical appraisal." journal of management, vol. 10 (1984), pp. 149-171. 12. thune, s. s. and house, r. j. "where long-range planning pays off." business horizons, vol. 13 (1970), pp. 81-87. 13. venkatraman, n., v. ramanujam, and j. c. camillus. "measuring strategic planning characteristics using guttman-type scales: a generalized examination." university of pittsburgh graduate school of business working paper (1984), pp. 1-29. 14. wood, d. r. and laforge, l. "the impact of comprehensive planning on financial performance." academy of management journal, vol. 22 (1979), pp. 516-526. 15. wood, d. r. and laforge, l. "toward the development of a planning sea.le: an example from the banking industry." strategic management journal, vol. 27 (1981), pp. 209-216. 52 the impact of formal planning on the financial performance of real estate firms fu11jristics: some lessons fur mar.k:enng managers ronald d. michman shippensburg university shippensburg, pennsylvania alan j. greco wmthrop college rock hill. south carolina michael a. mcginnis shippensburg university shippensburg, pennsylvania with responsibility for strategic planning often assigned to corporate strategic planning departments [13], marketing managers may inadvertently become too short term oriented in the planning process. to help avoid an exclusive focus on short run product-oriented planning, marketing departments should be encouraged to participate in longer range futures planning. philip kotler has maintained that marketing managers should use environmental strategies to influence conditions previously considered uncontrollable. according to kotler, the essence of creative strategic thinking is that the environment must be managed as well as the marketing mix. kotler has added two additional p's political power and public opinion formation to the traditional marketing mix of product, place, promotion, and price to emphasize the organization's need to proactively influence these environmental forces [5]. it has been stated that an environmental management perspective encourages marketers to confront environmental issues with an increased level of pragmatism and to assume a more integral role in corporate strategy [14]. the ability of the firm to shape its environment with new products, technologies, and administrative techniques is fundamental for successful strategic planning [7]. this integration of the marketer in strategy formulation appears to be lacking. in a study published in 1989, nearly half (48 percent) of the companies reported that the development of strategic plans was primarily the responsibility of the ceo and senior management [13]. in 40 percent of the firms this task was assigned to corporate strategic planning departments rather than to corporate marketing departments. the marketing departments were primarily responsible for new product development, ,market research, and tracking the activities of competitors. the above findings suggest that futurist activities are unlikely to emerge as specialized staff activities in most firms. rather, the contributions of futurist research will only be realized if operating and divisional line managers internalize its lessons in their planning activities. this article examines three lessons from futures research that should be useful in the planning activities of marketing managers and discusses how these three lessons can help improve the market planning process. 142 journal of business strategies the three lessons vol. 8, no.2 much of the literature on future research has focused on techniques of scanning and monitoring the external environment. too little attention has been given to understanding fundamental underlying issues that frequently shape the effectiveness of future planning activities. 1. asking the right questions developing sophisticated projections that do not answer relevant questions can mislead the marketing manager into formulating questions that fit the available answers [14]. the appropriateness of resulting marketing strategies will depend on happenstance rather than insight. the right questions to ask for futures planning typically relate to market needs, changes, and value-added benefits. for example, when full-sized automobile sales began to slow in the mid-1960s, the domestic automobile manufacturers should have asked-and attempted to answer-iluestions about (1) the potential impact of competition from imports, (2) the long term supply and sources of petroleum, (3) the impact of automobile engine emissions on the environment, (4) the need for safety equipment such as air bags and anti-lock brakes on automobiles, and (5) the feasibility of quality and reliability improvements to adapt to an increasingly competitive environment. bmw, for example, has recently re-directed its close association in the 19808 with the now fading yuppie lifestyle [12], to the technological capabilities of its vehicles [8]. futures planning questions should avoid narrow, product-specific questions directed to small incremental changes. examples of the latter in the automobile industry would include: (1) what type of sound system should the car have? (2) should clear coat metallic paint be added to the option list? (3) on what models should a digital dash readout be made available? if nearly all research effort is directed to short term product-related issues, then the critical long term futures issues are likely to be neglected with potentially harmful consequences. the right questions to ask for futures planning differ from the problem-specific questions asked in the market research process. the coca-cola company in the 1980s, for example, conducted market research on consumer taste preferences before introducing new coke in response to the market research question of what taste consumers preferred. market intelligence gathering often centers around product-specific information such as the monitoring of market share information. the right questions for futures planning are more far-reaching and longer term in nature and can help the olganization to develop alternative product-market scenarios for the future. a variety of qualitative and quantitative techniques have been adapted to scan the environment and forecast the future ([1],[4],[9]). qualitative techniques include: delphi technique, cross-impact analysis, barometric forecasts, multiple scenarios. quantitative techniques are trend analysis and econometric models. the successful application of these tools encourages the user to "formalize" the questioning process and, thus, can help steer management toward asking and answering the right questions. fall 1991 michman, greco & mcginnis: futuristics 143 while the qualitative and quantitative techniques can be helpful in predicting future issues, to a large extent, the major contributions of these techniques is that of raising questions regarding the future. this ability to ask good questions about the future is the key to the effective definition of marketing problems and opportunities. asking good questions enables the marketing manager to play ''what if" with various scenarios. this ability to anticipate alternate scenarios and to identify appropriate responses can help the marketing manager to avoid type iii errors (discussed in the next section) as well as helping the marketing manager to be less frightened by the unknowns. asking the right questions, when carried to a logical conclusion, becomes an interactive process between perceptions of the future, questions about the future, questions about future strategies, and increased awareness of which questions are answerable and which questions are unanswerable. figure 1 illustrates the components of this interactive process. asking the right questions does not guarantee that the marketing manager will have all of the answers regarding the future and future strategies. but, asking the right questions does increase the chances that marketing managers will have a balanced understanding of their grasp of the relevant questions and the extent to which they can be answered. in addition, ''what one knows always becomes clearer by knowing what one does not know" [3]. 2. avoiding type ill errors developing good question-asking skills leads to the second lesson discussed in this article. while most readers are familiar with type i errors (marketing a product that should not have been marketed) and type ii errors (not marketing a product that should have been marketed), the type iii errors is more insidious and more likely to be committed by those whose future market planning is weak. basically the type iii error is the probability of solving the «wrong" problem when you should have solved the "right" problem [10]. type iii errors frequently result from a rush to "find an answer" rather then to accept reality [10]. in some instances questions concerning the future may: a) not have answers and/or b) not be fathomable. the tendency to prematurely impose answers on questions often leads to misstatement of the problem and to development of an answer to the misstated problem. a key to avoiding type iii errors lies in learning to ask the right questions. the extent that the marketing manager knows what questions to ask, understands which questions are answerable, and which questions are unanswerable (at least for now), to a larger extent determines the chance that the marketing manager will make type iii errors. type iii errors also can originate from answering market research questions that are too narrow in focus. coca cola company focused on the results of taste tests for new coke vs. pepsi cola. however, the question of what consumer reaction would be if "old" coke was removed from the market was not adequately investigated. hence, in a market research sense, the company got the right answer to the wrong question. 144 journal ofbusiness strategies vol. 8, no.2 figure 1. future perceptions and the market planning environment. " .... perceptions about the future -.... questions about the future ...... ~ questions about future strategies answers to questions and m~ --"" awareness of unanswered questions ~ better understanding of the environment for marketing planning 3. becoming more aware of the unknowns to many, the idea of future planning by marketing managers implies a high level of understanding of the future. as far as we can determine, no one is clairvoyant. rather, estimates about the future are based on the combined experience, insights, and intuition of individuals. many future events cannot be deduced from what is presently known. the recently published boo~ megatrends 2000, for example, predicted that there would fall 1991 michman, greco & mcginnis: futuristics 145 be no oil aisis in the 1990s [11]. marketing managers, then, must be aware of the unknowns that cannot be predicted from what is already known [6]. for example, in 1980 the common wisdom was that by 1986 gasoline would cost only $2.50 per gallon if we were lucky. the reality was that gasoline had fallen to under $1.00 per gallon in 1986, but by 1990 had exceeded $1.35 per gallon. in a similar manner, market forecast~ ers predicted in 1982 that home computers would be present in nearly every household by the mid-1980s. instead, the video cassette recorder emerged as the dominant consumer electronics product of the period. this uncertainty about future events requires marketing managers to be constantly aware that unknowns lurk in the future. asking and answering the right questions can help reduce future uncertainty by planning for at least some contingencies not all of which will materialize. several years ago the wristwatch industry, for example, might have asked ''what if new technology permitted our product to offer the same or higher performance at a much lower price?" [2] seiko and tunex used new technology to develop accurate quartz watches and used mass marketing techniques in advertising, pricing, and distribution to reach a large market. rolex, however, continued to make pin-lever type watches and used a concentrated marketing strategy of high prices and more limited distribution to upscale consumers on the basis of status and quality. certainly everything is not predictable but "what if' analysis can provide managers with some degree of comfort in unstable environments. rather than trying to anticipate the vast array of highly unlikely events that could occur, the marketing manager that accepts these unknowns as part of the natural order will be better prepared to respond. those marketing managers who think: that their assessment of the future has considered all possible contingencies are far more likely to be immobilized by the unknowns because these events are, in fact, unknowns from an intellectual standpoint. however, the presence of unknowns does not mean that planning should be aborted. imptications for marketing planning the three lessons from futuristics suggest at least four implications for the process of marketing planning. rather than refuting conventional wisdom about the importance of environmental scanning, market research, analysis of competitors, forecasting, and budgeting, these implications complement these currently accepted information gathering and planning techniques. the first implication for marketing planning is that formulating the right questions about the future is an important first step in finding the answers. when questions are well formulated, the answers and unresolved or partially unresolved questions will more aam.rately reflect the issues on which future planning is based. when the emphasis is primarily on finding easy answers, attention is directed from attempting to answer the more difficult-but crucial-questions. the second implication is that the probability of committing 'jype m errors can be reduced by emphasizing the process of formulating questions. emphasis on finding answers when questions are not well developed increases the probability of making 'jype m errors. 146 journal ofbusiness strategies vol. 8, no.2 third, recognizing the existence of unknown dimensions in the future prepares the marketing manager to face surprises. conversely, ignoring the existence of the unknown misleads the marketing manager into assuming that the marketing plan is the future rather than merely an estimate of the future. the final implication is that uncertainty is an inherent part of market planning. even with thorough and careful assessment of the future, future events are in fact unknown until the future becomes the present. references 1. adams, f. g. the business forecastinl: revolution. new york: oxford university press, inc., 1986. 2. beam, h. h. "strategic discontinuities: when being good may not be enough." business horizons. vol. 33 (july-august 1990), pp. 10-14. 3. edmunds, s. w. "1be role of futures studies in business strategic planning." the journal of business strategy, vol. 3 (fall 1982), pp. 40-46. 4. kress, g. practical techniques of business forecasting. westport, cf: quorum books, 1985. 5. kotler, p. "rethinking the marketing concept: there are 6 ps, not 4." marketinl: news, vol. 18 (september 14, 1984), pp. iff. 6. !instone, h. a in h. a linstone and w. h. c. simmons (eds.), futures research: new directions. reading, ma: addison-wesley publishing company (1977), p. 143. 7. mcginnis, m. a ''the key to strategic planning: integrating analysis and intuition." sloan management review. vol. 26 (fall 1984), pp. 45-52. 8. mckenna, r. "marketing is everything." harvard business review, vol. 6 (january-february 1991), pp. 65-79. 9. michman, r. d. "linking futuristics with market planning, forecasting, and strategy." the journal of consumer marketin", vol. 1 (1984), pp. 17-23. 10. mitroff, i. i. "on the error of the third kind." in h. a !instone and w. h. c. simmons (eds.) futures research: new directions. reading, ma: addison-wesley publishing company (1977), pp. 45-52. 11. naisbitt, j. and aburdene, p. mel:atrends 2000: ten new directions for the 19908. new york: william marrow, 1990. 12. "popcorn: trends last, but fads fade fast." marketinl: news (march 14, 1988), p. 29. fall 1991 michman, greco & mcginnis: futuristics 147 13. raymond, m. a and barksdale, h. c. "corporate strategic planning and corporate marketing: toward an interface?" business horizons. vol 32 (september-october 1989), pp.41-48. 14. simmons, w. h. c. "the nature of futures problems." in h. a linstone and w. h. c. simmons (eds.) future research: new directions. reading, ma: addison-wesley publishing company (1977), pp. 13-26. futuristics: some lessons for marketing managers differentiation and cost leadership strategies: a strategic continuum of alternatives ronald f. green east tennessee state university johnson city, tennessee james p. jolly idaho state university pocatello, idaho alok srivastava georgia state university atlanta, georgia quite prominent in recent strategic management literature is the attempt of researchers to explain successful business-level performance in terms of strategic group membership. of the many models attempting to describe strategic groupings, two have dominated. miles and snow [7j developed a four strategy typology calling for classification of firms as either defenders, prospectors, analyzers, or reactors. classification depends upon the firm's perspectives on dealing with the basic problems referred to as the entrepreneurial, engineering, and administrative problems. defenders and prospectors represent opposing views on approaches to dealing with these problems, while analyzers represent firms following mid-ranged alternatives. reactors are strategic failures, characterized as reacting to environmental conditions rather following a consistent strategic plan. michael porter's [11] three dimension typology has also received much attention as an explanation of strategic groupings. porter emphasized that firms can best be described in terms of three generic strategies that explain how a firm can cope with the competitive forces of the marketplace. porter labeled these strategies as cost leadership, differentiation, and focus. cost leadership firms emphasize managerial attention to cost control with a general theme of outperforming competitors through efficiency rather than product quality or service. firms following such a strategy are better prepared to withstand pressures when prices are driven down by the forces of the marketplace. a differentiated firm attempts to create a real or perceived difference in its product or service, with the objective of establishing an industry wide customer base that views its product or service as being superior to that of competitors. ideally, differentiation will occur in several dimensions such as superior quality products, service, delivery, etc. the main benefit derived from such a strategy is that brand loyalty reduces price sensitivity and results in higher margins. while not insulating the firm from cost concerns, they are of secondary importance. it is important to note, however, that even through journal of business strategies, volume 7, number 1 (spring 1990) 8 spring 1990 green, jolly fj srivastava: continuum 9 buyers throughout the industry may acknowledge the differentiated firm's superiority they may not be able or willing to pay the higher prices that often result. the focus strategy may take several forms, but is based upon the firm's ability to identify a particular buyer group, segment of the product line, or geographic market upon which it can focus its attention. by narrowing its marketing target, the firm hopes to better meet the needs of its consumer base, resulting in either differentiation from better services or cost leadership through marketing efficiencies. porter also addressed the issue of those firms who fail to develop strategy consistent with at least one of his generic strategies by labeling such firms as "stuck in the middle." such firms are doomed to low market share and low profitability because of failure to attract high-volume customers who demand low prices or high-margin customers associated with the differentiation strategy. porter also issued the disclaimer that these relationships might not hold true for every situation. certain industries preclude focus or differentiation strategies because of price competition resulting from the nature of the product sold. in addition, some firms within an industry might be able to achieve differentiation or focus without losing their low-cost positions. porter's admission of these rare typology limitations is consistent with miles and snow's [7] view that typologies are not all encompassing and should be judged primarily on the existence of codification and prediction characteristics. porter's typology has generated considerable interest as researchers have critically examined his theory from a variety of perspectives. dess and davis [1] utilized multivariate techniques to study firms from the paint industry, finding evidence of differentiation and cost leadership strategies, but reporting mixed support for the focus strategy. karnani [6] argued that the focus strategy is simply a combination of the other two generic strategies. karnani also argued, along with others [10], that the two remaining strategies, differentiation and cost leadership, are independent, enabling a firm to follow both with equal intensity. while porter recognized this possibility, he maintained that they are mutually exclusive for the vast majority of firms. parks' [9] 1985 study found support for porter's claim, concluding that firms tend to pursue either strategy, but seldom both. murray's [8] more recent study linking generic strategies to external preconditions has given rise to a contingency view that support the non-exclusivity position. this study is indicative of a stream of research ([2], [5]) which supports the existence of viable strategic alternative combinations available to most firms. the mixed findings of those attempting to examine porter's typology supports porter's admission of typology limitations, with two areas of concern dominating the literature. the first deals with porter's contention that successful firms follow strategies that can be identified and typed by three broad generic categories. specifically, can the majority of firms be accurately labeled according to the typology and does strategic group membership correlate with success? the second concern deals with the mutual exclusivity of differentiation and cost leadership strategies. do successful firms follow one primary generic strategy as porter contends, or might success be 10 journal of business strategies vol. 7, no.1 achieved by firms that attempt to follow mixed strategies? a third concern dealing with the legitimacy of focus as a separate generic strategy has apparently been resolved by porter's [12] more recent reference to the focus strategy as a means of obtaining a differentiated or low cost position within a market. his use of the terms focus! differentiated and focus! cost leadership lends to this interpretation. methodology this research addresses these concerns by examining the typology's usefulness within the industrial marketplace. hambrick and lei's [4] study of contingency variables found the firm's user segment (consumer versus industrial) to be the most important contingency variable when examining a firm's strategic orientation. these findings, along with the lack of strategy research for the industrial marketplace, influenced the focus of this article. with regard to previous research, porter's use of discrete rather than continuous measures of a firm's strategic orientation is of particular concern. limiting the focus strategy's role to one of market selection rather than strategic orientation, is it appropriate to describe a firm's strategic orientation in terms of a continuum anchored by firm's following pure differentiation or cost leadership strategies? it may be concluded that if porter's contention were true, the majority of all successful firms would cluster to the extremes of the continuum, provided that a continuous measure of strategy is developed. the closer a firm's position to the mid-point of the continuum, the father away would the firm be clearly emphasizing a single generic strategy, a clear requirement for success according to porter. figure 1 illustrates the hypothesized distribution of successful firms along the differentiation! cost leadership continuum. should a continuous measure of strategy yield a significant number of successful firms ranging throughout the continuum, the interpretation follows that the mutual exclusivity of the differentiation and cost leadership orientation would be seriously challenged. sample and measurement a number of top executives of firms producing and selling industrial equipment and machinery were selected to participate in this study. this sample was felt to be representative of firms following a wide variety of strategic alternatives compatible with both differentiation and cost leadership strategies. to capture information concerning both strategic orientation and performance, a self-report instrument was developed and distributed. the work of dess and davis [1] influenced the portion of the instrument used to collect information on intended business-level strategy. respondents were asked to rate on a scale of 1 (not important) to 5 (very important) the importance of 21 competitive methods. dess and davis factor-analyzed these scales and compared respondents' perceived importance of competitive methods to those of a panel of experts. while the findings were inconclusive, the instrument and the panel's perspective on the importance of the competitive spring 1990 green! jolly fj srivastava: continuum 11 figure 1 theoretical distribution of successful firms number of successful firms ix xl lxx xxi lxxx xxxi lxxxx xxxxi lxxxxx xxxxxi lxxxxxxx xxxxxxxi ixxxxxxxxx xxxxxxxxxi lxxxxxxxxxxxxx xxxxxxxxxxxxxi lxxxxxxxxxxxxxxxx xxxxxxxxxxxxxxxxl lxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxl differentiation cost leadership (i.e., quality of (i.e., ability to product or service compete on prices methods to porters' generic strategies (see table 1) led to the development of a continuous measure of strategic orientation for use in this study. in the present study, index scores were calculated for each respondent for both differentiation and cost leadership strategies. the raw scores of the respondents' perceptions of competitive method importance to their firms' strategies were used as input. the differentiation index (d) was calculated by summing the raw scores for the competitive methods (items 1, 10, 11 and 18) considered most important to a differentiation strategy by the panel of experts from dess and davis. a similar procedure was used (including items 3, 7, 13, and 21) to calculate a cost leadership index (c l) for each respondent. finally, the differentiation index was subtracted from the cost leadership index, resulting in an overall strategy index (s). the four positive inputs to the differentiation index would result in a purely differentiated firm theoretically scoring a five for each each of the inputs, resulting in a d score of 20. a firm that perceives some of the competitive methods as being of less importance than 5 would be less differentiated, according to the panel, and would have the d score reduced accordingly. a similar rationale was used for the cost leadership index. the interpretation of the overall strategy index is that a firm following a pure strategy of either differentiation or cost leadership would achieve a s score of positive or negative 16, respectively. the closer the score to zero, the stronger the resemblance to a mixed strategy. finally, as an indicator of performance, the instrument required the respondent to indicate the firm's pre-tax return on investment (roi) for the last fiscal year. the respondent was asked to check an appropriate block, with alternatives ranging 12 journal of business strategies vol. 7, no.1 table 1 experts' views on competitive models experts competitive method d cl f 1 new product development most * * 2 customer service * least * 3 operating efficiency * most * 4 product quality control * * * 5 experienced/trained personnel * * * 6 maintain high inventory levels * * least 7 competitive pricing least most * 8 broad range of products least * least 9 developing/refining exiting products * * * 10 brand identification most * most 11 innovation in marketing techniques and methods most least * 12 control of channels of distribution * * * 13 procurement of raw materials least most least 14 minimizing use of outside financing least * least 15 serving special geographic markets * least most 16 capability to manufacture special products * least most 17 products in high price market segments * least * 18 advertising most * * 19 reputation within industry * * * 20 forecasting market growth * * * 21 innovation in manufacturing processes * most * from "less than 0%" to "15% and over" with a separate block for every three percent increment. results the mail survey generated a total of 47 usable responses from executives representing a variety of industrial product firms primarily engaged in the manufacture and sales of equipment and machinery. it was determined from the responses that the sampled firms provided services to a variety of industries and experienced a considerable degree of price competition within their respective markets. the sampled firms were relatively small, reporting a mean total sales of $23.84 million for the last. fiscal year. due to the ordinal nature of the scale used to measure performance, determination of actual profitability is difficult. a reasonable interpretation of the reported mean raw score of 4.30 would result in a mean pre-tax return of investment (roj) for the last fiscal year of 8.4 percent. spring 1990 green, jolly fj srivastava: continuum 13 of the 47 respondents, 11 reported the last fiscal year's roi to be under three percent. these firms were classified for the purpose of this research as "low performance" firms. those firms reporting raj's ranging from three to 11.99 percent (n=20) were classified as "medium performance" firms. this approximated the group of firms reporting profitability within one standard deviation of the mean. those firms reporting rois above 12 percent (n=16) were classified as "high performance" firms. figure 2 presents a scatterplot with the horizontal axis depicting the strategy score (s) and the vertical axis representing the raw performance score for all data points. the plotted number represents the number of observations at that space of the plot. note the wide distribution of firms along the strategy continuum for all performance levels. the only notable exception is the cluster of performance level one firms (negative rot for the last fiscal year) that is centered around the zero position on the strategy continuum. also note that the s scores ranged from ~8 to 8, while the maximum range was identified as -16 to 16. the absence of firms on the theoretical extreme points on the continuum can be attributed to the nature of the scoring system. a firm that follows a pure generic strategy would not necessarily feel all other competitive methods to be of no importance. rather, these competitive methods might be scored a somewhat neutral value of 3 on the 1 to 5 scale, resulting in a more realistic range of -8 to 8. figure 2 scatterplot of performance by strategy score performance high 7 1 1 2 2 2 6 1 2 1 1 5 1 1 3 3 1 medium 4 1 1 3 1 2 2 2 1 2 low 1 1 2 2 2 1 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 differentiation cost leadership strategy score figure 3 displays a bar-chart reflecting the distribution of the high performance group firms throughout the strategy score continuum. this figure should be compared to the theoretical distribution (based on porter) illustrated by figure 1. note the lack of support for the existence of the v-shaped curve. table 2 presents a cross-tabulation of performance and strategy. the sampled firms were found to have a mean strategy score of -.21 with a standard deviation of 3.28. firms with an s score within one standard deviation of the mean were deemed to be following a mixed strategy and were classified as such. firms with an s score greater than one standard deviation from the mean were classified as differentiated or cost leadership, dependent upon the direction of the variation. 14 journal 0/ business strategies figure 3 actual distribution of successful firms vol. 7, no.1 number of successful firms 4 x x 3 x x x x 2 x x x x x x x x x x x x x x x x x x x x x x x x x x -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 differentia.tion cost leadership stra.tegy score table 2 cross tabulation by performance and strategy performance high (16) medium (20) low (11) a b c (5) (9) (2) d e f (2) (16) (2) g h i (1) (10) (0) differentiated (8) mlxed (35) cost leadership (4) while the sample size and related cell distributions do not meet cell size requirements necessary to perform chi square tests, the distribution of firms as previously illustrated allows for generalizations concerning strategic orientation and performance. of the 11 low performance firms, 10 were classified as following a mixed strategy, consistent with porter's contention that such firms are "stuck in the middle." likewise, 11 of the 12 firms classified as following either differentiation or cost leadership strategies were found to be in the medium or high performance groups. again, this is entirely consistent with the claims of porter's typology. however, the distribution of firms in the high performance group is of major concern. nine of the 16 firms in this group were found to follow a mixed strategy. likewise, 16 of the 20 firms in the medium performance group were those with the mixed strategy. this is in conflict spring 1990 green, jolly & srivastava: continuum 15 with porter's claim that the vast majority of all firms must follow a single generic strategy in order to insure profitability and success. conclusions this study focuses on the use of discrete, mutually exclusive measures to describe a firm's strategic orientation. it was hypothesized that should porter's typology prove valid, a continuous measure of strategy would show successful firms to cluster at the extremes of the continuum, with unsuccessful firms assuming some mid-range position. with limited generalizations, this study clearly indicates that unsuccessful firms have, for the most part, failed to follow a single generic strategy resulting in s scores near zero. there is strong evidence, however, that many firms perform successfully while following some type of mixed strategy, failing to support the existence of the v-shaped curve of figure l. this finding is of particular interest in light of miles and snow's [7] allowance for mid-ranged firms described as analyzers. closer examination reveals that the analyzer resembles a reactor in dealing with the three problems of the firm, with the major distinction being differences in performance and planning. this interpretation proves helpful in describing the firms classified as following a mixed strategy. those low performance firms with s scores near zero might be best compared to the reactors of the miles and snow typology. this score represents the attempt to follow several strategic alternatives without a clear understanding of the need for strategic direction. this corresponds to porter's description of "stuck in the middle." those high performance firms with similar s scores might be compared to the analyzers of miles and snow, firms who follow a mid-ranged position by choice. such firms are successful, not because they follow a single generic strategy, but because they follow a consistent mixed strategy, accepting the trade-off of lower quality, but with corresponding lower prices. further examination of these firms' relative emphasis on competitive methods provides additional insight into their orientation. for example, an s score of zero indicates that relative emphasis on d and c l is equal, but does not describe the magnitude of the emphasis. a firm with d and c l scores of 20, respectively, would generate the same s score as one with d and c l of 12, respectively. while both firms are "stuck in the middle" according to porter (i.e., neither one dominates), there is a difference. the firm with the higher scores for d and c l attempts to emphasize both strategies equally, and to the fullest extent possible. the firm with the lower scores for d and c l attempts to emphasize the strategies equally, but realizes that a tradeoff exists due to the limited resources of the firm. of the 10 low performance-mixed strategy firms, 5 indicated a high emphasis on both d and c l, indicating that both strategies were highly emphasized with equal intensity. of the 9 high performancemixed strategy firms, only 2 indicate high relative emphasis on both d and c l. it follows that firms pursuing a mixed strategy are more likely to attain successful levels of performance by acknowledging the trade-off of strategic emphasis attributable to limited resources. 16 journal of business strategies vol. 7, no.1 porter's use of discrete, mutually exclusive groupings seems to lack the explanatory power of the miles and snow model. the ability to explain the strategic reasoning of firms who follow mixed strategies seems to be a useful tool for those who use typologies to establish strategic group membership. the use of a continuum such as the one proposed allows for classification of firms by type without disqualifying mid-ranged firms who follow clearly defined mixed strategies. validation of this (or a similar) strategy scoring system in a variety of business settings would yield significant insight into the actual application of porter's typology. references 1. dess, gregory g., and davis, peter s. "porter's (1980) generic strategies as determinants of strategic group membership and organizational performance," academy of management journal, vol. 27, no.3 (1984), pp. 467-88. 2. green, ronald f. "competitive bidding processes: an empirical investigation of strategic orientation and performance," unpublished dissertation, clemson university (1986). 3. hambrick, donald c. "high profit strategies in mature capital goods industries: a contingency approach," academy of management journal, vol. 26, no.4 (1983), pp. 687-707. 4. hambrick, donald c. and lei, d. "towards an empirical prioritization of contingency variables for business strategy," academy of management journal, vol. 28, no.4 (1985), pp. 763-88. 5. hill, charles w. l. "differentiation versus low cost or differentiation and low cost: a contingency framework," academy of management review, vol. 13, no.3 (1988), pp. 401-12. 6. karnani, a. "generic competition strategies-an analytical approach," strategic management journal, vol. 5 (1984), pp. 367-80. 7. miles, r. e., and snow, c. c. organizational strategy, structure and process. new york: mcgraw-hill (1978). 8. murray, alan i. "a contingency view of porter's generic strategies," academy of management review, vol. 13, no.3 (1988), pp. 390-400. 9. parks, d. m. "an empirical examination of the relationship between the strategic typologies proposed by miles and snow, porter, and hall," proceedings of the southern management association, orlando, fl (november, 1985). 10. phillips, l. w., chang, d. r., and buzzell, r. d. "product quality, cost position and business performance: a test of some key hypotheses," journal of marketing, vol. 47, no.2 (1983), pp. 26-43. 11. porter, m. e. competitive strategy. new york: free press (1980). 12. porter, m. e. competitive advantage. new york: free press (1985). differentiation and cost leadership strategies: a strategic continuum of alternatives personnel recruitment and the law: guidelines for managers of small business firms john p. kohl college of business and economics the university of nevada at las vegas las vegas, nevada david b. stephens college of business administration utah state university logan, utah no owner or manager of a small business can escape the ever-present influence of the law on daily decisions which must be made. this problem has become acute during the past twenty-five years, with a continual growth of federal laws, regulations and court decisions which affect virtually every area of a company's operations. in addition to federal intervention in the workplace, managers and owners must also deal with a myriad of state and local laws and regulations. these legal constraints pose special problems for individuals who want to ensure they are "doing the right thing" in such areas of personnel policies as compensation, benefits for employees, and questions which often arise in the area of equal employment opportunity (eeo). in fact, many owners-operators are unaware or uncertain of what they must be doing in order to a.,sure that their personnel practices are both legal and fair. there are a number of reasons for these problems. in recent years there has been an explosion of federal, state, and local laws and regulations which have sought to eliminate discriminatory employment practices. for many owners and operators of small business firms, the sheer numbers of such new requirements have been almost overwhelming. possessing limited resources, many smaller firms have often found it impossible to study, evaluate, and implement addition"l requirements under the law. many of the eeo rules and regulations have affected a wide-range of personnel activities. for example, in dealing with the issue of "selection", it must be remembered that such decisions involve a variety of personnel actions. equal employment requirements on selection affect not only the initial hiring decision, but recruiting practices, training decisions, layoffs and recalls, promotions, transfers, performance evaluations, and personnel assignments. journal of business stmtegies, volume 5, number 2 (fall 1988) 76 fall 1988 kohl and stephens: personnel recruitment 77 finally, some small businesses may not fall under federal requirements 1 , but nonetheless must meet state requirements. in states where fair employment statutes are more stringent than their federal counterparts, firms may need to consider not only federal requirements, but state as well. although no single study can address all employment issues, this article provides a basic foundation in assisting readers to a better understanding of specific problems involving recruitment and selection and to insure a sounder basis for legal action. the starting point involves the recruitment practices of many firms. the cutting edge of this issue involves the classified advertising, or "help wanted" ads, placed by firms. the wording of these advertisements is often questionable, if not blatantly illegal. because of the visible nature of such advertisements, and their relationship to the entire selection process, this article will share the findings of previous studies ([4],[5]) and offer suggestions regarding what can and should be done to assure sounder recrui tment efforts. first, a brief outline of what owners-managers can and cannot legally do in the area of personnel recruitment is presented. second, the findings of a study of "help wanted" ads in major national newspapers are reviewed in order to point out problem areas for firms of all sizes. special emphasis is placed on how smaller firms are affected. finally, a number of recommendations are provided for small firms regarding ways in which their recruitment practices can better comply with current legislative and regulatory restrictions. what does the law have to say regarding recruitment practices? the two primary federal laws affecting selection and recruitment practices are the civil rights act of 1964 and the age discrimination in employment act of 1967. these laws establish specific "classes" or "groups" of protected individuals, and make it an illegal practice to discriminate in employment decisions based on race, religion, sex, color, national origin, and age (40 years of age and older). what the laws do not explain is how they are to be interpreted in specific fact situations. this interpretation is the domain of federal agencies and the courts. since the middle 1960's, both the federal agencies and the courts have been hard at work seeking to explain exactly what can and cannot be done. as a result of interpretations by both the department of labor and the equal employment opportunity commission (eeoc), a number of regulations have arisen clarifying this issue. although these regulations are not law, they have the effect of law until successfully challenged in the court. a brief sample of restrictions under the civil rights act of 1964 and the age discrimination in employment act of 1967 is depicted in figure 1. 1 in general, businesses with 14 or fewer employees are exempt from coverage under most tederal employment statutes. 78 journal of bu.siness strategies vol. 5, no.2 figure 1 a brief summary of pre-employment praet.ices and federal law 1. the civil rights act of 1964 and the age discrimination in employment act of 1967 mver all aspects of the selection process, including (hut not limited to): • advertisements • questions on the application hlank/forrn • questions asked during the screening interview and interviews 2. no information should be sought from candidates regarding their age, religion, sex, color, national origin, or race. even questions sllch as "date of birth," or "year of graduation from high school" on application hlanks should he avoided. 3. all advertisements for positions, to include "classified ads." should simply state job requirements. requests for extraneous, unusual, or questionahle information should be avoided unless it is a bona fide occupational qualification (bfoq) and the hurden of proof of such bfoq's falls squarely on the shoulder of the firm. 4. there are no bfoq's for race or color. bfoq's for sex, religion, national origin, and age have been viewed very narrowly by both federal agencies and the courts. as with "buyer beware," the rule of thumb for the small business owner or manager is: "advertiser beware."______________------j some key points and clarifications of the law although no summary of equal employment restrictions can ever be complete, those samples cited in figure 1 shall serve as the focal point in discussing the recruitment of personnel. bfoq's. although there are exceptions to the law called bona fide occupational qualifications (bfoq's), such exceptions have always been narrowly interpreted by the agencies and the courts. bfoq's are job qualifications (based on sex, religion, national origin, or age) which are allowed because they are mnsidered to be reasonable job requirements. however, there are no exceptions for race or color, and even the other exceptions to the law are very limited. examples include authenticity (a male model) for sex; national security restrictions for national origin; religious affiliation for religious organizations; and public safety for age (an airline pilot with mandatory retirement age at 60). when a company goes beyond such limited uses of bfoq's, the burden of proof to show job relatedness falls squarely on the shoulders of the company. the tendency has ajways been for the agencies and courts to narrowly interpret such exemptions. problems in establishing a bfoq for ajob can be illustrated by an example involving a supreme court decision involving sex and a bfoq. two decades ago, women were the sale persons eligible for the job of stewardess on airplanes. pan american fall 1988 kohl and stephens: personnel recruitment 79 world airways, inc. was charged with sex discrimination by a male applicant. the company used as its bfoq defense a survey of customers indicating a preference of female flight attendants, as well as the expert testimony of psychologists to show that women were better able to respond to flight emergencies. in its decision, the united states supreme court ruled out customer preference as a bfoq, and consequently airlines employ both men and women for positions as flight attendants today [1]. job specifications must be justifiable. any specification based on religion, sex, national origi n or age is highly suspect and subject to c11arges of discrimination by job applicants. although firms no longer use such blatant terminology such as "help wanted males," many firms continue to utilize other gender-based terminology such as "ladies," "young men," "girls," and so forth. in addition, many commonly used terms have evolved which utilize gender terminology. examples include forman, and salesman. two types of age discrimination. one area which is often confusing to employers involves age discrimination against employees 40 years of age and older. these prescriptions of age discrimination prohibit two types of discriminatory actions. first, it would be illegal to express a preference for a younger person in an ad, thereby discriminating against a member of the protected class. for this reason, the earlier department of labor guidelines, and eeoc's acceptance of those interpretations, have prohibited ads which specify such terms as: boy, girl, young, teenage, 18 to 40, under 40, and so forth. second, age discrimination can ajso occur between members of the protected class, making this act different from other civil rights legislation. think about the possibility of a firm seeking to circumvent the intent of the law by making it a policy to recruit only individuals 40 to 45, and thereby not recruiting or hiring individuals over 45. on the surface, one could argue that fair employment practices were being extended to at least some member of the protected group. such practices are deemed discriminatory under the law since they discriminate against some members of the protected group in favor of other members. as a result, ads should not specify terms or phrases such as recenl retiree, retiree, 50 to 65, and so forth. what are business firms actually doing in recruiting personnel? up until this point, we have been discussing what firms can and cannot do legally. the issue remains: what are they actually doing in practice? the old adage, "the proof of the pudding is in the eat.ing," could easily be applied to the issue of classified ads: "one proof of the understanding and commitment of firms to equal employment opportunity lies in the kinds of help wanted ads they place in newspapers." for this reason, researchers have been actively investigating the nature of newspaper "help wanted" ads for the past three years. these previous studies have provided a number of interesting findings regarding what business firms are actually doing in the area of personnel recruitment: 80 journal of business strategies vol. 5, no.2 1. the percentage of advertisements classified as questionable or illegal ranged from 2.4 to 5.8 percent of all ads analyzed ([4], [5]). 2. the major problem areas identified involved firms advertising for specific job specifications based on sex, age, or bilingual abilities. 3. of all organizations, trade and hospitality firms ~ two industries heavily dominated by smaller business operations ~ contained the largest percentages of questionable language in their classified advertisement. as a result of this earlier work, and in order to better understand the nature of such questionable or illegal ads, the researchers decided to undertake a broader-based, national study of fifteen newspapers during the spring of 1986. in order to avoid regional bias, four papers were chosen from the northeast, four from the south/southeast, three from the midwest, and four from the west/southwest. the newspapers had a combined circulation of 7.5 million papers, and ranged in size from 250,000 to 1.7 million newspapers daily. a common date was chosen in order to assure uniformity of results, and a sunday edition of the classifieds was analyzed in an attempt to maximize the number of such ads. based on the previous discussion of illegal or questionable words which are often utilized in classified advertising, the researchers utilized terms and phrases such as those depicted in figure 2 to classify words as being questionable or illegal under the law. it must be emphasized that this list is far from complete, but only illustrative of many of the terms and phrases identified during the study. figure 2 questionable phrases in help wanted advertisements sex; age; bilingual: national origin: ---c--c---c-----,----...-.----------------...-.--man, woman, lady, boy, girl, gentleman, etc. foreman, presserman, waiter, waitress, maid, counterman, host, bartendress, etc. boy, girl, semi-retired, 40-55, college student, young, etc. bilingual preferred, bilingual required, spanish required, etc. any specification for a specific national origin group. the analysis of the advertisements included all of the advertisements appearing in the fifteen sunday editions of the newspapers. in all, more than 39,000 separate classified ads were counted, analyzed, categorized, and tabulated. a total of 1,077 (2.7 of the total) were considered to be questionable or blatantly illegal. the results of this study are reported below. findings first, 68 percent of the total questionable ads were sex-based, and utilized either gender-based terms or overtly discriminated against one sex in favor of another. although the gender-based terminology predominated in this group, many of the words fall 1988 kohl and stephens: personnel recruitment 81 which were considered to be gender terminology came suspiciously close to being overtly discriminatory (for example, sales ladies, or hostess). second, most of the sex-based ads were once again found in two industries the trades (crafts, laborers, factory workers) and hospitality (non-managerial personnel such as waiters/waitresses, bartenders, etc.)2 although trades and hospitality firms accounted for only 21.2 percent of all ads tabulated, these two industries had a total violation rate of 48.7 percent almost half of all questionable advertising noted in this study. these findings are somewhat understandable, although not acceptable, because many of the firms in both industries tend to be dominated historically by titles which utilize gender terminology (such as repairman or waitress). however, as we will point out later, there are a variety of options to such gender terminology, and such sex-neutral terms can provide larger applicant pools for employers. third, age specifications accounted for 7 percent of all questionable ads tabulated in this study. although this number may not appear significantly high, it does represent a continuing problem in recruitment practices. further, it must be noted that since the early 1980's, the number of complaints regarding age discrimination filed with the equal employment opportunity commission have been second only to charges of sex discrimination. fourth, one type of ad which appeared in a number of papers which does not necessarily run contrary to federal law, but is illegal under many state statutes, was the request for "couples," particularly in the area of apartment house management. most of the age specifications appeared in either this type of small business ad ("recentretiree" or "semi-retired"), or in hospitality ads (also for small businesses) looking for dancers who were "young girls." as indicated earlier, such ads were illegal specifications under the law. fifth, bilingual requirements continue to grow in number in the newspapers surveyed. in fact, this specification accounted for fully 24.4 percent of all questionable advertisements found in this study, and all such specifications were found in two newspapers one in the northeast, the second in the southeast. this finding may also be of interest to the present readership since most of the ads involved secretarial personnel and receptionists for small offices. the question of the status of bilingual requirements extends beyond the purposes of this article and has been discussed at length elsewhere [2]. as a job specification, bilingual ability must be proven to be job related, and not simply a "screening device" used to eliminate otherwise qualified applicants. many positions may, in fact, require some facility in a second or even a third language. however, such requirements must be defensible is challenged. 3the remaining five classifications utilized included office/secretarial (typist, secretary), professional (engineers, teachers), medical (physicians, nurses), managerial (managers, supervisors), and sales (salesman). 82 journal of business strategies suggestions to business owners and operators vol. 5, no.2 this article has pointed to a number of problem areas in the recruitment of individuals for business organizations. in view of the findings of this study, the following suggestions are offered. become better acquainted with the law. this article provides the reader with a sample of wbat can and cannot legally be done under both tbe civil rights act and the age discrimination in employment act in the area of recruitment. readers who seek additional information can find such assistance through both the federal equal employment opportunity commission, and (for federal contractors) the office of federal contract compliance programs. many private publications may also offer valuable assistance [6]. the discussion regarding help wanted advertisements should help readers who want to assure that their personnel policies are legal and within the bounds of the regulatory agencies. in this era of the "slipperiness" of all legislation, it is imperative that operators and owners assure that their recruitment practices do in fact fall within the requirements of the law. h one is unsure, he or she should seek additional help from applicable agencies, private publications, or legal counsel. check out applicable state laws which may affect your recruitment policies. this article has focused on two primary pieces of federal legislation. the legal rule of thumb is: federal law prevails over state law unless state law is more restrictive and many states have equal employment opportunity legislation which extends beyond that discussed in this article. the small business owner and manager must make certain that any and all recruitment and selection procedures meet the standards of the state(s) in which the company operates. a telephone call to the office of the equal employment opportunity commission often serves as an excellent starting point for assuring that employment practices meet such state standards as well. however, state fair employment practice commissions can also provide needed and helpful advice, and are yet another source of assistance for owners and managers of small business firms. become more aware of traditional problem areas. we have wanted to see what firms especially smaller firms in certain industries are doing in order to recruit personnel. although the percentage of questionable ads (less than 3 percent) may not appear to be large, it is nonetheless troublesome. especially troublesome is the continued predominance of sex discrimination in advertising. seek alternatives which are non-discriminatory in wording. many firms have already moved into sex-neutral job descriptions and specifications, 'and have learned how to avoid the use of terms and words which would be questionable. one excellent starting point is the dictionary of occupational titles, published by department of labor and containing over 20,000 titles and job descriptions. this document is available through local libraries, and provides a basis for developing formal job fall 1988 kohl and stephens: personnel recruitment 83 descriptions and job specifications which utilize sex-neutral terminology. this survey identified a number of firms which used such terminology quite effectively in their "help wanted" ads the word "greeter," for example, rather than "host" or "hostess." at times the use of sex-neutral terms may appear to be cumbersome or difficult. this research also identified a number of creative ways in which business firms actually used traditional terms in help wanted ads while avoiding discrimination based on sex. for example, some employers chose to use both male and female terms (host/hostess, or waiter/waitress) in an attempt to communicate a desire to consider both male and female applicants. in other situations, the male or female term was used, followed by "m/f" to indicate once again that the employer actively sought applicants of both sexes. always remember that recruiting is ii two-way street. not only must a firm find the right person, it must also ensure that its policies and procedures as it recruits personnel leave those who apply with a good feeling regarding the business firm. solid eeo is the beginning of such a process. non-discriminatory, positive ads devoid of discriminatory words, phrases, or job specifications are the first step in advancing the image that a small business firm seeks to present to the community, job seekers, and the public-at-large. references 1. diaz v. pan american world airways, inc. 404 u.s. 950 (1971). 2. kohl, john p. "legal aspects of bilingual hiring requirements." texas business review (july-august 1983), pp. 188-191. 3. kohl, john p. "small business compliance with the pregnancy discrimination act." journal of small business management (october 1983), pp. 49-53. 4. kohl, john p., david b. stephens, and gerald mccaulley. "questionable advertising practices by business firms: results of a national survey." labor law journal (september 1986), pp. 660-667. 5. kohl, john p., david b. stephens, and h. scott stanfield. "questionable recruitment practices: a study of newspaper advertisements in the southwest." southwest journal of business and economics (winter 1985-1986), pp. 1-11. 6. prentice-hall personnel management loose-leaf reports. englewood cliffs, nj: prentice-hall publishing company. personnel recruitment and the law: guidelines for managers of small business firms sunday closing laws: protection for small retailers? douglas w. mcniel mcneese state university lake oharles, louisiana shirley s. yu denison university granville, ohio "blue laws" which prohibit the sunday sale of certain merchandise are an example of public policy regulations affecting small businesses that have been the subject of much controversy and heated debate but little research. opponents argue that sunday closing laws are an unnecessary impediment to retail trade and that their elimination would lead to increased retail activity. on the other hand, proponents of blue laws contend that allowing sunday sales simply redistributes the same level of retail activity over seven days rather than six, and that the increased costs of doing business leaves both consumers and retailers (especially small retailers) worse off. background sunday closing legislation in the united states is most prevalent in the east and south, whereas states with no restrictions or limited restrictions tend to be concentrated in the midwest and west [1]. the trend in recent years has been toward liberalization or repeal of sunday closing laws. since 1961, general restrictions on sunday sales have been repealed in twelve states [6]. in the public policy debate over sunday closing legislation, small businesses tend to support blue laws and large chain stores tend to lobby for repeal. in states with sunday closing laws there are numerous examples where owners of small shops turn in larger competing establishments that violate the blue laws [6]. if sunday closing laws protect small retailers from the competition of larger, more efficient firms on a day of the week with the potential to result in the largest dollar-volume-per-hour for shopping center operations [4], then sunday closing legislation may be crucial to the survival of many small retailers. despite the controversy and debate over public policy toward sunday sales, there has been relatively little broad-based empirical research regarding the impact of sunday closing laws on small retailers versus large retailers. this study examines the effect of blue laws on (1) the total level of retail activity, (2) the number of retail establishments, and (3) the size of retail establishments. journal of business strategies, volume 6, number 2 (fall 1989) 99 100 journal of business strategies literature review vol. 6, no.2 most published empirical research on the impact of sunday closing laws has been limited in scope to a particular retail subsector, such as grocery stores ([10], [7]); to particular types of stores, such as shopping center chain stores [5] or small retailers in a limited geographical area [3]; to the profiles of sunday shoppers [2]; or to the reasons blue laws are enacted and repealed [8j. it is difficult to draw conclusions about the issues listed above from these studies since none utilize a very broad data base. in the most comprehensive study to data, laband and heinbuch [6j compare a nonrandom sample .of ten states which enforced blue laws throughout the 1970s and ten randomly selected states without blue laws. they conclude that sunday closing laws lead to an overall reduction in the level of commercial activity, as well as fewer and smaller retail establishments. in their view, "opening sundays to commercial activity has the net effect of (1) increasing the total amount economic activity, not simply redistributing six days worth of sales across seven" ... and (2) benefiting large stores without hurting small stores (defined alternatively as establishments employing less than 100 and 500 workers) [6, pp. 191, 193j. however, when small firms are defined less aggregately (as firms with 1-4,5-9,10-19,20-49,50-99,100-499 workers), laband and heinbuch conclude that "sunday-closing laws constitute a political weapon with which small businesses circumvent the competitive pressures that might otherwise reduce their numbers" [6, p. 198]. while laband and heinbuch present one of the most ambitious empirical studies of blue laws to date, it must be taken as more illustrative than conclusive because of (1) the small, nonrandom nature of the sample, (2) the lack of statistical tests to evaluate the significance of apparent differences between blue law and non-blue law states, and (3) the failure to adjust for other things that may not be equal between blue law and non-blue law states. do these same conclusions apply when the retail sectors of all blue law and non-blue law states are compared, taking into account other factors that may be responsible for differences between states with and without sunday closing laws? the objective of this research is to fill in the gaps and alleviate the deficiencies associated with previous empirical work by (1) comparing data from a representative sample of all retail firms operating in all jurisdictions with and without sunday closing laws in the united states, (2) testing for the statistical significance of apparent differences between blue law and non-blue law jurisdictions, and (3) adjusting for other factors (such as income) that may account for differences between blue law and non-blue law jurisdictions. data and methodology cross section data on the retail sectors in the 50 states and the district of columbia were obtained from the census of retail trade [11].1 these data contain information ] a complete census of retail trade with the broad regional data base necessary for this type of study is conducted only at five year intervals. fall 1989 mcniel fj yu: closing laws 101 on the level of retail activity, the number, and size of retail firms for a representative sample of all retail establishments operating in each of the 51 jurisdictions. data on the presence or absence of sunday closing laws were obtained from a survey by the association of general merchandise chains [ij. in view of the argument that blue laws may have a differential impact on small firms versus large firms, two subsamples of retail establishments also are examined for each jurisdiction. one subsample represents only the very small "mom and pop" retail operations without a payroll. the other subsample represents only larger retail establishments with a payroll and excludes "mom and pop" operations. the effect of sunday closing laws on each group is examined. since there is a possibility that blue laws may not affect the retail sector as a whole in each jurisdiction, but may affect the distribution of retail trade among various types of retail establishments, differences among the ten major two digit subseetors of retailing (listed by sic code in table 1) are also examined for each jurisdiction. table 1 description of major subsectors of retail trade sic 52 sic 53 sic 54 sic 55 (except 554) sic 554 sic 56 sic 57 sic 58 sic 591 sic 59 (except 591) building materials, hardware, garden supply, and mobile home dealers general merchandise group stores food stores automotive dealers gasoline service stations apparel and accessory stores furniture, home furnishings, and equipment stores eating and drinking establishments drug and proprietary stores miscellaneous retail stores the methodology initially assumes (as in the laband and heinbuch study) that all other factors except population are equal between the jurisdictions with blue laws and the jurisdictions without blue laws. the effect of blue laws on the level of retail activity, the number, and size of retail establishments is measured by examining differences in the means between blue law and non-blue law jurisdictions of the (1) retail sales per capita, (2) number of retail establishments per 100,000 population and (3) retail sales per establishment. next, to correct for a deficiency in previous work, the effects of differences in both population and per capita income are taken into account by comparing (4) retail sales per hundred dollars of effective buying income in each jurisdietion.2 2for the definition of a jurisdiction's effective buying income see sales marketing & management, "survey of buying power," annual issues. retail sales per hundred dollars effective buying income = (retail sales per capita)!(per capita effective buying income/ $100) = share of each $100 income spent on retail goods and services. 102 journal of business strategies vol. 6, no.2 to test for the significance of apparent differences between blue law and non-blue law states, the null hypotheses in each case are that the variances in the two groups are equal and the means in the two groups are equal. slightly different t-tests are used for evaluating differences in means of the two groups depending upon whether the variances are found to be significantly different [9]. empirical results an examination of the representative sample of all retail establishments operating in the 50 states and the district of columbia suggests that sunday closing laws have little impact on the overall level of retail activity or the average number or size of all retail establishments. however, when this sample is separated into two parts-very small retail establishments without a payroll and larger retail establishments with a payroll-the effects of blue laws become more apparent. retail sector as a whole analysis of data from the sample of all retail establishments (table 2) suggests that the aggregate impact of sunday closing laws is relatively minor for the retail sector as a whole. a comparison of the data for blue law and non-blue law jurisdictions indicates that the volume of retail sales per capita is slightly lower on average in states covered by blue laws, $4,547 vs. $4,890. but this measure of retail activity adjusts only for differences in population among the two groups of states. the concentration of blue law states in the south where per capita income, and therefore retail sales per capita, are traditionally lower may be partially responsible for this result. comparing a measure of retail activity that adjusts for differences in both population and income yields the opposite result. retail sales per $100 of effective buying income are slightly higher in states with blue laws, $52.18 vs. $51.24. both the number and the average size of all retail establishments are slightly smaller in blue law states. however, none of the differences reported in table 2 are found to be statistically significant. small retail firms data from the sample of very small retail establishments (table 3) suggest that sunday closing laws do provide some protection for small retailers. adjusting for differences in both population and income, a significantly larger share of effective buying income is spent in very small retail establishments in states with sunday closing laws, $1.56 vs. $1.29 per $100 effective buying income. these figures imply that if the small retailers in the 18 states with sunday closing laws at the time of the sample were no longer afforded the protection provided by blue laws, these small retailers would loose annually almost $2 billion in sales or slightly over 17% of their business. while table 3 shows no significant difference in the number of small retail establishments, sales per establishment for very small retailers are significantly increased when blue laws are present, $49,176 vs. $42,895 per establishment. fall 1989 mcniel 8 yu: closing laws 103 table 2 all retail establishments: i-tests for differences in means between blue law and non-blue law jurisdictions. means for states test of differences with without between means blue laws blue laws signifi(n:=18) (n'=33) i-value cance level of retail activity measured by: (1) retail sales per capita $4,547 $4,890 1.59 (2) retail sales per $100 effective buying income in the jurisdiction $52.18 $51.24 -0.59 number of retail establishments per 100,000 population in the jurisdiction 867.89 883.80 0.44 firm size retail sales per establishment $520,342 $543,998 1.07 note: difference of means significantly different from zero at the 1% (***), 5% (**), and 10% (*) level. larger retail firms consumers spend about $50 out of every $100 of effective buying income in the larger retail establishments (table 4) and only $1.56 or less of every $100 effective buying income in the very small retail establishments (table 3). for larger retail establishments as a group, the impact of sunday closing laws appears to be less important (although redistributions within this group may be significant-see next section). for the sample of larger retail establishments, there are no significant differences between blue law states and non-blue law states in the level of retail trade (after adjusting for differences in both population and income), the number, or the average size of these retail establishments (table 4). redistributions among larger retail firms while the impact on larger retailers as a group appears to be relatively minor, certain types of businesses in the sample of larger retail firms may be significantly affected by sunday closing laws (table 5). when sunday sales are restricted, a significantly smaller share of effective buying income is spent in larger eating and drinking establishments (sic 58) and fewer of these enterprises remain in business. the number of general merchandise (sic 53) and drug (sic 591) stores is increased when blue laws are present, but the average size of these establishments is reduced. the average size of food stores (sic 57) is also reduced when sunday sales are restricted. 104 journal of business strategies vol. 6, no.2 table 3 very small retail establishments without a payroll: i-tests for differences in means between blue law and non-blue law jurisdictions means for states test of differences with without between means blue laws blue laws signifi(n=18) (n'=33) t-value cance level of retail activity measured by: (1) retail sales per capita $129 $118 -1.35 (2) retail sales per $100 effective buying income in the jurisdiction $1.56 $1.29 -2.11 ** number of retail establishments per 100,000 population in the jurisdiction 264.60 277.86 0.78 firm size retail sales per establishment $49,176 $42,895 -2.97 *** note: difference of means sigmficantly different from zero at the 1% (***), 5% (**), and 10% (*) level. table 4 larger retail establishments with a payroll: i-tests for differences in means between blue law and non-blue law jurisdictions means for states test of differences with without between means blue laws blue laws signifi(n=18) (n'=33) t-value cance level of retail activity measured by: (1) retail sales per capita $4,319 $4,652 1.79 * (2) retail sales per $100 effective buying income in the jurisdiction $50.62 $49.95 -0.44 number of retail establishments per 100,000 population in the jurisdiction 603.29 605.94 0.12 firm size retail sales per establishment $724,798 $772,714 1.48 note: difference of means significantly different from zero at the 1% (***), 5% (**), and 10% (*) level. fall 1989 m eniel & yu: closing laws 105 table 5 larger retail establishments with a payroll: t-tests for differences in means between blue law and non-blue law jurisdictions means for states test of differences with without between means blue laws blue laws signifi(n=18) (n'=33) t-value cance level of retail activity measured by retail sales per $100 effective buying income in the jurisdiction: (a) in sic 52 $ 2.76 $ 2.71 -0.20 (b) in sic 53 (n'=30) 5.64 5.64 0.00 (c) in sic 54 11.59 11.27 -0.55 (d) in sic 55 9.77 8.90 -1.56 (e) in sic 554 4.54 4.83 1.10 (f) in sic 56 2.72 2.58 -1.31 (g) in sic 57 2.00 2.09 1.08 (h) in sic 58 4.43 5.13 2.97 *** (i) in sic 591 1.67 1.75 0.92 (j) in sic 59 5.23 4.99 -0.42 number of retail establishments per 100,000 population in the jurisdiction: (a) in sic 52 34.15 32.55 -0.45 (b) in sic 53 19.53 15.82 -2.47 ** (c) in sic 54 82.29 72.24 -1.71 (d) in sic 55 44.76 42.14 -0.88 (e) in sic 554 53.48 53.41 -0.02 (f) in sic 56 58.85 58.90 0.02 (g) in sic 57 40.68 41.60 0.59 (h) in sic 58 132.34 150.37 2.06 ** (i) in sic 591 24.01 20.70 -3.14 *** (j) in sic 59 109.99 117.39 1.21 firm size measured by retail sales per establishment ($) (a) in sic 52 719,468 816,277 1.38 (b) in sic 53 (n'=30) 2,769,628 3,744,985 2.80 *** (c) in sic 54 1,198,461 1,459,611 3.53 *** (d) in sic 55 1,930,312 2,033,140 0.85 (e) in sic 554 727,926 853,039 3.00 *** (f) in sic 56 399,818 424,527 1.01 (g) in sic 57 425,439 475,140 1.79 * (h) in sic 58 294,811 324,085 1.40 (i) in sic 591 605,016 852,426 2.79 *** (j) in sic 59 399,933 407,090 0.23 note: difference of means significantly different from zero at the 1% (***), 5% (**), and 10% (*) level. 106 journal of business strategies vol. 6, no.2 the results for eating and drinking establishments are somewhat unexpected since these types of establishments are often exempted from sunday closing laws. apparently restrictions on sunday sales induce potential shoppers to spend less on food and drink away from home-$4.43 per $100 effective buying income in states with blue laws vs. $5.13 in states without blue laws (table 4). in this instance one might conclude that blue laws penalize a subsector of retailing that is generally characterized by relatively small businesses. in the other sub sectors of retail trade where blue laws were found to have a statistically significant impact, the results lend additional credence to the argument that sunday closing laws create an environment more favorable for smaller retail establishments. blue laws tend to reduce the average size of general merchandise stores, drug stores, food stores, gasoline stations, and furniture stores. implications while the aggregate impact of sunday closing laws may be relatively minor, the impact on very small retailers does appear to be significant. the evidence suggests that blue laws provide a more protective regulatory environment that allows small retailers to capture a larger share of consumer spending. of course the success of small retail firms depends not only upon the regulatory environment in which they operate, but also upon the way they are managed. this study suggests that small retailers may have to manage their operations and market their services more aggressively if they are to survive without the protections afforded by sunday closing laws. finally, there is evidence to suggest that blue laws may affect the distribution of business among the various retail subsectors. the results indicate that certain types of larger retailers may also do well to heed the advice of barnes and chopoorian [3j about developing marketing plans to target potential sunday shoppers in order to avoid adverse redistributions when faced with a change in public policy toward sunday sales. references 1. association of general merchandise chains. summary of state laws which restrict retail business on sunday. (december, 1984) washington, dc. 2. barnes, n. g. "new shopper profiles: implications of sunday sales." journal of small business management (july, 1984), pp. 32-39. 3. barnes, n. g. and j. chopoorian. "small retailers and sunday sales." journal of small business management (april, 1987), pp. 40-46. 4. chain store age executive. "are sunday hours really profitable?" (april, 1970), pp. e19-21. fall 1989 mcniel (1 yu: closing laws 107 5. chain store age executive. "survey shows center stores should open sunday: profitability cited" (december, 1979), p. 10. 6. laband, d. n. and d. h. heinbuch. blue laws: the history, economics, and politics of sunday-closing laws. lexington, ma: d. c. heath and co. (1987). 7. moorehouse, j. c. "is tullock correct about sunday closing laws?" public choice, vol. 42 (1984), pp. 197-203. 8. price, j. and b. yandle. "labor markets and sunday closing laws." journal of labor research (fall, 1987), pp. 407-414. 9. steel, r. g. d. and j. h. torrie. principles and procedures of statistics, 2nd edition. new york, ny: mcgraw-hill (1980). 10. tullock, g. "the transitional gains trap." the bell journal of economics, vol. 6, no.2 (1975), pp. 671-78. 11. u. s. department of commerce. 1982 census of retail trade: geographic area series. washington, dc: bureau of the census (1984). sunday closing laws: protection for small retailers? real esrate divesitiures and stock. price performance: using .alwrnative event study variance estimators thomas h. strickland middle tennessee state university murfreesboro, tennessee edward l. buhnys suffolk university boston, massachusetts chen-chin chu memphis state university memphis, tennessee donald h. wort california state university hayward hayward, california introduction the question of pricing efficiency in securities markets is an important research topic that generates considerable interest. however, while many researchers have examined the general question of market efficiency, few have concentrated on the behavior of real estate markets. recent empirical work has been done by shilling, sirmans and benjamin [11], guntermann and smith [6], gau ([4], [5]), and skantz and strickland [12]. of particular interest to this research is a study by rite, owers and rogers (bor) [7] who examined the level and patterns of abnormal returns for firms separating real estate assets from their remaining operations through spinoffs. one of the questions addressed by hor was related to the claim by many managers of large publicly traded real estate :firms that certain accounting restrictions cause their shares to be systemically undervalued in the stock market [8]. while hor were unable to determine if real estate assets were really undervalued, they did find that the asset restructuring resulting from spinoff of real estate operations tended to increase the firms' aggregate market values. the objective of this study is to investigate the impact of a firm's decision to divest real estate assets. the decision's impact is viewed from the perspective of the firm's owner, i.e., change in shareholder value. the study includes a sample of forty-three divestitures between 1971 and 1984. event study methodology employed in this study is widely used in accounting and finance research and is becoming more common in the management literature [15]. the paper is outlined as follows. section two discusses issues and motivations pertaining to real estate divestitmes. section three explain'i the event study methodology, describes the data sample, and compares the two variance estimators used in the study. section four descnbes empirical results. a summary and conclusions are presented in the last section. 28 journal ofbusiness strategies vol. s, no.2 background and motivations for selling real estate holdings while this study can neither value individual assets held by public firms, nor ascertain the exact selling prices for a majority of the transactions, the net gains/losses experienced by firms divesting real estate assets are analyzed by using security market price data. this methodology is explained in the next sectiqn. a brief discussion of why firms might dispose of real estate assets follows. a firm's stock price response to the sale of a large real estate asset may be closely related to the reason for the sale. for example, if a firm is in financial difficulty its bargaining position for selling assets of any type may be impaired. the firm may wish to eam an accounting profit thus increasing reported earnings per share. some firms selling real estate for this reason may be be experiencing financial difficulties and are attempting to avoid disastrous drops in reported earnings. also, the finn may be in need of cash for financing other projects when alternative financing sources are limited. these reasons could explain "forced sales" at prices below market real estate sales may occur if previous plans for asset use have changed. perhaps the assets have lost strategic value to the firm. dispositions may also be due to the marginal tax benefits between the sellers and acquirers. likewise the sale may be an attempt by the firm to recognize the asset's "true value." several real estate firms, in particular, have given this reason. they felt their holdings were not properly valued by analysts and investors in the firms' securities [8]. if this perception is correct it might imply market inefficiency because investors and analysts are ignoring factors that become clear when the real estate asset is isolated. this may be analogous to a company take-over situation, where the break-up value may be greater than that of the firm as a whole. the actual reasons for selling real estate assets, however, are difficult to determine because the real motivations for asset disposition are often clouded by managements' vague and general statements. this research, therefore, tests only for the aggregate divestiturerelated impact on shareholder wealth. methodology, data and experimental design the ideal approach to analyze real estate disposition decisions would be to compare asset selling prices to pre-disposition ''fair market values." unfortunately, this direct approach is precluded by one of the salient features of real estate markets the dearth of publicly available :financial data. with the exception of single-family residential homes, sales prices are extremely difficult and expensive, if not impossible, to obtain. since neither sales prices nor ''fair market values" can be directly observed for these real estate assets, another approach is required. this investigation compares the :firm's market value before the sale with its post-divestiture value in order to measure shareholder gain or loss on each transaction. the methodology described below does just this. event study methodology, similar to that first used by fama, fisher, jensen and roll [3], measures the impact of a specific management decision on security market returns. spring 1991 strickland, bubnys, chen-chin & wort: real estate 29 the management decijion, le., "event," in this study is the divestiture or spinoff of a firm's real estate assets. suppose the research question is, for example, to measure the single, one-day effect of an event. three major steps are required for each firm in the sample. first, the actual return for a firm's stock is observed on the event day. second, by utilizing the familiar security market "beta" model, a prediction is made of what the stock's "normal" return should have been had the event not occurred. third, the impact of the event, defined as abnormal return, is the difference between the stock's actual market return presumably affected by the event's occurence and its "normal" return. this difference, if any, measures the event's one-day impact on stockholder wealth. the beta model and abnormal return are formally defined below in equations (1) and (2), respectively. daily security return data from the center for research in security prices (crsp) were obtained for the period 1963 through 1984. value-weighted returns including dividends for all nyse and amex stocks were used as the market index proxy. the final data set of 43 transactions was selected from an original list of approximately 110 firms obtained from several sources. these included the national newspaper index, the predicast index, and the wall street journal index. the underlying assumption is that an event is material for a firm if it is reported and indexed in a major financial newspaper such as the wall street journal, the new york times, or the los angeles times. the event date is defined as the time when the transaction's information was first made publicly available. this was determined in one of several ways. a newspaper index reference describing a firm's intent to enter into the transaction was considered the event. otherwise the related article was used to verify the event. when a reference alluded to an earlier event, for example "...the firm had a gain of $ x million on sale of land ...", we looked for an earlier reference in the index. finally, when several related references were discovered, a thorough search was conducted to determine whether the transaction had been made or not. if an actual event date could not be verified the potential event was not used. table 1 lists information about each of the 43 events included in the final sample. the finn's name is followed by its compustat industry number (approximately equivalent to 4-digit sic categories) and calendar date of the event. the return data for each divestiture was divided into three major periods based on event date: a beta estimation period of 120 days, a settling period of 90 days, and an analysis period of 181 days. a total of 391 daily return observations are used for each event with day t = 0 designated as the event date. data from the 120-day estimation period were used to estimate each firm's beta model. the model is, a a a rt,1 = uj + ()irm,i' (1) a where values of t range from -300 to -181 days relative to the event date; rt,1 is the expe'%,ted re~rn for security i on day t; rut,1 is the return on the market index on day t; and uj and ()i are ols coefficients from the estimation period. 30 journal ofbusiness strategies vol. 8, no.2 the next 90 days of returns (day -180 through day -91) are excluded from the study to allow for a settling-down period between the beta estimation and analysis periods. this is consistent with reints and vandenberg [9] and sanger and mcconnell [10], who suggest excluding time ~riods in which information concerning the event might influence the estimation of the <ij and ~j coefficients. the results are actually evaluated for the analysis period. for each finn i, and for each day t, each day's impact due to the event is the difference between the actual return and the "normal" return. this difference is defined as the abnormal return, a a., = r t r,~ '1, 1, 1, ' (2) where t ranges 181 days from -90 to +90; ~ t is the security's actual daily return; and ri,t is its "normal" return. "normal" return ~ predicted using the estimators aj and ~i from the beta model described in eq. (1) in conjunction with the actual returns of the market index, rm,t, during the analysis period. for each day in the analysis period, abnormal returns are averaged over all firms in the sample to obtain event-related impact results on a day by day basis. when the results for a cumulative effect of more than one day are desired, daily abnormal returns are summed over the relevant time window and designated cumulative abnormal returns (cars). the t value statistics described by brown and warner (bw) [1], (equations 5,6,7,8 and all) are calculated in two different ways. one uses the traditional variance estimator and one uses an alternative method. following the bw equation 7, the standard error measure is the square root of the sum of squared excess return deviations over the 120day estimation period. this provides the traditional variance estimator. the alternative variance estimator is tiku's [14] mmle, which censors the smallest and largest values from the excess return deviations. in effect, the estimation period's series of 120 deviations (bws equations 7 and 8) are arranged in order and the 10% lowest and highest deviations are dropped. the remaining 96 deviations are used in calculating the robust mmle estimate of variance and the corresponding mmle t values. the mmle standard deviation a is defined as: a = {b + (b2 4ac)5} / 2(a(a-1)}5 where a = n 2, b = l(~-1 x2) and n-1 c = l x2i + (x22 + x2n-1) 8 jl2 , i = 2 (3) (4) where xi is the deviation of mean excess returns for period i, (x2 and -"0-1 being the new lowest and highest deviations, respectively, after mmle censoring), and !!,l and e are given in tiku, tan and balakrishnan [14 pp. 74-75]. tiku [13] investigated the efspring 1991 striclcland, bubnys, chen-chin & wort: real estate 31 ficiencies of mmle's mean and variance for location and scale parameters of symmetric non-normal distributions. he found that the mmie parameters are more efficient than other more prominent robust estimators. also, the mmle meao/variance statistia; are explicit and simple functions of sample observations and are easy to compute. am, bubnys, and lee [2] used simulation analysis to investigate the robustness of the mmi.e for samples of daily stock returns. their results show that the mmle and ttaditional estimators yield similar estimates of stock market risk premium. however, the mmle method produces a smaller variation over time because the censoring method reduces the sensitivity of the mmle to extreme daily market returns. results using these two different t value calculation methods are described in the next section. empirical results selected results for the total sample of forty-three events are presented in tables 2 and 3. table 2 shows daily abnormal returns and corresponding t values for individual days -to through +10 using the traditional and mmle methods while table 3 presents the same information for different cumulative time windows. table 2 shows that the daily abnormal return for day -1 is +2.01%. traditional and mmle t values are, respectively, 45940 and 4.3685, both significant at the .001 level test statistic values are also significant for both estimators in day 2 after the event. interestingly the abnormal returns are not significant in day 0 or +1 after the event, nor are they of consequence during any other single day shown. the higher mmle variance estimate is reflected in mmle t values, which are about 5 percent lower than the traditional t values. qmmiative abmrmal return results presented in table 3 indicate that cars are not significantly different from uro during the period from day -90 to two days before the event (t values are 1.3061 and 1.2417). the event apparently was not anticipated by the market. there is a positive price response, however, for cumulative time windows starting at day -1. for the time window from -1 to +90 days, the event-related cars are +17.64%, significant at the 0.001 level. sample firms did well for approximately 90 trading days after the event. other time windows starting at day -1 show positive cars and significance levels at least at the 0.05 level. for the 4-day window, from -1 to +2, share prices increased by 35%, significant at the 0.001 level. these results suggest that the impact of real estate divestitures on stock prices was positive. the effect of using the robust mmle standard deviations was to reduce the test statistic values compared to the traditional approach. however, the t values were virtually the same. the mmle standard deviation for the estimation period was 0.004605 (from eq. (3», about 5% larger than the traditional estimate of 0.004378. nevertheless, use of the mmle approach may be a correct response to one of brown and warner's [1] points about variance increases during the event period. 32 journal ofbusiness strategies vol. 8, no.2 table 1 sample firm names, industry number, and events industry event date finn name number mmlol ubi :im u.s. steel 2911 02 17 83 first union republic 6798 02 27 81 oxford first 6150 05 28 80 san diego gas & eectric 4931 07 01 80 american standard inc. 3580 06 23 71 newhall 6552 01 06 72 buttes gas & oil 1311 01 03 79 delmarva power company 4931 08 05 83 faijchild industries 3721 12 27 83 at&t 4811 05 18 83 arlen corp. 6512 08 22 79 citicorp 6025 07 05 83 fluor 1600 06 29 83 texas pacific light 6798 06 21 83 american century 6199 05 17 83 martin marietta 3760 05 04 83 koger properties inc. 6552 04 18 83 first city properties 6552 04 05 83 sears 5311 12 20 82 amoco 2911 04 20 82 playboy 2721 03 25 82 rf. ahmanson 6120 11 05 81 pearce urstadt 6199 03 19 81 u.s. home corp. 6552 01 09 81 del e. webb 1540 05 31 83 western union 4890 09 25 81 city investing 6199 10 23 80 loews 6199 03 14 83 oxford first 6150 08 29 79 bay financial 6513 05 16 83 first union republic 6798 02 10 83 aetna life insurance 6312 12 31 82 federal realty investment 6798 12 09 82 aluminum co. of america 3330 01 04 71 mcgtaw-hill 2731 10 12 70 holiday inn 7011 01 06 71 otrysler 3711 08 23 79 general growth 6798 08 22 79 general motors 3711 01 05 82 horizon corp. 6532 04 15 83 arlen corp. 1700 05 25 84 dunlop 3000 11 26 84 aetna ufe insurance 6312 11 13 84 spring 1991 strickland, bubnys, chen-chin & wort: real estate table 2 abnormal daily returns and t values for traditional and mmle variance estimators 33 abnonnal return traditional mmle signtt signtt t value l&n:l t yalue level -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 o 1 2 3 4 5 6 7 8 9 10 0.0077 -0.0012 -0.0039 0.0026 -0.0044 0.0012 -0.0052 -0.0032 -0.0043 0.0201 0.0025 -0.0007 0.0131 -0.0070 0.0003 -0.0031 0.0061 0.0009 0.0020 -0.0007 -0.0015 1.7616 -0.2656 -0.8898 0.5931 -0.9944 0.2642 -1.1847 -0.7324 -0.9860 4.5940 *** 0.5778 -0.1649 2.9958 *** -1.5996 0.0605 -0.7178 1.3822 0.2113 0.4488 -0.1590 -0.3410 1.6751 -0.2526 -0.8461 0.5640 -0.9456 0.2513 -1.1265 -0.6965 -0.9375 4.3685 *** 0.5495 -0.1568 2.8487 *** -1.5211 0.0576 -0.6826 1.3143 0.2009 0.4267 -0.1512 -0.3242 lsignificance levels: .. = 0.05; ** = 0.01; *.. = .001 conclusions the main question addressed in this study is whether or not the divestiture of substantial real estate assets by publicly traded firms has a significant impact on shareholder value. forty-three divestitures over a fourteen year period are analyzed using event study methodology. the results show that shareholder wealth increases by economically and statistically significant amounts. in a four-day period surrounding the event date, for example, the eventrelated shareholder wealth increase was 3.5%, significant at the 0.001 level. although no definitive conclusions regarding real estate market efficiency or variance estimator improvement can be reached, the results do provide some insight into effects ofreal estate divestitures. 34 journal ofbusiness strategies table 3 cumulative abnormal returns and t values for traditional and mmle variance estimators vol. 8, no.2 cumulative traditional mmle timecumulative window abnonnal signfi sigut"in days returns t value level t value level -90 to -2 0.0539 1.3061 1.2417 -1 to +90 0.1764 4.1998 *** 3.9927 *** -1 to 0 0.0226 3.6575 *** 3.4772 *** -1 to +1 0.0219 2.8911 ** 2.7486 ** -1 to +2 0.0350 4.0018 *** 3.8046 *** -1 to +3 0.0280 2.8639 *** 2.7227 *** -1 to +8 0.0341 2.4631 * 2.3417 * tsignificance levels: • = 0.05; ** = 0.01; *** = .001 while results in this study strictly hold for the sample used and the time period analyzed, management's ability to dispose of property at relatively favorable prices increased total wealth of shareholders. the question of presumably higher real estate project values to the buyer than to the seller, while interesting, is beyond the scope of this research. it can be the focus of further research. references 1. brown, s.j. and warner, j.b. "using daily stock returns: the case of event studies." journal of financial economics. vol. 14 (1985), pp. 3-31. 2. chu, c.c., bubnys, e.l. and lee, c.f. "estimates of the expected market risk premium: empirical analysis." working paper presented at the joint national meeting of orsa/tims, (october 1987). 3. farna, e.f., fisher, l., jensen, m. and roll, r. "the adjustment of stock prices to new information." international economic review, vol. 10 (february 1969), pp. 1-21. spring 1991 strickland, bubnys, chen-chin & wort: real estate 35 4. gau, g.w. "public information and abnormal returns in real estate investment." areuea journal vol. 13 (1985), pp. 15-31. 5. gao, g.w. ''weak form tests of the efficiency of real estate investment markets." the financial review. vol. 19 (1984), pp. 301-320. 6. guntermann, k.l and smith, r.l. «efficjency of the market for residential real estate." land economics, vol. 63, no.1 (february, 1987), pp. 34-45. 7. hite, g., owers, j. and rogers, r. «the separation of real estate operations by spin-off." areuea journal vol. 12 (1984), pp. 318-332. 8. palmon, d. and sied1e, lj. «current value reporting of real estate companies and a possible example of market inefficiency." the accounting review, vol. 53 (1978), pp' 776-790. 9. reints, w.w. and vandenberg, pa "the impact of changes in trading location of a security's systematic risk." journal of financial and quantitative analysis. vol. 10 (1975), pp. 881.-889. 10. sanger, g.c. and mcconnell, jj. «stock exchange ustings, firm value, and security market efficiency: the impact of nasdaq." journal of financial and ouantitative analysis, vol. 21 (1986), pp. 1-25. 11. shilling, j.d., sirmans, c.f. and benjamin, j.d. "flood insurance, wealth redistribution and urban property value." working paper no. 401, louisiana state univelsity, (august 1984). 12. skantz, t.r. and strickland, t.h. "house prices and a flood event: an empirical investigation of market efficiency." journal of real estate researc~ vol. 2 (1987), pp. 75-83. 13. ttku, m.l. "robustness of mmle estimators based on censored samples and robust test statistics." journal of statistical p1annini and inference, vol. 4 (1980), pp. 123-143. 14. tiku, m.l, tan, w.y. and balakrishnan, n. robust inference. new york uty: marcel dekker, inc. (1986). 15. worrell, d.l., davidson, w.m., chandy, p.r. and garrison, s.l "management turnover through deaths of key executives: effects on investor wealth." academy of management journal vol. 29 (1986), pp. 674-694. real estate divestitures and stock price performance using alternative event study variance estimators a slralegic approaai for manufacturers facing mandated change arthur j. noetzel john carroll university cleveland, ohio john m. burnham tennessee technological university cookeville, tennessee introduction in the 1950's and 1960's, the u.s. economy benefitted from a strong rise in productivity. new and improved machinery, better production methods, and huge untapped domestic markets made it possible for american companies to increase and improve output., while holding down costs. profits increased and workers' wages rose. many u.s. manufacturing firms became complacent during the past fifteen years, however, growth in productivity bas collapsed. the days when u.s. companies had a near-monopoly on the domestic market and on mass-production technology are gone forever. american industry is now in the midst of a dynamic and broad-based change, which will fundamentally alter the ways corporations are managed many elements of this drastic transfondation of industry are well-known: a. the gathering force of information technologies; b. the globalization of industrial markets and the formations of cartels like opec; c. the ongoing wave of mergers, takeovers, and restructuring; d. the complex shifts in regulatory environments; e. the breakdown of traditional labor-management relationships; f. the shortening of product life cycles; g. the rising expectations of customers; and h. the fragmentation of many markets. mandated change the transformations in industry brought many manufacturers face to face with mandated change. mandated change arises from the external environment of a business; it is a change which upsets the well-established balance between a firm's resources and prospective opportunities. such changes render useless other internally generated goals, and mandate new goals imposed by the competitive environment mandated change can threaten the survival of a manufacturing business. mandated change is not satisfied by simple efforts to improve productivity. too often these approaches pare down labor costs and make factory workers more efficient., but simultaneously hinder innovation and alienate workers. mandated change requires more than a short-term fix [20]. it calls for new strategic thinking and the development and spring 1991 noetzez and burnham: a strategic approach 65 nurturing of new shared values. it commands that top management manage from the "outside-in" rather than from the "inside-out" [13]. further top management must recognize the difference between their perception of the change and the essential actuality of the change. imposed changes present manufacturing management with an important dilemma in the relationship between productivity and organizational change: the paradox of instability in the midst of stability [1]. in the past, too often, manufacturing was taken for granted; it was accepted as a "given" in the formulation of strategy. it was assumed that manufacturing operated in a closed system, insulated from external forces. it was the task of the plant managers to eliminate perturbations and to enhance stability of production. manufacturing was perceived to be embedded in rigid physical structures with technical details and routine decisions. it was seen as the substratum upon which the dynamic, broad, exciting strategies of finance and marketing rested. "good manufacturing operations" were believed to be merely the achievement of low costs and high efficiency. in times of intense competition, manufacturing cannot be taken for granted in the formulation of strategy. it should not be separated or isolated from strategy formulation and implementation in other functional areas. manufacturing is the trans1ation of the ideas from research and development into products, whose standards of quality, cost, availability, and customer service are equal or swpass the standards set by the most rigorous competitors in the futernational market this translation is not so much the production of innovative, breakthrough products as it is a matter of continuous improvement in process-and product-technology integrated with the effective utilization of human resources and with a keen and active understanding of the wants of customers and their buying behaviors. change created by the external environment of a firm, however, demands that organizations be adaptive and creative. goals set in the marketplace by customers and competitors call for organizations that are flexible, innovative, and seeking continuous improvement. adaptability, creativity, flexibility, and innovation are human attnbutes. these cannot be assigned to a special segment in an organization. they must be active in all operations from the receipt of raw materials to the delivery of the finished product and post-sales service. maintaining competitive advantage in the time of mandated change requires a sharp and steady focus on the marketplace simultaneously with a flexibility that permits change in style, attitude, control, and performance methods. manufacturing firms seeking both focus and flexibility are finding that four factors are important in building competitive advantage: a. a keen perspective of markets targeted [19]; b. a recognition that the use and conservation of time [6] and the widespread sharing of information [18] are key resources of the firm; c. a new orientation toward human resources, organization, and culture of the company; [22] and d. an integrated, proactive manufacturing strategy [10]. 66 journal ofbusiness strategies vol. 8, no. 1 many manufacturing companies have not recognized these factors, because the transformations in american industry have affected different industries and different companies in a variety of ways. some found that their environmental scanning had been weak. or incomplete; signals of change were not seen or understood. others could not believe that discontinuity could occur because they viewed the future as a continuing extrapolation of past trends. some were trapped by narrowly defmed markets, products, and competition. still others found they had neither the resources nor the will to respond effectively to world-class competition and worldwide markets. many manufacturers faced new forces in the external environment which they had never before experienced. too many failed to recognize that changes had been mandated. faced with the dual aspects of mandated change in american industry-the perception of the change and its aetuality-business reacted in one of four generic modes [2]: a. shock: so disturbed as not to be able to shake out of its provincialisms, unable to unlearn the habits of the past, and incapable of reducing bureaucratic rigidity. b. retreat: to flee to an available, protective market niche. c. survival: to shrink to the core of the business what it does best and to try to cope by reassessing the environment, learning new lessons, and by keeping spirits high. d. challenge: to create a new vision of the mission of the business and to apply new perspectives and ideas; to stretch the usual bounds of strategy formulation and implementation. the firms in each of these categories lost degrees of strategic freedom [15]. alliearned that the ability to adapt to externally imposed goals is critical for survival. the managements of companies in the first two categories wrapped themselves in a "code of silence," suffered from "the denial syndrome," became excessively cautious, and could not muster the intention to compete. only the firms in the last two categories were willing to face the struggle of adaptation to mandated change, either reactively or proactively. threat of discontinuity mandated change brings the threat of discontinuity into the marketplace. the nature of this threat may be visualized by the following venn diagram (figure 1) representing a firm's competitive advantage before a discontinuity begins [3]. the configuration of the three circles is a visualization of the judgment of the manufacturer concerning its competitive advantage. it is an abstract illustration, not a map with precision. since a manufacturer facing mandated change is more concerned about the impact of future competitive interactions than about the starting position of competitive forces, the initial venn diagram may be sketched arbitrarily. three overlapping circles with equal radii and equidistant centers may be drawn under the assumption of, at least, momentary equilibrium among the competitive forces. the manufacturer will be more interested in the movement of the circles than in their original position (figure 2). spring 1991 noetzel and burnham: a strategic approach figurel 67 increasing effective market orientation breadth and innovation in products increasing degree of customer satisfaction with product figure 2 some examples of movement in competitive space a strengthens distinctive competencies (increases diameter) b and c unchanged a strengthens market orientation (moves to the right) b and c unchanged a and b unchanged c tightens benchmarks (reduces diameter) a and c unchanged b shifts loyalty away from a's products (moves to the right) a and c unchanged b tightens the specifications of its needs (reduces diameter) a increases rate of new product development (moves down) b and c unchanged 68 journal ofbusiness strategies vol. 8, no.1 the three overlapping circles are in a region bounded by the dimensions of customer expectations and of the competitive standards of quality, cost, availability, and customer service. this region is the field of competitive interactions and may be termed competitive space; it is abstract construct of the marketplace. in the diagram, circle a symbolizes the attnbutes of the manufacturer and its product. the diameter of the circle represents the strength of the manufacturer's distinctive competencies. the stronger these competencies and skills and the more they directly relate to the changing critical success factors of the industry, the larger will be circle a whether the manufacturer follows a niche strategy (a narrow target market) or has a broad target market, or whether it follows a strategy of overall low cost leadership or one of differentiation [16], the diameter of circle a is a sign of the company's competitive strength. it should be noted that the diameter of circle a moves in a manner opposite to that of the diameters of the other two circles. circle b pictures the customers' satisfaction in terms of the quantity, quality, price, availability, and customer service provided by the manufacturer. its diameter is set by specificity of the customers' needs and wants. as the customers become more demanding of the manufacturer, as their needs and wants are presented with increasingly tight specifications, circle b becomes smaller; its diameter narrows. circle c represents the benchmarks set by major competitors. as competitive standards increase and benchmarks tighten, this diameter will become smaller. the hatched area, the area common to the three circles, represents the manufacturer's competitive advantage. in this area, the manufacturer's distinctive competencies and the attnbutes of its product satisfy customer needs and wants and simultaneously equal or surpass the benchmarks for quantity, quality, availability, service, and price set by major competitors. the dynamics of the marketplace, the forces of competition [17], can cause each circle to move horizontally and vertically. circle a, the manufacturer, may move to the right as it strengthens its market orientation and increases customers' satisfaction. circle a may move downward as the manufacturer successfully broadens its product line and develops new products. circle b, the customers, may move to the right, away from the manufacturer, with a shift toward substitute products and decreased loyalty to the manufacturer's products. of course, circle b can also move to the left, into the manufacturer's territory, with a growth in loyalty toward the manufacturer's products or with less willingness to accept substitute products from competitors of the manufacturer. but this move would not pose a problem to the manufacturer, but to the competition! circle b may move downward as customers gain competitive leverage, greater bargaining power into the market. circle c, the competition, moves to the right as competitors make advances in product or process technology favorable to the customers. circle c may move downward as key rivals of the manufacturer launch an attack on the manufacturer's market position; competitive intensity increases. thus, there are three movements within the configuration of the three circles: horizontal, vertical, and in the size of the diameter of the circles. if circle a, the manufacturer, does not move either horizontally, or vertically, and maintains the same level of comspring 1991 noetzel and burnham: a strategic approach 69 petitive strength (the diameter), while either of the two other circles moves to the right or downwards, the hatched area grows smaller and the manufacturer loses competitive advantage. if none of the circles move horizontally to the right or downward, but if competitive benchmarks become tighter or if customer standards of need satisfuction become more specific, again the hatched area of the manufacturer's competitive advantage grows smaller. the movements of circle b and circle c may be gradual or abrupt, but the manufacturer, circle a, must recognize the movement. unless the manufacturer has a strong market orientation and an ongoing capacity to meet competitive benchmarks, there is the threat of a fracture between the circles. the movements of the circles, b and c, and the changing length of their diameters are signals of mandated change. in the face of the threat of a fracture, of complete discontinuity, the manufacturer must give up degrees of freedom in its strategy formulation and must accept the norms imposed upon it by customers and competition. the threat of discontinuity, the danger of losing profitable participation in the marketplace, arises because manufacturers ignore one or more of the building blocks of competitive advantage targeted markets, effective use of time and information as resouires, vigorous development of human resources, and a proactive manufacturing strategy. this threat may precipitate a crisis following this scenario: a. the perspective of top management becomes increasingly distorted and increasingly blind to the external environment. b. top management focuses upon operational corrections and on the internal environment of the firm and gives less attention to customers and general trends affecting demand. c. top management's attention shifts to short term needs, cutting costs, and reducing assets. d. the emerging crisis causes some stakeholders, such as key suppliers or creditors, to desert the firm. e. the firm's resources become more constricted and constrained. defenses against discontinuity the strategic alternative to such an inwardly-focused crisis scenario lies in having defenses against the threat of discontinuity. these defenses are skill in scanning the external environment of the firm, in tracking industry trends and competitive forces, and in maintaining strategic "momentum,"-the ease and flexibility of adapting to environmental changes [11]. when a manufacturer is weak in these defenses or is complacent about its position in the marketp1al.':e, it also is unprepared for the threat of discontinuity and the concomitant decline in competitive advantage. it fails to see that its survival is in jeopardy. it does not have a clear realization that it must accept changes mandated by the environment which, in tum, mean that the firm must accept externally imposed goals. 70 joumal ofbusiness strategies vol. 8, no.1 the threat of discontinuity shows that competitive advantage can be lost resistance to or denial of mandated change will not restore competitive advantage: the threat of discontinuity tells that competitive advantage is the key to success over an extended period of time and that it can be built, maintained, and enhanced by [21]: a. providing value to customers; b. matching uniquely a company's resources and opportunities; c. crafting the advantage so that it is not easily copied or imitated by competition; d. founding it on the best industry practices worldwide; e. giving continuous, ongoing renewal to distinctive competencies; f. providing effective direction and motivation for the entire organization; and g. propelling the company toward a truly integrated strategy. one of the impacts of mandated change is to push competitive advantage with its complex and multiple dimensions to the forefront of management thinking. the american tire industry faced mandated change. since 1979, domestic tire companies closed fifteen plants in the united states. by 1987, foreign tires represented 25 percent of the market, an increase in market share of 14 percent in seven years. the demand for the industry's key product, bias-ply tires, declined 75 percent in ten years. using a new technology, radial tires had attained a threefold increase in service life. cooper tire, the world's fourteenth largest tire company, aggressively sought to gain competitive advantage while in the midst of threatening environmental changes. it did not fall into a crisis mode of management it moved forward by: a. improving customer service; b. enhancing its computer applications to new product development, design, and manufacturing; c. modernizing and expanding its production facilities; d. intensifying employee training programs at all levels; and e. introducing four lines of high performance tires specifically fitted to various segments of its customer market [8]. at xerox corporation, the original reprographic product patents were mnning out in the mid-seventies. the dominance once held by their copier products was being successfully challenged by a number of domestic and international competitors, each intent on the enormous market xerox had developed. xerox market share was dropping dramatically. indeed, discontinuity had occurred, and xerox was in danger of losing contact with its customers. following a study of the situation, it was determined by objective comparisons that xerox was far from being competitive in any of the key performance areas that were vital to survival. david t. keams, xerox ceo, announced the theme "leadership through quality" (l1'o) and 3et as his three goals: "breaking down the functional barriers between groups; concentrating on the customer; and providing customer satisfaction" [14]. ltq's two spring 1991 noetzei and burnham: a strategic approach 71 emphases were customer development and bringing suppliers up to world class quality standards. improvement in supplier-quality was important because 80 percent of manufacturing cost pertained to purchased parts and components. at first, xerox refused to accept the notion that its copier family was not competitive in the global marketplace. it suffered from "the denial syndrome." following the catharsis of facing hard evidence to the contrary, xerox responded. in 1980, xerox adapted the idea of competitive benchmarking and sought internal performance standards. tightly correlated to externally imposed performance targets. it then underwent a massive reeducation of suppliers and employees at all levels. six years after its acceptance of externally imposed goals, xerox was regaining market share, had reduced its costs, halved its inventory, reduced external lead-times by two-thirds, improved the quality of supplier parts, and cut equipment defects to one-eighth of their 1980 levels [9]. taking the benchmarks as current targets, xerox asserts that "if we don't happen to the best in a particular area, everyone will know that we're making a hard run at it [5]." in terms of the venn diagram, cooper tire moved to the right by improving customer service and moved downward by the introduction of four new lines of tires. it increased its diameter, the symbol of distinctive competencies, by an improved information system, modernized efficient plants, and by a very strong emphasis upon management and employee training and development. in a similar manner we may interpret xerox's strategic moves as a horizontal move to the right when it began focusing upon the customers and their satisfaction. much of its efforts were devoted to increasing the diameter of circle a to overlap competitor benchmarks (circle q. many suppliers to the automotive industry in the united states face mandated change the threat of discontinuity. automobile companies have been tightening their standards for quality, cost, and delivery time. in their streamlining, the automobile companies are seeking longer-term contracts with fewer supplier companies and requiridg them to provide higher quality items at lower costs; they want ''total system suppliers." these are suppliers who fully understand their products and processes, efficiently design and develop new products, control the quality and cost from raw materials to finished product, and deliver the complete assembly on time. some of the smaller suppliers may be at a disadvantage compared to larger :firms in terms of carrying out research and development and in engineering their products. on the other hand, smaller suppliers may have the advantages of flexibility, innovation, adaptability, and strong leadership. "however, in order to survive in the very severe competitive environment, it is most important that they utilize their advantages to the fullest and also that they modify their organizations so as to meet the new car makers' requirements" said masanobu myamoto, head of the purchasing division at the mazda assembly plant in flat rock, michigan [12]. myamoto's challenge to an automotive supplier is to strengthen distinctive competencies (increase the diameter of circle a) while customers set more rigorous product specifications (a narrowing of the diameter of circle b) and while competitor's establish higher benchmarks (decreasing the diameter of circle c). 72 journal ofbuyiness strategies an initial assessment voi. 8, no. 1 the first step in building a defense against the threat of discontinuity is an "here-andnow" assessment of the position of the manufacturer and its products in the marketplace. oment competencies and resources must be evaluated for strengths and weaknesses in terms relative to customer satisfaction and competitors' benchmarks. companies in the mode of shock or retreat from mandated change will hesitate to make such an assessment a judgment concerning current competitive advantage must be made, honestly and with integrity, and not with resistance, denial, or rosy optimism if there is to be a close correlation between internal standards of performance in manufacturing and distribution and the externally imposed norms of excellence. manufacturing companies must probe the total current and prospective resources and capabilities to find potential sources of competitive strength. what are our present competitive strengths? how large is the hatched area in the venn diagram? how fast is the size of the hatched area waning? what are the bases of our current advantages in the marketplace? how well do we understand our customers' needs, their loyalty to us, and the shifting patterns of need in the future? how fast are our customers streamlining their operations and tightening their specifications? in which areas have competitors established superior benchmarks pertaining to quality, service, delivery time, and cost? what is the rate of improvement competitors are achieving for these benchmarks? are there signs of weakness or strain in the competitive positioning of our key rivals? the following simple form (figure 3) may assist in assessing the manufacturer's competitive position. the form has a major limitation; it is time-static. it is simply a single frame :from the motion picture of the market as such, the assessment should be regularly repeated, to discover rates of changes in customer and competitor actions. more detailed and arialytic approaches to the evaluation of the relative lengths of the diameters of the circles in the venn diagram (figure 1) are benchmarking [4] and quality (function) deployment [7]. these approaches facilitate the development of internal goals that match those mandated externally. the assessment of competitive position will moreover be pointless unless it is immediately followed by a strong, positive commitment to formulate and to carry out a wellconceived strategy with a thrust toward improvement the initial assessment is but a first step. to be useful to the manufacturer, it must galvanize the organization, as a whole, to effective action. the first steps must be quickly following by a well-articulated statement of intentions for improvement. mandated change challenges each manufacturer to judge the size of the hatched area in the venn diagram (figure 1), to assess whether the area is growing or shrinking, and express poweifully and clearly to all within the organization its commitment to enlarge it in the face of worldwide competition. spring 1991 noetzel and burnham: a strategic approach figure 3 assesment ofmtemal perford1aoce staddards 73 potential so1ll'ce of present strength relative future importance to competitive advantage to competitive rivals ~orcustomers above equai below high modente low general company image relative market share financial strength profit margin knowledge of market patents technolomcal capability product promotion breadth of production line breadth of distribution customer service product availability order cycle time inquiry response time error in shipment damaged goods special services after sales services consistency of servi~ quality product reliability product durability conforman~ to s ons product desi~ product features ease of servicing product on-time delivery producdon tecllniqufs volume flexibility quality prowams process control material requirements planning lead-time reduction computer controlled machinery computer aided design restmetured suppliers automated material hand1i.n2 worker participation broad sharing of information price other 74 journal ofbusiness strategies vol. b,no.1 companies that can enhance their competitive advantage are those that, in response to the threat of discontinuity or rapidly changing environmental factors: a. are aware that changes are taking place; b. are able to face the arenas that must be change sometimes radically and have the will to act; c. are able to assess logically the various consequences for the company; d. recognize that time and infonnation are key resources and sources of distinctive competencies for the competitive struggle. e. can develop an overall strong commitment, discipline, and focus for what the business is to do and how it will best do it; f. can formulate a clear strategy based upon well-thought concepts of quality, efficiency, and customer service; g. can mobilize the organization's resources through leadership, decisiveness, and communications, so that people at all levels within the organization, know, understand, and accept wholeheartedly the strategy; h. is able to achieve full integration of functions and tasks across functional departments. the integration of proactive marketing and manufacturing strategies is necessary to give a manufacturer the capability to move horizontally toward customers and to move downward to meet or exceed competitive benchmarks (see figure 1). mandated change cannot be faced by partial effort. discontinuity is too serious a threat to survival not to be confronted by the holistic formulation and implementation of strategy. implementation of such a strategy will depend on activities that facilitate, encourage, and reward effective interaction among all functional areas. information, influence, and support must flow abundantly among the functions of finance, research and development, engineering, manufacturing, and marketing. it will require managers in each area who regard the others as equals and capable of making strategic contributions to areas other than their owo. it calls for managers with determination, vision, and the capacity to maintain a focused effort over a long time, and often in the face of organizational resistance. conclusion there is a chinese maxim: ''unless we change direction, we are likely to end up where we are headed." manufacturers confronted by mandated change and the threat of discontinuity in the marketplace must change direction. a manufacturer may no longer say: ''we make and sell what we are good at." the drastic transformation worldwide industry dramatically shows manufacturers that they must accept the view that what is "good" is determined by the present and future expectations of customers and the benchmarks set by worldwide competitors. manufacturers are challenged to develop a new integration of perspective, thinking, shared values, leadership, and strategy. spring 1991 noetzel and burnham: a strategic approach 75 lbis paper proposes that the first steps in setting a new direction are: (a) an understanding of the ideas of mandated change and marketplace discontinuity, (b) an assessment of the manufacturers' current and future competitive position in terms of customer services, quality, and production methods, and (c) a commitment to the formulation and implementation of a plan of action that integrates marketing and manufacturing strategies. the interrelationships and interdependencies between and among components of a manufacturer's business-level strategy, manufacturing strategy, and marketing strategy may be complex. properly linked these components can enhance distinctive competencies and provide strategic opportunities. a specific manufacturer seeking to move in a new direction will have to explore many subtle interrelationships peculiar to the business; these are not covered by this paper. some of the questions which a specific situation may call to the fore are such as the following. how does a manufacturer confronting mandated change achieve both focus and flexibility? how does each of the building blocks of competitive advantage-targeted markets, the effective use of time and information as strategic resources, a new thrust toward human resource development, and a proactive manufacturing strategy-contribute to a firm's distinctive competencies? how may the concepts of customer orientation, product development and improvement, and distinctive competencies be quantified, so as to provide a sharper tool for the analysis of changes in competitive advantage? how is an assessment of customer service, quality, and production methods converted into effective action in the marketplace? these and related questions open areas for research in the strategic management of manufacturing firms. while this paper does not attempt to answer the particular challenges facing a specific manufacturer, it may provide useful hints to one seeking competitive advantage while facing mandated change. references 1. bell, rr and burnham. j.m. "the paradox of manufacturing productivity and innovation." business horizons. vol. 32, no.5 (september/october, 1989). 2. binstead, d. "learning to cope with change." management decision. volume 23 (november 3, 1986). 3. bogazzi, rp. principles of marketing management. chicago, ll: science research associates, inc. (1986), p. 215. 4. camp, r.c. "benchmarking: the search for industry best practices that lead to superior performance." quality progress (march, 1989), pp. 76-82. 5. connor, l. and landry, p. 'workshop report: jit purchasing at xerox." target. volume 3, no. 4 (winter, 1987). 6. dumaine, b. ''how managers can succeed through speed." fortune (february 13, 1989), pp.54-59. 76 journal ofbusiness strategies vol. 8, no. 1 7. fortana, rm. nquality function deployment: taking quality upstream." tarfwt, vol. 3, no.4 (winter, 1987), pp. 11-16. 8. gorr, 1. "cooper tue: successful adaptation in a changing industry." the journal of business strategy (winter, 1987), pp. 83-86. 9. jacobson, g. and hillkirk, j. xerox: an american samurai. new york, ny: mcmillan and company (1986). 10. jaikumar, r "post industrial manufacturing:' harvard business review, vol. 64, no.6 (november/derember, 1986), pp. 69-76. 11. jennings, d.p. and lampken, j.r ''insights into the relationships between strategic momentum and environmental scanning: an empirical analysis." akron busineu and ec0nomic review, vol. 20, no.1 (spring, 1989), pp. 84-93. 12. miyamoto, m. remarks at conference sponsored by the office for the study of automobile transportation, university of michigan, ann arbor, mi (april 6-8, 1989). 13. morgan, g. riding the waves of chanfw: develo,ping managerial competencies for a turbulent world. san francisco, ca: jossey-bass publishers (1988), pp. 37-41. 14. parker, j.r. "xerox supplier total quality strategy:' sixth annual conference of the association for manufacturing excellence proceedings. st. louis, mo. (1988), p. 2. 15. obmae, k. the mind of the strategist. the art of japanese business. new york, ny: mcgraw-hill book company (1982), pp. 62 et seq. 16. porter, me competitive strategy: techniqyes for analyzing industries and competitors. new york, ny: the fall press (1980), chapter 1. 17. porter, m.e. op.cit., chapter 2 18. porter, m.e., and miller, v.e. "how information gives you competitive advantage." harvard business review. vol. 63, no.4 (1uly/august 1985), pp. 149-60. 19. shapiro, b.p. "what the hell is market oriented?" harvard business review vol. 66, no.6 (november/december 1988), pp. 119-125. 20. skinner, w. "the productivity paradol" harvard business review, vol. 64, no.4 (july! august, 1986), pp. 55-59. 21. wheelwright, s.c. "building excellence in manufacturing." in: quality. productivity. and innovation (ed. shetty, y.k. and buehler, v.m.), elsevier science publishing co. inc. (1987), pp.341-362 22 zuboff, s. "new world of computer-mediated work." harvard business review, vol. 60, no.5 (september/october, 1982), pp. 142-151. a strategic approach for manufacturers facing mandated change 145 journal of business strategies ownership culture and strategic adaptability peter b. thompson university of illinois at chicago • chicago, il mark shanley university of illinois at chicago • chicago, il abagail mcwilliams university of illinois at chicago • chicago, il abstract although abundant evidence demonstrates a positive relationship between employee ownership and firm performance, two questions remain unanswered: why does employee ownership fail to enhance the performance of some adopting firms, and what are the mechanisms by which employee ownership enhances performance? we argue that employee ownership has the potential to enable managers to shape organizational culture in support of firm strategy. in supporting firm strategy, employee ownership has the status of strategic choice. further, to the extent that organizational culture is strategy-appropriate, it leads to competitive advantage by increasing the availability of resources, the serviceability of those resources to the firm, and flexibility in the allocation of resources to address competitive threats and opportunities. when managers of employee-owned firms are unable to create such a culture, the performance of their firms suffers as a result. introduction strategic management, often called ‘policy’ or nowadays simply ‘strategy’…includes those subjects which are of primary concern to senior management, or to anyone seeking reasons for the success and failure among organizations. rumelt, schendel, and teece (1991) why do employee-owned companies perform better, on average, than conventionally-owned companies? and why do some esop companies perform better than others? employee ownership, also called “shared capitalism” (sc), or “earned capitalism” (ec), a term that includes employee stock ownership plans (esops) stock 146 journal of business strategies purchase plans, profitand gainsharing plans, and broad-based stock options (kruse, freeman, and blasi (2010), is a management practice that has been utilized by firms for decades.1 partly a tool of corporate finance, and partly a tool of human resource management, esops have become a small yet significant part of the economic landscape. congress created the esop in the 1974 employee retirement income security act (erisa), which established the legal basis for esops as a defined contribution retirement plan. laws and regulations pertaining to esops are regularly considered by congress and reported in the press. during the last two decades, the number of esop firms has held steady at around 10,000 firms (nceo, 2008). esops have a dual nature. on the one hand, they are a tool of corporate finance. for instance, the law permits the employee stock ownership trust (esot) to borrow money for the purpose of purchasing shares. as such it is a mechanism for raising capital or restructuring the balance sheet. and, they can be used to alter the governance structure of a company. however, as a tool of human resource management employee ownership has the potential to have a much greater impact on firm performance than do alterations to the right-hand side of the balance sheet. this is the basis of our discussion. there have been a large number of studies attempting to show that eo activities “work” – that they have results that are beneficial to a firm’s overall results. a considerable body of empirical work has demonstrated a positive link between employee ownership and firm financial performance (to be discussed in detail below). research has also demonstrated some positive effects of eo programs on individual attitudes and behavior (to be discussed in detail below). while both of these lines of research are promising, there is a gap in the theoretical basis of this work that limits its usefulness. specifically, there is a need for a clearer delineation of the mechanisms by which eo programs work at the individual level in motivating employees and yet are seen as contributing to significant firm level performance outcomes. explanations tend to point vaguely at factors such as increased motivation, culture, information sharing, even a multi-period prisoner’s dilemma, but generally lack detail. to compound the deficiency, no theory of which we are aware addresses the question of exactly how individual-level outcomes produce firm-level outcomes. this gap in the research is due to scholars approaching the topic from different disciplines and from studying the ownership phenomenon from a single level of analysis. 1for a typology of employee ownership, see toscano, 1983; ben-ner and jones, 1995. 2for details of the financial, tax, and other technical characteristics of an esop, smiley, gilbert, binns, ludwig, and rosen (2007) present an excellent discussion. 147 journal of business strategies because an empirical demonstration of (a) multi-level linkage(s) would be a monumental undertaking, requiring the simultaneous collection of data from two levels of analysis—individual-level and firm-level—and from a large sample of firms, it is not surprising that this knowledge gap persists. to our knowledge, this multi-level feat has been attempted only rarely (klein, 1987; kruse, freeman, and blasi, 2010; rosen, and quarrey, 1987; rosen, klein, and young, 1986). practical obstacles such as collecting individual-level data from a large number of firms have to date limited researchers’ progress in describing the complete causal chain linking these programs with corporate performance. as a consequence of the practical difficulties of uncovering causal mechanisms, the nature of those links remains a matter of speculation. the employee ownership→individual outcomes→firm outcomes linkage is a complex phenomenon that is not fully understood and not every study has shown a positive relationship (kruse, freeman, and blasi, 2010). background—employee ownership research employee ownership, whether realized in esops or other forms, has been studied from multiple perspectives.2 it has been treated extensively by political scientists (e.g., al-saigh, and buera, 1990; alperovitz, 1997; bradley, 1986; dugger, 1987; gibson-graham, 2003; gunn, 2000; howe, 1986; miller, 2003; mygind and rock, 1993; steinherr, 1978); philosophers (e.g., mill, 1871, 1998; miller, 2003) sociologists (e.g., whyte, and blasi, 1982, 1984) ; economists (e.g., ben-ner, 1988, blinder, 1990; doucouliagos, 1990, 1995; fama, and jensen, 1983; kruse and blasi, 1997; kruse, freeman, and blasi, 2010; vanek, 1976) legal scholars (e.g., ellerman, 1984; hansmann, 1990), and management scholars (e.g., conte, and svejnar, 1990; klein, 1987; pierce, and rogers, 2003) pierce, kostova, and dirks, 2001; pierce, rubenfeld, and morgan, 1991; rousseau, and shperling, 2003).3 in addition, a vigorous practitioner literature extols the virtues of employee ownership (e.g., brohawn, 1997; gates, 1998; quarrey, blasi, and rosen, 1986; rosen, and carberry, 2003; rosen, and rodgers, 2007, 2011; rosen and young, 1991; rosen, klein, and young, 1986; rosen, case, and staubus, 2005; young, rosen, and carberry, 1995). the central question motivating the bulk of this work is the relationship between employee ownership and firm performance. 2the authors wish to thank the following for their helpful suggestions: ginny vanderslice, corey rosen, anne-laure winkler, and jack veale. thanks also to our anonymous reviewers for their insightful comments. 3there are several excellent reviews of the employee ownership / shared capitalism literature, including for example, blasi, conte and kruse, 1992; bonin, jones and putterman, 1993; carberry, 2011; freeman, 2007; kruse and blasi, 1997; and the introduction to the monograph by kruse, freeman, and blasi, 2010). 148 journal of business strategies table 1 employee ownership outcomes individual level outcome authors satisfaction greenberg, 1980 hammer, stern and gurdon, 1982 long 1978a. 1978b, 1980, 1982 kruse, 1984 tucker, nock and toscano, 1989 buchko, 1993 french and rosenstein, 1984 russell, hochner, and perry, 1979 would take the same job again russell, hochner, and perry, 1979 organizational commitment / identification hammer, stern and & gurdon, 1982 keef 1994 long 1978a. 1978b, 1980 oliver, 1984 rhodes and steers, 1981 russell, hochner, and perry, 1979 long, 1982 tucker, nock and toscano, 1989 french and rosenstein, 1984 oliver, 1990 motivation, esop satisfaction goldstein, 1978 kruse, 1984 long 1978a. 1978b, 1980 rhodes and steers, 1981 russell, hochner, and perry, 1979 long, 1982 buchko, 1992, 1993 klein and hall, 1988 rosen, klein, and young, 1986 perceived and desired influence under employee ownership goldstein, 1978 hammer, stern and & gurdon, 1982 kruse, 1984 long, 1979, 1981, 1982 rhodes and steers, 1981 russell, hochner, and perry, 1979 sockell, 1985 hammer and stern, 1980 149 journal of business strategies table 1 (cont.) employee ownership outcomes firm level turnover, absenteeism, tardiness, injuries buchko, 1992, 1993 hammer, landau, and stern 1981 kruse, 1984 rooney, 1992 sales, and sales per employee bell and kruse, 1995 bloom, 1985 dunbar and kumbhakar, 1992 kumbhakr and dunbar, 1993 kruse, 1988, 1992, 1993 return on assets, market return bell and kruse, 1995 conte, blasi, kruse, and jampani, 1996 park and song, 1995 u. s. gov’t accounting office, 1986 tobin’s q, value added bell and kruse, 1995 kruse, 1993 profitability mitchell, lewin, and lawler, 1990 u. s. gov’t accounting office, 1986 empirical evidence firms sponsoring employee stock ownership plans tend to perform, on average, better than non-esop firms. empirical studies have overwhelmingly shown a link between esops and positive firm performance. however, the nature of that relationship, namely the mechanisms whereby employee stock ownership enhances organizational outcomes, remains obscure, raising the question—“can esops be a source of sustainable competitive advantage?” studies at the firm level of analysis document an employee ownership→ performance link, while individual-level studies tend to focus on the employee ownership→positive attitudes link. (the divide between the individual-level and the firm-level streams is evident in table 1.) moreover, esop research has also demonstrated that the linkage between esop firms and superior outcomes is especially strong when employee ownership is combined with participatory management (kruse, freeman, and blasi, 2010; quarrey, blasi, and rosen, 1986; rosen, klein, and young, 1986). the assertion that employee ownership is associated with superior performance has been settled, although how it affects firm performance remains an open question.4 firm-level outcomes associated with employee ownership include reduced turnover, absenteeism, tardiness and injuries, and increased 150 journal of business strategies sales, sales per employee, return on assets, market return, tobin’s q, value added and profitability. (see table 1 for citations.) individual level outcomes include satisfaction, organizational commitment, motivation, satisfaction with esop, increased perceived influence, and increased desired influence. when the empirical research is considered as a whole it is reasonable to conclude that shared capital programs enhance or in some way facilitate individual-level outcomes that translate into positive organization-level outcomes. but—and this is an important qualification—even when taken together, the two streams of research can do no more than hint at a causal connection. this is because firm-level studies treat the firm as a black box, as they do not measure differences in inner processes that cause differences in performance. on the other hand, individual-level studies report differences between employees in employee-owned firms and employees in conventionally-owned firms, but do not measure the performance of those firms. (some studies compare employee owners in a single firm with non-owners in the same firm (e.g., long, 1978b). nonetheless, in no study has the complete employee ownership→individual differences→organizational outcomes causal chain been observed or measured. it is essential that in order to show how interior processes lead to organizational outcomes, it is necessary to simultaneously observe and measure both internal processes and organizational outcomes across a sufficiently large set of firms. that is, it is necessary to conduct research at two levels of analysis. this point cannot be over-emphasized. as a consequence, our knowledge of the employee ownership phenomenon is incomplete and important questions remain unanswered: (1) for instance, it is possible that the observed ownership→outcome relationship is spurious, that there is some third variable driving both performance and the creation of an esop. candidates for this variable include the possibility that better-skilled managers are disposed to share returns with workers. or, a particular management philosophy leads to both performance and employee ownership. or, firms with some other form of competitive advantage wish to protect that advantage by linking employment with ownership. (2) alternatively, the linkage could be endogenous whereby better performing companies have the financial and human resources to implement an esop. (setting up an esop is time-consuming and costly.) 4for example, gary becker and richard posner criticize the performance of esops as stemming from their tax advantages to sponsoring firms rather from their effects on workers and suggest that the rationale for such advantages is questionable given available evidence (becker-posner blog, 4/08/07 www.becker-posner-blog. com/2007/04/employee-ownership-through-esopsa-bad-bargain-becker.html). 151 journal of business strategies (3) another possibility is some serendipitous outcome resulting from an action taken for completely different reasons. for example, a few esops have been created as a takeover defense, which could lead to the unexpected outcome of increased employee loyalty, motivation, and performance. similar outcomes might devolve to a firm whose retiring owner, rather than cash out to an outsider, sells to the employees. there are a large number of reasons why firms institute esops (see table ii), each with its own intended and unintended consequences. table 2 reasons for creating an esop • provide an alternative to the fiscal responsibilities of a defined-benefit plan • provide an alternative to the fiscal responsibilities of another defined-contribution plan • raise capital for the firm more cheaply • repurchase stock • buy out minority or majority shareholders • or sell whole companies to employees • sell a company threatened with shutdown to its employees • or divest an unwanted division or subsidiary • defend against takeover or maximize internal control • carry out hostile or friendly takeovers by employees • give workers stock at no cost to the company • tax savings • defer compensation to increase cash flow • repurchase shares to increase leverage • cash out large shareholders without losing control • take a public company private restructure right-hand side of balance sheet • finance a leveraged buyout of a public corporation • deduct employee dividends from corporate income • trade stock for wage or benefit concessions • develop a flexible compensation system • purchase life insurance for key executives or workers • resolve estate and estate-tax problems • use as a strategy in collective bargaining • increase the value and possibilities of charitable contributions • convert ownership of a proprietorship or partnership • refinance existing debt • finance acquisition of another company (blasi, 1988), • restructure wages and benefits • institute pay-at-risk or variable pay • trade stock for wages • replace defined benefit plans • replace profit sharing plans. source: blasi, (1988); blasi & kruse, (1991) alternatively, chaplinsky and niehaus (1990), and scholes and wolfson (1990) argue that the performance of esops is not predicated on tax benefits. 152 journal of business strategies explaining esop performance surprisingly, none of the reasons listed in table 2 have addressed the role that employee ownership might play in a firm’s competitive strategy. the surprise is even more puzzling because instituting an esop is a major administrative undertaking. our novel contribution is the application of strategy theory to an unexamined phenomenon combined with an explanation of the performance results of employeeowned firms. our main theme is that employee ownership programs in general and esops in particular have the potential to be of strategic importance to firms in that they can render a company’s existing culture more adaptable and capable of channeling employee motivation, effort, creativity, and buy-in to support overall firm results. realizing competitive potential is not easy, which is why some esop firms do not perform well and eventually drop out of the esop population. here we propose a theoretical framework to guide empirical study of our two questions: “why do employee-owned companies perform better, on average, than conventionally-owned companies?” and “why do some esop companies perform better than other esop companies?” answering these questions requires a framework that meets three criteria: it must be consistent with empirical observations, account for ownership phenomena at two levels of analysis and the interaction(s) between those levels, and be empirically testable. findings so far to summarize the foregoing discussion of the studies listed in table 1, at the individual level of analysis we know that: 1. employees who participate in an esop tend to be more satisfied than non-participants 2. employees who participate in esops report greater motivation than non-participants. 3. the greater the portion of an employee’s wealth that is invested in company stock the greater the employee’s commitment and satisfaction at the firm level of analysis we know that: 1. esop companies perform better, on average, than conventionallyowned companies 2. not all esop companies are high performers 3. esop companies that practice participatory management tend to perform better 4. esop firms are continuously created and terminated 153 journal of business strategies these findings raise intriguing questions, while failing to explain the performance of esop companies. for instance, do individual-level satisfaction and motivation account for enhanced firm-level performance? what role does the size of an employee’s stake in the firm play in firm performance? what accounts for the variance in firm performance across esop companies? what is the effect of participatory management—is it a moderator, mediator, or primary cause? why are esops continuously created and why do they disappear? motivation—individual level effects. one possible explanation for the superior performance of esops is that employee ownership is an incentive that motivates workers to work harder, increasing efficiency. criticisms of the assertion that employee ownership leads to productivity often rest on the observation that employee ownership is a reward system, and a group reward system at that. while it is true that there are (often substantial) financial rewards associated with esops, the more important rewards are intrinsic. we address this point below. table 3 lists six practices recommend by rosen and rogers (2011) for building an ownership culture. next to them, we have listed motivation theories that could explain why the component increases motivation. the list suggests that there appears to be ample theoretical support for increased motivation among employee owners. and, it is true that employees may be motivated by incentives—but to do what? individual motivation alone is not enough to explain the effect of employee ownership on firm performance. rather, the effects of an esop have been observed at both the firm level as well as the individual level so it is more likely the case that individual effort is directed not only toward each employee’s individual goal, but also toward a single, firm-level goal. put another way, having an emotional, psychological investment in the success of an esop has the potential to motivate an employee beyond her individual task(s) provided that individual motivation from an esop is linked to firm goals on account of the efforts of and messages from management. rosen and rogers (2011) debunk the individual-level motivation explanation for firm performance with a numerical example: assume that labor accounts for 30% of a firm’s costs. suppose further that about half the workers are fully engaged, and the other half are “incorrigibles,” indisposed to work hard no matter what. how many more minutes of labor will the engaged workers contribute? assuming they would work an additional 30 minutes, what effect would a ‘powerful’ incentive system have on costs? only about one percent! 154 journal of business strategies 0.5 percentage of engaged workers × .067 extra time worked i.e., from 7.5 hours to a full 8 hours × .30 percentage of operating costs owing to labor = 1.0% cost savings even more generous assumptions yield similarly unimpressive results. this example underscores the faulty logic of aggregating individual outcomes in order to explain a group outcome (danserau and cho, 2006; kozlowski, and klein, 2000; rousseau, 1985). the question now is: if a general increase in individuals’ aggregate motivation is unlikely to have a meaningful effect on firm performance, what role does individual-level motivation play in firm performance? in other words, what are the processes by which these six components drive organizational outcomes? we must look for a mechanism by which individual activity (perception, attitude and behavior) engender firm-level results. again, rosen and rodgers (2011) offer an answer: rather than working harder, the effect of an ownership culture is to stimulate employee owners to “work smarter.” table 3 prescriptions for creating an ownership culture components of an ownership culture possible theoretical explanation • level of ownership that is financially significant to employees • expectancy theory (valence) • two factory theory (hygiene factors) • understanding of the terms and conditions of the ownership plan • expectancy theory (instrumentality) • goal setting theory • skills training to increase effectiveness • self efficacy theory • path-goal theory • sharing financial and performance information with employees • instrumentality (expectancy theory) • short-term financial incentives like profit-sharing and bonuses (in addition to the long-term benefits of stock ownership) • reinforcement theory • employees have structured, regular opportunities to have meaningful input into decisions concerning the work they do. • voice • job characteristics model (feedback, autonomy) • two factory theory (motivating factors) source: rosen and rodgers, 2011 155 journal of business strategies ownership culture. the explanation most often given for the observed ownership→performance linkage is that these esops create an ownership culture that contributes to superior performance. while this general conclusion is defensible, we believe along with others (freeman, 2007; kruse and blasi, 1997; kruse, freeman, and blasi, 2010) that it is overly simplistic to argue that the simple adoption of employee ownership programs or continuing stable levels of employee participation in those programs improve firm performance. the census of esops, for example, is in dynamic equilibrium as existing esops are terminated and new ones created (nceo, 2008). this would be hard to predict from simple adoption rates and participation levels and suggests that other forces are needed to explain the linkage between employee ownership and firm performance. meantime, the census changes continuously as firms terminate esops and new ones are created. the concept of an ownership culture may be best introduced with a thought experiment. the reader might want to contemplate something he or she owns—a car, a house, a prized work of art. you probably know how much you paid for your car, the mileage you have put on it, and when it is due for service. likewise, you probably know the balance owed on your home mortgage, the amount of real estate taxes, and which repairs are needed. yet, if you rent an apartment, how likely is it that you know the amount of real estate taxes? consider another example: many travelers have had the experience of boarding a taxi at a strange airport and noticing its condition. if it is owned by the driver, it is likely to be clean, well maintained, and pleasant. drivers who lease their cabs do not take such good care of the company’s vehicle. property rights. ownership consists of three property rights: knowledge pertaining to the object owned, control over the object, and the right to residuals (rousseau and shperling, 2003). participants in an esop enjoy all three. as owners, they are entitled to increases (or decreases!) in the stock price, and to dividends. in esop companies practicing participatory management, employees can exert some degree of control. this is especially true when voting rights are passed through to employees.7 and finally, some, but not all, esop companies practice open book management (case, 1995; sockell, 1985) by sharing financial and operating information as a part of their “communication and participation” (c&p) programs (see below.). employee owners, like independent taxi drivers, have a special relationship with their work. 7technically, an employee stock ownership trust (esot) owns the employees’ shares. depending upon how the employee ownership plan document is written, the trustee(s) may vote those shares themselves or pass voting rights through to the employees. 156 journal of business strategies effective ownership culture and competitive advantage. ownership culture can be a resource that leads to competitive advantage according to the vrio theory developed by barney (1991). according to this theory, competitive advantage is derived from the effective management of heterogeneous resources that are valuable (to the consumer), rare (not abundantly traded in markets), inimitable (not readily imitated) and which the organization is ready and able to exploit. ownership culture is valuable, relatively rare and hard to imitate, so that with the correct organizational support such as effective strategic planning and excellent evaluation and control, management can create a more effective and efficient firm. accordingly, we first present the mechanism by which an esop has the potential to lead to competitive advantage (see figure 1), and then examine esops within the vrio framework. firm level. an esop by itself does not confer competitive advantage, as noted above. instead, it must be managed deliberately to enhance existing culture— to nudge as it were firm-specific values, beliefs, and norms in support of the firm’s (changing) strategy. as the empirical research suggests, an esop must be combined with participation in order to produce superior firm results. technically, an esop is a defined contribution benefit plan that provides employees with shares that they can cash in upon retirement. this has a cross-level effect of providing extrinsic rewards at the individual level. in addition to extrinsic, albeit deferred, rewards, an esop’s enhancing potential lies in combining it with “participation and communication programs” or their equivalent. individual level. participation and communication programs encourage participation, cooperation, group identity, and other psychological states that are intrinsically satisfying. two psychological states that are particularly important for the development of an ownership culture are shared risk and commitment to group goals (discussed below). the achievement of an uncertain goal to which all members of a group are committed is intrinsically satisfying, nowhere more evident than a sports team that has just won a challenging championship game. intrinsic rewards do not pay the bills, but company stock on top of salaries, bonuses, wages and sometimes even profit sharing do pay the bills. neither alone is enough to create an ownership culture. emergence8. but when extrinsic and intrinsic rewards are combined, they can foster an “ownership culture,” which may—if management is skilled enough— 9“shared unit properties are presumed…to originate in individual…members’ experiences…and to converge among group members….in this way shared unit properties emerge as a consensual, collective aspect of the unit as a whole.” (kozlowski and klein, 2000: 30) 157 journal of business strategies enable the company to make strategic changes more rapidly than the competition. ownership alone is not sufficient to shape culture. and participation without ownership is nothing less than manipulation. the two together succeed because financial ownership makes the work of participation worthwhile to the employee. information sharing, cooperation, mutual monitoring and similar norms—however intrinsically satisfying they may be—require extra effort, so must be reinforced with monetary rewards to have an effect on culture. with respect to esops competitive advantage is not one thing, but rather a combination of financial ownership and psychological engagement applied to competitive threats and opportunities. (v) value creation. in order to be successful the content of a culture must be open to adaptation (kotter, and heskett, 1992). by its definition, firm culture has an inertial and conservative bias to it, since it represents the cumulative sense making activities of individuals regarding a firm’s history. further, “all too often, major organizational change occurs only when an organization is in serious trouble and is faced with complete failure.” (lawler, 1994: xxxv). the firm’s culture must make sense out of past experiences with the firm, while also permitting the possibility of growth and adaptation. if the potential for growth and adaptation are not there, then the culture will be inertial and resistant to change, and the economic impact of the firm’s culture will be one of increased rather than reduced implementation costs. finally, the content of the culture should support the details of the firm’s strategy and not be antagonistic to them. each firm’s culture is unique and there is no one best culture; therefore, culture is a heterogeneous resource in the barney (1991) framework. any culture has the potential to be a source of competitive advantage in that certain core values and beliefs about how a company ought to conduct its business may be transformed into value-creating decisions and actions. an ownership culture has more value-creating potential than other cultures because it satisfies a higher order need, that is, the desire to help the firm prosper. an esop enables management to shape or change culture more effectively and more rapidly than would otherwise be possible in the absence of such a program. it amplifies management’s influence and its ability to engage workers more deeply. the financial rewards that such programs offer to participants are complemented by the more intrinsic rewards that come from achieving performance goals within an ownership culture—rewards that include increased levels of job satisfaction, personal autonomy, and even organizational commitment (buchko, 1993; chiu, 2003; klein, 1987; klein and hall, 1988). besides focusing participant attention on firm goals, an esop has the capability to intensify the effect of culture on the willingness and ability of workers to ex158 journal of business strategies ecute strategy. value-creators include (1) increased efficiency in information sharing and processing and decision-making (ben-ner,1988; bonin, jones, and putterman, 1993); conte and svejnar, 1990; young, rosen, and carberry, 1995; (2) increased self-monitoring while decreasing the need for supervision (ben-ner, 1988; bonin, jones, and putterman, 1993; conte, and svejnar, 1990; hansmann, 1990); and (3) increased cooperation among workers (fitzroy and kraft, 1987). more important than the strength9 of a culture, though, is its adaptability (kotter and heskett, 1992). because an esop aligns the (financial) interests of the firm with its employees, employees are more likely to be willing to change the way they do things to support new strategies in order to protect their emotional and financial investments—which they have paid for with their labor—as any entrepreneur or sole proprietor would do. in this lies the potential value of an ownership culture. however, employees’ willingness to alter their behavior is conditioned upon whether they perceive that their effort will make a difference, and whether that difference will show up in their wallets (lawler, 1994; vroom, 1964), accordingly, esop firms have the potential to deploy and redeploy those human resources quickly in order to adapt to changing conditions (penrose, 1959). this is affected by the ability of an esop to facilitate cultural change more rapidly than the non-esop competition. an esop can accelerate cultural change when management is able to use it to demonstrate to the workforce that “the way we do things here” affects their interests for better or for worse as well as those of the company. in an esop those interests are linked or, more precisely, they are the same (jensen and meckling, 1976). this leads to our first two propositions regarding the value of esops in supporting strategic change and flexibility. proposition 1(a): changes in employee perceptions, attitudes, and behaviors occur more rapidly in esop firms supporting an ownership culture than in comparable non-esop firms. proposition 1(b): the time requirement for strategic change in an esop company is shorter than in comparable nonesop firms. these changes in culture and improvements in flexibility make the esop valuable in the vrio (barney,1991) sense. (r) rarity of effective ownership culture. as noted above, at any one time, there are about 10,000 esop concerns in the u. s. with employee stock ownership plans. this may not on first blush seem rare, but it does represent a very small 9the strength of culture may be measured by scores on the organizational culture inventory (cooke and lafferty, 1987), or the ownership culture survey (mackin, freundlich, rodgers, and kerr, 2012). 159 journal of business strategies percentage of the firm population in the u.s. what is rarer is an effective ownership culture that depends on both the genesis and the management of the esop. reason for creating esop. not all esops are instituted with employee participation, the enhancement of human capital, etc., as primary concerns. many are established to realize tax benefits, cash out a retiring owner, protect against a takeover, or for similar non-human capital (i.e., non-cultural) purposes (see table 2). accordingly, one could make the case that instituting an esop in order to foster an ownership culture is relatively rare. one could also argue that fostering an ownership culture requires a significant investment of firm resources, thereby reducing the number of firms for whom such an investment is affordable. further, rarity is a matter of degree—some things are scarcer than others. there is no one best ownership culture, but many. it is not a question of having one or not. rather, it is a question of degree and of fit. unlike a patent or a corner location, the fit between culture and strategy can vary between good and bad, along a lengthy continuum. rarity lies in the quality of execution, which is itself, a heterogeneous resource. because ownership culture is heterogeneous, we expect differences in ownership culture, including how it is managed, to account for differences in esop performance. therefore, companies in which building a strategy-supportive culture is not the primary purpose of the esop, we would expect no direct ownership→performance effect. alternatively, in companies whose management aspires to use an esop as a complement or enhancement to its h r policies and practices, we would expect superior firm performance, except that because of the difficulty in creating an ownership culture, not all esops are likely to succeed. this is because, as barney (1991) pointed out, a “particular mix” of resources is required to implement a strategy. note that several measures of culture are on the market (e.g. cooke and lafferty, 1987) including one specifically tailored for employee-owned companies available from the national center for employee ownership (mackin, freundlich, rodgers, and kerr, 2012). these measures are normative, so that the investigator can test his/her hypotheses by degree of deviation from the norm. proposition 2: excluding esops that were created solely for corporate finance or governance purposes, the failure to create a strategy-supportive “ownership culture” increases the likelihood of the failure of an esop. strength of culture. most firms already have a culture (strong or weak), irrespective of the actions of managers, since the people in the firm will have some degree of shared values, beliefs, and norms of behavior. so it is not a question of 160 journal of business strategies creating a new culture but of shaping a firm’s existing culture. the first issue that managers must consider is whether the culture is supportive or not supportive of the firm’s strategy because “culture constrains strategy” (schein, 1985). there must be sharing of knowledge, beliefs, and values so that the ‘culture’ is not just nominal and a mere conceptual artifact of aggregating a set of individuals . without a strong culture, shared capitalism programs like esops are merely incentive programs that appeal to lower-order needs and are likely to lack strategic impact. difficulty. an ownership culture is difficult to cultivate, but not impossible, which may also account for the extent to which it is rare. in addition to the host of esop advisors, attorneys, investment bankers, commercial bankers, and compensation firms, there are experienced and dedicated organization development consultants and other practitioners who stand ready to institute an esop, a participation and communication program (see below), or an ownership culture for their clients. so, esops are to a certain degree off-the-shelf. participation and communication programs. management can influence culture in support of firm strategies by fostering supportive institutions (such as esops) and their related practices (scott, 2008). by establishing clear and objective sets of rules and procedures that link firm goals and operations with employee incentives and compensation, employee ownership programs focus employee attention around core values and activities and link individuals and groups to the goals of the firm and to firm performance. once established these programs persist and grow and in doing so become routine for employees, even taken for granted. this is the process of institutionalization (aldrich, 1999: 48-49), as exemplified by the prescriptions in table 3. as esops become institutions, they provide an objective focus for individuals in the firm that strengthens the link between culture and strategy. to sustain an ownership culture, many (but not all) esop companies invest considerable time and effort in their “participation and communication” programs. the intent of these programs is to shape perceptions and attitudes by increasing employee awareness and understanding of the esop of which they are the beneficiary. in addition to providing general information about esops, some participation and communication programs are intensely firm-specific. in addition, many firms practice “open book management” (e.g., case, 1995; stack, 1994). these firms not only share financial information with employees, but also offer instruction to teach employees to read and understand financial information so that employees fully appreciate the benefits (and risks) of owning the company’s stock. their purpose is to create a clear “line of sight” between effort and reward (lawler, 1995). train161 journal of business strategies ing often includes topics such as effective teamwork, leadership, decision-making, problem-solving, and effective communication. although participation and communication programs are as varied as the companies that sustain them, there are some commonalities. for example: sharing information, skill training, building awareness of and enthusiasm for the esop, emphasizing common interests, and participation in decision making. in addition, some esop sponsors choose to grant employees the right to vote their shares, thus giving them a role in governance. this leads to our next proposition. proposition 3: the greater the investment by an esop company in its “participation and communication” programs or the equivalent the stronger the ownership culture. all of the requirements for an effective ownership structure make them indeed rare in the sense of the vrio framework. (i) imperfect imitability of ownership culture. to be a source of sustainable competitive advantage, ownership culture must also be difficult to imitate. the difficulty of imitating an ownership culture comes from creating the incentives and personal satisfaction that come with ownership. no organizational structure short of ownership has been shown to create the same advantages as ownership on a broad or extended basis. this was the warning contained in berle and means’ (1932) discussion of the separation of ownership and control and it remains a driving force behind entrepreneurship. notwithstanding that employees may be attentive to their responsibilities and perform them diligently, it is still a big step from conscientious self-interest to commitment to organization performance. the failure to understand personal motivation and the lack of resources to create this link is what prevents firms from imitating an ownership culture to create parity with an effective esop. the hard part is to create an adaptive culture from an existing culture, not to create culture x de novo. when an entrepreneur creates a firm, he or she necessarily is obliged to create its culture from scratch (schein, 1985). rosen and rogers (2011) do not envision that there is one perfect culture, anymore than there is one perfect strategy for winning an nba championship. the coach must work with what s/he has. (o) organization of ownership culture. finally, for an ownership culture to be a resource in the barney (1991) sense, it must be managed effectively, that is, there must be appropriate organizational support. therefore, we describe how exceptional esops manage for competitive advantage. 11among managers of esop firms and practitioners like organization consultants who serve them, the term “participation and communication” has roughly the same meaning as corporate culture. 162 journal of business strategies multi-level effects. an ownership culture may be motivational at the level of the individual, and individual motivation is certainly a necessary condition, but it is not sufficient to explain firm performance. having observed that the mere creation of an esop is insufficient to enhance firm performance, and that aggregate individual-level motivation has a only slight effect on firm performance, we have argued that the strategic effect of an esop is due to the creation of a culture of cooperation and mutual support—i.e., an “ownership culture” characterized by “working smarter.” nonetheless, it is possible to create these conditions using conventional rewards and organization development efforts, and so they are not rare or inimitable. what sets an ownership culture apart is, well, ownership.11 in an esop, this means owning an enterprise jointly, where all participants are exposed to the same risk, and it means that one’s job has effects beyond one’s area of responsibility. in an ownership culture, effort is directed toward organizational goals in addition to individual goals. in a strong culture, values and norms are widely and deeply shared. accordingly, employee owners embedded in a strong ownership culture value and engage in such value-creating behaviors as sharing information, mutual monitoring and support, proposing new ideas, making adjustments to work procedures quickly, embracing new work methods enthusiastically, and otherwise cooperating to make the esop a success. these cooperative behaviors are individuallygenerated and pervade the enterprise, and thus have a collective effect, not through aggregation but through synergy. shared risk. shared risk is another individual-level factor contributing to firm outcomes. analogous to shared deprivation (tucker, nock, and toscano, 1989), shared risk is the perception—held by members of a group—that all are dependent upon each other to obtain individual outcomes. in extreme settings, such as armed combat, the rewards of mutual cooperation are highly desirable (survival) and the failure of mutual cooperation is catastrophic (death) (van der dennen, 2005). in the same vein, an employee’s thinking might go along these lines: “i have skin in the game, which i could lose, but it is more than just my skin that’s at stake—because i know that my co-workers also have skin in the game, and i do not want to let them down.” in addition to imparting decision-making and communication skills to employees, communication and participation programs educate employees about the risks and rewards—with emphasis on the rewards, naturally—of employee ownership. in successful esop companies it is not unusual for employee owners to 12 several authors have proposed that psychological ownership, an individual level variable, is a factor in the functioning of employee-owned companies (e.g., pierce, rubenfeld and morgan, 1991; pierce and rogers, 2003; pierce, kostova, and dirks, 2001) to save space, we omit this point and leave it for future discussion. 163 journal of business strategies enjoy substantial account balances, often exceeding $100,000, for unskilled or semiskilled work. higher-level effects should not be understood as the sum of all the individual risks added up into a total, but that each individual experiences the same risk. it is the global awareness that all are in it together that creates the higher-level effect. two factors. the rewards of an esop are twofold: financial and psychic. the genius of employee ownership is that it has the potential to satisfy both lower and higher-order needs, as predicted by herzberg’s (1968) two-factor theory. the financial rewards of an esop function as hygiene factors, while the social and psychological rewards function as motivators. the financial rewards of stock ownership, plus membership in a group pursuing a common goal, can be highly satisfying. it is workers’ perceptions of the esop as a higher purpose that fosters an ownership culture that makes them “think like an owner.” the important difference between a conventional culture and an ownership culture is that in the former a worker need only concern him/herself with his/her own job. choosing tasks and coordinating work in a conventionally-owned firm is the responsibility of management. accordingly, failure in scheduling, coordinating, resource allocation, etc. is the fault of supervisors. but when the activities of a given worker are seen to affect everyone’s outcome, the game changes. we are not referring to mere mutual monitoring. rather, one worker’s efforts can be perceived as part of a larger whole. one becomes aware of one’s membership in a group serving a larger purpose. that kind of awareness can satisfy higher order needs such as affiliation (mcclelland, 1985), relatedness and growth (alderfer, 1972), self-actualization, esteem, and love (maslow, 1943). the success of the esop itself becomes the overarching goal because it satisfies these higher order needs. an employee’s individual tasks are demoted, as it were, to satisfying lower order needs. in an effective ownership culture, individual tasks are merely the means to a greater end: the success of the esop. in this way, workers’ efforts are linked to a higher purpose, existing at the level of the firm. and so, the esop has the potential to create a workforce committed to making the company successful—a firm level outcome. it is this vision-driven commitment that has the potential to overcome the inertia that hampers strategic adaptability. because the financial rewards of an esop combined with the psychological benefits of participation and communication so thoroughly engage employees, we would expect such efforts to affect both individual-level and firm-level outcomes. this leads to the following propositions. 164 journal of business strategies proposition 4(a): the greater the investment by a company in its “participation and communication” programs or the equivalent, the greater the individual-level awareness of shared risk and the greater the individual commitment to firm goals. proposition 4(b): the greater the individual-level perception of shared risk, ceteris paribus, the better the firm-level performance. proposition 4(c): the greater the individual-level perception of mutual commitment, ceteris paribus, the better the firmlevel performance. in operationalizing these constructs, it is important to distinguish between individual level and organization-level phenomena. a survey item like “i have a significant amount of my wealth invested in the company” is an individual-level measure. in contrast, a firm-level measure of others’ risk positions might read, “my co-workers have a significant amount of their wealth invested in the company.” if this procedure is followed, the average score will be a measure of a firm-level outcome, not an aggregation of individual-level outcomes. figure 1 firm level structures esop perceived shared risk individual level processes participation and communication program ownership culture group goal (organizational) commitment) extrinsic rewards intrinsic rewards strategic flexibility competitive advantage the relationship of our propositions to each other are depicted graphically in figure 1, and neatly summarize our main theme. an esop—a firm-level variable— can provide extrinsic rewards in the form of stock ownership. when combined with firm-level “participation and communication” programs an esop can create two 165 journal of business strategies key perceptions—shared risk and groups goals—at the individual level. the feelings of sharing risk with co-workers while pursuing a group goal engenders intrinsic rewards. the combination of extrinsic and intrinsic rewards creates an ownership culture. finally, an ownership culture increases a firm’s flexibility to adapt to competitive opportunities and threats, and thereby achieve competitive advantage. taken together, we have outlined how an effective ownership culture within an esop can be valuable, rare, difficult to imitate and can be organized to create a competitive advantage. this explains why esops have been shown, on average, to create superior performance. in addition, the difficulty of creating and managing an appropriate culture, with esops as well as in other firms, explains why some esops outperform others. extensions and limitations testing the propositions. up to this point we have argued that an ownership culture can enable a company to achieve competitive advantage by making it more flexible and able to adapt to changing circumstances. here, we offer suggestions for testing the propositions by focusing on the interrelationships among the relevant constructs. the processes we’ve discussed encompass two levels of analysis: individual and firm. further, cause and effect travels along multiple pathways. multiple levels. the empiricist has a number of choices: test (1) the firm-level portion of the model i.e., propositions 1b, 2, and 3, showing the connection between the existence of an esop that is combined with a communication and participation program, with the effect of creating an ownership culture leading to strategic flexibility and competitive advantage (firm success). a test showing large effect sizes at an acceptable level of alpha error would tend to support the principal claim that to have an ownership culture an esop firm must invest in its human capital through communication and participation programs, and that these create the culture that enables a firm to respond quickly to competitive opportunities and threats. note, however, that this result would not confirm or disconfirm claims about employee perceptions, attitudes, or behaviors. (2) the individual-level portion of the model, showing the effect of a communication and participation program on perceived shared risk and organizational commitment (together called intrinsic rewards), and combined with the esop’s extrinsic (i.e., financial) rewards, contributes to an ownership culture. a test showing large effect sizes at an acceptable level of alpha error would tend to indicate that the reason why communication and participation programs are 166 journal of business strategies effective is that they alert employees to shared risk, and increase organizational commitment. note also that this result would not confirm the effect of culture on strategic flexibility or competitive advantage. (3) both levels together. (see discussion below.) a test showing large effect sizes at an acceptable level of alpha error would tend to confirm the strategic flexibility argument and the propositions regarding the internal mechanisms driving the formation of an ownership culture. (4) the between firm-level portion of the model by comparing esop firms with and without communication and participation programs. a test showing large effect sizes at an acceptable level of alpha error would tend to confirm the important role communication and participation programs play in creating an ownership culture. pathways. the discussion above is based on the assumption that cause and effect can be detected by comparing the yes-or-no existence of communication programs and the strength or degree of attitudes. alternatively, another way to study the effects of employee ownership on individuals and firms is to trace pathways among the variables (edwards and lambert, 2007). in the model in figure 1, multiple paths emerge from the box labeled “esop” and converge on ownership culture, then on flexibility and competitive advantage. given a large enough number of observations (see discussion below), it is possible to estimate path coefficients, test them, and draw conclusions about the fit of the model using structural equation techniques. if that is not feasible or desired, a researcher may wish to examine the strength of the mediators, i.e., those variables in between “esop” and competitive advantage. multi-level research. it is important to emphasize that empirical demonstration of a multilevel linkage would be a monumental undertaking, requiring the simultaneous collection of data from two levels of analysis—individual-level and firm-level—and from a large sample of firms. as noted above, overcoming this challenge has been a rarity. notwithstanding the lack of sufficient resources, undaunted researchers continue to explore the ownership→performance link from a single level of analysis. insofar as is practical, it would be well to investigate how cause and effect operate across level boundaries. nonetheless, in order to fully understand the employee ownership phenomenon, multi-level data collection and analyses are the ideal. when impracticality is invincible, the researcher would do well to introduce control variables into the analysis such as tenure, level in organization, account balance, department, level of compensation, and performance appraisals. cultural measures should not be omitted, but treated as an individual-level measure. 167 journal of business strategies equally important is avoiding aggregating individual-level data in an attempt to describe a firm level phenomenon (danserau and cho, 2006; kozlowski and klein, 2000; rousseau, 1985). note, however, that when an individual completes a paper-and-pencil questionnaire regarding his/her perception of an organization’s culture, these data may be aggregated because each one is a rating, in the same way that the scores given by olympic judges of gymnastics or diving are ratings of a single performance and may be combined. firm level. the place to begin is to document and measure the content of ownership cultures and then compare them with firm outcomes. this line of investigation faces the practical challenges discussed above. fortunately, there are several measures of organizational culture available to organizational development practitioners from which scholars may choose. an interesting avenue of research would be to determine which of them more accurately predicts relative success of esop companies. some publishers of measures of culture keep a databank against which esop companies may be compared, and the unique elements of an ownership culture highlighted. in the absence of quantitative measures, discussions of culture can hardly rise above speculation. managers want to know what specific values, beliefs, norms, and behaviors they can count on to improve adaptability and ultimately, firm performance. and scholars are hard pressed to illuminate the connection between culture and firm performance without a reliable and valid measure thereof. another important avenue of research would be to examine the ways in which an esop is capable of coping with certain dilemmas related to the management of human resources. coff, for example (1997, 1999) identifies the persistent threat of turnover, as well as three types of information dilemmas: (1) lack of relevant hiring information results in workers who do not fit the job (adverse selection), (2) motivation and moral hazard (i.e., an employee who shirks), or (3) ineffective management decision making (bounded rationality). information dilemmas arise from two sources: the first source creating these information dilemmas is social complexity, which is a potential shortcoming of team production, where individual contributions are unobservable, and so increases the risk of shirking. the second source is causal ambiguity, that is, the difficulty of identifying those factors that contribute to an organization’s performance. the fundamental question here is to what extent does an esop encompass the coping strategies proposed by coff (retention, rent sharing, organizational design, and information strategies)? one shortcoming of firm level research has been to make comparisons between companies matched according to size. as an analytical strategy, matching works only when the objects matched are identical in every respect, not just the 168 journal of business strategies matching variable. to see why this is so, imagine two companies, one with an esop, the other without. suppose company e pursues a low-cost strategy in an industry with intense competition, while company c pursues a differentiation strategy in an industry with moderate competition (porter, 1980). matching by size does not account for performance differences owing to strategy, the intensity of competition, and the multitude of other variables.12 individual level. at the individual and group levels of analysis, theory and empirical evidence have barely cracked the lid on the black box concealing the inner workings of an esop company. in general, existing research has focused on attitudes and motivation—interesting, but not enough to lift the lid. to better understand what goes on at the individual level, we would like to know to what extent, if any, do individuals in esop firms differ from non-esop firms on such variables as organizational commitment, organizational identification, self-efficacy, risk preference, openness to experience, locus of control, or self-monitoring? if there are differences, do they account for differences in firm performance? shared risk as a management concept is novel. we have not developed it here due to space considerations. yet the notion that employees respond to the knowledge of a shared fate has been around for a long time (melville, 1851, 1981; mill, 1871, 1998). accordingly, it requires further theoretical development and empirical testing, especially the creation of operational measures. a good first step would be an ethnographic study across a variety of employee-owned and conventionally-owned firms. from people’s stories, researchers could then develop a measure of individual-level risk perceptions and firm-level risk perceptions. example: “my wealth is at risk here.” “this is a risky place to work for all of us.” although the rosen and rogers’ (2011) example is convincing, it is based on a binary assumption: motivated vs. not motivated. investigators might instead adopt the view that level of motivation is continuous rather than categorical and explore how level of motivation interacts with level of fatigue. it would be worth exploring the relation between worker output and degree of motivation. output might vary proportionately. so questions like “how does level of motivation affect felt fatigue, and response to that fatigue?” might be appropriate. managerial implications. because the causal mechanism is not well understood (coff, 1997), esops are risky and forming an esop remains a major strategic decision. it is the exceptional manager who is willing to depart from tried-and-true ownership structures. the initial costs of creating an esop represent a major invest 12see cook and campbell (1979) and shadish, cook, and campbell (2002) for a discussion of the dangers in using matching in quasi-experimental research. 169 journal of business strategies ment for a small company and creation absorbs much management time and energy dealing with setting up the necessary legal, accounting, administrative and human resource processes. third, ongoing maintenance requires continual investments of time and energy. perhaps most importantly, though, is the challenge of managing an entity for which there is not much historical experience on which to draw—managers of esops are still something of pioneers. scholars can help by peering into the black box, as we have attempted to do here. the adventurous manager can, however, rely on past experiences of successful managers by adopting these and other practices: • describe and measure existing culture and track changes over time • engage employees early in the process of planning to adopt an esop • invest in training, especially open book management, problem solving, conflict resolution and decision-making • make the financial rewards meaningful • have a plan for employees who do not care to participate • encourage information-sharing and create a mechanism for doing so, such as an internal wiki further research. we have discussed the processes by which an ownership culture can help an esop firm respond more quickly to strategic opportunities and threats. yet, the effects of employee ownership are not limited to employees’ perceptions, attitudes, and behaviors, or to culture; it is logical to expect that its effects pervade all aspects of an organization’s functioning. a promising avenue of research is to explore the effect employee ownership might have on an organization’s structure, or the problem of allocating resources among internal stakeholders. there are many questions to answer, for instance: how does employee ownership affect the ways a firm manages its workflow, budgeting, human resource management, marketing, and finance functions? as we have said, much is known about employee ownership, but there is much more to be learned. summary and conclusion our purpose here has been to offer an explanation of why esop firms tend to perform, on average, better than conventionally-owned firms, and why some employee-owned firms tend to perform better than others. we conclude that employee ownership has the potential to enhance competitive capability and possibly make it sustainable by increasing the flexibility of the workforce in responding to environmental threats and opportunities quickly and cheaply, but requires proper management. 170 journal of business strategies empirical evidence indicates that an esop alone is not a sufficient condition for superior performance, but must be combined with participatory management. the common explanation, that increased motivation of employees is responsible for esop performance, is not sufficient because aggregate motivation is not a significant factor at the level of the firm. instead, a more convincing explanation points to the process through which increased strategic flexibility occurs in an ownership culture. strategic flexibility emerges from two conditions: shared risk combined with widespread perception of esop success as a group goal. this means that an employee perceives that the attainment of her individual goal is dependent upon every one attaining their goals, and that achieving firm success will provide psychic rewards in addition to material rewards. the two must occur together; neither condition is sufficient alone. when the two conditions are present they lead to cooperative behavior, efficiency, and strategic flexibility. when the common goal is achieved (higher stock price), individuals experience satisfaction of lower-order needs (wealth) and higher order needs (growth, esteem, self-actualization). to answer our two questions we stipulated a framework that meets three criteria: it must be consistent with empirical observations, account for ownership phenomena at two levels of analysis and the interaction(s) between those levels, and be empirically testable. we have met those criteria: (1) the difficulty of creating an ownership culture accounts for the varied performance of esops companies; and the necessity of combining financial rewards with group aspirations accounts for the superior performance of esops over conventionally-owned companies. (2) individual motivation is a necessary but not a sufficient condition for firm performance while shared purpose is also a necessary but insufficient condition. further, it is necessary to combine the two. (3) with sufficient resources to measure individual-level perceptions and attitudes and match them with measures of firm performance, it is possible to test empirically our claims. references al-saigh, n. m. and buera, a. m. (1990). privatization in the arab world: prerequisites for success. international review of administrative sciences, 56, 125-135. alderfer, c. p. (1972). existence, relatedness, and growth: human needs in organizational settings. new york: free press. aldrich, h. e. (1999). organizations evolving. thousand oaks, ca: sage publications. 171 journal of business strategies alperovitz, g. (1997). the old socialist idea and the new century. peace review, 9, 41-48. barney, j.b. (1991). firm resources and sustained competitive advantage, journal of management, 17(1): 99-120. bell, l. and kruse, d. (1995). evaluating esops, profit sharing and gain sharing plans in u.s. industries; a report to the u. s. department of labor, washington, d.c.: u.s. department of labor. ben-ner, a. (1988). the life cycle of worker-owned firms in market economies: a theoretical analysis. journal of economic behavior and organization, 10: 287313. ben-ner, a. and jones, d. c. (1995). employee participation, ownership, and productivity: a theoretical framework. industrial relations, 34, 532-54. berle, a.a. and means, g.c. (1932). the modern corporation and private property, harcourt, brace and world, new york 1967. blasi, j. r. (1988). employee ownership: revolution or ripoff? cambridge, ma: ballinger publishing company. blasi, j., conte, m. and kruse, d. (1992). the new owners: stock price performance for public companies with significant employee ownership. journal of employee ownership law and finance, 4: 95-130. blasi, j. r. and kruse, d. l. (1991). the new owners: the mass emergence of employee ownership in public companies and what it means for american business. harperbusiness. blinder, a. s. (1990). introduction. in blinder, a. s. (ed.) paying for productivity: a look at the evidence. washington, d. c.: the brookings institution. bloom, n., kretchmer, t., and van reenen, j. (2011). are family friendly workplace practices a valuable firm resource? strategic management journal, 32: 343-367. bloom, s. m. (1985). employee ownership and firm performance. unpublished doctoral dissertation, department of economics, harvard university. bonin, j. p., jones, d. c. and putterman, l. (1993) theoretical and empirical studies of producer cooperatives: with the twain ever meet? journal of economic literature, 31: 1290-1320. bradley, k. (1986). employee-ownership and economic decline in western industrial democracies. journal of management studies, 23, 51-71. brohawn, d. k. (1997). journey to an ownership culture: insights from the esop community. washington, d. c.: the esop association and scarecrow press, lanham md & london. 172 journal of business strategies buchko, a. a. (1992). effects of employee ownership on employee attitudes: a test of three theoretical perspectives. work and occupations, 19, 59-78. buchko, a. a. (1993). the effects of employee ownership on employee attitudes: an integrated causal model and path analysis. journal of management studies, 30, 633-657. carberry, e. j. (2011). employee ownership and shared capitalism. urbana-champaign, il: university of illinois at urbana-champaign, school of labor and employment relations. case. j. (1995). openbook management. new york: harpercollins publishers. chaplinsky, s. and niehaus, g. (1990). the tax and distributional effects of leveraged esops. financial management (spring). 29-38. chiu, w. c. k. (2003). employee stock ownership plans and organizational integration among workers in the people’s republic of china. human resource management review, 13, 407-421. coff, r. w. (1997). human assets and management dilemmas: coping with hazards on the road to resource-based theory. academy of management review, 22, 374402. coff, r. w. (1999). when competitive advantage doesn’t lead to performance: the resource-based view and stakeholder bargaining power. organizational science, 10, 119-133. conte, m. a., blasi, j. kruse, d., and jampani, r. (1996). financial returns of public esop companies: investor effects vs. manager effects. financial analysts journal, july/august, 51-61. conte, m. a. & svejnar, j. (1990). employee ownership plans. in blinder, a. s. (ed.) paying for productivity: a look at the evidence. washington, d. c.: the brookings institution. cook, t. d., and campbell, d. t. (1979). quasi-experimentation: design & analysis issues for field settings. boston: houghton mifflin company. cooke, r. a., & lafferty, j. c. (1987). level v: organizational culture inventory. plymouth, mi: human synergistics. danserau, f. and cho, j. (2006). avoiding the “fallacy of the wrong level.” group and organization management, 31, 536-577. doucouliagos, c. (1990). why capitalist firms outnumber labor-managed firms. review of radical political economics, 22: 44-67. doucouliagos, c. (1995). institutional bias, risk, and workers’ risk aversion. journal of economic issues, 29: 1097-1118. 173 journal of business strategies dugger, w. m. (1987). democratic economic planning and worker ownership. journal of economic issues, 21, 87-99. dunbar, a. e. and kumbhakar, s. c. (1992). an empirical investigation of the association of productivity with employee stock ownership plans. journal of the american taxation association. 22-39. ellerman, d. p. (1984). theory of legal structure: worker cooperatives. journal of economic issues, 18: 861-891. fama, e. f. and jensen, m. c. (1983). separation of ownership and control. journal of law and economics, 26: 301-325. fitzroy, f. r., and kraft, k. (1987). cooperation, productivity, and profit sharing. quarterly journal of economics, 102: 23-35. freeman, s. f. (2007). effects of esop adoption and employee ownership: thirty years of research and experience. university of pennsylvania organizational dynamics working paper #07-01. french, j. l., and rosenstein, j. (1984). employee ownership, work attitudes, and power relationships, academy of management journal, 27: 861-869. gao (general accounting office). (1986). employee stock ownership plans: benefits and costs of esop tax incentives for broadening stock ownership. gaopemd-87-8. washington, dc: u. s. government printing office. gates, j. (1998). the ownership solution: toward a shared capitalism for the twenty-first century. reading, ma: addison-wesley. gibson-graham, j. k. (2003). enabling ethical economies: cooperativism and class. critical sociology, 29, 123-161. goldstein, s. g. (1978). employee share ownership and motivation. journal of industrial relations, 20: 311-330. greenberg, e. s. (1980). participation in industrial decision-making and worker satisfaction: the case of producer cooperatives. social science quarterly, 60: 551-569. gunn, c. (2000). markets against economic democracy. review of radical political economics, 32, 448-460. hammer, t. h., landau, j. c., and stern, r. n. (1981). absenteeism when workers have a voice: the case of employee ownership. journal of applied psychology, 66: 561-573. hammer, t., and stern, r. (1980). employee ownership: implications for the organizational distribution of power. academy of management journal, 23: 78-100. 174 journal of business strategies hammer, t., stern, r,. and gurdon, r. (1982). worker ownership and attitudes toward participation. in f. lindenfeld and j. rothschild-whitt (eds.) workplace democracy and social change. boston: porter sargent publishers. hansmann, h. b. (1990). when does worker ownership work?: esops, law firms, codetermination, and economic democracy. the yale law journal, 99: 17491816. herzberg, f. (1968). one more time: how do you motivate employees? harvard business review (january-february) p. 56ff. howe, c. (1986). the politics of class compromise in an international context: considerations for a new strategy for labor. review of radical political economics, 18 1-22. jensen, m. c. & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3, 305360. keef, s. p. (1994). employee share ownership and job attitudes: the effects of share sale. asia pacific journal of management, 11: 91-102. klein, k. (1987). employee stock ownership and employee attitudes: a test of three models. journal of applied psychology, 72: 319-332. klein, k. j. and hall, r. j. (1988). correlates of employee satisfaction with stock ownership: who likes an esop most? journal of applied psychology, 73: 630638. kotter, j. p. and heskett, j. l. (1992). corporate culture and performance. new york: the free press. kozlowski, s. w. j. and klein, k. j. (2000). a multilevel approach to theory and research in organizations. in kozlowski, s. w. j. and klein, k. j. (eds.) multilevel theory, research, and methods in organizations. san francisco: jossey-bass. kruse, d. (1984). employee ownership and employee attitudes: two case studies. norwood, pa: norwood editions. kruse, d. (1988). essays on profit sharing and unemployment. unpublished doctoral dissertation, department of economics, harvard university. kruse, d. (1992). profit sharing and productivity: microeconomic evidence from the united states. economic journal, 102: 24-36. kruse, d. (1993). profit sharing: does it make a difference? kalamazoo, mi: w. e. upjohn institute for employment research. 175 journal of business strategies kruse, d. l. and blasi, j. r. (1997). employee ownership, employee attitudes, and firm performance: a review of the evidence. in handbook of human resource management. mitchell, d. j. b., lewin, d. and zaidi, m. (eds.) greenwich, ct: jai press. kruse, d., freeman, r. and blasi, j. (2010). shared capitalism at work: employee ownership, profit and gain sharing, and broad based stock options. chicago: university of chicago press. kumbhakar, s. c. and dunbar, a. e. (1993). the elusive esopproductivity link. journal of public economics, 52, 273-283. lawler, e. (1995). the new pay: a strategic approach, compensation and benefits review, 27, 14-22. lawler, e. e. (1994). motivation in work organizations. san francisco: josseybass. long, r. j. (1978a). the effects of employee ownership on organizational identification, employee job attitudes, and organizational performance: a tentative framework and empirical findings. human relations, 31: 29-48. long, r. j. (1978b). the relative effects of share ownership vs. control on job attitudes in an employee-owned company. human relations, 31: 753-763. long, r. j. (1979). desires for and patterns of worker participation in decision making after conversion to employee ownership. academy of management journal, 22: 611-617. long, r. j. (1980). job attitudes and organizational performance under employee ownership. academy of management journal, 23: 726-737 long, r. j. (1981). the effects of formal employee participation in ownership and decision making on perceived and desired patterns of organizational influence: a longitudinal study. human relations, 10: 847-876 long, r. j. (1982). worker ownership and job attitudes: a field study. industrial relations, 21: 196-215. mackin, c., freundlich, f., rodgers, l., and kerr, c. (2012). ownership culture survey. oakland, ca: national center for employee ownership. maslow, a. h. (1943). a theory of human motivation. psychological review, (july) 370-396. mcclelland, d. (1985). human motivation. new york: scott foresman. melville, h. (1851, 1981). moby-dick, or, the whale. berkeley: university of california press. mill, j. s. (1871, 1998). principles of political economy. new york: oxford press. 176 journal of business strategies miller, d. e. 2003 mill’s ‘socialism.’ politics, philosophy and economics, 2, 231238. mitchell, d. j. b., lewin d. & lawler, e. e. (1990). alternative pay systems, firm performance and productivity. in a. s. blinder (ed.) paying for productivity: a look at the evidence. washington, d. c. brookings institution. mygind, n. and rock, c. p. (1993). financial participation and the democratization of work. economic and industrial democracy, 14, 163-183. (nceo) national center for employee ownership (2008). employee ownership report, 28: 5. oliver, n. (1984). an examination of organizational commitment in six workers’ cooperatives in scotland. human relations, 37: 29-46. oliver, n. (1990). work rewards, work values, and organizational commitment in an employee-owned firm: evidence from the u.k. human relations, 43: 513-526. park, s,. and song, m. h. (1995). employee stock ownership plans, firm performance, and monitoring by outside blockholders. financial management, 24: 52-65. penrose, e. t. (1959). the theory of the growth of the firm. oxford: basil blackwell. pierce, j. l. and rogers, l. (2003). the psychology of ownership and worker-owner productivity. group organization management, 29: 588-613. pierce, j. l., kostova, t., and dirks, k. t. (2001). toward a theory of psychological ownership in organizations. academy of management review, 26: 298-310. pierce, j. l., rubenfeld, s. a., and morgan, s. (1991). employee ownership: a conceptual model of process and effects. academy of management review, 16: 121144. porter, m. (1980). competitive strategy. new york: the free press. quarrey, m. blasi, j. and rosen, c. (1986). taking stock: employee ownership at work. cambridge, ma: ballinger publishing company. rhodes, s. r. and steers, r. m. (1981). conventional vs. worker-owned organizations. human relations, 34: 1013-1035. rooney, p. (1992). employee ownership and worker participation: effects on health and safety. economic letters, 39: 323-328. rosen, c. and carberry, e. (2003). ownership management: building a culture of lasting innovation. oakland, ca: the national center for employee ownership. rosen, c. and quarrey, m. (1987). how well is employee ownership working? harvard business review, sept/oct, 126-129. 177 journal of business strategies rosen, c. and rodgers, l. (2007). the ownership edge: how employee ownership can make good companies great. oakland, ca: the national center for employee ownership. rosen, c. and rodgers, l. (2011). fundamentals of ownership culture: practical ideas for creating a great ownership company. oakland, ca: national center for employee ownership. rosen, c. and young, k. (1991). understanding employee ownership. ithaca: ilrr press. rosen, c. m., klein, k. j., and young, k. m. (1986). employee ownership in america; the equity solution. lexington, ma: lexington books. rosen, c., case, j. and staubus, m. (2005). equity: why employee ownership is good for business. boston: harvard business school press. rousseau, d. m. (1985). issues of level in organizational research: multi-level and cross-level perspectives. research in organizational behavior, 7, 1-37. rousseau, d. m. and shperling, z. (2003). pieces of the action: ownership and the changing employment relationship. academy of management review 28, 553570. rumelt, r. p., schendel, d. and teece, d. j. (1991). strategic management and economics. strategic management journal, 12: 5-29. russell, r., hochner, a. and perry, s. e. (1979). participation, influence and workerownership. industrial relations, 18: 330-341. schein, e. h. (1985). organizational culture and leadership: a dynamic view. san francisco: jossey-bass, inc. scholes, m. s., and wolfson, m. a. (1990). employee stock ownership plans and corporate restructuring: myths and realities. financial management, 19, 12-28. scott, w. r. (2008). institutions and organizations: ideas and interests. los angeles: sage publications. shadish, w. r., cook, t. d., and campbell, d. t. (2002). experimental and quasiexperimental designs for generalized causal inference. boston: houghton mifflin company. smiley, r. w., gilbert, r. j., binns, d. m., ludwig, r. l., and rosen, c. m. (2007). employee stock ownership plans: esop planning, financing, implementation, law and taxation. san diego. beyster institute at the rady school of management, university of california at san diego. sockell, d. (1985). attitudes, behavior, and employee ownership, some preliminary data. industrial relations, 24:130-138. 178 journal of business strategies stack, j. (1994). the great game of business. new york: crown publishing group. steinherr, a. (1978). the labor-managed economy: a survey of the economics literature. annals of public and co-operative economy, 24, 129-148. toscano, d. j. (1983). toward a typology of employee ownership. human relations, 7, 581-602. tucker, j., nock, s. l., and toscano, d. (1989). employee ownership and perceptions of work. work and occupations, 16: 26-42. u. s. general accounting office. (1986). employee stock ownership plans: benefits and costs of esop tax incentives for broadening stock ownership. gaopemd-87-8. washington, dc: u. s. government printing office. van der dennen, j. m. g. (2005). peace review: a journal of social justice, 17, 81-89. vanek, j. (1976). uncertainty and the investment decision under labor-management and their social efficiency implications. in collected essays on self-management, ithaca, ny: cornell university press. vroom, v. h. (1964). work and motivation. new york: john wiley & sons. whyte, w. f. and blasi, j. r. (1982). worker ownership, participation and control: a theoretical model. policy sciences, 14: 137-163. whyte, w. f. and blasi, j. r. (1984). employee ownership and the future of unions. annals of the american association of political and social science, 473: 128140. young, k. m., rosen, c., and carberry, e. j. (1995). theory o: creating an ownership style of management. oakland, ca: the national center for employee ownership. biographical sketch of authors peter thompson is an assistant clinical professor in the college of business administration at the university of illinois at chicago. prior to his academic career, he spent 12 years in the banking industry, including the northern trust, and the capital markets group at the first national bank of chicago, now j. p. morgan chase. he holds degrees from temple university, northwestern university, and the university of illinois at chicago. mark shanley is a professor of management and associate dean at the college of business administration of the university of illinois at chicago. he received his ph.d. from the university of pennsylvania and has taught at the university of 179 journal of business strategies chicago, northwestern university, and purdue university. he is a member of the editorial board for strategic management journal. his research interests include strategic groups, mergers and acquisitions, strategic alliances, and healthcare strategy. abagail mcwilliams is professor of strategic management at the university of illinois-chicago. she earned a bs in business and an ma and phd in economics from the ohio state university. her research interests include corporate social responsibility, methodology, strategic management and strategic human resource management. she has published extensively in leading management journals over the last 25 years and is co-editor of the oxford handbook of corporate social responsibility, 2008. psychological types, decision styles, and ethical decision-making kenneth e. bass frederic j. hebert east carolina university greenville, north carolina introduction concern over ethical behavior of managers of organizations has increased in recent years. this concern has been intensified recently by reports of unethical acts that include widely publicized abuses in the savings and loan industry collapse and managers' treatment of employees in organizational downsizing. clearly, managers are confronted daily with decisions involving ill-defined ethical issues that have serious implications for an organization's future. managerial decision-making processes in such situations are complex and not well understood by managers or organizational researchers (waters, bird and chant 1986). a number of models have appeared in the business ethics literature recently which were intended to explain individuals' ethical decision-making. these models, such as those presented by hunt and vitell (1986), dubinsky and loken (1989) and jones (1991) propose consistent relationships between (1) individual differences and ethical judgments, (2) between ethical judgments and ethical behavioral intentions, and (3) between behavioral intentions and actual decision-making behavior. ethical judgments is the degree to which an individual considers a particular behavior to be ethical. behavioral intentions is a person's belief that shelhe will perform a specific action (dubinsky and loken 1989). behavioral intentions is an important intervening variable that links ethical judgments with actual behavior. jungian psychological types and preferred decision styles provide a well-documented method of assessing individual differences. these individual differences have been proposed as factors which may affect ethical judgments and ethical decisionmaking behavior (fleming 1985; herden and lyles 1981; kroeger and thuesen 1992). decision styles refer to different ways in which individuals process information and make decisions. these decision styles are based on jung's (1971) psychological types of sensing/intuition and thinking/feeling. the overall purpose of this study was to determine whether or not individual differences based on the jungian psychological types and associated decision styles influence ethical judgments regarding issues common to business organizations. additionally, we evaluated the linkage between ethical judgments and ethical behavioral intentions. the business ethics issues are presented in six short scenarios and represent a variety of business situations. it was expected that ethical judgments of the business scenarios would be associated with differences in the respondents' functions of thinking and feeling as well as differences in decision styles. ethical behavioral intentions were expected to be positively related to ethical judgments. 80 journal ofbusiness strategies vol. 10, no.2 the next section describes the relevant concepts associated with jungian personality theory. a brief review of the pertinent literature and the rationale for the proposed relationships between the constructs are presented. we then discuss the research methodology and present the findings of the study. finally, implications for management practice and further research are discussed. literature review and theoretical rationale a significant amount of research has been directed recently toward explaining and predicting managers' ethical decision processes in organizations. these processes are likely to be affected by many individual differences factors as well as situational factors (hunt and vitell 1986; trevino 1986; wortruba 1990). a number of researchers have shown that individual differences are important antecedents to ethical decisionmaking (e.g., hegarty and sims 1978; 1979). in addition, several explanatory models have emphasized the importance of personality variables in explaining ethical behavior. jungian psychological types and decision styles are among psychological constructs which may affect the ethical decision-making process (fleming 1985; herden and lyles 1981; kroeger and thuesen 1992). psychological types the jungian theory of psychological type (jung 1971) provides a useful framework for studying individual differences in managerial decision-making. two psychological dimensions of particular importance are the ways that individuals acquire information and the ways that they make decisions about the information that has been acquired (ruble and cosier 1990). jung refers to these dimensions respectively as "perception" and "judgment." perception is represented by two contrasting psychological types of sensing (s) and intuition (n). judgment is represented by two opposing psychological types of thinking (t) and feeling (f). jung believed that individuals develop a preference for either s or n and either t or f. the s psychological type individual prefers to acquire information that is factual, precise, concrete, and practical-hard data that deal in specifics. the n psychological type individual prefers to receive information by looking at the whole of a situation and focusing on the overall meaning. the t psychological type individual uses a logical, analytical process to make rational judgments or decisions and tends to be impersonal. the f psychological type individual prefers to make judgments based on personal and subjective values (ginn and sexton 1990). since sin refers to information acquisition and tif describes different approaches to making judgments or decisions, the tif dimension appears to be particularly relevant to the analysis of judgments about business situations. once data have been perceived, individuals next make judgments or decisions. first we examine how t individuals prefer to make judgments or decisions and then we describe the preferences of f individuals. fall 1993 bass and hebert: psychological types, decision styles 81 t individuals prefer to make judgments or decisions based on a logical, rational set of principles. these persons tend to make decisions in an impersonal, value-free, and objective fashion, stressing rational economic business objectives. the thinking individual uses formal methods of reasoning, logic, models, rules, and principles in making decisions (fleming 1985; nutt 1986). in contrast, f individuals prefer to make judgments based on personal and subjective values. the feeling type process produces humanistic and value-laden judgments (fleming 1985). feeling involves consideration of decisions in personal terms the personal stakes of individuals and groups who will be affected by a decision. the feeling individual assesses the values involved for each alternative, how people will react, and whether the likely results will enhance the outcomes for individuals or groups (fleming 1985; nutt 1986). based on the different decision criteria of the two psychological types of thinking and feeling, it seems reasonable that these individuals would differ in their judgments of unethical situations. therefore, the following hypothesis is proposed: h1: significant differences in ethical judgments will exist between groups of individuals based on their tif orientation. decision styles one of the recent uses of the jungian psychological typology in the business world is in the assessment of decision-making behavior (murray 1990). the term "decision styles" has been used to refer to individual differences in the way that people process information and make decisions. ruble and cosier (1990) noted that only two of the jungian psychological dimensions, perception and judgment, are used in research on cognitive style. individuals combine their dominant perceiving and judging functions, thus determining a relatively permanent decision style. the possible decision styles are st (sensing-thinking), nt (intuition-thinking), sf (sensing-feeling) and nf (intuitionfeeling) (frisbie 1988). a number of researchers have discussed attributes of various decision styles (e.g., davis, grove and knowles 1990; hoy and hellriegel 1982; mitroff and kilmann 1975; nutt 1986; 1990). the st individual is a systematic, impersonal decision maker, concentrating on specifics and factual details which can be verified. practical, matter-offact decisions are made primarily through an impersonal evaluation of hard data. individuals serve the goals of the organization. the nt decision-maker also approaches problems with impersonal analysis, but focuses broadly on many alternative solutions to problems. a broad range of hypothetical possibilities originate in the intuitive mind of the decision-maker. decisions are then made in a formal, impersonal, and valuefree manner, directed toward the corporate good. the sf decision maker focuses on factual details and analysis of data, while interacting with others and showing consideration for them. information is processed through feeling, using value-laden personal judgments. problems are solved primarily through examining values and considering stakeholders in decisions. the nf decision maker perceives problems in a gestalt manner and recognizes many possible solutions. this type of individual focuses on 82 journal ofbusiness strategies vol. 10, no.2 idealistic general concepts. humanistic and value-laden decisions result from the feeling-type processing. a number of studies have linked decision styles with management variables. for instance, kilmann and thomas (1975) found that individuals with different decision styles prefer different ways of managing conflict. mitroff and kilmann (1975) and kilmann and mitroff (1976) found that preferences for different types of organizations vary with different decision styles. also, schweiger and jago (1982) investigated the relationship between decision styles and preferences for autocratic and participative management styles. several researchers have suggested that differences in individuals' preferred decision styles may be related to differences in preferred ethical decision criteria (e.g., fleming 1985; kroeger and thuesen 1992). fleming (1985) offered a framework of underlying decision criteria which were classified according to individuals' preferred decision styles. the framework proposes that individuals within each of the decision style categories will use different sets of criteria when analyzing ethical situations and making decisions. as an example of differences among the sets of criteria, fleming suggested that st individuals would refer to laws, rules, or codes of ethics when considering decision alternatives. individuals who prefer the nf style, with their realistic approach to problems and emphasis on interpersonal relationships, would adopt humanistic and value-laden processes in arriving at ethical judgments and decisions. fleming's propositions make an important contribution to the ethics literature. he contends that individuals with different decision style preferences would view ethical situations differently. though this proposition offers a valuable addition to the ethics literature, fleming offered no empirical support for his ideas. therefore, the following hypothesis is posited: h2: significant differences in ethical judgments will exist among groups of individuals with different preferred decision styles. ethical judgments and ethical behavioral intentions the theory of reasoned action (ajzen and fishbein 1980); (fishbein and ajzen 1975) suggests that attitudes toward a behavior are followed by intentions, which, in tum, may be followed by actual behavior. utilizing this conceptual base, dubinsky and loken (1989) and hunt and vitell (1986) proposed models of ethical behavior which suggest that individuals form ethical judgments in decision situations which have an ethical component, and that these ethical judgments are followed by ethical behavioral intentions prior to actual behavior. thus, ethical behavioral intentions may be an important link in the ethical decision-making process. ethical behavioral intentions are hypothesized to be related to ethical judgments in the following manner: h3: ethical judgments will be positively related to ethical behavioral intentions. fall 1993 bass and hebert: psychological types, decision styles 83 model of the hypothesized relationships a model of the hypothesized relationships is presented in figure 1. hypotheses one and two deal with linkages between individual differences (psychological types and decision styles) and ethical judgments, while hypothesis three is concerned with linkages between ethical judgments and ethical behavioral intentions. the final linkage shown in figure 1 (intentions-behavior) was not empirically tested in this research, but was inferred from the theory of reasoned action (fishbein and ajzen 1975). figure 1: model of hypothesized linkages individual differences ethical judgments ~ ethical decision behavioral ~ making intentions behavior methodology subjects participants in this study were students enrolled in npper level management courses in a medium-sized mid-atlantic university. participation was voluntary, and because of the nature of the study, students were assured that their responses were confidential and anonymous. respondents ranged in age from 19 to 40 years, with a mean age of approximately 22 years. of the 128 respondents, 37.5 percent were female and 62.5 percent were male. approximately 65 percent of the respondents were seniors, while about 35 percent were juniors. a majority of the respondents were business majors (62 percent). measures myers-briggs type indicator. individuals' psychological types and preferred decision styles were measured through administration of the myers-briggs type indicator, form g (mbti) (myers and myers 1987). the mbti is a forced-choice, self reporting personality assessment instrument which is based on jungian personality type theory. this instrument is used to measure the basic preferences of individuals regarding their psychological types and preferred decision-making styles. the mbti has been widely used in research and applied settings (ruble and cosier 1990). carlson (1985), in a review of psychometric studies, reported reasonable estimates of validity for the mbti. questionnaire. the other measures and ethical scenarios utilized in this research were presented in a two-part questionnaire. the first section presented six ethical scenarios, the multidimensional ethics scale (reidenbach, robin and dawson 1991), and a behavioral intentions melsure. the second section gathered classification data and provided a place for participants to record their psycholog;cal types as determined by the mbti instrument. 84 journal ofbusiness strategies vol. 10, no.2 ethical scenarios. this study utilized ethical scenarios to investigate the patterns of respondents' ethical judgments and ethical behavioral intentions in a number of business situations. scenarios have been an important tool for research regarding business ethics (weber 1992). for instance, fritzsche and becker (1983) and weber (1990) used scenarios to evaluate ethical judgments. also, laczniak and inderrieden (1987) and stead, worrell, spalding and stead (1987) utilized scenarios in their investigations of ethical behavioral intentions. six scenarios were selected to provide a variety of different business situations while minimizing the validity problems associated with respondents' fatigue and boredom. four of the six scenarios were gathered from previous research (fritzsche and becker 1983). the other two scenarios were chosen by the authors to represent contemporary business issues relating to the environment and employee downsizing. these scenarios offer a considerable range of positions with respect to perceived unethicalness. a summary of the scenarios and sources from which they were obtained are presented in the appendix. ethical judgments. ethical judgments of respondents were assessed using the multidimensional ethics scale (mes) (reidenbach and robin 1988; 1990; reidenbach, robin and dawson 1991). participants' responses were recorded on a seven-point scale for each of the eight items of the mes. this semantic differential scale is anchored by bipolar adjectives. an ethical judgment score was derived by computing the mean across the eight items. the higher the score, the more unethical a scenario was judged to be. reidenbach and robin reported that item scores demonstrate a high degree of reliability with coefficient alphas ranging between 0.71 and 0.92, with an average reliability of 0.8. also, acceptable levels of convergent, divergent, and predictive validity were demonstrated. for this study, reliabilities for the mes ranged from 0.831 to 0.941. ethical behavioral intentions. following hunt and vitell (1986), ethical behavioral intentions was determined by asking individuals to read the scenarios and then to express the likelihood that they would perform the behavior. a seven-point semantic differential scale was utilized to assess behavioral intentions. the scale was anchored with "highly likely" and "highly unlikely." a high score indicated that the respondent would be highly unlikely to perform the particular behavior. procedure respondents completed the mbti in one class period. the questionnaire bearing the business scenarios, the mes, the behavioral intentions measure, and classification data was completed during the subsequent class period. differences among group mean responses of participants' psychological types and associated decision styles were evaluated using the analysis of variance technique (anova). the relationship between participants' ethical judgments and ethical behavioral intentions was evaluated by regression analysis. ~.... ~ table 1: descriptive statistics and pearson correlation matrix 1.0000 8.8047" 1.0000 .4029" .3409" 1.0000 .2643" .3386" .8225" 1.0000 .1715 .1645 .1854* .2586" 1.0000 .1003 .2851" .1272 .2893" .7794" 1.0000 .1649 .0790 .2901" .2470" .1128 .0217 1.0000 .0595 .0782 .1126 .1602 .1343 .1589 .6625" 1.0000 .0321 .0190 .2177' .2062' .0656 .0359 .1260 -.0269 1.0000 .1053 .2034' .1615 .2147' -.0587 .1179 .2097' .1737' .6837" 1.0000 -.0674 -.0470 .0004 .0945 -.0183 .0509 .0145 -.0040 .0969 .0699 1.0000 -.0620 -.0061 -.0290 .0434 .0882 .1764' .0575 .1285 .2715" .1680 .2438"1.0000 -.0105 -.0362 -.1433 -.2134' -.0129 .0417 -.0344 .1086 -.0711 .0192 -.0049 .0386 1.0000 tif = thinking/feeling psychological types ej = ethical judgments hi = behavioral intentions vari. means s.d. 1 ables 0.46 1.0000 1.27 .2125' 1.0000 2.05 .1373 .7839" 1.0000 1.50 .1949' .0153 -.0140 1.96 .0972 .0680 .145 1.32 .2520" .1477 .1486 1.78 .2497" .2133' .2994" 1.18 .2114' .2666" .2324" 1.54 .0739 .2879" .4377" 1.46 .2396" .0836 .0875 1.83 -.0212 .0498 .1228 1.21 -.0024 -.0338 .0165 1.40 -.0388 .0054 .0917 2.68 -.0894 .1275 .1341 0.58 -.1248 .0415 .1204 0.49 -.0631 -.1773' -.1754' b (t> c"l 1:;' g' ~ ~ ~ c., ~ ~ $:i ~ ~ g::t '~ g. ~ ~§.~ ~ "c., 16is141312111098765432 • p < .05 •• p < .01 1. tif 0.30 2. ej (1) 4.45 3. bi (1) 4.25 4. ej (2) 5.15 5. bi (2) 5.27 6. ej (3) 5.16 7. bi (3) 4.87 8. ej (4) 5.37 9. hi (4) 5.41 10. ej (5) 5.62 11. hi (5) 5.59 12. ej (6) 6.07 13. bi (6) 6.21 14. age 22.20 15. rank 2.63 16. major 1.38 00 vl 86 journal ofbusiness strategies vol. 10, no.2 results table 1 presents a correlation matrix of the variables included in the study. this table indicates a number of positive and negative correlations among the variables. these correlations are generally consistent with the a priori expectations. the results indicate a statistically significant correlation (p<.05) between the tif psychological type preferences and ethical judgments for the first five scenarios. the results also indicate a strong relationship (p<.01) between ethical judgments and ethical behavioral intentions. the respondents' tif orientation and preferred decision styles were determined using the mbti instrument. the t orientation was preferred by 69.8 percent with 30.2 percent preferring the f orientation. the distribution of preferred decision styles was: sts-50.8%, sfs-19.8%, nts-19.0%, and nfs-10.3%. a statistically significant difference was found between males and females for the t and f psychological types (chisquare value = 11.61, p<.oo1) and the associated decision style preferences (chi-square value = 13.50, p<.oo5). table 2 provides the mean scores and standard deviations of ethical judgments for all respondents and the mean scores of ethical judgments for the t and f psychological type groups. the higher the score, the more unethical the situation was judged to be. scenario six was viewed by the respondents as the most ljoethical business situation, while scenario one was seen as the least unethical situation. table 2: ethical judgments of scenarios scenario 1 2 3 4 5 6 overall mean 4.45 5.15 5.16 5.37 5.62 6.07 sd 1.27 1.50 1.32 1.18 1.46 1.21 t mean 4.26 4.96 4.97 5.21 5.41 6.08 f mean 4.85 5.60 5.6g 5.75 6.17 6.08 in five of the six scenarios, the mean scores for the t psychological type group were greater than the f psychological type group. this potentially inlportant finding indicates that the t psychological group viewed the potentially unethical situations less harshly than the f psychological type group. testing for hypothesized differences between the t and f psychological type groups for each scenario was performed using an anova model. the dependent variable was the ethical judgment score on the mes, and the independent variables were the t and f psychological type groups. the anova results for each scenario that were statistically significant are shown in table 3. all models proved significant at the 0.05 level except for scenario six. therefore, hypothesis one was generally supported by the results. fall 1993 bass and hebert: psychological types, decision styles 87 age, rank, and major were included in each of the models as control variables. none of these control variables were significant and t/f remained significant for the first five scenarios. table 3: statistically significant differences between t and f psychological types scenario 1 source df sum of squares mean square f stat. prob. f model 1 9.11 9.11 5.86 0.017* error 124 192.66 1.55 total 125 201.77 scenario 2 source df sum of squares mean square f stat. prob. f model 1 10.87 10.87 4.90 0.029* error 124 275.21 2.22 total 125 286.08 scenario 3 source df sum of squares mean square f stat. prob. f model 1 13.43 13.43 8.41 0.004** error 124 198.08 1.60 total 125 211.51 scenario 4 source df sum of squares mean square f stat. prob. f model 1 7.76 7.76 5.76 0.018* error 124 165.83 1.35 total 125 173.59 scenario 5 source df sum of squares mean square f stat. prob. f model 1 15.24 15.24 7.55 0.007** error 124 250.27 2.02 total 125 265.51 * p < .05 ** p < .01 anoya models were also utilized to test for differences in ethical judgments among the four decision style groups. the anoya results for the two scenarios that 88 journal ofbusiness strategies vol. 10, no.2 were statistically significant and the accompanying probabilities are presented in table 4. the mes values served as the dependent variables and the independent variables were the four decision styles. differences between the decision style groups were significant at the 0.05 level for scenario 2 (p=.024) and scenario 3 (p=.026). these results offer limited support for hypothesis two. additionally, tukey multiple comparison tests were performed to identify significant differences among the various pairs of decision style groups. this test was performed as an additional technique to further evaluate hypothesis two. a statistically significant difference was found (p<.05) between the sf (mean: 5.72) and nt (mean=4.73) decision styles for scenario 3. no significant differences were found among the various pairs of decision style groups for scenario 2. table 4: statistically significant differences between preferred decision styles scenario 2 sum of squares mean square 21.10 7.03 sum of squares mean square 15.38 5.13 source df between 3 groups within 122 groups total 125 source df between 3 groups within 122 groups total 125 '" p < .05 264.98 286.08 196.13 211.51 scenario 3 2.17 1.61 f stat. 3.24 f stat. 3.19 prob. f 0.025* prob. f 0.026* a regression model was used to evaluate the relationships between ethical judgments and ethical behavioral intentions. table 5 presents the results of the regression analysis. fall 1993 bass and hebert: psychological types, decision styles table 5: regression analysis: ethical judgments related to ethical behavioral intentions 89 independent variable ethical judgments scenario 1 scenario 2 scenario 3 scenario 4 scenario 5 scenario 6 *** p < .001 r-squared .6144 .6476 .6765 .6074 .4389 .4674 t-statistic 14.170*** 15.217*** 16.234*** 13.906*** 9.928*** 10.517*** the r-squared values ranged from 0.44 to 0.68 and all were significant at the 0.001 level. therefore, hypothesis three was supported. these findings indicate a strong relationship between ethical judgments and ethical behavioral intentions. conclusions and managerial implications this study utilized empirically tested constructs to determine if differences in individuals' psychological types and decision styles could partially explain individuals' differences in judgments of several potentially unethical business situations. the relationship between ethical judgments and ethical behavioral intentions was also examined. generally, the findings of this study supported the hypotheses. first, groups of individuals with a t psychological type differed significantly from those with an f psychological type regarding their judgments of unethical business situations in five of the six scenarios. it seems rational to believe that individuals who possess a t orientation, whose mode of judgment is logical, analytical, impersonal and focused on rationality, would judge unethical situations differently than those with a f orientation, who tend to be alogical and concerned with matters of ethics and justice. a potentially important addition to our understanding of business ethics is the finding that ts judged unethical business situations less harshly that those with an f orientation across five of the six scenarios. while other authors (e.g., fleming 1985; kroeger and thuesen 1992) have suggested a relationship between psychological type and ethical decision-making, this study expands the current knowledge by finding a directional relationship between psychological type and ethical judgment. therefore, the t/f orientation of individuals seems to be a potentially important explanatory variable in models of ethical decision making. second, since the four decision styles represent very different styles of data acquisition and decision processes (herden and lyles 1981), differences in ethical judgments among these groups were expected. statistically significant differences in ethical 90 j oumal ofbusiness strategies vol. 10, no.2 judgments among groups with different decision style preferences were found in scenario two and scenario three. one possible insight into this result may be gleaned from the degree of ethicalness of the issue presented in the scenario. for instance, differences in judgments among the groups for scenario number six, rated as the most unethical, did not approach statistical significance, while differences for the first five were either significant or approached significance at the 0.10 level thus, when a scenario is judged to be highly unethical, differences in decision styles may not be relevant. at the other extreme, individuals do not make ethical judgments in decision situations where no ethical dimensions are perceived (hunt and vitell 1986). third, a strong link was confirmed between ethical judgments and ethical behavioral intentions. this result is consistent with previous research which indicates behavioral intentions are preceded by ethical judgments and may be followed by behavior. implications for managers the results of this study have far-reaching implications for management practices. the finding that individuals with a t psychological type differ significantly from those with an f psychological type regarding ethical judgments is particularly important as the united states workforce becomes more diverse. much has been written about the current and projected changes in the u.s. workforce. as an organization's workforce becomes more diverse, management also needs to be aware of changes in the psychological type preferences of its members. if significant changes begin to develop in the psychological type preferences, these changes could have a significant impact on the organization's ethical decision-making. a particular concern is the potential change in ethical judgments and ethical behavior that new entrants into the workforce may bring as they assume managerial positions. as these individuals join the workforce and become managers, their differing psychological types may affect ethical decision-making in organizations. as minorities and people of other cultures enter the managerial ranks, differences in their psychological type preferences may affect ethical decision-making. another important issue is the increased reliance on teams and teamwork and their effect on ethical decision-making. teams comprised of various psychological types may experience conflict in making ethical decisions. kroeger and thuesen (1992) note that the tip psychological types represent the most significant source of conflict among team members. organizations should ensure that team members are prepared to effectively resolve these conflicts, which may stem from differences in psychological types. as suggested by fleming (1985), knowledge of differences in psychological types and preferred decision styles could be used effectively in management 'development programs relating to business ethics. based on this results of this study, differences in ethical judgments of various psychological types provide new insights to managers about how ethical decisions are made. these management development programs could provide information to managers about their own ethical decision-making criteria and could also enhance their awareness of the ethical judgments of other managers. this would fall 1993 bass and hebert: psychological types, decision styles 91 result in more effective evaluation of alternatives and possibly lead to improved organizational decision-making. how might organizations proceed to address the issues raised in this study? one recommendation is to determine the composition of psychological types and decision styles of an organization's managers and team members. this action can be accomplished by administering the mbti periodically to managers and team members. if these personality dimensions change significantly as the workforce becomes more diverse, organizations should consider offering ethics training to ensure compliance with ethical standards such as a code of ethics. a second suggestion is to ensure that managers and team members understand the ways that different psychological types and decision styles affect ethical decision-making. through increased understanding of different viewpoints, managers and team members can lessen the level of conflict and may actually improve the quality of their ethical decision-making. these issues could be addressed through an organization's management development programs. the findings of this study present important implications for managers to consider in ethical decision-making. however, the use of students as respondents may present a concern in interpretation of the findings. though the subjects in this study were adults and primarily business students, few of the students had actual business experience. while this approach is appropriate for exploratory purposes, caution should be used in interpreting the results. therefore, replication of this study with practicing managers would add greatly to the usefulness of the findings. references ajzen, i. and m. fishbein. 1980. understanding attitudes and predicting social behavior. englewood cliffs, new jersey: prentice-hall, inc. carlson, j.g. 1985. "recent assessments of the myers-briggs type indicator." journal of personality assessment 49: 356-365. davis, d.l., sj. grove, and p.a. knowles. 1990. "an experimental application of personality type as an analogue for decision-making style." psychological reports 66: 167-175. dubinsky, a.j. and b. loken. 1989. "analyzing ethical decision making in marketing." journal of business research 19 (2): 83-107. fishbein, m. and i. ajzen. 1975. belief, attitude, intentions and behavior: an introduction to theory and research. boston, ma: addison-wesley. fleming, j.e. 1985. "a suggested approach to linking decision styles with business ethics." journal of business ethics 4: 137-144. frisbie, g.r. 1988. "cognitive styles: an alternative to keirsey's temperaments." journal of psychological type 16: 13-21. 92 journal ofbusiness strategies vol. 10, no.2 fritzsche, dj. 1991. "a model of decision-making incorporating ethical values." journal of business ethics 10: 841-852. fritzsche, dj. and h. becker. 1983. "ethical behavior of marketing managers." journal of business ethics 2 (4): 291-299. ginn, e.w. and d.l. sexton. 1990. "a comparison of the personality type dimensions of the 1987 inc. 500 company founders/ceos with those of slower-growth firms." journal of business venturing 5 (5): 313-326. hegarty, w.h. and h.p. sims jr. 1978. "some determinants of unethical decision behavior: an experiment." journal of applied psychology 63 (4): 451-457. hegarty, w.r. and b.p. sims jr. 1979. "organizational philosophy, policies, and objectives related to unethical decision behavior: a laboratory experiment." journal of applied psychology 64 (3): 331-338. herden, r.p. and m.a. lyles. 1981. "individual attributes and the problem conceptualization process." human systems management 2: 275-284. hoy, f. and d. hellriegel. 1982. "the kilmann and herden model of organizational effectiveness criteria for small business managers." academy of management journal 25 (2): 308-322. hunt, s.d. and s. viteh. 1986. "a general theory of marketing ethics." journal of macromarketing 6 (spring): 5-16. jones, t.m. 1991. "ethical decision making by individuals in organizations: an issue-contingent model." academy of management review 16 (2): 366-395. jung, e.g. 1971. psychological types. (r. g. baynes, trans., r f. c. hull), princeton, nj: princeton university press. kiimann, rb. and li. mitroff. 1976. "qualitative versus quantitative analysis for management science: different forms for different psychological types." interfaces 6 (2): 17-27. kilmann, rh. and k.w. thomas. 1975. "interpersonal conflict-handling behavior as reflections of jungian personality dimensions." psychological reports 37: 971·980. kroeger, o. and j.m. thuesen. 1992. type talk at work. new york: delacorte press. laczniak, g.r and ej. inderrieden. 1987. "the influence of stated organizational concem upon ethical decision making." journal of business ethics 6: 297-307. mitroff, li. and rh. kilmann. 1975. "stories managers tell: a new tool for organizational problem solving." management review 64: 18-28. fall 1993 bass and hebert: psychological types, decision styles 93 murray, j.b. 1990. "review of research on the myers-briggs type indicator." perceptual and motor skills 70: 1187-1202. myers, p.b. and k.d. myers. 1987. myers-briggs type indicator form g. palo alto, ca: consulting psychologists press, inc. nutt, p.c. 1986. "decision style and strategic decisions of top executives. technological forecasting and social change." technological forecasting and social change 30: 39-62. nutt, p.c. 1990. "strategic i ~isions made by top executives and middle managers with data and process dominant styles. journal of management studies 27 (2): 173-194. reidenbach, r.e. and d.p. robin. 1988. "some initial steps toward improving the measurement of ethical evaluations of marketing activities." journal of business ethics 7 (11) 871879. reidenbach, r.e. and d.p. robin. 1990. "toward the development of a multidimensional ethics scale for improving evaluations of business ethics." journal of business ethics 9 (8): 639652. reidenbach, r.e., d.p. robin, and l. dawson. 1991. "an application and extension of a multidimensional ethics scale to selected retail practices and retailer groups." journal of the academy of marketing science 19 (2): 83-92. ruble, t.l. and r.a. cosier. 1990. "effects of cognitive styles and decision setting on performance." organizational behavior and human decision processes 46: 283-295. schweiger, d.m. and a.g. jago. 1982. "problem solving styles and participative decision making." psychological reports 50: 1311-1316. solomon, j. 1990. "learning to accept cultural diversity." wall street journal. (september 12): p. b1. stead, w.e., d.l. worrell, j.b. spalding, and j.g. stead. 1987. "unethical decisions: socially learned behaviors." journal of social behavior and personality 2 (1): 105-115. trevino, lk. 1986. "ethical decision making in organizations: a person-situation interactionist model." academy of management review 11 (3): 601-617. waters, j.a., f. bird, and p.d. chant. 1986. "everyday moral issues experienced by managers." journal of business ethics 5: 373-384. weber, james. 1990. "managers' moral reasoning: a<;sessing their responses to three moral dilemmas." human relations 43 (7): 687-702. weber, james. 1992. "scenarios in business ethics research: review, critical assessment, and recommendations." business ethics quarterly 2 (2): 137-160. 94 journal ofbusiness strategies vol. 10, no.2 wortruba, t.r. 1990. "a comprehensive framework for the analysis of ethical behavior, with a focus on sales organizations." journal of personal selling and sales management 10 (spring): 29-42. appendix scenarios after being barred from selling in a foreign market, a bicycle manufacturing company paid a foreign businessman $500,000 to smooth the way to sell bicycles in that country and net about $5 million annually. the president of an economically hard-hit timber company planned a major timber cut, but subsequently discovered that a rare bird species would be destroyed. the president ordered the timber cut. an employee revealed to a new employer critical product developments made by former employer. a flour milling company developed a new milling process which created more dust than emission control equipment could handle. the company ran the process on the third shift while pollution would not be detected. a personnel manager refused to prepare a plan to eliminate older managers and was fired. an auto parts contractor found that a transaxle tended to fail at 120% of rated capacity. specifications called for the part to carry 130 percent of capacity. the contractor did not reveal the test results to the car maker. * denotes scenarios chosen specifically for this study. source fritsche & becker 1983 * fritsche & becker 1983 fritsche & bekcker 1983 * fritsche & baker 1983 psychological types, decision styles, and ethical decision-making functional background and business strategy: the impacf of executive-strategy fit on performance john a. parnell middle tennessee state university murfreesboro, tennessee for the past several decades, business experts have sought to identify functional backgrounds and personal characteristics most suitable for successful business leadership (govindarajan 1989; gupta and govindarajan 1984; hambrick and mason 1984; miller, kets de vries and toulouse 1982; norbum 1989; and thomas, iitschert, and ramaswamy 1991). some have emphasized the strengths of a given functional background such as engineering or marketing. others have focused on the likelihood that managers with given functional backgrounds will rise to the level of top executive (dommermuth 1966 and kurtz, boone, and fleenor 1989). still others have emphasized tasks and activities associated with the top executive or top management team and how various responsibilities necessitate specific top management skills (hise and mcdaniel 1988; litchfield 1990; and murray 1989). during this same time, strategists sought to discover the "perfect strategy," or at least identify the characteristics of successful business strategies in isolation of the managers responsible for their formulation and implementation. typologies proposed by porter (1980, 1985) and miles and snow (1978) sparked several insightful debates on the strategy-perfonnance relationship. although each generic strategy identified in the typologies suggests leadership competencies essential for its effective implementation, one key question remains: does the success of a given strategy hinge on the functional background of the top executive? this article seeks to answer this question by examining an executive-strategy contingency among retail department stores. in doing so, reviews of past functional background and strategy research are provided, followed by the development of propositions, a discussion of testing procedures, and results of the study. a discussion and prospects for future research are identified. the top executive and functional background most top executives possess a distinct functional orientation (hambrick and mason, 1984). dommermuth (1966) provided the earliest comprehensive analysis of top executive functional backgrounds. during the period from 1945 to 1964, he found that general management and production produced the greatest number of top executives in the sample (22%), while marketing (18%) and finance (16%) backgrounds were also common. in his conclusions, dommermuth identified one key trend: managers who successfully rose through the ranks of one specialization have the brightest prospects for becoming top executives. the two decades that followed vindicated dommennuth's assessment. the 1970s witnessed the culmination of the age of mass marketing, bringing about a demand for executives with marketing expertise. the tough economic times of the late seventies and 50 journal ofbusiness strategies vol. 11, no.1 early eighties spawned a demand for executives with strong financial backgrounds. however, the demand for top executives in the 1990s appears to have reversed this trend. recent surveys suggest that organizations are actively seeking visionaries with a generalist perspective and expertise in almost all functional areas (kichen and hardy 1992; kurtz, boone, and fleenor 1989; and litchfield 1990). nonetheless, many writers continue to argue the merits of top executives with expertise in one particular discipline or another. five broad functional areas are discussed below; (1) research and engineering, (2) marketing and sales, (3) accounting and finance, (4) manufacturing and production, and (5) general management. braham (1991) presented a strong case for promoting engineers to top executive p0sitions. indeed, activity during the past 15 years demonstrates that others agree. specifically, the number of top executives with engineering backgrounds has risen steadily from 7% of the largest 1000 u.s. companies in 1977 to 18% in 1987. further, of the 243 top executives who participated in kurtz et al.'s (1989) extensive study, 24% reported engineering backgrounds. braham argued that the increased global competition, often spurred by advanced japanese engineering and design, has increased the need for engineers at the top. further, engineers by nature tend to be innovative, research-oriented, and open-minded, attributes essential to effective organizational leadership (braham 1991). according to boone and milewicz (1989), the characteristics of the successful sales professionals-stable, self-sufficient, self-confident, goal-directed, decisive, speedy, accurateare most closely associated with those of successful top executives. futrell (1988) also noted that professional selling offers the fastest opportunity for advancement. indeed, more top executives over the past several decades have come from marketing backgrounds than any other (kurtz, dodge, and klompmaker 1988). however, there exists no conclusive evidence to suggest a continuance of this trend (boone and milewicz 1989). flannigan's (1986) survey of the nation's largest 800 corporations found the highest percentage of top executives (34%) to possess financial, banking, or accounting backgrounds. many experts have attributed the rise in the number of fmancial specialists as top executives to the increased emphasis on developing and maintaining a leaner, more competitive organization (flannigan 1986; litchfield 1990). indeed, banking and financial experts rose steadily in the 19808 (boone and kurtz 1988) but will likely decline as the environment changes in the 19908. the case for manufacturing and production specialists as top executives is similar to the one made for those with research and engineering backgrounds. however, proponents have argued that production and manufacturing backgrounds have better equipped managers to formulate and implement the quality-based strategies of the 1990s (eisman 1992; hendricks and triplett 1990). in addition, the successful implementation of total quality management (tom) techniques as part of a global strategy has been linked to top management teams with a production slant (sashkin and kiser 1992). the final functional area-general management-includes a wider variety of activities and experiences than any of the other four. the executive with a general management background likely possesses limited experience in some or all of the other more specific funcspring 1994 parnell: functional background and business strategy 51 tional areas (kotter 1982). however, the general manager retains expertise in no specific field. as a generalist, he or she may experience a greater understanding of the organization as a whole, but without a depth of knowledge in a key functional area. strategy and perfonnance researchers have classified business strategies into typologies to more effectively study relationships between strategy and performance (herbert and deresky 1987; hill 1988; lawless and finch 1989; namiki 1989; parnell and wright 1992). strategic typologies represent broad categorizations of businesses' strategic behaviors into a few types. the two most widely researched typologies were pioneered by porter (1980) and miles and snow (1978). according to porter's (1980, 1985) typology, a business can maximize performance either by striving to be the lowest cost producer in an industry or by differentiating its line of products or services from other businesses. a low cost strategy necessitates the business' ability to design, produce, and market a comparable product more efficiently than its competitors. the differentiation strategy emphasizes the ability of the business to provide unique and superior value to the buyer in terms of product quality, special fea~ tures, or after-sale service. differentiation leads to market success not based on a competitive price, but on the demands of a sophisticated consumer who wants a differentiated product and is willing to pay a higher price. according to porter, either approach may be employed in conjunction with a focus strategy~ncentrating ones efforts on a given segment of the market. porter suggested that businesses should seek to implement either a low cost or a differentiation strategy. those that do not, instead attempting to accomplish both simultaneously, become "stuck in the middle." as such, these businesses do not tend to achieve superior performance (dess and davis 1984; hambrick 1983). however, mounting empirical evidence has presented a strong case that, for many organizations, combination strategies are not only viable, but may be optimal (buzzell and gale 1987; hill 1988; jones and butler 1988; miller and friesen 1986; murray 1988; parnell and wright 1992; white 1986; wright 1987; and wright and parsinia 1988). indeed, businesses employing combination strategies may actually outperform those principally adopting either the cost leadership or differentiation strategies (cappel 1990). the miles and snow (1978) framework considers four strategic types: prospectors, defenders, analyzers, and reactors. prospectors perceive a dynamic, uncertain environment and maintain flexibility to combat environmental change. defenders perceive the environment to be stable and certain, and thus seek stability and control in their operations to achieve maximum efficiency. analyzers stress stability and flexibility, and attempt to capitalize on the best of both of the preceding strategic types. reactors lack consistency in strategic choice and perform poorly. numerous studies conclude that superior performance can typically be found in prospectors, analyzers, and defenders, while reactors tend to perform poorly (miles and cameron 1982; parnell and wright 1992; and snow and hrebiniak 1980). 52 journal ofbusiness strategies vol. 11, no.1 wright, kroll, pringle, and johnson (1990) proposed a fifth organization type. the ''balancer'' is a combination of three types of organizations identified by miles and snow: the prospector, the analyzer, and the defender. the ''balancer'' is not a compromise strategy whereas the analyzer has been viewed as such (hambrick 1983; and wright et al. 1990). the balancer represents an ideal that reflects the ability of a business to synergistically incorporate elements of all viable generic strategies. thus, the "balancer" and the "analyzer" should not be confused. the fit: strategy and top executive background the linkage between executive characteristics and organizational performance is not without previous discourse (norbum and birley 1988; and virnay and tushman 1986). over a decade ago, miller, kets de vries and toulouse (1982) argued for a relationship between top executive personality and strategic behavior. more specifically, different strategies require various distinct managerial tasks and behaviors for effective implementation (andrews 1971), and general managers differ in their abilities to perform the necessary tasks, in part due to differing functional backgrounds (kotter 1982). hence, the business units most likely to achieve superior performance are those that match the requirements of their strategies to the functional expertise of their general managers (govindarajan 1989; and gupta and govindarajan 1984). two notable studies have considered a fit between top executive and business strategy. gupta and govindarajan (1984) found that a marketing background was most appropriate for growth-oriented strategies, but inhibited performance of business units adopting a harvest-oriented strategy. govindarajan (1989) found that research and development and marketing backgrounds contributed to superior performance in the case of differentiation sbus, whereas manufacturing, finance, and accounting backgrounds were most appropriate for cost leadership business units. lbis paper builds on the existing foundation and empirical work pioneered by gupta and govindarajan (1984) and govindarajan (1989), but utilizes the miles and snow (1978) typology instead of porter's (1980) approach. to craft a better understanding of the relationship, this study considers four viable strategies (i.e., prospectors, defenders, analyzers, and balancers) instead of two polar strategies (i.e., low cost and differentiation), as addressed in the other studies. the following propositions are tested in this study: 1. prospector businesses with top executives from research and engineering or general management backgrounds tend to outperform prospector businesses with top executives from all other backgrounds. prospectors tend to possess a loose structure, a low division of labor, and low formalization and centralization. the strength of the prospector is the identification and exploitation of new product and market opportunities. miles and snow (1986) later referred to prospectors as the industry "designers." leontiades (1982) noted that such a strategy spring 1994 parnell: functional background and business strategy 53 necessitates product management and research skills. hence, top executives from research and engineering or generalist backgrounds appear to possess the skills necessary to most effectively formulate and implement the prospector strategy. 2. analyzer businesses with top executives from marketing backgrounds tend to outperform analyzer businesses with top executives from all other backgrounds. analyzers exert tight control over existing operations with loose control for new undertakings. the strength of the. analyzer is the ability to imitate or respond to prospectors while maintaining efficiency in operations. since analyzers are the "marketers" of an industry (miles and snow 1986), top executives with marketing backgrounds should be best equipped to oversee an analyzer organization. 3. defender businesses with top executives from accounting, finance, manufacturing, production, or general management backgrounds tend to outperform defender businesses with top executives from all other backgrounds. defenders incorporate an extensive division of labor, high formalization, and high centralization. defenders are the "producers" in an industry (miles and snow 1986). the strength of the defender is its high degree of concentration on only one segment of the market and its ability to serve this segment efficiently. since production efficiency lies at the core of this strategy, top executives from backgrounds such as accounting, finance, manufacturing, production, or general management should possess optimal skills for formulation and implementation of the defender strategy. 4. balancer businesses with top executives from general management backgrounds tend to outperform balancer businesses with top executives from all other backgrounds. the balancer organization is uniquely positioned to utilize the advantages of the prospector, analyzer, and defender strategies. specialist top executives that implement this strategy tend to operate at a disadvantage since their expertise may be severely limited in one of the strategic spheres. on the contrary, top executives from a generalist perspective may possess the "balance" of perspectives necessary to generate the synergy required for successful implementation of the balancer strategy. 5. businesses with top executives possessing high amounts of experience in an organization, experience as top executive, and experience in the industry, tend to outperform other businesses, regardless of strategy or top executive background. govindarajan (1989) found a positive correlation between managerial experience and business unit performance. as such, this proposition tests the notion that strategy and functional background may not provide a thorough explanation of business performance. 54 journal o/business strategies vol. 11, no.1 instead, the level of experience for the top executive should tend to result in superior performance aside from strategic or expertise considerations. methodology industry categories based on four-digit sic classifications have been a generally accepted unit of analysis in strategy research (thomas and venkatraman 1988). the industry examined in this study, sic5311, is comprised of department stores. top executives in the industry were asked to provide information concerning their years of experience in the industry, with the present organization, and as top executive. in addition, top executives were asked to classify their functional background as research/engineering, marketing/sales, manufacturing/production, [mance/accounting, law, or general management. fifteen items were generated to measure generic strategy (see table 1), including items typically associated with the five hypothesized strategic types. business performance was measured by return on assets (roa) and growth in revenues from 1987 and 1991. a likert-oriented instrument consisting of the top executive, strategy and performance items was sent to the top executives of the 299 largest businesses in the industry (ward's business directory, 1992). this sample constitutes all reporting businesses with sales in excess of $1,000,000 in 1991. usable responses were received from 129 businessesa 43 percent response rate. the application of a factor analysis and calculation of cronbach's (1951) alpha provided support for the integrity of the scale (peter, 1979). results of these preliminary tests appear in table 1. table 1: strategy items and their factor loadings item ability to be new product leader stability of product mix emphasis on new product development emphasis on securing short term profit emphasis on securing market share range of product line emphasis on being highly innovative attitude toward growth approach toward customer base stability of customer base stability of growth employee specialization flexibility of operations overall marketing strength emphasis on having lowest costs possible (coefficient alpha = 0.87) variable newprod stabpr npdevel slprof mshare range innovat attgrow appcust stabcus stagrow special flexibl mktgstr lowcost loading .85 .64 .83 -.48 .91 .88 .88 .88 .84 .91 .89 -.52 .74 .82 -.79 spring 1994 parnell: functional background and business strategy 55 scores for mean roa ("roa") and growth in revenue ("gro") were calculated for each business. the correlation between the two dimensions of performance was 0.44, significant at the .05 level. these two scores were then equally weighted relative to other businesses in the sample to form a composite measure of performan~a measure that incorporates two key facets of performance. the composite measure (com) was scaled such that performance at the sample median for each generic strategy would yield a score of zero, with a standard deviation of 100. hence, a positive com means that composite performance exceeded the median for businesses adopting the same strategy, while a negative com means that composite performance was below the median. ward's clustering method (see barney and hoskisson 1991) was applied to the fifteen strategic variables, yielding five clusters ranging from twelve to 52 businesses per cluster. mean scores for these items in each cluster appear in table 2. table 2: strategy item means for each cluster variable newprod stabpr npdevel stprof mshare range innovat atigrow appcust stabajs stagrow special flexibl mktgstr lowcost prospector (n=31) 4.61 4.48 4.68 1.84 4.71 4.65 4.84 4.71 4.42 4.48 4.52 1.84 4.68 4.65 1.42 cluster analysis reactor defender balancer analyzer (n=20) (n=2s) (n=28) (n=29) 1.70 1.60 4.79 3.04 1.60 4.60 4.00 2.89 1.50 1.52 4.66 3.21 4.75 3.28 4.28 3.00 1.35 2.96 4.69 3.11 1.10 3.16 4.14 3.11 1.45 1.48 4.52 2.86 1.40 3.16 4.34 2.96 1.45 3.44 4.83 2.93 1.40 2.84 4.83 3.04 1.15 2.96 4.72 3.25 4.35 3.00 3.83 2.89 2.10 2.96 3.86 3.11 1.40 1.92 4.55 3.75 4.70 2.48 1.97 3.00 businesses in the first cluster appear to be prospectors (n=31), tending to score high on prospector items (e.g., emphasis new product leadership, development, market share, and growth; development of the customer base, and flexibility) while scoring low on defender items (e.g., stable profits, specialization, low cost emphasis). in contrast, businesses in the second cluster appear to be defenders (n=25), tending to score low on prospector items and high on defender items. businesses in the third cluster appear to be reactors (n=20), tending to score low on both prospector and defender items. in contrast, those in the fourth cluster appear to 56 journal ofbuyiness strategies vol. 11, no.1 comprise the balancer cluster specifically sought in this study (n=28), tending to score high on both sets of items. the final cluster demonstrates no clear high or low response tendencies and appears to be comprised of analyzers (n=29). businesses in the prospector, analyzer, defender, and balancer clusters-a total of 109 businesses-were retained for further analysis. findings table 3 provides revenue growth, roa, and composite performance means for each of the strategy-background combinations addressed in the first four propositions. table 4 provides the results of t-tests pitting those top executives with superior background-strategy "fits" against other top executives. these tests utilized the composite (com) performance measure. table 3: business performance by ceo background and generic strategy generic strategy ceo background prospector analyzer defender balancer all strategies research com= 34.2 com=-75.7 i com=-40.9 com= 6.3 i engineering gro=16.77 gro=-1.58 i gro= 3.90 gro=12.02 i roa= 6.44 roa= 7.20 i roa= 7.53 roa= 6.78 i n= 8 n= 1 i n = 0 n= 3 n= 12 l marketing com=-16.2 com=25.49 i com=-65.2 com=-26.8 com=-12.8 i sales gro= 8.09 gro= 8.79 i gro= 4.30 gro= 7.32 gro= 7.55 i roa= 7.51 roa= 8.08 i roa= 5.40 roa= 6.72 roa= 7.19 i n= 12 n= 15 i n = 7 n= 10 n= 44 l accounting com=-80.1 com= -8.4 i com= 31.8 com=-40.8 com=-16.0 i finance gro= 1.47 gro= 7.05 i gro= 3.50 gro= 3.94 gro= 3.65 i manuf. roa= 3.03 roa= 8.15 i roa= 8.78 roa= 7.50 roa= 6.92 i production n= 6 n= 4 i n = 9 n= 3 n= 22 l com= 60.4 com=-25.9 i com= 55.8 com= 41.1 com= 26.5 i general gro=19.88 gro= 5.08 i gro= 5.71 gro=12.36 gro=10.84 i managemt. roa= 8.05 roa= 7.60 i roa= 8.45 roa= 9.41 roa= 8.50 i n= 6 n= 9 i n = 4 n= 12 n= 31 l all com= -1.2 com= -0.3 i com= 2.6 com= -1.4 com= 0 i backgrounds gro=11.23 gro= 7.04 i gro= 4.22 gro= 8.75 gro= 8.19 i roa= 6.50 roa= 7.91 i roa= 7.53 roa= 8.04 roa= 7.46 i n= 32 n= 29 i n = 20 n= 28 n= 109 l spring 1994 parnell: functional background and business strategy 57 table 4: hypothesized ceo background-generic strategy relationships. generic best fit performance other performance t-value signif. strategy ceo's (com) ceo's (com) prospector research 47.44 marketing -39.51 2.51 .018 engineering acclfinance gen mgmt production analyzer marketing 25.49 research -26.48 2.66 .013 engineering gen mgmt acclfinance production defender acclfinance 39.16 research -65.20 2.15 .045 production engineering gen mgmt marketing balancer gen mgmt 41.14 research -33.77 3.33 .003 engineering marketing acc/finance production the first proposition was supported. only top executives from the two hypothesized background&-research/engineering and general management-tended to perform above the sample median (com=47.44) when the prospector strategy was adopted. prospectors managed by top executives with marketing/sales, accounting/finance, and manufacturing/ production backgrounds were much less adept formulating and implementing the strategy (com=-39.51). the t-value of 2.51 suggested that these performance differences were significant at the .05 level. the second proposition was supported. considering analyzers, the only group of executives to average above the median was the marketing/sales group (com=25.49). all other groups performed below the median, with a mean composite measure of -26.48. the t-value of 2.66 suggested that these performance differences were significant at the .05 level. the third proposition was supported. considering defenders, top executives with general management backgrounds (com:55.8) and accounting/finance or manufacturing/production backgrounds (com=31.8) outperformed those with marketing backgrounds (com=-65.2). this difference was significant at the .05 level (t-value:2.15). the fourth proposition was supported. considering balancers, the only executive group to average above the performance median was the generalist group (com=41.14). all 58 journal ofbusiness strategies vol. 11, no.1 other groups of top executives performed well below the median, with an average composite measure of -33.77. this difference was significant at the .05 level (t-value=3.33). the fifth proposition was not supported. in fact, none of the three experience variablesexperience in the organization, experience as top executive, and experience in the industry-was significantly correlated with revenue growth, roa, or the composite performance measure. discussion and prospects for future research the significance of this initial study centers around three key points. first, the successful formulation and implementation of strategies at the business level is related to the skills and perspective of the top executive. specifically, top executives with expertise in the distinctive competencies highlighted by the prospector, analyzer, defender, or balancer strategy chosen tend to achieve greater performance for their organizations. this finding suggests that regardless of the increased influence by boards of directors and top management teams, the background of the top executive remains a major factor in the formula for high performance and should be a major consideration in appointment decisions. this study did not address how the top executive-strategy relationship emerged in the businesses. for example, did the top executives tend to mold the strategies around their own biases and specialties, or were the top executives originally selected to modify and implement a strategy already in action (litchfield 1990)? does top management team homogeneity or heterogeneity moderate or mediate the background-strategy-performance relationship (murray 1989)? this study also did not demonstrate the existence of a universal executive-strategy contingency. future research should also consider manufacturing industries. many of the skills and behaviors required for successful strategic implementation may be industryspecific as well as strategy-specific. hence, it is possible that a three-way interaction (i.e., strategy, functional background, and industry type) may be found. second, top executive characteristics not directly associated with their skills and competencies were not significantly associated with business performance. contrary to conventional wisdom, experience at the helm, with the company, and in the industry were not relevant. since it is generally accepted that many skills can be nurtured and strengthened over time, future research should consider the possible disadvantages associated with experience. these may center around the narrowing of perspectives over time, as top managers attempt to maintain their competitive advantage by recreating successful strategies in the past-strategies that may never again result in superior performance (parnell, lado, and wright 1992)! finally, this study did not address the superiority of any given background. although executives with general management backgrounds were most successful in this study, this did not hold true for all four viable strategies. indeed, numerous writers have suggested that the most appropriate top executive background is contingent on industrial and economic trends (boone and milewicz 1989; braham 1991; kichen and hardy 1992; spring 1994 parnell: functional background and business strategy 59 litchfield 1990). from this perspective, it is possible that optimal strategies can be identified for certain industries and time periods. tenets such as flexibility (stewart 1992), speed-to-market (stalk 1988), and quality (drucker 1990) may be characteristics of effective strategies in the 1990s, but they may be irrelevant to effective strategies in the next decade. hence, future research should consider how changes among industries and in the environment over time impact the effectiveness of a variety of strategy-related factors, including the background of the top executive. references andrews, kr. 1971. the concept of corporate strategy. homewood, il: dow-jones irwin. barney, j.b. and r.e. hoskisson. 1990. "strategic groups: untested assertions and research proposals." managerial and decision economics 11: 187-198. boone, l.e., and d.l. kurtz. 1988. "ceos: a group profile." business horizons 31(4): 38-42. boone, l.e., and j.e. milewicz. 1989. "is professional selling the route to the top of the corporate hierarchy?" journal of personal selling and sales management 9(1): 42-54. braham, j. 1991. "engineering your way to the top." machine design 63(7): 65-68. buzzell, r.d., and b.t. gale. 1987. the pims principles. new york: free press. cappel, s.d. 1990. "strategic profiles and performance in service organizations: examining retail department, variety and general merchandise stores." unpublished doctoral dissertation, memphis state university, memphis, tennessee. cronbach, lj. 1951. "coefficient alpha and the internal structure of tests." psychometrica 16: 297-334. dess, g.g., and p.s. davis. 1984. "porter's generic strategies as determinants of strategic group membership and performance." academy of management journal 26: 467-488. dommermuth, w.p. 1966. "on the odds of becoming company president." harvard business review 44(3): 65-72. drucker, p.f. 1990. "the emerging theory of manufacturing." harvard business review 68(3): 94-102. eisman, r. 1992. "why companies are turning to total quality." incentive 166(5): 22-26. flannigan, w.g. 1986. "how much the bosses earned." forbes 143(12): 150-188. futrell, c. 1988. sales management. hinsdale, il: dryden press. 60 journal ofbusiness strategies vol. 11, no.1 govindarajan, v. 1989. "implementing competitive strategies at the business unit level: implications of matching managers to strategies." strategic management journal 10: 251-269. gupta, ak, and v. govindarajan. 1984. "business unit strategies, managerial characteristics, and business unit effectiveness at strategy implementation." academy of management journal 27: 25-41. hambrick, d.c. 1983. "some tests of the effectiveness and functional attributes of miles and snow's strategic types." academy of management journal 26: 526. hambrick, d.c., and p.a mason. 1984. "upper echelons: the organization as a reflection of its top managers." academy of management review 9: 193-206. hendricks, c.f., and a triplett. 1989. "tqm: strategy for '90's management." personnel administration 34(12): 42-47. herbert, t.t., and h. deresky. 1987. "generic strategies: an empirical investigation of typology validity and strategy content." strategic management journal 8: 135-147. hill, c.w.l. 1988. "differentiation versus low cost or differentiation and low cost: a contingency framework." academy of management review 13: 401-412. hise, r.t., and s.w. mcdaniel. 1988. "american competitiveness and the ceo-who's minding the shop?" sloan management review 29(2): 49-55. jones, g.r., and j.e. butler. 1988. "costs, revenue, and business-level strategy." academy of management review 13(2): 202-213. kichen, s., and e.s. hardy. 1992. "putting it into perspective." forbes 149(11): 174-176. kotter, j.p. 1982. the general managers. new york: free press. kurtz, d.l., l.e. boone, and c.p. fleenor. 1989. ceo: who gets to the top in america. east lansing, mi: michigan state university press. kurtz, h., r. dodge, and j.e. klompmaker. 1988. professional selling. plano, tx: business publications, inc. lawless, m.w., and l.k finch. 1989. "choice and determinism: a test of hrebiniak and joyce's framework on strategy-environment fit." strategic management journal 10: 351-365. leontiades, m. 1982. "choosing the right manager to fit strategy." journal of business strategy 3: 58-69. litchfield, r. 1990. "they walk on water." canadian business 63(9): 46-49. miles, r.e., and k cameron. 1982. coffin nails and corporate strategies. englewood cliffs, nj: prentice-hall spring 1994 parnell: functional background and business strategy 61 miles, r.e., and c.c. snow. 1978. organizational strategy, structure. and process. new york: west. miles, r.e., and c.c. snow. 1986. "organizations: new concepts for new forms." california management review 18(3): 62-73. miller, d., and p.h. friesen. 1986. "porter's (1980) generic strategies and performance: an empirical examination with american data. part it: performance implications." organization studies 7: 255-261. miller, d., m.f.r. kets de vries, and j.m. toulouse. 1982. "top executive locus of control and its relationship to strategy-making, structure, and environment." academy of management journal 25: 237-253. murray, a.i. 1988. "a contingency view of porter's 'generic strategies.'" academy of management review 13: 390-400. murray, a.i. 1989. "top management group heterogeneity and firm performance." strategic management journal 10 (summer, special issue): 125-141. namiki, n. 1989. "miles and snow's typology of strategy, perceived environmental uncertainty, and organizational performance." akron business and economic review 20(2): 72-88. norburn, d. 1989. "the chief executive: a breed apart." strategic management journal 10(1): 1-15. norburn, d., and s. birley. 1988. "the top management team and corporate performance." strategic management journal 9: 225-238. parnell, la., a. lado, and p. wright. 1992. "why good things never seem to last: a dialectic perspective on long-term competitive advantage." journal of business strategies 9 (1): 6268. parnell, ja., and p. wright. 1992. "generic strategy and performance: an empirical test of the miles and snow typology." british journal of management, in press. peter, j.p. 1979. "reliability: a review of psychometric basics and recent marketing practices." journal of marketing research 16: 6-17. porter, m.e. 1985. competitive advantage. new york: free press. porter, m.e. 1980. competitive strategy. new york: free press. sashkin, m., and kiser, k. 1992. "what is tqm?" executive excellence 5 (5): 11. snow, e.e, and l.g. hrebiniak. 1980. "strategy, distinctive competence, and organizational performance." administrative science quarterly 25: 317-336. 62 j oumal ofbusiness strategies vol. 11, no.1 stalk, g., ji. 1988. "time-the next source of competitive advantage." harvard business review 66(4): 41-51. stewart, ta. 1992. "brace for japan's hot new strategy." fortune 126(6): 62-74. thomas, a.s., rj. litschert, and k. ramaswamy. 1991. "the performance impact of strategymanager coalignment: an empirical examination." strategic management journal 12: 509-522. thomas, h., and n. venkatraman. 1988. "research on strategic groups: progress and proposals." journal of management studies 25: 537-555. virnay, b., and ml tushman. 1986. "executive succession: the changing characteristics of top management teams." academy of management best paper proceedings, pp. 155-159. ward's business directory 1992. ward's directory of u.s. private and public companies. new york: gale research. white, r.e. 1986. "generic business strategies, organizational context, and performance: an empirical investigation." strategic management journal 7: 217-231. wright, p. 1987. "a refinement of porter's strategies." strategic management journal 8: 93101. wright, p., m. kroll, c. pringle, and j. johnson. 1990. "organization types, conduct, profitability and risk in the semiconductor industry." journal of management systems 2(2): 33-48. wright, p., and a. parsinia. 1988. "porter's synthesis of generic business strategies: a critique." industrial management 1: 20-23. functional background and business strategy: the impact of executive-strategy fit on performance assessing strategy relatedness in highly diversified firms jeffrey s. harrison ernest h. hall, jr. clemson university clemson, south carolina lee g. caldwell novell, inc. salt lake city, utah since its inception, the field of strategic management has been largely dominated by diversification studies. the primary hypothesis in these studies has been that relatedness among the business units of a corporation should lead to synergy and thus higher performance for the corporation as a whole [39]. although an enormous amount of research has been generated on the importance of relatedness, or lack thereof, inconsistent and contradictory findings have encouraged controversy. some studies find that related diversification is a~sociated with higher performance ([3], [32], [39], [42]), while others find the reverse to be true ((14], [29]). in addition, researchers in related fields of study, such as industrial organization in economics, have been unable to establish a consistent relationship between diversification and performance ([2], [15], [25]), and merger studies on the subject have likewise been inconclusive ([1], [8], [23]). even when the importance of the relatedness hypothesis is rejected, dissension exists over which types of relatedness are most relevant, with biggadike (5j, didrichsen [13], hopkins [18], howell [19], and rumelt [39] each proposing different typologies of relatedness. this lack of consensus among researchers may have contributed to the contradictions found in research studying the relatedness-performance relationship. furthermore, the widely-used grouping methodologies found in most diversification studies are unlikely to lead to a consensus since they do not allow for a direct comparison of different types of relatedness. for example, the categories of rumelt's [39j typology, which are still widely used in diversification research, were intuitively developed. one of rumelt's categories is dominant vertical. the dominant vertical category includes firms which are engaged in several different businesses, but which derive greater than 70% of their revenues from a vertically integrated sequence of processing activities. these vertically integrated firms exhibited low levels of performance in rumelt's initial study [39]. does this mean that vertical integration strategies should always be associated with low performance? not necessarily, since many of the companies in rumelt's sample may journal of business strategies, volume 7, number 1 (spring 1990) 34 spring 1990 harrison, hall, & caldwell: relatedness 35 have been using lesser amounts of vertical integration quite successfully in combination with other types of diversification. in summary, the rumelt methodology is incapable of isolating and assessing the effects of vertical integration on organizational performance when firms are simultaneously engaged in several forms of diversification. one way of overcoming the methodological problems associated with grouping methodologies is to use continuous measures of relatedness. continuous measures identify a firm's level or degree of relatedness and eliminate the need for arbitrary decision rules inherent in grouping methodologies. in this study, several continuous measures of relatedness (marketing relatedness, technological relatedness, and vertical integration) are employed in assessing the effects of relatedness on firm profitability, growth, and risk. in addition, the effects of industry structure on the relationship between relatedness and performance are investigated. the rationale of relatedness the relatedness concept is built on the idea of "strategic fit." strategic fit is achieved when businesses are related in some meaningful manner. for example, if businesses complement each other, supplement each other, or use similar resources and skills (marketing, technology, or vertical integration), then the potential for synergy exists ([361, [37]). according to rumelt, related diversification strategies should outperform unrelated strategies because of the many opportunities for product differentiation, segmentation, development of unique and defensible product-market positions, and shared facilities and marketing channels [39}. similarities among businesses enable the firm to exploit a particular skill or resource and reap the benefits of a "learning curve" effect [6]. such inter-business sharing and learning among sister businesses permits the overall firm to become more efficient and thus, more profitable. three widely mentioned types of relatedness are vertical integration, technology, and marketing ([5], [13}, [18}, [19], [39]). another frequently mentioned relatedness type, financial, is not explicitly measured in this study. the financial benefits associated with efficient capital allocation and financing are assumed to be available to all of the large highly-diversified firms included in the sample. vertical integration vertical integration provides a firm with the opportunity to expand its business, either forward (into distribution) or backward (into supplies), within the same industry, instead of entering into anew, unfamiliar business. some of the advantages available to vertically integrated firms include: 1. control of the quality and availability of raw materials or supporting services which are necessary for production; 2. influence over the manner of presentation of products to end consumers; 3. enhancement of product quality through greater attention to service; 4. competitive advantages arising from locking out rivals; and 36 journal of business strategies vol. 7, no.1 5. capturing the value added from different stages of production and distribution [16]. transaction cost theory suggests that vertical integration may also help firms avoid the bargaining costs and opportunistic behavior of suppliers and distributors ([21], [43]). technological relatedness business or products can be classified as being technologically related when they share common skills related to production, operations, machinery, etc. biggadike [5] classified firms as being technologically related if they developed new ventures using a skill already possessed by the firm. the experience and expertise associated with this skill allows the firm to transfer its learning to a different environment with similar technological processes. the benefits of diversifying on the basis of technological relatedness are evident in the chrysler/jeep acquisition. in addition, economies of scope may arise when equipment used in the production of one product is sufficiently flexible to allow production of other products ([33], [40]). with the increasing sophistication of technology, the ability to manufacture different products using the same equipment offers firms the option of reducing risk by diversifying into technologically familiar areas. marketing relatedness lines of business are marketing related if they benefit from similar marketing skills or marketing channels ([5], [13], [18], [19]). whenever products or businesses share the same or similar markets (customers), advertising media, distribution channels, or geographic areas, the potential for marketing synergy exists. furthermore, marketing researchers argue that the characteristics of goods determine the way they are priced, distributed, and promoted ([7], [11], [30], [34]). thus, a firm marketing products with similar characteristics should be able to enjoy substantial advertising, distribution, and pricing policy synergies. the rjr/n abisco acquisition is a good example of the potential for capturing marketing synergies through diversification. methods and hypotheses the present study argues that performance differences among highly diversified firms can be explained in part by the degree of relatedness or diversity incorporated along three dimensions: marketing, technology, and vertical integration. since the intent of this study is to compare and evaluate performance differences among several types of relatedness (as opposed to comparing diversified firms with undiversified firms), only highly-diversified firms are included in the sample. sample the sample was comprised of 254 highly-diversified firms selected from the 1978 fortune 500 industrial corporations (all of the firms which met the inclusion criteria). spring 1990 harrison, hall, & caldwell: relatedness 37 the year 1978 was selected for analysis as it is the most recent year for which data used in the vertical integration measure was available. firms were included in the sample if they were involved in at least six four-digit sic product groups and two two-digit product groups (similar to pitts' [35j methodology). the two-digit product group requirements insured that firms were engaged in at least two different technologies. the four-digit product group requirement further insured that firms had some diversity within each technology. standard and poor's register of corporations, directors and executives [41j was used to identify each firm's four-digit and two-digit sic codes. performance data were derived from the compustat database, annual reports, and moody's industrial manual. related diversification measures three continuous measures of relatedness were used simultaneously: vertical integration, technological relatedness, and marketing relatedness. vertical integration has predominantly been measured using one of three approaches: 1. value added as a percentage of sales (value added); 2. percentage of total product that is part of the vertical chain (vertical ratio); and 3. the vertical industry connection index (vic). while value added is easy to calculate, it suffers from two major problems: (1) the ratio is greater for firms involved in extractive processes and (2) factors other than vertical integration (such as profitability) influence the ratio. the vertical ratio used by rumelt [39j and others is problematic in that it measures horizontal as well as vertical integration. the vic, while more difficult to calculate, does not suffer from the deficiencies associated with the other measures. while a detailed mathematical description of the vic is unfeasible due to space considerations, a brief description is in order. the vic is derived from the inputoutput matrix of the u. s. economy, which was developed by the bureau of economic analysis, u. s. department of commerce. two industries often serve as input suppliers to each other. the input-output matrix measures these flows from industry to industry. derived from this matrix, the vic increases as more of a firm's inputs come from industries in which the firm is involved (backward) or as more of the firm's outputs are used by industries in which the firm is involved (forward). the vic is a continuous measure having values between 0 (no vertical integration) and 1 (total vertical integration). for more information on the vic, refer to maddigan [24j. the technological relatedness measure was a derivative of the number of technologies in which each firm was involved, where a technology was defined by the bureau of economic analysis as containing firms which were involved in some aspect of production for a similar good or service. technologies were constructed by the bureau according to similarities with respect to machinery used, type of manufacturing process, operation flow, and type of raw materials used. the bureau also publishes a 38 journal of business strategies vol. 7, no.1 chart listing each of the four-digit sics which were contained within each technology. this chart was used to determine the number of technologies in which each firm was involved. the reciprocal of this number was used as the technology measure since it was fund to be a better predictor of firm performance than the raw number of technologies ([20], [22]). therefore, a high score on this variable indicated a high degree of technological relatedness (few distinct technologies). marketing relatedness was measured along three dimensions: (1) advertising media, (2) distribution methodology, and (3) pricing strategy. each four-digit sic product group was classified based on whether the products/services were promoted through television advertising, whether the products/services were distributed directly to end consumers (or were intermediate products), and whether the products / services were priced differently for each customer (custom vs. standard products). three marketing variables were created for each firm based on the percentage of firm sales in product groups in each of the three categories. for example, if 30% of a firm's product groups were distributed directly to the end consumers, it's ratio is .30. similar ratios were calculated for advertising and pricing. these ratios were then standardized across companies. returning to the distribution example, this means that high positive values are associated with firms which distribute most of their products to end consumers and high negative values are associated with firms which distribute most of their products to intermediaries in other industries. the potential for synergy exists at both extremes; therefore, the last step in the process is to calculate the absolute values for each of the standardized ratios. this process results in three variables which indicate the potential for high synergy when they are high and low synergy when they are low. industry structure the seminal work of montgomery [31] and other researchers ([4], [9], [10], [31]) demonstrated the importance of industry structure in determining firm performance. the industry structure controls used in this study most closely parallel the work of montgomery and include variables for concentration, market growth (grow), industry profitability (1 p rf), market share (m sh r), and firm size (s1 ze). firm specific concentration (c r20), industry growth, and industry profitability were averaged across all four-digit sic groups in which the firm participated. relative market share, or the ratio of a firm's sales to the sales of its largest industry rival, was used as a proxy of market share [17]. firm size is calculated as a five-year average (19751979)of the reciprocal of the base 10 logarithm of total assets [31]. performance the use of several measures of firm performance assist in overcoming the weakness of using only one measure (vis., adds reliability) and insures this study's comparability with previous research. in accordance with prior research, accounting measures are employed ([10], [31], [39], [40]). spring 1990 harrison, hall, & caldwell: relatedness 39 profitability, measured as return on assets (roa) and return on equity (roe), is averaged over the five years surrounding 1977 (i.e., 1975-1979). an averaging process was employed to reduce the effects of temporary performance variations. change in sales from 1975 to 1979 is used as a measure of growth. risk (instability of earnings) is represented by the standard deviation of roa (rroa) and roe (rroe) across the five year time period (4]. hypotheses and statistics a three-tiered multiple regression analysis was used to isolate the effects of relatedness on performance. first, a series of multiple regressions were run using the five relatedness variables as predictor variables. multiple regression was used to test the general hypothesis that the nature and extent of related diversification affects firm performance (hd. second, the industry variables were introduced and the regressions rerun. concentration, market share, firm size, market growth, and industry profitability were hypothesized to have positive effects on firm performance (h2 ). third, a hierarchical regression analysis controlling for industry structure was performed to test the hypothesis that the relatedness variables contributed significantly to the explanation of firm performance even in the presence of industry structure variables (h3 ). this three-tiered multiple regression analysis highlighted the importance of industry structure in the strategy jperformance relationship. table 1 multiple regression equations for the basic model independent variables dependent (standard errors in parentheses) variable tech vint adv dist prce roa -.024 -.007 .008* -.002 .003 (.015) (.009) ( .003) ( .003) ( .003) int. = .0639 r2 = .0338 p = .1273 roe -.103** .002 .018** .003 .012 (.029) (.019) ( .006) ( .006) ( .006) int. = .1236 r2 = .0792 p = .0010 gsal -.473 -.037 .005 -.094 -.155** ( .260) (.168) ( .055) ( .050) ( .055) int. = .8031 r2 =.os17 p = .0213 rroa .013* -.002 -.002 .000 -.002 ( .005) ( .004) ( .001) ( .001) ( .001) int. = .0142 r2 = .0406 p = .0662 rroe .082** -.010 -.009 .000 -.006 (.029) ( .019) ( .006) ( .006) ( .006) int. = .0307 r2 = .0444 p = .0454 * p < .05 ** p < .01 40 journal of business strategies results vol. 7, no.1 basic model the regression equations for the basic model (hi) are presented in table 1. the preliminary tests offered some support for the notion that related diversification strategy affects firms performance. four of the five equations were at least marginally significant (p < 0.10). these results suggest that high levels of advertising relatedness (adv) are associated with high levels of profitability (roa and roe). there is also some support for the notion that high technological relatedness (t ec h) is connected with lower profitability (particularly roe) and higher risk (rroa and rroe). also, high pricing relatedness (p rce) is associated with faster growth (gsal). as indicated by the regression results, neither vertical integration (vint) nor distribution relatedness (dist) are associated with firm profitability (measured by either roa or roe), growth, nor risk (measured by either rroa or rroe). model adjusted for industry structure the results of the regression analysis for the complete model (h2 ) are presented in table 2. all of the equations increased in explanatory power. the results of the complete model parallel the results of the basic model, with the exception of the pricing relatedness variable (p rc e), which is no longer significant. only one of the coefficients changed sign (vi nt as an independent variable in the roa model specification). importantly, this variable was not significant in either the basic nor the complete model specification. as hypothesized, industry structure influences firm performance, with industry profitability exhibiting a strong positive relationship with profitability and growth and a strong negative relationship with risk. the other industry structure variables were not significantly associated with profitability, growth, nor risk. overall, industry profitability was the most important variable in determining firm profitability, growth, and risk. the results of the hierarchical regression analysis (h3 ) are presented in table 3. the results suggest that industry structure should be included in models investigating the relationship between relatedness and performance, since relatedness contributed significantly to explanatory power after the inclusion of the structure variables in only one case (roe). however, the findings do not necessarily reduce the importance of the relatedness variables in understanding diversification since firms within an industry often possesses similar corporate strategies [40]. therefore, relatedness is likely to be significantly correlated with industry profitability, which reduces the influence of the relatedness variables when industry profitability in included in the model. these relationships were found to hold true in the present study. for example, industry return on equity was significantly correlated with vertical integration (p < 0.05), technological relatedness (p < 0.01), and distribution relatedness (p < 0.01). spring 1990 harrison, hall, & caldwell: relatedness table 2 multiple regression equationso for the complete model dependent independent variables variable (standard errors in parentheses) roa tech vint adv dist prce -.003 .008 .007" -.001 .002 (.015) (.009) (.003) (.003) (.003) cr20 mshr size grow iprf .021 .000 .059 -.002 .788** (.018) (.000) (.035) (.101) (.136) int. = -.0237 r2 = .1639 p = .0000 roe tech vint adv dist prce -.081 ** .017 .017** .001 .011 (.030) (.019) (.006) (.006) (.006) cr20 mshr size grow iprf .039 .000 .121 .,001 .488** (.037) (.001 ) (.073) (.021) (.139) int. = -.0088 r2 = .1374 p = .0001 gsal tech vint adv dist prce -.264 -.096 .009 -.092 .106 (.267) (.172) (.054) (.053) (.056) cr20 mshr size grow iprf -.447 -.005 .231 .307 6.203** (.331) (.007) (.655) (.191) (2.408) int. = .5161 r2 = .1047 p = .0023 rroa tech vint adv dist prce .008 -.006 -.002 .000 -.001 (.006) (.004) (.001 ) (.001) (.001) cr20 mshr size grow iprf .012 .000 .013 .005 -.212** ( .007) (.000) (.014) (.004) (.053) int. = .0126 r2 = .1142 p = .0009 rroe tech vint adv dist prce .065' -.020 -.008 .002 -.004 (.031) (.020) (.006) (.006) (.006) cr20 mshr size grow iprf .017 .000 -.026 .005 -.340* (.037) (.001) ( .074) (.022) (.142) int. = .0700 r2 = .0686 p = .0632 a the industry profitability (i p rf) variable entered in each equation corresponding with the dependent variable used. for example, in the ro a equation, average industry ro a was used. * p < .05 ** p < .10 41 42 journal of business strategies table 3 tests of significance of relatedness variables after controlling for industry structure vol. 7, no.1 explanatory power (r2 ) complete structure equation model model roa .1639 .1424 roe .1374 .0776 gsal .1047 .0801 rroa .1142 .0878 rroe .0686 .0347 a d.f.=5, 243 significance test for relatedness variables f ratioa prob( f) 1.2497 .2866 3.3692 .0058 1.3354 .2499 1.4485 .2076 1.7689 .1199 basic model prob(f) .1273 .0010 .0213 .0662 .0545 discussion and conclusions this study investigated several types of relatedness and their effects on profitability, growth, and risk. the results suggest several conclusions. first, firms with high advertising relatedness had higher profitability without incurring higher risk. that is, firms which had diversified into product groups that were advertised through similar channels may have been better able to fully exploit synergy than firms that extended their product groups across advertising media. since products that are advertised on television are largely consumer products, these results may be generalizable to traditional consumer vs. industrial product classifications. however, further research is needed for clarification of this issue. the second important finding of this research is that high technological relatedness appears to be associated with low profitability and high risk. remember, high technological relatedness implies that a firm is involved in only a few technologies. therefore, firms which extended their r~sources into many technologies enjoyed both higher return on equity and reduced risk. this is precisely what financial economists have been saying for years and is consistent with both portfolio theory and transaction cost economics [431. consistent with montgomery's [31] earlier work, the introduction of industry structure, variables has significant impact on the relationship between diversity and performance. for example, the pricing relatedness variable lost its significance as a predictor of sales growth in the presence of the structure variables and the group of relatedness variables no longer contributed significantly to an understanding of firm risk. however, the other relationships among relatedness, profitability, and risk remained constant. some findings of this research are particularly interesting in light of past research. several studies ([271, [28], [38]) have discovered a positive relationship between diversity and performance. this study demonstrates that one form of relatedness spring 1990 harrison, hall, fj caldwell: relatedness 43 (technological) is associated with lower return on equity, while another (advertising) was associated with higher returns on both equity and assets. mcdougall and round [28] found that diversified firms had less accounting-determined risk, whereas bettis [3] found that increasing diversity did not lead to a reduction of risk. in this study, technological relatedness (taken as the opposite of diversity) was associated with higher risk, consistent with mcdougall and round. these initial findings suggest that the use of continuous measures of diversity may assist researchers in explaining the contradictions which currently exist in the diversification literature. in conclusion, this study accomplished three major purposes. first, it demonstrated the practicality of a new methodology for examining diversification strategy. second, it provided some evidence concerning which types of related diversification influences the performance of a firm. third, it confirmed the necessity of controlling for industry structure (especially industry profitability) when investigating the relationships between diversification and performance. practical applications this study provides evidence which may be helpful to executives making diversification decisions. one commonly stated reason for diversifying is to reduce variability in returns (risk). the present study demonstrates that expanding into multiple technologies can reduce this type of risk and also increase returns. on the other hand, evidence is provided suggesting that it is more profitable to specialize in products which are advertised using similar marketing channels (marketing related). further, while industry structure affects firm performance in this study, it does not alter these basic relationships. finally, this re~h reinforces the findings of rumelt and others that vertical integration may not be a profitable strategy. references 1. ansoff, h. i., r. g. brandenburg, r. e. portner, and r. radosevich. acquisition behavior of u. s. manufacturing firms l 1946-1967. nashville, tn: vanderbilt university press (1971). 2. arnould, r. j. "conglomerate growth and public policy." in economics of conglomerate growth, corvallis, or: oregon state university department of agricultural economics (1969), pp. 72-80. 3. bettis, r. a. "performance differences in related and unrelated diversified firms," strategic management journal, vol. 2 (1981), pp. 379-93. 4. bettis, r. a. and w. k. hall. "diversification strategy, accounting determined risk, and accounting determined return," academy of management journal, vol. 25 (1982), pp. 254-64. 5. biggadike, e. r. corporate diversification: entryi strategy, and performance. cambridge, ma; harvard university press (1979). 44 journal of business strategies vol. 7, no.1 6. boston consulting group. perspectives on experience. boston, ma: boston consulting group (1968). 7. bucklin, l. p. "retail strategy and the classification of consumer goods," journal of marketing, vol. 27, no.1 (1963), pp. 50-55. 8. burgman, r. j. a strategic explanation of corporate acquisition success, doctoral dissertation, purdue university (1983). 9. chang, y. and h. thomas. "the impact of diversification strategy on riskreturn performance," strategic management journal, vol. 10, no.3 (1989), pp. 271-84. 10. christensen, h. k. and c. a. montgomery. "corporate economic performance: diversification strategy vs. market structure," strategic management journal, vol. 2 (1981), pp. 327-43. 11. copeland, m. t. "the relationship of consumers' buying habits to marketing methods," harvard business review, vol. 1 (1923), pp. 282-89. 12. denoble, a. f. "an analysis of the association between an acquiring firm's corporate and business level strategies and its resulting post merger managerial decisions," paper presented at the annual meetings of the academy of management, boston, ma (1984). 13. didrichsen, j. "the development of diversified and conglomerate firms in the united states, 1920-1970," business histo",ry review, vol. 46 (1972), pp. 202-19. 14. dolan, m. j. "the case for the new conglomerate," working paper, booz, allen and hamilton, new york, ny (1985). 15. gort, m. diversification and integration in american industry. princeton, nj: princeton university press (1962). 16. harrigan, k. r. "vertical controls and corporate strategy," paper presented at the annual meetings of the academy of management, boston, ma (1984). 17. hedley, b. "strategy and the business portfolio," long-range planning, vol. 10, no.1 (1977), pp. 9-15. 18. hopkins, h. d. "acquisition strategy and market structure," proceedings of the 44th annual meeting of the academy of management (1984), pp. 17-21. 19. howell, r. "plan to integrate your acquisitions," harvard business review, vol. 48, no.6 (1970), pp. 66-76. 20. johnston, j. econometric methods, second edition. new york, ny: mcgraw-hill (1972). spring 1990 harrison, hall, fj caldwell: relatedness 45 21. klein, b., r. g. crawford, and a. a. alchian. "vertical integration, appropriate rents, and the competitive contracting process," journal of law and economics, vol. 21 (1978), pp. 297-326. 22. kleinbaum, d. g. and l. l. kupper. applied regression analysis and other multivariate methods. belmont, ca: wadsworth publishing company (1978). 23. kusewitt, j. b., jr. "an exploratory study of strategic acquisition factors relating to performance," strategic management journal, vol. 6 (1985), pp. 15169. 24. maddigan, r. j. "the measurement of vertical integration," review of economics and statistics, vol. 63 (1981), pp. 328-35. 25. markham, j. w. conglomerate enterprise and economic performance. cambridge, ma: harvard university press (1973). 26. markowitz, h. portfolio selection efficient diversification of investments. new haven, ct: yale university press (1959). 27. martin, s. "market, firm, and economic performance," the monograph series in finance and economics, vol. 1 (1983), pp. 1-72. 28. mcdougall, f. m. and d. k. round. "a comparison of diversifying and nondiversifying australian industrial firms," academy of management journal, vol. 27 (1984), pp. 384-98. 29. michel, a. and i. shaked. "does business diversification affect performance?" financial management, vol. 13, no.4 (1984), pp. 18-25. 30. miracle, g. e. "product characteristics and marketing strategy," journal of marketing, vol. 29 (1965), pp. 18-24. 31. montgomery, c. a. diversification, market structure, and firm performance: an extension of rumelt's model, doctoral dissertation, purdue university (1979). 32. palepu, k. "diversification strategy, profit performance, and the entropy measure," strategic management journal, vol. 6 (1981), pp. 239-55. 33. panzar, j. c. and r. d. willig. "economies of scope," american economic review, vol. 71 (1981), pp. 268-72. 34. peter, j. p., j. h. donnelly, jr., and l. x. tarpey. a preface to marketing management, revised edition. plano, tx: business publications, inc. (1982). 35. pitts, r. a. "strategies and structures for diversification," academy of management journa~ vol. 20 (1977), pp. 197-208. 36. porter, m. e. competitive strategy. new york, ny: free press (1985). 46 journal of business strategies vol. 7, no.1 37. reed, s. f. "corporate growth by strategic planning. part ii: developing a plan," mergers and acquisitions, vol. 12, no.3 (1977), pp. 4-27. 38. rhoades, s. a. "the effect of diversification on industry profit performance in 241 manufacturing industries: 1963," review of economics and statistics, vol. 55 (1973), pp. 146-55. 39. rumelt, r. p. strategy, structure, and economic performance. cambridge, ma: harvard university press (1974). 40. rumelt, r. p. "diversification strategy and profitability," strategic management journal, vol. 3 (1982), pp. 359-69. 41. standard and poor's corporation. standard and poor's register of corporations, directors! and executives 1979, vols. 1-3. new york, ny: standard and poor's (1979). 42. varadarajan, p. and v. ramanujam. "diversification and performance: a reexamination using a new two-dimensional conceptualization of diversity in firms," academy of management journal, vol. 30 (1987), pp. 380-97. 43. williamson, o. e. "assessing the modern corporation: transaction cost considerations," in j. f. weston (ed.), large corporations in a changing society, new york, ny: new york university press (1975). 44. wrigley, l. divisional autonomy and diversification, doctoral dissertation, harvard business school (1970). assessing strategy relatedness in highly diversified firms transformations in retailing: toward the 'r' establishment panos apostolidis walter pachllk university of scranton scranton, p a introduction various theories have attempted to explain institutional change and development in retailing based on cyclical or environmental phenomena ([19j, [12], [8)). these theories have contributed much in retail management although they have not been empirically tested. a brief review is cited later on. lt is the intent of this article to show that environmental changes indeed take place in the retail world and that several transformations subsequently occur. it could be argued, however, that these transformations are not the result of theoretical propositions or scientific inquiries. they, rather, are the result of precipitous, hasty responses of individual retailers who try to economize in energy costs, to scramble their merchandise, to upgrade their services or delivery, and to ultimately remain competitive. this is called "innovation and creativity" by the authors, not transformations. the thrust of the article is on presenting a prescriptive and synthesized conceptual approach that may guide retail management in the formation of new outlets and in transforming old ones in terms of structure, layout, and functions. the main theme borrows heavily from organization theory, where propositions for new establishments have been advocated on the basis of descriptive models, self-designing systems, and other dynamics [24). marketers have not systematically tackled the problems of institutional change (and store development) that represent new frontiers for transformations. most of the theories of retailing are cyclical theories which fall into the "wheel" theories of institutional change. review of early theories mcnair [19], the so-called father of the 'wheel of retailing, has offered an early theory concerning the growth and development of retail institutions. he stated that new types of retailers enter the market as a low-margin, low-price, low-status retailers. gradually, these new types add to their operating costs by providing new services and by improving their facilities. then, over time, they become high-cost retailers vulnerable to competition. critics against this have eluded that new retail institutions are led by cost-conscious, hard-working entrepreneurs who are profit maximizers with journal of business strategies, volume 6, number 2 (fall 1989) 79 80 journal of business strategies vol. 6, no.2 no interest in providing unprofitable services. mcnair and may [20], in a later paper admitted some of the deficiencies. not all retailing institutions in the united states have begun as a low-cost, low-margin, price-oriented firm. vending machines, for example, have always been a high-cost form of distribution as well as many of the contemporary innovations such as boutiques, specialty stores, health food stores, etc. hollander [12j contended that the wheel of retailing was not quite relevant as a theoretical explanation of retail growth, development, and change. his theory has been based on the premise that retail institutions evolve from broad-based retailers with wide assortments to transform into retailers offering specialized, narrow lines. then, over time, the retailers begin again to offer a wide assortment, thereby developing a renewal general specific pattern. hollander later modified his theory asserting that instead of comparing retailing to an accordion, we might better compare it to an orchestra or to a band of accordion players. indeed, he moved from a simple theory of assortment mixes to a larger notion a theory of retail growth and development. davidson et. ai. [8] described the institutional life cycle as having four stages. the first stage is characterized by the emergence of a new retailing institution. in the second stage, both sales volume and profits attain high rates of growth. a widespread expansion into new geographic territories takes place and new entrants are rapidly attracted. market share and profitability of the innovating firms increase steadily. by the end of the period, the favorable factors tend to be counterbalanced by cost pressures that arise from a larger staff, complex internal systems, more management controls, and diseconomies of large scale multi-unit organizations. in the maturity state, market share declines whereas managers find it more difficult to control their firms. consequently, managerial effectiveness is decreased. during the final stage of decline and death, a loss in market share occurs. profits are almost non-existent. managers find that their managerial effectiveness has diminished and they try to develop new retail concepts designed to, once again, become a dominant force. today, the evolutions in retailing occur at a faster pace and the transformations are more complex beyond the conventional changes in store layout, merchandise mix, and location. there are expectations that the post office will deliver fewer regular letters as electronic mail becomes more popular; bookstores already sell audio-visual texts as well as the printed ones; prudential insurance may soon manufacture and market new houses (the japanese do it now in two-hours time); multi-sclerosis groups may eventually operate hospitals; mcdonald's may sell hamburgers from luxurious vans in town squares; going to the movies has been long ago replaced by having movies come to us. these are a few examples of the transformations evolving in retailing and the society in general. with such a foundation, the article attempts to: (a) propose the formation of new outlets with focus on organizational propositions and managerial impetus rather than incidental actions of retail managers; (b) highlight several environmental phenomena and forces which may cause the transformations in retailing; and (c) discuss some of the sporadic, diverse responses of retailers to cope with. fall 1989 apostolidis fj pachuk: retailing a novel retail 'r' establishment 81 the authors have conceived the notion of a novel retail establishment to be designed on the basis of organization theory, contemporary consumer input, and new life styles. it is a proposal for viewing the new stores and retail outlets as self perpetuating, flexibly structured, and continually adaptive models to recurrent environmental changes. these new structures may be temporarily labeled retail 'r' establishments. i the proposed innovative retail outlet can be designed and organized on postulates derived partially from organization theory and partially from adapted japanese management. the proposition can be understood if we refer for a moment to theory type z. theory type z has been proposed by ouchi and jaeger [23] as a compromised blend of theories type a (american) and type j (japanese) to serve as an alternative to american management. as known, the japanese (j) advocate life time loyalty among other things whereas the americans (a) focus on immediate gains. similarly, in the proposed model, the extreme values of american and japanese management and life styles have been modified to display average values. the authors propose the inception and understanding of a retail 'r' establishment which could possess certain fundamen~al elements or characteristics. the assigned values on these elements would come from compromising on bipolar extremes and contrasting notions. the average points on a scale could determine the character and structure of the 'new outlet.' see figure 1. the extreme bipolar values would have two opposite ends. the choices are rated at the point 'r' between: a transitive, self-adapting establishment -versusa permanent one; having continuous consumer input -versusbeing delegated by rigid management decision making; gaining lifetime customer loyalty -versusachieving short term patronizing; based on a totality of responsibilities -versusautocratic management achievements; operating on informal basis -versusstriving on formal rigidity; to ultimately remain flexible and technological -versusstagnant and antiquated. specifically, the major properties of the new retail 'r' establishment may be described in the following passages: 1. the 'r' establishment may maintain the capacity to change itself in form, size, and location in order that as the market shifts, the appropriate adjustments can be made. 1 most of the above material is elaborated from organization theory. see, bo 1. t. hedberg, paul c. nystrom, and william h. starbuck, "designing organizations to match tomorrow," in pre5criptive models of organizations, north/hollanditims studies in the management sciences 5, ed. p.c. nystrom and w. h. starbuck (1977), 171-81; karl weick, "organization design: organizations as self-designing systems," organizational dynamics 6 (autumn 1977), 30-46; and bo l. t. hedberg, paul c. nystrom, (l,nd william h. starbuck, "camping on seesaws; prescriptions for a self-designing organization," administra.tive science quarterly 21 (1976), 41-65. 82 journal of business strategies vol. 6, no.2 figure 1 a comparison between the 'r' establishment and 'c' competition continuous consumer 'r' c rigidity in understanding input needs transitive, self'r' c permanent, solid in adjusting structure modern, technological ir' c antiquated, old pleasant interior with ir' c inferior in atmosphere surprises in merchandisea leadership in newest, latest 'r' c slow moving, me-too assortments customizing, tailored, and 'r' c ready made, nontargeted services uniform items distinctive events, wide shopping ir' .... .... c .... .... .... traditional high degree of repeat 'r' c low loyalty customers connecting home 'r' c standing apart helpful with informal 'r' c too much informality dialogue fair values, pricing 'r' c unfair and quality friendly salespersons 'r' .... c .... . . .. unfriendliness customer satisfaction 'r' c managerial profit orientation motive exclusive brands with 'r' c local and global rights regional a adopted in part from cravens, et. ai. [7]. fall 1989 apostolidis & pachuk: retailing 83 for example, marriott hotels can vary the footage of their ballrooms to accom~ modate from 50 up to 1200 guests. meals on wheels move now around and change locations invariably. funeral services are performed inside buses where the relatives are seated in a circle to avoid driving to the cemetery. ice cream parlors sell soups during the winter. nabisco claims that cold cereal can be warmed-up in the microwave oven to be (perhaps) positioned against soups and sold in fast food outlets. 2. the 'r' establishment may allow consumer input in store layout, merchandise selection, opening hours, price setting, and overall op· erations. for example, the clients of the new store may request openly and in dialogue certain changes. the store will avail suggestion boxes, informal dialogue with the salespersons, continuous consumer research, and catering to tastes of the patrons. this means a greater empathy to satisfy the consumer and especially those consumers who still love to shop. 3. the 'r' establishment may retain the values of consumer individualism in shopping with responsibility coming from concensual processes by both management and clientele with minimal profit exploitation. for example, typical personality motives of shoppers include role playing, sensory stimulation, physical activity, and self-gratification [17]. shopping should provide diversion, i.e., the opportunity to find what is new in clothing, electronics, foods, or other items, at fair pricing. new establishments are designed to provide such a sensory stimulation via store decor and merchandise arrangement emphasizing individuality and the increased importance of leisure time to the consumer. 4. the 'r' establishment may connect home, place of employment, and place of purchasing by information technology and consumer awareness while maintaining the home as the center of living. for example, advances such as two-way cable and personal computers allow consumers to shop from the comfort of their own homes and to sense the stimulation and satisfaction associated with shopping. customers are able to view merchandise on command by calling up tapes on in-home tv monitors and to communicate directly with the store. computers process the sale and activate the billing procedure. other changes in consumer lifestyles, increased leisure time, and the desire for convenience have brought direct marketing. 5. the 'r' establishment may promote a holistic concern for members and their families as a retail institution caring for affiliation and customer loyalty in sharing the shopping pleasures and fulfilling their needs. 84 journal of business strategies vol. 6, no.2 for example, the new stores may sustain the individual goals of consumers by enhancing those activities that patrons perceive to be associated with their personalities and life roles, i.e., i-am-me, self gratification, and other evolving concepts in modernized outlets. technically, this retail 'r' establishment can be designed and structured as a 'transitive and self adjusting' outlet with a commitment to serve the dynamic retail world of the next decades. it has been advocated that such management approaches can be employed in macromarketing with the assumptions that macro changes can be managed or at least guided; that managers' purposeful actions can become major causes of change; and that there are such intentions by management to seek causal explanations and influences [29]. environmental phenomena and changes retailers, as survivors, are required to adapt to the shifts and changes of the environment. they can monitor, manipulate, and respond properly at least to three areas of anticipated modifications: (1) technological advances, the machines and work processes; (2) consumers, their changing demographics, attitudes, beliefs and values; and (3) structure, form, and merchandise assortment of the establishment. consequently, flexible innovative organizational structures with advanced communication systems and open consumer input will be necessary for the future. technological changes some of the changes which have appeared in the area of technology are breakthroughs in genetic biochemistry, robotics, solar fusion, heat resistant ceramics, computer microchips, laser beams, and space technology. these are forces that can be harnessed to serve human needs and even reverse the negative effects of earlier abuses [10]. biomass, or organic materials from plants such as bagasse, can produce thermoelectric power to replace oil. assembly lines or self-service outlets, long the symbol of an industrial age, have been replaced by toffier's [25j process of demassification. economies of scale have been achieved by using lasers, computers, and other technologies. in many stores, video and terminals have altered shopping. catalog showrooms may require restructure. displays have substituted warehousing with direct shipments from the manufacturer. with fuller use of home computers, commuting time may be minimal. changes in consumer values values and attitudes have undergone a strong mutation. the ideology of growth has been changed to expectations of decay, of abundance to scarcity, and of consensus to conflict. the quiet ego revolution has become the goal of many individuals as citizens seek to fulfill their human potential. the search for peak experiences, inner-peace, and greater understanding are different from the activism of the 60s and the "me" decade of the 70s. retail shifts are manifested in fast serving places, smaller packages, lighter materials, and time and cost savings. modern retail outlets fall 1989 apostolidis fj pachuk: retailing 85 reflect the values of consumer individualism by connecting home, work, and shopping altogether. our cultural values are most often aligned with the goals of an affluent economy; that is, a rewarding performance with material payoffs and rich life styles through patterns of consumption [3]. the spirit of affluence surrounds such american cultural rites, as weddings and bar mitzvahs which bring in new ways of lavishly catering. consumers on the other hand have become thrifty in their choices of products and services. the intelligent retailers can take advantages of both trends by adjusting their offerings to specific consumer groups [17j. changes in structure and form changes are also anticipated in the economy with concerns in sharing global resources and know-how. we used to harness the scientific achievements in order to restructure the environment and satisfy our desires. new ideologies have emerged now. western thought presumes that the natural state of the world is chaos and that man's role is to provide order through rational activity. a continuous battle between the forces of good and evil is waged in the process. eastern thought takes an opposite position, assuming that the natural state of the world is order, not chaos. man's role is to place himself in a harmonious relationship with the other elements of nature. the energy situation has influenced window size, entrance design, insulation measures, heating and power units, and even the position of the building. transition means to pass from one condition or place to another. transmutation means to change one form, nature, substance into another. both terms apply to retailing [2]. space management is a major concern of marketing making consumer input necessary for store layout, merchandise selection and setting open-close hours. during the past several years, a number of technological advances have already been adopted by innovative outlets as the result of growing computerization [4]. the major technological advances include: 1. computerized checkout systems (upc or ocr-a) that speed up transactions, record data, and reduce cashier errors. 2. anti-shoplifting tags attached to merchandise to set off an alarm, if not properly removed by employees. 3. automatic energy-control systems that carefully monitor store temperature and reduce fuel costs. 4. site-selection programs which can evaluate the savings from alternative store locations. 5. improved credit systems that allow faster processing of credit authorizations and transfers of funds. 6. computerized inventory systems that reduce the need for physical inventory counts. 86 journal of business strategies vol. 6, no.2 in general, such technological advances enable retailers to improve efficiency, obtain information faster, hold down labor costs, minimize losses due to theft, and to make profits. sporadic responses: the metamorphosis occurs many retailers of the 1990s will develop aggressive response strategies. one challenge will be to make consumers perceive their retail outlets as destination stores rather than convenience stores. destination stores are units where selection and uniqueness of merchandise act as magnets for customers. as such, they are distinguished from their counterparts which are primarily patronized because of convenience. bloomingdale's flagship unit in new york is an outstanding example. at the other end of the spectrum, wholesales clubs appealing on price, such as bj's, sam's pace, and costco are blooming. according to loeb [14], the retailers that will prosper in the future are those who can define and project a destination store image. another illustration, is tasca lincoln-mercury in massachusetts with its cramped showroom-garage, with salesmen who look like sharks, and with mechanics who are scruffy. tasca has become successful by adapting to its environment and developing a tremendous consumer loyalty because of its customer service. tasca delivers vehicles in sparkling clean condition, it meets schedules, and keeps service appointments. it also has valet parking when customers pick up their vehicles, has salespeople who make follow-up calls after sales, and gives monthly bonuses to personnel who scored highest in customer satisfaction surveys [22]. to maintain its position as a large supermarket chain, safeway has embarked on an aggressive strategy. the firm has been "going up-scale" through its bon appetit stores that feature gourmet foods, a large selection of fine wines, exotic produce items, and sizable floral departments [26j. major chains are blazing trails into small town america. in lowe's home centers, the staff is trying to know customers on a first-name basis because people practically demanded that a store be opened in buffalo, missouri. according to the manager of the scaled-down 29,800 sq. ft. store people are just happy to have a store where they can get 90% of their needs avoiding to drive into the city [21]. j.c. penney recently introduced their video-ordering system in the chicago area cable television subscribers. members are wired to teladion's "black box," and after the television is on, they can select from a menu the product/service category/item and the name of the retailer to buy from [l1j. retailers are also competing in a market characterized by maturity, overcapacity, intense price competition, and an essential "sameness" among stores. all these forces were once reserved for the so-called commodities. not only are store types looking less and less different from one another, but a growing range of store types is selling the same kinds of merchandise [27j. these retailers will need new strategies to be successful. fall 1989 apostolidis eft pachuk: retailing 87 there are major and minor transformations evolving in retailing. in response to the shifts in the marketplace, retailers basically modernize their structures, increase their sizes, and relocate to prosper. unfortunately, these responses seem to be isolated or divergent because they come as an immediate solution to the problems of declining markets, rising costs, etc. the authors advocate that they are not based on predictions on the 'evolution of markets and on the totality of forthcoming causes. historical retail evolutions historically, retailers have been striving to survive and prosper. in the early 1950s they developed self-service shopping formats with wide aisles, bright lights and a large, varied stock of merchandise. this development revolutionized food retailing almost overnight [6]. chain stores displaced single proprietorships and, as they did, supermarkets proliferated in suburban shopping centers. other past retail innovations have combined two different businesses to form a successful partnership. albertsons and skaggs have joined forces and opened outlets in texas and florida that featured full food store lines and drugstore services. levitz pioneered the furniture warehouse concept, underpriced conventional furniture stores, and has added carpets, consumer electronics, and major appliances to its inventory. vigorous competition for the retailer has come from electronic communications, specifically the telephone. phone-ordering, distribution centers, and delivery services have dealt with groceries, drugs, flower arrangements, car rentals, etc. tele-mart enterprises of san diego has launched a similar delivery system. quarterly catalogs were sent for a membership fee and the products were shipped from the company's centralized distribution facility. the costs of personnel and equipment are partially offset by savings on physical plant leases. attempts for diversification have come from the addition of services. sears has established an automobile driving school, dental services, and has added life insurance to their allstate casualty insurance business. marshall field of chicago reweaves rugs and restores oil paintings. in other stores, cooking classes are offered and beauty parlors are associated with health restaurants. it is estimated that as much as 20 percent of department store revenues will be derived from new services. as a result, retailers have created bigger shopping centers using size to their com· petitive advantage [28). octopus stores, such as those of kroger, have been built around huge, centrally placed food departments surrounded by sections featuring specialty items as women's fashions, children's clothing, shoes, drugs, health products, and beauty aids. the day of the behemoth had arrived; aisles stretched the equivalent of a block, displays alternated with conventional shelving, and items ranging from sta.tionery to clothing were included [16]. dominant business firms, because of their market position, have created significant societal consequences through their marketing activities [29]. most of these firms have assumed macro responsibilities. 88 journal of business strategies concluding remarks vol. 6, no.2 adopting innovations and responding with sophistication and creativity are vitally important in retailing. both are considered as prerequisites for success. however, radical organizational designs have not been universally propagated although have appeared as plausible responses to new technologies, humanistic values, and the macroenvironment. in the past, changes in the environment have typically occurred slowly with minor implications. today, the pace of environmental change is accelerating at a substantial rate. the role of retail management is to find a consistent relationship between the firm and its environment. far-sighted retailers must monitor consumer demographics, shifts in life-styles, and the progress in technology. most retail institutional changes do occur because of the evolving environment. for example, non-store retailing has grown fast. more firms are engaged in riskminimization retailing, whereby others strive to hold down initial investment costs as well as operating expenses. rationalized retailing has combined highly centralized management control with rigorous operating procedures. two opposite strategies, mass merchandising and positioned retailing, have become quite popular as more firms capitalize on the "bigness" of their stores, while others concentrate on niching smaller market segments. retailers (in the micro level) operate efficiently their stores and cater satisfactorily to their clientele. however, they do not care for the totality of markets. it is the task of retail management (in the macro level) to be concerned with instituting and fostering planned transformations (of shape and place) for outlets and establishments in modern shopping. we may witness institutions (outlet conglomerates) which will reach the point where they will not only adapt to the innovations, but will also generate forms, values, and systems of their own to perpetuate themselves. the authors advocate that such a possibility is feasible and they propose the examination and study of the retail-r establishment which is conceived and postulated from relevant organization theories and management propositions. epilogue the role of marketing is pervasive. changes in future consumer markets will require new, unique and innovative approaches to retailing strategy. marketing in modern retail organizations should be more of a strategic endeavor and less of an extension of the advertising function. strategies will have to become more aggressive and competitive by utilizing a broader range of tools than merely pricing and sales promotions. the professionalization of retailing can be enhanced by the introduction of new and fresh marketing thoughts from diverse, external or internal (technological, managerial, and scientific) sources. references 1. anderson, patricia m. "association of shopping center anchors with performance of a nonachor specialty chain's stores." journal of retailing (summer 1985), pp. 61-74. fall 1989 apostolidis tj pachuk: retailing 89 2. apostolidis, panos. "managing future retailing systems." developments in marketing science, vol. 1 (1978), p. 243. 3. berkman, harold w. and christopher gilson. consumer behavior. boston, ma: kent publishing company (1986). 4. berman, barry and joel evans. retail management. new york, ny; macmillan publishing co. (1989). 5. bowles, samuel. "setting a moral agenda for the economy/' the new york times (november 6, 1988), p. b2. 6. butt, clifford and william hailes. introduction to supermarket occupations. new york, ny: delmar, inc. (1967). 7. cravens, david, gerald hills, and robert woodruff. marketing decision mak· lng. homewood, 1l: richard irwin (1976). 8. davidson, william, albert bates, and stephan bass. "the retail life cycle." harvard business review, vol. 54 (november·december 1976), p. 89-96. 9. dunkin, amy, michael o'neal, and stephen phillips. "power retailers," business week (december 21, i987), pp. 86-92. 10. gregory, gene, mike tharp, and james bartholomew. "japan's third revolution." world press review (march 1982), pp. 23-25. 11. hagedorn, ann. "penney's 'tv mall' makes its hate humbled debut." wall street journal (february 6, 1988), p. 6. 12. hollander, stanley. "notes on retail accordion." journal of retailing (summer 1966), pp. 29·40. 13. kaufman, s. "coping with rapid retail evolution." journal of consumer marketing (winter 1985), pp. 17-28. 14. loeb, walter. "retailers with destination store image will prosper in the '90s." discount store news (may 1987), pp. 171-172. 15. markin, rom and calvin duncan. "the tran~formation of retailing insti· tutions: beyond the wheel of retailing and life cycle theories." journal of macromarketing (spring 1981), pp. 58-66. 16. markowitz, arthur. "carrefou! opens u.s. hypermarket: maintains true to european roots." discount store news (february 1988), pp. 1, 100. 17. mason, barry, morris mayer, and hazel ezell retailing. plano, tx: business publications, inc. (1988). 90 journal of business strategies vol. 6, no.2 18. may, eleanor g., william ress, and walter salmon. "future trends in retailing." marketing science institute (february 1985). 19. mcnair, malcolm p. "significant trends and developments in the postwar period." in a. b. smith, ed., competitive distribution is a free, high level economy and its implication for the university. pittsburgh, pa: university of pittsburgh press (1958). 20. mcnair, malcolm p. and eleanor a. may. the evolution of retail institutions in the united states. cambridge, ma: marketing science institute (1976). 21. miller, norman. "rural retailing: the last frontier." chain store age executive (march 1986), pp. 18-19, 22. 22. moore, thomas. "would you buy a car from this man?" fortune (april 11, 1988), pp. 72-74. 23. ouchi, william, and alfred jaeger. "type z organization: stability in the midst of mobility." academy of management review (1978), pp. 305-314. 24. robey, darrel. designing organizations: a macro perspective. homewood, il: richar<;! irwin, inc. (1982). 25. toffier, alvin. the third wave. new york, ny: william morrow (1980). 26. wienstein, steve. "the new safeway." progressive grocer, (november 1987), pp.21-28. 27. wortzel, lawrence. "retailing strategies for today's mature marketplace." journal of business strategy (spring 1987), pp. 45-57. 28. zehr, leonard. "mega mall." wall street journal (october 7, 1985), pp. 1-14. 29. zif, jehiel. "a managerial approach to macromarketing." journal of marketing (winter 1980), pp. 36-45. transformations in retailing: toward the 'r' establishment forecasting business inventories as an economic indicator seyed-mahmoud aghazadeh department of business administration state university of new york college at fredonia fredonia, new york inventories, or business investment in stock, may be used as a major economic indicator. the movement in inventory reflects the changes in the volume of goods needed to support the changes in the rates of business operations. consequently, inventories usually react closely to movements in orders, production, and sales. since the inventory investment component of aggregate demand fluctuates greatly over the course of actual cycles in the business world, it is extremely difficult to forecast the level of inventories. this volatility can be attributed to excess stock held in case of a large increase in demand which in turn can cause an even greater change in inventory investment. this volatility can also be attributed to the lag between the change in sales and the desired response in inventory investment, along with numerous other factors that may shift in their impact on inventories and their level of importance. evidence [6] suggests that, in general, inventories seem to lag behind business activity, and inventory shifts occur about three to six months after a turn has occurred in general business activity. efforts to determine theoretical relationships in order to explain inventory investment have examined a wide range of influences ([2], [7], [8]), such as the costs of financing inventories, optimal costs (the cost of excess stocks contrasted with the cost of lost sales due inadequate inventories), and the state of capacity utilization and its implications for future supply flows. the major factor in all inventory theories, however, is the relationship to sales. theoretical framework and applications the ultimate goal of economic forecasting! in a business setting is to provide top management and line managers with expert advice about the present and future behavior of the economy, with special emphasis on how these developments are likely to impact the firms' business. journal of business strategies, volume 5, number 2 (fall 1988) 'two works which provide accessible treatments for the novice forecasters are: dominick salvatore, theory and problems of statistics and econometrics, new york, ny: mcgraw-hill (1982), and robert s. pindyck and daniel l. rubinfeld, econometric models and economic forecasts, new york, ny, mcgraw-hill (1976). a more advanced treatment, geared to forecasting, is michael d. intriligator, econometric models, techniques and applications, englewood cliff., nj, prenticehall (1978). a classical advanced treatment i. j. johnston, econometric methods, new york, ny, mcgraw-hili (1972). 104 fall 1988 aghazadeh: bllsine.~s inventories 105 forecasts of firmand industry-specific variables such as costs, product demand, market share, resource requirements, and market demand conditions, are vital functions of a business economic forecaster. this article translates the impact of these variables on sales, costs, and profitability of firm. the aim is to develop a set of simple equations for those sectors of the economy which are most sensitive to changing economic conditions, while basing the forecasts of other sectors on external factors and judgment. the application of this model will be on the level of inventories as a group of indicators, while we develop the model based on step-by-step procedures. in order to forecast business inventories based on sales, the types of inventories held by different businesses must be determined. these businesses, which include the stocks held by manufacturers, wholesalers, and retailers, are subject to different length lags between sales and changes in inventory investment. the problem comes from management's decisions in the firm to either increase, maintain, or reduce the level of inventory. these decisions are based on an expected future demand, price level, competition, and other internal decision-making factors. therefore, if managers base their decisions on whatever current information they have, they may be caught in an unwanted position due to the time lags associated with investment inventory, and may need even greater corrective action to return to stabilization. step 1 a: forecast of sales of manufacturers the theoretical model that is used takes time lags and cyclical economic fluctuations into account. retail sales, as an ongoing process, act as a determining factor manufacturer's and wholesaler's sales. this is because retail goods would have to be sold at an earlier time, either directly (by manufacturers) or indirectly (through wholesalers), to the retailers. the manufacturers' shipments are forecast using one month lagged total sales and the unemployment rate in the current month to detect any cyclical fluctuations. the estimating equation for manufacturers' shipments, using regression analysis from january 1975 to december 1985 (bureau of the census, u.s. department of commerce) is shown in logarithms as follows: 2 inm 5, = ina + btlnt rs'_l + b2 lnu r, (1) where ms, = manufacturers' shipments in the current month, and trs'_l = total retail sales in the prior month, and u r, = unemployment rate in the current month. 2sever al studies that determine theoretical relationships to explain inventory investments are: alan s. blinder i "retail inventory behavior and business fluctuations," brookings' papers on &onomic activity, no.2, pp. 443-505 (1981): michael a. lovell, "manufacturers' inventories, sales expectations, and the acceleration principle," &onometrica (july 1961), pp. 293-314: r.uth p. mack, information, expectations, and inventory fluctuations: a study of materials stock on hand and on order, new york, ny: columbia university press for the national bureau of &onomic r.esearch (1967). 106 journal of business strategies vol. 5, no.2 coefficients ina = 4.92 b1 = -0.52 b2 = -0.22 t statistics 13.36° -0.61 -5.05° 94.76" ser=0.01 p = .99 11'2=.91 dw=2.48 '----.. " ----------~ "statistically significant at .01 according to these results, after the equation has been corrected for autocorrela· tion, manufacturers' shipments are negatively related to both lagged retail sales and the unemployment rate. the negative coefficient for the unemployment rate (b 2 ) suggests, as expected, that the shipments are likely to decline when economic activity decreases. the coefficient (bd suggests that for every $1 increase in retail sales in the previous month, manufacturers' shipments decrease by $.53. this result was not expected, though the t statistic for the coefficient (b1 ) is not significant. this result possibly stems from the fact that employment generates income which, in turn, is largely spent on consumer goods and services. moreover, consumption fuels the economy not only because it directly comprises nearly two-thirds of total gnp, but also because it is the source of the derived demand for investment goods and for a large part of government services. retail sales, in turn, comprise a major portion of personal consumption expenditure. most purchases of durable and nondurable goods are made at retail outlets. thus, since retail sales are a large portion of consumption, it follows that retail sales are also likely to be a function of personal income. b. forecast of sales of wholesalers since forecasts of manufacturers' shipments and retail sales are available, total sales by manufacturers, wholesalers, and retailers were forecast using the following equation: in(ms + ws + rs), = ina + b1lnpi, + b2 1nur, + b3 intrs'_1 (2) where (m s + w 5 + rs), = total sales by manufacturers, wholesalers, and retailers, pi, = personal income, u rt = unemployment rate, and t rs'_l = total retail sales in the prior month the results for equation (2) are shown below. coefficients ina = 3.3 b 1 = 0.29 b2 =-.17 b3 = -.06 t statistics 14.82" 9.14" -5.92" 0.97 24.95" ser=.ol p = .90 11'2=.99 dw=2.28 -""-------_._"statistically significant at .01 fall 1988 aghazadeh: business inventories 107 except for the low insignificant coefficient for lagged retailed sales (corrected for autocorrelation), the results are as expected. wholesalers' shipments can then be estimated as in equation (3).3 inws. = in(ms + ws + rs.) -inms. -lnt rs. (3) the total retail sales (int rs.) must be estimated before we can estimate the wholesalers' shipments (inws.) in equation (3). a simple approach to forecasting retail sales can be performed, as in equation (4). (4) where t rst = total retail sales, pit == personal income, and urt == unemployment rate. it is logical that a forecast of retail sales estimates a relationship between retail sales and personal income. by this logic, an explanatory variable that is explicitly cyclical in nature should be included in the estimation of the more cyclical retail sales components. a choice for a cyclical variable would be the unemployment rate, which is hypothesized to have an inverse relationship to total retail sales. the expected result of a regression analysis of the data for equation (4) is shown below: coefficients ina =1.93 b1 = .28 fl2 == .14 p == .88 ji.2 =.89 dw =2.01 t statistics (30.33)a (30.82)a (-9.10)a (22.71 )a ser=.03 ·statistically significant at .01 step 2 forecast of inventory/sales ratio the moving average can control the changes in inventory/sales ratios over time and utilizes the most recent data in order to keep the forecast responsive.' the result can be improved by doing a regression of the actual inventory/sales ratio to its moving average, as in the following equation: i ins = ina + b1 inm ais 3equation (3) is the logarithm form of the following equation: ws, == (ms + ws + rs,) ms, trs, (5) where the estimated values for manufacturers' shipments and retail sales are suhtracted from the estimated levels for the total sales. 4the inventory/sales ratios for each sector can be derived 'based on the past trends. a twelvemonth moving average of actual inventory/sales ratios may be constructed for 1984, using the 108 journal of business strategies vol. 5, no.2 using equation (.5), regression results for manufacturing, wholesale, and retail are shown below. manufacturing coefficients t statistics ina = 4.60 -1.12 b 1 = .97 6.62 a fp -'-=-.-88-------------1.5.41 a r2 =.97 dw=1.94 ser=.01 23.20a ser=.09 t statis tics .89 .5.41 a i p; .80 r =.91 dw=1.8.5 --------' c retail i . coefficients ina = .01 b1 = .99 wholesale coefficients t statistics ina = .0.5 .08 b[ = .94 6.0.5 a p = .84 18.69 ji=.92 dw=2.20 ser=.03 a statistically significant at .oj. the results are expected. the 11 2 is high for all equations, suggesting that the large amount of variation in inventory/sales ratios is explained by the variation in the change in moving average of inventory/sales ratios for all equations. applications recent sales and production trends may provide a basis for refining forecast of the change in inventory levels of a compapy. inventory adjustment, because it aids the distribution and production of final goods, might be viewed as investment-type activity, in contrast to the coilsumption oriented activities. in addition, reports of the national association of purchasing managers on the current st.atus of sales, orders and inventories, supply helpful information about the intentions of business to invest in inventories. as was illustrated, the inventory forecast was obtained based on the product of forecast sales level by the forecast inventory/sales ratio. since these forecasts are built following equation: mais where mais = moving average of inventory/sales ratio and f = inventory/sales ratios. a good introduction to the nature and main aspects of the autoregressive integrated moving average (arima) method is provided in c.w.j. granger, fbrecasting in rusiness and economics, new york, ny: academic press (1980), ch. 3, p. 64. the original source on this technique is g.e_p. box and g.m_ jenkins, time series analysis, san francisco, ca: holden-day (1970). a more simplified version of the technique is provided by c. nelson, applied time series analysis, san francisco, ca: holden-day (1973). fall 1988 aghazadeh: business inventories 109 upon one another-due to their theoretical relationships-their consistency is assured. underlying this approach is the basic concept that these forecasts are interrelated. although the forecast relationships constituted a model of macroeconomic activity, an indicative forecast model of microeconomic processes, based on the same logical relationships, could be developed and used to anticipate future turning points. moreover, this approach is not very costly. there are only a few regression equations to be computed which need only be updated annually; forecast updates may be computed manually, or at little more cost but at much greater speed, using a microcomputer. the advantage of a macroeconomic model is that forecasts of overall macroeconomic conditions constitute the most expert contribution the forecaster makes to a firm's planning and general business operations. managers may have more detailed knowledge of firm-specified topics~such as product market conditions, capacity, and production methods-but the performance of the overall economy is where the economist's predictive knowledge is greater. alternatively, specific macroeconomic measures often are key inputs to the firms's own planning. summary change in the level of inventories is one of the most important classes of economic indicators. the change in inventories results from several factors, such as sales, production, and the intended inventory/sales ratio. the present paper developed a forecasting model based on the fact that an explicit forecast linkage does exist among the variables. this information was used to modify not just the subsequent forecasts of retail sales, but also those for the other variables as well. inventory/sales ratios for manufacturers, wholesalers, and retailers were forecast, and finally, the inventory forecast was obtained. the mode] described here was used to illustrate an approach to inventory forecasting. using a few simply derived, exogenous variables the forecaster is able to build a simple yet detailed forecast model for inventory. the model is more useful than the single-equation reduced form which is commonly employed because it allows the forecaster to draw conclusions about not only inventory but also its dynamic components. references l. bales, dale g. and larry c. peppers. business fluctuations: forecasting techniques and applications. englewood cliffs, n.j: prentice-hall (1982). 2. blinder, alan s. "r.etail inventory behavior and business fluctuations." brookings papers on economic activity, no.2 (1981), pp. 443-505. 3. bureau of economic analysis. u. s. department of commerce. 4. bureau of labor statistics. u. s. department of labor. 5. bureau of the census. u. s. department of commerce. 110 journal of business strategies vol. 5, no.2 6. butler, william f., robert a. kavesh, and robert b. plalatt. methods and techniques of business forecasting. part three ("inventories"), louis j. paradiso. englewood cliffs, nj: prentice-hall (1974). 7. lovell, michael a. "manufacturers' inventories, sales expectations, and the acceleration principle." econometrica. (july 1961), pp. 293-314. 8. mack, ruth p. "information, expectations, and inventory fluctuations: a study of materials stock on hand and on order." new york, ny: columbia university press for the national bureau of economic research (1967). 9. mcauley, john j. economic forecasting for business: concepts and applications. englewood cliffs, nj: prentice-hall (1986). 10. matzler, lloyd a. "the nature and stability of inventory cycles." review of economics and statistics, vol. 3 (august 1941), pp. 113-29. 11. mills, edwin s. "the theory of inventory decisions." econometrica, vol. 25 (april 1957), pp. 222-39. 12. whitman, marina von neuman. "economics from three perspectives." business economics (january 1983), pp. 20-24. forecasting business inventories as an economic indicator volume 31, number 1 263 estimation of consumption elasticities for oecd countries: testing price asymmetry with alternative dynamic panel data techniques edward f. blackburne sam houston state university • huntsville, tx donald l. bumpass sam houston state university • huntsville, tx introduction in recent years, the dynamic panel data literature has begun to focus on panels in which the number of cross-sectional observations ( n ) and the number of time-series observations ( t ) are both large. the availability of data with greater frequency is certainly a key contributor to this shift. some cross-national and cross-state data sets, for example, are now large enough in t such that each nation (or state) can be estimated separately. see blackburne and frank, (2007) for further details. the asymptotics of large n, large t dynamic panels are quite different from the asymptotics of traditional large n, small t dynamic panels. small t panel estimation usually relies on fixed or random effects estimators, or a combination of fixed effects estimators and instrumental variable estimators, such as the arellano and bond, (1991) gmm estimator. these methods require pooling individual groups and allowing only the intercepts to differ across the groups. one of the central findings from the large n, large t literature, however, is that the assumption of homogeneity of slope parameters is often inappropriate. this point has been made by pesaran and smith (1995); im et al. (2003), pesaran et al; (1997, 1999), phillips and moon, (2000)1. with the increase in time observations inherent in large n, large t dynamic panels, nonstationarity is also a concern. recent papers by pesaran et al. (1997, 1999) offer two important new techniques to estimate nonstationary dynamic panels in which the parameters are heterogeneous across groups: the mean-group and pooled mean-group estimators. the mean-group estimator (mg) (see pesaran and smith, 1995) relies on estimating n time series regressions and averaging the coefficients, while the pooled mean-group estimator (pmg) (see pesaran et al., 1997,1999) relies on a combination of pooling and averaging of coefficients. 1 for further discussion of this literature see chapter 12 in (baltagi, 2001). 264 journal of business strategies in recent empirical research, the mg and pmg estimators have been applied in a variety of settings. freeman, (2000), for example, uses the estimators to evaluate state-level alcohol consumption over the period 1961 to 1995. martinez-zarzoso and bengochea-morancho, (2004) employ them in an estimation of an environmental kuznets curve in a panel of 22 oecd nations over a period 1975 to 1998. frank, (2005) uses the mg and pmg estimators to evaluate the long-term impact of income inequality on economic growth in a panel of u.s. states over the period 1945 to 2001. this paper applies the mg and pmg estimators to a panel of oecd nations for the years 1970–2004. we present a simple dynamic model of oil consumption as a function of income and prices. as in previous studies, we allow demand to respond asymmetrically to price shocks. specifically, this paper has three goals: • test the degree of heterogeneity in oil consumption among the oecd nations • test the asymmetric response of oil consumption with respect to price • estimate precise price and income elasticities for oecd oil consumption this paper proceeds as follows. section 2 discusses the methods involved, including price decomposition and alternative dynamic panel estimators. section 3 briefly describes the data. section 4 presents the results and section 5 concludes. methodology demand asymmetries following the recent work of gately and huntington, (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt , into three components: describes the data. section 4 presents the results and section 5 concludes. 2 methodology 2.1 demand asymmetries following the recent work of gately and huntington (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt, into three components: pmax,t = max(pt, pt−1) (1) prec,t = t∑ t=1 max(0, (pt − pt−1) − (pmax,t − pmax,t−1)) (2) pcut,t = t∑ t=1 min(0, pt − pt−1) (3) pmax,t and prec,t are non-decreasing series while pcut,t is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: pt = pmax,t + prec,t + pcut,t (4) given a simple demand model of the form qt = α + β1pmax,t + β2prec,t + β3pcut,t + �t (5) the null hypothesis of price response symmetry is tested as β1 = β2 = β3. under the alternative hypothesis of price asymmetry, at least one βi is statistically different. prior research convincingly argues that |β1| > |β2| > |β3|. our results partially confirm this. (1) describes the data. section 4 presents the results and section 5 concludes. 2 methodology 2.1 demand asymmetries following the recent work of gately and huntington (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt, into three components: pmax,t = max(pt, pt−1) (1) prec,t = t∑ t=1 max(0, (pt − pt−1) − (pmax,t − pmax,t−1)) (2) pcut,t = t∑ t=1 min(0, pt − pt−1) (3) pmax,t and prec,t are non-decreasing series while pcut,t is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: pt = pmax,t + prec,t + pcut,t (4) given a simple demand model of the form qt = α + β1pmax,t + β2prec,t + β3pcut,t + �t (5) the null hypothesis of price response symmetry is tested as β1 = β2 = β3. under the alternative hypothesis of price asymmetry, at least one βi is statistically different. prior research convincingly argues that |β1| > |β2| > |β3|. our results partially confirm this. (2) describes the data. section 4 presents the results and section 5 concludes. 2 methodology 2.1 demand asymmetries following the recent work of gately and huntington (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt, into three components: pmax,t = max(pt, pt−1) (1) prec,t = t∑ t=1 max(0, (pt − pt−1) − (pmax,t − pmax,t−1)) (2) pcut,t = t∑ t=1 min(0, pt − pt−1) (3) pmax,t and prec,t are non-decreasing series while pcut,t is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: pt = pmax,t + prec,t + pcut,t (4) given a simple demand model of the form qt = α + β1pmax,t + β2prec,t + β3pcut,t + �t (5) the null hypothesis of price response symmetry is tested as β1 = β2 = β3. under the alternative hypothesis of price asymmetry, at least one βi is statistically different. prior research convincingly argues that |β1| > |β2| > |β3|. our results partially confirm this. (3) volume 31, number 1 265 pmax,t ,and prec,t , are non-decreasing series while pcut,t , is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: describes the data. section 4 presents the results and section 5 concludes. 2 methodology 2.1 demand asymmetries following the recent work of gately and huntington (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt, into three components: pmax,t = max(pt, pt−1) (1) prec,t = t∑ t=1 max(0, (pt − pt−1) − (pmax,t − pmax,t−1)) (2) pcut,t = t∑ t=1 min(0, pt − pt−1) (3) pmax,t and prec,t are non-decreasing series while pcut,t is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: pt = pmax,t + prec,t + pcut,t (4) given a simple demand model of the form qt = α + β1pmax,t + β2prec,t + β3pcut,t + �t (5) the null hypothesis of price response symmetry is tested as β1 = β2 = β3. under the alternative hypothesis of price asymmetry, at least one βi is statistically different. prior research convincingly argues that |β1| > |β2| > |β3|. our results partially confirm this. (4) given a simple demand model of the form describes the data. section 4 presents the results and section 5 concludes. 2 methodology 2.1 demand asymmetries following the recent work of gately and huntington (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt, into three components: pmax,t = max(pt, pt−1) (1) prec,t = t∑ t=1 max(0, (pt − pt−1) − (pmax,t − pmax,t−1)) (2) pcut,t = t∑ t=1 min(0, pt − pt−1) (3) pmax,t and prec,t are non-decreasing series while pcut,t is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: pt = pmax,t + prec,t + pcut,t (4) given a simple demand model of the form qt = α + β1pmax,t + β2prec,t + β3pcut,t + �t (5) the null hypothesis of price response symmetry is tested as β1 = β2 = β3. under the alternative hypothesis of price asymmetry, at least one βi is statistically different. prior research convincingly argues that |β1| > |β2| > |β3|. our results partially confirm this. (5) the null hypothesis of price response symmetry is tested as describes the data. section 4 presents the results and section 5 concludes. 2 methodology 2.1 demand asymmetries following the recent work of gately and huntington (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt, into three components: pmax,t = max(pt, pt−1) (1) prec,t = t∑ t=1 max(0, (pt − pt−1) − (pmax,t − pmax,t−1)) (2) pcut,t = t∑ t=1 min(0, pt − pt−1) (3) pmax,t and prec,t are non-decreasing series while pcut,t is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: pt = pmax,t + prec,t + pcut,t (4) given a simple demand model of the form qt = α + β1pmax,t + β2prec,t + β3pcut,t + �t (5) the null hypothesis of price response symmetry is tested as β1 = β2 = β3. under the alternative hypothesis of price asymmetry, at least one βi is statistically different. prior research convincingly argues that |β1| > |β2| > |β3|. our results partially confirm this. under the alternative hypothesis of price asymmetry, at least one describes the data. section 4 presents the results and section 5 concludes. 2 methodology 2.1 demand asymmetries following the recent work of gately and huntington (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt, into three components: pmax,t = max(pt, pt−1) (1) prec,t = t∑ t=1 max(0, (pt − pt−1) − (pmax,t − pmax,t−1)) (2) pcut,t = t∑ t=1 min(0, pt − pt−1) (3) pmax,t and prec,t are non-decreasing series while pcut,t is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: pt = pmax,t + prec,t + pcut,t (4) given a simple demand model of the form qt = α + β1pmax,t + β2prec,t + β3pcut,t + �t (5) the null hypothesis of price response symmetry is tested as β1 = β2 = β3. under the alternative hypothesis of price asymmetry, at least one βi is statistically different. prior research convincingly argues that |β1| > |β2| > |β3|. our results partially confirm this. is statistically different. prior research convincingly argues that describes the data. section 4 presents the results and section 5 concludes. 2 methodology 2.1 demand asymmetries following the recent work of gately and huntington (2002), this paper allows for asymmetric price response in oil demand. models that assume price symmetry when, in fact, it does not exist introduce model misspecification and downwardly bias income elasticity estimates. accordingly, we decompose the world price of oil (in logs), pt, into three components: pmax,t = max(pt, pt−1) (1) prec,t = t∑ t=1 max(0, (pt − pt−1) − (pmax,t − pmax,t−1)) (2) pcut,t = t∑ t=1 min(0, pt − pt−1) (3) pmax,t and prec,t are non-decreasing series while pcut,t is non-increasing. figure 1 presents the decomposed real oil price series for the period 1970-2004. the decomposition of price listed above is convenient since it allows for simple testing of symmetric consumption responses to price changes. at any point in time, the following identity holds: pt = pmax,t + prec,t + pcut,t (4) given a simple demand model of the form qt = α + β1pmax,t + β2prec,t + β3pcut,t + �t (5) the null hypothesis of price response symmetry is tested as β1 = β2 = β3. under the alternative hypothesis of price asymmetry, at least one βi is statistically different. prior research convincingly argues that |β1| > |β2| > |β3|. our results partially confirm this. our results partially confirm this. figure 1 price decomposition -1 00 -5 0 0 50 10 0 1970 1980 1990 2000 year real price oil (2006$) maximum cut recovery figure 1: price decomposition 266 journal of business strategies oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, (6) where the number of nations i=1,2, ..., n, the number of time periods t =1,2, ..., t,qit, is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl (1,1,1) dynamic panel specification of (6) is 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, (7) the error correction re-parametrization of (7) is 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, (8) where 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, . the error-correction speed of adjustment parameter, 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, , and the long-run coefficients, 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, and 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, are of primary interest. one would expect 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, , should be negative and the long-run income elasticity, 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. the mean-group and pooled | mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both and are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith, (1995). with this estimator, volume 31, number 1 267 the intercepts, slope coefficients, and error variances are all allowed to differ across groups. more recently, pesaran et al., (1997), pesaran et al., (1999) have proposed a pooled mean-group (pmg) estimator that combines both pooling and averaging. this intermediate estimator allows the intercept, short-run coefficients, and error variances to differ across the groups (as would the mg estimator), but constrains the long-run coefficients to be equal across groups (as would a fe estimator). since equation (8) is nonlinear in the parameters, pesaran et al., (1999) develop a maximum likelihood (ml) method to estimate the parameters. expressing the likelihood as the product of each cross-section’s likelihood and taking the log yields: the intercepts, slope coefficients, and error variances are all allowed to differ across groups. more recently, pesaran et al. (1997, 1999) have proposed a pooled mean-group (pmg) estimator that combines both pooling and averaging. this intermediate estimator allows the intercept, short-run coefficients, and error variances to differ across the groups (as would the mg estimator), but constrains the long-run coefficients to be equal across groups (as would a fe estimator). since equation (8) is nonlinear in the parameters, pesaran et al. (1999) develop a maximum likelihood (ml) method to estimate the parameters. expressing the likelihood as the product of each cross-section’s likelihood and taking the log yields: lt (θ ′ , ϕ ′ , σ ′ ) = − t 2 n∑ i=1 ln(2πσ2i ) − 1 2 n∑ i=1 1 σ2i (∆yi − φiξi(θ))′hi(∆yi − φiξi(θ)) (9) for i = 1, . . . , n, where ξi(θ) = yi,t−1 −xiθi, hi = it −wi(w ′i wi)wi, it is an identity matrix of order t , and wi = (∆yi,t−1, . . . , ∆yi,t−p+1, ∆xi, ∆xi,t−1, . . . , ∆xi,t−q+1). the parameter estimates from iterated conditional likelihood maximization are asymptotically identical to those from full-information maximum likelihood. but the estimated covariance matrix is not. however, since the distribution of the pooled mean-group parameters is known, we are able to recover the full covariance matrix for all estimated parameters. as shown in pesaran et al. (1999), the covariance matrix can be estimated by the inverse of   ∑n i=1 φ̂2i x ′ ixi σ̂2i −φ̂1x′1ξ̂1 σ̂21 · · · −φ̂n x ′ n ξ̂n σ̂2 n −φ̂1x′1w1 σ̂21 · · · −φ̂n x ′ n wn σ̂2 n ξ̂′1ξ̂1 σ̂21 · · · 0 ξ̂ ′ 1w1 σ̂21 · · · 0 ... ... ... ... ... ξ̂′ n ξ̂n σ̂2 n 0 · · · ξ̂ ′ n wn σ̂2 n w ′1w1 σ̂21 · · · 0 ... ... w ′ n wn σ̂2 n   (10) the mean-group parameters are simply the unweighted means of the individual coefficients. for example, the mean-group estimate of the error correction coefficient, (9) for i =1, ..., n, where , the intercepts, slope coefficients, and error variances are all allowed to differ across groups. more recently, pesaran et al. (1997, 1999) have proposed a pooled mean-group (pmg) estimator that combines both pooling and averaging. this intermediate estimator allows the intercept, short-run coefficients, and error variances to differ across the groups (as would the mg estimator), but constrains the long-run coefficients to be equal across groups (as would a fe estimator). since equation (8) is nonlinear in the parameters, pesaran et al. (1999) develop a maximum likelihood (ml) method to estimate the parameters. expressing the likelihood as the product of each cross-section’s likelihood and taking the log yields: lt (θ ′ , ϕ ′ , σ ′ ) = − t 2 n∑ i=1 ln(2πσ2i ) − 1 2 n∑ i=1 1 σ2i (∆yi − φiξi(θ))′hi(∆yi − φiξi(θ)) (9) for i = 1, . . . , n, where ξi(θ) = yi,t−1 −xiθi, hi = it −wi(w ′i wi)wi, it is an identity matrix of order t , and wi = (∆yi,t−1, . . . , ∆yi,t−p+1, ∆xi, ∆xi,t−1, . . . , ∆xi,t−q+1). the parameter estimates from iterated conditional likelihood maximization are asymptotically identical to those from full-information maximum likelihood. but the estimated covariance matrix is not. however, since the distribution of the pooled mean-group parameters is known, we are able to recover the full covariance matrix for all estimated parameters. as shown in pesaran et al. (1999), the covariance matrix can be estimated by the inverse of   ∑n i=1 φ̂2i x ′ ixi σ̂2i −φ̂1x′1ξ̂1 σ̂21 · · · −φ̂n x ′ n ξ̂n σ̂2 n −φ̂1x′1w1 σ̂21 · · · −φ̂n x ′ n wn σ̂2 n ξ̂′1ξ̂1 σ̂21 · · · 0 ξ̂ ′ 1w1 σ̂21 · · · 0 ... ... ... ... ... ξ̂′ n ξ̂n σ̂2 n 0 · · · ξ̂ ′ n wn σ̂2 n w ′1w1 σ̂21 · · · 0 ... ... w ′ n wn σ̂2 n   (10) the mean-group parameters are simply the unweighted means of the individual coefficients. for example, the mean-group estimate of the error correction coefficient, , is an identity matrix of order t, and the intercepts, slope coefficients, and error variances are all allowed to differ across groups. more recently, pesaran et al. (1997, 1999) have proposed a pooled mean-group (pmg) estimator that combines both pooling and averaging. this intermediate estimator allows the intercept, short-run coefficients, and error variances to differ across the groups (as would the mg estimator), but constrains the long-run coefficients to be equal across groups (as would a fe estimator). since equation (8) is nonlinear in the parameters, pesaran et al. (1999) develop a maximum likelihood (ml) method to estimate the parameters. expressing the likelihood as the product of each cross-section’s likelihood and taking the log yields: lt (θ ′ , ϕ ′ , σ ′ ) = − t 2 n∑ i=1 ln(2πσ2i ) − 1 2 n∑ i=1 1 σ2i (∆yi − φiξi(θ))′hi(∆yi − φiξi(θ)) (9) for i = 1, . . . , n, where ξi(θ) = yi,t−1 −xiθi, hi = it −wi(w ′i wi)wi, it is an identity matrix of order t , and wi = (∆yi,t−1, . . . , ∆yi,t−p+1, ∆xi, ∆xi,t−1, . . . , ∆xi,t−q+1). the parameter estimates from iterated conditional likelihood maximization are asymptotically identical to those from full-information maximum likelihood. but the estimated covariance matrix is not. however, since the distribution of the pooled mean-group parameters is known, we are able to recover the full covariance matrix for all estimated parameters. as shown in pesaran et al. (1999), the covariance matrix can be estimated by the inverse of   ∑n i=1 φ̂2i x ′ ixi σ̂2i −φ̂1x′1ξ̂1 σ̂21 · · · −φ̂n x ′ n ξ̂n σ̂2 n −φ̂1x′1w1 σ̂21 · · · −φ̂n x ′ n wn σ̂2 n ξ̂′1ξ̂1 σ̂21 · · · 0 ξ̂ ′ 1w1 σ̂21 · · · 0 ... ... ... ... ... ξ̂′ n ξ̂n σ̂2 n 0 · · · ξ̂ ′ n wn σ̂2 n w ′1w1 σ̂21 · · · 0 ... ... w ′ n wn σ̂2 n   (10) the mean-group parameters are simply the unweighted means of the individual coefficients. for example, the mean-group estimate of the error correction coefficient, the parameter estimates from iterated conditional likelihood maximization are asymptotically identical to those from full-information maximum likelihood. but the estimated covariance matrix is not. however, since the distribution of the pooled mean-group parameters is known, we are able to recover the full covariance matrix for all estimated parameters. as shown in pesaran et al., (1999), the covariance matrix can be estimated by the inverse of the intercepts, slope coefficients, and error variances are all allowed to differ across groups. more recently, pesaran et al. (1997, 1999) have proposed a pooled mean-group (pmg) estimator that combines both pooling and averaging. this intermediate estimator allows the intercept, short-run coefficients, and error variances to differ across the groups (as would the mg estimator), but constrains the long-run coefficients to be equal across groups (as would a fe estimator). since equation (8) is nonlinear in the parameters, pesaran et al. (1999) develop a maximum likelihood (ml) method to estimate the parameters. expressing the likelihood as the product of each cross-section’s likelihood and taking the log yields: lt (θ ′ , ϕ ′ , σ ′ ) = − t 2 n∑ i=1 ln(2πσ2i ) − 1 2 n∑ i=1 1 σ2i (∆yi − φiξi(θ))′hi(∆yi − φiξi(θ)) (9) for i = 1, . . . , n, where ξi(θ) = yi,t−1 −xiθi, hi = it −wi(w ′i wi)wi, it is an identity matrix of order t , and wi = (∆yi,t−1, . . . , ∆yi,t−p+1, ∆xi, ∆xi,t−1, . . . , ∆xi,t−q+1). the parameter estimates from iterated conditional likelihood maximization are asymptotically identical to those from full-information maximum likelihood. but the estimated covariance matrix is not. however, since the distribution of the pooled mean-group parameters is known, we are able to recover the full covariance matrix for all estimated parameters. as shown in pesaran et al. (1999), the covariance matrix can be estimated by the inverse of   ∑n i=1 φ̂2i x ′ ixi σ̂2i −φ̂1x′1ξ̂1 σ̂21 · · · −φ̂n x ′ n ξ̂n σ̂2 n −φ̂1x′1w1 σ̂21 · · · −φ̂n x ′ n wn σ̂2 n ξ̂′1ξ̂1 σ̂21 · · · 0 ξ̂ ′ 1w1 σ̂21 · · · 0 ... ... ... ... ... ξ̂′ n ξ̂n σ̂2 n 0 · · · ξ̂ ′ n wn σ̂2 n w ′1w1 σ̂21 · · · 0 ... ... w ′ n wn σ̂2 n   (10) the mean-group parameters are simply the unweighted means of the individual coefficients. for example, the mean-group estimate of the error correction coefficient, (10) the mean-group parameters are simply the unweighted means of the individual coefficients. for example, the mean-group estimate of the error correction 268 journal of business strategies coefficient, φ, is: φ̂ = n−1 n∑ i=1 φ̂i (11) with the variance ∆̂φ̂ = 1 n(n − 1) n∑ i=1 (φ̂i − φ̂)2 (12) the mean and variance of other short-run coefficients are similarly estimated2. 3 data we use annual aggregate data for 27 oecd nations to estimate the oil demand model in equation (8)3. these data are taken from alan heston and aten (2006); iea (2006), and encompass the years 1970 through 2004. summary statistics for the data are listed in table 1. figure 2 shows oil consumption (million tonnes) and income (real gdp per capita) for the 27 oecd countries in our sample. although we expect oecd countries, as a whole, to be a homogeneous group, our estimation procedures do not impose parameter homogeneity. at one extreme, the mean-group estimator allows for complete heterogeneity while the dynamic fixed effects estimator imposes parameter homogeneity across all countries. as a compromise, the pooled mean-group estimator allows for country-specific short-run adjustments while imposing common long-run elasticities4. the next section presents results of these alternative estimators. 4 results im et al. (2003) developed a unit root test for dynamic heterogeneous panels based on the the augmented dickey–fuller statistics averaged across all panels. 2all models are estimated in stata using the xtpmg command developed by blackburne and frank (2007). 3due to data sparsity, luxembourg, czech republic, and slovakia are dropped from our sample. 4our model (8) includes income in the long-run equation which imposes the same speed of adjustment parameter on income and price. when estimated in this way, the long-run income elasticities were implausibly large. following gately and huntington (2002), we reparametrized our model so that each country instantaneously adjusts to income. , is: φ, is: φ̂ = n−1 n∑ i=1 φ̂i (11) with the variance ∆̂φ̂ = 1 n(n − 1) n∑ i=1 (φ̂i − φ̂)2 (12) the mean and variance of other short-run coefficients are similarly estimated2. 3 data we use annual aggregate data for 27 oecd nations to estimate the oil demand model in equation (8)3. these data are taken from alan heston and aten (2006); iea (2006), and encompass the years 1970 through 2004. summary statistics for the data are listed in table 1. figure 2 shows oil consumption (million tonnes) and income (real gdp per capita) for the 27 oecd countries in our sample. although we expect oecd countries, as a whole, to be a homogeneous group, our estimation procedures do not impose parameter homogeneity. at one extreme, the mean-group estimator allows for complete heterogeneity while the dynamic fixed effects estimator imposes parameter homogeneity across all countries. as a compromise, the pooled mean-group estimator allows for country-specific short-run adjustments while imposing common long-run elasticities4. the next section presents results of these alternative estimators. 4 results im et al. (2003) developed a unit root test for dynamic heterogeneous panels based on the the augmented dickey–fuller statistics averaged across all panels. 2all models are estimated in stata using the xtpmg command developed by blackburne and frank (2007). 3due to data sparsity, luxembourg, czech republic, and slovakia are dropped from our sample. 4our model (8) includes income in the long-run equation which imposes the same speed of adjustment parameter on income and price. when estimated in this way, the long-run income elasticities were implausibly large. following gately and huntington (2002), we reparametrized our model so that each country instantaneously adjusts to income. (11) with the variance φ, is: φ̂ = n−1 n∑ i=1 φ̂i (11) with the variance ∆̂φ̂ = 1 n(n − 1) n∑ i=1 (φ̂i − φ̂)2 (12) the mean and variance of other short-run coefficients are similarly estimated2. 3 data we use annual aggregate data for 27 oecd nations to estimate the oil demand model in equation (8)3. these data are taken from alan heston and aten (2006); iea (2006), and encompass the years 1970 through 2004. summary statistics for the data are listed in table 1. figure 2 shows oil consumption (million tonnes) and income (real gdp per capita) for the 27 oecd countries in our sample. although we expect oecd countries, as a whole, to be a homogeneous group, our estimation procedures do not impose parameter homogeneity. at one extreme, the mean-group estimator allows for complete heterogeneity while the dynamic fixed effects estimator imposes parameter homogeneity across all countries. as a compromise, the pooled mean-group estimator allows for country-specific short-run adjustments while imposing common long-run elasticities4. the next section presents results of these alternative estimators. 4 results im et al. (2003) developed a unit root test for dynamic heterogeneous panels based on the the augmented dickey–fuller statistics averaged across all panels. 2all models are estimated in stata using the xtpmg command developed by blackburne and frank (2007). 3due to data sparsity, luxembourg, czech republic, and slovakia are dropped from our sample. 4our model (8) includes income in the long-run equation which imposes the same speed of adjustment parameter on income and price. when estimated in this way, the long-run income elasticities were implausibly large. following gately and huntington (2002), we reparametrized our model so that each country instantaneously adjusts to income. (12) the mean and variance of other short-run coefficients are similarly estimated2. data we use annual aggregate data for 27 oecd nations to estimate the oil demand model in equation (8)3. these data are taken from alan heston and aten, (2006), iea, (2006), and encompass the years 1970 through 2004. summary statistics for the data are listed in table 0. figure 2 shows oil consumption (million tonnes) and income (real gdp per capita) for the 27 oecd countries in our sample. although we expect oecd countries, as a whole, to be a homogeneous group, our estimation procedures do not impose parameter homogeneity. at one extreme, the mean-group estimator allows for complete heterogeneity while the dynamic fixed effects estimator imposes parameter homogeneity across all countries. as a compromise, the pooled mean-group estimator allows for country-specific short-run adjustments while imposing common long-run elasticities4. the next section presents results of these alternative estimators. results im et al., (2003) developed a unit root test for dynamic heterogeneous panels based on the the augmented dickey–fuller statistics averaged across all panels. 2 all models are estimated in stata using the xtpmg command developed by blackburne and frank, (2007). 3 due to data sparsity, luxembourg, czech republic, and slovakia are dropped from our sample. 4 our model (8) includes income in the long-run equation which imposes the same speed of adjustment parameter on income and price. when estimated in this way, the long-run income elasticities were implausibly large. following [gately and huntington, 2002], we reparametrized our model so that each country instantaneously adjusts to income. volume 31, number 1 269 figure 2 oecd per capita oil consumption and income] 1970 1980 1990 2000 year australia 1970 1980 1990 2000 year austria 1970 1980 1990 2000 year belgium 1970 1980 1990 2000 year canada 1970 1980 1990 2000 year denmark 1970 1980 1990 2000 year finland 1970 1980 1990 2000 year france 1970 1980 1990 2000 year germany 1970 1980 1990 2000 year greece 1970 1980 1990 2000 year hungary 1970 1980 1990 2000 year iceland 1970 1980 1990 2000 year ireland 1970 1980 1990 2000 year italy 1970 1980 1990 2000 year japan 1970 1980 1990 2000 year korea, south 1970 1980 1990 2000 year mexico 1970 1980 1990 2000 year netherlands 1970 1980 1990 2000 year new zealand 1970 1980 1990 2000 year norway 1970 1980 1990 2000 year poland 1970 1980 1990 2000 year portugal 1970 1980 1990 2000 year spain 1970 1980 1990 2000 year sweden 1970 1980 1990 2000 year switzerland 1970 1980 1990 2000 year turkey 1970 1980 1990 2000 year united kingdom 1970 1980 1990 2000 year united states figure 2: oecd per capita oil consumption and incomemean-group estimation the mean-group estimator is the least restrictive of all estimations we consider. model (8) is estimated independently for each country via ordinary least squares. the country-specific regression estimates for the mean-group model are listed in table 5. the estimated (instantaneous) income elasticity of .636 is quite plausible. further, the long-run adjustment parameter, 2.2 oil demand model we estimate a reduced form energy demand model where per capita oil demand is a log-linear function of the real price of oil (which is common across all countries) and real per capita gdp. assume the long-run demand function qit = θ0i + θ1ipt + θ2iyit + µi + �it (6) where the number of nations i = 1, 2, . . . , n, the number of time periods t = 1, 2, . . . , t , qit is the log of per capita oil consumption (million tonnes), pt is the log of real price of oil (2006$ per barrel), and yit is the log of real per capita income. if the variables are i(1) and cointegrated, then the error term is i(0) for all i. the ardl(1,1,1) dynamic panel specification of (6) is qit = δ10ipt + δ11ipt−1 + δ20iyit + δ21iyi,t−1 + λiqi,t−1µi + �it (7) the error correction re-parametrization of (7) is ∆qit = φi (qi,t−1 − θ0i − θ1ipt − θ2iyit) + δ11i∆pt + δ21i∆yit + �it (8) where φi = −(1 − λi), θ0i = µi1−λi , θit = δ10i+δ11i 1−λi , and θ2i = δ20i+δ21i 1−λi . the error-correction speed of adjustment parameter, φi, and the long-run coefficients, θ1i and θ2i are of primary interest. one would expect φi to be negative if the variables exhibit a return to long-run equilibrium. economic theory indicates the long-run price elasticity, θ1i, should be negative and the long-run income elasticity, θ2i to be positive. further, to allow for price asymmetries, we substitute the price decomposition from equation (1) above. 2.3 the mean-group and pooled mean-group estimators the recent literature on dynamic heterogeneous panel estimation in which both n and t are large suggests several approaches to the estimation of equation (8). on one extreme, a fixed effects (fe) estimation approach could be utilized in which the time series data for each group is pooled and only the intercepts are allowed to differ across groups. if the slope coefficients are in fact not identical, however, then the fe approach produces inconsistent and potentially misleading results. on the other extreme, the model could be estimated separately for each individual group, and a simple arithmetic average of the coefficients could be calculated. this is the meangroup (mg) estimator proposed by pesaran and smith (1995). with this estimator, =-.23, indicates oil demand moves toward long-run equilibrium at a rate of 23% per year. note the estimated price elasticities are not statistically different from zero. in fact, since the price coefficients are so imprecisely estimated, the hypothesis of price symmetry is not rejected5. these results exemplify the reason researchers pool data, if possible: there is not enough intra-country data variation for precise parameter estimates. 5 the test yields a table 2: augmented dickey–fuller unit root tests variable z(t) p-value pmax,t -3.664 0.0047 prec,t 2.305 0.9990 pcut,t 0.092 0.9655 critical values 1%: -3.689, 5%: -2.975, 10%: -2.619 table 3: im, pesaran, and shin panel unit root tests variable wtbar p-value yt -1.0459 0.1478 oilt -.5601 0.2877 demeaned, trend included lag lengths chosen via aic 4.1 mean-group estimation the mean-group estimator is the least restrictive of all estimations we consider. model (8) is estimated independently for each country via ordinary least squares. the summary results of the mean-group estimates are presented in table ??. the countryspecific regression estimates for the mean-group model are listed in table 5. the estimated (instantaneous) income elasticity of .636 is quite plausible. further, the long-run adjustment parameter, φ=-.23, indicates oil demand moves toward longrun equilibrium at a rate of 23% per year. note the estimated price elasticities are not statistically different from zero. in fact, since the price coefficients are so imprecisely estimated, the hypothesis of price symmetry is not rejected5. these results exemplify the reason researchers pool data, if possible: there is not enough intra-country data variation for precise parameter estimates. 5the test yields a χ22 statistic of 1.02. the corresponding p-value is .600. statistic of 1.02. the corresponding p-value is .600. 270 journal of business strategies table 1 oecd country mean statistics country oil consumption real gdp (2006$) population australia 31.62 20,230.15 16,316,271.49 austria 11.34 20,564.82 7,765,886.91 belgium 27.86 19,128.36 9,973,123.17 canada 81.78 20,777.17 26,935,737.46 denmark 12.23 21,876.40 5,164,047.06 finland 11.21 17,669.87 4,929,411.46 france 98.27 19,723.86 57,294,371.77 germany 136.82 19,797.17 79,676,279.66 greece 14.18 11,992.03 9,905,299.89 hungary 8.65 9,318.39 10,419,609.57 iceland 0.68 20,032.92 247,243.20 ireland 5.70 14,418.69 3,487,859.20 italy 93.74 17,764.94 56,570,715.43 japan 241.96 18,751.73 119,837,178.57 korea, south 51.47 8,755.94 41,245,183.86 mexico 58.44 6,874.63 79,701,564.94 netherlands 37.16 20,271.80 14,718,023.54 new zealand 4.94 17,551.91 3,377,838.74 norway 9.13 23,651.83 4,215,137.60 poland 16.00 6,506.01 36,741,996.60 portugal 10.47 12,248.06 9,850,355.97 spain 51.66 14,486.69 38,186,561.03 sweden 20.20 20,303.75 8,526,435.06 switzerland 12.63 25,252.59 6,769,738.29 turkey 20.82 4,424.15 52,663,862.60 united kingdom 85.84 18,683.08 57,450,871.43 united states 806.49 25,780.08 246,064,078.23 overall 72.64 16,919.89 37,334,617.88 volume 31, number 1 271 table 2 augmented dickey–fuller unit root tests variable z(t) p-value pmax,t -3.664 0.0047 prec,t 2.305 0.9990 pcut,t 0.092 0.9655 critical values 1%: -3.689, 5%: -2.975, 10%: -2.619 table 3 im, pesaran, and shin panel unit root tests variable wtbar p-value y1 -1.0459 0.1478 oilt -.5601 0.2877 demeaned, trend included lag lengths chosen via aic 272 journal of business strategies table 4 estimation results dynamic fixed effects mean group pooled mean group ec1 -0.0467*** -0.230*** -0.0770*** (0.00801) (0.0366) (0.00761) δpmax,t -0.0254*** -0.00556 -0.0153* (0.00815) (0.00866) (0.00852) δprec,t 0.0158 -0.00316 -0.00041 (0.0198) (0.0116) (0.0162) δpcut,t 0.00142 0.00298 0.000864 (0.0154) (0.0208) (0.015) δyt 0.524*** 0.636*** 0.661*** (0.0613) (0.0958) (0.095) pmax,t -0.779*** -0.471 -0.464*** (0.16) (0.352) (0.0766) δprec,t -0.556*** -0.182 -0.223** (0.214) (0.137) (0.0882) pcut,t -0.532*** -0.273 -0.267*** (0.147) (0.198) (0.0668) constant -0.493*** -2.974*** -0.897*** (0.109) (0.489) (0.0875) observations 918 918 918 r-squared 0.26 number of groups 27 volume 31, number 1 273 table 5 mean-group model estimates c ou nt ry e c t p m ax ,t p re c, t p cu t,t ∆p m ax ,t ∆p pr ec ,t ∆p cu t,t ∆g d p t c on st an t au st ra lia 0. 08 74 0. 34 3 0. 42 4 0. 35 3 0. 04 56 * 0 .0 41 7 0 .0 07 09 0 .2 52 1. 05 1 (0 .1 09 ) (0 .4 61 ) (0 .7 92 ) (0 .6 05 ) (0 .0 27 5) (0 .0 61 8) (0 .0 49 2) (0 .3 58 ) (1 .4 34 ) au st ria 0. 28 9* 0. 13 1 0 .2 67 * 0 .0 72 3 0. 04 49 0. 08 0. 06 59 0 .3 97 3. 74 3* (0 .1 61 ) (0 .1 25 ) (0 .1 39 ) (0 .0 81 1) (0 .0 41 3) (0 .0 97 5) (0 .0 70 7) (0 .4 59 ) (2 .2 11 ) b el gi um 0. 16 3 0. 35 2* 0 .3 11 0. 04 64 0. 06 12 0 .0 88 4 0. 11 9* 0 .7 95 * 1. 90 9 (.1 12 ) (0 .2 03 ) (0 .2 28 ) (0 .1 66 ) (0 .0 42 2) (0 .0 89 2) (0 .0 67 7) (0 .4 37 ) (1 .3 98 ) c an ad a 0. 01 41 1 .6 61 0 .8 3 1 .9 2 0. 03 13 0. 01 81 0 .0 38 8 0 .8 53 ** * 0 .2 32 (. 09 93 ) (1 1. 7) (4 .6 14 ) (1 2. 13 ) (0 .0 24 6) (0 .0 58 9) (0 .0 46 5) (0 .2 42 ) (1 .2 5) d en m ar k 0. 09 36 0. 40 1 0. 53 2 0. 32 6 0. 01 71 0. 03 57 0 .0 96 0 .9 32 ** 1. 09 4 (. 09 03 ) (0 .2 9) (0 .8 22 ) (0 .6 1) (0 .0 44 7) (0 .1 ) (0 .0 79 1) (0 .4 11 ) (1 .0 87 ) fi nl an d 0. 33 5* 0. 11 1 0 .0 69 5 0 .1 16 0. 04 82 0 .0 70 8 0. 05 01 0 .2 13 4. 16 5 (0 .1 97 ) (0 .1 03 ) (0 .1 29 ) (0 .0 81 4) (0 .0 43 7) (0 .0 96 9) (0 .0 77 4) (0 .2 44 ) (2 .5 64 ) fr an ce 0. 11 2 0. 57 2 0. 16 2 0. 18 7 5. 09 e05 0 .0 02 34 0. 00 01 5 1 .1 43 ** 1. 26 3 (0 .0 84 8) (0 .4 42 ) (0 .3 68 ) (0 .3 29 ) (0 .0 31 2) (0 .0 75 ) (0 .0 54 1) (0 .4 46 ) (1 .1 11 ) g er m an y 0. 17 2 0. 17 5 0 .0 31 1 0. 00 48 6 0. 00 73 5 0. 07 88 0. 04 59 1 .4 82 ** * 2. 18 8 (0 .1 05 ) (0 .1 27 ) (0 .1 64 ) (0 .1 03 ) (0 .0 29 6) (0 .0 69 9) (0 .0 51 8) (0 .3 59 ) (1 .3 88 ) g re ec e 0. 11 3 0. 12 5 0. 43 4 0. 34 3 0. 00 27 7 0 .1 64 ** * 0 .0 66 8 0 .7 04 ** * 1. 48 3 (0 .0 96 7) (0 .2 84 ) (0 .5 53 ) (0 .2 57 ) (0 .0 29 4) (0 .0 62 2) (0 .0 47 1) (0 .2 31 ) (1 .3 94 ) h un ga ry 0. 31 0* * 0 .0 72 1 0. 14 1 0 .1 38 0. 03 57 0 .0 43 6 0 .0 59 0 .1 84 4. 34 9* (0 .1 49 ) (0 .1 15 ) (0 .1 51 ) (0 .0 88 1) (0 .0 45 6) (0 .1 08 ) (0 .0 84 2) (0 .2 81 ) (2 .2 2) ic el an d 0. 37 8* * 0. 20 5* 0. 06 17 0. 19 6 0. 00 11 3 0 .0 16 4 0 .1 96 0. 30 8 -4 .5 73 ** (0 .1 59 ) (0 .1 07 ) (0 .2 25 ) (0 .1 45 ) (0 .0 81 6) (0 .1 81 ) (0 .1 4) (0 .4 34 ) (2 .0 15 ) ire la nd 0. 18 8* * -0 .3 37 0 .8 10 ** 0 .2 72 0 .0 87 6 0. 02 51 -0 .3 88 ** * 1 .6 69 ** * -2 .3 50 ** (0 .0 86 8) (0 .2 13 ) (0 .3 19 ) (0 .2 14 ) (0 .0 54 6) (0 .1 35 ) (0 .1 1) (0 .5 08 ) (1 .1 77 ) ita ly 0. 22 0* * 0. 17 7* * 0. 16 2 0. 12 5 0. 00 14 6 0 .0 03 64 0 .0 27 8 0 .7 37 ** * -2 .7 92 ** (0 .0 99 2) (0 .0 86 7) (0 .1 26 ) (0 .0 90 4) (0 .0 21 7) (0 .0 45 5) (0 .0 35 5) (0 .2 22 ) (1 .3 16 ) 274 journal of business strategies ja pa n 0. 13 6* 0. 41 8* 0. 49 5 0. 44 6 0 .0 45 4 0. 00 53 1 0. 07 56 0 .8 63 ** 1. 6 (0 .0 79 4) (0 .2 51 ) (0 .3 91 ) (0 .3 13 ) (0 .0 33 1) (0 .0 74 8) (0 .0 57 ) (0 .3 43 ) (1 .0 3) k or ea , s ou th 0. 02 71 0. 68 2. 84 7 2. 21 6 0. 03 9 0. 13 7 0 .1 52 1. 14 4* ** 0. 31 3 (0 .0 68 5) (2 .5 73 ) (7 .5 93 ) (4 .3 89 ) (0 .0 52 1) (0 .1 36 ) (0 .1 09 ) (0 .3 11 ) (1 .0 77 ) m ex ic o 0. 35 4* ** 0. 28 2* ** 0. 06 87 -0 .0 69 2* * -0 .0 46 7* * -0 .0 04 42 0. 00 39 5 0 .7 89 ** * -5 .4 52 ** * (0 .0 78 8) (0 .0 21 7) (0 .0 50 5) (0 .0 30 9) (0 .0 22 9) (0 .0 41 7) (0 .0 33 1) (0 .1 14 ) (1 .2 18 ) n et he rla nd s 0. 19 8 0. 24 0 .3 25 0 .0 82 3 0. 05 07 0 .0 14 6 0. 07 76 0 .9 16 2. 38 4 (0 .1 45 ) (0 .1 67 ) (0 .2 85 ) (0 .1 67 ) (0 .0 53 ) (0 .1 23 ) (0 .0 88 ) (0 .7 04 ) (1 .8 24 ) n ew z ea la nd -0 .3 25 ** -0 .2 01 ** * 0. 03 25 0. 18 8* * 0. 03 04 0. 02 11 0 .0 58 7 0. 54 6 4. 14 6* * (0 .1 28 ) (0 .0 71 2) (0 .1 31 ) (0 .0 89 7) (0 .0 43 7) (0 .0 92 1) (0 .0 74 1) (0 .3 49 ) (1 .7 02 ) n or w ay -0 .4 04 ** 0. 00 32 3 0. 09 28 0. 04 76 -0 .0 74 7* * 0 .0 28 6 0 .0 49 3 0 .7 44 * -5 .2 83 ** (0 .1 6) (0 .0 37 9) (0 .0 89 ) (0 .0 52 9) (0 .0 35 5) (0 .0 84 ) (0 .0 64 9) (0 .4 34 ) (2 .0 92 ) po la nd 0. 04 35 0. 21 3 0. 25 5 0. 38 2 0. 00 55 2 0 .0 13 2 0. 02 62 0 .9 10 ** * 0. 68 8 (0 .0 95 8) (0 .4 36 ) (1 .4 53 ) (1 .3 14 ) (0 .0 34 9) (0 .0 86 4) (0 .0 69 1) (0 .1 82 ) (1 .4 87 ) po rtu ga l 0. 47 3* ** 0 .0 75 0 .0 73 7 0. 19 0* * 0 .0 10 1 0. 09 99 0 .0 14 3 0 .0 64 6 -6 .7 85 ** * (0 .1 73 ) (0 .0 64 5) (0 .1 32 ) (0 .0 79 6) (0 .0 56 9) (0 .1 43 ) (0 .1 07 ) (0 .4 03 ) (2 .5 41 ) sp ai n -0 .0 51 7 0. 63 0 .0 58 4 0. 4 0 .0 36 1 0. 03 74 0 .0 60 8 0 .5 64 0. 57 6 (0 .1 24 ) (1 .9 27 ) (1 .2 26 ) (1 .3 93 ) (0 .0 39 6) (0 .1 02 ) (0 .0 71 8) (0 .5 28 ) (1 .7 68 ) sw ed en 0. 22 5 0. 20 4 0 .0 55 9 0 .1 58 0. 00 31 7 0. 04 33 0 .0 15 0 .2 99 2. 70 6 (0 .1 56 ) (0 .1 29 ) (0 .2 42 ) (0 .1 69 ) (0 .0 55 5) (0 .1 32 ) (0 .0 98 5) (0 .5 64 ) (1 .9 21 ) sw itz er la nd 0. 61 8* ** -0 .0 83 3* ** -0 .0 05 06 0 .0 43 6 0. 02 18 0. 00 36 3 0. 13 7* * 0 .4 27 -7 .9 10 ** * (0 .1 73 ) (0 .0 29 5) (0 .0 55 6) (0 .0 33 5) (0 .0 39 4) (0 .0 81 1) (0 .0 63 1) (0 .2 68 ) (2 .2 63 ) tu rk ey -0 .2 31 ** 0. 12 3 0. 15 8 0. 21 3* 0. 03 17 0 .0 27 1 0 .0 39 6 0 .6 75 ** * 3. 33 3* (0 .1 11 ) (0 .1 51 ) (0 .1 93 ) (0 .1 17 ) (0 .0 40 1) (0 .0 97 9) (0 .0 77 9) (0 .2 12 ) (1 .7 19 ) u ni te d k in gdo m 0. 76 8* ** -0 .1 50 ** * 0. 05 71 0. 01 38 0. 12 4* * 0. 03 36 0 .0 74 6 0 .2 11 -9 .8 23 ** * (0 .1 65 ) (0 .0 26 8) (0 .0 57 1) (0 .0 35 2) (0 .0 50 7) (0 .1 03 ) (0 .0 81 ) (0 .5 12 ) (2 .1 18 ) u ni te d st at es 0. 00 35 8 9. 37 1 1. 82 2 4. 42 8 0. 00 62 7 0 .0 23 1 0. 03 72 1 .0 58 ** * 0 .0 51 5 (0 .0 69 6) (1 82 .2 ) (3 7. 87 ) (8 8. 3) (0 .0 18 3) (0 .0 40 5) (0 .0 31 3) (0 .1 75 ) (0 .8 73 ) st an da rd e rr or s ar e lis te d in p ar en th es es . ** * < p 0. 01 , * * < p 0. 05 , * < p 0. 1 volume 31, number 1 275 pooled-mean group estimation table 4 lists results of the pooled mean-group estimator for model (8). in this context, the pmg estimator allows for heterogeneous short-run dynamics and common long-run price elasticities. the first equation presents the normalized cointegrating vector6. the country-specific estimates are listed in table 6. referring to table 4, the pooled mean-group estimated precisely. the longrun price elasticities are significantly negative. the estimated long-run price effect is asymmetric. the test of price symmetry is 4.2 pooled-mean group estimation table 4 lists results of the pooled mean-group estimator for model (8). in this context, the pmg estimator allows for heterogeneous short-run dynamics and common longrun price elasticities. the first equation presents the normalized cointegrating vector6. the country-specific estimates are listed in table 6. referring to table 4, the pooled mean-group estimated precisely. the long-run price elasticities are significantly negative. the estimated long-run price effect is asymmetric. the test of price symmetry is χ22 = 17.91, with p-value<0.001. results indicate demand responds equally to price recoveries and price cuts, but is twice as responsive to a new historical maximum price (comparing -.223, -.267, and -464, respectively). the average long-run income elasticity (0.661) is significant, correctly signed, and in line with previous studies. a serious potential problem exists, however, with the pooled mean-group estimation. since the model includes a lagged-dependent variable, there is a possibility of endogeneity bias in the parameter estimates. the existence of such an endogeneity problem is tested via the familiar hausman test. in this context the mean-group estimator is consistent under both the null and alternative hypotheses. the pooled mean-group estimator is efficient under the null, but is inconsistent under the alternative. the hausman test statistic is 1.62 with a p-value of 0.6552 which rejects the presence of endogeneity bias at the traditional levels of significance. this was to be expected since, in fact, the parameter estimates did not change much between procedures but the precision increased dramatically. 4.3 dynamic fixed effects we can further restrict the parameters by imposing complete parameter homogeneity. recall the pooled mean-group estimator restricted long-run price responses and speed of adjustment to be equal across countries yet allowed for country-specific income responses and short-run adjustments. under dynamic fixed effects all parameters are assumed equal across all countries. if dynamic fixed effects does not result in model misspecification, there are two advantages in such a specification. firstly, dynamic fixed effects results in a parsimonious model, which is always preferred. secondly, if we expect oecd countries to be a homogeneous group modelling as such is aligned with our prior. 6the vector has been normalized such that the coefficient on the first term in the cointegrating vector is 1. accordingly, the normalized term is omitted from the estimation output. , with p-value <0.001. results indicate demand responds equally to price recoveries and price cuts, but is twice as responsive to a new historical maximum price (comparing -.223, -.267, and -464, respectively). the average long-run income elasticity (0.661) is significant, correctly signed, and in line with previous studies. a serious potential problem exists, however, with the pooled mean-group estimation. since the model includes a lagged-dependent variable, there is a possibility of endogeneity bias in the parameter estimates. the existence of such an endogeneity problem is tested via the familiar hausman test. in this context the mean-group estimator is consistent under both the null and alternative hypotheses. the pooled mean-group estimator is efficient under the null, but is inconsistent under the alternative. the hausman test statistic is 1.62 with a p-value of 0.6552 which rejects the presence of endogeneity bias at the traditional levels of significance. this was to be expected since, in fact, the parameter estimates did not change much between procedures but the precision increased dramatically. dynamic fixed effects we can further restrict the parameters by imposing complete parameter homogeneity. recall the pooled mean-group estimator restricted long-run price responses and speed of adjustment to be equal across countries yet allowed for country-specific income responses and short-run adjustments. under dynamic fixed effects all parameters are assumed equal across all countries. if dynamic fixed effects does not result in model misspecification, there are two advantages in such a specification. firstly, dynamic fixed effects results in a parsimonious model, which is always preferred. secondly, if we expect oecd countries to be a homogeneous group modelling as such is aligned with our prior. 276 journal of business strategies table 6 pooled mean-group estimates c ou nt ry e c t p m ax ,t p re c, t p cu t,t ∆p m ax ,t ∆p pr ec ,t ∆p cu t,t ∆g d p t c on st an t au st ra lia 0. 07 05 ** * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 42 3* 0 .0 47 2 0. 02 07 0 .3 16 0. 81 8* ** (0 .0 22 5) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 23 ) (0 .0 46 7) (0 .0 36 3) (0 .2 99 ) (0 .2 66 ) au st ria 0. 10 6* ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 05 13 0. 02 2 0. 02 31 0 .2 81 1. 23 7* ** (0 .0 33 4) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 36 3) (0 .0 74 5) (0 .0 56 2) (0 .4 08 ) (0 .4 04 ) b el gi um 0. 08 95 ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 08 45 ** 0 .1 74 ** 0. 10 00 * 0 .7 13 * 1. 01 1* * (0 .0 39 7) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 34 3) (0 .0 71 9) (0 .0 54 9) (0 .4 07 ) (0 .4 47 ) c an ad a 0. 05 68 ** * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 27 4 0 .0 25 7 0 .0 31 5 0 .7 58 ** * 0. 64 1* ** (0 .0 20 3) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 21 1) (0 .0 45 ) (0 .0 35 6) (0 .2 11 ) (0 .2 28 ) d en m ar k 0. 07 31 ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 01 84 0. 06 87 0 .0 76 9 1 .0 01 ** * 0. 84 9* * (0 .0 29 9) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 37 2) (0 .0 77 3) (0 .0 59 4) (0 .3 46 ) (0 .3 39 ) fi nl an d 0. 08 15 ** * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 04 52 0. 02 38 0 .0 18 2 0 .2 03 0. 91 9* * (0 .0 31 6) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 37 8) (0 .0 77 8) (0 .0 60 3) (0 .2 28 ) (0 .3 64 ) fr an ce 0. 11 2* ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 08 13 0. 05 43 0 .0 35 9 1 .4 31 ** * 1. 31 6* ** (0 .0 25 4) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 25 8) (0 .0 55 2) (0 .0 41 6) (0 .3 59 ) (0 .3 1) g er m an y 0. 06 84 ** * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 01 6 0. 07 08 0. 03 6 1 .4 80 ** * 0. 81 8* ** (0 .0 24 ) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 23 2) (0 .0 50 1) (0 .0 38 7) (0 .2 86 ) (0 .2 85 ) g re ec e 0. 07 55 ** * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 02 28 0 .1 59 ** * 0 .0 31 2 0 .4 76 ** * 0. 87 5* ** (0 .0 17 2) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 24 4) (0 .0 47 3) (0 .0 36 ) (0 .1 73 ) (0 .2 1) h un ga ry 0. 05 90 ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 23 0. 17 1* 0 .1 53 ** 0 .3 52 0. 70 9* * (0 .0 26 7) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 43 8) (0 .0 93 5) (0 .0 73 8) (0 .2 79 ) (0 .3 31 ) ic el an d 0. 18 2* ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 05 71 0 .1 51 0 .0 98 3 0. 64 8* 1. 99 2* * (0 .0 69 2) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 68 ) (0 .1 43 ) (0 .1 06 ) (0 .3 52 ) (0 .7 89 ) ire la nd 0. 09 52 ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 78 4 0 .0 61 6 0. 27 2* ** 1 .4 11 ** * 1. 17 8* ** (0 .0 37 7) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 48 7) (0 .1 15 ) (0 .0 83 8) (0 .3 78 ) (0 .4 43 ) ita ly 0. 08 80 ** * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 01 64 0. 00 38 2 0 .0 00 77 2 0 .8 57 ** * 1. 03 5* ** (0 .0 21 ) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 17 6) (0 .0 35 6) (0 .0 27 7) (0 .1 91 ) (0 .2 6) ja pa n 0. 13 4* ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 3 0 .0 17 0 .0 29 7 0 .7 49 ** * 1. 54 3* ** (0 .0 31 9) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 26 2) (0 .0 55 4) (0 .0 44 2) (0 .2 55 ) (0 .3 87 ) volume 31, number 1 277 k or ea , s ou th 0. 01 37 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 05 35 0. 14 4 0 .0 82 1 .2 40 ** * 0. 15 8 (0 .0 14 9) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 45 9) (0 .1 1) (0 .0 76 7) (0 .2 51 ) (0 .1 82 ) m ex ic o 0. 01 48 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 34 6 0. 06 32 0. 01 11 0 .9 27 ** * 0. 17 3 (0 .0 13 1) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 22 4) (0 .0 49 1) (0 .0 39 1) (0 .1 45 ) (0 .1 64 ) n et he rla nd s 0. 09 28 * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 06 02 0 .0 83 9 0. 05 11 0 .6 24 1. 05 0* (0 .0 48 6) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 41 8) (0 .0 90 6) (0 .0 67 2) (0 .5 9) (0 .5 49 ) n ew z ea la nd 0. 10 5* ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 08 84 ** 0 .0 84 5 0. 02 64 0. 36 1. 21 8* * (0 .0 39 4) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 34 7) (0 .0 74 7) (0 .0 57 1) (0 .3 07 ) (0 .4 75 ) n or w ay 0. 02 08 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 09 35 ** * 0. 02 93 0 .0 43 3 0 .9 45 ** 0. 25 (0 .0 30 7) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 31 7) (0 .0 69 6) (0 .0 53 5) (0 .4 03 ) (0 .3 48 ) po la nd 0. 00 02 6 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 09 02 0. 02 24 0 .0 06 65 0 .8 61 ** * 0. 00 42 5 (0 .0 24 1) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 29 ) (0 .0 65 7) (0 .0 49 9) (0 .1 61 ) (0 .3 11 ) po rtu ga l 0. 05 78 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 17 4 0. 04 27 0. 05 24 0 .2 71 0. 67 7 (0 .0 36 1) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 52 3) (0 .1 29 ) (0 .0 91 1) (0 .3 68 ) (0 .4 39 ) sp ai n 0. 04 28 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 20 2 0 .0 05 39 0 .0 59 8 0 .7 41 * 0. 49 5 (0 .0 28 4) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 32 7) (0 .0 83 4) (0 .0 55 9) (0 .4 5) (0 .3 34 ) sw ed en 0. 06 22 ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 01 46 0. 08 05 0 .0 50 3 0 .3 3 0. 71 6* * (0 .0 31 6) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 46 4) (0 .1 04 ) (0 .0 73 4) (0 .4 92 ) (0 .3 56 ) sw itz er la nd 0. 08 23 ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 06 29 * 0. 07 81 0. 08 82 0 .4 81 * 0. 95 1* * (0 .0 36 2) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 35 4) (0 .0 75 ) (0 .0 58 2) (0 .2 88 ) (0 .4 24 ) tu rk ey 0. 11 0* ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 03 56 0 .0 39 3 0 .0 00 12 2 0 .7 27 ** * 1. 42 6* ** (0 .0 25 8) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 33 8) (0 .0 77 ) (0 .0 57 7) (0 .1 82 ) (0 .3 52 ) u ni te d k in gd om 0. 12 0* * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 14 6 0. 00 57 3 0 .0 05 76 0 .6 4 1. 42 7* * (0 .0 59 8) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 46 7) (0 .0 97 6) (0 .0 75 9) (0 .5 35 ) (0 .7 06 ) u ni te d st at es 0. 06 52 ** * 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0 .0 02 78 0 .0 20 8 0. 01 84 1 .0 44 ** * 0. 73 6* ** (0 .0 16 8) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 14 6) (0 .0 30 9) (0 .0 24 2) (0 .1 5) (0 .1 93 ) 0. 06 22 ** 0. 46 4* ** 0. 22 3* * 0. 26 7* ** 0. 01 46 0. 08 05 0 .0 50 3 0 .3 3 0. 71 6* * (0 .0 31 6) (0 .0 76 6) (0 .0 88 2) (0 .0 66 8) (0 .0 46 4) (0 .1 04 ) (0 .0 73 4) (0 .4 92 ) (0 .3 56 ) 278 journal of business strategies table 4 lists results from dynamic fixed effects. note all parameters of interest are correctly signed and significantly different from zero. the long-run price elasticities have increased in magnitude while the income elasticity has decreased in magnitude. unlike the previous models, the hypothesis of price symmetry is not rejected at the 5% level7. the hausman test statistic is 16.51 which a p-value of 0.0009. the test of parameter homogeneity across countries is rejected. the associated p-value of 0.0009 for the hausman specification test indicates the dynamic fixed effects model suffers from endogeneity bias. the bias is a result of the constraint that all oecd countries respond identically to income changes8. in other words, the hausman test leads us to the conclusion that the assumption that oecd nations share the same short-run dynamics and long-run income elasticity is incorrect. based on this, the dynamic fixed effects model is biased and the results should be discarded. conclusion using recently developed dynamic panel data techniques we estimated a non-structural demand model for oecd nations. according to our analysis, oil demand responds asymmetrically to price shocks. specifically, we observed the demand is quite sensitive to new historical maximum prices yet only moderately sensitive to price recoveries and cuts. unlike previous studies, we fail to reject that demand responds equally to price recoveries and price cuts. our results indicate the long-run price elasticity for a price maximum is nearly twice as great (-.464) as for other price movements (approx. -0.25). original models we estimated, but not reported here, imposed the same speed of adjustment of oil demand to income shocks as to the price shocks. doing so resulted in implausibly large income elasticities9. following gately and huntington (2002), the results presented in this paper allow oil demand to adjust immediately to income shocks. the resulting estimated income elasticity is 0.66 for oecd nations over the period 1970–2004, we conclude all countries share a common long-run price elasticity and speed of adjustment to equilibrium. with respect to income, each nation responds immediately. further, we reject the hypothesis of income elasticity homogeneity within our sample. 7 the corresponding p-value is 0.0516. 8 recall figure 2 to see why, in fact, that is unlikely. 9 by implausible we mean greater than unity. we expect income elasticities for oecd countries to be bound between 0 and 1. volume 31, number 1 279 references alan heston, r. s. and aten, b. (2006). penn world table version 6.2. center for international comparisons of production, income and prices at the university of pennsylvania. arellano, m. and bond, s. (1991). some tests of specification for panel data: monte carlo evidence and an application to employment equations. review of economic studies, 58:227–297. baltagi, b. h. (2001). econometric analysis of panel data. wiley, england, second edition. blackburne, e. f. and frank, m. w. (2007). estimation of nonstationary heterogeneous panels. stata journal, 7(2):197–208. frank, m. w. (2005). income inequality and economic growth in the us: a panel cointegration approach. sam houston state university working paper 05-03. freeman, d. g. (2000). alternative panel estimates of alcohol demand, taxation, and the business cycle. southern economic journal, 67(2):325–344. gately and huntington, (2002) the asymmetric effects of changes in price and income on energy and oil demand. the energy journal, 23(1):19–55. iea, (2006). world energy outlook 2006. paris: iea,oecd. im, k. s., pesaran, m. h., and shin, y. (2003). testing for unit roots in heterogeneous panels. journal of econometrics, 115(1):53–74. martinez-zarzoso, i. and bengochea-morancho, a. (2004). pooled mean group estimation of an environmental kuznets curve for 2co . economics letters, 82(1):121–126. pesaran, m. h., shin, y., and smith, r. p. (1997). estimating long-run relationships in dynamic heterogeneous panels. dae working papers amalgamated series 9721. pesaran, m. h., shin, y., and smith, r. p. (1999). pooled mean group estimation of dynamic heterogeneous panels. journal of the american statistical association, 94(446):621–634. pesaran, m. h. and smith, r. p. (1995). estimating long-run relationships from dynamic heterogeneous panels. journal of econometrics, 68(1):79–113. phillips, p. c. b. and moon, h. r. (2000). nonstationary panel data analysis: an overview of some recent developments. econometric reviews, 19(3):263–286. 280 journal of business strategies biographical sketch of authors edward blackburne (phd, texas a&m university) currently serves as chair of the department of economics and international business at sam houston state university. dr. blackburne has published a dozen articles in journals including the journal of business strategies, journal of developing areas, journal of economics and finance education, journal of finance case research, stata journal, and advances in economics of energy and resources. a popular speaker, dr. blackburne has over three dozen presentations to regional and national organizations. his research interests include regional economic development, energy, partial pooling of panel data, and asymmetries in structural relationships. donald l. bumpass (ba, ms, phd, oklahoma state university) currently serves as professor of economics at sam houston state university. dr. bumpass has published over 30 articles in numerous journals including atlantic economic journal, b.e. journal of economic analysis & policy, journal of business strategies, review of industrial organization, american economist, antitrust law & economics review, journal of economic education, and journal of economics. his research interests include regional economic development and energy. notes competing with global quality confrol: learning from japan andrew honeycutt denis ridley florida a&m university tallahassee, florida techniques for improving quality "if we learn only one thing from japan," says 3m corporate quality director douglas anderson, "it should be that quality improvement depends on a systematic approach throughout the total organization. there are no quick solutions to quality. rather, it must become a permanent, managed process that examines all products, procedures and processes on a continuous basis for constant improvement" [2]. at the 3m company five principles underlie the quality program: 1) management commitment that starts at the top of theorganization and must be built on the idea that quality improvement must be planned and actively managed like any other aspect of the business. 2) quality calls for the conforming to customers' expectations. 3) quality is attained through prevention-oriented improvement projects. 4) the objective is conformity to expectations 100 percent of the time. s) measurements of quality are based on indicators of customer satisfaction rather than indicators of self gratification. these include returns, lost business, sales adjustments, on-time deliveries, missed deadlines, exception reports, overtime worked and others [2]. in japan, the total quality control systems now used in the more successful organizations did not become reality overnight. organizations spent over 20 years developing the techniques delivered by u.s. specialists such as w. edward deming and joseph juran. their ideas were accepted by the japanese to improve an economy not yet recovered from world war ii. due to the limited resources available in japan, the ideas of using the resources efficiently and effectively contributed to the acceptance of the idea of total quality control. in order to achieve the success anticipated by the u.s. specialists, japan had to have managers believe in the approach and remain committed to the techniques. one such manager, dr. kaoru ishikawa, a major contributor to the development of total quality control in japan, stated that it was a revolutionary management philosophy characterized by the following five strategic goals: 126 journal ofbusinessstrategies vo1.7,no2 1) seek quality before profits. 2) develop employees infinite human potential through education, training, delegation, and positive reinforcement. 3) build long-term consumer orientation, both outside and inside the organization. (leading japanese firms known for quality products and services establish quality standards based on their market requirements, not on traditional financial considerations.) 4) communicate throughout the organization with facts and statistical data, and use measurement as motivation. s) develop a company-wide total quality control system focusing all employees on the quality-related implications of every decision and action at all stages of the product or service development continuum from design to sales [3}. japanese management demonstrate their support of the quality control systems by participating in various training sessions on statistical quality control, total quality control and participation in quality control circle programs. additionally, japanese workers receive an average of fifty days of training per year to improve their abilities and to help the employee to become an important component of the quality control system. in japan, all employees are indoctrinated to meet customer's quality requirements, directing their efforts and activities in a way that satisfies customer's quality needs. in fact, meeting the customer's demand for quality is the blueprint for improving products and services. the japanese believe in a total commitment to excellence; the ability to provide satisfaction to customers by giving them: (1) a quality product, (2) a quality service, (3) affordable cost, and (4) timely delivery. inventory management is an example of japanese management's commitment to quality control. the japanese even utilize the "just in time" inventory concept with economic lot sizes of one. the japanese are also experimenting with the idea of eliminating inventory (zero inventory) which they believe improves quality by unmasking mistakes and uncovering poor workmanship. many think culture plays a strong role in the success of quality control programs. however, the japanese have successfully transplanted their management techniques to their u.s. affiliates. quality cost measurement u.s. industry is finally realizing the tremendous cost of ignoring quality. in traditional u.s. factories that cost is probably the largest item on their list of expenses, and it is generally larger than gross profit. because the cost of quality is rarely broken out in detail, management usually has no idea of its true dimensions. when quality audits are performed, they invariable uncover huge "hidden plants" staffed and equipped just to find and fix defective products. for instance, ibm estimates that mistakes cost $1.00 to fix in the design stage, $20.00 fall 1990 honeycutt & ridley: competing 127 lo fix at the tooling stage and $50.00 to fix if the problem reaches the field [3]. the cost of rework does not help typical american companies compete with foreign competition which focuses on producing quality products. w. edward deming suggested that 85% of poor quality production of goods results from poor management not errors by employees [1]. studies have shown that a typical factory invests a staggering 20 to 25% of its operating budget in fmding and fixing mistakes. in some cases as many as one-quarter of all factory employees don't produce anything. they just rework things that were not done correctly the first time. when the expense of repairing or replacing flawed products is added to the total burden, "unquality" can amount to more than thirty percent of production cost. the japanese have learned to deal effectively with chronic problems through a program of total quality control. when products cost more that they should, quality periodically falls below the acceptable level. however, american manufacturers fail to view total quality control as an organizational asset. philip crosby, author of quality is free, expresses some commonly held assumptions. the assumption that cost and quality are correlated is discredited in the cost comparison between doing a job right the first time and making a mistake, finding it, tracking the defective work and eventually making it right. crosby concludes that organizations probably spend more time doing inferior work than if they adopted a clear, uncompromising, high-quality standard of zero-defects. crosby suggests that by tracking the cost of quality, one will be guided to areas where improvement in both quality and efficiency can be made. quality cost information can alert executives to the potential impact of poor quality on fmancial performance. furthermore, quality cost reporting can help management improve productivity through an increased focus on conformance quality. the relationship between conformance quality, productivity, and production costs can be summarized in three brief statements: 1) higher conformance quality means lower rejection rates. 2) lower rejection rates mean less waste of materials, labor, and/or equipment time. 3) less waste of inputs means greater output for a given level of inputs, resulting in lower costs per unit of output. increased productivity, achieved by producing a higher percentage of conforming products, can increase profits in a number of ways. one fundamental effect of increased productivity is lowering of unit costs. furthermore, high quality products may sell at a premium. organizations need to rely on some consistent mechanism to monitor and report on performance of quality system objectives against the expected norms. quality cost reports are periodic summaries of quality costs by organizational unit, by product, by any segment of interest, or for the organization as a whole. the reports typically organize costs based 128 joumalo/businessstrategies vo1.7,no.2 upon types of quality cost incurred, like prevention, appraisal, internal failure and external failure. the quality report shows various key factors relating to the operating environment for the period covered. it is important to note changes in level of activity because quality costs may have risen in each period. quality reports showing trend rates for the organization against standard measures, can reduce some of the confusion of pure dollar reporting. quality costs are costs incurred either because inferred quality may exist or because poor quality does exist. quality costs can be grouped into various categories based upon whether the costs are prevention, appraisal, and internal or external failure. prevention costs are costs incurred to prevent poor quality products from being produced. appraisal costs result from activities undertaken to prevent poor quality products from being processed beyond the point at which they become nonconforming or from being delivered to customers. failure costs are incurred because poor quality of conformance does exist. while some of the internal failure costs can be identified easily, some are hidden within the normal operating tolerance. external failure costs are incurred when nonconforming products are shipped to customers. while most accounting systems will include most expenses, the opportunity cost of lost future sales is not a normal accounting type expense and can be subjective in nature. of the four types of quality costs, prevention costs generally are regarded as the most preferable on which management should concentrate its expenditures for quality. it is less costly to prevent the production of poor quality products than to incur appraisal, internal failure and/or external failure costs. conclusion in a future characterized by intense competition and resource scarcity, successful companies will be those that produce the highest quality products at the lowest possible price. they will treat quality improvement as a continuous process, (in a spiral-like manner, as each phase of improvements is complete, the next begins). futhermore they will emphasize design quality. products will be reliable, easy , and economical to operate and service. as well as simple to manufacture. finally, the successful companies will employ an organizational measure of quality costs which they will use to improve financial performance and their long term strategic posture. bibliography 1. baille, s. "the deming approach: being better than the best." s.a.m. advanced management journal (autumn 1986), pp. 15-23. 2. "quality is a process." personnel administrator (feb. 1987), pp. 28-29. 3. rehder, r. and ralston, f. "total quality management: a revolutionary management philosophy." s.a.m. advanced management journal (summer, 1984), pp. 24-33. competing w ith global quality control: learning from japan notes quality and quantity goals in service industries: compatible or confucting stralegies? mohammad ahmadi rick driggans marilyn m. helms department of management the university of tennessee at chattanooga although the traditional belief has been that a tradeoff or negative relationship exists between quality and quantity, companies in the manufacturing industry have recently been successful in pursuing both goals simultaneously. this exploratory study was pedormed to determine whether these two goals (quality and productivity) are compatible within the context of a service industry. as a representative of the service sector, the authors examined the relationship between productivity figures and quality rates of claim processors within a medical insurance company. data collected from the computerized work measurement system revealed a slight, but significant positive relationship between quality and productivity. this existence of this positive relationship contradicted the popular belief that a tradeoff exists between these two variables. just as manufacturing-industry companies have discovered, service-industry companies (such as this medical insurance company) can simultaneously pursue compatible, not conflicting, goals of quality and quantity. background with the onset of the industrial revolution, quantity goals became the focus of managers as they strived for ever-increasing levels of production, often at the expense of quality. to remain viable among competitors, management found it necessary to increase output, thereby reducing costs to maintain competitive prices. however, in today's global competitive market, increased production alone is no longer sufficient to insure financial success. managerial objectives have evolved from a single goal of increasing productivity (or quantity) to a combination goal of improving both quantity and quality. methodology the goal of this study is to determine whether a significant relationship exists between productivity and quality in service industries. to address this research question, data were gathered for a group of claims processors in a major medical insurance company located in the southeastern united states. quality and productivity data were subjected to biva130 journal ofbusiness strategies vo1.7,no.2 riate regression analysis in order to determine the strength of the relationship between the two variables. the pearson product-moment correlation coefficient (r) and the coefficient of determination (r2) were used to identify the direction and strength of the relationship. the correlation coefficient and the coefficient of determination were used to evaluate the relationship between the independent variables and productivity and to show how well a claims processor's quality rating explains her productivity rating. analysis of variance and the t-test were used to evaluate the homogeneity of the population of claims processors with respect to quality and productivity ratings. data were available on 235 claims processors. these processors worked in 23 different sections and all used the same computer system to process claims (or performing the necessary procedures to pay, deny payment, or suspend a claim). all processors were female, had received equal training, and held similar job titles. they could be divided into two groups: those who process claims from only one company (single coverage) and those who process claims from different companies (multiple coverages). the following confounding or nuisance variables which could produce undesired sources of variation that may affect the dependent variable were icentified: (1) the subjects lergth of employment with the company; (2) the subject's work section; (3) single-coverage versus multiple-coverage processing; (4) the subject's absence rate; and (5) the month of the year. because any of these variables could have an effect on productivity equal to or greater than the effect of quality, subjects that had similar standings on the the nuisance variables were chooen. the instrument used to collect the data was a company-established system which calculated employee productivity and quality. the company began measuring productivity in 1980 when it purchased a comrilercially-available work measurement program-a program currently used by many other companies in the insurance industry. the basic measurement defines productivity as predetermined standard hours divided by actual hours. an example of the productivity computation is shown in figure 1. figure 1 productivity computations actual hours =ph • (nph + sah + uah + tah + ur) where: ph = paid hours nph = non productive hours (employee available for work, but no work available) sah =scheduled absence hours (planned or approved) uah = unscheduled absence hours (not planned or approved) tah =training or administrative hours (time in which processor is being trained or is performing activities to accomplish day-to-day department activities) uh =unmeasured hours (time for which standard hours have not been established) if a claims processor generated 80 standard hours of work in 75 actual hours, productivity would be 1.067 computed as: productivity =80/75 = 1.067 quality is defined as the percentage of total claims processed and paid correctly without dollar errors divided by the number of claims paid. fall 1990 ahmadi, driggans & helms: quality and quantity 131 the company's quality control program, established in 1982, randomly selects 4 claims per day (or approximately 80 claims per month, depending on the number of days worked) for each processor. then the company's quality control staff reviews the claims to detect dollar errors. if, from a monthly sample of 72 claims, a processor has 2 dollar errors, the employee's quality rating would be 97.2 percent. productivity figures are generated and distributed bi-weekly, while quality ratings are generated and distnbuted monthly. for this study, the bi-weekly productivity ratings were combined into a monthly figure. recognition is given to the "department of the month" with the highest productivity that meets a minimum quality performance level. individual employees are recognized for quality ratings if their work meets minimum productivity levels. reliability of the productivity and quality measure should be high since sources of error for productivity measurement would be limited only to incorrect allocation of hours and miscounting of claims processed. because the measurement system has been in effect over nine years, giving employees and management extensive experience in reporting these data, it was determined that the tracking of time and claims was accurate. sources of error in the quality measure would be limited to miscounting claims or to mistakes in the review process. support for the validity of the productivity and quality measures is based on their wide use within the insurance industry. the data for this study were compiled from various computer-prepared reports produced by the insurance company. for each claims processor, monthly productivity, quality, and absence rate measurements covering the one year period were collected, along with data on the number of months they had worked at the company, the section where they worked, and whether they processed claims from only one client company (single coverage) or several client companies (multiple coverages). bivariate regressions between quality and productivity were performed for each month for each employee. the number of cases available for this analysis was 107, as data were not available for every month for every employee. as a second step for determining whether or not productivity and quality were correlated, a correlation analysis was performed on the entire data set. for this latter analysis, the monthly records of each employee for the entire year were used to represent a case. this produced 2,585 separate combinations of productivity, quality, absence rate, work section, coverage type, and length of employment for the 235 employees. of these 2,585 cases, 1,727 had non-missing values for all of the variables. next, a multiple regression analysis was performed on the entire data set. the dependent variable productivity was regressed against the independent variables quality, absence rate, work section, coverage type, and the length of employment. a total of 1,882 cases was used in the regression. to investigate the effect of coverage type, the data were divided into two groups: employees who process single coverages and those who process multiple coverages. t-tests were performed to determine if the differences between the mean productivity and quality ratings for the two groups were significant. in order to investigate the effect of length of employment on productivity, a oneway 132 journal afbusiness strategies vol. 7, no. 2 analysis of variance was conducted, with employees divided into five employment categories: (1) 0 to 20 months' employment, (2) 21 to 40 months' employment, (3) 41 to 60 months' employment (4) 61 to 80 months' employment (5) more than 81 months' employment results table 1 shows the coefficients of correlation and their associated f values. the correlation coefficients are assigned significantly different from zero for seven of the eleven months for which data were available. table 1 summary of monthly correlation coefficients from bivariate regression between quality and productivity by month correlation f month coefficient value february .2807 8.978* march .1600 2.758 april .1358 1.972 may .2579 7.483* june .1513 2.461 july .1572 2.661 august .3745 17.133* september .3779 17.492* october .1950 4.149* november .2354 6.159* december .1996 4.354* * the months where the correlation coefficients are significant critical fi,105 = 3.950 the correlatbn coefficiert fur tre carelatim analysis was -to.881 (significait at pdxx(1) indicating the existence of a positive correlation between productivity and quality. in the multiple regression analysis the predominate independent variable was quality, followed by coverage type and length of employment (significant at p<.oool). however, the employee's absence rate and work section were not significant and were therefore excluded from the next analysis. using a multiple. regression analysis (which included only quality, coverage type, and length of employment) revealed that the relationships were significant. the correlation coefficient for this analysis was +0.2363 indicating that productivity was positively correlated with the independent variables. the t-tests showed that the productivity ratings differed significantly (p<.oool) for fall 1990 ahmadi, driggans & helms: quality and quantity 133 employees processing single versus multiple coverages;· however, the quality ratings did not significantly differ between the same groups. the results of the analysis of variance indicated that the productivity ratings of employees varied with their lengths of employment. interestingly, the mean productivity increased after 20 months' employment but then decreased for the group of employees who had worked for the company for more than 81 months. conclusions based on statistical analysis of data collected from a major medical insurance company's computer-based work measurement system, a positive relationship between productivity and quality was found to be significant at the 95% confidence level. the relationship was significant, but only 3.54% of the variation in productivity could be explained by the variation in quality. even when the additional significant independent variables for which data were available (coverage type and length of employment) were used in a regression analysis, only 5.58% of the variation in productivity could be explained. this existence of a positive relationship between quality and productivity io the service industry contradicts popular belief that quality and productivity are conflicting goals. the implications of these results are that acceptable levels of both productivity and quality can be maintained and that an increase in quality can have an associated improvement in productivity. while the generalizability of these results is limited, it does provide an impetus for additional studies using more rigorous research designs. quality and quantity goals in service industries: compatible or conflicting strategies? disparate treatment and disparate impact: a tale of two burdens c. ray gullett the university of texas at tyler ty ler, texas "it was the best of times, it was the worst of times ...." these famous words from charles dickens' a tale of two cities may describe rather well the current situation with regard to fair employment practice compliance. in its widely discussed decision, watson v. ft. worth bank & trust [7], the supreme conrt has both clarified and made more confusing the legal grounds on which employees and applicants can challenge hiring and promotion decisions and the bases on which employers can defend themselves. it is the purpose of this discussion to identify the crucial issues at stake in the case and to interpret their meaning for employees and employers alike. as will be seen, what we do not yet know is as important as what we do know. disparate 'lreatment v. disparate impact to understand the case and its implications, we should briefly review the two legal paths that may be taken when an employment discrimination claim is filed in the federal courts. if an individual believes he or she has been denied a job or turned down for promotion for discriminatory reasons, a charge may be filed under the legal doctrine set forth by the court in mcdonnell douglas v. green [4). this type of case is known as one of disparate treatment. in a disparate treatment situation, the plaintiff's burden is to show that the employer intentionally discriminated against him or her because of race, sex, or some other reason prohibited by equal employment laws. to meet this burden, the plaintiff must first show that he or she made application for the job, was then rejected for that job, and that the employer continued looking for someone with the rejected applicant's qualifications [4]. if this can be shown, the employer must put forth a justifiable business reason for the decision. in other words, the employer must convince the court that it had no intention to discriminate. it is very important to note that the employer does not have to prove that its reason for rejection is objectively related to job success; its only obligation is to show that it used some reason other that a discriminatory one for the decision. finally, the plaintiff has one more chance to produce evidence that the reason given was nothing more than a pretext (a trumped up excuse) for discrimination. as many well-publicized cases have shown [6], the employer's burden is much lighter than the plaintiff's unless there has been a history of discrimination in the organization. proving intentional discrimination is often a difficult task [7j. journal of business strategies, volume 6, number 1 (spring 1989) 55 56 journal of business strategie.~ vol. 6, no.1 by contrast, a msparate impact mscrimination charge msregards employer motive or intent. instead, the focus is on the effect of a selection practice upon a protected group. in its famous griggs v. duke power co. case [2], the supreme court ruled that a selection device which appears to be neutral and objective may still illegally mscriminate in practice. if a disproportionate number of persons from a protected group are screened out as a result of its use, the employer has the burden of proving that the selection device validly predicts success on the job [3]. satisfying this validity requirement is a much more demanding task than is refuting a charge of intentional mscrimination [1]. figure 1 is a summary of these two discrimination theories. figure 1 burdens for each side in disparate treatment and disparate impact cases (1 ) aggrieved person(s) must first show (2) employer must then (3) aggrieved person( s) must then disparate treatment l. application was made for provide some legitimate, show that the employa position for which he non-discriminatory reason er's reasons were a or she was qualified pretext 2. rejection was for reasons that raise an inference of discrimination 3. employer continued to search for others wi th similar qualifications disparate impact show a significant statistical provide convincing eviidentify an equally imbalance in the employer's dence of the job relatedvalid selection device workforce that suggests ness (or validity) of the which will have less discrimination caused by selection device disparate impact an apparently neutral and db jeclive method as a result of these mfficulties, it is not surprising that more claims are filed under the msparate impact theory of mscrimination than under msparate treatment. if an initial (or prima facie) case of mscrimination can be shown using the msparate impact approach, the employer is likely to have a much more mfficult time defeating the charge. but herein lies the mfficulty for many aggrieved employees or applicants. the supreme court's msparate impact rulings have dealt only with "objective" measurement techniques such as standardized tests and height and weight requirements ([1],[2]). thus, while not totally unified on the subject, lower courts have required that two criteria be met before a case could proceed under the msparate impact approach: a spring 1989 gullett: treatment and impact 57 class of protected workers must claim to have been disproportionately screened out, and the selection or other dec.ision making device must be objective and neutral on its face. a promotion system based on managerial judgment could thus be challenged only under disparate treatment theory. although discrimination could still be proved by the plaintiff(s), the employer's burden of proof would be much lighter that in a disparate impact case. this apparent inequity se-ts thestage for theissues discusse-d by the court in watson. watson v. ft. worth bank and 'frust the ce-ntral issuein this casewas thefollowing: can a subje-ctive promotion decision system be attacked under disparate impact analysis? in brief, the court unanimously said "yes," broadening thebasis for a prima facie caseof disparate impact. with all dght justices concurring (just(ce ke-nnedy had not ye-t joined the court), justice o'connor instructe-dthecourt of appe-als to de-termine if statistical evidence was sufficient to pursue a charge of disparate impact discrimination in this case [7]. if the court's opinion had stopped at this point., one could conclude that persons charging discrimination in employment practices had won a major victory in pursuit of their rights. the burden of proof for employers in many cases would be much heavier. but four of the justices went much further. although t.he-y were only a plurality (three of the remaining four dissented and one refused to address this issue), they re--framed the burde-n of proof for employers in all disparate impact cases. it is also important to note that their comments were not a part of the formal ruling in the case. the comme-nts were included as dicta (instructions) to lowe-r courts in de-aling wit.h lilture cases. these instructions we-rea response to argume-nts made against the use of disparate impact analysis in situations whe-reemploye-rs use subjective factors in their decision making proce-ss. essentially, justice o'connor and her three concurring colleagues stated that the employer's burden of proof is not as rigorous as some may have thought. in summary form, the "new" interpretation of disparate impact claims is as follows: 1. not only must the plaintiff show a statistical imbalance in the workforce, but. it must also identify which of the steps in t.he decision making process has supposedly caused the imbalance. for subjective selection or promotion steps, this may be particularly difficult. 2. where a statist.ical imbalance does occur, it must be strong enough to suggest a cause and effect. here the justices would commit to no standard, but as in t.he pa.st, they stated that the difference must be "subst.antial" they also reaffirmed employers' rights to challenge any deficiencies in the statistics. 3. the ultimate burden of proving that an employer has discriminated against a protected group always remains with the plaintiff. this is a major departure 58 journal of business strategies vol. 6, no.1 from earlier cases. here, the justices stated that formal "validation studies" are not required even in standardized or objective tests. instead, the employer must put forth a "legitimate business purpose" for the use of a selection or employment decision making device. if taken literally, this statement substantially lightens the burden on employers to justify their employment decisions. as one dissenting justice commented, "the echo from the disparate treatment cases is unmistakable" [7]. figure 2 summarizes these points. figure 2 new interpretation of disparate impact cases (1) aggrieved person(s) must first show 1. -sho~a';iatisticat~imbalance in the workforce which suggests discrimination 2. identify the specific employment practice of practices causing the discrimination (2) (3) employer must aggrieved person( s ) then must then prov;.r.;-a legit,""ma-t'e-','----.clccd"'e-n--cticcfy---an-...al-t-;;,:~ati~_;,_;_ non-discriminatory reason but job-related selection for the use of the device which will have employment practice less disparate impact implications with suggestions for employers in sum, the court has unanimously agreed that employees have the right to use the disparate impact theory to challenge personnel decisions which are subjective or judgmental in nature. this ruling broadens the basis on which such decisions may be attacked and would appear to be a victory for those who see themselves as victims of discrimination. employers are now more vulnerable to legal challenges of subjective employment decisions. but the added comments of four justices regarding standards of evidence and burden of proof in such cases may ultimately strengthen employers' defenses against any sort of disparate impact charge. it is very important to note that a fifth justice must concur on a case directly dealing with these two issues before firm conclusions can be drawn. if indeed this occurs, employment discrimination law may be affected more significantly than at any time since the early 1970s. given the somewhat contradictory but nevertheless significant impact of the watson case, several suggestions can be provided for employers for staying within equal employment guidelines. it should be noted that these comments are not intended to take the place of legal advice and should not be regarded as such. they do, however, draw upon sound personnel practices in the equal employment setting. spring 1989 gullett: treatment and impact 59 avoid obviously discriminatory employment decisions as in the past, employers must be careful to avoid selection or other employment practices which clearly exclude an individual because of employer prejudice. an employer who can be shown to have deliberately discriminated against persons for such reasons as race, sex, age, or other protected categories can be successfully prosecuted. "men's jobs" or "women's jobs" can, for example, rarely be defended successfully. questions or comments about an applicant's or employee's age, race, or national origin make a negative employment decision difficult to defend. carefully scrutinize subjective employment criteria now more than ever, the use of subjective bases such as supervisory judgment for employment decisions deserves careful attention by management. the supreme court has not prohibited these decision techniques, but they are now more vulnerable to an initial court challenge. before watson the person or persons claiming discrimination were required to show discriminatory intent of the kind noted in the previous section. now, such challenges may also be made on the basis of discriminatory impact or effect. by presenting statistical proof acceptable to the court, plaintiffs can make a case for discrimination which an employer must then disprove. to avoid such charges, employers should carefully examine the impact of their subjective employment practices. where such practices result in a disproportionate rejection of protected groups, they are targets for challenge. since the watson case has made unclear what a successful employer defense of an impact charge must be, it would be wise to follow past rulings until additional directions are given by the court. thus the employer's burden is still one of showing the "business necessity" of any employment practice challenged under the disparate impact doctrine. typically, this means showing either statistical validity or content validity of the offending employment procedure. since subjective decisions do not lend themselves to statistical validation, a content validity approach is most practical. essentially, content validity is based on the idea that the decision making tool is logically related to the person's future success. for example, a supervisor's evaluation of an applicant in an interview would be much more defensible if an up-to-date job description has been done and a standardized rating form is used to evaluate the characteristics believed necessary for successful job performance. while the interviewer's impressions are still somewhat subjective, they are more structured and thus more defensibly valid than a simple "pass fail" approach based on intuitive reasoning. subjective decision making tools may thus become more acceptable to a court and also more efficient in personnel decisions regardless of legal challenge. do not abandon current validation techniques for "objective" selection techniques employers who have developed validation studies (either statistical or content) for objective selection devices such as standardized tests should continue to monitor and update them. although the supreme court's plurality suggested that these studies 60 journal of business strategies vol. 6, no.1 may be less important in the future, this is not a settled issue. until further clarification is provided, employers should assume that such studies will continue to he needed in defense of disparate impact charges. keep a close watch on further court rulings both employers and employees should carefully watch for additional direction form the supreme court concerning discrimination in employment. all that can be said with assurance now is that those who claim unfair treatment have a broader basis on which to make that claim. there is also a strong suggestion that employers may have a less difficult burden of defending against such charges than in the past. only time and future clarification by the court can determine this highly important issue. references 1. albemarle paper company v. moody, 422 u.s. 405, 10 fep 1181 (1975). 2. griggs v. duke power company, 401 u.s. 424, 3 fep 175 (1971). 3. hazelwood school district v. united states, 433 u.s. 299, 15 fep 1 (1977). 4. mcdonnell douglas corp. v. green, 411 u.s. 792, 5 fep 965 (1973). 5. teamsters v. united states, 431 u.s. 324, 14 fep 1514 (1977). 6. texas department of community affairs v. burdine, 450 u.s. 248, 25 fep 113 (1981). 7. watson v. fort worth bank & trust, no. 86-6139, u.s. supreme court (6/29/88, bureau of national affairs). disparate treatment and disparate impact: a tale of two burdens a primer on management control structures carl brewer sam houston state university huntsville, texas responsibility accounting assigns a manager to be responsible for the operation of each organization segment where control is desired. a key aspect of responsibility accounting is that the manager will be held responsible only for those matters which the manager can control. it is often assumed, as in this presentation, that the concept of responsibility accounting has been established within an organization. it is the manager's task to insure that segment personnel perform in such a way that the goals assigned to the segment are achieved. to facilitate this task, the manager utilizes management control. the definition of management control given by anthony, dearden, and bedford will serve as a frame of reference in this discussion: management control is the process by which management assures that the organization carries out its strategies. ([1], p. 10) the same authors relate strategies and goals by stating: to coordinate organization activities in pursuit of goals, organizations develop strategies to indicate the path organization management wants fol· lowed to achieve [its] goals. ([1]' p. 93) essentially, then, management control is concerned with the achievement of the organization's goals. to this statement could be added the phrase " ... through the actions of people." the authors clearly intend that management (and, therefore, management control) can achieve the goals of the organization only through the efforts of the non-management and management people who work for the organization. management control concepts management control appears to consist, at least conceptually, of four elements: 1. goals. 2. actual performance data. 3. comparison. 4. action. journal of business strategies, volume 7, number 1 (spring 1990) 47 48 journal of business strategies vol. 7, no.1 goals to be in control, management must know where an organization is headed. questions of why an organization exists and what the organization is attempting to accomplish must be addressed. in different levels of an organization, various terms, such as goals, strategies, objectives, budgets, and standards, are used in addressing these questions. while the terms may vary, it is evident that the basic concept of something to be achieved is present at each level. the term "goal" is used in the model which is presented. however, the term is intended to convey the concept of something to be accomplished an aim. while it is recognized that organizations and segments do not have goals only people have goals the phrase organization goal is retained due to its common usage. goals are what should occur. goals represent the target toward which an organization's efforts are directed. further, this aim is intended to be applicable to any organizational level. without this target, an organization will flounder. it is critically important that the goal be measureable, either directly or indirectly, in some meaningful way. this is necessary because the goal will be used as the standard against which actual organization performance is measured. additionally, measureable goals indicate what performance data needs to be accumulated for management control purposes. the goals at the lower levels must support, and to an extent flow from, the goals at higher levels to achieve a coordinated effort among the various segments of an organization. the mechanics of implementing goals implies the need to have an appointed manager for each segment who will be responsible for achieving the goals of the segment over which the manager has control. data to determine whether an organization or segment is progressing as intended, measurements of current performance by the organization (or segment) must be made. data about actual performance, then, is a fundamental concept of control. without such data, organizational performance is only conjecture and there is no quantifiable method to identify if goals have been, or are being, accomplished. the actual performance data collected must relate to one or more measureable aspect of the goals of the organization or else the data is useless for management control purposes. therefore, the organization (or segment) goals must be measureable in some way, either directly or indirectly via the use of surrogates, if the goals are not measureable then they are inoperable because data which would indicate if the goal is or was being achieved could never be gathered. in other words, the performance data which must be collected for management control purposes is determined by the goals which are being evaluated. comparison a fundamental concept in management control is management's comparison of actual performance data against desired performance, as indicated by the standard spring 1990 brewer: management control 49 set by the goal the objective of this comparison is to identify performance which deviates significantly from the goal. this objective is complicated by two factors: the strength of the comparison and the significance of the deviation. strength of comparison. strength of comparison related to both availability of performance data and the measurability of the goal. without data about actual performance that relates to the goal, comparisons cannot be made. also, as the goal becomes less measureable, the comparison becomes less meaningful. both of these aspects must be considered by the manager when evaluating deviations from the goal. significance of the deviation. deviation from the goal is the primary indicator of actual performance which does not conform to the goal. determination of when a deviation, in absolute terms, is significant must be made only after considering the strength of the comparison being made. even though significance relates to the degree of the deviation from the goal, determination by the manager of the significance of any given deviation is highly judgmental. determination of whether a deviation is significant or not completes the two-phased analysis made in the comparison. action action is the most crucial phase of management control without it there is no operable control. when significant differences exist between actual performance and the goal, action must be taken by the manager regarding those differences over which that individual has control. for most of those differences over which a manager does not have control, some other level of management will have control. in this case, it is the other manager who should take action. further, it must be recognized that some of the differences may be imposed upon the organization by the external environment and not controllable by the organization. an action will not be effective, however, and consequently there will be no management control, unless the action leads to a convergence of the goal and future actual performance. for management control to exist, whatever action is taken must result in the attainment of the goal. it may be that performance must be modified. alternatively, it may be deemed that the goal is unattainable and must be changed. however, this second alternative should be extremely rare because changing an existing standard alters the basis of evaluating past performance. implications the concepts presented above explain the basis for management control. in addition, they provide a reference scheme for designing management control structures and also for evaluating existing management control in an organization. specifically, each concept goals, data, comparison, action must be present for management control to exist. further, they must be present in each organizational segment where control is desired. even in the most complex of organizations, the evaluation of management control can be resolved into a determination of whether or not these concepts are present and to what degree. 50 journal of business strategies vol. 7, no.1 in addition, the four concepts provide a useful classification of management control problems. any management control problem can be categorized as a problem in one or more of the following: goal, data, comparison, or action. once the type of problem is identified, correction is facilitated. for example, when faced with a management control problem as indicated by a manager being unable to meet an assigned goal, it is reasonable to ask whether the problem stems from an unreasonable goal, an unmeasureable goal, insufficient data, or inept management action. management control structures the four control concepts can be symbolized by the management control structure presented in figure 1. for management control purposes, each element must be present within any given segment of the organization where management control is desired. when evaluating management control in any given segment, each element must be evaluated. figure 1 management control structure goals actual performance data an organization can be depicted as a hierarchy of organization segments as illustrated in figure 2. in accordance with responsibility accounting, each segment should have a manager assigned to it who will be responsible for the operation of the segment. in this capacity, it is the manager who is responsible for those aspects of the segment's operations which can be controlled at that level of the organization. in designing a management control scheme within an organization, a management control structure must be embedded within each organization segment. this is graphically illustrated in figure 3. in this way, it can be assured that at least the elements of control are present within the organization. whether the control scheme operates 80s desired, however, is a different matter. the functioning of management control within the organization can be determined by evaluating each control element within each control structure embedded within each control segment. spring 1990 brewer: management control figure 2 simplified organization chart president 51 eastern division sales i 2 i western division sales foreign division sales production treasurer figure 3 management control structures embedded within organizational segments c i i i 1 c c c i i i i c c c additionally, there is a linking mechanism that should exist between echelons in the organization which should also be evaluated. goals between echelons should be related and flow down through the hierarchy, as presented in figure 4. upper echelon goals will influence the goals set for a lower echelon within the same segment. therefore, the goals of the president will influence the goals of sales which, in turn, influence the goals of the eastern, western, and foreign divisions. this downward 52 journal of business strategies figure 4 linking mechanism: downfiows of goals vol. 7, no.1 g d c a c a c a c a g d c a-..... figure 5 linking mechanism: upfiows of data g d c " a .. ' a_ .. ' ".. \ d, c i ; a.. flow is similarly applied to each of the four elements for all subordinate levels within the hierarchy. in a similar manner, there should be an upward linking for control. information about action and performance (i.e., data) should flow back up the organization so that each higher level can review the performance of the lower levels. figure 5 illustrates this upward flow path. spring 1990 brewer: management control environmental factors 53 how the management control elements are applied in any given organization will be influenced by several environmental factors, such as management style, the type of management information system, the informal organization, subordinate personnel behavior, the nature of the activity being controlled, or other factors. environmental factors affect issues such as how goals are set, how evidence about performance is gathered, how action is accomplished, and how frequently these activities are reviewed or occur within the organization. environmental factors are not discussed in detail since they do not alter in any fundamental way the basic elements of management control. summary the concepts of goal, data, comparison, and action are applicable to any organization level, including the overall organization. no matter what organization segment is under consideration, each of these concepts must be present or else control is absent or deficient. also, the concepts are applicable to any type of organization product, service, profit, not-for-profit, or governmental. management control is the process which assures the attainment of the organization's goals. for the concept of management control to be operative in an organization, the organization must articulate its goals. h any organization, regardless of type, articulates its goals, a functioning control scheme can be designed and effectively utilized to enhance its operations. reference 1. anthony, r. n., j. dearden, and n. m. bedford. management control systems, fifth edition. hinsdale, il: richard d. irwin (1984). a primer on management control structures judgment analysis: a methodology for merit-based salary allocation vern c. vincent dewayne hodges university of texas-pan american edinburg ,texas contrary to many predictions, the nationwide trend towards merit-based salary systems in higher education has not abated. in fact, the increase emphasis on accountability in higher education by the public has motivated a number of state legislative bodies to mandate salary increases solely on the basis of merit ([1], [3], [4]). administrators and legislators claim that faculty union stances which traditionally oppose faculty merit review and performance appraisal systems have increased public pressure for accountability and merit-based salary systems [4]. especially when funds are inadequate, some administrators and policy makers favor merit-based salary systems because they provide for rewarding the most productive faculty or, at least, provide a rational for administrative actions. critics of merit-based salary systems, however, cite a number of practical difficulties ([ij, [4], [7]). faculty point out that without cost-of-living increases during inflation cycles, merit-based salary systems result in a majority of faculty suffering real pay cuts. they further emphasize divergence in public and professional assessments of the relative importance of teaching, research, and service. most important, perhaps, is the identification of valid criteria. the identification of variables which appropriately measure each of these functional service areas as well as the weight each of these variable should receive is always an issue [11 j. further complications arise since most institutions characterize themselves as teaching institutions and yet are unable to agree on how they wish to measure the teaching function. for example, many faculty claim that grades are exchanged for positive student evaluations. when other measures of teaching effectiveness are used, they generally are mistrusted or lack complete information [1oj. most of the articles in the literature do agree, however, that whatever methods of evaluation are used, the potential for success is greater when faculty input to the evaluation process is high ([1], [9], [11]). an evaluation system which incorporates a high degree of faculty input and can ultimately produce a consensus opinion as to how merit allocation can be obtained is based upon a statistical technique called judgment analysis. 1 journal of business strategies, volume 1, number 1 (spring 1990) 1 editorial footnote: while the remainder of this article focuses on judgment analysis in a university environment, the principle outlines of the technique, its applications, and its uses are generalizable to a private sector, for-profit enterprise desiring to utilize a quantifiable method of merit-based salary adjustment. clearly, this is a topic of special interest for compensation analysis. 17 18 journal of business strategies judgment analysis technique vol. 7, no.1 judgment analysis (jan) is a statistical technique for combining multiple regression analysis and hierarchical grouping or clustering analysis in order to classify criteria in terms of the homogeneity of their prediction equations. originally introduced by ward [12] and later modified by bottenberg and christal [2], the technique had developed widespread popularity not only in business but also in education and psychology ([5], [6], [13]). technical and computational aspects of jan are available through cited references ([2], [13]). the jan procedure initially requires each of the decision-makers to rank stimuli on a set of predictor variables. the value assigned to each profile then serves as the criterion variable. in the first stage of jan, a coefficient of determination (r2 ) is calculated for each individual judge's policy. also, the r 2 measures the judge's reliability in evaluating the profiles and serves as input for a comprehensive measure for all judges. the second stage of jan involves a clustering of the two judges having the most homogenous prediction equations. this procedure reduces the number of policies by one and generates a new r 2 value. this new (unadjusted) r 2 is, of course, lower than the original ones. the grouping procedure continues. by examining one policy at a time and combining sequentially the most homogeneous policies, eventually all judgments will have been consolidated into one single policy with an overall r 2 value. as will later be shown in table 3, when significant drops in r 2 occur between systems, then interrater agreement is confirmed and group policies are defined. the final result of jan is that individual judgment policies as well as group policies can be examined, allowing for a better understanding of grouping dynamics in decision-making. a numerical example will help clarify these procedures. j an illustration to apply jan to faculty merit allocation, the first step is to establish faculty profiles containing the evaluation information on the service areas. for illustrative purposes, three faculty service areas to the university are defined as teaching, professionalism in the field, and service. the teaching function comprises two components student evaluations and an overall measure of teaching quality elements. how are these two measured? student evaluations derive from a student opinion survey while teaching quality (an indication of a faculty member's teaching ability) derives from a faculty peer group. teaching quality is an indication of any activity on the part of the instructor to manage the teaching function in such a manner that promotes the learning and achievement of students. typical sample activities would include curriculum innovation and development, special tutoring, attendance at conferences or workshops devoted to improving teaching quality, or documentation of output measures of student success before or after graduation. spring 1990 vincent (1 hodges: judgment analysis 19 professionalism in the field comprises faculty development activities and scholarly research. development activities are measured by a faculty member's accomplishments in remaining current in the discipline. sample activities would include additional graduate course work and attendance at institutes, short-courses, and professional meetings. scholarly research is measured by professional publications, such as books, refereed articles, program presentations, and non-refereed professional publications. service comprises contributions to the university and to the community. university service refers to documented activities at the department, school, or university level. typical activities include committee assignments, student advising, sponsorships, and other special assigned tasks. community service refers to work outside the university which effectively represents or promotes the university in the community-at-large. community service activities include public workshops, speeches, consultantships and pu blic-service assignments. six different measures, two per function area, were used to form the basis for policy determination in awarding merit. each variable was measured based upon a five point scale ranging from unsatisfactory (0), satisfactory (1), above average (2), outstanding (3), to exceptional (4). fifty-nine profiles of university faculty members based on the above describes six variables and their measurement scale were generated by the use of a random number table. in addition to maximizing both mathematical and administrative soundness, this procedure also produces minimum correlation and maximum variability among the six profile variables. the net result of the procedure is to reduce multicollinearity among the profile variables and, consequently, to simplify policy determination. the 59 developed profiles are presented in table 1. a total of ten business school faculty and administrators were contacted to serve as judges and were requested to assign an overall rating on a five point scale from unsatisfactory (0) to exceptional (4) on each of the 59 hypothetical faculty profiles presented in table 1. by using these profiles, the judges were required to determine merit ratings based solely upon academic credentials rather than allowing for the possibility of personalities to influence the ratings. in the next step of the procedure, the jan technique was applied to the judges' ratings in order to determine the merit policy present among the various administrator and faculty judges. jan validate neither the variables nor the methods for obtaining the data information used in determining variable ratings. the variables and their measurement process are assumed to be reliable and valid or at the very least their identification and measurement have been agreed upon by all faculty and administrators involved in the merit process. judges' reliability and merit policies results table 2 presents the r2 values for the ten faculty and administrators who serve as judges. all the r2 values are significantly different from zero at the .01 level with the exception of the r2 value associated with faculty judge number 5. the low r2 20 journal of business strategies table 1 instrument vol. 7, no.1 please review the six levels of performance for each hypothetical faculty member. circle the overall merit that you believe is appropriate. the overall merit rating is to be measured as follows: (e) exceptional, (0) outstanding, (a) above average, (s) satisfactory, and (u) unsatisfactory. teaching professionalism service faculty student teaching developreunivercommuno. evaluation quality ment search sity nity merit 1 e e u a a s e o a s u 2 0 a 0 0 u a e o a s u 3 s 0 a a a s e o a s u 4 0 u a u s u e o a s u 59 e u e s e s e 0 a s u value for judge 5 indicates inconsistent ratings, suggesting that this judge either has no policy for awarding merit or perhaps is opposed to the concept of merit based salary allocation. some investigators eliminate judges whose r 2 values are less then .50 [14]; however, before making this decision an interview with that judge would be appropriate to assess what policy is being addressed. table 2 judge consistency judge r2 1 0.7617* 2 0.8089* 3 0.9934* 4 0.9478* 5 0.1387 * p < .01 judge 6 7 8 9 10 0.8424* 0.8697* 0.9066* 0.8248* 0.6186* the ten stages of the jan clustering procedure for the ten judges with their corresponding drops in r 2 for each stage are presented in table 3. in stage two, judges 6 and 10 are identified as having the most similar policies in determining merit awards. the drop in r 2 between stages one and two, however, is only .0044, which is not statistically significant at .01 level. the jan procedure continues combining the similar policies until a significant drop in r 2 occurs between stages. spring 1990 vincent (1 hodges: judgment analysis table 3 j an stages with drops in r 2 21 stage judges r2 successive drops in r2 collective drops in r2 1 1,2,3,4,5,6,7,8,9,10 .7481 2 (6,10),1,2,3,4,5,7,8,9 .7437 .0044 .0044 3 (1,6,10),2,3,4,5,7,8,9 .7359 .0078 .0122 4 (1,6,10),(4,8),2,3,5,7,9 .7278 .0080 .0203 5 (1,6,10,7),(4,8),2,3,5,9 .7187 .0092 .0294 6 (1,6,10,7,9),( 4,8),2,3,5 .7001 .0186 .0480 7 (1,6,10,7,9,5),( 4,8),2,3 .6675 .0325** .0806r 8 (1,6,10,7,9,5),(2,4,8),3 .6247 .0428 .1234 9 (1,6,10,7,9,5,3),(2,4,8) .5317 .0930 .2163 10 (1,6,10,7,9,5,3,2),( 4,8) .4304 .1013 .3177 a first collective drop which satisfies the a priori criterion of a .05 drop in r z • u first statistically significant drop in rz at .01 level. note: parentheses indicates judges grouped by the jan procedure. although the most common procedure for determining how many policies are present in a group of judges is based on tests of statistical significance, researchers familiar with jan procedures caution that r z values calculated in jan procedures, as with many other statistical tests, are a function of the number of cases to be judged and can often artificially generate statistical significance while not being practically significant [13j. ward and hook [13j recommend looking for a break in the objectives function as measured by a drop in r 2 values between stages. the general rule recommended is an r 2 drop of more than .05 from the initial stage r 2 value [6]. applying this rule to the present analysis suggests that a reasonable break occurs between stages six and seven which results in a .0806 drop in r 2 from stage one. another reason that the break in policies should occur between steps six and seven has to do with the consistency of the judges' ratings. recall that judge 5 was identified as having inconsistent ratings. at stage six and all previous stages, judge 5 was identified as a single-member system. it would be inappropriate to include judge 5 with a group of judges in stage seven who have established consistent policies. stage six indicates that five decision making policies are present among the ten faculty judges. judges 1, 6, 10, 7, and 9 represent policy one, while judges 4 and 8 represent policy two. judges 2, 3, and 5 are single-member systems and represent three additional policies. a clearer representation of the five policies captured by the j an process is obtained by examining the validity coefficients, presented in table 4. a particular judge's policy can be determined by examining the six validity coefficients 22 journal of business strategies vol. 7, no.1 for each judge in question. each validity coefficient is determined by correlating the overall rating of the 59 hypothetical faculty with each independent variable. judge 2, for example, attends to only one variable student evaluations of teaching. table 4 validity coefficients student teaching university community judge evaluation quality development research service service 1 0.33"" 0040"" 0.07 0.54"" 0.28 0.38"'· 2 0.89*" 0.10 -0.27 0.06 0.07 -0.07 3 0.05 0.09 -0.07 0.99"" -0.02 0.25 4 0.79"" 0.15 -0.28 0.60 0.15 0.18 5 -0.02 -0.12 0.01 0.26 -0.06 0.26 6 0.38** 0046"" 0.08 0.58"" 0.34"'· 0.23 7 0.58"" 0043"" -0.29 0.57"" 0.21 0.46"" 8 0.66·'" 0.24 -0.19 0.70"· 0.10 0.14 9 0043"" oa5*'" -0.04 0.56** 0.33"'" 0.34** 10 0.54*" 0046""" -0.15 0040"" 0.23 0.16 *. p < .01 of the five policies presented, policy one (judges 1, 6, 10, 7, and 9) primarily addresses both variables in the teaching function, scholarly research and to a minor extent the service variables. policy two, judges 4 and 8, asserts that merit should be awarded on only two variables student evaluations of teaching and scholarly research. judge 2 attends to only one variable, student evaluations of teaching while judge 3 only considers scholarly research. because of the lack of consistency in ratings performed by judge 5, there is some question as to what policy is exhibited or even if this judge should be included in any further analysis. merit allocation model a logical extension to the jan procedures outlined above would be to include all of a school's faculty in the evaluation of the hypothetical profiles and use the last stage of the jan procedure as the model for merit-based salary allocation. the actual faculty profiles could be substituted into the regression equation generated in the last stage of the j an procedure. faculty merit awards could then be based upon the model. objectivity in the synthesis of ratings would be ensured because faculty names never are presented to a peer committee or university administrators during the evaluation process. also every faculty member would have input to the model and, consequently, have a determination as to how merit would be awarded. consideration could also be given to elimination of faculty or administrators from the model who failed to demonstrate consistency on their evaluations. spring logo vincent {1 hodges: judgment analysis 23 in conclusion, jan is a powerful statistical methodology which provides business school decision-makers an objective technique for identifying not only what policies exist in awarding merit-based salary allocations but also serves as a mechanism for setting or determining new salary allocation policies. references 1. baker, m. a. "merit-based salary systems: a continuing problem," the texas association of college teachers bulletin, vol. 41, no.1 (august, 1988), pp. 12, 24-25. 2. bottenberg, r. a. and r. e. christal. "an iterative technique for clustering criteria which retains optimal predictive efficiency," journal of experimental education, vol. 36 (1968), pp. 28-34. 3. brown, w. s. "performance review instruments and merit pay programs in an academic environment," journal of college and university personnel association, vol. 35 (1984), pp. 7-13. 4. ehil, g. j. "faculty attitudes toward merit pay in south dakota's public colleges and universities," journal of college and university personnel association, vol. 37 (1986), pp. 6-12. 5. glorfie1d, l. and g. fowler. "a multivariate methodology for simultaneous capturing and clustering judgment policies," decision sciences journal, vol. 19, no.3 (summer 1988), pp. 504-20. 6. houston, s. r. judgment analysis: tool for decision makers. mss information corporation (1974), pp. 69-73. 7. kasten, k. l. "tenure and merit pay as rewards for researching, teaching, and service at a research university," journal of higher education, vol. 55 (1984), pp. 500-14. 8. madden, j. m. "an application to job evaluation for a policy capturing model for analyzing individual and group judgment," journal of industrial psychology, vol. 2 (1964), pp. 36-42. 9. magnusen, k. o. "faculty evaluation, performance, and pay: application and issues," journal of higher education, vol. 58 (1987), pp. 516-29. 10. medley, d. m., h. coker, and r. s. soar. measurement-based evaluation of teacher performance. langman, ny: and landau (1984). 11. spaights, e. and e. bridges. "peer evaluations of salary increases and promotions among college and university faculty members," north central association quarterly, vol. 60 (1986), pp. 403-10. 24 journal of business strategies vol. 7, no.1 12. ward, j. h. "hierarchical grouping to optimize an objective function," journal of the american statistical association, vol. 58 (1963), pp. 236-44. 13. ward, j. h. and m. a. hook. "application of an hierarchical grouping procedure to a problem of graying profiles," education and psychological measurement, vol. 23 (1963), pp. 69-81. 14. williams, j. d., d. gab, and a. lindem. "judgment analysis for assessing doctoral admission policies," the journal of experimental education, vol. 38, no.2 (1969), pp. 92-96. judgment analysis: a methodology for merit-based salary allocation goal programming as a decision tool for new products planning: a case example ed timmerman university of tennessee at martin martin, tennessee james a. petty abilene christian university abilene, texas applications of goal programming (gp) to marketing decision environments have been relatively rare, even though its composition makes gp eminently suitable for many marketing contexts. it appears that the technique could be particularly helpful in industries that specialize in advancing new technologies where marketing efforts are constantly undertaken in uncharted waters. the practical meaning of goal programming, for an industry dealing with new products designed for new markets and marketed in unfamiliar settings, is that this technique would aid in the generation of more rational product introduction decisions. the purpose of this article is to present and illustrate the use of goal programming as an aid to making common product introduction decisions, especially where technologically innovative products are concerned. first, is a description of the origin and primary elements of the linear goal programming, then a demonstration of how the tool can be applied to media choice and planning, and finally the procedure is utilized in a. promising industry (cellular communication) which is fraught with problems introduced by the accelerating advances in technology and ever shortening product life cycles. background the concept of the profit maximizer, in classical economic theory, provides neither a sufficiently descriptive nor prescriptive model for the decision maker in a contemporary organizational setting. since a broad range of goal categories may i'dcist, including economic, social, ethical, and political ones, as well as multiple elements within each category, it is hopeless to think of treating these in a linear fashion or to compare these at the same priority level. in this context, the decision maker is not trying to maximize, but to "satisfice." he is positioned as one attempting to attain a set of goals in an environment. the primary difficulty in decision analysis is the treatment of these multiple conflicting objectives. the task becomes one of value trades in the social structure of conflicting interests. journal of business strategies, volume 6, number 1 (spring 1989) 14 spring 1989 timmerman & petty: goal programming 15 goal programming, a modification and extension of linear programming, is a technique for handling decision problems by means of a prioritized solution to a system of multiple conflicting objectives. the product of goal programming is no substitute for a decision, but it does enable the one making the decisioo to be more systematic in attaining goals. chames and cooper [3], who were also pioneers in the application of tilled! programming (lp), originated the concept of goal programming. the conventional lp method utilized unidimensional objective functions (usually the maximization of profits or the minimization of costs) which proved excessively limiting where complex decision environments were the norm. the gp model they developed would handle multiple goals in multiple dimensions, therefore yielding a more leasible solution. later ijiri [7] contributed the notion of "preemptive priority factors" to allow treatment of multiple goals according to their importance, ..,signing weights to goals of the same priority level. his work refined the concept of goal programming and developed it as a distinct mathematical programming technique. building upon this work, goal programming has found application in industrial and operations research settings, manpower and academic planning, management accounting, hospital admirnstration, and inventory control. despite this foundation, applications of goal programming have been relatively scarce in the area of marketing. exceptions to this occur in the areas of media planning ([4], [5], [11]), sales effort allocation [16], and in retail store selection modeling [12]. the practical usc of the goal programming method has been considerably advanced by the work of three writers. sang m. lee's text of general applications for decision analysis [131 and a later management science text [14] have solidly installed the approach as a standard decision tool. j. p. ignizio's writings in the area of operations research ([8), [9], [10]) have also given the concept valuable exposure. and marc j. schniederjans book on linear goal programming [17j is a practical and helpful aid for the first time user. the software available with this text is especially useful. the goal programming method the goal programming model consists of three basic components: a mathematical expression of the weighted multiple goals to be achieved (objective function) the limitations or restrictions on achieving the desired goals (goal constramls), and the provision that negative solution values are not acceptable (non-negativity requirements). using this approach, the algorithm seeks to minimize the deviations from each of a set of goals (objective criterion or function) subject to constraints imposed by the entire goal set (goal parameters or constraints imposed by limited resources, such as money, production capacity, time, etc., as restrictions on the ability to optimize the stated goals), rather than attempting to maximized or minimize an objective function directly. additionally, there is an implicit requirement that all decision variables take on non-negative values. this is appropriate for most marketing problems since they tend to deal with discrete variables. 16 journal of business strategies vol. 6, no.1 the most critical phase of the application of goal programming is the formulation of the model for the problem under consideration. in fact, considering the current availability of gp software, solution is not generally much of a difficulty once the model is constructed. formulation of the model includes the following procedural elements: 1. determine and specify whether the problem is one of maximization or minimization (as a rule, if the problem focuses on profit it is a maximization problem, or it on cost, it is a minimization problem). 2. identify and define all factors relevant to the choice (decision variables) along with the amount each of these factors affect a decision (contribution coefficients). 3. state the goal (objective function) for the decision problem. 4. identify and list the various constraints (also known as side constraints) working against the accomplishments of the goal. this usually shows up as limits on resource availability or resource usage. 5. indicate that the resulting values of the decision cannot be negative by setting each of the decision variables equal to or greater than zero. the formulation for a media decision case will take the general form of a maximization problem.! this goal mathematical programming procedure converges on an optimum solution within the constraints of the business environment. a critical difference in the gp approach and that of simple linear programming is that gp allows for a convex solution (i.e., one that expresses diminishing returns) which is much more realistic in most marketing contexts than a mere straight line solution. complex problems are invariably multidimensional. igoa] programming format for a maximization problem j maximize: z = 2:c) "') (objective function) j=l j subject to: 2:<i;j"'j ~ bi (goal constraints) ;;:;;1 8lld: 'j)j ~ 0 (non-negativity requirement) where: val ue to be maximized b; contribution coefficients i decision variables j technologicnl coefficients right-hand-side values number of side constraints number of decision variables spring 1989 timmerman ff petty: goal programming the new technology environment 17 product innovation and introductions into the marketplace are occurring at an ever increasing rate. the consequences of this for successful marketing planning and strategy formulation are complicated by the ever shortening average length of product life cycles [16]. consider that, layered on top of this, new product introductions are becoming more expensive and the chanced of succeeding with them are less than in previous years. taken a.ll together, these facts suggest that marketers of product innovations ought to be using the best and most efficient methods for selecting approaches to introduction, particularly in anticipation that the moment of strategic fit between the competencies of the business and the critical success factors in a market will quickly pass. the fast pace that revolutions in technology have set for business, highlights the relevance of the "strategic window" analogy [lj. when the "fit" between the competencies of the organization and market requirements are at an optimum for only brief spaces, it is essential that the firm be able to move through that opening expeditiously. one result of this environment is that the "better to be safe than sorry" market testing mentality of recent years is giving way, in some sectors, to an action posture as organizations adapt to a more dynamic marketplace. this calls for a streamlining of decision-making processes in order to more quickly respond to market opportunities. speed and agility in assessing opportunities. speed and agility in assessing opportunities in the marketplace is essential to expedite rapid entry. moving at the earliest opening of the "window" avoids preemptive actions on the part of competitors. the nature of this "new" environment emphasizes the value of tools which can improve the efficiency, as well as the effectiveness, of decisions related to how market entry should proceed. goal programming is just such a tool. a case in point for several decades there has been a shortage of vehicular telephone service in many metropolitan areas. as recently as 1982, only about one-tenth of 1% of all motor vehicles in the united states were equipped with mobile telephones, and long waiting lists for service existed in many areas [2]. additionally, with the advent of citizens band radios (cbs) and cordless home telephones, the general population was becoming more familiar with, and more receptive to, the concept of portable communication. to address this situation, the federal communications commission (fcc) approved the establishment of a "domestic public cellular radio telecommunications service." the system is defined as a "high capacity land mobile system in which the spectrum assigned is divided into discrete channels. these channels are assigned in groups to small geographic cells covering a defined service area [6]." two allocations are due to be licensed in each standard metropolitan statistical area (smsa)j one to a non-wireline common carrier (known as "radio common carriers"), and one to a wireline carrier. one june 7, 1982, the fcc accepted applications to provide cellular 18 journal of business strategies vol. 6, no.1 service m the 30 largest u.s. markets. considerable interest was demonstrated at this filing and intense competition for the smaller markets is in evidence. one of those in contention for this market activity is mobile phone of texas, the largest mobile telephone and pager provider in the northern and western areas of that state. mobile phone is about 15 years old, but has developed into the best known and most reputable radio common carrier (rcc) in its marketplace. eager to extend its operation into this potentially lucrative market, it has been a forerunner in prepanng application materials and monitoring the selection process. in anticipation of receiving the rcc award in the standard metropolitan statistical areas (smsas) in which it is filing, mobile phone is engaged in preparing a marketing plan. a major obstacle to confident planning is mobile telephone's unfamiliarity with the potency of various media available for gaining exposure for the new cellular concept to the potential market. in the past the company has relied almost exclusively on yellow page and newspaper advertising, but feels that the cellular concept will require a more aggressive approach. lacking experience, how do they construct a media mix suitable to the task of introduction? one answer is to employ goal programming in the search for a suitable blend of media. formulation of the model in the model, a linear goal programming (lgp) model has been used in conjunction with separable programming (sp) for advertising media selection. our model includes three levels of advertising each for television, radio, and newspaper (table 1). these levels are typical of the options offered by the media available in the geographic area of application. as in the typical marketing situation, the rates of audience exposure per level lti'e not linear. for instance, level 1 of television advertising, which costs $300, would yield 350 units of advertising exposure, while level 2, which costs $570, would yield a 560 units of advertising exposure, and level 3, which costs $660, would yield 660 units of advertising exposure. as established in this table, each of the three media exhibit a diminishing marginal return of exposure. table 1 linear goal programming formulation units of advertising medium deviations advertising r-tefevlsl-on fla,fi,,--newspaper from goal exposure tv, tv, tv, rad, rad, rad. pap, pap, pap. goal constraints 'ibtal units 350 560 660 450 530 560 300 500 690 d,~i()~oo.~ televisio;-=-max 350'560-660 d;~ 6,500 radi()-=~m~ . ___ ' 450 530 560 da+ 3,500 newspaper minr-330 500 690 <4"'2,000 newspaper max 330 500 690 <4+ 2,000 totai budg~t ,-'--constraint 1$300 $570 $660 $240 $475 $520 $175 $300 $330 ds+ $7,500 spring 1989 timmerman fj petty: goal programming 19 the model seeks to minimize the deviations from the goals as stated in table 1. goals are subjectively established by the advertiser as are the priority weights. specifically, the model seeks to minimize the following objective function: where: dl through ds are the negative deviations from the goals as stated in table 1; d1 + through de+ are the positive deviations from the goals as stated in table 1; pi through ps are the priorities of minimizing the deviations from the stated goals; and wi through w s are a weighting of the priorities. this statement dictates that the first priority (pi) will be to minimize the amount to which the total budget constraint (d s ) of $7,500 is exceeded. this priority will carry a weight of 1.2 relative to other priorities. of second importance (p2 ) is the minimization of any deviation below the goal of achieving 10,000 units of exposure to the advertising message by means of the total promotional scheme. the third priority in order (ps ) is to minimize the negative deviation from the goal of achieving 2,000 units of advertising exposure by means of the newspaper medium. the final priority is to minimize the positive deviations from the goals of achieving 6,500 units of exposure through the television medium, achieving 3,500 units of exposure through the medium of radio, and achieving 5,500 units of exposure through the medium of newspaper. newspaper is the only medium for which both positive and negative deviations from the goal are a concern. the objective function laid out above is minimized subject to the constraining goals in table 1. these constraints are not necessarily, or even usually, absolute and therefore constitute a kind of wish list. therefore the superordinate goal is to come as close as possible to achieving each goal given their assigned weights. table 2 linear goal programming solution levels of advertising medium levell level 2 level 3 units/exposure/cost units/exposure/cost units/exposure/cost television 15.13/5,296/$4,539 1.82/1,204/$1,204 radio newspaper 2.89/2,000/$957 ---~ total exposure = 10,000 cost = $7,500 as reported in table 2, the result of this process is that an optimum solution exists where 15.13 units of exposure at television rate 1 (tvl), 1.82 units of exposure at television rate 3 (tvs ), 3.33 units of exposure at radio rate 1 (rad i ), and 2.89 units of exposure at newspaper rate 3 (paps) are employed. since promotion cannot 20 journal of business strategies vol. 6, no.1 be purchased in fractional units and since a procedure of rounding these results to integers would, in this case, cause a budget overrun of only $30, a whole-number solution is available which very nearly matches the intended overall goal of spending no more than $7,500 while still achieving the intended exposure rates. even though a solution under a different set of constraints may indicate discontinuance or non-use of a particular medium (for example, newspaper), mobile phone of texas may be wise to continue using that medium for the purpose of maintaining relationship or because the medium will be a major adopter of cellular units. conclusions developing and solving the goal programming model not only assists managers in making decisions, but it also points out the trade-offs which must occur due to limited resources and conflicts among goals. this information puts the manager more in touch with the realities of the business environment and, consequently, clarifies the true nature of relationships within that environment. furthermore, the model allows the manager to review critically the priority structure for the goals in view of the solution derived by the model. for the sake of simplicity, some aspects of advertising were not given specific consideration. for example, the time dimension (i.e., time intervals between exposures in the same medium, harmonized exposures in various media for special purposes, etc.), weighted exposure index of each medium for specific market segments (i.e., women, men, teen-age market, etc.), and advertising goals for certain time periods, products, and market segments have been ignored in this model. however, if such data are available, these can easily be incorporated into the model. it appears that goal programming has a great potential for advertising media selection and scheduling when there are multiple conflicting goals of the advertising campaign. much of the decision making process relies heavily on relevant managerial experience. when deprived of this valuable resource, as in the case of new technology marketing, a systematic method of applying what is known about the decision context is especially useful. goal programming is such a technique and holds great promise for reducing the risk involved in a task more and more common to the marketer of this age. references 1. abell, derek f. "strategic windows." journal of marketing, vol. 42 (july, 1978), pp. 21-25. 2. bain, john 5., winston e. hinsworth, and susannah b. bristol. oellular mobile radio telecommunications service: applications fur the top 30 markets. lehman brothers kuhn loeb research (september, 1982), p. 1. 3. chames, abraham, and w. w. cooper. management models and industrial applications of linear programming. new york, ny: john wiley (1961). spring 1989 timmerman fj petty: goal programming 21 4. charnes, abraham, w. w. cooper, j. k. devoe, d. b. learner, and w. reinecke. "a goal programming model for media planning." management science, vol. 14 (april, 1968), pp. 423-430. 5. de kluyver, cornelis a. "hard and soft constraints in media scheduling." journal of advertising research, vol. 18 (june, 1978), pp. 27-31. 6. federal communications commission. "notice of inquiry and proposed rulemaking." cellular communications systems, docket cc-79-318 (january, 1980). 7. ljiri, y. management goals and accounting for control. chicago, il: rand mcnally (1965). 8. ignizio, j. p. "a review of goal programming-tool for multiobjective analysis." journal of the operational research society, vol. 29 (november, 1978), pp. 11091119. 9. ignizio, j. p. "an approach to the modeling and analysis of multiobjective generalized networks." european journal of operational research, vol. 12 (april, 1983), pp. 357-361. 10. ignizio, j. p., and j. h. perlis. "sequential linear goal programming: implementation via mxps." computers and opera.tions research, vol. 6 (october, 1979), pp. 141-145. 11. keown, a. j., and c. p. davis. "integer goal programming in advertising media selection." decision sciences, vol. 10 (october, 1979)' pp. 577-592. 12. kim, c. young. "a manufacturer's retail store selection model in the normative distribution channel design: a goal programming approach." akron business and economic review, vol. 14 (october, 1983), pp. 41-47. 13. lee, sang m. goal programming for decision sciences. philadelphia, pa: auerback publishers (1972). 14. lee, sang m. introduction to management science. new york, ny: dryden press (1983). 15. lee, sang. m., and m. bird. "goal programming model for sales effort allocation." business perspectives, vol. 6 (july, 1970), pp. 17-21. 16. qualls, william, richard w. olshavsky, and ronald e. michaels. "shortening of the plc-an empirical test." journal of marketing, vol. 45 (october, 1981), pp. 76-80. 17. schniederjans, marc j. linear goal programming. princeton, nj: petrocelli (1984). goal programming as a decision tool for new products planning: a case example an alternative strategy for improving performance appraisal communications william kilbourne paul reed sam houston state university huntsville, texas introduction managers at alilevels of the organization are continually faced with the difficult task of making decisions concerning the use of human resources. these strategic decisions often involve making trade-offs between alternatives, determining value judgments and ascertaining the preferences of superiors and/or subordinates. managers responding to such problems have been moving away from subjective trait evaluation and toward objective assessment of the degree to which goals have been met. while improvements have been made, there appears to be one problem that continues. employees frequently do not understand exactly what their superior desires in terms of performance. if a superior fails to communicate the "real" performance criteria, the value of any appraisal system will be diminished increasing potential ambiguity and conflict. bernardin and beatty [1] suggest that "just good communication" can be effective in reducing such conflict. it is to the end of better communication of performance appraisal criteria that this article is directed. performance appraisal strategies have some elements in common with decision strategies in other areas, such as marketing, in that they frequently require simultaneous ranking of multiple criteria. marketing researchers have, for some time now, employed techniques for evaluating such judgment processes. one technique that has been employed by marketing researchers and appears to have great potential for human resource management as well is conjoint measurement analysis. exploratory application of this technique has shown real promise in such areas as job choice, selection of applicants, and benefit preference [7]. reed and johnson [6j found that conjoint measurement offered a potentially valuable tool for quantifying the relative values a supervisor attaches to various levels of performance appraisal criteria. with such information available, a subordinate could, they concluded, be better able to evaluate his/her strengths in relation to what could be considered desirable performance. the subordinate then would be in a position to make decisions concerning how to best achieve optimal performance. optimal performance in this sense refers to achievement of the maximum performance rating available, given the subordinate's energy and ability constraints. journal of business strategies, volume 6, number 1 (fall 1989) 91 92 journal of business strategies vol. 6, no.1 this extends the reed and johnson study and will attempt to further refine and validate the use of conjoint measurement as a strategic option to assist in improving performance appraisal communication. performance appraisal strategies usually include attempts at measuring how successfully the various tasks which make up a job are performed. ideally, every subordinate should carry out each task in an optimal manner, though practically this seldom happens. most subordinates excel at some tasks and not at others. assuming an employee is interested in scoring high on his/her performance evaluation and being eligible for available rewards, the problem becomes one of effectively allocating his/her energies among the various tasks. this requires the subordinate to make trade-offs. for instance, more hours spent on task x may mean he/she will receive a higher score on a certain performance criterion, but task y might have to be neglected with a possible lower evaluation on another criterion. what should the optimum allocation of time and energy be in order to gain the most value among the various performance criteria? going to the supervisor for assistance may prove frustrating because of his/her inability to provide definitive guidance [2]. this may be particulary true if there are many tasks and associated performance evaluation criteria that go together to form a job. obviously, a subordinate's decision on trade-offs could be greatly enhanced if the supervisor's attitude concerning the importance of the various appraisal criteria were known. conjoint analysis the difficulty raised by these circumstances is not unresolvable. while infrequently used in human resource management applications, there are measurement strategies used in psychology and marketing research for assessing human judgment. one method which has great potential in the situation outlined here is conjoint analysis (4). conjoint refers to measuring relative values 6f things considered jointly that 'might be unmeasurable taken individually, thus permitting the development of a set of relative values (5). a typical application in marketing might involve analyzing the relative importance to potential consumers of various options on an automobile that might be offered in "special option packages" at various prices. the objective might be to determine what package of options results in the most positive buyer response given the additional cost. a manager's situation is analogous to a potential buyer making choices in that the relative desirability of various subordinate work performance components are compared. in applying conjoint analysis, the manager is asked to rank the possible packages of employee performance components. each package consists of varying combinations of performance levels associated with the specific evaluation criteria used in the organization's performance appraisal system. conjoint analysis of the ranking of these packages is decompositional in nature, as it attempts to identify consistencies in the rater's judgment of desirability. here, "decompositional" refers to an analysis of the data to determine the impact each variable has on the ranking arrived at by the rater. the algorithm first identifies the variable the supervisor fall 1989 kilbourne f3 reed: performance appraisal 93 implicitly has chosen as the most influential in a subordinate's rating, then the second most influential, and so on. weights are then assigned to each variable, so that when summed, the result is a ranking of performance packages that approximates the manager's ordering (2). methodology unlike the reed and johnson study, the approach taken in the present study to demonstrate the value of conjoint analysis was to apply it to an actual appraisal situation. by comparing the actual results to those that would be predicted on the basis of conjoint analysis, the value of the technique in effectively communicating the appraiser's true weighting of performance criteria becomes apparent. performance criteria since most performance appraisal strategies, as they stand, do not conform to the requirements of conjoint analysis, some minor modifications may be necessary in scoring. this was true in the present study which uses actual subordinate evaluations in an organization setting as the demonstration vehicle. the evaluation system and its modifications are described here. there were three criteria evaluated in the present study, quality of work, quantity of work, and interpersonal relations. while the system as constructed is relatively formal, the evaluator still has latitude in effectively weighting the importance of the different measures and, thereby, the final overall evaluation of the ratee. each of the areas was scaled to an ordinal ranking of excellent, good and poor by using a 33 and 67 centile split. this effectively reduced the actual interval scaled ratings to the ordinal requirement of monanova, the specific type of conjoint analysis to be used, in a straightforward way. each individual's rating was then reassigned according to this system. thus, for each of the three evaluation areas, quality, quantity and relations, there were three possible evaluations, excellent (e), good (g) and poor (p). analysis in the next phase of the study, the evaluator's "true weights," or utility scores, for the various performance criteria were determined using monanova. to accomplish this, the three evaluation criteria were each defined in terms of the three levels of performance. criteria, or performance standards, for determining the appropriate level of performance for each of the three evaluative areas were provided to the rater. a set of cards was then constructed such that each card contained one combination of varying levels of the three performance criteria. further, there was one card for every possible combination, or in this case, 27 cards. the evaluator's task was to rank order the set of cards from lowest to highest preference. in the event that there are too many combinations for the task to be feasible, orthogonal arrays (3) can be developed to effectively reduce the number of combinations to be evalua.ted though this wa.s not considered necessary in the present study. the results of this procedure are presented in table 1 94 journal of business strategies vol. 6, no.1 table 1 rank ordering of criteria-evaluation combinations quantity e g p quality e g p e g p e g p relations excellent 27 24 22 21 19 12 9 6 3 good 26 23 15 20 16 11 8 5 2 poor 25 17 13 18 14 10 7 4 1 (e=excellent, g=good and p=poor) rank orderings before discussing the monanova results, several things about table 1 should be noted. first, the evaluator preferred a combination of poor quantity, poor quality, and poor relations (rank = 1) least. the most preferred performance combination was excellent quantity, excellent quality, and excellent relations (rank = 27). next, the evaluator was willing to trade off first relations and then quality in order to retain excellent quantity as long as possible, i.e., until his 7th most preferred combination (rank = 21). this trade-off of relations first and then quality, is particularly noticeable in the last nine combinations, i.e., rank =: 9 through rank = 1. monanova results on the basis of the set of responses noted in table 1, monanova was used to determine the appropriate utility values for each evaluative level of each performance criterion. the results of this analysis, using kruskal's pc-mds version of monanova (8) are presented in table 2. from this table, a second set of performance evaluations can be determined for each of the ratees, i.e., the actual set and a new set using the rater's utility values applied to the ordinal ranking created previously. table 2 derived utilities for each level of each criterion excellent good poor quantity 1.492 0.835 -2.327 quality 0.506 0.029 -0.534 relations 0.246 0.000 -0.246 to find the total utility associated with the evaluator's most desirable combination (rank = 27) of the performance criteria in table 1, the individual utilities can be read in table 2 and summed. by adding the utility scores for the excellent ratings in each of the criteria (quantity, quality and relations), the total utility for the most preferred combination is seen to be 2.244. similarly, the least preferred combination can be found by summing the poor utility values for each of the performance criteria yielding fall 1989 kilbourne tj reed: performance appraisal 95 a utility score of -3.107. the evaluator's preference for any other combination can be found in a similar fashion. a test of consistency of the rankings based on the utilities generated by monanova indicates that the statistical ranking generated was significantly correlated (spearman's rd2=.98) with the respondent's actual rankings shown in table 1a graph of the derived utility functions is shown in figure 1. it clearly portrays the almost overwhelming importance of quantity to the evaluator. a poor quantity evaluation in effect negates the positive effects of excellent quality and relations in the total utility structure of the evaluator. conversely, excellent quantity more than makes up for poor quality and relations. figure 1 criterion utility values 2,-------------------------------, 1.5 --"·-doontity·· [f) q) ::j o > >. ;":::' 0.5 ·-·· .. ·· ... _...·..·-ooolity-relationso -~ _--..-..~.. -0.5 -1 .------.~.. -.--_ _ ----1.5 --.-..--.-.._.._ --·-.-00--.-.2.5 l..-.. -,----,--,. ----' excellent good evaluation poor 96 journal of business strategies vol. 6, no.1 strategy correspondence it should be recalled that in the original appraisal strategy, the actual evaluation was made on the basis of interval scaled data that were subjectively interpreted by the evaluator with no clear indication of how different areas would affect the total. furthermore, this study was made two months after, and unrelated to the actual evaluation. hypothetically, the evaluator could have used the same weights indicated in monanova, but there is no assurance of this. a comparison of the two methods is presented in table 3. table 3 actual performance ratings vs. monanova ratings employee 1 2 3 4 5 6 7 8 9 actual rating rank 5.96 5 6.91 1 6.48 3 2.87 9 5.48 7 6.20 4 5.58 6 5.05 8 6.85 2 monanova rating rank -2.067 5 2.244 1 1.275 3 -3.107 8-9 t -2.298 6-7 t -0.055 4 -2.298 6-7 t -3.107 8-9 t 1.998 2 as can be seen, there is a very close correspondence between the two rankings. the only deviations are the ties for sixth and seventh place and eighth and ninth place. it should be noted that the individuals in these ties were sixth and seventh place and eighth and ninth place in the original ranking. consequently, no individual was reranked to a lower or a higher position. this indicates the evaluator was very consistent in making the actual evaluations and then later ranking the criteria combinations that were used to determine the utlities calculated by monanova. debriefing session results many subordinates of the evaluator were surprised at the results of this study. the rater's emphasis on quantity had been underestimated. quality was found to carry less weight than expected and relations more. a few ratees stated that they planned to change their relative emphasis on performance criteria. the chairperson concurred with the results concerning his evaluation of quantity and, like the subordinates, was somewhat surprised at his weighting of quality and relations. after a few days' thought, he indicated that the monanova utilities for these latter two criteria were probably correct. fall 1989 kilbourne & reed: performance appraisal discussion 97 if one can assume that these various utility values are made available to employees at the beginning of an evaluation period, then each can determine the precise incremental benefit to be derived from expending more time and effort in one area and . less in another. for example, if an individual desired to move from good quantity (0.835) to excellent quantity (1.492), he/she could analyze 9 different combinations of quality and relations in order to find the one that permitted the most available time and energy with the least loss of utility. for those utility values to be of any real use, however, they should correspond closely to how the evaluator actually scored those combinations in the most recent annual evaluation period. given the close correspondence between the actual and monanova based ratings, the informed subordinate of this evaluator should be able, at least in the short-run, to make knowledeable decisions concerning the selection of tradeoffs from among the various criteria. because of these informed decisions, the ratee should then stand a better chance of receiving a higher performance rating by adoption of a different performance strategy given his/her energy and ability constraints. in brief, the findings of this study validate the earlier research by reed and johnson and indicate that, as a performance evaluation strategy, conjoint analysis offers a unique method for communicating performance appraisal criteria. whether the ratee does in fact receive a higher appraisal because of the use of monanova based utilities is open to question. this question can best be answered by conducting a longitudinal study of multiple evaluators and ratees over at least a two year period. references 1. bernardin, j. and beatty, r. performance appraisal: assessing human behavior at work. boston: kent publishing (1984). 2. churchill, g. marketing research: methodological foundation, chicago: dryden press (1983). 3. green, p. "on the design of choice experiments involving multifactor alternatives." journal of consumer research, vol. 1 (1974), pp. 61-68. 4. green, p. and v. srinivasan. "conjoint analysis in consumer research: issues and outlook/' journal of consumer research, vol. 5 (1978), pp. 103-122. 5. johnson, r. "trade off analysis of consumer values," journal of marketing research, vol. 11 (1974), p. 121. 6. reed, p. and h. johnson. "quantifying trade-offs among multiple appraisal criteria/' in proceedings, human resource management and organizational behavior (1987). 98 journal of business strategies vol. 6, no.1 7. sukla, p. and j. bruno. "a review of conjoint measurement analysis applications for human resource management," in proceedings, human resource management and organizational behavior (1984). 8. smith, m. pcs_mds multidimensional scaling and conjoint analysis. provo, ut: byu press (1987). pp. 6-1 to 6-19. an alternative strategy for improving performance appraisal communications the importance of the business plan to the small business cynthia c. ryans department of library administration kent state university kent, ohio john k. ryans, jr. michael a. pearson college of business administration kent state university kent, ohio some feel a good business plan can greatly increase any start-up or early-stage small business's chances for success. but good business plans are not always easy to develop. often, the preparation of a business plan is one of the most difficult tasks to tackle and complete. in a 1985 survey ackelsberg and arlow [ij reported that the majority of responding small-business firms do plan. the researchers demonstrated that organizations which engaged in planning had greater increases in sales and profits over a three-year period than non-planning organizations. if a business plan is lacking, it is quite possible that the marketing, production, finance, and other functions of the business will each operate under individual guidelines that might be directed toward different and conflicting goals. a sound business plan can go a long way toward avoiding such a situation. in this article various aspects of the business planning process will be explored, and the importance of the business plan for small businesses will be discussed. the results of a study conducted among faculty teaching small-business courses provide particular insights on this topic. what is a business plan? two definitions of a business plan suggest its breadth and content. bryan and welton ([21, p. 44) define a business plan as "a detailed written description of a company's past, current, and projected operations." according to welsh and white ([11]' p. 300), "{t)he plan for a new business is the description, in precise and concise language, of the activities that will take place and the net result of the "..xchanges of value in the transactions that will occur during the early months and years in the life of a new enterprise." journal of business strategies, volume 5, number 2 (fall 1988) 61 62 journal of business strategie.~ vol. 5, no.2 ma.ny will argue that it is actually the ability (or lack of ability) to develop a business plan which establishes the likelihood of a small firm's ultimate success or failure. if, for example, the management of a new business merely has a single "good idea" relating to a potential new product and forges ahead without a dear understanding of how to implement that idea, then the business is probably destined for failure. king [4] states that according to the small business administration, lack of planning is one of the two major causes of business failure (lack of capital is the other). businesses do fail, and by any measure, they fail all too often. in 1986, there were more than 80,000 small-business bankruptcies [10]. despite such a large number of small-business failures, some owners and managers of small firms feel their businesses are not suited for anything as formal as a business plan. their claim is that the operation of a business needs to be flexible and ready to change direction quickly; they see a business plan as inhibiting that flexibility. larson [5] points out that even some well-known businesses do not employ a formal planning process. the managements of these firms believe business plans are simply "dreams of glory" and enjoy listing all the companies that have been successful without relying on a business plan. although some organizations have shown they can "make it" without formal planning, most small businesses would be wise not to take the chance. for many small finns there is no choice. to a start-up company seeking venture capital, a spot in a business incubator facility, or a small-business grant or bank loan, the preparation of a business plan is likely to be a necessity. h resources are being requested by an organization, management will undoubtedly be required to demonstrate how they are to be used. even for a fully-funded start-up or early-stage small business, going through the steps in the business planning process should help to improve its probability of success. preparing a business plan forces the smaller firm to carefully identify its goals and outline what it views as a realistic course to achieve them. in addition to goals and expected courses of action, the business plan typically should specify a company's shortand longer-term financial needs, personnel requirements, manufacturing requisites (if appropriate), and projections of both a financial and market nature. in effect, what the business plan should contain are all of the elements needed to ensure that the firm knows exactly what is required to survive the critical infancy stage and initial years and then move on to a prosperous future. a good business plan minimizes surprises and encourages systematic operations. business plan coverage in small-business courses to determine what topics are being included in basic small business management courses at the college level today, an extensive survey was conducted among faculty members who are involved in teaching or administrating courses in small business. the survey was sent to 250 community/junior colleges and four-year colleges and universities in the united states and canada, with 110 being returned and employed in this 8jlalysis (a 44 percent response rate). fall 1988 ryans, ryans, and pearson: business plan 63 the survey results indicate "the business plan" is rated highest in importance among the various topics given course consideration. table 1 presents the respondents' ratings of 20 topics sometimes covered in the basic small business management course. thble 1 3 36 36 23 10 53 26 9 9 :17 41 10 5 24 45 2:) 0 10 46 41 0 3 34 61 18 41 36 3 15 41 31 12 5 34 4.3 16 41 43 13 1 2 29 16 21 3 30 47 18 4 36 35 21 2:1 16 22 7 not important 1 62 6 o 3 o ratings of small business management course topics question: how important do you feel each of the following topics is for coverage in a small business management course at a basic level? percent responding somewhat very important important ~fllpor~~ -~c:c23=------"--4:-::528 28 6 1 37 40 14 2 16 81 14 36 16 17 50 29 accounting auditing business law business plan en trepreneurs hi p finance form of business organization government relations insurance internal control management marketing office management organizational behavior personnel real estate sales management taxes venture capital women/minorities in small business source: authors' survey of facu\t,y members who are teaching or administrating courses in small-business management. results arc based on replies from 110 respondents. percentages are rounded and do not total 100 percent because not all respondents rated each topic. note that over 80 percent of the academics believe the business plan is a "very important" topic for inclusion in a basic course in small business management, with 64 jonrnal of business strategies vol. 5, no.2 none, of respondents rating the business plan as an unimportant topic. hence, it appears almost certain that small--businesspersons (or aspiring small--businesspersons) who enroll in a small business management wurse can expect that business plans will be given extensive coverage. among the remaining topics listed on the survey, only marketing is felt to be "very important" by over half of the faculty participating in the study. approximately 61 percent give marketing this rating. other topics receiving relatively high ratings are entrepreneurship, general management, sales management, finance, accounting, taxes, and internal control. several of the syllabuses received as another part of the research project indicate that instructors sometimes include the writing of a business plan as one of the wurse requirements. for example, some teachers require students to prepare a business plan, focusing primarily on what work is to be done, how it is to be done, and who will be doing it. students may also be expected to predict the time constraints under which their proposals will be operating, and then describe how to monitor the company's activities in order to meet the goals of the proposed business plan. other instructors require students to develop a business plan specifically for the purpose of obtaining venture capital still others ask students to write a business plan that includes extensive det.ails on strategy a.nd tactics. these syllabuses further indicate that the emphasis in many small-business wurses is on becoming a successful entrepreneur. vvhile there are numerous activities that must be mastered before an entrepreneur can successfully operate any type of small business, instructors realize t.hat the development, execution, reevaluation, and updating of a business plan is one of the mote important aspects of small-business management. in summary, our survey results suggest that respondents believe the business plan plays a significant role in small-husiness operations. to better prepare their students, many of th(' r('spond('nt college instructors have reinforced this notion by including the business plan as anint,egral part. of t.heir curriculums. it seems apparent that teachers of small business courses are of the opinion that the benefits of cond ucting business with a good business plan far outweigh the costs of preparing one. responsibility for developing the business plan it is important that those charged with writing the business plan have the necessary expertise to accomplish the t.ask successfully. this includes knowing how to develop goals for an organization and recognizing whom to cont.act for information. over 50 percent of the respondents to a recent. l/enture magazine survey [6) indicated that their planning input comes entirely from top management, while 24 percent work with depa,rtment-head level personnel in developing business plans. how does the small-businessperson obtain expertise in preparing a business plan? unfort.unately, many learn through trial"'and--error. some, on the other hand, develop proficiency by working v:ith paid consult.ants. other small-businesspersons hayp t.akpn it udon themselves to research extensively the plan-preparation process. fall 1988 ryans, ryans, and pearson: business plan 65 another way to hone busineso plan writing skills is to take advantage of educational programs offered by local institutions of higher education, including courses, workshops, and seminars. off-site management retreats for key planners are still another possibility. finally, the many services offered by the small business administration (sba) should not be overlooked [9]. for example, the sba provides management assistance programs, help for minority businesses, and the volunteer support of the service corps of retired executives (score). additionally, many colleges and universities offer various consultation services through entrepreneurship centers and small business institutes, many of which have been formed in conjunction with the sba's small business institutes program. this particular program provides small firms with the free counsel of graduate business students. preparing the business plan king ([4], p. 6) claims there are three basic questions that should be answered when writing a business plan: "what business is my company in; where do we want to go; how do we want to get there?" hankin and bagg 13) advise that business plans include the firm's objectives; the ongoing planning system; and the who, what, where, when, and how of the business's needs. the authors suggest that detailed descriptions of the key people in the organization are especially needed. two other writers, ormerod and burns 17]' offer seven tips for those preparing a business plan: market the management, establish a distinctive competence, address risks, set benchmarks, summarize the key points, keep the document short, and consider the reader.! the content of the business plan is of the utmost importance, yet the packaging of the plan can also be a critical factor. at times, the packaging just might be the deciding factor on a funding decision. potential investors eould view a poorlypackaged business plan as evidence that a business \\~1i not be managed well. rich and gumpert [8) suggest that plan writers pay particular attention to the appearance (should be neat but not overdone); the length (should not exceed 40 pages in length); the title page (should contain the name, address, and phone number of the company, as well as the current date); the table of mntents (should list each of the business plan's sections); and the executive summary (should explain in about two pages the present status of the mmpany, its products and services, financial forecasts, venture's objectives, and amount of financing needed). business plans are not "all things to all people," and some of the advantages and disadvantages should be mentioned or reiterated. a good plan can help to pinpoint strengths and weaknesses in an organization and provide an outline that enables the owners and managers to see all sides of the business. a business plan can be used as a management tool and as a device for obtaining venture capital. it can provide a blueprint for defining potential risks, outlining the needs of the business, projecting product pricings, and planning the directions the business should take. preparing a 1 although there are a number of ways to present a business plan, one typical approach appears in outline form in the appendix. 66 journal of business strategies vol. 5, no.2 business plan offers one the opportunity to think through all facets of the business. the business plan can also be used as a tool to evaluate the operation of the business on a regular basis. it is critical to remember that a business plan is never finished; it should be evaluated and updated constantly. not everything about a business plan is necessarily viewed as positive. some small-business owners and managers do not believe the plans are worthwhile. some claim a business plan requires an excessive amount of time to complete. some feel business plans, if prepared too comprehensively, cause owners and managers to lose sight of the "big picture." others note business plans often wind up in a drawer, unused. some perhaps are afraid to plan, preferring to keep the "mystery" of their businesses to themselves. still others view a business plan as limiting a small firm's flexibilit,y, locking the business into a series of actions inconsistent with the needs of a changing environment. while these concerns could have validity in some cases, the many advantages of a business plan especially a long-term plan clearly seem to outbalance any potential disadvantages. summary and conclusions simply stated, the business plan is essential to the successful start-up (and continuance) of most small businesses. in addition to providing the necessary decisionmaking data for the venture capitalist, other investors, or lenders that will typically be involved in a firm's funding, the business plan provides the operational directions a firm's management needs to achieve its early goals. additionally, since the planning process is viewed as continual, it assists in identifying and evaluating the existing firm's attainment of its ongoing goals. the importance of the business plan is further emphasized by the attention given to it, in today's college-level small business management courses. a survey conducted among small business management faculty has revealed that the business plan is considered the most important topic for course coverage. respondents most definitely recognize that "it all starts with the business planning process" and give it their highest priority. this should be a signal for those considering starting a small business and for those who are a.lready underway. committing time and resources to planning now enhances the likelihood of achieving success later. references 1. ackelsberg, robert and peter arlow. "small businesses do plan and it pays off." long range planning, odober 1985, pp. 61-67. 2. bryan, e. lewis and ralph e. welton. "let your business plan be a road map to credit." business, april/may/june 1986, pp. 44-47. 3. hankin, rock n. and wilfred j. bagg. "a growing plan: a written outline for success." management world, 1985, pp. 42-43. fall 1988 ryans, ryans, and pearson: business plan 67 4. king, ruth a. "developing a business plan." business fj economic review, july 1985, pp. 6-9. 5. larson, erik. "the best-laid plans." inc., february 1987, pp. 60-64. 6. madlin, nancy. "the venture survey: sticking to business plans." venture, april 1985, p. 25. 7. ormerod, john and ira burns. "the business plan: you'll be lost without it." accountancy, january 1986, pp. 112-113. 8. rich, stanley r. and david e. gumpert. "how to write a winning business plan." harvard business review, may/june 1985, pp. 156-163. 9. the small business answer desk directory. washington, dc: u. s. small business administration, 1985. 10. the state of small business: a report of the president. washington, dc: u. s. government printing office, 1987. 11. welsh, john a. and jerry f. white. the entrepreneur's master planning guide. englewood cliffs, nj: prentice-hall, inc., 1983. appendix sample business plan outline i. summary a. business description 1. name 2. location and plant description 3. product 4. market and competition 5. management expertise b. business goals c. summary of financial needs am! application of funds d. earnings projections and potential return to investors ii. market analysis a. description of total market b. industry trends c. target market d. competition 68 journal of business strategies vol. 5, no.2 ttl. products or services a. description of product line b. proprietary position: patents, copyrights, and legal/ technical considerations c. comparison to competitors' products lv. manufacturing process (if applicable) a. materials b. source of supply c. production methods v. marketing strategy a. overall strategy b. pricing strategy c. method of selling, distributing, and servicing products \'1. management plan a. form of business organization b. board of directors composition c. officers: organization chart and responsibilities d. resumes of key personnel e. staffing plan/number of employees f. facilities plan/planned capital improvements g. operating plan/schedule of upcoming work for next one to two years vtt. financial data a. financial statements (five years to present) n. five-year financial projections (first year by quarters; remaining years annually) 1. profit and loss statements 2. balance sheets 3. cash flow charts 4. capital expenditure estimates c. explanation of projections d. key business ratios source: "financing small business." bank of america small business reporter, vol. 14, no. 10, 1980, p. 19. the importance of the business plan to the small business post-deregulatory strategic performance: a study of the railroad industry curtis 1\1. grimm ken g. smith rex blankinship university of maryland college park, maryland in striving to maximize firm performance, management must adopt strategies which are in accord with environmental conditions and with their organizations' distinct competencies. this is essential because organizations are dependent on their environments for resources ([1],[16]) and he cause these organizations have limited competencies ([22j,[11]). studying strategies firms employ and distinguishing high performing strategies from low performing strategies can provide useful insights for strategic managers. a firm's strategy can be defined as a pattern of behavior with regard to strategic variables such as price, product quality, and degree of innovation [7]. for example, a firm may develop a pattern of behavior of having the lowest prices, the best product quality, or the most innovation. each of these patterns of behavior would represent a distinct strategy. the strategic management literature suggests that firms must seek distinct, focused strategies to survive. researchers have identified a number of different strategies ([2]'[7],[l1j ,[13],[14]'[15]'[17],[24]' and others.) for example, porter [17] has argued that at a ~road level, firms can choose between three strategies. firms may choose an overall low cost position, a differentiation position (e.g., high quality) or a focus position (e.g., a particular market segment). according to these writers, choosing a distinct strategy is essential to obtain an advantage over the competition. researchers in strategic management have also used empirical techniques to identify different strategies. typically, data are gathered on a number of strategic variables, and multivariate classification methods are used to categorize firms into groups based on the strategic variables. the technique most frequently used is cluster analysis, whereby firms most similar to each other arc grouped into "clusters," each of which represents a different strategy. the nature of each strategy is determined based on the values of the strategic variables. for example, it can be inferred that a cluster of firms achieving the lowest cost of all clusters is following a "low-cost" strategy. a number of different strategies have been identified empirically by using cluster analysis. for example, miller and friesen [14j first used cluster analysis to identify ten types of strategy from a data base comprised of case studies. these strategies ranged from an entrepreneurial strategy to a quality control strategy. galbraith and journal of business strategies, volume 6, number 1 (spring 1989) 33 34 journal of business strategies vol. 6, no.1 schendel [5] used the pims data base and cluster analysis to identify ten different competitive strategies. dess and davis [3] studied strategic variables in the paint manufacturers industry and found strategies which correspond to porter's theory: a low cost, a differentiation, and a focus strategy. finally, hawes and crittenden [10] identified four different retailing strategies by studying food retailing strategic variables. the strategies identified in the above studies are well-defined. researchers have also identified strategies that are less focused. for instance, dess and davis [3] identified a "stuck in the middle" strategy-one without strategic direction. also, hawes and crittenden [10) identified a "submissive defender" strategy, another unfocused one. researchers have also linked strategy types with varying levels of performance ([3j,[5j,[8],[10],[13]). an important finding from this research is that strategic focus tends to correlate with higher performance. for example, dess and davis [3j found no difference in performance levels of firms pursuing low cost, focus or differentiation strategies. however, they did find that firms which followed the unfocused "stuck in the middle" strategy performed at significantly lower levels than the other three. also, hawes and crittenden [10j found that the "submissive defender" strategy was associated with poor firm performance. though much has been written on different strategies and their relationship to firm performance, few studies have focused on regulated industries and, in particular, on different railroad strategies [6j. a major purpose of regulatory reform in the railroad industry was to improve rail carrier performance. for decades, the railroad industry had been in decline, consistently losing ground to competitive modes. from 1940 to 1975, the rail industry's share of total freight revenues fell from 76 to 38 percent [23). much has been written as to the causes of the industry decline. several writers, including harris and grimm [9], have argued that the fundamental problems of the industry are not technological or economic, but organizational. in the most comprehensive study of railroad management, wyckoff [25] details the lack of organizational flexibility, innovation and adaptiveness that prevailed in most railroads prior to deregulation. he condemns regulation for promoting a false sense of insulation from the firm's environment and a sense of timidness regarding innovation. mahon and murray [12] also argue that regulation will in general impede management performance. the 1980 staggers act, along with other legislative and administrative actions, has substantially reduced railroad regulation. in an effort to improve industry performance, regulatory reform has provided rail management with much greater freedom to design and implement specific strategies. as a result of this important environmental change, firms may exercise strategic choice by designing service, pricing and marketing strategies with few or no regulatory constraints. the purpose of our paper is to identify the different strategies employed by railroads and to investigate the link between these different strategies and organizational performance. using cluster analysis, the post-staggers railroad strategies were identified. objective performance measures such as return on investment were then spring 1989 grimm, et al.: deregulatory performance 35 obtained for each strategic group to shed light on the relationship between organization strategy and performance. methodology assessment of strategy there are a number of methods by which a firm's strategy may be assessed. these methods range from self-typing, where a firm's managers identify the firm's strategy based on what he/she thinks the strategy of the firm is, to more objective methods where published archival data or industry judges are used to assess strategy ([201,[21]). objective data derived from railroad annual reports, interstate commerce commission records, and the standard and poor's directories were used for the present study. it is well accepted in the strategic management literature that valid inferences regarding strategy can be drawn from such data (see [5]'[8],[10],[19]). a number of researchers have identified the various strategic variables that firms can select to successfully align themselves with their environments ([131,[14],[17],[8]). in his seminal work organizations in action, thompson [22] argues that managers neither yield to nor control all organizational and environmental forces. rather these managers ensure the survival of their organizations by finding strategic variables (variables within the control of management) and manipulating these variables in such a way as to maintain a proper alignment with their environment. within this context writers such as miles and snow [13] and porter [17j identify a number of important strategy variables that managers can select, including cost position, degree of innovativeness and product/market focus. specific indicators of strategy which reflect these variables were developed based on the authors' extensive research on railroad mergers, deregulation and structure (see [6],[20]) along with the availability of data from objective sources. the six indicators are as follows: 1. commodity concentration was calculated from interstate commerce commission data. the total carloads of the five most frequently carried commodities were divided by the total carloads of all commodities. this is a measure of the degree to which the business specializes in transporting a small number of commodities. in the statistical analyses, commodity concentration was labeled comconc. 2. cost was calculated on a net ton mile basis by dividing the total of all operating costs by the total net ton miles of rail traffic. in performing the statistical analyses, this variable was labeled cost. 3. innovation was measured by the number of individual contracts each railroad negotiated with its customers. since contracting with customers was illegal prior to deregulation, it can be considered as a new and innovative competitive approach for this industry. the number of contracts the railroad had signed as of june 1984 was scaled (divided) by net ton miles of freight carried. in the statistical analyses, this variable was labeled innovate. 36 journal of business strategies vol. 6, no.1 4. organizational diversit'y was operationalized as net income from non-rail activities illvided by nd ton miles of freight carried. this indicates the extent to which the firm pursues activities other than rail. in the statistical analyses, organizational illversity was labeled 0 rg d iv e r. 5. average haul length indicates a form of scale economies. firms carrying out a low cost strategy could be expected to have longer average haul length, where organization and terminations costs are spread over more output. average haul length was calculated as i)et ton miles illvided by net freight tons. in the statistical analyses, average haul length was labeled .4vgh au l. 6. abandonmellt of railroad track demonstrates an aggressive, profit oriented approach. miles of track abandoned were scaled by the net ton miles of freight carried. in the statistical analyses, this variable was labeled aban don. cluster analysis was used to identify the illfferent railroad strategies based on the six illmensions described above. cluster analysis is a quantitative technique which classifies a sample of firms into illfferent groups. in this instance it is argued that each group is reflective of a illfferent strategy. four illfferent groups corresponding to four strategies were identified. performance measures four performance measures were calculated for the present research. these were: 1. return on investment in 1983, this variable was labeled ro /83. 2. return on equity in 1983. this variable was labeled ro e83. 3. net ton miles in 1983. this variable was labeled ntli1size. 4. leverage. leverage can be thought of as the extent to which the organization's assets are financed by debt vs. equity. as a general rule organizations financed by debt are at greater risk than those financed by equity. consequently, a willingness to increase leverage could be viewed as aggressive, risk-taking behavior. because more illrect measures of leverage were unavailable, a crude measure of the extent of leverage was calculated by illviding ro e83 by ro 183. generally, a high score would represent high leverage (debt financing). a low score would represent low leverage (equity financing). this variable was labeled lev erage. results and discussion the means and standard deviations of the six illmensions are shown in table 1. this table also reports results of one-way anova tests, which demonstrate that five of the six strategic illmensions are significantly illfferent between the clusters. table 2 provides a comparison of cluster performance and size. reviewing the results for each of the variables and focusing on clusters that received the lowest and highest spring 1989 grimm, et al.: deregulatory performance 37 scores on each variable provides insight into the characteristics of each of the clusters on each of the variables considered. the following paragraphs elucidate each cluster's ranking on the strategic dimensions and performance. however, it should be noted that performance differences across clusters are not statistically significant, and the overall significance of the results should be tempered accordingly. table 1 cluster means variable cluster 1 cluster 2 cluster 3 cluster 4 -~_._------------"._---------_.. comconc .6821 .6527 .9660 .7187 orgdiv er .1128 .0834 .5599 .2805 abandon .0001 .0006 .0003 .0005 innovate .0012 .0052 .0032 .0009 cost 2.7476 3.9115 4.8137 3.2309 avghaul 6.0930 3.3359 .8234 2.9906 n 7 7 3 8 f-ratio 7.58' 10.32' 1.42 15.18' 5.93' 39.15' • denotes that differences in means across clusters are significant at the 99% level. variables used for clustering comconc commodity concentration. the number of carloads of the five most frequently carried commodities, divided by the total carloads of all commodities (source: icc quarterly commodity statistics). orgdiv er organizational diversity. amount of non-rail income earned per net ton mile of freight carried (source: lo-k reports). aban don number of miles of track abandoned per net ton mile of freight carried. indicates aggressive, innovative behavior (source: icc abandonment records ). in nov at e innovation. number of contracts signed as of june 1984, divided by net ton miles of freight carried (source: icc rail contract advisory service). cost total of all costs, divided by net ton miles of freight carried (source: railroad annual report data). avgh au l average haul length (source: railroad annual report data). cluster 1 is the lowest on cost and highest on avghaul. as expected, long hauls and low costs go together. the costs of loading and unloading cars and coupling trains are spread over many miles in long haul run. firms in cluster 1 appear to be following a "low-cost" strategy and are labeled "cost-leaders." firms in this cluster appear to be exploiting economies of scale, as indicated by their large output (ntmsize). in terms of performance, this cluster had the second highest roi83. 38 journal of business strategies vol. 6, no.1 however, because of a conservative capital structure (lowest leverage), roe83 was a distant third. table 2 comparison of cluster performance and size variable cluster 1 cluster 2 cluster 3 cluster 4 f-value prob roi83 1.9857 2.8500 -1.9333 1.6778 .7560 .5312 roe83 2.8429 8.5833 -19.3000 7.5222 2.1157 .1287 leverage 2.2103 4.1643 4.6874 5.2943 3.9630 .0220 ntmsize 639.4097 100.0460 12.6077 357.1339 .4906 .6930 cluster 2 scored highest on abandon and in nov ate. firms in this cluster appear to be aggressive, abandoning track which is unproductive. they have been quick to take advantage of legalization of contracting. because they scored highest on the innovation dimension, firms in this cluster have been labeled "innovators." as mentioned previously, miles and snow have argued that an innovative strategy is appropriate in turbulent environments. since the transition to deregulation is a dramatic environmental change for railroad firms, it was expected that firms scoring high on innovation should have high performance scores as well. the results confirm this expectation, with the innovators scoring highest on both roi83 and roe83. in addition, cluster 2 was lowest in comconc and orgdiv er. these firms earn relatively little income from non-rail operations, and are not concentrating in transporting anyone commodity. the low orgdiv er could indicate the management team is a group of highly committed rail specialists, rather than having broader experience and investments. firms in cluster 3 are the smallest in the industry and have the shortest average haul length. their net ton miles of freight were only about 2% of the net ton miles by firms in the lowest cluster and about 8% of the net ton miles by the innovators. they are very specialized, as nearly 97% of their business is in only five commodities. probably as a result of their small size and short haul length, they have the highest costs per net ton mile and the poorest roi83 and roe83 in the industry. in addition, firms in cluster 3 are quite diversified. these firms are rail divisions of parent companies, and their high cost positions suggest they are "neglected." however, losses in the rail division could by used to offset profits from other divisions such as land and mineral holdings and reduce tax burdens on these profits. considering this tax savings, these firms may not be in as much financial trouble as would be indicated by examining only their profits from rail operations. firms in cluster 4 score in the middle on most variables and seem to be the slowest to adopt the new marketing technique of contracting. they appear to fit the pattern described by porter as "stuck in the middle" and by hawes and crittenden [10] as "conservative reactors." however, performance is relatively high for these firms, indicating that a "poised in the middle" strategy may be appropriate in the turbulent aftermath of deregulation. when the environment settles down these firms spring 1989 grimm, et ai. .' deregulatory performance 39 may be able to quickly move in any direction which proves profitable. an alternative explanation is that these firms are performing well because they are not incurring the costs and stresses of a more distinct strategy. it could be predicted that in the long run performance will suffer for these "in the middle" firms if they do not become more specialized. tobie 3 summary of cluster and performance --. -._--_ .._... --------.----------variable cluster 1 cluster 2 cluster 3 cluster 4 "poised in "cost-leaders" "innovators" "cash cows" the middle" comconc medium low high medium orgdiver low-medium low high medium abandon low high medium medium innovate low-medium high medium low cost low medium high medium roi83 roe83 leverage ntmsize high low high low low high high low cluster interpretation cluster 1 long haul, low cost, moderate profit. cluster 2 aggressive, innovative, high profit. cluster 3 costs out of control. unprofitable rail operations. profitable non-rail activities. cluster 4 contingent, low innovation. moderate profits. firms, then, appear to be grouped into clusters based on discernible strategies. however, an issue worth addressing is whether the regional markets served by a railroad force it into a particular cluster. to test this hypothesis, the primary region served by each railroad was identified, based on previous work by harris and grimm [9]. these authors classified all major u.s. railroads into one of four regions: northeast, southeast, northwest and southwest. the results of this analysis were that railroads of a particular region did not tend to cluster together. each of the four clusters contained railroads from at least three of the four clusters and no particular regioi.1 represented more than one-half of the railroads in any cluster. conclusion this paper uses objective data to examine the relationship between strategy and performance in the railroad industry. although the performance differences are not 40 journal of business strategies vol. 6, no.1 statistically significant the results do indicate important variations in performance associated with the different strategies. overall, the results indicate that management strategies will likely be important determinants of firm profitability in newly deregulated industries. if they are not already so doing, firms should ensure that adequate attention is now being paid to all aspects of strategic management. future researchers could extend this work in many directions. in particular, similar research should also be undertaken in other deregulated industries. in particular, the motor carrier and banking indnstries offer the potential for a substantially larger sample size and a rich array of strategic dimensions. references 1. aldrich, h. e. organizations and environment. englewood cliffs, nj: prenticehall (1979). 2. buzzell, r. d., b. t. gale, and v. sultan. "market share a key to profitability." harvard business review (january-february, 1975), pp. 97-106. 3. dess, g. g. and p. s. davis. "porter's (1980) generic strategies as determinants of strategic group membership and organizational performance." academy of management journal, vol. 27, no.3 (1984), pp. 467-488. 4. dess, g. g. and a. miller. "the appropriateness of porter's (1980) generic strategies as a method of classification and its implications for business unit performance." presented to academy of management's 1985 annual meetings in san diego, ca. 5. galbraith, c. and d. schendel. "an empirical analysis of strategy types." strategic management journal, vol. 4 (1983), pp. 153-173. 6. grimm, c. m. and k. g. smith. "impact of deregulation on railroad strategies and performance." proceedings of the 1985 transportation research forum annual meeting, pp. 540-544. 7. hambrick, d. c. "high profit strategies in mature capital goods industries: a contingency approach." academy of management journal, vol. 26 (1983), pp.687-707. 8. hambrick, d. c. "taxonomic approaches to studying strategy: some conceptual and empirical issues." journal of management, vol. 10 (1984), pp. 27-42. 9. harris, r. g. and c. m. grimm. "revitalization of the u. s. rail freight industry: an organizational perspective." in k. j. button and d. e. pitfield (eds.), railway economics, pp. 49-84. aldershot, england: gower (1985). 10. hawes, j. m. and w. f. crittenden. "a taxonomy of competitive retailing strategies." strategic management journal, vol. 5, no.3 (1984), pp. 275-287. spring 1989 grimm, et al.: deregulatory performance 41 11. hofer, c. w. and d. schendel. strategy formulation: analytical ooncepts. st. paul, mn: west publishing company (1978). 12. mahon, j. f. and e. a. murray. "strategic planning for regulated companies." strategic management journal (april-june, 1981), pp. 251-262. 13. miles, r. e. and c. c. snow. organizational strategy, structure and process. new york, ny: mcgraw-hill (1978). 14. miller, d. and p. friesen. "archetypes of strategy formulation." management science, vol. 24, no.9, (1978), pp. 921-933. 15. mintzberg, h. "patterns in strategy formation." l\,fanagement science, vol. 24 (1973), pp. 934-948. 16. pfeffer, j. and g. r. salancik. the external control of organizations. new york, ny: harper & row (1978). 17. porter, m. competitive strategy. new york, ny: free press (1980). 18. quinn, j. b. strategies for change. homewood, il: richard d. irwin inc. (1980). 19. schendel, d. e. and c. hofer (eds.). strategic management: a new view of business policy and planning. boston, ma: little, brown & co. (1979). 20. smith, k. g. and c. m. grimm. "environmental variation, strategic change and firm performance: a study of railroad deregulation." strategic management journal, vol. 8 (1987), pp. 363-376. 21. snow, c. c. and d. c. hambrick. "measuring organizational strategy: some theoretical and methodological problems." academy of management review, vol. 5, no.4 (1980), pp. 527-538. 22. thompson, j. a. organizations in action. new york, ny: mcgraw hill book company (1967). 23. u. s. department of transportation, office of the secretary. a prospectus for change in the freight railroad industry. washington, dc: u. s. government printing office (october, 1979). 24. wissema, j. g., h. w. van der pol, and h. m. messer. "strategic management archetypes." strategic management journal, vol. 1 (1980), pp. 37-47. 25. wyckoff, d. railroad management. washington, dc: heath (1976). post-deregulatory strategic performance: a study of the railroad industry influences of demograpidc and psychograpidcs on consumer payment preferences charles h. rader matiur rahman shane r. premeaux mcneese state university lake charles, la introduction this investigation explores the influences of certain demographic and psychographic variables on consumer payment preferences. the important demographic factors include age, gender, education, income, occupation, marital status, race, religious beliefs and political affiliations (rutledge and callahan 1992; slocum and mathews 1975; warren et al. 1990). in general, the psychographic factors normally considered include consumer attitudes toward different types of goods, credit orientation, price awareness, f'mancial satisfaction, life styles, etc., (kinnear and taylor 1976; lesser and hughes 1986; nunnally 1967; tigert 1969; wells 1975,1974). currently, the preferred means of payment in the u.s. are cash, personal checks, charge accounts, and credit cards (hirschman 1982). at the beginning of 1991, the number of credit cards issued by different banks was over 218 million, up from 161 million in 1985. these credit cards are used by over 60 million people in the united states (mishkin 1992). in addition, 28 million t&e cards were in circulation. sears' discover card, introduced in 1985, has grown to over 21 million accounts (sinkey 1992). in this study, personal checks and cash are used synonymously because money in checking accounts is presumably as liquid as cash. it is important to have a clear understanding of the relationship between consumer payment preferences and their demographic and psychographic attnbutes because the means of payment greatly influence the size, frequency and location of purchases. for example, credit cards are usually used to buy furniture, gasoline, household goods, electronics, and clothings, (mandell 1972; russell 1975; white 1975), while cash is usually used to buy food items. exclusive reliance on cash as a means of payment is found primarily among low-income families, and therefore their volume of check and credit-card expenditures is relatively low. cash is generally used to make small dollar purchases and also to make purchases at remote locations (avery et al. 1986; hirschman 1982). ·the authors are deeply indebted to three anonymous referees for their invaluable comments and suggestions that led to a substantial qualitative improvement of the paper. however, the authors themselves are responsible for any remaining errors and deficiencies. last but not least, the authors greatly appreciate mrs. bridgett friend for her splendid typing work on this paper. 90 j oumal ofbusiness strategies vol. 11, no.2 bank charge-cards are emerging fast as one of the newest mediums of exchange and credit in the u.s. economy. unlike credit cards, the use of bank chargecards usually allows the consumer to obtain merchandise and borrow up to thirty days without interest. bank charge-cards are primarily used for convenience and to meet emergency needs but not to make any big purchases for which the payment period exceeds 30 days (awh and waters 1974). a great deal of research attention has been devoted to analyzing the patterns and determinants of consumer expenditures in terms of income, demographic and life style profiles (plummer 1971; warren et al. 1990). several studies have also investigated consumer choices as they relate to alternative means of payment and various determinants thereof. but most of these earlier studies are descriptive and empirical without any significant discussions of implications. at least from that viewpoint, there exists a gap in the existing literature. in an earlier study, avery et a1. (1986) emphasized that families with annual incomes less than $10,000, those with household heads with less than 12 years of education, and nonwhite or hispanic families each use cash as their primary means of payment. previous research also established that the use of all three payment methods rises in absolute terms with income, education, and the number of earners in the family. clearly, household members substitute credit cards and charge cards for cash as income rises. on the contrary, low-income, less educated, older and non-white families are less likely to possess and/or use credit cards. significant marketing research has been conducted to enhance the understanding of consumer buying behavior, but little has been done with regard to consumer attitudes toward alternative means of payment. prior payment research concentrated mainly on developing descriptive profiles of credit card users. a review of published literature reveals that research on cash and checking accounts as alternative means of payment is quite inadequate. however, at least one study found that consumers' perceptions of alternative means of payment and the attributes of users of various means of payment directly impacted their buying decisions (hirschman 1982). furthermore, lindley et a1. (1989) found that an increased tendency among household members to use credit cards, as a means of payment for both durable and nondurable goods, was dependent upon whether the family's decision-making process was joint or individual (bass et al. 1968; reiss 1981). for highly complicated decisions, and for decisions related to purchases of expensive goods or services joint-decision-making was most common (menasco and curry 1989). segmentation is a key tenant of marketing because certain segments of the population often behave quite differently. segmentation commonly results from geographic, demographic, psychographic, and behavioristic factors. for instance, geographic location may lead to the formation of market segments comprised of customers from different geographic areas. furthermore, the unique characteristics of each segment of the market may exert significant influences on consumer buying decisions and pay· ment preferences (etzel 1974; rutledge and callahan 1992). further refinements in various market segmentation strategies based on the means of payment preference could result in more effective marketing strategies. fa1l1994 rahman, et al:/nfluences ofdemo. & psycho. on consumer pref. 91 the survey design and methodology the sampling frame for this study consists of families with preschoolers (ages o to 6). there are three primary reasons for selecting this stage of the family life cycle. first, families in this stage are very important to marketers because families with preschoolers, make up approximately 24 percent of the u. s. population. second, the questionnaire response rate from families in the preschool age stage is normally high. in previous national surveys, families in this stage had the second highest response rate which reduces potential errors due to non-response bias. third, such families are characterized by numerous financial strains, and the consumption process is directly related to these financial strains (wind 1978; wind and green 1974). these strains may necessitate the use of alternate means of payment. the data collection method consists of a telephone survey administered to 1,000 families in the preschool age stage of the family life cycle. six hundred seventy-four of the respondents were found suitable for inclusion in this analysis. this sample consists of 565 whites and 109 nonwhites; 322 people had high school degrees and 352 had college degrees; 355 of the sample set were catholics and 319 were noncatholics; there were 328 political conservatives and 346 political moderates and liberals; and 134 respondents had annual incomes of $20,000 or less and 540 had annual incomes above $20,000. the sampling frame was a list of randomly generated telephone numbers for the city of lake charles, louisiana. only residential telephone prefixes in service were included. the lake charles area was selected because its standard metropolitan statistical area is large enough to contain a diverse population which is presumed to offer a reasonably good representative sample. the eligibility of respondents is determined by asking classification questions. if the household contains a married couple with one or more children under the age of six:, they are selected as fitting into the preschool age stage of the family life cycle. both husband and wife are asked to complete the questionnaire. the questionnaire is divided into two major sections with questions pertaining to family demographics and psychographies. since no prior research work is available to provide the exact time frame for questioning, the time frame is determined by the pilot study in which the questionnaire was pretested. as a result of this pretesting, the research instrument is customtailored to the preschool stage of the family life cycle. demographic variables were included because such factors have proven useful to marketers in their quest to understand better the consumer buying decision. consequently, such variables should be of equal importance in promoting understanding in consumer payment preferences. the list of demographic variables considered in this study include gender, race, occupation, education, age, income, religious beliefs, and political affiliations. psychographic variables include the consumer life style, as determined by the respondents' orientation towards sports, the community and cultural activities; price awareness; brand loyalty; family togetherness; financial optimism; and satisfaction. 92 journal ofbusiness strategies vol. 11, no.2 psychographic research is of particular importance to marketers, and this study solicits the opinions of family members to gather information on their activities, interests and shared perspectives of the world. furthermore, psychographic variables often provide additional insight regarding the substantial differences among various groups of consumers in terms of payment preferences and buying decisions. these differences are often more profound than those produced by standard demographic profiles. to determine the payment preference orientation of respondents, they were asked about the number of things they buy with a credit or charge card, the frequency of cash payments, their preference for having charge accounts, and their utilization experience with credit cards. answers are rated on a four-point-evaluation-scale ranging from strongly agree to strongly disagree, with a "no opinion" option. limitations may exist because this study concentrates on one geographic area, which may not be representative of the total consumer population in the u.s. the chi-square test was employed to investigate the null hypothesis of independence between demographic as well as psychographic variables (one variable considered at a time) and consumer payment preferences. empirical results the level of education appears to significantly influence consumer payment preference whereas race appears to have no discernible influence on consumer payment preference. however, gender plays some role in favor of cash purchases and consumer political affiliation was found to significantly impact payment preferences. possibly, politically conservative individuals are financially more stable and economically more advanced so they are more likely to possess and use credit and charge cards. in contrast, religious beliefs show less influence in favor of the use of both cash and credit cards as means of payment. the empirical results are summarized in table 1. it is somewhat obvious from these findings that astute marketers should adjust their marketing mixes to take into account payment preferences based on the consumer's level of education, income, gender, political affiliation, and, to a lesser degree, on religious beliefs. individuals with high school and college/university educations are more inclined to use charge and credit cards. on the other hand, the less educated use cash more frequently as a means of payment. the level of personal annual income significantly influences consumer payment preference. respondents with annual incomes above 20,000 dollars are more likely to use charge and credit cards. in sharp contrast, those with incomes below 20,000 dollars per year prefer to use cash as a means of payment. caucasians tend to use charge and credit cards more frequently than cash as a means of payment. however, non-caucasians llsually make relatively more cash purchases. males and females are almost evenly split between the use of charge/credit cards and cash/personal checks as means of payment. political conservatives and moderates use charge and credit cards more frequently than do liberals. catholics and protestants strongly prefer the possession and use of charge and credit cards as means fa1l1994 rahman, et al:lnfluences ofdemo. & psycho. on consumer pref. 93 of payment. those of other religious faiths included in the sample (although very small in number) display very strong proclivities toward cash purchases. table 1 further reveals that within the broad category of psychographies, family togetherness or disjointness has no effect on having a charge card. however, the effect of these factors is considerable in favor of cash and credit cards as means of payment. joint-buying decision-making strongly favors the use of credit cards and cash as means of payment. but it has no effect on charge card usage. presumably, the desire to use charge cards is latent because of prolonged non-usage. higher income expectations have a profound influence on all three methods of payment. impatient! impulsive buying behaviors have an even greater influence on all types of payment preference. individuals who frequently travel have a stronger tendency to use charge and credit cards relative to cash and personal checks. also, those who are easily enticed by newly introduced products appear to have no significant payment preference. more interestingly, families with children that fulfill the preschoolers' demands immediately have a strong preference for charge and credit card usage. implications individuals with higher levels of education and higher incomes, political conservatives, the economically more advanced and those with impatient buying habits are more likely to frequently use credit and charge cards to make purchases of relatively expensive durable goods, airline tickets and hotel accommodations. furthermore, joint decision-making for large purchases frequently results in the use of credit and charge cards. also, families with children are likely to use credit cards more often. on the other hand, the less educated, the poor, and the vast majority of socioeconomically disadvantaged people are very likely to use cash/personal checks as a means of payment because it is difficult for them to obtain credit and charge cards. because of their socioeconomic disadvantages they make relatively small purchases of basic necessities and simple goods and make few long distance trips. the poor and the less educated also live mostly in rural areas and inner cities, so their cash/check purchases take place either at relatively remote locations or at economically depressed areas. religious faith appears to have no discernible influence on consumer payment preferences. the above findings have multifarious implications for banks, credit card companies, marketers and retailers. as innovations take place and society advances economically and educationally, the market for credit cards expands. because of such market expansions and yields of between 60 and 100 percent, commercial banks and credit card issuing companies must target the right groups of consumers to seize these market opportunities and enhance their profit potential (sinkey 1992). credit card revenue results from interest charges, annual fees, other customer charges, and interchange fees. additionally, the issuance of credit cards in larger volumes and varieties will enable banks to enjoy economies of scale and scope. the use of cash is still high in economically depressed areas, among the poor, as well as among the less educated. 94 journal ofbusiness strategies table 1 summary of empirical results vol. 11, no.2 charge credit account cash cards demographies d.l. x2 x2 x2cc c education 12 45.992 39.376 39.353 (a,b,c)* (a,b,c)" (a,b,c)* income 16 31.507 53.219 64.361 (h.c)" (a,b,c)* (a,b,c)* race a 1.296 5.197 4.978.... gender 4 18.008 1.558 10.412 (a,b,c)* (c)* politics 8 12.407 5.301 9.993 religion 8 17.073 14.088 11.674 (c) * psychographies family togetherness 16 12.520 31.538 28.787 (h,c)* (c)* joint decision 16 17.186 26.053 37.135 higher income expecations 16 52.397 58.416 36.733 (a,b,c)* (a,b,c)* (a,b,c) inpatient/lmpulsive buying 16 68.156 104.080 66.067 (a,b,c)* (a,b,c)* (a,b,c)· travel 16 76.961 59.744 74.007 (a,b,c)* (a,b,c)* (a,b,c)· attraction for new things 16 71.509 77.933 67.153 (a,b,c)* (a,b,c)* (a,b,c)· buying dominance of 16 50.435 33.062 36.382 children (a,b,c)* (b,c) * (a,b,c)* *in parentheses for two-tailed cases a, b, and c denote statistical significance at 99, 95 and 90 percent confidence intervals respectively. fa1l1994 rahman, et al:/nfluences ofdemo. & psycho. on consumer pre! 95 smaller banks have an opportunity to extend retail services to these consumers at convenient locations. effective market segmentation may improve the chance of their survival because they cannot compete with larger banks which tend to dominate the market for credit and charge cards. large retailers of durable, luxury and complicated expensive goods, the airlines, hotel and restaurant businesses, providers of services in large volumes, international business firms, manufacturers should devise marketing strategies to satisfy the needs and aspirations of the credit card holders and users. because people use charge cards to meet emergency needs and for convenience, marketers and retailers should tailor their strategies to better satisfy such needs. small businesses may concentrate on sales promotions at remote locations and to the poor, as well as the less educated, who prefer to use cash/personal checks as a means of payment. when small businesses cannot compete with larger ones, they may enhance their profitability by addressing the needs of a specific group of consumers. however, speciality goods would be an exception because they are usually purchased by the economic and social elites. manufacturers of expensive toys and producers of new model autos, electronic goods and computers may target families with children, joint-decision-making families, and impatient buyers with economic surpluses or credit. again, these people have a greater tendency to use credit and charge cards and therefore should constitute the target group of customers for the above items. these findings also have implications for the u.s. federal reserve system that is in charge of u.s. monetary policy. the monetary policy-makers need to keep track of changes in consumption patterns and consumer payment preferences to help predict the velocity of money and the money demand in order to determine the country's total money supply (mishkin 1992). a mismatch between money demand and money supply will trigger price instability and produce economic zig-zags. the conventional definitions of money and money supply aggregates need some refmements due to continuing financial innovations. all these changes are bound to impact the financial markets through factors such as interest rate changes and economic cycles. a better understanding of changes in consumer payment preferences may provide some preludes to re-evaluate the mechanics of monetary policy formulations. again, any changes in consumer payment preferences are conditional upon variations in demographic and psychographic variables. sometimes these changes go unnoticed and therefore there is an undeniable need for periodic investigation of such issues. caution must be exercised in generalizing these findings because of the limited geographic representation. however, these findings supplement the existing body of knowledge in this area. 96 journal ofbusiness strategies references vol. 11, no.2 avery, robert b., gregory e. elliehausen, arthur b. kennickell, and paul a spindl 1986. "the use of cash and transaction accounts by american families." federal reserve bank bulletin (february): 87-108. awh, r.v. and d. waters. 1974. "a discriminant analysis of economic, demographic and attitudinal characteristics of bank charge-card holders: a case study." journal of finance 29: 973-80. bass, fran m., douglas j. tigert, and ronald t. lonsdale. 1968. "market segmentation: group versus individual behavior." journal of marketing research 5: 264-70. etzel, michael. 1974. "using multiple discriminant analyses to segment the consumer credit market." in combined proceedings. ed. ronald c. curban. chicago: american marketing association. hirschman, elizabeth c. 1982. "consumer payment systems: the relationship of attribute structure to preference and usage." journal of business 55: 531-45. kinnear, thomas c. and james r. taylor. 1976. "psychographies: some additional find ings." journal of marketing research 13: 422-25. lesser, jack a and marie a hughes. 1986. "psychographic market segments across geographic locations." journal of marketing 50: 18-27. lindley, james t., patricia rudolph, and edward b. selby, jr. 1989. "credit card possession and use: changes over time." journal of economics and business 41: 127-42. mandell, lewis. 1972. credit card use in the united states. ann arbor, michigan: institute for social research. menasco, michael b. and david j. curry. 1989. "utility and choice: an empirical study of wife/husband decision making." journal of consumer research 16: 87-97. mishkin, frederic s. 1992. the economics of money. banking and financial institutions. third edition. new york: harper-collins publishers. nunnally, jum c. 1967. psychometric theor.y. new york: mcgraw-hill book company. plummer, joseph t. 1971. "life style patterns and commercial bank credit card usage." journal of marketing 35: 35-41. fall1994 rahman, et al:/nfluences ofdemo. & psycho. on consumer pref. 97 reiss, d. 1981. the family's construction of reality. cambridge: harvard university press. russell, thomas. 1975. the economics of bank credit cards. new york: praeger. rutledge, dan and thomas callahan. 1992. "geo-demographic market segmentation: an application in marketing management." journal of business strategies 9: 124-36. sinkey, joseph f., jr. 1992. commercial bank financial management. fourth edition. new york: macmillan publishing company. slocum, john w., jr. and h. lee mathews. 1975. "social class and income as indicators of consumer credit behavior." journal of marketing 35: 59-74. tigert, douglas j. 1969. "psychographies: a testwretest reliability analysis:' in marketing involvement in society and the economy. ed. p.r. mcdonald. chicago: american marketing association, 310-15. warren, william e., robert e. stevens, and william mcconkey. 1990. "using demographic and lifestyle analysis to segment individual investors." financial analyst journal 46: 74-77. wells, william d. 1975. "psychographies: a critical review." journal of marketing research 12: 196-211. -. 1974. life style and psychographies. chicago: american marketing association. white, kenneth j. 1975. "consumer choice and use of bank credit cards: a model and cross-section results." journal of consumer research 2: 10-18. wind, jerry and paul green. 1974. "some conceptual, measurement and analytic problems in life style research." in life style and psychographies. ed. william d. wells. chicago: american marketing association, 99-126. wind, yoram. 1978. "issues and advances in segmentation research." journal of marketing research 15: 324-25. influences of demographic and psychographics on consumer payment preferences stra1egic success and member commitment donald r. domm john carroll university university heights, ohio charles m. byles virginia commonwealth university richmond, virginia strategy formulation and implementation are more of a complex and inexact art than science. while data tends to support the importance of strategic planning ([28], [12], p.ll) inexact, incorrect, or poorly-eonceived pl~ns can make its achievement difficult. however, flrms often achieve success in spite of poorly-formulated strategies. in the clear light of hindsight, it is evident that these strategies should have resulted in failure and were very likely irrational. success was nonetheless achieved as the commitment and effort of both management and operatives rose to the occasion. the high level of commitment necessary to make a poorly formulated strategy work is important to the success of the flrm and provides a clear competitive advantage. the role that commitment plays toward this end may be seen in the behavior of employees who are also owners of the flrm [20] those more likely to feel committed to the success of the firm ([29], p. 25). committed individuals normally have a strong belief in, and acceptance of, the organization's goals, a willingness to exert considerable effort on behalf of the firm, and a definite desire to maintain membership within the firm [19]. all of these attributes are significant factors in successful formulation and implementation. thompson and strickland state, "[o]bviously, it is important for organizational sub-units and individuals to be committed to implementing and accomplishing strategy" ([30] , p.231). the significance of the relationship between commitment and organizational success has also been suggested by schein [23]. while significant, the data which supports the importance of commitment in implementing strategy and the achievement of strategic goals are limited. the intriguing, though largely unquantified, relationship between commitment and success is the subject of this exploratory study. strategy implementation deflning successful strategy implementation is complicated by the numerous definitions of a firm's success. factors important in a flrm's success range from the seventeen different perspectives discussed by steers [26], to multiple flnancial ratios [32], to the more restricted domain of financial performance found in most strategy research [31]. upon reviewing various available measures and definitions, this study conceptually dermes strategic implementation as a process leading to the state the flrm strives to attain [3, 7] based on its operative goals [1, 26], which is indicative of the firm's ability to use its resources in attaining specific ends [5]. 68 journal of business strategies vol. 7, no.2 although a firm addresses multiple goals [9] (for example, adaptability, flexibility, productivity, and satisfaction [26]), it may be concluded that the various measures must be ordered into a hierarchy of importance. however, it may be further concluded that none of the multiple goals are ultimately more important than the achievement of the narrow strategic goal of financial performance profit. certainly profit emerges as the dominant variable in empirical strategy research [11]. for the purpose of this study, return on assets (roa) was selected as the profit measure, being the best single indicator of the firm's performance in the selected industry banking. the multidimensional nature of profits in the banking industry reflects many factors, such as loan quality, earnings, net interest margin, and operating efficiency. a high roa is almost always associated with superior all-around performance of a business firm [4]. roa "is a more reliable measure of profitability because it measures the true amount of capital which companies [or individuals] have invested in the business" [6]. in a study of 105 large banks in the united states, roa was found to be the most common goal quantified in the long-range plan [13]. roa meets the strategic implementation criteria discussed earlier: a state which the firm strives to attain, an operative goal, and an indicator of the firm's ability to use resources in obtaining a specific objective. the working hypothesis of this study is that a positive correlation exists between employee commitment and financial performance, as measured by roa. that is, banks employing a workforce which exhibits a high level of commitment will have a higher level of financial performance than banks with employees exhibiting a low level of commitment. method the organizational commitment questionnaire (ocq) [14] was used to measure commitment. mowday, porter, and steers [14] have provided reasonable evidence of the internal consistency for the ocq with a median at .90. based on administration to 2,563 employees, the reported alpha coefficient and test-retest reliability of the ocq are well within ranges expected for an internally consistent instrument. to create a sample for the purpose of assessing organizational performance, a list of banks in three performance categories was obtained from sheshunoff banks of ohio [25j. five chief executive officers of banks within the required deposit amount and socioeconomic categories agreed to participate. a sixth bank, having a slight difference in deposit size, was also selected for the study. no apparent material impact on the research results can be attributed to this difference. based on bank performance data obtained from dun and bradstreet [4], the banks selected for the study were ranked as either "low-performance" (roa of .7 and below), "medium-performance" (roa between .8 and 1.2), or "ligh-perl'ormaoce" qtoa of 1.4 am above). a gap between the low-, medium-, and high-performance categories was established to clearly differentiate the categories. from the total of six banks, each category could equally be represented: two high-, two medium-, and two low-performance firms. each bank, which had between 1 and 4 branches, was located in a small to mid-sized fall 1990 domm&byles: strategic success 69 ohio town having similar socio-economic characterisitics. the survey group banks had deposits in the range of $37-72 million. the number of employees per bank, which ranged between 40 and 60, permitted all employees to be surveyed. characteristics of banks included in the study are found in table 1. table 1 bank characteristicsa banksb performance groupc total domestic deposits $(000) total assets $(000) employees branches a high 36,361 40,026 40 1 b high 73,416 69,867 55 2 c medium 50,139 48,391 50 3 d medium 55,120 63,022 50 4 e low 55862 n/a 60 1 f low 52,517 55,286 50 2 a. source: sheshunoff banks of ohio, 1985. b. bank a is in shesbunoff deposit size group e. banks b-f are in deposit size group d. c. performance h based uopn a 5-year average return on average assets. an individual was designated within each bank to receive and distribute the materials of the survey: cover letters, questionnaires, and return envelopes. employees completed, sealed, and returned envelopes to this individual. confidentiality was stressed in all discussions with management, the designated individuals, and participants. the number of usable returned questionnaires which were included in the sample totaled 210. respondents were representative of the survey population and included bank presidents, loan officers, branch managers, tellers, and clerks. respondents ranged from post-high school to pre-retirement. the majority of respondents were female, with a larger number of males clustered at the management level. of the 210 questionnaires, 66 were from high-performance banks, 74 were from medium-performance banks, and 70 were from low-performance banks. findings commitment and bank performance groups to test the hypothesis that roa and commitment are positively correlated, the e-test was used initially, followed by supplementary nests. the level of commitment measured by the ocq was different across groups of high-, medium-, and low-performance banks. as reported in table 2, low-performance banks possessed the highest level of employee commitment, medium-performance banks had the lowest level of commitment, and high-performance banks demonstrated the middle commitment score, while employee commitment did differ across the performance spectrum, the relationship was not anticipated, results of the analysis of variance within and between groups are presented in table 3. 70 journal of business strategies table 2 commitment within bank perfonnance categories means and standard deviations vol. 7, no.2 bank performance group high medium low commitment group means 5.06 4.72 5.35 standard deviation 1.31 1.30 0.84 table 3 analysis of variance commitment and bank performance commitment between groups sum of mean squares squares 14.15 7.05 within groups sum of mean squares squares 281.70 1.37 f ratio 5.17 fprob .0064 commitment within hierarchial levels and across performance groups the mean value of commitment for each hierarchial level within each performance group is reported in table 4. one attribute of the means reported in table 4 is the rank-ordering table 4 commitment and bank performance (mean commitment by organizational level) high medium top management 6.56 5.73 middle & lower management 5.29 4.65 non-managerial operatives 4.82 4.62 5.71 5.18 5.32 of mean commitment by organizational level of the respondent. in high and mediwn performance banks, there is a consistent rank ordering of the commitment value, with top management possessing the highest value, followed by middle and lower management, followed by non-managerial operatives. in low-performance banks, middle and lower management possess the lowest degree of commitment among the three organizational levels in that performance level. while not a statistically significant finding, it is interesting to note and may be a source for future study. analysis of variance was used to determine whether any differences existed in commitment levels between performance groups within each hierarchial level. the e test showed a significant difference at the .05 level between means for the non-managerial operative group. a subsequent! test of means showed significant differences at the .05 level in commitment levels between the high and low performance firms, and between the medium and low performance firms as shown in table 5. fall 1990 domm & byles: strategic success 71 table 5 comparisons of average commitment within hierarchical levels and across perfonnance groups performance groups non-managerial operatives ilvalues are for a 2-tailed test. high to medium 1=0.854 12=0.601 high to low 1=2.074 12=0.038 medium to low 1=2.984 12=·004 in summary then, commitment levels did not vary significantly within top or middle/ lower management groups across performance levels. but among non-managerial operatives, the low performance banks showed significantly higher levels of commitment than their top and middle/lower management counterparts. commitment within performance groups and across hierarchial levels table 6 shows that top management was the most committed group in all performance categories. analysis of variance was used to test whether significant differences occurred between commitment means for each of the hierarchial levels. the e test showed significant differences at .05 level for the high performance group only. subsequent! tests showed significant differences between the top management and non-managerial operative group only (alpha=.05), and top management and middle management (alpha=.10). table 6 comparisons of average commitment within perfonnance groups across hierarchical levels hierarchical levels high performance top to middle management 1=1.882 12=·075 top management to operative 1=2.885 12=·006 middle management to operative 1=1.169 12=·245 12 values are for a 2-tailed test discussion this exploratory study has examined the relationship between strategic success, defined as return on assets (roa) and the level of commitment to the firm. it has been suggested that commitment is important in implementing and accomplishing strategy ([30], p. 213) and results in greater effort to achieve success ([29], p. 25, [20]. [14]). within top performing banks, top management was found to be significantly more committed to the firm than their subordinates and somewhat more committed than top management in other banks. the high commitment and associated work behavior of top managers are compatible with top management behavior displayed in other high-performance firms-these individuals work harder and show a greater indication of "marry" 72 journal of business ·strategies vol. 7, no.2 their jobs than their counter-parts in lower-performing organizations [15], behaviors which would increase the probability of strategic success-high roa. the low commitment (relative to that of top management) of middle and lower management and operative employees in high-performing banks may constrain general management's decision making ([2], [1], [18]) and potentially result in middle and lower managers giving low priority to strategy implementation [22]. although subordinate commitment in high-performing banks was not significantly higher than that of their peers from lower-performing banks, a highly committed top management's probable demands for high performance, well-established control systems, and tight performance reviews has greater potential for directing subordinate behavior to desired performance outcomes-an important factor in strategic implementation [21]. and while important within the work group [27], high commitment may not be vital to strategic success when the above-mentioned control systems are in place. even though support from a segment of a firm's members may be required to implement those strategic activities that accomplish a firm's objectives, "it is not the case that such support be given because of commitment to the firm" [22] or that commitment exist throughout the organization. highly committed top management may require achievement regardless· of the level of commitment of their employees. conversely, highly committed operatives with less highly committed managers were not significantly related to high bank performance. their top managers did not appear willing or able to capitalize upon the commitment of their operatives in achieving a high roa. one may tentatively conclude that regardless of the level of commitment of an organization's employees, commitment of top management is critical to the success of the enterprise. strategy, the balancing of focused commitment on the one hand and flexible resource allocation on the other, requires both commitment and mental flexibiltiy from management in considering options in strategy formulation [10]. without the stability of high commitment, top managers may be disinclined to explore all available options or be unwilling to carry or force a chosen strategy to completion. even when high commitment is evident within the operative ranks, it does not appear to overcome the limitations imposed by less-committed top managers who are responsible for strategic formulation and implementation. conclusion this study has provided some suggestions for theory and tentative support for the relationship between top management's commitment and strategic success, defined as a firm's return on assets. it also presents and demonstrates the importance of the issue of commitment for strategic management while providing suggested avenues for extension of and potential benefits of future research in this area. fall 1990 domm & byles: strategic success references 73 1. ansoff, h. 1. corporate strategy. new york, ny: mdjraw-hill (1965). 2. bacharach, s. b. and lawler, e. j. bargaining power! tactics. and outcomes. san francisco: jossey-bass (1981). 3. bennis, w. g. "towards a 'truly' scientific management: the concept of organizational health." general systems yearbook, vol. 7, ann arbor, michigan (1962) pp. 269-82. 4. dun and bradstreet credit services. industiy norms and key business ratios. library edition, new york (1984-1985). 5. etzioni, a. ''two approaches to organizational analysis: a critique and a suggestion." administrative science ouarterly, vol. 5 (1960), pp. 257-78. 6. forbes. 36th annual report on american industiy, (january 2, 1984). 7. friedlander, f. and h. pickle. "components of effectiveness in small organizations." administrative science quarterly, vol. 13 (1968), pp. 289-304. 8. guth, w. d. and l c. macmillan. "strategy implementation versus middle management." strategic management journal, vol. 7 (1986), pp. 313-27. 9. hall, r h. organizations: structure and process. 3rd edition. englewood cliffs, nj: prentice hall, inc. (1982). 10. hambrick, d. c. and r d. aveni. "top management characteristics and strategic failure." paper presented at the 4th international conference, strategic management society, philadelphia, pa (1985). 11. hofer, c. w. "rova: a new measure for assessing organizational performance." in r lamb, ed., advances in strategic management, new york, ny: jai press, vol.2 (1983), pp. 43-55. 12. hofer, c. w. and d. schendel. strategy formulation: analytical concepts. st. paul, mn: west publishing company (1978). 13. kudla, r. j. "the current practice of bank long-range planning." long range planning, vol. 15 (1982), pp. 132-38. 14. mowday, r t., l. w. porter, and r m. steers. employee organization linkages: the psychology of commitment, absenteeism and turnover. new york, ny: academic press (1982). 15. norburn, d. "gogos, yoyos and dodos: company directors and industry performance." strategic management journal, vol. 7 (1986), pp. 101-17. 74 journal of business strategies vol. 7, no.2 16. ohio bank directory. norcross, ga: american bank directory (1984). 17. pfeffer,1. and g. r. salancik. "detenninants of supervisory behavior: a role set analysis." human relations, vol. 28 (1975), pp. 139-54. 18. pfeffer, j. and g. r. salancik. the external control of organizations: a resource dependence perspective. new york, ny: harper & row (1978). 19. porter, l. w., r. m. steers, r. t. mowday, and p. v. boulian. "organizational commitment, job satisfaction, and turnover among psychiatric technicians." journal of applied psychology, vol. 59 (1974), pp. 603-09. 20. rosen, c. "employee stock ownership plans: a new way to work." business horizons. vol. 26 (september-october, 1983), pp. 48-54. 21. rothschild, w. e. "how to insure the continuous growth of strategic planning." journal of strategic planning, vol. 1 (summer. 1980), pp. 1-18. 22. salancik, g. r. "commitment and the control of organizational behavior and belief." in b. m. staw and g. r. salancik, eds., new directions in organizational behavior, chicago, il: s1. clair press (1977), pp. 1-21. 23. schein, e. organizational psychology. 3rd edition. englewood cliffs, nj: prentice-hall, inc. (1980). 24. schendel, d. e. and c. w. hofer, eds. strategic management: a new view of business policy and planning. 3rd edition. boston. ma: little brown (1979). 25. sheshunoff and co., inc. banks of ohio (1985). 26. steers, r. m. "problems in the measurement of organizational effectiveness," administrative science quarterly, vol. 20 (1975), pp. 546-58. 27. steers, r. m. organizational effectiveness: a behavioral view. santa monica, ca: goodyear publishing company (1977). 28. steiner, g. a., j. b. miner, and e. r. gray. management policy and strategy. 2nd edi tion. new york, ny: macmillan publishing company (1986). 29. tannenbaum, a. "employee-owner companies," in cummings, l. and b. staw, research in organizational behavior: an annual series of analytical essays and reviews, vol. 5, greenwich, conn: jai press (1983). 30. thompson, a. a. and a. 1. strickland, iii. strategic management: concepts and cases. plano, tx: business publications, inc. (1984). fall 1990 domm & byles: strategic success 75 31. venkatraman, n. and v. ramanujam. "measurement of business performance in strategy research: a comparison of approaches." academy of management review, vol. 11 (1986), pp. 801-14. 32. westwick, c. a. how to use management ratios. new york, ny: john wiley (1973). strategic success and member commitment the male outshopper: an overlooked market segment joanne s. hopper thomas j. lipscomb college of business administration southeastern louisiana university hammond, louisiana in recent years the phenomenon of consumer outshopping has become of concern to both practitioners and researchers in the field of marketing. outshopping occurs when consumers leave their local retail area in order to make purchases in nearby localities [2]. outshopping is known to be a widespread phenomenon. the loss of retail dollars from the local trading area, however, most adversely affects smaller municipalities. studies have reported that the median percentage of residents of smaller towns who routinely shop at least once a month outside of their local trading area is approximately 65%, as compared to about 20% of the residents of larger cities who shop beyond the trading area of local merchants ([3],[6]). in general, the cities and towns patronized by "outshoppers" are larger in size and offer a greater number and variety of retail outlets as compared to those available in the outshoppers' local trading area. previous research has demonstrated that variables such as selection, price, and quality were important motives underlying consumer outshopping behavior ([lj, [2], [3j, [4j, [5], [6]). in addition, income and age were found to be significant demographic indicators associated with outshopping tendencies with outshoppers generally being younger and more affluent than nonoutshoppers. with respect to psychographic variables, outs hoppers have been found to be more fashion-conscious, more self-confident, more optimistic concerning their futures, and to demonstrate greater innovation in their patronage behavior as compared to nonoutshoppers [lj. although a growing body of literature concerned with the phenomenon of consumer outshopping has begun to emerge, existing studies have been focused upon the identification and description of outshoppers in general and on differentiating outshoppers from nonoutshoppers. little, if any, attention has been given to attempts to identify important market segments within the general category of outshoppers. the purposes of the present study were to provide a detailed examination of the male outs hopper and to attempt to differentiate between men who engage in a significant amount of outshopping and those who do not. journal of bu~ine~~ strotegie~, volume 5, number 2 (fall 1988) 84 fall 1988 hopper and lipscomb: male outshopper methodology 85 data collection the present study was conducted in a moderate sized town (population 25,000) located in the south central united states. this locale was considered to be ideal for a study of consumer outshopping as it is located within 45 miles of two major metropolitan areas of approximately 1,000,000 and 250,000 residents. both metropolitan areas offer numerous major shopping mallr and centers and are accessible by interstate highways. the retail outlets in the town in which the data was collected are located primarily in the downtown area, in several community shopping centers, and in a multilevel mall with approximately 80 retail stores including three major department stores. a census approach was utilized to contact area residents. in order to provide a comprehensive database for the study of outshopping, an effort was made to contact each household in the city in which the study was conducted. the official city map was used to identify each street and road within the city limits. with only a few exceptions, each subdivision, road, and apartment complex was canvassed. thus, an effort was made to contact every household. questionnaires were hand-delivered and potential respondents were asked to complete the questionnaire at their leisure. individuals who were not at home on the initial attempt to contact them were contacted during following week. the majority of completed questionnaires were collected within one hour of being distributed. in all cases the completed questionnaires were collected within 48 hours of being distributed. every effort was made to contact as many residents as possible. the comprehensiveness of the data collection procedure resulted in a broadly representative sample of consumers. a total of 437 completed usable questionnaires were received from the male respondents, providing a response rate in excess of 90%. all members of this sample were 18 years of age or older and were employed full time. measures the information collected in the study concerned four areas of interest: (1) attitudes toward shopping in the local market area, (2) attitudes toward outshopping, (3) psychographic profiles, and (4) demographic characteristics. a five point likert-type scale was used to assess the respondents' attitudes toward the local area, outshopping behavior, and psychographic characteristics. analysis for the purpose of the present study, an outs hopper was defined as a consumer who reported one or more shopping excursions outside the local trading area each month. an inshopper was defined as a consumer who made less than one shopping excursion outside the local trading area each month. of a total sample of 437, 299 men were classified as outshoppers and 138 were classified as inshoppers. the data were analyzed by manova to test for overall differences between outshoppers and inshoppers. this multivariate effect indicated a significant difference (p < .023) between the two groups. appropriate univariate tests were then performed on the 86 journal of business strategies vol. 5, no.2 responses to individual items in order to investigate differences in male inshopper and outshopper attitudes toward the local market area, outshopping behavior, and psychographic characteristics. the demographic differences between the two types of shoppers were analyzed by means of chi square tests. results and discussion extent of the problem the study included information on purchases of clothing, groceries, automobiles, home furnishings, and recreation equipment outside of the local trading area. approximately half of the males reported buying automobiles out of town. in regard to personal clothing, 57% of the men reported buying 50% or more of their clothing out of town. retail expenditures out of town for home furnishings, groceries, and recreational equipment purchases were not as large. about 30% of the men reported purchasing half or more of their horne furnishings and recreational equipment out of town. less than 10% of the men bought half or more of their groceries out of town. the respondents' attitudes toward the hometown merchants' selection of merchandise and pricing were surveyed. in regard to price, the majority of the men indicated that their hometown merchants had prices the same or cheaper than out-of-town merchants. the major problem cited in the study was the lack of selection available through local retailers. more than 50% of the shoppers stated that clothing and automobile selection was poorer in their home town when compared to out-of-town merchants. thus, selection appears to be a major motivation for outs hopping activity. attitudes toward the local trading area the respondents were asked questions concerning their opinions regarding the local trading area and their opinions regarding shopping in ~rea retail stores. the attitudes toward the downtown merchants and mall merchants were both examined. the results of this analysis indicated significant differences between outshoppers and inshoppers on several key dimensions as depicted in table i. specifically, the outshoppers viewed parking as being significantly less convenient, prices as significantly higher in the downtown area, selection of merchandise in the mall location as more inadequate, and shopping in the mall location as less enjoyable as compared to inshoppers. although both groups indicated their town of residence as being "a nice place to live," there was a significant difference between the groups with outshoppers displaying less favorable attit udes overall. thus, it appears that the male outshoppers are not as pleased with local merchants as are inshoppers and may be drawn to outof-town merchants due to their dissatisfaction with local retail merchants' offerings and location. attitudes toward outshopping several questions concerning attitudes toward outshopping activities were addressed in the survey. respondents were asked about the enjoyment of going out fall 1988 hopper and lipscomb: male outshopper 87 significance level b p < .001 p < .001 p < .001 p < .001 p < .001 p < .001 of town to shop, time and trouble involved in outshopping, loyalty toward local merchants, and large purchase and gift buying behavior. as indicated in table 2, the differences among inshoppers and outs hoppers were highly significant. outshoppers were found to be less loyal to local mercbants, to enjoy leaving town to shop more, and to believe that the time and economic costs involved in outshopping excursions were worth the time and money investment required to a greater extent than inshoppers. table 1 differences in the attitudes of male outshoppers and inshoppers toward local 'lrading area merchants ----~--~-~~~---------c;;:_;______.=_ attitude significance levelb convenience of mall to shoppers p < .023 mall well stocked p < .008 mall is a fun place to shop p < .014 mall prices are high p < .768 mall salespersons are helpful p < .344 mall parking is adequate p < .040 central business district stores have high prices p < .001 downtown stores have a wide selection of merchandise p < .225 downtown stores salespersons are friendly p < .188 it's not convenient to shop downtown p < .030 it's fun to shop downtown p < .870 parking downtown is a problem p < .005 i enjoy shopping in my hometown p < .005 a analyzed by t-tests table 2 differences in the attitudes of male outshoppers and inshoppers toward local 'lrading area merchants attitude people should outshop only when they can't find merchandise in their hometown people should shop where they live big cities are too impersonal it's too much trouble to shop out of town shopping in my hometown is convenient enjoy getting out of town for shopping considering time and gas, it costs too much to shop out of town p < .001 christmas gifts are bought out of town p < .001 buy expensive merchandise out of town p < .001 -~~_.__._------------------"-----------' aanalyzed by t-te,t, 88 journal of business strategies vol. 5, no.2 with regard to the purchases of gifts and expensive items, outshoppers indicated a significantly greater disposition to purchase these types of products outside their local trading area. it is in this area that outshoppers and inshoppers displayed the largest difference in behavior and attitudes. the results of this analysis indicated outshoppers to perceive outshopping as more pleasurable and more worth the effort while inshoppers were found t:> be inclined to remain in their local trading area, in part, to avoid the time and costs of outshopping. this would also imply that local merchants are losing a large number of retail sales for large dollar purchases and gift buying. the local economy would be most adversely affected during major gift buying seasons and with respect to durable goods purchases. psychographic characteristics a number of questions posed of the respondents were concerned with psychographic characteristics. these included: fashion orientation, convenience orientation, bargain shopping, and media habits. this analysis indicated the male outshoppers to be more fashion-oriented and less convenience-oriented than the inshoppers. these results indicate that outshoppers may be drawn to larger cities for fashion, while inshoppers stay in town for convenience. shopping for bargains does not appear to be a significant motivation for outs hopping activity. no differences exist between outshopper and inshopper media habits, readership of out-of-town newspapers or listenership to out-of-town radio stations. demographic characteristics striking differences were found between demographic characteristics of outshoppers and inshoppers. chi-square analysis revealed significant differences in the areas of marital status, age, income, years of residence, and ownership of out-of-town credit cards. of all the demographic characteristics investigated, income was the only area in which no meaningful differences existed between inshoppers and outshoppers. the demographic profile indicates that a large percentage of the outshoppers are single males and that outshoppers are by far younger than are the inshoppers. the outshoppers report having resided in the area for a relatively brief period of time with the largest percentage having been residents of the area for less than one year. not surprisingly, the outshoppers also owned a much larger number of out-of-town credit cards than did inshoppers. figure 1 presents a summary profile of the demographic and psychographic characteristics of outshoppers. summary one of the major findings of the present study is that a significant number of men make purchases outside their local trading area on a routine basis. in the present sample, 75% of the men surveyed reported making purchases of this type two or more times per month. also quite importantly, the results of this investigation vividly point out that outshoppers and inshoppers differ in meaningful ways. outshoppers tend to be unmarried and are younger than their inshopper counterparts. the outs hoppers fall 1988 hopper and lipscomb: male outshopper 89 also report a greater degree of dissatisfaction with local retail outlets and are driven to seek a wider selection and more fashionable merchandise in the nearby larger metropolitan areas. figure 1 demographic and psychographic characteristics of male outshoppe1'8 • residents of town less than five years • possess out-of-town retailer charge cards • very likely to be single • aged 18-45 • reads out-of-town newspapers • likes to be fashionable • not concerned with time or bargains a major difference between the male outshoppers and inshoppers is that the outshoppers believe that the outshopping experience is enjoyable and worth the time and effort, while the inshoppers do not. the outshoppers are less loyal to local merchants and are very likely to make expensive purchases and holiday purchases out of town. it also appears that the male outshopper is less concerned with the amount of time spent in shopping, and is more fashion conscious than is the male inshopper. strategic implications for retailers the results of this study indicate that outshoppers are a viable market segment who have a significant impact on the viability of a retail trading area. the phenomenon of outs hopping by its nature creates two potentially competing retail strategies. small town merchants may strive for outshopper retention while out-of-town merchants engage in retailing strategies designed to attract outshoppers. the following discussion explores such possible strategies for both types of merchants. supporting figures and tables portray specific steps that retailers may choose to consider when seeking to capture this important market segment. small town merchants' strategies for retaining outshoppers the multiplier effect begins to mushroom as dollars flow out of small towns into the pockets of big city merchants. sales tax collections fall and the result is less money for schools, public works, and special projects. not only do merchants suffer by depressed sales due to outshopping, but the economy of the entire town is ultimately negatively affected. because outshoppers are leaving their local area to seek greater selection, it is important for all of the area merchants to work together to provide better selection 90 journal of business strategies vol. 5, no.2 across product offerings in the local trading area. a truly cooperative effort is needed among retailers. optimally, this cooperative effort would include promotional campaigns that incorporate a theme of improved selection among merchants. through advertising, sales promotion, and publicity, the message of better merchandise selection would be communicated to the male outshopper. merchants would also offer special orders for custom merchandise, and would stock more fashionable items that appeal to a large segment of the outshoppers. it is important to note that pricing does not seem to be a problem. most outshoppers are not bargain hunters. thus, the thrust of the local merchants would be a cooperative effort to retain outshoppers as well as an actual change in product selection. the local chamber of commerce might also engage in a campaign promoting the increased level of consumer services and quality of life that are generated through local sales tax collections. thus, outshoppers may become aware of the benefits of shopping in town and its effect on the local quality of life of the town's residents. figure 2 strategies for small town merchants to retain outshoppers • cooperative promotional compaigns • increase merchandise selection • increase fashionable merchandise • offer special and custom orders • do not change prices • increase shopping excitement • be more service-oriented • train sales personnel properly outshoppers also displayed displeasure with the local sales personnel and lack of fun and excitement in shopping. by bringing in special attractions and/or festivals into malls and shopping areas, more enthusiasm about shopping in the local area should result. also additional emphasis on being served by service-oriented and courteous sales personnel should generate a more favorable response by outshoppers. large city merchants' strategies for attracting outshoppers with the intense competition in larger city trading areas, merchants may feel that it's worth the effort to look "in their own backyards" for additional customers. the findings of the study imply that the larger metropolitan areas are successfully attracting the male outshopper. in particular, single males appear to be a very promising customer base. in regard to strategies aimed at attracting male outshoppers, there is no indication of needed changes in pricing or location by larger city merchants. changes in marketing strategies are needed in the areas of advertising, services, and fall 1988 hopper and lipscomb: male outshopper 91 credit policies. it may be possible to attract more outshoppers with promotions aimed at the out-of-town market. the out-of-town merchant should consider advertising in the outs hoppers ' home town a.reas. the additional advertising might increase sales to higher levels. an intensive direct mail campaign could be used to attract outshoppers with preapproved credit cards. additional sales may also occur when outshoppers a.re offered a toll free number for phone order and free delivery of large dollar value purchases. figure 3 strategies for small town merchants to attract outshoppers • advertise in local small town media • offer credit cards to out-of-town customers through direct mail • offer free out-of-town delivery • emphasize selection and fashion in advertising to outshoppers • do not change prices • employ cooperative advertising among large city merchants to specifically attract outshoppers in local media • provide toll free telephone numbers as intracity competition increases among the merchants in larger cities, outlying a.reas have the potential to provide lucrative markets for increasing sales volume. rather than ignoring the outshopper, strategies should be undertaken to attract larger numbers of outshoppers. additional sales may also be generated through cooperative efforts among large city merchants. through ads placed in the small town newspapers and radio stations, outshoppers will be more aware of a wide variety of shopping opportunities. since small town media have lower rates than large cities, the additional advertising costs may be feasible by many merchants through horizontal cooperative advertising. thus, by attracting this viable market segment, large city merchants may profit greatly without large capital expenditures. references 1. darden, w. r. and w. d. perreault, jr. "identifying interurban shoppers: multiproduct purchase patterns and segmentation profiles." journal of marketing research, vol. 13 (february, 1976), pp. 51-60. 2. herrman, r. d. and 1. l. beik. "shopper movements outside their local retail area." journal of marketing, vol. 32 (october, 1968), pp. 45-51. 92 journal of business strategies vol. 5, no.2 3. papodopoulos, n. g. "consumer outshopping research: review and extension." journal of retailing, vol. 56 (winter, 1980), pp. 41-58. 4. reynolds, f. d. and w. r. darden. "intermarket patronage: a psychographic study of consumer outshoppers." journal of marketing, vol. 36 (october, 1972), pp. 50-54. 5. samali, s. c. and e. b. uhr. "the outshopping spectrum: key for analyzing intermarket leakages." journal of retailing, vol. 50 (summer, 1974), pp. 7080. 6. thompson, j. r. "characteristics and behavior of outshopping consumers." journal of retailing, vol. 47 (spring, 1971), pp. 70-80. the male outshopper: an overlooked market segment an empirical assessment of the relationship between management levels and planning among small business practitioners james w. carland joann c. carland carroll d. aby, jr. college of business western carolina university cullowhee, north carolina planning in small businesses has been the subject of considerable research. virtually every issue of the strategic management journal contains at least one article dedicated to that subject. numerous researchers have found that planning activities improve organizational pedormance (i.e., [17j, [22j, [15j, [26j, [27], [28]), but there is not uniform agreement in support of this conclusion (i.e. [5], [8], [18], [3]). neither can scholars agree as to how organizational performance should be measured [19]. furthermore, unanimity of thought does not exist on how strategic planning takes place in a small business [24j. rhyne [16] presents an excellent overview of the studies on planning and performance, pointing out inconsistencies and suggesting that the diversity of findings may result from omission of planning characteristics. despite the controversy, one thing that most scholars have in common is a recognition that vast numbers of small firms do not plan at all! a number of studies have dealt with this problem (i.e. [7], [20], [4]). according to chandler [2j, one of the most important factors in management is the structure of the organization. chandler's work reveals that lower levels of management are more oriented toward operations and therefore less toward planning. chandler makes it clear that planning and structure are inextricably bound. miller and toulouse [1oj examined the impact of structure and other variables on the performance of a firm and found that delegation of authority was highly correlated with performance. thus one might argue implicitly that the simpler the structure of a firm, the less likely it is to engage in planning activities. this study will examine the interaction of organizational structure and the presence of planning activities without regard to planning type, intensity, or impact. considering that a more simplistic management structure results in a greater level of involvement of owner/managers in operational issues, the joumal of bu,ine" strategiu, volume 5, number 1 (spring 1988) 31 study will examine whether the theoretical freedom from operations inherent in organizations with more complex ma.nagement structures results in greater planning activities. planning activities will refer to whether an owner/manager has engaged in the development of a formal, written plan for the development and growth of the firm; engaged in the development of an informal, unwritten plan; or failed to develop either a written or unwritten plan. definitional issues with regard to small businesses will be discussed and a taxonomy of small businesses espoused. the results of an empirical test of the taxonomy with respect to the presence of written or unwritten plans will conclude the paper. small business definitions a frequently cited definition of small business is contained in the small business administration guidelines for loan assistance. the sba requires that a firm be independently owned and operated. further, to be classified as a small business the firm must not be dominant in its field. to activate this definition, the sba publishes a booklet with arbitrary cut oft' points in sales or employees, but will examine any firm which fails to fulfill published guidelines to ascertain whether it qualifies 88 a small business. mcguire [9] reeognized the need for classification criteria and suggested that businesses which encompass a single "profit center" be classified "small." firms comprised of more than one profit center would connote a large business. mcguire's "profit center" corresponds to the "strategic business unit" described by glueck [6]. glueck's [6] sbu was an entity or operating division serving a distinct product/market segment and having authority to make its own strategic decisions. an sbu can have multiple outlets or locations so long as those sites serve the same product/market segment. schollhammer and kuriloft' [23] considered a business small if the proprietor could know each company member by name. although their meaning is clear, such a definition could hardly be utilized to strudure research. many writers circumvent the issue entirely by neglecting to define a. sma.ll business. this la.tter practice is pa.rticularly preva.lent in normative writings. carland, hoy, boulton and carland (1] provide a sampling of the definitions appearing in the small business literature. that sa.mpling makes clear that there is no consensus regarding the definition of a small business. furthermore, the literature does not support the subclassification of small firms. however, most resea.rchers implicitly or explicitly recognize that there are differences among small firms relative to their size. the purpose of a taxonomy is to prod uce criteria which permit the partitioning of a data set into mutually exclusive categories for more fruitful study and understanding. such a taxonomy does not exist in the field of small business. 32 numerous state and federal agencies have expressed goals of assisting small businesses. the lack of an established definition and supporting taxonomy impairs their prospects. nappi and vori [11] conducted research among government agencies in each of the fifty states and two districts to determine a viable definition of a small business. they found that half the states did not have any definition, while there was no consensus among those definitions which were in use in the remaining states. furthermore, most agencies could offer no rationale for the definitions or classification criteria which they used. problems such as these make the need for a taxonomy readily apparent. small business thxonomy the sba definition does not take into consideration the management structure of a business. consequently, that definition is of little use in research because both highly complex and simplistic firms can be deemed small through its application. a definition is needed which makes explicit the role of management complexity. building on the work of mcguire [9j, glueck [6] and carland, hoy, boulton and carland [1], the following definition is proposed: a small business is any business which is independently owned and operated, not dominant in its field and consisting of a single strategic business unit. by this definition, businesses with multiple "profit centers" or "strategic business units" are considered large firms regardless of their sales, employees or other factors. multiple sbus create managerial complexity beyond the recognition of needs and demands of a single product/market. the management of such firms must behave differently from managers of small businesses because of this greater complexity in markets and operations. chandler's work is of value in understanding the incidence of planning in small business. structure and strategy are bound. strategy cannot be seen, but structure can be easily identified. following chandler's [2] lead, a taxonomy of small business keyed to their respective management structures is suggested. at the lowest level are firms whose managers personally perform or directly supervise all activities of the organization. such businesses have no management personnel other than the general manager. these organizations have a single level of management and can therefore be termed "unilevel." managers of such firms are by necessity operationally oriented. the second level of the taxonomy includes those businesses which have two levels of management. in other words, there is a level of supervisors between the general manager and the employees. such firms are "duolevel." there is every reason to believe that the general managers of such firms have some freedom from operational issues as a result of a management layer whose concerns are operational in nature. hopefully, these mana.gers will use the time freed from operations to practice strategic management or planning. 33 the last level of the taxonomy covers those firms which have more than two levels of management. these "multilevel" firms may have more than one member at the general management level. theoretically speaking, the top managers of these firms can devote themselves to strategic planning because there are management layers whose concerns are operational and tactical. regardless of the level of a fum within the taxonomy, it must consist of a single strategic business unit in order to be classified as a small business. this taxonomy has the power to distinguish between groups of small businesses. in other words, the classification criteria make explicit the view that not all small businesses are the same size or complexity. the small business taxonomy described above is illustrated in figure 1. figure 1 small business taxonomy multilevel firms duolevel firms unilevel firms general general general manager( s) manager( s) manager(s) i i i __m_an_a-7g,,--e_r(,-s~)_-----ji 1__s_u-=--p_er_v,-is_o_r(-,-s..!...)--"i 1__e_m~p_io-=-y_ee_s__ i i __s_u...:p,-e_r...,.vi_so_r~(-,s):""---ji i employees i i employees i small businesses may originate at any of the three included levels. after their inception, small businesses may remain stationary, or migrate to different levels of the taxonomy. the creator of the business, the small business practitioner, will define its structure. methodology using the theoretical model of a small business taxonomy as the basis for the research, an empirical examination of the incidence of written or unwritten plans was undertaken. questionnaires were developed which contained inquiries regarding planning, levels of management, and demographic characteristics. in every case the respondent was a small business practitioner. each practitioner was asked how many levels of management existed in the business. respondents were also asked whether there was (1) a formal, written plan for the development and growth of the fum or, (2) an informal, unwritten plan for development and growth. respondents indicating that neither written nor unwritten plans existed were deemed to have no plans. 34 the sample the sample was drawn as part of a class project and included 334 respondents from more than twenty states. each respondent had started and was currently managing the business. the participants were selected and solicited by graduate students on a convenience basis. consequently, there was an extremely high ratio of response. less' than one in twenty practitioners approached, declined to participate in the study. the business owners were active managers and reported that the business consumed the majority of their time and provided most of their family income. all of the businesses would qualify as small firms under the small business administration guidelines for loan assistance. every firm was independently owned and operated, none were dominant in their fields, and each consisted of a single strategic business unit. consequently all of the businesses qualify as small firms under our definition as well. the employee breakdown was as follows: 282 firms reported 10 or fewer employees; 37 reported between 10 and 50 employees; 11 reported 51 to 100 employees; and, 4 reported 101 to 250 employees. in terms of annual sales volume, 169 firms had sales of $100,000 or less, 106 had sales between $100,000 and $500,000, 29 had sales between $500,000 and $1,000,000 and 30 had sales over $1,000,000. there were 133 service firms, 15 manufacturing firms, 21 construction companies, 156 retailers and 9 wholesalers. there were 111 corporations, 151 proprietorships and 72 partnersliips. respondents were asked to indicate the number of levels of management and it was ascertained that 237 firms were unilevel, 66 firms duolevel, and 31 firms were multilevel with regard to the taxonomy. with respect to the existence of plans, 58 firms indicated that formal, written plans existed for the development and growth of the firm; 180 respondents indicated that unwritten plans existed; and, 96 participants indicated that no plans existed for the firm at all. no attempt was made to evaluate appropriateness or effectiveness of plans. the research question the research question was whether a relationship existed between the organizational structure of the business and the existence of written or unwritten plans among the sample firms. theoretically, one would believe that at the unilevel the small business practitioner is too involved with the day-to-day business operations to have the time for developing plans. however, as more management personnel become involved in the operation of the business, one would assume that top management is afforded greater freedom from operational issues and therefore has more time to devote to the development of plans. results of the analysis because the data consists of frequency counts, a chi square test is implemented. the chi square statistic is designed to measure whether the actual 35 frequencies found in a sample differ from the expected frequencies [14]. in this case, the null hypothesis to be tested states that there is no difference in the occurrence of written or unwritten plans between levels in the taxonomy. consequently, the expected frequencies should be proportionate to the range of possibilities. our data is divided into three groups: firms with formal, written plans, firms with informal, unwritten plans and firms with no plans. if organi~ zational level makes no difference then all three levels of firms should have the same proportion of respondents in each of the three categories. the number of firms in each category as well as percentages for the breakdown of firms within each level are displayed in table 1. as shown in the table, the chi square test indicated that a significant relationship does exist between the classification of the company within the taxonomy and the existence of written or unwritten plans. table 1 planning vs. structure written unwritten no levels plans plans plans totals unilevel 29 12.2% 129 54.4% 79 33.3% 237 100.0% duolevel 19 28.9% 31 47.0% 16 24.2% 66 100.0% multilevel 10 32.3% 20 64.5% 1 3.2% 31 100.0% totals 58 180 96 334 x: = 22.98 d.f. = 4 probability = 0.000 further reference to table 1 reveals that 30 of the 31 multilevel firms had either written or unwritten plans: 10 had written plans and 20 had unwritten plans. at the duolevel, 50 of 66 firms had plans: 19 had written plans and 31 had unwritten plans. most of the unilevel firms also reported the existence of plans, 79 or 33% had no plans. further investigation was undertaken to determine whether the results of this research were affected by the size of the business. chi square tests were conducted between sales volume and the existence of written or unwritten plans and between number of employees and the existence of plans. both tests indicated that there was no significant difference between firms in the sample classified by sales volume or number of employees and the existence of written or unwritten plans. consequently, organiza.tional structure a.ppears to be a major factor influencing the occurrence of planning in the sample firms. significance of the findings the study demonstrated that differences in the existence of plans existed between sample firms within the proposed taxonomy. we conclude that a case 36 exists for a statistically rigorous examination of the taxonomy as a potential classification model for small businesses. ramifications for researchers small business research has been plagued by the absence of a consensual definition. if supported by further research, the definition and taxonomy proposed in this article could provide a tool for greater understanding of small businesses. all small businesses are not alike. the taxonomy could provide researchers with a tool of control for major differences between firms in any data set, thereby increasing the confidence that observed differences in behavior are a result of the factors of interest. the relationship of structure to strategy has long been recognized in large firms; it should be recognized in their smaller counterparts. implications for practitioners there has been considerable discussion in the literature about the presence of planning, its value to the business, and its specific content and process (i.e., [7j, [13j, [4j, [12j, [21j, [10]). the impact of planning on long term survival is generally considered positive. in the sample examined in this study, planning was more likely to occur in firms with multiple levels of management. this suggests that practitioners would be well advised to pay more attention to organizational structure if they intend to incorporate planning activities in their firms. if validated by additional research, these findings would imply that organizational issues must be addressed before any issues of quality of planning can be addressed. that is, the ability to plan is in jeopardy without proper orga.nizational structure. all too often practitioners are wont to shoulder all control and responsibility in their firms. if the findings of this study are valid, a clea.r need is demonstrated for the delegation of responsibility and authority by any practitioner who wishes to employ strategic planning in the firm. absent the development of an organiza.tional structure which can nurture planning, it may never exist. references 1. carland, j. w., f. hoy, w. r. boulton, and j. a. carland. "differentiating entrepreneurs from small business owners: a conceptualization." the academy of management review, vol. 9, no.2 (april 1984), pp. 354359. 2. chandler, a. d., jr. strategy and structure. cambridge, ma: the massachusetts institute of technology press (1962). 3. fredrickson, j. w. and mitchell, t. r. "strategic decision processes: comprehensiveness and performance in an industry with an unstable environment." academy of management journal, vol. 27 (1984), pp. 399423. 37 4. fry, f. l. and stoner, c. r. "business plans: two major types." journal of small business management, vol. 23, no.1 (january 1985), pp. 1-6. 5. fulmer, r. m. and rue, l. w. "the practice and profitability of long range planning." managerial planning, vol. 22, no.6 (1974), pp. 1-7. 6. glueck, w. f. business policy and strategic management. new york, ny: mcgraw-hill book company (1980). 7. kelley, c. a. and young, j. e. "is your small business ready for planning?" journal of small business management, vol. 21, no.1 (january 1983), pp. 28-33. 8. lindsey, w. m., w. r. boulton, s. franklin, and l. w. rue. "strategic planning: determining the impact of environmental characteristics and uncertainty." academy of management journal, vol. 25, no.3 (1982), pp. 500-509. 9. mcguire, j. w. "the small enterprise in economics and organization theory." journal of contemporary business, vol. 5, no.2 (1976), pp. 115138. 10. miller, d. and toulouse, j. m. "strategy, structure ceo personality and performance in small firms." american journal of small business, vol. 10, no.3 (winter 1986), pp. 47-62. 11. nappi, a. t. and vori, j. "small business eligibility: a definitional issue." journal of small business management, vol. 18, no.4 (october 1980), pp. 22-27. 12. o'neill, h. m. and duker, j. "survival and failure in small business." journal of small business management, vol. 24, no.1 (january 1986), pp.30-32. 13. orpen, c. "the effects of long-range planning on small business performance: a further examination." journal of small business management, vol. 23, no.1 (january 1985), pp. 16-23. 14. phillips, j. l. statistical thinking. san francisco, ca: w. h. freeman and company (1982). 15. rhyne, l. c. "the hnpact of strategic planning on financial performance." paper presented at the 43rd annual meeting of the academy of management, dallas, tx (1983). 16. rhyne, l. c. "the relationship of strategic planning to financial performance." strategic management journal, vol. 7 (1986), pp. 423-436. 38 17. robinson, r. b. "an empirical investigation of the impact of sbdc strategic planning consultation upon the short term effectiveness of small business in georgia." unpublished doctoral dissertation, university of georgia (1980). 18. robinson, r. b. and pearce, j. a. "the impact of formalized strategic planning on financial performance in small organizations." strategic management journal, vol. 4, no.3 (1983), pp. 197-207. 19. robinson, r. b. "measures of small firm effectiveness for strategic planning research." journal of small bt""iness management, vol. 2, no. 2 (april 1983), pp. 22-29. 20. robinson, r. 8., j. a. pearce, g. s. vozikis, and t. s. mescon. "the relatiqnship between stage of development and small firm planning and performance." journal of small business management, vol. 22, no.2 (april 1984), pp. 45-52. 21. robinson, r. b., j. e. logan, and m. y. salem. "strategic versus operational planning in small retail firms." american journal of small business, vol. 10, no.3 (winter 1986), pp. 7-16. 22. sanford, m. new enterprise management. reston, va: reston publishing company (1982). 23. schollhammer, h. and kuriloff, a. h. entrepreneurship and small business. new york, ny: john wiley and sons (1979). 24. sexton, d. l. and van auken, p. m. "prevalence of strategic planning in small business." journal of small business management, vol. 20, no.3 (july 1982), pp. 20-26. 25. stoner, c. r. "planning in small manufacturing firms: a survey." journal of small business management, vol. 2, no.1 (january 1983), pp. 4341. 26. timmons, j., 1. smallen, and a. dingee. new venture creation: a guide to small business development. homewood, il: richard d. irwin (1977). 27. tootelian, p. h. and gaedeke, r. m. small business management: operations a.nd profiles. santa monica, ca: goodyear (1978). 28. vozikis, g. and glueck, w. f. "small business problems and stages of development." academy of management proceedings (1980), pp. 373-378. 39 an empirical assessment of the relationship between management levels and planning among small business practitioners notes reverse stock spuis as a useful management tool: the case of quasi-reorganization james f. hopson mojtaba seyedian state university of new york college at fredonia fredonia, new york a reverse stock split is an accounting procedure which is used by a corporation to reduce the number of outstanding shares and, simultaneously, increase its par value. given certain circumstances, a reverse stock split could help corporations achieve certain financial goals. however, compared to the direct stock split, not many corporations seem to take advantage of the reverse split. on the average, during the last decade, only about 5 percent of all splits performed by the companies listed on the new york stock exchange were of the reverse type [8]. this is probably due to a lack of familiarity, on the part of the corporate managers and business advisors, with the procedure and its consequences. many are possibly familiar with the procedure but are not sure how to use it as part of an "action package" of improving the company's financial health. a survey of related literature reveals that during the last decade most corporations that embarked on a reverse stock split were in some type of financial distress. many of these corporations implemented the reverse stock split to eliminate the image of penny or low-priced stock, while improving the market for the company's shares by decreasing the transaction costs. taking the company private, though, has become a principal motive behind some of the more recent splits performed by both financially sound and financially distressed companies. no matter what the underlying objective has been, it is hard to argue that a reverse split on its own could accomplish it. according to the well documented "theory of efficient markets," sophisticated investors would see the reverse stock split for what it is an accounting transaction with no real substance [2]. in other words, only fundamental variables such as expected earnings, growth rate, and economic conditions should affect stock prices, not a mere "paper shuffiing." however, given many success stories, it would also be hard to reject the possibility of synergy between a reverse split and some other actions designed to increase shareholders' wealth ([1], [3], [4], [9], [10d. in other words, if a reverse split is performed as part of a comprehensive "action package" of boosting the profitability and share prices, chances are good for the split to show a synergy rather than a liability. it is the purpose of this paper to show ways a reverse stock split, in conjunction with the measures to boost profitability, may improve the chance of recovery for a corporation involved in a quasi-reorganization. in the following sections we will first provide a critical evaluation of the reverse stock split as a means to: (a) boost market demand for a company's shares, and (b) take a company private. we will then, present the details of the case of a reverse stock split combined with a quasi-reorganization. the final section of the paper will be devoted to our concluding remarks. fall 1991 hopson & seyedian: reverse stock splits an evaluation of the reverse stock split 135 basically, the mechanics of a reverse stock split are the same as a direct stock split, except that the stockholders exchange multiple shares of lower value par stock for a single share of higher value par stock, resulting in a decrease in the number of outstanding shares. to illustrate, assume a company has 50,000,000 outstanding shares of one penny par value stock and desires to reduce the number of outstanding shares to 500,000 with one dollar par value. the shareholder would surrender 100 shares of existing stock for one share of the new one dollar par value stock. the company will record the transaction through a memo to its capital account. as with the direct stock split, corporate charters not authorizing the type and the value of par stock that the company desires to issue must be amended. mayimizing shareholders' wealth reverse stock splits have been used often by corporations in the hope of stimulating the market for their outstanding shares. as far as the demand side is concerned a reverse split may directly affect the demand by reducing the transaction costs. given all the revelant variables, a reverse split should always result in an increase in the market price per share by the ratio of the split. the increased price reduces the per share percentage of the stock transaction cost. in the over-the-counter market, for example, the transaction cost is the spread between the asked and bid price. if the spread is 1/8, the transaction cost is 1.2% for a $10 stock, but 12% for a $1 stock. the reduction in transaction cost should increase the rate of return on investors' stock investment. the lower the original price the more apparent is the increase in the rate of return. the increase in the rate of return, in turn, could have a positive effect on the demand for the stock and therefore the price. however, the disadvantage is that investors may perceive the split as a negative signal that may indicate long-term financial difficulty [7]. earlier empirical studies such as r. radcliff and w. gillespie [5] and r woolridge and d. chambers [11] showed a significant decline in the trading price around the announcement date, reflecting investors' concern about the company's future financial security. a second way that the reverse stock split might help the price per share is through cutting certain corporate expenses. one of the advantages of reducing the number of outstanding shares is that the company might be able to reduce the number of the potential shareholders. this reduction, in turn, could reduce the expenses in reporting to shareholders, registrar's fees, paying dividends and shareholders' meetings. although these reductions in expenses usually are insignificant to justify the reverse stock split by themselves, they provide some additional benefits when split fulfills other corporate objectives. reverse stock splits can also help companies whose stock is trading at an extremely low price per share and eliminate the image of being abnormally risky that is usually associated with penny stocks. of course, according to the semi-strong form of the efficient market hypothesis, security prices should always reflect all the available public information [2]. in other words there is never an underor over-valued stock. however, it is a fact that not all segments of the u. s. stock market, at all timest can be charac136 journal ofbusiness strategies vol. 8, no.2 terized as "efficient" [6]. for the market to be completely efficient first all the revelant information should reach all the market participants quickly at the same time; and second the market participants should react to the new information as fast as possible. certainly relative to many large prestigious corporations with national following the small, newly established companies do not always enjoy an efficient market for their stock. in a recent study, m. seyedian [8] tracked the price performance of 45 industrial companies listed on the new york stock exchange that experienced a reverse stock split from 1970 to 1987. the closing prices for 20 days before and 20 days after the day a reverse stock split was announced were used. according to the results, companies that embarked on a reverse split experienced an increase in their value beyond the increase associated with the overall market following the announcement date. the study does not offer information on the status of the companies beyond 20 days. however, one could safely guess that over a longer run prices re-adjusted to their original levels unless the split was complemented by positive growth in sales, productivity, and profitability. taking a company private the reverse stock split has been used to take companies private. metropolitan maintenance company was purchased by two officers using a reverse stock split. the split was 1 for 3,000, but anyone with less than 3,000 shares received cash. by coincidence only the two officers had more than 3,000 shares. there are several advantages that a successful reverse stock split may produce for a company. the first is control. obviously, most public companies were once founded by one or a few entrepreneurs in the pursuit of profit. in the case a company is just a family business, the number of shareholders might increase to the point considered to be a potential threat to the controlling family. a reverse stock split that requires rounding down could force smaller shareholders to sell odd shares. a careful determination of the split ratio is required to determine the effect on all shareholders. moreover, this procedure may help the corporation qualify as an s corporation if the number of shareholders are reduced to 35 or less. smaller publicly traded companies with shareholders numbering just over 500, may use the reverse stock split to reduce the number of shareholders to below 500. this reduction of shareholders to below 500, limits the company's required public disclosure within their sec filin~. this reduces both the information competitors may obtain and the compliance cost. the benefits descn'bed are, obviously, dependent upon the degree of success that the majority stockholders will experience in taeir attempt to privatize their company. the most important obstacle in the way of a successful split is the potential opposition of the minority stockholders to the proposed plan. at times the minority shareholder could be some sizable corporation with the intention of one day acquiring or taking over the company in which it is a minority in terms of the number of votes. in that case, a long and expensive legal battle in the courts is a very probable outcome. this situation is more likely to occur when the price offered to the minority groups for the redemption of their fractional shares is considered unfair. the cash offer price is fundamental to a successful split. prudent companies contemplating a reverse split should fall 1991 hopson & seyedian: reverse stock splits 137 give a lot of thought to the determination of an appropriate price if they are interested in avoiding a legal battle. reverse stock split combined with quasi-reorganization for corporations that have experienced hardship in the past but expect an increasingly profitable future, the use of a reverse stock split combined with a quasi-reorganization may help increase the market value. when management has successfully implemented a comprehensive plan of actions to maximize shareholders' wealth, the use of the split combined with a quasi-reorganization can only augment the chance of total recovery. in such cases the alleged benefits of the reverse split discussed earlier will surely outweigh the associated negative effects. the quasi-reorganization permits a previously troubled company to realign its capital structure without filing bankruptcy, provided creditors cannot or agree not to force the company into bankruptcy. this capital realignment usually improves the company's financial statement credibility from the creditors' viewpoint and accelerates the time period before the company can legally pay dividends from retained earnings. the quasi-reorganization, which usually requires shareholder approval, is rather simple to implement. assets are revalued at their fair market value, and tax benefits arising prior to the quasi-reorganization that will benefit the company after the reorganization should be recorded as an asset (i.e., loss carry forwards). the net results of the asset reevaluation (usually a loss) and any known unrecognized losses are charged to retained earnings. the deficit in retained earnings is charged against contnbuted capital or additional paid-in capital. if there are no contributed capital or additional paid-in capital, or they are insufficient to absorb the entire retained earnings deficit, then they must be created. the additional capital may be created in one of several ways. first, existing shareholders, without receiving anything in return, may contribute additional capital to the corporation. second, shareholders could donate a percentage of the stock to the corporation, thereby reducing the amount required in the common stock account. third, the company could reduce the par value of its outstanding common stock and transfer the difference to additional paid-in capital. fourth, the corporation could combine number one andlor number two with a reverse stock split. the primary purpose of the quasi-reorganization is to enhance the corporation's image with creditors and potential new investors. the quasi-reorganization reduces the deficit in retained earnings, but why not at the same time increase the company's stock trading price? this can be accomplished by a disproportionate reverse stock split. that is, the increase in par value is not proportionate to the decrease in outstanding shares. for example, a company has 2,000,000 shares of outstanding $1 par value stock before it implements a reverse stock split. the reverse stock split is 1 for so, but instead of issuing $so par value common stock, the company issues $10 par value common stock. the excess in the common stock account is credited to additional paid-in capital. to fully illustrate the accounting procedures for a quasi-reorganization coupled with a disproportionate reverse stock split, consider the following example. continuing with the company above that has 2,000,000 shares of outstanding $1 par value stock, assume fur138 joumal ofbusiness strategies vol. 8, no.2 ther that the stock is tiading for 50 cents a share. the company's balance sheet on december 31, 1989 is as follows: assets cash accounts receivable property, plant & equipment less accumulated depreciation other assets total assets $ 785,000 230,000 $ 85,000 825,000 555,000 120,000 $ 1.585,000 liabilities and stockholdels' equity current liabilities long-term notes payable total liabilities $ 535,000 225,000 $ 760,000 stockholders' equity common stock, $1 par value retained earnings (deficit) ~ooo,ooo (1,175,000) total stockholders' equity 825,000 total liabilities & stockholders' equity $ 1.585,000 400,000 1,600,000 1 share of $10 par $ 2,000,000 additional facts include: 1. an additional $115,000 of accounts receivable need to be written off. 2. the plant and property have appreciated $85,000 since purchased. 3. other assets contain $35,000 of goodwill that is to be written off. the journal entries for quasi-reorganization and the disproportionate stock split are: a) retained earnings 125,000 ~antandpro~~ 85,000 goodwill 35,000 accounts receivable 175,000 to write down goodwill and accounts receivable and write up plant pro~rty as part of a quasi-reorganization. b) common stock, $1 par value common stock, $10 par value paid-in capital in excess of par to record disproportionate reveise stock split which exchanges value stock for 50 shares of $1 par value stock. c) paid-in capital in excess of par 1,300,000 retained earnings 1,300,000 to eliminate the deficit in retained earnings as part of a quasi-reorganization, ($1,175,000 balance sheet amount plus 125,000 from joumal entry a, above). the balfad 1991 hopson & seyedian: reverse stock splits 139 ance sheet should carry the date of the quasi~reorganization in the retained earnings section until it loses its significance (5 to 10 years). for example, assume the company's net income that is closed to retained earnings is $100,000 in 1990, the balance sheet should read: retained earnings, since jan. 1, 1990 $100,000 after the quasi-reorganization the corporation starts fresh and should follow generally accepted accounting principles. also, the market price of the stock should increase to approximately $17.50 per share immediately after the quasi-reorganization ($400,000 common stock + $300,000 paid-in capital in excess of par)/ 40,000 shares outstanding. although quasi-reorganizations are not everyday events, they have been used when specific industries have experienced a recession. examples during the 1980's include: first wisconsin mortgage trust, lockheed corporation, astrotech international corporation, and perception technology corporation. the primary benefit to investors is the elimination of the deficit in retained earnings, since most states require dividends to be paid from "positive" retained earnings. conclusion reverse stock splits and quasi-reorganization are not tools that lend themselves to solving everyday corporate problems and are therefore infrequently seen. however, when the situation arises where they are applicable, they can be beneficial. corporations that have been in financial trouble in the past but have turned themselves around so that there are every evidence of a continuing positive growth in profitability, a reverse stock split could enhance the chance of a successful quasi-reorganization. when such companies have negative retained earnings, a disproportionate split can be combined with the quasi-reorganization to restate the balance sheets with retained earnings having zero balance. under such circumstances it would be safe to expect that the splits' advantages of reducing the stocks trading cost and shareholders administration expenses, and eliminating the ''penny stock" image would not hurt the management's primary objective of maximizing the shareholders' wealth. references 1. archbold, p. "moving ahead hy going into reverse." forbes (february 14, 1988), p. 56. 2 hirt, ga and block, s.b. fundamentals of investment management 3rd ed homewood, il: hwin (1990), pp. 262-85. 3. johnson t.e. "how herbert kohler won his bid for privacy." fortune (february 12, 1979), pp. 84-5. 140 journal ofbusiness strategies vol. 8, no. 2 4. mcgough, r. "squeeze play," forbes (november 19, 1984), p. 54. 5. radcliff, r.c. and gillespie, w. "the price impact of reverse splits." financial analysts journal (january/february, 1979), pp. 63-67. 6. reilly, f.c. investments. 2nd ed., new york, ny: dryden press (1988), pp. 165-89. 7. reilly, f.k. and drzycimski, b.f. "short-run profits from stock splits." financial management, (summer, 1981), pp. 64-74. 8. seyedian, m. "reverse stock splits and the efficient matket hypothesis: the case of the new york stock exchange." the proceedings of northeast business and economics aslociation annual conference (1988), pp. 26-7. 9. sherrid, p. "a split too far?" wall street letter (may 1977), pp. 97-8. 10. white, r. "sending away for a mail-order multiple." wall street letter (may 1977), p. 42. 11. woolridge, 1.r. and chambers d.h. "reverse stock splits and shareholder wealth." financial management (autumn 1983), pp. 5-15. reverse stock splits as a useful management tool: the case of quasi-reorganization employment of the physically handicapped and the ada edward k. marlow nancy d. marlow eastern illinois university charleston, illinois ''i'm going to do whatever it takes to make sure the disabled are included in the mainstream... they're not going to be left out anymore." [george bush endorsing the americans with disabilities act of 1989 (so 933)] 'they never even gave me a chance." [michele marlow, a seventeen year-old girl in a wheelchair, denied employment by hardee's because "the company manual says that employees must be on their feet while they are working."] introduction many businesses are experiencing difficulty finding qualified employees, and this situation is expected to get worse. a recent article in the wall street journal indicated that almost 80 percent of the business firms surveyed expected a shortage of skilled labor in the next decade [2]. this predicted labor shortage is expected to force companies to recruit more aggressively and to look at sources they may not have considered seriously before. a 1988 survey revealed that two-thirds of americans with disabilities between the ages of 16 and 64 are unemployed [13]. in the past businesses ignored the physically handicapped in most employment situations. the emphasis in equal employment opportunity (eeo) and affirmative action (aa) programs was on other groups of people. however, aa programs are now being required to correct past discrimination against this large segment of the population. the americans with disabilities act (ada) will focus employers' attention on hiring the physically handicapped. definition of handicapped under the rehabilitation act of 1973, handicapped conditions included: conditions where the disability requires multiple services over an extended period of time and results from amputation, blindness, cancer, cerebral palsy, cystic fibrosis, deafness, heart disease, hemiplegia, mental retardation, mental illness, multiple sclerosis, muscular dystrophy, neurological disorders (including strokes and epilepsy), paraplegia, quadriplegia, and other spinal cord conditions, renal failure, respiratory or pulmonary dysfunction and other disability specified by the secretary in regulations he shall prescribe. [po 753] the department of labor has further defined a handicapped individual as ii any person who has a physical or mental impairment which substantially limits one fall1990 marlow&marlow:physicallyhandicapped 97 or more of the person's major life activities." however, the handicapped individual must be recorded as having the impaired condition. life activities are any activity such as employment, education, communication, walking, or caring for one's self. this clearly means any handicapped individual who has difficulties in obtaining a job or advancing a career. rather than develop a new definition for the term "qualified individual with a disability," the ada includes a comparable definition to the one above. the term applies,to people with a record of such an impainnent, such as someone recovered from cancer, as well as people "regarded" as having a disability, such as a person with a disfiguring injury. it would add aids victims and recovering drug and alcohol abusers to the list of those eligible for legal protection. developments up to the ada over forty years ago, the department of labor conducted a study and found that there were no "significant differences in productivity, injuries on the job, absenteeism, or voluntary resignation between disabled and non-disabled workers." [217] current research indicates the same results as found in 1948. the question wti11 remains, why do the handicapped still have so many problems obtaining employment? over eight million disabled americans who wanted to work were unemployed in 1986, and half had household incomes of $15,000 or less. transfer payments to the disabled are reaching nearly $60 billion a year. to date, the major piece of legislation affecting the handicapped has been the rehabilitation act of 1973, sections 503 and 504. section 503 states that "any employer entering into a government contract or subcontract with a value in excess of $2,500 must pursue a policy of non-discrimination against the handicapped." businesses with federal contracts in excess of $50,000 and 50 or more employees are required to prepare affirmative action plans [23]. section 504 prohibits discrimination of the handicapped in any program receiving federal financial aid-this applies to government agencies, hospitals, schools, social services, businesses, any program or activity conducted by an executive agency, and by the u. s. postal service [12]. the only contracts that are exempt from this clause are insurance contracts, procurement contracts, or guaranty contracts. sections 503 and 504 protect individuals from employers who do not provide "reasonable accommodation" to their employees. any act performed by a business to help a handicapped individual perform his job is a form of "reasonable accommodation." reasonable accommodation includes physical or architectural changes of the building or work area, or changing the work hours or schedules, or slightly modifying the job responsibilities [7]. unfortunately there is no standard definition of "reasonable accommodation" and most working definitions have been decided in the courts on a individual case basis. it is the responsibility of the employer to prove that hiring handicapped individuals will put an "undue hardship" on his business. the other alternative for a company in a discrimination case is to prove that it has done everything "rea98 journal of business strategies vol. 7, no.2 sonable" to advance and employ handicapped individuals. only if an individual cannot meet or produce at the company's standards can a company refuse to hire or dismiss a handicapped individual. (this would apply only after any reasonable accommodations have been made). the ada will drastically change the way business views hiring the handicapped. this will be the most sweeping civil rights bill in more than 25 years, perhaps the most sweeping ever. estimates are that 43 million people in the u.s. have some disability. ironically, this new legislation will enhance the employment capabilities of the disabled at the very time the employment potential of other minorities is being diminished by recent supreme court rulings. americans with disabilities act in may, the house overwhelmingly passed the ada; the senate had already approved the bill. after a joint conference to resolve the differences, president bush has indicated that he will sign the bill into law. the ada will guarantee the nation's 43 million deaf, blind, lame, and otherwise infirm people against job discrimination. the legislation would make employment discrimination against any qualified person with a disability forbidden. employers must make facilities accessible to the person hired, and make the necessary adjustments for that person to work businesses and other employers with fewer than 15 employess are exempt (so far). in senate debate, proponents compared the ada to the civil rights act of 1964. some turned the comparison back to the freeing of the slaves. the legislation borrows form the 1964 civil rights act and sections of the rehabilitation act of 1973 dealing with companies, institutions, and groups that receive government money. as mentioned earlier, rather than list specific disabilities-€stimated to exceed 90d-the law defines disability as "a physical or mental impairment that substantially limits one or more of the major life activities." disabled individuals must be hired if they are qualified to do the "essential functions" of the job. exceptions-surely food for numerous future legal tests-exist. the disabled need not be hired if it would pose"an undue hardship." existing public accommodations must be made accessbile as long as the changes are "readily achievable" without creating an "undue financial burden." no one has given any guideline as to what these phrases really mean, although the terminology is the same as previous civil rights legislation. the disabled are one of the newest of the "dispossessed minorities" to come to public attention. it has only been in recent years that society has started to address the problems and needs of disabled persons. society has slowly recognized their fundamental right to live complete lives and receive simple respect. as laws, regulations, and programs are being enacted to deal with legal, institutional, and architectural barriers that the disabled must face, the basic prejudice against disfall 1990 marlow&marlow: physicallyhandicapped 99 abled person must be acknowledged. this prejudice, like all prejudice, stems from the thoughts and attitudes of individuals. most discrimination against the disabled occurs without animosity. it is based on assumptions about work and the people who have worked before; it is based on decisions about disability, not about individual disabled people. unlike many prejudices, those against blacks or homosexuals, for example, the prejudice against the disabled does not stem from hatred or fear as much as it does from embarrassment or discomfort. few people hate the disabled the way a racist hates blacks or a sexist hates women. most people don't even think about the disabled at all unless they are nearby, and then they feel uncomfortable-for a variety of reasons. lew hankins, the late director of united cerebral palsy, spent most of his life in a wheelchair and once commented how often he had people tell him how "amazing" he was. he noted that a disability is not something you sign up for to prove how "brave" you are. rather, it's a fact of life, and you try to give it as little importance as possible. a recent article on perceptions of the handicapped in the media pointed out that if disabled persons are not portrayed as helpless, they are seen as having super-human compensatory powers. neither of these are accurate, nor are they fair. the disabled aren't "cripples" and they're not as a rule completely helpless, but they aren't necessarily noble either. they don't need constant compliments about how well they're "adjusting." while it is inspiring to see movies about onelegged men who walk across the country, it doesn't do most of the disabled any good to be compared to that kind of standard. according to the department of education, as of july 1988, there were more than 55,000 disabled students who graduated from college last year. twenty percent of these individuals graduated with business degrees, fifteen percent with computer degrees, and the rest with degrees in education, arts, languages, and science [29] besides increased education, increased activism by the disabled was stated as a reason for more individuals with disabilities actively participating in the labor force. because of increased education and activism, there are more handicapped applicants looking for corporate job. [3] in a study conducted by the personnel magazine, 95 percent of 300 responding human resources directors felt that the quality of work is the number one concern when hiring a physically or mentally handicapped individual. [9] another survey found employers' concerns to be fear of rejection by co-workers, how the public will perceive the employer, how it will affect business, employee turnover, increased operating costs, cost of plant and equipment adoptions, training and safety accommodations, and cost of insurance. [4] the united states chamber of commerce and national association of manufacturers found that 90 percent of the companies learned that hiring the handicapped had no effect on insurance costs [16]. under current legislation, benefit packages must be equal for both handicapped and non-handicapped workers. the cost is determined individually be each insurance carrier. peters found that 100 journal of business strategies vol. 7, no.2 handicapped workers have higher attendance and lower turnover rates than nonhandicapped workers, perhaps because the handicapped employee values her job more. in addition, handicapped workers weredescribed as hardworking, safe, and dependable. also, handicapped workers were found to have a longer tenure than the non-handicapped. [23] the ada will force a tremendous change in the way american small business looks at the physically handicapped. viewpoint may be one of the key issues affecting how well a company can adjust to the ada. companies that resist the intent of the law or wish to make only minimal commitment will encounter the same difficulties that companies have had with eeo / aa and osha legislation. companies that take a more positive perspective will be more able to find and employ the physically. fortunately, there are several agencies that can provide help for a small business seeking to employ the handicapped and several incentives to do so. aids to hiring the handicapped financial incentives the federal government provides a nwnber of economic incentives for companies to hire the handicapped. in addition to purely humanistic concerns, the government benefits economically when the handicapped are hired since it reduces worker compensation and other government programs. section 190 of the tax reform act of 1986 allows companies to receive an annual tax credit up to $35,000 for site improvements that make their organizations more accessible to individuals with disabilities. the targeted jobs tax credit program, created by the internal revenue act of 1978 and the work incentive program, applies to newly disabled workers who qualify as a targeted class. in the first year a company can claim 50 percent of the first $6,000 paid in wages as a tax credit. twenty-five percent of the $6,000 paid in the second year is deductible. the credit is limited to 90 percent of the company's tax liability. there is no limit to the number of employees that can be covered under this grant. if an employee moves from one company to another, the new employer is also entitled to this credit. the purpose of this tax credit is to help compensate for lost productivity during the emplyee's training period hire (help through industry retraining and employment) will also pay for the cost of training handicapped workers. this program will reimburse half of the new worker's beginning hourly wage for up to six months. program and support services there, are a number of additional programs and support services designed to help the handicapped individual enter and become estabished in the workforce. with technological aids and training, handicapped employees can be as productive as the non-handicapped. fall 1990 marlow&marlow: physically handicapped 101 the job accomodation network uan) is an agency that makes available to businesses a database of ways to accomodate handicapped workers. "it is a free computer database that provides employers with practical solutions of adapting jobs for disabled applicants and employees." [5, p.10j it includes information aoour job modifications, technological devices,and various work place adoptions. jan has set up a toll free number (1-800-jan-pceh) for easy access. this agency was started may, 1984 by the president's committee on employment of the handicapped. this service is provided to any business, regardless of size, willing to share its information about the accommodation of the handicapped. the advantage of this database is that companies can have easy access to solutions to situations rather than allowing them to dismiss problems as being too costly or complex. every company does not have to reinvent the wheel; this is an obvious advantage for small businesses. a survey conducted by jan found that 99.6 percent of the companies surveyed said thay would use jan again. however, slightly over half of the companies were willing to provide follow-up information. overwhelmingly, companies reported that they received their information promptly and that they had no trouble contacting jan [22]. jan receives over 150 calls a day with the vast majority of them coming from private companies and federal agencies. its success rate is 73 percent and in 70 percent of the cases the expense of modification required was less than $100 [1] employee support services there are a number of employee support services available for the handicapped worker. these services are set up by rehabilitation agencies and businesses. in order for these services to be successful, all people in the company, especially top management, must be involved in them. while there are many types of support services, probably the most important one is the preparation of handicapped workers for the work place. these programs are developed around areas such as vocational training, work adjustment, job modification, or job placement services [10j a study conducted by young, rosati and vandergoot [30] found that respondents perceived the rehabilitation services as a source for job applicants. businesses contacted these services frequently to fill job openings in their organizations. according to stace [21] the group that would benefit most from vocational rehabilitation is young women with disabilities seeking to enter the work force. this protected class is less likely to have work experience or education qualifications. this group has the double disadvantage of being female and being handicapped. microcomputer education for the employment of the disabled or meed is a project set up by miami university (florida) that trains the handicapped on microcomputers and teaches specific knowledge needed to become a manager. this year-long program teaches microcomputer packages such as dbase in, lotus i, 2, 3 and microsoft's word. according to the chairman of meed's business advi102 journal of business strategies vol. 7, no.2 sor council, the businesses who employ meed graduates are 11 able to get highly qualified, strongly motivated employees-----at the same time reducing training costs." [6, p. 78]. the students in this program receive software portfolios donated by ashton-tate and microsoft. also donated are free speech input devices which allow quadraplegics to give commands to the computer by voice. the "phoenix corporation" is a project funded by thirty different companies, one being ibm. these companies donate computer time, training materials, and any needed equipment, such as terminals. the project has locations in both stanford, connecticut and white plains, new york. it is a year-long program which provides on-the-job computer programming education and other related information processing skills. the program combines classroom lectures with work such as writing reports and programs and serving on various committees [11]. the use of flex-time, job sharing, or part-time hours can be inexpensive ways to handle the question of "reasonable accommodation." according to a recent study, 45 percent of 447 daily newspapers in the country had recently or were in the process of altering their newspaper plants. this involved either access into various rooms or installing elevators. the cost ranged from $200 to $15,000 [18]. there are various technological aids available that help the handicapped increase their job opportunities; however, some of the aids can be expensive. conclusions congress is poised to pass another major civil rights act; this one aimed at 43 million americans-the disabled. the americans with disabilities act will have a major impact on the employment practices of american business. viewed correctly this legislation can help businesses solve one of their major problems of the 1990s. with the decreasing labor pool of applicants, companies can increase their recruitment pool by including the handicapped-a source which is increasing in size. several major corporations, ibm, dupont, union carbide, have done this successfully and there is no reason that small businesses couldn't be just as successful. a major reason for the success of these companies is the commitment by the company's top management to the accommodation of the handicapped worker. managers have been encouraged to study the job design and work environment and look for changes that will benefit these workers. successful accommodation experiences are shared within the firm as well as with other companies. training is provided to help company personnel change their beliefs about the capabilities of the handicapped-conunon myths are examined and tested. the way has been paved for increased utilization of a productive segment of the labor force. fall19ro marlow&marlow: physicallyhandicapped references 103 1. jj ada update." worklife. (fall, 1989), pp. 21-25. 2. allard, h. s. and jaboe, g. "removing barriers in the electronic workplace." personnel administrator (february, 1986), pp. 65-75. 3. bauer, d. and j. green. "the disabled battle job prospects." mana~ement review (april, 1988), pp. 59-61. 4. berlinski, p. "a hidden resource." restaurant business (july i, 1987), p. 16. 5. bragman, r. 5., and j. couch sole. "free services help employer accommodate disabled workers." training and development tournai (october, 1984), p. 10. 6. brown, a. "tapping an untapped resource." personnel administration (august, 1982), pp. 65-75. 7. carrell, m. r. and w. t. heavin jr. "the 'hand-capable' employee: an untapped resource." personnel (august, 1987), pp. 40-45. 8. combs, 1. h. and c. p. omvig. "accommodations of disabled people into employment: perceptions of employers." journal of rehabilitation (april/may/june 1986), pp.37-41. 9. feldman, d. "employing physically and mentally impaled employees." personnel (january, 1988), pp. 14-15. 10. galvin, d. e. and r. t. roessler. "employee support services: a sound investment." personnel (july, 1986), pp. 54-58. 11. "helping the disabled join the business world." the office (may, 1986), p. 52. 12. jarvis, s. s. "for employers of handicapped workers" obligations and ideas." personnel (july, 1985), p. 42. 13. kraus, 1. e. jldisability and work" worldlife, vol. 2, no.3 (fall, 1989), pp. 37-39. 14. larson, d. a. "what disabilities are protected under the rehabilitation act of 1973?" labor law journal (november, 1986), pp. 752-766. 15. mcclure, f. g. and r. k. robinson. "aids and the law." personnel administrator (april, 1988), pp. 118-121. 16. "ordinary people." american demographics (1987), p. 17. 104 journal of business strategies vol. 7, no.2 17. peters, j. "alternative labor pool" restaurant business (september i, 1987), pp. 183187. 18. popovich, m. and s. c. willis. "study: newspapers want to hire more handicapped workers." editor and publisher (may 3, 1986), p. 60. 19. "report of the disability advisory council: executive summary." social security bulletin. vol. 51 (1988), pp. 13-17. 20. schapire, j. and f. berger. "responsibilites and benefits in hiring the handicapped." the cornell hr.a. quarterly (february, 1984), pp. 59-67. 21. solomoi\ j. "firms address workers' cultural variety." wall street journal (february 10, 1989), p. b-1. 22. stace, s. "vocational rehabilitation for women with disabilities." international labor review, vol. 126 (1987), pp. 301-314. 23. stackel,l. "accommodating the disabled in the work place." employment relation today (summer, 1986), pp. 177-181. 24. strom, 1. j. and g. r. ferris. "issues in hiring the handicapped: a positive outlook." personnel administrator (august, 1982), pp. 75-81. 25. u. s. coinmissions on civil rights: civil rights issues of handicapped americans: public policy implications. washington, d.c. (1980). 26. wagel, s. h. "project ace: new opportunities for people with disabilities." personnel aanuary, 1988), pp. 9-13. 27. williams, j. m. "talking computers help blind programmers." aba banking journal aune, 1983), pp. 92-3. 28. williams, j. m. "tst's jim bliss on computers and disabled workers." personnel administrator (august, 1986), pp. 61-62. 29. williams, j. m. "technology and the disabled." personnel administrator auly, 1988), pp.81-83. 30. young, j., rosati. r., and d. vandergoot. "initiating a marketing strategy by assessing employer needs for rehabilitation services." journal of rehabilitation (april/may/ june, 1986), pp. 37-41. . employment of the physically handicapped and the ada strategic guidelines for responding to consumer boycotts dennis e. garrett college of business administration university of oklahoma norman, oklahoma introduction although consumer boycotts have been used as a protest vehicle for centuries [18], the past decade has proven to be an era of exceptional boycott activity. the frequency of boycott usage has increased in recent years [11], and boycotts are now being used by protest groups from both ends of the political spectrum [13]. for example, liberals have recently used boycotts to protest the inclusion of meat products on restaurants' menus, the purchasing of coffee beans from allegedly repressive foreign governments, the marketing of war toys, and the manufacture of nuclear weapons components. to advance their causes,. conservatives have employed boycotts recently to protest the allegedly pro-abortion content of magazines, the sexual and violent pro.., gramming on television, the staging of a play satirizing catholicism, and the sale of adult magazines in convenience stores. what many business managers fail to realize is that almost any business can be the target of a boycott. the following well-known companies have all been the targets of boycotts during the 1980's: american broadcasting company, anheuser-busch, burger king, chicago sun-times newspaper, coca-cola, coors brewing, dow chemical, folger's coffee, general electric, general foods, hasbro industries, macmillan publishing, marriott hotels, mcdonalds, mellon bank, national brqadcasting company, nestle, scott paper, smithkline beckman pharmaceuticals, southland corporation, and union carbide. in addition, consumer boycotts have also been directed at many smaller businesses that operate on a local or regional basis. literature review consumer boycotts have received attention in a variety of academic disciplines, including sociology ([4], [14], [17], [23], [24]), consumer affairs ([8], [10], [20]), psychology [19], and economics ([5]' [26]). the bulk ofthis research has focused on explaining why consumers choose to support a boycott. these scholars have hypothesized that a consumer's decision to support a boycott is dependent on factors such as the consumer's general attitude toward social journal of busineu strategies, volume 4, number 2 (fall 1987) 48 protest actions, the consumer's attitude toward the specific issue involved in the boycott, the cost to the consumer to participate in the boycott, the social pressure placed upon the consumer to participate, and the consumer's perception of the credibility of the boycott's leaders. more recently, some research has considered the strategic actions employed by boycotting groups to maximize the effectiveness of their boycotts [12]. also, some attention has been directed at the recent nestles boycott in which a coalition of groups protested the company's marketing of infant formula in third world countries [25]. one critical area that previous research has generally neglected is the strategic actions that the targets of boycotts should utilize to protect their interests. the previous research, with its emphasis on the boycotting groups' perspective, has failed to evaluate the position of the targets of boycotts. the only exception is a recent article in which a nestle official described his company's handling of the baby formula dispute [21]. no prior research has sought to interview a broad range of corporate managers who have experienced the effects of boycotts directed at their organizations. as a result, little is known about how corporate managers have attempted to respond when their organizations have been the targets of boycotts. this paucity of research is unfortunate because much has been written lately about the need for corporate executives to manage effectively their relevant environments ([16], [30]). a consumer boycott is clearly an environmental force that deserves attention. corporate managers who fail to respond in an appropriate manner to consumer boycotts may jeopardize the viability of their organization's disputed business practices and thereby adversely affect organizational productivity. purpose because boycotts are being increasingly used for a variety of liberal and conservative causes against a broad range of national and local businesses, business managers must be prepared to respond if they are suddenly confronted with a consumer boycott. the purpose of this article is to suggest strategic guidelines that business managers could utilize to respond effectively and efficiently when their organization becomes the target of a consumer boycott. conceptual framework although the specific subject of managerial strategies for responding to consumer boycotts has not been extensively studied, the broad subject of how business managers should respond to environmental trauma has been studied from three related perspectives-the consumerism perspective, the consumer information processing perspective, and the crisis management perspective. the consumerism perspective has considered what stance managers should adopt when consumers, whether acting individually or as organized pressure 49 groups, complain about or seek to influence the operations of a business. recent research in the consumerism area has suggested that conflict is often exacerbated by the differing perceptions held by managers and consumers ([9l [27]), effective communications is crucial to the resolution of consumer complaining [28], and managers may adopt either a proactive or reactive posture in response to consumerism pressure [2]. the consumer information processing perspective has attempted to utilize information processing theory [1] to evaluate the optimal strategies to modify con~umer beliefs about an organization. for example, tybout, calder, and sternthal [29] recently demonstrated in a laboratory experiment that false rumors regarding a business' marketing policies can be mitigated using information retrieval and storage strategies. finally, the crisis management perspective has concentrated on the importance of organizational planning and managerial responsiveness to crises or disasters. particular emphasis has been placed recently on the need for all organizations to develop strategic response plans for a variety of disaster scenarios [7] and the importance of managing "aftershocks" that occur following the initial crisis [22]. in summary, these three perspectives suggest that businesses' ability to manage environmental trauma is influenced by factors such as perceptions of the adversaries, communications between the adversaries, information processing by consumers, and managerial preparedness for crises. these three perspectives offer a framework for studying boycotts that is particularly helpful for the development of questions used in the data collection interviews in this study. methodology to identify consumer boycotts to include in this study, sixteen newspaper and periodical indices were reviewed for their entries under "boycotts." a boycott was selected if it met all of the following criteria: 1. the boycott was active during the period of january 1, 1981 to december 31, 1984. boycotts prior to 1981 were not included because pretest interviews indicated that respondents encountered recall problems due to the elapsed time. 2. the boycott focused on consumer issues regarding product quality, pricing, promotion policies, distribution arrangements, etc. boycotts associated with labor strikes were not included because of the problems involved with separating the effects of the boycott and the strike. 3. the boycott was based primarily in the united states or canada. language problems and data collection costs prevented consideration of boycotts based in other countries. 50 this review yielded 38 reported consumer boycotts which met these selection criteria. of this set, five boycotts were removed because efforts to identify the current location of the boycotting group were unsuccessful. also, three more boycotts w.ere dropped because the target managers and boycott leaders indicated that the news media had incorrectly reported the occurrence of a boycott. thus, 30 identifiable and confirmed boycotts were included in the final set. using the factors suggested by the consumerism, consumer information processing, and crisis management perspectives in the conceptual framework, a series of open-ended questions was constructed. these questions were pretested on a set of three labor relations boycotts to ensure content validity. the following questions were included in the final interviewing guide for boycott targets: 1. what were the protesting group's complaints against your organization? 2. what was your attitude toward these complaints? 3. did you make any of the changes sought by the protesting group? 4. did the boycott create any problems for your organization? 5. what did the protesting group do to promote the boycott? 6. how did your organization respond to the boycott? 7. what advice would you give to other organizations that become the targets of boycotts? probing questions were used to encourage respondents to provide greater detail in their answers to the seven basic questions listed above. the wording of the questions was modified accordingly for the interviews with the boycott leaders. efforts were made to conduct telephone interviews with respondents from both the targets of the boycotts and the organizations promoting the boycotts. this is the first research study in the boycott area to obtain information from both parties involved in boycotts. in all interviews, preliminary questions were asked to identify and locate the person in each organization most qualified to answer questions regarding the boycott. the telephone interviews lasted on average approximately 25 minutes. to encourage respondent cooperation and candor, the respondents were guaranteed anonymity. the interview completion rate was 77% for boycott targets (23 of 30) and 80% for boycott leaders (24 of 30). the most common reason given for noncooperation was the lack of time to complete the interview. given the highly sensitive nature of most boycott situations, this completion rate was encouragmg. 51 analysis the recent methodological literature regarding business research suggests that qualitative analysis should be employed in the early stages of conceptual development ([3]' [6]' [15]). because this is the first broad-based study to consider the strategies that companies should employ as targets of boycotts, a qualitative analysis was considered the most appropriate approach. the strategic guidelines outlined in figure 1 and discussed in the remainder of this paper evolve from the qualitative analysis and are illustrated with supporting comments from the interview respondents. figure 1 strategic guidelines 1. corporate managers must realize that any organization could be the target of a consumer boycott. 2. corporate managers should listen attentively to dissatisfied groups in their environment. 3. corporate managers should adopt a responsive, non-defensive posture for legitimate complaints raised by dissatisfied groups. 4. corporate managers should be prepared to utilize the news media as a strategic weapon. 5. corporate managers should be prepared to rally support among their constituents. strategic guidelines as summarized in figure 1, five prominent themes emerged in the interviews that are of direct strategic importance to corporate managers who might be confronted with a consumer boycott: 1. corporate managers must realize that any organization could be the target of a consumer boycott. many target respondents in this study remarked on the need for all businesses to be aware that they could face a crisis situation if they become the target of a boycott. they advocated that all organizations should adopt contingency response plans even though a consumer boycott may not appear to be imminent. based on their often harsh experiences, they realized that it is much more difficult to react effectively to a boycott if prior strategic planning has not been prepared: any business should not be surprised if this happens to them. first you ask, 'why us?' and sometimes it defies logic to understand. but you have to be prepared for something like this. we now have a crisis communications plan in place. we hired a consulting firm.... we now know better how to respond to the 52 media in a crisis. before it was just by the seat of oui pants.... every organization should be prepared with crisis planning (for boycotts). if you are hit by a boycott and you have to turn to someone else for advice, you are in bad shape. you should monitor the environment and be prepared for this .... we were not surprised. we had contingency plans already prepared. 2. corporate managers should listen attentively to dissatisfied groups in their environment. every business will at some time institute policies that offend certain groups. if a group of concerned citizens finds that a business practice is offensive to them, they will usually first try to contact the business and express their dissatisfaction. the boycott leaders interviewed for this study often indicated that the only reason they resorted to using a boycott was because the managers of the target companies refused to listen and respond in a timely manner to their complaints: (a boycott) was oui only option. we had tried everything else. we had written to (the company)l but they wouldn't listen.... we decided enough is enough. it is not our policy to boycott. we would rather deal with them from a different way. we would rather negotiate and reach a reasonable solution.... there was some trouble with communication. they were not listening as well as they should have (to our complaints). this pivotal role of communication was also recognized by many boycott target managers. they stressed the importance of listening to complaints registered by groups in the environment. also, beyond this recognition of dissatisfaction, the managers suggested that companies should be willing to explain their positions on these controversial issues so that the disagreement with the concerned group can be resolved or at least minimized: you have to find out, 'what is their beef?' then you have to try to deal with it and clean up any miscommunication. see what their problem is before you act. you can defuse a problem by getting information out. be sure there is an understanding of views and positions. . .. communication is good as long as there is a sincerity of interest .... there is some risk in communication, but (oui company) has maintained an open disclosure policy. 3. corporate managers should adopt a responsive, non-defensive posture for legitimate complaints raised by dissatisfied groups. both 53 business managers and boycott leaders stated that boycotts can become battles of egos if corporate leaders respond defensively to complaints. for example, one boycott leader described the intense feelings of corporate management in her dispute: the chairman (of the company) said, when i was testifying at a hearing (regarding the dispute), 'that is one of the most (expletive deleted) economic statements i ever heard!' he was ready to attack me physically. he had his finger at my nose. the emotional stress created by boycotts was also acknowledged by some corporate managers: don't take (the boycott) personally. boycotts create a great deal of stress but you cannot afford to take it personally. when the complaints raised by the concerned group are legitimate, corporate managers should clearly explain how and when they plan to modify these improper practices. the stubborn refusal to alter obviously incorrect corporate policies only invites the imposition of a consumer boycott which may cost the company dearly in the long lun, as these managers explained: be realistic .... realize what it may ultimately cost you and then ask yourself if you are willing to pay this price (to defend your policies). make sure the company is committed to the business practice that is under attack. if this is a questionable business practice, it is harder to defend against these attacks. you should never ignore the wishes of your customers. meet with them to hear their views and to explain your position. if you are wrong, you should beat a hasty retreat. 4. corporate managers should be prepared to utilize the news media as a strategic weapon. in many situations the company will conclude that the protesting group's complaints are not legitimate and no reasonable compromise is attainable. in these cases the company must pursue defensive strategies that allow the maintenance of these disputed practices while the costs to the company of the consumer boycott are minimized. when these situations arise, corporate managers who are experienced boycott veterans stressed the importance of conveying the company's position in the media. they stressed that, if the company's views are not transmitted in the media, the boycott organizers will dominate the information the public receives iii the dispute and thereby encourage more consumers to join the boycott: 54 in the beginning we were quite passive. but after the (boycott) group issued blatant misrepresentations, we became more aggressive in our response. now, more newspaper editors and consumers are more acceptant of our position. we had a contingency plan. we knew what our response would be. . .. we knew which reporters in new york and washington would cover this dispute.... after (the boycott leaders') news conference announcing the boycott, we called up those reporters and offered our views. try to be more evident about what you are doing to help the problem (that is the subject of the boycott). we never before bragged about or issued press releases about what we did in these areas. but now we do. 5. corporate managers should be prepared to rally support among their constituents. consumer boycotts can generate broad repercussions for the target company. the corporate managers emphasized the importance of sharing information and coordinating boycott strategy with associated business units, such as distributors, retailers, franchisees, suppliers, and advertisers. if the boycott target refuses to share information with its business partners, rumors and misinformation will flourish and compound the target's problems: lobby quietly among your members to try to maintain unity .... quickly respond in a positive way before the psychological pressure of the boycott has a domino effect. the best thing you can do is to avoid the impulse to not share information with your constituency. some people here felt we should be selective in disseminating information to our constituency. but i argued that we should present our view. you need to mobilize your facts to deal with the inaccuracies put out by the other side.... you need to pass along these facts to your local people. discussion the strategic suggestions offered by the experienced managers were in many respects highly similar to factors suggested by scholars writing in the consumerism, information processing, and crisis management literatures. for example, the managers in this study highlighted the critical importance of organizational preparedness (crisis management perspective), the pivotal role played by effective communication (information processing perspective), and the impact of differing perceptions of reality (consumerism perspective). however, these managers also brought out other variables that generally have been overlooked in the existing literature. for instance, they placed 55 special emphasis on the role of communication with and through the news media, instead of communication just with the immediate group of protesters. also, they stressed the need to coordinate strategy with constituents, such as channel members, advertisers, and banking institutions. because the managerial perspective on boycotts has received little attention, additional research is still required. based on the results of this study, potential future research topics could include: 1. how do constituents respond when they discover that an organization is the target of a boycott? how can a target organization maximize constituent support and minimize constituent costs during the boycott? 2. what are the most effective tactics for dealing with the news media and maximizing favorable press coverage? 3. instead of merely listening to complaints raised by dissatisfied groups in the environment, what can organizations do to review and modify business practices before they instigate dissatisfaction? is the use of consumer advisory panels a sufficient solution? conclusion consumer boycotts are environmental forces that cannot be ignored by prudent corporate managers. as stated by the respondents in this study, the failure to develop strategic guidelines for responding to consumer boycotts may cause corporate managers to utilize ineffective and inefficient actions that only exacerbate their problems when they actually face a boycott. however, if a well-conceived strategic response plan is implemented, a potential boycott target may be able to minimize dissatisfaction from consumer groups and, in turn, maximize corporate productivity. references 1. bettman, james r. an information processing theory of consumer choice. reading, ma: addison-wesley, 1979. 2. bloom, paul n. and greyser, stephen a. "the maturing of consumerism." harvard business review, november-december 1981, pp. 130139. 3. bonoma, thomas v. "case research in marketing: opportunities, problems, and a process." journal of marketing research, vol. 22, may 1985, pp. 199-208. 4. clark, kenneth b. dark ghetto: dilemmas of social power. new york, ny: harper & row, publishers, 1965. 56 5. decrespigny, a.r.c. and mckinnell, r.t. "the nature and significance of economic boycott." the south african journal of economics, vol. 28, no. 4, december 1960, pp. 319-336. 6. deshpande, rohit. "paradigms lost: on theory and method in research in marketing." journal of marketing, vol. 47, fall 1983, pp. 101-110. 7. dilenscheider, r.l. and hyde, richard c. "crisis in communic,ations: planning for the unplanned." business horizons, january-february 1985, pp. 35-38. 8. forbes, james d. "organizational and political dimensions of consumer pressure groups." journal of consumer policy, vol. 8, june 1985, pp. 105-131. 9. fornell , claes and westbrook, robert a. "the vicious circle of consumer complaints." journal of marketing, vol. 48, summer 1984, pp. 68-78. 10. friedman, monroe. "the 1966 consumer protest as seen by its leaders." the journal of consumer affairs, summer 1971, pp. 1-23. 11. "consumer boycotts." proceedings of the american council on consumer interests, 1982, pp. 96-97. 12. . "consumer boycotts in the united states, 1970-1980: contemporary events in historical perspective." the journal of consumer affairs, vol. 19, summer 1985, pp. 96-117. 13. garrett, dennis e. "consumer boycotts: are targets always the bad guys?" business and society review, vol. 58, summer 1986, pp. 17-21. 14. hines, ralph h. and pierce, james e. "negro leadership after the social crisis: an analysis of leadership changes in montgomery, alabama." phylon, vol. 24, no. 2, summer 1965, pp. 162-172. 15. hirschman, elizabeth c. "humanistic inquiry in marketing research: philosophy, method, and criteria." journal of marketing research, vol. 23, august 1986, pp. 237-249. 16. hutt, michael d., michael p. mokwa, and stanley j. shapiro. "the politics of marketing: analyzing the parallel political marketplace." journal of marketing, vol. 50, january 1986, pp. 40-51. 17. jackson, j acquelyne j. "two black boycotts: a contrast of success and failure." afro-american studies, vol. 2, september 1971, pp. 87-94. 18. laidler, harry w. boycotts and the labor struggle. new york, ny: russell & russell, 1913. 57 19. mahoney, john. "the relation of anticipated effectiveness, alienation, and value structure to planned participation in a national meat boycott." psychology, vol. 13, may 1976, pp. 39-47. 20. miller, kenneth e. and sturdivant, frederick d. "consumer responses to socially questionable corporate behavior: an empirical test." journal of consumer research, vol. 4, june 1977, pp. 1-7. 21. pagan, rafael d., jr. "the nestle boycott: implications for strategic business planning." the journal of business strategy, spring 1986, pp. 12-18. 22. phelps, norman l. "setting up a crisis recovery plan." the journal of business strategy, spring 1986, pp. 5-10. 23. petrof, john v. "the effect of student boycotts upon the purchasing habits of negro families in atlanta, georgia." phylon, vol. 24, no. 3, fall 1963, pp. 266-270. 24. phillips, w.m., jr. "the boycott: a negro community in conflict." phylon, vol. 22, no. 1, spring 1961, pp. 24-30. 25. post, james e. "assessing the nestle boycott: corporate accountability and human rights." california management review, vol. 27, winter 1985, pp. 113-131. 26. rea, samuel a., jr. "the economics of a consumer boycott." journal of economics and business, vol. 27, no. 1, fall 1974, pp. 89-92. 27. resnik, alan j. and harmon, robert r. "consumer complaints and managerial response: a holistic response." journal of marketing, vol. 47, winter 1983, pp. 86-97. 28. richins, marsha l. "negative word-of-mouth by dissatisfied consumers: a pilot study." journal of marketing, vol. 47, winter 1983, pp. 68-78. 29. tybout, alice m., bobby j. calder, and brian sternthal. "using information processing theory to design marketing strategies." journal of marketing research, vol. 18, february 1981, pp. 73-79. 30. zeithaml, carl p. and zeithaml, valarie a. "environmental management: revising the marketing perspective." journal of marketing, vol. 48, spring 1984, pp. 46-53. 58 strategic guidelines for responding to consumer boycotts volume 36, number 2 49 musky tweets: information transfer in the age of unbridled social media xiaoman duan sam houston state university • huntsville, texas robert stretcher sam houston state university • huntsville, texas introduction announcements concerning public corporations have traditionally been carefully crafted statements in pre-announced venues where the opportunity for wide absorption of the information is quickly achieved. this is because problems can arise from spilling critical information in ways that favor few investors or send erroneous signals to those paying attention. in recent years, however, a greater number of social media posts have occurred from politicians, celebrities (either existing ones or those quickly created by viral postings) and even from top managers in corporations, with or without prior consultation with the company’s directors. one of the most notorious posting ceos, elon musk, has posted many eccentric statements about his own views and statements of seeming authority about the company he still runs as ceo (no longer chairman of the board after some lawsuits), tesla corporation. in some cases, the information relayed in his “tweets” has been provocative and surprising to financial market participants. in one case, a tweet implied that the firm would be taken private, and that funding for the action had been secured. this created a tremendous reaction in the firm’s stock price, both positive after the tweet and negative after the validity of musk’s statement was challenged. whether it was meant to be manipulative or was just an inadvisable public rant on twitter, the posts attracted the attention of the securities exchange commission and other regulatory agencies, and placed musk under legal and regulatory scrutiny. this case provides a brief history of elon musk’s recent (as of november 2018) publicly acclaimed behavior as a basis for classroom discussion. it is appropriate for use in finance, economics, and even business communication courses. we anticipate that a 30-45 minute discussion is in order after a preparatory reading of the case. it is easily supplemented with additional materials either provided by the instructor or gathered by students. 50 journal of business strategies the age of sharing on a whim in the decade from 2009 until the present, social media has grown in scale and public reach. with that growth, the brashness and audacity, even vulgarity of the comments and reactions to those comments seem to escalate. often, posts or reactions to posts on social media take the other extreme, overly-sensitive rants equally radical in their wording. perhaps it shouldn’t be so surprising that individuals of prominent stature such as leaders of countries or chief executive officers of large corporations would take to social media and post extreme statements, or that others, as self-appointed “fact checkers” or “righteous social conscience,” would rebut those statements. in fact, twitter strategies have even been suggested for executives wishing to use the platform to bring about predictable public response that is likely to positively affect a corporate objective (malhotra and malhotra 2016). a fine line is crossed, however, when readers of a tweet from a company’s executive officer interpret a statement meant to be informal and humorous as a valid signal concerning the policies or decisions actually made at the company. if this is the case, then regulators have shown that they consider the communication to be exposed to the same scrutiny as official and perhaps carefully crafted statements made by the firm’s management via traditional communication channels. elon musk tweets a series of tweets from elon musk underscore the importance of this realtime communication medium. it was obvious early in musk’s tweeting career that the financial markets carefully observed his tweets, trying to glean information that could positively affect positions in tesla stock, or derivatives based on tesla stock. many of his tweets are written with ambiguity, and have numerous variations in interpretation, as evidenced by the flurry of retweets and responses that surface after musk’s initial tweets. timeline of elon musk’s twitter activities in this section, we document the major twitter events created by elon musk in a chronological order. when introducing each event, we incorporate detailed background to provide more depth into the events, and we also discuss the financial market implications on his twitter posts. volume 36, number 2 51 june 4, 2010 musk posted his first tweet and since then, he has composed more than 7100 tweets over the 9-years interval, making him one of the most active chief executive officers (ceos) on social media from a major us public companies. he has also built a huge fan base of 25.5 million twitter followers.1 his direct, unpredictable and often quite frank communication style via social media often surprises investors, shakes the market and attracted controversy to himself and his companies. more often than not, we observe that his tweets have the ability to move the financial market. march 30, 2015 on march 30, 2015, musk made a surprising announcement on twitter that a “new and major product line” that is “not a car” will be released by tesla in a month. although he did not reveal any product details, the stock market reacted strongly to his announcement. tesla’s stock price jumped more than 3 percent in 10 minutes following his twitter post, adding $900 million to tesla’s market value.2 largely consistent with the market speculations, it turned out tesla was unveiling a home battery and a utility scale battery. 3 major new tesla product line -not a car -will be unveiled at our hawthorne design studio on thurs 8pm, april 30 elon musk @elonmusk 1 the statistics are gathered from elon musk’s twitter site at: https://twitter.com/elonmusk 2 news and data source is from forbes and pando: https://www.forbes.com/sites/briansolomon/2015/03/30/elon-musk-bootstesla-stock-with-major-new-product-tweet-tease/#304b0d293f9a; https://pando.com/2015/03/30/elon-musk-created-nearly1b-in-value-today-with-a-single-tweet/ 3 here is one example on the market speculations: https://www.businessinsider.com/this-is-going-to-be-teslas-new-productline-2015-3; the product information can be found here: https://www.wsj.com/articles/tesla-to-announce-grid-scalebattery-pack-home-battery-april-30-1429659606 9:35 am mar 30, 20151.1k people are talking about this5.6k 52 journal of business strategies april 1, 2018 april 1 is a traditional day for pranks and musk seemed to be in a good mood to participate in such activities. musk posted on twitter a series of april fool’s day jokes centered on the electric car maker’s bankruptcy. in his first twitter post, musk made a statement that tesla had gone “completely and totally bankrupt.” he followed up with additional posting, including him passed out drunk against a side of a model 3 car and held a cardboard sign that reads “bankwupt!” in theory, a joke cannot carry any real material information on the company and therefore should not affect tesla’s stock price. however, it turned out to be an inopportune time for musk to publicly post jokes about his company’s demise. there were already quite a few tensions in the market in regard to tesla’s performance around the time, and investors did not handle his jokes lightly. we discuss the series of negative events that the company went through in the preceding month in the following paragraphs. to start, the company was stranded in a “production hell” of its first massmarketed car, the model 3. not enough cars were being produced on time to meet the demand from consumers.4 there were also growing concerns that the company was running out of cash. a week before his twitter posts, moody’s investor service, one of the big three credit rating agencies in the u.s., cut tesla’s corporate debt rating from b3 to b2. the purpose of the credit ratings is to provide assessment of a company’s ability to repay their debt. a downgrade is bad news because it broadcasts to the market the credit rating agency’s belief that the company has a higher risk of defaulting on its debt. according to moody’s, the downgrade reflected a “significant short fall” in the production of the company’s model 3 electric car, and a tight liquidity position in which the company would have to raise a large amount of capital to meet its liquidity needs and pay off its maturing debts.5 in addition, on march 29th, tesla issued a recall of 123,000 model s electric cars around the world because of the defect with the power steering component. the recall was the largest recall ever for tesla, and the massive number of recalled car represented almost half of all the cars that the company had built as of that date.6 to add to the company’s problems, the u.s. national transportation safety board (ntsb) was conducting an investigation into a fatal tesla model x accident 4 the news is from the following source: https://money.cnn.com/2018/03/28/news/companies/tesla-model-3-cash-crunch/ index.html 5 https://www.moodys.com/research/moodys-downgrades-teslas-corporate-family-rating-to-b3-senior-notes--pr_381481 6 https://www.nbcnews.com/business/autos/tesla-recalls-almost-half-cars-it-ever-built-shares-tank-n861421 volume 36, number 2 53 in mountain view, california in march. tesla admitted that autopilot driving system was involved in the fatal crash. against this backdrop, tesla was already having the worst monthly performance in years and musk’s april fool’s day joke sent tesla shares plunging further. on the day musk posted his bankruptcy joke, tesla’s stock price was down over 7 percent, indicating investors’ high level of anxiety about the company’s prospects.7 tesla goes bankrupt palo alto, california, april 1, 2018 -despite intense efforts to raise money, including a lastditch mass sale of easter eggs, we are sad to report that tesla has gone completely and totally bankrupt. so bankrupt, you can’t believe it. elon musk @elonmusk aug 7, 2018 musk dropped a bombshell into the internet community and to the financial markets when he announced his intention to take tesla private on twitter. his first tweet at 10:48 am (pst) states that he is “considering taking tesla private at $420” per share price. he further states that the funding needed for this massive buyout is “secured”, although he did not provide further information on the source of the funding. amid some questions from tesla’s investors, musk added another tweet at 11:00 am (pst) saying that he “hopes all the current investors remain with tesla” even after the company transformed to a private company. in a follow-up tweet at 11:13 am (pst), he lays out two options for the existing shareholders: “either to sell at $420 or stay with the company and go private.” at 12:36 pm (pst), he further states that the deal has confirmed “investors’ support” 7 https://www.wsj.com/articles/tesla-shares-sink-as-musk-jokes-about-bankruptcy-1522682691 8 the statistics is from wall street journal article: https://www.wsj.com/articles/elon-musks-twitter-account-am-consideringtaking-tesla-private-at-420-1533661152 4:02 pm apr 1, 201828.6k people are talking about this131k 54 journal of business strategies and the only reason that the deal is not finalized is that it is still “contingent to a shareholder’s vote.” why did his tweets on taking the company private draw lots of attention from the public? if the deal went through, the company would be valued at above $70 billion, making it the largest take-private transaction in the history of the mankind.8 tesla’s stock price was closed at a price of $343.84 on the previous trading day and according to musk, the existing shareholders can sell their shares at $420. this indicates that the electric car company is willing to offer a deal premium of 22% above its current stock price in order to attract the existing shareholders to sell their stakes. later the same day, musk explained more on his rationale for taking tesla private on the official corporate blog. he argued that taking tesla private is for “creating the environment for tesla to operate best.” 9 giving up the public status of the company means that tesla can be less distracted to the wild swings in its stock market performance, and it allows the company to pursue long-term goals instead of immediate profits. a privately held tesla also does not need to file quarterly earnings reports and there will be no more short sellers, which distort the company from its most efficient and long-term mission driving operations. musk held roughly 20% of the company and this would largely remain the same after the company became private. although he did not disclose his funding sources at the time he tweeted his intention for tesla to go private, one of the market speculations was that the oilrich saudi arabia could be the major fund provider. one the same day, the market learned that not long ago the public investment fund of saudi arabia (pif), one of the world’s largest sovereign wealth funds, had acquired close to 5% stake in tesla.10 on aug 13, musk provided an update on the whole go-private event on the official corporate blog and answered some important questions including why he made the announcement publicly and the source of the funding. he confirmed that he had been in talks with the saudi sovereign wealth fund several times over the past two years. during their most recent meeting on july 31st, the official from saudi side had “strongly expressed his support for funding a going private transaction for tesla at this time.” therefore, when musk walked out of the meeting, he had strong belief that the deal could be reached at his proposed $420 if they end up pursuing the going-private path. according to musk, the reason that he made this important piece of information public through his twitter account social media is to ensure fairness in information 9 the full statement can be found at: https://www.tesla.com/en_gb/blog/taking-tesla-private?redirect=no 10 the information is obtained from the following news source: https://www.reuters.com/article/us-tesla-musk-saudi/saudisovereign-fund-pif-has-bought-a-below-5-percent-stake-in-tesla-source-iduskbn1ks1yt volume 36, number 2 55 release to all tesla’s investors: tesla’s retail investors and big investors can obtain this important news at the same time. he thought it was the right thing to do. am considering taking tesla private at $420. funding secured. elon musk @elonmusk shareholders could either to sell at 420 or hold shares & go private elon musk @elonmusk investor support is confirmed. only reason why this is not certain is that it’s contingent on a shareholder vote. elon musk @elonmusk my hope is *all* current investors remain with tesla even if we’re private. would create special purpose fund enabling anyone to stay with tesla. already do this with fidelity’s spacex investment. elon musk @elonmusk 10:48 am aug 7, 201822.7k people are talking about this88.7k 11:00 am aug 7, 2018518 people are talking about this8.5k 11:13 am aug 7, 20181.3k people are talking about this19k 9:35 am mar 30, 20158.7k people are talking about this19k 56 journal of business strategies on aug 24, musk posted a statement on his corporate blog: “i believe the better path is for tesla to remain public.” he quoted the reasons for reaching this decision: the existing shareholders prefer to keep tesla public, and going private could present more challenges than he initially anticipated. stock price reaction musk’s tweets on taking tesla private were followed by dramatic upward movement in tesla’s stock price on the same day. by the time nasdaq halted the trading of tesla’s shares, tesla’s shares were already up by more than 7 percent. the reason for nasdaq to halt the trading in less than two hours from his first tweet was to wait for more information and further clarification to come. during the halting period, musk continued his tweets and tesla also posted a letter musk wrote to its employee on his corporate blog. after slightly more than an hour and a half after halting, tesla trading was resumed and tesla’s stock price continued to rise and was closed at $379.57, gaining about 11 percent in value.11 the trading volume had also exhibited more than three times its norm, from an average daily volume of 8.7 million shares to 29.8 million shares.12 sec prosecution the day after musk posted his taking-private tweets, the wall street journal reported that the officials at the securities exchange commission were making inquiries on his statements to check if the disclosed information was supported by facts. at that time, it was not clear whether the sec had opened a formal enforcement investigation.13 in summary, the potential troubles that he was facing were on three fronts: stock market manipulation, releasing untrue or incomplete material information, and not following the right procedure to release the information. on september 27th, the sec filed a formal complaint against elon musk and tesla. according to the complaint, musk made a series of “materially false and misleading” statements using his personal twitter account on august 7. those statements had led to “significant confusion and disruption in the market” (sec, 2018). for example, he claimed that he was considering taking tesla for private at 11 the above price information is from the following news source: https://www.nytimes.com/2018/08/07/business/teslastock-elon-musk-private.html; https://seekingalpha.com/news/3379457-tesla-trading-live-updates 12 the above information on trading volume is from the following news source: https://seekingalpha.com/news/3379457tesla-trading-live-updates 13 https://www.wsj.com/articles/sec-has-made-inquiries-to-tesla-over-elon-musks-taking-private-tweet1533757570?mod=hp_lead_pos2 volume 36, number 2 57 $420 per share and the funding for this massive transaction had been secured. the sec argues that in reality, he had never confirmed, nor seriously discussed the deal with the $420 price offer with the saudi swf or with any potential funding source. musk also claimed that the going-private deal had won investors’ confirmed support and the only reason the deal was not certain at this point is that it was subject to a shareholder vote. according to the sec, musk had never obtained the confirmed support from tesla’s investors and there were other contingencies that he had not taken into serious consideration. therefore, it was misleading to claim the deal had a good likelihood of occurring. one of the penalties sought by the sec was to ban elon musk from serving as an officer or director of a public company. in other words, he could be forced to step down from his ceo role or the chairman of the board role of tesla. tweets summary twitter is a casual platform for making brief statements (given its word limit) compared to tesla’s official communication outlets or other media outlets. it allowed musk to engage in impulsive and direct conversations with his followers, including tesla’s investors. it is natural for a twitter user to spend less time to contemplate short posts, or instantly reply to other users, even when a post deserves more scrutiny before publication. an important lesson, however, needs to be learned. as the chairman and ceo of a public company, an icon on corporate innovation, a celebrity with great publicity, and a prolific user of twitter with 25 million followers, musk has the duty to convey accurate (and avoid misleading) material information to the public. this message is echoed by sec as one of its officer states that: “an officer’s celebrity status or reputation as a technological innovator does not give license to take those responsibilities lightly.” 14 sec settlement on september 29, the news came out that musk had reached a settlement with the sec. on october 4, musk posted a tweet to ridicule the sec, that the acronym sec stands for “shortseller enrichment commission.” tesla’s stock price 14 the above statement is from steven peikin and the statement can be found at the sec news release: https://www.sec.gov/ news/press-release/2018-219 15 the price information can be found here: https://www.cnbc.com/2018/10/05/tesla-shares-drop-nearly-5percent-after-muskmocks-sec-on-twitter.html 58 journal of business strategies went down by 7%, indicating investors were anxious on the increased uncertainty of the settlement caused by his oral attack on sec.15 on october 16, a federal judge approved the settlement. among the agreed terms, musk and tesla would evenly split a total of $40 million in fines, which the sec sought to return to “harmed investors.” besides financial penalties, musk was to step down from his chairman role before the november 13 deadline, and he wouldn’t be eligible to be chairman again for a period of three years. in addition, tesla would appoint two independent directors to the board and set up a system to oversee its ceo’s public communications just want to that the shortseller enrichment commission is doing incredible work. and the name change is so on point! elon musk @elonmusk when being asked by a twitter follower how he feels about his tweets that ended up costing him $20 million, musk replied with two words: “worth it.”16 on november 8, tesla announced that robyn denholm would replace elon musk as the new chairman, serving as the head of tesla’s board of directors. robyn denholm had been a board member of tesla since 2004 and she was considered to have fewer business and personal ties with musk.17 on oct 29, musk issued another surprise to the market when he tweeted that he had removed his tesla titles and he would now be referred to as the “nothing of tesla.” in his follow-up tweet, he decided to keep his ceo role as he discovered that a company needs to have a president, along with treasurer and secretary, to fulfill legal requirements. 16 see the twitter post available at: https://twitter.com/elonmusk/status/1056012218897059841?lang=en 17 this statement is from wall street journal: https://www.wsj.com/articles/tesla-names-robyn-denholm-as-chairman-toreplace-elon-musk-1541659771 2:16pm oct 4, 20188.9k people are talking about this36.6k volume 36, number 2 59 deleted my tesla titles last week to see what would happen. i’m now the nothing of tesla. seems fine so far. elon musk @elonmusk a teaching strategy this case provides background on elon musk’s publicly acclaimed behavior as a basis for classroom discussion. we suggest that it be assigned as preparation for subsequent classroom discussion. the materials may easily be supplemented with other items at the discretion of the professor, which could either be assigned to students for collection, or provided by the professor. the case is appropriate for use in finance, economics, and even business communication courses. it often produces a lively discussion among students, and is usually good for a 30-45 minute discussion. in more advanced courses, the case could simply be assigned to students as preparation for class discussion. in less advanced courses, and at the professor’s option, guidance questions could be assigned such as: 1. what are the company’s major businesses? who is the ceo and board of directors? what are the ceo’s responsibilities? 2. what are public companies? what are private companies? what are the differences? 3. which stock exchange does tesla list its shares on? 4. when did tesla first become a public company? what is this process called? 5. what are the drawbacks of being a public company that made musk want to go private? 6. why was tesla stock being shorted? why did musk hate the stock being shorted? 7. what was musk’s rationale for taking tesla private? 8. why did musk choose to make the announcement public via twitter? was his intention dishonorable? 3:43 pm oct 29, 201813.9k people are talking about this135k 60 journal of business strategies 9. what lessons could musk learn from the events? do you think he learned the right lessons? 10. is verbal desire sufficient for making a claim that funding is secured? why does sec say it is misleading to investors? why is securing that funding so important? why does it even matter to the investors? 11. what happened to tesla’s stock price when his statements came out? can you explain why the stock price is affected? references https://twitter.com/elonmusk https://www.forbes.com/sites/briansolomon/2015/03/30/elon-musk-boots-teslastock-with-major-new-product-tweet-tease/#304b0d293f9a https://pando.com/2015/03/30/elon-musk-created-nearly-1b-in-value-today-with-asingle-tweet/ https://www.businessinsider.com/this-is-going-to-be-teslas-new-productline-2015-3 https://www.wsj.com/articles/tesla-to-announce-grid-scale-battery-pack-homebattery-april-30-1429659606 https://money.cnn.com/2018/03/28/news/companies/tesla-model-3-cash-crunch/ index.html https://www.moodys.com/research/moodys-downgrades-teslas-corporate-familyrating-to-b3-senior-notes--pr_381481 https://www.nbcnews.com/business/autos/tesla-recalls-almost-half-cars-it-everbuilt-shares-tank-n861421 h t t p s : / / w w w. w s j . c o m / a r t i c l e s / t e s l a s h a r e s s i n k a s m u s k j o k e s a b o u t bankruptcy-1522682691 https://www.wsj.com/articles/elon-musks-twitter-account-am-considering-takingtesla-private-at-420-1533661152 https://www.tesla.com/en_gb/blog/taking-tesla-private?redirect=no https://www.reuters.com/article/us-tesla-musk-saudi/saudi-sovereign-fund-pif-hasbought-a-below-5-percent-stake-in-tesla-source-iduskbn1ks1yt https://www.nytimes.com/2018/08/07/business/tesla-stock-elon-musk-private.html; https://seekingalpha.com/news/3379457-tesla-trading-live-updates https://seekingalpha.com/news/3379457-tesla-trading-live-updates https://www.wsj.com/articles/sec-has-made-inquiries-to-tesla-over-elon-muskstaking-private-tweet-1533757570?mod=hp_lead_pos2 volume 36, number 2 61 https://www.sec.gov/news/press-release/2018-219 https://www.cnbc.com/2018/10/05/tesla-shares-drop-nearly-5percent-after-muskmocks-sec-on-twitter.html https://twitter.com/elonmusk/status/1056012218897059841?lang=en https://www.wsj.com/articles/tesla-names-robyn-denholm-as-chairman-to-replaceelon-musk-1541659771 malhotra, claudia k., and arvind malhotra (2016). how ceos can leverage twitter. mitsloan management review 57(2), winter, 73-79. sec complaint—elon musk: https://www.sec.gov/litigation/complaints/2018/ comp-pr2018-219.pdf short biographical sketch of authors dr. robert stretcher is a professor of finance at sam houston state university. he earned his phd in finance and monetary economics from the university of tennessee in 1995. his research focuses on empirical market studies, applied finance and finance education. dr. stretcher has held prominent positions in the academy of economics and finance, financial education association, and institute of finance case research, and has served as editor and on editorial boards of various finance journals. dr. xiaoman duan is an assistant professor of finance at sam houston state university. she earned her phd in finance from the university of oklahoma in 2017. her research interests include corporate finance and international finance. strategies for u. s. firms to better penetrate japanese markets nobuaki namiki school of business & public administration california state university sacramento, california there has been much heated debate over japanese trade barriers mainly because of huge and growing trade deficits with japan. until the late 1970's, many u.s. government officials, businessmen and academics have blamed tariff and non-tariff barriers imposed by the japanese government. after intense negotiation with japan, the u.s. government has been successful in reducing or eliminating legal barriers for many manufacturing goods and financial services. also, in addition to the trade liberalization programs, the japanese government has initiated capital liberalization programs so foreign companies can acquire japanese companies to gain ready access to japanese markets. in spite of these programs and recent drastic appreciation of japanese currency against the u.s. dollar, except for a few specific products, u.s. trade deficits with japan have continued to increase. quite simply, many american companies still have not succeeded in penetrating the japanese markets. two explanations are offered for this phenomenon. first, some argue that the japanese government, through various forms of assistance to private business and subtle legal restrictions, helps prevent foreign companies from entering japanese markets [10]. additionally, the unique japanese culture is itself considered a non-tariff barrier against foreign companies [15]. for example, japanese value long-term, personal, trusting business relationships, which are not easily established with american businessmen because of language barriers and cultural differences. however, another barrier, not so well known but much more formidable than those mentioned above, also exists. this barrier is related to the unique economic environment-or more specifically, the market structure-in japan. a distinctive feature of japanese markets is the grouping of companies or interfirm relationships. unlike the competitive market structures of the united states and other countries, powerful groups of companies in japan, referred to as keiretsu or industrial groups, control nearly half of the japanese economy. american companies without knowledge of such barriers and means to deal with them have considerable difficulties in entering japanese markets. this article will explain why and how market-structure based barriers work against american --------------journal of business strategies, volume 5, number 1 (spring 1988) 1 companies attempting to penetrate the japanese market, and suggest strategies for u.s. companies in overcoming these barriers. the market~structurebased barriers the essence of market-structured based barriers is related to the complex relationships established between companies within industrial groups, and between groups of companies. the interfirm relationships raise trade barriers by influencing japanese companies' decision making processes, thereby binding their behavior patterns. as a consequence, their behavior or action patterns in conducting business or in competing in the markets are substantially different from those of american companies. there are basically three types of relationships: (1) relationships between a parts supplier, a manufacturer, and a distributor, with a single product line; (2) cooperative relationships between companies within a group; and (3) competition between groups of companies, or industrial groups. the following sections will describe the major characteristics of industrial groups and explain each type of interfirm relationship. industrial groups until the end of the world war ii, the japanese economy was virtually controlled by the zaibatsu, ten family owned and controlled industrial and banking combines. they accounted for about one-third of incorporated business in japan [81. mter the war, the allied occupation force dissolved the zaibatsu in order to reduce the concentration in the economic sector and to promote democracy in japan. however, these companies later regrouped, and the groups are now called keiretsu or industrial groups, without family control. today, there are six industrial groups that were regrouped based on the old zaibatsu. they are mitsui, mitsubishi, sumitomo, fuji, sanwa and dai-ichi kangyo. the first three keiretsu are the direct successors of old zaibatsu, and the latter three are tied through their main banks and also successors of some former, smaller zaibatsu brethren [7j . an industrial group consists of many large firms plus numerous small-to medium-sized companies. selected large companies are represented by their presidents in the group's president club, the overall policy making organ, and are called "member companies." the member companies are usually oligopolists in their respective markets. their predecessor zaibatsu had tried to achieve an oligopolistic position in a wide range of industrial activities. as a result, few member companies in an industrial group are monopolists, and each industrial group includes almost every industry in japan. there are twenty-three member companies participating in the president club in mitsui group, twenty-eight in mitsubishi, and twenty-one in sumitomo [17j. each member company with its subsidiaries and related companies represents one broadly defined industry. each keiretsu has only one member company representing each industry in order to ensure minimum competition and conflict within the industrial group. 2 unlike prewar zaibatsu whose companies were privately owned and controlled by the family owned holding company, ownership control is absent within an industrial group. however, there is a considerable coordination among companies within a group, through financial control, interlocking directorates and personal relations, in addition to the regular meetings of member companies' presidents at the group's presidents' club. every industrial group includes the main bank and its related financial institutions which are usually considered the group's leaders and provide financing mainly to the companies within the group, and the trading company which conducts import and export transactions mainly for the group's companies. though financing institutions are prohibited by law from owning more than ten percent of any company, the group's main bank, through provision of huge financial as well as management resources, has considerable influence over the member companies [4j. the companies usually accept the bank's management personnel who oversee them as the companies' top executives, thereby lo;>ing their management autonomy to, and allowing substantial control by, the main bank. it should be noted, however, that the influence of main banks over member companies has recently been somewhat reduced because of financial successes by many large japanese companies. coordination within an industrial group is also enhanced by cross stockholdings and interlocking directorates. companies within industrial groups hold their shares mutually, usually much less than ten percent each. however, a considerable portion of a company's stock is held by companies belonging to the industrial group. nearly seventy percent of japanese corporate shares are held by institutions ([111, 112]). large japanese firms belong to industrial groups because of the benefits from the association and of the high costs of not belonging to a group, in addition to the japanese desire to belong to groups-often called "groupism," a cultural norm in japan. the benefits are substantial, and include access to financial and capital markets through the main bank, access to export market and distribution channels, and improved corporate image/status. an industrial group also helps its member companies compete with those in different groups. moreover, a group provides protection to those member companies with financial problems. though bankruptcy rates for smaller firms are high in japan, those for large firms me extremely low because of protection by industrial groups. there are only a few large companies, including such notables as sony and honda, which do not belong to industrial groups. the six industrial groups explained above are sometimes called "financially linked" keiretsu or industrial groups. in addition, there are ten or so manufacturers' groups or enterprise keiretsu, each composed of one huge manufacturer and numerous parts suppliers, without the main bank. the examples are toyota, matsushita, nissan, tokyo shibaura (toshiba), and hitachi groups. most of them participate in presidents' dub of one financially linked keiretsu because of the benefits from the association mentioned above. some of them participate 3 in presidents' clubs of two financially linked groups, such as nissan and hitachi [13]. manufacturer-distributor relationships japanese distribution channels are usually perceived as extremely complex, having many layers of wholesalers in the distribution structure. however, the nature of relationships between manufacturers and distribution channels in japan differs greatly from that in the united states. in japan, each distributor is a loyal and exclusive wholesaler for one manufacturer in each product category ([15], [18}). this is one of the reasons that many foreign companies have difficulty in obtaining distribution channels in japan. large manufacturing companies (member companies) have for a long time expended tremendous effort and energy in developing and maintaining the exclusive distribution networks. japanese manufacturers often own substantial stocks of their key distributors. most manufacturers extend generous financing (or credit) to the wholesalers, and the wholesalers are also expected to provide their retailers with generous financing. manufacturers are also expected to be responsible for unsold items; retailers can return unsold items and get full credit. in return, manufacturers expect their distributors to aggressively push their products and often to maintain retail prices at the same level in all classes of trade. manufacturer-parts supplier relationship many american businessmen have claimed that large japanese manufacturing companies tend to procure parts from other japanese companies rather than from foreign companies. this tendency stems mainly from the large-sized manufacturers' substantial control over small-sized parts suppliers, and the resulting benefits for the manufacturers .. they have established key large-sized suppliers as their own subsidiaries, often with substantial ownership and financial control. in turn, these key subsidiaries have developed their own network of smaller-sized parts suppliers and subcontractors. and these smaller-sized parts suppliers and subcontractors have developed their own network of even smaller-sized parts suppliers and subcontractors. in other words, they have developed a pyramid-type subcontracting structure which has a hierarchy of parts suppliers. the relationship of a company with lower-level hierarchy to that with higher-level hierarchy is exclusive, i.e., captive of the hjgher-ievel hierarchy company. this industrial structure, of course, tremendously benefits big business. because of the structure, most large manufacturing firms do not have incentives to be integrated into labor-intensive, low-productivity parts manufacturing, and instead, procure parts at minimal cost from substantial numbers of subcontractors who usually pay low wages. the japanese economy is characterized as ~~dual structure" because large-sized companies co-exist with numerous small 4 companies and there are wide gaps in productivity and wages. employees at smaller companies receive around 35% to 45% lower wages than workers at big companies, get considerably fewer fringe benefits, and enjoy no lifetime employment privilege [2]. in 1971, almost sixty percent of small and medium-sized manufacturing companies in japan were classified as subcontractors [14j. more-over, because of the dependency of subcontractors on their manufacturer, the manufacturing companies can depend on the subcontractors for quick delivery of these low-cost, high quality parts. an example of the close working relationship can be found in the kanban or "just-in-time" inventory system employed by toyota motor company. across-industry cooperation within an industrial group member companies within an industrial group conduct substantial economic transactions among themselves, often through their group's trading company. it should be noted that this is an across-industry cooperation within an industrial group, while the previous section deals with a member company relationship with' its suppliers and subcontractors within its respective industry. the intra-group buying and selling originated in the prewar zaibatsu, when the family-owned holding company encouraged business between the subsidiaries mainly through the trading company [7j. though the business conducted between member companies within a group has been much less than in the prewar zaibatsu, member companies have still preferred to do business with their group's members and their related companies. however, the degree of cohesiveness among member companies within a group differs considerably from one group to others. nearly three-fourths of the managers in mitsui, mitsubishi and sumitomo groups, the three direct successors of the prewar zaibatsu, expressed their pride in belonging to their respective groups. on the other hand, only half of managers in sanwa group, a smaller industrial group tied through the main bank-sanwa bank-expressed this pride. also, about two-thirds to three-fourths of managers in the three groups expressed their wish primarily to buy commodities produced by their member companies of the same group, compared to only about one-third of those in sanwa group [13]. competition between industrial groups while there is strong cooperation within an industrial group, competition exists between industrial groups. it should be noted that "competition" in the japanese context is different from that in american or western context. 111 the united states, competition exists between individual companies with the same or similar product lines or in the same industry. in japan, competition exists not only between individual companies with the same product line, but also between companies (with different product lines) belonging to different industrial groups. the major driving force for competition in markets is the desire to 5 improve status and prestige of the industrial group. in japan, where a cooperative rather than individualistic business philosophy prevails, competition means intergroup rivalry for status and prestige [8j. a larger, stronger member company helps improve the industrial group's prestige and image.. also, a group's status of image is considered higher if it includes a larger number of big, growing companies, and represents larger numbers of industries, compared to other industrial groups. an industrial group's member companies have strong needs to expand internally, add new product divisions, or establish new subsidiaries. therefore, competition among japanese companies in japanese and overseas markets tends to center on capturing market share or increasing sales volume, sometimes even at the sacrifice of short-term profits. since substantial blocks of shares are held by companies in the industrial group, a company can forego short-term profits when it needs to aggressively compete with companies with the same product line in different industrial groups. also, the main bank in the group can help the company with financing, the trading company with marketing, and other companies in the group with capital infusion and other assistance, when needed. a challenge by a company against those in different groups can lead to competition between industrial groups, and can escalate to "excessive competition" whereby rival groups lower and continue to maintain prices below production costs [8j. strategies to penetrate the japanese market-structure based barriers the structure of japanese markets is substantially different from that of markets in the united states and other western countries. it is essential for american businesspeople to understand the japanese market structure and, based on that knowledge, to position themselves in the market. the following strategies and approaches are recommended to american executives preparing to enter the japanese market. assessing competitors' responses in the japanese market when considering entry into the japanese market, it is important to assess accurately the likely responses of established japanese competitors. intensity of resistance or response depends largely on the number of participants in the market, their sizes and stakes in the market, and more important, the commitment or policy of the involved industrial groups to the market. when a foreign company enters a market that is represented by many large-sized member companies of industrial groups, it can expect formidable resistance. member companies of an industrial group are the "flagships" of the group; the group's status and prestige depend largely on these companies' growth and performance. therefore, other member companies and the related 6 companies in the group directly and indirectly support a member company facing substantial threats from a foreign company. this competition, then, is not only with the member companies in the industry but also with the other companies in the industrial groups. member companies threatened with substantial market penetration by foreign companies can raise the entry barriers through many means, such as financial and other assistance from the main bank and other member companies, cooperation from the distribution channels and the parts suppliers, and even assistance from the japanese government. one of the major reasons why some american and other foreign companies have failed in the japanese market is that they have underestimated japanese responses in the market. another indicator of the intensity of the resistance is the japanese government's industrial policy. the japanese government, notably the ministry of international trade and industry (miti), has promoted development of certain industries through "administrative guidance," subsidies, and tax incentives [9]. industrial groups tend to make their resource allocation decisions based on governmental policy or guidance. in the industries targeted for development by the government, competition is fierce even for japanese companies. for example, under governmental guidance, all the industrial groups have been supporting development of computer and semiconductor companies within their groups. in many industrial groups, some member companies have formed joint ventures in order to combine their technical and other resources to develop and compete with other companies in different industrial groups. the result in the semiconductor industry is overcapacity (and overproduction) and "excessive competition" by japanese companies in the japanese as well as world markets. competition in the computer industry is similar; all industrial groups have been developing their own computer companies, some of which have been challenging, and gradually gaining ground against, the market leader, i.b.m. two of lb.m.'s responses to the increased competition are to closely monitor government policy on the market and to have a voice in the policymaking process by joining industry associations and government advisory groups [3]. therefore, it is essential for american companies to monitor policies of the japanese government and industrial groups on the industry. many large-sized american and other foreign companies have been successfully exporting to or operating in japan. examples are 1.b.m., esso, and nestle. the companies tend to possess superior technologies, new products, or brand identification to highly differentiate themselves from japanese companies, thereby avoiding head-on competition in the markets. also, these companies tend to possess considerable capital, technology, and managerial resources [16]. moreover, in some cases, industrial groups have "accepted" the foreign companies because the group's member companies have no capability to produce the foreign companies' products or similar products, yet need their products. however, foreign companies without such capital, technology, and managerial 7 resources would have considerable difficulties in penetrating and succeeding in the japanese market. these companies seek a niche in the market. the strategy to carving a niche in the japanese market, however, is considerably different from that in the u. s. market. seeking a "niche" or "void" in industrial groups the approach is to seek a "niche" in an industrial group. though all industrial groups attempt to be the leaders or oligopolists in each industry or market, some groups have weaker positions than others. in some cases, an industrial group supports a marginal company to maintain presence in the industry in order to sustain the group's image and prestige. moreover, not every group is represented in each industry. the largest three, mitsui, mitsubishi, and sumitomo groups, represent a broader range of industries than the others. some industries are dominated by a few groups because of group history. the prewar zaibatsu had emphasized certain industries during their development stages. for example, the mitsui zaibatsu controlled paper, coal, synthetic dyes and much of the foreign trade; the mitsubishi zaibatsu controlled heavy industry, shipbuilding, marine transportation, and plate glass [lj. the differences in representation or strengths of industrial groups in markets present opportunities for the entry of foreign companies to japanese markets. an industrial group with weak or no market position in an industry may even encourage foreign companies to "associate" with the group in order to compete with other companies in different industrial groups. the opportunity is presented due to intense intergroup rivalry for status and prestige. the association benefits both the industrial group and the foreign company. in selling an industrial product to japanese companies, search for an industrial group without a company producing the product. because the industrial group needs to "import" the industrial goods from other industrial group's companies, companies in that group may be much more inclined to buy from foreign companies than those in groups which have their own producers, given superior services, technologies, and other available amenities. also, companies in an industrial group which includes a company that is producing the industrial product but is only marginally competitive in the market due to obsolete technologies, poor services, or other controllable reasons, may be willing to buy from outsiders. for consumer products, the wholesalers or distributors which belong to an industrial group without companies manufacturing the products may be more likely to carry foreign goods. also, an industrial group usually has large-sized department store chains that mainly distribute its group member companies' products. therefore, in order to identify an established distribution channel that is willing to carry foreign products, search for a niche or void in one of japan's industrial groups. 8 since the larger industrial groups, mitsui, mitsubishi, and sumitomo, represent a wider range of industries, there would be a higher chance of associating with the other smaller industrial groups, such as fuji, sanwa, and dai-ichi kangyo. however, as mentioned previously, there are more cohesive, cooperative relationships among companies in the larger industrial groups than among those in the smaller industrial groups. investigating the interfirm relationships so far, the above recommendations are made mainly based on "generic" behavior patterns by japanese companies that are influenced by the presence of industrial groups and the cooperative nature of interfirm relationships in japan. however, the degree of cooperation or the nature of the relationship between companies may differ greatly depending on specific ties between companies, industry conditions, and industrial groups. investigation of the nature of interfirm relationships in the specific industry or market is important because the knowledge can help: 1. identify japanese companies which are more likely to buy foreign products or carry the products in their distribution channels, within the specific industry; 2. identify with what objective japanese companies conduct business or compete in the market; 3. develop and nurture relationships with japanese parts suppliers or distribution channels, when a foreign company decides to make direct investment in japan; and 4. develop and nurture business relationships with japanese companies in the market or in related industries. the basic web of relationships can be based on familial ties, marital ties, personal friendships, long-term business relationships, or other factors, between top managers of companies. these relationships can be reinforced by interlocking directorates, cross stockholdings, and exchange of management personnel between companies. in some cases, relationships among related companies are so strong that it is virtually impossible for a foreign company to supply parts or to conduct business with the japanese target company. for example, the toyota motor company procures most parts from firms whose presidents are from the toyoda family, the founding family of the company [6j. in other cases, the relationships are weak. firms have business, but less cooperative, relationships due to a short history of business transactions between the companies. newer companies such as honda, tend to have loose ties with other companies. the relationship may also be weak in a changing, volatile business. in these 9 cases, a japanese company may be much more receptive to dealing with foreign compames. moreover, the investigation of these relationships can lead to better understanding of a japanese company's behavior patterns, as well as its motivations and expectations in conducting business. unlike a u. s. company, where more business decisions are made in "rational" fashion, japanese companies may behave irrationally (in an american or western sense) mainly because of their intricate web of relationships with other companies. for example, it may be judged "prudent" by japanese parts suppliers to help their customers compete in the growing market by reducing their prices for their parts below market prices, based on the close relationships, such as marital ties, and the expectations that they will benefit in the long-run. it would be understandable that, without knowing the nature of interfirm relationships, misunderstandings and resulting mistrust would develop between japanese and american companies conducting business together. this is one of the major reasons why many joint ventures between japanese and american companies have failed in the past. therefore, it is essential for u. s. companies conducting business with japanese companies or operating in japan to understand what kinds of behavior are expected and required. also, for american companies making direct foreign investment in japan, it is important to know the expected behavior in developing parts suppliers' networks and distribution channels, as well as developing and nurturing relationships with other entities, such as banks and trading companies, in order to facilitate smoother business transactions in japan. conclusion the japanese market is substantially different from that in the united states or other western countries in many aspects, of which the major differences stem not only from culture and government policy, but also unique market structure. the market-structure based barrier is a formidable obstacle against american companies entering japanese markets mainly due to lack of experience with this type of trade barrier. better understanding of the japanese market structure can greatly help u. s. firms overcome the barrier and, moreover, formulate and implement viable strategies to enter japanese markets. armed with this knowledge, they must make renewed efforts to enter the large and potentially very profitable markets of japan. references 1. bieda, k. the structure and operation of the japanese economy. new york, ny: john wiley and sons australasia pty., ltd. (1970). 2. broadbridge, s. industrial dualism in japan: a problem of economic growth and structural change. chicago, il: aldine publishing company (1966). 10 3. browning, e. s. "lobbying in japan so daunts u. s. firms that few even try." wall street journal. april 1, 1986, pp. 1, 19. 4. caves, r. e. and uekusa, m. "industrial organization." in h. patrick and h. rosovsky (eds.), asia's new giant: how the japanese economy works. washington, dc: the brookings institution (1976), pp. 461-523. 5. czinkta, m. r. "distribution in japan: problems and changes." columbia journal of world business, vol. 20, no.3 (fall 1985), pp. 65-71. 6. "frugal, reclusive commanders of an industrial army." business week, november 4, 1985, pp. 45-46. 7. hadley, e. m. antitru.9t in japan. princeton, nj: princeton university press (1970). 8. haitani, k. the japanese economic system. lexington, ma: lexington books (1976). 9. johnson, c. m.l. t.!. and the japaneae miracle: the growth of industrial policy, 1925-1975. stanford, ca: stanford university press (1982). 10. johnson, c. "the 'internationalization' of the japanese economy." cali~ fornia management review, vol. 15, no.3 (spring 1983), pp. 5-26. 11. nishiyama, t. "the structure of managerial control: who owns and controls japanese business?" in k. sato and y. hoshino (eds.), the anatomy of japanese business., armonk, ny: m. e. sharpe, inc. (1984), pp. 123-163. 12. ohmae, k. the mind of the strategist: the art of japanese business. new york, ny: mcgraw-hill (1982). 13. sasaki, n. management and industrial structure in japan. new york, ny: pergamon press (1981). 14. small and medium enterprises agency. chusho kigyo hakusho, showa 50-nen ban (white paper on small and medium enterprises, 1975). tokyo, japan: ministry of finance, printing bureau (1975). 15. woronoff', j. world '!rade war. new york, ny: praeger (1984). 16. wright, r. w. "joint venture problems in japan." columbia journal of world business, vol. 14, no.1 (spring 1979), pp. 25-31. 17. yoshihara, k. sogo sosha: the vanguard of the japanese economy. oxford, uk: oxford university press (1982). 18. zimmerman, m. how to do business with the japanese. new york, ny: random house (1985). 11 strategies for u.s. firms to better penetrate japanese markets the wealth effects of proactive and reactive corporate name change strategies nils-erik aaby thomas j. zwirlein university of colorado at colorado springs colorado springs, colorado lisa f. borstadt northern arizona university flagstaff, arizona introduction planning and implementing corporate identity programs are important aspects of corporate and marketing strategy. corporate identity programs embrace everything from the design of corporate names and logos to the very elusive business of image management. a company's image is not only important with respect to present and potential customers, but also to convey the right image to other stakeholders such as employees, stockholders, commercial bankers, investment bankers, rating agencies, the financial press and even government agencies. one core element of a firm's image and identity is its corporate name. some practitioners view the corporate name as a "business brand" that must be managed strategically just as product brands. as reported by rawsthorne [12], a significant consulting industry in the "name and identity management" business, with total 1988 income of $9.6 billion, serves firms world-wide. the development of a number of name generation software programs also reflects the importance attached to corporate names. expenses associated with developing and changing individual corporate names appear significant. for example, in 1986 ual, inc., the parent of united airlines, spent an entire year and $7.3 million to produce the new name a1legis. exxon spent $200 million to develop and implement its name change from esso to exxon. in spite of substantial amounts spent on changing and creating new names, our knowledge of the importance of corporate names is meager. many corporate executives question the high fees charged by marketing services organizations for name change development. the purpose of this paper is to examine the merit of such services by assessing the short-term financial consequences of corporate name changes. given that corporations invest substantial resources to change their corporate name, it is important to know if these investments yield acceptable returns. a corporate name change could be perceived negatively by the investment community due to: 1) the high cost of implementing the name change, or 2) the sacrifice or loss of established name equity. (name equity refers to the inherent value of a recognizable name including all attributes associated with the name.) alternatively, a corporate name change might signal a new business strategy and drive by management and be perceived positively by investors. perceptions regarding corporate name changes should be reflected in stock price movements 42 journal ofbusiness strategies vol. 10, no.1 if the announcement of the name change provides new information about the firm. however, if the name change conveys no new information, no share price reaction should be observed. review of the literature many prescriptive efforts related to corporate identity can be found in the literature ([1], [5], [6], [9], [10], [13]). most of these hail the importance of corporate identity and the importance of having relevant, recognizable, and memorable corporate names. prior research into the wealth effects of corporate name changes suggests that name changes are of little or no value to shareholders. howe [7] found no share price reaction to name change announcements. karpoff and rankine [8] found a positive 1.9 percent increase in shareholders' wealth over the two days surrounding the public announcement of a name change for a limited sample of 40 firms. bosch and hirschey [2] also found that share prices react positively at the time of the public announcement of name changes, however over the 21 day period surrounding the name change, no significant wealth effect was observed. for their total sample of 79 firms, they report a positive and significant share price response over the eleven day period preceding and including the public announcement date, however this is reversed over the ten day period following the name change announcement. bosch and hirschey also partitioned their sample into 32 "major" and 47 "minor" corporate name changes similar to our "complete" and "partial" categorization. their results for "major" and "minor" name changes are the same as for their total sample, i.e., a positive announcement effect that is dissipated over the subsequent ten day period. more recently, ravichandran, melicher, and hearth [11] report positive two-day announcement returns for a sample of 27 "major" (complete) name changes, however no significant differences in risk-adjusted stock performance were found between the one-year preand post-name change announcement periods. the existing evidence suggests that although the public announcement of name changes is met with a positive share price response, the increase in value is not sustained beyond a two-day announcement period horizon. to the contrary, the empirical results of this paper indicate that firms making complete name changes experience a 3.2 percent increase in market value during the 21-day period surrounding the public announcement. modifications to an existing name however, have no effect on firm value.! 1 prior studies have used much smaller samples. this study contains 151 firms which almost doubles the sample size of the next largest study by bosch and hirschey [2], which contained 79 firms. spring 1993 aaby, borstadt, & zwirlein: corporate name change 43 although a 21-day cumulative share price response is not considered to be a long term measure of performance, a 21-day window should be sufficient to capture investors expectations concerning the long-run impact of the name change.2 our evidence is consistent with the view that complete name changes act as a signal of commitment to a new corporate strategy or as a positive net present value investment in a new corporate identity. motivation for corporate name changes although corporations change names for a wide variety of reasons, the underlying motivations can be summarized into two overall categories; reactive and proactive. reactive name changes are the result of events which have already occurred such as corporate restructuring, mergers, acquisitions, or diversification into new products or markets. although, these events may cause valuation adjustments, the name changes should not, because they are reactive alignments with little strategic value. name changes made in response to past events should not affect market valuation since no new information is conveyed to the market. in contrast, a substantial number of corporate name changes are made for proactive reasons, i.e., the name change is made in a deliberate attempt to create a new image or corporate identity. this can be viewed as 1) a capital budgeting decision in which an investment is made to generate higher future cash flows to the firm or 2) an information signal, whereby the name change is a means of communicating a new strategy orientation or movement into new and attractive business areas. a name change may be the right medium for communicating such a change if the firm does not wish to divulge their strategic plans to competitors, yet management wants to convey to the market their favorable expectations about future firm performance. if the name change is viewed as a value increasing investment or as a positive information signal, then market values should increase at the announcement of the change. we categorize name changes into reactive and proactive categories depending on whether the firm completely changed its name or only modified an existing name. of the 92 partial name changes in our sample, 54 involve dropping a product from the name. examples of this are melville shoe corp. to melville corp., american general insurance corp. to american general corp., lukens steel co. to lukens inc., bic pen corp. to bic corp., st. regis paper co. to st. regis corp. these types of name changes reflect past changes in corporate strategy such as the evolution from single product companies to multi-product companies or to reflect recent diversification into new products or services. the remaining 38 partial name changes can be described 2 since event study methodology assumes that markets are efficient, any share price response to new information about the firm should reflect the present value of all future cash flows that investors expect as a result of the event. thus, although we do not measure performance over a long period of time, the 21-day window is sufficiently large to capture the abnormal returns that reflect long-run expectations. 44 journal ofbusiness strategies vol. 10, no.1 as follows: 13 involve dropping a name from the name (e.g., fischbach and moore inc. to fischbach corp.), 13 involve changing product emphasis (e.g. peoples gas co. to peoples energy co.), and 12 involve some type of restructuring (e.g., m.d.c. corp. to m.d.c. holdings inc.). these partial name changes appear to be reactive in nature, reflecting past strategic actions and therefore, are not likely to convey any new information to the market. therefore, we hypothesize that partial name changes will have a non-positive effect on equity value. alternatively, complete name changes appear to be for proactive reasons. approximately one-half of the 59 complete name changes involved the creation of a "synthetic" name where word fragments are combined to make new words. often, "synthetic" names are imagery names designed to convey valuable messages about the benefits of a product, service, or company's business. for example, united airlines new name, allegis, was derived from "allegiance" (loyal) and "aegis" (protection). the name was designed to convey the concept of longevity. in some cases synthetic names are nonsense names which combine suffixes, prefixes, and other word fragments into new words with no ostensible meaning (e.g., acura). while nonsense names, by themselves, don't communicate any valuable message about the company, they are more likely designed to be short, catchy, and easily recognizable. amoco, citgo, and exxon are examples of this type of synthetic name. in our judgement, the underlying motivation for adopting a "synthetic" name, whether a nonsense or imagery name, is to create a new and different corporate image or identity. firms that change their names completely not only sacrifice existing name equity, but also are likely to incur heavier advertising expenditures as these firms must publicize their new name. rational managers would not make these decisions if there were no clearly identified performance benefits associated with these costs. thus, these firms are more likely to be sending stronger strategic signals than firms that make only minor adjustments to their name. since complete name changes appear to be made for proactive reasons, we hypothesize that the announcement of complete name changes will increase shareholders' wealth. methodology sample a sample of firms that changed their nam~ during the 1976-1987 period was identified from two sources; the wall street journal index and moody's industrial and bank and finance manuals.3 beginning in 1979, the wsj index has a section titled "name changes". thus it was possible to identify all firms that had changed names during the 1979-1987 period and for which an announcement was published in the wall street journal. to identify name changes that occurred in the 1976-1978 period, the section in the moody's manuals entitled "additional companies formerly included" was searched. this section lists companies which appeared in previous editions of the 3 this period was chosen to provide a sufficient sample size and to ensure sufficient data availability from the 1989 crsp tape. spring 1993 aaby, borstadt, & zwirlein: corporate name change 45 moody's manual, but had been dropped in the current edition. this list indicates if a company was dropped due to a name change and gives the year of the change. the wsj index was then searched for the date of the public announcement of the name changes, as well as for any other announcements occurring within plus or minus 10 days of the name change announcement. firms whose name change announcements were contaminated by any other news announcements within plus or minus ten days of the name change announcement were eliminated from the sample. additionally, firms whose name change was associated with a merger were dropped from the sample. of the remaining firms, only companies whose shares are traded on the new york or american stock exchanges were included in the final sample. this restriction enabled us to use the crsp (center for research' in security prices, university of chicago) daily returns file to obtain capital market data. this search yielded 151 firms to be considered for analysis.4 measurement and study design the market model residuals method is used to measure the stock price reaction to public announcements of name changes. this empirical technique is used extensively in the financial economics literature.5 this methodology measures the "abnormal" stock price reaction to the announcement of a corporate event. under the assumption that the stock market is "efficient" in processing new information, the abnormal return is a measure of the stock markets revaluation as a result of an unanticipated news announcement. 4 the sample of 151 firms over a 12 year period seems small when compared to various business publications that have reported over a thousand name changes every year since 1983. this small sample size relative to the huge number of firms changing names results from the various screening procedures we employed. first, the wall street journal index only publishes a small fraction of the total name changes made in a given year. for example, in 1986 an article in the wall street journal reported that a record 1,382 firms changed their name, yet in the wall street journal index section on name changes, only 52 firms are listed. second, use of the crsp tapes limits the sample to only nyse and amex firms. third, as reported in the wall street journal, about half of all name changes are attributable to mergers and acquisitions, and these have not been included in our sample. finally, because of the well documented announcement effects, many firms whose name change announcements were contaminated by other news announcements within plus or minus 10 days, were eliminated from the final sample. s the strengths and weaknesses of this standard event study methodology are discussed thoroughly in two papers by brown and warner ([3], [4]). 46 joumal ofbusiness strategies vol. 10, no.1 the market model relates the companies stock returns over time to the general stock market returns using ordinary least squares regression. the market model is: where, aj' bj = ols regression coefficients estimated with daily return data for each firm in the sample for the 150 day trading period ending 20 trading days before the event date, where day t = 0 is defined as the event date, rmt = ~t = ejt = the contemporaneous rate of return on the equally weighted market portfolio on day t, (t = -170 to -21) the rate of return of security j over day t, (t == -170 to -21) residual error term of security j on day t (li.d. normal with mean zero and constant variance). regression parameters obtained from the 150 day estimation period prior to the name change are used to predict the expected return for each security in the sample, or, abnormal return (ar) is the difference between the expected (forecasted) return and the actual return for each security j on day t as follows, the cumulative abnormal return (car) for each security j (carj) is calculated by summing the abnormal returns over the days in the event period under study, or, t carj == ~ arjt t=1 for a sample of n securities, the measure of abnormal performance between the two dates is given by the mean cumulative abnormal return, car == lin ~ carj j=l spring 1993 aaby, borstadt, & zwirlein: corporate name change 47 in the absence of any abnormal perfom1ance, the expected value of the mean cumulative abnormal return is equal to zero. to determine whether or not the mean cumulative abnormal return is significantly different from zero, a z-statistic is calculated. the abnormal return for each firm is measured in the period surrounding the public announcement of the name change. there are three potential times when information about the name change becomes known to various market participants. firms must notify the stock exchange two weeks (10 trading days) prior to the name change. the exchange then notifies member :firms about the impending name change one week (5 trading days) prior to the name change. finally, the firm typically makes a public announcement (press release to wall street journal) when they change their name. accordingly we examine the cumulative abnormal returns over several time periods relative to day t=o, defined as the wsj announcement date: 1) a two-day return from day t = -1 to day t = 0, 2) a six-day return from day t = -5 to day t = 0, 3) an 11 day return surrounding the public announcement from day = -5 to day = +5 and 4) a 21-day return surrounding the public announcement from day = -10 to day = +10. analysis and results the results of the analysis are presented in table 1. for the entire sample of 151 firms the 2-day mean cumulative abnormal return (mcar) is positive, but not statistically significant at the .10 level. the six-day mcar is a positive 1.1 percent, marginally significant at the .10 level (z = 1.67).6 table 1: mean cumulative abnormal returns (mcar) (z-statistics in parentheses) sample days -1,0 days -5,0 days -5,+5 days -10,+10 entire 0.6% 1.1% 0.5% 1.4% sample (1.61) (1.67)* (0.54) (0.91) (n = 151) complete 0.9% 2.1% 2.5% 3.2% name change (1.82)* (2.66)*** (2.75)*** (2.23)** (n = 59) partial 0.5% 0.4% -0.8% 0.0% name change (0.60) (0.02) (-1.52) (-0.70) (n = 92) .p < .10 ••p < .05 ."p< 01 6 the results for the entire sample for the 2-day (not significant) and 6-day (significant) mears suggests that the event date (day = 0) may be misspecified. the information about the name change appears to be capitalized when the exchange notifies member firms rather than when announced in the wall street journal. 48 j oumal ofbusiness strategies vol. 10, no.1 however, when we look at the two time periods surrounding the name change (days -5 to +5 and days -10 to +10) we fmd no significant shareholder wealth effects. when the sample is partitioned into complete and partial name changes the results are more dramatic. for the 59 firms who completely changed their names, the two-day mcar is 0.9 percent (z = 1.82, statistically significant at the .10 level). the six-day mcar is a positive 2.1 percent (z = 2.66, statistically significant at the .01 level). moreover, looking at the time periods surrounding the name change announcements, this positive valuation effect does not appear to be transitory. share prices, on average, increase by 2.5 percent (z = 2.75) over the ll-day period from day -5 to day +5 and by 3.2 percent (z = 2.23) over the 21-day period from day -10 to day +10. this positive market reaction is consistent with investors interpreting complete name changes as a favorable signal of commitment to a new corporate strategy or as a positive net present value investment in a new corporate identity. in contrast, for the sample of 92 firms who made only minor modifications in their names (partial name changes) we observe no abnormal share price performance upon or surrounding the name change announcement. while a minor modification to a corporate name could also signal a change in strategy, the results indicate that the signal (if any) is very weak. more likely, partial name changes don't provide any new information to the market because they are reactive in nature, reflecting changes in corporate strategy that have already taken place. looking at table 2, the corresponding mean dollar abnormal returns are quite large for the complete name change sample and negligible for the partial name change group. over the 21-day period surrounding complete name change announcements, firm values increase by $19.371 million, on average. in contrast, partial name changes have no effect on firm value over the same 21-day period. table 2: dollar abnonnal returns (in millions of dollars) sample days -1,0 entire $ 3.779 sample (n = 151) complete $ 5.448 name changes (n = 59) partial name changes (n = 92) $ 3.228 days -5,0 $ 6.928 $12.712 $ 2.582 days -5,+5 $ 3.149 $15.134 -$ 5.165 days -10,+10 $ 8.819 $19.371 $ 0.000 *the mean dollar abnormal return is calculated by multiplying the mean market value of equity for a particular sample times the cumulative abnormal return for that sample. spring 1993 aaby, borstadt, & zwirlein: corporate name change conclusions and implications 49 this research examines the strategic motivations and shareholder wealth consequences of corporate name changes made by 151 firms over the period 1976-1987. the empirical results indicate that complete name changes elicit a positive share price reaction, while firms that only modify an existing name experience no change in shareholder wealth. although the reported results are only valid for a 21-day period surrounding the name change announcement, this window should be sufficient to capture investors long-term expectations regarding the impact of the name change. our evidence supports the view that corporate name changes can be an effective means of signaling a new strategic emphasis. however, this effect is confined to firms that completely change their names. complete name changes require large expenditures to change and advertise the new corporate name as well as the loss of existing name equity. thus, choosing to make a complete name change may reflect commitment by managers to pursue a change in corporate strategy. alternatively, the positive wealth effects among the complete name change firms, could also be interpreted as a positive net present value investment resulting from a new corporate identity that is expected to generate higher future cash flows to the finn. references 1. ackerman, lawrence d. "what makes successful service companies distinctive?" !abc communication world, (october 1986), pp. 17-19. 2. bosch, jean-claude and hirschey, mark. "the valuation effects of corporate name changes." financial management, (winter 1989), pp. 64-72. 3. brown, stephen j. and warner, jerold b. "measuring security price information." journal of financial economics, vol. 8 (1980), pp. 205-258. 4. brown, stephen j. and warner, jerold b. "using daily stock returns: the case of event studies." journal of financial economics, vol. 14 (1985), pp. 3-31. 5. dowling, grahame r. "managing your corporate images." industrial marketing management, vol. 15 (1986), pp. 109-115. 6. gray, edmund r. and smeltzer, larry r. '.'planning a face-lift: implementing a corporate image program." journal of business strategy, vol. 8 (summer 1987), pp. 4-10. 7. howe, j. s. "a rose by any other name: a note on corporate name changes." financial review, (1982), pp. 271-278. 8. karpoff, j. m. and rankine, g.w. "the motives and wealth effects of corporate name changes." presented at the 17th annual meetings of the financial management association, (october 1987). 50 journal ofbusiness strategies vol. 10, no.1 9. kennedy, sherril h. "nurturing corporate images." european journal of marketing, vol. 11, (1977), pp. 119-164. 10. portugal, joel and halloran, keith d. "avoiding a corporate identity crisis." management review, vol. 75 (april 1986), pp. 43-45. 11. ravichandran, r., melicher, r.w., and hearth, d. "valuation effects and risk-return performance characteristics associated with corporate name changes." journal of financial and strategic decisions, forthcoming. 12. rawsthome, alice. "laying it all on the line." financial times, (march 29, 1989), p. 27. 13. stancill, james mcn. "upgrade your company's image-evaluation." harvard business review, (january-february 1984), pp. 16-23. the wealth effects of proactive and reactive corporate name change strategies 1nrernal voice mechanisms and communication from employees about enncal issues tim barnett louisiana tech university ruston, louisiana daniel s. cochran mississippi state university mississippi state, mississippi organizational theorists have long recommended open and supportive communication climates as a means to encourage upward communication from employees (mayo 1937; roethlisberger and dickson 1939; likert 1967, redding 1972). most researchers still view open communication as desirable, although it is not regarded as a panacea (eisenberg and witten 1987). despite its generally beneficial effects, open communication is sometimes difficult because subordinates may be reluctant to share sensitive or negative information with their superiors. this may be especially tme when subordinates are aware of possible violations of ethical standards by their co-workers, immediate supervisors, or superiors. organizational "blocks," such as uncertainty about organizational priorities, skepticism about the effectiveness of internal disclosure, and fear of retaliation, may inhibit communication from employees about issues of ethics and morality (waters 1978). in addition, employees may be uncertain as to legal protection available to them when they report their knowledge of the ethical violations of others. organizational leaders would seem to have a definite interest in removing such barriers so that employees feel free to share their concerns about sensitive legal and moral issues. by doing so, organizations may be able to avoid the negative consequences associated with external revelations of wrongdoing. dworkin and near (1987) point out that employees who disclose their knowledge of ethical problems internally provide organizations a chance to investigate and take corrective action. 'this paper focuses on one potential way to encourage employees to communicate their concerns about perceived wrongdoing, the internal voice mechanism. an internal voice mechanism, as defmed here, is any communication channel within the organization specifically designated as an appropriate channel for the expression of employees' concern about ethical and moral issues. such voice mechanisms might include "open-door" policies, suggestion programs, designated human resources officers, ethics boards, organizational ombudsmen, and anonymous telephone "hotiines," among others (graham 1986). one purpose of such voice mechanisms is to encourage internal communication about sensitive issues, which, while they may not affect complainants personally, do violate their sense of ethics and morality. graham (1986) points out that there are many types of voice mechanisms and that some may be more effective than others in encouraging internal disclosures. this paper presents the results of an empirical study concerning the relationship between internal voice mechanisms and employees' internal disclosures about ethical and spring 1994 barnett & cochran: internal voice mechanisms 37 moral issues. two research hypotheses are tested using data collected from 208 human resource executives, representing organizations in various industries across the country. results are discussed and implications are considered. theoretical background and research hypotheses employees have several alternatives when they become aware of wrongdoing within the organization. they may do nothing, either out of loyalty to the firm or fear of reprisals. they may leave the company in silent protest. or they may engage in employee voice, a communication effort to "change, rather than escape from, an objectionable state of affairs" (hirschman 1970; graham 1986). voiced concerns may be expressed through communication channels within the organization (internal whistleblowing). they may also be expressed to parties outside the organization such as regulatory agencies, law enforcement officials, and/or the media (external whistleblowing). employee whistleblowing is generally defined as the disclosure by organization members of illegal, immoral, or illegitimate practices under the control of their employers, to persons or organizations that may be able to effect action (near and miceli 1985). this definition has several crucial components. first, the subjects of whistleblowers' complaints are perceived violations of legal and/or ethical standards. therefore, voicing disagreement about company policies that do not concern principled issues is not whistieblowing. second, whistleblowers perceive that their employers have the ability to alter or stop the objectionable behavior. third, whistleblowers may communicate their concerns to parties inside or outside the organization. several theoretical perspectives have been suggested as possible frameworks within which to study whistleblowing, including the principled dissent (graham 1983; graham 1986) and political behavior perspectives (farrell and petersen 1982). currently, however, the most useful theoretical framework appears to be the prosocial behavior literature (miceli and near 1992). prosocial behavior is positive social behavior intended to benefit others (staub 1978). prosocial behavior differs from pure altruism, which requires that an act be totally unselfish, voluntary, and result in good outcomes. prosocial actors may have partially selfish motives, as their behaviors may benefit themselves as well as others, and may not always result in outcomes that society deems good (staub 1978). in an organizational context, prosocial behavior is behavior that is performed by an organizational member with the intent of promoting the welfare of the individual, group, or organization toward which it is directed (brief and motowidlo 1986). whistleblowing can be considered a form of prosocial organizational behavior since whistleblowers generally act in an attempt to benefit individuals, the organization, or society-at-iarge (dozier and miceli 1985). however, whistleblowers also may be motivated by selfish, as well as altruistic motives. they may seek personal gain from their behavior. in addition, the act of whistleblowing may not always be entirely voluntary, as some individuals are required to report wrongdoing (internal auditors, for example). and finally, whistleblowing does not always result in good outcomes. whistleblowers are sometimes mistaken, and innocent individuals may be accused. therefore, whistleblowing appears to meet the re38 journal ofbusiness strategies vol. 11, no.1 quirements of the prosocial behavior definition, but not the altruism standard (dozier and miceli 1985; miceli and near 1992). as a form of prosocial behavior, whistleblowing is likely to be influenced by many of the same individual and contextual variables that impact on other types of prosocial behaviors. for example, research evidence suggests that personality variables influence the likelihood that an individual will engage in prosocial behavior (smith, organ, and near 1983). theoretically, these personality traits should affect the whistleblowing process as well (miceli and near 1992). since prosocial actors are likely to weigh the consequences to themselves and others of acting, situational variables may also influence their decision. therefore, in an organizational context, variables such as the existence of role models, reinforcement contingencies, and organizational climate are possible antecedents to prosocial behavior {brief and motowidlo 1986). in general, organizational actions may serve several purposes in regard to prosocial behavior by employees. first, they may help employees clarify organizationally sanctioned behaviois. second, they may provide employees with instructions as to how to behave prosocially. third, may they increase the perceived efficacy of prosocial actions. and fourth, they may lessen employees' inhibitions to engage in prosocial behaviors. because whistleblowing is so controversial and sensitive, the signals sent by the organization are especially important. employees are likely to be confused and unsure as to the appropriate behavior when confronted with behavior that they believe unethical, and they are likely to look to the organization for guidance. what can the organization do to assure employees thai whistleblowing to appropriate parties within the organization wrongdoing is acceptable behavior? first, the organization should ensure that employees understand that the organization is committed to an ethical business climate, and supports employees' good faith internal disclosures of possible unethical or illegal acts. one way in which many organizations attempt to do this is through ethics codes, which often contain clauses that encourage employees to report knowledge of wrongdoing. evidence from one research study suggests that ethics codes that defme the reporting of unethical behavior as a role responsibility may increase internal reporting of wrongdoing ([revino and victor 1992). second, to make their support of internal disclosures more concrete and to clarify the appropriate manner in which employees should report their ethical concerns, some organizations have began to develop formal internal disclosure policies that specify in detail how employees should communicate their concerns and how the organization will respond (barnett and cochran 1991). such policies should provide employees with behavioral guidelines when they are confronted with possible wrongdoing. they may also lead to greater confidence in the procedural justice of the disclosure process, which should encourage greater levels of communication (victor, trevino, and shapiro 1993). empirical studies indicate that policies may also increase employees' perception that the company encourages disclosures (keenan 1990), and lead to an increase in internal disclosures and a decrease in external disclosures (barnett, cochran, and taylor 1993). also, overall levels of internal communication about perceived wrongdoing may be higher in organizations with formal policies than in organizations without such policies (barnett, et al. 1993). spring 1994 barnett & cochran: internal voice mechanisms 39 third, research indicates that prosocial behaviors are influenced by the extent to which the individual involved believes that action will be efficacious (dozier and miceli 1985; miceli and near 1992). empirical research suggests that the perceived responsiveness of organizations to employee concerns is associated with internal whistleblowing (miceli and near 1984; miceli and near 1988; miceli and near 1992; miceli, roach, and near 1988). organizations may be able to influence employees' perceptions of their responsiveness by creating formal internal disclosure policies (keenan 1990; barnett, et al. 1993). finally, organizations should attempt to break down employees' inhibitions about communicating their ethical concerns. studies indicate that many whistleblowers suffer reprisals at the hands of individuals within their organizations (jos, tompkins, and hays 1989; miceli and near 1989). research suggests that protecting employees from retaliation may be essential to an effective internal disclosure process (graham 1986; near and miceli 1985). perhaps the key component of internal disclosure policies are the voice mechanisms through which employees are to communicate their concerns. internal disclosure policies are likely to be ineffective if they do not designate specific voice mechanisms. empirical research suggests that policies should provide employees with several alternative communication channels. for example, spencer (1986) examined the relationship between the number of available internal voice mechanisms in several hospitals and the perceived effectiveness of the hospitals' problem resolution processes. employees in hospitals with a higher total number of voice mechanisms had a significantly higher perception of the effectiveness of the internal disclosure procedure. organizations whose internal disclosure policies include multiple internal voice mechanisms explicitly recognize factors that may inhibit employees from using certain communication channels. for example, some employees may have good relations with their superiors, and these employees may not hesitate to discuss sensitive issues with their supervisors. but other employees may feel inhibited in speaking to their superiors or may wish to voice concerns about actions of their superiors. these employees will probably be more likely to utilize voice mechanisms that allow them to disclose their concerns outside the chain of command. employees who are concerned about reprisals may be more likely to use anonymous voice mechanisms, such as telephone "hotlines." spencer (1986) concludes that ". . . when employees have many opportunities to voice dissent they appear to be predisposed to take advantage . . . and appear to consider procedures for problem resolution effective." therefore, based on the preceding discussion, the following research hypothesis is offered: research hypothesis 1in companies with fonnal internal disclosure policies, a higher number of alternative voice mechanisms will be positively associated with a higher perceived level of communication about ethical and moral issues. it seems reasonable that the !w of voice mechanism is also important in terms of influencing employees to report wrongdoing (graham 1986). one type of voice mecha40 journal ofbusiness strategies vol. 11, no.1 nism that may be particularly effective allows those who disclose ethical problems to remain anonymous. as noted previously, evidence suggests that employees who make sensitive disclosures often suffer negative consequences, making it imperative that organizations remove this barrier to internal communication. some of the more common forms of retaliation include ostracism, undesirable transfer, demotion, and even termination (parmerlee, near, and jensen 1982; near and jensen 1983; jos, et a1. 1989). anonymity is likely to lower employees' assessment of the possible personal costs involved in communicating their concerns internally, and increase the perceived effectiveness of the internal procedure (elliston 1982). there is some empirical evidence that suggests that anonymity may be an important component of effective internal voice mechanisms. miceli and near (1989) found that among government employee whistleblowers, 40 percent reported anonymously. johnson and pany (1981) surveyed 45 internal auditors and found that the auditors were more likely to disclose serious activities such as embezzlement, kickbacks, and bribes when they could remain anonymous. miceli, roach, and near (1988) found that government employees who made anonymous internal disclosures were more aware of internal channels and more confident that their identity would not be revealed. it seems logical to conclude that voice mechanisms that allow employees to bypass the chain of command and disclose their concerns anonymously may be relatively more effective in encouraging upward communication concerning ethical and moral issues. internal disclosure policies that specify that employees should communicate ethical and moral concerns to their immediate superior or to other superiors within the chain of command may be ineffective, since such requirements may increase the natural reluctance of employees to discuss very sensitive issues. employees may fear negative consequences, or may wish to avoid the complexity and publicity of a difficult and very public investigative process. in many cases the immediate superior is the subject of employees' concern. requiring employees to confront their superior will often stifle communication regarding ethical and moral issues. based on this discussion, the second research hypothesis is offered: research hypothesis 2in companies with internal disclosure policies, the existence of voice mechanisms outside the chain of command that allow employees to remain anonymous will be positively associated with a higher perceived level of communication about ethical and moral issues. research design the society for human resource management provided the names of 1,125 human resources executives, who were then contacted and asked to respond to questions concerning their companies' policies and procedures regarding the communication of ethical and moral concerns by employees. three hundred (300) responses were received, an overall response rate of approximately 26 percent. of these, 208 had a formal internal disclosure policy. the results of comparisons between companies with and without formal disclospring 1994 barnett & cochran: internal voice mechanisms 41 sure policies have been presented elsewhere (barnett, et al. 1993). only the 208 companies with formal policies were included in the present study. human resources executives were chosen for the survey because of their familiarity with company policies regarding employee disclosures and because their position allows them to accurately assess the level of internal disclosure by employees. respondents to the survey had spent an average of 10 years with their companies. all the respondents held managerial positions, and about 70 percent had attained the rank of vice president. roughly 95 percent of the responding companies had over 500 employees. two-thirds had more than 1,000, and 19 percent had more than 5,000 employees. responding companies represented a wide range of industries, including the manufacturing sector (34 percent), the service (28 percent), and the financial (21 percent). the society provided demographic information on their entire membership list. the demographic characteristics of the list were compared to the characteristics of the respondents. there were no statistically significant differences between the shrm membership and the respondents, other than those built into the design of the study (the study targeted upper-level executives in larger organizations). also, randomly selected non-respondents were telephoned, and information obtained from them was compared to the characteristics of the respondents. this comparison showed no significant differences between respondents and non-respondents. measures number of available voice mechanisms. respondents were asked to indicate internal voice mechanisms designated for employees to "communicate their knowledge of activities they perceive to be illegal, immoral, and/or unethical." voice mechanisms included immediate superiors, other officials within the chain of command, the personnel office, company ombudsmen, ethics committees, anonymous suggestion systems, and anonymous telephone hotlines. an "other" category was also included. if respondents checked the "other" category they were asked to list the additional voice mechanisms available. type of voice mechanism. the available voice mechanisms fell into three distinct categories. first, some voice mechanisms required employees to disclose information to the immediate superior and/or to others within the chain of command. these voice mechanisms were combined to form the "chain of command voice mechanisms" variable. other voice mechanisms were outside the chain of command but required employees to identify themselves when making a disclosure. these voice mechanisms were combined to form the "employee identified voice mechanisms" variable. two voice mechanisms were outside the chain of command and allowed employees to remain anonymous. these mechanisms were an anonymous employee suggestion procedure, and an anonymous telephone "hotline." these mechanisms were combined to form the "anonymous voice mechanisms" variable. each of the three variables was coded "0" if none of the voice mechanisms within that category were present. each variable was coded "i" if one or more of the voice mechanisms within that category was present. management responsiveness. this variable measured the perceived responsiveness of management to employee voice. it was included as a covariate in the present study, be42 j oumal ofbusiness strategies vol. 11, no. 1 cause a previous study indicated its possible association with internal disclosure (barnett et al. 1993). responsiveness was measured on a five-point, twelve-item likert scale. items on this scale attempted to assess the degree to which management encouraged, supported, and investigated employee concerns. responses on each item of the scale were summed and scaled to yield "responsiveness scores" ranging from 1 to 5 for each company. higher scores indicated relatively more responsiveness to employee concerns. the reliability coefficient alpha for the scale was .87. internal disclosures. the measure of internal disclosures was a five-point scale. respondents were asked to indicate their perception of the number of employee concerns voiced within the company. possible responses ranged from "1" = "no disclosures" to "5" = "very many disclosures." data analysis analysis of variance with covariates was used to test the research hypotheses. the perceived level of internal disclosures was the dependent variable. independent or grouping variables were the three distinct types of voice mechanisms. the covariates were the number of alternative voice mechanisms available and the level of management responsiveness to employee concerns. this research design allowed a comparison of the levels of internal disclosure in companies with and without each of the three types of voice mechanisms, and an assessment of the association between internal disclosures and the overall number of internal voice mechanisms. data analysis considered both main effects and interaction effects. results table 1 reports means, standard deviations, and correlations for the variables in this study. the mean number of voice mechanisms available was 2.95. the number of voice mechanisms available ranged from zero in some companies to eight in others. spring 1994 barnett & cochran: internal voice mechanisms 43 table 1: pearson correlations, standard deviations, and means (n=.208) variable #1 #.2 #3 #4 #5 #() 1. internal disclosure a 1.00 2. # of voice mechanisms b .16* 1.00 3. management responsiveness c .10 .07 1.00 4. chain of command voice mechanisms d .11 .65** .01 1.00 5. employee identified voice mechanisms d -.06 .23** .12 -.13 1.00 6. anonymous voice mechanisms outside the me d .24** .59** .09 .13 .18* mean 2.77 2.95 4.02 sid dev .60 1.56 .50 * p < .05 ** p < .01 a measured on five-point likert scale with 1 :;;: "no disclosures" and 5 == "very many disclosures" b number of voice mechanisms ranged from 0 to 8. e measured on :five~point likert scale with 1 being relatively unresponsive and 5 being extremely responsive to employee concerns d measured as dummy variables with 0 = no voice mechanisms of a particular type and 1 = the presence of one or more voice mechanisms of a particular type correlations, between the variables of interest were generally in the predicted direction. one hundred :fifty of the 208 respondents reported the existence of voice mechanisms within the chain of command (72 percent). forty of the companies had voice mechanisms outside the chain of command which required employees to identify themselves (19 percent). seventy of the companies had voice mechanisms outside the chain of command which provided employees with the opportwlity to remain anonymous (34 percent). most companies had more than one type of voice mechanism available. twenty-eight 44 joumal ofbusiness strategies vol. 11, no.1 reported no voice mechanisms, which raises a question as to the comprehensiveness of their internal disclosure policy. tests of research hypotheses hypothesis one. the results of the analysis of variance are summarized in table 2. the first hypothesis stated that a higher number of voice mechanisms would be associated with a higher perceived level of communication about ethical and moral issues. results supported this hypothesis (p < .02). the greater the number of voice mechanisms available to employees, the higher was the perceived level of internal disclosures by employees. table 2: analysis of variance results of the relationship between internal voice mechanisms and the perceived level of employees' internal disclosure 2.1 .04 f significance level source of sum of degrees of variation squares freedom covariates 2.57 2 # ofvm 1.86 1 mgt. resp. .56 1 main effects 2.83 3 cacvm .16 1 emp. ided vm .53 1 anony. vm 1.99 1 explained 6.25 9 residual 63.72 189 multiple r2 = .08 multiple r = .28 3.8 5.5 1.6 2.8 .2 1.6 5.9 .02 .02 .20 .04 .49 .21 .02 eta .12 .05 23 cae vm = voice mechanisms within the chain of command emp. ided vm = voice mechanisms outside the chain of command which require employees to identify themselves anony. vm = voice mechanisms outside the chain of command which allow employees to remain anonymous hypothesis two. the second hypothesis stated that anonymous voice mechanisms outside the chain of command would be associated with a higher perceived level of communication about ethical and moral issues. the analysis of variance supported h2 (p < .02). when companies provided one or both of the anonymous voice mechanisms, reported levels of internal disclosures were significantly higher. spring 1994 barnett & cochran: internal voice mechanisms discussion 45 all the companies considered in this study had developed formal internal disclosure policies of some kind a previous study using this data base compared the reported level of internal disclosures in the 208 companies with formal policies to the 92 companies with no formal policies and found significantly higher levels of reported internal disclosures in companies with internal disclosure policies (barnett et al. 1993). the current study reveals that in those companies with formal policies, the number and~ of voice mechanisms the policy designates is associated with the level of communication about ethical and moral issues. several implications may be drawn from these results. first, results seem to largely conftrm that as a form of prosocial behavior, whistleblowing is influenced by organizational actions which sanction internal whistleblowing and remove barriers that inhibit communication about ethical issues. results also confirm previous conceptual research on whistleblowing that suggests providing a variety of internal voice mechanisms as part of an internal disclosure policy is an effective strategy to increase communication about ethical and moral issues. companies wishing to generate employee communication concerning such issues in order to identify and correct wrongdoing within the organization may be well advised to provide such mechanisms. results also suggest that anonymity may be a key factor that influences the actions of employees when confronted with questionable activities. the anonymous voice mechanisms in this study, anonymous telephone "hotlines" and employee suggestion/complaint boxes, are very uncomplicated and non-threatening to use. the anonymity of these types of disclosures serves as perhaps the most effective deterrent to possible retaliation. companies who are serious about discovering and correcting wrongdoing within their organizations might consider the establishment of some type of anonymous voice mechanism in addition to other available communication channels. although such anonymous voice mechanisms may encourage internal disclosures, they pose a difficult ethical dilemma for the organization. for example, anonymous disclosures could create a climate of suspicion within the organization. also, anonymous disclosures are usually more difficult to investigate, and therefore the validity of charges is more difficult to determine. finally, anonymous disclosures may violate standards of justice. individuals with malicious motives could, behind the protective wall of anonymity, hurl irresponsible charges against innocent people within the organization. those accused would have little opportunity to confront their accusers (elliston, 1982). how does the organization achieve its goal of increasing its awareness of legitimate employee concerns, which anonymous voice mechanisms appear to do, and at the same time prevent abuses which may harm the organization and violate fundamental rights of individuals? while there are no easy answers to this question, several suggestions come to mind. first, the internal disclosure policy should stress that anonymous channels are reserved for relatively serious wrongdoing. second, the policy should require employees to provide evidence to substantiate their claims, or to at least provide necessary leads to facilitate the investigative process. finally, the company should strive to create a communication climate that lessens the need for anonymous disclosures. 46 journal ofbusiness strategies vol. 11, no.1 results suggest that in the absence of anonymous voice mechanisms, other types of voice mechanisms may be ineffective in generating internal disclosure of sensitive issues. employees may be inhibited by their fear of retaliation or their reluctance to confront their superior. employees may perceive that established procedures are not effective, or that they do not have a high degree of procedural or distributive justice. companies should recognize that if they depend exclusively on channels that require employees to openly identify themselves, they may be stifling employee communication about ethical and moral issues, and that wrongdoing within the organization may go unreported. there were several limitations inherent in the research design. the study relied exclusively on the perceptions of the human resources executive from each company. these managers should be in a relatively good position to assess the available voice mechanisms and the level of internal disclosures. but, as members of the management team, respondents may have desired to provide socially desirable answers to the inquiries on the survey. every effort was made to assure respondents of the confidentiality of their responses, thus removing incentives to make their companies appear ideal. and in fact, respondents seemed very candid, sometimes including handwritten elaborations of their answers. more objective measures of internal disclosures are needed, however, and this should be a focal point for future research. the study was cross-sectional, and therefore no conclusions about causality can be made. although the present study seems to indicate that the establishment of internal voice mechanisms encourages communication about ethical and moral issues, it is possible that such communication channels are established precisely because the level of employee disclosures is already high. future research is needed to better explain the possible relationships identified here. although correlations among variables were in the predicted direction, relationships did not appear to be very strong. explained variance was relatively low. other variables not included in the present analysis certainly affect the level and direction of employee voice. future studies should concentrate on identifying and testing other possible influences on internal employee disclosures. in an era of increased concern for employee rights, and increased legal protection for whistleblowers, research into the effect of organizational actions to stimulate internal discussion of ethical and moral issues can provide needed guidance to executives. researchers should continue efforts to provide this guidance. references barnett, t. r. and d. s. cochran. 1991. "making room for the whistleblower." hr magazine, 36(1): 58-61. barnett, t. r., d. s. cochran, and t. g. taylor. 1993. 'the internal disclosure policies of private-sector employers: an initial look at their relationswp to employee whistle-blowing." jour~ nal of business ethics, 12: 127-136. spring 1994 barnett & cochran: internal voice mechanisms 47 brief, a. p. and s. j. motowidlo. 1986. "prosocial organizational behaviors." academy of management review, 11: 710-725. dozier, j. b. and m. p. miceli. 1985. "potential predictors of whistieblowing: a prosocial behavior perspective."academy of management review, 10: 823-836. dworkin, t. m. and j. p. near. 1987. "whistleblowing statutes: are they working?" american business law journal, 25: 241-263. elliston, f. a. 1982. "anonymity and whistleblowing." journal of business ethics, 1: 167-177. eisenberg, e. m. and m. g. witten. 1987. "reconsidering openness in organizational communication." academy of management review, 12: 418-426. farrell, d. and j. c. petersen. 1982. "patterns of political behavior in organizations." academy of management review, 7: 403-412. graham, j. w. 1986. "principled organizational dissent: a theoretical essay." in b. staw and l. l. cummings eds., research in organizational behavior, 1-52. jai press inc. graham, j. w. 1983. "principled organizational dissent." unpublished doctoral dissertation, northwestern university. hirschman, a. o. 1970. exit. voice and loyalty: responses to declines in firms, organizations, and states. cambridge: harvard university press. johnson, d. a. and k k pany. 1981. "expose or cover-up: will an employee blow the whistle?" management accounting, 59: 32-36. jos, p. h., m. e. tompkins, and s. w. hay. 1989. "in praise of difficult people: a portrait of the committed whistleblower." public administration review, november-december: 552-561. keenan, j. p. 1990. "upper-level managers and whistleblowing: determinants of perceptions of company encouragement and information about where to blow the whistle." journal of business and psychology, 5: 223-235. likert, r. 1967. the human organization. new york: mcgraw-hill. mayo, e. 1937. the social problems of an industrial civilization. cambridge, ma: harvard university press. miceli, m. p. and j. p. near. 1992. blowing the whistle. riverside, new jersey: macmillian publishing company. miceli, m. p. and j. p. near. 1989. "the incidence of wrongdoing, whistleblowing and retaliation: results of a naturally occurring field experiment." employee responsibilities and rights journal, 2: 91-108. 48 journal ofbusiness strategies vol. 11, no.1 miceli, m. p. and j. p. near. 1988. "individual and situational correlates of whistleblowing." personnel psychology, 41: 267-281. miceli, m. p. and j. p. near. 1985. "characteristics of organizational qimate and perceived wrongdoing associated with whistleblowing decisions." personnel psychology, 38: 525-544. miceli, m. p., b. l. roach. and j. p. near. 1988. "the motivations of 'deep throat': the case of anonymous whistleblowers." public personnel psychology, 17: 281-296. miceli, m. p. and j. p. near. 1984. "the relationship among beliefs, organizational position and whistleblowing: a discriminant analysis." academy of management journal, 27: 687-705. near, j. p. and t. c. jensen. 1983. "the whistleblowing process: retaliation and perceived effectiveness." work and occupations, 10: 3-28. near. j. p. and m. p. miceli. 1985. "organizational dissidence: the case of whistleblowing." journal of business ethics, 4: 1-16. parmedee, m. a.. j. p. near, and t. c. jensen. 1982. "correlates of whistleblowers' perceptions of organizational retaliation." administrative science quarterly, 27: 17-34. redding. w. c. 1972. communication in the organization: an interpretive review of the research. new york: industrial communication council. roethlisberger, f. and w. dickson. 1939. management and the worker. cambridge, ma: harvard university press. smith, c. a., d. w. organ, and j. p. near. 1983. "organizational citizenship behavior: its nature and antecedents." journal of applied psychology, 68: 653-663. spencer, d. g. 1986. "employee voice and employee retention." academy of management journal. 29: 488-502. staub. e. 1978. positive social behavior and morality: volume 1: social and personal influences. new york: academic press. trevino. l. k and b. victor. 1992. "peer reporting of unethical behavior: a social context perspective. academy of management journal, 35: 38-64. victor. b., l. k. trevino, and d. l. shapiro. 1993. "peer reporting of unethical behavior: the influence of justice evaluations and social context factors." journal of business ethics, 12: 253263. waters, j. a. 1978. "catch 20.5: corporate morality as an organizational phenomenon." organizational dynamics, 6 spring: 3-19. internal voice mechanisms and communication from employees about ethical issues evaluating merger performance on a longitudinal basis: an empmical investigation ram subramanian grand valley state university allendale, michigan essam mahmoud american graduate school of international management glendale, arizona mary s. thibodeaux university of north texas denton,texas bahman ebrahimi university of north texas denton, texas introduction in the past, researchers from a myriad of disciplines have attempted a number of studies on merger performance and related issues. even using a wide range of performance measures (e.g., stock returns, return on investment, risk, market share), the essence of their results was that mergers benefit the acquired firm and its stockholders, but do not result in any significant benefit to the acquiring firm or its stockholders ([14], [16]). however, researchers from the field of strategic management have recently found evidence that contradicts the earlier findings of scholars who were predominantly from the finance discipline. the strategic management researchers ([21], [32]), using the same methodology as the finance scholars but with different time frames and slightly different assumptions, have concluded that mergers yield significant benefits to stockholders of both firms. thus, a question currently exists as to whether mergers benefit only one (the acquired) or both firms involved. a priori, from the recent merger wave [4] it would appear as though both firms benefit. the clarion call for researchers in the area of mergers and acquisitions research is for more micro studies (focusing on individual industries) rather than macro approaches (pooling firms from different industries into one single sample) that examine merger outcomes from a longitudinal perspective ([9], [29]). this is seen as a way of resolving the current controversy that exists regarding merger performance. the purpose of this study was to measure merger performance on a longitudinal basis using a micro perspective. specifically, this study looked at the performance of 88 journal olbusiness strategies vol. 9, no.2 a sample of mergers drawn from the food and kindred products industry, standard industrial classification code 20, for a period of five years before and five years after the mergers using two performance measures. the performance measures, namely market returns to stockholders and return on investment, have been used extensively in the literature ([17], [18], [21], [24], [36]) to study the performance of mergers, albeit on macro samples. because previous research provides conclusive support for increased returns following a merger to stockholders of acquired firms ([14], [16], [21]), this study uses the two measures mentioned earlier to determine returns only to the acquiring firms' stockholders. also, because the effect of a merger can best be felt only in the long run [29], performance was measured for a period of five years after the merger and compared to performance five years prior to the merger. such a longitudinal scope ensured that the anticipated synergies ([6], [7]) have had a chance to be effective. theoretical framework while table 1 provides detailed descriptions of an illustrative list of studies on merger performance, this section discusses those studies that have a direct impact on the current work and help in the development of the research hypotheses. table 1: mustrative studies on merger performance author(s) measure: returns halpern (1983) jensen and ruback (1983) lubatkin (1983) methodology conceptualreview of literature. conceptualreview of literature. conceptualreview of literature. findings while empirical evidence points out that mergers bring significant returns to stockholders of acquired firms, not enough evidence exists to suggest the same for the acquiring firms' stockholders. stockholders of acquired firms benefit, but not stockholders of acquiring firms. empirical studies point out that all significant benefits go to the acquired firm. fall 1992 subramanian, et al: evaluating merger performance table 1: d1ustrative studies (continued) 89 lubatkin (1987) singh and montgomery (1987) measure: risk langeteig, haugen, and wichern (1980) lubatkin and o'neill (1987) empiricalarchival data. sample size 439 acquiring firms and 340 acquired firms. event study approach using market-based performance measure. empiricalarchival data. 105 firms from the period 1975-1980. used a market-based performance measure. empiricalarchival data. sample of 149 firms from the period 19291969. used a selfdeveloped measure of risk. empiricalarchival data. sample of 297 firms from the period 19541973. used beta as a measure of risk. however, the strategic management literature suggests that the acquiring firms get tremendous benefits. these claims have not been supported by empirical evidence. mergers do lead to permannent gains in stockholder value for both acquiring and acquired rums, but differences not significant across merger types. acquired rums in related acquisitions performed better than acquired firms in unrelated acquisitions. mergers increase the risk for the merged firm. part of the risk is due to increased leverage, other parts not explained by study results. lowered risk is a valid rationale for mergers. all mergers increased the unsystematic risk for the merged fum, while related acquisitions lowered the systematic and total risks. 90 journal ofbusiness strategies table 1: lliustrative studies (continued) vol. 9, no.2 measure: market share mueller (1985) empiricalarchival data. sample of 332 firms from the period 1950-1972. mergers result in a loss of market share to the acquired firm. hopkins (1987) other measures montgomery and wilson (1986) neely and rochester (1987) empiricalarchival data. sample of 64 firms from fortune 1000 for 1965. empiricalarchival data. samples of 434 firms that were aquired during 1967-1969. empiricalarchival data from 37 s&ls that merged matched with 37 that did not. market share decreased for the acquired firm after the merger except in the case of marketing-related mergers where it went up. used resale value to measure performance. not enough evidence to suggest that unrelated acquisitions are bad. merged savings and loans firms showed significant increases in profits and return on net worth. in their extensive review of the literature on merger performance, subramanian, ebrahimi, and lbibodeaux [37] emphasized the existing controversy regarding merger benefits. halpern [14] reviewed finance literature on merger performance using an event study approach. he concluded that there exists strong evidence to suggest that higher than normal returns accrue to stockholders of acquired firms following a merger. the findings of the reviewed literature by halpern [14] were, however, inconclusive regarding the returns to the stockholders of acquiring firms. while langeteig [18] and michel, shaked, and yobaccio [26] found empirical evidence to suggest that the returns to the stockholders of acquiring firms actually declined after a merger, mandelkar [24] found that the returns were similar to other investments of comparable risk. lubatkin [21] found evidence to suggest gains accruing to stockholders of both the acquired and the acquiring firms. pettway and yamada [32] found similar evidence in their study of mergers in japan. their conclusion is also supported by the empirical fall 1992 subramanian, et al: evaluating merger performance 91 research of burgman [5], chatterjee [7], shelton [35], and singh and montgomery [36]. thus, while the finance and strategic management disciplines agree on returns to stockholders of acquired firms, they are divided as to the returns to stockholders of acquiring firms. table 2 summarizes the conclusions of prior researeh on merger performance. table 2: summary of conclusions from prior research on merger performance using market return as measure (a) inconclusive evidence regarding merger benefits researcher(s) *mandelker (1974) langeteig (1978) michel, shaked and yobaccio (1983) halpern (1983) jensen and ruback (1983) (b) conclusive evidence regarding merger benefits researcher(s) lubatkin (1983) burgman (1984) pettway and yamada (1986) chatterjee (1986) singh and montgomery (1987) lubatkin (1987) shelton (1988) methodology empirical event study empirical event study empirical event study review of literature review of literature methodology review of literature empirical event study empirical event study empirical event study empirical event study empirical event study empirical event study *actually concluded that mergers provided returns comparable to investments of similar risk several explanations, such as different time frames (daily stock data versus monthly stock data) and the use of "clean" data (discarding firms engaged in multiple mergers from sample) by the finance researchers, have been offered to explain these conflicting results [23]. additionally, recent researchers have emphasized the need to control for industry effects [10] and also to examine merger performance using a longitudinal instead of a cross-sectional time frame in order to fully capture its effect. 92 journal ofbusiness strategies methodology vol. 9, no. 2 the study method used for this research was statistical analysis of historical data obtained from published sources. while prior studies ([21], [36]) have used samples of fmns drawn from a variety of industries, the analysis group for the current study was composed entirely of fmns in the food and kindred products industry (sic code 20). this study considered all publicly reported mergers and acquisitions (for which data were available) for the period from 1968 through 1984. the united states federal trade commission's (ftc) large merger series contained in its statistical report on mergers and acquisitions [11] as well as "merger rosters" of various issues of mergers and acquisitions were used to identify target firms in the food and kindred products industry. there are many gaps in the publicly reported mergers and acquisitions activity data. therefore, some firms were eliminated from the population of firms that were engaged in merger and acquisition activity during the period from 1968 to 1984. although this reduced the sample size, the number of mergers and acquisitions that occurred during this period remained large enough for statistical analysis. based on the guidelines suggested by the ftc [11], the sample of firms was classified into vertical, horizontal, product extension, market extension, and pure conglomerate merger types. a vertical merger occurs when a firm merges with or acquires a firm. that supplies it with inputs or are customers for its outputs. a merger or acquisition involving competitors is called a horizontal merger. merging with or acquiring a firm. that makes related products involves a product extension merger. when a firm merges with or acquires another fum for the purpose of increasing its market coverage, it is involved in a market extension merger. finally, merging with or acquiring a firm that is in a totally unrelated industry is an example of a pure conglomerate merger. this classification system has been used by other researchers [e.g., 21] to study merger pedormance. the dependent variable examined in this research study was pedormance. for the variable pedormance, two measures were used: accounting return on assets and market return to stockholders. the accounting return on assets (roa) measure was calculated based on after-tax earnings (including extraordinary items) on year-end book value of total assets. the use of accounting-based pedormance measures have been criticized in the literature ([14], [23], [27]). their use in this study is, however, justified on the ground that they measure an important aspect of pedormance, namely, the earnings stream that is at the disposal of the acquiring firm. as a percentage of the assets employed to earn the return. as an ex-post facto measure, return on assets complements an ex-ante measure such as market return to give a complete picture of pedormance. while there are several methods to measure market pedormance [38], this study used the relationship suggested by kusewitt [17] in his work on factors associated with acquisitions pedormance. the justification for using this formula was that it is simple fall1992 subramanian, et al.: evaluating merger performance 93 to understand, easy to use, and is based on sound theoretical grounds. moreover, it has been used to measure merger and acquisition performance in the past [e.g., 17]. using kusewitt's [17} formula, the individual year's market return was computed for each acquiring firm as follows: r = (pt + dt ) --------------1 where, pt-l r = return on acquirer's stock for the year, pt = arithmetic mean of high and low market price per share of stock in calendar year t, pt-l = arithmetic mean of high and low market price per share of stock for the previous year, and dt = dividend per share in year t. the market performance of a fliid for a period of five years before and five years after a merger was obtained by taking the geometric mean of the individual years' returns. the geometric mean was used because it is a more conservative average than the arithmetic mean and is better suited to account for outliers [8}. merger type was the independent variable used in the study. based on the categorization scheme suggested by the ftc [11}, the sample of firms was grouped into the five merger types mentioned previously. this independent variable assessed the impact of merger type on performance. using moody's industrial manual and value line investment surv(!y. data on each acquiring company's net income, year-end book value of assets, high and low stock prices, and dividends per share were obtained. because both moody's industrial manual and value line investment survey report data only on selected publicly held companies, several fliids had to be eliminated from the list. incomplete data also resulted in the elimination of another set of firms. finally, 80 of a possible 138 firms for which data were complete were assembled for the study. since meeting the data requirements was the criterion employed in choosing firms, the sample was not a random sample in the probabilistic sense and any resulting biases could not be avoided. results the descriptive statistics for the analysis group are shown in table 3. as indicated by the means and standard deviations, the range of performance in the analysis group is remarkably large, particularly when one considers that this is over a ten-year period. some acquiring firms did extremely well with their acquisition program while others did very poorly. this is indicated very clearly, especially by the jump in the average market return from 9.54 percent before merger to 30.44 percent after merger. this performance variability is consistent with other research fmdings [e.g., 17]. the descriptive statistics broken down by the type of merger are shown in table 4. 94 journal ofbusiness strategies table 3: descriptive statistics of analysis group (0 =so) vol. 9, no.2 return on assets mean standard deviation market return mean standard deviation • significant at the go.05 level before 6.66 2.92 9.54 25.82 f 4.41* 9.46* after 7.92 3.58 30.44 24.47 table 4: descriptive statistics of analysis group by merger types (n = so) merger typea 1 2 3 4 5 f mean roa before 5.49 7.31 6.80 6.78 6.72 sd before 1.32 4.01 3.31 2.63 2.55 1.05b mean roa after 6.91 7.65 7.34 12.33 8.06 sd after 2.16 2.62 3.02 6.02 4.01 mean mkt. ret. before sd before mean mkt. ret. after sd after 7.20 40.18 39.87 48.91 20.23 33.35 34.83 26.79 12.57 18.75 32.19 17.61 6.80 11.79 27.25 11.97 4.68 29.45 1.7~ 23.34 14.82 n 16 12 22 10 20 a 1 = horizontal, 2 = vertical, 3 = product extension, 4 = market extension, and 5 = pure conglomerate b not significant at the go.05 level yijk = y = t· =i fall 1992 subramanian, et al: evaluating merger performance 95 yertical mergers reported the highest roa before merger, and market extension mergers showed the highest roa after merger. while vertical mergers showed the highest market return before merger, the mean market return after merger was the highest for horizontal mergers. the standard deviations for market return was much higher than those for roa two hypotheses were generated from a review of the literature. the first dealt with merger performance in general while the second sought to identify differences in performance among merger types. the prior literature is not conclusive as to the benefits accruing to the stockholders of the acquiring firm, nor to differences in merger performance across merger types [21]. therefore, ho1: in the food and kindred products industry, mergers do not result in any change in performance by acquiring firms following the merger. ho2: in the food and kindred products industry, there is no difference in performance among merger types. the following analysis of variance (anoya) model was constructed to test the hypotheses: i.l. +ti +bj +ck(i) +l:iik where, performance measure, i.e., market return or roa, merger type (1 = horizontal, 2 = vertical, 3 =market extension, 4 = product extension, and 5 = conglomerate), b· = time period where, 1 = before merger 2 = after merger, ck(i) = company k within merger type i, and l:ijk = error term. the imt hypothesis was rejected at the ao.05 level (f = 9.46, pr>f = 0.0034 for market return; f = 4.41, pr>f = 0.0653 for roa) providing support for the contention that mergers did result in improved performance on both measures. however, neither performance measure yielded results to indicate that the difference among merger types was statistically signiftcant. this is consistent with prior research findings by lubatkin [21]. discussion this study attempted to analyze merger performance within an industry-specific domain. using two performance measures, it offered significant statistical support for the hypothesis that mergers benefit the acquiring firm and its stockholders. this evidence, while being consistent with lubatkin's [21] findings, contradicts earlier results from the finance discipline reported by halpern [14] and jensen and ruback [16]. this could be attributed to two possible reasons. 96 journal ofbusiness strategies vol. 9, no.2 first, researchers from the finance discipline used short time frames to measure merger performance--the most common time period used was 180 days before and 180 days after the merger [25]. presumably, this short time period was used to reduce bias associated with extraneous events. because market models have been shown to factor in the effects of time [13], it is argued by strategic management researchers [e.g., 23] that a five-year time period captures the strategic impact of a merger better than a shorter time frame. thus, lubatkin's [21] study, using a five-year time frame both before and after the merger, reported results that contradicted earlier findings of researchers from the finance discipline. second, none of the earlier researchers studying merger performance controlled for industry effects. in other words, their samples included firms from a myriad of industries with no countervailing checks-and-balances to account for this diversity that may have contaminated the results. lubatkin [21] argues that market models adjust for industry variation. this, of course, assumes a perfectly efficient market. but, other researchers ([3], [10]) report that inefficiencies in the market create "noise," rendering it less than perfect. limiting the sample to firms from only one industry is one of the ways of controlling for industry effect [10]. in this study, the average roa for the focus group increased from 6.66 percent to 7.92 percent after the merger-an increase of 18.9 percent compounded for the fiveyear period. a look at the standard deviation (2.92 before and 3.58 after the merger) indicates that the range of performance in the analysis group was remarkably large. some a<xj.uiring firms did extremely well with their a<xj.uisition programs, while others did very poorly. one possible cause of this fluctuation in performance within the analysis group is the fact that for a merger to be successful both pre-merger planning and post-merger integration are important. international multifoods is a case in point. in the 19708, the company's strategy was diversification away from flour milling by a<xj.uiring consumer foods companies. the strategy did not succeed because the company failed to anticipate the oncoming recession and was timid in the implementation of its plans. the average market return for the focus group increased from 9.54 percent to 30.44 percent after the merger-an increase of more than 219 percent over the five-year period. again, the large standard deviations (25.82 before and 24.47 after the merger) reflect the variance in performance among the target group. market return is an exante measure while roa is an ex-post facto measure. in other words, while roa measures the performance of the firm after the event, market return is an anticipatory measure. stockholders push the market price up or down depending upon their perception of the effects of a merger on a firm. therefore, market return reflects the net change in the wealth of stockholders during the period under study after factoring in the anticipated benefits that propelled the firm to merge or a<xj.uire in the first place, as well as the price paid to the a<xj.uired firm. while the market return for firms such as coca cola and quaker oats increased more than 200 percent during the study period, stockholders either did not perceive beatrice's mergers to be strategically viable or felt that the price paid was too steep. fa1l1992 subramanian, et al.: evaluating merger performance 97 this is reflected by the market price for beatrice, which actually decreased in the period following its merger. in some cases, a comparison of the two measures proved very interesting. in the early 198os, campbell soup acquired several food companies including snow king frozen foods and mrs. paul's kitchens. while the stockholders perceived this move as beneficial to them (as reflected by the market return which more than tripled during this period), in effect the rda actually decreased from 9.2 percent prior to these acquisitions to 8.2 percent after they were acquired. therefore, while these acquisitions did not help the company's bottom line, they were perceived as strategically sound by the stockholders. in a majority of cases, however, the two performance measures moved in the same direction and, therefore, were consistent. like lubatkin's [21] findings, this study also did not provide empirical support for the contention that one type of merger was better than the other. in other words, there were no significant differences among merger types at the 0.0.05 level. one possible explanation for this is that investors may evaluate mergers on characteristics other than market and product relatedness. some of the characteristics identified by earlier researchers are the quantity of human capital acquired ([16],[31]), the structural characteristics of the acquired market [12], and the competitive position of the acquired business in each of their respective markets [33]. in addition, the lack of significant difference in roa among merger types underscores the importance of post-merger integration on the acquiring firm's bottomline. more than the type of merger, it is the management of the merger that affects the acquiring firm's performance. two conclusions about the food and kindred products industry emerge from the study. the first is that mergers do benefit the stockholders of both the acquired as well the acquiring firms. the second conclusion is that there does not appear to be a difference in performance across the different types of mergers. the important implication of these two conclusions is that a merger is a viable strategic alternative for improving financial and market performance regardless of the type of merger used. but, to get the most out of a merger, post-merger integration is vital. the human aspect of mergers is an important factor that oftentimes determines the success of such endeavors. mergers are trying times for employees of both the acquired and the acquiring firms. fear of job loss or a loss of identity are very pressing concerns for employees of both firms following a merger announcement. therefore, the financial and strategic success of a merger depends largely on post-merger integration. because the study used firms from one industry, its findings are not generalizable across other industry groups. it is also possible that by using other performance measures (such as ability to attract capital and technology, access to markets, etc.) the results could have been different. there are several areas where further research on merger performance can be done. one, as suggested above, is to use performance measures other than roa and market return. such a study could survey the top managers of the acquiring firm to determine their objectives for the merger and empirically analyze if in fact their objectives were achieved. also, using other methods for controlling for industry effects, such as 98 journal ofbusiness strategies vol. 9, no.2 stratified samples and measuring all critical dimensions in order to isolate those that are being studied [10], is a research direction that would lead to more generalizable results. references 1. adams, w. and brock, j.w. daneerous pursuits: mer&e1's and acquisitions in the ale of wall street. new york: pantheon books (1989). 2. berenson, m.l. and levine, d.m. statistics for business and economics. englewood cliffs, new jersey: prentice hall (1990). 3. black, f. "noise." journal of finance, vol. 41 (1986), pp. 529-543. 4. bremner, b. "the age of consolidation." business week (october 14, 1991), pp.86-94. s. burgman, r.j. "a strategic explanation of corporate acquisition success." ph.d dissertation, purdue university, indiana (1983). 6. chang, p.c. "a measure of the synergy in mergers under a competitive market for corporate control." atlantic economic journal, vol. 16, no.2 (1986), pp. 59-62. 7. olatterjee, s. "types of synergy and economic value: the impact of acquisitions on merging and rival firms." stratelic man.lement journal, vol. 7, no.2 (1986), pp. 119-139. 8. clarke, c.t. and scbkade, i...i... statistical analysis for administrative decisions. oeveland, ohio: south west publishing (1974). 9. datta, o.k., rajagopalan, n. and rasheed, abdul ma "diversification and performance: critical review and future directions." journal of mana~ment studies, vol. 28, no.5 (1991), pp. 529-558. 10. dess, 0.0., ireland, r.d., and hitt, ma "industry effects and strategic management research." journal of mana~menl vol. 16, no.1 (1990), pp. 7-27. 11. f. t. c. statistical re.port on mer.&ers and acquisitions. washington: bureau of economics (1980). 12. galbraith, c.s., and stiles, c.h. "merger strategies as a response to bilateral market power." academy of management journal vol. 17, no.3 (1984), pp. 511-524. 13. oonedes, n.j. "evidence on the informational context of accounting numbers: accounting-based and market-based estimates of systematic risk." journal of financial and quantitative analysis, vol. 8, no.3 (1973), pp. 407-433. fa1l1992 subramanilln, et al: evaluating merger performance 99 15. hopkins, h.d. "acquisition strategy and the market position of acquiring firms." strategic management journal vol. 8, no. 6 (1987), pp. 535-547. 16. jensen, m.c., and ruback, r. "'the market for corporate control: the scientific evidence." journal of financial economics, vol. 11 (1983), pp. 3-50. 17. kusewitt, j.b., jr. "an exploratory study of strategic acquisitions factors relating to performance." strate~ management journal vol. 6 (1985), pp. 151-169. 18. langeteig, t. "a three-factor performance index to measure gains from merger." journal of financial economics, vol. 6 (1978), pp. 365-383. 19. langeteig, t., haugen, r.a. and wichern, d.w. "mergers and stockholder risk." journal of financial and ouantitative analysis, vol. 15 (1980), pp. 689-710. 20. lubatkin, m. "mergers and the performance of the acquiring firm." academy of management review, vol. 8, no. 2 (1983), pp. 218-225. 21. lubatkin, m. "merger strategies and stockholder value." strategic management journal vol. 8 (1987), pp. 39-53. 22. lubatkin, m. and o'neill, h.m. "merger strategies and capital market risk." academy of management journal, vol. 30, no. 4 (1987), pp. 665-684. 23. lubatkin, m., and shrieves, r.e. "towards reconciliation of market performance measures to strategic management research." academy of management review, vol. 11, no. 3 (1986), pp. 497-512. 24. mandelkar, g. "risk and return: the case of merging firms." journal of financial economics, vol. 1 (1974), pp. 303-335. 25. michel, a and shaked, i. "evaluating merger performance." california management review, vol. 27, no. 3 (1985), pp. 109-118. 26. michel, a., shaked, i., and yobaccio, b. "evidence of stockholder returns from alternative merger types." working paper, boston university school of management (1983). 27. montgomery, ca., and wilson, v.a. "mergers that last: a predictable pattern?" strategic management journal vol. 7, no.1 (1986), pp. 91-96. 28. mueller, d.c. "mergers and market share." review of economics and statistics, vol. 67, no. 2 (1985), pp. 259-267. 100 journal ofbusiness strategies vol. 9, no. 2 29. napier, n.k. "mergers and acquisitions, human resource issues and outcomes: a review and suggested typology." journal of mana~ement studies. vol. 26, no.3 (1989), pp. 271-289. 30. neely, w.p. and rochester, d.p. "operating performance and merger benefits: the savings and loan experience." financial review, vol. 22, no.1 (1987), pp. 111-130. 31. paine, f.t. and power, oj. "merger strategy: an examination of drucker's five rules for successful acquisitions." strategic management journal, vol. 6 (1984), pp. 99-110. 32. pettway, r.h., and yamada, t. "mergers in japan and their impact upon stockholders' wealth." financial management vol. 15, no.4 (1986), pp. 43-52. 33. porter, m. e. competitive strategy. new york: free press (1980). 34. salter, m. s. and weinhold, wa diversification through acquisition: strategies for creating economic value. new york: the free press (1979). 35. shelton, lm. "strategic business fits and corporate acquisitions: empirical evidence." strategic management journal vol. 9, no.3 (1988), pp. 279-287. 36. singh, h., and montgomery, c.a. "corporate acquisition strategies and economic performance." strategic management journal vol. 8 (1987), pp' 377-386. 37. subramanian, r., ebrahimi, b., and thibodeaux, m.s. "research on merger performance: a review and a critique." international journal of commerce and management. forthcoming. 38. weston, j.f., chung, k.s. and hoag, s.e. mergers. restructuring, and corporate control. englewood cliffs, new jersey: prentice hau (1990). evaluating merger performance on a longitudinal basis: an empirical investigation understanding medical service outshopping: can psychographics enhance understanding? robert a. swerdlow mark guidroz marleen roosth swerdlow lamar university beaumont, texas the two spatial aspects of consumer shopping behavior, intramarket and intermarket patronage, have been widely studied by researchers. intramarket patronage, deals with the movement of consumers within a local market and is of particular interest when selecting retail shopping sites, while intermarket patronage or "outshopping," deals with the movement of consumers between or among markets. in addition to being an important factor in choosing retail sites, it also influences the overall rate of sales for particular markets and contributes to establishing trade area boundaries ([8], p. 200). outshopping has intrigues theorists since markets were first studied [8j. in practical terms, outshopping results in the transfer of retail revenues and profits from small to large centers and "is one of the key determinants of the overall health of the economic base" ([15], p. 3) of the area. in their studies of the spatial aspects of consumer shopping behavior, market researchers have mainly focused on the purchase of products as opposed to services. furthermore, very few have directly examined the process of consumers who shop for medical services outside of their local trade area ([lj, p. 173). health care in the united states is currently experiencing a vast restructuring process, and is beginning to change the role of consumers. furthermore, "the industry, has changed dramatically in the past 10 years due to a variety of governmental, economic, demographic, and professional factors" ([6j, p. 27), and detailed studies of the impacts that these changes have made on the consumer segment are merited. good health and the quality of health care services are extremely high in the priorities of most americans. health care is one of the largest industries in the country, and much of its growth can be accounted for in the period from 1960 to 1984. during this time, americans increased their expenditures for health care services from $26.9 billion dollars per year to $387.4 billion dollars per year ([4], p. 96). translated into gross national product (gnp) figures, in 1960 our health care expenditures accounted for 5.3 percent of the gnp, and by 1984, it had doubled to 10.6 percent of the gnp ([4], p. 96). currently, health care providers whose costs exceed the diagnostic related groups (drgs), must pay for the differences. this development has not only made health journal of business strategies, volume 6, number 2 (fall 1989) 108 fall 1989 swerdlow, et al.: medical outshopping 109 care providers more cost efficient, but has also forced them to be more competitive. recognizing this, "professionals in the health care industry are beginning to realize that understanding the needs and wants of the target group for any health care service is vital." ([16], p. 9) this idea is also supported by researchers who noted that this approach "represents a coordinated effort to establish a management system that effectively links the institution with all the elements of its service community." ([17]' p. 75) two authors felt that during the 1980s the health care industry would see consumers address "issue of cost, quality, and access" to include "shopping for healthcare services" ([7j, p. 76). it was observed that consumers "want more information about products and services, and they are likely to take advantage of health care alternatives that offer them convenience and quality at a reasonable cost." ([12], p. 36) furthermore, it was stated that today's health care consumer is "more likely to get second opinions, shop around for specialized medicine, and even travel to other communities for medical care without a referral from a doctor." ([12], p. 36) the earliest works dealing with the spatial movements of consumers are classified as macro-analytical because they deal with market characteristics, rather than consumers, and attempt to determine trade area boundaries. the first writing on the subject of the movement of consumers between markets was authored by william j. reilly [14]' followed by converse [5] and huff [10]. the more current research on intermarket patronage has focused on the consumer characteristics of the particular market. these studies are classified as microanalytical and mostly deal with a consumer's demographics, psychographies, and attitudes. the results of these studies have provided various measurements of inshopping and outshopping and have formulated descriptive profiles of the consumer groups ([8), p. 201). products and outshopping the majority of the earlier micro-analytical research has been concerned with consumers who purchase products outside of their local trade area, and has not tested the intermarket patronage of services. in their 1968 article, herrmann and beik [9] collected data about out-of-town shopping patterns from a survey of the residents of state college, pennsylvania. the researchers defined an outshopper as one who had shopped outside a five mile radius of the downtown area at least one time during the previous year. it was found that 71.4 percent had shopped out-of-town in the previous year. among this outshopper group, the median number of trips made was three, more often among higher income families, those who possessed out-of-town charge accounts, as well as those families with older of fewer children. thompson [19] conducted two intermarket patronage studies in georgia. in both studies, he considered an outshopper to be one who made at least one purchase out· of-town in the last six months. in the first study, the data were provided by 340 permanent residents of the city of athens, a university town, located about 70 miles from atlanta. of the respondents, 61 percent had shopped out-of-town at some time 110 journal of business strategies vol. 6, no.2 within the six months prior to the survey. the median number of outshopping trips was three, over 75 percent chose atlanta as their shopping location, it was most prevalent among high income groups, highly educated groups, younger families, and families holding out-of-town charge accounts. the most commonly given reasons for outshopping were poor selection, high prices, and parking problems of the local trade area. the data for the second thompson study [18] were provided by 1,543 consumers who resided in ten towns in counties which generally lie to the south and west of augusta, georgia. the level of consumer outshopping in the study area was found to be over 84 percent. in addition, almost 64 percent of the respondents reported that they had shopped out-of-town six or more times in the prior six months. almost twothirds of the respondents chose augusta as their outshopping location. the research profiled an outshopper as one who was more likely to be younger, white, earn a higher income, and possess an out-of-town charge account. local conditions with which outshoppers were most dissatisfied proved to be the same as in thompson's first study. in addition to the product categories studied, samli, riecken, and yavas [15] included several service categories in their outs hopping analysis which was published in 1983. the service categories studied were barber/beauty shops, dry cleaning, automobile repair, television and radio repair, medical, dental, and insurance. two hundred questionnaires were obtained by a telephone survey from a small midwestern community situated within twenty miles of two larger trading areas for the analysis. they found that "various products and services for which convenience would be important (including professional services) are predominately bought in the local facilities." ([15], p. 9) in a study of intermarket patronage, six service categories in addition to several product categories were studied. researched were insurance, legal, accounting, banking, medical, and dental services. it was found that legal, insurance, and accounting services were purchased significantly more out of a southwestern msa than the other service categories [2]. recently, two articles have been published that deal specifically with medical services outshopping, although both deal with rural consumers. the first study was conducted by the national research corporation for modern healthcare [11]. the research firm interviewed 1,500 consumers in non-metropolitan areas and found that 42 percent did not believe specialized and sophisticated medical services existed in their areas. also, 30 percent of those surveyed revealed that they had to go to large metropolitan areas to receive medical care. furthermore, while 78 percent of the total sample believed adequate medical facilities were available in their areas, only 57 percent believed their communities offered all the services needed. in addition to the above findings, the report also stated that 47 percent of the rural consumers go to other areas for specialized care, such as cardiac and cancer treatment, or for women's services. also, 10 percent left their local trade area for surgery and 15 percent for hospitalization [11]. fall 1989 swerdlow, et al.: medical outshopping 111 the second recent study focused on rural consumers who purchase medical services from physicians outside of their local trade areas. the study was conducted in a rural, agricultural community in iowa, and yielded a sample of 216 household for the analysis. the dependent variable was defined as shopping outside of the local trade area for medical services within a one year time frame [1]. the findings indicated that the rural medical outs hopper was more dissatisfied than the medical inshopper with local medical services, the competence of the local physicians, the fees physicians charge, the waiting time in the physician's office, and experiences with other local office personnel such as nurses. also, when medical outs hoppers were compared to medical inshoppers, the outs hopping group was more likely to think that the local office did not have adequate equipment, that the health care needs of the local community were not being met and that they should see the same physician on successive visits [1]. research design the objective of this study was to formulate a medical service outs hopper profile for a specific geographic area. the study used a sample of consumers in order to gain information concerning their medical service purchases, outshopping behavior, attitudes, life-styles, and demographics. a southwestern metropolitan statistical area (msa) was the specific geographic area studied. the msa is a three county area with a total population of 394,700 ([13], p. 87). a questionnaire, which measured four major areas of study, was employed as the data collection instrument for this study. it included questions on the respondents' outshopping behavior, attitudes, psychographies, and demographics. after the questionnaires were completed, statistical analysis of the data was performed to discover any relationships that existed among the four areas of the survey instrument. in order to obtain a 95 percent level of confidence in estimating the percentage of consumers who outshop for medical services in the msa studied, at least 307 completed questionnaires were needed according to a normal sample size determination formula ([3], p. 321). there were 359 usable questionnaires completed. data analysis outshopping behavior of the 359 people responding to the questionnaire, 64 (17.8 %) had not shopped outside of the msa in the past twelve months. fifty respondents (13.9%) had shopped outside of the area once, 68 (18.9%) twice, 29 (10.9%) three times, and 20 of the respondents (5.6%) had shopped outside their local msa four times. the plurality of the respondents (107, or 29.8%) had outshopped over four times in the past year. finally, nine respondents (2.5%) were unsure of the proper response and 2 respondents (.6%) did not provide a response. among selected non-medical professional services purchased by respondents within the past 12 months, insurance services (15.9%) and banking services (13.9%) were 112 journal of business strategies vol. 6, no.2 purchased more often than legal services (6.7%), dental services (6.7%), or accounting services (5.3%) outside of the msa. with respect to medical services (excluding emergency care) purchased by households outside of the msa in the past two years, the results indicated that 91 (25.3%) of the respondents had outs hopped for medical services while 267 (74.4%) had not. one respondent indicated not sure. this pool of 92 medical outshopper respondents serves as the basis for analysis in the following section. medical services outshopping of the 92 respondents identified as medical outshoppers within the past two years, 11 (12%) had not outs hopped for medical services in the past year, 27 (29.3%) had outs hopped once, 16 (17.4%) had outshopped twice, 12 (13%) had outshopped three times, and seven (7.6%) had outshopped four times. eighteen of the respondents (19.6%) had outshopped for medical services more than four times in the past year, with one respondent not sure. the next series of medical outshopping questions related to the respondents' most recent medical service purchase outside of the msa. first, respondents were queried on the factor which most influenced their decision to make their most recent medical service purchase out of the msa. a physician's recommendation of referral was listed by 31 (33.7%) of the medical service outs hoppers as the factor that influenced them the most, while 29 (31.5%) said that their decision to outshop for medical services was based on a personal or family decision. a decision based on a recommendation from a friend or a relative was identified by 22 (23.9%) of the respondents as the determining factor, while only two of the medical outs hoppers (2.2%) felt that their insurer influenced them the most to leave the msa area to purchase medical services. ten respondents (10.8%) listed other factors. asked if the medical service they most recently purchased out of the area could have been purchased in the msa, the majority of the outshoppers (51, or 55.4%), reported that the service could have been purchased in their local msa, while 27 (29.3%) said the service could not have been purchased in the local area. fourteen (15.3%) of the outshoppers were not sure if the service was available in their local msa. frequency distribution analysis on the full 359-respondent pool was performed for those questions which sought to determine attitudes toward several factors related to medical services. asked if they believed the msa area offers all the medical services they and members of their households need, the majority of the respondents (209, or 58.2%), felt that the msa had the medical services they and members of their households need. on the other hand, 92 (25.6%) did not think that the local area had all the medical services they required, while 52 (14.5%) of the respondents were not sure. respondents were asked to rank the importance of ten salient attributes of health care when selecting a medical service. the respondent ranked each of these attributes on a five point likert scale. the first health care attribute studied was l'modern fall 1989 swerdlow, et al.: medical outshopping 113 physical appearance of facilities." of the 359 people responding, 149 (41.5%) felt that this attribute was very important, 135 (37.6%) thought it was slightly important, and 58 (16.2%) were neutral. a listing of the ten points polled and their results are presented in table 1. table 1 respondent's attitude toward salient health care attributes when choosing a medical service by frequency and percent response: very slightly important scale value: 5 4 slightly very neutral unimportant 3 2 1 no response health care attribute modern physical appearance of facilities 149 (41.5%) 135 (37.6%) 58 (16.2%) 5 (1.4%) 7 (1.9%) 5 (1.4%) clean facilities 343 (95.40) 11 (3.100) 2 (0.600) 2 (0.60) 1 (0.30) reputable physicians and specialists 339 (94.40) knowledgeable staffs 326 (90.80) 14 (3.900) 24 (6.700) 3 (0.800) 6 (1. 700) 2 (0.60) 1 (0.30) 3 (0.80) friendly staffs 242 (67.40) 93 (25.90) 17 (4.700) 2 (0.60) 4 (1.10) 1 (0.30) latest medical technology available 303 (84.20) 44 (12.30) 6 (1.700) 4 (1.10) 1 (0.30) prompt treatment 316 (88.00) 32 (8.900) 6 (1.700) 4 (1.10) 1 (0.30) free and ample parking 132 (36.80) 110 (30.60) 86 (24.00) 23 (6.40) 7 (1.90) 1 (0.30) convenience to my home 125 (34.80) 127 (35.40) 74 (20.60) 18 (5.00) 14 (3.90) 1 (0.30) reasonable prices 231 (64.40) 77 (21.40) 38 (10.60) 7 (1.90) 6 (1.70) 114 journal of business strategies vol. 6, no.2 psychographic variables the next section of the questionnaire tested a new area in medical services outshopping research-psychographies. this section included 15 variables which sought to determine the respondents' life-style characteristics which were related to health care. to make it possible for this data to be presented in a concise table format, the following codes will be used in table 2 for the variables listed on the questionnaire. table 2 psychographic variables considered code psychographic variable listed on questionnaire do you: a have a yearly medical checkup or physical? b currently have a membership in a health club or spa? c currently receive your medical services through a health maintenance organization (limp) or a preferred provider organization (ppo)? d read (a) medical or healthcare/fitness related book(s), magazine(s), journal( s), or newsletter( s) regularly? e read the medical column in the newspaper regularly? f watch healthcare/fitness television programs regularly? g smoke cigarettes or use some form of tobacco regularly? li exercise or participate in a sport regularly? i take vitamins or nutritional supplements regularly? j usually maintain a healthy/nutritional diet? k currently have some form of health insurance? l currently have a family physician in the msa area? have you: m ever purchased medical services from a free standing unit (medi-quick, statcare, etc.) as opposed to a hospital emergency room or physician's office? n seen, read, or heard an advertisement for a hospital, care center, or physician within the past month? o ever purchased medical services from a hospital in the msa area for you or a member of your household? results of these topical responses are presented below in table 3. briefly, of the 359 respondents, the majority reported that they did have a medical checkup or physical each year (66.3%), exercised or participated in a sport regularly (60.4%), took vitamins or nutritional supplements regularly (50.7%), usually maintained a healthy /nutritional diet (71.9%), currently had some form of health insurance (88%). in addition, most of the respondents had seen, read; or heard an advertisement for a fall 1989 swerdlow, et al. : medical outshopping 115 hospital l care center l or physician within the past month (87.4%)1 and had purchased medical services from a hospital in the msa area for themselves or a member of their household (76.9%). on the other hand l the majority of the respondents did not currently have a membership in a health club or spa (72.1 %)1 did not currently receive their medical services through a hmo or ppo (80.5%)1 did not read the medical column in the newspaper regularly (52.9%)1 did not watch health care/fitness television programs regularly (54.6%l or did not smoke cigarettes or use some form of tobacco regularly (78%). in addition l most of the people responding to the survey had not purchased medical services from a free standing unit as opposed to a hospital emergency room or physicianls office (61.3%). one psychographic variable in which no one response was selected by a majority of the persons completing the survey was identified. one hundred and seventy-four (48.4%) respondents indicated that they read a medical or health care related book or magazine regularlyl while 173 (48.2%) did not. in addition l 11 (3.1%) respondents were not sure l and one (0.3%) did not answer the question. table 3 health care related psychographic characteristics of respondents by frequency and percent code a b c d e f g h i j k l m n o yes 238 (66.3%) 98 (27.30) 21 (5.800) 174 (48.40) 164 (45.70) 145 (40.40) 74 (20.60) 217 (60.40) 182 (50.70) 258 (71.90) 316 (88.00) 296 (82.50) 136 (37.80) 314 (87.40) 276 (76.90) no 116 (32.3%) 259 (72.10) 289 (80.50) 173 (48.20) 190 (52.90) 196 (54.60) 280 (78.00) 135 (37.60) 174 (48.50) 80 (22.30) 39 (10.90) 59 (16.40) 220 (61.30) 38 (10.60) 80 (22.30) not sure 4(1.1%) 2 (0.60) 43 (12.0) 11 (3.10) 4 (1.10) 13 (3.60) 4 (1.10) 6 (1.70) 3 (0.80) 17 (4.70) 3 (0.80) 3 (0.80) 2 (0.60) 6 (1.70) 3 (0.80) no response 1 (0.3%) 6 (1.70) 1 (0.30) 1 (0.30) 5 (1.40) 1 (0.30) 1 (0.30) 4 (1.10) 1 (0.30) 1 (0.30) 1 (0.30) 1 (0.30) demographic variables the final section of the questionnaire was comprised of 11 demographic questions. these questions sought to determine the respondents' sex, marital status, occupation l age, educationl and number of dependent children in the household. also included were questions pertaining to home ownership, length of residence in the msa l number of individuals employed in the household l and level of income. the full 359-resondent 116 journal of business strategies vol. 6, no.2 pool statistically mirrored the area studied with regard to demographic variables. outshopping characteristics using chi· square analysis, outs hopping for medical services proved to be significantly related to outs hopping for legal services, banking services, and dental services. first, 16.5 percent of the respondents reported that they had purchased legal services outside of the msa had also outshopped for medical services, in contrast to only 3.4 percent who had outshopped for legal services, but not for medical services. in addition, 25.3 percent of the respondents who had purchased banking services out of the local area proved to be medical services outshoppers, while medical inshoppers purchased out-of-town banking services only 9.7 percent of the time. finally, 12.1 percent of the persons who reported purchasing dental services out of the msa were classified as medical service outs hoppers. only out of the msa were classified as medical service outshoppers. only 4.5 percent of those who had not purchased medical services out the local area chose to purchase dental services out of the msa. these results are presented in table 4. table 4 percentage of respondents by outshopping for legal, banking, and dental services vs. outshopping for medical service outshopping for: outshopping for medical services yes no legal services yes 16.5% no 76.0 not sure 7.5 totals 100.0% level of significance -.0004 banking services yes 25.3% no 71a not sure 3.3 totals 100.0% level of significance -.0022 dental services yes 12.1% no 802 not sure 7.7 totals 100.0% level of significance -.0004 3.4% 92.0 4.6 100.0% 9.7% 84.3 6.0 100.0% 4.5% 88.8 6.7 100.0% fall 1989 swerdlow, et al.: medical outshopping 117 attitude characteristics three questions on the survey instrument sought to determine the respondents' attitudes toward several health care related factors. the first significant finding in this section is shown in table 5. while the majority (69.7%) of medical inshoppers felt that the msa area offered all the medical services needed by their households, only 30.1 percent of medical outshoppers felt the same way. table 5 percentage of respondents by attitudes toward availability of medical services vs. outshopping for medical services area offers all medical services outshopping for medical services needed yes no yes 30.1 % 69.7% no 49.1 17.6 not sure 20.8 12.7 totals 100.0% 100.0% level of significance -.0000 the second attitudinal question studied dealt with the importance that respondents placed on salient attributes when selecting a medical services. of the ten attributes listed on the questionnaire, two proved to be significantly related to medical services outshopping. medical service outshoppers ascribed less importance to convenience and reasonable prices as salient attributes of health care than those respondents who purchased their medical services in the msa. these results are detailed in table 6. the final question in this section sought to determine the respondents' attitudes toward the msa area's medical facilities, services, and personnel. medical services outshopping was found to have significant relationship with seven out of the ten factors examined. the seven significant factors included; "modern physical appearance of facilities/' "clean facilities," "reputable physicians and specialists," "knowledgeable staffs,", "friendly staffs," "latest medical technology available," and "prompt treatment." those respondents who were medical services outshoppers indicated that these factors described the local msa less appropriately than did medical services inshoppers. the results, according to related factors, are illustrated in table 7. 118 journal of business strategies vol. 6, no.2 table 6 percentage of respondents by importance placed on salient attributes of health care vs. outshopping for medical services salient attribute of health care outshopping for medical services yes no convenience to my home very important 30.8% slightly important 23.1 neutral 27.5 slightly unimportant 8.8 very unimportant 9.8 totals 100.0% level of significance -.0050 reasonable prices very important 53.8% slightly important 22.0 neutral 16.5 slightly unimportant 5.5 very unimportant 2.2 totals 100.0% level of significance -.0468 36.7% 39.3 18.4 3.7 1.9 100.0% 67.8% 21.3 8.6 0.8 1.5 100.0% table 7 percentage of respondents by attitudes toward medical facilities of the msa vs. outshopping for medical services medical service factor and responses modern physical appearance of facilities outshopping for medical services yes no completely describes slightly describes neutral usually does not describe does not describe at all totals level of significance -.0001 16.5% 47.3 27.5 7.7 1.0 100.0% 43.4% 39.7 15.4 1.1 0.4 100.0% fall 1989 swerdlow, et at.: medicaloutshopping 119 table 7 continued (1) percentage of respondents by attitudes toward medical facilities of the msa vs. outshopping for medical services medical service factor and responses clean facilities outshopping for medical services yes no completely describes slightly describes neutral usually does not describe does not describe at all totals level of significance -.0000 reputable physicians/specialists completely describes slightly describes neutral usually does not describe does not describe at all totals level of significance -.0000 knowledgeable staffs completely describes slightly describes neutral usually does not describe does not describe at all totals level of significance -.0006 friendly staffs completely describes slightly describes neutral usually does not describe does not describe at all totals level of significance -.0013 23.1% 31.9 19.8 19.8 5.4 100.0% 2.8% 20.9 29.7 30.1 16.5 100.0% 3.3% 33.0 37.3 15.4 11.0 100.0% 14.2% 26.4 45.1 6.6 7.7 100.0% 55.8% 37.8 5.2 0.8 0.4 100.0% 53.6% 33.0 11.2 2.2 100.0% 43.4% 40.4 13.9 2.3 100.0% 45.3% 37.8 15.8 1.1 100.0% 120 journal of business strategies vol. 6, no.2 table 7 continued (2) percentage of respondents by attitudes toward medical facilities of the msa vs. outshopping for medical services medical service factor and responses latest medical technology available outshopping for medical services yes no completely describes slightly describes neutral usually does not describe at all does not describe at all no response totals level of significance -.0000 prompt treatment 2.2% 26.4 40.6 19.8 11.0 100.0% 37.8% 43.4 12.0 4.1 1.2 1.5 100.0% completely describes slightly describes neutral usually does not describe does not describe at all 11.0 no response totals level of significance -.0006 13.1% 35.3% 28.6 33.0 36.3 21.7 11.0 5.2 3.7 1.1 100.0% 100.0% psychographic characteristics three of the 15 psychographic variables tested on the survey instrument proved to be significantly related to medical service outshopping as a result of further chisquare analysis performed. first, t.he respondents who were classified as medical services outshoppers were more likely to have a current membership in a health club or spa (36.3%) than medical inshoppers (24.3%). second, a greater percentage of medical services outs hoppers (24.2%) reported not currently having some type of health insurance than the group of consumers who chose to purchase medical services in the msa (10.1 %). finally, outshoppers of medical services were more likely not to currently have a family physician in the msa (28.6%) than medical inshoppers (12.4%). these results are presented in table 8. fall 1989 swerdlow, et al.: medical outshopping table 8 percentage of respondents by psychographic characteristics vs. outshopping medical services 121 psychographic characteristic outshopping for medical services yes no currently have a membership in a health club or spa yes no not sure totals level of significance -.0199 currently have some form of health insurance? yes no not sure totals level of significance -.0231 currently have a family physician in the msa? yes no not sure totals level of significance -.0000 36.3% 61.5 2.2 100.0 74.7% 24.2 1.1 100.0% 71.4% 28.6 100.0% 24.3% 75.7 100.0% 88.8% 10.1 1.1 100.0% 86.5% 12.4 1.1 100.0% conclusions the conclusions drawn from the data collected can be summarized as follows: • outshoppers for medical services lived in the msa a shorter period of time than inshoppers. • outshoppers were more likely to have a current membership in a health club or spa. • outshoppers were less likely to have health insurance, or a family physician. • medical outshoppers felt the home msa did not offer all the medical services needed and were less concerned with convenience and reasonable prices. 122 journal of business strategies vol. 6, no.2 • outshoppers felt the home msa did not have as positive feelings regarding salient characteristics of the medical facilities/providers or did inshoppers . • the medical outshoppers held negative views of local medical facilities, personnel) and services. the area of medical outshopping deserves significant further study. for regional medical centers grow, outshopping from surrounding areas will have to flourish. marketing health care services, both within and outside of a geographical area, will clearly be of greater importance as the industry of regional medical centers develops further in these coming years. more generally, as regional service centers for all industries develop and grow, detailed knowledge of how consumers perceive quality, combined with the relationship between perceived quality and consumer characteristics, will become increasingly important. once these perceptions and relationships are identified and understood, firms and regions may more effectively and efficiently develop strategic niches for their enterprise. references 1. andrus, david and frank j. kohout. "the effect of rural consumer satisfaction on outshopping for medical services." health marketing quarterly, vol 2 (spring and summer 1985). 2. beckcom, lisa hooks and robert a. swerdlow. "intermarket patronage: a consumer oriented approach." proceedings, decision science institute, 1986. 3. boyd, harper w. jr., ralph westfall, and stanley f. stasch. marketing research: text and cases. homewood, il: richard d. irwin, inc. (1981). 4. bureau of the census. statistical abstract of the united states, 1986. washington, dc: u. s. department of commerce (1986). 5. converse, p. d. "new laws of retail gravitation." journal of marketing, vol. 14 (october 1949). 6. elsesser, janice m. "prognosis for marketing research in health-care industry: excellent." marketing news, may 25, 1984. 7. evans, jay and daniel l. galles. "consumer attitudes increase buyer sophistication." healthcare financial management, vol 36 (december 1982). 8. hawes, jon m. and james r. lumpkin. "understanding the outshopper." jouinal of the academy of marketing science, vol 12 (fall 1984). 9. herrmann, robert o. and leland l. beik. "shoppers' movements outside their local retail area." journal of marketing, vol. 32 (october 1968). fall 1989 swerdlow, et al.: medicaloutshopping 123 10. huff, david. "defining and estimating a trading area." journal of marketing, vol. 28 (july 1964). 11. jensen, joyce. "42% of rural residents are traveling to urban areas for medical treatment." modern healthcare, december 8, 1985. 12. jensen, joyce. "health care alternatives." american demographics, vol. 8 (march 1986). 13. "population." sales and marketing management. october 27, 1986. 14. reilly, william j. the law of retail gravitation. new york, ny: william j. reilly (1931). 15. samli, a. coskun, glen riecken, and ugar yavas. "intermarket shopping behavior and the small community: problems and prospects of a widespread phenomenon." journal of the academy of marketing science, vol 11 (winter 1983). 16. scammon, debra and jon kennard. "improving health care strategy planning through assessment of perceptions of consumers, providers and administrators." journal of health care marketing, vol. 3 (fall 1983). 17. swerdlow, robert and larry t. patterson. "the health care industry-a case for the marketing concept." appalachian business review, vol. 8, no.1 (1981). 18. thompson, john r. "characteristics and behavior of out· shopping consumers." journal of retailing, vol. 47 (spring 1971). 19. thompson, john r. "shopper mobility." atlanta economic review, vol. 21 (january 1971). understanding medical service outshopping: can psychographics enhance understanding? occupational stress: an analysis dean elmuti eastern illinois university charleston, illinois yunus kathawala eastern illinois university charleston, illinois sudhir chawla angelo state university san angelo, texas introduction stress is a part and parcel of modem day life, but the stress in the workplace has become a major contributor to many diseases in the modem industrial society. some of the problems resulting from undue stress are headaches, heart attacks, hypertension, peptic ulcers, weakening of the immune system, anxiety, lack of job involvement, job dissatisfaction, and occupational burnout [13]. this relationship between stress and diseases has had a major impact on american business. it is estimated that it costs about $150 billion annually for health insurance and disability claims, lost productivity, and other expenses [12]. the term stress is difficult to derme as no universal defmition has been accepted among scientists and researchers [3]. in general, stress involves the interaction of environmental stimuli, the physiological and psychological reactions to those stimuli, and coping responses of the person. stress can be broken down into two basic components: external and internal stressors. external stressors can be separated into physical factors, such as low lighting, poor ventilation, and taxing physical tasks; and psychological factors such as job or role demands. internal stressors are primarily a person's attitudes and expectations through which stress is placed on the self [4]. stress can originate from variou-; spheres of a person's life, for example, home, oommuoity, job, and soci~conomic conditions of the society at large. stressors from home and oommunity conditions are age old, but stressors from the workplace have increased dramatically due to the rapid technological and economic advancement. these are expressed in the form of many issues such as job satisfaction, job security, participation in decision making, role in organization, career development, male-female equality, etc. due to changing state oompensation laws businesses have become interested in their employees' health because they may be held liable for a worker's ill health resulting from occupational stress [7]. another change in the business world is that in recent years women have become a significant part of the labor force with over half of them employed outside the home at any given time. two-thirds of married women in the 25-44 year-old age group work outside the home. even though it is illegal to discriminate against women in the workplace, 2 journal ofbusiness strategies vol. 8, no.1 there are many obstacles to equality of the sexes. the most notable inequality is the earnings gap between males and females [1]. there is also an enormous growth in younger women entering jobs which were formerly dominated by males. as a result female managers are subjected to a greater number work-related pressures compared to their male counterparts [6]. in their study davidson and cooper found that women in junior and middle management experienced the highest overall occupational stress levels; followed by male supervisors; senior women managers; male junior managers; female supervisors, and male middle managers [6]. however, senior male managers reported the lowest occupational stress levels. other studies contradict these results. tung found that female administrators experienced significantly less occupational stress than male administrators in an educational setting [15]. senatra also reported no statistically significant differences between men and women in job-related stress in public accounting firms [11]. since most of the past studies on occupational stress have used exclusively male samples, beehr and newman suggest that sex should be used as a moderator [3]. among types of managers the group considered to be more vulnerable to occupational stress are mid-level management. stress related illnesses are also more common in this group than among top-level executives [9]. people often make jokes about one, two, and three-ulcer jobs because it is assumed that when executives reach a top-level in their organization, they are more prone to illnesses than their subordinates. however, the bell telephone system studies contradicted those assumptions. top-level executives as a group were found to be less susceptible to heart attacks than other persons in the company. the heart disease rate of both the workers and the supervisors more than doubled that of the executive group [2]. on the basis of this literature review, it seems that marc research is warranted to investigate male and female differences with respect to occupational stress. furthermore, it would be interesting to study the effects of managerial rank with sex differences, as stress levels are found to be different among different managerial rank. the purpose of this study then is to investigate the relationship of sex and managerial rank with occupational stress. the independent variables in this study are sex and managerial rank. managerial rank will be varied at three levels, (1) first-line supervisors, (2) mid-level managers, and (3) top-level executives. occupational stress will be measured by the 14 scales of occupational stress inventory (osi) resulting in the three factors or dependent variables. hypotheses the three main hypotheses arc presented below. 1. therc will be a significant diffcrcnce betwecn groups of malc and female managers in regard to their mean scores on all three occupational strcss factors. 2. there will be significant differences among the three groups of managers (first-line supervisors, mid-level managers, and top-level executives) in regard to their mean scorcs on all three occupational stress factors. spring 1991 elmuti, kathawala & chawla: occupational stress 3 3. there will be a significant difference between sex and managerial rank in regard to the mean scores on all three occupational stress factors. method the relationship of sex and managerial rank with occupational stress was examined using a questionnaire administered to ninety-six male and female managers, employed by a large multinational corporation in a mid-western state. the goal was to obtain six groups consisting of 16 male first-line supervisors, 16 female first-line supervisors, 16 male midlevel mangers, 16 female mid-level managers, 16 male top-level executives, and 16 female top-level executives. the personnel director of the corporation was contacted to obtain permission to conduct the study and obtain names of managers. sixteen managers were randomly selected from each group specified by sex and managerial rank. once all managers were selected each individual was contacted by phone to obtain their agreement to participate in the study. in addition, an informed consent form was used to obtain permission of all subjects for their volunteer participation in this study and to allow their results to be used in a group form. the subjects were assured of complete confidentiality in this informed consent form. when fourteen managers refused to participate in the study for different reasons, an additional fourteen names were randomly selected from those persons' respective sex by rank category in order to meet our goal of obtaining sixteen managers for each group. then the packet containing questionnaires were sent to the subjects along with a preaddressed, pre-paid postage envelope. approximately one week later, the entire sample was sent a follow up. this procedure produced a total of ninety-six usable questionnaires. measures occupational stress. occupational stress was measured with occupational stress inventory (osl). this inventory includes 140 items, and is designed to measure different kinds of stresses people experience in their work. responses are on 5-point scales anchored by most of the time and rarely or never. the osi has been shown to have acceptable levels of reliability and validity across a variety of settings. nonnative data for this 14-scale inventory are available for 909 adult subjects in 130 different occupations employed primarily in technical professions and managerial positions. alpha coefficients for the scales range from .71 to .94. since osi was a published and validated inventory, a total of 100 copies were purchased from psychological assessment resources in florida. (a list of items in the inventory is presented in appendix a.) analysis of occupational stress inventory (osi). the osi was developed for two primary reasons: 1) to develop generic measures of occupational stressors that would apply across different occupational levels and environ4 journal ofbusiness strategies vol. 8, no.1 ments; and 2) to provide measures for an integrated theoretical model linking sources of stress in the work environment, the psychological strains experienced by individuals as a result of work stressors, and the copying resources available to combat the effects of stressors and alleviate strains [10]. for the purpose of this study, the occupational stress was measured by three major factors resulting in three dependent variables. factor 1 was measured by a set of six scales which were collectively called the occupational roles questionnaire (oro). the oro scales were: role overload (ro), role insufficiency (ri), role ambiguity (ra), role boundary (rb), responsibility (r), and physical environment (pe). the second factor in our study was the personal strain questionnaire (psq) which was a measure of the domain of psychological strain and composed of four scales: vocational strain (vs), psychological strain (psy), interpersonal strain (is), and physical strain (phs). coping resources was the third factor of the osi. this factor was assessed by the four scales which made up the personal resources questionnaire (prq). these four scales were: recreation (re), self-care (sq, social support (ss), and rationavcognitive coping (rc). coefficients of internal consistency and median item correlations were also calculated by applying the cronbach's alpha formula to provide further justification for utilizing occupational stress inventory as a multidimensional construct. these were presented in table 1 which indicated that a coefficient alpha for each index was above .70. table 1 pearson correlation coefficient for indices of occupational stress inventory with coefficient alpha on diagonal factor matrixfactorl factor occupational roles factor 1 (.79) personal strain factor 2 .44 (.80) personal resources factor 3 .38 .39 median item correlations within .44 .61 between .20 .18 (.77) .31 .19 • coefficient alpha are indicated in the diagonal of the factor matrix. the question of how large the coefficient alpha should be for an item to be reliable is not consistent among researchers; however, some consider alpha at .70 to be a good criterion for adequate scale reliability [5]. in addition, to the scales descnbed above, basic demographic questionnaire including sex, managerial rank, age, and length of employment with the company were included in the packet spring 1991 elmuti, kathawala & chawla: occupational stress results 5 demographic characteristics of respondents are shown in table 2. the average subject was 41 years old and had 10 years of administrative experience. the median hours worked per week per subject were 52. a majority (60%) of respondents were married with children, and the median percentage of total life stress attributed to work was 70%. approximately 50% (or 48) of the respondents was female, and 50% (or 48) was male. table 2 demographic characteristics of respondents percent % commfot l. sex male 50 as planned female 50 2. age 20 29 22 average age 30 39 40 41 years old 40 49 20 50 59 12 60 and over 06 3. managerial rank first-line supervisor 34 one individual occupied mid-line manager 33 two positions at the top-level executive 33 time of survey 4. service with the company average service 1 5 years 30 10 years 6 9 years 23 10 14 years 18 15 19 years 10 20 24 years 08 25 and over 11 5. median hours worked per week 40 45 15 median hours worked 46 51 32 per week 52 57 40 52 58 and over 13 6 journal ofbusiness strategies comparative analysis of stress profiles vol. b,no.1 to investigate the relationship of sex and managerial rank: with occupational stress factors, a 2 x 3 factorial design was used, (see figure 1), a 2 x 3 factorial analysis of variance was also used to analyze the data, with an alpha level of .05 for all tests. figure 1 research design sex male female first-line supervisor mid-level managers top-level executives 2* 5 m score =(23.62) m score =(22.00) n= 16 n= 16 4 1 m score = (22.18) m score = (24.31) n= 16 n= 16 6 3 m score =(21.06) m score =(23.00) n= 16 n= 16 average mean score average mean score for for male-managers female-managers (22.29) (23.10) avg. mean score for firstline supervisors (22.81) mid-level managers (23.24) top-level executives (22.03) *numbers in parenthesis indicate the levels of stress experienced by the groups of managers hypothesis one predicts that there will be a significant difference between groups of male managers and female managers in regard to their mean scores on the occupational stress inventory factors. to determine the levels of stress experienced by male managers on all three dimensions or factors of occupational stress inventory were compared against those of their female counterparts (fable 3). spring 1991 elmuti, kathawala & chawla: occupational stress 7 table 3 means, standard deviations for the orq'l, psqb, and prqc scales for managerial rank and sex qlid rsq. prq orq. psq &prq group n m sd m sd m sd m sd male first line super. 1 16 9.20 4.75 7.15 2.94 7.37 2.24 23.62 9.57 mid level mgr. 2 16 9.37 3.25 5.62 2.30 7.18 2.98 22.18 8.15 top level exec. 3 16 6.87 2.72 4.75 2.05 10.43 3.90 21.06 8.05 total male (1,2,3) 48 9.08 3.20 5.05 2.25 10.14 3.86 22.29 8.17 female first line superv. 4 16 9.12 3.21 5.52 2.26 5.35 2.99 22.00 8.10 mid level mgr. 5 16 11.62 4.84 7.37 2.99 5.31 2.20 24.3110.15 top level exec. 6 16 10.00 3.80 6.75 2.73 6.25 2.47 23.00 9.45 total female (4,5,6) 48 10.25 3.90 6.54 2.59 6.31 2.49 23.10 9.50 • orq = occupational roles questionnaire. the orq scales are: role, insufficiency, ambiguity, boundary, responsibility and physical environment. " psq '" personal strain questionnaire. the psq scales are: vocational strain, psychological strain, interpersonal strain and physical strain. /) prq ;:: personal resources questionnaire. the prq scales are: recreation, self care, social support and rational/cognitive coping. table 4 presents the results of one-way analyses of variance between the male and female subgroups on all three factors while controlling for effects such as managerial rank, number of years in present position, and age. table 4 indicates that the levels of stress experienced by male mangers on all three factors were lower than that of their female counterparts. mean differences for male and female managers on all three factors are found to be significant with more than 95 percent confidence. this confirmed hypothesis one which led to its acceptance. hypothesis two predicts that there will be significant differences among the three groups of mar.agers (first-line supervisors, mid-level managers, and top-level executives) in regard to their mean scores on the occupational stress dimensions. table 3 presents perceived occupational stress inventory indices mean scores and standard deviations for male first supervisors, male mid-level managers, male top-level executives, female firstline supervisors, female mid-level managers, and female top-level executives. variations can been seen for mean scores on all indices. the question is bow significant statistically are these differences. 8 journal ofbusiness strategies vol. 8, no. 1 table 4 anova: male versus female subgroups on au three factors of occupational stress inventory factor 1 factor 2 factor 3 occupational personal personal catezories role rorl strain <psl resources {prl total male x 9.20 5.52 7.43 total female x 9.12(.015) 5.15(.52) 5.37(.77) managerial rank first line supervisor total male x 9.37 5.62 7.18 total female x 11.62(.096) 7.37(.99) 5.31(.75) managerial rank mid-level manager total male x 6.87 4.75 10.43 total female x 10.00(.90) 6.75(.88) 6.25(ns) managerial rank top-level manager total male x 9.78 7.25 6.85 total female x 9.88(ns) 7.6o(ns) 6.24(ns) 10 years or less years of service in present position total male x 10.25 7.21 7.10 total female x lo.34(ns) 7.4o(ns) 7.05(ns) 11 years or more of service in present position total male x 6.88 6.25 8.20 total female x 7.12(ns) 6.41(ns) 8.14(ns) age « 41 years) total male x 6.99 5.61 6.40 total female x 6.75(ns) 5.2o(ns) 6.2o(ns) note: figures in parentheses are significance levels at p< .05. ns = not significant at p< .05. age and length of service using only average age and average years of service at this fum. to answer this question, the student's t statistic was used to test for mean-score differences among the three groups of managers on the occupational stress inventory dimensions. the t values were significant at the p=.05 level for all indices. in addition, table 3 indicates that the levels of stress experienced by mid-level managers on all three spring 1991 elmuti, krlthawala & chawla: occupational stress 9 factors were higher than that of first-line supervisors and top-level executives. hypothesis three predicts that there will be a significant difference between sex and managerial rank in regard to the mean scores on the occupational stress dimensions. table 4 presents the results of one-way analyses of variance between the three groups of managers on all three factors while controlling for effects such as age and number of years in present position. the reason for controlling for such effects was to make sure that any difference in means between the three groups of managers could not be attributed to differences in age nor to number of years in present position. table 4 indicates that females in mid-level managerial rank experienced the highest overall occupational stress levels; followed by male supervisors; top-level female executives; male middle managers; female supervisors; and top-level male executives who reported the lowest occupational stress levels. mean differences for male and female managers on all three levels of management, (first-line supervisors, mid-level managers, and top-level executives), on all three occupational stress factors are found to be significant with more than 95 percent confidence. tiris confinned hypotheses two and three which led to their acceptance. other findings emerged from this study which indicated that the most clear and significant differences between sex and managerial rank in regard to occupational stress factors were those for factor 3. the personal resources stress (factor 3) experienced by female managers in all "managerial rank," ''number of years in present position," and "age" categories was substantially lower than that of male managers. the occupational-role stress (factor 1), and personal strain stress (factor 2), experienced by female managers were significantly higher than that of their male counterparts in all categories with the exception of the "42 and above" age category. the pattern of scores suggests that female managers are likely experiencing both emotional and physical symptoms of distress, in association with doubts about work performance and impaired interpersonal relationships. this pattern of scores on the personal resources stress scales portrays individuals (mainly females in mid-level managerial rank) who probably have little relief from psychological strain at work, home, or in the social environment. conclusions and discussion several significant conclusions seemed to emerge as a result of this study. first, this research data indicated that the levels of stress experienced by male managers on all occupational stress dimensions (the occupational-role based stress, the personal strain based stress, and the personal resources based stress) was lower than that of their female counterparts. second, the research findings also suggested that the levels of stress experienced by junior and mid-level managers on all three occupational stress factors or dimensions were higher than that of first-line supervisors or top-level executives. third, the findings clearly revealed that females in junior and middle management positions experienced the highest overall occupational stress levels; followed by male supervisors; top-level female executives; male middle managers; female supervisors; and top-level male executives who reported the lowest occupational stress levels. females in middle 10 journal ofbusiness strategies vol. b,no.1 management positions also did experience significant interference or conflict between work and home roles. sixty percent of the female middle managels felt that they come home from work too tired to do things they would like to do, felt the demands of their business took away from their personal interests, and made it difficult to relax at home. interestingly, marital status, age, number of years in present position, and houis worked were not significantly related to occupational stress levels between male and female managers. the conclusions from this study may not be generalizable beyond the organization studied, but they are generally consistent with and tend to support much of the previous research in this area ([6], [14]). considerably more research on the relationship of sex and managerial rank with occupational stress would be helpful for employer and employee alike. broader measurements of both individual and organizational outcomes influenced by occupational stress dimensions should be conducted to develop action plans to minimize or eliminate the stresses and strains in the work environment. certainly, both attitudinal and behavior measures of the consequences of occupational stress in the workplace should be investigated across various organizational contexts. management consultants and top managels might also benefit from research producing more substantive information on: (1) causes of occupational stress in the work environment, (2) problems resulting from undue stress, (3) impact of undue stress on productivity and organizational performance, and (4) relationship between the use of social support and feelings of stress and strain. although there are obvious limitations to the perceptual and self-reported data collected in this study, as well as with correlational analysis of such data, this study represents an effort at investigating the relationship of sex and managerial rank with occupational stress. many issues are raised from these findings. with more women entering the male dominated job of management, more female managers are subjected to a greater number of work related pressures. females and their family members are required to alter their personal and family roles, expectations and behavior so that areas of role conflict can be accepted and more effectively handled [14]. the overall profile of women in junior and middle management positions in this study suggests that further assessments of stress and stress interventions are needed. practical applications: a caveat existing research and business practices regarding occupational stress suggest forms of intervention strategies to minimize or eliminate the stresses and strains in the work environment. on the corporate level, corporations should begin to take more initiatives in providing employees with training programs designed to help them deal with related stress. corporations might choose to provide, for example, wellness and relaxation programs within their facilities. exercise releases the body's own natural opiates called endorphins that are mood enhancing. the good feeling that comes from a work-out or a brisk walk is not incidental. that period of exercise affects the body's chemistry by dissipating the stress and tension and activating the body's natural opiates. furthermore, it is incumbent on corporations to develop corporate policies which will spring 1991 elmuti, kathawala & chawla: occupational stress 11 minimize stress and strain on women in managerial positions. these polices might include flexible working arrangements, reasonable maternity leave, adequate day-nursery facilities, and opportunities to work at home. in addition, family members are needed to provide social and morale support for women in managerial positions in order to cope with occupational stress and strains in the work and home environment. family members will be required to alter their personal and family roles, expectations, and behaviors, so that areas of conflict can be accepted and effectively managed. finally, each person must recognize that stress is ever a part of our lives. we can't avoid it. dealing with it emotionally means accepting that we are not always in control of the work we cannot make everything right. dealing with stress behaviorally means managing time and priorities and paying attention to diet and exercise. appendix a scale descriptions and possible high score interpretation 1 scale name interpretation role overload (ro) role insufficiency (ri) role ambiguity (ra) high scorers may describe their work load as increasing, unreasonable, and unsupported by needed resources. they may describe themselves as not feeling well trained or competent for the job at hand, needing more help, and working under tight deadlines. high scorers may report a poor fit between their skills and the job they are performing. they may also report that their career is not progressing and has little future. needs for recognition and success may not be met. they may report boredom and/or underutilization. high scorers may report a poor sense of what they are expected to do, how they should be spending their time, and how they will be evaluated. they seem not to know where to begin on new projects and experience conflicting demands from supervisors. they may also report no clear sense of what they should do to "get ahead." role boundary (rb) high scorers may report feeling caught between conflicting supervisory demands and factions. they may report not feeling proud ofwhat they do, or not having a stake in the enterprise. they may also reportbeing unclear about authority lines and having more than one person telling them what to do. 10sipow and spokane [10]; reported with permission. 12 journal ofbusiness strategies vol. 8, no.1 responsibility (r) high scorers may report high levels of responsibility for the activities and workperfonnance ofsubordinates. they are worried that others will not perfonn well. they are sought out for leadership and frequently have to respond to other's problems. they may also have poor relationships with people at work or feel pressure from working with angry or difficult employees or the public. physical environment (pe) high scorers may report being exposed to high levels of noise, wetness, dust, heat, cold, light, poisonous substances, or unpleasant odors. they may also report having an erratic work schedule or feeling personally isolated. vocational strain (vs) high scorers may report poor attitudes toward theirwork, including dread, boredom, and lack of interest. they may report making errors in their work or having accidents. they may also report that the quality of their work is suffering. concentration problems and absenteeism may be in evidence. psychological strain (psy) high scorers may report feeling depressed, anxious, unhappy, and! or irritable. they may report complaining about little things, responding badly in routine situations, and having no sense of humor. they may report that things are not "going well." interpersonal strain (is) high scorers may report frequent quarrels or excessive dependency on family members, spouses, and friends. they may report wanting to withdraw and have time alone or, conversely, not having time to spend with friends. physical strain (phs) high scorers may report :frequent worries about their health as well as a number of physical symptoms (colds, heart palpitations, aches and pains, stomach aches, and erratic eating habits). they may report unplanned weight changes, overuse of alcohol, and distwbances in sleeping patterns. they may also report feeling lethargy and apathy. recreation (re) high scorers may report taking advantage of the recreational! leisure time coming to them and engaging in a variety of activities which they find relaxing and satisfying. they may also report doing the things they most enjoy in their spare time. self-care (sc) high scorers may report that they regularly exercise, sleep eight hours per day, are careful about their diet, practice relaxation techniques, and avoid harmful substances (e.g., alcohol, drugs, tobacco, coffee). spring 1991 elmuti, kathawala & chawla: occupational stress 13 social supports (ss) high scorers may report feeling that there is at least one person they can count on and who values and/or loves them. they may report having sympathetic people to talk: to about work problems and report having help to do important things and/or things around the house. they may also report feeling close to another individual. rational/cognitive (rc) high scorers may report that they have a systematic approach to solving problems, think through the consequences of their choices, and are able to identify important elementsofproblems encountered. they may report being able to set and follow priorities, and have techniques to avoid being distracted. they may also report being able to reexamine and reorganize their work schedule. they put their jobs out of their minds when they go home and feel that there are other jobs besides their present one which they can do. references 1. atwater, e. psychology of adjustment personal growth in a changing world. englewood cliffs: nj.: prentice hall (1987), pp. 16-34. 2. bass, b.m. and barrell, g.v. people, work, and organizations. boston: allyn and bacon, inc. (1981), pp. 256-324. 3. beehr, t.a and newman, j.e. "job stress, employee health, and organizational effectiveness: a factor analysis, model, and literature review." personnel psychology, vol. 31 (1978), pp. 665-699. 4. brodzinski, j.d., scherer, r.f. and goyer, ka. "workplace stress." personnel administration, (july 1989), pp. 76-80. 5. cronback, lj. "coefficient alpha and the internal structure of tests." psychometrika, vol. 6 (september 1951), pp. 297-334. 6. davidson, mj. and cooper, c.l. "occupational stress in female managers: a comparative study. journal of management studies, vol. 21 (1984), pp. 185-205. 7. greenberg, j.s. comprehensive stress management. dubuque, iowa: wm. c. brown publishers (1987) pp. 278-214. 8. gunderson, m. "male-female wage differentials and policy responses." journal of economic litemture (march 1989), pp. 43-72. 9. maier, n.r.f. and verser, g.c. psychology in industrial organizations. boston: houghton miffin· company (1982), pp. 218-236. 14 journal ofbusiness strategies vol. 8, no.1 10. osipow, s.h. and spokane, ar. occuptational stress inventory. research. version, odessa, florida: psychological assessment resources, inc., (1987), pp. 2-5. 11. senatra, p. "what are the sources and consequences of stress? do men and women differ in their perceptions?" the woman cpa (july 1988), pp. 13-15. 12. smith, e.t., brott, j., cuneo, a and davis, j. "stress: the test americans are failing." business week (april 1988), pp. 74-78. 13. spector, p.e., dwyer, dj. and jex, s.m. "relation of job stressors to affective, health, and performance outcomes: a comparison of multiple data sources." journal of applied psychology, vol 73 (1988), pp. 11-19. 14. stoner, c.r., hartman, r.i. and arora, r. "work-home role conflict in female owners of small business: an exploratory study." journal of small business management (january 1990), pp. 30-38. 15. tung, r. "comparative analysis of the occupational stress profiles of male versus female administrators. journal of vocational behavior, vol. 17 (1980), pp. 344-355. occupational stress: an analysis strategy as a culturally dependent phenomenon: toe interpretation of japanfse corporale strategy through tile analysis of aikido michael j. cotter grand valley state university grand rapids, michigan morgan p. miles georgia southern university statesboro, georgia james a. henley university of tennessee at chattanooga chattanooga, tennessee japanese maxim: "alto no saki-take your opponent's technique and turn it into your own." "if japan told washington it would no longer sell computer chips to the united states, the pentagon would be totally helpless. furthermore, the global military balance could be completely upset if japan decided to sell its computer chips to the soviet union instead of the united states" (ishihara 1989). the first popular maxim describes many of the corporate strategies and industrial policies implemented by post-war japan in their intense struggle with the west for economic success and influence. the second statement represents the changing perspective of post war japan, suggesting as japan prospers it must exercise more economic, political, and ultimately military power (ishihara 1989). as western business leaders utilize combative sports based strategies for marketing purposes, so the japanese use a martial art orientation in the development of their business strategies and tactics. while a number of similarities exist between traditional u.s. sportive combat skills and traditional japanese combat techniques, there are significant differences with opposing approaches and strategies. western firms competing with japanese keiretsus, coordinated industrial groups composed of manufacturers/trading companies/banks (johnson 1985), may gain a substantial competitive advantage by understanding the basic principles and tactics that underlie and color much of japanese corporate strategy. purpose the purpose of this manuscript is to offer an interpretation of examples of japanese strategic behavior through the cultural phenomenon of a japanese martial art, aikido. two aikido techniques, extension and projection, are used to offer an enhanced understanding 64 journal ofbusiness strategies vol. 11, no.1 of japanese strategic conduct from a cultural perspective. in addition, it is proposed that this latent orientation toward the principles of aikido may be the contextual foundation of japanese marketing protection. the present study first considers aikido's contribution to japanese marketing strategy. next, a general discussion of aikido covers the combat philosophy concentrating on differences between the u.s. and japan's competitive orientation. finally, an examination of the aikido defense tactics of extension and projection focuses on its use in marketing strategy with managerial implications offered. aikido's relevance to combat and marketing competition marketing strategy is convincingly compared to military science for use in developing viable business strategies for market competition. kotler and singh (1981) drew parallels between marketing and military science offering a view of business as a battlefield. ries and trout (1986) used kotler and singh's work as a base in generating and implementing business strategies. cook (1983) offered an arrangement to aid executives in choosing the optimal strategy while parasuraman and varadarajan (1985) propounded new dimensions for progress in a critical analysis of cook's framework. while the marketing/military science fusion offered fresh perspectives on market competition, aikido's hand-to-hand combat offers further insight into another facet of japanese managers' orientation. while embracing some common elements, the japanese personal combat technique of aikido differs both in philosophy and action when compared to the traditional western combat sport of boxing. knowledge of these differences in a cultural orientation toward conflict may offer western firms the enhanced understanding required to successfully compete with the japanese. table 1 provides a summary of the different orientations between aikido and boxing. table 1: a comparison of japanese and western martial arts aikido boxing objective to avoid or stop the attack to destroy the opposition movement grcular linear orientation horizontal, vertical frontal relationsidp a long-term immediate results with time vision perspective cooperative towards opponent balance retain always combative willingness to temporarily sacrifice in an attack spring 1994 cotter, et al.: strategy as a culturally dependent phenomenon 65 aikido's philosophy the word "aikido" means "method or way (do) for the coordination or hannony (ai) of mental energy or spirit (ki)" (westbrook and ratti 1970). westbrook and ratti (1970) suggest aikido's philosophy is best undeistood by examining its: (1) objectives, (2) theory, and (3) principles. aikido objectives westbrook and ratti (1970) relate three crucial elements that differentiate aikido from other japanese martial arts. fiist, aikido as self-defense is entirely reactive. there is no attack strategy. second, an aikidoist's source of power is derived from the person's center or "hara" where a concentration of inner energy known as "ki" exists. this energy is integrated in aikido techniques to dramatically bolster the physical mechanics. third, aikido's evasive movement strategy heavily relies on circularity or "sphericity." another contrasting element of aikido compared to some japanese combat styles includes responsibility for the attacker's welfare. when using aikido properly, physical aggression is neutralized swiftly with control over the attack so effective that self-defense is possible without inflicting serious injury upon an aggressor. this japanese culturallybased attitude towards competitors has proved to be advantageous against highly visible and vocal u.s. firms in the automobile or computer industry. for example, if japanese firms were to attempt to use a more dramatic ''knock-out'' punch on a company such as chrysler it could generate considerable hostility, ultimately leading to a loss of goodwill, market access, and sales potential. aikido also offers a method to strengthen the mind and body while fusing the person's physical and mental powers to emerge as a more fully integrated individual. japan certainly emulates this style with kotabe's (1984) "japan, inc." merging of business, labor, government and the general public interest to strive toward superiority in the global marketplace. aikido defense theory aikido defense consists of perception, evaluation-decision, and reaction (westbrook and ratti 1970). aikidoists strive to develop an ever-vigilant awareness of events to avoid physical attack in the same way marketers seek to use levitt's (1975) suggestion pertaining to myopic corporate vision to eschew unexpected marketing attacks. once the awareness of an attack is established, the most appropriate defense is applied based on a split-second analysis. the effectiveness of any defensive plan depends largely upon the time lapse between the first consideration an attack might occur and the defensive reaction. aikido principles a primary aikido defense factor includes dynamic momentum of convergence or the amount of force generated by the attacker (westbrook and ratti 1970). the aikidoist is acutely aware that a human body in motion becomes extremely easy to maneuver and its vertical stability is greatly reduced. aikidoists seek to induce the attacker to move 66 journal ofbusiness strategies vol. 11, no.1 faster and more recklessly thereby leading to a greater loss of balance and control. to illustrate this tactic in a business context, consider japanese auto firms' relentless focus on shortening product development cycles. this allows them to exact a premium for the exclusive product, react more rapidly to changing market demands, generate increasingly modem technology and focus enormous pressure on u.s. competitors. an early u.s. automobile makers' response to this japanese strategy can be illustrated by general motor's premature introduction of the pontiac fiero. while the fiero was introduced to the market ahead of other low-cost, two-seat sport cars, it had a tendency to burst into flames (bussey and sease 1988). the principle of extension an intrinsic element of aikido is represented by ki or a person's centralized energy. this aspect animates the application of all aikido techniques when practiced properly. all persons possess ki. however, only when the force is concentrated in a single, unified stream is energy extended and channeled into a nearly irresistible action of defense through physical movements. while the vast majority of aikido uses involve a dynamic ki, there is also use of a static ki frequently described as the "unbendable arm" and is a demonstration of the extension principle (westbrook and ratti 1970). in short, an aikidoist is able to channel concentrated ki through an arm and, although the muscles of the arm are not strained or muscular tension generated, another individual is not able to bend the arm. this physical demonstration points out the difference in the west and east perspectives. westerners tend to measure strength in terms of muscle power, while those in the east often refer to the "power of the spirit" or "mind over matter." this refers to an integration of a person's mental and physical attnbutes. if a person does not maintain this "unbendable arm" at all times (or the extension is abandoned), the person will be unable to perform the aikido defensive techniques correctly. this "unbendable arm," permits the defender to guide and direct an attacker's force without smashing directly into it (westbrook and ratti 1970). as a business example of the pervasive nature of the protectionist philosophy of the extension principle, consider japan's ability to protect itself from import products. foreign pressure exerted on japan has forced japan to lower many of its formal trade barriers. nevertheless, informal cultural barriers remain nearly impenetrable. at one point, approximately sixty percent of japan's city governments required national retailers to gain approval from all existing shopkeepers within one-third mile radius of the proposed site before opening (darlin 1988). further, the ministry of international trade and industry (mrti) typically required 8-10 years to pass before a retail establishment was allowed to open, and once open approximately seventy-one licenses were needed to operate the establishment (darlin 1988). these factors allowed the japanese "papa-mama stores" to gain fifty-six percent of retail sales (compared to 3% in the u.s. and 5% in europe) and to control a majority of store shelves that could potentially display u.s. products (darlin 1988). a second example of this "extension" defense is illustrated with dow corporation's attempts to build a plant in japan. dow's efforts to build a plant were fitst blocked by spring 1994 cotter, et al.: strategy as a culturally dependent phenomenon 67 miti (mason 1992). when dow tried to purchase land in japan for a plant, local japanese civic authorities again blocked attempts. after considerable time and expense, dow decided to change the proposed site location. once again, a different japanese locality thwarted dow's attempt to·purchase the necessary land for plant construction. dow then tried to use the japanese media to explain its position and the benefits the locals could expect to enjoy from the plant construction. locals counter-attacked by calling dow a foreign influence that would operate in an intrusive, non-japanese manner. dow never constructed the plant (mason 1992). an example of parrying through extension and then leading an opponent into a relatively hannless circuit around the defender's center is found in japanese dealings with motorola. the ministry of posts and telecommunications in japan excluded the u.s. finn of motorola from the majority of the japanese car phone market by giving them a license for only western japan, excluding tokyo. the car phone market in tokyo was awarded to nippon telegraph and telephone and teleway of japan (the wall street journal 1987). therefore, the motorola marketing strike was not directly blocked, but deflected to a relatively hannless area around the defender's center of power. there are times when japanese will abruptly shut out foreign-based multinational corporations. japan's nippon telegraph & telephone public corp. grants contracts exclusively to a few local suppliers, resulting in no opportunities for outsiders to gain such business regardless of price, service, or quality @usiness week 1982). japanese martial arts may be generally divided into "soft" and "hard" dynamic ki systems. in aikido, the ki or centralized energy acts as more of an all-pervading, forcefield type, as compared with the concentrated and laser-like form of energy that cuts through an opposing target, penetrating anything in its line. "hard" ki is more sharp and concentrated to a dangerous point like that found on a japanese sword. strikes are predominantly straight (direct), although there are circular forms of hard ki (slashing extension). this very concentrated form of ki usually requires that a single anatomical weapon, i.e., arm, leg, hand, foot, elbow, etc. be employed to deliver the force of the focused energy. the "soft" ki appears as an evenly diffused and expanding power that acts like a huge sphere to completely envelop the target or spin tangentially against it (westbrook and ratti 1970). its force brings to mind power more resembling that of "massed wind or water." "soft" ki does not cut through the target; it sweeps it away in a tangential, circular pattern sending the target spinning in centrifugal unbalance or extends and stretches it in a desired direction. this ability to impart additional momentum to an attacking force and send him or her in a harmless direction is considered in a discussion of projections. projections projections are techniques of neutralization in which physical contact between the defender and aggressor ceases (although the defender's follow-through continues) when the attacker is thrown spinning to the ground. projections are possible since the attacker is extended dynamically in the desired direction and the defender's position and central spinning motion is faster than the attacker's peripheral motion as he or she circles the 68 journal ofbusiness strategies vol. 11, no.1 defender (westbrook and ratti 1970). the attacker's head, often in direct contact with the defender's body (the spinning axis of the action), is extended ahead of the rest of his or her body which follows in a circular pattern. in a projection, usually the aggressor's orbital motion and frontal extension is ultimately channeled back in the direction of the source (westbrook and ratti 1970). in short, the attacker's momentum is led in a circular pattern. this dynamic reversal or circle must be achieved smoothly, with minimal interruption. the unified projection is derived from simultaneous centralization and extension of centralized energy. this seeming paradox is often referred to as "explosive stability." leg sweep in a projection known as the aiki otoshi, the defender's hips are used to remove the attacker's feet from the ground and project him or her back down to the ground (westbrook and ratti 1970). the aikidoist sweeps both legs of the aggressor from the front, practically clasping them together. the defender's lower abdomen at this point is the operational center of the projection. the defender releases the attacker when her or his feet are high in the air and trunk is parallel to the ground. an important point in this technique is never to allow the central weight of the attacker to fall on the defender. the attacker's total weight, at the moment when natural supports are swept away, is left floating in space, not resting on the defender. therefore, the action is swift and effortless, since the aikidoist is not "loading the attacker up" onto his or her hips, which is incorrect, but simply "cutting the aggressor down" from underneath. the attacker's legs, once the central weight no longer presses down, become extremely light and easy to maneuver. correct timing of the attacker's unbalance and the defender's circular sweep determines the projection's success. this technique has been used effectively in the computer field where japanese companies have adopted strategies differing from those usually chosen by u.s. computer producers. hitachi ltd. entered the u.s. as an original equipment manufacturer (oem) to intel corporation that sold hitachi computers under intel's name. as intel grew more dependent on hitachi to supply computers, hitachi had a greater opportunity to study and understand the distribution intricacies of the u.s. computer industry. hence, while intel gained sales momentum partially inspired by the japanese firm, intel's market position became more dependent on the japanese support (the japan economic journal 1980). based on aikido principles, one option for hitachi is to continue to inspire more and more intel dependence on hitachi and then sweep the means of support out from under intel. this could be accomplished by recruiting intel's distnbution people, with business contacts and practices as the primary goals. another possibility is for hitachi to generate more joint projects with u.s. firms for purposes of distribution. this may pressure intel to offer concessions in the form of distribution control instead of profits. this arrangement does not permit the international firm an opportunity to generate a strong identity in the local market. however, the joint venture does allow hitachi to reach a high volume more quickly by sacrificing independence and control over its distribution system. japanese firms often have oems with a number of different firms at once. spring 1994 cotter, et al.: strategy as a culturally dependent phenomenon 69 comer drop another aikido projection technique is known as sumi otoshi (comer drop) (westbrook and ratti 1970). this throw permits the defender to channel the attacker's force on one side of his or her body, that side becoming the axis around which the aggressor rotates in unbalance until falling. this motion involves a particularly delicate, spiraling pattern which is a key factor in drawing the attacker in a direction away from the vulnerable area of the defender. an example of this technique is demonstrated by the competition in super-computers between japanese and v.s. firms. the u.s. dominated super-computer industry pressured japan's government to purchase the superior product for appropriate use (ratan 1991). the purchase was blocked by the japanese government on one pretext after another for a period of seven years, resulting in the v.s. firms' resources being directed toward bureaucratic battles and away from technical innovation in the super-computer business. by the time the v's, computer firms were able to break down the barriers thrown up by the japanese government to permit selling to the japanese public-sector buyers, the japanese computer firms had learned how to make the machines themselves and had secured a majority of japan's government market (ratan 1991). scarf throw another intriguing aikido projection technique is the "scarf' throw. the characteristic feature of this method is wrapping one of the attacker's arms around his or her own neck to cause the attacker to rotate vertically around the person's own spinal axis (westbrook and ratti 1970). this aikido move is illustrated in the global marketplace through sales of computer components. japan has managed to engender competition within the u.s. computer industry to the advantage of japan. japanese technology has become so important to ffim, apple, compaq, and tandy that they defended japan's electronics exporters against charges by smaller u.s. competitors claiming japan is dumping flat-panel displays (ratan 1991). the u.s. computer giants say american suppliers cannot meet the demand for this crucial computer component. in essence, one appendage of the u.s. industry is used to "choke" and "project" another part of the u.s. industry (ratan 1991). dangling bait while many of the aikido projection techniques are structured to take advantage of an attacker gripping the defender, some are performed dynamically so the attacker does not have a chance to securely clutch a wrist (westbrook and ratti 1970). it is extremely important for the defender not to move too fast or the attacker will lose the defender causing the defender to lose the aggressor. it is equally crucial not to move too slow or the attacker will be able to seize and control the defender's wrist. this is a peculiar, tantalizing form of motion which makes a target appear to be so near and accessible. in reality, the target is receding and drawing the aggressor out into uncontrolled extension before the attacker realizes what has happened. if the aggressor has already contacted the defender's wrist, it is still possible to lead the attacker out into unbalanced extension because "contact" does not mean "hold." a 70 journal ofbusiness strategies vol. 11, no.1 hold requires a few moments to become stabilized (westbrook and ratti 1970). a hold, to be secured, requires some form of stability or balance. providing the defender flows smoothly with the motion of the attacker's hands toward the defender's wrists, the attacker does not retain a strong balance because the defender is fading away, and the aggressor is stretching forward. the aggressor's power still flows out toward a target he or she cannot grasp and cannot stop. this strategy of dangling the possibility of a solid hold on the japanese market for u.s. businesses is a technique the japanese businesses have used with regularity. according to killing (1982), in japan foreign multinational companies typically used joint ventures to gain access to distribution channels, while the japanese partners were primarily interested in new technology. the difference between the two objectives is dramatic. while access for u.s. firms to the japanese market is valuable, that access can be blocked abruptly, offering no future value. however, japanese access to u.s. technology results in efficiencies in research and development, and ultimately leading to industry control by the japanese firm. when assessing this type of exchange in the history of joint ventures between japanese and non-japanese firms, a pattern appears to emerge. according to killing (1982), between 1972 and 1976 some 90 major joint ventures eventually failed in japan. many of these ventures involved large u.s. technology oriented firms such as general mills, trw, and avis. the u.s. firms gained access to the japanese markets for a brief period and the japanese frrms retained use of the technological knowledge forever. somersault another interesting projection technique appears simple, but is one of the most sophisticated examples of centralization coordinated with an opponent's movement of attack. combat is suddenly shifted from a vertical dimension to the horizontal before the attacker realizes what is happening and can adapt the attack to the new circumstances. hence, the projection rests upon an accurate estimation of the opponent's commitment to the primary attack-an essential aspect for successful use of the technique. the aikido artist leads the attacker out with a few circular steps in order to increase the momentum of the initial attack motion. as the attacker converges, the defender sinks down deeply under the aggressor as if the defender was a huge stone suddenly emerging in the opponent's way. the defender then rises behind the attacker after the person has soared up and over the aikidoist's body in the somersault necessitated by the abruptness of the aikido maneuver and by the attacker's own dynamic commitment to the attack (westbrook and ratti 1970). an example of this technique may be seen in the u.s. attack on the japanese tobacco market. r.j. reynolds saw what appeared to be an excellent opportunity to market its modem long, brown-wrapper cigarette more in japan (jeannet and hennessey 1988). the new style hit the market and seemed ready to take a significant share of the market. abruptly, the japanese tobacco and salt public corporation, a government monopoly, swept the legs of r.j. reynolds out from under them by keeping more in a limited test market for two years. during those two years, the japanese developed their own brownspring 1994 cotter, et al.: strategy as a culturally dependent phenomenon 71 wrapper cigarette. by the time more was released to the general market, it faced a direct domestic competitor already securely entrenched in the niche (jeannet and hennessey 1988). a second example of such a technique is found in the steel~making industry. for years, the v.s. was a dominant global industrial power and operated in a fashion which assumed such a world position would remain. management in the steel-producing organizations, assuming long-term industry dominance, offered long-term commitments to labor unions which made layoffs costly. at the time, the possibility of forced layoffs seemed extremely remote, if not impossible, and appeared to be a costless bargaining chip for management. then japan greatly expanded its steel-making capacity in the 1970s while v.s. firms tried to keep pace. presently, with a global over-capacity for producing steel v.s. plants are unprofitable (the wall street journal 1987). japan spurred the over~development or incited the momentum of the v.s. steel-making capacity based on the worldwide market. now with the scale of operations of v.s. steel mills, the u.s. rums cannot shut down unprofitable plants because of the high cost of laying off workers. japan, on the other hand, has cut production capacity and is able to patiently wait for the u.s. firms to self-destruct or severely weaken themselves before rising again to capture an increasing market share (the wall street journal 1987). managerial implications the managerial implications of this cultural interpretation of japanese corporate strategy are threefold: (1) japanese and western firms while engaging in the same game are playing by implementing different principles, (2) japanese firms have a very different orientation toward competition, (3) to be successful in engaging in competition with the japanese, western corporations must attempt to understand the both the strategy and the cultural underpinnings that underlie much of japanese corporate behavior. one recent attempt to understand the latent dimensions of japanese corporate strategy was kotabe and duhan's (1993) analysis of 882 japanese manufacturing corporations. kotabe and duhan (1993) found that japanese firms tend to fall into one of three distinct strategy clusters. these strategic clusters are based on the interaction of market position and product related factors with the stage of the product life-cycle and business orientation. high performing japanese manufacturers based on relative measures of roi tended to be categorized into one of three strategic clusters: (1) "brand skeptics," (2) "true believers," or (3) "mavericks" (kotabe and duhan 1993). firms that adopt a brand skeptic strategic cluster create their competitive advantages through product innovation. true believers utilize both brand development and value enhancement in an effort to develop a sustainable competitive advantage (kotabe and duhan 1993). firms following the maverick strategic cluster tend to highly cost focused, with constant efforts made to achieve a cost oriented advantage. the implications of the present study and the findings of the kotabe and duhan (1993) analysis suggests that western firms must be prepared to compete with firms that tend to: (1) be innovative, (2) constantly seek to enhance value to the customer, (3) develop unique and sustainable 72 journal o/business strategies vol. 11, no.1 cost advantages, (4) have a long-run perspective, (5) prefer cooperation rather than competition, and (6) typically have an overall objective of long-run survival and ultimately market dominance. strategic responses while specific aikido techniques were cited previously with corresponding examples, what is more salient to the western manager is to develop an appreciation of the principles underlying japanese strategy and appropriate strategic responses. five strategic responses are offered to western strategists who operate from a culturally derived linear ''boxing'' perspective and attempt to compete with the swirling and obtuse aikido-oriented japanese. first, western strategists should not interpret soft resistance from japanese firms as a forecast of a market concession and impending western success. an aversion to a boxing style of "toe-to-toe" marketplace combat by the japanese does not imply surrender. in this situation, the western manager must respond by carefully assessing if the firm is being guided by the aikidoists down an inopportune path. the strategic advantage accruing to the japanese for utilizing this obtuse strategy is that the opponent may fail to comprehend the incorrect decision and direction until it is too late to effectively compete. second, western strategists should carefully consider all of the consequences when attempting to beat the japanese "at their own game," particularly in situations when the japanese appear to have only a marginal competitive advantage. the fatal attraction of a relatively easy target for an aggressive boxing-oriented western firm may encourage it to attack with reckless abandon. the false appearance of being nearly in reach may be the ''bait'' utilized to draw western firms into the ineffective response of attempting to catch-up, by re-allocating time, capital, and critical resources from other more advantageous projects. the japanese firm may then continue advancing just slightly ahead of the western firm retaining market share while squandering the competition's resource base. third, the japanese ability to recognize and react to market demand dynamics in a more timely fashion than western firms typically respond may be due to the more intuitive nature of the aikido-oriented strategists. japanese decision makers tend to be more likely to trust feelings and subtle signals than an analytical westerner. this acute sense of nearly imperceptible movement provides the aikido master with the additional time required to prepare an appropriate response to an attack. while western boxers typically bum energy bobbing and feinting non-stop as a defensive technique, the aikidoists remain motionless until movement by the opponent. what appears as a lightning japanese response to environmental dynamics is owed to a sensitive intelligence system and superior timing. westerners should try to emulate the japanese in this respect by sharpening their market perceptiveness with enhanced marketing information and decision support systems. fourth, westerners should respond to the circular orientation of the japanese competitors by seeking a harmonious balance in their strategic plans, core capacities, production operations, and market implementations by refraining from a heavy dependence on any particular customers, suppliers, and distributors. leaning too heavily on one support ofspring 1994 cotter, et al.: strategy as a culturally dependent phenomenon 73 fers the japanese competitor a much greater opportunity to sweep away that critical prop, leaving the western firm unbalanced and vulnerable. fifth, like aikido masters, japanese firms are highly cognizant of stability and seek exceptional balance with extensive and long-range planning. for example, japanese keiretsus bolster stability by engineering a high level of interdependence between the manufactures, suppliers, creditors, and customers. this institutional interdependence results in a system of captive exchange partners that engage in dwyer, schurr, and oh's (1987) system of relational transactions, exhibiting unswerving loyalty regardless of market, technology, or price changes. dwyer, schurr, and oh's (1987) concept of discrete transactions describes the principle governing exchanges between western firms that values short-term performance over inter-organizational loyalty. like boxers launching a strike, western firms will temporarily sacrifice stability when making abrupt changes in suppliers or customers. once the punch is landed, the boxer rapidly seeks equilibrium again just as the western firm attempts to re-establish balance after market changes. westerners may attempt to exploit the institutional interdependence of the keiretsus with its implicit long term supplier relationships by constantly altering the industry's distribution technology and channel structure. summary analogies drawn between military science and marketing strategies have helped marketers attain better understanding of strategies possible in competition. this manuscript extends this tradition by examining the japanese martial art of aikido. since some aikido principles differ greatly from those of american combat and sport strategies, this paper offers insight into an unexplored aspect of japanese marketing philosophy that may prove useful in the decisionmaking process of western managers. specific aikido defense principles of extension and projection were examined in detail. by examining these principles, it was demonstrated how extension and projection are used by japanese businesses to protect themselves from attacks by foreign business forces. by understanding the cultural context of how the japanese aikidoist reacts to any type of threat from an outside force, the u.s. strategist can better plan ventures involving competition with japanese firms. in addition, western managers may also benefit by understanding the latent strategies successful japanese corporations have adopted such as customer value enhancement, innovation, cost leadership, relational exchange, and differentiation as potential strategic responses. references business week. 1982. "high-technology gateway," (august 9): 40. bussey, john and douglas r. sease. 1988. "speeding up." in awlications in basic marketing 1990, 94-95. eds. e. jerome mccarthy and william d. perreaut. homewood, il: richud d. irwin, inc. 74 journal ofbusiness strategies vol. 11, no.1 cook, victor j. jr. 1983. "marketing strategy and differential advantage::toumal of marketing, 47 (spring): 68-75. darlin, damon. 1988. "papa-mama stores in japan wield power to hold back imports." in applications in basic marketing 1991-1992, 182-183. edited by e. jerome mccarthy and william d. perreault. homewood, il: richard d. irwin, inc. dwyer, f. robert, paul h. schurr, and sejo oh. 1987. "developing buyer-seller relationships." journal of marketing 51(2): 11-27. ishihara, shintaro. 1989. the japan that can say no. new york: simon and schuster, 21-68. jeannet, jean-pierre and hubert d. hennessey. 1988. international marketing management. boston: houghton mifflin company, 173-174. johnson, chalmers. 1985. "the institutional foundations of japanese industrial policy." california management review, 27(4). killing, j. peter. 1982. "how to make a global joint venture work." harvard business review (may-june): 121. kotabe, masaaki. 1984. "changing roles of the sogo shoshas, the manufacturing firms, and the mill in the context of the japanese 'trade or die' mentality." columbia journal of world business 14(3), 33-42. kotabe, masaaki and dale f. duhan. 1993. "strategy clusters in japanese markets: firm performance implications," journal of the academy of marketing sciences 21(1): 21-31. kotler, philip and ravi singh. 1981. "marketing warfare in the 19808." journal of business strategy 1(winter): 30-42. levitt, theodore. 1975. "marketing myopia." harvard business review 53(september-october): 26-44. mason, mark. 1992. "foreign direct investment in japan: lessons from business history." the international executive 34 (january/february): 7-13. parasuraman, a. and p. varadarajan. 1985. "more on marketing strategy and differential advantage." journal of marketing 49(spring): 124-128. ratan, suneel. 1991. "the big split." fortune (may 6) 123(9): 38-42. ries, ai and jack trout. 1986. marketing warfare. new york: mcgraw-hill. the japan economic journal. 1980. "hitachi and fujitsu step up their computer exports," (may 6): 9. spring 1994 cotter, et al.: strategy as a culturally dependent phenomenon 75 the wall street journal. 1987. "glutted markets." in applications in basic marketing 1990 edition, 6-10. eds. e. jerome mccarthy and william d. perreault. homewood, il: richard d. irwin, inc. westbrook, a and o. ratti. 1970. aikido and the dynamic sphere. rutland, vt: charles e. tuttle company. strategy as a culturally dependent phenomenon: the interpretation of japanese corporate strategy through the analysis of aikido consumer learning and the creation of primacy advantages for followers brian t. engelland bruce l. alford mississippi state university mississippi state, ms abstract this paper examines the basis for the primacy advantages that pioneers enjoy, then applies it to the strategic plight offollowers. the authors develop and test a model of innovation learning that shows how individuals relate their understanding of new products to those with which they've had previous exposure. in an application of the model to the introduction of a new packaged good, three factors relative advantage, expertise, and familiarity are found to have statistically significant effects on perceived distinctiveness; and perceived distinctiveness is found to be a predictor of perceptual separation and primacy advantage. suggestions are given to assist in strategy formulation decisions for followers. introduction every brand cannot be first to market, and being first may not prove to be a consistent approach to achieving dominant market share and long term profitability. researchers have documented some of the pitfalls of pioneering, and suggest that an aggressive follower strategy may be more effective in some situations (haines, chandran & parkhe, 1989; schnaars, 1986). however, the literature has provided little actionable advice for followers that can be used to develop an effective marketing strategy. except for carpenter and nakamoto (1990), the orientation is predominantly toward strategies for the pioneer. accordingly, this paper explores preference formation by consumers, building upon the work of carpenter (1989), carpenter & nakamoto (1989,1990,1994), kardes & gurumurthy (1992) and others. person-related and product-related constructs distilled from four literature streams are incorporated into a model of innovation learning that is empirically tested. implications are then presented which show how followers may earn the advantage of primacy. conceptual background in the following paragraphs, we review important conclusions developed by four streams of research. first, we explore the strategy literature related to market 146 journal of business strategies vol. 17, no.2 entry timing, then we turn to learning theory, attitude change theory and the innovation adoption literature. market entry timing the order of entry for competing brands within a product category has been examined for its effect on brand success. the literature suggests that the first brand of a product form, the pioneering innovation, has distinctive advantages that ahow it to maintain the highest share as other products enter the market (huff & robinson, 1994; mascarenhas, 1997; miller, gartner & wilson, 1989; robinson & fornell, 1985; urban, carter, gaskin & mucha, 1986). advantages to pioneering include preemption of competition, gaining a leader reputation, building customer loyalty, proprietary experience effects, access to scarce resources, and a sustainable lead in technology. however, the conceptualizations of carpenter & nakamoto (1989, 1994), kardes & gurumurthy (1992), and kardes, kalyanaram, chandrashekaran & and dornoff (1993) suggest that these advantages transcend the economics-based explanations, and are really the result of being first into the mind of the customer. the preference distribution shifts toward the first innovation in a category so that it becomes the prototype of that category (carpenter & nakamoto, 1989). this action achieves a protected position for the pioneering innovation. learning theory the existence of hierarchical connections between stored pieces of information has a long tradition in learning theory (for example, miller, 1956; and osgood, 1949). research continues to explore the psychodynamic mapping, connecting or associative function that enables memory to store and retrieve information (alba & hutchinson, 1987; bruce, 1991; cowan, 1988; kardish et al., 1988; macklin, 1996). scholars suggest that information is stored in long-term memory on the basis of meaning and importance, and is encoded in such a way that it is associated with previously stored information of similar meaning and importance in a hierarchical framework. although the precise nature of what goes on in the brain is uncertain, the existence of hierarchical traces has been validated and scholars are in agreement that information is stored in long-term memory on the basis of meaning and importance. these hierarchical traces are especially relevant as consumers learn about innovations. brand learning can be enhanced in consumers through the development of appropriate consumption vocabulary in those consumers (west, brown & hoch, 1996). in effect, appropriate vocabulary serves as an organizing framework (or hierarchical trace) that speeds the learning of new innovations, and prescribes meaning and importance attributes that lead to associative memory storage. fall 2000 engel/and and alford: consumer learning 147 attitude change research in attitude change has identified a number of person-related variables that affect individual perception of the distinctiveness of new information received about a product or brand. among these variables are familiarity with the previous brand, category expertise, and personal innovativeness. familiarity develops from repetition of the stimulus-response interplay, either through exposure to promotional communications or repeated use of a product or service. research suggests that high familiarity adversely impacts the meaningfulness and distinctiveness of new information that consumers receive (ratneshwar, shocker & stewart, 1987; ratneshwar & shocker 1991). alternatively, expertise in a product category has an opposite effect on perceived distinctiveness. as an individual gains expertise in an area of interest, that expertise heightens his or her ability to discriminate information and categorize inputs (howard, shay & green, 1988). finally, individuals have different levels of innovativeness, receptivity or motivation to change which can influence the perception of distinctiveness between two innovations (hoch & deighton, 1989). those individuals who have a propensity to seek out and try new brands have an enhanced ability to comprehend and differentiate the information they receive about those new brands. the adoption of innovations rogers (1983) summarized research evidence of 33 studies on the rate of adoption of innovations and found that relative advantage, compatibility, complexity, trial ability and observability all affect adoption rate. this list can be divided according to two classes, those that provide some calculable economic performance advantage to the holder (relative advantage), and those that foster easy communication through society (compatibility, complexity, trialability, and observability). the former class encompasses the economic factors of porter (1985); the latter class encompasses the behavior-related factors of rogers (1983). because a decision-maker is an individual that makes decisions regarding the adoption of an innovation, a decision-maker can be an individual in a consumer purchase context, or an organizational buying context. given this perspective, the rogers (1983) definition of innovation is appropriate: an innovation is a brand, product or service that is perceived as new to the decision-maker. two classes of innovations are necessary to precisely explain consumer innovation learning. innovation[ is the innovation in any category which first becomes known by the decision-maker. innovation2 is one that becomes known after innovation[ has already become so. please note that this is an important distinction. the innovation that is chronologically first on the market, the pioneering innovation, may not be the first in the mind of every decision-maker. to achieve innovation[ status, that innovation must be retained in the mind before any competing innovation can, otherwise, it becomes innovation2• 148 journal of business strategies vol. 17, no.2 all innovations, whether pioneering or secondary, can be classified according to distinctiveness on two dimensions: relative advantage and complexity. naturally, relative advantage is judged in the eye of the beholder. if the decision-maker sees a price/value/performance advantage based upon what he knows about the innovation, then the innovation is considered to have relative advantage. if the decision-maker perceives no discernible advantage, than the innovation is considered a "me-too" alternative. communication complexity is also determined individually. if the decision-maker finds the innovation to be relatively easy to understand, try, and use, then it is classified as simple to communicate (rogers, 1983). if the decision-maker experiences trouble in accomplishing this understanding due to its detail or involvement, then the innovation is considered complex. in line with our previous discussion, new information is stored in the human mind so that it is perceptually linked with other information that has previously been stored. similar information is stored in perceptual proximity within the encoding hierarchy, while dissimilar information is stored at perceptual separation. thus, the perceptual distance between various information bits stored in the mind refers not to its physical location, but to its relative position within the storage hierarchy. a model of innovation learning a general contingency model is proposed to represent the learning processes necessary to process information about innovations, leading to the adoption decision (see figure 1). the model assumes that the decision-maker already has stored information (knowledge) about a prior innovation, innovation 1• when presented with communications regarding some innovation 2 , the mental processing function assesses the information and determines its distinctiveness. this processing function is mediated by three person-related variables, (1) familiarity (or "habit strength") with innovation" (2) category expertise, and (3) personal innovativeness; and two product-related variables, (1) message complexity and (2) relative advantage. the perceptual location where information is stored is contingent upon the perceived distinctiveness of the attended innovation. if the new information is sufficiently indistinct so that it fails to exceed the decision-maker's contrast threshold, the information will not be stored. if the new information is marginally distinctive, it will be stored in perceptual proximity to the innovation] information stored previously. if the distinctiveness is great, the information will be stored at perceptual separation from innovation i information. whether the information is stored separately or in proximity makes a difference upon recall. information stored together will be recalled together in a hierarchy that places the innovation, in a primary position; information stored apart is recalled apart. fall 2000 engelland and alford: consumer learning figure 1 model of innovation learning 149 product-related relative + advantage complexity perceptual perceived + separation distinctiveness from innov 1 person-related familiarity + expertise + innovativeness research hypotheses six hypotheses are derived based upon the proposed model. first, the complexity of the innovation communication will have an impact on comprehension and learning for the decision-maker. if innovation2 is complex, and thus difficult to comprehend, the decision-maker utilizes more stages in evaluation (kardes et al., 1993) and is more likely to misunderstand the communication, or fail to treat the information accurately. this mis-handling can result in misunderstanding and misappreciation of the nature of the innovation. thus, hypothesis 1: the greater the complexity in the innovation2 communication, the less will be the perceived distinctiveness of the information learned. 150 journal of business strategies vol. 17, no.2 the familiarity or habit strength that a consumer develops with innovation\ affects his perception of distinctiveness for innovation2 • habit strength develops with repetition of the stimulus-response interplay and results from repeated use of the product or service, or from exposure to promotional communications about it. brown & lattin (1994) found that this learning effect translates into an advantage for the pioneering brand commensurate with the time in market prior to the next entrant. we suggest that a primary reason behind this performance differential is related to perceived distinctiveness. thus, hypothesis 2: the more a decision-maker has familiarity with innovation}, the less will be the perceived distinctiveness of innovation]. an individual decision-maker gains expertise in an area of interest as a result of past learning, socioeconomic characteristics, learning capability and the evaluation of new brands. expertise heightens the decision-maker's ability to assess context accurately (pan & lehmann, 1993), discriminate brands, and categorize inputs. thus, hypothesis 3: the greater the decision-maker's expertise in the area of concern, the greater will be the perceived distinctiveness of innovation 2 as compared to innovation •. consumers have different levels of innovativeness, and this affects the perception of distinctiveness between two or more innovations. innovativeness is determined by several factors, including previous practice, felt needs, acceptable norms in the appropriate social system, and personality characteristics. one who seeks out and tries new things has a higher innovativeness level. thus, hypothesis 4: the greater a decision-maker's innovativeness, the greater will be the perceived distinctiveness of innovation] as compared to innovation}, the relative advantage of innovation 2 versus innovation! has a positive effect on its perceived distinctiveness. thus, hypothesis 5: the greater the relative advantage of innovation] versus innovation}, the greater will be the perceived distinctiveness of innovation]. finally, when knowledge is accessed from storage, its associations with other pieces of information are still intact. the learned information about innovation[ has the advantage of being more accessible than information about innovation2, fall 2000 engelland and alford: consumer learning 151 and it comes to mind first. the relative hierarchical position accorded to innova~ tion2 in long tenn memory is contingent upon the perceived distinctiveness of the innovation. innovations that are quite differentiated from what has come before are stored apart; innovations that are substantially the same are stored together; innovations that have no discernable difference do not pass the individual's con~ trast threshold, and are forgotten. thus, hypothesis 6: the greater the perceived distinctiveness ofinnovation 2• the greater will be the perceptual separation established in long term memory between innovation2 and innovation,. methodology a test ofthe proposed model was conducted during the period when the coca-cola company was engaged in the early launch of a new beverage named surge™ that was targeted toward college-age youth. several of the company's introductory advertising spots had just aired on the super bowl, and product had been made available in the traditional retail beverage outlets and vending machines. because many consumers purchase soft drinks and were just beginning to fonn impressions about this new product, surge™ was selected as the innovation2 for this study. undergraduate students drawn from a convenience sample of 10 business classes at a midwestern university were administered a questionnaire containing mea~ sures of the seven constructs of interest. this elicitation resulted in a total of 193 completed questionnaires across four grade levels. potential respondents were told only that they were participating in a questionnaire on consumer attitudes toward soft drinks. participation was voluntary. after administration, data was analyzed using lisrel structural equation modeling. measurement four constructs were operationalized with previously developed and validated scales as follows: (i) relative advantage was measured by using a modified four~item scale based on deighton, romer & mcqueen, (1989); (2) complexity using the three~item stimulus complexity scale (holbrook, 1981); (3) familiarity using the five-item object familiarity scale (oliver & bearden, 1985); and (4) innovativeness with a four-item scale developed by hawes & lumpkin (1984). in addition, three measures were de~ vel oped specifically for this study. scales for expertise and perceived distinctiveness were developed following item generation, purification and validity assessment as per churchill (1979), and unidimensionality assessment using structural equation modeling as per gerbing & anderson (1988). the measure for perceptual separation was developed based upon a multidi~ mensional scaling approach from which euclidian distances were imputed. multidimensional scaling is concerned primarily with the spatial representation of 152 journal of business strategies vol. 17, no.2 consumer preferences (carroll & oreen, 1997) and is particularly appropriate in obtaining comparative evaluations when the specific bases of consumer comparison are unknown or undefinable (hair, anderson, tatham & black, 1992). accordingly, multidimensional scaling was used to represent and measure the relative separation respondents perceived between innovation l and innovation2. the measurement was structured so that four different assessments of separation could be recorded allowing for the computation of coefficient a as a measure of reliability. after reading a description of surge™ taken from advertising copy, respondents were asked to name a brand that they perceived as being "most similar" to surge™. the named brand became innovation l in subsequent analyses. respondents were then asked to rate the similarity between surge™ and the named brand on a seven-point scale, and this became the first measurement of perceptual separation. in addition, the similarities among these and three other brands were also requested. absolute values of the difference in euclidean distance between these assessments served as three additional measurements of perceptual separation between surge™ and the named brand. results measurement model. confirmatory factor analyses were performed to establish the scales to be used in the structural model estimation. removal of items from the analysis was based on examination of the theta delta matrix, the standardized residuals, and the modification indices. items with large theta delta loadings, large residuals and cross loadings to other constructs were removed from the analysis. table i provides parameter estimates, composite reliability and average variance extracted for each construct/variable. the composite reliability for each construct is acceptable as is the average variance extracted, with two notes. the average variance extracted for innovativeness and perceptual separation is not as high as desired. while innovativeness was measured using an existing scale from the literature, perceptual separation measures were developed for this study. this suggests future measurement of these constructs should attempt to improve the performance of these measures. in addition, results from this study concerning these constructs should be interpreted carefully. the overall model with x2303df of 329.68 (p =.14) displays an acceptable level of fit to the data. the goodness of fit index (ofi) of .95, adjusted goodness of fit index (aofi) of .93, and the root mean square residual (rmsr) of .06 are also acceptable figures (bagozzi & yi, 1988). these measures indicate a model that represents the data reasonably well. for a comparison, the null confirmatory factor model was calculated to have a x2351drof2331.42 (p ~ .01), resulting in a x2348df difference of2001.74 (p ~ .01). these results indicate that the measurement model is a significant improvement over the null model. fall 2000 engel/and and alford: consumer learning 153 table 1 confirmatory factor analysis of measurement scales constructs parameter composite avg. variance variables estimates reliability extracted relative advantage xl 0.66 x2 0.84 x3 0.81 x4 0.84 0.81 0.63 complexity x5 0.69 x6 0.65 x7 0.71 0.72 0.46 familiarity x8 0.78 x9 0.68 xio 0.75 xii 0.64 xi2 0.91 0.87 0.58 expertise xi3 0.81 xi4 0.64 xi5 0.75 xi6 0.70 0.82 0.53 innovativeness xi7 0.61 xi8 0.62 xl9 0.66 x20 0.57 0.71 0.38 perceived distinctiveness x21 0.74 x22 0.74 x23 0.72 0.78 0.54 perceptual separation x24 0.59 x25 0.62 x26 0.56 x27 0.69 0.71 0.38 x' 'ojd( =329.68 (p =.14) gfi =.95 agfi =.93 rmsr =.06 154 journal of business strategies vol. 17, no.2 reliability. once the confirmatory factor analyses yielded the measurement model, a reliability assessment of the scales was performed. the item-to-total correlations and the standardized coefficient (x for each scale are shown in the appendix. all scales performed acceptably with coefficient 0: above .70. low item-to-total correlations for some items (e.g. x l9 ::::; .45 and x24 =.41) were found. for this reason, other combinations of perceptual separation and innovativeness items were assessed for use in the measurement model in hopes of a better fit. the results of this examination yielded no improvements without extreme costs. for each improvement in item-to-total correlations there was a corresponding decrease in performance of the confirmatory factor analysis model. it was deemed that a slight sacrifice of reliability was allowable for a confirmatory factor analysis that provided a better measurement model. the hypotheses tests. the structural model standardized coefficients and tvalues are displayed in table 2, along with the overall fit statistics for the model. the x} iidf of 22.32 (p = .02) indicates a reasonably good fit to the data. this is also suggested by the goodness of fit index (gfi) of .97, the adjusted goodness of fit index (agfi) of .92, and the root mean square residual (rmsr) of .07. given that the proposed model represents an acceptable level of fit with the data, the research hypotheses were evaluated. hypothesis one (hi) posits that greater complexity in the innovation2 communication will result in less perceived distinctiveness of the information. the coefficient for this path is not significant at the .05 level (t::::; 1.61), providing no support for hypothesis one (table 2). this suggests that complexity of innovation2 information did not influence the distinctiveness ofthe communication concerning innovation2 • the second hypothesis (h2) states that more familiarity with innovation l leads to less perceived distinctiveness of innovation2 • this path is significant (t =-2.33, p .s; .05) and the path coefficient has a negative sign (-.22). thus, the second hypothesis is supported. hypothesis three (h3) posits that greater expertise will result in greater perceived distinctiveness. this hypothesis is supported with a positive path coefficient of .19 and a t-value of 1.93 (p ~ .05). the next hypothesis (h4) states that a greater level of innovativeness in the decision maker results in greater perceived distinctiveness. this path coefficient failed to achieve significance, so hypothesis four is not supported. hypothesis five (hs) predicts a significant and positive relationship between relative advantage and perceived distinctiveness. the path coefficient is indeed positive (.47) and significant (t =5.32, p:5 .05 ), providing support for the fifth research hypothesis. the final hypothesis (h6) maintains that perceived distinctiveness will have a positive influence on perceptual separation. with a significant, positive coefficient of .35 (t = 3.76, p:5 .05 ), the sixth hypothesis is supported. fall 2000 engel/and and alford: consumer learning table 2 structural model parameter estimates 155 model linkage standardized estimate complexity -> perceived distinctiveness .16 familiarity -> perceived distinctiveness -.20 expertise -> perceived distinctiveness .19 innovativeness -> perceived distinctiveness .02 t-value 1.61 -2.33' 1.93' 0.22 relative advantage -> perceived distinctiveness perceived distinctiveness -> perceptual separation x211df = 22.32 (p = .02) gfi =.97 agfi = .92 rmsr =.07 • significant at the .05 probability level discussion .47 .35 5.32' 3.76' we began with a summary review of the literature in which we paraphrased carpenter & nakamoto's (1989) assertion that the first innovation into the mind becomes that standard against which all followers are judged. we then developed and tested a model of innovation learning, which suggests that perceptual separation between innovations determines whether the second innovation received is perceived as a follower or as a pioneer in another category. if it is perceived as a pioneer in another category, the new product would be accorded the primacy advantage that the literature suggests leads to market share success. our study found that relative advantage and category expertise had positive effects on perceived distinctiveness between the innovations, while product familiarity had a negative effect on perceptual separation. we also found indications that perceived distinctiveness acts as an intervening variable to fix a consumer's perceptual separation between two innovations. our contribution has been to develop the model, operationalize the variables and test the relationships on a new product undergoing national launch. as indicated in the results section, four of the effects predicted by the model were supported by the data, while two were not. one product-related characteristic (relative advantage) and two person-related characteristics (familiarity and 156 journal of business strategies vol. 17, no.2 expertise) influenced the perceived distinctiveness of innovation2. this suggests that while person-related characteristics are not modified by marketers, there are actions that can be taken to provide a higher degree of success for the follower. consumer brand familiarity and expertise changes over time, and followers would do well to capitalize on differences in both variables. marketers who follow quickly after the pioneer should reach consumers while they still have a low level of familiarity associated with the pioneering brand. this timing would lessen the negative effect of familiarity on perceived distinctiveness. on the other hand, quickly following a pioneer is not always feasible. in this case, marketers would desire expertise among consumers in order to develop their ability to discriminate among choice alternatives. communication programs launched with innovation2 should strive to inform consumers about the key attributes concerning the products and how to assess the products. this way, consumers are better prepared to evaluate the products and marketers can thus take advantage of the positive relationship between expertise and perceived distinctiveness. the product related characteristic (relative advantage) is based on consumers' perception of the new product providing a price, value or performance advantage. while this is a perception by consumers, marketers have great influence over this characteristic. the design of the product, pricing of the product, and image of the product are controlled by the marketer. designing a differentiable product and communicating this to consumers will aid in their perception of the relative advantage of the new pwduct, which will increase the perceived distinctiveness of the product. the result of creating a perception of distinctiveness is perceptual separation of innovationz from innovation). information concerning innovationz is stored separately and apart from innovation). this means that different referents will activate retrieval of information concerning innovation2. marketers then have a mechanism for aiding consumers' retrieval of innovation2 for future purchase decisions without alluding to or interference from innovation,. two variables failed to achieve significance, one product-related (complexity) and one person-related (innovativeness). the reason that complexity failed to reach significance as a moderator of perceived distinctiveness may be related to the product category chosen for this test. the characteristics of soft drinks are generally simple to comprehend for most consumers, and this lack of variability may have adversely affected the power of the analysis. the fact that innovativeness failed to reach significance may indicate that its role may be overstated. additional testing is needed to verify this result. the challenge for followers our model and results suggest that the fundamental challenge for a marketer of a following innovation is to obtain separation from innovation! in the minds of fa112000 engelland and alford: consumer learning 157 potential adopters. target customers must be encouraged to learn information about the product by storing the information at a perceptual distance from any information stored about the pioneering innovation. in this way, the follower's product will not be associated with the pioneer's product upon recall. in addition to designing a good product that provides superior relative advantage, five strategies may be appropriate to increase perceptual distance, including (1) quick response; (2) communication frequency; (3) communication design; (4) communication differentiation; and (5) prospect education. we discuss each approach in the following paragraphs. quick response. a follower can introduce its entry quickly to minimize the amount of time available for the pioneer to establish its image with target consumers. this strategy can incorporate pre-announcing communications that precede the actual introduction by a significant number of weeks (robertson, eliashberg & rymon, 1995). quick reactive communications lessens the opportunity for a large percentage of the potential market to develop familiarity with the pioneering innovation first. this strategy is the "fast second" strategy frequently employed by ibm. communications frequency. another strategy that a follower can employ consists of increasing the number and frequency of communication exposures to assist in building familiarity with the follower's innovation. this action will support the primacy advantage in situations where the follower's product has achieved innovation j status, but will be less fruitful where the pioneer has attained a high penetration into the target population. a good example application of this strategy is microsoft's massive introductory promotional campaign for windows 95, a follower innovation. the product was essentially a dressed-up version ofibm's as, but the integrated promotional campaign orchestrated by microsoft managed to convince enough computer purchasers to regard windows 95 as the real "standard of comparison." communication design. a third strategy is the design of marketing communications that help the target decision-maker encode the information with terms and concepts that are favorable to the follower. vocabulary has a powerful influence on how consumers understand the features and benefits of product innovations (west, brown & hoch, 1996). when marketers provide connections with previously known products or concepts, they assist potential adopters in learning about the innovation. this action can assist the adopter in associating the new information in an appropriate mental hierarchy. an interesting example is the enterprise rent-a-car advertising campaign that features cars wrapped with brown paper and string and looking very much like a special delivery package. this communication with the "package" referent dramatizes the distinctive delivery capability that enterprise possesses and makes it seem to customers as a new category of car rental company_ communication differentiation. another strategy to increase the distinctiveness of the follower innovation is through differentiation in communication de158 journal of business strategies vol. 17, no.2 sign. when anheuser busch introduced its bud light as a follower brand in the light beer category, it employed the distinctive theme involving the tag line, "don't just ask for a light, ask for a bud light" and showed all manner of strange consequences for beer drinkers who violated this advice. the campaign did more to create distinctiveness than any real differences in product. prospect education. the final strategy involves prospect education to increase familiarity with the follower brand and expertise in the product category. for instance, old town canoe company is an example of a firm that has developed an extensive catalog and home page that helps prospects gain information about the various designs, types and material choices used in canoe construction. consumers who visit the old town site become more familiar with old town products, appreciate their distinctiveness and favorably evaluate them. with respect to the strategy followed for the new surge™ brand, our results suggest that the consumers in our sample perceive surge™ as having achieved very little perceptual separation from mountain dew™. the mean value for our measure of perceptual separation was 1.17 on a 7-point scale. if national consumers view the product similarly, we expect that surge™ will always reside in mountain dewtm>s shadow, and will fail to achieve the market dominance aspirations that coca cola company has for the new product. fall 2000 engelland and alford: consumer learning appendix reliability analysis of measurement scales 159 items ittca relative advantage xi 0.62 x2 0.76 x3 0.77 x4 0.73 complexity x5 0.62 x6 0.52 x7 0.48 familiarity x8 0.67 x9 0.66 xlo 0.70 xli 0.62 xi2 0.80 expertise xl3 0.74 xi4 0.59 xis 0.67 xi6 0.51 innovativeness xl? 0.48 xi8 0.57 xi9 0.45 x20 0.48 perceived distinctiveness x21 0.66 x22 0.60 x23 0.59 perceptual separation x24 0.41 x25 0.57 x26 0.48 x27 0.53 a item-to-total correlation standardized coefficient alpha 0.86 0.72 0.86 0.80 0.71 0.78 0.71 160 journal of business strategies references vol. 17, no.2 alba,1. w. & hutchinson, 1. w. (1987). dimensions of consumer expertise. 19umal of consumer research. 13 (march), 411-446. bagozzi, r. p. & yi, y. (1988). on the evaluation of structural equation models. journal of the academy of marketing science. 16 (1),74-94. brown, c. l. & lattin, 1. m. (1994). investigating the relationship between time in market and pioneering advantage. management sci~nce. 40(l0), 1361-1369. bruce, d. (1991). mechanistic and functional explanations of memory. american psychologist. 46, i (january),46-48. carpenter, g. s. (1989). perceptual position and competitive brand strategy in a two-dimensional, two-brand market. mana~rnent science. 35, 9 (september), 1029-1044. carpenter, g. s. & nakamoto, k. (1994). reflections on 'consumer preference [onnation and pioneering advantage.' journal of marketin~ research. 31 (november), 570-573. carpenter, g. s. & nakamoto, k. (1990). competitive strategies for late entry into a market with a dominant brand. mana~ement science. 36, 10 (october), 1268-1278. carpenter, g. s. & nakamoto, k. (1989). consumer preference fonnation and pioneering advantage. journal of marketing research. 26 (august), 285-298. carroll, 1. d. & green, p. e. (1997). psychometric methods in marketing research: part ii, multidimensional scaling. journal of marketing research. 33 (may), 193-204. churchill, g. a, jr. (1979). a paradigm for developing better measures of marketing constructs. joyrnal of marketing research. 16 (february), 64-73, cowan, n. (1988), evolving conceptions of memory storage, selective attention, and their mutual constraints within the human information-processing system. psycholo~ical bulletin. 104(2), 163-191. deighton, 1., romer, d. & mcqueen, j. (1989). using drama to persuade. journal afconsumer research. 1<) (december), 335-343. gerbing. d. w. & anderson, j. c. (1988). an updated paradigm for scale development incorporating unidimensionality and its assessment. joyljlal of marks;ting research. 25 (may), 186-192. haines, d. w" chandran, r. & parkhe, a (1989), winning by being the first to market. , . or second? journal of consumer marketing. 6,1 (winter),63-69. fall 2000 engelland and alford: consumer learning 161 hair, j. e, jr., anderson, r. e., tatham, r. l., & black, w. c. (1992). multivariate data analysis with readings, 3rd ed., new york: macmillan. hawes, 1. m. & lumpkin, 1. r (1984). understanding the outshopper. journal ofthe academy of marketing science. 12 (fall), 200-218. hoch, s. 1. & deighton, 1. (1989). managing what consumers learn from experience. journal of marketing. 53 (april), 1-20. holbrook, m. b. (1981). integrating compositional and decompositional analyses to represent the intervening role of perceptions in evaluative judgements. journal of marketing research. 18 (february), 13-28. howard, j. a., shay, r p. & green, c. a. (1988). measuring the effect of marketing information on buying intentions. journal of consumer marketing. 5(3), 5-14. huff, l. c. & robinson, w. t. (1994). the impact ofleadtime and years of competitive rivalry on pioneer market share advantages. management science. 40(0), 1370-1377. kardish, c. a. m., royer, j. m. & greene, b. a. (1988). effects of schemata on both encoding and retrieval of in formation from prose. journal of educational psychology. 80(3), 324-329. kardes, e r, kalyanaram, g., chandrashekaran, m. & dornoff, r j. (1993). brand retrieval, consideration set composition, consumer choice, and the pioneering advantage. journal of consumer research. 20 (june), 62-75. kardes, e r & kalyanaram, g. (1992). order-of-entry effects on consumer memory and judgement: an information integration perspective. journal of marketing research. 29 (august),343-57. macklin, m. c. (1996). preschoolers' learning of brand names from visual cues. journal of consumer research. 23 (december), 251-261. mascarenhas, b. (1997). the order and size of entry into international markets. journal of business venturing. 12,287-299. miller, a. gartner, w. b., & wilson, r (1989). entry order, market share, and competitive advantage: a study of their relationships in new corporate ventures. journal of business venturing. 4,3 (may), 197-209. miller, g. a. (1956). the magical number seven, plus or minus two: some limits on our capacity to process information. psychological review. 63, 81-97. oliver, r. l. & bearden, w. o. (1985). crossover effects in the theory of reasoned action: a moderating influence attempt. journal of consumer research. 12 (december), 324-340. 162 journal of business strategies vol. 17, no.2 osgood, c. e. (1949). the similarity paradox in human learning: a resolution. psychological review. 56,132-143. pan, y. & lehmann, d. r. (1993). the influence of new brand entry on subjective brand judgments. journal of consumer research. 20 (june), 76-86. porter, m. e. (1985). competitive advantage: creating and sustaining superior performance, new york: the free press. ratneshwar, s. & shocker, a. d. (1991). substitution in use and the role of usage context in product category structures. journal of marketing research. 28(3), 281-295. ratneshwar, s. & shocker, a. d., & stewart, d. w. (1987). toward understanding the attraction effect: the implications of product stimulus meaningfulness and familiarity. journal of consumer research, }3(4), 520-533. robertson, t s., eliashberg, 1. & rymon, t (1995). new product announcement signals and incumbent reactions. journal of marketing. 59(3), 1-20. robinson, w. t & fornell, c. (1985). sources of pioneer advantages in consumer goods industries. journal of marketing research. 22 (august), 305-317. rogers, e. m. (1983). diffusion of innovations, 3rd ed., new york: the free press. schnaars, s. p. (1986). when entering growth markets, are pioneers better than poachers? business horizons, march-april, 27-36. urban, g. l., carter, t, gaskin, s. & mucha, z. (i986). market share rewards to pioneering brands: an empirical analysis and strategic implications. management science. 32, 6 (june), 645-659. west, p. m., brown, c. l., & hoch, s. j. (1996). consumption vocabulary and preference formation. journal of consumer research. 23 (september), 120-135. brian t. engelland (dba, southern illinois university at carbondale) is associate professor of marketing at mississippi state university. his current research interests are marketing strategy, marketing education and measurement, and his work has been accepted for publication in a variety of outlets, including the jou71ul1 ofthe academy of marketing science, journal of business research, journal of marketing management, marketing education review, and jou71ul1 ofbusiness strategies. broce l. alford (ph.d., louisiana state university) is assistant professor of marketing at mississippi state university. his current research interests are reference prices, services marketing and measurement issues. he has published in such journals as jou71ul1 ofprofessional services marketing, health marketinr quarterly, jou71ul1 of business research, and jou71ul1 ofbusiness strategies. consumer learning and the creation of primacy advantages for followers redefining corporate strategic fit virginia l. blackburn charles b. shrader iowa state university ames, iowa a consensus seems to be forming tha:t related corporate acquisitions are superior to unrelated acquisitions. the arguments center around the idea that related acquisitions present greater opportunities for the exploitation of synergies and that any risk reduction benefits of unrelated acquisitions are more easily and cheaply achieved through diversification of individual investor portfolios. in addition, related acquisitions are considered less risky since they do not take the firm into entirely unfamiliar territory. historically, empirical evidence has supported the prevailing wisdom of "sticking to the knitting" ([11], [10j, [1], [7]). more recent evidence, however, indicates that unrelated mergers and acquisitions are positively valued by the market, suggesting the expectation of risk reduction or synergy exploitation ([2], [5]). this more recent empirical evidence and the mere fact that unrelated mergers continue, suggests that the possible risk reduction or synergistic benefits of unrelated mergers has probably been underestimated. unrelated diversification is generally viewed as precluding synergies other than those related to cash flows. the importance of nonfinancial synergies including those related to multipoint competition, management and market power is minimized. from a diversification standpoint, to argue that individual investors can achieve equivalent results through their own diversification efforts requires assuming that individual investors are equally capable of achieving cash flow and debt capacity synergies resulting from diversification. this is doubtful. there is also abundant anecdotal evidence that related mergers are not universally successful. witness the recent failure of united airlines to successfully exploit the apparent synergies of airlines, car rental, and hotels. philip morris also has had difficulty establishing the profitability of seven-up and miller beer which are related to philip morris' traditional product line by virtue of sharing end users and distribution outlets. recent work also indicates that related diversification efforts are divested no less frequently than unrelated attempts [6j. overall, it seems clear that the potential synergies of related mergers may sometimes be overestimated or at least more difficult to achieve than originally thought. on the other hand, it appears that unrelated mergers may provide synergistic or risk reduction benefits not previously thought possible. these developments run contrary to current wisdom regarding diversification and consequently deserve some clarification. actually two alternative conclusions are suggested by the current evidence. one conclusion might be that the potential of related acquisitions has been historically journal of business strategies, volume 7, number 1 (spring 1990) 1 2 journal of business strategies vol. 7, no.1 overestimated while the potential for unrelated acquisitions has been underestimated. an alternative conclusion is that we have simply not captured the most relevant dimensions of relatedness. this latter conclusion would suggest the need to re-evaluate our working definition of relatedness to more accurately specify those aspects of relatedness that lend themselves to the successful exploitation of synergies. this paper explores the possibility that the concepts of "relatedness" and its corollary "corporate strategic fit" can be redefined to more clearly address the full scope of managerial, structural and competitive decisions embodied in the corporate strategy formulation and implementation process. relatedness has traditionally been defined to include horizontal integration, vertical integration and diversification into related product lines. the extent of relatedness is generally construed as the potential for exploiting marketing, manufacturing and distribution synergies. this narrow definition of relatedness fails to capture a number of the dimensions of relatedness that either enhance the strategic position of the firm or contribute to the failure of the firm to successfully integrate the acquisition. the premise of this paper is that related mergers and acquisitions are superior to unrelated acquisitions, but that the definition of relatedness must be redefined to consider the full range of issues relevant to the successful integration of the acquisition. a more promising definition of relatedness explicitly considers the respective business level strategies of the acquiring and acquired firm. business level strategy defines the competitive positioning of the firm in its industry. porter [8] has identified two primary business/competitive strategy alternatives. firms can establish themselves as the low price provider in the industry. implicit to the successful implementation of this strategy is the requirement that the firm also maintain a low cost production position. alternatively, firms can attempt a differentiation strategy whereby the firm establishes the perceived uniqueness of its product to the customer. successfully differentiated products can, of course, be sold at a premium over non-differentiated products. as porter and others have pointed out, the successful implementation of these strategies requires unique resource bases, distinctive competencies, structural and organizational characteristics. these differences further imply differences in managerial style and organizational culture appropriate to low cost/price and differentiation strategies. the following sections of this paper point out how the mixing of strategic orientations, and by definition, firms with different resource, managerial and organizational configurations may result in less than maximum performance of the combined firm. in general we suggest that if business strategies are consistent, then the problems of integration are minimized and the possibility of synergies exists regardless of the relationship among product lines. on the other hand, mergers between firms who do not pursue similar business/competitive strategies are more likely to fail regardless of the relatedness of product lines. spring 1990 blackburn & shrader: strategic fit resource bases 3 porter [8] details very specific resource and skill requirements for the successful implementation of low cost and differentiation strategies. low cost strategies imply the need for extensive and sustained capital investment, process engineering capabilities, diligent supervision of labor, products designed for ease of manufacture and low-cost distribution systems. from an organizational standpoint, the low-cost strategy requires a generally more structured, tightly controlled organization which relies heavily on quantitative incentive programs. the emphasis by necessity is on cost control and organizational efficiency with innovativeness generally confined to that which has the potential to enhance production efficiency. an entirely different set of resources, skills and organizational configurations is necessitated by a differentiation strategy [8]. the emphasis here is on marketing capabilities, product innovation, basic research, company reputation and cooperation of distribution channels. organizations are more loosely structured and rely on subjective performance measures applied in an atmosphere designed to foster individual creativity and cooperation between functional responsibilities. clearly, these sets of skills, resources and organizational requirements ate largely mutually exclusive within the same business unit. unless a firm does all things well and has access to virtually unlimited capital and human resources, they are not likely to successfully pursue both strategic avenues. partly because of the unique resource and organizational requirements, the exclusivity of low-cost and differentiation strategies at the business level is generally acknowledged. the mutual exclusivity of competitive strategies is, however, not acknowledged at the corporate level. strategic "fit" at the corporate level is typically not defined in terms of the consistency of the various competitive strategies simultaneously being pursued by the business units within the corporation. rather it is defined in terms of the relatedness of product lines. this perspective fails to fully acknowledge the realities of corporate level strategy. as with single business corporation, a multi-business firm operates under a constraint of finite resource availability. resource constraints are no less salient simply because a business unit becomes a part of a multi-business firm. in fact, resource dilemmas may be exacerbated if related business units pursuing different competitive strategies begin to vie for larger shares of the existing resource base. consequently, with respect to resource and organizational requirements, it is more appropriate to view business/competitive strategies as mutually exclusive at the corporate level also. dominant logic and strategic complexity when relatedness is defined as the relatedness of product lines, strategic complexity is generally defined as function of the number of businesses the firm operates in. little if any mention is made of the uniqueness and number of business level strategies being pursued. it seems appropriate that strategic complexity at the corporate level should be considered both a function of the number of relevant industries and the 4 journal of business strategies vol. 7, no.1 variability of competitive strategies implemented in each. if both aspects of strategic complexity are considered it is clear that strategic complexity at the corporate level can be increased without becoming involved in multiple industries but simply by pursuing multiple competitive strategies among related product lines within a single industry. the complexity of the management process and the need for multiple dominant logic is increased as the strategic variety and complexity of the corporation increases. prahalad and bettis ([9], p. 490) define dominant logic as follows: "a dominant general management logic is defined as the way in which managers conceptualize the business and make critical resource allocation decision-be it in technologies, product development, distribution, advertising, or in human resource management. these tasks are performed by managing the infrastructure of administrative tools like choice of key individuals, processes of planning, budgeting, control, compensation, career management and organization structure." the tasks associated with dominant general management logic are more likely to vary with respect to business/competitive level strategies rather than with respect to product line variety. for a firm pursuing multiple competitive strategies, at some point the need for multiple dominant logic will exceed the capabilities of management and the performance ofthe firm is likely to suffer. it is not, however, simply a question of the number of dominant logics required. dominant logics can also be considered mutually exclusive. the dominant logic required to implement a low-cost strategy is largely inconsistent with that required to implement a differentiation strategy. from this perspective, dominant logic serves as a constraint on the simultaneous pursuit of multiple business/competitive strategies; performance will decline when management is simultaneously required to employ multiple and inconsistent dominant logic. on the other hand, dominant logic can also be viewed as a resource which if exploited can enhance the overall performance of a diversified firm. dominant logics are learned tools and experiences that provide management the expertise to make decisions crucial to strategy formulation and implementation. as prahalad and bettis point out, dominant logics are derived from the core business which has provided the basis for internal corporate growth. to the extent that the skills and experience inherent to dominant logic can be generalized to related businesses a powerful management synergy can be exploited for the betterment of the combined firm. clearly, whether dominant logics are viewed as constraints or resources the implications for corporate diversification strategy are significant. in order to avoid the need for multiple dominant logics and exploit the existing dominant logic, firms are well advised to pursue a single competitive/business level strategy throughout their strategic business units. businesses that are related in the traditional sense do not necessarily fulfill this criterion. similarly, combining businesses that are unrelated in the traditional sense does not preclude adherence to the single dominant logic criterion. spring 1990 blackburn & shrader: strategic fit strategic capability transfer 5 lenz [4] has articulated the concept of "strategic capability" to refer to a firm's ability to "successfully undertake action that is intended to affect its long-term growth and development (p. 226)." this concept has since been elaborated in terms of competitive advantage. competitive advantage is that which makes the firm's products or services preferable to the competition. strategic capability then is the "firm's ability to use its skills, knowledge, resources or ways of managing to develop or sustain a competitive advantage." ([3]' p. 7) as pointed out previously, alternative business / competitive strategies require unique and largely mutually exclusive sets of skills, knowledge bases, resources and management characteristics. consequently, strategic capabilities might also be considered mutually exclusive and a function of the competitive/business strategy of the firm. with regard specifically to acquisitions, jemison makes the distinction between value capture and value creation. value capture creates no new value and only involves subsuming the value of the acquired firm under the acquiring firm. value creation results in the value of the combined firm being greater than the sum of the values of the individual firms. for value creation to occur,there must be a transfer of strategic capability between the acquiring and the acquired firm. further, for strategic capability transfer to be meaningful and viable, both firms should potentially benefit from sharing similar competitive advantages. this later condition is most likely to occur, of course, when the combining firms are pursuing similar business/competitive strategies. the potential for strategic capability transfer should be greater between firms pursuing consistent business level strategies since the combined firm can exploit those things which individually gave them a competitive advantage. in addition the constraints on effective strategic capability transfer should be minimized when two firms share strategic philosophies and resource bases appropriate to their given business/ competitive strategy. a redefinition we have proposed that the traditional definition of related diversification does not capture the full range of issues important to corporate level strategy formulation and implementation. we do not suggest that these definitions be dropped, but that they be expanded to consider the business/ competitive strategy of the firms. these arguments hold regardless of whether the diversification is developed internally or is acquired. it is necessary to explicitly consider both the type of corporate level diversification strategy and type of business level strategy. corporate level diversification strategy alternatives include horizontal, backward and forward integration, market related diversification, product related diversification and unrelated diversification. business/ competitive strategy alternatives include differentiation or low cost. the central idea present here is consistency of business strategies is a precondition for successful corporate diversification. the importance of business strategy consistency is a function of the choice of diversification strategy. with respect to horizontal 6 journal of business strategies vol. 7, no.1 integration, forward and backward integration and related diversification, business strategy fit is critical to the successful assimilation of the new operation and the subsequent achievement of desired synergies. only in the case of unrelated product lines is business strategy fit not entirely necessary to the success of the diversification attempt. even in this case, however, consistent business strategies among unrelated product lines is advantageous. it is helpful to consider the necessity of business strategy fit for each of the corporate level strategy alternatives. horizontal integration involves expansion through acquisition of directly competing firms which by definition offer equivalent product lines. this strategy basically represents an increasing commitment to a concentration strategy. although product lines are equivalent the two firms may be pursuing different competitive strategies prior to acquisition. if so, the differences in required resource bases and organizational configurations will preclude most expected synergies and make it extremely difficult to assimilate the acquired firm. from the customer's perspective, mixing of competitive strategies may create confusion, consequently threatening the viability of both competitive strategies. vertical integration involves moving forward or backward along the production/ distribution chain. the potential benefits of integration include reliable, cost efficient supply sourcing or product outlets, smoothing of scale economies and absorption of profit centers. the pursuit of either backward or forward vertical integration should ideally enhance the firm's ability to pursue either a low cost or differentiation strategy within their core business. for this to occur, it is necessary that the acquired firm pursue a business level strategy consistent with that of the focus firm. otherwise the strategy of the focus firm may be undermined by attempting to assimilate inconsistent strategies. for example, the cost of supplies will be a function of the strategy pursued by the acquired firm. it will likely not be cost effective for a firm pursuing a low cost strategy to purchase a firm pursuing differentiation in order to establish a low cost, reliable source of supply. levels of scale economies are also likely to be different for low cost and differentiated producers. consequently, the desired benefit of smoothed scale economies may be difficult to achieve when mixing business level strategies. finally, the price/cost structure of low cost producers and differentiators is not similar, thereby reducing the value of the acquired firm as a profit center. finally, in the case of unrelated acquisitions, it is probably less important that consistency of business level strategies be maintained. among unrelated businesses, the potential for some synergies and consequently, the need for integration into the existing organization is lower. on the other hand, consistency of strategic orientations among unrelated product lines may result in synergies associated with resource allocations, managerial talent and dominant logic. management may be able to apply, in unrelated areas, those skills that provided them their competitive advantage within their focus industry. inconsistency of business level strategies may not preclude unrelated diversification, however, consistency of strategies may often go unexploited as a major source of potential synergies. spring 1990 blackburn e1 shrader: strategic fit conclusion 7 this article has outlined the arguments supporting a redefinition of relatedness and corporate strategic fit. in sum it is suggested that definitions of relatedness in terms of product line characteristics do not capture the full range of resource, competitive, management and organizational issues relevant to the successful integration of diversification efforts. a more promising conceptualization considers an additional aspect of relatedness regarding the consistency of competitive strategies across strategic business units. it is argued here that inconsistency of business unit competitive strategies can undermine efforts to achieve synergies through related diversification. with respect to unrelated diversification, inconsistency of competitive business strategies may not preclude integration of new diversification efforts. if, however, the unrelated product lines share common competitive strategies, managerial and organizational synergies which would otherwise be unattainable may be exploited. references 1. christensen, h. k. and c. a. montgomery. "corporate economic performance: diversification versus market structure." strategic management journal, vol. 2 (1981), pp. 327-43. 2. elgers, p. t. and j. j. clark. "merger types and shareholder returns: additional evidence." financial management, vol. 9 (1980), pp. 66-72. 3. jemison, d. b. "process constraints on strategic capability transfer during acquisition integration." paper presented at the academy of management, new orleans, la (august, 1987). 4. lenz, r. t. "strategic capability: a concept and framework for analysis." academy of management review, vol. 5 (1980), pp. 225-34. 5. lubatkin, m. "merger strategies and stockholder value." strategic management journal, vol. 8 (1987), pp. 39-53. 6. montgomery, c. a. and v. a. wilson. "mergers that last: a predictable pattern?" strategic management journal, vol. 7 (1986), pp. 91-96. 7. peters, t. j. and r. h. waterman, jr. in search of excellence. new york, ny: harper & row (1982). 8. porter, m. e. competitive strategy. new york, ny: free press (1980). 9. prahalad, c. k. and r. a. bettis. "the dominant logic: a new linkage between diversity and performance." strategic management journal, vol. 7 (1986), pp. 485-501. 10. rumelt, r. p. "diversification strategy and profitability." strategic management journal, vol. 3 (1982), pp. 352-69. 11. rumelt, r. p. strategy, structure and economic performance. boston, ma: harvard university press (1974). redefining corporate strategic fit japanese versus american corporate competitive advantages: differences in turnaround strategy antecedents, actions, and results charles r. gowen, iii northern illinois university dekalb, illinois the japanese competitive advantage can be summarized by the dilemma stated by takeo fujisawa, co-founder of the honda motor company, that "japanese and american management is ninety-five percent the same and differs in all important respects" ([48], p. 85). strategic competitive differences have been exploited by japanese corporations with respect to human resource management, finance, production, marketing, environmental, and strategic factors. competitive advantages have dictated corporate success for several key industries which the japanese government has targeted and supported as crucial to the long-range growth of the japanese economy. the electronics industry has recently been a key sector for government policy and competition. the steep 1987 u.s. tariffs on japanese electronic products have forced japanese corporations to design turnaround strategies to reverse declining market share and profitability. there has been an increasing need for american electronics firms to confront the japanese challenge and for japanese electronics firms to overcome greater market entry barriers. against that backdrop, this study focuses on the application of the current turnaround strategy theories for understanding competitive differences between american and japanese approaches to turnaround antecedents, strategic actions, and corporate performance results. american vs. japanese human resource strategy from a human resource management perspective, the american spirit of competitiveindividualism within corporations contrasts sharply with the japanese philosophy of wit (harmony). this pervades all aspects of japanese corporate culture ([52], [59]), even to the extent that it has been labeled by american scholars as a unique form of management called theory z ([11], [45], [48], [64], [68]). prospective japanese employees are ultimately selected on the basis of demonstrating an accommodating type of personality, given that they meet certain ability and educational requirements ([52], [55]). role-socialization by the japanese corporate culture continues during several months of initial job training. it actually continues throughout employment in the form of worker cross-training ([47j, [52]) and transfers of managers to all phases of corporate operations ([16], [55], [57]). the continual journal of business strategies, volume 6, number 2 (fall 1989) 132 fall 1989 gowen: corporate competitive advantages 133 process of training or transferring employees results in a highly skilled and flexible workforce, establishment of personal contacts in all departments of the corporation, and a clan-like sense of loyalty to the firm [52]. major japanese firms have justified the costs of cross-training and frequent transfers as effective investments, considering that their employees are committed to a lifetime of the job with the corporation ([1], [36], [53]), awarded to male employees ([52], [57]). the personal costs of lifetime job security involve extra unpaid hours demanded from those employees [41] and the layoffs of primarily female and temporary employees during recessionary years [52]. the japanese "lifetime" security system does not guarantee the same employment stability as an american "no-layoff" system [36]. another consequence of the japanese cross-training and transferring system has been the exceptional effectiveness of communication and teamwork within the corporation ([52l [55]). even the japanese compensation system has been team-oriented. for example, annual salary increases are based on corporate performance instead of individual achievement ([3], [47], [52]). gain-sharing programs that provide monthly bonus checks for american employees as a consequence of increasing individual worker productivity ([49], [63], [67]) contrast sharply with the traditional japanese bonasu system of semi-annual corporate profitsharing payment ([ij, [12l [55]). the bonasu system was designed in the 1940s to supplement low base wages so that workers would receive a semi-annual bonus equivalent to six months' wages during the best years, but might receive no bonus during unprofitable years ([42j, pp. 12-13). the bonus has averaged the equivalent of two months' wages for each of the semi-annual payments in the past two years [12]. such non deferred profit-sharing plans have enhanced the ability of japanese corporations to weather recessions while honoring lifetime employment contracts. similarly, japanese executives are compensated with salaries that amount to about a seventh of the salary of comparable american executives [1, pp. 192-195j. japanese tax laws provide little means to shelter high income so that executives are compensated with perquisites to a greater extent than their american counterparts [59j. the overall effect of lower fixed personnel costs has granted japanese firms a commanding degree of flexibility in their cost structure. the japanese human resource system does reward individual performance in ways other than direct compensation. although promotions are based primarily on seniority, small differential promotions based on annual individual performance appraisals can result in significant differences over several years [52j. managers who are promoted to the executive level must demonstrate high team effort and high individual ability. japanese human resource management has become world renowned for the consultative decision-making process called nemawashi, the accommodation of employee input in a middle-down-up collaborative style [47]. although it has been characterized as participative or concensual ([19j, [45l [48j, [55l [57]), the delegation of decisions to middle managers can be accompanied by preferred solutions which may be modified only somewhat by consultation with subordinates. whether or not a real 134 journal of business strategies vol. 6, no.2 consensus emerges, as would be implied by the official ringi seido (signed decision memo), the consultative process does demonstrate concern for employees ([6]' [52]). the process also serves as an illustration of the japanese concept of kaizen, constant incremental improvement ([6], [47]) and as an outlet for employee creativity.} greater emphasis on employee creativity in the future [43j may enhance the shortcomings of many traditional japanese personnel practices [24j. this would compensate for the current trend away from some traditional practices, such as lifetime job security and senioritybased promotion. this trend is the result of greater life expectancy and later employee retirement ([ij, [4]). in essence l the radical differences between traditional american and japanese human resource practices are beginning to decrease with recent societal and corporate changes [2j. american vs. japanese production, financial, and marketing strategy the characteristics of the production, financial, and marketing subsystems differ greatly between american and japanese corporations. recent american production management techniques have emphasized computer-oriented methods, such as materials requirements planning, as well as emulating the traditional people-oriented japanese techniques, such as kanban (just-in-time inventory control) [55], jidoka (problem-seeking by consulting workers) [39], quality control circles ([45], [52]), and shop-floor quality consciousness [39]. a recent empirical study has demonstrated great disparity between quality levels for the best american firms and average japanese firms [19]. the contrast for american versus japanese corporations appears to be greater with less propensity of convergence in their financial characteristics. although most major american firms are capitalized by equity, japanese firms are financed by about sixty percent debt, twenty-five percent retained earnings, and only fifteen percent equity ([37], p. 31). the higher debt-to-equity ratio may be somewhat inflated by differences between american and japanese accounting practices ([1], [39], [52]); greater debt structure results from the very low interest rates offered by japanese financial institutions ([1], [39], [41]). the phenomenal abundance of capital is created by the five-fold difference in personal savings rates; for example, the japanese rate was 19 percent as compared to the american rate of 4 percent in 1988. however, the savings rate differential may decrease slightly in the future as japanese people expand their use of consumer credit and as the social security system evolves to become more than just the historical minimal supplement to income generated by retirement and savings plans. as a result, the cost of capital must increase for japanese corporations, as well as the marketing cost structure for their mature industries. the marketing strategy of japanese firms tends to follow an escalating five-stage process. the process includes: (1) searching for opportunities provided by vacant niches, (2) creating opportunities with innovative products, (3) developing markets 1 for example, at progressive firms such as sony corporation [62]. fall 1989 gowen: corporate competitive advantages 135 by creative marketing, (4) adapting to and changing consumer preferences, and (5) learning from competitors to create opportunities [37]. the success of japanese corporations in foreign markets has been enhanced by the provision of market intelligence by a unique system of government-subsidized organizations, such as the japan external trade organization ([1], [39]). although significant differences exist between american and japanese firms, successful american corporations need not imitate japanese firms ([11], [24]). even japanese corporations have experienced difficulty in transferring their techniques to foreign subsidiaries as demonstrated by a study that disclosed fourteen negative factors, such as poor technology transfer, and seventeen positive factors, such as quality control circles [55]. american vs. japanese task environment impacts on corporations governmental and trade organization differences between japan and the united states have made a significant impact on their competitive advantages. american firms have generally remained self-reliant for competitive purposes. some exceptions include the purchasing of environmental information primarily from private sources such as consulting firms, and externally-oriented promotion such as lobbying government sectors by industry associations. 'in contrast, japanese firms receive free information about foreign markets from government agencies such as the japan external trade organization (jetro), the ministry of international trade and industry (miti), and the industrial structure council (isc) ([i], [37], [39]). remunerative provision of global marketing intelligence to a firm results from association with one of the keiretsu or sago shasha. most major japanese firms belong to a keiretsu (business group) which is dominated by a large bank that holds an equity position in and guarantees loans for member corporations ([1], [39]). foreign market information can also be purchased from the unique japanese sago shosha (general trading companies, or gtcs) that dominate world trade and trade development [37]. overall, access to global marketing intelligence at a moderate cost is greater for most japanese firms than for their american counterparts. differences between american and japanese governmental policy have also resulted in competitive advantages. the american social security system has encouraged reliance on the federal government for a retirement and social service safety net. by contrast, the minimal japanese social security system has reinforced the highest rate of personal savings in the world and reliance on the corporat.ion to provide a wide array of social benefits from subsidized housing to retirement benefits ([i], [39], [41]). the firms are supported by governmental subsidies and protective policies; for example, tariffs and quotas for industries which are targeted by the government as crucial to the growth of the japanese economy. corporations in targeted industries, such as electronics, can develop successful products in a sheltered domestic market before confronting foreign competitors in global markets ([37], [62]). however, many environmental differences between japan and the united states in the future may prove to be less significant than corporate strategic planning [38]. 136 journal of business strategies vol. 6, no.2 corporate turnaround strategy: antecedents, actions, and results turnaround strategies have accounted for an increasingly important role in the revitalization of recently declining firms or industries. a popular example was the dramatic turnaround of the chrysler corporation in the early 19805. when lee iacocca arrived as the chief executive officer in 1979, chrysler was producing vehicles of increasingly inferior quality, had decreasing productivity and sales, and was facing greater foreign competition. chrysler adopted turnaround strategies that included (1) the divestiture of chrysler defense, inc. in 1982 for $348.5 million, (2) cutting half of the managerial and work force costs to save $1.2 billion annually, (3) reducing assets by closing or consolidating twenty plants to save about $2 billion annually, (4) modernizing the remaining forty plants, (5) simplifying the production processes by reducing one-third of the number of parts, thus eliminating $1 billion in inventory, (6) implementing the latest statistical quality control techniques, (7) restructuring $1.3 billion of debt into preferred stock, and (8) refocusing products so that by 1985 ninety percent of productive capacity was dedicated to technologically advanced front-wheel drive vehicles [33]. antecedents of turnaround strategy a turnaround strategy is appropriate for a firm that exhibits antecedent characteristics such as a declining internal or environmental business situation ([27], [29], [30]). those antecedents include decreasing profit margins, sales, market share, price levels, plant capacity utilization, return on assets, managerial effectiveness, employee morale, capital improvements; and increasing operating costs, debt/equity ratio, or competitiveness of rival firms ([15], [20j, [22], [28], [32j, [40]. [56j. [58j, [60]). although a poorly managed company can become unsuccessful in any industry, corporations in declining industries most often exhibit antecedents calling for turnaround actions. declining growth in product demand had characterized two-thirds of the industries such as the american electrical and electronics industry, the annual growth rate of industry-wide sales fell below the annual real growth rate of the u.s. economy for five of the past ten years [56j. corporations that have been categorized as parts of declining, mature, or stagnant industries are most often described as potential can· didates for turnaround strategies ([10], [21j, [23j, [25], [26], [27j, [29j, [50], [51]). for japanese corporations, the recent antecedents of turnaround strategies have included the doubled dollar/yen exchange rate since 1985 and the punitive u.s. import tariffs on electronic products in 1987 ([4j, [12]). types of turnaround strategy actions the literature for turnaround strategy actions can be integrated into a fourcategory action typology: revenue generation, product/market refocusing, asset reduction, and productivity improvement. this typology was proposed by hofer [32j) who expanded on the leading empirical research by schendel, patton, and riggs [56]. revenue generation turnaround actions have been described in other theoretical models as "revenue push" by hambrick [22], and market share "leadership" by porter fall 1989 gowen: corporate competitive advantages 137 [50]. specific revenue generation actions include raising product prices, increasing cash discounts to customers, loosening customer credit criteria [60l and market share domination [20]. revenue generation strategies account for most profit turnarounds [46j. japanese revenue generation strategies have justified raising product prices by improving the product design or features so that profitability can be increased without sacrificing market share ([24l [44]). product/market refocusing turnaround actions described by hofer [32j are related to "selective product/market pruning" as described by hambrick and schecter ([22], [23]), "shrinking cures" as described by schendel, patton, and riggs [56]. specific product/market refocusing actions include the elimination of unprofitable products, customers, channels of distribution, sales regions, or sales representatives ([20], [60]). asset reduction turnaround actions are described by hofer [32], and referred to as "asset surgery" by hambrick and schecter [23], as "immediate cash flow" by sloma [60], as "major retrenchment" by hambrick [22], and as divestiture "strategic cures" by schendel, patton, and riggs [56]. specific asset reduction actions include the liquidation of inventory, equipment, or physical plant, and the divestiture of a subsidiary, product line, or holdings ([20l [60]). productivity improvement turnaround actions are described as "cost cutting" by hofer [32j and hambrick [22], as "operating cures" by schendel, patton, and riggs [56], and as "cost surgery" and "piecemeal productivity" by hambrick and schecter [23]. specific cost cutting action include several means for reducing administrative, personnel, financial, product related, plant related, and production expenses ([14j, [20], [35l [60]). productivity improvement actions can also be implemented as proactive strategies; for example, greater plant capacity utilization and employee gainsharing or profit-sharing plans ([8], [9], [29], [31l [35], [49], [63], [65], [67]). equally important would be effective timing of the stages of turnaround action implementation ([5l [18]). turnaround strategy results the successful implementation of turnaround strategy actions produces results that reverse declining corporate performance. turnaround strategy results can be measured in terms of sales and profits ([22l [32]), return on investment [23], or some multidimensional approach ([20], [21], [25], [26], [27], [56]). depending on the reasons for the need to implement a turnaround strategy, the turnaround results can be some combination of relative improvements in corporate cash flow, operating profit margin, market share, return on investment, sales growth, employee morale, inventory turnover, and unit labor costs ([20j, [60]). in general, american corporations tend to emphasize short range results such as profitability, but japanese firms tend to stress long range results such as market share ([24], [35], [44]). survey methodology turnaround strategy antecedents, actions and results were examined by surveying the presidents of one hundred and thirty american electronics firms and one 138 journal of business strategies vol. 6, no.2 hundred and twenty japanese electronics firms' subsidiaries in the united states. the electronics industry was selected for the following reasons: (1) the large number of firms that could be surveyed in a fragmented industry [50], (2) the need for tuniaround strategies for an industry with increasing costs and foreign competition, (3) the greatly fluctuating foreign currency rates, and (4) the declining revenues for five of the past ten years [56]. the electronics industry involves direct competition between american and japanese corporations in all four segments: electrical products (e.g., westinghouse and hitachi), electronics (e.g., gm hughes electronics and matsushita), instruments (e.g., honeywell and nissei sangyo), and semiconductors (e.g., motorola and nec). the japanese electronics industry accounts for about onethird of japan's export revenues ([i], p. 278). as the largest export segment, it was significantly affected by the punitive 1987 u.s. tariffs on japanese electronic products. the turnaround strategy survey was directed to the president of each corporation to capture information directly at the policy-making level of the firm. the president would be the executive held most responsible for the formulation, implementation, and control of the corporate policy and strategic planning processes. for each japanese corporation, their american subsidiary was selected because if faced market forces more comparable to those of american electronics firms. american corporations and japanese subsidiaries were randomly selected from among electronics firms with standard industrial codes in the 3600 and 3800 series. the size of the selected corporations varied greatly, averaging about five thousand employees for both samples ([71], [61], [66]). the respondents were promised anonymity and a copy of the survey results at a later date. the research advantages of the survey included obtaining information about strategic planning which is seldom accessible in public documents. the subjective nature of the survey responses presents some limitations; however, previous research demonstrates a high correlation between subjective and objective measures of corporate strategy and performance [13]. survey measures and procedures the turnaround strategy consisted of a descriptive paragraph introducing each of three sections which included a total of eighteen items. the six antecedent to turnaround items were (1) decreasing product line profitability, (2) decreasing account profitability, (3) fluctuating foreign currency rates, (4) increasing financial expenses, (5) increasing production/operation costs, and (6) decreasing employee morale. the six turnaround strategic action items were (1) expanding revenue by raising product prices, (2) eliminating unprofitable products, (3) using gain-sharing or nondeferred profit-sharing, (4) renegotiating credit lines and debt, (5) increasing capacity utilization, and (6) reducing fixed personnel costs. the six turnaround results items were (1) increasing return on investment, (2) increasing operating profit margin, (3) increasing cash flow, (4) increasing employee morale, (5) increasing sales growth, and (6) decreasing unit labor costs. the eighteen survey items were designed based on the previously described literature about turnaround strategies ([5], [22]' [23], [25], [26], [27], [32], [56], [60]) and fall 1989 gowen: corporate competitive advantages 139 were selected based on the results of a prior 56-item exploratory survey of turnaround strategies of forty-two american corporations [20]. the respondents to the survey were asked to rate each action item according to its "degree of improvement" in the past ten years as a result of turnaround actions. the likert-type response scale included: (1) was described as "none," (2) as "low," (3) as "medium," (4) as "high," and (5) as "great." based on past research, a ten-year time frame included a potential four-year downturn phase, a two-year action phase, and a four-year upturn phase for significant turnaround results [56]. the survey questionnaire was translated into japanese by a group of american and japanese management consultants at strategic global enterprises, ltd., in chicago, illinois. the japanese translation was translated back into english by an independent group of american and japanese consultants to assure accuracy of translation of the terms used in the survey. the double translation process was necessary because many english business concepts are difficult to express in japanese terms. the english version was also included with the japanese questionnaire which was sent to the japanese version of the questionnaire. a cover letter described the purpose of the survey; a self-addressed postage-paid envelope was also enclosed. fifty-nine fully-usable and six partially-completed questionnaires were received from american firms. japanese firms returned fifty-nine fully-usable responses and three partially-completed responses. the overall response rates that amounted to fifty percent for each of the american and the japanese sample were achieved by several follow-up mailings. data analysis analysis of the survey data tested the differences of mean responses and regression models between the american and japanese firms. stepwise regression analysis initially established significant relationships between turnaround antecedents and turnaround strategy actions. regression models were established separately for the american and japanese samples to determine whether they would differ for each turnaround action. dissimilar models would indicate that under certain conditions american firms adopt different turnaround strategies than japanese firms. further stepwise regression analysis tested whether the relationships of turnaround actions regressed onto turnaround results were different between the american and japanese samples. survey results the statistical means and tests of differences between the american and japanese firms are represented in table 1. first, for the turnaround antecedents, the average japanese response was significantly greater than the average american response for the following four items: (1) decreasing product line profitability, (2) decreasing account profitability, (3) fluctuating foreign currency rates, and (4) increasing financial expense. second, for turnaround strategy actions, the japanese firms reported 140 journal of business strategies vol. 6, no.2 significantly greater implementation than the american firms for the following two items: (1) expand revenue by raising product prices and (2) use gain-sharing or nondeferred profit-sharing. however, the degree of implementation was similar between american and japanese firms for the highest reported action, increasing capacity utilization. finally, the american firms achieved significantly greater results than the japanese firms for the following two items: (1) increasing return on investment and (2) increasing operating profit margin. table 1 american and japanese firms' mean responses and significance tests for turnaround antecedents, actions, and results variable category and american japanese t-test specific items mean mean value turnaround antecedents: decreasing product line profitability 3.00 3.51 2.33** decreasing account profitability 2.76 3.56 4.07*** fluctuating foreign currency rates 2.51 4.54 10.30*** increasing financial expense 2.46 2.81 1.83* increasing production/operations cost 3.02 3.24 1.21 turnaround actions: expand revenue by raising product prices 2.61 3.22 3.72*** eliminate unprofitable products 2.98 3.12 0.62 use gain-sharing/nondeferred profit-sharing 1.69 2.36 3.44*"'* renegotiate credit lines and debt 2.41 2.53 0.54 increase capacity utilization 3.34 3.54 1.10 reduce fixed personnel costs 2.68 2.80 0.62 turnaround results: increasing return on investment 3.34 2.93 2.47"''' increasing operating profit margin 3.32 2.98 2.00" increasing cash flow 3.25 3.07 1.12 increasing employee morale 3.08 3.15 0.39 increasing sales growth 3.51 3.59 0.50 decreasing unit labor costs 2.83 3.03 1.25 * significant difference between the means at the .05 level. ** significant difference between the means at the .01 level. ....'" significant difference between the means at the .001 level the results of regression analysis of the turnaround antecedents regressed onto the turnaround strategy actions are reported in table 2. the standardized regression beta coefficients indicate the magnitude of each significant relationship between the turnaround antecedents and the strategy action. the model for the american firms fall 1989 gowen: corporate competitive advantages 141 was completely different from the model for the japanese firms for the following four actions: (1) expanding revenue by raising product prices, (2) eliminating unprofitable products, (3) using gain-sharing or non deferred profit-sharing, and (4) increasing capacity utilization. for each of the two remaining strategy actions, the regression results included somewhat different antecedents between the american and japanese models. table 2 american and japanese firms' responses for turnaround antecedents regressed onto each turnaround action: standardized regression beta coefficients decreasing employee morille decreasing product line profitability decreasing employee morale decreasing employee morale decreasing product line profitability increasing financial expenses increasing financial expense decreasing product line profitability decreasing employee morale increasing production/operation cost decreasing account profitability .38**" .43·.,·.... .24* .31*" .30' -.33'· increasing capacity utilization: american firms' model japanese firms' model reduce fixed personnel costs: america.n firms' model japanese firms' model action: dependent variable beta antecedents: independent variables expand revenue by raising product prices: american firms' model .26' increasing production/operations cost japanese firms' model .26' fluctuating foreign currency rates eliminate unprofitable products: american firms' model .29" japanese firms' model .30' use gain-sharing/nondeferred profit-sharing: american firms' model .36·... increasing production/operations cost .26* increasing financial expense -.32'" fluctuating foreign currency rates japanese firms' model .31'· decreasing product line profitability renegotiate credit lines and debt: american firms' model .43··.. japanese firms' model .27' .24' " significant at the .05 level for the f statistic . .... significant at the .01 level for the f statistic. ....* significant at the .005 level for the f statistic. ...."" significant at the .001 level for the f statistic. regression analysis revealed that several strategy actions were significantly related to most of the turnaround results as demonstrated in table 3. the only completely different models between the american and japanese firms occurred for increasing 142 j oumal of business strategies vol. 6, no.2 profit margin. there were somewhat different strategy actions between the american and japanese models for the following four turnaround results: (1) increasing return on investment, (2) increasing cash flow, (3) increasing employee morale, and (4) decreasing unit labor costs. the only similar american and japanese models resulted for increasing sales growth. the frequency of each significant strategy action in table 3 showed the following distribution: ten times for increasing capacity utilization, unprofitable products, four times for reducing fixed personnel costs, and once for using gain-sharing or nondeferred profit-sharing. although the regression models differ between american firms and japanese firms, the results demonstrate predominant patterns of strategy actions, especially for increasing capacity utilization. discussion and conclusions the turnaround survey findings support previous literature and suggest specific strategic differences between american and japanese electronics corporations. the common belief that the ninety-five percent similar management practices are unimportant, but the five percent different management practices are all-important ([48], p. 85) appears to be overstated in two respects. first, american and japanese turnaround strategies were reported as similar for most dimensions overall but differed for two-thirds of the antecedents, one-third of the actions, and one-third of the turnaround result items. second, the differences between american and japanese firms could have resulted from a common cause; for example, the 1987 u.s. import tariffs on electronic products could have led to declining japanese firms' line profitability, account profitability, and financial competitiveness. the greater american turnaround results of profitability, such as increasing return on investment and operating profit margin items, demonstrate the common japanese practice of lower expected profitability in capturing market share ([1]. [37], [52]). however, the significantly different strategy actions confirm the previously reported japanese competitive advantages for marketing and human resource management. the greater propensity of japanese firms to expand revenue by raising product prices from year to year has been most visible for consumer electronics [37]. japanese corporations have supported high pricing policies by appropriately increasing marketing strategies; for example, sony's massive promotional strategy and annual new product features or designs ([37j, [62)). in addition to raising product prices, japanese firms have also excelled in another proactive turnaround strategy action of profit-sharing. the japanese semi-annual bonasu system has rewarded teamwork and productivity ([1], [12], [42], [55]). the japanese competitive advantage could be reduced if american corporations continue the recent trend toward implementation of productivity gain-sharing programs ([49], [63], [67]). the regression results demonstrated that different strategies were usually implemented by the american firms than by the japanese firms for each turnaround antecedent, as in table 2. fluctuating foreign currency rates affected only the japanese regression models, and the japanese firms responded by raising product prices. for american firms, increasing production/operation costs led to eliminating unprofitable fall 1989 gowen: corporate competitive advantages 143 table 3 american and japanese firm.s' responses for turnaround actions regressed onto each turnaround result: standardized regression beta coefficients result: dependent variable beta actions: independent variables increasing return on investment: american firms' model .36-** .27* .21 * japanese firms' model .38*** .21* increase capacity utilization renegotiate credit lines and debt eliminate unprofitable products increase capacity utilization renegotiate credit lines and debt increase capacity utilization reduce fixed personnel costs increase capacity utilization eliminate unprofitable products renegotiate credit lines and debt reduce fixed personnel costs renegotiate credit lines and debt increase capacity utilization increase capacity utilization increase capacity utilization renegotiate credit lines and debt reduce fixed personnel costs eliminate unprofitable products increase capacity utilization renegotiate credit lines and debt increase capacity utilization eliminate unprofitable products use gain-sharingjnondeferred profit-sharing increase capacity utilization reduce fixed personnel costs .50**** .36*** .23* .34*** .33*"* .33*** .28** .24* .35** .26* -.23* .31 ** .24* .22* japanese firms' model increasing sales growth: american firms' model japanese firms' model decreasing unit labor costs: american firms' model japanese firms' model japanese firms' model increasing employee morale: american firms' model .23-.22.24* .23* increasing operating profit margin: american firms' model .46*"* japanese firms' model .34*" increasing cash flow: american firms' model * significant at the .05 level for the f statistic. *. significant at the .01 level for the f statistic. * •• significant at the .005 level for the f statistic. .•*. significant at the .001 level for the f statistic. 144 journal of business strategies vol. 6, no.2 products, adopting gain-sharin~, and raising product prices. for japanese firms, decreasing account profitability ~d product line profitability led to eliminating unprofitable products, adopting p~ofit-sharing, renegotiating credit lines and debt, increasing capacity utilization, and"reducing fixed personnel costs. american strategies were similar to japanese strategies for only two turnaround antecedents; for example, increasing financial expense led to renegotiating credit lines and debt. several turnaround strategies yielded differential competitive advantages between american and japanese firms but some strategies, such as increasing capacity utilization, led to similar results, as in table 3. only for the american firms, the elimination of unprofitable products was related to increasing return on investment, increasing cash flow, increasing employee morale, and decreasing unit labor costs. in contrast, reducing fixed personnel costs led to increasing return on investment, increasing operating profit margin, and increasing cash flow only for the japanese firms. the most frequent strategy action, increasing capacity utilization, was related to similar results for american and japanese firms. greater capacity utilization led to increasing return on investment, increasing cash flow, increasing sales growth, and decreasing unit labor costs. the predominant effect of increasing capacity utilization supports a previous cross-sectional study of corporate financial data [23]. greater capacity utilization would also be consistent with a more recent study of 301 american executives concerning how their firms have confronted japanese competition [35]. the most frequent strategy was investment in more efficient plant and equipment, which was elected by twenty-seven percent of the american firms. the pragmatic implications of the present survey of turnaround situations focus on successful proactive strategies for american and japanese electronics firms. at the risk of over-generalization, the traditional american competitive advantages have included industry associations that lobby for government support, computer-oriented production techniques, and superior marketing strategies for the north american market. in contrast, the traditional japanese competitive advantages have been government subsidized global marketing information, superior human resource practices in terms of productivity and teamwork, low-cost debt financing, and high quality production. however, the competitive equilibrium can shift rapidly due to unanticipated environmental changes, for example, the doubled dollar/yen exchange rate from 1985 to 1987, as well as the punitive 1987 u.s. tariffs on japanese electronic products. as the present study revealed, the greater financial difficulties faced by japanese electronics firms led to the continuation of traditional practices such as the bonasu profit-sharing system and recent strategies such as raising product prices. although these strategies seem to have yielded minimal profitability results, the japanese firms are renown for emphasizing long-range rather than short-range results. this study indicates that american and japanese firms have implemented proactive production strategies such as increasing capacity utilization during a time of rising costs. given the significant effect of greater capacity utilization on all of the turnaround result measures, investment in more efficient plant and equipment appears to command a preeminent consideration for the future. american and japanese fall 1989 gowen: corporate competitive advantages 145 firms can be expected to continue to expand the implementation of proactive strategies such as greater capacity utilization and productivity gain-sharing or non deferred profit-sharing. however, present production and human resource competitive advantages may diminish in favor of marketing and financial strategies as japanese society matures and the american market changes. to remain successful in a rapidly changing environment, an american or japanese corporation must fully exploit its present competitive advantages as well as aggressively seek new strategic opportunities and plan for future threats. references 1. abegglen, james c. and george stalk jr. kaisha: the japanese corporation. new york, ny: basic books (1985). 2. barton, m. frank, surendra p. agrawal, and 1. mason rockwell, jr. "meeting the challenge of japanese management concepts." management accounting (usa), vol 70 (september, 1988), pp. 49-53. 3. beatty, james r., joseph t. mccune, and richard w. beatty. "a policycapturing approach to the study of united states and japanese managers' compensation decisions." journal of management, vol 14 (september, 1988), pp.465-474. 4. berger, michael "the japanese forge ahead to tackle their world problems." international management, vol 42 (march, 1987), pp. 43-47. 5. bibeault, donald b. corporate turnaround. new york, ny: mcgraw-hill (1982). 6. brown, stanley j. "the japanese approach to labor relations: can it work in america?" personnel, vol 64 (april, 1987), pp. 20-29. 7. cameron, kim s., robert i. sutton, and david a. whetten (eds.). readings in organizational decline. cambridge, ma: ballinger (1988). 8. cameron, kim s. and raymond zammuto. "matching managerial strategies to conditions of decline." human resource management, vol. 22 (winter 1983), pp. 359-375. 9. cissell, michael j. "designing effective reward systems." compensation and benefits review, vol. 19 (november-december, 1987), pp. 49-55. 10. cool, karel and dan schendel. "performance differences among strategic group members." strategic management journal, vol. 9 (1988), pp. 207-223. 11. cosier, richard a. and dan r. dalton. "search for excellence, learn from japan-are these panaceas or problems." business horizons, vol. 29 (novemberdecember, 1986), pp. 63-68. 146 journal of business strategies vol. 6, no.2 12. cutler, blayne (ed.). "tokyo's labor force, part 2: worker-household income and spending patterns." international demographics, vol. 6 (march, 1987), pp. 10-12. 13. dess, greg and r. robinson, jr. "measuring organizational performance in the absence of objective measures." strategic management journal, vol 5 (1984), pp. 265-273. 14. dicamillo, gary t. "winning turnaround strategies at black & decker." journal of business strategy, vol. 9 (march-april, 1988), pp. 30-33. 15. diprima, a. "when turnaround management works." journal of business strategy, vol. 9 (january-february, 1988), pp. 61-64. 16. drucker, peter f. "what can we learn from japanese business." harvard business review, vol. 49 (march-april, 1971), pp. 110-122. 17. dun and bradstreet. american's corporate families and international affiliates (vol. ii). parsippany, nj: dun and bradstreet corp. (1988). 18. finkin, eugene f. "company turnaround." journal of business strategy, vol. 5 (spring 1985), pp. 14-24. 19. garvin, david a. "quality problems, policies, and attitudes in the united states and japan: an exploratory study." academy of management journal, vol. 29 (december, 1986), pp. 653-673. 20. gowen, charles r., iii, and joseph w. leonard. "turnaround strategies to reverse declining corporate performance: analyzing a survey of turnaround symptoms, actions, and results." southern ohio business review, vol. 4 (fall, 1986), pp. 4-8. 21. hall, william k. "survival strategies in a hostile environment." harvard business review, vol. 58 (september-october, 1980), pp. 75-85. 22. hambrick, donald c. "turnaround strategies." in w. d. guth (ed.), handbook of business strategy (chapter 10, pp. 1-32). boston, ma: warren, gorham & lamont (1985). 23. hambrick, donald c. and steven m. schecter. "turnaround strategies for mature industrial-product business units." academy of management journal, vol. 26 (june, 1983), pp. 231-248. 24. harper, stephen c. "now that the dust has settled: learning from japanese management." business horizons, vol. 31 (july-august, 1988), pp. 43-51. 25. harrigan, kathryn r. strategies for declining businesses. lexington, ma: heath (1980). fall 1989 gowen: corporate competitive advantages 147 26. harrigan, kathryn r. "strategy formulation in declining industries." academy of management review, vol 5 (1980), pp. 599-604. 27. harrigan, kathryn r. managing maturing businesses. lexington, ma: lexington books (1988). 28. harris, j. m. "corporate turnaround strategy." in k. j. albert (ed.), the strategic management handbook (chapter 20). new york, ny: mcgraw-hill (1983). 29. hayes, robert h. and william j. abernathy. "managing our way to economic decline." harvard business review, vol. 58 (july-august, 1980), pp. 67-77. 30. hill, charles w. t., michael a. hitt, and robert e. hoskisson. 'declining u.s. competitiveness: reflections on a crisis." academy of management executive, vol. 2 (february, 1988), pp. 51-60. 31. hodges, michael. "the japanese industrial presence in the usa: trading one source of friction for another?" multinational business, (spring, 1988), pp. 114. 32. hofer, charles w. "turnaround strategies." journal of business strategy, vol 1 (summer, 1980) pp. 19-31. 33. iacocca, lee a. "the rescue and resuscitation of chrysler." journal of business strategy, vol 4 (summer, 1983), pp. 67-69. 34. imai, masaaki. kaizen: the key to japan's competitive success. new york, ny: random house (1986). 35. jackson, stuart e. "bwfharris poll: sure, japan is a problem, but not mine." business week (august 26, 1985), p. 68. 36. johson, chalmers. "japanese-style management in america." california management review, vol. 30 (summer, 1988), pp. 34-45. 37. kotler, philip, liam fahey, and somkid jatusripitak. what theory z didn't tell you about marketing. prentice-hall (1985). the new competition: englewood cliffs, nj: 38. leonard, joseph w. "review of beyond national borders: reflections on japan and the world by kenichi ohmae." mid-american journal of business, vol. 3 (spring, 1988), p. 60. 39. mccallum, john s. "the japanese industrial miracle: it is not hard to explain." business quarterly, vol. 51 (summer, 1986), pp. 41-47. 148 journal of business strategies vol. 6, no.2 40. michel, peter a. ~'failures in strategic planning." in j. r. gardner, r. rachlin, and h. w. sweeny (eds.) handbook of strategic planning (chapter 11, pp. 1-13). new york, ny: wiley (1986). 41. minahe, shigeo. "japanese competitiveness and japanese management." science, vol. 233 (july 18, 1986), pp. 301-304. 42. nakamura, junichi (ed.). tatemae and honne: distinguishing between good form and real intention in japanese business culture. new york, ny: free press (1988). 43. nonaka, ikujiro. "self-renewal of the japanese firm and the human resource strategy." human resource management, vol. 27 (spring, 1988), pp. 45-62. 44. ohmae, kenichi. the mind of the strategist: business planning for competitive advantage. new york, ny: mcgraw-hill (1982). 45. ouchi, william g. theory z: how american business can meet the japanese challenge. reading, ma: addison-wesley (1981). 46. pant, laurie w. "fueling corporate turnaround through sales growth." journal of commercial bank lending, vol. 70 (december, 1987), pp. 25-32. 47. pascale, richard t. "perspectives on strategy: the real story behind honda's success." california management review, vol. 26, no.3 (1984), pp. 47-72. 48. pascale, richard t. and anthony g. athos. the art of japanese management. new york, ny: simon and schuster (1981). 49. peters, thomas j. thriving on chaos: handbook for a management revolution. new york, ny: alfred a. knopf, inc. (1987). 50. porter, michael. competitive strategy. new york, ny: free press (1980). 51. porter, michael. competitive strategy. new york, ny: free press (1985). 52. pucik, vladimir and nina hatvany. "management practices in japan and their impact on business strategy." in robert lamb (ed.), advances in strategic management (pp. 103-131). greenwich, ct: jai press (1983). 53. richardson, bradley m. and taro ueda (eds.). business and society in japan: fundamentals for businessmen. new york, ny: praeger (1981). 54. sasaki, noato. mana.gement and industrial structure in japan. oxford, england: pergamon (1981). 55. sasaki, naoto. "the potentiality for internationalization of japanese management." management japan, vol. 20 (spring, 1987), pp. 25-28. fall 1989 gowen: corporate competitive advantages 149 56. schendel, dan, g. r. patton, and james riggs. "corporate turnaround strategies: a study of decline and recovery." journal of general management, vol. 3 (fall, 1976), pp. 3-11. 57. sethi, s. prakash, nobuaki namiki, and carl l. swanson. the false promise of the japanese miracle: illusions and realities of the japanese management system. boston, ma: pitman (1984). 58. shostack, g. lynn. "a turnaround is a delicate operation." journal of business strategy, vol. 9 (march-april, 1988), pp. 59-61. 59. siegel, jay s. 'the fairness factor in dispensing bonuses." new england business, vol. 10 (july 4, 1988), pp. 80-81. 60. sloma, richard s. the turnaround manager's handbook. new york, ny: free press (1985). 61. standard and poor. register of corporations, directors, and executives (vol. 1). new york, ny: standard and poor's corp. (1987). 62. steel, tim. "insider info on the rise of japan: review of made in japan by akio morita with edwin reingold and mitsuko shimomura." marketing, vol. 28 (february 5, 1987), pp. 31-32. 63. tyler, linda s. and bob fisher. "the scanlon concept: a philosophy as much as a system." personnel administrator, vol. 28 (july, 1983), pp. 3-37. 64. vogel, ezra. japan as number one. cambridge, ma: harvard university press (1979). 65. waterman, robert h., jr. the renewal factor: how the best get and keep the competitive edge. new york, ny: bantam (1987). 66. west, louise (ed.) illinois manufacturers directory. chicago, il: manufacturers' news, inc. (1988). 67. white, j. kenneth. "the scanlon plan: causes and correlates of success." academy of management journal, vol. 22 (june, 1979), pp. 292-312. 68. yamaguchi, tamotsu. "the challenge of internationalization: japan's kokusaika." academy of management executive, vol 2 (february, 1988), pp. 33-36. japanese versus american corporate competitive advantages: differences in turnaround strategy antecedents, actions, and results relationships between export success, export strategifs, and export planning granger macy bruce barringer university of missouri columbia, missouri max wortman iowa state university ames, iowa the remarkable pace of change in world markets has caused a fundamental shift in the number of possible avenues of growth for u.s. exporters. eastern bloc countries and the republics of the former soviet union are actively soliciting trade. asian economies are experiencing growth at an unprecedented rate. the approaching unification of th~ european community and the possibility of a ratified north american free trade agreement may provide additional opportunities for well-positioned u.s. firms. for many u.s. companies, exports represent a small but still vital portion of their overall sales. exports can also decrease the trade deficit and reduce unemployment. depending on the source, it has been estimated that each additional billion dollars worth of exports creates between 19,600 and 30,000 new jobs. the commerce department, the department of labor, and the u.s. exportjimport bank have made estimates within this range. a deeper understanding of how firms reach their full export potential is important for american businesses and the nation as a whole. background for many firms, target market selection and product considerations are the main dimensions of their export programs ([3],[5]). some u.s. firms, for example, export regionally and may compete primarily on price. others export across the globe and emphasize customer satisfaction and quality products. recent developments in the international economy with regard to regional trade agreements such as naffa and ec92, and the outcome of the gait negotiations, will affect all types of exporters. one key to competing successfully may be the development of complementary product/market strategies. the primary thrust of this paper is to examine the role of planning in this process. here we examine a specific type of planning we refer to as 'export planning.' it is deimed as the development of a distinct export plan and the systematic incorporation of that plan into the firm's annual strategic plan. firms that practice export planning may be better equipped to develop and execute synergistic export strategies. several studies have examined the simple bivariate relationship between export planning and export success. cooper and kleinschmidt [5] found that the best per2 journal ofbusiness strategies vol. 10, no.1 fonners among canadian exporters in the electronics industry conducted the most extensive export planning. madsen [16] found similar results with danish manufacturing finns. in addition, walters and samiee [26] found a positive relationship between what they called "strategic export planning activities" and export success. to the best of our knowledge, only walters [25], in a study of the lumber industry, found no relationship between export planning and the relative importance of exporting to the firm. with regard to the success of export strategies, however, planning appears to be a factor that is consistently important. this study extends existing export success research by examining the importance of export planning to specific product and market aspects of a finn's export strategies. we will examine the interaction between export planning, product/market strategies, and export success. based upon the existing literature, the strategies most commonly associated with export success are identified and discussed. hypotheses are then proposed and tested in order to examine the role of export planning in creating sound product/market strategies. export strategy and export planning the eventual success of any export program may depend on the synergy between its market selection and product strategies. carefully crafted product/market strategies are not ad hoc events. there is significant support in the literature that conscientious strategic and functional planning improves both the technical and the strategic elements of export plans ([5], [12], [22]). we expect that successful, value building strategies will be structured to best position a company within its relevant market. for exporters, this usually means developing product and market selection strategies that complement each other and deliver maximum value to a highly competitive global marketplace. a market selection strategy should complement a finn's strengths, be consistent with its long tenn goals and objectives, and ultimately lead to exporting success. in the following sections we will defme and discuss specific elements of export market selection and product strategies. in support of this discussion, we also review key aspects of the relevant literature. this literature is summarized in table 1. we then examine the role of export planning and present hypotheses describing its place in achieving successful product/market strategies. market selection strategy market selection strategy refers to the overall company program for selecting foreign markets. exporters typically adopt a market selection strategy that emphasizes either market diversification (exporting across the globe) or market concentration (exporting to only a few key markets). as shown in table 1 market diversification has been commonly found to be positively related to export growth and export intensity. market concentration may be a more deliberate, risk adverse approach. once a presence in a foreign market has been established, attention may be shifted toward expansion within that market, rather than entering additional markets. accordingly, steps spring 1993 macy, et al.,: relationships between export success 3 table 1: summary of selected empirical studies on the determinants of export success i:: '" '" '"i:: .~ ~~ .... cj .f:: .~ ...i:: tl:l e~ ~ ... .~ cjtl:l clii c ~rrj... cj .... 1:: .5 '"'-~ ].~.... q,,~ c .~ e ='"':a (; e el:: "'e"ci ~ §'c q"c '"'~ tl:lq"... e tl:l>b tl:l 0 = ll<tl:l ~ll< q ul:l. ~ ci '"' ~a: ~q ~~fi.l l:l. cavusgil [3] 1984 + degree of internationalization christenson, 1987 + + + exportingino longer exp. etal.[4] + ns + ns export intensity cooper & 1985 + ns + export growth kleinschmidt [5} diamanto1988 ns + export intensity poulos [6] + roi douglas & 1983 ns + market share craig [7] kirplani & mac1980 • + export growth intosh [12] + export intensity lee & yang [13) 1990 + export growth export profitability + export intensity louter [15] 1991 + relative export profitability ns ns + + export sales madsen [16] 1989 + + + + export growth ns ns + + export profitability namiki [20] 1988 + export intensity rocha, et ai. [21] 1988 + + + aggress. v. passive exporters + export intensity samiee & 1990 + market diversification walters [22] ns export profits seifert & ford [23] 1989 + satisfaction with exp. prog suzman & 1984 + + tech. prof. & exp. strat. fit wortzel [24] walters [25] 1985 ns relative importance of exp. + + export intensity walters & 1990 + profit samiee [26] +/. direction of significant effect between factor and export success ns no significant effect 4 journal ofbusiness strategies vol. 10, no. 1 are taken to widen the local market base and enter new segments [7]. to maximize market share, products are often designed or differentiated specifically for those markets. conversely, firms that follow the market diversification approach export to a higher number of countries [13]. by taking a low market share in a large number of countries, these firms can usually avoid direct competition with the major players in each market [21]. as a result, they can generally export a more standardized product as long as product quality meets global standards. product strategies product strategy involves blending different marketing mix elements in order to develop the right product or service for the intended market [1]. here we conceptualize product strategy in four dimensions; price, quality, modification, and promotion. developing product and market selection strategies as a cohesive whole should produce more effective strategies. together, these elements are used to define the basis on which a firm chooses to compete. exporters typically follow one of three price strategies: price leadership, price parity (matching local prices in the destination country), or price at the domestic price plus a premium. cooper and kleinschmidt [5] found that exporters who establish a price advantage generally fit a fairly narrow proflle. they typically export fairly generic products to nearby or convenient markets. this is generally a low cost strategy emphasizing economies of scale. although some have reported that successful exporters tend to price competitively in their destination countries ([2], [4], [19]), table 1 shows that the empirical results are mixed. alternatively, some exporters may consider their products to be unique and choose not to price competitively. such an approach may yield higher margins but lower market penetration and may account for the weak findings in this area. in contrast to price, high product quality should be considered a virtual prerequisite for export participation and growth. table 1 shows many positive relationships between product quality and success across studies. in a study of manufacturing firms, cavusgil [2] found that exporters don't need a new product to be successful, but the product must be of high quality. firms that compete on quality typically emphasize some product characteristic that exceeds the norms. this can take on several forms including product style, service level, durability, or technological sophistication. product modification is another product strategy. this refers to the practice of designing or customizing products to appeal to specific foreign markets [23]. like quality, this strategy can take on a number of different dimensions. product design, packaging, method of delivery, or a customer service developed specifically for a particular market are examples of a product modification strategy. modification strategies are typically aimed at building market share within a particular foreign market. as such, product modification is generally associated with a market concentration approach. the empirical studies shown in table 1 have generally supported the value of product modification in a competitive export strategy. spring 1993 macy, et al.,: relationships between export success 5 however, not all experts agree. levitt [14] argued against product modification. he stated that simplicity and economies of scale are the key factors, and that globalization of markets should imply standardization of products worldwide. this brings costs down which can potentially expand world markets. nevertheless, many exporters encourage product modification. a popularaxiom among exporters combines the two approaches, "standardize what is possible, differentiate where necessary" [15]. such conflicting viewpoints have yet to be adequately resolved. the final dimension of export product strategy considered here is promotion. this area is not well researched but tends to be positively related to export success. it is generally believed that most firms invest much less in promotion for export markets than for domestic markets. exporters may rely on their importers to promote their products once ownership has changed hands. seifert and ford [23] asked 65 u.s. exporters from diverse industries about their export promotion budgets. only 4.5% of the companies spend proportionally more on exports than domestic products. firms that did promote their exports typically fell within the market concentration category. such firms are more able to focus their promotional efforts by concentrating on fewer markets. promoting products across multiple markets could spread resources too thin and be ineffective within individual markets. selection of product/market strategy although we believe that there is no one best export strategy, the empirical literature does suggest that certain combinations of product and market selection strategies are conceptually more reasonable. competitive pricing is typically associated with the market concentration approach. these firms typically sell a standardized, high volume product to a limited number of markets [18]. a much different but also potentially effective market concentration approach emphasizes product modification. this is a differentiation strategy that is aimed at building market share in selected markets. product promotion is also associated with building market share in a limited number of markets. in contrast, the optimal approach for market diversification may be high quality. as discussed previously, there are several paths available to achieve high quality. the importance of quality may be due to the wide market demand for intrinsically appealing products. export planning planning is proposed to be a key antecedent to export success. in this study, export planning is conceptualized as the extent of effort on the part of an exporter to systematically incorporate exporting into the firm's strategic plans. it is analogous to a firm carefully integrating a business strategy into its broader corporate strategies and narrower functional strategies. such planning helps assure that a firm's export program is consistent with its overall goals, objectives, and internal capabilities. as mentioned earlier and summarized in table 1, a relationship between export planning and export success has been supported by previous empirical research. 6 journal ofbusiness strategies vol. 10, no.1 howard and herremans [9] conducted a subjective study of 273 winners of the department of commerce "e" award for excellence in exporting. each of the firms were asked to evaluate 23 different activities in terms of overall importance to export operations. planning activities received the highest rankings. our purpose was to investigate a more complex relationship that considers export planning, product/market strategies, and export success. different strategies may require different degrees of rigor in export planning. the next section posits potential relationships between specific product/market strategies, export planning, and export success. hypotheses taken together these hypotheses posit that export success may be achieved through one of several complementary product/market strategies. it is not our intention to find some 'ideal' combination of export strategies and planning intensity. export planning is examined as a potential catalyst in the development of sound export strategies, and specified as a moderating variable in the following hypotheses. h1a: competitive pricing will be related to increased export success under conditions of market concentration regardless of the level of export planning. hlb: competitive pricing will be related to increased export success under conditions of market diversification and high levels of export planning. firms that price their exports competitively typically sell standardized, high volume products designed for manufacturing efficiency. the focus on planning is at home, rather than abroad, so as to support the complexities required to maintain high volume production facilities. frequently, the same product can be sold domestically and abroad. in this approach, profitability results from the effectiveness of the manufacturing process rather than premium pricing. the level of export planning should not be critical for firms that match competitive pricing with the market concentration approach. markets can be selected for stability and minimal risk. distribution channels can be established and exporting can be managed on a rather routine basis. conversely, export planning is more critical for fums that match competitive pricing with the market diversification approach. as market diversification increases, the need for market scanning and thus export planning increases. in this situation, competitive pricing is more likely to be successful where higher planning intensity is present to adequately assess market pricing. competitive pricing appears most useful for standardized products without any clearly defined product advantage. noncompetitive pricing is expected to be appropriate where product uniqueness generates the demand. noncompetitive pricing may require extensive market scanning and careful market selection. such an approach may create high profitability; but the selectivity of the approach may not necessarily yield high sales levels or a large export market in terms of the number of countries. since the measures of success in this study do not focus on profitability, a noncompetitive pricing strategy is not likely to be related to the measures of success used in this study. spring 1993 mary, et al.,: relationships between export success 7 h2: high product quality will be related to increased export success under conditions of market diversification regardless of the level of export planning. high product quality has consistently been linked with export success ([15], [16], [17]). a quality strategy focuses on product strength and technology rather than on low price. a market diversification approach is indicated in that high quality products can penetrate even particularly demanding markets. in addition, madsen [16] found that exporters of high quality products are more successful in attracting successful agents and distributors. these intermediaries may facilitate reaching additional markets. this may also allow firms to leave their export planning to the intermediaries and concentrate on other product issues. in this case, high product quality may actually be associated with relatively low levels of export planning. on the other hand, products need to be differentiated to be successful using a quality approach. a company may thus need to keep abreast of consumer preferences and plan to adapt to changing preferences. thus a quality approach may be successful under either low or high levels of export planning. h3: product modification will be related to increased ~xport success under conditions of market concentration and high levels of export planning. firms that practice product modification typically select one or more attributes that many buyers in a particular foreign market perceive as important, and position their products to meet those needs. this is typically done in an effort to capture a specific market. rather than export a general product, the product is modified to accommodate local needs. as a competitive strategy, product modification may be more effective for firms pursuing a market concentration approach. logistical problems can exist under a product modification policy due to the need to maintain different versions of the product and to set up multiple, shorter production runs. an effective modification strategy will become increasingly complex as a firm diversifies into a greater number of markets. thus it may be in the firm's best interest to concentrate on achieving penetration in fewer markets. product modification also represents a more deliberate, methodological approach than price leadership or quality differentiation. export planning is expected to be higher so that firms can monitor local preferences and continue to modify their products accordingly. h4: product promotion will be related to increased export success under conditions of market concentration and high levels of export planning. it was mentioned previously that export product promotion is not well researched. it is expected that traditional promotional strategies such as advertising and point of sale marketing can be used more effectively by firms pursuing a market concentration approach. promotion across a large number of markets may be impractical. planning intensity for promotion is expected to be high. effort, managerial input, and intense monitoring of effectiveness are required to maintain promotional programs. 8 j oumal ofbusiness strategies methodology vol. 10, no.1 sample the data for this study were collected from a survey of midwest agricultural exporters. the companies were identified by using state export directories. an initial mailing was sent to 281 firms. a total of 151 firms provided usable surveys resulting in a response rate of 54%. a wide variety of firms were represented in the survey includingoquipment manufacturers and chemical producers. agricultural firms were chosen because they are heavily involved in exporting and they include a broad cross section of firms that use various product/market strategies. the typical survey respondent had 10 to 20 years of export experience, employed 50 to 100 people, and exported to 3 continents and 8 different countries. the firms also varied in terms of how much they exported; 41 % export up to 6% of sales, 34% export 6-15% of sales, and 25% export more than 15% of sales. variables the study employed three sets of variables including product strategy, export planning, and export success. 1. product strategy measures included the four product strategy variables of price, quality, modification, and promotion. these were the anticipated predictors of export success. the price variable asked respondents to indicate the category that best described how they priced their products for export. this measured whether competitive pricing was used in the destination country. codes ranged from 0 to 2 with higher numbers representing more competitive pricing. the modification variable measured the extent to which the firm relied on modifying its products to suit the taste of its foreign markets. this was coded: 0 no modifications; 1 minor modifications; 2 major modifications. the quality measure asked respondents about the relative quality level of the firm's products as compared to competitors in destination countries. it was coded: 0 below average; 1 average; 2 above average; 3 quality leader. the promotion variable measured the extent to which the firm relied on promotion to compete in foreign markets. promotion was operationalized by asking firms whether their promotional spending for exports was lower; the same as; or higher than their promotional spending for domestic markets. these choices were coded 0 through 2 respectively. 2. export planning was used as a moderator variable. each hypothesis was tested under conditions of "low planning" and "high planning." the export planning variable asked respondents to evaluate to what extent the export plan was incorporated into their annual strategic and operating plans. firms in the "low planning" category reported that there was either no export plan or that their export plan was not incorporated into their annual strategic and operating plans. 3. export success included two dependent variables; export intensity (total export sales divided by total firm sales) and the number of countries to which products are spring 1993 macy, et al.,: relationships between export success 9 exported. the export intensity variable (ei) measured overall export success. this data was collected in categories with 5% increments. thus a code of 1 equates to an export intensity up to 5%; a 2 equates to export intensity up to 10%, and so on. the variable for number of countries (nucfy) indicated the geographic scope of a firm's export operations and in combination with ei represents a proxy for market selection strategy. it was coded as 1 up to 5 countries; 2 6 to 10 countries; 3 11 to 20 countries; 4 more than 20 countries. analysis the means and response counts for each variable are presented in table 2. note that these data are categorical. table 2: variable means and distributions mean 0 1 2 3 4 5 6 7 8 9 price 1.18 30 55 56 modification .83 44 84 19 quality 2.21 1 23 66 57 promotion .51 87 50 13 export planning .77 34 117 export intensity 2.46 61 41 11 17 12 2 2 3 2 number countries 1.83 82 28 22 17 the distributions of export intensity and nucfy, the dependent variables, are not normally distributed. this is consistent with other export success studies [1]. normally, many of the commonly applied linear tests are robust to non-normal dependent variables. however, in this case, there is a very high level of non-normality. as a result, the study employed techniques designed to offset this difficulty. first, a spearman rank order correlation matrix was used. this is appropriate for ordered categorical data. these correlations are used to show population wide associations. second, logit analysis, a multivariate test, was used to analyze the hypotheses. this form of regression is appropriate for categorical data and is used extensively in evaluating dichotomous dependent variables. to utilize this approach, the dependent variables were reduced to dichotomous categories. all export intensities (ei) above the lowest response were combined into one category. the same was done for number of countries (nucfy). this reduced each of the dependent variables into two categories of relatively balanced size representing a low and high level for each variable. the moderator variable, export planning (ep), was then used to partition the data into firms representing "low" and "high" levels of export planning. logistic regression was then applied to each dependent variable twice, once for each level of ep. 10 journal ofbusiness strategies vol. 10, no.1 following this, matching models were computed using ordinary least squares regression. these tests were conducted for comparison to the logit analysis. in this case, the original data was used for the dependent variables; i.e., no dichotomous categorization. if these results were found to be reasonably consistent, then it could be concluded that little information was lost by combining the dependent variables into categories for hypothesis testing. results the spearman rank order correlations are shown in table 3. consistent with previous studies, export planning (ep) was found to have a· high positive correlation with both dependent variables, export intensity (ei) and number of countries (nucfy). table 3: spearman rank order correlations 1 2 3 4 5 6 price modification .181* quality .108 .147 promotion -.107 .066 .109 export planning .132 .273** .119 .206* export intensity .090 .263** .215 .393** .239** number countries .196* .156* .378** -.041** .303** .306** *p = <.05 **p = <.01 the results of the logit analysis are shown in table 4. the logistic regression coefficients are difficult to interpret due to logarithmic transformations, and thus the raw coefficients are not reported. table 4: logistic regression chi-square test of significance strategy total model price modification quality promotion ei nuciy ep=o ep=1 ep=o ep=1 ns *** ** *** ns *** * ** ns ns ns ** *** *** *** ns *p = <.10 ** p = <.05 ***p = <.01 spring 1993 macy, et al.,: relationships between export success 11 this table presents the differences between low levels and high levels of planning on each of the four product variables. this is shown for each dependent variable; export intensity (ei) which is the measure of overall export success and the number of countries (nucfy) which is a measure of the achievement of market diversification. the results shown in this table largely support the central premise of this study; i.e., export planning differentially affects the success of product/market strategies. the ordinary least squares (ols) results are presented in table 5. these results attest to the robustness of the ols procedure. all tests of significance between the logit analysis and ols agreed except for pricing and number of countries under the low planning condition. furthermore, only one coefficient, indicated in table 5, did not agree as to the direction of the effect; and this coefficient was not significant in either analysis. table 5: ordinary least squares regression coefficients strategy ei ep=o ep=1 nucfy ep=o ep=1 price -.01 .05 modification .04.53* quality .31 .12 promotion .23c .68* ·indicates significance in both logit and ois techniques c indicates sign change between logit and ols techniques -.14 .16* .11 .03 .19* .20· -.24* -.07 evaluation of hypotheses all hypotheses were evaluated with respect to the logit results shown in table 4. the effect of pricing strategy as proposed in hypothesis la was not supported. pricing had no significant effect on export intensity. however, hypothesis ib was supported in that competitive pricing exhibited a positive effect on number of countries (nucfy) under high planning. in table 5 note the difference in the effect of competitive pricing between levels of planning for nucfy. this is a clear indication of the effectiveness of planning in a market diversification strategy. under high planning there was a positive relationship significant in both the ois and logistic regressions. under low planning, there was an inverse relationship that was significant in the logistic regression. hypothesis 2 was accepted. quality had a significant positive relationship only with nuciy and this occurred regardless of the level of planning. these results were uniformly significant across both regressions in tables 4 and 5. this supports the importance of quality to a market diversification strategy. hypothesis 3 was also supported. modification was significant for export intensity (ei) under high export planning but was not significant for number of countries. again, this result was consistent in both regression procedures. 12 journal ofbusiness strategies vol. 10, no.1 hypothesis 4 was accepted. product promotion was significantly and positively related to ei under high planning but inversely related to nucfy with similar results found in both the ols and logistic regression. this strongly indicates the importance of market concentration to the success of promotional activities. discussion the findings of this study demonstrate that the effectiveness of certain export product/market strategies are strongly related to the firm's l~vel of export planning. recall that export planning is a specific type of planning. it was defmed as the development of a distinct export plan and the systematic incorporation of that plan into the firm's annual strategic plan. previous studies had established a simple bivariate relationship between export planning and. export success. this study has demonstrated one important reason why export planning contributes to export success. apparently, firms that practice export planning are able to develop more complementary product/ market strategies. for example, export intensity (ei) was influenced by product modification and promotion, but only when accompanied by high levels of export planning. low planners were not able to execute these strategies with as much success. different patterns emerged for the dependent variable, number of countries (nucfy). to the best of our knowledge, this has only been utilized once as a dependent variable in previous export success studies. nucfy actually has a dual impact, both as a dependent and an independent factor. 111 one sense, it represents a firm's deliberate selection of countries; yet, the firm must also be successful in those markets to remain in them. the results of this may be especially useful as exporters contemplate entering new markets. nucfy was related to competitive pricing, promotion, and product quality. the finding of the effectiveness of competitive pricing under conditions of high planning was not unexpected. although this hasn't been examined previously, it is contrary to suggestions in much of the export success literature. the relationship between' nucfy and quality replicates previous studies. apparently high product quality is associated with export success in this context regardless of the level of planning. the inverse relationship between nucfy and product promotion under low export planning is also noteworthy. promotional spending appears to have limited usefulness in penetrating a large number of markets. the results for quality require additional comment. only one :firm reported its quality as zero, or "below average." there are different ways to explain this. first, these companies are all exporters. exporters may be expected to represent a biased frame of above average producers. second, the respondents may have been reluctant to assess their products as low quality. this would reflect an inherent limitation of self-assessed measures. the first problem would result in a 'restriction of range' while the second could be considered 'noise' in the data. such problems limit the ability of statistical tests to detect a significant effect. nevertheless, there were still clear relative rankings among the firms and the statistical tests for quality were significant. spring 1993 macy, et al.,: relationships between export success 13 it would thus appear that the effect of quality is quite strong; enough to be detected regardless of the source of the skewed response. although there was a significant relationship between quality and number of countries, the relationship between quality and export intensity was not significant. this finding is counter to previous studies which have generally found a positive relationship between quality and measures of export success. however, caution should be exercised in interpreting this result. this result may be an artifact of the methodological issues just discussed rather than the actual contribution of product quality. on the other hand, the correlations reported in table 2 between quality and export intensity were significant and consistent with previous studies. it thus seems more likely that this data is actually similar to other studies. perhaps the data in other studies were also skewed but were simply not examined for this problem. perhaps a more important reason for this lack of significance is that the control for other dimensions of product strategy provides a more accurate representation of the true relationship. further research is needed to resolve this dilemma. one suggestion for dealing with the limitation of the quality variable in future research would be to use multiple item scales to assess product quality. garvin [8], for example, proposed that product quality can be captured in eight dimensions. another suggestion is to use at least a seven point scale. operationalizing quality consistent with these suggestions may help to reduce respondent resistance and broaden the range of responses. the analyses also revealed some important patterns regarding export planning and the product variables. planning was important to product modification and promotion strategies as expected. earlier it was argued that these product strategies require high levels of planning because of the managerial input and process complexities involved. with or without planning it is also clear that quality is the primary means for achieving success in a market diversification strategy. on the other hand, promotion appears to be a relevant strategy for market penetration but not market diversification. this can be seen in its differing effects of promotion on export intensity and number of countries. under low levels of planning, there was a significant negative relationship between product promotion and the number of countries exported to. this is an important result. as proposed in hypothesis 4, it suggests that firms pursuing geographic dispersion in their export programs are actually hindered by channeling resources into product promotion. alternately, promotion contributed to export intensity under high planning; a seemingly contrary finding. this suggests that promotion can be effective as long the market breadth is not large. thus the success of a promotional strategy appears to be highly dependent on the overall fit of the strategy. conclusions this study has examined complex relationships between three crucial export variables; market selection strategy, product strategy, and export planning. it has supported 14 journal ofbusiness strategies vol. 10, no.1 the premise that export planning plays an important role in the development of complementary product/market strategies. product/market strategies that are not complementary may not be viable in an increasingly competitive global marketplace. while past research has convincingly supported the relationship between export planning and export success, the specific contribution of export planning bad received minimal attention. we have offered an critical first step in a promising line of inquiry. unlike many previous studies investigating bivariate relationships replicated in other export studies, our study has revealed the importance of planning to the effectiveness of many strategies, most notably pricing and quality. results of this study help to increase our understanding of the complexity in crafting a successful export strategy and give more detailed guidance to managers attempting to determine the steps necessary to increase their export performance. several specific guidelines emerge that may be of particular interest to active and would-be exporters. first, product quality and competitive pricing are important for achieving market diversification. market diversification is a relatively aggressive strategy that must be complemented by a favorable product and price to facilitate continued entry into new markets. second, product modification and promotion are important for increasing exports overall. these strategies may particularly appeal to firms trying to build market share in selected markets. finally, export planning is an important component to export success. defined here as the systematic incorporation of exporting into a firm's strategic plans, export planning apparently helps to equip managers to formulate effective export strategies. this study has also shown that successful export strategies are situationally determined by many factors. research should continue to explore the relationships of other factors which may impact on export success. other factors are likely to influence the optimal strategy for companies to pursue. such elements as firm size and specific elements of non price competition, if researched, could help to understand other situational factors likely to effect export success. references 1. boone, l.e. and kurtz, d.l contemporaty marketing. chicago: dryden (1986). 2. cavusgil, s.t. "differences among exporting firms based on their degree of internationalization." journal of business research, vol. 12 (1984), pp. 195-208. 3. cavusgil, s.t. and naor, j. "firm and management characteristics as discriminators of export marketing activity." journal of business research, vol. 15, no.3 (1987), pp. 221-232. 4. christensen, ch., rocha. a & gertner, rk. "an empirical investigation of the factors influencing exporting success of brazilian firms." journal of international business studies, vol. 18, no.3 (1987). pp. 61-77. spring 1993 macy, et al.,: relationships between export success 15 5. cooper, r.g. and kleinschmidt, e.j. "the impact of export strategy on export sales performance." journal of international business studie~ vol. 16, no.1 (1986), pp. 3754. 6. dianantopoulos, a. "identifying differences between highand low-involvement exporters." international marketing review, vol. 5, no. 2 (1988), pp. 52-59. 7. douglas, s.p. and craig, s.c. "evaluation of global marketing strategy." columbia journal of world business, (fall 1989), pp. 47-59. 8. garvin, d.a. "quality on the line." harvard business review, vol. 61 (septemberoctober 1983), pp. 65-73. 9. howard, d.g. and herremans, 1m. "sources of assistance for small business exporters: advice from successful firms." journal of small business management, vol. 26, no. 3 (1988), pp. 48-54. 10. johnson, w.j. and czinkota, m.r. "export attitudes of industrial manufacturers." industrial marketing management, vol. 14 (1985), pp. 123-132. 11. kathawala, y., judd, r., monipallil, m., and weinrich, m. "exporting practices and problems of illinois firms." journal of small business management, vol. 27, no.1 (1989), pp. 53-58. 12. kedia, b.l and chhokar, j. "factors inhibiting export performance of firms: an empirical investigation." management international review, vol. 26, no.4 (1986), pp. 3343. 13. lee, c.s. and yang, y.s. "impact of export market expansion strategy on export performance." international marketing review, vol. 7, no. 4 (1990), pp. 41-50. 14. levitt, t. "the globalization of markets." harvard business review, vol. 61, no.3 (1983), pp. 92-102. 15. louter, p.j., ouwerkerk, cok and bakker, ben a. "an inquiry into successful exporting." european journal of marketing. vol. 25, no.6 (1991), pp. 7-23. 16. madsen, t.k. "successful export marketing management: some empirical evidence." international marketing review, vol. 6, no.4 (1989), pp. 41-57. 17. mcguinness, n.w. & little, b. "the influence of product characteristics on the export performance of new industrial products." journal of marketing, vol. 45, no.2 (1981), pp. 110-122. 18. miller, d. "relating porter's business strategies to environment and structure: analysis and performance implications." academy of management journal, vol. 31, no. 2 (1988), pp. 280-308. 16 j oumal ofbusiness strategies vol. 10, no.1 19. moon, j. and lee, h. "on the internal correlates of export stage development: an empirical investigation in the korean electronics industry." international marketing review, vol. 7, no.5 (1990), pp. 16-26. 20. namiki, n. "the impact of competitive strategy on export sales performance: an exploratory study." the mid atlantic journal of business, vol. 25, no.6 (1989), pp. 21-37. 21. rocha, a. da, christensen, c.h. and eduardo, eduardo da cunha, c. "aggressive and passive exporters: a study in the brazilian furniture industry." international marketing review. vol. 7, no.5 (1990), pp. 6-15. 22. samiee, s. and walters, p.g.p. "influence of firm size on export planning and performance." journal of business research, vol. 20 (1990), pp. 235-247. 23. seifert, b. and ford, j. "are exporting firms modifying their products, pricing and promotion policies?" international marketing review, vol. 6, no.4 (1989), pp. 53-69. 24. suzman, c.l and wortzel, lh. "technology profiles and export marketing strategies." journal of business research. vol. 12 (1984), pp. 221-235. 25. walters, p.g. "a studyof planning for export operations." international marketing review, vol. 2, no. 3 (1985), pp. 74-81. 26. walters, p.g.p. and samiee, s. "a model for assessing performance in small u.s. exporting firms." entrepreneurship theory & practice, vol. 15, no.2 (1990), pp. 3350. relationships between export success, export strategies, and export planning volume 36, number 1 45 the decision to build a fence: a real-option problem garland simmons stephen f. austin state university • nacogdoches, tx abstract real-option methods of net present value (npv) analysis are applied to understand a capital budgeting decision concerning flexibility. the capital budgeting problem under study here is the decision of whether spade ranch (spade) should build a fence. if this fence is built, then a hay-meadow could be converted into pasture land, which would in turn permit the herd-size of the spade ranch to increase. however, this fence building does not require the spade to take the newly-fenced land out of hay production and put it into cattle production. instead, once the fence is built, the spade has the ability to switch land use from hay production to cattle production and vice versa. the decision of whether or not to create this flexibility by fence-building is the crux of this paper. what is the value of flexibility? if the fence costs less than the value of this flexibility then we build the fence, otherwise no. for two different scenarios, a linear programming model is employed to define the relationship of economic value added (eva) to the question of whether or not one should produce hay or cattle given that the existence of a fence permits a decision maker to switch back and forth between hay and cattle production. these two scenarios, each of which work under different pricing assumptions, produce different eva results and different production choices. from this scenario work, the paper moves to the question of npv. is the decision to build a fence a positive npv investment decision or not? an option pricing model is used to approach this question. given a fence that provides for the ability to switch back and forth between cattle and hay production, what is the value of choosing additional cattle production by giving up the additional production of hay for sale? as it turns out, the question of npv for an investment that provides a firm more flexibility by switching from the production of one product to another can be answered. but the answer depends on the volatility of possible rates of return on investment for both hay and cattle production, and their correlation with one another. 46 journal of business strategies introduction in this paper real-option methods of net present value (npv) analysis are applied to understand a capital budgeting decision concerning flexibility. the capital budgeting problem under study here is the decision of whether spade ranch (spade) should build a fence. if this fence is built, then a hay-meadow could be converted into pasture land which would in turn permit the herd-size of the spade ranch to increase. however, this fence building does not require the spade to take the newlyfenced land out of hay production and put it into cattle production. instead, once the fence is built, the spade has the ability to switch back and forth from hay production to cattle production and vice versa. the decision of whether or not to create this flexibility by fence-building is the crux of this paper. the inspiration for this problem comes from conversations with mr. john c. mast, owner of the spade ranch and other ranches in texas and new mexico. the historic spade located in east texas raises and sells beef cattle. the spade can sell all the cattle and the hay that they could produce, but they have no control over either cattle or hay prices. prices for these products that are sold by the spade fluctuate a great deal, and so too do prices for many of their inputs – water, farmland, fuel, hay, and fertilizer. management has chosen to accept the large price fluctuations in cattle prices: they do not employ derivative contracts to hedge against commodity price movements; but they have chosen to protect themselves against large price swings in water, farmland, and hay. instead of renting pasture land and attendant water access, spade ranch land and associated water rights are owned fee simple. moreover, under current operating policies, the spade produces more than enough grass and hay to feed their own cattle, so fluctuating prices for these inputs is of no immediate concern. but if enough of the hay production of the spade is transformed into cattle production, the need to go into the open market to purchase hay will be realized. should management acquire the ability to increase their herd size at the expense of hay production? this problem in real-option valuation is informed by a related linear programming problem that works on two scenarios, each with a different price for yearling calves which is one of the major products of the spade. to make this linear programming problem work, an objective function, the maximization of economic profits, is described using real-world parameter estimates (and some not so realworld assumptions where need be) of the prices and variable costs and capital costs associated with hay and cattle production. and the linear programming problem constraints are described by productivity data that relates how many yearling calves and how much hay can be produced per acre of farmland. volume 36, number 1 47 from the linear programming problem the paper moves to the question of net present value (npv). is the decision to build a fence a positive npv investment decision? an option pricing model is used to approach this question. given a fence that provides for the ability to switch back and forth between cattle and hay production, what is the value of choosing additional cattle production by giving up the additional production of hay for sale? as it turns out, the question of npv for an investment that provides a firm more flexibility by switching from the production of one product to another can be answered. but the answer depends on the volatility of possible rates of return on investment for both hay and cattle production, and their correlation with one another. it is hoped that in this real-option problem undergraduate business students can see the connection of a simple investment decision of whether to build a fence, which adds flexibility to a texas ranch’s ability to produce larger and smaller quantities of two products, hay and cattle. and then perhaps they can go on from that point to understand how to estimate the net present value (npv) of this flexibility. some results in this problem are counterintuitive to many beginning students. unexpectedly, they find that the more volatile hay and cattle prices are, the more valuable the fence that is built. they also find that the smaller the correlation of hay with cattle prices, the more valuable the fence, and vice versa. data sources and data estimates data reported in this paper concerning cattle prices, the costs of growing hay, agricultural land prices, and the cost of building fence are factual. information about the costs of growing hay is taken from wilder ferreira of clemson extension. the web: http://www.clemson.edu/extension/aes/budgets/files/bermudagrass.pdf. this report is current as of january 2014. information about cattle prices and land prices for agricultural land was secured from mr. john c. mast of nacogdoches, texas. this information is current as of march 2014. information about the cost of fence building is taken from jeff caldwell of agriculture.com. the web: http:// www.agriculture.com/news/livestock/what-will-a-new-fence-cost-this-year_3ar22518. this information is current as of february 29, 2012. information about the daily consumption of grass by cattle was obtained from dr. ronald lott, dvm, of nacogdoches, texas. this information is current as of april 4, 2014. 48 journal of business strategies from these data sources it is estimated that a fence around the perimeter of a 640 acre, square tract of land can be built for $2 per linear foot: total cost equals $42,240. (no holding pens or cattle loading chutes will be required.) the market value of 640 acres of farmland is estimated at $5,000 per acre. so, the market value of these 640 acres is estimated to equal $3,200,000. if put into cattle production, a 640 acre pasture could either permit the herd size to increase by 116 animal units (a cow and calf comprises one animal unit.) or permit the production of 3,200 tons of hay. the contribution per ton of hay produced for sale is estimated to equal $30 per ton. the contribution per yearling calf sold is estimated to equal $1,000. cows eat about two percent of their body weight per day in grass or hay, something more than that if their diet is not supplemented by feed. so a 1,000 pound animal will eat twenty pounds of grass or hay per day. data assumptions five acres should produce 25 tons of grass per year. one animal unit, a mother cow and her calf, consumes about 6 or 7 tons of grass per year. so we can easily justify the assumption that five acres will support one animal unit. so, why five acres? the cost of growing five tons of grass per acre per for cows to eat is not the same as for growing five tons per acre for producing hay to be sold. but when feeding cows the rancher can choose to use more acres to make grass than she would for making hay for sale – five acres per animal unit in this case. so the fertilizer, labor, capital equipment cost necessary to growing grass for producing hay for sale is reduced from what would be required to grow grass so that hay could be produced and sold. it is assumed in this study that if five acres are allocated for each animal unit, no cash outlays will be required to grow grass for the cows to eat. by contrast, five acres of hay production for sale will cost $3,750 in fertilizer, labor, and capital equipment cost. and these five acres will produce 25 tons of hay, far more than pastureland where only 6-7 tons of grass production is needed to support an animal unit. some other inputs are also assumed. the cost of capital for the spade ranch is assumed to be ten percent. the standard deviation of possible rates of return on investment in raising cattle is assumed to be sixteen percent, as is the standard deviation of possible rates of return on investment in growing hay for sale. the correlation of the possible rates of return on investment in raising cattle with the possible rates of return on investment in growing hay for sale is unknown. the size of the pasture to be fenced (or not) is assumed to be equal to 640 square acres. economic depreciation per cow is assumed to equal $60 per year. the marginal tax rate is assumed to equal zero. volume 36, number 1 49 the mortality problem associated with raising yearling calves are ignored, and so too is the problem of fertilizing and otherwise maintaining pastureland used for grazing cows and calves. some other details that may prove important for a later problem are also ignored here. accounting depreciation for tax purposes could be estimated with straight-line depreciation methods for five years to a zero salvage value. there are some small anticipated maintenance costs associated with a fence. but this paper ignores these costs as well as the benefits of a depreciation tax shield. the problem of this paper a new fence will permit the use of 640 acres of pasture for either cattle raising operations or for hay production. currently, these 640 acres, located across a farm to market road from spade ranch headquarters, planted in bermuda grass, could be used as a hay meadow for the production of hay for sale. but if a fence is built this hay meadow could be used instead for cattle production. should management acquire the ability to increase their herd size at the expense of hay production? in this regard the problem of this paper is to value the flexibility associated with the decision to build a new fence on one of the spade ranch pastures in nacogdoches county, texas. if the net present value of the decision to build this fence is positive, then the value of the spade with the fence is larger than the value of the spade without the fence. so how does one go about estimating this net present value? two business models for one enterprise a cattle ranch grows grass for their cows to eat and some cattle ranches also grow grass so that they can produce hay for sale. if a ranch grows more grass than their cows can eat then they either store it for later use or the sell it. an acre that is fertilized and maintained for hay production will produce about five tons of grass per year. if hay is to be produced for sale, then the cows must be kept out of the pasture where it grows. to keep cows out of a hay meadow requires a fence. the initial cost of the fence is projected to be $42,240. fences are durable, but every ten to twenty years fences should be replaced. if the hay produced is to be sold, the contribution to economic value added per acre of hay sold equals $150. given that each acre produces five tons of hay, that contribution to economic value added per ton of hay produced for sale equals $30. 50 journal of business strategies the business of growing hay for sale is not the same as the business of raising yearling calves for sale. when growing grass for feeding mother cows and their calves the cost per acre and the quantity of grass produced per acre is less. to grow grass in order to produce hay for sale requires an annual investment of $750 per acre in fertilizer, labor and capital. to grow grass to feed cows is another matter. if five acres are allocated for each animal unit (a mother cow and her calf), it is assumed in this study that no cash outlays will be required to grow grass for the cows to eat. in fact some costs would be incurred to lime and fertilize the pastureland where cows and calves graze, but these costs are ignored. to raise yearling calves for sale, mother cows are bred every year and from this a calf is produced. at the end of the year, these yearling calves are sold and then the cycle starts over again. currently a yearling calf will bring $1,200 at market. mother cows can often produce eight to ten calves, one each year. every year some of the older, less-productive mother cows are sold, hence there is depreciation which is assumed to equal $60 per calf per year. so that calf production can continue, each mother cow sold must be replaced with a cow carrying a calf. current cost of purchasing a young, healthy cow that has been bred is equal to $2,500. given an assumed weighted cost of capital equal to ten percent, the annual dollar cost of capital of investing in one cow that has been bred is equal to $250. also, since each calf requires a mother cow, the ratio of mother cows to calves should be maintained at one-to-one. from 640 acres 116 yearling calves can be produced every year and 116 mother cows can be maintained. a linear programming analysis in our linear programing problem there is one objective function and three constraints. the objective is to maximize annual economic value which is a function of the prices and costs associated with yearling calf production and hay production. the objective function is shown below: max eva = (ccalf) (δ calves) + (chay) (δ hay) – (δ depreciation + δ capital cost) (δ cows) where: eva is economic value added for one year; ccalf is a parameter variable, the dollar contribution to eva from selling one yearling calf; δ calves is a choice variable, the number of yearling calves raised for sale; δ hay is a choice variable, tons of hay; chay is a parameter value, the dollar contribution to eva from volume 36, number 1 51 selling one ton of hay; δ depreciation is a parameter variable, the dollar value of economic depreciation per year for one mother cow; δ capital cost is a parameter value, the dollar value of capital cost per animal unit for one year; δ cows is a choice variable, the number of mother cows maintained. with regard to parameter values, for both scenarios below: chay = $30 per ton of hay sold; δ depreciation = $60 per mother cow; δ capital cost = $250 per number of mother cows; for one scenario below: ccalf = $1,200 per yearling calf sold, and for the other scenario ccalf = $1,000 per yearling calf sold. there are three constraints. the first constraint defines a relationship between the number of yearling calves raised for sale every year and the number of mother cows: δ calves δ cows = 0 in this paper, if the land to be fenced is to be used for cattle production, then the herd should increase: δ calves and δ cows both increase in a one-to-one relationship. if the land to be fenced is to be used for hay production, then the herd will not increase in size: δ calves and δ cows are both estimated to equal zero in this case. the second constraint defines how the 640 acres is divided between cow and calf production and hay production: (lcalf)(δ calves) + (lcow)(δ cows) + (lhay)(δ hay) ≤ 640 acres where: lcalf is a parameter value, the number of acres of land required to raise one yearling calf -in both scenarios below lcalf = 2.5 acres per yearling calf; lhay is a parameter value, the number of acres required to raise one ton of hay for sale – in both scenarios below lhay = 0.20 acres per ton of hay produced for sale; lcow is a parameter value, the number of acres of land required to maintain one mother cow -in both scenarios below lcow = 2.5 acres per mother cow. the third constraint defines all choice variables, the number of yearling calves raised, the number of mother cows to be maintained, and the number of tons of hay produced for sale, δ calves, δ cows, and δ hay, to be positive quantities. δ calves, δ cows, δ hay ≥ 0 52 journal of business strategies two scenarios, each with a different contribution for yearling calves produced and sold, are considered in the light of this linear programming model. in table 1 below the contribution to eva for each yearling calf produced and sold (ccalf) is permitted to equal $1,200 and the contribution to eva for each ton of hay produced for sale (chay) is permitted to equal $30 per ton. in table 2 below the contribution to eva for each yearling calf produced and sold (ccalf) is permitted to equal $1,000 which is less than that of the first scenario, and as before the contribution to eva for each ton of hay produced for sale (chay) is permitted to equal $30 per ton. in table 1 one sees that the best choice when calves are priced at $1,200 each is to produce 116 calves and 20 hay for sale. in table 2 ones sees that the best choice when calves are priced at $1,000 is to produces 3,200 tons of hay and no calves. in both scenarios, both tables, eva is found to be positive. table 1 higher prices for calves make it feasible to curtail hay production in favor of increased cattle production δ calves δ hay δ cows choice variables 116 0.00 116 eva contribution $1,200 $30 -$310 $103,240 constraints: used available land available 2.5 0.20 2.5 640 ≤ 640 ratio of cows to calves 1.0 0 -1.0 0 = 0 contribution per unit: per calf $1,200 per ton of hay $30 cost parameters: cost of one animal unit $2,500 cost of capital 10.00% volume 36, number 1 53 table 2 current prices for calves make it feasible to increase hay production δ calves δ hay δ cows decision variables 0 3,200 0 eva contribution $1,000 $30 -$310 $96,000 constraints: used available land available 2.5 0.20 2.5 640 ≤ 640 ratio of cows to calves 1.0 0 -1.0 0 = 0 contribution per unit: per calf $1,000 per ton of hay $30 cost parameters: cost of one animal unit $2,500 cost of capital 10.00% an option pricing model analysis in these two scenarios above one finds the spade generating positive eva as they respond to changing prices (contribution per unit). the spade is behaving in an optimal fashion in each of these scenarios. in one scenario as they optimize they choose to produce hay for sale and in the other as they optimize choose to produce yearling calves for sale. the existence of a fence provides for the flexibility to move from one optimum to another optimum. without the fence the spade cannot switch back and forth from hay production to cattle production. with the fence they can. given that the spade can create eva in two ways, by in some circumstances selling hay and in other circumstances by selling cows, this flexibility to switch back and forth between these two products has itself economic value. the decision of whether or not to create this flexibility by fence-building is the crux of this paper. what is the value of flexibility? if the fence costs less than the value of this flexibility then we build the fence, otherwise no. to see this consider the future value of flexibility. 54 journal of business strategies et is the uncertain future value at time period one of an option to increase the cattle herd size by an amount equal to δ calves + δ cows = 116 animal units, by giving up a quantity of hay production equal to δ (hay) = 3,200 tons. in this case equal to et = max [ 0, fv(δ calves + δ cows) – fv(δ hay) ]. this uncertain future value is the maximum of two future values, one associated with calf production and the other associated with hay production. in the circumstances when the choice to produce hay is optimum this future value is larger than the future value of the choice to produce calves, and vice versa. an option pricing model that estimates the present value of these possible future values is provided below. this model is a specialization of the work done by (margrabe, 1978). the present value of the option to take cattle production in exchange for hay production is equal to the value of flexibility that comes from the decision to build a fence. e0 = pv(δcows+δ calves )n(d1) pv(δ hay)n(d2) e0 is the present value of an option to increase the cattle herd size by an amount equal to δ (cows) = 116 animal units, by giving up a quantity of hay production equal to δ (hay) = 3,200 tons. pv (δ calves + δ cows) the present value of the spade ranch if cattle herd size increases by 116 animal units and if hay production does not increase, which is the result if the 640 acres to be fenced is devoted to cattle production instead of hay production. given this choice pv (δ calves + δ cows) is estimated to equal the value of the 640 acres to be fenced, $3,200,000 plus the value of 116 animal units, $290,000. this total equals $3,490,000. pv (δhay) is the present value of the spade ranch if hay production for sale increases by 3,200 tons and if cattle production does not increase, which is the result if the 640 acres to be fenced is devoted to hay production instead of cattle production. given this choice pv (δ hay) is estimated to equal the value of the 640 acres of land to be fenced, $3,200,000, plus the value of a 3,200 ton hay crop produced for sale from this 640 acres, which is equal to $576,000. this total equals $3,776,000. σδ2c the variance of possible (instantaneous) rates of return on the present value of the decision to change cattle herd size equal to δ calves + δ cows. in this paper σδ2c is assumed to equal 16 percent squared. σδ2h the variance of possible (instantaneous) rates of return on the present value of the decision to change hay production equal to δ hay. in this paper σδ2h is assumed to equal 16 percent squared. volume 36, number 1 55 ρ is the correlation coefficient measuring the possible (instantaneous) rates of return on the present values of the decisions to change both cattle and hay production. in this paper different values for this correlation coefficient are assumed in order to study the effect of changes in correlation on the option to increase cattle production by giving up an increase in hay production. σ2 = σδ2c + σδ2h 2ρ∆c,∆h σ∆c σ∆h and where σ2 is the variance of each possible (instantaneous) difference between the state-contingent rate of return on investment in cattle production and in hay production: σ2 = σδ2c + σδ2h 2ρ∆c,∆h σ∆c σ∆h and where a z number equal to d1 under a standardized normal density and where a z number equal to d2 under a standardized normal density 56 journal of business strategies in table 3 below a solution to the value of an option to exchange hay production for calf production is illustrated given certain parameter value assumption. table 3 inputs and solution: valuing the option to get cattle production by giving up hay production pv(∆c) $3,490,000 present value of cow/ calf investment pv(∆h) $3,776,000 present value of hay investment t 1 one year σ 2 0.01024 variance of difference of rates of return on hay and cattle investments when correlation equals 0.80 and both σ∆c and σ∆h equal 16 percent. σ 0.101193 standard deviation of difference of rates of return on hay and cattle investments when correlation equals 0.80 and both σ∆c and σ∆h equal 16 percent. d1 -0.72775 assumes correlation of returns equal to 0.80 and both σ∆c and σ∆h equal 16 percent. d2 -0.82895 assumes correlation of returns equal to 0.80 and both σ∆c and σ∆h equal 16 percent. n(d1 ) 0.23338 cumulative probability of a z number equal to d1 under a standardized normal density n(d2 ) 0.20357 cumulative probability of a z number equal to d2 under a standardized normal density e0 $45,834 the value of an option to increase cattle production by giving up an increase in hay production when correlation equals 0.80 and both σ∆c and σ∆h equal 16 percent. volume 36, number 1 57 in table 4 below students see that the correlation of possible rates of return on investment in hay production with those of investing in cattle production are decisive in determining the value of flexibility that is accorded by building a fence. ceteris paribus, if correlation could be reduced then the value of flexibility is enhanced. although not apparent from a reading of table 4 below, it is the case that the larger the volatility of possible rates of return on investment in hay production and also the larger the volatility of possible rates of return on investment in cattle production, the larger the value of flexibility to switch back and forth between hay production and calf production. table 4 correlation affects the value of the option to increase cattle production by giving up an increase in hay production correlation of returns option value 0.80 $ 45,834 0.40 $135,820 0 $203,786 -0.40 $260,395 -0.80 $209,859 also important are the parameter estimates that one does not have to make in order to value an option to exchange one asset for another. estimating expected rates of return on investment is not required when valuing flexibility. one does not have to estimate the expected return on investment in hay production, and one is not required to estimate the expected rate of return on investment in yearling calf production. both of these parameter estimates are irrelevant to estimating the value of flexibility. now to the question of the net present value (npv) of flexibility. the npv of the decision to build a fence that provides the flexibility of making optimal production choices in several different circumstances by switching back and forth between hay production and calf production as prices dictate, is equal to the option value less the cost of building the fence. a fence that lasts many years has a larger npv than a fence that costs the same amount of money but is not as durable. why? for each year the fence last, there is another option that is provided. so in this case, if the fence were to last for twenty years, to calculate the npv of building the fence, one would subtract the cost of building the fence from the values of twenty exchange options. 58 journal of business strategies references arrow, kenneth j. (1964). the role of securities in the optimal allocation of risk bearing. review of economic studies 31(2), april 1964. pp. 91-96. black, fisher, and myron scholes. (1973). the pricing of potions and corporate liabilities. journal of political economy may-june 1973. 81(3), pp. 637-654. breeden, douglas, and robert litzenberger. (1978). prices of state-contingent claims implicit in option prices. journal of business october 1978. 51(4), pp. 621-651. copeland, tom, and peter tufano. (2004). a real-world way to manage real options. harvard business review march 2004. 44(3), pp. 90-99. dantzig, george b. (1963). linear programming and extensions. princeton, new jersey: princeton university press. debreau, gerald. (1959). the theory of value. new york: john wiley & sons. fisher, irving. (1930). the theory of interest. new york: the macmillan co. margrabe, william (1978). the value of an option to exchange one asset for another. journal of finance march 1978. 33(1), pp. 177-186. merton, robert c. (1973). the theory of rational option pricing. bell journal of economics and management science spring 1973. 4(1), pp.143-181. stern, joel m. and john s. shiely with irwin ross (2001). the eva challenge. new york: john wiley & sons. brief biographical sketch of author garland (mark) simmons teaches business finance, financial statement analysis, and speculative markets to finance majors in the rusche college of business at stephen f. austin state university. his teaching and research are chiefly concerned with business decisions that can be approached with game-theory and linear programming or with pricing models that can be created and interrogated with logical methods of theorem and proof. his consulting work focuses on the construction and evaluation of equity and bond portfolios owned by foundations or trusts. the mysteries of forecasting paul herbig john milewicz james e. golden jacksonville state university jacksonville, alabama this paper reports the result of a study on american business forecasting, who does the forecasting, how often do they do forecasts, which areas are forecasted, what techniques are used, why they do it, and whether they are satisfied or dissatisfied with their forecasting efforts. we propose a set of hypotheses concerning forecasting behavior, provide results, provide conclusions, and make recommendations. introduction to forecasting woody hayes, the former ohio state football coach, when asked why he believed in the three yards and a pile of dust rushing attack replied, "because, when you pass the football three things can happen, two of which are bad." managers have the same dread of forecasting that woody had of the pass. three things can happen when one forecasts, two of which are bad: one can over forecast or one can under forecast. looking at forecasting at a time when they may need good forecasts more than ever, many managers are downplaying their importance. one reason may be that, like many other things, when forecasts are right, you don't hear about them. but when they're wrong.... forecasting is predicting, projecting, or estimating some future event or condition which is outside of an organization's control and provides a basis for managerial planning. organizations forecast so they can plan and help shape their future. forecasting is a crucial input for planning in almost all companies. in a recent survey of 175 companies, 92% of the respondents indicated that forecasting was important for their company's success (makridakis 1990). forecasts are a major component of the business decision-making process. when accurate, estimates of future economic activity associated with specific courses of action can correctly guide corporate strategy in an uncertain environment; when inaccurate, they can bankrupt. forecasting plays an important role in every major functional area of business management. more companies probably undertake some form of forward estimation of their markets and their sales than of any other aspect of their activities. the estimates produced may then be used in a variety of ways, such as in production planning, planning the sales force, setting advertising appropriations, estimating cash flow, assessing the need for innovation or diversification, and in considering the general position of the company in the future. in marketing, forecasting is doubly important; not only does it have a central role in marketing itself, but marketing-developed fore96 journal ofbusiness strategies vol. 10, no.2 casts play a key role in the planning of production, finance, and other corporate activities. forecasting techniques range from simple to complex. all arc intended to produce accurate, unbiased estimates of future activity in the presence of uncertainty. applications of forecasting techniques can be improved as the forecaster gains experience and sophistication; however, there is always a risk that the forecaster's experience, expectations and hopes, among other things, may also introduce bias and error. forecasting demand for new, complex, and rapidly changing high-technology products is particularly difficult, because of both limited experience and greater than usual number of unknowns. some useful generalizations about forecasting are as follows: 1. forecasts are almost always wrong. the only real question is, by how much? why then should one forecast bad numbers? a forecast is better than no forecast. in most businesses, a certain amount of error can be tolerated. this is called acceptable error, which varies from company to company, industry to industry. this variable depends on many factors including reaction time, size of company, and cost of an error to a company (jain 1990). 2. the time horizons of forecasting: the longer the time horizon of the forecasts, the greater the chance that established patterns and relationships will change, invalidating forecasts. specifically, the more time competitors have to react to predicted events or the predictions themselves, the more able they will be to influence future events for their own benefit. changes in the environment, including technology, competitors' strategy, buyer behavior, and government regulations, impact the long term. farther into the future that one forecasts, the more likely unexpected environmental changes will occur. many of these environmental changes cannot even be imagined for very long term predictions. if they cannot be imagined, they cannot be predicted and hence their effects on business can not be predicted either. thus, all else being equal, forecasting accuracy decreases as the time horizons increase. 3. technological change: the higher the rate of technological change in a given industry, all other things being equal, the greater the chance that established patterns and relationships will change, and the greater the chance that competitors will be able to influence the industry through technological innovation. an excellent example is high-tech industries, where forecasting is almost impossible as firms strive to create the future according to their own conceptions. by bringing out new technologies, they hope to shape the future in desired directions in order to achieve competitive advantage. thus, forecasting accuracy decreases as the rate of technological change increases. 4. barriers to entry: the lighter the barriers to entry, all other things being equal, the more inaccurate the forecasting, as new competitors (both domestic and foreign) can drastically change established patterns and relationships in their quest to gain competitive advantage. 5. dissemination of information: the faster the dissemination of information, all other things being equal, the less useful the value of forecasting, as everyone will have the same information and can arrive at similar predictions. in such a case it becomes fall 1993 herbig, milewicz & golden: the mysteries offorecasting 97 impossible to gain advantages from accurate forecasting, as everyone else will also attempt to do so. however, those large firms which can organize information and disseminate it quickly to critical employees, would seem to have an advantage over those smaller organizations unable to do so. 6. elasticity of demand: the more elastic the demand, all other things being equal, the less accurate the forecasts. thus, demand for necessities (for example, food items) can be predicted with a higher degree of accuracy than for non-necessities (such as vacationing). obviously, people must eat and acquire necessities, which are given priority over other purchases in case of income reduction, as during periods of recession. 7. consumer versus industrial products: forecasts for consumer products, all other things being equal, are more accurate than those for industrial products. industrial products are sold to a few customers. if only one of those customers is lost, the resulting error can represent a substantial proportion of sales, because of the large qualities, or sales value, such customers buy. those customers are well informed and can receive offers of bargain terms from competitors because of the large quantities or amounts they buy (makradaris 1988). 8. aggregate forecasts for families or groups of products are usually more accurate than item forecasts. this is true because the pattern of aggregate data does not change as rapidly as that of disaggregate (individual units). insurance companies can reasonably predict how many auto accidents will occur in the united states next year or how many men age 40-50 will die, but not the particular individuals affected. on aggregate forecasts, some of the errors tend to cancel out; overestimates of some products cancel out underestimates of other products. literature review examples of studies in the area of business forecasting policies and practices which have been done include those by: dalrymple (1975), dalrymple (1987), mentzer and cox (1984), wheelwright and clarke (1976), sparkes and mchugh (1984), rothe (1978), rush and page (1979), cerullo and avila (1975), pokemper and bailey (1970), pan, nichols, and joy (1977), mahmoud, et al. (1988), piercy (1989), mentzer (1988), alsen, et al. (1989), methews and diamantpoulous (1986), and wright (1988). these primarily have used only leading business firms, fortune 500 american finns. sample sizes have been relatively small. they predominantly used mail questionnaires. the studies have addressed many forecasting issues. they suggest that dissatisfaction seems oriented more towards quantitative methods (mentzer and cox 1984) than qualitative. one fifth of finns have tried and rejected quantitative methods, twice as many as other techniques (dalrymple 1987). most companies aim for accuracy of within plus or minus 10 percent but only about 2/3 of them achieved this goal (mahmoud 1984). the average error is 6.9% (dalrymple 1975). forecasts based on opinions of the sales force and corporate executives gave less accurate results than did other methods. quantitative techniques cost less and took less time (mabert 1975). quantitative 98 journal ofbusiness strategies vol. 10, no.2 methods provided better forecasts than judgmental methods (dalrymple 1975; cerullo and avila 1975). however, mahmoud (1984) indicated simple forecasting methods perform reasonably well in comparison to more sophisticated methods. businesses tended to use qualitative techniques for shorter forecast durations while objective quantitative techniques for longer term (over 2 years) (mentzer and cox 1984; dalrymple 1987). industrial concerns prefer sales force composite over consumer firms (dalrymple 1987). industrial firms have higher error rates than consumer oriented firms (7.65% on average versus 6.7%) (dalrymple 1975). larger firms reported smaller errors than smaller firms (dalrymple, 1987) which contradict previous results which indicate this did not vary inversely with the size of the firm (dalrymple 1975). sales forecasts are typically prepared annually (dalrymple 1975). the more people involved the more accurate the forecast (dalrymple 1975). the most popular techniques over the past twenty years have been the sales force composite and jury of executive opinion.1 the naive model2 was third in popularity (dalrymple 1987). forecasting accuracy can be improved by combining techniques (mahmoud 1984). the most commonly used types of forecast include three main qualitative techniques: the jury of executive opinion, sales force composite, and survey of buying intentions (customers)3 and several quantitative ones including trend analysis (regression) and market share analysis. the three qualitative techniques are the most commonly used by companies. all of these have their advantages and disadvantages and varying with the accuracy, costs, and lead time necessary, each has a particularly optimum usage in one or more situations. hypotheses based upon previous literature and generalizations from the forecasting literature, the following hypotheses appear reasonable: hypothesis 1: the larger the organization, the more likely it is to: a: use objective techniques rather than subjective processes. b: use quantitative forecasting processes rather than qualitative techniques. c: use greater number of techniques compared to smaller firms. d: have more people involved in the forecasting process. 1 sales force composite is a "bottoms up" technique whereupon the sales force is queried to provide forecasts which are then compiled at the regional and national level into one integrated forecast. jury of executive opinion is a "tops down" forecasting technique whereupon senior management of a firm compile the forecast for the firm. 2 naive model is where one uses the last period forecast (or results) as the forecast for this ~eriod without modification. the survey of buyer (or customer) intentions is simply to ask your customers what they think they will buy for the period being forecast. fall 1993 herbig, milewicz & golden: the mysteries offorecasting hypotheses (cant,) 99 e: forecast externalities and competitive forces. f: rate its forecasting process higher in importance and accuracy. hypothesis 2: the smaller the organization, the more likely it is to: a: have greater executive involvement than larger organizations. b: have greater use of simpler forecasting processes. c: provide quicker feedback or' results of the forecasting process. hypothesis 3: manufacturers will tend to: a: have fewer people involved in forecasting process than service-oriented firms. b: have less executive involvement than service-oriented firms. c: will tend to forecast more and rate more highly forecasts by productlbrand product life cycle, and product line than service-oriented firms. d: will tend to utilize more quantitative, complex, objective forecasting processes than service-oriented firms. e: should rate forecasting more important and have higher accuracy levels than service-oriented firms, f: should have longer duration of feedback between forecast and receiving results than do service-oriented firms, g: should have more iterations in the forecasting process than do service-oriented firms. hypothesis 4: industrial-product firms: a: should use jury of executive opinion and sales force composite to a much greater extent than consumer-product firms. b: should not be as quantitative, complex, or objective as consumer-product firms. c: should not rate as highly or forecast competition as heavily as consumer-product firms. d: should forecast industry trends, applications, and technologies to a much greater extent than do consumer-product firms. e: should not have as high of satisfaction or accuracy in their forecasting processes as do consumer-product firms. hypothesis 5: forecasting behavior should be different for worldwide-oriented firms than for domestic-focused firms. hypothesis 6: if forecasts are highly used in the managerial process than: a: higher satisfaction of the process should result. b: more executive involvement in the forecasting process should be seen, c: more forecasting techniques should be used and more comparisons made among techniques. methodology of the study data for this study was collected by mail survey with telephone follow-up to enhance sample size. a cover letter with university letterhead was utilized to provide 100 journal ofbusiness strategies vol. 10, no.2 legitimacy. the surveys were addressed to "forecasting/marketing" manager to guide it to the most relevant respondent within the company. 1000 surveys were mailed to a sample of functioning entities. this sample included a randomly chosen 200 each from leading 500 u.s. industrial concerns (business week), services 500 (fortune), the forbes top small businesses' list, the 500 largest u.s.-based multinationals (foreign headquarters) and 200 of the largest national non-profit/governmental affiliates. the sampling was randomized by selecting every nth listing. we varied the lists among the major three business periodicals (fortune, forbes, and business week) so as to eliminate any biases inherent in using just one. a second mailing (of 500) was made after 60 days. this mailing was to nonrespondents with particular attention paid to under-sampled types of firms. this was followed by a random phone survey of non-respondents after an additional thirty days so as to encourage their involvement in the survey and to check for respondent versus non-respondent bias. one hundred and sixty-five (165) responses were received, of which 150 were usable for a response rate of 15%. information of importance to this study was gathered via a 5 point bi-polar horizontal scale across eight dimensions. respondents were asked to rate the output of their forecasting process on the basis of its: (1) simplicity, (2) understandability, (3) ease of usage, (4) comprehensiveness, (5) effectiveness, (6) timeliness, (7) accuracy, and (8) overall satisfaction with the forecasting process. data were then analyzed by the use of factor analysis to assess whether each dimension assessed was indeed independent of the other dimensions. questions asked in the main body of the survey included who is involved in the preparation of forecasts for the surveyed company, type and frequency of forecast, importance and usage of forecasting techniques, uses of forecasted data within the company, number of iterations in the forecasting cycle, duration between forecast and availability of results, usage of more than one forecasting technique, a comparison of accuracy of forecast versus technique used, and who from a company is typically involved in the forecasting process. the questions were predominantly to be answered on a likert-type scale or by checking the appropriate box. several open-ended questions were also included which asked: what is the biggest outside influence and what information is found most useful, least useful, and which information of that surveyed should be examined in more detail. organizational profile information requested included type of business, customer type, geographic area served, number of employees, company revenues, number of offices or plants, years in business, and years of forecasting experience for individual being surveyed. results table 1 profiles the respondents. in general, manufacturers and service firms responded while the response rate from non-profits and governmental entities was negligible. a balance between industrial and consumer firms was noted. the majority of the firms surveyed indicated they marketed principally in north america (not fall 1993 herbig, milewicz & golden: the mysteries offorecasting 101 surprising a finding); however 45 firms indicated they were worldwide in their marketing efforts. a balance of small, medium and large firms was achieved as well as one between young firms and experienced firms. table 1: profile of survey respondents all industrial consumer mfgr service number respondents 150 55 75 71 64 size of firm: $ revenues < $10 million 10 5 2 3 6 $10-100 m 35 13 15 22 8 100-500 m 31 12 14 14 12 > $500 million 66 22 42 28 35 number of employees 1-100 small 8 7 1 2 6 100-500 mid 32 14 15 21 8 500-1000 med 15 1 9 9 3 1000-5000 large 41 17 20 18 20 >5000 very large 46 16 30 18 27 sites: officeslplants 1 (single site) 15 7 6 8 5 2-10 52 23 23 34 15 11-50 32 13 16 11 18 50-500 32 7 23 11 19 >500 12 5 7 5 7 years in operation for firm <10 15 5 8 8 5 10-40 51 23 25 26 22 40-100 55 19 30 23 28 >100 21 7 11 11 8 note 1: columns do not necessarily add up due to non-response note 2: differences between total sample and consumer-industrial firms; mfgr-service, are due to other categories not included. a factor analysis of eight questions was completed regarding how the respondent rated the output of the forecasting process. the eight concepts were effectiveness, ease of use, accuracy, simplicity, meaningfulness, timeliness, understandability, and satisfaction with the process. table 2 shows loadings. the factor analysis (principal components varimax rotation) performed on respondents' rating of their forecasting pro102 j oumal ofbusiness strategies vol. 10, no.2 cess produced two dominant dimensions. the two factors explain nearly 63% of the variance. factor one, "simplicity," consists of simplicity, understandability, and ease of usage. factor two, "usefulness," consists of meaningfulness, effectiveness, timeliness, accuracy, and satisfaction. it is important and interesting to note that satisfaction with the forecasting process clearly is related not to its ease of use but to the effectiveness and usefulness of the process as a whole. table 2: results of factor analysis variable factor 1 factor 2 factor 3 factor 4 simplicity *0.592 *0.463 0.340 -0.410 understandability -0.087 *0.870 -0.241 -0.005 ease of use -0.118 *0.852 -0.202 0.129 meaningfulness *0.845 0.052 0.176 0.062 effectiveness *0.846 -0.010 0.064 0.282 timeliness *0.561 -0.280 -0.359 -0.380 accuracy *0.747 0.053 -0.179 0.440 satisfaction *0.746 -0.023 0.133 -0.269 eigenvalues 3.096 1.918 0.733 0.679 % variance 38.69 23.97 9.1 8.4 explained table 3 discusses the summary of results for hypothesis 1; table 4 discusses the summary of results for hypothesis 2. it appears the larger the company, the more people involved; the larger the firm, the higher importance given and more often does the company use complex quantitative techniques; the larger the firm, the more objective it becomes in the forecasting process; the larger the firm, the more attuned and alert the firm is to external influences; the larger the firm, the more the firm tends to forecast facility needs; the larger the firm, the more the firm will tend to forecast by geographical region; and the more employees, the more complex the forecasting process tends to become. on the other hand, the smaller the company, the more executives which are involved in forecasting process. small firms tend to use more subjectivity in the forecasting process than either large firms or medium sized firms. smaller firms tend to rate their ease of use of the forecasting process and its results higher than do either medium or larger firms. although smaller firms have quicker turnaround between forecast and results received than do larger firms, mid-sized firms appear to have best and quickest results. similarly, medium-sized firms rate the importance and accuracy of forecasting by product line higher than smaller firms which in tum rate it higher than fall 1993 herbig, milewicz & golden: the mysteries offorecasting 103 large firms. likewise, medium-sized firms rated the importance and accuracy of forecasting by application higher than smaller firms and larger firms. table 3: summary of results: hypothesis 1 h la: the larger the firm the more objectivity (less personal subjectivity) exists in the forecasting process (f=5.872, p<.017). lb: the larger the firm, the higher the importance given and more often does the company use complex quantitative techniques (x2=7.62l; p<.029). 1c: the more employees a firm has, the more branches/offices a firm has, the more complex the forecasting process tends to become (x2=16.328; p<.01) (f=4.633, p<.008). ld: the larger the firm, the more people involved in the forecasting process (x2=24.971; p<.003). 1e. the larger the firm, the more employees a firm has, the more branches/ offices a firm has, the more the firm tends to forecast externalities (x2=9.298; p<.026); (x2=9.452; p<.030) (x2=lo.58l;p<.014). 1£: the longer a firm has been in business, the larger the firm the more confident it is of its forecasting system (x2=6.21; p<.039) (f=5.182, p<.023). 19: the more branches/offices a firm has, the more the firm tends to forecast competition (x2= lo.13lp<.018). table 4: summary of results for hypothesis 2 h 2a: the smaller the organization, the greater the executive involvement (x2= 12.787; p<.012). ***2b: the smaller the organization, the greater the ease of use of the forecasting process (f=3.388, p<.037). smaller firms do indicate greater ease of use than larger firms but medium sized firms significantly show higher than both. ***2c: the smaller the organization, the quicker the feedback of forecasting results (x2::: 12.64, p<.013). smaller firms do have quicker feedback than larger firms but once again medium sized firms respond quicker than either small or large firms. note: a * indicates non-significance of results; a ** indicates a contrary finding and *** indicates an interesting sidenote. table 5 summarizes the results from hypothesis 3. similarities between manufacturers and service-oriented firms were few. both groups reported similar interest and frequency in forecasting by customers, by applications, by geographical region, by competition, and by industry trends. both groups reported similar perceived levels of forecasting complexity, forecasting comprehensibility, forecasting meaningfulness, forecasting effectiveness, and forecasting accuracy in their forecasting processes. 104 journal ofbusiness strategies table 5: summary of hypothesis 3 results vol. 10, no.2 h 3a: manufacturers tend to have fewer employees involved in the forecasting process than do service-oriented firms (x2=11.933; p<.018). 3b: manufacturers tend to have less executive involvement in the forecasting process than do service-oriented firms (x2 =16.455; p<.039). ***3c: manufacturers tend to more extensively utilize, view as important (x2=28.879; p<.012), and estimate higher accuracy on forecasting by productlbrand (x2=14.536; p<.ool), product line (x2=7.259; p<.027), and product life cycle (x2= 18.729; p<.005). however, those service firms which do forecast by products, tend to rate their forecasting by product line to be more accurate than do manufacturers (x2=10.692; p<.030) as well as more frequent (x2=21.89; p<.ool). **3d: manufacturers do not tend to have more quantitative, complex, subjective (f=5.872; p<.0l6) forecasting techniques than do service-oriented firms. service finns tend to use more regularly the weighted moving average technique than do manufacturers (x2=17.040; p<.009). manufacturers tend to use more regularly the sales force composite forecasting technique (x2=14.601; p<.ool) and the jury of executive opinion forecasting technique (x2=31.182; p<.ool) than do service-oriented firms, both highly qualitative, subjective processes. 3e: manufacturers tend to rate higher importance to forecasting process than do service oriented firms (x2=4.077, p<.043). a significant difference exist between both groups in their rating of satisfaction (f=5,182, p<.023) as well as in the two groups' perception of ease of use (f=6.28, p<.0l5). service-oriented firms do rate their forecasting process as more accurate than do manufacturers (x2=13.234; p<.030). **3f: service firms do not have shorter duration of feedback between forecast and receiving results (x2=16.160; p<.013) but do rate their forecasting output as more timely than do manufacturers (x2=10.41o; p<.035). 3g: manufacturers do have more iterations in the forecasting process than do service-oriented firms (x2=21.42; p<.oll). several significant differences were found between manufacturers and service-oriented firms. manufacturers tended to have more iterations in the forecasting process and to provide quicker forecasting feedback of results to users of the forecast. they tend view sales force composite as the most important forecasting technique with jury of executive opinion as the second most important technique. they tend to use more frequently, and rate more highly, forecasts according to: product line, product life cycle analysis, and by product or brands. manufacturers tend to have a higher level of overall satisfaction with the forecasting process and to rate the forecasting process higher in its importance and relative level of accuracy than do service-oriented firms. nonetheless, contrasting to what was predicted, manufacturers do not tend to use more quantitative (objective) tcchniques in their forecasting process than do service-oriented finns. service-oriented firms, on the other hand, tend to have more people involved in the forecasting process with a higher percentage of executive involvement. they tend fall 1993 herbig, milewicz & golden: the mysteries offorecasting 105 to view weighted moving average as an important forecasting technique and be less likely to forecast by product line. although they rated their forecast output as more timely than do manufacturing firms, feedback to users tends to take longer. serviceoriented firms tended to use subjective forecasting processes to a much higher degree than manufacturers. whether related or not, service-oriented firms reported that their forecasting process tends to be more cumbersome, they are less satisfied with the output of the forecast process, and thus have a tendency to rate forecasting less important than do manufacturing firms. table 6 summarizes the results for hypothesis 4. we had expected to see great differences in the forecasting behavior between industrial-oriented firms and consumeroriented firms. this was not the case in that more similarities than differences were observed. we observed that the number of people involved and their levels within the company tend to be similar for both consumer-oriented firms and industrial-oriented firms. both groups indicated similar number of iterations in their forecasting process as well as a similar duration before feedback results were available to users. the level of subjectivity within the forecasting process and general overall level of satisfaction with the forecasting processes were similar. table 6: summary of results for hypothesis 4 h 4a: industrial oriented firms utilize sales force composite (x2=13.l9; p<.ool) and jury of executive opinion (x2=12.356; p<.002) forecasting techniques more often than do consumer-oriented firms. *4b: consumer-oriented firms do not tend to use more complex, quantitative, objective forecasting techniques than do industrial-oriented firms. no significant differences found in forecasting behavior. consumer oriented firms, however, do put much lower importance on exponential smoothing techniques than do industrial firms (x2::::7.474; p<.024). **4c: consumer-oriented firms tend not to forecast more often nor place higher importance on forecasting competition (x2=6.72; p<.035). *4d: industrial-oriented firms tend to forecast more often and place hi~her importance on forecasting industry trends (x2=9.819; p<.007), applications (x =6.643; p<.036), and technologies (x2=26.927; p<.ool) but not necessarily customers (not significant). *4e: consumer-oriented firms should have greater accuracy (x2:::: 7.893; p<.026) but not necessarily satisfaction (not-significant) in their forecasting process. however, several significant differences between the two groups were found. consumer-oriented firms believe their forecasting processes exhibit greater accuracy than do industrial firms. consumer-oriented firms put much lower importance on exponential smoothing. consumer-oriented firms do not use sales force composites as often as do industrial oriented firms. consumer firms do not competitively forecast nor do they forecast industry trends as often as do industrial firms. 106 journal ofbusiness strategies vol. 10, no.2 industrial-oriented firms, on the other hand, rated sales force composite much higher in importance and usage than did consumer firms. competitive forecasting is done more often and considered more important by industrial oriented firms than by consumer firms. forecasting industry trends tends to be more often used and more highly rated by industrial oriented firms than by consumer firms. industrial firms tend to forecast more by application than do consumer firms. industrial firms rated their forecasting process as more easier to understand than did consumer firms. the fifth hypothesis, forecasting behavior is different for worldwide-oriented firms than it is for domestic~focused firms, was tested by comparing self-report responses from firms who declared themselves north-american-focused and those declaring themselves worldwide-oriented in their geographic coverage. many similarities were found between the two groups. both groups reported similar number of iterations in the forecasting process and duration before results are available to users. both groups indicated the number of people involved and the levels of involvement were similar. agreement was also found in the forecasting techniques used and the importance of forecasting techniques in the forecasting process. several significant differences were found in forecasting behavior between the two groups. north american-focused firms tended to less frequently forecast by customers (x2=14.603; p<.002), by geographical region (x2=17.735; p<.ool), by product line (x2=9.460; p<.024), and by product or brands (x2=9.655; p<.022) than did worldwide-oriented firms. nonetheless, north american-focused firms tended to perceive greater accuracy in their forecasting of applications (x2= 12.328, p<.ool), products (x2=9.731; p<.027), and product lines (x2=3,587, p<.058) than did worldwide-oriented firms. worldwide-oriented firms, on the other hand, reported to have more complex and less easily understood forecasting processes. worldwide-oriented firms also report to have less meaningful (f=5.162, p<.007) and easy-to-use (f=3.469, p<.034) forecasting processes than do north american-focused firms. worldwide-oriented firms rated the importance and accuracy of forecasting competition much lower than do north american-focused firms. interestingly, worldwide-oriented firms indicate less effective (f=4.457, p<.013) and less timely forecasting processes than did north american-focused firms. also, paradoxically, north american-focused firms indicated their level of accuracy (x2= 6.137, p<.013) and satisfaction (f=3.493, p<.035) to be much higher than worldwide-oriented firms. finally, hypothesis 6 was also confirmed. the greater utilization in the managerial process for forecasting :rrocesses within a firm, the higher satisfaction there is with the forecasting process (x = 23.857; p<.ool). the greater utilization in the managerial process for forecasting processes within a firm, the more executive involvement within the forecasting process (x2=ll784; p<.ool). the greater utilization in the managerial process for forecasting processes within a firm, the more forecasting techniques are used and more comparisons among techniques (x2=10.704; p<.ool). fall 1993 herbig, milewicz & golden: the mysteries of forecasting conclusions and implications 107 the general implications of the exploratory forecasting study are a verification of previous results. prior research has noted that the sales force composite and jury of executive opinion techniques are predominant for industrial concerns. our findings indicate this preference can be extended as well to manufacturers over service-oriented firms. of new interest is the fact that products and brands appear to be still considered the domain of goods producers (manufacturers) as forecasts revolving around products-products, product line, product life cycles-still remain heavily and predominantly used by manufacturers and not service firms. this may indicate a weakness in service-oriented firms since they are not looking at their market in a product-by-product, brand way. interestingly enough, although more people are involved in the forecasting process and at higher levels for service-oriented firms, manufacturers tend to have more iterations, faster feedback, and more general satisfaction with the overall forecasting process than do service firms. this could be traced to the intangibility of the service firm's products and the difficulty in forecasting intangibles. this weakness could also be a source of potential for marketing firms wishing to do business with service entities. providing greater ease, accuracy, and utilitarianism to the forecasting process for service-oriented firms appears to be a highly demanded latent product. the most surprising finding was the high level of agreement in most questions between consumer product firms and industrial product firms. we would expect to see considerable contrast due to the different classes of customers. this, though, was not so. in virtually every other category, no differences between the groups were noted. even the factor analyses were nearly identical. perhaps, contrary to popular opinion, the two groups might be more similar in behavior than different, at least for forecasting. none of the industrial product firms predominantly used sales force composite and jury of executive opinion, confirming previous research. industrial product firms were found to use more often and value more highly forecasting by industrial trends, competitive analysis, and applications. consumer product firms believe their forecasting accuracy is higher than industrial firms, confirming previous research. another interesting and crucial finding is the fact that north american-focused firms do less forecasting by product/brand, product line, application, customers and geographical region than do worldwide-oriented firms. they also report greater confidence in forecasting accuracy for those items. north american-focused firms indicate greater feelings of meaningfulness, ease of use, effectiveness, satisfaction and importance for the forecasting process than worldwide-oriented firms. yet, as many a result shows, performance, in terms of competitive superiority, is the reverse. perhaps the arrogance that made many an american firm fall victim to aggressive international competition can also be seen in forecasting. less optimism and more realism might be more appropriate. if the north american-focused firms are actually doing a better job in the forecasting process, than there can be no excuse for being caught unprepared and surprised competitively. 108 journal ofbusiness strategies references vol. 10, no.2 alsem kj., p.s.h. leeflang and j.e. reuyl. 1989. "the forecasting accuracy of market share models using predicted values of competitive marketing behavior." international journal of research in marketing 6:3: 183-198. armstrong, j.s. 1985. long range forecasting: from crystal ball to computer. new york: john wiley & sons. ayres, robert u. 1989. "the future of technological forecasting." technological forecasting and social change 36 (august): 49-61. barnett, f. william. 1988. "four steps to forecast total market demand." harvard business review (july/august): 28-35. cerullo, michael j. and alfonso avila. 1975. "sales forecasting practices: a survey." managerial planning 24: 33-39. chambers, j.e., s.k mullick and d.d. smith. 1971. "how to choose the right forecasting technique." harvard business review 49 (july-august): 45-71. compton, joan callahan and stephen s. compton. 1990. successful business forecasting. blue ridge summit pa: liberty hall press. cox, jr., james e. 1989. "approaches for improving salespersons' forecast." industrial marketing management 18: 307-311. dalrymple, douglas j. 1975. "sales forecasting methods and accuracy." business horizons (december): 69-73. ~ 1987. "sales forecasting practices." international journal of forecasting 3: 380-391 davis, j. 1987. "techniques and marketing forecasting." management decision 25 (3): 62-71. einhorn, hillel j. and robin m. hogarth. 1982. "prediction, diagnosis, and causal thinking in forecasting." journal of forecasting 1: 23-36. evans, jonathan 51. 1982. "psychological pitfalls in forecasting." futures (august): 258-265. flores, benito e. and d.e. why bark. 1985. "forecasting laws for management." business horizons (july/august): 48-52. georgoff, david m. and robert g. murdick. 1986. "manager's guide to forecasting." harvard business review (januaryifebruary): 110-120. fall 1993 herbig, milewicz & golden: the mysteries of forecasting 109 gerstenfeld, a. 1971. "technological forecasting." journal of business 44:1 (january): 10-18. hogarth, robin m. and spyros makridakis. 1981. "forecasting & planning: an evaluation." management science 27: 115-138. jain, cl. 1990. "myths and realities of forecasting." the journal of business forecasting methods aijd systems 9 (fall): 18-22. kamakura, wagner a. and siva k. balasubramanian. 1987. "long term forecasting with innovation diffusion models: the impact of replacement purchases." journal of forecasting 6: 1-19. klopfenstein, bruce c 1989. "forecasting consumer adoption of information technology and services: lessons from home video forecasting." journal of the american society for information science 40 (january): 17-27. lewis, cd. 1982. industrial and business forecasting methods. london: butterworth scientific. lilien, gary l. 1987. "business marketing: present and future." industrial marketing and purchasing (uk). 2:3: 3-21. mabert, v.a. 1978. "forecast modifications based upon residual analysis." decision sciences 9:2 (april): 285-296. mahmoud, essam. 1984. "accuracy in forecasting: a survey." journal of forecasting 3: 139159. mahmoud, e., g. rice and n. malholtra. 1988. "emerging issues in sales forecasting and decision support systems." journal of the academy of marketing science 16:3/4 (fall): 4761. makridakis, spyros g. 1990. forecasting: planning and strategy for the 21st century. new york: free press. ~ and steven c wheelwright. 1977. "forecasting: issues and challenges for marketing management." journal of marketing (october): 24-37. mathews, b.p. and diamantopoulos. 1986. "managerial intervention in forecasting. an empirical investigation of forecast manipulation." international journal of research in marketing 3:1: 3-10. mclaughlin, robert l. 1983. "forecasting models: sophisicated or naive?" journal of forecasting 2: 274-276. mentzer, j.t. and j.e. cox, jr. 1984. "familiarity, application, and performance of sales forecasting techniques." journal of forecasting 3: 27-36. 110 journal ofbusiness strategies vol. 10, no.2 mentzer j.t. 1988. "forecasting with adaptive extended exponential smoothing." journal of the academy of marketing science 16:3/4 (fall): 62-70. mesak, hi and william mikhail. 1988. "prelaunch sales forecasting of a new industrial product." omega 16:1: 41-51. pan, judy, nichols, d.r. and o.m. joy. 1977. "sales forecasting practices of large us industrial firms." financial management 6:3: 72-77. piercy, n.f. 1989. "the power and politics of sales forecasting: uncertainty absorption and the power of the marketing department." journal of the academy of marketing science 17:2 (spring): 109-120. pokemper, stanley j. and e. bailey. 1970. "sales forecasting practices." the conference board, new york. prigogine, liya. 1989. "the philosophy of instability." futures 21 (august): 396-401. reilly, robert f. 1980. "developing a sales forecasting system." managerial planning (july/ august): 24-26. richter, jake. 1988. "forecasting firms, please come down to earth." pc week 5 (october): 57. rothe, james t. 1978. "effectiveness of sales forecasting methods." industrial marketing management 7: 114-118. sales management. 1987. "sales forecasting: is five percent error good enough?" (december): 41-48. schnaars, steven p. 1984. "situational factors affecting forecast accuracy." journal of marketing research 21 (august): 290-298. __________. 1987. "the use of multiple scenarios in sales forecasting." the international journal of forecasting 3: 405-419. __________. 1989. megamistakes. new york: free press. _________. 1989. "where forecasters go wrong." across the board 26 (december): 38-43. sparkes, john r. and ak. mchugh. 1984. "awareness and use of forecasting techniques in british industry." journal of forecasting 3: 37-42. tersine, richard j. 1980. "logic for the future: the forecasting function." managerial planning (march/april): 32-36. fall 1993 herbig, milewicz & golden: the mysteries offorecasting 111 tyebjee, tyzoon t. 1987. "behavioral biases in new product forecasting." international journal of forecasting 3: 393-404. wheeler, david r. and charles j.shelley. 1987. "toward more realistic forecasts for hightechnology products." journal of business and industrial marketing 2:3: 55-63. wheelwright, s.c. and d. clarke. 1976. "corporate forecasting: promise and reality." harvard business review (novemberldecember). wright d.j. 1988. "decision support oriented sales forecasting methods." journal of the academy of marketing science 16:3/4 (fall): 71-78. the mysteries of forecasting the strategic flexibility of interest rate swaps russ ray school of business the university of louisville louisville, kentucky the purpose of this article is to articulate a new and remarkably powerful financial tool which affords firms a previously unavailable degree of financial flexibility. interest rate swaps-an exchange of interest-rate payments between two parties without an exchange of the underlying debt-were developed in the 1980's and are already approaching $200 billion in annual volume. swap applications include: decreasing borrowing costs; increasing asset yields; altering asset and liability structures; changing borrowing indices; and managing basis risk. this article demonstrates these applications and thereby articulates the strategic and tactical flexibility effected by utilizing interest rate swaps. arranging swap agreements swap agreements are easily arranged by intermediaries-mostly commercial and investment bankers-who match up parties needing one or more of the services discussed below. frequently, the intermediating bank will match up parties anonymously, so that the opposite parties to a swap agreement remain unknown to each other and deal only with the respective bank. swap agreements are virtually risk-free, because if one party defaults on an interest-rate payment to a second party, the second party simply stops payment to the first party. if an intermediary bank is used (as is usually the case), the bank will only swap payments once both payments have been made. thus, default risk is mechanically precluded. besides specifying the dollar amounts and due dates of the payment, the swap contract typically specifies the length of the agreement, the method and provisions for terminating the contract, and any other such information deemed pertinent to the execution of the contract. swap agreements are legally binding agreements. although the swap market is usually a market for wholesale money (say, for transactions of $1 million and up), some banks will intermediate for lesser amounts. a firm interested in swaps should contact its bank to determine the benefit/cost feasibility of using swaps. typically, the intermediating bank will charge each party a fee of about 1/8 to 1/5 percent of the amount being journal of business strategies, volume 5, number 1 (spring 1988) 40 swapped, depending upon the dollar volume. as this market evolves, freemarket competition will probably reduce bank fees even further. some typical swap applications one of the most common applications of swaps is to lower a firm's borrowing rate. typically, a smaller, less creditworthy firm enters into a swap agreement with a larger, more established firm, with the result being that both firms reduce their borrowing costs. consider two firms: an aaa-rated firm which can borrow short-term on a floating-rate basis at 7%, and long-term on a fixed-rate basis at 9%; and an a-rated firm which can borrow short-term (floating rate) at 8%, and long-term (fixed rate) at 12%. suppose the aaa-rated firm needs short-term, floating rate funds, 8.ild the a-rated firm needs long-term, fixed-rate funds. each firm can obtain its funds more cheaply by entering into an interest rate swap with the other firm. (see figure 1) figure 1 how interest rate swaps lower borrowing costs a corp. --------->aaa corp. 1. st borrowing rate = 8% 2. lt borrowing rate = 12% 3. desires lt fun ding 1. st borrowing rate = 7% 2. lt borrowing rate = 9% 3. desires st funding aaa corp's cost of st funding = 6~% (9~% 9%) = 6% a corp's cost of lt funding = 9l% + (8% 6l%) = 11% the aaa-rated firm could borrow $x long-term at 9%, and the a-rated firm could borrow $x short-term at 8%. the two firms could then enter into a swap agreement whereby the aaa-rated firm agrees to pay 6~170 to the a-rated firm on a short-term basis, and the a-rated firm agrees to pay 9~170 to the aaa-rated firm on a long-term basis. the result is that each firm obtained its desired type of funding more cheaply than it otherwise could have. the aaa-rll.ted firm is effectively paying 6% for short-term, floating rate money (6% = 6!170 l%); 8.ild the a-rated firm is effectively paying 11% for long-term, fixed rate money (11% = 9~% + 1~%). thus, before bank fees, each firm obtained its desired funding at 100 basis points 41 less than it otherwise could have. after bank fees of 1/8 to 1/5 percent, each firm will obtain its funding at 80 to 87 ~ basis points less than otherwise would have been possible. for large sums of money, such a reduction in borrowing rates translates into significant savings. this example also exemplifies another common application of interest rate swaps; transforming variable-rate loans into fixed-rate loans, and vice versa. h the hypothetical loans in the example above had already been on the books of the two firms, then a swap agreement would have effectively exchanged loans between the two firms. notice that the aaa-rated firm effectively transformed its fixed-rate loan into a variable-rate loan, and the a-rated firm effectively transformed its variable-rate loan into a fixed-rate loan. the ability to quickly and easily transform loans from variable to fixed-rate (or vice versa) gives a firm a tremendous degree of flexibility 8jld protection, especially during periods of volatile interest rates. instead of exchanging the interest payments on debt, these two firms could have just as easily exchanged the interest receipts on interest-bearing assets. the result of 8jl income exchange is twofold: 1) to increase the yield or assets; and, 2) to change variable-rate assets into fixed-rate assets (or vice versa). other applications of interest rate swaps include: unlocking high-coupon debt, changing borrowing indices, 8jld closing balance-sheet gaps. the principle of comparative advantage interest rate swaps are nothing more than a modern-day application of the principle of comparative advantage, first derived by the economist david ricardo to explain international trade. in the example above, the aaa-rated firm has an absolute advantage of borrowing in both the short-term 8jld the long-term markets, but it has a comparative advantage in the long-term market. therefore, it behooves both firms for the aaa-rated firm to borrow in the long-term market 8jld the a-rated firm to borrow in the short-term market, 8jld to thereafter trade interest payments. the spread differential of 2% (3% longterm differential, less 1% short-term differential) represents the total savings tesultingfrom 8jl interest rate swap. in this example, the savings were divided evenly, although they could have been divided in 8jly manner summing to 2%. in general, 8jly time two firms have differing borrowing costs in the money 8jld capital markets, both firms can economically benefit from 8jl interest rate swap. the same holds true with respect to assets as long as a spread differential exists. the benefits accruing to two parties engaging in 8jl interest rate swap are the domestic 8jlalogue of the benefits accruing to two countries engaged in international trade. 42 conclusion interest rate swaps are a new, innovative, and remarkably powerful finanda.! tool, the market for which is growing rapidly. the technique affords firms a previously unavailable degree of flexibility in their financial planning and in their financially adapting to environmental circumstances. because swaps are based upon the principle of comparative advantage, they will likely become a permanent financial practice, perhaps listed and traded on major exchanges. references 1. arnold, t. "how to do interest rate swaps." ham/am business review, vol. 62 (september/october 1984), pp. 96-101. 2. bicksler, j. and chan, a. "an economic analysis of interest rate swaps." journal of finance, vol. 61 (july 1986), pp. 645-655. 3. lereah, d. "the growth of interest rate swaps." bankers magazine, may/june 1986, pp. 36-41. 4. walmsley, j. "interest rate swaps: the hinge between money and capital markets." the banker, april 1985, pp. 37-40. 5. walmsley, j. "understanding interest rate swaps." bankers magazine, july/ august 1984, pp. 44-47. 6. wishon, k. and chevalier, l. "interest rate swaps-your rate or mine?" journal of accountancy, vol. 63 (september 1985), pp. 63-84. 43 the strategic flexibility of interest rate swaps new concepts for the management of information resources walter r. kendall university of north colorado greeley, colorado c. richard scott radford university radford, virginia charles j. capps iii sam houston state university huntsville, texas successful mangers of the future are likely to be well~informed opportunists who use information strategically and have the flexibility to respond to opportunities. the success of these managers will be determined by their ability to combine the right information with the right opportunities. information strategy is increasing in importance and will assist firms in building a competitive edge. information has always been at the heart of organizations. while always vital, the increasing availability of various types of information has led to its growing organizational importance. only within the last few years has the availability of information become such that managers have been able to obtain it at the time and place when they need it. although much information has to be sifted to identify key information which is timely and complete, those managers that have it and know how to use it achieve a form of leverage over competing firms which do not possess similar information. utilizing that latest and best information for aggressive management is prudent, if not imperative, in view of today's realities. given the importance of information, it is critical for an organization not to lag behind competitors in the development and utilization of information resources. often, it takes years of lead time to develop an efficient information resource. for a lagging competitor, the race is likely over about the time this critical distinction sets in. the importance of organizational information is not going to lessen over time. as more firms think competitively, their attitudes toward information must change. they must come to think of information as a strategic asset an asset that becomes the enabler of their business plans. the economic gap between those which do and do not possess and employ information resources effectively will likely widen appreciably in the 1990s and beyond. only those managers who best understand this impact and direct their organizational resources in such a way as to best utilize information as a productive asset are likely to survive in an increasingly competitive global environment. journal of business strategies, volume 7, number 1 (spring 1990) 25 26 journal of business strategies vol. 7, no.1 the trust of this article is twofold. first, it is advocated that information should be added to the list of the traditionally accepted factors of production. second, an information protection decision model coupled with a classification scheme based on the economic value of differing types of information to the firm is presented. information as a factor of production incorporating information as a strategic corporate resource means managing a dynamic balance between the conceptual thinking of economists and managers. economists have generally grouped productive factors into three broad categories: land, labor and capital. these factors have been viewed as the necessary inputs to any productive process. land had been used to represent the input of raw materials which are derived as "gifts of nature;" labor the efforts of man; and, capital the input of man-made resources, such as machinery. usually, money is added to the process as a means of facilitating trade, thereby providing some common denominator for valuation between the inputs and the output of the firm. these inputs, or factors of production, have generally been viewed as substitutes for one another, tradiitionally assumed to be substitutable for one another at some diminishing rate of return. thus, the use of labor could be increased and substituted for inputs of capital or land. due to the scarcity of these inputs, however, a continual increase in the amount of labor applied to a productive process (while land and capital remain fixed) result in less and less output per unit of labor added. even if labor were extremely cheap, diminishing returns will eventually be reached where further increases in output can only be obtained by increasing the input quantities of land or capital. a primary concern of theoretical economists and practicing managers is the optimal allocation of resources under their control. they are concerned with producing the highest possible level of output (utility) given the productive resources available. this translates into using the firm's factor endowments in the most efficient way possible finding the best fit of input combinations to accomplish the productive task. information inputs which enhanced the productive process are a key organizational resource, and as such should be viewed as a factor of production. management theorists have extended the list of factors of production that was originated by economists. many management scholars subscribe to the ideas of frederick w. taylor [4j. that is, they accept the proposition that management makes a unique contribution to the productive process. as a result, they contemporarily include management talent or entrepreneurial ability as a fourth basic factor of production, in addition to land, labor, and capital. this additional factor is usually defined in terms of the professional managerial skills and the necessary risk-taking that is involved with innovation and ownership of a successful business enterprise. thus, managers would list land, labor, capital, and management or entrepreneurial ability as the factors of production which are under their control. the inclusion of information as a productive input should not entail as great a conceptual leap for managers as for economists. as land, labor, and capital are all spring 1990 kendall, scott & capps: information 27 tangible inputs, it is easy for both economists and managers to recognize their value to the productive process. management and entrepreneurial ability are far less tangible and are, therefore, more difficult to evaluate. but, because managers have already accepted management and entrepreneurial ability (relatively intangible factors), they should be more open to the concept of information as a productive input. information however, possesses special characteristics which makes it unique. it is these special characteristics which should be understood if information is to be utilized and handled properly in the context of a factor of production. the special nature of information information is unlike any of the other productive inputs in many important aspects. these differences cause the need for decision-makers to re-evaluate the way in which productive factors are combined to produce goods and services. there may also be an impact on those that own the other factors of production, since the way in which the other inputs are allocated may be greatly altered as information use, flows, and values are altered. some of the salient characteristics of information are outlined in an article by harlan cleveland in the futurist ([1], pp. 34-39). we have drawn on cleveland's work, but have expanded and modified his thoughts. these extensions represent an effort to develop a framework to better guide managerial thought with regard to the nature, use, abuse, and safeguarding of information within the corporate environment. within this expanded framework, information is viewed as simultaneously expansible, compressible, substitutional, transportable, shareable, and diffusive. these unique features of information are discussed below. information is expansible most information tends to expand with use. thus, as information is used, even more is generated. on the surface, this attribute may seem to be of little consequence. however, when the idea is applied to the efficient use of productive inputs, the special nature of information as a factor of production may be seen. all of the other factors· of production are viewed as being scarce that is, there is a limited supply of these inputs at any point in time. moreover, few of the traditional resources are selfrenewing, much less self-generating. if information expands with use, it must not be viewed as being a scarce input, but rather an input of potential glut. the only limits on the use of information would be the capacity of users to analyze, store, and retrieve it. however, even the limitation of analytical ability may diminish as artificial intelligence is further developed. the non-scarce nature of information must bring about a re-thinking of the dimensions associated with the calculus of utility maximization and cost minimization. information is compressible it is possible to concentrate, integrate, or summarize vast amounts of information for easier handling. through the selection and compression of information into 28 journal of business strategies vol. 7, no.1 knowledge and wisdom, some of it is necessarily lost. the compression process, while necessary, is also a potential source of error, for the compression process eliminates information which may ultimately be needed. managers must familiarize themselves as to the value of their information holdings (just as they know the worth of their tangible assets) in order to be able to distinguish the important from the trivial and preserve that which is needed. further, managers must be able to retrieve previouslydiscarded information should it become viably important to the firm. information is substitutional the evolution of the mental process which allows managers to think of information as a factor of production will also cause them to grasp the idea that information can be substituted for land, labor, capital, entrepreneurial ability and management. in many cases, managers will come to the realization that information can be substituted for those other, often more expensive and less substitutional, factors of production. for instance, when the other resources are used more efficiently (i.e., less of the resource is used due to the input of new information), the net result will be a substitution of information for other factors in the productive process. information is transportable using telecommunications technology, information can be transported at the speed of light! thus, is provides a lightning response time for decisions. also, information movement can be a strategic competitive tool in that its ease of movement does well what physical distribution often does poorly. with information, managers are not faced with the problem of physical transportability associated with the other factors of production. while some cost is involved in the "transportation" of information, its speed and lack of physical bulk should keep this cost relatively low. information is shareable the premise that information can be easily shared should cause a change in managerial thought. with information, managers must not think in terms of traditional exchange transactions, where one party gives up something of value in exchange for something else of value. information is shareable. that is, i may give information to you without losing it myself. for example, if information is shared, we both have it my stock is not diminished because yours is increased. in fact, the same information can be sold, bartered, or otherwise exchanged. information is diffusive information tends to leak. it is difficult to contain information as one would think of containing a physical object. because information lends itself to diffusion, the issues of secrecy, property rights, and confidentiality are potentially called into question. however, since information is easily transported, potential unauthorized, as well as authorized, users can have ready access to it. therefore, processes must be established to deny or limit the pilferage of information by persons or organizations spring 1990 kendall, scott fj capps: information 29 which the owner wishes to restrict from access. that is, ways must be found to secure stocks of information much in the same manncr as the other factors of production, but these methods must not be overly restrictive in its legitimate transportation. policies which are aimed at the husbanding of the other factors of production have been given considerable attention by prudent strategic managers. for example: personnel policies exist in an effort to retain and further develop an organization's l<human capital." warehouses are built to house the inventories of a firm's raw materials, finished goods, and other property. extensive procedures have been developed to limit pilferage of these resources. elaborate investment models and programs have been developed to protect the capital investment of the firm. it does appear, however, that the development of models which could help managers formulate plans and procedures for the protection of the firm's information resource are in a state of relative infancy. because of the special nature of information, the models which have been developed for the protection of a firm '5 other resources are generally not directly applicable. safeguarding the information source many of the aspects which make information unique among the factors of production necessarily lead to the conclusion that information is relatively difficult to safeguard. this conclusion is supported by the current legal turmoil surrounding the meaning, application, and enforcement of copyright laws regarding modern forms of intellectual property, such as computer software. it is simply not an easy task to protect the intellectual property of a firm, whatever form it may take. while corporations would like to be able to build a protective wall around their intellectual property, much as a fence is built around a factory or a stockpile of coal, the intangibility of intellectual property makes the task futile. to date, no one had developed a truly effective safeguard against the "leakage" of information. does this mean that managers should not try to safeguard information? quite the contrary! however, two facts should be borne in mind. first, it is not presently possible to totally prevent information leakage. therefore, managers must factor the costs of leakage into their planning process by realizing that any information advantage is likely to be compromised. second, managers should be aware that not all information is worth protecting. this realization calls for a conscious managerial decision to identify when the information possessed by the firm possesses sufficient value to warrant the expense and effort involved in attempting to safeguard it. to help managers decide which information is worth protecting, a bi-polar model of information value is presented in figure 1. the proprietary nature of information is plotted along the horizontal axis of the model. ubiquitous information is defined to include that information which is readily available to anyone. propriety information, on the other hand, is defined to include that information which was generated specifically for use by the firm (usually at considerable expense and effort). ubiquitous information lies at the right extreme of the horizontal axis, while proprietary information anchors the right side of this axis. values of the information to the firm 30 journal of business strategies vol. 7, no.1 are measured vertically. the left vertical axis represents the value of the information to the firm or the estimated cost of gathering it. alternately, the right vertical axis represents either the value of information to the firm's competitors or the value of safeguarding information. notice that the scales of value are reversed on the two vertical axes. figure 1 the information protection decision model high low expense of gathering or value to the firm low ubiquitous economic value of information proprietary value to competitors or value of safeguarding high there are two relationships shown in figure 1. the first is the relationship between the value of information to the firm or the cost of gathering it and the nature of information plotted on a continuum from ubiquitous to proprietary. thus, the higher the value of information to the firm or the cost of gathering it, the more proprietary the information becomes. the second relationship is between the value of information to competitors, or the expense of safeguarding, and the nature of information. this relationship lies on the ubiquitous-proprietary continuum. here, also, the higher its value to competitors or value of safeguarding, the more proprietary the information becomes. figure 1 depicts these two relationships as being linear for illustrative convenience only indeed, it is very probable that they are not. in order for managers to reach decisions as to which information they should attempt to safeguard, they must operationalize the relationships described above and presented in figure 1. this will necessarily entail the assignment of dollar values to the variables described on the vertical axes. thus, any time that the dollar value of information gathering, or the dollar value of the information to the firm, exceeds the dollar value to competitors or the dollar value of safeguarding the information, it becomes worthwhile for management to spend any amount up to this difference to safeguard their information. thus, the vertical distance between the two functions shown in figure 1 represents the dollar amount that management should be willing to spend to safeguard information. this difference will be referred to as the "economic value of information to the firm." operationalization of the information protection decision model can help managers in two ways. first, it assists managers in separating information which should spring 1990 kendall, scott & capps: information 31 and which should not be protected. second, managers will realize that from an economic standpoint, a large portion of the information which is possessed by the firm is not worth protecting. in actual use the model presented in figure 1 may be unwieldy for many firms. therefore, to simplify the process, items of information may be classified into one of the four categories depicted in figure 2. the military and many corporations have classified their important information for many years. however, many of these classification schemes have not been economically-based. the key requirement that must be met within the author's classification scheme is that items of information be classified solely on the basis of its economic value to the firm. information may therefore be classified as platinum, gold, silver, or bronze, as illustrated in figure 2. figure 2 classification of information based on its economic value to the firm high expense of gathering or value to the firm low bronze ubiquitous silver gold platinum low value to competitors or value of safeguarding high proprietary the classification scheme which is presented in figure 2 allows managers to treat the various classes of information separately with regard to the expenditure of funds for the safeguarding of each class of information. obviously, platinum information has the highest economic value to the firm, and every effort should be made to safeguard it from unwarranted diffusion. at the other extreme, bronze information is of little economic consequence to the firm. due to its low economic value of information to the firm, such information may be handled casually with little, if any, expenditure or effort being made to safeguard it. implications managers must adjust to this new way of thinking and recognize that information is one of its important productive inputs. depending on its economic value to the firm, information may require protection as a potential marketable output of the organization. in making their adjustment, managers will also have to reconsider the nature of the managerial process. thinking of information as a peripheral activity, 32 journal of business strategies vol. 7, no.1 often relegated to a staff slot, is no longer viable. information gathering, processing, and dissemination is fast becoming a key activity of many organizations. the more traditional functional activities, such as finance, marketing, and manufacturing, are shifting in importance as the global information-based society grows. the cloistered nature of the information function is certainly fading as it is being reshaped by both user needs and corporate realities. in this context, greater strides must be made in establishing uniform protocols allowing for the total integration of information into the organizational structure. the past privileged status and attendant mobility of "computer experts" is proving perishable with the explosion of information technology and the growth of computer literacy among more and more managers. out of necessity, information managers will have to move toward a way of thinking which places them more in tune with the reality of new organization structures. the day may be at hand when top level managers will no longer place control of such valuable corporate assets in the hands of a "computer expert" who may have little knowledge or understanding of the strategic implications regarding the operations of the organization. this is not an easy change. it necessitates a remodeling of the firm a remodeling to a vastly different conceptual model which recognizes today's realities. as edwards suggests, "... it's becoming clear that the successful organizations will be the ones which manage information most effectively." ([2]' p. 125) a study by feldon indicates that organizations with" ... formal business and systems plans and programs to plan, organize, monitor, and control the[ir] information resources outperformed [other firms] by 300 percent." ([3], p. 18) feldon also underscores that firms which effectively utilize their information resources can leverage their other factors of production to financially outperform their competitors. other questions regarding the use of information as a productive input should be addressed. for example, if information can supplant the other factors, what will happen to the value of the other factors? if their demand is lessened, their worth as productive assets is likely to be cheapened. since the united states is considerably better endowed than many nations with generous amounts of land, labor, capital, management and entrepreneurship than many other nations yet, is on par with, or perhaps behind, many other nations in terms of information resources will the u. s. economy be weakened in head-to-head competition in the world market? as the value and use of information in the productive process increases, smart managers should strive to retain or increase the value of other productive assets. these managers will weave information into the fabric of their production function. this new fabric should possess a symbiotic result, wherein all factors, including information, collectively operate to produce more efficiently, while increasing in value. conclusions the many unique aspects information must be recognized as it becomes more important as a factor of production, along with land, labor, capital, and management or entrepreneurial ability. some changes in managerial thinking are called for, especially spring 1990 kendall, scott f1 capps: information 33 with regard to the safeguarding of information as a corporate asset. any dislocations, however, can be minimized through planning and adjustment of conceptual models to take into account the growing importance of organizational information. based on a recognition of information as a major factor of production, managers at all organizational levels, but under the impetus of top management, must formulate and implement a new organizational model which recognizes the implications and the unique characteristics of information: expansibility, compressibility, substitutability, transportability, its diffusive nature, shareability, and recognition as to which information requires safeguarding. this mental revolution, similar to that which was called for earlier this century when taylor proposed that management be viewed as a separate factor of production, should result in a new way of thinking about the nature of organizations, the purposes which they serve in the economy, and the manner which they serve in society as a whole. furthermore, this new strategic vision about the role of information must be woven into the fabric of the organization and not just a passing fancy. those managers which recognize that information is a productive factor on a global scale and subsequently take action to alter their conceptual models will be in the best position to take advantage of the potential opportunities that are a by-product of this change. the firms that seize this opportunity to renew themselves are likely to prosper and lead the way into the twenty-first century. references 1. cleveland, harlan. "information as a resource," the futurist, vol. 16 (december 1982), pp. 34-39. 2. edwards, morris. "information wars: where east meets west," infosystems, vol. 29 (september 1982), p. 125. 3. feldon, o. a. "irm and the bottom line," infosystems, vol. 28 (october 1981), p.18. 4. taylor, federick w. the principles of scientific management. new york: w. w. norton co., inc. (1911). new concepts for the management of information resources psychological antecedents of work role perceptions: business founders and managers richard m. castaldi san francisco state university san francisco, california kenneth e. marino san diego state university san diego, california one tradition of entrepreneurial research has as its focus the evaluation of factors that influence entrepreneurial careers. the factors identified can be classified into three categories: 1. psychological factors, such as need achievement [27] and control beliefs [37] j 2. personal factors, such as exposure to entrepreneurial role models [7] and previous work experiences [40]; and 3. environmental factors, such as capital availability [8] and skill level of the local labor market [13]. this article is intended to extend the literature on the psychological characteristics of entrepreneurs beyond its traditional focus. the thrust of that line of inquiry has been to identify the characteristics which people who pursue an entrepreneurial venture from those that engage in other forms of enterprise. much less attention has been directed toward understanding how these psychological factors affect the managerial behavior of entrepreneurs as they operate their ventures after the start-up phase. it will be argued here that the psychological makeup that prompted the founding of a business also has a predictable affect on the work roles that are emphasized in the management of the firm. first, prior research on the psychological factors associated with entrepreneurs and the research on managerial work roles are reviewed. second, our method and data describing the differences in work role perceptions among a group of business founders and a group of business managers are presented. finally, those differences are discussed in light of the well-documented psychological differences between the two groups. prior research research on the psychology of entrepreneurs mill [28] has been credited with bringing the term entrepreneur to general use. inherent in his definition was the notion of risk-taking behavior as a characteristic which journal of business strategies, volume 7, number 1 (spring 1990) 54 spring 1990 castaldi fj marino: perceptions 55 separated entrepreneurs from the general population. schumpeter [39] brought the concepts of innovation and creativity to early attempts at defining the entrepreneur. while these and other early writers clearly had psychological traits in mind, it is the work of mcclelland ([26j, [27]) which provided direction and rigor to this line of research. today, the two most widely-recognized psychological characteristics of entrepreneur! are need for achievement and locus of control beliefs. mcclelland's early work established the need achievement construct as an important component of the psychological set of the entrepreneur. high achievement 'need is associated with a desire to possess personal responsibility for problem solving and the desire to reach goals through individual effort. such individuals also have a strong desire to know how they are performing on the tasks they have chosen. rotter's work [37j similarly established and stimulated research on the locus of control construct. entrepreneurs exhibit an internal belief in the locus of control. that is, they believe that they can influence the events in their lives and the rewards they obtain. the external, on the other hand, attributes much of what occurs to luck, fate, and other such forces outside an individual's control. this construct has been employed in a variety of studies, with results indicating that internals are more satisfied with work, show greater motivation, performed better under stressful conditions, and were more innovative ([18j, [29j, [38], [48]). further, a series of studies have confirmed that entrepreneurs hold internal locus of control beliefs ([2], [22j, [35]). while these are accepted components of the entrepreneur's psychological set, it is important to view them as antecedents to the entrepreneur's approach to managerial work. in this study, differences in the perceived importance of various managerial work roles between ceos who are owner-managers and ceos who are nonownermanagers are evaluated in light of locus of control and ne~d achievement differences. the objective is to determine if observed differences in work role orientation can be traced back to known psychological differences. research on work behavior of entrepreneurs recognizing that entrepreneurs possess a distinctive set of psychological traits, a related stream of research sought to identify behavioral differences between entrepreneurs and managers of businesses. these results can be organized around three themes: differences in planning and goal-setting orientation; differences in management styles; and the development of taxonomic schemes which capture a host of characteristics. goals have been found to be vague, inadequately defined, and short-ranged ([9j, [10]). a growth orientation also appears to separate entrepreneurial from "managed" firms ([4j, [14]). recent work by mintzberg and waters [33j discussed the role of personal vision of the entrepreneur regarding the future of the firm. this is consistent with the view of goals being vague and poorly articulated, and dominated by personal values [17]. 56 journal of business strategies vol. 7, no.1 management style differences have been explored in another set of studies. the use of strategic management techniques [4] and boundary-spanning activities (112], [15]) have been related to entrepreneurs. calculated risk-taking and a bias toward developing activities within the firm have also been identified as a part of the entrepreneur's behavioral repertoire [45]. in light of the complex array of motives and behaviors that compose this phenomenon of entrepreneurship, several authors sought to classify these people into types of entrepreneurs. each proposed type captured a "gestalt" of perceptions and actions. boswell [1j classified four types of entrepreneurs: innovator favoring growth and self-realization. proprietor interested in maintaining control and financial independence. technician inclined toward technical efficiency, productivity, and profits over growth. artisan favoring personal independence and survival over economic success. smith and miner [42j classify two types: craftsman and opportunistic, which has been supported in several other studies ([2], [23j, [44]). another typology developed by filley and aldag [16j is also supportive of the craftsman/opportunistic distinction. while each of the above studies provides insight to the work behaviors of entrepreneurs, they rarely deal with specific actions that might be undertaken in the course of managing a firm. the typologies and goal orientations do point to a predilection for certain actions. however, the domain offeasible actions within any typological classification is quite broad. for example, a technician in boswell's taxonomy might be expected to monitor raw material consumption and personally negotiate with vendors all in an effort to improve productivity. because the intent of the present study is to relate psychological traits to aspects of managerial behavior, this article relies on the managerial work role literature. that literature offers a more detailed partitioning of work activities. method managerial work roles several categorizations of managerial work roles are available in the literature. perhaps the best-known is the partitioning of management activities presented by mintzberg [32j. however, the mintzberg categories are not mutually exclusive and many specific work activities can be related to more than one role. other researchers have noted this problem in empirical settings [43]. the work roles utilized in this study were those crated by hemphill [21]. he generated his set of managerial work roles by compiling a list of 575 work activities from interviewing managers and examining job description statements. this list of work activities was evaluated by 93 executives in five large manufacturing firms. using a likert scale, each manager rated the extent to which each statement applied to his or her job. the work roles were determined by correlating the response of spring 1990 castaldi & marino: perceptions 57 pairs of 93 subjects. tucker's interbattery factor analysis method was applied to an off-diagonal 8ubmatrix of these inter-correlations, which generated a set of work activities representing each work role. reliabilities for each set of work activities ranged from. 74 to .89. low inter-correlations among the work roles indicated their relative independence. this analysis produced a set of eight work roles which would be germane to studying the positions of the ceo. these roles and examples of related work activities are: 1. providing a staff service in non-operational areas; • selection of new employees • assign jobs to subordinates 2. supervision of work; • trouble shoot special operational problems as they arise • decide the best use of available facilities 3. business control; • review of budgets for operations • maintenance of proper inventories 4. technical concerns with products and markets; • assist sales people in securing important accounts • anticipate new or changed demand for products 5. human, community, and social affairs; • active in community affairs • promotion of company to public 6. long-range planning; • formulation of long-term objectives for organization • determination of business activities to engage in 7. business reputation; and • oversees delivery schedule • oversees the quality of company products 58 journal of business strategies vol. 7, no.1 8. preservation of assets . • oversees capital expenditures • determines utilization of capital assets although these work roles were formulated in 1960, they are supported by recent work on managerial behavior. in his study of managerial work behavior, whitely ([69], p. 344) notes, "[s]tudies as widely spaced in time as hemphill [21] and tornow and pinto [46] identify similar behavioral (work) dimensions." brunswik lens model the primary thrust of this research centers on the judgment of the ceos as to their perception of the relative importance of the managerial work roles identified with their position. one method of accomplishing this would be to simply ask each ceo to rank each work role in terms of relative importance. however, slovic, and lichtenstein [41] established that most decision makers have poor insight when utilizing such subjective estimates of their own multiple-criteria decision process. to overcome this problem, brunswik's lens model was used to study the judgment process of ceos who are owner-managers and ceos who are nonowner-managers. in this model, each subject is required to make a quantitative evaluation of a large number of situations, each of which is defined by certain cue dimensions. these cue variables must be quantifiable, even if only to the extent of a binary (0 vb. 1) relationship. each ceo was presented with a set of profiles ("situations"), each describing a hypothetical ceo based on his/her ability to perform the eight work roles ("cue dimensions"). utilizing this information, the subjects rated the predicted effectiveness of each of the hypothetical ceos. by varying two different levels of ability for each work role on each hypothetical profile, it is possible to determine the relative degree of importance that the ceo places on each work role. this model was selected for two reasons. first, it uses an ideographic-statistical approach to hypothesis testing, which allows for the utilization of a small sample size. ideographic implies that each subject's behavior (judgment) must meet a statistical test of significance ([19], [41]). this, in turn, demands that a sufficient number of situations be given to each subject to perform a sufficient number of tests. thus, the lens model provides a quantified, descriptive summary of the way each ceo weighs and combines information. second, with its inferential qualities, this model allows the ceo to make judgments in an atmosphere that approximates his or her own decision-making environment. as mitroff states: the important point to appreciate about the brunswik paradigm is that it specifically incorporates the idea of a probabilistic, uncertain decisionmaking environment. unlike most psychological experiments where both the cues and the variables to be estimated are "visible," in a brunswik experiment a subject is forced to engage in inferential decision-making, i.e., to infer the value of a variable that is hidden from his "direct view." ([34), p. 49) spring 1990 castaldi fj marino: perceptions 59 data collection the research design utilized is a 4-4 split of a fixed-effect 2'<; factorial anova. each work role was described in terms of two ability levels: excellent or poor. the two levels used in this study were distributed in a 4:4 ratio. thus, each hypothetical ceo profile has four excellent-ability work roles and four poor-ability work roles. in using such a split, the design is controlled for rater judgment bias which may occur should the profile be weighted unevenly with either more "excellent" or "poor" work role abilities. in order to create an instrument of reasonable length, a one-half fractional replication was employed. this design produced a set of 35 hypothetical profiles for each subject. with instruction by the researcher, each subject made judgments as to the predicted effectiveness of each hypothetical ceo, based on a scale of one to nine. for data analysis purposes, these judgments were recoded 1, 2, and 3, representing extremely ineffective, average effectiveness, and extremely effective performance. subjects the subjects of this research project consisted of eight ceos of wood furniture manufacturing firms. four ceos are considered owner-managers, as they started their own firms, while four ceos were promoted to their position and are considered nonowner-managers. a single industry was selected to hold constant as many extraneous variables as possible. all firms meet the small business administration's definition of "small business" in terms of dollar sales and number of employees. each ceo was interviewed and the data collection instrument was completed in the author's presence. results in table 1, the magnitude of effect of each work role and the mean effect for each subject group are presented. these calculations are based upon the degree to which the dependent variable (i.e., "predicted effectiveness") shifted as the levels of the work roles varied from poor to excellent. a positive magnitude of effect indicated the work role is unimportant. in other words, a negative magnitude of effect occurs if the predicted effectiveness variable is reduced when the level of ability goes from poor to excellent. therefore, this index provides the "direction" and "degree" of importance associated with each work role. these results indicate that three categories of work roles exist among these subjects: universally important roles, universally unimportant roles, and those roles whose importance is moderated by ownership status. long-range planning and preservation of assets are considered the most important roles by each group of subjects. the mean effects are statistically identical for the owners and nonowners. neither the magnitude of importance of these roles nor the consistency across subject groups is surprising. business control, human, community, and social a.ffairs, and business reputation are three managerial roles which are considered relatively unimportant by both groups 60 journal of business strategies table 1 direction and degree of work role importance for each ceo" vol. 7, no.1 ceo owner-manager 1 2 3 4 ~ magnitude of effect of managerial work roles" abc d e f g h .188 -.058 -.062 -.076 -.326 .326 -.326 .350 -.188 -.247 -.188 -.012 -.198 .452 -.071 ,483 .000 -,408 -.250 .227 -.311 .191 -.063 .666 -.375 -.188 -.125 .324 -.254 .382 -.127 .400 -.094 -.225 -.156 .116 -.274 .338 -.147 .475 ceo nonowner-manager 5 .125 .016 .375 -.307 -.667 .159 -.159 .466 6 .000 -.125 -.625 -.259 -.259 .635 .127 .533 7 .357 .612 -.500 .308 -.095 .223 -.476 .476 8 .000 -0408 -.250 -.021 -.221 .404 -.041 ,485 :c .125 .024 -.250 -.070 -.324 .355 -.137 .488 p value""* .021 .005 .322 .032 .569 .873 .912 .888 * calculation based upon the degree to which the dependent variable (predicted effectiveness) shifted as the level of the work role varied from poor to excellent. a minus (-) sign indicates the work role is considered unimportant. *" a: providing a staff service in a non-operational area b: supervision of work c: business control d: technical concerns with products and markets e: human, community, and social affairs f: long-range planning g: business reputation h: preservation of assets ..... scheffe's test for pmlt hoc comparisons of each group of subjects. of subjects. both business control and business reputation roles involve operational activities associated with inventory control, quality control, and budgetary reviews. even in these small firms, it is likely that these activities are delegated to lower-level managers. the subjects did not perceive the work role human, community, and social affairs to be important. this may be attributable to the geographic characteristics of the sampled firms. all of the companies were located in rural settings which was hundreds of miles from the closest metropolitan area. hence, there was little public and consumer visibility, which may have reduced the importance of this role for ceos in the survey. providing a staff service, supervision of work, and technical concerns with products and markets are the three roles which are perceived significantly different in spring 1990 castaldi & marino: perceptions 61 importance by the owner and nonowner groups. while dearly moderated by ownership status, the purpose here is to relate these role perceptions to the underlying psychological attributes of the owners and nonowners. discussion much of the research on the psychology of entrepreneurs is directed at the identification of traits that might compel an individual to commence a business venture. the entrepreneurs in this study each formed the companies they now own and manage. their perceptions of the importance of particular work roles differ from nonownermanagers of similar firms in the same industry. supervision of work owner-managers perceive this role to be unimportant in the managerial repertoire. indeed, except for human, community, and social affairs, it was the least important of the eight roles examined. this result is consistent with an internal locus of control belief. internals have been reported to be more trusting [20j and to be more satisfied with a participative management style [38]. externals have been reported to favor a more directive and structured form of supervision ([25j, [30]). recent findings from miller, droge, and toulouse [31] also offer an explanation regarding high achievement motivation. they found that centralization and formalization were positively affected by the level of achievement motivation in their sample of small firm ceos. in highly structured firms, the need for close supervision is eliminated. that is, if decision making authority is centralized in the hands of a few top executives and the behavior of workers is controlled by rules and procedures, supervision may not enhance effectiveness. technical concerns for products and markets since the owners were more probably motivated to enter the furniture business due to the technical expertise or market knowledge, their continued concern for this role is not surprising. however, a high need for achievement is also consistent with this result. direct contact with customers is implied within this role and will likely provide the immediate performance feedback intrinsic to the need achievement construct. also, being close to product concerns and markets would be instrumental in setting goals and supporting the sense of personal responsibility for their attainment, which is also manifest in the need achievement drive. providing a staff service in a non-operational area this role is perceived as the third most important among the nonowner-managers. there is evidence which suggests that managers who are p'romoted tend to place priorities on working behaviors closely related to their former positions ([5j, [6j, [36], [47]). this may well be the best explanation for this observed difference. however, need achievement among the owner-managers can also be evoked as an explanation. 62 journal of business strategies vol. 7, no.1 sta.ff support of a non-operational area might bear, at best, a tenuous relation to goal achievement and provide the least feedback to the owner. conclusions in conclusion, this research posits that differences in work role orientation among owners and nonowners may well be attributable to a personality set which motivates the initial entrepreneurial event. it is believed that this position offers opportunities for future research and also has implications for practicing managers in these types of organizations. managerial attention should be directed toward supplementing the owner's repertoire. if it is acknowledged that each of the managerial work roles are, to some extent, necessary as the firm grows and prospers, then strategies for filling some voids in work supervision and staff services must be developed. delegation is an obvious solution, yet it is one which must be justified by growth of the firm. the creation of a product supervisor, director of operations, or a similar position is an approach to relieving the owner of supervisory responsibilities. management 'development training in the development of policies and procedures or in job design may assist the owner in reducing the need for supervision within the organization. restructuring work flows and installing performance pay systems can also reduce supervision requirements. use of outside resources, either consultants or special services providers such as employee leasing firms, can supplement support service inadequacies. finally, the judicious selection of outside directors can be used to complement the skills and interests of the owner. research might well extend the understanding of how these psychological attributes influence managerial work activities after the venture formation stage. the channeling of the owner's attention into particular roles is likely to influence structural designs, commitments to staff development, growth strategies, product development efforts, and a host of other organizational outcomes. the call for research by jennings and zeithaml [24j concerning the locus of control construct, and the recent work by miller, et al. [31] on ceo need achievement are examples. these may be viewed as logical and potentially fruitful extensions of the rich history of psychologica.l inquiry in entrepreneurial research. references 1. boswell, j. "corporate planning in small manufacturing firms," journal of business policy, vol. 2 (1971), pp. 49-53. 2. bracker, j. s. planning and financial performance among small manufacturing firms: an industry study, doctoral dissertation, georgia state university ( 1982). 3. brockhaus, r. s. "ie locus of control scores as predictors of entrepreneurial intention," proceedings of the academy of management (1975), pp. 433-35. spring 1990 castaldi pj marino: perceptions 63 4. carland, j. w., f. hoy, and j. c. carland. "differentiating entrepreneurs from small business owners: a conceptualization," academy of management review, vol. 9 (1984), pp. 354-59. 5. choran,1. the manager of a small company, master's thesis, mcgill university, montreal (1969). 6. cohn, t. and r. a. lindberg. survival and growth: management strategies for the small firm. new york, ny: amacom (1978). 7. collins, o. and d. moore. the organization makers: a behavioral study of independent entrepreneurs. new york, ny: meridith (1970). 8. cooper, a. "entrepreneurial environment," industrial research(1970), p. 12. 9. d'ambroise, g. personal characteristics, organizational practices, and managerial effectiveness: a comparative study of french and english speaking executives in quebec, doctoral dissertation, the university of california, los angeles (1974). 10. d'ambroise, g. and y. gasse. "performance in small firms and the utilization of formal management techniques," paper presented at the joint national meeting timsjorsa, washington, dc (1980). 11. dollinger, m. j. "environmental boundary spanning and information processing effects on organizational performance," academy of management journal, vol. 27 (1984), pp. 3&1-68. 12. draheim, k. "factors influencing the rate of formation of technical companies." in a. cooper and j. komiver (eds.), technical entrepreneurship: a symposium, milwaukee, wi: center for venture management (1972). 13. dunkelberg, w. c. and a. cooper. "entrepreneurial typologies." in k. h. verspe (ed.), frontiers of entrepreneurship research, wesley, ma: babson center for entrepreneurial studies, pp. 1-15 (1982). 14. evans, m. g. "extensions of a path-goal theory of motivation," journal of applied psychology, vol &9 (1974), pp. 172-78. 15. filley, a. c. and r. j. aldag. "characteristics and measurement of an organizational typology," academy of management journal, vol. 21 (1978), pp. 578-91. 16. gasse, y. entrepreneurial characteristics and practices: a study of the dy, namics of small business organizations and their effectiveness in differen environments. sherbrooke, quebec: rene prince imprimeur (1977). 17. goodstadt, b. e. and hjelle, l. a. "power to the powerless: locus of control and the use of power," journal of personality and social psychology, vol. 27 (1973), pp. 190-96. 18. hammond, k. r. and n. e. wascoe (eds.). new directions for methodology for social and behavioral science, p. 3. 64 journal of business strategies vol. 7, no.1 19. hamner, w. and d. organ. organizational behavior: an applied psychological approach. dallas, tx: business publications, inc. (1978). 20. hemphill, j. k. dimensions of executive positions. columbus, oh: bureau of business research, ohio state university (1960). 21. hornaday, j. a. "characteristics of successful entrepreneurs," personnel psychology, vol. 24 (1971), pp. 141-53. 22. hornaday, j. a. and c. s. bunker. "the nature ofthe entrepreneur," personnel psychology, vol. 23 (1970), pp. 47-54. 23. jennings, d. e. and c. p. zeithaml. "locus of control: a review and directions for entrepreneurial research,t' proceedings of the academy of management (1983), pp. 417-21. 24. marino, k. and s. white. "departmental structure locus of control and job stress: the effects of a moderator," journal of applied psychology, vol. 70 (1985), pp. 782-84. 25. mcclelland, d. "achievement motivation can be developed," harvard business review (november/december 1965). 26. mcclelland, d. the achieving society. princeton, nj: d. van norstrand (1961). 27. mill, j. s. principles of political economy with some of their applications to social philosophy. london, uk: john w. parker (1848). 28. miller, d., m. kets de vries, and j. toulouse. "locus of control and its relationship to strategy, environment, and structure," academy of management journal, vol. 25 (1982), pp. 237-53. 29. miller, d. and c. droge. "psychological and traditional determinants of structure," administrative science quarterly, vol. 31 (1986), pp. 539-60. 30. miller, d., c. droge, and j. toulouse. "strategic process and content as mediators between organizational context and structure," academy of management journal, vol. 31 (1988), pp. 544-69. 31. mintzberg, h. the nature of managerial work. new york, ny: harper and row (1973). 32. mintzberg, h. and j. a. waters. "the mind of the strategist." in srivastva & associates (eds.), the executive mind, san francisco, ca: jossey-bass (1983). 33. sitroff, i. "a brunswik lens model of dialectical inquiring systems," theory and decisions, vol. 5 (1974), pp. 45-67. 34. pandey, j. and n. b. tewary. "locus of control and achievement of values of entrepreneurs," journal of occupational psychology, vol. 50 (1979), pp. 107-11. 35. paolillo, j. g. p. "role profiles for managers at different hierarchical levels," proceedings of the academy of management (1981), pp. 211-14. spring 1990 castaldi & marino: perceptions 65 36. rotter, j. "generalized expectations for internal versus external control of reinforcement," psychological monographs, vol. 80, no. 609 (1966). 37. ruyon, k. e. "some interactions between personality variables and management styles'" journal of applied psychology, vol. 57 (1973), pp. 288-94. 38. schumpeter, j. a. the theory of economic development. cambridge, ma: harvard university press (1934). 39. shapero, a. an action program of entrepreneurship. austin, tx: multidisciplinsry research (1971). 40. slovik, p. and s. lichtenstein. "comparison of bayesian and regression approaches to the study of information processing in judgment," organizational behavior and human performance, vol. 2, no.6 (1971), pp. 649-744. 41. smith, n. r. and j. b. miner. "motivational considerations in the success of technologically innovative entrepreneurs." in j. a. hornaday, et al. (ed.), frontiers of entrepreneurship research, wesley, ma: babson center for entrepreneurial studies, pp. 488-95 (1984). 42. snyder, n. h. and t. l. wheelen. "managerial roles: mintzberg and the management process theorists," proceedings of the academy of management (1981), pp. 320-24. 43. still, t. an exploratory investigation of strategic planning behavior in small business, doctoral dissertation, florida state university (1974). 44. toulouse, j. m. entrepreneurship in quebec. montreal: les presses h.e.c.fides (1979). 45. tornow, w. s. and p. pinto. "the development of a managerial job taxonomy: a system for describing, classifying, and evaluating executive positions,' journal of applied psychology, vol. 61 (1976), pp. 410-18. 46. van roorn, t. "strategic planning in small and medium-sized companies," long-range planning (april 1979), pp. 84-91. 47. watson, d. and e. baumol. "effects of locus of control and expectation of future control upon present performance," journal of personality and social psychology, vol. 6 (1967), pp. 212-15. 48. whitely, w. "managerial work behavior: an integration of results from two major approaches," academy of management journal, vol. 28, no.2 (11985), pp. 344-51. psychological antecedents of work role perceptions: business founders and managers note transfer pricing: a multinational strategy vernon e. sweeney linda s. sweeney sam houston state university huntsville, texas introduction in large firms, diseconomies of scale cause long-run average costs to increase, and management becomes less efficient. the answer to the problem of lost efficiency has been the decentralization of the large firm. the finn is divided into product lines, or territorial, or multinational divisions, that are separate profit centers. each profit center (foreign or domestic) is directed by a manager whose salary and bonus depend upon the performance of that division. the profits of each division will depend in part upon the interfirm or transfer price. a transfer price is the price that one subsidiary charges another subsidiary for goods and services exchanged between the divisions. an inappropriate transfer price may lead to maximized profits in one division, but result in decisions made by the other division which reduce the total profits of the firm. a transfer price may be assigned as a strategy that will optimize multiple objectives. these objectives are: (1) adapting to currency fluctuation. (2) reduction of import tariffs. (3) avoidance of exchange control. (4) reducing income tax liability. a subsidiary operating in a country where exchange rates are appreciating relative to the us dollar may appear to be performing efficiently as revenues are translated into us dollars. however, examination reveals that rising revenues are not the result of good management and that performance bonuses are not indicated. accounting statements adjusted by appropriate transfer prices yield realistic appraisal of the company's financial condition. low interfirm transfer prices between multinational affiliates allow the imposition of low ad valorem import tariffs. as long as the corporate income tax rate is low and the import duties are high, low transfer prices give the firm an advantage. a country that exercises control over repatriation of profits will expect to encounter firms that use transfer prices between parent and local subsidiary which will reduce profit levels for the subsidiary to a minimum. recent announcements suggest that the clinton administration will tax foreign corporations doing business in the united states at higher tax rates. tax rate differentials between countries may aggravate transfer pricing problems as multinational finns seek to avoid or minimize taxes. there is general agreement by scholars, reinforced by a series of new tax rules, that the most important abuse of transfer pricing is the use of fall 1993 sweeney & sweeney: transfer pricing 151 transfer pricing to reduce corporate income taxation (abdullah 1989; arpan and radebaugh 1985; levey, et a1. 1989). to illustrate the transfer pricing problem, consider a french firm producing a product whose cost of production is $40. the french firm sells the product to its irish subsidiary at a price of $40. the tax rate on corporate income in france is 48 percent, but since there was no profit in the transaction, there is no french tax liability. the irish subsidiary sells the same unit to the american parent for $120, earning an $80 profit. ireland's industrial development tax rate is but 4 percent, resulting in a tax obligation of $3.20. in the united states, over the strenuous objection of the us manager and the irs, the item is sold at $120, earning no profit. if tax rate on business profit in the united states is 34 percent, the transaction in the us made no profit, and therefore the firm has no tax obligation on the transaction. this multinational strategy allows the irish subsidiary to loan capital funds to both the french and american firms at low interest rates as compensation. transfer prices of the type described above not only evade legitimate taxes, but misallocate resources. transfer pricing methods controlling the abuse of tax rate differentials with interfirm transfer prices, as in the example above, has become an important concern of tax authorities around the world. arpan and radebaugh found that reduction of tax obligation was the major factor in interfirm pricing decisions by multinational corporations (arpan and radebaugh 1985). in the early part of this century, most firms made one product or a narrow line of related products. then distribution firms began to integrate backward into manufacturing, and manufacturing firms integrated forward into distribution. vertical integration of firms was followed by the development of interfirm transfer pricing. one issue in the department of justice case against at&t, western electric, and the bell telephone system in the 1960s was the alleged abuse of interfirm pricing to the bell system, giving that firm an advantage over independent telephone companies. allocation of resources within the market is the role of prices in economic theory. inappropriate transfer prices misallocate resources within the firm. jack hirshleifer wrote an early paper on transfer pricing, approaching it as a problem in marginal analysis. hirshleifer said that the price is determined by the market only when the transferred or intermediate good was exchanged in a perfectly competitive market. in other cases, the optimal solution was marginal cost or a price between marginal cost and market price. according to hirshleifer, the marginal cost solution applies only if two conditions hold. the first is the assumption of technological independence, which means that the operating costs of the divisions are independent of each other. the second condition, of demand independence, states that an external sale by either division does not affect the demand of the other division. he concluded that transfer prices applied only to short-term decisions with no change in existing capacity (hirshleifer 1956). 152 journal ofbusiness strategies vol. 10, no.2 there are difficulties with practical application of the economic approach to transfer pricing. first, very few transferred goods are exchanged in perfectly competitive markets. second, marginal cost is often hard to calculate from information gathered by cost accounting systems, and marginal cost pricing focuses on economic decisions and is not concerned with the policies for performance measurement, evaluation, reward, and individual fairness (eccles 1985). accounting theory the objective of accountants, like economists, is to arrive at a transfer price that will result in decisions made at the divisional level that will optimize the firm as a whole. transfer pricing will affect output levels of all related divisions, the amount of the product the selling division will transfer, the amount the buying division will source internally, make-order decisions, capital budgeting, and pricing of the final goods. therefore, accountants debate whether market price or standard variable cost should be used. in some situations, standard variable cost approximates marginal cost (eccles 1985). the current accounting view on the transfer pricing problem is expressed by anthony and deardon. they believe market prices should be used if they are available. this makes the selling division look at make-or-buy decisions and produce only products that will earn a sufficient profit. cost-based prices should be used when market prices or rough estimates are not available. anthony and deardon make the point that full cost transfers can cause the division selling the final good to produce at a level that optimizes its profits, but full cost price may be too low to optimize corporate profits. as in the economic approach, the accounting approach has no role for strategy and administrative process of transfer pricing policies. also, the criterion for individual fairness is not addressed in accounting theory (eccles 1985). management theory management theory, regarding interfirm pricing, deals with the relationship between transfer pricing practices and administrative processes. it presents a broader view on the problems of management than economic or accounting theory. managers generally replace the profit maximizer with profit "satisficer", where rewards are not connected as strictly to divisional performance. bonuses and salary increases may be influenced by subjective qualitative standards and corporate performance. transfer pricing is a way of communicating corporate strategy. the rules of transfer pricing can be negotiated to improve the measured performance of a unit. transfer prices are part of a bargaining process in which division managers try to solve divisional problems. fairness and management of conflict, along with economic decision making, are as important as divisional profitability, and in the long view, may be instrumental in reaching optimum firm profitability (eccles 1985). fall 1993 sweeney & sweeney: transfer pricing cases illustrating transfer pricing issues 153 diversified multinationals are concerned with the selection of transfer prices in order to avoid retribution by governments of the world (arpan and radebaugh 1985). the tax reform act of 1986 (tra) brought renewed interest to the transfer pricing issue because corporate tax rates were reduced, and the united states became a tax haven for some multinational corporations. the tra instructed the internal revenue service to study and interpret the intercompany pricing rules in code section 482. section 482 puts intercompany sales on par with sales involving unrelated parties, or "at arm's length." the treasury regulations which interpret this section provide the following methods to arrive at arm's length prices: (1) comparable uncontrolled price this price is determined by comparing sales in which buyers and sellers are not related through corporate affiliation. (2) resale price this price is determined by comparing controlled and uncontrolled resales of products to establish an acceptable gross profit percentage. (3) cost-plus percentage this is determined by comparing the markup on the cost of goods sold in uncontrolled sales. these three methods for pricing tangible property, called the pricing comparability standard, must be successfully applied to achieve an "arms length" price. an additional fourth method has sometimes been used: (4) the profit split a "reasonable" distribution of income between two or more contributing divisions within the firm. the pricing of intangible property is also addressed in section 482. any income from an exchange or license of intangibles must be "commensurate with the income attributable to the intangibles" (levey, et al. 1989). guenter schindler found that more than two-thirds of the corporations surveyed stated that the arm's length standard was difficult to apply. in some vertically integrated industries, there are few transactions involving unrelated parties. the transfer of valuable intangibles is not easily priced using the comparability standard. a company does not often sell valuable intangibles to its subsidiaries or to unrelated parties (schindler 1988). the irs has ample authority in determining the amount of income allocation as a result of intercompany pricing. in an audit, the transfer pricing rationale can be overturned. these disagreements can lead to appeal and litigation which can last for years. for this reason, a majority of the transfer pricing issues are settled out of court between the corporate tax department and revenue agents (schindler 1988). because of the deficiencies above, the irs proposed revenue procedure 91-22, generally called an "advanced pricing agreement," (apa). revenue procedure 91-22 required a taxpayer to propose a transfer pricing methodology and to submit documentation (which can be extensive) to show that the taxpayer had set an "arm's length" 154 journal ofbusiness strategies vol. 10, no.2 transfer price, all this before the actual transaction. when the irs completes its analysis of the taxpayer's documents, the participants may enter into an apa (paul 1991). on january 13, 1993, the irs published 146 pages of rules to clarify and replace the unworkable "arms length" standard. alan wilensky, acting assistant treasury secretary for tax policy, summarized these rules as requiring the taxpayer to use an interfirm price policy which is based on the actual functions performed by the corporate unit selling the product or service (wartzman 1993). the eli lilly case the case of eli lilly and company v united states is an example of the difficulties involved in complying with the rules of section 482. eli lilly ("lilly") purchased the drug darvon from its wholly owned manufacturing subsidiary in puerto rico, lilly p.r. they entered into a pricing agreement whereby lilly p.r. was given the manufacturing rights, and lilly would market the product worldwide making use of its name, reputation, and sales force (the marketing intangibles) (rafferty 1989). lilly was audited in 1969 and agreed to adjustments to its transfer price for darvon. in spite of these adjustments, the irs determined a deficiency for years 19711973. according to the irs, lilly p.r.'s prices for darvon sold to lilly were not in accordance with the arm's length standard. about $75 million in income was reallocated to lilly in the united states, subject to a 34 percent tax rate (rafferty 1989). the bausch and lomb case bausch and lomb corporation (b&l) decided to expand its soft contact lens manufacturing capabilities in the 1970s. a new manufacturing facility was established in the republic of ireland. a major consideration in this decision was an income tax exemption by the republic of ireland on all export profits through 1990. b&l entered into a licensing agreement with b&l ireland for the right to use certain manufacturing intangibles and the b&l trademarks. in exchange, the affiliate agreed to pay b&l a royalty of five percent of net contact lens sales. this was common to the contact lens industry (shanda 1989). the irs reallocated income for the years 1979-1981 in order to state its opinion of the arm's length consideration for the intangibles licensed to b&l ireland. as a result of the notice of deficiency, the case went to the tax court in bausch and lomb inc. 92 tc no 33. the court ruled that a five percent royalty for the use of licensed intangibles was not appropriate and determined a twenty percent royalty based on a 50-50 profit split. the irs reallocated income from b&l ireland to b&l stating that $7.50 was not an arm's length price because b&l could manufacture the product for $1.50. the irs said that a seller could not purchase a product for $7.50 that it could produce for $1.50 (farber and silverman 1989). the court ruled against the irs' arguments. it found that bausch and lomb was a distributor of contact lens purchased from its subsidiary, and that comparable sales from manufacturers to distributors should be used. the transfer price of $7.50 was an fall 1993 sweeney & sweeney: transfer pricing 155 arm's length price, and that by reallocating the income, the irs had abused its discretion (farber and silverman 1989). in addition to the two landmark cases outlined above, the irs has successfully prosecuted transfer several recent cases that involve the japanese ftrms, toyota and yamaha, and the u. s. firms, westinghouse and apple computer. according to the wall street journal, the services of an arbitrator will be used in an attempt to settle the apple computer case. the use of arbitration, if succesful, may represent a new approach to the transfer pricing problem (wall street journal april 3, 1992). conclusion and recommendations < managers of decentralized firms, using transfer pricing as part of a strategy to reach their firms' goals, must review and document their transfer pricing procedure with more care than most have devoted to the task in the recent past. the irs will probably rely on the "advanced pricing agreement" to identify those transactions that require special attention, and the rules of january 13, 1993, to determine the legitimacy of the transfer price (wall street journal april 3, 1992). an article in the wall street journal, on january 20, 1993, said that the treasury was calling for a new study of the multinational portions of the tax code, and that the current code in that area was "excessively complex" (wartzman 1993). interpretation of the newly issued transfer pricing regulations (january 13, 1993) seem to provide for greater flexibility than earlier proposals however, there are increased documentation requirements. a detailed strategy for united states multinational corporations will be different for each corporation because of differences in subsidiary location, type of product(s), and unique market structure features. however, a basic strategy in the opinion of the authors will include: (1) compliance with record and reporting stipulations contained in section 6038a of the internal revenue code. (2) detailed documentation to provide evidence of arm's length pricing between the firm's subsidiary units. (3) using the data from items 1 and 2 above, negotiate the most favorable advanced pricing agreement possible with the internal revenue service. a massive federal deficit and the lack of new revenue sources have focused the interest of the irs multinational taxation, but irs policy remains fluid and less than predictable. legislation in this technical area is adequate, but the law continues to be shaped by the "white papers" of policy makers in the irs, and ultimately tempered by the dicta and the rules of law that originate from the various levels of the judiciary. 156 ] oumal ofbusiness strategies references vol. 10, no.2 abdullah, w. m. 1989. "how to motivate and evaluate managers with international transfer pricing systems." management international review 29 (winter): 65-71. arpan, j. s. and l. h. radebaugh. 1985. international accounting and multinational enterprises. new yark: wiley: 261-263. badaracco, joseph l., jr. 1991. the knowledge link: how firms compete through strategic alliances. boston: harvard business school press. eccles, robert g. 1985. the transfer pricing problem. lexington, mass.: d. c. heath: 21-24. farber, peter l. and mark j. silverman, editors. 1989. "discretion abused in reallocating income." journal of taxation 70 (june): 330-332.. hirshleifer, jack. 1956. "on the economics of transfer pricing." journal of business 29: 172184. hoshower, leon b. and linda ann mandel. 1986. "transfer pricing policies of diversified u. s. based multinationals."lnternational journal of accounting_22 (fall): 51-59. levey, marc m., stanley c. ruchelman, and william r. seto. 1989. "transfer pricing of intangibles after the section 482 white paper."journal of taxation 71 (july): 38-46. liao, woody m. and james l boockholdt. 1988. cost accounting for managerial planning, decision making, and control. houston: dame publications. paul, herbert. 1991. "irs agreement on transfer pricing now possible.':journal of accountancy 9 (july): 23-25. rafferty, james g. 1989. "the profit split method of income allocation in intercompany pricing disputes: the eli lilly case." taxes 64 (october): 662-671. schindler, guenter. 1988. "intercorporate transfer pricing." the tax advisor 19 (may): 378384. shanda, lawrence p. 1989. "royalties and super-royalties."taxes 67 (september): 576-582. staff reporter. the wall street journal, april 3, 1992, p. all. wartzman, rick. the wall street journal, january 14, 1993, pp. a3-a4. wartzman, rick. the wall street journal, january 20, 1993, p. a6. transfer pricing: a multinational strategy an analysis of selected accounting provisions of the tax reform act of 1986 james f. hopson college of business administration texas a & i university kingsville, texas jack r. ethridge college of business administration stephen f. austin university nacogdoches, texas the enactment of the tax reform act of 1986 (tra-86) [7j has created numerous changes in the tax system which have impacted financial reporting. this article analyzes selected tra-86 provisions and highlights their effects on financial reporting and the deferred tax accounts in particular, since the effects of these changes are generally to accelerate taxable income and defer deductions. the overall significance and impact of these changes will vary among business enterprises. however, it is likely that many of these changes will affect tax and financial reporting 88 well 88 tax planning. one important consequence of the tra-86 is that it changed the acceptable tax method for accounting for certain types of transactions. the changes in accounting methods will affect tax reporting, and as a consequence, deferred taxes reported on the balance sheet may be affected because of the timing differences created due to the differences between taxable and financial incomes. cash method tra-86 will place restrictions on the use of the cash method by prohibiting c corporations, partnerships with any c corporation partners, tax shelters, and tax-exempt trusts with unrelated business income from using the cash method or some modification of reporting partly on a cash basis. however, tra-86 will allow certain exceptions to the new rule. businesses with average annual gross receipts of $5 million or less for the three preceding tax years, qualified personal service corporations, and farming and timber businesses may continue to use the cash method. a qualified personal service corporation is defined 88 a corporation in which 95 percent of the stock is owned by employees or retired employees and where all the activities of the corporation are in the field of journal of business strategies, volume 5, nwnber 1 (spring 1988) 12 health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting. the restriction on the use of the cash method of accounting will place tax reporting on similar footing with financial reporting. under most financial reporting circumstances, the use of the cash method is restricted to situations where the probability of recovering product or service costs is remote. therefore, the move towards accrual accounting for tax reporting may reduce the number of timing differences created each year by certain reporting companies. with the complexities involved in determining deferred taxes, any relief in this area should be welcome because of the savings in time and cost. the change in accounting method is required for tax years beginning after december 31, 1986. the change is treated as if initiated by the taxpayer, but it will be automatically approved by the internal revenue service (irs) without the taxpayer receiving special permission. therefore, any adjustment required by internal revenue code (irc) [81 section 481 as a result of the changes shall be recognized over a period not to exceed f<'ur years. hospitals required to change their accounting method may recognize the change over a period not to exceed ten years. corporations affected by the required change may elect to be taxed as an s corporation, which may lower the total tax bite since top marginal tax rates for individuals will be lower than that of corporations under tra-86. dollar-value lifo the tra-86 will make it possible for businesses with average gross receipts of $5 million or less to ded, without obtaining irs' permission, a simplified dollar-value lifo. last-in, first-out (lifo) is an inventory method which allows taxpayers to match current cost with current revenue, with the objective of mitigating the effects of inflation. for many small businesses, the use of lifo may be complex and very time consuming. to overcome some of these problems, a simplified approach called dollar-value lifo was developed. this method is based upon: (1) using price indexes related to inventory, instead of units and unit costsj and (2) applying the price indexes to groups of products called inventory layers, rather than to each individual product. these features have reduced the complexity of lifo and made it available to small businesses. specifically, the new lifo method will require the development of inventory pools grouped by bureau of labor statistics (bls) producer and consumer general price index categories. for retailers, the pools are based on eleven general categories from the i'consumer price index for all urban consumers," and for other taxpayers the pools are based on 15 general categories from the "producer prices and price indexes for commodity groupings and individual items." the indexing of annual cost changes will be developed by using bls indexes and cumulative indexes developed by the link-chain-method. 13 the use of lifo is one of the few areas where tax and financial accounting must agree. therefore, as the irs changes its rules for lifo, financial ac· counting must also change. this is usually considered one of the disadvantages of using lifo for financial reporting. however, the use of lifo for financial reporting does not mean that a different method cannot be used for internal reporting. long-term contracts generally, long-term contracts are defined as contracts for a building, installation, construction or manufacture that is not completed within the taxable year in which it was started. there are two primary methods for accounting for long-term contracts: (1) the completed-contract method, and (2) the percentage-of-completion method. the basic difference between the two methods concerns the timing of profit recognition during the contract. the completed-contract method recognizes the entire profit on the contract in the year in which the contract was finished, whereas the percentage-of-completion method recognizes a proportionate share of the profit during each year of the contract. tra-86 will limit the use of the completed-contract method for contracts entered into after february 28, 1986, to taxpayers who are engaged in the construction or improvement of real property where construction is expected to be completed within two years of the contract date, and have average annual gross receipts of $10 million of less for the three preceding tax years. under tra-'-86, as modified by the revenue act of 1987, there will be two acceptable methods available for companies who cannot use the completedcontract method: (1) percentage-of-completion of (2) the new percentage-ofcompletion-capitalized cost method. in terms of application, the percentageof-completion method may be used as before with an exception for changes in the capitalization rules. the second approach is a hybrid approach which calls for 40 percent of the contract to be reported by using the percentage-ofcompletion method and for 60 percent to be accounted for. using the company's normal method of accounting for long-term contracts. the revenue act of 1987 modified the second approach for contracts entered into after october 13, 1987. the 1987 act now requires that 70 percent of the contract to be accounted for using the percentage-of-completion method and 30 percent of the contract using the completed contract method. under generally accepted accounting principles (gaap), long-term construction contracts should be reported by using either the completed-contract method or the percentage-of-completion method. however, the two methods should not be viewed as acceptable alternatives for the same circumstances. according to statement of position 81-1, there is a preference for use of the percentage-of-completion method when certain conditions are met ([4], para. 23). the limitation on the use of the completed-contract method for tax purposes will bring it more in line with financial accounting. however, the <:rite· ria for selecting the completed-contract method are still different between tax 14 and financial accounting. also, the percentage-of-completion-capitalized cost method is not acceptable for financial reporting, therefore, under certain situations it is likely that an enterprise will be required to select different methods for tax and financial reporting. this will result in the need to create a deferred tax account to record the effect of the timing differences. taxpayers subject to the alternative minimum tax (amt) may elect to use the percentage-of-completion method to reduce the effects of amt while also avoiding the differences in tax and financial accounting. bad debts for tax years beginning after 1986, tra-86 eliminates the use of the bad debt reserve method of deducting uncollectible accounts for enterprises other than certain financial institutions. congress believed the reserve method allowed enterprises to deduct losses for uncollectible accounts for tax purposes that may or may not occur in the future. congress generally believed this approach was inconsistent with the treatment of other deductions. existing reserves at the beginning of the 1987 tax year will be taken into income ratably over four years as an irc section 481 adjustment, while any debt becoming worthless is deducted in the year it becomes worthless. this view is completely contrary to accounting theory which supports the need to recognize uncollectible accounts in the year of sale so that current revenues may be matched with related expenses. this change in tax policy will again result in the need to create a deferred tax account to record the effect of the timing differences. it is anticipated that this change will affect most enterprises because of the limited acceptability of the direct write-off method for financial reporting. the originating timing difference will most likely result in an increase in the deferred charge account because the allowance method will allow the deduction of bad debts losses before they are actually determined to occur (making taxable income less than financial income). for 1986, those fiscal year corporations whose year end tax return has not yet been filed may want to consider increasing adjustments to bad debt expense to the maximum reasonable amount. this procedure allows a greater deduction for this higher tax year, allowing the taxpayer to recognize the reserve as income over the next four years (when tax rates are lower), but deduct receivables when they are actually written off (usually within the next year). capitalization of inventory cost tra-86 changes the types of costs that must be included in inventory costs for tax years beginning after 1986. under the old law all direct material and labor costs plus certain indired manufacturing costs were required to be included in inventory and deducted as part of cost of goods sold. tra-86 expands the types of indired costs that must now be capitalized in inventory and deducted 15 as part of cost of goods sold. in effect, those costs which were once considered period costs (i.e., costs that are deducted as an expense when incurred and not included in the cost of the product) will now be considered product costs (i.e., costs included as part of the cost of the product and not deducted as an expense until the product is sold). this change will result in an increase in the valuation of inventory through the deferral of deductions which will increase a company's taxable income. the indirect costs which must now be capitalized include: 1. costs related to purchasing inventory; 2. costs related to repackaging and assembly, incurred while 10 the enterprise's possession; 3. storage costs; 4. part of general and administrative costs related to the above functions; 5. part of pension and profit-sharing costs; and 6. certain interest costs (including imputed interest). these rules will only affect inventory valued at cost; and therefore, will not affect inventory valued at market using the lower of cost or market method. however, the rules do apply to inventory on hand at the beginning of the 1987 tax year. this inventory must be revalued using the new rules and any inventory value adjustment must be recognized over a four year period under ire section 481. the impact of the rule changes for valuation of inventory for financial accounting will probably vary from enterprise to enterprise. under gaap, the costs to be included in inventory normally include all direct and indirect costs necessary to acquire and prepare the inventory for sale. however, in practice, the treatment of certain costs, such as the costs of the purchasing department and the cost of pensions, may be recorded as period or product costs. under tra-86, one situation where differences between tax and financial valuation of inventory will probably arise involves the capitalization of interest to be included in the cost of inventory. the overall implication of these rule changes will involve the need to create deferred tax account( s) to record the effect of the timing differences due to the different classification of period and product costs. the increased tax cost of carrying inventory can be minimized by increasing inventory turnover and lowering ending inventory. the just-in-time inventory technique lowers inventory, provides cash management benefits, and produces tax benefits 88 well. 16 installment sales for sales made after february 28, 1986, in taxable years ending after december 31, 1986, the installment method of accounting for income tax purposes is not allowed in three situations: 1. certain installment receivables based on the enterprise's outstanding debt; 2. revolving credit plans; and 3. sales of publicly traded property. additionally, the revenue act of 1987 generally repealed the installment method for sales of property by dealer occurring after december 31, 1987. the limitation on the use of the installment method is in line with the conclusion reached by the accounting principles board in 1966. the board stated, "... except for special circumstances, the installment method of recognizing revenue is not acceptable for reporting purposes" ([3], para. 12). even with the limitation on the use of the installment method, the problem of recording the effect of timing differences may still exist because of the possibility of using different accounting methods to determine financial 8jld taxable income. short-term sales are taxed at the ordinary income tax rate and are not eligible for the special 28% capital gain tax rate in 1987. therefore, taxpayers who previously sold short-term securities at year end but deferred recognizing the gain on the settlement date until the next year should consider deferring not only year--end short-term sales, but also any short-term sales with built-in gains until next year when tax rates are lower. taxpayers desiring to lock in gains may either sell short against the tax. or purchase a put option that may be exercised ea.rly next year. taxpayers affected by the amt may elect out of installment sale treatment and narrow the differences between amt and the regular tax. taxpayers should evaluate the effects of this on future years since amt planning is a long-range process after tra-86. potential accounting issues as stated previously, tra-86 will create changes that will impact different enterprises in different ways. each fum will be faced with questions concerning how to recognize and report the effects of changes required by tra-86 in their financial statements. some of the questions to be raised involve how to account for certain provisions during the transition phue, rate reductions, the alternative minimum tax, 8jld modification of the investment tax credit carryover. these and other questions have already been addressed by the financial accounting standard board (fasb). in response to many questions, fasb proposed a technical bulletin [5], and in december 1987, fasb adopted exposure draft (ed) [6] with minor changes as fasb 96, "accounting for income tax." 17 the technical bulletin addressed two major issues: (1) in what period(s) should the tax effects of any retroactive provision of tra-86 be recognized and (2) what changes should be made to deferred tax accounts because of the rate reductions. in addressing question one, fasb indicated that potential tax effects of retroactive provisions on interim and annual periods to the october 23, 1986, enactment date should be recognized lui a part of income tax expense in the financial statements of the interim and annual period that included the enactment date. the technical bulletin takes the position "... that the event to be recognized is the enactment of the new legislation, and therefore, the appropriate period of enactment" ([5), para. 10). the second question concerned whether it would be appropriate to adjust deferred tax accounts created prior to the enactment date of tra-86 for changes in income tax laws and rates. fasb responded by indicating the provisions of apb opinion no. 11 [1] are still in effect and therefore the deferred tax accounts should not be adjusted except where required by existing provisions. the guidelines provided by apb opinion no. 11 indicate that the deferred approach should be used to account for the tax effect of a timing difference between taxable and financial income. under this approach, the tax effect of a timing difference should be determined in the year in which the timing difference originated and not adjusted until the difference reverses. accordingly, once a deferred tax account has been established for a timing difference no adjustment is made to the deferred tax account until it reverses. this would be true even if the current tax rate is different from the original rate used to establish the account or will be different when the timing difference reverses. the ed [6j would allow reductions in the future income tax rate to be refleeted in the deferred tax accounts immediately. fasb no. 96, a.dopted in december 1987, does not apply until years beginning after december 15, 1988. companies may adopt the statement now, but it must be applied cumulatively as of the beginning of the year and it may be adopted retroactively by restating prior periods. fasb 96 would require a fundamental change in the method of accounting for deferred taxes from the deferred approach to the liability approach. the primary difference between the two approa.ches is that the liability approach would require deferred taxes to be adjusted for tax rate changes, which is not required under the deferred approach. this change will a.f£eet nearly all companies. the first application of this approach may create confusion and record-keeping problems. however, after the initial confusion and record-keeping problems are solved, it is generally believed that this approach should make accounting and reporting of deferred taxes more understandable because it focuses on a company's current or future tax return. in addition, the securities and exchange commission (sec) has issued a release [9} which requires disclosure of material effects upon future liquidity including reversal of book/tax differences that have or have not been booked pursuant to apb opinion no. 29, [2j. companies desiring to quanti!y the 18 effects may disclose upper and lower limits of the anticipated effects based upon the fasb exposure draft. conclusion tra-86 has introduced numerous changes in the tax law, many of which will have a direct impact on the financial condition of the business enterprise and subsequently upon the enterprise's financial reporting practices. unfortunately, the effects of many of these changes are still being evaluated and will not be resolved in the near future. a major issue that most business enterprises must face immediately is the problem of deferred taxes. as discussed in this article, tra-86 will have a major impact on companies' deferred taxes through changes in the acceptable accounting methods. however, both the fasb and the apb have issued pronouncements designed to offer assistance to companies as they strive to account for and disclose the effects of the changes related to deferred taxes. references 1. accounting principles board. "accounting for income taxes," opinion no. 11. new york, ny: american institute of certified public accountants (1967). 2. accounting principles board. "accounting for income tax special areas," opinion no. 23. new york, ny: american institute of certified public accountants (1972). 3. accounting principles board. "omnibus opinion-1966," opinion no. 10. new york, ny: american institute of certified public accountants (1967). 4. construction contractor guide committee of the accounting standards division, aicpa. "accounting for performance of construction-type and certain production-type contracts," statement of position 81-1. new york, ny: american institute of certified public accountants (1981). 5. financial accounting standards board. "accounting for certain effects of the tax reform act of 1986," proposed technical bulletin no. 86-a (1986). 6. financial accounting standards board. "accounting for income taxes," exposure draft (1986). 7. tax reform act of 1986. statutes at large, vol. 1 (1986). 8. internal revenue code of 1954, §481. 19 9. u. s. house of representatives. report of the committee on ways and means, tax reform act of 1986. h. r. 3838, 99th congress, 1st session (1985). 10. u. s. congress. conference committee report, taz reform act of 1986. h. r. 3838, 99th congress, 2nd session (1986). 11. u. s. senate. report of the committee on finance, taz reform act of 1986. h. r. 3838, 99th congress, 2nd session (1986). 20 an analysis of selected accounting provisions of the tax reform act of 1986 a study of mission statements among large u. s. manufacturers fred r. david college of business administration auburn university auburn, alabama daniel s. cochran college of business and industry mississi ppi state university mississippi state, mississippi an increasing number of organizations around the world are developing a formal mission statement as part of the strategic management process. a mission statement reveals the long-term vision of an organization in terms of what it wants to be and who it wants to serve. a clear mission statement answers a key question about an enterprise: "what is our business?" a good answer to this question makes s.trategy formulation, strategy implementation, and strategy evaluation activities much easier. sometimes called a statement of purpose, philosophy, or creed, a mission statement is increasingly being perceived among firms as indication of strategic management sophistication [8]. the importance of a mission statement to effective strategic management is recognized by many practitioners, but considerable diversity and confusion exists regarding the composition of these documents. the present study was thus undertaken to examine the content of corporate mission statements. based on the findings, this paper offers suggestions for writing a corporate mission statement. literature review a mission statement should define what an organization is and what it aspires to be ([4], [9]). mission statements should be limited enough to exclude some ventures and be broad enough to allow for creative growth. a mission document should distinguish a particular organization from all others and should serve as a framework for evaluation both current and prospective activities [8]. mission statements should be stated in terms sufficiently clear to be widely understood throughout the organization. an example mission statement for eli lilly and company is given below: journal of bu8ineu strategie8, volume 4, number 2 (fall 1987) 59 eli lilly and company is a research-based corporation that develops, manufactures, and markets human medicines, medical instrument systems, diagnostic products, agricultural products, and cosmetics. to guide its affairs, the company follows certain fundamental principles. these principles, which we believe are in the best long-term interests of all shareholders, are the following: the company is committed to the discovery and marketing of innovative products of the highest quality that offer benefits to customers in all of our markets. the company is dedicated to the highest levels of ethics, integrity, and excellence in research, manufacturing, marketing, and all other phases of its operations. the company recognizes primary responsibility to its. employees because of the key role employees play in the achievement of corporate goals. the company's objective is to attract and retain outstanding people at all levels and in all parts of the organization. it is committed to fair and equitable treatment of all employees and to policies and programs that offer the opportunity for employees to develop meaningful and rewarding careers. the company feels an obligation to be a good corporate citizen wherever it operates. previous studies reveal eight components that are important for inclusion in a mission statement ([3], [7]). subsequently called literature-derived components in this paper, these variables are "customers," "products or services," "location," "technology," "concern for survival, growth, and profits," "philosophy," "self-concept," and "concern for public image." pearce [7] indicates that "products or services," "location," and "customer" are especially important components. want [9] concludes that "customer," "products or services," "concern for survival, growth, and profitability," "philosophy," and "concern for public image" as the most important components. drucker [4] suggests that the "customer" component is most important for inclusion in a mission statement. although a number of conceptual articles and business policy texts [2] discuss mission statements, the composition of mission statements varies among different types of firms. more information is needed to assist practitioners chargecl with developing a formal mission statement. all organizations have a reason for being, even if top managers have not consciously transformed this into a written document. a clear and meaningful mission statement can ensure unanimity of purpose within an organization, can provide a basis for motivating the use of organizational resources, can develop organizational climate. a mission statement is often the most visible and public part of a strategic plan (6]. as such, an enterprise should insure that its statement of mission clearly communicates appropriate information to guide and motivate employees, customers, shareholders, and other constituencies. 60 methodology the sample a personal letter was mailed to the chief executive officers of all fortune 500 manufacturing firms in the united states. the letter requested a copy of the organization's formal mission statement. a mission statement was defined as "an enduring statement of purpose that reveals an organization's product or service, markets, customers, and philosophy; a mission statement is sometimes referred to as a statement of purpose, philosophy, or creed." responses were received from 218 firms, representing an overall 44 percent response rate. among the responding firms, 88 corporations had not prepared a mission statement, but 130 firms said they did have a mission statement. among the 130 firms, 11 corporations replied that their mission statement was confidential and they could not send us a copy. there were 58 firms which sent material such as an annual report that did not clearly include a formal mission statement. finally, 61 of the 130 firms provided a usable mission statement that was evaluated using content analysis. the hypothesis type of industry is an important contingency variable in strategic management research. a tecent empirical study of pims program data revealed that type of industry (industrial versus consumer products forms) was the most important contingency variable in business strategy [5]. it was hypothesized in this study that the mission statements of industrial products firms would include a different mix of literature-derived components than mission statements of consumer products firms. among the 61 sample firms, there were 27 consumer products companies and 34 industrial products companies. ten of the consumer products firms were in the food industry and six industrial products companies manufactured farm equipment. the investigation of this hypothesis was justified from the growing evidence that consumer and industrial firms are different in many ways that impact strategy decisions. specifically, consumer products firms produce goods that are marketed directly to individuals through various types of retail organizations. consumer goods include items such as tobacco products, soap, newspapers, furniture, clothing, used cars, major appliances, photographic equipment, men's suits, life insurance, cemetery plots, gravestones and encyclopedias. consumer products are often categorized as convenience goods, shopping goods, and specialty goods. on the other hand, industrial products include items such as farm products, petroleum products, pig iron, yarn, generators, drill presses, elevators, lift trucks and office equipment. industrial goods are often categorized as materials and parts, capital equipment, and su pplies and services. industrial products firms differ significantly from consumer products firms in their strategic attributes and performance [5]. the competitive environment and primary policy areas differ significantly according to user sector. for 61 example, r&d personnel and engineers are frequently the strategy decisionmakers in industrial products firms, whereas marketing managers are generally the primary decision-makers in consumer products firms. industrial products firms stress a different facet of competitive strategy compared to the consumer products firms. industrial markets have certain unique characteristics, such as fewer and larger buyers, graphically concentrated buyers, and derived demand. industrial products firms differ significantly from consumer products firms in their competitive intelligence-gathering efforts. industrial products firms more often gather information for offensive rather than defensive purposes [5]. measures content analysis can be used to develop, write, and evaluate mission statement documents [1]. in the present study, two independent raters read the sample mission statements and recorded whether or not each statement included the literature-derived components. if a mission statement was judged as exhibiting a particular component, the rater recorded a value of "i" to the statement for that component. when a particular mission statement did not "clearly" exhibit a literature-derived component, a "0" was assigned to the statement for that component. the eight mission statement components were operationalized systematically whereby each rater independently asked the following key questions about each document: 1. customer does the mission statement identify the firm's major customers? 2. product or service does the mission statement identify the firm's major products or services? 3. location does the mission statement identify the location of the firm's business markets? 4. technology does the mission statement identify the firm's basic technology? 5. concern for survival, growth, and profits does the mission statement reveal that the firm is concerned about survival, growth, and profitability? 6. philosophy does the mission statement reveal the firm's basic beliefs, values, aspirations, and philosophical priorities? 7. self-concept does the mission statement reveal the firm's competitive advantages and major strengths? 8. concern for public image does the mission statement reveal that the firm is concerned about its public image? . 62 interrater reliability coefficients revealed no significant differences between the two independent raters' scores. ' the computed chi-square value of 3.73 indicated no significant difference between the two raters on their evaluation of the mission statements. the critical chi-square value was 21.67 at the .01 level of significance and nine degrees of freedom. some degree of subjectivity is always involved in evaluating written documents using content analysis, so the present raters studied mission statement articles and documents carefully before beginning the evaluation process. the results parametric t-test analyses were used to test the hypothesis that mission statements of industrial products firms include a different mix of literaturederived components than the mission statements of consumer products firms. as indicated in table 1, the mission statements of industrial products firms include the "product" component significantly more often than the mission statements of consumer products, firms (76 percent of the time compared to 56 percent of the time). in addition, 29 percent of the mission statements of industrial products firms include the "technology" component, compared to 8 percent of the mission statements of consumer products firms. this difference was also statistically significant. the mission statements of industrial products firms more often include the "customer," "location," "concern for survival, growth, and profits," and "self-concept" components as indicated table 1 comparing mission statements of consumer products firms and industrial products firms (n = 61) consumer products industrial products firms (n = 26) firms (n = 35) variable mean sa. mean s t-value customer .4400 .507 .5000 .508 -0.45 product or service .5600 .507 .7647 .431 -1.63*1> location .3200 .476 .4412 .504 -0.94 technology .0800 .277 .2941 .462 -2.21**e concern for survival, growth, and profits .8800 .332 .9412 .239 -0.78 philosophy .8800 .332 .7353 .448 +1.43 self-concept .7200 .458 .8235 .387 -0.91 public image .9200 .277 .8235 .387 +1.12 a. s = sample standard deviation u p < .10 e* p < .05 63 by higher mean values. these results support the hypothesis that the mission statements of industrial products firms include a different mix of literaturederived components than the mission statements of consumer products firms. discussion implications for practitioners it should be noted initially that this study did not examine organizational performance or effectiveness. hence, no conclusions can be made regarding whether more articulate mission statements impact organizational performance or effectiveness in a positive or negative way. prior research does suggest that comprehensive mission statements impact organizational performance positively, but this study did not examine that hypothesis ([3], [8]). in this study, the mean values associated with industrial products firms are higher than the mean values associated with consumer products firms on all variables except "philosophy" and "concern for public image." thus, industrial products firms appear to prepare a more comprehensive mission statement than consumer products firms. this finding could indicate that top managers of consumer products firms especially need to review their mission statement document to assure that it includes desired components and communicates the desired message. the low percentage values of 8, 32, and 44 for consumer products firms and 29, 44, and 50 for industrial products firms indicate that large u.s. manufacturers overall tend not to include the "technology," "location," and "customer" components respectively when developing a mission statement document. first, technology changes are shortening the product life cycle in nearly all industries, so this finding suggests that large u.s. manufacturers may not adequately be considering technological opportunities and threats in formulating and implementing strategies. improvement could especially be warranted among consumer products firms which on average include "technology" only eight percent of the time in a mission statement. second, large u.s. manufacturers should consider including geographic "location" more often in developing a mission statement document because foreign manufacturers are gaining an increasing market share in many industries. third and perhaps most important is the need. for large u.s. corporations to more often include "customers" in developing a formal mission statement. customers are what give meaning to any business organization. writing a mission statement the key questions outlined in the measures section of this paper provide a basis for writing a formal mission statement. the mission statement for mary kay cosmetics, an international, consumer products firm, is given in figure 1. mary kay cosmetics' mission statement was judged by both independent raters in this study as including all eight literature-derived components. the actual evaluative process for the mary kay statement is described here to aid 64 practitioners in developing a mission statement. first, the mary kay document reveals the firm's "customers" to be women. the company's "product" is a "personalized skin care regimen." mary kay's "location" or geographic area for business is the world. mary kay's "technology" is based on "quality assurance and research." the company's "concern for survival and growth" is evident since the statement describes the desire for "high productivity" and "growth of the company." the company's "philosophy" is "based on the golden rule." mary kay's "self-concept" and desired "public image" is to be the "finest teaching-oriented skin care organization in the world." figure 1 mary kay cosmetics' mission statement mary kay cosmetics choices. a woman's life is filled with them. her busy world demands choices about how she uses her time, juggles her commitments and reaches her goals. but whatever her lifestyle, mary kay is right for the times. because we understand a woman's needs and care about meeting them. we do more than just sell a woman cosmetics. we teach a personalized skin-care regimen, help her discover her own glamour look, and provide continuing service to assure that her skin care and beauty programs stay consistent with her changing needs. our corporate goal for the 1980's is to be the finest teachingoriented skin-care organization in the world. we're doing that by teaching women about their skin and how to care for it. our program is based on a personal relationship with an individual beauty consultant, who guides, instructs, and counsels each of her clients. women appreciate the service and knowledge they get from their mary kay beauty consultant. our careful quality assurance and research means we're so confident about our products that we offer a 100 percent satisfaction guarantee. we can do this because mary kay understands the way women want to look and live, offering products and services to meet their needs in the '80s. equally important, we care about our customers-and make sure they know it. because customers don't care how much we know until they know how much we care. it's all part of the mary kay philosophy-a philosophy based on the golden rule. a spirit of sharing and caring where people give cheerfully of their time, knowledge, and experience. our management believes strongly in human resources. excellent compensation, recognition, opportunity for growth, and pride motivate our employees, as well as 196,755 independent beauty 65 consultants. a key element in the mary kay success equation is the company's organizational structure which stimulates individual and group creativity, communication, and performance. this results in a high level of personal satisfaction, which in turn is reflected in high productivity. this success-oriented attitude leads everyone to new heights and greater achievements. achievements which are based on discipline and determination, and mean growth for each individual as well as the company. (source: mary kay cosmetics, annual report, 1982, p.5) conclusions developing an effective mission statement is a primary responsibility of chief executive officers. many practitioners recognize mission statements as an important strategic management tool, but published research on mission statements is limited. additional studies are needed before general recommendations can be made regarding the composition of mission statement documents. profiles of the mission statements of high performing firms versus low performing firms need to be developed by size of firm and type of industry. the present study provides insight to managers who may be in the process of developing, writing, and evaluating a formal mission statement. specific components to include in writing a mission statement are exemplified through the mary kay cosmetics document. the results of this study provide a basis for devising and investigating future research hypotheses to extend management's understanding of the relationship betwen mission statements and other organizational variables. the relationship between mission statements and organizational development, employee motivation, communication systems, and social responsibility needs examination. differences between the composition and intent of business unit and corporate mission statements should be explored. further research could determine particularly effective uses of mission statements. additional information regarding mission statements could allow these documents to become an effective tool for improving corporate performance. references 1. cochran, d.s., f.r. david, and c.k. gibson. "a framework for developing an effective mission statement." journal of business strategies, vol. 2, no. 1, fall 1985, pp. 4-17. 2. david, f.r. fundamentals of strategic management. columbus, or: merrill publishing company, 1986. 3. david, f.r. and cochran, d.s. "mission statements: an important strategic tool." long range planning, 1987 (in press). 66 4. drucker, p. management: tasks, responsibilities, and practices. new york, ny: harper & row, publishers, 1974. 5. hambrick, d.c. and lei, d. "toward an empirical prioritization of contingency variables for business strategy." academy of management journal, vol. 28, no. 4, december 1985, pp. 763-788. 6. mcginnis, v.j. "the mission statement: a key step in strategic planning." business, november-december 1981, pp. 39-43. 7. pearce, j.a., ii. "the company mission as a strategic tool" sloan management review, spring 1982, pp. 15-24. 8. pearce, j .a., ii and david, f.r. "corporate mission statements: the bottom line." academy of management ezecutive, vol. 1, no. 2, may 1987, pp. 109-116. 9. want, j .h. "corporate mission: the intangible contributor to performance." management review, august 1986, pp. 46-50. 67 a study of mission statements among large u.s. manufacturers strength of organizational culture and performance: strategic implications charles m. byles oklahoma state university stillwater, oklahoma robert .t. keating university of north carolina at wilmington wilmington, north carolina in the last decade, the concept of a "strong culture" has been in vogue among academicians ([8],[23]) and practitioners. concerns about the increased complexity and turbulence in the macroenvironment and industry with its potential to increase costs or erode revenues have shifted attention toward the financial viability of wellentrenched values and beliefs (i.e., a "culture"). one line of thinking holds that such strong cultures arc financially viable because they provide direction [8] and reduce the need for explicit control mechanisms such as extensive reports, policies, procedures, and direct supervision [231. in addition, strong cultures provide pathways for executive and rrriddle management decisions by capturing the essence of what has worked well in the past ([19],[23]). thus, with a reduction in the need for monitoring and guiding, executives are ahle to focus upon the creative task of developing new strategies or rethinking old ones. similarly, rrriddle managers can devote greater portions of time to increasing the efficiency or innovativeness of processes for which they are responsible. however, despite these advantages, strong cultures made up of values and beliefs which fundamentally underrrrine the competitive advantage of the firm would be undesirable. for example, where a firm derives a distinct advantage from offering superior quality products, a widely held value of short-run profitability through cost containment will, in the long-run, undermine such an advantage. it seems logical that the viability of a strong culture depends on the extent to which it supports the competitive needs of the firm at a particular time. the research focus in this area ought to be directed at first exploring broa.dly the internal and external conditions for a firm which necessitate a strong or weak culture. a second step should delineate the specific recommendations for particular kinds of firms and industries. while much culture research to date has concentrated on content issues such as martin and siehl's [17] exposition of core values (such as respecting authority, fitting in, and being loyal) at general motors and barney's [3] "valuable, rare, and imperfectly imitable" cultures, others have paid more attention to cultural strength. specifically, peters and waterman found that better performing companies had "a well defined set of guiding beliefs ... " ([23], p. 251). similarly, deal and kennedy [8j journal of business strategies, volume 6, number 1 (spring 1989) 42 spring 1989 byles fj keating: culture and performance 43 have argued that cohesive values in japanese firms contribute significantly to their success. the paper has three purposes. first, "culture" and "cultural strength" are defined. second, the outcomes of strong cultures are discussed. third, implications of culture for organization theory and strategy implementation are discussed. finally, the relationships between cultural strength and strategy formulation are explored. very generally, it is suggested that very strong cultures do not develop easily in all organizations and do not contribute to feelings of belongingness and satisfaction [8], and thus indirectly contribute to positive organizational performance through increased commitment. but at the macro level, a strong culture may discourage executives from making radical strategic changes in the face of new external opportunities and threats (such as gm's undue emphasis on profits and cost control without much concern for its effect on its many stockholders) [36]. similarly, where organizational members have been encouraged to do things in a particular way, they can be expected to resist when required to make radical changes in response to a different strategic focus. it seems then that the ceo's role is to develop a balance between the advantages and disadvantages of having a strong or weak culture. this balance is ultimately developed through considerations of the fit between culture, environment, and strategy. definitions of organizational culture and cultural strength organizational culture is commonly defined as a network of shared values, beliefs assumptions, or ideologies ([8]'[19],[20]'[25]'[26],[28]'[331). stories, symbols, rituals, and language systems are sometimes' included in definitions of culture but will only be cqilsidered here as the more visible means by which culture is communicated. culture provides the means by which organizational members interpret their social context and hence it governs the interaction of members with stakeholders and resources. as a result, culture has an indirect effect on the formulation of both strategic and administrative decisions. culture can be distinguished from the similar concept "organization climate." climate typically measures whether people's expectations in the organization are being met while culture is a reflection of the expectations themselves. some research on the content of culture identifies specific characteristics such "product quality emphasis", "profitability emphasis" [29] and "respect for the individual" [6]. others, such as barney [3] are less specific, but conceptualize cultures as being "valuable", "rare", or "imperfectly imitable". besides the content of culture, the extent to which certain values and beliefs are widely shared is a measure of its strength. at one extreme, (see figure 1) one may speak of a "strong" culture (in the strict sense) in which values and beliefs are widely shared across decision-making levels, functional units, and divisions. this would be synonymous with the idea of a single culture which is probably quite rare if not nonexistent in most organizations. at the other extreme is the weak culture in which values and beliefs differ across decision-making levels, functional units, and divisions. these values and beliefs will typically oppose one another, thereby producing a number 44 journal of business strategies vol. 6, no.1 of countercultures. between these extremes, one may conceptualize the organization with a dominant set of core values (such as "innovation is our key competitive strength" or "customers come first") existing along with subcultures which may support or oppose the dominant culture values. typically, a "strong culture" is identified as being one which falls towards the left on the continuum in figure 1. similarly, a "weak culture" would be one which falls towards the right in the same figure. in accordance with this, the terms "strong" and "weak" will be used throughout this paper to refer to the "loose definitions" in figure 1. figure 1 classification of strong and weak cultures -~-------~-strict strong culture (single culture) , dominant-core vj;~s ----with supporting, neutral, or opposing subcultures strict weak culture (countercultures) v range for loose definition of strong culture range for loose definition of weak culture outcomes of strong cultures those who argue that strong cultures are associated with positive performance outcomes ([8],[23]) do so on the basis of two propositions. first, strong cultures provide day-to-day and strategic decision guidelines which clarify tasks and hence increase performance. second, strong cultures instill feelings of belonging and identification with a particular organization, increasing commitment, and hence increasing performance. figure 2 hypothesized effects of a strong culture on organizational performance (based on deal and kennedy [8] and peters and waterman [23]) functions of cj!lture proposition 1 provision of pathways and integration hypothesized relationship to performance + goal clarity + individual and ---+ and ---+ organizational coordination performance proposition 2 support and identification + organization + ---+ commitment ---+ individual and organizational performance perhaps the most forceful argument in favor of strong cultures is presented by deal and kennedy who argue that "the people who built the companies for which america spring 1989 byles & keating: culture and performance 45 is famous all worked obsessively to create strong cultures within their organizations" ([8]' p. 8). they attempt to support this in two ways (which are methodologically questionable). first, deal and kennedy cite an informal study among mckinsey consultants which concluded that from a sample of 80 firms, the 18 top performers all had strong cultures. second, in order to follow up the initial evidence, they examined biographies of successful business leaders such as thomas watson (ibm), will durant (gm), william kellogg (kellogg's), and others. this led deal and kennedy to conclude that a unique characteristic of these leaders was their building of a strong culture within their firms. the specific influence of culture on performance is explained in two ways. first, they argue that "(a) strong culture is a system of rules that spelt exactly how people are to behave most of the time" ([8j, p. 15). second, a strong culture "enables people to feel better about what they do, so that they are more likely to work harder" ([8), p. 16). the second major proponents of the link between strong culture and positive performance are peters and waterman [23]. they point out that all the "excellent" companies had a strong culture (i.e. hands-on, value-driven). to quote: without exception, the dominance and coherence of culture proved to be an essential quality of the excellent companies. moreover, the stronger the culture and the more it was directed toward the marketplace, the less need was there for policy manuals, organization charts, or detailed procedures and rules. in these companies, people way down the line know what they are supposed to do in most situations because the handful of guiding values is crystal clear. ([23], pp. 75-76) peters and waterman also emphasize the "support and identification" role of culture, although indirectly. this is done primarily in their discussion of "productivity through people" (chapter 8), where it is emphasized that excellent companies emphasize respect for the individual by viewing that individual as an integral part of the organization. this is evidenced by a number of practices such as full employment in times of recession, and referring to employees as "crew members" (mcdonald's), "hosts" (disney), and "associates" (j. c. penney). the hypothesized effects on organizational performance (figure 2) are that through increasing goal clarity, coordination, and commitment, strong cultures function to enhance organizational performance. in light of research on goal setting, it may be argued that proposition 1 in figure 2 is partially supported. for example, latham and baldes propose that "the setting of a goal which is both specific and challenging leads to an increase in performance because it makes clear to the individual what he is supposed to do" ([15], p. 173). however, the claim of "partially supported" is employed because culture provides only general guidelines.' other writers such as sathe [25), schein [26], and wilkins [35) have stated that this is a major function of culture. the second proposition is questionable. there is some evidence that culture is connected to commitment [34j and that commitment leads to positive job outcomes 46 journal of business strategies vol. 6, no.1 such as effort, retention, attendance, job involvement [31], and turnover reduction [2]. but the assumption of a simplistic relationship between commitment and positive performance outcomes is seriously questionable [2]. in the next section, the extent to which the two propositions about strong cultures have affected thinking about the role which culture plays in the execution of day-today tasks in organizations is explored. in a subsequent section, the culture's role in strategic decision-making is addressed. implications for organization theory and strategy implementation the two basic functions of culture articulated by peters and waterman [23j and deal and kennedy [8] were traditionally treated through concepts from the bureaucratic and human relations schools [22]. as summarized in table 1, bureaucracy provided guidance through rules and procedures, task specialization, and an explicit hierarchy of authority [7]. integration of activities took place through the use of task forces, teams, and committees [11]. the support and identification function was originally suggested by the human relations school [21) beginning with ideas developed from the hawthorne study. the human relations model essentially argued that considerate leadership and allowing people to realize their higher order needs such as autonomy and self-actualization were all associated with higher performance levels. table 1 'iraditional and cultural models traditional (macro/micro) cultural bureaucracy school rules, company philosophy, direction procedures; leadership values, beliefs. path goal; mbo goal setting; motivation (pr) support human relations, human ceremonies, stories, heroes, and resources, leadership, recognition (e.g., "salute identification job redesign to the stars" and "pink cadillacs" at mary kay; "beer busts" at hewlettpackard today, guidance and control of employees is frequently based on a cybernetic model of some kind [13] where standards are set, accomplishment is measured and variance information is fed back to the participant. drucker's [9] concept of management by objective (mbo) is a kind of cybernetic model, different only from the traditional in that those being "controlled" are allowed some participation in the standard setting process. although the cybernetic models have limitations, according to hofstede they seem to be widely used in management practice today. spring 1989 byles fj keating: culture and performance 47 it seems then that up until the identification of culture as a management concept, the "guidance" and "support and identification" functions were carried on in organizations by managers who drew on concepts from the bureaucratic and human relations schools, as well as other concepts such as mbo. more recent refinements in human relations (the human resources or organizational behavior approaches) have developed a number of models in leadership ([10],[14]) and motivation ([1],[161,[18)) which have specifically addressed the handling of human resources. table 2 organizotional level function of middle & upper level culture non-monoger5 monogers task characteristics: task characteristics: simple, routine complex, changing pathways culture provides guidculture provides guide& ance when surprises occur lines for coping with integration that are not covered by continuous anlbiguity. a rule or policy. culture cultural control is more red uces the need for uprational under 5uch conward referral and tradiclitions than the traditional integration mechational cybernetic control rllsm5, such as task forces, mechanism" committees, and mutual adjustment .• ~_._----------_.. _.-------support where jobs possess few culture provides an & intrinsically satisfying understanding of the identification features, culture may promain purpose of the vide identification and organization and allevisupport through shared ates managerial frustraways of doing things tions through stories of ("groupness" ).e this inother similar problems creases understan ding in the past. for, and identification v..ith the whole organization. "see galbraith [11] for an exposition of these mechanisms. bsee hofstede [13]. hofstede argues that the cybernetic model is not appropriate for conditions where standards do not exist, accomplishment is not measurable, and feedback information cannot be used. cschein [26] argues that "(t)he process of culture formation is, in 8 sense, identical with the process of group formation in that the very essence of 'groupness' or group identity the shared patterns of thought, belief, feelings, and values that result from shared experience and common learning is what we ultimately end up calling the 'culture' of that group." (p. 50) 48 journal of business strategies vol. 6, no.1 a "strong culture" now seems to be offered as a "substitute" and "complement" to bureaucracy, leadership, and motivation. as shown in table 2 culture may function as a substitute or complement at two organizational levels. for fairly simple and routine jobs characterized by specialization, social isolation, and little task significance, culture provides identification with the organization and in part substitutes for that which is lost in jobs with little prestige and autonomy. the culture allows the worker to identify with a larger more significant job. for example, at mary kay cosmetics, beauty consultants (sales representatives) are made to feel that they are truly an important part of the company through ceremonies (the salute to the stars) and the general pomp and show that accompanies their tenure at the company [32]. thus, in line with hackman and oldham's [12] job characteristic model, culture has the potential for increasing the meaningfulness of work (albeit indirectly) by bringing the individual in touch with the organization and alerting him to its broader purpose. in essence then, where the organization cannot enrich the job, and hence contribute to pride in work, it attempts to appeal to a broader definition of pride pride of working for that particular organization. thus, culture to some degree "substitutes" for supportive leadership practices, especially where the task is not intrinsically satisfying or where the employee is socially isolated. in higher level jobs where there is difficulty on clearly determining jobs and measuring performance, culture provides broad guidelines of what the executive needs to do to achieve success. as noted by hofstede [13], cybernetic models do not work under such conditions. strength of organizational culture and strategy formulation strategists have three basic roles. first, they must select from the repertoire of rational models (for example, pims, portfolio planning, environmental analysis, and porter's industrial analysis framework) those which enable the organization to identify external opportunities and threats. second, they must convince their colleagues that this more time-consuming approach is justified by (1) the complexity of the problem at hand, and (2) the potential payoffs of a more accurate decision. third, they must convince those involved in implementation to go along with the recommendations coming out of the formal plan. at this point, strategic decision makers face the problem of overcoming precedents set by the prevailing culture (akin to starbuck's [30] "behavior programs"). this culture has (broadly and non-specifically) laid down guidelines for completing both strategic and day-to-day tasks. the culture implicitly tells decision-makers which markets the firm traditionally competes in and how it interacts with its various stakeholders. where strategic decision-makers perceive the need for radical change, they are unlikely to be supported when the firm has experienced past success with an established strategy. for example, in john delorean's account of events at general motors, he describes the rationale for automobile design and building: "(m)ore than one car was built and designed a certain way because a top executive thought it was spring 1989 byles f'1 keating: culture and performance 49 a nice car, despite numerous marketing analyses that dictated a different approach" ([36], p. 149). in attempting to explain why this mode of decision-making was so prevalent at gm, delorean continues, "(f)or the most part, a top executive by the time he works his way through the system is a carbon copy of his predecessors. if the men in place cannot do the job, there is no reason to believe that their hand-picked successors can. there never was, in most of my days ";1th general motors, an attempt to a.na.lyze previous corporate decisions to see if they were right for the company, and to use this information in perfecting the management pror:ess of the future" ([361, p. 215, emphasis added). it should be emphasized that delorean spoke of a mode of decision-making which had strategic implications for the firm. in business week's later accounts of gm's response to ·the fall in gasoline prices in the early 1980s, it seems that this mode was still in place. why didn't gm respond? one explanation: executives became more intent on carrying out the program than in asking whether it made sense. "the presumption was that whatever we were doing was very, very, good," recalls gerald p. hirschberg, a former chief designer for pontiac and buick who is now director of design for nissan design international inc. in san diego. the company was full of executives, including designers, who only had to keep things going. the muscles of creativity atrophi(>d. ([4), p. 105) in many organizations, decision-makers resist changes in the interest of preserving the wellbeing of the organization and hence their own survival, even if the decisions made are misguided. this resistance is not irrational, but instead reflects a different belief about how strategies should he developed. in reality, most decision-makers depend on both analytical and traditional/cultural guidelines. however, the cultural guidelines are usually less costly in the short term, and not as intellectually exhaust· ing. in many ways, the culture acts as a mechanism of "programming" the decision process in a manner similar to programming via rules. the major difference is in the breadth of the guidelines rather than its overall results. in this manner, culture places a limit on the number of alternatives to be considered when a problem is encountered. the decision-maker will then choose the most readily available alternative within the mix of potential solutions. very frequently, unless the firm is faced ",;th severe external conditions which challenge its very existence, the array of decisions considered will not move toward a more exhaustive analysis of the forms internal and external situation. in addition, if an exhaustive analytical process challenges the current strategy or suggests major internal changes, the decision-maker may allow cultural norms to override and influence in the organization. the proponents of analytical approaches to strategy formulation attempt to "sell" it through supporting evidence that it allows the firm to achieve higher performance levels ([5],[24],[27]). nevertheless, analytical decisions in organizations are constrained by the "conventional wisdom" which is frequently disseminated through a system of 50 journal of business strategies vol. 6, no.1 stories, legends, and ceremonies in addition to other formal control mechanisms such as rules, procedures, and reward systems. this "conventional wisdom" will remain in place despite sm"li challenges to its viability. until an adequately severe challenge is faced which threatens the existence of the firm (for example, those introduced by japanese firms to the automobile and electronics industries), the "conventiona: wisdom" will remain intact. recent challenges to u.s. management practices by japanese firms, especially in areas of product quality and handling of human resources, have been this sort of adequately severe challenge. only where a superior practice was identified which translated into a competitive advantage did companies react and look inward with the hope of modifying these practices. the preceding discussion has shown that culture is important in the strategy process. but under what conditions are strong or weak cultures appropriate? conditions favoring strong or weak cultures the position that strong cultures are always bett.er than weak ones may he rejected. while culture cannot be "managed," the ceo will influence the direction which cultural development takes. the ceo must recognize the tradeoff of cohesiveness and direction provided by a strong culture, with the inability to change easily in response to new opportunities. some will argue that strong cultures, emphasizing innovation and change, do not present difficulties to the firm where major change is needed. but this argument can be misleading. many firms with these "innovative" cultures will resist change to bring about a more mechanistic and efficiency-oriented system as requirea in pursuing a cost leadership strategy. the reasoning is simple. those comfortable with the ambiguity and challenge of an innovative or flexible culture will prob-ably not find a more routine and mechanistic environment to their liking. strong cultures are appropriate if they allow the firm to focus on the "right" things, irrespective of whether the firm is operating under stable or turbulent conditions. thus, the strong culture which specifies the manner of environmental linkage (i.e., the customer comes first) or c.ertain internal practices which allow the firm to be successful in its industry (i.e., "innovation is important," "failure is tolerated") 'nill be a better performer to the extent that the culture emphasizes a critical success factor. a strong culture is also appropriate to the extent that it emphasizes true diversity in approaches to problems. this is not easily attained in practice as many growing and "innovative culture" firms may resist becoming more mechanistic as this could entail the loss of some freedoms associated with a looser structure. at any transition point in the life of a firm, it is primarily the ceo's role to anticipate change and prepare the firm for this transition. weak cultures are appropriate in stable or turbulent environments if firms in that industry are young, and if no superior methods of doing things have been established. firms at this stage are experimenting and the culture is slowly beginning to develop. usually, a weak culture in a stable environment is acceptable in the short run, but it must soon move towards being strong. in a turbulent environment, weak cultures spring 1989 byles fj keating: culture and performance 51 are often found in young firms and at transition points. to the extent that a mismatch between the firm and its environment exists, the prevailing culture may weaken somewhat as transitions occur. at this point, the ceo is either instrumental in such changes, or a new ceo with different views has taken over. table 3 summarizes these points. tobie 3 appropriate conditions for strong and weak cultures environment stable turbulent appropriate if allows true flexibility. usually bet ter in smaller firms. appropriate if allows firm to focus on critical issues. i .... c1e~j~ecll movement· appropriate in short-run only where technologies are evolving. i appropriate as firm goes through ! transition, or where a young firm i is trying to find new ways of l..-'-i._a...p...p_ro_a_c_h_ing_its_ind.':l~try.__ summary, conclusions, and research questions "weak culture" "strong culture" while a strong culture has positive outcomes with administrative tasks through the provision of direction and support, it generally may not have positive consequences in turbulent environments where rapid strategic change is needed. to the extent that the culture does emphasize true flexibility and openness, the firm may adapt well to environmental demands. but the possession of an "innovative culture" alone is not enough. events at apple computer, necessitating a change toward a different kind of structure, required the influence of a new executive. strong cultures are typically best where they focus the firm's energies on critical success factors and, at the same time, provide room for generating and implementing new ideas. this situation is similar to "moderately strong cultures" which consist of dominant core values with supporting, neutral, or opposing subcultures. weak cultures exist in young firms and are appropriate where the firm needs to find new ways of doing things. as the firm gains an understanding of its environment and industry, its values and beliefs begin to strengthen and provide overall guidance to the firm. in stable environments, weak cultures may be appropriate in the short term, but as an understanding of the firm's environment develops and its cultures become stronger, the firm will realize the benefits of a strong culture. weak cultures are primarily useful in facilitating transitions whereas strong cultures will inhibit them. in concluding, three major research questions are suggested. first, do strong cultures, foster commitment and individual performance as proposed in figure 2? second, how can firms diagnose and change their cultures in order to more appropriately match environmental conditions? finally, how can strategic managers overcome 52 journal of business strategies vol. 6, no.1 values and beliefs that fundamentally undermine the competitive advantage of the firm? references 1. adams, j. s. "inequality in social exchange." in 1. berkowitz (ed.), advances in experimental .'locial psychology, vol. 2, pp. 267-299. new york, ny: academic press (1965). 2. angle, h. l. and perry, j. l. "an empirical assessment of organizational commitment and organizational effectiveness." administrative science quarterly, vol. 26 (1981), pp. 1-14. 3. barney, j. b. "organizational culture: can it be a source of sustained competitive advantage?" academy of management review, vol. 11 (1986), pp. 656-665. 4. business week. "general motors: what went wrong?" march 16, 1987. 5. camerer, c. "redirecting research in business policy and strategy." strategic management journal, vol. 6 (1985), pp. 1-15. 6. chace, s. "the corporate culture at ibm: how it reinforces strategy." in a. a. thompson, a. j. strickland, and w. e. fulmer (eds.), readings in .'ltrategic management. plano, tx: business publications inc. (1984). 7. daft, r. l. organization theory and design, 2nd edition. st. paul, mn: west publishing company (1986). 8. deal, t. e. and a. a. kennedy. corporate cultures: the rites and rituals of corporate life. reading, ma: addison-wesley (1982). 9_ drucker, p. f. the practice of management. london, england: pan books. (1968; first edition 1955). 10. fiedler, f. e. a theory of leadership effectiveness. new york, ny: mcgrawhill (1967). 11. galbraith, j. r. "matrix organization designs." business horizons, vol. 14 (1971), pp. 29-40. 12. hackman, j. r. and g. r. oldham. work redesign. reading, ma: addisonwesley (1980). 13. hofstede, g. "the poverty of management control philosophy." academy of management review, (1978), 450-461. 14. house, r. j. and t. r. mitchell. "a path goal theory of leadership." journal of contemporary business, vol. 3 (1974), pp. 81-99. spring 1989 byles fj keating: culture and performance 53 15. latham, g. p. and j. j. baldes. "the "practical significance" of locke's theory of goal setting." .journal of applied psychology, vol. 60, (1975), pp. 122-124. 16. luthans, f. and r. kreitner. organizational behavior modification. glenview, il: scott, foresman and company (1975). 17. martin, .j. and c. siehl. "organizational culture and counterculture: an uneasy symbiosis." organizational dynamics, (autumn, 1983), pp. 52-64. 18. j\'litchell, t. r. and 1. r. beach. "a review of occupational preference and choice research using expectancy theory and decision theory." .journal of occupational psychology, vol. 99 (1976), pp. 231-248. 19. ouchi, w. g. theory z: how american business can meet the .japanese challenge. reading, ma: addison-wesley (1981). 20. pascale, r. "fitting new employees into the company culture." fortune, vol. 109 (1984), pp. 28-43. 21. perrow, c. complex organizations: a critical essay, 3rd edition. new york, ny: random house (1986). 22. perrow, c. "the short and glorious history of organization theory." organizational dynamics, (summer, 1973). 23. peters, t. j. and r. h. waterman. in search of excellence: lessons from america's best-run companies. new york, ny: harper and row (1982). 24. porter, m. e. competitive advantage. new york, ny: free press (1985). 25. sathe, v. culture and related corporate realities. homewood, 11: richard d. irwin (1985). 26. schein, e. h. organizational culture leadership. san francisco, ca: josseybass (1985). 27. schoeffler, s., r. d. buzzell, and d. f. heany. "impact of strategic planning on profit performance." harvard business review (march-april, 1974). 28. schwartz, h. and s. m. davis. "matching corporate culture and business strategy." organizational dynamics (summer, 1981), pp. 30-48. 29. siehl, c. and j. martin. "the role of symbolic management: how can managers effectively transmit organizational culture?" in j. g. hunt, d. hosking, c. a. schriesheim, and r. stewart (eds.), leaders and managers, new york: pergamon (1984). 30. starbuck, w. h. "organizations as action generators." american sociological review, vol. 48 (1983), pp. 91-102. 54 journal of business strategie.~ vol. 6, no.1 31. steers, r. m. "antecendents and outcomes of commitment." administrative sciences quarterly, vol. 22 (1977), pp. 45-56. 32. thompson, a. a. and a. j. strickland. strategic management: concepts and cases, 4th edition. plano, tx: business publications, inc. (1987). 33. trice, h. m. and j. m. beyer. "studying organizational cultures through rites and ceremonial." academy of management review, vol. 9 (1984), pp. 653-669. 34. wiener, y. "commitment in organizations: a normative view." academy of management review, vol. 7 (1982), pp. 418-428. 35. wilkins, a. l. "the cultural audit: a tool for understanding organizations." organizational dynamics (autumn, 1983), pp. 24-38. 36. wright, j. p. on a clear day you can see general motors. grosse point, mi: wright enterprises (1979). strength of organizational culture and performance: strategic implications the analytical hierarchy process as a technique for retail store location selection roger j. calantone university of kentucky lexington, kentucky c. anthony di benedetto university of kentucky lexington, kentucky martin s. meloche east carolina university greenville, north carolina store location is perhaps the most important factor affecting the ultimate success of a retail business. an unfavorable site selection is a potential hindrance to consumer awareness, and additional promotional expense may be necessary to compensate. the store location decision is typically much less easily changed, once a commitment is made, than promotional or product decisions. furthermore, competitors may aggres· sively respond to a store opening in an important territory, and major changes in the legal or social environment may affect the chances for success at a given location. moreover, the store location decision is likely to be made by a number of managers, all' of whom may have different perceptions of the relative attractiveness of various locations under consideration or different criteria for selecting an optimal location. this article illustrates how a location model based upon the analytical hierar· chy process (ahp) can be applied to the store location decision. the article will show how an ahp store selection model can handle these complications which make location selection a difficult process. ahp is a useful technique for structuring mul· ticriteria decisions it identifies the preferred alternatives, based totally upon the respondent's judgment, intuition and experience. the ahp technique has certain properties which make it attractive for application to this decision: it requires only easily-obtainable, inexpensive data, and actively incorporates in fact, is driven by managers' subjective judgment inputs. furthermore, the "expert choice" version is inexpensive to use in terms of both time and money, even when sensitivity analysis is employed. traditional retail location models among the store location decisions facing the retailer is the choice of optimal site(s) from a set of identified possibilities and deciding the best store configuration (i.e., size, design, layout) ([25], p. 445). a number of classes of location selection journal of business strategies, volume 6, number 1 (spring 1989) 61 62 .journal of business strategies vol. 6, no.1 techniques have been proposed and discussed in the literature, including checklist methods, analog approaches, regression models, and location allocation models. in the checklist method, the manager evaluates a set of factors (such as demographics, level of competition, and expenditure patterns) that are likely to have an effect on sales and costs at various sites [5]. for a discussion of problems with checklists, see stanley and sewall [34j. under the analog approach, the manager chooses an existing store or stores which match the proposed store on important variables (store type, competition, site, etc.). sales volume for the proposed store is estimated using the per-capita sales volume of the analog store(s). this method reportedly is popular among retail managers [1]; however it suffers from selection bias in determining the analog store. regression models use multiple regression to analyze the determinants of performance. performance is expressed as some function of a collection of performance factors (i.e., distance, image, etc.). for a general statement of the functional relationship, see haynes and forthingham [15]. anderson [2j provides an application of this technique, and other examples are present in the literature ([4],[7],[28]). common problems of multiple regression models are reviewed by craig, ghosh, and mclafferty [5j. location allocation models are used to evaluate simultaneously a set of facility locations, with the intent of optimizing market area sales or profits. the main objective in location allocation models is to "allocate" customers across store locations (existing and proposed), to predict resulting sales and profits. the huff model ([18],[19],[20]) is a simple location allocation model, based on a gravity model, that determines probability of shopping at a given store as a function of size and distance. related models and discussions appear in ([3],[9],[10],[16j, [211,[22],[34],[35]). another simple location allocation model, multiloc ([1],[38]), is a multiple store extension of the basic huff approach. more complex location allocation models include the multiplicative competitive interaction (mci) model of nakanishi and cooper [27], which incorporates many store attributes in addition to size in projecting sales volume, such as store image, location, and credit availability (see [23]). for sample applications, see ([14j,[16j,[17]). certain other location allocation models have also been developed ([8j,[101,[11],[12], [13]'[26]). many of these are generalizations of the mci or multiloc models suitable for application in specific complex environment. for example, the game-theoretic approach of ghosh and craig [10j is appropriate when the retail environment is unstable. in the application of the more complex models, data requirements, cost, and complexity of use are comparatively high. for a good review of the literature on location models, see craig, ghosh, and mclafferty [5]. limitations of traditional models and potential contributions of ahp there are some drawbacks associated with the use of the currently available store location models. the simpler models are easy to understand and apply, and use readily available data.. however, much useful data are ignored, such as store attributes, spring 1989 calantone) et ai.: retail store location 63 environmental characteristics, competitive retaliation, and so on. these models also provide no guidelines for extension to more difficult problems. on the other hand, the more complex location allocation models are capable of handling very complex problems but data collection requirements and resulting costs may be prohibitive. additionally, managers may not be receptive to a highly complex model (which they may not fully understand) making location decisions for them as they may not feel involved in the decision-making process. none of the current versions of the complex models described above incorporates the subjective inputs of multiple decision makeis. ideally, the decision process should combine judgment based on objective analysis of relevant data (sales, costs, etc.) with subjective inputs from expert managers. a location decision model based on the analytical hierarchy process (ahp) overcomes several significant drawbacks of both simple and complex methods. it has relatively low data requirements and is relatively simple and inexpensive to apply. nonetheless, ahp is capable of handling situations with many factors that can have an impact upon sales or profits, such as environmental uncertainties, nature of the competition, new store types, etc. it also provides the advantage of permitting several managers to provide subjective inputs. in fact, an appealing feature of ahp is that the decision maker is actively involved in the decision process his or her managerial expertise, experience, and intuition are reflected in judgments which drive the model. making the location decision with ahp the ahp approach to modeling allows one to structure complex, multiperson, and multicriteria decisions using a practical method directly accessible by managers. numerous applications have been developed in such diverse areas as economic planning, energy policy, health, conflict resolution, materials purchasing, portfolio selection, accounting, sociology and architecture ([61,[33j,[36]). a recent review by zadehi [37 listed well over 200 published applications. according to johnson [24], the ahp involves four basic steps: step 1: set up the decision hierarchy by breaking down the decision problem based on managerial purposes (top levels) through relevant intermediate levels, down to the level where the problem can be operationally solved. this resuits in the construction of a tree-like hierarchical model, such a.~ appears in figure 1. step 2: collect input data in the form of pairwise contributions of each element with regard to the objective of criterion on the next higher level. ("pairwise" means that the elements are taken two at a time, and the extent of one's impact relative to the other is assessed.) step 3: solve the eigenvalue problem of the matrix specified in step 2 to estimate the relative weights of the decisions elements (for each matrix). step 4: aggregate the relative weights of decision elements by hierarchical composition to obtain composite priorities of the elements at each level. simply put, given the hierarchical model of step 1 and the input data of step 2, the weights 64 journal of business strategies vul. 6, no.1 of each branch of the hierarchical tree are calculated (step 3), and the available choices are ranked in order of how well each would achieve the manager's stated objectives (step 4). figure 1 complete hierarchy: store location decision scenarios objective criteria objective domains stores segment 1 segment 2 segment 3 segment 4 segment 5 store 1 store 2 store 3 store 4 store 5 store 6 segment 1 segment 2 segment 3 segment 4 segment 5 store 1 store 2 store 3 store 4 store 5 store 6 segment 1 segment 2 segment 3 segment 4 segment 5 --] i store 1 i store 2 store 3 store 4 store 5 store 6 transport services union management employees store 1 store 2 store 3 store 4 store ii store 6 initial $$ rent and mortgage maintenance special $$ store 1 store 2 store 3 store 4 store 5 store 6 legend: goal: pick the best store location. scenarios: planmost likely scenario. risk worst case scenario. opportunity best case scenario. objective criteria: distaoce distance preference of each segment for each store. size width of product line preference of each segment for each store. appeal attractiveness preferences of each segment for each store. network importance of each providing function for each store. costs -cost category importance impact for each store. note: for additional explanation, please refer to the appendix. "expert choice" software (decision support software inc.) is a commercially available ahp package. although the problem complexity it can handle is slightly constrained, it is mathematically consistent with the "true" ahp procedure. given spring 1989 calantone, et al.: retail store location 65 figure 2 detail of hierarchy for plan sceilario: store location decision distance egment 1 egment 2 segment 3 segment 4 segment 5 initial $$ rent and mortgage maintenance special $$ the hierarchical model and input data, it performs the mathematical computations to produce the weights and priorities of steps 3 and 4. the availability of this software makes ahp accessible to a larger number of potential users. sample application of ahp to retail location we illustrate the application of ahp to store location using the example of a fast-growing, but small, midwest grocery chain (prior obligations require anonymity of the chain). the chain must open one new store (to be chosen from a set of six possibilities) in one geographic sector of kentucky during the next planning period. although some details of the problem are simplified for illustrative purposes, several real world externalities have been included for consideration, such as management's concern for employees, management and union preferences, and likelihood.s of resistance. also, various multiple objective or two-level concerns such as profitability and size (square footage) which may he highly correlated over locations ~ possibly nonlinearly ~ are considered. let us examine the ahp-aided decision process step by step. step 1. the ahp was used to guide the selection of the best store from the six potential sites. a hierarchy was developed jointly by the researcher and the vice-president for retail operations and is shown as figure 1. some detail is lost in this figure due to the complexity of the problem, so an expanded view containing only the plan scenario is shown in figure 2. 66 journal of business strategies vol. 6, no.1 figure 3 results of pairwise comparisons: likelihood of scenarios risk plan opportunity risk 1 5 1 figure 1 indicates that, given the overall goal of picking the best store, one must consider several levels of criteria. at the highest level is the realization that the environmental situation (competitive reaction, economic conditions, consumer reactions, etc.) may occur as foreseen by management ("plan"), may be worse than foreseen, leading to lower profits ("risk"), or may be better than foreseen ("opportunity"). at the next level, five objective criteria (selected by the manager as being the most important criteria in store selection) are detailed. under each of these criteria is a set of objective domains specific to each store's ultimate profitability. the criteria selected by the manager were distance, size, appeal, network and costs, whose operational definitions for this study appear in the appendix. under the objective criteria are the objective domains (see figures 1 and 2). for network and costs criteria, the relevant objective domains are as listed in the figure. for the distance, size and appeal criteria, sales potential of each market segment was selected as the appropriate objective domain. since the projection of potential sales at each store location requires the evaluation of distance, store size, and appeal on a segment-by-segment basis, one must also adjust for some segments having greater sales potential than others, due to size or buying power. a useful way to incorporate sales potential into the model is to get the responding managers to assess subjectively the sales potential of each identified segment on a numerical scale, and to use these values to "weight" each segment's impact on sales in the model. thus, for each considered store location, the manager separately assesses both potential sales and the associated cost tradeoffs, as well as other relevant factors. under each of the objective domains are the "leaves" of the analysis (in this case, the six store locations). in order to pick the best store using this method, each of the six stores must be evaluated under the relevant eri terion for each scenario. step 2. the objective is for management to evaluate each level of the hierarchy by means of paired comparison rankings. the dominance scaling approach employing a scale of 1 to 9 suggested by saaty [33] is used. experience with the nine-point scale has shown that it provides a reasonable representation of the magnitude of the relationships between the items (see discussion in the expert choice manual, pp. 5-2 to 5-5.) spring 1989 calantone, et al.: retail store location 67 begin at the top of figure 1. the manager, when prompted by either the researcher's questions or the expert choice program, may say that the plan scenario is five times more likely to occur than either the risk or opportunity scenarios, which are equally likely. this input would result in the pairwise comparison table as shown in figure 3. the first row can be interpreted as: "risk is as likely to occur as risk; risk is one-fifth as likely to occur as plan; risk is as likely to occur as opportunity." the elements of the lower triangle are the reciprocal of the upper triangle; thus, only the data for the upper triangle of the matrix must be collected. the procedure was carried down to the next level, and so on. for example, at the next lower level, the relative importances of distance, size, appeal, network and costs in the location decision were pairwise compared by management. inputs were obtained in this manner for the entire process. step 3. in step 3, each input matrix is analyzed using the eigenvalue method to produce relative weights for each alternative under each objective. the argument for this solution technique is based axiomatically on saaty [33] and is discussed in ([29j,[30],[31j, [32j,[33]). briefly stated, if the evaluator could know the relative weights at each level, he or she would be perfectly consistent across the comparisons of step 2. since this is generally impossible due to problem size, the weights are evaluated for consistency using a consistency index based on the eigenvalues (weights) derived from the input matrices. by general agreement, 10% is taken as the baseline maximum inconsistency level in large problems, and 6% or less in small problems. incidentally, in a real decision-making situation, it is possible that inconsistencies may arise for example, the respondent may actually prefer x to y, y to z, and z to x. ahp will "flag" this seemingly inconsistent set of inputs by reporting a high inconsistency level. but, if the respondent confirms that these inputs accurately represent his or her subjective judgments, the ahp model uses them. in short, it can handle seeming inconsistencies in managerial judgment. the final synthesized weights for the objective criteria under the three scenarios were calculated by expert choice (see figure 4a). since these are global weights (that is, after synthesis), the plan objectives are weighted higher than those for risk or opportunity. however, it is easy to see that management has substantially different views of the importance of the objective criteria, depending on which scenario they are considering. simply comparing the within-scenario rank order of the objectives will reveal this tendency. compare the relative importance of the objective criteria under the risky scenario (column 1) in figure 4a to the importance obtained under the opportunity scenario (column 3). in the risky case, management would place greatest importance upon minimizing costs (global weight of 0.051 for cost is the highest). the network functions (0.024) are also important here. the only other criterion of importance is size (0.039), which refers to the width of product line available in the store. by contrast, under the opportunity scenario, importance shifts away from costs and network and 68 journal of busines.~ strategies vol. 6, no.1 toward the criteria of size, distance and appeal. management would take advantage of the greater opportunities in this optimistic scenario by opening a bigger store, closer to the major market segments, and by providing services and features (such as all in-store bake shop, photo lab, etc.) to increase attractiveness (appeal). the relative importances of the five objective criteria are more closely comparable under the plan scenario (all are within the range 0.114 to 0.139). figure 4 results of the ahp application a) final synthesized weights of criteria under each scenario distance (0.015) size (0.039) appeal (0.014) network (0.024) costs (0.051) distance (0.191) size (0.139) appeal (0.131) network (0.114) costs (0.139) distance (0.043) size (0.051) appeal 0.034) network (0.010) costs (0.005) b) synthesis of leaf nodes with respect to goal (overall store location ranking) store 2 store 1 store 6 store 4 store 3 store 5 (0.222) (0.211) (0.154) (0.150) (0.148) (0.116) step 4. step 4 aggregates and synthesizes all the weights calculated in step 3. these composite or global weights show the relative contribution or impact of the particular cell on the overall (global) objective of the ahp decision problem. the expert choice software performs all required computations and syntheses required 8jid checks for consistency levels; also, it allows the manager or researcher to re-input inconsistent matrices. the expert choice program solved for the full ahp result (not shown here in the interest of space) 8jid presented it in the form of a synthesized tree listing, as appears in figure 4b. in figure 4b, store 2 is shown as the overall best choice, being slightly preferred to store 1. stores 6, 4, 8jid 3 were closely clustered, while store 5 was clearly the spring 1989 calantone, et al.: retail store location 69 last choice among the six. this final ranking is the overall result of the synthesis of the dominance scaling of each leaf (store) under the hierarchy of decision criteria previously presented. the overall consistency in the model is 3% which may be considered a very good score for a moderate-sized problem such as this ([33],[37]). practical issues in model use the authors have used aup in this and other applications with favorable results. despite the apparent complexity of the model, most respondents are enthusiastic and curious about the technique, and express little difficulty in completing the paired comparison task. at any point in model construction or paired comparison elicitation, the researcher can stop, get the model up on the screen, and ask the manager if he or she is "comfortable" with the criteria and weights included so far. if not, these can be adjusted. as a final check, once the model is run, a visual representation of the rankings (figure 4b) is shown to the respondent, who then is asked whether the ordering as calculated by aup is an accurate representation of his or her own subjective orderings. thus, the respondent has an opportunity to review his or her input to the model, and the researcher can revise the entries according to the comments of the respondent. in the authors' experience, almost all respondents confirm that the model had indeed captured his or her understanding of the decision problem and in some cases were surprised at the insights provided in the results. many respondents (even those somewhat wary of personal computers) make favorable comments about the computer graphics contained in expert choice this appealing feature enhances their interest in the task. the authors feel confident in the solutions provided by aup, because of the high degree of interaction between manager and researcher. summary and conclusions the purpose of this article has been to offer the analytical hierarchical program approach as an alternative selection process to many of the techniques currently in use. the currently-available store location models all have certain limitations which have been briefly discussed. as a possible alternative, the aup approach reduces or eliminates many of these problems. the aup store location model presented here is a judgment-based model suitable in situations of a highly risky and unpredictable environment, as well as in less complex environments. it is a flexible process which overcomes the weakness of simple checklists and gravity models, which ignore much useful data, while being simpler to use than the math programming methods. although checklist methods may contain or list similar objectives to the ones included here, these approaches do not provide explicit rules for the selection of the best location, nor provide criteria such as environmental risk or instability of segment preferences. also, the methods based on integer programming have not yet been adequately extended to allow for multiple objectives, multiple decision makers, nor subjectively weighted goals. 70 journal of business strategies vol. 6, no.1 ahp relies heavily on managerial judgment for input, which can be eitht'r a strength or a weakness. on the one hand, it may have greater appeal among practicing managt'rs than the math programming models, and is less likely to be criticized by management for giving unrealistic answers, since the answers will reflect managerial thought. in the illustrative example, managt'ment was concerned with satisfying union requirements and placating employees as well as meeting customer needs when choosing a retail location. on the other hand, if the manager's judgments are wrong or insufficit'nt (for example, not all the relevant branches of the hierarchical model have beeri identified), this will be reflected in a poor choice model. it is up to the researcher to be thorough and persistent, and to probe for further information from management whenever possible. ahp compares favorably to other methods for reducing subjective comparison data to interval data, such as monanova (monotonic analysis of variance). unlike monanova, ahp does not require orthogonal arrays. hence, ahp can use manager's criteria, even if they are non-orthogonal. also, if more than one manager is included, they are not required to use the same criteria. furthermore, they are allowed to weight criteria directly, or indirectly weight the criteria by using paired comparisons. ahp is thus superior for this type of choice problem, providing for non-orthogonal arrays, direct combination rules, and global ranking of alternatives (as opposed to part-worths from monanova). ideally, it would be desirable to present empirical evidence indicating that the manager's store location decision was improved by the use of ahp. however, since the manager's personal preference prior to the application of ahp was not provided, this was not possible. one could therefore still ask if ahp is capable of improving the manager's (unaided) decision or, to put it another way, whether the solution to the eigenvalue problem is the solution to the managerial problem. the goal of applying the ahp model is perhaps not to make "better" decisions, but more correctly to make "more rational" decisions. many managerial decisions (such as store location selection), as well as personal choices (choosing a home or career), are extremely complex and require the consideration of several factors and their relative effects and importance all at the same time. the ahp model, as made available in the expert choice software, is not designed to "tell (the respondent) how to think, but it does make (his or her) own thoughts clearer, easier to organize, and more presentable to others .... (the program) does what the unaided mind has difficulty doing. it treats a decision as a whole system and not as isolated parts" (from the expert choice manual, p. 22). the decision maker may have little difficulty setting up the hierarchical structure, once he or she sets out to do so; and indeed may easily be able to make all the individual paired comparisons. however, in a complex decision, it is almost impossible to take into account all of these factors appropriil-tely. it is easier for the respondent to make his or her decision based on only one or two important criteria (i.e., looking at only maximizing sales when choosing store location), while not placing enough importance on other criteria (transportation costs, likely union problems, etc.). ahp simply makes the decision process more rational by taking as spring 1989 calantone, et al.; retail store location 71 datum ab of the manager's judgments and combining them in a way that the manager might not be able to do by him or herself. the ahp approach is not without limitations to its application to the retail location process. while this technique allows for multiple objectives, multiple decision makers, and subjectively weighted goal, it is not likely to be readily adaptable to extremely complex decision problems. the complex math programming models have an ability to achieve near optimization within "network" location problems which are not directly assessed with the ahp, thus in some instances the complex models will be preferred. when the problem is extremely large, as in ghosh and craig's study [12], ahp can be a useful adjunct for manager-based sensitivity analysis or phase-in (ramp-up) operational planning. since the use of ahp depends in part on the ability of managers to rate and rank properly the various decision elements as inputs to the model, the complexity which the model can handle at anyone level is limited to the level of complexity which the manager can handle at anyone level of the hierarchy (the model itself handles complexity across levels). a possible related stream of research would be to determine whether the direct management involvement in the retail location decision process improves management's commitment to the success of the decision. since commitment frequently determines success, such a finding would offer strong support to retail location decision techniques (such as one based on ahp) which involve management's subjective inputs. regardless of the results of this or any further research in the retail location area, the location decision itself will continue to be one, of the most important decisions the retailer faces. thus, any resear~h activity whose results can help to improve the quality of decisions made should be of interest to conscientious retail planners. references 1. achabal, dale d., wilden 1. gorr, and vijay mahajan. "multiloc: a multiple store location decision model." journal of hetailing, vol. 58 (summer, (1982), pp. 5-25. 2. anderson, patricia m. "association of shopping center anchors with performance of a nonanchor specialty chain's stores." journal of retailing, vol. 61 (summer, 1985), pp. 61-74. 3. clark, w. a. v. and g. rushton. "models of intra-urban consumer behavior and their implications for central place theory." economic geography, vol. 46 (1970), pp. 486-497. 4. cottrell, j. "an environmental model of performance measurement in a chain of supermarkets." journal of retailing, vol. 49, (fall 1973), pp. 51-63. 5. craig, c. samuel, avijit ghosh and sara mclafferty. "models of the retail location process: a review." journal of retailing, vol. 60 (spring, 1984), pp. 536. 72 journal of business strategies vol. 6, no.1 6. crawford, diane. "software support for the intuitive thinker." wall street computer review (november, 1984). 7. davies, r. "evaluation of retail store attributes and sales performance." european journal of marketing, vol. 7 (1973), pp. 89-102. 8. eagle, thomas c. "parameter stability in disaggregate retail choice models: experimental evidence." journal of retailing, vol. 60 (spring, 1984), pp. 101-23. 9. gautschi, d. a. "specification of patronage models of retail center choice." journal of marketing research, vol. 18 (1981), pp. 162-174. 10. ghosh, avijit and c. samuel craig. "formulating retail location strategy in a changing environment." journal of marketing, vol. 47 (1983), pp. 56-68. 11. ghosh, avijit and c. samuel craig. "a location allocation model for facility planning in a competitive environment." geographical analysis, vol. 16 (january, 1984), pp. 39-56. 12. ghosh, avijit and c. samuel craig. "determining optimal locations for new services." journal of marketing research, vol. 23 (november, 1986), pp. 354362. 13. ghosh, avijit and sara mclafferty. "locating stores in uncertain environments: a scenario planning approach." journal of retailing, vol. 58 (winter, 1982), pp. 5-22. 14. hansen, m. m. and c. b. weinberg. "retail market share in a competitive environment." journal of retailing, vol. 55 (spring, 1979), pp. 37-46. 15. haynes, kingsly e. and a. stewart forthingham. gravity and spatial interaction models. beverly hills, ca: sage publications (1984). 16. houston, franklin s. and john stanton. "evaluating retail trade areas for convenience stores." journal of retailing, vol. 60 (1984), pp. 124-136. 17. hubbard, r. "a review of selected factors conditioning consumer travel behavior." journal of consumer research, vol. 5 (1978), pp. 7-21. 18. huff, david 1. "a probabilistic analysis of shopping center trade areas." land economics, vol. 39 (1963), pp. 81-90. 19. huff, david l. "defining and estimating a trading area." journal of marketing, vol. 28 (july, 1964), pp. 34-38. 20. huff, david l. "a programmed solution for approximating an optimum retail location." land economics, vol. 42 (1966), pp. 294-295. 21. huff, david l. and l. blue. "a programmed solution for estimating retail sales potential." lawrence, ks: center for regional studies (1966). 22. ingene, c. and r. lusch. "market selection decision for department stores." journal of retailing, vol. 56 (1980), pp. 21-40. spring 1989 calantone, et al.: retail store location 73 "a disaggregate journal of retail23. jain, arun d. and vijay mahajan. "evaluating the competitive environment in retailing using multiplicative competitive interactive models." in j. sheth (ed.), research in marketing, pp. 217-235. greenwich, ct: jai press (1979). 24. johnson, c. r. "constructive critique of a hierarchical prioritization scheme employing paired comparisons." proceeding of the international conference of cybernectics and society of the ieee, pp. 373-378. cambridge, ma: institute of electrical engineers (1980). 25. lilien, gary l. and philip kotler. marketing decision-making: a model build· ing approach. new york: harper and row (1983). 26. meyer, r. j. and t. c. eagle. "context-induced parameter instability in a disaggregate stochastic model of store choice." journal of marketing research, vol. 19 (1982), pp. 62-71. 27. nakanishi, m. and 1. g. cooper. "parameter estimate for multiplicative interactive choice model: least squares approach." journal of marketing research, vol. 11 (1974), pp. 303-311. 28. olsen, l. and j. lord. "market area characteristics and branch bank performance." journal of bank research, vol. 10 (1979), pp. 102-110. 29. saaty, thomas 1. "a scaling method for priorities in hierarchical structures." journal of mathematical psychology, 15, (june, 1977), pp. 234-281. 30. saaty, thomas 1. "scenarios and priorities in transport planning: application to sudan." transportation research, vol. 11 (1977), pp. 343-350. 31. saaty, thomas l. "the sudan transport study." interfaces, vol. 8 (1977), pp. 37-57. 32. saaty, thomas 1. "modeling unstructured decision problems: a theory of analytical hierarchies." proceedings of the first international conference on mathematical modeling, university of missouri-rolla, vol. 1 (1977), pp. 69-77. 33. saaty, thomas l. the analytic hierarchy process. new york, ny: mcgraw-hill book company (1980). 34. stanley, thomas j. and murphy a. sewall. "image inputs to a probabilistic model: predicting retail potential." journal of marketing, vol. 40 (july, 1976), pp.48-53. 35. weisbrod, glen e., robert j. purcells and clifford kern. model for predicting shopping area marketing attraction." ing, vol. 60 (spring, 1984), pp. 65-82. 36. wind, yoram and thomas l. saaty. "marketing applications of the analytic hierarchy process." management science, vol. 26 (july, 1984), pp. 641-658. 37. zadehi, fatemeh. "the analytic hierarchy process a survey of the method and its applications." interfaces, vol. 16 (july-august, (1986), pp. 96-108. 74 journal of business strategies vol. 6, no.1 38. zeller, richard e., dale d. achabal, and lawrence a. brown. "market penetration and locational conflict in franchise systems." decision sciences, vol. 11 (january, 1980), pp. 58·80. appendix criteria used for ahp application distance: distance of a site from major user segments is evaluated as to the preferences of each segment. in this application, distance was evaluated in terms of physical separation between the user segments as well as the ease of traveling (i.e., whether the distance could be traversed on a highway or on slower city streets). estimated time of travel to each store site was also considered by management. size: the square footage of the proposed store is evaluated. this is an important criterion as larger stores allow the store manager to stock a wider product line. for some (but not necessarily all) market segments, availability of a wide product line is an important factor in choosing a store. appeal: store placement and overall aesthetics of the proposed layout (for example, the appeal of the surrounding shopping mall, if applicable) are evaluated segment by segment, recognizing that differences in preference may exist across segments. network: an evaluation of store fit into the current network is carried out over the domains of transportation (time and costs), services availability, possible union problems, management preferences and attractiveness for employees. the degree to which each of these factors is likely to be a problem at each location is estimated by the manager. costs: the major costs which must be incurred to do business at a location are estimated by the manager. these include initial dollars invested, rent or mortgage expenses, maintenance costs, and any special costs peculiar to a location. two of the criteria (network and costs) may be classed as operations criteria, while the others (distance, size, and appeal) are marketing criteria. the domains under the operations criteria are different from those under the market criteria. under network, one finds several resources providing functions: management considers the availability of each of these in the location decision. under costs appear several categories of costs which must be considered. by comparison, under the market criteria, the views of each of five market segments are appropriately placed. note also that the relative importances of the criteria may differ for different scenarios; hence, one must repeat the analysis three times, once for each of the possi ble scenarios. the analytical hierarchy process as a technique for retail store location selection measuring logistics service quality theodore p. stank the university of georgia athens, georgia increased competition and price deregulation in many service industries have caused service providing firms to seek to differentiate themselves to remain competitive. as in manufacturing, improving the quality of the product (the service provided) is an effective way to gain this competitive advantage. the successful application of a differentiation strategy depends on the firm's ability to identify the critical service quality determinants, and then to efficiently allocate resources to develop strengths in these determinants. a proficient quality assurance system is the key to defining and measuring the service quality determinants for the firm's service area. meaningful measures of the actual effectiveness of service quality initiatives on customer satisfaction must be developed and used [3]. therefore, feedback from customers on the effectiveness of the strategy is critical to its long-term success. many manufacturing corporations, confronted by greater competitive pressures and limited resources, face difficult decisions regarding how they will meet the ever-increasing customer demand for quality. critical to these decisions is how the firm chooses to handle its logistics function, the process by which raw materials and finished goods are moved from point of supply to end user. the central issue involves the choice between expending scarce resources developing a quality in-house logistics function or contracting this function out to external logistics service firms. while only 5 percent of the nearly $500 billion annual domestic logistics expenditures are currently outsourced, current trends indicate that this figure is likely to double or triple in the next 10 years [13]. these external firms, known as third party logistics providers, specialize in logistics functions. the services provided by these "middle men" may include transportation, freight consolidation and packaging, warehousing, information processing services (including freight bill auditing and payment, tracking, transaction processing, mis reporting, etc.), customs brokering, and materials management and inventory control [13]. for example, freight forwarders provide such varied services as arranging domestic and international transportation; storage, breaking and sorting materials for reshipment to end users; packing and containerization; electronic da~ processing of ordering, invoice, payment and tracking documentation; and customs brokerage. increasingly, manufacturing firms are focusing resources on their core business(es) and outsourcing the logistics function to these third-party experts. the quality of service offered by contract, or third-party, logistics firms has been identified as the most critical aspect in manufacturers' selections of logistics providers ([3], [4], [8], [9]). the level of service quality required by customers, and subsequent use of this information in the strategic planning process, are necessary components of successful competition for third party logistics firms. measures of service quality must reflect actual customer perceptions, not operationally derived substitutes. for example, 52 joumal ofbusiness strategies vol. 10, no.1 federal express corporation, winner of the 1990 malcolm baldridge national quality award, replaced its old measure of performance quality (percent of on-time deliveries) with a 12 component index that comprehensively describes how its performance is viewed by customers. however, there is no agreed upon measure of service quality for the industry. an instrument has been developed to aid retail firms in the defmition and measurement of customers' perceptions of the determinants of service quality [10). this instrument was designed as a generic "skeleton" that could be adapted to a great variety of service industries. its applicability in measuring the level of service quality in several retail, professional and financial service settings has been tested with generally positive results ([2], [6], [7], [11], [12]). the instrument has also been adapted to measure the service quality perceptions of purchasers of motor carrier services in the business-to-business market [5], incorporating industry specific findings from the transportation literature [1]. it has not been applied to the many other services provided by third-party logistics firms, however. the purpose of this paper is to propose a logistics service quality measurement tool based upon this established instrument to aid managers of third-party logistics firms, and purchasers of these services in the business-to-business marketplace, in defining and measuring perceptions of the determinants of logistics service quality. the instrument will be adapted to the logistics setting by incorporating commonly used logistics measures into the existing framework. the objectives of this adaptation are to provide third party logistics firms and the purchasers of their services with 1) a dependable delineation of critical determinants of service quality which may facilitate effective allocation of resources; and 2) a meaningful tool to measure the level of service quality on these determinants provided by the firm. the paper first reviews the concept of logistics service quality and the attempts made recently to define and measure it. the retail service quality model and measurement instrument is then introduced and modifications are made to adapt it to the logistics service area. finally, implications to managers and conclusions are discussed. logistics service quality economic and competitive pressures dictate that the success of third-party logistics firms center on the effective use of inventory assets. pressure to more effectively utilize assets has been experienced throughout all levels of the distribution channel. strategies designed to improve inventory turns, reduce inventory levels, and eliminate slow tum items have become important to operational managers [8]. yet to achieve overall effectiveness, managers must focus on how these strategies impact the valueadded benefits derived by the customer. third-party logistics firms must be cognizant of service requirements and deliver services that fulfill these requirements. these must be compatible with the firm's overall strategic objectives. obtaining information on customer product and service requirements in a timely and accurate manner is of utmost importance to maximize the value of the service spring 1993 stank: measuring logistics service quality 53 provided. as a result, the subject of measurement of customer satisfaction with service quality must shift from internally generated operational features to meaningful measures which actually tap the customers' perception of the service quality provided. this will allow executives to be proactive in the management of an important strategic weapon of competitive advantage. the particular dimensions used to define and measure customer service are dependent upon the industry in which the firm competes and the functional area of the respondent. little standardization of the dimensions of customer service exists within logistics firms. this has created problems in designing an instrument to measure customer satisfaction levels. as a result, many third-party logistics firms rely on operational measures such as delivery and/or inventory reliability, speed of order fulfillment, and/or transit time to generate an internal measurement of service quality. more meaningful measures of service quality must be based upon the customers' perception of the value of service received. these measures must reflect service dimensions identified by businesses as critical to the performance of logistics functions. measurements of customer service in logistics research on customer service in logistics has indicated that certain characteristics or dimensions of service are particularly important in the logistics setting, although no standardized measurement tool has been proposed. the following dimensions of customer service have been identified in past research as areas critical to the satisfaction of customers of third-party logistics firms [8]: pre-transaction elements 1. written statement of policy 2. customer receipt of policy statement 3. organizational structure 4. system flexibility 5. management services transaction elements 1. stock-out levels 2. order information 3. elements of order cycle 4. expedition of shipments 5. transshipment 6. system accuracy 7. order convenience 8. product substitution 54 journal ofbusiness strategies post-transaction elements 1. installation, warranty, alterations, repair parts 2. product tracing 3. customer claims, complaints, returns 4. temporary replacement of product vol. 10, no.1 the strong emphasis on service functions indicated by these dimensions reflects the trend toward creating customer satisfaction through service quality. subsequent studies have continued this trend. a study on the critical characteristics of leading logistics firms included the following features used by customers to evaluate logistics providers ([4], pp. 205-206): 1. customer support 2. easy to work with 3. good communication 4. early notification 5. flexibility 6. willing to customize service these features summarize the critical dimensions of customer service identified in the earlier study. they also resemble the ten determinants used in developing the retail service quality measurement instrument. table 1 provides the ten key service determinants and their definitions from the original retail service quality study [11], as well as common logistics-related measures of these determinants. an instrument designed to measure customers' perceptions of these determinants would provide managers of third-party logistics firms with a meaningful assessment of the competitive advantage created by the level of service quality provided. table 1: determinants of service quality and corresponding common logistics measures reliability: consistency of performance and dependability avoidance of work stoppage/stock-outs meets promised deadlines on-time pick-up/delivery responsiveness: willingness or readiness of employees to provide timely service delivery speed/transit-time delivers services when requested meeting client deadlines competence: possession of the required skills and knowledge to perform the service knowledge/expertise quality of personnel spring 1993 stank: measuring logistics service quality 55 table 1: determinants of service quality and corresponding common logistics measures (continued) access: approachability, ease of contact, and availability of services availability of service equipment convenient schedule frequency of service geographic area served pick-up and delivery service courtesy: politeness, respect, consideration, and friendliness of contact personnel co-operation rapport ready/willing to help responsiveness to request communication: keeping customers informed in language they can understand; listening ability to follow instructions information provided to user listening to demands credibility: trustworthiness, believability, honesty, acts in the customer's best interests experience financial stability past performance reputation/image trustworthy security: freedom from danger, risk, or doubt claims processing record loss and damage record tracing capabilities understanding: making the effort to understand the customers's needs flexibility co-operative planning tangibles: physical evidence of the service equipment capabilities physical facilities/special services/equipment available a service quality model unlike tangible goods quality, which can be defined and measured by objective attributes, defining and measuring service quality is a difficult task which must take into account the unique characteristics of services. four characteristics are generally considered to distinguish services from goods: intangibility, inseparability of production and consumption, heterogeneity, and perishability [10]. intangibility refers to the 56 journal ofbusiness strategies vol. 10 , no.1 fact that services do not possess objective attributes which can be measured, such as durability or number of defects. inseparability of production and consumption involves the simultaneous production and consumption of services provided to consumers. heterogeneity concerns the potential for high variability in the level of service provided, depending upon the actual employee of the service firm providing the service at the time of consumption. perishability means that service customers cannot consume the service at a later time, but rather must consume the service (i.e., be served) at the time the service is rendered. each characteristic unique to services leads to particular problems for service marketers. a definition of service quality and its determining factors (as identified by retail service providers and consumers in a national study) have been developed [to]. the definition attempts to capture the unique problems faced by managers of service firms and the strategies used to overcome them. this approach identifies four "gaps" occurring in organizations that can cause quality problems. these gaps are defined as follows: 1. marketing information gap: inadequate or inaccurate understanding of customer's service expectations. 2. standards gap: failure to develop performance specifications reflecting customer's expectations. 3. service perconnance gap: discrepancy between performance specifications and service actually delivered. 4. communication gap: discrepancy between descriptions of the service to customers and service actually delivered. these organizational gaps create a gap between customers' expectations of the quality of service prior to consumption and their perceptions of it following consumption. this final gap is the ultimate gauge of the customers' evaluation of the level of service quality provided. the critical dimensions or determinants used by customers in assessing service quality have been identified in a study conducted to measure retail service quality [11]. with minor modifications (e.g. changing industry specific wording, deleting inapplicable items, or adding items pertinent to the industry) this instrument may be adapted to other industries or service settings including business-to-business logistics. table 1 identifies the critical determinants used in the retail service quality model along with common measures of these determinants used in the logistics setting. modification of the measurement instrument the retail service quality measurement instrument was designed to allow adaptation by a great variety of service industries. it has been successfully adapted for many other retail, professional, and financial service settings ([2], [6], [7], [11], [12]). some recommendations to improve the instrument have resulted from these efforts [6]. one spring 1993 stank: measuring logistics service quality 57 such recommendation regarded collecting importance weights assigned by the customer to each quality determinant. importance weights are relevant to the concept of service quality used here, since overall service quality is equivalent to the summation of the individual service determinant expectation-perception differences, multiplied by the importance weight assigned by respondents to that determinant. therefore, the importance weights are just as critical in determining the contribution of the individual determinants to overall quality as the differences in perceptions and expectations are. importance weights for each service feature could be collected at the same time as the service quality difference data. alternatively, importance weights could be collected separately. averaged weights could then be used with subsequent measurements of expectation-perception differences. another recommendation regarded the administration of the instrument. the original method called for collecting customer expectation data prior to receiving the service and collecting customer perception data after consuming the service. this method created practical difficulties because service providers were often unwilling to allow collection of expectation data before provision of the service. therefore, it was recommended that the items ask about the customer's expectation-perception differences, rather than ask separate questions about each and subtracting one score from the other. modifications to the retail service quality instrument regarding industry specific wording, deletions of inapplicable items, and additions of pertinent items have been made based upon the critical logistics service determinants identified earlier and the common logistics-related measures presented in table 1. the appendix contains the measurement instrument, as adapted for the logistics service setting. implications and conclusions the ability to meaningfully measure the level of service quality as perceived by a firms' customers is critical to the effectiveness of customer service differentiation strategies. quality assurance has become standard for goods-producing firms. however, the intrinsic nature of services has made it difficult for service firms to assess the level of quality provided to customers. while other customer-oriented programs have been adopted by service firms, the difficulty of measuring service quality from the customers standpoint has limited their success. as a result, the ability to utilize the value of a customer service orientation to create competitive advantage has been limited. adapting an instrument which measures the customers' perception of the quality of service received from third-party logistics firms will enable managers of those firms to anchor service quality assurance programs on meaningful quality assessments. the purpose of this paper is to propose an instrument which will enable third-party logistics firms to determine and measure the critical determinants of logistics service quality. with the instrument proposed here as a tool, managers of logistics firms will be able to ascertain the actual effectiveness of service initiatives as opposed to depending upon internally generated operational performance measures. 58 journal ofbusiness strategies vol. 10, no.1 additionally, managers of these firms will be able to customize service programs based upon the importance of the determinants to customers. this will make it possible to highlight those service areas considered critical to each customer by allocating resources to the areas providing the greatest impact on quality. the result will be more efficient and effective service quality programs, creating greater value for customers. the instrument may also be used by firms purchasing services from third-party logistics providers as an objective internal measurement of satisfaction with the level of quality received. this could prove particularly useful in firms that receive logistics services across functional areas. an aggregate service quality score compiled by managers of the different functional areas using the services of a particular logistics firm would be useful. the measure could also be used by firms that purchase the same logistics services from multiple third-party providers, using the results as an objective comparison between firms. this tool should find ready acceptance among providers and purchasers of thirdparty logistics services. with escalating costs of logistics activities, managers need meaningful measures of the output of logistics service. the success of the instrument in the related service areas of retail, professional and financial services should provide managers with the assurance they need to utilize it. previous testing of the instrument in these related service areas indicated that the scale was a valid and reliable tool for measuring service quality. the focus of future research must be to empirically test this adaptation of the instrument to ensure its validity and reliability in the logistics service setting. to summarize, service providers, like manufacturers, must have quality assurance programs to monitor the level of service quality. the instrument presented here proposes a meaningful measurement of customers' perceptions of logistics service quality by incorporating commonly used logistics service measures into an established scale of service quality. this will make it possible for purchasers and providers of logistics services to manage resources more efficiently and effectively. references 1. abshire, r.d. and premeaux, s.r. "motor carrier selection criteria: perceptual differences between shippers and carriers." transportation journal, vol. 31 (1991), pp. 31-35. 2. babakus, e. and boller, g.w. "an empirical assessment of the servqual scale." journal of business research, vol. 24 (1992), pp. 253-268. 3. bowersox, d.j., daugherty, pj., droge, c.l., germain, r.n., and rogers, d.s. logistical excellence: its not business as usual. burlington, ma: digital press (1992). 4. bowersox, d.j., daugherty, p.j., droge, c.l., rogers, d.s., and wardlow, d.l. leading edge logistics: competitive positioning for the 19905. oak brook, il: the council of logistics management (1989). spring 1993 stank: measuring logistics service quality 59 5. brensinger, r.p. and lambert, d.m. "can the servqual scale be generalized to business-to-business services?" in knowledge development in marketing, 1990 ama's summer educators' conference proceedings (1990), p. 289 (abstract). 6. carman, j.m. "consumer perceptions of service quality: an assessment of the servqual dimensions." journal of retailing, vol. 66 (1990), pp. 33-55. 7. finn, d.w. and lamb, c.w. "an evaluation of the servqual scales in a retailing setting." advances in consumer research. vol. 18 (1991), p. 18. 8. lalonde, rj. and zinszer, p.h. customer service: meaning and measurement. oak brook, il: the council of logistics management (1976). 9. lalonde, bj., cooper, m.e., and noordewier, t.g. customer service: a management perspective. oak brook, il: the council of logistics management (1988). 10. parasuraman, a, zeithaml, v.a, and berry, ll "a conceptual model of service quality and its implications for future research." journal of marketing, vol. 49 (1985), pp. 4150. 11. parasuraman, a., zeithaml, v.a., and berry, l.l. "consumer perceptions of service quality: an assessment of the servqual dimensions." journal of retailing, vol. 64 (1988), pp. 33-55. 12. parasuraman, a, zeithaml, v.a., and berry, l.l. (1991), "refinement and reassessment of the servqual scale." journal of retailing, vol. 67 (1991), pp. 420-450. 13. sheffi, y. "third party logistics: present and future prospects." journal of business logistics, vol. 11 (1990), pp. 27-39. 60 j oumal ofbusiness strategies vol. 10 , no. 1 appendix: adaptation of the measurement instrument directions: this survey deals with how you feel xyz company met your expectations of the level of service which should be provided by logistics firms. a list of possible service features is given below. for each service feature described, please show the extent to which you think. the service provided by xyz met your expectations of what that service should be. do this by circling one of the seven numbers next to each statement. if you strongly agree that the level of the service feature provided by xyz met your expectations exactly, circle number 1. if you strongly disagree that the level of the service feature provided by xyz met your expectations, circle number 7. if your feelings are not strong, circle one of the numbers in the middle that best shows how closely the level of the service feature actually provided by xyz came to your expectations. for example, circling number 3 would indicate that the service provided more closely matched your expectations than circling number 4 would indicate, but not as closely as circling number 2 would indicate. i. please respond to the following statements regarding xyz. the xyz firm: strongly strongly agree disagree 1. provides up-to-date equipment. 1 2 3 4 5 6 7 2. maintains modem, efficient facilities. 1 2 3 4 5 6 7 3. meets promised deadlines. 1 2 3 4 5 6 7 4. deals with customer problems in a sympathetic 1 2 3 4 5 6 7 and reassuring way. 5. offers dependable and on-time pick-up/delivery 1 2 3 4 5 6 7 service. 6. tells customers exactly when services will be 1 2 3 4 5 6 7 performed. 7. has fast and accurate information and records 1 2 3 4 5 6 7 tracing capabilities. 8. delivers prompt service. 1 2 3 4 5 6 7 9. employees are readily willing to help 1 2 3 4 5 6 7 customers. 10. employees are not too busy to respond to 1 2 3 4 5 6 7 requests. 11. employees are trustworthy. 1 2 3 4 5 6 7 12. cooperates with customer to help him/her do 1 2 3 4 5 6 7 the job well. 13. is flexible, provides service tailored to 1 2 3 4 5 6 7 customer needs. 14. knows the needs of its customers. 1 2 3 4 5 6 7 spring 1993 stank: measuring logistics service quality 61 strongly strongly agree disagree 15. knows its own business well. 1 2 3 4 5 6 7 16. employees are highly qualified for their jobs. 1 2 3 4 5 6 7 17. provides operating hours convenient to their 1 2 3 4 5 6 7 customers. 18. provides services which allow customers to 1 2 3 4 5 6 7 avoid work stoppages or stock-outs. 19. provides service to the geographic area of the 1 2 3 4 5 6 7 customer's market. 20. provides frequent service. 1 2 3 4 5 6 7 21. provides door-to-door pick-up and delivery 1 2 3 4 5 6 7 service. 22. has equipment/facilities available when needed. 1 2 3 4 5 6 7 23. listens to customer demands and needs. 1 2 3 4 5 6 7 24. is able to follow explicit customer instructions. 1 2 3 4 5 6 7 25. has a record of superior past performance. 1 2 3 4 5 6 7 26. is financially stable. 1 2 3 4 5 6 7 27. is experienced in the industry. 1 2 3 4 5 6 7 28. has a good loss and damage record. 1 2 3 4 5 6 7 29. accepts and processes claims rapidly. 1 2 3 4 5 6 7 30. possesses the equipment necessary to meet 1 2 3 4 5 6 7 customer's special needs. ii. for the following statements, please indicate how important you feel each is to the overall quality of logistics service provided by xyz. the xyz firm: extremely not imimportant portant 1. provides up-to-date equipment. 1 2 3 4 5 2. maintains modem, efficient facilities. 1 2 3 4 5 3. meets promised deadlines. 1 2 3 4 5 4. deals with customer problems in a sympathetic and 1 2 3 4 5 reassuring way. 5. offers dependable and on-time pick-up/delivery service. 1 2 3 4 5 6. tells customers exactly when services will be performed. 1 2 3 4 5 7. has fast and accurate information and records tracing 1 2 3 4 5 capabilities. 8. delivers prompt service. 1 2 3 4 5 9. employees are readily willing to help customers. 1 2 3 4 5 62 journal ofbusiness strategies vol. 10, no.1 extremely not imimportant portant 10. employees are not too busy to respond to requests. 1 2 3 4 5 ii. employees are trustworthy. 1 2 3 4 5 12. cooperates with customer to help him/her do the job well. 1 2 3 4 5 13. is flexible, provides service tailored to customer needs. 1 2 3 4 5 14. knows the needs of its customers. 1 2 3 4 5 15. knows its own business well. 1 2 3 4 5 16. employees are highly qualified for their jobs. 1 2 3 4 5 17. provides operating hours convenient to their customers. 1 2 3 4 5 18. provides services which allow customers to avoid work 1 2 3 4 5 stoppages or stock-outs. 19. provides service to the geographic area of the customer's 1 2 3 4 5 market. 20. provides frequent service. 1 2 3 4 5 2i. provides door-to-door pick-up and delivery service. 1 2 3 4 5 22. has equipment/facilities available when needed. 1 2 3 4 5 23. listens to customer demands and needs. 1 2 3 4 5 24. is able to follow explicit customer instructions. 1 2 3 4 5 25. has a record of superior past performance. 1 2 3 4 5 26. is financially stable. 1 2 3 4 5 27. is experienced in the industry. 1 2 3 4 5 28. has a good loss and damage record. 1 2 3 4 5 29. accepts and processes claims rapidly. 1 2 3 4 5 30. possesses the equipment necessary to meet customer's 1 2 3 4 5 special needs. measuring logistics service quality toward a more comprehensive marketing strategy wayne norvell kansas state university manhattan, kansas shalini v. gogumalla university of alabama tuscalossa, alabama c. glenn walters nicholls state university thibodaux, louisiana david m. andrus kansas state university manhattan, kansas sujata ramnarayan kansas state university manhattan, kansas marketing decisions have expanded over the years with the advent of mass production, mass distribution, and more intense competition in markets. first, mass production and mass distribution led to business concentrating on distribution and selling problems. as the number of buyers and sellers of products increased over the years the element of heterogeneity became significant ([2], [3], [4]) on both the supply and demand side of exchange. firms had different capabilities and households had a variety of needs. the process of exchange became more a process of matching heterogeneous product benefits of the firms with heterogeneous consumer needs. firms realized they must identify consumers with needs they could fulfill. also, consumers realized they had a choice in purchasing. the change from a relatively simple marketplace to a multiplicity market with increased competition and wide consumer choice necessitated the implementation of more sophisticated marketing strategy ([1], [15]). it became necessary to identify consumer targets, develop products to fulfill their needs, and price competitively while earning a reasonable return on investments. the last thirty years has witnessed a higher level of technological sophistication and the implementation of strategic planning ([ij, [12], [13]). however, in our zeal to compete more favorably in the marketplace we may have ignored important social, cultural, political, economic and natural environmental goals in our marketing decisions. we experienced the consumerist movement, political and social unrest, environmental problems, and an economy that is still facing difficulty in competing in a world market. we have seen regulation set by both trade associations and various levels of government. these restrictions have been set, lifted, and in some cases reset again with somewhat minimal success. what is needed is a comprehensive marketing strategy which incorporates the total environment into marketing decision-making. this is the purpose of this paper. first, the pre-consumer orientation period will be discussed in strategic terms. second, journal of business strategies, volume 6, number 2 (fall 1989) 124 fall 1989 norvell, et al.: marketing strategy 125 strategic decision-making will be presented in the era of consumer orientation. finally, a strategic framework will be presented to include the total environment in marketing decisionmaking. strategic marketing in the pre-consumer orientation era prior to world war ii strategic marketing primarily focused on distribution and sales in the united states. the period from 1900 to 1920 was dominated by transportation decisions. emphasis was placed by marketers on moving products from manufacturing facilities primarily in the east to potential buyers in the west. individual firms were focusing on the strategic variable of distribution as a means of unloading excessive supply of product. this strategy of primarily emphasizing the distribution variable simply transferred stockpiles of products from eastern manufacturing sites to stockpiles of products in warehouses in the midwest. obviously, a strategy was needed to dispose of the stockpiles. the emphasis in marketing now switched to sales. this period of aggressive sales was prominent in the 1920s and the 1930s in the u.s. business executives started realizing in the latter part of the sales era that a good product, a sound distribution system, and silver tongued salespeople were not enough to compete in an ever increasing competitive environment. this realization coupled with technology derived from world war ii led to more rigor in marketing strategy. alderson ([3], p. 356) stated that sales are a function of organized marketing effort and marketing opportunity, but he never expresses this concept in the form of an equation. alderson perceived opportunity as basically demand and effort as supply. thus alderson's equation can be stated in the following matter: s = !(e,o) in this equation s is sales, e is effort, and 0 is opportunity. he conceptualized that a business obtains sales as a result of the demand (number of potential customers who have "wants") and the supply (marketing effort by the firm). the marketing effort included product, place, promotion, and price ([7]' pp. 2-7). the emphasis became one of organized firm effort conceming all four marketing mix variables. one must remember that alderson was looking at marketing from the perspective of the firm. sales was probably used as the objective of business since it is the first item on the income statement from which all cost and profit must be figured. we will continue to use sales as the objective of business throughout this paper. however, s can stand for any business objective such as customer satisfaction. marketing strategy under the consumer orientation the wide acceptance of the marketing concept by businesses in the late 1950s and early 1960s led to marketing strategy emphasizing the consumer orientation. emphasis was switched form the supply side of marketing to the demand side with the 126 journal of business strategies vol. 6, no.2 consumer as the focal point. e. jerome mccarthy ([9], p. 37) was one of the earliest authors to focus on consumer orientation in strategic terms. he identified marketing strategy as a two step process: (1) identification of a target market, and (2) development of a marketing mix. the target market consisted of identified consumers, grouped into segments by similar wants. the marketing mix ([7], pp. 2-7) consisted of coordinated product, place (channel) promotion, and price policies. the marketing mix was directed at satisfying the wants of segments making up the target. if marketing did its job properly then sufficient sales were generated to cover cost and assure a profit for the organization. martin bell ([6], p. 17) related alderson's theory to mccarthy's application of marketing strategy and proposed an improved version of the original marketing equation. bell ([6], p. 17) incorporated the environmental factor and expressed the equation in the following manner: s = f(o,e,r) the s is sales. the 0 is the firm's potential consumers who represent an opportunity. the e is the firm's marketing mix consisting of product, place, promotion, and price policies which represent effort. the r is resistance imposed by environmental constraints on marketing. thus, the firm achieves its objective by employing a mar· keting mix designed to satisfy consumers within the constraints of the environment. in this statement of marketing strategy, the consumer is the objective of marketing effort. the marketing mix is a set of policies, established by the organization and controllable by the management of that organization. the environment is a group of external constraints which are uncontrollable by the organization's management. management can react to these constraints, but can do nothing to control them. since most firms have more than one market segment, it is necessary to expand the marketing strategy formula. it becomes: s f[(0l, o2 , 0 3 " .. , on), (e1 , e2 , e3 , ••• , en), (r1 , r2 , r3 ,···, rn)j this expanded version of the formula indicates that sales are a function of several specific marketing efforts directed at, and tailored for, several individualistic consumer market segments within the constraints set by the environment in each case. since the original inclusion of the environment into marketing strategy, efforts have been made to make it operational. mccarthy and perreault [10], bagozzi [5] and other scholars today, have statements such as "and accomplish the objectives of society" as a part of the definition of marketing. the problem is that when marketing is perceived to focus only on consumers can be included in the decision process. it is contradictory to state that consumer satisfaction in the objective of marketing then admit that other groups beyond the firm's control must also be satisfied. thus, bell's marketing equation cannot accommodate environmental objectives. fall 1989 norvell, et al.: marketing strategy 127 despite its shortcomings, bell's equation of marketing strategy was a significant contribution. it recognizes the concept of marketing strategy, it identifies the firm and its environment as the important variables affecting marketing, and it pulls the consumer out of the environment. thus for the first time, marketing strategy was perceived as outward looking to the satisfaction of persons in the environment (at least one group in that environment) rather than completely obsessed with internal efficiency and profit. it was only a matter of time until it was recognized that other groups making up the firm's environment effect and are affected by marketing in essentially the same manner as consumers. kotler ([8], pp. 1,22,24) states "i now believe that marketers can influence the environment in which the firm operates and do not simply have to accept and adapt to it." he suggested that there are six p's with political power and public opinion formulation added to the traditional four p's. zeithaml and zeithaml, ([16], pp. 41-53) believe that "marketing is a significant force which the organization can call upon to create change and extend its influence over the environment." next logical step towards a comprehensive marketing strategy walters, norvell and bruno ([14]' pp. 18,23) developed a conceptual framework for marketing which integrates the environment il;lto the decision process. they advance the hypothesis, and that marketing is situational rather than consumer oriented, and this requires a re-definition of the field. a situational orientation means that: marketers develop policies in response to the common wants and interests of identified persons from within all environmental groups in proportion to the importance of each group to the decision. based on a situational orientation, marketing can be defined as: policies to manage and exchange between the firm and its environment to provide products: (1) profitable to the firm, (2) wanted by buyers, (3) legal to governments, (4) competitive with other managements, (5) acceptable to special interest groups, and (6) efficient outlets for suppliers. this definition requires a marketing strategy sufficiently comprehensive to satisfy together multiple group wants. this approach recognizes that marketing focuses on people rather that either "things" or "ideologies," and people can be influenced. groups of people can be identified with every aspect of the environment, i.e., competition (other business managers), markets (buyers), legal (government officials), physical (suppliers), and social and cultural (special interest groups). thus to market managers, governments are not ideologies but agency heads and bureaucrats. buyers are not demand, rather they are individuals with wants. social and cultural norms are embodies in special interest groups who promote them. even the physical environment is represented by persons that marketing managers can influence. they are the suppliers of resources and services, who provide insurance against natural 128 journal of business strategies vol. 6, no.2 disasters, build the stores that allow customers to shop in bad weather) and innovate alternatives to scarce physical resources. the concept of marketing based on a situational orientation causes a necessary adjustment in the statement of marketing strategy. the strategy steps become: 1. define marketing target (buyers, governments, special interest groups, competitors, suppliers) 2. develop marketing mix (product, place, promotion, price policies) the marketing target consists of identified persons form each environmental group that have wants or interests in common that can be appealed to by the firm with a single marketing mix. the strategic marketing equation must be changed to accommodate the situational orientation. the change makes the equation more realistic and comprehensive. the change equation can be stated: s where: ms and: &s/mm &s/mt f(ms) (mm,mt) f(mt) f(mm) (1) (2) (3) in the equation s is sales, or other marketing objectives, m s is marketing strategy, m m is the marketing mix and mt the marketing target. the first equation specifies that sales is a function of marketing strategy. marketing strategy is a combination of the marketing mix and the marketing target. the final two equations involve the interaction between the firm and external groups. equation two indicates that change in shales that result form a change in the marketing mix is a function of the marketing target. in other words, managers modify their marketing mix due to pressures placed on the organization by the several groups in the environment. for example, pressure form government may cause the firm to change the materials or performance standards of their product. supplier pressure (sales effort) may induce in their assortment. pressure from buyers may cause management to lower product price. the fact is that marketing management needs a coherent strategy designed to respond to the needs of all relevant persons in the five environmental groups at the same time. even as management responds to external groups, they are utilizing strategy to influence those groups. the third equation specifies that change in sales that results from a change in the marketing target is a function of the marketing mix. management directs personal selling and promotion at all groups in the environment in order to obtain a desired response from them. for example, marketing executives meet directly with government officials and also employ lobbyists to influence their decisions. management designs ads that, simultaneously, appeal to buyers, specify government fall 1989 norvell, et al.: marketing strategy 129 standards, employ positive stereotyping for special interest groups and meet competition. thus it is obvious that sales result form a total interaction between the firm and its environment. the marketing equation has to account for the fact that most firms appeal to more than one marketing target at a time. the equation must be modified as follows: that is, a marketing strategy must be developed for each marketing target to which the firm is attempting to appeal. management will not attempt to enter a target, or continue operations in a target market where the actions of even one group is prohibitive. for example, a firm would not enter (i) a target market that lacked sufficient buyers, (2) a target where competition was so intense as to preclude adequate sales, or (3) target where government regulations made it impossible to make a profit, or (4) target where there was an absence of adequate suppliers of land, labor, and capital. there are four fundamental differences between the situational orientation to marketing and the consumer orientation as demonstrated by the marketing strategy equation presented above. first, the situational orientation broadens the objective of marketing from consumer satisfaction to include satisfaction for all groups in the environment. second, a situational orientation specifically recognized the need for the firm to make a profit, as well as satisfying the needs of the external environment. third, the buyer, in a situational orientation, is a more inclusive term than consumer. the term consumer is generally taken to mean final household consumer, and under a consumer orientation only households are specified as the goal of marketing effort. the term buyer includes institutions as well as final consumers, and it is the buyer that is the goal of situational oriented marketing. fourth, under the situational orientation, the environment is not perceived as an uncontrollable constraint. management can affect the environment in which they operate. managers take specific action directed at all groups in the environment to reward behavior consistent with the firm's objectives and to change behavior that is inconsistent. marketing strategy in the future this explanation of the progressive development of marketing strategy has bet-.n necessarily sweeping. there is much work to be done. the impact of a situational orientation is just now beginning to be felt. many refinements will no doubt be necessary over time. the implications of the changes that this broadened perspective has on marketing practice will have to be fully explored. most importantly, the equation itself must be tested for theoretical consistency and relevance to the real world. 130 journal of business strategies vol. 6, no.2 summary due to the complex nature of marketing, the marketing manager is confronted with a great deal of uncertainties in marketing decision-making. however, the odds for success improve if the manager deals with the situation in realistic-comprehensive terms. initially, the marketing strategy centered on directing marketing effort in relation to an understanding of demand. the objective was to make the most out of a market opportunity. later, marketing scholars recognized environmental constraints on marketing programs. thus, a firm achieved its objective by employing a marketing mix designed to satisfy consumers within the constraints of the environment. consumers become the objective of marketing effort. the environment is a group of external constraints which are uncontrollable by the management of the organization. management only has control over the marketing mix within the context of the total environment. however, this approach does recognize the concept of marketing strategy. it identifies the firm and its environment as the important variables affecting marketing, and it pulled the consumer out of the environment. for the first time marketing strategy was perceived as outward looking to the satisfaction of consumers in the environment rather that obsessed with internal efficiency and profit. viewing the external environment groups, except consumers, as uncontrollable tends to cause managers to take these ~roups for granted or to simply react to existing conditions. in either case, management is missing a opportunity by ignoring the goals of these external groups. a more comprehensive marketing strategy and decision model is presented in this article which enables the marketing manager to fully integrate the external environment into marketing strategy. marketers must realize that all external environment groups affect and are affected by marketing decisions. managers must evaluate which environmental variables affect a given marketing decision and to what degree. the response should be positive and designed to manage the attitudes and behavior of external groups. this more comprehensive marketing strategy enables marketing managers to develop marketing plans that are more comprehensive, realistic, and effective in the competitive world. the result should be a higher level of goal attainment by all groups in the environment plus greater efficiency and profits by firms. references 1. abell, derek f. and john s. hammond. strategic market planning. englewood cliffs, nj: prentice hall (1979). 2. alderson, wioe and reavis cox. "toward a theory of marketing." journal of marketing, vol. 13 (october, 1948), pp. 137-152. 3. alderson, wroe and reavis cox. marketing behavior and executive action. homewood, il: richard d. irwin (1957). fall 1989 norvell, et al.: marketing strategy 131 4. alderson, wroe and reavis cox. "the analytical framework for marketing." delbert duncan (ed.), proceedings: conference of marketing teachers from far western states, berkeley, ca: university of california (1958). 5. bagozzi, richard p. principles of marketing management. chicago, il: science research associates, inc. (1986). 6. bell, 1. martin. marketing: concepts 8 strategy. boston, ma: houghton mifflin company (1966). 7. borden, neil h. "the concept of the marketing mix." journal of advertising research, (june, 1964). 8. kotler, philip. "rethink the marketing concept." marketing news, (september 16, 1984), pp. 1, 22, 24. 9. mccarthy, e. jerome. basic marketing: a managerial approach. homewood, il: richard d. irwin, inc. (1960). 10. mccarthy, e. jerome and william d. perreault, jr. basic marketing: a managerial approach. homewood, il: richard d. irwin, inc. (1984). 11. oxenfeldt, alfred r. "the formulation of a market strategy." in eugene j. kelley and william lazer, managerial marketing: perspectives and viewpoints, homewood il: richard d. irwin, inc. (1958). 12. porter, michael e. "how competitive forces shape strategy." harvard business review, (march-april 1979). 13. porter, michael e. competitive strategy. new york, ny: the free press (1980). 14. walters, c. glenn, d. wayne norvell and sam j. bruno. basic marketing: a situation orientation. bessemer, al: colonial press (1988). 15. smith, wendell r. "product differentiation and market segmentation as alternative marketing strategies." journal of marketing, vol. 21, no.1 (july, 1956). 16. zeithaml, c. and v. zeitha.ml. "environmental ma.nagement: revising the marketing perspective." journal of marketing, (spring 1984), pp. 41-53. toward a more comprehensive marketing strategy turnover in the top management cohort and financial performance roy a. cook fort lewis college durango, colorado daniel s. cochran gareth stephen taylor mississippi state university starksville, mississippi introduction the subject of turnover in organizations has always captured the attention of both practitioners and academicians. stories of management upheaval and change abound as organizations downsize and restructure to meet the challenges of a globally competitive environment. corporate giants such as sears, tenneco, chrysler, general motors, and wang have made dramatic management changes. research on this subject has ranged from the frequlmtly suggested approach of comparing an organization's turnover with some type of industry standard ([14], [23]) to analyses of specifically targeted positions and occupational groupings ([8], [32]). published investigations of the relationship between turnover and organizational performance have typically focused on the movement of individuals into and out of the top positions within an organization or on the outcomes of movement by more than one individual into or out of an organization. however, with few exceptions, the relationship between top management turnover and organizational performance has received scant attention. specifically, literature on managerial succession has proven to be inconclusive in regard to subsequent organizational performance [3]. consequently, the nature of the managerial turnover-organizational performance relationship has not been fully specified. for example, is there a relationship between managerial turnover and organizational performance? if so, are there relevant points at which varying. levels of turnover either enhance or retard the overall financial performance of an organization? if there is a significant relationship between varying levels of turnover in the top management cohort and long-term organizational financial performance, then it would seem reasonable to use organizational resources in an attempt to influence the level of turnover within this group. theoretical background the need for a team or cohort of individuals rather than one person to accomplish top management tasks of an organization was well-documented almost twenty years ago [9]. speculation as to the relationship between managerial succession and subsequent organizational performance can be traced to barnard [1] who hypothesized that a change in the top management team would result in organizational chaos. staw 18 journal ofbusiness strategies vol. 10, no.1 [31] also observed that the loss of large numbers of key employees may be detrimental to the organization because of the general disruption that may occur. however, the significance of this disruption will depend on the specialized knowledge of the position holder and/or the interdependence of established work roles between key group members. researchers, noting that strategic decision makers ultimately determine organizational success or failure, have begun the task of focusing attention on the significance of top management turnover and chief executive officer succession ([2], [22], [20], [35]). however, the empirical investigations into this subject have been limited and inconclusive. the primary focus appears to have been on single top management positions rather than multiple positions in the top management cohort. "some evidence suggests that succession creates an organizational crisis and thus negatively affects organizational performance. other evidence suggests that succession enhances performance. and finally, a third body of evidence suggests that succession and performance are unrelated" ([3], p. 93). the scarcity of research into the specific question of turnover in the top management cohort can be seen by reviewing the findings of the key studies on this subject presented in table 1. some of the contradictory findings of the early studies may be traced to small sample sizes. later studies, however, began to point to the possibility of a relationship between top management turnover and organizational performance. as researchers examined the potential impacts of employee turnover on organizations, it was observed that some level of exchange of human resources between the organization and the environment is required for the organization to remain viable [21]. this would preclude the possibility of maintaining a long-term rate of zero turnover. however, it should also be noted that turnover in top management positions could result in disruption of reporting relationships due to changes in cohort membership. hopefully, the results of the present research will provide insights for strategic decision makers as they face key human resource issues. based on the fmdings of previous research and professional opinions from members of the banking community ([11], [13], [29], [30]), the following independent variables were included in our analyses: percentage of agricultural and commercial loans in loan portfolio; percentage of real estate loans in loan portfolio; percentage of individual loans in loan portfolio; income production; net loan charge offs to average loans; loan to deposit ratio; total overhead expense to average earning assets; effective tax rate; and equity multiplier (see the appendix for a defmition of each variable.). by examining the joint effects of turnover and previously identified variables related to the overall financial performance of banks, a more complete picture of the significance of turnover in the top management cohort can be identified. therefore, we tested the following hypothesis: turnover in the top management cohort is related to organizational financial performance in the presence of other theoretically specified independent variables. spring 1993 cook, cochran & taylor: turnover in the top management 19 table 1: turnover and top management organizational performance investitime statistical succession performance major gator organizations frame technique variable(s) variable(s) findings trow 108 small varies cross tabuannual rate changes in organizations (1961) manufacturing by comlations; of succesprofitabilthat plan for companies pany tests of sion of manity succession significance agers show profitability grusky business cor1949chi square changes in size; amt. frequency of (1961) porations 1959 top manageof bureausuccession ment cracy positively related to size brown 26 nfl teams 1970regression changes of percentage no relation(1982) 1978 head coach, of games ship between chief operwon in succession ational manregular and perforager, assisseason of mance tant coaches, a given players year wagner, 31 fortune 1976multiple proportion of return on proportion of pfeffer, & 500 companies 1980 regression turnover in investment turnover in o'reilly the top mgt. top mgt. group (1984) group inversely relaed to financial performance & positively related to coefficient of variation of distance between managers reinganum 353 new york 1978event study change in abnormal succession (1985) & american 1979 chairman stock mkt effects depenstock exand/or presperformdent on size of changes traded ident ance firm, origin of companies successor, and disposition of predecessor goodstein 327 califor1980pooled time ceo & board number of changes in & boeker nia hospitals 1986 series; crosscomposition product hospital ow(1991) sectional changes and/or sernership & mgt. structure vice addisignificant using lagged tions or catalysts to serindep. variable deletions vice changes structure adapted from glenn r. carroll, (1984), "dynamics of publisher succession in newspaper organizations," administrative science quarterly, 39:96. 20 journal ofbusiness strategies research design vol. 10, no.1 in order to gain a better understanding of the potential relationship between varying levels of top management turnover and fmancial performance, we analyzed data from all regulated banks in the state of nebraska over a seven-year time span. this period provided an interesting strategic window for analysis since the banking industry was experiencing a great deal of turbulence and change due to the impact of regulatory changes initiated by the depository institutions deregulation and monetary control act of 1980 (didmca). didmca brought comparability to the banking industry as federal reserve requirements were extended to institutions which had previously avoided this control. in addition to providing a large relatively homogeneous group of organizations for our research, the possibility of industry effects was controlled by using a single industry. since researchers have failed to reach a consensus on a universal measure of organizational financial performance, we identified two measures of performance commonly monitored in the banking industry: return on average assets and return on average equity ([10], [13], [28], [30]). return on average assets captures the response of an organization's fmancial performance relative to managerial policies, while return on average equity captures the concept of investor wealth maximization. sample and data in order to control for differences in the external environment, the banks selected for this study were all domiciled in the state of nebraska. the banking industry in nebraska provided a large number of observations (391) as well as a relatively homogeneous group due to state-mandated legislative restrictions on interstate and branch banking. information about managerial turnover was taken from a listing of bank officers reported in the nebraska edition of the american bank directory. financial performance data are based on uniform bank performance reports submitted to the federal deposit insurance corporation and published annually in sheshunoff banks of nebraska ([24], [25], [26], [27], [28], [29]). the time frame selected for analysis begins after the passage and phase-in of the depository institutions deregulation and monetary control act of 1980 (didmca). as previously noted, didmca brought comparability in financial reporting standards to the banking industry. top management turnover in this environment was measured over a two-year time frame which is in keeping with previous turnover research in top management conducted by helmich and brown [17] and wagner, et al. [33]. no attempt has been made to separate voluntary and involuntary turnover for purposes of analysis because it is virtually impossible to obtain accurate information as to the voluntary/involuntary status of separations in the top management hierarchical level ([18], [19]). in fact, individuals leaving the upper echelons of organizations are often described as "pursuing other opportunities" which makes it difficult to determine the actual nature of departures. spring 1993 cook, cochran & taylor: turnover in the top management 21 since the present research required identifying turnover among persons who are in positions that can have an impact on long-run organization [mandai performance, it was necessary to limit the number of positions to those who participate in top management decisions. an earlier survey of banks operating in the state of nebraska identified the following positions as part of the top management cohort: chairman of the board, president, chairman of the executive committee, executive vice president, senior vice president, vice president, cashier, and treasurer [7]. total turnover in this group was defined by the percentage of individuals who were no longer in the top management cohort over a two-year period between the spring of 1980 following the passage of didmca and the spring of 1982. statistical analyses the recorded data were analyzed using the stepwise procedure for multiple linear regression in order to identify representative models applicable for each dependent variable and year being studied. the relationship between turnover in the top management cohort and organizational financial performance was analyzed by lagging financial performance for one-, two-, three-, four-, and five-year periods. tills procedure is in keeping with the previously reported research where lagged time periods were used for analyzing organizational performance ([22], [34], [35]). in addition to using the stepwise multiple regression procedure for analysis, the correlations among the independent variables in each of the samples were screened for the presence of multicollinearity. although the potential problem of multicollinearity was recognized, it was not considered to be a significant problem since previously tested performance models were being utilized. however, reported unadjusted r2 and adjusted r2 statistics were compared to check for any unusually large differences between these statistics which might indicate a potential problem with multicollinearity. additionally, analyses were performed using a chow test [5] to determine whether the specified models could be universally applied to those banks experiencing some turnover as well as those experiencing no turnover in the top management cohort. results an abridged presentation of the results highlighting the turnover variable and adjusted r2 of each separate regression equation for the return on average assets and return on average equity models is shown in table 2. our analyses of the data indicated that there were no statistically significant relationships evident between turnover in the top management cohort and the organizational financial performance measures of return on average assets or equity in the presence of the other theoretically specified variables for any of the years investigated. in addition, an examination of the correlation matrices for all variables by year in both models indicated that turnover was significantly correlated with return on average assets only in 1983 (-.002, p<.05) and 1987 (-.106, p<.05). however, there appears to 22 journal ofbusiness strategies table 2: partial summary of regression statistics return on assets model vol. 10, no.1 year turnover variable b p value adjusted r2 1983 1984 1985 1986 1987 -.037 -.032 .037 .031 .017 -1.053 -1.234 1.353 1.155 .506 .293 .218 .177 .249 .613 .544* .744* .728* .716* .602* return on equity model turnover variable year b p value adjusted r2 1983 0.000 -.218 .828 .550*** 1984 0.000 -.120 .904 .728* 1985 .045 1.664 .097 .725* 1986 -.027 .992 .322 .724* 1987 .023 .616 .539 .511* *p<.05 **p<.oi ***p<.ooi be little practical significance to observed correlations of this magnitude. more importantly, turnover was not correlated with return on average equity in any of the years studied. therefore, the a priori null hypothesis that turnover in the top management cohort is not related to return on average assets in the presence of other theoretically specified independent variables cannot be rejected. however, there were variables significantly related to the financial performance measures selected for this study. the variables found to be significantly related to return on average assets and equity were net loan charge offs, income production, loans-to-deposits, overhead, real estate loan mix, loans to individuals, and the equity multiplier. although the relationships between the independent variables identified as being statistically significant in the specified models were not of specific interest to this research, they are similar to previous research findings investigating variables within managerial control that contribute to bank performance ([13], [4]). comparison of those banks experiencing some turnover in the top management cohort (146) and no turnover in the top management cohort (245) were conducted using the chow test [5]. the results from these tests for the return on average assets and equity models are presented in tables 3 and 4 respectively. spring 1993 cook, cochran & taylor: turnover in the top management 23 table 3: chow test comparisons of banks exhibiting some turnover with those exhibiting no turnover in the top management cohort return on assets model year n nl n2 ssen sseni ssen2 f f(k, n-2k) 1983 389 243 143 121.89912 86.44974 28.96013 4.2621* 2.21 1984 388 242 146 167.11605 116.90118 46.70638 1.6212 2.21 1985 387 242 145 169.70026 116.25415 50.34694 1.4026 2.21 1986 391 245 146 239.67803 168.16200 68.56420 .9502 2.21 1987 375 234 141 94.65772 60.46571 32.40972 1.4009 2.21 n = all banks nl = turnover = 0 nz = turnover> 0 p<.05 table 4: chow test comparisons of banks exhibiting some turnover with those exhibiting no turnover in the top management cohort return on equity model year n nl n2 ssen sseni ssen2 f f(k, n-2k) 1983 384 239 145 9956.59524 5782.24242 3515.16104 4.39584* 2.10 1984 377 236 141 11822.88687 7266.05243 3965.80560 3.20115* 2.10 1985 377 236 141 12630.04959 8928.26000 3086.42309 3.11578* 2.10 1986 378 235 143 19434.64098 11648.98351 7169.25776 1.99808 2.10 1987 370 230 140 12620.95809 6340.90090 5346.76392 4.76456* 2.10 n = all banks nl = turnover = 0 nz = turnover;> 0 p<.05 24 journal ofbusiness strategies vol. 10, no.1 in order to perform these tests, a standard model was specified based on the variables that consistently entered the stepwise regression procedure with significant coefficients, and then an hierarchical regression procedure [6] was utilized to analyze each subgroup by year to insure comparability. this procedure is designed to test statistically whether the relationships between the coefficients of the dependent performance variables and the coefficients of the independent variables differ significantly between the subgroups. discussion the absence of empirical evidence confirming the significance of the relationship between top management turnover and subsequent organizational financial performance should concern academicians and practitioners alike. although the chow tests indicated turnover was not significant in either of the specified models, the mixed results obtained from these comparisons may have been influenced by the possibility of ritual scapegoating ([12], [15]) or pruning of management deadwood [34] as a result of unacceptable organizational performance. moreover, banking regulations requiring bank officers to have significant experience may lead to homogeneity within the top management ranks [16]. these findings may prove to be important for several reasons. first, this research adds to the developing body of knowledge about the relationship between turnover and organizational performance which has proven to be inconclusive or contradictory. second, there is no evidence in this research to indicate that banks experiencing some turnover in the top management cohort will have significantly different financial performance than those banks which experience no turnover in the top management cohort. third, our findings point out potential flaws in singularly focusing attention and resources on attempting to control the turnover process within the top management group. fourth, it points to the need for a better understanding of the environmental influences beyond the control of strategic decision makers that may constrain organizational performance and the possible need to focus attention on specific performance criteria within their control. fifth, since it has been assumed that it takes time for changes to occur in organizational performance after strategic decisions have been made, the use of a longitudinal design with time lags has important implications. the absence of a significant relationship between turnover and financial performance during the research time frame proved to be revealing since it appeared that financial performance was not materially effected by turnover in the top management cohort. however, the absence of any relationship is significant since it may call into question focusing time and attention on identifying responsible levels of turnover or a specific "equilibrium" point of acceptable turnover for the top management cohort. although these ideas may be found to be true in other industries or within groups at lower hierarchical levels of an organization, they were not present in the current findings. the future holds the promise of increasing our understanding of the potential impact of turnover within identified organizational hierarchies or groups. however, spring 1993 cook, cochran & taylor: turnover in the top management 25 in order to make generalizable statements, additional research is needed. by expanding the present research within industries to include large groupings of comparably sized organizations operating within similar economic constraints as well as undertaking more complex, across industry studies, it should be possible to make more generalizable statements as to potential relationships. it would also seem reasonable to investigate similar relationships in succeedingly lower hierarchical levels within the organization since individuals at these lower levels engage in strategy implementation [36]. individuals at these lower levels engage in multiple decisions which, cumulatively, may have a significant affect on organizational performance and, therefore, could be fertile ground for further research and managerial attention. insights into the cohort turnover/performance relationship could prove to be helpful for strategic decision makers in today's highly competitive environment as they face difficult decisions relating to downsizing, restructuring, consensus building, and work team composition and stability. references 1. barnard, chester j. the functions of the executive. cambridge, ma: harvard university press (1948). 2. brown, m. craig. "administrative succession and organizational performance: the succession effect." administrative science quarterly, vol. 27 (1982), pp. 1-16. 3. carroll, glenn r. "dynamics of publisher succession in newspaper organizations." administrative science quarterly, vol. 29 (1984), pp. 93-113. 4. cates, david c. "are small banks still profitable?" aba banking journal, vol. 78, no.9 (1986), pp. 49-52. 5. chow, gregory c. "tests of equality between sets of coefficients in two linear regressions." econometrica, vol. 28 (1960), pp. 591-605. 6. cohen, jacob and cohen, patricia. applied multiple regression/correlation analysis for the behavioral sciences. new york: john wiley & sons (1975). 7. cook, roy a and jeryl nelson. "will the real top managers please stand up? a study of nebraska banks." management proceedings of the midwest management society. midwest business administration association, chicago, il, (march 1989). 8. dalton, dan r. and tudor, william d. "turnover turned over: an expanded and positive perspective." academy of management review, vol. 4 (1979), pp. 225-235. 9. drucker, peter f. management: tasks, responsibilities, practices. new york: harper & row, publishers, (1974). 26 journal ofbusiness strategies vol. 10, no.1 10. federal financial institutions examination council. user's guide for uniform bank performance report. second revision, washington, d. c.: federal financial institutions examination council (1986). 11. ford, william f. and olson, dennis. "how 1,000 high-performance banks weathered the recent recession." banking, vol. 70 (1968); pp. 36-48. 12. gamson, william a. and scotch, norman a. "scapegoating in baseball." american journal of sociology, vol. 70 (1964), pp. 69-72. 13. gillis, harvey n., lumry, iii, rufus w., and oswold, thomas j. "a new approach to analyzing bank performance." bankers magazine, (march/april 1980); pp. 67-73. 14. goodstein, jerry and boeker, warren. ''turbulence at the top: a new perspective on governance structure changes and strategic change." academy of management journal, vol. 34, no.2 (1991), pp. 306-330. 15. grusky, oscar. "reply to scapegoating in baseball." american journal of sociology, vol. 70 (1964); pp. 72-76. 16. hambrick, donald c. and mason, phyllis a. "upper echelons: the organizational change as a reflection of its top managers." academy of management review, vol. 9 (1984); pp. 371-391. 17. helmich, donald l. and brown, warren b. "successor type and organizational change in the corporate enterprise." administrative science quarterly, vol. 27 (1972); pp. 371381. 18. jackson, susan e., brett, joan f., sessa, valerie i., cooper, dawn m., julin, johan a., and peyronnin, karl. "some differences make a difference: individual dissimilarity and group heterogeneity as correlates of recruitment, promotions, and turnover." journal of applied psychology, vol. 76 (1991); pp. 675-689. 19. james, david r. and soref, michael. "profit constraints on managerial autonomy: managerial theory and the unmaking of the corporation president." american sociological review, vol. 46 (february 1981); pp. 1-18. 20. john, kose, lang, larry h. p., and netter, jeffry. "the voluntary restructuring of large firms in response to performance decline." journal of finance, vol. 57 (1992); pp. 891-892. 21. katz, daniel and kahn, robert l. the social psychology of organizations. second edition, new york: john wiley & sons (1978). 22. lieberson, stanley and o'connor, james f. "leadership and organizational performance: a study of large corporations." american sociological review, vol. 37 (1972); pp. 117-130. spring 1993 cook, cochran & taylor: turnover in the top management 27 23. price, james l. the study of turnover. ames, ia: the iowa state university press (1977). 24. sheshunoff banks of nebraska. austin, tx: sheshunoff & company, inc. (1984). 25. sheshunoff banks of nebraska. austin, tx: sheshunoff & company, inc. (1985). 26. sheshunoff banks of nebraska. austin, tx: sheshunoff & company, inc. (1986). 27. sheshunoff banks of nebraska. austin, tx: sheshunoff & company, inc. (1987). 28. sheshunoff banks of nebraska. austin, tx: sheshunoff & company, inc. (1988). 29. sheshunoff banks of nebraska. austin, tx: sheshunoff & company, inc. (1989). 30. sinkey, joseph f., jr. commercial bank financial management in the financial services industry. third edition, new york: macmillian publishing company (1989). 31. staw, barry m. "the consequences of turnover." journal of occupational behavior, vol. 1 (1980); pp. 253-273. 32. treborg, james r. and lee, thomas w. "a predictive study of organizational turnover rates." academy of management journal, vol. 27 (1984); pp. 793-810. 33. wagner, w. gary, pfeffer, jeffrey, and o'reilly, charles a., iii. "organizational demography and turnover in top-management groups." administrative science quarterly. vol. 29 (1984); pp. 74-92. 34. walsh, james p. and ellwood, john w. "mergers, acquisitions, and the pruning of managerial deadwood." strategic management journal, vol. 12 (1991); pp. 201-217. 35. weiner, nan and mahoney, thomas a. "a model of corporate performance as a function of environmental, organizational, and leadership influences." academy of management journal, vol. 24 (1981); pp. 453-470. 36. woolridge, bill and floyd, steven w. "the strategy process, middle management involvement, and organizational performance." strategic management journal, vol. 11 (1990); pp. 231-241. 28 journal ofbusiness strategies appendix: definitions of independent variables vol. 10, no. 1 percentage of agricultural and commercial loans in loan portfolio: the percentage of agricultural and commercial loans to total domestic loans percentage of real estate loans in loan portfolio: the percentage of real estate loans to total domestic loans percentage of individual loans in loan portfolio: the percentage of individual loans to total domestic loans income production: combination of interest income (tax adjusted) and total non-interest income as a percentage of average assets net loan charge offs to average loans: net loans actually written off as losses, recognizing recoveries from previously written off loans, as a percentage of the average loan portfolio loan to deposit ratio: the percentage of total loans to total deposits after reduction for all governmental deposits total overhead expense to average earning assets: the aggregate of salaries and benefits, occupancy expense, and other operating expenses to average earning assets effective tax rate: calculation of taxes paid as a percentage of income before extraordinary items for each year equity multiplier: leverage component-<:alculated by dividing average annual assets by average annual equity turnover in the top management cohort and financial performance a strategic model for issues management communication: how to respond to accusations of unethical corporate behavior dennis e. garrett jeffery l. bradford renee a. meyers university of oklahoma norman, oklahoma the telephone call you receive upon arriving at your office on a monday morning is from an associated press reporter. the reporter opens the conversation by saying, "i have just received a call from the alliance for corporate responsibility, and they have accused your company of engaging in business practices that are unethical and harmful to customers. what is your response to these accusations?" this is clearly a delicate situation. from prior experience, you know that the alliance is a powerful group that is adept at using the media to its advantage. you also know that the response you give to this reporter will undoubtedly appear in many major newspapers. if the newspapers' readers, many of whom are considered by your company's management to be key constituents, find your response to be appropriate given the nature of the accusation, your company will probably be able to minimize the impact of the alliance's protest action. however, if your response is inappropriate, many readers may question your company's motives and sympathize with the alliance's goals. additionally, an inappropriate response may fuel the alliance's cause, generate additional media inquiries and coverage, and severely damage your company's public image and sales. certainly, your response to this is critically important. what do you say? this is the type of situation which corporate executives would prefer to avoid. however, recent evidence suggests that external protest groups are increasing this pressure on corporations in a variety of public areas ([7], [8], [10], [11]). as a result, executives find that increasingly they must be prepared to respond to accusations of improper corporate behavior raised by external protest groups. in recent years the research domain of "issues management" has sought to analyze and understand such contentious situations ([3], [4], [14], [24]). issues management research investigates how corporations can most effectively identify and respond to environmental developments that present opportunities of threats to corporate welfare ([1], [27]). communication plays a central strategic role in the issues management process, especially in situations where an organization is accused of unethical behavior ([6], [13], [14]). the type of communicative response offered by managers significantly journal of business strategies, volume 6, number 2 (fall 1989) 150 fall 1989 garrett, et ai.: responses to accusations 151 influences the evolution of conflict with the accusing group, the perceptions of the outside viewers, and the media coverage. effective communication strategies are essential for blunting the potential negative impact of the accusations, for advocating the organizations' position, and for preserving the corporation's positive public image. even though the importance of managerial communication to the issues management process is widely accepted, little research has focused on the developing a strategic model for issues management communication. previous research has tended to present list of possible communicative responses without fully specifying when and why particular strategies should be used ([17], [22], [23], [26]). lacking strong theoretical underpinnings, these models are unable to neither provide guidelines for analysis of accusations by protest groups, nor suggest communication strategies appropriate for mitigating such indictments. in this paper we propose a strategic model for issues management communication that focuses specifically upon situations in which a corporation is accused of unethical organizational behavior. first, we briefly review recent theoretical work on impression management [18], and utilize that perspective as a framework for grounding our model of strategic communication. second, we present a model of issues management communication that incorporates three stages of analysis: (1) evaluation of commission, (2) assessment of responsibility, and (3) review of evaluation standards. third, we utilize examples of actual communication strategies used by managers whose organizations were recently accused of unethical behavior to more fully explicate and validate our proposed model. finally, we will discuss the strategic implications of our model for issues management. theoretical framework to frame our issues management communication model, we draw upon recent theoretical work in the research domain of impression management. impression management theory suggests that social actors must continually analyze and adjust their communication so that other actors form favorable impressions of them ([9], [12], [18]). impression management is especially important in situations where an actor has been accused of wrongdoing, has performed an irresponsible act, or has made a public mistake. such predicaments call for the actor to provide an "account" of his/her behavior that will mitigate forthcoming adverse c.onsequences. within the impression management framework, accounts are defined as communication strategies designed to minimize negative repercussions that may accrue when an actor is accused of improper behavior ([5], [18]). previous research on accounting behavior of individuals accused of wrongdoing indicates that accounts fall into four basic categories: denials, excuses, justifications, and concessions ([5], [18], [20]). further, research has suggested that the the type of account offered by an accused actor affects the resolution of conflict with the accusing actor ([5], [21]) and the judgments made by other parties concerning the legitimacy of the accusations ([2l [18]). impression management theory and its analysis of accounts provides an excellent theoretical basis for development of a strategic model for issues management communication. yet, we think previous impression management research is limited in two 152 journal of business strategies vol 6, no.2 respects, each of which we address in this paper. first, most previous impression management research on accounts has focused on the interpersonal context, investigating individuals who have been accused of improper personal behavior, rather than managers whose corporations have been accused of unethical organizational behavior. second, even though impression management research has established the four categories of accounts (denial, excuses, justifications, and concessions), we extend that finding by proposing a strategic model for managerial use that explains how the choice among these four communication strategies should be made. in so doing, we think our proposed model promises to provide a more complete description of the strategy selection process, and allows more effective selection of appropriate communication strategies for given issues management situations. proposed model as indicated earlier, previous discussions of strategic communication in the issues management process have tended to focus on the lists of strategies without providing a systematic and coherent foundation for building a manager's choice of an appropriate response ([17], [22], [23], [26]). in this section we propose a strategic model based on impression management theory which (a) identifies the steps a manager should follow in analyzing the accusations of protest groups, and (b) indicates which communication strategies are most appropriate given the outcome of this analysis process. more, specifically, as shown in figure 1, our model posits that managers should progress through three stages of analysis: (1) evaluation of commission, (2) assessment of responsibility, and (3) review of evaluation standards. this three-stage analytical process then guides the manager's choice of the most effective and appropriate communication strategies, which include (a) denials, (b) excuses, (c) justifications, or (d) concessions. in the next section, we employ actual communication strategies used by corporate managers who faced accusations of unethical organizational practices to demonstrate the practicality of the model. prior to that exposition, we briefly describe the survey methodology used to obtain these managerial communication strategies. survey methodology the examples we utilize to explicate the model emanate from a larger study of consumer boycotts. because consumer boycotts represent an important, widespread, and increasingly occurrent issues management situation and moreover, because they typically generate public debate ([10], [11], [15]), they provide an excellent base from which to validate a model of strategic issues management communication. consumer boycotts were identified by careful examination of sixteen newspaper and periodical indices which represented a broad cross-section of national and regional sources for boycott activity. this review yielded a total of 30 identifiable and conformed boycotts. telephone interviews were conducted with the person in each of the 30 boycott organizations most qualified to respond to inquires regarding the fall 1989 garrett, et ai.: responses to accusations 153 figure 1 a strategic model for issues managment communication evaluation of commission did we commit this act? i denials i assessment of responsibility are we responsible for this act? no iexcuses i a) legal constrainst b) financial conditions review of evaluative standards do we agree wi th the standards of evaluation? yes i concessions i no ijustifications i a) higher royalties b) avoidance of greater harm c) competitive standards d) legal right e) malicious intentions of accusers dispute [25]. although using multiple respondents from an organization has certain benefits [16], only one respondent per organization was used because in most organizations only one person was adequately informed or authorized to answer these questions. to encourage respondent cooperation and candor, the respondents were guaranteed anonymity. communication strategies were solicited by asking the respondents a set of openended questions regarding their organizations' perceptions of the protest groups' accusations of allegedly unethical organizational policies. interviews were completed with respondents from 23 of the 30 eligible organizations (77% completion rate). the most common reason for non-response was lack of time complete the interview. the managers' responses are utilized in the next section to clarify and validate the proposed strategic model. following presentation of these examples, the advantages and disadvantages of the communication strategies are outlined. explication of model and examples stage one: evaluation of commission the first logical stage in the issues management communication process is to evaluate whether the accusations leveled by the protesters are valid. the manger must ask "did we actually commit the act we are accused off committing?" surprisingly, in some cases the protesters receive erroneous information and incorrectly accuse a company of using a certain harmful policy. the manager's first take is to carefully understand the exact nature of the protesters' complaint. after the complaint is fully 154 journal of business strategies vol. 6, no.2 understood, the manager should contact the necessary personnel in the company who are most closely associated with these allegedly harmful policies or practices to determine if the company is really doing what the protesters are claiming. if this information check shows that the company is not involved in these disputed policies, the most appropriate communications strategy is a strong and emphatic denial. for example, in one dispute the protesters accused a fast food chain of using veal that is raised under alleged inhumane conditions. having determined that the organization did not commit this act, the restaurant manager denied the charge: the group accused us of using a special veal that is bred under special conditions and which is very expensive. but we were actually using rangefed veal which is not bred under these supposedly inhumane conditions. end quote another interesting example of a denial occurring when a protest group accused a major nonprofit organization of being involved in abortion-related programs. the director of the nonprofit organization argued that the accusation was unfounded and that the organization had not committed any wrongdoing: there was a misunderstanding of what we were going to do. this program was only in the draft proposal stage, but erroneous information got out.... this group rescinded their remarks after we explained the situation to them. the major advantage to a denial is that it offers the greatest potential protection for the accused company and may quickly put an end to the issue. however, managers in accused companies must be careful not to offer a denial if there is any chance that the protesters' allegations may be true. if a denial is made then information emerges that the company was in fact involved in the disputed policy area, the company's credibility may be severely damaged and it may appear that the company was trying to "cover up" the truth. therefore, a denial should be used only when the facts conclusively show that the protesters have incorrectly accused the company. if the manager determines that his/her company is or was involved in the disputed policy area the protesters claim, then the manager should move to the model's second stage, assessment of responsibility. stage two: assessment of responsibility the major task at this second stage is to determine the level of responsibility that the accused organization should accept for any negative consequences that accrue from its involvement in the disputed policy areas. the assessment of responsibility is directly related to the amount of control the organization has over the policy area that is repugnant to the protesters. fall 1989 garrett, et al.: responses to accusations 155 managers may determine that their organization either (a) lack complete control over policy options because of certain constraints, or (b) have freedom to exercise complete control over policy options. if managers conclude that their organization lacks complete control over policy options, and therefore cannot make the changes demanded by the protesters, the most appropriate communication strategy to be employed is the excuse. excuses are used to argue that, due to a lack of control over policy options, the organization should not be held responsible for any negative outcomes from its policies. two major categories of excuses, legal constraints and financial conditions, are often applicable when organizations are accused of engaging in unethical behavior. legal constraint excuses argue that the organization's control over policy options is limited by certain legal or governmental regulations. for example, a major manufacturing company was accused of using a potentially-harmful chemical in its production processes. the manager responded by offering a legal constraint excuse: this was the only herbicide approved for use in nova scotia by the government. . .. our hands were tied. we had to spray and the only thing available to spray was this product. financial conditions excuses, on the other hand, are used to argue that economic factors constrain the policy alternatives available to the accused organization. this type of excuse contends that the policy changes advocated by the protesters are unreasonable because the organization could not possibly afford to meet the protesters' demands. the manager argues that the overwhelming financial burden created by the protesters' proposed changes limits the organization's degree of control and responsibility in this dispute. for example, a group advocating greater rights for the handicapped pressed a major hotel chain to extensively modify its rooms to make them more accessible for the handicapped. the hotel chain executive responded with a financial condition excuse: they wanted us to change the widths of the doorways to the bathrooms .... this is not easy to do because you would have to relocate also the electrical systems .... these modifications would have been expensive. the major advantage of excuses is they allow a manager to demonstrate his/her organization's innocence because of a lack of control in the contentious policy area. if the organization absolutely cannot make the policy modifications demanded by the protesters because of legal or financial constraints, then an excuse helps to protect the organization's public image from the nega.tive repercussions of the conflict. it seems especially likely 156 journal of business strategies vol. 6, no.2 that legal constraint excuses will be perceived as credible because key constituents are apt to believe that organizations, even major corporations, are limited by the law in certain policy areas. if managers who choose to use a legal constraint excuse are careful to thoroughly document their position with ample explanation of legal regulations, the legal constraint excuse may be especially powerful. however, the excuses may also carry a certain amount of risk, especially the financial conditions excuse. many key constituents assume that organizations, especially major corporations, have an unlimited financial capacity to institute policy changes. therefore, if a manager argues that his/her corporation is unable to make the changes because of the expense involved, many constituents are likely to view this excuse as unacceptable. they may even believe that the organization's use of this financial conditions excuse is further evidence of the accused organization's preoccupation with money and its insensitivity to the protesters' concerns. in sum, both the advantages and disadvantages of excuses must be weighed very carefully before utilization. finally, if a manager determines that his/her organization's policy options are not constrained, and excuses are therefore inappropriate, then the anal· ysis should progress to the third stage of our model, review of evaluative standards. stage three: review of evaluative standards in the final analysis stage, managers who determine that their organiza. tions have control over policy options must ask whether the evaluative standards employed by the group are appropriate. protesters often use a certain evaluative standard in their accusations that differ dramatically from the standard for behavior adopted by the accused organization. as a result, the impetus for the dispute is the protesters' belief that the target organization's policies do not meet an acceptable standard of organizational behavior. at this third stage of analysis, a manager must analyze the standards that the protesters are using to evaluate his/her organization's policies, as well as the standards the organization used in adopting its disputed policies. this analysis may yield two potential outcomes: (a) the manager concludes that the protesters' standards are not appropriate and that instead the organization's standards are more appropriate criteria, or (b) the manager concludes that the accuser's standards are legitimate. in the first case, when the manager determines that the protester's evaluative standards are faulty and the other standards demonstrate the merit of the organization's policies, the most appropriate communication strategy a manager can offer is a justification. justifications suggest that, even though the organization fall 1989 garrett, et al.: responses to accusations 157 is fully responsible for the disputed policies, certain factors support the legitimacy of these policies and diminish the negative implications of the accusations. at least five types of justifications may be used by managers in accused organizations: (a) higher loyalties, (b) avoidance of greater harm, (c) comparative standards, (d) legal right, and (e) malicious intentions of accusers. the first justification, higher loyalties, asserts that the disputed policy is acceptable because the organization is pursuing goals so important that they offset any negative consequences of the disputed policies. for example, when protesters tried to force a major military weapons manufacturer to stop the production of nuclear components, the manager responded with a higher loyalties justification based on the government's expressed need for higher national security: we agree with the objectives of peace and arms control, but the government policy has determined the need for production of military equipment. ... we have decided that we will participate selectively in the production of this equipment. the second type of justification, avoidance of greater harm, allows the manager to argue that greater damage would be created if the organization actually made the policy changes demanded by the protesters. because greater harm would be created, this justification suggests that the evaluative standards used by the protesters are seriously flawed and their accusations unfounded. for example, a manager of a leading drug company used this type of justification to argue against the protesters' demands that his company should remove a particular drug from the market: (this drug) revolutionized the treatment of mental health.. " this was a revolutionary drug which had beneficial effects .... the side effects of the drug are no secret. they are listed in the physicians' reference. comparative standards is the third type of justification which may be employed by managers as a communication strategy. with this justification, a manager compares his/her organization's record in the disputed policy area with other similar organizations which have not been singled out and accused of unethical behavior by the protesters. by demonstrating that his/her organization is consistent with or superior to the norms of other unaccused organizations, the manager seeks to show that the protesters' specific accusations against his/her organization are capricious and unfounded. when protesters accused a major food chain of discriminatory hiring practices, the manager responded with a comparative standards justification: 158 journal of business strategies vol. 6, no.2 the first thing we wondered is 'why have we been singled out?' .... our statistics showed we were better than the national average in this area. the fourth justification, legal right, bears a strong resemblance to the legal constraint excuse discussed earlier. however, whereas a legal constraint excuse suggests that an organization cannot make the protesters' desired changes due to legal restrictions, a legal right justification argues that the organization's disputed policy is legally acceptable. thus, the legal right justification indicates that, even though the organization could legally make the demanded changes, the organization is not legally required to do so. because the law does not mandate the changes demanded by the protesters, a manager could argue that his/her organization's allegedly harmful policies are appropriate. for example, when protesters challenged a bank's rewriting of mortgages at a higher interest rate, the manager responded with a legal right justification: we had a legal right to rewrite these mortgages at the higher rate. the fifth justification, malicious intentions of accusers, focuses on the motives of the protesters in the dispute. by using this justification, a manager hopes to demonstrate that, while his/her organization's allegedly improper actions are actually based on acceptable standards of conduct, the accusers are malicious and devious. a manager may use this justification to cause key constituents to question the character of the accusers and the validity of their accusations, for example, a manager in a bank accused of unfair lending practices used this justification: (the protesters) do not want to deal with the issues. they are not serious about helping unemployed workers. this is socialistic and they are trying to undermine the free market system. they know it and they don't give a damn! the effectiveness of justifications depends on two factors: (a) key constituents' perception of the comparative credibility of the accused organization to that of the protesting group, and (b) the value structures of key constituents. first, one factor that key constituents will use to evaluate the acceptability of justifications is the comparative credibility of the accused organization and the protesting group. justifications are likely to be more persuasive if the accused organization has a history of socially responsible behavior and the protesters have a history of making unfounded accusations solely to generate media coverage. in contrast, if the accused organization has repeatedly been found "guilty" of socially irresponsible behavior and been unwilling to correct past problems, and the protesters have a history fall 1989 garrett, et ai.: responses to accusations 159 of uncovering and proving gross organizational abuses, justifications are likely to be less influential. second, justifications may not be equally persuasive to all groups of constituents because they possess varying value structures. a manager may have to offer several types of justifications to persuade different groups of constituents. for example, a legal right justification may be most persuasive to governmental regulators, an avoidance of greater harm justification may be most acceptable to consumers, and a malicious intentions of accusers justification may be most credible to distributors and suppliers. in addition, the use of justifications is not without certain risks, particularly when the legal right justification or the malicious intentions of the accusers justification is utilized. in the first case, the distinction between legal acceptability and moral appropriateness has always been open to debate. as many issues managers have concluded from their own experience, just because an organizational policy is legally accepted does not automatically mean that it is beyond reproach. a legal right justification may help to blunt the negative consequences of an accusation, but a manager should also be prepared to defend the contentious policy on moral grounds. to establish this moral appropriateness argument, a manager may choose to use an avoidance of greater harm justification and suggest that any change from the disputed policy would only generate more damage and therefore be an immoral action. in heated conflicts many managers are inclined to vent their frustration with the protesters by offering justifications focusing on the malicious intentions of the accusers. this justification is especially risky because many constituents may perceive this communication strategy as a "cheap shot" used by an organization which is overly defensive and perhaps has no other rational basis for responding to these accusations. the potential for negative consequences with this justification is particularly great when key constituents perceive that the protesters' concerns are genuine and that they are not pursuing ulterior motives for their own personal gain. finally, as discussed earlier, in this third stage of analysis, the manager may conclude that the evaluative standards of the protesters are either inappropriate or appropriate. if she/he concludes they are inappropriate, we have demonstrated that the justification is the most suitable communication response. however, if a manager determines that the standards used by the accusers are legitimate, then a manager must consider the concession as the most timely communication strategy. a concession indicates that (a) the organization is involved in the disputed area, (b) does have control and responsibility in this area, and (c) basically agrees with the evaluative standards used by the accusers. for example, when a group of real estate developers accused a major city newspaper of unfair coverage, the editor of 160 journal of business strategies the paper offered a concession: vol. 6, no.2 they had a legitimate bitch. the editorial department was not equipped to handle the real estate section .... management realized that we made a bad mistake. managers may be reluctant to offer a concession because they fear it will be perceived as a sign of organizational weakness. further, managers may be concerned that a concession will encourage other protest groups to also confront the organization with their particular demands for policy changes. for example, a publisher of a major city newspaper, which was accused of unfair coverage of minority news, stated: to give in to the demands of one group just attracts more trouble from other groups. while a manager should not concede to unfounded accusations, we believe that too often managers refuse to acknowledge organizational mistakes and offer a concession as a appropriate communication response. this type of managerial intransigence is unfortunate because the prompt and sincere offering of an apology for organizational errors may be quite beneficial. key constituents are likely to react positively to an organization which is willing to be responsive to legitimate external criticism [18]. for example, when chrysler was accused of selling repaired cars as new to the public, lee iacocca received widespread praise for his frank acknowledgment of chrysler's error and his promise that such actions would not reoccur [19]. while concessions are often the most difficult communication strategy to employ, if communicated with sincerity and tact, they can be very effective in defusing potentially harmful conflicts. conclusion communication plays a central strategic role in the issues management process, especially when an organization has been accused of unethical practices. in such circumstances, organizations cannot afford to let protesters control the communicative agenda. managers must be prepared to respond quickly and effectively to accusations before key constituents form enduring opinions based solely upon information provided by the protest group. prompt and effective communicative responses can only emerge if managers are familiar with and understand the strategic implications of available communication response options. this paper proposes a model for strategic issues management communication aimed at helping managers evaluate contentious situations and choose an appropriate communicative response. framing this model within impression management theory both represents a significant advancement over previous models which have simply offered fall 1989 garrett, et al.: responses to accusations 161 lists of possible communication response options, and provides managers with a firm basis from which to evaluate and choose effective communication strategies. references 1. ansoff, h. igor. "strategic issue management." strategic management journal, vol. 1 (1980), pp. 131-148. 2. brade1y, gifford weary. "self-serving biases in the arbitration process: a re-examination of the fact of fiction question." journal of personality and social psychology, vol. 36, no.1 (1978), pp. 56-71. 3. brown, james k. this business of issues: coping with the company's environments. new york, ny: the conference board inc. (1979). 4. chase, w. howard. issue management: origins of the future. stamford, ct: issue action publication (1984). 5. cody, michael j. and margaret l. mclaughlin. "models for the sequential construction of accounting episodes: situational and interactional constraints on message selection and evaluation." in r. 1. street jr. and j. n. capella (eds.), sequence and pattern in communicative behavior, baltimore, md: edward arnold (1985), pp. 50-69. 6. crable, richard e. and stephen 1. vibbert. "managing issues and influencing public policy." public relations review, vol. 11 (summer 1985), pp. 3-16. 7. friedman, monroe. "consumer boycotts." proceedings of the american council on consumer interests (1982), pp. 96-97. 8. friedman, monroe. "consumer boycotts in the united states, 19701980: contemporary events in historical perspectives." journal of consumer affairs, vol. 19 (summer 1985), pp. 96-117. 9. gardner, william l. and mark j. martinko. "impression management: an observational study linking audience characteristics with verbal self-presentations." academy of management journal, vol. 31, no.1 (1988), pp. 42-65. 10. garrett, dennis e. "the effectiveness of marketing policy boycotts: environmental opposition to marketing." journal of marketing, vol. 51, (april, 1987), pp. 46-57. 11. garrett, dennis e. "strategic guidelines for responding to consumer boycotts." journal of business strategies, vol. 4, no.2 (fall 1987), pp. 48-58. 12. goffman, e. relations in public. new york, ny: basic books (1971). 162 journal of business strategies vol. 6, no.2 13. heath, robert l. "corporate advocacy: an application of speech communication perspectives and skills and more." communication education, vol. 29 (september, 1980), pp. 370-377. 14. heath, robert 1. and richard alan nelson. issues management: corporate public policymaking in an information society. beverly hills, ca: sage publications (1986). 15. meyer, alan d. "adapting to environmental jolts," administrative science quarterly. vol. 27 (1982), pp. 515-537. 16. phillips, lynn. "assessing measurement error in key informant reports: a methodological note on organizational analysis in marketing." journal of marketing research, vol. 18, (november, 1981), pp. 395~415. 17. ressler, judith a. "crisis communications." public relations quarterly, vol. 27 (fall 1982), pp. 8-10. 18. schlenker, barry r. impressions management: the self-concept, social identity! and interpersonal relations. monterey, ca: brooks/cole publishing co. (1980). 19. schlesinger, jacob m. "chrysler finds a way to settle odometer issue." the wall street journal, november 12, 1987 1 p. 7. 20. schonbach, peter. ~~a category for account phases." european journal of social psychology, vol. 10 (1980), pp. 195-200. 21. scott, marvin b. and stanford m. lyman. "accounts." american sociological review, vol. 23 (february, 1986), pp. 46-62. 22. sethi, s. p. ~'a conceptual framework for environmental analysis of social issues and evaluation of business response patterns." academy of management review, vol. 4, no.1 (1979), pp. 63-74. 23. shelbyl annette n. "a typology of communication strategies for corporate advocacy." journal of business strategies, vol. 2, no.1 (spring 1985), pp. 33-38. 24. stanley, guy d. d. managing external issues: theory and practice. greenwich, ct: jai press (1985). 25. sudman, seymour and norman m. bradburn. asking questions. san francisco, ca: jossey-bass publishers (1982). 26. vitell, scott j. and stephen j. grove, "marketing ethics and techniques of neutralization." journal of business ethics, vol. 6 (1987), pp. 433-438. 27. wartick, stephen 1. and robert e. rude. "issues management: corporate fad or corporate function?" california management review, vol. 29, no.1 (fall 1986), pp. 124-140. a strategic model for issues management communication: how to respond to accusations of unethical corporate behavior volume 36, number 1 1 board characteristics and the acquisition of newly public firms christopher r. reutzel sam houston state university • huntsville, tx carrie a. belsito sam houston state university • huntsville, tx abstract this study examines the relationship between board characteristics and the likelihood that newly public firms will be acquired. drawing upon signaling and agency theory, this study considers the influence of various board characteristics in addressing the information asymmetry and agency issues faced by potential acquirers of newly public firms. in doing so, this study extends the focus of research on a unique form of entrepreneurial harvest, public dual tracking. in order to test study hypotheses, we conducted logistic regression on a sample of 175 newly public firms that underwent initial public offerings (ipo) in the u.s. during the calendar year of 2007. study results provide moderate support for study hypotheses. first, no support was found for a relationship between the percentage of outside directors and the likelihood of newly public firms being acquired. second, chief executive officer (ceo) duality was found to be negatively related to the likelihood of a newly public firms being acquired. third, opposite the hypothesized effect, study results suggest that the presence of women directors is negatively related to the likelihood that newly public firms are acquired. finally, study results suggest a weak positive relationship between board size and the likelihood of newly public firms being acquired. introduction scholarly attention to the acquisition of firms that have completed their initial public offerings (ipos), sometimes referred to as public dual-tracking, represents a growing area of interest to scholars in finance, management, and entrepreneurship (brau, sutton, & hatch, 2010; ragozzino & reuer, 2007b). this attention is due, at least in part, to the relative frequency with which newly public firms (arend, patel, & park, 2014; garg, li, & shaw, 2018) are acquired by other firms upon completion of their ipos (brau, francis, & kohers, 2003; pagano, panetta, & zingales, 1998) as well as the potential for such acquisitions to create wealth for newly public firm owners (reuer, tong, & wu, 2012). indeed, research on this topic suggests that this type of ‘public-dual tracking’, where firms go public and are then acquired by 2 journal of business strategies another firm thereafter, represents a potentially lucrative form of entrepreneurial exit for founders and shareholders (field & karpoff, 2002; zingales, 1995). while the acquisition of a newly public firm provides founders and shareholders with an opportunity to create financial wealth (brau et al., 2010), substantial challenges to the realization of such gains exist. for example, the relatively short track records of newly public firms serve to increase uncertainty surrounding their long-term viability (certo, 2003; fischer & pollock, 2004). difficulties associated with the valuation of newly public firm resources and growth prospects serve to further exacerbate the uncertainty faced by potential acquirers of newly public firms (cooper, woo, & dunkelberg, 1988; heeley, matusik, & jain, 2007). these challenges give rise to potentially high degrees of information asymmetry between newly public firms and their prospective acquirers, exposing potential acquirers to the hazards of adverse selection and moral hazard (ragozzino & reuer, 2007b; reuer & ragozzino, 2008). as a consequence of these challenges, prospective acquirers of newly public firms may choose not to proceed with what might otherwise represent seemingly attractive acquisitions (ragozzino, 2016). relatively little is known about what factors lead firms to be acquired after their ipos. extant research often draws upon the logic of signaling theory (arrow, 1973; spence, 1981), to argue that when faced with the uncertainty presented by evaluating newly public firms as potential acquisition targets, prospective acquirers of newly public firms screen potential acquisition targets based upon indicators of firm viability (ragozzino & reuer, 2007a, 2007b). tests of the insights provided by signaling theory have proven fruitful in furthering our understanding of which firm characteristics are salient to prospective acquirers of newly public firms. for example, research suggests that affiliations with venture capitalists, prestigious underwriters, as well as ipo performance represent signals of newly public firm quality that prospective acquirers value (ragozzino & reuer, 2007a). while the focus of research on the role played by such external affiliations and endorsements has contributed to our understanding of the evaluative processes undertaken by potential acquirers of newly public firms, ample room exists for extending research in this vein. for example, relatively little is known about the role played by boards of directors in shaping the likelihood that newly public firms will be acquired. in conducting this study we extend extant research in multiple ways. first, we shift the focus of research on the acquisition of newly public firms from the effects of external affiliations and endorsements towards indicators of internal agency conditions occurring within newly public firms as reflected by their boards of directors. while the findings of management research identify the role of external volume 36, number 1 3 endorsements such as venture capital (vc) backing, underwriter reputation, and ipo performance in addressing the information asymmetry problems faced by prospective acquirers of newly public firms, (e.g. ragozzino, 2016; ragozzino & reuer, 2007a), they do so without acknowledging the issues related to managerial control suggested by agency theory that may shape the acquisition prospects of newly public firms. in doing so, they ignore the potential for internal agency conditions to shape the supply of suitable newly public firms in acquisition markets. second, this study extends research on the influence of boards of directors by considering the influence of multiple board characteristics on the likelihood of newly public firms being acquired. in doing so we add to the list of organizational outcomes shaped by board of director structure and composition. finally, this study extends entrepreneurship research on the role of adverse selection and agency conditions in shaping firm ability to obtain access to financial resources from external stakeholders. the results of this study provide insights to entrepreneurs seeking to harvest their firms through public dual tracking with respect to staffing and structuring their boards of directors. the central proposition of this study is that board characteristics convey information regarding the agency conditions within newly public firms, and as such, provide insight into how managers are likely to respond to the prospect of being acquired, and in doing so, shape prospective acquirer perceptions of newly public firm suitability as an acquisition target. our focus on boards of directors allows us to examine the potential role played by board characteristics in addressing two main problems faced by prospective newly public firm acquirers; acquisition target valuation and acquisition deal execution. towards this end, we integrate agency theory (eisenhardt, 1989; jensen & meckling, 1976) with signaling theory (arrow, 1973; spence, 1981) to highlight the role played by boards of directors in indicating the nature of internal agency conditions to potential acquirers, thereby reducing two potential sources of uncertainty, namely target firm managerial opportunism and adverse selection. as a consequence, this study provides insight into the question of whether boards of directors influence the screening process engaged in by prospective acquirers of newly public firms. the remainder of this study proceeds as follows. first, we discuss extant research on the role of internal agency conditions in shaping the acquisition prospects of newly public firms. we then discuss the role of boards of directors as signals of the nature of agency conditions within newly public firms. next, we develop hypotheses regarding the influence of four specific board characteristics that may convey information regarding the nature of agency conditions within a given newly public firm. subsequently, we provide a discussion of our research 4 journal of business strategies methodology and empirical results of hypotheses tests. we conclude by discussing the contributions of study findings to existing research and identify potential paths for building upon this work. literature review research on the role of agency conditions in shaping the likelihood of newly public firm acquisition has largely taken place in the field of finance. drawing upon agency theory, finance scholars consider the potential private benefits that owners and managers may extract through the enactment or prevention of post-ipo acquisitions. studies in this vein argue that the acquisition of newly public firms represents a potential threat to the private wealth of newly public firm managers, whose earnings prospects and job tenures are potentially reduced upon completion of such an acquisition (e.g. brau et al., 2003; field & karpoff, 2002). viewed in this way, the acquisition of newly public firms is thought to create potential conflicts of interest between newly public firm managers and shareholders, which may lead to managerial opportunism (brennan & franks, 1997). while empirical tests of this logic remains limited, some support for this view that internal agency conditions influence the likelihood of newly public firm acquisition can be seen in the research of field and karpoff (2002), who found that the presence of anti-takeover defenses in newly public firms reduces the likelihood of such takeovers. in contrast to the field of finance’s focus on the role of internal agency conditions shaping post-ipo acquisition outcomes, research within the field of management has largely focused on the influence of external affiliations and endorsements in shaping the likelihood that a newly public firm will be acquired. these studies emphasize the fact that prospective acquirers of newly public firms are motivated by the potential to gain access to innovative technological resources and/or opportunities for growth (ragozzino & reuer, 2007b; reuer & ragozzino, 2008). although such opportunities do exist in the market for newly public firm acquisitions (reuer et al., 2012), the acquisition market for newly public firms is also rife with uncertainty due to the often limited operating histories of newly public firms (pollock, fischer, & wade, 2002; stuart, hoang, & hybels, 1999). given the high degree of uncertainty surrounding newly public firms, there exists a high potential for adverse selection on the part of prospective acquirers of newly public firms arising from the high degree of information asymmetry between newly public firms and prospective acquirers (ragozzino & reuer, 2011). these disparities in information create at least two difficulties for prospective acquirers of newly public firms. first, would be acquirers of newly public firms face volume 36, number 1 5 difficulty in determining which newly public firms represent viable acquisition targets with respect to the resources that the newly public firms possess (heeley et al., 2007; reuer & ragozzino, 2008). this is due in part to the fact that information about newly public firm human resources, production technologies, brand capital, growth opportunities, and social capital with other firms and customers is often unknown by both buyers and sellers given their relatively short track records (ragozzino & reuer, 2011). second, newly public firm managers and owners have incentives to inflate the value of the firm in order to achieve private gains upon completion of the acquisition (r. j. gilson & schwartz, 2005). as a consequence, newly public firms often suffer from a liability of market newness when disclosing information about their value, even if they are completely forthcoming and abstain from opportunistic behavior during the deal making process (certo, 2003; ravenscraft & scherer, 1987) as a consequence of these difficulties, management scholars typically argue that prospective acquirers of newly public firms are exposed to the risks of paying too much for the newly public firms they target for acquisition (reuer et al., 2012) as well as acquiring newly public firms that do not make strategic sense (ragozzino & reuer, 2011). this, in turn, results in prospective acquirers of newly public firms discounting their offer prices, thereby reducing the likelihood that the parties to a potential acquisition transaction agree upon terms of a deal (ragozzino & reuer, 2007a, 2007b). in effect, the risks of adverse selection due to the information asymmetries between acquirers and newly public acquisition targets increases the transaction costs associated with post-ipo acquisitions, and in turn, reduces the attractiveness of acquisition targets to potential acquirers (milgrom & stokey, 1982; puranam, powell, & singh, 2006). drawing upon signaling theory (arrow, 1973; spence, 1981), management scholars have begun to explore the role played by various indications of firm quality in remedying the information asymmetry surrounding newly public firms and its corresponding adverse selection problem in post-ipo acquisition markets. generally, when employing signaling theory logic, management researchers posit that in order to reduce the likelihood of adverse selection, prospective acquirers of newly public firms engage in a search for indicators of newly public firm quality to filter them (ragozzino & reuer, 2011; reuer & ragozzino, 2008). signaling theory logic suggests that newly public firms found in possession of characteristics that indicate their higher quality are thought to represent more attractive acquisition targets to prospective acquirers, and as a result, are more likely to be acquired than firms not found in possession of such characteristics. consistent with this view, research has found that indicators of newly public firm quality, such as external affiliations 6 journal of business strategies (venture capital backing and underwriter reputation) as well as market endorsements (ipo performance) increase the likelihood of newly public firms being acquired (ragozzino & reuer, 2007a). while prior research from the fields of both finance and management has enhanced our understanding of the factors which shape the likelihood of newly public firm acquisition, scholars have paid little attention to the role played by boards of directors in newly public firms. we find the paucity of research in linking boards to the acquisition prospects of newly public firms surprising for two reasons. first, research on ipo performance suggests that board characteristics play a key role in shaping external stakeholder perceptions of newly public firms both during (bruton, filatotchev, chahine, & wright, 2010; chahine & filatotchev, 2008; reutzel & belsito, 2012) and after ipos (chancharat, krishnamurti, & tian, 2012; kroll, walters, & le, 2007). as rather visible indicators of the nature of agency conditions within a given firm, board characteristics have been found to signal firm quality (certo, daily, & dalton, 2001b; chahine & filatotchev, 2008). second, extant research suggests that the nature of agency conditions within a firm may shape that firm’s acquisition prospects (boone & mulherin, 2017; field & karpoff, 2002). given the prominent role boards play in both shaping agency conditions within a firm (eisenhardt, 1989; jensen & meckling, 1976), as well as signaling the nature of agency conditions within newly public firms (certo et al., 2001b; filatotchev & bishop, 2002), an investigation of how newly public firm board characteristics influence the likelihood of being acquired represents a natural extension of extant research. in doing so, this study also heeds calls for greater research on the acquisition patterns of firms undergoing the ipo transition (certo, holmes, & holcomb, 2009). drawing upon the insights of prior research on boards of directors, ipos, and acquisition markets, we identify four board characteristics which we argue may influence potential acquirer perceptions of newly public firm agency conditions and attractiveness as an acquisition target. these board characteristics are the ratio of outside to inside directors serving on the board, ceo duality, board size, and female presence on the board. we focus on each of these board characteristics as a result of their potential to provide insight into board ability to monitor firm managers (campbell & minguez-vera, 2008; certo et al., 2001b; chahine & filatotchev, 2008; dalton, daily, ellstrand, & johnson, 1998; dalton, daily, johnson, & ellstrand, 1999; filatotchev & bishop, 2002; reutzel & belsito, 2015). our central thesis is that each of these board characteristics signal a given boards’ ability to monitor managers. in doing so, these board characteristics shape the attractiveness of newly public firms to prospective acquirers as a result of the information they provide regarding the volume 36, number 1 7 managerial opportunism and adverse selection problems faced by acquirers of newly public firms (d’aveni & kesner, 1993; davis, 1991). in the following sections we expand this logic in the development of research hypotheses. signaling managerial monitoring managers of acquisition target firms may have incentive to inflate value of their firms by selectively disclosing positive information and withholding negative information regarding firm performance and prospects for future growth (d’aveni & kesner, 1993; field & karpoff, 2002). target firm managers may also have an incentive to maintain the private benefits associated with corporate control that continue as long as their firms are not acquired (brennan & franks, 1997). as a result of these incentives, absent effective managerial monitoring, newly public firm managers may thwart the acquisition attempts of prospective acquirers by enacting various forms of takeover defense, resulting in higher acquisition premiums paid by acquirers as well as complicating the integration of acquired newly public firms (field & karpoff, 2002). such forms of managerial opportunism enacted by acquisition target firm management represent sources of adverse selection due to their potential to reduce the value that prospective acquirers realize through the acquisitions that they undertake (ragozzino & reuer, 2007a; reuer et al., 2012). monitoring managerial actions represents a central role of boards of directors (mizruchi, 1983; walsh & seward, 1990). in doing so, boards are thought to mitigate the agency problems stemming from the conflicting interests of managers and shareholders which give rise to various forms of managerial opportunism (fama, 1980; jensen, 1986). drawing upon this logic, corporate governance scholars commonly argue that the ability of boards of directors to effectively monitor managers represents a key indicator of their effectiveness (hermalin & weisbach, 1998; john & senbet, 1998; tuggle, sirmon, reutzel, & bierman, 2010). research on boards of directors suggests that board characteristics influence their ability to effectively monitor managers (finkelstein, hambrick, & cannella, 2009). for example, the ratio of outside directors to inside directors on the board (brickley, coles, & terry, 1994; byrd & hickman, 1992), board leadership structure (krause, semadeni, & cannella, 2014; tuggle et al., 2010), and board size (coles, daniel, & naveen, 2008; eisenberg, sundgren, & wells, 1998) have all been linked to board ability to monitor managers. research also suggests that the presence of women directors on boards may also enhance board monitoring of management (campbell & minguez-vera, 2008; dailey & dalton, 2003). 8 journal of business strategies further examination of research on boards of directors also suggests that external stakeholder perceptions of board ability to monitor managers contributes to newly public firm legitimacy and shapes a variety of organizational outcomes (certo et al., 2009; connelly, ireland, certo, & reutzel, 2011). evidence of this can be seen in research which suggests that the percentage of outside directors (chahine & filatotchev, 2008; filatotchev & bishop, 2002), board leadership structure (chahine & tohme, 2009), board size (carter & frederick, 1998; certo et al., 2001b) and the presence of women on the board (nelson & levesque, 2007; reutzel & belsito, 2015) influence equity market perceptions of newly public firms’ viability. drawing upon prior research linking board characteristics to board ability to monitor managers as well as research on external stakeholder perceptions of newly public firm quality, we posit that the aforementioned board characteristics may shape the likelihood of newly public firms being acquired. specifically, we posit that board characteristics that indicate board ability to monitor managers, signal a reduced potential for managerial opportunism to prospective acquirers of newly public firms. in doing so, such board characteristics may increase the likelihood that newly public firms are acquired. in the sections that follow we draw upon this logic to develop hypotheses for the following board characteristics: percentage of outside directors serving on the board, ceo-duality, the presence of women directors on the board, and board size. each of these board characteristics were selected because extant research suggests that they shape firm ability to monitor top management. percentage outside directors outside directors serving on a firm’s board shape that board’s ability to monitor management (jensen & meckling, 1976; walsh & seward, 1990). consistent with this view, research suggests that the percentage of outside directors serving on a given board represents an indicator of board ability to monitor management to external stakeholders. for example, research suggests that the percentage of outside directors increases the capital received by ipo firms (chahine & filatotchev, 2008; sanders & boivie, 2004). studies in this vein argue that the percentage of outside directors serves as a proxy for the quality of managerial monitoring conducted by the boards. extending this logic to the market for post-ipo acquisitions suggests that the percentage of outside directors serving on a given firm’s board may convey information regarding the quality of managerial monitoring taking place within a newly public firm to prospective acquirers. such an indicator of effective managerial monitoring may reduce prospective acquirer concerns regarding target volume 36, number 1 9 firm managerial opportunism which give rise to the adverse selection problem that prospective acquirers face. as such, we hypothesize the following: hypothesis 1: the percentage of outside directors serving on a newly public firm’s board is positively related to the likelihood that a newly public firm will be acquired. ceo duality research also suggests that ceo duality, instances in which one individual holds both the ceo and chairperson of the board titles, weakens managerial monitoring by the board of directors (krause et al., 2014). studies suggest that ceo duality provides managers with influence over the board’s attention and ability to monitor managers, resulting in lower levels of managerial monitoring behaviors engaged in by boards (tuggle et al., 2010). consistent with this view, research also finds that ceo duality signals a lack of managerial monitoring to external stakeholders. for example research suggests that investors react negatively to the combination of the ceo and board chair titles (dahya, lonie, & power, 1996; worrell, nemec, & davidson, 1997). extending this logic to post-ipo acquisition markets suggests that ceo duality may convey a lack of managerial monitoring to prospective acquirers of newly public firms. such a signal of managerial monitoring issues may increase prospective acquirer concerns regarding target firm managerial opportunism and adverse selection. as such, we hypothesize the following: hypothesis 2: ceo duality is negatively related to the likelihood that a newly public firm will be acquired. women on the board research also suggests that women serving as directors may increase the quality of managerial monitoring conducted by boards of directors. support for this view can be found in research which suggests that gender diversity increases the amount of effort that boards allocate to monitoring management (adams & ferreira, 2009). further support for this notion can be found in research suggesting that the presence of women directors in the boardroom reduces the likelihood of rubberstamping managerial decision making by boards of directors (huse & solberg, 2006). additional support for the notion that women on the board enhance the ability of boards to monitor managers is provided by research suggesting that boards with women directors exhibit greater degrees of strategic control, more collaboration 10 journal of business strategies within the board room, and engage in greater amounts of development activities than those without women directors (nielsen & huse, 2010). finally, research suggests that boards with at least one women serving as a director exhibit a lower likelihood of restating their financial statements than those without women directors (abbott, parker, & presley, 2012). research also suggests that the presence of women on the board provides insights to external stakeholder regarding the quality of managerial monitoring taking place within a given firm. for example, the popular press in the u.s. increasingly calls for greater gender diversity in the boardroom (hillman, shropshire, & cannella, 2007). research also suggests that investors react positively to the appointment of women directors (kang, ding, & charoenwong, 2010) and that investor reactions to women directors in ipo firms are increasingly positive over time (reutzel & belsito, 2015). drawing upon these findings, we suggest that the presence or absence of women on the board may be interpreted as an indicator of managerial monitoring quality by prospective acquirers of newly public firms. as a result, we expect women directors on the board to increase the attractiveness of a newly public firm to prospective acquirers to the extent that their presence signals board ability to monitor management thereby reducing the prospective acquirer’s concern regarding target firm managerial opportunism and adverse selection. as a consequence, we hypothesize the following: hypothesis 3: the presence of women directors serving on a newly public firm’s board is positively related to the likelihood that a newly public firm will be acquired. board size board size may also shape the quality of managerial monitoring conducted by boards of directors. research on this topic often argues that larger boards possess greater capability to monitor firm managers (alexander, fennell, & halpern, 1993), particularly when managerial monitoring is taking place within small and medium sized enterprises, such as those undertaking their ipos (dalton et al., 1999). while research does suggest that excessively large boards can result in director free-riding issues (pearce & zahra, 1992; raheja, 2005), newly public firm boards generally do not approach such extremes given their relative youth and small size (certo et al., 2001b; daily & dalton, 1993). the effect of board size on managerial monitoring in such firms is thought to arise from the fact that as boards increase in size they typically add outside directors, who possess greater motivation and ability to monitor volume 36, number 1 11 managers (shleifer & vishny, 1997; walsh & seward, 1990). indeed, before being willing to serve as an outside director, individuals are thought to evaluate the relative quality of the firm and its managers in order to minimize the potential risk they face (fama & jensen, 1983), as affiliation with failed firms can reduce future opportunities to serve as a director on other boards (s. c. gilson, 1989). additionally, research suggests that larger boards require greater compromise in order to reach consensus, and as such, the decisions of larger boards tend to be less extreme than those of smaller boards, resulting in less variability in firm performance (cheng, 2008). drawing upon this logic, research argues that board size may serve as an indicator of managerial monitoring quality to post-ipo external stakeholders. support for this notion can be found in research by certo and colleagues (2001b) which finds that board size is negatively related to ipo underpricing. extending this logic to the market for post-ipo acquisitions suggests that board size may serve as a signal of board monitoring quality to prospective acquirers of newly public firms. as such, board size may reduce prospective acquirer’s concern regarding target firm managerial opportunism and adverse selection. as a result, we hypothesize the following: hypothesis 4: board size is positively related to the likelihood that a newly public firm will be acquired. sample we test our hypotheses on a sample of u.s. firms that made initial public offerings during the calendar year of 2007. we selected ipo firms as the subject of this study for three main reasons. first, firm harvest through acquisition represents a commonly stated reason for undertaking the ipo process (brau & fawcett, 2006; brau et al., 2003). second, ipos represent a transformational event in the development of a firm (fischer & pollock, 2004). this event often requires firm managers and investors to evaluate the composition and structure of their boards at the time of the ipo (chancharat et al., 2012; kroll et al., 2007) board staffing at the time of a firm’s ipo represents a decision which may have an enduring effect on post-ipo outcomes (fischer and pollock, 2004). third, sampling ipo firms facilitates the comparison of this study’s results with those of prior research on the effects of prior studies on the acquisition of newly public firms (e.g. field & karpoff, 2002; ragozzino & reuer, 2007a). we selected ipos from 2007 for multiple reasons. this calendar year was relatively active with respect to ipo activity. as such, this sample time frame provided a sample size large enough to achieve the statistical power requisite to 12 journal of business strategies conduct hypotheses tests while simultaneously controlling for ipo market conditions that might influence observed board effects on the likelihood of newly public firm acquisition. utilizing a cohort of ipo firms from the 2007 calendar year also allowed for the collection of post-ipo firm acquisition data when we initiated this study. we drew our base sample for this study from the securities data corporation global new issues (sdc) database. we eliminated firms from our final sample using the following criteria. first, ipo firms were required to make their equity offerings on publicly traded markets (i.e., nasdaq, nyse, and amex) for the first time. second, sample firms were required to be headquartered in the u.s. at the time of their ipo. we imposed this criterion in order to control for potential cultural and institutional differences between firms that are beyond the scope of this study. third, and in line with prior ipo research (ritter, 1991), we excluded firms that were classified as any of the following: corporate spin-offs, unit issues, mutual to stock conversions, real estate investment trusts, or leveraged buyouts. subjecting our initial sample to the above criteria and after eliminating firms for which data were unavailable, we were left with a final sample of 175 newly public firms. measures dependent variable consistent with prior research, our dependent variable was coded based upon crsp delisting codes during the three year windows following each sample firm’s ipo (field & karpoff, 2002). we choose a three year post-ipo window for two main reasons. first, our theoretical and empirical focus is on newly public firms, rather than more established publicly traded firms. as a consequence, relying upon a time window longer than three years weakens our claim that we are studying firms that are newly public which are subject to the liability of market newness (certo, 2003; fischer & pollock, 2004). second, prior research on the acquisition of newly public firms generally relies upon independent and control variables that are measured at the time of a firm’s ipo such as underwriter reputation, venture capital backing, ipo performance, etc. the effects of these ipo related measures are time invariant, and as such, are likely to weaken in their effects as newly public firms establish records of performance in publicly traded markets (certo, 2003; fischer & pollock, 2004). utilizing delisting codes provided by crsp, we created our dependent variable, acquisition of newly public firm, by coding sample firms that were acquired during the three year period following their ipos as 1, and 0 if they were not acquired during the three year window following their ipo. volume 36, number 1 13 independent variables we utilized information from sample firm ipo prospectuses in order to construct the measures of the board level characteristics necessary to test our hypotheses. consistent with prior research (sanders & boivie, 2004; weisbach, 1988), we constructed a measure of the percentage of outside directors by dividing the number of outside directors by the total number of directors on a given sample firm’s board. also consistent with prior research on board leadership structure and monitoring (certo, 2003; tuggle et al., 2010), we coded ceo duality as (1) when the roles of ceo and chairperson were combined and (0) when separated. we created a measure of women’s service on the board of directors, number of women directors, by summing the number of women directors serving on a sample firm’s board (adams & ferreira, 2009). consistent with prior research (reutzel & belsito, 2015), we identified women directors based on their name and the use of gender specific terms in the director biographies provided in sample firm ipo prospectuses. we operationalized board size by counting the number of directors on each ipo firm board (cheng, 2008; dalton et al., 1999). we calculated the logarithm of this variable to in order to correct for skewness. control variables in addition to our explanatory variables, we also controlled for several other factors that might shape the likelihood of newly public firms being acquired. because motivations to go public can vary, we controlled for newly public firm growth intentions by calculating the rate of revenue growth during the first fiscal year immediately following the ipo event. firms who have gone public in order to fuel future growth may not view acquisition as a desirable harvest strategy. in order to control for the effect of firm performance on firm acquisition prospects, we calculated each sample firm’s roa at the time of the ipo using data from compustat and the ipo prospectus. we transformed this variable by taking its natural logarithm in order to address skewness issues. we also controlled for ipo risk factors by summing the total number of risks factors identified by prior ipo studies (cyr, johnson, & welbourne, 2000). in order to correct for skewness, the data collected for this variable was transformed by calculating the natural logarithm. we also controlled for firm size by identifying the number of individuals employed by each sample firm. this variable was constructed by coding the number of firm employees listed in the ipo prospectus of each sample firm. we then calculated the logarithm of that value to correct variable skewness. 14 journal of business strategies prior research suggests that as firms progress through their life cycles they become more complex, thereby influencing board characteristics (lynall, golden, & hillman, 2003). accordingly, we controlled for firm age by taking the natural log of the number of years passed since the date of incorporation provided in the ipo prospectus. because firms operating in high technology industries are commonly targeted for acquisition (desyllas & hughes, 2008) we created a control measure based upon whether a firm operates in a high technology industry (1) or not (0) (certo et al., 2001b; daily, certo, & dalton, 2005). this measure was based upon primary standard industrial classification (sic) codes identified as high technology sectors and was accessed through sdc’s new issues database. prior research suggests potential links between venture capital backing, underwriter prestige, ipo performance, and the likelihood that a newly public firm will be acquired. as such, we controlled for venture capital backing with a dummy variable indicating whether a firm was vc backed (1) at the time of its ipo or not (0). we also controlled for underwriter prestige by utilizing the widely used (ritter & welch, 2002) carter-manaster measure of underwriter prestige (carter, dark, & singh, 1998; carter & manaster, 1990). ipo proceeds represent the financial capital accumulated as a result of the ipo. firms that garner greater ipo proceeds are better equipped to expand and grow (jain & kini, 2000). we controlled for ipo proceeds by calculating the natural logarithm of the product of shares offered and the share price at the end of a firm’s first day of trading. finally, we controlled for ipo underpricing by taking the percentage change in stock price between the initial price set for the stock and the closing price of the stock on the first day of trading (certo, covin, daily, & dalton, 2001a). we collected the data on ipo underpricing from sdc. analysis and results table 1 presents the means, standard deviations, and correlations of all study variables. consistent with prior research examining post-ipo firm level outcomes (aruǧaslan, cook, & kieschnick, 2004; cyr et al., 2000; field & karpoff, 2002), and due to the cross-sectional and dichotomous nature of our dependent variable (long & freese, 2003), we utilized logistic regression to test the hypotheses developed in this study. the absence of multi-collinearity represents a key assumption of logistic regression. in order to ensure that sample data met this assumption, we examined the variance inflation factors (vifs) for study variables independently and jointly. all vifs were within acceptable ranges (cohen, cohen, west, & aiken, 2003), suggesting that multi-collinearity assumptions were met for our sample data. volume 36, number 1 15 ta bl e 1 m ea ns , s ta nd ar d d ev ia tio ns , a nd c or re la tio ns a # va ria bl e m ea n st d. d ev . 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 ac qu is iti on o f n ew ly p ub lic f irm 0. 22 3 0. 14 7 2 % o ut si de d ire ct or s 0. 76 2 0. 13 1 0. 06 8 3 c eo d ua lit y 0. 48 0 0. 50 1 -0 .1 57 -0 .2 63 4 # of w om en d ire ct or s 0. 46 3 0. 70 1 -0 .0 99 0. 07 9 -0 .1 45 5 b oa rd s iz e 2. 10 8 0. 22 6 0. 09 1 0. 15 2 -0 .0 04 0. 20 3 6 fi rm g ro w th in te nt io ns 0. 46 0 1. 28 9 -0 .1 13 -0 .0 26 0. 07 3 -0 .0 41 -0 .0 45 7 r o a 11 .0 71 1. 21 5 0. 04 4 0. 00 6 0. 06 6 0. 04 2 -0 .0 58 0. 00 5 8 ip o r is k fa ct or s 1. 72 5 0. 34 3 0. 16 1 0. 12 9 -0 .0 37 -0 .0 06 0. 01 0 0. 11 8 -0 .0 25 9 fi rm s iz e 5. 75 1 1. 53 9 0. 01 7 0. 01 0 0. 04 8 0. 14 1 0. 19 2 -0 .1 50 0. 01 8 0. 02 1 10 fi rm a ge 2. 28 2 0. 89 1 0. 04 0 0. 12 9 0. 05 8 -0 .0 87 0. 10 7 -0 .2 34 -0 .0 45 -0 .0 37 0. 23 8 11 h ig h te ch no lo gy 0. 53 1 0. 50 0 0. 17 3 0. 11 0 0. 07 7 -0 .0 17 -0 .0 53 -0 .0 23 0. 06 6 0. 29 4 0. 07 1 -0 .1 11 12 ve nt ur e c ap ita l 0. 33 1 0. 47 2 0. 11 9 0. 06 4 0. 10 1 0. 03 7 0. 03 4 0. 04 2 0. 04 5 0. 37 9 0. 01 7 -0 .0 47 0. 46 7 13 u nd er w rit er p re st ig e 8. 10 4 1. 60 5 0. 08 6 0. 10 6 0. 03 1 0. 10 6 0. 15 3 0. 07 9 -0 .0 42 0. 17 5 0. 16 7 -0 .1 84 0. 07 5 0. 19 8 14 ip o p ro ce ed s 18 .8 71 0. 99 2 -0 .1 28 -0 .0 88 0. 07 3 0. 07 4 0. 18 3 0. 01 8 0. 02 6 0. 08 0 0. 35 0 -0 .0 93 -0 .2 88 -0 .1 59 0. 52 4 15 ip o u nd er pr ic in g 0. 10 8 0. 25 7 -0 .0 08 -0 .0 62 -0 .0 13 0. 07 3 0. 05 3 0. 00 4 0. 03 0 0. 13 6 -0 .0 10 -0 .0 47 -0 .0 25 0. 05 5 0. 18 7 0. 35 3 a co rr el at io ns g re at er th an |. 15 2| a re s ta tis tic al ly s ig ni fic an t a t p < .0 5 16 journal of business strategies the results of tests of study hypotheses are presented in table 2. model 1 includes the control variables suggested by prior research. the results presented in model 1 provide some support for the influence of variables suggested by prior research on the acquisition of newly public firms. specifically, consistent with prior research (ragozzino & reuer, 2007a) we find that underwriter prestige positively influences the likelihood of a newly public firm being acquired. we also find statistical support for the inclusion of additional control variables in model 1. for example, ipo proceeds appears to negatively influence the likelihood of a newly public firm being acquired. the results of model 1 also suggest that firm growth intentions are negatively related to the likelihood that a newly public firm will be acquired. finally, ipo risk factors appear to be positively related to the likelihood that a newly public firm will be acquired. model 2 presents the result of tests of hypotheses 1-4. the coefficient for percentage outside directors is not statistically significant. as a consequence model 2 provides no support for hypothesis 1 regarding the influence of the percentage of the board occupied by outside directors on the likelihood of newly public firms being acquired. the coefficient for ceo duality is both negative and statistically significant (p<.05). this result supports hypothesis 2 regarding the negative influence of ceo duality on the likelihood of a newly public firm being acquired. hypothesis 3, which suggested a positive relationship between the number of women on the board of directors and the likelihood of newly public firm acquisition, was not supported. this is evidenced by the negative and statistically significant (p<.05) coefficient for number of women directors in model 2. finally, the coefficient for board size shown in model 2 is positive and weakly statistically significant (p<.10), thereby providing weak support for hypothesis 4 regarding the influence of the number of directors serving on a newly public firm’s board and the likelihood it will be acquired. volume 36, number 1 17 table 2 logistic regression acquisition of newly public firms variable model 1 model 2 intercept -1.055 1.756 firm growth intentions -1.040 * -0.930 * roa 0.854 0.451 ipo risk factors 1.605 * 1.574 * firm size 0.092 0.087 firm age -0.020 0.088 high technology 0.243 0.508 venture capital -0.297 -0.130 underwriter prestige 0.474 * 0.500 * ipo proceeds -0.890 * -0.907 * ipo underpricing 0.457 0.369 % outside directors -1.588 ceo duality -1.215 * # of women directors -0.794 * board size 1.629 ^ pseudo r2 0.133 0.196 ^ x2 24.760 ** 36.400 *** n=175;^ p<.10; * p<.05; ** p<.01; *** p<.001 discussion this study examines the influence of board characteristics on the likelihood that newly public firms are acquired. in doing so, this study also heeds calls for greater research on the acquisition of firms undergoing the ipo transition (certo et al., 2009) filling an empirical gap in extant research on the acquisitions of newly public firms and providing insight into how newly public firms should staff their boards of directors if their desire is to be acquired. drawing upon research from finance and management we hypothesized that the percentage of outside directors, ceo duality, women directors, and board size all influence a newly public firm’s likelihood of being acquired. taken collectively, the results of this study provide support for the role of newly public firm board characteristics in shaping a unique and potentially lucrative form of entrepreneurial exit. the results of this study provide insights into the question 18 journal of business strategies of whether board characteristics of newly public firms influence the screening process engaged in by prospective acquirers of newly public firms. our first hypothesis suggested a positive relationship between the percentage of outside directors and the likelihood of newly public firm acquisition. we did not find support for our first hypothesis, as study results did not find a statistically significant relationship, either positive or negative, between the percentage of outside directors and the likelihood of newly public firm acquisitions. the absence of a statistically significant influence of the percentage of outside directors and newly public firm acquisition likelihood, is similar to the pattern of mixed findings exhibited by research examining the impact of the percentage of outside directors serving on a firm’s board and other organizational outcomes (dalton, daily, certo, & roengpitya, 2003; finkelstein et al., 2009). we found a negative relationship between ceo duality and the likelihood of newly public firm acquisition. this finding adds to research on the organizational consequences of ceo duality by linking ceo duality to an organizational outcome that prior research has not considered. furthermore, this finding lends support to the agency and signaling theory-based logic relied upon to theoretically ground this study. specifically, study findings suggest that ceo duality is viewed as a potential indicator of agency problems by prospective acquirers of newly public firms. the finding of a negative relationship between the number of women serving on the board of directors and the likelihood of newly public firm acquisition was surprisingly opposite the relationship suggested by our hypothesis. although the findings of multiple studies suggest that women have made progress in the boardroom in the eyes of a variety of stakeholders (dailey & dalton, 2003; reutzel & belsito, 2015), this study’s finding may suggest that that prospective acquirers adhere to gender stereotypes (ryan, haslam, hersby, & bongiomo, 2011) which stigmatize (devers, dewett, mishina, & belsito, 2009) women directors with respect to ability to monitor top managers. this finding extends research on stakeholder reactions to women in roles historically held by men by linking women directors to the reaction of a unique stakeholder group, prospective acquirers of newly public firms, which prior research has heretofore not examined. finally, we found weak support for our final hypothesis, which suggested a positive relationship between board size and the likelihood of newly public acquisition. we emphasize that, while weak, statistically speaking, this finding provides additional support for the notion that board size may convey information to external stakeholders regarding board managerial monitoring capability. as such, this finding extends research on the effects of board size by linking board size to an volume 36, number 1 19 organizational outcome, the acquisition prospects of newly public firms that prior research has not considered. as a potentially lucrative form of entrepreneurial harvest, the acquisition of newly public firms represents both a practically and theoretically interesting phenomena that has received relatively little attention in extant research (brau et al., 2003; brau et al., 2010). this study represents the first to focus primarily on the characteristics of newly public firm boards in shaping their prospects in acquisition markets. this study highlights the role played by the board of directors in ameliorating potential acquirer concerns regarding agency conditions within newly public acquisition targets. prior research has largely focused on the role of external endorsements in addressing the adverse selection problem faced by prospective acquirers of newly public firms. in this study, we integrate the logic from both signaling and agency theories to highlight the signaling role played by boards of directors in newly public firms. in doing so, this study demonstrates the benefits of integrating multiple theoretical perspectives to examine the acquisition of newly public firms. limitations and future research while this study extends existing research in multiple ways, it is not without its limitations. first, this study does not consider the role of other governance mechanisms which may shape the likelihood of newly public firm acquisitions, such as executive compensation and ownership. future research might provide valuable insights into how such alternative governance mechanisms exacerbate, or mitigate, the impact of board characteristics on the likelihood of newly public firm acquisition. second, due to the cross sectional nature of the data, this study does not consider how board characteristics and the likelihood of newly public firm acquisition evolve over time. future research might also consider how board changes influence the likelihood of newly public firm acquisition. for instance, does the departure of outside directors during the years immediately following a firm’s ipo influence the likelihood of that newly public firm being acquired? does a change in board leadership structure from the case of ceo duality to non-ceo duality impact the likelihood of newly public firm acquisitions? answering such questions may represent potentially fruitful avenues for future research that are left unanswered by this study. third, given this study’s focus on newly public firms, the findings of this study may not generalize to non-newly public firms. due to the heightened level of scrutiny faced by firms as they transition to public markets, newly public firms strive to put their best selves forward in terms of board staffing. this desire may 20 journal of business strategies cause newly public firms to staff their boards in a manner that is more consistent with stockholder interests and less consistent with managerial interests. as a result, future research may provide insight into the extent to which board characteristics shape the likelihood of acquisition for firms that successfully navigate the transition from being ‘newly public’ to simply ‘public references abbott, l. j., parker, s., & presley, t. j. (2012). female board presence and the likelihood of financial restatement. accounting horizons, 26(4), 607-629. adams, r. b., & ferreira, d. g. (2009). women in the boardroom and their impact on governance and performance. journal of financial economics, 94, 291-309. alexander, j. a., fennell, m. l., & halpern, m. t. (1993). leadership instability in hospitals: the influence of board-ceo relations and organizational growth and decline. administrative science quarterly, 38(1), 74-99. arend, r. j., patel, p. c., & park, h. d. (2014). explaining postipo venture performance through a knowledge-based view typology. strategic management journal, 35(3), 376-397. arrow, k. j. (1973). higher education as a filter. journal of public economics, 2(3), 193-216. aruǧaslan, o., cook, d. o., & kieschnick, r. (2004). monitoring as a motivation for ipo underpricing. the journal of finance, 59(5), 2403-2420. boone, a. l., & mulherin, j. h. (2017). who monitors the monitor? the use of special committees by target firms in corporate takeovers. journal of corporate finance, 44, 388-404. brau, j. c., & fawcett, s. e. (2006). initial public offerings: an analysis of theory and practice. journal of finance, 61(1), 399-436. brau, j. c., francis, b., & kohers, n. (2003). the choice of ipo versus takeover: empirical evidence. the journal of business, 76(4), 583-612. brau, j. c., sutton, n. k., & hatch, n. w. (2010). dual-track versus single-track sell-outs: an empirical analysis of competing harvest strategies. journal of business venturing, 25(4), 389-402. brennan, m. j., & franks, j. (1997). underpricing, ownership and control in initial public offerings of equity securities in the uk. journal of financial economics, 45(3), 391-413. brickley, j. a., coles, j. l., & terry, r. l. (1994). outside directors and the adoption of poison pills. journal of financial economics, 35, 371-390. volume 36, number 1 21 bruton, g. d., filatotchev, i., chahine, s., & wright, m. (2010). governance, ownership structure, and performance of ipo firms: the impact of different types of private equity investors and institutional environments. strategic management journal, 31(5), 491-509. byrd, j. w., & hickman, k. a. (1992). do outside directors monitor managers? journal of financial economics, 32, 195-221. campbell, k., & minguez-vera, a. (2008). gender diversity in the boardroom and firm financial performance. journal of business ethics, 83, 435-451. carter, r. b., dark, f. h., & singh, a. k. (1998). underwriter reputation, initial returns, and the long-run performance of ipo stocks. journal of finance, 53, 285-311. carter, r. b., & frederick, h. (1998). dark, and ajai k. singh. 1998b.“board of directors: size and composition and the effect on ipos.” iowa state university working paper. carter, r. b., & manaster, s. (1990). initial public offerings and underwriter reputation. journal of finance, 45(4), 1045-1067. certo, s. t. (2003). influencing initial public offering investors with prestige: signaling with board structures. academy of management review, 28(3), 432446. certo, s. t., covin, j. g., daily, c. m., & dalton, d. r. (2001a). wealth and the effects of founder management among ipo-stage new ventures. strategic management journal, 22(6-7), 641-658. certo, s. t., daily, c. m., & dalton, d. r. (2001b). signaling firm value through board structure: an investigation of initial public offerings. entrepreneurship theory & practice, 26(2), 33-50. certo, s. t., holmes, m., & holcomb, t. r. (2009). ipo research in management and entrepreneurship: moving the agenda forward. journal of management, 25(1340-1378). chahine, s., & filatotchev, i. (2008). the effects of information disclosure and board independence on ipo discount. journal of small business management, 46(2), 219-241. chahine, s., & tohme, n. s. (2009). is ceo duality always negative? an exploration of ceo duality and ownership structure in the arab ipo context. corporate governance: an international review, 17(2), 123-141. chancharat, n., krishnamurti, c., & tian, g. (2012). board structure and survival of new economy ipo firms. corporate governance: an international review, 20(2), 144-163. 22 journal of business strategies cheng, s. (2008). board size and the variability of corporate performance. journal of financial economics, 87(1), 157-176. cohen, j., cohen, p., west, s., & aiken, l. (2003). applied multiple regression/ correlation analysis for behavioral sciences (3rd ed.). hillsdale, nj: lawrence erlbaum associates. coles, j. l., daniel, n. d., & naveen, l. (2008). boards: does one size fit all? journal of financial economics, 87(2), 329-356. connelly, b., ireland, r. d., certo, s. t., & reutzel, c. r. (2011). signaling theory: a review and assessment. journal of management, 37(39-67). cooper, a. c., woo, c. y., & dunkelberg, w. c. (1988). entrepreneurs’ perceived chances for success. journal of business venturing, 3(2), 97-108. cyr, l. a., johnson, d. e., & welbourne, t. m. (2000). human resources in initial public offerings firms: do venture capitalists make a difference? entrepreneurship theory & practice, 25(1), 93-106. d’aveni, r. a., & kesner, i. f. (1993). top managerial prestige, power and tender offer response: a study of elite social networks and target firm cooperation during takeovers. organization science, 4(2), 123-151. dahya, j., lonie, a., & power, d. (1996). the case for separating the roles of chairman and ceo: an analysis of stock market and accounting data. corporate governance: an international review, 4(2), 71-77. dailey, c. a., & dalton, d. r. (2003). women in the boardroom: a business imperative. journal of business strategy, 24(5), 8-10. daily, c. m., certo, s. t., & dalton, d. r. (2005). investment bankers and ipo pricing: does prospectus information matter? journal of business venturing, 20(1), 93-111. daily, c. m., & dalton, d. r. (1993). board of directors leadership and structure: control and performance implications. entrepreneurship theory & practice, 17(3), 65-81. dalton, d. r., daily, c. m., certo, s. t., & roengpitya, r. (2003). meta-analyses of corporate financial performance and the equity of ceos, officers, boards of directors, institutions, and blockholders: fusion or confusion? academy of management journal, 46(1), 13-26. dalton, d. r., daily, c. m., ellstrand, a. e., & johnson, j. l. (1998). meta-analytic reviews of board composition, leadership structure, and financial performance. strategic management journal, 19(3), 269-290. volume 36, number 1 23 dalton, d. r., daily, c. m., johnson, j. l., & ellstrand, a. e. (1999). number of directors and financial performance: a meta-analysis. academy of management journal, 42(6), 674-686. davis, g. f. (1991). agents without principles? the spread of the poison pill through the intercorporate network. administrative science quarterly, 36, 583-613. desyllas, p., & hughes, a. (2008). sourcing technological knowledge through corporate acquisition: evidence from an international sample of high technology firms. the journal of high technology management research, 18(2), 157-172. devers, c. e., dewett, t., mishina, y., & belsito, c. a. (2009). a general theory of organizational stigma. organization science, 20(1), 154-171. eisenberg, t., sundgren, s., & wells, m. t. (1998). larger board size and decreasing firm value in small firms. journal of financial economics, 48(1), 35-54. eisenhardt, k. m. (1989). agency theory: an assessment and review. academy of management review, 14, 57-74. fama, e. f. (1980). agency problems and the theory of the firm. journal of political economy, 88, 288-307. fama, e. f., & jensen, m. c. (1983). separation of ownership and control. journal of law and economics, 26, 301-325. field, l. c., & karpoff, j. m. (2002). takeover defenses of ipo firms. the journal of finance, 57(5), 1857-1889. filatotchev, i., & bishop, k. (2002). board composition, share ownership, and underpricing’ of ukipo firms. strategic management journal, 23(10), 941955. finkelstein, s., hambrick, d. c., & cannella, a. a., jr. (2009). strategic leadership: theory and research on executives, top management teams and boards. new york: oxford university press. fischer, h. m., & pollock, t. g. (2004). effects of social capital and power on surviving transformational change: the case of initial public offerings. academy of management journal, 47(4), 463-481. garg, s., li, q., & shaw, j. d. (2018). undervaluation of directors in the board hierarchy: impact on turnover of directors (and ceos) in newly public firms. strategic management journal, 39(2), 429-457. gilson, r. j., & schwartz, a. (2005). understanding macs: moral hazard in acquisitions. journal of law, economics, and organization, 21(2), 330-358. gilson, s. c. (1989). management turnover and financial distress. journal of financial economics, 25, 241-262. 24 journal of business strategies heeley, m. b., matusik, s. f., & jain, n. (2007). innovation, appropriability, and the underpricing of initial public offerings. academy of management journal, 50(1), 209-225. hermalin, b. e., & weisbach, m. s. (1998). endogenously chosen boards of directors and their monitoring of the ceo. american economic review, 88(1), 96-118. hillman, a. j., shropshire, c., & cannella, a. a. (2007). organizational predictors of women on corporate boards. academy of management journal, 50(4), 941952. huse, m., & solberg, a. g. (2006). gender related boardroom dynamics: how women make and can make contributions on corporate boards. women in management review, 21(2), 113-130. jain, b. a., & kini, o. (2000). does the presence of venture capitalists improve the survival profile of ipo firms? journal of business finance & accounting, 27, 1139-1176. jensen, m. c. (1986). agency costs of free cash flow, corporate finance and takeovers. american economic review, 76, 323-329. jensen, m. c., & meckling, w. h. (1976). theory of the firm: managerial behavior, agency costs and ownership structure. journal of financial economics, 3(4), 305-360. john, k., & senbet, l. w. (1998). corporate governance and board effectiveness. journal of banking & finance, 22(4), 371-403. kang, e., ding, d. k., & charoenwong, c. (2010). investor reaction to women directors. journal of business research, 63(8), 888-894. krause, r., semadeni, m., & cannella, a. a., jr. (2014). ceo duality: a review and research agenda. journal of management, 40(1), 256-286. kroll, m., walters, b. a., & le, s. a. (2007). the impact of board composition and top management team ownership structure on post-ipo performance in young entrepreneurial firms. academy of management journal, 50, 1198-1216. long, j. s., & freese, j. (2003). regression models for categorical dependent variables using stata. college station, tx: stata press. lynall, m. d., golden, b. r., & hillman, a. j. (2003). board composition from adolescence to maturity: a multitheoretic view. academy of management review, 28(3), 416-431. milgrom, p., & stokey, n. (1982). information, trade and common knowledge. journal of economic theory, 26(1), 17-27. volume 36, number 1 25 mizruchi, m. s. (1983). who controls whom? an examination of the relation between management and board of directors in large american corporations. academy of management review, 8, 426-435. nelson, t., & levesque, l. l. (2007). the status of women in corporate governance in high-growth, high-potential firms. entrepreneurship theory and practice, 31(2), 209-232. nielsen, s., & huse, m. (2010). the contribution of women on boards of directors: going beyond the surface. corporate governance: an international review, 18(2), 136-148. pagano, m., panetta, f., & zingales, l. (1998). why do companies go public? an empirical analysis. the journal of finance, 53(1), 27-64. pearce, j. a., ii, & zahra, s. a. (1992). board composition from a strategic contingency perspective. journal of management studies, 29(4), 411-438. pollock, t. g., fischer, h. m., & wade, j. b. (2002). the role of power and politics in the repricing of executive stock options. academy of management journal, 45, 1172-1182. puranam, p., powell, b. c., & singh, h. (2006). due diligence failure as a signal detection problem. strategic organization, 4(4), 319-348. ragozzino, r. (2016). who gets first dibs? a buy-side investigation of the dual tracking phenomenon in m&a. long range planning, 49(2), 207-220. ragozzino, r., & reuer, j. j. (2007a). initial public offerings and the acquisition of entrepreneurial firms. strategic organization, 5(2), 155-176. ragozzino, r., & reuer, j. j. (2007b). mind the information gap: putting new selection criteria and deal structures to work in m&a. journal of applied corporate finance, 19(3), 82. ragozzino, r., & reuer, j. j. (2011). geographic distance and corporate acquisitions: signals from ipo firms. strategic management journal, 32(8), 876-894. raheja, c. g. (2005). determinants of board size and composition: a theory of corporate boards. journal of financial and quantitative analysis, 40(2), 283306. ravenscraft, d. j., & scherer, f. m. (1987). mergers, sell-offs, and economic efficiency. reuer, j. j., & ragozzino, r. (2008). adverse selection and m&a design: the roles of alliances and ipos. journal of economic behavior & organization, 66(2), 195-212. 26 journal of business strategies reuer, j. j., tong, t. w., & wu, c.-w. (2012). a signaling theory of acquisition premiums: evidence from ipo targets. academy of management journal, 55(3), 667-683. reutzel, c. r., & belsito, c. a. (2012). examining the relative influence of upper echelons ties on ipo underpricing. international entrepreneurship and management journal, 8(1), 1-14. reutzel, c. r., & belsito, c. a. (2015). female directors and ipo underpricing in the us. international journal of gender and entrepreneurship, 7(1), 27-44. ritter, j. r. (1991). the long-run performance of initial public offerings. journal of finance, 46(1), 3-27. ritter, j. r., & welch, i. (2002). a review of ipo activity, pricing, and allocations. journal of finance, 57(4), 1795-1828. ryan, m. k., haslam, s. a., hersby, m. d., & bongiomo, r. (2011). think crisisthink female: the glass cliff and contextual variation in the think managerthink male stereotype. journal of applied psychology, 96(3), 470-484. sanders, w., & boivie, s. (2004). sorting things out: valuation of new firms in uncertain markets. strategic management journal, 25(2), 167-186. shleifer, a., & vishny, r. w. (1997). a survey of corporate governance. journal of finance, 52(2), 203-249. spence, m. (1981). signaling, screening, and information studies in labor markets (pp. 319-358): university of chicago press. stuart, t. e., hoang, h., & hybels, r. c. (1999). interorganizational endorsements and the performance of entrepreneurial ventures. administrative science quarterly, 44(2), 315-349. tuggle, c. s., sirmon, d. g., reutzel, c. r., & bierman, l. (2010). commanding board of director attention: investigating how organizational performance and ceo duality affect board members’ attention to monitoring. strategic management journal, 31(9), 946-968. walsh, j. p., & seward, j. k. (1990). on the efficiency of internal and external corporate control mechanisms. academy of management review, 15, 421-458. weisbach, m. s. (1988). outside directors and ceo turnover. journal of financial economics, 20, 431-460. worrell, d. l., nemec, c., & davidson, w. n., iii. (1997). one hat too many: key executive plurality and shareholder wealth. strategic management journal, 18(6), 499-507. zingales, l. (1995). insider ownership and the decision to go public. review of economic studies, 62(3), 425-448. volume 36, number 1 27 brief biographical sketch of authors christopher r. reutzel is an associate professor of strategic management at sam houston state university. his research interests include strategic leadership, initial public offerings and new venture strategy. dr. reutzel earned his ph.d. from texas a&m university. carrie a. belsito is an assistant professor of human resource management at sam houston state university. her research interests include strategic human resource management, strategic leadership, and entrepreneurship. dr. belsito earned her ph.d. from texas a&m university. *specialj?eature a "new" quality tool for leveraging human resources on large and complex problems greg a. mann sandia national laboratories albuquerque, nm problem many american companies, government agencies, and universities are finding they have to do things differently to survive in today's marketplace and economy. quality improvement and meeting customer requirements are edicts coming from everyone's lips. but, the problem we face is going beyond the cheerleading rhetoric and putting these mandates into action. to meet the changes in today's environment requires the understanding and application of proven management and process improvement tools. from this viewpoint, the systems-level problem has two components: (1) how to most effectively combine the strengths of two proven quality tools, and (2) how to apply this "new" methodology to organization-level management problems. this "new" quality tool is based on combining at&t's process quality management and improvement (pqmi) methodologies with quality function deployment (qfd) techniques for the analysis of a complex policy management issue. this case study illustrates how a large team (approximately 45 people) in the u.s. department of energy (doe) used this methodology to improve a critical management communication process. this methodology provided the analysis framework for determining the action required to design a new directives system within the doe.1 the directive system was not working; it was broken by all performance measures. at the very least, the directives system had lost all credibility as an effective communication management and policy-making tool. senior management had lost confidence in using the system and were routinely using other means to bypass it. individuals in the field questioned the feasibility of the published guidelines because the instructions were often of questionable relevance, extremely expensive to implement, or took control away from the individuals who best understood the intricacies of field operations. when an organization's communication process breaks down, the efficiency of the organization is seriously jeopardized and can result in substantial misuse of scarce human resources. people are no longer doing the right things right. in this instance, * this is an invited paper by greg a. mann. mann is a senior member of the technical staff at sandia national laboratories in albuquerque, nm. he is also a consultant and instructor with the productivity and decision analysis group. mann specializes in organizing and facilitating large teams and adapting various process improvement techniques necessary to resolving complex problems. parts of this paper were presented to the strategic management classes at sam houston state university during the spring, 1993, semester. 1 directives may be known by other names, for example, corporate procedures, company regulations, operating instructions, or policy standards to name a few common labels. 158 journal ofbusiness strategies vol. 10, no.2 and typical to similar cases when communication fails, there was considerable waste, scrap, and rework of human effort because of the inefficiencies in the current directives process. the communication process was perceived by most everyone as a oneway process, top-to-bottom. because of the complex and varied operations across the department, the requirements passed down by this process often failed to fit the situation. in other words, field operations personnel did not understand the senior management's requirements, and at the top levels, senior management did not understand how best to ensure proper execution of the field operations. written instructions are routinely used by large organizations for communicating management's polices into the day-to-day operational guidelines and practices in the organization. the doe has approximately 300 directives which are costly to develop and to implement across 180,000 employees and operations that are geographically dispersed throughout the u.s. these directives or management guidelines cover a wide spectrum of activities from the mundane administrative issues to those that are essential to the management and safe operation of critical activities. for example, there are instructions ranging from parking lot procedures and smoking policies to assessing environmental risks and operating limits of nuclear power plants. background the methodology presented in this paper is based on the quality principles taught by dr. w. edwards deming, the founder of the new economic and industrial era, and dr. yoji akao, japan's leading quality function deployment (qfd) expert and teacher. deming's 14 principles of quality management provide the overarching framework for total quality management programs. qfd is most frequently used to define customer requirements, identify and resolve conflicts between requirements, develop performance measures and prioritize areas for improvement opportunity. to understand the development of the "new " methodology and to appreciate its strength requires a general understanding of the two underlying methodologies: pqmi and qfd. • pqmi. process quality management and improvement (pqmi) is based on dr. deming's work at florida power and light in the early 1980's. fpl successfully applied deming's principles and was the fust and only non-japanese company to win the deming prize for quality. at&t studied fpl's quality program and developed their own version of the quality improvement process pqmi. pqmi is based on the premise that all work is part of a process. deming's influence is strongly seen in the emphasis that the worker is motivated to do good work. therefore, when poor quality products or services are produced, we should not blame the worker, but management should be held accountable. for management to be successful in a total quality environment, it must yield the authority and accountability for quality to the workers who are most knowledgeable about the process. this is the essence of pqmi. let those individuals who best understand the process decide how best to improve the process. the pqmi methodology is broken down into seven steps for investigating a process and deciding where process improvements should be made. the steps are: 1. establish process management responsibilities. this step identifies both the process and someone who is most knowledgeable about the process. this fall 1993 mann: a "new" quality tool for leveraging 159 process owner is also the individual that is accountable for the performance or process outputs, and is capable of making changes to the process. 2. define the process. this includes identifying suppliers and process inputs, and identifying customers and process outputs. there are frequently several stakeholders with numerous interfaces involved in the process. a flowchart is often a useful means of understanding stakeholders responsibilities and graphically illustrating the relationships between activities. 3. define and establish performance measures. this step requires a good understanding of how the process is satisfying customer requirements and internal business objectives. these measures are best developed through direet interview with the customer where possible. 4. assess conformance to customer requirements. this is a gap analysis that compares process outputs (step 2) to customer requirements (step 3) and identifies potential problems in meeting customer requirements.. 5. investigate process to identify improvement opportunities. once data is collected, the analysis turns to understanding how process problems have adversely affected customer satisfaction and turning these problems into opportunities for improvement. 6. rank improvement opportunities and set objectives. after identifying improvement opportunities, the team needs to establish a priority for each improvement opportunity based on the impact to customer expectations. 7. improve process quality. this is the implementation step which provides a structure for carrying out the corrective actions necessary to achieve process improvements. • quality function deployment (qfd). quality function deployment is a systematic approach for planning and decision making that can be used throughout the product or service realization process. it is driven by customer needs and is characterized by the use of crossfunctional teams and the application of graphical tools to aid and document decisions. the qfd team translates customer needs and requirements into appropriate company or technical requirements at each stage of the project. the methodology stresses understanding customer needs, focusing effort and resources on the most important customer needs, and communicating or deploying customer needs to all organizations involved in providing the product or service. the structure qfd approach consists of five essential steps: 1. identify customer needs. customer inputs are needed if the product or service is to be based on customer needs. ideally, the "voice of the customer" is direct. if customer inputs are not directly available, the team will need to validate "assumed needs" for qfd to be truly effective. in qfd jargon, customer needs are sometimes referred to as the "whats." 2. rank the priority of customer needs. the customer focus is further emphasized by gathering and validating customer perceived priorities. it is important to recognize that if there are various customer groups, the team should maintain a connection between the need statements and priorities and the particular customer. 3. identify performance characteristics or "customer satisfaction measures." this step focuses on the things or actions that the company or organi160 journal ofbusiness strategies vol. 10, no.2 zation can do to satisfy the customer needs. these performance characteristics can, in general, be described as things that the organization can control, characteristics that are quantifiable or measurable, and characteristics that do not dictate solutions to the problem. in qfd jargon, performance characteristics are sometimes referred to as the "hows." 4. map the performance characteristics (le., customer satisfaction measures) to the customer needs. the team determines the relationships between the performance characteristics identified in step 3 and the customer needs. a mapping matrix organizes large groups of information in order to graphically display the logical relationships or correlations between the "whats" and "hows" (i.e., house of quality). as the team examines each cell of the matrix they also must decide on the importance or correlation strength of each relationship strength relative to every other strong, medium, weak, or none. 5. identify the most important performance characteristics. the team determines the value or importance of each of the performance characteristics in addressing or satisfying customer needs. this importance is determined by combining the customer priority for a need with the relationship between the customer need and the performance characteristic. the performance characteristics that are strongly related with high priority needs are the most "important." mer completing the above steps, the team must ask themselves: "does this make sense?" this is a common sense or intuition based sanity check of the process that is extremely critical before going further. it also checks team member "buy in" before transitioning from the "problem analysis" phase to the "problem fixing" phase of a study. • the "new" quality tool. from comparing the two quality tools, it is obvious that there are overlaps and similarities between the pqmi and qfd. additionally, from experience in applying the tools, it becomes clear that each tool has shortcomings and as well as strengths. these shortcomings are especially apparent when challenged with improving large complex systems level problems. since neither tool alone provides a complete solution and both have contributing strengths, the answer becomes obvious: combine the two to develop a "new" robust quality tool that eliminates the overlap, minimizes the deficiencies and maximizes the strengths of each approach. approach how to apply the "new" quality tool the "new" tool requires a name. therefore, from its heritage, it takes the "process analysis " techniques from pqmi. it takes the voice of the customer and "improvement deployment" techniques for comprehending complex issues from qfd. thus, with some liberty, the "new" tool is referred to as the process analysis and improvement deployment (proald) methodology.2 2 note the word "quality" is not in the title of the proaid methodology. why? it is the author's contention that, rightfully or wrongfully, the word is overused, hackneyed, and people are "jaded" by the use of the word "quality." this is particularly the case at the lower levels of fall 1993 mann: a "new" quality tool for leveraging 161 the proaid methodology is based on a four step process: (1) system definition, (2) requirements analysis, (3) developing systems-level critical requirements and system redesign, and (4) implementing improvements. the fours steps of this new "tool" is supported by several subtasks.3 each step of the proaid process is discussed in context of its application to the directives system project case study. 1. system definition identification of the system owner (pomi) description of the current system using a process flowchart (pomi) identification of the system users or customers (pomi and ofd). the system owner is the single individual that coordinates the multiple functions and activities of interrelated processes and is ultimately accountable for the effectiveness of the system if implemented as defined. the system (or process) owner must have the authority to change the system across organizational or functional boundaries with agreement from these organizations. in the directives project the system owner was a mid-level manager who was given control and accountability for the redesign of the directives system. in the directives project, three subsystem teams (development, coordination, implementation) were formed to define the existing directives system activities on a flowchart for each subprocess. the three subsystem flowcharts were integrated into one flowchart that described the entire directives system as it existed before any changes were made. 2. requirements analysis identification of customers requirements (pomi and ofd) prioritization of customers requirements (ofd) definition of performance or satisfaction measures for prioritized customer requirements (pomi and ofd) determination of relationships between all customer requirements and all performance measures (ofd) assessment of current system's ability to meet customers requirements (pomi and ofd) identification of the most critical performance measures (ofd) translation of most critical performance measures into the most critical system requirements. a basic premise of the doe directives system improvement project was that the new system must meet the major requirements of the key users (customers) of the system to ensure acceptance of the system. there were five distinct customer groups of the directive system. they ranged from the secretary of energy and his senior staff to the field level staff and technicians. each customer brought their parochial positions to the study. this caused real, as well as emotional conflicts with expectations of the new directives system. it was necessary that team members represent their organizations and therefore consensus building among the team members was an ongoing activity throughout the project. consensus building required the involvement and an organization where action speaks louder than words. the workers in an organization are motivated to do "quality" work and the use of the term in reference to their work processes may be perceived as blaming. 3 the parentheses identifies each step of the analysis task as originating as either a step from pqmi or a step from qfd. 162 j oumal ofbusiness strategies vol. 10, no.2 active participation by all affected organizations with points of contact identified for each. it also required an aggressive communications plan to inform and enlist support from all levels of the user/customer organizations. each customer group developed their respective set of requirements. this resulted in a combined set of 182 customer driven requirements, needs, or expectations of the organizations's directives system. representatives from each of the five identified customer groups met independently to analyze and consolidate this larger set of requirements. each of the five customer groups were tasked to limit their requirements to ten and to rank them in priority order. thus, the 182 base requirements were reduced to 50 prioritized customer requirements. the 50 requirements were analyzed and the subsystem teams developed performance measures that allowed the system owner to know when the customer requirement is satisfied. this resulted in 33 specific performance measures of customer satisfaction. each of the performance characteristics and the associated performance measures were compared to all the prioritized customer requirements. this resulted in a 50 x 33 relationship matrix (ie., house of ouality). relationships between requirements and performance characteristics were assessed as either strong, moderate, weak, or none. a numerical value was associated with the relationship strengths and resulted in an overall relative importance rating for each performance characteristic. the performance characteristics with the highest importance ratings were candidates for becoming the most critical performance characteristics for a new directive system. these semi-quantitative results were subjected to the common sense test and scrutinized on the basis of "do they make sense?" this resulted in the project team's consensus on the twenty most critical performance characteristics which were translated into the twenty most critical system requirements for the new directive system. the identification of systems-level requirements now provided a solid basis for changing and improving the directives system. thus a new system, with these improvements implemented, provides the greatest opportunity of satisfying the greatest number of system customers. 3. critical system requirements and system redesign focus cross-functional ouality action teams (3-5 people) on the most critical system requirements (pomi) identify improvement opportunities and action plans (pomi&ofd) define the components of the new or improved system (pomi) design flow chart for the new system that connects critical system requirements (pomi) develop the new system based on solutions to critical system requirements (pomi). twenty quality action teams were formed to develop candidate improvement solutions (or fixes) to each of the 20 most critical system requirements. since the teams worked independently and in parallel to develop options, they used the larger combined project team meetings to validate their proposed fixes and to resolve trade-offs and interfaces with other action teams. each quality action team was tasked to develop a component level flowchart for their activity. the 20 component flowcharts were integrated into a single systems-level flowchart. the new system identified the sequence of events, decision points, and key process steps, along with the system requirements they satisfied. this flowchart provided a graphical illustration that assured a consisfall 1993 mann: a "new" quality tool for leveraging 163 tent end-to-end process for developing and coordinating, and implementing new directive requirements. narrative descriptions and procedures were required to describe the specific process details ~or the operation of the new directives system. at this point, it is critical that the results of the analytical, consensus-based, and customer-focused proaid methodology are communicated to all system users. this is the highest risk element of the project: gaining consensus and acceptance outside of the project team from the larger organizational interest. this is when system users at all levels are afforded the opportunity to identify and accept the most critical system needs, the proposed solutions, and the new system requirements. on the directives project, emphasis was placed on satisfying users and not just on concentrating on process requirements. it was accepted that it was not possible to develop and implement a directives system that met all the requirements of all the system customers. as a result, several system issues were too contentious and too difficult for easy agreement on a solution. they were deferred and will be addressed later as part of continuous improvement initiative. considerable time was required to coordinate and resolve problems with the design for the new system, however, this effort was successful and the directives requirements document was signed by the secretary of energy. 4. implementing improvements establish schedules for near and long-term actions (pomi) prototyping and testing solutions (pomi) reviewing all existing directives in agreement to the new system. the last step of the proaid methodology is implementing the approved system. the implementation process must now consider other organizational issues such as culture, resource availability, and management support. implementing large systems changes and dealing with these three organizational issues can be extraordinarily difficult. these constraints will greatly affect developing realistic schedules and action plans. most of these issues should have surfaced during the coordination process with the organization and should not be a surprise. however, it is now time for decision and management must be involved. these organizational issues are best dealt with by identifying the decision criteria and ensuring that senior management participates, along with the system owner, in the analysis and development of a feasible plan for implementing major systems-level changes. communication of this plan throughout the organization is extremely important to let everyone know what is happening and their role in the implementation process. other considerations for systems-level studies some suggestions on the organization and logistics are discussed to help minimize problems when using proaid methodology on large systems-level improvement studies. some of the more significant issues are the formation of the project team, developing the project plan, using consultants/facilitators, meeting coordination and support. • project team. the directives project team was chaired by a mid-level manager from the office of human resource management. this person should be a well respected risk-taker, willing to release considerable control to the project team, and willing to adopt recommendations out of the team. the permanent membership of the project team included representatives from several departmental elements and as well from all 164 journal ofbusiness strategies vol. 10, no.2 levels of the organization. this wide spectrum of participation provides a wide range of viewpoints and is very important when working large organizational problems. the project team was supported by three i5-person subsystem teams with each responsible for one of three phases of the directives process: development; coordination, and implementation. since a large team is often necessary to address all aspects of a large organizational issue, it is important to break the team up, if possible, into subteams (less than 15 members per subteam) to make the group size more manageable and more productive. • project plan. a project plan should outline the study, and include the charter for the project, project leadership, team membership, expectations from senior management, scope of activities (i.e., what is within and outside of the team's authority), and identify deliverables. large studies, because of the human resource requirements, are costly and require management's commitment to investing the effort. the plan should provide for periodic corporate management review and opportunities for study redirection, an organization communications plan, and a schedule for the approval of proposed actions by senior management. periodic management review and communication feedback on progress to stakeholder organizations is critical to preventing surprises and obstacles in coordinating the final redesigned or new system. the directives project plan divided the project into three phases: analysis of requirements, developing system corrective actions, and implementation. eight monthly, 2-day team working sessions, were scheduled to complete the first two phases, analysis, and developing corrective actions for the directive system. the third phase, implementation, was scheduled for completion within 12 months after sign off on the design by the secretary for a total of 20 months devoted to the project. • project consultants/facilitators. because of the magnitude of the directives study, three consultants were required to support the various phases of the study and analysis. the consultants worked on behalf of the project leader and the three subsystem team leaders. the facilitators and leaders met prior to each exercise to review the process agenda, determine the objectives for the working sessions, and recommendations for resolving any teamwork related problems. the facilitators' role was to get the evaluation and redesign completed in the most efficient manner. they were responsible for the process and where constantly collaborating on the team dynamics and the proald methodology. the importance of using outside consultants/ facilitators for large-complex issues cannot be overemphasized. as outsiders, they are responsible for moving the team through the proald methodology, and yet they are neutral on the content with no particular bias to the outcome of the new design for the system. they should be systems-level thinkers and capable of pulling the many disconnected pieces together into a complete system. for example, the consultants' major concern on the directives project was the reconfiguration of the numerous component activities and subprocesses into a new and coherent systems design for the new directives system. • meeting coordination and support. meeting logistics were complicated by the large team size, coordinating the availability of team members, making travel arrangements, and consolidating the volumous data coming out of the meetings. the initial team was large because of many organizations with vested interests. the team size continued to grow as the momentum for the project was boosted by early successes and broad senior management support. the large team was both a problem and a fall 1993 mann: a "new" quality tool for leveraging 165 benefit. progress was often slow because of varied viewpoints and extended discussions, however, the large team also provided the necessary resources required to address the numerous quality action teams. availability of team members for meetings was fully never resolved because of individual schedule conflicts. however, by scheduling project team meetings three to four months in advance, the project maximized attendance and continuity in membership. the most cumbersome support task was collecting "rough draft" data outputs from the meetings and transforming the material into useful charts, matrices, glossaries, minutes, and project deliverables. this is an essential task that can be greatly assisted by dividing the work among all participants with a single project "assignment" coordinator responsible for pulling the information together. on large projects, this "assignment" coordinator function can be a full-time function for the duration of the study. leveraging human resources proaid is a disciplined approach for investigating complex systems level processes and placing priority on the "voice of the customer." it is based on the formation of crossfunctional teams where team members each bring a different point of view to a problem. as such, it is a robust approach for developing teamwork, gathering and synthesizing enormous amounts of data, and identifying critical system deficiencies and greatest opportunities for improvements. because all decisions are based on consensus and a fair amount of discussion takes place, people feel that all their interests are addressed, not always to their satisfaction, but at least their opinions are heard. this communication at the functional interface between two or more functions or organizations is critical. as people see the larger picture, individual concerns may not be as critical and some rationalization takes place. the greatest advantages of the proald methodology is leveraging of human resources. for example: • communications tool. the four step methodology provides an analysis roadmap to team members. it breaks down large system-level problems into manageable phases and then logically addresses each phase of the analysis in detail by the sequence of subtasks. the communication process is further supported by the use of graphical tools that capture the various activities, relationships, requirements, and priorities necessary to develop a set of systems level requirements. this approach helps reduce the ambiguity and increases the understanding of interrelationships when dealing with many complex and interacting variables of a large problem. the graphical presentations not only leverage internal team-eommunication process between team members, but is also beneficial when communicating to decisionmakers and individuals outside the team. • handling large amounts of data. teams can generate enormous amounts of data and without an effective means of capturing and handling this data, much effort will go to waste or become a major retrieval problem. the methodology provides a systematic means of handling and using this data to identify critical needs and performance characteristics. the data capture and storage process is supported by commercially available software. the software files can be manipulated, if necessary, and allows sensitivity analyses to be conducted by modifying either inputs, priorities, or relationship weights. these large data files are important in assisting the continuity in transitioning 166 journal ofbusiness strategies vol. 10, no.2 from meeting to meeting, particularly when the meeting participants are not always the same. • increased teamwork. the methodology helps large systems-level teams cooperate and communicate effectively. since teams are made up of cross-organizational members who bring different perspectives to the problem, they will typically go through the "storming"phase. however, this methodology may help leverage the team's ability to move more quickly out of "storming" into performing and making positive gains on system improvements. the methodology provides a logical sequence of efforts and provides the team a systematic focus on the application of the team's resources. • emphasis on the customer. in general customer requirements are vague, incomplete, and often conflicting. the methodology is beneficial in developing explicit and measurable definitions of customer requirements. by clarifying and validating requirements and priorities with the customers, a team also demonstrates to the customer that they are concerned for customer satisfaction. in so doing, the team leverages its credibility with the customer. • resolving conflicts between requirements. large systems studies often have multiple customers and customer requirements which may be in conflict with one another. the methodology accommodates each customer's prioritized set of requirements without bias. when all requirements are integrated through the relationships analysis, all customer requirements are given the priority assigned by the customer and the team does not have to directly decide which customer is most important. the methodology's relationship analysis and method of developing of the most important performance characteristics in a semi-quantitative manner avoids the subjective arguments over importance. summary in summary, this case study presents the results of the application of a newly developed methodology for handling systems-level process improvement challenges presented by large and complex management problems. this quality tool breaks down barriers and leverages the talent of human resource in their quest for quality. the methodology is based on combining the best features of two quality tools: pqmi and qfd. the result is called process analysis and improvement deployment (proaid). proaid is a logical, customer focused, disciplined methodology that can be applied in a flexible, adaptive manner for the identification of critical system requirements. once critical system requirements are identified, they are used as the basis for redesigning or developing a new systems-level solution to the complex problem. the methodology requires that the study team take chances with the four step process and in the application of the subtask under each step of the methodology. systems-level problems typically present an overwhelming challenge when first assessed. however, the complexity of issues that are pervasive and run across all operations of a large organization can be dealt with effectively when broken down. this methodology provides a systematic approach to identifying sub-processes and looking at each in the context of satisfying customer performance on a limited number of critical system requirements. fall 1993 mann: a "new" quality tool for leveraging references 167 hauser, john r. and don clausing. 1988. "the house of quality." harvard business review (may/june). "process quality management and improvement." 1987. at&t bell laboratories: issue 1.1. a "new" quality tool for leveraging human resources on large and complex problems mission statements of hospitals: an empirical analysis of them. contents and their relationsffip to organizational facfors ram subramanian grand valley state university allendale, michigan kamalesh kumar charles c. yauger arkansas state university state university, arkansas introduction the 1980s saw a dramatic shift in the external environment faced by health care organizations. changes such as increased competition, demographic shifts [14], and increased cost-consciousness from "customers" in the form of the government and other employers who paid for their employees' health care costs have transformed this industry significantly [12]. the domain of health care organizations now became similar to the environment faced by organizations in the more traditional industries such as automobiles and manufacturing. observers are of the opinion that the rules for success in the health care industry now include better management skills and the implementation of strategic planning programs ([14], [19]). strategic planning involves aligning the organization in terms of its environment [24]. an important step in the strategic planning process is the development of a statement that delineates the organization's mission. such a statement, called the "mission" statement or the "credo", helps the organization define itself and differentiate it from its competitors [22]. johnson and johnson's successful handling of the tylenol crisis has been attributed largely to the guidance provided by its mission statement [10]. the company's mission clearly states that its first responsibility is to the users of its products. such an unequivocal prioritization of purpose enabled the company's managers to take whatever actions possible to get the defective product out of the market and design a new package that would prevent a similar crisis from happening again. there has been an increasing amount of research done on mission statements in recent times. much of the research, though, has used mixed samples drawn from manufacturing and service companies. in other words, very few studies have looked at mission statements from an industry specific viewpoint. as pearce and david [22] point out, further research is needed to determine particular industries, conditions, and situations where specific components of a mission statement are useful. the objectives of this paper are: (1) to empirically analyze mission statements of hospitals, (2) to examine the relationship between mission statement components and organizational characteristics such as size and profit orientation, as well as occupancy rate (a factor denoting performance), and 64 journal of business strategies vol. 10, no. 1 (3) to examine the relationship between comprehensiveness (in terms of the inclusion of mission statement components) and the three factors indicated above. the paper is divided into four parts. the first part reviews the literature on mission statements, while the second part describes the research methodology. the third part presents the results of the study and the implications are discussed in the fourth part. review of the literature mission statements in the general setting as pearce and david [22] observe, while strategic management textbooks dwell at length on the importance of mission statements, research interest in this area has been scant until recently. while table 1 summarizes the extant research on mission statements, three studies are described in detail here because they directly provide the theoretical backdrop for the current effort. table 1: review of mission statement literature author(s) campbell and yeung (1991) klemm, et al (1991) ackoff (1987) article intent theory building theory testing prescription methodology interviews with 42 companies. survey and content analysis of 59 statements. discussion. findings commitment to mission is best when there is a match between employees' values and company's values. mission statement important tool for managers. participation in mission statement preparation is important for its success. spring 1993 subramanian, kumar & yauger: mission statements 65 table 1: review of mission statement literature (continued) author(s) article intent methodology findings pearce and theory building content eight components david (1987) analysis of found in most mis61 fortune sion statements. 500 statealso, more comments. prehensive statements characteristic of high performers. david (1989) theory testing content service and manuanalysis of facturing compa75 mission nies differ in the statements. inclusion of certain components. pearce (1982) prescription discussion. mission statements are valuable tools for strategic management. want (1986) prescription discussion. mission sets a course for the organization's future. bettinger prescription discussion. successful strate(1985) gic planning depends on a clear, concise mission statement. nash (1988) prescription discussion. good mission statements provide a benchmark for success. byars and prescription discussion. development of a neil (1987) mission statement is an important part of the strategic planning process. 66 journal of business strategies vol. 10, no.1 table 1: review of mission statement literature (continued) author(s) article intent methodology findings mcginnis prescription discussion. mission state(1981) ments are a fundamental part of an organization's strategic planning process. cochran theory testing content the tone and readand david analysis of ability of mission (1986) 61 company statement are imand 74 portant if they are university to be effective. mission statements. mcmillan prescription discussion. identified comp(1985) onents of a hospital's mission statement. gibson, et. theory testing survey of identified populal (1990) 176 hospital ar components of administrators. hospital mission statements. pearce and david's [22] empirical work on the mission statements of fortune 500 companies was the first in-depth examination of the components of mission statements and their relationship to firm performance. using content analysis of 61 statements, they concluded that eight components were commonly found in mission statements. these components were: target customers and markets, principal products or services, geographic domain, core technologies, concern for survival, growth, and profitability, company philosophy, company self-concept, and desired public image. table 2 provides a list of the eight components. spring 1993 subramanian, kumar & yauger: mission statements table 2: list of mission statement components derived from literature 1. specification of target customers and market. 2. the identification of principal products or services. 3. the specification of geographic domain. 4. the identification of core technologies. s. the expression of commitment to survival, growth, and profitability. 6. the specification of key elements in the company philosophy. 7. the identification of the company self-concept. 8. the identification of the company's desired public image. 67 source: pearce ii, j. a, and david, f.r. "corporate mission statements: the bottom line." academy of management executive, 1(2), (1987) p. 109. the researchers found the mission statements of better performing companies to be more comprehensive (in terms of the number of components included) than those of poor performers. david [b] found the mission statements of service companies to be less comprehensive than those of manufacturing companies. few service companies had mission statements that described the organization's philosophy and the core technology used. however, he did not find support for any link between comprehensiveness of mission statements and economic performance. mission statements in the hospital setting gibson, newton, and cochran [13] studied mission statements of hospitals with a view to identifying their existence and usage. using 176 survey responses from members of the "society for hospital planning and marketing of the american hospital association", they concluded that hospitals use mission statements much the same way as their counterparts in the business community. however, the researchers also noted strong disagreement by their respondents about the usefulness of mission statements for planning purposes. the disagreement also extended to the relevance of certain mission statement components. for example, more than 40 percent of the respondents felt that the self-concept component was irrelevant, while 2b percent felt the same way about the technology component. a detailed examination of the mission statements also revealed that unlike manufacturing companies, most hospital mission statements did not include the organizational goals, technology, and the public image components. it is clear from the review of the literature that only exploratory work has been done in the realm of mission statements. with the exception of two studies ([b], [22]), little effort has been made by prior researchers to study mission statements comprehensively in an effort to link them and their components to salient organizational factors as well as performance. such a linkage done in an industry-specific context will provide a better perspective on the usefulness of such statements. the current study attempts to fill the gap in the literature by replicating and extending prior research on mission statements. 68 journal of business strategies methodology vol. 10, no. 1 data for this study were collected as part of a larger study on the management practices in health care organizations. a six-part questionnaire was designed to collect data. the parts relevant to this study were those dealing with the existence of a formal, written mission statement, the inclusion of the eight literature-derived [22] mission statement components, and data concerning organizational characteristics such as number of beds and profit orientation. data was also collected on performance of hospitals as reflected by the surrogate measure of occupancy rate. the presence of the eight components has been validated by the empirical work of david [8] and used in research on hospital mission statements by gibson, newton, and cochran [13]. while it may be desirable to measure the productivity and efficiency of hospitals in terms of financial information, such data is difficult to obtain. the competitive situation facing many hospitals, the absence of a clear profit motive among some hospitals, and a lack of knowledge on the part of many administrators about what data to gather and how to use them makes them reluctant to respond to questionnaire surveys on the subject of organizational productivity and profits [7]. nevertheless, the "american hospital association guide to the health care field" does contain data on a variety of factors, such as number of beds, total expenditures, number of admissions per year, and census (average number of in-patients) that may be reflective of performance. this study used occupancy rate as the performance measure since this data was easily obtainable and more reliable than other measures. since this measure includes both hospital size (number of beds) and census (average number of in-patients receiving care each day), it allowed us to take into account two of the factors that have been frequently used to determine hospital differences [n]. a pilot study was conducted using a subset of the population used for the study itself. the pilot questionnaire was mailed to the executive officers of five hospitals. the participants were asked to complete the questionnaire and to comment about the length of time necessary to fill out the questionnaire, any survey questions or statements that needed clarification, methods of response improvement, and follow-up techniques. personal interviews were also conducted with four of the five executive officers. modifications were made to the questionnaire based on these suggestions. also, alpha coefficients were computed for all items on the questionnaire. the eight mission statement components had a coefficient of alpha of 0.7789, indicating the instrument's reliability. from the "american hospital association guide to the health care field," 647 acute care hospitals from southeastern united states (comprising the states of arkansas, missouri, louisiana, tennessee, kentucky, mississippi, alabama, georgia and south carolina) were identified as the target group. this geographic area was selected for the convenience of the researchers in gathering data from a population large enough to yield an adequate number of responses. this strategy was quite successful in maximizing the number of responses. in terms of the generality of the findings of this study, we feel that the characteristics represented in this sample is also represenspring 1993 subramanian, kumar & yauger: mission statements 69 tative of the characteristics of hospitals in other geographic regions. feldstein [11] cited a number of variables frequently used to determine hospital differences. the list includes such factors as: hospital size, percentage occupancy of hospital beds, total expenditures, and payroll expenditures. analyses of the sample population used in this study, in terms of these characteristics, show that the sample used in this study covers a wide range of hospitals and, therefore, can be deemed to represent the larger population on a nationwide level. the questionnaires were sent to the chief administrators of the sample group. the initial mailing followed by a reminder resulted in 357 responses (55 percent) of which 339 were usable. a chi-square test indicated that the respondent group was consistent with the total population on the variables of occupancy rate (x2 = 15.37, p = 0.47) and size (x2 = 12.61, p = 0.36). results presence of literature-derived components of the 339 responding organizations, 291 (85.8 percent) had a formal, written mission statement. this percentage is consistent with the findings of gibson, newton, and cochran [13] in their work on hospital mission statements, but considerably higher than the percentage of fortune 500 companies that have formal, written mission statements ([22], [8], [6]). table 3 lists the percentage of respondents' mission statements that included the eight literature-derived components. table 3: percentage of mission statements that included various components component philosophy self concept desired public image target customers principal services geographic domain core technologies concern for survival, growth, and profitability percent included 88 48 86 66 59 61 25 84 a vast majority (88 percent) of the sample mission statements included the basic beliefs component, while the desired public image and concern about survival, growth, 70 journal of business strategies vol. 10, no. 1 and profitability components were included in a large number (86 and 84 percent, respectively) of the sample mission statements. the least popular components were the identification of the technology used to deliver the hospital's services (25 percent) and a description of the hospital's strengths (48 percent). relationship of components to organizational characteristics and perfonnance a comparison of the inclusion of the eight components of the sample mission statements in relation to profit-orientation and organizational size are shown in tables 4 and 5. table 4: relationship between mission statements and occupancy component lowa moderate high x2 ph (n=79) (n=142) (n=70) yes noc yes no yes no philosophy 85 15 88 12 89 11 1.77 <.30 image 64 36 88 12 89 11 10.18 <.06 * self concept 21 79 45 55 62 38 10.22 <.001 target eust. 59 41 61 39 68 32 1.17 >.50 services 43 57 60 40 71 29 10.57 *<.01 geo. domain 56 44 59 41 63 37 0.49 >.80 technology 22 78 24 76 27 73 0.32 >.80 concerns 68 32 81 19 82 18 2.18 >.30 a low = occupancy of 49% or less, moderate = 50-69%, high :::: >70% b degrees of freedom :::: 2 c percent response • significant at the 0.05 level spring 1993 subramanian, kumar & yauger: mission statements 71 table 5 compares the presence of the eight components in relation to occupancy rates. table 5: relationship between mission statements and size component smaua medium large x2 pb (n=85) (n=114) (n=92) yes noc yes no yes no philosophy 90 10 94 6 97 3 4.90 <.10 image 87 13 86 14 82 18 0.67 >.70 self concept 47 53 44 56 51 49 1.01 >.60 target cnst. 62 38 67 33 66 34 0.38 >.80 services 61 39 59 41 56 44 0.48 >.80. geo. domain 56 44 62 38 70 30 6.15 <.05 technology 19 81 27 73 28 72 2.01 >.30 concerns 83 17 80 20 85 15 0.87 >.60 a small = 200 or less beds, medium = between 201 and 399 beds, large :;; 400 or more beds. b degrees of freedom = 2 c percent response • significant at the 0.05 level table 6: relationship between mission statements and profit orientation of hospitals component governmenta not-for-profit for-profit "i: pb (n= 148) (n= 80) (n= 63) yes noc yes no yes no philosophy 80 20 84 16 99 1 4.05 >.10 image 85 15 83 17 3 7 2.71 >.20 self concept 47 53 46 54 52 48 0.69 >.60 *target cust. 56 44 62 38 74 26 6.15 <.05•services 54 46 65 35 69 31 6.05 <.05 oeo. domain 43 57 40 29 10.49 *60 71 <.001 technology 22 78 23 77 37 63 4.86 <.10 concerns 82 18 81 19 91 9 2.76 >.20 a government = state and county hospitals, not-for-profit = church and other non-profit organizations, for-profit = privately owned b degrees of freedom = 2 c percent response • significant at the 0.05 level 72 journal of business strategies vol. 10, no. 1 consistent with health car~ industry practices [13], the sample organizations were divided into three groups based on occupancy and three groups based on size (number of beds). thus, hospitals with occupancies of 49 percent or less were classified as "low", while those with occupancies of 50 to 69 percent were classified as "moderate". hospitals were classified as "high" if their occupancies were 70 percent or more. similarly, the organization's size was "small" if it had 200 or less beds, "medium" if it had between 201 and 399 beds, and "large" if it had 400 or more beds. also, based on questionnaire responses, the sample was divided into government (federal, state, or county funded), not-for-profit, and for-profit hospitals. the objective of this classification was to examine the relationship between organizational size, performance, and profit orientation with inclusion of mission statement components. the responses were converted to percentages and a chi-square analysis was used to examine the difference across the three groups for the three measures used (occupancy, size, and profit orientation). based on occupancy, two components showed significant differences across the three groups-identification of strengths (self-concept) and principal services. division of the responding hospitals in terms of size (number of beds) indicated that only one component, location of principal services (geographic domain), showed significant difference in means across the three groups. the mean scores on the other seven components were not statistically significant. based on profit orientation, significant differences were found in the means of the three groups for three components: location of principal services (geographic domain), identification of customer groups (target customers and markets) and principal services. in all three cases, the incidence of these components was significantly greater in forprofit hospitals than in government and not-for-profit hospitals. to test the relationship between comprehensiveness (in terms of inclusion of the eight components) and the three factors studied (size, profit orientation, and occupancy), the following procedure was used. first, a score of 1 was given if the mission statement did not include the particular component, while a score of 2 signified inclusion of the component. based on these scores, a composite was obtained for each hospital by adding up the scores for the eight components. the composite score indicated the degree by which a hospital contained more or fewer of the eight components relative to others. an anova (analysis of variance) was used to examine the difference between groups of hospitals divided on the basis of the three factors. significant differences in comprehensiveness were observed only in profit-orientation (see table 7). spring 1993 subramanian, kumar & yauger: mission statements table 7: analysis of variance of comprehensiveness of mission statement and hospital size, profit orientation and occupancy rate 73 hospital characteristics size small medium large profit orientation government not-for-profit for-profit comprehensiveness of mission statementa 10.92 10.99 11.36 10.10 10.70 11.80 f-statistics 0.87 4.32 p-value 0.42 0.01* occupancy rate low 10.35 moderate 10.55 1.04 0.24 high 11.11 a comprehensiveness measure has been calculated by adding up the responses to the eight components of the mission statement. it shows to what degree a hospital contains more or fewer of the eight components relative to others. • significant at the 0.05 level discussion the importance of the health care sector is underscored by the fact that it currently accounts for about 12 percent of the country's gnp [3]. as competition in the industry increases, more and more health care organizations are applying management techniques that, hitherto were confined to the more traditional industries. however, as fottler [12] points out, the environment of the health care industry is so unique that many of the generic management techniques cannot be applied directly. this leads to the need for examining the applicability of current management theory to health care organizations with a view to determining their generalizability [3]. research interest in organizational mission statements has increased during recent times. however, much of the work has been using pooled samples drawn from a number of industries. to the best of the current researchers' knowledge, only one study [13] examined the mission statements of hospitals. the objective of this effort, therefore, was to replicate the work of gibson, newton, and cochran [13] using a larger sample and extend it by examining the relationship between mission statements and organizational factors such as size and profit orientation as well as a performance measure, viz., occupancy rate. using theory generated in a context-free (generic management) domain, its application to a context-specific (health care management) environment is examined [3]. 74 journal of business strategies vol. 10, no. 1 the current study (as well as the gibson, newton, and cochran [13] study on hospital mission statements) found more hospitals having mission statements (85.6 percent) than did fortune 500 companies ([22], [8]). two reasons could be attributed to this phenomenon. it is possible that the turbulent environment faced by hospitals, especially in the 1980s, has forced administrators to clearly articulate their vision of the organization and its place in the competitive environment [9]. in this environment, successful hospitals (and those that survive) are those that spend more time communicating and coordinating goals among organizational subunits, and more thought and effort determining what society will appreciate [15]. often, the mission statement is the starting point for such an objective. the second reason for a large incidence of mission statements in hospitals may also be due to the fact that many hospitals, because of religious and/or charitable affiliations, have extensive prior experience in developing written statements about issues such as purpose and goals, which are also mission statement components [13]. lack of experience in similar endeavors was cited as the primary reason by many fortune 500 companies for not having mission statements [22]. pearce and david's [22] study of mission statements of fortune 500 companies indicated that two components-concern about survival, growth, and profitability, and desired public image-were found in a majority of statements. however, in the case of hospital mission statements, the current study identified the basic beliefs component to be the most popular. a large number of the responding hospitals (88 percent) included this component in their mission statements. this could again, be attributed to the fact that many hospitals either are, or have been, affiliated with religious and/or charitable institutions, where a written articulation of purpose is often necessary to get started. components such as strengths (48 percent), identification of principal services (59 percent), and geographic domain (61 percent) were less popular. however, only 25 percent (74 out of 291 statements) included the component identifying the core technology to be used in delivering the hospital's services. the reasons for this could possibly be drawn from pearce and david's [22] study on fortune 500 companies' mission statements. in that study, two reasons were attributed for only 20 percent of the companies including the core technologies component in their mission statement. the first was the difficulty in succinctly describing the several technologies used in producing many products. presumably, those companies that produced many different kinds of products were unable to describe briefly the different technologies that went into the production of these products. a hospital can be envisaged as an entity delivering many kinds of services-akin to a company producing multiple products. it is possible that this leads to the difficulty in identifying succinctly the technologies that go into the various services that a hospital provides. the second reason that emerged from the pearce and david [22] study was that service technologies are far more difficult to identify than manufacturing technologies. since hospitals are in the service sector, the difficulty in identifying the technologies used presumably leads to only a few organizations including this component in their mission statements. spring 1993 subramanian, kumar & yauger: mission statements 75 pearce and david [22] provided empirical support for their contention that better performing organizations differed from their poor performing counterparts in the inclusion of certain mission statement components. their study indicated that high performers and low performers differed significantly in the inclusion of the beliefs (basic philosophy), image, and strengths (self concept) components. however, they also argue that the desirability of including certain components could vary across industries. the current study provided partial empirical support for that argument. hospitals that showed higher occupancy rates (high performers) were significantly different from moderate and low performers in the inclusion of the strengths (selfconcept) and identification of principal services components. hospitals are thus similar to other organizations in the inclusion of the strengths component, yet different in including the identification of the principal services component. due to a lack of prior research effort in this direction, one can only speculate on the reasons for these two components being included more often in better performing hospitals than in the moderate and poor performers. a clear identification and articulation of the organization's strengths helps prioritize its activities [9] and position it in terms of its environment [14]. this prioritization is extended to activities such as allocation of resources as well as in the external communication of the organization's abilities. this, presumably, helps draw patients to the hospital, thereby increasing its occupancy. a clear identification of the hospital's principal services is also important, both for strategic planning as well as for external communication purposes. industry experts (e.g., [16]) point out that in the future successful hospitals will be those that communicate clearly the various benefits (services) the organization provides to its myriad stakeholders. inclusion of this component in its mission statement helps in communicating this information to the users of its services, thereby yielding better occupancy rates. the number of beds in a hospital indicates its relative size. only one component, location of principal services (geographic domain), showed significant difference in means across the three groups of hospitals. as a hospital's size increases, it often becomes unnecessary to specify its domain of activities. this component appears to be more necessary for smaller hospitals which have to clearly state its geographic domain, lest they get caught up in competition they cannot effectively compete in. for-profit hospitals in the sample differed significantly from government and notfor-profit hospitals in the inclusion of three mission statement components: principal services, target customers, and geographic domain (location of principal services). it is possible that these three components were found more in for-profit hospitals than in the others because of the profit orientation of these hospitals. these three components specifically help focus an organization's resources in ways that would help it create and sustain a competitive advantage [25]. on the other hand, since the focus of government and not~for-profit hospitals is usually on providing service (not necessarily on a profit-making basis), it is possible that these three components are not considered extremely important. 76 journal of business strategies vol. 10, no.1 in looking at comprehensiveness of mission statements, only the grouping of hospitals by their profit-orientation yield significant differences. it indicated that for-profit hospitals contain more mission statement components than government and not-for-profit hospitals. it is difficult to establish a direct link between comprehensiveness of mission statements and the performance of the organization. performance may be determined by a variety of factors, some specific to the organization, others related to general industry trends. however, a more comprehensive mission statement is the starting point for strategic planning purposes. it helps to clearly articulate an organization's position on various domains. such articulation helps prioritize its activities. the findings of this study are important for strategic management scholars as well as for hospital administrators. by extending research generated in general manufacturing and service industries, using a sample drawn from the health care field, this study demonstrated the need to consider the industry context in theory building. while many of the current study's results were consistent with those of pearce and david [22] and david [8], the differences that were found signify that the health care context is quite different from that of general manufacturing and services and underscore the necessity of doing research using industry specific samples. for the hospital administrator, the findings of this study describe the state-of-the art practices in strategic planning in the industry. by grouping the sample hospitals according to size, profit orientation, and occupancy rates, the presence or absence of literature-derived mission statement components were clearly portrayed. by identifying significant differences in the inclusion of certain components among the different groups of hospitals, the study's results provide pointers to hospital administrators. in addition, the study also looked at the relationship between the comprehensiveness of mission statement components and the three factors studied. while, except in the case of profit orientation, the differences were not significant, the current study attempts to build theory in the field of health care strategic planning by extending empirical research drawn from the general strategic planning field. limitations and future research directions one of the limitations of the current study was that the data was based on survey responses. thus, it examined "intended" actions, and not "actual" ones. future research using content analysis of hospital mission statements may lend further empirical support to the findings of the current study. such an analysis is necessary to complement the current effort. future research should also examine how mission statements are actually used in strategic planning. currently, one can only speculate on the benefits of mission statements. an examination of their use in setting objectives, generating strategic alternatives, as well as in helping select alternatives will provide objective data instead of subjective speculations. spring 1993 subramanian, kumar & yauger: mission statements references 77 1. ackoff, rl. "mission statements." planning review, vol. 15 (1987), pp. 30-31. 2. bettinger, c. "behind the mission statement." aba banking journal, vol. 127 (1985), pp. 154-160. 3. blair, j.d. and boal, k.b. "strategy formation processes in health care organizations: a context-specific examination of context-free strategy issues." journal of management, vol. 17 (1991), pp. 305-344. 4. byars, l.l. and neil, t.c. "organizational philosophy and mission statements." planning review, vol. 15 (1987), pp. 32-35. 5. campbell, a. and yeung, s. "creating a sense of mission." long range planning, vol. 24 (1991), pp. 10-20. 6. cochran, d.s. and david, f.r. "communication effectiveness of organizational mission statements." journal of applied communication research, vol. 14 (1986), pp. 108-118. 7. coddington, d.c. and moore, k.d. market-driven strategies in health-care. san francisco, california: jossey-bass publishers (1987). 8. david, f.r. "how companies defme their mission." long range planning, vol. 22 (1989), pp. 90-97. 9. denis, j., langley, a., and lozeau, d. "formal strategy in public hospitals." long range planning, vol. 24 (1991), pp. 71-81. 10. falsey, t.a. corporate philosophies and mission statements. new york: quorum books (1989). 11. feldstein, m. the rising cost of health care. washington d.c: the information resource press (1971). 12. fottler, m.d. "health care organizational performance: present and future research." journal of management, vol. 13 (1987), pp. 367-391. 13. gibson, c.k., newton, d.j., and cochran, d.s. "an empirical investigation of the nature of hospital mission statements." health care management review, vol. 15 (1990), pp.35-45. 14. ginter, p.m., duncan, w.j., richardson, w.o., and swayne, l.e. analyzing the health care environment: "you can't hit what you can't see." health care management review, vol. 16 (1991), pp. 35-48. 78 journal of business strategies vol. 10, no. 1 15. griffith, j.r. "the mission of the well-managed community hospital." michigan hospitals, vol. 24 (1988), pp. 43-46. 16. johnson, d.e.l "multi-unit providers will focus on benefits rather than size." health care strategic management, vol. 9 (1991), pp. 2-3. 17. klemm, m., sanderson, s., and luffman, g. "mission statements: selling corporate values to employees." long range planning, vol. 24 (1991), pp. 73-78. 18. mcginnis, v.j. ''the mission statement: a key step in strategic planning." business, november-december (1981), pp. 39-43. 19. mcmillan, n.h. ''the mission statement: where it all begins." in planning for survival: a handbook for hospital trustees (1985). chicago, illinois: american hospital ass0ciation. 20. nash, l "mission statements-mirrors and windows." harvard business review, marchapril (1988), pp. 155-156. 21. pearce, ii, j.a. "the company mission as a strategic tool." sloan management review, spring (1982), pp. 15-25. 22. pearce, ii, j.a. and david, f.r. "corporate mission statements: the bottom line." academy of management executive, vol. (2) (1987), pp. 109-116. 23. want, j.h. "corporate mission: the intangible contnbutor to performance." management review, august (1986), pp. 46-50. 24. zahra, s.a. "corporate strategic types, environmental perceptions, managerial philosophies and goals: an empirical study." akron business and economic review, vol. 18 (1987), pp. 64-77. 25. zaleznik, a. "power and politics in organizational life." harvard business review, 48(3) (1970), pp. 47-60. mission statements of hospitals: an empirical analysis of their contents and their relationship to organizational factors linking undergraduate business degree speciauzation to etlucal behavior: an empirical investigation shane r. premeaux sonya a. premeaux jeanne daboval a.km. matiur rahman mcneese state university lake charles, louisiana according to widener university's school of management professors reilly bernard and myroslaw kyj any behaviors that lessen, deter or stand in the way of the goal (of maximizing shareholder equity) are considered "inefficiencies" to be eliminated by responsible corporate managers ([4], p. 23). in an effort to assure maximization of shareholder equity managers sometimes behave unethically [9]. unethical incidents and moral impunity are often daily occurrences. examples of these questionable business practices include: rockwell international defrauding the air force, hertz overcharging customers and ocean spray's indictment for pollution ([5], p. 56). such unethical actions usually result in extreme criticism of those in business and often results in public outcries for managers to behave more ethically. education may be one method of improving the ethical foundation of business students, which may in tum lead to more ethical behavior. the current ethical impact of a business education on those in various degree specializations may provide the baseline on which to judge if anyone degree specialization is doing a better job of providing a solid ethical foundation. undergraduate business degree specializations were investigated to determine if such a baseline exists, and to assess the ethical outlook of those educated in the various business specializations. the question addressed here is, "does an individual's undergraduate business degree specialization have any effect on the ethical behavior of that person?" specifically, does the ethical behavior of managers educated in the areas of finance, economics, marketing, management, and accounting differ significantly? no study to date has directly addressed the link between ethical behavior and business degree specialization. such a linkage could possibly be useful in understanding the formation of ethical behavior patterns of managers with different educatiomil backgrounds. if in fact students majoring in certain business disciplines are more ethical in their responses to ethical vignettes it is possible that the ethical foundation provided in certain business disciplines better prepares students to act in a responsible, ethical manner. research design for the results to be useful in linking business degree specialization with ethical behavior by managers, the data collected must represent a wide variety of business 30 journal ofbusiness strategies vol. 10, no.1 scenarios. a series of vignettes were used to gather data related to ethical linkages. these vignettes are firmly grounded in ethical theory and the ethical response options provided with each vignette were utilized by fritzsche and becker in their 1984 study of ethical linkages. each vignette describes a business decision containing a potential ethical dilemma [7]. respondents to the mail survey were asked to assume the role of decision maker and indicate how they would resolve each situation. vignettes allow the injection of a greater amount of background information and detail into ethically questionable issues. these types of research vignettes are thought to elicit higher quality data than is possible from simple questions [1]. four categories of ethical problems which represent a wide variety of ethical issues were included in this study [1]. the four categories investigated are coercion and control, conflict of interest, physical environment, and personal integrity.. a coercion and control issue exists when some external force attempts to compel a manager to make a specific decision by using threats, extortion, or other sources of power. a conflict of interest situation arises when a manager has more than one interest that, if mutually pursued, may result in injury to individuals or to the firm [3]. the physical environment vignette is a special case of conflict of interest in which the environment is affected. finally, personal integrity problems occur when decisions raise issues of conscience [1]. the original vignettes were developed by fritzsche and becker, and were once again pretested on a group of individuals working in the field of ethics. the ethics group consist of philosophers, business practitioners, and business professors in each of the business disciplines involved. the vignettes were revised in line with the pretest results and the comments received from the ethics group. the revised vignettes were placed in the questionnaire in random order. respondents were asked to indicate the likelihood of behaving in accordance with a requested behavior of questionable morality. a 0to lo-point likert scale anchored with "definitely would not" (0) and "definitely would" (10) phrases was used. mter making a decision, the respondent was asked why the particular decision was made. five copies of the questionnaire were mailed to a systematic random sample of 200 practicing human resource managers. one hundred and sixteen human resource managers assisted in this investigation. the sample was drawn from slightly over 1300 human resource managers who are affiliated with the personnel accreditation institute. it was believed that a reasonably accurate representation of the actual population was secured. however, smaller firms were slightly under-represented among those who participated in this study. non-response bias should not be a problem because the survey procedure continued until each segment of the population was well represented, with the exception of economics majors. supplementary analysis indicated that the non-respondents did not differ materially from the respondents. the pretest results were also quite similar to those of the sample population. the human resource managers were asked to give a copy of the questionnaire to five employees, one with an undergraduate business degree in accounting, economics, finance, management, and marketing. only managers who had been with the company for five years or more were surveyed. three hundred and sixty-one usable questionspring 1993 premeaux, et al.: linking undergraduate business degree 31 naires were received, which yielded a response rate of 36.1 percent. not all managers responded to each question, thus the category frequencies related to each question are somewhat less than 361. mean scores were computed for every rationale selected in each vignette on a lo-point scale. analysis of variance (anova) was used to determine whether significant differences existed between the rationales espoused by respondents with different degree specializations. differences across responses were analyzed using the scheff6 a posteriori test with a significance level of p<.lo. the demographic data obtained from the respondents indicate that a wide spectrum of managers in each of the degree specializations, with the exception of economics, participated in the survey. because of the limited responses from those with an economics specialization, the finance and economics categories were collapsed. twentynine percent of the respondents had undergraduate degrees in accounting, 2 percent had degrees in economics, 22 percent had finance undergraduate degrees, 30 percent had management degrees, and 17 percent had marketing degrees. sixty-one percent of the respondents were from the ranks of middle management. an additional 27 percent occupied top management positions. ninety-four percent of the respondents had college business degrees and 67 percent had masters degrees. ninety-eight percent of the accountants were cpas. the respondents' age distribution was relatively uniform across categories from 30 to 49, with a minor drop-off in the 50 to 59 age group. findings open-ended questions were designed to determine the rationale for each ethical decision made by the respondents. the responses to these open-ended questions were aggregated into common response categories. individual responses tended to be well thought out and somewhat complex, but there was no evidence of a patterned response. few multicategorical responses were received, but when a complete response contained elements from several response categories, it was classified according to the first response category discussed. the findings are discussed by the type of ethical dilemma faced. initially, the vignette eliciting the response is presented, followed by the question posed to the respondent, then a table containing the rationales for each response by those in each separate degree specialization is presented. brackets enclose responses that did not differ significantly from each other per the scheff6 test. coercion and control collusive efforts of local manufacturers have barred the rollfast bicycle company from entering a large asian market. rollfast management expects to net 5 million dollars annually from bicycle sales if it could penetrate the market. last week a businessman from the country contacted rollfast management and assured them that he could smooth the way for the company to sell in his country for a "grease" fee of $500,000. 32 journal ofbusiness strategies vol. 10, no.1 if you were responsible, would you pay the bribe or so-called "grease" fee? basically, the higher the mean scores the greater the acceptability of bribes, regardless of the rationale selected. overall, only 114 of the respondents definitely ruled out paying a bribe. the majority of those surveyed exhibited a slight tendency toward paying the bribe or the so-called "grease fee." the six response categories relating to the reason for the action taken in the coercion and control vignette are shown in exhibit 1. the response categories were classified according to the respondent's undergraduate business specialization. the fifty respondents selecting the "against company policy" rationale would not pay the bribe, as is obvious from the mean ratings of between .47 and .51. the sixty-four respondents selecting the "illegal under the corrupt business practices act" rationale would also not pay the bribe. the ninetyfour respondents selecting the "unethical bribe" rationale are more likely to pay the bribe than those who preferred the first two rationales, but are still unlikely to pay the bribe. the accounting group selecting this rationale were even less likely to pay the bribe than the other three groups. the thirty-five respondents selecting the "no one is hurt" rationale are much more likely to pay the bribe than those subscribing to the other three rationales, with accountants being the group who were least likely to pay the bribe, even if no one is hurt. the sixty-five respondents selecting the "is an acceptable practice in other countries" rationale were, as a group, likely to pay the bribe, with the accounting and marketing groups somewhat less likely to pay. finally, the thirty-six respondents selecting the rationale that it "is not unethical, but just the price paid to do business" were most likely to pay the bribe, with the accounting group less likely than the other three groups. the views of both accountants and marketers were significantly different from the views of others in the group in relation to bribes being an acceptable practice in other countries. however, overall accountants were less tolerant of bribes, even when bribes were an acceptable practice in other countries. none of the four "other" responses appear to have anything to do with ethical considerations. conflict of interest bill smith has recently accepted a job with an aggressive microcomputer manufacturer. microcomputer manufacturers are engaged in intense competition to become the first to develop a software package which utilizes the english language, and thus is easily used by the average customer. smith's former employer is rumored to be the leader in this software development. when smith was hired he was led to believe his selection was based on his management potential. however, the morning beginning the third week of his new job, smith received the following memo from the company president: "please meet with me tomorrow morning at 8:15 for the purpose of discussing the progress your former employer has made in the development of language driven software." if you were smith, would you provide your new employer with the software information? spring 1993 premeaux, et az.: linking undergraduate business degree exhibit 1: rationale for coercion and control responses 33 response acct mean' freq fin/econ mean' freq mgmt mean'freq mktg mean' freq totals against company {.47 policy illegal under { .48 corrupt business practices act 22 23 .51 13 .49 14 .49 10 .48 18 .47 .45 5} 50 9} 64 bribe, unethical no one is hurt is an acceptable practice in other countries 1.72 31 3.61 14 {2.54 20 {5.43 12 {6.74 10 2.51 29 5.78 6 6.77 29} 2.43 14} 94 5.96 3} 35 5.68b 15 65 is not unethical, 6.04 just the price paid to do business totals 5 106 {7.83 7 76 7.81 18 110 7.54 6} 36 52 344 total total specific responses 344 other responses 4 overall total 348 a high average indicates that the respondents would pay the bribe, which would probably be interpreted as unethical. 'the braces enclose responses that did not differ significantfy from each other per the scheffe test. a 0to 10-point likert scale anchored with "definitely would not" (0) and "definitely would" (to) was used. bthere are no significant differences between the accounting and marketing groups. in interpreting exhibit 2 it is important to remember that the higher the mean scores the more likely that individuals would provide the software information. overall, the majority of those surveyed exhibited a slight tendency toward providing the software information. six response categories for the conflict of interest vignette are presented in exhibit 2. for the first and fourth rationales, the responses of accountants did not differ significantly from those with other business specializations. there was basic agreement that the information would not be provided if the rationale were that it was unethical for smith to provide information and unethical for the employer to 34 journal ofbusiness strategies vol. 10, no.1 ask, and a near neutral response was received for providing some but not all of the information. accountants who believed that it was unethical for the employer to mislead smith when he was hired, and that protecting smith's reputation was important, were more adamant that the information should not be provided than those in the other groups. while those in the non-accounting group were nearly neutral in their decision regarding providing the information based on whether a security agreement was in force, accountants leaned more toward it being less acceptable as a rationale. respondents in the group who would probably provide the information rationalized that doing so would show loyalty to the new employer, and thereby help assure continued employment. however, accountants who chose this rationale were not so willing to accept it as an appropriate course of action, as were members of the other groups. forty-two of the respondents chose the "other" response option and listed rationales different from those provided. seven of these respondents stated that they did not believe that the scenario was reasonable, thirteen of the respondents believed that there was no conflict of interest, and the remaining respondents gave rationales which appear to have nothing to do with ethical considerations. physical environment master millers has developed a special milling process which yields a wheat flour which when used for bread provides a lighter more uniform texture than conventionally milled wheat flour. unfortunately, the process gives off more dust than the emission control equipment presently installed can handle and still maintain emissions within legal limits. due to lack of availability, the company is unable to install new emissions control equipment for at least two years; however, if it waited that long to introduce the new process, competitors would very likely beat it to the market. the general manager wants to use the new process during the third shift which runs from 10 p.m. to 6 a.m. by using the process at that time, the new flour could be introduced and the excess pollution would not be detected due to its release in the dark. by the time demand becomes great enough to utilize a second shift, new emission control equipment should be available. if you were responsible, would you approve the general manager's request? once again, the higher the mean scores the more likely that the general manager's request to use the special milling process would be approved. overall, the majority of those surveyed exhibited a slight tendency toward approving the request to use the special milling process over the short term. exhibit 3 contains the six response categories for the environment vignette. the responses of accountants did not differ significantly from other respondents for the fifth rationale. those who rationalized that .the pollution would not really hurt the environment were likely to grant permission to use the new process. however, the majority of those surveyed would not approve the new process. like several other instances accountants were more adamant about not compromising. committing an illegal act, threatening the environment, and possibly getting caught were viewed as less viable options by accountants. while those in the spring 1993 premeaux, et al.: linking undergraduate business degree exhibit 2: rationale for conflict of interest responses 35 response acct meanfreq fin/econ meanfreq mgmt mean-freq mktg meanfreq totals unethical for smith {.81 to provide and unethical for employer to ask unethical for em1.62 ployer to mislead smith when he was hired protect smith's 1.39 reputation provide some but {5.48 not all information 32 28 12 13 .89 18 {z.14 17 {1.67 7 5.59 11 .84 15 2.17 22 1.71 8 5.54 14 .82 2.04 1.68 5.49 6} 71 7} 74 3} 30 5} 43 decision based on 3.90 whether security agreement in force to keep job, 6.18 loyalty to new employer totals 8 4 97 {4.77 5 {7.23 14 72 4.74 16 7.18 28 103 4.69 7} 36 7.20 12} 58 40 312 total total specific responses 312 other responses 42 overall total 354 a high average indicates that the respondents would provide the software information, which would probably be interpreted as unethical. -the braces enclose responses that did not differ significantly from each other per the scheffe test. a 0to 10-point likert scale anchored with "definitely would not" (0) and "definitely would" (10) was used. non-accounting group were nearly neutral in their decision to use the process, since it was impossible to install the equipment, accountants viewed using the process as somewhat less acceptable. finally, the views of accountants, and those in the finance group, were significantly different from the views of others in relation to going ahead with the 36 journal ofbusiness strategies vol. 10, no.1 process if there is a large potential for gain with little risk. basically, more of those in the accounting and finance groups had greater reservations than those in the other groups regarding this option. twenty-six of the respondents chose the "other" option and listed rationales different from those provided. nine of these respondents stated that harm to the environment is never acceptable under any circumstances, seven of the respondents believed that technology is such that a relatively quick solution could have been found, and the remaining respondents gave rationales which appear to have nothing to do with ethical considerations. personal integrity jack ward is working in product development for an auto parts contractor. ward's firm received a large contract last summer to manufacture transaxles to be used in a new line of front wheel drive cars which a major auto manufacturer plans to introduce in the near future. the contract is very important to ward's firm, which has recently fallen on hard times. just prior to obtaining the contract, half of the firm's employees, including ward, had been scheduled for an indefinite layoff. final testing of the assemblies ended last friday and the first shipments are scheduled for three weeks from today. as ward began examining the test reports, he discovered that the transaxle tended to fail when loaded at more than 20% over rated capacity and subjected to strong torsion forces. such a condition could occur with a heavily loaded car braking hard for a curve down a mountain road. the results would be disastrous. the manufacturer's specifications call for the transaxle to carry 130% of its rated capacity without failing. ward showed the results to his supervisor and the company president who indicated that they were both aware of the report. given the low likelihood of occurrence and the fact that there was no time to redesign the assembly, they decided to ignore the report. if they did not deliver the assemblies on time, they would lose the contract. ward must now decide whether to show the test results to the auto manufacturer. if you were ward, would you notify the automobile manufacturer? for the final vignette, the higher the mean scores the more ethical the decision, and the greater the likelihood that ward would notify the automobile manufacturer. overall, the majority of those surveyed exhibited a very strong tendency toward notifying the automobile manufacturer. as is evident from the information in exhibit 4, this vignette yielded a high degree of personal integrity among the majority of the respondents regardless of their undergraduate degree specialization. there was general consensus in relation to the overall acceptability of three of the five rationales. the majority of those in all groups viewed that ward has an additional responsibility to report the problem, and that loyalty is irrelevant. all groups also believed that the risk of injury or death is unacceptable, and because of the chances of injury or death ward should not remain silent. accountants would definitely not remain silent if doing so would be either dishonest or criminal. respondents with different educational backgrounds would also go public, but not with the same degree of conviction that acspring 1993 premeaux, et af.: linking undergraduate business degree 37 countants exhibited. both accountants and marketers would definitely not risk the firm's image, profitability, and long run potential by remaining silent. to a lesser degree those with undergraduate specializations in economics, [mance, and management would also not risk similar repercussions. of the twenty-one "other" responses, eight individuals believed that the risk of injury or death is always most important, five individuals felt that the case did not illustrate a personal integrity issue, and the remaining respondents gave rationales which appear to have nothing to do with ethical considerations. exhibit 3: rationale for physical environment responses acct fin/econ mgmt mktg response mean" freq mean" freq mean" freq mean"freq totals it would be illegal .96 31 { 1.36 30 1.41 28 1.35 13} 102 concern for the 1.21 23 { 1.53 18 1.51 18 1.49 6} 65 environment-life risk of getting 1.34 20 { 1.74 14 1.69 17 1.61 5} 56 caught with resulting negative consequences too great not their fault, 4.11 7 {5.57 3 5.49 12 5.31 7} 29 equipment would be installed if available the pollution {7.01 5 7.06 5 7.06 27 7.01 16} 53 would not really hurt the environment large potential { 6.41 13 6.49 8} {7.51 5 7.63 2} 28 gain with low risk totals 99 78 107 49 333 total total specific responses 333 other responses 26 overall total 359 a high average indicates that the respondents would allow the use of the new milling process, which would probably be interpreted as unethical. "the braces enclose responses that did not differ significantly from each other per the scheffe test. a 0to 10-point likert scale anchored with "definitely would not" (0) and "definitely would" (10) was used. 38 journal ofbusiness strategies discussion vol. 10, no.1 fortunately, the majority of those responding had a preference toward the "ethical" end of the scale. however, it is also obvious from the unethical business practices which have come to light in recent years that more needs to be done to instill in all business majors a stronger ethical foundation. while it is true that ethical reasoning does not assure ethical behavior, it at the very least, may indicate a greater awareness of the importance of ethics in business. since accountants exhibited a greater tendency toward more ethical reasoning than those with other business specializations, it may be possible to gain some insight into the contribution of their educational experiences to their ethical reasoning. although other factors could influence ethical behavior such as working in different capacities within the company or an individual's level of experience, it is quite revealing that a linkage appears to exist between undergraduate business degree specialization and ethical behavior. with all of the emphasis on ethical issues in the last decade it is somewhat surprising that managers with accounting backgrounds appear to be somewhat more ethical in their rationalizations than managers with educational backgrounds in finance, management, and marketing. basically, accounting-trained managers were somewhat more likely to choose ethical positions than were managers trained in other business disciplines. the results of this study represent only one observation for each type of ethical dilemma examined, and only reveals what managers said they would do in various scenarios. possibly, managers with accounting undergraduate degrees are prone to behave more ethically because they are exposed to the "code of professional conduct of the aicpa." no other business field has such a readily available, universally accepted code of conduct. the professional code of conduct for accountants encourages behavior in line with society's strict ethical requirements [6]. the code outlines the responsibilities of those in the accounting profession, and encourages members to act in the public interest, with integrity, exercising objectivity and independence, and always observe the profession's technical and ethical standards [6]. fewer unethical occurrences are regularly noted in accounting than in other areas of business, but those in the accounting profession are not ethically blameless [8]. some ethicists have suggested that managers need more than codes of ethics to behave ethically [9]. kenneth r. andrews concluded in his study of the gte corporation that, "education can highlight the importance of ethics and clarify ways in which rationale business decisions can include ethical considerations, but behavior change can only come about when the organization as a whole provides both the environment and the mechanisms for supporting ethical practices ([2], p. 47)." possibly, cpas are more ethically aware than other managers because in addition to their code of conduct, they are continually performing work that is subject to public scrutiny. are managers with accounting backgrounds really more ethical, or were the accountants surveyed just more ethical in their rationalizations? it would be quite useful to isolate the reason or reasons for the ethical gap between those with backgrounds spring 1993 premeaux, et al.: linking undergraduate business degree 39 in accounting and those in other business fields. possibly, an effort should be made to encourage the development of a general code of business ethics, or a code of ethics specific to each business discipline. however, an effort should definitely be made to create more ethical managers regardless of their undergraduate business degree specializations. exhibit 4: rationale for personal integrity responses response acct meanfreq fin/econ meaofreq mgmt meanfreq mktg meanfreq totals ward has no addi{ 3.21 tional responsibility, loyalty will keep him quiet risk of injury or {3.83 death too low to halt sale 5 6 3.29 3.84 3 2 3.31 11 3.81 5 3.26 6} 25 3.79 3} 16 the company has 9.86 27 a responsibility to the public--criminal and dishonest to remain silent {8.16 18 8.19 12 8.03 7} 64 risk to firm's 9.91b 13 image, profitability, and long-run potential too great to remain silent {8.64 11 8.53 25} 9.68b 13 62 chances of causing{9.48 51 injury or death too great to remain silent 9.37 44 9.41 44 9.48 24} 163 total specific responses 330 other responses 21 overall total 351 totals 102 78 97 53 330 total a high average indicates that the respondents would notify the automobile manufacturer, which would probably be interpreted as unethical. "'the braces enclose responses that did not differ significantly from each other per the scheffe test. a 0to 10-point likert scale anchored with "definitely would not" (0) and "definitely would" (10) was used. bthere are no significant differences between the accounting and marketing groups. 40 journal ofbusiness strategies references vol. 10, no.1 1. alexander, c.s., & becker, h.j. "the use of vignettes in survey research." public opinion quarterly, vol. 42 (1978), pp. 93-104. 2. andrews, k.r. "ethics in policy and practice at gle corporation." in james k, ed. cor:porate ethics: a prime business asset-a report on policy and practice in company conduct. new york: the business roundtable (1988), p. 47. 3. beauchamp, t.l., & bowie, n.e. ethical theory and business. englewood cliffs, n.j., prentice-hall (1979). 4. bernard r.j. & kyj, m.j. "ethical business and the ethical person." business horizons, vol. 33 (november-december 1990), p. 23. 5. byrne, j.a. "businesses are signing up for ethics 101." business week, (february 15, 1988), p. 56. 6. code of professional conduct and bylaws. "the code of professional conduct of the alcpa." new york: american institute of certified public accountants (1988), pp. 1-55. 7. fritzsche, d.j. & becker, h. "linking management behavior to ethical philosophy: an empirical investigation." academy of management journal, vol. 27 (march 1984), pp. 166-175. 8. hammaker, paul m., horniman, a.b., & rader, l.t. standards of conduct in business. charlottesville, va: the center for the study of applied ethics (1977), pp. 11-19. 9. hyman, m.r., skipper, r., & tansey, r. "ethical codes are not enough." business horizons, vol. 33 (march-april 1990), pp. 15-22. linking undergraduate business degree specialization to ethical behavior: an empirical investigation the nature of codes of business ethics: a strategic perspective fred r. david auburn university auburn, alabama don robin louisiana tech university ruston, louisiana mike gia110urakis mississippi state university mississippi state, mississippi the role of business ethics in corporate strategy has been largely ignored in theory and practice. an unfortunate result of this phenomena is that many organizations today encounter ethics problems and pursue strategies that appear not to be based on a foundation of ethics. business ethics should become an integral part of strategy formulation, implementation, and evaluation activities in all types and sizes of organizations. ethics is sometimes defined as the clarification of what constitutes human welfare and the conduct necessary to promote it [9]. ethicians use the term "ethics" to refer to the study of what is morally right or wrong [21]. business ethics is a specialized study of moral judgments and values that focuses on individual behavior in organizations ([3],[6],[17]]). in his book business and society, steiner [25] defines business ethics as behavior "that is fair and just, over and above obedience to ... laws ... and regulations. loucks [23], chief executive officer of baxter travenol, says ethics isn't a matter of law or public relations or religonj rather, it is a matter of trust. discussing business ethics with any degree of honesty means balancing the interests of an organization's stakeholder [23]. for example, employees want high wages and good benefits, whereas customers want low prices and high quality. thus, division xyz may be divested while division abc is strengthened. the risk of an airplane engine failing by a tenth of one percent may be approved in order to reduce manufacturing costs and price by thirty percent? difficult decisions such as these characterize business ethics. newspapers and business magazines daily report legal and moral breaches of ethical conduct in organizations. bank fraud losses for the decade of the 1980s are expected to exceed $20 billion, compared to losses of less than $1.5 billion for the decade of the 1970s. baxter travenol laboratories, ibm, caterpillar tractor, and celanese are example firms tha.t have formalized their own code of business ethics. the chief executive officer of these and many other firms have spelled out the ethical standards journal of bu8inc88 s!ra!cgic8, volume 6, number 1 (spring 1989) 2 journal of business strategies vol. 6, no.1 and values expected of all their managers and employees. corporate strategy i'f'fieets an understanding of the values of organizational members and constituencies of the firm. when stakeholders of the firm benefit from certain strategies, while other stakeholders lose. ethical tradeoffs characterize strategic choice. the purpose of this article is to report the findings of a recent study that examined the codes of business ethics of major companies in the united states. the research results could provide a basis for improving codes of business ethics. using content analysis and a clustering procedure, specific variables currently being included in corporate codes of business ethics are identified and grouped into categories. profiles of the codes of business ethics of manufacturing and service firms are developed. an approach for developing an effective code of business ethics is proposed. the findings of this study could be useful to top managers, owners of small businesses, and other strategists who are responsible for developing a code of business ethics for their organization. the results could also benefit researchers who develop theory and test hypotheses regarding the relationship between business ethics and organizational behavior. literature review an integral part of the responsibility of all managers is to provide ethics leadership by constant example and demonstration [11]. however, primary responsibility for having an effective code of business ethics rests largely with a firm's top managers or strategists. drucker ([12], p. 462-63) contends that no individual should ever become a strategist unless that person is willing to have his or her character serve as the model for subordinates: a man (or woman) might know too little, perform poorly, lack judgment and ability, and yet not do too much damage as a manager. but if that person lacks in character and integrity no matter how knowledgeable, how brilliant, how successful he destroys. he destroys people, the most valuable resource of the enterprise. he destroys spirit. and he destroys performance. this is particularly true of individuals at the head of an enterprise. for the spirit of an organization is created from the top. if an organization is great in spirit, it is because the spirit of its top people are great. if it decays, it does so because the top rots; as the proverb has it, "trees die from the top." previous research indicates that a clear code of business ethics can provide guidance and impetus for managerial leadership ([191,[20],[22]). barnard ([2], p. 278) concluded that a lack of moral responsibility on the part of a strategist will be detrimental to an organization. he says, "the best solution in such cases would often be resignation, demotion, or discharge." effectively mixing moral and business imperatives and making appropriate decisions in complex situations is a prerequisite for having strategic responsibilities ([15] ,[22]' [23j ,[27]). one reason why top managers spring 1989 david, et ai.: business ethics 3 are paid 50 much more than middle managers is because they take the moral risks of the firm [1]. owners of businesses, chief executive officers, and top administrators are responsible for developing, communicating, and enforcing a set of values for their organization ([2j,[15]). horton [ibj emphasizes that personal financial gain is often an underlying motive for unethical conduct in organizations. gellerman ([14], p. 88]) identifies three rationalizations that often explain why individuals sometimes act unethically in ways that ultimately inflict harm to their organization: 1. since everyone else does it, the unethical action is not really illegal or immoral. 2. since the corporation will benefit, the unethical action is justified. 3. since no one will find out about the unethical action, it is worth doing. the general value structure rooted in religion, coupled with local, state, and federallaws, can provide a baseline for appropriate ethical behavior in organizations [13j. laczniak and naor [21j stress that bases for ethical conduct vary across different foreign countries. they assert that strategists of multinational firms are generally less familiar with foreign markets than with domestic markets. this varying degree of familiarity, coupled with pervasive ethnocentric orientations, makes ethical misjudgments more likely for domestic companies operating in foreign countries. there is a feeling by some practitioners and academicians today that codes of business lack much ''impact'' [7j. for example, cressey and moore ([10j, p. 73) suggest that any improvements in business ethics taking place in the last decade are not from codes of business ethics themselves, but rather have stemmed from conditions imposed by outsiders. these researchers ([10], p. 73) conclude that codes of business ethics tend to imitate the criminal law and thus contain few innovative ideas about how ethical standards of a firm can be improved. another study by chonko and hunt ([8], p. 356) involving marketing managers found that the existence of corporate codes of business ethics seems to be unrelated to the extent of ethical problems in marketing management. previous research thus accents the need for an improved understanding of codes of business ethics, so that more effective codes can be developed. method and analysis sample a personal letter was mailed to the chief executive officer of all firms included in the business week 1,000 list of manufacturing and service firms. the letter asked for a copy of the firm's code of business ethics. business week uses market value, determined by multiplying a firm's stock market price by its number of shares outstanding, to annually determine the top 1,000 corporations in america. market value is a composite measure of how large and healthy a firm is at a given point in time. a total of 178 responses were received, 83 firms providing a formal code of business ethics (46%) and 95 chief executive officers indicating their firm had not developed a 4 journal of business strategies vol. 6, no.1 code of business ethics (54 %). among the 83 firms providing a formal code of business ethics, there were 32 manufacturing firms and 51 service firms. this ratio of manufacturing firms to service corporations is representative of the entire business week 1,000 population of companies. responding firms in this study do not differ significantly from nonrespondents on organizational size or performance measures. however, it may be that 46 percent overestimates the actual percentage of firms with codes of business ethics, since nonresponding finns are likely to be those without formal codes. content analysis content anaylysis was used to evaluate the sample codes of business ethics. content analysis entails selecting a message to be studied, developing categories for measurement, measuring frequency of appearance of the categories using coding rules, applying an appropriate test to the data collected, and then drawing conclusions ([4],[16]). content analysis is a qualitative research technique often used for analyzing message content and message handling [16]. tn this study, two coders independently read the sample documents and recorded the presence of particular variables in the documents. variables were recorded just as they appeared in the documents. a total of 28 variables were found in the sample codes of business ethics. an overall interrater reliability coefficient of 100 percent indicated that the two raters were able to easily identify the ethics variables in the sample documents. the 28 ethics variables found in the sample codes are listed in table 1 in order of frequency of occurrence. the most often included variable was "conduct business in compliance with all lawsj" the least often included variable was "firearms at work are prohibited." cluster analysis the 28 variables were grouped into clusters using a two-step process. first, the two coders independently grouped the variables under broader, more descriptive headings where appropriate. the broader headings generated by the two coders were then compared and titles for these groupings were agreed upon. suggested labels for the three clusters were as follows: cluster 1: cluster 2: cluster 3: be a dependable organizational citizen do not do anything unlawful or improper that will harm the organization be good to our customers as shown in table 2, the three "named" clusters accounted for 23 of the 28 variables. five variables did not fit into a cluster. the second step in the cluster analysis process involved a third reviewer. this person selected a random sample of ten codes and independently placed the ethics variables into categories identified as clusters by the two previous coders. the ten codes contained 218 ethics variables. this check for reliablility of the raters produced perfect agreement with previous efforts. the third reviewer correctly classified all 218 spring 1989 david, et al.: business ethics 5 items. given the broad cluster labels and itemized character of the codes, this high test-retest rate of reliability should not be surprising. table 1 variables included in the sample codes of business ethics· 1. conduct business in compliance with all laws 2. payments for unlawful purposes are prohibited 3. avoid outside activities that impair duties 4. comply with all antitrust and trade regulations 5. comply with accounting rules and controls 6. bribes are prohibited 7. maintain confidentiality of records 8. participate in community and political activities 9. provide products and services of the political activities 10. exhibit standards of personal integrity and conduct 11. do not propogate false or misleading information 12. perform assigned duties to the best of your ability 13. conserve resources and protect the environment 14. comply with safety, health, and security regulations 15. racial, ethnic, religious, and sexual harassment at work is prohibited 16. report unethical and lllegal activities to your manager 17. convey true claims in product advertisements 18. make decisions without regard for personal gain 19. do not use company property for personal benefit 20. demonstrate courtesy, respect, honesty, and fairness 21. lllegal drugs and alcohol at work are prohibited 22. manage personal finances well 23. employees are personally accountable for company funds 24. exhibit good attendance and punctuality 25. follow directives of supervisors 26. do no use abusive language 27. dress in a business-like attire 28. firearms at work are prohibited "the variables are presented in descending order with regard to frequency of occurrence in the sample documents. to further check the validity of the cluster groupings, each organization received a oor 1 for each of the 28 ethics variables to indicate whether that variable appeared in their code of ethics. the three coders jointly completed this analysis. a zero indicated that the particular variable was not included in the particular code, whereas a one indicated that the variable was included. a 28 x 28 correlation matrix between the variables was produced. correlations among variables in the cluster groupings were then subjected to a test for internal consistency using coefficient alpha. the coefficient 6 jonrnal of business strategies vol. 6, no.1 alpha valu ..s for th .. thr.... nam ..d clusters w..r.. 0.84, 0.76, and 0.66 r..speetively. these relatively high values indicate significant homog..n..ity within clust..rs. table 2 clusters of variables found in corporate codes of business ethics cluster 1: 1. 2. 3. 4. 5. 6. 7. 8. 9. be a dependabl.. organizational citizen comply with safety, h.. alth, and security regulations demonstrat .. courtesy, respect, honesty, and fairness m..gal drugs and alcohol at work are prohibit..d manage personal finances well exhibit good att..ndance and punctuality follow dir..ctiv..s of sup..rvisors do not use abusive language dr..ss in a rusin ..ss·lik.. attir.. firearms at work are prohibited clust"r 2: do not do anything unlawful or improper that will harm the organization 1. conduct business in complianc" with all laws 2. payments for unlawful purposes are prohibited 3. bribes ar.. prohibit..d 4. avoid outside activities that impair duties 5. maintain confid..ntiality of records 6. comply "rith all antitrust and trade regulations 7. comply "rith accounting rules and controls 8. do not use company property for personal benefit 9. employees are p..rsonally accountabl.. for company funds 10. do not propogate false or misleading information 11. make decisions without regard for personal gain cluster 3: be good to our customers 1. conv..y true claims in product adv..rtis..m..nts 2. perform assigned duties to the best of your ability 3. provide products and services of the highest quality unclust..r..d variabl..s 1. exhibit standards of personal integrity and conduct 2. racial, ethnic, religious, and sexual harassment at work is prohibited 3. report unethical and illegal activities to your manager 4. participate in community and political activities 5. conserve resources and protect the environment spring 1989 david, et at.: bv,siness ethics 7 comparing manufacturing and service firms service organizations, such and banks and utilities, were heavy users of variables in cluster 1 titled "be a dependable organizational citizen." example firms including many cluster 1 variables were bank of boston, city national bank, wachovia corporation, wisconsin electric power, itt, northeast utilities, and texas utilities. on the other hand, manufacturing firms, such as exxon, dow chemical, monsanto, sara lee, dupont, and celanese, more often included ethics variables in cluster 2 titled "do not do anything unlawful or improper that will harm the organization," and cluster 3 titled "be good to our customers." a detailed profile of the sample codes of business ethics of manufacturing firms and service firms was developed. as indicated by significant i-values in table 3, manufacturing and service firms' codes of business ethics differ significantly on twelve variables. specifically, the codes of manufacturing firms more often include the following six variables: 1. conduct business in compliance with all laws 2. comply with all antitrust and trade regulations 3. provide products and services of the highest quality 4. perform assigned duties to the best of your ability 5. conserve resources and protect the environment 6. comply with safety, health, and security regulations codes of business ethics of service firms more often include the following six variables: 1. avoid outside activities that impair duties 2. do not use company property for personal benefit 3. lllegal drugs and alcohol at work are prohibited 4. manage personal finances well 5. make decisions without regard for personal gain 6. dress in a business-like attire implications variables included in cluster 1 titled "be a dependable organizational citizen" all seem to direct the employee to be "nice." these variables focus upon desirable characteristics of people, such as to be courteous, honest, fair, and punctual; to not use drugs or alcohol, and to manage personal finances well. these kinds of personal characteristics are important for manufacturing as well as service employees, so perhaps manufacturing firms should more often include cluster 1 variables in their code of business ethics. being dishonest, tardy, or drug dependent can obviously disrupt 8 journal of business strategies vol. 6, no.1 manufacturing operations and reduce efficiency and productivity to an alarming extent. although manufacturing employees typically do not interact with customers and the general public as much as employees of service firms, cluster 1 type variables can still dramatically affect the competitiveness of manufacturing firms. table 3 comparing codes of business ethics of manufacturing firms with service firms (n = 83) variables included mean for mean for in the sample codes manufacturing service of business ethics firms (n=32) _ !,i~iils(~==~~_ t-value 1. conduct business in .7500 .5098 2.21" compliance with all laws 2. payments for unlawful .6363 .5882 0.61" purposes are prohibited 3. avoid outside activities .5938 .8039 -2.11" that impair duties 4. comply with all antitrust .5983 .3529 2.18" and trade regulations 5. comply with accounting .5625 .5490 0.12 rules and controls 6. bribes are prohibited .5313 .7059 -1.62 7. maintain confident.5000 .7059 -1.91 tiality of records 8. participate in community .4375 .6275 -1.70 and political activities 9. provide products and services .4375 .1765 -2.66"" of the highest quality 10. exhibit standards of personal .4375 .3137 1.14 integrity and conduct 11. do not propogate false or .3438 .3333 0.10 misleading information 12. perform assigned duties .3125 .0980 2.30" to the best of your ability 13. racial, ethnic, religious, .2188 .2353 --0.17 and sexual harassment at work is prohibited 14. conserve resources and .2813 .0588 2.55"" protect the environment 15. comply with safety, health, .2500 .0588 2.26" and security regulations 16. report unethical and lllegal .1563 .2745 -1.24 activities to your manager spring 1989 david, et ai.: business ethics 9 ~-----~variables included mean for mean for in the sample codes manufacturing service of business ethics firms (n=32) firms (n=51) t-value 17. convey true claims in .1563 .0980 0.79 product advertisements 18. make decisions without .0938 .2745 -2.02' regard for personal gain 20. do not use company property .0625 .3725 -3.83'" for personal benefit 21. demonstrate courtesy, respect, .0625 .1765 -1.65 honesty, and fairness 23. manage personal finances .0000 .1373 ~2.23' well 24. megal drugs and alcohol .0000 .1176 -2.04' at work are prohibited 25. dress in business-like attire .0000 .0784 -1.63" 26. firearms at work are .0000 .0588 -1.40 prohibited 27. do not use abusive language .0000 .0588 -1.40 28. exhibit good attendance .0000 .0196 -0.79 and punctuality * p < .05; ** p < .01; *** p < .001 notes to accompany table 3 1. the mean values could range from .0000 (no firms included this variable in their code of business ethics) to 1.0000 ( all firms included this variable in their code of business ethics). 2. the variables are listed in order of frequency of occurrence among manufacturing firms. for example, 75 percent of all manufacturing firms included the ''conduct business in compliance with all laws" variable. 3. manufacturing firms have a standard industrial classification (sic) code of less than 40; service firms have sic codes ranging from 40 to 99, ie the first two digits . • • • • • • •• cluster 2 titled "do not do anything unlawful or improper that will harm the organization" contained the largest number of variables [l1j and was by far the most subscribed to group. over 50 companies included many of these variables in their code of business ethics. the legalistic character of the variables in cluster 2 seem to give it a preventive tone designed to protect the organization, rather than a sense of values to guide behavior. for example, two of the variables in cluster 2 deal with bribery. the issue seems to be that bribery is prohibited because it is against the law, and the organization could get into trouble if bribes were given or taken. this is certainly a desirable message, but it is substantially different from an organizational 10 journal of business strategies vol. 6, no.1 value statement such "do unto others as you would have them do unto you." value statements are broad based and could be proactive in shaping behavio. a more appropriate forum for communicating rules of the firm may be in a policy manual, rather than a code of busines ethics. managers of both manufacturing and service firms should perhaps consider including values to a greater extent in their code of business ethics. values seek ethical behavior "beyond the law for the good of all." cluster 3 titled "be good to our customers" contained variables that concern ways in which the behavior of employees could satisfy customers, such as to "convey true claims in product advertisements." organizations including these variables in their code exhibited no tendency toward a specific industry, but rather came from a variety of industries. customers are what give meaning to a business, so perhaps both manufacturing and service organizations should include additional cluster 3 type variables in a code of business ethics to reflect the primary importance of obtaining and keeping customers. among the unclustered variables, "exhibit standards of personal integrity and conduct" was included in 31 of the sample codes of business ethics. two unclustered variables appeared in 19 codes. these were "racial, ethnic, religious, and sexual harassment at work is prohibited" and "report unethical and lllegal activities to your manager." included in 46 sample codes of business ethics, the variable "participate in community and political activities" was the most popular of the unclustered items, being included by 46 companies. finally, only 12 of 83 sample codes of business ethics included the "conserve resources and protect the environment" variable. developing 0 code of business ethics an effective approach for developing a code of business ethics could be to identify key ethical threats and opportunities facing the company and the industry. this activity could be part of a firm's strategic management process. core values a could be specified which [1) act on those threats and opportunities, [2j incorporate the guidance of ethical philosophies such as deontology and utilitarianism, and [3] fit or enhance the existing organizational culture. developed during the strategic management process, a code of business ethics could become a part of the documentation for an organization's culture. the code could have "impact" and be proactive. the document could contain broad values that have been carefully devised to fit the environment of the firm. a code of business ethics developed in this way could be more responsive to the firm's external and internal constituencies and needs. the result could be a document that all organizational members could understand, accept, and support. many individuals should have input into develoment of the document. laczniak and naor [21] offer four recommendations for developing a code of business ethics in multinational corporations. first, codes of business ethics of multinational corporations should be company-wide, regardless of the area of operation. second, the codes should serve as input information in the strategy-formulation process. third, when unbridgeable gaps appear between the ethical values of a host spring 1989 david, et al.: business ethics 11 country and those of a multinational corporation, the multinational corporations should regularly develop and issue "ethical impact statements." conclusion less than 50 percent of the sample corporations in this study had developed a formal code of business ethics. this finding was unfortunate because it may be desirable for all firms to have a written code of business ethics. cadbury [5j and litzinger and schaefer [22] stress the need for all organizations to develop a clear code of business ethics. a formal code of business ethics can be an effective tool for setting ethical boundaries in a firm. when an ethical boundary or variable is violated, swift action is needed to emphasize the importance of adhering to ethical standards of business conduct. drucker [12], gellerman [14], and velasquez [26] emphasize that responsibility for developing and communicating a clear code of business ethics rests primarily with top managers or strategists of the firm. as such, business ethics should be an intergral part of the strategic management thought process. this artide provides information that could be used to develop a more effective code of business ethics. the results and implications of this study could provide impetus for more research that is needed to better understand the nature and role of codes of business ethics of america's "best" manufacturing and service firms are provided to give direction for top managers of other organizations. a "proactive" approach is recommended for developing and revising codes of business ethics. references 1. barach, j. a. "the ethics of hardball." california management review, vol. 27, no.2 (1985), pp. 132-39. 2. barnard, c. i. the functions of the executive. cambridge, ma: harvard university press (1968). 3. behrman, j. n. essays on ethics in business and the professions. englewood cliffs, nj: prentice-hall (1968). 4. budd, r. w., r. k. thorp, and l. donohew. conent analysis of communications. new york, ny: macmillan company (1967). 5. cadbury, s. a. "ethical managers make their own rules." harvard business review, vol. 65, no.2 (september/october 1987), pp. 69-73. 6. carr, a. z. "is business bluffing ethical?" harvard business review (january /february 1968), pp. 20-29. 7. center of business ethics. "are corporations institutionalizing ethics?" journal of business ethics (april 1986), pp. 86-94. 12 journal of business strategies vol. 6, no.1 8. chonko, l. b. and s. d. hunt. "ethics and marketing management: an empirical examination." journal of business research (august 1985), pp. 356-66. 9. clasen, e. a. "marketing ethics and the consumer." harvard business review (january/february 1967), pp. 79-85. 10. cressey, d. r. and c. a. moore. "managerial values and corporate codes of ethics." california management review (summer 1983), pp. 73-80. 11. david, f. r. strategic management, second edition. columbus, oh: merrill publishing company (1989, in press). 12. drucker, p. management: tasks, responsibilities, and practices. new york, ny: harper & row, publishers (1974). 13. epstein, e. m. "the corporate social policy process: beyond business ethics, corporate social responsibility, and corporate social responsiveness." california management review (spring 1987), pp. 99-114. 14. gellerman, s. w. "why 'good' managers make bad ethical choices." harvard business review (july/august 1986), pp. 85-90. 15. genfan, h. "formalizing business ethics." training and development journal (summer 1987), pp. 35-37. 16. goldhaber, g. m. organizational communication, third edition. dubuque, ia: william c. brown company (1983). 17. hauserman, n. r. "whistle-blowing: individual morality in a, corporate society." business horizons (march/ april 1986), pp. 4-9. 18. horton, n. r. "the ethics of crisis continues: what to do." miwagement review (november j986), p. 3. 19. keifer, f. "what some companies are doing to teh ethical line." christian science monitor (october 1983), pp. 13-14. 20. kelly, c. m. "the interrelationship of ethics and power in today's organizations." organizational dynamics (summer 1987), pp. 4-18. 21. laczniak, g. r. and j. naor. "global ethics: wrestling with the corporate conscience." business (july/september 1985), pp. 3-10. 22. litzinger, w. d. and t. e. schaefer. "business ethics bogeyman: the perpetual paradox." business horizons (march/ april 1987), pp. 16-21. 23. loucks, v. r. jr. "a ceo looks at ethics." business horizons (march/ april 1987), pp. 2-6. spring 1989 david, et al.: business ethics 13 24. pastin, m. "business ethics, by the book." business horizons (january/ february 1985), pp. 2-6. 25. steiner, g. a. business and society: cases, second edition. new york, ny: random house (1972), pp. 211. 26. velasquez, m. g. business ethics: concepts and cases, second edition. englewood cliffs, nj: prentice-hall (1988). 27. wokutch, r. e. and b. a. spencer. "corporate saints and sinners: the effects of philanthropic and illegal activity on organiza.tiona.l performance." california management review, vol. 29, no.2 (1987), pp. 62-77. the nature of codes of business ethics: a strategic perspective